Ubcomfsi.1 Fybcom Account Semester I

31
F.Y.B.Com
ELECTIVE COURSES (EC)
DISCIPLINE SPECIFIC ELECTIVE
(DSE) COURSES
SEMESTER - I
UBCOMFSI.1- ACCOUNTANCYAND
FINANCIAL MANAGEMENT I
SUBJECT CODE : UBCOMFSI.1
© UNIVERSITY OF MUMBAI
Dr. Suhas Pednekar
Vice-Chancellor
Universityof Mumbai,
Mumbai
Dr. Kavita Laghate Anil R Bankar

Professor cum Director, Associate Prof. of History & Asst. Director &
Institure of Distance & Open Learning, Incharge Study Material Section,
Universityof Mumbai, Mumbai IDOL, University of Mumbai, Mumbai
Course and Programme : Dr. Madhura Kulkarni

Co-ordinator Asst. Prof-cum-Asst. Director, IDOL,
University of Mumbai, Mumbai-400 098.
Course Writer : Prof. M.A. Gandhi
Maharshi Dayanand College ofArts, Science
& Commerce, Shri Mangaldar Verma Chowk,
25 - Dr. S. S. Road, Parel, Mumbai - 400012.
: Dr. V. N. Yadav
Shankar N. College of Arts & Commerce,
Bhyander (E), Dist. Thane.
: Prof. Ashok A. Gujar
102, Gomati Niwas Sasmira Road,
Worli, Mumbai - 400030.
: Prof. Jaya Maglani
H.R. College,
Churchgate, Mumbai - 400020
Re-Edited : Dr. Atul V. Bhave
Department of Commerce,
Rayat Shikshan Sanstha's,
Abasaheb Marathe Arts & New Commerce,
Science College, Rajapur, (Vikhare-Gothane)
Dist. Ratnagiri -416702
DEC, 2020 F.Y.B.Com., ELECTIVE COURSES (EC) DISCIPLINE SPECIFIC

ELECTIVE (DSE) COURSES
UBCOMFSI.1-ACCOUNTANCYAND FINANCIAL MANAGEMENT I
Published by : Director Incharge,

Institute of Distance and Open Learning ,
University of Mumbai,
Vidyanagari, Mumbai - 400 098.
DTP Composed : Ashwini Arts

Gurukripa Chawl, M.C. Chagla Marg, Bamanwada,
Vile Parle (E), Mumbai - 400 099.
Printed by :
CONTENTS
Unit No. Title Page No.
SEMESTER - I
MODULE - 1
1 Introduction to accounting standards 1
2. AS - 1 Disclosure of Accounting Policies 13
3. AS - 2 Valuation of Inventories 25
4. AS- 9 Revenue Recognition 52
5. Inventory Valuation - I 65
6. Inventory Valuation II - 80
7. Capital, Revenue Expenditure & Receipts 98
MODULE -2
8. Final Accounts of Manufacturing Concern - I
(Proprietary Firm) 134
9. Final Accounts II 165
MODULE -3
10. Departmental Accounts - I 198
11. Departmental Accounts - II 217
MODULE -4
12. Hire Purchase - I 241
13. Hire Purchase - II 257

I
Revised Syllabus of Courses of B.Com. Programme

Elective Courses (EC)
Discipline Specific Elective (DSE) Courses
Accountancy and Financial Management I

Semester- I
Modules at a Glance
Sr. No. Modules

1 Accounting standards issued by ICAI and Inventory
valuation
2 Final Accounts
3 Departmental Accounts
4 Accounting for Hire Purchase
Sr.No. Modules / Units

1 Accounting standards issued by ICAI and Inventory
valuation
 Accounting standards:
Concepts, benefits, procedures for issue of accounting
standards Various AS :
AS – 1: Disclosure of Accounting Policies
Purpose, Areas of Policies, Disclosure of Policies,
Disclosure of Change in Policies, Illustrations
AS – 2: Valuation of Inventories (Stock)
Meaning, Definition, Applicability, Measurement of
Inventory, Disclosure in Final Account, Explanation
with Illustrations.
AS – 9: Revenue Recognition
Meaning and Scope, Transactions excluded, Sale of
Goods, Rendering of Services, Effects of
Uncertainties, Disclosure, Illustrations.
II
 Inventory Valuation
Meaning of inventories Cost for inventory valuation
Inventory systems : Periodic Inventory system and
Perpetual Inventory System Valuation: Meaning and
importance
Methods of Stock Valuation as per AS – 2 :
FIFO and Weighted Average Method Computation of
valuation of inventory as on balance sheet date: If
inventory is taken on a date after the balance sheet or
before the balance sheet
2 Final Accounts
Expenditure: Capital, Revenue Receipts: Capital,
Revenue Adjustment and Closing Entries
Final accounts of Manufacturing concerns (Proprietary
Firm)
3 Departmental Accounts
Meaning
Basis of Allocation of Expenses and Incomes/Receipts
Inter Departmental Transfer : at Cost Price and Invoice
Price Stock Reserve Departmental Trading and Profit &
Loss Account and Balance Sheet
4 Accounting for Hire Purchase

Meaning Calculation of interest
Accounting for hire purchase transactions by asset
purchase method based on full cash price
Journal entries, ledger accounts and disclosure in balance
sheet for hirer and
vendor (excluding default, repossession and calculation of
cash price)
III
Question Paper Pattern

Question Particular Marks
No
Q-1 Objective Questions 20 Marks

A) Sub Questions to be asked 12 and to
be answered any 10
B) Sub Questions to be asked 12 and to
be answered any 10
(*Multiple choice / True or False / Match
the columns/Fill in the blanks)
Q-2 Full Length Question 15 Marks
OR

OR

OR

OR
Q-6 A) Theory questions 10 Marks

B) Theory questions 10 Marks
OR
Q-6 20 Marks
Short Notes
To be asked 06
To be answered 04
Note:
Question of 15 marks may be divided into two sub questions

of 7/8 and 10/5 Marks.
IV
Reference Books
 Introduction to Accountancy by T. S. Grewal, S. Chand and

Company (P) Ltd., New Delhi Advance Accounts by Shukla &
Grewal, S. Chand and Company (P) Ltd., New Delhi
 Advanced Accountancy by R. L Gupta and M Radhaswamy, S.
Chand and Company (P) Ltd., New Delhi
 Modern Accountancy by Mukherjee and Hanif, Tata Mc. Grow
Hill & Co. Ltd., Mumbai Financial Accounting by
LesileChandwichk, Pentice Hall of India Adin Bakley (P) Ltd.
 Financial Accounting for Management by Dr. Dinesh
Harsalekar, Multi-Tech. Publishing Co. Ltd., Mumbai.
 Financial Accounting by P. C. Tulsian, Pearson Publications,
New Delhi Accounting Principles by Anthony, R.N. and Reece
J.S., Richard Irwin Inc.
 Financial Accounting by Monga, J.R. Ahuja, GirishAhuja and
Shehgal Ashok, Mayur Paper Back
 Compendium of Statement & Standard of Accounting, ICAI.
 Indian Accounting Standards, Ashish Bhattacharya, Tata Mc.
Grow Hill & Co. Ltd., Mumbai Financial Accounting by Williams ,
Tata Mc. Grow Hill & Co. Ltd., Mumbai
 Company Accounting Standards by Shrinivasan Anand,
Taxman. Financial Accounting by V. Rajasekaran, Pearson
Publications, New Delhi. Introduction to Financial Accounting by
Horngren, Pearson Publications.
 Financial Accounting by M. Mukherjee. M. Hanif. Tata McGraw
Hill Education Private Ltd; New Delhi

1
Unit-1
INTRODUCTION TO ACCOUNTING
STANDARDS
Unit Structure:
1.0 Objectives
1.1 Introduction
1.2 Meaning of Accounting Standards
1.3 Formation of the Accounting Standards Board
1.4 Scope of Accounting Standards
1.5 Procedure for Issuing an Accounting Standard
1.6 Compliance with the Accounting Standards
1.7 List of the Accounting Standards as issued by ICAI
1.8 List of IAS / IFRS and corresponding IND AS notified by
MCA
1.9 List of IFRS issued by IASB
1.10 Questions
1.0 OBJECTIVES
After studying the unit students will be able to:

 Understand the meaning of Accounting Standard.
 Know the scope of Accounting Standard.
 Understand the composition, objectives and functions of
Accounting Standard Board.
 Explain the procedure for issuing Accounting Standards.
 Know the list of Accounting Standards issued by ICAI
1.1 INTRODUCTION
Financial statements are prepared to summarize the end-

result of all the business activities by an enterprise during an
accounting period in monetary terms. These business activities
vary from one enterprise to the other. It is very difficult to compare
the financial statements of different reporting enterprises because
of different methods and principles adopted by these business
enterprises in preparing their financial statements. Accounting
standards are evolved to make these methods and principles
2
uniform and financial statements comparable to the possible extent.

Following are the different group of persons interested in the
financial statements:-
1. Bankers
2. Shareholders
3. Investors
4. Creditors
5. Customers
6. Employees
7. Competitors
8. Income tax/Sales tax/Excise authorities
1.2 MEANING OF ACCOUNTING STANDARDS
1.2.1 MEANING
‘Accounting Standards are written, policy documents
issued by expert accounting body or by Government or other
regulatory authorities covering the aspects of recognition,
measurement, treatment, presentation and disclosure of accounting
transaction in the financial statement.’ The main purpose of
formulating accounting standard is to standardize the diverse
accounting policies with a view to eliminate to the extent possible
the incomparability of information provided in financial statements
and add reliability to such financial statements. Accounting
standards ensure the consistency and the comparability of the
financial statements reported by the different enterprises creating a
general sense of confidence that users have in the fairness and
reliability of the statements they rely.
Accounting Standards will not, however, apply to

enterprises only carrying on the activities which are not of
commercial, industrial or business nature, e.g., an activity of
collecting donations and giving them to flood affected people.
Exclusion of an enterprise from the applicability of the Accounting
Standards would be permissible only if no part of the activity of
such enterprise is commercial, industrial or business in nature.
Even if a very small proportion of the activities of an enterprise are
considered to be commercial, industrial or business in nature, the
Accounting Standards would apply to all its activities including
those which are not commercial, industrial or business in nature.
1.2.2 OBJECTIVES:
1. To standardise the diverse accounting policies.
2. To standardise the accounting practices.
3. To enhance the reliability of financial statements.
4. To eliminate non-comparability of financial statements
3
1.2.3 ADVANTAGES:
1. It provides the accountancy profession with useful working rules.
2. It assists in improving quality of work performed by accountant.
3. It strengthens the accountant’s resistance against the pressure
from directors to use accounting policy which may be suspect in
that situation in which they perform their work.
4. It ensures the various users of financial statements to get
complete crystal information on more consistent basis from
period to period.
5. It helps the users to compare the financial statements of two or
more organizations engaged in same type of business
operation.
1.2.4 DISADVANTAGES:
1. Users are likely to think that said statements prepared using
accounting standard are foolproof.
2. They have been derived from social pressures which may
reduce freedom.
3. The working rules may be rigid or bureaucratic to some users of
financial statement.
4. The more standards there are, the more costly the financial
statements are to produce.
1.3 FORMATION OF THE ACCOUNTING

STANDARDS BOARD
The Institute of Chartered Accountants of India (ICAI),

recognizing the need to harmonize the diverse accounting policies
and practices in use in India, constituted the Accounting Standards
Board (ASB) on 21st April, 1977.
1.3.1 COMPOSITION OF THE ACCOUNTING STANDARDS

BOARD (ASB)
The composition of the ASB is fairly broad-based and
ensures participation of all interest-groups in the standard-setting
process. Apart from the elected members of the Council of the ICAI
nominated on the ASB, the following are represented on the ASB:
1. Nominee of the Central Government representing the

Department of Company Affairs on the Council of the ICAI.
2. Nominee of the Central Government representing the Office of
the Comptroller and Auditor General of India on the Council of
the ICAI.
4
3. Nominee of the Central Government representing the Central

Board of Direct Taxes on the Council of the ICAI.
4. Representative of the Institute of Cost and Works Accountants
of India.
5. Representative of the Institute of Company Secretaries of
India.
6. Representatives of Industry Associations (1 from Associated
Chambers of Commerce and Industry (ASSOCHAM), 1 from
Confederation of Indian Industry (CII) and 1 from Federation of
Indian Chambers of Commerce and Industry (FICCI)
7. Representative of Reserve Bank of India
8. Representative of Securities and Exchange Board of India
9. Representative of Controller General of Accounts
10. Representative of Central Board of Excise and Customs
11. Representatives of Academic Institutions (1 from Universities
and 1 from Indian Institutes of Management)
12. Representative of Financial Institutions
13. Eminent professionals co-opted by the ICAI (they may be in
practice or in industry, government, education, etc.)
14. Chairman of the Research Committee and the Chairman of
the Expert Advisory Committee of the ICAI, if they are not
otherwise members of the Accounting Standards Board
15. Representative(s) of any other body, as considered
appropriate by the ICAI
1.3.2 OBJECTIVES OF THE ACCOUNTING STANDARDS

BOARD
The following are the objectives of the Accounting Standards
Board:
i. To conceive of and suggest areas in which Accounting
Standards need to be developed.
ii. To formulate Accounting Standards with a view to assist the

Council of the ICAI in evolving and establishing Accounting
Standards in India.
iii. To examine how far the relevant International Accounting

Standard/International Financial Reporting Standard can be
adapted while formulating the Accounting Standard and to
adapt the same.
5
iv. To review, at regular intervals, the Accounting Standards from

the point of view of acceptance or changed conditions, and, if
necessary, revise the same.
v. To provide, from time to time, interpretations and guidance on

Accounting Standards.
vi. To send comments on various consultative papers such as

exposure drafts, discussion papers etc., issued by
International Accounting Standards Board and various other
International bodies such as Asian-Oceania Standard-Setters
Group (AOSSG).
vii. To carry out such other functions relating to Accounting

Standards.
1.3.3 FUNCTIONS OF THE ACCOUNTING STANDARDS BOARD
The main function of the ASB is to formulate Accounting

Standards so that such standards may be established by the ICAI
in India. While formulating the Accounting Standards, the ASB will
take into consideration the applicable laws, customs, usages and
business environment prevailing in India.
The ICAI, being a full-fledged member of the International

Federation of Accountants (IFAC), is expected, inter alia, to actively
promote the International Accounting Standards Board’s (IASB)
pronouncements in the country with a view to facilitate global
harmonization of accounting standards. Accordingly, while
formulating the Accounting Standards, the ASB will give due
consideration to International Accounting Standards (IASs) issued
by the International Accounting Standards Committee (predecessor
body to IASB) or International Financial Reporting Standards
(IFRSs) issued by the IASB, as the case may be, and try to
integrate them, to the extent possible, in the light of the conditions
and practices prevailing in India.
1.4 PROCEDURE FOR ISSUING AN ACCOUNTING

STANDARD
The Accounting Standards are issued under the authority of

the Council of the ICAI. The ASB has also been entrusted with the
responsibility of propagating the Accounting Standards and of
persuading the concerned parties to adopt them in the preparation
and presentation of financial statements. The ASB will provide
interpretations and guidance on issues arising from Accounting
Standards. The ASB will also review the Accounting Standards at
periodical intervals and, if necessary, revise the same. The
6
following procedure is adopted for formulating Accounting

Standards:
1. The ASB determines the broad areas in which Accounting

Standards need to be formulated and the priority in regard to the
selection thereof.
2. In the preparation of Accounting Standards, the ASB will be

assisted by Study Groups constituted to consider specific
subjects. In the formation of Study Groups, provision will be
made for wide participation by the members of the Institute and
others.
3. The draft of the proposed standard will normally include the

following:
a) Objective of the Standard,
b) Scope of the Standard,
c) Definitions of the terms used in the Standard,
d) Recognition and measurement principles, wherever
applicable,
e) Presentation and disclosure requirements.
4. The ASB will consider the preliminary draft prepared by the
Study Group and if any revision of the draft is required on the
basis of deliberations, the ASB will make the same or refer the
same to the Study Group.
5. The ASB will circulate the draft of the Accounting Standard to
the Council members of the ICAI and the specified bodies for
their comments.
6. The ASB will hold a meeting with the representatives of

specified bodies to ascertain their views on the draft of the
proposed Accounting Standard. On the basis of comments
received and discussion with the representatives of specified
bodies, the ASB will finalize the Exposure Draft of the proposed
Accounting Standard.
7. The Exposure Draft of the proposed Standard will be issued for

comments by the members of the Institute and the public. The
Exposure Draft will specifically be sent to specified bodies (as
listed above), stock exchanges, and other interest groups, as
appropriate.
8. After taking into consideration the comments received, the draft

of the proposed Standard will be finalized by the ASB and
submitted to the Council of the ICAI.
The Council of the ICAI will consider the final draft of the
proposed Standard and if found necessary, modify the same in
7
consultation with the ASB. The Accounting Standard on the

relevant subject will then be issued by the ICAI.
1.5 COMPLIANCE WITH THE ACCOUNTING

STANDARDS
Accounting Standards are mandatory from the respective

dates mentioned in the standards. Hence, it is the duty of the
management to see that all the Accounting Standards are complied
with while preparing financial statement, in the case of any
deviation, necessary disclosure should be made in the audit report
so as to make the readers aware of the deviations.
The mandatory status of an Accounting Standard implies

that while discharging their attest functions, it will be the duty of the
members of the Institute
(a) To examine whether ‘Statements’ relating to accounting matters

are complied with in the presentation of financial statements
covered by their audit. In the event of any deviation from the
‘Statements’, it will be their duty to make adequate disclosures in
their audit reports so that the users of financial statements may be
aware of such deviations; and
(b) To ensure that the ‘Statements’ relating to auditing matters are

followed in the audit of financial information covered by their audit
reports. If for any reason a member has not been able to perform
an audit in accordance with such ‘Statements’, his report should
draw attention to the material departures there from.
1.6 LIST OF THE ACCOUNTING STANDARDS AS

ISSUED BY ICAI
The council of the Institute of the Chartered Accountants of

India has so far issued 32 Accounting Standards, However AS- 8
on Accounting for Research and Development (stands withdrawn
after introduction of AS-26), thus effectively there are 31
Accounting standards.
8
Accounting Title of Accounting Standard

Standard No.
AS-1 Disclosure of Accounting Policies
AS-2 Valuation of Inventories
AS-3 Cash Flow Statements
AS-4 Contingencies and Events (Occurring after
the Balance Sheet Date)
AS-5 Net Profit or Loss for the Period, Prior

Period Items and Changes in Accounting
Policies
AS-6 Depreciation Accounting
AS-7 Construction Contracts
AS-8 Accounting for Research and Development
(standard withdrawn after introduction of
AS-26)
AS-9 Revenue Recognition
AS-10 Accounting for Fixed Assets
AS-11 The Effect of Changes in Foreign
Exchange Rates
AS-12 Accounting for Government Grants
AS-13 Accounting for Investments
AS-14 Accounting for Amalgamations
AS-15 Employee Benefits
AS-16 Borrowing Cost
AS-17 Segment Reporting
AS-18 Related Party Disclosures
AS-19 Leases
AS-20 Earnings per Share
AS-21 Consolidated Financial Statements
AS-22 Accounting for Taxes on Income
AS-23 Accounting for Investment in Associates in
Consolidated Financial Statements
AS-24 Discontinuing Operations
AS-25 Interim Financial Reporting
9
AS-26 Intangible Assets

AS-27 Financial Reporting of Interests in Joint
Venture
AS-28 Impairment of Assets

AS-29 Provisions, Contingent Liabilities and
Contingent Assets
AS-30 Financial Instruments: Recognition and

Measurement
AS 31 Financial Instruments: Presentation

AS 32 Financial Instruments: Disclosures
1.7 LIST OF IAS / IFRS AND CORRESPONDING IND

AS NITIFIED BY MCA
IAS No. Title Corresponding

Converged IND
AS
IAS-1 Presentation of Financial IND AS 1
Statements
IAS-2 Inventories IND AS 2
IAS- 7 Cash Flow Statements IND AS 7
IAS-8 Accounting policies, change in IND AS 8
accounting estimates and errors
IAS-10 Events after the Balance Sheet IND AS 10

date
IAS-12 Income Taxes IND AS 12

IAS-16 Property, Plants and Equipment IND AS 16
IAS- 17 Leases IND AS 17
IAS-19 Employees Benefits IND AS 19
IAS-20 Accounting for Government IND AS 20
Grants and Disclosure of
Government Assistance
IAS-21 The Effect of Changes in IND AS 21
Foreign Exchange Rates
IAS-23 Borrowing Costs IND AS 23
10
IAS-24 Related Party Disclosures IND AS 24

IAS-26 Accounting and Reporting by
Retirement Benefit Plan
IAS-27 Consolidated and Separate IND AS 27
Financial Statements
IAS-28 Investments in Associates and IND AS 28
Joint Ventures
IAS-29 Financial Reporting in Hyper IND AS 29
Inflationary Economies
IAS-32 Financial Instruments :- IND AS 32
Presentation
IAS-33 Earnings per Share IND AS 33
IAS-34 Interim Financial Reporting IND AS 34
IAS-36 Impairment Assets IND AS 36
IAS-37 Provisions, Contingent Liabilities IND AS 37
and Contingent Assets
IAS-38 Intangible Assets IND AS 38
IAS-40 Investment Property IND AS 40
IAS-41 Agriculture IND AS 41
1.8 LIST OF IFRS ISSUED BY IASB
IFRS:-
The term ‘IFRS’ includes standards and interpretations approved by
IASB and the International Accounting Standards and
interpretations issued by the International Financial Reporting
Interpretations Committee.
International Accounting Standards Board (IASB) has issued the

following International Financial Reporting Standards (IFRS):-
IAS No. Title Corresponding

Converged IND AS
IFRS-1 First Time Adoption of IFRS IND AS 101

IFRS-2 Share based payments IND AS 102
IFRS-3 Business Combination IND AS 103
IFRS-4 Insurance Contracts IND AS 104
11
IFRS-5 Non-currents Assents held for IND AS 105

sale and discontinued
operations
IFRS-6 Exploration for and evaluation IND AS 106
of mineral resources
IFRS-7 Financial instruments: IND AS 107
disclosure
IFRS-8 Operating segment IND AS 108
IFRS-9 Financial instruments IND AS 109
IFRS-10 Consolidated Financial IND AS 110
Statements
IFRS-11 Joint Arrangement IND AS 111
IFRS-12 Disclosure of Interest in Other IND AS 112
Entities
IFRS-13 Fair Value Measurement IND AS 113
IFRS-14 Regulatory Deferral Accounts IND AS 114
IFRS-15 Revenue from contracts with IND AS 115
customers
IFRS-16 Leases -
1.9 QUESTIONS
1. What do you understand by Accounting standard?

2. What is the need and purpose of accounting standards?
3. Briefly explain the importance of accounting standards?
4. What is the duty of the auditor in case of non-compliance of
mandatory accounting standard?
5. Briefly explain the procedure for issuing an accounting
standard?
6. Select Correct Alternative:
i. Accounting standards are important

1. For making correct financial statements
2. For correct valuation of inventories
3. For correct treatment of depreciation and lease and
investment
4. All of the above
12
ii. Accounting standards are statements prescribed by

1. Law
2. Bodies of shareholders
3. Professional accounting bodies
4. All of the above
iii. The Policy of ‘anticipate no profit and provide for all possible
losses’ arises due to convention of
1. Consistency
2. Disclosure
3. Conservatism
4. All of Above
iv.Accounting has certain norms to be observed by the

accountants in recording of transactions and preparation of
financial statements. These norms reduce the vagueness and
chances of misunderstanding by harmonizing the varied
accounting practices. These norms are
1. Accounting regulations.
2. Accounting guidance notes.
3. Accounting standards.
4. Accounting framework.
v. Following is the example of external users:

1. Government.
2. Owners.
3. Management.
4. Employees.
vi. Following is the example of internal users:
1. Government.
2. Investors.
3. Creditors.
4. Employees.
vii. The information provided in the annual financial statements

of an enterprise pertain to
1. Business Industry.
2. Economy.
3. Individual business entity.
4. None of the above.
Answers: i-4, ii-3, iii- 3, iv-3, v-1, vi-4, vii-3

13
Unit-2
AS-1 DISCLOSURE OF ACCOUNTING
POLICIES
Unit Structure:
2.0 Objectives
2.1 Introduction
2.2 Meaning and Nature of Accounting Policies
2.3 Areas of different Accounting Policies
2.4 Notes to Accounts
2.5 Disclosure of Accounting Policies
2.6 Disclosure of Change in Accounting Policies
2.7 Illustrations
2.8 Practical Applications
2.9 Questions
2.0 OBJECTIVES
 Understand the meaning and nature of accounting policies.

 Explain the areas of different accounting policies.
 Know the disclosure of accounting policies.
 Know the disclosure of change in accounting policies.
 Give some examples of significant accounting policies.
 Solve the practical problems related to accounting policies.
2.1 INTRODUCTION
Accounting Standard (AS) 1 issued by the Accounting

Standards Board, the Institute of Chartered Accountants of India on
‘Disclosure of Accounting Policies’ deals with the disclosure of
significant accounting policies followed in preparing and presenting
financial statements. It may be noted that this Accounting Standard
is now mandatory for use by companies listed on a recognized
stock exchange and other large commercial, industrial and
business enterprises in the public and private sectors. Accounting
Standards are intended to apply only to items which are material.
14
2.2 MEANING AND NATURE OF ACCOUNTING

POLICIES
‘Accounting policies are the specific accounting principles

and methods of applying those principles adopted by the enterprise
in the preparation and presentation of the financial statements.’ E.g.
to depreciate fixed asset of the company over a period of time is
accounting policy and which method should follow to depreciate the
asset (SLM or WDV) is method of accounting.
There is no single list of accounting policies which are

applicable to all circumstances. The differing circumstances in
which enterprises operate in a situation of diverse and complex
economic activity make alternative accounting principles and
methods of applying those principles acceptable.
IMPORTANCE OF ACCOUNTING STANDARD (AS) 1

The view presented in the financial statements of an
enterprise of its state of affairs and of the profit or loss can be
significantly affected by the accounting policies followed in the
preparation and presentation of the financial statements. The
accounting policies followed vary from enterprise to enterprise.
Disclosure of significant accounting policies followed is necessary if
the view presented is to be properly appreciated. The disclosure of
some of the accounting policies followed in the preparation and
presentation of the financial statements is required by law in some
cases.
PURPOSE OF ACCOUNTING STANDARD (AS) 1

The disclosure of significant accounting policies and the
manner in which accounting policies are disclosed in the financial
statements would facilitate better understanding of financial
statements and a more meaningful comparison between financial
statements of different enterprises.
FUNDAMENTAL ACCOUNTING ASSUMPTIONS

The Financial Statements are prepared with the following three
Fundamental Accounting Assumptions. Unless otherwise
specified, it is assumed that the Financial Statements are prepared
according to following assumptions:
1. Going Concern,
2. Consistency,
3. Accrual.
15
They are explained as follows:

1. Going Concern:
The enterprise is normally viewed as a going concern, that
is, as continuing in operation for the foreseeable future. It is
assumed that the enterprise has neither the intention nor the
necessity of liquidation or of curtailing materially the scale of the
operations.
2. Consistency:
It is assumed that accounting policies are consistent from
one period to another.
3. Accrual:
Revenues and costs are accrued, that is, recognized as they
are earned or incurred (and not as money is received or paid) and
recorded in the financial statements of the periods to which they
relate.
It is mandatory to disclosure if the above mentioned

assumptions are not followed.
2.3 AREAS OF DIFFERENT ACCOUNTING POLICIES
The following are examples of the areas in which different

accounting policies may be adopted by different enterprises.
 Methods of depreciation, depletion and amortization
 Treatment of expenditure during construction
 Conversion or translation of foreign currency items
 Valuation of inventories
 Treatment of goodwill
 Valuation of investments
 Treatment of retirement benefits
 Recognition of profit on long-term contracts
 Valuation of fixed assets
 Treatment of contingent liabilities.
CONSIDERATIONS IN THE SELECTION OF ACCOUNTING

POLICIES
The primary consideration in the selection of accounting

policies by an enterprise is that the financial statements prepared
and presented on the basis of such accounting policies should
represent a true and fair view of the state of affairs of the enterprise
as at the balance sheet date and of the profit or loss for the period
ended on that date.
16
For this purpose, the major considerations governing the

selection and application of accounting policies are:—
1. Prudence
2. Substance over Form
3. Materiality
They are explained as follows:
1. Prudence: In view of the uncertainty attached to future events,

profits are not anticipated but recognized only when realized
though not necessarily in cash. Provision is made for all known
liabilities and losses even though the amount cannot be
determined with certainty and represents only a best estimate in
the light of available information. Example of Prudence is to
select an accounting policy where inventory valuation is at lower
of cost or net realizable value.
2. Substance over Form: The accounting treatment and

presentation in financial statements of transactions and events
should be governed by their substance and not merely by the
legal form. Best example of this assumption can be state is hire
purchase. If company is purchasing any asset on hire purchase
system then purchaser is not legal owner at the time of
purchase. In hire purchase ownership is transferred on the
payment of the last installment but actually the asset is in the
possession of purchaser and he is using in his business
operation, so substantially he is better owner than legal. It
should be recorded in the books of purchaser.
3. Materiality: Financial statements should disclose all “material”

items, i.e. items the knowledge of which might influence the
decisions of the user of the financial statements. That means if
profit & loss accounts contains an irregular transaction which is
not routine and probably effects shareholders or investors, the
same should be disclosed separately. Example- Any expense
having amount more than Rs.5000 or 1% of turnover whichever
is higher should be disclosed separately rather to club with
miscellaneous expenses.
2.4 NOTES TO ACCOUNTS
Notes to accounts are the explanation given by the

management about the items in the financial statements i.e. Profit
and Loss Account and Balance Sheet. The management of the
institute has to give more explanation and information as regards
the items given in the Profit and Loss Account and Balance Sheet
and any other item in the way of notes to accounts. E.g. Disclosure
17
of details of contingent liability by notes to accounts. Notes to

accounts are part and parcel of the financial statement.
2.5 DISCLOSURE OF ACCOUNTING POLICIES
To ensure proper understanding of financial statements, it is

necessary that:-
1. All significant accounting policies adopted in the preparation and

presentation of financial statements should be disclosed.
2. The disclosure of the significant accounting policies as such

should form part of the financial statements and the significant
accounting policies should normally be disclosed in one place.
3. Disclosure of accounting policies or of changes therein cannot

remedy a wrong or inappropriate treatment of the item in the
accounts.
4. If the fundamental accounting assumptions of Going Concern,

Consistency and Accrual are followed in financial statements,
specific disclosure is not required. If a fundamental accounting
assumption is not followed, the fact should be disclosed.
2.6 DISCLOSURE OF CHANGE IN ACCOUNTING

POLICIES
A change in the accounting policies should be made in

the following conditions:
1. Adoption of different accounting policies is required by statue

or for compliance with an Accounting Standard.
2. It is considered that change would result in more appropriate

presentation of financial statements.
In case if there is a change in accounting policies, the

following information must be disclosed:
1. Any change in the accounting policies which has a material

effect in the current period or which is reasonably expected to have
a material effect in later periods should be disclosed.
2. In the case of a change in accounting policies which has a

material effect in the current period, the amount by which any item
in the financial statements is affected by such change should also
be disclosed to the extent ascertainable. Where such amount is not
ascertainable, wholly or in part, the fact should be indicated.
18
2.7 ILLUSTRATIONS
Significant accounting policies can be found in financial

statements of public companies. Some examples of significant
accounting policies are as follows:
1. Inventories
This significant accounting policy comes from 2017-18
annual financial statements of Zimmer Holdings, Inc.
Inventories are stated at the lower of cost or market, with

cost determined on a first-in first-out basis.
2. Property and Equipment

annual financial statements of Google, Inc.
We account for property and equipment at cost less

accumulated depreciation and amortization. We compute
depreciation using the straight-line method over the estimated
useful lives of the assets, generally two to five years. We
depreciate buildings over periods up to 25 years. Depreciation for
equipment commences once it is placed in service and depreciation
for buildings and leasehold improvements commences once they
are ready for our intended use. Land is not depreciated
3. Cash and Cash Equivalents

annual financial statements of Hill-Rom, Inc.
We consider investments in marketable securities and other
highly liquid instruments with a maturity of three months or less at
date of purchase to be cash equivalents. Investments which have
no stated maturity are also considered cash equivalents.
2.8 PRACTICAL APPLICATIONS
1. A Company has switched over to weighted average formula for

ascertaining the cost of inventory, from the earlier practice of using
FIFO. The closing inventory by using FIFO is Rs. 4 lakh and that by
weighted average formula is Rs.3.85 lakh. Explain the Accounting
Treatment/Disclosures as necessary
Ans: The fact that change in accounting policy pull down profit and
value of inventory by Rs.15,000 is to be disclosed.
2. Shreya’s Ltd. prepared Profit and Loss Account and the Balance
Sheet for the year 2017-18.The accounting policies about Profit and
19
Loss Account have been disclosed below Profit and Loss Account
and accounting policies about Balance Sheet have been disclosed
before Balance Sheet. Comment
Ans: As per AS-1, the accounting policies adopted for preparation

of final accounts should form part of the final accounts. These
policies should be disclosed at one place only forming part of the
accounts. It should not be disclosed separately.
3. PG Ltd. prepared Profit & Loss Account and Balance Sheet on

cash basis. Comment.
Ans: As per AS-1, accrual basis is the fundamental accounting

assumption. The company follows cash basis. The fundamental
accounting assumption is not followed; it should be disclosed in the
form of a note to the accounts.
4. Akshata Ltd. prepared final accounts for the year 2017-18.

During the year accident took place in the factory, the worker who
got injured lodged a claim of Rs.3,00,000 against the company .The
claim is under dispute, the accountant did not mention this in the
accounts, Comment.
Ans. Claim for compensation under dispute is a contingent liability.

As per AS-1, it should be disclosed as a foot-note to the final
accounts. The company must make a disclosure about the
contingent claim.
5. Draft the Accounting policies to be disclosed in the financial

statements for the following items:
i. Revenue Recognition-Sale of goods
Ans. Sales are recognized when good are invoiced and dispatched
to customers and are recorded inclusive of excise duty, net trade
discount and sales tax.
ii. Revenue Recognition-Sale of Equipment
Ans. Sale of Equipment is recognized when (1) it has a firm

contract, (2) the product has been shipped to and accepted by the
customer or the service has been provided, and (3) amounts are
reasonably assured of collection. Most equipment sales require
installation of the product. As such, revenue is recognized at the
time of delivery and installation at the customer location. Equipment
revenues are based on established prices by product type and
model and are net of discounts.
20
iii. Revenue Recognition-Sales Return
Ans. A sales return is accepted only when the equipment is

defective and does not meet product performance specifications.
iv. Inventories
Ans. Inventories, other than scrap, are valued at cost, on weighted

average basis. Scrap is valued at realizable value.
v. Depreciation – Machinery Spares
Ans. Machinery spares which can be used only in connection with

an item of fixed asset and whose use is expected to be irregular are
capitalized and depreciated over the residual useful life of the
related plant and machinery.
vi. Depreciation- Fixed Assets
Ans. Fixed assets ( Other than leasehold land, technical knowhow

and temporary structure) are depreciated on straight-line method
(SLM) at the rate and in the manner prescribed in schedule XIV to
the Companies Act, 1956 by writing off 95% of the cost of the
assets over the specified period of the assets.
6. Explain requirement in the following cases with reference to

DISCLOSURE OF ACCOUNTING POLICIES (AS-1)
1. Where proper disclosures regarding changes in accounting

policies have not been made by a company, in the method of
providing depreciation on plant and machinery from straight line
method to written-down value method and due to the change the
net profit for the year, the net block as well as the reserves and
surplus lowered by Rs.50,00,000.
Ans. The company has not disclosed in its accounts the fact of
change, from this year, in the method of providing depreciation
on plant and machinery from straight line method to written-down
value method, as also the effect of this change. As a result of this
change, the net profit for the year, the net block as well as the
reserves and surplus are lower by Rs.50,00,000 each as compared
to the position which would have prevailed had this change not
been made.
2. Where a company has not disclosed all significant accounting

policies like treatment of research and development costs and has
also not disclosed the accounting policies at one place.
21
Ans. The company had disclosed those accounting policies the

disclosure of which is required by the Companies Act, 1956. Other
significant accounting policies, viz., those relating to treatment of
research and development costs have not been disclosed nor have
all the policies been disclosed at one place, which is contrary to
Accounting Standard (AS) 1, `Disclosure of Accounting Policies'
issued by the Institute of Chartered Accountants of India.
2.9 QUESTIONS
1. What is an accounting policy?

2. List out different Accounting policies?
3. Mention the areas in which different policies may be adopted
by different organizations?
4. Write a short note on selection of accounting policies?
5. What are basic accounting assumptions?
6. What are the disclosure requirements of AS-1 issued by ICAI?
7. What do you understand by “notes to accounts”?
i. Accounting policy is
1. accounting postulate
2. accounting convention
3. accounting standard
4. specific accounting principle or method chosen by
management out of permissible alternatives
ii. Example of accounting policy is

1. Method of depreciation chosen by management
2. Separate entity concept
3. Balance sheet
4. Standard audit
iii. RPC Ltd. follows the written down value method of

depreciating machinery year after year due to
1. Comparability.
2. Convenience.
3. Consistency.
4. All of the above.
iv. A change in accounting policy is justified

1. To comply with accounting standard.
2. To ensure more appropriate presentation of the financial
statement of the enterprise.
3. To comply with law.
4. All of the above.
22
v. Fundamental accounting assumptions are

1. Materiality.
2. Business entity.
3. Going concern.
4. Dual aspect
vi. M/s ABC Brothers, which was registered in the year 2000,
has been following Straight Line Method (SLM) of
depreciation. In the current year it changed its method from
Straight Line to Written down Value (WDV) Method, since
such change would result in the additional depreciation of
Rs. 200 lakhs as a result of which the firm would qualify to
be declared as a sick industrial unit. The auditor raised
objection to this change in the method of depreciation.
The objection of the auditor is justified because

1. Change in the method of depreciation should be done only with
the consent of the auditor.
2. Depreciation method can be changed only from WDV to SLM

and not vice versa.
3. Change in the method of deprecation should be done only if it is

required by some statute and change would result in
appropriate presentation of financial statement.
4. Method of depreciation cannot be changed under any

circumstances.
vii. State the case where the going concern concept is applied?
1. When an enterprise was set up for a particular purpose,

which has been achieved, or to be achieved shortly.
2. When a receiver or liquidator has been appointed in case of

a company which is to be liquidated.
3. Fixed assets are acquired for use in the business for earning
revenues and are not meant for resale.
4. When an enterprise is declared sick.
viii. Principle requires that the same accounting method should

be used from one accounting period to the next.
1. Conservatism.
2. Consistency.
3. Business entity.
4. Money measurement.
23
ix. The cost of a small calculator is accounted as an expense

and not shown as an asset in a financial statement of a
business entity due to __________
1. Materiality concept.
2. Matching concept.
3. Periodicity concept.
4. Conservatism concept.
x. It is generally assumed that the business will not liquidate in

the near foreseeable future because of
1. Periodicity.
2. Materiality.
3. Matching.
4. Going concern.
xi. The accounting concept requiring the practice of crediting

closing stock to the trading account
1. Going concern
2. Cost
3. Matching
4. All of Above
xii. Accounting Principles are generally based on

1. Practicability
2. Subjectivity
3. Convenience in recording
4. All of Above
xiii. “Substance of any transaction should be considered while

recording them and not only the legal form” is the statement
which holds true for
1. Substance over form.
2. Disclosure of accounting policies.
3. Both (a) and (b).
4. None of the three.
xiv. Change in the method of depreciation is change in

________.
1. Accounting estimate.
2. Accounting policy.
3. Measurement discipline.
Answers: i-4, ii-1, iii-3, iv-4, v-3, vi-3, vii-3, viii-2, ix-1, x-4, xi-1, xii-1,
xiii-3, xiv-2
8. State whether the following statements are true or false:
1. The ‘materiality concept’ refers to the state of ignoring small

items and values from accounts.
24
2. Accounting principles are rules of action or conduct which are

adopted by the accountants universally while recording
accounting transactions.
3. The ‘conservatism concept’ leads to the inclusion of all

unrealized profits.
4. Accounting concepts are broad assumptions.
5. India is a member of IASC (International Accounting Standards

Committee).
6. The Institute of Chartered Accountants of India (ICAI), the apex

body of accounting and auditing, constituted an Accounting
Standards Board (ASB) on April 21, 1977, to pronounce
standards on various items of the financial statements.
Answers: True: 1, 2, 4, 5, 6
False: 3.

25

Unit-3
AS-2 VALUATION OF INVENTORIES
Unit Structure:
3.0 Objectives
3.1 Introduction
3.2 Objective and Scope of AS-2
3.3 Measurement of Inventories
3.4 Net Realisable Value
3.5 Disclosures
3.6 Disclosure Practice on Valuation of Inventories (AS-2)
3.7 Guidance Note on MODVAT / CENVAT issued by the ICAI
and Valuation of Inventory
3.8 Cost of Inventories
3.10 Exercises
3.0 OBJECTIVES

 Understand objective and scope of AS-2.
 Make the measurement of inventories at various cases.
 Solve the examples related to allocation of Fixed Overheads
 Calculate the cost of inventories.
 Solve the problems on calculation of the cost of inventories.
3.1 INTRODUCTION
Accounting Standard (AS) 2 'Valuation of Inventories', issued

by the Council of the Institute of Chartered Accountants of India
supersedes Accounting Standard (AS) 2, 'Valuation of Inventories',
issued in June, 1981. The revised standard comes into effect in
respect of accounting periods commencing on or after 1.4.1999 and
is mandatory in nature. Inventories consist of Finished Goods
which are held for sale in the ordinary course of business, Raw
Material & Work in Progress.
26
DEFINITION
1. INVENTORY
Inventories are assets:
 Held for sale in the ordinary course of business,
 In the process of production for such sale or
 In the form of materials or supplies to be consumed in the
production process or in the rendering of services.
Inventories encompass goods purchased and held for

resale, for example, merchandise purchased by a retailer and held
for resale, computer software held for resale, or land and other
property held for resale. Inventories also encompass finished goods
produced, or work in progress being produced, by the enterprise
and include materials, maintenance supplies, consumables and
loose tools awaiting use in the production process. Inventories do
not include machinery spares which can be used only in connection
with an item of fixed asset and whose use is expected to be
irregular; such machinery spares are accounted for in accordance
with Accounting Standard (AS) 10,Accounting for Fixed Assets.
2. NET REALISABLE VALUE

Net realizable value is the estimated selling price in the ordinary
course of business less the estimated costs of completion and the
estimated costs necessary to make the sale.
3.2 OBJECTIVE AND SCOPE OF AS-2
3.2.1 OBLECTIVE
A primary issue in accounting for inventories is the
determination of the value at which inventories are carried in the
financial statements until the related revenues are recognized. This
Statement deals with the determination of such value, including the
ascertainment of cost of inventories and any write-down thereof to
net realizable value.
3.2.2 SCOPE
This Statement should be applied in accounting for inventories
other than:
a. work in progress arising under construction contracts, including
directly related service contracts (see Accounting Standard (AS)
7, Accounting for Construction Contracts 3);
b. work in progress arising in the ordinary course of business of
service providers;
c. shares, debentures and other financial instruments held as
stock-in-trade; and
27
d. producers' inventories of livestock, agricultural and forest

products, and mineral oils, ores and gases to the extent that
they are measured at net realizable value in accordance with
well established practices in those industries.
The inventories referred to in paragraph (d) are measured at net

realizable value at certain stages of production. This occurs, for
example, when agricultural crops have been harvested or mineral
oils, ores and gases have been extracted and sale is assured under
a forward contract or a government guarantee, or when a
homogenous market exists and there is a negligible risk of failure to
sell. These inventories are excluded from the scope of this
Statement.
3.3 MEASUREMENT OF INVENTORIES
Inventories should be valued at the lower of cost and net

realizable value.
3.3.1 Cost of Inventories

The cost of inventories should comprise all costs of
purchase, costs of conversion and other costs incurred in bringing
the inventories to their present location and condition.
3.3.2 Costs of Purchase

The costs of purchase consist of the purchase price
including duties and taxes (other than those subsequently
recoverable by the enterprise from the taxing authorities), freight
inwards and other expenditure directly attributable to the
acquisition. Trade discounts, rebates, duty drawbacks and other
similar items are deducted in determining the costs of purchase.
3.3.3 Costs of Conversion

The costs of conversion of inventories include costs directly
related to the units of production, such as direct labour. They also
include a systematic allocation of fixed and variable production
overheads that are incurred in converting materials into finished
goods. Fixed production overheads are those indirect costs of
production that remain relatively constant regardless of the volume
of production, such as depreciation and maintenance of factory
buildings and the cost of factory management and administration.
Variable production overheads are those indirect costs of
production that vary directly, or nearly directly, with the volume of
production, such as indirect materials and indirect labour.
28
Fig 3.1: Measurement of Inventory

3.3.4 Allocation of fixed Overheads
The allocation of fixed production overheads for the purpose
of their inclusion in the costs of conversion is based on the normal
capacity of the production facilities. Normal capacity is the
production expected to be achieved on an average over a number
of periods or seasons under normal circumstances, taking into
account the loss of capacity resulting from planned maintenance.
The actual level of production may be used if it approximates
normal capacity. The amount of fixed production overheads
allocated to each unit of production is not increased as a
consequence of low production or idle plant.
Unallocated overheads are recognized as an expense in the
period in which they are incurred. In periods of abnormally high
production, the amount of fixed production overheads allocated to
each unit of production is decreased so that inventories are not
measured above cost. Variable production overheads are
assigned to each unit of production on the basis of the actual use
of the production facilities.
29
1.3.5 Examples - Allocation of Fixed Overheads

Example 1.
Total Production 100 Units

Normal Capacity 50 Units
Goods Sold 80 Units
Closing Stock 20 Units
Direct Cost 10 per unit
Fixed Overhead Rs.80
Variable Overhead Rs.120
Ans: Valuation of Stock = Direct Cost + Fixed Cost + Variable Cost

=10 + 0.8 + 1.2
= Rs.12
Fixed Cost= (80/100) = Rs.0.8
Variable cost= (120/100) = Rs.1.2
Note: In case of Actual Production is abnormally high then, Fixed

Overhead is allocated to Finished Goods on actual Production
basis.
3.3.6 Joint Products

A production process may result in more than one product
being produced simultaneously. This is the case, for example,
when joint products are produced or when there is a main product
and a by-product. When the costs of conversion of each product
are not separately identifiable, they are allocated between the
products on a rational and consistent basis. The allocation may be
based, for example, on the relative sales value of each product
either at the stage in the production process when the products
become separately identifiable, or at the completion of production.
Most by-products as well as scrap or waste materials, by their
nature, are immaterial. When this is the case, they are often
measured at net realizable value and this value is deducted from
the cost of the main product. As a result, the carrying amount of the
main product is not materially different from its cost.
3.3.7 Other Costs

Other costs are included in the cost of inventories only to the
extent that they are incurred in bringing the inventories to their
present location and condition. For example, it may be appropriate
to include overheads other than production overheads or the costs
30
of designing products for specific customers in the cost of

inventories.
Interest and other borrowing costs are usually considered as

not relating to bringing the inventories to their present location and
condition and are, therefore, usually not included in the cost of
inventories.
3.3.8 Exclusions from the Cost of Inventories

In determining the cost of inventories in accordance with
paragraph 6, it is appropriate to exclude certain costs and
recognize them as expenses in the period in which they are
incurred. Examples of such costs are:
(a)Abnormal amounts of wasted materials, labour, or other

production costs;
(b)Storage costs, unless those costs are necessary in the

production process prior to a further production stage;
(c) Administrative overheads that do not contribute to bringing the
inventories to their present location and condition; and
(d) Selling and distribution costs.
3.3.9 Cost Formulae

1. Specific Identification Method for–
i) Goods not ordinarily interchangeable;
ii) Goods/services produced and segregated for specific
projects.
Specific identification of cost means that specific costs are

attributed to identify items of inventory. This is an appropriate
treatment for items that are segregated for a specific project,
regardless of whether they have been purchased or produced.
However, when there are large number of items of inventory which
are ordinarily interchangeable, specific identification of costs is
inappropriate since, in such circumstances, an enterprise could
obtain predetermined effects on the net profit or loss for the period
by selecting a particular method of ascertaining the items that
remain in inventories.
2. FIFO, Weighted Average Method in other cases.

The cost of inventories, in other cases should be assigned
by using the first-in, first-out (FIFO), or weighted average cost
formula. The formula used should reflect the fairest possible
approximation to the cost incurred in bringing the items of inventory
to their present location and condition.
31
A variety of cost formulae is used to determine the cost of

inventories other than those for which specific identification of
individual costs is appropriate. The formula used in determining the
cost of an item of inventory needs to be selected with a view to
providing the fairest possible approximation to the cost incurred in
bringing the item to its present location and condition. The FIFO
formula assumes that the items of inventory which were purchased
or produced first are consumed or sold first, and consequently the
items remaining in inventory at the end of the period are those most
recently purchased or produced. Under the weighted average cost
formula, the cost of each item is determined from the weighted
average of the cost of similar items at the beginning of a period and
the cost of similar items purchased or produced during the period.
The average may be calculated on a periodic basis, or as each
additional shipment is received, depending upon the circumstances
of the enterprise.
3.3.10 Techniques for the Measurement of Cost
Techniques for the measurement of the cost of inventories,
such as the standard cost method or the retail method, may be
used for convenience if the results approximate the actual cost.
Standard costs take into account normal levels of consumption of
materials and supplies, labour, efficiency and capacity utilization.
They are regularly reviewed and, if necessary, revised in the light of
current conditions.
The retail method is often used in the retail trade for
measuring inventories of large numbers of rapidly changing items
that have similar margins and for which it is impracticable to use
other costing methods. The cost of the inventory is determined by
reducing from the sales value of the inventory the appropriate
percentage gross margin. The percentage used takes into
consideration inventory which has been marked down to below its
original selling price. An average percentage for each retail
department is often used.
3.4 NET REALISABLE VALUE
3.4.1 MEANING
It means the estimated selling price in ordinary course of
business, less estimated cost of completion and estimated cost
necessary to make the sale. Estimation of NRV also takes into
account the purpose for which the inventory is held.
3.4.2 When cost of inventories may not be recoverable?
i. If inventories are damaged,
ii. If they have become wholly or partially obsolete,
iii. If their selling prices have declined.
iv. If the estimated costs of completion or the estimated costs
necessary to make the sale have increased.
32
The practice of writing down inventories below cost to net

realizable value is consistent with the view that assets should not
be carried in excess of amounts expected to be realized from their
sale or use. An assessment is made of net realizable value as at
each balance sheet date.
3.4.3 Net Realizable Value for Raw Material - Para 24 of AS 2

1) If finished goods in which Raw Material is used, is sold at or
above cost, then net realizable value of Raw Material is considered
more than its cost.
2) If finished goods in which Raw Material used is sold below cost,
then net realizable value of Raw Material is equal to replacement
price of Raw Material.
3.4.4 Analysis of Inventory valuation under cost and NRV
Aspects
33
Example 2:
Suppose, there are 1,00,000 units in stock, of which 60,000 are to
be delivered for Rs.40 each as per contract with one of the
customer. Cost of stock is Rs.45 per unit & NRV is estimated of
Rs.50 per unit. What will be the value of stock?
Ans. In this case, 60,000 units will be valued at Rs.40 & balance
stock of 40,000 units will be valued at Rs.45 per unit.
Example 3:
Items X Y Z Total
Cost 20 16 8 44
NRV 14 16 12 42
How will you value the stock under provisions of AS-2?
Ans:
Items X Y Z Total
Cost 20 16 8 44
NRV 14 16 12 42
Value
14 16 8 38
(under AS 2)
3.5 DISCLOSURES
The financial statements should disclose:

i. Accounting policies relating to inventories
ii. Cost formula used
Iii.Carrying amount of inventories with appropriate classifications
Information about the carrying amounts held in different

classifications of inventories and the extent of the changes in these
assets is useful to financial statement users. Common
classifications of inventories are raw materials and components,
work in progress, finished goods, stores and spares, and loose
tools.
3.6 DISCLOSURE PRACTICE ON VALUATION OF

INVENTORIES (AS-2)
Illustration:
This significant accounting policy comes from 2006 annual financial
statements of Bharat Forge America Inc.
34
Inventories are stated at the lower of cost or market, with the cost
determined on the First-In, First-Out (FIFO) method.
Explain requirement in the following cases with reference to
VALUATION OF INVENTORIES (AS-2)
1. The company is valuing its stocks at `cost' instead of `lower of

cost or net realizable value". Further, in valuing the closing stock at
cost, the company has included interest and other borrowings in
`cost'.
Ans. That the company is valuing its stocks at ‘cost' instead of

`lower of cost and net realizable value’. Further, in valuing the
closing stock at cost, the company has included interest and other
borrowings in ‘cost'. This is not in accordance with principles of
valuation of inventory as laid down in Revised Accounting
Standard AS-2 on Valuation of Inventories , issued by the
Institute of Chartered Accountants of India, which recommends,
inter alia, that the inventories should be valued at `lower of cost
and net realizable value' and that the interest and other borrowing
should not normally be included in the cost.
2. The Company in respect of its Chemical Division followed the

practice of valuing its inventories on FIFO basis. This year it
changed the basis of valuation from FIFO to LIFO basis. If this
change had not been made, the profit of the Company would have
been higher by Rs.20 lakhs and inventories would have been
higher by Rs.20 lakhs.
Ans. The Company in respect of its Chemical Division followed the

practice of valuing its inventories on FIFO basis. This year it
changed the basis of valuation from FIFO to LIFO basis. Had this
change not been made, the profit of the Company would have been
higher by Rs.20 lakhs and inventories would have been higher by
Rs.20 lakhs. This is not accordance with principles of valuation of
inventory as laid down in Revised Accounting Standard AS-2 on
`Valuation of Inventories', issued by the Institute of Chartered
Accountants of India, which recommends, inter alia, that the
inventories should be value at FIFO and at LIFO.
3. As per the past practice, the excise duty paid on finished

goods inventory amounting to Rs.3 crores has been treated as
prepayment till the goods are sold and estimated excise duty of
Rs.2 crores on finished goods lying in the factory premises but not
cleared from excise bonded warehouse as on March 31, 2011 has
not been included in inventory valuation.
35
Ans. As per the past practice, the excise duty paid on finished
goods inventory amounting to Rs.3 crores has been treated as
prepayment till the goods are sold and estimated excise duty of
Rs.2 crores on finished goods lying in the factory premises but not
cleared from excise bonded warehouse as on March 31, 2011 has
not been provided and hence, not included in inventory valuation.
This treatment, however, has no effect on the profits for the year.
3.7 GUIDANCE NOTE ON MODVAT/CENVAT ISSUED

BY THE ICAI AND VALUATION OF INVENTORY
ICAI issued a “Guidance Note on Accounting Treatment for

MODVAT / CENVAT”, with the substitution of the MODVAT Credit
Scheme with CENVAT w.e.f. 1-4-2000. The revised Guidance Note
has provided clarification on the above anomaly, with examples on
both the inclusive method (Sec.145A) and exclusive method (AS-
2), where it is clear that the above anomaly is only in respect of the
disclosure, with no effect on the total profit/loss of the enterprise.
Therefore, for purposes of tax filings and tax audit forms, the
inclusive method should be used as per section 145A of the
Income-tax Act, whereas for purposes of general purpose financial
statements, the exclusive method under AS-2 should be followed.
Inclusive Method (Gross Value Approach)
 Raw material is accounted for at gross value inclusive of

specified duty.
 CENVAT credit available on final products can be accounted for
through a separate account CENVAT Credit Availed Account.
 Inputs may be consumed partly. CENVAT Credit available
should be segregated into two parts:
- CENVAT Credit on inputs consumed in respect of final
products;
- CENVAT credit on inputs lying in the stock.
CENVAT credit available on inputs consumed for final products is

adjusted with the cost of raw material consumed.
CENVAT credit available on inputs lying in the godown should be

adjusted against the value of closing stock of raw material.
Exclusive Method (opening separate CENVAT Credit Account)
 Specified duty (i.e., duty paid against which CENVAT credit is

available) paid on inputs is debited to a separate account,
namely CENVAT Credit Receivable (Input) Account.
36
 As and when CENVAT credit is actually utilized against

payment of excise duty on final products, CENVAT Credit
Receivable (Input) Account is credited.
 Inputs consumed and inventory is valued excluding specified
duty.
Balance standing in the CENVAT Credit Receivable (Input)

Account is shown on the asset side of the Balance Sheet
under Advances.
3.8 COST OF INVENTORIES
A] Cost of Purchase:
I] Purchase Price xx
ii] Duties & Taxes xx
iii] Freight Inward xx
iv] Other Expenditure directly
attributable to acquisition xx xx
Less: i] Duties and Taxes recoverable
from tax authorities xx
ii] Trade discount xx
iii] Rebate xx
iv] Duty Drawback xx
v] Other similar items xx xx xxx
B] Cost of Conversion:
Direct Materials xx
Direct Labour xx
Direct Expenses xx
Systematic allocation of:
Variable Production Overheads xx
Fixed Production Overheads xx xxx
C] Other Costs:
Cost incurred for bringing the
inventories to their present xxx
location and condition xxx
Illustration 1: (Duties and taxes not recoverable)

Ambalal furnishes you following details
Ascertain the cost of purchase of inventory
i] Purchase of Raw materials Rs. 10 lakhs
ii] Duties and Taxes paid on the
acquisition and are not recoverable Rs. 2 lakhs
iii] Carriage inward Rs. 1 lakhs
iv]Others paid for acquisition of inventory Rs. 1 lakhs
37
Solution:
Cost of Purchase Rs. in lakhs
Cost of Purchase of Raw Materials 10
Duties & Taxes not recoverable 02
Carriage inward 01
Other Expenses 01
Total 14
Illustration 2
Big Bagha Associates furnishes you following details from which
you are required to ascertain cost of purchase of inventories.
i] Cost of Purchase of Inventory Rs. 20 lakhs
ii] Duties & Taxes paid and are
recoverable from Tax Authorities Rs. 5 lakhs
iii] Trade Discount Rs. 2 lakhs
iv] Duties & Taxes paid and not recoverable Rs. 2 lakhs
v] Freight Inwards Rs. 1 lakhs
vi] Other Expenses directly attributable
to Acquisition of Inventory Rs. 2 lakhs
Solution : Big Bagha Associates
Calculation of Cost of Purchase Rs. in lakhs

Cost of Purchase 20
Duties & Taxes paid and not recoverable 02
Freight Inward 01
Other Expenses 02
25
Less : Duties & Taxes recoverable from
Tax Authorities 05
Trade Discount 02 07
Total 18
Illustration 3
Chrome Ltd. manufactures different types of Dichromates.
From the following information find the value of inventory per kg
of Sodium Dichromate
Material cost Rs. 150 per kg
Direct Labour Cost Rs. 50 per kg
Direct Variable Production Overheads Rs. 20 per kg
Fixed production overheads for the year on normal capacity of
1,00,000 kgs is Rs.15 lakhs.
Finished goods on stock at the end of the year 3,000 kgs.
Solution: Chrome Ltd.

Cost per kg of Sodium Dichromate
As per AS-2 cost of conversion includes a systematic
allocation of fixed and variable production overheads, which are
38
incurred for converting materials into finished goods. The allocation

of fixed production overheads is based on normal capacity.
Statement of Cost (Per Kg) Rs.

Material Cost 150
Direct Labour 50
Direct Variable Production Overheads 20
 15,00,000 
Fixed Production Overheads   15
 1,00,000 
235
Value of Stock = 3,000 kgs @ Rs. 235
= Rs. 7,05,000
Illustration 4
Ind Ltd. manufacture computers, during the year ended 31st March,
2008 the company manufactured 550 computers, it has the policy
of valuing finished stock of goods at a standard cost of Rs.1.8 lakhs
per computer. The details of the cost are as under;
(Rs. in Lakhs)
Raw material consumed 400
Direct Labour 250
Variable production overheads 150
Fixed production overheads 290
(Including interest of Rs. 100)
Compute the value of cost per computer for the purpose of

closing stock.
Solution: As per AS-2 (Revised) (refer point 3.6), on valuation of

Inventories, finished stock of goods should be valued on the basis
of absorption costing. While absorbing fixed production overheads
the normal production capacity is considered. In this case, finished
stock has been valued at a standard cost of Rs.1.8 lakhs per
computer which incidentally synchronizes with the value computed
on the basis of absorption costing as under:
, (Rs. in lakhs)
Materials 400
Direct Labour 250
Less : Interest 100 190
Total Cost 990
Number of computers produced 550

(Assumed to be normal production)
Cost per computer 990/550 = Rs. 1.80 lakhs
Policy of the company to value closing stock is not as per

AS-2. As per para 18 of AS-2, (refer point 3.9-1) the techniques of
39
standard cost method may be used for convenience if the result

approximates to the actual cost and standard cost is regularly
reviewed if necessary. In the instant case, the cost of inventory can
be conveniently calculated as per absorption costing. Therefore,
there is no reason that standard costing method should be adopted.
Illustration 5
Dolphin Simulators Ltd. manufactures simulators.

Raw material was purchased at Rs. 100 per kg. Price of raw
material is on the decline. The finished goods in which the raw
material is incorporated are expected to be sold at below cost.
10,000 kgs of raw material is in stock at the year-end. Replacement
cost is Rs. 80 per kg. How will you value the inventory?
Solution :
Dolphin Simulators Ltd.
As per para 24 of AS-2, on valuation of inventories, material and
other supplies held for use in the production of inventories are not
written down below cost if the finished products in which they will
be incorporated are expected to be sold at or above cost. However,
when there has been a decline in the price of materials and it is
estimated that the cost of the finished products will exceed net
realisable value, the materials are written down to net realisable
value. In such circumstances, the replacement cost of the material
may be the best available measure of their net realisable value.
Hence, in this case, the stock of 10,000 kgs. of raw material will
be valued at Rs.80 per kg. The finished goods, if on stock, should
be valued at cost or net realisable value, whichever is lower.
Illustration 6
Lurcko Pvt. Ltd. manufactures computers. During the year
ended 31st March, 2017, the company manufactured 1000
computers. The break up of cost is as under:
Raw Material Rs. 450 lakhs
Direct Labour Rs. 300 lakhs
Variable Production Overheads Rs. 200 lakhs
Fixed Production Overheads
(Includes interest of Rs.100 lakhs) Rs. 300 lakhs
Compute the cost per computer for the purpose of closing
stock.
Solution:
As per AS-2 Inventory should be valued as per absorption
costing. The cost is calculated as under :
40
Calculation of Cost of Purchase

Rs. in lakhs
Raw Material 450
Direct Labour 300
Variable Production Overheads 200
Fixed Production Overheads 300
Less Interest 100 200
1150
Cost per computer = 1,150 Lakhs /1,000 = Rs. 1.15 lakhs

Note: Interest is excluded from cost of inventory.
Illustration –7
Gurecha Pvt. Ltd. furnishes you following information from
which you are required to value inventory of Finished Goods.
Material cost Rs. 200 per kg.
Direct Labour cost Rs. 40 per kg.
Direct variable production overhead Rs. 20 per kg.
Fixed production charges for the year on normal capacity of
one lakh kgs. is Rs. 20 lakhs. 2000 kgs. of finished goods are on
stock at the year-end.
Solution: Gurecha Pvt. Ltd.
In accordance with paras 8 & 9 of AS-2, (refer point 3.6) the
cost of conversion include a systematic allocation of fixed and
variable production overheads that are incurred in converting
materials into finished goods. The allocation of fixed production
overheads for the purpose of their inclusion in the cost of
conversion is based on the normal capacity of the production
facilities.
Thus, cost per kg. of finished goods can be computed as
follows:
Rs Rs.
Material cost 200
Direct Labour cost 40
Direct variable production overhead 20
Fixed production overhead
(Rs. 20,00,000/100000) 20 80
280
Thus, the value of 2000 kgs. of finished goods on stock at

the year-end will be Rs.5,60,000 = (2000 kgs. X Rs. 280)
Illustration 8
Hirel Techno points Associates is a company situated at MIDC,
Pune. The company deals in three products A, B and C, which are
neither similar nor interchangeable. At the time of closing of its
41
accounts for the year 2016-17; the historical cost and net realisable
values of the items of closing stock are given below:
Items : Historical Cost Net Realisable Value

(Rs. in lakhs) (Rs. in lakhs)
A 25 20
B 20 20
C 10 15
55 55
What will be the value of stock?
Solution: HIREL TECHNOPOINTS, PUNE

Historical Cost or Net Realisable Value whichever is less is
the value of stock. This should be done item by item as given
below:
Rs. in lakhs
A. Net Realisable Value 20
B. Historical Cost 20
C. Historical Cost 10
Value of Closing Stock 50
Illustration 9
The company deals in three products, A, B and C, which are
neither similar nor interchangeable. The Historical Cost and Net
Realizable Value of the items of closing stock for the year 2016-17
are determined as follows:
Items Historical Cost Net Realizable Value

A 40 28
B 32 32
C 16 24
What will be the value of Closing Stock?

Ans: As per Para 5 of AS 2 on Valuation of Inventories, inventories
should be valued at the lower of cost and net realizable value.
Inventories should be written down to net realizable value on an
item-by item basis in the given case.
Items Historical Cost Net Realizable Valuation of

Value closing stock
(Rs. in lakhs) (Rs. in lakhs) (Rs. in lakhs)
A 40 28 28
B 32 32 32
C 16 24 16
Total 88 84 76
Hence, closing stock will be valued at Rs. 76 lakhs.
42
Illustration 10
X Co. Limited purchased goods at the cost of Rs.40 lakhs in
October, 2011. Till March, 2012, 75% of the stocks were sold. The
company wants to disclose closing stock at Rs.10 lakhs. The
expected sale value is Rs.11 lakhs and a commission at 10% on
sale is payable to the agent. Advice, what is the correct closing
stock to be disclosed as at 31.3.2012.
Ans: As per Para 5 of AS 2 “Valuation of Inventories”, the
inventories are to be valued at lower of cost and net realizable
value. In this case, the cost of inventory is Rs.10 lakhs. The net
realizable value is 11, 00,000 @ 90% = Rs.9, 90,000. So, the stock
should be valued at Rs.9, 90,000.
Illustration 11
The Company X Ltd. has to pay for delay in cotton clearing
charges. The company up to 31.3.2017 has included such charges
in the valuation of closing stock. This being in the nature of interest,
X Ltd. decided to exclude such charges from closing stock for the
year 2006-07. This would result in decrease in profit by Rs.5 lakhs.
Comment.
Ans: As per Para 12 of AS 2 (revised), interest and other borrowing
costs are usually considered as not relating to bringing the
inventories to their present location and condition and are therefore,
usually not included in the cost of inventories. However, X Ltd. was
in practice to charge the cost for delay in cotton clearing in the
closing stock. As X Ltd. decided to change this valuation procedure
of closing stock, this treatment will be considered as a change in
accounting policy and such fact to be disclosed as per AS 1.
Therefore, any change in amount mentioned in financial statement,
which will affect the financial position of the company should be
disclosed properly as per AS 1, AS 2 and also a note should be
given in the annual accounts that, had the company followed earlier
system of valuation of closing stock, the profit before tax would
have been higher by Rs. 5 lakhs.
Illustration 12
Normal capacity = 20,000 units
Production = 18,000 units
Sales = 16,000 units
Closing Stock = 2,000 units
Fixed Overheads = Rs. 60,000
Calculate cost of fixed overheads to closing stock
Ans: Fixed Overheads = Rs.60,000 / 20,000 = Rs. 3 per unit
Fixed Overheads will be bifurcated into three parts:
Cost of Sales: 16,000*3 = 48,000
Closing Stock: 2,000 *3 = Rs. 6,000
Under normal capacity: 2,000 *3 = Rs. 6,000
(to be charged to P/L A/c)
43
Illustration 13
Normal capacity = 20,000 units

Production = 25,000 units
Sales = 23,000 units
Closing Stock = 2,000 units
Fixed Overheads = Rs 60,000
Calculate Cost of fixed overheads to closing stock
Ans: Fixed Overheads = Rs 60,000/20,000 = Rs.3 per unit

But, Due to production above normal capacity = Rs.60,000 / 25,000
= Rs. 2.40 per unit
Cost of Sales: 23,000 * 2.4 = Rs. 55,200
Closing Stock: 2,000 * 2.4 = Rs. 4,800
Illustration 14
Ascertain the cost of Inventory by using the data given below:
i. Purchase Price Rs.20 lakhs

ii. Duties and Taxes paid on acquisition and are Rs.2 lakhs
not recoverable
iii. Freight inward Rs.2 lakhs
iv .Others paid for acquisition of inventory Rs.1 lakhs
Ans. Cost of Purchase:

Cost of Inventory Rs. in lakhs
Purchase Price 20
Duties and Taxes paid on acquisition and are not 02
recoverable
Freight inward 02
Others paid for acquisition of inventory 01
Total 25
Illustration 15
Zenith Ltd. manufactures computers. During the year ended 31st
March 2017, the Company manufactured 5,000 computers and
incurred following cost:
i. Raw Material Rs.400 lakhs

ii. Direct Labour Rs.400 lakhs
iii.Variable Production overheads Rs.150 lakhs
iv. Fixed Production overheads Rs.250 lakhs
(including interest 50 lakhs)
Compute cost per computer for the purpose of closing stock.

44
Ans.
Cost of Purchase Rs. in lakhs

Raw Material 400
Direct Labour 400
Variable Production overheads 150
Fixed Production overheads 200
Total 1,150
Note: Interest excluded from cost of Inventory
Cost per Computer (1,150 lakhs / 5,000) Rs. 23,000
3.10 EXERCISE
3.10.1 PRACTICAL PROBLEMS
1. How do you ascertain the cost of purchase of inventory by using

the following data
i] Purchase Price Rs. 5,00,000
ii] Duties and Taxes paid on the Acquisition
of Inventory and are not recoverable Rs. 2,00,000
iii] Freight Inward Rs. 1,00,000
iv] Other Expenses for Acquisition of Materials Rs. 2,00,000
[Ans. Rs. 10,00,000]
2. Ganesh Pvt. Ltd. produces product x 2007.

The production cost per unit
Raw Materials Rs. 15
Labour Rs. 6
Direct Expenses Rs. 5
Normal capacity 10,000 units p.a.
Actual production 7,000 units
Fixed Factory overheads Rs. 30,000 p.a.
Closing Stock 2500 units
Calculate the value of closing stock
Normal Capacity 10000units

Actual Production 7000 units
Total Fixed overheads 30000
Fixed overhead per unit 3Rs
Ans. Value of closing stock= 2500 units@29 =72500

45
3. Company deals in three products X, Y and Z, which are neither

similar nor interchangeable. At the time of closing its account for
the year 2001-2002. The historical cost and net realisable
values of the items of closing stock are determined as below :
Items Historical Cost Net realisable value
X 20 14
Y 16 16
Z 8 12
44 42
What will be the value of closing stock?
[Ans. : Rs. 38]
4. Company is collecting Gumkriya from the plant of forest for

collecting Gumkriya. Company paid Rs.5 crores to forest
department as license fee for financial year 2001-2002. During
the year it collected 1 crore kg. of Gumkriya from the forest and
sold 60 thousand kg. for Rs.12 crores. Other direct expenses
and overheads were Rs.7 crores for the financial year 2001-
2002. The company valued the closing stock of 40,000 kg. at
Rs. 4.80 crores following the AS-2. Whether the valuation is
correct.
[Ans. : AS-2 does not apply to forest product]
5. X Ltd. is selling refrigerator; purchase price of the Refrigerator is

Rs.15,000 as per the terms of sales. The refrigerator is to be
delivered and installed at customer’s house free of cost. X Ltd.
has hired Y & Co. for the purpose and being paid Rs.1,000 –
per Refrigerator for delivery and installation. At year ended on
31-3-2002, 10 refrigerator were in stock. The market price of the
refrigerator is Rs.15,750. Calculate the value of closing stock as
per AS-2.
[Ans. : Rs. 1,47,500]
6. Apple Consultancy Ltd. is the management consultant giving the

consultancy in the field of re-structuring, amalgamation and
valuation. The company has got consultancy contract worth
Rs.20 lakhs from Y Ltd. for giving their report of restructuring of
the organization. X Consultancies Ltd. commences the work on
1-3-2008 and expect that work will take four months to be
completed. X Consultancy Ltd. has deployed four senior
consultants for the assignment whose salary is Rs. 20,000 per
month. For the year ended 31-3-2008. The company values the
work-in-progress of Rs.80,000 in its financial statement applying
the formula of valuation of cost or nets realisable value
whichever is less as per AS-2.
Is the valuation of W.I.P. of Rs. 80,000 is correct. If not why?
[Ans. : AS-2 does not apply to service contract]
46
7. Z Ltd. produced 10,000 units of product A during 2007-2008 per

unit cost is as follows :
Raw Material Rs. 100
Direct wages Rs. 50
Rs. 152
Production overhead is Rs. 20,000 of which 40% is fixed. The
company sold 800 units and 2,000 units were in stock as on 31st
March 2008. Normal capacity is 50,000 units.
Calculate the value of closing stock.
[Ans.: Rs. 309600]
8. Historical Cost and Net Realibsable Value of five inventory

items are given below :
Items : Historical Cost Net Realisable Value
Rs. Rs.
A 20,000 30,000
B 12,000 10,000
C 12,000 18,000
D 32,000 26,000
E 28,000 26,000
1,04,000 1,10,000
Determine the value of inventory.
[Ans. Rs. 94,000]
9. Cost of Production of Product x 100 is given below :

Direct Material per unit Rs. 150
Direct Wages per unit Rs. 100
Overheads per unit Rs. 50
Rs. 300
As on the balance sheet date, replacement cost of material is

Rs. 120 per unit. There were 2,000 units of material on 31st March,
2008
Calculate the value of stock of material under the following
conditions:
i] If finished product is sold at Rs.320 per unit, what will be the

value of stock of material.
ii] If finished product is sold at the rate of Rs.280 per unit, what will
be the value of closing stock of materials.
[Ans. (i) Rs. 3,00,000. (ii) Rs. 2,40,000]
10. Indulkar Ltd. produced 1,00,000 units during the year 2006-07.
The cost per unit is as follows:
Direct Materials Rs. 100
Direct Labour Rs. 50
47
Production overheads are Rs. 2,00,000 of which 60% is

variable. The company sold 80,000 units and 20,000 units were in
stock as on 31st March, 2007. Normal capacity is 50,000 units.
Calculate the value of Closing Stock.
[Ans. Variable Production Overheads Rs. 1,20,000
Fixed Production Overheads Rs. 80,000

Variable Production Overheads
per unit Rs. 1,20,000
Rs. 1,00,000 = 1.20
Fixed Production Overheads Rs. 80,000 = 1.60
Per unit Rs. 50,000
Cost per unit Rs. 162.80
Value of Stock = 20,000 x 162.80
= Rs. 32,56,000]
3.10.2 THEORY QUESTIONS

1] What are the objectives of AS-2?
2] Under what circumstances AS-2 is applicable?
3] Define the term ‘Inventories’?
4] Write a detailed note on ‘Measurement of Inventories’?
5] State and explain important aspects of ‘Inventory Valuation’.
6] Write short notes on
i] Treatment of other cost
ii] Inclusion of excise duty in valuation of finished goods
iii] Exclusion from cost of inventories
iv] Disclosure of inventory valuation policy in financial
statement.
v] Cost formula
vi] Net realisable value
7] Explain the following
a] Cost of purchase
b] Cost of conversion
c] Standard method
d] Retail method
e] Specific cost method
f] Net Realisable value
8] Compare the following
i] Standard cost and retail method
ii] Historical cost and Realisable value
9] Briefly explain Main Product, Joint Product and By Product.
48
3.10.3 OBJECTIVE TYPE QUESTIONS

1. Under inflationary conditions, ________ method will show

highest value of closing stock?
a. FIFO
b. LIFO
c. Weighted Average
d. None of the above
2. The inventory valuation method that identifies the invoice cost of
each item in ending inventory to determine the cost assigned to
that inventory is the:
a. Weighted-average inventory method.
b. Retail inventory method.
c. Specific identification method.
d. First-in, First-out method.
3. A company had the purchases shown below during the current

year. On December 31, there were 26 units remaining in ending
inventory. These 26 units consisted of 2 from January, 4 from
February, 6 from May, 4 from September and 10 from
November. Using the specific identification method, what is the
cost of the ending inventory?
January 10 units @ 120

February 20 units @ 130
May 15 units @ 140
September 12 units @ 150
November 10 units @ 160
a. 3,500
b. 3,800
c. 3,960
d. 3,280
4. The original cost of an inventory item is above the replacement

cost. The inventory item's replacement cost is above the net
realizable value. Under the lower of cost or market method, the
inventory item should be valued at:
a. Original cost.
b. Replacement cost.
c. Net realizable value.
d. Net realizable value less normal profit margin.
49
5. A manufacturer has the following per-unit costs and values for

its sole product:
Cost Rs.10.00
Current replacement cost Rs.5.50
Net realizable value Rs. 6.00
Net realizable value less normal profit margin Rs. 5.20
In accordance with AS 2, what is the per unit carrying value of
inventory in the manufacturer’s statement of financial position?
a. 5.20
b. 5.50
c. 6.00
d. 10.00
6. AS-2 is related to :
a. Valuation of inventories
b. Accounting for Construction Contracts
c. Cash Flow Statements
d. Depreciation accounting
7. Assuming constant inventory quantities, which of the following
inventory-costing methods will produce a lower inventory
turnover ratio in an inflationary economy?
a. FIFO (first in, first out).

b. LIFO (last in, first out).
c. Moving average.
d. Weighted average.
8. In specific identification method of inventory valuation the
method applicable will be
a. FIFO
b. LIFO
c. Average cost
d. None of the above
9. Sales for the year ended 31st March, 2005 amounted to
Rs.10,00,000. Sales included goods sold to Mr. A for Rs. 50,000
at a profit of 20% on cost. Such goods are still lying in the
godown at the buyer’s risk. Therefore, such goods should be
treated as part of
a. Sales.
b. Closing stock.
c. Goods in transit
d. Sales return
50
10. Approximate actual cost method of inventory valuation is --
a. Actual cost
b. Standard cost
c. Weighted average cost
d. FIFO
11. A company normally sells its product for Rs.20 per unit, which
includes a profit margin of 25%. However, the selling price has
fallen to Rs.15 per unit. This company's current inventory
consists of 200 units purchased at Rs.16 per unit. Replacement
cost has now fallen to Rs.13 per unit. Calculate the value of this
company's inventory at the lower of cost or market.
a. 2,600
b. 2,550
c. 2,700
d. 3,000
12. A businessman purchased goods for Rs.25,00,000 and sold
70% of such goods during the accounting year ended 31st
March, 2005. The market value of the remaining goods was
Rs.5,00,000. He valued the closing stock at Rs.5,00,000 and
not at Rs.7, 50,000 due to
a. Money measurement.
b. Conservatism.
c. Cost.
d. Periodicity.
13. At the end of the accounting year, material A costing Rs.10,000
was having net realizable value of Rs.9,500 only, while material
B costing Rs.12,000 was having a net realizable value of
Rs.13,000 in the market and material C costing Rs.15,000 was
having net realizable value of Rs.14,000 only. The total amount
of closing stock will be
a. Rs.37, 000.
b. Rs. 35,500.
c. Rs. 36,500.
d. Rs. 38,000.
14. The following data has been provided by Omega Ltd.:
Item No. Units Cost per unit Realization value
per unit
1 2 10 11
2 10 5 4
3 2 2 2
51
The value of inventory on item by item basis will be

a. Rs. 40.
b. Rs.64.
c. Rs.66.
d. Rs.60.
15. “Inventories should be out of godown in the sequence in which

they arrive” is based on
a. HIFO.
b. LIFO.
c. FIFO.
d. Weighted average.
Answers: 1- a, 2-c, 3-b, 4-c, 5-c, 6-a, 7- a, 8-d, 9- a, 10-c, 11-a,

12- b,13- b,14-b, 15-c.



52
Unit-4
AS-9 REVENUE RECOGNITION
Unit Structure:
4.0 Objectives
4.1 Introduction
4.2 Purpose
4.3 Non Applicability of AS-9
4.4 Revenue Recognition
4.5 Effect of Uncertainties on Revenue Recognition
4.6 Disclosure Requirements
4.8 Exercises
4.0 OBJECTIVES
After studying the unit the students will be able to:

 Understand the purpose and scope of AS-9.
 Know the non applicability of AS-9
 Explain the effects of uncertainties on revenue recognition.
 Understand the circumstances in which revenue recognition has
been postponed.
 Recognize revenue practically.
4.1 INTRODUCTION
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. This Statement AS-9, Revenue
Recognition issued in 1985 deals with the bases for recognition of
revenue in the statement of profit and loss of an enterprise. The
statement is concerned with the recognition of revenue arising in
the course of the ordinary activities of the enterprise from
1. The sale of goods,

2. The rendering of services, and
3. The use by others of enterprise resources yielding interest,
royalties and dividends.
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Revenue recognition is mainly concerned with the timing of

recognition of revenue in the statement of profit and loss of an
enterprise. The amount of revenue arising on a transaction is
usually determined by agreement between the parties involved in
the transaction. When uncertainties exist regarding the
determination of the amount, or its associated costs, these
uncertainties may influence the timing of revenue recognition. This
standard is mandatory for all enterprises.
4.2 PURPOSE
The Purpose of AS-9 is recognizing revenue arising in the

course of the ordinary activities of the enterprise.
SCOPE of AS-9
It includes the following activities:
 Sale of goods.
 Rendering of services.
 Use by others of enterprise resources yielding interest,
royalties and dividends.
4.3 NON APPLICABLITY of AS-9
This Statement does not deal with the following aspects of revenue
recognition to which special considerations apply:
1. Revenue arising from construction contracts.
2. Revenue arising from hire-purchase, lease agreements.
3. Revenue arising from government grants and other similar
subsidies.
4. Revenue of insurance companies arising from insurance
contracts.
5. Profit or loss on sale of fixed assets
6. Realized or unrealized gains resulting from changes in foreign
exchange rates
Examples of items not included within the definition of “revenue” for

the purpose of this Statement are:
1. Realized gains resulting from the disposal of and unrealized
gains resulting from the holding of, non-current assets e.g.
appreciation in the value of fixed assets;
2. Unrealized holding gains resulting from the change in value of

current assets and the natural increases in herds and
agricultural and forest products;
54
3. Realized or unrealized gains resulting from changes in foreign

exchange rates and adjustments arising on the translation of
foreign currency financial statements;
4. Realized gains resulting from the discharge of an obligation at

less than its carrying amount;
5. Unrealized gains resulting from the restatement of the carrying

amount of an obligation.
4.4 REVENUE RECOGNITION
1. Sale of goods
A key criterion for determining when to recognize revenue
from a transaction involving the sale of goods is that the seller has
transferred the property in the goods to the buyer for a
consideration. The transfer of property in goods, in most cases,
results in or coincides with the transfer of significant risks and
rewards of ownership to the buyer. However, there may be
situations where transfer of property in goods does not coincide
with the transfer of significant risks and rewards of ownership.
Revenue in such situations is recognized at the time of
transfer of significant risks and rewards of ownership to the
buyer. Such cases may arise where delivery has been delayed
through the fault of either the buyer or the seller and the goods are
at the risk of the party at fault as regards any loss which might not
have occurred but for such fault. Further, sometimes the parties
may agree that the risk will pass at a time different from the time
when ownership passes.
At certain stages in specific industries, such as when

agricultural crops have been harvested or mineral ores have been
extracted, performance may be substantially complete prior to the
execution of the transaction generating revenue. In such cases
when sale is assured under a forward contract or a government
guarantee or where market exists and there is a negligible risk of
failure to sell, the goods involved are often valued at net realizable
value. Such amounts, while not revenue as defined in this
Statement, are sometimes recognized in the statement of profit
and loss and appropriately described.
Thus, sale of goods is recognized when

1. The property in goods in transferred for a price.
2. All significant risks and rewards have been transferred and
no effective control is retained.
3. No significant uncertainty exists regarding the amount of
consideration.
4. It is reasonable to expect ultimate collection of
consideration.
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2. Rendering of Services
Revenue from service transactions is usually recognized as
the service is performed, either by the proportionate completion
method or by the completed service contract method.
i) Proportionate Completion Method — Performance consists

of the execution of more than one act. Revenue is recognized
proportionately by reference to the performance of each act.
The revenue recognized under this method would be
determined on the basis of contract value, associated costs,
number of acts or other suitable basis. For practical purposes,
when services are provided by an indeterminate number of acts
over a specific period of time, revenue is recognized on a
straight line basis over the specific period unless there is
evidence that some other method better represents the pattern
of performance.
ii) Completed service Contract Method — Performance consists

of the execution of a single act. Alternatively, services are
performed in more than a single act and the services yet to be
performed are so significant in relation to the transaction taken
as a whole that performance cannot be deemed to have been
completed until the execution of those acts. The completed
service contract method is relevant to these patterns of
performance and accordingly revenue is recognized when
the sole or final act takes place and the service becomes
chargeable.
Revenue recognition in rendering of services

Completed service method recognises revenue only
 When service complete or substantially complete.
 In such cases there are more than one act involved and
revenue is recognised on' execution of all those acts.
Proportionate completed method

 Recognises revenue proportionate with the degree of
completion of services.
 There is more than one act involved and revenue is
recognised on execution of certain acts.
Thus, Service is recognized when

 Service is recognised either on completed service or
proportionate completion method.
 No significant uncertainty exists regarding amount of
consideration.
 It is reasonable to expect ultimate collection of
consideration.
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EXAMPLES
1] On sale, buyer takes title and accepts billing but delivery is
delayed at buyer’s request.
Ans. Revenue should be recognised notwithstanding that physical

delivery has not been completed.
2] Sale on approval.
Ans. Revenue should not be recognised until the goods have been
formally accepted or time for rejection has elapsed or where no
time has been fixed, a reasonable time has elapsed.
3] Sales with the condition of ‘money back if not completely

satisfied.
Ans. It may be appropriate to recognize the sale but to make

suitable provision for returns based on previous experience.
4] Consignment sales.
Ans. Revenue should not be recognised until the goods are sold to
a third party.
5] Instalment sales.
Ans. Revenue of sale price excluding interest should be recognised

on the date of sale.
6] Special order and shipments.
Ans. Revenue from such sales should be recognized when the

goods are identified and ready for delivery.
7] Where seller concurrently agrees to repurchase the same goods

at a later date.
Ans. The sale should not be recognised, as this is a financial

arrangement.
8] Subscriptions received for publications.
Ans. Revenue received or billed should be deferred and

recognised either on a straight-line basis over time or where the
items delivered vary in value from period to period, revenue should
be based on the sales value of the item delivered.
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9] Sale of show tickets.
Ans. Revenue should be recognised when the event takes place.
10] Guaranteed sales of agricultural crops.
Ans. When sale is assured under forward contract or government

guarantee, the crops can be recognised at net realizable value
although it does not satisfy the criteria of revenue recognition.
Rendering of Services
1] Installation Fees
Ans. In cases where installation fees are other than incidental to
the sale of a product, they should be recognised as revenue only
when the equipment is installed and accepted by the customer.
2] Advertisement commission received
Ans. It is recognised when the advertisement appears before

public.
3] Insurance agency commission received
Ans. It is recognised on the effective commencement or renewal

dates of the related policies.
4] Tuition fees received
Ans. It should be recognised over the period of instruction.
5] Admission fees
Ans. Revenue from artistic performances, banquets and other

special events should be recognised when the event takes place.
When a subscription to a number of events is sold, the fee should
be allocated to each event on a systematic and rational basis.
6] Entrance and membership fees

Ans. Revenue recognition from these sources will depend on the
nature of the services being provided. Entrance fee received is
generally capitalised. If the membership fee permits only
membership and all other services or products are paid for
separately, or if there is a separate annual subscription, the fee
should be recognised when received. Publications to be provided
during the year, it should be recognised on a systematic and
rational basis having regard to the timing and nature of all services
provided.
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3. Use of enterprise resources by others:

The use of such enterprise resources by others gives rise to:
(i) Interest—charges for the use of cash resources or amounts
due to the enterprise;
(ii) Royalties—charges for the use of such assets as know-how,
patents, trademarks and copyrights;
(iii) Dividends—rewards from the holding of investments in
shares.
Revenue recognition in use of enterprise resources by others

1.Interest: Revenue is recognized on the time basis determined by
the amount outstanding and the rate applicable.
2.Royalty: Revenue is recognized in accordance with the terms of

the relevant agreement.
3.Dividends: Revenue is recognized only when a right to receive

payment is established.
When interest, royalties and dividends from foreign countries

require exchange permission and uncertainty in remittance is
anticipated, revenue recognition may need to be postponed.
4.5 EFFECT OF UNCERTAINTIES ON REVENUE

RECOGNITION
1. Recognition of revenue requires that revenue is measurable

and that at the time of sale or the rendering of the service it
would not be unreasonable to expect ultimate collection.
2. Where the ability to assess the ultimate collection with

reasonable certainty is lacking at the time of raising any claim,
e.g., for escalation of price, export incentives, interest etc., and
revenue recognition is postponed to the extent of uncertainty
involved. In such cases, it may be appropriate to recognize
revenue only when it is reasonably certain that the
ultimate collection will be made. Where there is no
uncertainty as to ultimate collection, revenue is
recognized at the time of sale or rendering of service even
though payments are made by installments.
3. When the uncertainty relating to collectability arises

subsequent to the time of sale or the rendering of the service,
it is more appropriate to make a separate provision to
reflect the uncertainty rather than to adjust the amount of
revenue originally recorded.
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4. An essential criterion for the recognition of revenue is that the

consideration receivable for the sale of goods, the rendering of
services or from the use by others of enterprise resources is
reasonably determinable. When such consideration is not
determinable within reasonable limits, the recognition of
revenue is postponed.
5. When recognition of revenue is postponed due to the effect
of uncertainties, it is considered as revenue of the period
in which it is properly recognized.
4.6 DISCLOSURE REQUIREMENTS
In addition to the disclosures required by Accounting

Standard 1 on ‘Disclosure of Accounting Policies’ (AS 1), When
recognition of revenue is postponed due to the effect of
uncertainties, an enterprise should disclose the circumstances in
which revenue recognition has been postponed.
Question:-Explain requirement in the following cases with reference
to REVENUE RECOGNITION (AS-9)
Accounts of certain items of income are recorded on cash basis, As
a result, the net profit for the year and current assets are
understated by Rs.20,000 each.
Ans. Accounts of certain items of income recorded on cash basis

which is not in line with the Accounting Standard 9 regarding
"Revenue Recognition" issued by the Institute of Chartered
Accountants of India. As a result, the net profit for the year and
current assets are understated by Rs.20,000 each as compared to
the position which would have prevailed if the company has
accounted for interest income on accrual basis." should be
disclosed.
1) Arjun Ltd. sold farm equipments through its dealers. One of the
conditions at the time of sale is payment of consideration in 14
days and in the event of delay interest is chargeable @ 15% per
annum. The Company has not realized interest from the dealers
in the past. However, for the year ended 31.3.2018, it wants to
recognize interest due on the balances due from dealers. The
amount is ascertained at Rs.9 lakhs. Decide whether income by
way of interest from dealers is eligible for recognition as per AS
9.
Ans. As per AS 9 “Revenue Recognition”, where the ability to

assess the ultimate collection with reasonable certainty is lacking at
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the time of raising any claim, the revenue recognition is postponed

to the extent of uncertainty expected. In such cases, the revenue is
recognized only when it is reasonably certain that the ultimate
collection will be made.
In this case, the company never realized interest for the
delayed payments made by the dealers. Hence, it has to recognize
the interest only if the ultimate collection is certain.
The interest income hence is not to be recognized.
2) Y Ltd. used certain resources of X Ltd. In return X Ltd. receives

Rs.10 lakhs and Rs.15 lakhs as interest and royalties
respectively, from Y Ltd. during the year 2017 –2018. State on
what basis X Ltd. should recognize their revenue, as per AS 9.
Ans. As per AS 9 on ‘Revenue Recognition’, interest of Rs.10

lakhs received in the year 2017-2018 should be recognized on the
time basis, whereas royalty of Rs.15 lakhs received in the same
year should be recognized on accrual basis as per the terms of
relevant agreement.
3) The Board of Directors of X Ltd. decided on 31.3.2017 to

increase sale price of certain items of goods sold retrospectively
from 1st January, 2017. As a result of this decision the company
has to receive Rs.5 lakhs from its customers in respect of sales
made from 1.1.2017 to 31.3.2017. But the Company’s
Accountant was reluctant to make-up his mind. You are asked
to offer your suggestion.
Ans. As per Para 10 of AS 9 ‘Revenue Recognition’, the additional
revenue on account of increase in sales price with retrospective
effect, as decided by Board of Directors of X Ltd., of Rs.5 lakhs to
be recognized as income for financial year 2016-17, only if the
company is able to assess the ultimate collection with reasonable
certainty. If at the time of rising of any claim it is unreasonable to
expect ultimate collection, revenue recognition should be
postponed.
4) X Limited has recognized Rs.10 lakhs on accrual basis income
from dividend on units of mutual funds of the face value of
Rs.50 lakhs held by it as at the end of the financial year 31st
March, 2017. The dividends on mutual funds were declared at
the rate of 20% on 15th June, 2017. The dividend was proposed
on 10th April, 2017 by the declaring company. Whether the
treatment is as per the relevant Accounting Standard? You are
asked to answer with reference to provisions of Accounting
Standard.
Ans. Paragraph 8.4 and 13 of Accounting Standard 9 on Revenue
Recognition states that dividends from investments in shares are
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not recognized in the statement of profit and loss until a right to

receive payment is established. In the given case, the dividend is
proposed on 10th April, 2017, while it is declared on 15th June,
2003. Hence, the right to receive payment is established on 15th
June, 2017. As per the above mentioned paragraphs, income from
dividend on units of mutual funds should be recognized by X Ltd. in
the financial year ended 31st March, 2018.
5) The stages of Production and sale of the producer are as

follows (all in rupees):
Stage Activity Cost to Net Realizable

date(Rs.) Value(Rs.)
A Raw Materials 45,000 43,000
B WIP 1 47,000 48,000
C WIP 2 50,000 54,500
D Finished Product 55,000 1,10,000
E For Sale 55,000 1,10,000
F Sale Agreed 55,000 1,10,000
G Delivered 56,950 1,10,000
H Paid For 56,950 1,10,000
State and explain the stage at which you think revenue will be
recognized?
Ans. According to As-9, sales will be recognized only when
1. The sale value is fixed and determinable.
2. Property of the goods is transferred to the customer.
Both these conditions are satisfied at stage F, when sales are
agreed at a price and goods allocated for delivery purpose.
4.8 EXERCISE
4.8.1 PRACTICAL PROBLEMS

1. AST Co. Ltd. uses certain resources of BST Co. Ltd. In return
BST Co. Ltd. received Rs. 8 lakhs and Rs. 12 lakhs as interest and
royalties from AST Co. Ltd. during the year 2017-18.You are
required to state on whether and what basis this revenues can be
recognized by BST Co. Ltd.?
2. X Limited has recognized Rs.10 lakhs on accrual basis income
from dividend on securities of the face value of Rs.50 lakhs held by
it as at the end of the financial year 31st March, 2017. The
dividends on mutual funds were declared at the rate of 20% on 25th
May, 2017. The dividend was proposed on 10th April, 2017 by the
declaring company. Whether the treatment is as per the relevant
Accounting Standard? You are asked to answer with reference to
provisions of Accounting Standard.
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3. The Board of Directors of X Ltd. decided on 31.3.2017 to

increase sale price of certain items of goods sold retrospectively
from 1st January, 2017. As a result of this decision the company
has to receive Rs.5 lakhs from its customers in respect of sales
made from 1.1.2017 to 31.3.2017. The decision was communicated
to customers and was approved. Can X Ltd. recognize revenue
pertaining to increase in sale -price?
4. Goods worth Rs.6 lakhs are supplied to Ram & Co on 15th March
2017 on sale on approval basis. Comment in light of AS-9 whether
revenue should be recognized?
4.8.2 THEORY QUESTION

1. When can revenue be recognized in the case of transaction of
sale of goods?
Ans. As per AS 9 Revenue Recognition, revenue from sales

transactions should be recognized when the following
requirements as to performance are satisfied, provided that at
the time of performance, it is not unreasonable to expect
ultimate collection:
(i) The seller of goods has transferred to the buyer the
property in the goods for a price or all significant risks and
rewards of ownership have been transferred to the buyer
and the seller retains no effective control of the goods
transferred to a degree usually associated with ownership;
and
(ii) No significant uncertainty exists regarding the amount of
the consideration that will be derived from the sale of
goods.
2. What are the two general criteria that must be satisfied before a
company can recognize revenue?
3. Explain why, in most cases, a seller recognizes revenue when it
delivers its product rather than when it produces the product.
4. Distinguish between the percentage-of-completion and
completed contract methods of accounting for long-term
contracts with respect to income recognition. Under what
circumstances should a company use the completed contract
method?
5. When does a consignor recognize revenue for a consignment
sale?
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4.8.3 OBJECTIVE TYPE QUESTIONS

i. In AS-9 Revenue recognition applies to

1. Sale of goods only
2. Sale of services only
3. Use of enterprises resources by other only
4. All the above
ii. In AS-9 Revenue recognition requires that revenue from divided
be recognized
1. On date of proposal
2. On date of declaration
3. On date of dispatch of divided warrant
4. On accrual basis
iii. Revenue from sale of products, is generally, realized in the
period in which
1. Cash is collected.
2. Sale is made.
3. Products are manufactured.
iv. AS-9 deals with Revenue recognition except:
1. Revenue arising from construction contracts.
2. Revenue arising from hire-purchase, lease agreements.
3. Both (1) & (2)
4. None of these
v. Revenue is the gross inflow of cash through
1. sale of goods,
2. rendering of services,
3. Yielding interest, royalties and dividends.
4. All of the above
.vi. As per AS 9 items not included in the definition of “revenue” are:

1. Unrealized holding gains resulting from the change in value
of current assets, and the natural increases in herds and
agricultural and forest products;
2. Realized gains resulting from the discharge of an obligation
at less than its carrying amount;
3. Unrealized gains resulting from the restatement of the
carrying amount of an obligation.
4. All of the above
Answers: i-4, ii-2, iii-2, iv-3, v-4, vi-4

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2. Match the following:
1. AS 1 (i) Revenue Recognition

2. AS 9 (ii)Disclosure of Accounting
policies.
3. AS 10 (iii) Non- Refundable Taxes
4. AS 2 (iv) Accounting for Fixed Assets.
5. Cost of Purchase include (v) Inventory Valuation
6. Completed contract method (vi) Refundable Taxes
7. Percentage of completion method (vii)Defers recognition until project
is complete
8. Consignment sales (viii)Recognition proportion to work
completed.
(ix)Risks and rewards of ownership
retained by seller
Answers: 1-ii, 2-i, 3-iv, 4-v, 5-iii, 6-vii, 7-viii, 8-ix


65
Unit-5
INVENTORY VALUATION - I
UNIT STRUCTURE
5.0 Objectives
5.1 Introduction
5.2 Importance of inventory / stock valuation
5.3 Methods of stock valuation
5.4 Valuation of stock at lower of cost or market price
5.5 First In First Out (FIFO)
5.6 Average Cost
5.7 Reconciliation at Physical Stock and Stock as Per Stock
Register
5.8 Exercise
5.0 OBJECTIVES

 Understand the meaning of inventory and importance of
inventory valuation.
 Explain the methods of stock valuation.
 Know the advantages and disadvantages of FIFO method
and Average cost method.
 Understand the reconciliation of physical stock and stock as
per stock register.
 Solve the problems of stock valuation.
5.1 INTRODUCTION
The stock that kept to meet further requirements of

production and sales is called “Inventory”. The basic reason for
holding stock is to keep up the production activities undisturbed. It
is neither physically possible nor economically justifiable to wait for
the stocks to arrive at the time when they are actually required.
Therefore, keeping of inventory is a must for the efficient working of
an industrial unit. The principal types of inventories are:
(i) Raw materials and suppliers,
(ii) Work-in progress and
(iii) Finished goods.
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Raw materials represent goods kept by a manufacturing
firm prior to being utilized in the production process generally
include tools, stores and spares which are consumed in the
production of goods and service.
Work-in progress represent the semi finished goods and

include those materials that have been commuted to production
process but have not yet been converted into finished goods.
Finished goods are completed goods awaiting sale. In a

manufacturing concern or in case of trading concern, it will
comprise only finished goods or stock in trade owned by it for sale
to customers in the normal course of business.
5.2 IMPORTANCE OF INVENTORY / STOCK

VALUATION
The balance sheet of a concern must show true and fair view
of the financial position of the concern. For this purpose assets
including inventory should be properly valued to exhibit a true and
fair view.
If stock is valued at a value which is less than the actual

value and as a result, the profits will reduce. Shareholders would
get less dividend. On the other hand, if inventory is valued at a
value which is more that the actual value, the profits would be
inflated and the shareholders would receive more dividend, a part
of which would thus be paid out of capital. Payment of dividend out
of capital would exhaust the capital and the company would be
insolvent. Moreover, under / over valuation of inventory will not only
affect the operating results and financial position of the current
period but will also affect those of the next period.
The following are some of the important reason for too

much emphasis on inventory or stock valuation:
1. Sufficient stock for production / sale process :

For all manufacturing and trading concerns, inventory
represents a major current asset investment. Adequate inventory is
essential for the Production / Sales process of an enterprises as
insufficient inventory hampers production and fails to generate
sufficient sales. This shows the necessity for proper valuation of
inventory.
2. Proper determination of profit :

The proper determination of profit depends upon the proper
valuation. If the ending inventory is valued at a lower figure, profit is
under stated and if it is overvalued, profit is overstated. This shows
that proper method of valuation of inventory should be followed.
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3. True financial position :
Over valuation of inventory amounts to window dressing
which gives wrong idea about the liquid position of the company.
The proper valuation of inventories which constitute a significant
portion of current assets is essential so that short term creditors
may not be misled about the liquid position of the company.
Balance sheet can exhibit a true and fair view of the financial
position of a company if there is a proper valuation of inventory
which constitutes a major portion of current assets.
5.3 METHODS OF STOCK VALUATION

Methods of taking inventories / stock
Method of Inventory
(1) Periodic inventory method. (2) Perpetual inventory Method
1. Periodic Inventory Method:

Under this method of taking inventories, value of stock is
determined by physical counting of the stock on the accounting
date of preparation of the final accounts. It is possible that stock
taking may take a week or so in large enterprises and purchases
and sales may have to be suspended for that period to get correct
figure of closing inventory. This method of ascertaining the value of
stock at the end of the year is also known as annual stock taking.
Thus this method is based on physical stock taking, it provides data
once in a year. It is simple and economical method of stocktaking. It
can be adopted in small concerns. It does not provide basis for
control.
2. Perpetual Inventory Method:
Perpetual Inventory Method is defined as a system under
which records are maintained by the controlling department, which
reflects the physical movements of stock and their current balance.
Under this method, stock registers are maintained to make a record
of the physical movements of stock and their current balance.
Stores ledger is maintained to keep a record of the receipt and
issue of the materials and also reflects the balance in store.
Similarly, work-in-progress ledger is maintained to give the value of
work-in-progress on hand and a finished goods ledger is
maintained to know the value of finished goods on hand. Thus, this
system provides a running record of inventories on hand at any
time. To ensure the accuracy of perpetual inventory records ,
physical verification of the inventory is made by a program of
continuous stock taking.
It is possible that the balance of stock by the perpetual
inventory may differ from the actual balance of stock as ascertained
by physical verification. Any difference noted between actual stocks
68
as disclosed by the physical verification and the stocks shown by
stock records should be investigated and rectification will be made.
If the physical verification reveals that actual balance of stock is
more than the balance shown by the stores ledger or work-in-
progress ledger or finished goods ledger, debit note is prepared
and stock records are adjusted accordingly so that balance may
reconcile with actual balance. A Stock Adjustment Account is
prepared and debited with the shortage of stock and credited with
surplus.
Continuous stock taking is an essential feature of the
perpetual inventory system. But the two terms, perpetual inventory
and continuous stock taking should not be taken as one; perpetual
means the system of stock records and continuous stock taking
whereas continuous stock taking means only the physical
verification of stock records with actual stocks.
In continuous stock taking, physical verification is spread
throughout the year. Every day 10 to 15 items are taken at rotation
and checked in order to maintain surprise element in short
verification and each item is checked for a number of times during
the year. On the other hand, surprise element is missing in case of
periodical checking because checking is usually done at the end of
the year. In short, this method is based on records. It requires a lot
of recording and is thus expensive. It can be adopted only in big
concerns. It provides data on running basis and thus facilitates the
preparation of financial statements at shorter intervals. It also
provides basis for control by investigation of the discrepancies
arising from the comparison of physical stock with their book
values.
Difference between Periodic Inventory and Perpetual
Inventory.
The following are the main differences between the two
methods of taking inventory.
Periodic Inventory Perpetual Inventory

1. It is based on physical 1. It is based on records.
stock taking
2. It provides data 2. It provides the data on running
periodically i.e. once in basis and thus facilitates the
year. preparation of financial
statements at shorter intervals.
3. It does not provide basis 3. It provides basis for control by
for control. investigating the discrepancies
arising from the comparison of
physical stock with book values.
69
4. It is simple and 4. It is expensive as it requires a lot

economical method of of recording because of an
taking inventory and can elaborate method of taking
be adopted in small inventory. It can be adopted by
concern. big concerns only.
5.4 VALUATION OF STOCK AT LOWER OF COST

OR MARKET PRICE
Stock is valued at cost or market price whichever is lower.

Stock is valued at lower of cost or market price to ensure that
anticipated profits must not be accounted for until they have been
realized and that full provision should be made for anticipated
losses. This principle of valuation is on the important accounting
convention of conservatism. Conservatism means taking the
gloomy view of a situation. It is policy of caution or playing safe and
had its origin as a safeguard against possible losses in a world of
uncertainty. According to this principle of valuation based on
convention of conservatism, if market price of the stock is higher
than the cost of the stock, the higher amount is ignored in the
accounts because profit is not booked by valuing inventory at
market value which is higher than cost value. It is possible that
dividends to shareholders may be distributed out of unrealized
profit. It will not be sound policy and in the future, if the expected
market price is not realized and there is a loss, unrealized profit
distributed will amount to distribution of dividend out of capital. On
the contrary, if the stock is valued at market price which is lower
than the cost. In this way, anticipated loss is taken into
consideration and even if a loss occurs in the future, the business
will not be affected adversely because loss has already been
provided by valuing the asset at a lower value and if there is no loss
as expected, it is quite good for the business.
Cost in relation to stock is outlay of cash or its equivalent in

the acquisition or manufacturing of the inventory concerned. In
other words, cost of stock is the sum of the applicable expenditure
and charges directly or indirectly incurred in brining inventory to its
existing condition and location.
Market value in relation to stock is the realizable value of the

stock in the market i. e. the price at which it can be replaced, the
valuation of stock affects the profit of the year. Therefore, the
method of valuation of stock should not be changed from year to
year to enable comparison of profits of different years.
Methods for Valuation of Stock:

The following are the various methods of the valuation of inventory:
70
5.5 FIRST IN FIRST OUT (FIFO)
5.5.1 Meaning
Under this method, the earliest lot of materials or goods purchased
or goods manufactured are exhausted first and closing stock is out
of the latest consignments received or goods manufactured and is
valued at the cost of such goods. In other words, cost of goods sold
is calculated keeping in view the earliest lots exhausted on the
presumption that units are sold in which they were acquired. In
short, under this method, it is assumed that goods or materials
which are purchased first are issued first. Stock consist of latest
purchase. Hence items lying in the stock should be valued at latest
purchase price.
5.5.2 Advantages
(1) This method is simple to understand and easy to operate.
(2) It is logical method because it takes into consideration the

normal procedure of utilizing first those items of inventory which
are received or manufactured first.
(3) This method is very useful when prices are falling because cost
of goods so sold will be high on account of using earliest lots
which are costly.
(4) Closing stock is valued nearer the market price as it would

consist of recent purchase of units.
(5) This method is useful when transactions are not too many and
prices are fairly steady.
(6) This method is useful when inventory is subject to deterioration

and obsolescence.
5.5.3 Disadvantages
(1) This method increases the possible clerical errors if the price
fluctuates, considerably at every time as issue of material is
sold, the store ledger clerk will have to go through his and
ascertain the price to be changed.
(2) If the prices fluctuate, comparison between different jobs

executed by the concern becomes difficult because one job
started a few minutes later than another of the same nature may
have consumed the supply of lower priced or higher priced
stock.
71
5.6 AVERAGE COST
The principal on which the average cost method is based is

that all items on the store are so mixed up that consumption of
material or sale of finished goods are carried out at the average
cost of the various items on hand. Average may be of two types:
(a) Simple Average Method (not in syllabus)

(b) Weighted Average Method
Stock taking is done which consist of following items :-

1,000 units purchased @ Rs. 10 per unit
Weighted Average Method : This price is obtained by dividing the

total cost of items in stock by the total quantity of items in hand.
Per unit weighted average cost is calculated as follows :-

(1.000  10)  (2,000  11)  (3,000  12)
Rs. 11.33 
(1,000  2,000  3,000)
The above rate is used to value the cost of sale of goods or cost
of consumption of goods.
Weighted average method is quite superior to other methods
and it is better to follow this method. This method can be used with
advantage in those cases where price and quantity vary widely.
The average rate does not change with issue but would vary with a
fresh supply of materials received when a new average will have to
be calculated. In a period of fluctuating price, this method will even
out the fluctuations. This method is goods as the weighted average
rate lies in between the extreme rates as shown by FIFO and LIFO
method. However, the difficulty is that fresh calculations are needed
at every purchase of materials or goods.
Practical Problems
Problem No: 01
A firm has just completed six months operations from 1st
January, 2000, to 30th June, 2017. It is about to value its stock at
cost price. It has dealt with only one type of goods. From the
particulars given below, your are required to value closing stock at
the half year ending 30th June, 2017 under following method of
stock valuation –
(i) FIFO Method and

(ii) Weighted Average Method
72
Purchase Sales
Amount Amount
Date Units Rate Units Rate
Rs. Rs.
15-1-17 200 20 8,000 - - -
16-2-17 - - - 300 25 7500
17-3-17 600 22 13,200 - - -
18-4-17 - - - 400 - 12,00
19-5-17 800 25 20,000 - - -
10-6-17 - - - 400 32 12,800
30-6-17 - - - 200 38 7,600
The firm had opening stock of 200 units at Rs.19 per unit.
Solution :
We have to prepare ‘Store Ledger’ showing of goods and the
closing stock as on 30th June, 2017.
STORE LEDGER
FIFO METHOD
Receipt (Purchase) Issue (Sales) Balance
Qty. Qty. Qty.
Date Rate Amount Rate Amount Rate Amount
Unit Unit Unit
(Rs.) (Rs.) (Rs.) (Rs.) (Rs.) (Rs.)
Op.St.
1-1-
- - - - - - 200 19 3,800
17
15-1-
200 20 4,000 - - - 200 19 3,800
17
- - - - - - 200 20 4,000
16-1-
- - - 200 19 3,800
17
- - - 100 20 2,000 100 20 2,000
17-3-
600 22 13,200 - - - 100 20 2,000
17
- - - - - - 600 22 13,200
19-4-
- - - 100 20 2,000 300 22 13,200
17
- - - 300 22 6,600
19-5-
800 25 20,000 - - - 300 22 6,600
17
- - - - - - 800 25 20,000
10-6-
- - - 300 22 6,600 700 25 17,500
17
- - - 100 25 2,500
30-6-
- - - 200 25 5,000 500 25 12,500
17
28,500
Cost of Goods sold
Value of Closing stock
73
Receipt (Purchase) Issue (Sales) Balance

Qty. Qty. Qty.
Date Rate Amount Rate Amount Rate Amount
Unit Unit Unit
(Rs.) (Rs.) (Rs.) (Rs.) (Rs.) (Rs.)
1-1-17 - - - - - - 200 19.00 3,800
15-1-17 200 20.00 4,000 - - - 400 19.50 7,800
16-1-17 - - - 300 19.50 5,850 100 19.50 1,950
17-3-17 600 22.00 13,200 - - - 700 21.64 15,150
19-4-17 - - - 400 21.64 8,657 300 21.64 6,493
19-5-17 800 25.00 20,000 - - - 1100 24.08 26,493
10-6-17 - - - 400 24.08 9,634 700 24.08 16,859
30-6-17 - - - 200 24.08 4,817 500 24.08 12,042
28,954
Cost of Goods sold
Value of Closing stock
Notes :
(i) The rate changes every time goods are purchased. The
average rate is found out by dividing the total amount with the
total units on hand.
(ii) The rate remains unaffected with the issue or sale of goods.
5.7 RECONCILIATION AT PHYSICAL STOCK AND

STOCK AS PER STOCK REGISTER.
Problems of stock taking for the purpose of final accounts:

At the end of the last day of the accounting year, stocks in
hand are verified and valued for the purpose of recording in the
final accounts. But in case of big organisations, it may not be
possible to verify the stock exactly on the last date of the
accounting period owing to certain difficulties. In such a case, stock
is taken under either few days earlier or later, according to the
situation or convenience and assuring least disturbance in the
normal flow of work. Therefore, stock taken under circumstances
shall always be subject to some adjustments where stock taking is
completed few days before the closing date should be adjusted with
the value of stock taking so as to arrive at the value of stock on the
ending date of accounting year, Similarly, if stock taking takes place
on the date after the closing date, the whole of the transactions of
goods from the closing date (*i.e. stock taking date) are to be
adjusted with the value of stock on the date of stock taking so as to
arrive at the value of stock on the closing date of accounting year.
74
(A) When stock taking takes place on any date after the year
end dates
If the stock is taken on a later date, the following
adjustments are required to arrive at the stock as on the closing
date.
Statement showing value of stock as to the end of the
accounting year.
Rs.
The value of stock on the later date …. X
Add : Sales at cost between two dates
i.e. date of closing and Date of stock taking (Actual goods X
between)
Add : Purchase returns during the said period X
Less : Purchase between two dates i.e. date of closing and

date of stock taking (Actual – goods received between
the Two dates) X
Less : Sales return (At cost price) between the above two
dates X
Add : Any under costing in stock sheet X
Less : Any over costing in stock sheet X
Less: Any goods held on consignment basis (as Agent) X
Less : Any goods included in stock but title of such has been
transferred to the buyer X
Less : Goods purchased between the two dates but already

received before the closing date (such represents
purchases of next accounting year) (normally it
happens when goods are received first & invoice is
received later on) X
Add : Goods sold between the two dates but already X

delivered before Closing date (Such goods represents
sales of next accounting Year) (Normally it happens
when goods are delivered to Customer first & invoice
is prepared on later date)
75
Add : Any goods sent to consignee between the two dates

(Whether They sold by consignee or not) X
Value of physical stock as on the date of closing X
Add : Any goods purchased before closing date hence

included in Purchase of the last accounting year but
not received until the Date of stock-taking
X
Add: Any goods sent to customer before closing date on X

approval basis but lying with them as an approved as
on the date closing (Such goods must be taken at cost
price) Value of stock-in-trade as on the date of closing
for inclusion In final accounts.
B) If
stock are taken on an earlier date
If stock is taken on a date before the closing date of
accounting year, the necessary adjustments should be made in
respect of transactions of goods taken place between the date of
stock-taking and closing date so as to obtain the correct value of
stock as on the closing date.
Statement showing value of stock as on the ending date of
accounting year.
Rs.
The value of stock on the later date X
Add : Purchase between the two dates i.e. from the date
of stock taking to the date of closing (Goods
actually received up to the date of closing X
Add: Sales returns (at cost price) between the two dates X
Less: Sales (at cots) between the two dates (goods

actually delivered) X
Less: Purchase returns between the two dates X

Less: Goods sent on approved basis (at cost price)
between the two dates X
Less: Goods sent to consignee (at cost price) (whether

sold or not) between the two dates X
76
Less: Goods received from consignor and held on their

behalf X
Add: Any under costing in stock sheet X
Less: Any over costing in stock sheet X

Value of physical stock on the date of closing X
Add: Goods purchased before the closing date but not

received upto the end of the accounting year
(Goods-in-transit) X
Add: Cost of goods sent on approval basis but not
approved before the closing date still lying with the
customers as on the date of the closing. X
Add: Unsold goods in the hands of the consignee as on

the date of closing. Value of stock-in-trade as on
the date of closing for inclusion in final accounts X
5.8 EXERCISE
1. Select the correct alternative:

1. If Cost of goods sold is Rs.80,700, Opening stock Rs.5,800 and
Closing stock Rs.6,000. Then the amount of purchase will be
(a)Rs.80,500
(b)Rs.74,900
(c)Rs.74,700
(d)Rs.80,900.
2. If sales are Rs. 2,000 and the rate of gross profit on cost of
goods sold is 25%, then the Cost of goods sold will be
(a)Rs. 2,000.
(b)Rs. 1,500.
(c)Rs. 1,600.
(d)None of the above.
3. The total cost of goods available for sale with a company during
the current year is Rs.12,00,000 and the total sales during the
period are Rs.13,00,000. If the gross profit margin of the
company is 331/3% on cost, the closing inventory during the
current year is
(a)Rs.4,00,000
(b)Rs.3,00,000
(c)Rs.2,25,000
(d)Rs.2,60,000.
77
4. C Ltd. recorded the following information as on March 31, 2005:
Rs.
Stock as on April 01, 2016 80,000
Purchases 1, 60,000
Sales 2, 00,000
It is noticed that goods worth Rs.30, 000 were destroyed due
to fire. Against this, the Insurance company accepted a claim of
Rs.20,000.The Company sells goods at cost plus 33 %. The value
of closing inventory, after taking into account the above
transactions is,
(a)Rs.10,000
(b)Rs.30,000
(c)Rs.1,00,000
(d)Rs.60,000
5. Consider the following for Alpha Co. for the year 2017-18:
Cost of goods available for sale Rs.1, 00,000
Total sales Rs. 80,000
Opening stock of goods Rs. 20,000
Gross profit margin 25%
Closing stock of goods for the year 2017-18 was
(a)Rs.80,000
(b)Rs.60,000
(c)Rs.40,000
(d)Rs.36, 000.
6. Cost of physical stock on 15.4.16 was Rs.3,00,000. Sales
amounting Rs.1,00,000 and purchases worth Rs.50,000 were
held between 31.3.16 and 15.4.16. Goods are sold at a profit of
20% on sales. Value of inventory as on 31.3.16 is
(a)Rs.3,50,000.
(b)Rs.2,70,000.
(c)Rs.3,30,000.
(d)Rs.3,00,000.
7. Record of purchase of T.V. sets.
Date Quantity Price per unit

Units Rs.
March 4 900 5
March 10 400 5.50
Record of issues
March 5 600 Units
March 12 400 Units
The value of T.V. sets on 15 March, as per FIFO will be
(a)Rs.1,500
(b)Rs.1,650
(c)Rs.1,575.
(d)None of the three.
78
8. Goods costing Rs.4,80,000 were sent on consignment basis.
Goods are invoiced at 125% of the cost price. The invoice price
and the loading will be:
(a)Rs.6,00,000 and Rs.1,00,000.
(b)Rs.5,00,000 and Rs.1,00,000.
(c)Rs.6,00,000 and Rs.1,20,000.
(d)Rs.5,00,000 and Rs.1,20,000.
9. A firm dealing in cloth has 15000 meters of cloth on April 1,

2015 valued at Rs.1,50,000 according to FIFO. The firm
purchased 20,000 meters @ Rs.12 per meter during the year
ending 31st March, 2016 and sold 30,000 meters @ Rs.25 per
meter during the same period. As per FIFO, the closing stock
will be valued at:
(a)Rs.60,000
(b)Rs.1,25,000
(c)Rs.50,000
10. A minimum quantity of stock always held as precaution against

out of stock situation is called _________
(a)Zero stock.
(b)Risk stock.
(c)Base stock.
11. A trader has credited certain items of sales on approval

aggregating Rs.60,000 to Sales Account. Of these, goods of the
value of Rs.16,000 have been returned and taken into stock at
cost Rs.8,000 though the record of return was omitted in the
accounts. In respect of another parcel of Rs.12,000 (cost being
Rs.6,000) the period of approval did not expire on the closing
date. Cost of goods lying with customers should be
(a)Rs. 12,000.
(b)Rs. 54,000.
(c)Rs. 6,000.
12. If cost of physical stock on 31.3.2018 is Rs.2,80,000 and out of

which stock of Rs.1,20,000 is held as consignee. Goods costing
Rs. 25,000 were damaged beyond repair and were expected to
realize at Rs.5,000 only. The value of own stock on 31.3.2018
will be
(a)Rs.2,60,000
(b)Rs.1,60,000
(c)Rs.1,35,000
(d)Rs.1,40,000
79
13. Bank overdraft as per trial balance is Rs.1,60,000. Bank has
allowed the customer to overdraw 80% of the hypothecated
value of the stock. Hypothecation of stock has been done by the
bank at 80% of the original closing stock value. The amount of
closing stock is
(a)Rs. 2,00,000.
(b)Rs. 2,50,000.
(c)Rs. 1,02,400.
(d)Rs. 1,28,000.
14. Mr. Prakash sells goods at 20% above cost. His sales were
Rs.10,20,000 during the year. However, he sold damaged
goods for Rs.20,000 costing Rs.30,000. This sale is included in
Rs.10, 20,000. The amount of gross profit is:
(a)Rs. 1,90,000
(b)Rs.2,50,000
(c)Rs.2,40,000
(d)Rs.2, 00,000.
15. Opening stock of raw material of a manufacturing concern is

Rs.10,000, Purchase during the year is Rs.2,00,000, Wages
Rs.50,000, Carriage Rs.5,000, Factory overheads
Rs.1,25,000 and closing stock of raw material is Rs. 15,000.
The amount to be transferred is
(a)Rs. 3,75,000 to cost of goods manufactured account.
(b)Rs.3,75,000 to cost of goods sold account.
(c)Rs. 3,75,000 to cost of sales account.
(d)Rs. 3,75,000 to cost to company account.
16. Goods costing Rs. 600 is supplied to Ram at the invoice of 10%
above cost and a trade discount for 5%. The amount of sales
will be
(a)Rs. 627.
(b)Rs. 660.
(c)Rs. 570.
(d)Rs. 620.
17. Goods purchased Rs.1,00,000. Sales Rs. 90,000. Margin 20%

on sales. Closing stock is
(a)Rs. 10,000.
(b)Rs. 25,000.
(c)Rs. 28,000.
Answers: 1- d, 2- c, 3-c, 4-d, 5-b, 6-c, 7-b, 8-c, 9-b, 10-c, 11-c, 12-d,
13-b, 14-a, 15-a, 16-a, 17-c

80
Unit-6
INVENTORY VALUATION II
ILLUSTRATION & EXERCISE
Unit Structure :
6.0 Objectives
6.1 Solved Problems
6.2 Exercises
6.0 OBJECTIVES
After studying the unit, students will be able to solve the practical
problems on inventory valuation.
6.1 SOLVED PROBLEMS

Illustration No. 1
From the following particulars prepare Stores Ledger for the month
of March 2018
(a) FIFO to “ABC”,
(b) Weighted average to “XYZ”.
ABC XYZ
Stocks (Kgs) on1-3-2018 2,000 @ Rs. 28 4,000 @ Rs. 13
Purchases (Kgs)
[i] On 11-3-2018 1,800 @ Rs. 27 2,500 @ Rs. 14
[ii] On 21-3-2018 1,700 @ Rs. 25 2,000 @ Rs. 18
Sales (Kgs)
[i] On 6-3-2018 1,300 2,500
[ii] On 15-3-2018 1,400 2,000
[iii] On 18-3-2018 700 1,300
[iv] On 29-3-2018 1,100 1,700
(IDE, Nov. 1999, adapted)
81
Solution :
(A) FIFO to “ABC”
STOCK LEDGER OF ABC
Date Receipts Issues Balance
Units Price Amt. Units Price Amt. Units Price value
01-3-2008 Opening - - - - - 2,000 28.00 56,000
06-3-2008 - - - 1,300 28.00 36,400 700 28.00 19,600
700 28.00 19,600

11-3-2008 1,800 27.00 48,600 - - -
1,800 27.00 48,600
700 28.00 19,600

15-3-2008 - - - 1,100 27.00 29,700
700 27.00 18,900
18-3-2008 - - - 700 27.00 18,900 400 27.00 10,800
400 27.00 10,800

21-3-2008 1,700 25.00 42,500 - - -
1,700 25.00 42,500
400 27.00 10,800

29-3-2008 - - - 1,000 25.00 25,000
700 25.00 17,500
Therefore, the value of stock of ABC as on 31-3-2004 :

1,000 units @ Rs. 25.00 = Rs. 25,000
(B) Weighted Average (Under Perpetual System of Inventory)
STOCK LEDGER OF XYZ
Wt. Avg. Wt. Avg.
Units Price Amt. Units Amt. Units Value
Rate Rate
01-3-2008 Opening - - - - - 4,000 13.00 52,000
06-3-2008 - - - 2,500 13.00 32,500 1,500 13.00 19,500
11-3-2008 2,500 14 35,000 - - - 4,000 13.63 54,500
15-3-2008 - - - 2,000 13.63 27,250 2,000 13.63 27,250
18-3-2008 - - - 1,300 13.63 17,712 700 13.63 9,538
21-3-2008 2,000 18 36,000 - - - 2,700 16.87 45,538
29-3-2008 - - - 1,700 16.87 28,672 1,000 16,866

82
Working Notes :
1] Issued of XYZ on March 15 is valued at Rs. 13.63 which is the
weighted average rate, arrived at as follows :
19,500  35,000 54,500

  13.625r / o13.63
1,500  2,500 4,000
2] Issue of XYZ on March 29 is valued at Rs. 16.87 per kg. which

is the weighted average rate arrived at as follows :
9,538  36,000 45,538

  16.865r / o16.87
700  2,000 2,700
Therefore, the value of stock as on 31-3-2008 : 1,000 units @

Rs. 16.87 = Rs. 16,867
Illustration : 2
From the following information relating A to Z item, value closing
stock on 31-12-2008 applying – (a) FIFO, (b) Weighted Average
Stocks (Kgs) on 1-12-2008 5,000 units @ Rs. 14
Purchases (Kgs)
[i] On 18-12-2008 4,200 units @ Rs. 13
[ii] On 23-12-2008 3,800 units @ Rs. 9
Sales (Kgs)
[i] On 7-12-2008 1,200 units
[ii] On 16-12-2008 2,600 units
[iii] On 19-12-208 1,800 units
[iv] On 30-12-2008 3,400 units
(IDE, April 1999, adapted)
83
Solution :
(A) FIFO
STOCK LEDGER
01-12-2008 Opening - - - - - 5,000 14.00 70,000
07-12-2008 - - - 1,200 14.00 16,800 3,800 14.00 53,200
16-12-2008 - - - 2,600 14.00 36,400 1,200 14.00 16,800
1,200 14.00 16,800

18-12-2008 4,200 13.00 54,600 - - -
4,200 13.00 54,600
1,200 14.00 16,800

19-12-2008 - - - 3,600 13.00 46,800
600 13.00 7,800
3,600 13.00 46,800

23-12-2008 3,800 9.00 34,200 - - -
3,800 9.00 34,200
200 13.00 2,600

30-12-2008 - - - 3,400 13.00 44,200
3,800 9.00 34,200

Rs. 36,800
B] Weighted Average (Perpetual Inventory system)

STOCK LEDGER
Wt. Avg. Wt. Avg.
Rate Rate
01-12-2008 Opening - - - - - 5,000 14.00 70,000
07-12-2008 - - - 1,200 14.00 16,800 3,800 14.00 53,200
16-12-2008 - - - 2,600 14.00 36,400 1,200 14.00 16,800
18-12-2008 4,200 13.00 54,600 - - - 5,400 13.22 71,400
19-12-2008 - - - 1,800 13.22 23,800 3,600 13.22 47,600
23-12-2008 3,800 9.00 34,200 - - - 7,400 11.05 81,800
30-12-2008 - - - 3,400 11.05 37,584 4,000 44,216

84
Working Notes :
[1] Issue on December 19 is valued at Rs. 13.22 which is the
16,800  54,600 71,400
  13.222r / o13.22
1,200  4,200 5,400
[2] Issue on December 30 is valued at Rs. 11.05 per kg. which is
the weighted average rate arrived at as follows :
47,604  34,200 81,804
  11.054r / o11.05
3,600  3,800 7,400

Rs.11.05 = Rs. 44,216
Illustration : 3
The following particulars have been extracted in respect of
Material X. Prepare a Stores Ledger Account showing the receipts
and issues, pricing the materials issued on the basis of
(a) Weighted Average and
(b) First In First Out.
[i] 01-10-2017 Opening Stock 200 units at Rs. 3.50 per unit
[ii] 03-10-2017 Purchased 300 units at Rs. 4.00 per unit
[iii] 13-10-2017 Purchased 900 units at Rs. 4.30 per unit
[iv] 23-10-2017 Purchased 600 units at Rs. 3.80 per unit
Issues :
[i] 05-10-2017 Issued 400 units
[ii] 15-10-2017 Issued 600 units
[iii] 25-10-2017 Issued 600 units
85
Solution:
(A) FIFO
STOCK LEDGER OF ‘X’
01-10-2017 Opening - - - - - 200 3.50 700
200 3.50 700

03-10-2017 300 4.00 1,200 - - -
300 4.00 1,200
200 3.50 700

05-10-2017 - - - 100 4.00 400
200 4.00 800
100 4.00 400

13-10-2017 900 4.30 3,870 - - -
900 4.30 3,870
100 4.00 400

15-10-2017 - - - 400 4.30 1,720
500 4.30 2,150
400 4.30 1,720

23-10-2017 600 3.80 2,280 - - -
600 3.80 2,280
400 4.30 1,720

25-10-2017 - - - 400 3.80 1,520
200 3.80 760
Therefore, the value of stock as on 31-10-2017 : 400 units @

Rs. 3.80 = Rs. 1,520
(B) Weighted Average (Perpetual Inventory System)

STOCK LEDGER OF ‘X’
Wt. Wt.
Units Price Amt. Units Avg. Amt. Units Avg. Value
Rate Rate
01-10-2017 Opening - - - - - 200 3.50 700

03-10-2017 300 4.00 1,200 - - - 500 3.80 1,900
05-10-2017 - - - 400 3.80 1,520 100 3.80 380
13-10-2017 900 4.30 3,870 - - - 1,000 4.25 4,250
15-10-2017 - - - 600 4.25 2,550 400 4.25 1,700
23-10-2017 600 3.80 2,280 - - - 1,000 3.98 3,980
25-10-2017 - - - 600 3.98 2,388 400 3.98 1,592
86
Working Notes:
[1] Issue on October 5 is valued at Rs. 3.80 which is the weighted
average rate, arrived at as follows :
700  1,200 1,900

  3.80
200  300 500

380  3,870 4,250

  4.25
100  900 1,000

1,700  2,280 3,980

  3.98
400  600 1,000
Illustration 4
From the following particulars, prepare stock record by FIFO and
Weighted Average Method.
Date Transaction Units Rate Rs.
04-1-2018 Purchase 40 30
17-1-2018 Purchase 60 28
20-1-2018 Sale 50 35
22-1-2018 Purchase 80 29
25-1-2018 Sale 80 33
28-1-2018 Sale 20 34
30-1-2018 Purchase 100 26
31-1-2018 Sale 90 35
Stock on hand on 1st January 2018 was 50 units @ Rs.25 each.

87
Solution :
(A) FIFO
STOCK LEDGER X’

01-1-2018 Opening - - - - - 50 25.00 1,250
50 25.00 1,250
04-1-2018 40 30.00 1,200 - - -
40 30.00 1,200
50 25.00 1,250
17-1-2018 60 28.00 1,680 - - - 40 30.00 1,200
60 28.00 1,680
40 30.00 1,200
20-1-2018 - - - 50 25.00 1,250
60 28.00 1,680
40 30.00 1,200
22-1-2018 80 29.00 2,320 - - - 60 28.00 1,680
80 29.00 2,320
40 20
30.00 1,200 28.00 560
25-1-2018 - - -
28.00 1,120 29.00 2,320
40 80
28-1-2018 - - - 20 28.00 560 80 29.00 2,320
80 29.00 2,320
30-1-2018 100 26.00 2,600 - - -
100 26.00 2,600
80 29.00 2,320
31-1-2018 - - - 90 26.00 2,340
10 26.00 260
Therefore, the value of stock as on 31-01-2008 : 90 units @ Rs.

26 = Rs. 2,340.
[B] Weighted Average (Perpetual Inventory System)

STOCK LEDGER

Wt. Avg. Wt. Avg.
Rate Rate
01-1-2018 Opening - - - - - 50 25.00 1,250
04-1-2018 40 30.00 1,200 - - - 90 27.22 2,450
17-1-2018 60 28.00 1,680 - - - 150 27.53 4,130
20-1-2018 - - - 50 27.53 1,377 100 27.53 2,753
22-1-2018 80 29.00 2,320 - - - 180 28.18 5,073
25-1-2018 - - - 80 28.18 2,254 100 28.18 2,819
28-1-2018 - - - 20 28.18 564 80 28.18 2,255
30-1-2018 100 26.00 2,600 - - - 180 26.97 4,855
31-1-2018 - - - 90 26.97 2,427 90 26.97 2,428
88
Working Notes :
[1] Issue on January 20 is valued at Rs. 27.53 which is the
1,250  1,200  1,680 4,130

  27.533r / o 27.53
50  40  60 150
[2] Issue on January 25 is valued at Rs. 28.18 per kg. which is the
weighted average rate arrived at as follows:
2,753  2,320 5,073

  28.183r / o 28.19
100  80 180
[3] Issue on January 31 is valued at Rs. 26.97 per kg. which is the
2,255  2,600 4,855

  26.971r / o 26.97
80  100 180

26.97 = Rs. 2,428.
[4] Note: The Stock Book entries for both purchases / receipts and
sales / issued are always made at cost. The selling price, even if
given, is to be ignored.
Illustration: 5
Sumit Ltd. has purchased and issued the materials in the following
order:
Month Date Particulars Units Cost Per Unit Rs.

August, 2017 01 Purchases 300 3
04 Purchases 600 4
06 Issues 500 -
10 Purchases 700 4
15 Issues 800 -
20 Purchases 300 5
23 Issues 100 -
Ascertain the quantity of closing stock as on 31st August, 2017
and what will be the value under the following methods.
[i] First in first out method.
[ii] Weighted Average method.
(IDE, Nov. 2000, adapted)
89
Solution :
(A) FIFO
STOCK LEDGER
1-8-2017 Opening - - - - - Nil Nil Nil
1-8-2017 300 3.00 900 - - - 300 3.00 900
300 3.00 900

4-8-2017 600 4.00 2,400 - - -
600 4.00 2,400
300 3.00 900

6-8-2017 - - - 400 4.00 1,600
200 4.00 800
400 4.00 1,600

10-8-2017 700 4.00 2,800 - - -
700 4.00 2,800
400 4.00 1,600

15-8-2017 - - - 300 4.00 1,200
400 4.00 1,600
300 4.00 1,200

20-8-2017 300 5.00 1,500 - - -
300 5.00 1,500
200 4.00 800

23-8-2017 - - - 100 4.00 400
300 5.00 1,500
Therefore, the value of stock as on 31-8-2003 : Rs. 2,300

[B] Weighted Average (Perpetual Inventory System)
STOCK LEDGER
Wt. Avg. Wt. Avg.

Rate Rate
01-8-2017 Opening - - - - - Nil Nil Nil
01-8-2017 300 3.00 900 - - - 300 3.00 900
04-8-2017 600 4.00 2,400 - - - 900 3.67 3,300
06-8-2017 - - - 500 3.67 1,834 400 3.67 1,466
10-8-2017 700 4.00 2,800 - - - 1,100 3.88 4,266
15-8-2017 - - - 800 3.88 3,103 300 3.88 1,163
20-8-2017 300 5.00 1,500 - - - 600 4.44 2,663
23-8-2017 - - - 100 4.44 444 500 4.44 2,219

90
Working Notes :
[1] Issue on August 6 is valued at Rs. 3.67 which is the weighted
900  2,400 3,300

  3.666r / o3.67
300  600 900
[2] Issue on August 15 is valued at Rs. 3.88 per kg. which is the
weighted average rate arrived at as follows :
1,465  2,800 4,265

  3.877r / o 3.88
400  700 1,100
[3] Issue on August 23 is valued at Rs. 4.44 per kg. which is the
1,161 1,500 2,661

  4.435r / o 4.44
300  300 600

4.44 = Rs. 2,219.
Illustration :6
Following are the purchases and sales of wheat in the
months of March, 2018. Prepare a statement showing valuation of
stock on the basis of Weighted Average method.
Date Purchases Rate Sales

2018 (Kg.) (Rs.) (Kg.)
March 1 600 4 -
4 - - 300
5 300 3.80 -
10 - - 200
18 200 4.20 -
23 - - 400
29 400 4.40 -
31 - - 300
Out of purchases on March 5, 50 Kgs were returned to the
supplier on March 8.Out of Sales on March 23, a customer returned
20 Kgs. on March 26.
91
B] Weighted Average (Perpetual Inventory System)

STOCK LEDGER
Wt. Avg. Wt. Avg.
Rate Rate
01-3-2018 600 4.00 2,400 - - - 600 4.00 2,400
04-3-2018 - - - 300 4.00 1,200 300 4.00 1,200
05-3-2018 300 3.80 1,140 - - - 600 3.90 2,340
05-3-2018 - - - 50 3.90 195 550 3.90 2,145
10-3-2018 - - - 200 3.90 780 350 3.90 1,365
18-3-2018 200 4.20 840 - - - 550 4.01 2,205
23-3-2018 - - - 400 4.01 1,604 150 4.01 601
26-3-2018 20 4.01 80 - - - 170 4.01 681
29-3-2018 400 4.40 1,760 - - - 570 2,441

4.28
31-3-2018 - - - 300 4.28 1,285 270 1,156
4.28
Working Notes :
[1] Issue on March 5 & March 10 is valued at Rs. 3.90 which is the
1,200  1,140 2,340

  3.90
300  300 600
[2] Purchase returns of 50 kg. are out of the total stock of 600 kg.
which was valued at Rs. 3.90 per kg.
[3] Issue on March 23 is valued at Rs. 4.01 per kg. which is the
weighted average rate arrived at as follows :
1,365  840 2,205

  4.01
350  200 550
[4] Sales on March 23 are out of stock valued at Rs. 4.01 per kg.
Hence returns of 20 kg. are also taken at a rate of Rs. 4.01 per kg.
[5] Weighted Average Rate on March 31 is arrived at as follows :
681 1,760 2,441

  4.28
170  400 570
92

4.28 = Rs. 1,156
Illustration : 7
A company deals in 3 products viz. A, B and C. The details for
purchases and sales for January 2018 are as under.
Product A B C
Units Rs. Units Rs. Units Rs.
Selling Price per
100 200 250
Unit
Opening Stock 100 60 100 100 50 120
Purchases :
Jan 9 300 65 200 110 50 135
Jan 20 100 64 50 120 100 140
Jan 29 50 68 50 125 20 130
Closing Stock 140 70 60
You are required to prepare a trading and profit and loss account
for the month assuming the selling and distribution expenses to be
Rs. 63,000. Use FIFO method for stock valuation.
Solution
Stock Ledger (FIFO Method)
Product – A
Date Purchases Sales Closing Stock
Qty. Rs. Qty. Qty. × Rs. = Amount
01-1-2018 - - 100 × 60 = 6,000
09-1-2018 300 × 65 - 100 × 60 = 6,000
300 × 65 = 19,500
25,500
20-1-2018 100 × 64 - 100 × 60 = 6,000
300 × 65 = 19,500
100 × 64 = 6,400
31,900
29-1-2018 50 × 68 - 100 × 60 = 6,000
300 × 65 = 19,500
100 × 64 = 6,400
50 × 68 = 3,400
35,300
Total Sales 100 ×60 90 × 64 = 5,760
During 300 ×65 50 × 68 = 3,400
January 10 × 64 9,160
410
93
Product – B

01-1-2018 - - 100 × 100= 10,000
09-1-2018 200 × 110 - 100 × 100= 10,000
200 × 110= 22,000
32,000
20-1-2018 50 × 120 100 × 100= 10,000
200 × 110= 22,000
50 × 120 = 6,000
38,000
29-1-2018 50 × 125 100 × 100= 10,000
200 × 110= 22,000
50 × 120 = 6,000
50 × 125 = 6,250
44,250
Total Sales 100× 100 20 × 120 = 2,400
During 200 × 110 50 × 125 = 6,250
January 30 × 120 8,650
330
94
Product C
01-1-2018 - - 50 × 120 = 6,000
02-1-2018 50 × 135 50 × 120 = 6,000
50 × 135 = 6,750
12,750
20-1-2018 100 × 140 - 50 × 120 = 6,000
50 × 135 = 6,750
100 × 140= 14,000
26,750
29-1-2018 20 × 130 - 50 × 120 = 6,000
50 × 135 = 6,750
100 × 140= 14,000
20 × 130 = 2,600
29,350
Total Sales 50 × 120 40 × 140 = 5,600
During 50 × 135 20 × 130 = 2,600
January 60 × 140 8,200
160
Note : 1
Number of units sold during January :
Product A B C
Opening Stock 100 100 50
Add : Total Purchase 450 300 170
550 400 220
Less : Closing Stock 140 70 60
Units Sold 410 330 160
95
Dr. Trading Account Cr.

Particulars Rs. Particulars Rs.
To Opening Stock By sales
A 100 × 60 =6,000 A 410 × 100 = 41,000
B 100 × 100 = 10,000 B 330 × 200 = 66,000
C 50 × 120 = 6,000 22,000 C 160 × 250 = 40,000 1,47,000
To Purchases By Closing Stock
A 29,300 A 9,160
B 34,250 B 8,650
C 23,350 86,900 C 8,200 26,010
To Gross Profit c/d 64,110
1,73,010 1,73,010
Dr. Profit & Loss Account Cr.
To Selling & Distribution

63,000 By Gross Profit b/d 64,110
Expenses
To Net Profit 1,110
64,110 64,110
6.2 EXERCISES
Problem 1
From the following particulars, value the closing stock
separately under : (A) FIFO; (B) Weighted Average
1st April, 2018 Opening Stock 800 @ Rs. 4
4th April, 2018 Sales 200
8th April, 2018 Purchase 1,000 @ Rs. 5
15th April, 2018 Purchase 700 @ Rs.5.50
20th April, 2018 Purchase 1,200 @ Rs.6.00
96
The market value of 30th April, 2018 is Rs. 5.75.

Problem 2
The following is an extract of the record of receipt and issue of
certain chemicals in a chemical factory during the month of March,
2018.
Date Particulars Units Rate
2018
Opening balance 500 Tonnes @ Rs.200
March 1
“3 Issue 70 Tonnes
“ 13 Received 200 Tonnes @ Rs.190
Returned from
“ 14 150 Tonnes
Department
“ 16 Issue 180 Tonnes
“ 20 Received 240 Tonnes @ Rs.-192
Issues are to be priced on the principle of ‘First-in-First-out’

Principle. The stock verifier has found shortage of 10 tonnes on the
22nd June, 1999 and left a note accordingly.
Prepare a Store Ledger Control Account for the material
showing the above transactions.
97
Problem 3
Find the value of closing stock on FIFO method
Receipts : Purchase of Pipes
04.06.2017 20 Pipes @ Rs. 15.00 each
17.06. 2017 30 Pipes @ Rs. 14.00 each
02.07. 2017 40 Pipes @ Rs. 14.50 each
30.07. 2017 30 Pipes @ Rs. 13.00 each
Sold :
20-6-2017 25 Pipes
05-7-2017 40 Pipes
31.07. 2017 45 Pipes
On 28.07.2017, 2 pipes sold on 20.6.2017 were received

back, out of which one pipe was found damaged on 28.7.2017 and
had to be discarded.



98
Unit-7
CAPITAL, REVENUE EXPENDITURE
AND RECEIPTS
Unit Structure :
7.0 Objectives
7.1 Introduction
7.2 Characteristics / Tests for Capital or Revenue
7.3 Expenditure
7.4 Capital Expenditure
7.5 Revenue Expenditure
7.6 Distinctions between Capitals Expenditure and Revenue
Expenditure
7.7 Deferred Revenue Expenditure
7.8 Capital Receipts
7.9 Revenue Receipts
7.10 Distinctions between Capital Receipts and Revenue
Receipts
7.11 Deferred Revenue Income
7.12 Revenue Profit and Capital Profit
7.13 Revenue Loss and Capital Loss
7.14 Effect of Wrong Treatment On Profit
7.15 Illustration
7.16 Exercises
7.0 OBJECTIVES

 Understand the meaning and characteristics of capital
expenditure and revenue expenditure.
 Distinguish between capital expenditure and revenue
expenditure.
 Understand the meaning and characteristics of capital receipts
and revenue receipts.
 Distinguish between capital receipts and revenue receipts.
 Understand the meaning and characteristics of deferred
revenue expenditure
 Know the disclosure of various items in final accounts.
99
 Recognise with reason the given item is of capital nature or

revenue nature or deferred revenue nature.
7.1 INTRODUCTION
Final Accounts prepared at the end of the year consists of

Income Statement and Balance Sheet. These are prepared from
trial balance. Debit balance shown in trial balance represents either
revenue expenses or capital expenditure, credit balances are either
revenue income or capital receipts. All revenue expenses & gains /
incomes are transferred to Income Statement. Capital expenditure
represents assets shown on assets side of the Balance Sheet.
Credit balance represents either gains or capital receipts, various
gains shown in Income Statement and capital receipts shown on
liabilities side of the Balance Sheet. Therefore, it is very essential to
know, WHICH and WHY, how to distinguishing which are capitals
or revenue? While recording transaction in various books of
accounts, it is necessary to classify them into revenue or capital.
This classification is relevant for adherence to the requirements as
per A.S. 9 & the accounting concept of matching costs with
revenue.
7.2 CHARACTERISTICS / TESTS FOR CAPITAL OR

REVENUE
For deciding whether it is CAPITAL OR REVENUE following

features should be tested.
1. Business Activity / Nature :

In case such activities are recurring nature i.e. purchases or
sales of goods or rendering serves, it is revenue. Expenditure
pertains to investing / financing activity, it is capital expenditure.
2. Long / Short Term Benefits :

Benefits of expenditure is for short term, normally it is
Revenue e.g. wages paid, rent paid, while if benefits for long term,
it is capital, e.g. purchase of Plant, Furniture, etc.
3. Recoverable :
Amount spent is recoverable in short term, it is revenue, if it
is recoverable in long term, it is capital e.g. sale of goods is
revenue, sale of assets is capital receipts.
4. Recurring - Non-recurring :
Any recurring receipts / payments are recurring in nature,
then it is revenue, if such receipts are non-recurring, it may be
capital expenditure e.g. issue of shares is capital receipts and
interest received is revenue income.
100
5. Effect on Funds and Profits :

Revenue receipts and revenue payments affects profits
whereas capital receipts increases funds, capital payments or
expenditure increases assets.
6. Treatment in Final Accounts :

Revenue receipts or payments are shown in Income
Statement, capital expenditure or receipts are shown in the Balance
Sheet.
7. Materially of amount :
Huge or small amount doesn’t indicate whether it is capital or
revenue.
8. Treatment by other party :

Treatment by other party to transaction is not relevant. E.g.
furniture sold by furniture manufactures is revenue receipts for him,
it is capital expenditure for buyer as it is assets purchased, thus,
there are no clear cut tests / rules, whether it is capital or revenue,
it can be decided upon nature of transactions / nature of business /
ultimately nature of receipts or payments.
7.3 EXPENDITURE
7.3.1 Meaning:
As per guidance notes issued by I.C.A.I. in relation to
Financial Statements, “Expenditure means incurring a liability or
disbursement of cash or transfer of property for the purpose of
obtaining goods, services or assets” Expenditure does not only
involve outflow of resources, but also giving rise to liability or
transfer of property. Such expenses may be Capital or Revenue
expenditure, depends up benefits that firm gets i.e. short term or
long term. An expenditure whether it is Capital or Revenue is
dependent on various factors, such as:
7.3.2 Benefit of expenditure:

In case benefit of it is available for short period i.e. less than
12 months, it is revenue expenditure. Expenditure is for longer
period i.e. more than one year, it is capital expenditure.
7.3.3 Recurring or non-recurring:

Revenue expenditure is reoccurring, is payable again and
again, i.e. rent, wages, salaries etc. It is considered as period cost.
However, capital expenditure is not payable as per period, it is
incurred only when Fixed Assets are purchased.
101
7.3.4 Decreases Cost of production / increased earning

capacity
Expenses on increasing earning capacity are treated as
capital expenditure whereas expenses incurred for keeping assets
in working condition are revenue expenditure.
7.4 CAPITAL EXPENDITURE
7.4.1 Meaning:
Capital Expenditure means an expenditure carring probable
future benefit [Guidance Notes - I.C.A.I.] Eric. Kohler has defined
Capital expenditure as “expenditure intended to benefit future
periods, an addition to fixed assets. The term is generally restricted
to expenditure that add to Fixed Assets units or those have effects
of increasing earning capacity, efficiency, life span or economy of
an existing assets.”
In short, Capital Expenditure means:

i) Expenditure incurred for acquisition of Fixed Assets.
ii) Expenditure incurred in connection to acquisition of Fixed
Assets.
iii) Expenditure which results in increases earning capacity of
business.
iv) Expenditure which decreases cost of operation.
Balance in capital expenditure being an asset is carried

forward to subsequent period; still it is fully depreciated or disposed
off. Depreciation is charged annually either on book value or cost of
Fixed Assets.
7.4.2 Characteristics / Tests:

If expenditure has any of the following features, then it is
treated as Capital Expenditure.
1. Long Term Benefits :

The benefits of capital expenditure can be enjoyed for long
periods and future period of time e.g. purchased of Plant &
Machinery.
Any expenditure incurred in connection with acquisition of

fixed assets, e.g. Custom duty paid on machinery imported,
installation cost of machinery.
2. Investing Activity :
Such expenditure pertains to investing activity. Capital
expenditure helps to set up and develop a business. It creates and
increases earning capacity of the business. It gives birth to a new
source of income. It leads to acquisition of new asset. Examples
102
are Fixed Assets like Machinery, Furniture & Fixtures, Computer,

etc.
3. Recoverable :
Money spent on capital expenditure can be recovered
though income generated by the Assets itself or even by selling the
assets at the end of its economic life or at the time of replacement
of assets.
4. Non-recurring :
Capital expenditure is non-recurring in nature, i.e. it need not
be incurred again and again. If a firm takes Building on rent, it is
payable every month, but if it purchased Building, it does not
purchase another building for many years.
5. Effect on Funds and Profits :

Capital expenditure decreases funds in current year as
money goes out of business. But it may increase profits in future
from income derived by using such assets. Investment purchased
is capital expenditure, income earned from investment is Revenue
Receipt.
6. Increases in performance of existing Assets :

Normally amount spent is large, but not necessarily, e.g.
Calculator purchased, it is shown in the Balance Sheet as assets at
book value [cost less depreciation].
7.4.3 Examples of Capital Expenditure:

Purchase of any Fixed Asset for use in the business, as per
AS-10, cost of fixed asset includes :
a. Cost of purchase of Fixed Assets.
b. Custom duty, taxes, cusses on cost.
c. Freight paid for transportation to factory site.
d. Professional charges paid in connection with acquisition of
Fixed Assets, Installation of assets e.g. Legal charges paid
for preparing documents, project report, conducting
feasibility study, market surveys, negotiations for
Collaboration etc.
e. Office and administrative expenditure connected with
project.
f. Interest on loan taken for purchase of Fixed Assets till it is
put to use.
g. Any expenditure incurred during construction period.
h. Cost of an addition or extension to an existing asset.
i. Cost of development of Wasting Assets.
j. Cost of acquisition of an Intangible Assets.
103
7.5 REVENUE EXPENDITURE
7.5.1 Meaning:
1. REVENUE EXPENDITURE
Revenue expenditure means expenditure incurred for

carrying out the day to day business activities and from which no
future benefits expected. [Guidance Notes - ICAI].
Eric Kohler has defined revenue expenditure as

“Expenditure charged against operations, a term used to contrast
with capital expenditure”.
Any expenditure which is not capital expenditure is Revenue

Expenditure. The items of expenditure having immediate or short-
term benefices less than 12 months are treated as Revenue
Expenditure.
2. COST
Cost means amount of expenditure incurred on a specific article,
product or activity [Guidance notes ICAI]. Thus, cost may be the
cost of an asset or cost of goods or cost of services.
3. Expenses
Expenses means:
a) A cost relating to the operation during the accounting period.
b) A cost relating to the income earned during the accounting
period.
c) A cost whose benefits do not extend beyond the accounting
period.
d) An expired cost i.e. that portion of expenditure from which no
further benefits are expected. [Guidance Notes ICAI].
e) Expenditure incurred to maintain assets in working condition.
f) Expenditure of revenue nature incurred after the plant starts
commercial production. [AS-10].
g) Research and development cost written off.
In short, Revenue expenses means operating costs,

matching costs, period cost, product cost and expired costs
incurred during the accounting year.
7.5.2 Characteristics / Test:
If expenditure have any of the following characteristics or

tests, it should be treated as Revenue Expenditure:
104
1. Business Activity :
The expenditure that pertain to business activity is recorded
as revenue expenditure, as it helps to run a business and earn
income. Examples are purchase of goods, fees paid etc.
2. Maintain Assets :
Expenditure that helps to maintains fixed assets in working
condition is treated as revenue expenditure. e.g. repairs,
maintenance.
3. Not Recoverable :
Money spent on revenue expenditure is not irretrievably
gone. It can be recovered hence expired costs and revenue losses
are treated as revenue expenditure.
4. Recurring :
Revenue expenditure is recurring in nature. A same type of
expenditure is incurred again and again. e.g. salaries paid, rent,
traveling expenses, audit fees.
5. Reduces Funds and Profits :

Revenue expenditure reduces both funds and profits of the
current year. As money goes out, the funds available with the
concern are reduced. And as the money goes out irretrievably (i.e.
never to comes back), it reduces the profits of the concern.
7.5.3 Disclosure in final accounts:

Revenue expenditure pertains to current year is shown as
expenditure in the Profit & Loss A/C. However, part of the
expenses, if pertains to next year, is shown in the Balance Sheet as
prepaid expenditure, on the assets side. Revenue expenditure
incurred but not paid is taken in Profit & Loss A/C and it is shown in
the Balance Sheet as liabilities.
7.5.4 Examples:
1. Cost relating to business activities during the accounting year is
treated as revenue expenditure i.e.
 Cost of production [purchases of goods, wages paid.
manufacturer expenses etc.]
 Cost of administration [salaries, rent, printing & stationery,
audit fees etc.]
 Selling & Distribution cost [commission, traveling expenses,
advertisement, etc.]
 Cost of raising finance [interest on loans, debentures
interest, and cash discount, etc.]
105
2. Cost relating to income earned during the same accounting

period are treated as revenue expenditure e.g. carriage, freight,
buying expenses, interest on loans.
 Costs whose benefits do not extend beyond the accounting year

are treated as revenue expenditure i.e. white washing factory,
loose tools and packing materials.
 Expired Costs: Expenditure from which no future benefits

expected is treated as revenue expenditures e.g. Depreciation
on Fixed Assets, when any asset is sold at loss, book value
represents loss on sale of assets, it is treated as expired cost &
written off as expired cost, debited to Profit and Loss A/C.
 Revenue Loss: is treated as revenue expenditure e.g. goods

destroyed by fire, bad debts and unsalable goods written off.
Revenue losses arises in respect of business activities [trading
or / and manufacturing] or in respect to current assets such as
stock, cash lost, debtors etc.
 Revenue expenditure incurred after the plant has begun

commercial production is treated as expenses. AS - 10.
 Expenditure on repairs which maintains the standard of

performance of an existing fixed assets and machinery spares
consumed are treated as revenue expenditure . A.S.-10.
 According to A.S.8, any Research & Development costs

incurred but it is not certain whether it will give rise to any
benefit in future can be treated as revenue expenditure.
7.6 DISTINCTIONS BETWEEN CAPITAL

EXPENDITURE AND REVENUE EXPENDITURE
No. Capital Expenditure Revenue Expenditure

1. Its benefit extends for more It benefits only for current
than one accounting year . accounting year [12 months]
2. It is incurred for acquisition of It is incurred for earning
fixed assets . revenue.
3. It may be incurred to improve It maintained fixed assets in
the existing fixed assets held working condition.
by the concern.
4. It increases revenue earning It does not change revenue
capacity. earning capacity.
106
5. It benefits more than one It benefits only in the same

accounting year. accounting year.
6. It decreases funds, but It decreases funds as well
benefits for longer period. as profits of business.
7. It may decreases cost of It decreases profits of
production. current year.
8. It is shown on assets side of It is shown as expense in
Balance Sheet. Revenue A/C.
9. Examples = goodwill, plant & Examples = purchases of
machinery, land, building, goods, wages, salaries,
furniture & fixtures, railway legal fees, rents. Insurance,
sidings etc. carriage, interest, selling
expenses, commission. etc.
CHECK YOUR PROGRESS
1. Fill in the blanks

a. Revenue expenditure is shown on ------------- side of Profit &
Loss A/C.
b. -------------- expenditure is incurred for acquisition of Fixed
Assets.
c. -------------- expenditure benefits only in same accounting
year.
d. Purchase of goods is the example of ------------------
expenditure.
e. Goodwill is the---------------------------expenditure.
f. Cost relating to income earned during the --------- accounting
period are treated as revenue expenditure.
g. Expenditure from which no future benefits expected is
treated as --------------expenditures.
h. Goods destroyed by fire is a ------------------------- expenditure.
i. Expenditure pertains to investing / financing activity is --------
expenditure.
j. Custom duty, taxes, cusses on cost is a -----------
expenditure.
k. Expenditure which results in increase in earning capacity of
business is ---------------------- expenditure
l. Expenditure which decreases cost of operation is --------------
expenditure.
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2. Enlist the tests for treating the expenditure as Revenue.

3. Define the following terms:
a. Revenue expenditure
b. Capital expenditure
c. Cost
d. Expenditure
7.7 DEFERRED REVENUE EXPENDITURE
7.7.1 Meaning:
Deferred Revenue Expenditure is that of revenue
expenditure which is carried forward on the presumption that it will
benefit over subsequent periods.
Guidance note issued by ICAI “Deferred Revenue

Expenditure is that part of expenditure for which payment has been
made or a liability incurred but which is carried forward on
presumption that it will benefit over a subsequent period or
periods”.
They are of a Quasi Capital Expenditure. Any heavy revenue

expenditure which is incurred in one year but it is likely to benefit
more than one accounting year, are considered as deferred
revenue expenditure. To defer means to postpone. Deferred
Revenue Expenditure has mixed nature and has same features of
both revenue and capital expenditure.
7.7.2 Medium term Benefits:

The Deferred Revenue Expenditure has medium term
benefits, may be 3 to 4 years, therefore, cost of expenditure is
divided in say 3 to 4, or 5 years, the part of Deferred Revenue
Expenditure benefit for current year debited to Profit & Loss A/C,
remaining balance carried to subsequent years till It is fully written
off. e.g. Discount allowed Rs.1,00,000 on issue of Debentures,
Debenture, likely to be redeemed after 10 years. The benefits of
issue of Debentures are for 10 years. Every year 1,00,000/10 =
Rs.10,000 shall be written off, balance in Discount on issue of
Debentures carried forward. After ten year, there will be no balance
in that account.
7.7.3 Nature of Expenses :

Deferred Revenue Expenditure should be Revenue
Expenditure by nature in the first instance, for example,
advertisement. But its matching with revenue may be deferred
considering the benefit to be accrued in future.
108
7.7.4 Revenue Expenses, Deferred Revenue Expenditure &

Prepaid Expenditure:
A thin line of difference exists between revenue expenses,

deferred revenue expenditure and prepaid expenses. Revenue
Expenditure is short time expenses, benefits of all these are
excused in the same accounting year. In some cases, part of
Revenue Expenses is treated as Deferred Revenue Expenditure
and is carried forward on the presumption that it will benefit over
subsequent period or periods. e.g. heavy advertisement for new
product launch in the market, such expenses may be assumed, it is
going to benefit for 3 to 5 years, hence it can be treated as
Deferred Revenue Expenditure. The benefits available from prepaid
expenses can be precisely [not presumption] estimated but that is
not so in case of Deferred Revenue Expenditure. e.g. Insurance
premium paid for the year ended 30th June 2018 Rs. 24,000/-
Accounting year ended 31st March 2018. In this case three months
premium pertains to subsequent period, = 24000/12*3 = Rs. 6000.
Amount is ascertained and carried forwards according as prepaid
insurance Rs. 6000/-.
7.8 CAPITAL RECEIPTS
7.8.1 Meaning:
Receipts means an amount received by a concern either
during its business activity [supply of goods or services] or during
its financing [obtaining money as capital or loan or sale of assets].
Receipt arising out of business activity is known as revenue
receipts, wherever receipts arising out of financing activity are
known as capital receipts or liability.
Capital receipts means an amount received by a concern in

the course of financing activity [obtaining money as capital or loan
or sale of Assets]. A concern need money to carry on its business
activities and investing activities. The money is obtained either from
the owner or loans or sales of assets or sales of investment. Capital
receipts are non-recurring in nature.
 Capital means the amount invested in the concern by its
owners, it to be refunded only when the concern finally stops its
business and is closed down.
 Liability means amounts received as loan basis from outsiders
e.g. from Bank, financial institution.
 Capital receipts are recognized on accrual basis as soon as the
rights of receipts are established. Capital receipts are not
credited to Profit & Loss A/C, it is shown as the liability or it may
reduce from Fixed Asset. However, it may be credited to Profit &
Loss A/C to the profit realized on sale of asset.
109

If receipts have any of the following features, then it should
be treated as Capital Receipts:
 Financing Activity:
Receipts which arises from financingl activities are
concerned as Capital Receipts. It provides funds to acquire
new fixed assets. e.g. capital introduced, loan taken from
sale of assets, etc.
 Non-recurring:
Capital receipts are always non-recurring in nature. Such
amounts are not received again and again. These are long
term commitments.
 Returnable:
Money received as loan is returnable, as per various terms
agreed upon. Capital introduced is paid back to owner when
business is closed down.
 Effect on fund and profits:

Capital receipts increases fund available to business in the
year of receipts, as money comes in the business. But it may
decreases profits in future as one has to pay interest on
loan. However, in long term, it will increase profits of the firm.
e.g. Say you are borrowing @ 12%; return on investment to
firm say 18% and then extra 6% increases return to owner,
without additional capital. This is possible only when returns
are higher from the business.
7.8.3 Disclosure in Final Accounts:

Capital receipts are shown in Balance Sheet on liability side.
Capital receipts from sale of fixed assets are deducted from
concerned fixed assets.
7.8.4 Example:
a) Additional capital introduced by the owner Rs. 1,50,000.
b) Loan of Rs. 5,00,000 taken from H.D.F.C. Bank.
c) Investment costing Rs. 75,000 sold.
d) Grants from government received Rs.1,75,000 for
construction of building.
7.9 REVENUE RECEIPTS
7.9.1 Meaning:
 Revenue receipts are those items of income, which are
received or accrued in ordinary course of business. Revenue
receipts means receipts from customers for sale of goods or
110
rendering services or for use of funds or use of assets.

[Guidance Notes - I.C.A.I.] Revenue receipts are recurring
in nature; this gives rise to Gross Income regularly so long
as the business continues.
 Income means revenue earned during the particular

accounting year.

If receipts have any of the following features, then it should
be treated as Revenue Receipts:
a) Business Activity:
Receipts in course of business activities are recorded as
Revenue Receipts e.g. Sale of goods, interest received, dividend
received, discount earned, etc.
b) Recurring:
Revenue Receipts are recurring in nature. Same types of
receipts are received again and again on regular basis, periodically
received in gap of two or three months, like interest on loan given.
c) Not Returnable:
Revenue Receipts are not returnable / refundable. It needs
not be paid back as concern has supplied goods or rendered
services to customers. Amounts received for sale of goods or
rendering reverses, in normal case, money is not to be refunded to
customers back. Legal ownership is with seller and need not to be
paid back.
d) Increase in funds and profits:
Revenue receipts increases both funds and profits of the
current year. As money received in the from of income, it increases
profits and it is not to be refunded. It increases funds available at
disposals with the concern.
7.9.3 Disclosure in final accounts:

Revenue receipts pertaining to current year are credited to
Profit & Loss A/C. Revenue receipts relating to future period shown
in the Balance Sheet as received in advance, on liability side. [as
income received in advance]. However income is different than
receipts. Income excludes revenues relating to the further period,
received in advance & includes income earned in current year but
not received [income receivable] and income received in earlier
years for current year.
111
7.9.4 Examples:
Sales of goods:
Goods means the commodities in which the concern deals.
Sales of goods whether manufactured or purchased are revenue
income.
Revenue is said to be arise from sale of goods when sale is

complete and the buyer has no legal right to return the goods or
ask for refund. If at the time of receipts, sale is not complete or
buyer has right to ask for refund, [sale on approval, goods sent on
consignment] then it is treated as advance and the receipt is based
on advance and not as revenue. Only when the sale is complete,
such advance is to be treated as revenue.
Rendering of Services:
Services means ‘AID TO TRADE’, such as marketing,
financing, administration, distribution, transport etc. Receipts are
taken as revenue when services are provided.
 Interest :
Interest is taken as income on loan given by the concern.
Amount received when such loan itself is returned, then it is
capital receipt.
 Dividend :
Receipt is treated as dividend when it is in the form of a reward
from investment in shares. Amount is received on sales of such
shares themselves are treated as capital receipts.
 Royalty :
Receipt is treated as royalty when it is received for used of
assets such as know-how, patents, trademarks and copyrights.
Amount received on outright sales of such patents etc. are
capital receipts.
 Insurance claim :
Compensation received from insurance company for loss of
current assets e.g. loss of goods, loss of cash due to theft etc.,
are treated as revenue receipts.
7.9.5 GOVERNMENT GRANTS

Grants received from Government are of two types. Grants
received for capital expenditure is capital receipt e.g. for road
construction, for Equipments to be purchased. However, grant
received to re-imbrue or compensate for specified revenue
expenditure or revenue losses are revenue receipts. [e.g. salary
grant, rent, power grant] are treated as Revenue Receipts [A.S. -
15 on Government Grants]. In brief, any receipt is recurring &
112
benefits are likely to be lost for not more than 12 months, are
Revenue Receipts.
7.10 DISTINCTIONS BETWEEN CAPITAL RECEIPTS

AND REVENUE RECEIPTS
No. Capital Receipts Revenue Receipts

1. It is non-recurring in nature. It is recurring in nature.
2. It arises from financial / It arises from business
investing activity. activity.
3. Capital receipts which are They are not repaid in
liabilities are to be repaid as normal course of business.
per terms.
4. They are not gains to the They are gains to the
concern. concern.
5. They appear in Balance They appear in Income
Sheet. Statement.
6. Capital receipts are Revenue receipts are
recognized on accrual basis matched with Revenue
but not matched with capital expenditure at the end of
expenditure. accounting year.
7. Examples of capital receipts Examples of revenue
are capital brought in by receipts are sale of goods,
owner, loan taken, sale of rent received, interest
fixed assets and sale of received, discount earned,
investment. income from investment etc.
8. Capital receipts may be In increases profits as well
capital profit, it increases as funds of business
funds available. concern.
CHECK YOUR PROGRESS

a. Commission received is --------------receipt.
b. Rent received by sub-letting premises is -------------receipt.
c. Sale proceeds on sale of old car is -------------receipt.
d. Sale of furniture by furniture dealer is -------------receipt.
e. --------------- means assets held for short period.
f. Capital of owner of business is shown on -------------- side of
balance sheet.
g. ------------- assets does not have physical identity.
h. Grants received from Government for capital expenditure is
a--------------------------receipt.
113
i. Grant received for road construction is a ------------receipt.

j. Grant received for re-imbrues or compensate for specified
revenue expenditure or revenue losses are--------------
receipts.
k. Sales of goods whether manufactured or purchased are ------
income.
l. Revenue receipts pertaining to current year are ------------ to
Profit & Loss a/c.
m. Revenue receipts relating to ---------- period shown in the
balance sheet as received in advance, on-------- side.
n. Deferred revenue expenditure should be ----------expenditure
by nature in the first instance.
o. Discount on issue of debenture is a ----------------expenditure.

a. Revenue receipts
b. Capital receipts
c. Deferred revenue expenditure
3. What is the difference between income and receipt.
7.11 DEFERRED REVENUE INCOME
7.11.1 Meaning:
Deferred Revenue Income means income received in

advance before it is earned, which is carried forward to subsequent
period to which it relates [Guidance note - ICAI] such income is
received in advance. Such items of income is shown as ‘Income
received in advance’ on the liability side of Balance Sheet.
7.11.2 Examples:
Club annual membership fees received in advance from

some members is to be treated as income received in advance, to
be carried forward to the period it belongs.
Educational institution fees may be collected for entire

course, say three years, two years fees received is income
received in advance.
Grants received from Government for acquiring depreciable

assets are treated as deferred income. Proportionate amount of
grant basined on useful life of asset [i.e. total grant divided by the
useful life of assets] is taken as income every year and credited to
Profit & Loss A/C. [A.S. - 15 on Government Grants - I.C.A.I.]
114
7.12 REVENUE PROFIT AND CAPITAL PROFIT
Business activities give rise to revenue profit whereas

investing and financing activities give rise to capital profit. Revenue
profit / operating profit mean the net profit arising from the normal
operations / operating activities of the concern. Net operating profit
means excess of gross operating income over total operating
expenditure during the particular period. Capital profit arises when
assets or investment sold at higher price than cost. Shares are
issued by the company at higher price than face value / nominal
value, extra amount received is credited to Securities Premium A/C
and not to Profit and Loss A/C. In case of sale of Fixed Assets,
difference between sale proceeds and cost is capital profit,
difference between cost and book value is revenue profit. e.g. Plant
costing Rs. 7,50,000/- book value on date of sale Rs. 4,50,000/-
[due to depreciation], sold for 9,00,000/-
Capital profit = 9,00,000 - 7,50,000= Rs. 1,50,000 [sale proceeds -

cost]
Revenue profit = 7,50,000 - 4,50,000 = Rs. 3,00,000 [cost - book
value]
7.13 REVENUE LOSS AND CAPITAL LOSS
Revenue due to business activity is revenue loss, e.g. loss

on sale of goods, bad debts, goods lost by theft. Such revenue
losses are expired cost and debited to Profit & Loss A/C. On the
other hand, losses due to investing and financing activity is capital
loss. Capital loss due to investing activity is debited to Profit and
Loss A/C as expired cost with no future benefits whereas losses
due to capital, financing i.e. discount on issue of shares is carried
forward as ‘fictitious assets’ shown in the Balance Sheet under the
heading “Miscellaneous Expenditure”.
7.14 EFFECT OF WRONG TREATMENT ON PROFIT
We believe that to erris human, to ignore its effect will cost

on someone, who may blame accountant.
Any error in classification of payments / receipts will affect
final accounts. Every receipts and payments are classified into
either Revenue or Capital. Revenue expenditure & incomes are
transferred to Profit & Loss A/C to ascertain net profit or loss for the
period. Capital expenditure and capital receipts are shown in the
balance sheet. Balance shown in the balance sheet are carried
forward to subsequent period. Thus, any error in classification will
effect on accuracy of entire final accounts. Effect of such error can
be as under:-
115
1. Revenue Expenditure is shown as Capital Expenditure:
Revenue expenditure wrongly capitalized will increase profits

of this year and assets are overvalued, depreciation part in
subsequent year shall decrease profits of all subsequent years e.g.
Repairs to Machinery Rs. 60.000 wrongly debited to Machinery
A/C. Since it is wrongly capitalized, expenditure not debited to Profit
& Loss A/C profit shall be shown at higher amount and also at
higher amount, in subsequent year, due to higher depreciation, it
will reduce profits.
2. Capital Expenditure is shown as Revenue Expenditure :

As capital expenditure is debited to Profit & Loss A/C, Profit
& Loss A/C will show lower profit and Balance Sheet shows lower
assets. It will affect profits / loss in subsequent years also, as
depreciation shall not be charged, as entire amount is already
debited to Profit & Loss A/C e.g. Furniture purchased for
Rs.51,000, wrongly recorded in purchase day book. In this case,
gross profit as well as net profit reduced by Rs. 51,000/- .Furniture
is not added to furniture in Balance Sheet. So, Balance Sheet
shows fixed assets lower by Rs.51,000 if this type of error results in
to Window Dressing.
3. Capital Receipts are shown as Revenue Receipts:

The Profit & Loss A/C shows higher profits and the Balance
Sheet shows lower liabilities or higher assets. e.g. Sale of old
assets for Rs. 25,000 recorded in Sales Day Book. In this case, as
sales are shown at higher amount, Gross Profit, Net Profit shall be
higher, since it is not deducted from assets, they are shown at
higher amount by Rs. 25,000. Profit or loss on sale of assets are
also not accounted. Deposit received from customers’ Rs. 27,000,
wrongly credited to interest A/C, profit shown by Profit & Loss A/C
will be higher and liabilities are shown lower by Rs. 27,000.
4. Revenue Receipts are shown as Capital Receipts:

The Profit & Loss A/C shows lower profit and the Balance
Sheet shows higher liabilities, or lower assets e.g. Commission
received Rs. 71,000, from Z & Co. credited to Z & Co., income is
shown less and Z & Co. as liability.
Sale of goods wrongly credited to Furniture A/C, sales is

shown lower results in lower income and Furniture is reduced by
the same amount, assets are shown at lower amount.
116
7.15 ILLUSTRATION
Illustration 1:
State with reason whether following are capital or revenue
expenditure:
i) Rs.12,000, paid for removable of stock to new site.
ii) Purchase of NOKIA mobile phone Rs.5,000 for office work.
iii) Expenses incurred in connection with obtaining a licence for
starting the factory for Rs.27,000.
iv) Legal fees to acquire property Rs.10,000.
v) The amount spent for replacement of work out part of
machine Rs.50,000.
vi) Money spent to reduce working expenses Rs.25,000.
vii) Ring & Pistons of an engine were changed at cost of
Rs.10,000 to get fuel efficiency.
Solution :
i) Rs.12,000, paid for removable of stock to new site is
revenue expenditure. This is neither bring enduring benefit
nor enhance the value of the asset.
ii) Purchase of NOKIA mobile phone Rs.5,000 is capital
expenditure; as it is incurred for acquisition of fixed assets.
iii) Money paid Rs. 27,000 for obtaining license to start a factory
is a capital expenditure. This is an item of expenditure
incurred to acquire the right to carry on business.
iv) Legal fees to acquire property Rs.10,000 are part of cost of
that property. It is incurred to possess the ownership rights
of the property and hence it is a capital expenditure.
v) The amount spent for replacement of work out part of
machine Rs.50,000 is revenue expenditure since it is part
of its maintenance cost. If was incurred to keep machine in
working condition.
vi) Money spent on reducing working expenses Rs.25,000 is
capital expenditure, as it generates long term benefit to the
entity. It is part of intangible fixed assets. if is incurred for
any specific assets then it is also capital expenditure. It
should be capitalized.
vii) Rs.10,000 spent in changing rings and pistons of an engine
to get fuel efficiency is capital expenditure. This is an
expenditure on improvement of fixed assets. It results in
increasing profit earning capacity of the business by cost
reduction.
117
Illustration 2 :
State whether the following expenditure is a capital, revenue
or deferred revenue expenditure. Give reasons :
1. Legal expenses incurred in connection with issue of capital.
2. Cost of replacement of a defective part of the machinery.
3. Expenditure incurred in preparing a project report.
4. Expenditure for training employees for better running of
machinery.
5. Expenditure incurred for repairing cinema screen.
Solution:
1. Deferred revenue expenditure: Legal expenses incurred in
connection with issue of capital are not treated as revenue
expenditure because the funds from issue of shares will benefit
the concern for many years, it is not treated as capital
expenditure because it does not create any real asset. Hence, it
is treated as deferred revenue expenditure and written off over
certain number of years.
2. Revenue expenditure: As replacement of a defective part will

help to maintain the machinery in working condition.
3. Capital expenditure: If the project is implemented; as

according to Accounting Standard 10, all expenditure till a
project commences is capitalized. However, if the project is
given up or not implemented and the amount is small, it will be
written off as revenue expenditure (as expired costs which will
bring no benefit in future); if the project is not implemented and
the amount is heavy, it will be treated as deferred revenue
expenditure.
4. Revenue expenditure: As expenditure for training employees

for better running of machinery is cost of administration related
to normal business activities incurred in order to earn income
during the year.
5. Revenue expenditure: As expenditure incurred for repairing

cinema screen is a cost incurred to maintain an existing asset in
working condition.
Illustration 3:
State, with reasons, whether you would consider the
following as capital expenditure or revenue expenditure :
1. Amount spent on uniform of workers.
2. White-washing of the factory building.
118
3. Cost of stores consumed in manufacturing machinery for

installation in own factory.
4. Wages paid for construction of the building extension.
5. Import duty on raw material purchased.
(June 1980, adapted)
Solution :
1. Revenue expenditure: As amount spent on uniform of workers
is an administration cost related to normal business activities.
2. Revenue expenditure: As white-washing of the factory of
building is a cost of maintaining an asset in working condition.
3. Capital expenditure: As cost of stores consumed in
manufacturing machinery for installation in own factory is a
direct cost incurred for manufacturing an asset which is to be
capitalized as per Accounting Standard 10.
4. Capital expenditure: As wages paid for construction of an
extension to an existing asset is a direct cost incurred for
acquiring an asset which is to be capitalized as per Accounting
Standard 10.
5. Revenue expenditure: As import duty on raw material
purchased is a direct product cost related to normal business
activities incurred in order to earn income during the year.
Illustration 4:
State with reasons, whether you would consider the following as
capital expenditure or revenue expenditure.
1. Raw material costing $ 2,000/- was imported when 1 dollar was
worth Rs. 40; when payment was actually made the foreign
exchange was purchased at the rate of 1 dollar equal to Rs. 42.
2. Premium paid in connection with acquisition of leasehold
premises.
3. Renovation of factory canteen.
4. Fees paid for renewal of licence for factory.
(April 1984 adapted)
Solution :
1. Revenue Expenditure: As due to change in exchange rate, raw

material cost, which is a direct product cost, has gone up. Cost
of raw materials = 2000 × 40 = `80,000. it is purchased of
goods. However, extra amount paid 2000 × (42 - 40) = 4,000
119
shall be treated as loss due to exchange fluctuation is also

revenue expenditure, should be debited to profit & loss a/c.
2. Capital expenditure: As premium paid in connection with

acquisition of leasehold premises is a direct cost incurred in
connection with the acquisition of an asset to be added to the
cost of the asset [Accounting Standard 10].
3. Revenue expenditure: As renovation of factory canteen helps

to maintain the asset in working condition.
4. Revenue expenditure: As fees for renewal of factory licence is

a recurring expenditure incurred in the course of normal
business activities.
Illustration 5:
Electric Engineers Private Limited removed their factory to a
more suitable premises in Navi Mumbai. State with reasons the
accounting treatment for the following items:
1. A sum of Rs.99,500 was spent for dismantling, removing and re-

installing plant, machinery and fixtures.
2. The removal of stock from the old factory to the new at a cost of
Rs.1,000.
3. Plant and Machinery which stood in the books at `1,50,000
included a machine at a book value of Rs. 1,50,000 included a
machine at a book value of Rs. 3,400. This being obsolete, was
sold off at Rs. 900 and was replaced by a new machine which
cost Rs. 4,800.
4. The freight and cartage on the new machine amounted to `300
and erection charges Rs.550.
5. The furniture appeared in the books at Rs.15,000. Of these,
some portion of the book value at Rs.3,000 was discarded and
sold at Rs.1,200. New furniture of the book value of `2,400 was
acquired.
6. A sum of Rs.2,200 was spent on painting the new factory
(Oct. 1981, adapted)
Solution:
1. Deferred revenue expenditure: Cost of dismantling, removing
and re-installing plant etc. is not treated as revenue expenditure
because it is not a normal operating cost. If it is not treated as
capital expenditure because it does not create any real asset.
120
Hence it is treated as deferred revenue expenditure and written

off over certain number of years.
2. Revenue expenditure: As removal of stock from the old factory
to the new is a normal operating cost related to a current asset
(stocks) and not capital asset.
3. When a machine costing Rs.3,400 is sold for Rs.900 received
on sale of machinery is treated as capital receipt; and the book
value of the machine becomes Rs.2,500. As the machine has
been sold at its book value represents an ‘expired cost’ with no
future benefits i.e. loss on sale of asset which is to be written off
by debit to the Profit and Loss Account. Cost of new machine
(Rs.4,800) will be treated as Capital expenditure.
4. Capital expenditure: As freight and cartage on the new
machine as well as the erection cost is a direct cost of bringing
an asset to a condition where it can be put to use, which is
5. Loss on sale of old furniture (Rs.3,000 - Rs. 1,200) is written off
as expired cost by debit to the Profit and Loss Account; cost of
new furniture (Rs.2,400) will be treated as Capital expenditure.
6. Capital expenditure: painting the new factory is a direct cost till
an asset is first put to use, which is capitalized as per
Accounting Standard 10.
Illustration 6:
State with reasons whether the following are Capital or
Revenue Expenditure:
1. Freight and cartage on new machine Rs.150, and erection

charges Rs.200.
2. Fixtures of the book value of Rs.1,500 was sold off at Rs.600
and fixtures of the value of Rs.10,000 was acquired, cartage on
purchase Rs.50.
3. A sum of Rs.100 was spent on painting the factory.
4. Rs.5,150 spent on repairs before using a second-hand car
purchased recently to put it in useable condition.
(FY, March 1995, adapted)
Solution :
1. Capital expenditure: Freight and cartage on new machine and
erection charges are capitalized as all costs till an asset is
installed are added to its cost as per Accounting Standard 10.
2. When fixtures are sold at Rs.600.Amount received on sale are
treated as Capital receipt and credited to Fixtures A/C; the
book value of the fixtures indicating Loss on sale of old fixtures
121
(1,500-600) is treated as an expense (expired cost) and written

off by debit to the Profit and Loss Account cost of new fixtures
(Rs.10,000) and cartage (Rs.50) will be treated as Capital
expenditure.
3. Revenue expenditure: As painting the factory helps to maintain
the asset in good working condition.
4. Capital expenditure: Repairs before using a second-hand car
purchased recently to put it in useable condition are capitalized
as per Accounting Standard 10 which states that all direct costs
of bringing the asset to its working condition for its intended use
form part of the cost of the asset.
Illustration 7:
State with reasons whether the following items relating to a
sugar mill company are capital or revenue:
1. A motor truck costing Rs.15,000 and standing in the books at

Rs.7,250 was sold for Rs.12,000.
2. Rs.20,000 received from the issue of further shares, the
expenses of the issue being Rs. 2,500.
3. Rs.75,000 being cost of land purchased for agricultural farm and
`450 paid for land revenue.
4. Rs.1,50,000 paid for excise duty on sugar manufactures.
5. Rs.50,000 invested in a government loan, interest received
Rs.4,500
6. Rs.60,000 spent on construction of railway siding.
(FY, March 1996; adapted).
Solution :
1. Capital receipt: As Rs.12,000 is received from sale of a capital
asset. The profit on sale of asset (Rs.12,000 - Rs. 7,250) will be
credited to the profit and loss account as an extraordinary item
of income on sale of motor truck.
2. Capital receipt: (Rs.20,000) : As amount has been received
from issue of shares in the course of financing activity of the
company. Rs.2,500 spent as expenses on issue of shares will
be treated as deferred revenue expenditure. It is not treated as
revenue expenditure because it is not a normal operating cost. It
is a nonrecurring expenditure. It is not treated as capital
expenditure because it does not create any real asset. Hence it
is treated as deferred revenue real asset. Hence, it is treated as
deferred revenue expenditure and written off over certain
number of years.
122
3. Rs.75,000 will be treated as capital expenditure as agricultural

land is a capital asset; Rs.450 paid for land revenue is revenue
expenditure in the course of normal operations of business.
4. Revenue expenditure: Excise duty on sugar manufactured is
the cost incurred during the course of normal business
operations incurred in order to earn income. It is recurring
expenses payable on manufacture of excisable goods.
5. Capital expenditure: Purchase of government loan is an
investment which will be returned on due date. Interest received
Rs.4,500, being income revenue income to be credit to Profit &
Loss A/C.
6. Capital expenditure: As cost of construction of railway siding is
for acquisition of a capital asset.
Illustration 8 :
State which of the following items are capital, revenue and
deferred revenues. Explain with reasons.
1. Expenditure incurred on overhauling machinery.
2. Taxes paid.
3. Wages paid to the workers for election of a new machinery.
4. Cost of goodwill.
5. Heavy expenditure incurred on advertisements.
6. Cost of construction of a building.
7. Machinery costing Rs.10,000 sold for Rs.12,000
8. Purchased machinery for Rs.15,000.
(FY, October 1996; adapted)
Solution :
1. Revenue expenditure: As expenditure incurred on overhauling

machinery helps to maintain the machinery in working condition.
2. Revenue expenditure: If taxes are on goods purchased e.g.
sales tax (Income tax is treated as drawings), goods
manufactured, then excise duty has to pay.
3. Capital expenditure: Wages paid to workers for erection of a
new machinery are capitalized as all costs till an asset is
installed are added to its cost as per Accounting Standard 10.
4. Capital expenditure: As cost of goodwill is an acquisition of
capital (intangible) asset.
5. Deferred revenue expenditure: If the heavy expenditure
incurred on advertisements is going to benefit for a number of
years.
123
6. Capital expenditure: As cost of construction of a building helps

to create a capital asset.
7. Capital receipt: As the amount of Rs.10,000 is received on sale
of fixed asset. Profit on sale (Rs.2,000) is credited to the Profit &
Loss A/c as an extra-ordinary item of income.
8. Capital expenditure: As it is an acquisition of a fixed asset.
Illustration 9:
or deferred revenue expenditure. Give reasons:
1. Legal expenses incurred in connection with issue of Equity
Shares of the company.
2. Cost of replacement of a defective part of the machinery.
3. Expenditure incurred in preparing a project report.
4. Expenditure for training employees for better running of
machinery.
5. Purchase of machinery for sale.
6. Daily wages paid to office peon.
(FY, April, 1996, adapted)
Solution:
1. Deferred revenue expenditure: Legal expenses incurred in
connection with issue of equity shares are not treated as
revenue expenditure because the funds received from issue of
shares will benefit the concern for many years. It is not treated
as capital expenditure because it does not create any real
asset. Hence, it is treated as Deferred Revenue Expenditure
and written off over certain number of years.
2. Revenue expenditure: As replacement of a defective part will
help to maintain the machinery in working condition.
3. Capital expenditure: If the project is implemented; as
according to Accounting Standard 10, all expenditure till a
project commences is capitalized. However, if the project is
given up or not implemented and the amount is small, it will be
written off as revenue expenditure (as expired costs which will
bring no benefit in future); if the project is not implemented and
the amount is heavy, it will be treated as Deferred Revenue
Expenditure.
4. Revenue expenditure: As expenditure for training employees
for better running of machinery is cost of administration related
to normal business activities incurred in order to earn income
during the year.
124
5. Revenue expenditure: As expenditure incurred for purchase of

machinery for sale is a direct product cost related to normal
business activities incurred in order to earn income during the
year.
6. Revenue expenditure: As daily wages paid to office peon is
cost of administration related to normal business activities
incurred in order to earn income during the year.
Illustration 10:
or deferred revenue expenditure. Give reasons:
1. Payment for purchase of goods.
2. Payment for purchase of stationery.
3. Payment for purchase of a car.
4. Payment for heavy inaugural expenses.
5. Partial refund of capital to a partner.
6. Payment of a loan taken earlier.
7. Payment of salaries.
8. Wages for erection or machinery.
(FY, October, 1996 adapted)
Solution :
1. Revenue expenditure: As expenditure incurred for purchase of

goods is a direct product cost related to normal business
activities incurred in order to earn income during the year.
2. Revenue expenditure: As purchase of stationary is cost of
administration related to normal business activities incurred in
order to earn income during the year.
3. Capital expenditure: As purchase of a car helps to create a
capital asset.
4. Deferred revenue expenditure: Heavy inaugural expenses are
not treated as revenue expenditure because these will benefit
the concern for many years. These are not treated as capital
expenditure because these expenses do not create any real
asset. Hence these are treated as deferred revenue expenditure
5. Capital expenditure: As partial refund of capital to a partner
reduces the liabilities of the concern.
6. Capital expenditure: As payment of a loan taken earlier
reduces the liabilities of the concern.
125
7. Revenue expenditure: As salaries is cost of administration

related to normal business activities incurred in order to earn
income during the year.
8. Capital expenditure: As wages for erection of machinery is a
direct cost incurred for acquiring an asset which is to be
Illustration 11. :
following as capital expenditure or revenue expenditure:
1. Stock of Rs.25,000 was destroyed by fire of which Rs.15,000
was received from the Insurance Company.
2. The concern spent Rs.1,00,000 on heavy advertisement
campaign to introduce a new product in the market.
3. Cost of dismantling a plant from a particular locality and
reinstalling the same in another locality.
4. Cost of transporting newly purchased furniture.
5. Amount spent by factory in overhauling its plant which has
enhanced the life of the plant by five years.
6. Travelling expenses for a trip abroad for purchase of capital
goods.
7. Amount spent on replacement of defective part of an old plant.
8. Cost of Goodwill purchased.
(FY, May 1998, adapted)
Solution :
1. Revenue loss / expenditure: Of net amount of Rs.10,000 as
loss of stock by fire is related to loss of current assets (stocks)
and not capital assets. Insurance claim received is revenue
receipts.
2. Deferred revenue expenditure: Expenses on heavy
advertisement campaign to introduce a new product in the
market are not treated as revenue expenditure because these
will benefit the concern for many years. These are not treated
as capital expenditure because these expenses do not create
any real asset. Hence these are treated as deferred revenue
expenditure and written off over certain number of years.
3. Deferred revenue expenditure: Cost of dismantling a plant
from a particular locality and reinstalling the same in another
locality is not treated as revenue expenditure because it will
benefit the concern for many years. It is no treated as capital
126
expenditure because it does not create any real asset. Hence, it

is treated as deferred revenue expenditure and written off over
certain number of years.
4. Capital expenditure: As cost of transporting newly purchased
furniture is a direct cost incurred for acquiring an asset which is
to be capitalized as per Accounting Standard 10.
5. Capital expenditure: Amount spent by factory in overhauling its
plant which has enhanced the life of the plant by five years is an
expenditure which helps to improve the standard of
performance (working life) of an existing asset and is to be
6. Capital expenditure: As traveling expenses for a trip abroad for
purchase of capital goods is a direct cost incurred for acquiring
an asset which is to be capitalized as per Accounting Standard
10.
7. Revenue expenditure: As amount spent on replacement of
defective part of an old plant will help to maintain the plant in
working condition.
8. Capital expenditure: As cost of Goodwill purchased is a direct
cost incurred for acquiring an asset which is to be capitalized
as per Accounting Standard 10.
Illustration 12:
following as capital expenditure or revenue expenditure:
1. Professional fees paid in connection with acquisition of
leasehold premises.
2. Cost of registration and documentation of a newly formed
company.
3. Compensation paid to a retrenched employee for loss of
employment.
4. Expenditure incurred on purchase of cloth for uniform of
employees.
5. Payment of import duty on purchase of raw materials.
(FY, November 1998, adapted)
Solution:
1. Capital expenditure: As professional fees paid in connection
with acquisition of leasehold premises is a direct cost incurred in
connection with the acquisition of an asset to be added to the
cost of that asset [Accounting Standard 10].
127
2. Deferred revenue expenditure: Cost of registration and

documentation of a newly formed company is not treated as
revenue expenditure because it will benefit the concern for
many years. It is not treated as capital expenditure because it
does not create any real asset. Hence it is treated as deferred
revenue expenditure and written off over certain numbers of
years. This type of expenses may be group known as
preliminary expenses.
3. Revenue expenditure: As compensation paid to a retrenched
employee for loss of employment is an administrative
expenditure incurred in the course of normal business activities.
However, if the amount is heavy, it may be treated as Deferred
Revenue Expenditure, as it is a non-recurring expenditure, not
in the normal course of business which benefits the business for
many years by way of reduction in salary.
4. Revenue expenditure: As purchase of cloth for uniform of
employees is an administrative expenditure incurred in the
course of normal business activities.
5. Revenue expenditure: As payment of import duty on purchase
of raw materials is a direct product cost incurred in the course of
normal business activities in order to earn income. It should be
added to cost of material purchased.
Illustration 13 :
Saraswati Sisters removed their factory to their New Mumbai
premises. They carried out the following transactions:-
1. Cost of dismantling, transporting and re-installing the plant
Rs.50,500.
2. An old plant having depreciated value of Rs.60,000 was sold for
Rs.55,000.
3. A new machine was purchased for Rs.2,00,000 and installed at
the cost of Rs.35,000.
Apportion these into capital and revenue.
(IDE March 2000, adapted)
Solution :
1. Deferred revenue expenditure: Cost of dismantling,
transporting and re-installing plant etc. is not treated as revenue
expenditure because it is not a normal operating cost. It is not
treated as capital expenditure because it does not create any
real asset. Hence it is treated as deferred revenue expenditure
128
2. Capital receipt: As the machine has been sold, its book value
represents an ‘expired cost’ with no future benefits i.e. loss on
sale of asset which is to be written off. Rs.55,000 is treated as
capital receipt.
3. Capital expenditure: Cost of new machine (Rs.2,00,000) will
be treated as capital expenditure. Installation cost (Rs.35,000) is
a direct cost of bringing an asset to a condition where it can be
put to use which is capitalized as per Accounting Standard 10.
Therefore, cost of machinery shall be Rs.2,35,000.
7.16 EXERCISES
1. Write short notes on

a) Capital Expenditure
b) Deferred Revenue Expenditure
c) Capital Profit
d) Revenue Expenditure
e) Revenue Profit.
2. Distinguish between
a) Capital expenditure & revenue expenditure.
b) Revenue expenditure & deferred revenue expenses.
c) Revenue receipts & income.
d) Revenue profits & capital profit.
e) Revenue receipt & capital receipt.
3. Practical problems
Exercise 1 : S. Jaggi sells and services typewriters. State which of

the following are capital expenditure and which are revenue
expenditure, giving reasons for your answer.
a. Purchase of a typewriter for office use.
b. Purchase of typewriters for re-sale.
c. Traveling expenses to service typewriters.
d. Purchase of spare parts to service typewriters.
e. Wages of mechanic
f. Wages of office staff.
g. Telephone charges.
h. Purchase of tools for servicing work.
[Ans. Capital - (a), (h); Revenue - other]
Exercise 2: Indicate - briefly giving your reasons in each case -

which of the following represent capital receipts, capital
expenditure, revenue income, revenue expenditure.
129
a. Interest on bank overdraft.

b. Purchase of typewriter for re-sale by the Office Supplies Co.
c. Purchase of typewriter for office use by the Sonali Social
Club.
d. Sale of a delivery van by Office Supplies Co.
e. Receipt of commission by a firm of brokers.
[Ans. CR - (d); CE - (c); RI - (e); RE - (a), (b)]
Exercise 3: State which of the following are Capital Expenditure

and which are Revenue Expenditure, giving reasons in each case.
i) Payment by cheque for carriage on purchases.
ii) Purchase of packing material for distribution of goods from
the Calcutta Paper Mill Ltd.
iii) Purchase of duplicator for use in own office from Gulab &
Co.
iv) The firm acquired a private car from B. Raha, one of the
partners of the firm.
[Ans. RE - (i) & (ii); CE - (iii) & (iv)]
Exercise 4: During the year 2017 A. Ashar had the following

transactions :-
1. Purchased a new motor van Rs.17,500 from B.G. Traders Ltd.
on credit.
2. Paid cheque Rs.740 to Office Furnishing Ltd. being Rs.650 for a
new office desk and Rs.90 for repair of an existing desk.
3. Paid Rs.1,420 by cheque for repairs and improvements to
premises. Rs.1,000 of this amount is to be capitalized.
4. Purchased additional premises for Rs.30,000 which was paid by
cheque.
State the total amount of capital expenditure involved in the above
transactions.
[Ans. Capital expenditure - Rs. 49,150]
Exercise 5: State with reasons whether the following are Capital or

Revenue expenditure:
1. Expenses incurred in connection with obtaining a licence for
starting the factory were Rs. 8,000.
2. Rs.1,500 paid for removal of stock to a new site.
3. Rings and Pistons of an engine were changed at a cost of Rs.
4,000 to get fuel efficiency.
130
4. Rs. 2,500 spent as lawyer’s fee to defend a suit claiming that

the firm’s factory site belonged to the plaintiff. The suit was not
successful.
5. Rs. 8,000 were spent on advertising the introduction of a new
product in the market, the benefit of which will be effective
during four years.
6. A factory shed was constructed at a cost of Rs.1,20,000. A sum
of Rs.7,000 had been incurred in the construction of temporary
huts for storing building material.
[Ans. : CE - (i), (iii), (vi), RE - (ii), (iv); DRE - (v)]
4. Objectives type Questions:

Multiple Choice Questions:
1) Amount received from insurance company on account of
machinery damaged completely by fire.
a) Capital Receipts b) Revenue Receipt
c) Revenue Expenditure d) Capital Expenditure
2) Subsidy of Rs.20,000 received from Government by a

manufacturing concern.
a) Capital Receipt b) Capital Expenditure
c) Deferred Revenue income d) Revenue Receipts
3) Grant Rs.5,00,000 received from Government for construction

of Building.
a) Revenue income b) Capital Income
c) Capital Receipts d) Non of the above
4) Amount received from I.F.C.I. as a medium term loan for

working capital.
a) Deferred Revenue income b) Capital Receipt
c) Revenue Receipts d) Capital Profit
5) Painting of office premises Rs.---1,00,000 once in five year.

a) Revenue Expenditure b) Revenue loss
c) Deferred Revenue Expenditure d) Capital Expenditure
Ans. : 1 - a, 2 - d, 3 - c, 4 - b, 5 - c

Pick up the correct answer from the following choices:
1) Amount received from S.B.I. as a term loan.
a) Revenue Receipt b) Capital Receipt
b) Capital Loss d) Non of above
131
2) Dividend on shares received

a) Deferred Revenue Income b) Revenue expenses
c) Revenue Income d) Capital Gain
3) Insurance claim received for loss of stock by fire.

a) Revenue Loss b) Capital Loss
c) Revenue Receipt d) Capital Receipt
4) Subsidy of Rs.10,000 received from Government for purchase

of computer.
a) Capital Receipt b) Revenue Receipt
c) Capital Loss d) Liability payable
5) Audit fees paid to Chartered Accountant.

a) Revenue Expenditure b) Capital Expenditure
c) Capital Loss d) Revenue Receipts
6) Legal fees paid to lawyer to defend civil suit.

a) Capital Expenditure b) Revenue expenditure
c) Deferred Revenue expenditure d) Non of the above
7) Travelling expenses of the director on trips abroad for purchase

of machinery.
a) Revenue expenditure b) Capital Expenditure
c) Revenue Loss d) All of the above
Ans. : 1 - b, 2 - c, 3 - c, 4 - a, 5 - a, 6 - b, 7 - b

Pick up the correct answer from the following choices :
1) A bad debts recovered during the year.
a) Capital receipt b) Revenue Receipt
b) Revenue loss d) Capital expenditure
2) Sale of old plant & machinery at loss.
a) Capital loss b) Capital gain
c) Capital Receipt d) Revenue receipt
3) Heavy advertisement expenditure to launch a new product.
a) Revenue Expenditure b) Capital expenditure
c) Deferred Revenue Expenditure d) Revenue loss
4) Annual white-washing expenses.

a) Capital Expenditure b) Revenue Expenditure
c) Revenue loss d) Deferred Revenue expenditure
132
5) Goods withdrawn by proprietor for own use.

a) Capital Gain b) Capital loss
c) Capital Receipt d) Non of the above
6) Stationery purchased for office use.
a) Revenue expenditure b) Capital expenditure
c) Revenue loss d) Capital loss
7) Amount spend on the overhauling of old machinery purchased.
a) Capital expenditure b) Revenue expenditure
c) Deferred revenue expenditure d) Capital loss
8) Placed an order for purchase of plant.
a) Capital expenditure b) Revenue expenditure
c) Revenue loss d) None of the above
Ans. : 1 - b, 2 - c, 3 - c, 4 - b, 5 - d, 6 - a, 7 - a, 8 - d
Match the following columns :
Column A Column B
1) Capital work-in-progress a) Deferred revenue expenditure
2) Raw material purchased b) Capital Receipt
3) Heavy advertisement c) Investment
4) Sale of old furniture d) Revenue expenditure
5) Purchase of shares e) Drawing
f) Capital expenditure
g) Deferred revenue income
Ans. : 1 - g, 2 - d, 3 - a, 4 - b, 5- c
Match the following columns :
Column A Column B
a) Capital receipt i) Profit for current year
b) Revenue expenditure decrease ii) Sundry debtors
c) Current assets iii) Current liability
d) Bills payable iv) Revenue expenditure
e) An Expenditure from which no v) Non-recurring nature
future benefit is expected
f) Capital introduced by the vi) Capital receipt
proprietor
vii) Fixed Assets
viii) Fictitious assets
Ans. : a - v, b- i, c- ii, d- iii, e- iv, f - vi

133
State with reasons whether the following statements are True

or False.
i) Legal fees paid to acquire a property is capital expenditure.
ii) Expenses incurred on the repairs & white washing for the first
time on purchase of an old building are revenue expenditure.
iii) Amount spent for replacement of worn out part of machine is
revenue expenditure
iv) Expenditure means payment made by business to obtain some
benefit.
v) Capital expenditure is recurring in nature.
vi) Intangible asset is an asset which has a physical identify.
vii) Revenue expenditure reduces profit & funds for the year.
Ans. : True : i, ii, iv, vii
False : iii, v, vi
State with reasons whether the following statements are True

or False.
a) Carriage paid for purchases of machinery is capital expenditure.
b) Repairs to furniture Rs.500 is capital expenditure.
c) A petrol car engine was replaced by a diesel engine is revenue
expenditure.
d) Purchase of 10% Govt. loan is capital expenditure.
e) Custom duty paid on import of raw materials is revenue
expenditure.
f) A sum of Rs.45,000 was spent on painting of office building
once in five years is revenue expenditure.
Ans. : True : a, d, e,
False : b, c, f.


134
Unit-8
FINAL ACCOUNTS OF MANUFACTURING
CONCERN [PROPRIETARY FIRM]
UNIT STRUCTURE
8.0 Objectives
8.1 Introduction
8.2 Manufacturing Account
8.3 Trading Account of A Manufacturer
8.4 Profit & Loss Account
8.5 Balance Sheet
8.6 Specimen Forms
8.7 Adjustments
8.8 Exercise
8.0 OBJECTIVES
After studying the unit, students will be able to:

 Understand the meaning, purpose, form and items of
Manufacturing A/C.
 Understand the form and items of Trading A/C and Profit &
Loss A/C.
 Know the meaning and form of Balance sheet.
 Draw the specimen forms of final accounts.
 Understand the meaning, types and closing entries for
adjustments.
8.1 INTRODUCTION
All business transactions are recorded in books of accounts.

The primary function of accounting is to accumulate accounting
data in a manual that the amount of profit or loss suffered during
the period can be determined along with status of the business in
financial terms. Final Accounts are prospered for this purpose. Final
Accounts are also known as Financial Statements. Preparation of
Final Accounts is last phase of the accounting process.
The accounting process starts from recording all business

transactions in set of books. At the end of accounting year, a
135
statement is proposed listing all balances namely Debit & Credit.

This statement is called Trial Balance. The total of debit and credit
balances must tally with each other.
This chapter deals with preparation of Final Accounts of

manufacturing concern carried on by sole proprietor. Sole
proprietor concern means business is camped and headed by one
person only.
Final Accounts of Manufacturers include Manufacturing A/C,

Trading A/C, Profit & Loss A/C and Balance Sheet. Normally Final
Accounts are prepared for a period of 12 months, called as
Accounting Year, Calendar Year (ending on 31st December) or
Financial Year / Govt Year (ending on 31st March) or it many any
other year ended (Diwali).
The purpose of preparing Manufacturing A/C is to ascertain

cost of goods produced during the period. Manufacturing A/C is
part of Final Account, it addition to Trading A/C and Profit & Loss
A/C. Costs of finished goods produced are then transferred to
Trading Account. Trading and Profit & Loss A/C is prepared to find
out gross profit and net profit/loss of the year. These accounts
measure the result of business operations. It is essential to match
revenues of an accounting period with costs assignable in earning
the said revenues. This process is known as “The Matching
Concept” which leads to the preparation of Final Accounts. Balance
Sheet is prepared to show the financial position of the business at
the end of accounting year.
Once all the adjustment entries are passed, the Trial

Balance contains a ready list of the closing balances of all ledger
accounts. The Trial Balance can now be directly used for preparing
the Final Accounts i.e. the Profit & Loss Account and the Balance
Sheet. In case of a Manufacturer, the Profit & Loss Account is
divided into: (a) Manufacturing Account, (b) Trading Account and
(c) Profit & Loss Account. In case of a trader, the Profit & Loss
Account is divided into: (a) Trading Account, and (b) Profit & Loss
Account. Each account in the Trial Balance must be shown in either
the Profit & Loss Account or the Balance Sheet.
8.2 MANUFACTURING ACCOUNT
8.2.1 Meaning:
A manufacturer sells finished goods manufactured by

himself in his factory; while a trader sells goods purchased by him
from the manufacturer. The manufacturer purchases raw materials
and converts them into finished goods by means of machinery and
136
labour in the factory. So, it is necessary for a manufacturer to

spend on wages to workers, on the manufacturing process, on the
factory etc. The manufacturer, therefore, prepares a “Manufacturing
Account” to find out his cost of finished goods manufactured.
Manufacturing A/C means an account showing the summary of the
cost of the manufacturing activity during the accounting year.
8.2.2 Purposes
The manufacturing account serves the following purposes.

i) It shows total cost of finished goods manufactured.
ii) It also shows cost of raw material consumed.
iii) It also provide details of appropriate i.e. direct and indirect
manufacturing cost.
iv) Comparison of cost of finished goods as per Manufacturing
Account and as per cost records kept by Costing Department.
v) Finished goods manufactured may be transferred to Trading
at market price. In such care production profit can be
ascertained.
8.2.3 FORM
Manufacturing Account is a ledger account. Its title is written
as Manufacturing Account for the year ended ….. It is divided into
two equal sides Debit and Credit, (see Worksheet 6.5 for specimen
Manufacturing Account.)
8.2.4 ITEMS
A Manufacturing Account contains the following items:
1. Opening Stock of WIP:
The opening stock of Work-in-process (WIP) is shown as the
first item on the debit side of the Manufacturing Account. Work-
in-process means raw materials not yet fully converted into
finished goods, also known as partly finished goods. The value
of Work-in-Process is made up of the cost of raw material and
the manufacturing expenses incurred for processing.
2. Raw Materials:
Next, the consumption of raw materials (also called Rs.direct
materials’) is shown as follows:
Opening stock of raw materials.
Add : Purchase of raw materials
Add : Direct Purchase Expenses
(Carriage inwards, freight inwards, octroi, customs duties)
Less : Purchase returns of raw materials
Less : Closing stock of raw materials
= Consumption of raw materials
137
Direct purchase expenses means all expenses incurred in

connection with purchase of raw materials e.g. transportation,
loading and unloading, coolie charges, insurance etc. Goods may
be purchased locally or imported from other countries. Local
purchases involve expenses of Carriage inward, Freight inward,
Coolie charges and cartage etc. Imported goods involves imports
expenses of dock dues, customs duties, insurance etc. These
expenses increase the cost of purchased raw materials.
a) Carriage Inward: Carriage expenses means expenses for

transporting goods. These are also known as freight, cartage,
coolie and cartage etc. The expenses for transporting the goods
purchased from the supplier to manufacturer’s premises, known
as Carriage inward. Freight inward etc. are debited to the
Manufacturing Account. The expenses on transporting the
goods sold from manufacturer’s premises to the customer,
known as Carriage outward, Freight outward, are debited to the
Profit & Loss A/C. The expenses on transporting new machinery
etc. purchased are debited to the Machinery A/C. i.e. that
expenses are capitalized.
b) Octroi Duty: Octroi duties mean the taxes paid to a Municipality

on goods brought within the municipal area from outside. Octroi
on purchase of goods is debited to the Manufacturing Account.
Octroi on machinery purchased is debited to the Machinery A/C.
c) Dock Dues, Custom Duties: Dock dues mean the expenses of

unloading the goods in a port. Custom duties means the taxes
paid to the Government; on goods imported from other
countries, also known as import duties. Freight, insurance, dock
dues and customs duties on imports of Raw Materials are
debited to the Manufacturing Account. However, if goods are
sold to other countries (exported), expenses on such exports
(freight, dock dues for loading the goods on ship, export duties
etc.) should be debited to the Profit & Loss Account, since they
are selling expenses. Dock dues and custom duties on
machinery imported are debited to the Machinery A/C.
(3) Wages: These include the wages paid to workers directly

engaged in production, also known as direct or productive
wages or direct labour costs. (A combined item of Wages and
Salaries appearing in the trial balance is shown in the
Manufacturing Account, while a combined item of Salaries and
Wages is shown in the Profit & Loss Account).
(4) Manufacturing Expenses: These include the expenses directly

connected to manufacture such as royalty, hire charges of
special machinery, design expenses etc. While royalty for using
know-how connected with manufacturing process is taken to
138
Manufacturing Account, royalty for use of trade mark is a selling

expense shown in the Profit and Loss Account.
(5) Factory Expenses : These include all expenses incurred at the

factory such as (a) stores, oil, grease (b) salary to supervisors
(c) power and fuel (d) repairs and maintenance of factory
building and machinery (e) depreciation of factory assets such
as factory building and machinery (f) rent, rates and taxes,
insurance, lighting of factory building and so on.
(6) Closing Stock of WIP: The value of closing stock of work-in-

process is shown on the credit side of the Manufacturing
Account.
[Note: Alternatively, instead of showing opening WIP on debit and

closing WIP on credit, the difference between the opening and
closing stocks of WIP is calculated first. If opening stock is more
than closing stock, the difference (opening stock of WIP – closing
stock of WIP) is shown on the debit side of the Manufacturing A/C;
if closing stock is more than opening stock (closing stock of WIP –
opening stock of WIP), the difference is shown on the credit side of
the Manufacturing A/C].”
(7) Sale of Scrap: Sale of scrap is shown on the credit side of the
Manufacturing Account.
(8) Cost of Production: The cost of production of goods is found

out by balancing the Manufacturing Account. The Manufacturing
Account is balanced like a ledger account. We take the totals of
both the debit and credit sides of the Manufacturing A/C. In a
Manufacturing A/C, the debit side will always be bigger than the
credit side. This indicates the Net Cost of Production of the
concern. Thus, Gross cost of production Less WIP (Closing)
and Sales of scrap = Net cost of production. We write the
amount of cost of production on the credit side of the
Manufacturing A/C and carry it down to the debit side of the
Trading Account. The cost of production (also known as cost of
manufacture or cost of goods produced is transferred to the
Trading Account in order to find out the Gross Profit or Gross
Loss on sale of finished goods.
8.2.5 CLOSING ENTRIES:
The following worksheet shows entries to be passed to

transfer the closing balances of the Goods Accounts and other
Manufacturing Expenses Accounts, to the Manufacturing Account:
139
WORKSHEET 1: CLOSING ENTRIES

(MANUFACTURING A/C)
No. Entries Amount

(1) Transfer Debit Balances : Dr. Cr.
Manufacturing Account Dr. X
To Opening Stock of WIP A/c X
To Raw Material Purchases A/c X
To Direct Purchase Expenses A/c X
To Wages A/c X
To Manufacturing Expenses A/c X
To Factory Expenses A/c X
(2) Closing Stock of WIP :
Closing Stock of WIP A/c Dr. X
To Manufacturing Account X
(3) Sales of Scrap :
Sales of Scrap A/c Dr. X
(4) Transfer Cost of Production to Trading
A/c.
Trading Account Dr. X
8.2.6 TRANSFER AT PRICE HIGHER-THAN-COST:
1) Transfer at Sales Price or Cost + Fixed %: We have already

seen how manufacturing account is prepared when the
manufactured items are transferred at cost to the Trading
account. However, the items produced by the manufacturing
section may be transferred to the Trading A/C at a price higher
than the cost i.e. (i) at cost plus a mark-up (e.g. cost + 25%); or
(ii) at selling price.
2) Entries for Transfer: If the goods are transferred at a higher-

than-cost price, the transfer to the Trading A/C will be credited
to the Manufacturing Account at the transfer value (i.e. loaded
price or selling price) and not at cost of manufacturing. The
excess of transfer price over the cost of manufacturing will
indicate the manufacturing profit. If, cost of manufacturing is
more than the transfer price it shows as manufacturing loss.
140
3) Closing Stock of Finished Good at Transfer Value: If some

of the manufactured goods remain unsold and form part of the
closing stock of finished goods at the year-end, such closing
stock will be valued at the transfer price in Trading A/C.
If the transfers to the Trading Account were made at cost price,

the closing stocks would also be valued at cost and no further
adjustment is needed.
If all the goods transferred at higher-than-cost have been sold, it

means that the anticipated profits have been actually earned
and no further adjustment need be made.
However, if any of the finished goods transferred to the Trading

Account at loaded price or selling price are in stock, the value of
the stock needs to be adjusted. Thus, if the cost is Rs.100 and
the goods are transferred at Rs.120, the profit element (Rs.20)
is included in the closing stock. Otherwise, it will amount to
taking credit for anticipated or unrealised profit which is against
the accounting principle of “conservatism.” Unrealised profit
included should be considered as Stock Reserve.
4) Stock Reserve: The unrealised profit in closing stock is

eliminated by creating a stock reserve in respect of the stock of
manufactured goods. The amount of stock reserve is calculated
by the following formula:
Stock reserve =
Profit Included in Transfer Price

Transfer Value of Stock
Transfer Price
5) Entry for Stock Reserve: The creation of the reserve is made

by the concern in the General Profit and Loss Account as
follows:
Profit of Loss A/c. Dr.
To Stock Reserve A/c.
(Being the reserve created for unrealised profit included in
closing stock)
6) Balance Sheet: The relevant part of the Balance Sheet will
appear as follows:
141
Balance Sheet as at….
Assets Rs.
Current Assets :
Closing Stock (Transfer Value) xx x y
Less : Stock Reserve (xx) XX
XX
7) Next Year: In the beginning of the next year, the above entry
is reversed as follows:
Stock Reserve A/c. Dr.
To Profit & Loss A/c.
8.3 TRADING ACCOUNT OF A MANUFACTURER
8.3.1 ITEMS
1) Opening Stock of Finished Goods: The opening stock of

Finished Goods (FG) is shown as the first item on the debit side
of the Trading Account.
2) Cost of Finished Goods manufactured: Next, the Cost of

goods manufactured transferred from the Manufacturing
Account is shown on debit side of the Trading Account.
3) Sales of Finished Goods: The net sales of finished goods

(sales less returns) are shown on the credit side of the Trading
Account.
4) Other Out Going of Finished Goods : Sometimes, the Trial

Balance or it may be given by way of adjustment may contain
Other Goods Accounts such as Goods Lost by Fire A/c, Goods
Withdrawn by Proprietor, Goods Distributed as Free Samples,
etc. These accounts record the cost of finished goods lost,
withdrawn or distributed. Since goods go out, these accounts
are shown on credit side. These balances are transferred on the
credit of the Trading Account.
5) Closing Stock of Finished Goods: The closing stock of

Finished Goods is shown as the next last item on the credit side
of the Trading Account.
6) Gross Profit or Gross Loss: The final result is found out by

balancing the Trading Account. The Trading Account is
balanced like a ledger account. We take the totals of both the
debit and credit sides of the Trading A/c. If the credit side is
higher, it indicates that the value of sales is more than the cost
of goods manufactured & sold. This is called the Gross Profit
142
earned by the business. Thus, Income From Goods Sold Less

Cost of Goods Sold = Gross Profit. We write the amount of
Gross Profit on the debit side and carry it down on credit side of
the Profit and Loss Account. If the debit side is higher, it
indicates that the cost of manufacture is more than the value of
sales. This is called Gross Loss. Gross Loss = Cost of Goods
Sold Less Sales. We write the amount of Gross Loss on the
credit side of the Trading A/c and carry it down to the debit side
of the Profit and Loss Account. The Gross Profit or Gross Loss
is transferred to the Profit and Loss Account in order to find out
the Net Profit or Net Loss after deducting other indirect
expenses. Thus, Gross Profit Less Expenses = Net Profit. In
case expenses are more than Gross Profit, then it amounts
to Net Loss.
8.3.2 Closing Entries:

The following worksheet shows entries to be passed to
transfer the closing balances of the Sales Accounts and other
Accounts, to the Trading Account:
WORKSHEET 2: CLOSING ENTRIES (TRADING A/C)
A/o. Entries Amount

To Opening Stock of Finished Goods A/c X
To Returns Inwards A/c X
(2) Transfer Credit Balances :
Sales of Finished Goods A/c. Dr. X
Finished Goods Lost/Taken/Distributed A/c X
(at cost) Dr. X
To Trading A/c X
(3) Closing Stock of Finished Goods
Closing Stock of Finished Goods A/c Dr. X
To Trading Account X
(4) Transfer Gross Profit or Gross Loss to
Profit & Loss A/c:
(i) Gross Profit :
To Profit & Loss A/c X
(ii) Gross Loss :
Profit & Loss A/c Dr. X
To Trading Account X
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8.4 PROFIT & LOSS ACCOUNT
8.4.1 Meaning
Closing balances of all nominal accounts, relating to the

remaining income and expenses are transferred to Profit & Loss
A/c. Debit side of the Profit & Loss A/c shows expenses like
Administrative Expenses, Selling Expenses, Financial Expenses,
Depreciation and other Unusual Expenses and Losses. Credit side
of the Profit & Loss A/c shows Other Business Incomes and Gains.
The balance of the Profit & Loss A/c shows the result of business
operations during the year. The net profit or net loss shown by the
Profit & Loss A/c is transferred to the Capital Account of the
proprietor.
8.4.2 FORM
Profit & Loss Account is a ledger account. Its title, is written
as “Profit & Loss Account for year ended….. “ It is divided into two
equal sides: Debit and Credit as per the specimen shown in
Worksheet 7.
8.4.3 ITEMS
The following items normally appear in a Profit & Loss
Account.
(1) Gross Profit or Gross Loss b/d : The Gross profit b/d from the
Trading Account is the first item on the credit side of the Profit &
Loss Account. If there is Gross loss, it is the first item shown on
the debit side of the Profit & Loss Account.
(2) Administrative Expenses: Administrative expenses are the
expenses incurred to plan, organize, administer and control the
business. Examples are (a) Salaries to office staff, (b) Rent,
rates, insurance, lighting of office, (c) Printing, telephones, telex,
postage, (d) Depreciation and repairs of office equipments,
building, furniture, vehicles, (e) Legal charges, Audit charges,
Bank charges etc.
(3) Selling and Distribution Expenses: Selling expenses are the
expenses incurred to create and increase demand for goods.
Distribution expenses are the expenses incurred from the time
goods sold leave the trader’s premises till the goods reach the
customer. Examples are (a)Packing materials (b) Salaries of
Sales and Distribution staff (c) Traveling, Conveyance (d)
Commission or discount on sales (Advertisement or showroom
expenses (f) Warehouse or sales office rent, rates, insurance,
lighting etc. (g) Freight outward, carriage outwards, expenses
on exports (h) Depreciation and repairs or delivery van, vehicles
etc.
144
(4) Finance & Interest Expenses: Finance expenses are the

expenses incurred to obtain loans, bank charges and cash
discount to debtors etc. The other item shown under this head is
interest paid on loans.
(5) Losses: Losses include amounts lost by the business by way of

Goods lost by fire, Goods distributed as free samples, Bad
debts, Loss on sale of fixed assets etc. These are debited to the
Profit & Loss Account.
(6) Other Income : Other income includes amounts received by

way of interest on loans given, dividends received on amounts
invested in shares, rent received from premises given on rent,
discount received, commission received, Profit on sale of fixed
assets and so on. All these amounts/incomes are credited to the
Profit & Loss Account.
(7) Gains: Gains includes amounts received by the business by

way of recovery of bad debts, subsidies or grants received etc.
These are credited to the Profit & Loss Account.
(8) Appropriations: Appropriations mean amounts transferred out

of net profits for payment of income-tax or creating a reserve
(e.g. reserve for contingencies). These appear on the debit side
of the Profit & Loss A/c. Income Tax is considered as personal
expenses. Therefore, it should be treated as Drawings.
9) Net Profit or Net Loss: The net profit or the net loss is found
out by balancing the Profit & Loss Account. The Profit & Loss
Account is balanced like a ledger account. We take the totals of
both the debit and credit sides of the Profit & Loss Account. If
the credit side is higher, it indicates that the Total Income is
more than the Total Expenses. This is called the Net Profit
earned by the business. Thus, Income Less Expenses = Net
Profit. In the next step, the amounts of income tax or transfer to
Reserves etc. (known as Rs. appropriations’ out of profits) are
debited to the Profit and Loss Account. Appropriations can be
made only after ascertaining the amount of net profits (as the
amount of income-tax depends upon the amount of net profits).
Then, write the amount of Net Profit on the debit side and
transfer it to the credit of the Capital Account.
If the debit side is higher, it indicates that the Expenses are

more than Income. This is called Net Loss. Thus, Expenses Less
Income = Net Loss. In case of net losses, there can be no
appropriations (e.g. no income-tax is payable if there is a net loss).
We write the amount of Net Loss on the credit side of the Profit &
Loss Account A/c and transfer it to the debit of the Capital Account.
The Net Profit or Net Loss belongs to the owner and hence is
145
transferred to the Capital Account. The net profit is a reward to the

owner for his money invested in the business, for his efforts in
running the business and for the risks taken by him.
8.4.4 Closing Entries:
The following work-sheet shows entries to be passed to

transfer the closing balances of the Nominal Accounts to the Profit
& Loss Account:
WORKSHEET 4: CLOSING ENTRIES (P & L A/C)
No. Entries Amount

Profit & Loss Account Dr. X
To Various Expense Accounts X
To Various Losses Accounts X
(2) Transfer Credit Balances :
Various Income Accounts Dr. X
Various Gains Accounts Dr. X
To Profit & Loss Account X
(3) Appropriations :
To Income-tax (Drawings) X
To Reserve (e.g. Contingency Reserve) A/c X
(4) Transfer Net Profit or Net Loss to Capital A/c
(i) Net Profit:
To Capital A/c X
(ii) Net Loss :
Capital A/c X
To profit & Loss A/c X
CHECK YOUR PROGRESS
1. Define the following terms

a. Appropriations
b. Finance expenses
c. Selling and distribution expenses
d. Administration expenses
146
e. Manufacturing A/c
f. Direct Expenses
g. Stock reserve.
2. Fill in the blanks:
a. If the debit side of the Profit and Loss A/c is higher, it
indicates ----------------.
b. Gross loss is shown on the ----------------side of the P &L A/c.
c. --------- side of the Profit & Loss A/c shows Expenses.
d. The Income From Goods Sold Less Cost of Goods Sold = ---
------------------.
e. Manufacturing Account is prepared to find out cost of ---------.
f. Opening and closing balances of finished goods are shown
on the ----------------------- A/c.
3. Enlist the items to be shown on the debit side of the
Manufacturing A/c.
4. Give the formula for calculating the consumption of raw
materials.
8.5 BALANCE SHEET
8.5.1 Meaning
From the Trial Balance, all Nominal (manufacturing
Expenses) Accounts are transferred to the manufacturing and
Trading Account and all the Nominal Accounts of Income and
Expenses are transferred to the Profit & Loss Account. At this
stage, only the Real Accounts pertaining to Assets and the
Personal Accounts of debtors, creditors and liabilities remain in the
Trial Balance. All these remaining accounts are shown in a
statement known as the Balance Sheet. Balance Sheet is a
statement containing the list of all Real and Personal Accounts as
on a particular day, normally the year end. The Real Accounts and
Personal Accounts are classified in the Balance Sheet into Assets
and Liabilities. Debtors are included under Assets and Creditors
and Capital Account are shown under liabilities. Hence, Balance
Sheet also means a statement of assets and liabilities of the
business as on the last day of the accounting year. Balance Sheet,
thus, shows the financial position of the business i.e. what it
owns and what it owes.
Balance Sheet is not an account; it is a statement. As its

name suggests, it is a Sheet of Balances, remaining after the
Manufacturing, Trading and Profit & Loss Account is prepared.
While preparing a Balance Sheet, no closing entries are passed, as
the balances are not transferred from the Trial Balance, but only
listed in the Balance Sheet. Various Assets & External Liabilities
may be transferred to Capital Account by passing following entries.
147
Date Particulars L. F. Dr. Cr.

Rs. Rs.
31.3 1] Capital A/c Dr. X
To Fixed Assets A/c X
To Current Assets X
[Being various assets transferred
to capital A/c]
2] Loans A/c Dr. X
Sundry creditors A/c Dr. X
Bills Payable A/c Dr. X
Other Sunday Liabilities A/c Dr. X
To Capital A/c X
After passing above entries at the end of the year, all

accounts are closed.
In next year above entries are revised, to open books of

Accounts.
The balances appearing in the Balance Sheet are carried

forward as the opening balances of these accounts in the ledger of
the next year. A Balance Sheet need not be balanced; its totals
must always tallied. The Total Assets must always be equal to the
Total Liabilities.
8.5.2 Form:
The title is written as Balance Sheet as on… Balance Sheet

is not an Account, hence the words DR. and CR. are not required.
Balance Sheet is vertically divided into two side: Left Hand Side
and Right Hand Side. Left hand side of the Balance Sheet shows
Liabilities like Capital, Reserves, Loans, Creditors for goods,
outstanding expenses etc. Right hand side of the Balance Sheet
shows Assets e.g. Fixed Assets (Gross Cost Less Depreciation),
Investments, Current Assets like pre-paid expenses, advances,
debtors, stock, cash bank etc. (See Worksheet 8.)
8.5.3 Order:
The Various items of assets and liabilities are listed in the

order of permanence of the items. On the Assets side, the
permanent or the long term items i.e. the Fixed Assets are shown
first, followed by short term assets i.e. the current assets. On the
Liabilities side, the long term liabilities i.e. Capital and Loans are
148
shown first, followed by short term liabilities i.e. current liabilities. In

case, the items are shown in order of liquidity, the assets and
liabilities are shown in the reverse order, i.e. short term items are
shown first, followed by long term items.
8.5.4 Items:
(1) Fixed Assets: Fixed Assets are items like Goodwill, Land,
machinery, building and trucks etc, which benefit the business for a
long term. Fixed assets are not normally sold: Fixed Assets may be
tangible or intangible. Tangible Assets are items like machinery,
building etc. which physically exist (tangible means that which can
be touched). Intangible Assets are invisible items like Goodwill,
Patent, and Trade Marks etc. which do not physically exist, but do
benefit the business over a long period of time. Goodwill means the
reputation of a concern which attracts more and more customers to
it., enables to earn more super profit on Capital employed. Patent
means a legal right of an inventor or of a new product to exclusively
use or sell such product. Trade Mark is a registered name or
symbol of a product which can be used only by the owner of the
trade mark.
(2) Investments: Investments includes items like Shares,

Debentures and Savings certificates etc. which earn interest or
dividends.
(3) Fictitious Assets: Fictitious Assets include items like Deferred

Revenue Expenses, Preliminary Expenses etc. Deferred Revenue
Expenses is defined as the expenses which are carried forward as
their benefit is also available in subsequent years. To defer means
to carry forward. For example, if advertising expenses of
Rs.1,00,000 incurred in 2012 are expected to benefit the business
for 5 years, the entire amount of Rs.1,00,000 is not debited to the
Profit & Loss Account in 2012. Only 1/5th amount (Rs.20,000) is
debited to the Profit & Loss Account every year for 5 years from
2012 to 2016. The amount not yet written off at the year end will be
shown as Deferred Advertising Expenses on the Asset side in the
Balance Sheet.
(4) Current Assets: Current Assets are items like cash, debtors,
stock etc. which remain in the business only for a short time [less
than 12 months]. Current assets are constantly changed into cash.
Thus, goods are sold and cash is received, debtors pay their dues
and cash is received and so on. Current Assets also includes
Pre-paid Expenses and Income Receivable.
(5) Capital: Capital means the amount due to the owner of the
business. Capital is shown on liabilities side of the Balance Sheet
as follows:
149
Capital A/c b/d (opening balance)

Add: Net Profits for the year
Less: Net Loss for the Year
Less: Drawings
= Closing Balance of Capital
(6) Reserves: Reserve means part of profits “reserved” for future

use. It is an amount set aside out of profits to meet any unknown
sudden liability in future. Out of Net Profits, some amount is
transferred first to the Reserve, only if it is asked the only part of
profit to be transferred to reserve and only the balance is
transferred to the Capital Account.
(7) Loans: Loans include Bank Loans and the amounts borrowed
from others on which interest is paid.
(8) Current Liabilities: Current Liabilities are short term liabilities.

These include creditors for goods, outstanding expenses, various
provisions for expenses, income received in advance, Bank over
draft. Current liabilities are payable within 12 months.
CHECK YOUR PROGRESS

1. Fill in the blanks:
a. A Balance Sheet need not be balanced; its totals must
always -------------------.
b. Balance Sheet is not an Account, it is a -----------------------.
c. Left hand side of the Balance Sheet shows ----------------.
d. Right hand side of the Balance Sheet shows --------------.
e. Goodwill and patents are --------------------assets.
f. Deferred Revenue Expenses is a ----------------------asset.
g. Balance Sheet is a statement containing the list of all ---------
and ----------- Accounts.
h. Current assets are constantly changed into -----------------.
i. Current liabilities are payable within ----------months.
j. The items which earn interest or dividends are termed as ---.
2. Enlist the items shown on the assets side of the Balance Sheet.
a. Balance Sheet
b. Current Assets
c. Tangible Assets
d. Intangible Assets
e. Capital
f. Current Liabilities
150
8.6 SPECIMEN FORMS:
8.6.1 Specimen Form of Manufacturing Account
Dr. Manufacturing Account for the year ended… Cr.

Particulars Rs. Rs. Particulars Rs.
To Work-in-process xxx By Work-in-process xxxx
(Opening) (Closing)
To Raw materials By Sales of scrap xxxx
consumed:
Opening Stock xxx By Trading Account xxxx
Add : Purchase xxx (Cost of production
tfd Bal.)
Add : Purchase expenses
- Carriage Inward xxx
- Octroi duty xxx
- Dock dues xxx
- Custom duties xxx
Less : Purchase Returns (xxx)
Less : Closing stock of (xxx) xxxx
materials
To Direct Wages xxxx
To Direct manufacturing
expenses
To Royalty related to xxx
manufacture
To Hire of special xxx
machinery
To Design Expenses xxx xxxx
To Direct factory
expenses
To Stores, oil, grease xxx
To Salary to supervisors xxx
To Power and fuel xxx
To Repairs of factory xxx
assets
To Deprecation on factory xxx
assets
To Rent, lighting of xxx xxxx
factory building
Total xxxx Total xxxx
151
8.6.2 Trading Account for the year ended …..

Dr. Cr.
To Opening stock (FG) xxxx By Sales xxxx
To Manufacturing Less:Return inwards xxxx xxxx
Account (cost of xxxx By Goods lost or xxxx
destroyed
Production tfd.) By Goods taken by xxxx
proprietor
To Purchase of FG By Goods given as free xxxx
sample
To Gross profit c/d xxxx By Closing stock (FG) xxxx
By Gross loss c/d xxxx
8.6.3 WORKSHEET 7: PROFIT & LOSS ACCOUNT
Profit & Loss Account for the year ended……

Dr. Cr.
Particulars Rs. Particular Rs.
To Gross Loss xxxx By Gross Profit b/d xxxx
b/d Other Income or Gains
To Administrative xxxx By Commission received xxxx
Expenses
To Rent, insurance & xxxx By Discount received xxxx
repairs
To Office salaries xxxx By Provision for discount xxxx
To Postage, telephones, xxxx From creditors
Telex etc. xxxx By Interest on loans xxxx
To Printing & stationery xxxx Given to outsiders xxxx
To Fees (legal/audit etc.) By Income (dividend) on xxxx
To Sundry/general xxxx Investments
Expenses xxxx By Profit on sale of fixed
To Selling & Distribution xxxx Assets
Expenses xxxx By Net loss tfd. to capital
To Salesmen’s salaries, xxxx
Commission, etc, xxxx
To Traveling xxxx
152
To Carriage outwards,
Freight, duties xxxx
To Warehousing charges
To Packing expenses xxxx
To Royalties on sale xxxx
To advertising & sales xxxx
Promotion expenses
To Goods given as free
Samples
To Financial Expenses & xxxx
Interest
xxxxx
To Interest & bank xxxx
charges
To Bad debts & provision xxxx
for Bad debts
To Discount given
To provision for discount xxxx
on Debtors
Depreciation xxxx
To Depreciation on :
- Building xxxx
- Motor vehicles/delivery
vans
- Office equipments
To Unusual Expenses or
Losses
To Goods lost or
destroyed
(Cost less insurance
claim)
To Loss on sale of fixed
Assets
To Appropriations
To Reserves
To Net profit tdf. to
Capital ….. xx
153
8.6.4 WORKSHEET 8: BALANCE SHEET :

There may be either Net Profit or Net Loss.
Balance Sheet as at ……….
Liabilities Rs. Assets Rs.

Capital A count : Fixed Assets
Balance b/d (opening) x Goodwill xxxx
Land xxxx
Add : Fresh capital x Plants & machinery xx
Brought in
Add : Net profit for the x Less : Depreciation x
Years xxxx
Less : Drawing xx Premises/Building x
xxxx
Less : Loss during the - Less Depreciation x
Year xx xxxx
Reserves Vehicles
General Reserve xx
Loans -Less : Depreciation xx
Loans from bank xx xxxx
Bank overdraft xx xxxx Furniture & fittings xx
Current Liabilities
Sundry creditors xx - Less Depreciation xx xxx
Less : Provision for xx Investments xxxx

Discount Investment in xxxx
Bills payable xx Shares/bonds xxxx
Outstanding expense xx Current Assets xxxx
Income received in Closing Stock xxxx
Advance xx xxx Debtors xx xxxx
- Less; Prov, for bad x xxxx
Debts x
- Recoverable x
- Less : Prov, for
Discounts xx
- Relisable xx
154
Loans and advance xx

Given xx
Bills receivable xx
Prepaid expenses xx
Cash at bank xx
Cash in hand
Fictitious assets
Deferred expenses
Not written off xx
Capital account debit
Balance xx xxx
8.7 ADJUSTMENTS:
8.7.1 Meaning:
The trial Balance prepared indicates summery of all actual

transactions recorded in the Book of Accounts. The trial balance
ignores items not yet recorded in the books of accounts. e.g.
closing stock, outstanding expenses, prepaid expenses,
Depreciation, bad about etc. unless & until these items are not give
true and fair view of business operations and financial position.
These items must be recorded in books of accounts. The book
balances need to be adjusted from all items which pertains for the
period but not recorded in books. Adjustments mean recording
such items relating the current year but not appearing in the Trial
Balance.
8.7.2 Accounting:
Adjustment entries are passed in the journal proper at the

end of the year. Entries are passed by following rules of debit &
credit, then they are posted into the ledger. It should be noted that
each adjustment has two effects in the final Accounts.
Adjustments may be given below the Trial Balance, or may

be given in the Trial Balance, called implied adjustment,
155
Adjustment Journal Entries Manufacturing Balance Sheet

Trading
Profit & Loss A/c.
1) Closing Stock i. Stock of Raw Debit from Raw Show as “Stock of

(Goods Material A/c Dr material Raw Material on
Purchased but To Raw Material Purchases, or debit Asset Side”
remain unsold). . Consumed. side of
a. Raw Material. Manufacturing A/c.
b. Work in ii. Stock of work Credit side of mfg Show as “Stock of

Progress in progress A/c Dr A/c Show on credit W.I.P on Asset
To Trading A/c side of Trading A/c. Side.
Show as “Stock of
Finished Goods”
on Asset Side.
c. Finished iii. Stock of - All stock may be
Goods. Finished Goods as under Stock of
A/c Dr. To Raw Material
Trading A/c. Stock W.I.P. Stock
of Finished Goods
2) Prepaid Prepaid Deduct from the Show as “Prepaid
Expenses Expenses A/c. Dr conserved Expense Expenses” on
To Expenses. on debit side. asset side.
A/c.
3) Outstanding Expense A/c Dr Add to concerned Show on
expense related To outstanding exp. on debit side. “outstanding exp.”
to current year expenses A/c on liabilities side.
but not record /
paid.
4) Income Income Add to Concerned Show “income
Receivable Receivable A/c Dr income on credit Receivable” on
To Income A/c. side. asset side.
5) Income Income A/c Dr. Deduct from Show as |income

Received in To Income concerned income received in
advance income Received in on credit side. advance” as on
Received but not allowance A/c. liabilities side
accrued. i.e.
relates to
subsequent year.
6) Depreciation Depreciation A/c Depreciation on Deduct
Dr. factory Assets debit Depreciation from
To Fixed Asset to mfg. a/c Concerned Asset
A/c Depreciation on on asset side. OR
other asset debit to Add to provision
profit & A/c. for depreciation
A/c
156
7) Goods Loss by Fire/Theft a)” Loss by fire” -

destroyed Lost & A/c. Dr. To debit A/c profit &
Stolen. trading A/c. or loss A/c.
a) Uninsured To purchases
goods. Good lost A/c. b) Credit Cost of
goods lost to
trading A/c.
8) Unrecorded Sundry debtors Add to sales on Add to Sunday
Sales. A/c Dr To Sales Credit side of debtors on assets
A.c. trading a/c. side.
9) Unrecorded
Sales (return) Sales Return A/c Deduct from Sales Deduct from
Good Returned Dr. Credit side of Sunday Debtor on
by Customer but Trading A/c. Asset Side.
To Sundry
Credit not, is not
Debtor.
Prepared.
Recorded.
10) Unrecorded Purchase A/c Dr Add to Purchase on Add to Sunday
Purchases: To Supplier A/c. debit side of mfg. Creditors on the
Goods Purchase A/c Or Trading A/c. Liabilities Side.
but not recorded
in Purchase day
book.
11) Unrecorded Supplier A/c Dr. Deduct from Deduct from
Purchase return. To Purchase Purchase on debit Sunday Creditors
Goods retuned Return A/c side of mfg. A/c Or on the liabilities
to suppliers but Trading A/c.. side.
debit note not
prepaid
preceded.
12) Goods Free samples A/c Deceit to P & L A/c -
distributed as Dr as Advertisement
free sample. To Trading A/c. A/c
Credit to Trading
A/c as goods
distributed as free
samples.
13] Good Drawings A/c Dr. Credit to Trading Deduct from
withdrew by To Trading A/c. A/c as personal use capital on
owner for goods withdrawn Liabilities Side
personal use for own use.
14] Interest on Interest A/c Dr. Added to interest Add to Loon, as
Loan outstanding To Loon A/c on debit side Profit interest
& Loss A/C. outstanding on
Liabilities Side.
157
15) Good Sold a)For consolation a) Deduct from a) Deduct from

on approve not of Sales Sales on Trading Sunday Debtor on
yet approved. a) at sales Price A/c Credit Side. asset side.
Goods sold on b) Credit to Trading b) Add to Closing
Sales A/c Dr To
Sales or Return A/c on stock with Stock on asset
Customer
basis Customer customer i.e. add to side.
save right to b) For stock with
closing stock.
return goods Customer at cost.
Stock on approval
A/c Dr
To Trading A/c.
16)Baddebts Bad debts A/c Dr Add Bad depts. on Deduct from
/Further bad To Sunday debit side of Profit Sunday debtors an
debit to be Debtors. & Loss A/c. [as new Assets Side.
written off bad debts]
17) Provision for Profit & Loss Ac Profit & loss A/c Asset Side Sundry
Bad Debts/ Dr. Debit Side Debtors x –
doubtful debts: To R.D.D. A/c To new BDD x (Adj) Further / New Bod
Provision made debts)x) x – New
+ Bad debts x (Trial
for future out of R.d.d. X = x (x)
Bal)
present credit final Balance after
sales. + New Bad debts all other
x adjustment tilting
(adj)
x to Sunday
Debtors.
x
-Old R.D.D
x
(T.Bal)
18) Reserves for Discount A/c Dr When old R.D.D is Deduct from
Discount on To R.F.D.C. A/c more than required Sunday debtors on
Debtors: should be credited Asset side, after
Provision made to profit & loss A/c. adjustment as
for Discount on Add to discount on R.D.D.
Debtors: the debit side of the
Profit & Loss A/c.
19) Reserve for Reserve for Add it discount on Deduct from
discount on discount on Credit side of the sundry Creditors
Creditors: Creditors A/c Dr Profit & Loss A/c. on Liabilities Side.
To Discount A/c.
8.7.3 HIDDEN ADJUSTMENT/TEMPLED ADJUSTMENT.
Sometimes information about adjustments is given in the trial

balance. These adjustments should be considered while preparing
final accounts.
For example, Trial balance shows the following information.

158
Trial Balance as on 31st December 2012.
No. Particulars Rs. Rs.

1 Rent (11 months) 22,000
2 Insurance (For the Year 31.3.13) 12,000
3 10% Govt Bonds (30-06-12) 1,00,000
4 Interest on Govt Bonds - 2,500.
5 12% Investment (Face value Rs. 1.12.000
1,00,000)
6 Interest on investment - 9,000.
7 18% Bank Loan (01.10.12) 2,00,000
8 Advertisement (3 years) 30,000.
9 Building Rent (3/4 Factory) 60,000
Solution: Explanation:
1) Rent Paid for 11 months Rs. 22,000. It implies that Rent for one
month is outstanding.
= 22,000 / 11 = Rs. 2,000.
Add to Rent on Debit side of P & L A/c, Show in the Balance Sheet
Liabilities
2) Insurance Premium Paid for the year ended 31/03/13. Trial

Balance as on 31/12/12.
Therefore, 3 months insurance is paid in advanced  Prepaid

Insurance = 12,000 x 3/12 = Rs. 3,000/-.
Less from insurance on P & L A/c. Debit Side and write on Asset
side of Balance Sheet.
3 and 4: 10% Govt Bonds Purchased on 30-06-12; Interest on

6
Bonds for SDC months = 1,00,000 x 10% x = Rs. 5,000/-. Out of
12
Rs.5,000, Rs.2,500 are only received. Balance interest
Rs.2,500/- still not received. It is outstanding. Income on date of
Balance Sheet. Add to interest on credit side of P & L. A/c. and
show on asset side of Balance sheet as Interest Account bat not
received.
5 and 6: 12% Investment face value of Rs.1,00,000 Purchase for

Rs.1,12,000. Interest on this investment received Rs.9,000 only.
Interest should be always calculated on face value.
Interest for the year = 1,00,000 x 12%
= Rs.12,000/-.
159
Out of this, Rs.9,000/- only received. Balance Rs.3,000 still

receivable. Add to credit side of P & L A/c to income and show on
assets side of Balance sheet as Interest Receivable.
7. 18% Bank Loan taken on 1st Oct. 12.

Therefore, 3 months interest due to be provided
Outstanding Interest = 2,00,000 x 18% x 3/12
= Rs. 9,000/-.
Add to interest on Debit side of P & L A/c and add to Bank Loan on
Liabilities Side of Balance Sheet.
8. Advertisement Rs.30,000 paid for 3 years.

2
Two years advertisement 3,00,000 x = Rs. 20,000 is prepaid.
3
Prepaid Advertisement Rs.20,000, deduction from
Advertisement on debit side of P & L A/c show on Assets Side of
Balance Sheet, as a Prepaid Insurance.
9. Building Rent Rs.60,000.

3 3
Offices. Therefore, 60,000 x = Rs.45,000 should be
4 4
1
debited to the Manufacturing A/c. balance (i.e. ) Rs.15,000 to be
4
debited to Profit & Loss A/c.
Journal Entries
No Particulars J.H. Rs. Rs.

1 Rent A/c. Dr. 2000
To Outstanding Rent A/c 2000
2 Prepaid Insurance A/c Dr. 3000
To insurance A/c 3000
3-4 Interest Receivable A/c Dr. 2500
To interest. A/c 2500
5-6 Interest Receivable A/c Dr. 3000
To Interest A/c. 3000
7 Interest A/c. Dr. 9000
To 18% Bank Loan. A/c 9000
8 Prepaid Advertisement A/c Dr. 20,000
To Advertisement A/c 20,000
9 Manufacturing A/c Dr. 45,000
Profit & Loss A/c Dr. 15,000
To Building Rent A/c. 60,000.
160
8.8 EXERCISES
1. Write Short note on

a. Manufacturing A/c
b. Work in Progress.
c. Transfer of Goods at price higher than cost.
d. Stock Reserve
e. Trading A/c
f. Current Assets
2. Explain goods sold on sales or return basis.
3. Why Manufacturing A/c is prepared.
4. Explain how to calculate Raw Material consumed.
5. Objective Type Questions:
a. Multiple Choice Question
1. Debit Balance of Manufacturing A/c show:

a) Gross Profit b) Gross Loss,
c) Net Loss d) None of above.
2. Carriage inward shown in Trial Balance debited to:

a) Manufacturing A/c b) Profit & Loss A/c
c) Capital A/c d) Selling & Distribution exp.
3. Raw Material Consumed is transferred to:

a) Trading A/c b) Purchase A/c
c) Manufacturing A/c d) Balance Sheet.
4. Sale of scrap is credited to:

a) Manufacturing A/c. b) Cash/Bank A/c
c) Raw Material Consumer d) Trading A/c.
5. Credit Balance in Trading A/c shows.

a) Net Loss b) Cost of Goods sold
c) Gross Profit d) Gross Loss.
6. Carriage on machinery purchased debited to:

a) Manufacturing A/c b) Trading A/c
c) Plant & Machinery A/c d) Trading A/c
7. Prepaid Insurance shown in the Trial Balance is shown in :

a) Profit & Loss A/c
b) Liability side of Balance Sheet
c) Asset Side of Balance Sheet
d) Deducted insurance on Dr. side of Profit & Loss A/c.
161
8. Consumption of Raw Materials shown to:

a) Credit Side of Trading A/c
b) Credit side of Profit a Loss A/c
c) Debit Side of Manufacturing A/c
d) Purchases A/c
9. Stock of Raw Material given in Trial Balance is shown on:
a) Debit Side of Manufacturing A/c
b) Credit side of manufacturing A/c
c) Asset gives of the balance sheet
10. Opening work-in-progress appearing in the trial balance is
shown on:
a) Debit Side of manufacturing A/c
b) Trading A/c.
c) Credit side of manufacturing A/c
d) Asses side of Balance sheet
e) Non-of the above.
11. Depreciation of Factory Building is shown under.
a) Trading A/c b) Profit & Loss A/c.
c) Manufacturing A/c d) All of the above.
12. Trade Mark is:
a) Current Assets b) Fixed Asses
c) Intangible Asset d) Movable properties
13. Opening Stock of Raw Materials is :
a) Added to purchase of finished Goods.
b) Deducted from Raw Material Consumed.
c) Added to purchase of Raw Materials.
d) None of the above.
14. Reserve for Discount on creditors shows :
a) Credit Balance b) Debit Balance
c) Nil Balance d) Non of above
15. Manufacturing A/c balance always shows.
a) Gross Profit b) Net Profit
c) Cost of production d) Cost of sales.
16. Goodwill is:
a) Current Assets b) Fictitious Assets
c) Fixed Assets d) Terrible Assets
17. Trade Discount shall be shown:
a) Debit Side of Mfg. A/c b) Deducted from purchases
c) Debit side of p & L A/c. d) None of the above
Ans. 1-d, 2-a, 3-c, 4-a, 5-c, 6-c, 7-c, 8-c, 9-a, 10-a, 11-c, 12-c, 13-c,
14-a, 15-c, 16-b, 17-d.
162
b. Fill in The Blanks.

1) Debit balance of Manufacturing A/c indicates _______.
2) Plant & machinery is a --------------- asset.
3) Income received in advance is shown on _______ side of
Balance Sheet.
4) Income Tax Paid is transferred to ________ A/c.
5) Goods distributed as free samples is credited to _____ A/c.
6) Goods withdrawn by proprietor is credited to ______ A./c.
7) Commission paid is credited to ______ A/c.
8) _______ shows the finical position of business.
9) Manufacturing A/c is prepared only by ______.
10) Debit balance of Profit & Loss A/c shows ________.
11) Net Profit is transferred to ________ A/c.
12) Prepaid Insurance is credited to ______ A/c.
13) Depreciation on office equipments is credited to _______ A/c.
14) Bad debt written off is credited to _____ A/c.
15) _______ note is prepared for sales return of goods.
16) Gross Profit, 25% on cost is equal to _____ % on sales.
17) Bank Overdraft is shown on ______ side of Balance Sheet.
18) Stock of Stationery is shown on ______ side of Balance Sheet.
19) Carriage paid on furniture purchased is debited to _______ A/c.
20) Debit balance of Manufacturing A/c is transferred to ____ A/c.
21) Carriage outward paid is credited to _______ A/c.
22) Opening stock of work in progress is debited to _______ A/c.
23) Recovery of bad debts is credited _______ A/c.
24) Octroi paid on plant purchased is debited to ________ A/c.
Ans.
1) Cost of production, 2)Fixed, 3) Liabilities,
4) Drawings, 5) Trading A/c, 6) Trading A/c
7) Cash A/c Bank A/c, 8) Balance Sheet 9) Manufacturer
10) Net Loss 11) Capital A/c 12) Insurance A/c,
13) Office Equipment 14) Sundry debtors 15) Credit Note
16)20% 17) Liabilities 18) Assets
19) Furniture 20) Trading 21) Cash / Bank A/c,
22) Manufacturing 23) P & L 24) Plant
163
c. Match the following Columns:

1)
COLUMN A COLUMN B
a) Purchase of Raw Material i) Credit Balance
b) Bank Overdraft ii) Assets side of Balance Sheet.
c) Outstanding Wages iii) Manufacturing A/c
d) Prepaid Insurance iv) Capital A/c
e) Goodwill v) Liabilities side
vi) Intangible Assts
Ans. a) - iii, b)- i c)v d)- ii e)- vi
2)
COLUMN C COLUMN D
i) Income due but not received a) Bills Payable
ii) Current Liabilities b) Manufacturing A/c
iii) Tallied Balance sheet c) Carriage paid on Good sold
iv) Carriage Inward d) Capital A/c
v) Drawings e) Profit Loss A/c
f) Asset side of Balance Sheet
j) Arithmetical accountancy
Ans. i) f, ii) – a, iii) – j, iv) b, v) –d
3)
COLUMN E COLUMN F
i) Raw Material consumed a) Profit & Loss A/c Credit Side
ii) Profit on Sale of Assets b) Added to income.
iii) Accrued Income c) Tangible Assets
iv) Furniture d) Manufacturing A/c
v) Outstanding Expenses in Trial e) Profit & Loss A/c Debit Side
Balance
f) Liabilities Side
g) Fixed Asset
Ans. i) – d, ii) – a, iii) – b, iv) – g, v) – f
164
d. State Whether the following statements are True or False :-
1) Trial Balance shows financial position of the concern.

2) Goodwill written off is credited to Trading A/c
3) Credit balance of Profit & Loss A/c is net profit
4) Interest on capital is credited to Drawing A/c
5) The Drawing A/c always shows debit balance.
6) Income received in advance is asset.
7)Provision for Depreciation is also known as Accumulated
Depreciation.
8) Interest on Drawings is debited to Profit and Loss A/c.
9) Stock is always valued at cost.
10) Prepaid expenses in Trial balance is shown on Assets side of
the Balance Sheet.
11) Withdrawal of cash by the proprietor is credited to Cash A/c.
12) Trading A/c shows Net Profit or Net Loss.
13) All income and expenses are shown in the Balance Sheet.
14) Balance Sheet is always prepared for the year ended.
15) Carriage Outwards is credited to Trading A/c.
16) Capital A/c of proprietor is always shown on Asset Side of
Balance Sheet.
17) Manufacturing A/c is prepared to find out Gross Profit.
18) Interest on investment is calculated on Face Value of the
investment.
Ans. False: 1,2, 4, 6, 7, 9, 12, 13, 14, 15, 16, 17

True: 3, 5, 8, 10, 11, 18

165
Unit-9
FINAL ACCOUNTS II
UNIT STRUCTURE
9.0 Objectives
9.1 Solved Problems
9.2 Exercise
9.0 OBJECTIVES
After studying the unit students will be able to solve the

practical problems on final accounts.
9.1 SOLVED PROBLEMS
Illustration 1: (Mfg. & Tr. A/c)

From the following particulars, prepare a Manufacturing
Account and a Trading Account for the year ended 31-3-2018.

Raw Materials 12,000 Carriage Inwards 1,000
(1-4-2012)
Work –in-Progress 8,000 Returns Outward 2,000
(1-4-2012)
Finished Goods 9,000 Royalty on 1,000
(1-4-2012 Production
Purchase of Raw 80,000 Purchase of Finished 8,000
Materials goods
Direct Wages 10,000 Carriage Outwards 500
Indirect Wages 8,000 Fuel and Power 2,500
Sales 1,74,000 Repairs and 1,500
Maintenance
Returns Inward 5,000 Raw Materials (31-3- 6,000
2013)
Depreciation on 4,000 Work-in-Progress 2,500
Factory Assets (31-3-2013)
Purchase of 37,000 Finished Goods (31- 5,000
Finished Goods 3-2013)
166
Adjustments:
(i) Outstanding Direct Wages amounted to Rs. 3,000; (ii) Prepaid

Fuel and Power amounted to Rs.500.
Manufacturing Account
For the year ended 31-3-2018
Dr Cr
To Work-in-Progress 8,000 By Work-in- 2,500
(Opening Progress
(Closing)
To Raw Materials By Trading A/c 1,20,000
consumed :
Opening Stock 12,000 (Cost of
Production
transferred)
Add : Purchase 80,000
Add : Carriage 1,000
Inward
93,000
Less : Returns 2,000
outward
91,000
Less : Closing Stock 6,000 85,000
To Direct Wages 10,000
Add : Outstanding 3,000 13,000
To Manufacturing
Expenses :
- Royalty on 1,000
Production
To factory Expenses
:
- Indirect Wages 8,000
- Depreciation on 4,000
Factory Assets
- Fuel and Power
2,500
Less : Prepaid 500 2,000
- Repairs and 1,500 15,500
maintenance
1,22,500 1,22,500
167
Trading Account
Dr Cr
Particulars Rs. Particulars Rs. Rs.
To Opening stock 9,000 By Sales 1,74,000
(FG)
To Manufacturing 1,20,000 Less : Returns 5,000 1,69,000
A/c (Cost of Inward
Production tfd.)
To Purchase (FG)
37,000 By Closing 5,000
To Gross Profit c/d
(tfd. To P & L A/C) 8,000 Stock (FG)
1,74,000 1,74,000
Note: The concern is a manufacturer as well as a trader. Hence the

Trading a/c shows purchase of finished goods (for re-sale) and
closing stock of such goods held for re-sale.
Illustration 2: (Mfg. Tr., P & L A/c + Adjustments)
The following information is given to you from the books of a

manufacturer in respect of the year ending 31st March, 2018.

Stock of Raw 25,000 Electricity & 6,000
Material (1-4-2017) Telephone
Freight Inward 8,500 Selling Expenses 6,000
Freight Outward 6,000 Miscellaneous 14,000
Expenses
Direct Wages 18,000 Stock of Finished 30,000
Goods : (31-3-2018)
Indirect Wages 14,000 Provision for Doubtful 8,500
Debts
Sales 4,80,000 Depreciation on Plant 4,000
and Machinery
Stationery 1,500 Depreciation of
Office
Traveling Expenses 5,000 Furniture and 3,000
Equipments
Salaries (H.O.) 26,000 Repairs to Plant and 4,650
Machinery
168
Factory Expenses 26,000 Sale of Scrap 3,700

Interest on Loan 1,800 Purchase of Raw 2,50,000
paid Materials
Returns-Inward 5,000 Coal Consumed 9,000
Returns-outward 3,500 Work-in-progress 7,000
(1-4-2017)
Power and fuel 8,000 Bank Interest 2,600
received
Adjustments necessary for the following:
(a) Finished goods worth Rs.5,000 were distributed as free

samples.
(b) A loan was obtained on 1st October, 2017 for Rs. 50,000
carrying interest 10% p.a.
(c) Bad debts to be written off Rs..750 and provision for doubtful
debts to be maintained Rs.7,000.
(d) Electricity and Telephone to be apportioned as Factory 3/5th
and Office 2/5th.
(e) A fire occurred destroying finished goods worth Rs.15,000.
Insurance Company admitted a claim of Rs.12,000 not yet
received.
(f) Stock on 31-3-2018 stationery in hand Rs.150, Raw Materials
Rs.22,000.Work-in-Progress Rs.4,000, Finished Goods
Rs.40,000.
You are required to prepare the Manufacturing Account and

Trading Account and Profit and Loss Account for the year ended on
31st March 2018. (ICWA adapted)
169
Solution:
Dr. Cr.
To Work-in Progress 7,000 By Work-in 4,000
(Opening) Progress
(Closing)
To Raw Materials By Sale of scrap 3,700
Consumed :
Opening Stock 25,000 By Trading A/c 3,44,550
Add : Purchases 2,50,000 (Cost of
production tfd.)
Inwards
2,83,500
Less : Returns 3,500
outward (-)
2,80,000
Less : Closing Stock 22,000 2,58,000
To Wages 18,000
To Factory
Expenses :
Wages indirect 14,000
Factory expenses 26,000
Power and fuel 8,000
Coal consumed 9,000
Electricity and 3,600
telephone
(3/5 x 6,000)
Depreciation on 4,000
Machinery
Repairs to Plant 4,650 69,250
3,52,250 3,52,250
170
Trading and Profit & Loss Account

For the Year ended 31-3-2018
Dr. Cr.
Particulars Rs. Rs. Particulars Rs. Rs.
To Opening 30,000 By Sales 4,18,000
Stock (FG)
To 3,44,550 Less : 5,000 4,13,000
Manufacturing Returns
A/c
(Cost of By Goods
production distributed
efd.) as
To Gross Profit 98,450 Free 5,000
c/d samples
By Goods 15,000
destroyed
by fire
By Closing 40,000
Stock (FG)
4,73,000 4,73,000
To Salaries 26,000 By Gross 98,450
Profit b/d
To Electricity & 2,400 By Bank 2,600
Telephone Interest
received
(2/5x6,000) By Provision 750
for doubtful
To Stationery 1,500 Debts not
required
Less : Stock- 150 1,350 (8,500-750-
in-hand 7,000)
To Interest on 1,800
loan
Add : 700 2,500
Outstanding
[(50,000 x 6/1 700
2 x 10% -
1,800]
To Traveling 5,000
expenses
To Selling 6,000
expenses
To Fright 6,000
outward
171
To 14,000
Miscellaneous
expenses
To Loss by fire 15,000
Less : Claim
admitted by
Insurance Co. 12,000 3,000
To
Depreciation
Office
Furniture & 3,000
Equipments
To 5,000
Advertisement
s
(free samples)
To Net profit 27,550
tfd. To Capital
A/c.
1,01,800 1,01,800
Illustration 3:
Vinayaka’s Trial Balance as on 31st March 2012 is as follows:
Particulars Dr. Rs. Cr. Particulars Dr. Rs. Cr. Rs.

Rs.
Opening Printing and 5,200
Stock Stationery
- Raw 2,50,000 Bank Charges 2,500
Materials
- Work-in- 80,000 Traveling 10,000
Progress Expenses
- Finished 2,20,000 Discount 3,300
Goods
Purchases 2,15,000 Sales Return 11,000
Buildings 1,50,000 Advertisement 5,500
Plant & 3,60,000 Sales 7,80,000
Machinery
Furniture 40,000 Capital 8,50,000
Trade Mark 30,000 Sundry 52,000
Creditors
172
Wages 83,000 Sundry 82,500

Debtors
Factory 4,000 Discount 2,500
Taxes
Motive 9,000 Miscellaneous 5,500
Power Expenses
Factory 5,000 Bills Payable 34,000
Insurance
Salary to 11,000 Bill 16,000
Office Staff Receivable
Office Rent 10,500 Corporation 98,000
Bank
Carriage 2,500 Cash on hand 9,000
Inward
17,18,500 17,18,500
Adjustments:
(1) Closing Stock: Rs.

Raw Materials 85,000
Work-in-Progress 30,000
Finished Goods 2,05,000
(2) Factory taxes prepaid Rs.2,000
(3) Depreciation: Furniture 10%
Plant & Machinery 15%
Trade Mark 20%
Building 5%
Prepare Manufacturing, Trading and Profit & Loss Account for the
financial year 2017-18 and Balance Sheet as on 31-3-2018.
(IDE, Mar. 2000, adapted)
173
Solution:
VINAYAK
Manufacturing & Trading Account
Dr. Cr.
To Work-in- 80,000 By Work- 30,000
process in-process
(Opng.) (CI.)
To Raw By Trading 5,85,500
materials Account
consumed: (Cost of
Opening 2,50,000 production
Stock tfd.)
Add : 2,15,000
Purchase
- Carriage 2,500
Inward 4,67,500
Less : Closing 85,000 3,82,500
stock
To Direct 83,000
Wages
To Direct
factory
expenses
- Factory 4,000
Taxes
Less : 2,000 2,000
Prepaid taxes
To Motive 9,000
Power
- Factory 5,000
Insurance
To
Depreciation
Plant & 54,000
Machinery
(15%)
6,15,500 6,15,000
174
To Opening 2,20,000 By Sales 7,80,000

stock (FG)
To Less : 11,000 7,69,000
Manufacturing Return
Account Inwards
(Cost of 5,85,500 By Closing 2,05,000
production stock (FG)
tfd.).
To Gross 1,68,500
profit c/d
9,74,000 9,74,000
Profit & Loss Account

Dr Cr
To Salaries to 11,000 By Gross Profit 1,68,500
Office Staff B/d
To Office Rent 10,500 By Discount 2,500
Received
To Printing & 5,200
stationery
To Bank charges 2,500
To Traveling 10,000
Expenses
To Miscellaneous 5,500
Expenses
To Advertisement 5,500
To Discount 3,300
To Depreciation on
- Tr. Mark (20%) 6,000
- Building (5%) 7,500
- Furniture (10%) 4,000 17,500
To Net profit tfd. 1,00,000
To capital
1,71,000 1,71,000
175
Balance Sheet As At 31-3-2018
Liabilities Rs. Rs. Assets Rs. Rs.

Capital Fixed Assets :
Account :
Balance 8,50,000 Building 1,50,000
b/d
(opening)
Add:-Net 1,00,000 9,50,000 Less: Depreciation -7,500 1,42,500
profit for @5%
the years
Current Plant & machinery 3,60,000
Liabilities :
Sundry 52,000 Less : Depreciation 54,000 3,06,000
Creditors @15%
Bills 34,000 Furniture 40,000
Payable
Less : Depreciation 4,000 36,000
@10%
Trade Mark 30,000
Less : Depreciation 6,000 24,000
@20%
Current Assets :
Closing Stock :
- Raw Materials 85,000
- Work-in-Progress 30,000
- Finished Goods 2,05,000 3,20,000
Debtors 82,500
Bills receivable 16,000
Prepaid taxes 2,000
Corporation Bank 98,000
Cash in hand 9,000
10,36,000 10,36,000
176
Illustration 4:
Amar Chemicals has the following Ledger Balance as on 31st
March 2018.
Particulars Dr. Rs. Cr. Rs.

Goodwill 50,000 Net Sales 11,00,000
Factory 20,000 Miscellaneous 4,000
Shed Income
Machinery 1,30,000 Bad Debts 5,000
Reserve
Furniture 8,000 Purchase of 8,60,000
Materials
Investments 10,000 Freight on 50,000
Materials
Capital 1,95,000 Factory Power 15,000
Bank Loan 3,00,000 Salaries and
Wages
Creditors 1,50,000 - Factory 1,50,000
Debtors 1,35,000 - Office 65,000
Stock on Repairs and 2,500
1-4-2018 Renewals
- Materials 1,30,000 Rent and Taxes 16,500
-Work-in- 7,500 Insurance 3,900
Progress
-Finished 82,500 General 18,100
Goods Expenses
17,54,000 17,54,000
The following additional information is available:
(1)Closing Stock: Materials Rs.2,10,000; Work-in-Progress

Rs.12,500 and Finished Goods Rs.2,07,500.
(2) Depreciation to be provided at 2.5% on Factory Shed, 10%

on Machinery and 15% on Furniture.
(3) Repairs and rent and taxes are to be apportioned between

Factory and Office in the ratio of 3: 2.
(4) Reserve for bad and doubtful debts are to be provided at 4% on

debtors.
(5) Insurance Premium covers a period of one month in advance.

177
You are required to prepare Manufacturing, Trading, and Profit and

Loss Account for the year ended 31st March 2018 and Balance
Sheet as on that date.
(Mumbai, Nov. 1998, adapted)
Solution:
AMAR CHEMICALS
Manufacturing & Trading Account
Dr Cr
To Work-in- 7,500 By Work-in- 12,500
process(Opng.) process (CI.)
To Raw By Trading 10,14,900
materials Account
consumed : (Cost of
Opening Stock Production
1,30,000 efd.)
Add : Purchase
8,60,000
Add : Freight on
Materials 50,000
10,40,000
Less: Closing 2,10,000 8,30,000
stock
To Direct
factory
expenses
- Factory Power 15,000
- Salary & 1,50,000
wages
- Repairs etc. 1,500
(3/5)
- Rent & Taxes 9,900
(3/5)
- Depreciation
on factory
assets
Factory shed 500
- Machinery 13,000 1,89,900
10,27,400 10,27,400
178

stock (FG)
To 10,14,900 By Closing 2,07,500
Manufacturing stock (FG)
Account (cost of
Production tfd.)
To Gross profit 2,10,100
c/d
13,07,500 13,07,500
Profit & Loss Account

Dr Cr
To Office Salary & Wages 65,000 By Gross profit b/d 2,10,100
To Repairs & Renewals 1,000 By Miscellaneous 4,000
(2/5) Income
To Rent & Taxes (2/5) 6,600
To Insurance 3,900
Less : Prepaid 325 3,575
(3,900 x 1/12)
To General Expenses 18,100
To Depreciation on 1,200
Furniture
To Reserve for Doubtful 5,400
Debts
Less : Old RDD 5,000 400
To Net profit tfd. To capital 1,18,225
2,14,100 2,14,100
179
Balance Sheet
As At 31-03-18

Capital Fixed
Account : Assets :
Balance b/d 1,95,000 Goodwill 50,000
(opening)
Add : Net 1,18,225 3,13,225 Machinery 1,30,000
profit for the
year
Loans : Less : 13,000 1,17,000
Depreciation
@10%
Loans from 3,00,000 Factory 20,000
bank Shed
Current Less : 500 19,500
Liabilities : Depreciation
@2.5%
Sundry 1,50,000 Furniture 8,000
creditors
Less 1,200 6,800
Depreciation
@15%
Investment 10,000
Current
Assets :
Closing
Stock
- Raw 2,10,000
material
- Work-in- 12,500
process
- Finished 2,07,500 4,30,000
goods
Debtors 1,35,000
Less : Prov. 5,400
for bad
1,29,600
debts
325
Prepaid
insurance
7,63,225 7,63,225
180
Illustration 5:
Following is the Trial Balance of Mrs. Rashmi as on 31-3-2018
Particulars Dr. Rs. Cr. Rs. Particulars Dr. Rs. Cr. Rs.
Capital/Drawings 40,000 8,00,000 Printing and 41,400
Stationery
Opening Stock Office Rent 64,600
* Raw Materials 50,800 Bills 3,01,000
Receivable
* Work in 25,800 Bills 1,00,000
progress Payable
* Finished goods 2,18,000 Sundry 6,00,000 4,00,000
Debtors
and
Creditors
Purchase of 22,24,000 Plant and 16,00,000
Raw Materials Machinery
Wages 79,200 Motor Car 6,00,000
Power and Fuel 48,500 Returns 24,000 30,000
* Factory Rent 25,000 Interest @ 22,000
14% on
Investments
Carnage 34,700 Investments 2,00,000
outward (1-4-2011)
48,74,000 Bad Debts 10,000
Ins. Durance 51,000 Provision
Premium for Bad and
Cr.
Discount 5,000 19,000 Doubtful 6,000
debts
Life 8,000
Insurance
Premium
paid
62,51,000 62,51,000
181
a) Closing Stock Cost Price Market Price

Raw Materials 90,000 1,00,000
Work in Progress 90,000 50,000
Finished Goods 4,00,000 3,60,000
b) Depreciate Plant & Machinery @ 15% p.a. and Motor Car @
20% p.a.
c) General Insurance prepaid was Rs.9,000.
d) Provide for outstanding factory rent Rs.13,000.
e) Finished goods costing Rs.20,000 and Raw materials costing
Rs.30,000 were destroyed by fire. Insurance Company
admitted claim of Rs.15,000 for finished goods and Rs.20,000
for Raw Materials by the date of Balance Sheet.
f) Write off Rs. 20,000 as Bad debts.
g) Create provision for doubtful debts and provision for discount
on debtors @ 5% and 2% respectively.
h) On 30-3-2018 goods costing Rs.40,000 were purchased on
credit (included in closing stock) which remained unrecorded.
i) Purchase include Rs.80,000 in respect of Plant and
Machinery purchased on 1-10-2011.
j) Proprietor had withdrawn goods at sale price of Rs.30,000
which included profit element of 20% on cost.
This amount was recorded through sales register and was wrongly
debited to Mrs. Rama’s (Debtor) Account. Being the Accountant of
Mrs. Rashmi, you are required to prepare Manufacturing, Trading
and Profit and Loss Account for year ended 31st March, 2018 and
Balance Sheet as at the date.
(Oct. 1996)
182
Solution:
Dr. Mrs. RASHMI
Dr. Cr.
Progress Progress
(Opening) (Closing)
To Raw Materials By Trading 24,72,300
consumed : A/c (Cost of
production
transferred)
Opening Stock 50,800
Add : Purchases 22,24,000
Add : Unrecorded 40,000
purchases
Less : Purchases 30,000
Returns
Less : Machinery
Purchased 80,000
Less : Destroyed 30,000
by fire
Less : Closing 90,000 20,84,800
Stock
To Wages 79,200
To Factory
Expenses.
Factory Rent 25,000
Add : Outstanding 13,000
38,000
Power and Fuel 48,500
Depreciation : 2,46,000 3,32,500
Plant & Machinery
25,22,300 25,22,300
183
Trading and Profit and Loss Account

Dr. Cr.
To Opening stock 2,18,000 By Sales 48,74,000
(FG)
To Manufacturing 24,72,300 Less : Sales 24,000
A/c returns
(Cost of Production 48,50,000
tfd.)
To Gross profit c/d 25,34,700 Less : Goods 30,000 48,20,000
for personal
use
By Goods for 25,000
personal use
(cost)
By Goods 20,000
destroyed by
fire
By Closing 3,60,000
stock (FG)
52,25,000 52,25,000
To Carriage 34,700 By Gross 25,34,700
Outwards Profit b/d
To Discount Allowed 5,000 By Discount 19,000
Received
To Printing and 41,400 By Interest on 22,000
Stationery Investments
To Insurance 51,000 Add : Interest 6,000 28,000
Receivable
Less : Prepaid 9,000 42,000
To Office Rent 64,600
To Bad Debts 10,000
Add : Further Bad 20,000
Debts
Add : New R.D.D. 27,500
Less : Old R.D.D. 6,000 51,500
To Provision for 10,450
discount on debtors
To Depreciation on 1,20,000
car (20% x 6,00,000)
To Loss by Fire :
- Finished Goods 5,000 15,000
To Net profit tfd. To 21,97,050
capital
25,81,700 25,81,700
184
Balance Sheet
As at 31-03-2018
Capita / Fixed Assets :
Account :
Balance b/d 8,00,000 Plant and 16,00,000
(opening) Machinery
Add : Net 21,97,050 Add : New 80,000
Profit Machinery
29,97,050 16,80,000
Less : 73,000 29,24,050 Less : 2,46,000 14,34,000
Drawing Depreciation
[WN3] [WN1]
Current Motor Car 6,00,000
Liabilities :
Bills Payable 1,00,000 Less : 1,20,000 4,80,000
Depreciation @
20%
Sundry 4,00,000 Investments :
Creditors
Add : 40,000 4,40,000 Investment 2,00,000
Unrecorded (1-4-2017)
Purchase
Outstanding 13,000 Current Assets :
Rent
Closing Stock :
- Work in 50,000
Progress
- Finished 3,60,000 5,00,000
Goods
Debtors 6,00,000
Less : Goods for 30,000
own use
5,70,000
Less : Further 20,000
Bad Debts
5,50,000
185
Less : Prov. for

doubtful debts
(5/100x5,50,000) 27,500
5,22,500
Less : Prov. for 10,450 5,12,050
Discount on
Debtors (2/100 x
5,22,500)
Insurance Claim
:
- for Raw 20,000
Materials
- for Finished 15,000 35,000
Goods
Bills Receivable 3,01,000
Interest 6,000
Receivable
[WN2]
Prepaid 9,000
Insurance
34,77,050 34,77050
Working Notes:
1. Depreciation of Plant and Machinery Rs.

Depreciation on Rs. 16,00,000 for
Full year @ 15% 2,40,000
Depreciation on Rs. 80,000 for 6 months
(80,000 x 15/100 x 6/12) 6,000
2,46,000
2. Interest Receivable on Investments Rs.

Total Interest on Investments
(2,00,000 x 14/100) 28,000
Less: Interest actually received 22,000
Balance Interest receivable 6,000
3. Total Drawings made Rs.

Drawings as per Trial Balance 40,000
Add: Goods withdrawn for personal use 25,000
Add: Life Insurance paid as per
Trial Balance 8,000
Total Drawings 73,000
186
Illustration 6:
The Trial Balance Mr. Lakhamichand is as below, Prepare final

accounts for the year ended 31-12-2017.
Debit Balances Rs. Credit Balances Rs.

Cash in hand 1,000 Capital Account 41,860
Machinery 30,000 Sales 1,38,780
Drawings 2,500 R.D.D. 560
Factory, Power 450 Sundry Creditors 8,800
and Fuel
Office Salaries 6,225
Carriage outwards 500
Manufacturing 9,300
wages
Furniture and 3,400
Fixture
Opening Stock :
- Finished goods 4,000
- Work-in-progress 7,250
Carriage Inwards 1,000
Rent (Factory ¾) 4,000
Sundry Debtors 21,600
Advertisement 775
Printing & 1,200
Stationery
Factory Insurance 1,280
Purchase of Raw 82,950
Material
Balance at Bank 8,530
Discount Allowed 610
Miscellaneous 630
Expenses
1,90,000 1,90,000
187
Adjustments:
(1)Closing Stock: Finished Goods Rs.6,500, Raw Materials Rs.750

and Work-in-progress Rs.4,750.
(2) A Motor car purchased on 1-10-2017 for Rs.10,000 has been

included in purchases.
(3) Depreciate Machinery at 15% p.a., Motor Car at 20% p.a.,

Furniture and Fixtures at 15% p.a.
(4) Provision for R.D.D. should be maintained at 10% of the

debtors.
(5) Provision for unrealised Rent in respect of portion of the office

sub-let at Rs.120 p.m. from 1-10-2017 has to be made.
(April 96, adapted)
Solution:
LAKHAMICHAND
Dr. Cr.
Progress Progress
(Opening) (Closing)
To Raw Materials To Trading 97,030
consumed : A/c
Opening Stock 2,800 (Cost of
production
transferred)
Add : Purchases 82,950
Inwards
86,750
Less : Motor Car 10,000
Purchase
Less : Closing 750 76,000
Stock
To Manufacturing 9,300
Wages
188
To Factory
Expenses :
Rent 3,000
[3/4 x 4,000]
Insurance 1,280
Power and Fuel 450
Depreciation on 4,500 9,230
Plant
1,01,780 1,01,780
Trading Account
Dr. Cr.
To Opening stock 4,000 By Sales 1,38,780
(FG)
To Manufacturing A/c 97,030 By Closing stock 6,500
(Cost of Production (FG)
tfd.)
To Gross profit c/d 44,250
1,45,280 1,45,280
Profit and Loss Account

Dr. Cr.
To Office Salaries 6,225 By Gross 44,250
Profit b/d
To Carriage 500 By Rent 360
Outwards Accrued
To Office Rent (1/4 x 1,000
4,000)
To Advertisement 775
To Printing and 1,200
Stationery
To Discount Allowed 610
189
To Miscellaneous 630
Expenses
To Prov. for Bad &
Doubtful Debts
New R.D.D. 2,160
Less : Old R.D.D. 560 1,600
To Depreciation :
- on Motor Car 500
(10,000x20/100x3/12)
- on Furniture & 510 1,010
Fixtures
(3,400 x 15/100)
To Net profit tfd. To 31,060
capital
44,610 44,610
Balance Sheet
As at 31-12-2017

Capital Fixed Assets :
Account :
Balance b/d 41,860 Plant and Machinery 30,000
(opening)
Add : Net profit 31,060 Less : Depreciation @ 4,500 25,500
15%
72,920 Motor Car 10,000
Less : 2,500 70,420 Less : Depreciation @ 500 9,500
Drawings 20% (for 3 months)
Current
Liabilities :
Sundry 8,800 Furniture & Fixtures 3,400
creditors
Less : Depreciation @ 510 2,890
15%
Current Assets :
Closing Stock :
190
- Raw Materials 750

- Work in Progress 4,750
- Finished Goods 6,500 12,000
Debtors 21,600
Less : New R.D.D. 2,160 19,440
Rent Accrued 360
Balance at Bank 8,530
// Cash in Hand 1,000
79,220 79,220
Illustration 7:
The following balances are extracted from the ledger accounts of
Mr. Bharat as on 31st December, 2017.
Particulars Dr. Rs. Cr. Rs. Particulars Dr. Rs. Cr. Rs.
Mr. 1,40,000 Wages 30,000
Bharat’s
Capital Salaries 22,000
Plant and 45,000 Trade
Machinery
Opening Expenses 9,000
Stock
Raw 20,000 Rent 12,000
Materials
Finished 5,000 Consignment 33,000
goods (Mr. X) A/c.
Purchases 3,74,000 4,60,000 Cash 5,000
and Sales
Debtors 1,35,000 90,000
and
Creditors
6,90,000 6,90,000
Adjustments:
(1) Opening stock of finished goods include stock of stationery

of Rs.200.
(2) Closing stock of raw materials Rs. 10,000, closing stock of
finished goods Rs.20,000 (including stock of stationery
Rs. 100.)
191
(3) Trade expenses include payment of stationery of Rs.2,000.
(4) Closing creditors include creditors for stationery of Rs.500 for

credit purchases.
(5) Mr. Bharat sent goods costing Rs.33,000 to Mr. X (consignee)

who sold two third of the quantity for Rs.35,000. The consignee
has incurred expenses of Rs.2,000 and is entitled for
commission of 5% on sales.
(6) Sales include a sum of Rs.32,000 received on sale of all goods

received on behalf of Mr. Y (consignor). Mr. Bharat is entitled to
a commission of 10% on these sales for which no entries were
passed. The expenses of Rs.1,000 for sale on behalf of Mr. Y
are debited to trade expenses (the expenses should be incurred
by Mr. Y)
(7) Provide 10% depreciation on plant and machinery.

Prepare manufacturing account, trading account and profit
and loss account for the year ended 31st December, 2017 and
the Balance Sheet on that date.
(March 95, adapted) 2012.
MR. BHARAT
Dr. Cr.
To Raw Materials By Trading A/c 4,18,000
consumed (Cost of
Opening Stock 20,000 production tfd.)
Add : Purchases 3,74,000
3,94,000
Less : Purchases (500)
of Stationery
Less : Closing (10,000) 3,83,500
Stock
To Wages 30,000
To Factory
Expenses :
To Depreciation 4,500
on Machinery
4,18,000 4,18,000
192
Trading Account
Dr. Cr.
stock (FG)
Less : Stock 200 4,800 Less : 32,000
of Stationery Consignment
Sales [Y]
To 4,18,000
Manufacturing
A/c Cost of
Production
To Gross 38,100 [35,000 – 2,000 4,30,000
profit c/d 33,000]
By Closing
stock
Finished 20,000
Goods
Less :
Closing
stock of
Stationery 100
19,900
Add : Unsold 11,000 30,900
Goods of
Consignment
[X]
4,60,900 4,60,900
193
Profit and Loss Account
Dr. Cr,
To Office Salaries 22,000 By Gross 38,100
Profit b/d
To Trade 9,000 By 3,200
Expenses Commission
from
Consignor
Less : Payment for (2,000) By Net Loss 5,050
Stationery tfd. To Capital
Less : Expense of (1,000) 6,000
Consignor Y
To Stationery
Consumed
Opening stock 200
Add : Stationery 2,000
Add : Credit 500
Purchase
2,700
Less : Closing (100) 2,600
Stock
To Rent 12,000
To Commission to 1,750
Consignee
(5% x 35,000)
To Expenses 2,000
incurred by X
46,350 46,350
194
Balance Sheet
As on 31-12-2017

Capital / Account : Fixed Assets :
Balance b/d 1,40,000 Plant and 45,000
(opening) Machinery
Add : Net profit 5,050 1,34,950 Less : 4,500 40,500
Depreciation
@ 10%
Current Liabilities
Sundry creditors 90,000
Less : Creditors for 500 89,500
Stationary
Creditors for 500 Current
stationary Assets :
Due to Y 32,000 Closing Stock
:
Less: Commission 3,200 - Raw 10,000
(10%) Materials
Less : Expenses of 1,000 27,800 - Finished
consignor Y Goods 19,900
included in trade Add : Unsold 30,900
goods (x)
11,000
- Stock of 100 41,000
stationary
Debtors 1,35,000
Consignment 33,000
A/c Mr. X
Add : sales of 2,000
X
35,000
Less : 2,000
Expenses
Less : 2,000
Expenses
Less: 1,750 31,250
Commission
(5%)
Cash in hand 5,000
2,52,750 2,52,750
195
9.2 EXERCISE
Illustration 1
From the following details for the year ended 31st March 2018
prepare Manufacturing, Trading and Profit & Loss Account of M/s
Razavi Traders:

Opening stock: Electric and water charges 4,000
Raw Material 60,000 Wages 1,40,000
Work in progress 50,000 Salary of works manager 6,000
Finished goods 75,000 Office salaries 5,000
Purchase of raw materials 3,20,000 Advertisement 2,000
Sales 6,25,000 Deprecation
Purchase returns 5,000 - on Plant 3,000
Sales returns 4,000 - on Factory Shed 1,000
Carriage inward 1,500 - on Office Furniture 6,00
Carriage outward 1,000 Closing Stock
Duty and clearing charges 2,000 - Raw material 40,500
Factory rent 3,000 - Work in progress 60,000
Office rent 2,000 - Finished goods 55,000
Illustration 2
From the following Trial Balance and additional information of Miss.
Shabana, prepare Manufacturing, Trading and Profit and Loss A/c
for the year ended 31st March, 2018 and Balance Sheet as on that
date.
Trial Balance
As on 31st March, 2018

Bank Overdraft 49,000
Advertising 18,400
Audit Fees 10,500
Bad Debts 1,600
Bills of Exchange 20,350 20,000
Goodwill 50,000
Commission received 1,000
Discount received 2,000
196
Drawings 2,650
Land and Building 40,000
General Expenses 12,350
Insurance 3,150
Interest on Bank Overdraft 2,000
Investment in Shares 56,000
Plant and Machinery 1,00,000
Capital 2,70,000
Purchases 2,10,320
R.D.D. 1,000
Return Inwards 1,280
Return Outwards 3,320
Debtors 81,750
Wages 30,250
Creditors 65,000
Opening Stock 40,000
Sales 3,21,280
Salaries 52,000
7,32,600 7,32,600
The following further information is available:

(1)Closing Stock on 31st March, 2018 is Rs.87,000.
(2) Outstanding Wages Rs.2,500.

(3)Insurance is prepaid to the extent of Rs.650.
(4) Depreciate Plant and Machinery @10% p.a. and Land and
Building@5% p.a.
(5) Write off Rs.1,750 for Bad debts. Provide 5% for Doubtful Debts
on debtors.
(Ans.: G/P – Rs. 1,27,250, N/P Rs. – 14,150, Balance sheet total-
4,18,000.)
197
Illustration 3:
From the following particulars presented by Mazumdar Bros,

prepare a Manufacturing Account for the year ended 31-03-2012.

Opening Stock : Carriage Inward 1,000
- Raw Materials 3,000 Hire of Special Plant 2,000
- Work-in-Progress 4,000 Factory Rent 4,000
- Finished Goods 8,000 Repairs to Plant 2,000
Closing Stock : Repairs to Factory 1,000
- Raw Materials 1,000 Supervisor’s Salary 8,000
- Work-in-Progress 5,000 Factory Wages 1,000
- Finished Goods 4,000 Royalties on 2,000
production
Purchase of Raw 40,000 Works Manager’s 6,000
Materials Salary
Wages of workers 20,000 Salary of Works Staff 3,000
Light, Gas etc. 2,000
(Factory)



198
Unit-10
DEPARTMENTAL ACCOUNTS I
UNIT STRUCTURE
10.0 Objectives
10.1 Introduction
10.2 Branch Accounts and Departmental Accounts
10.3 Departmental Accounting
10.4 Basis of Allocation
10.5 Inter Department Transfers of Goods / Services
10.6 Closing Stock at Transfer Value
10.7 Stock Reserve
10.8 Departmental Final Accounts
10.9 Proforma of Departmental Accounts
10.10 Exercise
10.0 OBJECTIVES

 Distinguish between Branch and Departmental Store.
 Know the purpose of Departmental Store.
 Understand the accounting procedure of Departmental Store.
 Explain the Basis of allocation of common expenditure and
common income among different departments
 Understand the accounting procedure for Inter-Departmental
Transfers of Goods.
 Calculate the value of closing stock and preparation of Stock
Reserve A/c.
 Prepare Departmental Final Accounts.
10.1 INTRODUCTION
A large business concern may be divided into different

segments; each segment is known as department. All departments
operate under one roof. The division into various departments may
199
be on basis of functions, processes or products or may be any

combination of above as it may be suitable to the organisation.
Management is usually interested in finding out the working results
of each department to ascertain their relative efficiencies.
Departmental Accounts are of great help to the management as
information for taking various types of decisions. Management can
compare result of one department with other departments.
Company may intra or inters departmental comparison, may

be again that of same departments in the previous periods. This will
help them to formulae sound policy of expansion/diversion/merger
even if required, may be closing down a particular unprofitable
departments.
10.2 BRANCH ACCOUNTS AND DEPARTMENTAL

ACCOUNTS
A business may be expanded having number of branches as

well as having number of departments under one roof. A large
business may have various departmental stores at different places.
e.g. Big Bazaar has departmental stores at various places, like in
Mumbai, Pune, Navi Mumbai, Surat, and so on .
Distinguish between Branch & Departmental Store
No. Branch Departmental Store

1. Located at different places, Departmental stores are
may be in different countries. always located under one
roof.
2. Normally branches are Normally concerns purchase
opened by manufacturer to different types of goods
avoid middleman’s chain. directly from manufactures,
sales to end users.
3. Branches sale one type of Departmental Stores
goods manufactured by purchase goods from different
them. manufactures & sales under
one roof.
4. Branches may be domestic Departments are located at
[in same country] &/ or one place, under one roof
foreign branches. only.
5. Since the branches located Common expenses are
at different places, the always allocated in some
problem of allocation of ratio.
common expanses does not
arises.
200
6. Accounting treatments The departments are located

depends upon types of under one roof, all accounting
branches, i.e. dependent records are maintained by
branch or impendent branch. head office.
7. Reconciliation may be Question of such
required for cash & goods in reconciliation doesn’t arise,
transit. as all departments are at
same place.
8. In case of foreign branch, This problem does not arise
question of conversion of in Departmental Accounting.
foreign currency in Head
Office currency arises.
10.3 DEPARTMENTAL ACCOUNTING
10.3.1 Purpose:
In Departmental Accounting, if only a single Profit & Loss

Account is prepared for the entire business, then profit / loss of
each department cannot be ascertained. In Departmental
Accounting, each department is treated as separate entity for the
purpose of recording and reporting. In same premises, a separate
Account Department records all transactions of all departments.
Books of Accounts are so designed, so it is possible to prepare
separate Trading A/c, Profit & Loss A/c for each department. The
working of one department can be compared with another
department. It facilities infra / inter comparison for same period with
that of same department in the previous periods. This helps
management to formulate sound policy for expansion, merger of
departments, closing of loss making departments. Preparation of
separate accounts serves the following purposes :
a) Gross Profit or Loss, Net Profit or Loss of each department

can be ascertained.
b) Running cost of each department can be calculated.
c) Corrective timely measures for inefficient department can be
taken.
d) It helps to fix branch manager’s commission on basis on
profit.
e) Departmental transfers can be recorded at transfer price /
selling price.
f) Stock reserve, unrealized profit on goods transferred can be
calculated.
g) Assist the management for controlling the business more
efficiently, intelligently.
201
h) Wastage of material, money, human recourses can easily

detect.
i) A separate stock records can be maintained department
wise for controlling stock.
j) Department managers responsibly can be fixed and called
for various reporting.
k) Department budget can be prepared.
10.3.2 Books of Accounts:

For preparation of Profit & Loss A/c of each department, it is
necessary that separate sets of Books of Accounts should be
maintained for each department. Instead of that Accounts
Department maintains various Subsidiary Books in columnar form,
it will also be necessary to devise a basis for allocation of common
expenses among the departments. Normally, each department
records its sales & maintains stock records. Daily cash collection in
department is transferred to main cashier or deposited in Bank.
Stocks are physically verified periodically.
10.3.3 Divisions of Subsidiary Books:

Subsidiary Registers are designed in such a way to record
transactions of each department in same register; separate
columns are made for each department in same subsidiary book,
such as purchase Journal, Sales Journal, Return Inwards, Return
Outwards, etc.
Specimen of Departmental ------- Journal

[Purchases, Purchases Returns, Sales, Sales Returns etc.]
Date Serial Name L.F. Total Depts. Dept. Dept. Dept. Ref.
No. Rs I II III IV
Total Rs xxxxx x x x x
Direct Expenses / Sales etc. can be recovered in department, e.g.

cash sales; cash is to be deposited with main cashier on same day.
10.4 BASIS OF ALLOCATION
Allocation of common expenditure among different

departments:
Expenses incurred specially for each department are
recorded separately and charged directly thereto, e.g. Salaries paid
to staff working in the particular dept.
202
10.4.1 Common expenses:
The benefits of which is shared by all the departments and which

are capable of precise allocation are distributed among the
department concerned on equitable basis considered suitable in the
circumstances of the case.
10.4.2 Common indirect expenses:
Common indirect expenses are the expenses which cannot

be directly identified with particular departments, however
departments are benefited. Such expenses which are not capable
of accurate measurement are dealt with as shown in the chart.
The following table gives suitable basis for allocation of such

expenses.
Item of Expenses / Income Basis of Allocation

1. Rent and Rate Floor space occupied by each
department
2. Lighting On the basis of actual
consumption, if actual is not
available on the number of
electric points or Power of
Lamps used or area covered
3. Advertisement Sales
4. Sales Commission Sales
5. Discount Allowed to Sales
Customers
6. Bad debts Actual of each department or
on sales
7. Electric Power for Machines On the H.P. of equipments or
number of machines in each
department and the number of
working hours.
8. Works Manager’s Salary Time spent by him for each
department
9. Depreciation Value of assets employed by
each department
10. Air-conditioning Space occupied
11. Insurance :
i) Stock Value of stocks held in each
of the departments
203
ii) Buildings Floor space occupied or

capital value of the assets
insured
12. Staff Welfare No. of employees in each of
the department
13. Printing and Stationery Turnover of the departments
14. Freight
a) Inward Net purchases of each of the
department
b) Outward Net sales of each of the
department
15. Repairs to Building On the basis of space
occupied by each department
16. Heating On the basis of points, lamps
used or area
17. Discount Earned Sales ratio
18. Commission Received Sales ratio
19. Discount Received On the basis of purchases
20. Delivery Van Expenses On the basis of sales.
21. Traveling Expenses On the basis of sales.
22. Administration Expenses On the basis of time devoted
23. Postage, Telephone, Printing Sales following the rule “What
and Stationery the traffic will bear”.
24. Workmen’s Compensation Wages incurred by each
department.
25. PF and ESI Contribution Wages
26. Canteen Subsidy, Medical Number of workers
Benefits
27. Store Expenses, Expenses Material consumed or Net
On Purchase, Direct Purchases of each
Expenses On Purchases, department
Octroi Expenses
28. All Production, Factory Either on cost of material
Expenses consumed or wages of each
dept.
29. Selling and Distribution Exp. Sales ratio or k.g. or units sold
by each dept.
204
10.4.3 Non Allocable Expenses / Uncommon Expenses / Gains

 The other common expenses which can’t be identified or
allocable on suitable basis.
 The financial or accounting expenses or losses / income e.g.
interest/ loss on sale of investment.
 Examples - Interest on loans and advances, legal fees, loss
on sale of any asset, income tax, audit fees, loss by fire.
 All these expenses should be debited to General Profit and
Loss Account.
 Normal income may be as a whole, which can’t be allocated
to particular department. However, some income on basis of
purchases (discount earned) or sales e.g. discount allowed,
commission received etc.
CHECK YOUR PROGRESS

1. Define the terms:
a. Department
b. Branch
c. Non Allocable Expenses
d. Common Expenses
e. Common Indirect Expenses
2. Give the examples of uncommon expenses.

3. Give suitable basis for allocation of the following expenses:
a. Factory Expenses
b. Canteen Subsidy
c. Delivery Van Expenses
d. Commission Received
e. Discount Received
f. Works Manager’s Salary
g. Air Conditioning
h. Bad Debts
10.5 INTER DEPARTMENT TRANSFERS OF GOODS /

SERVICES
Usually department supply goods / services to one another.

These transactions should be separately recorded and changed to
the department benefiting these by & credited to the department
providing it. Total of such benefits should be disclosed in the
Departmental Trading, Profit & Loss A/c, to distinguish them from
other items of income or expenses.
205
The departmental transfer may be:

1) At cost
2) At cost plus profit (loading) (transfer value)
3) At selling price (transfer value = sale value)
10.5.1 Transfer at cost:
Usually goods are transferred at cost on the assumption that

departmental stores as a whole one entity profit / loss earned or
suffered only when goods are sold to outsides / external parties.
10.5.2 Transfer at cost plus profit:
Goods may be transferred at cost plus profit [transfer value /

loaded price] so that both departments are in a position to ascertain
profit / loss accurately.
10.5.3 Transfer at selling price:
In such case departmental transfers are recorded at usual

selling price. Each department records such transfers as its goods
are sold to outsiders. In such a case, each department is in position
to account for profit or losses accurately, due to this, profit or loss of
one department would not be affected due to efficiencies or
inefficiency of another department.
10.5.4 Accounting for transfer of goods or services:
Receiving department should be debited at transfer price

and department transferring goods / services should be credited at
same value. [Transfer Price / Selling Price].
10.6 CLOSING STOCK AT TRANSFER VALUE
When one department transfers goods, at transfer price

[may be at cost plus profit or selling price], is included profit
charged by another department. In case, at the end of accounting
year, part of goods remains unsold i.e. closing stock valued at cost
to receiving department which includes profit charged by
transferring department. Profits are always accounted only when
realized. Therefore, value of stock needs to be adjusted by creating
stock reserve.
10.7 STOCK RESERVE
The unrealized profit included in closing stock of receiving

department is eliminated by creating stock reserve. Stock reserve is
calculated as under:
206
Stock Reserve =
Profit included in transfer price

Transferred value of closing stock ×
Transfer price
Entry for unrealized profit, is passed by concern in the

General Profit & Loss A/c as under :
General Profit & Loss A/C Dr.

To Stock Reserve A/C
The amount of stock reserve is deducted from value of stock in the

Balance Sheet.
In the beginning of the next year, entry passed for stock

reserve is reversed.
Stock Reserve A/C Dr.

To General Profit & Loss A/C
E.g. Goods costing Rs.20,000 transferred by A department to Z

department at Rs.24,000. Half of goods remained unsold at the end
of the year.
For recording transfer:
i) Department Z’s Trading A/c Dr. 24,000

To Department A’s Trading A/c 24,000
ii) Stock of Department Z

Stock A/c Dr. 12,000
To Department Z’s Trading A/c 12,000
iii) General Profit & Loss A/c Dr. 2,000

To Stock Reserve A/c 2,000
10.8 DEPARTMENTAL FINAL ACCOUNTS
The Departmental Final Accounts contain:
 Departmental Trading A/c

 Departmental Profit & Loss A/c
 General Profit & Loss A/c
Departmental Profit & Loss A/c is prepared in columnar form

at the end of the year. The respective columns indicate the gross
profit & net profit or net loss from each department as well as total.
207
The net profit or loss of the respective department will be carried to

General Profit & Loss A/c where in expenses and incomes, which
are not allocated to the various departments, are debited or
credited. The balance of this account is transferred to Balance
Sheet. However, the Balance Sheet is in usual form and not in the
columnar form.
10.9 PROFORMA OF DEPARTMENTAL ACCOUNTS
Departmental Trading A/c

For the year ended
Particulars Basis Dept. Dept. Total Particulars Basis Dept. Dept. Total
A B A B
To Opening A xxx xxx xxxx By Sales A xxx xxx xxxx
Stock
To Purchase A xxx xxx xxxx Less : xxx xxx xxxx
Returns
Less: xxx xxx xxxx By A xxx xxx xxxx
Purchase Transferred
Returns to Dept. A
To Received A xxx xxx xxxx By Cost of A xxx xxx xxxx
from Dept. B Goods Lost
To Purchase A xxx xxx xxxx By Cost of A xxx xxx xxxx
Expenses Goods
Damaged
To Direct A xxx xxx xxxx By Closing A xxx xxx xxxx
Wages Stocks
To Lighting, xxx xxx xxxx
Power
To Repairs xxx xxx xxxx
Workshop
Cost
To Stores xxx xxx xxxx
Dept. Cost
To Other xxx xxx xxxx
Factory
Expenses
To Gross xxx xxx xxxx By Gross xxx xxx xxxx
Profits c/d loss c/d
Total Rs xxx xxx xxxx Total Rs xxx xxx xxxx
208
Profit & Loss A/c
For the year ended
Particulars Basis Dept. Dept. Total Particulars Basis Dept. Dept. Total
A B A B
To Gross xxx xxx xxxx By Gross xxx xxx xxxx
Loss b/d Profit b/d
To xxx xxx xxxx By xxx xxx xxxx
Salesman’s Discount
Salaries Received
Commission
To Traveling xxx xxx xxxx
Expenses
To Carriage xxx xxx xxxx
Outwards
To Ware xxx xxx xxxx
Housing
Charges
To Packing xxx xxx xxxx
Expenses
To xxx xxx xxxx
Advertising
Selling
Expenses
Distribution
Expenses
To Bad xxx xxx xxxx
Debts /
Discount
To Rent, xxx xxx xxxx
Taxes
Repairs
To Staff xxx xxx xxxx
Welfare
To Canteen xxx xxx xxxx
Expenses
To xxx xxx xxxx
Contribution
to PF, ESIS
To Insurance xxx xxx xxxx
209
- Assets xxx xxx xxxx

- Stocks xxx xxx xxxx
- Workmen xxx xxx xxxx
To Officer xxx xxx xxxx
Salaries
To Postage xxx xxx xxxx
Telephones
To Printing xxx xxx xxxx
and
Stationary
Admin /
Office
Expenses
To xxx xxx xxxx
Depreciation
on Assets
To Net Profit xxx xxx xxxx By Net xxx xxx xxxx
Ltd. Loss Ltd.
To Gen. xxx xxx xxxx By Gen. xxx xxx xxxx
Profit & Loss Profit &
A/C Loss A/C
Total Rs xxx xxx xxxx Total xxx xxx xxxx
General Profit and Loss Account
For the year ended
Particulars Amounts Particulars Amounts

Rs. Rs.
To Net Loss from By Net Profits tfd. From
Depts. Deptts.
- Department A Xxxx - Department A Xxxx
- Department B Xxxx - Department B Xxxx
To Stock Reserve Xxxx By Interest on Loans Xxxx

(Opening Stock) Given
- Department A Xxxx By Dividends on Shares Xxxx
Received
- Department B Xxxx By Profits on Sale of Xxxx
Assets
210
To General Admin. Xxxx By Stock Reserve (on

Expenses Closing Stock)
To Audit / Legal Xxxx - Department A Xxxx
Fees
\\1h00
To Interest and Xxxx - Department B Xxxx
Bank Charges Paid
To Depreciation Xxxx
(General Assets)
To Loss on Goods Xxxx
Destroyed /
Damaged
To Loss on Sale of Xxxx
Fixed Assets
To Income Tax Xxxx
To Transfer to Xxxx
Reserves
To Net Profit tfd. to Xxxx But Net Loss tfd. to xxxx
Capital Capital
Balance Sheet
As on
Liabilities Amounts Assets Amounts

Rs. Rs.
Capital : x Buildings x
Add : Net Profit x Furniture x
x Closing Stock x
Less: Drawings x x Less Profit on Inter
Loans x Departmental Goods x
Sundry Creditors x Sundry Debtors x
Bills Payable x Bill Receivable x
Outstanding Expenses x Bank Balance x
Cash on hand x
Total xxx Total xxx
211
10.10 EXERCISE
A) Theory Questions
1. What is meant by Departmental Accounts?

2. What are the advantages of Departmental Accounts?
3. What difficulties are faced in the preparation of Departmental
Profit & Loss Account?
4. What are the different methods of allocating expenses
among the departments?
B) Objective Questions
a. Test your understanding by selecting the most appropriate
alternative:
1. Repairs and maintenance charges relating to Plant & Machinery

are apportioned over different departments according to :
a) The number of machines in each department.
b) Book value of machines.
c) Area occupied by each machine.
2. Lighting charges are apportioned over the departments on the

basis of :
a) Number of light points.
b) Cost of machines.
c) Sales.
3. Items of expenses not connected with any department are :

a) Charged to departments on the basis of total sales.
b) Charged to the General Profit & Loss Account.
c) Charged to departments on the basis of fixed assets
employed.
4. Cost of electric power should be apportioned over different

departments according to :
a) H.P. of motors
b) No. of light points.
c) Cost of machines.
5. Supervision charges should be apportioned over the different

departments on the basis of :
a) Time devoted for supervision.
b) Area occupied by each department.
c) Sales of each department.
212
6. Which of the following is divided in the ratio of number of

employees?
a) Rent b) Repairs
c) Wages d) Carriage
7. Following entry is passed in journal means :

Stock Reverse A/c Dr.
To General Profit & Loss A/c.
a) Unrealized profit on closing stock
b) Loss on sale of goods by department.
c) Unrealized profit on opening stock.
d) Profit on sale of goods.
8. Which of the following allocated in the sales ratio :

a) Discount allowed b) Advertisement
c) Commission d) All the above
9. Credit balance in Departmental Trading A/c means

a) Gross Loss b) Gross Profit
c) Net Profit d) Non of the above
10. Which of the following not debited to Department Trading A/c.

a) Loss due to fire b) Purchases
c) Carriage d) Opening Stock
11. Which of the following not debited to department Trading, Profit

& Loss A/c.
a) Abnormal gain b) Abnormal loss
c) Income tax d) All of the above
12. Canteen subsidy is allocated on the basis of each department.

a) Sales b) Purchases
c) No. of workers d) Value of assets in canteen
13. Air - conditioning is allocated on the basis of each department.

a) Purchases b) Sales
c) Area occupied d) No. of employees
14. Postage is allocated on the basis of each department.

a) Purchases b) No. of employees
c) Value of stock d) Sales
213
15. Which of the following debited to General Profit and Loss A/c.
a) Wages b) Closing stock reserve
c) Opening stock reserve d) Net loss
16. Debit balance in General Profit & Loss A/c means :

a) Net loss b) Net profit
c) Departments profit transferred d) All of the above
Answer: 1-b, 2-a, 3-b, 4-a, 5-a, 6 - C, 7 - C, 8 - d, 9 - b, 10 - a,

11 - d, 12 - c, 13 - c, 14 - d, 15 - b, 16-a.
b) State whether True or False

1) Carriage outwards debited to Departmental Trading A/c.
2) Distribution expenses are allocated to Department on the
basis of sales of each department.
3) Audit fees is credited to General Profit & Loss A/c.
4) Management expenses debited to al& Loss A/c.
5) Insurance of stock is allocated in the ratio of value of stock in
each department.
6) Net loss appears on the debit side of Departmental Profit &
Loss A/c.
7) Bad debts recovery is debited to General Profit And Loss A/c.
8) Return inwards deducted from purchases of each department.
9) Rent of building is allocated on the basis of sales of each
department.
10) All expenses are allocated on the basis of sales of each
department.
11) Goods transferred by department must be recorded at cost.
12) Stock reserve is reduced from stock in the Balance Sheet.
13) Departmental gross profit is credited to Departmental Profit &
Loss A/c.
14) Depreciation is to be apportioned on the basis of value of
assets in each department.
15) If purchases & sales are double in Department A as
compared to Department B, gross profit is also double in
Department A as compared to Department B.
16) Cost of insurance of stock is allocated in the ratio of
employees employed in each department.
17) Each department is treated as separate entity for the purpose
of preparing Trading, Profit & Loss A/c.
214
18) Loss due to fire in department is debited to general profit &

loss a/c.
19) Legal expenses incurred by a department is debited to
General Profit & Loss A/c.
Answer:
False: 1, 3, 6, 7, 8, 9, 10, 11, 15, 16
True: 2, 4, 5, 12, 13, 14, 15, 17, 18, 19
c) Fill in the blanks:

1) Income Tax paid is debited to --------------- A/c.
2) Closing stock reserve is credited to --------------- A/c.
3) Power is allocated on the basis of ------------ of each
department.
4) Depreciation is allocated on the basis of ------------ of each
department.
5) Legal charges should be debited to -------------- A/c.
6) Goods transferred by A Department to B Department credited
to -------------- Department Trading A/c.
7) Depreciation on delivery van should be allocated on basis of
-------- of each department.
8) Goods transferred by Z department to K Ltd. should be
credited to -------------- Department Trading A/c.
9) Stock Reserve is not required if goods are transferred at ------.
10) Income from investment should be credited to --------------- a/c.
11) Contribution to P.F. is allocated on the basis of ---------- of
each department.
12) Profit of a department is credited to ------------- A/c.
13) For transferring opening stock reserve ------------- A/c is
credited.
Answer:
1) Drawing, 2) Stock Reserve, 3) No. of electric points,
4) value of assets, 5) General Profit & Loss A/c, 6) A dept.,
7) Sales, 8) Z dept., 9) cost, 10) General Profit & Loss A/c,
11) Wages or Salaries, 12) General Profit & Loss, 13) Stock
Reserve.
215
d) Match the following:

I)
Column A Column B
Common Expenses Basis of Allocation
A) Rent 1) No. of employees in each
department
B) Cost of stores 2) Value of plant in each
department
C) Depreciation on plant 3) Floor area of each department
D) Labour welfare 4) Purchase of each department
5) Material consumed by each
department
Answer: I)A - 3, B - 5, C - 2, D - 1
II)
Column A Column B
1) Stock Reserve a) General Profit & Loss A/c
2) Loss due to fire b) Debit to A Dept. Trading A/c
3) Transfer of goods from A c) Debited to Dept. Trading A/c
Dept. to K Dept.
4) Selling expenses d) Sales of each department
e) Deduct from stock in Balance
Sheet
f) Debit to K Dept. Trading A/c
Answer: II) 1 - e, 2 - a, 3 - e, 4 - d
III)
Column A Column B
A) Insurance of machinery 1) Wages
B) Power 2) On the basis of credit sales
C) E.S.I. contribution 3) General Profit & Loss A/c
D) Discount received 4) W.D.V. of machinery
E) Audit fees 5) H.P. of machinery
6) On the basis of credit
purchases
Answer: A – 4, B – 5, C – 1, D – 6, E - 3
216
IV)
Column A Column B
i) Repairs to Building 1) Space occupied by each
Department
ii) Bad debts 2) Purchases of each Department
iii) Carriage inwards 3) Sales of each Department
iv) Medical benefits 4) Stock of each Department
5) Sales Return of each department
6) Purchases of each dept.
7) No. of workers
Answer: I - 1, ii - 3, iii - 2, iv - 7
V)
Column A Column B
1) Manager salaries a) On basis of sales of each dept.
2) Building Insurance b) Actual of each dept.
3) Traveling expenses c) On the basis of time devoted
4) Discount received d) Floor space occupied
e) On basis of purchases of each dept.
Answer: 1 - c, 2 - d, 3 - a, 4 - e
VI)
Column A Column B
1) Depreciation of Delivery a) On the basis of points in each
Van dept.
2) Lighting b) On the basis of purchases of
each dept.
3) Works manager’s c) On the basis of sales of each
salaries dept.
4) Purchase manager’s d) Value of stock purchased by
salary each dept.
e) Time spent by him for each
dept.
Answers: 1 -c, 2 - a, 3 - e, 4- b

217
Unit-11
DEPARTMENTAL ACCOUNTS II
UNIT STRUCTURE
11.0 Objectives
11.1 Solved Problems
11.2 Exercise
11.0 OBJECTIVES
After studying the unit students will be able to prepare the

Departmental final accounts
11.1 SOLVED PROBLEMS
Illustration 1
Mr. Ramkrushna is the proprietor of Venus; a shop selling
books and toys for the purpose of his accounts. He wishes the
business to be divided into two departments: Department R: Books,
Department V: Toys.
The following balances have been extracted from his books

as at 31st March 2018.
Name of the Account Amount

(Rs)
Sales : Department R 3,00,000
: Department V 2,00,000
Stock : Department R 5,000
: Department V 4,000
Purchases : Department R 2,36,000
: Department V 1,64,000
Salesmen : Department R 20,000
: Department V 15,000
Book delivery wages 3,000
General office salaries 15,000
218
Rates 2,600
Fire insurance - building 1,000
Heating & lighting 2,400
Repairs to premises 500
Telephone 500
Cleaning 600
Audit Fees 2,400
General office expenses 1,200
Discount Allowed 5,000
Discount Received 2,000
Stock (closing) Department R 6,000
Department V 3,000
The floor area occupied Department R one fifth Department V four -

fifth. Prepare Trading and Profit and Loss Account for the year
ended 31st March 2018 apportioning the overhead expenses, where
necessary to show the Departmental Profit or Loss. Show clearly
the basis on which the expenses are apportioned.
Solutions : 1
Venus Trading
For the year ended 31st March 2018
Particulars Dept. R Dept. V Particulars Dept. R Dept. V

(Rs) (Rs) (Rs) (Rs)
To Opening stock 5,000 4,000 By Sales 3,00,000 2,00,000

To Purchases 2,36,000 1,64,000 By Closing Stock 6,000 3,000
To Gross Profit c/d. 65,000 35,000
3,06,000 2,03,000 3,06,000 2,03,000
To Salaries 10,000 15,000 By Gross profit 65,000 35,000
b/d
To Delivery Wages 3,000 -- By Dis. Received 1,180 820
To Gen Office 9,000 6,000
Salaries
To Rates 520 2,080
To Fire Insurance 200 800
219
To Lighting & 480 1,920

Heating
To Repairs to 100 400
Premises
To Telephone 300 200
To Cleaning 120 480
To Audit Fees 1,440 960
To General Office 720 480
Exp.
To Dis. Allow 3,000 2,000
To Net profit 37,300 5,500
66,180 35,820 66,180 35,820
Working Notes:
1) Sales ratio: 3: 2
2) Purchase ratio: 59: 41
3) Floor space ratio: 1: 4
Illustration No. 2
From the following particulars of Kirti Enginer’s prepare a

departmental Trading and Profit and loss account for their two
departments viz. Cars Department and Dolls Department for the
year ended 31st March 2018:
Particulars Cars Dolls

Opening stock 50,000 1,50,000
Wages 30,000 60,000
Sales 9,00,000 1,80,000
Closing stock 1,20,000 60,000
Other Information :
Raw materials consumed (Cars) 3,60,000
Stores consumed 90,000
Advertising 15,000
Packing expenses (Dolls) 6,000
Office expenses 48,000
Depreciation on factory equipment 32,000
Building 16,000
220
Additional Information :
a) Dolls making does not require any equipment
b) Only 1/8 of the total area of building is occupied by dolls
Department.
c) Office expenses are to be allocated in ratio of 5:1.
d) Value of materials used by Dolls department is Rs. 20,000
out raw materials consumed.
Kirti Engineers
For the year ended 31st March 2018
Particulars Cars Dolls Particulars Cars Dolls
(Rs.) (Rs.) (Rs.) (Rs.)
To Opening 1,50,000 50,000 By Sales 9,00,000 1,80,000
Stock
To Raw Material 3,40,000 20,000 By Closing 1,20,000 60,000
Stock
To Stores 85,000 5,000
To Wages 60,000 30,000
To Gross Profit 3,85,000 1,35,000
c/d
10,20,000 2,40,000 10,20,000 2,40,000
To Packing Exp. -- 6,000 By Gross 3,85,000 1,35,000
Profit b/d
To 12,500 2,500
Advertisement
To Office Exp. 40,000 8,000
To Dep. On 32,000 --
Factory
Equipment
Building 14,000 2,000
To Net Profit 2,86,500 1,16,500
3,85,000 1,35,000 3,85,000 1,35,000
Notes :
1) Stores are allocated in proportion of raw materials consumed
it. 17:1.
2) Sales Ration 5:1.
221
Illustration 3: (Transfer of goods at cost)

The following figures are extracted from the books of M/s
Krishna. For the year ended 31st December 2017.
Particulars Department
P Q R
Rs Rs Rs
Purchases 4,40,000 5,20,000 1,10,000
Sales 6,10,000 9,25,000 3,20,000
Return Inward 10,000 25,000 20,000
Return Outward 40,000 20,000 10,000
Wages 8,000 5,000 7,000
Stock on 01.01.2017 45,000 35,000 40,000
Stock on 31.12.2017 65,000 20,000 10,000
Other Information’s :
1. Goods transferred from P to Q Rs.10,000 and to R Rs.8,000.

2. Goods transferred from R to P Rs.5,000 and to Q Rs.6,000.
3. Goods transferred from Q to P Rs.6,500 and to R Rs.5,600.
4. Telephone charges Rs.15,800 to be apportioned in the ratio
of 3:1:1 among departments P, Q and R respectively.
5. Rent Rs.24,000 to be divided as ¼, 2/4 and ¼ among
Departments P, Q and R respectively.
6. Other Expenses
Discount allowed Rs.18,000
Bad debts Rs.15,000
Income tax Rs.58,000
Legal expenses Rs.24,000
Insurance of goods Rs.8,600
You should allocate aforesaid expenses as you deem best

indicating the basis of allocation. All working should form a part of
your answer.
Prepare Departmental Trading and Profit and Loss account.

In columnar form and General Profit and Loss accountant for the
year ended 31st December, 2017.
222
M/s Krishna
Departmental Trading and Profit & Loss Account
For the year ended 31.12.2017
Particulars Departments Particulars Departments

P (Rs.) Q (Rs.) R (Rs.) P (Rs.) Q (Rs.) R (Rs.)
To Opening 45,000 35,000 40,000 By Sales 6,00,000 9,00,000 3,00,000
Stock (Net)
To 4,00,000 5,00,000 1,00,000 By Closing 65,000 20,000 10,000
Purchases stock
(Net)
To Wages 8,000 5,000 7,000 By Transfer 18,000 -- --
To Transfer -- 10,000 8,000 By Transfer -- -- 11,000
To Transfer 5,000 6,000 -- By Transfer -- 12,100 --
To Transfer 6,500 -- 5,600
To Gross 2,18,500 3,76,100 1,60,400
Profit c/d
6,83,000 9,32,100 3,21,000 6,83,000 9,32,100 3,21,000
To 9,480 3,160 3,160 By Gross 2,18,500 3,76,100 1,60,400
Telephone Profit b/d
To Rent 6,000 12,000 6,000
To Discount 6,000 9,000 3,000
To Bad debts 5,000 7,500 2,500
To Insurance 3,440 4,300 860
To Net Profit 1,88,580 3,40,140 1,44,880
2,18,500 3,76,100 1,60,400 2,18,500 3,76,100 1,60,400
General P & L Account


To Legal Expenses 24,000 By Net Profit b/d
To Income Tax 58,000 P 1,88,580
To Net Profit c/d 5,91,600 Q 3,40,140
To B/S -- R 1,44,880
6,73,600 6,73,600
Notes :
1. Purchases and Sales are recorded at Net.

2. Telephone charges are apportioned in the ratio 3:1:1.
223
3. Discount allowed and Bad debts are apportioned in the ratio of

Sales 2:3:1.
4. Insurance on goods is assumed to be on purchases & hence
allocated in the ratio of purchases 4:5:1.
Alliteratively, it may be assumed to be on stock and

allocated in the ratio of closing stock 65:20:10.
Illustration No. 4 (Inter department transfer at selling Price)
Following are the particulars of Dilip Kumar for the year ended 31st
March 2018.
Particulars Dept. A Dept. B

Rs. Rs.
Opening Stock 20,000 14,000
Sales 1,44,000 1,88,000
Purchases 1,40,000 1,80,000
Transfer to other Department 16,000 12,000
Transfer to other Department 12,000 16,000
1. Closing stock of ‘B’ department is Rs.30,000. In which goods

worth Rs.8,000 are such which were transferred by A
department.
2. Closing Stock of A department is Rs.32,000 in which goods
worth Rs.12,000 are such, which were transferred by B
department.
3. Opening Stock of A department includes goods of Rs.1,600
which were transferred by B department. Gross Profit of B
department in the last year was 10%.
4. Opening stock of B department includes goods of Rs.3,200
which was transferred by A department. Gross Profit of A
department in the last year was 25%.
Prepare Department Trading and Profit & Loss Account and

General Profit & Loss Account of Dilip Kumar from the above
particulars.
224
Solution :
Dilip Kumar
Particulars Dept. P Dept. Q Particulars Dept. P Dept. Q
Rs. Rs. Rs. Rs.
To Opening Stock 20,000 14,000 By Sales 1,44,000 1,88,000
To Purchase 1,40,000 1,80,000 By Transfer 16,000 12,000
To Transfer 12,000 16,000 By Closing 32,000 30,000
Stock
To Gross Profit 20,000 20,000
b/d
1,92,000 2,30,000 1,92,000 2,30,000
General Profit & Loss Account

To Stock Reserve By Gross Profit
b/d
Department (A) W.N.1 1,040 Department A 20,000
Department (B) W.N.2 200 Department B 20,000
To Net Profit c/d 38,760
40,000 40,000
Working Note No. (1)
Total Sales of Dept. B = (1,88,000 + 12,000) = 2,00,000

20,000 100
Gross Profit Ratio of Dept. B =  10%
2,00,000 1
12,000 10
Stock Reserve of Department A is  1200
100 1
Stock Reserve of Department A on opening stock is
Opening stock of Department A includes goods of Rs. 1,600
From Department B
Gross profit of last year is 10%
 Stock reserve on opening stock of department A =
16,00 10
 160
100 1
Net Stock Reserve = 1200 - 160 = 1040
225
Working Note No. (2)

Total Sales of department A (Rs. 1,44,000 + 16, 000 = 1,60,000
20,000 100
Gross profit Ratio of Dept A  12.50%
1,60,000 1
Stock Reserve of department A
8,000 12.5
On closing stock 1000
100
3,200 25
On opening stock   800
100 1
Net stock Reserve = 1,000 - 800 = 200
Illustration 5:
Ram Krishna Motors has three departments i.e. Jeep, Car

and Servicing. The Department Jeep and Department Car sell
spare parts and occupy a showroom. The servicing department
uses a garage.
From the following particulars, prepare

a) Departmental Trading, Profit & Loss A/c
b) General Profit and Loss Account
Particulars Department
Jeep Car Servicing
Rs. Rs. Rs.
Opening Stock 70,000 25,000 --
Purchases 1,75,000 35,000 --
Sales 3,00,000 1,00,000 50,000
Wages 10,000 5,000 7,000
Closing Stock 40,000 8,000 --
Discount allowed 2,000 3,000 --
Other Expenses : Rs.

Show room Expenses 11,000
Lighting Expenses 6,000
Transfer from Jeep to Servicing at cost 18,000
Transfer from Car to Servicing at cost 5,000
Directors fees 2,000
Bad debts 1,800
Income from Investment 1,500
Depreciation on Garage Equipment 4,000
Depreciation on showroom Furniture 2,000
226
Additional Information:
1. Show-room rent for one month is out-standing Rs. 1,000.
2. The departments using show room share the space and
furniture equally.
3. 50% of light bill is to be charged to servicing department and the
balance equally to other departments.
4. Allocate the above expenses as you deem best indicating the
base of allocation.
Solution :
Ram Krishna Motors

Departmental Trading and Profit & Loss A/c
For the year ended
Particulars Departments Particulars Departments

P (Rs.) Q (Rs.) R (Rs.) P (Rs.) Q (Rs.) R (Rs.)
To opening 70,000 25,000 -- By Sales 3,00,000 1,00,000 50,000
stock (Net)
To 1,75,000 35,000 -- By Transfer 18,000 5,000 --
Purchases
To Wages 10,000 5,000 7,000 By Stock 40,000 8,000 ---
To Transfer -- -- 23,000
To Gross 1,03,000 48,000 20,000
Profit c/d
3,58,000 1,13,000 50,000 3,58,000 1,13,000 50,000
To 5,500 5,500 -- By Gross 1,03,000 48,000 20,000
Showroom Profit b/d
To lighting 1,500 1,500 3,000
To Bad-debts 1,200 400 200
To Deep on -- -- 4,000
G.
To Dep on 1,000 1,000 --
Fur
To o/s. Rent 500 500 --
To Discount 2,000 3,000 --
To Net Profit 91,300 36,100 12,800
1,03,000 48,000 20,000 1,03,000 48,000 20,000
227
For the year ended

To Directors fees 2,000 By Income from 1,500
Investment
By Net Profit :
To N.P. c/d to B/s 1,39,700 Jeep 91,300
Car 36,100
Servicing 12,800
1,41,700 1,41,700
Illustration 6:
A firm has two departments X and Y. From the following
figures prepare the Departmental Trading and Profit and Loss
Account for the year ended 31st December 2017.
Particulars Departments
X Y
Rs. Rs.
Opening Stock 40,000 50,000
Purchase 1,50,000 1,00,000
Sales 2,50,000 1,50,000
Salaries 16,800 12,000
Particulars Rs.
General Salaries 20,000
Carriage Inward 20,000
Carriage Outward 16,000
Advertising 12,000
Rent and Rates 18,000
Interest on Bank Loan 5,000
Lighting 2,400
Insurance 2,000
228
Area occupied by the two departments is in the ratio of 2:1.

General salaries are to be allocated equally. Insurance premium is
for a comprehensive policy, allocation being inconvenient. Closing
Stocks were : X Rs. 36,000, Y Rs. 40,000.
(April 2003, adapted)
Solution :

Particulars Dept. X Dept. Y Particulars Dept. X Dept. Y

Rs. Rs. Rs. Rs.
To Opening 40,000 50,000 By Sales 2,50,000 1,50,000
Stock
To Purchase 1,50,000 1,00,000 By Closing 36,000 40,000
Stock
To Carriage 12,000 8,000
Inward (3:2)
To Gross Profit 84,000 32,000
c/d
2,86,000 1,90,000 2,86,000 1,90,000
To Salaries 16,800 12,000 By Gross 84,000 32,000
Profit b/d
To General 10,000 10,000 By Discount 1,800 1,200
Salaries (1:1) Received
(3:2)
To Carriage 10,000 6,000 By Net Loss 6,100
Outward (5:3) c/d
To Advertising 7,500 4,500
(5:3)
To Rent & 12,000 6,000
Rates (2:1)
To Lighting 1,600 800
(2:1)
To Net Profit 27,900 --
c/d
85,800 39,300 85,800 39,300
229

To Net Loss b/d 6,100 By Net Profit b/d 27,900
(Department Y) (Department X)
To Interest on Bank Loan 5,000

To Insurance 2,000
To Profit transferred to 14,800
Capital A/c
(Balance Figure)
27,900 27,900
Working Notes :
1) Purchase Ratio (PR) : Department X Department Y

1,50,000 1,00,000
3 2
2) Sales Ratio (SR) : Department X Department Y

2,50,000 1,50,000
5 3
Illustration 7
From the following information of Mr. Apte a proprietor

having three departments X, Y and Z prepare Departmental
Trading and Profit & Loss A/c for the year ended 31st December
2017 and Balance Sheet on that date.
Trial Balance as on 31st December 2017
Particulars Debit Rs. Credit Rs.

Mr. Apte’s Capital 1,00,000
Stock :
X 20,000
Y 15,000
Z 10,000
230
Purchases :
X 90,000
Y 70,000
Z 50,000
Sales
X 1,00,000
Y 75,000
Z 50,000
Salaries 25,000
Rent & Rates 5,000
Selling & Distribution Expenses 9,000
Land & Building 25,000
Furniture & Fixtures 10,000
Cash in Hand 5,000
Cash at Bank 10,000
Sundry Creditors 44,000
3,69,000 3,69,000
Other Information :
1. Stock in Trade as on 31st December, 2017 was X
Rs. 35,000, Y Rs. 25,000 and Z Rs. 20,000.
2. Salaries are to be allocated in the ratio of 40%, 30%, 30%
amongst all the departments.
3. The floor space occupied by each department is in the
proportion of 40%, 30% and 30%.
4. Selling and distribution expenses are to be allocated on the
basis of sales of each department.
(IDE - November 2010, April 2005, adapted)
231
Solution :
Dr. Cr.
Particulars Basis Dept. X Dept. Y Dept. Z Total
Rs. Rs. Rs. Rs.
To Opening Given 20,000 15,000 10,000 45,000
Stock
To Purchase Given 90,000 70,000 50,000 2,10,000
To Gross Profit 25,000 15,000 10,000 50,000
1,35,000 1,00,000 70,000 3,05,000
To Salaries 4:3:3 10,000 7,500 7,500 25,000
To Rent & Rates 4:3:3 2,000 1,500 1,500 5,000
To Selling & Sales 4,000 3,000 2,000 9,000
Distribution
To Net Profit c/d 9,000 3,000 - 12,000
25,000 15,000 11,000 51,000

For the year ending 31-12-2017
Dr. Cr.
Particulars Basic Dept. X Dept. Y Dept. Z Total
Rs. Rs. Rs. Rs.
By Sales Given 1,00,000 75,000 50,000 2,25,000
By Closing Given 35,000 25,000 20,000 80,000
Stock
1,35,000 1,00,000 70,000 3,05,000
By Gross 25,000 15,000 10,000 50,000
Profit b/d
By Net Loss 1,000 1,000
b/d
25,000 15,000 11,000 51,000
232
Balance Sheet
As on 31-12-2017
Particulars Basic Dept. X Assets Rs.

Mr. Apte’s Capital 1,00,000 Land & Building 25,000
Add : Net Profit 11,000 1,11,000 Furniture & Fixtures 10,000
Sundry Creditors 44,000 Sundry Debtors 25,000
Closing Stock 80,000
Cash at Bank 10,000
Cash in Hand 5,000
1,55,000 1,55,000
Illustration 8:
Tailors Ltd. have two departments, A and B. The latter
department gets all its requirements from the A department at the
usual selling price. On 31st December 2017 the following was the
trial balance :
Particulars Debit Rs. Credit Rs.

Share Capital 1,00,000
Stock (A Department) 40,000
Stock (B Department) 2,500
Purchases : A 5,50,000
Purchases : B 5,000
Sales A 6,25,000
Sales B 75,000
Transfer of Goods to B Department 25,000 25,000
Director’s Fees and Remuneration 15,000
Wages and Salaries : A 10,000
Wages and Salaries : B 20,000
Rent and Rates (3/4 to A) 4,000
Lighting ¾ to B) 1,000
Depreciation : B 2,500
Depreciation : A 500
Office Expenses 1,500
Furniture and Fittings 10,000
233
Office Salaries 8,000

Equipment 25,000
Carriage Inwards (A) 33,000
Investment 50,000
Income from Investments 5,000
Cash at Bank 27,000 -
8,30,000 8,30,000
Closing stock of A on hand was Rs. 48,000 and that in B

amounted to Rs. 3,750. It is desired to ascertain profit or loss on
strict accountancy principles.
Solution :
Trading and Profit & Loss A/c
For the year ended 31st December 2017
Particulars Dept. X Dept. Y Particulars Dept. X Dept. Y

Rs. Rs. Rs. Rs.
To Opening 40,000 2,500 By Sales 6,25,000 75,000
Stock
To Purchase 5,50,000 5,000 By Transfer 25,000 --
of Goods to
Dept. (B)
To Transfer of -- 25,000 By Closing 48,000 3,750
Goods From Stock
Dept. (A)
To Carriage 33,000 --
Inwards
To Wages & 10,000 20,000
Salaries
To Gross 65,000 26,250
Profit c/d
6,98,000 78,750 6,98,000 78,750
To Rent & 3,000 1,000 By Gross 65,000 26,250
Rates (3:1) Profit b/d
To Lighting 250 750
(1:3)
To 500 2,500
Depreciation
To Net Profit 61,250 22,000
c/d
65,000 26,250 65,000 26,250
234

For the year ended 31st December 2017
Particulars Amt. Particulars Amt.

Rs. Rs.
To Director’s Fees & 15,000 By Net Profit b/d
Remuneration Department (A) 61,250
To Office Salaries 8,000 Department (B) 22,000 83,250
To Office Expenses 1,500 By Income from Investment 5,000
To Stock Reserve A/c 375
To Net Profit c/fd 63,375
88,250 88,250
Balance Sheet
As on 31st December 2017
Liabilities Amt. Assets Amt.
Rs. Rs.
Share Capital 1,00,000 Furniture & Fittings 10,000
Profit & Loss A/c 63,375 Equipment 25,000
Investments 50,000
Stock
Department (A) 48,000
Department (B) 3,750
51,750
Less : Stock Reserve 375 51,375
Cash at Bank 27,000
1,63,375 1,63,375
Working Note :
The gross profit of department (A) is Rs. 65,000 and its sales
(including transfers) amount to Rs. 6,50,000.
65,000
Gross Profit Rate = × 100 = 10%
6,50,000
Stock Reserve = 10% on 3,750 = 375
235
11.2 EXERCISE
Practical Exercises:
1. Trading, Profit & Loss A/c of the Modern Electronics Ltd. for the
year ended 31st March 2018 is presented in the following form.
Trial Balance
As on 31st March 2018
Particulars Amt. Particulars Amt.
Rs. Rs.
To Purchases : By Sales
T.Vs(A) 2,81,400 T.Vs(A) 2,71,200
Refrigerators (B) 1,81,200 Refrigerators (B) 2,00,000
Spare Parts (C) 1,00,000 Spare Parts and 50,000
Receipts from servicing
(C) Department
To Spare parts 28,800 By Transfer from 28,800
received by (C) Department (A) to
Department from Department (C)
(A) Department
To Indirect Wages 96,000

& Salaries
To Rent 21,600 By Closing stock :
To Office 22,000 T.Vs (A) 1,20,200
Expenses
To Net Profit 69,000 Refrigerators (B) 40,600
-- Spare Parts (C) 89,200
8,00,000 8,00,000
Prepare Departmental Accounts for each of the three

Departments A, B and C after taking into consideration the
following information:
a) T.Vs and Refrigerators are sold at the showroom and

repairing and servicing jobs are carried out at the workshop.
b) Salaries and wages comprise as follows :
Showroom ¾ and workshop ¼
It was decided to allocate showroom salaries and wages in
the ratio of 1:2 between Departments A and B.
236
c) The workshop rent is Rs. 500 per month. The rent of the
showroom is to be divided equally between Departments A
and B as both the Departments occupy equal floor space.
d) Allocate office expenses on the basis of turnover of each
department.
e) Inter-departmental transfers take place at cost to transferor
department.
[Ans. Gross Profit - A : Rs. 1,38,800: B : Rs. 59,400, C : Rs. 10,400,
Net Profit - A : Rs. 95,553, B : Rs. 4,842, C : Rs. 21,711]
2. Dadar Departmental Stores has three departments X, Y and Z.

The following particulars regarding the three departments are
given :-
Particulars X Y Z
Rs. Rs. Rs.
Opening Stock 30,000 30,000 60,000
Purchases 1,00,000 60,000 2,00,000
Sales 4,00,000 3,00,000 3,00,000
Closing Stock 20,000 40,000 40,000
The following expenses were also incurred:
Particulars Amt.
Rs.
Rent and Taxes 18,000
General Expenses 24,000
Discount Allowed 30,000
Sales Promotion Expenses 40,000
Salesman’s Salary 10,000
Commission Received 10,000
a) Goods worth Rs. 8,000 were transferred from Department X

to Department Y.
b) Allocate general expenses, rent and taxes equally among
the three departments.
237
c) Commission received is to be divided in the ratio of 4:3:3

respectively.
Prepare Departmental Trading and Profit & Loss Account.
(M.U. November 1998)
3. The following Trail Balance for the year ended 31st March 2018
was extracted from the books of Shri Mukesh.
Trial Balance
As on 31st March 2018
Particulars Debit Credit

Rs. Rs.
Capital on 1.4.2017 50,000
Drawings Account 10,000
Stock on 1.4.2017
Radios 45,000
Watches 21,000
Sales :
Radios 2,94,000
Watches 1,46,000
Purchases :
Radios 2,25,000
Watches 1,15,000
Salaries 12,600
Publicity Expenses 8,900
Rent, Rates and Taxes 3,200
Commission 10,600
Sundry Expenses 5,000
Furniture and Fixtures 12,400
4% Govt. of India Loan 10,000
Sundry Creditors 8,800
Interest 400
Reserve for Bad and Doubtful Debts 800
Cash Balance 4,500
5,00,000 5,00,000
238
Prepare the Departmental Trading and Profit & Loss Account

for the year ended 31st March, 2018 after taking into account the
following :
a) Stock as on 31st March, 2018 was : Radios : Rs. 30,000

Watches Rs. 24,000
b) An amount of Rs.1,200 out of sundry debtors has to be
written off as bad debts and the provision for doubtful debts
has to be increased thereafter to 10% of the debts
outstanding.
c) The expenses outstanding as on 31st March, 2018 are
Publicity Rs.1,300, Salaries Rs.1,200 and Commission
Rs.1,700.
d) Provide 10% depreciation on furniture & fixtures.
e) Revenue items to be allocated in ratio 2:1 between Radio
and Watches.
(Answer: Net Profit - Radio - 22,467 Watches – 18,233)
4. From the following particulars given by M/s Tins and Toys,

prepare a Departmental Trading and Profit & Loss Account for
their two departments, viz. Tins Dept. and Toys Dept. for the
year ended 31st March, 2018.
Particulars Rs.
Opening Stock Toys 5,000
Tins 15,000
Raw Material consumed (Tins) 36,000
Stores consumed 9,000
Wages : Tins 6,000
Toys 3,000
Advertisement 1,500
Packing Expenses (Toys) 600
Office Expenses 4,800
Depreciation : Factory Equipment 3,200
Building 1,600
Sales : Tins 90,000
Toys 18,000
Closing Stock : Toys 6,000
Tins 12,000
239
You are also given the following additional information :

a) Toys are made of end bits of sheets of raw material used by
Tins Department. The value of such material used during the
year by Toys Department Rs. 2,000.
b) Toy-making does not require any equipment.
c) Only one-eighth of the total area of building is occupied by
Toys Department.
[Ans. Net Profit - Toys : Rs. 11,650, Tins : Rs. 28,650]
5. Following information is available from the books of Trupti

Departmental Stores for the year.
Account heads Departments Total

A B C
Rs. Rs. Rs. Rs.
Purchases 1,00,000 1,50,000 4,00,000 6,50,000
Sales 3,05,000 6,10,000 9,15,000 18,30,000
Returns inwards 5,000 10,000 15,000 30,000
Returns outwards 10,000 5,000 15,000 30,000
Opening stock 25,000 35,000 50,000 1,10,000
Closing stock 40,000 25,000 20,000 85,000
Wages 90,000
Postage 1,500
Salaries 3,000
Office expenses 4,500
Rent 12,000
Discount allowed 9,000
Professional 12,000
charges
Bad debts 6,500
Interest 31,500
Insurance 3,400
240
Additional Information :
1) Departmental transfers :
i) Department A to B Rs. 5,000 and to C Rs. 10,000.
ii) Department B to C Rs. 5,000 and to A Rs. 2,500.
iii) Department C to A Rs. 3,500 and to B Rs. 4,500.
2) Allocation of expenses.
i) Postage, salaries, office expenses and professional
charges : Equally
ii) Rent A - 1, B - 1, C - 2
iii) Insurance A - 8, B - 5, C - 4
iv) Wages and interest A - 2, B - 3, C - 4.
You are required to prepare Departmental Trading and Profit

and Loss Account for the year.
[Ans. Gross profit A Rs. 2,14,000 B Rs. 4,13,000; C Rs. 4,38,000 Net
profit A Rs. 1,92,817; B Rs. 3,86,333; C Rs. 4,02,450]

241
Unit-12
HIRE PURCHASE - I
Unit Structure :
12.0 Objectives
12.1 Introduction
12.2 Meaning of Hire-Purchase Transaction
12.3 Difference between Installment Payment and Hire-Purchase
System
12.4 Calculation of Interest
12.5 Interest Included in Amount of Installment
12.6 When Interest is not included in Installments
12.7 Rate of Interest is not given
12.8 Calculation of Depreciation
12.9 Accounting Methods
12.10 Full Cash Price Method (Credit Purchase/Sale Method)
12.11 Practical Problems
12.12 Exercises
12.0 OBJECTIVES
 Know the meaning of Hire purchase.

 Distinguish between Installment system and Hire purchase
system.
 Calculate interest under different conditions.
 Calculate depreciation under Hire purchase system.
 Journalise the hire purchase transactions.
 Understand the accounting procedure.
12.1 INTRODUCTION
All big business houses and multinationals make sales

on cash basis as well as on credit basis. When the goods are
sold the purchaser may either make the full payment at one time
(cash basis) or may defer the payment (credit basis). The credit
242
sales are very important and essential for the growth of business.
The sale proceeds under credit sales are not immediately collected
but are collected in monthly, quarterly or yearly installments. When
the price of an article is paid by installments, the total amount
paid is higher than the actual cash price of the article. The
excess price is the charge for interest and the risk involved. This
arrangement of making the payment in installments is beneficial to
both the seller and the buyer. There are two systems of deferred
payments, namely, (i) Hire Purchase System, and (ii) Installment
Payment System. Hire-purchase system is the most secured and
effective tool of collecting the proceeds of a credit sale. Under
this system, the goods are delivered to the purchaser at the
time of agreement before the payment of installments but the title
on the goods is transferred after the payment of all
installments as per the hire-purchase agreement.
12.2 MEANING OF HIRE-PURCHASE TRANSACTION
12.2.1 Meaning
Hire-purchase is a credit purchase of an asset by the
hire-purchaser from the hire- vendor. The asset is delivered in the
possession of the purchaser at the time of commencement of the
agreement. The price under hire-purchase system is paid in
installments. The installments may be annual, six monthly,
quarterly, etc. The installment includes the part of the outstanding
cash price and the interest on the outstanding cash price from the
date of the last installment paid to the due date of the installment.
The hire-purchaser becomes the owner of the goods after the
payment of all installments as per the agreement. The hire-
purchaser has a right to use the goods as a bailer and terminate
the agreement at any time in the capacity of a hirer.
12.2.2 Default in the payment of any installment:

Hire-purchase means a transaction where the goods are
sold by hire-vendor to the purchaser under the hire-purchase
agreement. If there is a default in the payment of any
installment, the hire vendor will take away the goods from the
possession of the purchaser without refunding him any amount.
The payment of every installment is treated as the payment
of hire charges by the purchaser to the hire vendor till the
payment of the last installment. After the payment of the last
installment, the amount of various installments paid is appropriated
towards the payment of the price of the goods sold and the
ownership or the goods is transferred to the purchaser. Hire
vendor continues to be the owner of the goods till the payment of
last installment.
243
12.2.3 Hire-Purchase Agreement
A hire purchase agreement is one under which the buyer

takes delivery of goods, promising to pay the price in certain
number of installments and until full payment is made, to treat the
payment as hire charges for using the said goods. In fact, a hire
purchase agreement stipulates that (i) the delivery of goods will be
given by the owner of goods to the hire purchaser; (ii)
payment will be made in installments, (iii) each installment will
be treated as hire charge so that if default in respect of payment
of even the last installment is made, the seller will be entitled to
take away the goods without compensating, the hire purchaser in
any form, and (iv) if all installments are paid and the other
conditions are fulfilled, the ownership of the goods will pass to the
buyer. Hire-purchase agreement means a contract between the
hire vendor and the hire purchaser regarding the sale of goods
under certain conditions.
Usually every hire-purchase agreement shall contain the
following terms.
1. Date of hire-purchase: The date on which the hire-purchase

agreement will commence.
2. Description of the goods: The description of the goods that

will be delivered to the hire-purchaser at the commencement of the
agreement.
3. Hire-Purchaser: A Person who gets the possession of the

asset/goods from the owner under a hire-purchase agreement. He
is the buyer (Hire-Purchaser) of the goods.
4. Hire-Vendor: A Person who sells goods under a hire-purchase

agreement.
5. Cash price of the goods: Cash price means the price at which
goods may be purchased against cash payment.
6. Hire-purchase price: Hire purchase price means the total

amount which is payable by the hire-purchaser under the
agreement.
7. Down payment: The down payment means the amount which

is required to be paid by hire-purchaser to the hire vendor at the
time of commencement of hire-purchase agreement.
8. Rate of interest: The rate of interest is the interest charged

by the hire vendor on the outstanding amount of the cash price
due to the hire-purchaser.
244
9. Installments: The number of installments to be paid by the

hire-purchaser along with the amount of each installment and the
date of payment of each installment. The installment paid by the
purchaser is also called as “Hire”.
12.3 DIFFERENCE BETWEEN INSTALLMENT

PAYMENT AND HIRE-PURCHASE SYSTEM
Installment payment transaction is a system of purchase

and sale of goods in which title of goods is immediately transferred
to the purchaser at the time of sale of goods and the sale price
of the goods is paid in installments. The followings are the
differences between Hire-purchase system and Installment
payment system:
Hire-purchase system Installment payment system

1.The transfer of ownership 1.The ownership is transferred
takes place after the payment immediately at the time of
of all installments. agreement.
2. Hire-purchase agreement is 2.The agreement is like a
like a contract of hire though contract of credit purchase.
later on it may become a
purchase after the payment of
last installment.
3.The vendor has a right to 3.The vendor has no right to

take back goods from the take back the goods from the
possession of the hire- possession of the purchaser; he
purchaser. can simply sue for the balance
due.
4.The provisions of the Hire- 4.The provisions of Sale of
Purchase Act apply to the Goods Act apply to the
transaction. transaction.
CHECK YOUR PROGRESS

1. Enlist the terms included in the Hire Purchase Agreement.
2. Define the terms:
a. Hire Purchase
b. Hire Purchaser
c. Hire Vendor
d. Installment
e. Hire Purchase Agreement
f. Down Payment
245

a. A contract for sale of goods may be either a sale or an
................... to sell.
b. Under a hire purchase agreement payments are made in ...
..,...........
c. Each installment payment is treated as...................
d. A hirer has the right to .................. the agreement before
payment of the last installment by paying the seller the agreed
amount.
Answers: i) agreement, ii) installment,
iii) hire charges iv) terminate
4. State whether the following statements are True or False:

a. If the hirer fails to pay the last installment, the amounts paid
earlier are considered as hire charges.
b. Under hire-purchase system the purchaser becomes the
owner of the goods immediately after the down payment.
c. Under hire-purchase system the buyer does not charge the
depreciation on the asset till he becomes the owner.
d. Interest is calculated on the hire purchase price at the given rate
of interest.
Answers: True - (i). False - (ii), (iii), (iv).
12.4 CALCULATION OF INTEREST
Interest is to be calculated on the outstanding balance

except down payment. The calculation of interest is made under
three conditions:
1. Rate of Interest given and Interest included in amount of

installment:
2. Rate of Interest given and Interest is not included in
installments:
3. Rate of interest not given:
12.5 INTEREST INCLUDED IN AMOUNT OF

INSTALLMENT
In case if hire-purchase price i.e. payment made in the
form of down payment and all installments is more than the cash
price, it is regarded that the interest is included in installments.
Following steps should be followed for calculating the amount
of interest on each installment.
i) Calculate the outstanding cash price at the time of first
installment by subtracting Down Payment from the Cash Price.
246
ii) Calculate interest on the outstanding cash price at the time of

first installment by applying the given rate of interest, the mode of
installment must be considered (whether the installment is annual,
half-yearly or quarterly).
iii) Calculate the amount of cash price included in the first

installment by subtracting the amount of interest as calculated
in step (ii) from the amount of the first installment.
iv) Calculate the outstanding cash price at the time of second

installment by Subtracting the amount of cash price of the first
installment from the outstanding Cash price at the time of first
installment i.e., (i) - (iii).
v) Calculate interest on the second installment by applying the rate

of interest to the outstanding cash price at the time of second
installment. It is explained in the following example.
Example : On 1st January, 2009, Mr. A purchased from M/s B &

Co. one 'Motor Car' under hire-purchase system, Rs.10,000 being
paid on delivery and the balance in three annual installments of
Rs.10,000 each payable on 31st December each year. The cash
price of the motor car is Rs. 37,250 and vendors charge interest @
5% per annum on yearly balances. Find out the amount of
cash price and interest included in each installment.
Calculation of
Cash Cash Interest Installment
Price price (Rs.) (Rs.)
paid
Date Calculation (Rs.)
(Rs.)
1/1/2009 Cash Price 37250
1/1/2009 Less Down Payment paid 10000 10000 0 10000
1/1/2009 Outstanding cash price 27250
31/12/09 Add Interest@5% 1363
31/12/09 Total Amount Due 28613
31/12/09 Less Installment paid 10000 8637 1363 10000
31/12/10 Add Interest@5% 931
31/12/10 Total Amount Due 19544 9069 931 10000
31/12/10 Less Installment paid 10000
*Add Interest@5%
31/12/11 (Bal fig) 456
31/12/11 Installment paid 10000 9544 456 10000
247
CHECK YOUR PROGRESS

1. A Ltd. purchased a machine on hire purchase from Z Ltd, on
January 1, 2009, paying Rs.8,000 immediately and agreeing to
pay three annual installments of Rs.8,000 each on December
31, every year. The cash price of the machine is Rs.29,800 and
the vendors charge interest @ 5% per annum. Calculate the
amount of interest paid by the buyer to the seller every year.
st nd rd
Answers: Interest for 1 Year: 1090, 2 Year: 745, 3 Year: 365
12.6 WHEN INTEREST IS NOT INCLUDED IN

INSTALLMENTS
When the total amount paid in the form of down payment
and all installments is exactly equal to the cash price, it is
regarded that the interest, is not included in installments. It means
that interest is payable in addition to the agreed amount of
installment. It is explained in the following example.
Example: On 1st January, 2009, Mr. A purchased from M/s B &

Co. one 'Motor Car' under hire-purchase system, the cash price
being Rs.37,250. Rs.10,000 being paid on delivery and the
balance in three equal annual installments payable on 31st
December every year. In addition to it, interest at 5% per annum
was also payable to vendors on outstanding balances. Find out
the amount of cash-price and interest included in each installment.
Calculation of Interest
Cash Cash Interest Installment
Price Price (Rs.) (Rs.)
Date Calculation (Rs.) paid
(Rs.)
1/1/2009 Cash Price 37250

31/12/09 Add Interest@5% 1363
31/12/09 Less Installment paid 10446 9083 1363 10446
31/12/10 Add Interest@5% 908
31/12/10 Total Amount Due 19075 9083 908 9991
31/12/10 Less Installment paid 9991
31/12/11 *Add Interest@5%(Bal fig)
454
31/12/11 Total Amount Paid 9538 9084 454 9538
248
CHECK YOUR PROGRESS
1. A Ltd purchased machinery on hire purchase basis from B

ltd on the following terms: Cash price Rs.79,250, Cash Down
Payment 25% and Balance to be discharged in 3 equal
installments together with interest @10% p.a. to be paid at
the end of each year. Compute the payment of interest and
installment to be made each year
st nd rd
Answers: Interest for 1 Year: 5,944, 2 Year: 3,962, 3 Year: 1,981,
st nd rd
Installment for 1 Year: 25,757, 2 Year: 23,775, 3 Year: 21,792
12.7 RATE OF INTEREST IS NOT GIVEN
When rate of interest is not given, there can be two situations.
1. When cash price and the amounts of installments are given and
the amount of each installment is same.
2. When cash price and the amounts of installments are given and
the amount of each installment is not same.
12.7.1 When Rate of Interest is not given and installments are

of same amount:
When cash price and the amounts of installments are given and the
amount of each installment is same.
Example: On 1st January, 2009, Mr. A purchased from M/s B &
Co. one 'Motor Car' under hire-purchase system, Rs.10,000 being
paid on delivery and the balance in three annual installments of
Rs. 10,000 each payable on 31st December every year. The
cash price of the motor car is Rs.37,250. Find out the amount of
cash price and interest included in each installment.
*Add Interest@5% 477

Bal fig(Amount Due-Amount Paid) 456
Consider balancing figure while calculating last installment
The total interest of Rs 2,750 is to be apportioned among the 1st,

2nd and 3rd installment in the ratio of 3:2:1.(since there are three
installments 3/6, 2/6, and 1/6 respectively)
(1)Share of 1st installment in the Interest= 2,750x3/6 = Rs1,375
(2)Share of 2nd installment in the Interest= 2,750x2/6 = Rs.917
(3)Share of 3rd installment in the interest= 2,750x1/6 = Rs.458

249
CHECK YOUR PROGRESS
1. A purchased a machine for down payment of Rs.20,000 and

3 annual installments of Rs.20,000 each. Cash price is
Rs.74,500. Find out the amount of cash-price and interest
included in each installment.
st nd rd
Answers: Interest for 1 Year: 2,750, 2 Year: 1,833, 3 Year:
st nd
917, Cash Price included for 1 Year: 17,250, 2 Year: 18,167,
rd
3 Year: 19,083
12.7.2 When Rate of Interest not given and Installments given

of different amounts
When cash price and amounts of installments are given but the
amount of each installment is not equal:
Example: Cash price of a machine is Rs.1,25,000 on 1st

January, 2009. Its hire- purchase price is Rs.1,50,000. This hire
purchase price is paid in the following manner: Rs.30,000 on 1st
January, 2009, Rs. 35,000 at the end of the first year, Rs.40,000
at the end of second year; Rs. 45,000 at the end of third year.
Calculate interest and cash price included in each installment.
Step 1: Calculation of Interest
Hire Purchase Price 1,50,000

Less: Cash Price 1,25,000
Total Interest 25,000
Step 2: Apportionment of Interest
Total Interest of Rs.25,000 is to be apportioned among the three

installments in the following manner:
At the end of Year 1 2 3 T

Outstanding Hire 120000 85000 45000 250000
Purchase Price
*Interest 12000 8500 4500 25000
* Interest = Outstanding Hire Purchase Price before

Installment* Total Interest /Total of Outstanding Hire
Purchase Price for all installments
250
Interest at the end of year 1 =120000* 25000 = Rs.12000

250000
Interest at the end of year 2 = 8500 * 25000 = Rs.8500

250000
Interest at the end of year 3 = 45000* 25000 = Rs.4500

250000
CHECK YOUR PROGRESS
1. MTC purchased a taxi on hire purchase terms. The cash

price was Rs.87,092.
Payments were to be made as under

On 1.1.2009 Rs.20,000 (down Payment)
On 31.12.2009 Rs.35,000
On 31.12.2010 Rs.25,000
On 31.12.2011 Rs.20,000
Calculate interest and cash price included in each installment.
st nd rd
Answers: Interest for 1 Year: 7122, 2 Year: 4006, 3 Year:
st nd rd
1780, Cash Price included for 1 Year: 27878, 2 Year: 20994, 3
Year: 18220
12.8 CALCULATION OF DEPRECIATION
Under Hire-Purchase system, the ownership is not

transferred to the buyer. Hence, there is a dispute about charging
of the depreciation on the asset. However, from practical point of
view, depreciation on asset should be charged at a certain rate on
the cash price of the asset acquired. The logic behind provision of
depreciation on asset is
1. Asset is used by the buyer

2. Asset is to be shown at its real value
3. The Hire-purchaser is going to be owner after the payment of
last installment
Depreciation should be provided as a matter of policy in the

books of the buyer. Depreciation should be charged on asset every
year on the cash price under straight line or reducing balance
method.
251
12.9 ACCOUNTING METHODS
The method of accounting for hire-purchase transactions

depends on the value of sales. Hire purchase accounting
methods for goods of small sales value may be Debtors Method
or Stock and Debtors Method. If the goods have substantial
sales value then the accounting methods as per AS 10, which
deals with the valuation of the Fixed Assets, Assets acquired on
hire-purchase terms, are to be recorded at their cash- price. The
interest has to be written off as an expense. The accounting
entries can be passed by the buyer in any of the three methods
1. Asset Accrual Method (Actual Cash Price Method)

2. Interest Suspense Method
3. Full Cash Price Method
Assets taken on Hire purchase basis should be considered

like ordinary purchase.
12.10 FULL CASH PRICE METHOD

(CREDIT PURCHASE / SALE METHOD)
Under Full Cash Price Method, the Hire-Purchaser is

considered as the owner of the asset, the asset is recorded at
full cash price on the basis of the substance over form. The full
cash price of the asset is debited to the Asset account and
credited to the Hire-Vendor account. Interest account is debited
and the Hire-Vendor account is credited with the interest on the
outstanding balance. When the installment is paid, the Hire-
Vendor A/c is debited and the Bank A/c is credited .At the time of
the preparation of the final accounts, Interest is transferred to
Profit & Loss Account and Asset is shown in the Balance Sheet
at the cost less depreciation. The balance due to Hire- Vendor is
shown in the Balance Sheet as a Liability.
252
 BOOKS OF HIRE PURCHASER
13.10.1 Journal Entries in the books of Hire-Purchaser:
1. For buying assets (entering

agreement) on hire purchase: A
Full Cash Price
Asset A/c Dr.
To Hire-Vendor A/c
2. For paying the down Down Payment
payment to vendor:
Vendor A/c Dr
To Cash/ Bank A/c
3. When Interest is Due on Interest on outstanding

unpaid installments: balance
Interest A/c Dr.
To Hire Vendor A/c
4. For Installment Payment Amount of Installment

( Interest payment will
be also included in it):
Vendor A/c Dr
To Cash/ Bank A/c
5. For charging Depreciation: Calculated on Cash Price
Depreciation A/c Dr.
To Asset A/c
6. For transferring Interest and

Depreciation to Profit and
Loss Account:
Profit and Loss A/c Dr.
To Interest A/c
To Depreciation A/c
(Repeat entry Nos. 3, 4, 5, and 6 in subsequent years)
However, a firm may maintain a Provision for Depreciation A/c

instead of charging depreciation to asset on Hire-purchase A/c, in
such case the journal entry is
Profit and Loss A/c Dr.

To Provision for Depreciation for Asset on Hire-Purchase A/c
(Being the asset on hire-purchase is shown on its historical cost).
253
12.10.2 Disclosure in Balance Sheet
Balance Sheet of Hire-Purchaser
Liabilities Rs. Ass Rs.

Hire-Purchase Fixed Assets:et xxxx
Balance in Hire- xxxx Asset(at cash Price) xxxx
Less :Instalment xxxx Less Depreciation xxxx
Instalment not yet xxxx
 BOOKS OF HIRE VENDOR
12.10.3 Journal Entries in the books of Vendor:
1. For selling on hire purchase:

Hire-Purchaser A/c Dr. Full Cash Price
To Hire Sales A/c
2. For receiving the down payment: Down Payment
Cash/ Bank Dr
To Hire-Purchaser A/c
3. For Interest receivable Interest on outstanding
Hire-Purchaser A/c Dr balance
To Interest A/c
4. For Installment Received Amount of Installment

( Interest receipt will
be also included in it):
Cash/ Bank A/c Dr.
To Hire-Purchaser A/c
5. For transferring Interest to
Profit and Loss Account:
Interest A/c Dr.
To Profit and Loss A/c
(Repeat entry Nos. 3, 4, and 5, in subsequent years)
12.10.4 Disclosure in Balance Sheet
Balance Sheet of Hire-Vendor

Liabilities Rs. Asset Rs.
Hire-Purchase Debtors
Balance in Hire- Purchaser xx
254
12.11 EXERCISE
1. Explain the meaning of Hire-Purchase System.
2. Write notes on:

(a) Hire-Purchase Price (b) Cash Price (c) Initial Payment
3. Objective Questions
 MULTIPLE CHOICE QUESTIONS
1. Hire Purchase Price means the total amount payable by the hirer,
made up of ---------
(a) the cash price of the article and the interest
(b) the cash price of the article less interest
(c) the cash price of the article and the down payment
(d) the installments and the interest
2. Each Hire Purchase installment amount is made up of ---------

(a). part payment towards cash price only
(b). part payment towards interest only
(c). part payment towards cash price plus interest
(d).none of the above
3. Under ---------method, entries are made as if asset is purchased

for full price on credit on the date of Hire Purchase agreement
itself.
(a). Actual Cash Price
(b). Full Cash Price
(c). Asset Accrual
(d).None of the above
4. The Hire Purchaser can record the asset under Full Cash Price
Method at its ---------
(a). Hire Purchase Price
(b). Cash price
(c).None of the above
5. Interest in the Hire Purchase transaction, is charged on the -------

-- cash price
(a). Outstanding
(b). Full cash price
(c).None of the above
6. Under Hire –Purchase system buyer becomes the owner of

goods ---------
(a). immediately after the receipt of goods
(b). immediately after the down payment
255
(c). immediately after the payment of the last installment

(d).None of the above
7. Under Hire –Purchase agreement the buyer agrees to pay --------

(a). Cash price only.
(b). Interest only
(c). Cash Price and Interest
8. The last installment paid under Hire –Purchase comprises ---------

(a). Cash price only.
(b). Interest only
(c). Cash Price and Interest
Answers:1.-(a), 2. -(c), 3.- (b). 4. - (b), 5.-(a), 6. -(c), 7. -(c), 8 -(c).
 FILL IN THE BLANKS
1. is the purchase price payable if full payment is

made immediately.
2. means the total amount payable by the hirer,

made up of the cash price of the article and interest.
3. is the initial amount payable at the time of

signing the agreement.
4. As soon as payment is made, the hirer gets

possession of the article and can start using it immediately
5. Each Hire Purchase installment amount is made up of part

payment towards plus interest
6. Each Hire Purchase installment amount is made up of part

payment towards cash price plus
7. Under the Hire –Purchase system, depreciation is provided on

price
8. Under the Hire –Purchase system, depreciation is provided by

the
9. If the Hire –Purchaser makes a down payment on signing the

contract, it will not include any amount of
10. Depreciation is to be calculated on the full as the

same is not affected by the extent of payment made.
256
Answers: 1. - Cash Price - 2. - Hire Purchase Price, 3. – Down

Payment, 4. -Down, 5. - Cash Price 6. - Interest, 7. –Full Cash, 8. -
Hire –Purchaser, 9. –Interest, 10. - Cash Price
 STATE WHETHER TRUE OR FALSE
1. Actual Cash Price Method is also known as Interest Suspense

Method.
2. Full Cash Price Method is also known as Asset Accrual Method.

3. Asset Accrual Method is also known as Credit Purchase Method.
4. Actual Cash Price Method is also known as Credit Purchase

Method.
5. The hire-purchaser has the right to terminate the agreement at

any time before the property passes.
6. If the amount of each installment is equal, the total interest can

be allocated to different installments by the fixed installment
method.
7. Under the Hire –Purchase system, the buyer has the option to
return the goods.
8. When assets are acquired under the hire purchase system,

depreciation need not be provided as the vendor still continues
to be the legal owner of the asset.
9. Hire Purchase Price is equal to Cash Price
10. Under the Hire –Purchase system, the interest is paid by the
vendor to the hirer.
11. Cash Price is the purchase price payable if full payment is

made immediately.
12. Hire Purchase Price is the initial amount payable at the time of
signing the agreement.
Answers: TRUE: (5) (6) (7) (11)

FALSE: (1) (2) (3) (4) (8) (9) (10) (12)




257
Unit-13
HIRE PURCHASE - II
Unit Structure :
13.0 Objectives
13.1 Solved Problems
13.2 Exercises
13.0 OBJECTIVES
After studying the unit students will be able to the practical

problems on Hire purchase system.
13.1 SOLVED PROBLEMS
Illustration 1.
Raj Textiles Ltd. purchased Motor Car on hire-purchase

system. According to the terms, Rs. 30000 was payable on
delivery on 1st January, 2005: and the balance by 4 annual
installments of Rs.30000 each on 31st December. Krishna Motor
Ltd who sold the Motor Car charged 5 % p.a. interest on the
yearly balances. The cash value of the Car on delivery was
1,36,338. Depreciation @ 20% on diminishing balances was
written off in each year. Show Journal Entries in the books of Raj
Textiles Ltd
258
Journal Entries
In the books of Raj Textiles Ltd.
Date Particulars Debit(Rs.) Credit(Rs.)
1/1/05 Motor Car A/c Dr. 136338

To Krishna Motor Ltd A/c 136338
(Being total cash price due to the hire-vendor
for purchase of Motor Lorries)
1/01/05 Krishna Motor Ltd A/c Dr 30000
To Cash/ bank 30000
A/c
(Being down payment paid)
31/12/05 Interest A/c Dr. 5317
(Being Interest due on unpaid Cash Price)
To Cash/ bank 12000
A/c
(Being Installment
31/12/05 Depreciation A/c Dr. 27268
To Motor Car A/c 27268
(Being Depreciation charged)
31/12/05 Profit and Loss A/c Dr. 32585

To Interest A/c 5317
To Depreciation A/c 27268
(Being Interest and Depreciation transferred
to profit and loss account)
To Cash/ bank 30000
A/c
(Being Installment paid)

To Motor Car A/c 21814

259
To Cash/ bank 30000
A/c
To Motor Car 17451
A/c
31/12/07 (Being Depreciation charged)
Profit and Loss A/c Dr. 20238
31/12/08 Krishna Motor Ltd A/c 30000
Dr 30000
To Cash/ bank
A/c
To Motor Car 13961
A/c
Working Note: 1. Calculation of Interest
Date(1) Opening Cash Inter Instalme Closing

Cash Price est nt Cash Price (Rs.)
Price paid(Rs.) (Rs. (Rs (6)=(2)-(3)
(Rs.) (3)=(5-4) ) .)
(2) @5 (5)
% (4) Given
1/1/2005 136338 30000 0 30000 106338
31/12/2005 106338 24683 5317 30000 81655
31/12/2006 81655 25917 4083 30000 55738
31/12/2007 55738 27213 2787 30000 28525
31/12/2008 28525 28574 1426 30000 0
Total 136387 13613 150000
260
Working Note: 2.
Calculation of Depreciation
Date Calculatio (Rs.)
1/1/2005 Cash Price n 136338
31/12/05 less Depreciation 27268
31/12/05 Book-Value 109070
31/12/06 Book-Value 87256
31/12/07 Book-Value 69805
31/12/08 Book-Value 55844
Illustration 2.
Rama Company purchased Machinery from XY Trading Ltd. on 1st
January, 2009 on hire-purchase system. The cash price of the
Machinery was Rs.3,00,000 which was payable as under:
On 01-01-2009, Rs.1,00,000
On 31-12-2009, Rs.80,000
On 31-12-2010, RS.80,000
On 31-12-2011, RS.80,000
The purchasing company decided to write off depreciation @
20% of the cost price each year. You are required to give the
necessary journal entries in the books of both the parties for three
years. Also show the calculation of interest, depreciation and the
installment.
Journal Entries
In the books of Rama Company
1/1/09 Machinery A/c Dr. 300000

To XY Trading Ltd A/c 300000
(Being total cash price due to the hire-vendor
for purchase of Truck)
1/1/09 XY Trading Ltd A/c Dr 100000
To Cash/ bank A/c 100000
(Being Down Payment paid)
31/12/09 Interest A/c Dr. 20000

261

To Machinery A/c 60000

(Being Interest and Depreciation transferred to
profit and loss account)
31/12/10 Interest A/c Dr. 13333




262
Journal Entries
In the books of XY Trading Ltd A/c
1/1/09 Rama Company A/c Dr. 300000

To Sales A/c 300000
(Being total cash price due from the
hire- Purchaser for sale of Truck)
1/1/09 Cash/ bank A/c Dr 100000
To AB Transport Company A/c 100000
(Being Down Payment Received )
31/12/09 (Being
Cash/ Interest
bank A/c Drdue on unpaid Cash Price) 80000
(Being Installment Received)
31/12/09 Interest A/c Dr. 20000
To Profit and Loss A/c 20000
(Being Interest transferred to profit and loss
account)
31/12/10 Cash/ bank A/c Dr 80000
31/12/10 Interest A/c Dr. 13333
(Being Interest transferred to profit and
loss account)
31/12/11 Cash/ bank A/c Dr 80000
(Being Interest transferred to profit and loss A/c)
Step 1: Calculation of Total Interest:

Hire-purchase Price = 1,00,000 + (80,000 x 3) = Rs.3,40,000
Less: Cash Price - Rs.3,00,000
Total Interest = Rs.40,000
263
Step 2: Apportionment of Interest:
The total interest of Rs 40,000 is to be apportioned among the

1st, 2nd, and 3rd installment in the ratio of 3:2:1.(since there are
three installments3/6,2/6, and 1/6 respectively)
(1)Share of Interest in the 1st installment = 40000x3/6 = Rs.20,000
(2)Share of Interest in the 2nd installment = 40000x2/6 = Rs.13,333
(3)Share of interest in the 3rd installment = 40000x1/6 = Rs.6,667
Working Note: 2. Calculation of Depreciation

Cost of Machinery = Rs. 300000
Less Depreciation (@ 20% of the cost price)=
60000(300000*20/100)
Illustration 3.
Ramsons purchased two printing machines from King Printers on
Hire-purchase basis on 1st July ,2007 .The terms of the contract
were as follows:-
i) The cash price of the each printing machine was Rs.75,000
ii) Rs.15,000 was paid on the signing of the contract on 1stJuly 2007
ii)The balance was paid in installments of Rs. 20,000 plus interest

at 15% per annum
iv)The installments were paid on 31st December every year

commencing from 31st December 2007. King Printers charged
depreciation at 10% per annum under S.L.M. system. They closed
their books on 31st December. Show in books of Ramsons
necessary account.
264
In books of Ramsons
King Printers A/c
Date Particulars RS. Date Particulars RS.

01/07/2007 To Cash A/c 30000 01/07/2007 By Machine 150000
31/12/2007 To Cash A/c 49000 31/12/2007 By Interest A/c 9000
31/12/2007 To Balance 80000
159000 159000
31/12/2008 To Cash A/c 52000 01/01/2008 By Balance b/d 80000
31/12/2008 To Balance 40000 31/12/2008 By Interest A/c12000
92000 92000
31/12/2009 By Interest A/c 6000
46000 46000
Interest A/c

31/12/07 To King Printers A/c 9000 31/12/07 By Profit & Loss A/c 9000
9000 9000
12000 12000
31/12/08 To King Printers A/c
31/12/08 By Profit & Loss A/c
12000 12000
6000 6000
31/12/09 To King Printers A/c By Profit & Loss A/c
31/12/09
6000 6000
Machine A/c

1/7/2007 To King Printers A/c 150000 31/12/2007 By Depreciation A/c 7500
31/12/2007 By Balance c/d 142500
75000 150000
1/1/2008 To Balance b/d 142500 31/12/2008 By Depreciation A/c 15000
31/12/2008 By Balance c/d 127500
142500 142500
31/12/2009 By Balance c/d 112500
127500 127500
265
Depreciation A/c
Date Particulars RS. Date Particulars RS

31/12/2007 To Machine A/c--1 7500 31/12/2007 By Profit &Loss A/c .
7500
7500 7500
31/12/2008 To Machine A/c--2 15000 31/12/2008 By Profit &Loss A/c 15000
15000 15000
31/12/2009 To Machine A/c--3 15000 31/12/2009 By Profit &Loss A/c 15000
15000 15000
Working Note: 1
1/7/2001 Cash Price 150000
31/12/01 less Depreciation for 6 months-----------1 7500
31/12/01 Book-Value 142500
31/12/02 less Depreciation-----------------------------2 15000
31/12/02 Book-Value 127500
31/12/02 less Depreciation-----------------------------3 15000
31/12/02 Book-Value 112500
Working Note: 2
Calculation of Interest
Cash Cash Interest Instalment
Calculation
(Rs.) paid
(Rs.)
1/7/2007 Cash Price 150000
Less Down Payment
1/7/2007 paid 30000 30000 0 30000
31/12/07 Add Interest@ 15% 9000
31/12/07 Less Instalment paid 49000 40000 9000 49000
31/12/08 Add Interest@ 15% 12000
31/12/08 Total Amount Due 92000 40000 12000 52000
31/12/08 Less Instalment paid 52000
31/12/09 Add Interest@ 15% 6000
31/12/09 Total Amount Paid 46000 40000 6000 46000
266
Illustration 4.
On 1st January, 2003 Kavita Ltd. purchased Machinery on Hire-
Purchase System from Jaya Traders for Rs. 26,000. They paid
Rs. 2000 on signing the contract and four half –yearly
installments of Rs. 6,000 plus interest at 20% per annum each
on 30th June and 31st December every year thereafter.
Depreciation was written off at rate of 10% per annum on the
diminishing balance system.
i) Prepare Ledger accounts in the books of Kavita Ltd and Jaya
Traders for the years 2003-2004; and
ii) Disclose the relevant items in Balance sheet of Kavita Ltd and
Jaya Traders as on 31st December 2003
In books of Kavita Ltd. Industries Ltd

Jaya Traders A/c

01/01/2003 To Cash A/c 2000 01/01/2003 By Plant A/c 26000
31/12/2003 To Balance 12000
30200 30200
30/06/2004 To Cash A/c 7200 01/01/2004 By Balance 12000
31/12/2004 By Interest A/c 600
13800 13800
Interest A/c

30/06/2003 To Jaya Traders A/c 2400 31/12/2003 By Profit &Loss A/c 4200
31/12/2003 To Jaya Traders A/c 1800
4200 4200
30/06/2004 To Jaya Traders A/c 1200 31/12/2004 By Profit &Loss A/c 1800
31/12/2004 To Jaya Traders A/c 600
1800 1800
267
Machinery A/c

1/1/2002 To Jaya Traders A/c 26000 31/12/2002 By Depreciation A/c 2600
31/12/2002 By Balance c/d 23400
26000 26000
31/12/2003 By Balance c/d 21060
23400 23400
Depreciation A/c

31/12/2003 To Machinery A/c 2600 31/12/2003 By Profit &Loss A/c 2600
31/12/2004 To Machinery A/c 2340 31/12/2004 By Profit &Loss A/c 2340
An Extract of Balance sheet of Kavita Ltd. as on 31st

December 2003

Hire-Purchase Creditors Fixed Assets:
Balance in Jaya Traders 12000 Machinery (at cash Price) 26000
Less Depreciation 2600
23400
In books of Jaya Traders

Kavita Ltd. A/c

01/01/2003 To Sales A/c 26000 01/01/200 By cash A/c 2000
30/06/2003 To Interest A/c 2400 30/06/200 By cash A/c 8400
31/12/200 By Balance 12000
30200 10400
01/01/2004 To Balance b/d 12000 30/06/200 By cash A/c 7200
31/12/2004 To Interest A/c 600
13800 13800
268
Interest A/c

31/12/2003 To Profit & 4200 30/06/2003 By Kavita Ltd. 2400
LossA/c A/cKavita Ltd.
31/12/2003 By 1800
4200 A/c 4200
31/12/2004 To Profit & 1800 30/06/2004 By Kavita Ltd. 1200
31/12/2004 By Kavita Ltd. 600
1800 1800
An Extract of Balance sheet of Jaya Traders as on 31st December

2003

Hire-Purchase Debtors
Kavita Ltd A/c 12000
Working Note: 1
Calculation of
Cash Cash Interest Instalment
Date Calculation (Rs.) paid
(Rs.)
01/01/2003 Cash Price 26000
30/06/2002 Add Interest@ 20%* 2400
31/12/2003 Add Interest@20%* 1800
30/06/2004 Add Interest@20%* 1200
31/12/2004 Add Interest@20%* 600
*Interest calculated for 6 months
269
Illustration 5.
Farhan Industries Ltd. acquired a plant at Cash Price of Rs.

75,000, delivered on 1st January 2002, on the following hire
purchase terms:
1) An initial payment of Rs. 20,000 payable on delivery: and
2) Four half –yearly installments of Rs. 15,000 each commencing

from 30th June, 2002.
In arriving at these terms the plant manufacturer computed

interest at 7% per annum. Farhan Industries Ltd decided to write
off depreciation @ 10% of the cost price each year. You are
required to show the accounts in the books of Farhan Industries
Ltd for the years ending on 31st December 2002 and 31st
December 2003, necessary to record the above transactions
In books of Farhan Industries Ltd

Vendors A/c

01/01/2002 To Cash A/c 20000 01/01/2002 By Plant A/c 75000
31/12/2002 To Balance 28392
78392 78392

30000 30000
Interest A/c

30/06/2002 To Vendors A/c 1925 31/12/2002 By Profit &Loss A/c 3392
31/12/2002 To Vendors A/c 1467
3392 3392
30/06/2003 To Vendors A/c 994 31/12/2003 By Profit &Loss A/c 1608
31/12/2003 To Vendors A/c 614
1608 1608
270
Plant A/c

01/01/2002 To Vendors A/c 75000 31/12/2002 By Depreciation A/c 7500
31/12/2002 By Balance c/d 67500
75000 75000
31/12/2003 By Balance c/d 60000
67500 67500
Depreciation A/c

31/12/2002 To Plant A/c 7500 31/12/2002 By Profit &Loss A/c 7500
31/12/2003 To Plant A/c 7500 31/12/2003 By Profit &Loss A/c 7500
Opening Cash Interest Instalment Closing

Date Cash Price (Rs.) (Rs.) Cash Price
(1) Price paid(Rs.) @5% (5) Given (Rs.) (6)=(2)-(3)
(Rs.) (3)=(5-4) (4)
(2)
1/1/2002 75000 20000 0 20000 5500

31/6/2002 55000 13075 1925 15000 4192
31/12/2002 41925 13533 1467 15000 5
2839
31/06/2003 28392 14006 994 15000 2
1438
31/12/2003 14386 14386 614* 15000 60
Total 75000 5000 80000
*Balancing Figure
Illustration 6.
Bombay Trading Company purchased on 1st January, 2005 a
machine on Installment purchase system. The cash price of the
machine was Rs. 15,450 payment was to be made as under:
1. On 1st January, 2005 (on signing the contract) Rs. 3,000
2. On 31st December, 2005 Rs. 7,500
271
Bombay Trading Company charged depreciation at
10% p.a. under diminishing balance method; you are required
to prepare necessary accounts in the books of Bombay
Trading Company.
In books of Bombay Trading Company

Hire-Vendor A/c
01/01/2005 To Cash A/c 3000 01/01/2005 By Machine 15450
31/12/2005 To Cash A/c 7500 31/12/2005 A/c
By Interest A/c 1500
31/12/2005 To Balance 6450
16950 16950
31/12/2006 To Balance 2700 31/12/2006 By Interest A/c 750
7200 7200
3000 3000
Interest A/c
31/12/05 To Hire-Vendor A/c 1500 31/12/05 By Profit & Loss A/c 1500
1500 1500
750 750
300 300
Machine A/c
1/1/2005 To Hire-Vendor A/c 15450 31/12/2005 By Depreciation A/c 1545
31/12/2005 By Balance c/d 13905
75000 75000
31/12/2006 By Balance c/d 12514
13905 13905
31/12/2007 By Balance c/d 11263
12514 12514
272
Depreciation A/c

31/12/2005 To Machine A/c 1545 31/12/2005 By Profit &Loss A/c .
1545
1545 1545
31/12/2006 To Machine A/c 1391 31/12/2006 By Profit &Loss A/c 1391
1391 1391
31/12/2007 To Machine A/c 1251 31/12/2007 By Profit &Loss A/c 1251
1251 1251

Hire-purchase Price = Rs.18000
Less: Cash Price - Rs.15450
Total Interest = Rs.2550

Total Interest of Rs.2550 is to be apportioned among the three
At the end of Year 2005 2006 2007 Total

Purchase Price
*Interest 1500 750 300 2550

Installment* Total Interest
Total of Outstanding Hire Purchase Price for all installments
Interest at the end of year 1 =15000* 2550 = 1500

25500
rest at the end of year 2 = 7500 * 2550 = 750

25500
Interest at the end of year 3 = 3000* 2550 = 300
25500
273

1/1/2005 Cash Price 15450
31/12/05 Book-Value 13905
31/12/06 Book-Value 12515
31/12/07 Book-Value 11263
Illustration 7.
Doshi Roadways purchased t wo trucks f rom Tata Ltd. on
hire-purchase system on 1st January, 2006. The cash price of
each truck was Rs. 125,000. Payment was made as follows:
1.1.2006: RS 30,000 per truck.
31.12.2006: RS 45,000 per truck.
31.12.2007: RS 40,000 per truck.
31.12.2008: RS 35,000 per truck.
Depreciation at 20% per annum on original cost is charged.
You are required to: Calculate interest per year; and show the
necessary accounts in the books of Doshi Roadways.
In books of Doshi Roadways

Tata Ltd A/c
01/01/2006 To Cash A/c 60000 01/01/2006 By Truck A/c 250000
31/12/2006 To Balance 126087
276087 276087
31/12/2007 To Balance 62391 31/12/2007 By Interest A/c 16304
142391 142391
31/12/2008 By Interest A/c 7609
70000 70000
274
Interest A/c

31/12/06 To Tata Ltd. A/c 26087 31/12/06 By Profit & Loss A/c 26087
26087 26087
16304 16304
7609 7609
Truck A/c

1/1/2006 To Tata Ltd. A/c 250000 31/12/2006 By Depreciation A/c 25000
31/12/2006 By Balance c/d 225000
250000 250000
31/12/2007 By Balance c/d 200000
225000 225000
31/12/2008 By Balance c/d 175000
200000 200000
Depreciation A/c

31/12/2006 To Truck A/c 25000 31/12/2006 By Profit &Loss A/c .
25000
31/12/2007 To Truck A/c 25000 31/12/2007 By Profit &Loss A/c 25000
31/12/2008 To Truck A/c 25000 31/12/2008 By Profit &Loss A/c 25000

Hire-purchase Price = Rs. 300000
Less: Cash Price - Rs. 250000
Total Interest = Rs. 50000
Total Interest of Rs.2550 is to be apportioned among the three

275
At the end of Year 2005 2006 2007 Total

Purchase Price
*Interest 26087 16304 7609 50000

Installment* Total Interest
Total of Outstanding Hire Purchase Price for
all installments

460000

460000
Interest at the end of year 3 = 70000* 50000 =7609

460000
Cost of Truck= Rs. 125000
.
Less Depreciation (@ 20% of the cost price) = Rs.25000

( 125000*20/100)
Illustration 8.
Priya Trading purchased a machine on 1.1.2010 on hire purchase
system from Rita Traders. The necessary details are given below:
Cash Price Rs.60000

Amount paid on signing the agreement Rs.20000
First Annual Installment Rs.18000
Second Annual installment Rs.16000
Last annual installment Rs.13860
Rate of Interest 10% p.a.
Depreciation at 20% on cash price of machine by reducing

installment method is charged. Calculate interest per year; and
show the necessary accounts in the books of Rita Traders.
276
In books of Rita Traders
Priya Trading A/c

01/01/2010 To Sales A/c 60000 01/01/2010 By cash A/c 20000
31/12/2010 By Balance 26000
64000 64000
01/01/2011 To Balance b/d 26000 31/12/2011 By cash A/c 16000
31/12/2011 To Interest A/c 2600 31/12/2011 By Balance 12600
28600 28600
01/01/2012 To Balance 12600 31/12/2012 By cash A/c 13860
31/12/2012 To Interest A/c 1260
13860 13860
Interest A/c
31/12/2010 To Profit & Loss 4000 31/12/2010 By Priya 4000
A/c Trading A/c
4000 4000
A/c Trading A/c
2600 2600
A/c Trading A/c
1260 1260
Date(1) Opening Cash Interest Installment Closing

Cash Price (Rs.) (Rs.) (5) Cash
Price paid @10%(4) Given Price
(Rs.)(2) (Rs.) (Rs.)
1/1/2010 60000 20000 0 20000 40000
31/12/2010 40000 14000 4000 18000 26000
31/12/2011 26000 13400 2600 16000 12600
31/12/2012 12600 12600 1260 13860 0
13.2 EXERCISE
1. Raja Transport Ltd. purchased a Motor car on 1st January,

2005, on hire-purchase basis from Meenakshi Motors Ltd. The
cash –price of the Motor car was Rs.74,500. Under the agreement,
277
a sum of Rs.20,000 was payable initially on 1st January, 2005:
and the balance in three annual installments of Rs. 20,000 each
falling due from 1st April, 2005. The financial year of the Raja
Transport Ltd. end on the 31st March. The company charges
interest at 5% p.a. and depreciation at 10% p.a on cash price of
the Motor-car on diminishing balance method. Prepare Motor-car
Account, Meenakshi’s Motors Ltd Account and Interest Account in
the books of Raja Transport Ltd.
st
Answers: Interest for 3 months till 1 April, 2005: Rs. 681, Interest
st
for year ending 31 March, 2006: Rs. 1759, Interest for year ending
st
31 March, 2007: Rs. 847.
2. On 1.1.2002 Mr. Singh purchases machinery on Hire purchase

system. The hire purchase agreement provided an initial down
payment of Rs.1,500; the balance is to be paid in 4 equal half-
yearly installments of Rs.2,000 each. Cash price is Rs.8,934. Rate
of interest per annum is 6% and the rate of depreciation is 10% on
original cost. Pass journal entries in the books of Mr. Singh from
1.1.2002 to 31.12.2003
Answers: Interest for half year ending 30/06/02: 223, Interest for
half year ending 31/12/02: 170, Interest for half year ending
30/06/03: 115, Interest for half year ending 31/12/03: 58.
3. X Company Ltd. purchased a machine from Y Machines Ltd.

on hire-purchase basis, the cash price being Rs.55,850
Rs.15,000 was paid on the signing of the contract and the
balance in three annual installments of Rs.15,000 each on
31st March each year. Interest is charged at 5% per annum.
Depreciation was written off at rate of 10% per annum on the
diminishing balance system. Give journal entries in the books of X
Company Ltd. whose accounting year ends on 31st March
each year, under Full Cash Price Method.
st nd rd
Answers: Interest for 1 Year: 2043, 2 Year: 1395, 3 Year: 714.
4. M/s Asha Refrigeration Ltd. supplied Refrigerators to Ashok

Hotel on the installment system, on 1st July, 2004. The cash price
of Refrigerator was Rs. 22,350. Under Installment system, it was
agreed to pay Rs.6,000 on that date and Rs.6,000 annually for
three years. Depreciation was to be written off the asset 10% p.a.
Show the relevant Ledger account in the books of both the parties
for three years.
st nd rd
Answers: Interest for 1 Year: 825, 2 Year: 550, 3 Year: 275.
278
5. On 1st April, 2008 Modern Traders Ltd. took delivery of one
Truck from GEM Motors Ltd. on Hire-Purchase Agreement,
payable in three equal installments of Rs.60,000 each on 31st
March, 2009, 2010, 2011. The cash value of the Truck on
delivery was Rs.1,63,400. Vendor charges interest at 5% per
annum on the yearly balances. The purchaser wrote off
depreciation @ 25 per cent on the diminishing value method for
each year. Pass the necessary Journal entries to record the above
transactions in the books of both the parties.
st nd rd
Answers: Interest for 1 Year: 8170, 2 Year: 5579, 3 Year:
2852.

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31

Dr. Kavita Laghate Anil R Bankar

Course and Programme : Dr. Madhura Kulkarni

DEC, 2020 F.Y.B.Com., ELECTIVE COURSES (EC) DISCIPLINE SPECIFIC

Published by : Director Incharge,

DTP Composed : Ashwini Arts

Revised Syllabus of Courses of B.Com. Programme

Accountancy and Financial Management I

Sr. No. Modules

Sr.No. Modules / Units

4 Accounting for Hire Purchase

Question Paper Pattern

Q-1 Objective Questions 20 Marks

Q-3 Full Length Question 15 Marks

Q-4 Full Length Question 15 Marks

Q-5 Full Length Question 15 Marks

Q-6 A) Theory questions 10 Marks

Question of 15 marks may be divided into two sub questions

 Introduction to Accountancy by T. S. Grewal, S. Chand and

After studying the unit students will be able to:

Financial statements are prepared to summarize the end-

uniform and financial statements comparable to the possible extent.

1.2 MEANING OF ACCOUNTING STANDARDS

Accounting Standards will not, however, apply to

1.3 FORMATION OF THE ACCOUNTING

The Institute of Chartered Accountants of India (ICAI),

1.3.1 COMPOSITION OF THE ACCOUNTING STANDARDS

1. Nominee of the Central Government representing the

3. Nominee of the Central Government representing the Central

1.3.2 OBJECTIVES OF THE ACCOUNTING STANDARDS

ii. To formulate Accounting Standards with a view to assist the

iii. To examine how far the relevant International Accounting

iv. To review, at regular intervals, the Accounting Standards from

v. To provide, from time to time, interpretations and guidance on

vi. To send comments on various consultative papers such as

vii. To carry out such other functions relating to Accounting

1.3.3 FUNCTIONS OF THE ACCOUNTING STANDARDS BOARD

The main function of the ASB is to formulate Accounting

The ICAI, being a full-fledged member of the International

1.4 PROCEDURE FOR ISSUING AN ACCOUNTING

The Accounting Standards are issued under the authority of

following procedure is adopted for formulating Accounting

1. The ASB determines the broad areas in which Accounting

2. In the preparation of Accounting Standards, the ASB will be

3. The draft of the proposed standard will normally include the

6. The ASB will hold a meeting with the representatives of

7. The Exposure Draft of the proposed Standard will be issued for

8. After taking into consideration the comments received, the draft

consultation with the ASB. The Accounting Standard on the

1.5 COMPLIANCE WITH THE ACCOUNTING

Accounting Standards are mandatory from the respective

The mandatory status of an Accounting Standard implies

(a) To examine whether ‘Statements’ relating to accounting matters

(b) To ensure that the ‘Statements’ relating to auditing matters are

1.6 LIST OF THE ACCOUNTING STANDARDS AS

The council of the Institute of the Chartered Accountants of

Accounting Title of Accounting Standard

AS-5 Net Proﬁt or Loss for the Period, Prior

AS-26 Intangible Assets