Advantages And Disadvantages Of Job Order Costing

Advantages Of Job Order Costing

* Job order costing offers a detailed analysis of the costs of materials, labor cost and overheads by functions and nature.
* Job order costing makes it possible to appraise the profitability of a job.
* Job order costing facilitates the estimation of the cost of a similar job.
* Job order costing allocates overheads on the basis of a predetermined rate.
* Job order costing makes easy to identify spoilage and defects to take corrective actions.
* Job order costing evaluates efficiency of different types of jobs with cost records by using statistical techniques.

Disadvantages Of Job Order Costing

* Job order costing needs a great deal of clerical work in recording material issue, wage computation and payment and overhead charges.
* Ascertainment of overhead rate needs allocation and apportionment of the overheads from service department to production department by using reasonable parameters like selecting a suitable basis.
* Strict control of costs associated with a job is difficult since overheads are allocated on estimation.

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Concept And Meaning Of Job Order Costing

A manufacturing firm generally produces goods based on demand forecasting. However,it sometimes produces them also on receipt of order from its customers. Goods produced and works done as per customers' order are called job. Therefore, the costing method designed to determine the cost of a job is very essential. Job order costing is the costing system that determines the cost of the jobs received from the client.. Thus, job order costing system estimates the costs of manufacturing products as per customers' orders.

Individual job need different quantities of raw materials, labor, and expenses depending upon the quality of the jobs to be performed. The size and quality of products requested may differ. Thus, such a job may not demand a normal manufacturing process. No two jobs are exactly alike. The end product may not be homogeneous. obviously, the cost of each job may differ with the uniqueness of the work order received from customers.
In the job order costing method, each job is treated as separate cost center. Overheads to a job are allocated on the basis of either processing hours or DLH or labor cost or machine hours.

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Differences Between Government Accounting And Commercial Accounting

Following are the main differences between government accounting and commercial accounting:

1. Meaning
The accounting system maintained by the government offices is known as government accounting. The accounting system maintained by business organizations is known as commercial accounting.

2. Objective
Government accounting is maintained by the government offices to know the position of public fund. Commercial accounting is maintained by business organizations to know the profit or loss and the financial position of the business.

3. Budget
Government accounting strictly follows the government budgeting system. commercial accounting does not follow the government budgeting system.

4. Basis
Government accounting is prepared on cash basis. Commercial accounting is prepared on cash as well as accrual basis.

5. Level Of Accounting
Government accounting has the system of central level and operating level accounting. Commercial accounting has no provision of central level and operating level accounting.

6. Rules And Provisions
Government accounting is strictly maintained by following the financial rules and provisions of government. Commercial accounting is maintained by following the rules and principles of 'Generally Accepted Accounting Principles'.

7. Information
Government accounting provides information to the government about the receipts, transfer and deposition of public funds. Commercial accounting provides information to the concerned parties about the operating result and financial position of the business.

8. Auditing
An Auditor General Office audits the book of accounts kept under government accounting. A professional auditor can audit the books of accounts kept under commercial accounting.

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Objectives Of Government Accounting

The following are the main objectives of government accounting:

* To record financial transactions of revenues and expenditures related to the government organizations.
* To avoid the excess expenditures beyond the limit of the budget approved by the government.
* To make expenditures according to the appropriate act, rules and legal provisions of the government.
* To provide reliable financial data and information about the operation of public fund.
* To prevent misappropriation of government properties by maintaining the systematic records of cash and store items.
* To facilitate for making auditing of the books of accounts.
* To help for preparing different financial statements and reports.
* To facilitate for estimating the annual budget by providing historical financial data of government revenues and expenditures.

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Features Of Government Accounting

The following are the main features of government accounting.

1. Profit And Loss
Since government is a public institution, its main objective is to maintain law and order in the country. Therefore, the accounting system used by an institution is not supposed to reveal its profit and loss, but to reveal how public funds and properties have been used for that purpose.

2. Government Regulations
Government accounting is maintained according to government rules and regulations. The financial policies, rules and regulations determine the system of government accounting.

3. Double Entry System
Government accounting is based on the principles and assumptions of double entry system of book keeping. Accordingly, every government financial transactions are recorded showing their double effects. One aspect of the transaction is debited and the other aspect is credited for each government financial transaction.

4. Budget Heads
All the expenses of government offices are classified into different budget heads and expenditures are made only on approved budget heads.

5. Budgetary Control
Government accounting facilitates budgetary control. No government office can make expenditure more than the allocated budget amount.

6. Banking Transaction
All government transactions are supposed to be performed through banks.

7. Auditing
The concerned department of the government must audit the books of accounts maintained by government office so as to avoid misuse and misappropriation of public funds.

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Meaning Of Government Accounting

Accounting is concerned with the processing of financial transactions of an entity. It generates and communicates necessary financial information to its users. It is, therefore, a process of recording, classifying and summarizing the financial transactions and communicating the results of its operations.
There are different branches of accounting. One of its branches is government accounting. Government accounting is that branch of accounting, which is used in government institution. The government accounting is different from other branches of accounting such as commercial accounting.
The accounting system used in government offices to record and report their financial transactions is known as government accounting. Government accounting is concerned with systematic and scientific recording of government revenues and expenditures. It is the systematic process of collecting, recording, classifying, summarizing and interpreting the financial transactions relating to the revenues and expenditures of government offices. It reveals how public funds have been generated and utilized for the welfare of the general public. Therefore, government accounting may be defined as an accounting system used in government institution for the purpose of recording, classifying, summarizing and communicating the financial information regarding the collection and utilization of public funds and properties. It is concerned with keeping records of government revenues and their expenditure in different development and administrative works. It reflects the receipt and payment position of the public funds.

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Differences Between Balance Sheet And Statement Of Affairs

Following are the main differences between balance sheet and statement of affairs:

1.Basis
Balance sheet is prepared on the basis of double entry system of book keeping. Statement of affairs is prepared on the basis of incomplete records.

2. Purpose
Balance sheet is prepared to present financial position of the business. Statement of affairs is prepared to find out either the amount of opening capital or closing capital.

3. Financial Position
Balance sheet shows the true financial position of the business. Statement of affairs does not show the true financial position of the business.

4. Stage Of Preparation
Balance sheet is prepared at the final stage of accounting procedure. Statement of affairs is not prepared at the final stage of the accounting procedure.It is prepared before the preparation of statement of profit or loss.

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Concept Of Statement Of Affairs And Its Preparation

Statement of affairs is a statement of capital, liabilities and assets. Statement of affairs is prepared under the single entry system in order to find out the amount of opening or closing capital of the business. For the purpose of determining the amount of opening capital, the statement of affairs is prepared on the opening date. The statement of affairs is prepared on the closing date for the purpose of determining the amount of closing capital. It is also known as the balance sheet of single entry system.

Preparation Of Statement Of Affairs
Statement of affairs is prepared like the balance sheet. All the liabilities are shown on left-hand side and all the assets are shown on right-hand side. The difference between the total assets and total liabilities is considered as the amount of capital.
Capital = Total Assets - Total Liabilities

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Calculation Of Profit Or Loss Under Single Entry System

The following method is used for the calculation of profit or loss under single entry system.

Net Worth Method
Net worth method is also called statement of affairs method or capital comparison method. According to this method profit or loss of the business is determined by making comparison between the capital of two dates of a period. For example,
Capital as on 1st January 2009 = $ 150000
Capital as on 31st December 2009 = $ 200000
Profit for the year 2009 = Closing capital -Opening capital = $200000-$150000 = $50000.

If there are other capital related items such as drawing, additional capital, interest on capital etc. are to be adjusted to ascertain the amount of profit or loss.
These items include:

* Drawing: If the drawing is made during the year, it should be added to the amount of closing capital.
* Additional capital: If additional capital is introduced in the business during the year, it should be deducted from the amount of closing capital.
* Interest on capital: If the interest is provided on capital, it should be deducted from the amount of closing capital.

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Differences Between Single Entry And Double Entry System

The following are the differences between single entry and double entry system:

1. Meaning
Single entry system is an incomplete system of recording financial transactions. Double entry system is a complete system of recording and reporting financial transactions.

2. Duality
Single entry system is not based on the concept of duality. Double entry system is based on the concept of duality.

3. Accounts
Single entry system maintains only personal accounts of debtors and creditors and cash book. Double entry system all personal, real and nominal accounts.

4. Trial Balance
Single entry system can not prepare a trial balance and hence, arithmetical accuracy of books of accounts can not be checked. Double entry system prepares trial balance and hence, arithmetical accuracy of the books of accounts can be checked.

5. Profit Or Loss
Single entry system can not ascertain the true amount of profit or loss of the business as it does not maintain nominal accounts. Double entry system ascertains true profit or loss of the business as it maintains all nominal accounts.

6. Financial Position
Single entry system can not ascertain the true financial position of the business because it does not maintain real accounts except cash book. Double entry system ascertains financial position of the business as it maintains all personal and real accounts.

7. Suitability
Single entry system is suitable to a small business where only limited number of transactions are performed. Double entry system is suitable for a large business.

8. Tax Purpose
Single entry system is not acceptable for the purpose of assessment of tax. Double entry system is acceptable for the purpose of assessment of tax.

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Disadvantages Of Single Entry System

The following are the notable disadvantages of single entry system:

1.Unscientific And Unsystematic
The single entry system is unsystematic and unscientific system of recording financial transactions. It does not have any set of fixed rules and principles for recording and reporting the financial transactions.

2. Incomplete System
Single entry system is incomplete system because it does not record the two aspects or accounts of all the financial transactions of the business. It does not maintain any record of the transactions relating to the nominal account and real account except cash account.

3. Lack Of Arithmetical Accuracy
Single entry system is not based on the principles of debit and credit. It fails to provide the arithmetical accuracy of the books of accounts. Trial balance can not be prepared under this system to check the arithmetical accuracy of books of accounts.

4. Does Not Reflect True Profit Or Loss
Under single entry system, the true amount of profit or loss can not be ascertained because it does not maintain the nominal accounts.

5. Does Not Reflect True Financial Position
The single entry system does not maintain real accounts except cash book. Therefore, it can not reveal the true financial position of the business.

6. Frauds And Errors
The single entry system of book-keeping is incomplete, inaccurate and unscientific. It does not help to check the arithmetical accuracy of the books of accounts. Therefore, there is always a possibility of committing frauds and errors in the books of accounts.

7. Unacceptable For Tax Purpose
The single entry of book keeping has incomplete records of the financial transactions of the business. Hence, the tax office can not accept the account maintained under this system for the purpose of assessment of tax.

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Advantages Of Single Entry System

The following are the important advantages of single entry system:

Simple And Easy
Single entry system is simple to understand and easy to maintain as it has no fixed set of principles to follow while recording financial transactions.

Economy
Single entry system is an economical system of recording financial transactions. It does not require hiring skilled accounting personnel to record financial transactions of the business. Further, it does not require large number of books to record the limited number of financial transactions.

Easy To Calculate Profit
Under single entry system, the amount of profit can be determined easily. The amount of profit or loss of the period can be determined by making comparison between the amounts of closing capital and opening capital.

Suitable For Small Business
The single entry system is simple, easy, and economical system. It is suitable for small businesses because they can not afford the cost of double entry system. Besides, small business are not required to maintain their books of accounts under double entry system.

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Meaning And Features Of Single Entry System

Meaning Of Single Entry System
Single entry system is an incomplete form of recording financial transactions. It is the system, which does not record two aspects or accounts of all the financial transactions. It is the system, which has no fixed set of rules to record the financial transactions of the business. Single entry system records only one aspect of transaction. Thus, single entry system is not a proper system of recording financial transactions, which fails to present complete information required by the management. Single entry system mainly maintains cash book and personal accounts of debtors and creditors. Single entry system ignores nominal account and real account except cash account. Hence, it is incomplete form of double entry system, which fails to disclose true profit or loss and financial position of a business organization.

Features Of Single Entry System
The following are the main features of single entry system:

1. No Fixed Rules
Single entry system is not guided by fixed set of accounting rules for determining the amount of profit and preparing the financial statements.

2. Incomplete System
Single entry system is an incomplete system of accounting, which does not record all the aspects of financial transactions of the business.

3. Cash Book
Single entry system maintains cash book for recording cash receipts and payments of the business organization during a given period of time.

4. Personal Account
Single entry system maintains personal accounts of all the debtors and creditors for determining the amount of credit sales and credit purchases during a given period of time.

5. Variations In Application
Single entry system has no fixed set of principles for recording financial transactions and preparing different financial statements. Hence, it has variations in its application from one business to another.

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Differences Between Receipts And Payments Account And Income And Expenditure Account

The following are the main differences between receipts and payments account and income and expenditure account:

1. Nature
Receipts and payments account is a summary of cash transactions for a period and it is a real account. Income and expenditure account is a summary of expenditure and income like trading and profit and loss account and it is a nominal account.

2. Objective
Receipts and payments account is prepared to show cash and bank receipts and payments during the period to derive closing balance of cash and bank. Income and expenditure account is prepared to show the net result of the operation during the period to derive surplus or deficit.

3. Recording
All cash and cheque receipts are recorded on debit side of receipts and payments account where as all cash and bank payments are recorded on credit side. In income and expenditure account all expenditure of revenue nature are recorded on debit side and all incomes of revenue nature are recorded on credit side.

4. Capital And Revenue Items
There is no distinction between capital and revenue receipts and payments in receipts and payments account. All expenses and incomes of revenue nature are recorded on accrual basis in income and expenditure account.

5. Contents
Receipts and payments account contains only cash and bank transactions. Income and expenditure account contains both cash and non-cash expenses and incomes of revenue nature.

6. Balance Sheet Requirement
Receipts and payments account is not required to prepare balance sheet. Income and expenditure account is required to prepare balance sheet.

7. Adjustments
No adjustments are required in receipts and payments account. In income and expenditure account adjustments are made because it is prepared on accrual basis.

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Concept And Features Of Income And Expendiutre Account

Concept Of Income And Expenditure Account
Income and expenditure account is prepared by non-trading concern to reveal the surplus or deficit arising out of the operating activities during the accounting period. It is one of the final accounts of non-trading concern like the profit and loss account of trading concern. All the revenue incomes during the accounting period are shown on income side and all of the revenue expenses during the period are shown to debit (expenditure) side of income and expenditure account. The excess of credit side over the debit side or excess of income over expenditure is termed as surplus, where the excess of expenses over the revenue income is termed as deficit. The surplus or deficit of income over expenditure is transferred to capital fund. The surplus is added to capital fund and vice-verse. Income and expenditure account is prepared on the accrual basis.

Features Of Income And Expenditure Account

* Income and expenditure account is prepared on accrual basis.
* Income and expenditure account records all cash and non-cash expenses and income, which are revenue nature.
* Income and expenditure account is debited with the expenses and losses and credited with the incomes and gains.
* The closing balance of income and expenditure account either surplus or deficit is transferred to capital fund in the balance sheet.

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Concept Of Receipts And Payments Account, Its Features And Limitations

Concept Of Receipts And Payments Account
Receipt and payment account is a summary of cash receipts and payments during the accounting period. It records all cash receipts and cash payments including capital receipts and revenue revenue receipts irrespective of accounting period. All cash receipts are recorded on debit side or receipts side and all cash payments are recorded on credit or payments side of receipts and payments account.

Features Of Receipts And Payments Account
The essential features of receipts and payments account are as follows:

1. Summary Of Cash Transactions
All cash receipts and payments made by the concern during the accounting period are recorded in this book. Therefore, receipts and payments account can be taken as a summary of cash transactions.

2. Cash And Bank Items In One Column
All receipts either cash or bank are recorded in receipts column of receipts side where all cash and bank payments are recorded in one column of payment column of receipts and payments account. The cash and bank transactions are merged to avoid contra entries of cash and bank transactions.

3. No Distinction Between Capital And Revenue
All cash receipts and cash payments irrespective of capital and revenue nature are recorded in receipts and payments account. No distinct is made for capital receipts , revenue receipts, capital expenditures and revenue expenditures.

4. Opening And Closing Balance Of Cash
Receipts and payments account starts from opening balance of cash and bank ends with the closing balance of cash and bank.

5. Recording Of Cash Receipts And Payments
All cash and cheque receipts are recorded on debit side where as all cash and cheque payments are recorded on credit side of receipts and payments account.

6. Ignores Non-cash Transactions
Receipts and payments account does not record non-cash transactions.

Limitations Of Receipts And Payments Account
The receipts and payments accounts suffers from the following limitations:

1. Receipts and payments account does not differentiate capital and revenue expenses and incomes.
2. Receipts and payments account fails to show expenses and incomes on accrual basis.
3. Receipts and payments account fails to show surplus and deficiency.
4. Receipts and payments account fails to show non-cash transactions such as depreciation of fixed assets, pilferage etc.

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Concept Of Non-Trading Concern And Its Accounting System

The organizations, which are established for the purpose of rendering social services to its members and to the society is known as non-trading concern. Such organizations include clubs, schools, colleges. hospitals, libraries, trusts, professional associations and unions. These organizations render their service to the members and to the general public, such as a club provides sports and other recreational services to the members. Schools and colleges provide education services, hospital provides treatment and services to the patients.
The sole object of non-trading concern is to provide necessary services to its members and the society at large through welfare activities. The aim of such organization is not to make profit. They should prepare systematic books of account to provide necessary information about receipts and payments. It also helps to know, whether the current income is sufficient to meet the current expenditures or needs. The balance sheet is prepared to know the financial position, besides providing information about the proper utilization of grants, donations, and so on.
Proper accounting is essential for non-trading concern to provide the required information. Such institutions prepare receipts and payment account to show the receipts and payments of cash. Income and expenditure account is prepared to know the surplus or deficit for the period. Balance sheet is prepared to know the financial status of the concern.
The detailed and transparent financial information of non-trading concern can be obtained by preparing receipts and payment account, income and expenditure account as well as balance sheet.

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Differences Between Reserve And Provision

The following are the main differences between reserve and provision:

1. Mode Of Creation
Reserve is created against the charge of the profit and loss appropriation account. Provision is created against the charge of the profit and loss account.

2. Objective
Main objective of reserve is to strengthen the financial position and to meet future unknown losses and liabilities. Objective of provision is to meet known losses and liabilities the amount of which is not certain.

3. Accounting Treatment
Reserve is shown on debit side of profit and loss appropriation account and liabilities side of balance sheet. Provision is shown on debit side of profit and loss account and assets side of balance sheet as deduction from the concerned asset.

4. Relation With Profit
Reserve is created when there is enough profit in the business. Provision is created even if there is loss in the business.

5. Distribution
Reserve can be distributed to shareholders as dividend. Provision can not be distributed as dividend to shareholders.

6. Future Requirement
Reserve is created without considering the future requirement of the business. Provision is created by estimating the future requirement of the business.

7. Impact
Impact of reserve will be on financial position. Impact of provision will be on profit or loss of the business.

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Meaning And Objectives Of Provision

Meaning Of Provision
A provision is the sum of amount set aside by charging against the profit and loss account. It is created for meeting a known loss or liability. Provision is maintained for meeting an anticipated loss or liability of uncertain amount. Such amount of anticipated loss or liability can only be estimated. If the present regular transactions undoubtedly bring certain losses or liabilities of unknown amount in further then provisions should be made for them in current year's book. Such provisions should be made every year by debiting the profit and loss account without considering whether the business is in profit or loss. A provision is always created for the specific purpose. It is not for the distribution to the shareholders. The provision, in fact, reduces the figure of profit and not the figure of divisible profit.
Generally, a business maintains different types of provisions with some specific purposes. They are as follows:

* Provision for doubtful debts
* Provision for discount on debtors
* Provision for taxation
* Provision for repairs and renewals

Objectives Of Provision
Some of the important objectives of maintaining provisions are as follows:
* To Meet Anticipated Losses And Liabilities
Provisions are created for meeting anticipated losses and liabilities such as provision for doubtful debts, provision for discount on debtors and provision for taxation.
* To Meet Known Losses And Liabilities
Provisions are created for meeting known losses and liabilities such as provision for repair and renewals.
* To Present Correct Financial Statements
In order to present correct financial statements and to report true profit and financial position, the business must maintain provision for known liabilities and losses.

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Concept Of Secret Reserve, Its Objectives, Advantages And Disadvantages

A reserve which maintained to strengthen the financial position of the business without disclosing it in the book is known as secret reserve. Secret reserve is hidden reserve which is not disclosed by the balance sheet. Secret reserve is also known as internal reserve. It is created by showing the figure of net profit less than actual. Its existence makes the financial position of the business better than what the balance sheet is disclosing. Generally, it is maintained by bank, Insurance and other financial institutions.
A secret reserve is created in any of the following ways:
* By depreciating the fixed assets at excessively high rates.
* By undervaluing the current assets.
* By eliminating the assets altogether from the books.
* By over-valuing the liabilities.
* By showing contingent liabilities as real assets.
* By creating excessive amount of reserve for future contingencies.
* By treating capital expenditure as revenue reserve.
* By ignoring accrued income or treating income as liability.

Objectives And Advantages Of Secret Reserve
The following are the objectives and advantages of secret reserve:
* Secret reserve helps in strengthening the financial position of the business.
* Secret reserve gives the sense of financial stability to the shareholders and creditors by equalizing the rate of dividend.
* Secret reserve helps in eliminating unhealthy competition by not showing true profit to the competitors.
* Secret reserve provides additional working capital.

Disadvantages Of Secret Reserve
The following are the disadvantages of secret reserve
* The existence of secret reserve is known to the management only and not to the real owners or shareholders.
* Secret reserve makes the information of financial statements false and inaccurate.
* Secret reserve may be the strong cause of loosing trust and confidence of the shareholders and outsiders.
* Secret reserve may cover up the inefficiency and fraud committed by the managers and directors.

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Concept And Meaning Of Revenue Reserve And Types Of Revenue Reserve

Concept And Meaning Of Revenue Reserve
A reserve which is created out of the revenue profit is called revenue reserve. Revenue profit is earned in the normal course of the business. Revenue reserve refers to the undistributed revenue profit. It is created for strengthening the financial position, replacing deprecialble assets, redeeming liabilities, declaring uniform rate of dividend and conducting research and development functions. If the reserve is not needed in the future, it can be distributed as dividend to the shareholders.

Types Of Revenue Reserve
There are two types of revenue reserve:
a) General Reserve
A reserve which is created out of the profit not for a specific purpose is known as general reserve.General reserve is used for general purpose as per the discretion of the management. Usually, general reserve is used for strengthening the financial position and meeting future contingencies and losses.

b) Specific Reserve
A reserve which is created out of the profit for a particular purpose is known as specific reserve. Such reserve can not be utilized for any purpose other than specified. Specific reserve is created by debiting the profit and loss appropriation account. It can be invested in outside securities. It serves for a specific purpose as to equalize dividend or to redeem a fixed liability or to replace a fixed assets or to conduct a research and development work.
The following are the important types of specific reserve:
* Dividend equalization fund
* Sinking fund
* Research and development fund

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Concept And Meaning Of Capital Reserve, Its Objectives, Advantages And Disadvantages

Concept And Meaning Of Capital Reserve
A reserve which is created out of the capital profit is known as capital reserve. It is not created out of the profit earned in normal course of the business. Capital reserve is created out of the profit earned from some specific transactions of capital nature. Capital reserve is not available for the distribution to the shareholders. The examples of capital profit from which capital reserve is created are as follows:

* Profit on sale of fixed assets
* Profit on sale of investment
* Profit on revaluation of assets and liabilities
* Premium on issue of shares and debentures
* Profit on re-issue of forfeited shares
* Discount on redemption of debentures
* Profit on purchase of an existing business

Objectives And Advantages Of Capital Reserve
The following are the objectives and advantages of capital reserves
* Capital reserve helps in making the organization financially strong.
* Capital reserve helps in writing off the capital losses arising from the sale of fixed assets, shares and debentures.
* Capital reserve helps in the issue of fully paid bonus shares to the existing shareholders.

Disadvantages Of Capital Reserve
The following are the disadvantages of capital reserve
* Capital reserve is not available for the distribution to shareholders.
* Capital reserve does not give any indication of operating efficiency of the business.
* Capital reserve does not help in making the management responsible to sale old assets at satisfactory price.

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Types Of Reserve

The following are the main types of reserves

1. Capital Reserve
2. Revenue Reserve
a)General Reserve
b) Specific Reserve
*Dividend Equalization Fund
* Research And Development Fund
*Sinking Fund
- Sinking fund for replacement of assets
- Sinking fund for redemption of liabilities
3. Secret Reserve

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Meaning And Objectives Of Reserve

Meaning Of Reserve

A reserve is a part of the profit set aside to meet future contingencies and losses. Usually, the whole amount of profit earned by the business is not distributed to the owners or shareholders. A part of the profit is retained in the business either for meeting its unexpected future liabilities and losses or for strengthening financial position. It can be created for redeeming liabilities or replacing depreciable assets or declaring uniform rate of dividend over years. It is created out of the profit only. If there is no profit in a particular year, no reserve can be created in that year. It is created by debiting the profit and loss appropriation account. It does not reduce the figure of net profit because it is created after determining profit. The reserve, therefore, reduces only the figure of divisible profit. It belongs to the owners and shareholders. It can be distributed to the shareholders if its existence is no longer required.

Objectives Of Reserve

The main objectives of maintaining reserve are as follows:
* To meet unexpected future losses, liabilities and contingencies.
* To strengthen the financial position of the business.
* To redeem debentures, preference shares and other loans and liabilities.
* To replace wasting or depreciating assets.
* To declare and distribute the uniform rate of dividend over years.
* To meet the need of fund from internal sources.
* To provide additional working capital and to improve the working capacity of the business.

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Concept And Meaning Of Annuity Method Of Depreciation, Its Advantages And Disadantages

Concept And Meaning Of Annuity Method Of Providing Depreciation

Under this method, it is assumed that the amount spent in the purchase of the assets is an investment which should earn interest. The amount spent in acquiring an asset is assumed as an investment and interest is charged at a certain rate on the diminishing balance of assets and is debited to assets account and credited to interest account which is transferred to profit and loss account. The asset is credited year by years with a fixed amount of depreciation. The amount of depreciation charged every year is such that in spite of asset being debited with interest every year, the asset is reduced to zero or its residual value. The amount of depreciation is calculated on the basis of annuity table.

When additions are made to asset account, calculations have to be revised. This method is used in the case of leases having large amount spread over a number of years.

Advantages Of Annuity Method Of Depreciation

The following are the advantages of annuity method:

i. Annuity method takes interest on capital invested in the asset into account.

ii. Annuity method is regarded as most exact and precise from the point of view of calculations. So it is a scientific method.

Disadvantages Of Annuity Method Of Depreciation

The following are the disadvantages of the annuity method:

i. The annuity method is difficult to understand.

ii. The burden on profit and loss account goes on increasing with the passage of time whereas the amount of depreciation charged each year remains constant. The amount of interest credited goes on diminishing as years pass by, the ultimate consequence being that the net burden on profit and loss account grows heavier each year.

iii. When the asset requires frequent addition and extensions, the calculation have to be changed frequently, which is very inconvenient.

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Concept Of Double Declining Balance Method Of Providing Depreciation And Its Calculation

According to double declining method, the depreciation is charged on the reducing balance method but the rate of depreciation is determined by multiplying the straight line rate by 2.

Calculation Of Amount Of Depreciation Under Double Declining Balance Method

Purchase price of assets = $ 2,000

Useful life of the assets = 3 Years

Scarp value = $ 200

Required: Annual depreciation under double declining balance method

Solution,

Cost = $ 2000

Scarp value = 0 (under this method scarp value is ignored)

Straight line depreciation per year = 2000-0/3 = $ 667

Rate of depreciation under straight line method= 667/2000 = 33.33%

Double declining balance depreciation rate = 33.33% X 2 = 66.67%

Now,

Depreciation of first year = 2000 x 66.67% = $ 1,333

Depreciation of second year = 666.67 x 66.67% = $ 444

Depreciation of third year = 223 x 66.67% = $ 147

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Differences Between Fixed Installment And Reducing Balance Method Of Depreciation

Following are the main differences between fixed installment method and reducing balance method of depreciation:

Basis
Depreciation is charged on the original cost of assets in fixed installment method. In reducing balance method, depreciation is charged on the book value of asset.

Yearly Depreciation
The amount of depreciation is the same in each year over the life of assets in fixed installment method. The amount of depreciation decreases every year in reducing balance method.

Ending Value
In fixed installment method, book value of asset generally reaches to zero. Book value of asset does not reach to zero in reducing balance method.

Acceptance
Fixed installment method of depreciation is not acceptable for tax purpose. Reducing balance method is acceptable for tax purpose.

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Concept Of Machine Hour Rate Method Of Providing Depreciation And Its Calculation

Under machine hour rate method, the total number of working hours of a machine during the whole of its effective life is estimated, and then, the cost of machine is divided by the expected number of hours of useful life, this gives the rate per hour. The annual depreciation is calculated by multiplying this rate by the number of hours, the machine actually runs in a year.

Calculation Of Machine Hour Rate Method Of Depreciation

Illustration,

The life of machine costing $ 10,00,000 is estimated 10,000 hours. Calculate the amount of depreciation for the year in which the machine runs for 1,500 hours.

Solution

Depreciation per hour = cost of machine - salvage value/total machine hours

= $ 10,00,000/10,000 hours

= $ 100.

Therefore, depreciation for the year = 1500 hours X 100 = $ 1,50,000

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Concept Of Sinking Fund Method Of Providing Depreciation, Its Advantages And Disadvantages

Concept Of Sinking Fund Method Of Depreciation

The methods discussed in the previous posts do not help in accumulating the amount of depreciation which can be readily available for the replacement of the asset when it is completely unusable. Sinking fund method is designed in such a way that it incorporates the advantages of depreciating the assets as well as accumulating the necessary amount for its replacement.

Under this method, a fixed amount is debited every year to depreciation amount and credited to depreciation fund account instead of asset account. The asset is shown at its original cost, in the books, in every year. The amount which is credited in the sinking fund, is invested in gilt-edged securities. The interest on such investment is also invested in similar securities. The securities are readily convertible into cash. Investments are purchased every year. When the assets become useless, the inestments are sold away and thus new assets can be purchased without disturbing the financial position of the firm. The sinking fund method is adopted specially when it is desired not merely to write off an asset but also to provide enough funds to replace the asset at the end of its working life. The amount set aside as depreciation is such that this, with compound interests, will be sufficient to meet the cost of new asset, less scrap value, if any, for replacement. The depreciation under this method can be calculated with the help of sinking fund table for a particular period at a given rate of interest.

Advantages Of Sinking Fund Method Of Depreciation

i. Sinking fund method makes available a sum of money for the replacement of asset by maintaining separate provision.

ii. Sinking fund method helps to strengthen financial position of a concern.

Disadvantages Of Sinking Fund Method Of Depreciation

i. The burden on profit and loss account goes on increasing as years pass by since the amount of depreciation every year remains same but the amount spent on repairs goes on increasing as the asset become old.

ii. Sinking fund method creates complication due to frequent investment.

iii. Prices of securities may fall at the time when they are to be realized as a result of which loss may have to be suffered.

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Concept And Meaning Of Sum Of Year's Digits Method (SYD) Of Providing Depreciation And Its Calculation

Sum of year's digits method is an accelerated method of depreciation which is also based on the assumption that the loss in the value of fixed asset will be greater during the earlier years and goes on decreasing gradually with the decrease in the life of such asset. The sum of year's digit (SYD) is found by estimating an asset's useful life in years, then assessing consecutive numbers to each year, and totaling these numbers. For n years, SYD = 1+2+3+4+...........+n.

For example, if the life of an asset is 5 years, the SYD would be 1+21+3+4+5=15. Determining the SYD factor by simple addition can be somewhat laborious for long-lived assets. For these assets the formula(n+1)/2 where, n= the number of periods in the asset's useful life can be applied to derive the SYD.

Sum of year digit = 5(5+1)/2 = 30/2= 15

The yearly depreciation is then calculated by multiplying the total depreciable amount for the life of the asset by a fraction whose numerator is the remaining useful life and whose denominator is the SYD. Thus in our example the calculation would:

First year depreciation = 5/15 X Depreciation cost

Second year depreciation = 4/15 X Depreciation cost

Third year depreciation = 3/15 X Depreciation cost

Fourth year depreciation = 2/15 X Depreciation cost

Fifth year depreciation = 1/15 X Depreciation cost

The formula for depreciation for sun of year's digits method is:

Depreciation = Depreciation cost X (Remaining useful life/SYD)

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Advantages And Disadvantages Of Reducing Balance Method Of Depreciation

Advantages Of Reducing Balance Method Of Depreciation

The main advantages of reducing balance method of depreciation are listed below
* Reducing balance method is easy to understand and simple to implement. Depreciation is calculated every year on the opening balance of asset.
* Reducing balance method equalizes the yearly burden on profit and loss account in respect of both depreciation and repairs. The amount of depreciation goes on decreasing while the expenses on repairs goes on increasing, so that the total charge against revenue over different years remains more or less the same.
* Reducing balance method is acceptable for income tax purposes
* Reducing balance method matches the cost and revenue of the business. The greater amount of depreciation provided in initial years is matched against the higher amount of revenue generated by increased production by the use of new asset.

Disadvantages Of Reducing Balance Method Of Depreciation

The main demerits of reducing balance method are as follows:
* Reducing balance method charges heavy amount of depreciation in earlier years.
* The formula to obtain rate of depreciation can be applied only when there is residual value of the asset.

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Concept And Meaning Of Reducing Balance Method Of Depreciation

Reducing balance method is also termed as diminishing balance method or written down value method or declining value method or book value method. Under the reducing balance method, depreciation is charged at fixed rate on the reducing balance of asset derived after deducting depreciation of every year out of the cost of the fixed assets. The balance in the asset account will go on decreasing but will never become zero. The remaining balance in the asset account is taken as scrap value. The following points should be considered while calculating the amount of depreciation on asset.
* The annual amount of depreciation will not remain fixed or equal. It decreases gradually since the current value of the asset deceased every year.
* The amount of depreciation is calculated by using the given rate of depreciation on the diminishing value(written down value) of an asset.
Written down value = Cost - depreciation
* If the rate of depreciation is not given in the question, the rate is determined by using the following formula

Rate of depreciation = 1-(s/c) 1/n
Where,
n= Estimated useful life of the asset
s = Scrap value
c= Cost of assets

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Advantages And Disadvantages Of Fixed Installment Method Of Depreciation

Advantages Of Fixed Installment Method Of Depreciation

The main advantages of fixed installment method of depreciation are given below

* Fixed installment method is simple to understand and easy to calculate the amount of depreciation.
* Fixed installment method provides the same amount of depreciation throughout the life of the asset.
* Fixed installment method helps to estimate the amount of depreciation in advance.

Disadvantages Of Fixed Installment Method Of Depreciation

Following are the main disadvantages of fixed installment method of depreciation.

* Fixed installment method does not take into consideration the seasonal fluctuations in the use of fixed assets. Depreciation amount per month will remain the same irrespective of the use of machine.
* Equal amount of Depreciation is charged even though the capacity of the machine declines every year.

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Concept Of Fixed Installment Method Of Providing Depreciation

Fixed installment is the earliest and one of the widely used methods of providing depreciation. This method is based on the assumption of equal usage of asset over its entire useful life. It is also called straight line method for the reason that if the amount of depreciation and corresponding time period is plotted on a graph, it will result in a straight line. It is called fixed installment method because the amount of depreciation remains constant from year to year. According to this method, a fixed and an equal amount is charged as depreciation in every accounting period during the life time of an asset.

This method is referred to an equal installment method or original cost method or straight line method. The following points should be considered while calculating the amount of depreciation.
* The amount of depreciation is always fixed or equal in the years to come. Depreciation is charged equally throughout the effective life of the asset.
* The amount of depreciation is calculated where the rate of depreciation is given:
Annual Depreciation= Given%/100 X(cost of assets+installation cost-estimated scrap value)
*The amount of depreciation is calculated where the life of the fixed asset is given:
Annual Depreciation(D) = (O+I-S)/N x100
Where,
O= Original cost of an assets
S= Estimated scrap value
D= Annual depreciation
I= Installation cost
N= Life of the asset

Alternatively,
* The rate of depreciation to be applied where the rate of depreciation is not given
Rate of depreciation= 1/N X100 = .....% p.a

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Methods Of Providing Depreciation

There are various methods of calculating the amount of depreciation. These methods are listed below.

1. Fixed Installment Method
2. Diminishing Balance Method
3. Annuity Method
4. Depreciation Fund Method
5. Insurance Policy Method
6. Revaluation Method
7. Machine Hour Rate Method
8. Sum Of The Year's Digits Method

Fixed installment method and diminishing balance method are most commonly used methods of providing depreciation.

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Factors Affecting The Amount Of Depreciation

Following are the important factors which should be considered for determining the amount of depreciation.

1. Cost Of Assets
The cost of asset include the purchase price, less any trade discount plus all the costs essential to bring the asset to a usable condition.In other word, the total cost of asset includes from purchase price to the installation.

2. Estimated Scrap Value
Scrap value refers to the value estimated to be realized after the expiry of the useful working life of the asset. This is also known as residual value or salvage value. Depreciation should be determined after deducting the estimated scrap value from the cost of asset.

3. Estimated Useful Life
An asset can not work forever. Every asset has a certain working and useful life. The longer the working life, the amount of depreciation will be lower and vice verse. Therefore, the useful life of an asset is generally to be taken in terms of asset's expected use. This estimated useful life of asset determines the rate or the amount of depreciation.

4. Legal Provisions
The amount of depreciation also depends upon the statutory and legal provisions prescribing the admissible rate of depreciation on fixed assets.

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Advantages Of Providing Depreciation

The following are the advantages of providing depreciation:

1. Ascertainment Of True Profits
When an asset is purchased, it is nothing more than a payment in advance for for the use of asset. Depreciation is the cost of using a fixed asset. To determine true and correct amount of profit or loss, depreciation must be treated as revenue expenses and debited to profit and loss account.

2. Reporting Of True And Fair Financial Position Of A Business
The value of assets decrease over a period of time on account of various factors. In order to present a true state of affairs of the business, the assets should be shown in the balance sheet, at their true and fair values. If the depreciation is not provided then the asset will appear in the balance sheet at the original value. So, in order to show the true financial position of a business, depreciation is required to be charged on the assets.

3. Replacement Of Assets
Assets used in the business need to be replaced after the expiry of their useful life. Depreciation can be taken as a source of fund for replacing worn out asset by a new asset. Thus, depreciation charges help in accumulating funds for the replacement of an asset.

4. Saving In Taxes
The profit and loss account will show more profits if depreciation is not charged on asset. So, the business needs to pay more income tax to the government. Depreciation charges on assets save the amount of tax equivalent to tax rate. Since it is shown as expense in the profit and loss account, it reduces the amount of the profit.

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Major Causes Of Depreciation

The major causes of depreciation are as follows:

1. Wear And Tear
wear and tear refer to a decline in the efficiency of asset due to its constant use. When an asset losses its efficiency, its value goes down and depreciation arises. This is true in case of tangible assets like plant and machinery, building, furniture, tools and equipment used in the factory.

2. Effusion Of Time
The value of asset may decrease due to the passage of time even if it is not in use. There are some intangible fixed assets like copyright, patent right, and lease hold premises which decrease its value as time elapse.

3. Exhaustion
An asset may loss its value because of exhaustion too. This is the case with wasting assets such as mines, quarries, oil-wells and forest-stand. On account of continuous extraction, a stage will come where mines and oil-wells get completely exhausted.

4. Obsolescence
Changes in fashion are external factors which are responsible for throwing out of assets even if those are in good condition. For example black and white televisions have become obsolete with the introduction of color TVs, the users have discarded black and white TVs although they are in good condition. Such as loss on account of new invention or changed fashions is termed as obsolescence.

5. Other Causes
Market value and accident of an asset are other causes of depreciation which decrease in the value of assets.

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Concept, Meaning And Features Of Depreciation

Concept Of Depreciation

Every business acquires some non-trading fixed assets. These fixed assets are used in the business for facilitating its trading activities and enhancing its revenue earning capacity. These assets are basically purchased for the business with the intention of permanent use and not for resale.
All fixed assets except the value of land decreases with the passage of time. The value of these assets decrease each year. Such gradual reduction or decrease in the value of fixed assets for the purpose of earning revenue is called depreciation. Depreciation is closely related with the determination of profit or loss for the period. Unless depreciation is charged to the revenues, the true income of the business can not be ascertained properly. As such, depreciation is a revenue expense.
Fixed assets are also called depreciable assets. The characteristics of depreciable assets are as follows.

* The expected life of the asset is more than one accounting period.
* Those assets have a limited useful life.
* Those assets are held by the business for use in production of goods and services.
* Those assets are not for the purpose of sale in the ordinary course of business.

The cost of fixed asset indicates 'the price for the future service of the assets'. It is necessary to spread its cost over a number of years during which benefit of the asset is received. This process of allocating the cost of fixed assets is termed as 'depreciation'.

Meaning Of Depreciation

In general words, depreciation is the reduction in the value of an asset due to usage, passage of time, wear and tear, technological out dating or obsolescence, depletion, inadequacy, decay or other such factors.

In accounting, depreciation is a term used to describe any method of attributing the historical or purchase cost of an asset across its useful life, roughly corresponding to normal wear and tear. It is mostly used when dealing with assets of a short, fixed service life, and which is an example of applying the matching principle as per generally accepted accounting principles.

Depreciation is calculated on all depreciable assets which can be defined as those which have a useful life for more than one accounting period but is limited and are held by an enterprise for use in the production or supply of goods and services. Examples of depreciable assets are machines, plants, furniture, buildings, computers, trucks, vans, equipment, etc. Moreover, depreciation is the allocation of 'depreciable amount' which is the 'historical cost' or other amount substituted for historical cost less estimated salvage value.

Depreciation has significant effect in determining and presenting the financial position and results of operations of an enterprise. Depreciation is charged in each accounting period by reference to the extent of the depreciable amount.

In this way, depreciation is an allocation of the cost of assets over their useful life. A systematic procedure of for allocating the cost over the periods of its useful life in a rational manner is called depreciation accounting.

Features Of Depreciation

Following are the main features of depreciation:

1. Depreciation is decline in the book value of fixed assets.

2. Depreciation includes loss of value of assets due to passage of time, usage or obsolescence.

3. Depreciation is a continuing process till the end of the useful life of assets.

4. Depreciation is an expired cost and hence must be deducted before calculating taxable profits.

5. Depreciation is a non-cash expense. It does not involve ant cash flow.

6. Depreciation is the process of writing-off the capital expenditure already incurred.

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Differences Between Capital Reserve And Revenue Reserve

Following are the main differences between capital reserve and revenue reserve

Source
Capital profit is the source of capital reserve. Revenue profit is the source of revenue reserve.

Use
Capital reserve is used to meet capital losses. Revenue reserve is used to strengthen the financial position, distribute dividend, replace fixed assets, and redeem liabilities.

Indication
Capital reserve does not indicate the operating efficiency of the business. Revenue reserve indicates the operating efficiency of the business.

Existence
Capital reserve does not exist if there is no capital profit. Revenue reserve may exist even if there is loss in a particular year.

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Concept And Meaning Of Capital Reserve And Revenue Reserve And Their Related Items

Concept And Meaning Capital Reserve

The reserve which is created out of the capital profit is known as capital reserve. Capital reserve is created out of the profit of some specific transactions of capital nature. It is not available for the distribution to shareholders as dividend. It is used to meet capital loss. Capital reserve is shown on the liabilities side of the balance sheet. Sometimes, it can be used to issue fully-paid bonus shares.

Items of capital profit out of which capital reserve is created:
* Profit on revaluation of assets and liabilities.
* Profit on sale of assets
* Profit on sale of shares and debentures
* Profit on forfeiture of shares
* profit on redemption of debentures
* profit on purchasing running business

Concept And Meaning Of Revenue Reserve

Revenue reserve is created out of the revenue profit earned in the normal course of the business. It refers to the undistributed revenue profit. It can be distributed as dividend to the shareholders. Revenue reserve helps to strengthen the financial position of the company and also helps to declare uniform rate of dividend.

Items relating to revenue reserve
* General reserve
* Dividend equalization fund
* Sinking fund
* Research and development fund

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Differences Between Capital Loss And Revenue Loss

Followings are the main differences between capital loss and revenue loss

Causes
Capital loss occurs due to the sale of assets, share and debentures at a price less than their face value or book value. Revenue loss occurs due to heavy amount of operating expenses and low turnover or sales.

Nature
Capital loss does not occur in the normal course of the business. Revenue loss occurs in the normal course of the business.

Indication
Capital loss does not indicate the inefficiency of the business. Revenue loss indicates the inefficiency of the business.

Treatment
Capital loss is shown on the asset side of the balance sheet. Revenue loss is shown on the debit side of the trading and profit and loss accounts and asset side of the balance sheet as accumulated loss.

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Concept And Meaning Of Capital Losses And Revenue Losses And Their Related Items

Concept And Meaning Capital Losses

The amount of loss suffered due to the sale of fixed assets, shares and debentures at a price less than their book value or face value is capital loss. It does not occur in the normal course of the business. It occurs in the course of selling assets and raising capital. Usually, it is shown on the asset side of the balance sheet and written off out of the capital profit.

Items relating to capital loss
* loss on sale of fixed assets
* Discount on issue of shares and debentures
* Premium on redemption of debentures
* Loss on sale of investment

Concept And Meaning Of Revenue Losses

Revenue loss occurs in the ordinary course of the business. It results due to inefficiency in operating regular activities of the business. It results from the heavy amount of operating expenses and low amount of turnover. It is shown as debit balance on the debit side of the trading and profit and loss accounts. It adversely affects the amount of capital and stability of the business.

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Differences Between Capital Profit And Revenue Profit

Following are the main differences between capital profit and revenue profit.

Mode Of Earning
Capital profit is earned by selling assets, shares and debentures at a price more than their book value and face value. Revenue profit is earned in the ordinary course of the business.

Distribution
Capital profit is not available for the distribution to shareholders as dividend. Revenue profit is available for the distribution to shareholders as dividend.

Use
Capital profit is transferred to capital reserve and used for meeting capital losses. Revenue profit is used to distribute dividend and create reserve and fund for various purposes.

Treatment
Capital profit is shown on the liabilities side of the balance sheet as capital reserve. Revenue profit is shown as debit balance on the debit side of the trading and profit and loss accounts and on asset side of the balance sheet as accumulated loss.

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Concept And Meaning Of Capital Profits And Revenue Profits And Their Related Items

Concept And Meaning Of Capital Profits

The amount of profit earned by the business from the sale of its assets, shares, and debentures is capital profit. If assets are sold at a price more than their book values then the excess of book value is capital profit. Similarly, if the shares and debentures are issued at a price more than their face value, then the excess of face value or premium is capital profit. Such profit is not earned in the ordinary course of the business. It is not available for the distribution to shareholders as dividend. Such profits are transferred to capital reserve. It is used for meeting capital losses. It is shown on the liabilities side of balance sheet.

Items relating to capital profits
* Profit on sale of fixed assets
* Premium on issue of share
* Premium on issue of debenture
* Share forfeited amount
* Profit on sale of investment

Concept And Meaning Of Revenue Profits

Revenue profit is the difference between revenue incomes and revenue expenses. It is earned in the ordinary course of the business. It results from the sale of goods and services at a price more than their cost price. Revenue profit is he outcome of regular transactions of the business. It is shown as gross profit and net profit in trading and profit and loss accounts. It is available for the distribution to shareholders as dividend or for creating reserve and fund for various purposes. It shows the efficiency of the business . In fact, earning revenue profit is the main objective of every business.

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Differences Between Capital Receipts And Revenue Receipts

Following are the differences between capital receipts and revenue receipts.

Source
Capital receipt is the amount received from the sale of assets, shares and debentures. Revenue receipt is the amount received from the sale of goods and services.

Nature
Capital receipt is of non-recurring nature. Revenue receipt is of recurring nature.

Impact
Main items of capital receipt are capital and loan, which affect financial position of the business. Main items of revenue receipt are sale of merchandise, discount and commission, which affect operating results of the business.

Treatment
Capital receipt is shown on the liabilities side of the balance sheet. Revenue receipt is shown on the credit side of the trading and profit and loss accounts.

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Concept And Meaning Of Capital Receipts And Revenue Receipts And Their Related Items

Capital Receipts

An amount received in the form of capital from the owner and as loan from outsiders is known as capital receipts. Besides, cash received by selling shares, debentures and permanent assets is also capital receipt. It is of non-recurring type of receipt. It is treated as obligation of the business and shown on liabilities side of the balance sheet.

Items relating to capital receipts
* Amount received from the owner as capital.
* Amount received through the sale of shares and debentures.
* Amount of loan received
* Amount received from the sale of old assets.
* Other receipts of non-recurring nature.

Revenue Receipts

Revenue receipt is an amount which is received from the regular transaction of a business. It is the amount received from the sale of goods and services. It is the main source of income. It is a regular type of income. It is shown on the credit side of the trading and profit and loss accounts.

Items relating to revenue receipts
* Amount received from the sale of goods and services.
* Amount received by way of discount, commission, rent, interest and dividend.
* Amount received from the sale of waste paper and packing cases.

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Differences Between Capital Expenditures And Revenue Expenditures

The following are the main differences between capital and revenue expenditures

Nature
Capital expenditure is of non-recurring nature. Revenue expenditure is of recurring nature.

Purpose
Capital expenditure is incurred in acquiring permanent assets or improving their existing capacity. Revenue expenditure is incurred in managing day-to-day activities of the organization and maintaining its fixed assets.

Benefit
Capital expenditure gives benefit over a number of years. Revenue expenditure gives benefit not for more than one year.

Earning
Capital expenditure helps in increasing earning capacity of the business. Revenue expenditure helps in earning capacity of the business.

Treatment
Capital expenditure is shown on asset side of the balance sheet. Revenue expenditure is shown on the debit side of the trading and profit and loss account.

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Concept And Meaning Of Capital Expenditure And Revenue Expenditures And Their Related Items

Capital Expenditures
The expenditures which generates revenue or income is called capital expenditure. Capital expenditure incurred either for buying permanent assets or for improving their exiting working capacity. Capital expenditure helps in increasing production volume or decreasing cost of production. Such expenditures are shown on the asset side of balance sheet.

Items relating to capital expenditure

* Expenditure incurred in buying transporting and installing a permanent asset.
* Expenditure incurred in overhauling and installing an old asset to put it in production process.
* Cost of registration and legal charges incurred in buying or constructing a permanent assets.
* Expenditure incurred in improving or extending the working capacity of an existing asset.
* Expenditure incurred in getting benefits over a number of years.
* Expenditure incurred in raising capital like brokerage and commission for underwriting shares and debentures.

Revenue Expenditures
Any expenditure incurred in connection with the operation and administration of daily activities of the business is called revenue expenditure. Revenue expenditure is incurred for maintaining earning capacity and working efficiency of the fixed assets. Revenue expenditure is incurred for acquiring merchandise for resale either in its original or improved form. Its benefit expires within a year. Revenue expenditure is shown on debit side of the trading and profit and loss accounts.

Items relating to revenue expenditure

* Expenditure incurred in acquiring raw materials for manufacturing process or finished goods for resale.
* Wages and all other items of manufacturing expenses
* All items of office, administration, selling and distribution expenses
* Repair, maintenance, and depreciation of all the fixed assets.
* Interest on loan and other financial expenses.

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Concept And Meaning Of Capital And Revenue

The main objective of accounting is to ascertain the true profit or loss and to reveal the financial position of a business at the end of financial year.
To achieve the objectives, the business must take a clear distinction between its capital and revenue items. The distinction between capital and revenue items is essential for their correct treatment in the final accounts. Any incorrect treatment of those two items in the final accounts adversely affects the operating results and financial position of the business.
Capital is the wealth invested by an investor for producing additional wealth. The original figure of wealth is known as capital. Making of additional wealth with the investment of original capital is known as revenue. Thus, capital is the source of the basis of revenue. In other words, capital is invested in the business to earn revenue. For example, a trader has started a business with $ 1,00,000 and earns a profit of $ 30,000 during the year. The original investment of the trader, i.e $ 1,00,000 is the capital and the profit of $ 30,000 earned by the investor out of the investment is the revenue.
Capital items concerned with the payment for assets and receipt from the owners and outsiders. It is the item of the balance sheet. It is of long-term nature and its benefit is long-lasting. In fact, capital items are assets, liabilities and capital that determine the financial strength of the business.
Revenue item is concerned with the payment for producing or buying goods and receipt from sale of goods and services. Those revenue incomes and expenditures are the items of trading and profit and loss accounts. It is of short-term nature. Its benefit expires within the year. In fact, revenue items are incomes and expenses, which determine the operating result (profit or loss) of the business.

The following capital and revenue concepts are relevant for accounting purpose

* Capital and revenue expenditures
* Capital and revenue receipts
* Capital and revenue losses
* Capital and revenue profits
* Capital and revenue reserves

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Concept And Meaning Of Suspense Account And Utility Of Suspense Account

Suspense Account
The account opened to rectify the previous year's one-sided errors is called suspense account. Suspense account is opened for a temporarily period only. Suspense account shows no balance after rectification of all errors and it disappears automatically. Opening of suspense account does not mean that the errors detected should be left unrectified.
Suspense account is opened with a purpose to correct the previous year's one-sided errors. It is used for temporary period only. One-sided errors affect only one side of account. Therefore, rectification of one-sided errors is done by opening suspense account. Opening suspense account makes possible to prepare journal entries for correcting one-sided errors. Suspense account shows no balance after rectifying one-sided errors and disappears automatically.

Utility Of Suspense Account
Suspense account is opened when one-sided errors detected after preparation of trial balance. It is the account opened for temporary period till one sided errors are rectified. Suspense account is debited when the debit total of trial balance remain less. It is credited by the amount short of the credit total of trial balance. The suspense account does not show any balance after the rectification of all one-sided errors. Therefore utilities for opening suspense account are as follows.

* Suspense account helps to carry one-sided errors amounts to suspense account
* Suspense account helps to show the total amount of errors needed to be rectified
* Suspense account helps to show the different accounts where in rectifications are to be made
* Suspense account helps to draft final account along with checking of errors simultaneously.

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Concept And Meaning Of Rectification Of Accounting Errors And Its Methods

Rectification Of Accounting Errors
Once an error is located, it should be properly corrected. The correction of accounting errors in a systematic manner is called the rectification of errors. In other words, the process of systematically correcting the accounting errors is known as rectification of errors. The presence of accounting errors affects accuracy of the profit and loss and the financial position of the business shown by the final accounts, therefore, no error should be left uncorrected.

Methods Of Rectification Of Accounting Errors

The following method should be followed to rectify the accounting errors

1. Rectification of errors located before preparation of trial balance
2. Rectification of errors after preparation of trial balance

1. Rectification Of Errors Located Before Preparation Of Trial Balance
Errors may be detected in the process of closing books and accounts for preparation of trial balance. The errors detected in the process may be either one-sided errors or two-sided errors. However, once such errors are located they must be rectified immediately.

* Rectification Of One-sided Errors Located Before Preparation Of Trial Balance
One-sided errors are those errors which affect only one side of an account. Wrong totaling of subsidiary books, posting a wrong amount, posting on the wrong side are some of the examples of one-sided errors. Since two accounts are not involved in these errors, journal entry can not be passed for rectifying such errors. The one-sided error is rectified by making an additional posting on the affected side of the ledger account.

* Rectification Of Two-sided Errors Located Before Preparation Of Trial Balance
The errors that affect two or more accounts are called two-sided errors. Correction of such two-sided errors needs to make rectification journal entries since such errors involve two or more accounts. Therefore, one account is debited and another account is credited to rectify two-sided errors. The rules of debit and credit are applied to rectify these errors.
The following three steps are taken to rectify the two-sided errors.
a. Identify correct entry
b. Rewrite wrong entry
c. Find rectifying entry by making adjustment of correct entry and wrong entry

2. Rectification Of Errors After Preparation Of Trial Balance
Sometimes, errors may be detected after an accounting year is over. Those are the errors detected after preparation of trial balance. The errors detected after the completion of accounting year may be one-sided and two-sided errors. Rectification of the errors seen after preparation of trial balance can be made by preparing rectifying journal entries in the subsequent year only.
Double entry system is followed to rectify the errors detected after preparation of trial balance. Two accounts are affected by the two-sided errors. Therefore, one account is debited and another affecting account is credited for such errors. But one-sided errors are rectified by opening 'Suspense Account'.

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Methods Of Locating Accounting Errors

If any errors exists in the books, it affects the accuracy of results of business operations revealed by the financial statements. Therefore, the error must be located for its rectification. The task of locating error is, however not easy. The location of errors will be easier if the following steps are systematically taken.

* Check the total of the trial balance
* Compare the ledger account balances carried to the trial balance
* Check the total of debtors' and creditors' accounts and compare with the balance of debtors' and creditors' amounts shown in the trial balance
* Verify the total of subsidiary books and their posting to ledgers
* Compare the items of trial balance of the current year with the items of trial balance of the previous year to see if any balancing figure is omitted.
* Verify that all journal entries are posted into ledgers

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Types Of Accounting Errors Based On Disclosure By Trial Balance

The accounting errors based on disclosure by trial balance can be of the following types:

1.Accounting Errors Shown By Trial Balance
The errors that effect the agreement of the trial balance are called the errors shown by trial balance. The following are the errors that affect the totals of trial balance.

* Partial Omission
If a transaction is recorded or posted partially in the journal or in the ledger, such an error affects the agreement of the trial balance. For example, the total of trial balance disagrees if goods costing $ 600 sold to Mr. Jack on credit is recorded in sales book but no posting is done in Mr. Jack's account. Similarly, failure to carry forward the balance of $ 5000 of the purchase return account to the trial balance also affects the totals of trial balance.

* Posting A Wrong Amount In An Account
Posting a wrong amount from the book of original entry to a ledger account affects the total of trial balance. For example, cash of $ 10,000 received from National Enterprises was posted in cash book but only $ 1,000 was posted in National Enterprises' account. Such an error affects the agreement of the trial balance.

* Posting On The Wrong Side Of An Account
If an amount is posted on the wrong side of an account from the book of original entry, such an error affects the totals of trial balance. For example, stationary costing of $ 500 purchased from Chitika Stationers recorded in the journal was wrongly posted on the debit side of Chitika stationers' account.

* Wrong Casting Of Subsidiary Books And Wrong Balancing Of An Account
Incorrect totaling of subsidiary books and balancing of ledger account also result in the disagreement of the trial balance. For example, if sales return book was incorrectly totaled as $ 100 instead of $ 1,000 and if the debit side of electricity account incorrectly balanced $ 12,000 instead of $ 1,200, then the total of the trial balance is adversely affected.

2.Accounting Errors Not Shown By Trial Balance
The errors that do not affect the agreement of trial balance are called the errors not shown by trial balance. That means, the trial balance agrees if such errors exist. The following are some of the errors not shown by trial balance.

* Complete Errors Of Omission
The complete omission of recording a financial transaction in the boom of original entry or omission of posting an entry from journal to ledger accounts makes no impact on the totals of the trial balance. The totals of trial balance remain equal as no posting takes place on the debit and credit sides of accounts. For example, cash of $ 400 received from Miss Lily was omitted to record in journal. similarly, the sale of goods for cash amounting to $ 2,000 was recorded in journal but no posting was made in cash account as well as in sales account. These complete omissions do not affect the totals of trial balance.

* Posting A Wrong Amount In Subsidiary Books And Ledger
Entering a wring amount for instance $ 4,000 is purchase book for the purchase of goods costing $ 4,500 from National Trading Concern cannot reveal by trial balance.

* Posting In Wrong Account
If an amount is wrongly posted on the right side of a wrong account then the error will not be affect the agreement of trial balance. Payment of $ 3,000 made to Mr. Tom was wrongly posted on the debit side of John's account, will certainly not affect the trial balance totals.

* Compensating Errors
Compensating errors are also not shown by the trial balance. For example, $ 500 posted in the costumer's account for sale of goods for $ 5,000 and $500 posted in the supplier's account for purchase of goods for $ 5,000 compensate their affects on the trial balance as both the accounts remained short of $ 4,500 on the debit and credit sides respectively. Hence, the trial balance would still be in agreement.

* Errors Of Duplication
The errors of duplication are also not revealed by the trial balance. For example, the totals of trial balance will be in agreement even though wage of $ 500 paid for the month of June 2010 was recorded twice in cash book.

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