Financial Accounting WorkBook ICMR

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Financial Accounting ICMR Workbook

Text of Financial Accounting WorkBook ICMR

Financial Accounting II


The ICFAI University# 52, Nagarjuna Hills, Hyderabad 500 082

ICFAI April, 2005. All rights reserved.No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means - electronic, mechanical, photocopying or otherwise - without prior permission in writing from The ICFAI University.

ISBN. No. 81-314-0232-0 Ref. No. FA-II WB 04200501 For any clarification regarding this book, the students may please write to the ICFAI University giving the above reference number of this book specifying chapter and page number. While every possible care has been taken in type-setting and printing this book, the ICFAI University welcomes suggestions from students for improvement in future editions.

PrefaceThe ICFAI University has been upgrading its study material to make it more beneficial to the students for self-study through the Distance Learning mode. We are delighted to publish a workbook for the benefit of the students preparing for the examinations. The workbook is divided into three parts. Brief Summaries of Chapters A brief summary of all the chapters in the textbook are given here for easy recollection of the topics studied. Part I: Questions and Answers on Basic Concepts (with Explanatory Notes) Students are advised to go through the relevant textbook carefully and understand the subject thoroughly before attempting Part I. In no circumstances should the students attempt Part I without fully grasping the subject material provided in the textbook. Part II: Problems and Solutions The students should attempt Part II only after carefully going through all the solved examples in the textbook. A few repetitive problems are provided for the students to have sufficient practice. Part III: Model Question Papers (with Suggested Answers) The Model Question Papers are included in Part III of this workbook. The students should attempt all model question papers under simulated examination environment. They should self score their answers by comparing them with the model answers. Effective from April, 2003, the examinations for all the subjects of DBF/CFA (Level-I) consist of only multiple choice questions. Each paper consists of Part A and Part B. Part A is intended to test the conceptual understanding of the students. It contains 40 questions carrying one point each. Part B contains problems with an aggregate weightage of 60 points. Please remember that the ICFAI University examinations follow high standards that demand rigorous preparation. Students have to prepare well to meet these standards. There are no short-cuts to success. We hope that the students will find this workbook useful in preparing for the ICFAI University examinations. Work Hard. Work Smart. Work Regularly. You have every chance to succeed. All the best.

Detailed CurriculumAccounting for Intangible Assets: Characteristics, Operating Expenses versus Intangible Assets, Amortization, Valuation of Goodwill, Patents, Trade Marks and Trade Names, Copyrights, Other Intangibles and Deferred Charges, Research and Development Costs, Investments in Securities and Innovative Property. Accounting for Shares: Accounting Treatment for Issues of Shares, Issue of Shares at a Premium and discount, Forfeiture and Re-issue of shares, Rights and Bonus Shares, Preference Shares: Issue, Conversion and Redemption, Underwriting and Brokerage on Shares, Valuation of Shares. Accounting for Debentures: Issue of Debentures, Redemption of Debentures, Debenture Redemption Reserve, Purchase of Own Debentures, Fully Convertible, Partly Convertible and Nonconvertible Debentures. Preparation of Financial Statements of Limited Companies: Requirements of the Companies Act for presentation of Profit and Loss Account and Balance Sheet of a Company, Preparation of Trial Balance, Profit and Loss Account and Balance Sheet of Limited Companies, Treatment of Special items relating to Company Final Accounts. Statutory Audit and Annual Reports: Legal Requirements for Statutory Audit, Auditors Duties and Liabilities, Qualifications in Auditors Reports, Auditors Duties in relation to Accounting Standards. Contents of Annual Reports, Chairmans Statement, Directors Report, Notes to Financial Statements. Limitations of Financial Statements: Critical Review of Financial Statements, Reworking Financial Statements after Removing the Effect for Abnormal Items and Changes in Accounting Policies. Introduction to Consolidated Accounts of Holding and Subsidiary Companies: Introduction, Determining the Types of Control, Legal Definition and Requirement, Meaning of Holding Company and Subsidiary Company, Particulars of Balance Sheet of a Holding Company with regard to its Subsidiaries, Financial year of the Holding Company and its Subsidiaries, Rights of Holding Companys Representatives and Members, Advantages and Disadvantages of Consolidation of Financial Statements, Basic Rules for Preparing a Consolidated Balance Sheet, Forms and Techniques, Some Special Adjustments. Current Developments and ERP.


Brief Summaries of Chapters


Part I: Questions and Answers on Basic Concepts (with Explanatory Notes)


Part II: Problems and Solutions


Part III: Model Question Papers (with Suggested Answers)


Brief Summaries of ChaptersAccounting for Intangible Assets Intangibles are non-physical but valuable resources like goodwill, patents, and copyrights owned by the firm. The intangible assets can be classified into the following four categories: Goodwill: Arises when payment is made in acquiring another business or asset at higher than the book value. It represents the extraordinary profit earning capability of the enterprise due to reputation, brand name, location, management. Rights: Example, Patents, Copyrights, Trademarks, Licenses, Secret Processes, Franchises, etc. Deferred Revenue Expenditure: Expenditure for which the payment is incurred in one year and the benefits arising out of the asset would be for a number of years. Example, R&D costs are deferred, and appear on the assets side of the balance sheet. Debit balance or deficit in the profit and loss account representing accumulated losses.

Methods of Valuing Goodwill Simple Profit Method: While calculating the goodwill under this method, the following are ascertained: a. b. The average annual profit expected to accrue in the future. The number of years of purchase of goodwill.

Super Profit Method: This method tries to ascertain whether or not the existing business is capable of earning higher than the normal profit (i.e., are there any super profits). The super profits are then multiplied by an agreed number of years of purchase to arrive at the value of goodwill. To evaluate goodwill under this method, the following are ascertained: a. b. c. Expected average annual profits. Reasonable Rate of Return or Normal Rate of Earnings. Capital Employed in the Business.

Amortization of Goodwill Usually the value of the goodwill is amortized over a period of time. The journal entry to be passed for amortization of goodwill is Profit and Loss a/c To Goodwill a/c Technical know-how should be recorded in the books of account only when some consideration in money or moneys worth has been paid for it. Technical know-how can be of two types: i. Relating to manufacturing processes, and ii. Relating to plans, designs and drawings of buildings or plant and machinery. The cost of an intangible asset is measured by (a) the amount of cash disbursed or the fair value of other assets distributed, (b) the present value of amounts to be paid for liabilities incurred, and (c) the fair value of consideration received for stock issued. Dr

Cost of Intangibles

Disclosure A description of intangible assets, method of amortization, and estimated useful lives should be appropriately disclosed in the financial statement or in the footnotes (APB-17, par.30). Enterprises hold investments for diverse reasons. For some enterprises, investment activity is a significant element of operations and assessment of the performance of the enterprise may largely or solely depend on the reported results of this activity. Cost of an investment includes acquisition charges like brokerage, etc. On disposal of an investment, the difference between net disposable proceeds and carrying amount should be recognized as income or expenditure. The total capital of the company divided into units of small denominations are called shares.


Accounting for Shares

Classes of Shares The Companies Act provides for two classes of shares: Equity and Preference shares. Equity shareholders enjoy the voting rights but the company has no obligation to pay the dividends to them at a fixed rate every year. Even at the time of winding up of the company, they receive their share capital after payment to preference shareholders. The preference shareholders enjoy preferential treatment with regard to payment of dividend and return of capital at the time of winding up of the company. Share capital is the capital raised by the company by the issue of shares. a. Authorized or Nominal Share Capital: It is the maximum amount up to which a company is authorized to issue shares to the public without altering the memorandum of association. b. Issued Capital: The nominal value of the shares which are offered to the public for subscription. c. d. e. Subscribed Capital: The nominal value of the shares taken up by the public. Called-up Capital: It is that part of the subscribed capital which has been called up. Paid-up Capital: It is that part of the called up capital which has been paid-up by the shareholders.

Issue of Shares The Companies Act stipulates that when shares are issued to the public for cash, the co