If purchases journal is short by Rs. 1,000, it will affect trial balance.

In financial accounting, every single event occurring in monetary terms is recorded. Sometimes, it just so happens that some events are either not recorded or it is recorded in the wrong head of account or wrong figure is recorded in the correct head of account. Whatever the reason may be, there is always a chance of error in the books of accounts. These errors in accounting require rectification. When there is a difference in a trial balance a suspense account is opened with the amount of the difference so that the trial balance agrees (pending the discovery and correction of the errors causing the difference).

Here Syam prepared a trial balance for his factory on 31st March, 2010. The debit total of trial balance was short by Rs. 500. He transferred the deficiency to suspense A/c. After a close examination he found that the purchase day book for Sept. 2009 was undercast by Rs. 500.

Since purchases has debit balance Necessary Journal entry to rectify the error will be:

Purchases A/c Dr. 500

To Suspense 500

Loan amount = 10,000

Interest payable = 6% of 10,000 = Rs. 600

Interest on loan paid = 300

Thus interest outstanding = 600 – 300 = Rs. 300

The adjustment of insurance claim will be reflected in all three-trading A/c, P&L and balance sheet.

Under average profit method goodwill is calculated on the basis of the average of some agreed number of past years. The average is then multiplied by the agreed number of years. This is the simplest and the most commonly used method of the valuation of goodwill.

Goodwill = Average Profits X Number of years of Purchase

Before calculating the average profits the following adjustments should be made in the profits of the firm:

(a) Any abnormal profits should be deducted from the net profits of that year.
(b) Any abnormal loss should be added back to the net profits of that year.
(c) Non operating incomes e.g. Income from investments etc should be deducted from the net profits
of that year.

Profit of the year 1 : 40000

Profit for the year 2 : 50000

Profit for year 3 : 60000

Profit for year 4 : 50000

Average profit of last 4 years = (40,000 + 50,000 + 60,000 + 50,000)/4 = Rs. 50,000
Goodwill = 50,000 × 3 = Rs. 1,50,000.

Gross profit is a company’s revenue minus its cost of goods sold. Gross profit is a company’s residual profit after selling a product or service and deducting the cost associated with its production and sale.

Cost of goods sold is the direct costs attributable to the production or purchase of the goods
sold by a company. It excludes indirect expenses such as distribution costs and sales force cost.

Cost of goods sold in the above case = purchases less returns = 60,000 – 10,000 = 50,000

Profit = sales less return – cost of goods sold = 80,000 – 10,000 – 50,000 = Rs. 20000

The provision for doubtful debts is identical to the allowance for doubtful accounts. The provision is the estimated amount of bad debt that will arise from accounts receivable that have been issued but not yet collected. The provision is used under accrual basis accounting, so that an expense is recognized for probable bad debts.

An increase in provision for bad debts is recorded as follows

DEBIT the difference (new provision minus old one) to Income Statement*

CREDIT provision for bad debts

*Note : In the Income Statement this is recorded as an increase in provision for bad debts and listed in expenses

Here opening Provision for Bad Debts is Rs. 6,500

Closing Provision for Bad Debts = 5% on (trade receivables – bad debts) = 4% on (1,95,000 – 4,200) = 7632

Opening provision less bad debts = 6,500 – 4,200 = 2,300

Increase in provision for bad debts = – 7,632 – 2,300 = 5,332

Provision for bad debts debited to Profit and Loss A/c will be Rs. 5,332.

The monetary value of an asset decreases over time due to use, wear and tear or obsolescence. This decrease is measured as depreciation. The depreciation method selected should be applied consistently from period to period. A change from one method of providing depreciation to another should be made only if the adoption of the new method is required by statute or for compliance with an accounting standard or if it is considered that the change would result in a more appropriate preparation or presentation of the financial statements of the enterprise. When a change in the method of depreciation is made, depreciation should be recalculated in accordance with the new method from the date of the asset coming into use. The deficiency or surplus arising from the retrospective recomputation of depreciation in accordance with the new method would be adjusted in the accounts in the year in which the method of depreciation is changed. In case the change in the method results in deficiency in depreciation in respect of past years, the deficiency should be charged to the profit and loss account. In case the change in the method results in surplus, it is recommended that the surplus be initially transferred to the ‘Appropriations’ part of the profit and loss account and thence to General Reserve through the same part of the profit and loss account.