PAPER 2 – ACCOUNTING & FINANCE FOR BANKERS – ONLY SOME PORTION OF MATERIAL TAKEN TO SHOW WHAT TYPE OF MATERIAL WE HAVE MADE…. ACCOUNTING & FINANCE FOR BANKERS INDEX Chapter 1. Basics Of Accounts 2. Accounting Equation 3. Journalizing and Posting Transactions 4. Trial Balance & Financial statement 5. Capital v/s revenue expenditure 6. Introduction to accounting standards 7. Bank Reconciliation Statement 8. Errors & their rectification 9. Special Treatment of Bad & doubtful debts 10. Depreciation 11. Inventory Valuation 12. Share Capital Accounting 13. Partnership 14. Banks Accounts 15. Time Value Of Money 16. Bond Valuation 17. Basics Of Foreign Exchange 18. Ratio Analysis 19. Bills of Exchange 20. Consignment & Joint Venture 21. Lease & Hire Purchase 22. Accounting of Not for Profit Organisation Multiple Objective Question Bank

Page No. 1 10 14 29 35 36 41 46 52 54 64 72 81 100 121 132 138 144 154 158 163 170 175

CHAPTER 1 BASICS OF ACCOUNTS What you should Know? What is Accounting, its nature, purpose & definition. Objective of Accounting, its subdivisions. Basic concepts Conventions of accounting Golden Rule of Accounting INTRODUCTION In all activities (whether business activities or non-business activities) and in all organizations (whether business organizations like a manufacturing entity or trading entity or non-business organizations like schools, colleges, hospitals, libraries, clubs, temples, political parties) which require money and other economic resources, accounting is required to account for these resources. In other words, wherever money is involved, accounting is required to account for it.

Accounting is often called the language of business. The basic function of any language is to serve as a means of communication. Accounting also serves this function. What is Accounting? Accounting, as an information system is the process of identifying, measuring and communicating the financial information of an organization to its users who need the information for decision making. It identifies transactions and events of a specific entity. A transaction is an exchange in which each participant receives or sacrifices value (e.g. purchase of raw material). An event (whether internal or external) is a happening of consequence to an entity (e.g. use of raw material for production). Economic Events Business organisations involves economic events. An economic event is known as a happening of consequence to a business organisation which consists of transactions and which are measurable in monetary terms. For example, purchase of machinery, installing and keeping it ready for manufacturing is an event which comprises number of financial transactions such as buying a machine, transportation of machine, site preparation for installation of a machine, expenditure incurred on its installation and trial runs. Thus, accounting identifies bunch of transactions relating to an economic event. If an event involves transactions between an outsider and an organisation, these are known as external events. The following are the examples of such transactions: a. Sale of Reebok shoes to the customers. b. Rendering services to the customers by Bank. c. Purchase of materials from suppliers. d. Payment of monthly rent to the landlord. An internal event is an economic event that occurs entirely between the internal wings of an enterprise, e.g., supply of raw material or components by the stores department to the manufacturing department, payment of wages to the employees, etc. Generally Accepted Accounting Principles (GAAP): Concepts and Conventions Evolution of accounting is spread over several centuries and during this period certain rules, procedures and conventions have come to be accepted as useful. These rules etc. represent a consensus view of the profession for good accounting practices and procedures and are commonly referred to as Generally Accepted Accounting Principles (GAAP). It means the set of rules and practices followed in recording transactions and preparing the financial statements (profit and loss account and balance sheet). The GAAP provide a set of guidelines to be observed by the accounting profession for preparing and reporting the accounting information and can be broadly classified into two categories – concepts and conventions. Concepts and Conventions in accounting: Basic concepts: Accounting principles are built on a foundation of a few basic concepts. These concepts are so basic that most accountants do not consciously think of them; they are regarded as being selfevident. Non-accountants will not find these concepts to be self-evident. Some accounting theorists argue that certain of the present concepts are wrong and should be changed. But in order to understand accounting, as it now exists, one must understand what the underlying concepts currently are. The different aspects are :— 1. Business Entity Concept 2. Money Measurement Concept 3. Cost Concept

4. 5. 6. 7. 8.

Going Concern Concept Dual-aspect Concept Realisation Concept Accrual Concept Accounting Period Concept

1. Business Entity Concept: This concept assumes that, for accounting purposes, the business enterprise and its owners are two separate independent entities. Thus, the business and personal transactions of its owner are separate. For example, if the owner of a shop, who has started a business paid Rs. 10,000 for school fees of his daughter, then this fees will not be treated as business expenditure and will be treated as personal expenditure of owner and hence required to be recorded as withdrawal of capital. Without such a distinction the affairs of the shop will be mixed with the personal affairs of the owner and records fail to show the true profit from business activity. For a company the distinction is easier as legally the company is a distinct entity from the persons who own it. Therefore, an entity is a business organisation or activity in relation to which accounting reports are compiled. It may include universities, voluntary organisations, government and non-business units Significance: The following points highlight the significance of business entity concept: a. This concept helps in ascertaining the profit of the business as only the business expenses and revenues are recorded and all the private and personal expenses are ignored. b. This concept restraints accountants from recording of owner’s private/ personal transactions 2. Money Measurement Concept: This concept assumes that all business transactions must be in terms of money, that is in the currency of a country. In our country such transactions are in terms of rupees. The advantage of doing this is that money provides common denominators by means of which variety of facts can be expressed as numbers that can be added and subtracted. This enables addition and subtraction of varied items since money provides the common denominator. Thus, as per the money measurement concept, transactions which can be expressed in terms of money are recorded in the books of accounts. For example, sale of goods worth Rs.400000, purchase of raw materials Rs.200000, Rent Paid Rs.10000 etc. are expressed in terms of money, and so they are recorded in the books of accounts. But the transactions which cannot be expressed in monetary terms are not recorded in the books of accounts. For example, sincerity, loyalty, honesty of employees are not recorded in books of accounts because these cannot be measured in terms of money although they do affect the profits and losses of the business concern. Significance: The following points highlight the significance of money measurement concept: a. This concept guides accountants what to record and what not to record. b. It helps in recording business transactions uniformly. c. If all the business transactions are expressed in monetary terms, it will be easy to understand the accounts prepared by the business enterprise. d. It facilitates comparison of business performance of two different periods of the same firm or of the two different firms for the same period. 3. Cost Concept: Cost concept states that all assets are……………………….. How to record and maintain journal: In the above section we have discussed the nature of business transactions and the manner in which they are analyzed and classified. The primary emphasis was the “why” rather than the

“how” of accounting operations; we aimed at an understanding of the reason for making the entry in a particular way. We showed the effects of transactions by making entries in T accounts. However, these entries do not provide the necessary data for a particular transaction, nor do they provide a chronological record of transactions. The missing information is furnished by the use of an accounting form known as the journal The journal, or day book, is the book of original entry for accounting data. Afterward, the data is transferred or posted to the ledger, the book of subsequent or secondary entry. The various transactions are evidenced by sales tickets, purchase invoices, check stubs, and so on. On the basis of this evidence, the transactions are entered in chronological order in the journal. The process is called journalizing. A number of different journals may be used in a business. For our purposes, they may be grouped into general journals and specialized journals. To illustrate journalizing, we here use the general journal, whose standard form is shown be low. …………………… Practice Exercise for chapter 1 & 2 1. Which of the following is not a sub-field of accounting? (a) Management accounting. (b) Cost accounting. (c) Financial accounting. keeping.

(d) Book-

2. Revenue from sale of products, is generally, realized in the period in which (a) Cash is collected. (b) Sale is made. (c) Products are manufactured. (d) None of the above. 3. The determination of expenses for an accounting period is based on the principle of (a) Objectivity. (b) Materiality. (c) Matching. (d) Periodicity. 4. It is essential to standardize the accounting principles and policies in order to ensure (a) Transparency. (b) Consistency. (c) Comparability. (d) All of the above. 5. On March 31, 2010 after sale of goods worth Rs. 2,000, he is left with the closing stock of Rs. 10,000. This is (a) An event. (b) A transaction. (c) A transaction as well as an event. (d) Neither a transaction nor an event. CHAPTER 3 Journalizing and Posting Transactions Introduction Preparing a new equation A = L + C after each transaction would be cumbersome and costly, especially when there are a great many transactions in an accounting period. Also, information for a specific item such as cash would be lost as successive transactions were recorded. This information could be obtained by going back and summarizing the transactions, but that would be very time-consuming. Thus we begin with the account. The Account An account may be defined as a record of the increases, decreases, and balances in an individual item of asset, liability, capital, income (revenue), or expense. The simplest form of the account is known as the “T” account be cause it resembles the letter “T.” The account has three parts:

Journalizing We describe the entries in the general journal according to the numbering in the table above: 1. Date. The year, month, and day of the first entry are written in the date column. The year and month do not have to be repeated for the additional entries until a new month occurs or a new page is needed. 2. Description. The account title to be debited is entered on the first line, next to the date column. The name of the account to be credited is entered on the line below and indented. 3. P.R. (Posting Reference). Nothing is entered in this column until the particular entry is posted, that is, until the amounts are transferred to the related ledger accounts. The posting process will be described in the next section. 4. Debit. The debit amount for each account is entered in this column. Generally, there is only one item, but there could be two or more separate items. 5. Credit. The credit amount for each account is entered in this column. Here again, there is generally only one account, but there could be two or more accounts involved with different amounts. 6. Explanation. A brief description of the transaction is usually made on the line below the credit. Generally, a blank line is left between the explanation and the next entry. Journal Format:Date

Particulars

P.R Debit Amt.

Credit Amt.

Transaction1. Amit started business on 1.4.2012 with capital Rs 5,00,000. Transaction Analysis: This transaction affects Amit’s capital account and cash account. Capital account is the proprietor’s personal account and the liability for business and hence by our rule liability increased credit that account will be applicable. And since Cash account an asset is also increased the rule says ‘Debit the asset if increased’ will be applicable. Therefore, the journal entry for this transaction will be Rs. Rs. Cash Account ……………. Dr 5,00,000 To Amit's Capital Account Cr 5,00,000 (Amit started business with cash) Transaction 2. April I 2012. He opened a savings bank account with State Bank of India with Rs 3,00,000. Transaction Analysis: The two accounts affected by this transaction are cash account and bank account. Cash a/c is asset and bank a/c is also asset. The rule for says ‘Debit if asset increased and credit if asset decreased. Here bank is increased, Bank account will be debited. Since cash from the business is going out i.e decreased in asset, cash account will be credited. Therefore, the journal entry will be Rs. Rs. Bank Account…………….. Dr 3,00,000 To Cash Account Cr 3,00,000 (deposited cash into bank) ……….. Illustration 3. Enter the following transactions in the journal of M/s. Harish & Co., and post them into the ledger and balance the ledger accounts. 2012 Rs.

Mar. 1 Started business with cash Mar 2. Paid into Bank Mar 3. Purchased goods for cash Mar 5. Purchased furniture and paid by cheque Mar 7. Sold goods for cash

90,000 50,000 30,000 10,000 19,000

The Journal will be as follows: Mar . 1 Cash A/c……………………....…………Dr. To Capital A/c Cr (Started business) Mar . 2 Bank A/c……………………….... ………Dr. To Cash Cr (Paid to bank) Mar . 3 Purchases A/c………………… ..………Dr. To Cash A/c Cr. (Purchased goods)

90,000 90,000 50,000 50,000 30,000 30,000

…………………… Practice Exercise: Prepare Trial Balance & Financial statements for the exercises given in Page no. 28 & 29 by using ledger drawn by you for that exercise. 1. Given below are the ledger balances of a management consultancy firm: Capital Rs.4,00,000, Computer Rs. 25,000, Air conditioner and furniture Rs. 1,00,000, Fixed Deposits Rs.2,00,000, Salaries Rs.8,00,000, Fees received Rs. 12,00,000, Travelling expenses Rs.1,50,000, Rent and office expenses Rs.2,40,000, Cash balances Rs. 1,80,000. Bank overdraft Rs. 95,000. The total of trial balance will be (a) Rs. 16,00,000. (b) Rs. 16,95,000. (c) Rs. 14,50,000. (d) Rs. 15,00,000. …………………………………….. CHAPTER 7 Bank Reconciliation Statement Both business as well as bank maintains the bank account kept by the business. The book in which business maintains is called Bank a/c in ledger and the book in which bank maintains is called Bank statement. While we are preparing final accounts of the business bank balance as per bank a/c is taken into consideration. And bank as per bank statement might not be same due to some errors in either of the books, to reconcile these balance we prepare BRS. It is statement prepared normally every month to reconcile between the balance as per bank a/c in ledger and the balance as per bank statement. The reconciliation statement reveals how the disagreement between the two is reconciled. Causes for Disagreement * Cheques issued to the customer but which is not yet presented to the bank by him. * Cheques deposited in the bank but which is not cleared and collected by it. * Interest on overdraft, Bank charges debited by the bank in the bank statement for which no corresponding entry is made in the cash book. * Dishonoured cheques and bills debited in the bank statement but not entered in the cash

book. * Direct receipts by way of interest, rent, etc., credited by bank for which no corresponding entry is passed in the cash book. * Wrong credit made by bank in the bank statement . * Wrong debit committed by bank in the bank statement. * Cheques received but omitted to be banked. Note:- Before proceeding for bank reconciliation one has to be very cautious as regards the debit & credit is concerned. Most of the times due to workings in bank, we may get confused as while passing entries in bank, the customers accounts are usually credited for receipt and debited for payment, however here we are not making any entry in bank for customer but making entries in customers books and hence reverse effect will have to be taken care. ………… Bank Reconciliation Statement: Format of Bank Reconciliation:Particulars Balance as Per Ledger (bank A/c)/Cash Book(with bank col.) Cheques issued but not presented for payment Cheques deposited but not cleared or collected by bank Cheques deposited but dishonoured, not in books Bank charges/Interest charged by bank not in books Interest income not in books Direct deposit of money by customer not in books ( e.g. rent, payment by customer etc. is possible due to CBS) Total Balance As per Bank statement

Dr. Amt. XX XX

Cr. Amt.

XX XX XX XX XX XXX XXX

XXX XX XXX

Total Notes:Not in Books means customer knows these adjustments only when he obtain the information through passbook/bank statement/now a days by net banking. And hence no reverse effect has been given in bank reconciliation. One has to give the norma effect as if accounting in normal manner. In case of overdraft account or CC accounts, bank reconciliation will be prepared in the same manner as above but only the op. balance has to be written in credit side of it. Rest all will be the same. Particulars Dr. Amt. Balance as Per Ledger (bank A/c)/Cash Book(with bank col.)

Cr. Amt. XX

Some Practice problems: Illustration 1 : On 31st December, 2009 the balance of bank as per bank a/c showed Rs. 10,000. The balance as per BANK STATEMENT was Rs. 12,200. On the Scrutiny of accounts it was found that the cheques worth Rs. 3,000 issued to the customer on 25th December were not encashed unit 2nd January. Cheques worth Rs. 1,000 deposited with bank on 29th

December were not credited unit 4th January. Interest of Rs. 300 on Government securities was credited in the BANK STATEMENT but was not entered in the bank a/c.. The bank debited Rs. 100 towards bank charges. Prepare the reconciliation statement. Bank Reconciliation Statement as on 31st December, 2009 Rs. Bank Balance as per ledger book Debit: Cheques issued but not presented for payment Interest on Government securities credited in the bank statement but not adjusted in the ledger book.

P.

Rs. P. 10,000.00

3,000.00 300.00 _________

3,300.00 ________ 13,300.00

…………………. CHAPTER 14 BANKING ACCOUNTS ACCOUNTING SYSTEM IN BANKS: An accounting system can be defined as the series of tasks in an entity by which transactions are processed as a means of maintaining financial records. Such a system recognizes, calculates, classifies, posts, analyses, summarizes and reports transactions. It may be stated here that even in a fully computerised branch, some work is presently Carried out manually, e.g., preparation of vouchers, preparation of letters of credit and guarantees, preparation of some returns and statements, etc. In partly computerised branches, generally the back-office work (i.e. the internal processing of transactions of the branch) is carried out on computers whereas the customers? transactions (i.e. the frontoffice work) are processed manually. Many of the banks in the private sector have networked all or most of their branches in the country; this has given them the capability of handling most of the transactions of their customers at any of the branches. ………………….. Suggested format of Balance Sheet of UCBs

Capital and Liabilities

Schedule

Capital Reverse and Surplus Principal/ Subsidiary State Partnership Fund Deposits Borrowing Other liabilities & Provisions

1 2 3 4 5 6

Total Assets

As on 31.3 As on 31.3 (Current (previous Year) Year) Rs. Rs.

Cash & Balances with Reserve Bank of India, State 7 Bank of India, State Coop. bank and Central Coop. bank ……………………………………Contd….. Disclosure Requirements as per Accounting Standards where RBI has issued guidelines in respect of disclosure items for “Notes to Accounts” a) AS-5 – relating to Net Profit or Loss for the period, prior period items and changes in accounting policies. b) AS -9 – Revenue Recognition giving the reasons for postponement of revenue recognition. c) AS – 15 – Employee Benefits d) AS – 17 – Segment Reporting such as Treasury, Corporate/wholesale Banking, Retails Banking, ‘Other Banking Operations’ and Domestic and International segments, etc. e) AS – 18 – Related Party Disclosures …………….. 2. NPA:- MEANING : 2.1 Non performing Assets 2.1.1 An asset, including a leased asset, becomes non performing when it ceases to generate income for the bank. 2.1.2 A non performing asset (NPA) is a loan or an advance where; i.interest and/ or instalment of principal remain overdue for a period of more than 90 days in respect of a term loan, ii.the account remains ‘out of order’ as indicated at paragraph 2.2 below, in respect of an Overdraft/Cash Credit (OD/CC), iii.the bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted, iv. the instalment of principal or interest thereon remains overdue for two crop seasons for short duration crops, ……………………………….. Advances covered by ECGC guarantee In the case of advances classified as doubtful and guaranteed by ECGC, provision should be made only for the balance in excess of the amount guaranteed by the Corporation. Further, while arriving at the provision required to be made for doubtful assets, realisable value of the securities should first be deducted from the outstanding balance in respect of the amount guaranteed by the Corporation and then provision made as illustrated hereunder: Example Outstanding Balance

Rs. 4 lakhs

ECGC Cover

50 percent

Period for which the advance has More than 2 years remained remained doubtful (say as on March 31, 2012) Value of security held

Rs. 1.50 lakhs

Answer: ……………………… …………………………………………………. MCQ Question Bank: The following multiple choice questions are for practice purpose.

doubtful

1. Which method of depreciation is approved as per the income tax rules? a) Sinking fund method b) Written Down Value Method c) Annuity Method above 2. Capital A/c is a _______ A/c. a) Personal b) Real c) Nominal 3. Cash A/c is a ________ A/c. a) Personal b) Real c) Nominal

d) None of the

d) None d) None

4. Which is not only a subsidiary book, but also a principal book? a) Cash book b) Sales book c) Purchase book d) Bills receivable book 5. The principle “Debit the receiver and credit the giver” is related to_____ a) Personal a/c b) Real a/c c) Nominal a/c d) None …………….. 10. Interest on drawings is a ___ to the business a) Expenditure b) Gain c) Liability d) Loss 11. If a contingent liability becomes probable, it has to be: a) Shown in notes on accounts b) Provided in the books of accounts c) Ignored and no entry will be passed d) Shown in director’s report 12. Capital work in progress is shown in the balance sheet under _____ a) Share capital b) Current Assets c) Fixed Assets d) Current Liabilities 13. Which of the following statements is correct? a) Goodwill is a fictitious asset b) Patents are intangible asset c) Debtors are current liability d) None of the above ….Around 250 such multiple objective questions including case studies with answers………. THANK YOU & WISH YOU ALL THE BEST