Chapter 5 Solutions: Business Accounting

Answers to the Chapter 5 exercises. Each answer is as long as its marks call for: a sentence or two for 1 mark, and five marks’ worth of explained points, tables or working for 5 marks.

Group A: Very Short Answer Questions (1 Mark Each)

1. What is Business Accounting?

Business Accounting is the systematic process of recording, classifying and summarizing the monetary transactions of a business in order to find its profit or loss for an accounting period and show its financial position (assets, liabilities and equity) on a given date.

2. Write the full forms of NAS, NFRS, GAAP, and ICAN.

NAS: Nepal Accounting Standards. NFRS: Nepal Financial Reporting Standards. GAAP: Generally Accepted Accounting Principles. ICAN: Institute of Chartered Accountants of Nepal.

3. Why is Cost Accounting used in a manufacturing business?

A manufacturing business uses Cost Accounting to find the exact total cost and per-unit cost of the goods it produces, to control wastage and unnecessary costs, and to fix a competitive selling price.

4. What is a Chart of Accounts?

A Chart of Accounts is a systematic, coded list of all the ledger accounts kept by a business, classified under five main groups: Assets, Liabilities, Equity (Capital), Revenue and Expenses.

5. For which organizations has NFRS been made mandatory in Nepal?

NFRS is mandatory for multinational companies, commercial banks and financial institutions (BFIs), insurance companies, state-owned enterprises, and public listed companies that issue shares to the public.

Group B: Short Answer Questions (5 Marks Each)

1. Define Business Accounting and explain any four objectives of maintaining business accounts.

Business Accounting is the systematic process of identifying, measuring, recording, classifying, summarizing and interpreting the financial transactions of a business enterprise that can be expressed in money. Its purpose is to find the operating result (Profit or Loss) for an accounting period and to present the true financial position (Assets, Liabilities and Equity) of the business on a specific date.

Four objectives of maintaining business accounts are:

1. Systematic and permanent record: Human memory is limited, and a business makes too many transactions for anyone to remember. Accounting records every transaction in date order in the Journal and classifies it in the Ledger, so the record can be checked at any time and used as evidence.
2. Ascertainment of profit or loss: At the end of the fiscal year, the Trading and Profit & Loss Account (Income Statement) is prepared from the accounts. It shows the net profit or loss of the year, so the owner knows whether the business is doing well and what needs to change.
3. Depiction of true financial position: The Balance Sheet prepared from the accounts shows the total assets, liabilities and owner’s capital on a specific date. It tells the owner and outsiders what the business owns and what it owes.
4. Information to internal and external stakeholders: Owners, management, banks, investors, creditors, employees and tax authorities all need reliable financial information. Accounting provides it in the form of financial reports, on which these users base their decisions about the business.

The other objectives are the assessment of tax liability, since audited accounts are the evidence on which Income Tax and VAT are assessed, and the prevention and detection of errors and fraud through double-entry bookkeeping and the Trial Balance.

2. Differentiate between Financial Accounting and Cost Accounting in five points.

Financial Accounting records the monetary transactions of the business as a whole, while Cost Accounting works out what each product or service costs. They differ as follows:

3. What are Accounting Standards? Describe Nepal Accounting Standards (NAS) and Nepal Financial Reporting Standards (NFRS).

Accounting Standards are authoritative written policies, rules and principles issued by a national or international accounting body. They govern how accounting transactions are recognized, measured, treated, presented and disclosed in financial statements. They are needed to bring uniformity and consistency to the financial statements of different organizations, to make comparison between firms and between years possible, to prevent manipulation and window-dressing, and to increase transparency and credibility for domestic and foreign investors.

In Nepal, accounting standards are formulated by the Accounting Standards Board (ASB), Nepal, established by the Government of Nepal in 2002 A.D. (2059 B.S.) through an amendment to the Nepal Chartered Accountants Act, 1997 (2053 B.S.). The Institute of Chartered Accountants of Nepal (ICAN) pronounces the standards and enforces compliance with them.

1. Nepal Accounting Standards (NAS): NAS are the national benchmarks and rules formulated by ASB Nepal. Business and public entities in Nepal must follow them when preparing their financial statements, so that statements prepared by different entities follow the same rules and can be compared. For the smallest entities, NAS for Micro Entities applies.
2. Nepal Financial Reporting Standards (NFRS): NFRS have been implemented since 2013 A.D. (2070 B.S.) in full convergence with the International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB). They are mandatory for multinational companies, commercial banks and financial institutions (BFIs), insurance companies, state-owned enterprises, and public listed companies that issue shares to the public. Smaller entities follow NFRS for SMEs.

Because NFRS follows IFRS, the financial statements of Nepal’s large and listed entities can be understood and compared by investors anywhere in the world.

4. Explain the five main categories of accounts under a Chart of Accounts with examples of each.

A Chart of Accounts is a systematic, coded list of all the accounts kept in an organization’s general ledger, classified by their financial nature so that transactions can be recorded accurately and computerized easily. Its five main categories are:

1. Assets Account, 1000 series: Assets are the economic resources owned by the business that will give it future economic benefit. They include non-current or fixed assets such as Land & Building, Plant & Machinery, Furniture, Goodwill and Patents, and current assets such as Cash in hand, Cash at bank, Inventory (Stock), Sundry Debtors, Bills Receivable and Prepaid Expenses. Asset accounts normally have a debit balance.
2. Liabilities Account, 2000 series: Liabilities are the debts and obligations the business owes to outside parties. They include long-term liabilities such as Bank Loans, Debentures and Bonds, and current liabilities such as Sundry Creditors, Bills Payable, Bank Overdraft, Outstanding Expenses and Advance Income. Liability accounts normally have a credit balance.
3. Shareholders’ Equity / Capital Account, 3000 series: Equity is the owner’s residual claim on the assets of the business, worked out as Equity = Assets - Liabilities. It includes Owner’s Capital, Ordinary and Preference Share Capital, Reserves and Retained Earnings. Equity accounts normally have a credit balance.
4. Revenue / Income Account, 4000 series: Revenue is the inflow the business earns from its main operations and from other sources. Examples are Sales Revenue, Service Fee Revenue, Commission Received, Interest Received, Rent Received and Discount Received. Revenue accounts normally have a credit balance.
5. Expenses Account, 5000 series: Expenses are the costs incurred to earn revenue and run the business. Examples are Purchases, Wages, Salaries, Office Rent, Depreciation, Insurance, Electricity and Water, Advertisement, Bad Debts and Interest Paid. Expense accounts normally have a debit balance.

In short, Assets and Expenses normally carry debit balances, while Liabilities, Equity and Revenue normally carry credit balances.