Unit 10 Solutions: Bookkeeping and Accounting

Answers to the Unit 10 exercises. Each answer is as long as its marks call for: a sentence or two for 1 mark, four explained points for 4 marks, and an introduction, explained points and a conclusion for 8 marks.

A. Very Short Answer Questions (1 Mark Each)

1. Define bookkeeping in one sentence.

Bookkeeping is the systematic, day-to-day art and science of recording financial transactions in the books of original entry and posting them into ledger accounts.

2. Who is regarded as the Father of Modern Bookkeeping, and in which year was his book published?

Fra Luca Pacioli, an Italian Franciscan friar and mathematician, is regarded as the Father of Modern Bookkeeping. His book Summa de Arithmetica, Geometria, Proportioni et Proportionalita, which first set out the Double Entry System, was published in Venice in 1494 A.D.

3. Define accounting according to the AICPA.

According to the American Institute of Certified Public Accountants (AICPA), “Accounting is the art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the results thereof.”

4. Name the four major branches of accounting.

Financial Accounting, Cost Accounting, Management Accounting and Government Accounting.

5. List the sequential steps of the Accounting Cycle.

Identification of transactions from source documents → Recording in the Journal and Subsidiary Books → Classifying (posting to and balancing the Ledger) → Summarizing in the Trial Balance → Preparing the Final Accounts → Analysis, interpretation and communication of the results.

B. Short Answer Questions (4 Marks Each)

1. Explain any four objectives and four limitations of accounting.

Objectives of accounting:

1. Maintaining complete and systematic records: Human memory is limited, so accounting records every monetary transaction in date order. No cash receipt, credit sale or expense is forgotten, and the record can be checked later.
2. Ascertaining profit or loss: At the end of the fiscal year, the Income Statement (Trading and Profit & Loss Account) is prepared to find out whether the business earned a net profit or suffered a net loss.
3. Showing the true financial position: The Balance Sheet, prepared on the closing date of the fiscal year, shows the exact balances of the assets, liabilities and capital of the business.
4. Communicating financial information to users: Accounting supplies reliable reports to internal users (owners, directors, managers and employees) and external users (banks, investors, creditors, the Inland Revenue Department and researchers).

Two more objectives given in the unit are assessing liquidity and solvency, and preventing and detecting errors and frauds.

Limitations of accounting:

1. Records only monetary transactions: Qualities such as employee honesty, managerial skill, customer loyalty or good industrial relations are not recorded, because they cannot be measured in money, even though they affect the success of the business.
2. Based on historical cost: Fixed assets are shown at their original purchase price, not at their current market or replacement value, so the effect of rising prices is ignored.
3. Influenced by personal judgment: Figures such as the useful life of an asset (for depreciation) or the provision for doubtful debts are estimates, so two accountants may show different results for the same business.
4. Possibility of window dressing: Dishonest management may manipulate the figures for a time to make the Balance Sheet look stronger than it really is.

2. Differentiate between Bookkeeping and Accounting on any five bases.

3. Briefly explain Financial Accounting, Cost Accounting, and Management Accounting.

1. Financial Accounting: Financial accounting records the past transactions of a business in the Journal and Ledger and uses them to prepare the Trial Balance, the Income Statement (Trading and Profit & Loss Account) and the Balance Sheet. It shows the profit or loss for the year and the financial position on the closing date, and its reports are used by both internal users (owners and managers) and external users (banks, investors, creditors and tax authorities).
2. Cost Accounting: Cost accounting identifies, classifies, allocates and controls the total cost and the per-unit cost of making a product or providing a service. The cost is broken into material cost, labour cost and overhead expenses. This helps management fix selling prices, compare costs from period to period and reduce waste. For example, a biscuit factory uses cost accounting to find the cost of making one packet of biscuits.
3. Management Accounting: Management accounting uses financial and cost data together with tools such as ratio analysis, budgeting, break-even (CVP) analysis and cash flow statements. Its purpose is to help internal management plan for the future, frame policies and make decisions. Financial accounting mainly records the past, while management accounting looks ahead.

The fourth branch, Government Accounting, keeps the records of public revenue, budget appropriations and public expenditure of government offices on a cash and budgetary basis.

C. Long Analytical Questions (8 Marks Each)

1. “Accounting begins where bookkeeping ends.” Justify this statement by explaining the scope, functions, and complete Accounting Process (Cycle) of a business organization.

Bookkeeping and accounting are two stages of the same financial information system. Bookkeeping records transactions in the Journal and Subsidiary Books and classifies them in the Ledger. Accounting takes over the balanced ledger accounts that bookkeeping produces and summarizes, analyzes, interprets and communicates them. Bookkeeping lays the foundation (Journal and Ledger), and accounting builds the superstructure (Trial Balance, Final Accounts and financial analysis) on top of it. The statement can be justified by looking at the scope, functions and process of accounting.

Scope:

• Scope of bookkeeping: Bookkeeping covers identifying transactions from source documents, recording them in the books of original entry, and classifying them by posting them to the Ledger and balancing each account. It is routine, clerical work done by a junior clerk or bookkeeper.
• Scope of accounting: Accounting includes all of bookkeeping and goes further: it summarizes the ledger balances in the Trial Balance and Final Accounts, analyzes and interprets them, and communicates the results to users. It is done by a senior accountant, and it has four branches: financial, cost, management and government accounting.

Functions of accounting:

1. Keeping complete records: All monetary transactions are recorded systematically. This function is carried out through bookkeeping.
2. Ascertaining profit or loss: The Trading and Profit & Loss Account shows the gross and net profit or loss of the year.
3. Showing the financial position: The Balance Sheet shows the assets, liabilities and capital on the last day of the fiscal year.
4. Assessing liquidity and solvency: Accounting tracks cash, debtors and creditors so that the firm can pay its short-term and long-term debts on time.
5. Communicating information: Reports go to internal users (owners, directors, managers, employees) and external users (banks, investors, creditors, the Inland Revenue Department).
6. Preventing and detecting errors and frauds: The Trial Balance and voucher checking support internal check and statutory audit.

Only the first function is bookkeeping; the other five can begin only after the books have been written up.

The Accounting Process (Cycle):

1. Identification and source documents: A transaction is recorded only when an invoice, cash memo, receipt, pay-in-slip or debit/credit note proves that it has taken place.
2. Recording (journalizing): Both the debit and credit aspects of each transaction are recorded in date order in the Journal and the Subsidiary Books (Purchase Book, Sales Book, Return Books and Cash Book).
3. Classifying (posting and balancing): Entries are posted to individual Ledger accounts, and each account is balanced (Balance c/d and Balance b/d). Bookkeeping ends here.
4. Summarizing (Trial Balance): All debit and credit ledger balances are listed on a given date to check the arithmetical accuracy of the books. Accounting’s own work begins here.
5. Preparing Final Accounts: The Trading Account, Profit & Loss Account and Balance Sheet are prepared to find the gross profit or loss, the net profit or loss and the financial position at year-end.
6. Analysis, interpretation and communication: Financial ratios, audit reports and AGM presentations explain the results to management and outside stakeholders so that they can make decisions.

This cycle is repeated every fiscal year (Shrawan 1 to the end of Ashadh in Nepal).

Conclusion: Accounting includes bookkeeping, but its distinctive work of summarizing, analyzing and interpreting can start only when bookkeeping has finished recording and classifying the transactions. Without balanced ledger accounts there can be no Trial Balance, no Final Accounts and no analysis. Steps 1 to 3 of the cycle belong to bookkeeping and Steps 4 to 6 to accounting, so it is rightly said that accounting begins where bookkeeping ends.