The document discusses the key differences between cash basis and accrual basis accounting systems. Under the cash system, expenses are recorded when paid and income when received. The accrual system records income when earned and expenses when incurred, regardless of actual cash flow. The document also notes that small businesses primarily selling services often use the cash system as it is easier to track.

2. Cash Vs Accrual system of accounting
Cash system of accounting:
 Most small businesses use the cash basis method of
accounting, which is based on real-time cash flow.
 In cash method, you report an expense when it is paid
and record income when it is received.
 In most cases, small businesses that primarily sell
services will choose the cash basis method of
accounting because it is easier to track and account for.
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3. Accrual system of accounting:
 With accrual accounting, you record income when it
is earned, not when it is paid.
 Similarly, you record your expenses when the
obligation arises, not when you pay it.
 It is not necessary for cash to change hands.
 India follows HYBRID accounting
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4.  When is delivery complete?
 When does the title to goods and the risk of
loss transfer from the seller to the buyer?
 Does the buyer have the right to return the
product?
 Has payment been received for a service to
be provided in the future?
 Is any or all of a sales agreement contingent
on a future event?
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5. Why to control inventory?
 Starting point of production.
 Need based purchase is possible.
 More flexible.
 Controllable input.
 Indian Materials Management Association says that in
every one rupee spent:
 64 paise – Material cost
 16 paise – Labour cost
 20 paise – Overheads.
 Improves profitability – A study says that “5% saving in
the material cost, would be as good as increasing
production or sales by 36%”
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6.  Managing materials and inventories is important
because, on average, the cost of materials account
for more than 50% of total cost in manufacturing
companies and over 70% of total costs in trading
companies.
 In the normal course of business, managers respond
to the high cost of materials and inventory in several
ways.
 The top management always focuses on reducing
the purchasing cost of materials without dilution of
quality.
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7.  In India valuation of inventories has been dealt with Indian
Accounting Standards (AS 2) given by ICAI.
 As per AS 2 inventories are assets
▪ held for sale in the ordinary course of business;
▪ in the process of production for such sale; or
▪ in the form of materials or supplies to be consumed in
the production process or in the rendering of services.
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8.  The financial statements should disclose:
▪ the accounting policies adopted in measuring
inventories, including the cost formula used; and
▪ the total carrying amount of inventories and its
classification appropriate to the enterprise.
▪ All time inventories should valued at the lower of the
cost and net realisable value.
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9.  The cost of inventories should comprise all
 costs of purchase,
▪ (Basic purchase price + Duties)
 costs of conversion
▪ (Labour, Fixed and Variable cost in Prod.)
 other costs incurred in bringing the inventories to their
present location and condition.
▪ (e.g. cost involved in designing the customer’s requirement)
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10.  Exclusions from the cost of inventory:
▪ abnormal amounts of wasted materials, labour, or
other production costs;
▪ storage costs, unless those costs are necessary in the
production process prior to a further production stage;
▪ administrative overheads that do not contribute to
bringing the inventories to their present location and
condition; and
▪ selling and distribution costs.
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11.  In general, the term “Depreciation” means decline in
the value of a fixed assets due to use, passage of time
or obsolescence.
 In other words, if a business enterprise procures a
machine and uses it in production process then the
value of machine declines with its usage.
 Even if the machine is not used in production process,
we can not expect it to realise the same sales price
due to the passage of time or arrival of a new model
(obsolescence).
 It implies that fixed assets are subject to decline in
value and this decline is technically referred to as
depreciation.
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12.  There are some terms — like depletion and amortization,
which are also used in connection with depreciation.
 The term depletion is used in the context of extraction of
natural resources like mines, quarries, etc. that reduces
the availability of the quantity of the material or asset.
 Amortization refers to writing-off the cost of intangible
assets like patents, copyright, trade marks, franchises,
leasehold mines which have entitlements to use for a
specified period of time. The procedure for amortization
or periodic write-off of a portion of the cost of intangible
assets is the same as that for the depreciation of fixed
assets.
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13. Causes
 Wear and Tear due to usage and passage of time.
 Expiration of legal rights.
 Obsolescence.
 Abnormal factors like natural calamities.
Need
 Matching of cost and revenue
 Consideration of tax
 True and fair financial position
 Compliance with law
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14.  Basic cost of the asset
 Estimated residual value of the asset
 Estimated life of the asset
 Depreciable cost
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15. Straight Line Method
 It is also called fixed installment method because the amount of
depreciation remains constant from year to year over the useful life of
the asset.
 According to this method, a fixed and an equal amount is charged as
depreciation in every accounting period during the lifetime of an asset.
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18. 1. A company purchased Furniture for Rs.28,000. Depreciation is to be
provided annually according to the Straight Line Method. The useful life
of the furniture is 5 years and the residual value is Rs.2,000. You are
required to find out the amount of depreciation. (Ans: 5200)
2. From the following particulars, find out the rate of depreciation, under
Straight Line Method.
• Cost of Fixed Asset Rs. 50,000
• Residual Value Rs. 5,000
• Estimated Life 10 years (Ans: Rate of Dep. 9%)
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24.  M/s. Shankar & Co. purchased a Machinery on 1.1.2002 for
Rs.10,00,000. The firm writes off depreciation at 10% on the
original cost every year. The books are closed on 31st March every
year. Pass the necessary journal entries, prepare Machinery
account and Depreciation account for the first three years.
 (Answer: Balance at the end of the third year : Rs. 7,75,000)
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25. Written Down Value Method
 Under this method, depreciation is charged on the book value of the
asset.
 Since book value keeps on reducing by the annual charge of
depreciation, it is also known as reducing balance method.
 This method involves the application of a pre-determined proportion /
percentage of the book value of the asset at the beginning of every
accounting period, so as to calculate the amount of depreciation. The
amount of depreciation reduces year after year.
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26. Written Down Value Method – Calculation
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30.  A firm bought a machinery on 1.1.2002 for Rs.5,00,000. On
31.12.2003 the machinery was sold for Rs.3,90,000. The firm
charges depreciation at the rate of 10% per annum on Diminishing
Balance Method. The books are closed on 31st March every year.
Prepare Machinery account and Depreciation account.
 (Answer: Loss on sale of machinery Rs.15,844)
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33.  Depreciation – is a non-cash expense.
 Depreciation – is tax deductible expense.
 Depreciation – is subject to window dressing.
 Can we use depreciation as internal source of finance?
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34.  Sometimes depreciation is also loosely spoken of as a 'source of internal funds'.
You now know that depreciation expense is a 'book entry' that reduces the
amount of non-current assets (in the position statement) and reduces profit (in
the performance statement). There is no cash transaction or any other external
transaction so depreciation is not a form or source of finance.
 However, recording depreciation expense does have two important financial
effects:
 It reduces the profit available for dividends and may reduce the cash outflow
for dividend payments
 It reduces taxable income and the amount payable for income tax, which may
also reduce cash outflows.
 In this sense it is possible to argue that recording depreciation has a savings effect
by reducing possible cash outflows, and that managers can use the cash 'saved'
for other purposes.
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35.  Buildings
i. Buildings which are used mainly for residential purposes 5%
ii. Buildings which are not used mainly for residential purposes - 10%
 Furniture & Fittings 10%
 Computers 60%
 Machinery & Plant 15%
 Motor Car 15%
 Plant & Machinery 15%
 A.C, Electrical office equipment, fax machine & water cooler at 10% because all
are electrical fittings
 If the value of asset is less than Rs.5000 we can claim 100% depreciation as per
sec.32 of income tax act,1961
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