Account 6 Marks Question

The Profit and Loss Account and the Balance Sheet can be prepared from the incomplete book of accounts through Conversion Method. According to this method, incomplete records are converted into double entry records. In case of incomplete records, details of some transactions are easily available like cash sales, cash purchases, creditors, debtors; however, there are number of transactions, the details of which may not be available directly. Yet, these details can be found out indirectly or logically. Some of the important items that are vital for preparing Balance Sheet are given below.

1. Opening Capital.
2. Closing Capital.
3. Credit Purchases.
4. Cash Purchases.
5. Credit Sales.
6. Cash Sales.
7. Payment from Debtors.
8. Payment to Creditors.
9. Opening Stock.
10. Closing Stock.

Below given are the steps included in the conversion method in a chronological order:

1. If opening capital is not given, then the first step is to prepare opening Statement of Affairs that gives the Opening Capital.
2. The second step is to prepare Cash Book that gives the opening or the closing cash and bank balance.
3. The next step is to prepare Total Debtors Account. It is prepared in order to find out one of the missing figures, such ascredit sales, opening debtors, closing debtors and cash received from debtors.
4. The subsequent step is to prepare Total Creditors Account to ascertain one of the missing figures, such as credit sales, opening creditors, closing creditors and cash paid to the creditors.
5. The last step is to prepare final accounts. On the basis of the missing figures ascertained in each of the above steps, along with other mentioned information, Trading and Profit and Loss Account and Balance Sheet can be prepared.

Working Notes:

Difference between Double Entry System and Single Entry System:

S.No.	Basis	Double Entry System	Single Entry System
1.	Aspect of a Transaction	Under this system, both aspect of a transaction are recorded.	Under this system, both aspect of transaction may not be recorded. In fact, for some transaction both the aspect, for some others one aspect and yet for others no aspect at all are recorded.
2.	Accounts Maintained	Under this system, personal, real and nominal etc.., all the accounts are maintained. Thus, it is a complete and scientificsystem of accounting.	Under this system, only personal accounts and Cash Book and maintained. Hence, it reamin an incomplete record of accounts.
3.	Trial Balance	Under this system, Trial Balance is prepared and thus, the arithmetical accuracy of all books of account is verified.	Under this system, Trial Balance cannot be prepared due to incomplete system of accounting. Therefore, arithmetical accuracy of the accounting cannot be verified.
4.	Profit or Loss	Under this system, after a certain period, net profit or net loss can be ascertained by preparing the Profit and Loss Account.	Under this system, Profit and Loss Account is not prepared to ascertain the net profit or loss. Method for ascertaining the profit or loss is not adequate.

A Statement of Affairs is a statement of assets and liabilities. Difference between the amounts of the two sides is taken as capital.
Under the Single Entry System, it is necessary to prepare Statement of Affairs at the end of the year and also in the beginning of the year, if not already prepared to determine profit. Statement of Affairs like Balance Sheet, has two sides-right-hand side for Assets and left-hand side for Liabilities. The difference between the total of assets and liabilities is capital.
Capital = Total Assets - Liabilities
Difference between Balance Sheet and Statement of Affairs:

	Basis	Balance Sheet	Statement of Affairs
1	Objective	The main objective of preparing Balance Sheet is to know about the financial position of the business.	The main objective of preparing Statement of Affairs is to know about capital at a point of time.
2	Accounting System	Balance Sheet is prepared when accounts are maintained under Double Entry System.	Statement of Affairs is prepared when accounts are maintained under Single Entry System.
3	Accounts and Information	This is prepared exclusively on the basis of ledger accounts.	In view of incomplete accounts, its preparation is based on limited accounts, calculations, estimates and other information.

Accounting records not strictly based on principles of double entry system but based on incomplete records and mere memory is known as accounting from incomplete records. Single entry is a misnomer, as no such system exists for recording transaction in accounting. Actually, accounting from incomplete records is a mixed system of recording business transactions in which some transactions are recorded as per double entry system and for certain transactions only a single entry is made in the books of accounts.
It is worth mentioning that for certain transactions no recording is made in the books of accounts. Under this system, records related to cash account and personal accounts of debtors and creditors are maintained as per double entry system. Information relating to cash sales, cash purchases are recorded partially and information related to depreciation etc. are not recorded at all. In other words, we can say that accounting from incomplete records is just an attempt to record business transactions on the lines of double entry system.

A Statement of Affairs resembles Balance Sheet; however, it is not called a Balance Sheet. The statement of affairs is a Statement of Assets and Liabilities. The main difference between a Statement of Affairs and a Balance Sheet is that while the former is prepared on the basis of physical counts and improper source documents, the latter is prepared purely on the basis of ledger accounts. Thus, the authentication and relevance of the latter is guaranteed. The excess of assets over liabilities (i.e., balancing figure) is denoted as the capital of the firm. The performa of the statement of affairs is presented below.

When liabilities are more than assets, then the balancing figure is denoted by Capital-Deficiency in the assets side of the statement of affairs.
When the assets’ balance exceeds liabilities’ balance, the balancing figure is denoted by Capital in the liabilities side of the statement of affairs.
For ascertaining profit or loss, if capital in the beginning is not given, then opening statement of affairs is prepared in order to calculate the capital in the beginning. Once the opening capital and closing capital is calculated, a Statement of Profit or Loss is prepared to determine the amount of profit earned or loss incurred during the accounting period.

Difference between Balance Sheet and Statement of Affairs Basis Balance Sheet:

S.No.	Basic	Balance Sheet	Statement of Affairs
1.	Objective	The main objective of preparing Balance Sheet is to know about the financial poistion of the business.	The main objective of preparing Statement of Affairs is to know about capital at a point of time.
2.	Accounting System	Balance sheet is prepared when accounts are maintained under Double Entry System.	Statement of Affairs is prepared when account are maintained under Single Entry System.
3.	Accounts and Information	This is prepared exclusively on the basis of ledger accounts.	In view of income accounts, its preparation is based on limited accounts, calculation, estimates and other information.
4.	Reliability	Being based on actual figures, Balance Sheet is regarded as a reliable statement.	Since it is based on the accounts and partly on other information and one's memory, hence, it is not regarded as areliable statement.
5.	Trial Balance	Trial Balance is prepared before Balance Sheet is prepared.	In the case of statement of Affairs, Trial Balance is not prepared.

Working Note:
Calculation of additional capital introduced during the year.
Value of Investments = 10,000
Premium = 500 (10,000 × 5%)
Sale Value of Investments = ₹ 10,500(Aditional Capital)

The assets and liabilities are recorded in a statement of affairs just like a Balance Sheet, it should not be described as a Balance Sheet because of the following differences:

S.No.	Basis of Difference	Balance Sheet	Statement of Affairs
1.	Double Entry	It is prepared with the list of ledger balances drawn from the books of accounts kept on the basis of double entry.	It is not prepared with the list of ledger balances but with such information as is available from the accounting records kept on the basis of single entry.
2.	Arithmetical Accuracy	The tallying of balance sheet proves arithmetical accuracy of accounting books because it is prepared on the basis of a trial balance.	A statement of affairs does not prove the arithmetical accuracy of accounting books because it is not prepared on the basis of a trial balance.
3.	Value of Assets and Liabilities	The values of assets and liabilities shown in a Balance Sheet are the actual value based on ledger accounts.	The values of assets and lliabilities shown in the statement of affairs are merely the estimates based on physical inspection.
4.	Object	It is prepared for ascertaining the financial position of a business.	It is prepared for ascertaining the capital of a business.
5.	Omission of an Assets or a Liability	If an asset or liability is omitted while preparing a Balance Sheet, it will be easily detected because the Balance Sheet will not tally.	If an asset or liability is omitted while preparing statement of affairs, it cannot be easily detected.
6.	Reliability	A Balance Sheet is treated as more reliable because it is based on double entry principles.	It is treated as less reliable because it is based on oncomplete records and estimates.

Working Notes:




Rate of Gross Profit (on cost) = 25%
Rate of Gross Profit (on sales) = 20%
Gross Profit = 20% of (30,000 + 1,04,000) = 26,800
Gross Profit = Net Sales - Cost of Goods Sold
26,800 = 1,34,000 - Cost of Goods Sold
Cost of Goods Sold = 1,34,000 - 26,800 = ₹ 1,07,200
Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses - Closing Stock
1,07,200 = Opening Stock + 66,000 + (15,000 + 200) - 20,000
Opening Stock = 1,07,200 - 66,000 - 15,200 + 20,000 = ₹ 46,000

Working Notes:


Rate of Gross Profit (on sales) = 20%
Gross Profit = 20% of 90,000 = 18,000
Gross Profit = Net Sales – Cost of Goods Sold
18,000 = 90,000 – Cost of Goods Sold
Cost of Goods Sold = 90,000 – 18,000 = ₹ 72,000
Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses - Closing Stock
72,000 = 20,000 + 69,500 + 2,000 - Closing Stock
Closing Stock = 20,000 + 69,500 + 2,000 - 72,000 = ₹ 19,500

.

Working Notes:



Rate of Gross Profit (on sales) = 25% Gross Profit = 25% of (1,000 + 9,000) = 2,500 Gross Profit = Net Sales - Cost of Goods Sold 2,500 = 10,000 - Cost of Goods Sold Cost of Goods Sold = 10,000 - 2,500 = ₹ 7,500 Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses – Closing Stock 7,500 = Opening Stock + (1,600 +6,400) + 0 - 1,700 Opening Stock = 7,500 - 8,000 + 1,700 = ₹ 1,200

The following are the difficulties that are encountered by a trader due to incompleteness of accounting records:

1. Accuracy of accounts: Arithmetical accuracy of accounts can not be ascertained, since proper records of accounts are not maintained. Consequently, Trial Balance cannot be prepared.
2. Encourages fraud: As the arithmetical accuracy cannot be determined; so, this encourages fraud and provides sufficient scope for bluffing and carelessness.
3. Difficult to ascertain correct profit or loss: Since all expenses and income are not recorded, true profit or loss cannot be correctly ascertained.
4. Difficult to analyse the true financial position: As profit or loss cannot be ascertained easily, so the Balance Sheet cannot be easily prepared. Hence, the absence of Balance Sheet will notreflect the true financial position of the business.
5. Difficulty in comparison: Due to the incomplete records and non-availability of previous years’ data, comparison is not possible. By the same token, comparisons with other firms are also not possible.
6. Unacceptable to tax authorities: It does not reflect the true and acceptable presentation of expenses and revenues. Hence, these are not acceptable by the tax authorities.
7. Raising funds: Since analysis of solvency, profitability and liquidity of business cannot be done, it is difficult to raise fund from outside.

Note: As per the solution, the loss incurred during the year 2011 is ₹ 60,900; while the answer given in the book shows ₹ 57,900.

Accounting records that are not maintained according to Double Entry System are known as Accounts from Incomplete Records or Single Entry System of Accounting.
Kohler defines Single Entry System as, “A system of book keeping in which as a rule only records of cash and of personal accounts are maintained, it is always incomplete double entry varying with the circumstances."
Single Entry System is an incomplete and insufficient system of information, hence it has the following disadvantages:

1. Arithmetical Accuracy cannot be Proved: Trial Balance cannot be prepared hence, arithmetical accuracy of books cannot be proved or tested. Chances of error, mischief or fraud remaining undetected are high.
2. No Control on Assets: Since assets accounts are not maintained, it is difficult to keep full control, in order to avoid misappropriations of assets.
3. Correct Profit or Loss cannot be Determined: Trading and Profit and Loss Account cannot be prepared hence, correct profit earned or loss incurred during the accounting period cannot be determined.
4. Financial Position of the Business cannot be Assessed: In the absence of assets accounts, it is difficult to determine correct financial position of the business on any particular day by preparing a Balance Sheet.
5. No Internal Check: Since internal check is not possible, the method leaves room for errors and frauds, besides their detection becomes difficult.
6. Difficult to Ascertain the Value of Business: The records being inadequate, it is difficult to value the business, especially goodwill.
7. Incomplete and Unscientific System: This system is incomplete and unscientific as both the aspects of a transaction are not recorded and no set rules are followed for recording them.
8. Comparative Study is Difficult: A major defect of this system is that the financial position of the current year cannot be compared with that of the previous year due to incomplete information of transactions of business.

Difference between Double Entry System and Single Entry System:

	Basis	Double Entry System	Single Entry System
1	Aspects of a Transaction	Under this system, both aspects of a transaction are recorded.	Under this system, both aspects of transaction may not be recorded. In fact, for some transactions both the aspects, for some others one aspect and yet for others no aspect at all are recorded.
2	Accounts Maintained	Under this system, personal, real and nominal, etc., all the accounts are maintained. Thus, it is a complete and scientific system of accounting.	Under this system, only personal accounts and Cash Book are maintained. Hence, it remains an incomplete record of accounts.
3	Trial Balance	Under this system, Trial Balance is prepared and thus, the arithmetical accuracy of the books of account is verified.	Under this system, Trial Balance cannot be prepared due to incomplete system of accounting. Therefore, arithmetical accuracy of the accounting cannot be verified.
4	Profit or Loss	Under this system, after a certain period, net profit or net loss can be ascertained by preparing the Profit and Loss Account.	Under this system, Profit and Loss Account is not prepared to ascertain the net profit or loss. Method for ascertaining the profit or loss is not adequate.
5	Financial Position	Under this system, correct financial position of the business can be ascertained by preparing the Balance Sheet.	Under this system, Balance Sheet is not prepared. Only Statement of Affairs is prepared. The reason is that the assets and liabilities do not stand at real amounts but at estimated amounts.
6	Adjustments	Under this system, adjustments are made at the time of preparing the Final Accounts.	There is no provision to make adjustments primarily because of incompleteness of accounts.
7	Use	This system is used by almost all the businesses.	This system is used by only tiny businesses and institutions.
8	Authenticity	This system is considered authentic by the Court.	The Court does not consider this system as authentic.

Working Notes:

Working Notes: