A Comprehensive Guide to Financial Accounting: From Bank Reconciliation to Partnership Dissolution

Posted on Jun 4, 2024 in Economy

Need and Importance of Preparing a Bank Reconciliation Statement

It is necessary for a businessman to reconcile both cash book balances and bank passbook balances; otherwise, it might result in a serious lapse on either part. To locate the difference in the bank passbook and cash book balance, a reconciliation statement is prepared. A Bank Reconciliation Statement gives assurance that the balance as per the bank cash book and bank passbook is tallying or the same and that there is no difference as they are reconciled. In the absence of a bank reconciliation statement, no one can guarantee that the bank cash book balance matches the bank passbook balance. Therefore, it is prepared after a specific period, maybe monthly, quarterly, and so on.

Nowadays, every field has been computerized, and banks are no exception. If the information provided to the computer is wrong, it will create many problems and may show an inaccurate balance. For having control over all these things, a bank reconciliation statement becomes necessary, and it is also useful for the bank and the businessman.

State the Difference Between a Trade Bill and an Accommodation Bill

Trade Bill: Bill of Exchange

A bill of exchange is an unconditional order in writing addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at a fixed future time a sum certain in money to order or to bearer.
A bill of exchange is legally defined as,
“an instrument in writing containing an unconditional order signed by the maker directing a certain person to pay on demand or at a future date a certain sum of money only to the order of a certain person or to the bearer of the instrument.”
In short, a bill of exchange is a written instrument given by one person to another stating to pay the amount mentioned therein. A person who draws the bill is called a ‘Drawer,’ and he has to receive the money from another person. A ‘Drawee’ is a person on whom the bill is made payable.

Renewal of a Bill

Sometimes, the drawee requests the drawer to grant him an extension of the period for payment if he cannot pay on the due date. If the drawer agrees to this, the old bill is canceled, and the new bill is drawn and accepted by the drawee. This is called ‘Renewal of a Bill.’ Generally, on the renewal of the bill, the drawer charges interest for the extended period of the bill.

Steps Taken on Renewal of a Bill:

1. Cancellation of the old bill.
2. Recording of interest due from the drawee.
3. Recording the receipt of cash from the drawee in part payment.
4. Drawing a new bill on the drawee and its acceptance by him.

What are the Objects for Providing Depreciation?

Depreciation is a loss to the business. It is necessary to anticipate such loss by charging depreciation. The following are the objects of providing for depreciation.

1. To find out the true profit or loss: Ascertainment of true profit or loss is not possible without providing depreciation. A loss in the value of assets contributes to the earning of profits. Therefore, depreciation should be considered an expense and charged to the profit and loss account. Then only the true profit or loss can be found out.
2. To present a true value of the asset: Due to the wear and tear of assets, the value of such assets declines. Hence it is essential to show the true value of the asset. The fixed assets should be shown at their proper values in the balance sheet. Depreciation enables the presentation of the fixed assets at their realistic values.
3. Spreading over the loss due to depreciation: The entire expenditure for a fixed asset is incurred at one time, and the proportionate amount of this total expenditure is spread over the useful economic life of the asset. This proportionate amount is depreciation.
4. Replacement of an asset: After the expiry of the economic life of an asset, it is necessary to buy a new asset.

Reducing Balance Method

Under this method, the amount of depreciation does not remain fixed, but the percentage of depreciation remains fixed. The depreciation is charged at a fixed percentage on the opening balance of each year and not on the original cost of the asset. This method is useful for providing depreciation on assets having a long life and involves huge capital.
The difference between the fixed installment method and the reducing balance method:

1. In the fixed installment method, depreciation is charged on the original cost of the asset, while in the reducing balance method, depreciation is charged at a fixed rate on the reduced balance of the asset.
2. In the fixed installment method, the amount of depreciation remains the same/constant while in the reducing balance method the amount of depreciation changes every year.

Types of Dissolution

There are two types of dissolution: (A) Voluntary Dissolution (B) Compulsory Dissolution

(A) Voluntary Dissolution – Causes

1. When all partners agree to dissolve the firm.
2. When a firm is formed for a specific period, and that period of the firm expires.
3. When a firm is formed for a particular venture, and that period of the firm expires.
4. With the suggestion of other partners.
5. When one or more partners retire from business Or When one or more partners expire.
6. When one partner becomes insolvent.

(B) Compulsory Dissolution – Causes

1. With the consent of all partners.
2. When all partners or all except one become insolvent.
3. If the business of the partnership firm becomes illegal.
4. By the court order –
   
   1. If a partner becomes of unsound mind.
   2. If a partner becomes permanently incapable of managing the partnership business.
   3. Misconduct of partners

Classification (Type) of Bills of Exchange

Bills of Exchange can be classified based on time, place, and transactions.

(a) On the Basis of Time

These are further classified as follows:

1. Demand Bills: When payment of a Bill of Exchange is to be made on demand, the bill is known as “Demand bills.”
2. Time Bills: When payment of a Bill of Exchange is to be made after a particular period, the bill is termed a ‘Time Bill.’

(b) On the Basis of Place

On the basis of the place of payment, bills of exchange can be classified as:

1. Inland Bills: If the bills are drawn and made payable in the same country, the bills are called Inland Bills.
2. Foreign Bills: If the bills are drawn in one country and made payable in another country, they are called Foreign Bills.

(c) On the Basis of Transactions

On the basis of the transaction, bills of exchange can be classified as:

1. Trade Bills: Where a bill of exchange has been drawn and accepted for a genuine business transaction, it is termed as ‘Trade Bills.’
2. Accommodation Bills: Where a bill of exchange is drawn and accepted for providing funds, it is termed an Accommodation Bill.

5.2.3 Specimen Profit & Loss Account

All expenses and losses other than transferred to manufacturing and trading accounts are debited to this account along with the gross loss as per the trading account. All incomes along with gross profit are credited to this account. Similarly, profit on the sale of assets and any gain is credited to this account, and loss on the sale of assets is debited to this account. It is a nominal account. The specimen profit and loss account is as follows:

5.2.4 Specimen Profit and Loss Appropriation Account

For future expansion and progress, it is convenient to keep part of the business in reserves. Similarly, at the end of each financial year, the amount payable to partners like sales, commission, and receivables from them, like interest on partners’ drawings, are to be shown separately. Hence, a profit and loss appropriation account is to be opened. The purpose of opening this account is to show appropriations of the profits of the business.
Hence, net profit or net loss of the profit and loss account is to be transferred to the profit and loss appropriation account.
The Profit and Loss Appropriation Account is a part of the profit and loss account. Profit or loss as per the profit and loss appropriation account is to be transferred to the partners’ capital account or partners’ current account. Such profit or loss share of the partner may be added to or deducted from the partner’s capital/current account. The specimen of this account is as follows.

Adjustments of Capital Expenditure, Revenue Expenditure, and Deferred Revenue Expenditure

Expenses of trade or business are divided into two classes, i.e., Capital expenditure and Revenue expenditure. In the long-term existence of a business, expenses of the business are divided into expenses giving long-term benefits and expenses giving short-term benefits, and then these are recorded. In general, expenses giving long-term benefits are called capital expenditure, and expenses giving short-term benefits are called revenue expenditure. Hence, expenditure on the purchase of assets is capital expenditure. But expenses like made expenses, sales expenses, finance expenses, and management expenses are recurring expenses. Hence these are revenue expenses.
But some special expenditures are treated as capital expenditure instead of revenue expenditure. For example, preliminary expenses for the commencement of business, like legal expenses, import-export licenses expenses, etc., are expenses for long-term benefits. It is capital expenditure. Such preliminary expenses are not debited in the year in which they are incurred but are charged over four to five years. Hence it does not affect the profit of the first year. Such preliminary expenses are to be shown on the asset side of the balance sheet, and at the end of each financial year, a certain amount is written to the profit and loss account.

Repayment to Retiring Partner

The total amount due to the retiring partner can be paid off in a lump sum. In such a case, the entry will be:

Retiring Partner’s Capital A/c Dr.
To Cash A/c or Bank A/c
(Being the amount paid to the retiring partner)

Many times, the total amount due to the retiring partner is not paid in a lump sum. It affects the cash, liability balance, and working capital of a firm. In such a case, the amount due is credited to the retiring partner’s loan account. For the transfer of the amount to the Loan A/c:

Retiring Partner’s Capital A/c Dr.
To Retiring Partner’s Loan A/c
(Being the transfer of the amount due to the retiring partner’s loan A/c)

For payment of cash:

Retiring Partner’s Loan A/c Dr.
To Cash A/c or Bank A/c
(Being the amount paid)