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JAIIB MADE SIMPLE

ACCOUNTING AND FINANCE FOR BANKERS( JAIIB PAPER -2)

Version 1.0

(A Very useful book for Day to Day Banking and allKnowledge Based Examinations)

COMPILED BY

Mr. SANJAY KUMAR TRIVEDY ( Sr. Manager & College-in-charge )

& Team RSTC, Mumbai

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[,- ,13 , , [, , -

REGIONAL STAFF TRAINING COLLEGE : MUMBAIMaker Tower E , 13th Floor , 85, G D Somani Marg, Cuffe Parade , Mumbai 400005

Phone :22184871 22185980 Fax: email: [email protected]

Compiled by Sanjay Kumar Trivedy & Team RSTC, Mumbai 1 | P a g e

PrefaceDear Friends,

Banking/Financial sector in our country is witnessing a sea change and bankers business has

become more complex & difficult in this driven era of knowledge & technology. There are

mass retirements happening due to super annuation & many new recruits are joining the Bank.

More than 40% staff strength is newly recruited in last three to four years. An official

working in the Banking sector has to keep pace with Updated knowledge, skills & attitude, as

the same is required everywhere. There is need to issue a comprehensive book covering all

the aspects so that new recruits get updated very fast without referring many voluminous

books.

This book titled JAIIB MADE SIMPLE has many unique features to its credit & consists

of all topics/syllabus required for JAIIB examination with clear concept & simple language

with latest changes during 2015-16 ( upto June/July 2015 as per IIBF/ JAIIB exams.

requirement ) also included. This Book is divided into four Modules namely A,B,C & D &

Practice Teat Papers / Teat Yourself based on latest IIBF syllabus for JAIIB examination.

The Book also covers the full syllabus (latest) of JAIIB examination and also recalled

questions (one line approach & MCQ (based on IIBF examination Pattern ) will be helpful to

all aspirants who are taking up JAIIB examination

During preparation of this book, I have received tremendous support from Team RSTC,

Mumbai, many friends & colleagues especially my wife Mrs Renu, who is also a banker, my

son Master Ritwiz Aryan & our clerk Mr Sanjeev V Karamchandani. Special thanks to Sri B P

Desai Sir (Our Ex. AGM & now Faculty on Contract at RSTC,Mumbai ) for vetting &

compilation of this book.

As any work will have scope for some improvement, I shall be grateful if any feedback is

provided for improvement in contents of the book.

I wish you all the best for the written test & hope the study material will help in achieving the

goal.

Place: Mumbai SANJAY KUMAR TRIVEDY

Date: 16.11.2015 Senior Manager & College-in-Charge

RSTC, MUMBAI


CONTENTS

TOPIC PAGE NO.

1. ABOUT JAIIB EXAMINATION .03-05

2. MODULE : A ( B. MATHEMATICS & FINANCE).06-23

3. MODULE : (BOOK KEEING & ACCOUNTANCY ) .... 24-54

4. MODULE : C ( FINAL ACCOUNTS ) ............................. 55-79

5. MODULE : D ( BANKING OPERATIONS ) ........ 80-122

6. PRACTICE TEST PAPERS .......................................123-156


ABOUT JAIIB EXAMINATION

JAIIB & CAIIB EXAMINATION Nov/Dec 2015

OBJECTIVE

JAIIB aims at providing required level of basic knowledge in banking and financial services, bankingtechnology, customer relations, basic accountancy and legal aspects necessary for carrying out day today banking operations.

MEDIUM OF EXAMINATION : Either in Hindi or English

Cut-off Date of Guidelines / Important Developments for ExaminationsIn respect of the exams to be conducted by the Institute during May / June of a calendar year, instructions /guidelines issued by the regulator(s) and important developments in banking and finance up to 31stDecember of the previous year will only be considered for the purpose of inclusion in the question papers.In respect of the exams to be conducted by the Institute during November / December of a calendar year,instructions / guidelines issued by the regulator(s) and important developments in banking and finance upto 30 June of that year will only be the considered for the purpose of inclusion in the question papers.Reference: IIBF Monthly Magazine : VISION , June 2015, Page no. 7.

PATTERN OF EXAMINATION : Each Question Paper will contain approximately 120 objective typemultiple choice questions, carrying 100 marks including questions based on case study / case lets. TheInstitute may, however, vary the number of questions to be asked for a subject. There will NOT be negativemarking for wrong answers.

TYPES OF QUESTIONS

120 Objective Type Multiple Choice Questions - carrying 100 marks 120 minutes and question will bebased on Knowledge Testing, Conceptual Grasp, Analytical / Logical Exposition, Problem Solving & CaseAnalysis

A. MULTIPLE CHOICE ( Each Questions 0.5 Marks ) QUESTIONS & ANSWERS ( 70-74QUES )

B. MULTIPLE CHOICE ( Each Questions 01 Marks ) PROBLEMS & SOLUTIONS (18-20QUES)C. MULTIPLE CHOICE ( Each Questions 02 Marks ) APPLIED THEORY QUES. & ANS.(10 -14 QUES)D. MULTIPLE CHOICE ( Each Questions 02 Marks ) CASE STUDIES & CASE LETS (PROBLEMS &SOLUTIONS ) ( 12-15QUES )

QUESTIONS MODELS : TYPES OF QUESTIONS

Type A : MULTIPLE CHOICE QUESTIONS & ANSWERSThe Best Method for assessing working capital limit used by the bank for seasonal Industries is :1. Operating Cycle Method, 2. Projected Networking Method, 3. Projected Turn over Method & 4. CashBudget MethodType B : MULTIPLE CHOICE PROBLEMS & SOLUTIONSMr. Ram Kumar is having overdraft account with Canara bank upto Rs.100,000. The present Debit Balancein the account was Rs. 80550.00. The bank has received attachment order from Income tax deptt. For Rs.16,200.00. What can the bank do in this situation ?


- Unless the bank is a debtor, there can be no attachment and an unutilized overdraft account doesnot render the bank a debtor ( but creditor ) & hence can not attach.

Type C : MULTIPLE CHOICE APPLIED THEORY QUES. & ANSFinancial Institution wish to have the money lent by them repaid in time. Secured advances sanctioned bybanks possess what kind of security ?- Secured Advances have impersonal security i.e. Tangible Security

Type D : MULTIPLE CHOICE CASE STUDIES & CASE LETS (PROBLEMS & SOLUTIONS )Economic development of a country to a large extent depends upon Agril. & Industrial sectors.

Development of agril. Depends upon irrigation facilities while industrial development on availability ofpower,good transport and fast communication facilities. All these are called infrastructure. Read the caselet& explain which industries constitute infrastructure ?a. Energy, Transport & Communicationb. Irrigation, construction of bridges & dams over Rivers & stable govt. at Centre.c. Availability of Funds for PMEGP , SJSRY & Indira Awas Yojana

DURATION OF EXAMINATION : The duration of the examination will be of 2 hours.Important dates for JAIIB are First paper : Principles & Practices of Banking - 15.11.2015Second paper : Accounting & Finance for Bankers 22.11.2015Third paper : Legal & Regulatory Aspects of Banking 29.11.2015

PERIODICITY AND EXAMINATION CENTRES ; The examination will be conducted normally twice ayear in May / June and November / December on Sundays.

Pass : Minimum marks for pass in every subject - 50 out of 100 marks.

Candidate securing at least 45 marks in each subject with an aggregate of 50% marks in allsubjects of JAIIB examination in a single attempt will also be declared as having passed JAIIBExamination.

Candidates will be allowed to retain credits for the subject/s they have passed in one attempt till the expiryof the time limit for passing the examination as mentioned bellow:

TIME LIMIT FOR PASSING THE EXAMINATION

Candidates will be required to pass JAIIB examination within a time limit of 2 years (i.e. 4 consecutiveattempts). Initially a candidate will have to pay examination fee for a block of one year i.e. for two attempts.In case a candidate is not able to pass JAIIB examination within 1st block of 2 attempts, he / she can appearfor a further period of 1 year (2nd block) i.e. 2 attempts on payment of requisite fee. Candidates who haveexhausted the first block of 2 attempts, should necessarily submit the examination application form for thenext attempt, without any gap. If they do not submit the examination form immediately after exhaustingthe first block, the examination conducted will be counted as attempts of the second block for the purposeof time limit for passing.

Candidates not able to pass JAIIB examination within the stipulated time period of two years are required tore-enroll themselves afresh by submitting fresh Examination Application Form. Such candidates will not begranted credit/s for subject/s passed, if any, earlier.

Attempts will be counted from the date of application irrespective of whether a candidate appears at

Type of Questions Basically four types of Multiple Choice Questions asked in Exam of

Which Type A : Concept based Straight Questions ( 70-71 QUES - 0.5 MARKS EACH ) ;

Type B : Problems & Solutions (20-25 QUES - 1.0 MARKS EACH); Type C : Applied

theory based Questions (10-15 QUES - 2.0 MARKS EACH) ; Type D : Case Study & Case-

lets based Questions ( 10-15 QUES - 2.0 MARKS EACH )


any examination or otherwise.

CLASS OF PASS CRITERIA

The Institute will consider the FIRST PHYSICAL ATTEMPT of the candidate at the examination as firstattempt for awarding class. In other words, the candidate should not have attempted any of the subject/spertaining to the concerned examination any time in the past and has to pass all the subjects as per thepassing criteria and secure prescribed marks for awarding class. Candidate re-enrolling for the examinationafter exhausting all permissible attempts as per the time limit rule will not be considered for awarding class.

First Class : 60% or more marks in aggregate and pass in all the subjects in the FIRST PHYSICALATTEMPT.

First Class with Distinction : 70% or more marks in aggregate and 60 or more marks in each subjectin the FIRST PHYSICAL ATTEMPT.

Candidate who have been granted exemption in the subject/s will be given "Pass Class" only.

JAIIB EXAMINATION Nov/Dec 2015(Last date for applying for examination : 28/08/2015)

ONLINE MODE

Examination DATE TIME SUBJECTS

15/11/2015 SundayONLINE - Will be given in the admit

LetterPrinciples & Practices of Banking


LetterAccounting & Finance for Bankers


LetterLegal & Regulatory Aspects of Banking

Last Date for receipt of Change of Centre Requests at the respective Zonal Offices for the JAIIB Examination scheduled for

Nov 2015 : 10th October 2015

Revised Examination Fees inclusive SERVICE TAX @14% with effect from 1st June, 2015

(Examination Eligible for Members Only)

Sr. No. Name of the Exam Attempts Fee (Rs)

1 JAIIB First Block of 2 attempts 2736

Second Block of 2 attempts 2736


Module: A

BUSINESS MATHEMATICS AND FINANCE

Syllabus

Calculation of Interest and Annuities :Calculation of Simple Interest & CompoundInterest; Calculation of Equated Monthly Instalments; Fixed and Floating Interest Rates;Calculation of Annuities; Interest Calculation using Products/Balances; Amortisation of aDebt; Sinking Funds

Calculation of YTM : Debt- Definition, Meaning .& Salient Features; Loans; Introduction toBonds; Terms associated with Bonds; Cost of Debt Capital; Bond value with semi-annualInterest; Current Yield on Bond; Calculation of Yield-to Maturity of Bond; Theorems forBond Value; Duration of Bond; Properties of Duration; Bond Price Volatility

Capital Budgeting : Present Value and Discounting; Discounted Technique for InvestmentAppraisal; Internal Rate of Return (IRR); Method of Investment Appraisal; NPV and IRRcompared; Investment Opportunities with Capital Rationing; Investment Decision makingunder condition of uncertainty; Expected NPV Rule; Risk Adjusted Discount Rate Approachfor NPV Determination; Sensitivity Analysis for NPV Determination; Decision Tree Analysisfor NPV Estimation; Payback Methods; ARR.

Depreciation and its Accounting :Depreciation, its types and methods; ComparingDepreciation Methods

Foreign Exchange Arithmetic :Fundamentals of Foreign Exchange; Forex Markets;Direct and Indirect Quote; Some Basic Exchange Rate Arithmetic Cross Rate, ChainRule, Value date, etc.; Forward Exchange Rates Forward Points; Arbitrage; CalculatingForward Points; Premium/discount; etc.


CALCULATION OF INTEREST

Banking business mainly consists of accepting deposits and lending. Bank pays interest to thedepositors On lending to customers, the bank charges a certain interest at a specified rate. Theinterest is payable either at periodic intervals or at the end of a loan period. The calculation of theinterest will be based on the terms of agreement, i.e. whether at a definite interval or at theperiod end. Sometimes, it also happens that the customer is interested in paying a part ofprincipal along with interest. As the customers pay the principal in instalments, the impact of theinterest gets reduced over the tenure of loan. It may also happen that the bank may want torecover the loan in equal instalments called annuities. Annuities are essentially a series of fixedpayments required to be paid at a specified frequency over the course of a fixed period of time.Payment of annuities may be at the beginning of each period or at the end of each period. Thecalculations of annuities are different for each situation. Sometimes, the bank also needs tomake a cost-benefit analysis of the series of annuities and is required to calculate the presentvalue of all the annuities by suitably discounting the annuities receivable at the end of eachperiod. The sums of the present value of the annuities are compared with the cash outflow toreach certain decisions.Simple interest : Simple interest is paid by the borrower at the end of each year at a fixed rate(called rate of interest). In other words no interest is paid on the amount of interest. The simpleinterest can be calculated as: Interest = principal x rate x time i.e. I=PRT (where P is principal, Ris rate of interest and T is time).Example : A lends Rs.30000 to B at 8% interest rate. The annual interest would be Rs.2400i.e. (30000 x 1 x 8)1100. Total amount payable by the borrower to the lender = Principal +interest.Amount of instalments: Repayment of the loan can be made on a yearly, half-yearly, quarterly,monthly or even weekly periodicity. Hence the total amount repayable can be divided by theunits of time period in a year. For example in the above case, the total loan repayable isRs.32400 (30000 + 2400). If repayment is half-yearly, the amount of instalment would beRs.16200 (32400/2), if it is quarterly it would be Rs.8100 (32400/4), if it monthly the amountwould be Rs.2700 (32400/12) and so on.

Compound interest : When interest is paid by the borrower not on the amount of principal only buton the interest amount that has accrued also (i.e. accumulated portion of interest), it is calledcompound interest. In this case, the formula for calculation of interest is not that simple as in caseof simple interest, Formula for calculation of amount due after a certain period on compound rateof interest is: A= P (1+R)n where 'A' is total amount due after n years., 'P' is the principal amountand 'R' is rate of interest per annum expressed as fraction.Formula for half yearly compounding will be modified by reducing rate of interest to half itsoriginal value and multiplying time by 2. Likewise for compounding of interest at quarterly rests,the rate of interest will, be divided by 4 and time period multiplied by 4. So the formulae undersuch dispensation will be:- A=P(1+r/2)2n for half yearly compounding and A=P(1+r/4)4n, forquarterly compounding.For monthly compounding, the annual rate will be_divided by 12 and time period multiplied by12making the formula as A=P(1+r/12)12nCompound interest will be CI =A-P where CI stands for compound interest, A for total amount dueand P for principal amount.

Q. 1 The simple interest in 3 years and the compound interest in 2 years on a certain sum at thesame rate are RS. 1,200 and RS. 832 respectively. Find (i) the rate of interest, (ii) the principal, (iii)the difference between the C.I. and S.I. for 3 years.

Ans. Let the principal be RS. P and rate of interest be R per cent p.a. According to the first


condition of the question, (p x R x 3)/100 = 1200, P x R= 40,000

According to the second condition of the question, (P+ 832) = P(1 + R/100)2, or, (P+ 832)/P= (1 +R/100)2= (100)2(1 + 832/P) = (100 + R)2 or, (100)2 + 832(100)2/P= (100 + R)2,

By putting P= 40,000/R from equation 1, we get, [832*R*(100)2]/40,000 = (100 + R)2 (100)2

4[(100)2 + R2 + 2*100*R (100)2] = 832 R , R2+ 200 R = 208 R = R2+ 200 R 208 R = 0R2 8R = 0,R(R 8) = 0, Either R = 0 or R 8 = 0Either R = 0 or R = 8, but R cannot be Rs.ero. Hence the

rate of interest = 8% p.a. On using (1), we get P x 8 =40,000, so P = 5,000

(iii). Rate of compound interest = 8% p.a. and principal = RS. 5,000

Amount due after 3 years = RS. 5,000 x (1 + R)3,= RS. 5,000 x 1.2597 = RS. 6,298.56

Hence, C.I. for 3 years = A P= RS. 6,298.56 RS. 5,000 = 1,298.56

The difference between the C.I. and Si. for 3 years = RS. 1,298.56 RS. 1,200 = RS. 98.56

Amount becoming double of the amount lent : On a compounded basis, when the amount is lentit becomes double after different time periods depending upon the rate of interest at which it hasbeen borrowed. For this purpose the Rule of 72 can be used. According to this rule, to find out thetime period during which the amount would become double, the number 72 is divided by the rateof interest. For example, the money lent at 9% would become appx. double in 8 years and themoney lent at 8% would become appx. double in 9 years.

A depositor deposits Rs.20000 with the bank at prevailing interest rate of 12%. He wants to takeback nearly double the amount of the deposit. After how many years, he would get the amountas per his desire: 6 years (72/12). He would get Rs.19738 with annual compounding andRs.20327 with quarterly compounding.

Rule of '72' enables us to calculate the period during which our deposit or loan will becomedouble. It is to divide'72' by annual rate of interest and the result will be the period during whichthe amount will become double. For example if you availed a personaloan @12% as per rule of'72' it will double in 6 years (72/12). Likewise if you have placed deposit with a bank at 8% rateof interest, the amount of deposit will be double in 9 years (72/8).There is a modified version of rule of '72' which is referred to as rule of '69'.It says thatperiod during which the amount will double will be calculated by dividing 69 by the rate of interest+0.35. To illustrate with 9% rate of interest the period will be 69/9+0.35 i.e. 7.67+0.35 years i.e.around 8.02 years.

Q 2 You borrowed RS. 1,000 at 6 per cent interest. Then, 72 divided by 6 is 12. That makes 12the approximate number of years it would take for your debt to double to RS. 2,000, if you did notmake any payment.

Ans Similarly, a saving account with RS. 500 deposited in it, earning 4 per cent interest andcompounded yearly, will take 18 years for RS. 500 to double to RS. 1,000 if you do not make anyfurther deposit, as 72 divided by 4 is 18.

FIXED AND FLOATING INTEREST RATES : There are two different modes of interest. They areFixed Rates & 2. Floating Rates also called as variable rates.

Fixed Rate: In the fixed rate, the rate of interest is fixed. It will not change during entire period ofthe loan. For example, if a home loan, taken at an interest rate of 12 per cent, is repayable in 10years, the rate will remain the same during the entire tenure of 10 years even if the market rateincreases or decreases. The fixed rate is, normally, higher than floating rate, as it is not affectedby market fluctuations.

Floating Rate: In the floating rate or variable rate, the rate of interest changes, depending uponthe market conditions.Under floating rate, the interest rate is usually linked to a benchmark ratewhich could be the base rate of the bank or any other benchmark rate of the banking industry. It


may increase or decrease depending upon the change in the benchmark rate.For example, if ahome loan is taken at an interest rate of 12 per cent, repayable in 10 years, inApril 2014, and ifthe benchmark rate increases to 12.5 per cent in April, 2015, the interest rate of this loan will alsobe increased to 12.5 per cent. If the loan is under an EMI system, depending upon the change ininterest rate, the repayment period varies, but equated monthly instalment remains the same.However, the borrower may choose to have the repayment period same and pay a higher EMI.FRONT-END AND BACK-END INTEREST RATESIf the interest is deducted from the principal amount and only the net amount is disbursed, it iscalled front-end interest. For example when the bank discounts a bill, the interest applicable forthe tenure of the bill is calculated and is deducted from the bill amount along with other chargesand the net amount is paid to the customer. However, the normal practice in banking industry isto charge back-end interest rate which means that the full amount of the loan is disbursed andthe interest is charged subsequently on monthly/quarterly/agreed basis. For example, in a termloan, the interest is calculated on the actual daily balances in the account during a period andapplied at the end of the period. Obviously, the front-end interest application results in effectiveinterest rate being more as the borrower gets less amount for use whereas, the interest is appliedon the full amount.CALCULATION OF INTEREST USING PRODUCTS/BALANCESCalculation of front end interest like in bill discounting is easy as the amount is assumed to beconstant over the entire period. For example, if the tenure of the bill of 2 lac is 3 months and therateof discount is 16% p.a., the interest amount will be 8000.

In banks, many of the cases of deposit and loan accounts involve calculation of interest on thebasis of daily balance in the customer's account. While this method was prevalent in case of theloan accounts, even in case of Savings Account, the interest is now required to be calculated onthe basis of daily balances. In this method, the closing balance in the account is multiplied by thenumber of days for which that balance remains unchanged.

ANNUITIES :At some point in your life, you may have had to make a series of fixed paymentsover a period of time such as rent or car payments or have received a series of paymentsover a period of time, such as bond coupons. These are called annuities. If you understand thetime value of money and have an understanding of the future and present value, it would beeasy to understand annuities.

Annuities are essentially a series of fixed payments required from you or paid to you at aspecified frequency over the course of a fixed period. The most common paymentfrequencies are yearly (once a year), semi-annually (twice a year), quarterly (four times ayear), and monthly (once a month). There are two basic types of annuities: ordinaryannuities and annuities due.

Ordinary Annuity: Payments are required at the end of each period. For an illustration,straight bonds usually make coupon payments at the end of every six months until thebond's maturity date.

Annuity Due: Payments are required at the beginning of each period. Rent is anillustration of annuity due. You are usually required to pay rent when you first move in atthe beginning of the month, and then on the first of each month thereafter.

Since the present and future value calculations for ordinary annuities and annuities due areslightly different, we will first discuss the present and future value calculation for ordinaryannuities.

Time value of money : The money has a time value. Rs.5000 in hand with a person as atpresent and an amount of Rs.5000 coming in his hand after, say a year, would carry differentvalues. The same amount of money received in future carries less value because of timeelement, during which the money can earn interest. The present value of Rs.5000 to be availableafter a year, would be less at present. Hence the concept of future value of an annuity andpresent value of annuity comes in.


Future value of an Ordinary annuity : A depositor depositing a fixed sum of amount in his accountregularly till the end of pre-determined period at a given interest rate, can find out how muchmoney he would get at the end of the period he has chosen for deposit.Calculation of Future Value of AnnuitiesFuture Value (FV) for Ordinary Annuity=C X [{(1+i)n-1}/i] where 'C' stands for cash flow perperiod,'I is the rate of interest , 'n' stands for number .of payments. Since in case of annuity dueeach payment is received, one period sooner, the formula stands modified.Future Value of Annuity Due will be = C X [{(1+i)n-1}-1} X (1+i)Calculation of Present Value of AnnuitiesPresent Value (PV) for Ordinary Annuity= C X [{1- (1+i)n}/i]Present Value (PV) for Annuity Due = C X [{1- (1+i)n}/i] x (1+i)

For payment made at the end of 4th year = 10000 (1 r)1 = 10000 (1 + 0.05)1 = 10500For payment made at the end of 5th year = 10000 (1 + r)1 = 10000 (1 + 0.05)1 = 10000Total = 55256,The above value can be worked out on the basis of formula:FV = C * [(1 +i)" -11 Where C=Cash flow i=intt.rate n=no. of payments.55256 = 100000 * [(1 +0.05)5-11=0.05Present value of an Ordinary annuity : Where a person is receiving regular payment ofRs.10000 per annum for 5 years at 5% interest rate, he can also calculate the present value ofthe cash flows he is to receive over the next 5 years as under:For amount received at the end of 11 year = 10000 (1 + r)1 = 10000 (1 + 0.05)1

= 9524For amount received at the end of 2"d year = 10000 (1 + r)2 = 10000 (1 + 0.05)2 =9070 For amount received at the end of 3'11 year = 10000 (1 + r)3 = 10000 (10.05)3 = 8638For amount received at the end of 4th year = 10000 (1 + r)4 = 10000 (1 + .05)4

= 8227For amount received at the end of 5111 year = 10000 (1 + r)5 = 10000 (1 + 0.05)5 =7835Total = 43294, The above value can be worked out on the basis of formula:PV = C * [(1-(1+in Where C=Cash flow i=intt.rate n=no. of paymentsPV = 10000 * [(1-(1+0.05)0= 10000 * 4.3294 = Rs.43294

0.05Future value of an annuity due : A depositor depositing a fixed sum of amount in his accountin the beginning of a particular period at regular intervals at a given interest rate can find out howmuch money he would get at the end of the period he has chosen for deposit. Similarly if aborrower is making regular payment of a loan in equal instalments, he can find the cost of loan.For an amount of Rs.10000 to be paid every year (for 5 years), the future value would beRs.58019 at 5% interest rate, as under:For payment made in the beginning of 15' year = 10000 (1 +r )4 = 10000 (1 + 0.05)4 = 12763For payment made in the beginning of 2nd year = 10000 (1 + r)4 = 10000 (1 + 0.05)3= 12155For payment made in the beginning of 3rd year = 10000 (1 + r)3 = 10000 (1 + 0.05)2= 11576For payment made in the beginning of 4th year = 10000 (1 + r)2 = 10000 (1 + 0.05)1= 11025For payment made in the beginning of 5111year = 10000 (1 + r)1 = 10000 (1 + 0.05)1= 10500Total = 58019The above value can be worked out on the basis of formula:FV = C * [(1 +i)n -11 * (1+i) where C=Cash flow i=intt.rate n=no. of payments

FV = 10000 * [(1 +0.05)"-11 * (1+0.05) = 10000 * 5.53 * 1.05 = Rs.580190.05

Present value of an annuity due : Where a person is receiving regular payment of Rs.10000 perannum for 5 years at 5% interest rate, he can also calculate the present value of the cash flowshe is to receive over the next 5 years as under:For amount received at the end of 51h year = 10000 (1 + r) = 10000 (1 + 0.05) = 10000


For amount received at the end of 4`h year = 10000 (1 + r)1 = 10000 (1 + 0.05)1= 9524For amount received at the end of 3rd year = 10000 (1 + r)2 = 10000 (1 + 0.05)2 = 9070For amount received at the end of 2nd year = 10000 (1 + r)3 = 10000 (1 + 0.05)3 = 8638For amount received at the end of 151 year = 10000 (1 + r)4 = 10000 (1 + 0.05)4 = 8227Total = 45459The above value can be worked out on the basis of formula:PV = C * [(1-(1+I )n* (1+i), where C=Cash flow i=intt. rate n=no. of payments

PV =10000 * [(1-(1+0.05)51* (1+0.05) =10000 * 4.33 * 1.05 = 100000 * 4.5459 = Rs.454590.05

AMORTISATION OF DEBTS : Amortisation means liquidation (repayment) of an interestbearing loan through periodic payments. With payment of each instalment, the interest liabilitycomes down. When the loan is amortised through equal payments, the debt becomes thediscounted value of an annuity. The total time period during which this repayment is made iscalled term of the annuity. The regular time periods, during which the repayment isaffected, are called payment periods.Present value of annuity: When an investor expects the rate of return on purchase of a bond,equal to the coupon rate, the value of the bond is equal to its par value. On the other

hand when an investor expects the rate of return on purchase of a bond, more than thecoupon rate, the value of the bond is, less than its par value. Similarly, when an investorexpects the rate of return on purchase of a bond, less than the coupon rate, the value of thebond is more than its par value. When the required rate of return is more than the coupon rateand as the maturity approaches the discount on bond declines. When the required rate ofreturn is less than the coupon rate and as the maturity approaches, the discount on bondincreases. The bond price is inversely proportional to its yield to maturity.Future value of annuity : The future value of annuity can be worked out with the help of thefollowing formula. This helps us to understand as to how much amount is required to be investedat a regular interval to get a targeted consolidated amount, at the end of a particular period.Sr (S=value at the end of the period.R = --------- (R= Periodic payment){(1+r)"-1} ( r= rate per period)

SINKING FUND : A fund created, by gradual periodic deposits, with the objective of getting a targetedamount to pay off future debts, is called a sinking fund. The sinking funds can be created for a no. ofpurposes such as repayment of debt in lump sum, redemption of bonds, replacement of a worn outequipment, buying of a new equipment etc. This can be done by knowing the future value of an annuity,by using the following formula:

(1+i)" -1 (F=Future value of an annuity)F = A ----------- ,(A= Annuity)

( rate of interest)

Test your self1. A student purchases a computer by obtaining loan on simple interest. The computer costsRs 15000 and the interest rate on the loan is 12 per cent. If, the loan is to be paid back inweekly instalments over two years, calculate the followinga) The amount of interest paid over the two years , b)The total amount to be paid backc)The weekly payable amount

2. Ramesh has one saving account with interest rate of 3.3% and one money market accountwith interest rate of 5.1% in a bank. If he deposits Rs 1200 to the savings account and Rs 1800to the money market account, how much money will he have after 6 years?3. Your friend borrows Rs 1000 from you for purchase of a sofa. The loan will be repaid in a year.


She wants to pay the principal in 12 equal monthly instalments and interest as applicable onmonthly basis. How much amount will be payable at the end of the first month and second monthif interest rate is 8% p.a. (or 0.667% per month)4. What will be the EMI for a loan of Rs 100,000 at an interest rate of 12% p.a. to be repaid in12 months5. You have deposited Rs 100,000 in the bank. You want that it should be deposited for such aperiod that it is doubled. For how long you will have to deposit if interest rate is 9% assuming thatthere is no TDS6 A person deposits Rs 1000 at the end of each year for 5 years. If the interest rate is 5% perannum, how much amount will he have at the end of 5 years? (Ordinary Annuity)7.A person receives Rs 1000 at the end of each year for 5 years. If interest rate is 5% per annum,what will be the present value of total amount received by him? (Ordinary Annuity)8. In question no 6 if the amount is deposited at the beginning of each year, what amount will hehave at the end of 5 years9. In question no 7, if the amount is received at the beginning of each year, what will be presentvalue of total amount received by him (Annuity due)10. The population of an industrial town is increasing by 5 per cent every year. If the presentpopulation is 1 million, estimate the population five years hence. Also estimate the populationthree years ago.11. Rama publishers buy a machine for Rs 20,000. The rate of depreciation is 10%. Find thedepreciated value of machinery after 3 years. Also find the amount of depreciation. What is theaverage rate of depreciation?

BONDS AND DEBENTURESThe mix of debt and equity of a company is called capital structure of a company. Debt capital ispreferable to equity capital both to the company and the investors as the bond holder gets interest on thebonds irrespective of the amount of profit. He can also force the company to go in for liquidation. For thecompany, the debt capital is preferable, due to tax planning, as interest paid is an expenditure on which notax is required to be paid. The debt capital has normally the lower overall cost compared with the equitycapital. Main components of the debt capital are bonds and debentures. The buyers of the bonds anddebentures, issued by a company are called creditors of the company, who lend money to the company.The specific interest rate that is carried by a bond is called 'coupon rate'. Various terms are used in thecontext of bonds that include face value, redemption value, redemption at discount, redemption at apremium etc. Rate of interest on bonds is fixed.Face value of a bond and the maturity : The value that is written on the face of the bond is called facevalue. This value represents the amount that a company has to return to the bond holder after thespecified time period. A specified time period at the end of which the repayment of the face value is to bemade is called 'maturity'.

Redemption and value for redemption : The bonds are repayable according to the terms on whichthese are issued. The value of bond, that the bond holders get on maturity of the bond, is known as'redemption value'. The bonds can be redeemed at a premium or at a discount.

Bond redeemable at premium means the value to be returned to the bond holder would behigher than the face value. Bond redeemable at discount means the value to be returned to thebond holder would be lower than the face value.

Failure of a company to redeem the bonds : If a company fails to make payment of interest or principal,the company may be forced to in to bankruptcy as per the prevailing provisions of the law includingliquidation.

YIELD TO MATURITY : YTM is the rate of return that an investor can earn, when he purchases a bondand holds it till its maturity. In other words, it is the discount rate, which equals the present value of theexpected cash flows to the current market price or the purchase price.

When an investor expects the rate of return on purchase of a bond, equal to the coupon rate, the value


of the bond is equal to its par value. On the other hand when an investor expects the rate of return onpurchase of a bond, more than the coupon rate, the value of the bond is, less than its par value.Similarly, when an investor expects the rate of return on purchase of a bond, less than the coupon rate,the value of the bond is more than its par value.When the required rate of return is more than thecoupon rate and as the maturity approaches the discount on bond declines. When the required rate ofreturn is less than the coupon rate and as the maturity approaches, the discount on bond increases. Thebond price is inversely proportional to its yield to maturity.

Test your self1. A Bond whose par value is Rs 1000 bears a coupon rate of 12 per cent and has a maturityperiod of 3 years. The required rate of return on the bond is 10 per cent. What is the value of thisbond if (PVIFA 10% 3 years is 2.487 and PVIF 10% 3 years is 0.751)2. If a bond of face value Rs 1000 carrying a coupon interest rate of 8% is quoted in the market atRs 800, then what is the Current yield on the bond?

3.There is a bond with par value of Rs 1000. The market value of the bond is Rs 850. Thebond carries a coupon rate of 8% and has maturity period of nine years. What would be therate of return that an investor earns if he purchases the bond and holds until maturity?

4.There is a bond with a face value of Rs 1000, coupon rate is 10 per cent and periodof maturity is ten years. If the current market rate 10 per cent is changed to 11 percent, the price of the bond changes to In the above question, what is the interest rateelasticity?

5.The face value of the bond is Rs 100,000. The coupon rate is 8%. The YTM is 6%. The time tomaturity is 5 years. Interest payments are made annually. What will be the Duration of the Bond?What is Modified Duration? Calculate the percentage change in price of the bond if the YTM fallsby 100 basis points or 1% from 6% to 5%.

6.There are two bonds with the following features:Bond A Bond B

Face Value Rs 100 Rs 100Coupon Rate 14% 14%Current Market Price Rs 100 Rs 100Term to maturity 4 years 7 yearsCoupon payment Annually Annually(a) Compute the YTM of Bond A and B(b) If the interest rate falls by 1% what would be the new market price of bonds(c) What is the percentage change in the price of two bonds(d) If interest rates increased by 1% what will be the current price of Bond A?

CAPITAL BUDGETINGDISCOUNTED CASH FLOW TECHNIQUESFinancing fixed assets either by replacement of existing assets or addition of new assets forms part ofany company's overall capital budget and this kind of budgeting is extremely difficult due to uncertaintiesof future economic conditions and need for ensuring reasonable return on the long term investment. Thecapital budgeting decisions are based on (a) conventional method of (i) return on capital or investmentand (ii) payback period and (b) discounted cash flow methods of (i) net present value and (ii) internal rateof return.CONVENTIONAL METHODS - RETURN ON CAPITAL OR INVESTMENTThis is calculated as a percentage of operating profit on total investment and is a crudemethod of estimating financial viability of the project and suffers from following:a the percentage indicator will vary from year to year in view of the variations in operating profit. It may be

difficult to identify one figure which correctly represents the return on the total capital employed.


b The term capital is vague and is subject to more than one interpretation. It is not clear whether thereturn should be calculated on the equity capital or total owned resources plus borrowed funds.C it is not clear as to what should be operating period of the project on which the return on capital shouldbe calculated. There is no basic assumption regarding the total economic life of the project in thistechnique.d It ignores the time value of money concept. A rupee earned tomorrow is worth fess than arupee in hand today. Earlier we get the return, it carries greater value to us.

CONVENTIONAL METHODS - PAYBACK METHOD ,It is commonly used method of investment appraisal in view of the simple mode of its calculation. Thepayback period represents the number of years it takes for the operating earnings from a project torecoup the total investment on the project and is computed taking into account:Net investment / Profit before depreciation and tax = Payback period (years).

The method is useful both for firms with plenty of investment opportunities but limited financial resourcesand for those projects which have obsolescence risk i.e. larger wear and tear.The method has following limitations:a It can lead to incorrect ranking of industrial projects as the method ignores return of the project

after the payback period.b The method does not give us any objective cut-off criterion. What should be the minimum or

maximum payback ?c The projects which have low return initially but a longer economic life may be preferable to

those projects which have high earning capacity initially but have shorter life span.d This method like return on investment ignores the time value of money.eThis method attaches undue importance to the quick yield and gives the impression that the projectshave little or no development significant. It is a not enough to recoup the investment. The principalconcern of the investor is to optimise the return/benefits. In view of the aforesaid limitations, the paybackmethod is better accepted as a secondary method of investment appraisal rather than the final criterionfor investment.The calculation is made from the year investment is made to the period when the capital hasbeen recovered plus the project has yielded a minimum return on the investment. This can beexamined in the light of the following:

Year Cash flow Present value of Re.1 at 11% cashflow

Discounted Cumulative

present value

0 (2500) 1.000 (2(2500)

1 1000 0.901 9(1599)2 1000 0.812 8( 787)3 1000 0.731 7( 56)4 1000 0.659 6603The payback of 3.1 years in the above project = 3 + 56/659 = 3.085 (say 3.1 years)

DISCOUNTED CASH FLOW METHODSIt is stated to be realistic and rational method of investment appraisal and takes into account the actualtiming of cash outgo and cash inflow. It is rational as it fulfills the needs of modern financial managementand economic analysis of projects. Any investment appraisal technique should serve the objective that itshould help the analyst in ranking projects in order of preference and it should give a cut-off criterionwhich should be used to accept or reject the project. The DCF techniques can meet these objectives.


The technique involves discounting cash flows at discount rate carefully selected taking intoaccount the prevailing cost of credit or the return from competing projects within the frame-workof undernoted assumptions:a DCF technique clearly recognises the time value of money. Both the compounding and discounting

processes may be used to express the time value of money. In compounding, the present sumgrows as the interest at a given rate is added. Discounting is reverse of compounding. From a futurevalue the present value is determined at a discount rate.

b DCF focus attention on cash receipts and expenditures as against profits after depreciation onaccrual basis of receipts and expenses.

c it is assumed that all operating cash inflows or outflows are assumed to take place at the endof the year in question, for simplifying the calculations.

d The cost of capital, opportunity cost of capital or discount rate is selected by the managementhaving regard to various relevant factors.

DCF criteria is based on total cash flow over the life of the project and as such it is independentof annual variations of cash flows.

The important rules regarding application of DCF techniques are as under:a Higher the rate of discount applied in calculation, the less point there is in spreading the exercise over

distant years. This may be 50% for 7-8 years, 20% for 16-17 years and 12% for 25-26 years.b Higher returns in later years of project's life do not materially affect the DCF rate. What really matters

is the cash flow during the early years. Or shorter the period during which positive returns arereceived, higher would be rate of return.

c Higher the rate of discount, the more important are the returns earned during the early yearsof an assets life.

Limitation of DCFa The application of DCF technique has become primarily the function of the finance manager. Other

departments of a project have little say in assumptions selected for DCF calculations. This adverselyaffects the reliability of the DCF criterion. An acceptable DCF rate of return is one which is the resultof a composite managerial, economic and technical assessment of the project over a fairly longperiod. Such an integrated forecast is the dream of every project analyst which is rarely realised.

b The external effects of the project such as pollution, noise congestion etc. are not ordinarily accountedfor in DCF calculations for financial analysis. As a result, the economic cost-benefit analysis isnecessary. The full utility of DCF therefore depends on the fact whether or not the exercise iscomprehensive one including economic cost-benefit analysis, particularly in case of large andcomplex projects.

c Future being uncertain, no investment appraisal technique can accurately forecast the futureviability of projects. Reliability of DCF, as such, is no better than other conventionalmethods.

d It is difficult to estimate the economic life of a project. Some assets depreciate faster thanothers. Some projects need major replacement or renovation within 4-5 years of theirworking. No general rule such as assumption of project life of 15 years in all cases, wouldyield a helpful solution.

e Irregular cash flows including a negative cash flow following some positive flows, pose aproblem, which would yield more than one IRR.

f There is an unresolved controversy whether or not inflation should be taken into account whilefinalising cash outlays for DCF. it is claimed that inflation has come to stay and any financialforecasting which does not take into account the impact of inflation is by and largemeaningless.

g It is difficult to forecast the future salvage/terminal value of assets. The current practice ofvaluing fixed assets only at 5% of their original value is somewhat arbitrary.

There are two principal measure of DCF, namely Net Present Value and Internal Rate of Return:


DISCOUNTED CASH FLOW (DCF) METHODSDCF takes into account the actual timing of cash outgo and cash inflow. It is based on totalcash flow over the life of the project. There are two principal measures of DCF, i.e. NPV & IRR.

Net present value (NPV) : NPV is the difference between cash outflows at base period andpresent value of future cash inflows. It helps the bank to ascertain, whether a oroject should betaken up for financing or not.

Project AYear Discount rateCash inflow NPV(DCF) 10%

Project BCash inflow NPV

0 (-)5000 -5000 (-) 500050001 0.91 1100 1000 1125 10242 0.83 1210 1000 1235 20253 0.75 1330 999 1355 10164 0.68 1460 997 1485 10105 0.62 1500 931 1525 945Total 6600 4927 6725 5020

Net present value 4927 - 5000 = (-) 73 5020-5000 = 20

This is initial investment in the project is an outflow.In project A while the cash outflow is 5000 (original investment), the future cash inflow is 6600 andits net present value at 10% discount rate is 4927. Hence the NPV is less than Zero (i.e. 73). Onthe other hand, for project B, against cash outflow of 5000, the net present value of the inflow of6725 is 5020 which is more than Zero. Hence, the project B can be taken up for financing.If the above project had positive NPV and many other projects also had positive NPVs the choice wouldbe limited by raising the discount rate and by selecting that project which has the highest present valuerelative to investment expenditure. For calculating NPV, we require a statement of cash outgoes andinflows, assumptions regarding total economic life of the project and a rate of discount. The selection ofeconomic life and rate of discount can pose certain problems.In the case of industrial projects, it is customary to assume a working life of 10-20 years depending uponthe expected life of the equipment. The selection of rate of discount depends on a composite of factorssuch as:a Weighted average of the borrowing rate for funds.b The expected rate of return from the competing projects.c The company's internal record of growth.d An acceptable price earnings ratio for equity shares ande The industrial growth rate assumption accepted by the government or planning authorities.

Internal rate of return (IRR)IRR is the rate of discount at which the net present value is ZERO. In the following example it is34.62%. At this discount rate the discounted value of the net cash flow from a project is equal tothe amount which has been invested to obtain that net cash flow (in the following case, theinvestment is 1500. At 30% discount, the NPV of cash inflow is 1633 and at 35% it is 11, but at34.62%, it will be 1500, making the net value as Zero).Illustration:

The exact IRR would be 34.62% which can be worked out as under, at which the net presentvalue of the cash Inflow would be Zero which is (-) 11 at 35% and 133 at 30% discount rate.

(Lower discount rate + difference between two discount rates) X Net present value of the cashflow at lower discount rate / absolute difference between the NPV of cash flow stream at twodiscount rates.

= 30 + 5 (133/144) i.e. = 30 + 5 (.924) = 34.62%Year Cash flow DCF-30% Discounted DCF-35% Discounted


0 Cash flow(-)1500

cash flow(-)1500

1 500 0.769 384 0.741 3702 750 0.592 444 0.549 4123 1000 0.455 455 0.406 4064 1000 0.350 350 0.301 3015 3250 1633 1489Net position 1633-1500 = 133 1489-1500=(-)11This is initial investment. Hence an outflow.

Test your self1.What is the discounting factor for 1 year % at 10rate? What is the discounting factor for 2 yearand 3 year at 10% rate?2. Company A is considering a new piece of equipment. It will cost Rs 6000 and will produce acash flow of Rs 1000 every year for the next 12 years (The first cash flow will be exactly one yearfrom today). What is the NPV if appropriate discount rate is 10%?

DEPRECIATIONDepreciation means reduction in the value of a fixed asset over the years. This is a continuing processdue to which the book value of the assets declines. The rate at which this value declines varies fromasset to asset depending upon a number of factors such as wear and tear, passage of time,obsolescence, fall in market price etc. Charging depreciation is a process of distribution of cost of thefixed assets over the useful life of the asset.Objective of charging depreciationThe depreciation is charged in order to ascertain the profit and loss appropriately, record propervalue of the assets and retain profits for replacement of the asset.Basis for charging depreciation:The elements that are taken into account for fixation of rate of depreciation and charging the depreciationare (a) the original cost of the assets (including installation etc), (b) the expected time period forcommercial use of the asset and (c) expected sale value (called scrap value) at the end of thecommercial use of the asset. The depreciation is debited to the profit and loss account and credited torespective fixed asset account.Methods of charging depreciationThough there are a number of methods for charging depreciation, but two methods are very common.These are straight line method (SLM) also called fixed instalment method and written down value (WDV which is recognised by Income Tax department) also called diminishing balance method. Othermethods include annuity method, depreciation fund method, insurance policy method, depletion methodand machine hour rate method.

Depreciation = (Original cost scrap value) / estimated life(Scrap value is the sale price of the asset after it is estimated useful value )

Name of the method How charged

Fixed instalment or SLM Details given below

WDV Details given below

Annuity method Calculated from annuity table and is different according to rate ofinterest and according to the period over which asset is to be written off

Depreciation fund Kept as fund and usedwhen asset is to be replaced. It is investedinsecurities and rate of interest is provided in sinking fund table.


Insurance policy It is similar to depreciation fund method but investment is made ininsurance company to which premium is paid. After fixed period thematurity amount is received. Premium is equal to annualdepreciation

Depletion method Suitable for mines, queries etc as after extraction of the entirequantity, the mine loses value. It is calculated as per tonne bydividing the cost of mine by total quantity of mineral available.

Machine hour rate Life of machine is fixed in hours of work and depreciation iscalculated by dividing cost of machine by total no. of hours of whichmachine is expected to be used.

Straight Line Method or fixed instalment methodUnder SLM method, the depreciation is charged on the original value of the asset inclusive of itsinstallation and transportation cost but excluding scrap value, if any. For example, an asset has beenpurchased for Rs.2 lac including tax and Rs.10000 has been incurred on its installation and anotherRs.5000 on its transportation etc. If it is also estimated that its scrap value is Rs.35000, at the end of 4years' commercial use, the amount of annual depreciation would be Rs.45000 ((200000+10000+5000-35000)/4).Written down value method or diminishing balance methodUnder WDV method depreciation is charged at fixed rate on the reducing balance (called written downbalance i.e. original cost less depreciation). This also means that the cost of the asset reduced by thescrap value is to be written off over its expected commercial life. In the above example, the rate ofdepreciation of 25% will be applied on Rs.180000 during the first year, while during the 2114 year it will beon Rs.135000 (180000-45000), when the amount of depreciation would be Rs.33750 (25% ofRs.135000).Change in method of depreciation from one method to another:The method of depreciation can be changed both with prospective effect (for future) or withretrospective effect (from past date). In case of retrospective effect, it will be essential to adjust thedepreciation already charged till the date of change. For that purpose, we have to calculate the amountof depreciation according to the old method, and as per proposed method. The difference in both thecalculations will be adjusted by debiting or crediting the asset account and crediting and debiting thedepreciation head in the profit and loss account. In the subsequent period, the depreciation will becharged according to the new method. For instance, for a machinery purchased for Rs.2 lac(commercial life 5 years and no scrap value), when depreciation method during the 15' two years isSLM and subsequently changed to WDV, the following adjustment would be needed.Amount of depreciation for 15' two years would be Rs.40000 x 2 = Rs.80000 and written down value ofthe asset Rs.120000 (2 lac 80000). The amount of depreciation for the 3rd year would be Rs.30000(25% of WDV of Rs.120000). This will result in increase in profit by Rs.10000 in the 3k1 year because inthe SLM, the amount of depreciation would have been Rs.40000.Effect of shift from one method to another : Whenever there is shift in method of depreciation fromSLM to WDV, the amount of depreciation declines, due to which the profit increases along with increasein the written down value of the asset. This also increases the net worth of the promoters of the business.On the other hand, a shift from WDV to SLM method increases the amount of depreciation andreduces the profit, book value of the assets and net worth.Journal entries :

Depreciation Dr , To fixed asset account Cr.Illustrations:

1. Machinery worth Rs.82000 is purchased and the firm spent Rs.8000 on its installation. Itseffective commercial life is estimated as 10 years and scrap value Rs.10000. What will be written downvalue at the end of 3rd year, under straight line method?.Answer The amount of annual depreciation would be Rs.8000 (82000+8000-10000, divided by 10).

For 3 years it will be Rs.24000 (8000 x 3).The WDV would be Rs.66000 (90000-24000).


2. In the above question, if the method would have been written down value method, whatwould be the amount of depreciation for 3 years and WDV of the machinery?

Answer For 151 year the amount of depreciation would be Rs.8000, for 2nd year Rs.7200 (80000-8000x 10%) and for 3rd year Rs.6480 (72000-7200 x 10%). The total depreciation for three years would be

Rs.21680. There would be saving of Rs.2320 (24000-21680) on account of change in the method ofdepreciation. To that extent profit would increase along with the WDV of the fixed asset.

3 A firm purchased machinery worth Rs_76000 on January 01, 2003 and its life is expected tobe 8 years, with scrap value at the end Rs.12000. What is amount of depreciation.

Solution Depreciation = (Cost-Scrap value) / no. of years of expected economiclife = 76000-12000 / 8 = Rs.8000 per annum

4 A company purchased machinery worth Rs.4.00 lac on July 1st, 1999 and depreciation was providedat 10% p.a. on SLM basis with yearly closing of Dec 315t. The company changed the method ofdepreciation wef Jan 01, 2001 from SLM to WDV with change in depreciation rate to 15%. On July01, 2002 the machinery was sold for Rs.2.40 lac. What is the amount of loss or profit to thecompany ?

Solution -Original valueDepreciation up to 31.12.1999

= Rs.4.00 lac= 20000(for1/2year)

Depreciation for the year ended Dec 00 = 40000Depreciation for y.e. Dec 2001 @ 15% wdv =51000 (for Rs.340000)Depreciation for 6 m ended June 30, 02 = 21680 (for Rs.289000)Sale price realised = 240000Total of all items above = 372680Loss on sale = 27320Total = 400000

5. A firm purchased certain machinery on January 01, 2003 for Rs.1 lac. It added more machinery onJuly 01, 2003 for Rs.50000. 1/2 of the machinery purchased on January 01, 2003 was sold forRs.25000 on Dec 31, 2004. The rate of depreciation is to be assumed 20% and the annual closingof accounts as on Dec 31. Find the value of machinery as on Dec 31, 2004.

Solution :WDV of 1st machine as on Dec 31, 2004 would be Rs.30000 as under:

Original value = 1,00,000 2 years' depreciation @ 20% = 40000Hence, WDV = 60,000Sale of IA of machinery : Rs.25000Loss on sale of machinery= 30000-25000 = 5000Hence WDV = 600000-30000= 30000WDV of 2nd machinery : Original value = 50,000 depreciation of1-1/2 year i.e. Rs.5000 + 10000 = 15000.WDV = 50000 15000 = 35000Total WDV : 30000 + 35000 = 65000

FOREIGN EXCHANGE ARITHMETIC

DIRECT QUOTATION

In a direct quotation, there is a variable unit of the home currency and fixed unit of the foreign currency.When it is quoted that 1 US = Rs.49.10, it is a direct quotation. With a view to make profit, the rulefollowed for quotation is buy low and sell high. For instance, if the US $ is purchased at Rs.48.90 andsold at Rs.49.10, there will be gain to the dealer. By buying low, the dealer will be required to pay

lesser units of home currency and by selling high, he would receive more units of home currency.INDIRECT QUOTATION

In an indirect quote, there is fixed unit of home currency and a variable unit of foreign currency. WhenRs.100 = US $ 2.04 is quoted, it is a case of indirect quotation. The principle followed in indirect


quotation to earn profit is to buy high and sell low. By buying high, the dealer will get more US $ perRs.100 and by selling low he would have to part with lesser US $.

Direct Rates Indirect Rates1 US $ = Rs.49.40 Rs.100 = US $ 2.51

TWO WAY QUOTATIONS : Banks quote two rates in foreign exchange quotation out of which one is forbuying and the other for selling. For instance, when the quotation is US $ 1 = Rs.48.90 - 49.10, the buyingrate on the basis of principle of buy low and sell high, would be Rs.48.90 and the selling rate Rs.49.10.The buying rate is also called a 'bid rate' and the selling rate as 'offer rate'.

CROSS RATES OR CHAIN RULE : When rate between two currencies is not directly available, it hasto be calculated through a 3rd currency which is called cross rate. This is done by using chain rule.For example, US $ 1 = Rs.50.00 and US $ 1 = Euro 0.7500. Euro 1 = 50 / 0.75 = Rs.66.67

A bank is offered to purchase an export bill of Pound 100000 and the inter-bank rates are US $1 = Rs.50.00/10 and Pound 1 = US $ 1.5000/10.

In this case, the bank will purchase pounds at given US $ rate of Rs.50 and deliver rupees to exporter.Bank will sell pounds in London in inter-bank market at US $ 1.50. The amount will be worked with chainrule. Pound 1 = 1.50 x 50 = Rs.75.

SPOT TRANSACTIONS & FORWARD TRANSACTIONSIn a contract, the actual payment in rupees and receipt in say US $ may take place on thesame day, two days later or a month later.

Value date : While quoting the rates, the banks take into account the time factor i.e. how much is goingto be taken to get the purchased currency credited to the NOSTRO account abroad. This date is knownas value date. There are three time frames for this i.e. cash value, torn value and spot value.Cash Value : When the payment is rupees and receipt in US $ takes place on the same day, it iscalled a cash transaction or value today.Tom value and spot value

When the payment is rupees and receipt in US $ takes place after some time (due to timeinvolved in administration of the transaction) it may be torn rate (where deal is settled on theimmediately succeeding working day) and spot transaction when it is settled within 48 hours.

Date of Contract Delivery Date / settlementdate

Rate to be used

Oct 12, 2008 Oct 12, 2008 Cash/ Ready Rate

Oct 12, 2008 Oct 13, 2008 Tom Rate

Oct 12, 2008 Oct 14, 2008 TT or Spot Rate

Exchange margin While selling or buying foreign exchange banks retain sufficient margin to cover theadministrative cost, cover the exchange fluctuation and also to make some profit on the transaction. This isdone by adding or reducing the margin from the prevailing market rate.The exchange margins were previously prescribed by FEDAI. These were (a) 0.025% to0.080% for TT purchase rate (b) 0.125% to 0.150% for bills purchase rate (c) 0.125% to 0.150%for TT selling rate and (d) 0.175% to 0.200% for bills selling rate.

Fineness of the quotation : At the time of calculation of merchant rates, the calculation can beup to 5 decimal places which are rounded off to the nearest multiple of 0.0025. A dollar rate of42.12492 will be rounded off as 42.1250Problem-I: A mail transfer is received on June 15, by International Bank from its correspondent bank inNew York for $ 10000 which is to be paid to saving bank customer of the bank. The correspondent bankhas credited the International Bank's account for an equal amount. Calculate the exchange rateassuming that (a) inter-bank spot rate is 1$ = 42.25/42.27 (b) bank requires an exchange margin of0.080% (c) rounding to be done in nearest rupee.


Solution : (1) Rate to be applied = TT buying rate (bank has received the foreign exchange)=42.2500(2) Less exchange margin @ 0.080% on the rate of 42.25 = 00.0338

Rate payable (1 2) = 42.2162Amount payable for $ 10000 = Rs.422162

Forward rate calculation : Premium is added to the spot rate to work out the forward rate.Discounted is deducted from the spot rate. This makes the transaction beneficial to the bank. The forward premium includes interest differential.

While calculating the bills buying rate, where the forward is at a premium, the bankwill round off the transit and usance period to the lower month.

While calculating the bills buying rate, where the forward is at a discount, the

bank will round off the transit and usance period to the higher month.

Forward rates are quoted though forward margins or forward differentials (which can beeither premium or discount). For example Euro 1 = US $ 1.2000/10. One month forward30-28, 2 month forward 60-55 and 3 months forward 95-90.

In this case Euro is at a discount and in that case, the US $ is at a premium.In this case, the one month forward US $ can be purchased at the following rate:Spot Euro 1 = US $ 1.2010 0.0028 = 1.1982In this case, the one month forward Euro can be sold at the following rate:Spot Euro 1 = US $ 1.2000 0.0030 = 1.1970

Premium or discount on forward transactionsThe forward rate of a currency is normally either costlier or cheaper than its spot rate. Thedifference between the spot rate and forward rate is called forward margin or swap points.When the forward margin is at premium the forward rate will be higher/costlier than the spotrate. Similarly, if the forward margin is at a discount, the forward rate shall be lower orcheaper than the spot rate.Under a direct quotation, the premium is added to the spot rate for reaching the forwardrate and discount is deducted from the spot rate to arrive at the forward rate.If US $ is quoted on a particular day as spot at US $ 1 = Rs.48.90/49.10, this wouldbe interpreted as buying rate of Rs.48.90 and selling rate as Rs.49.10.Factors such as (a) rate of interest prevailing at home centre and the concerned foreigncurrency centre, (b) demand and supply position of the foreign currency, (c) speculationabout spot rates and (d) exchange control regulations generally determine the premium ordiscount.

Forward Premium Forward discountSpot rate 1 US $ = Rs.48.10Forward 1 US $ = Rs.48.30

Spot rate 1 US $ = Rs.48.10Forward 1 US $ = Rs.48.00

Forward Points: Forward rate comprises spot rate and forward points being interest ratedifferentials. For example if spot rate is Euro 1 = US$ 1.4000 and 3 months forward is 1.4300,the difference of 200 points is called forward point. The forward point is determined by (a)supply and demand position of the currency (b) market expectation (c) interest rate differencebetween two countries.

How to calculate forward differential : Euro 1 = US $ 1.40, Euro Interest rate is 6% and US$rate is 12%. If a person borrows Euro 100 for year and by converting these into US$ invests asdeposit for one year, the flow will be as under:

(1) Euro Spot borrowing 100 + interest 6. Total outflow = 106

(2) US $ - Gets 140 US$ (for 100 Euro at 1.40) + get interest of 12 for one year = 152(3) If US $ 152 are converted into Euro at 1.40 = 108.57. Hence gain (1) (3) = US$ 2.57


In this case the Euro 106 = US$ 152. Hence Euro 1 = 1.4340Here the difference between the spot rate 1.40 and 1.4340 = 0.340 is the forward differential.

How to calculate forward points (or the SWAP cost) : Euro 1 = US $ 1.40, Interest ratedifferential is 6%. For a 90 days forward calculate the forward points.Spot rate = 1.40. Int differential = 6% Forward period = 90 days (no. in a year to be taken

360 days) Forward points = (Spot rate x interest rate differential x forward period) I no. ofdays in the year x 100 = (1.4000 x 6 x 90) / 360 x 100 = 0.0210.

How to calculate interest differential from forward points : In the above example, thecalculation can be made with the help of formulae:Interest rate differential = (forward points x no. of days in the year x 100) / (Spot rate xforward period) = (0.0210 x 360 x 100) / 1.40 x 90 = 6%

How to quote forward rate:The forward can be at premium or forward can be at a discount. Incase of direct quotation, the premium is added in the spot rate and discount is deducted from thespot rate both in the buying or selling rate.

When there is premium : Let us take an example. Euro/US$ spot rate = 1.3200/20 and forwarddifferential one month 20-25, 2 months 40-45 and 3 months 60-65. This shows that Euro is at apremium here.

A. 2 month Euro buying rate (bid rate) = 1.3200 + 0.0040 = 1.3240 and selling rate (offer rate) =1.3220 + 0.0045 = 1.3265.Hence, the bid and offer rate would be = 1.3240/65

When there is discount : Let us take an example. Euro/US$ spot rate = 1.3200/20 and forwarddifferential one month 25-20, 2 months 45-40 and 3 months 65-60. This shows that Euro is at adiscount here.

A 2 month Euro buying rate (bid rate) = 1.3200 - 0.0040 = 1.3160 and selling rate (offer rate) =1.3220 - 0.0045 = 1.3175.Hence, the bid and offer rate would be = 1.3160175

Test your self01 Which of the following is a direct quote:a 1 Pound sterling = US $ 1.70 b 1 US $ = Rs.48.90 c Rs.100 = US $ 2.10 d a and b02 Which of the following is a direct quote:a 1 Pound sterling = US $ 1.70 b 1 US $ = Rs.48.90 c Rs.100 = US $ 2.10 d a and c03 A person wants to remit Euro and there is no quotation with the bank for Euro. Bank works outthe rate through Re/$ rate and $/Euro rate. This is called:a bid rate b offer rate c cross rate d floating rate04 Forex rate in Delhi is 1 US $ = 48.80/90. In London the 1 US $ = 0.60 pound sterling. What isthe buying rate for Re/Euro. a 81.51 b 81.33 c 80.67 d 80.34 (Hint-48.80 / 0.60)05 Forex rate in Delhi is 1 US $ = 48.80/90. In London the 1 US $ = 0.60 pound sterling. What isthe selling rate for Re/Euro. a 81.51 b 81.33 c 80.67 d 80.34 (Hint-48.90 / 0.60)06 Forex rate in Delhi is 1 US $ = 48.80/90. In London the 1 Euro = US $ 1.60/65 pound sterling.What is the cross rate for Euro. a 78.08 b 77.92 c 77.65 d 77.0207 Forex rate in Delhi is 1 US $ = 48.80/90. In London the 1 Euro = US $ 1.60/65 pound sterling.An exporter wants an export bill of Euro 50000 to be purchased by the bank. E-low much amountwill be given to the exporter in domestic currency.a 3851000 b 3882500 c 3904000 d 389600008 If the exchange of currencies (delivery) is to be completed on the same date, which of thefollowing rates will be used: a cash or ready rate b TOM rate c Spot rate d Forward


09 if the exchange of currencies (delivery) is to be completed on the next date i.e. tomorrow,which of the following rates will be used:a cash or ready rate b TOM rate c Spot rate d Forward10 If the exchange of currencies (delivery) is to be completed on the 2rid working day, which ofthe following rates will be used:a cash or ready rate b TOM rate c Spot rate d Forward11 If the exchange of currencies (delivery) is to be completed after the spot date, which of thefollowing rates will be used:a cash or ready rate b TOM rate c Spot rate d Forward12 Spot rate is 1 US $ = 48.10 and 2 months forward is available at 1 US = 48.50.a Forward is at a premium b Forward is at a discountc Spot is at a premium d Spot is at a discount

13 A foreign exchange sale purchase agreement is made on January 04, 2009 and deliveriesare completed on Jan 05, 2009. Which of the following rate will be applied:a cash or ready rate b TOM rate c Spot rate d Forward14 1 Euro = US $ 1.3280/90. One month forward = 36-33, 2 month forward = 73-71. If bank hasto buy one month forward, the rate will be: a 1.3158 b 1.3212 c 1.3257 d 1.3299 (Hint-Here the Euro is at a discount i.e. $ at a premium. To purchase the base rate would be 1.3290less premium 0.0033)15 1 Euro = US $ 1.3280/90. One month forward = 36-33, 2 month forward = 73-71. If bank hasto sell one month forward, the rate will be: a 1.3244 b 1.3208 c 1.3158d 1.3136 (Hint-Here the Euro is at a discount i.e. $ at a premium. To sell the base rate would be1.3280 less premium 0.0036)16 1 Euro = US $ 1.3280 spot and forward rate is US $ 1.3480. The difference of 200 points inthis case is called: a exchange difference b forward discount c forward premium dforward points17 1 Euro = US $ 1.60. Interest for Euro is 4% and for US $ 6%. A person borrows Euro$ 100one year. Assuming that there is no change in Euro and $ rate, what will be gain of the personborrowing in Euro and converting them in $ and after one year converting $ into Euro.a Euro 1 b Euro 2 c Euro 3 d inadequate information(Hint-On 100 Euro interest for one year is Euro 4 hence total outflow of Euro is 104. On the otherhand, on $ 160 interest at 6% will be $ 9.60. Hence total $169.60 which at exchange rate of 1.60is converted into Euro 106. Accordingly gain is Euro 2 i.e. 106-104)18 In the above problem, what will be Euro-$ rate (i.e. forward rate).a 1 Euro = $ 1.6403 b 1 Euro = $ 1.6352 c 1 Euro = $ 1.6308d 1 Euro = $ 1.6286 (Hint-169.60/104)19 In the above problem what is the forward differential between spot and one year forward: a0.0308 b 0.0312 c 0.0326 d 0.0343 (Hint-Forward rate - spot rate = 1.6308 - 1.6000)20 1 Euro = US $ 1.40. Interest for Euro is 3% and for US $ 6%. A person borrows Euro$ 100one year. Assuming that there is no change in Euro and $ rate, what will be gain of the personborrowing in Euro and converting them in $ and after one year converting $ into Euro.a Euro 1 b Euro 2 c Euro 3 d inadequate information

1 B 2 C 3 C 4 B 5 A 6 A

7 C 8 A 9 B 10 C 11 D 12 A

13 B 14 C 15 A 16 D 17 B 18 C 19 A 20 C


MODULE BPRINCIPLES OF BOOK-KEEPING & ACCOUNTANCY

Syllabus

Definition, Scope and Accounting Standards : Nature and Purpose of Accounting;Historical Perspectives; Origins of Accounting Principles; Accounting Standards in Indiaand its Definition and Scope; Generally Accepted Accounting Principles of USA (US GAAP);Transfer Pricing; Overview of IFRS; Difference between GAAP & IFRS.

Basic Accountancy Procedures : Concepts of Accountancy; Going Concern Entity;Double Entry System; Principle of Conservatism; Revenue Recognition and Realisation;Accrual and Cash Basis. Maintenance of Cash/Subsidiary Books and Ledger RecordKeeping Basics; Account Categories; Debit and Credit Concepts; Accounting andColumnarAccounting Mechanics; Journals; Ledgers; subsidiary books; etc.

Bank Reconciliation Statement : Need for Bank Reconciliation; Causes of Differences;Preparation of Bank Reconciliation Statement; How to prepare a Bank ReconciliationStatement when Extracts of Cash Book and Pass Book are given; Adjusting the Cash BookBalance; Advantages of Bank Reconciliation Statement.

Trial Balance, Rectification of Errors and Adjusting & Closing Entries : Meaning of aTrial Balance; Features and Purpose of a Trial Balance; Types of Trial Balance andPreparation of a Trial Balance; Disagreement of a Trial Balance; Classification of Errors;Location of Errors; Rectification of Errors; Suspense Account and Rectification;rectification of Errors when Books are closed; Adjusting and Closing Entries.

Capital and Revenue Expenditure : Expenditure; Distinction between Capital andRevenue Expenditure; Deferred Revenue Expenditure; Receipts; General Illustrations.

Bills of Exchange : Types of Instruments of Credit; Term and Due Date of a Bill; CertainImportant Terms; Accounting Entries to be Passed; Accommodation Bill etc.


DEFINITION, SCOPE AND ACCOUNTING STANDARDSAccounting: An art of recording, classifying and summarising in a significant manner and in termsof money, transactions and events, that are, in part at least, of a financial character andinterpreting the results thereof.Financial Statement: A set of documents that shows the results of business operations during aperiod, how the results were achieved and the position of assets and liabilities on a given date. Itnormally means the balance sheet, profit and loss account, statement of changes in the financialposition (which may be either a fund flow statement or a cash flow statement), explanatorystatements, notes and relative schedules forming part of financial statement.

BOOK-KEEPING : Book-keeping means maintenance of a proper and systematic record of books ofaccount by a business enterprise, which means that it is a process of making original records. Alltransactions are recorded in the books of the business in terms of their monetary value after properverification. It involves 4 activities i.e. (a) identifying the transactions of financial character from amongstvarious other transactions, (b) measuring them in terms of money, (c) recording them in the books ofprimary entry and then (d) classifying them.It has nothing to do with the interpretation of such accounting and is different from accounting.

ACCOUNTING : Accounting on the other hand has a large scope and begins where the book-keepingends. It is a long process which begins with summarizing the already recorded transactions, interpretationof all business transactions or statement and communicating the results to the interested parties.Accounting can be classified as (a) financial accounting, (b) cost accounting and (c) managementaccounting.

Basic objective of accounting : To maintain records of business,To make calculation of profit or lossTo depict the financial position, To make the financial information available to the management and other interestedgroups of users of the information.

VARIOUS KINDS OF ACCOUNTINGFinancial Accounting : This accounting system is concerned with the financial state of affairs of abusiness. The results of the financial operations are called Financial Accounting. It includes working outthe profits or losses and net worth. Financial accounting is done more for the use of the owners,creditors, regulatory authorities, taxing authorities and investors etc. and is done on a post-facto basis.Further it should be accurate as it is subject to audit.Cost Accounting : It involves estimating the cost in advance. This accounting helps in analyzing theexpenditure involved with a view to ascertain the cost of various products produced by an organisationfor the purpose of fixation of their prices and exercising proper control over the cost being incurred.Management Accounting : Management accounting is the process of identification, measurement,classification, analysis, preparation, interpretation and communication of information that assists themanagement of a business in taking decisions for fulfillment of business objectives. It is meant for thebusiness managers who require detailed meaningful information for decision making and is prospectivein nature i.e. estimates for future.

BASIC ACCOUNTING CONCEPTSThe accounting framework on the basis of which the statements are prepared is based oncertain elements which are popularly known as concepts or principles or rules, such as:

a: Entity conceptb: Money measurement conceptc: A going-concern conceptd: Cost concepte: Conservatism conceptf: Dual aspect conceptg: Accounting period concept


h: Accrual conceptI: Realisation conceptJ: Matching conceptk:: Materiality concept.l : Consistency conceptm: Full disclosure concept

Entity concept : For the purpose of accounting, a business concern is considered to be an entity, separate from thepromoters, owners, share-holders, investors etc. For example, when A puts in Rs. 1 lac in a business, it would beconsidered that he has given Rs. 1 lac to his business, which his business would show as an amount payable (orliability) to A. In other words the accounts are maintained for this entity as distinct from the person(s) connected with it.Although this distinction is easily understandable in case of company cases, but at times confusions get created inrespect of proprietary or partnership concerns. Whatever the position, the recording of transactions has to be in termsof their effect on the business entity considering the owners, creditors, suppliers, customers etc. as the partiestransacting business with the entity.

Money measurement concept :Accounting is done for those transactions only which can be expressed in monetaryterms and this makes the heterogeneous elements such as land, plant, machinery, building, stocks etc. comparablemeaningfully. The aspects or the events which cannot be expressed in monetary terms cannot be accounted for,howsoever important those may be. For instance, the quality of the operations (a liability if poor and an asset if good)or the quality of efforts of the staff and dedication with which these are put in (liability if put in without dedication but anasset if put in with complete dedication) cannot be recorded in monetary terms, hence, do not find place in theaccounting.This concept also becomes important in understanding the state of affairs of the business. For instance, if twobusiness concerns have the piece of land of the same size but located at different places and purchased on thesame date, it may be taken as an asset having equal value unless value is specified. But when monetary value isexpressed, the financial worth of the entities may come out to be different.

Going concern concept : The accounting is based on the premise that the entity would remain a going (continue tobe in business) concern for an indefinitely long period and not a concern which is likely to be wound up in near futureand the promoters or any one else, has no intention to liquidate the business in a foreseeable future.This is essentialbecause the assets are normally recorded and carried in the books at their cost less depreciation and not at theirliquidation (realisable) value. For a concern which is to continue in business, the value is equal to the cost lessdepreciation, if any. Similarly the liabilities are carried at values that reflect what the business owes and not atvalues for which the creditors would settle for, in case of liquidation.As a matter of exception, at times the businessentity reflects certain signals which point out that the concern is unlikely to remain a going concern or likely to ceaseits activities. The accounting for such business concern has to be done taking into account the fact that it is ceasingto be a going concern and the assets have to be taken at realisable value.

Cost concept : Assets which a business entity may acquire would generally be recorded at their cost i.e. theamount or the price at which the acquisition has been affected. This cost becomes a reference point for allsubsequent accounting and a small example would clarify the matter. An asset purchased at Rs. 1 lac would berecorded in the books at Rs. 1 lac in spite of its value increasing or decreasing for any reasons, over a time period.The concept of cost, brings in objectivity in reckoning the value of the assets in the absence of which subjectivity caninfluence the accounting. For instance, in the above example, the value of the asset for A could be Rs. 90000 and forB (depending upon his own information, perception or consideration) it may be Rs.1.20 lac. In the preparation ofaccounts by A, he is likely to take into account the asset at Rs. 90000 while by B, the value may be taken at Rs. 1.20lac. Similarly the inflationary or deflationary conditions may create accounting problems in respect of the assets heldby the business for use over a long period.

Conservatism concept: Closely related to the cost concept is the concept of conservatism which modifies the costconcept in respect of current assets. The concept stipulates that no profits should be anticipated (as these maymaterialise or not and may result in non-acceptance of accounting figures by the users), but all possible losses mustbe accounted for. The current assets, as per this concept, are

generally valued at cost price or market price, whichever is lower. The concept itself may appear to be not in line with


the general accounting principle of consistency on the basis of cost or market value, but the practice followed by theaccountants is generally conservative even at the cost of consistency. The adoption of this principle also helps increation of secret reserves and to that extent it may be said that the financial statements do not reflect or depict thetrue position of the business. However, when the conservatism is applied with due caution, care and soundjustifications, the position becomes more acceptable.Dual aspect concept : This concept of accounting is the most fundamental and provides the conceptual basis foraccounting mechanics. Because of this concept the resources owned by an entity should be equal to the liability,since each transaction has two aspects. A simple example would clarify the matter. Let us assume that Z contributesRs. 50000 as cash to his business which is placed by the business entity in a bank. The accounting records of thetransaction reflect this amount as owner's equity on the liability side and the deposit in the bank, as the asset. If asum of Rs. 10000 is spent out of the above amount to purchase stocks, the amount of Rs. 50000 would still beshown as the liability and Rs. 40000 as bank deposit and Rs. 10000 as stocks on the assets' side. If a loan of Rs.15000 is raised to acquire fixed assets worth Rs. 35000 (and a part of bank deposit is used to purchase these fixedassets), the position would be reflected as under:

Owner's equity Rs. 50000 Fixed Assets Rs. 35000Loan raised Rs. 15000 Stocks Rs. 10000

Bank deposit Rs. 20000

Total Rs.65000 Rs.65000

This also is known as the principle of double entry, in book keeping.

Accounting period concept :Though a business continues indefinitely according to the going concern concept,.but its performance measurement has to be done after a reasonable time period and not after a long or uncertainperiod of time, which would not be desirable since it may create a position of uncertainty. Hence, the business issegmented into appropriate parts for judging the performance shown in each such identified segment. Suchsegment is known as an accounting period, say of a year or a quarter or an half-year. At the close of suchaccounting period, financial statements are prepared.

Accrual concept :This concept takes into account the accounting of receipt or payment or otherwise recording atransaction (which actually might have taken place/ materilised or not), to be considered as part of and relating tothe accounting period. For example, the business may raise a loan from a bank, the interest on which is payable tothe bank immediately after the close of the accounting period. In the accounting period, a provision on accrualbasis would be required to be made irrespective of the fact that the payment would be made after the close ofaccounting period. This is generally done in respect of profit and loss or trading and manufacture account. Apayment or receipt account on the other hand, reflects actual receipt and payment and does not generally take intoaccount the accrual.

Realisation concept :This concept gives recognition to a particular transaction as having been complete at aparticular point of time, when the benefit is actually passed on to the party to whom it is due. For instance, if Z, inorder to sell goods to Y purchases raw material, the goods would not be considered to be have passed on to Yunless these are actually delivered.

Matching concept : This concept

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