ANSWER

1.

If investors want to compare the financial statements of different organizations, then there needs to
be some commonality so that two totally different businesses from different industries even from
different countries can be compared.

This is important because when you want to invest in companies, you need higher returns and
therefore investor needs to understand and compare the profit, losses, size, growth and other
important parameters of the companies.

One cannot compare financial statements of different organizations directly as that can lead to
incorrect judgements due to difference in currency values, size of company. Therefore common size
analysis is used for decision making were common size financial statements are preared. In this, all
financial statements are reported in form of percentage.

Base figure is taken which is divided with all items in the statement and are reported as percentage
of gross sales.

Reasons to use Common Size analysis are:
1. Comparision can be done between different periods.
2. Comparison can be done among competitors
3. Comparing financial statements with global companies where currency is different

Towo types of common size analysis are:
1. Horizontal Common Size Analysis

It uses one type of financial statement at a time. It compares several consecutive years, usually 3 and
more to measure long-term trends in the organizations growth and performance.
Baseline year is compared with following years and we can see the growth pattern.

Current
Previous Year Percentage ( Year Percentage
2016 2016 ) 2017 ( 2017 )
Net sales 975 100.00% 1200 123.08%
Less: Cost of goods sold 438.75 100.00% 600 136.75%
Gross profit 536.25 100.00% 600 111.89%
Less: Selling and distribution
Exp. 140 100.00% 180 128.57%
Operating Profit 396 100.00% 420 106.06%
Less: Interest expenses 101 100.00% 126 124.75%
Earnings before taxes 295 100.00% 294 99.66%
Less: Taxes 118 100.00% 117.6 99.66%
Earnings after taxes 177 100.00% 176.4 99.66%

We perform the calculations as follows:
1. ((Net Sales in 2017) / (Net Sales in 2016) )* 100 = 123%
2. ((Cost of Goods Sold in 2017) / (Cost of Goods Sold in 2016) )* 100 = 136%
3. ((Gross Profit in 2017) / (Gross Profit in 2016) )* 100 = 111.8%
 and so on.

In this, we can observe that Net Sales have drastically growth from 975 to 1200 which means net
sales has grown to 123% in 1 year. Likewise, COGS has growth to 136%, Gross Profit has grown to
111%, Operating Profit has grown to 106%. The only components which displayed minuscule
reduction are Earnings before taxes, Less: Taxes, Earnings after taxes.

2. Vertical Common Size Analysis

It refers to propotional analysis of the financial statements. In Vertical common size analysis,
each item is recorded as percentage of base item which is the gross sales ( whenever Income
Statement is taken ) and when Balance sheet of the organization is undertaken, total Assets is
taken as base and is divided with each of the items in the financial statement.

In the question below,since it is an income statement, we have taken Net Sales as the Base
value and each of the items such as COGS, Gross profit, Less: Selling and Distribution
expenditure, operating profit, all are divided by the Net Sales to calculate the percentage.

Vertical Common Size Analysis of Income Statement 1:

Previous Year Percentage (

2016 2016 )
Net sales 975 100.00%
Less: Cost of goods sold 438.75 45.00%
Gross profit 536.25 55.00%
Less: Selling and distribution Exp. 140 14.36%
Operating Profit 396 40.62%
Less: Interest expenses 101 10.36%
Earnings before taxes 295 30.26%
Less: Taxes 118 12.10%
Earnings after taxes 177 18.15%

Vertical Common Size Analysis of Income Statement 2:


Current Year Percentage (
2017 2017 )
Net sales 1200 100.00%
Less: Cost of goods sold 600 50.00%
Gross profit 600 50.00%
Less: Selling and distribution Exp. 180 15.00%
Operating Profit 420 35.00%
Less: Interest expenses 126 10.50%
Earnings before taxes 294 24.50%
Less: Taxes 117.6 9.80%
Earnings after taxes 176.4 14.70%
For deeper analysis, users can also take total liabilities as the base for calculating the liabilities in the
balance sheet.

Findings:
1. Operating Profit has increased in 2017 as compared to 2016.
2. Earnings after tax with respect to sales have decreased.
3. Net sales have increased but with respect to Net sales in 2017, comparing with 2016, it has
decreased.

So, this is how we convert any financial statement into a common size income statement.




ANSWER 2.

Matching concept is the accounting practice in which businesses recognize revenues and their
expenses in the same accounting period.

Purpose of the matching concept is to avoid misstating earning for a period as then the
profit and losses will be wrongly shown in financial statements. Also, all expenses should be
mapped in the same accounting period or else the profits will be overstated which will lead to
false assumptions about companys growth.
Matching concept requires accrual accounting which means that the moment the revenues
are earned or expenses are done, they are recognized then only. Actual cash flow may occur
later too.
Profits can be defined as the difference of Revenue and Expenses.
Expenses of any previous year should not be factored in the current accounting year so
income or expense done prior or later should not be included in the current years
calculations.
Therefore it is prudent that Mr. Ramchandani matches the expenses done with the revenues
his business generated to calculate the net profit failing in which the profits or the expenses
can be overstated or understated.

There are two types of Expenditures:
1. Capital Expenditure
a. It can be used for long term and its effect is reduced gradually over years. It doesnt
occur over and over.
A part of this expenditure is entered in the trading and P&L account or the Income and
expenditure account as depreciation.
b. It is shown in balance sheet till it is fully exhausted.
c. It wont reduce the revenue.

2. Revenue Expenditure
a. It can be used for short period i.e. it is temporary.
b. It needs to be purchased again and again.
c. This expenditure helps in operations.
d. Whole amount is shown in trading and P&L account
e. It reduces revenue. Payments of salaries to employees decreases revenue.
 f. This is a cost which is included in the accounting year when it happened.
g. In any factory plant when repairs are done or any maintenance work is done so these
costs are added to the Repairs and Maintenance Expense.

CASE OF THE QUESTION
1. Mr. Ramchandani purchased a Shaper Jet 3D printer for INR 90,000 and also some printer
cartridges and ink for INR 10000
2. As we know that Printers are machines which stays usable for long time so it is a long term
asset. It is a Capital expenditure.
3. Cartridges and Inks are consumables and are used by the printers. So it is revenue
expenditure. It will be charged in the repairs and maintenance expense.

We will treat the expenditure by preparing the financial statements as below:
1. Since Capital expenses and revenue expenses are different , we cannot have them in same
financial statement.
2. Capital expenses ( Printer ) will be added to the assets side of the balance sheet.
3. Revenue expenses ( Cartridges ) will be debited to Repairs and Maintenance Expense
account.
Depreciation
- Whenever the value is decreased of any asset, due to age, usage, it is called Depreciation. We
provide this to:
o Calculate true profit and loss
o To adjust for the replacement of assets which will be worn out completely

To calculate the depreciation, we have two methods:
1. Straight Line method In this method the depreciation will be fixed for every year at the
rate mentioned of the Asset Purchase Price.
a. In this, in every successive year, we are reducing the 10% of the cost of the capital
expense which is the cost of printer ( i.e. INR 90000 * 10% = INR 9000 )

Printer's Printer's Printer's Printer's
Value of Value in Value in Value in Value in Printer's Value
Printer 2nd year 3rd year 4th year 5th year in 6th year
90000 81000 72000 63000 54000 45000

2. Written down Value Method Depreciation will be taken at the residual amount at the end
of each year after the depreciation done amount.
a. In this the scrap value is ignored.
b. In every successive year, 10% of the cost is reduced and added to the expense which
reduces the profit of that particular year.

Printer's Printer's Printer's Printer's
Value of Value in Value in Value in Value in Printer's Value
Printer 2nd year 3rd year 4th year 5th year in 6th year
90000 81000 72900 65610 59049 53144.1





ANSWER 3a.

Accounting Standards They are the primary source of GAAP which is acronym of generally
accepted accounting principles.
They help in standardizing the Accounting process globally. They are authorized standards for
reporting the transactions and creating the financial statements of different types.




ANSWER 3.b

Rectification of error In accounting, every monetary transaction is recorded. At times, the entries
goes to wrong head or they are missed and thats when we fix those through the concept of
Rectification of Error.

How to rectify the errors?

There are two types of errors which are as follows:
Error of Omission This is the common type of error in which the event is escaped from getting
recorded. This means that though the event happened, we didnt record it.
For example, the bank charges were deducted without our knowledge but they didnt mention it in
the statements. This is Error of Omission.

Error of Commission When event has happened, is even classified and recorded correctly but in
the wrong classification. For example: When A payment to Mr. Ram is the debtor, is recorded in the
account of Mr. Shyam who is also a debtor. This classification is correct but entry is posted in wrong
account.

Error of Principle : When errors in which entry is recorded in the wrong class of account. Purchase
of fixed asset is recorded in the expense account.

Error of Original Entry : When errors happened in the figures as for example a receipt of INR
50,000 from debtor is recorded as INR 5000 in his account.

1. Errors can be rectified by passing opposite entries to erroneous entry and whenever there is
the error of omission, we pass the omitted transaction.
In the first case,

Paid INR 15000 for advertisement but debited to electricity expenses so we have to credit it from
electricity expense and debit it to the advertisement account.

Date Particular LF Debit Credit

Advertisement A/c ..........Dr 15000
To electricity account 15000


2. In this cash sales entry of INR 250000 is omitted and therefore we can to pass the correct
entry.

Date Particular LF Debit Credit

To Cash A/c Dr 250000
To Sales A/c 250000