DEPARTMENTAL EXAMINATION OF INDIAN REVENUE SERVICE (C & CE) GROUP A PROBATIONERS- April-May 2009

PART-1- PAPER IV ELEMENTS OF ACCOUNTANCY AND AUDIT(WITHOUT BOOKS)

(Solved)

Q1) Trading and Profit & Loss account and Balance Sheet Trading and Profit & Loss account for the year ended 31st March Particulars To Opening Stock To Purchases 67,000 Less: Return outwards 8,000 To Carriage inwards To Gross Profit c/d To carriage outwards To wages 15,000 Add- outstanding2,500 To salaries To bad debts To electricity Charges To rent To depreciation To Net Profit Amount Particulars 9,000 By Sales 2,28,000 67,000 Less: Return inwards 6,000 By Closing Stock 59,000 3,000 Amount 2,22,000 7,000

1,53,500 2,29,000 3,000 By Gross profit b/d 17,500 6,500 4,500 7,250 10,000 7,500 97,250 1,53,500 Balance Sheet as on 31st March 2008

2,29,000 1,53,500

1,53,500

Liabilities Capital account Less: Drawings

Amount 75,000 20,000

Assets Building Plant & Machinery 75,000 Less: Depreciation 7,500 Sundry debtors

Amount 1,00,000 67,500 65,000

Add: Net profit 97,250 Bank Overdraft Sundry Creditors Bills Payable Wages Outstanding

1,52,250 48,750 78,000 12,000 2,500 2,93,500 Bills receivable Furniture Stock Cash 7,000 35,000 7,000 12,000 2,93,500

Q2)

TRIAL BALANCE

PARTICULARS Goodwill Machinery Capital Discount Received Purchases Sales Furniture Rent Wages Carriage Inwards Returns Inwards Bad debts Bank Opening Stock

DEBIT (Rs.) 65,000 48,000

CREDIT (Rs.)

1,02,000 3,000 89,000 2,05,000 10,000 12,000 21,000 4,000 6,000 2,500 46,000 6,500 3,10,000 3,10,000

Q3) (i) State whether True or False:a) False, In a Trial Balance loan is shown as a credit entry. b) False, Financial Accounting is of immense use to managers. c) False, CERA Audit cannot be debarred by Excise Act. d) True, as Wages outstanding is a liability.

e) True (ii) Depreciation refers to permanent and continuous decrease in the book value of a Fixed or Tangible asset due to use, effluxion of time, obsolescence etc. Physical wear and tear and Passage of time is prime causes of depreciation. E.g. Plant & machinery, Buildings Amortization refers to economic deterioration by the expiration of intangible assets like patent, copyright, trademark etc. in a systematic manner over their useful life. It reflects the consumption, expiration, obsolescence or decline in the value of intangible asst. (iii) Income tax act depreciation chart is given in Sec. 32 of Income Tax act 1961, and is required for the computation of 'income from business and profession' as per income tax act. Whereas companies act, 1956 Schedule XIII gives the depreciation rates as per companies act. This chart is applicable only to companies. Under the Income Tax Act, depreciation is charged on block of assets or group of assets rather than on individual assets as under Companies Act. Under Income Tax Act, written down value method of charging depreciation is used except in case of power generating and distributing unit where as under Companies act both written down value and straight line methods are used for charging depreciation. Unabsorbed depreciation, if remains unadjusted from the income of that year can be carried forward to the next year under Income Tax act but this is not applicable to depreciation under Companies act.

Q4) ABC analysis The ABC tool is used to identify the vital few from the trivial many, according to a defined set of criteria (e.g. annual expenditure, number of orders, number of claims, occupied space in the inventory, etc.). Different decisions may be taken on the basis of the ABC analysis. The basic utilization of the ABC analysis for a buyer is to use it with the spend as a criterion. In order to filter out the irrelevant or relatively insignificant data, ABC analysis is an important technique. In ABC analysis, the whole data population is classified into three categories based on importance. A- category is the class of data that is most important from the point of view of managing and controlling the same. B-category is the class of data that should invariably be controlled ,but the degree of control is not as intense as in A. C-category is the class of data, which has much less revenue implications and can be controlled by suitable test checks. The Auditor can apply ABC analysis specially in case the quantum of data /information to be analyzed is voluminous. If helps tha auditor to take up audit of vulnerable units frequently. Materials claiming higher CENVAT utilization can be easily checked and verified. Services giving maximum revenues can be taken up for the audit on priority and exempted services can be can be ignored. It also enables the auditor to go for comparative risk assessment of the units and finalize the auditee units accordingly.

Q5)

Journal Entries Date 15th jun 17 jun 17 jun 18th jun 18th jun 18th jun 19th jun 20th jun
th th

Particulars Cash a/c Dr To Capital a/c (Being the capital brought in by Ibrahim) Furniture a/c Dr To cash a/c (Being furniture bought) Rent a/c Dr To Cash a/c (Being Rent paid) Bank a/c Dr To Cash a/c (Being cash deposited in bank) Purchases a/c Dr To Cash a/c (Being goods bought for cash) Purchases a/c Dr To Ramdas & Bros. (Being goods bought on credit) Cash a/c Dr To Sales a/c (Being goods sold for cash) Machinery a/c Dr To Bank a/c (Being machinery bought and paid by cheque) Mr. Natekar a/c Dr To Sales a/c (Being goods sold on credit) Wages a/c Dr To Cash a/c (Being wages paid) Ramdas & Bros a/c Dr To Bank a/c (Being payment made by cheque) Cash a/c Dr To Mr. Natekar a/c (Being cash received)

Debit (Rs.) 2,00,000

Credit (Rs.)

2,00,000 20,000 20,000 5,000 5,000 1,50,000 1,50,000 10,000 10,000 10,000 10,000 12,000 12,000 25,000 25,000 8,000 8,000 5,000 5,000 5,000 5,000 2,000 2,000

21st jun 21st jun 24th jun 24th jun

24th jun

Cash a/c To commission a/c (Being Commission received) TOTAL

Dr

500 500 4,52,500 4,52,500

Part-C

Q6) (i) Observations and Conclusions from the given studyIt has been observed that Consumption per kilograms of PNCB has increased continuously in 2000-01, 2001-02 to 2002-03 from 2019000 to 2371110 to 2578520 respectively. This rising trend is against the proposition that Productivity of the industry increases with greater experience in manufacturing. It is further noticed that Ratio of consumption per Kg of production is also increasing, showing inefficiency of the unit. Moreover being the High value material, its consumption should have been lesser or more or less static. Production increases very less in 2001-02 and falls drastically in 2002-03 despite a significant rise in consumption of high value raw material. It may be a purposeful attempt to divert the material for the production of other related goods and take the benefit of CENVAT credit in this account. With the production showing significant decline, Excise duty liability will also be reduced significantly on the manufacture of this drug and the manufacturer may escape from this duty. (ii) The auditor should obtain the statistical data from related/similar industries and find out the level of variance in them as compared to in this industry. The assessee should be asked to record reasons in writing for the variance and complete information regarding the production cycle should be obtained for verification with the material utilized. Special Audit for CENVAT utilization can also be initiated under cost audit mechanism as provided in the excise rules.

Q7)

COST SHEET

PARTICULARS Raw Materials Purchased Direct Wages Direct Expenses(Carriage inwards) (1) PRIME COST Add:Factory Expenses Less: Sale Of Scrap

AMOUNT 65,000 29,500 2,600 97,100 7,200 800 6,400

(2) FACORY COST/WORKS COST Add:Office on Cost (3) COST OF PRODUCTION Add:Opening Stock of Finished Goods Less:- Closing Stock of Finished Goods (4) COST OF GOODS SOLD Add:Selling Expenses (5) COST OF SALES Add:Profit (6) SALES

1,03,500 4,650 1,08,150 13,500 10,750

2,750 1,10,900

3,600 25,500

3,600 1,14,500 25,500 1,40,000

Q8) Ledger is a book where transactions of same nature are grouped together in the form of an account. For e.g. all transactions relating to excise duty payment may be entered in Excise duty payment account. Ledgers are of 3 types:a) Debtors LedgerThis contains the accounts of all debtors. All transactions made with a customer are entered in the individual account of each customer. Details of credit invoices and debit note issued to a customer and payment received from a customer are entered in the customers individual account. i) Ledger account of major customers should be scrutinized. Documents used to record the sales need to be verified. These documents mat be sales invoices, Jvs, credit notes etc. If credit note and JVs are also found entered in the customers account , such documents should be verified to find out the reasons for such recoveries and whether the excise duty has been paid or not. ii) if substantial amount of advances are recovered regularly, this may also be verified from customers account. In such cases there may be credit balance showing receipt of advance payment. b) Creditors LedgerThis ledger contains the account of all creditors like suppliers and service providers. In the case of suppliers account, the details like purchase invoices, debit note or JV may be available in suppliers account. The Debit note or JV might have been prepared for rejection of purchase material or for short receipt of purchase material.

If the customers account shows details of debit note or JV, it is to be enquired into whether CENVAT credit has been reversed or not. c) General LedgerThis ledger contains all accounts, of asstes, liabilities, incomes and expenses. Scrutiny of this ledger is very important for a tax auditor as the income and expenditure account have a direct impact on availment of credit, valuation of finished goods and payment of Excise duty. Selection of account for scrutiny is an important task for an auditor. Accounts should be selected from Trial Balance with greater emphasis on i) Credit entries in raw material purchases account. ii) Credit entries in Expense account iii) Income accounts and unusual accounts. In these accounts, an auditor may verify Raw material consumption account to find out the use of raw material for non-production purpose, verify existence and additions to plant and machinery, verify the claim of depreciation on capital goods, verify the expenditure account for any recoveries being made from customers etc.

Q9) (i) Financial Accounting:It is the process of identifying, measuring, recording, classifying, summarizing, analyzing, interpreting and communicating the financial transactions and events. The purpose is to keep the systematic records to ascertain financial performance and to communicate the accounting information to interested parties like shareholders, investors, banks, creditors etc. Cost Accounting:It is the process of accounting and controlling the cost of a product, operation and function. The purpose is to ascertain the cost, to control the cost and to communicate the information for decision-making. Management Accounting :It is the application of accounting techniques for providing information designed to help all levels of management in planning and controlling the activities of business enterprise and in decision making. The purpose is to supply all information that is needed by the management at all levels to take decisions and evaluate the impact thereof. It covers the areas like Capital expenditure decisions, Capital structure decisions, Dividend decisions etc.

(ii) Accruals in costing refers to those expenses which have been incurred but have not been paid till date. It is the item of the current year and is shown as a liability at the end of the year. It continues to stand as a liability till it is finally paid or settled. Matching principle desires that the expenses of the year may be adjusted from the revenues earned in that year but since the accounts are kept on the accrual basis, actual expenses as well as accrued expenses are recorded in the statements. Examples:- Labour wages unpaid, factory overheads like rent, lighting charges, indirect expenses etc qualify for accrued expenses.

Q 10) (i) Auditing:Auditing is a systematic examination of books of accounts, records of a business or other organizations, in order to ascertain or verify, whether the balancesheet and profit and loss account exhibit a true and fair view of the state of affairs of the concern and to report upon the facts regarding its financial operations and results thereof. It includes inspecting, comparing, checking, reviewing, scrutinizing the vouchers, invoices, challans, ledgers etc. The purpose of Audit is to enable the department and the assessee to perform their jobs effectively by complying with various provisions of Central Excise Act & Rules, Customs Act and Service Tax Rules. Audit is essential to protect the interests of an assessee as well as Government revenue, to provide advice regarding systems, policies, procedures etc.

(ii)

Declining Balance Method Of Depriciation :-

Depreciation methods that provide for a higher depreciation charge in the first year of an asset's life and gradually decreasing charges in subsequent years are called accelerated depreciation methods. This may be a more realistic reflection of an asset's actual expected benefit from the use of the asset: many assets are most useful when they are new. To illustrate, suppose a business has an asset with $1,000 original cost, $100 salvage value, and 5 years useful life. First, calculate straight-line depreciation rate. Since the asset has 5 years useful life, the straight-line depreciation rate equals (100% / 5) 20% per year. With double-declining-balance method, as the name suggests, double that rate, or 40% depreciation rate is used. The table below illustrates the double-decliningbalance method of depreciation.

Book value at Depreciation beginning of year rate $1,000 (original cost) 40% $600 40% $360 40% $216 40% $129.60 $129.60 - $100

Depreciation Accumulated Book value at expense depreciation end of year $400 $400 $600 $240 $640 $360 $144 $784 $216 $86.40 $870.40 $129.60 $29.60 $900 $100 (scrap value)

It is possible to find a rate that would allow for full depreciation by its end of life with the formula:

, where N is the estimated life of the asset (for example, in years).

this method is logical in the sense that as the asset grows older, the amount of depreciation also goes on decreasing. It is suitable for those assets in relation to which the amount repairs and renewals goes on increasing as the asset grows older or the possibilities of obsolescence are more especially for plant and machineries, buildings etc. major demerits include difficulty in calculating the rate of depreciation , does not take into consideration the interest on capital invested in the asset and does not provide for the replacement of asset on the expiry of its useful life.

(iii)Activity Depriciation:The useful life of some assets, particularly vehicles and equipment, is frequently determined by usage. For example, a toy manufacturer may expect a certain machine to produce one million dolls, or an airline may expect an airplane to provide ten thousand hours of flight time. Units-of-activity depreciation, which is sometimes called units-of-production depreciation, allocates the depreciable cost of an asset based on its usage. A per-unit cost of usage is found by dividing the asset's depreciable cost by the number of units the asset is expected to produce or by total usage as measured in hours or miles. The per-unit cost times the actual number of units in one year equals the amount of depreciation expense recorded for the asset that year. Calculating Units-of-Activity Depletion

If a truck with a depreciable cost of $80,000 ($90,000 cost less $10,000 estimated salvage value) is expected to be driven 400,000 miles during its service life, the truck depreciates $0.20 each mile ($80,000 400,000 miles = $0.20 per mile). The following table shows how depreciation expense is assigned to the truck based on the number of miles driven each year. Units-of-Activity Depreciation Per-Unit Depreciation Cost Year 1 110,000 Year 2 70,000 Year 3 90,000 Year 4 80,000 Year 5 50,000 $0.20 0.20 0.20 0.20 0.20 = = = = = $90,000 $22,000 $22,000 68,000 14,000 18,000 16,000 10,000 36,000 54,000 70,000 80,000 54,000 36,000 20,000 10,000

(iv) Straight Line Method of depreciation :Straight-line depreciation is the simplest and most-often-used technique, in which a fixed and equal amount, according to a fixed percentage on the original cost, is written off during each accounting period over the expected useful life of the asset. Original cost of the asset as reduced by the expected salvage value at the end of the useful life, will be charged at a fixed annual rate of depreciation so that its value becomes zero after the end of useful life. The salvage value is an estimate of the value of the asset at the time it will be sold or disposed of and is also known as scrap value or residual value. This method is suitable for furniture, patent, copyright, trademark etc.

For example, a vehicle that depreciates over 5 years, is purchased at a cost of US$17,000, and will have a salvage value of US$2000, will depreciate at US$3,000 per year: ($17,000 $2,000)/ 5

years = $3,000 annual straight-line depreciation expense. In other words, it is the depreciable cost of the asset divided by the number of years of its useful life.

Shalabh Katiyar (9999669436)