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Q.N.7. Explain the different methods of ascertaining profits when the books of accounts are maintained under single entry system. Explain them briefly.

 

Ans: Profit under single entry system can be ascertained by two methods:

1. Statement of Affairs Method or Net Worth Method

2. Conversion Method                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

          1.       Statement of Affairs or Net Worth Method: When books of accounts are maintained under single entry system, it is not possible to prepare trading and profit and loss account because no record is maintained for nominal accounts. However in order to determine profit or loss, Statement of affairs method based on fundamental balance sheet equation is followed. Under this method, two balance sheets (Statement of affairs) are prepared. One at the beginning of the period for finding out the opening capital and the other at the end of the period for finding out the closing capital. But necessary adjustments is required to be made for Drawings made by the proprietor, additional capital introduced during the year, interest on drawings and on capital for ascertaining the true operating profit.

 

                    Steps for ascertaining Profit under Statement of affairs Method:    

a)      A Statement of Affairs at the beginning of the year is prepared to determine the amount of capital of the proprietor at the beginning of the year.

 

b)            Similarly, A Statement of Affairs at the end of the year is prepared to determine the amount of capital at the end of the year.

 

c)       Drawings made by the proprietor during the year should be added to the amount of Capital at the end of the year for the reason that the capital at the end would have been more if there is no such withdrawal by the proprietor.   

                   

d)      Similarly, Capital introduced during the year should be deducted from the Capital at the end of the year for the reason that the capital at the end would have been less if there is no such addition by the proprietor.

 

e)      Capital at the beginning of the year should be deducted from the closing capital as adjusted in step (c) and (d) above and the difference will be either a trading profit or loss. If the adjusted capital exceeds the opening capital, the excess will be profit for the year. But if the adjusted capital is less than the capital at the beginning of the year, the difference will be loss for the year.

 

f)       Interest on capital and interest on drawings (if any) are to be adjusted in profit or loss as derived in step (e) to arrive at the net profit or loss for the year.

 

2.       Conversion from Single Entry System to Double Entry System:

                    The following Steps should be followed if it is desired to change the system of accounting from Single entry to double entry:

 

a)      A statement of affairs should be prepared at the beginning of the accounting period to determine the opening capital of the business.

 

b)      The Cash Book should be gone through and entries relating to impersonal accounts should be posted to their respective accounts as impersonal accounts are not maintained under single entry system. This would complete the double entry of the cash book. If no cash account is maintained, pass book should be carefully examined and all cash transactions relating to business to be identified and with the help of it cash book should be prepared.

 

c)       If a Petty cash book is maintained, the monthly analysis should be posted to the debit of the various accounts for expenses and the total credited to Petty cash account.

 

d)      Prepare Total Debtors account, Total Creditors account, Bills receivable and Bills payable account, Total Sales and Total Purchases account. This helps in finding out different missing figure relating to these accounts.

 

e)      Now, the personal accounts and Cash book, which have already been kept under single entry system, should be scrutinized in order to find out the nominal items. Such items should be posted to their respective impersonal accounts so that the two-fold effect of such transactions should be completed.

 

f)       After completing the double entry of all the transactions, a Trial balance should be prepared to test the arithmetical accuracy of the books.

 

g)      From the Trial balance, Trading and Profit and Loss account and Balance sheet can be prepared after taking into consideration the necessary adjustments like outstanding expenses and incomes, depreciation, provision for bad debts and discounts etc.

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