AIOU 5418 Solved Assignment Autumn 2025

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ALLAMA IQBAL OPEN UNIVERSITY

(Department of Commerce)

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WARNING

1. Plagiarism or hiring of ghost writer(s) for solving the assignment(s) will debar the student from award of degree/certificate if found at any stage.

2. Submitting assignment(s) borrowed or stolen from other(s) as one's own will be penalized as defined in the "Aiou Plagiarism Policy".

Assignment Submission Schedule
6 Credit Hours	Due Date	3 Credit Hours	Due Date
Assignment 1	15-12-2025	Assignment 1	08-01-2026
Assignment 2	08-01-2026
Assignment 3	30-01-2026	Assignment 2	20-02-2026
Assignment 4	20-02-2026

Course: Financial Accounting (5418)	Semester: Autumn-2025
Level: ADC/ADB/BS (A&F)

Total Marks: 100	Pass Marks: 50

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ASSIGNMENT No. 1

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Q1. Describe the purpose of accounting and explain its role in business and society. Also, Identify the primary users of accounting information. ▶

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Introduction to Accounting
Accounting is often called the language of business because it records, summarizes, and communicates financial information about an organization. The primary purpose of accounting is to provide accurate and timely information that helps managers, investors, and other stakeholders make informed decisions. Accounting involves identifying, measuring, recording, and reporting financial transactions in a systematic manner. It ensures transparency, accountability, and reliability in financial reporting. Without accounting, businesses would struggle to track income and expenses, assess profitability, or comply with legal and regulatory requirements. Accounting provides the foundation for financial planning, performance evaluation, and strategic decision-making in both private and public organizations.

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Purpose of Accounting
The main purpose of accounting is to provide relevant financial information to support decision-making. It helps businesses determine profitability, liquidity, and solvency by tracking revenues, expenses, assets, and liabilities. Accounting also ensures compliance with tax laws and regulations, aiding in the preparation of tax returns and preventing legal issues. Furthermore, accounting serves as a tool for planning and controlling business operations, helping managers allocate resources efficiently, monitor performance, and identify areas for improvement. Beyond internal decision-making, accounting builds trust with external stakeholders by presenting a true and fair view of the company’s financial position. This purpose extends to enhancing transparency, minimizing fraud, and supporting sustainable growth.

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Role of Accounting in Business
In business, accounting plays a critical role in recording and analyzing financial transactions. It enables management to evaluate profitability, monitor cash flows, and make strategic decisions such as pricing, budgeting, and investment. Accounting provides insights into cost management, helping businesses optimize operations and reduce waste. Financial statements, prepared through accounting, are essential for securing loans, attracting investors, and facilitating partnerships. Accounting also assists in performance evaluation by comparing actual results with planned objectives. Overall, it acts as a tool for planning, controlling, and decision-making, ensuring that businesses operate efficiently, remain competitive, and achieve their financial goals.

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Role of Accounting in Society
Accounting extends its role beyond business operations to benefit society as a whole. Accurate financial reporting promotes transparency, accountability, and trust in the economic system. Investors, creditors, and government agencies rely on accounting information to make informed decisions that impact economic growth. Accounting helps in the allocation of resources by guiding investment and credit decisions. It also ensures that businesses comply with tax laws, contributing to national revenue used for public services, infrastructure, healthcare, and education. By promoting ethical business practices and reducing the risk of fraud, accounting strengthens confidence in the market and supports sustainable economic development.

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Primary Users of Accounting Information
Accounting information serves a wide range of users who rely on it for different purposes. Internal users include management, employees, and owners. Management uses accounting data for planning, controlling, and decision-making. Employees may be interested in financial stability to assess job security and potential bonuses. Owners or shareholders rely on accounting to evaluate returns on investment and overall business performance. External users include investors, creditors, government agencies, suppliers, customers, and the general public. Investors use accounting reports to make informed investment decisions, while creditors assess creditworthiness and repayment ability. Government agencies utilize financial statements for taxation and regulatory purposes. Suppliers may review financial information to determine the company’s reliability, and customers may be interested in the long-term stability of the business. By providing relevant information to these users, accounting facilitates decision-making, trust, and accountability in both business and society.

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Conclusion
In conclusion, accounting serves the vital purpose of providing accurate and reliable financial information that supports decision-making, planning, and control. Its role in business includes evaluating profitability, monitoring cash flows, managing costs, and facilitating strategic decisions. In society, accounting promotes transparency, accountability, and trust, while contributing to national revenue and economic development. The primary users of accounting information include internal users such as management, employees, and owners, as well as external users like investors, creditors, government agencies, suppliers, and customers. By serving both business and societal needs, accounting acts as a cornerstone for economic stability, ethical practices, and sustainable growth.

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Q2(a). What do you understand by Generally Accepted Accounting Principles (GAAPs)? Explain the need for GAAPs in financial reporting and discuss at least five fundamental GAAPs with appropriate examples. ▶

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Introduction to Generally Accepted Accounting Principles (GAAPs)
Generally Accepted Accounting Principles, commonly known as GAAPs, are a set of standardized guidelines and rules that govern the preparation and presentation of financial statements. They ensure that financial information is consistent, reliable, and comparable across different organizations. GAAPs provide a framework that accountants follow to record, summarize, and report financial transactions, allowing stakeholders to understand the financial position and performance of a business. By adhering to GAAPs, businesses maintain transparency and accuracy, enabling informed decision-making by investors, creditors, regulators, and management.

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Need for GAAPs in Financial Reporting
The need for GAAPs arises from the importance of consistency, clarity, and credibility in financial reporting. Without standardized principles, companies might report financial information differently, making comparisons difficult and increasing the risk of misinformation. GAAPs provide a uniform method of recording transactions, preparing financial statements, and disclosing information, which enhances investor confidence and facilitates regulatory compliance. They also prevent manipulation of financial data and help detect fraud, ensuring that all users have a fair and accurate view of a company’s financial health. In essence, GAAPs serve to promote transparency, maintain trust in financial markets, and support effective economic decision-making.

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Fundamental GAAPs
GAAPs consist of several fundamental principles that guide accounting practices. While many principles exist, five fundamental GAAPs are widely recognized and applied in financial reporting. Each of these principles provides a foundation for ethical, accurate, and consistent accounting practices.

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1. The Business Entity Principle
The business entity principle states that the financial activities of a business should be kept separate from the personal financial activities of its owners or other businesses. This ensures clarity and prevents the mixing of personal and business transactions. For example, if the owner of a manufacturing company purchases a car for personal use, the expense should not appear in the company’s financial records. Conversely, business expenses such as raw materials or machinery purchases must be recorded separately from personal expenditures. This principle allows stakeholders to accurately assess the financial performance and position of the business without distortion from personal transactions.

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2. The Going Concern Principle
The going concern principle assumes that a business will continue its operations in the foreseeable future and will not be forced to liquidate its assets unexpectedly. This assumption allows accountants to record assets and liabilities at their historical cost rather than at liquidation values. For example, a factory building purchased for 5 million rupees is recorded at its purchase cost rather than its potential sale value, assuming the business will continue using it. This principle is critical because it provides stability in financial reporting, enabling management and investors to plan for long-term growth and investment.

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3. The Matching Principle
The matching principle requires that expenses be recorded in the same accounting period as the revenues they help generate. This ensures that financial statements reflect the true profitability of a business. For instance, if a company sells goods in December but pays the salaries of employees involved in production in January, the salaries expense must still be matched with December’s revenue to accurately calculate profit. By applying the matching principle, businesses avoid misleading representations of profit and loss, allowing stakeholders to assess financial performance accurately.

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4. The Cost Principle
The cost principle states that assets should be recorded at their historical purchase cost rather than their current market value. This provides reliability and verifiability in financial reporting. For example, if a business purchases machinery for 2 million rupees, it will be recorded at 2 million rupees on the balance sheet, even if the current market value increases to 2.5 million rupees. By using the cost principle, accounting information remains objective, reducing subjectivity and manipulation in asset valuation. It provides a consistent and verifiable basis for financial reporting.

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5. The Revenue Recognition Principle
The revenue recognition principle dictates that revenue should be recorded when it is earned, regardless of when cash is received. This ensures that financial statements accurately reflect business performance during a specific period. For example, if a software company delivers a service in June but receives payment in July, the revenue should be recognized in June when the service was performed. This principle prevents overstatement or understatement of revenue and provides a true picture of the company’s financial performance. It is essential for accurate profit measurement and reliable financial reporting.

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Other Important GAAPs
While the five principles discussed are fundamental, there are other important GAAPs such as the Full Disclosure Principle, which requires all relevant information to be disclosed in financial statements; the Consistency Principle, which ensures that accounting methods are applied consistently across periods; and the Conservatism Principle, which advises recording expenses and liabilities promptly while delaying recognition of revenues to avoid overstatement of financial health. Together, these principles strengthen transparency, comparability, and reliability in accounting practices.

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Conclusion
In conclusion, Generally Accepted Accounting Principles (GAAPs) are essential for maintaining consistency, accuracy, and transparency in financial reporting. They provide a standardized framework that helps businesses record transactions, prepare financial statements, and communicate financial information reliably to stakeholders. The need for GAAPs arises from the importance of comparability, credibility, and compliance in accounting practices. Fundamental principles such as the business entity principle, going concern principle, matching principle, cost principle, and revenue recognition principle ensure that financial statements reflect the true financial position and performance of a business. By adhering to GAAPs, organizations promote trust, facilitate informed decision-making, and support the overall stability and integrity of the financial system.

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Q2(b). The following transactions occurred in the books of Naeem Traders during the year ended 31st December 2023. Identify the accounting principle or concept applied in recording each transaction under GAAP and briefly justify your answer:

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1. The business paid Rs. 60,000 as rent for the office premises. However, the owner included this in his personal financial records.
2. The company purchased machinery worth Rs. 500,000 but recorded it at the purchase price, not at its current market value of Rs. 620,000.
3. Goods costing Rs. 80,000 were sold to a customer on credit. The company recorded the sale in the books even though payment had not been received yet.
4. A sum of Rs. 200,000 was expected from a customer but was not recorded as revenue due to uncertainty regarding recovery.
5. The company recorded the salary expense of Rs. 150,000 relating to December 2023 even though it was paid in January 2024.

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Required:
(i) Identify the GAAP or accounting concept applied in each case.
(ii) Justify your identification with reasoning. ▶

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Introduction
Generally Accepted Accounting Principles (GAAPs) guide the recording, reporting, and presentation of financial transactions. Each transaction in an organization reflects one or more accounting principles to ensure accuracy, consistency, and transparency in financial statements. The following analysis identifies the relevant GAAP or accounting concept applied in each of the transactions of Naeem Traders for the year ended 31st December 2023 and provides reasoning for each.

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Transaction 1: Payment of Rent Included in Owner’s Personal Records
Accounting Concept Applied: Business Entity Concept
Justification: The business entity concept states that the financial affairs of a business should be kept separate from the personal financial affairs of the owner. In this case, the business paid Rs. 60,000 as rent for office premises, but the owner recorded it in his personal financial records. This violates the business entity concept. Proper application requires that the rent expense be recorded in the books of the business to accurately reflect business operations and not be mixed with personal transactions. This separation ensures clarity and reliability in financial reporting for the business.

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Transaction 2: Purchase of Machinery Recorded at Historical Cost
Accounting Concept Applied: Cost Principle (Historical Cost Principle)
Justification: The cost principle requires that assets be recorded at their original purchase price, regardless of changes in market value. The company purchased machinery for Rs. 500,000 but did not adjust it to its current market value of Rs. 620,000. Recording the machinery at historical cost follows this principle, ensuring objectivity, verifiability, and consistency in financial reporting. This avoids subjectivity that could arise from constantly changing market values and provides a reliable basis for depreciation and accounting records.

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Transaction 3: Sale of Goods on Credit
Accounting Concept Applied: Revenue Recognition Principle
Justification: The revenue recognition principle states that revenue should be recorded when it is earned, regardless of when cash is received. Goods costing Rs. 80,000 were sold to a customer on credit, and the company recorded the sale even though payment was not yet received. This correctly applies the revenue recognition principle because the revenue is earned at the point of sale, and the corresponding receivable is recognized. This ensures that financial statements reflect the actual performance of the business for the period.

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Transaction 4: Expected Revenue Not Recorded Due to Uncertainty
Accounting Concept Applied: Conservatism (Prudence) Principle
Justification: The conservatism principle advises accountants to record expenses and liabilities as soon as they are known but only recognize revenue when it is reasonably certain. In this case, a sum of Rs. 200,000 was expected from a customer but was not recorded as revenue due to uncertainty regarding recovery. By not recording the uncertain revenue, the company is following the conservatism principle, which prevents overstatement of assets and income and ensures that financial statements do not mislead stakeholders.

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Transaction 5: Salary Expense Paid in January but Related to December
Accounting Concept Applied: Matching Principle
Justification: The matching principle requires that expenses be recognized in the same period as the revenues they help generate. The company recorded the salary expense of Rs. 150,000 for December 2023, even though it was paid in January 2024. This is consistent with the matching principle because the salaries relate to services provided in December, and recording them in the same period ensures accurate measurement of profit for that period. This principle provides a true representation of financial performance and prevents distortion of income statements.

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Conclusion
In conclusion, each transaction of Naeem Traders demonstrates the application of fundamental GAAPs and accounting concepts. The payment of office rent relates to the business entity concept, purchase of machinery applies the cost principle, sale on credit follows the revenue recognition principle, unrecorded uncertain revenue reflects the conservatism principle, and the salary expense for December aligns with the matching principle. Proper application of these principles ensures that financial statements are accurate, reliable, and consistent, providing a true picture of the company’s financial performance and position for stakeholders.

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Q3. Shop Rite Services is ready to prepare its financial statements for the year ended December 31, 2022. The following information can be determined by analyzing the accounts:

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1. On August 1, 2022, Shop Rite received a Rs. 4,800 payment in advance for the rental of office space. The rental period is for one year beginning on the date payment was received. Shop Rite recorded the receipt as unearned rent.
2. On March 1, 2022, Shop Rite paid its insurance agent Rs. 3,000 for the premium due on a 24-month corporate policy. Shop Rite recorded the payment as prepaid insurance.
3. Shop Rite pays its employees wages in the middle of each month. The monthly payroll (ignoring payroll taxes) is Rs. 22,000.
4. Shop Rite received a note from a customer on June 1, 2012, as payment for services. The amount of the note is Rs. 1,000 with interest at 12%. The note and interest will be paid on June 1, 2024.
5. On December 20, 2022, Shop Rite received a Rs. 2,500 check for services. The transaction was recorded as unearned revenue. By year-end, Shop Rite had completed three-fourths of the contracted services. The rest of the services won’t be completed until at least the middle of January 2023.
6. On September 1, Shop Rite purchased Rs. 500 worth of supplies. At December 31, 2022, one-fourth of the supplies had been used. Shop Rite initially recorded the purchase of supplies as an asset.

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Required: Where appropriate, prepare adjusting journal entries at December 31, 2022, for each of these items. ▶

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Sr. No	Account Title	Debit (Rs.)	Credit (Rs.)
1	Unearned Rent		2,000
	Rent Revenue	2,000
	Recognize 5 months rent revenue earned
2	Insurance Expense	1,250
	Prepaid Insurance		1,250
	Record insurance expense for 10 months
3	Wages Expense	11,000
	Wages Payable		11,000
	Accrue half-month wages for December
4	Interest Receivable	70
	Interest Revenue		70
	Accrue interest on note receivable for 7 months
5	Unearned Revenue		1,875
	Service Revenue	1,875
	Recognize 3/4 of service revenue earned by year-end
6	Supplies Expense	125
	Supplies		125
	Record supplies used during the period

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Q4. A company that records credit purchases in a purchases journal and records purchase returns in a general journal made the following errors. Indicate when each error should be discovered.

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1. Posted a purchase return to the Accounts Payable account and to the creditor’s subsidiary account, but did not post the purchase return to the Inventory account.
2. Posted a purchase return to the Inventory account and to the Accounts Payable account, but did not post to the creditor’s subsidiary account.
3. Correctly recorded a Rs. 4,000 purchase in the purchases journal but posted it to the creditor’s subsidiary account as a Rs. 400 purchase.
4. Made an addition error in determining the balance of a creditor’s subsidiary account.
5. Made an addition error in totaling the Office Supplies column of the purchases journal. ▶

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Introduction
In accounting, errors can occur during the recording or posting of transactions. Identifying when each error should be discovered is crucial to ensure accurate financial reporting and reconciliation. Errors can typically be detected during the preparation of the trial balance, reconciliation of subsidiary accounts, or when reviewing individual ledger accounts. The following analysis explains when each of the given errors in recording credit purchases and purchase returns should be discovered.

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Error 1: Purchase Return Not Posted to Inventory
The company posted a purchase return to the Accounts Payable account and the creditor’s subsidiary account, but did not adjust the Inventory account. This error should be discovered during the **preparation of the trial balance** or **inventory reconciliation** at the end of the accounting period. Since the Inventory account is understated, the discrepancy will show when comparing physical stock counts to the ledger balance. Adjusting entries can then correct the Inventory account.

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Error 2: Purchase Return Not Posted to Creditor’s Subsidiary Account
In this case, the purchase return was posted to the Inventory account and Accounts Payable account, but the creditor’s subsidiary account was not updated. This error will be discovered during **reconciliation of the subsidiary ledger with the general ledger**. When the total of the subsidiary accounts is compared with the Accounts Payable control account, the mismatch will highlight the missing entry in the subsidiary ledger.

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Error 3: Purchase Recorded Correctly but Posted to Subsidiary as Rs. 400 Instead of Rs. 4,000
Here, the transaction was recorded correctly in the purchases journal but posted incorrectly in the creditor’s subsidiary account. This type of error should be discovered during **subsidiary ledger reconciliation** or when reconciling the Accounts Payable control account with individual creditor accounts. The difference of Rs. 3,600 will appear as a discrepancy between the total of subsidiary accounts and the control account.

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Error 4: Addition Error in Creditor’s Subsidiary Account Balance
An addition error in determining the balance of a creditor’s subsidiary account will be discovered during **reconciliation or verification of ledger balances**. This could occur when preparing statements for individual creditors or when checking that the sum of all creditor balances equals the Accounts Payable control account in the general ledger. Such errors usually do not affect the trial balance totals unless they are carried over to the control account incorrectly.

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Error 5: Addition Error in Totaling Purchases Journal Column
An addition error in totaling the Office Supplies column of the purchases journal will typically be discovered during **preparation of the trial balance** or when verifying the journal totals against ledger postings. If the error is not caught during posting, the incorrect total will affect the related ledger accounts, and the trial balance will not agree. Careful checking of column totals can correct this error before final statements are prepared.

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Conclusion
In summary, the timing of discovering accounting errors depends on the type of error. Posting errors and omissions in subsidiary accounts are usually discovered during **subsidiary ledger reconciliation**, whereas errors affecting control accounts, journal totals, or Inventory are often discovered during the **preparation of the trial balance** or **inventory verification**. Regular reconciliation and review procedures are essential to detect and correct errors promptly, ensuring accurate financial reporting and reliable accounting records.

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Q5. Prepare journal entries to record the following transactions involving both the short-term and long-term investments of Sophia Corp., all of which occurred during calendar year 2021. Use the account Short-Term Investments for any transactions that you determine are short-term.

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a. On February 15, paid Rs. 150,000 cash to purchase American General’s 120-day short-term notes at par, which are dated February 15 and pay 10% interest (classified as held-to-maturity).
b. On March 22, bought 700 shares of Frain Industries common stock at Rs. 25 cash per share plus a Rs. 250 brokerage fee (classified as long-term available-for-sale securities).
c. On June 15, received a check from American General in payment of the principal and 120 days’ interest on the notes purchased in transaction a.
d. On July 30, paid Rs. 50,000 cash to purchase MP3 Electronics’ 8% notes at par, dated July 30, 2021, and maturing on January 30, 2012 (classified as trading securities).
e. On September 1, received a Rs. 0.50 per share cash dividend on the Frain Industries common stock purchased in transaction b.
f. On October 8, sold 350 shares of Frain Industries common stock for Rs. 32 cash per share, less a Rs. 175 brokerage fee.
g. On October 30, received a check from MP3 Electronics for three months’ interest on the notes purchased in transaction d. ▶

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Sr. No	Account Title	Debit (Rs.)	Credit (Rs.)
a	Short-Term Investments	150,000
	Cash		150,000
	Purchase of 120-day American General short-term notes.
b	Long-Term Investments	17,750
	Cash		17,750
	Purchase of 700 shares of Frain Industries common stock including brokerage.
c	Cash	155,000
	Short-Term Investments		150,000
	Interest Revenue	5,000
d	Short-Term Investments	50,000
	Cash		50,000
	Purchase of MP3 Electronics 8% notes (trading securities).
e	Cash	350
	Dividend Revenue		350
	Receipt of cash dividend on Frain Industries stock.
f	Cash	11,025
	Long-Term Investments		8,750
	Gain on Sale of Investments	2,275
	Being sale of 350 Frain Industries shares at a gain.
g	Cash	1,000
	Interest Revenue		1,000
	Receipt of three months' interest on MP3 Electronics trading notes.

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ASSIGNMENT No. 2

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Q1(a). What do you know about stockholder equity? Explain. Also, draw the specimen of Stockholders’ Equity section of the balance sheet. ▶

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Stockholders’ Equity
Stockholders’ equity, also called shareholders’ equity or owners’ equity, represents the residual interest in the assets of a company after deducting its liabilities. It is essentially what belongs to the owners of the company once all debts are paid. Stockholders’ equity includes components such as common stock, preferred stock, additional paid-in capital, retained earnings, and treasury stock. Common stock reflects ownership shares issued to investors, while preferred stock represents shares with fixed dividends and priority over common stock in case of liquidation. Additional paid-in capital shows the amount paid by investors above the par value of stock. Retained earnings represent accumulated profits that have been reinvested in the business rather than paid out as dividends. Treasury stock is the cost of shares repurchased by the company and is subtracted from total equity. Stockholders’ equity is important because it indicates the company’s net worth from the shareholders’ perspective and acts as a cushion against losses.

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Specimen of Stockholders’ Equity Section of Balance Sheet

Particulars	Amount (Rs.)
Common Stock, Rs. 10 par value, 50,000 shares issued	500,000
Preferred Stock, Rs. 100 par value, 1,000 shares issued	100,000
Additional Paid-in Capital	50,000
Retained Earnings	200,000
Less: Treasury Stock	(25,000)
Total Stockholders’ Equity	825,000

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Q1(b). Prepare journal entries to record the following four separate issuances of stock.

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1. A corporation issued 2,000 shares of no-par common stock to its promoters in exchange for their efforts, estimated to be worth Rs. 30,000. The stock has no stated value.
2. A corporation issued 2,000 shares of no-par common stock to its promoters in exchange for their efforts, estimated to be worth Rs. 30,000. The stock has a Rs. 1 per share stated value.
3. A corporation issued 4,000 shares of Rs. 10 par value common stock for Rs. 70,000 cash.
4. A corporation issued 1,000 shares of Rs. 100 par value preferred stock for Rs. 120,000 cash. ▶

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Sr. No	Account Title	Debit (Rs.)	Credit (Rs.)
1	Organization (Promotion) Expense	30,000
	Common Stock (no-par)		30,000
	Issued 2,000 shares of no-par common stock to promoters for services rendered
2	Organization (Promotion) Expense	30,000
	Common Stock (stated value Rs. 1/share)		2,000
	Paid-in Capital in Excess of Stated Value		28,000
	Issued 2,000 shares of no-par common stock with Rs. 1 stated value to promoters for services
3	Cash	70,000
	Common Stock (par value Rs. 10/share)		40,000
	Paid-in Capital in Excess of Par		30,000
	Issued 4,000 shares of Rs. 10 par value common stock for Rs. 70,000 cash
4	Cash	120,000
	Preferred Stock (par value Rs. 100/share)		100,000
	Paid-in Capital in Excess of Par - Preferred Stock		20,000
	Issued 1,000 shares of Rs. 100 par value preferred stock for Rs. 120,000 cash

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Q2. The stockholders’ equity of Whiz.com Company at the beginning of the day on February 5 follows.

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Common stock—Rs. 25 par value, 150,000 shares
authorized, 60,000 shares issued and outstanding Rs. 1,500,000
Paid-in capital in excess of par value, common stock 525,000
Retained earnings 675,000
Total stockholders’ equity Rs. 2,700,000

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On February 5, the directors declared a 20% stock dividend distributable on February 28 to the February 15 stockholders of record. The stock’s market value is Rs. 40 per share on February 5, before the stock dividend. The stock’s market value is Rs. 34 per share on February 28.

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1. Prepare entries to record both the dividend declaration and its distribution.
2. One stockholder owned 750 shares on February 5 before the dividend. Compute the book value per share and total book value of this stockholder’s shares immediately before and after the stock dividend of February 5.
3. Compute the total market value of the investor’s shares in part 2 as of February 5 and February 28. ▶

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1. Journal Entries for Stock Dividend
On February 5, the directors declared a 20% stock dividend.

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Sr. No	Account Title	Debit (Rs.)	Credit (Rs.)
1	Retained Earnings	720,000
	Common Stock Dividend Distributable		720,000
	Record 20% stock dividend declaration.
2	Common Stock Dividend Distributable	720,000
	Common Stock		720,000
	Record distribution of stock dividend on February 28

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2. Book Value Per Share and Total Book Value of Stockholder
Stockholder owns 750 shares before dividend. Total shares before dividend: 60,000

Book value per share before dividend:

Book value per share = Total Stockholders' Equity / Total Shares Outstanding = 2,700,000 / 60,000 = Rs. 45 per share

Total book value of stockholder's shares before dividend = 750 × 45 = Rs. 33,750

After 20% stock dividend, new shares for stockholder = 750 × 20% = 150 shares Total shares held after dividend = 750 + 150 = 900 shares

Total stockholders' equity remains 2,700,000 (equity only reallocated) New book value per share = 2,700,000 / (60,000 + 12,000) = 2,700,000 / 72,000 = Rs. 37.50 per share

Total book value of stockholder after dividend = 900 × 37.50 = Rs. 33,750 (unchanged)

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3. Total Market Value of Investor's Shares

Market value per share on February 5 = Rs. 40 Shares before dividend = 750 Total market value = 750 × 40 = Rs. 30,000

Market value per share on February 28 = Rs. 34 Shares after dividend = 900 Total market value = 900 × 34 = Rs. 30,600

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Summary
Book value per share decreased from Rs. 45 to Rs. 37.50, total book value remained Rs. 33,750. Market value of investor's shares increased slightly due to the stock dividend despite the decrease in market price per share.

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Q3. Koral Corporation engaged in the transactions listed below. Identify each transaction as (a) an operating activity, (b) an investing activity, (c) a financing activity, (d) a noncash transaction, or (e) not on the statement of cash flows. (Assume the indirect method is used.)
1. Declared and paid a cash dividend.
2. Purchased a long-term investment.
3. Increased accounts receivable.
4. Paid interest.
5. Sold equipment at a loss.
6. Issued long-term bonds for plant assets.
7. Increased dividends receivable.
8. Issued common stock.
9. Declared and issued a stock dividend.
10. Repaid notes payable.
11. Decreased wages payable.
12. Purchased a 60-day Treasury bill.
13. Purchased land. ▶

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Sr. No	Transaction	Cash Flow Classification
1	Declared and paid a cash dividend	Financing activity
2	Purchased a long-term investment	Investing activity
3	Increased accounts receivable	Operating activity
4	Paid interest	Operating activity
5	Sold equipment at a loss	Investing activity
6	Issued long-term bonds for plant assets	Noncash transaction
7	Increased dividends receivable	Operating activity
8	Issued common stock	Financing activity
9	Declared and issued a stock dividend	Noncash transaction
10	Repaid notes payable	Financing activity
11	Decreased wages payable	Operating activity
12	Purchased a 60-day Treasury bill	Investing activity
13	Purchased land	Investing activity

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Q4. Moss issues bonds with a par value of Rs. 90,000 on January 1, 2021. The bonds’ annual contract rate is 8%, and interest is paid semiannually on June 30 and December 31. The bonds mature in three years. The annual market rate at the date of issuance is 10%, and the bonds are sold for Rs. 85,431.
1. What is the amount of the discount on these bonds at issuance?
2. How much total bond interest expense will be recognized over the life of these bonds? ▶

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Bond Issuance Details:
Moss Corporation issued bonds with a par value of Rs. 90,000 on January 1, 2021. The bonds have an annual contract rate of 8%, pay interest semiannually on June 30 and December 31, mature in three years, and were sold for Rs. 85,431. The annual market rate at issuance was 10%.

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1. Discount on Bonds at Issuance:
The discount is the difference between the par value and the selling price:
Par value = Rs. 90,000
Selling price = Rs. 85,431
Discount = 90,000 − 85,431 = Rs. 4,569

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2. Total Bond Interest Expense:
Cash interest per period = 90,000 × 8% ÷ 2 = Rs. 3,600
Total number of semiannual payments = 3 years × 2 = 6
Total cash interest paid = 3,600 × 6 = Rs. 21,600
Total interest expense (including discount amortization) = 21,600 + 4,569 = Rs. 26,169

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3. Semiannual Interest and Carrying Value Schedule (Effective Interest Method):

Period 1 (June 30, 2021):
Cash interest paid = Rs. 3,600
Interest expense = 85,431 × 10% ÷ 2 = Rs. 4,272
Discount amortization = 4,272 − 3,600 = Rs. 672
Carrying value = 85,431 + 672 = Rs. 86,103

Period 2 (Dec 31, 2021):
Cash interest paid = Rs. 3,600
Interest expense = 86,103 × 10% ÷ 2 = Rs. 4,305
Discount amortization = 4,305 − 3,600 = Rs. 705
Carrying value = 86,103 + 705 = Rs. 86,808

Period 3 (June 30, 2022):
Cash interest paid = Rs. 3,600
Interest expense = 86,808 × 10% ÷ 2 = Rs. 4,340
Discount amortization = 4,340 − 3,600 = Rs. 740
Carrying value = 86,808 + 740 = Rs. 87,548

Period 4 (Dec 31, 2022):
Cash interest paid = Rs. 3,600
Interest expense = 87,548 × 10% ÷ 2 = Rs. 4,377
Discount amortization = 4,377 − 3,600 = Rs. 777
Carrying value = 87,548 + 777 = Rs. 88,325

Period 5 (June 30, 2023):
Cash interest paid = Rs. 3,600
Interest expense = 88,325 × 10% ÷ 2 = Rs. 4,416
Discount amortization = 4,416 − 3,600 = Rs. 816
Carrying value = 88,325 + 816 = Rs. 89,141

Period 6 (Dec 31, 2023):
Cash interest paid = Rs. 3,600
Interest expense = 89,141 × 10% ÷ 2 = Rs. 4,457
Discount amortization = 4,457 − 3,600 = Rs. 857
Carrying value = 89,141 + 857 = Rs. 90,000

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Summary:
Total cash interest paid over the life of the bond = Rs. 21,600
Total interest expense including discount amortization = Rs. 26,169
Bond discount at issuance = Rs. 4,569

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Q5(a). Define liquidity and efficiency ratios in the context of financial statement analysis. Explain the significance of these ratios in evaluating a company’s short-term financial health. ▶

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Liquidity Ratios
Liquidity ratios are financial metrics that measure a company’s ability to meet its short-term obligations using its current assets. These ratios indicate how easily a company can convert its assets into cash to pay off liabilities that are due within a year. Common liquidity ratios include the current ratio, which compares current assets to current liabilities, and the quick ratio, which excludes inventory from current assets to focus on the most liquid resources. High liquidity ratios generally indicate that a company has sufficient resources to cover its short-term debts, while very low ratios may signal potential financial distress.

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Efficiency Ratios
Efficiency ratios, also known as activity ratios, assess how effectively a company uses its assets and manages operations to generate sales and revenue. These ratios evaluate the efficiency of inventory management, accounts receivable collection, and overall asset utilization. Key efficiency ratios include inventory turnover, accounts receivable turnover, and total asset turnover. High efficiency ratios suggest that the company is effectively using its assets to produce revenue, whereas low ratios may indicate underutilization or operational inefficiencies.

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Significance of Liquidity and Efficiency Ratios
Liquidity and efficiency ratios are crucial for evaluating a company’s short-term financial health. Liquidity ratios help investors, creditors, and management determine whether the company can meet its immediate obligations without raising external funds. Efficient management of assets, as reflected by efficiency ratios, ensures that the company can generate maximum revenue with minimum resources, reducing the risk of cash flow problems. Together, these ratios provide a comprehensive view of a company’s operational effectiveness and its ability to sustain short-term financial stability, which is essential for day-to-day business operations and long-term growth.

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Q5(b). The following financial data was extracted from the financial statements of three consecutive years of Arshad Trading Cooperative:

Item	2022	2023
Sales	3,000,000	3,200,000
Cost of Goods Sold	2,300,000	2,500,000
Current Assets	1,500,000	1,650,000
Current Liabilities	1,100,000	1,150,000
Inventories	750,000	800,000
Accounts Receivable	400,000	450,000
Prepaid Expenses	50,000	40,000

Required:
Compute the following ratios for the years 2022 and 2023 and comment on each to ascertain liquidity analysis:
a) Working Capital
b) Current Ratio
c) Acid Test ratio
d) Days' Sales in Receivables
e) Accounts Receivable Turnover ratio
f) Days' sales in inventories
g) Inventory turnover ratio
h) Operating cycle

▶

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Liquidity Analysis of Arshad Trading Cooperative

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a) Working Capital
Working capital = Current Assets − Current Liabilities

2022: 1,500,000 − 1,100,000 = Rs. 400,000
2023: 1,650,000 − 1,150,000 = Rs. 500,000

Comment: Working capital has increased from Rs. 400,000 to Rs. 500,000, indicating improved short-term liquidity and the company’s greater ability to cover current obligations.

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b) Current Ratio
Current Ratio = Current Assets ÷ Current Liabilities

2022: 1,500,000 ÷ 1,100,000 ≈ 1.36
2023: 1,650,000 ÷ 1,150,000 ≈ 1.43

Comment: The current ratio has slightly improved, showing that the company’s current assets are now better able to meet its short-term liabilities.

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c) Acid-Test (Quick) Ratio
Acid-Test Ratio = (Current Assets − Inventories − Prepaid Expenses) ÷ Current Liabilities

2022: (1,500,000 − 750,000 − 50,000) ÷ 1,100,000 = 700,000 ÷ 1,100,000 ≈ 0.64
2023: (1,650,000 − 800,000 − 40,000) ÷ 1,150,000 = 810,000 ÷ 1,150,000 ≈ 0.70

Comment: The acid-test ratio is below 1 but has improved slightly, indicating a better ability to pay current liabilities without relying on inventory sales.

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d) Days' Sales in Receivables
Days' Sales in Receivables = (Accounts Receivable ÷ Sales) × 365

2022: (400,000 ÷ 3,000,000) × 365 ≈ 48.7 days
2023: (450,000 ÷ 3,200,000) × 365 ≈ 51.3 days

Comment: Collection period has slightly increased, suggesting that receivables are taking a bit longer to convert into cash.

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e) Accounts Receivable Turnover Ratio
Accounts Receivable Turnover = Sales ÷ Accounts Receivable

2022: 3,000,000 ÷ 400,000 = 7.5 times
2023: 3,200,000 ÷ 450,000 ≈ 7.11 times

Comment: Slight decrease in turnover shows slower collection efficiency in 2023 compared to 2022.

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f) Days' Sales in Inventories
Days' Sales in Inventories = (Inventories ÷ Cost of Goods Sold) × 365

2022: (750,000 ÷ 2,300,000) × 365 ≈ 119 days
2023: (800,000 ÷ 2,500,000) × 365 ≈ 117 days

Comment: Inventory turnover period has slightly decreased, indicating faster inventory movement in 2023.

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g) Inventory Turnover Ratio
Inventory Turnover = Cost of Goods Sold ÷ Inventories

2022: 2,300,000 ÷ 750,000 ≈ 3.07 times
2023: 2,500,000 ÷ 800,000 ≈ 3.13 times

Comment: A marginal improvement in inventory turnover indicates slightly better efficiency in using inventory to generate sales.

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h) Operating Cycle
Operating Cycle = Days' Sales in Receivables + Days' Sales in Inventories

2022: 48.7 + 119 ≈ 167.7 days
2023: 51.3 + 117 ≈ 168.3 days

Comment: The operating cycle remains almost stable, showing that overall cash conversion from inventory and receivables is consistent year over year.

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