Case Study
Passage with linked questions
Case Set 1
Case AnalysisPassage
Ramesh is a sole proprietor running a stationery shop in Delhi. At the end of the financial year, his accountant prepares a Profit and Loss Account and a Balance Sheet. Ramesh notices that his accountant records every purchase, sale, expense and receipt in the books. The accountant explains that accounting is not merely recording but involves identifying economic events, measuring them in monetary terms, recording in chronological order, and communicating the results through financial statements. Ramesh realises that the salary paid to his two employees, the credit sale made to a school, and the goods purchased on credit from a supplier are all economic events that need to be captured in the accounts. He now understands why systematic accounting is essential for running his business efficiently and for making informed decisions.
Question 1: Define accounting as understood from the passage and state its four main steps.
- Accounting is the process of identifying, measuring, recording and communicating the required information relating to economic events of an organisation to interested users.
- The four steps are: (1) Identification of economic events, (2) Measurement in monetary terms, (3) Recording in chronological order, (4) Communication through financial statements.
Question 2: From the passage, identify two external economic events (transactions with outsiders) and explain why they are classified as external events.
- Credit sale to a school – involves an outsider (school), hence external event.
- Goods purchased on credit from a supplier – involves an outsider (supplier), hence external event.
- External events are those transactions that occur between the organisation and an outside party (not entirely within the enterprise).
Question 3: Ramesh wants to know whether the appointment of a new sales manager and a rise in his shop's reputation should be recorded in books of accounts. Using the concept of identification and measurement in accounting, advise Ramesh with justification.
- Appointment of a new sales manager cannot be recorded because it does not involve a financial transaction measurable in monetary terms; it is a qualitative event.
- Rise in reputation (goodwill generated internally) cannot be recorded because it cannot be reliably measured in monetary terms at this stage.
- Accounting only records events that are of financial character and can be expressed in monetary terms (rupees and paise). Non-monetary and qualitative events are excluded from books of accounts.