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IMT-57: FINANCIAL ACCOUNTING
PART – A Q1. What is a Contingent Liability? Where is it shown in the Balance Sheet? Give three examples of Contingent Liabilities? Solution: A “contingent liability” is a possible obligation that arises from past events and the existence of which will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise. It is a present obligation that arises from past events but is not recognised because: (i) it is not probable that an outflow of resources will be required to settle the obligation; or (ii) a reliable estimate of the amount of the obligation cannot be made. Contingent liability is not included in Balance Sheet but shown by note. The distinction between a real liability and a contingent liability depends on the certainty of the payment to be made. A real liability exists when it is certain that the payment will be made. A contingent liability exists when it is only possible that the payment will be made an example of a contingent liability is a product warranty. If a company promised to replace a defective unit at no cost to the customer within one year of purchase, the company will have an actual liability only if units are defective. Another example is of any case, say a Tax case is pending before the court, the payment of which depends on the outcome of the court verdict. It is a potential liability that depends on a trigger to actually become a liability. Insurance companies have recently entered into contingent capital structures - some with debt capital. These structures give the insurance company the right to issue debt securities to the vendor of the contingent capital structure on pre-agreed terms if a large insurance event. The contingent debt is not a liability on the insurer's balance sheet as it is not issed and can not be issued. However, if the event happens (ie there is a big Hurricane in Florida) then the insurer can issue the debt and it becomes an actual liability.

Q2: State which of the errors will affect the agreement of the Trial Balance and which will not. Give rectifying journal entries (with full narration) assuming the difference in trial balance has been placed to suspense account a. Purchase of second hand Motor Car for Rs 10000/- has been debited to car maintenance account. b. A sale of Rs 7500/- to Mr A has been wrongly entered in sales day book as Rs 750/c. An entry in the Purchase return book of Rs 3000/- has been omitted to be posted in the account of Mr B the supplier. d. An amount of Rs 12000 received from Mr X has been posted to the credit of Mrs X a/c as Rs 1200/e. The total of sales Day Book for the month of December Rs 750000/- has been omitted to be posted f. Wages for installation of machinery has been debited to wages account Rs 10000/Solution: a. Motor Car a/c ………Dr To Car Maintenance a/c 10000/10000/-

(Being car purchased debited to car maintenance a/c). This is an error of principle and hence will not affect agreement of trail balance.

b. A a/c………….Dr To Sales a/c (Being sales understated, now corrected).

6750/6750/-

This is an error of original entry and hence will not affect agreement of trail balance.

C. B a/c…………Dr To Purchase Return a/c

10800/10800/-

(Being purchase return understated, now corrected. This is an error of omission and hence will not affect agreement of trail balance.

D. Mrs. X a/c………Dr

1200/-

Cash a/c………..Dr To Mr.X

10800/12000/-

(Being amount received from Mr.X posted to wrong a/c and understated) It will affect agreement of trial balance as cash received has been posted wrongly in the ledger.

E. Sales of Rs.750000 has been understated and it will result in trail balance having understated sales. No rectification entry will be passed for the same.

F. Machinery a/c……..Dr To wages a/c

10000/10000/-

(Being machinery installation debited to wages a/c) It will not affect agreement of trial...
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