Introduction to Financial Accounting

Introductionto Financial

Accounting

(As per the Revised Syllabus 2014-15 of Mumbai University for

F.Y. BMS, Semester I)

Dr.NisikantJha

[Winner of “Best Commerce Author 2013-14” by Maharashtra Commerce Association]

Ph.D., ICWA, PGDBM (MBA), M.Com.,

International Executive MBA UBI, Brussels, Belgium; BEC Cambridge University,

Assistant Professor in Accounts & Coordinator

for

BAF, Thakur College of Science and Commerce,

UGC Recognised, University of Mumbai.

Visiting Faculty for: MBAin United Business Institutes, Brussels, Belgium, Europe,

CFA& CFP Professional Courses of USA, CIMAProfessional Courses of London,

CA & CS Professional Courses of India, M.Com. & M.Phil., Hinduja College,

Ph.D. Guide [Research Supervisor] & Professor for Research Methodology.

Prof.Nimesh Jotaniya Prof.Poonam Kakad

PGDFM, M. Com., UGC-NET Co-ordinaotor BAF, BMS

Assistant Professor in Accounts at Nirmala College of Commerce

Thakur College of Science & Commerce Kadivali, East

MUMBAI  NEW DELHI  NAGPUR  BENGALURU  HYDERABAD  CHENNAI  PUNE  LUCKNOW

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First Edition: 2014

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Preface

It is a matter of great pleasure to present this new edition of the book on Introduction to

Financial Accounting to the Students and Teachers of Bachelor of Management and studies started

by University of Mumbai. This book is written on lines of syllabus instituted by the university. The

book presents the subject matter in a simple and convincing language.

We owe a great many thanks to a great many people who helped and supported me during the

writing of this book which includes Principal, Co-coordinator, and Students of BMS Section.

The syllabus contains a list of the topics covered in each chapter which will avoid the

controversies regarding the exact scope of the syllabus. The text follows the termwise, chapter-topic

pattern as prescribed in the syllabus. We have preferred to give the text of the section and rules as it is

and thereafter added the comments with the intention of explaining the subject to the students in a

simplified language. While making an attempt to explain in a simplified language, any mistake of

interpretation might have crept in.

This book is an unique presentation of subject matter in an orderly manner. This is a

student-friendly book and tutor at home. We hope the teaching faculty and the student community

will find this book of great use.

We are extremely grateful to Mr. Pandey of Himalaya Publishing House Pvt. Ltd. for their

devoted and untiring personal attention accorded by them to this publication.

We gratefully acknowledge and express my sincere thanks to the following people without

whose inspiration, support, constructive suggestions of this book would not have been possible.

Mr. Jitendra Singh Thakur (Trustee, Thakur College)

Dr. Chaitaly Chakraborty (Principal, Thakur College)

Mrs. Janki Nishikhant Jha

Mrs. Anita Ninesh Jotaniya

Mr. Kalpesh Jotaniya & Mrs. Anita K. Jotaniya

Mr. Pritesh Gangar & Mr.Alpesh Gangar

Mr. Kalpesh Tank & Mr. Rahul Tank

Where we stand Today is because of our reverred parents whom we owe much.

We welcome suggestions from students and teachers for further improvement of quality of the

book.

Authors

Our Well-wishers .....

1. Prof. Monica Chandiwala (BMS/BAF/BBI Coordinator, Balbharti College)

2. Porf. Kavita Shah (BMS/BAF/BBI Coordinator, N. K. College)

3. Prof. Poonam Kakkad (BMS Coordinator, Nirmala College)

4. Dr.Anand Dharmadhikari (BAF Coordinator, Hinduja College)

5. Prof. Kuldeep Sharma (BAF Coordinator, Hinduja College)

6. Dr.A.C. Vanjani (Principal, MMK College)

7. Dr. Jayant Apte (Vice Principal, G.D. Saraf College)

8. Mr. Vinod D. Tibrewala (Trustee, SRSS College)

9. Mr. Rajubhai Desai (Trustee, St. Rock’s College)

10. Prof. S.B. Arya (Vice Principal, KGMittal College)

11. Dr. V.S. Kannan (Vice Principal, KES College)

12. Dr. Malini Johri (Principal, Chinai College)

13. Prof. Piyush Shah (Vice Principal Burhani College)

14. Prof. Prachi Kadam (BMS Coordinator, Gokhle College)

15. Dr. Sharda S.C. (Principal, L. N. College)

16. Prof. Anita Bobade & Prof. Sanjeev Thakur (Alkesh Dinesh Modi Institute)

17. Prof. Bysi Panikar (BMS Coordinator, Patuk College)

18. Prof. Shirley Pillai (BBI Coordinator, St. Andrew’s College)

19. Prof. Rupal Shah (N.M College)

20. Prof. Tiwari (BMS Coordinator, Birla College)

21. Prof. Nanda (BMS Coordinator, SRSS College)

22. Prof. Arvind Dhond (St Xevier College)

23. Prof. Leena Nair (Tolani College)

24. Dr. Vinita Pimple (Poddar College)

25. Prof. Darshan Pagdhre (Lala College)

Syllabus

The objectives of the course are:

To understand and apply the theoretical aspects of accounting methods used for collecting,

recording and reporting financial information.

To analyze and interpret the financial environment in which accounting information is used in

managing a business;

To apply accounting and financial management decision-making techniques to practical

situations that are likely to be encountered by a manager.

Unit – 1

Meaning and Scope of Accounting: Need and development, definition: Book-Keeping and

accounting, Persons interested in accounting, Branches of accounting, Objectives of accounting.

Accounting Principles: Introductions to Concepts and conventions.

Introduction toAccounting Standards: (Meaning and Scope)

 AS 1: Disclosure to Accounting Policies

 AS 6: Depreciation Accounting.

 AS 9: Revenue Recognition.

 AS 10: Accounting For Fixed Assets.

International Financial Reporting Standards(IFRS):

 Introduction to IFRS

 IAS-1: Presentation of Financial Statements (Introductory Knowledge)

 IAS-2: Inventories (Introductory Knowledge)

Accounting In Computerized Environment

(Introduction, Features and application in various areas of Accounting)

Unit – 2

 Accounting Transactions: Accounting cycle, Journal, Journal proper, Opening and closing

entries, Relationship between journal & ledger: Rules regarding posting: Trial balance:

Subsidiary books (Purchase, Purchase Returns, Sales, Sales Returns & cash book –Triple

Column), Bank Reconciliation Statement.

 Expenditure:

 Classification of Expenditure-Capital, revenue and Deferred Revenue expenditure

 Distinction between capital expenditure and revenue expenses

 Unusual Expenses: Effects of error: Criteria test.

 Receipts: Capital receipt, Revenue receipt, distinction between capital receipts and revenue

receipts.

 Profit or Loss: Revenue profit or loss, capital profit or loss

Unit – 3

 Depreciation Accounting: Practical problem based on depreciation using SLM and RBM

methods.(Where Provision for depreciation Account not maintained).

 Preparation of Trial Balance:

Introduction and Preparation of Trial Balance

Unit – 4

Final Accounts of a Sole Proprietor

 Introduction to Final Accounts of a Sole proprietor.

 Rectification of errors.

 Manufacturing Account, Trading Account, Profit and Loss Account and Balance Sheet.

 Preparation and presentation of Final Accounts in horizontal format

 Introduction to Schedule 6of Companies Act, 1956

Contents

Chapter 1: Meaning and Scope of Accounting 1 — 37

Chapter 2: Introduction to Accounting Standard 38 — 61

Chapter 3. Introduction to IFRS and Accounting in Computerised

Environment 62 — 84

Chapter 4. Accounting Procedure 85 — 156

Chapter 5. Reconciliation and Rectification 157 — 188

Chapter 6. Capital and Revenue 189 — 203

Chapter 7. Depreciation, Provisions and Reserves 204 — 231

Chapter 8. Final Accounts 232 — 289

Chapter 9. Final Accounts of Companies 290 — 309

INTRODUCTION

All of you at one point of time would have visited a grocery shop or a medical shop. You might

have wondered how the business person maintains the record of all the transactions done during a

particular period of time say a year. You might have also thought why he or she has to maintain a

record, how is it beneficial and whether it is mandatory or not? As against this, imagine the role of a

business organization. They provide goods that might range from simple safety pin to fighter air crafts.

Those who are in service industry provide various services such as transportation services, hospitality

services, developing complex software programmes etc.

To make sound decision, a business enterprise need accounting information. This information is

also needed by government agencies, regulatory bodies, analysts and individuals at various point of

time and at different levels.

Accounting is perhaps one of the oldest and structured management information system. It has

evolved in response to the social and economic needs of society. Accounting as an information system

is concerned with identification, measurement and communication of economic information of an

organization to its users who may need the information for rational decision making. The accounting

system is a means to provide relevant and reliable financial information to all the interested parties.

Each and every person of the society is required to keep some accounts. In the stream of social

and economic activities of today, each and every person or institution is accountable to someone or to

other for his or its economic activities or the wealth acquired, income earned and the expenditure

incurred. Different types of transactions occur in business. Without maintaining proper accounts, it is

neither possible to ascertain profit or loss of the business nor to know the financial position of the

business at any particular date. This chapter will describe meaning, evaluation, scope and objects of

financial accounting. It also discusses importance and uses of accounting in daily life. Let's go through

the entire chapter and know introduction to financial accounting.

Definition of Accounting

Accounting is both the science and art of correctly recording in books of accounts all those

business transactions that result in the transfer of money or money's worth. It may also be defined as

the art of recording merchantile transactions in a regular and systematic manner; the art of keeping

accounts in such a manner that a man may ascertain correct result of his business activities at the end

of a definite period and also can know the true state of affairs of his/her business and properties by an

inspection of his/her books.

Accounting has been defined as, "the art of recording, classifying and summarizing in a

significant manner in terms of money, transactions and events which are, in part at least, of financial

character, and interpreting the results thereof. " This definition has been given by the AICPA.

CHAPTER

Meaning and Scope of

Accounting

2 Introduction to Financial Accounting

More Definitions of Accounting

American Accounting Association (AAA): AAA defines "Accounting refers to the process of

identifying, measuring and communicating economic information to permit informed judgment and

decisions by users of the information."

A.W. Johnson: "Accounting may be defined as the collection, compilation and systematic

recording of business transactions in terms of money, the preparation of financial reports, the analysis

and interpretation of these reports and the use of these reports for the information and guidance of

management."

Weygandt, Kieso and Kimmel: "Accounting is an information system that identifies, records

and communicates the economic events of an organization to interested users."

This definition views accounting as an information system that identifies and records the

financial transactions, ascertains the results and provides information to the various interested users in

the desirable way or according to their needs. Basically, accounting is not a recording procedure. It is

an information device or a tool that works to provide information to interested users to rationalize their

decision making.

SCOPE OF ACCOUNTING

The scope of field of accounting is very wide. Accounting is needed not only by business class

but also by non-business class. Starting from the private life of a man, the financial activities of school,

college, club, society, hospitals and government institutions come within the purview of accounting.

The jurisdiction of accounting also includes the financial activities of professionals including doctors,

engineers and layers. The monetary transactions which take place in the private life of a man are

recorded properly in the books of accounts; it becomes possible to ascertain his receipts and

expenditure as well as personal assets and properly in the books of accounts, it becomes to ascertain

his receipts and expenditure as well as his personal assets and liabilities. When the financial

transactions of a business are prepared, it is essential to maintain accounts of non-profit organizations

like school, college, hospital, club, society etc. In the same way, it is necessary to keep accounts of

professionals like service-holders, doctors, lawyers, actors/actress etc. to ascertain their incomes and

calculation of income-tax on the basis of those incomes. Maintaining accounting is practiced to

determine the income and expenditure of different government offices and public bodies as well as to

run those offices and organizations properly. By preparing and evaluating national plan and budget

with the help of accounting, it is possible to know the development and deterioration of the country.

Hence, in a nutshell, we can say that the scope of accounting is wide enough to cover all the fields of

the society.

Objectives of Accounting

The principal object of accounting is to keep permanent record of all monetary transactions

effected by a person or enterprise during a definite period and ascertainment of results of those

transactions at the end of the period. The main objects of accounting are enumerated below:

1. Proper Recording of Transactions: The first and foremost object of accounting is to keep

record of monetary transactions in a systematic manner.

2. Determination of Results: Every person or institution is always interested to know the

results of his/its monetary transactions at the end of a definite period. So, ascertainment of

result of financial transactions is an important object of accounting.

3. Ascertainment of Financial Position: Another object of accounting is the ascertainment of

debtors and creditors, assets and liabilities and the overall financial position.

Meaning and Scope of Accounting 3

4. Supplying Financial Information: Another important object of accounting is to make

available all sorts of financial reports and statements to all parties interested in the affairs of

the concerned institution as soon as possible after preparing those reports and statements.

5. Defalcation Prevented: Another special object of accounting is the prevention of

defalcation of money made through fraud by the officials of the institution as well as control

of expenditure.

NEED, IMPORTANCE AND USES OF ACCOUNTING IN DAILY LIFE

Accounting has become part of our daily activities as it implicates monetary transactions of life.

People spend money, invest money for future; all these require proper accounting. Let's discuss the

matter in detail.

Necessity and Importance of Accounting

The necessity and importance of accounting is limitless or unbounded to men in their day-today

personal life, family life, and intuitional life. The necessity of accounting is described below:

Institutional Necessity

1. Accounting supplies numerical information to the institution relating to its management and

administration.

2. Exact results of the institution are disclosed through accounting.

3. The firm can ascertain the financial status of the business operation.

4. Firm can compare the financial position of two/more years.

5. Books accounts are very valuable documents.

6. Proper accounting makes the firm credible to other party.

7. Tax authority can assess taxes for the firm using the accounting information.

8. Firm can determine the actual assets and liabilities.

9. Using accounting data, a firm can formulate policy and take many decisions on future

operations.

Uses of Accounting in Day-to-day Life

1. Someone can ensure smooth financial management in his life.

2. He/she can bring financial solvency because financial plan helps to be economical.

3. Accounting helps in preparing personal budget.

4. Accounting promote saving habits.

5. Accounting helps to solve family and social disputes as it provides for authentic records.

ACCOUNTING: WHETHER SCIENCE OR ARTS?

There is a great controversy whether accounting is science or arts. According to some scholars

accounting is science, someone is describing accounting as arts. But actually accounting is a

composition of both science and arts.

4 Introduction to Financial Accounting

Why Accounting is 'Science'?

Science refers to systematic process. In scientific activities, it follows certain rules —

observation, analysis, taking actions and then evaluation of activities. Like scientific activities before

taking any action, accounting observes the activities, analyses the various alternatives, chooses the

best alternatives and takes feedback to evaluate the performance. So, accounting is termed as science.

ACCOUNTING PROCESS

Accounting is the process of identifying the transactions and events, measuring the transactions

and events in terms of money, recording them in a systematic manner in the books of accounts,

classifying or grouping them and finally summarizing the transactions in a manner useful to the users

of accounting information.

1. Identifying the Transactions and Events: This is the first step of accounting process. It

identifies the transaction of financial character that is required to be recorded in the books of

accounts. Transaction is transfer of money or goods or services from one person or account

to another person or account. Events happen as a result of internal policies or external needs.

Events of non-financial character cannot be recorded even though such events may have an

impact on the operational results of the firm.

2. Measuring: This denotes expressing the value of business transactions and events in terms

of money (in terms of rupees in India).

3. Recording: It deals with recording of identifiable and measurable transactions and events in

a systematic manner in the books of original entry that are in accordance with the principles

of accountancy.

4. Classifying: It deals with periodic grouping of transactions of similar nature that appear in

the books of original entry into appropriate heads by posting or transfer entries. For example,

all purchases of goods made for cash or on credit on different dates are brought to purchase

account.

5. Summarizing: It deals with summarizing or condensing transactions in a manner useful to

the users. This function involves the preparation of financial statements such as income

statement, balance sheet, statement of changes in financial position and cash flow statement.

6. Analyzing: It deals with the establishment of relationship between the various items or

group of items taken from income statement or balance sheet or both. Its purpose is to

identify the financial strengths and weaknesses of the enterprise. The above six process in

the present-day scenario are generally performed using software packages.

7. Interpreting: It deals with explaining the significance of those data in a manner that the

end-users of the financial statement can make a meaningful judgment about the profitability

and financial position of the business. The accountants should interpret the statement in a

manner useful to the users, so as to enable the user to make reasoned decision out of the

alternative course of action. They should explain various factors on what has happened, why

it happened, and what is likely to happen under specific conditions.

8. Communicating: It deals with communicating the analyzed and interpreted data in the form

of financial reports/statements to the users of financial information, e.g., Profit and Loss

account, Balance Sheet, Cash Flow and Funds Flow statement, Auditors Report etc. The

Accounting Information system.

Meaning and Scope of Accounting 5

The Accounting Information System

Input Processing

1. Business transaction 1. Accounting concepts, conventions and

principles

2. External events measured in financial terms  2. Management plans and policies

3. Law and regulation

4. Classification and interpretation

Out put Users

1. Profit and Loss a/c 1. Shareholder

2. Balance sheet 2. Regulation

3. Cash flow statement 3. Lender

4. Explanatory notes 4. Employees

5. Audit report 5. Management

6. Regulatory filing 6. Rating agencies

LIMITATIONS OF ACCOUNTING

1. Though accounting system is the only source for extracting financial information of the firm,

it grossly lacks qualitative elements. Qualitative resources could include leadership of top

brass, highly talented human resource, highly motivated team, best products, the power of

resource and development, brand image etc.

2. Accounting is not free from bias. The accountants have some leeway or freedom on the

methods of depreciation charged, inventory valuation etc. Though the convention says

consistency has to be maintained on the policies adopted, there is considerable room for bias,

favourism and personal judgment.

3. Accounting reveals the estimated position and not the real position of the firm. Generally,

financial statements are prepared on separate entity concept, conservatism concept etc.

which are based on the estimates that may lead to overvaluation or undervaluation of assets

and liabilities. The exact picture of the financial situation can be ascertained only on the

liquidation of an enterprise.

4. Accounting ignores the price level changes when financial statements are prepared on

historical cost. Fixed assets are shown in the balance sheet at historical cost less accumulated

depreciation and not at their replacement value. Land value is shown at historical cost but

the replacement value could be far higher than the value stated in the balance sheet due to

appreciation of land value over the period of time.

5. The danger of window dressing arises when the management decides to incorporate wrong

figures to artificially inflate revenue or deflate losses or when there is a threat of hostile

takeover. In such a situation, the management fails to provide true and fair view of the

financial position to the various users of the financial statement. Satyam Computer Services,

the fourth largest software firm, went into bust when the information on inflated income to

the extent of ` 7,000 crore was revealed.

6 Introduction to Financial Accounting

MEANING OF ACCOUNTING PRINCIPLES, CONCEPTS AND POLICIES

Accounting information is used by various stakeholders. Since all the stakeholders should

understand the accounting language in the same sense, certain principles, concepts and policies of

accounting have been laid down.

1. Accounting Principles: Accounting Principles are basically the rules of action adopted by

the accountants universally while recording accounting transactions. The principles are

doctrines associated with theory and procedures and current practices of accounting. These

principles may be classified as concepts and conventions.

2. Concepts: Concepts take the form of assumptions or conditions, which guide the

accountants while preparing accounting statements.

Example: Business is started with an assumption that it shall be continued for a long period

of time and none wishes it to close down within a short period of time.

Based on this assumption, businessperson purchases fixed assets, uses long-term source to

fund the fixed assets etc. This strong assumption that the business will continue for a long

period of time is called a concept.

3. Conventions: Conventions are those customs and traditions which guide the accountants

while preparing the financial statements.

Example: Inventory (stock) in a business is valued at the end of an accounting period, at

cost or market price whichever is lower. This is an accepted convention or a practice in

accounting.

4. Accounting Policy: Accounting policy refers to the specific accounting principles and

methods of applying those principles adopted by the enterprise in the preparation and

presentation of financial statements.

Example: While depreciating an asset, the practice of adopting straight line method or

diminishing balance method or any other method is a convention.

The choice of selecting straight line method of depreciation or any other is the policy of the

management. No management can exercise discretion regarding fundamental presumptions of

accounting. But every management has a choice of making an accounting policy.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

The double entry system of accounting is based on a set of principles which are called generally

accepted accounting principles. It incorporates the consensus at a particular time as to:

Customs and

Traditions

Accounting

Conventions

Accounting

Concepts

Assumptions or

Conditions

Accounting policy is one which is adopted by

management relevent to the situations

Accounting Principles

Meaning and Scope of Accounting 7

1. which economic resources and obligations should be recorded as assets and liabilities by

financial accounting,

2. which changes in assets and liabilities should be recorded,

3. when these changes are to be recorded,

4. how the assets and liabilities and changes in them should be measured,

5. what information should be disclosed and

6. which financial statement should be prepared.

For example, an entity having research and development department may follow the policy of

deducting all the R&D expenses incurred in a year as revenue expense while for the same situation

another entity may classify R&D expenses into projects and may write off only when the project is not

expected to offer any future benefits.

US GAAP Indian GAAP

It is established under FASB and AICPA It is established by ICAI

Balance sheet, Income statement and Fund flow

statement are alone mandatory

Statement are mandatory

Any change in foreign exchange fluctuations

cannot be capitalized but the difference can be

shown or debited to income statement

Any difference in foreign exchange can be

capitalized

Financial accounting, management accounting and

income tax accounting are prepared separately

Only financial accounting and income tax

accounting are prepared

The basic tenets is globalization of business The basic tenet is localization

Any long-term loan repayable in the current

financial year is shown separately

Long-term loan maturing in the current financial

year need not be disclosed separately

In lease contract, lease is more beneficiary

because he can claim depreciation allowance

In lease contract, lessor is eligible for depreciation

allowance and not the lease

It is more transparent and accepted worldwide.

More disclosure is required

It is comparatively less transparent. For listing the

securities in other country’s stock exchange US

GAAP is mandatory

INTRODUCTION TO BOOK-KEEPING

Every business involves exchange of goods or services. That means a businessman or business

concern deals with other parties in exchange of goods or services. Such dealings, in business, are

called business transactions. The business transactions include purchase of goods or services, sale of

goods or services, payments, receipts etc. In a business concern, the transactions are numerous. All the

details of these varied transactions cannot be remembered by the businessman.

So there was a need to record all business transaction in a systematic way and this job of

recording of transactions have been later on called as “Book-keeping”.

Meaning of Book-keeping

Book-keeping is a process of recording business transactions in the books of accounts in a

systematic manner.

Book-Keeping is the process of analysing, classifying and recording transactions in a systematic

manner to provide information about the financial affairs of the business concern.

8 Introduction to Financial Accounting

Book-Keeping may be defined as the science and the art of the recording monetary, business

transactions in a set of books.

‘Book’ means ‘Book of Accounts’ and ‘keeping’ means ‘maintaining’ the books of accounts.

Thus, the writing of business transactions in the books of accounts for future use is a simple meaning

of Book-Keeping.

All the transactions are recorded date wise. A person who records the same is called as an

Accountant who has to show the business results from such records at the end of financial year which

ends on 31

March every year. In India this system of book-keeping was in operation from 23

centuries ago at the time of Chandragupta Maurya. Chanakya was recording the accounting

transactions. He wrote a famous book known as “Arthashashtra”. After some years this system was

called as “Deshi Nama”. The Double entry system of book-keeping was originated in Italy, developed

by Luca De Bergo Pacioli in the year 1494.

Definition of Book-keeping

R. N. Carter has defined, “Book-keeping is the science and art of correctly recording in the

books of accounts, all those business transactions that results in transfer of money’s worth.”

J. R. Batliboi has defined, “Book-keeping is the art of recording business dealings in a set of

books.”

Book-keeping is a Science or an Art:

Book-keeping is a science as well as an art. Book-keeping has some rules and principles as (like)

science. Book-keeping is a systematic body of knowledge governed by certain rules. Therefore, it is

called as science. However, it is not a physical, natural or pure science like chemistry, Biology or

Mathematics, but a social science evolved by man and society. Therefore answers provided by Book-

keeping are not always fixed or rigid, but largely dependent upon the needs of the business and the

society.

An art means an action of doing a thing with some skill and experience. Therefore, Book-keeping

is an art. An accountant (Book-keeper) can represent any typical transactions in an easy way with his

art. In book-keeping some transactions can be represented in alternate (different) ways.

Features of Book-keeping:

1. It is the process of recording business transactions

2. It is an art of recording business transactions scientifically.

3. It needs documentary support for each transaction.

4. Transactions are recorded in specific set of books only.

5. It records only monetary transactions. Non monetary transactions can not be recorded.

6. The system of recording should be universal.

7. The business organisation records its own transactions with others.

8. Record is prepared for a specific period but presented for future references.

Objectives of Book-keeping:

1. To know the profit or Loss of business during a particular (specific) period.

2. To know the financial position (Assets & liabilities) of the business on a particular date.

3. To know the amount of capital invested in the business.

4. To have a systematic, permanent record of business transactions.

Meaning and Scope of Accounting 9

5. To know the amount due to business from various debtors.

6. To know the amount due to creditors from business.

(To know what the businessman owes to others and what others owes to him)

7. To know the amount of various taxes payable to the Government.

8. To provide valuable information for legal purposes.

9. To compare his business with that of other concerns engaged in a similar line.

10. To find out the total incomes and total expenditures of the business.

11. To know the Goodwill of the business.

12. To know the progress of the business.

13. To know how the amount of profit or loss is made up.

14. To keep a check on the properties.

15. To review the progress of the business from year to year.

16. To prevent and minimise the accounting errors and frauds.

17. To know the total business purchases and sales.

18. To help in taking decisions on important business matters.

Importance of Book-Keeping:

Following points explain the Importance of Book-keeping.

1. Aid to Memory: Human memory has certain limitations. A businessman cannot remember

all the business transactions. Book-keeping helps the businessman in this regard also. Due to

Book-keeping, it is not necessary to remember the transactions.

2. Facilitates Planning: Proprietors have to plan their business operations for years to come.

Book-keeping generates valuable information about production, sales, expenses and incomes,

which helps planning.

3. Decision Making: Management has to take valuable decisions about business. Book-

keeping makes available necessary information, which facilitates decision-making.

4. Controlling: With the help of available financial information and figures the executives of

the business can control the business.

5. Comparison: A businessman can do yearly comparative study to understand the business

position over the years. He can also do the comparative study with other business units.

6. Helpful in Getting Discharge: In case of insolvency of a proprietor, he can get discharge

from the court on the basis of record of business transactions.

7. Settlement of Tax Liability: Book-keeping is useful to find out tax liability in case of Sales

Tax, Income Tax, Property Tax etc. Proper record of transactions would enable a

businessman to fix up the amount of his tax liability and discharge it.

8. Protection Against Theft and Dishonesty: A businessman can protect himself against theft

and dishonesty of employees by keeping books of accounts in a systematic manner. He can

exercise greater control on his finance through systematic recording only.

9. Evidence in Litigations: Court considers the record provided by businessman as an

evidence in case of any disputes.

10. Sale of Business: In case the business is sold out, the purchase consideration can be decided

on the basis of the accounts maintained.

10 Introduction to Financial Accounting

11. Helpful in Getting Loans: A businessman may require loans from banks for financing his

expansion scheme. Properly kept accounts can convince the banks about financial soundness

of business.

Utility of Book-keeping

1. To Owner: It helps to find out profit, losses, Assets, liabilities in the business at any time.

2. To Management: It helps the management in planning, decision making, controlling and

managing the overall business activities.

3. To Government: Book-keeping helps various department of government to decide how

much taxes are collected from business.

4. To Investors: Investors can decide whether to invest or not to invest their funds in the

business on the basis of information provided by the Book-keeping and Accountancy.

5. To Customers: Customers can judge the financial capacity of the business and can remain

assured about smooth supply of goods.

6. To Lenders: Lenders can study the creditworthiness of the business firm with the help of

books of accounts which assures continuous supply of funds.

7. To Purchaser: Book-Keeping helps the purchaser to find out the true value of the business.

8. To Trade Union: Book-keeping helps the trade union to know that wages, salaries or bonus

given to employees are fair or not. A Trade union is able to demand high wage (Wage hike)

on the basis of book-keeping.

9. To Partner: In case of partnership firm, partners are able to get information about

admission, retirement or death of a partner from book-keeping.

Distinction between Book-keeping & Accountancy

Book-keeping Accountancy

Meaning

Book-keeping is a process of recording business

transactions in the books of accounts in a

systematic mannermeans of collecting,

summarizz.

Accountancy is concerned with the processes of

recording, sorting & summarising data resulting

from Business operations & events. Accountancy

also refers to systematic analysis of the recorded

data.

Stage

Book-keeping is the first stage and it comes

immediately after transaction.

Accountancy comes after recording and

classification. Accountancy is the next stage after

Book-keeping.

Objectives

Book-keeping aims at keeping the record and

provides primary information.

Accountancy aims at finding the profits or losses

and gives financial position.

Level of work

In book-keeping, the level of work is less. It is

done by junior staff.

In accountancy, the level of work is high. It is done

by senior staff.

Results

Meaning and Scope of Accounting 11

Book-keeping basically results in Journal and

Ledger.

The results of Accountancy is Profit and Loss A/c

and Balance sheet.

Period

Book-keeping gives day to day details. Accountancy gives details of entire year.

Scope

Book-keeping has a limited scope. Accountancy has a wider scope.

Procedure

Book-keeping includes recording the entries of

day-to-day transactions by following basic rules of

double entry Book-keeping system.

Accountancy includes processing of Primary

information available from books of accounts and

preparation of financial statements.

Principles

Book-keeping requires principles of elementary

knowledge of Journalising and Posting.

Accountancy requires all the Accounting

Principles.

User

Book-keeping records are used by accountant as it

provides the basis for accountancy.

Accounting records are used by owners,

managements, Government and other stock holders.

Basis of Accountancy/Accounting

1. Cash Basis: Under this system only cash transactions are recorded. Under cash basis an

income is recorded only when cash is actually received and expenses are recorded when cash in

actually paid. The business records every cash that comes in business and every cash that goes from

business.

2. Accrual Basis: An income is recorded when it is earned (whether cash received or not) and

expenses is recorded when they become payable. Both cash as well as credit transactions are recorded.

This is also called Mercantile Basis of Accounting.

Branches of Accounting

In order to satisfy the needs of different people interested in the accounting information, different

branches of accounting have been developed. The changing business scenario has given birth to the

specialized branches of accounting which are:

1. Financial Accounting: Financial Accounting is concerned with recording of financial

transactions, summarizing and interpreting them and communicating the results. It is original form of

accounting that ascertains profits earned or loss suffered during a specific period (generally a year)

and ascertains the financial position on the date when the accounting period ends.

2. Cost Accounting: It is the process of accounting and controlling the cost of product, operation

or function. The purpose of this branch of accounting is to ascertain the cost, to control the cost and to

communicate information for decision.

3. Management Accounting: It is an accounting for the management i.e. accounting which

provides necessary information to the top level management for discharging its functions.

Management accounting covers various areas such as cost accounting, budgetary control, inventory

control, statistical methods, internal auditing etc. The purpose of this branch of accounting is to supply

all information that management may need in taking decisions and to evaluate the impact of its

decisions and actions.

12 Introduction to Financial Accounting

ACCOUNTING PRINCIPLES

Meaning of Accounting Principles

The literal (dictionary) meaning of the term Principle is that it is a basic fundamental truth or

treaty, which is uniformly accepted and followed by everyone and everywhere. Development of

accounting principle took place from time to time based on experience, usage and necessity.

Accounting principles are those rules of action or conduct, which are accepted universally by all

accountants in recording transactions in the books of accounts. (Accounting principles are those rules

which are to be adopted by Accountants) These principles are usually developed by professional

accounting bodies.

Accounting principles can be broadly classified into two main categories

(a) Accounting Concepts

(b) Accounting Conventions

ACCOUNTING CONCEPT OR ASSUMPTIONS

Meaning of Accounting Concept

Accounting is the language of business. In the absence of systematic approach, accountants may

use their own language and it may not be understood in the same sense by all concerned parties. With

a view to make accounting language a standard language, certain accounting concepts have been

developed over a course of period. Accounting concepts are general guidelines for sound accounting

practices.

Accounting concepts are assumptions and conditions on which the whole accounting structure

stands. They are the predetermined condition which a book - keeper must keep in mind, while

recording transactions in the books of accounts.

Importance of Accounting Concepts/Principles

1. Ensure uniformity in presentation of financial statements. (Uniformity in presentation)

2. Serve the purpose of providing proper information to the stakeholders. (Proper information

to all)

3. All the stakeholders believe that assumptions on which financial statements are based are

valid and appropriate. (Valid & appropriate assumptions)

4. Make financial statements reliable. (Reliable financial statements)

5. Provide a basis for measurement that is generally acceptable. (Generally acceptable basis of

measurement)

Some of the Important Concepts are as follows

1. Entity Concept/Business Entity Concept

Entity means something that has real separate existence. In other words, entity refers to status or

personality. The business has separate existence from its owner or proprietor. For instance Mr. X has

been conducting business under the title Ganesh Medicals for last so many years. Here in this case Mr.

X and Ganesh Medicals are different from each other.

The business unit is separate from its owner is the basic meaning of entity. Under this concept

sole trading concern and sole proprietor are treated as two different entities. According to this concept

Meaning and Scope of Accounting 13

only business transactions are recorded in the business book of accounts. Proprietor’s personal

transactions are not recorded in the books of accounts

e.g.: Half of the building is used for business office and other half of the building is used for the

residence of the proprietor. If the total rent of the building is ` 50,000 then only ` 25,000 will be

deducted as drawings from proprietor’s capital.

2. Money Measurement Concept

There is a need to express transactions in common unit of measurement, Every transaction is

recorded in terms of money. In India all the accountants use only Indian currency i.e., ‘Rupee’ (`)

Because of this concept only monetary items are recorded.

In accounting, everything is recorded in terms of money. Events or transactions, which can not be

expressed in terms of money, are not recorded in the books of accounts, even if they are very

important or useful for the business. Purchase and sale of goods, payment of expenses and receipt of

income are monetary transactions which find place in accounting. Death of executive, resignation of a

manager are the events which can not be expressed in money. Thus, they are not recorded in the books

of accounts.

E.g., A businessman owns following properties;

Land 2000 Sq. Mtrs. Cost ` 5,00,000, Building 40 Rooms, Cost ` 9,00,000,

Raw Material 8 Tonnes, Cost ` 4,00,000

Here total assets will be recorded by common unit of money measurement and will be valued at

` 18,00,000 in the books of accounts.

3. Cost Concept

This concept does not recognise the realisable value, the replacement value or the real worth of

an asset. Thus, as per cost concept.

(a) An asset is ordinarily recorded at the price paid to acquired (got/purchased) it i.e. At its

cost, and

(b) This cost is the basis for all subsequent accounting for the asset.

For Example: If a plot of land is purchased for ` 1,00,000 & It is recorded in the books at

` 1,00,000. In case market value goes to ` 2,00,000 or ` 60,000 it will not be considered.

4. Going Concern Concept

It is the basic assumption that business will continue for a quite long time, it will go on and on

and will not be closed down or stopped for a quite long time. Business is not to be closed at its early

stage but should give a long life. This principle helps may investors to invest, many suppliers to give

credit, many workers or employees to give services.

e.g. A stall for marketing of any product or introduction of new product of any business has to be

closed immediately after the exhibition is over. But once the business is set up, it continues for a long

time.

5. Realisation Concept

Income is recorded only when it is realized i.e. either it is received or earned. Revenues are

recorded only when sale are affected or the services are rendered. Sales revenues are considered as

recognized when sales are effected during the accounting period irrespective of the fact whether cash

is received or not.

14 Introduction to Financial Accounting

e.g.

(i) A company gets an order for sale of goods ` 1,00,000/- in May 2014 goods of only

` 60,000/- are sold and delivered in June 2014. Cash is received for ` 60,000/- in Sept., 2014.

As per the principle of realisation, sale is to be recorded in June 2014.

(ii) A businessman purchased 2 washing machines from manufacturers for ` 15,000/- each. One

out of two is sold for ` 17,000/- and earned a profit of ` 2000/-. The other one is not sold out

then he can’t anticipate and record a profit of ` 2000/- on the second machine unless and

until a sale is realised.

(iii) Money received in advance along with an order is not treated as revenue until the goods are

dispatched & sold or services are rendered.

(iv) Similarly, until the asset is sold, appreciation in value of the asset is not to be considered.

E.g. land is purchased for ` 50,000 in 2010 and after one year if the market price increases to

` 70,000, then ` 20,000 which is appreciation on land should not be considered.

6. Accrual Concept Dual Concept

It implies recording of revenues (Incomes) and expenses of a particular accounting period,

whether they are received or paid in cash or not. Income is recorded when it accrues (earned) and

expenses are recorded when they accrue (become payable) All expenses and revenues related to the

accounting period are to be considered irrespective of the fact, the revenues (Incomes) are received in

cash or not or expenses are paid in cash or not. Outstanding expenses & outstanding incomes are

entered in the books of Account due to accrual concept.

e.g. A company invested ` 2,00,000 with a bank for one year on 1st July, 2009, Bank has to pay

interest at 10% p.a. on it maturity i.e. 30th June, 2010. As per principal of accrual Interest of 6 months

is ` 10,000 to be shown in income statement as Interest receivable during financial year 1/1/2009 to

31/12/2009.

7. Dual Aspect Concept

Every business transaction has two effects and involves exchange of benefits. Benefit received

and benefit given both the aspects should be recorded in the books. The system which records such

dual aspects in the books is known as Double Entry System.

This principle also considered as the concept of debit & credit. The account where the benefit

comes in is debited and the account where benefit goes out is credited.

e.g.: A proprietor invested ` 1,00,000 into the business. At one side business gets asset (Cash)

` 1,00,000/- and the other side business owes ` 1,00,000/- as capital to the proprietor. Thus all the

debit in the ledger will be equal to all the credits.

8. Revenue Recognition Principle

This principle is mainly concerned with the revenue, being recognised in the Income Statement

of an organization. Revenue is the gross inflow of cash receivables or other considerations arising in

the course of ordinary activities.

e.g. Sale of goods, rendering of services and use of resources by other, yielding interest, royalties

and dividends. It excludes the amount collected on behalf of third parties such as certain taxes. In an

agency relationship the revenue is the amount of commission and not the gross inflow of cash

receivable or other consideration. Revenue is recognized in the period in which it is earned

irrespective of the fact whether it is received or not received during that period.

Meaning and Scope of Accounting 15

9. Matching Concept

This concept is very important for determination of profit or loss correctly. According to this

concept, the profit of the business is calculated by matching total revenue earned during the year with

total expenses incurred during the same period. The difference between the two represents profit or

loss. Excess of revenue over expenses is profit while Excess of expenses over revenue is a loss.

Following points should be considered

(i) Any expenses payable for the period should be considered & added to expense.

(ii) Any prepaid expenses should be deducted from expenses paid.

(iii) Income receivable should be added to the revenue (Income).

(iv) Income received in advance should be deducted from the revenue.

For example:

If a broker has received commission of ` 10,000. Here, ` 10,000 can not be considered as his

profit. He must deduct expenses incurred by him to earn this commission. If he has spent ` 200 on

travelling, ` 300 on stationery and ` 500 on advertisement then his real profit will be as shown below:

Commission Received (Income/Revenue) 10,000

Less: Expenses

1 Travelling 200

2 Stationery 300

3 Advertisement 500

Real Profit 9,000

In the above case his revenue ` 10,000 are matched with his expenses of ` 1,000.

10. Accounting Period Concept

A business organisation is a going concern. It has continuous life. The correct results cannot be

ascertained unless the business is closed down. The proprietor cannot wait indefinitely till the closure

of business to know the financial results. Hence, the life span of an organisation is divided into the

periods of 12 months which is known as accounting year or accounting period. It is also known as

fiscal or financial year. It is essential to measure financial health of an organisation periodically to

enable the stakeholders to take right decision. Hence, financial results are ascertained every year. All

the organisations therefore, prepare financial statements every year.

11. Objective Evidence Concept

According to this concept all accounting transactions must be supported by proper documentary

(paper) evidence. This document includes bills, contracts, pass book, copy of receipt, vouchers etc.

This documentary evidence helps the auditor (C.A.) to check the entries in the books of account with

their supporting papers. Thus, for each and every entry in the books of account there should be

documentary evidence. Similarly, for each and every documentary evidence of monetary nature there

should be entry in the books of account.

16 Introduction to Financial Accounting

ACCOUNTING CONVENTIONS

Meaning of Accounting Conventions

Dictionary meaning of convention is behaviour and attitudes that most people in a society

considered to be normal and right. Accordingly, accounting conventions refer to rules which have

common acceptance and agreement in accountancy. In other words, customs or traditions which guide

or direct the preparation of accounts are called accounting conventions. In this sense, accounting

conventions and accounting concept are synonymous. In short, accounting conventions means customs

or traditions which are followed years together to prepare accounts of the business concern.

An accounting convention may be defined as a custom or generally accepted practice which is

adopted either by general agreement or common consent among accountants.

Difference between Concepts and Conventions

Following is the difference between concepts and conventions:

Concepts

are

established

law

whereas

conventions

are

guidelines

based

upon

customs

usage.

adoption

concepts,

there

role

personal

judgment

where

conventions

adoption

affected

personal

Judgment.

Accounting

concepts

are

adopted

different

enterprises

bring

uniformity.

There

cannot

be uniformity in adoption of accounting conventions by different enterprises.

Different Accounting Conventions are as follows

1. Convention of Disclosure/full Disclosure

The accounts must disclose all material (important) information. The accounting reports should

disclose full and fair information to the related parties. The financial position and performance should

be disclosed very honestly to all the users. The financial position means the Balance Sheet of the

business and financial performance means business results in terms of profits or losses and income

and expenses in profit and loss account.

All the information disclosed should be relevant, reliable, comparable and understood by all the

concerned authorities.

This accounting convention is more relevant or made applicable to a joint stock company where

there is separation of ownership and management. As per the provisions of companies act, 1956,

financial statement and report prepared by the company must give a true and fair view of the state of

affairs of the company.

Note: Full disclosure does not mean all small points which should be discussed and mentioned

like purchase of motor car, its number, colour, which company, with or without carrier, etc.

2. Convention of Materiality

Material means important. The accountant should attach importance to material (important)

details and ignore insignificant (unimportant) details. If this is not done accounts will be overburdened

with minute (small) details. As per the American Accounting Association, “an item should be

regarded as material, if there is a reason to believe that knowledge of it would influence the decision

of informed investor.” Therefore, keeping the convention of materiality in view, unimportant items are

either left out or merged with other items or shown as foot notes.

Note: However, an item may be material for one purpose but immaterial for another, material for

one concern but immaterial for another, or material for one year but immaterial for next year.

Meaning and Scope of Accounting 17

3. Convention of Consistency/Consistency Concept

Any policy adopted for accounting should be continuous or consistent throughout the business

and it need not be changed generally unless and until circumstances demand. However it does not stop

any improvement of new techniques. But that should be disclosed with a note.

For instance, there are several methods of depreciation, to charge depreciation on fixed assets.

Once particular method of depreciation is adopted to charge depreciation on fixed assets, it should be

followed consistently for years together.

The convention of consistency has the following advantages:

(i) It ensures comparability of financial statements of different years.

(ii) It eliminates an element of uncertainty regarding the accounting procedure to be followed.

(iii) It also eliminates the element of any personal bias regarding preparation of accounts and

accounting reports.

4. Convention of Conservatism

It refers to the policy of ‘playing safe’. As per this convention all prospective (possible &

expected) losses are taken into consideration but not all prospective (possible & expected) profits. In

other words anticipate no profit but provide for all possible losses.

Under this convention if there are two figures representing losses or liabilities, then the higher

one must be selected and on the other side, if there are two figures representing profit or assets, then

the lower one should be selected. In short conservatism means to follow the safe side.

However, this convention is being criticised on the ground that it goes not only against the

convention of full disclosure but also against the concept of matching costs and revenues. It

encourages creation of secret reserves by making excess provision for depreciation, bad and doubtful

debts etc. The Income statement shows a lower net income and the Balance sheet overstates the

liabilities and understates the assets.

Following are the examples of application of conservatism

(i) Making provision for doubtful debts and discount on debtors.

(ii) Not providing for discount on creditors.

(iii) Valuing stock in trade at cost or market price whichever is less.

(iv) Creating provision against fluctuations in the price of Investments.

(v) Showing Joint Life Policy at surrender value and not at the paid up value.

Accounting Principles

Accounting Concepts Accounting Convention

1. Entity concept 1. Convention of Disclosure

2. Money measurement concept 2. Convention of Materiality

3. Cost concept 3. Convention of consistency

4. Going concern concept 4. Convention of Conservatism

5. Realisation concept

6. Accrual concept

7. Dual aspect concept

8. Revenue recognition concept

9. Matching concept

10. Accounting period concept

11. Objective evidence concept

18 Introduction to Financial Accounting

INTRODUCTION TO DOUBLE ENTRY SYSTEM

There are different methods of recording accounting information. They are as follows:

1. Indian system

2. English system

(a) Single Entry system

(b) Double Entry system

3. Conventional Accounting System

INDIAN SYSTEM

It is the most conventional (traditional) system of accounting. It is also called Mahajani\

Marwadi\Deshi Nama system. Under this system records are maintained in Indian Language, such as

Marathi, Hindi, Marwadi, Urdu etc. Transactions are recorded in long books known as kird and Bahi

Khata. This system of accounting is not based on Double Entry system. Though this system is not

scientific, it is still being used in India in small sized business.

ENGLISH SYSTEM

In English system, business transactions are recorded systematically in a separate set of books

such as journal and ledger, in the English language as per modern style. English system is more

advanced and extensively used now-a-days all over the world. Even in India, English system is more

preferred and extensively used in almost all types of business organisations. English Book-keeping

system is broadly reclassified as (A) Single entry book-keeping system and (B) Double entry book-

keeping system.

Single Entry Book-keeping System

Under this system only Cash Book (Cash A/c) and Personal Accounts, are maintained. This

system is known as incomplete system of recording because it changes with the convenience of

businessman. Therefore it is not a scientific and complete method of recording. It cannot provide

accurate information about the financial position of business. It is unscientific method having number

of defects. It is suitable to small traders.

Due to many limitations (defects/drawbacks) now single entry system is rarely used is modern

business.

Double Entry Book-keeping System

Origin of Double Entry System

Double Entry System of Book-keeping has emerged in process of evolution of various

accounting techniques.

The credit of evolving the present Double Entry Book Keeping system goes to a philosopher

turned mathematician Italian merchant “Luca D. Bargo Pacioli” in 1494.

Meaning of Double Entry System

Every business transaction involves an exchange of money or money’s worth (i.e. goods or

services or anything). An exchange involves two parts i.e. receiving and giving. The system of book-

keeping which records both the aspects of transactions is known as double entry system of book-

keeping. There cannot be business transactions without two effects. When a businessman gives

Meaning and Scope of Accounting 19

something, he gets something else in return. These two aspects affect two accounts - one account

receives the benefit and the other account gives the benefit. A business transaction is comparable with

a coin with two sides. As a coin has two sides, a transaction affects two accounts.

Double entry book-keeping does not mean the transaction is to be recorded two times. It is a

complete record of business transactions, that is, recording both the aspects of a transaction i.e. debit

and credit. Amount of benefit received by one account is equal to the amount of benefit given by the

other account. In other words, amount of debit is always equal to the amount of credit. Today, most of

the business concerns have adopted this system.

Recording dual (double) aspects of business transactions in the books of accounts in terms of

Debit & credit is known as ‘Double Entry System of Book-keeping’.

Definition of Double Entry System

“Every business transaction has a two fold effect and that it affects two accounts in opposite

directions and if a complete record is to be made of each such transaction it would been necessary to

debit one account and credit another account. It is this recording of two fold effect of every

transaction that has given rise to the term Double Entry”

– J. R. Batliboi

“The Double Entry System seeks to record every transaction in Money or Money’s worth in its

double aspect- the receipt of a benefit by one account and the surrender of a like benefit by another

account, the former entry being to the debit of the account receiving and the later to the credit of the

account surrendering.”

– William Pickles

Principles/Features of Double Entry System

Following are the main principles/features of Double Entry System of Book-keeping.

1. Every transaction has minimum two aspects.

2. These two aspects involve two accounts i.e. every transaction affects two accounts.

3. One account receives the benefit and the other account gives the benefit.

4. One account is debited and the other account is credited with equal amount.

Main Principle of Double Entry System

“Every debit has corresponding credit and every credit has corresponding debit with equal

amount.”

Examples:

(a) Furniture is purchased for ` 2,000 for which cash is paid.

Here, furniture comes in and cash goes out.

Two accounts are affected i.e. Furniture and Cash.

(b) Cash paid to Mr. Rakesh ` 3,000.

Here, two accounts are affected. One is Mr. Rakesh A/c. (who is receiver) and second is

Cash A/c. (goes out)

20 Introduction to Financial Accounting

Advantages of Double Entry System of Book-keeping

1. Complete Record: Since both the debit and credit aspects of every transaction are fully

recorded, a complete record of all transactions is obtained.

2. Accuracy: As every debit has a corresponding credit, and every credit has a corresponding

debit, the arithmetical accuracy of the books of account on any given date can be easily

verified.

3. Item Wise Details: The detail information with respect to different types of expenses,

incomes, losses, gains, assets, liabilities, debtors, creditors, etc. is easily made available

under double entry system of book-keeping. This is because under this system all ledger

accounts are prepared separately.

4. Comparative Study/Facilitates Planning: Under double entry book-keeping system

comparison between the results of current year with the previous year can be done easily

which in turn helps to prepare planning for the future activities.

5. Common Acceptance: The records prepared and maintained under double entry book-

keeping system have common approval and acceptance from financial institutions,

government authorities and others.

6. Provides Useful Financial Information: Financial position of the business and yearly

performance of the business activities i.e. profit or loss can be known easily if double entry

book-keeping system is followed. On the basis of such financial information management

can easily provide useful information to various users.

7. Helpful for Management: Under this system accountants can easily provide periodical

financial information to the management on various aspects of the business. On the basis of

these data and information, management can take corrective steps to develop and control

business activities.

8 Control Errors and Frauds: Because of the counter-checks provided by the equality of

debits and credits, it is difficult to commit errors and frauds, and easy to detect them if at all

they are committed. Thus, double entry book-keeping system is useful to control errors and

frauds.

INTRODUCTION TO ACCOUNTS

As per the concept of Double entry system, every business transactions has a two effects, i.e.,

Debit and Credit.

An account as we understand it, as a systematic record of transaction related to a person, property,

expenses, or income. Every account has a two sides. The left hand side known as the Debit side and

the right hand side is known as Credit side. To debit an account means to record the transaction on

debit side and credit an account means to record the transaction on credit side.

Dr ____________A/c Cr.

Date Particulars J.F.

Meaning and Scope of Accounting 21

For complete record of business transaction, the firm has to record all the business transactions

that it has deal with. For this purpose, accounts are classified as follow.

TYPES OF ACCOUNTS

Accounts are classified as follows:

(I) Personal Account

(II) Impersonal Account

(a) Real Account

(b) Nominal Account

ACCOUNTS

Personal A/c Impersonal A/c

1. Natural or Living Person Real A/c Nominal A/c

2. Artificial or Legal Person 1. Tangible 1. Expenses & Losses

3. Representative or Groups 2. Intangible 2. Incomes & Gains

(I) Personal A/c

Personal Accounts includes the accounts of persons or parties with whom the business deals.

Personal Accounts can be classified into three categories.

(a) Natural or Living Personal A/cs

These accounts are related to natural or living persons. Natural persons means persons who are

creation of God. In other words human beings are natural persons. These are the accounts of persons

created by nature.

e.g. Meena’s A/c, Mr. Raj’s A/c, Miss Reshma’s A/c, Ram’s A/c, Rahim’s A/c etc.

(b) Artificial or Legal Personal A/cs

These persons do not have life, body or soul but transactions are done by it in its own name and

exist in the eyes of law or recognized by law. These are the accounts of person created by provisions

of law.

These accounts are related to non-living persons, artificial persons or legal persons. These

accounts include accounts of corporate (registered) bodies or institutions. e.g. Partnership Firms, Co-

Operative Societies, Companies, Clubs, Associations, Municipality, Central or State Government,

Insurance Companies, Charitable Trust, Legal Authorities etc.

These accounts represents certain person or Groups.

e.g. Capital, Drawing, Debtors, Creditors, Outstanding rent, Interest payable, Prepaid Insurance,

Salary paid in advance, Interest receivable, Pre-received commission, rent received in advance,

Unexpired Insurance.

22 Introduction to Financial Accounting

PERSONAL A/C

Natural or living Artificial or legal Representative or Group

1. Mr. Ramesh’s A/c. 1. N.L. College A/c 1. Capital A/c

2. Miss Rati’s A/c 2. Bank of India A/c 2. Drawings A/c

3. Mrs. Kapoor’s A/c 3. Bank A/c 3. Debtors A/c

4. Mr. Ravi’s A/c 4. Paras Classes A/c 4. Creditors A/c

5. Raj’s A/c 5. Suchak Hospital A/c 5. Outstanding Rent A/c

6. Clubs A/c 6. Interest Payable A/c

7. Tata Ltd A/c 7. Prepaid Insurance A/c

8. Asian Paints Ltd A/c 8. Salary paid in advance

A/c

9. Nutan School A/c 9. Interest Receivable A/c.

10. Western Railway A/c 10. Pre-received

commission A/c

11. Government 11. Rent received in adv.

of India’s A/c A/c

12. Unexpired Insurance A/c

13. Unpaid wages A/c

Examples:

1. Mr. A paid ` 500 to Mr. B on our behalf.

Soln: B’s A/c - Personal A/c - Receiver - Debit

A’s A/c - Personal A/c - Giver - Credit

2. Mr. X received ` 1,000 from Mr. Y on our behalf.

Soln: X’s A/c - Personal A/c - Receiver - Debit

Y’s A/c - Personal A/c - Giver - Credit

3. Laxmi Medical paid ` 5,000 to Ganesh medical on our behalf.

Soln: Laxmi Medical A/c - Personal A/c - Giver - Credit

Ganesh medical A/c - Personal A/c - Receiver - Debit

4. Raj received ` 7,000 from XYZ General Stores on our behalf.

Soln: Raj’s A/c - Personal A/c - Receiver - Debit

XYZ General Stores’s A/c - Personal A/c - Giver - Credit

Note: Outstanding (O/s) (accrued)/ Receivable/

Payable/Pre-received/prepaid/received in

advance paid in advance/unexpired (pre-paid)

/unpaid.

Rule of Personal

Account

Debit the Receiver

Credit the Giver

Meaning and Scope of Accounting 23

(II) Impersonal A/c

All accounts other than personal accounts are called impersonal account. There are two types of

impersonal accounts.

(a) Real A/c

(b) Nominal A/c

(a) Real Account

It is also known as Property A/c. These accounts relate to all kinds of properties and assets

possessed by business. The assets may be tangible or intangible.

(i) Tangible Real A/cs: These accounts consists of assets and properties which can be seen,

touched, felt & measured.

e.g. Cash A/c, Building A/c, Stock A/c, Machinery A/c, Furniture A/c etc.

(ii) Intangible real accounts: These accounts consists of assets and properties which cannot be

seen, touched but they are capable of measurement in terms of money.

e.g. Goodwill, Copyright, Trade Marks, Patent Right etc.

REAL OR PROPERTIES A/C

Tangible real A/c Intangible real A/c

1. Cash A/c 1. Goodwill A/c

2. Goods A/c 2. Patent Right A/c

3. Machinery A/c 3. Trade Marks A/c

4. Stock A/c 4. Copy right A/c

5. Building A/c

6. Furniture A/c

7. Motor Car A/c

Rule of Real A/c

Debit what comes in

Credit what goes out

Examples:

1. Goods purchase for cash ` 5,000

Soln: Goods A/c - Real A/c - Comes in - Debit

Cash A/c - Real A/c - Goes out - Credit

2. Goods sold for Cash ` 8,000.

Soln: Cash A/c - Real A/c - Comes in - Debit

Goods A/c - Real A/c - Goes out - Credit

3. Goods purchase of ` 3,000 from Raj on credit.

Soln: Goods A/c - Real A/c - Comes in - Debit

Raj’s A/c - Personal A/c - Giver - Credit

4. Goods sold of ` 6,000 to Pankaj Stores on credit.

Soln: Goods A/c - Real A/c - Goes out - Credit

Pankaj Stores’ s A/c - Personal A/c - Receiver - Debit

24 Introduction to Financial Accounting

5. Goods purchase of ` 2,000 and amount paid by cheque.

Soln: Goods A/c - Real A/c - Comes in - Debit

Bank A/c - Personal A/c - Giver - Credit

6. Paid ` 12,000 to Rajnikant by Cash.

Soln: Rajnikant’s A/c - Personal A/c - Receiver - Debit

Cash A/c - Real A/c - Goes out - Credit

(b) Nominal Account

These are the accounts of expenses or losses and incomes or gains. These accounts are called

fictitious accounts as they do not represent any tangible asset. They exist only in name and cannot be

seen or touched. A separate account is maintained for each head of expense or loss or income or gain.

For example; interest account, commission account, discount account, postage and telegrams account,

rent account, salaries account etc.

Nominal A/cs or Fictitious A/cs

1. Bank charges A/c 2. Rent A/c

3. Salaries A/c 4. Clearing charges A/c

5. Wages A/c 6. Audit fees A/c

7. Insurance Premium A/c 8. Printing & Stationery A/c

9. Repairs A/c 10. Loss by fire A/c

11. Advertisement A/c 12. Import Duty A/c

13. Brokerage A/c 14. Commission A/c

15. Carriage A/c or Cartage A/c 16. Postage and Telegram A/c

17. Membership fees /Subscription A/c 18. Sundry Expenses A/c

19. Royalties A/c 20. Freight A/c

21. Travelling Expenses A/c 22. Discount A/c

23. Dividend A/c 24. Interest A/c

25. Electricity Charges A/c 26. Purchase A/c

27. Sales A/c 28. Purchase Return A/c

29. Sales Return A/c

Rule of Nominal Account

Debit all expenses & losses

Credit all incomes & gains.

Examples:

1. Salary paid ` 2,000/-

Soln: Salary A/c - Nominal A/c - expenses - Debit

Cash A/c - Real A/c - goes out - Credit

2. Rent paid ` 5,000/- by cheque.

Soln: Rent A/c - Nominal A/c - expenses - Debit

Bank A/c - Personal A/c - giver - Credit

Meaning and Scope of Accounting 25

3. Interest received ` 1,500/-

Soln: Cash A/c - Real A/c - Comes in - Debit

Interest A/c - Nominal A/c - Income - Credit

4. Commission received ` 2,500/- by cheque.

Soln: Bank A/c - Personal A/c - Receiver - Debit

Commission A/c - Nominal A/c - Income - Credit

5. Goods purchase for cash.

Soln: Purchase A/c - Nominal A/c - Expenses - Debit

Cash A/c - Real A/c - goes out - Credit

6. Goods sold on credit to Mr. Nayak.

Soln: Nayak's A/c - Personal A/c - Receiver - Debit

Sales A/c - Nominal A/c - Income - Credit

RULES

(1) PERSONAL A/C (2) REAL A/CS (3) NOMINAL A/CS

Debit the Receiver

Credit the Giver

Debit what comes in

Credit what goes out.

Debit all expenses & losses

Credit all incomes & gains.

CONCLUSION

In this chapter, we have studied the basic concept and convention in Book Keeping and

Accounting and also studied the application of this concept and convention in financial account. A

strong conceptual base is a backbone of Financial accounting, reporting and analysis.

In this chapter, we studied the concept of double entry system. This system says that, every

business transaction has a two effect, like a two sides of a coin. And its superiority over conventional

method of accounts. This system is legally approved by all the authorities.

Practical Problems

Q.1. Classify the following Accounts into Personal, Real & Nominal

1. Stock A/c 2. Bank of India’s A/c

3. Capital A/c 4. Furniture & Fitting A/cs

5. Pratap Nagar Co-op Hsg. Soc. Ltd. A/c 6. Cash A/c

7. Building Repair A/c 8. Outstanding salary A/c

9. Debtors A/c 10. Investments A/c

11. M/s Raj & Co’s A/c 12. Plant and Machinery A/c

13. Drawing A/c 14. Mahesh Stores A/c

Q.2. Classify the following Accounts into Personal, Real & Nominal

1. Loan to Shashikant A/c 2. Deposit A/c

3. Motor Van A/c 4. Typewriter A/c

5. Freight A/c 6. Loan from Khan A/c

26 Introduction to Financial Accounting

7. Govt. of India A/c 8. Loose Tools A/c

9. Royalties A/c 10. Chate Coaching classes A/c

11. Navneet Pub. Ltd A/c 12. Shares in Reliance Ltd. A/c

13. Stationery A/c 14. Dividend Received A/c

15. Electric Fittings A/c 16. Rent received A/c

17. Rent receivable A/c 18. Rent received in advance A/c

19. Rent paid A/c 20. Rent payable A/c

21. Rent paid in advance A/c 22. Prepaid Rent A/c

23. Outstanding Rent A/c 24. Subscriptions A/c

25. Audit fees A/c 26. Drawing A/c

27. Capital A/c 28. Import Duty A/c

Q.3. Classify the following Accounts into Personal, Real & Nominal

1. Raj Library A/c 2. Electricity A/c

3. Live Stock A/c 4. Goods A/c

5. Purchase A/c 6. Sales A/c

7. Unpaid Wages A/c 8. Purchase Return A/c or

Return Outward A/c

9. Sales Return A/c or Return Inward A/c 10. Prepaid Insurance A/c

11. Investment A/c 12. Gas & Light A/c

13. Shares A/c 14. Debentures A/c

15. Machine upkeep A/c 16. Bad debts A/c

(Repair/Maintenance)

17. Bank commission A/c 18. Tools and Equipment A/c

19. Leasehold/Freehold Premises 20. Profit on sale of Furniture A/c

(Building) A/c

21. Telephone Deposit A/c 22. Bills receivable A/c

23. Bills payable A/c 24. Freight A/c

25. XYZ Pvt. Ltd. A/c 26. Loss on sale of Investment A/c.

Q.4. State with the help of a table, which account will be debited & which account will be

credited. Give reasons. (Analysis of Transaction)

1. Rajesh commenced (started) business with cash. OR

Rajesh invested cash in the business.

2. Goods purchased for cash from Mahesh.

3. Goods purchased on credit from Rahul.

4. Sold Goods for cash to Pankaj.

5. Sold Goods to Ali on credit.

6. Purchased Machinery for cash.

7. Purchased furniture from Sanjay on credit.

8. Paid for purchase of stationery.

Meaning and Scope of Accounting 27

9. Paid salary to clerk Mr. Sharma.

10. Purchased Goods from Piyush on credit.

11. Paid office rent.

12. Commission received from Chintan by cheque.

13. Interest received from Sumit.

14. Cash deposited into Bank.

15. Cash withdrawn from Bank.

Q.5. Prepare a chart showing the names of two accounts affected, their types, Rule applied

and nature of effect - Debit/Credit from the following transactions. (Analysis of transaction)

1. Commenced business with cash.

2. Goods purchased for cash from Mr. Chand.

3. Goods purchased from Mr. Suraj and amount paid by cheque.

4. Goods purchased from Mr. Mangal on credit.

5. Cash purchases of ` 3,000.

6. Purchased Goods from Mr. Ravi.

7. Goods purchased of ` 6,000.

8. Further cash introduced (brought) in business by owner.

9. Machinery brought in the business by owner.

10. Received dividend from Reliance Industries Ltd.

11. Opened Bank A/c with ` 5,000.

12. Return goods to Mr. Ravi.

13. Travelling expenses paid to clerk Mr. A.

14. Carriage paid on goods sold to Mr. King.

OR Carriage paid on sale of goods to Mr. King.

15. Insurance premium paid by cheque.

Q.6. Record the following transactions in a tabular form after applying the steps of Golden

rule. (Analysis of Transaction)

1. Proprietor brought his personal car into business.

2. Cash withdrawn from business for personal use.

3. Borrowed (Loan taken) from Miss Rajani.

4. Goods sold for cash to Mr. Sarad.

5. Goods sold to Mr. Shishir and amount received by cheque.

6. Goods sold to Mr. Vasant on credit.

7. Cash sales of ` 5,000/-.

8. Sold goods to Miss Varsha.

9. Goods sold of ` 10,000/-.

10. Goods return from Mr. Vasant.

11. Paid College fees of Proprietor‘s son studying at H. R. College.

12. Paid salary to Ramu.

28 Introduction to Financial Accounting

13. Postal stamps bought of ` 50.

14. Loan taken from Mr. Changu of ` 10,000.

15. Loan given to Mr. Mangu of ` 25,000.

Proforma for Analysis of Transaction

Transaction No.

Names of A/cs

or Two A/cs

involved

Types of

A/c

How each

aspect is

affected

Rules

Applied

Effect

Debit/Credit

EXERCISE

Self assessment questions

1. Bookkeeping _________ the transactions and events, _________the identified transactions

and events in a common measuring unit, records them in proper books of accounts and

finally classifies them in the ledger.

2. Accounting in addition to bookkeeping involves ________ the classified transactions and

________ the summarized results.

3. ____________ interprets the analyzed results and communicates the interpreted information

to the interested parties.

4. Accounting is a tool for _______________ and ________.

5. Expand SEBI.

6. Mention any five stakeholders.

7. ________ as chief provider of risk capital is keen to understand both the return from their

investments and the associated risk.

8. _________ use financial reports for negotiating wage package, declaration of bonus and

other benefits.

9. ___________ has a legitimate interest in financial reports of publicly held enterprise to

ensure efficient operation of capital market.

10. The regulatory agencies use _____________ to take action against the firm when

appropriate returns are not filed in time or when the returns fails to provide true and fair

position of the business or to take appropriate action against the firm when

complaints/misappropriation are being lodged.

11. Accounting grossly lacks ____________elements.

12. The exact picture of the financial situation can be ascertained only on the ________of an

enterprise.

13. The danger of ___________ arises when the management decides to incorporate wrong

figures to artificially inflate revenue or deflate losses or when there is a threat of hostile

takeover.

14. Accounting ignores the price level changes when financial statements are prepared on

__________.

[Ans: 1. Identifies, measures, 2. Summarizing, analyzing, 3. Accounting, 4. Effective planning,

controlling, 5. Securities Exchange Board of India, 6. Shareholders, Creditors, Bankers, Government,

Meaning and Scope of Accounting 29

Employees, 7. Investors, 8. Trade Union, 9. Stock Exchange, 10. Financial Reports, 11. Qualitative,

12. Liquidation, 13. Window dressing, 14. Historical Cost.]

[B]

1. Accounting principles are _______, associated with theory and practice of accountings.

2. Accounting principles are classified as ________ and ________.

3. Assets may be depreciated on fixed installment method or reducing balance method. Is it a

concept or a convention?

4. A business is started with an assumption of making profit. Is this assumption, a concept or a

convention?

5. The purpose of establishing ICAI and ASB is to ________.

6. How many accounting standards are issued by ASB so far?

7. State true or false:

(a) If the household expenses of ` 25,000 of a proprietor are shown as business expenses, the

profit of the business will be understated to the extent of ` 25,000.

(b) If a proprietor invests ` 1,00,000 in the business, it is deemed that the proprietor has

given ` 1,00,000 to the “business” and it is shown as an asset in the books of the business.

8. Business and its owner are _______________ entities.

9. Profits earned in business form an addition to the _____________ of the owner.

10. Accounting of a small calculator as an expense and not as an asset is the application of

principles of prudency.

11. Classification of assets as current and fixed assets is the application of going concern

concept.

12. Purchase of a building for your business is made under the assumption that it would last for

a long period. This is in accordance with the materiality principle.

13. What is the underlying intention in making a provision every year when an asset is

purchased?

14. An event or a transaction expressed in monetary value is measured but inflation or changes

in the purchasing power are ignored in money measurement concept.

15. Transactions or events should be expressed in ___________

16. Revenues are matched with expense in accordance with money measurement principle.

17. The economic life of the entity is artificially split into periodic intervals in accordance with

periodicity concept.

18. The accounting data must disclose all relevant information in accordance with periodicity

concept.

19. The accountants are free to submit financial statement at arbitrary points in time during the

life of the entity. This is in accordance with periodicity concept.

20. Interest earned but not received within an accounting period is called _______.

21. Following straight line method of depreciation of a particular asset year after year adhere to

consistency concept.

22. Accrued income should be _________ to compute profit and prepaid expenses should be

_____ according to accrual concept of accounting.

30 Introduction to Financial Accounting

23. Accrual concept considers not only cash transactions but also ______ transactions.

24. Income is considered as earned only when it is ____________.

25. Income is realized whether it is actually received in cash or promised to be received.

26. Income realized is different from cash received.

27. A sale is made on credit. Does it constitute income realization?

28. An order is received for sale of goods. Is it realization of income?

29. An order is received with an advance of ` 1,00,000 cash. Can this be called income?

30. A cash payment may be a revenue payment or capital payment.

31. A payment which is revenue in nature is expenditure.

32. Plant is purchased and payment is made. Is it an expenditure or acquisition of asset?

33. All revenue expenses are charged against ___________.

34. Capital payments resulting in acquisition of assets appear in the balance sheet.

35. Matching concept of accounting considers only revenue incomes and expenses relating to a

particular accounting period.

36. Incomes and expenses for an accounting period are considered to compute _____.

37. Expenditure paid or payable and revenue earned whether realised or not in cash are taken

into account to find out profit or loss.

38.

For

the

actual

revenue

received,

outstanding

incomes

are

________

and

income

received

advance

are_________________

find

out

the

revenue

income

for

the

given

period.

39.

For

the

actual

revenue

expenses

(costs)

paid

during

the

accounting

period,

outstanding

expenses

are

_____

and

prepaid

expenses

are

_____

find

out

expenses

for

the

accounting

period.

40. All assets are shown at historical cost in balance sheet.

41. Depreciation is charged against the historical cost of assets.

42. Historical cost is the cost at which an asset is actually purchased.

43.

Machinery

bought

for

2,00,000

and

its

market

value

80,000.

Which

these

values

you

consider

mention

the

balance

sheet

according

cost

principle?

44.

Inflation

accounting

has

emerged

result

limitation

historical

cost

concept.

45.

The

principle

full

disclosure

implies

that

information

which

___________

should

stated in financial statements.

46. The material information that is disclosed should be of great interest to the average investors.

47. Non-disclosure of material information amounts to ___________.

48.

Disclosing

about

assets

without

disclosing

about

liabilities

against

the

principle

full

disclosure.

49.

Under

dual

aspect

principle,

total

benefits

received

business

should

match

with

total

benefits

given.

50.

Total

liabilities

should

equal

___________

per

dual

aspect

principle.

51. For every debit, there should be an equivalent credit. This is called _________ of accounting

52. Modifying principle is also known as _____________.

53.

The

modifying

principles

states

that

benefit

derived

should

overweigh

the

cost

implementing it. .

54.

firm

plans

establish

costing

department.

doing

so,

was

estimated

that

the

cost

the product would increase by 50%. Is it advisable to have cost department?

55.

Principle

materiality

states

that

relevant

information

should

given

relevant

parties.

Meaning and Scope of Accounting 31

56. Details of debtors should be given to creditors.

57. The material information to one party need not be so for another party.

58. The method of depreciation adopted should be disclosed to Income Tax Authorities.

59.

The

purpose

principle

consistency

help

for

______

from

one

period

another

period.

60.

Consistency

principle

helps

for

proper

assessment

profit

loss.

61. Provision should be made whenever _____________ is anticipated.

62. The underlying spirit of principle of conservatism is __________ .

63. State the name of the relevant accounting principles for the following statements.

(a) Following FIFO method of stock valuation year after year

(b) Appending notes to the financial statements.

Ans: 1. Doctrines, 2. Concepts, conventions, 3. Convention, 4. Concept, 5. Bring uniformity in

accounting terminology and principles, 6. 32, 7. (a) True, (b) False, 8. Separate, 9. Capital, 10. False,

11. True, 12. False, 13. To replace it after a certain period, 14. Yes, 15. Monetary value, 16. False,

17. True, 18. False, 19. False, 20. Accrued interest, 21. True, 22.Added, Deducted, 23. Credit,

24. Realized, 25. True, 26. True, 27. Yes, 28. No, 29. No, 30. True, 31. True, 32. Asset Acquisition,

33. Profit, 34. True, 35. True, 36. Profit or loss, 37.True, 38. Added, Deducted, 39. Added, Deducted,

40. True, 41. True, 42. True, 43. ` 2,00,000, 44. True, 45. Substance, 46. True, 47. Fraud, 48. True,

49. True, 50. Total Assets, 51. Double entry principle, 52. Cost-benefit principle, 53. True, 54. No,

55. True, 56. False, 57. True, 58. True, 59. Comparison, 60. True, 61. Risk, 62. Anticipate no profit

but provide for all anticipated losses, 63. (a) Principles of consistency, (b) Principles of full disclosure,

Multiple choice questions

1. The art or science which teaches the technique of recording and explaining financial

transaction is called:

(a) Recording transactions (b) Bookkeeping

2. The origin of modern accounting was in _________

(a) England (b) India

3. Who is the father of modern accounting?

(a) L.C. Cooper (b) A.W. Johnson

4. Which year indicates the period of origin of double entry system of book-keeping?

(a) 1414 (b) 1394

5. What was the name of the book written by Luca Pacioli?

(a) Accounting in ancient Italia

(b) The modern concept on accounting

(d) Accounting in the past

32 Introduction to Financial Accounting

6. The history of accounting is:

(a) A new discipline (b) Invention of science

7. The principal object of bookkeeping is:

(a) Keeping written records of transaction

(b) Keeping written records of expenditure

(d) Ascertainment of debit and credit

8. The fields and scope of accounting are-

(a) Confined within business field only

(b) Extended over individual life only

(d) Like individual life and business fields

[Ans: 1. B, 2. C, 3. C, 4. C, 5. C, 6. C, 7. A, 8. D.]

Essay type questions

1. Define accounting.

2. Explain the objects of accounting.

3. Explain the necessity of accounting in a business organization.

4. Explain the process involved in accounting.

5. What are the objectives of accounting?

6. How accounting information is used by investors and lenders?

7. How Government and Regulatory agencies use accounting information to regulate the

activities of the firm?

8. Distinguish between financial accounting and management accounting.

9. What are the basic principles of Accountancy?

10. The salaries paid in 2004 ` 5,00,000; Salaries outstanding ` 20,000; Salaries paid in advance

for 2004 ` 30,000; What is the actual salary expenditure for 2004? What is the accounting

principle involved in this?

11. What is wrong if assets like buildings are shown at market value in the balance sheet?

12. A business receives capital of ` 1,00,000 and a loan is raised for ` 50,000. This is

represented by cash ` 15,000; Machinery ` 85,000; Furniture ` 20,000 and goods ` 30,000.

Find the total of debits and credits from business point of view. What principle of

accounting is underlying in this case?

13. What is substance over form?

Match the column

Group X Group Y

1 Books of accounts (a) Property belonging to a person or a firm

2 Book-keeping (b) Inability to clear financial obligations

3 Goods (c) Evidence in court of law

Meaning and Scope of Accounting 33

4 Assets (d) Commodities in which trader deals

5 Insolvency (e) Record of financial trasactions

(f) Capital - Liabilities = Assets

(g) Journal

(h) Ability to clear financial obligations

Ans.: 1. (c), 2. (e), 3. (d), 4. (a), 5. (b).

Group A Group B

(a) Transaction (1) Trader regularly deals in

(b) Journal (2) Main books of accounts

(d) Goods (4) Social science

(e) Book-Keeping (5) Property belonging to person

Ans.: (a) 3, (b) 2, (c) 5, (d) 1, (e) 4.

Group A Group B

(a) Book-Keeping (1) Property of any description

(b) Transaction (2) Dealings between two or more persons

(d) Goods (4) Commodity in which trader deals

Ans.: (a) 3, (b) 2, (c) 1, (d) 4.

Group A Group B

(a) Book-Keeping (1) Basis for wage demand

(b) Accounting Reports (2) Evidence in a court of law

(d) Business dealings (4) Inability to pay obligations

(e) Insolvency (5) Record of financial transactions

Ans.: (a) 5, (b) 1, (c) 2, (d) 3, (e) 4.

Give one word, term or phrase for the following statement

1. Property of any description.

2. A science which facilitates to maintain proper record of business transactions.

3. Amount invested in a business by the owner.

4. A person whose total assets exceed his liabilities.

5. Excess of assets over outside liabilities.

6. A commodity in which a trader regularly deals.

7. Cash or goods withdrawn from business for personal use.

8. Dealings between two persons.

9. Obligations towards others.

10. A person whose assets are sufficient enough to meet business obligations.

34 Introduction to Financial Accounting

11. A person from whom amount is receivable.

12. A person to whom amount is payable.

Ans.: 1. Assets, 2. Book-keeping, 3. Capital, 4. Solvent, 5. Capital (Net worth), 6. Goods,

7. Drawings, 8. Transaction, 9. Liabilities, 10. Insolvent, 11. Debtor, 12. Creditor.

Short answers

(a) Distinguish between Book-keeping and Accountancy.

(b) Objectives of Book-keeping and Accountancy.

Long answers

(a) Define Book-keeping and explain its features.

(b) Explain the importance of Book-keeping and Accountancy.

Match the column

Group X Group Y

1. Concept (a) Rules or norms

2. Principles (b) Continuity of activity

3. Going concern (c) Common idea

4. Cost concept (d) Not providing for discount on creditors

5. Conservatism (e) The balance sheet shows true position

6. Convention of disclosure (f) Suggests to consider purchase price of an asset

for recording

(g) Goodwill

(h) Contingent liabilities

Ans.: 1. (c), 2. (a), 3. (b), 4. (f), 5 (d), 6. (e)

Group A Group B

(a) Dual Aspect 1. Continuity of activity

(b) Going Concern 2. Every business transaction has a dual effect

is actually realised

(d) Realisation 4. In accounting everything is recorded in

terms of money

Ans.: (a) 2, (b) 1, (c) 4, (d) 3.

Give one word, term or phrase for the following statement

1. The concept which states that assets when purchased should be recorded at cost price.

2. The concept which states that business operations will continue forever.

3. A concept on which double entry book keeping system is based.

4. Concept that provides a link between present and future.

5. Amount that is paid or payable for acquisition of asset.

Meaning and Scope of Accounting 35

6. System in which entry is recorded for cash as well as credit transactions.

7. Concept which applies to all business organizations.

8. In accounting everything is recorded in terms of money.

9. Concept which does not recognize the realizable value, the replacement value or the real

worth of an asset.

10. A method whereby revenue and expenses are identified with specific periods of time like a

month, half year or a year.

11. The accounts must be honestly prepared and they must disclose all material information.

12. Concept under which importance has to be attached to material details and insignificant

details are to be ignored.

13. Concept under which comparison of one accounting period with the other is possible.

Ans.: 1. Cost concept, 2. Going concern concept, 3. Dual aspect concept, 4. Going concern

concept/concept of continuity/concept of permanency, 5. Cost concept, 6. Accrual system, 7. Entity

concept, 8. Money measurement concept, 9. Cost concept, 10. Accrual concept, 11. Disclosure

concept, 12. Material concept, 13. Consistency concept.

Short answers

1. What do you mean by accounting principles?

2. What is Business entity concept?

3. What is going concern concept?

4. Principle of conservatism.

5. Explain dual aspect concept.

Match the columns

Group A Group B

(a) Double Entry Book-Keeping 1. Deshinama system

(b) Indian System of Accounting 2. Every transaction has two effects

(d) Every account 4. Cash transactions

Ans.: (a ) 2, (b) 1, (c) 4, (d) 3.

Fill in the blanks

1. Double entry system of book-keeping denotes that every business transactions has ____

effects.

2. The method of writing every financial transaction in two accounts in called as ____ system

of Book-keeping.

3. In every transaction, at least ____ parties are involved.

4. In ____ system, businessman writes accounts in vernacular of Indian language.

Ans.: 1. two fold, 2. double entry system, 3. two, 4. Indian system

36 Introduction to Financial Accounting

Long answers

1. Explain the double entry system of Book Keeping.

2. Explain the advantages and disadvantages of Double entry system.

3. Difference between double entry system and single entry system.

Match the column

Group A Group B

(a) Recording both the aspects of transactions 1. Personal Account

(b) Abhay’s Account 2. Double entry system

(d) Goodwill Account 4. For incomes and gains

(e) Nominal Account is debited 5. Tangible Real Account

(f) Nominal Account is credited 6. For expenses or losses

Ans.: (a) 2, (b) 1, (c) 5, (d) 3, (e) 6, (f) 4.

Group A Group B

(a) Real Account is debited 1. Personal Account

(b) Interest Account 2. When something goes out

(d) Real Account is credited 4. When something comes in

Ans.: (a ) 4, (b) 3, (c) 1, (d ) 2.

Group A Group B

(a) Machinery Account 1. Real Account

(b) Left hand side of the Account 2. Debit side

(d) Bad Debts Account 4. Credit side

Ans.: (a) 1, (b) 2, (c) 4, (d ) 3.

Group A Group B

(a) Nominal Account is debited 1. When person is giver

(b) Nominal Account is credited 2. Nominal Account

(d) Personal Account is credited 4. Personal Account

(e) Audit Fees Account 5. For Expenses

(f) Mumbai credit club Account 6. When person is receiver

Ans.: (a) 5, (b) 3, (c) 6, (d) 1, (e) 2, (f) 4.

Give one word, term or phrase for the following statement

1. Left side of an account.

2. Traditional method of book keeping.

3. Type of account in which transactions related to assets are recorded.

Meaning and Scope of Accounting 37

4. Effect given in personal account for receiver of benefit.

5. The accounts of persons.

6. Right side of an account.

7. The accounts of assets and properties.

8. The accounts of expenses and losses.

9. A cash book written in local language by Munimji to record all types of transactions.

10. Most scientific system of recording business transactions

Ans.: 1. debit side, 2. conventional system of book keeping, 3. real account, 4. debit, 5. personal

account, 6. credit, 7. real account, 8. nominal account, 9. conventional cash book, 10. double entry

system.

Fill in the blanks

1. An account is always divided into ____ sides.

2. The left hand side of the account is called ____ side.

3. Cash Account shows the receipts and ____ in cash.

4. The accounts of properties and assets are called the ____ accounts.

5. ____ accounts are those of people.

6. Sales Tax Account is a ____ Account.

7. Manufacturing wages Account is a ____ Account.

8. Dividend Received Account is a ____ Account.

9. Audit Fees Account is a ____ Account.

10. Bombay University Account is a ____ Account.

11. Live Stock Account is neither a ____ Account nor a ____ Account.

12. Investment Account is a ____ Account.

13. Insurance Premium Account is a ____.

Ans.: 1. two, 2. debit, 3. payments, 4. Real, 5. Personal, 6. Nominal Account, 7. Nominal

Account, 8. Nominal A/c, 9. nominal, 10. Personal Account, 11. nominal Account, Personal, 12. Real

Account, 13. Nominal Account.

Short answers

1. What are the types of accounts?

2. What is personal account and its rule?

3. What is real account and its rule?

4. What is nominal account and its rule?

[

ACCOUNTING STANDARDS

Accounting is the art of recording transactions in the best manner possible, so as to enable the

reader to arrive at judgments/come to conclusions, and in this regard it is utmost necessary that there

are set guidelines. These guidelines are generally called accounting policies. The intricacies of

accounting policies permitted Companies to alter their accounting principles for their benefit. This

made it impossible to make comparisons. In order to avoid the above and to have a harmonised

accounting principle, Standards needed to be set by recognised accounting bodies. This paved the way

for Accounting Standards to come into existence.

Accounting Standards in India are issued By the Institute of Chartered Accountants of India

(ICAI). At present there are 30 Accounting Standards issued by ICAI.

OBJECTIVE OF ACCOUNTING STANDARDS

Objective of Accounting Standards is to standarize the diverse accounting policies and practices

with a view to eliminate to the extent possible the non-comparability of financial statements and the

reliability to the financial statements.

The institute of Chatered Accountants of India, recognizing the need to harmonize the diversre

accounting policies and practices, constituted at Accounting Standard Board (ASB) on 21

April,

1977.

ACCOUNTING STANDARDS BENEFITS

Running a business is not just about earning profits, depositing money in the bank, paying

employees, and luring more clients and customers. It is about knowing if the business is thriving or if

the owner is just investing in something that is not going to earn at all.

Businesses have to have accounting standards to ensure that everything goes smoothly and that

cash flow is running perfectly. These accounting measures for businesses also have to adhere to the

accounting standards set by regulating bodies like the ASB and the ICAI. This is because there are

policies and other documents that are imperative to every accounting act. In many cases, businesses

hire the services of auditors and bookkeepers in order to make sure that all record-keeping practices

re done correctly. Doing so will provide access to investor capital, facilitate reasonable assessment of

performance, and prevent costs brought about by legal action.

Here are other reasons why accounting standards are important to every business:

Protecting Investors: By employing accounting standards, investors' interests are ensured as the

documents they review are definitely accurate and genuine. As investors, they are interested to know

CHAPTER

Introduction to Accounting

Standard

Introduction to Accounting Standard 39

that their money will eventually earn and go back to them. Accounting standards increase the

investors' confidence in the business.

Regulatory Compliance: Government regulators set accounting standards that have to be

adhered to by all companies. This is both beneficial to the investor or business owner as well as to the

customers or clients because it protects all of them from fraud in businesses. It also promotes

transparency among the business' transactions, which will eventually lead to the improved efficiency

of the markets. Following accounting standards set by the ASB and the ICAI will help prevent a

company or business from spending on legal actions initiated by the government against it.

Assessing Business Performance: The use of accounting standards will enable a business to see

or assess its performance. By doing so, it can also compare and contrast its performance with other

companies or competitors. These standards also help a business see its strengths and weaknesses. By

also comparing past and current performances, a business can assess the success of its strategies.

Businesses will either prosper or fall. Depending on the trends and the economy of the country,

an investment may grow or go down the drain. But in the end, accounting standards will make a

difference. That is why all businesses have to follow and strictly adhere to these accounting standards.

Accounting Standards Issued by the Institute of Chatered Accountants of India are as below:

Number of

the

Accounting

Standard

(AS)

Title of the Accounting Standard Date from which

Mandatory

(Accounting

Periods

Commencing on

or After)

Enterprises to

which

Applicable

AS-1 Disclosure of accounting policies 1-4-1993 All

AS-2

(Revised)

Valuation of inventories 1-4-1999 All

AS-3

(Revised)

Cash Flow Statement 1-4-2001 Level-1

AS-4

(Revised)

Contingencies and events occurring after the

balance sheet date

1-4-1998 All

AS-5

(Revised)

Net profit or loss for the period, prior period

items and changes in accounting policies

1-4-1996 Level - I

AS-6

(Revised)

Depreciation Accounting 1-4-1995 All

AS-7

(Revised)

Construction Contacts 1-4-2002 All

AS-8 Withdrawn and included in AS-26 ----- ------

AS-9 Revenue Recognition 1-4-1993 All

AS-10 Accounting for fixed assets 1-4-1993 All

AS-11

(Revised

2003)

The effects of changes in foreign exchange rates 1-4-2004 All

AS-12 Accounting for government grants 1-4-1994 All

40 Introduction to Financial Accounting

AS-13 Accounting for investments 1-4-1995 All

AS-14 Accounting for amalgamations 1-4-1995 All

AS-15 Employees benefits 1-4-2006 All

AS-16 Borrowing costs 1-4-2000 All

AS-17 Segment reporting 1-4-2001 Level - I

AS-18 Related party disclosures 1-4-2001 Level - I

AS-19 Leases 1-4-2001 All

AS-20 Earning per share 1-4-2001 Level - I Refer

AS - 12

AS-21 Consolidated financial statements 1-4-2001 See note 1

AS-22 Accounting for taxes on income 1-4-2001 For listed co.

1-4-2002 Co. Other than

listed

1-4-2006 See note 2

1-4-2002 All

AS-23 Accounting for investment in associates

in consolidated financial statements

AS-24 Discounting operations 1-4-2004 All

AS-25 Interium financial reporting 1-4-2002 Level - I

AS-26 Intangible assets 1-4-2003 Level - I

AS-27 Financial reporting of interests in joint ventures 1-4-2002 See note I

AS-28 Impairment of asset 1-4-2004 Level - I

Amendments 1-4-2006 Level - II

Amendments 1-4-2008 Level - III

AS-29 Provisions, contingent liabilities and contingent

assets

1-4-2004 All

AS-30 Financial Instruments — Recognition and

Measurement

1-4-2011 Non SMC

AS-31 Financial Instruments — Presentation 1-4-2011 Non SMC

AS-32 Financial Instruments — Disclosure 1-4-2011 Non SMC

1. AS - 8 was withdrawn in pursuant to AS-26 becoming mandatory.

2. 29 accounting standards are issued as of date and only 28 are applicable

AS-30,

AS-31,

AS-32

are

published

but

they

will

come

into

effect

from

1.4.2009.

mandatory on or after 1.4.2011.

AS – 1: Disclosure of Accounting Policies

Effective date April 1993

This statements deal with the disclosures of significant accounting policies followed in preparing

and presenting financial statements. The purpose of this statement is to promote preparing and

Introduction to Accounting Standard 41

presenting financial statements by instituting the disclosure of significant accounting policies in the

financial statements and the manner of doing it.

The emphasis in AS-1 is on disclosure of accounting policies in the presentation of financial

statements. These are normally to be disclosed at one place. All the companies now follow this

practice. Accounting Polices refer to the specified accounting principles, adopted by the enterprise and

methods of applying these principles in the preparation and presentation of financial statements. Some

of the areas in which such disclosure is to be made are as under:

1. Methods of depreciation, depletion, and amortization.

2. Treatment of expenditure during construction

3. Valuation of inventories

4. Conversion or translation of foreign currency items’

5. Treatment of goodwill

6. Valuation of investments

7. Valuation of fixed asset

8. Recognition of profits on long term contracts

9. Treatment of retirement benefits

10. Treatment of contingent liabilities

It is for the management to select the accounting policy to be followed by the enterprise.

However, while making this selection, it is necessary to ensure that the financial statements present a

true and fair view of the state of affairs. The major considerations to be followed during the selection

of accounting policies are stated in AS-1 as under.

1. Prudence: this is a world of uncertainty. Profits are recognized only when realized. At the

same

time,

provisions

for

all

known

liabilities

and

losses

are

made

though

the

amount

represents

only

the

best

estimate.

Substance

over

form:

the

accounting

treatment

and

presentation

transactions

and

events

the

financial

statements

should

governed

their

substance

and

not

just

the

legal

form.

For

example,

the

accounting

finance

leases

based

the

substance

rather

than

the

form

transaction.

The

lessee

capitalizes

the

lease

equipment

fixed

assets

being

the

owner in the substance, whereas the lessor records the investment made as debtor

Materiality:

financial

statements

disclose

all

material

facts.

The

IASC

audit

materiality

under.

“Information is material if its omission or misstatement could influence the economic decision of

users taken on the basis of financial statements. Materiality depends on the size of the item or error

judged in the particular circumstances of its omission or mist statements. Thus materiality provides a

threshold or cut-off point rather than being a primary qualitative characteristic whose information

should be there to be useful.”

There are no hard and fast rules for determining materiality. Materiality is a matter of judgment.

For instance, what is material to the financial statements of one firm may not be material to the

financial statements of another firm of a different nature or size.

Why are Accounting Policies required to be disclosed:

Accounting

Policies

means

principles

and

methods

apply

the

principles

adopted

the

enterprise

the

preparation

and

presentation

financial

statements.

Example,

providing

for

depreciation

accounting

principle

and

the

methods

are

SLM,

WDV

any

other

appropriate method.

42 Introduction to Financial Accounting

The

state

affairs

and

the

profit

loss

can

significantly

affected

the

accounting

policies

followed.

The

need

for

disclosure

accounting

policies

arises

because

accounting

policies

may

differ

from

enterprise

and

for

different

years

within

the

same

enterprise. Accounting policies can differ in many areas, example;

(a) Depreciation on Fixed Assets.

(b) Valuation of Inventories.

(d) Valuation of Fixed Assets.

(e) Treatment of Foreign Currency Translations.

(f) Treatment of Government Grants.

(g) Treatment of Goodwill.

(h) Treatment of Research and Development Costs.

(i) Treatment of Retirement benefits

(j) Recognition of Profit on Long Term Contracts.

(k) Treatment of Contingent Liabilities, etc.

What are Fundamental Accounting Assumptions? Are they required to be disclosed in the

financial statements?

Certain fundamental accounting assumptions underlie the preparation and presentation of

financial statements. These accounting assumptions are assumed to have been followed in preparation

of Financial Statements and need not be disclosed. If any of these fundamental assumptions are not

followed then this fact must be disclosed in the Financial Statements. The fundamental accounting

assumptions are as follows;

1. Going Concern/Concept of Continuity/Concept of Permanency:

According

this

concept

any

business

concern

will

continue

operate

its

activities

for

fairly

long

time,

i.e.

will

have

perpetual

succession.

assumed

that

the

business

enterprise

has

got

intention

down

its

business

activities.

Continuing

activity

the

normal

business

process.

Business

enterprise

will

never

assume

its

closure

till

the

circumstances

are

such

that

closure becomes inevitable.

Consistency:

The

comparison

one

accounting

period

with

the

other

possible

only

when

the

Consistency

followed.

means

accounting

from

one

accounting

period

another

should be on the same basis.

Accrual:

Revenues

and

costs

are

accrued

i.e.,

recognised

they

are

earned

incurred

(and

not

money

received

paid)

and

recorded

the

financial

statements

the

periods

which

they

relate.

The

accrual

concept

forces

the

matching

revenues

against

relevant

costs.

What are the Principles Governing selection of Accounting Policy:

The overriding obligation to provide “True and Fair View” of the state of affairs of the enterprise

is the major consideration in selection of Accounting Policies. Major points which are considered for

the purpose of selection and application of Accounting Policies are:

1. Prudence (Conservatism): Prudence is the caution in the exercise of judgements when

making estimates. According to this principle, business enterprise should consider all future losses but

ignore all the anticipated profits. Profits should be considered only when it is actually realised. In

other words “Anticipate no profit but provide for all losses”. Example; inventory is valued at cost or

Net Realisable Value, whichever is less.

Introduction to Accounting Standard 43

2. Substance over Form: Economic reality of the transaction is important than the legal form for

its accounting treatment and presentation in financial statements. Example, Assets purchased on hire

purchase are shown in the books of Buyer in spite of the fact that the hire purchase buyer is not the

legal owner.

3. Materiality: Financial statements should disclose all “material” information. Information is

material if it can influence the decision of the user of financial statement or information is material if

its omission or wrong statement could influence the economic decisions taken by the user based on

such financial statements.

CAN ACCOUNTING POLICIES BE CHANGED?

Accounting policies can be changed if the change is required by statute or the change would

result in more appropriate presentation of financial statement. If there is a change in accounting

policies and such change affects the financial statement of current year or financial statements of later

periods then such change must be disclosed. The amount by which the financial statement is affected

must also be disclosed to the extent ascertainable.

All Significant accounting policies should be disclosed at one place and should form part of the

financial statement.

The disclosure is not a remedy for an inappropriate treatment in the accounts.

Illustration 1

B.K.C. Ltd. Prepared final accounts for the year 2012-13. During the year, accident took place in

the factory. The worker who injured lodged a claim of ` 2,50,000 against the company. The case is

pending in the court. The accountant did not disclose this in the accounts. Comment.

Solution

Claim for compensation pending in the court is a contingent liability. As per AS-1, it should be

disclosed as a foot note to the final accounts. The company did not respect provisions of AS-1.

Illustration 2

ICICI Prudent Ltd. Has sales of ` 500 crores in 2012-13. Cash sale of ` 500 was shown

separately by the company. Comment.

Solution

As per AS-1, materiality convention should be followed. Cash sale of ` 500 in total sales of

` 500 crores is not material. It need not be disclosed separately.

Illustration 3

Lethargic Ltd. Followed WDV Method of depreciation till 31

March, 2013. On 1

April, the

company changed the method of depreciation to Fixed Instalment Method. The company did not

disclose this is the notes. Comment.

Solution

As per AS-1, any change in the policy should be disclosed in the year in which the change is

made. The company did not follow AS-1.

44 Introduction to Financial Accounting

Illustration 4

ACC Ltd. Prepared Profit & Loss Account and Balance Sheet for the year 2012-13. The

accounting policies about Profit & Loss Account have been disclosed below Profit & Loss Account

and accounting policies about Balance Sheet have been disclosed below Balance Sheet. Comment.

Solution

As per AS-1, the accounting policies adopted for preparation of final accounts should form part

of final accounts. These policies should be disclosed at once place only forming part of account. It

should not be disclosed separately.

Illustration 5

HCL Ltd. Prepared Profit & Loss Account and Balance Sheet on cash basis. Comment.

Solution

As per AS-1, accrual basis is the fundamental accounting. The company follows cash basis, i.e.,

records income when it is actually received and expenses when actually paid. If the accounting

assumption is not followed, it should be disclosed in the form of a note to the accounts.

Illustration 6

Thakur Educational Trust sent a copy of Income & Expenditure Account and Balance Sheet for

the year 2012-13 to all its members. Mr. Jitendra singh, Managing Trustee of the Trust sent a separate

letter to each member containing a note on the accounting policies followed for preparation of

financial statements.

Comment on the above.

Solution

As per AS-1, accounting policies followed for preparation of financial statements should form

part of final accounts. Separate letter about the accounting policies should not be sent. The policies

should have been disclosed as a part of note to the final accounts.

Illustration 7

The finished goods inventory is valued at prime cost and at market value whichever is lower.

Comment.

Solution

The policy is not as per AS 2.

Illustration 8

Draft the accounting policies to be disclosed in the financial statements for the following items:

(a) Revenue recognition – Sale of goods

(b) Depreciation

Solution

(a)

Sales

are

recognized

when

goods

are

invoiced

and

dispatched

customers

and

are

recorded

inclusive of excise duty and net trade discount and sales tax.

(b)

Depreciation

charged

straight

line

method

the

rates

specified

schedule

XIV

the

companies

act.

Introduction to Accounting Standard 45

Illustration 9

The gross block of fixed assets are shown at cost of acquisition. It includes taxes, duties and

other identified direct cost. Interest on borrowing to finance the fixed assets is not capatalised

comment.

Solution

The policy appears to be correct.

AS – 9: REVENUE RECOGNITION

Meaning and Scope

AS-9: Revenue Recognition is mandatory and applicable to all enterprises for accounting periods

commencing on or after 1st April, 1993. Accounting standard explains when the revenue should be

recognised in Profit & Loss Account and also states the circumstances in which revenue recognition

can be postponed.

Revenue is gross inflow of cash, receivable or other consideration arising in the course of

ordinary activities of the reporting entity from sale of goods, rendering of services, and from the use of

entity’s resources by others yielding interest, dividend and royalties.

TRANSACTIONS EXCLUDED

Revenue recognition criteria as specified in Para 3 of AS-9 is not applicable to –

(i)

Realised

capital

gains

arising

out

disposal

non-current

assets

and

unrealised

capital

gains, i.e. appreciation in the value of fixed assets;

(ii)

Unrealised

holding

gains

the

value

current

assets

i.e.

increase

the

market

value

stock-in-trade;

(iii) Natural increase in the herds of livestock and agricultural and forest products;

(iv)

Realised/unrealised

gains

arising

out

fluctuations

foreign

ex-change

rates

translation

of foreign currency financial statements,

(v)

Realised

gains

resulting

from

discharge

obligation

lesser

amount

than

the

carrying

amount;

(vi) Unrealised gains resulting from restatement of the carrying amount of the obligation.

Timing of Revenue Recognition – Rendering of Services

Revenue from sale of rendering services should be recognised at the time of the sale or rendering

of services. However, if at the time of rendering of services or sale there is significant uncertainty in

ultimate collection of the revenue, then the revenue recognition is postponed. In such cases, revenue

should be recognised only when it becomes reasonably certain that ultimate collection will be made. It

also applies to the revenue arising out of escalation of price, export incentive, interest etc.

REVENUE FROM SALES OF GOODS

per

paras

10-11

AS-9,

revenue

from

sale

goods

recognized

when

the

seller

transfers the goods to the buyer for a consideration.

Revenue is recognized when all the following conditions are fulfilled:

46 Introduction to Financial Accounting

(i)

Seller

has

transferred

the

ownership

goods

buyer

for

price.

All

significant

risks

and rewards of ownership have been transferred to buyer.

(ii) Seller does not retain any effective control of ownership of the transferred goods.

(iii)

There

significant

uncertainty

collection

the

amount

consideration

(i.e.

cash,

receivables etc.)

Delivery

delayed

buyer

’

request:

some

cases,

the

buyer

may

request

for

delayed

delivery

although

purchases

the

goods,

takes

the

title

and

accepts

billing.

such

situations,

sale

complete

although

physical

delivery

the

goods

delayed.

Accordingly,

revenue

should

recognised

and

the

inventory

level

should

reduced.

prudent

disclose

the

value

goods

held

behalf

the

buyer

the

Balance

Sheet

date

way

of note.

Revenue

Recognition

when

delivery

goods

sold

subject

conditions:

(i) Installation and inspection: Revenue should be recognised when

(a) Goods are installed at the buyer’s place to his satisfaction.

(b) Goods are inspected and accepted by the buyer.

(ii)

Sale

approvel:

Revenue

should

recognised

when

buyer

confirms

his

desire

buy

such goods by communication.

(iii)

Guaranteed

sales:

this

case,

revenue

should

recognised

per

the

substance

the

agreement of sale or after the reasonable period has expired.

(iv)

Warranty

sales:

Sales

should

recognised

immediately

but

the

provision

should

made to cover unexpired warranty.

(v)

Consignment

sales:

this

regard,

revenue

should

recognised

only

when

the

goods

are

sold to third party.

(vi)

Special

Order

Shipments:

Revenue

from

such

sales

should

recognised

when

the

goods

identified and ready for delivery.

(vii) Subscriptions for publication:

(a)

Items

delivered

vary

value

from

period

period.

Revenue

should

recognised

on the basis of sales value of items delivered.

(b)

Items

delivered

not

vary

value

from

period

period.

this

case,

revenue

should be recognised on straight-line basis over time.

(viii)

Installment

sales:

Revenue

sale

price

excluding

interest

should

recogised

the

date of sale. Interest should be recognised proportionately to the unpaid balance.

(ix)

Revenue

swaps:

IAS-18

contains

the

provision

for

revenue

swaps.

However,

such

corresponding

provisions

are

given

AS-9.

per

IAS-18,

when

goods

services

are

exchanged

swapped

for

goods

services,

which

are

similar

nature

and

value,

the

exchange

not

regarded

transaction,

which

generates

revenue.

However,

when

goods

are

sold

services

are

rendered

exchange

for

dissimilar

goods,

the

exchange

regarded

transaction,

which

generates

revenue.

Such

revenue

measured

the

fair

value

the

goods

service

received,

adjusted

the

amount

any

cash

equivalents transferred.

(x)

Repo

Arrangements:

Under

IAS-18,

the

recognition

criteria

are

applied

two

transactions

together

when

they

are

linked

such

way

that

the

commercial

effect

connot

understood

without

reference

the

series

transactions

whole.

For

instance,

company

may

sell

goods

and,

the

same

time,

enter

into

separate

Introduction to Accounting Standard 47

agreement

repurchase

the

goods

later

date.

Thereby

the

substantive

effect

the

transaction

negated.

such

case

the

two

transactions

are

dealt

with

together.

The

accounting

standard-9

too

case

repo

arrangements

requires

that

such

transactions

should

recorded

financing

arrangements.

Therefore,

the

resulting

cash

inflow

not

revenue and should not be recognised as revenue.

REVENUE FROM RENDERING OF SERVICES

Normally, revenue from service is recognised as the service is performed. The performance of

service is measured by employing to methods:

1. Completed Service Contract Method:

Revenue

recognised

when

service

about

completed

and

significant

uncertainties

exist

about

the

collection

amount

service

charges.

Proportionate

Competition

Method:

this

method,

revenue

recognised

reference

the

performance

each

Act.

Under

this

method,

the

revenue

recognised

determined

the

basis

contract

value,

associated

cost,

number

Acts

other

suitable

basis.

Further,

significant

uncertainty

exists

about

the

collection

amount

service

charges

performed Acts.

Revenue Recognition Norms

The norms for revenue recognition for rendering of service under special condition are as follows:

1. Installation Fees:

recognised

when

the

installation

completed

and

accepted

the clients.

Advertising

and

Insurance

Agency

Commission:

this

regards,

the

norms

are

laid

down

under:

(i) Advertising commission is recognised when the advertisement appears before public.

(ii)

Insurance

commission

recognised

the

effective

commencement/renewal

date

the

policies.

Financial

Service

Commission:

Revenue

recognition

financial

service

commission

dependent upon:

(i)

Whether

the

service

has

been

provided

‘

once

and

for

all

’

continuing

basis.

(ii) The incidence of costs relating to the service.

(iii)

When

the

payment

for

the

service

will

received.

As regards to commission charged for arranging or granting loan and other facilities, it should be

recognised when a loan is sanctioned and accepted by borrower. Commitment facility or loan

management fees that relate to continuing obligations or services, should normally be recognised over

the life of the loan.

4. Admission Fee:

Revenue

from

artistic

performance,

banquets

and

other

special

events

should be recognised when event takes place.

Tuition

Fee:

Revenue should be recognized over the period of instruction.

Entrance

and

Membership

Fees:

Revenue

recognition

from

entrance

and

membership

fees

depends

upon

the

nature

service

being

provided.

However,

entrance

fees

are

generally

capitalised.

Membership

fees

should

recognised

systematic

and

rational

basis

having

regard to timing and nature of service provided.

48 Introduction to Financial Accounting

Revenue

from

Interest:

Revenue

from

interest

should

recognised

time

proportion

basis.

Revenue

from

Royalties:

Revenue

from

royalties

recognised

accrual

basis

per

terms of agreement.

Revenue

from

Dividend:

Revenues

from

dividend

recognised

when

the

declaring

company declared dividend.

EFFECT OF UNCERTAINTIES (SUBSEQUENT UNCERTAINTY IN

COLLECTION)

When uncertainty of collection of revenue arises subsequently after the revenue recognition, it is

desirable to make provision for the uncertainty in collection rather than adjustment in already

recognised revenue.

DISCLOSURE

When

revenue

recognition

postponed,

the

disclosure

the

circumstances

necessitating

such

postponement

should

made.

2. Disclosure of Revenue from Sales Transactions (ASI-14):

(i)

Disclosure

Excise

Duty

presentation

Profit

Loss

Statement:

per

ASI-14,

the

manner

disclosure

excise

duty

the

presentation

revenue

from

sales

transactions

(turnover)

the

statement

profit

and

loss

should

given

below:

Turnover (Gross) xx

Less:

Excise

Duty

Turnover (Net) xx

(ii)

Guidance

Note

Revenue

Recognition

Real

Estate

Sale:

The

term

‘

Real

Estate

’

meant

land

well

building.

The

issue

when

should

the

revenue

recognised

case

real

estate

sales

the

enterprises

engaged

such

activities

(commonly

referred

‘

real

estate

developers

’

‘

builders

’

‘

property

developers

’

regards

real

estate,

Revenue

should

recognised

when

all

the

following

conditions are fulfilled:

(a)

The

seller

has

transferred

the

buyer

all

significant

risk

and

reward

ownership

and

the

seller

retain

effective

control

the

real

estate

transferred

degree

usually

associated

with

ownership.

(b)

the

time

transfer

all

significant

risks

and

rewards

ownership

not

unreasonable to expect ultimate collection.

(c)

significant

uncertainty

exists

regarding

the

amount

the

consideration

that

will

derived.

Once

the

seller

has

transferred

all

risks

and

rewards

ownership

the

buyer

and

other

conditions

for

recognition

revenue

satisfied,

any

further

act

real

estate

performed

the

seller

are

substance,

performed

behalf

the

buyer

the

manner

similar

contractor.

Therefore,

the

seller

obliged

perform

any

substantial

acts

after

the

transfer

significant

risks

and

rewards

ownership,

revenue

recognised

applying

the

percentage

completion

method

manner

as specified in AS-7, ‘Construction Contract’.

Introduction to Accounting Standard 49

Export Related Benefits Such as DEPB

DEPB denotes Duty Entitlement Pass Book. The objective of DEPB is to neutralise the incidence

of basic custom duty on the import content of the export products. The neutralisation is provided by

way of grant of credit against the export product.

In this regard, a recent ICAI opinion, the benefit of DEPB should be recognised in the year of

export itself (provided no uncertainty exists). This is based on the matching concept. The activity of

export results in an entitlement of DEPB credit and accordingly, this credit cannot be related to duty

payable at the time of subsequent imports. At the time of subsequent imports, the full duty payable on

such imports would form part of cost of purchase, which is paid partly, or fully by way of adjustment

of DEPB credit. The export benefits should be booked separately as revenue by creating claim against

it on the asset side. Accordingly, the cost of purchase of material subsequent to exports should be

valued at full cost including the import duty saved i.e. full custom duty should be loaded irrespective

of its payment in cash or payment by utilization of DEPB credit. If DEPB credit is held for sale, the

treatment of DEPB credit would be similar to the treatment when it is intended to be utilised for

imports. However, significant uncertainty as regards to the amount of consideration realisable and

uncertainty regarding its ultimate collection has to be taken into account.

Treatment of Inter-divisional Transfers

ICAI has announced that inter-divisional transfers/sales are not the revenue as per Accounting

Standard-9 ‘Revenue Recognition’.

Since in case of inter-divisional transfers, risks and rewards remain within the enterprise and as

there is no consideration from the point of view of the enterprise as a whole, the recognition criteria

for revenue recognition are also not fulfilled in regard to inter-divisional transfers.

Illustration 10

Goods worth ` 10 lakhs are sent to Amritlal & Co. Ltd. by Sudhir & Co. Ltd. as per their order.

Goods are delivered to them and communicated by Amritlal that goods are in order.

Comment on whether it should be recognised as revenue.

Solution

Yes, it should be recognised as revenue as it fulfilled all the conditions of sale of goods, which is

complete in this respect. Against this sale, the amount of the sale is receivable. Hence, as per AS-9, it

should be recognized as revenue.

Excercise

Neelkanth Publishers Co. Ltd, supplied the books of ` 5 lakhs to Narendra Book Stores Ltd., as

per their order. Narendra Book Stores intimated to Neelkanth Publishers Co. Ltd. that the books are in

order.

Comment on whether it should be recognised as revenue.

Illustration 11

Computers worth ` 5 lakhs are supplied to Maganlal & Co. Ltd. by Chhaganlal & Co. Ltd on sale

on approval basis.

Mention what AS-9 suggests in this respect. Should it be recognised as revenue?

50 Introduction to Financial Accounting

Solution

As per AS-9, revenue should be recognised for sale on approval basis when the buyer confirms

his desire to buy such goods by communication. In this, there is no communication from Maganalal &

Co. Ltd. who are the buyers about their desire to buy the computers. Hence, no revenue should be

recognised in this case. It will be recognised as revenue only after receipt of communication from

Maganlal & Co. Ltd. indicating that they want to buy the computers, which were sent on sale on

approval basis.

Excercise

Goods of ` 2 lakhs are sent to Abhijit & Co. for sale on approval.

Comment on whether revenue should be recognised and state answer as per AS-9.

Illustration 12

Goods of ` 300 are sent to Gambhir as advertising samples.

Comment on whether it should be recognised as Revenue as per AS-9.

Solution

In this case refer solution to Illustration 1. No consideration is involved. Although goods are sent

to Gambhir, they are sent as advertising samples free of charge for advertising purpose. Hence, there

is no consideration in this case. Therefore, as per AS-9, no revenue can be recognised in this case.

Excercise

Goods of ` 500 are sent to Abhay as advertising samples.

Comment as to whether it will be recognised as Revenue as per AS-9.

Illustration 13

Abhay solds some goods to Abhijit without any consideration although goods are sent to Abhijit.

Offer your comment in this case on Revenue Recognition as per AS-9.

Solution

In this case, revenue will not be recognised. As per AS-9, it is clear that for revenue recognition

the following conditions should be fulfilled:

(i)

The

seller

has

transferred

the

ownership

goods

buyer

for

price

All

significant

risks

and rewards of ownership have been transferred to buyer.

(ii)

The

seller

does

not

retain

any

effective

control

ownership

the

transferred

goods.

(iii)

There

significant

uncertainty

collection

the

amount

consideration.

(i.e.

cash,

receivables etc.)

the

above

case,

there

consideration,

hence

there

sale,

hence

revenue

should

not

recognised.

Excercise

Sanjay sells goods to Ajay without any consideration although goods are sent to Ajay.

Comment in this case on Revenue Recognition as per AS-9.

Illustration 14

Jai & Co. Ltd. have an order for ` 1 crore from Jayashree & Co. Ltd. Jai & Co. Ltd. have yet to

execute the order.

Introduction to Accounting Standard 51

Will this be recognised as revenue? What do the AS-9 suggest in this regard? What are the

condition to be fulfilled for revenue recognition

Solution

It is mere receipt of an order and hence it is not a transaction of sale. The order is not even

executed. Hence, no revenue can be recognised in this regard as per AS-9. The conditions to be

fulfilled for sale of goods to be recognised as revenue are given under solution to Illustration 1.

Excercise

We have an order for ` 1 lakh from XYZ Co. Ltd. We have yet to execute the order.

Will this be recognised as revenue? What do the AS-9 suggest in this regard? What are the

conditions to be fulfilled for revenue recognition?

Illustration 15

The Madanlal and Co. Ltd. have purchased the goods worth ` 5 crores. They have taken the title

and accepted the billing from Tejas & Co. Ltd. But goods are not delivered to Madanlal and Co. Ltd.

At their request.

In such a case, will the revenue be recognised? Comment with reference to AS-9.

Solution

Yes, in this case, the revenue from the sale will be recognised since all the conditions of revenue

recognition from the sale of goods are fulfilled. Hence, the sale is complete although goods are not

delivered to Madanlal & Co. Ltd. at their request. Therefore, as per AS-9, revenue recognition is

correct.

Excercise

The Amritlal & Co. has purchased the goods worth ` 5 lakhs. The company has taken the title

and accepted billing from us. But goods are not delivered to Amritlal by us.

In such a case, will the revenue be recognised? Comment with reference to AS-9.

Illustration 16

Indu Ltd. used certain resources of Priyanka Ltd. In return, Priyanka Ltd. received ` 25,00,000

and ` 30,00,000 as interest and royalties respectively from Indu Ltd. during the year 2012-13.

State whether and on what basis, the revenue can be recognised by Priyanka Ltd.

Solution

As per AS-9, revenue arising from use. By other company resources yielding interest and

royalties should be recognised only when no significant uncertainty exists.

Interest is recognised on time proportion basis and royalty is recognised on accrual basis. Interest

is recognised in the year to which it pertains. It is not clear as to which year it belongs. Same is the

case with royalty. If bothpertains to 2006-07, it should be recognised during this year only.

Excercise

S & Co. used certain resources of P & Co. In return, P & Co. received ` 30,00,000 and

` 40,00,000 as interest and royalty respectively from S & Co. during the year 2012-13.

On what basis, the revenue can be recognised by P & Co.

52 Introduction to Financial Accounting

Illustration 17

XYZ Ltd. has recognised ` 6,00,000 on accrual basis income from dividend on securities and

units of mutual funds of the face value of ` 60 lakhs held by it as at the end of the year ending 31

March, 2013. The dividends were declared at the rate of 10% on 15

June, 2013. The dividend was

proposed on 10

April, 2013 by the declaring company.

Comment.

Solution

The treatment is not as per AS-9. Dividend is recognised as income when the right to receive is

established. In this case, right to receive is established on 15

June, 2013. Hence, dividend income

should be recognised during the year 2013-14.

Excercise

Rajita Ltd. has recognised ` 12,50,000 on accrual basis income from dividend on shares of the

face value of ` 50,00,000 held by the company at the end of the year ending 31

March, 2013. The

dividends were declared at the rate of 25% on 1

July, 2007. The dividend was proposed on 15

May,

2013 by the company.

Is this treatment right as per AS-9?

Illustration 18

The directors of Rajashree Ltd. decided on 31st March, 2013 to increase the sale price of certain

items retrospectively from 1st January, 2013. In view of the revision of price, the company has to

receive ` 20 lakhs from its customers in respect of sales made from 1

January, 2013 to 31

March,

2013 and the accountant being inexperienced, cannot decide whether ` 20 lakhs due to price revision

is revenue in the sale for 2012-13.

Give your suggestions.

Solution

The company stands to receive ` 20 lakhs due to price revision. If there is a certainty about

collection, the revenue arising from price revision should be recognised in 2012-13.

Excercise

The directors of Monica Ltd. decided on 31st March, 2013 to increase the sale price of its

products by 10% on sales taking place from 30th June, 2012 onwards. The intimation regarding the

same was sent to all the customers by 15

June, 2012.

From which date, should the revenue pertaining to increase in sale price by 10% be recognised.

[Hint: Revenue will be recognised from 2012-13 provided there is a certainty that customers will

accept the decision of the directors.]

Illustration 19

Installation fees of ` 5,00,000 are recognised as revenue by a company when the installation is

completed at the buyer’s place and goods are inspected and accepted by the buyer.

Comment on whether it is correct as per AS-9.

Solution

Revenue recognition in this respect is correct as the sale of services is complete as per AS-9.

Introduction to Accounting Standard 53

Excercise

Installation fees of ` 1 lakh are recognised as revenue when the installation is completed.

Comment as per AS-9.

Illustration 20

Pfizer Ltd. 2002-03:

Revenue Recognition: Revenue from sale of goods is recognised when significant risks and

rewards of ownership are transferred to the customers, which is at the point of dispatch of goods to the

customers. Revenue from services is recognised on rendering of services. Interest income is

recognised on time proportion basis.

Illustration 21

Ceat Ltd. 2002-03:

Sales are recognised on despatch to customers. Sales include excise duty but exclude sales tax

and freight recovery. Export incentives, Dividend and interest are accounted for on an accrual basis.

Illustration 22

Nicholas Piramal India Ltd. 2002-03:

The Company recognizes sales at the point of dispatch of goods to the customer. Sales are net of

discounts, sales tax, excise duty and returns.

Illustration 23

P C I Papers Ltd. 2002-03:

Revenue Recognition: Sales include exports sales, domestic sales, inter-division transfer,

conversion income and net of returns, claims and discount allowed.

Domestic sales includes excise duty realised but net of sales tax.

Export sales includes the foreign exchange rate difference arising upon subsequent realisation of

invoices.

Benefits on account of entitlement of import duty free materials under the ‘Duty Exemption

Passbook Scheme’ is accounted for in the year of export.

Illustration 24

Dr. Reddy’s Laboratories Ltd. 2002-03:

Revenue Recognition: Revenue from sale of goods is recognised when significant risks and

rewards in respect of ownership of the products are transferred to the customer. Revenue from

domestic sales of formulation products is recognised on despatch of products to stockists by clearing

and forwarding agents of the Company. Revenue from domestic sales of active pharmaceutical

ingredients and intermediates is recognised on dispatch of products from the factories of the Company.

Revenue from export sales is recognised on shipment of products.

Revenue from product sales is stated inclusive of excise duty and exclusive of returns, sales tax

and applicable trade discounts and allowances.

Revenue from services is recognised as per the terms of the contracts with the customers when

the services are performed.

Non-refundable up-front and milestone payments (“license fees”) are recognised as revenue

when earned, in accordance with the terms prescribed in the license agreements.

54 Introduction to Financial Accounting

Dividend income is recognised when the unconditional right to receive the income is established.

Income from interest on deposits and interest bearing securities is recognised on the time

proportionate method.

Export entitlements under the Duty Entitlement Pass Book (“DEPB”) scheme are recognised in

the profit and loss account when the right to receive credit as per the terms of the scheme is

established in respect of the exports made and where there is no significant uncertainty regarding the

ultimate collection of the relevant export proceeds.

AS – 6: DEPRECIATION ACCOUNTING (AS6)

Where an asset, e.g. machinery, generates revenue over more than one accounting period, the

matching principle demands that the cost of the asset be recognised over same number of accounting

periods. Also, the allocation, as far as possible should be in the proportion of revenue generated by the

asset. Depreciation for an accounting period is the cost of assets allocated to that accounting period.

However, the allocated historical cost of an asset may not always reflect the appropriate charge against

revenue. This can happen for example, when the asset has a terminal value or when the asset is

revalued. For this reason, depreciation for an accounting period is regarded as amount of depreciable

value allocated to an accounting period. The depreciable value is historical cost ± Change in historical

cost due to revaluation or otherwise - terminal value expected on disposal of the asset.

The depreciation is a non-cash charge, Le. a charge of depreciation reduces profit available for

distribution without reducing the available cash. The cash thus retained in the business is intended to

be used for replacement of the depreciable asset. For this reason, section 205 of the Companies Act

1956, provides that companies can pay dividend only out of profit available after charging

depreciation in accordance with subsection 2 of that section. For the purpose, Schedule XIV of the

Companies Act prescribes certain rates of depreciation. These are minimum rates of depreciation a

company must charge.

Accounting standard 6, sets the broad principles for computation of depreciation without

prescribing any specific rate or method of depreciation. Enterprises other than companies to which the

standard applies, must compute and charge depreciation in accordance with the standard. In case of

companies, the depreciation charged should be higher of (i) depreciation under Companies Act

(ii) depreciation as per AS 6.

AS 6 is mandatory in respect of accounting periods commencing on or after April 1, 1995. It

applies to all enterprises.

Land has indefinite life and hence does not permit allocation of value over finite number of

accounting periods. Hence, the standard does not apply to land, unless it has a limited useful life. The

standard applies to all depreciable assets except the following to which special considerations apply:

(i) forests, plantations and similar regenerative natural resources

(ii)

wasting

assets

including

expenditure

the

exploration

for

and

extraction

minerals,

oils,

natural gas and similar non-regenerative resources

(iii) expenditure on research and development

(iv) livestock

Accounting Standard 6 defines depreciation as a measure of the wearing out, consumption or

other loss of value of depreciable asset arising from use, efflux of time or obsolescence through

technology and market changes. Depreciation is allocated so as to charge a fair proportion of the

depreciable amount in each accounting period during the expected useful life of the asset.

Depreciation includes amortization of assets whose useful life is pre-determined.

Introduction to Accounting Standard 55

“Depreciable assets” are assets which:

1. are expected to be used during more than one accounting period; and

2. have a limited useful life; and

are

held

enterprise

for

use

the

production

supply

goods

and

services,

for

rental

others,

for

administrative

purposes

and

not

for

the

purpose

sale

the

ordinary

course

business.

“Useful life” is Either

(a) the period over which a depreciable asset is expected be used by the enterprise; or

(b)

the

number

production

similar

units

expected

obtained

from

the

use

the

asset

the

enterprise.

“Depreciable amount” of a depreciable asset is its historical cost, or other amount substituted for

historical cost in the financial statements, less estimated residual value. The depreciable amount of a

depreciable asset should be allocated on a systematic basis to each accounting period during the useful

of the asset.

The useful life of a depreciable asset should be estimated after considering:

expected physical wear and tear

(i) obsolescence and

(ii) legal or other limits on the use of the asset.

The useful lives of major depreciable assets or classes of depreciable assets may be reviewed

periodically. Where there is a revision of the estimated useful life of an asset, the unamortised

depreciable amount should be charged over the revised remaining useful life. (Paragraph 23)

Example

A machine of cost 1,20,000 is depreciated straight-line assuming 10 year working life and zero

residual value for three years. The estimate of remaining useful life after third year was reassessed at 5

years.

Depreciation per year charged for three years = ` 1,20,000/10 = ` 12,000

WDV of the machine at the end of third year = ` 1,20,000 - ` 12,000 × 3 = ` 84,000

Remaining useful life as per previous estimate = 7 years

Remaining useful life as per revised estimate = 5 years

Depreciation for the fourth year on wards = ` 84,000/5 = ` 16,800.

Additions and Extensions (Paragraph 24)

(a)

When

addition

extension

retains

separate

identity

and

capable

being

used

after

the

existing

asset

disposed

off,

depreciation

should

provided

independently

the

basis

of an estimate of its own useful life.

(b)

Where

addition

extension

becomes

integral

part

existing

asset,

should

depreciated

over

the

asset's

remaining

useful

life.

The

depreciation

such

addition

extension may also be provided at the rate applied to the existing asset.

Example

The estimated working life of a machine is 6 years. The machine is used with an attachment

having a useful life of 10 years. The cost of the machine and that of the attachment are ` 60,000 and

` 6,000 respectively. The terminal value is zero for both. Straight-line depreciation is in use.

56 Introduction to Financial Accounting

Depreciation for the year:

(a) if the attachment retains a separate identity and is capable of being used after the machine is

disposed

off

60,000/6

6,000/10

10,600

(b) if the attachment becomes an integral part of the machine =

66,000/6 =

11,000

Change in Depreciable Amount

(a)

The

historical

cost

depreciable

asset

may

change

due

increase

decrease

long-

term

liability

account

exchange

fluctuations

(See

note),

price

adjustments,

changes

duties

other

similar

factors.

these

cases,

depreciation

the

revised

unmortised

depreciable

amount

should

provided

prospectively

over

the

residual

life

the

asset.

(b)

Where

the

depreciable

assets

are

revalued,

the

provision

for

depreciation

should

based

the

revalued

amount

and

the

estimate

the

remaining

useful

lives

such

assets.

case

the

revaluation

has

material

effect

the

amount

depreciation,

the

same

should

disclosed separately in the year in which revaluation is carried out

The aforesaid two requirements ensure that no amortisation of depreciable amounts remain

pending after the assets cease to be useful. Since an asset does not generate any revenue after its useful

is over, any amortisation charged against revenue after such time, defeats the principle of matching

revenue and costs.

Example

A machine of cost 1,20,000 is depreciated straight-line assuming 10 year working life and zero

residual value for three years. At the end of third year, the machine was revalued upwards by ` 6,000

the remaining useful life was reassessed at 9 years.

Depreciation per year charged for three years = ` 1,20,000/10 = ` 12,000

WDV of the machine at the end of third year = ` 20,000 - ` 12,000 × 3 = ` 84,000.

Depreciable amount after revaluation = ` 84,000 + ` 6,000 = ` 90,000

Remaining useful life as per previous estimate = 7 years

Remaining useful life as per revised estimate = 9 years

Depreciation for the fourth year onwards = ` 90,000/9 = ` 10,000.

Change in Method of Charging Depreciation

The depreciation method selected should be applied consistently from period to period. A change

from one method of providing depreciation to another should be made only if the adoption of the new

method is required by statute or for compliance with an accounting standard or if it considered that the

change would result in a more appropriate preparation or presentation of the financial statements of

the enterprise. When such a change in the method of depreciation is made, depreciation should be

recalculated in accordance with the new method from the date of the asset coming into use.

The deficiency or surplus arising from retrospective recomputation of depreciation in accordance

with the new method should be adjusted in the accounts in the year in which the method of

depreciation is changed. In case the change in the method results in deficiency in depreciation in

respect of past years, the deficiency should be charged in the statement of profit and loss. In case the

change in the method results in surplus, the surplus should be credited to the statement of profit and

loss. Such a change should be treated as a change in accounting policy and its effect should be

quantified and disclosed.

Introduction to Accounting Standard 57

Example

A company acquired a machine on 01/04/06 for ` 5,00,000. The company charged straight-line

depreciation based on 10 year working life estimate and residual value ` 50,000 upto 2008-09. From

2009-10, the company decided to change to 20% reducing balance method of depreciation. show

adjustment required in books of the company.

Solution

Annual depreciation charged by the company upto 2008-09

= (` 5,00,000 – ` 50,000)/10 = ` 45,000

WDV of machine at the end of 2008-09 = ` 5,00,000 – ` 45,000 × 3 = ` 3,65,000

WDV of machine at the end 2008-09 (by reducing balance method)

= ` 5,00,000 ( 1 – 0.20)

= ` 2,56,000

Depreciation to be charged in 2009-10

= (` 3,65,000 – ` 2,56,000) + 20% ` 2,56,000 = ` 1,60,200

Books of the Company

` 000 ` 000

Depreciation 160.2

To Machine 160.2

Profit & Loss A/c 160.2

To Depreciation 160.2

Machine A/C

` 000 ` 000

To Balance b/d 365.0 By Depreciation 160.2

By Depreciation 204.8

365.0 365.0

Disclosures

1. The following information should be disclosed in the financial statements:

(i)

The

historical

cost

other

amount

substituted

for

historical

cost

each

class

depreciable

assets;

(ii)

Total

depreciation

for

the

period

for

each

class

assets

and

the

ccumulated

depreciation.

addition

above,

the

following

information

should

disclosed

the

financial

statements

along

with

the

disclosure

other

accounting

policies:

(i) Depreciation methods used; and

(ii)

Depreciation

rates

the

useful

lives

the

assets,

they

are

different

from

the

principal

rates

specified

the

statute

governing

the

enterprise.

any

asset

disposed

off,

discarded

the

net

surplus

deficiency;

material

should

disclosed separately

58 Introduction to Financial Accounting

AS – 10: ACCOUNTING FOR FIXED ASSETS

After introduction AS – 16; 19 and 26, provision relating to respective AS are held withdrawn

and the rest is mandatory from the accounting year1-4-2000.

This statement does not deal with accounting for the following items to which special

considerations apply:

1. Forests, plantations and similar regenerative natural resources.

Wasting

assets

mineral

rights,

expenditure

the

exploration

for

and

extraction

minerals,

oil, natural gas and similar non-regenerative resources.

3. Expenditure on real estate development and

4. Livestock.

Identification of Fixed Assets

Fixed assets is an asset held with intention of being used for the purpose of producing or

providing goods or services and is not held for sale in the normal course of business.

Stand-by equipment and servicing equipment are normally capitalised. Machinery spares are

usually charged to the profit and loss statement as and when consumed. However, if such spares can

be used only in connection with an item of diced asset, it may be appropriate to allocate the total cost

on a systematic basis over a period not exceeding the useful life of the principal item.

Components of Cost

Gross book value of a fixed asset is its historical cost or other amount substituted for historical

cost in the books of account or financial statements. When this amount is shown net of accumulated

depreciation, it is termed as net book value.

The cost of an item of fixed asset comprises it purchase price, including import duties and other

non-refundable taxes or levies and any directly attributable cost of bringing the asset to its working

condition for its intended use; any trade discounts and rebates are deducted in arriving at the purchase

price.

The cost of a fixed asset may undergo changes subsequent to its acquisition or construction on

account of exchange fluctuations, price adjustments, changes in duties or similar factors.

The expenditure incurred on start-up and commissioning of the project, including the expenditure

incurred on test runs and experimental production, is usually capitalised as an indirect element of

construction cost. If the interval between the date a project is ready to commence commercial

production and the date at which commercial production actually begins is prolonged, all expenses

incurred during this period are charged to the profit and loss statement.

Self-constricted Fixed Assets

Included in the gross book value are costs of construction that relate directly to the specific asset

and costs that are attributable to the construction activity in general and can be allocated to the specific

asset. Any internal profits are eliminated in arriving at such costs.

Introduction to Accounting Standard 59

Example

ABC Ltd. Is constructing a fixed asset. Following are the expenses incurred on the construction:

Materials

10,00,000

Direct Expenses ` 2,50,000

Total Direct Labour ` 5,00,000

(1/10

of the total labour time was chargeable to the construction)

Total office and administrative expenses

` 8,00,000

(5% is chargeable to the construction)

Depreciation on the assets used for the construction of this assets

` 10,000

Calculate the cost of fixed assets.

Solution

Calculation of the Cost of Construction of Assets

Particulars `

Direct Materials 1,000,000

Direct Labour 50,000

Direct Expenses 2,50,000

Office and Administrative Expenses 40,000

Depreciation 10,000

Cost of the Asset 1,350,000

Non-monetary Consideration

When a fixed asset is acquired in exchange for another asset, its cost is usually determined by

reference to the fair market value of the consideration given. It may be appropriate to consider also the

fair market value of the asset acquired if this is more clearly evident.

When a fixed asset is acquired in exchange for shares or other securities in the enterprise, it is

usually recorded at its fair market value, or the fair market value of the securities issued, whichever is

more clearly evident.

Fair market value is the price that would be agreed to in an open and unrestricted market between

knowledgeable and wiling parties dealing at arm’s length who are fully informed and are not under

any compulsion to transact.

Improvements and Repairs

Any expenditure that increase the future benefits from the existing asset beyond its previously

assessed standard of performance is include in the gross book value, e.g. an increase in capacity.

The cost of an addition or extension to an existing asset, which has a separate identity and is

capagle of being used after the existing asset is disposed of , is accounted for separately.

Amount Substituted for Historical Cost

The revalued amounts of fixed assets are presented in financial statements either by restating

both the gross book value and accumulated depreciation so as to give a net book value equal to the net

60 Introduction to Financial Accounting

revalued amount or by restating the the net book value by adding therein the net increase on account

of revaluation.

Different bases of valuation are sometimes used in the same financial statements to determine the

book value of the separate items within each of the categories of fixed assets or for the different

categories of fixed assets. In such cases, it is necessary to disclose the gross book value included on

each basis.

It is not appropriate for the revaluation of a class of assets to result in the book value of that class

being greater than the recoverable amount of the assets of that class.

An increase in net book value arising on revaluation of fixed assets is normally credited directly

to owner's interests under the heading of revaluation reserves and is regarded as not available for

distribution. A decrease in net book value arising on revaluation of fixed assets is charged to profit and

loss statement except that, to the extent that such a decrease is considered to be related to a previous

increase on revaluation that is included in revaluation reserve.

Retirements and Disposals

Items of fixed assets that have been retired from active use and are held for disposal are

stated at the lower of their net book value and net realisable value and are shown separately in the

financial statements. Any expected loss is recognised immediately in the profit and loss statement.

On disposal of a previously revalued item of fixed asset, the difference between net disposal

proceeds and the net book value is normally charged or credited to the profit and loss statement except

that, to the extent such a loss is related to an increase which was previously recorded as a credit to

revaluation reserve and which has not been subsequently reversed or utilised, it is charged directly to

that account. The amount standing in revaluation reserve following the retirement or disposal of an

asset which relates to that asset may be transferred to general reserve.

Hire Purchases

In the case of fixed assets acquired on hire purchase terms, although legal ownership does not

vest in the enterprise, such assets are recorded at their cash value, which, if not readily available, is

calculated by assuming an appropriate rate of interest. They are shown in the balance sheet with an

appropriate narration to indicate that the enterprise does not have full ownership thereof.

Joint Ownership

Where an enterprise owns fixed assets jointly with others, the extent of its share in such assets,

and the proportion in the original cost, accumulated depreciation and written down value are stated in

the balance sheet. Alternatively, the pro rata cost of such jointly owned assets is grouped together with

similar fully owned assets. Details of such jointly owned assets are indicated separately in the fixed

assets register.

Goodwill

Goodwill, in general, is recorded in the books only when some consideration in. money or

money's worth has been paid for it. As a matter of financial prudence, goodwill is written off over a

period. However, many enterprises do not write off goodwill and retain it as an asset.

Patents

Patents are normally acquired in two ways: (i) by purchase, in which case patents are valued at

the purchase cost including incidental expenses, stamp duty, etc. and (ii) by development within the

enterprise, in which case identifiable costs incurred in developing the patents are capitalised. Patents

Introduction to Accounting Standard 61

are normally written off over their legal term of validity or over their working life, whichever is

shorter.

Know How

Know-how in general is recorded in the books only when some consideration in money or

money's worth has been paid for it. Know-how is generally of two types: Relating to manufacturing

processes and Relating to plans, designs and drawings of buildings or plant and machinery.

Know-how related to plans, designs and drawings of buildings or plant and machinery is

capitalised under the relevant asset heads. In such cases depreciation is calculated on the total cost of

those assets, including the cost of the know-how capitalised. Know-how related to manufacturing

processes is usually expensed in the year in which it is incurred.

Disclosure

Gross

and

net

book

values

fixed

assets

the

beginning

and

end

accounting

period

showing additions, disposals, acquisitions and other movements;

Expenditure

incurred

account

fixed

assets

the

course

construction

acquisition;

and

Revalued

amounts

substituted

for

historical

costs

fixed

assets,

the

method

adopted

compute

the

revalued

amounts,

the

nature

any

indices

used,

the

year

any

appraisal

made,

and

whether

external

valuer

was

involved,

case

where

fixed

assets

are

stated

revalued amounts.

Example

On March 01, 2011, X Ltd. purchased ` 5 lakhs worth of land for a factory site. Company

demolished an old building on the property and sold the material for ` 10,000. Company incurred

additional cost and realized salvaged proceeds during the March 2011 as follows:

Legal fees for purchase contract and recording ownership ` 25,000

Title guarantee insurance ` 10,000

Cost for demolition of building ` 30,000

In March 31, 2011 balance sheet, X Ltd. should report a balance in the land account.

Solution

Calculation of the Cost for Purchase of Land

Particulars

Cost of Land 5,00,000

Legal Fees 25,000

Title Insurance 10,000

Cost of Demolition 50,000

Less: Salvage value of Material 10,000 40,000

Cost of the Asset 5,75,000

INTRODUCTION

The Institute of Chartered Accountants of India (ICAI) has decided the strategy for adoption of

IFRS in India with effect from 1

April, 2011. At present over 110 countries in the European Union,

Africa, West Asia and Asia Pacific regions either or permit the use of IFRS. Even in the US there is on

going debate about adoption of IFRS replacing the US GAAP. Now the International Accounting

Standards Board (IASB) that issues IFRS and the Financial Accounting Standards Boards (FASB) that

issues the US GAAP are cooperating and they have long term projects and short term projects to

converge US GAAP into IFRS.

MEANING OF IFRS

LF.R.S. represent sets of financial reporting standards issued by International Accounting

Standards Board (JASB). This Board is independent standard setting body of International Accounting

Standard Committee Foundation (IASC). In July 2005 IASC Foundation was formed. It constitutes

team of 22 trustees from various countries.

FEATURES

1. IFRS is said be complied with only if this is an explicit statement of compliance with IFRS.

2. An entity should comply with each IFRS effective at the end of its first IFRS reporting

period,

3. An entity is to do the following in the opening IFRS statement of financial position that it

prepares as a starting point for its accounting under IFRS.

(a) Recognise all assets and liabilities which are recognized by IFRS

(b) Not recognize items as assets or liabilities if IFRS do not permit such recognition.

(d) Apply IFRS in measuring all recognized assets & liabilities.

4. IFRS grants limited exemptions from these requirements.

5. IFRS requires disclosures that explain how the transition from previous GAAP to IFRS

affected the entity's reported financial position.

OBJECTIVE

The objective of IFRS is to ensure that an entity’s first financial statements, and its interim

financial reports contain high quality information which is:

CHAPTER

Introduction to IFRS and

Accounting in Computerised

Environment

Introduction to IFRS and Accounting in Computerised Environment 63

1. Transparent for users

2. Provides a suitable starting point for accounting under IFRS.

3. Can be generated at a cost which does not exceed the benefits to users.

BENEFITS

Indian corporates are likely to reap significant benefits from adopting IFRS. European Union’s

experience highlights many benefits of adoption of IFRS. The important benefits are as follows:

1. Improvement in comparability of financial information and financial performance with

global pears and industry standards.

2. IFRS enhances uniformity in the accounting principles.

3. Indian financial statements will be liked by foreign investors.

4. IFRS are expected to result in better quality of financial reporting.

5. Cost of raising funds in abroad will be lower.

6. It will lead to increased trust and reliance placed by Indian Investors.

7. Better access and reduction in the cost of capital 'raised from global capital markets.

The above benefits will accrue only to the big corp orates in India. The SME sector will not

benefit much as they do not have necessary set up to cope with the problems that may arise by

switching to the mote rigorous IFRS.

Two separate sets of accounting standards under see 211 (3C) of the companies Act have been

agreed upon by the core group for convergence of Indian Accounting Standards with IFRS. For

banking and insurance companies, there will be a separate road map. The core group committee of the

government fma1ized the road map for IFRS convergence in India. The ICAI said that all the entities

having networth in excess of ` 1,000 crore will have to follow IFRS. The list includes all NSE and

BSE listed companies, insurance entities, manual funds, venture capital funds and all scheduled banks

having operations outside India.

CHALLENGES

There are several practical challenges in adoption of and full compliance with IFRS in India.

1. Several laws and regulations governing financial accounting and reporting in India need to

be amended.

2. There are certain sections of the companies Act that over ride the provisions on IFRS.

3. There is a shortage of professionals with practical IFRS conversion experience and therefore

many companies will have to depend on external advisors and their auditors.

4. There is an urgent need, to build adequate IFRS skills among the Indian accounting

professionals to manage the conversion.

INTERNATIONAL FINANCIAL REPORTING STANDARD (IFRS)

IFRS refers to Standard to be applied for reporting of financial statements. These lay down

standards for reporting, presentation, carrying amounts, disclosure of financial statement.

64 Introduction to Financial Accounting

There are references to IAS on some topics/issues. Till date 9 IFRS are issued. The details are as

follows:

IFRS No. Title

1 IFRS 1 First time adoption of international financial reporting standards

2 IFRS 2 Share-based payment

3 IFES 3 Business combinations

4 IFES 4 Insurance contracts

5 IFRS 5 Non-current assets held for sale and discontinued operations

6 IFRS 6 Exploration for and evaluation of mineral resources

7 IFRS 7 Financial Instruments Disclosures

8 IFRS 8 Operating Segments

9 1 IFRS 9 Financial Instruments

INTERNATIONAL ACCOUNTING STANDARD (IAS)

IAS relates to standards, on various aspects of accounting issues. These are mainly relevant for

maintenance of accounts as well as disclosure of information.

Till date 41 IAS have been issued, but 12 have been withdrawn, As on date 29 IAS are in force.

IAS No. Title

1 IAS 1 Presentation of financial statements

2 IAS 2 Inventories

3 IAS 7 Statement of cash flows

4 IAS 8 Accounting policies, changes in accounting estimates and errors

5 IAS 10 Events after the reporting period

6 IAS 11 Construction contracts

7 IAS 12 Income taxes

8 IAS 16 Property, plant and equipment

9 IAS 17 Lease

10 IAS 18 Revenue

11 IAS 19 Employee benefits

12 IAS 20 Accounting for Gov. Grants and disclosure of Gov. Assistance

13 IAS 21 The effects of changes in foreign exchange rates

14 IAS 23 Borrowing costs

15 IAS 24 Related party disclosures

16 IAS 26Accounting and reporting by retirement benefit plans

17 IAS 27 Consolidated and separate financial statements

18 IAS 28 Investments in associates

19 IAS 29 Financial reporting in hyperinflationary economics

Introduction to IFRS and Accounting in Computerised Environment 65

20 IAS Interests in joint ventures

21 IAS 32 Financial instruments: presentation

22 IAS 33 Earnings per share

23 IAS 34 Interim financial reporting

24 IAS 36 Impairment of assets

25 IAS 37 Provisions, contingent Liabilities and contingent assets

26 IAS 38 Intangible assets

27 IAS 39 Financial instruments: Recognition and measurement (To be replaced by IFRS 9)

28 IAS 40 Investment property

29 IAS 41 Agriculture

INTERPRETATIONS ISSUED BY INTERPRETATION COMMITTEES

(IFRIC/SIC)

Interpretations on application of IAS/IFRS are issued to provide guidance on relevant issues.

This committee known as Standing Interpretations Committee (SIC) and renamed as International

Financial Reporting Interpretation Committee (IFRIC)

The interpretations issued refer to applicable IAS/IFRS. Till date 11 SIC Interpretation and 18

IFRIC Interpretation have been issued. These relate to specific IAS/IFRS

The adoption of, IFRS is inevitable for many nations, particularly when many enterprises have

international/multinational associates/activities. This adoption requires convergence' of local/national

accounting standards with IFRS.

IASC Foundation has framed uniform/standardized procedures and time frame for convergence.

Accordingly time frame commences on 1.4.2010. This requires preparing opening Balance sheet on

31.3.2010 as per Accounting Standard and prepare reconciliation statement which will explain

difference between two standards. 2011-12 will be the first IFRS reporting period and 31-3-2012 will

be the first reporting date as per IFRS.

DEVELOPMENTS IN INDIA

In India the ICAI decided to have convergence of AS issued by ICAI with IFRS in July 2007.

The Ministry of Corporate Affairs (MCA) constituted

1. A Core Group

2. High powered group-supported by two sub groups.

The objective of these groups.is to discuss and resolve implementation challenges.

The major areas covered by the groups related to:

1. Convergence of AS with IAS and IFRS. This needs analysis and comparison of two and

thereafter revise various AS as per the requirement.

2. Identify changes required in various laws, regulations and as to converge with IFRS.

These Core groups issued press release as on 22-1-2010.

66 Introduction to Financial Accounting

The group decided to have application of first stage of converged AS in three phases as follows:

w.e.f Companies

Phase I April 2011 Part of BSE - Senses 30

Part of NSE - Nifty 50

Listed Outside India

Listed/Unlisted - Net worth over ` 1,000 Cr.

Phase II April 2013 Listed/Unlisted - Net worth between ` 500 Cr ` 1,000 Cr

SME are other entities not covered by mandatory implementation of IFRS. SME (Small &

Medium Enterprises) refer to companies with turnover not over ` 100 crores or borrowing not over

` 25 Crores.

Small enterprise is one where the investment in plants & machinery is more than ` 25,00,000 but

less than ` 5 crores. A medium enterprise is one where investment in plants & machinery is more than

` 5 cores but less than ` 10 crores. Such companies are comply with requirements of IFRS for SME.

The ICAL has also taken measures to compare Accounting Standards issued in India with

corresponding IAS and IFRS requirements. Based on comparison, steps are taken to revise as to meet

the convergence requirements.

IFRS: I

The Significant difference between Indian GAAP and IAS/IFRS is that the Financial Statements

are prepared and presented as per historical cost concept and accrual method of accounting. IAS/IFRS

requires presentation of various items in Financial Statements at Fair Value. Measurement assumes

special significance as per IFRS. Fair Value represents transaction value on relevant date. Present

value technique can be adopted to ascertain Fair Value.

To provide guidance to entity which adopts IFRS for fist time, IASB has issued IFRS. 1 which is

titled as, “First Adoption of IFRS”.

IFRS. l provides that when an entity is required to comply with IFRS it should prepare:

1. Statements of financial position at preceding date as per local GAAP.

2. Prepare reconciliation statement explaining changes in two approaches on the same date.

3. For next year IFRS Statements are prepared.

4. Thereafter, full fledged IFRS compliant statements are to be prepared.

IFRS. 1 also provides detailed guidance on preparation of Financial Statement with appropriate

reference to IAS; IFRIC; SIC.

Accounting under IFRS

Accounting under IFRS Requires

1. Recognition of all assets and liabilities as per IFRS and not to recognize any other item not

permitted under IFRS.

2. Reclassify items as per IFRS.

3. Apply IFRS for measurement of assets and liabilities.

This would require change in certain matters where cost of compilation is likely to exceed the

benefits to the user. In such cases, compliance is optional.

Introduction to IFRS and Accounting in Computerised Environment 67

Further a concession is provided to Small and Medium sized Entities (SME). For such entities,

IFRS for SME is issued by IASB. IFRS for SME provides for omission of topics not related for SME

and simplification of recognition and measurement of various items in Financial Statements.

The salient points specified in IFRS 1 are explained hereafter:

Financial Statements (under IFRS)

A, complete set of Financial Statements comprises:

1. Statement of financial position as at the end of the year. (Balance Sheet)

2. Statement of Comprehensive Income. (Profit & Loss Account)

3. Statement of changes in Equity. (Appropriation)

4. Statement of Cash Flows.

5. Notes, comprising, a summary of significant accounting policies and explanatory notes.

Features of Financial Statements

1. General Features:

(a) Fair Presentation.

(b) Going Concern.

(d) Materiality and aggregation.

(e) Consistency of presentation.

(f) Offsetting to achieve substance of the transaction or event

This indicates disclosure of net assets and liabilities as well as incomes or expenses.

(g) Frequency of Reporting – At least annually

(h) Comparative Information – current and previous period

2. Title of the Statement to disclose:

(a) Name of the entity-including changes

(b) Whether single entity or group of entities is covered

(d) Presentation currency

(e) Level of rounding off used

3. Presentation of Financial statements should be in compliance with IFRS and IAS, as also

Interpretations developed by IFRIC and SIC.

Non - Current Liabilities:

The liabilities other than the current liabilities are non current liabilities.

The flowing are the examples of current liabilities:

(a) Trade and other payable

(b) Provision

(d) Liabilities and assets for current tax as defined in IAS - 12 Income Taxes;

(e) Deferred tax liabilities and deferred tax asset, as defined in IAS- 12

(f) Labilities included in disposal groups classified as held for sale in accordance with IFRS-5

68 Introduction to Financial Accounting

Equity

Equity is the residual interest in the assets of the entity after deducting all its liabilities. Equity

comprises:

(i) Equity Instruments

(ii) Share Premium (Share Issue Expenses to be deducted)

(iii) Retained Earnings & Reserve arising put of other comprehensive item.

Income

Income increases the economic benefits during the accounting period in the form of inflows or

enhancements of assets or decrease of liabilities that result in increase in equity, other than those

relating to contributions from equity participants. Incomes are termed as:

(i) Total Comprehensive Income

Total comprehensive income as the change in equity during a period resulting from transactions

and other events, other than those changes resulting from transactions with owners in their capacity as

owners. Total comprehensive income comprises of all components of profit or loss and of other

comprehensive income.

(ii) Other Comprehensive Income

Other comprehensive income comprises of items of income and expenses (including

reclassification adjustment) that are not recognized in profit or loss as required or permitted by other

IFRSs. The components of other comprehensive income include:

1. Revaluation surplus

2. On translation of the financial statements of a foreign operations

3. Fair value re-measurement available for sale of financial assets.

4. Actuarial gain or loss on defined benefit pension plans.

5. The effective portion of gains and losses on hedging.

Expenses

Expenses are decreases in economic benefits during the accounting period in the form of

outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than

those relating 'to distributions to equity participants.

Structure of Statement of Financial Position

Statement of Financial Position as at 31 ________2014

2014 2013

Assets

Non-current Assets

Property, Plant and Equipment

Goodwill

Other Intangible Assets

Investments in Associates

Introduction to IFRS and Accounting in Computerised Environment 69

Available for sale Investments

Current Assets

Inventories

Trade Receivables

Other Current Assets

Cash & Cash Equivalents

Total Assets

Equity And Liabilities

Equity Attributable to the Owners

Share Capital

Retained Earnings

Other components of Equity

Non-controlling: Interest

Total Equity

Non-current Liabilities

Long-term borrowings

Deferred tax

Long term provisions

Total non-current liabilities

Current Liabilities

Trade and other payables

Short term borrowings

Current portion of long-term borrowings

Current tax payable

Short-term provisions

Total current liabilities

Total Liabilities

However, liquidity based presentation is more appropriate for financial institutions. Even IAS 1

allows mixed basis of presentation. i.e. some of the assets or liabilities are presented based on current

non-current classification while others are presented on liquidity basis.

Structure of Statement of Comprehensive Income

Statement of Comprehensive Income for the year Ended 31 ________ 2014

2014 2013

Revenue

Cost of sales

Gross Profit

Other Income

Distribution Costs

70 Introduction to Financial Accounting

Administrative Expenses

Other Expenses

Finance costs

Share of profit of associates

Profit Before Tax

Income-tax expense

Profit for the year from continuing operations

Profit (loss) for the year from discontinued operations

Profit for the year

Other Comprehensive Income

Exchange differences in translating foreign operations

Gain (loss) on fair value changes in available for sale

financial instruments

Gain (loss) fair value changes in cash flow hedges

Gain on Revaluation property, plant & equipment

Actuarial Gain (loss) on defined: benefit pension plans

Share of other comprehensive income of associates

Income-tax relating to items of other comprehensive

income

Other Comprehensive Income net of tax

Total Comprehensive Income of the year

Profit attributable to:

Owners of the equity

Non:controlling interest

Total Comprehensive Income attributable to:.

Owners of the Equity

Non-controlling interest

Earning per share

Basic

Diluted

Notes:

1. An entity may present each item of other comprehensive income net of tax

2. If the entity prefers to present each item of comprehensive income net of tax, it has to

disclose in the notes the details as given below:

Amount before tax

Amount of tax

Amount after tax

3. Computed on the basis of the profit for the year.

Introduction to IFRS and Accounting in Computerised Environment 71

Fair Value

The fundamental basis of preparation arid reporting is that the statements should present fair

presentation of financial position. It should satisfy qualitative characteristic such as :

1. Understandability.

2. Relevance.

3. Comparability.

The Fair Value as per IFRS and relevant IAS refer to the present realizable value of asset or

liability. Thus the statements have to be prepared at present realizable value and not at historical cost

in relation to Non-Current (i.e. Fixed Asset/Investment).

This is a major departure from statement prepared in India, both per law (Companies Act) as well

as Accounting Standard.

Several IFRSs require or permit entities to measure or disclose the fair value of the assets,

liabilities or equity instruments. But IFRSs provide disparate and sometimes limited guidance on how

to measure fair value.

The fair value of a financial liability with a demand feature (e.g. a demand deposit) is not less

than the amount payable on demand, discounted from the first date that the amount could be required

to be paid.

Fair value is the price that would be received on sale of an asset or paid to transfer a liability in

an orderly transaction between market participants at the measurement date.

To ascertain fair value, appropriate technique should be applied considering the availability of

information or data. Fair Value may be:

1. Observable Market Price.

2. Transaction Price.

3. Present value of future cash flow.

4. Current Replacement value.

Measurement of Fair Value

1. The asset or liability: Fair value measurement is carried out fer a particular asset or liability.

The asset or liability might be a stand-alone asset or liability, or, a group of assets or liabilities.

2. Orderly transaction: Fair value measurement assumes that the asset or liability is exchanged

in an orderly transaction between market participants to sell the asset or transfer the liability at the

measurement date.

An orderly, transaction distinguishes a normal transaction from forced or distressed transaction.

It is the transaction in which the asset or liability was exposed in the market for a period before the

measurement date to allow for marketing activities that are usual and customary for transactions

involving such assets or liabilities. It is not a forced transaction.

The transaction shall occur in most advantageous market, after considering transaction costs and

transport costs. This implies market where sell value of asset would be maximized and that of liability

would beminimized.

Market

participants:

establish

the

fair

value

asset

liability,

not

necessary

identify a specific market participant. It will rather consider the characteristics of market participants

who will enter into the transaction to buy or sell a specific asset or liability in the most advantageous

market.

72 Introduction to Financial Accounting

They are buyers and sellers in the most advantageous market for the assets or liabilities that are:

(i) Independent of each other (not related parties),

(ii) Knowledgeable-Sufficiently informed to lack proper decision,

(iii) Able to enter into a transaction- The ability may be legal or intellectual,

(iv) Willing to enter into a transaction- Voluntary and not under compulsion or force.

4. The price: It is exit price on the measurement date which is either observable price or derived

based on the characteristics of market participants.

This normally represents transaction value at which asset or liability is transacted by parties

except when participants (parties) are related.

The price may be exit price or entry price.

5. Application to assets: Fair value measurement is carried out taking into account a market

participant’s ability to generate economic benefit by using assets or by selling it to another market

participant who will use the asset in its highest and best use.

This would maximize the value of the asset considering various factors such as :

(i) Physically possible,

(ii) Legally permissible,

(iii) Financially feasible

INTRODUCTION TO COMPUTERISED ACCOUNTING

By now the students are familiar with the concepts of accounting and how different methods of

accounting are to be adopted in different situations. We now look into accounting in a computerised

environment. The first and foremost thing to remember is that the fundamentals of accounting does

not change whether books of account are maintained manually or are computerised. The same

principles of debit and credit that we apply for recording income or expenditure, purchase or sale of

assets or creation or discharge of liability in a manual accounting system is equally applicable in a

computerised environment. However, since the recording medium is something else compared to hard

copy documents, and considerable reliance have to be placed on the software for the input, processing

and output of the data certain precautions, methodologies and techniques are to be adopted while

maintaining accounts in a computerised environment.

Meaning of Computerised Accounting

1. It captures business transactions in the form of accounting entries.

2. The accounting entries are then used to prepare financial statements

3. The financial statements are prepared based on accounting standards.

4. Various financial reports are prepared from the data available in the financial statements.

The above functions are performed by using a computer, the system so developed is called

Computerised Accounting.

Salient Features of Computerised Accounting System

The Main Features of Computerised Accounting

1. Speed: Work done by the computers at a very high speed. Let us imagine the quantum of

manpower required if 1,000 sales invoices are to be accounted daily and also to keep track of

such sales, due date of receipt of money against the sale, money received in advance, etc.

Introduction to IFRS and Accounting in Computerised Environment 73

With the help of computers, these things can be managed by a few people and in a shorter

time.

2. Accuracy: Unlike people, machines do not make errors once they are programmed to work

correctly. Thus, let us say a clerk is preparing a trial balance of an entity having 100 sales

transactions daily and the trail balance does not tally. It would take days to find out the

mistake. However, calculations done by machine are accurate and after all the transactions

are fed into computer, the trial balance is ready within seconds after the completion of data

feeding work.

3. Various Informative Reports can be Generated: In a computerised accounting system, it

is possible in a manual system. Let us say a clerk is asked to prepare an area-wise list of

sales from total sales throughout the year and the volume of sales transactions is about 500 a

day. It would take the clerk or the accounts staff a few weeks to prepare such a statement.

However, by using computers, such a statement can be prepared in a few minutes from the

sales records by giving a few commands only.

4. Economy: Nowadays, computerised accounting has become cheaper as compared to human

labour that has become more costly because of inflation. It is now economical to buy a

computer and perform the accounting operations rather than employ a large number of

people who would carry out the same job in a longer period.

5. A Computerised System may be a Single Stand Alone Unit or a Multiple User, i.e. LAN,

WAN, etc.: A computerised system may be a single machine containing software and

operated by only a single user. It could also be several computer machines interconnected by

LAN (Local Area Network), WAN (Wide Area Network)or other means such as telephone

connections, satellites, etc., used by multiple users at the same time, in multiple user

computer system, data can be proceed faster as more than one person is at work at the same

time to complete the data feeding. In a computerised accounting system with multiple users,

each user handles a particular segment of the transactions only, say, either sales, purchase,

cash, bank, etc., and the ledger gets updated automatically based on the feedings done by all

the users.

Computer information system environment exists when one or more computer(s) of any type or

size is (are) involved in the processing of financial information, including quantitative data, of

significance to the audit, whether those computers are operated by the entity or by a third party

A computerised accounting environment will therefore have the following salient features:

1. The processing of financial information will be by one or more computers.

2. The computer or computers may be operated by the entity or by a third party.

3. The processing of financial information by the computer is done with the help of one or

more computer software e.g. tally.

4. A Computer Software includes any program or routine that performs a desired function or

set of functions and the documentation required to describe and maintain that program or

routine.

5. The computer software used for the accounting system may be acquired software or may be

developed for the business.

6. Acquired software may consist of a spread sheet package or may be prepackaged accounting

software. Larger organisations may use an Enterprise Resource Planning (ERP) package for:

(a) Developing a customised accounting package is an option that some organisation prefers

so as to suit the peculiarities of their business function.

74 Introduction to Financial Accounting

(b) Outsourcing of the accounting system is also becoming popular where an organisation is

having the financial accounting processed from a third party.

Advantages of Computerised Accounting System are

1. Accurate, High Speed and Low Cost of Operation: In a manual accounting system,

special journals, subsidiary ledgers, etc., are used for recording accounting data. A

computer-based system performs the accounting functions more rapidly, more accurately

and (if the volume of repetitive transactions is large) at lower cost.

2. Availability of Various Reports from the Same Accounting Data: A computerised

accounting system can generate as per instructions various reports in addition to the

traditional balance sheet and profit and loss account. These reports that are generated as per

requirements are useful for various purposes.

3. Error free Accounting: Computerised Accounting is error - free. A computer can perfor

millions of operations without committing any error unlike a human being.

4. Automatic Completion of all Records by Feeding Only One Entry into the Computer:

In computerised accounting, once the initial feeding of the transactions is done in the

computer, the entries set of accounts gets ready automatically. As required in manual

accounting, there is no need to first write the subsidiary books, ledger, the general ledger,

etc., and then prepare the financial statement.

5. Multiple Set of Printouts Available: Number of printouts with various modifications and

including/excluding narrations can be taken and the data used more freely unlike manual

system where there is only one set of accounts.

Disadvantages of Computerised Accounting System are

1. Requirement of Special Programme and Professional: Special programmes are required

to enable the computer to carry out accounting operations that can be written only by

programmers. Thus. Efficient computerised accounting system and its programmes are

sometimes costly.

2. Qualified Staff Required for Operations: Only a technically qualified person can operate a

computer. Hence, the accounting staff has to be initially trained in a computer operations by

a computer professional. This increases staff cost initially cost when there is a change from

manual to computerised accounting.

3. Costly Computer Peripherals and Stationery: A computer requires various peripherals

such as floppy disks for storage, printers, etc., and other special stationery items that are

costly as compared to the traditional books of account.

4. Regular back-up is Required as Data may be Lost for Various Reasons: Regular back-

ups on various storage devices such as hard disks, floppy disks, magnetic tape, etc., have to

be taken to guard against possible loss of data. It is difficult to retrieve data lost from the

computer due to inadvertence.

5. Computer Viruses: Data in a computer are subject to various risks including those by

computer viruses. a computer viruses is a mischievous computer software written for fun/

frolic. It damages data inside a computer. A computer virus may destroy the entire data in a

computer and those kept in a back-up.

Introduction to IFRS and Accounting in Computerised Environment 75

A Terms Used In Computerised Accounting

The various terms used in computerised accounting and computer language are:

1. Data: Data mean any facts, observations, assumptions, or occurrences. In accounts, these

would mean accounting entries to be passed to prepare financial statements and other related

information e.g. in sales, invoices, details such as price, sales tax, date of sale, etc., are data.

2. Record: It consists of a group of data items related to an object of data processing, e.g. sales

3. Data File or File: It is a compilation of related records maintained in some pre-arranged

order. It is similar to manual files wherein various papers are stored. An example of a

computer file would be a payroll file of 1,000 employees of an entity.

4. System: It means various components that process the data, i.e. transactions/occurrences and

give output, i.e. results. It a manual accountings system, the components would be persons,

books of account such as ledgers, cash book, etc., which gives results in the form of trail

balance. In a computerised accounting system, it would mean the computer machine, the

software programme and computer peripherals such as keyboard monitor, etc

Significance of Computerised Accounting System

With computers becoming extensively used in business today, it is obvious that accounts which

were earlier maintained in a manual form will be gradually replaced with computerised accounts.The

speed with which accounts can be maintained is several fold higher. Basic difficulties faced like

balancing of trial balance, correct posting into the general ledger and subsidiary ledger is a thing of the

past. Today any person maintaining accounts in the computer does not have to consider that while

making say a cash expense entry through the cash payment screen that the corresponding ledger

posting of the expense has been done properly or not. Similarly the trial balance should automatically

tally unless some mistake is made while recording the opening balances. The only concern that has

increased today are concerns for controls, security and integrity of the computer system as more and

more information is stored not in the hard print but as soft copies inside the computer. Issues like

unauthorised access to the data either through the local area network or through the internet by

hacking into the company server are becoming potential threat to the computer usage.

Pre-packaged Accounting Software

There are several pre-packaged accounting software which are available in the market and are

used extensively for small and medium sized organisations. These softwares are easy to use, relatively

inexpensive and readily available.

The installation of these softwares is very simple. An installation diskette or CD is provided with

the software which can be used to install the software on a personal computer. A network version of

this software is also generally available which needs to be installed on the server and work can be

performed from the various workstations or nodes connected to the server.

Along with the software an user manual is provided which guides the user on how to use the

software

After installation of the software, the user should check the version of the software to ensure that

they have been provided with the latest. The vendor normally provides regular updates to take care of

the changes of law as well as add features to the existing software.

These softwares normally have a section which provides for the creation of a company. The

name, address, phone numbers and other details of the company like VAT registration number, PAN

76 Introduction to Financial Accounting

and TAN numbers are feeded into the system. The accounting period has to be set by inserting the first

and the last day of the financial year.

The next step in the use of this software could be the creation of accounts. This is done by adding

the accounts along with their codes into the master file files. Each account has to be classified into

whether it is an asset or liability or an income or expenditure account. Whether the account has other

subsidiary ledgers under it needs to be indicated to the system. The opening balances are to be entered

into the master file files. The company parameters need to be set at this point of time so that the

accounts which are the cash, bank, sundry debtors, sundry creditors, etc are known to the system. The

customer's name, address and other basic details are also entered in the customer master file.

Similarly, the creditors details are entered into the creditor master file files. Product details are

entered through the product master file files. Here the unit of measurement and the opening stock

quantities including the values are provided. The system of valuation of stock like the FIFO, LIFO,

Weighted average, etc are defined in the product master file files. Once the basic parameters are set

and the master files are updated, the system is ready for use.

Once the basic parameters are set and the master files are updated, the system is ready for use.

Advantages of Pre-packaged Accounting Software

1. Easy to Install: The CD or floppy disk is to be inserted and the setup file should be run to

complete the installation. Certain old DOS based accounting softwares required some

settings to be added in the system configuration file and the system batch file. These

instructions are generally provided in the user manuals.

2. Relatively Inexpensive: These packages are sold at very cheap prices nowadays.

3. Easy to Use: Mostly menu driven with help options. Further the user manual provides most

of the solutions to problems that the user may face while using the software.

4. Backup Procedure is Simple: Housekeeping section provides a menu for backup. The

backup can be taken on floppy disk or CD or harddisk.

5. Flexibility: Certain flexibility of report formats provided by some of the softwares. This

allows the user to make the invoice, challan, GRNs look the way they want.

6. Very Effective for Small and Medium Size Businesses: Most of their functional areas are

covered by these standardised packages.

Disadvantage of Pre-packaged Accounting Software

1. Does not Cover Peculiarities of Specific Business: Business today are becoming more and

more complex. A standard package may not be able to take care of these complexities.

2. Does not Cover all Functional Area: For example production process may not be covered

by most pre-packaged accounting software.

3. Customisation May not be Possible in most Such Softwares: The vendors for these

softwares believe in mass sale of an existing source. The expertise for customisation may not

have been retained by the vendor.

4. Reports Generated is not Sufficient or Serve the Purpose: The demands for modern day

business may make the management desire for several other reports for exercising

management control. These reports may not be available in a standard package.

5. Lack of Security: Any person can view data of all companies with common access

password. Levels of access control as we find in many customised accounting software

packages are generally missing in a pre-packaged accounting package.

Introduction to IFRS and Accounting in Computerised Environment 77

6. Bugs in the Software: Certain bugs may remain in the software which takes long to be

rectified by the vendor and is common in the initial years of the software.

EXERCISE

Q1. Define Computerised Accounting.

Q2. What are the salient features of Computerised Accounting?

Q3. Explain Computerised Accounting with its advantages and disadvantages.

Q4. Explain Codification and Grouping of Accounts with its classification in brief.

Q5. Short Note on:

(a) Maintaining the Hierarchy of Ledgers.

(b) Consideration for Selection of Pre-Packaged Accounting Software

Q6. What considerations should be taken during selection of accounting packages?

Q7. Explain Pre-Packaged Accounting Software with its advantages and disadvantages in details.

Q8. Discuss the advantages and disadvantages of spreadsheet software as an accounting tool.

Q9. What do you mean by IFRS?

Q10. What are the features of IFRS?

Q11. Explain the benefits of IFRS.

Q12. What are the challenges posed by IFRS?

Q13. Give titles of IFRS

Q14. What are the provisions of IFRS?

Q15. What are the features of financial statements as per IFRS norms?

Q16. What are the elements of financial statements?

Q17. Give the structure of of statements of financial position.

Q18. Give the structure of the statements of Comprehensive Income,

Q19. What is fair value measurement?

Q20. How would you measure fan- value of liabilities?

Q21. What are the valuation techniques?

Q22. What is the process of first time conversion to IFRS?

Q23. Give a check list for first time adoption IFRS

Multiple Choice Questions

1. Following is an example of a non-monetary item __________.

(a) Debtors (b) Creditors

2. The mean of Ate exchange rates in force during a period is known as __________.

(a) Average rate (b) Closing rate

78 Introduction to Financial Accounting

3. Reporting currency is the currency used for __________.

(a) presenting financial statements (b) recording financial transactions

4. Non-monetary items are the items __________.

(a) other than assets and liabilities

(b) assets and liability as other than monetary items

(d) none of the above

5. Monetary items are the assets and liabilities __________.

(a) to be received or paid in money

(b) to be received in fixed or determinable amount of money

6. As applicable for translation of foreign currency is __________.

(a) AS 11 (b) AS 13

7. The amount of exchange difference is recorded in __________.

(a) Foreign Exchange Fluctuation A/c (b) General Reserve A/c

8. At the end of the year the balance on Foreign Exchange Fluctuation A/c is transferred to

__________.

(a) General Reserve A/c (b) Profit and Loss A/c

9. IFRS are issued by __________.

(a) IASB (b) ICAI

10. The ICAI has decided to adopt IFRS wef. __________.

(a) 1-4-2012 (b) 1-4-2011

11. US GAAP are issued by __________.

(a) ICAI (b) FASB

12. The countries which have adopted IFRS are __________.

(a) Africa (c) Asia pacific Regions

(b) West Asia (d) All of the above

13. IFRS are the __________.

(a) Sets of financial Reporting standards

(b) Rules of accounting

Introduction to IFRS and Accounting in Computerised Environment 79

(d) none of the above

14. The objective of IFRS is to __________.

(a) ensure preparation of financial statements

(b) ensure that the financial statements contain high quality information.

(d) none of the above.

15. IFRS will facilitate. __________.

(a) better access and reduction in cost of capital raised from global market.

(b) easy borrowing from Indian Capital market.

(d) a + c

16. IFRS are applicable to All the entities having networth in excess of ` __________.

(a) ` 500 crores (b) ` 1000 crores

17. IASC was formed on __________.

(a) 1-1-2008 (b) 1-7-2007

18. Till date the IFRS issued are __________.

(a) 18 (b) 9

19. The IAS issued so far are __________.

(a) 46 (b) 45

20. As on today the IAS in force are __________.

(a) 25 (b) 21

21. The number of IAS withdrawn amounted to __________.

(a) 11 (b) 15

22. Interpretations on application of IFRS are issued by __________.

(a) SIC (b) IFRIC

23. Till date the number of IFRI interpretations issued is __________.

(a) 12 (b) 18

80 Introduction to Financial Accounting

24. Time frame for convergence to IFRS commences on __________.

(a) 1-5-2010 (b) 1-4-2010

25. The first reporting period as per IFRS is __________.

(a) 2009-10 (b) 2011-12

26. The first reporting date as per IFRS is __________.

(a) 31-3-2011 (b) 31-3-2010

27. The core group issued press release as on __________.

(a) 1-1-2010 (b) 22-1-2010

28. The core group has decided to converge to IFRS IN __________.

(a) 2 phases (b) 3 phases

29. The first phase begins on __________.

(a) May 2010 (b) April 2011

30. The second phase begins on __________.

(a) May 2011 (b) March, 2010

31. SME are those organizations whose turnover does not exceed __________.

(a) 101 crores (b) ` 100 crores

32. Snakall enterprises are those enterprises whose investment in plant and machinery does not

exceed. __________.

(a) ` 2 crores (b) ` 2.5 crores

33. Medium enterprises are those enterprises whose investment in plant & Machinery is

__________.

(a) More than ` 5 crores but less than ` 10 crores

(b) More than ` 5.5 cores but less than ` 15 crores

(d) More than ` 10 crores but less than ` 25 crores

34. Financial statements aas per IFRS are presented at __________.

(a) historical cost (b) market value

Introduction to IFRS and Accounting in Computerised Environment 81

35. As per Indian GAAP financial statements are presented at __________.

(a) market value (b) historical cost

36. Fair value represents __________.

(a) transaction value (b) average value

37. Financial statements as per IFRS include __________.

(a) Balance sheet (b) Profit & Loss A/c

38. Financial statements as per IFRS include __________.

(a) Cash flow statement (b) Summary of significant accounting policies

39. Presentation of financial statements should be in compliance with __________.

(a) IAS

(b) IFRS

(d) none of the above

40. Current assets are expected to realize within __________.

(a) 12 months (b) 20 months

41. Non current assets include __________.

(a) tangible assets (b) intangible assets

42. Intangible assets include __________.

(a) software (b) website

43. Property includes __________.

(a) Freeholde land (b) Building

44. Biological asset include __________.

(a) Building (b) Machinery

45. Current liabilities are those liabilities which are to be settled with in a period of __________.

(a) 18 months (b) 12 months

82 Introduction to Financial Accounting

46. Equity comprises __________.

(a) Equity instruments (b) share premium

47. Incomes are __________.

(a) increases in the economic benefits (b) decreases in the economic benefits

48. Expenses are __________.

(a) Increases in the economic benefits (b) decreases in the economic benefits

49. Fair value may be __________.

(a) market price (b) transaction price

50. The approaches to fair valuation include __________.

(a) In use valuation premise (b) IN exchange valuation premises

51. The methods of valuation include __________.

(a) Market approach (b) Cost approach

52. While applying the P.V techniques the factors to be considered include __________.

(a) Risk (b) Uncertaintanty

53. The process of conversion to IFRS include __________.

(a) initial phase (b) planning

[Ans. 1. d, 2. a, 3. a, 4. b, 5. c, 6. a, 7. a, 8. b, 9. a, 10. b, 11. b, 12. d, 13. a, 14. a, 15. a, 16. b, 17.

c, 18. b, 19. c, 20. d, 21. c, 22. b, 23. b, 24. b, 25. b, 26. c, 27. b, 28. b, 29. b, 30. c, 31. b, 32. d, 33. a,

34. c, 35. b, 36. a, 37. d, 38. d, 39. c, 40. a, 41. d, 42. d, 43. d, 44. c, 45. b, 46. d, 47. a, 48. b, 49. d, 50.

c, 51. d, 52. c, 53. d].

Match the following

Group ‘A’ Group ‘B’

1. IFRS (a) Date of implementation of IFRS

2. 1-4-2011 (b) Set of financial reporting standards

3. USGAP (c) Investment on P&M not exceed 5 crores

4. IFRS (d) FASB

5. Small enterprises (e) Issued by IASB

[Ans. (1 – e), (2 – a), (3 – d), (4 – b), (5 – c)]

Introduction to IFRS and Accounting in Computerised Environment 83

Group ‘A’ Group ‘B’

1. First Reporting da!e (a) begins on April 2011

2. First Reporting period (b) Presented at fair value

3. First Phase (c) expected to realise with in 12 months

4. Financial statement as, per IFRS (d) 2011-12

5. Current Assets (e) 31.3.2012

[Ans. (1 – e); (2 – d); (3 – a); (4 – b); (5 – c)].

Group ‘A’ Group ‘B’

1. Non-current Assets (a) Land & building

2. Software (b) Biological asset

3. Property includes (c) Equity

4. Living animals (d) Intangible assets

5. Equity instruments (e) Tangible assets

[Ans. (1 – e); (2 – d); (3 – a); (4 – b); (5 – c)].

Fill in the blanks with proper words

1. IFRS are issued by __________.

2. The date of implementation of IFRS is __________.

3. US GAAP are issued by __________.

4. IASC was formed on __________.

5. Till date __________ IFRS are issued.

6. So far __________ IAS are issued.

7. Interpretations on application of IFRS are issued by __________.

8. Till date __________ IFRI are issued.

9. The first reporting date as per IFRS __________.

10. The, first reporting period as per IFRS is __________.

11. Investment in plant & machinery of small enterprises does not exceed __________.

12. Financial statements as per Indian GAAP are presented at __________.

13. Financial statements as per IFRS are presented at __________.

14. Fair value represents __________ Value.

15. Current assets are expected to realize within __________ months.

16. Tangible assets are __________

17. Software is an __________ asset.

18. Living animal is a __________ assets.

19. Share premium is included in __________.

20. Fair value may be __________ value.

21. __________ Increases the economic benefits.

84 Introduction to Financial Accounting

[Ans. (1) IASB, (2) 1-4-2011, (3) FASB, (4) 1-7-2005, (5) 9, (6) 41, (7) IFRIC,

(8) 18, (9) 31-3-2012, (10) 2011-2012, (11) 5 crores, (12) historical cost, (13) Fair value,

(14) transaction value, (15) 12, (16) non-current, (17) intangible, (18) biological, (19) equity,

(20) market value, (21) income.]

State whether the following statements are True or False

1. IFRS are issued by ICAl.

2. IFRS are applicable to all the companies.

3. IFS will be adopted w.e.f. 1-4-2011.

4. US GAAP are issued by ICWAI.

5. The objective of IFRS is to have uniformity in financial statements.

6. IFRS will reduce cost of raising funds from global market.

7. IFRS are applicable to those enterprises which are having networth in excess of ` 1,000

crores.

8. IASC was formed on 1

July 2005.

9. AS on today these are 8 IFRS issued.

10. There are 21 LAS in force.

11. IFRIC is formed to issue interpretation of the IFRS.

12. So far, 18 IFRI are issued.

13. Time frame for convergence to IFRS commences on 1-4-2010.

14. The first reporting date as per IFRS is 31-3-2011.

15. The first phase of conversion begins in April 2011.

16. The enterprises having net worth in excess of ` 100 crores are small enterprises.

17. The enterprises having investment in plant & marchinery not exceeding ` 5 crores are small

enterprises.

18. AS per IAS Financial statements care presented at fair value.

19. AS per IFRS, financial statements are presented at historical cost.

20. Fair value represent average value.

21. Cash flow statement is not included in financial statements as per IFRS.

22. Current assets are expected to realize in 24 months.

23. Building is a biological assets.

24. Living animal is a biological asset.

25. Share premium is a part of equity.

26. Expenses increase the economic benefits.

27. Incomes decrease the economic benefits

[Ans. 1. False, 2. True, 3. True , 4. False, 5. True, 6. True, 7. True, 8. True, 9. False, 10. False,

11. True, 12. True, 13. True, 14. False, 15. True, 16. False, 17. True, 18. False, 19. False, 20. False,

21. False, 22. False, 23. False, 24. True, 25. True, 26. False, 27. False.]

DOUBLE-ENTRY BOOKKEEPING SYSTEM

A double-entry bookkeeping system is a set of rules for recording financial information in a

financial accounting system in which every transaction or event changes at least two different nominal

ledger accounts.

The name derives from the fact that financial information used to be recorded using pen and ink

in paper books — hence "bookkeeping" (whereas now it's recorded mainly in computer systems) and

that these books were called journals and ledgers (hence nominal ledger, etc.) — and that each

transaction was recorded twice (hence "double-entry"), with the two transactions being called a

"debit" and a "credit".

It was first codified in the 15

century by Luca Pacioli. In deciding which account has to be

debited and which account has to be credited, the golden rules of accounting are used. In modern

accounting, this is done using debits and credits within the accounting equation: Equity = Assets –

Liabilities. The accounting equation serves as an error detection tool. If at any point the sum of debits

does not equal the corresponding sum of credits, an error has occurred. It follows that the sum of

debits and the sum of the credits must be equal in value.

Double-entry bookkeeping is not a guarantee that no errors have been made — for example, the

wrong ledger account may have been debited or credited, or the entries completely reversed.

ACCOUNTING ENTRIES

The double-entry accounting system records financial transactions in relation to asset, liability,

income or expense related to it through accounting entries. Any accounting entry in the double-entry

accounting system will result in the recording of equal debit and credit amounts; that is, debits must

equal credits. If the accounting entries are recorded without error, at any point in time the aggregate

balance of all accounts having positive balances will be equal to the aggregate balance of all accounts

having negative balances. The double-entry bookkeeping system ensures that the financial transaction

has equal and opposite effects in at least two different accounts. Accounting entries use terms such as

debit and credit to avoid confusion regarding the opposite effect of the accounting entry, e.g., if an

accounting entry debits a particular account, the opposite account will be credited and vice versa. The

rules for formulating accounting entries are known as "Golden Rules of Accounting". The accounting

entries are recorded in the "Books of Accounts". Regardless of which accounts and how many are

impacted by a given transaction, the fundamental accounting equation A = L + OE will hold.

CHAPTER

Accounting Procedure

86 Introduction to Financial Accounting

APPROACHES

There are two different approaches to the double-entry system of bookkeeping. They are

Traditional Approach and Accounting Equation Approach. Irrespective of the two approaches, the

effect on the books of accounts remain the same.

Traditional Approach

This approach is also called as the British Approach. Recording of business transactions under

this method are formed on the basis of the existence of two aspects (debit and credit) in each of the

transactions. Under the traditional approach, the transactions are entered in the books of accounts by

following the golden rules of accounting. Under traditional approach, the accounts are classified

based on their nature as real, personal and nominal accounts. After classifying the accounts, the

following golden rules of accounting are applied to record the financial transaction:

1. Personal Account: Debit the receiver and credit the giver.

Real

Account:

Debit what comes in and credit what goes out.

Nominal

Account:

Debit all expenses and losses and credit all incomes and gains.

Accounting Equation Approach

This approach is also called as the American Approach. Under this approach, transactions are

recorded based on the accounting equation, i.e., Assets = Liabilities + Capital. The accounting

quation is a statement of equality between the debits and the credits. The rules of debit and credit

depend on the nature of an account. For this purpose of accounting equation approach, all the accounts

are classified into the following five types based on periodicity of flow as: Assets Accounts, Capital

Account, Liabilities Accounts, Revenues or Incomes Accounts and Expenses or Losses Accounts.

If there is an increase or decrease in one account, there will be equal decrease or increase in

another account. There may be equal increases to both accounts, depending on what kind of accounts

they are. There may also be equal decreases to both accounts. Accordingly, the following rules of

debit and credit in respect of the various categories of accounts can be obtained. The rules may be

summarized as below:

1. Assets Accounts: Debit increases in assets and credit decreases in assets.

Capital

Accounts:

Credit increases in capital and debit decreases in capital.

Liabilities

Accounts:

Credit increases in liabilities and debit decreases in liabilities.

Revenues

Incomes

Accounts:

Credit

increases

incomes

and

gains

and

debit

decreases

in incomes and gains.

Expenses

Losses

Accounts:

Debit

increases

expenses

and

losses

and

credit

decreases

in expenses and losses.

Illustration 1

Classify the following accounts according to Traditional and Modern approach:

1. Capital a/c, 2. Drawings a/c, 3. Building purchased, 4. Purchases account, 5. Sales account,

6. Carriage inward, 7. Carriage outward, 8. Cash received, 9. Cash paid, 10. Interest paid, 11. Interest

received, 12. Commission paid, 13. Commission received, 14. Discount allowed, 15. Conveyance

charges, 16. Sales promotion expenses, 17. Entertainment expenses, 18. Subscription paid,

19. Subscription received, 20. Light, power and electricity, 21. Telephone, postage and telegram,

22. Repairs incurred, 23. Insurance premium paid, 24. Bad debts written off, 25. Bad debts recovered,

26. Discount received, 27. Postage and stationery purchased, 28. F&F purchased, 29. Bank a/c,

Accounting Procedure 87

30. Wages and salaries paid, 31. Travelling expenses, 32. Current a/c of the partner, 33. Loan a/c of a

partner, 34. Sales return, 35. Bank overdraft a/c, 36. Loan a/c of the partner, 37. O/s salaries a/c,

38. Prepaid rent a/c, 39. Interest accrued a/c, 40. Interest received in advance.

Solution

According to Traditional Approach:

Personal a/c: 1, 2, 29, 32, 33, 35, 37, 38, 39, 40

Real a/c: 3, 8, 9, 28

Nominal a/c: 4, 5, 6, 7, 10, 11, 12, 13, 14, 15, 16, 17, 18, 19, 20, 21, 22, 23, 24, 25, 26, 27, 30,

31, 34, 36

According to Accounting Equation or Modern Approach:

Asset a/c: 3, 8, 9, 28, 29, 38, 39

Liabilities a/c: 33, 35, 37, 40

Capital a/c: 1, 2, 32

Revenue a/c: 5, 11, 13, 19, 25, 26, 34

Expenses a/c: 4, 6, 7, 10, 12, 14, 15, 16, 17, 18, 20, 21, 22, 23, 24, 27, 30, 31, 36

ACCOUNTING TRIAL

Accounting Trial is a sequential order in which the accounting process flows. All transactions are

recorded first in a book called journal. The transactions are posted to the respective accounts,

maintained in a separate book called ledger. Later, all adjustments such as opening entries, closing

entries, adjusting entries are made in a book called journal proper and thereafter, the ledger balances

are summarized to form a trial balance. From trial balance, trading account, profit and loss account

and balance sheet are prepared.

Accounting trial is the process of:

88 Introduction to Financial Accounting

Transactions and Events: A transaction is a business activity involving transfer of money or

money's worth. It may be cash transaction or credit transaction. In cash transaction, cash flows

immediately whereas in credit transaction, cash will be paid or received at future date. Assets acquired

or sold, liabilities incurred or paid, expenses paid or payable, incomes received or receivable — are all

business transactions. But there are events which are neither cash nor credit transactions but it has an

impact on the financial position of a business. These events may include provision for bad debts,

provision for repairs, depreciation, taxation, transfer of profit towards reserve fund or sinking fund or

investment fluctuation fund, etc. Events happen as a result of internal policies or external needs. In

accounting, transactions and events have equal relevance and they must be recorded to arrive at the

financial results of the business concern.

Illustration 2

Analyze the following transactions according to traditional approach and modern approach:

(a) Subramanya started his business with cash

(b) Borrowed from Mahesh

(d) Purchased furniture from Mohan on credit

(e) Purchased goods for cash

(f) Purchased goods from Ram on credit

(g) Sold goods for cash

(h) Sold goods to Shyam on credit

(i) Received cash from Shyam

(j) Paid cash to Ram

(k) Deposited into bank

(l) Withdrew cash for personal use

(m) Withdrew from bank for office use

(n) Withdrew from bank for personal use

(o) Received a cheque from a customer, Shyam at 5 pm

(p) Deposited Shyam's cheque next day

(q) Bank intimated that Shyam's cheque was dishonoured

(r) Paid Ram by cheque

(s) Paid salary

(t) Paid rent by cheque

(u) Goods withdrawn for personal use

(v) Paid an advance to suppliers of goods

(w) Received an advance from customers

(x) Paid interest on loan

(y) Paid installment of loan

(z) Interest allowed by bank

Accounting Procedure 89

Solution

Analysis of Transaction under Traditional Approach

Sl.

No.

Account Involved Account Involved Account Involved Debit/

Credit

a Cash a/c

Capital a/c

Real

Personal

Cash is coming in

Subramanya is the giver

Debit

Credit

b Cash a/c

Loan from Mahesh

Real

Personal

Cash is coming in

Mahesh is the giver

Debit

Credit

c Furniture a/c

Cash a/c

Real

Furniture is coming in

Cash is going out

Debit

Credit

d Furniture a/c

Cash a/c

Real

Personal

Furniture is coming in

Cash is going out

Debit

Credit

e Purchase a/c

Cash a/c

Nominal

Real

Purchase is an expense

Cash is going out

Debit

Credit

f Purchase a/c

Ram's a/c

Nominal

Personal

Purchase is an expense

Ram is the giver

Debit

Credit

g Cash a/c

Sales a/c

Real

Nominal

Cash is coming in Sales

is a revenue

Debit

Credit

h Shyam's a/c

Sales a/c

Personal

Nominal

Shyam is the receiver

Sales is a revenue

Debit

Credit

i Cash a/c

Shyam's a/c

Personal

Nominal

Cash is coming in Shyam

is the giver

Debit

Credit

j Ram's a/c

Cash a/c

Personal

Real

Ram is the receiver

Cash is going out

Debit

Credit

k Bank a/c

Cash a/c

Personal

Real

Shyam is the receiver

Cash is going out

Debit

Credit

l Drawings a/c

Cash a/c

Personal

Real

Subramanya is the

receiver Cash is going

out

Debit

Credit

m Cash a/c

Bank a/c

Real

Personal

Cash is coming in

Bank is the giver

Debit

Credit

n Drawings a/c

Bank a/c

Personal

Subramanya is the

receiver Bank is the giver

Debit

Credit

o Cash a/c

Shyam's a/c

Real

Personal

Cash (Cheque) is coming

in Bank is the giver

Debit

Credit

p Bank a/c

Cash a/c

Personal

Real

Bank is the receiver Cash

(Cheque) is going out

Debit

Credit

q Shyam's a/c

Bank a/c

Personal

Shyam is the receiver

Bank is the giver

Debit

Credit

90 Introduction to Financial Accounting

r Ram's a/c

Bank a/c

Personal

Ram is the receiver Bank

is the giver

Debit

Credit

s Salary a/c

Cash a/c

Nominal

Real

Salary is an expense

Cash is going out

Debit

Credit

t Rent a/c

Bank a/c

Nominal

Personal

Rent is an expense Bank

is the giver

Debit

Credit

u Drawings a/c

Purchase a/c

Personal

Nominal

Subramanya is the

receiver Decrease in

stock

Debit

Credit

v Advance to suppliers

a/c

Cash a/c

Personal

Real

Suppliers are the receiver

Cash is going out

Debit

Credit

w Cash a/c

Advance from

customers a/c

Real

Personal

Cash is coming in

Customers are the giver

Debit

Credit

x Interest on loan a/c

Cash a/c

Nominal

Real

Interest is expense

Cash is going out

Debit

Credit

y Loan a/c

Cash a/c

Personal

Real

Lender is the receiver

Cash is going out

Debit

Credit

z Bank a/c

Bank interest a/c

Personal

Nominal

Bank is the receiver Bank

interest is an income

Debit

Credit

Accounting Equation

The preparation of balance sheet is the final step in accounting process. The accounting equation

indicates that the sources of funds should be equal to uses of funds. In other words, proprietor's equity

and liabilities to outsiders should be equal to assets.

Sources of Funds = Applications of funds OR

Owner's equity = Assets OR

Owner's equity + Outside liabilities = Assets

A = L + P

L = A – P

P = A – L

A – L – P = Zero, where L is liabilities, P is Proprietor' equity and A is Assets.

Steps Involved in Developing Accounting Equation

Ascertain

the

variables

(assets,

liabilities

capital)

equation

affected

the

transaction.

Find

out

the

effect

(in

terms

increase

decrease)

transaction

the

variables

the

equation.

3. Show the effect on the appropriate side of an equation.

Accounting Procedure 91

Illustration 3

Transaction 1: Started business with ` 1,00,000

Variable Affected Asset and Capital

Effect of the transaction Increase in assets and capital

Accounting equation Assets = Liabilities + Capital 1,00,000 = 0 + 1,00,000

Transaction 2: Purchased goods for cash ` 20,000.

Variable Affected Asset and Capital

Effect of the transaction Increase in assets (stock) and decrease in another asset (cash)

Accounting equation Assets = Liabilities + Capital – 20,000 + 20,000 = 0 + 0

Transaction 3: Sold goods costing ` 10,000 for cash ` 12,000.

Variable Affected Asset and Capital

Effect of the transaction Increase in assets (cash) and decrease in another asset (stock)

and increase in capital

Accounting equation Assets = Liabilities + Capital – Stock + Cash – 10,000 +

12,000 = 0 + 2,000

Illustration 4

Show what accounts are affected in the following transactions. Also show the accounting

equation for the transactions.

1. Madan commenced business with cash

70,000

2. Purchased goods on credit

14,000

3. Withdrew for private use

3,000

4. Goods purchased for cash

12,000

5. Paid wages

5,000

6. Paid to creditors

10,000

7. Sold goods on credit (cost price

18,000)

22,000

8. Sold goods for cash (Cost price

3,000)

6,000

9. Purchased furniture for cash

5,000

10. Received from debtors

11,000

92 Introduction to Financial Accounting

Solution

Analysis of Transaction under Traditional Approach

Transaction

No.

Accounts affected in the books

of the business

Account to be debited and account to be credited

1 Capital account and cash account Cash account being real account is debited and

Capital account being personal account is credited

2 Goods account and creditors account Goods account being real account is debited and

creditors account being personal account is credited

3 Personal drawings account and cash

account

Drawings account being personal account is debited

and cash account being real account is credited

4 Goods account and cash account Cash account being real account is debited and cash

account being real account is credited

5 Wages account and cash account Wages account being nominal account is debited

and cash account being real account is credited

6 Cash account and creditors account Creditors account being personal account is debited

and cash account being real account is credited

7 Goods account, Debtors account and

profit account

Debtors account being personal account is debited,

profit transferred to capital account being personal

account is credited and goods account being real

account is also credited

8 Furniture account and Cash account Furniture account being real account is debited and

cash account being real account is credited

9 Cash account and debtors account Cash account being real account is debited and

debtors account being personal account is credited

Accounting Equations for the Transactions

Trans-

action

No.

Assets = Liabilities + Owner’s Equity

Cash (+) Goods (+) Debtors (+) Furniture

(+)

Creditors

(+)

Madan’s

Capital

01 70,000 7,000

02 14,000 14,000

03 –3,000 –3,000

04 –12,000 +12,000

05 –5,000 –5,000

06 –10,000 –10,000

07 –18,000 22,000 +4,000

08 +6,000 –3,000 +3,000

09 –5,000 5,000

Accounting Procedure 93

10 +11,000 –11,000

End

equat-

ion

52,000+ 5,000+ 11,000+ 5,000+ 4,000+ 69,000

=73,000 =73,000

SUBSIDIARY BOOKS

Journal is a book of original entry and only one journal is maintained if the business is very small

in size and the transactions are limited. However, if the transactions are multifarious, then subsidiary

books which are known as books of original entry are prepared. The types of subsidiary books include:

(a) Purchase Book: To record all credit purchases of goods only.

(b)

Sales

Book:

To record all credit sales of goods only.

(c)

Purchase

Return

Book:

record

goods

returned

suppliers

out

credit

purchase.

(d)

Sales

Return

Book:

To record goods returned by customers out of credit sales of goods.

(e)

Cash

Book:

record

all

cash

transactions

only.

(f)

Analytical

Petty

Cash

Book:

To record petty payments.

(g)

Bills

Receivable

Book:

record

all

bills

exchange

which

are

received

from

debtors.

(h)

Bills

Payable

Book:

To record all bills of exchange accepted and given to creditors.

(i)

Journal

Proper:

used

record

only

those

business

transactions

which

cannot

entered

any

above

eight

books.

INTRODUCTION/ORIGIN OF SUBSIDIARY BOOK

In earlier stage (times), businessmen used only one Journal for recording all the business

transactions. ‘Journal’ as a book of accounts was convenient because the volume of business was

small and the number of transactions are very few. But with the growth of business, the number of

transactions increased & need was felt for better method of recording transactions. If all these business

transactions recorded in one & the same journal, the journal would be bulky. Moreover, it is

impossible for many clerks to work on the same journal at one & the same time. Under such situation,

it becomes necessary to divide the whole Journal into several subsidiary journals so that work can be

assigned to many at one and the same time. In each separate journal, one particular class of business

transactions is recorded.

‘Journal’ & ‘Subsidiary books’ are the books of original entry or books of prime entry. In a small

business, transactions are few & therefore, only one book is maintained i.e. Journal. On the other hand

in a big business, number of transactions are large & therefore one book is not enough to record all the

transactions & therefore subsidiary books maintained.

94 Introduction to Financial Accounting

General Journal

(Journal)

1. Small scale operation

2. Few trasactions

3. Transactions not repetitive in

nature

4. Engaged in providing

services

E.g. Tax consultant, Legal

consultant, Tutorial classes

etc.

Special Journal

(Subsidiary books)

1. Large scale operation

2. Daily trasactions are large in

number

3. Transactions are repetitive in

nature

4. Engaged in buying and selling

goods

E.g. Manufacturers,

Wholesalers, Retailers, etc.

Types of Journal

Needs of Subsidiary Books

The need of subsidiary books is as follows:

1. Division of work:

Since

Journal

divided

into

number

books,

facilitates

division

work among clerks, it avoids overburdening clerks.

Specialization:

When

person

assigned

same

type

work

wil

lead

specialization

and increased efficiency.

Time

saving:

Since

the

work

and

responsibility

divided

among

number

people,

various accounting processes can be undertaken simultaneously which helps in saving time.

Ready

information:

When

separate

books

are

kept

for

each

type

transaction,

the

information relating to each transaction is readily available.

Effective

internal

audit:

Subsidiary

books,

due

’

effective

design,

helps

achieving

effective internal audit or check.

MEANING

Subsidiary books are nothing but sub-division of journal. A subsidiary book is a divided part of

journal meant for recording specific types of business transactions. Sub-divided books (journal) on the

basis of nature of transactions like sales, purchases etc. are called subsidiary books.

When a journal is divided into many sub-parts, each of those sub-parts is called as subsidiary

books. Subsidiary books are also known as the books of original entry or prime entry because

transactions are first recorded in Subsidiary books and then posted to the ledger.

Types of Subsidiary Books

In order to meet the requirement of modern business the original journal is divided into the

following.

1. Purchase Journal (Book)

2. Sales Journal (Book)

3. Purchase Return Journal (Book)

Accounting Procedure 95

Return Outward Journal (Book)

4. Sales return Journal (Book)

Return Inward Journal (Book)

5. Cash Journal (Book)

6. Bills receivable Journal (Book)

7. Bills Payable Journal (Book)

8. Journal Proper

Advantages of Subsidiary Books

1. Many clerks can be employed at one & the same time in writing different Journal.

2. It saves time & energy as work is reduced.

3. It helps to have internal check more effectively.

makes

the

work

simple

therefore

all

the

persons

appointed

need

not

with

high

qualifications.

5. Each subsidiary book becomes handy. Therefore it can be carried to any place at any time.

6. The transactions are grouped & classified, which helps in proper analysis.

7. It facilitates easy reference.

details

business

transactions

can

recorded

subsidiary

books

this

not

possible in the Journal.

9. The ledger clerk can do ledger posting at his convenience.

10. Two/Three auditors can simultaneously audit the records.

Bills

Receivable

Book

Bills Payable

Book

Cash

Book

Petty Cash

Book

Cash/Bank

transaction

Business Transactions

Credit

transaction

Bills received

& accepted

Residuary or

Other

Journal

Proper

Purchase

Book

Sales

Book

Sales

Return Book

Purchase

Return Book

96 Introduction to Financial Accounting

Subsidiary Books Source Document

Basis of writing

the Subsidiary Books OR

Documentory Evidence

Nature of business

Transaction

Category of Business

Transaction Recorded

1. Purchase Book Inward Invoice/bill/Credit memo Credit Purchase of goods only

2. Sales Book Outward Invoice/bill/Credit memo Credit Sales of goods only

3. Purchase Return Book

(Return Outward book)

Debit Note Return of goods purchased on

credit

4. Sales Return Book

(Return Inward Book)

Credit Note Return of goods sold on credit

5. Cash Book Receipts issued, receipts received,

Cash memos issued, Cash memos

received, Vouchers, Pay-in-slips,

cheques, Pass Book, Advice &

Statement received from Bank

All Cash & Bank transaction

6. Bills receivable Book

(not in syllabus)

All bills received by us. OR

Duly accepted bill received from

Customers (Debtors/Drawee)

All bills received by us OR

Bills accepted by customers

7. Bills Payable Book (not

in syllabus)

All bills accepted by us. OR

Duly accepted bill sent to

suppliers (Sellers/Creditors/

Drawer)

All bills accepted by us OR

Bill of suppliers accepted by

8. Journal proper Depends on the type of transaction All the other transactions

which cannot be entered in the

above subsidiary book.

Business Transactions

Cash/Bank

transaction

1.Cash Book

2. Petty Cash Book

Credit

transaction

Other OR

residuary

Purchase Journal

1. Purchase Book

2. Purchase Return Book

3. Bills payable Book

Sales Journal

1. Sales Book

2. Sales Return Book

3. Bills Receivable Book

Accounting Procedure 97

GOODS JOURNAL

It is divided in to (i) Purchase Book (ii) Sales Book (iii) Purchase Return Book & (iv) Sales

Return Book. It is also known as proper subsidiary book. To record a transaction in the proper

subsidiary books the main conditions are.

1. It should be a credit transactions.

should

transaction

goods.

If only one condition is satisfied, then that transaction can not be entered in Goods Journal.

Both the conditions should be satisfied to enter a transaction in the proper subsidiary books.

Example:

1. Goods sold to Mahesh & cash received (Here it is a goods transaction; but it is not a credit

transaction)

Purchased

Plant

Machinery

from

Kamesh

credit

(This

credit

transaction,

but

not relating to goods)

Furniture

sold

Haresh

cash

basis.

(It

neither

credit

transaction

nor

relating

goods)

1. Purchase Book

This is the book of prime entry which records all transactions of credit purchases of goods.

In this book, all the goods purchased on credit are recorded. Furniture or Machinery purchases on

credit or goods purchase for cash etc. are not entered in the purchase book.

This book is maintained mainly to record credit purchases of goods in business. A transaction to

find place in purchase book must comply two necessary condition, (i) It should be credit transactions,

(ii) it must involve purchase of “Goods” only. Cash purchases of goods are recorded in the Cash

Book. Credit purchase of assets are recorded in the Journal proper.

A purchase Book is also known as purchase journal, Invoice book, Purchase Register, Bought

Book, Purchase Day Book etc.

Basis of Writing a Purchase Book

Invoice or Bill or credit memo is the basis of writing a purchase book.

An Invoice is a statement sent by the seller to the buyer giving a full description of the goods

supplied. An Invoice or Bill prepared by the supplier of the goods. Seller prepared an invoice normally

in duplicate or triplicate.

From seller’s point of view, this invoice is an outward invoice, & from buyer’s point of view the

same invoice is an inward invoice. Entries are recorded in the Purchase Book on the basis of Inward

invoice & entries are recorded in the Sales Book on the basis of outward invoice.

When the buyer receives such an invoice, he has to verify whether the goods are received as per

the details given in the invoice in regard to quantity, quality rates etc. The buyer can verify

thecalculation & terms & conditions of the purchase. For the seller invoice is a proof for goods sold

while for the buyer invoice is a proof for goods purchased.

The amount of trade discount is deducted from the invoice itself. Therefore a trade discount does

not appear in the purchase book. Only the net value is recorded in the purchase Book.

98 Introduction to Financial Accounting

Rulling/Format/Proforma of Purchase Book

Date Name of Suppliers Particulars L.F. Inward

Invoice No.

Note:

1. The columns of the purchase book may differ according to necessity.

2. L.F. column : Purchase book is a book of original entry therefore as per regular practice the page number

of ledger on which supplier’s Account appears is entered in this column.

3. Details column : Trade discount, unit, rate etc. are written in the column. Generally, the value of goods

purchased (Gross price) & amount of trade discount are written in this column.

Posting of the Purchase book

As and when a trasaction is entered in the Purchase Book on the same day it is credited to the

Personal Accounts of Suppliers with respective amount of Purchase as ‘By Purchase’. But no posting

is immediately done in Purchase Account in ledger. At the end of the month or at a certain period

“Purchase Account” in the ledger is debited with the total amount of Purchase Book as “To Sundries

as Per Purchase Book.” In other words, Supplier’s A/c will be credited with the amount of purchase

on the same day of transaction. The corresponding debit to Purchase Account will not be done for

individual transaction of purchase on same day, but the total purchase of entire month shall be posted

to Purchase Account at the end of the month or a certain period so specified.

Q. 1. Recorded the following transactions in the purchase Book of Mr. Kartik & post them

in the ledger.

2001

Jan.

Bought

goods

from

Ramnik

Co.

800.

Purchased

one

Fan

for

office

use

from

Srinath

Traders

200

Bhavesh

Co.

invoiced

goods

000

Cash

purchases

300.

Rajesh

sold

goods

(

500

Less:

10%

T.D.)

350.

Purchase

goods

from

Jayesh

400

exchange

furniture

the

same

amount.

Purchase

goods

from

Yogesh

Co.

600.

Solution

In the Books of Mr. Kartik

Date Name of Suppliers L.F. Inward Invoice No. `

2001 Jan

1 Ramnik & Co. 800

8 Bhavesh & Co 1,000

11 Rajesh 1,350

13 Yogesh 600

Total 3750

Accounting Procedure 99

Note:

1. No entry in P.B for 2 Jan 2001 Entry for this transaction comes in J.P. as follows.

Fan A/c Dr. 1200

Srinath

traders

A/c

1200

2. No entry P.B. For 10

Jan 2001 Entry for this transaction comes in CB as follows.

Perches

A/c

Dr.

300

To Cash A/c 300

Entry

for

Jan

2001

Entry

for

this

transaction

comes

J.P

follows.

Parches A/c Dr. 1400

furniture

A/c

1400

Dr. Ramnik & Co’s A/c Cr.

Date Particulars JF ` Date Particulars JF `

2001

Jan 1 By Purchase A/c 800

Dr. Bhavesh & Co’s A/c Cr.

Date Particulars JF ` Date Particulars JF `

2001

Jan 8 By Purchase A/c 1,000

Dr. Rajesh & Co’s A/c Cr.

Date Particulars JF

2001

Jan 11 By Purchase A/c 1,350

Dr. Yogesh & Co’s A/c Cr.

Date Particulars JF

2001

Jan 13 By Purchase A/c 600

Dr. Purchase A/c Cr.

Date Particulars JF

2001 2001

Jan 13 To sundries as

purchase book

3750 Jan 13

2. Sales Book

This is the book of prime entry which records all transaction of credit sales of goods.

In this book, all the goods sold on Credit are recorded. Sale of old machinery on credit or goods

sold on cash basis etc are not entered (recorded) in the sales Book. As similar to Purchase Book, a

separate Sales book is maintained to record all credit sales of goods. A transaction to find place in

100 Introduction to Financial Accounting

Sales Book must comply with two conditions, viz. (i) The trasaction must be a credit transaction. (ii) It

must involve sale of “goods” kept in business for resale purpose. Cash sales of goods are recorded in

the Cash Book, while Credit Sale of assets are recorded in the Journal Proper.

A sales Book is also known as Sales Journal, Sales Register, Sales Day Book, sold Book etc.

Basis of writing a Sales Book

Out ward invoice is the base for writing of sales book.

An Invoice is prepared when the goods are sold. Such an invoice is known as the outward

invoice for seller of goods.

The original copy of an invoice is given to the buyer who purchases goods on credit & the carbon

copy is kept by seller for reference.

Ruling/Format/Proforma of Sales Book

Date Name of Customers or Particulars L.F. Outward

Invoice

No.

Note: The columns of Sales Book may differ according to necessity.

Posting of the Sales Book

As and when a transaction is entered in the Sales Book, on the same day it is debited to the

Personal Accouts of customers with respective amount of sale as ‘To Sales’. But no posting is

immediately done in the ‘Sales A/c’ in ledger. At the end of the month or at a certain period ‘Sales

A/c’ in the ledger is credited with the total amount of Sales Book as ‘To Sundries as per Sales Book’,

In other words, customer’s A/c will be debited with the amount of Sales on the same day of

transaction. The corresponding credit to Sales Account will not be done for individual transaction of

sale on the same day, but the total sales of entire month shall be posted to Sales Account at end of the

month or a certain period so specified.

Q. 2. Record the following transactions in the Sales Book of Mr. Rajput & post them to ledger

accounts.

1999

Sept.

1 Sold goods to Rajesh Bros. 1,500

5 Goods sold to Prakash Stores on cash basis 1,000

8 Supplied Goods to Pooja & Co. 1,200

12 Sold old typewrite to ABC Co. Ltd. 2,000

15 Invoiced goods to Pratap & Co. 1,800

18 Machinery sold for Cash to Girish 2,000

25 Manish purchased goods from us. 900

Accounting Procedure 101

Solution

Sales Book of Mr. Rajput

Date Name of Customers JF Out word No. `

1999

Sept 1 Rajesh & Co. – 1,500

3 Pooja & Co. – 1,800

15 Pratap & Co. – 1,800

25 Manish – 900

Total 5,400

Note:

entry

SB.

for

Sept.

1999

Entry

for

this

transaction

comes

follows.

Entry

for

Sept,

1999

Entry

for

this

transaction

comes

follows.

Entry

for

Sept,

1999

Entry

for

this

transaction

comes

follows.

Dr. Rajesh A/c Cr.

Date Particulars JF

1999 1999

Sept. 1 To Sales A/c 1,500 Sept.

Dr. Pooja & Co’s A/c Cr.

Date Particulars JF

1999 1999

Sept. 3 To Sales A/c 1,200 Sept.

Dr. Pratap & Co’s A/c Cr.

Date Particulars JF

1999 1999

Sept.

To Sales A/c 1,800 Sept.

Dr. Manish A/c Cr.

Date Particulars JF

1999 1999

Sept.

To Sales A/c 900 Sept.

Dr. Sales A/c Cr.

Date Particulars JF ` Date Particulars JF `

1999

Sept. 30 By Sundry as sales

book

5,400

102 Introduction to Financial Accounting

Q. 3. Prepare Purchase Book & Sales Book of Mr. Dilwala from the following transaction.

2001

July

Sold

Mr.

Shashtri

goods

4,000.

5 Bought from Mr. Bhavanji goods of

3,000.

Purchased

Fan

credit

from

Usha

Fan

Co.

for

1,200.

12 Mr. Kasyap purchased from us goods worth of

6,000.

Mr.

Mansukh

sold

goods

4,000.

18 Placed an order with Ramesh for goods of

2,500.

Mr.

Yogesh

bought

goods

from

worth

5,000

less

10%

T.D.

24 Ramesh executed our order & goods received along with the invoice No. 402.

Sold

goods

Mr.

Shyam

10,000

discount.

26 Sold goods to Mr. Kartik of

2,500 for which cheque is received.

Purchase

goods

from

Raj

3,000.

Solution

In the books of Mr. Dilwala.

Purchase Book

Date Name of Supplier L.F. Ilw Inv. No. `

2001

July 5 Bhavanji – 3,000

16 Munsukh – 4,000

24 Ramesh 402 2,500

30 Raj – 3,000

Total 12,500

Sale A/c

Date Name of Customber L.F. Olw Inv. No. `

2001

July 1 Shastri – 4000

12 Kasyap – 6000

21 Yogesh – 4500

25 Shyam – 5500

24,000

Note:

1. No entry in PB. for 10th July 01 entry for the this transaction comes in J.P as follows:

Fan A/c Dr. 1200

To Usha Fan A/c 1200

2. No entry in books of A/c for 18th July 01because it is not a transaction.

3. No Entry is SB. For 26th July 01 Entry for this transaction comes in CB as follows:

Accounting Procedure 103

Bank A/c Dr. 2500

To Sales A/c 2500

In the Books of Mr. Dilwala

Dr. Bhavanjis A/c Cr.

Date Particulars JF

2001

July 5 By Purchase A/c 3,000

Dr. Purchase A/c Cr.

Date Particulars JF ` Date Particulars JF `

2001

July

To Sundry as per A/c 12,500

Dr. Yogesh A/c Cr.

Date Particulars JF ` Date Particulars JF `

2001

July 21 Top sale A/c 4,000

Dr. Sales A/c Cr.

Date Particulars JF ` Date Particulars JF `

2001 By Supalries 2,400

July 31 as per S.A.

Dr. Shyam A/c Cr.

Date Particulars JF ` Date Particulars JF `

2001

July 25 To sales A/c 9,500

Dr. Rajs A/c Cr.

Date Particulars JF ` Date Particulars JF `

2001

July 30 By Purchase A/c 3,000

Dr. Mansukh A/c Cr.

Date Particulars JF ` Date Particulars JF `

2001

July 16 By Purchase A/c 4,000

Dr. Ramesh A/c Cr.

Date Particulars JF ` Date Particulars JF `

2001

104 Introduction to Financial Accounting

July 24 By Purchase A/c 2500

Dr. Shastries A/c Cr.

Date Particulars JF ` Date Particulars JF `

2001

July 1 To sales A/c 4,000

3. Purchase Return Book

This is the book of prime entry which records all returns of goods purchased on credit.

In this book, all the transactions of return of goods purchased on credit are recorded. A

transaction of a return of assets will not comes in the purchase Return Book.

A Purchase return Book is also known as Purchase Return Journal or Return Outward Book.

The goods purchased may be returned for one or two of the following reasons:

1. If the goods supplied are not as per the sample/order.

2. If the goods are in excess of the requirements.

3. If the goods are damaged in transit.

4. If the supply of goods is delayed.

5. If the goods are of different designs & colour.

6. If the goods supplied are of inferior quantity.

Basis of writing a Purchase Return Book

Debit Note is the base for recording a transaction in purchase Return Book.

A debit note is a statement sent by buyer to the supplier (seller) stating the full details of the

goods returned. A debit note is sent to the supplier at the time of return of goods or after the goods

returned. Debit note intimates (informs) the supplier (seller) that his account has been debited by the

amount of goods returned to him.

Sometimes, goods are received correctly as per the Invoice but the Invoice is over charged.

Therefore, the Invoice shows a higher amount than what it should be in such a case, the debit note is

sent without return of goods. On receiving the debit note the supplier (seller) also sends a credit note

to us.

Ruling/Format/Proforma of Purchase Return Book

Date Name of Suppliers or Particulars L.F. Debit Note No. `

Note: The columns of Purchase Return Book may differ according to necessity.

Posting of the Purchase Return Book

Debit the personal account of the suppliers with the respective amount of the purchase return as

‘To Purchase Return A/c’

At the end of the month credit the Purchase Return A/c in the ledger with the total of the

purchase return book as ‘By sundries as per Purchase Return Book’.

Accounting Procedure 105

Q. 4. Record the following transactions in Purchase Return Book of Jalpa & Company and

post them to ledger.

2002

Feb.

1. Returned goods to Reema & Co. of

700.

4. M/S Keshav Stores received goods returned by us

500.

10.

Machine

costing

4,000

Returned

M/s

Seema

Engineering

Work

because

not

working well.

18. Returned goods to Kanta Stores as they were defective of

200.

25. Sent debit note to Reshma & Co. of

400 for goods returned.

28. Returned goods to Janata stores of

300 as it was defective and received cash for it.

Solution

In the books of Jalpa & Co.

Date Name of Supplier L.F. Dr. Note No. `

2002

Fab 1 Reema & Com. – 700

4 Keshav Stores – 500

15 Kanta Stares – 200

25 Reshma & Co. – 400

Total 1,800

Note:

1. No entry in PRB – for 10th Feb. 2002 entry for this transaction comes in J.P.

Seema Eng workers 4,000

To Machinery 4,000

2. No entry in PRB for 28th Feb. 2002 Entry for this transactions in CB is as follows:

Cash A/c Dr. 300

To PR A/c 300

Dr. Reema & Co. A/c Cr.

Date Particulars JF ` Date Particulars JF `

2002 2002

Feb 1 To P/RA/c 500 Feb

Dr. Keshav Stores A/c Cr.

Date Particulars JF ` Date Particulars JF `

2002

Feb 4 To P/R A/c 500

106 Introduction to Financial Accounting

Dr. Kantas A/c Cr.

Date Particulars JF ` Date Particulars JF `

2002

Feb 18 To P/R A/c 200

Dr. Reshma & Co A/c Cr.

Date Particulars JF ` Date Particulars JF `

2002

Feb 25 To P/R A/c 400

Dr. P/R A/c Cr.

Date Particulars JF ` Date Particulars JF `

2002

Feb 22 By Sundry as per

sales A/c

1,800

4. Sales Return Book

This is the book of prime entry which records all returns of goods sold on credit.

In this book, all the transactions of returns of goods sold on credit are recorded. A transaction of

return of assets will not come in the Sales Return Book.

Sales Return means goods sold by a supplier are returned by a Customer.

A Sales Return Book is also known as Sales Return Journal or Return Inward Book.

Goods sold to customers may be returned by them if the goods supplied to them are not up to the

sample or of inferior quality or damaged etc.

Basis of writing a Sales Return Book

Credit Note is the base for recording the transaction in Sales Return Book.

A Credit Note is a statement sent by supplier (seller) to the buyer stating the full details of goods

returned by buyer. A Credit Note is sent to the buyer (Customer) when supplier (seller) received goods

returned by the buyer. Credit note intimates (informs) the buyer (customer) that his account has been

credited by the amount of goods returned by him.

Credit Note is also sent for correcting the mistake like over charging in the invoice. Credit note

gives the details of goods returned by a buyer (customer) or over charging of Invoice. From the credit

note, buyer’s (customer’s) Account will be Credited.

Ruling/Format/Proforma of Sales Return Book

Date Name of Customers or Particulars L.F. Debit Note

No.

Note: The columns of the Sales Return Book may differ according to necessity.

Accounting Procedure 107

Posting of the Sales Return Book

At the end of the month debit the Sales Return A/c in the ledger with the total of the Sales Return

Book as ‘To Sundries as per Sales Return Book’.

Credit the personal account of the customers with the respective amount of the Sales Return as

‘By Sales Return A/c’.

Q.5. Record the following transactions in the Sales Return Book & post them to ledger.

2014

March

Bajirao

returned

goods

200.

5 Goods returned to us by Kamraj of

300 and paid cash for it.

Mayank

returned

goods

250.

16 Goods sold to Rajesh is defective therefore returned from Rajesh goods of

400.

Sent

credit

note

Rajeev

450

for

goods

returned

him.

30 Received Debit note from Adesh of

500 for goods returned by him.

Solution

Date Name of Customber L.F. Cr. Note No. Amount

2002

March 1 Bajirao – 200

12 Mayank – 250

16 Rajesh – 400

25 Rajeev – 450

30 Adesh – 500

Total 1,800

Note:

1. No entry in SRB 5th March 2000. Entry for this transaction comes in as follows:

S/R Dr. 300

To Cash A/c 300

Dr. Bajirao’s A/c Cr.

Date Particulars JF ` Date Particulars JF `

2002

March 1 By S/R A/c 200

Dr. Mayank’s A/c Cr.

Date Particulars JF ` Date Particulars JF `

2002

March 12 By S/R A/c 250

108 Introduction to Financial Accounting

Dr. Rajesh A/c Cr.

Date Particulars JF ` Date Particulars JF `

2002

March 16 By S/R A/c 400

Dr. Rajeev A/c Cr.

Date Particulars JF ` Date Particulars JF `

2002

March

By S/R A/c 450

Dr. Adesh A/c Cr.

Date Particulars JF ` Date Particulars JF `

2002

March

By S/R A/c 500

Dr. S/R A/c Cr.

Date Particulars JF ` Date Particulars JF `

2002

March 31 To Sandries per

S/R Book

1800

Q.6. Following is the transaction in the Book of A. Say in which subsidiary book (goods

journal) entry comes.

1. Goods sold to Mr. Z

(A) Sales Book.

2. Goods returned to Manish.

(A) Purchase Return Book.

3. Goods Purchased by Rakesh.

(A) Sales Book.

4. Goods returned by Balu which is unacceptable.

(A) No Entry.

5. Goods purchased from Mr. P.

(A) Purchase Book.

6. Furniture sold on credit to Imandar.

(A) No Entry.

7. Goods returned by Ram of

1,500.

(A) Sales Return Book.

8. Above goods sold to Mr. Raghunath at the loss of

200/- in the Invoice price.

(A) Sales Book (Amt.

1,300)

Accounting Procedure 109

9. Goods returned by Mr. Bhola.

(A) Sales Return Book.

10.

Goods

worth

800/-

returned

Mr.

Sherkhan

was

defective.

exchange

fresh

lot

goods received of the same value. Neither Debit Note prepared nor bill is issued for it.

(A) No Entry.

11. (a) Goods purchased from Badal worth of

3,000/-

(A) Purchase Book.

(b) Above goods sold to Mr. Sky at

4,000.

(A) Sales Book.

(A) Sales Returned Book (Amt.

2,000)

Purchase Returned Book (Amt.

1,500)

12. Mr. A, proprietor withdrawn goods for his personal use.

(A) No Entry.

13. Purchased goods worth

5,000 from Miss Bijali. Half the amount paid in cash.

(A) Purchase Book. (Amt.

2,500)

14. A Debit Note issued to Mr. K.

(A) Purchase Return Book

15. A Credit Note issued to Mr. M.

(A) Sales Return Book.

16. Goods sold by Rohan to us.

(A) Purchase Book.

17. Purchased stationery from Kamal.

(A) No Entry.

18. Goods sold to Sohan for cash.

(A) No Entry.

19.

Goods

costing

800

received

from

Tata

Co.

Ltd.

Free

sample,

the

type

goods

latest introduced by them.

(A) No Entry.

20. Goods purchased from Rahul for which cheque paid.

(A) No Entry.

21.

Mr.

proprietor

withdrawn

goods

for

his

personal

use

worth

2,000

for

which

invoice

prepared on his name.

(A) Sales Book.

22. A debit note received from Mr. D.

(A) Sales Return Book.

23. A Credit Note received from Mr. L.

(A) Purchase Return Book

110 Introduction to Financial Accounting

Problems for Self Assessment

Q.7. From the particulars given below prepare proper Subsidiary books of Shri Mulchand.

2014

May

1 Bought goods from Rasik ` 2,000 less 10% T.D. & 5% C.D. terms.

4 Sold goods to Laherchand of ` 1,000 less 10% T.D. & 2% C.D. terms.

5 Purchased goods from Laherchand of ` 1,500 at 5% T.D.

8 Vimal bought goods from us ` 800.

10 Returned goods to Laherchand ` 200 (gross).

12 Cash Sale of ` 500.

14 Rasik received goods returned by us ` 500.

15 Sold machinery for ` 5,000.

16 Bought goods worth ` 8,000 Less 5% T.D. & 2% C.D. from Bhushan Stores.

18 Invoiced goods worth ` 1,000 on 4% T. D. & 1% C.D. to Heena Ltd.

19 Returned goods to Bhushan Stores worth ` 1,000 (gross value) as they were

defective.

22 Returned goods to us of ` 100 (Gross value) by Heena Ltd. as they were not as per

sample.

24 Received an order for the supply of good ` 6,000 from Bharat & Co.

25 Placed a purchase order with Ratan & Sons for the supply of goods ` 8,000.

28 Despatched goods to Bharat & Co. as per order received on 24

May, 2014.

Q. 8. Record the following transactions in Sales Book, Purchase Book & Return Book of

Shri Tarachand For April, 2014.

1 Purchased goods of ` 7,000 from Sajeed as per his invoice No. 0425.

Sold

goods

Amit

Traders

for

3,500

per

Invoice

No.

202.

5 Sold goods to Sangam Bazar for

2,000 as per Invoice No. 203.

Purchased

goods

worth

5,000

from

Arihant

Co.

per

their

Invoice

No.

A-4052.

Sangam

Bazar

returned

goods

worth

500

for

which

they

were

given

Credit

Note

No. A-11.

Returned

goods

worth

500

Sajeed

issued

Debit

Note

No.

D-8.

12 Sold goods to Anmol Stores for

500 on 5% T.D. terms as per Invoice No. 204.

Anmol

Stores

returned

goods

worth

100

(gross)

being

defective.

Credit

Note

No.

A-12

issued

them.

Purchased

Furniture

worth

750

for

office

from

Star

Furniture

Mart,

per

their

Invoice No. 508.

Sold

goods

Narayan

General

Stores

for

1,000

per

Invoice

No.

205

purchased

from

them

goods

worth

200

per

their

Invoice

No.

99.

25 Sold goods worth

400 to Dev & Co. as per Invoice No. 206.

Sold

old

typewriter

Ashok

Bros.

for

1,000.

Accounting Procedure 111

Purchased

goods

worth

3,000

from

Patil

Stores

asked

them

deliver

these

goods

Akshay

Stores.

Patil

Stores

sent

their

invoice

No.

4252

our

sales

invoice No 207 for

3,500 was sent to Akshay Stores.

Q.9. From following instruction prepare Subsidiary books of goods for Nikunj Traders.

2014 July

Purchased

from

Patkar

Co.

goods

lumpsum

price

2,255,

Invoice

No.

XY42529.

4 Sold old machinery for

3,000 to Kartik works.

Returned

goods

Pankaj

Stores

800

(gross)

T.D.

was

allowed

10%

debit

note

No.108

received

from

him

while

our

Credit

Note

No.

AB708

given

for

the

same

amount.

The

goods

was

supplied

excess

than

ordered.

Goods

sold

Mr.

Manek

worth

10,000

15%

T.D.

C.D.,

cheque

received

from him.

Returned

goods

worth

600

Patkar

Co.

Debit

Note

No.

L304

sent

while

Credit

note

received

from

him

No.CD/202

for

the

Same

amount.

12 Goods sold by Keshavchandra & Co. to us of

10,000 at 10% T.D.

Sent

our

Invoice

Mayank

Traders

for

goods

supplied

(Quantity

dozens

0.45

size)

8,000

(net)

after

deducting

T.D.

20%

Sagar

Co.

supplied

goods

Catalogue

price

6,000

10%

T.D.

10%

C.D. if the payment will be made within one week.

Despatched

goods

worth

5,000

Mangal

Stores

per

their

order

which

pending

since

last

month.

20 Received an order from M/s Kanji Stores for goods worth

3,000.

Trade Discount

It is a reduction granted by a supplier from the list price of goods or services on business

consideration (such as quantity bought, trade practices etc). For prompt payment, cash discount is

allowed.

Example: If 5 gold coins are sold at the list price of ` 15,000 each subject to trade discount of

12%, the trade discount will be calculated as under:

5 Gold coins @ ` 15,000 75,000

Less: Trade discount @ 12% 9,000

Amount payable as per invoice 66,000

Cash Discount

It is the reduction granted by the supplier from the invoice price in consideration of immediate

payment or payment within a stipulated period.

Example: If 5 gold coins are sold at the list price of ` 15,000 each subject to trade discount of

12%, the invoice price after trade discount is ` 66,000. Cash discount terms are 2%, 30 days. This

denotes the buyer will get 2% cash discount if he makes payment within 30 days. The cash discount is

calculated as follows:

Amount payable as per invoice 66,000

Less: Cash discount @ 2% 1,320

Cash payable within 30 days 64,680

112 Introduction to Financial Accounting

Difference between Trade Discount and Cash Discount:

1. Trade discount is a reduction granted by a supplier from the list price on goods or services

business

considerations

such

quantity

bought,

trade

practices

etc.

while

cash

discount

reduction

granted

from

the

invoice

price

consideration

immediate

payment

within

stipulated

period.

Trade

discount

allowed

promote

the

sales

while

cash

discount

allowed

encourage

early or prompt payment.

Trade

discount

shown

the

way

deduction

the

invoice

itself.

Hence,

further

entry

required

the

books

accounts.

Cash

discount

shown

expense

profit

and

loss

account.

Trade

discount

may

vary

with

the

quantity

purchased

while

cash

discount

varies

with

the

period.

Illustration 5

From the following transactions, prepare the purchase book of Adithya Bros and post the

transactions recorded in the Purchase book to the Ledger:

Date Invoice No. Particulars

5.3.2014 442 Purchased on credit from Goyal Bros – 55 Polyester sarees @ ` 100

Less: Trade Discount @ 10%

8.3.2014 445 Purchased for cash from Greg Mac – 100 Orissa cotton sarees @ ` 200

15.3.2014 450 Purchased on credit from Adikari Mills – 10 Silk sarees @ 10%

Solution

Purchase Book

Date Purchase

Invoice No.

Name of the supplier L.F. Details `

5.3.2014 442 Goyal Bros

Less: Trade Discount @ 10%

5,500

500 4,950

8.3.2014 450 Adikari Mills

Less: Trade Discount @ 10%

25,000

2,500 22,500

Cash purchases from Greg Mac will be recorded in cash book.

Ledger of Adithya Bros

Dr. Goyal Bros a/c Cr.

Date Particulars L.F. ` Date Particulars L.F. `

5.3.2014 By Purchases a/c 4,950

Dr. Adikari Mills a/c Cr.

Date Particulars L.F. ` Date Particulars L.F. `

8.3.2014 By Purchases a/c 22,500

Accounting Procedure 113

Dr. Purchases a/c Cr.

Date Particulars L.F. ` Date Particulars L.F. `

31.3.2014 To Sundries as per

purchase book

27,450

Observe that in every case of credit purchase, the supplier's account is credited and goods

account is debited.

At the end of the day or week or month, the total of purchases is transferred to one ledger account

known as Purchases account in the ledger.

Illustration 6

From the following transactions, prepare the Sales Book of Adithya Bros and post the

transactions recorded in the Sales book to the Ledger:

Date Invoice No. Particulars

5.3.2014 442 Sold on credit from Goyal Bros – Polyester sarees @ ` 100

Less: Trade Discount @ 10%.

8.3.2014 450 Sold on credit from Adikari Mills – 10 silk sarees @ ` 2,500

Less: Trade Discount @ 10%.

Solution

Sales Book

Date Sales

Invoice No.

Name of the supplier L.F. Details `

5.3.2014 442 Goyal Bros

Less: Trade Discount @ 10%

5,500

500 4,950

8.3.2014 450 Adikari Mills

Less: Trade Discount @ 10%

25,000

2,500 22,500

Cash Sales from Greg Mac will be recorded in cash book.

Ledger of Adithya Bros

Dr. Goyal Bros a/c Cr.

Date Particulars L.F.

5.3.2014 To Sales a/c 4,950

Dr. Adikari Mills a/c Cr.

Date Particulars L.F. ` Date Particulars L.F. `

5.3.2014 To Sales a/c 22,500

114 Introduction to Financial Accounting

Dr. Sales a/c Cr.

Date Particulars L.F. ` Date Particulars L.F. `

5.3.2014 By Sundries as

per sales book

27,450

Example:

Book of Sham Sunder & Co.

Bills Receivable

No. of

the Bill

Date of

Receipt

From

Whom

Received

Acce-

ptor

Where

payable

Term

of the

Bill

Due

Date

L.F. ` Rema

-rks

1 04.7.14 04.70.4 Mr. X Delhi 3 mths 7.10.14 7,000

2 1.8.14 01.8.04 Mr. Y Noida 4 mths 4.12,14 9,000

3 9.9.14 09.9.04 Mr. A Agra 3 mths 12,12.1

12,000

4 10.9.14 10.9.04 Mr. B Delhi 4 mths 13.1.14 10,000

38,000

For every bill, the due date is calculated after adding three days of grace. The total of the bill

receivable is transferred to bills receivable account in the ledger. The bills receivable account shows

debit balance and the amount receivable against them is an asset.

Example:

Book of Sun Shine Co.

Bills Payable

No. of

the

Bill

Date of

Receipt

To Whom

Given

Dra-

wer

Payee Where

Paya-

ble

Due Date L.F.

Date

paym

-ent

Rema

-rks

1 7.6.2014 Ram &

Co.

Ram &

Co.

Agra 3 mths 10.9.2014 56,000

2 12.6.2014 Sunder Sunder Delhi 4 mths 15.10.2014 72,000

3 20.6.2014 KV. & Co. KV. &

Co.

Chennai 5 mths 23.11.2014 50,000

1,78,000

CASH BOOK

MEANING

A subsidiary book or book of original entry in which cash transactions as well as banking

transactions are recorded is known as cash book. Thus cash book is a Subsidiary Book or a book of

Accounting Procedure 115

original entry meant for the recording of all receipts & payments of cash. All cash transactions are

recorded in the cash book. Credit transactions are not recorded in cash book.

Cash book is a book of original entry in which only cash receipts and cash payments are recorded.

It is divided into two sides, ‘Receipt side’ and ‘Payment side’. When cash, cheque or draft is received,

the details are recorded on the left hand side which is known as Receipt side or Debit Side. When cash,

cheque or draft is issued, the details are recorded on the right hand side which is known as Payment

side or Credit Side. Cash book is a chronological record of all cash transactions. The cash book serves

the purpose of book of original entry and also represents cash account in ledger. In fact it is more of a

ledger than a journal. It is a journal since cash transactions are recorded in chronological manner. It is

a ledger since it constitutes a classified record of all cash transactions in the form of ledger with

narrations and helps in finding out cash balance at the end of a particular accounting period. Thus, it

can be said that cash book serves dual purpose of journal as well as ledger. Hence the cash book is

considered as a combination of journal & Ledger.

Utility of Cash Book

From the following points, we can see and understand the utility of Cash Book.

1. Avoid duplication of work:

When

Cash

Book

maintained,

there

need

draft

journal

entries

for

Cash

transactions

operate

cash

A/c

the

ledger.

This

avoids

Duplication of work.

2. Dual role: The Cash Book plays dual (double) role as a Journal (subsidiary book) as well as

a ledger.

3. To ascertain the cash balance: Businessman gets information of inflow and outflow of

cash from Cash Book.

4. Useful to all: Cash Book is useful to all types of business organisation.

5. Saves labour, time and money: Both, Cash transaction and Banking transactions are

recorded in Cash Book. Journal and ledger A/cs are not required for both the transactions.

Thus Cash Book Saves labour, time & money.

6. Cross checking and verification of correctness:

Cross

checking

and

verification

correctness of cash and Banking transactions are possible due to Cash Book.

Features of Cash Book

1. Cash Book is just similar to Cash A/c.

Receipt

cash

are

always

recorded

the

left

hand

side

i.e.

debit

side

cash

book

and

payment of cash are recorded on the right hand side i.e. credit side of Cash Book.

3. Cash transactions and banking transactions are recorded in Cash Book.

Totaling

and

balancing

cash

book

can

done

daily,

weekly,

fortnightly

monthly

find out (to know) cash and bank balance.

cash

Book

has

two

sides

left

hand

side

known

Receipt

side

and

Right

hand

side

known as payment side.

Types of Cash Book (Detail)

1. Single column cash book/Simple Cash book

Double

column

cash

book

(a) Cash & Discount columns

(b)

Cash

Bank

columns

116 Introduction to Financial Accounting

3. Triple column cash book having Cash, Bank & Discount columns

4. Petty Cash Book

Types of Cash Book (as per Govt. Text book)

Cash Book can be maintained in different ways depending on the need & nature of business

concerns. Following are the different types of cash book:

1. Single column Cash book/Simple Cash book (Cash column only)

Double

(Two)

column

cash

book

(Cash

Book

with

Cash

Bank

columns)

3. Petty Cash Book

SIMPLE CASH BOOK

Meaning

Simple cash book has one amount column on each of receipt side and payment side. It records

only cash receipts and payments. This cash book is suitable for traders operating on a very small scale.

The cash book is prepared to keep record of all cash transactions and find the cash balance at the end

of a particular accounting period.

Source documents for writing Simple cash book are as under:

1. Cash receipts received

2. Cash receipts issued

3. Cash memos received

4. Cash memos issued

5. Vouchers

Format/Proforma of Simple Cash book:

In the books of ……………

Simple Cash Book

Dr (Receipts) (Payments) Cr

Date Particulars R.No. L.F. ` Date Particulars V.No. L.F. `

To By

Columns in Simple Cash book

The Simple cash book is vertically divided into two sides where the left hand side is receipt side

and the right hand side is payment side.

Receipt side

1. Date column: The date of transaction is written in this column.

Receipt

number

column:

The

serial

number

receipts

and

cash

memos

supporting

the

entry

recorded

this

column.

Particulars:

The

account

which

affected

along

with

brief

narration

recorded

this

column. It always begins with the word “To”.

Accounting Procedure 117

Ledger

folio:

contains

the

page

number

the

ledger

where

the

transaction

has

been

posted.

Amount

column:

The amount received is recorded in this column.

Payment side

1. Date: The date of the transaction is recorded in this column.

Voucher

number:

The

serial

number

voucher

and

cash

memos

supporting

the

entry

recorded in this column.

Particulars:

The

account

which

affected

along

with

brief

narration

recorded

this

column.

always

begins

with

the

word

“

”

Ledger

folio:

contains

the

page

number

the

ledger

where

the

transaction

has

been

posted.

Amount

column:

The

amount

paid

recorded

this

column.

Recording in Simple Cash Book

The procedure for recording in the simple cash book is explained below:

Previous month’s balance or opening balance, if any, appears on the receipt side as “To Balance

b/d” (b/d means brought down). In case of new business capital contributed by proprietor appears on

receipt side as “To Capital A/c” When cash is received on any account the name of account is entered

in particulars column on the receipt side. When cash is paid on any account the name of account is

entered in particulars column on the payment side. Transactions are to be recorded in the order of date

only.

This cash book is suitable for traders operating on a small scale.

Balancing of simple cash book:

After recording transactions of a particular period simple cash book is balanced to find out

balance of cash in hand. This is done by recording the excess of receipts on the payment side or excess

of debit on the credit side as “By Balance c/d” (c/d means carried down) to make the two sides equal.

This balance is then entered on the receipt side as “To balance b/d” to start the next period. Since, one

cannot pay more than what one has actually received, the cash book recording only cash transactions

(Simple cash book) will always have excess of receipts over payments.

The cash book is a book of original entry where all cash and bank transactions relating to receipts

and payments are recorded. It serves the purpose of journal as well as ledger.

Since the cash book enables the trader to find out the daily cash and bank balance, there is no

need to open separate Cash a/c and Bank a/c.

Different Types of Cash Book:

(i) Simple Cash Book is single column cash book with one cash column on each side.

(ii) Double column cash book, viz., Cash and Discount column on each side.

(iii) Triple column cash book, viz., Cash, Discount and Bank column on each side.

Example:

Single Column Cash Book of Rekha & Bros

Date Receipts Cash Date Payments Cash

2014 2014

July 1 To Balance b/d 4,500 July 1 By Rent of shop 900

4 To Sales 8,050 3 By Postage 50

118 Introduction to Financial Accounting

10 To Interest on FD 2,000 14 By Purchases 7,000

20 To Commission 4,000 20 By Stationery 800

28 To Sale of goods 10,000 28 By Wages 2,000

30 To Balagopalan 5,000 31 By Narasimhan 9,000

By Balance c/d 13,800

Total 33,550 Total 33,550

Example:

Two Column Cash Book of Simpson Co.

Date Receipts Cash Bank

Date Payments Cash Bank

2014 2014

Apr 5 To Balance b/d 1,500 13,000 Apr 2 By Wages 400

To Sales 800 5 By Electricity 50

7 To Ashok Co. 2,000 8 By Repairs 400

11 To Beta Co. 2,350 15 By Venki Ltd. 10,800

20 To Sale 500 30 By Balance b/d 2,350 6,150

Total 2,800 17,350 Total 2,800 17,350

Example:

Three Column Cash Book of Janardhan Works

Date Receipts Disco-

unt

Cash Bank Date Payments Disco

-unt

Cash Bank

2014 2014

Jan 2 To Balance b/d 3,700 4,500 Jan 6 By Wages 1,550

5 To Patel 100 2,400 3 By Agarwal 50 950

10 To Neelima 6,000 15 By Cash (C) 3,000

15 To Bank (C) 3,000 22 By Drawings 2,000

30 To Cash (C) 1,000 30 By Bank (C) 1,000

31 To Dividend

from X Co.

2,000 31 By Rent 1,500

31 By Bal c/d 5,600 7,000

Total 100 9,100 13,500 50 9,100 13,500

Note the following points from the above illustration:

(a)

Discount

column

the

debit

side

represents

discount

allowed

and

the

credit

side,

represents

discount

received.

Balancing

not

done

for

these

columns

for

simple

reason

find out separately the discount allowed and discount received.

(b)

There

are

two

contra

entries

each

15th

and

30th.

15th,

the

transaction

cash

withdrawn

from

bank

3,000.

payment

from

bank

and

receipt

business

cash.

Similarly,

30th,

cash

deposited

bank

1,000.

receipt

the

bank

account

and

payment from cash account.

Accounting Procedure 119

(d) Drawings represent the amount withdrawn from bank for business purposes.

(e)

Dividend

from

Co.

received

cheque

and

the

company

should

have

remitted

the

dividend directly to the bank account of the businessman.

(f)

The

balance

c/d

the

closing

balance

for

the

month

January

2002

and

this

becomes

opening balance for February 2002.

Illustration 7

Enter the following transactions in the single column cash book of Gopichand.

March, 2014 `

1st Commenced business with cash 20.000

2nd Bought goods for cash 5.000

3rd Sold goods for cash 4.000

4th Goods purchased from Ravi Kumar 10.000

10th Paid to Ravi Kumar 7.000

14th Cash sales 8.000

18th Purchased furniture for office 4.000

22nd Paid wages 500

25th Paid rent 600

30th Received commission 4.000

30th Withdrew for personal purpose 1.000

31st Paid salary 900

Solution

Cash Book of Gopichand

Date Particulars

2014 2014

March 1

To Capital 20,000 March 2

By Goods 5,000

To Sales 4,000 10

By Ravi Kumar 7,000

To Sales 8,000 18

By Office furniture 4,000

To Commission 4,000 22

By Wages 500

By Rent 600

By Drawings 1,000

By Salary 900

By Balance c/d 17,000

36,000 36,000

Hint: Goods purchased from Ravi Kumar is a credit purchase.

120 Introduction to Financial Accounting

Illustration 8

Record the following transactions in two column cash book (Cash and Bank) in the books of Soft

Silk Co. for the month of July, 2014. Find out the closing balances for the month of July 2004.

July, 2014 `

Opening balance b/d (Cash) 14,500

Opening balance b/d (Bank) 7,000

Cash purchases 6,700

Rent for June month paid by cheque 2,500

Cash sales 15,200

Dividend paid by cheque 4,350

Cash deposited into bank 5,000

Cash paid to Rahim & Bros to settle his account 10,000

Repairs paid 1,000

Commission paid by cheque 2,000

Customer, Deepak remitted to our bank account 20,000

Cash withdrawn from bank for office use 5,000

Drawings made from business cash for personal purpose 2,000

Purchased stationery by cash 3,000

Cash withdrawn for personal use from bank 1,400

Solution

Two Column Cash Book

Date Particulars Cash Bank Date Particulars Cash Bank

July 14 July 14

1st To Op bal b/d 14,500 7,000 4

By Purchases 6700

9th To Sales 15,200 5

By Rent 2,500

15th To Cash (C) 5,000 12

By Dividend paid 4,350

23rd To Deepak 20,000 15

By Bank (C) 5,000

25th To Bank (C) 5,000 18

By Rahim & Bros 10,000

By Repairs 1,000

By Comm. paid 2,000

By Cash (C) 5,000

By Drawings 2,000

By Stationery 3,000

By Drawings 1,400

By Balance c/d 7,000 16,750

34,700 32,000 34,700 32,000

To Balance b/d 7,000 16,750

Accounting Procedure 121

Illustration 9

Enter the following transactions in the cash book with discount, cash and bank columns. Prepare

three columnar cash book for the month of May.

May 1

Balance of cash in hand ` 14,000; bank overdraft at bank ` 5,000

Invested further capital ` 10,000 out of which ` 6,000 was deposited in the bank

Sold goods for cash ` 30,000

Collected from debtors of last year ` 80,000; Discount allowed to them ` 2,000

Purchased goods for cash ` 55,000

Paid Ram Vilas, our creditor ` 25,000; discount allowed by him ` 650

Commission paid to our agent ` 5,300

Office furniture purchased for cash ` 2,000

Rent paid ` 400; electricity charges paid ` 1,000

Drew cheque for personal use ` 7,000

Cash sales ` 25,000

Collection from Atal Bihari ` 40,000, deposited in the bank on 19th April

Drew from the bank for office use ` 5,000

Drew cheque for petty expenses ` 1,500

Dividend received by cheque ` 500, deposited in the bank on the same day

Commission received by cheque ` 2,300, deposited in the bank on 28th April

Drew from the bank for salary of the office staff ` 15,000

Deposited cash in the bank ` 10,000.

Solution

Three Column Cash Book

Particulars Disc ` Cash ` Bank ` Particulars Disc ` Cash ` Bank `

To Balance b/d 14,000 By Balance b/d 5,000

To Capital 4,000 6,000 By Purchases 55,000

To Sales 30,000 By Ram Vilas 650 25,000

To Debtors 2,000 80,000 By Commission 53,000

To Sales 25,000 By Office furniture 2,000

To Atal Bihari 40,000 By Rent 400

To Cash (C) 40,000 By Electricity 1,000

To Bank (C) 5,000 By Drawings 7,000

To Dividend 500 By Bank (C) 40,000

To Comm 2,300 By Cash (C) 5,000

To Cash (C) 2300 By Petty expenses 1,500

To Cash (C) 10,000 By Bank (C) 2,300

By Salary 15,000

By Bank (C) 10,000

122 Introduction to Financial Accounting

By Balance c/d 59,300 25,300

Total 2,000 2,00,300 58,800 Total 650 2,00,300 58,800

PETTY CASH BOOK

Petty cash book is a separate cash book where we record small or petty cash expenses of routine

nature. It is of two types:

(i) Simple Petty Cash Book

(ii) Analytical or Columnar Petty Cash Book

In large organizations, petty expenses like stationery, postage, stamps, refreshments, carriage,

cartage, daily wages etc. are incurred day in and day out. All these expenses are more in number and

very insignificant in value. To look after payment of such expenses, a separate petty cashier is

appointed who obtains a definite sum of money at the beginning of a month and gives a statement of

account at the end of the period to the chief cashier. To record such payments, a separate book, known

as petty cash book is maintained.

There is a distinct method, namely Imprest system which is adopted in maintaining such petty

cash book. Under this system, at the beginning of a month, a definite sum of money is given by chief

cashier to petty cashier for petty expenses. At the commencement of the next period, the petty cashier

is reimbursed equal to what he had spent during the earlier period.

Illustration 10

Enter the following transactions in an analytical petty cash book. Also open relevant ledger

accounts.

2014 Nov `

Received a cheque for petty cash 1,000

Paid bus fare to messengers 50

Paid auto fare 70

Postal stamps purchased 80

Paid for stationery 90

Paid for carriage 60

Purchased envelopes 50

Wages paid 100

Tips given to driver 50

Telephone calls paid 20

Accounting Procedure 123

Solution

Petty Cash Book

Partic-

ulars

Amo

-unt

Date

Nov

Particulars V.

No.

Total

paym

-ents

Analysis of Payments L.F. Le

dg-

a/cs

Tra

Post

Ca-

rr `

S `

-ges

Sun-

day

To Bank 100 1st By Bus fare 50 50

2 By Auto fare 70 70

By Postal

80 80

10 By Stationery 90 90

12 By Carriage 60 60

15 By Envelopes 50 50

16 By Wages 100 100

20 By Tips 50 50

25 By Telegram 20 20

30 Total exp. 570 120 100 60 140 100 50

No.

By Balance c/d 430

Total

1000

-c

1st

To Bal

b/d

To Cash

430

570

Cash Book

Date Receipts ` Date Payments `

Nov By Petty cash 1,000

1,000

Ledger

Dr. Travelling Expenses A/c Cr.

Date Receipts ` Date Payments `

Nov To Petty cash 120

Dr. Postage Expenses A/c Cr.

Date Receipts

Date Payments

Nov To Petty cash 100

124 Introduction to Financial Accounting

Dr. Carriage Expenses A/c Cr.

Date Receipts ` Date Payments `

Nov To Petty cash 60

Dr. Printing and Stationery A/c Cr.

Date Receipts ` Date Payments `

Nov To Petty cash 140

Dr. Wages A/c Cr.

Date Receipts ` Date Payments `

Nov To Petty cash 100

Dr. Sundry Expenses Account Cr.

Date Receipts ` Date Payments `

Nov To Petty cash 50

Illustration 11

Prepare petty cash book on imprest system from the following particulars:

(i) Jan 1

Received for petty cash payment 500/-

(ii) Jan 2

Paid for postage 40/-

(

iii)

Jan

Paid

for

stationery

25/-

(iv) Jan 8

Paid for advertisement 150/-

(v) Jan 12

Paid for wages 50/-

(vi)

Jan

Paid

for

carriage

25/-

(vii) Jan 20

Paid for conveyance 22/-

(viii) Jan 25

Paid for travelling expenses 80/-

(ix)

Jan

Paid

for

postage

50/-

(x) Jan 28

Paid wages to cleaner 10/-

(xi) Jan 30

Paid for telegram 20/-

(xii)

Jan

Sent

registered

notice

10/-

Accounting Procedure 125

Solution

Petty Cash Book

Cash

recd

Date Particulars L.F. Total

payment

P&T Carriage P&S Advt. Travel

exp.

Wages Sundry

500 2014

Jan

To Cash

By Postage 40 40

By Stationery 25 25

By Advt 150 150

By Wages 50 50

By Carriage 25 25

By Conveyance 22 22

By Travelling 80 80

By Postage 50 50

By Wages 10 10

By Telegram 20 20

By Register 10 10

Total

By Balance b/d

482

120 25 25 150 102 60

Books of Accounts

Generally the following books of Accounts are maintained by a businessman for recording the

business transactions.

Books of Accounts

Primary Books/Books of Original Entry/ Secondary Books/

Books of Prime Entry/Books of first Entry Books of final Entry

Memorandum Books Journal Subsidiary Books Ledger Book

(Waste Books) (Special Journals) (Ledger Accounts)

Purchase Sales Purchase Sales Cash Bills Bills Journal

Book Book Return Return Book Receivable Payable Proper

126 Introduction to Financial Accounting

Memorandum Book (Waste Book)

A Waste Book is just like a diary. It is kept for the sake of memory. The transactions are first

recorded in the Waste Book-in the manner in which they occur. Then at leisure (free time), appropriate

entries are made in the journal. The transactions are recorded in the Waste Book as follows:

Date Particulars `

2011 July 1 Started business with cash 18,000

7 Purchased goods from y & co. 900

10 Cash Sales 1200

14 Paid for Salaries 500

20 Rent paid 700

Meaning of Journal

The word ‘Journal’ is derived from the French word “Jour” which means a day. Therefore,

Journal means a ‘daily record’.

Journal is a book where all the transactions are recorded (entered) first in a chronological or date

wise order (in the order of their occurrence/taken place). Therefore it is called as a book of first entry

or a book of original entry or a book of prime entry.

In a journal, all types of business transactions are recorded systematically, by debiting one

account & crediting another account.

The transactions are recorded in the journal on the basis of some documentary evidence which is

called as a source document, such as cash memo, Invoice (Bill), receipt etc.

Journalising

Recording of business transactions in the journal book on the basis of rules of double entry

system is called as Journalising. Journalising means to enter or to record the business transactions in

the journal book.

Steps in journalising/Steps for converting transaction into Journal Entry/Procedure for

Journalising.:

1. Read the transaction carefully & find out what actually happened in the transaction.

2. Determine the nature of a transaction. Think of the effect of the transaction on the business.

3. Determine the two aspects of the transaction i.e. find out the two accounts involved.

Determine

the

types

accounts

involved

i.e.

classify

the

affected

accounts

Personal,

Real

& Nominal Account.

5. Apply the rule of debit & credit, looking at the type/class of account.

Apply

the

rule

Journalising

decide

which

account

debited

and

which

account

credited.

7. Record the transaction in journal by debiting one account & crediting another account.

Journal Entry: The record of a business transaction in a journal is called as journal entry.

Note: ‘Journalising’ means recording a transaction in a journal & the form in which it is recorded

is called ‘Journal Entry’.

Accounting Procedure 127

Narration: It means a brief explanation (description) of the Journal Entry. Narration is written

on the next line of entry in bracket. It is started with the word “being”. Narration shows the reason for

passing of the Journal Entry. A journal entry without a proper narration is incomplete.

IMPORTANCE AND UTILITY OF JOURNAL

Complete

Record

Transaction:

complete

record

all

transactions

available

one

place

i.e.

journal.

Quick

Reference:

Business

transactions

are

recorded

chronological

(date

wise)

order

journal. Therefore, it facilitates quick and easy reference to any transaction.

Proper

Understanding:

Narration

the

transaction

given

below

each

entry.

helps

understand

recorded

transaction

(Journal

Entry)

properly.

Avoids

the

Necessity

Immediate

Posting:

Transactions

are

recorded

systematic

manner in Journal. Therefore, there is no urgency to post them to the ledger.

Evidence

the

ourt:

the

entries

the

journal

are

made

from

source

documents

receipts,

voucher

etc.,

the

court

considers

the

entries

the

journal

proof

(evidence)

transactions.

acts

legal

evidence

(proof)

the

court

Law.

Minimum

rrors

(

istakes):

can

ensure

arithmetical

accuracy

because

journal

records

debit

and

credit

aspects

all

the

transactions.

errors

are

committed,

they

can

located

immediately with the help of journal.

Format/Specimen/Proforma/Ruling of Journal

Date

Voucher No.

Particulars L.F.

Debit

(`)

Credit

(`)

Year

Month

/Date

Name of the A/c debited Dr

To Name of the A/c credited

(Narration of the entry)

EXPLANATION OF COLUMNS OF JOURNAL

Date:

Date

Column

the

first

column

from

the

left.

records

year,

month

and

the

date

every transaction.

Particulars:

this

column,

the

names

the

accounts

debited

credited

are

written.

After debiting & crediting the accounts narration is written in bracket.

In short, Journal entry and narration are written in Particulars column.

L.F.

(Ledger

Folio):

Folio

means

page

number

therefore,

ledger

folio

means

page

number of ledger.

While

recording

the

transactions

journal

nothing

has

written

this

(L.F.)

Column.

The

Journal

entries

are

required

posted

the

Ledger.

that

time,

the

page

number

the

ledger

which

the

two

accounts

appear

are

entered

this

column.

Usually,

these

page

numbers are written in red ink.

Debit

Amount

(

In this column, amount of debit account is written.

Credit

Amount

(

In this column, amount of credit account is written.

128 Introduction to Financial Accounting

JOURNAL VOUCHERS

The details of each transactions are recorded on a separate sheet of paper which is known as a

Voucher. This Voucher is given a serial number and this number is known as Journal Voucher

Number. The number is entered in second column. The Journal Voucher must be signed by an

authorized person. The Journal entry is passed on the basis of the Vouchers, under the authentication

of the authorized person.

PRACTICAL PROBLEM FOR JOURNAL

Illustration 12

Journalise the following transactions with narration in the books of Mr. Pritesh

2014

Feb.1

Purchase

goods

from

Mr.

15,000.

3 Cash purchases

3,000.

Sold

goods

worth

7,000.

10 Purchased goods from Mr. A of

2,500.

Paid

Mr.

1,500

account.

18 Sold goods to Mr. D of

4,000.

Received

from

Mr.

3,000

account.

25 Goods returned to Mr. A of

500 & balance paid in cash.

Rent

paid

500.

Journal of Mr. Pritesh

Date

Voucher

No.

Particulars L.F.

Debit

(`)

Credit

(`)

Feb.’14

Goods /purchase a/c Dr.

To Mr.Z’s a/c

(Being goods purchase on credit)

15,000

Goods /purchase a/c Dr.

To cash a/c

(Being goods purchase for cash)

3,000

Cash a/c Dr.

To goods/sales a/c

(Being goods sold for cash)

7,000

Goods /purchase a/c Dr.

To Mr.A’s a/c

(Being goods purchase on credit)

2,500

Mr. A’s a/c Dr.

To cash a/c

(Being cash paid on a/c)

1,500

Accounting Procedure 129

Mr. D’s a/c Dr.

To goods/sale a/c

(Being goods sold on credit)

4,000

Cash a/c Dr.

To Mr.D’s a/c

(Being cash received on a/c)

3,000

Mr. A a/c Dr.

To goods/purchase return a/c

(Being goods returned)

500

Mr. A a/c Dr.

To cash a/c

(Being cash paid on a/c)

500

Rent a/c Dr.

To cash a/c

(Being rent paid)

500

Total

37,500 37,500

Journal of Mr. Pritesh

Date

Voucher

No.

Particulars L.F.

Debit

(`)

Credit

(`)

Feb.’14

Goods /purchase a/c

To Mr.Z’s a/c

(Being goods purchase on credit)

Dr. 15,000

15,000

Goods /purchase a/c

To cash a/c

(Being goods purchase for cash)

Dr. 3,000

3,000

Cash a/c

To goods/sales a/c

(Being goods sold for cash)

Dr. 7,000

7,000

Goods /purchase a/c

To Mr.A’s a/c

(Being goods purchase on credit)

Dr. 2,500

2,500

Mr. A’s a/c

To cash a/c

(Being cash paid on a/c)

Dr. 1,500

1,500

Mr. D’s a/c

To goods/sale a/c

(Being goods sold on credit)

Dr. 4,000

4,000

130 Introduction to Financial Accounting

Cash a/c

To Mr.D’s a/c

(Being cash received on a/c)

Dr. 3,000

3,000

Mr. A a/c

To goods/purchase return a/c

(Being goods returned)

Dr. 500

500

Mr. A a/c

To cash a/c

(Being cash paid on a/c)

Dr. 500

500

Rent a/c

To cash a/c

(Being rent paid)

Dr. 500

500

Total 37,500 37,500

Illustration 13

Journalise the following transactions in the books of Mr. Kalpesh.

2014

January 1 Mr. Kalpesh started diamond business with cash ` 10,00,000.

5 Mr. Kalpesh bought a raw stones of ` 4,50,000 as his capital.

8 Sold diamonds to Mr. Rahul for ` 7,00,000.

10 Purchased an Air condition for business ` 70,000.

13 Mr. Rahul paid cash ` 4,00,000 on a/c.

15 Paid labor charges ` 85,000.

18 Received commission ` 35,000.

22 Received cash from Mr. Rahul ` 2,80,000.

25 Paid electricity bill ` 3,000.

26 Diamond packet sold for ` 1,25,000.

30 Balance amount due from Mr. Rahul is not recoverable.

31 Withdraw for personal use ` 1,00,000

Date

Voucher

No.

Particulars L.F

Debit

(`)

Credit

(`)

Jan.’

Cash a/c

To Capital a/c

(Being Business started with cash)

Dr.

10,00,000

Goods/purchase a/c

To capital a/c

(Being goods bought as a capital)

Dr.

4,50,000

Accounting Procedure 131

Mr. Rahul’s a/c

To goods/sales a/c

(Being goods sold on credit)

Dr.

7,00,000

Fixed asset a/c

To cash a/c

(Being air condition purchased for

business)

Dr.

70,000

Cash a/c

To Mr. Rahul’s a/c

(Being cash received on a/c)

Dr.

4,00,000

Labor charges/wages a/c

To cash a/c

(Being labor charges paid)

Dr.

85,000

Cash a/c

To commission a/c

(Being commission received)

Dr.

35,000

Cash a/c

To Mr. Rahul’s a/c

(Being cash received on a/c)

Dr.

2,85,000

Electricity a/c

To cash a/c

(Being electricity bill paid)

Dr.

3,000

Cash a/c

To goods/sales a/c

(Being good sold for cash)

Dr.

1,25,000

Bad debts a/c

To Mr. Rahul’s a/c

(Being amount written off as a bad debts)

Dr.

15,000

Drawings a/c

To cash a/c

(Being amount withdraw for personal use)

Dr.

1,00,000

Total

32,68,000

Illustration 14

During January 2014, Narayan transacted the following business:

Dates `

1 Commenced business with cash 40,000

2 Purchased goods on credit from Shyam 30,000

3 Purchased goods for cash 1,000

4 Paid Gopalan an advance for goods ordered 2,000

5 Received cash from Murthy as advance for goods ordered by him 3,000

132 Introduction to Financial Accounting

6 Purchased furniture for goods for office use for cash 2,000

7 Paid wages 500

8 Received commission (in cash) 600

9 Goods returned to Shyam 200

10 Goods sold to Kamal 10,000

12 Paid for postage and telegrams 200

13 Goods retuned by Kamal 500

15 Paid for stationery 200

18 Paid into bank 500

20 Goods sold for cash 750

22 Bought goods for cash 1,000

25 Paid salaries 700

28 Paid rent 500

31 Drew cash for personal use 1,000

Solution

Journal Entries

Date Particulars L.F. Debit

Credit

Jan1 Cash Account

To Narayan’s Capital Account

(Being the cash brought into business as capital)

(Logic: Cash is a real account. Debit what comes in.

Proprietor’s

capital is a personal account. Credit the giver.)

Dr. 40,000

40,000

Jan 2 Purchases Account

To Shyam’s Account

(Being the goods purchased on credit)

(Logic: Purchases is expenses. Debit all expenses. Shyam is a

personal account. Credit the giver.)

Dr. 30,000

30,000

Jan 3 Purchases Account

To Cash Account

(Being the goods purchased for cash)

(Logic: Purchases is expenses. Debit all expenses. Cash is a

real

account. Credit what goes out.)

Dr. 1,000

1,000

Jan 4

Gopalan’s Account

To Cash Account

(Being the amount paid to Gopalan)

(Logic: Gopalan is a personal account. Debit the receiver.

Cash is a real account. Credit what goes out.)

Dr. 2,000

2,000

Accounting Procedure 133

Jan 5

Cash Account

To Murthy’s Account

(Being the cash received from Murthy)

(Logic: Cash is a real account. Debit what comes in. Murthy is

a personal account. Credit the giver.)

Dr. 3,000

3,000

Jan 6

Furniture Account

To Cash Account

(Being the furniture purchased for office use for cash)

(Logic: Furniture is a real account. Debit what comes in. Cash

a real account. Credit what goes out.)

Dr. 2,000

2,000

Jan 7

Wages Account

To Cash Account

(Being the wages paid)

(Logic: Wages is a nominal account. Debit all expenses. Cash

a real account. Credit what goes out.)

Dr. 500

500

Jan 8

Cash Account

To Commission Received Account

(Being the commission received)

(Logic: Cash is a real account. Debit what comes in.

Commission

(received) is a nominal account. Credit all incomes.)

Dr. 600

600

Jan 9

Shyam’s Account

To Purchase Returns Account

(Being goods returned to Shyam)

(Logic: Shyam is a personal account. Debit the receiver.

Purchase returns is nominal a/c. Credit all income.)

Dr. 200

200

Jan 10

Kamal’s Account

To Sales Account

(Being goods sold to Kamal on credit)

(Logic: Kamal is a personal account. Debit the receiver. Sale

is nominal a/c. Credit all incomes)

Dr. 10,000

10,000

Jan 12

Postage & Telegrams Account

To Cash Account

(Being the amount paid for postage & telegrams)

(Logic: Postage and telegrams is a nominal account. Debit all

expenses. Cash is a real account. Credit the giver.)

Dr. 200

200

Jan 13 Sales Return Account

To Kamal’s Account

(Being the goods returned by Kamal)

(Logic: Sales returns is nominal account. Debit all reduction in

income. Kamal is a personal account. Credit the giver.)

Dr. 500

500

Jan 15 Stationery Account

To Cash Account

Dr. 200

200

134 Introduction to Financial Accounting

(Being the amount paid for stationery)

(Logic: Stationary is a nominal account. Debit all the

expenses.

Cash is a real account. Credit what goes out.)

Jan 18 Bank Account

To Cash Account

(Being the amount deposited into the bank)

(Logic: Bank is a real account. Debit what comes in. Cash is a

real account. Credit what goes out.)

Dr. 500

500

Jan 20 Cash Account

To Sales Account

(Being the goods sold for cash)

(Logic: Cash is a real account. Debit what comes in. Sales is

income. Credit all income.)

Dr. 750

750

Jan 22 Purchase Account

To Cash Account

(Being the goods purchase for cash)

(Logic: Purchase is expenses. Debit all the expenses. Cash is a

real account. Credit what goes out.)

Dr. 1,000

1,000

Jan 25 Salaries Account

To Cash Account

(Being the amount paid as salaries)

(Logic: Salaries is a nominal account. Debit all expenses. Cash

is a real account. Credit what goes out.)

Dr. 700

700

Jan 28 Rent Account

To Cash Account

(Being the rent paid)

(Logic: Rent is a nominal account. Debit all the expenses.

Cash is a real account. Credit what goes out.)

Dr. 500

500

Jan 31 Narayan's Drawings Account

To Cash Account

(Being the cash drawn for personal use)

(Logic: Personal drawing is a personal account. Debit the

receiver.

Cash is a real account. Credit what goes out.)

Dr. 1,000

1,000

POSTING IN THE LEDGER ACCOUNTS

An account is a summarized record of all the transactions related to one person, firm or one type

of asset or property or one type of expense or income.

The short form of the word Account is A/c.

Accounting Procedure 135

An account is divided into two sides. The left hand side is called “Debit Side”, and the right hand

side is called the “Credit Side”.

Head of an Account: Head of an account means the name of the account.

The name of an account is written at the top, followed by the word “Account”. e.g. An account

relating to Mahesh Shah will bear the head “Mahesh Shah Account”.

To Debit an Account: It means to record the transaction on the left hand side i.e. the debit side

of an account.

To Credit an Account: It means to record the transaction on the right hand side i.e. the credit

side of an account.

MEANING AND DEFINITION OF LEDGER

All the accounts are kept in one book which is known (called) as ledger. A book in which all

accounts are kept is called as ledger. Ledger is a bound book of accounts. It is called as secondary

book of accounts or principal (main) book of accounts or book of final entry. Transactions cannot be

directly recorded in the ledger. Each entry from the books of prime entry i.e. Journal & Subsidiary

books is posted in the ledger. Therefore ledger is a derived or secondary record. Ledger provides all

accounting entries in a summarised form relating to various accounts. It is a set of accounts. An

account in ledger is called ‘Ledger account’. Separate accounts are opened for each head in the ledger

book. Ledger contains Personal accounts, Real accounts & Nominal accounts. The ledger is a book

containing (including) many ledger accounts. The number of ledger accounts depends upon the

number of transactions of different nature & with different parties.

The term ‘Ledger’ is derived from the Dutch word ‘Legger’ which means to lie. Therefore,

ledger means a book where the various account lie.

The definition of ‘Ledger’ as given in the Encyclo-pedia is as under.

“A group of accounts is known as a ledger.”

Features of Ledger

1. Ledger is a book of secondary or final entry. It is a main book of account.

2. It is a derived or secondary record.

3. It is a king of books of accounts.

keeps

item

wise

and

account

wise

record

business

transactions

and

provides

instant

information.

provides

overall

summary

the

business

transactions

relating

persons,

properties,

expenses, incomes, profits and losses.

6. It provides base to prepare trial balance.

7. It facilitates cross checking of business transactions entered in the journal.

Need and Importance of Ledger

All the business transactions are first recorded in the Journal. However, from the journal we are

not able to know the perfect position regarding total dealings or balance of any person or anything.

The journal gives a scattered information regarding a particular account. Thus, recording of

transactions in journal only is not sufficient.

A businessman cannot get sufficient information about the business transactions from the journal.

For example, the amount receivable from debtors, the amount payable to creditors, total payment on

any head of expenses etc. In order to get above information, a ledger has to be maintained. Ledger is

136 Introduction to Financial Accounting

very useful or important for business. Need, Importance, usefulness or utility of ledger is shown from

the following points.

Ledger

provides

classified

information

various

accounts

expenses,

incomes,

losses,

gains,

assets,

persons

etc.

This

information

provided

ledger

useful

for

controlling the business.

2. Trial balance is easily prepared on the basis of balance shown by ledger Account.

Businessman,

management

the

government

take

policy

decisions

the

basis

record

maintained in the ledger.

All

personal

accounts

ledger

would

show

how

much

money

payable

creditors

receivable from debtors.

5. All real account in ledger would show the value of assets & properties.

All

nominal

accounts

ledger

would

show

the

sources

income

the

amount

spent

various heads of expenses.

Ledger

has

great

utility

businessman

(because)

gives

information

about

particular

account at one place.

Total

amount

receivable

from

the

debtors

customers

and

total

amount

payable

the

creditors

suppliers

can

known

easily

and

quickly

from

the

ledger.

Accordingly

businessman prepares a plan for collection and payment of such dues.

Contains of Ledger book or Nature of a Ledger

A Ledger book contains various accounts. A ledger is a bound book. It contains many pages

which are called folios. Every page in a ledger is serially numbered. Page number allotted to an

account is called ledger folio. Every ledger has an alphabetical Index. Index in ledger indicates the

page number allotted to every account. The names of all the accounts are written in alphabetical order.

This facilitates immediate reference. Index helps in tracing any account in ledger.

Specimen/Ruling/Format/Proforma of a Ledger Accounts

The format of an account varies depending upon the system following in an organisation. The

generally accepted forms are as under;

1. ‘T’ form of Account.

Statement

form

Account

Balance

form

Account

1. ‘T’ form of Account: Specimen of an account in ‘T’ form is as under

Specimen or Ruling or Standard form or Proforma of Ledger Account

In the books of ________

Dr. Name / Head of A/c Cr.

Date Particulars

Folio

J.F.

Date Particulars

Folio

J.F.

To “The name of

credit A/c”

By “The name of

Debit A/c”

Ledger Account is divided into two sides. The left hand side is known as debit side and the right

hand side is known as credit side. Title (Name/Head) of the account is written at the top in the centre.

Accounting Procedure 137

The words ‘Dr’ & ‘Cr’ is written at the top on the left hand side corner and right hand side corner

respectively. The columns ‘Date’, ‘Particulars’, ‘J.F. /Folio’ & ‘amount’ appear on both the sides of a

ledger account.

2. Statement form of Account (Balance form of Account): Specimen of an account in

Statement form is as under

Date Particulars

Folio

J.F.

Date Particulars

Folio

J.F.

To “The name of

credit A/c”

By “The name of

Debit A/c”

Nowadays this form of account is used mostly in the computerised system of accounting. The

features of statement form of account are stated as follows :

1. Side: It does not have two sides.

Columns:

Statement form of account has the following six columns :

(

Date:

In this column, date of transaction is written.

(

Particulars:

In this column, the name of the other account affected in the entry is written.

(

Folio:

this

column,

the

page

numbers

the

journal

subsidiary

book

from

where

entry is transferred to the ledger.

(

Debit

Amount:

In this column, amount of the transaction is written in figures.

(

Credit

Amount:

In this column, amount of the transaction is written in figures.

(

Balance:

this

column,

balance

written

figures

after

considering

all

the

posting

made therein.

LEDGER POSTING

The process of transferring entries from the books of prime entry (Journal & Subsidiary books) to

ledger is called as posting (Ledger posting).

1. Process/Procedure of Ledger Posting (form Journal to Ledger)

(a)

Date

column:

Write date of the transaction as recorded in the journal.

Particulars

olumn

Debit

side:

Write Name of Credited Account in the Journal entry after the word “To”.

Credit

side:

Write Name of Debited Account in the Journal entry after the word “By”.

J.F.

/Folio

column

Write page number of the journal from where the entry is posted.

Amount

column

Write

the

amount

the

debit

side

from

debit

column

Journal

credit

side

from

credit

column of Journal.

138 Introduction to Financial Accounting

BALANCING OF LEDGER ACCOUNTS

Meaning

At the end of a certain period (say a month, a quarter or a year) the businessman will be

interested in knowing the position of a particular account. Therefore, he will find out the net balance

of an account after considering the totals of both the sides. The difference between the debit &

credit totals is a balance of that account.

‘Balancing’ means technique of finding out the net balance of an account.

Steps in Balancing

1. Make the total of both the sides of a ledger account on a rough sheet.

Find

out

(compute)

the

difference

between

the

totals

both

the

sides.

This

difference

must

written

the

lighter/shorter

side

account,

writing

against

it,

in ‘Particular’ column as “By balance cld (clf)” or “To balance cld (clf)” as the case may be.

(a)

the

debit

side

heavier,

the

difference

will

appear

(put)

the

credit

side

“

balance

c/d

”

This

known

debit

balance

account.

(b)

the

credit

side

heavier,

the

difference

will

appear

(put)

the

debit

side

account as, “To balance c/d”. This is known as credit balance of an account.

(c)

case

the

total

debit

equal

the

total

credit,

then

that

account

said

‘

Squared

’

has

nil

balance.

Make

the

total

both

sides.

Now

total

both

the

sides

comes

equal

i.e.

total

both

sides

agree with each other.

Total

both

the

sides

must

appear

the

same

line.

6. Draw a single line above the totals & two lines below the totals.

Closing

balance

(i.e.

balance

c/d

c/f)

always

comes

the

shorter

lighter

side.

Closing

balance

becomes

the

opening

balance

(i.e.

balance

b/d

b/f)

always

comes

the

heavier

side.

NOTE

personal

account

has

debit

balance,

means

the

amount

due

from

outsider

i.e.

outsider

our

debtor.

personal

A/c

has

credit

balance,

means

the

amount

due

outsider

i.e.

outsider is our creditor.

Personal

A/cs

may

also

have

nil

balance.

2. All the Real Accounts always have debit balance or Nil balance.

All

the

accounts

expenses

losses

always

have

debit

balances.

4. All the accounts of incomes & gains always have credit balance.

debit

side

total

heavier,

then

net

balance

debit

balance.

credit

side

total

heavier,

then

net

balance

credit

balance

(Debit

balance

comes

when

debit side’s total is heavier & credit balance comes when credit side’s total is heavier)

the

total

debit

equal

the

total

credit,

then

net

balance

nil

balance.

Accounting Procedure 139

Why Balancing of Ledger Accounts?

Personal

Accounts

These accounts are balanced for finding out whether a person is a debtor or a creditor. A debit

balance on a personal account indicates that the person is our debtor. A credit balance on a personal

account indicates that the person is our creditor. A zero balance on personal account indicates that the

account has been closed. It means the person is neither debtor nor creditor of the firm. At the end of

the year the total debtors and total creditors are ascertained by balancing personal accounts.

2. Real Accounts

(a) Cash Account: The purpose is to find out cash at hand. Cash Account will always have a

debit balance or no balance. It can never have a credit balance. But Bank Account may have a credit

balance.

(b) Goods Account: The purpose is to find out total sales, total purchases, total returns etc. In the

case of Goods Account like Sales Account, Purchase Returns Account, there is a credit balance.

Purchase Account and Sales Returns Account will have a debit balance.

date.

Real Accounts will generally have a debit balance. The debit balance shows the value of property

in possession, a credit balance shows profit on disposal of property.

3. Nominal Accounts

The purpose is to find out the total amount spent on each type of expenditure, and the total

amount of income earned from various sources.

A debit balance in a Nominal Account signifies a loss or an expense. A credit balance in a

Nominal Account signifies an income or a gain. A zero balance in the account shows that income or

gain is equal to expense or loss.

Now let us prepare the ledger accounts based on the entries passed earlier. A separate account is

opened in ledger for each account. All the debit entries and credit entries are duly entered. At the end,

the accounts are properly balanced. In other words, the total of all debit entries is adjusted against the

total of credit entries and balance is brought forward to the next accounting period.

Cash Book, Subsidiary Books and General Ledger

Cash Book

Date Receipts L.F. Cash

Bank

Date Payments L.F. Cash

Bank

1991 1991

Jan. 1 To Capital a/c 40,000 Jan. 3 By Purchase a/c 1,000

Jan. 5 To Murthy’s a/c 3,000 Jan. 4 By Gopalan a/c 2,000

Jan. 8 To Commission

a/c

600 Jan. 6 By Furniture a/c 2,000

Jan. 18 To Cash a/c C 500 Jan. 7 By Wages a/c 500

Jan. 20 To Sales a/c 750 Jan. 12 By Postage &

Telegrams a/c

200

Jan. 15 By Stationery 200

140 Introduction to Financial Accounting

a/c

Jan. 18 By Bank a/c C 500

Jan. 22 By Purchase a/c 1,000

Jan. 25 By Salary a/c 700

Jan. 28 By Rent a/c 500

Jan. 31 By Drawings

a/c

1,000

Jan. 31 By Balance c/d 34,350 500

44,350 500 44,350 500

Note: The letter ‘C’ in the Ledger Folio column denotes a ‘contra entry’. That is an entry for

which the debit and credit aspects are found in the Cash Book itself.

Purchases Book

Date Name of Supplier L.F. Inward Invoice No. `

1991

Jan. 2

Shyam

30,000

Total 30,000

Purchase Returns Book

Date Name of Supplier L.F. Inward Invoice No. `

1991

Jan. 2

Shyam

200

Total 200

Sales Book

Date Name of Supplier L.F. Outward Invoice No. `

1991

Jan. 10

Kamal

10,000

Total 10,000

Sales Return Book

Date Name of Supplier L.F. Inward Invoice No. `

1991

Jan. 13

Kamal

500

Total 500

Accounting Procedure 141

General Ledger

Dr. Capital Account Cr.

Date Particulars JF

No.

` Date Particulars JF

No.

1991

Jan. 31

To Balance c/d 40,000 1991

Jan.1

By Cash a/c 40,000

40,000 40,000

40,000 Feb. 1 By Balance b/d 40,000

Dr. Shyam’s Account Cr.

Date Particulars JF

No.

` Date Particulars JF

No.

1991

Jan. 9

To Purchase

Returns

200 1991

Jan.1

By Purchases a/c 30,000

Jan. 31 To Balance c/d 29,800

30,000 30,000

Feb. 1 By Balance b/d 29,800

Dr. Purchase Account Cr.

Date Particulars JF

No.

` Date Particulars JF

No.

1991

Jan. 2

To Shyam a/c 30,000 1991

Jan. 31

By Balance b/d 32,000

Jan. 3 To Cash 1,000

Jan. 22 To Cash 1,000

32,000 32,000

Feb.1 To Balance b/d 32,000

Dr. Sales Account Cr.

Date Particulars JF

No.

` Date Particulars JF

No.

1991

Jan. 31

To Balance c/d 10,720 1991

Jan. 13

By Kamal’s a/c 10,000

Jan. 20 By Cash 750

10,750 10,750

Feb. 1 By Balance b/d 10,750

142 Introduction to Financial Accounting

Dr. Purchase Returns Account Cr.

Date Particulars JF

No.

` Date Particulars JF

No.

19 × 1

Jan. 31

To Balance c/d 200 19 ×1

Jan. 9

By Shyam’s a/c 200

200 200

Feb. 1 By Balance b/d 200

Dr. Sales Returns Account Cr.

Date Particulars JF

No.

` Date Particulars JF

No.

19 × 1

Jan. 13

To Kamal’s a/c 500 19 × 1

Jan. 31

By Balance c/d 500

500 500

Feb. 1 To Balance b/d 500 Feb.1

Dr. Gopalan Account Cr.

Date Particulars JF

No.

` Date Particulars JF

No.

1991

Jan. 6

To Cash a/c 2,000 1991

Jan. 31

By Balance c/d 2,000

2,000 2,000

Feb. 1 To Balance b/d 2,000 Feb.1

Dr. Wages Account Cr.

Date Particulars JF

No.

` Date Particulars JF

No.

1991

Jan. 7

To Cash a/c 500 1991

Jan. 31

By Balance c/d 500

500 500

Feb. 1 To Balance b/d 500

Dr. Commission Received Account Cr.

Date Particulars JF

No.

` Date Particulars JF

No.

1991

Jan. 1

To Balance b/d 600 1991

Jan. 31

By Cash a/c 600

600 600

Feb. 1 By Balance b/d 600

Accounting Procedure 143

Dr. Kamal’s Account Cr.

Date Particulars JF

No.

` Date Particulars JF

No.

1991

Jan. 10

To Sales a/c 10,000 1991

Jan. 31

By Sales returns a/c 500

Jan. 31 By Balance b/d 9,500

10,000 10,000

Feb. 1 To Balance b/d 9,500

Dr. Postage and Telegrams Account Cr.

Date Particulars JF

No.

` Date Particulars JF

No.

1991

Jan. 10

To Cash a/c 200 1991

Jan. 31

By Balance c/d 200

200 200

Feb. 1 To Balance b/d 200 Feb.1

Dr. Stationery Account Cr.

Date Particulars JF

No.

` Date Particulars JF

No.

1991

Jan. 15

To Cash a/c 200 1991

Jan. 31

By Balance c/d 200

200 200

Feb. 1 To Balance b/d 200

Dr. Salaries Account Cr.

Date Particulars JF

No.

` Date Particulars JF

No.

1991

Jan. 25

To Cash a/c 700 1991

Jan. 31

By Balance c/d 700

700 700

Feb. 1 To Balance b/d 700

Dr. Rent Account Cr.

Date Particulars JF

No.

` Date Particulars JF

No.

1991

Jan. 28

To Cash a/c 500 1991

Jan. 31

By Balance c/d 500

500 500

Feb. 1 To Balance b/d 500

144 Introduction to Financial Accounting

Dr. Drawings Account Cr.

Date Particulars JF

No.

` Date Particulars JF

No.

1991

To Cash a/c 1,000 1991

Jan. 31

By Balance c/d 1,000

1,000 1,000

Feb. 1 To Balance b/d 1,000

Dr. Murthy’s Account Cr.

Date Particulars JF

No.

` Date Particulars JF

No.

1991

Jan. 31

To Balance c/d 3,000 1991

Jan. 5

By Cash a/c 3,000

3,000 3,000

Feb. 1 By Balance b/d 3,000

Dr. Furniture Account Cr.

Date Particulars JF

No.

` Date Particulars JF

No.

1991

Jan. 6

To Cash a/c 2,000 1991

Jan. 31

By Balance c/d 2,000

2,000 2,000

Feb. 1 To Balance b/d 2,000

Notes:

(i) In a specific ledger, Ledger A/c can never be debited on credited.

(ii)

Ledger

a/c

having

opening

balance,

then

will

start

with

the

word

Balance

b/d"

(i.e.,

brought

down).

However,

the

Ledger

a/c

having

closing

balance,

then

will

close with the word "Balance c/d" (i.e., carried down).

(iii)

All

closing

balance

Ledger

a/c

transferred

"Trial

Balance"

the

end

every

financial year.

(iv)

Trial

Balance

statement

showing

the

list

accounts

with

their

closing

balance,

i.e.,

either debit or credit balance.

INTRODUCTION TO TRIAL BALANCE

In the previous unit we learnt how about various secondary books that include purchase book,

sales book, purchase return book, sales return book, bills receivable book, bills payable book, cash

book and journal proper. Cash book is an important subsidiary book that records all cash receipts and

payments during a particular period. Posting of entries in ledger and the procedure for balancing in

ledger account was briefly dealt.

Accounting Procedure 145

In this unit we have dealt with the meaning, the need of trial balance, and the methods of

preparing trial balance. There are different types of errors. Students should be acquainted with types of

errors and how they are rectified. There are certain errors that are disclosed in the trial balance while

certain errors are not disclosed in the trial balance. Trial Balance is a statement of debit balances and

credit balances that are extracted from ledger accounts on a particular date. It stands as a bridge

between primary and secondary books on one hand and final statements of accounts on the other hand.

Objectives

After going through this unit, you should be able to:

1. Explain the meaning and recall the format of trial balance.

Explain

the

objectives

preparing

trial

balance

3. List the guidelines to prepare a trial balance.

Identify

and

rectify

the

errors

that

are

disclosed

trial

balance

5. Identify and rectify the errors that are not be disclosed by trial balance

Know

the

steps

locate

the

errors.

7. Prepare trial balance after incorporating adjustments.

MEANING

Trial Balance is a statement containing the various ledger balances on a particular date. It is

prepared to check the arithmetical accuracy of the posting of transactions to the ledger. It is a list of

debit and credit totals or a list of debit and credit balances of all the ledger accounts prepared on any

particular date to verify whether the entries in books of accounts are authentically correct. As the

primary and secondary books are maintained on the double entry concept, the balances in the trial

balance must tally.

A trial balance is not a part of books of account. It is drawn as a separate statement, and this

becomes the source document for preparing external financial statement such as profit and loss

account, cash flow statement and Balance Sheet.

OBJECTIVES OF PREPARING A TRIAL BALANCE

There are three objectives of preparing a trial balance.

(

check

the

arithmetic

accuracy

entries

made.

double

entry,

every

debit

has

equivalent

credit.

Even

General

Journal,

have

seen

that

the

total

debits

equals

the

total

credits.

Similarly,

the

debits

and

credits

tally

trial

balance,

indicates

that

the

books

account

are

arithmetically

accurate.

(

Basis

for

financial

statements.

stated

earlier,

trial

balance

bridge

between

ledger

and

final

statements.

Trial

balance

facilitates

the

preparation

trading

account,

profit

and

loss

account

and

balance

sheet.

(

summarized

ledger.

The

position

ledger

account

judged

simply

looking

the

trial

balance.

because,

all

ledger

accounts,

after

being

balanced,

are

grouped

those

showing

debit

and

those

showing

credit

balances.

The

total

all

debit

balance

equal

total

all

credit

balance.

any

case

the

trial

balance

does

not

tally,

the

difference

temporarily transferred to suspense account till such difference is rectified.

146 Introduction to Financial Accounting

METHODS OF PREPARING A TRIAL BALANCE

Totals method and Balance method are the two techniques of preparing trial balance. In the first

method, the totals of debits and credits of every account are shown in the trial balance. For instance, a

cash account has a debit total of ` 45,000 and credit total of ` 35,000. Creditors has a debit total of

` 70,000 and credit total of ` 80,000. Both these totals are carried to trial balance.

Performa of Trial Balance under Totals Method

Trial Balance as On _________

Debit Totals ` Credit Total `

Cash 45,000 Cash a/c 35,000

Creditors 70,000 Creditors 80,000

Total 1,15,000 Total 1,15,000

The same logic is applied for all other accounts.

Balance Method

In the Balance method, instead of transferring the totals of both debit and credit, the net balance

of every account for example in case of cash account of ` 10,000 (45,000 – 35,000) is shown on the

debit side of trial balance.

Cash Account

To _____ xxxx By _____ xxxx

By balance c/d 10,000

Total 45,000 Total 45,000

To balance b/d 10000

If the debit side is greater than the credit side the difference is termed as debit balance. Creditors

have ` 70,000 as debit total and ` 80,000 as credit total. The closing balance is shown on the credit

side.

Creditors Account

To ______ xxxx By ______ xxxx

To balance c/d 10000

Total 80000 Total 80000

By balance b/d 10000

If the credit side is greater than the debit side the difference is termed as credit balance.

Proforma of Trial Balance under Balance Method

Trial Balance as On _________

Particulars Debit balance

Credit Balance

Cash 10,000

Creditors 10,000

Total 10,000 10,000

Accounting Procedure 147

In the second method only the difference (debit balance/credit balance) is alone considered. The

same principle is adopted for all the other accounts. In the first method, more details are revealed but it

is cumbersome. The second method gives the gist of the account and hence the second method is

popular.

PREPARATION OF TRIAL BALANCE

The following steps should be followed to prepare a Trial Balance.

(a) Prepare the ledger accounts

(b) Balance them at the end of accounting period

(d) Group all those accounts showing credit balance and show them on the right hand side of

trial balance.

(e)

Total

the

debits

and

credits

and

they

must

equal,

what

ever

the

method

preparing

the trial balance.

We can conclude that normally the balances are debit or credit according to following tabular

summary.

Debit Balances Credit Balances

Drawing a/c Capital a/c

Purchases a/c Sales a/c

Sales return a/c Purchase return a/c

Opening stock a/c Income a/c

Expenses a/c Bank overdraft a/c

Real a/c or Property a/c Bank loan a/c

Bank a/c Creditors a/c

Cash a/c Lender’s or Depositor’s a/c

Debtors a/c Advances from customers a/c

Accounts of the persons to whom loans are given Reserves and provident funds a/c (Except

reserve for discount on creditors

Advances to supplier’s a/c

Investment a/c

Illustration 15

On 31st March, 2008 the totals of debit and credit sides of various ledger accounts and receipts

and payments sides of cash and bank columns of cash book of Ronak were as under:

Total of debit

side `

Name of the account Total of credit

side `

10,000 Capital 1,35,000

25,000 Drawings –

15,000 Stock on 31st March, 2008 –

1,90,000 Purchases 4,000

148 Introduction to Financial Accounting

– Purchase returns 18,000

6,000 Sales 2,45,000

13,000 Sales returns –

12,000 Expenses –

3,05,000 Customers 2,50,000

2,00,000 Suppliers 2,35,000

1,00,000 Car –

2,81,000 Dena Bank 2,75,000

43,000 Cash 38,000

You are asked to prepare gross trial balance of Ronak as on that date.

Solution

Ronak

Gross Trial Balance as on 31st March, 2008

Sr. No. Account Head L.F. Dr. ` Cr. `

1 Ronak’s capital a/c 10,000 1,35,000

2 Ronak’s drawings a/c 25,000 –

3 Opening stock 15,000 –

4 Purchases 1,90,000 4,000

5 Purchase returns – 18,000

6 Sales 6,000 2,45,000

7 Sales returns 13,000 –

8 Expenses 12,000 –

9 Customers 3,05,000 2,50,000

10 Suppliers 2,00,000 2,35,000

11 Car 1,00,000 –

12 Dena Bank 2,81,000 2,75,000

13 Cash 43,000 38,000

12,00,000 12,00,000

Trial Balance: (Net trial balance)

Net trial balance is taken in the following stages:

1. Take totals of debit column of each ledger account.

Take

totals

credit

column

each

ledger

account.

3. Find out which of the totals is greater and the extent by which it is greater.

Take

totals

receipts

side

cash

and

bank

columns.

5. Take totals of payments side of cash and bank columns.

Find

out

which

the

total

greater

and

the

extent

which

greater.

Accounting Procedure 149

Write

the

names

all

accounts

per

the

ledger,

and

also

cash

and

bank

accounts

per

the

cash book onto a statement.

Enter

the

trial

balance

the

differences

between

the

debit

and

credit

sides

each

ledger

account, cash and bank accounts on that side on which the total is greater. Thus

(a)

the

total

the

debit

side

account

600

and

the

total

the

credit

side

the

accounts is

400, enter

200 in the “debit” column of the trial balance, and

(b)

the

other

hand,

the

total

the

debit

side

account

500

and

the

total

the

credit

side

the

account

800,

enter

300

the

“

credit

”

column

the

trial

balance;

and

(c)

the

total

the

debit

side

1,000

and

the

total

the

credit

side

also

1,000,

not enter any figure in either the debit or the credit columns.

9. Take the total of the debit column.

10. Take the total of the credit column.

If should be noted that all the above steps should be taken as on one particular date.

Taking the facts of Illustration1, let us process the data.

Total of Heavler balance

Sr.

No.

Account head L.F Debit ` Credit ` Debit side ` Credit side `

1 Ronak’s capital 10,000 1,35,000 – 1,25,000

2 Ronak’s drawings 25,000 – 25,000 –

3 Opening stock 15,000 – 15,000 –

4 Purchases 1,90,000 4,000 1,86,000 –

5 Purchase returns – 18,000 – 18,000

6 Sales 6,000 2,45,000 – 2,39,000

7 Sales returns 13,000 – 13,000 –

8 Expenses 12,000 – 12,000 –

9 Customers 3,05,000 2,50,000 55,000 –

10 Suppliers 2,00,000 2,35,000 – 35,000

11 Car 1,00,000 – 1,00,000 –

12 Dena Bank 2,81,000 2,75,000 6,000 –

13 Cash 43,000 38,000 5,000 –

` 12,00,000 12,00,000

We can now prepare the trial balance.

Solution

Ronak’s trial balance as on 31st March, 2008

Sr.

No.

Account head L.F. Dr. ` Cr. `

1 Ronak’s capital – 1,25,000

2 Ronak’s drawings 25,00 –

3 Opening stock 15,000 –

150 Introduction to Financial Accounting

4 Purchases 1,86,000 –

5 Purchases returns – 18,000

6 Sales – 2,39,000

7 Sales returns 13,000 –

8 Expenses 12,000 –

9 Customers 55,000 –

10 Suppliers – 35,000

11 Car 1,00,000 –

12 Dena Bank 6,000 –

13 Cash 5,000 –

` 4,17,000 4,17,000

Illustration 16

Gautam hands over to you his books of accounts for the year ended 31

March, 2008 and also the

following gross trial balance as on that date:

Sr.

No.

Account Head L.F. Dr. ` Cr. `

1 Customers 15,80,000 12,40,000

2 Suppliers 8,75,000 10,90,000

3 Fixed assets 2,55,000 42,000

4 Stock on 31/3/2008 1,00,000 –

5 Cash 2,45,000 2,43,000

6 Bank of India 8,90,000 9,50,000

7 Bank of Baroda 5,80,000 5,75,000

8 Purchases 9,00,000 25,000

9 Sales 30,000 13,00,000

10 Purchase returns – 40,000

11 Sales returns 50,000 –

12 Expenses 60,000 –

13 Interest 50,000 –

14 Lenders 2,00,000 5,00,000

15 Advances to suppliers 2,65,000 55,000

16 Advances from customers 1,20,000 1,30,000

17 Capital 3,00,000 3,10,000

65,00,000 65,00,000

Gautam wants you to prepare his trial balance.

Accounting Procedure 151

Solution

Gautam’s trial balance as on 31st March, 2008

Sr.

No.

Account head L.F. Dr. ` Cr. `

1 Customers 3,40,000

2 Suppliers – 2,15,000

3 Fixed assets 2,13,000

4 Stock on 31/3/2008 1,00,000 –

5 Cash 2,000 –

6 Bank of India – 60,000

7 Bank of Baroda 5,000 –

8 Purchases 8,75,000 –

9 Sales – 12,70,000

10 Purchase returns – 40,000

11 Sales returns 50,000 –

12 Expenses 60,000 –

13 Interest 50,000 –

14 Lenders – 3,00,000

15 Advances to suppliers 2,10,000 –

16 Advances from customers – 10,000

17 Capital – 10,000

` 19,05,000 19,05,000

Illustration 17

Pooja started business on 1st June 2008 with cash balance of ` 5,000. The following transactions

took place during June 2008:

Transaction Dates

Cash purchases: 1st June 4,000

5th June, 5,000

10th June, 6,000

15th June, 6,000

20th June, 7,000

25th June, 7,000

30th June, 7,000

Cash sales: 1st to 4th June, 5,200

5th to 9th June, 6,300

10th to 14th June, 6,400

15th to 19th June, 7,500

152 Introduction to Financial Accounting

20th to 24th June, 7,500

25th to 29th June, 7,500

30th June, 1,500

Expenses: 5th June, 200

10th June, 300

15th June, 300

20th June, 300

25th June, 300

30th June, 300

You are asked to show ledger accounts and prepare gross and net trial balances as on 30

June,

2008.

Solution

Dr. Cash a/c LF 1 Cr.

2008 Particulars JF ` 2008 Particulars JF `

Jun. 1 To Capital a/c 5,000 Jun. 1 By Purchase a/c 4,000

4-7 “ Sales a/c 5,200 5 “ “ “ 5,000

5-9 “ “ “ 6,300 “ Expenses a/c 200

10-14 “ “ “ 6,400 10 “ “ “ 300

15-19 “ “ “ 7,500 “ Purchase a/c 6,000

20-25 “ “ “ 7,500 15 “ “ “ 6,000

25-29 “ “ “ 7,500 “ Expenses a/c 300

30 “ “ “ 1,500 20 “ “ “ 300

“ Purchases a/c 7,000

25 “ “ “ 7,000

“ Expenses a/c 300

30 “ “ “ 300

“ Purchases a/c 7,000

“ Closing balance 3,200

46,900

Dr. Poojas capital a/c LF 2 Cr.

2008 Particulars JF

Jun. 30 To Balance c/d 5,000 Jun.1 By Cash a/c 5,000

Accounting Procedure 153

Dr. Purchase a/c LF 3 Cr.

2008 Particulars JF ` 2008 Particulars JF `

Jun 1 To Cash a/c 4,000 Jun. 30 By Balance c/d 42,000

5 “ “ “ 5,000

10 “ “ “ 6,000

15 “ “ “ 6,000

20 “ “ “ 7,000

25 “ “ “ 7,000

30 “ “ “ 7,000

` 42,000 ` 42,000

Dr. Purchase a/c LF 3 Cr.

2008 Particulars JF ` 2008 Particulars JF `

Jun 1 To Cash a/c 200 Jun. 30 By Balance c/d 1,700

5 “ “ “ 300

10 “ “ “ 300

15 “ “ “ 300

20 “ “ “ 300

25 “ “ “ 300

30 “ “ “ 300

` 1,700 ` 1,700

Dr. Purchase a/c LF 3 Cr.

2008 Particulars JF ` 2008 Particulars JF `

Jun. 30 To Balance c/d 41,900 Jun. 1-4 By Cash a/c 5,200

5-9 “ “ “ 6,300

10-14 “ “ “ 6,400

15-19 “ “ “ 7,500

20-24 “ “ “ 7,500

25-29 “ “ “ 7,500

30 “ “ “ 1,500

41,900

Pooja’s trial balance as on 30th June, 2008

L.F. Gross Net

Dr. ` Cr. ` Dr. ` Cr. `

Cash 1 46,900 43,700 3,200 –

Pooja’s capital 2 – 5,000 – 5,000

154 Introduction to Financial Accounting

Purchases 3 42,000 – 42,000 –

Expenses 4 1,700 – 1,700 –

Sales 5 – 41,900 – 41,900

90,600 90,600 46,900 46,900

PROBLEMS ON SIMPLE CASH BOOK

Q.1. Enter the following transactions in a simple cash Book of Mr. Deven & also post them

to ledger.

2009 March

1 Started business with cash

25,000.

Purchased

goods

for

cash

3,000.

7 Sold goods for cash worth

2,000.

Deposited

into

Bank

2,000.

14 Purchased goods from Mr. Suraj worth 10,000 & paid half the amount immediately.

Received

Interest

4,000.

19 Sold goods to Mr. Popatlal worth

5,000.

Paid

Rent

1,000.

25 Received commission

3,000 from Mr. Keshavchandra.

Paid

Life

Insurance

Premium

proprietor

2,500.

29 Cash purchases

3,000.

Cash

sales

5,000.

Q.2. Record the following transactions in a simple Cash Book of Mr. Mohit for the month

March 2011.

2011 Mar.

Started

business

with

cash

55,000.

4 Opened a current account with bank and deposited

20,000.

Purchased

goods

for

cash

15,000.

9 Paid electricity bill

1,000.

Invested

Government

Bonds

3,000.

17 Sold goods for cash

7,000.

Paid

life

insurance

premium

Mr.

Mohit

2,400.

22 Purchased goods for cash

5,000 @10% trade discount.

Received

dividend

4,000.

26 Paid for transport

760.

Received

account

from

Rahul

3,240.

31 Deposited into bank cash in excess of

4,000.

Q.3. Journalise the following transactions in the books of Abhijit.

2014

June1 Abhijit started business with

20,000.

Accounting Procedure 155

4 Paid into State Bank of India

10,000.

9 Purchased goods from Kiran

5,500.

15 Goods sold for cash

4,500.

20 Total cash purchases

7,500.

21 Sold goods to Heena

5,000.

23 Received a cheque of

5,000 from Heena.

27 Withdrew from Bank for personal use

3,000.

28 Received commission

2,700.

30 Paid staff salaries

1,500.

Q.4. Journalise the following transactions in the books of Mr. Jamshed.

2014

Dec.

Business

started

with

cash

50,000,

Machinery

40,000,

Furniture

20,000,

Loan

from

Ratan

10,000,

Bills

payable

5,000.

5 Cash deposited into bank

10,000 for opening an account.

Goods

purchased

from

Mr.

Dhiru

bhai

50,000

10%

T.D.

Sold

goods

Mr.

Mafat

lal

10,000

10%

T.D.

10%

C.D.

Half

amount

received in cash & other half received by cheque.

Paid

salary

500,

wages

200

Interest

300.

20 Received commission

1,000 & dividend

3,000 by cheque.

Goods

purchased

from

Dhiru

bhai

20,000

10%

T.D.

10%

C.D.

half

amount

paid

cash.

Goods

sold

Mr.

Birla

10,000

C.D.

10%

T.D.

Received

1/4th

amount

cash & 1/4th amount by cheque.

Paid

Salary

400,

Wages

300

Interest

100

cheque.

29 Received commission from Mr. Anil

2,000.

Withdrawn

for

personal

use

from

office

cash

600

from

Bank

400.

Q.5. Give Journal entries for the following transactions and Prepare Trial balance

2014

Jan.1. Pratik started the business with cash ` 10,000/- & machinery ` 2,000.

4. Purchased Goods worth ` 7,000 from Amar & paid ` 1,000 to Amar immediately.

6. Office rent paid ` 400.

10. Cash sale ` 6,000.

14. Mr. Pratik took away cash ` 450 for his domestic use.

20. Sold Goods on credit to Vinay for ` 10,000 with T.D. @ 10%.

24. Purchased machinery worth ` 7,000 on credit from Mehul Engineering Ltd. & paid

carriage there on ` 500.

27. Old machinery cost ` 2,000 (Book value = ` 1,400) was sold for cash ` 1,800.

31. Vinay paid the amount due in cash.

156 Introduction to Financial Accounting

EXERCISE

Give one word, term or phrase for the following statement

The

amount

discount

which

deducted

from

invoice.

2. An allowance made by the receiver of cash to the giver of cash who pays it.

allowance

deduction

made

manufacturer

wholesaler

retailer

purchaser

the

catalogue

price

invoice

price.

4. The book of daily records

The

process

recording

transactions.

6. Account of proprietor.

Page

Journal.

8. Discount which is recorded in books of account

Discount

which

not

recorded

the

books

account

Ans.: 1. Trade discount, 2. Cash discount, 3. Trade discount, 4. Journal, 5. Journalisation,

6. Capital, 7. Journal folio, 8. cash discount, 9. Trade discount.

Short Answers

1. What are the contents of Journal?

2. Explain in brief the utility of Journal.

3. What is Compound entry?

Long Answers

1. What is the significance of Journal as a book of prime entry?

2. Why and when discount is allowed? How they are recorded?

BANK RECONCILIATION STATEMENT

The Bank Reconciliation Statement is an aid used to ensure the accuracy of transactions

appearing in the bank columns of the cash book. Such transactions can be verified through an external

record, namely, the bank statement received periodically from the banker. While the business keeps a

record of its transactions through the bank columns in the cash book, the banker in turn maintains the

bank's transactions with the business in his ledger. An extract from this ledger showing details of the

transactions during a specified period is sent at frequent intervals by the bank to the business and this

extract is referred to as a bank statement.

Reasons for Difference between Bank Balances as per Cash Book and Pass

Book

The relationship between the customer and the banker is that of a creditor and a debtor. So, if the

bank columns of the cash book show a debit balance as on a specified date, the bank statement should

show an equal amount of credit balance as on that date and vice versa. However, the balances shown

by the two independent records may not always agree due to the following:

(a)

Checks

issued

the

business

its

suppliers

other

parties

may

not

have

been

presented

for payment.

(b) Checks received from customers and deposited may not have been collected by the banker.

(c)

Deposits

may

have

been

directly

made

the

customers

into

the

bank

account

the

enterprise.

(d)

Collection

charges,

service

charges

and

interest

overdraft

charged

the

banker.

The

business

can

ascertain

the

exact

amount

charges

and

record

them

the

cash

book

only

after the receipt of the bank statement.

(e)

Interest

credited

bank

for

the

balance

maintained

with

and

any

other

income

such

interest

securities,

dividend,

etc.

collected

the

bank

behalf

the

business

can

ascertained only from the bank statement.

(f)

Wrong

entries

made

the

business

the

cash

book

errors

committed

the

bank

its

ledger.

(g) Omission of entries in the two sets of books.

(h) Dishonour of customers checks deposited in the bank account.

The Effect of Each of These Entries is Explained Below

Cheques Issued but not Presented for Payment: When a check is issued to a third party, it is

entered in the cash book by crediting the Bank a/c resulting in reducing the bank balance in the

CHAPTER

Reconciliation and Rectification

158 Introduction to Financial Accounting

depositor's books. But bank debits the customer's account only when the check is presented by that

third party. So, till it is presented and paid for, the bank’s pass book shows more balance than shown

by the depositor's cash book.

Cash Book (Bank Column only)

Date Particulars ` Date Particulars `

04.03.14 To Balance b/d 15,000.00 05.03.14

05.03.14

By Rajan Traders a/c

By Balance c/d

2,00,000

13,000.00

15,000.00 2,00,000

Pass Book

Date Particulars Dr. (withdrawn) Cr. (deposited) Balance `

04.03.14 To Balance b/d 15,000.00 (cr)

Cheques Deposited and Remaining Uncollected: Whenever a check is received by a person

from a third party and he deposits it in a bank, he will debit Bank a/c and credit the a/c of third party in

his own books. His bank balance (in cash book) is therefore increased. But bank will credit that

cheque not when it is deposited but only when that amount has been realized. Until the cheque has

been collected, the balance appearing in the pass book would be less than the balance in the Bank a/c

of cash book.

Cash Book (Bank Column only)

Date Particulars ` Date Particulars `

05.05.14

07.05.14

To Balance b/d

To Mr. Balaram a/c

10,000

5,000

05.03.14

By Balance c/d 15,000

15,000 15,000

Bank Statement

Date Particulars Dr. (withdrawn) Cr. (deposited) Balance `

04.03.14 To Balance b/d 10,000.00

So, balance as per bank statement is ` 5,000 less than the balance in the cash book.

Deposits Directly Made into Bank a/c of the Enterprise: If suppose a debtor credits the

amount directly into the bank account of a company, the balance in the pass book increases without a

corresponding increase in the cash book (bank column) until it receives the information from the bank.

Dr. Cash Book (Bank Column only) Cr.

Date Particulars ` Date Particulars `

To Balance b/d 5,000 By Balance c/d 5,000

5,000 5,000

Reconciliation and Rectification 159

Pass Book

Date Particulars Dr. Cr. Balance `

04.03.14 To Balance b/d

By Cash

10,000 5,000

15,000

Bank Charges: Bank charges some amount from customer by way of incidental charges,

collection charges, etc. These adjustments are shown in the pass book as and when they occur and

hence the balance in the pass book decreases. Only when the customer collects his pass book and

verifies it, he will not know about it and hence the balance in the bank column of cash book shown is

more.

Dr. Cash Book (Bank Column only) Cr.

Date Particulars ` Date Particulars `

To Balance b/d 3,000 By Balance c/d 3,000

Pass Book

Date Particulars Dr. Cr. Balance `

To Balance b/d

By Cash 15 10,000

3,000(cr)

2,985(cr)

Similarly, interest on deposits credited by the bank leads to an increase in balance in bank’s pass

book without corresponding increase in the cash book.

1. In addition to the above-mentioned transactions, the balances may not agree because of

omission

entries

two

sets

books.

Wrong

entries

made

the

business

cash

book

errors

committed

the

bank

its

ledger.

Dishonour

customers

cheques

deposited

the

bank

account.

THE RECONCILIATION STATEMENT

On receipt of the bank statement, a comparison of the entries in the Cash Book with those

appearing in the bank statement will help in identifying the items causing the difference in the two

balances. While the difference due to (i) and (ii) above will be eliminated in the near future (that is,

creditors will soon present their cheques for payment and customer checks will be collected by the

bank in due course), the difference due to items (iii) to (v) can be eliminated only if such items are

recorded in the cash book. In addition, the business must rectify any errors in the cash book, include

any transactions omitted and record the dishonour, if any, of customers' cheques. After these

adjustments have been recorded, a statement will be prepared to reconcile the balance as shown by the

cash book with that shown by the pass book. This statement is referred to as Bank Reconciliation

Statement. It must be understood that this reconciliation statement will generally contain details of:

(a) Cheques issued and not presented,

(b) Cheques deposited and remaining uncollected,

(d) Omission of entries in the bank statement.

160 Introduction to Financial Accounting

The bank reconciliation statement is, thus, an additional tool available to check the accuracy of

the bank columns of the cash book.

Advantages of Bank Reconciliation Statement

(i)

Error

Detection:

helps

detection

errors

omission

transactions

wrong

recording

transactions

either

the

bank

the

business

enterprises.

Errors

identified

the books by preparing BRS can be rectified.

(ii)

Delay

Collection

Revealed:

The

delay

the

collection

cheques,

bills,

etc.,

any,

are

revealed,

when

BRS

prepared.

The

matter

can

pursued

avoid

unnecessary

delays

collection.

also

helps

the

management

keep

track

the

cheques

and

bills

sent

for

collection.

(iii)

Completion

Cash

Book:

Business

enterprises

get

information

about

bank

charges,

cheques

dishonoured,

direct

payments,

direct

deposits,

etc.

from

the

bank

statement

only.

Entries

the

same

are

made

the

cash

book

the

basis

bank

statement.

Thus,

complete

the

cash

book,

comparison

and

reconciliation

cash

book

and

bank

book

essential.

(iv)

Chances

Embezzlements

are

Reduced:

Periodical

comparison

cash

book

and

pass

book

keeps

check

the

office

staff.

For

example,

entry

for

cash

deposit

appearing

the

cash

book,

but

not

the

pass

book,

indicates

fraud

being

committed

the

staff.

This

type of frauds come to light when Bank Reconciliation Statement is prepared.

STEPS IN PREPARATION OF BRS

Take

the

cash

book

passbook

balance

starting

point.

The

following

points

have

noted

while

taking

the

starting

balance.

(i) Debit balance as per cash book indicates favourable balance.

(ii)

Credit

balance

per

cash

book

means

overdraft

unfavourable

balance.

(iii) Debit balance as per pass book means overdraft or unfavourable balance.

(iv)

Credit

Balance

per

pass

book

means

favorable

balance.

the

starting

point

denotes

favourable

balance

per

cash

book

pass

book,

take

positive

figure.

However,

the

starting

point

denotes

negative

unfavourable

balance,

take it as a negative figure.

Adjust

the

starting

point

amount

per

the

information

given

and

analyze

its

impact

the

other

balances.

After

adjusting

all

the

differences

errors,

the

balance

per

the

other

book

obtained.

the

final

balance

positive,

denotes

favourable

balance

(Debit

balance

per

cash

book

credit

balance

per

the

pass

book).

However,

the

final

balance

negative,

denotes

the

unfavorable

balance

overdraft.

(Credit

balance

per

cash

book

debit

balance

per

pass book).

The following table summarizes the impact of various differences and errors on the starting

balance.

Reconciliation and Rectification 161

Bank Reconciliation Statement

Item ` `

Bank Balance as per Cash Book *******

Overdraft balance as per Pass Book

Add:

1. Cheques issued but not cleared *****

2. Direct payments made by customers *****

3. Amount collected by bank (rent, dividends, interest, on investment, etc.) *****

4. Cheques deposited but omitted to be recorded in cash book *****

5. Wrong credit on the credit side of pass book *****

*****

Less:

1. Cheques deposited but not collected *****

2. Cheques paid into the bank but dishonoured *****

3. Bank charges and interest charges *****

4. Payments made by the banker on behalf of the trader *****

5. Cheques issued but not recorded in the cash book *****

6. Wrong entry on the debit side of the pass book *****

*****

Illustration 1

On March 31, 1991, the cash book of Prithvi Limited showed a bank balance (debit) of ` 48,500.

However, the bank statement showed a credit balance of ` 53,900 as on the same date. A detailed

comparison of entries revealed the following:

(a) Customers' cheques amounting to ` 8,450 had not been collected by the bank as on

31.3.1991.

(b) Certain cheques amounting to

8,850 had not been presented for payment as on 31.3.19 91.

(c)

Bank

charges

1,000

and

interest

investments

2,500

collected

the

banker

appear

only

the

bank

statement.

(d) A wrong credit of

2,500 in the bank statement.

(e)

Swaroop

Limited,

customer,

had

paid

into

the

bank

directly

sum

3,000

March

29,

1991.

This

has

not

been

recorded

the

Cash

Book.

(f)

cheque

for

2,000

received

from

Excel

Limited,

customer,

and

deposited

had

been

returned unpaid. The dishonour of this cheque has not been entered in the Cash Book.

Prithvi Limited will first pass the necessary rectification entries in the cash book and then prepare

a reconciliation statement.

162 Introduction to Financial Accounting

Cash Book of Prithvi Limited (Bank Colums only)

Date Receipts Bank ` Date Payments `

1991 1991

March 31 To Balance b/d By 48,500 March 31 Bank Charges 1,000

March 31 To Interest Received 2,500 March 31 By Excel Limited 2,000

March 31 To Swaroop Limited 3,000 March 31 By Balance c/d 51,000

54,000 54,000

Solution

Bank Reconciliation Statement as on March 31, 1991

Particulars ` `

Bank Balance as per Cash Book 51,000

Add: Checks Issued and Not Prsented 8,850

Wrong Credit in the Bank Statement 2,500 11,350

62,350

Less: Checks Deposited and Remaining Uncollected 8,450

Bank Balance as per bank Statement 53,900

Illustration 2

Mr. Q maintains two accounts known as account No.1 and account No. 2 in Bank of Maharashtra.

On 31

December 1991, the overdraft as per pass book for account No. 1 is ` 86,552. But the

overdraft as per cash book is not the same, and on comparing the pass book and the cash book, he

finds the following:

(i)

Out

the

total

cheques

7,400

deposited

December,

one

cheque

amounting to

2,650 was collected on 4

January, 1992.

(ii)

Out

the

total

cheques

12,560

issued

December

two

cheques

1,500

each were not presented until 31

December, 1991.

(iii)

cheque

amounting

2,260

was

sent

the

supplier,

through

post

December,

1991 and it is expected to reach him only after 3

January, 1992.

(iv)

Bank

charges

amounting

and

interest

charges

amounting

262

have

not

yet

been

recorded in the cash book.

(v)

Mr.

has

deposited

cheque

his

account

No.2,

for

1,000

December,

was

wrongly credited to account No.1 by the bank.

(

vi)

cheque

deposited

December,

for

500

was

returned

dishonoured

bankers

on 2

January, 1992.

(vii)

cheque

200

issued

for

account

No.1

mistake

was

recorded

bank

column

the

cash

book

for

account

No.

and

this

cheque

was

presented

for

payment

January,

1992.

From the above particulars, prepare a bank reconciliation statement to find out the Bank

Overdraft as per cash book.

Reconciliation and Rectification 163

Solution

Bank Reconciliation Statement as on 31

December, 1991

Particulars ` `

Bank Overdraft as per Pass book: 86,552

Add: Cheques issued but not presented for payment 3,000

Add: Cheque sent to the supplier through post, but has not reached him,

hence, not presented for payment

2,260

Add: Cheque wrongly credited to account No.1 by bank instead of account

No. 2

1,000 6,260

92,812

Less: Cheques deposited but not yet collected by the bank 2,650

Less: Bank charges and interest not recorded in cash book 325

Less: Cheque deposited on 15th December, 1991, but not cleared by the until 500 3,475

December, 1991

Bank Overdraft as per Cash Book 8,933

Note: Item No. (vii), will not make impact as on 31

December, 1991, as it was presented for

payment only on 4

January, 1992 and the cash book (Bank column) of account No. 2 is affected and

not account No. 1.

Illustration 3

On 31, March, 2001, the Cash Book of a firm showed a balance at bank for ` 40,000. From the

information given below prepare a Bank Reconciliation Statement.

1. Cheques issued for ` 7,000 have not yet been presented at the bank for payment.

Cheques

amounting

8,000

were

paid

March

but

have

not

been

credited

the

bank.

One

cheque

for

2,500

was

entered

the

Cash

Book

March,

but

was

banked

April.

cheque

from

Suresh,

for

3,000,

paid

March

was

dishonoured

but

the

advice

the dishonour was received only on the 2

April 2001.

Pass

book

included

bank

charge,

100

its

debit

side.

6. Pass book showed

2,500 collected by the bank as interest on securities.

Solution

Bank Reconciliation Statement as on March 31, 2001

Particulars

` `

Balance as per Cash Book 40,000

Add:

Cheques issued but not yet presented 7,000

Interest collected by the bank but not yet entered in the Cash Book 2,500 9,500

49,500

164 Introduction to Financial Accounting

Less:

Cheques paid in but not yet collected 8,000

Cheques entered in Cash Book but not yet paid in 2,500

Cheques dishonoured but not yet entered in Cash Book 3,000

Bank charges not yet entered in Cash Book 100 13,600

Balance as per Pass Book 35,900

Illustration 4

On March 31, 2001, the cash book of Sai Apna Ltd. showed an overdraft balance of ` 12,500 and

this balance did not agree with the balance as per bank statement. On verification, the following facts

were discovered.

(a)

cheque

for

3,400

deposited

March

24,

2001

was

dishonoured

bankers

April

3, 2001.

(b)

Bank

charges

amounting

180

and

interest

charges

amounting

615

have

not

been

recorded

the

cash

book.

(c)

Certain

cheques

amounting

7,250

have

not

been

presented

for

payment

March

31,

2001.

(d) Interest on investment of

2,000 collected by the banker appears only in the bank statement.

(e)

The

debit

side

the

cash

book

had

been

overcasted

900.

You are required to find out the balance as per bank book.

Solution

Bank Reconciliation Statement of Sai Apna Ltd.

` `

Overdraft balance as per Cash Book 12,500

Add:

(a) A cheque deposited on March 24, 2001 dishonoured 3,400

(b) Bank charges (entered only in pass book) 180

(d) Adjustment of cash book 900 5,095

Less:

(a) Cheques issued but not presented for payment 7250

(b) Interest on investment directly credited to bank account 2000 9250

Overdraft as per Pass Book 8,345

Reconciliation and Rectification 165

Illustration 5

Prepare a Bank Reconciliation Statement as on 30

September, 1991 from the following entries

in the Bank Column of the Cash Book and the corresponding Pass Book

Cash Book (Bank Column only)

Date Particulars ` Date Particulars `

Sept. 1 To Balance b/d 8,000 Sept. 4 By Drawings 700

3 To Kamlesh 2,200 8 By Suresh 3,300

9 To Prabhu 1,500 12 By Salary 2,800

16 To Pawan 3,400 16 By Manish 1,700

23 To Satish 2,600 18 By Shyam 4,200

27 To Mohan 100 21 By Kapil 2,000

30 To Kapoor 350 26 By Seeta 1,100

30 By Commission 100

30 By Balance c/d 2,250

18,150 18,150

Bank Pass Book

Date Particulars Debit ` Credit ` Balance

Sept. 1 By Balance b/d Cr. 8,000

4 To Cheque-Drawings 700 Cr. 7,300

5 By Cheque-Kamalesh 2,220 Cr. 9,500

9 To check-Suresh 3,300 Cr. 6,200

11 By Cheque-Prabhu 1,500 Cr. 7,700

12 To Cheque-Salary 2,800 Cr. 4,900

17 To Cheque-Manish 1,700 Cr. 3,200

20 By Cheque-Satish 2,600 Cr. 5,800

30 By Dividend Received 900 Cr. 6,700

To Bank Charges 15 Cr. 6,685

To Electricity Bill 60 Cr. 6,625

To Check-Commission 100 Cr. 6,525

Solution

Bank Reconciliation Statement as on 30. 9.1991

Particulars `

Balance as per Bank column of cash Book 2,250

Add: Cheques Issued but not presented

166 Introduction to Financial Accounting

Shyam 4,200

Kapil 2,000

Seeta 1,100 7,300

9,550

Less: Cheque deposited but not cleared

Pawan 3,400

Mohan 100

Kapoor 350 3,850

5,700

Add: Amount credited in Pass Book only

Dividend received

900

6,600

Less: Amounts debited in Pass Book only

Bank charges 15

Electricity bill 60 75

Balance as per Pass Book 6,525

Errors and their Rectification: An error is an unintentionally committed mistake. When the

Trial Balance does not tally it is a clear indication that there are some errors in the preparation of

accounts. The errors may be committed at various stages:

1. Journalizing,

2. Posting,

3. Casting (totaling),

4. Balancing,

5. Transferring to trial balance and so on.

Mere tallying of the trial balance does not ensure an error free statement. There are certain errors

such as errors of omission, error of principle and compensating errors are not disclosed by trial

balance while errors of casting, posting to wrong side of an account or posting a wrong amount can be

detected by trial balance.

Errors whether disclosed or not disclosed by trial balance have to be corrected or rectified in

order to obtain the correct picture of profit or loss. It should be remembered that errors will have their

impact not only on profit but also on the asset and liability position of the business organization.

Errors Disclosed by Trial Balance: Those errors that can be disclosed by trial balance can

easily be located. As soon as the trial balance does not tally, the accountant can proceed to find out the

spots where the errors might have been committed. The total amount of difference in the trial balance

is temporarily transferred to a 'Suspense Account' so that it can be mitigated as and when the errors get

rectified. Therefore, the suspense account gets debited or credited as the case may be on rectification

of these types of errors. The following are the errors which are disclosed by trial balance:

Reconciliation and Rectification 167

(a)

Posting

Wrong

Amount:

This

mistake

may

occur

while

posting

entry

from

subsidiary

book to ledger.

(b)

Posting

the

Wrong

Side

Account:

This

error

committed

while

posting

entries

from subsidiary books to ledger.

168 Introduction to Financial Accounting

(c)

Wrong

Totaling:

Both

undercasting

and

overcasting

are

detected

trial

balance.

any

account is wrongly totaled, it gets reflected in the trial balance.

(d)

Omitting

Post

Entry

from

Subsidiary

Book

Ledger:

entry

made

the

subsidiary book does not get posted to ledger, the trial balance does not tally.

Reconciliation and Rectification 169

(e)

Omission

Account

Altogether

from

Being

shown

Trial

Balance:

(f)

Posting

Amount

Correct

Account

than

Once:

This

result

imbalance

the

trial

balance.

170 Introduction to Financial Accounting

(g) Posting an Item to the Same Side of Two Different Ledger Accounts: If two accounts are

debited/credited for the same transaction, this type of error occurs.

(h)

Errors

Not

Disclosed

Trial

Balance:

There

are

four

errors

regarded

those

which

not

affect

trial

balance

and

difficult

locate

them.

brief

description

the

four

errors

is offered in the following paragraphs:

(a)

Error

Omission:

Error

omission

occurs

when

transaction

completely

omitted

from the books of accounts.

Since

both

aspects

—

debit

and

credit

—

the

transaction

are

missing,

the

trial

balance

not

affected

all.

rectify

such

errors,

the

transaction

should

recorded

when

traced.

Reconciliation and Rectification 171

(b)

Error

Commission

the

error

wrong

posting,

wrong

casting,

wrong

calculation

etc., committed in the books of original entry or ledger, it is said to be error commission.

(c)

Error

Principle:

While

drawing

journal

entries,

often

error

principle

committed

and this goes unnoticed because it does not affect the total of trial balance.

172 Introduction to Financial Accounting

Similarly,

treating

incomes

liabilities,

providing

insufficient

provision

for

bad

and

doubtful

debts,

inadequate

depreciation

against

assets

etc.,

come

under

errors

principle.

They must be rectified by applying the correct principles of accounting.

(d)

Compensating

Errors:

also

called

off-setting

error.

Compensating

error

one

which

is counterbalanced by another error.

Steps to Locate the Errors: The following steps help to locate the errors. In spite of the efforts,

if the difference in the trial balance persists, a suspense account may be created and subsequently the

suspense account can be eliminated as and when the errors are located and rectification is made.

1. Check the totals of both debit side and credit side of the trial balance.

Check

the

totals

debtors

and

creditors

accounts.

3. Find out whether all ledger balances are carried to trial balance.

Verify

the

totals

all

the

ledger

accounts.

Divide

the

amount

difference

the

trial

balance

and

see

any

item

the

debit

credit side, equal to that amount has been posted to the opposite side.

Check

whether

the

opening

balances

are

brought

down

correctly

from

the

accounting

period.

Make

comparison

with

trial

balance

the

year

find

out

there

are

any

items

missing.

Where

the

difference

the

trial

balance

divisible

then

the

difference

likely

due

misplacement

figures

for

21;

for

42;

for

and

on.

When errors are located, they should be rectified. It is not a good practice nor do we have the

legal right to erase the mistakes and rewrite the correct ones. Rectification entries are recorded in

General journal or journal proper.

Reconciliation and Rectification 173

Example

Goods ` 3,000/- sold to Nishikant has been debited to M/s Nishi & Co. A/c.

Solution

Entry Dr. Cr.

Wrong Entry

M/s Nishi & Co. a/c Dr. 3,000

To Sales a/c 3,000

Reverse Entry

Sales A/c Dr. 3,000

To M/s Nishi & Co. a/c 3,000

Correct Entry

Nishikant's a/c Dr. 3,000

To Sales a/c 3,000

Rectification Entry

Nishikant's a/c Dr. 3,000

To M/s Nishi & Co. a/c 3,000

Example

A credit purchase of ` 3,000 from Nishikant is posted to his account as ` 30,000.

Solution

Entry Dr. Cr.

Wrong Entry

Purchase a/c Dr. 3,000

To Nihikant's a/c 3,000

Reverse Entry Dr.

Nishikant's a/c 3,000

To Purchase a/c 3,000

Correct Entry

Purchase A/c Dr. 3,000

To Nishikant's a/c 3,000

Rectification Entry

Nishikant's a/c Dr. 3,000

To Purchase a/c 3,000

Example

A credit purchase from Nishi & Co. has been wrongly recorded in sales book ` 3,000/-

174 Introduction to Financial Accounting

Solution

Entry Dr. Cr.

Wrong Entry

M/s Nishi & Co. a/c Dr. 3,000

To Sales a/c 3,000

Reverse Entry

Sales a/c Dr. 3,000

To M/s Nishi & Co. a/c 3,000

Correct Entry

Purchase A/c Dr. 3,000

To M/s Nishi & Co. a/c 3,000

Rectification Entry

Purchase a/c Dr. 3,000

Sales a/c Dr. 3,000

To M/s Nishi & Co. a/c 3,000

Illustration 6

An accountant finds that the trial balance of his client did not tally and it showed an excess credit

of ` 69.74. He transferred it to a suspense account and later discovered the following errors.

(a) ` 44.37 paid to Anand has been credited to his account as ` 34.37.

(b) A purchase of

145.50 has been posted as

154.50 to the purchases account.

158 on repairs has been debited to the Buildings account.

(d)

80 was allowed by B as discount which has not been entered in the books.

(e) A sum of

125.05 realized on the sale of old furniture has been posted to the sales account.

Give journal entries to rectify the errors

Solution

Date Particulars L.F. Debit (`) Credit (`)

1 Anand's account Dr. 78.74

To Suspense account

(Being wrong amount, wrongly credited

to Anand's a/c recifited)

78.74

2 Suspense account Dr. 9.00

To Purchases account

(Being over debit of purchase a/c

rectified)

9.00

3 Repairs account Dr. 158.00

To Building account

(Being wrong debit given to building

account rectified)

158.00

Reconciliation and Rectification 175

4 B's account Dr. 80

To Discount received account

(Being discount received from B, omitted

earlier, brought to account)

5 Sales account Dr. 125.05

To Old furniture account

(Being sales of old furniture wrongly

transferred to sales account rectified)

125.05

Note:

1. The entry should have been:

Anand a/c Dr. 44.37

To Cash a/c 44.37

(Being cash paid to Anand accounted)

When

amount

paid

Anand,

his

account

should

have

been

debited.

the

other

hand,

his

account

was

credited

for

wrong

amount

34.37.

Hence,

there

has

been

excess

credit

the

extent

78.74

(44.37

34.37).

rectify

this

double

error

need

debit

Anand's

account to the extent of

78.74 and credit suspense account.

Purchases

account

was

overdebited

(

154.50

–

145.50).

rectify

this

error,

need to credit purchase account to the extent of

9 and debit suspense account.

Repairs

spent

building

are

mistake

debited

building

account.

This

error

principle. Repairs account is debited and buildings account is credited to rectify the error.

Discount

received

from

has

not

been

taken

records.

This

error

omission.

Therefore, it is now brought to accounts. This has not affected the trial balance.

When

old

furniture

sold,

the

furniture

account

should

have

been

credited.

the

other

hand,

sales

account

was

credited

against

the

principle

accounting.

rectify

the

error,

sales account is debited and old furniture account is credited.

Illustration 7

The trial balance of Evergreen Co Ltd. taken out as on 31

December, 2002 did not tally and the

difference was carried to suspense account. The following errors were detected subsequently.

(a) Sales book total for November was undercast by ` 1,200.

(b) Purchase of new equipment costing

9,475 has been posted to Purchases a/c.

(c)

Discount

received

1,250

and

discount

allowed

850

September

2002

have

been

posted

wrong

sides

discount

account

(d)

cheque

received

from

Mr.

Longford

for

1,500

for

goods

sold

him

credit

earlier,

though entered correctly in the cash book has been posted in his account as

1,050.

(e)

Stocks

worth

255

taken

for

use

Mr.

Dayananda,

the

Managing

Director,

has

been

entered

sales

day

book.

(f)

While

carrying

forward,

the

total

Returns

Inwards

Book

has

been

taken

674

instead

647.

(g)

amount

paid

cashier,

Mr.

Ramachandra,

775

salary

for

November

month

has

been

debited

his

personal

account

757.

(h) Pass journal entries and draw up the suspense account.

176 Introduction to Financial Accounting

Solution

Journal Proper of Evergreen Co. Ltd.

Date Particulars L.F. Debit (`) Credit (`)

31.12.2002 Suspense account Dr. 1,200

To sales account

(Being undercasting of sales book

rectified)

1,200

31.2.2002 New Equipment account Dr. 9,475

To Purchases account

(Being wrong debit given to

purchase account rectified)

9,475

31.12.2002 Discount allowed account Dr. 1,700

Suspense account Dr. 800

To Discount received account 2,500

(Being discount received and

discount allowed posted to wrong side of

discount account rectified)

2,500

31.12.2002 Suspense account Dr. 450

To Longford account

(Being short credit given to

Longford account)

450

31.2.2002 Sales account Dr. 255

To Suspense account

(Being stock used for personal

purpose wrongly credited to sales

account rectified)

255

31.2.2002 Suspense account Dr. 27

To Return Inwards account

(Being excess debit given to return

inwards account to the extent of ` 27 now

rectified)

31.2.2002 Salary account Dr. 775

To Ramachandra's account

To Suspense account

(Being the wrong debit of salary to

the personal account of Ramachandra

now rectified)

775

Note:

In Q. No.(c): Discount received ` 1,250 is posted on the wrong side of discount account.

Discount received (income) should be credited and discount allowed (expenses) should be debited.

Reconciliation and Rectification 177

Instead of crediting the discount received account, it has been wrong debited. To rectify this error, we

need to credit discount received account to the extent of ` 2,500 (` 1,250 + ` 1,250).

In the same context, discount allowed which is an expense should be debited instead, it is

credited. To rectify the error, we need to debit discount allowed to the extent of ` 1,700 (850 + 850).

The difference between discount received and discount allowed account is transferred to suspense

account.

Illustration 8

The trial balance of M/s. J Ltd. on 31

March, 1991 did not balance. The difference amount of

` 76 was transferred to the credit of suspense account, and the accountant proceeded with the

preparation of final accounts. Before completion of final accounts, the following errors were

discovered:

(a) Total of sales figure was taken as ` 58,726 instead of ` 58,762.

(b) A discount of

52 allowed to Mr. X was not recorded in the discount allowed account.

43.

(d) Sale of old furniture for

130 was wrongly entered in Machinery a/c.

(e)

credit

purchase

for

made

from

Mr.

was

recorded

purchases

book,

but

was

omitted to record in Y's account.

(f)

320 received from P was posted to the credit of R.

(g) A credit sale made to Mr. S for

250 was recorded twice in his account.

(h) Depreciation on plant and machinery was wrongly recorded as

750, instead of

950.

(i)

50 wages paid on 30th March, 1991, are not debited to wages account.

Give journal entries to rectify the above errors, and prepare suspense account.

Solution

Rectification of Errors

Particulars L.F. Debit (`) Credit (`)

a Suspense a/c Dr. 36

To Sales a/c

(Being the sales figure undercast by ` 36)

b Discount allowed a/c Dr. 52

To Suspense a/c

(Being the discount allowed not recorded earlier)

c Suspense a/c Dr. 43

To Purchase returns a/c

(Being the total of purchase returns undercast by

` 43)

d Machinary a/c Dr. 130

To Furniture a/c

(Being the sale of furniture wrongly credited to

Machinery a/c earlier)

130

178 Introduction to Financial Accounting

e Suspense a/c Dr. 49

To Y's a/c (or Creditor's a/c)

(Being the credit purchase made from Y was not

recorded in his account)

f R's a/c 320

To P's a/c

(Being the entry to rectify the wrong credit given

to R instead of P)

320

g Suspense a/c 250

To S's a/c

(Being the entry to rectify the error of debiting S

twice)

250

h Depreciation a/c 200

To Suspense a/c

(Being the entry to record depreciation figure

correctly)

200

i Wage a/c 50

To Suspense a/c

(Being the entry to record the wages, which was

not recorded earlier)

Illustration 9

The accountant of Jay Ltd. has reconciled the trial balance by putting the difference in a suspense

account and has prepared a trading and profit and loss account and balance sheet. Subsequent scrutiny

of the books disclosed the following errors:

(a)

credit

sale

goods

Mr.

Roshan

for

2,100

has

been

credited

his

account.

(b)

Goods

purchased

from

Mr.

Kanithkar

amounting

1,200

were

entered

the

purchase

day

book,

but

were

omitted

entered

the

name

Mr.

Kanithkar

the

creditors

ledger.

(c)

Office

furniture

purchased

for

2,100

has

been

passed

through

the

purchase

account.

(d)

Repairs

office

car

amounting

850

were

debited

the

office

car

account.

You are required to:

(a) Pass the journal entries for rectification of the above errors.

(b) Prepare suspense account.

Solution

Jay Ltd.

Journal Entries

Particulars L.F. Debit (`) Credit (`)

a Mr. Roshan account (` 2,100 × 2) Dr. 4,200

To Suspense account

(Being sales to Mr. Roshan wrongly credited

to his account, now rectified)

4,200

Reconciliation and Rectification 179

b Suspense account Dr. 1,200

To Mr. Kanithkar’s account

(Being purchase from Mr. Kanithkar omitted

to be posted to his account in the ledger, now

rectified)

1,200

c Office Furniture account Dr. 2,100

To Profit and loss adjustment account

(Being purchase of office furniture wrongly

passed through the purchase day book, now

rectified)

2,100

d Profit and loss adjustment account Dr. 850

To Office car account

(Being repairs to office car wrongly debited to

office car account, now rectified)

850

Illustration 10

In the month of April 2002, the accountant of Mapani & Co. found the following errors in the

books of accounts for the year 2001-2002 in spite of the agreed balance sheet:

(i) A sale of ` 20,050 to Mr. Dutta was entered in the sales day book as ` 20,500 and it has

been

debited

Mr.

Dutta's

account

25,000.

(ii)

purchase

16,000

from

Mr.

Philip

30th

March

2002

was

taken

stock,

but

the

invoice was not passed through the purchase day book.

(iii)

Goods

the

value

2,750

returned

Mr.

Rajkumar

had

been

debited

his

account

and

also

sales

return

account.

(iv) The purchase day book for the month of March 2002 was undercast by

10,000.

(v)

Bank

interest

overdraft

for

the

month

March

2002,

amounting

3,750

has

not

been

recorded

the

books

accounts.

(vi)

credit

sale

20,000

March

2002,

has

been

completely

omitted

from

the

sales

day book.

You are required to pass the necessary journal entries to rectify the above errors.

Solution

Mapani & Co.

Journal Entries

Particulars L.F. Debit (`) Credit (`)

a Profit & Loss Adjustment a/c.

Suspense a/c.

Dr. 450

4,500

To Mr. Dutta a/c.

(Being sale to Mr. Dutta of ` 20,050 wrongly

entered in the sales book as ` 20,500 and posted to his

account as ` 25,000 now rectified)

4,950

b Profit & Loss Adjustment a/c. 16,000

To Mr. Philip a/c. 16,000

180 Introduction to Financial Accounting

(Being goods purchased on 30

March 2002

were included in stock but not recorded in the

purchase book, now rectified)

c Suspense a/c. 5,500

To Mr. Rajkumar a/c (` 2,750 × 2)

(Being goods returned by Mr. Rajkumar

wrongly debited to his account, now rectified)

5,500

d Profit & Loss Adjustment a/c. 10,000

To Suspense a/c.

(Being error caused by undercasting of the

purchase book in the month of March 2002, now

rectified)

10,000

e Profit & Loss adjustment a/c. 3,750

To Bank a/c.

(Being bank interest previously not recorded

now rectified)

3,750

f Sundry Debtors a/c. 20,000

To Profit & Loss adjustment a/c.

(Being credit sales completely omitted from sales day

book, now rectified)

20,000

EXERCISE

Self Assessment Questions

Normally,

trader

’

cash

book

shows

______________

balance

while

his

bank

statement

shows a _____________ balance.

2. A debit balance of the Pass Book represents _____________

Cheques

deposited

trader

and

cleared

the

bank

appear

the

_____________

side

his Pass Book.

Cheques

issued

trader

and

encashed

his

creditors

are

_____________

his

Pass

Book.

5. Interest on overdraft is ______________ by the bank in the Pass Book.

6. Balance as per Cash Book and Pass Book are always equal.

7. A bank reconciliation statement is not prepared when the trader has no bank account.

Errors

the

Cash

Book

Pass

Book

cannot

found

preparing

Reconciliation

Statement.

While

reconciling

the

Cash

Book

and

Pass

Book

Balance

the

debit

side.

Cash

Book

compared with the credit side of Pass Book and vice versa.

10.

the

bank

gives

bank

statement

instead

the

Pass

Book

reconciling

statement

necessary.

11.

Errors

can

committed

all

stages,

beginning

from

journal

entries,

posting

entries

ledger accounts, while balancing the closing balances etc.

Reconciliation and Rectification 181

12.

Errors

omission,

error

principle

and

compensating

errors

are

not

disclosed

trial

balance.

13.

Errors

casting,

posting

wrong

side

account

posting

wrong

amount

etc.

Can

detected by trial balance.

14. Suspense account is the difference between debit total and credit total of a trial balance.

15.

Suspense

account

created

temporarily

and

later,

removed

and

when

errors

are

detected and suitable rectified.

16.

amount

paid

Rama

500

credited

Ramanan

’

account,

what

type

error

has

occurred and give the rectification entry.

17.

Instead

putting

1,500

debit

wages

account,

15,000

recorded.

Identify

the

type

of error and tell what impact it has on profit?

18. Refer Q. No.17. How do you rectify the above error?

19.

error

wrong

posting,

wrong

casting,

wrong

calculation

are

committed

the

books

original entry or secondary books, such errors are called ________.

20. Error of commission affects trial balance.

21. Furniture purchased for cash

5,000/- is not recorded in journal. Mention the type of error?

22.

Error

omission

can

detected

only

after

careful

review

ledger

balances

years.

23. Error of principle affects the value of revenue and capital items.

24. It is very difficult to find out the compensating errors.

25. Summary of all ledger balances is called _____________________ .

26. Trial balance is necessary to prepare _________________________ .

27. The broad two categories of errors are: (a) ________________ (b) ____________.

28. Is casting error, an error of principle or error of commission?

29. Purchase of machinery is included in the purchases book. What type of error is it?

30. What is error of omission? Illustrate.

31. What are the errors that cannot be disclosed by trial balance?

32. The sum of errors in accounting is transferred temporarily to _________ account.

33. In which journal do you make rectification entries?

34. State any four steps to locate errors.

35. If sales account is undercast by

45, what is the rectification entry?

36. Return inwards book is overcast by

9. Write the rectification entry.

37.

Salary

paid

Gopal

debited

his

personal

account.

What

the

rectification

entry

correct the error?

38.

Discount

received

transferred

the

debit

side

discount

account.

Write

the

rectification entry.

39.

invoice

purchase

for

760

entered

670.

What

type

error

this?

How

rectify this error?

(Answers: 1. debit, credit, 2. overdraft, 3. credit,4. debited, 5. debited, 6. False, 7. True, 8. False,

9. True, 10. False, 11. True, 12. True, 13. True, 14. True, 15. True,

16. It is a wrong posting and hence it is error of commission.

182 Introduction to Financial Accounting

Rama's a/c Dr. 500

Ramanan's a/c Dr. 500

To Suspense a/c 1,000

(Being amount paid to Rama wrongly credited to Ramanan's account rectified)

17. Posting of wrong amount - Trial balance is affected. Profit (gross) is reduced by

13,500,

18. Suspense a/c Dr. 13,500

To Wages a/c 13,500

(Being excess debit to wages account rectified)

19. Error of commission, 20. False, 21. Error of omission, 22. True, 23.True, 24. True, 25. Trial

balance, 26. final accounts, 27. Error that are disclosed by trial balance and those which cannot be

disclosed by trial balance, 28. Error of commission, 29. Error of principle, 30. Omitting completely a

transaction from books of original entry. Sales made to Raghu of ` 12,000 completely ignored,

31. Error of omission, commission, principle, compensating error, 32. Suspense account, 33. Journal

proper, 34. Four steps to locate the errors: (i) Check the total of both sides of trial balance, (ii) Total

debtors and creditors accounts, (iii) Verify whether balancing is done correctly, (iv) Check the totals

of ledger balances etc.

35. Suspense a/c Dr. 45

To Sales a/c 45

(Being

sales

account

which

was

under

cast

rectified.)

36. Suspense a/c Dr. 9

Return

Inwards

a/c

(Being returned inward book which was overcast rectified.)

37.

Salary

a/c

Dr.

To Gopal a/c

(Being

wrong

debit

given

Gopal

rectified.)

38. Suspense a/c Dr.

100

Discount

received

a/c

100

(Being wrong posting in discount received a/c rectified.)

39.

This

error

commission.

checking

the

original

invoice

document,

can

rectified.

Purchase

a/c

Dr.

Creditors

a/c

(Being

wrong

posting

purchase

book

rectified.)

Terminal Questions

31st

March

2002

the

cash

book

Shri

Bhima

showed

balance

24,000,

but

the

bank

pass

book

showed

different

balance.

comparing

the

cash

book

with

the

pass

book,

the

following

discrepancies

were

noticed.

Prepare

bank

reconciliation

statement

31st

March 2002.

(i)

Cheques

issued

26th

March

1,000,

but

were

presented

for

payment

April

2002.

(ii) Cheques of

900 were deposited into the bank, but they were collected on 1st April 2002.

Reconciliation and Rectification 183

(iii) Interest allowed by bank

300 but it was not recorded in the cash book.

(iv)

customer

directly

deposited

500

into

the

bank

account.

The

entry

the

same

was

made in the cash book on 4th April 2002.

(v)

Bank

debited

the

pass

book

for

bank

charges.

The

corresponding

entry

for

the

same was not found in the cash book.

(vi)

Under

the

standing

instructions,

the

bank

made

the

payment

telephone

bill

225

our behalf. No corresponding entry was found in the cash book.

M/s

Archana

Enterprises

has

current

account

with

the

State

Bank

India.

Their

pass

book

showed

balance

35,200

30th

June

2003.

Taking

into

account

the

following,

prepare a bank reconciliation statement to find out the balance as per the cash book.

(i) Cheque issued to creditors amounting to

10,000 not presented for payment.

(ii)

Cheque

received

for

7,000

was

sent

the

bank

for

collection,

29th

June.

was

collected on 2nd July 2003.

(iii)

Dividend

collected

bank

our

behalf

500.

The

intimation

the

same

was

received

on 3rd July 2003.

(iv)

Bank

had

paid

insurance

premium

800

behalf

the

company

for

which

there

was no entry in the cash book.

(v)

Interest

bank

balance

credited

the

pass

book

300

but

was

not

recorded

the

cash book.

(vi) Bank charges of

100 charged by bank, but not recorded in the cash book.

From

the

following

details,

prepare

Vipin's

Bank

Reconciliation

Statement

March

2003.

(i) Balance as per cash book

3,000.

(ii)

Cheques

issued

March

8,000

out

which

cheques

for

3,000

were

encashed

March.

(iii) Cheques issued but not presented

500.

(iv) Cheques issued but dishonoured

700.

(v)

Cheques

deposited

March

3,000

out

which

cheques

for

2,000

were

cleared

April and thereafter.

(vi)

Cheques

deposited

but

dishonoured

500

but

dishonour

entry

not

made

cash

book.

(vii)

Dividends

collected

the

bank

800

not

entered

cash

book.

(viii)

Bank

charges

not

entered

cash

book.

(ix)

Direct

deposit

customer

250

not

entered

cash

book.

(x)

Interest

credited

the

bank

150

not

entered

cash

book.

(xi)

Direct

payment

for

LIP

250

not

entered

cash

book.

The

following

are

the

necessary

extracts

from

the

Cash

Book

and

the

Pass

Book.

You

are

required to prepare a Bank Reconciliation Statement as on 31st December 2012.

Dr. Cash Book (Bank Column) Cr.

Date Particulars ` Date Particulars `

2012 2012

Dec. 1 To Balance B/d 400 Dec. 20 By Sharmila’s a/c 65

5 To Sharda’s a/c 100 24 By Urmila’s a/c 150

184 Introduction to Financial Accounting

10 To Smita’s a/c 20 26 By Pramila’s a/c 75

16 To Shila’s a/c 125 31 By Balance c/d 460

20 To Sunita’s a/c 75

750 750

Dr. Bank Pass Book Cr.

Date Particulars

2012 2012

Dec. 25 To Sharmila’s a/c 65 Dec. 1 By Balance b/d 400

27 To Urmila’s a/c 125 9 By Sharda’s a/c 100

29 To Ramila’s a/c 100 16 By Smita’s a/c 50

31 To Balance c/d 270 25 By Interest 10

560 560

Set

out

below

are

extracted

from

cash

book

(Bank

columns

only)

and

bank

pass

book

Babulnath. Prepare a bank reconciliation statement as on 15th January 2012.

Dr. Cash Book (Bank Column) Cr.

Date Particulars

2012 2012

Jan. 1 To Balance b/d 1,132 Jan. 2 By Wages a/c 850

5 To K. Kamdar a/c 900 6 By Investment a/c 1,000

8 To Sales a/c 609 8 By Purchase a/c 306

10 To Rent a/c 56 9 By Furniture a/c 160

12 To Ganpat a/c 1,252 10 By Bapat a/c 210

13 To Raman a/c 888 10 By Drawings a/c 80

15 To Balance c/d 401 14 By Fakir a/c 1,822

15 By Mustafa a/c 810

5,238 5,238

Dr. Pass Book Cr.

Date Particulars ` Date Particulars `

2012 2012

Jan. 2 To Wages a/c 850 Jan. 1 By Balance 1,132

6 To Investment a/c 1,000 6 By K.Kamdar a/c 900

7 To Purchase a/c 306 8 By Sales a/c 609

9 To Furniture a/c 160 10 By Rent a/c 56

10 To Self (Drawings) a/c 80 14 By J. Jamdar a/c 200

13 To Bills Payable a/c 100

15 To Balance c/d 401

2,897 2,897

Reconciliation and Rectification 185

From

the

entries

the

Cash

Book

(Bank

Column)

and

the

corresponding

Bank

pass

book

Mr.

Reddy,

you

are

asked

prepare

Bank

Reconciliation

Statement

January

2013.

Dr. Cash Book (Bank Column) Cr.

Date Particulars ` Date Particulars `

2013 2013

Jan. 1 To Balance b/d 2150 Jan. 10 By Shakti & Co.’s a/c 1,400

6 To Bills Receivable a/c 325 12 By Salaries a/c 300

16 To Sales a/c 610 18 By Drawings a/c 125

22 To R. Ramchandra’s a/c 135 29 By Joshi Bros. A/c 210

30 To Naresh Bros. A/c 250 29 By Wages a/c 500

31 To Interest a/c 58 31 By N. Narayan’s a/c 320

31 To G. Ganesh’s a/c 156 31 By P.Piyush’s a/c 175

31 By Balance c/d 654

3,684 3,684

Dr. Bank Pass Book Cr.

Date Particulars ` Date Particulars `

2013 2013

Feb. 2

To Joshi Bros a/c 210 Feb. 1 By Balance b/d 1,400

2 To Commission a/c 1 2 By Naresh Bros. a/c 300

3 To N. Narayan’s a/c 320 3 By G. Ganesh’s a/c 125

3 To P. Piyush’s a/c 175 3 By Ramchandra’s a/c 210

3 To Commission a/c 1 8 By Cash a/c 500

8 To S.Sirish’s a/c 300 10 By M. Manoj’s a/c 320

10 To Wages a/c 300 12 By T. Tarawala’s a/c 175

The

following

errors

were

traced

while

preparing

the

Final

accounts

firm

for

the

year

ending 31

December 2012. The entries are to be rectified before the books are closed.

(a)

3000 purchase of machinery has been entered in the purchase book.

(b)

Goods

worth

838

sold

Mr.

credit

recorded

purchase

983

Purchase

book

250.

(d)

Repairing

charges

180

paid

for

repairing

machine

have

been

debited

the

Machinery Account.

(e)

400/-

paid

the

owner

the

shop

Shri

for

rent

has

been

debited

his

personal

account.

(f) The balance of

300 of the salaries account has been shown as debit balance.

(g)

Goods

worth

550

cost

price

were

distributed

free

samples

but

entry

made

the books.

186 Introduction to Financial Accounting

(h)

220

received

from

Mr.

which

were

written

off

last

year

bad

debts

were

received

cash which have been credited to his personal account.

(i)

received

cash

from

Mr.

entered

the

discount

column

cash

book

through

an error.

Correct

the

following

errors

found

the

books

Mr.

Dutt.

The

trial

balance

was

out

493/- excess credit the difference has been posted to Suspense Account.

(a)

amount

100

was

received

from

Dhiraj

31st

December,

2012

but

had

been

entered in the cash book on 3rd Jan 2013.

(b) The total of Return inward book for December had been cast

100 short.

(c)

The

purchase

office

table

costing

300/-

had

been

passed

through

the

purchase

book.

(d)

375

paid

for

the

wages

workmen

for

making

showcases

had

been

charged

wages

account.

(e) A purchase of

67 had been posted to the creditors account as

60/-.

(f)

cheque

for

200/-

received

from

P.C.

Joshi

had

been

dishonoured

and

was

passed

the debit of allowances account.

(g)

1000

paid

for

the

purchase

motor

cycle

for

Mr.

Dutt's

personally

use

had

been

charged to miscellaneous expenses account.

(h)

Goods

amounting

100

had

been

returned

the

customers

and

were

taken

stock,

but no entry in respect thereof was made into the books.

(i) A sale of

200/- to Sanghvi & Co. was wrongly credited to their account.

EXCERSISE

Q.1. Name different classes of errors?

Ans:

(i) Bookkeeping errors (ii) Trial balance errors.

Q.2. Define bookkeeping errors?

Ans:

Errors

which

are

committed

the

books

original

entry

ledgers

are

called

bookkeeping errors.

Q.3. Name different classes of bookkeeping errors?

Ans:

(i) Errors of omission (ii) Errors of commission

Q.4. Define errors of omission?

Ans:

The

errors

resulting

from

the

complete

failure

entry

transaction

the

books

are

called errors of omission.

Q.5. Name different classes of errors of omission.

Ans:

(i) Complete errors (ii) Partial errors.

Q.6. What do you mean by complete errors and gives its two examples?

Ans:

When

any

particular

transaction

has

not

all

been

entered

the

book

original

entry,

known

complete

errors.

Examples:

(i)

Cash

received

from

Ali

was

not

recorded

cash book. (ii) Goods sold to Shahid were not recorded in cash book.

Q.7. What do you men by partial errors and give its two examples?

Reconciliation and Rectification 187

Ans:

transaction

has

been

recorded

book

original

entry

but

has

not

been

posted

ledger

account,

called

partial

error.

Examples:

(i)

Cash

received

from

Ali

was

not

recorded in cash book. (ii) Goods sold to Shahid were not recorded debited to his account.

Q.8. Define error of commission.

Ans:

Error

which

occurs

when

transaction

wholly

partially

incorrectly

recorded

the

books of account are called errors of commission.

Q.9. What are different classes of errors of commission?

Ans:

(i)

Errors

principle,

(ii)

Compensating

errors,

(iii)

Errors

posting

and

(iv)

Errors

of casting.

Q.10. Define compensating errors.

Ans:

Compensating

errors

means

errors

which

are

cancelled

other

errors

same

amount

the

same

account

error

same

amount

the

opposite

side.

These

errors

are

neturalizing nature.

Q.11. Define error of posting.

Ans:

transaction

has

been

recorded

the

book

original

entry

but

has

been

posted

wrongly in the ledger account, it is known as error of posting.

Q.12. Define errors of casting and give its two examples.

Ans:

The

errors

which

may

occur

due

shortcasting

excess

casting

any

book

original

entry

the

ledger

account.

Examples:

(i)

Sales

day

book

was

undercast,

(ii) Purchases day book was overcast.

Q.13. What do you know about the "Trial balance errors"?

Ans:

Errors which are made in the preparation of Trial balance are called trial balance errors.

Q.14. What is suspense account?

Ans:

ledger

account

which

entries

are

made

temporary

basis

when

the

correct

account cannot be immediately identified is called suspense account.

Q.15. Give any three examples of trial balance errors.

Ans:

(i)

Transfer

balance

the

wrong

column

the

trial

balance,

(ii)

Omission

balance from trial balance and (iii) Wrong casting of trial balance.

Q.16. Give any two examples of errors of principle.

Ans:

(i)

Incorrect

application

capital

and

revenue

expenditures,

(ii)

Wrong

estimation

depreciation etc.

Q.17. Pass the rectifying entry, sale of old furniture has been credited to sales account of

200.

Ans:

Sales Account Dr. 200

To Furniture Account 200

Q.18. What rectifying entry will be passed, if sales book was undercast by

300?

Ans:

Suspense Account Dr. 300

To Sales Account 300

Q.19. Name different stages available for rectifying errors in account.

Ans:

(i)

Before

the

preparation

trial

balance,

(ii)

After

the

preparation

trial

balance

but

before the preparation of final accounts, (iii) After the preparation of final accounts.

188 Introduction to Financial Accounting

Q.20. Write down the procedure for correcting errors?

Ans:

There

are

three

questions

which

must

answered

before

error

can

corrected.

They

are:

(i)

What

should

happened,

and

(ii)

What

has

happened?

(iii)

What

action

will

correct the error.

Q.21. Differentiate between errors of omission and errors of commission.

Ans:

Errors of omission Errors of commission

1. They represent absolute omission. 1. They represent incorrect recording

They

have

effect

agreement

They

may

effect

agreement

trial

trial balance. balance.

Q.22. Give any four types of errors which do not affect the trial balance agreement?

Ans:

(1)

Errors

principle,

(2)

Compensating

errors,

(3)

Wrong

posting

the

same

head

account, and (4) Errors of complete omission.

Q.23. Write any two examples of errors which affect agreement of Trial balance?

Ans:

(1) Partial omission, and (2) Posting to wrong side of ledger.

Q.24. Differentiate between errors of posting and errors of casting.

Ans:

Errors

posting

Errors

casting

1. They represent wrong posting. 1. They represent wrong casting.

They

involved

transferring

They

normally

consist

wrong

casting

transactions form Journal to ledger. of books of original entry or ledger's account.

Q.25. What rectifying entry will be passed, if sales book was overcast by

1,500?

Ans:

Sales a/c

1,500

To Suspense a/c

1,500

(Being casting error in sales book rectified)

Q.26. What rectifying entry will be passed, if purchases day book was overcast?

Ans:

Suspense a/c

To Purchases a/c

(Being casting errors in purchases book rectified)

Q.27.

What

rectifying

entry

will

assed

000

freight

paid

machinery

was

charged

freight a/c.

Ans:

Machinery a/c 2000

To Freight a/c 2000

(Being error in freight recording rectified).

INTRODUCTION

Accounting is the recording and reporting of business transactions. Business transactions involve

activities of actual business (selling goods or services), investment (purchasing assets) and financing

(raising money for investment). In accounting, business activities give rise to revenue income and

revenue expenditure; investment activities give rise to capital expenditure; financing activities give

rise to capital receipts, P & L a/c is a summary of revenue income and revenue expenses, Balance

Sheet is summary of capital receipts and capital expenditure.

Expenditure is usually of two types:

1. Capital Expenditure

2. Revenue Expenditure

1. Capital Expenditure: Capital expenditure consists of expenditure, the benefit of which is not

fully enjoyed in one accounting period but spread over several accounting periods. It includes assets

acquired for the purpose of earning income or increasing the earning capacity of the business or

effecting economy in the operation of an asset. These are not meant for sale. Expenditure incurred for

improving assets and extending an existing asset is also capital expenditure.

Definition: Eric Kohler has defined capital expenditure as “an expenditure intended to benefit

future periods; an addition to fixed assets. The term is generally restricted to expenditures that add

fixed asset units or that has the effect of increasing the capacity, efficiency, life span or economy of

operation of an existing asset.”

Examples:

(a) Interest on capital paid during the period of construction of company.

(b) Expenditure in connection with or incidental to the purchase or installation of an asset

(d) Expenditure incurred for putting the old asset purchased into working condition.

(e) Additions and extensions to existing assets.

(f) Betterment of fixed assets or improvement of an asset to produce more to improve its

earning capacity or to reduce its operating expenses or to increase the life of asset.

2. Revenue Expenditure: Revenue expenditure consists of expenditure incurred in one period of

the accounting, the full benefit of which is enjoyed in that period only. This does not increase the

earning capacity of the business but it is incurred in order to maintain the existing earning capacity of

the business. It includes all expenses which arise in normal course of business. The benefit of such

CHAPTER

Capital and Revenue

190 Introduction to Financial Accounting

expenditure is for a short period, say, one year only and it is not to be carried forward to the next year.

The expenditure is of a recurring nature, i.e., arises again and again.

Definition: Eric Kohler has defined revenue expenditure as “an expenditure charged against

operation: a term used to contrast with capital expenditure.”

Examples:

(a) Purchase of raw materials for conversion into finished goods.

(b) Selling and distribution expenses incurred for sale of finished goods, e.g., sales office

expenses, delivery expenses, advertisement charges, etc.

office equipment.

(d) Depreciation of plant, machinery and equipment.

(e) Expenses incurred in order to maintain the existing fixed assets in an efficient and workable

state such as repairs to building, repairs to plant, whitewashing and painting of building.

Difference between Capital and Revenue Expenditures

Capital Expenditures Reventue Expenditures

1. Its effect is long term, i.e., it is not exhausted

within the current account year. Its benefit is

enjoyed in future year or years also. In a word,

its effect reduces gradually.

2. An asset is acquired or the value of an asset is

increased as a result of this expenditure.

3. It does not occur again and again – it is

nonrecurring and irregular.

4. Generally, it has physical existence, i.e., it can

be seen with eyes.

5. This expenditure improves the position of the

Concern.

6. A portion of this expenditure is shown in the 6

trading and profit and loss account or income

and expenditure account as depreciation.

7. It pertains to investing activity

8. It does not reduce the revenue of the concern

Purchase of fixed assets does not affect

revenue.

1. Its effect is temporary, i.e., it is exhausted

within the current accounting year.

2. Neither an asset is acquired nor is the value of

an asset increased.

3. It occurs repeatedly. It is recurring and regular.

recurring and irregular.

4. It has no physical existence, i.e., it cannot be

seen with eyes.

5. This expenditure helps to maintain the position

of the concern.

6. The whole amount of this expenditure is

shown in trading and profit and loss account or

income and expense account. But deferred

revenue expenditures and prepaid expenses are

not shown.

7. It pertains to business activity.

8. It reduces revenue. Payment of salaries to

employees decreases revenue.

Deferred Revenue Expenditure: Deferred revenue expenditure is a revenue expenditure which

has been incurred during one accounting year which is applicable either wholly or in part to further

accounting years.

Definition: According to Prof. A.W. Johnson, “Deferred revenue expenditure includes those

non-recurring expenses, which are expected to be of financial nature, distributed to several accounting

periods of indeterminate total length. These are of revenue nature but are deferred or postponed.

Capital and Revenue 191

It is of quasi-capital nature.” In simple words, we can say that Deferred Revenue Expenses are

those expenses, the benefit of which may be extended to a number of years, say, 3 to 5 years. It is

basically expenditure while forming company. The benefit of this will be derived in the future years

also. Any expenditures relating to capital (shares, debentures, securities) is called deferred revenue

expenditure. launching of new project (Advertisement Expenditure).

(a) Expenditure for the issue or raising loan or capital or debentures.

(b) Expenditure for the formation or registration of company.

Illustration 1

State with reasons whether the following are capital, revenue or deferred revenue expenses:

(a) Payment for purchase of goods.

(b) Payment for purchase of stationery.

(d) Payment for heavy inaugural expenses.

(e) Payment of salaries.

(f) Wages for erection of machinery.

Solution

(a) It is a Revenue expenditure. It doesn’t result in acqeisition of any fixed asset and it is

recurring in nature.

(b) It is a Revenue expenditure. It doesn’t result in acqeisition of any fixed asset and it is

recurring in nature.

nature.

(d) It is basically Revenue in nature, even though it is heavy. It doesn’t result in existance of

any assets.

(e) It is a Revenue expenditure. It doesn’t result in acqeisition of any fixed asset and it is

recurring in nature.

(f) It is a Capital expenditure as it increases the cost of new asset.

Illustration 2

State with reasons whether the following are capital, revenue or deferred revenue expenses:

(a) Expenditure incurred on overhauling of new machinary.

Ans: It is a capital expenditure as it increases the efficiency of the asset and life.

(b) Tax paid.

Ans: It is revenue expenditure, because the benifit of such taxes is exhausted in one year

and it is recurring in nature.

Ans: It is a capital expenditure, because it brings into existance of new asset.

(d) A petrol driven enging of passenger bus was replaced by diesel engine.

Ans: It is a capital expenditure as it increases the efficiency of the passenger bus and it is

nonrecurring in nature.

192 Introduction to Financial Accounting

(e) Cost of improving sitting capacity of cinema hall.

Ans: It is a capital expenditure as it would result in increased earning

(f) Heavy amount spent on leagal suit.

Ans: It is a revenue expenditure even though it is heavy. It is recurring in nature.

(g) Expenditure for training to employees.

Ans: It is a deffered revenue expenditure as it’s benifit is available for subsequent year.

(h) Expenditure on research project, which ultimately results in success.

Ans: It is a deffered revenue expenditure as it’s benifit is available for subsequent year.

Problems for Self Practice

1. State whether the following expenditure is Capital, Revenue or Deferred revenue expen-

diture Give reasons:

(a) Legal expenses incurred in connection with issue of Equity Shares of the company.

(b) Cost of replacement of defective part of the machinery.

(d) Expenditure for training employees for better running of the machinery.

(e) Purchase of machinery for sale.

(f) Daily wages paid to an office peon.

2. State, which of the following expenses are Capital, Revenue and Deferred revenue. Explain

with reasons:

(a) Professional fees paid in connection with acquisition of leasehold premises.

(b) Cost of Registration and documentation of a new form company.

(d) Expenditure incurred on purchase of cloth for uniform for employees.

(e) Payment of Import duty on purchases of new materials.

3 Classify the following expenses between Capital and Revenue, starting reasons in each case:

(a) Petrol driven engine of a passenger bus was replaced by a diesel engine.

(b) Expenses incurred on research for a particular product, which ultimately did not result in

success.

(d) Cost of repairing the factory shed.

CAPITAL RECIEPTS AND REVENUE REIEPTS

Capital Reciepts: Capital reciepts are those reciepts which are non-recurring in nature and they

are not arising out of normal ctivity of business. They are un-usual in nature. For eg.

1. Amount recieved on issue of shares and debentures.

2. Loan recieved

3. Proceeds from sale of fixed assets.

4. Primum reciepts on issue of shares.

Generally Capital reciepts are recorded in balance sheet.

Capital and Revenue 193

Revenue Reciepts: Revenue reciepts are those reciepts, which are recieved on the ordinary

course of business. They are recurring in nature. They are arising through the normal business activity.

For e.g.

1. Commission or discount reciept.

2. Inrest or divident on investment.

3. Transfer fees.

4. Profit on sale of asset or investment.

Generally Revenue reciepts are credited to profit and loss account.

Capital Payment Revenue Payment

1. Capital receipt pertains to financing activity.

1. Revenue receipts pertains to business activity.

2. Examples are capital from owner, loans from

bank, etc.

2. Examples are revenue receipts from sale of

goods, fees, interest, dividend, royalty.

3. Capital receipts are shown as liability in

balance sheet.

3. Revenue receipt pertaining to current year is

shown as income in P & L a/c. Revenue receipt

pertaining to future period is shown as liability

(advance income) in balance sheet.

4. Capital receipts may be returned back. 4. Revenue receipt cannot be returned/refunded.

5. Capital receipts is non-recurring in nature. 5. Revenue receipt is recurring in nature

6. Capital receipts increases funds available for

investment, but may reduce profits as interest is to

be paid on loans obtained.

6. Revenue receipts increases profits and funds.

Capital Payment and Revenue Payment

Capital Payment: These are the payment which results in reduction in long term liabilities of the

business. They are generally non-recurring in nature. For e.g.

1. Repayment of capital

2. Redemtion and buyback of shares and debentures

3. Repayment of bank loan or term loan

Revenue Payment: These are the payment which results in reduction in short term liabilities of

the business and they are generally recurring in nature. For e.g.

1. Payment of outstanding liabilities

2. Payment to creditors

3. Proposed divident paid

CAPITAL AND REVENUE PROFITS

Definition and Explanation

Capital profit means a profit made on the sale of a fixed asset or profit earned on raising monies

for the business. For example, a building purchased for ` 20,000 is sold for ` 25,000. The profit

` 5,000, thus, made is a capital profit. Revenue profit, on the other hand, is a profit made by the

business, e.g., profit on the sale of goods, interest from investments, commission earned etc.

Whenever capital profit is made, it should either be transferred to the capital account of the

proprietor or credited to capital reserve account which would appear as a liability on the balance sheet.

194 Introduction to Financial Accounting

But capital profits, should in no case be transferred to profit and loss account because it is non-trading

profit. Revenue profits, on the other hand, should be transferred to profit and loss account because

they arise out of regular trading operation.

CAPITAL AND REVENUE LOSSES

Definition and Explanation

Capital loss means a loss made on the sale of a fixed asset or a loss incurred in connection with

the raising of money for business. Capital loss may be shown as an asset in the balance sheet. But as

this asset is of fictitious nature, it would advisable to write off it.

Revenue loss, on the other hand, is the loss incurred in trading operations such as loss on the sale

of goods. Revenue losses are charged to profit and loss account of the year in which they occur.

CAPITALIZED OR DEFERRED REVENUE EXPENDITURES

Where a certain revenue expenditure incurred is of such a nature that its benefit is likely to be

spread over a certain number of years, or where it is of non-recurring and special nature and large in

amount, in such circumstances, instead of debiting the entire amount to the profit and loss account of

the year in which it has been incurred, it may be spread over a number of years, a proportionate

amount as Revenue Expenditure being charged to each year’s Profit and Loss account. The remaining

portion of the expenditure is carried forward and is known as Capital Expenditure or Deferred

Revenue Expenditure and is shown as an asset in the Balance Sheet. Items such as preliminary

expenses, cost of issue of debentures are examples that may be classified under this head.

Exceptions to General Rules

There are certain expenses which are usually of revenue in nature but under certain

circumstances they become capital expenditures. The following are the examples of expenses which

are usually revenue but under certain circumstances become capital.

Legal Charges: These are, as a rule, revenue charges, but legal charges incurred in connection

with the purchase of a fixed asset are capital expenditures as they form an additional cost of the asset

acquired.

Wages: Wages are ordinary revenue expenditure. But in a manufacturing business where the

firm’s own men are employed in making of fixed asset, the wages paid for such purpose would be

capitalized. For example, if the firm’s own men are employed in making extension to the factory

building or in erection of plant or manufacturing tools for own requirements, the wages and salaries

paid to the persons are not revenue but capital expenditures.

Brokerage and Stamp Duty: Normally, these are revenue expenditures, but brokerage paid on

acquisition of a property and stamp duty involved thereon can be capitalized. Freight and Carriage:

This is revenue charge, but freight and carriage paid on newly acquired plant or fixed assets are capital

expenditures.

Advertising: Ordinarily, amount expended on advertising is revenue charge but the cost of

special advertising undertaken for the purpose of introducing a new line of goods may be capitalized.

Development Expenses: In concern like collieries, mines, tea, rubber etc., all expenses incurred

during the period of development are treated as capital.

Preliminary Expenses: These are the expenses incurred in connection with the formation of a

public company. These expenses although are revenue in nature but are allowed to be capitalized and

can be shown as an asset in the balance sheet.

Capital and Revenue 195

Illustrations 3

1. State with reasons whether the following items relating to sugar mill company are capital or

revenue:

(a)

Motor

truck

costing

15,000

and

standing

the

books

7,250

was

sold

for

12,000.

Ans:

Amount

equivalent

book

value

i.e.

7,250

treated

capital

reciept

and

4,750

will

treated

Revenue

profit

(b)

Building

costing

2,00,000

and

standing

books

for

1,30,000

was

sold

for

2,30,000.

Ans:

Out

this

2,30,000,

amount

equivalent

book

value

i.e.

1,30,000

will

treated

Capital

reciept

and

amount

excess

original

cost

i.e.

30,000

will

treated

capital

profit

and

the

balance

amount

70,000

will

considerd

Revenue

profit.

(c)

20,000

received

from

issue

shares,

the

expenses

issue

being

2,500.

Ans:

20,000

will

considered

Capital

reciept

and

expenses

such

issues,

i.e.

2,500

ill

considered

Deferred

Revenue

expenditures

(d)

50,000

invested

Government

Loan..

Ans:

capital

payment

asset,

but

doesn

’

chargable

depriciation.

(e)

Subsidy

recieved

from

government.

Ans:

revenue

reciept

recurring

nature.

EXERCISE

A. Match the Column

Group ‘X’ Group ‘Y’

(a) Expenditure on training

(b) Expenditure on project report

(d) Custom duty on import of machine

(e) Invested in Government loans

1. Capital

2. Capital

3. Capital

4. Revenue

5. Capital

6. Deferred revenue expenditure

Ans: (a) 4, (b) 5, (c) 3, (d) 1, (e) 3.

Group ‘X’ Group ‘Y’

(a) Repayment of loan.

(b) Fees for acquisition of lease

(d) Renewal of licencer

(e) Legal expenses on collection form

debetors

1. Capital expenditure

2. Capital reciept

3. Revenue expenditure

4. Revenue expenditure

5. Capital expenditure

6. Capital loss

Ans: (a) 5, (b) 1, (c) 2, (d) 3, (e) 4.

B. Fill in the blanks

1. _______ expenditure is recurring.

2. _______ expenditure in non-recurring.

3. _______ expenditure is shown in Balance Sheet on asset side.

4. _______ expenditure is shown in Profit & Loss account.

196 Introduction to Financial Accounting

5. _______ reciepts are shown in income in Profit & Loss account.

6. _______ reciepts are shown in Balance Sheet.

7. _______ is expenditure on asset held for generation of interest/divident.

8. _______ expenditure does not give any further benefits.

9. Wages paid for installation for machinary is a _______ expenditure.

10. Carriage on purchase of furniture is _______ expenditure.

11. Repairs of machinary is _______ expenditures.

12. Payment of penalty is a _______ expenditure.

13. Documentation charges regarding purchase of a building is a _______ expenditure.

14. Depreciation is _______ in nature.

15. Advertising is _______ expenditure.

16. Demolition cost of old building is _____ ______ ______.

17. Overhauling of machinary is a _______ reciept.

18. Amount recieved on scale of goods is a ______ reciept.

19. Commision recieved is a _______ reciept.

20. Heavy legal expenses are _____ _____ _____.

21. Bad debt recovery is a _______ reciept.

Ans: 1. Revenue, 2. Capital, 3. Capital, 4. Revenue, 5. Revenue, 6. Capital, 7. Investment,

8. Revenue, 9. Capital, 10. capital, 11. revenue, 12. revenue, 13. capital, 14. revenue, 15. revenue,

16. deferred revenue expenditure, 17. revenue, 18. revenue, 19. revenue, 20. deferred revenue

expenses, 21. revenue.

C. True or False

1. Pre advence expenses are revenue expenses.

2. Heavy expenses incurred on advertising at the time of introducing a new produce is a

deferred revenue expenditure.

3. Expenses incurred to keep the machine in working condition is a capital expenses.

4. An expenditure intended to befenit the curent period is a revenue expeniture.

5. Amount written off from cost of the fixed asset is capital expenditure.

6. Deferred revenue expenditure is current years revenue expenditure to be paid in the last year.

7. Expenditure, which results in acquisition of a permanent asset, is a capital expenditure.

8. Wages paid for erection of machinary are debited to Profit & Loss Account.

9. Amount paid for acquiring goodwill is deferred revenue expenditure.

10. Overhaul expenses of a second half machinary purchased are revenue expenditure.

11. Major repairs charges include replacement of certain worn out parts incurred before using a

second hand car purchased recently is a capital expenditure.

12. The gain from sale of capital assets need not be added to revenue to ascertain the net profit

of a business.

13. Capital work in progress is a capital expenditure.

14. Capital expenditure is non-recurring in nature.

Capital and Revenue 197

15. Revenue expenditure is recurring in nature.

16. Capital reciept is recurring in nature.

17. Revenue earned in the current year but not recieved is an asset.

18. If revenue expenditure is shown as capital expenditure, Profit & Loss Account shows more

profit.

19. If capital expenditure is shown as revenue expenditure, Balance sheet shows less assets.

20. Expenses incurred to bring the second hand machine in working condition is a capital

expenditure.

21. Expenditure on carriage of machinary is a capital expenditure.

22. Expenditure on documentation regarding purchase of building is a revenue expenditure.

23. Wages paid for installation of machinary are debited to Profit & Loss Account.

24. Heavy expenditure on advertising at the time of opening of a new branch is a deferred

revenue expenditure.

25. Expenditure intended to benifit current period is a revenue expenditure.

26. Amount paid for acquisition of patents is a capital expenditure.

27. An error of principle results in incorrect allocation of expenditure between capital and

reciept.

28. Wages paid to workers to produce a tool is a capital expenditure.

29. Amount paid for replacement of worn out part of machine is a capital expenditure.

30. Amount spent on white washing of factory building done after 6 months is a capital

expenditure.

31. Temporary shed constructed to store material at project site is a capital expenditure.

32. Expenditure incurred on renovation of a shop, which increased the capacity, is a capital

expenditure.

33. Legal expenses incurred for abuse of a trademark is a capital expenditure.

34. Fictitious assets are tangible.

35. Revenue expenditure increases the profit earning capacity of an organisation.

36. Repairs of a furniture is a capital expenditure.

37. Expenses for ragistration of the purchase of the building is a revenue expenditure.

38. Expenses on extension of a gallery to the building is a revenue expenditure.

39. Expenses incurred for purchase of livestock is a capital expenditure.

40. New tyres to replace old tyres of a car is capital expenditure.

Answers: 1. False, 2. True, 3. False, 4. True, 5. False, 6. False, 7. True 8. False, 9. False,

10. False, 11. True, 12. True, 13. True, 14. True, 15. True, 16. False, 17. True, 18. True, 19. True,

20. True, 21. True, 22. False, 23. False, 24. True, 25. True, 26. True, 27. True, 28. True, 29. False,

30. False, 31. True, 32. True 33. False, 34. False, 35. False, 36. False, 37. False, 38. False, 39. True

40. False.

D. A newly set up manufacturing concern incurred various types of expenses during the

construction period.

1. Travelling expenses of Directors for a trip abroad for purchasing Capital goods.

2. Salaries and Wages paid to technical staff for erection of machinery.

198 Introduction to Financial Accounting

3. Salaries and Wages paid to non-technical staff, during erection of machinery.

4. Miscellaneous expenses such as rent, stationery and printing, postage and telegram

conveyance etc.

The factory is still under construction. The Company desires to capitalise the above

expenses.

State with reasons whether the expenditure is properly chargeable to Capital. Show how you

would deal with the above expenditure in final accounts of the Company.

E. Classify the following between Capital expenditure and Revenue expenditure giving

brief reasons in each case.

1. Cost of ` 30,000 for dismantling, removing and reinstalling plant by a sugar milk incurred in

connection with the removal of works to a more suitable locality.

2. A sum of ` 10,000 spent for alteration of existing plant incorporating thereby new devices,

which could effect substantial reduction in power consumption.

3. Imported goods worth ` 25,000 confiscated by custom authority for non-disclosure of

material facts.

4. A petrol driven engine of a passenger bus was replaced by a diesel engine.

5. Cost of repainting the factory shed.

6. Cost of transportation ` 5,000 in connection with a new acquired machine.

7. Heavy amount spent in a legal suit.

8. ` 1,000 spent on replacement of defective parts of an old plant.

F. State with reasons whether the following are capital, revenue or deferred revenue

expenses.

1. Payment for purchase of goods.

2. Payment for purchase of Stationery.

3. Payment for purchase of a car.

4. Payment for heavy inaugural expenses

5. Partial refund of capital to a partner

6. Payment of loan taken earlier.

7. Payment of salaries

8. Wages for erection of machinery.

G. State which of the following expenses are Capital, Revenue and Deferred revenue.

Explain with reasons.

1. Expenditure incurred on overhauling machinery.

2. Taxes paid

3. Wages paid to the workers for erection of new machinery.

4. Cost of goodwill

5. Heavy expenditure incurred on advertisements.

6. Cost of construction of a building.

7. Machinery costing ` 10,000 (WDV 3,000) sold for ` 4,000

8. Purchased machinery for ` 15,000

Capital and Revenue 199

H. Determine whether the following expenditure is Capital or Revenue expenditure:

1. Repairs of building

2. Legal Expenses incurred in connection with issue of share capital.

3. Amount realised from sale of old machinery.

4. Amount brought by the Proprietor as capital.

5. Building costing ` 20,000 sold for ` 35,000 (WDV ` 12,000).

I. State, which of the following expenses are Capital, Revenue and Deferred revenue.

Explain with reasons:

1. Stock of ` 25,000 was destroyed by fire of which ` 15,000 was received from the Insurance

Company.

2. The Concern spent ` 1,00,000 on heavy advertisement campaign to introduce a new product

in the market.

3. Cost of dismantling a plant from particular locality and reinstalling the same in another

locality.

4. Cost of transporting newly produced furniture.

5. Amount spent by factory in overhauling its plant, which has enhanced the life of the plant by

five years.

6. Travelling expenses for a trip abroad for purchase of Capital goods.

7. Amount spent on replacement of defective parts of old plants.

8. Cost of goodwill purchased.

Select the Right Answer

1. Legal expenses incurred in connection with issue of capital.

(a) Revenue expenditure (b) Capital expenditure

2. Cost of replacement of a defective part of the machinery.

(a) Revenue expenditure (b) Capital expenditure

3. Expenditure incurred in preparing a project report.

(a) Revenue expenditure (b) Capital expenditure

4. Expenditure for training employees for better running of machinery.

(a) Revenue expenditure (b) Capital expenditure

5. Amount spent on uniform of workers.

(a) Revenue expenditure (b) Capital expenditure

6. White - washing of the factory of building.

(a) Revenue expenditure (b) Capital expenditure

200 Introduction to Financial Accounting

7. Import duty on raw material purchased.

(a) Revenue expenditure (b) Capital expenditure

8. Fees paid for renewal of licence for factory

(a) Revenue expenditure (b) Capital expenditure

9. The freight and cartage on the new machine amounted to ` 300 and erection charges ` 550.

(a) Revenue expenditure (b) Capital expenditure

10. ` 5,150 spent on repairs before using a second - hand car purchased recently to put iuseable

condition.

(a) Revenue expenditure (b) Capital expenditure

11. Gave ` 1 lakh as custom duty on the machinery imported.

(a) Revenue expenditure (b) Capital expenditure

12. Invested ` 2 lakhs on the purchase of ` 2,000 equity shares of ` 100 each of a subsidiar

company.

(a) Revenue expenditure (b) Capital expenditure

13. Placed a deposit of ` 3 lakhs with the bankers as margin money for obtaining guarantee of

` 10 lakhs in favour of Bharat Petroleum Limited.

(a) Revenue expenditure (b) Capital expenditure

14. Furniture worth ` 19,500 destroyed by fire, which was not insured.

(a) Revenue expenditure (b) Capital expenditure

15. Spent ` 39,600 on research, but subsequently the project was abandoned by the management.

(a) Revenue expenditure (b) Capital expenditure

16. ` 60,000 spent on construction of railway siding.

(a) Revenue expenditure (b) Capital expenditure

17. Expenditure incurred on overhauling machinery.

(a) Revenue expenditure (b) Capital expenditure

18. Cost of goodwill.

(a) Revenue expenditure (b) Capital expenditure

Capital and Revenue 201

19. Purchase of machinery for sale.

(a) Revenue expenditure (b) Capital expenditure

20. Amount spent by factory in overhauling its plant which has enhanced the life of the plant by

five years.

(a) Revenue expenditure (b) Capital expenditure

21. Spent towards additions to machinery in order to double the production, ` 40,000.

(a) Revenue expenditure (b) Capital expenditure

22. Incurred for repairs to machinery, necessitated by the negligence of the employees, ` 24,000.

(a) Revenue expenditure (b) Capital expenditure

23. ` 12,000 interest has accrued during the year on term loan obtained and utilised for the

construction of factory building and purchase of machineries. However, the production has

not commenced till the last day of the accounting year.

(a) Revenue expenditure (b) Capital expenditure

24. Office rent paid in advance for three years.

(a) Revenue expenditure (b) Capital expenditure

25. ` 10,000 were spent on advertising for the introduction of a new product in the market, the

benefit of which will be effective during four years.

(a) Revenue expenditure (c) Deferred revenue expenditure

(b) Capital expenditure (d) None of the above

26. Visit of sales manager abroad, total cost ` 16,000 for promoting export sales; visit was quite

successful.

(a) Revenue expenditure (b) Capital expenditure

27. Cost of purchasing copyright from author.

(a) Revenue expenditure (b) Capital expenditure

28. Amount received from landlord as compensation for surrender of tenancy rights to the shop

of the concern.

(a) Revenue expenditure (b) Capital expenditure

29. Donation given to Army Central Welfare Fund.

(a) Revenue expenditure (b) Capital expenditure

202 Introduction to Financial Accounting

30. Gift received from father of proprietors deposited in bank account of concern.

(a) Revenue expenditure (b) Capital expenditure

31. Profits before incorporatoin of the company.

(a) Revenue expenditure (b) Capital expenditure

32. Profit on re-issue of forfeited shares.

(a) Revenue expenditure (b) Capital expenditure

33. Amount received from a sundry debtor.

(a) Revenue expenditure (b) Capital expenditure

34. Gratuity and pension paid to employees after retirement.

(a) Revenue expenditure (b) Capital expenditure

35. Renewal of Factory License.

(a) Revenue expenditure (b) Capital expenditure

36. Expenditure incurred on account of Trade Fair.

(a) Revenue expenditure (b) Capital expenditure

37. Preliminary expenses paid ` 12,000.

(a) Revenue expenditure (b) Capital expenditure

38. Receipt of commission by a firm a brokers.

(a) Revenue expenditure (b) Capital expenditure

39. (i) Purchased a new motor van ` 17,500 from B. G. Traders Ltd. on credit.

(ii) Paid cheque ` 740 to Office Furnishing Ltd. being ` 650 for a new office desk and ` 90

for repair of an existing desk.

(iii) Paid ` 1,420 by cheque for repairs and improvements to premises ` 1,000 of this amount

is to be capitalised.

(iv) Paid an additional ` 2,400 into the business bank account from his private bank account.

(v) Purchased additional premises for ` 30,000 which was paid by cheque.

State the total amount of capital expenditure involved in the above transactions

(a) ` 53,800, (b) ` 49,150,

Capital and Revenue 203

40. Petrol expenses of ` 420 paid for the car of one of the partners for an official visit, the car

not being an asset of the firm.

(a) Revenue expenditure (b) Capital expenditure

41. Interest on investment received from UTI.

(a) Revenue expenditure (b) Capital expenditure

42. A bad debt recovered during the year -

(a) Revenue expenditure (b) Capital expenditure

43. Cost of experimenting a new product which did not result in success.

(a) Revenue expenditure (b) Capital expenditure

44. Amount embezzled by employee during his employment.

(a) Revenue expenditure (b) Capital expenditure

45. Development costs in a new mine.

(a) Revenue expenditure (b) Capital expenditure

46. Amount of ` 5,000 spent as lawyer’s fee to defend a suit claiming that the firm’s factory site

belonged to the plaintiff’s land.

(a) Capital expenditure (b) Revenue expenditure

47. Insurance claim received on account of machinery damaged completely by fire.

(a) Capital receipt (b) Revenue receipt

(d) Revenue expenditure (c) Capital expenditure

48. Amount received from IDBI as a mediam term loan for working capital.

(a) Capital expenditure (b) Revenue expenditure

49. Revenue from sale of products ordinarily is reported as part of the earning in the period.

(a) the sale is made (b) the cash is collected

50. If repair cost is ` 25,000, Whitewash expenses are ` 5,000, cost of extension of building is

` 2,50,000 and cost of improvement in electrical wiring system is ` 19,000; the amount to

be expensed is

(a) ` 2,99,000 (b) ` 44,000

INTRODUCTION

Every business concern acquires and holds certain fixed assets like Land, Building, Plant,

Machinery, Furniture and fixture, Computer etc. for long term in the business. They are brought with

the view to use them in the course of the business for a long period of time. Due to the use of the fixed

assets the value declines. Shrinkage in the book value of fixed asset is of permanent and continuing

nature. Such permanent and continuing decline in value of fixed asset is called Depreciation.

MEANING OF DEPRECIATION

The word ‘depreciation’ is derived from Latin word ‘Depretium’ which means ‘decline’ or

‘reduction’ in price or value. Depreciation is concerned with fixed assets only. Fixed assets have long

life and loose their value due to the usages. Even if the asset is not put to use, its value goes on

reducing due to time span i.e. efflux. In other words depreciation means fall in the value of an asset

because of usage or with efflux of time or due to obsolescence or accident.

Accordingly depreciation is the continuous, gradual and permanent reduction in the value of

fixed asset brought about by factors like wear and tear, erosion, rot or rust, obsolescence, depletion or

exhaustion, passage (efflux) of time, etc.

DEFINITIONS OF DEPRECIATIONS

Carter defines “Depreciation is the gradual and permanent decrease in the value of an asset

from any cause whatsoever”

According to William Pickles, “Depreciation is the permanent and continuing diminution in the

quality, quantity or value of an asset”

From the above definitions the following facts can be noted or Important features of

depreciation.

1. Depreciation is a loss.

2. It is a reduction in the value of an asset.

The

decrease

the

value

asset

due

its

use,

caused

wear

and

tear

any

other

reason.

Such

reduction

the

value

gradual

and

continuous

except

Land.

Because

land

does

not

have definite economic life.

5. The term depreciation is used only in respect of fixed assets.

6. Depreciation is a charge against profit.

CHAPTER

Depreciation, Provisions and

Reserves

Depreciation, Provisions and Reserves 205

7. Depreciation is different from maintenance.

Depreciation

part

operating

cost.

Therefore,

transferred

profit

loss

account

the end of financial year.

9. It is a permanent and continuous decrease in the book value of an asset.

(Reduction

the

value

fixed

Asset

account

depreciation

not

temporary

but

permanent.)

CAUSES OF DEPRECIATION

Wear

Tear:

Wear

and

tear

refers

loss

utility

usefulness

asset

due

its

use.

Wear and tear takes place in the case of tangible fixed asset such as machinery, furniture, etc.

Efflux

time

Passage

time:

Even

fixed

asset

not

used,

its

value

declines

over

period of time. Thus, depreciation is required to be charged on idle machinery or building.

Obsolescence:

account

new

invention

introduction

new

technology,

the

old

existing

asset

becomes

outdated

useless.

Such

loss

reduction

called

obsolescence,

e.g. introduction of computers, reduces market value of typewriters.

Exhaustion

Depletion:

Assets

may

get

exhausted

depleted

due

its

constant

use

working, e.g. mines, quarries, oil wells, etc.

Damage:

Damage

assets

due

fire,

accident,

natural

calamities

floods,

earth-quakes,

etc. reduces their values.

NEED FOR DEPRECIATION

ascertain

true

rofit

oss:

Depreciation

expense

and

becomes

important

element

the

cost

production.

Though

not

visible

other

expenses

and

never

paid

the

outside

party,

yet

considerable

charge

depreciation

fixed

assets,

these

are

used

for

earning

purposes.

the

reduction

the

value

fixed

assets

must

deducted

from the income earned in order to calculate the true and real profit or loss of the business.

show

true

financial

position:

Balance

sheet

shows

the

true

and

fair

financial

position

the

business.

the

fixed

assets

are

required

shown

their

true

values.

depreciation

not

provided

assets,

amounts

overstatement

assets

the

Balance

Sheet

and

will

not

reflect

the

true

financial

position

the

business.

Therefore

necessary

that

depreciation must be deducted from the fixed asset in the Balance Sheet.

make

provisions

for

replacement

fixed

assets:

The

amount

depreciation

charged

and

debited

profit

and

loss

account

every

year

not

paid

other

expenses.

This

amount

retained

the

business

and

invested

some

securities

the

business.

The

funds

accumulated

made

available

the

business

for

replacement

fixed

assets

when

its life is over or it becomes unproductive.

meet

the

legal

requirements:

necessary

charge

depreciation

comply

with

the

provisions of Companies Act and the Income Tax Act.

FACTORS AFFECTING DEPRECIATION OR CONCEPTS IN

DEPRECIATION

Cost

the

asset:

The

total

cost

asset

means

the

purchase

price

asset

plus

incidental

expenses

the

asset

such

freight,

transport

charges,

installation

charges,

wages

for errection, fixation charges etc. upto the point the asset is ready for use.

206 Introduction to Financial Accounting

Estimated

scrap

value:

the

residual

value

the

asset

which

can

realised

the

end

the

effective

life

the

asset.

The

asset

may

become

outdated

after

its

estimated

life,

then

it may be sold as scrap.

Estimated

useful

life

asset:

Life

any

fixed

asset

refers

total

period

for

which

fixed

asset

can

used.

The

useful

life

the

asset

may

calculated

terms

years.

asset

may

still

exist

physically

but

may

not

capable

producing

the

same

results

reasonable

cost.

physical

life

the

asset

not

important,

rather

its

useful

life

important from accounting point of view.

FORMULA FOR CALCULATION OF DEPRECIATION

assettheoflifeEstimated

ValueScrapEstimatedAssettheofCost

p.a.onDepreciati



assettheofLife

Value

Scrap

charges

Installati

Asset

the

Cost

.a.ponDepreciati



onDepreciatiofRateAssettheofCostp.a.onDepreciati



onDepreciatiofRateAssettheofbalanceingvalue/OpenBookp.a.onDepreciati



METHODS OF DEPRECIATION

The different methods of depreciation are stated below:

1. Straight Line Method/Fixed Installment Method

2. Written Down Value Method/Reducing Balance Method

Annuity

Method

4. Depreciation Fund Method

Revaluation

Method

6. Insurance Policy Method

Sum

the

digits

method

8. Machine hour rate method

Depletion

method

As per the Syllabus students are required to study the following two methods of Depreciation.

These methods are:

1. Straight Line Method and

2. Written Down Value method.

1. Straight Line Method: Under this method, the depreciation is usually charged at fixed

percentage on the original cost of the Fixed Asset every year.

This method is very simple and easy. Under this method a fixed percentage of the original value

of the asset is written off every year, so as to reduce the asset account to nil or to its scrap value at the

end of the estimated life of the asset.

Depreciation, Provisions and Reserves 207

If the charge of depreciation plotted annually on graph paper and the points are joined together,

then it will show a straight line, so this method is called as “Straight Line Method”.

As the amount of depreciation per year remains constant, this method is called as "fixed

Installment Method".

As the depreciation is charged on original cost every year. This method is also called as

"Original Cost Method".

Features

1. The rate of depreciation is fixed as a fixed percentage.

2. Depreciation is charged as a fixed percentage on original cost of the assets.

The

amount

depreciation

same

during

the

economic

life

the

asset.

Merits

1. It is the simplest method of charging depreciation.

2. The provision for depreciation is spread equally.

3. It is suitable to leasehold properties and patents.

Demerits

1. If additional asset does not have the same working life; separate calculations are to be made.

does

not

take

account

effective

utilization

asset.

When provision for Depreciation Account is not maintained i.e. Depreciation is charged or

credited to the Asset A/c.

Under this method the amount of depreciation is charged to (Debited to) the Depreciation

Account and credited to the Asset Account. The Asset Account appears in the Balance Sheet at the

value remaining after deducting depreciation. Depreciation Account, being nominal Account, is

transferred to Profit and Loss Account at the end of accounting year. The Journal entries under this

method are as follows.

1. For Purchase of Asset

Asset

A/c

To Cash/Bank/Party’s (supplier’s) A/c

(Being Asset purchased for cash or on credit)

2. For expenses paid on Asset

Asset A/c Dr

To Cash/Bank A/c

(Being expenses paid on asset)

the

end

every

accounting

year

(a) For providing depreciation

Depreciation

A/c

To Asset A/c

(Being depreciation charged on asset for the year ___ at ___% p.a. by FIM/RBM)

(b) For Transfer of depreciation to Profit & Loss A/c

Profit & Loss A/c Dr

To Depreciation A/c

(Being depreciation for the year ___ transfer to Profit & Loss A/c) Or

(Being

balance

depreciation

A/c

transfer

Profit

Loss

A/c)

208 Introduction to Financial Accounting

4. For Sale of Asset

(a) For sale proceeds of Asset

Cash/Bank/Party’s (Purchaser’s A/c) Dr

To Asset A/c

(Being asset sold for cash or on credit)

(

For

Depreciation

Asset

sold

(according

the

period

use

i.e.

day

accounting

year till the date of sale)

Depreciation A/c Dr

To Asset A/c

(Being depreciation charged on asset sold for___ period at ___% p.a. by FIM/RBM)

Profit or loss = Selling price – Book value of the Asset sold as on date of sale.

profit

Asset A/c Dr

To Profit & Loss A/c

(Being profit on sale of asset transferred to Profit & Loss A/c)

loss

Profit & loss A/c Dr

To Asset A/c

(Being loss on sale of asset transferred to Profit & Loss A/c)

PROFORMA LEDGER ACCOUNTS

In the books of ……………

Dr. Asset A/c Cr.

Date Particulars Amt. Date Particulars Amt.

To balance b/d XX By Depreciation A/c

(Depreciation charged)

To Cash/Bank/Party’s A/c

(Purchase of Asset)

XX By Cash/Bank/Party’s A/c

(Sale of Asset)

To Cash/Bank A/c

(expenses on asset)

XX By Profit & Loss A/c

(Loss on sale of asset)

To Profit & Loss A/c

(profit on sale of asset)

XX By balance c/d XX

XX XX

Depreciation, Provisions and Reserves 209

Dr Depreciation A/c Cr

Date Particulars Amt. Date Particulars Amt.

To Asset A/c

(for depreciation)

XX By Profit & Loss A/c

(for transfer)

XX XX

Illustration 1

Duryodhan purchased a Motor Truck at a cost of ` 60,000/- on 1

January, 1985. Its useful life is

9 years, at the end of which it is estimated to fetch ` 10,000/-. The incidental expenses for the

purchases of the truck amounted to ` 4,000/-. Duryodhan wants to write off depreciation on fixed

installment basis.

How much depreciation should be written off every year? Prepare a Motor Truck A/C for the

year 1985, 1986, 1987 and 1988.

Solution

In the books of Duryodhan

Date Particulars JF ` Date Particulars JF `

1/01/85 To Cash A/c

(60000+4000)

64,000

31/12/85 By Depreciation A/c

By bal c/d

6,000

58,000

64,000 64,000

1/01/86 To bal b/d 58,000 31/01/86 By Depreciation A/c

By bal c/d

6,000

52,000

58,000 58,000

1/01/87 To bal b/d 52,000 31/12/87 By Depreciation A/c

By bal c/d

6,000

46,000

52,000 52,000

1/01/88 To bal b/d 46,000 31/01/88 By Depreciation A/c

By bal c/d

6,000

40,000

46,000 46,000

Dr. Depreciation A/c Cr.

Date Particulars JF ` Date Particulars JF `

31/12/85 To M.T. A/c 6,000 31/12/85 By P & L A/c 6,000

6,000 6,000

31/11/86 To M.T. A/c 6,000 31/12/86 By P & L A/c 6,000

6,000 6,000

31/12/87 To M.T. A/c 6,000 31/12/87 By P & L A/c 6,000

6,000 6,000

31/12/88 To M.T. A/c 6,000 31/01/88 By P & L A/c 6,000

6,000 6,000

210 Introduction to Financial Accounting

Depreciation p.a. =

Life

V.SCost



100004000



54000

= 6,000 p.a

Illustration 2

A company purchased Machinery worth ` 1,00,000/- on 1

March, 1985. Accounting year of the

company closes on 31

March, every year. Company provides depreciation at 10% p.a. on the original

cost. On 31

March., 1988, the machinery was sold for ` 1,20,000/- Give the machinery Account for

three years.

Solution

In the books of Company

Dr. Machinery A/c Cr.

Date Particulars JF ` Date Particulars JF `

1/04/85 To Cash A/c (P) 1,00,000 31/03/86 By Depreciation A/c

By bal c/d

10,000

90,000

1,00,000 1,00,000

1/04/86 To bal b/d 90,000 31/03/87 By Depreciation A/c

By bal c/d

10,000

80,000

90,000 90,000

1/04/87

31/03/88

To bal b/d

To P & L (pr)

80,000

50,000

31/12/87

31/03/88

By Cash A/c

By Depreciation A/c

1,20,000

10,000

1,30,000 1,30,000

Illustration 3

Raj purchased following plants and Machinery on various dates:

1.1.1986 ` 50,000/- 1.7.1986 ` 20,000/-

1.10.1987 ` 40,000/- 1.4.1988 ` 60,000/-

31.12.1989 ` 1,00,000/-

On 1.7.1989, he sold ½ of the Machine bought on 1.1.1986 for ` 20,000/-.

He writes off depreciation on the fixed installment system which he has estimated to be 10% p.a.

of the original cost. Prepare machinery Accounts in the ledger of Raj for the year 1986, 1987, 1988

and 1989.

Depreciation, Provisions and Reserves 211

Solution

In the books of Raj

Dr. Machinery A/c Cr.

Date Particulars JF ` Date Particulars JF `

1/01/86

To Cash A/c (P)

50,000

80,000

31/03/86

31/12/86

By Depreciation A/c

(5000+1000)

By bal c/d

6,000

64,000

70,000 70,000

1/01/87

To bal b/d

To Cash A/c (P)

64,000

4,000

31/03/87 By Depreciation A/c

(5000+2000+1000)

By bal c/d

8,000

96,000

1,04,000 1,04,000

1/01/88

31/03/88

To bal b/d

To Cash A/c (P)

96,000

60,000

31/12/88

03/12/88

31/12/88

By Depreciation A/c

(5000+6000+4000

+4500)

By bal c/d

1,20,000

10,000

1,40,500

1,56,000 1,56,000

1/01/89 To bal b/d 1,40,500 1/07/89 By Cash A/c 20,000

1/07/89 To P/L A/c 8750 1/07/89 By Depreciation A/c 1250

1,00,000 7/08/89 Depreciation A/c

(2500+2000+4000+6

000+0)

14590

31/03/89 By bal c/d 2,08,500

2,49,250 2,49,250

1/01/90 To bal b/d 2,08,500

Dr. Depreciation A/c Cr.

Date Particulars

C/F

` Date Particulars C/F `

31/12/88 To Machinery A/c 6,000 31/12/88 By P & L A/c 6,000

6,000 6,000

31/11/87 To Machinery A/c 8,000 31/12/86 By P & L A/c 8,000

8,000 8,000

31/12/89 To Machinery A/c 15,500 31/12/87 By P & L A/c 15,500

15,500 15,5000

31/07/89 To Machinery A/c 1,250 21/08/89 By P & L A/c 15,750

15,750 15,750

212 Introduction to Financial Accounting

Illustration 4

Sanika Enterprises, Pune purchased furniture for ` 40,000 on 1st July 2005. Additional furniture

on 1

January 2007 was purchased for ` 20,000. They charged depreciation at 15% p.a. on original

cost.

On 1

October 2007 they sold the furniture purchased on 1st July 2005 for ` 32,000 and on the

same date new furniture was purchased for ` 10,000. Show Furniture Account and Depreciation

Account for the years 2005-06, 2006-07, and 2007-08 assuming that the financial year closes on 31

March, every year.

Solution

In the books of Sanika enterprises

Dr. Furniture A/c Cr.

Date Particulars JF ` Date Particulars JF `

1/07/05 To Cash A/c (P) 40,000 31/03/06

31/08/06

By Depreciation A/c

By bal c/d

4,500

25,500

40,000 40,000

1/01/06

1/01/87

To bal b/d

To Cash A/c (P)

25,500

20,000

31/03/07

By Depreciation A/c

By bal c/d

6,750

38,750

45,500 45,500

1/04/07

1/10/07

To bal b/d

To P & L (P)

To Cash A/c (p)

38,750

6,500

10,000

1/10/07

31/12/88

31/03/08

By Cash A/c

By Depreciation A/c

By bal c/d

32,000

3,000

3,750

16,500

52,250 52,250

Dr. Depreciation A/c Cr.

Date Particulars C/F ` Date Particulars C/F `

31/03/06 To Furniture A/c 4,500 31/12/88 By P & L A/c 4,500

4,500 4,500

31/03/07 To Furniture A/c 6,750 31/12/86 By P & L A/c 6,750

6,750 6,750

1/10/07 To Furniture A/c 3,000 31/03/08 By P & L A/c 6,750

31/03/08 To Furniture A/c 3,750

6,750 6,750

Working Note

(1) Profit or Loss on sale of machine (1/10/07)

Cost (1/07/05) 40,000

Less Depreciation up to 31/03/07 10,500

Depreciation, Provisions and Reserves 213

W.D.V. (1/04/07) 29,500

Less Depreciation for months

(40,000 × 15% ×

) 3,000

W.D.V. (1/10/07) 26,500

Sold for 32,000

Profit on sale 6,500

(2) Depreciation on balance in 2007

20,000 × 15% = 3,000

10,000 × 15% ×

= 7,50

3,750

Problems for Practice

Q. 1. New Trading Company, Mumbai purchased Machinery for

90,000 on 1

April 2008.

October

2008

additional

Machinery

was

purchased

for

60,000.

October

2010

the Company sold the Machinery purchased on 1

October 2008 for

40,000.

Depreciation

charged

10%

p.a.

under

Straight

Line

Method

31st

March

every

year.

Prepare

Machinery

Account

and

Depreciation

Account

for

three

years

i.e.

2008-09,

2009-10

and 2010-11.

Ankita

company,

Solapur

bought

Machinery

worth

25,000

April

2004

and

paid

5,000

its

installation.

The

company

depreciation

the

Machinery

10%

p.a.

original

cost on 31

March, every year.

October

2006

the

company

sold

part

the

Machinery

for

7,000,

the

original

cost

which

was

10,000,

the

company

purchased

new

Machinery

for

20,000

the

same

date

show

Machinery

Account

and

Depreciation

Account

for

the

year

2004-05,

2005-06

and

2006-07.

Radhika

Traders

purchased

Office

Furniture

October,

2006

for

46,000

and

spent

16,000 for its Fixation.

The

estimated

Life

the

Furniture

years,

Radhika

Traders

also

estimated

that

the

scrap

value

the

end

its

life

would

12,000

The

entire

Furniture

was

sold

for

47,000

October

2009.

Show

Furniture

Account

and

Depreciation

Account

for

the

years

2006-07,

2007-08,

2008-09

and

2009-10

assuming

that

the

accounts

were

closed

March,

every

year.

WRITTEN DOWN VALUE METHOD

Under this method depreciation is charged at a certain percentage each year on balance of the

asset which is brought forward from the previous year. The amount of depreciation charged in each

period is not fixed but it goes on decreasing gradually, as the opening balance of the asset in each year

will reduce. In other words a fixed rate on the written down value of the asset is charged as

depreciation every year over the expected useful life of the asset. Thus, the amount of depreciation

becomes higher at the earlier period and becomes gradually lower in subsequent periods, when repairs

and maintenance charges increase gradually.

214 Introduction to Financial Accounting

As the depreciation is charged on Written Down Value (i.e. Cost less total depreciation), this

method is called as "Written Down Value Method". Similarly as the amount of depreciation per year

goes on reducing every year upto the useful life of the asset it also called as “Reducing Balance

Method” or “Diminishing Balance Method”.

If this method of depreciation is followed, the amount of depreciation remains higher but

repairing and maintenance charges remains very low in the earlier years. In the later years, amount of

depreciation remains low while amount of repairing and maintenance charges remains higher. It

means the total charges of depreciation and repairs and maintenance debited to profit and loss account

every year remains more or less same. As a result profit remains constant over the number of years.

This method of depreciation is more logical, scientific and realistic as compared to other methods of

depreciation. This method of depreciation is accepted under the Income Tax Act. Under this method

of depreciation assets are never completely written off. Because of this, some charges however they

are small, are made to revenue to save the taxes. Under this method of depreciation, higher amount of

depreciation is charged in the initial years gets match with the higher revenues earned from the

increased production carried out by the use of new assets.

Features:

1. The rate of deprecation is fixed.

2. The depreciation is computed on reducing balance of the asset.

3. The annual depreciation diminishes as the asset gets older.

4. The value of asset never becomes zero even after the economic life of the asset.

Merits:

1. It is not necessary to calculate every year the additions made to the asset.

2. It is simple and easy to understand.

3. Since the asset is not completely written off, some charge is made to revenue every year.

4. It is generally followed by every business concern and even tax authority.

Demerits:

1. Interest on capital invested in the asset is not considered.

2. Determination of suitable rate of depreciation is difficult.

Difference between Straight Line Method and Written Down Value Method

Straight Line Method Written Down Value Method

1 Meaning

The method of depreciation in which

depreciation is charged at a fixed percentage

on the original cost of fixed asset every year

is called Straight Line Method of

depreciation.

The method of depreciation in which

depreciation is charged at a fixed percentage

on the written down value of fixed asset at the

beginning of each year is called ‘Written

Down Value Method’.

2 Depreciation charged

Depreciation is charged on the original cost

of the asset every year.

Depreciation is charged on the written down

value (cost less total depreciation) of the asset

every year.

Depreciation, Provisions and Reserves 215

3 Book value/Zero balance

The book value of the asset becomes zero or

to scrap value at the end of its useful life.

The book value of the asset never becomes

zero or to scrap value at the end of its useful

life.

4 Amount of Depreciation

The amount of depreciation remains constant

for all the years.

The amount of depreciation goes on reducing

every year.

5 Recognition/Acceptability

This method of depreciation is not

recognised or accepted by the Income tax

authority.

This method of depreciation is recognised or

accepted by the Income tax authority.

6 Suitability

This method is suitable where repair charges

are less and obsolescence is not frequent.

This method is suitable where repair charges

are more in later years and also obsolescence.

Method

Straight Line Method

Fixed Installment Method

Original Cost Method

Method

Written Down Value Method

Reducing Balance Method

Diminishing Balance Method

Example: ` Example: `

Cost (1/1/2008) 10,000 Cost (1/1/2008) 10,000

Less: Depreciation 2008 10% p.a. (1000) Less: Depreciation 2008 10% p.a. (1000)

Book value/W.D.V./Balance

01/01/09

31/12/08

9000

Book value/W.D.V./Balance

9000

Less: Depreciation 2009 10% p.a. (1000) Less: Depreciation 2009 10% p.a. (900)

Book value/W.D.V./Balance

8000

Book value/W.D.V./Balance

8100

Less: Depreciation 2010 10% p.a. (1000) Less: Depreciation 2010 10% p.a. (810)

Book value/W.D.V./Balance

7000

Book value/W.D.V./Balance

7290

Illustration 5

Wasim Raja & Co., purchased following Plant & Machinery on the dates mentioned hereunder

Jan, 1986 ` 5,000/- 1

April, 1987 ` 2,000/-

July, 1987 ` 4,000/- 1

April, 1988 ` 6,000/-

216 Introduction to Financial Accounting

On 1

July, 1989 they sold the machine bought on 1

January, 1986 for ` 4,000/-. They write off

depreciation on the Reducing Balance Method @ 20% p.a. On 31

December every year.

Prepare Machinery Account in the ledger of Wasim Raja & Co. for the years 1986, 1987, 1988

and 1989.

Solution

In the books of Wasim Raja & Co

Machinery A/c

Date Particulars JF ` Date Particulars JF `

1/01/86 To Cash/Bank A/c 5,000 31/12/86

31/12/86

By Depreciation A/c

By bal c/d

1,000

4,000

5,000 5,000

1/01/87

1/04/87

1/07/87

To bal b/d

To Cash/Bank

4,000

2,000

4,000

31/12/87

By Depreciation A/c

(N – 1)

By bal c/d

1,200

8,800

10,000 10,000

1/01/88

1/04/88

To bal b/d

To Cash/bank

8,800

6,000

31/12/88

31/12/08

By Depreciation A/c

(N – 2)

By bal c/d

2,660

12,140

14,800 14,800

1/01/89 To bal b/d 12,140 1/07/89 By Cash/bank 4,000

1/07/89 To P/L A/c

(Profit on Sale)

(N – 3)

1696 By Depreciation

(M. Sold)

2,56

31/12/89 By Depreciation

(on balance) (N – 4)

1,916

31/12/89 By bal. C/d 7,664

13,836 13,836

1/01/90 By bal. b/d 7,667

Working Notes

(1) Depreciation for 1987

` 4,000 × 20% = ` 800

` 2,000 × 20% ×

= ` 300

` 1,000 × 20% ×

= ` 100

` 1,200

(2) Depreciation for 1988

` 8,800 × 20% = ` 1,760

Depreciation, Provisions and Reserves 217

` 6,000 × 20% ×

= ` 900

` 2,660

(3) Machine sold on 1/07/89

Cost (1/01/86) ` 5,000

(-) Depreciation for 1986 @ 20% ` 1,000

W.D.V. (1/01/87) ` 4,000

Less: Depreciation @ 20% ` 800

W.D.V. (1/01/88) ` 3,200

Less: Depreciation @ 20% ` 6,40

W.D.V. (1/01/89) ` 2,560

Less: Depreciation @ 20%

for 6 months ` 2,56

W.D.V. (1/07/89) ` 2,304

Sold for ` 4,000

Profit ` 1,696

(4) Depreciation on balance for 1989

W.D.V. (1/01/89) ` 12,140

(-) W.D.V. of M. Sold (1/01/89) ` 2,560

Balance ` 9,580

Depreciation @ 20% ` 1916

Illustration 6

The Machinery Account in the books of Ramji & Co., showed a balance of ` 7,540/- as on 1

January, 1990. They purchased a new Machinery of ` 2,200/- on 1.7.1990. They have also sold an old

machine on 1.1.1990 at a price of ` 5,000/-. This Machine was purchased on 1.1.1987 for ` 7,500/-.

Ramji & Co., write off depreciation @ 20% on Readucing Balance Method. Prepare Machinery

Account for the year 1990.

Solution

In the books of Ramji & Co.

Machinery A/c

Date Particulars JF ` Date Particulars JF `

1/01/90

1/07/90

To bal b/d

To P/L A/c

To Cash/Bank

7,540

1,160

2,200

1/01/90

31/12/90

By cash/bank

By Depreciation (N– 2)

To bal c/d

5,000

960

4,940

10,900 10,900

1/0191 To bal b/d 4,940

218 Introduction to Financial Accounting

Working Notes

(1) Machine sold on 1/01/90

Cost (1/01/87) ` 7,500

Less: Depreciation @ 20% ` 1,500

W.D.V. (1/01/87) ` 6,000

Less: Depreciation @ 20% ` 1,200

W.D.V. (1/01/89) ` 4,800

Less: Depreciation @ 20% ` 960

W.D.V. (1/01/90) ` 3,840

Sold for ` 5,000

Profit on sale ` 1,160

(2) Depreciation on Balance Machine and new purchase for 1990

Opening ` 7,540

(-) W.D.V. (1/01/90) (M. Sold) ` 3,840

` 3,700

= Depreciation @ 20% ` 740

On new machine

` 2200 × 20% ×

` 220

Total ` 960

Illustration 7

The Machinery Account in the books of Joker shows a debit balance of ` 15, 000/- on 1

April,

1990.

(i) On 1

October, 1990, he purchased a Machinery costing ` 10,000/-.

(ii)

January,

1991

sold

out

one

old

Machine

for

2,000

whose

book

value

the

beginning of the year was

3,000.

Machinery is to be depreciated at the fixed rate of 10% on diminishing balance method.

Show the Machinery Account for the year ending 31

March, 1991.

Solution

In the books of Joker

Machinery A/c

Date Particulars JF ` Date Particulars JF `

1/04/90

1/10/90

To bal b/d

To Cash/Bank

15,000

10,000

1/01/91

31/3/91

31/03/91

By cash/bank

By P/L A/c

By Depreciation

(M. Sold)

By Depreciation (N – 2)

By bal c/d

2,000

775

225

1,700

20,300

Depreciation, Provisions and Reserves 219

25,000 25,000

01/04/91 To bal b/d 20,300

Working Notes

(1) Sale of Machinery on 1/01/91

B.N. n (1/04/90) ` 3,000

Less: Depreciation @ 10%

for 9 months ` 225

W.D.V. (1/01/91) ` 2,775

Sold for ` 2,000

Loss on Sale Rs. 775

(2) Depreciation on Balance and during the year

opening (1/04/90) ` 15,000

(-) B.V. Machine sold ` 3,000

` 12,000

Depreciation @ 10% × 12,000 ` 1,200

New Purchase

10,000 × 10% ×

` 500

Total Depreciation ` 1,700

Problems for Practice

Q. 1. M/s Subhash & Company purchased Machinery on 1

April 2011 for

1,50,000.

Additional

Machinery

was

purchased

September

for

20,000.

March

201

the

Machinery

purchased

September,

became

obsolete

and

was

sold

for

12,000.

The

company

provides

depreciation

20%

p.a.

Reducing

Balance

Method

March every year.

Prepare Machinery Account and Depreciation Account for 3 years ending 31

March 2014.

ABC

Co.

Purchased

Furniture

April

for

60,000.

Additional

Furniture

was

purchased on 1

October 2011 for

30,000.

October

Company

sold

half

the

Furniture

purchased

April

for

20,000.

Depreciation

was

provided

annually

March

under

Written

Down

Value

Method

@ 10% p.a.

Show Furniture Account and Depreciation Account for 2011-12, 2012-13 and 2013-14.

Q.3

M/s

Medha

Trading

Company,

Nasik,

purchased

Machinery

1,20,000

April

Additional Machinery Costing

80,000 was purchased on 1

October 2011.

October

Machinery,

which

had

cost

20,000

April

was

sold

for

10,000.

220 Introduction to Financial Accounting

Company

provides

depreciation

under

Written

Down

Value

Method

March

every

year.

Prepare Machinery Account & Depreciation Account for 3 year, ending 31

March 2014.

When provision for Depreciation Account is maintained

Under this method the amount of depreciation is charged to (Debited to) the Depreciation

Account & Credited to the provision for depreciation Account. The Asset Account appears in the

Balance Sheet at its original value (cost price) on the asset side. Depreciation Account, being nominal

Account, is transferred to Profit & Loss Account at the end of the accounting year while provision for

Depreciation Account appears in the balance Sheet on liability side or deducted from Asset side from

concerned Asset.

In case the Asset is sold, the Provision for Depreciation on the asset sold is transferred to the

Asset Account. Similarly amount realized from the sale of asset is also transferred to Asset Account.

The balance, if any, in the Asset Account is either Profit or Loss, being transferred to Profit & Loss

Account.

The journal entries under this method are as follows:

1. For Purchase of Asset

Asset

A/c

To Cash/Bank/Party’s (Supplier’s) A/c

(Being

Asset

purchased

for

cash

credit)

For

expenses

paid

Asset

A/c

To Cash/Bank A/c

(Being

expenses

paid

asset)

the

end

every

Accounting

year

(a)

For

providing

depreciation

Depreciation A/c Dr

Provision

for

depreciation

A/c

(Being depreciation charged on asset for the year ___ at ___ % p.a. by FIM/RBM)

(b)

For

transfer

depreciation

Profit

Loss

A/c

Profit & Loss A/c Dr

Depreciation

A/c

(Being depreciation for the year ___ transfer to Profit & Loss A/c)

(Being balance in depreciation A/c transfer to Profit & Loss A/c)

For

sale

Asset

(a)

For

sale

proceeds

Asset

Cash/Bank/Party

’

(Purchaser

’

A/c

To Asset A/c

(Being

asset

sold

for

cash

credit)

(b)

For

Depreciation

Asset

sold

(according

the

period

use

i.e.

1st

day

accounting

year

till

the

date

sale)

Depreciation, Provisions and Reserves 221

Depreciation A/c Dr

To Provision for Depreciation A/c

(Being depreciation charged on asset sold for ___ period at ___ % p.a. by FIM/RBM)

(c)

For

transfer

Total

provision

for

Depreciation

A/c

asset

sold

Asset

A/c

(Transfer

accumulated

depreciation

asset

sold

Asset

A/c)

Provision for Depreciation A/c Dr

To Asset A/c

(Being provision for depreciation A/c on asset sold transfer to Asset A/c)

(Being accumulated depreciation on asset sold transfer to Asset A/c)

(d)

Entry

for

profit

loss

sale

Asset

Profit or loss = Selling price – Book value of the asset sold as on date of sale

If profit

Asset A/c Dr

To Profit & Loss A/c

(Being profit on sale of Asset transferred to Profit & Loss A/c)

If loss

Profit & Loss A/c Dr

To Asset A/c

(Being loss on sale of Asset transferred to Profit & Loss A/c)

Proforma ledger Accounts

In the books of ……………

Dr Asset A/c Cr.

Date Particulars JF Amt. Date Particulars JF Amt.

To balance b/d XX

To Cash/Bank/Party’s A/c

(Purchase of Asset)

XX By balance c/d

(Closing balance)

XX XX

To balance b/d XX

To Cash/Bank/Party’s A/c XX By balance c/d XX

(Purchase of Asset) (Closing balance)

XX XX

To balance b/d XX By Cash/Bank/Party’s

A/c

(Sale of Asset)

To Profit & Loss A/c

(Profit on sale of asset)

XX By Provision for Depn.

A/c

222 Introduction to Financial Accounting

(Transfer of PFD on

asset sold)

By Profit & Loss A/c

(Loss on sale of

Asset)

By Balance c/d

(Closing Balance)

XX XX

Dr. Provision for Depreciation A/c Cr.

Date Particulars JF Amt. Date Particulars JF Amt.

To balance c/d XX By balance b/d XX

(Closing Balance) By Depreciation A/c XX

XX XX

To balance c/d

(Closing Balance)

By balance b/d

By Depreciation A/c

XX XX

To Asset A/c XX By balance b/d XX

To balance c/d

(Closing Balance)

XX By Depreciation A/c

(on asset sold)

By Depreciation A/c XX

XX XX

Dr. Depreciation A/c Cr.

Date Particulars JF Amt. Date Particulars JF Amt.

To Provision for Depreciation

A/c

XX By Profit & Loss A/c XX

XX XX

To Provision for Depreciation

A/c

XX By Profit & Loss A/c XX

XX XX

To Provision for Depreciation

A/c

XX By Profit & Loss A/c XX

Depreciation, Provisions and Reserves 223

To Provision for Depreciation

A/c

XX XX

DIFFERENCE BETWEEN PROVISIONS AND RESERVES

Provisions Reserves

1 Nature

Provision is a charge on the profit i.e. charge

against profit.

Reserve is an appropriation of profit.

2 Purpose

It required for future liabilities and charges or

for valuation adjustment.

It is created for safeguarding the business

against unforeseen loses or for capital

formation.

3 Disclosure

Usually provisions are debited to Profit and

Loss Account.

Usually reserves are debited to Profit and Loss

Appropriation A/c.

4 Investment

It is not invested any where. It may be invested outside the business.

5 Utilisation

It cannot be used for distribution of dividend. It can be used for distribution of dividend.

6 Compulsion

Provisions are made mainly due to legal

compulsion.

Reserves are created out of profits as a matter of

prudence or safety.

7 Presentation

It is shown either as a liability under the head

‘current liabilities’ or as a deduction from the

asset.

A Reserve is shown on the liability side of

Balance Sheet under the head 'Reserves and

Surplus'.

Illustration 8

A Company whose accounting year is the calender year purchased on 1

April, 2004, machinery

costing ` 30,000.

It further purchased on 1st October 2004, machinery costing ` 20,000 and on 1

July, 2005, it

purchased additional machinery costing ` 10,000

On 1

July, 2006, one third of the machinery which was installed on 1

April, 2004, become

obsolete and was sold for ` 3,000.

Show how the machinery account would appear in the books of the company the machinery

being depreciated at 10 per cent per annum on the Fixed Instalment Method and a separate Provision

for Depreciation A/c being maintained for the year 2004, 2005 & 2006.

224 Introduction to Financial Accounting

Solution

Dr. Machinery A/c Cr.

Date Particulars ` Date Particulars `

1/4/04 To cash bank A/c 30,000

1/10/04 To cash bank A/c 20,000 31/12/04 By balance c/d 50,000

50,000 50,000

1/1/05 To cash bank A/c 50,000

1/7/05 To cash bank A/c 10,000 31/12/05 By balance c/d 60,000

60,000 60,000

1/1/06 To balance b/d 60000 1/7/06 By bank A/c 3,000

1/7/06 By P/L A/c (Loss) 4,750

1/7/06 By Provision for

depreciation A/c

(dep. On Machine sold)

2,250

31/12/06 By balance C/d 50,000

60,000 60,0000

1/1/07 To balance b/d 50,000

Workings:

Depreciation

for

2004

30,000

10%

9/12

2,250

20,000

10%

3/12

500

2,750

Dr. Provision for Depreciation A/c Cr.

Date Particulars ` Date Particulars `

31/12/04 To balance C/d 2,750 31/12/04 By depreciation A/c

(N-1)

2,750

2,750 2,750

1/1/05 By balance b/d 2,750

31/12/05 To balance c/d 8,250 31/12/05 By depreciation A/c 5,500

8,250 8,250

1/7/06 To Machinery A/c

(dep. on machine sold)

2,250 1/1/06 By balance b/d 8,250

1/7/06 By depreciation

(on Machine sold)

500

31/12/06 To balance C/d 11,500 31/12/06 By depreciation A/c

(on balance)

5,000

13,750 13,750

1/1/07 By balance b/d 11,500

Depreciation, Provisions and Reserves 225

2. Depreciation for 2005 3. For 2006

Machine sold (1/7/06) 10,000

` 30,000 × 10% = ` 3,000 (

× ` 30,000) (1/4/04)

` 20,000 × 10% = ` 2,000 Less: Depreciation @ 10% (for 9 mths) 750

` 10,000 × 10%

= ` 500 W.D.V. (1/01/05) 9,250

= ` 5,500 Less: Depreciation @ 10% 1,000

4. Depreciation for 2006 W.D.V. (1/1/06) 8,250

` 20,000 × 10% = ` 2,000 Less: Depreciation @ 10% 500

` 20,000 × 10% = ` 2,000 (for 6 mths)

` 1,000 × 10% = ` 1000 W.D.V. 1/7/06 7,750

` 5,000 Sold for 3,000

Loss on sale 4,750

Illustration 9

Rajesh maintains his fixed assets at cost. Depreciation provision accounts are maintained

separately for each asset. On 31

Dec., 2005 the position was as under:

Cost ` Depreciation `

Plant and Machinery 1,50,710 62,350

Furniture and Fixture 26,450 11,500

He purchased a machine for ` 10,000 on 1

April, 2006 and furniture for ` 3,000 on 1

June,

2006. A machine purchased on 1

January, 2004 for ` 6,000 was sold on 30

June, 2006 for ` 5,500.

Depreciation is provided @ 10% p.a. on Written Down Value method. Show the relevant account

for the year ended 31

December, 2006.

Solution

In the Books of Rajesh

Dr. Plant and Machinery A/c

Date Particulars ` Date Particulars `

1/1/06 To balance b/d 1,50,710 30/6/06 By cash bank A/c 5,500

1/4/06 To cash bank A/c 10,000 30/6/06 By provision for dep. A/c

(Dep. on Machinery sold)

1,383

30/6/06 To P/L A/c

(Profit)

883 31/12/06 By balance c/d 1,54,710

1,61,593 1,61,593

226 Introduction to Financial Accounting

Provision for Depreciation A/c

Dr. (Plant and Machinery) A/c

Date Particulars ` Date Particulars `

30/6/06 To Machinery A/c 1,383 1/1/06 By balance b/d 62,350

(Depreciation an Machine

sold)

30/6/06 By depreciation

(on Machine sold)

243

31/12/0

To balance c/d 76,575 31/12/06 By depreciation

(on balance) (N-7)

15,335

77,928 77,928

Notes: Sold on 30/6/06

1. Machine cost (1/1/04) ` 6,000 2. Depreciation on balance

Less: Depreciation @ 10% ` 600 Cost on 1/1/06 ` 1,50,710

W.D.V. (1/1/05) ` 5,400 Less: Machine

Less: Depreciation @ 10% ` 540 Sold Value ` 4,860

W.D.V. (1/1/06) ` 4,860 (1/1/06)

Less: Depreciation @ 10% ` 1,45,850

(6 mths) ` 243 ` 1,45,850 × 10% ` 14,585

W.D.V. (30/6/06) ` 4,617 ` 10,000 × 10 ×

= ` 750

Sold for ` 5,500 Total ` 15,335

Profit on sale ` 883

Dr. Furniture Fixture A/c Cr.

Date Particulars ` Date Particulars `

1/1/06 To balance b/d 26,450

1/4/06 To cash bank A/c 3,000 31/12/06 By balance c/d 29,450

29,450 29,450

Dr. Provision for depreciation A/c Cr.

Date Particulars ` Date Particulars `

31/12/06 To balance b/d 13,170 1/1/06 By balance c/d 11,500

31/12/06 By depreciation (N-1) 1,670

13,170 13,170

1. Depreciation for the year 2006

On opening balance

Cost

26,450 Provision

11,500 = W.D.V.

For depreciation

14,950

Depreciation, Provisions and Reserves 227

@ 10%

1,495

On new purchase

` 3,000 × 10% ×

= ` 175

16,70/-

Illustration 10

A Machinery having original cost in the books as on 1

April, 2008 at ` 20,000 was sold for

` 12,000 on 30

September 2008. ` 7,500 was set aside by the firm by way of depreciation on the

Machinery upto 31

March 2007.

On 1

January 2009 new Machinery was purchased for ` 25,000

The accounts were closed on 31

March every year and depreciation was provided @ 10% on

original cost of Machinery.

Show Journal Entries and Prepare and necessary ledger accounts, if Provision for Depreciation

Account is maintained for the year 2008-09

Solution

Date Particulars L.F. Debit ` Credit `

30/9/08 Cash bank A/c Dr 12,000

To Machinery A/c 11,500

To P/L A/c 500

(Being machine sold and Profit recorded)

30/9/08 Depreciation A/c Dr Dr 1,000

To provision for depreciation the

(Being depreciation charge during year on

machine sold)

1,000

30/9/08 Provision for depreciation A/c Dr. Dr 8,500

To Machinery A/c 8,500

(Being accumulate depreciation machine

sold transfer)

1/1/09 Machinery A/c Dr. Dr 25,000

To cash /bank A/c 25,000

(Being new machinery purchased)

31/3/09 Depreciation A/c Dr. Dr 625

To Provision for depreciation A/c 625

(Being depreciation charged during year)

31/3/09 P/L A/c Dr. Dr 1,625

To depreciation A/c 1,625

(Being depreciation transfer P/L A/c)

228 Introduction to Financial Accounting

Dr. Machinery A/c Cr.

Date Particulars L/F ` Date Particulars L/F `

1/4/08 To balance b/d 20,000 30/9/08 By cash bank A/c 12,000

30/9/08 To P/l A/c 500 30/9/08 By provision for

depreciation A/c

8500

1/1/09 To cash bank A/c 25,000 31/3/09 By balance c/d 25000

45,500 45,500

Dr. Provision Depreciation A/c Cr.

Date Particulars ` Date Particulars `

30/9/08 To Machinery A/c

(depreciation on machine

sold

8,500 1/4/08 By balance b/d 7,500

31/3/09 To balance c/d 625 30/9/08 By depreciation A/c 1,000

31/3/09 By depreciation A/c 625

9,125 9,125

Notes:

1. Sale of machinery on 30/9/08

Original

cost

1/1/08

20000

Less: Depreciation upto dute (6 mths) 7500

12500

W.D.V.

Less:

Depreciation

10%

mths)

(20000

10%)

1000

W.D.V. (30/9/08) 11,500

Less:

Solling

Price

12,000

Profit on sale 500

Depreciation

balance

machinery

25,000 × 10% × 3/12 =

625

Problems for Practice

Q.1.

April

2003

firm

purchased

Machinery

for

2,00,000.

October

the

same

year

new

Machinery

was

purchased

for

1,00,000.

October

2004,

the

Machinery

purchased

April

2003

was

sold

for

90,000.

October 2005 additional new Machinery was purchased for

2,50,000.

The

firm

provides

depreciation

Machinery

10%

under

Reducing

balance

Method

March

every

year.

Pass

Journal

Entries

and

also

prepare

Machinery

Account,

Provision

for

depreciation

Account and Depreciation Account for 3 year ending upto 31

March 2006.

April,

2009

following

balances

appeared

the

Books

Mangesh

Traders;

Machinery

A/c

4,00,000,

Provision

for

Depreciation

A/c

1,60,000

the

above

date

Depreciation, Provisions and Reserves 229

they

decided

sell

the

Machinery

for

1,00,000

which

was

purchased

April

2006

for

1,50,000.

The

firm

provides

depreciation

March

every

year.

@10%

p.a.

under

Straight

Line

Method.

Show Machinery Account and Provision for Depreciation Account as on 31

March 2010.

EXERCISES

Match the Column

Group ‘A’ Group ‘B’

(a) Diminishing balance method 1. Assets at original cost recorded

(b)Current assets 2. Value of asset never become zero

(d) Fixed assets 4. Expected value on disposal of asset

(e) Provision for depreciation 5. Depreciation is not charged

6. Depreciation on original cost

Ans: (a)-2, (b)-5, (c)-4, (d)-3, (e)-1

Fill in the blanks

1. Depreciation is ________ in the value of asset.

2. All ________ assets are depreciated.

3. Under ________ system, the amount of depreciation change every year.

4. ________ Method in which depreciation remains constant.

5. At the end of the year, depreciation is transferred to ________ account.

6. In any method of depreciation, depreciation is charged on ________ of the asset in first year.

7. Depreciation account is a ________ account.

8. Depreciation is ________ to the business.

9. Amount spent on installation of new machinery is ________ to the cost of the machine.

10. Rate of depreciation depends upon the ________ of the asset.

11. Profit or loss on sale of the asset is transferred to ________ account.

Ans. 1. decline, 2. fixed, 3. written down value, 4. fixed installment, 5. profit and loss a/c, 6. cost,

7. nominal, 8. loss/expenditure, 9. added, 10. economic life, 11. profit and loss a/c.

PROBLEMS

(A) Fixed Installment Method

Kunal

Kapoor

purchased

some

Plant

Machinery

1.4.1

for

4,500/-

and

spent

500/-

erection.

1.10.1

sold

the

Machine

for

4,000/-

and

the

same

date

purchased

another Machine for

10,000/-.

writes

off

depreciation

Fixed

Installment

System

which

has

estimated

10%

p.a. Accounting year of the Company closes on 31

March every year.

230 Introduction to Financial Accounting

Pass

Journal

entries

also

prepare

Machinery

Account

Depreciation

A/c

for

the

year

2011-2012, 2012-2013 & 2013-2014.

From

the

books

Mr.

Amitabh,

the

following

particulars

regarding

Machinery

A/c

are

available.

Prepare

the

Machinery

A/c

for

the

year

2014

assuming

that

depreciation

written

off at 10% p.a. on Straight Line Method.

(a) Balance on 1.1.2014

52,000/-.

(b) Purchased of machinery on 1.7.2014

20,000.

5,000.

(d) Sale on 1.10.2014 for

22,000 of machinery originally costing

20,000 on 1.7.2012.

(e) The opening balance includes Machinery purchased on 31.12.2013 for

35,000.

Q.3. M/s. Sharad Agency showed a debit balance of

36,000/- to the Machinery A/c on 1.7.2010.

The original cost of machinery was

60,000/-.

January,

2011

Sharad

Agency

bought

additional

Machinery

48,000/-

and

spent

2,000/-

for

its

installation.

One

machinery

costing

25,000/-

was

purchased

30.6.2011.

30.6.

2013

part

machinery

acquired

January

2011

was

sold

for

7,250/-

the

original cost of which was

10,000/-.

31.12.

2013

the

Agency

sold

out

the

machinery

for

16,000/-

which

was

purchased

30.6.2011.

Agency

charged

10%

depreciation

fixed

installment

basis

and

their

financial

year

closed

on 30

June every year.

Show Machinery Account for the year 2010-11, 2011-12, 2012-13 and 2013-14.

(B) Reducing Balance Method

Aurangabadkar

purchased

furniture

worth

20,000/-

1.1.

2012

charges

depreciation

the

rate

10%

Reducing

Balance

Method.

1.7.

2013

sold

out

part

the

furniture

for

2,000/-,

the

original

cost

which

1.1.

2012

was

4,000/-.

The

financial

year of Aurangabadkar ends on 31st March every year.

You

are

required

prepare

his

Furniture

Account

for

the

First

Four

Years,

and

pass

journal entries for the transaction of the fourth year.

Ankita

Trading

Company,

Pune

purchased

Furniture

April

for

25000.

the

same year additional furniture was Purchased for

10,000 on 1

October 2012.

October

the

Furniture

Purchased

April,

was

sold

for

15,000

and

on the same date new Furniture was Purchased for

12,000.

The company charge depreciation @ 8% p.a. on Diminishing Balance Method.

Pass

Journal

entries

also

prepare

Furniture

Account

Depreciation

A/c

for

years

i.e.

assuming

that

the

accounting

year

the

company

closes

March every year.

XYZ

Company

Jalgaon

purchased

Building

for

8,00,000

July

April

2012 an extension was made to the above building by spending

4,00,000.

October

half

the

building

was

sold

for

5,60,000

and

brokerage

the

selling price was paid.

Depreciation, Provisions and Reserves 231

Depreciation

charged

March

every

year

10%

p.a.

under

diminishing

balance

method.

Prepare Building Account and Depreciation Account for 2011-12, 2012-13 and 2013-14.

M/s.

Vishal

Traders,

Bombay,

purchased

Machinery

1.1.

2012

for

68,000.

The

Installation

Charges

amounted

2,000/-.

They

decided

depreciate

the

machinery

10%

per

annum

under

fixed

installment

system.

1.7.

2014

machinery

having

original

cost

10,000/-

was

sold

for

5,000/-

and

the

same

date

new

machinery

amounting

10,000/-

was

purchased.

Pass

journal

entries

the

trader

’

book

and

also

prepare

Machinery

account,

Provision

for

Depreciation

Account&

Depreciation

A/c

from

1.1.

2012

to 31.12.2014. The accounts of the firm are closed on 31

December every year.

Sangam

Trading

Co.

purchased

some

machinery

1.1.

2012

costing

88,000/-

and

spent

2,000/- on its erection. On 30.6.2012 additional machinery is purchased for

10,000/-

31.12.

2013

part

the

machinery

was

sold

for

2,100/-

which

had

cost

price

4,000/- on 1.1.2012.

Prepare

Machinery

A/c,

Provision

for

Depreciation

Account&

Depreciation

A/c

for

the

year

2012

2013

and

2014

and

pass

journal

entries

for

the

year

2013

assuming

that

Machinery

depreciated at 10% p.a. on diminishing balance method on 31

Dec., each year.

INTRODUCTION

Accounting is the recording and reporting of business transactions. Business transactions involve

activities of actual business (selling goods or services), investment (purchasing assets) and financing

(raising money for investment). In accounting, Business activities give rise to revenue income and

revenue expenditure, Investment activities give rise to capital expenditure, Financing activities give

rise to capital receipts. P & L A/c is a summary of revenue income and revenue expenses, Balance

sheet is summary of capital receipts and capital expenditure.

Thus, preparation of final accounts is the last step in the accounting cycle. In fact, final accounts

include a number of accounts such as (i) trading accounts (ii) profit and loss account, and (iii) balance

sheet. Though balance sheet is a statement, for all practical purposes, it is treated as one of the final

accounts. Once the “trial balance” is extracted and ‘errors’ rectified, a trader prepares the “final

accounts” so as to know the final results (i.e., net profits or loss) and the financial position (i.e., assets

and liabilities) of his business. Trading account and profit and loss account concerning goods by

passing entries known as “closing entries”. All remaining accounts, viz., real and personal account

pertaining to properties, debtors and creditors are just shown in statement called balance sheet

Manufacturing Account

Those concerns which are converting raw materials into finished goods and then sell the finished

goods, are required to prepare manufacturing account besides preparing trading and profit and loss

account. This account is prepared to calculate the cost of goods manufactured, which is transferred to

the trading account. The expenses relating to the factory are transferred to manufacturing account. The

main object of manufacturing account is to show:

(i) Cost of finished goods produced and

(ii) Constituent items thereof such as cost of material consumed, productive wages, direct and

indirect expenses.

Features of Manufacturing Account

(a) Stock of Finished Goods

Since the main purpose of preparing this account, is to find out the cost of goods produced during

the year, the opening and closing stock of finished gods are not to be shown in this account. They will

be shown in the trading account.

(b) Raw Material Consumed

The cost of raw materials consumed during the year is to be debited in the account. It can be

found out as follows:

CHAPTER

Final Accounts

Final Accounts 233

Cost of raw material consumed

Opening stock of raw materials ×××

Add: purchase of raw materials ×××

Less: closing stock of raw materials ×××

×××

In a manufacturing business concern, there are always some unfinished goods, the cost of closing

work-in-progress is credited in the account, shown in the balance sheet and debited to the

manufacturing account of the next year as an opening balance.

(d) Factory Expenses

All factory expenses are debited to this account. Example, rent, rates, salaries of supervising staff,

light, heat and fuel, repairs and renewals, depreciation relating to factory property (i.e., machinery) etc.

(e) Sale of Scrap

Scrap is the incidental residue from certain types of manufacture. The value realized from the

sale of scrap is credits to the manufacturing account.

(f) Cost of Production

At this stage, the difference between the two sides of the manufacturing account, shows the cost

of goods produced during the year.

The balancing figure in the account is the cost of goods manufactured which will be debited to

trading account. The trading account therefore, will compromise only the opening stock of finished

goods, cost of goods manufactured, sales (less sales returns), and the closing stock of finished goods.

A proforma of manufacturing account is given below:

Manufacturing a/c for the year ended 2014

Particulars ` Particulars `

To Work-in-progress (opening)

To material used

Opening stock

Add: Purchases

Less: Closing stock

To Wages

To Factory expenses

To Purchase expenses

To Import duty

To Carriage inward

To Depreciation on machinery

To Repairs to machinery

xxx

By Sales of scrap

By Work-in-progress

(closing)

By Cost of goods produced

transferred to Trading A/c

(bal. fig.)

xxx

xxxx

Trading account is prepared for specific period to know the trading results of the business. It

contains in a summarized form all the transactions occurring during a trading period which have direct

relation to the goods dealt-in by the business. It Is prepared usually by merchandising concerns which

purchase goods and sell the same during a particular accounting period. It is mainly prepared to

ascertain the gross profit or gross loss. Gross profit or gross loss is the difference between actual sale

proceeds and the cost of goods sold. (gross profit = excess of sale proceeds over cost of goods sold

234 Introduction to Financial Accounting

and gross loss = excess cost of goods sold over sale proceeds). The “cost of goods sold” includes the

“purchase value” of such goods plus the “buying and bringing” expenses and the “conversion

expenses of raw materials into saleable finished goods”. Thus, “cost of goods” consists of:

(i) The opening stock of goods plus net purchases (i.e., purchases less returns) less closing

stock of such goods, and

(ii) All expenses of bringing the goods into saleable condition and also to the point of sale, i.e.,

all manufacturing expenses, carriage, cartage, freight, duty, etc.

Preparation of Trading Account

Trading account is a ledger account. Therefore, its form and construction conform to the rules of

double entry principles of debit and credit.

As the trading account contains the results of operations over a period, the heading should be

“Trading account for the year (or any period) ended…..”.

A proforma of a trading account is given below:

Trading Account for the year Ended 2014

Particulars

` `

Particulars

To Opening stock

To Purchases

Less: Purchase returns

To Direct expenses:

Carriage inward

Wages

Freight

Import duty

Gas and fuel

Royalty on production

Factory expenses, etc.

To Gross profit c/d*

transferred to Profit and Loss A/c

xxx

By sales xxx

Less: Sales returns xxx

By Closing stock

By Gross loss c/d*

xxx

xxx xxx

*Balancing figure will be either gross profit or gross loss.

Items Appearing on the Debit Side of Trading Account

1. Opening Stock: Stock on hand at the beginning of the year is called opening stock. This

item is usually shown as the first item on the debit side of the trading account. The figure is

available from the trial balance. It may include raw materials, work-in-progress and finished

goods.

2. Purchases: It shows the gross amount of purchase made of the materials, and saleable goods.

It includes both cash and credit purchases of goods made during the year which are meant

for resale.

3. Purchase Returns: The purchase returns is a credit balance showing the return of goods to

the suppliers. It should be subtracted from the total purchases to get the net purchases. Net

purchases are shown in the trading account.

Final Accounts 235

4. Direct Expenses: It refers to those expenses which are incurred for making the goods

saleable. It may include factory or manufacturing expenses incurred on purchase of goods.

Factory rent, wages, octroi, freight on purchases, manufacturing expenses, import duty,

carriage inward, customs duty, dock dues, clearing charges, motive power, oil, grease and

waste, packing charges, wages and salaries, cartage, royalty on production etc., these

expenses are shown on the debit side of the trading account.

Items Appearing on the Credit Side of Trading Account

1. Sales: It is a credit balance indicating the total sales of goods made during the year. It

includes both cash and credit sale of goods.

2. Sales Return: This is a debit balance, showing the total amount of goods returned by the

customers. Sales returns should be subtracted from the total sales to find net sales which are

shown on the credit side of trading account.

3. Closing Stock: It refers to the unsold goods which is lying in the godown at the end of the

accounting year. Generally, the closing stock does not appear in the trial balance. It appears

outside the trial balance. But when purchases are adjusted with opening and closing stocks,

closing stocks appears as a debit balance in the trial balance. If it is given outside the trial

balance, it will be shown on the credit side of trading account and also in the assets side of

the balance sheet. If it is given in the trial balance, it will have to be shown only in assets

side of the balance sheet. It may include raw materials, work-in-progress and finished goods.

Closing Entries in Respect of Trading Account

The following entries are passed in the journal to transfer the relevant ledger balances to the

trading account.

(i) For transferring opening stock, net purchases and direct expenses to trading account

Trading account Dr. xxx

To Opening stock A/c xxx

To Purchases (net) A/c xxx

To Direct expenses A/c xxx

(ii) For transfering net sales and closing stock to trading account

Sales (net) A/c Dr. xxx

Closing stock A/c xxx

To Trading A/c xxx

(iii) (a) For gross profit: (b) For gross loss:

Trading A/c Dr. Gross loss A/c Dr.

To Gross profit A/c To Trading A/c

Profit and Loss Account

According to Prof. Carter, “profit and loss account is an account into which all gains and losses

are collected in order to ascertain the excess of gains where the losses or vice versa”. Profit and loss

account is prepared in order to calculate the net profit or net loss of the business. This account starts

with the credit from the trading account in respect of gross profit (or debit if there is gross loss). From

gross profit, operation and non-operating expenses are deducted and operating and non-operating

income is added in order to calculate the net profit. When total of all the expenses is more than gross

profit and other income, there remains a deficit and this is called net loss. The net profit or net loss

ultimately transfers to capital account of the proprietor or to partners’ capital accounts in case of

partnership firm.

236 Introduction to Financial Accounting

Preparation of Profit and Loss Account

As in the case of a trading account the profit and loss account is an account and hence, its form

and construction conform to the rules of ledger account and principles of double entry system. Since

the profit and loss account is prepared to show the net profit earned to net loss incurred during a

particular period, it should be headed as under:

“Profit and Loss A/c of 2014 for the year ended”

The specimen proforma of a profit and loss account is given below:

Profit and Loss A/c of for the year Ended 2014

Particulars ` Particulars `

To Gross loss b/d

To Management expenses:

Office salaries

Rent, rates and taxes

Printing and stationery

Postage and telegrams

Telephone charges

Legal charges

Audit fees

Insurance

General expenses

Office lightning

To Financial expenses:

Interest on capital

Interest on loans

Discount allowed

Discount on bills

To Selling and distribution expenses:

Advertising

Traveler’s salaries

Expenses and commission

Bad debts

Godown rent

Carriage outwards

Agent’s commission

Upkeep of motor vans

Export expenses

To Depreciation and maintenance:

Depreciation

Repairs and maintenance

To Extraordinary expenses:

Loss by fire (no covers by

insurance)

Cash defalcations

To Net profit transferred to Capital A/c

By gross profit b/d

By interest received

By ddiscount received

By commission received

By rent from tenants

By income from investments

By apprenticeship premium

By interest on debentures

By miscellaneous revenue receipts

By net loss transferred to capital A/c

xxx

Final Accounts 237

Items Appearing on Debit Side of Profit and Loss A/c

The business expenses are divided into two types: direct expenses which are recorded in the

Trading A/c and indirect expenses which are recorded in the debit side of Profit and Loss A/c. indirect

expenses can be further divided into two varieties: (i) Operating expenses, and (ii) non-operating

expenses.

(i) Operating Expenses: It refers to those expenses which are incurred in order to operate the

business efficiently and smoothly. These include administration, selling, distribution, finance and

maintenance expenses..

(ii) Non-operating Expenses: The expenses are not related to the operation of the business and

include capital losses as loss on the sale of furniture, etc., writing off fictitious assets, as preliminary

expenses, underwriting commission, etc., writing off intangible assets as goodwill, copyright, patents,

etc.

Items Appearing Credit Side of Profit and Loss Account

Gross profit is shown on the credit side of profit and loss account. Also other gains and incomes

of the business are shown on the credit side. The other incomes are generally classified into two types,

i.e., (a) operating income, and (b) non-operating income.

(a) Operating Income: It refers to that portion of income which is earned for the operations of

the business. Examples: interest, commission and discount earned, etc.

(b) Non-operating Income: This income is not earned from the routine operations of the

business. Examples are profit on sale of any fixed assets, refund of tax.

Closing Entries for Profit and Loss A/c

(i) For transferring the various expenses to Profit and Loss A/c

Profit and loss A/c Dr.

To Various expenses A/c

(ii) For transferring the various incomes again to Profit and Loss A/c.

Various incomes gains A/c

To Profit and loss A/c

(iii) (a) For net profit: (b) For net loss:

Profit and loss A/c Dr. Capital A/c Dr.

To Capital A/c To Profit and loss A/c

Balance Sheet

It is a classified summary of balances remaining open in the general ledger after all the income

and expenditure accounts have been closed off by transfer to trading and profit and loss account. It

shows readily the financial position of the business at a given date by disclosing the amount of capital

contributed and how the same has been invested and the values of assets and liabilities and their nature.

The capital and liabilities of the business are shown on the left hand side and assets and other debit

balances are shown in the right hand side. It is a statement containing all the unclosed balance “real”

and “personal” accounts. Balance sheet is prepared with a view to measure the correct financial

position of a business enterprise on a certain fixed date. It is a device for describing the financial

position of a business in systematic standard form. By putting the financial position into such a form,

it is possible to tell a complicated story of the enterprise in less time and space than if the same story

were to be written as an extended narration: “Balance Sheet is a snapshot of the financial condition of

238 Introduction to Financial Accounting

the business”. At one glance, the situation of the enterprise at certain date, can be understood.

Therefore, it is rightly called as “Mirror” of the business, wherein the business can see its face, i.e., its

true position. An important thing to note about the balance sheet is that it always balances; that is to

say; the total value of the assets is always equal to the total value of the claims or liabilities. In other

words,

Assets = Liabilities + Capital (or)

Assets – Liabilities = Capital

In the other words of Fransis R. Stead “ Balance sheet is a screen picture of the financial position

of a going business at a certain moment”. According to R.N. Antony “Balance sheet is a statement

which reports the property values owned by the enterprise and the claims of the creditors and owners

against the properties. It shows the status of the business as at a given moment of time, in so far as a

counting of figures can show its status”.

Classification of Assets and Liabilities

Assets

Assets represents everything which a business owns and has many values. Assets are always

shown as debit balances. The various types of assets are:

(i) Fixed Assets: It refers to those assets which are held by way of equipment and not for the

purpose of resale. They are of a permanent nature and it is by their help that the business is carried on.

These are acquired for the purpose of creating production capacity, e.g., plant and machinery, building,

furniture, fixtures and motor, vehicles, etc., the assets may be further subdivided into (a) tangible

assets, and (b) intangible assets.

(a) Tangible Assets: it refers to those assets which can be seen, touched and have volume such

as machinery, land and building, furniture, etc.

(b) Intangible Assets: These assets do not have physical existence. Goodwill, patents,

trademarks and copyrights are examples of intangible assets. Though they are intangible,

they are fixed assets as they are represented by certain values. Further, patents, trademarks

and copy rightsetc are all useful for earning revenues.

(ii) Current Assets: Current assets are those assets which are to be converted into cash within

one year or during the normal operating cycle of the business. E.g., cash, bank, marketable securities,

debtors, bills receivable and inventory which consists of debtors materials, work-in-progress and

finished goods. These are also called floating assets because their value is constantly floating, i.e.,

changing from one form to another as given in the following chart.

(iii) Liquid Assets: Liquid assets are readily convertible into cash at short notice with little or no

risk of loss. Conversion of inventory into cash will take more time and hence it is not a liquid asset.

Example: cash, bank, marketable securities, debtors and bills receivable.

(iv) Fictitious Assets: As the name implies such “assets” are to really assets. Only for the sake of

convenience the amount is shown as an asset in the balance sheet. No amount can be realized or

further benefit derived from the expenditure concerned. These assets are shown on the assets side of

balance sheet till they are fully written off. It is prudent to write-off these assets to profit and loss

account as early as possible

Examples would be:

Preliminary expenses

Expenses on issue of

Share and debentures

Final Accounts 239

Discount on issue of

Shares and debentures

Debit balance of profit and loss A/c

(v) Contingent Assets: Contingent asset is one, the existence of which depends upon the

happening of a certain event which may or may not take place. Examples would be (a) claim for

income tax refund (b) uncalled share capital of a public limited company (c) claim by the firm for

infringement of trade-marks or patent or copy right, etc., by others. These assets need not be shown in

the balance sheet. They are usually shown as a footnote to the balance sheet.

(vi) Wasting Assets: The fixed assets which have a limited useful life and which, by nature,

depreciate rapidly are termed as wasting assets. A wasting asset is as asset that diminishes in value by

reason of and commensurately with the extraction or removal of a natural product. As soon as, say all

the oil in an oil well has been extracted, the oil well becomes valueless. Mines and quarries have the

same characteristics.

Liabilities

All that the business owes to others are called liabilities. It also includes proprietor’s capital.

They are known as credit balances in the ledger. Liability is a claim by an outsider on the assets of the

business. Liabilities may be classified into four categories:

(i) Proprietor’s capital or net worth: Proprietor’s capital is the original fund with which he

entered a business. Later on he may introduce further amounts towards capital and he may withdraw

some amounts from the business. Net worth means the amount of capital outstanding on the particular

date plus any profits retained in the business. The total amount belongs to the proprietor. This is

shown on the liabilities side of the balance sheet as it is payable by the business to the proprietor.

(ii) Long-term liabilities: The liabilities which are repayable after a long period of time are

known as fixed liabilities, i.e., they do no become due for payment in the ordinary course of the

business within a relatively short period, E.g. long-term loans and debentures. These may be secured

or unsecured. But generally, they are secured.

(iii) Current liabilities: It refers to those liabilities which are repayable within one year or

during the normal operating cycle of the business by the use of the existing resources of current assets

or by the creation of similar current liabilities. E.g., trade creditors, bills payable, accrued expenses,

bank overdraft, provision for taxation, proposed dividend, etc.

(iv) Contingent liabilities: Contingent liability will become an actual liability only on the

happening of a certain event which may or may not happen. These are:

(a) Bills discounted and endorsed which may be dishonoured.

(b) Claim by others which has been disputed by the firm or pending in the court of law.

These are to be disclosed by way of not to the balance sheet.

Grouping and Marshalling of Assets and Liabilities

A balance sheet is usually prepared in the form of a statement, with assets on the right hand side

and liabilities and capital on the left-hand side. The component items of a balance sheet should be

arranged in an orderly manner and in a sequence that should be adhered to year-by-year. Such an

arrangement of the items in a balance sheet is known as ‘Marshalling’. There are two ways in which

the assets and liabilities can be arranged in balance sheet. They are: (a) Order of performance, and

(b) order of liquidity.

240 Introduction to Financial Accounting

The first method is commonly used by companies, whereas the second one is popular among sole

traders and partnership firms. However, in case of certain concerns, such as banking companies,

insurance companies, railway companies, other joint stock companies, etc., form of balance sheet is

prescribed by the law.

(i) Proforma of balance sheet in the order of permanency

Balance Sheet of as on

Liabilities

Assets

Capital:

Add: Net profit xx

Add: Interest on capital xx

Less: Drawings xx

Less: Interest on drawings xx

Less: Loss if any xx

Long-term liabilities:

Loan on mortgage

Bank loan

Current liabilities:

Sundry creditors

Bills payable

Bank overdraft

Creditors for outstanding expenses

Income received in advance

xxx

Fixed assets:

Goodwill

Land and building

Loose tools

Furniture and fixtures

Vehicles

Patents

Trademarks

Long-term loans (advances)

Investments

Current assets

Closing stock

Sundry debtors

Bills receivable

Prepaid expenses

Accrued income

Cash at bank

Cash in hand

Fictitious assets:

Preliminary expenses

Advertising expenses

Underwriting commission

Discount on issue of shares

Discount on issue of debentures

xxx xxx

(ii) Proforma of balance sheet in the order of liquidity:

If the liquid principle is followed then the sequence of presentation of items will be as under

Balance Sheet of as on

Liabilities ` Assets `

Current liabilities

Fixed or long-term liabilities

Liabilities to owner or owner's funds

xxx

Current assets

Investments

Fixed assets

Fictitious assets

xxx

xxxx xxxx

Final Accounts 241

ADJUSTMENTS

Final accounts are prepared for a completed period. It must be kept in mind that expenses and

incomes for the full accounting period are to be taken while preparing final accounts. If an expensehas

been incurred but not paid during the period, a liability for the unpaid amount should be created before

finding out the operating results and financial position of a concern. In order to prepare the final

accounts on mercantile system of accountancy, all expenses and incomes relating to the period

whether incurred or not, received or not should be brought into account. For doing this, a concern is

required to pass certain entries at the end of the year to adjust the various items of incomes and

expenses. Such entries are called adjusting entries. The various adjustments required are given below:

(i) Closing Stock: It refers to the value of unsold goods lying in stock at the end of the

accounting period. It should be valued either at cost price or market whichever is lower. It consists of

three items, i.e., raw materials, work-in-progress and finished goods.

The adjustments entry is

Closing stock A/c Dr. xxx

To Trading A/c xxx

The value of closing stock will appear on the assets side of balance sheet and on the credit side

trading account.

(ii) Outstanding Expenses: These are certain expenses which relate to a particular accounting

period but they are not paid in that accounting period due to certain reason, i.e., all expenses which are

due for payment in one accounting year but actually paid in future accounting years or payment on

which it postpones are all outstanding or unpaid expenses. At the end of the accounting year, all such

expenses must be brought into books, otherwise the profit will be overstated.

The adjustment entry is

Expenses A/c Dr. xxx

To Expenses outstanding A/c xxx

Expenses outstanding are added to the respective expenses accounts in trading or profit and loss

A/c and also shown on the liabilities side of the balance sheet. Next year, the expenses outstanding

account will be transferred to the expenses account. If the outstanding expenses A/c appears in the

trial balance, it means that the adjustments has already has bee made and hence nothing has to be done

in trading or profit and loss account. But the liability already appearing in the trial balance should be

shown in the balance sheet.

(iii) Prepaid Expenses: Prepaid expenses are those expenses which have been paid in advance

but relating to the future accounting period. These are also called the unexpired expenses.

The adjustment entry is:

Prepaid expenses A/c Dr. xxx

To expenses A/c xxx

Prepaid expenses account is shown no asset side of balance sheet and expense account is shown

as a deduction from the respective expense account in trading and profit and loss account prepaid

expenses appear in the trial balance, it means that the adjustments has already been made nothing is to

be done in trading and profit and loss accounts. But the prepaid expense will appear as an asset in the

balance sheet. Generally, insurance, taxes, telephone subscription, and etc., are paid in advance thus,

requiring adjustments.

(iv) Accrued Income: Outstanding or accrued income is the income which has been earned but

not received during the accounting period.

The adjustment entry is

242 Introduction to Financial Accounting

Accrued income A/c Dr. xxx

To income A/c xxx

Accrued income is shown on the asset side of balance sheet and it is added to the respective

income account in profit and loss account credit side. No adjustment is required in the profit and loss

account if accrued income A/c appears in the trial balance, but such an account must be shown as an

asset in balance sheet

(v) Income Received in Advance: Many a time, traders receive money during a particular

trading period for the work to be done in future period. Thus, without rendering any service they

receive income.

Such an income is known as income received in advance, i.e., the income received but not earned

during the accounting period

The adjustment entry is

Income A/c Dr. xxx

To income received in advance A/c xxx

Income received in advance is shown as deduction from the respective income in profit and loss

account is shown on the liabilities side of the balance sheet. No treatment is required in the profit and

loss account if income received in advance account appears in the trial balance. But such account must

be shown as a liability in the balance sheet.

(vi) Depreciation of Assets: Depreciations is a permanent decrease or reduction in the value of a

fixed asset. The asset may reduce in value due to its constant use or even sometimes due to its non use,

i.e., merely by passage of time. Whatever may be the cause for decline, the fact is that such reduction

is a loss to the business. Therefore, it must written off from the asset so as to arrive at the true results

of the business.

The adjustment entry for depreciation assets is:

Depreciation A/c Dr. xxx

To Asset A/c xxx

Depreciation is shown on the debit side of profit and loss account and is deducted from the asset

in the balance sheet. Depreciation account (Dr.) appearing in the trial balance has to be debited to

profit and loss account and no deduction from asset balance is required because this has already been

done.

(vii) Interest on Capital: In order to see the real profitability of the business, it is desirable to

charge interest on capital treating it as a business expenses. In order to bring this interest books, the

following adjustment entry is passed:

Interest on capital A/c Dr. xxx

To Capital A/c xxx

Interest on capital is shown on the debit side of profit and loss account is added to the capital on

the liabilities side of balance sheet. Interest on account appearing in the trial balance is only to be

shown in profit and loss account inside and it is not required to be included in capital account because

such it has been already included.

(viii) Interest on Drawings: When the proprietor withdraws money from the business for

personal use almost to temporary loan by the business to the proprietor. This should be treated on par

with loan to an outsider from whom interest in receivable by the business. Therefore, the business

charges the proprietor with interest on amounts drawn by him. Thus, interest on drawings is a business

income. The following adjustment entry is to be passed on bring this item into account

Capital A/c Dr. xxx

Final Accounts 243

To interest on drawings A/c xxx

Interest on capital is shown on the credit side of profit and loss account and it is deducted from

the capital account on the liabilities side of balance sheet. Interest on drawings account appearing in

the trial balance has to be transferred to profit and loss account credit side alone.

(ix) Bad Debts: When a claim against a debtor becomes irrecoverable, it is called bad debt. If a

person files a petition in bankruptcy, his creditors generally write-off the irrecoverable amount due as

a bad debt. The entry in the books of the creditor is:

Bad debts A/c Dr. xxx

To Debtor’s A/c xxx

Bad debts is shown on the debit side of profit and loss account also deducted from debtors in the

balance sheet. Alternatively, bad debts amount is closed by transfer to the debit of provision for bad

and doubtful debts.

Provision for doubtful debts A/c Dr. xxx

To bad debts A/c xxx

If the bad debt amount is recovered in future years, the cash is debited and bad debts recovered

A/c is credited in that year. The balance in the later account is closed by transferring it to the credit of

profit and loss account as revenue in that year. If the bad debt appears in the trial balance, it means

that adjustments has already been made and this will appear only in the debit side of profit and loss

account. It need not be reduced from debtors in the balance sheet.

(x) Provision for Bad and Doubtful Debts: Sometimes, a merchant feels that there are certain

debtors from whom the money may or may not be realizable. As there is a possibility of anticipated

losses and in order to provide for such loss in the accounts, a provision or doubtful debts is required to

be made. It generally a percentage on the debtors and the percentage is fixed on the basis of past

experience. The following adjusting entry will be made in order to bring the provision for doubtful

debts into the books:

Profit and loss A/c Dr. xxx

To provision for doubtful debts A/c xxx

In this case also the amount of ‘provision required’ should be shown as a deduction from the

existing debtors on the assets side of the balance sheet. The object of making the provision is to show

the debtors on the balance sheet at a realistic value. Sometimes, bad debts may be written off during

the year. Some additional bad debts are to be written off at the time of finalizing the accounts. There

may be existing provision for doubtful debtors (old provision). Provision is required on the debtors as

on the closing date. The following is the usual way of dealing with all these items.

Profit and loss A/c (debit side)

Bad debts (as per trial balance) xxx

Add: bad debts ( as per adjustments) xxx

Add: new provision required xxx

xxx

Less: existing provision (given in trial balance) xxx

Net debit to profit and loss account xxx

The new provision required is to be reduced from the debtors in the balance sheet along with

additional bad debts as per adjustments

(xi) Provision for Discount on Debtors: The provision for discount on debtors is calculated at a

certain percentage on good debtors. No discount is allowed on doubtful debtors. This is to provide a

certain amount for allowing discount to customers for prompt payment. The adjustment entry is

244 Introduction to Financial Accounting

Profit and loss A/c Dr. xxx

To Provision for discount on debtors xxx

The provision for discount on debtors is shown as a deduction from good debtors on the asset

side of balance sheet and is debited to profit and loss account.

(xii) Provision for Discount on Creditors: The creditors may offer some discount for prompt

payment by the firm. This is calculated at a certain percentage on sundry creditors. The adjustment

entry is

Provision for discount on creditors A/c Dr. xxx

To Profit and Loss A/c xxx

The provision for discount on creditors is shown as a deduction from sundry creditors on the

liabilities of balance sheet and is credited to Profit and Loss A/c.

(xiii) Loss of Stock by Accident, Fire, etc.: Stock of goods destroyed due to abnormal causes

must be treated as abnormal loss. If there is no insurance the entire stock lost should be treated as

abnormal loss.

The entry is:

Abnormal loss A/c Dr. xxx

To Trading A/c xxx

Since there will be no recovery, the abnormal loss has to be closed.

Profit and loss A/c Dr. xxx

To Abnormal loss A/c xxx

If there is insurance, amount recoverable from the insurance company has to be debited to

insurance company and the balance of abnormal loss is written off to Profit and Loss A/c.

Profit and loss A/c Dr. xxx

Insurance company A/c Dr. xxx

To Abnormal loss A/c xxx

Illustration 1

Prepare Trading Account of Archana for the year ending 30-12-2014 from the following

information:

Particulars `

Opening stock

Purchases

Freight inward

Wages

Sales

Purchase Returns

Sales Returns

Import duty

80,000

8,60,000

52,000

24,000

14,40,000

10,000

3,16,000

1,00,000

30,000

Final Accounts 245

Solution

Dr. Trading Account of Archana for the year ending 30-12-2014 Cr.

To Opening stock

To Purchases

Less: Purchase returns

To Freight inward

To Wages

To Import duty

To Gross Profit c/d

8,60,000

10,000

80,000

8,50,000

52,000

24,000

30,000

1,88,000

12,40,000

By Sales

Less: Sales returns

By Closing stock

14,40,000

3,16,000

11,24,000

1,00,000

12,40,000

Illustration 2

From the following particulars prepare manufacturing account for the year ended 31

March,

2014

Raw materials (1-4-2013) 33,000

Work-in-progress (1-4-2013) 17,000

Finished goods (1-4-2013) 27,000

Purchases:

Raw materials 1,00,000

Finished goods 10,000

Carriage inwards:

on Raw materials 2,500

on Finished goods 100

Purchases returns:

on Raw materials 5,000

on Finished goods 200

Freight and octroi:

on Purchases of Raw materials 500

on Purchases of Finished goods 100

Sales:

Sales of scrap 150

Sales of finished goods 3,00,000

Rent (3/4

for factory) 4,000

Insurance (20%for factory) 1,000

Productive wages 6000

Repairs to building (40% on office building) 1,000

Depreciation on machinery 2,100

Factory supervisor’s salary 2,400

Manager’s salary (1/4th for factory) 5,000

Raw materials (31-3-2014) 22,000

Work-in-progress (31-3-2014) 13,500

Finished goods (31-3-2014) 40,000

246 Introduction to Financial Accounting

Solution

Dr. Manufacturing Account for the year Ended 31-3-2014 Cr.

Particulars ` ` Particulars ` `

To Opening stock

Raw materials

(1-4-2008)

Work-in-progress

(1-4-2008)

To Purchases of:

Raw materials

Less: Purchases returns

Carriage inwards

Freight and octroi:

Rent (3/4th for factory)

Insurance, (20% for

factory)-----------

Productive wages--------

repairs to building

(60%) depreciation on

machinery---------

Factory supervisor's

salary---------

Manager's salary(1/4th)

33,000

17,000

1,00,000

5,000

50,000

95,000

2,500

500

4,000

1000

6,000

600

2,100

2,400

1,250

By Sales of scrap

By Cost of production

(TRFD to Trading a/c (b/f)

By Closing stock

Raw materials

Work in progress

22,000

13,500

150

1,27,900

35,500

1,63,550 1,63,550

Illustration 3

The following are the balances in the Ledger of Mr. Sherif for the year ended 31

March 2014.

Particulars

Opening stock

Raw materials

Work-in-progress

Finished goods

Purchase of raw materials

Sales

Fuel and coal

Wages

Factory expenses

Office expenses

Depreciation on plant and machinery

Closing stock

Raw materials

Work-in-progress

Finished goods

20,000

3,000

10,800

50,000

2,40,000

1,000

32,000

40,000

30,000

3,000

2,000

4,000

8,000

Prepare manufacturing and Trading accounts for the year ended 31

march, 2014

Final Accounts 247

Solution

Manufacturing and Trading Account of Mr. Sherif for the year Ending 31.3.2014

Particulars

To opening work-in-progress

To cost of materials consumed

Opening stock 20,000

Add: purchases 50,000

70,000

Less: closing stock 20,000

To wages

To fuel and coal

To factory expenses

To depreciation on

Plant and machinery

To opening stock of finished goods

To cost of goods manufactured

To gross Profit c/d

3,000

50,000

32,000

1,000

40,000

3,000

1,29,000

10,800

1,25,000

1,12,200

By closing work-in-progress

By cost of goods manufactured

(transferred to trading A/c)

(B/F)

By sales

By closing stock of

Finished goods

4,000

1,25,000

1,29,000

2,40,000

8,000

2,48,000 2,48,000

Comprehensive Illustrations

Illustration 4

The following are the ledger balances extracted from the books of WEIFA.

WEIFA capital 50,000 Sales 3,01,000

Bank overdraft 8,400 Return inwards 5,000

Furniture 5,200 Discount (cr) 800

Business premises 40,000 Taxes and insurance 4,000

Creditors 26,600 General expenses 8,000

Opening stock 44,000 Salaries 18,000

Debtors 36,000 Commission allowed 4,400

Rent from tenants 2,000 Carriage on purchases 3,600

Purchase 2,20,000 Provision for doubtful debts 1,000

Bad debts written off 1,600

Adjustments

(i) Stock on hand on 31-12-14 was estimated at ` 4,0120.

(ii) Write-off depreciation on business premises ` 600 and furniture ` 520.

(iii) Make a provision of 5% on debtors ` for bad and doubtful debts.

(iv) Allow interest on Capital at 5% and carry forward ` 1,400 for unexpired insurance.

Prepare Final Accounts for the year ended 31-12-14.

248 Introduction to Financial Accounting

Solution

In the Books of WEIFA

Trading and Profit and Loss Account for the year Ending 31-12-14

To Opening stock 4,400 By Sales 3,01,000

To Purchases 2,20,000 Less: Sales returns 5,000 2,96,000

To Carriage on purchases 3,600 By Closing stock 40,120

68,520

3,36,120 3,36,120

To Gross profit c/d 4,000 By gross profit b/d 68,520

To taxes and insurance 2,600 By rent 2,000

Less: prepaid 1,400 By discount 800

To general expenses 8,000

To salaries 1,600 18,000

To commission 4,400

To bad debts 2,400

Add: new provision for

doubtful debts

3,400

Less: existing Provision 1,000

To Depreciation:

On business premises 600

On furniture 520

To interest on capital 2,500

To Net profit transferred 32,300

71,320 71,320

Balance Sheet of WEIFA as at 31-12-2014

Liabilities

` `

Assets

` `

Creditors

Bank overdraft

Capital

Add: Net profit

Add: Interest on capital

50,000

32,300

2,500

26,600

8,400

84,800

Debtors

Less: Provision for

B/D

Stock

Prepaid insurance

Furniture

Less: Depreciation

Business premises

Less: Depreciation

36,000

1,800

5,200

520

40,000

600

34,200

40,120

1,400

4,680

39,400

1,19,800 1,19,800

Final Accounts 249

Illustration 5

Prepare Trading, Profit and Loss Account and Balance Sheet from the following Trial Balance of

Mr. Madan.

Debit balances

Credit balances

Sundry debtors

Plant and machinery

Interest

Rent,rates, taxes & Insurance

Conveyance charges

Wages

Sales returns

Purchases

Opening stock

Madan's drawings

Trade expenses

Salaries

Advertising

Discount

Bad debts

Business premises

Furniture and fixtures

Cash in hand

92,000

2,000

430

5,600

1,320

7,000

5,400

1,50,000

60,000

22,000

1,350

11,200

840

600

800

12,000

10,000

2,060

Madan's capital

Purchase returns Sales

Sundry creditors

Bank overdraft

70,000

2,600

2,50,000

60,000

20,000

4,02,600 4,02,600

Adjustments

(i) Stock on hand 31-12-09 ` 90,000.

(ii) Provide depreciation on premises at 2.5%, plant and machinery at 7.5 % and furniture and

fixtures at 10%.

(iii) Write-off ` 800 as further bad debts.

(iv) Provide for doubtful debts at 5% on sundry debtors.

(v) Outstanding rent was ` 500 and outstanding wages were ` 400.

(vi) Prepaid insurance ` 300 and prepaid salaries ` 700.

Dr. Trading and Profit and Loss A/c for the year ended 31-12-14 Cr.

Particulars ` ` Particulars ` `

To Opening stock

To Purchases

Less: Purchases returns

To wages

Add: Outstading

To Gross profit c/d

1,50,000

2,600

7,000

400

60,000

1,47,40

7,400

1,19,800

3,34,600

By sales

Less: Sales

returns

By closing stock

2,50,000

5,400 2,44,600

9,000

3,34,600

250 Introduction to Financial Accounting

To Trade expenses

To Salaries

Less: Prepaid

To Conveyance charges

To Advertising

To Rent, rates, taxes and

insurance

Add: Rent outstanding

Less: prepaid insurance

To Discount

To Interest

To Bad debts

Add: Additional bad

debts

Add: New provision for

bad debts

To Depreciation:

Premises

Plant and machinery

Furniture and fixtures

To Net profit transferred

to capital A/c

11,200

700

5,600

500

6,100

300

800

4,560

300

1,500

1,000

1,350

10,500

1,320

840

5,100

5,800

600

430

6,160

2,800

90,000

By gross profit

b/d

1,19,800

1,19,800 1,19,800

Balance Sheet of Mr. Madan as at 31-12-14

Liabilities

` `

Assets

` `

Sundry creditors

Bank overdraft

Outstanding Rent

Add: Wages

Capital

Less: Drawings

Add: Net profit

500

400

70,000

22,000

48,000

90,000

60,000

20,000

900

1,38,000

Cash in hand

Sundry debtors

Less: Bad debts

Less: provision for

Stock

Prepaid insurance

Salaries

Plant and achinery

Less: Depreciation

Business premises

Less: Depreciation

Furniture and

fixtures

Less: Depreciation

92,000

800

91,200

4,560

300

700

20,000

1,500

12,000

300

10,000

1,000

2,060

86,640

90,000

1,000

18,500

11,700

9,000

2,18,900 2,18,900

Final Accounts 251

Illustration 6

From the following trail balance extracted from the books of Kamalnath. Prepare Trading and

profit and loss Account and balance sheet for the year ended 31-12-14.

Debit balances ` Credit balances `

Cash at bank 2,610 Creditors 4,700

Book debts 11,070 Discounts 150

Salaries 4,950 Creditors for expenses 400

Carriage inwards 1,450 Returns outwards 2,520

Carriage outwards 1,590 Sales 80,410

Bad debts 1,310 Capital 40,000

Office expenses 5,100

Purchases 67,350

Return inwards 1,590

Furniture 1,500

Stock 14,360

Insurance 3,300

Depreciation 1,200

Freehold property 10,800

1,28,180 1,28,180

Adjustments

(i) Make provision for doubtful debts at 5%.

(ii) Calculate discount on creditors @5%.

(iii) Office expenses include stationery purchased ` 800.

(iv) Carriage inwards includes carriage paid on purchase of furniture ` 50.

(v) Outstanding salaries ` 150.

(vi) Prepaid insurance ` 300

(vii) Stock on hand ` 10,700 (including stationery stock ` 200)

Solution

Trading and Profit and Loss Account of Kamalnath for the year Ending 31-12-14

Particulars

` `

Particulars

` `

To Opening stock 14,360 By Sales 80,140

To Purchases 67,350 Less: Sales return 1,590 7,880

Less: Purchases returns 2,520 64,830 By Closing stock 10,700

To Carriage inwards 1,450 Less: Stock of stationery 200 10,500

Less: Paid for furniture 50 1,400

252 Introduction to Financial Accounting

To Gross profit c/d 8,730

To Salaries 4,950 89,320

Add: Outstanding 150 By gross profit b/d 8,730

To Insurance 3,300 5,100 By discount 150

Less: Prepaid 300 3,000 By provision for

discount on creditors

To Office expenses 5,100

Less: Stationery

purchased

800 4,300 By Net loss (transferred

to Capital A/c

8,679

To bad debts 1,310

Add: New provision for

bad debts

553 1,863

To Carriage outwards 1,590

To Stationary 800

Less: Stock 200 600

To Depreciation on

Property

1,200

17,653 17,653

Balance Sheet of Kamalnath as at 31-12-14

Liabilities

` `

Assets

` `

Sundry Creditors:

Trade Creditors:

Less: provision for discount

Outstanding creditors:

for expenses

Add: Salary

Capital

Less: net loss

4,700

400

150

40,000

8,679

4,606

550

31,321

Cash at bank

Book Debts

Less: Provision

for BD

Stock of goods

Stock of stationery

Prepaid insurance

Furniture and

fixtures (1,500 + 50)

Freehold property

11,070

553

2,610

10,517

10,500

200

300

1,550

10,800

36,477 36,477

Illustration 7

The following are the ledger balances extracted from the books of Ramani as on 31-12-14.

Particulars

Debit balances:

Drawings

Goodwill

3,000

6,000

Credit balances:

Sales

Provision for bad and doubtful debts

24,000

900

Final Accounts 253

Land and buildings

Plant and machinery

Loose tools

Bills receivable

Stock, 1

Jan., 1996

Purchases

Wages

Carriage inwards

Carriage outwards

Coal, gas, and coke

Sales return

Furniture and fixtures

General expenses

Provision for discount on

Creditors

Interest on loan

Salaries

Rent, rates and taxes

Discount allowed

Cash at bank

Cash in hand

Sundry debtors

Repairs

Printing and stationery

Bed debts

Advertisements: (special)

(normal)

12,000

8,000

600

1,600

8,000

10,200

4,000

200

1,160

400

240

1,050

320

120

1,000

560

300

5,000

9,000

360

110

640

6,000

700

Provision for discount on debtors

Loan at 6%

Capital

Sundry creditors

Purchase returns

Discount received

Commission received

Bills payable

342

4,000

40,000

8,000

500

300

400

2,278

80,720 80,720

Adjustments

(i) Closing stock on 31-12-14 amounted to ` 15,654.

(ii) Depreciate plant and machinery at 5%, loose tools at 15% and furniture and fixtures at 20%.

(iii) Provide for bad and doubtful debts at 5% and for discount on debtors and creditors at 2%.

(iv) Outstanding wages ` 200 and rent, rates and taxes ` 100.

(v) Write of one-third of advertisement (special)

(vi) Interest on loan has been paid for six months only.

(vii) A bill for ` 1,000 included in bills receivable has been dishonoured.

(viii) The manager is entitled to a commission of 5% on net profit after charging such commission.

Prepare final accounts for the year ended 31-12-14

254 Introduction to Financial Accounting

Solution

Trading and Profit and Loss Account of Kamalnath for the year Ending 31-12-14

To opening stock 8,000 By sales 2,400

To purchase 10,200 Less: Returns 400 23,600

Less: Returns 500 9,700 By closing stoc 15,654

To carriage inwards 200

To wages 4,000

Add: Outstanding 200 4200

To coal, agas & coke 1,160

To gross profit c/d 15,994

39,254 15,994

To carriage outwards 80

To salaries 560 1000

To rent, rates and taxes By gross profit b/d 300 400

Add: Outstanding 100 660 By commission 160

To repairs 360 By discount received 460

To printing and

stationery

110 Add: New provision 140

To advertisement

(normal)

700 Less: Existing provision 320

To general expenses 120 1050

To interest on loan

Add: Outstanding 120 240

To bad debts 640

Add: New provision for

bad debts

500

1,140

Less: Existing provision

for bad debts

900 240

To discount allowed 300

Add: New provision for

discount

190

342

490 148

Less: Existing provision

for discount

342

To advertisement

(special)

2,000

Final Accounts 255

Written off (6000 × 13)

To depreciation on Plant

and machinery

400

Loose tools 90

Furniture and fixtures 48

To manager's

commission

538

To net profit transferred 448

To capital A/c 8,960

16,534 16,534

Balance Sheet of Ramani as on 31-12-2014

Particulars

` `

Particulars

` `

Sundry creditors 8,000 Cash in hand 80

Less: Provision for

discount

160 7,840 Cash at bank 1,600 5,000

6% loan 4,000 Bills receivable 1,000 600

Add: Interest

outstanding

120 4,120 Less: Dishonoured 9,000

Bills payable 200 2,278 Sundry debtors 1,000

Outstanding expenses: Add: B/R dishonoured 10,000

Wages 100 Less: Provision for BD 500

Rent, rates & taxes 448 Less: Provision for 9,500

Managers commission 40,000 748 Discount 190 9,310

Capital opening 8,960 Stock 15,654

Add: Net profit 48,960 Loose tools 600

Less: drawings 3,000 45,960 Less: Depreciation 90 510

Furniture and fixtures 240

Less: Depreciation 48 192

Plant and machinery 8,000

Less: Depreciation 400 7,600

Land and buildings 12,000

Advertisement (special) 6,000

Less: Written off 2,000 4,000

Goodwill 6,000

60,946 60,946

256 Introduction to Financial Accounting

Illustration 8

From the following trial balance of Sri Naranayan, you are required to prepare a trading and

profit & loss A/c for the year ended 31

December 2014 and a balance sheet as on that date.

Debit balances ` Credit balances `

Stock on 1

Jan., 2014

Plant and machinery

Rent

Depreciation on plant and machinery

Drawings

Wages

Income tax

Salary for 11 months

Cash

Buildings

Depreciation on buildings

Purchases

Debtors

Bills receivable

Discount (Dr.)

Carriage inwards

Bad debts

Sales returns

70,000

50,000

3,000

5,000

40,000

20,000

2,000

11,000

5,000

1,60,000

8,000

3,00,000

80,000

30,000

2,000

4,000

6,000

3,000

Capital

Wages outstanding

Sales

Creditors

Bills payable

Discount (CR.)

Bank overdraft

Commission (CR.)

Purchase returns

2,00,000

4,000

5,00,000

45,000

16,000

12,000

9,000

8,000

5,000

7,99,000 7,99,000

Adjustment

(i) Stock on 31st Dec., 2014 was ` 96,000

(ii) Stock destroyed by fire was ` 6,000 and the insurance company accepted a claim for ` 3,600.

(iii) ` 1,600 paid as rent of the office was debited to landlord account and was included in the list

of debtors.

(iv) Goods invoiced ` 10,000 was sent to customers on sale or return basis on 28

December,

2014, the customer still having the right to return the goods. The rate of gross profit was 1/5

a of sale.

(v) Write-of further bad debts ` 4,000 and maintain 5% provision for bad debts on debtors.

(vi) One month’s salary was outstanding.

Solution

Trading and Profit and Loss A/c of Sri. Narayanan for the year Ended 31-12-14

Particulars

` `

Particulars

` `

To opening stock 70,000 By sales 5,00,000

To purchase 3,00,000 Less: returns 3,000

Less: returns 5,000 2,95,000 4,97,000

To carriage inwards 4,000 Less: goods sent on 10,000 48,700

Final Accounts 257

sale or return

To wages 20,000 By closing stock 96,000

To gross profit c/d 2,08,000 Add: stock with

Customers

8,000

To salaries 11,000 Add: stock destroyed 6,000 1,10,000

5,97,000 5.97, 000

Add: outstanding 1,000 12,000 By gross profit b/d 2,08,000

To rent 3,000 By discount 12,000

Add: debited to landlord 1,600 4,600 By commission 8,000

To discount 6,000 2,000

To bad debts 10,000

Add: further bad debts 4,000 13,220

Add: new provision for

bad debts

3,220

To depreciation on:

Plant and machinery 5,000

Buildings 8,000

To loss on stock

destroyed

2,400

To net profit transferred 1,80,750

To capital A/c

22,800 22,800

Balance Sheet of Sri. Narayanan as on 31-12-2014

Particulars

` `

Particulars

` `

Bills payable

Bank overdraft

Creditors

Outstanding expenses:

Salary

Wages

Capital

Less: drawing

Less: income tax

Add: net profit

1,000

4,000

2,00,000

40,000

2,000

1,58,000

16,000

9,000

45,00

5,000

3,38,780

Cash

Bills receivable

Debtors

Less: rent included

Less: goods on sale or

return

Less: bad debts

Less: provision for BD

Insurance company

Stock

Stock with customers

On sale or return

Plant and machinery

Buildings

80,000

1,600

78,400

10,000

68,400

4,000

64,400

3,220

5,000

30,000

61,180

3,600

96,000

8,000

50,000

1,60,000

4,13,780 4,13,780

258 Introduction to Financial Accounting

Illustration 9

The following is the schedule of balance on 31-3-2014 extracted from the books of Manikandan.

Particulars ` Particulars `

Cash in hand 22,800 Capital account 3,24,000

Cash at bank 5,200 Discount received from

creditors

3,200

Sundry debtors 1,72,000 Purchase returns 5,200

Stock as on 1-4-13 1,24,000 Sales 4,60,000

Furniture and fixtures 42,800 Provision for bad debts 6,000

Office equipments 32,000 Loan from Gopu 60,000

Buildings 1,20,000 Sundry creditors 1,06,000

Motor car 40,000

Purchases 2,80,000

Sales returns 8,400

Salaries 22,000

Rent for godown 11,000

Interest on loan from Gopu 5,400

Rates and taxes 4,200

Discount allowed to debtors 4,800

Freight on purchases 2,400

Carriage outwards 4,000

Drawings 24,000

Printing and stationery 3,600

Electric charges 4,400

Insurance premium 11,000

General office expenses 6,000

Bad debts 4,000

Bank charges 3,200

Motor car expenses 7,200

9,64,400 9,64,400

Prepare trading and profit and loss account for the year ended 31-3-2014 and the balance sheet as

at that date after making provision for the following:

(i) Value stock on 31-3-2014 was ` 88,000.

(ii) One month’s rent for godown is outstanding.

(iii) One month’s salary is outstanding.

(iv) Interest on loan from GOU is payable at 12%. This loan was taken on 1-5-2014.

(v) A provision for bad debt is to be maintained at 5% on sundry debtors.

(vi) Insurance premium includes ` 8,000 paid towards proprietor’s life insurance policy and the

balance of the insurance charges covers the period from 1-4-14 to 30-6-14.

Final Accounts 259

(vii) Depreciate:

(a) Buildings used for business by 5%.

(b) Furniture and fixtures by 10% — one steel table purchased during the year for ` 2,800

was sold for same price but the sale proceeds were wrongly credited to sales account.

been wrongly debited to purchase account.

(d) Motor car by 20%

Solution

Trading and Profit and Loss Account of Manikandan for the year ended 31-3-14

Particulars ` ` Particulars ` `

To Opening stock 1,24,000 By Sales 4,60,000

To Purchases 2,80,000 Less: Sale of fittings 2,800

Less: Purchase of office

equipment

8,000 4,57,200

Less: returns 2,72,000 2,66,800 Less: Returns 8,400 44,88,000

To Freight on purchases 5,200 2,400 By Closing stock 8,800

To Gross Profit c/d 1,43,600

5,36,800 5,36,800

To Salaries 22,000 By Gross profit b/d 1,43,600

Add: Outstanding 200 24,000 By Discount received 3,200

To Rent for godown 11,000

Add: Outstanding 1,000 12,000

To Interest on loan 5,400

Add: Outstanding 1,200 6,600

To Rates and taxes 4,200

To Discount allowed 4,800

To Carriage outward 4,000

To Printing & stationery 3,600

To Electric charges 1,10,000 4,400

To Insurance premium

Less: Premium on own 8,000

Life policy 3,000 Nil

Less: Prepaid 3,000

To General office exp. 4,000 6,000

Add: new provision 12,600

Less: existing provision 6,600

To bank charges 3,200

To motor car expenses 7,200

To depreciation on :

260 Introduction to Financial Accounting

Building 3,000

Furniture and fittings 4,000

Office equipments 6,000

Motor car 8,000

To net profit transferred 39,200

Capital A/c

1,46,800 1,46,800

Balance Sheet of Manikandan as on 31-3-14

Liabilities

` `

Assets

` `

Capital 3,24,000 Buildings 1,20,000

Add: Net profit 39,200 Less: Depreciation 3,000 1,17,000

3,63,200

Less: Drawings 3,31,200 Furniture and fittings 42,800

(24,000 + 8,000) 32,000 Less: Sale 2,800

Loan from Gopu 6,000 40,000 36,000

Add: Outstanding interest 1,200 61,200 Less: Depreciation 4,000

Sundry creditors 1,06,000 Office Equipments 32,000

Outstanding expenses: Add: Purchase 8,000

Salaries 2,000 40,000

Rent for godown 1,000 3,000 Less: Depreciation 6,000 34,000

Motor car 40,000

Less: Depreciation 8,000 32,000

Stock 88,000

Sundry debtors 7,72,000

Less: Provision for

B.D

8600 1,63,400

Cash at Bank 5,200

Cash at Hand 22,800

Prepaid Insurance 3,000

5,01,400 5,01,400

Illustration 10

From the following particulars presented by Mr. S. Tendulkar, prepare a Trading A/c, Profit and

Loss A/c for the year ended 31

Dec. 2014 and Balance sheet as on that date.

Debit balances ` Credit balances `

Plant and machinery

Drawings

Purchases

Sundry debtors

1,00,000

36,000

1,20,000

80,000

Sales (net)

Capital

Creditors

Bank overdraft

40,000

1,00,000

40,000

20,000

Final Accounts 261

Wages

Carriages

Salaries

Rent

Repairs

Insurance

Opening stock

Land and buildings

Furniture

Discount

Suspense A/c

20,000

6,000

14,000

12,000

6,000

10,000

24,000

80,000

20,000

40,000

32,000

Provision for debts

Cash credit

Bills payable

4,000

20,000

16,000

6,00,000

6,00,000 6,00,000

Adjustment

(i) Closing stock ` 60,000

(ii) Purchases include purchase of materials used for the construction of buildings ` 10,000.

(iii) Sales include sale of furniture at a selling prices of ` 2,000 (book value ` 4,000)

(iv) Purchased a plant for ` 10,000, wrongly debited to purchase account.

(v) A sale of goods to a customer not debited to customers account ` 32,000

(vi) Stock destroyed by fire amounted ` 20,000. Insurance Company admitted only ` 16,000 as

its liability.

(vii) Wages include ` 6,000 incurred for the erection of a machinery.

(viii) The proprietor Mr. S. Tendulkar took goods for his own from the business amounted to

` 2,000.

(ix) Rent included ` 2,000 paid for Mrs. S. Tendulkar’s residential portion.

(x) Purchase of stationery for ` 200 was debited to repairs account

(xi) A customer’s cheque returned dishonoured wrongly debited to discount account ` 2,000

Solution

Trading and Profit and Loss Account of S. Tendulkar for the year Ended 31-12-14

Particulars ` ` Particulars ` `

To opening stock 24,000 By sales 4,00,000

To purchases 1,20,000 Less: Furniture 2,000 3,98,000

Less: Buildings 10,000 By Closing Stock 60,000

1,10,000 By Stock destroyed by

fire

2,000

Less: Drawings 2,000

1,08,000 98,000

Less: Plant and

Machinery

10,000

262 Introduction to Financial Accounting

To wages 20,000

Less: Plant and

Machinery

6,000 14,000

To Carriage 6,000

To Gross profit c/d 3,36,000 By Gross profit b/d 3,36,000

4,78,000 4,78,000

To Salaries 12,000 14,000 By Provision for bad

debts

4,000

To Rent

Less: Drawings 2,000 10,000

To Repairs 6,000

Less: Stationery 200 5,800

To Insurance 10,000

To Discount 40,000

Less: Cheque

Dishonoured

2,000 38,000

To loss on sale of

furniture

2,000

To Stationery 200

To Loss of stock by fire 4,000

To Net profit transferred

to Capital A/c

2,56,000

3,40,000 3,40,000

Balance Sheet of Mr. S. Tendulkar as on 31-12-14

Liabilities

` `

Assets

` `

Capital 1,00,000 Plant and Machinery 1,00,000

Less: Drawings 2,56,000 Add: Wages 6,000

3,56,000 1,06,000 1,16,000

Add: Net profit 36,000 Add: Additions 10,000

3,16,000 Land and Buildings 80,000

Purchases (2000) Add: Additions 10,000 90,000

Rent (2000) Furniture 20,000

Creditors 40,000 Less: Sale of furniture 4,000 16,000

Bank Overdraft 20,000 Stock 60,000

Cash Credit 20,000 Sundry debtors 80,000

Bills Payable 16,000 Add: Cheque 2,000

Dishonoured 82,000

Add: Suspense 32,000 1,14,000

Final Accounts 263

Suspense A/c 32,000

Less: Debtors 32,000 Nil

Insurance claim 16,000

4,12,000 4,12,000

Illustration 11

The following figures have been extracted from the records of Fancy Stores, a proprietor concern

as at 31

December, 2014.

Particulars

Furniture 15,000 Insurance 60,000

Capital 5,40,000 Rent 2,20,000

Cash in hand 30,000 Sundry debtors 6,00,000

Opening stock 5,00,000 Sales 60,00,000

Fixed deposits 13,46,000 Advertisements 1,00,000

Drawings 50,000 Postage and telephone 34,000

Provision for bad debts 30,000 Bad debts 20,000

Cash at Bank 1,00,000 Printing and stationery 90,000

Purchases 30,00,000 General charges 1,30,000

Salaries 1,90,000 Sundry creditors 4,00,000

Carriage inwards 4,10,000 Deposit from customers 60,000

Prepare Trading and Profit and Loss account an Balance Sheet after taking into consideration the

following further information:

(i) The closing stock as on 31-12-2014 was ` 1,00,000.

(ii) A sale of ` 2,50,000 made for cash had been credited to the purchases accounts

(iii) Salary of ` 20,000 paid to an employee had been entered in the cash book bank column as

` 10,000.

(iv) Charge depreciation on furniture at 10%.

(v) Furniture had been sold during the year for ` 1,00,000 and the proceeds had been credited to

furniture account. The written down value of furniture sold was ` 50,000.

(vi) Sum of ` 1,00,000 received from a party which had purchased some stock belonging to a

separate business of the proprietor was credited to the sundry debtors account.

(vii) The proceeds of a matured fixed deposits amounting to ` 2,54,000 had been credited to the

fixed deposit account. The original amount of the deposit was ` 2,00,000.

(viii) There was an outstanding liability for rent of ` 20,000.

(ix) An advance of ` 10,000 paid to an employee against his salary of January 1996 had been

debited to the salary accounts

(x) The office premises were sublet from December 2014 for a monthly rental of ` 10,000, but

the rent for December has not yet been received.

264 Introduction to Financial Accounting

Solution

Trading and profit and loss accounts of fancy stores for the year ended 31-12-14.

Particulars ` ` Particulars ` `

To opening stock 5,00,000 By Sales 62,50,000

To purchases 32,50,000 By Closing stock 1,00,000

To Carriage inwards 4,10,000 63,50,000

To gross profit c/d 21,90,000 By Gross profit b/d 21,90,000

1,90,000 63,50,000 By Interest on deposit 54,000

To Salaries 10,000 By rent from subletting 10,000

2,00,000 1,90,000 By profit on sale of

furniture

50,000

Less: Advance salary 10,000

To insurance 60,000

To Advertisement

1,00,000

To postage and

telephone

3,40,00

Bad debts 20,000

To Printing and

stationery

90,000

To General charges 1,30,000

To Depreciation on

furniture

20,000

To Net profit transferred

to capital A/c

1,420,000

23,04,000 23,04,000

Balance Sheet of Fancy Stores as on 31-12-14

Liabilities ` ` Assets ` `

Deposits from

customers

Sundry creditors

Outstanding rent

Capital

Add: Addition

Less: Drawings

Add: Net profit

5,40,000

1,00,000

6,40,000

50,000

5,90,000

14,20,000

60,000

4,00,000

20,000

20,10,00

Cash in hand

Cash in bank

(1,00,000 – 10,000)

Stock

Sundry debtors

Less: provision for

B D

Advance salary

Rent outstanding

Furniture

Less: Depreciation

Fixed deposits

7,00,000

30,000

2,00,000

20,000

30,000

90,000

1,00,000

67,000

10,000

1,80,000

14,00,00

24,90,000 24,90,000

Final Accounts 265

Illustration 12

Sasikala is a manufactures. From the following details prepare:

(i) Sasikala’s manufacturing account to show the cost of goods manufactured during the year

ended 31

December, 2014, and

(ii) Sasikala’s Trading and Profit and Loss Account for the same period

Particulars

Stock as on 1

Jan., 1994

Raw material

Work-in-progress

Finished goods

Purchase of raw materials

Carriage of raw materials

Sale of finished goods

Stock on 31

Dec., 1994

Raw materials

Work-in-progress

Finished goods

Factory wages

Factory expenses

Return inwards

Depreciation on machinery

Repairs to machinery

Interest on bank overdraft

Miscellaneous expenses

Depreciation on office furniture

Selling expenses

7,000

1,000

25,400

90,000

2,000

3,80,000

13,000

12,000

28,000

60,000

4,800

4,600

10,800

9,200

600

2,600

2,200

10,400

Travelling expenses

Manufacturing expenses

Miscellaneous

Returns outwards

Discount allowed

Discount Received

Import duty on raw materials

Sale of waste materials

Carriage outwards

Factory insurance, rent and taxes

Bad debts

Salaries (including Sasikala's

Salary ` 9,600)

Salary of works manager

Office rent and insurance

Motive power

5,400

4,000

1,000

600

2,400

6,000

1,600

12,000

1,200

25,600

3,000

14,400

3,000

7,000

Sasikala’s salary is to be allocated 2/3rd to factory and 1/3rd to office.

Solution

Manufacturing Account of Sasikala for the year Ended 31-12-14

Particulars ` Particulars `

To work-in-progress on 1-1-94

To material consumed during the

opening stock + net purchases -

closing stock [7,000 + 86,000

(i.e., 9,000 – 4,000) – 13,000]

To carriage on raw materials

To import duty on raw materials

To factory wages

To salary of works manager

To 2/3 of sasikala's salary

To motive power

10,000

80,000

2,000

24,000

60,000

14,400

6,400

7,000

By sale of waste material

By work-in-progress year on

31-12-94

By cost of finished goods

Transferred to trading account

6,000

12,000

2,28,000

266 Introduction to Financial Accounting

To factory expenses

To factory insurance, rent and taxes

To manufacturing expenses

To depreciation of machinery

To repairs of machinery

4,800

12,000

5,400

10,800

9,200

2,46,000 2,46,000

Trading and Profit and Loss Account of Sasikala for the year Ended 31-12-14

Particulars

To stock of finished goods

(1-1-94)

To manufacturing account

(cost of finished goods)

To gross profit c/d

To depreciation on office furniture

To interest on bank overdraft

To miscellaneous expenses

To travelling expenses

To selling expenses

To discount allowed

To carriae outwards

To bad debts

To salaries

Less: 2/3 of Sasikala's

salary 6,400

To office rent and

insurance 5,600

To net profit transferred to capital

account

25,400

2,28,000

1,50,000

4,03,000

2,200

600

2,600

5,400

10,400

1,000

1,600

1,200

19,200

3,000

1,03,400

By sales 3,80,000

Less: Returns inwards 4,600

By stock of finished goods on

31-12-04

By gross profit b/d

By discount received

3,75,400

28,000

4,03,400

1,50,000

600

1,50,600 1,50,600

EXERCISES

(A) Short answer problems

1. Pass necessary adjustments in Mr. x’s journal on 31

December, 2014;

(a) ` 20,000 for wages was outstanding.

(b) Write-off depreciation on machinery ` 50,000

2. Pass adjustment entries for the following:

(a) Closing stock ` 49,280

(b) Provide depreciation on vehicles @ 10% on cost of ` 1,40,000.

Final Accounts 267

` 10,000

3. Pass necessary journal entries for the following while finalizing the annual accounts:

(a) Debtors include ` 500 receivable from the proprietor for goods drawn by him.

(b) Trade debtors of ` 1,05,000 include ` 5,000 which are considered bad. Provide for

doubtful debts @ 2.5%.

4. The trial balance of a trader shows ` 3,000 to the debit of general expenses A/c included in

that are:

(a) Travelling expenses ` 1,000

(b) School fees of his children ` 30

Make the necessary adjusting journal entry.

[Ans: debit ` 1,000 to travelling exp A/c and ` 800

To drawings A/c, crediting general exp A/c ` 1,800]

5. Dawson, a businessman, has invested on 1-4-2014 ` 10,000 in Government securities on

which he gets a net interest of 6%p.a. after 31

March every year. His accounts are closed on

December every year. Find out the interest earned by him but not yet received and show

by means of journal entry the necessary adjustment.

[Ans: Accrued interest ` 450]

6. Pass journal entries for the following transactions:

(a) Samples worth ` 5,000 distributed during a sale campaign programme.

(b) Proprietor brought his personal car into the business and the value of the same is

` 1,00,000.

Bonds).

The above interest was net of income tax.

7. Show the necessary adjustments in Trading account and Balance Sheet from the following

information.

31.12.2014 value of goods still with

Customers’, sols on sale or

Return basis, treated as sales ` 40,000

G.P on Cost – 25%

[Ans: cost of stock with customer : ` 32,000]

8. Which of the following items of expenditure and income belong to the current accounting

year?

(a) Cash sales;

(b) Outstanding expense;

(d) Salaries paid to employees;

268 Introduction to Financial Accounting

(e) Rent received in advance;

(f) Commission received but not yet earned

[Ans . (a) ; (b) ; (c) ; (d)]

9. Mr. Gotham has ` 50,000 to the credit of his capital account on 1-1-2014. His drawings

during the same year amounted to ` 7,000.

You are to charge interest on capital at 5% p.a. and ` 430 on drawings. Ascertain his closing

capital, assuming that his net profit for the year after all adjustments is ` 12,400.

[Ans: ` 57,470]

10. Form the following calculate the amount of provision for doubtful debts to be debited to

profit and loss account:

Opening provision for doubtful debts ` 2,400

Closing sundry debtors ` 42,000

Bad debts yet to be written off ` 2,000

Provide for doubtful debts at 10% on debtors.

[Ans: Amount to be debited to profit and loss account ` 3,600]

11. On 1

Jan., 2014, the provision for doubtful debts account in the books of a firm which

maintain it at 5% had a credit balance of ` 3,300. During the year the bad debts amounted to

` 2,400 and the debtors at the end of the year were ` 60,000. Show provision for doubtful

debts account and bad debts account for the year 2014.

[Ans: Debit to profit and loss account – ` 2,100]

12. Make adjustments from the information given below while preparing profit and loss account.

Dr. Cr.

Loan @ 15% p.a. 20,000

Interest on loan 2,000

Deposit @ 14% p.a. 15,000

Interest on deposit 1,000

[Ans: Add ` 1,000 interest outstanding to ` 2,000 on the debit side of profit and loss account

add ` 1,100 to interest on deposit of ` 1,000 and show the total on the credit side of profit

and loss account]

13. During the year ended 31-12-2014 a firm suffered the following losses. Explain how you

would treat them in the accounts on 31-12-2014:

(a) Stock lost ` 15,000

(b) A machinery of the value of ` 21,000 was discarded, being totally out of order.

[Ans: (a) credit trading account ` 15,000 and debit profit and loss account ` 15,000

assuming no insurance; (b) debit profit and loss account and credit machinery account

` 21,000; (c) debit profit and loss account and credit building account with ` 12,000]

14. A manager gets 5% commission on net profit after charging such commission. What shall be

his commission if gross profit is ` 0.96,000 and expenses of indirect natures other than

manager’s commission are ` 12,000?

[Ans: manager’s Commission ` 4,000 i.e., 84,000 x 5/105]

Final Accounts 269

15. Calculate gross profit and cost of goods sold from the following information Net sales

` 2,00,000

Gross Profit is 25% on cost.

[Ans: G.P. ` 40,000; C.O.G.s. ` 1,60,000]

16. Ascertain soc tog goods sold from the following :

` `

Opening stock 17,000 Indirect expenses 10,400

Purchases 61,400 Closing stock 18,000

Direct expenses 9,600

[Ans: C.O.G.s. ` 70,000]

17. Calculate Net Profit from the following:

Purchase (200 units) 10,000

Freight and carriage 1,200

Rent and advertising 600

Sales (150 units) 10,800

[Ans: NP ` 180; closing stock ` 2,800] Hint: closing stock ` 11,200 x 50 /200

18. The drawings of appropriate for the year 2014 are ` 30,000. profit for the year ` 50,000 and

capital at the end ` 1,40,0,00. calculate the capital at the beginning.

[Ans: opening capital: ` 1,20,000]

19. Prepare trading account of a trader for the year ending 31

December, 2014 from the

following data:

Opening stock (1.1.14) 50,000

Goods purchased during 2014 2,80,000

Freight and packing on the above 20,000

Closing stock (31.12.14) 60,000

Sales 3,80,000

Packing expenses on sales for distribution 12,000

[Ans: Gross profit – ` 90,000]

Hint : ignore packing expenses

20. From the information given below prepare Trading Account.

Opening stock 1,00,000

Purchases 1,50,000

Purchases returns 25,000

Direct expenses 10,000

Carriages inwards 5,000

Sales 4,00,000

Closing stock 50,000

[Ans: gross profit: ` 2,10,000]

270 Introduction to Financial Accounting

Provision on Debtors and Creditors

1. From the following figures, you are required to prepare:

(a) Provision for doubtful debts account

(b) Bad debts account

Jan., 1,2000 Provision for bad debts ` 2,500

Dec., 31, 2000 Bad debts ` 2,870

Dec., 1, 2000 Debtors ` 20,000

Information: make provision for bad debts at 5% on debtors.

[Ans: Debit to profit and loss: ` 370]

2. The provision for bad and doubtful debts stood at ` 3,200 on 31

December, 2013. On 31

December, 2014, debtors stood at ` 1,42,250 out of which ` 2,250 had to be written, off. On

December 2015, the debtors were ` 76,900 out of which ` 1,900 had to be written off as bad

debts. The firm creates a bad debts provision to the extent of 5% on the debtors. Make the

necessary journal entries and show the provision for bad and doubtful debts account for

2014 and 2015.

[Ans: In 2014 Debit profit and loss ` 6,050; In 2014 credit profit and loss ` 1,350]

3. On 1

Jan., 2012 M/s. Kamakshi had a bad debt provision of ` 2,600. on 31

December,

2012, the total debtors amounted to ` 73,600 out of which ` 1,600 were bad and had to be

written off. The firm wants to maintain a provision for bad debts @5% of the debtors.

On 31

December, 2013, the total debtors amounted to ` 1,280 out of which ` 1,280 had to

be written off as bad debts. The provision for bad debts is to be maintained at 5% of debtors.

Show the bad debts account and the provision for bad debts account for 2012 and 2013.

[Ans: In 2012 debit profit and loss account ` 2,600 and in 2013 Credit profit and loss

account ` 320]

4. Following details are provided to you:

2008 2009 2010

Debtors at the end 50,000 30,000 70,000

Bad debts written off 4,000 1,000 5,000

Provision for doubtful debts (opening) 3,000 – –

Provision to be maintained for doubtful debts 10% 5% 6%

prepare provision for doubtful debts account for three years.

[Ans: 2012: balance of PBDD account debited to profit and loss account ` 6,000; 2008:

balance of PBDD account credited to profit and loss account ` 2,500 2013: Balance of

PBDD account debited to profit and loss account ` 7,700)

5. The trial balance of Thiru Manain as on 1-12-2012 shows the following (among others).

Debtors 80,000

Bad debts 1,000

Provision for bad debts (1-1-12) 2,000

Final Accounts 271

You are required to provide for bad and doubtful debts at 5% on debtors. Give the necessary

Journal entries and shoe the bad debts account provision for bad debts A/c, Profit and Loss

account and the balance sheet.

[Ans: Debit profit and loss account – ` 3,000]

Preparation of Final Accounts

1. From the following trial balance of Ravi, prepare trading and profit and loss account for the

year ended December 31

2014 and a balance sheet as on that date.

Trial balance

Particulars

` `

Capital

Sales

Purchases

Salaries

Rent

Insurance

Drawings

Machinery

Bank balance

Cash

Stock 1.1.14

Debtors

Creditors

15,000

2,000

1,500

300

5,000

28,000

4,500

2,000

5,200

2,500

40,000

25,000

1,000

66,000 66,000

Adjustment Required

Stock on 31.12.14 ` 4,900

Salaries unpaid ` 300

Rent paid in advance ` 200

Insurance prepaid ` 90

[Ans: G.P. ` 9,700, N.P. ` 5,890; B/s Total ` 42,190]

2. From the following trial balance, prepare trading, profit and loss account for the year ended

31.12.2014 and a balance she as on that date :

Trial Balance

Purchases

Debtors

Return inwards

Bank deposit

Rent

Salaries

11,870

7,580

450

2,750

360

850

Capital

Bad debts recovered

Creditors

Return outwards

Bank overdraft

Sales

8,000

1,250

350

1,570

14,690

272 Introduction to Financial Accounting

Travelling expenses

Cash

Stock

Discount allowed

Drawings

300

210

2,450

600

Bills payable 1,350

27,650 27,650

Adjustments

(i) The closing stock on 31.12.14 was ` 4,200.

(ii) Write-off ` 80 as bad debts and create a reserve for bad debts at 5% on sundry debtors.

(iii) Three months rent is outstanding.

[Ans: Gross Profit – ` 4,470 Net profit – ` 2,595;

Balance sheet total – ` 14,285]

3. From the following balances as at 31

December, 2014 of a trader, prepare a trading and

profit and loss account for the year 2004 and a balance sheet as on that date:

Particulars ` Particulars `

Salaries

Rent

Cash

Debtors

Trade expenses

Purchases

Advances

Bank balance

5,500

1,300

1,000

40,000

600

25,000

2,500

5,600

Creditors

Sales

Capital

loans

9,500

32,000

30,000

10,000

81,500 81,500

Adjustments

(i) The closing stock amounted to ` 9,000

(ii) One month’s salary is outstanding.

(iii) One month’s rent has been paid in advance.

(iv) Provide 5% for doubtful debts.

[Ans: Gross Profit — ` 16,000; Net profit – ` 6,200; Balance sheet total – ` 56,200]

4. Prepare a trading and profit and loss account for the year ended 31

December, 2014 and a

balance sheet as on that date from the following trial balance of Mr. Akilan:

Particulars ` Particulars `

Drawings

Goodwill

Buildings

Machinery

Bills receivable

Opening stock

Purchase

45,000

90,000

60,000

40,000

6,000

40,000

51,000

Capital

Bills payable

Creditors

Purchase returns

Sales

1,60,000

35,000

70,000

2,650

2,18,000

Final Accounts 273

Wages

Carriage outwards

Carriage inwards

Salaries

Rent

Discount

Repairs

Bank

Cash

Debtors

Bad debts

Sales returns

Furniture