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(c) UNIT 20: Case Study

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Business Accounting

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Course Design

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Advisory Council

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Chairman
Dr Parag Diwan

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Members
Dr Kamal Bansal Dr Anirban Sengupta Dr Ashish Bhardwaj
Dean Dean CIO

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Dr Satya Sheel Dr Sanjay Mittal Mr M K Goel
VP – Academic Affairs Professor – IIT Kanpur Management Consultant

SLM Development Team


Wg Cdr P K Gupta
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Dr Joji Rao
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Dr Neeraj Anand
Dr K K Pandey
for

Print Production

Mr Kapil Mehra Mr A N Sinha


Manager – Material Sr Manager – Printing
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Author

Nitin Balwani
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All rights reserved. No part of this work may be reproduced in any form, by mimeograph or any other means,
without permission in writing from Hydrocarbon Education Research & Society.
E
UP

Course Code: BBCF-131D

Course Name: Business Accounting


(c)

Version: July 2013

© MPower Applied Learning Enterprise


UNIT 20: Case Study

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Contents

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Block-I

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Unit 1 Introduction to Accounting ............................................................................................ 3
Unit 2 Principles of Accounting............................................................................................... 25
Unit 3 Accounting Standards in India .................................................................................... 43

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Unit 4 Accounting Equation and Accounting Cycle ............................................................... 57
Unit 5 Case Study .................................................................................................................... 69

Unit 6
Block-II
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Preparation of Journal, Ledger and Balancing........................................................... 75
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Unit 7 Subsidiary Books .......................................................................................................... 95
Unit 8 Trial Balance............................................................................................................... 117
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Unit 9 Financial Statements ................................................................................................. 137


Unit 10 Case Study .................................................................................................................. 161
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Block-III

Unit 11 Managerial Remuneration ......................................................................................... 165


Unit 12 Dividends & Dividends Declaration Out of Past & Current Profits ........................ 179
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Unit 13 Amalgamation, Absorption & External Reconstruction........................................... 205


Unit 14 Internal Reconstruction ............................................................................................. 227
Unit 15 Case Study .................................................................................................................. 241
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Block-IV
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Unit 16 Holding Company Accounts ....................................................................................... 247


Unit 17 Liquidation of Companies .......................................................................................... 285
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Unit 18 Accounts of Banking Companies................................................................................ 299


Unit 19 Accounts of Insurance Companies ............................................................................. 321
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Unit 20 Case Study .................................................................................................................. 337


Business Accounting
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Block-V

Unit 21 Inflation Accounting ................................................................................................... 341

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Unit 22 Human Resource Accounting ..................................................................................... 355

Unit 23 Government System Accounting................................................................................ 365

Unit 24 Responsibility Accounting .......................................................................................... 377

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Unit 25 Case Studies................................................................................................................ 387

Glossary ............................................................................................................................................ 389

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UNIT 1: Introduction to Accounting

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1
Notes

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Detailed Contents Business Accounting

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2
Notes
UNIT 1: INTRODUCTION TO ACCOUNTING
___________________ UNIT 3: ACCOUNTING STANDARDS IN INDIA
Introduction Introduction

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z z
___________________
z Meaning and Definition of Accounting z Accounting Standards
___________________
z Scope and Objectives of Accounting z Statements of Accounting Standards (AS 1)
___________________ Disclosure of Accounting Policies
z Importance and Limitations of Accounting

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___________________
z Process of Accounting UNIT 4: ACCOUNTING EQUATION AND
___________________ ACCOUNTING CYCLE
z Book-keeping
z Introduction

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z Types of Accounts
___________________
z Accounting Equation
___________________
UNIT 2: PRINCIPLES OF ACCOUNTING z Accounting Cycle
___________________

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z Introduction z Account
___________________
z Meaning and Need of Accounting Theory
UNIT 5: CASE STUDY
z Generally Accepted Accounting Principles (GAAP)

z Capital and Revenue Items


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UNIT 1: Introduction to Accounting

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Unit 1
3
Notes
Activity
Make a presentation to
Introduction to Accounting
___________________
explain meaning of

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management with the help of
___________________
examples.
___________________
Objectives
___________________
After completion of this unit, the students will be aware of the following

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topics: ___________________

\ Meaning and Definition of Accounting ___________________


\ Scope and Objectives of Accounting

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___________________
\ Importance and Limitations of Accounting
___________________
\ Process of Accounting

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___________________
\ Book-keeping
\ Types of Accounts ___________________

Introduction
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The main object of a business house is to earn profit. Accounting is
the medium of recording the business activities and it considered
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as a language of business. To find out the results of a business, the


information relating to the cost of the products and revenues from
the products is collected. Then the costs and revenues are
compared to find out the profit or loss of the business. If volume of
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sales of the products is high and the number of transaction of the


business is very high, it is impossible to keep all these transactions
in the mind of a business man. Thus a need of recording of all
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these business transactions rose. The recording of business


transactions or activities is done through a process of accounting.
There is an old quotation of a well known author of accounting
Prof. R.R. Gupta, First write or record before one deliver the goods
or renders the services and if there is any disagreement in future,
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use the writing or record as an evidence to resolve the


misunderstanding or rectifying the errors.
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Today the business activities are recorded not only to find out the
profit or loss of the business, but are also to judge the financial
position of the business. Accounts of the business are prepared
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from the point of view of owner and also serve the purpose of
outsiders. Creditors and investors want to know how safe their
(c)

investment is—Labours in conducting the negotiations for wages


and government to determine the economic policies etc. Thus
Business Accounting

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4 accounts of a business are the evidence on the basis of which the
Notes
Activity financial decisions are taken.
Make student teams and work
___________________
on terminology related to the

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___________________
Accounting to be posted to the
Meaning and Definition of Accounting
class, etc.
___________________ Accounting is treated as the language of business. It records all the
___________________ transactions which can be measured in money and have occurred
in a particular period. Accounts of a business provide useful

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___________________
information to its users.
___________________
There are many definitions of accounting. Some of the most

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___________________
important definitions are given below:
___________________
1. As per Robert N. Anthony – "Accounting system is a means of
___________________ collecting, summarizing, analyzing and reporting, in monetary

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___________________ terms, information about the business".
2. The American Accounting Association (AAA) has defined
accounting as, “the process of identifying, measuring and
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communicating economic information to permit informal
judgments and decisions by users of information”.
3. The Committee on Terminology of American Institute of
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Certified Public Accountants gave a generally accepted


definition of accounting – “Accounting is the art of recording,
classifying and summarizing in a significant manner and in
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terms of money transactions and events which are, in part at


least, of a financial character, and interpreting the results
thereof.”
On the basis of above definitions we conclude that accounting is a
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science as well as an art of recording of activities of the business


which can be measured in money and analyzing and interpreting
them.
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Characteristics of Accounting
On the basis of above definitions, the characteristics of accounting
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may be drawn as follows:


1. Accounting is the art of recording of financial
transactions of the business: All those transactions of
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business which are financial in nature are recorded in


accounting and those which are not of financial nature are not
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recorded in accounting. As the honesty of the workers cannot


be measured in money, it cannot be recorded into accounting.
UNIT 1: Introduction to Accounting

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2. Classifying and summarising of recorded data is done in
Notes
accounting: In accounting the financial transactions are
recorded in the journal. With the help of journal, the recorded ___________________

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data are classified into ledger under appropriate heads. Then ___________________
with the help of ledger the trial balance and financial
___________________
statements are prepared.
___________________
3. Data are recorded in terms of money: In accounting, the

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___________________
financial data are recorded in a definite term i.e. money. No
other unit is accepted to record the business transaction. If ___________________
there is sale of 100 articles at the rate of `50 per article, only

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___________________
the monetary value of these articles i.e. ` 5,000 (100 x ` 50) is
___________________
recorded.

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___________________
4. Accounting is a science also: On account of recording of
___________________
business transactions in a systematic manner, it is also called
a science. First the business transactions are recorded in the
primary books i.e. journal, for classification the ledger is
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prepared. With the help of ledger the trail balance, profit and
loss account and balance sheet is prepared. Profit and loss
account is prepared after a period to find the result of the
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business and balance sheet to know the financial position of


the business.
5. Analysing and interpretation of the results is done in
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accounting: It not only record classifies and summaries the


business data but also analyse and interprets the results for
the future decisions. On the basis of data forecasting regarding
profit, sales etc. may be done.
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Check Your Progress


Fill in the blanks:
1. ………………is the process of recording, classifying,
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summarizing in a significant manner of transactions


which are in financial character and finally results are
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interpreted.
2. The users of accounting are ………………… and
external.
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3. The primary objective of the accounting is to maintain


the records of all ………………..of the business.
(c)
Business Accounting

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Scope and Objectives of Accounting
Notes
Activity
The Scope of accounting is divided into following two parts:
Prepare a presentation
___________________
showing the scope and (a) Branches of Accounting

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___________________
objectives of accounting.
___________________ (b) Accounting as a science or an art

___________________ Branches of Accounting

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___________________ The main objectives of the accounting are to record the business
___________________ transactions and to provide the necessary information to the
internal and external users of the financial statements. For the

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___________________
said objectives, the accounting is classified into followings:
___________________
(i) Financial Accounting: It is the original form of accounting.
___________________

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It refers to the recording of daily business financial
___________________ transaction. Recording of the transaction is done in such a way
that the profit of the business may be ascertained after a
definite period and the picture of the financial position of the
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business may be presented.
(ii) Cost Accounting: As the name indicates, this accounting is
related with the ascertainment of cost of the product in a
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period. Under this system record of raw materials used in


production, wages and labour paid and other expanses
incurred on production are kept to control the costs.
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(iii) Management Accounting: The accounting which provides


the necessary information to the management is called
management accounting. Under this the analysis and
interpretation of the accounts, prepared by financial
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accounting, are done in a manner so that the managers may


forecast, plan for future and frame the policy.
(iv) Tax Accounting: Under tax accounting, the accountants
prepare the accounts as per the provisions of taxation. The
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accounts prepared as per taxation provisions may differ from


the accounts prepared as per financial accounting.
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(v) Inflation Accounting: Actually the financial statements are


prepared on the basis of historical cost which do not present
the true picture of the financial position and correct profit or
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loss of the business due to inflation. Thus the fresh financial


statements are prepared keeping in mind the price level
(c)

changes under inflation accounting.


UNIT 1: Introduction to Accounting

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7
(vi) Human Resource Accounting: Human Resource Accounting
Notes
means the accounting for human being as now in an
organization human being is treated as an asset like other ___________________

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physical assets. It is recorded in the books like other assets. ___________________
HRA deals with the measurement of costs on recruiting,
___________________
selecting, hiring, training, placing and development of the
employees in one side and on the other side it deals with the ___________________

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present economic value of the employees. For the ___________________
determination of the value of human being different methods ___________________
are used under HRA.

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___________________
(vii) Responsibility Accounting: Responsibility accounting is a
___________________
special technique of management under which accountability
is established according to the responsibility delegated to the

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___________________

various levels of management. Management information and ___________________


reporting system is instituted to give adequate feedback in
terms of the delegated responsibility. Under this system, units
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of an organization, under a specified authority in a person, are
developed as responsibility centre and evaluated individually
for their performance.
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Accounting as Science or an Art


Accounting is both the science and art. Study of science is based on
some principles and it is systemized. It is a science because the
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business transactions are recorded on the basis of some principles


and journal of transaction, ledger posting, trial balance and
preparation of final statements are done in a sequence. Art is the
creation of practical applications and rules for the completion of
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any work. On the basis of it, accounting is an art as we do not only


study principles of accounting but also we learn to apply these
principles in practice to record the business transaction. Thus
accounting is both science and art.
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Objectives of Accounting
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The main purpose of book-keeping and accounting is to furnish the


necessary financial data to the persons interested in the business.
These persons can be the internal users of the business and
external users of the business. Among the internal users all the
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managers at lower, middle and top level are included. While


among the external users, investors, creditors, government and
(c)

public are included. The financial statements are supplied to the


Business Accounting

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8 external users for the necessary information. In brief, following are
Notes the objectives of accounting:
___________________
1. To maintain the systematic records of the business: The

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___________________ primary objective of the accounting is to maintain the records
___________________ of all transactions of the business. As the memory of human
being is very limited and short, it would be very difficult to
___________________
remember all the transactions especially if there is a huge

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___________________ amount of transaction. So it is very necessary to record all
___________________ business transactions properly to determine the amount of
profit or loss and the financial position of the business on a

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___________________
particular date.
___________________
2. To ascertain the profit or loss of the business: The main
___________________
objective of the business is to earn a profit. Exact profit can be

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___________________ ascertained with the help of financial accounting. Which helps
to determine the net profit or loss of the business over a
period? For the determination of the amount of profit or loss, a
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trading and profit and loss account is prepared at the end of a
period. If there is excess of revenue for a period over the
expenses incurred to earn that revenue, it is said to be a profit.
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And if there is excess of expenses over the revenue, it is said to


be a loss. In the case of profit the management can take the
decisions relating to selling price and output etc. In the case of
loss, the causes of such a loss are investigated and remedial
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action is taken by the management.


3. To present the financial position of the business: The
objective of the accounting is not only recording of the financial
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transactions of the business and determination of profit or loss


but also to present the financial position of the business. To
present the financial position, financial accounting helps in the
preparation of balance sheet. Balance sheet is the statement of
assets and liabilities of the business. It also gives the
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information about the borrowed capital as well as owned


capital along with different assets such as fixed assets, current
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assets and miscellaneous. Balance sheet is the reflector of the


financial position of a business (solvency and insolvency).
4. To provide the financial information to the various
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users: One more objective of the accounting is to provide the


required financial information to the different users - internal
(c)

as well as external users. Internal users of the financial


statements are owners, shareholders, management and
UNIT 1: Introduction to Accounting

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external users of the financial statements are debenture 9
holders, creditors, investors, employees, government, etc. Notes
Activity
As ___________________
per the double entry
Check Your Progress

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system of accounting what will
be ___________________
the impact of following
Fill in the blanks:
transactions on balance sheet:
___________________
1. Accounting is both the ………………. and art. a. Mr. Rakesh started
___________________
business with cash of
2. The main objective of the business is to earn a

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`___________________
1,00,000
………………. .
b. Gods sold on credit for
___________________
` 10000
Importance and Limitations of Accounting

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___________________
c. Furniture purchased for
` 5000
___________________
Appropriate and adequate accounting system plays a vital role for
the successful operation of the business. It also helps in the

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___________________

determination of cost of production, controlling internal as well as ___________________


external activities of the business, forecasting of profit, cost and
sales, etc. Accounting is also useful in locating the errors,
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distribution of dividend and bonus to shareholders. Thus,
accounting is being used as a means to achieve the objective of the
business. The other advantages of the accounting are as follows:
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(1) Replacement of human memory: As the human's memory is


limited and short, it is difficult to remember all the
transactions of the business. Therefore, all the financial
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transactions of the business are recorded in the books. By this


way the businessmen cannot only see the records at the
required time but can also remember them for a long time.
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Thus, recording of the transactions is the replacement of


human's memory.

(2) Helpful in the determination of financial results and


presentation of financial position: Accounting is very
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useful in the determination of the profit and loss of a business


and showing the financial position of the business.
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(3) Helpful in assessing the tax liability: Generally, a


businessman has to pay corporate tax, VAT and excise duty,
etc. Therefore, it is necessary that proper accounts should be
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maintained to compute the tax liability of the business.


(c)

(4) Helpful in the case of insolvency: Sometimes the


businessman becomes the insolvent. If he has properly
Business Accounting

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10 maintained the accounts, he will not face the problems in
Notes explaining few things in the court.
___________________
(5) Helpful in the valuation of business: If the business is shut

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___________________ down and sold, accounting helps the businessman to determine
___________________ the value of business. It would be possible only in that case
___________________ when the accounts of the business are properly maintained.

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___________________ (6) Helpful in the valuation of goodwill and shares: If
___________________ accounts of the business are properly maintained, it would be
quite convenient to determine the value of goodwill. Goodwill

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___________________
is very important for the determination of the value of shares
___________________
of the company.
___________________

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(7) Accounting makes comparative statement possible:
___________________
Proper and adequate accounting helps in comparing the
income, expenditure, purchase, sale of the current year with
that of the previous years. And then future plans, policies and
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forecasting may be possible.

Limitation of Accounting
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In spite of being so many uses and advantages of accounting, it has


a number of limitations which are as follows:
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(1) Recording of monetary items only: In accounting only those


transactions which have the monetary value are recorded, And
those transactions which do not have the financial value
whether those are important in business, are not recorded in
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the accounting. For example, efficiency of the management,


honesty of the workers, etc.

(2) Effect of inflation: In accounting the transactions are


recorded at the historical cost. Accordingly the assets of the
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business are shown at cost in the balance sheet. Thus the


balance sheet prepared on the basis of historical cost ignores
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the price-level changes (inflation). In this way the balance


sheet of the business does not present the true and fair picture
of the business.
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(3) Conflict between accounting principles: In accounting, one


accounting principle conflicts another. For instance, inventory
(c)

should be valued on the basis of 'least of the cost and market


UNIT 1: Introduction to Accounting

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price' as per the principle of the conservatism. If in the first 11
year, inventory is valued on the basis of cost (being lower than Notes
Activity
market price) and in the second year at the market price You and your group members
___________________
are required to develop an

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(being lower than cost), this principle conflicts the accounting assignment on process of
___________________
principle of the consistency. accounting.
___________________
(4) Financial statements are affected by personal judgment ___________________
of the accountants: Personal decisions of the accountants

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___________________
regarding the adoption of accounting policies, affects the
___________________
results of the financial statements. As a result the financial

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statements lose their objectivity. ___________________

___________________
(5) Financial statements do not reflect the right picture of
the business: Sometimes the profit and loss account of the

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___________________

business does not show the accurate profit/loss and the balance ___________________
sheet does not show the true picture of the business because
the assets shown in the balance sheet are shown at the
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realizable (resalable) value which is wrong. Some worthless
figures are also shown in the balance sheet as preliminary
expenses, discount on issue of shares/debentures, etc.
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Check Your Progress


State true or false:
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1. Accounting is useful in locating the errors, distribution


of dividend and bonus to shareholders.
2. In accounting only those transactions which have the
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monetary value are recorded.

Process of Accounting
Accounting is described as origin for the creation of information
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and the continuous utility of information. Now the question is how


is this information created? For this, there is a step by step
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process, as shown in Figure 1.1.


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(c)
Business Accounting

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12
Notes

___________________

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___________________

___________________

___________________

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___________________

___________________

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___________________

___________________

___________________

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___________________
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Figure 1.1: Process of Accounting

After the creation of information, the developed information should


be appropriately recorded.
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Classifying: It is one of the most important processes of the


accounting. Under this, grouping of transactions is carried out on
the basis of certain segments or divisions. It can be described as a
method of rational segregation of the transactions. The segregation
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is generally done into two categories, viz.


1. Cash transactions, and
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2. Non-cash transactions.
The preparation of the ledger accounts and subsidiary books is
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done on the basis of rational segregation of accounting


transactions. For e.g., the preparation of cash book is involved in
(c)

the unification of cash transactions.


UNIT 1: Introduction to Accounting

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13
Summarizing: The ledger books are appropriately balanced and
Notes
listed one after another.
___________________
The list of the name of the various ledger book accounts and their

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___________________
accounting balances is known as Trial Balance. The trial balance is
summary of all unadjusted name of the accounts and their ___________________
balances. ___________________

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Preparation: After preparing, the summary of various unadjusted ___________________
accounts are required to adjust to the tune of adjustment entries ___________________
which were not taken into consideration at the time of preparing

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___________________
the trial balance. Immediately after the incorporation of
___________________
adjustments, the final statement is readily available for
interpretations.

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___________________

Are there any scales/guides available for the recording of ___________________

information? If yes, what are they?

They are as follows:


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1. What to record: Financial Transaction is only to be recorded

2. When to record: Time relevance of the transaction at the


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moment of recording

3. How to record: Methodology of recording — It contains two


different systems of accounting viz. cash system and accrual
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system.

Cash System
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The revenues are recognized only at the moment of realization but


the expenses are recognized at the moment of payment. For
example sale of goods will be considered under this method that
only at the moment of receipt of cash out of sale of goods. The
charges which were paid only will be taken into consideration but
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the outstanding, not yet paid will not be considered.


Example: Rent paid only will be considered but not the
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outstanding of rent charges.

Accrual System
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The revenues are recognized only at the time of occurrence and


expenses are recognized only at the moment of incurring. Whether
(c)

the cash is received or not out of the sales, that will be


registered/counted as total value of the sales.
Business Accounting

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The next most important step is to record the transactions. For
Notes
Activity
recording, the value of the transaction is inevitable, to record
Do ___________________
you agree with the
values; the classification of values must be essentially done.
statement "The modern

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___________________
system of book keeping is
based on the double entry Values
___________________
system”. What is your There are four different values in the business practices that
opinion?
___________________
should be followed or recorded in the system of accounting:

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___________________
1. Original Value: It is the value of the asset only at the
___________________ moment of purchase or acquisition
2. Book Value: It is the value of the asset maintained in the

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___________________

___________________ books of the account. The book value of the asset could be
computed as follows:
___________________

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Book Value = Gross (Original) value of the asset –
___________________
Accumulated depreciation
3. Realizable Value: Value at which the assets are realized
4. Present Value: Market value of the asset
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Check Your Progress
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Fill in the blanks:


1. The …………..are recognized only at the moment of
realization but the ……………….are recognized at the
moment of payment.
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2. For …………………, the value of the transaction is


inevitable, to record values; the classification of values
must be essentially done.
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3. ………………….the value of the asset only at the


moment of purchase or acquisition.

Book-keeping
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Book- keeping includes recording of journal, posting in ledgers and


balancing of accounts. All the records before the preparation of
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trail balance are the whole subject matter of book- keeping. Thus,
book- keeping many is defined as the science and art of recording
transactions in money or money’s worth so accurately and
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systematically, in a certain set of books, regularly that the true


state of businessman’s affairs can be correctly ascertained. Here it
(c)

is important to note that only those transactions related to


business are recorded which can be expressed in terms of money.
UNIT 1: Introduction to Accounting

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Definition 15
Notes
“Book- keeping is the art of recording business transactions in a
systematic manner”. ___________________

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—A.H. Rosenkamph. ___________________

___________________
“Book- keeping is the science and art of correctly recording in books
___________________
of account all those business transactions that result in the transfer

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___________________
of money or money’s worth”.
___________________
—R.N. Carter

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___________________
Importance of Book Keeping ___________________
Following are the importance of book keeping:

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___________________
i. Book- keeping provides a permanent record of each
___________________
transaction.
ii. Soundness of a firm can be accessed from the records of assets
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and abilities on a particular date.
iii. Entries related to incomes and expenditures of a concern
facilitate to know the profit and loss for a given period.
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iv. It enables to prepare a list of customers and suppliers to


ascertain the amount to be received or paid.
v. It is a method gives opportunities to review the business
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policies in the light of the past records.


vi. Amendment of business laws, provision of licenses, assessment
of taxes etc., are based on records.
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Methods of Accounting
Business transactions are recorded in two different ways.
z Single Entry: It is incomplete system of recording business
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transactions. The business organization maintains only cash


book and personal accounts of debtors and creditors. So the
complete recording of transactions cannot be made and trail
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balance cannot be prepared.


z Double Entry: It this system every business transaction is
having a twofold effect of benefits giving and benefit receiving
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aspects. The recording is made on the basis of both these


aspects. Double Entry is an accounting system that records the
(c)

effects of transactions and other events in at least two


accounts with equal debits and credits.
Business Accounting

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16
The modern system of book keeping is based on the double entry
Notes
system. Therefore, we are discussing this system only. The father
___________________
of this system is the Lucas Paciolo. He gave the details of this

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___________________ system in his book "De Compute Set Scripturise" in Italy in 1494
___________________ A.D. As per this system every transaction of the business has
double aspects/double effect. Therefore, every transaction must be
___________________
recorded at two places or accounts. If in a transaction someone is a

tio
___________________ giver, some other will be a receiver.
___________________ This system is so organized, accurate, complete and scientific that
it is now adopted universally. In the words of Keller, M.J. Keller

uc
___________________

___________________
in–Intermediate Accountancy, "The most common system of
accounting data for an enterprise is the double entry system. As
___________________
the name implies, the entry made for each transaction is composed

rod
___________________ of two parts, a 'debit' and a 'credit'.

Importance of Double Entry System


ep
As we know that double entry system of accounting is a systematic
and scientific system of accounting, so it offers a number of
advantages. The following are the most important advantages of
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the system:
1. Complete record of transactions: Under this system,
recording of all transactions is done whether related to
t fo

personal or impersonal accounts.


2. Ascertainment of profit or loss: Under this system of
accounting complete profit and loss account can be prepared by
which profit or loss of a particular period can be ascertained.
No

3. Mathematical check on accuracy: Every debit has a credit,


so it is an accurate system as far as mathematical accuracy is
concerned which may be proved by preparing trial balance.
S,

4. Check for fraud: Scope of fraud is limited as it minimizes the


chances of fraud because of scientific system.
PE

5. Ascertainment and knowledge of financial position of


the business: Under this system, it is possible to know the
financial position of the business at any time. For this purpose
Balance Sheet can be prepared any time.
U

6. Possibility of full control over business: Under this system


(c)

full information is available which enables the management to


exercise full control over the business.
UNIT 1: Introduction to Accounting

ale
17
7. Easy accessibility of information: Under this system all
Notes
information is easily available and accessible which is very
helpful and useful for the management. ___________________

n/S
8. Possibility of comparative study: Under this system, it is ___________________

possible to prepare comparative statement and also compare ___________________


the previous year's results with the current year's result and ___________________
take corrective steps as and when necessary to improve the

tio
___________________
operational results.
___________________
9. Reliable information: Under this system information

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received is reliable. ___________________

___________________
Steps involved in Double entry system

rod
___________________
(a) Preparation of Journal: Journal is called the book of
___________________
original entry. It records the effect of all transactions for the
first time. Here the job of recording takes place.
(b) Preparation of Ledger: Ledger is the collection of all
ep
accounts used by a business. Here the grouping of accounts is
performed. Journal is posted to ledger.
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(c) Trial Balance preparation: Summarizing. It is a summary


of ledge balances prepared in the form of a list.
(d) Preparation of Final Account: At the end of the accounting
t fo

period to know the achievements of the organization and its


financial state of affairs, the final accounts are prepared.

Rules of Double Entry System


No

As per the principles of the double entry system, each


transaction of the business is recorded at two places. In other
words, two entries are made for every financial transaction of
the business. If someone is giving something in the business, it
S,

has two sides – one is giver and other is receiver. The system of
double entry can be understood easily by an equation which is
called accounting. Following are some transactions of the
PE

business to explain it.


For example
U

1. Mr. Kamlesh started business with cash of `2, 00,000.


In this transaction, one side cash is coming into business and
(c)

in the other side capital is being brought by Mr. Kamlesh.


Thus:
Business Accounting

ale
18
Capital = Assets (Cash)
Notes

___________________
` 2,00,000 = ` 2,00,000

n/S
___________________ 2. In the next transaction, if a plant of ` 50,000 is purchased in

___________________
cash, this transaction will also leave two sides. In one side
cash is going and in other side plant is coming. In this
___________________
situation, the accounting equation will be as follows:

tio
___________________
Capital = Plant + Cash (Assets)
___________________
` 2, 00,000 = ` 50,000 + (` 2,00,000 – 50,000)

uc
___________________

___________________ 3. If a loan of `1,50,000 are taken from the SBI, it will also affect
the accounting equation by two sides. On one side, cash will
___________________

rod
increase and on the other side, liabilities of the business will
___________________
increase. This may be depicted as follows:

Capital + Liability (Loan) = Plant + Cash


ep
` 2, 00,000 + 1,50,000 = ` 50,000 + (1,50,000 + 1,50,000)

` 3,50,000 = ` 3,50,000
rR

4. If some goods of ` 20,000 are purchased on credit, it will also


affect the accounting equation in two ways. On one side it
increases the goods and on the other side it increases the
t fo

liability (creditors). Now the changed form of the above


accounting equation will be as follows:

Capital + Loan + Creditors = Plant + Cash + Goods


No

` 2,00,000 + 1,50,000 + 20,000 = ` 50,000 + 3,00,000 + 20,000

` 3,70,000 = ` 3,70,000

Capital + Liabilities = Assets


S,

Check Your Progress


Fill in the blanks:
PE

1. ………………..is incomplete system of recording business


transactions.
U

2. ………………….system of accounting is a systematic and


scientific system of accounting, so it offers a number of
(c)

advantages.
UNIT 1: Introduction to Accounting

ale
Types of Accounts 19
Notes
Activity
The object of book-keeping is to keep a complete record of all the
“The___________________
object of book-keeping is
transactions that place in the business. To achieve this object,

n/S
to keep a complete record of
business transactions have been classified into three categories: ___________________
all the transactions that place
in the business”. Elaborate
i. Transactions relating to persons. ___________________
this statement and explain the
underlying concept.
___________________
ii. Transactions relating to properties and assets

tio
___________________
iii. Transactions relating to incomes and expenses.
___________________
The accounts falling under the first heading are known as

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‘personal Accounts’. ___________________

The accounts falling under the second heading are known as ‘Real ___________________

Accounts’, the accounts falling under the third heading are called

rod
___________________
‘Nominal Accounts’. The accounts can also be classified as personal ___________________
and impersonal. The following chart will show the various types of
accounts:
ep
Personal Accounts: Accounts recording transactions with a
person or group of persons are known as personal accounts. These
accounts are necessary, in particular, to record credit transactions.
rR

Personal accounts are of the following types:


(a) Natural persons: An account recording transactions with an
individual human being is termed as a natural persons’
t fo

personal account. e.g., Kamal’s account, Mala’s account,


Sharma’s accounts. Both males and females are included in it
(b) Artificial or legal persons: An account recording financial
transactions with an artificial person created by law or
No

otherwise is termed as an artificial person, personal account,


e.g. Firms’ accounts, limited companies’ accounts, educational
institutions’ accounts, Co-operative society account.
(c) Groups/Representative personal Accounts: An account
S,

indirectly representing a person or persons is known as


representative personal account. When accounts are of a
PE

similar nature and their number is large, it is better tot group


them under one head and open a representative personal
account. e.g., prepaid insurance, outstanding salaries, rent,
U

wages etc.
When a person starts a business, he is known as proprietor. This
(c)

proprietor is represented by capital account for that entire he


invests in business and by drawings accounts for all that which he
Business Accounting

ale
20 withdraws from business. So, capital accounts and drawings
Notes account are also personal accounts.
___________________
The rule for personal accounts is:

n/S
___________________
Debit the receiver
___________________
Credit the giver
___________________
Real Accounts

tio
___________________

___________________
Accounts relating to properties or assets are known as ‘Real
Accounts’, A separate account is maintained for each asset e.g.,

uc
___________________
Cash Machinery, Building, etc.
___________________
Real accounts can be further classified into tangible and
___________________ intangible.

rod
___________________
(a) Tangible Real Accounts: These accounts represent assets
and properties which can be seen, touched, felt, measured,
purchased and sold. e.g. Machinery account Cash account,
ep
Furniture account, stock account etc.
(b) Intangible Real Accounts: These accounts represent assets
and properties which cannot be seen, touched or felt but they
rR

can be measured in terms of money.


e.g., Goodwill accounts, patents account, Trademarks account,
Copyrights account, etc. The rule for Real accounts is:
t fo

Debit what comes in


Credit what goes out
No

Nominal Accounts
Accounts relating to income, revenue, gain expenses and losses are
termed as nominal accounts. These accounts are also known as
fictitious accounts as they do not represent any tangible asset. A
S,

separate account is maintained for each head or expense or loss


and gain or income. Wages account, Rent account Commission
account, Interest received account are some examples of nominal
PE

account
The rule for Nominal accounts is:
U

Debit all expenses and losses


Credit all incomes and gains
(c)
UNIT 1: Introduction to Accounting

ale
21
Check Your Progress
Notes
Fill in the blanks:
___________________
1. Accounts recording transactions with a person or group

n/S
___________________
of persons are known as ………………
___________________
2. An account recording transactions with an individual
___________________
human being is termed as a …………………….

tio
___________________
3. Accounts relating to properties or assets are known as
…………………. ___________________

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4. Accounts relating to income, revenue, gain expenses and ___________________

losses are termed as ………………….. ___________________

rod
___________________
Summary ___________________

Accounting is the medium of recording the business activities and


considered as a language of business. Identification of financial
ep
transactions, recording, classifying them into different groups,
summarizing them into trial balance and preparation of financial
statements and analyzing and interpreting them, are included in
rR

the accounting process. Financial accounting, cost accounting,


management accounting, responsibility accounting, tax accounting,
inflation accounting, etc. are the branches of accounting.
t fo

Accounting is an art as well as a science. Accounting is done for the


following objective: For maintaining the systematic records, For
ascertaining the profit/loss of the business, To present the financial
position and To provide the financial information.
No

Accounting plays an important role in the determination of profit,


financial position, tax liability, valuation of goodwill and shares
and comparative study. There are also some limitations of
S,

accounting as only monetary items are recorded, effect of inflation


is neglected, financial statements do not present the right picture
PE

of the business etc.

Lesson End Activity


U

Present the key points which make double entry accounting system
more significant than the other traditional accounting systems.
(c)
Business Accounting

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22
Keywords
Notes
Accounting Process: It includes the recording of financial
___________________
transactions, ledger posting, preparation of financial statements

n/S
___________________ and analyzing and interpretation of them.
___________________
Cost Accounting: Accounting relating to the ascertainment of cost
___________________ of the product.

tio
___________________ Management Accounting: Presenting of accounting information
___________________ in such a way as to assist the management in taking the important
decisions and making the policies.

uc
___________________

___________________ Basic Accounting Concept or Assumptions: These are common


basic accounting principles which are used in the preparation of
___________________

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financial statements.
___________________

Questions for Discussion


1. What do you mean by Accounting? Explain its different
ep
objectives.
2. Explain the characteristics of accounting.
rR

3. What are the importance and limitations of accounting


4. Briefly explain the various branches of accounting.
t fo

5. What is the accounting process? Explain each of the them.


6. Explain the meaning and importance of double entry system of
accounting.
7. What is meaning of Debit and Credit?
No

8. Explain the meaning and importance of bookkeeping.


9. Explain the various types of accounts.
S,

Further Readings
PE

Books
T.S. Grewal, M.C. Shukla. “Advanced Accounts”. S. Chand, New
Delhi.
U

R.L. Gupta, M. Radhaswami. “Advanced Accountancy”. Sultan


Chand, New Delhi.
(c)

Dr. S.N. Maheshwari, Sharad, K. Maheshwari. “Financial


Accounting”. Vikas Publishing Co. Pvt. Ltd., New Delhi.
UNIT 1: Introduction to Accounting

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23
Pandikumar, M. P (2007). “Management Accounting, Excel Books”.
Notes
New Delhi.
___________________

n/S
Web Readings
___________________
www.futureaccountant.com
___________________
http://www.globusz.com/ ___________________

tio
http://churmura.com/business/types-of-accounts/27737/ ___________________

http://www.netmba.com/accounting/fin/process/ ___________________

uc
___________________

___________________

rod
___________________

ep ___________________
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t fo
No
S,
U PE
(c)
Business Accounting

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24
Notes

___________________

n/S
___________________

___________________

___________________

tio
___________________

___________________

uc
___________________

___________________

___________________

rod
___________________
ep
rR
t fo
No
S,
U PE
(c)
UNIT 2: Principles of Accounting

ale
Unit 2
25
Notes
Activity
You and your group members
Principles of Accounting
___________________
are required to develop an

n/S
assignment on Accounting
___________________

___________________
Objectives
___________________
After completion of this unit, the students will be aware of the following

tio
topics: ___________________

\ Meaning and Need of Accounting Theory ___________________


\ Generally Accepted Accounting Principles (GAAP)

uc
___________________
\ Capital and Revenue Items
___________________

rod
___________________
Introduction
___________________
The transactions of the business enterprise are recorded in the
business language, which routed through accounting. The entire
ep
accounting system is governed by the practice of accountancy. The
accountancy is being practiced through the universal principles
which are wholly led by the concepts and conventions.
rR

Meaning and Need of Accounting Theory


Strong theoretical base is required for the development of any
t fo

discipline of knowledge. Similarly accounting is also having its


theory. Accounting theory is developed with the development of
commerce. In the present economic and social environment, the
importance of the study of the accounting theory has increased as
No

all the financial statements are prepared by the accountants on the


basis of this theory. These financial statements provide very useful
information to the owner of the business, creditors, financial
institutions and government. It is necessary to study the theory of
S,

accounting which provides a base of recording, analyzing and


interpreting the financial statements. In the absence of generally
PE

accepted principles and scientific assumptions, accountants will


prepare the financial statements in their own ways. They will
control and mould the accounting cycles by their ways which will
be based on their past practices. As a result, it will not be possible
U

to compare the study of one business with another concern


similarly inter-period comparison of a firm will not be possible. If
(c)

each accountant has his own approach in preparing the financial


statements, it will be difficult to understand them. Hence, there is
Business Accounting

ale
26 a need for using a standard, logical and sound reasoning language
Notes
Activity which everyone can understand in correct perspective. All this led
Distinguish between material
___________________ to the development of sound theoretical base of accounting.
and immaterial transactions of Hendriksen defined the accounting theory as "logical reasoning in

n/S
___________________
business.
the form of a set of broad principles that (i) provide a general frame
___________________
of reference by which accounting practice can be evaluated, and (ii)
___________________ guide the development of new practices and procedures". Thus

tio
___________________ theory includes the systematic principles and methodology which
are used in the practice.
___________________
So far, a universally acceptable basic accounting theory is not

uc
___________________
developed. A multiplicity of theories is found and used by the
___________________
different users. But at the international level an effort is made to
___________________ frame a generally acceptable conceptual framework of accounting

rod
___________________ i.e. International Accounting Standards and in India also
Accounting Standards. The main objective to frame these
standards is to make the accounting language more effective and
to be easily understood by all. These standards are the scientific
ep
and logical base of accounting. These standards are termed as
Accounting Principles.
rR

Check Your Progress


Fill in the blanks:
1. ……………………… includes the systematic principles
t fo

and methodology which are used in the practice.


2. The main objective to frame ………………………
standards is to make the accounting language more
No

effective and to be easily understood by all.

Generally Accepted Accounting Principles (GAAP)


Accounting principles are those rules of actions on the basis of
S,

which the transactions of the business are recorded, classified and


summarized. If the financial statements are not prepared on the
PE

basis of these principles, there will be low acceptability and


difficulty to understand them, and the comparison will be
impossible and unreliable. Therefore, the accountants recommend
U

that there should be common concepts and conventions of


accounting so that the above difficulties and problems may not
occur. These common concepts and conventions of accounting have
(c)

become the basic accounting concepts and conventions as these are


commonly accepted by the body of the professional accountants all
UNIT 2: Principles of Accounting

ale
over the world to prepare the financial statements. Therefore, they 27
are termed as Generally Accepted Accounting Principles (GAAP). Notes

___________________
Classification of Accounting Principles

n/S
___________________
Accounting principles are broadly classified into three categories,
these are: ___________________

___________________
I. Basic Assumptions

tio
___________________
II. Basic Principles (Concepts)
___________________
III. Modifying Principles (Conventions)

uc
___________________
Basic Accounting Assumptions ___________________

i. Separate Business Entity: As per this assumption, business

rod
___________________
is considered a separate entity from its owner(s). This
___________________
assumption helps in keeping the business transactions strictly
free from the effect of personal affairs of the owner. For
instance, when a person start the business with cash of
ep
`2,00,000 then this amount increases the balance of cash from
the point of business and on the other hand the owner is
rR

treated as a liability and this is shown in the liability side of


the balance sheet as owner's capital. For this transaction this
journal entry is passed -
Cash A/c Dr. 2, 00,000
t fo

To Owner's Capital A/c 2, 00,000

This concept is becoming more popular because in one sense


capital itself may be regarded as a liability — the amount due
No

from the business to the owner. This concept is applicable to


the all forms of business organizations whether it is a limited
company, partnership firm or a sole trader.
ii. Going Concern Concept: As per International Accounting
S,

Standards, it is a fundamental accounting assumption


underlying the preparation of financial statements. Under this
PE

assumption, "the enterprise is normally viewed as a going


concern, that is, as continuing in operation for the foreseeable
future. It is assumed that the enterprise has neither the
intention nor the necessity of liquidation or of curtailing
U

materially the sale of its operations". Under this assumption


the assets of the business are valued by the accountants on the
(c)

basis of going concern concept, historical cost and expected life


of the assets.
Business Accounting

ale
28
iii. Money Measurement Concept: As per this assumption, only
Notes
those transactions of the business are recorded in the
___________________
accounting which can be measured in money. Those

n/S
___________________ transactions/activities of the business which cannot be
___________________ measured in money are not recorded in accounting.

___________________ iv. Accounting Period Assumption: As per the going concern


concept, the income of the business can be measured at the

tio
___________________
time of the liquidation of the business or at the time when
___________________ business is sold. But practically it is very difficult to wait such
a long period that is also not definite. Therefore, it is agreed

uc
___________________

___________________
among the accountants that the economic life of the business is
divided into different segment for the purpose of preparing of
___________________
the financial statements and the determination of profits.

rod
___________________ Generally this segment of time is one year either calendar year
or a financial year. Sometime it may be less than twelve
months i.e., quarterly, half yearly etc. Reports made for less
ep
than twelve months are called interim reports and are less
reliable than annual reports. At the end of each segment
(period) profit and loss account and balance sheet are
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prepared.

Basic Accounting Principles (Concepts)


These basic accounting principles are commonly accepted/agreed
t fo

principles by the accountants to record the business financial


transactions. These are as follows:
i. Revenue Reorganization Principle: It is also called revenue
No

realization principle. As per this principle the revenue is


recorded in accounting when the sales have taken place. If
there is expectation that will be a particular transaction there
in future, that is not recorded in accounting. Revenue/sales is
S,

considered to be made when title of ownership of goods passes


from the seller to buyer and the buyer become legally liable to
pay.
PE

However, this principle has some exemptions which are as


follows:
U

a. In the case of sales made on the basis of hire purchase


system where ownership is not transferred at the time of
(c)

sales while it is transferred at time of final payment.


UNIT 2: Principles of Accounting

ale
Herewith, sales are presumed to the extent of instalment 29
received. Notes

b. In the case of contract accounts, if the contract is for long ___________________

n/S
period revenue cannot be realized until the contract is not ___________________
completed. Here, only a part of total revenue is treated as
___________________
realized.
___________________
ii. Cost Principle: This principle is closely related to the going

tio
___________________
concern concept. As per this principle every transaction of the
business should be recorded at its historical cost and not at its ___________________
market price. At the time of recording of the transactions,

uc
___________________
their market price is not considered. Sometimes its market
___________________
price may be less than or more than its actual cost but its
actual cost is recorded in accounts because of cost principle.

rod
___________________

Under this principle the historical cost of a transaction ___________________


becomes the base cost for the subsequent years. On the basis of
this cost, the depreciation is charged on the assets and the
ep
balance is shown in the balance sheet. All the fixed assets and
current assets are recorded at historical cost. Thus we observe
that the balance sheet prepared on the basis of historical cost
rR

does not give us actual results for those applicable of fixed


assets and current assets. Due to the changing in the price
level changes, the financial statements become irrelevant for
the users. This led to the inflation accounting to came into
t fo

existence.
iii. Dual Aspect Principle: This is the basic principle of
accounting. As per this principle every financial transaction of
No

the business has dual effect and recorded at two places.


Therefore, it is called double entry system. On the basis of this
principle it is said that every debit must have an equivalent
credit and every credit must have an equivalent debit because
every transaction of the business has two aspects. For
S,

instance, if Mr. Aditya Raj started a business for cash


` 2,00,000 there will be two aspects of this transaction. In one
PE

aspect cash is coming into business while in the other aspect


the business has to pay this amount to Mr. Aditya Raj.
Because Mr. Aditya Raj has given the amount to the business.
U

For this transaction the following journal entry will be passed-


Cash A/c Dr.
(c)

To Mr. Aditya Raj


Or To Capital A/c
Business Accounting

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30
This transaction can be expressed in the following equation:
Notes

___________________
Capital = Assets (Cash)

n/S
___________________ `2, 00,000 = `2, 00,000

___________________ Here cash (assets) is the resource of the business and capital is
the claim of the proprietor as business has to return this
___________________
amount to the proprietor.

tio
___________________
If the business purchases furniture of `20, 000 on credit, the
___________________
above equation will change as follows:

uc
___________________
Capital + Creditors = Cash + Furniture
___________________
`2,00,000 + 20,000 = `2,00,000 + `20, 000
___________________

rod
Capital + Liabilities = Assets
___________________
Thus we find that in the above equations the total of assets is
always equal to the liabilities. Technically we can say that for
every debit there is an equivalent credit. This relationship of
ep
assets and liabilities is also called accounting equation.
iv. Full Disclosure Principle: As per this principal, the
rR

financial statements should disclose true and fair view so that


these may provide accurate and sufficient information to the
users of financial statements. Disclosure principle means to
give all the information relating to the economic activities of
t fo

the business to the owner, creditors and investors. Now-a-days


this principle is getting more importance as big business
houses are being run in the form of limited companies. As per
Companies Act 1956, the profit and loss account and the
No

balance sheet of the company must show true and fair view of
the company. Therefore, companies are giving the foot notes
regarding some items as investments, contingent liabilities
etc. along with the balance sheet.
S,

v. Matching of Cost and Revenue Principle: As per the going


concern concept, the accurate profit/loss of the business can be
PE

determined at the time of liquidation of the business or sale of


the business. But it will generate a lot of problems. Therefore,
the economic life of the business is divided into different
U

segments in order to determine the profit/loss of the business.


Generally a segment of the economic life of the business
(c)

becomes of a year. To compute the operational profits/loss of


the business in a year, it is necessary to find the expenses and
UNIT 2: Principles of Accounting

ale
revenues relating to the period. Then all the revenues of that 31
period are matched with all the expenses/costs incurred to Notes
earn that revenue. This matching is called the principle of ___________________
matching of cost and revenue. The results of this match

n/S
___________________
becomes as follows:
___________________
Profit = Revenue - Expenses
___________________
Herewith the matching means an appropriate association

tio
___________________
between the revenues of a period and expenses/costs of that
period. In other words the incomes/loss of the business can be ___________________
determined if the revenues (incomes) of a period are compared

uc
___________________
(matched) with the expenditure of that period. For the
___________________
recognition of the revenues/expenses the accurate system of
accounting is adopted. Therefore, a proper adjustment is also

rod
___________________

made in the accounts for the outstanding expenses, prepaid ___________________


expenses, accrued incomes and unaccrued incomes. At the time
of reorganization of the revenue/expenses, the following points
ep
are kept in mind:
a. The expenses which are being spent to earn revenue must
be of the same period for which profit is being computed.
rR

b. Revenues/expenses of a period must be computed on the


basis of accrual accounting system.
c. If some revenues are received in advance, they must be
t fo

treated as the income of that period in which goods are


supplied/services are rendered.
vi. Objectivity Principle: It is also known as objective evidence
No

concept. As per this principle the transactions which are


recorded in accounting must be on the objective and factual
basis. There should be a voucher or documentary evidence
behind each entry in the accounting. The entry must be free
S,

from personal bias and based on the rational approach. If the


entries are made without evidence, it will lose the confidence
of the several users of the financial statements about their
PE

reliability. For the auditing of the financial statements, there


is also a need of objective evidence.
U

The Modifying Accounting Principles (Conventions)


Basic accounting assumptions and principles provide us the
(c)

various rules to prepare the financial statements. If these financial


statements are relevant and reliable, they will give much useful
Business Accounting

ale
32 information to the various users of the financial statements. In
Notes order to prepare the true and fair financial statements, there is a
___________________ need to modify the accounting assumptions and principles. These

n/S
___________________ modified accounting principles are as follows:

___________________ i. Conservation (Prudence): As per the law of conservatism, at


___________________ the time of preparing the financial statements, all the possible
losses must be kept in mind and all anticipated profits/gains

tio
___________________
should be left out. In other words the accounts must follow the
___________________
policy of playing safe. Likewise stock-in-trade is valued at
'market price or cost whichever is least', provision for bad and

uc
___________________

___________________ doubtful debt, provision for depreciation on fixed assets, etc.


___________________ are maintained. This principle is being criticized now-a-days

rod
on the ground that it goes against the principle of disclosure.
___________________
The accountants create a secrete reserve through the provision
of bad and doubtful debts, depreciation and the valuation of
stock. The financial statements loose their true and fair view.
ep
Profit and loss account depicts the lower income and the
balance sheet understates the assets and the liabilities of the
rR

business.
Today the law of conservatism has been replaced by prudence.
It means that conservatism is adopted only in the inevitable
t fo

uncertainties and doubts. The accountants should also give the


reasons for adopting a particular accounting techniques,
method and policies without undue conservatism.
ii. Consistency: In order to enable the management to do the
No

comparison of the results of the several years of the business,


whatever accounting policy is adopted in a year, must be
adopted in the coming years.
S,

According to Kohlar there are three forms of consistency:


(a) Vertical Consistency is used in the different financial
PE

statements of the business on the same date. For instance,


depreciation on fixed assets is used in the income
statement and the balance sheet on the same date.
U

(b) Horizontal Consistency enables the comparison of the


profit or performance of a business in a year with the
(c)

performance of another year for example the depreciation


methods.
UNIT 2: Principles of Accounting

ale
33
(c) Third Dimensional Consistency refers to the same
Notes
principles or practices of accounting adopted by the
different firms in an industry. ___________________

n/S
___________________
iii. Timeliness: Accounting information given in the financial
statements must be reliable and relevant. In order to be ___________________

relevant, this information must be supplied in time. If late and ___________________

tio
obsolete information is provided, it will hamper the ___________________
management and the users of the financial statements to take
___________________
appropriate, timely and rational decision.

uc
___________________
iv. Materiality: Herewith, the materiality means that only that
___________________
information should be disclosed and attached with financial

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___________________
statements which influence the decisions of shareholders,
investors and creditors, etc. and the other insignificant details ___________________

must be ignored. Moreover, an item of information may be


material for one purpose while that may be immaterial for
ep
other. This is a subjective matter. For example, the cost of the
component may be very much significant for small
rR

businessman while it may be insignificant for a large


businessman. In one more example, the Companies Act
permits to ignore the paise at the time of preparation of
financial statements while for the income tax purpose the
t fo

income is rounded off to the nearest ten.

v. Cost-Benefit Principle: As per this principle the cost of using


an accounting principle should not exceed its benefits. It does
No

not mean that to curtail the costs, no information or a little


information should be given to the users of the financial
statements.

vi. Industry Practice: Different accounting principle/practice is


S,

adopted in the different industries. At the time of preparing


the financial reports and presenting the accounting
PE

information the prevailing accounting practices in a particular


industry should be kept in mind. For example, disclosing of
investments and stock at the cost or market price whichever is
U

lower. Thus we see that the prevailing accounting practices in


an industry play an important role in adopting the accounting
(c)

practices.
Business Accounting

ale
34
Check Your Progress
Notes
Activity
Fill in the blanks:
Prepare a presentation
___________________
showing the Capital and 1. Accounting records all the transactions which can be

n/S
___________________
Revenue Items.
expressed either in ………………… .
___________________
2. Every financial transaction of the business has
___________________
………………… and recorded at two places.

tio
___________________
3. ………………… enables the comparison of the profit or
___________________
performance of a business in a year with the
performance of another year.

uc
___________________

___________________ 4. The revenues are recognized only at the moment of


___________________ ………………… .

rod
___________________ 5. Book Value = Gross (Original) value of the asset –
………………… .
6. The ………… are the persons who owe to an enterprise
ep
an amount for receiving goods or services on credit.
7. ………………… is a liability which arises only on the
happening of an uncertain event.
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8. ………………… = total assets – total liabilities

Capital and Revenue Items


t fo

A businessman is interested to know the net result of his business


operations after a certain period. But neither the trial balance nor
the books of accounts reveal the net results of the business. For
No

this, the financial statements are prepared. But before you learn
how to prepare these statements, it is all the more necessary to
know about the nature of expenditure and receipts i.e. capital and
revenue. This will help in recording correctly the items in these
S,

statements.

Capital and Revenue Expenditures


PE

In business, there are thousands of items of expenditure. The


following are some of these expenditures which are generally
incurred in all types of business:
U

1. Purchase of goods
(c)

2. Purchase of fixed assets such as Building, Furniture, Machine,


etc.
UNIT 2: Principles of Accounting

ale
35
3. 'Carriage inwards'
Notes
4. Octroi
___________________
5. Purchase of Raw Material

n/S
___________________
6. Import duty
___________________
7. Coal, gas, water, oil, grease, fuel, heating and lighting
___________________
8. Wages paid to workers for installation of machinery

tio
___________________
9. Salaries
___________________
10. Rent, rates and taxes

uc
___________________
11. Stationery and printing
___________________
12. Postage and Telegrams

rod
___________________
13. Entertainment
___________________
14. Repairs and renewals
15. Depreciation on fixed assets
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16. Office expenses
17. Bank charges
rR

18. General expenses


19. Travelling expenses
20. Overhauling of second hand machinery purchased
t fo

21. Major repairs affected for reconditioning a machinery/the old


assets
22. Increasing the seating capacity of a cinema hall
No

23. Constructing an additional room


24. Carriage for bringing a fixed asset to place of business
25. Shifting business to convenient premises
S,

26. Advertisement on introducing a new product in market


27. Replacement of hand driven machine by automatic machine
PE

28. Research and development


On the basis of items of expenditure, the expenditure can be
classified into three categories:
U

1. Capital Expenditure,
(c)

2. Revenue Expenditure, and


3. Deferred Revenue Expenditure.
Business Accounting

ale
36 Capital Expenditure
Notes
The expenditure incurred for acquiring a fixed asset or which
___________________
results in increasing the earning capacity of the business is known

n/S
___________________ as Capital Expenditure.
___________________ The benefits of capital expenditures are generally availed in
___________________ several accounting years. Following are some of the examples of
Capital Expenditure.

tio
___________________

___________________ 1. Expenditure incurred for the acquisition of a fixed asset


Example: Building, furniture, machinery etc.

uc
___________________

___________________ 2. Expenditure incurred for the inward carriage or erection of a


fixed asset
___________________

rod
___________________ Example:
(a) Carriage paid in connection with the purchase of fixed
asset;
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(b) Wages paid to labourers’ in connection with the
installation of machinery.
rR

These expenses form part of the cost of the fixed asset.


3. Expenditure incurred for extension or improvement of an
existing fixed asset
t fo

Example: Money spent in connection with increasing the


seating capacity of a cinema hall or constructing an additional
room.
4. Expenditure incurred for the major repairs of an old asset
No

Example: Repairs for reconditioning machinery.


5. Expenditure incurred for the replacement of an old asset with
a new asset.
S,

Example: Replacing a hand-driven machine by automatic


machine.
PE

Revenue Expenditure
An expenditure incurred in the course of regular business a
U

transaction of a concern is availed during the same accounting


year is known as Revenue Expenditure. Following are some of the
examples, of Revenue Expenditure.
(c)

1. Expenditure incurred on the purchase of raw materials.


UNIT 2: Principles of Accounting

ale
37
2. Expenditure incurred in the day-do-day running of business,
Notes
Example: Wages, salaries, rent, rates and taxes, office
___________________
expenses, interest, discount, etc.

n/S
___________________
3. Expenditure incurred for the upkeep of an asset
___________________
Example: Repairs, maintenance charges, etc.
___________________

tio
4. Expenditure incurred for the purchase of goods meant for sale ___________________

Example: Purchases, carriage inwards, import duty, octroi, ___________________


etc.

uc
___________________

5. Depreciation of fixed assets. ___________________

The above examples are not exhaustive and are not universally

rod
___________________
accepted. Whether expenditure is capital expenditure or revenue ___________________
expenditure depends upon its purpose and nature of the business.

Examples:
ep
1. Amount spent on the purchase of furniture is a capital
expenditure but it is revenue expenditure for a business
rR

dealing in furniture.

2. Amount spent on Plant and Machinery is a capital expenditure


but it is revenue expenditure for a business dealing in
t fo

engineering goods.

3. Amount spent on wages or carriage are revenue expenditure,


but when wages are paid for the installation of a new
machinery or carriage paid to bring the machine to the place of
No

business, they are capital expenditure as they increase the


value of fixed asset i.e. machinery here.

Deferred Revenue Expenditure


S,

There are certain revenue expenditures that are incurred during


one accounting year but are applicable wholly or in part in future
PE

periods such as heavy expenditure on advertisement for


introducing a new product in the market or for exploring new
markets for the product. These expenditures appear to be revenue
U

expenditure. But it is not so because the benefit from this is likely


to the enjoyed over a number of years. Such expenditure whose
(c)

benefit is enjoyed not in one year but over a number of years is


known as deferred revenue expenditure.
Business Accounting

ale
38
Examples:
Notes
1. Heavy initial expenditure incurred on Advertisement for
___________________
introducing a product in the market.

n/S
___________________ 2. Expenditure incurred in shifting business to more convenient
___________________ premises.
___________________ 3. Expenditure incurred on research and development

tio
___________________
Distinction between Capital and Revenue Expenditure
___________________
Following are the main points of difference between capital and
revenue expenditures.

uc
___________________

___________________ Basis of Difference Capital Expenditure Revenue Expenditure


___________________ Purpose It is incurred for the It is incurred for the

rod
purchase of fixed assets. maintenance of fixed
___________________ assets.
Earning capacity It increases the earning It does not increase the
capacity of the business. earning capacity of the
business.
ep
Periodicity of benefit Its benefits are spread Its benefit is only for
over a number of years. one accounting year.
rR

Placement in It is an item of Balance It is an item of Trading


financial statements Sheet and is shown as an and Profit and Loss
asset. Account and is shown
on the debit side of
either of the two.
t fo

Occurrence It is non-recurring It is usually a recurring


expenditure in nature. expenditure.

Capital and Revenue Receipts


No

Just as expenditures are classified into Capital or Revenue


Expenditure, in the same way receipts are classified into:
1. Capital Receipts, and
2. Revenue Receipts.
S,

Capital Receipts
PE

The receipts which do not arise out of normal course of business


are known as Capital Receipts.
Examples:
U

1. Receipts from sale of fixed assets.


2. Additional capital introduced by the Proprietor
(c)

3. Loans raised
UNIT 2: Principles of Accounting

ale
39
Revenue Receipts
Notes
The receipts which arise out of normal course of a business are
___________________
known as Revenue Receipts.

n/S
___________________
Examples:
___________________
1. Income from sale of goods
___________________
2. Rent received form letting out the business property

tio
___________________
3. Dividend received from shares
___________________
4. Interest received from investment

uc
___________________

Check Your Progress ___________________

Fill in the blanks:

rod
___________________

1. The expenditure incurred for acquiring a fixed asset or ___________________

which results in increasing the earning capacity of the


business is known as …………………..
ep
2. An expenditure incurred in the course of regular
business a transaction of a concern is availed during the
same accounting year is known as ………………………..
rR

3. The receipts which do not arise out of normal course of


business are known as ………………..
t fo

4. The receipts which arise out of normal course of a


business are known as ………………..

Summary
No

Accounting concepts and convention which are commonly accepted


by the accountants to record the transactions are called Generally
Accepted Accounting Principles (GAAP). Accounting principles are
classified into three categories: Basic Accounting Assumptions,
S,

Basic Accounting Concepts, Basic Accounting Conventions.


The revenues are recognized only at the moment of realization but
PE

the expenses are recognized at the moment of payment. The


charges which were paid only are taken into consideration but the
outstanding, not yet paid is not considered. The revenues are
U

recognized only at the time of occurrence and expenses are


recognized only at the moment of incurring. The financial
(c)

statements are found to be more useful to many people


Business Accounting

ale
40 immediately after presentation only in order to study the financial
Notes status of the enterprise in the angle of their own objectives.
___________________
The entire accounting system is governed by the practice of

n/S
___________________ accountancy. The accountancy is being practiced through the
___________________ universal principles which are wholly led by the concepts and
conventions. Money measurement concept tunes the system of
___________________
accounting as fruitful in recording the transactions and events of

tio
___________________ the enterprise only in terms of money. Business entity concept
___________________ treats the owner as totally a different entity from the business.
Going concern concept deals with the quality of long lasting status

uc
___________________
of the business enterprise irrespective of the owners' status,
___________________
whether he is alive or not. Matching concept only makes the entire
___________________ accounting system as meaningful to determine the volume of

rod
___________________ earnings or losses of the firm at every level of transaction. Duality
or Double entry accounting concept is the only concept which
portrays the two sides of a single transaction.
ep
Lesson End Activity
Singania Chartered Accountants Firm established in the year
rR

1956, having very good number of corporate clients. It continuously


maintains the quality in audit administration with the clients
since its early inception. The firm is eagerly looking for promising
t fo

students who are having greater aspirations to become auditors.


The firm is having an objective to recruit fresher to conduct
preliminary auditing process with their corporate clients.
For which the firm would like to select the right person who is
No

having conceptual knowledge as well as application on the


subjects. It has given the following Balance sheet to the
participants to study the conceptual applications. The participants
are required to enlist the various concepts and conventions of
S,

accounting.
(a) List out the various accounting concepts dealt in the above
PE

balance sheet.
(b) Explain the treatment of accounting concepts.

Keywords
U

Basic Accounting Principles: These are the rules of recording


(c)

the financial transactions which are adopted by the accountants


universally.
UNIT 2: Principles of Accounting

ale
41
Accounting Conventions: Customs and traditions which guide
Notes
the accountants to record the financial transactions.
___________________
Accounting Process: It includes the recording of financial

n/S
transactions, ledger posting, preparation of financial statements ___________________

and analyzing and interpretation of them. ___________________

Accrual System: The revenues are recognized only at the time of ___________________

tio
occurrence and expenses are recognized only at the moment of ___________________
incurring.
___________________
Book Value: It is the value of the asset maintained in the books of

uc
___________________
the account. The book value of the asset could be computed as
follows: ___________________

rod
___________________
Book Value = Gross (Original) value of the asset – Accumulated
depreciation ___________________

Assets: The economic resources of an entity. They include such


items as cash, accounts receivable (amounts owed to a firm by its
ep
customers), inventories, land, buildings, equipment, and even
intangible assets like patents and other legal rights and claims.
Assets are presumed to entail probable future economic benefits to
rR

the owner.
Liabilities: Amounts owed to others relating to loans, extensions
of credit, and other obligations arising in the course of business.
t fo

Questions for Discussion


1. What do you mean by generally accepted accounting principle
No

(GAAP)? Classify the accounting principles.


2. What is the meaning of accounting conventions? Explain them.
3. What is the dual aspect principle? Explain with five examples.
S,

4. Explain the following accounting principles:


a. Revenue Reorganization Principle
PE

b. Matching of Cost and Revenue Principle


c. Full Disclosure Principle
U

d. Cost Principle
5. Write short notes on the following (approximately 50 words
(c)

each):
(i) Conservatism Principle
Business Accounting

ale
42
(ii) Materiality Principle
Notes

___________________
(iii) Consistency Principle

n/S
___________________ (iv) Money Measurement Concept

___________________ (v) Going Concern Concept

___________________ 6. What do you mean by business entity concept? Is it different


from proprietary concept? Explain.

tio
___________________

___________________ 7. The entire accounting system is governed by the practice of


accountancy. What are the key principles used in accounting?

uc
___________________
8. What are the key assumptions of going concern concept?
___________________

___________________
9. Every debit transaction is appropriately equated with the

rod
transaction of credit. Define.
___________________
10. Classify the various kinds of values in accounting process.

Further Readings
ep
Books
rR

T.S. Grewal, M.C. Shukla. “Advanced Accounts”. S. Chand, New


Delhi.
R.L. Gupta, M. Radhaswami. “Advanced Accountancy”. Sultan
t fo

Chand, New Delhi.


Dr. S.N. Maheshwari, Sharad, K. Maheshwari. “Financial
Accounting”. Vikas Publishing Co. Pvt. Ltd., New Delhi.
No

Pandikumar, M. P (2007). “Management Accounting, Excel Books”.


New Delhi.

Web Readings
www.futureaccountant.com
S,

http://www.principlesofaccounting.com/chapter1/chapter1.html
PE

http://www.legalzoom.com/business-management/running-your-
business/general-accepted-accounting-principles-or
http://www.ofm.wa.gov/policy/80.20.htm
U
(c)
UNIT 3: Accounting Standards in India

ale
Unit 3
43
Notes
Activity
Find out how many
Accounting Standards in India
___________________
Accounting Standards that are

n/S
given by the Institute of
___________________
Chartered Accountants of
___________________
India is made mandatory.
Objectives
___________________
After completion of this unit, the students will be aware of the following

tio
topics: ___________________

\ Accounting Standards ___________________


\ Need and Formulation of Accounting Standards

uc
___________________
\ Statements of Accounting Standards (AS 1) Disclosure of Accounting
Policies ___________________

rod
___________________

Introduction ___________________

For the interest of customers, investors, owners, it is necessary


that financial statement of a company should be transparent,
ep
properly disclosed, consistent and reliable. For this purpose
accounting standards are framed by ICAI in India.
rR

Accounting Standards
There are many users of financial statements as investors,
t fo

creditors, government, consumers, owners, etc. They take many


economic decisions on the basis of financial statements. If the
financial statements are not properly regulated, there is possibility
that the financial statements may mislead and provide the
No

distorted picture of the business in the place of true and fair


picture of the business. Proper regulation of the process of
accounting it is essential so that these statements should be
transparent, properly disclosed, consistent and reliable. Adequate
S,

disclosure in the accounts is also required. For this purpose,


accounting standards are prepared at the national and
international level. Actually the generally accepted accounting
PE

principles are codified by the accounting standards. Accounting


standards prepares the norms and guidelines to prepare the
financial statements and annual reports. At the international level
U

the International Accounting Standard Committee (IASC) has


issued the International Standards. In this committee, there are
(c)

leading professional bodies of UK, USA, Australia, France and


Canada. India is also a member of this committee. India has also
Business Accounting

ale
44 prepared its own accounting standards, which are prepared by the
Notes
Activity Institute of Chartered Accountant of India (ICAI).
Collect recent data
___________________ on
Accounting Standards on Meaning of Accounting Standards

n/S
___________________
India with the help of Financial
Accounting Standards Board It is a set of certain generally accepted rules, principles, concepts
___________________
(FASB) and conventions issued by the Institute of chartered Accountants
___________________ of India in consultation with other International Accounting

tio
___________________ bodies. The purpose of making uniform rules and principles is to
make the preparation and presentation of financial statement
___________________
easy, relevant, reliable, understandable and finally comparable. In

uc
___________________ other words, Accounting standards are the basis of accounting
___________________ policies and practices to facilitate the recording of transactions and
___________________
events in such a way which can change them into financial

rod
statements, to be used by the persons interested in getting the
___________________
correct and reliable information with a view to take future
decisions.
The basic objective of Accounting Standards is to remove
ep
variations in the treatment of several accounting aspects and to
bring about standardization in presentation. They intent to
rR

harmonize the diverse accounting policies followed in the


preparation and presentation of financial statements by different
reporting enterprises so as to facilitate intra-firm and inter-firm
comparison.
t fo

Need and Formulation of Accounting Standards


What is the need of adoption of accounting standards in the
accounting process? How do the accounting standards help in
No

improving the quality of the financial Statement? The answer of


these questions may be explained by an example, suppose a
company adopts LIFO method for the valuation of its closing stock
and another company adopts FIFO method for the valuation of its
S,

closing stock, valuation of the closing stock of both the companies


will differ. As a result the profit or loss of both companies will also
differ. In order to avoid such situation, AS-2 is made.
PE

Take another example of depreciation, if a company adopts


diminishing balancing method for the depreciation and another
company adopts the fixed instalment method for depreciation, the
U

amount of depreciation of both the companies will differ. As a


result profit/loss will also differ and the comparison of these
(c)

companies will not be possible. For the purpose AS-6 is prepared


by ICAI in India. Similarly, AS-1 gives guidelines for the disclosure
UNIT 3: Accounting Standards in India

ale
of accounting policies, so that the users of financial statements 45
may perceive the reported profits in its correct perspective. Notes

In India, the Accounting Standards are formulated by the ___________________

n/S
Accounting Standard Board (ASB). ASB determines the broad area ___________________
requiring for formulation of AS. At the time of preparation of
___________________
Accounting Standards, ASB gets help from different groups for this
purpose a study group is made. In this group the members of ICAI ___________________

tio
participates. Then a wide discussion is held. In this discussion, the ___________________
representatives of Government, Public Sector Units, and other ___________________
organizations participate. After the discussion an Exposure Draft

uc
___________________
(ED) for AS is proposed and issued by ICAI. Then it is dispatched
to different outside bodies as ICWAI, ICSI, CBDT, SCOPE, etc. ___________________
This ED comprises the following points:

rod
___________________

i. A Statement of concepts and fundamental accounting ___________________


principles relating to the standard.
ii. Definitions of the terms used in the standard.
ep
iii. The manner in which the accounting principles have been
applied for the formulation of the standard.
rR

iv. The presentation and disclosure requirements in complying


with the standard.
v. Class of enterprises to which the standard will apply.
t fo

vi. Date from which the standard will be effective.


After the publication of ED, the comments and views are collected
from the different corners. Then ASB finalizes the proposed
No

standard and submit it to the council of the Institute of chartered


accountant of India for the approval. The council considers the ED
and, if found necessary, modifies with the consolation of the
Accounting Standard Board. Then final shape of the standard is
issued under the authority of the council. In the beginning, this is
S,

recommendatory and after some period it becomes mandatory. The


board has issued the following standards for adoption worldwide. A
PE

number of provisional standards relating to other aspects of


accounting are an anvil.

Nature
U

The Institute of chartered Accountants of India had set up


(c)

Accounting Standards Board on 22nd April, 1977 to formulate


accounting standards on a number of accounting issues, taking
Business Accounting

ale
46 into account the accounting standards developed by the
Notes International Accounting Standard Committee, prevailing laws in
___________________ India, business customs usages and conventions etc. The
Accounting Standards made were not mandatory in the beginning

n/S
___________________
but after the amendment in the Sec 211(3C) of Companies Act,
___________________
1956 Accounting Standards out of 28 have been made mandatory.
___________________ The Auditor is required to give in his report to the shareholders

tio
___________________ that accounts are prepared (drawn) in accordance with the
provisions relating to Accounting Standards in India.
___________________
The Purpose of this exercise is to make the financial statements

uc
___________________
more reliable, comparable, consistent and transparent. These
___________________
standards are made taking into account the laws of the country,
___________________ business custom, environments etc. If there is a change in any law

rod
___________________ of the country or change in business custom or environment, the
accounting standards are also changed/altered. This flexibility of
Accounting Standards is a special feature which makes them more
popular and friendly with the users.
ep
If any enterprise wants to change/modify any business
custom/practice the same must be properly disclosed along with its
rR

effects. For example—change of depreciation method, must be


disclosed along with its effect on profit or loss.
The Institute of chartered Accountants of India has issued the
t fo

following accounting standards.


z AS.1. Disclosure of Accounting policies.
z AS.2. Valuation of Inventories.
No

z AS.3. Cash Flow Statement.


z AS.4. Contingencies and Events occurring after the Balance
Sheet Date.
AS.5. Net Profit or loss for the period, prior items and changes
S,

z
in accounting policies.
AS.6. Depreciation Accounting.
PE

z AS.7. Accounting for Construction Contracts.


z AS.8. Accounting for research and development.
U

z AS.9. Revenue Recognition.


AS.10. Accounting for fixed Assets.
(c)

z
UNIT 3: Accounting Standards in India

ale
47
z AS.11. Accounting for the effects of changes in foreign
Notes
Exchange rates.
___________________
z AS.12. Accounting for Government grants.

n/S
___________________
z AS.13. Accounting for Investments.
___________________
z AS.14. Accounting for Amalgamations.
___________________

tio
z AS.15. Accounting for Retirement benefits in the financial ___________________
statements of employers.
___________________
z AS.16. Borrowing Costs.

uc
___________________
z AS.17. Segment Reporting. ___________________

z AS.18. Related Party Disclosures.

rod
___________________

z AS.19. Leases. ___________________

z AS.20. Earnings Per share.


ep
z AS.21. Consolidated financial statements.

z AS.22. Accounting for Taxes on Income.


rR

z AS.23. Accounting for Investments in Associates in


Consolidated Financial Statements.

z AS.24. Discontinuing operations.


t fo

z AS.25. Interim Financial Reporting.

z AS.26. Intangible Assets.

z AS.27. Financial Reporting of Interests in Joint Ventures.


No

z AS.28. Impairment of Assets.

z AS.29. Contingent Liabilities and Contingent Assets.

z AS 30. Financial Instruments: Recognition and Measurement


S,

z AS 31. Financial Instruments: Presentation

z AS 32. Financial Instruments: Disclosures and limited revision


PE

to AS-19

According to Government of India, there are 31 accounting


standards. But 32 are also included in 31st accounting standard
U

(Financial Instrument: Presentation). So we can say that there are


32 accounting standards.AS-3, AS-6 and AS-24 are desirable but
(c)

the rest are mandatory.


Business Accounting

ale
48
Check Your Progress
Notes
Activity
Fill in the blanks:
Find___________________
out the legal status of
accounting standards in India? 1. The basic objective of …………………is to remove

n/S
___________________
variations in the treatment of several accounting
___________________
aspects and to bring about standardization in
___________________ presentation.

tio
___________________ 2. The …………………………are codified by the accounting
___________________ standards.

uc
___________________

___________________
Statements of Accounting Standards (AS 1) Disclosure
___________________
of Accounting Policies

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___________________ The following is the text of the Accounting Standard (AS) 1 issued
by the Accounting Standards Board, the Institute of Chartered
Accountants of India on 'Disclosure of Accounting Policies'. The
Standard deals with the disclosure of significant accounting
ep
policies followed in preparing and presenting financial statements.
In the initial years, this accounting standard will be
rR

recommendatory in character. During this period, this standard is


recommended for use by companies listed on a recognised stock
exchange and other large commercial, industrial and business
enterprises in the public and private sectors.
t fo

Introduction
1. This statement deals with the disclosure of significant
accounting policies followed in preparing and presenting
No

financial statements.
2. The view presented in the financial statements of an
enterprise of its state of affairs and of the profit or loss can be
S,

significantly affected by the accounting policies followed in the


preparation and presentation of the financial statements. The
accounting policies followed vary from enterprise to enterprise.
PE

Disclosure of significant accounting policies followed is


necessary if the view presented is to be properly appreciated.
3. The disclosure of some of the accounting policies followed in
U

the preparation and presentation of the financial statements is


required by law in some cases.
(c)

4. The Institute of Chartered Accountants of India has, in


Statements issued by it, recommended the disclosure of certain
UNIT 3: Accounting Standards in India

ale
accounting policies, e.g., translation policies in respect of 49
foreign currency items. Notes

5. In recent years, a few enterprises in India have adopted the ___________________

n/S
practice of including in their annual reports to shareholders a ___________________
separate statement of accounting policies followed in preparing
___________________
and presenting the financial statements.
___________________
6. In general, however, accounting policies are not at present

tio
regularly and fully disclosed in all financial statements. Many ___________________
enterprises include in the Notes on the Accounts, descriptions of ___________________
some of the significant accounting policies. But the nature and

uc
___________________
degree of disclosure vary considerably between the corporate and
the non-corporate sectors and between units in the same sector. ___________________

7. Even among the few enterprises that presently include in their

rod
___________________

annual reports a separate statement of accounting policies, ___________________


considerable variation exists. The statement of accounting
policies forms part of accounts in some cases while in others it
ep
is given as supplementary information.
8. The purpose of this Statement is to promote better
understanding of financial statements by establishing through
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an accounting standard the disclosure of significant accounting


policies and the manner in which accounting policies are
disclosed in the financial statements. Such disclosure would
t fo

also facilitate a more meaningful comparison between


financial statements of different enterprises.

Explanation
No

Let us discuss:

Fundamental Accounting Assumptions


9. Certain fundamental accounting assumptions underlie the
preparation and presentation of financial statements. They are
S,

usually not specifically stated because their acceptance and use are
assumed. Disclosure is necessary if they are not followed.
PE

10. The following have been generally accepted as fundamental


accounting assumptions:

a. Going Concern: The enterprise is normally viewed as a


U

going concern, that is, as continuing in operation for the


foreseeable future. It is assumed that the enterprise has
(c)

neither the intention nor the necessity of liquidation or of


curtailing materially the scale of the operations.
Business Accounting

ale
50
b. Consistency: It is assumed that accounting policies are
Notes
consistent from one period to another.
___________________
c. Accrual: Revenues and costs are accrued, that is,

n/S
___________________
recognised as they are earned or incurred (and not as
___________________ money is received or paid) and recorded in the financial
___________________ statements of the periods to which they relate. (The
considerations affecting the process of matching costs with

tio
___________________
revenues under the accrual assumption are not dealt with
___________________ in this Statement.)

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___________________
Nature of Accounting Policies
___________________
11. The accounting policies refer to the specific accounting
___________________

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principles and the methods of applying those principles
___________________
adopted by the enterprise in the preparation and presentation
of financial statements.
12. There is no single list of accounting policies which are
ep
applicable to all circumstances. The differing circumstances in
which enterprises operate in a situation of diverse and
complex economic activity make alternative accounting
rR

principles and methods of applying those principles acceptable.


The choice of the appropriate accounting principles and the
methods of applying those principles in the specific
t fo

circumstances of each enterprise call for considerable


judgment by the management of the enterprise.
13. The various statements of the Institute of Chartered
Accountants of India combined with the efforts of government
No

and other regulatory agencies and progressive managements


have reduced in recent years the number of acceptable
alternatives particularly in the case of corporate enterprises.
While continuing efforts in this regard in future are likely to
S,

reduce the number still further, the availability of alternative


accounting principles and methods of applying those principles
PE

is not likely to be eliminated altogether in view of the differing


circumstances faced by the enterprises.

Areas in which Differing Accounting Policies are Encountered


U

14. The following are examples of the areas in which different


accounting policies may be adopted by different enterprises.
(c)

™ Methods of depreciation, depletion and amortisation


UNIT 3: Accounting Standards in India

ale
51
™ Treatment of expenditure during construction
Notes
™ Conversion or translation of foreign currency items
___________________

n/S
™ Valuation of inventories
___________________
™ Treatment of goodwill ___________________
™ Valuation of investments ___________________

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™ Treatment of retirement benefits ___________________

™ Recognition of profit on long-term contracts ___________________

Valuation of fixed assets

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™ ___________________

™ Treatment of contingent liabilities ___________________

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15. The above list of examples is not intended to be exhaustive. ___________________

___________________
Considerations in the Selection of Accounting Policies
16. The primary consideration in the selection of accounting
ep
policies by an enterprise is that the financial statements
prepared and presented on the basis of such accounting
policies should represent a true and fair view of the state of
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affairs of the enterprise as at the balance sheet date and the


profit or loss for the period ended on that date.
17. For this purpose, the major considerations governing the
t fo

selection and application of accounting policies are:


a. Prudence: In view of the uncertainty attached to future
events, profits are not anticipated but recognised only
when realised though not necessarily in cash. Provision is
No

made for all known liabilities and losses even though the
amount cannot be determined with certainty and
represents only a best estimate in the light of available
information.
S,

b. Substance over Form: The accounting treatment and


presentation in financial statements of transactions and
PE

events should be governed by their substance and not


merely by the legal form.
c. Materiality: Financial statements should disclose all
U

"material" items, i.e. items the knowledge of which might


influence the decisions of the user of the financial
(c)

statements.
Business Accounting

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52 Disclosure of Accounting Policies
Notes
18. To ensure proper understanding of financial statements, it is
___________________
necessary that all significant accounting policies adopted in

n/S
___________________ the preparation and presentation of financial statements
___________________ should be disclosed.

___________________ 19. Such disclosure should form part of the financial statements.

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___________________ 20. It would be helpful to the reader of financial statements if they
___________________ are all disclosed as such in one place instead of being scattered
over several statements, schedules and notes.

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___________________
21. Examples of matters in respect of which disclosure of
___________________
accounting policies adopted will be required are contained in
___________________ paragraph 14. This list of examples is not, however, intended

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___________________ to be exhaustive.
22. Any change in an accounting policy which has a material effect
should be disclosed. The amount by which any item in the
ep
financial statements is affected by such change should also be
disclosed to the extent ascertainable. Where such amount is
not ascertainable, wholly or in part, the fact should be
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indicated. If a change is made in the accounting policies which


has no material effect on the financial statements for the
current period but which is reasonably expected to have a
material effect in later periods, the fact of such change should
t fo

be appropriately disclosed in the period in which the change is


adopted.
23. Disclosure of accounting policies or of changes therein cannot
No

remedy a wrong or inappropriate treatment of the item in the


accounts.

Accounting Standard
S,

(The Accounting Standard comprises paragraphs 24-27 of this


Statement. The Standard should be read in the context of
PE

paragraphs 1-23 of this Statement and of the 'Preface to the


Statements of Accounting Standards'.)
24. All significant accounting policies adopted in the preparation
U

and presentation of financial statements should be disclosed.


25. The disclosure of the significant accounting policies as such
(c)

should form part of the financial statements and the


UNIT 3: Accounting Standards in India

ale
significant accounting policies should normally be disclosed in 53
one place. Notes

26. Any change in the accounting policies which has a material ___________________

n/S
effect in the current period or which is reasonably expected to ___________________
have a material effect in later periods should be disclosed. In
___________________
the case of a change in accounting policies which has a
material effect in the current period, the amount by which any ___________________

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item in the financial statements is affected by such change ___________________
should also be disclosed to the extent ascertainable. Where ___________________
such amount is not ascertainable, wholly or in part, the fact

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___________________
should be indicated.
___________________
27. If the fundamental accounting assumptions, viz. Going
Concern, Consistency and Accrual are followed in financial

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___________________

statements, specific disclosure is not required. If a ___________________


fundamental accounting assumption is not followed, the fact
should be disclosed.
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Check Your Progress
Fill in the blanks:
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1. Statements of Accounting Standards (AS 1) Disclosure


of Accounting Policies deals with the disclosure of
significant accounting policies followed in preparing and
t fo

presenting ……………..
2. ……………….is made for all known liabilities and losses
even though the amount cannot be determined with
certainty and represents only a best estimate in the
No

light of available information.

Summary
S,

Accounting Standards is a set of certain generally accepted rules,


principles, concepts and conventions issued by the Institute of
chartered Accountants of India in consultation with other
PE

International Accounting bodies.


The basic objective of Accounting Standards is to remove
variations in the treatment of several accounting aspects and to
U

bring about standardization in presentation. The accounting


policies refer to the specific accounting principles and the methods
(c)

of applying those principles adopted by the enterprise in the


preparation and presentation of financial statements.
Business Accounting

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54
Lesson End Activity
Notes
Go to this site http://www.mca.gov.in/Ministry/accounting_
___________________
standards.html and prepare an assignment on 35 Indian

n/S
___________________ accounting standards.
___________________

___________________ Keywords

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___________________ Accounting Standards: It is a set of certain generally accepted
___________________ rules, principles, concepts and conventions issued by the Institute
of chartered Accountants of India in consultation with other

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___________________
International Accounting bodies.
___________________
Accounting Policies: The accounting policies refer to the specific
___________________

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accounting principles and the methods of applying those principles
___________________ adopted by the enterprise in the preparation and presentation of
financial statements.
Going Concern: The enterprise is normally viewed as a going
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concern, that is, as continuing in operation for the foreseeable
future.
rR

Materiality: Financial statements should disclose all "material"


items, i.e. items the knowledge of which might influence the
decisions of the user of the financial statements.
t fo

Questions for Discussion


1. Write down the meaning of accounting standards.
2. What do you understand by accounting standards? Explain.
No

3. What is the legal status of Accounting Standards in India?


4. Explain the need and formulation of accounting standards.
Discuss the nature of accounting policies.
S,

5. How many Accounting Standards are given by the Institute of


Chartered Accountants of India?
PE

Further Readings
U

Books
T.S. Grewal, M.C. Shukla. “Advanced Accounts”. S. Chand, New
(c)

Delhi.
UNIT 3: Accounting Standards in India

ale
55
R.L. Gupta, M. Radhaswami. “Advanced Accountancy”. Sultan
Notes
Chand, New Delhi.
___________________
Dr. S.N. Maheshwari, Sharad, K. Maheshwari. “Financial

n/S
Accounting”. Vikas Publishing Co. Pvt. Ltd., New Delhi. ___________________

___________________
Pandikumar, M. P (2007). “Management Accounting, Excel Books”.
New Delhi. ___________________

tio
___________________
Web Readings
___________________
http://www.mca.gov.in/Ministry/accounting_standards.html

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___________________
http://www.scribd.com/doc/11524125/Accounting-Standards-in-
___________________
India

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___________________
http://220.227.161.86/9548Indian%20Accounting%20Standards.pdf
___________________
http://www.svtuition.org/2009/05/accounting-standards-in-india-
simple.html
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No
S,
U PE
(c)
Business Accounting

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56
Notes

___________________

n/S
___________________

___________________

___________________

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___________________

___________________

uc
___________________

___________________

___________________

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___________________
ep
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No
S,
U PE
(c)
UNIT 4: Accounting Equation and Accounting Cycle

ale
Unit 4
57
Notes
Activity

Accounting Equation and


Do ___________________
you agree with the

n/S
statement “The basic
___________________
accounting equation is the
Accounting Cycle foundation for the double-
___________________
entry bookkeeping system.”
What is your experience?
___________________

tio
Objectives ___________________
After completion of this unit, the students will be aware of the following
___________________
topics:

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___________________
\ Accounting Equation
\ Accounting Cycle ___________________

\ Account

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___________________

___________________

Introduction
As discussed earlier accounting is the art of recording, classifying
ep
and summarizing the business transactions of the financial nature.
Under the recording process of accounting journal and subsidiary
rR

books are maintained, under classification of transactions the


ledger is maintained while in the summarizing process trial
balance and final accounts (P. & L. A/c and Balance Sheet) are
prepared.
t fo

Accounting Equation
The basic accounting equation is the foundation for the double-
No

entry bookkeeping system. It shows how assets were financed:


either by borrowing money from someone (liability) or by paying
your own money (shareholders' equity).
Assets = Liabilities + (Shareholders or Owners equity)
S,

The accounting equation is also the basis for the most basic of
accounting reports, the aptly named Balance Sheet. A balance
PE

sheet reports what a business owns (assets), what it owes


(liabilities) and what remains for the owners (equity) as of a
certain date. This equation should remain in balance at all times
U

because of double-entry accounting or bookkeeping. This can be


further understood by the following illustrations.
(c)

An owner's investment into the company will increase the


company's assets and will also increase owner's equity. When the
Business Accounting

ale
58 company borrows money from its bank, the company's assets
Notes increase and the company's liabilities increase. When the company
___________________ repays the loan, the company's assets decrease and the company's
liabilities decrease. If the company pays cash for a new delivery

n/S
___________________
van, one asset (cash) will decrease and another asset (vehicles) will
___________________
increase. If a company provides a service to a client and
___________________ immediately receives cash, the company's assets increase and the

tio
___________________ company's owner's equity will increase because it has earned
revenue. If the company provides a service and allows the client to
___________________
pay in 30 days, the company has increased its assets (Accounts
Receivable) and has also increased its owner's equity because it

uc
___________________

___________________ has earned service revenue. If the company runs a radio


___________________
advertisement and agrees to pay later, the company will incur an

rod
expense that will reduce owner's equity and has increased its
___________________
liabilities.
Example: If a business has `1,000 of assets at a particular time
those assets must be matched by the total of the claims of creditors
ep
and owners. Here is one example of an infinite number of
acceptable balance sheets:
rR

Fazal-ur-Rehman and Sons


Balance Sheet

`
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Assets 1000
Liabilities 500
Equity 500
Total Liabilities and Equity 1000
No

Equity as Residual Claims


Equity is simply the difference between assets and liabilities. The
owner has positive equity only to the extent that assets exceed
S,

liabilities.

Example: If a business has `1,000 of assets and ` 600 of liabilities


PE

the ` 600 of liabilities are, in effect, a claim on the assets. Equity is


the difference between the assets and liabilities, or `400.

Equity = Assets – Liabilities


U

Equity is simply the difference between assets and liabilities. The


(c)

owner has positive equity only to the extent that assets exceed
liabilities.
UNIT 4: Accounting Equation and Accounting Cycle

ale
59
Example: If a business has ` 1,000 of assets and ` 500 of liabilities
Notes
the `500 of liabilities are, in effect, a claim on the assets. Equity is
the difference between the assets and liabilities, or ` 500. ___________________

n/S
If a business ceases operations remaining assets first go to outside ___________________

creditors. The claims of owners can be realized only after outside ___________________
creditors' claims are satisfied. So equity represents the owners'
___________________
residual claim on business assets.

tio
___________________

Rules for Accounting Equation ___________________


Following rules help in making the accounting equation:

uc
___________________

i. Assets: If there is increase in assets, this increase is debited in ___________________


assets account. If there is decrease in assets, this decrease

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___________________
credited in assets account.
___________________
ii. Liabilities: When liabilities are increase, outsider’s equities
are credited and when liabilities are decreased, outsider’s
equities are debited.
ep
iii. Capital: When capital is increased, it is credited and when
capital is withdrawn, it is debited.
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iv. Expenses: Owner’s equity is decreased by the amount of


revenue expenses.
v. Income or profits: Owner’s equity is increased by the amount
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of revenue income.

Effect of Transactions on the Accounting Equation


You have learnt that assets, liabilities and capital are the three
No

basic elements of every business transaction, and their


relationship is expressed in the form of accounting equation which
always remains equal. At any point of time, there can be a change
in the individual asset, liability or capital, but the two side of the
S,

accounting equation always remain equal. Let us verify this fact by


taking up some transactions and see how these transactions affect
PE

the accounting equation:


Example
1. Mr. Kamlesh started business with cash of `2, 00,000.
U

In this transaction, one side cash is coming into business and


in the other side capital is being brought by Mr. Kamlesh.
(c)

Thus:
Business Accounting

ale
60
Capital = Assets (Cash)
Notes

___________________
` 2, 00,000 = ` 2, 00,000

n/S
___________________ 2. In the next transaction, if a plant of `50,000 is purchased in
cash, this transaction will also leave two sides. In one side
___________________
cash is going and in other side plant is coming. In this
___________________ situation, the accounting equation will be as follows:

tio
___________________
Capital = Plant + Cash (Assets)
___________________
` 2, 00,000 = ` 50,000 + ` (2, 00,000 – 50,000)

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___________________
3. If a loan of ` 1, 50,000 are taken from the SBI, it will also
___________________ affect the accounting equation by two sides. On one side, cash
___________________ will increase and on the other side, liabilities of the business

rod
will increase. This may be depicted as follows:
___________________
Capital + Liability (Loan) = Plant + Cash
` 2, 00,000 + 1, 50,000 = ` 50,000 + (1, 50,000 + 1, 50,000)
ep
` 3, 50,000 = ` 3, 50,000
4. If some goods of `20,000 are purchased on credit, it will also
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affect the accounting equation in two ways. On one side it


increases the goods and on the other side it increases the
liability (creditors). Now the changed form of the above
accounting equation will be as follows:
t fo

Capital + Liabilities = Assets


Capital + Loan + Creditors = Plant + Cash + Goods
` 2, 00,000 + 1, 50,000 + 20,000 = ` 50,000 + 3, 00,000 + 20,000
No

` 3, 70,000 = ` 3, 70,000

Check Your Progress


S,

Fill in the blanks


1. The basic accounting equation is the foundation for the
PE

...................... system.
2. A ..................... reports what a business owns (assets),
what it owes (liabilities) and what remains for the
U

owners (equity) as of a certain date.


3. An owner’s investment into the company will increase
(c)

the company’s assets and will also increase .....................


UNIT 4: Accounting Equation and Accounting Cycle

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Accounting Cycle 61
Notes
Activity
Accounting is described as origin for the creation of information Find out Describe how
___________________
and the continuous utility of information. Now the question is how technology has affected the

n/S
is this information created? For this, there is a step by step first___________________
three steps of the
accounting cycle.
process, as shown below. The major steps involved in the ___________________
accounting cycle are:
___________________
1. Analyse Transactions: The first step of an accounting cycle is

tio
___________________
to know what type of transaction we are dealing with; we also
need to verify that the information is correct and that ___________________

transactions have taken place only with proper authorization.

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___________________
Most accounting transactions originate with what are called
___________________
source documents, which are the invoices, invoices, orders, time

rod
cards, checks, and other “paperwork” (or now, commonly digital ___________________

files) which provide the first indication that a transaction has ___________________
taken place (or will be taking place in the future.)
2. Preparing Journals: The journal is the “book of original
ep
entry,” the place where the transactions first become part of
the official financial records of the organization. We make
journal entries which specify the accounts which are affected
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by a transaction, and the amount of money involved.


3. Post to Ledger A/c: The ledger is the entire group of accounts
maintained by an organization. Posting refers to the transfer
t fo

of the journal entries to the ledger. In a manual system,


posting was a separate process. In computerized systems,
posting is typically accomplished contemporaneously with
recording the transaction in the journal.
No

4. Preparation of Trial Balance: A trial balance is nothing


more than a summation of the account balances to be sure that
the books do, in fact, balance.
5. Prepare financial statements: After preparing the trial
S,

balance the next step is to prepare the financial statements


like income statement, balance sheet and cash flow statement.
PE

6. Post Closing Entries: Closing entries are the entries that we


make to close the temporary accounts (the expense and
revenue accounts). In manual systems, each closing entry had
to be made individually. In computerized systems, a single
U

command closes the books.


7. Preparation of Financial Statement: Last step includes
(c)

the preparation of Trading and Profit & Loss A/c and opening
and closing balance sheet.
Business Accounting

ale
62
The following figure explains the key steps of accounting cycle:
Notes

___________________

n/S
___________________

___________________

___________________

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___________________

___________________

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___________________

___________________

___________________

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___________________
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Figure 4.1: Accounting Cycle

What are the purposes of preparing financial statements?


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1. Accounting provides necessary information for decisions to be


taken initially and it facilitates the enterprise to pave way for
the implementation of actions
t fo

2. It exhibits the financial track path and the position of the


organization.
3. Being business in the dynamic environment, it is required to
face the ever changing environment. In order to meet the
No

needs of the ever changing environment, the policies are to be


formulated for the smooth conduct of the business.
4. It equips the management to discharge the obligations at
every moment.
S,

5. Obligations to customers, investors, employees, to


renovate/restructure and so on.
PE

Check Your Progress


Fill in the blanks:
U

1. Accounting Equation serves as a basis for preparing


....................................
(c)

2. Liabilities = ................... – Capital


UNIT 4: Accounting Equation and Accounting Cycle

ale
Account 63
Notes
Activity
An account is a statement in which the date wise details regarding
Differentiate between
___________________
the business transactions as persons, companies, representatives,

n/S
American Approach and
assets liabilities, income and expenditures and profit and loss are ___________________
English Approach.
given. ___________________

___________________
Kinds of Accounts

tio
For the purpose of ruling of debit and credit, under double entry ___________________

system the accounts are classified on the basis of two approaches. ___________________
These are:

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___________________
(a) American Approach ___________________

(b) English Approach

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___________________

___________________
Kinds of Accounts ep
American Approach English Approach

Assets Liabilities Revenue Expenses


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Account Account Account Account

Personal Accounts Real accounts Nominal Accounts


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(Persons, Companies, (Properties and (Incomes Gains,


firms & Representatives) Assets) Expenses & Losses

Figure 4.2: Chart of Classification of Accounts

(a) American Approach: As per this approach the accounts


No

relating to financial transactions are classified as follows:


i. Assets Accounts: Under this heading those transactions
are kept which are relating to the business assets as
plant, machinery, land, building, etc.
S,

ii. Liabilities Account: Under this heading those accounts are


kept which are relating to the credit purchases and
PE

outstanding expenses, loans, capital, etc.


iii. Revenue Accounts: Revenue accounts include the
transactions relating to income, commission, interest,
U

dividend, sales, etc.


iv. Expenses Accounts: These include those accounts which
(c)

are relating to the expenses of business as repairs, rent,


maintenance, insurance and lighting, etc.
Business Accounting

ale
64
(b) English Approach: Under this approach accounts are
Notes
classified into following three categories:
___________________
i. Personal Account: Here those accounts are included which

n/S
___________________
are relating to persons, firms, companies, representatives
___________________ and organizations as Shiam Lal & Company's Account,
___________________ etc.

tio
___________________ ii. Real Account: Accounts which are relating to the assets
and properties of the business are counted under this
___________________
heading. Assets can be real or intangible. Real assets are

uc
___________________
as land & buildings, plant & machinery, cash and stock,
___________________ etc. While intangible assets may be as goodwill, patents
___________________ and trademarks, etc.

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___________________ iii. Nominal Account: Accounts which are relating to the
revenues, incomes, expenses and losses of the business are
called nominal accounts. For example, rent, commission,
interest, dividend, etc.
ep
Check Your Progress
rR

Fill in the blanks:


1. …………………… is described as origin for the creation
of information and the continuous utility of information.
t fo

2. Under …………………… heading those transactions are


kept which are relating to the business assets as plant,
machinery, land, building, etc.
No

Summary
The recording of business transactions in the books of account is
based on a fundamental equation called Accounting Equation. This
equation expresses the equality of assets on the one side and other
S,

side equity
Expenses and Revenue also affect the accounting equation. Their
PE

effect is always on the capital account. The accounting equation is


also the basis for the most basic of accounting reports, the aptly
named Balance Sheet. A balance sheet reports what a business
U

owns (assets), what it owes (liabilities) and what remains for the
owners (equity) as of a certain date. Accounting is described as
(c)

origin for the creation of information and the continuous utility of


information.
UNIT 4: Accounting Equation and Accounting Cycle

ale
Lesson End Activity 65
Notes
“Accounting equation remains intact under all circumstances”
___________________
Justify the statement with the help of example.

n/S
___________________

Keywords ___________________

___________________
Accounting Equation: The recording of business transactions in

tio
the books of account is based on a fundamental equation called ___________________
Accounting Equation. ___________________
Asset: Any physical thing or right owned that has money value is

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___________________
an asset.
___________________
Liability: It means the amount which the firm owes to outsiders

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___________________
that is, accepting the proprietors.
___________________
Stock: The goods purchased are for selling, if the goods are not
sold out fully, a part of the total goods purchased is kept with the
trader unlit it is sold out, it is said to be a stock.
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Questions for Discussion
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1. “Accounting is described as origin for the creation of


information and the continuous utility of information.”
Discuss.
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2. Why accounting equation does remains in balance?


3. “Accounting is the process of recording, classifying and
summarizing of accounting transactions.” Discuss.
No

4. Prepare accounting equation from the following Transactions:


Hemant started business with cash `3, 00,000

Purchased goods for cash `80,000


S,

Sold goods [costing `30,000] for cash `45,000

Purchased goods from Monika `70,000


PE

Salary paid `7,000

Commission received `5,000


U

Paid Cash to Monika in full settlement `69,000

Goods sold to Rahul {Costing `20,000} for cash `25,000


(c)
Business Accounting

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66
5. Prepare accounting equation on the basis of the following:
Notes

___________________
i. Anup started business with cash `250,000

n/S
___________________ ii. Purchased goods for cash `35000

___________________ iii. Purchased office furniture for cash `12000

___________________ iv. Paid rent `7000

tio
___________________ v. Sold goods (costing `30000) for `50000 for cash
___________________ 6. Show the accounting equation on the basis of the following
transactions

uc
___________________

___________________ i. Manu started business


___________________ Cash `600000

rod
___________________ Goods `100000

ii. Purchased office machine for cash `90000


ep
iii. Sold goods (costing `60000) for credit to Asha

iv. Purchased building for cash `130000


rR

v. Cash received from Ashu ` 80000

vi. Purchased goods on credit to M/S Ashok Trader for cash


` 70000
t fo

vii. Salaries paid ` 000

viii. Insurance prepaid `10000

ix. Cash paid to M/s Ashok traders in full settlement `68000


No

Further Readings

Books
S,

T.S. Grewal, M.C. Shukla. “Advanced Accounts”. S. Chand, New


Delhi.
PE

R.L. Gupta, M. Radhaswami. “Advanced Accountancy”. Sultan


Chand, New Delhi.
Dr. S.N. Maheshwari, Sharad, K. Maheshwari. “Financial
U

Accounting”. Vikas Publishing Co. Pvt. Ltd., New Delhi.


Pandikumar, M. P (2007). “Management Accounting, Excel Books”.
(c)

New Delhi.
UNIT 4: Accounting Equation and Accounting Cycle

ale
Web Readings 67
Notes
http://www.dummies.com/how-to/content/the-eight-steps-of-the-
accounting-cycle.html ___________________

n/S
http://bizfinance.about.com/od/accountingandcash/tp/Accounting_C ___________________
ycle.htm ___________________

http://teachersites.schoolworld.com/webpages/LChytra/files/summa ___________________

tio
ry%20sheet%20of%20text1.pdf
___________________
http://www.life123.com/career-money/small-business/cpa/basic- ___________________
accounting-equation.shtml

uc
___________________

___________________

rod
___________________

ep ___________________
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(c)
Business Accounting

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68
Notes

___________________

n/S
___________________

___________________

___________________

tio
___________________

___________________

uc
___________________

___________________

___________________

rod
___________________
ep
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(c)
UNIT 5: Case Study

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Unit 5
69
Notes

Case Study
___________________

n/S
___________________

___________________
Objectives
___________________
After analyzing this case, the student will have an appreciation of the

tio
concept of topics studied in this Block. ___________________

___________________

uc
___________________
Case Study:Rule versus Principle
___________________
Students of accounting would be well aware of the long discussed
differences between rule-based accounting and principle-based

rod
___________________
accounting. Both have their protagonists. While the US GAAP is
___________________
rule-based, the International Accounting Standards (IAS), both as
IAS and IFRS, are principle-based.

The debate on which is better will be put to rest when the US


ep
GAAP converges with IFRS eventually and becomes principle-
based. Being principle-based means that broad principles are laid
out by the standard-fixing body and the interpretation is left to
rR

the users of these standards.

The problem (and also the benefit) with principle-based


accounting is that most of the times, in a situation which requires
t fo

a finding, one would have to exercise a great deal of judgment


based on substance as opposed to a readymade solution being
available for a particular issue prescribed in the rule-based
accounting.
No

While the US accounting is considered to be rule-based, one can


find echoes of principle-based accounting also in it. In the widely
publicised 1969 case of Continental Vending where the auditors
were questioned for lack of professional standards, the court gave
a direction to the jury to look at the facts and the substance of the
S,

case rather than rules of accountancy and mere adherence to


GAAP.
PE

The court held that in the audit report the statement “fairly
presented … in accordance with generally accepted accounting
principles” is two statements rather than one, i.e., “fairly
presented” are principle-based and the other “in accordance with
U

generally accepted accounting principles” is rule-based.


Contd…
(c)
Business Accounting

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70 Problems for Auditors
Notes
The preparation of financial statements in accordance with the
___________________ GAAP in a rule-based environment, however, presents problems
to the auditors. If an auditor were to confront the management

n/S
___________________
over a certain treatment of a transaction, the management is
___________________ likely to ask the auditor “show me where it says I can't do that”.
___________________ In other words, in a rule-based environment, the onus is on the

tio
___________________ auditor to demonstrate clearly that the particular treatment is
not permitted and hence closes the avenues for the auditor to
___________________
develop further arguments that would be available in a principle-
based accounting environment (Principles-based Accounting, by

uc
___________________
Ronald M. Mano, Matthew Mouritsen and Ryan Pace, published
___________________
in the CPA Journal, February 2006).
___________________

rod
Since accounting standards followed in India have their origin in
___________________ the IAS, the Indian accounting standards are principle-based.
However, there are exceptions to the rule. One prime example is
the Income Recognition and Asset Classification (IRAC) norms
prescribed by the Reserve Bank of India for provisioning for non-
ep
performing assets applicable to banks.

Thus, if any asset is non-performing, based on certain prescribed


rR

criteria, a provision is created for the potential loan loss


irrespective of the security available with the bank.

Subjectivity Issue
t fo

Principle-based accounting has its own issues too. Ian Wright,


Director of Corporate Reporting at the Financial Reporting
Council of UK, writing in accountancy magazine (October 2008),
talks about the subjectivity that is present in the IFRS.
No

The IFRS is full of words and phrases that are open to


interpretation. The accompanying table has a selection of the
probabilities in IFRS literature that a user is expected to
interpret in the context of understanding what an accounting
standard requires.
S,

Ian Wright also identifies other issues that are potentially


problematic.
PE

The IFRS literature contains an increasing range of technical


terms which don't translate well into languages other than
English. Also, the standards were written in different eras and
U

sometimes by individual national standard-setters due to which


the usage of the English language differs resulting in them being
structured in disparate ways.
(c)

Contd…
UNIT 5: Case Study

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71
One can therefore see the potential hazards in interpreting a
principle-based accounting standard that contains highly Notes

subjective phraseology. ___________________

n/S
In this context, one can expect problems of interpretation in India ___________________
also. For instance, the word “shall” (a key word in accounting
___________________
standards) is used in a manner that is completely different from
its usage in countries where English is the mother tongue. Any ___________________

tio
user of IFRS would therefore need to be alive to these issues when
___________________
interpreting IFRS.
___________________
Question

uc
___________________
Read the case carefully and write down the case facts. Also give a
brief overview of debate between GAAP converges with IFRS. ___________________

rod
Source: www.thehindubusinessline.com ___________________

ep ___________________
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No
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(c)
Business Accounting

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72
Notes

___________________

n/S
___________________

___________________

___________________

tio
___________________

___________________

uc
___________________

___________________

___________________

rod
___________________
ep
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No
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(c)
UNIT 6: Preparation of Journal, Ledger and Balancing

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73
Notes

___________________

n/S
___________________

___________________

___________________

tio
___________________

___________________

uc
___________________

___________________

rod
___________________

ep ___________________

BLOCK-II
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No
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(c)
Detailed Contents Business Accounting

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74
Notes
UNIT 6: PREPARATION OF JOURNAL, LEDGER
___________________ UNIT 8: TRIAL BALANCE
AND BALANCING
Introduction

n/S
z
z ___________________
Introduction
z Meaning of Trial Balance
z Books of Original Record
___________________
z Methods of Preparation of Trial Balance
z Ledger
___________________
z Types of Errors

tio
z Balancing
___________________
UNIT 9: FINANCIAL STATEMENTS
___________________
UNIT 7: SUBSIDIARY BOOKS
z Introduction

uc
z ___________________
Introduction z Meaning of Financial Statements
z Meaning of Subsidiary Books
___________________
z Final Accounts with Adjustments
z Cash Book
___________________ Balance Sheet

rod
z
z Other Subsidiary Books
___________________
UNIT 10: CASE STUDY
ep
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(c)
UNIT 6: Preparation of Journal, Ledger and Balancing

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Unit 6
75
Notes
Activity
What is the rule for posting the
Preparation of Journal, Ledger
___________________
debit account from the journal

n/S
into___________________
the ledger account?

and Balancing ___________________

___________________

tio
Objectives ___________________
After completion of this unit, the students will be aware of the following
___________________
topics:

uc
___________________
\ Books of Original Record
\ Ledger ___________________

\ Balancing

rod
___________________

___________________

Introduction
Journal is a book of accounts in which all day to day business
ep
transactions are recorded in a chronological order i.e. in the order
of their occurrence. Transactions when recorded in a Journal are
known as entries. It is the book in which transactions are recorded
rR

for the first time. Journal is also known as ‘Book of Original


Record’ or ‘Book of Primary Entry’.
The accounting process does not stop here. The transactions are
t fo

recorded in number of books in chronological order. Such recording


of business transactions serves little purpose of accounting. Items
of same title in different books of accounts need to be brought at
one place under one head called an account. There are numerous
No

account titles of items/ persons or accounts. All the accounts, if


brought in one account book, will be more informative and useful.
The account book so maintained is called Ledger.
S,

Books of Original Record


The accounting process includes the identification of financial
PE

transactions, recording of them and summarizing. Thus, after


identifying the financial nature items the first step of accounting process
is the recording the transactions. The books in which these transactions
U

are recorded first time are called the books of original entries or records.
These books of original records are divided into following three:
(c)

(a) Memorandum Book: It is also called the waste book. When a


transaction takes place in the business it is first roughly
Business Accounting

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76 written in the memorandum book chronologically for the
Notes memory only. Then after some time, these transactions are
___________________ recorded in the journal and subsidiary book. After recording
these transactions, this book is destroyed. Therefore, it is

n/S
___________________
called waste book.
___________________
(b) Journal: 'Journal' word is derived from French word 'Jour'
___________________
which means a day book. Journal is a primary book of original

tio
___________________ entries for accounting data. In the Journal the business
___________________ transactions are recorded chronologically that is called
Journalising. Thus the accounting data are recorded first time

uc
___________________
in this book. In the words of Carter, "A Journal, as originally
___________________
used, is a book of primary entry in which transactions are
___________________ copied in the order of date from a memorandum or waste book.

rod
___________________ The entries are then copied and classified into debts and
credits, so far to facilitate their being correctly posted
afterwards in the ledger". The proforma of a Journal is given
here under:
ep
Pro forma of a Journal
rR
t fo

As per the above pro forma of Journal the first column is kept for
date means date of transaction is recorded, second wide column for
particulars of business transactions in which the related accounts
No

are showed along with their narrations. Third column is for ledger
folio number where the journal entry is posted in ledger. The
fourth and fifth columns are kept for debit amount and credit
amount.
S,

At the time of Journalising of the transactions, when an account is


debited it is denoted by 'Dr.' and crediting of an account by 'To'.
PE

When a transaction is recorded first of all its two aspects


(accounts) are identified, those may of the same group (same type
of account) or different groups (different types of accounts). Then
the rules of debiting and crediting are applied. On the completion
U

of a page of the Journal it is totalled and the balance is carried


forward to the next page.
(c)
UNIT 6: Preparation of Journal, Ledger and Balancing

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77
Illustration 1 (Journal)
Notes
Journalise the following transactions in the books of Mr. Ram
___________________
Krishna:

n/S
___________________
2012 `
___________________
July 1 Mr. Ram Krishna Started business with cash 2, 00,000
July 4 Goods purchased in cash 20,000 ___________________

tio
July 5 He deposited in Bank 40,000
___________________
July 7 Goods sold 15,000
___________________
July 10 Goods purchased from Mr. Kamlesh on credit 25,000

uc
July 11 Furniture purchased 18,000 ___________________
July 12 Wages paid 4,000
___________________
July 20 Interest received 500

rod
July 25 Cash paid to Mr. Kamlesh 25,000 ___________________

July 30 Additional capital brought by Mr. Ram Krishna 50,000 ___________________

Solution

Journal of Mr. Ram Krishna


ep
Instruction: convert 2007 in to 2012
Date Particulars L.F. Amount Dr. Amount Cr.
` `
rR

2007
July 1 Cash Account Dr. 2,00,000
To Capital Account 2,00,000
(Being start of business by Mr. Ram Krishna)
July 4 Purchase Account Dr. 20,000
t fo

To Cash Account 20,000


(Being purchase of goods in cash)
July 5 Bank Account Dr. 40,000
To Cash Account 40,000
(Being deposit of cash into Bank)
July 7 Cash Account Dr. 15,000
To Sales Account 15,000
No

(Being sale of goods in cash)


July 10 Purchase Account Dr. 25,000
To Mr. Kamlesh 25,000
(Being purchase on credit from Mr. Kamlesh)

July 11 Furniture Account Dr. 18,000


S,

To Cash Account 18,000


(Being purchase of furniture)
July 12 Wage Account Dr. 8,000
To Cash Account 8,000
PE

(Being payment of wages in cash)


July 20 Cash Account Dr. 500
To Interest Account 500
(Being receipt of interest)
July 25 Mr. Kamlesh Dr. 25,000
To Cash Account 25,000
U

(Being payment of credit purchases)


July 30 Cash Account Dr. 50,000
To Capital Account 50,000
(c)

(Being introduction of additional


capital in business
Total 3,97,500 3,97,500
Business Accounting

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78
For the purpose of Journalising of the transactions, the goods are
Notes
classified into purchases, sales, purchase returns and sales
___________________
returns.

n/S
___________________
When some amount is brought into to start the business it is called
___________________ Capital. Therefore, such an amount is transferred to Capital
___________________ Account.

tio
___________________
Compound Journal Entry
___________________
When two or more transactions take place in the business relating
to a same account on the same date, in the place of passing many

uc
___________________

___________________ entries for the same account a single journal entry is pass which is
called a compound journal entry. Compound entry can be of
___________________

rod
following three types:
___________________
(a) Single debit account and more than one credit account
(b) Single credit account and more than one debit accounts
ep
(c) More than one debit account and more than one credit account

Opening Journal Entry


rR

The closing balances of accounts of one year are transferred to the


next year. In the next year these balances become the opening
balances. After recording the opening balances, the transactions of
the year are recorded. To record the opening balances a Journal
t fo

entry is passed which is called opening entry. Suppose in a


business there are closing balances of cash of `10,000, plant
`90,000 and capital of `1, 00,000, and then opening Journal entry
No

will be as follows:
Assets Account Dr. 90,000

Cash Account Dr. 10,000

To Capital Account 1, 00,000


S,

Subsidiary Books of Original Records


PE

If all the transactions of the business are recorded in Journal it


will be too bulky to manage. Therefore, now-a-days original records
are maintained in the subsidiary books. These subsidiary books are
also called sub-division of Journal. They are classified as follows:
U

(a) Cash Book or Journal: When it is the part of ledger it is


called cash account. In the cash book all the cash transactions
(c)

are directly recorded. As per Carter, "Cash book is a book of


UNIT 6: Preparation of Journal, Ledger and Balancing

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original entry, the object of which is to record all receipts and 79
payments of money". In the cash book all the cash receipts are Notes
recorded in the left hand sides and all the cash payments are ___________________
recorded in the right hand side. And the difference of these two

n/S
___________________
sides is called the closing balance of cash. Generally, four types
of cash book are prepared. These are: ___________________

i. Simple Cash Book or One Column Cash Book ___________________

tio
___________________
ii. Cash and Discount Cash Book or Double Column Cash
Book ___________________

uc
iii. Cash, Bank and Discount Cash Book or Three Column ___________________

Cash Book ___________________

iv. Petty Cash Book

rod
___________________

The pro forma of the simple cash book is given below: ___________________

Pro forma of a Simple Cash Book


ep
Date Particulars L.F. Amount Date Particulars L.F. Amount
` `
rR

(b) Special Journal: This journal is the part of general journal.


Under this division of Journal, the following Journals or books
t fo

are included:
i. Purchase Book is also known as Bought Book or Purchase-
Day Book. All the credit purchase of goods is recorded in
No

this book. In this book the data wise transactions of


purchase are recorded. This book has six columns. In the
first column the date of transaction is recorded, in second
column invoice number is mentioned, in third column
details of the transactions are kept, in the fourth column
S,

ledger folio number is given, and the last two columns are
left for amount in the transaction. The proforma of the
PE

purchase day book is given below:

Pro forma of Purchase Book


Date Invoice Particulars L.F. Details Amount
U

No. ` `
(c)
Business Accounting

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80
ii. Sales Book is known by the different names as Sales-Day-
Notes
Book, or Sales Journal. In this book all the credit sales of
___________________
goods are recorded. At the time of sale of goods an invoice

n/S
___________________ is prepared. On the basis of this invoice, all the credit
___________________ sales are recorded in this book. The sale of others except
goods is recorded in the Journal Proper. Its columns are
___________________
similar to that of the Purchase book. It is given below:

tio
___________________
Pro forma of Sales Book
___________________
Date Invoice Particulars L.F. Details Amount
No. ` `

uc
___________________

___________________

___________________

rod
___________________
iii. Purchase Return Book is also called Purchase Return
Journal or Return Outward Book. In this book those goods
are entered which are returned to the suppliers. If the
ep
goods were purchased in cash and returned, then such
goods are not entered in this book. Entry for such goods is
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done in these books which were purchased on credit.


When the goods are returned to the supplier, along with
the goods a note is also sent to the supplier which carries
all the details of the goods returned, such a note is called
t fo

Debit note. It is prepared in duplicate copy. One copy is


sent to the supplier and one copy is kept safe for future
reference. This note in the hands of seller is called credit
note. In other words purchaser will dispatch a debit note
No

to the seller and seller will send a credit note to


purchaser.
S,

Pro forma of Purchase Return Book


PE

Date Debit Note Particulars L.F. Details Amount


No. ` `
U

iv. Sales Return Book is known as Sales Return Journal or


Return Inwards Book. In the case of goods sold on credit
(c)

some goods are being returned by the customers, such


goods are recorded in this book. Here same columns are
UNIT 6: Preparation of Journal, Ledger and Balancing

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maintained as in the Purchase Return Book except Debit 81
Note No. In the place of debit note no., credit note no. is Notes
given in this book. ___________________

n/S
When some goods are returned by the customer, a note is ___________________
provided to them which is called credit note. Credit note
___________________
means that his account has been credited with the amount
of goods return. This credit note works as a debit note for ___________________

tio
the party receiving back the goods. The customers debits ___________________
the account of that party from whom it has been received. ___________________
Thus

uc
___________________

___________________

rod
___________________
Pro forma of Sales Return Book
___________________
Date Credit Particulars L.F. Details Amount
Note No. ` `
ep
v. Bills Receivable Book is also called the Bills Receivable
rR

Journal. When a company receives various bills from its


debtors, details of all these bills are date wise recorded in
the Bills Receivable Book. The proforma of this book is
given below:
t fo

Pro forma of Bills Receivable Book


S.No. Date From whom Date of Period Due Date L.F. Amount
received Bill `
No

vi. Bills Payable Book is also known as Bills Payable Journal.


When the various bills are accepted for its various
creditors, details of such bills are recorded in this book in
S,

chronological order. The proforma of this book is given


below:
PE

Pro forma of Bills Payable Book


S.No. Date From whom given Date of Period Due Date L.F. Amount
Bill `
U
(c)
Business Accounting

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82
c. Journal Proper: According to the rules of accounting, all the
Notes
business transactions are recorded into Journal first, and then
___________________
they are posted in Ledger. If all the credit and cash

n/S
___________________ transactions are recorded into Journal, there will be a large
___________________ number of transactions and it will become too bulky.
Therefore, Journal is sub-divided into cash and credit
___________________
transactions. Cash transactions are directly recorded into cash

tio
___________________ book and credit sales and credit purchase are directly recorded
___________________ in the sales and purchase books and the remaining
transactions are recorded into Journal Proper. These

uc
___________________
transactions may be relating to:
___________________
i. Opening Entry
___________________

rod
ii. Closing Entry
___________________
iii. Transferring
iv. Rectification, and
ep
v. Adjustment
d. Other Subsidiary Books: As per the nature of the business,
rR

the entrepreneurs may maintain some other books also. These


may be:
i. Consignment Outwards Book
t fo

ii. Sale and Return Book


iii. Cash Collection Book
iv. Cash Sales Book.
No

Journalising can be generally categorized into following various


categories:
1. Taking place within the same natured accounts
S,

2. Taking part in between accounts of two different in categories.


Illustration 2 (Subsidiary Books)
PE

Record the following transactions into various Subsidiary Books


and Journal Proper of Mr. Shiv Kumar:
2012
U

January 1 Cash in hand `31,400, Cash at Bank ` 50,800 and Capital Account
`82,200.
(c)

January 2 Bought goods for cash `8,200.


UNIT 6: Preparation of Journal, Ledger and Balancing

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83
January 5 Purchased goods from Lalit Mohan & Co. for `11,600 less 10% trade
discount. Notes
January 7 Sold goods to Shobhit & Co. for `17,800 less 20% trade discount. ___________________

n/S
January 9 Withdrew `1,000 from bank for private use.
___________________
January 12 Sold goods to Karim for `12,800.
___________________
January 15 `10,000 paid to Lalit Mohan in full settlement of their claim.
January 18 Goods worth `800 returned by Karim. ___________________

tio
January 20 Received `8,000 from Karim ___________________
January 21 Purchased goods from Krishna & Co. for `17,400. ___________________
January 23 `12,000 paid to Krishna & Co. by cheque, discount allowed `600.

uc
___________________
January 24 Purchased furniture for `1,600 from Sardar Furniture House on
credit. ___________________
January 26 Paid into bank `4,400.

rod
___________________
January 28 Karim declared insolvent, a first and final dividend of 50 paise in a
rupee is received from him. ___________________
January 29 Goods worth `1,200 returned to Krishna & Co.
January 31 Interest on capital provided `822.
ep
January 31 Goods worth `800 taken by Mr. Shiv Kumar for his personal use.
January 31 Paid salaries to staff `3,600.
January 31 Paid into bank `40,000.
rR

January 31 Bought 200 shares in Dehradun Chemicals Ltd. at ` 11, per share
Brokerage paid `50.
January 31 Received `11,800 from Shobhit & Co. discount allowed ` 200.

Solution
t fo

Journal Proper
Instruction: Change 2008 to 2012
Date Particulars L.F. Amount Amount
(Dr.) (Cr.)
No

2008 ` `
January 01 Cash Account Dr. 31,400
Bank Account Dr. 50,800
To Capital Account 82,200
(Entry made for opening balances)
January 24 Furniture Account Dr. 1,600
To Sardar Furniture House 1,600
S,

(Being purchase of furniture on credit from


Sardar Furniture House)

January 28 Bad Debts Account Dr. 2,000


To Karim 2,000
(On the insolvency of Karim 50 paise in a
PE

rupee received and balance treated as bad


debts)
January 31 Interest on Capital Account Dr. 822
To Capital Account 822
(Interest on capital charged)
January 31 Drawing Account Dr. 800
U

To purchase Account 800


(Proprietor took goods for personal use)
January 31 Capital Account Dr. 1,800
To Drawing Account 1,800
(c)

(Balance of drawing account transferred to


Capital account)

Total 89,222 89,222


Business Accounting

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84 Sales Book
Notes Date Particulars L.F. Details Amount
` `
___________________

n/S
___________________ 2008
Jan. 7 Shobhit & Co.: Sale of goods 17,800
___________________ (–) 20% discount 3,560 14,240
Jan. 12 Karim: Sale of goods 12,800
___________________
Jan. 31 Total: Sale – Credit balance 27,040

tio
___________________
Purchase Book
___________________
Date Particulars L.F. Details Amount
` `

uc
___________________

___________________
2008
___________________ Jan. 5 Lalit Mohan & Co.: Goods purchased 11,600

rod
(-) 10% Discount 1,160 10,440
___________________ Jan. 21 Krishna & Co. 17,400
Jan. 31 Total: Purchases debited 27,840

Sales Return Book


ep
Date Particulars L.F. Details Amount
` `

2008
Jan. 18 Karim: Sales return 800
rR

Jan. 31 Sales Return debited 800

Purchase Return Book


Date Particulars L.F. Details Amount
` `
t fo

2008
Jan. 29 Krishna & Co.: Returns 1,200
Jan. 31 Purchase Returns Credited 1,200

Cash Book
No

Date Particulars L.F. Discount Cash Bank Date Particulars L.F. Discount Cash Bank
` ` ` ` ` `

2008 2008
Jan 1 To balance - 31,400 50,800 Jan 2 By Purchases A/c - 8,200 -
b/d - Jan 9 By Drawings A/c - - 1,000
Jan 20 To Karim - 8,000 Jan 15 By Lalit Mohan 440 10,000 -
S,

Jan 26 To cash A/c c - - 4,400 Jan 23 By Krishna & Co. 600 - 12,000
Jan 28 To Karim - 2,000 - Jan 26 By Bank A/c c 4,400
Jan 31 To sales A/c - 43,600 Jan 31 By Advertisement A/c - - 1,000
Jan 31 To cash c - - 40,000 Jan 31 By Salaries A/c - 3,600 -
Jan 31 To Shobhit & 200 11,800 Jan 31 By Bank A/c - 40,000
Co. Jan 31 By Investment A/c c - 2,250 -
PE

Jan 31 By Balance C/d - 28,350 81,200


200 96,800 95,200 1,040 96,800 95,200
Feb 1 To balance 28,350 81,200
b/d

The points to be observed at the moment of journalizing:


U

1. The nature of the accounts to be identified


2. The accounts to be correlated to the golden rules
(c)

3. The entry to be passed through proper debiting and crediting


of the accounts respectively.
UNIT 6: Preparation of Journal, Ledger and Balancing

ale
85
Check Your Progress
Notes
Activity
Fill in the blanks:
What are the key steps in
___________________
1. Journalising is the process of entering transactions in

n/S
balancing a ledger a/c?
___________________
.....................
___________________
2. Another name for Journal is .....................
___________________
3. Transactions, when recorded in Journal, are known as

tio
___________________
.....................
___________________
4. The explanation of a Journal entry is known as

uc
..................... ___________________

___________________
5. In a Journal entry preposition ..................... is used
before the name of the account to be credited.

rod
___________________

6. Journal is a ………………… of original entries for ___________________


accounting data.
7. The journal is known as the ………………… .
ep
8. The process of transferring the entries from Journal to
Ledger accounts is called ………………
rR

Ledger
Journal of a business is very useful but it does not reply the
t fo

different queries as how much amount is due from debtors, how


much is to be paid to creditors and what is the balance of a
particular account etc. For the reply of all these queries the ledger
is prepared from the Journal entries. Ledger is the set of accounts
No

in which all types of account (personal, real or nominal) are kept.


There can be two forms of ledger:
(a) Bound Ledger
(b) Loose Leaf Ledger
S,

Posting
PE

The process of transferring the entries from Journal to Ledger


accounts is called posting. In other words account wise selection of
debit or credit items and recording them into the relevant side of
the relevant account is called posting. The process of posting is
U

done after a period as week, fortnight or a month. For example, if


rent as an expense is shown in the debit in Journal, this will be
(c)

posted in the debit side of the Rent (Expenses) A/c in the Journal.
The proforma of a Ledger account is given below:
Business Accounting

ale
86 Proforma of An Account
Notes Name of Account………

___________________ Date Particulars L.F. Amount Date Particular L.F. Amount


(Dr.) ` (Cr.) `

n/S
___________________

___________________

___________________
In the above proforma of an account, there are two sides of an

tio
___________________
account. Left hand side is debit side and right hand side is credit
___________________ side. In both the sides, the first column is for date and second
column for details, third column for the Journal folio number and

uc
___________________
in the last column the amount of the transaction is recorded.
___________________

___________________ Rules of Posting in Ledger Account

rod
___________________ At the time of posting of transactions from Journal to ledger the
following points/rules should be kept in mind:
1. In the debit side of a ledger account, the word 'To' be used
ep
while in the credit side word 'By' is used.
2. All those accounts are opened in the Ledger which is given in
the Journal.
rR

3. All the debit items of an account given in Journal are posted in


the debit side of the respective account. And all the credit
items of an account given in Journal are posted in the credit
t fo

side of the respective account in ledger.


4. The name of the account, in which posting is being made, is
not written. But the posting is done by the name of other
No

account given in the opposite side of that entry in the Journal.


5. At the time of posting if the page is full and account is not
complete, its total is carried to the next page and then
remaining posting is done.
S,

Check Your Progress


Fill in the blanks:
PE

1. Ledger contains various ...................... in it.


2. The process of transfer of entries from Journal and
U

special purpose books to ledger is called......................


3. Ledger is also called......................
(c)
UNIT 6: Preparation of Journal, Ledger and Balancing

ale
Balancing 87
Notes
Activity
There can be several transactions relating to a particular account
Identify nature
___________________of the
in the different places in the Journal. Such transactions are

n/S
transactions:
collected and recorded in the concerned account. At the end of the ___________________
Ramchander has purchased
accounting period, the businessman becomes interested to know goods on credit from M/s
___________________
the position of these accounts. The position of an account is Royals Aventis for `15,000.
determined by calculating the net balance of the account for which The___________________
portions of the goods

tio
were___________________
found to be damaged
debit and credit sides of the account are totalled separately. If total which worth of `5,000.
of debit side is greater than the total of credit side, difference is ___________________
Ramchander immediately
written in the credit side of the account and that is carried to next returned the damaged goods

uc
___________________
to Royals. Identify the various
year. And if the total of credit side is greater than the total of debit
ypes___________________
of accounts involved in
side, difference is written in debit side and carried to next year. the above illustrated
Thus totals of both the sides become equal and account is closed.

rod
___________________
transactions. Pass the journal
entries with regards to the
___________________
Balancing of Different types of Accounts nature of accounts involved.

Assets: All asset accounts are balanced. These accounts always


ep
have a debit balance.
Liabilities: All Liability accounts are balanced. All these accounts
have a credit balance.
rR

Capital: This account is always balanced and usually has a credit


balance.
Expense and Revenues: These Accounts are not balanced but are
t fo

simply totalled up. The debit total of Expense/Loss will show the
expense/Loss. In the same manner, credit total of Revenue/
Income will show increase in income. At the time of preparing the
No

Trial Balance, the totals of these are taken to the Trial Balance.
Illustration 3 (Journal and Posting in Ledger)
Record the following transactions in the Journal and post them
into Ledger of Mr. Aditya Raj:
S,

2012 `
March 1 Purchase of Goods from Ramautar 3,20,000
PE

March 10 Paid Rent for the month 2,000


March 11 Purchase of Plant 1,00,000
March 12 Paid Salaries 12,000
March 15 Paid Ramautar 1,00,000
U

March 20 Sold Goods to Shyam 20,000


March 25 Received from Shyam 30,000
(c)

March 31 Reserved Cash from Cash Sales 2,50,000


March 31 Wages Paid 5,000
Business Accounting

ale
88
Solution:
Notes

___________________
Change all 2008 to 2012

n/S
___________________ Journal of Mr. Aditya Raj
Date Particulars L.F. Amount (Dr.) Amount (Cr.)
___________________ ` `

___________________
2008

tio
___________________ March 1 Purchase Account Dr. 3,20,000
To Ramautar 3,20,000
___________________ (Being purchase of goods on credit)
March 10 Rent Account Dr. 2,000

uc
___________________
To Cash Account 2,000
___________________ (Being payment of rent)
March 11 Plant Account Dr. 1,00,000
___________________

rod
To Cash Account 1,00,000
(Being purchase of plant)
___________________
March 12 Salaries Account Dr. 12,000
To Cash Account 12,000
(Being payment of salaries)
ep
March 15 Ramautar Dr. 1,00,000
To Cash Account 1,00,000
(Being payment to Ramautar)
March 20 Shyam Dr. 20,000
rR

To Sales Account 20,000


(Being goods sold on credit)
March 25 Cash Account Dr. 30,000
To Shyam 30,000
t fo

(Being receipts of cash)


March 31 Cash Account Dr. 2,50,000
To Sales Account 2,50,000
(Being goods sold in cash)
March 31 Wages Account Dr. 5,000
No

To Cash Account 5,000


(Being payment of wages)

Total 8,39,000 8,39,000

Ledger
S,

Cash Account
Date Particulars L.F. Debit Date Particulars L.F. Credit
` `
PE

2008 2008
March 25 To Shyam 30,000 March 10 By Rent A/c 2,000
March 31 To Sales A/c 2,50,000 March 11 By Plant A/c 1,00,000
March 12 By Salaries A/c 12,000
March 15 By Ramautar 1,00,000
U

March 31 By Wages 5,000


March 31 By Balance c/d 61,000
2,80,000 2,80,000
(c)

2008
April 1 To Balance b/d 61,000
UNIT 6: Preparation of Journal, Ledger and Balancing

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Purchase Account 89
2008 ` 2008 ` Notes
March 1 To Ramautar 3,20,000 March 31 By Balance c/d 3,20,000
3,20,000 3,20,000 ___________________

n/S
___________________
2008
April 1 To Balance b/d 3,20,000
___________________
Ramautar's Account ___________________

tio
2008 ` 2008 `
___________________
March 15 To Cash A/c 1,00, 000 March 1 By Purchase 3,20,000

March 31 To Balance c/d 2,20,000 A/c ___________________


3,20,000 3,20,000

uc
___________________
April 1
By Balance b/d 2,20,000
___________________
Rent Account

rod
___________________
2008 ` 2008 `
___________________
March 10 To Cash A/c 2,000 March 31 By Balance c/d 2,000
2,000 2,000

2008
ep
April 1 To Balance 2,000
b/d

Plant Account
rR

2008 ` 2008 `

March 11 To Cash A/c 1,00,000 March 31 By Balance c/d 1,00,000


1,00,000 1,00,000

2008
t fo

April 1 To Balance b/d 1,00,000

Salaries Account

2008 ` 2008 `
No

March 12 To Cash A/c 12,000 March 31 By Balance c/d 12,000


12,000 12,000

2008
April 1 To Balance b/d 12,000
S,

Shyam's Account

2008 ` 2008 `
PE

March 20 To Sales A/c 20,000 March 31 By Balance c/d 30,000

March 31 To Balance b/d 10,000


30,000 30,000

April 1 By Balance b/d 10,000


U
(c)
Business Accounting

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90 Sales Account
Notes ` `
2008 2008
March 1 To Balance b/d 2,70,000 March 20 By Shyam 20,000
___________________
March 31 By Cash A/c 2,50,000

n/S
___________________ 2,70,000 2,70,000

April 1 By Balance b/d 2,70,000


___________________

___________________ Wages Account

tio
2008 ` 2008 `
___________________
March 31 To Cash A/c 5,000 March 31 By Balance c/d 5,000
___________________ 5,000 5,000

uc
___________________
2008
April 1 To Balance b/d 5,000
___________________

___________________
Check Your Progress

rod
___________________
Fill in the blanks:
1. Ledger is a ...................... book of accounting system.
ep
2. Classification of transactions is being done only on the
basis of preparing the......................
rR

Summary
Journal is the first book of the original entries in which all the
business transactions of the financial nature are recorded, then
t fo

posted to ledger accounts. Subsidiary Books of Original Entries are


classified into - Cash Book, Special Journal, Journal Proper and
Others. Posting is the process of selecting of transactions from
Journal on the basis of accounts and writing them into ledger
No

accounts.
To test the arithmetical accuracy of the ledger accounts, the Trial
Balance is prepared. Trial Balance is the list of accounts taken
from ledger. Ledger is nothing but preliminary book of accounting
S,

transactions at which, each account is separately maintained


through the allotment of various pages for exclusive recording.
PE

Posting is the process of selecting of transactions from Journal on


the basis of accounts and writing them into ledger accounts.
U

Lesson End Activity


Visit this site http://college.cengage.com/accounting/mcquaig/
(c)

college _acc/8e/students/demo/ch03.pdfand provide a solution to the


G. Bell fitness center.
UNIT 6: Preparation of Journal, Ledger and Balancing

ale
Keywords 91
Notes
Process of Accounting: It includes the recording of transactions
___________________
into Journal, classifying into Ledger and summarizing into Trial

n/S
Balance and Final Accounts. ___________________

Double Entry System: Accounting which is based on the two ___________________

aspects of the transactions. ___________________

tio
Personal A/cs.: Accounts which are related to person, firms, ___________________
companies and representatives. ___________________
Real A/cs: All the assets accounts are included into it.

uc
___________________

Nominal A/cs.: Accounts of incomes, expenses and gains or losses. ___________________

Debit: Receiver in Personal Account, Coming Assets in Real

rod
___________________
Account and Expenses in Nominal Accounts. ___________________
Credit: Giver in Personal Account, Going assets in Real Accounts
and Incomes in Nominal Accounts.
ep
Journal: The primary book in which the transactions are recorded
first time.
rR

Ledger: It is the classification of accounts in which various


accounts are maintained.

Questions for Discussion


t fo

1. What do you mean by Posting? Give the rules of posting.


2. State the relation between journalizing and ledger posting
with suitable examples.
No

3. Why is ledger known as the primary book or the principal -


book of accounts? Can profit of the business and its financial
position be known without maintaining ledger?
S,

4. Why is ledger prepared?


5. Enumerate the various types of ledgers which may be
PE

maintained by a business.
6. Mr. Kamal Nath was doing a business as a cloth merchant. On
1st July, 2012 his assets were : Furniture and Office
U

Equipment = `12,500, Stock `1,25,000 Cash in Hand `3,000,


Bank Balance `42,500, Amounts due from Brijesh `6,000,
(c)

Amount due from Girijesh `7,500. On the date he owed


`10,000 to Manish and `7,250 to Naresh. His transactions
Business Accounting

ale
92 during the month were as follows. You have to Journalise
Notes these transactions and from that information prepare his
___________________ Ledger.
2012 `

n/S
___________________
July 2 Sold cloth on credit to Xavier 2,500
___________________ July 3 Purchased cloth from Yogesh 10,000
July 4 Paid Rent by cheque 4,000
___________________
July 5 Purchase of cloth by cheque 10,000

tio
___________________ July 7 Cash sales 2,250
July 8 Received cheque from Brijesh 5,900
___________________ allowed him discount 100
July 9 Paid for stationery 250

uc
___________________
July 10 Drawn cash for private use 1,250
___________________ July 11 Purchased cloth on credit from Manish 12,500
July 12 Sent cheque to Manish (in full settlement for July
___________________

rod
1 transactions) 9,750
___________________ July 13 Sold cloth on credit to Girijesh 9,000
July 14 Paid telephone charges 400
July 15 Cash Sales 1,500
July 18 Paid for Advertisement 1,750
ep
July 19 Cash Purchases 3,000
July 30 Paid Salaries for July
4,000
rR

7. Prepare the account of X & Co. from the following:


2012 `
Feb 1 Balance due from X & Co. 1,000
Feb 3 Cash sales to X & Co. 700
t fo

Feb 4 Bought furniture from X & Co. 250


Feb 6 Murthy returned goods to us 200
Feb 9 X & Co. Purchased goods from us 1,200
Feb 10 Return of goods from X & Co. 150
No

Feb 20 X & Co. settled his account by cheque and received discount 20

8. How do we balance the following types of accounts?


(a) Assets
S,

(b) Expense
(c) Capital
PE

(d) Revenue

Further Readings
U

Books
(c)

T.S. Grewal, M.C. Shukla. “Advanced Accounts”. S. Chand, New


Delhi.
UNIT 6: Preparation of Journal, Ledger and Balancing

ale
93
R.L. Gupta, M. Radhaswami. “Advanced Accountancy”. Sultan
Notes
Chand, New Delhi.
___________________
Dr. S.N. Maheshwari, Sharad, K. Maheshwari. “Financial

n/S
Accounting”. Vikas Publishing Co. Pvt. Ltd., New Delhi. ___________________

___________________
Pandikumar, M. P (2007). “Management Accounting, Excel Books”.
New Delhi. ___________________

tio
___________________
Web Readings
___________________
http://www.kkhsou.in/main/EVidya2/BPP%20Commerce%20Rerint

uc
ed/journal.html ___________________

___________________
http://www.futureaccountant.com/accounting-process/study-
notes/ledger-preparation-balancing-illustration.php

rod
___________________

http://college.cengage.com/accounting/mcquaig/college_acc/8e/stude ___________________
nts/demo/ch03.pdf
http://www.theglobaltutors.com/financial-accounting/book-keeping-
ep
preparation-of-journals-ledger-accounts-and-trial-balance.aspx
rR
t fo
No
S,
U PE
(c)
Business Accounting

ale
94
Notes

___________________

n/S
___________________

___________________

___________________

tio
___________________

___________________

uc
___________________

___________________

___________________

rod
___________________
ep
rR
t fo
No
S,
U PE
(c)
UNIT 7: Subsidiary Books

ale
Unit 7
95
Notes
Activity

Subsidiary Books
Make the proforma
___________________ of

n/S
purchase return book and
___________________
sales return book and explain
it.
___________________
Objectives
___________________
After completion of this unit, the students will be aware of the following

tio
topics: ___________________

\ Meaning of Subsidiary Books ___________________


\ Cash Book

uc
___________________
\ Other Subsidiary Books
___________________

rod
___________________
Introduction
___________________
Before we list various books into which the journal is sub-divided,
let us understand the’ basis for its subdivision. You may adopt any
ep
basis. But, the principle generally followed is that transactions of
the same nature are to be recorded at one place. For example, the
cash receipts and cash payments may be grouped into one category
rR

and recorded in a separate book. Similarly, all credit purchases of


goods may be grouped into one category, all credit sales of goods
into another category and recorded in separate books.
t fo

Meaning of Subsidiary Books


In the past, traders use to keep record of the transaction in the
journal. But it was later found not convenient. If all the
No

transaction is recorded in the journal then the journal book


becomes more thick and difficult to handle it. In big business
houses, it becomes impossible to carry on the work of recording
business transaction. Therefore now a day’s large scale business
S,

firms like to keep record of transaction in subsidiary books instead


of journal. Subsidiary books are the book of original entry and it is
PE

also called primary records because the first entry of transaction is


made in subsidiary books. Subsidiary Books refers to books meant
for specific transactions of similar nature. Subsidiary Books are
also known as Special journals or day books. To overcome
U

shortcoming of the use of the journal only as a book of original


entry, the journal is subdivided into specific journals or subsidiary
(c)

books. In practice, the journal is sub-divided in such a way that a


separate book is used for each category of transactions which are
Business Accounting

ale
96 repetitive in nature and are sufficiently large in number. In any
Notes large business the following subsidiary books are generally used.
___________________
1. Cash Book: It is used for recording all receipts and payments

n/S
___________________ of cash, including cash purchases and cash sales of goods.
___________________ 2. Purchases Journal: It is used for recording credit purchases
___________________ of goods only.

tio
___________________ 3. Purchases Returns Journal: It is used for recording goods
returned to suppliers.
___________________
4. Sales Journal: It is used for recording credit sales of goods

uc
___________________
only.
___________________
5. Sales Returns Journal: It is used for recording goods
___________________

rod
returned by the customers.
___________________
6. Bills Receivable Journal: It is used for recording bills of
exchange and promissory notes received from the debtors.
ep
7. Bills Payable Journal: It is used for recording bills of
exchange and promissory notes accepted by the business in
favour of creditors.
rR

8. Journal Proper: This book is used for recording all such


transactions which are not covered by any of the above
mentioned special journals, for example, credit purchases of
t fo

fixed assets, opening entry, rectification entries, etc.


It must, however, be noted that there is no rigidity as to the
number of special journals. Depending on the necessity, the
number of journals may be increased or decreased.
No

9. Non-cash transaction: A Non-cash transaction is a


transaction in terms of credit and conditions of the enterprise.
The Non-cash transactions shall include the following transactions
of the enterprise, which do not involve any cash; they are as
S,

follows:
PE

1. Credit sales Book


2. Credit purchases Book
3. Credit Sales Return Book
U

4. Credit Purchases Return Book


(c)

5. Bills Payable Book- Outcome of Credit transaction, and


6. Bill Receivable Book - Outcome of Credit transaction
UNIT 7: Subsidiary Books

ale
Advantages of Subsidiary Books 97
Notes
The following are the advantages of having a number of subsidiary Activity
books: Prepare a Cash Book with
___________________

n/S
Bank column only:
i. Classification of transactions becomes automatic: As ___________________
Change 2009 to 2012
there is a separate book for each type of transactions, the ___________________
transactions of same nature are automatically brought at one
___________________
place. For example, all credit purchases of goods are recorded

tio
Subsidiary Books: Cash Book in the Purchases Book. ___________________

___________________
ii. Reference becomes easy: If any reference is required, it can

uc
be traced easily by referring to the appropriate subsidiary Hint:___________________
Total of Cash Book
book. You do not have to go through all the transactions ` 24,700, Closing Balance
___________________
` 16,400.
recorded in the journal.

rod
___________________
iii. Facilitates division of work: The division of journal into
___________________
various subsidiary books facilitates division of work among
many persons. This, in turn, facilitates prompt recording of
transactions and saves a lot of time.
ep
iv. More particulars: More details about the transactions can be
given-in subsidiary books than would be possible in one book.
rR

v. Responsibility can be fixed: The work of maintaining a


particular book can be entrusted to a particular person. He
will be responsible for keeping it up-to-date and in order.
t fo

vi. Facilitates checking: When the Trial Balance does not


agree, the location of errors will be relatively easy.

Check Your Progress


No

Fill in the blanks:


1. ……………….. is used for recording all receipts and
payments of cash, including cash purchases and cash
sales of goods.
S,

2. A ……………….. is a transaction in terms of credit and


conditions of the enterprise.
PE

Cash Book
U

Having outlined various subsidiary books, we shall now discuss the


most important subsidiary book called 'Cash Book'. Cash book is
(c)

the book of accounts where most of the transactions are generally


related with the receipts and payment of cash. It may be either
Business Accounting

ale
98 purchase of goods for cash or sale of goods for cash or it may be
Notes either payment of expenses or receipts of income. In any business
___________________ there would be numerous cash transactions which involve either
receipts or payments of cash. Cash sales, receipt of cash from

n/S
___________________
debtors, cash purchases, and payments to creditors, payment of
___________________
various expenses such as salaries, wages, rent, taxes, etc., are
___________________ some examples of transactions involving cash. AU these are

tio
___________________ recorded in cash book, receipts on one side and payments on the
other.
___________________
‘Every business unit, small or big, maintains a cash book. It

uc
___________________
enables the businessman to know and verify the amount of cash in
___________________
hand from time to time. As a matter of fact, cash book plays a dual
___________________ role. It is a book of prime entry and also serves the purpose of a

rod
___________________ Cash Account. It is designed in the form of a ledger account and
records cash receipts on the debit side and payments on credit side.
It is also balanced in the same way. Hence, when cash book is
maintained, there is no need to have a Cash Account in the ledger.
ep
Kinds of Cash Book
rR

There are different types of cash books maintained by the business.


They are:
1. Simple or Single Column Cash Book
t fo

2. Two or Double Column Cash Book


3. Three or Triple Column Cash Book
4. Petty Cash Book
No

We shall now consider them one by one and learn how they are
prepared and posted into ledger.

Single Column Cash Book


S,

Look at the pro forma of a Single Column Cash Book shown in


table 7.1 Doesn't it look like a ledger account? Yes, it does. In fact a
Single Column Cash Book is nothing but a Cash Account. It is used
PE

for recording all cash receipts and cash payments and serves the
purpose of Cash Account as well. It is called Single Column Cash
Book just because it has only one amount column on each side.
U
(c)
UNIT 7: Subsidiary Books

ale
Table 7.1: Single Column Cash Book 99
Dr. Cr. Notes
Date Particulars L.F. Amount Date Particulars L.F. Amount
(Receipts) (`) (Payments) (`) ___________________

n/S
___________________

___________________

___________________

tio
___________________

Note: ___________________

1. c/d stands for Carried Down whereas b/d stands for Brought

uc
___________________
Down. ___________________
2. One thing which is very important to remember while

rod
___________________
recording a transaction in the Cash Book is that no distinction
___________________
is adopted about capital or revenue nature of transactions i.e.,
all the transactions are recorded in the Cash Book.
ep
Recording in Single Column Cash Book
You know that Cash Account is a real account. According to rules,
rR

Cash Account is to be debited when cash is received and credited


when cash is paid. Hence, the debit side of the cash book is used for
recording all cash receipts and the credit side for all cash
payments. Let us now discuss how entries are made in this book.
t fo

As explained above, whenever cash is received, it is to be recorded


on the debit side. The date on which it is received is recorded in the
date column. The name of the account from which it is received is
mentioned in the particulars column. In the L.F. (Ledger Folio)
No

column the page number of the account in the ledger, where the
posting is made, is to be recorded at the time of posting. The
amount column is meant for recording the amount received.
Similarly, whenever cash is paid, it is recorded on the credit side.
S,

Here, in particulars column we write the name of the party to


whom payment is made, and complete the other columns in the
PE

same manner as on the debit side.

Posting the Single Column Cash Book


U

As said earlier, Cash Book also serves the purpose of a Cash


Account, so there is no need to open a Cash Account in the ledger.
(c)

When a cash transaction is recorded in the cash book, posting of


the cash aspect of the transaction in Cash Account stands fully
Business Accounting

ale
100 covered. What remains to be posted is the other aspect of the
Notes transaction. The posting of this aspect will complete the double
___________________ entry. The rules of posting therefore are:

n/S
___________________ i. for all transactions entered on the debit side of the cash book,
___________________ credit the concerned Subsidiary Books: C accounts in the
ledger individually by writing 'By Cash Account';
___________________
ii. for all transactions entered on the credit side, debit the

tio
___________________
concerned accounts in the ledger individually by writing T o
___________________ Cash Account'.

uc
___________________
Thus, the posting into the ledger accounts is completed. The
___________________ transactions entered on the debit side of the cash book are to be
___________________ posted on the credit side of the accounts in the ledger and vice

rod
versa.
___________________

Balancing of Single Column Cash Book


You have already learnt how to balance a ledger account. The cash
ep
book is balanced just like any other ledger account. The cash book
will always show a debit balance. This is because the cash
payments can never exceed the amount of cash available. For
rR

example, if you have ` 10 in your pocket, can you pay ` 15? You
cannot. So the total of the debit side in the cash book will always
be more than the total of the credit side his difference indicates the
t fo

cash in hand. It shall be entered on the credit side by writing 'By


Balance c/d' in particulars column and showing the amount in the
amount column. Now total the amount columns and you will find
that the two sides are equal.
No

After closing the cash book, the balance is shown on the debit side
by writing 'To Balance b/d'. It becomes the opening balance of cash
for the next period. Note that the cash book shall generally show a
debit balance and occasionally a nil balance. Look at Illustration 1.
S,

It shows the recording, posting and balancing of a Single Column


Cash Book.
PE

Example: Prepare a cash book from the following:


U
(c)

Contd…
UNIT 7: Subsidiary Books

ale
101
Notes

___________________

n/S
___________________

___________________

___________________

tio
___________________

___________________
Solution:

uc
___________________
Cash Book
Dr. Cr. ___________________
Date Particulars L.F. ` Date Particulars L.F. `

rod
2010 2010 ___________________
June 1 To Balance b/d 7,850 June 2 By Purchases a/c 2,300
___________________
June 3 To Sales a/c 6,250 June 4 By Wages a/c 25
June 7 To Mohan’s a/c 2,260 June 6 By Ram’s a/c 1,220
June 14 To Sales a/c 2,670 June 8 By Creditor’s a/c 4,410
June 17 To Sales a/c 7,500 June 9 By Cartage 15
ep
June 18 To Amit a/c 2,500 June 17 By Bank a/c 5,700
June 18 By Bank a/c 2,500
June 24 By Rent a/c 500
June 29 By Electricity a/c 1,210
rR

June 30 By Purchases a/c 2,450


June 30 By Balance a/c 8,700
July 1 To Balance b/d 29,030 29,030

Notes:
t fo

1. Cheque issued on June 10 to a creditor is not recorded in the


Cash Book.
2. Goods purchased from Arun on June 11 is also not recorded as
No

per rule no credit transaction is recorded.


3. Similarly goods sold to Amit on credit are also not recorded.
4. Cheque received from a debtor is recorded treating it as cash
received as it is banked immediately.
S,

Two Column Cash Book


PE

When cash is received from a debtor, some discount may be


allowed to him. Similarly, when payment is made to a creditor,
some discount may be allowed by him. This is termed as Cash
Discount and it has to be recorded in the books of account. While
U

making compound journal entries for such transactions, you learnt


that cash and discount go together. You know that receipts from
(c)

debtors and payments to creditors are to be recorded in the cash


book. Now the question arises as to how to record the cash
Business Accounting

ale
102 discount. One method is to record the discount aspect separately in
Notes the journal. But this would be cumbersome, and the possibility of
___________________ failing to record can also happen. Hence accountants have
developed a practice of recording the discount aspect in tile cash

n/S
___________________
book itself. For this, an extra amount column is added on both
___________________
sides of the cash book. Look at the proforma shown in Table 7.2.
___________________ The discount glowed to debtors is recorded on the debit side and

tio
___________________ the discount received from creditors is recorded on the credit side.
Thus, now there are two amount columns on both sides of the cash
___________________
book, one for discount and the other for cash. It is called 'Two
Column Cash Book'.

uc
___________________

___________________
Discount is of two types:
___________________
1. Trade Discount: It is given for increasing the volume of sales

rod
___________________ and it is adjusted in the invoice, hence no entry is passed in
the books of the business, as it is always deducted from the
catalogue price. It is usually allowed by a whole seller to a
ep
retailer.
For example, if the printed price of a book is `200 and 10% is
offered as a trade discount, then it is `20/- and the net price
rR

would be `180/- i.e., (`200 – `20) accordingly entries are to be


made by the seller as well as the buyer for ` 180 in their books.

2. Cash Discount: It is given for prompt payment; hence, it is


t fo

recorded in the Cash Book. When discount is given for prompt


payment, it is a loss, hence, it is to be shown on the debit side
of the Cash Book whereas discount received is to expedite
payment to the outsiders, hence, it is shown on the credit side
No

of the Cash Book.


No balance of discount columns is taken; simply the total of both
the sides is given. The following is the form of Double Columns
Cash Book.
S,

Table 7.2: Two Column Cash Book


PE

Dr. Cr.

Date Receipts L.F. Discount Cash Date Payment L.F. Discount Cash
(`) (`) (`) (`)
U
(c)
UNIT 7: Subsidiary Books

ale
Recording in Two Column Cash Book 103
Notes
Recording of cash transactions in a Two Column Cash Book is
similar to Single Column Cash Book. As for cash discount, it is ___________________

n/S
entered on the debit side if allowed to the debtor and on the credit ___________________
side if received from the creditor.
___________________
For example, Roop owes `1000 to M/s. Goyal Traders of Muzaffar ___________________
Nagar. The firm offers a discount of 1% if payment is made within

tio
___________________
one month. Roop makes the payment within stipulated time. So he
is offered ` 10 as discount and he makes the payment of ` 990 to ___________________

the firm. The following entry is required to be passed in the

uc
___________________
Journal if no Cash Book is used in the books of M/s. Goyal Traders.
___________________
Dr. Cr.

rod
___________________
Date Particulars L.F. ` `
Cash A/c Dr. 990 ___________________
Discount A/c Dr. 10
To Roop 1000
(Cash received and discount allowed.)
ep
If Cash Book is used, then both the accounts namely cash and
discount are to be recorded on the debit side of the Cash Book.
rR

Similarly, if discount is received for making prompt payment then


such items are to be recorded on the credit side of the Cash Book,
i.e., amount received or paid in the Amount/Cash column and
discount allowed/received in the discount column.
t fo

Posting the Two Column Cash Book


The entries in the cash columns of Two Column Cash Book are
posted to the ledger accounts in the same way as we did in the case
No

of single column cash book. The entries in the discount columns


are also to be posted to the respective personal accounts. The
entries in discount allowed column will be posted to the credit side
of the respective personal accounts by writing 'By Discount
S,

Allowed A/c'. Similarly, the entries in the discount received column


will be posted to the debit side of the respective personal accounts
PE

by writing 'To Discount Received A/c'.


For example: Cash received from Devi Traders ` 490 and discount
allowed ` 10: This transaction will be entered in particulars
U

column on the debit side of the cash book by writing 'To Devi
Traders A/c'. An amount of ` 10 will be shown in discount allowed
(c)

column and ` 490 in cash column. Its posting into Devi Traders'
Account in the ledger will be made as follows:
Business Accounting

ale
104 Devi Traders Account
Notes

___________________

n/S
___________________

___________________ As for the transactions relating to cash, the double entry is


___________________ complete as soon as postings have been made to the respective
personal accounts. But it is not so for the discount aspect. The cash

tio
___________________
book does not serve the purpose of discount account. We have to
___________________ open 'Discount Allowed Account' and 'Discount Received Account'
in the ledger. The total of discount allowed columns on the debit

uc
___________________
side of the cash book is posted to the debit side of the 'Discount
___________________
Allowed Account' in the ledger by writing 'To Sundries'. Similarly,
___________________ the total of discount received column on the credit side of the cash

rod
___________________ book is posted to the credit side of the 'Discount Received Account'
in the ledger by writing 'By Sundries'. This will complete the
double entry in respect of discount allowed and discount received.
The postings in the two discount accounts are made only for the
ep
totals and not for the individual transactions. Thus we save time
and labour.
rR

Balancing the two Column Cash Book


In case of Two Column Cash Book, only the cash columns are
balanced. Procedure is similar to Single Column Cash Book. The
t fo

discount columns are not balanced, they are simply totalled. This
is because the two discount columns relate to two separate
accounts-the Discount Allowed Account and the Discount Received
Account.
No

Example of Two Column Cash Book:


From the following transactions write up a two column cash
book and post into ledger:
S,

2012
Jan. 1 Cash in hand ` 2,000
PE

" 7 Received from Riaz & Co. ` 200; discount allowed ` 10


" 12 Cash sales ` 1,000
" 15 Paid Zahoor Sons ` 500; discount received ` 15
" 20 Purchased goods for cash ` 300
U

" 25 Received from Salman ` 500; discount allowed ` 15


" 27 Paid Hussan & Sons ` 300.
(c)

" 28 Bought furniture for cash ` 100


" 31 Paid rent ` 100
UNIT 7: Subsidiary Books

ale
Solution: 105
Notes
Cash Book
Debit Side Credit Side ___________________

n/S
Date Particulars V.N. L.F. Discount Cash Date Particulars V.N. L.F. Discount Cash ___________________
2012 2012
Jan.1 To Balance 2,000 Jan.5 By Zahoor & 15 500 ___________________
" 7 b/d 10 200 " 20 Sons 300
" 12 To Riaz & 1,000 " 27 By purchase 300 ___________________
" 25 Co. 15 500 " 28 a/c 100

tio
To Sales a/c " 31 By 100 ___________________
To Salman Hussan&Sons 2,400
25 3,700 By Furniture 15 3,700 ___________________
a/c
2012 2,400 By Rent a/c

uc
Feb1 By Balance c/d ___________________

To Balance ___________________
b/d

rod
___________________
Riaz & Co.
___________________
2012 `
Jan. By Cash 200
7 By Discount 10
ep
Sales Account
2012 `
rR

Jan. By Cash 1,000


12

Salman Account
t fo

2012 `
Jan. By Cash 500
25 By Discount 15

Babar Account
No

2012 `
Jan. To Cash 1,000
18

Zahoor Account
S,

2012 `
Jan. To Cash 500
PE

15 To Discount 15

Purchases Account
2012 `
U

Jan. To Cash 300


20
(c)
Business Accounting

ale
106 Hussan & Sons
Notes 2012 `
Jan. To Cash 300
___________________
27

n/S
___________________
Furniture Account
___________________
2012 `
___________________ Jan. To Cash 100
28

tio
___________________

___________________ Rent Account


2012 `

uc
___________________
Jan. To Cash 100
___________________ 31
___________________

rod
Discount Account
___________________
2012 ` 2012
Jan. To Sundries as Jan. By Sundries as
31 per Cash book 25 31 per cashbook 15
ep
Three or Triple Column Cash Book
rR

This type of Cash Book is used by the big business organisations


because (i) there is large number of transactions and (ii) receipts
and payments are through cheques. Under these Cash Book three
columns meant for (A) Discount, (B) Cash, and (C) Bank, are
t fo

shown on both the sides of the Cash Book. Other columns remain
as usual. This Cash Book contains three columns; hence it is
termed as Three Column Cash Book.
In the debit side of Triple Column Cash Book, cash receipt, cheque
No

receipts and cash discount columns respectively. Similarly in the


credit side of Triple Column Cash Book payment of cash, payment
by cheque and cash discount received are recorded in Cash, Bank
and Discount columns respectively. The transactions which affect
cash and bank account at a time are called contra entries and are
S,

recorded in both sides of Triple Column Cash Book. The balance of


cash column is the closing cash in hand; the balance of bank
column is the cash at bank or bank overdraft. The discount column
PE

is not balanced but only totalled.


Following is the form of Three Columns Cash Book:
U

Three Columns Cash Book


Date Particulars L.F. Discount Cash Bank Date Particulars L.F. Discount Cash Bank
(`) (`) (`) (`) (`)
(c)

(`)
UNIT 7: Subsidiary Books

ale
107
Important points to be noted while recording the transactions:
Notes
z When opening cash and bank balances are given, record on the
___________________
debit side of cash and bank columns

n/S
___________________
z When opening bank balance is given as overdraft, it should be
___________________
recorded on the credit side in the bank column
___________________
z When cash is received, it should be recorded on the debit side

tio
cash column, in the same way cash payments made by the firm ___________________
shown in the cash column on credit side. ___________________

When cash or Cheque is received from debtors through cash

uc
z ___________________
sales or any other sources, it is recorded in the cash column on
___________________
debit side, if the Cheque is deposited into bank on the same

rod
___________________
day or assumed to be deposited on the same day; it is recorded
in the bank column on the debit side. ___________________

z If any payment is made or debt is cleared in the form of


Cheques, it is recorded in the bank column on the credit side.
ep
z If the firm allows discount, it is recorded in the discount
column on the debit side.
rR

z If the discount is received, it is recorded on the discount


column on the credit side.
z If the Cheques sent to bank for collection are dishonoured,
t fo

these should be recorded in the bank column on the credit side.


Similarly, if we receive any information that the Cheques
issued by us are dishonoured, it should be promptly noted in
the bank column on the debit side.
No

z If cash is withdrawn from the bank for the business use, it


should be recorded in the cash column on debit side and bank
column on the credit side.
If we deposit cash into bank it should be recorded in the bank
S,

z
column on debit side and credit side in the cash column. This
type of transaction is called as contra entry. Where both the
PE

sides are affected. To indicate that is a contra entry, the


alphabet ‘C” is mentioned in the Ledger folio column on the
both sides.
U

Contra entries will appear in the following occasions:


When an account is opened with a bank
(c)

z The firm’s cash is deposited in the bank


Business Accounting

ale
108
z The cash is withdrawn from bank for office use
Notes

___________________
z The Cheques received from debtors, are deposited in the bank.

n/S
___________________ Example: From the following particulars, write up the Cash Book
of M/s K.K. of Chennai with Cash and Bank columns and bring
___________________
down the final balance.
___________________
Change 2009 to 2012

tio
___________________

___________________

uc
___________________

___________________

___________________

rod
___________________
ep
rR

Solution:
t fo

Three Columns Cash Book


Date Particulars L.F. Discoun Cash Bank Date Particulars L.F. Discount Cash Bank
(`) (`) (`) (`) (`) (`)

2009 2009
Oct. 1 To Balance b/d 100 3,500 Oct. 5 By Salaries A/c – 250
Oct. 9 To B & Co. – 2,500 Oct. 7 By K & Co. – 260
No

Oct. 15 To S. Chand 1,500 Oct. 12 By Purchase A/c – 750


Oct. 17 To Cash A/c (C) – 1450 Oct. 17 By Bank A/c (C) 1450 –
Oct. 19 To Debitors 1,780 – Oct. 18 By S. Creditors – 1250
Oct. 22 A/c 2,500 – Oct. 20 By B & Co. – 2,500
Oct. 24 To B & Co. 30 470 Oct. 27 By Shyam Lal 5 395
Oct. 31 To R & Co. (C) 2,200 Oct. 31 By Bank A/c (C) 2,200
To Cash A/c By Balance c/d 4,885 5,110

30 5,880 10,120 5 5,880 10,120


S,

Petty Cash Book


PE

The Petty Cash Book records all the transactions which are very
small in terms of money. In such situation, a fixed amount of cash
in the beginning of the month is given to a person who is known as
petty cashier. After a fixed period say a week or month, he is again
U

reimbursed or paid back the amount whatever he has spent at the


end of week or period. Such a system is known as imprest system.
(c)
UNIT 7: Subsidiary Books

ale
109
Thus, this type of system (the Imprest System) is very useful. It
Notes
contains one column to record the receipt of cash to be taken from
the head cashier and other column to record payments of various ___________________

n/S
counts. All such payments are to be totalled to know the total ___________________
amount spent, so that necessary accounts are debited. The
___________________
following is the proforma of Petty Cash Book:
___________________
Analytical Petty Cash Book

tio
___________________
Receipts Date Particulars Voucher No. Total Amount Printing & Cartage Postage
(Rs.) (`) Stationery ___________________

uc
___________________

___________________
Example: Enter the following transactions in Analytical Petty

rod
___________________
Cash Book.
ep ___________________
rR
t fo

Solution:

Analytical Petty Cash Book


No
S,
U PE
(c)
Business Accounting

ale
110
Check Your Progress
Notes
Activity
Enter the following Fill in the blanks:
___________________
transactions in the Purchases
1. Only ................................. are recorded in the cash book.

n/S
Book___________________
and post the same in the
relevant ledger accounts.
___________________ 2. Cash payments are recorded on the .............................. of
2012 ` the cash book.
___________________
Aug. 1 Bought 1,500
3. According to the rules of accounting, all the business

tio
goods from
___________________
S transactions are firstly recorded in journal and then
___________________
Aug. 4 Bought 1,000 posted in.........................................
goods from

uc
___________________
N 4. The .................................. is an incentive given or
___________________
Aug. 8 Bought 500 received for prompt payment.
goods from
___________________

rod
A
___________________ Other Subsidiary Books
Following are other subsidiary books:
ep
Purchases Day Book
All credit purchases are recorded in this book which are either
used for resale or raw materials used for production. The
rR

purchases which are made for cash are not at all recorded in this
book. Similarly, the assets which are bought for running the
business are also not recorded such as machinery, furniture, etc.
t fo

All these assets and cash purchases are separately recorded in the
journal Cash Book. Following is the form of Purchases Day Book:

Purchases Day Book

Date Particulars Invoice No. L.F. Amount ( ` )


No

I II III IV V

(a) Column is meant for date.


S,

(b) Column is meant for writing details regarding name of


supplier, name of articles purchased & number i.e., quantities.
PE

(c) Invoice No.: An Invoice is given to the seller when purchases


are made on credit
(d) Ledger Folio
U

(e) Amount of the purchase


Thus, all the credit purchases are totalled which give us the
(c)

amount of total credit purchases made during the period.


UNIT 7: Subsidiary Books

ale
Sales Day Book 111
Notes
The goods which are sold on credit are recorded in this book but if
sales are made for cash or assets are sold either for cash or on ___________________

n/S
credit, they are not at all recorded in this book, but are recorded ___________________
either in the cash book or in the journal. The form of this book is
___________________
similar to that of purchases book. Following is the form of Sales
Day Book. ___________________

tio
___________________
Date Particulars Invoice No. L.F. Details (`) Amount (`)
___________________
I II III IV V VI

uc
Details of goods-sold-trade discount if ___________________
any total
___________________
Thus, all the credit sales are totalled which give us the amount of
total credit sales made during the period.

rod
___________________

Invoice: An Invoice is given to the buyer when sales are made on ___________________

credit.
ep
Purchase Returns Book
This book is also known as Returns Outward Book. This book
records all the returns to the suppliers which are made during the
rR

period. The return is of goods or raw materials purchased from the


Suppliers and Return is on account of difference in quantity or
quality. This book is used when the returns are in sufficient
t fo

number. If returns are not much, then it may be recorded in the


Journal. The form of Purchase Returns Book is similar to that of
Purchase Day Book.

Form of Purchase Returns Book


No

Date Particulars L.F. Debit Note No. Amount (`)


I II III IV V
S,

Debit Note: Whenever goods are returned to the supplier, a letter


PE

which is known as the debit note is also sent along with returned
goods. The purpose of this note is to inform the supplier about this
deduction or debit given to his account. This note contains the
following particulars such as:
U

(a) Name and address of the supplier


(c)

(b) Description of the goods returned


(c) Rate and total value
Business Accounting

ale
112
(d) Invoice No., along with date
Notes

___________________
(e) ignature

n/S
___________________ Sales Returns Book
___________________ This is also known as Returns Inward Book. This book records all
___________________ the transactions related to the return of goods by the customers. As
and when goods are returned by the customers, a credit note is

tio
___________________
issued and the entry is made in this book. This book again contains
___________________
the same columns which a Purchases Returns Book contains.
There is only one difference i.e. in place of Debit Note No. the

uc
___________________

___________________ column is used to note the Credit Note No. The form of sales
Returns Book is as follows:
___________________

rod
Sales Returns Book
___________________
Date Particular Credit Note No. L.F. Amount (`)
I II III IV V
ep
Credit Note: As and when goods are returned by the customers, a
rR

credit note is being sent to him. Credit note means that his account
has been credited with the amount of goods return.

Bills Receivable Book


t fo

A bill of exchange accepted by a customer is called bills receivable.


When bills are received from debtors and number of such bills
received is larger (big) then such bills are recorded in a separate
book, known as bills Receivable Book. All such bills are totalled for
No

a particular period and are posted in the accounts of the debtors


from whom such bills are received. Following is the form of Bills
Receivable Book.

Bills Receivable Book


S,

Date Date From Drawer Acceptor Endorser Date Tenor or Due Where L.F. Cash Amount Re-
of of Whom (s) of Terms of date payable Discount of bill marks
Receipt Receipt Received Bill Bill allowed (`)
U PE

Bills Payable Book


Where either purchase is made for credit or loans are taken, then
(c)

Bills are issued which are termed as Bills Payable. The book in
which these bills are recorded is termed as Bills Payable Book. All
UNIT 7: Subsidiary Books

ale
such Bills are totalled after a lapse of a certain period and are 113
posted in the accounts of the creditors to whom such bills are Notes
issued. Following is the form of Bills Payable Book: ___________________

n/S
Bills Payable Book ___________________
Date To Term Drawer Acceptor Endorser Due Where L.F. Amount Remarks ___________________
Whom (s) Date payable (`)
Payable
___________________

tio
___________________

___________________

Check Your Progress

uc
___________________
Fill in the blanks: ___________________

1. The ………………….. records all the transactions which

rod
___________________
are very small in terms of money.
___________________
2. An ………………….. is given to the buyer when sales are
made on credit
ep
3. Purchase return book is also known as ………………….. .

Summary
rR

The regular/frequent occurrence of transactions are recorded only


in the separate books which are known as subsidiary book of
t fo

accounts or subsidiary journals, instead of being recorded in the


regular journal. Subsidiary books are classified on the basis of
transactions viz. Cash transactions and Non-cash transactions.
The purchases book is known in other words as purchase journal.
No

It is a book meant for credit purchases only for resale. Purchase


return book is a book of goods returned to the supplier which are
out of credit purchases. Sales book is a book maintained by the
enterprise only during the moment of selling the goods on credit. It
S,

is known in other words as a sales journal. Sales return is a book


that registers the goods sold on credit and received from the
PE

buyers.

Lesson End Activity


U

Illustrate the preparation of records for non cash transactions with


suitable examples.
(c)
Business Accounting

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114
Keywords
Notes
Bill of Exchange: A bill of exchange is an unconditional order
___________________
signed by the maker which directs the recipient to pay a fixed sum

n/S
___________________ of money to a third party at a future date.
___________________
Journal: The primary book in which the transactions are recorded
___________________ first time.

tio
___________________ Ledger: It is the classification of accounts in which various
___________________ accounts are maintained.
Subsidiary book: It is a book maintained for routine transactions

uc
___________________

___________________ of the enterprise.

___________________ Trial Balance: Trial balance is a list in which all the balances of

rod
the accounts of Ledger are showed to test the arithmetical
___________________
accuracy of the posting in ledger.
Non-cash Transactions: A Non-cash transaction is a transaction
in terms of credit and conditions of the enterprise.
ep
Purchase Book: It is known in other words as purchase journal.
It is a book meant for credit purchases only for resale.
rR

Sales Book: It is a book maintained by the enterprise only during


the moment of selling the goods on credit. It is known in other
words as a sales journal.
t fo

Sales Return Book: Sales return is a book that registers the


goods sold on credit and received from the buyers.

Questions for Discussion


No

1. Explain the nature of petty cash book.


2. What is the difference between a petty cash book and a simple
cash book?
S,

3. Prepare a Cash Book form the transactions given below:


U PE
(c)
UNIT 7: Subsidiary Books

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115
4. Compose three columns Cash Book from the following
Notes
transactions:
___________________

n/S
___________________

___________________

___________________

tio
___________________

___________________

uc
___________________

___________________

rod
___________________

ep ___________________
rR

5. What are the different types of trade bills books?


6. Write a short note on the following:
(a) Debit Note
t fo

(b) Credit Note


7. Enter the following transactions in Analytical petty Cash
Book:
No
S,
PE

8. Explain the significance of preparing subsidiary books of


U

accounts.
(c)
Business Accounting

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116
Further Readings
Notes

___________________ Books

n/S
___________________ T.S. Grewal, M.C. Shukla. “Advanced Accounts”. S. Chand, New
___________________
Delhi.

___________________ R.L. Gupta, M. Radhaswami. “Advanced Accountancy”. Sultan


Chand, New Delhi.

tio
___________________
Dr. S.N. Maheshwari, Sharad, K. Maheshwari. “Financial
___________________
Accounting”. Vikas Publishing Co. Pvt. Ltd., New Delhi.

uc
___________________
Pandikumar, M. P (2007). “Management Accounting, Excel Books”.
___________________
New Delhi.
___________________

rod
Web Readings
___________________
http://www.careerride.com/fa-subsidiary-books.aspx.
http://bookkeepingaccounting.blogspot.in/2010/07/subsidiary-
books.html
ep
http://www.scribd.com/doc/22575438/Subsidiary-Books
http://www.wisegeek.com/what-are-subsidiary-books.htm
rR
t fo
No
S,
U PE
(c)
UNIT 8: Trial Balance

ale
Unit 8
117
Notes
Activity

Trial Balance
Prepare a presentation
___________________

n/S
showing the Trial Balance.
___________________

___________________
Objectives
___________________
After completion of this unit, the students will be aware of the following

tio
topics: ___________________

\ Meaning of Trial Balance ___________________


\ Methods of Preparation of Trial Balance

uc
___________________
\ Types of Errors
___________________

rod
___________________
Introduction
___________________
Every transaction which takes place in the business is recorded
either in the journal or in the subsidiary books. It is posted in the
ep
concerned accounts. After posting is over, final accounts are
prepared in order to know the operational results of the business
during a particular or fixed period and also to depict financial
rR

position of the business on a particular date. Final accounts can be


prepared only if information relating to balances of all accounts are
available. This function of supplying necessary and accurate
balances is performed by Trial Balance so it is very much
t fo

necessary to know the meaning of Trial Balance.

Meaning of Trial Balance


No

Trial balance is a list in which all the balances of the accounts of


Ledger are showed to test the arithmetical accuracy of the posting
in ledger. It is prepared after the end of a particular period - year,
half year or quarter. Trial balance prepares a base for the
S,

preparation of final accounts. After the completion of trial balance,


the financial accounts - P. & L. Account and Balance Sheet are
PE

prepared to disclose the overall results of the business after a


period. The proforma of a trial balance is given hereunder:

Proforma of Trial Balance


U

Particulars Amount Dr. Amount Cr.


` `
(c)
Business Accounting

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118
Generally three columns are made in the trial balance. The first
Notes
Activity wide column is kept for the particulars of accounts and the two
Rectify the following Errors:
___________________ columns for debit amount and credit amount are made.

n/S
Sales to Vinod `143
(i) ___________________
posted to his account as ` Objects and Functions of Trial Balance
___________________
134.
The main objectives of preparing a trial balance are to check the
Sales to Vinod ` 143
(ii) ___________________
debited to his account as
arithmetical accuracy of all transactions. In every trial balance,

tio
` 134.
___________________ the total of debit balances must agree with the total of credit
Sales to Vinod ` 143
(iii) ___________________ balances. It is a proof of arithmetical accuracy of postings but it is
credited to his account as not a conclusive evidence of correctness of the books of accounts.

uc
___________________
` 134.
The other objects and functions of a trial balance are as under:
___________________
1. It serves as a summary of all accounts.
___________________

rod
2. It helps in locating errors if any.
___________________
3. It acts as a base for the preparation of final accounts.

Check Your Progress


ep
Fill in the blanks
1. …………….. is a statement which shows balances of all
rR

accounts on a particular date.


2. The balances of all the liabilities and capital accounts
are recorded in the …………….. of the Trial Balance.
t fo

Methods of Preparation of Trial Balance


A trial balance is prepared by the following three methods:
No

a. Balance Method
b. Total Method
c. Balance and Total Method
S,

Among the above methods the balance method is the most popular
and statutory method to prepare the Trial Balance. Under this
method the balance of all the accounts are recorded. If an account
PE

shows a debit balance in the ledger, this balance is recorded in the


debit side of the trial balance and if it has a credit balance, in the
credit side of it is written. If any account has no balance means its
U

total of debit side is equal to the total of credit side, it is not


recorded in the Trial Balance. After recording the balances of all
(c)

accounts of the Ledger, the amounts of both the sides are totalled
to check the arithmetical accuracy of the ledger. If the total of debit
UNIT 8: Trial Balance

ale
side agrees with the total of credit side, it proves that books are at 119
least arithmetically correct. However, the trial balance is not the Notes
sole proof of accuracy of the books of Ledger. ___________________

n/S
Illustration (Trial Balance) ___________________

Prepare a Trial Balance on the basis of the ledger accounts as ___________________


given in illustration No. 3.
___________________

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Solution ___________________

In the Books of Aditya Raj ___________________


Trial Balance

uc
___________________
(as on 31st March, 2012)
Particulars Amount (Dr.) Amount (Cr.)
___________________
` `

rod
___________________
Cash Account 61,000 -
Purchase Account 3,20,000 - ___________________
Ramautar’s Account - 2,20,000
Rent Account 2,000 -
Plant Account 1,00,000 -
Salaries Account 12,000 -
ep
Shyam’s Account - 10,000
Sales Account - 2,70,000
Wages Account 5,000 -
Total 5,00,000 5,00,000
rR

Preparation of Trial Balance with the Help of Balances


In the examination problems the Ledger accounts are not given but
a list of balances of accounts is given. With the help of these
t fo

balances the students are asked to prepare the Trial Balance.


Students should keep in mind the following rules to prepare a Trial
Balance:
(a) The balances of all the assets accounts and drawing accounts
No

are recorded in the debit side of the Trial Balance.


(b) The balances of all the liabilities and capital accounts are
recorded in the credit side of the Trial Balance.
S,

(c) The balances of all expenses and losses of the business are
showed in the debit side of the Trial Balance.
PE

(d) The balances of all incomes and gains are disclosed in the
credit side of the Trial Balance.
(e) The balances of sales and sale returns are disclosed in the
U

credit side and debit side of Trial Balance respectively.


(f) The balances of purchases and purchase returns are disclosed
(c)

in the debit side and credit side of the Trial Balance


respectively.
Business Accounting

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120
Illustration (Preparation of Trial Balance)
Notes

___________________
Mr. Akshey Kumar furnishes the following balances as on 31st
March, 2012. You have to prepare a Trial Balance with the

n/S
___________________
following information:
___________________
Particulars ` Particulars `
___________________ 24,000 1,28,000
Interest on Capital Salaries

tio
Creditors 6,00,000 Capital 8,00,000
___________________
Discount Received 23,000 Drawings 2,46,000
Loan 1,74,000 Machinery 3,00,000
___________________
Purchase Returns 40,000 Bills Payable 20,000
6,000 6,00,000

uc
___________________ Sales Return Furniture
Advertisement 1,63,000 Debtors 5,00,000
___________________ Commission Received 20,000 Bank Loan 2,00,000
Rent 10,000 Patents 60,000
___________________

rod
Purchases 19,00,000
Sales 32,60,000
___________________
Opening Stock 12,00,000

Solution:
ep
Trial Balance
(as on 31st March, 2012)
rR

Particulars Amount (Dr.) Amount (Cr.)


` `
Interest on Capital 24,000 -
Creditors - 6,00,000
Discount Received - 23,000
Loan - 1,74,000
t fo

Purchase Returns - 40,000


Sale Returns 6,000 -
Advertisement 1,63,000 -
Commission Received - 20,000
Rent 10,000 -
No

Purchases 19,00,000 -
Sales - 32,60,000
Opening Stock 12,00,000 -
Salaries 1,28,000 -
Capital - 8,00,000
Drawings 2,46,000 -
Machinery 3,00,000 -
S,

Bills Payable - 20,000


Furniture 6,00,000 -
Debtors 5,00,000 -
PE

Bank Loan - 2 00 000


Patents 60,000 -
Total 51,37,000 51,37,000

From the above trial balances it is clear that the total of debit side
U

will agree with the total of credit side if Ledger accounts are
arithmetically correct. If these totals do not tally with each other,
(c)

there will be some error in the ledger accounts.


UNIT 8: Trial Balance

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121
Check Your Progress
Notes
Activity
Fill in the blanks:
You___________________
and your group members
1. The balances of all incomes and gains are disclosed in

n/S
are required to develop an
___________________
assignment on types of errors.
the ……………… of the Trial Balance.
___________________
2. . ……………… is found when one account is debited or
___________________
credited in the place of another account.

tio
___________________
3. …………………. occur when any business transaction is
completely or partially omitted from the recording in the ___________________
books of original records.

uc
___________________

___________________
Types of Errors

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___________________
There are two types of errors: ___________________

Errors which cannot be located by Trial Balance


The following errors cannot be detected by the trial balance means
ep
in spite of agreeing the totals of debit side and credit side, these
errors occur in the accounts.
rR

1. Error of Omission: These errors occur when any business


transaction is completely or partially omitted from the
recording in the books of original records.
t fo

Example: As goods, sold of Rs.10, 000 to Mr. Ram is entered


nowhere in the original books then will its effect also not come
on the ledger and trial balance. Thus such type of errors
cannot be located by trial balance.
No

2. Error of Commission: such types of errors are found when


one account is debited or credited in the place of another
account.
Example: As cash received from Shyam Rs.1, 000 has been
S,

credited in the name of Ram. Such type of errors do not affect


the agreement of the totals of the debit and credit side of the
PE

trial balance but they affect the result of the business.


3. Error of Principle: These errors occur when there is wrong
classification between the capital and revenue nature incomes
U

or expenditures.
Example: As the purchases of furniture of Rs.20, 000 are
(c)

entered in the book of purchases while it should be in furniture


account. Such errors cannot be located by trial balance.
Business Accounting

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122
4. Compensating Error: When two errors of the same account
Notes
occur and the effect of one error is compensated by the effect of
___________________
other error, it is called compensating error.

n/S
___________________
Example: if purchase of ` 10, 000 from Ajay is credited only
___________________ by ` 1, 000 while the purchases from Vijay for ` 1, 000 is
___________________ credited by ` 10, 000. Thus, such type of errors do not affect on
the agreement of the Trial Balance.

tio
___________________

___________________ Errors which can be located by Trial Balance


The error which affects the agreement of the totals of the Trial

uc
___________________

___________________ balance can be located easily. These errors may be relating to:

___________________ 1. Totals of the subsidiary books or ledger accounts.

rod
___________________ 2. Balancing of an account of the ledger.
3. Wrong posting of any amount in any account.
4. Posting of any account may be in the wrong side of the
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account.
5. Balance of any account may be omitted in writing in the Trial
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Balance.
6. Wrong total of the Trial Balance.
Errors are of two types:
t fo

1. Errors which are disclosed by the trial balance.


2. Errors which are not disclosed by the trial balance.
1. Errors which are disclosed by the Trial Balance:
No

Sometimes the trial-balance does not agree, it is because of the


following reasons:
™ The balancing of an account is not O.K.
S,

™ The amount has been wrongly posted.


™ Totalling of subsidiary books is wrong.
PE

™ Any amount which is left out from posting to ledger


accounts.
™ Any balance of an account is left out from trial balance.
U

Thus, we see that it is very important to detect the errors


which are disclosed by the trial balance, so that correct results
(c)

can be depicted by the ledger accounts, but sometimes it


happens that the trial balance is OK even then there may be
UNIT 8: Trial Balance

ale
certain errors which are not disclosed by the trial balance. So 123
it is also very much desirable and necessary to know such Notes
errors which are not disclosed by the Trial Balance. ___________________

n/S
2. Errors which are not disclosed by the Trial Balance: ___________________

Following are the 4 types of errors: ___________________

™ Error of Omission ___________________

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™ Error of Commission ___________________

™ Error of Principle ___________________

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___________________
™ Compensatory Error
___________________
Now we can explain the above errors one by one in detail:

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___________________
1. Error of Omission: If any transaction is completely omitted,
then it is an error of omission. For example, if goods worth ` ___________________

100 are sold to Ram on credit and if this transaction is omitted


completely or left out, then it would not affect the trial balance
ep
but the results given by the final accounts would not be
accurate. The omission may be of the entire transaction or a
part of the transaction. If it is of a part of the transaction, then
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it would affect the trial balance.


2. Error of Commission: When any account is either debited or
credited in place of some other account then it is termed as an
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error of commission. Though this would not affect the trial


balance, but the overall results would not be correct. For
example, if goods worth ` 100 are sold to Ram on credit, but in
place of Ram, Shyam’s account is debited then the error is
No

committed which must be rectified to maintain accuracy.


3. Error of Principle: As we know that the expenses are of two
types- namely (a) Capital expenses and (b) Revenue expenses.
A. Capital Expenses: When benefits can be / are derived for
S,

more than one year or for a longer period, such expenses


are termed as Capital expenses, such as purchases of
PE

building / machinery, etc. These assets are not for sale but
are the permanent assets of the business.
B. Revenue Expenses: Where benefits are derived only for a
U

shorter period or less than one year such expenses are


known as Revenue expenses, such expenses are also form
(c)

the part of the current year's profit and loss account.


Business Accounting

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124
After understanding the nature of expenses, it is very much
Notes
essential to have a distinction between Revenue and Capital
___________________
expenses, but if it is not observed strictly or ignored, there

n/S
___________________ would be an error of principle. Though this type of error would
___________________ not affect the trial balance, but the results given would not be
correct, hence rectification of such errors is must to have the
___________________
accuracy of ledger accounts.

tio
___________________
4. Compensatory Errors: Compensatory errors are the errors
___________________ which are committed while posting or recording of a
transaction, an error is committed and the same error is again

uc
___________________

___________________
committed in another recording or posting. Such error is
termed as compensatory error. For example, Goods sold to Mr.
___________________
Jai Bhagwan for ` 500 on credit though the recording is

rod
___________________ correctly done, but posting is done only for Rs. 50. Similarly
Goods sold to Bhagwan Das for ` 50 on credit is posted in
Bhagwan Das's A/c as ` 500. This would be compensatory error
ep
without affecting the trial balance.
Thus we see that it is very much essential to rectify such errors in
order to maintain the accuracy of the financial results.
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Thus we see that errors are of two types:


1. Error of Principle.
t fo

2. Clerical errors which are of the following types:


(i) Error of Omission.
(ii) Error of Commission.
No

(iii) Compensatory errors.

Steps to point out errors


If the trial balance does not agree, the following steps can be taken
S,

in order to point out the errors. These are based on hit and trial
method.
PE

1. To see whether the total of both the columns agree or does not
agree. In order to see it, it must be again totalled.
2. It is also necessary to see whether the balances of all the
U

accounts including cash and bank have been properly recorded


or not.
(c)

3. Difference of both the sides must be checked carefully and if


possible see whether any such item is there which is exactly of
UNIT 8: Trial Balance

ale
the same amount being omitted/left out. If it is not then have 125
half of the difference and again compare it with the amount of Notes
any item of the same amount which is being left out or wrongly ___________________
put.

n/S
___________________
4. Subsidiary books must also be checked again, so that if any
___________________
error has taken place could be rectified.
___________________
5. Still, if there is any error, thorough and complete checking of

tio
___________________
all ledger accounts is required.
___________________
Rectification of Errors

uc
___________________
Errors are/can be rectified if the correcting entries are passed in ___________________
the books of account. For this, care and alertness is exercised to see

rod
___________________
whether error is in both the accounts or is in one account only. If
the error affects both the accounts, then a fresh entry is to be ___________________

passed and if it affects only one account, the rectification is done by


recording in one account only.
ep
1. Rectification of Errors when error affects only one
account: If it is so, no journal entry is required to pass; it is
corrected by debiting or crediting the concerned account. For
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example, Sales book was overcasted by ` 250 [As the sales


book was overcasted by ` 250]; hence sale account is to be
debited by ` 250 in order to rectify the error. This error affects
t fo

only one account. Similarly, if the Purchases Day Book is


undercasted by ` 100 then the error also affects only one
account and this can be corrected by debiting purchases
account by ` 100. Likewise paid ` 20 as repairs were recorded
No

` 25 in Repairs account again the error is in one account i.e.,


repair account. It may be corrected by crediting repair a/c by
` 5 i.e. the difference (` 25 - ` 20).

2. Rectification of Errors when it affects both the accounts:


S,

If it is so, it is rectified by passing a journal entry. For


example, received ` 150 from Shri Bhagwan was credited to
PE

sales account. This error affects both the accounts i.e., (i) Shri
Bhagwan A/c and (ii) Sales A/c.
Journal entry for correction would be:
U

Dr. Cr.
S.No. Particulars L.F. ` `
1. Sales a/c Dr. 150
(c)

To Shri Bhagwan a/c 150


Error in Sales a/c and
Shri Bhagwan a/c rectified
Business Accounting

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126
Similarly, if Building is purchased for ` 2 lac is recorded in the
Notes
Purchases Book, again the error affects both the accounts i.e. (1)
___________________
Building a/c (2) Purchases a/c.

n/S
___________________
Though the error is of principle, in the above case Purchases a/c is
___________________ unnecessarily debited and Building a/c is wrongly left out. In order
___________________ to rectify the error the following entry (correcting the error) is to be
passed:

tio
___________________

___________________ Journal Entry for Correction (Rectification)


S.No. Particulars L.F. ` `.

uc
___________________ 1. Building a/c Dr. 2,00,000
To Purchases a/c 2,00,000
___________________ Error in Building a/c and
Purchases a/c rectified
___________________

rod
___________________
Journal Entry already passed which was a wrong entry
S.No. Particulars L.F. ` `
1. Purchases a/c Dr. 2,00,000
ep
To Cash / Creditor a/c 2,00,000
Building Purchased

Correct entry required to pass


rR

S.No. Particulars L.F. ` `


1. Building a/c Dr. 2,00,000
To Cash/Creditor a/c 2,00,000
Buildings purchased
t fo

Thus, we see that if the error affects both the accounts, then it can
be rectified by passing a journal entry as explained above.

Suspense Account
No

Sometimes, it is not possible to point out errors easily, and then


the difference is put to an account, known as suspense account.
Suspense a/c is shown in the trial balance. As and when Errors are
located, the same is debited or credited for rectifying the error and
S,

the other account which is credited or debited is the suspense


account. Thus, the suspense account is automatically closed.
PE

Illustration
Rectify the following Errors:
U

(a) A sale of goods to Raja Ram for ` 2500 was passed through the
Purchases book.
(c)

(b) Salary ` 800 paid to Hari Babu was wrongly debited to his
personal account.
UNIT 8: Trial Balance

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127
(c) Furniture purchased on credit from Mohan Singh for ` 1000
Notes
was entered in the Purchases book.
___________________
(d) ` 5000 spent on the extension of building was debited to the

n/S
buildings repairs account. ___________________

___________________
(e) Goods returned by Mani Ram ` 1200 were entered in Returns
outward book. ___________________

tio
Solution: ___________________

___________________
Journal Entries to rectify the errors

uc
Dr. Cr. ___________________
S.No. Particulars L.F. Amount Amount
` ` ___________________
(a) Raja Ram Dr. 5,000

rod
To Purchases a/c 2500 ___________________
To Sales a/c 2500
A sale of goods to Raja Ram through the Purchases book is rectified ___________________
(b) Salary a/c Dr. 800
To Hari Babu 800
Salary wrongly debited in his personal a/c is rectified.
ep
(c) Furniture a/c Dr. 1,000
To Purchases a/c 1000
Furniture purchased was wrongly entered in the Purchases book is rectified.
(d) Buildings a/c Dr. 5,000
To Buildings Repairs a/c 5000
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Spent on extension of building was wrongly debited to Building repairs a/c is


rectified.
(e) Returns Inward a/c (Sales Returns) Dr.
Returns Outward a/c (Purchases Returns a/c) Dr. 1,200
To Mani Ram 1,200
Goods returned by Mani Ram were entered in returns outward book. 2400
t fo

Illustration
Rectify the following errors:

(a) Sales book was overcasted by ` 200.


No

(b) ` 100 received as rent from the tenant was debited to rent
account.
(c) Received ` 500 from Sudan Mittal was credited to Sales book.
S,

(d) Paid ` 200 as salary, but were debited ` 20 in Salary account.

(e) Paid ` 20 as repairs were recorded ` 25 in Repairs account.


PE

Solution:
(a) As the sales book was overcast by ` 200, so sales a/c is to be
U

debited by ` 200 in order to rectify the error, this error affects


only one account.
(c)
Business Accounting

ale
128 Dr. Cr.
Notes S.No. Particulars L.F. Amount Amount
` `
___________________ (b) Suspense a/c Dr. 200

n/S
To Rent a/c 200
___________________ Rent a/c was wrongly debited, hence rectified by Rs. 200.
(c) Sales a/c Dr. 500
___________________
To Sudan Mittal 500
___________________ Sales a/c was wrongly credited in place of Sudan Mittal, rectified.
(d) Salary a/c Dr. 180

tio
___________________ To Suspense a/c 180
Salary a/c was debited less by Rs. 180, hence rectified.
___________________ (e) Suspense a/c Dr. 05
To Repairs a/c 05

uc
___________________
Excess in repairs a/c credited to rectify the error.

___________________
Illustration
___________________

rod
___________________ Rectify the following errors:
1. ` 700 paid for the purchase of new office furniture charged to
office expenses a/c.
ep
2. Goods worth ` 174 were sold to Roop but latter a/c was
actually credited by ` 147.
rR

3. Sales Day book was undercasted by ` 200.

4. The total of the discount column on the debit side of the Cash
book was short by ` 30.
t fo

5. An amount of ` 1000 withdrawn by the proprietor for his


personal use was debited to Trade expenses a/c.
6. ` 200 was received on account of rent but was credited to
dividend a/c.
No

7. Goods sold to Mr. Rakesh for ` 705 but entry was made for `
570.

8. An amount of ` 325 owing by Mukesh was omitted from the


S,

list of Sundry debtors.


Solution
PE

Journal Entries to Rectify the Errors


Dr. Cr.
S.No. Particulars L.F. Amount Amount
U

` `
(i) Office Furniture a/c Dr. 700
To Office expenses a/c 700
(c)

Error in office expenses a/c rectified.

Contd…
UNIT 8: Trial Balance

ale
(ii) Roop Dr. 321 129
To Suspense a/c 321
Error in Roop a/c rectified. Notes
(iii) Suspense a/c Dr. 200
___________________
To Sales a/c 200

n/S
Error in sales a/c rectified. ___________________
(iv) Discount a/c Dr. 30
To Suspense a/c 30 ___________________
Discount columns on debit side short by Rs. 30 corrected.
___________________
(v) Proprietor Drawings a/c Dr. 1000

tio
To Trade expenses a/c 1000
___________________
Error in trade expenses a/c rectified.
(vi) Dividend a/c Dr. 200 ___________________
To Rent a/c 200

uc
Error in dividend a/c rectified. ___________________
(vii) Rakesh Dr. 135
___________________
To Sales a/c 135
Error in Rakesh and Sales a/c rectified (Rs. 705 – 570).

rod
___________________
(viii) Mukesh (Sundry Debtors) Dr. 325
To Suspense a/c 325 ___________________
Error in Mukesh a/c rectified.

Effects of errors on the profits and losses (profit and loss a/c
ep
and Balance Sheet) (Final Accounts): If the error/errors are
there or committed, the effect of such errors would be either
decrease or increase in the Gross Profit/Net Profit. The Profit/Loss
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depicted by profit and loss account would not be correct, so it is


necessary to rectify the errors and arrive at the correct amount of
profit/loss of the period. Similarly, financial position as given by
t fo

the Balance Sheet would also not be correct if some errors are
there/committed. Again, it is also must to rectify the errors at the
earliest, so that Balance Sheet can depict a true and fair view of
the business. The following illustrations would clarify the above
No

points.
Illustration
On 31st Dec, 2012 the Trial balance of Sunil & Co balanced after
inserting a suspense account in the nominal ledger. In the course
S,

of audit, the following facts were discovered:

1. ` 120 received from A had been posted to B's account in the


PE

sales ledger.
2. ` 50 paid for postage stamps had been entered correctly in the
cash book, but not posted.
U

3. In casting the Sales Day Book ` 878 were carried forward as `


(c)

787.
Business Accounting

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130
4. An Invoice of ` 960 in respect of Motor Car debited to Motor
Notes
Car a/c included the cost of licence ` 60.
___________________
5. ` 540 credited to Partners' current Account for interest on

n/S
___________________
capital had been debited to Bank Interest account.
___________________
6. Discount received from Mittal & Co. ` 200 had not been posted
___________________ to Discount a/c. Pass entries necessary to correct the errors

tio
___________________ and prepare the suspense account. Also find out what effect
___________________
these errors would have on the profit for the year ending 31st
Dec, 2012.

uc
___________________
Solution
___________________
Journal Entries to rectify the errors
___________________

rod
Dr. Cr.
___________________ S.No. Particulars L.F. Amount Amount
` `
(a) B Dr. 120
To A 120
Error in B’s a/c Corrected.
ep
(b) Postage a/c Dr. 50
To Suspense a/c 50
Postage a/c Omission corrected.
(c) Suspense a/c Dr. 91
rR

To Sales a/c 91
Sales Day Book balance
Wrongly carried forward
Hence corrected 878 - 787
(d) Motor licence a/c Dr. 60
To Motor Car a/c 60
t fo

Error in Motor Car a/c corrected.


(e) Suspense a/c Dr. 1080
To Partner’s Current a/c 540
To Bank Interest a/c 540
Error in Bank Interest a/c corrected and partners’ a/c credited.
(f) Suspense a/c Dr. 200
To Discount a/c 200
No

Omission in Discount a/c corrected.

Suspense A/c
Dr. Cr.
S.No. Particulars J.F. Amount S.No. Particulars J.F. Amount
` `
S,

(c) To Sales a/c 91 (b) By Postage a/c 50


(e) To Partners’ current a/c 540 By Balance 1321
To Bank Int. a/c 540
PE

(f) To Discount a/c 200


1371 1371

Effects on the profit for the year 2012:


U

(a) No effect.

(b) Net profit is higher by ` 50.


(c)

(c) Gross profit and Net profit is reduced by ` 91.


UNIT 8: Trial Balance

ale
131
(d) Net profit is higher by ` 60.
Notes
(e) Net Profit is reduced by ` 540.
___________________

n/S
(f) Net profit is lower by ` 200.
___________________
The total effect of all errors on profit is ` 721.00 i.e. profit is lower ___________________
to the extent of ` 721 and if corrected, Net profit increases by `
___________________
721.

tio
___________________
Check Your Progress ___________________
Fill in the blanks:

uc
___________________
1. …………………. occur when there is wrong classification ___________________
between the capital and revenue nature incomes or

rod
___________________
expenditures.
___________________
2. Suspense A/c is shown in the ………………….
3. The balances of all the assets accounts and drawing
ep
accounts are recorded in the ………………. of the Trial
Balance.
4. The balances of all incomes and gains are disclosed in
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the ……………. of the Trial Balance.

Summary
t fo

Trial Balance is a list of accounting balances and their names; of


the enterprise during the specified period which includes debit and
credit balances of the various balanced ledger accounts out of the
journal entries. Purposes of preparing the Trial Balance are to
No

prepare a statement of disclosure of final accounting balances of


various ledger accounts on a particular date.
There can be certain errors in recording the accounting
S,

transactions in primary and secondary books of accounts. The


following errors cannot be detected by the trial balance means in
spite of agreeing the totals of debit side and credit side: Error of
PE

omission, Error of commission, Error of principle and


Compensating error.
The errors which can be located in the trial balance are wrong
U

total, balancing error, positioning error etc. Sometimes, it is not


possible to point out errors easily, and then the difference is put to
(c)

an account, known as suspense account.


Business Accounting

ale
132
Lesson End Activity
Notes
Is the agreement of a Trial Balance a conclusive proof of accuracy
___________________
of ledger accounts? If not, what are the errors which remain

n/S
___________________ undetected by the Trial balance?
___________________

___________________ Keywords

tio
___________________ Bill of exchange: A bill of exchange is an unconditional order
___________________ signed by the maker which directs the recipient to pay a fixed sum
of money to a third party at a future date.

uc
___________________

___________________ Suspense account: Sometimes, it is not possible to point out


errors easily, and then the difference is put to an account, known
___________________

rod
as suspense account.
___________________
Trial balance: It is the list of accounts taken from the ledger.
Error of Omission: These errors occur when any business
transaction is completely or partially omitted from the recording in
ep
the books of original records.
Error of Commission: Such types of errors are found when one
rR

account is debited or credited in the place of another account.


Error of Principle: These errors occur when there is wrong
classification between the capital and revenue nature incomes or
t fo

expenditures.

Questions for Discussion


No

1. What is a Trial Balance? Name the errors that are disclosed by


Trial Balance.
2. What is Trial Balance? Is it true to say that results are
accurate if Trial Balance tallies?
S,

3. What do you mean by a Trial Balance? Discuss its main objects


& show how it is prepared.
PE

4. Give two examples each of the one sided and doubles sided
errors. How are they corrected?
5. Explain the errors (i) which are revealed by the Trial Balance
U

and (ii) the errors which are not revealed by the trial balance.
(c)

6. Discuss the errors which do not affect the agreement of a trial


balance.
UNIT 8: Trial Balance

ale
133
7. Distinguish between -
Notes
(a) Balance Sheet and a Trial Balance
___________________

n/S
(b) Errors of commission and errors of omission.
___________________
8. Write short-notes on the following: ___________________
(i) Error of Principle ___________________

tio
(ii) Compensatory errors ___________________

(iii) Factors affecting disagreement of Trial Balance. ___________________

9 The following balances are extracted from the books of Mr.

uc
___________________
Rakesh as on 31.12.2005 ___________________
` `

rod
Capital 15,000 Purchases 7 ,200 ___________________
Land & Building 15,600 Provision for bad debts 370
Bank overdraft 2,500 Sales 17,000 ___________________
Cash in hand 680 Wages 1250
Stock in Trade as on 1.1.04 6,000 Salaries 700
Advertisement 210 Insurance 40
ep
Rent & Taxes 160 Discount allowed 300
Interest & Discount received 300 Repairs to building 210
Debtors 6420 Creditors 4,100
General Expenses 500
rR

Prepare a trial balance


10. Give the journal entries necessary to rectify the following
errors:
t fo

(i) A payment of Rs. 250 for purchase of a Typewriter for


office use has been debited to Purchases a/c.

(ii) A credit sale of ` 127 to Mr. Chandra has been posted to


No

the debit of Mr. Kuchhal's account from the Sales Day


book.
(iii) A payment of ` 96 for white washing the office has been
charged to Buildings accounts.
S,

11. Rectify the following Errors:


(i) Wages paid for the construction of office debited to wages
PE

account ` 1,500.

(ii) Cartage paid for the newly purchased furniture ` 10


posted to cartage account.
U

(iii) Furniture purchased on credit from Ram for ` 300 posted


as ` 30.
(c)

(iv) Sales to X ` 400 posted to Y's account.


Business Accounting

ale
134
(v) Wages paid ` 2,550 were recorded in the cash book as Rs.
Notes
2,505.
___________________
(vi) Purchases from Y ` 1,002 were omitted from the books.

n/S
___________________
12. There was difference in the trial balance of Sri Arihant which
___________________
was put to a newly opened suspense account. Subsequently the
___________________ following mistakes were discovered. Pass journal entries to

tio
___________________ rectify them and ascertain the difference in the trial balance.
___________________ (i) Materials Costing ` 1700 in the erection of the machinery
and the wages for it amounting to ` 1,400 were included in

uc
___________________
the purchases account and the wage account respectively.
___________________
(ii) Goods sold under credit terms ` 16,900 to music were
___________________

rod
recorded properly in the sales book but were debited to his
___________________
account as ` 19600 and carriage outward and freight paid
` 700 chargeable from him were posted to sales expenses
account.
ep
(iii) Sales return by Yogeshwar ` 2300 was correctly recorded
in the sales return book from where they were debited to
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Yogeshwar's account by ` 32.

(iv) Old furniture originally purchased for ` 1800 written


down to ` 1100 was sold for ` 1700 and was credited to
furniture account.
t fo

(v) Machinery purchased on credit ` 17000 was recorded in


purchases book and transport charges for the machine `
1200 were debited to trade expenses account.
No

13. From the following transactions, pass journal entries, prepare


ledger accounts and also prepare Trial Balance under:
`

1. Anil started business with 8,000


S,

2. Purchased furniture 1,000


3. Purchased goods 6,000
PE

4. Sold goods 7,000


5. Purchased from Raja 4,000
6. Sold to Somu 5,000
U

7. Paid to Raja 2,500


8. Received from Somu 3,000
(c)

9. Paid rent 200


10. Received commission 100
UNIT 8: Trial Balance

ale
Further Readings 135
Notes
Books ___________________

n/S
T.S. Grewal, M.C. Shukla. “Advanced Accounts”. S. Chand, New ___________________
Delhi.
___________________
R.L. Gupta, M. Radhaswami. “Advanced Accountancy”. Sultan
___________________
Chand, New Delhi.

tio
___________________
Dr. S.N. Maheshwari, Sharad, K. Maheshwari. “Financial
___________________
Accounting”. Vikas Publishing Co. Pvt. Ltd., New Delhi.

uc
___________________
Pandikumar, M. P (2007). “Management Accounting, Excel Books”.
New Delhi. ___________________

rod
___________________
Web Readings
___________________
www.futureaccountant.com
http://www.cliffsnotes.com/study_guide/The-Trial-
ep
Balance.topicArticleId-21081,articleId-21014.html
http://www.futureaccountant.com/accounting-process/study-
notes/trial-balance.php
rR

http://www.lapasserelle.com/online_courses/accounting/from_trial_
balance_to_balance_sheet/index.html
t fo
No
S,
U PE
(c)
Business Accounting

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136
Notes

___________________

n/S
___________________

___________________

___________________

tio
___________________

___________________

uc
___________________

___________________

___________________

rod
___________________
ep
rR
t fo
No
S,
U PE
(c)
UNIT 9: Financial Statements

ale
Unit 9
137
Notes
Activity

Financial Statements
Prepare a presentation
___________________

n/S
showing the meaning and
___________________
persons interested in financial
statements.
___________________
Objectives
___________________
After completion of this unit, the students will be aware of the following

tio
topics: ___________________

\ Meaning of Financial Statements ___________________


\ Final Accounts with Adjustments

uc
___________________
\ Manufacturing Account
___________________
\ Balance Sheet

rod
___________________

___________________
Introduction
In the present unit, you will study about the final accounts with
ep
adjustments. After studying this unit, you will be able to
understand the trading and profit and loss account, balance sheet
and key adjustments related to them. Every organisation prepares
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its final accounts after a particular period to know its financial


results and financial position. Final accounts mean profit and loss
account and the balance sheet. Profit and loss account also
contains one more account, known as trading account, and if the
t fo

business is manufacturing any item or article, then Manufacturing


account is also there. All these accounts are prepared only after
preparing trial balance.
No

Meaning of Financial Statements


Financial statements mean (i) Balance sheet, (ii) profit and loss
account, and (iii) several other schedules. Now-a-days one more
S,

statement is also prepared that is funds flow statement or cash


flow statement.
PE

Whatever business activities are done, it is essential to know its


operational results i.e. whether business is running at profit or
loss, for this purpose balances of all ledger accounts are taken and
U

a statement of balances is prepared which is known as trial


balance. Final accounts are prepared from such balances.
(c)

Therefore, it is necessary to know the meaning and object of final


accounts.
Business Accounting

ale
138
Final accounts mean profit and loss account and the balance sheet.
Notes
Profit and loss account also contains one more account, known as
___________________
trading account, and if the business is manufacturing any item or

n/S
___________________ article, then Manufacturing account is also there. All these
___________________ accounts are prepared only after preparing trial balance.

___________________ Objective of Preparing Final Accounts

tio
___________________ There are two objectives of preparing Final accounts- 1) know the
___________________ operational results i.e. profit or loss during a particular period
through the profit and loss account which is also known as income

uc
___________________
statement, and 2) ascertain the financial position of the business
___________________
on a particular date through the balance sheet, also known as
___________________ position statement.

rod
___________________
Persons Interested in Financial Statements
There are two types of persons interested in financial statements—
1. Internal users and 2. External users.
ep
1. Internal Users: These are a) Shareholders, b) Management,
and c) Trade unions employees etc.
rR

a. Shareholders are very much interested in the financial


statements. They are very much interested in the welfare
of the business. They can know the operational results
t fo

through such financial statements and the financial


position of the business along with the earning capacity of
the business.
b. Management is interested to take important decisions
No

relating to fixing up the selling prices and making future


policies.
c. Trade unions and employees are interested to know the
operational results because their bonus etc. is dependent
S,

on the profit earned by the business. Financial Statements


also help in their negotiations for wages/salaries.
PE

2. External Users: There are number of persons interested in


financial statements. They are termed as external users. The
following are most important external users of financial
U

statements.
3. Investors: They are interested to know the earning capacity of
(c)

business which can be known through financial statements.


UNIT 9: Financial Statements

ale
They can also know the financial soundness of the business 139
through financial statements. Notes
Activity
4. Creditors, Lenders of Money etc: The creditors and lenders Find___________________
out the requirement of

n/S
Schedule VI (Part I&II) of the
of money etc. can also know the financial soundness through ___________________
Companies Act, 1956 in
financial statement. They have to see two things (i) Regularity respect of:
___________________
of income and (ii) solvency of the business so that their (i) Fixed Assets
investment is risk free. ___________________
(ii) Investments

tio
5. Government: Government is interested to formulate laws to (iii) ___________________
Turnover
regulate business activities and also law relating to taxation (iv) ___________________
Contingent Liabilities
etc. Financial statements help while computing National (v) ___________________
Debtors

uc
Income statistics etc.
___________________
6. Taxation authorities: Financial Statements provide

rod
___________________
information relating to operational results as well as financial
___________________
position of the business. Tax authorities decide the amount of
tax as per financial statement. It is very useful to other
taxation authorities such as sales tax etc.
ep
7. Stock Exchange: Stock Exchange is meant for dealing in
share/securities. Purchase and sale of such shares and
rR

securities are possible through stock exchanges which provide


financial information about each company which is listed with
them.
Thus, we see that financial statements are very helpful and useful.
t fo

Check Your Progress


Fill in the blanks:
No

1. ……………….. mean profit and loss account and the


balance sheet.
2. There are two types of persons interested in financial
statements—(a) ……….. users and (b) ………………..
S,

users.
PE

Final Accounts with Adjustments


Final accounts are prepared from the various balances depicted by
the Trial Balance. Some balance of the Trial Balance accounts are
U

used to prepare the Trading Account and some for the preparation
of the Profit and Loss Account and the remaining balances are
(c)

transferred to the Balance Sheet. Thus all the balances of accounts


Business Accounting

ale
140 of the Trial Balance are used in the final accounts. Therefore the
Notes preparation of final accounts is the final stage of accounting.
___________________
Trading and Profit & Loss Account

n/S
___________________
In the Trading and Profit & Loss Account all those accounts are
___________________
disclosed which affect the profit or loss of the business. In other
___________________ words all the nominal accounts of the Trial Balance are used to

tio
___________________ prepare the Trading and Profit & Loss Account. In the left hand
side, all the expenses incurred during a period and in the right
___________________
hand side all the incomes earned during a period are disclosed.

uc
___________________ This account contains two parts:
___________________
z Trading Account
___________________

rod
z Profit & Loss Account
___________________
Trading Account
Trading account is the comparison of sales and purchase. This
ep
account is prepared to determine the amount of gross profit or
gross loss on sales. The proforma of Trading Account is given
below:
rR

Proforma of Trading Account


IN THE BOOKS OF …………….
Trading Account
t fo

(for the year ending …………….)

Particulars Dr. Particulars Cr.


Amount Amount
(`) (`)
To Opening Stock ------- By Sales ----------
No

To Purchases --------- Less : Returns ---------- -------


Less: Returns --------- ------- By Closing stock -------
To Wages & Salaries ------ By Gross Loss (if any)
To Carriage Inwards ------- Transferred to P/L A/c -------
To Cartage ------
To Frieght -------
To Light Power & Heating in
S,

factory ------
To Factory Insurance -------
To Works Manager’s Salary ------
PE

To Foreman’s Salary -------


To Factory Rent & Taxes ------
To Motive Power -------
To Factory Repairs ------
To Factory Expenses -------
To Octroi duty ------
U

To Custom Duty -------


To Manufacturing Exps. ------
To Consumable Stores -------
(c)

To Gross Profit ------


Transferred to P/L A/c. -------
------ -------
UNIT 9: Financial Statements

ale
Note: 141
Notes
z There is no particular proforma of the Trading Account. The
___________________
above proforma given is traditional one. That is not as per law.

n/S
Here the students are advised to follow this proforma. ___________________

z If the total of credit side is more than the total of debit side, ___________________
difference is called gross profit or vice versa gross loss. ___________________

tio
Illustration ___________________

From the following information, calculate the stock at the end: ___________________

uc
___________________
`
Opening stock 62,000 ___________________
Purchases 4, 20,000

rod
___________________
Sales 6, 00,000
___________________
1
Rate of Gross Profit on Cost = 33
3
Solution
ep
1
Gross profit on cost = 33
3
rR

1
33
Hence Gross profit on Sales = 3 = 1 or 25%
1 4
133
t fo

Trading Account
(for the year ended………)

Particulars Rs. Particulars Rs.


No

To opening stock 62,000 By sales (given) 6,00,000


To purchases 4,20,000 By closing stock
To gross profit (Balancing figure) 32,000

1 1,50,000
On cost 33 % or
S,

25% on sales which is Rs. 6,00,000


PE

6,32,000 6,32,000

Thus, we can say that the value of stock at the end was ` 32,000.
U

Profit & Loss Account


(c)

Profit & Loss Account is the second part of Trading and Profit &
Loss Account. Trading Account depicts the gross profit which is the
Business Accounting

ale
142 difference of sales and cost of sale. Thus the gross profit cannot
Notes treated as net profit while the businessman wants to know how
___________________ much net profit he has earned from the operating activities during
a period. For this purpose Profit & Loss Account is prepared

n/S
___________________
keeping in mind all the operating and non-operating incomes and
___________________
losses of the business. In the debit (left hand side) side all the
___________________ expenses and losses are disclosed and in the credit side (right hand

tio
___________________ side) all the incomes are disclosed. The excess of credit side over
debit side is called net profit while the excess of debit side over
___________________
credit side shows net loss. Net profit increases the net worth of the
business; therefore, it is added to the capital of owner. Net loss

uc
___________________

___________________ decreases the net worth of business so it is subtracted from capital.


___________________
The proforma of Profit & Loss Account is given below:

rod
___________________ Proforma of Profit & Loss Account
ep
rR
t fo
No
S,
U PE
(c)

Contd…
UNIT 9: Financial Statements

ale
143
Notes

___________________

n/S
___________________

___________________

___________________

tio
___________________

___________________

uc
___________________
Illustration
___________________
Compute operating profit and net profit from the following

rod
___________________
information:
___________________
Particulars `. Particulars `
Gross profit 2,50,000 Donation 4,250
Salaries 77,000 Rent received 2,300
Advertizing 4,000 General Expenses 550
Rent and taxes 26,500 Interest on investment 4,300
ep
Insurance charges 3,720
Audit fee 2,700
Carriage outward 1,210
Loss on sale of plant 3,100
Printing and stationery 1,100
rR

Interest on loans 15,000


Loss by theft 12,500
Profit on sale of Machinery 41,000

Solution:
t fo

Statement showing operating profit & Net profit


Particulars ` `.
Gross Profit 2,50,000
Less
Office and administrative expenses
Salaries 77,000
No

Rent and taxes 26,500


Insurance charges 3,720
Audit fee 2,700
Printing and stationery 1,100
General expenses 550 1,11,570

Less
Selling and distributive expenses 1,210
S,

Carriage outwards 4,000 5,210 -1,16,780

Advertising 1,33,220
Operating profit
Add-
PE

Non operating Income-


Interest on investments 4,300
Rent received 2,300
Profit on sale of Machinery 41,000 47,600 +47,600
Less 1,80,820
Non operating expense-
U

Interest on loans 15,000


Loss on sale of plant 3,100
Donations 4,250
Loss by theft 12,500 34,850 – 34,850
(c)

Net profit 1,45,970


Business Accounting

ale
144 In case of Net loss reverse entry is to be passed i.e.
Notes
Capital a/c (Net loss) Dr.

___________________ To profit and loss a/c

n/S
Net loss transferred
___________________

___________________ Illustration:

___________________ Following is the trial balance of R. Prasad on 30 June 2012.

tio
___________________ Dr. Cr.
Particulars ` `
___________________ Capital - 15,000
Purchases 20,000 -

uc
___________________ Sales - 30,000
Wages 1,200 -
___________________ Furniture 800 -
Salaries 900 -
Traveling Expenses 700 -
___________________

rod
Commission 300 -
Cash in hand 1,000 -
___________________ Cash at Bank 3,400 -
Buildings 16,000 -
Debtors & Creditors 4,500 4,000
Bills Payable & Bills Receivable 600 800
Telephone 100
ep
Returns 500 200
50,000 50,000

On 30th June 2012 stock was valued at ` 7,500. Prepare Trading


rR

and Profit and Loss account for the year ended on 30th June 2010
Solution:
t fo

Trading and Profit and Loss account of Mr. R. Prasad


(for the year ended on 30th June 2012)
Particulars ` Particulars `
To Purchases 20,000 By sales 30,000
-Returns 200 19,800 -Returns 500 29,500
No

To Wages 1,200 By Closing stock 7,500


To Gross Profit c/d 16,000

37,000 37,000
To Salaries By Gross profit b/d
To Travelling Expenses 900 16,000
To Commission 700
To Telephone 300
S,

To Net Profit 100


14,000
16,000 16,000
PE

Manufacturing Account
If in the business some goods are being manufactured along with
the trading activities, a manufacturing account is also prepared. In
U

the case of trading activities (selling and purchasing of goods) only,


the Trading and Profit and Loss Account is prepared to compute
(c)

the net profit which is discussed in the preceding pages. In case


UNIT 9: Financial Statements

ale
there is a manufacturing unit in the business with the trading, 145
such a businessman's income statement will include: Notes

(i) Manufacturing Account ___________________

n/S
(ii) Trading Account ___________________

___________________
(iii) Profit and Loss Account
___________________
Manufacturing Account is prepared to know the results of

tio
manufacturing unit i.e. cost of production. This account is prepared ___________________
before the trading account. The balance of this account is ___________________
transferred to Trading Account. The proforma of Manufacturing

uc
___________________
Account is given hereunder:
___________________
Pro forma of Manufacturing Account

rod
___________________
Manufacturing Account
(for the year ending ………) ___________________

Particulars ` Particulars `
ep
To Opening Stock By Closing Stock
Raw Materials -------- Raw Materials ------
Work-in-progress -------- ---- Work-in-progress ------ ----
To Purchase of materials ----- By Sale of Scrape ----
rR

Less returns ----- ---- By Cost of Production (Transferred ----


To Manufacturing Wages ---- to Trading A/c)
To Carriage Inwards ----
To Factory Expenses ----
To Stores Consumed ----
t fo

To Factory Rent ----


To Electricity ----
To Depreciation on Plant ----
To Repairs of Plant ----
To Works Manager’s Salary ----
To Coal and Fuel ----
No

To Other Factory exps. ----


---- -----

Illustration (Manufacturing, Trading and Profit & Loss A/c)


From the following particulars of Mr. Amit Agrawal, prepare a
S,

Manufacturing Account, Trading and Profit and Loss Account for


the year ended 31st March, 2012.
PE

`
Purchase of Raw Material 39,58,500
Return Inwards 21,000
U

Stock on 31st March, 2010:


Raw Materials 3,63,000
(c)

Work-in-Progress 3,00,000
Finished Goods 4,11,000
Business Accounting

ale
146 Productive Wages 6,00,and 000
Notes Factory Expenses 5,52,000
___________________ General Office Expenses 90,000

n/S
___________________ Salaries 1,80,000
Distribution Expenses 30,000
___________________
Selling Expenses 2,10,and 000
___________________
Purchase Expenses 1,80,000

tio
___________________
Export Duty 90,000
___________________
Import Duty 60,000

uc
___________________ Interest on Bank Loan 1,80,000
___________________ Stock on 1st April, 2009:

___________________ Raw Material 1,20,000

rod
___________________ Work-in-Progress 90,000
Finished Goods 1,23,000
Sales 58,50,000
ep
Return Outwards 25,500
Carriage Inwards 31,500
Discount allowed 3,000
rR

Sale of Scrap 6,000


Depreciation on Plant 1,50,000
Depreciation on Furniture 12,000
t fo

Solution:

Manufacturing Account
(for the year ending 31st march, 2012)
No

Particulars ` Particulars `

To Opening Stock
Materials 1,20,000 By Sale of Scrap 6,000
Work-in-Progress 90,000 By Closing Stock:
To Purchase less Returns Materials 3,63,000
S,

(39,58,500- 25,500) 39,33,000 Work-in-Progress 3,00,000


To Productive Wages 6,00,000 By Cost of Production
To Factory Exps 5,52,000 (Transferred to Trading A/c) 50,76,000
To Purchase Exps. 1,80,000
PE

To Import Duty 60,000


To Carriage Inwards 30,000
To Depreciation on Plant 1,50,000
To Repairs to Machines 30,000
57,45,000 57,45,000
U
(c)
UNIT 9: Financial Statements

ale
Trading and Profit & Loss Account 147
(for the year ending 31st march, 2012) Notes
Activity
Particulars Amount Particulars Amount List___________________
the five items which
` `

n/S
appear in the liability side of
the___________________
Balance Sheet of a
To Opening Stock of Finished By Sales less Returns
Goods 1,23,000 (58,50,000 – 21,000) 58,29,000 company.
___________________
To Cost of Production By Closing Stock 4,11,000
(Transfer from Manufacturing
A/c)
___________________

tio
50,76,000
To Gross Profit c/d
10,41,000 ___________________
62,40,000 62,40,000
90,000 By Gross Profit b/d 10,41,000 ___________________
To General Office Exps.
1,80,000

uc
To Salaries
___________________
To Depreciation on Furniture 12,000
To Discount Allowed 9,000
___________________
To Carriage Outwards 25,500
To Interest on Bank Loan 1,80,000

rod
___________________
To Export Duty 90,000
To Selling Expenses 2,10,000 ___________________
To Distribution Expenses 30,000
Not Net Profit (Transferred to
Capital A/c.) 2,14,500
10,41,000
ep
10,41,000

Check Your Progress


rR

Fill in the blanks:


1. In the …………………………all those accounts are
disclosed which affect the profit or loss of the business.
t fo

2. …………………..is the comparison of sales and purchase.


3. …………………..is prepared to know the results of
manufacturing unit i.e. cost of production.
No

Balance Sheet
After the determination of the net profit of the business through
the Trading and Profit and Loss Account, the businessman wants
S,

to know the financial position of the business. For this purpose he


prepares a statement which is called the Balance Sheet. The
PE

Balance Sheet depicts the financial position of the business on a


fixed date. Balance Sheet is prepared with those balances of Trial
Balance which are left out (personal and real accounts) after
U

taking out the nominal accounts' balances to prepare the Trading


and Profit and Loss Account. A Balance Sheet has two sides–assets
(c)

side and liabilities side. The assets and liabilities are shown in a
particular order.
Business Accounting

ale
148 Definition of Balance Sheet
Notes
1. "The Balance Sheet is a statement at a given date showing on
___________________
one side the traders' property and possessions and on the other

n/S
___________________ hand his liabilities".
___________________ - Palmer
___________________ 2. "Balance Sheet is a screen picture of the financial position of a

tio
___________________ business at a certain moment."
___________________ - R. Stead
3. "Balance Sheet is a list of balances in the assets and liability

uc
___________________

___________________ accounts. This list depicts the position of assets and liabilities
of a specific business at a specific point of time".
___________________

rod
- American Institute of Certified Public Accountants
___________________

Marshalling of Assets and Liabilities


Order of presenting the assets and liabilities in the Balance Sheet
ep
is called marshalling of assets and liabilities. A Balance Sheet may
be prepared by marshalling the assets and liabilities in the
following orders:
rR

(a) Balance Sheet prepared in Liquidity Order: Here liquidity


means conversion of assets into cash. When a Balance Sheet is
prepared on the basis of liquidity order, more easily
t fo

convertible assets into cash are shown first and those assets
which cannot be easily converted into cash are shown later and
so on. In the case of liabilities, first those liabilities are shown
which are payable earlier and then those liabilities are shown
No

which are payable later. The proforma of such a Balance Sheet


is given below:

Proforma of Balance Sheet in Order of Liquidity


S,

(as on ………………….. )
Liabilities Amount Assets Amount
` `
PE

Current Liabilities Current Assets


Sundry Creditors ------ Cash in Hand ------
Bank Overdraft ------ Cash at Bank ------
Short-term Loan ----- Short-term Investment ------
Outstanding Expenses ----- Prepaid Expenses ------
U

Unaccrued Income ----- Bills Receivable ------


Bills Payable ----- Accrued Incomes ------
Long-term Liabilities Debtors ------
Capital ------- Closing Stock ------
(c)

+ Net Profit ------- Fixed Assets


------- Land & Building -----
- Drawings ------- ----- Plant & Machinery -----
Contd…
UNIT 9: Financial Statements

ale
Long-term Loans ----- Furniture ----- 149
Contingent Liabilities Investments (Long-term) -----
-------- Goodwill ------ Notes
-------- Patents & Trademarks ------
Livestock ------ ___________________

n/S
------- -------
___________________
(b) Balance Sheet prepared in Permanency Order: Balance ___________________
Sheet prepared under this order is the reverse of the Balance
___________________
Sheet prepared in liquidity order. In this case first those assets

tio
are shown which are more permanent means fixed assets and ___________________

then less permanent assets (Current Assets) are shown. ___________________


Similarly, first long-term liabilities (more permanent) are

uc
___________________
shown then less permanent (short-term on current) liabilities
___________________
are shown. The proforma of such type of Balance Sheet is
given below:

rod
___________________

Proforma of Balance Sheet in Permanency Order ___________________

(as on ……………. )
Liabilities Amount Assets Amount
ep
` `

Long-term Liabilities Fixed Assets


Capital ------ Land & Building -----
+ Net Profit ------ Plant & Machinery -----
rR

------ Furniture -----


- Drawings ------ ------ Long-term Investment -----
Long-term Loans ------ Goodwill -----
Current Liabilities Patents & Trademarks -----
Sundry Creditors ------ Livestock etc. -----
Bank Overdraft ------ Current Assets
Bill Payable ------ Cash in Hand -----
t fo

Short-term Loan ------ Cash in Bank -----


Outstanding Expenses ------ Short-term Investments -----
Unaccrued Incomes ------ Bill Receivable -----
Prepaid Expenses -----
Accrued Incomes -----
Debtors -----
Closing Stock -----
No

------ -----

Illustration (Manufacturing, Trading and Profit and Loss


Account and Balance Sheet)
From the following Trial Balance of Mr. Aditya, prepare a Trading
S,

Manufacturing and Profit and Loss Account and Balance Sheet as


on 31st December, 2012.
PE

Trial Balance
(as on 31 December, 2012)
Amount Amount
U

Particulars
` `
(c)

Stock on 1.1.2007:
Raw Materials: 8,000 ---
Work-in-Progress 20,000 ---
Contd…
Business Accounting

ale
150
Finished Goods 40,000 ---
Notes Manufacturing Wages 40,000 ---
Purchases of Raw Materials 1,20,000 ---
___________________
Factory Rent 20,000 ---

n/S
___________________ Carriage of Raw Materials 12,000 ---
Salary of the Works Manager 8,000 ---
___________________ Office Rent 8,000 ---
Printing and Stationary 4,000 ---
___________________ Bad Debts 4,000 ---

tio
Sales --- 2,40,000
___________________
Land and Buildings 1,20,000 ---
___________________ Plant and Machinery 80,000 ---
Depreciation on Plant 8,000 ---

uc
___________________ Sundry Debtors 20,000 ---
Sundry Creditors --- 1,20,000
___________________ Cash in Hand 20,000 ---
Capital --- 1,72,000
___________________

rod
5,32,000 5,32,000
___________________
Closing stock on 31st December, 2012 were as follows:
`
ep
Raw Materials 20,000
Work-in-Progress 16,000
Finished Goods 40,000

Solution:
rR

In the Books of Mr. Aditya


Manufacturing Account
(for the year ended 31 December, 2012)
t fo

Particulars ` Particulars `
To Opening Stock: By Closing Stock:
To Raw Materials 8,000 By Raw Material 20,000
To Work-in-Progress 20,000 28,000 By Work-in-Progress 16,000 36,000
No

To Purchase of Materials 1,20,000 By Cost of Production


To Carriage on Raw Materials 12,000 (Transfer to Trading A/c.) 2,00,000
To Depreication on Plant 8,000
To Manufacturing Wages 40,000
To Factory Rent 20,000
To Salary of Works Manager 8,000
S,

2,36,000 2,36,000

Trading and Profit & Loss Account


PE

(for the year ending 31st December, 2012)

Particulars Amount Amount


` `

To Opening Stock: By Sales


U

Finished Goods By Closing Stock 2,40,000


To Cost of Production 40,000 Finished Goods
2,00,000 40,000
(c)

(Transfer from Manufacturing A/c)


To Gross Profit
Contd…
UNIT 9: Financial Statements

ale
(carried to P. & L. A/c)
151
40,000
Notes
To Office Rent 2,80,000 By Gross Profit (brought 2,80,000
To Printing & Stationary 8,000 from Trading A/c) ___________________

n/S
To Bad Debts 4,000 40,000
4,000 ___________________
To Net Profit (carried to Capital A/c)
___________________
24,000
40,000 40,000 ___________________

tio
Balance Sheet ___________________

(as on 31st December, 2012) ___________________


Liabilities Amount Assets Amount

uc
` ` ___________________

Capital 1,72,000 Land and Buildings 1,20,000


___________________
+ Net Profit 24,000 1,96,000 Plant and Machinery 80,000

rod
Sundry Creditors 1,20,000 Sundry Debtors 20,000 ___________________
st
Stock on 31 Dec., 2007:
Raw Materials 20,000 ___________________
Work-in-Progress 16,000
Finished Goods 40,000
Cash in Hand 20,000
3,16,000 3,16,000
ep
Adjustment Entries
rR

Final accounts are prepared from the balances of Trial Balance.


The final account will show the true and proper picture of the
business only when all the transactions of the business are
properly recorded. Therefore, before the preparation of final
t fo

accounts the accountant must see that all the transactions of the
current year have been recorded properly in the books or not. If the
accountant finds that some transactions are not incorporated in
the books or wrongly incorporated in books or partially
No

incorporated in books, to complete the records and rectifying the


errors done, some adjustments are done. These adjustments
entries are made in accounts through passing the adjustment
entries. Usually adjustment entries are made in the books before
S,

preparing the final accounts for the following items:

(1) For Outstanding Expenses of the business


PE

Relating Expenses Account Dr.


To Outstanding Expenses Account
U

The outstanding expenses at the time of preparation of final


account are shown in the liability side and on the other hand it
(c)

is added in the relating expenses in the Trading and Profit &


Loss Account.
Business Accounting

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152
Notes (2) For Prepaid Expenses of the Business

___________________ Prepaid Expenses Account Dr.

n/S
___________________ To Relating Expenses Account
___________________
The prepaid expenses are disclosed in the assets side of the
___________________ Balance Sheet and subtracted from the relating expenses in

tio
___________________ the debit side of Trading and Profit & Loss Account.
___________________ (3) For Accrued Incomes of the Business

uc
___________________
Accrued Income Account Dr.
___________________
To Relating Income Account
___________________

rod
The accrued incomes are disclosed in the assets side of the
___________________
Balance Sheet and showed in the credit side of the Trading
and Profit & Loss Account.

(4) For Unaccrued Incomes of the Business


ep
Relating Income Account Dr.
rR

To Unaccrued Income Account

Unaccrued incomes are disclosed in the liability side of the


Balance Sheet and subtracted from the relating incomes in the
t fo

credit side of the Trading and Profit & Loss Account.

(5) For the Depreciation on Assets

Depreciation Account Dr.


No

To Relating Assets Account

Depreciation is subtracted from the relating assets in the


assets side of the Balance Sheet and disclosed in the debit side
of Trading and Profit & Loss Account.
S,

(6) Interest on Capital and Drawings:


PE

(i) For Interest on Capital

Interest on Capital Account Dr.


U

To Capital Account

Interest on Capital is added to the capital of owner in the


(c)

liabilities side of the Balance Sheet and disclosed in the


debit side of the Trading and Profit & Loss Account.
UNIT 9: Financial Statements

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153
(ii) For Interest on Drawings
Notes
Drawings Account Dr. ___________________

n/S
To Interest on Drawings Account ___________________

Interest on Drawings is subtracted from the amount of capital ___________________

along with the drawings and also shown in the credit side of ___________________

tio
Trading and Profit & Loss Account. ___________________

(7) Interest on Loan and Investments: ___________________

uc
(i) For Interest on Loan Payable ___________________

___________________
Profit & Loss Account Dr.

rod
___________________
To Interest on Loan Account
___________________
Interest on Loan payable is added to the amount of Loan
in the liability side of the Balance Sheet and also shown in
the debit side of Profit & Loss Account.
ep
(ii) For Interest on Investment Receivable
rR

Interest on Investment Account Dr.

To Profit & Loss Account

Interest on Investment Receivable is added to investment in


t fo

the assets side of the Balance Sheet and also shown in the
credit side of Profit & Loss account.

8. For Bad Debts


No

Bad Debts Accounts Dr.

To Sundry Debtors Account

Bad Debts are deducted from the sundry debtors in the assets
S,

side of the Balance Sheet and shown in the debt side of Profit
and Loss Account.
PE

9. For Provision for Bad and Doubtful Debts

(i) When the provision is created:


U

Profit & Loss Account Dr.

To Provision for Bad and Doubtful Debts Account


(c)
Business Accounting

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154
Such a provision is subtracted from the debtors in the
Notes
assets side of Balance Sheet and also shown in the debt
___________________
side of Profit and Loss Account.

n/S
___________________
(ii) When Bad Debts are written off against the Provision
___________________
for Bad and Doubtful Debts :
___________________
Provision for Bad and Doubtful Debts Account Dr.

tio
___________________
To Bad Debts Account
___________________
(iii) When excess amount of the provision is transferred:

uc
___________________

___________________
Provision for Bad and Doubtful Debts Account Dr.

___________________ To Profit & Loss Account

rod
___________________ 10. For Discount Provision on Debtors

(i) When the provision for discount on debtors is created:

Profit & Loss Account Dr.


ep
To Provision for Discount on Debtors Account

Provision for discount on Debtors is subtracted from


rR

Sundry Debtors in the assets side of Balance Sheet and


shown in the debit side of Profit and Loss Account.

(ii) When the amount of discount is written off against the


t fo

Provision for Discount Account:

Provision for Discount on Debtors Account Dr.

To Discount on Debtors Account


No

(iii) When excess amount of provision is transferred:

Provision for Discount on Debtors Account Dr.

To Profit and Loss Account


S,

11. For Discount Provision on Creditors


PE

(i) When provision for discount on creditors is created:

Provision for Discount on Creditors Account Dr.


U

To Profit and Loss Account

Provision for discount on creditors is deducted from


(c)

Creditors in the liability side of Balance Sheet and shown


in the Credit side of Profit and Loss Account.
UNIT 9: Financial Statements

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155
(ii) When discount on creditors is written off against the
Notes
provision:
___________________
Discount on Creditors Account Dr.

n/S
___________________
To Provision for Discount on Creditors Account
___________________
Illustration (Final Accounts with Adjustment)
___________________
Prepare final accounts from the following balances of Mr. Ankit as

tio
___________________
on 31st December, 2012.
___________________
Extracts of Balances

uc
___________________
As on 31st December, 2012
Debit Balances ` Credit Balances ` ___________________

rod
Drawings 45,000 Capital Account 6,09,000 ___________________
Goodwill 90,000 Bills Payable 41,400
Land and Building 1,80,000 Sundry Creditors 91,500
___________________
Plant and Machinery 1,20,000 Purchase Returns 7,950
Loose tools 9,000 Sales 3,45,000
Bills Receivable 6,000
ep
Stock 1.1.2007 1,20,000
Purchase 1,53,000
Wages 60,000
Carriage Inwards 3,600
rR

Carriage Outwards 4,500


Coal and Gas 16,800
Salaries 12,000
Rent, Rates and Taxes 8,400
Discount allowed 4,500
t fo

Cash at Bank 75,000


Cash in Hand 4,200
Sundry Debtors 1,35,000
Repairs 5,400
Printing and Stationery 1,500
Bad Debts 3,600
No

Advertisments 10,500
Sales Returns 6,000
Furniture and Fittings 3,600
General Expenses 15,750

Adjustments
S,

(a) Closing stock on 31st December, 2007 was `1,80,and 000.

(b) Depreciate Plant and Machinery at 5%, Loose Tools at 15%


PE

and Furniture and Fittings at 5%.


(c) Provide 21/2% for Discount on Sundry Debtors and Creditors
and 5% for Bad and Doubtful Debts.
U

(d) Outstanding Wages `4,500 and Rent and Taxes `2,550.


(c)
Business Accounting

ale
156 Solution:
Notes
In the Book of Mr. Ankit
___________________
Trading and Profit & Loss Account

n/S
___________________ (for the year ending on 31st December, 2012)
Particulars Amount Particulars Amount
___________________ ` `

___________________ To Opening Stock 1,20,000

tio
To Purchases Less Returns By Sales Less Returns 3,39,000
___________________ (Rs.1,53,000 – 7,950) 1,45,050 (Rs.3,45,000 – 6,000) 1,80,000
Wages 60,000 By Closing Stock
___________________ + O/s Wages 4,500 64,500
To Carriage Inwards 3,600

uc
___________________ To Coal and Gas 16,800
To Gross Profit C/d 1,69,050
___________________ 5,19,000 5,19,000
To Carriage Outwards 4,500 1,69,050
___________________ To Salaries 12,000 By Gorss Profit b/d

rod
To Rent, Rates & Taxes 8,400 By Reserve for Discount on 2,250
1
+ Outstanding 2,550 10,950 Creditors @2 /2%
___________________
To Discount Allowed 4,500
To Repairs 5,400
To Printing & Stationary 1,500
To Bad Debts 3,600
ep
+ New Provision (D/D) 6,750
10,350
+ Provision for Discount 3,206 13,556
To Advertisement 10,500
To General Expenses 15,750
rR

To Depreciation on:
Plant & Machinery 6,000
Loose tools 1,350
Furniture & Fittings 180 7,530
To Net Profit
(transferred to Capital A/c) 85,114
t fo

1,71,300 1,71,300

Balance Sheet
(as on 31st December, 2012)
Amount Amount
No

Liabilities Assets
` `

Capital 6,09,000 Goodwill 90,000


Add: Net Profit 85,114 Land & Buildings 1,80,000
6,94,114 Plant & Machinery 1,20,000
S,

Less: Drawings 45,000 6,49,114 Less: Depreciation 6,000 1,14,000


Bills Payable 41,400 Furniture & Fittings 3,600
Creditors 90,000 Less: Depreciation 180 3,420
Less: Provision for Loose Tools 9,000
PE

Discount 2,250 87,750 Less: Depreciation 1,350 7,650


Outstanding Wages 4,500 Sundry Debtors 1,35,000
Outstanding Rent 2,550 Less: Prov. for D/D 6,750
1,28,250
Less: Prov. for
U

Discount 3,206 1,25,044


Bills Receivable 6,000
Closing Stock 1,80,000
(c)

Cash in Hand 4,200


Cash at Bank 75,000
7,85,314 7,85,314
UNIT 9: Financial Statements

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157
Check Your Progress
Notes
Fill in the blanks:
___________________
1. The ………………….. will show the true and proper

n/S
___________________
picture of the business only when all the transactions of
the business are properly recorded. ___________________

___________________
2. ………………….. prepared under this order is the

tio
reverse of the Balance Sheet prepared in liquidity order. ___________________

3. Order of presenting the assets and liabilities in the ___________________


Balance Sheet is called ………………….. of assets and

uc
___________________
liabilities.
___________________

rod
___________________
Summary
___________________
Final accounts include the Trading and Profit & Loss Account and
Balance Sheet. Trading and Profit and Loss Account is prepared to
calculate the net profit earned by business during a period.
ep
Balance Sheet of a business is prepared to disclose the financial
picture of the business. The Trading Account shows the gross profit
rR

which is the difference of sales and cost of sales. Profit & Loss
Account shows the net profit which is computed by matching the
total revenues and expenses of the business.
Balance Sheet is a statement which has two sides - Liability side
t fo

and Assets side. Before preparing the final accounts of the


business some adjustments are also done (if required).
No

Lesson End Activity


Prepare a Proforma of Balance Sheet in horizontal form as per
requirement of the Schedule VI of the Companies Act, 1956.
S,

Keywords
Trial Balance: It is the list of accounts taken from the ledger.
PE

Financial Statements: These include the Trading and Profit and


Loss Account, and Balance Sheet of the business.
U

Gross Profit: It is calculated by comparing the sales and cost of


sales. It is the excess of sales over cost of sales.
(c)

Gross Loss: It is the excess of cost of sales over sales.


Business Accounting

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158
Net Profit: It is the excess of revenues over expenses. It is
Notes
depicted by P. & L. A/c.
___________________
Net Loss: Excess of expenditures over revenues is called net loss.

n/S
___________________

___________________ Final Account: Final accounts include the Balance Sheet and
Profit & Loss Account.
___________________
Balance Sheet: The balance sheet of a company is a statement

tio
___________________
which shows the total value of assets owned and total of the
___________________ company's liabilities owed by of trading on a particular date or at
the end of trading period.

uc
___________________

___________________ Dividend: Dividend is that part of the profit which is divided


___________________ among the shareholders of the company.

rod
___________________
Preliminary Expenses: Cost of formulation of a company is
treated as preliminary expenses.

Questions for Discussion


ep
1. What do you mean by errors? Which type of errors can not be
detected by Trial Balance? Explain.
rR

2. What do you mean by Trading Account? Give the proforma of


Trading Account and explain why it is prepared.
3. What is the importance of Balance Sheet? Give a form of
t fo

Balance Sheet in Liquidity order with imaginary examples.


4. What do you mean by adjustment? Explain the different
adjustment entries.
No

5. From the following balances draw up a Trading and Profit and


Loss Account and Balance Sheet:
`
Amit Joseph's Capital 30,000
S,

Bank Overdraft 7,500


Machinery 20,100
Cash in hand 1,500
PE

Fixture & Fitting 8,250


Opening stock 67,500
Bills Payable 10,500
Creditors 60,000
U

Debtors 94,500
Bill receivable 7,500
Purchases 75,000
(c)

Sales 1, 93,500
Returns from customers 1,500
UNIT 9: Financial Statements

ale
Returns to Creditors 1,650 159
Salaries 13,500 Notes
Manufacturing Wages 6,000
Commission 8,250 ___________________

n/S
Trade Expenses 2,250
___________________
Discount (Cr.) 6,000
Rent 3,300 ___________________

The Closing Stock amounted to `78,000. ___________________

tio
6. The following balances are extracted on 31st March, 2012 from ___________________
the book of Mr. Rajesh Pratap. ___________________
` `

uc
4,90,000 1,57,600
___________________
Capital Loan
Drawing 40,000 Sales 13,07,200
General Expenses 50,000 Purchases 9,40,000 ___________________
Buildings 2,20,000 Motor Car 40,000

rod
Machinery 1,86,800 Prov. for Bad Debts 18,000 ___________________
Opening Stock 3,24,000 Commission (Cr.) 26,400
Coal and Power 44,800 Car Expenses 36,000 ___________________
Taxes and Insurance 26,300 Bills Payable 77,000
Wages 1,44,000 Cash in Hand 1,600
Debtors 1,25,600 Bank Overdraft 66,000
ep
Creditors 50,000 Donation 2,100
Discount (Dr.) 11,000

Prepare the Final Accounts for the year ending 31st March,
rR

2012, after taking into accounts the following adjustments:


a. Write off `3,200 for bad debts and make provision for Bad
debts @5% on debtors.
t fo

b. Depreciate Machinery by 10% and Motor Car by 12%.


c. Interest `15,000 is outstanding of Loan.

d. It was decided to transfer `5,000 every year to charity


No

fund.
e. 1/3 of car expenses and depreciation amount is to be
transferred to owner's account.
f. Stock valued on 31st March, 2012 was ` 4,70,000.
S,

Further Readings
PE

Books
T.S. Grewal, M.C. Shukla. “Advanced Accounts”. S. Chand, New
U

Delhi.
R.L. Gupta, M. Radhaswami. “Advanced Accountancy”. Sultan
(c)

Chand, New Delhi.


Business Accounting

ale
160
Dr. S.N. Maheshwari, Sharad, K. Maheshwari. “Financial
Notes
Accounting”. Vikas Publishing Co. Pvt. Ltd., New Delhi.
___________________
Pandikumar, M. P (2007). “Management Accounting, Excel Books”.

n/S
___________________
New Delhi.
___________________

___________________
Web Readings
www.b-u.ac.in/sde_book/dip_fintally.pdf

tio
___________________

___________________
www.egyankosh.ac.in/bitstream/123456789/35031/1/Unit19.pdf
www.futureaccountant.com/final-accounts-financial-accounting/

uc
___________________

___________________ www.sgbau.ac.in/accounting-for-managers.pdf

___________________ http://www.cashiksha.com/Material/CPT/Quick%20Revision%20No

rod
___________________
tes/Accounts/Lecture%2011.%20Final_Accounts_Part_2.pdf
ep
rR
t fo
No
S,
U PE
(c)
UNIT 10: Case Study

ale
Unit 10
161
Notes

Case Study
___________________

n/S
___________________

___________________
Objectives
___________________
After analyzing this case, the student will have an appreciation of the

tio
concept of topics studied in this Block. ___________________

___________________

uc
___________________
Case Study: Singania Charted Accountants Firm
___________________
Singania Charted Accountants Firm established in the year 1956,
has very good number of corporate clients. It continuously

rod
___________________
maintains quality in audit administration with the clients since
___________________
its early inception. The firm is eagerly looking for promising
students who are having greater aspirations to become auditors.
The firm has an objective of recruiting freshers to conduct
ep
preliminary auditing process with their corporate clients.

For this, the firm would like to select the right person who is
having conceptual knowledge as well as application on the
rR

subjects. It has given the following balance sheet to the


participants to study the conceptual applications. The
participants are required to enlist the various concepts and
conventions of accounting.
t fo

Balance Sheet
as on date 31st March 2012
Liabilities Assets
No

Capital(A.Pandit) 1,00,000 Building 80,0000


(+) Commission 4,925 Depreciation 2,000
2.5%
1,04,925 78,000
(+) Net profit 11,869 Furniture 23,000
1,16,794 Depreciation 2,050
S,

10%
(-) Drawings 16,000 20,950
1,00,794 Closing stock 1,14,500
Capital ( B.Pandit) 1,00,000 Sundry Debtors 25,000
PE

(+)Commission 1,187 Cash in hand 400


1,01,187
(+) Net profit 11,869
1,13,056
U

(-)Drawings 16,000 97,056


Bank overdraft 29,000
Sundry creditors 12,000
(c)

2,38,850 2,38,850
Contd…
Business Accounting

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162
Question:
Notes
1. List out the various accounting concepts dealt in the above
___________________
balance sheet.

n/S
___________________
2. Explain the treatment of accounting concepts.
___________________ Source: Pandikumar M P (2010). “Management Accounting: Theory and Practice”. Excel Books.

___________________

tio
___________________

___________________

uc
___________________

___________________

___________________

rod
___________________
ep
rR
t fo
No
S,
U PE
(c)
UNIT 11: Managerial Remuneration

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163
Notes

___________________

n/S
___________________

___________________

___________________

tio
___________________

___________________

uc
___________________

___________________

rod
___________________

ep ___________________

BLOCK-III
rR
t fo
No
S,
U PE
(c)
Detailed Contents Business Accounting

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164
Notes
UNIT 11: MANAGERIAL REMUNERATION
___________________ UNIT 13: AMALGAMATION, ABSORPTION &
EXTERNAL RECONSTRUCTION
Introduction

n/S
z
___________________ z Introduction
z Meaning of Managerial Remuneration
___________________ z Amalgamation and Absorption of Companies
z Provisions Regarding Overall Maximum and
Minimum Limits
___________________ z Reconstruction of Companies

tio
z Remuneration to Directors
___________________ z Calculation of Purchase Consideration

z Remuneration to Manager
___________________ z Accounting Treatment

uc
___________________ UNIT 14: INTERNAL RECONSTRUCTION
UNIT 12: DIVIDENDS & DIVIDENDS
DECLARATION OUT OF PAST & CURRENT
___________________ z Introduction
PROFITS
___________________ z Reconstruction of Companies

rod
z Introduction
z Accounting Treatment for Reduction of Capital
___________________
z Disposal of Profit and Divisible Profits

z Dividends UNIT 15: CASE STUDY

Declaration of Dividend out of Capital Profit


ep
z

z Issue of Bonus Shares


rR
t fo
No
S,
U PE
(c)
UNIT 11: Managerial Remuneration

ale
Unit 11
165
Notes
Activity
Make an honest assessment
Managerial Remuneration
___________________
of your organisation and

n/S
prepare a brief write up about
___________________
the managerial remuneration
___________________
in your organization.
Objectives
___________________
After completion of this unit, the students will be aware of the following

tio
topics: ___________________

\ Meaning of Managerial Remuneration ___________________


\ Provisions Regarding Overall Maximum and Minimum Limits

uc
___________________
\ Remuneration to Directors
___________________
\ Remuneration to Manager

rod
___________________

___________________
Introduction
The managerial personnel include the director, managing director
ep
and manager. The remuneration which is paid to these personnel
is called managerial remuneration. The provisions regarding the
maximum and minimum limits of the managerial remuneration
rR

are given in the Schedule XIII Part II of the Company Act. The
chapter discusses the provisions and methodology to compute the
managerial remuneration.
t fo

Meaning of Managerial Remuneration


The remuneration which is paid to the managerial personnel
(directors, managing directors and managers) by the company is
No

called managerial remuneration. This remuneration is shown in


the debit side of profit and loss account of the company. Besides
salary, dearness allowance perquisites, commission and other
allowances, the managerial remuneration includes the following as
S,

per Section 198:


(a) expenditure incurred by the company in providing any rent-
PE

free accommodation, or any other benefits or amenity in


respect of accommodation free of charge,
(b) expenditure incurred by the company in providing any other
U

benefit or amenity free of charge or at a concessional rate,


(c) expenditure incurred by the company in respect of any
(c)

obligation or service which but for such expenditure by the


company, would have been incurred by them, and;
Business Accounting

ale
166
(d) expenditure incurred by the company to affect any insurance
Notes
on the life of, or to provide any pension, annuity, or gratuity
___________________
for any of the managerial personnel, or his spouse or child.

n/S
___________________
Managerial Personnel
___________________
The management and administration of a company is delegated to
___________________
the managerial personnel as per the provisions of the Company

tio
___________________ Act. The managerial personnel include the following personnel:
___________________
(a) Director: Directors are the representatives of the company.
They manage and control the company. Directors are also the

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___________________

___________________ trustees for the company's property. Therefore, it is their duty


to use company's property for its benefit alone. It is
___________________

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compulsory for every company to have a board of directors.
___________________ Board of directors is a group of directors. A contract signed by
the directors on the behalf of the company is binding on the
company and the concerned third party. If the directors use
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their reasonable care and skill to perform their duties and yet
the company suffers a loss, the directors will not be
responsible for such a loss. But if the loss is due to the
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negligence of directors and breach of trust, they must have to


compensate the loss suffered by the company. There can be
two types of directors in a company i.e. full-time director and
part-time directors. A whole-time director is not a new
t fo

category of managerial personnel. But a director who is in the


whole-time employment of the company is called a whole-time
director. Managing directors are also called the whole-time
directors. Part-time directors are those who devote part of
No

their time in the affairs of the company. There can be more


than one part-time director in a company.
(b) Managing Director: A company can have one or more than
one managing director. The board of directors may appoint one
S,

of themselves as the managing director of the company by


giving more powers to manage the company. According to
PE

Section 2(26) of the Companies Act, a managing director is a


director who (i) by virtue of an agreement with the company,
or (ii) of a resolution passed by the company in general
U

meeting, or (iii) by its board of directors, or (iv) by virtue of its


Memorandum or Articles of Association is entrusted with
(c)

substantial powers of management which would not otherwise


be exercisable by him and includes a director occupying the
UNIT 11: Managerial Remuneration

ale
position of a managing director, by whatever name called. 167
Without unanimous approval of the board of directors, a Notes
Activity
managing director cannot manage more than one company at Give___________________
the main provisions of
a time.

n/S
Company Law regarding
___________________
managerial remuneration.
(c) Manager: There cannot be a manager and a managing
___________________
director both in a company. Like managing director, a
manager is also appointed by board of directors. His tenure ___________________

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cannot be more than five years at a time. According Section ___________________
2(24) of the Companies Act, a manager means a person who, ___________________
subject to the superintendence, controls and manages the

uc
___________________
company according to the direction of the board of directors,
has the management of the whole or substantially the whole of ___________________
the affairs of a company, and includes a director or any other

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___________________
person occupying the position of a manager by whatever name
___________________
called and whether under a contract of service or not. A
company cannot have more than one manager at a time. The
same disqualifications and restrictions will be applicable for
ep
the manager which exists for a managing director.

Check Your Progress


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Fill in the blanks:


1. The remuneration which is paid to these personnel is
called ………………….. .
t fo

2. ……………. are the representatives of the company.

Provisions Regarding Overall Maximum and


No

Minimum Limits
As per Section 198 of the Companies Act 1956, these are several
restrictions on the managerial remuneration. These are as below:
S,

Maximum Limit
The managerial remuneration of the managerial personnel (as
PE

director, manager and managing director) should not more than


11% of the net profit of that company as per Section 198 of the
Companies Act 1956. Any fees payable to the directors for
U

attending the meeting of board of directors will not be included in


the above ceiling of the remuneration. For this purpose the profit
(c)

of the company will be calculated as per Sections 349, 350 and 351
of the Companies Act.
Business Accounting

ale
168
Minimum Limit
Notes
In case a company has no profit or its profits are inadequate in any
___________________ financial year, the company will pay the minimum amount of

n/S
___________________ remuneration to the director, managing director, manager or
whole-time director. This minimum amount will vary from ` 75,000
___________________
to ` 2,00,000 p.m., which will depend on the effective capital of the
___________________
company as specified in Part II of Schedule XIII of the Companies

tio
___________________ Act as given below.
___________________
Schedule XIII, Part II

uc
___________________
Section I: Remuneration Payable by Companies having Profits–
___________________
Subject to the provisions of Sections 198 and 309, a company
___________________

rod
having profits in a financial year may pay any remuneration by
___________________ way of salary, dearness allowance, perquisites, commission and
other allowances, which shall not exceed 5% of its net profit for one
such managerial person and if there is more than one such
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managerial person, 10% for all of them together.

Section II: Remuneration payable by companies having no profit


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or inadequate profit:
Notwithstanding anything contained in this part, wherein any
financial year during the currency of tenure of the managerial
person, a company has no profits or its profits are adequate, it may
t fo

pay remuneration to a managerial person, by way of salary,


dearness allowance, perquisites and any other allowance, as per
scale prescribed in Part II which have been revised vide
notification GSR No. 215(E) dated 2-3-2000. These revised scales
No

are as below:

Where the effective capital of the company is Monthly salary


payable shall
not exceed
S,

(i) Less than ` 1 crore. ` 75,000


(ii) Rupees 1 crore or more but less than ` 5 crore. ` 1, 00,000
(iii) ` 5 crore or more but less than ` 25 crore. ` 1, 25,000
PE

(iv) ` 25 crore or more but less than ` 100 crore. ` 1, 50,000


(v) ` 100 crore or more. ` 2, 00,000

Explanation I: For the purpose of Section II of this Part,


U

"effective capital" means the aggregate of:


(i) Paid up share capital (excluding share application money or
(c)

advances against shares).


UNIT 11: Managerial Remuneration

ale
169
(ii) Credit balance of share premium account.
Notes
(iii) Reserve and Surplus (excluding revaluation reserve).
___________________

n/S
(iv) Long-term loans and deposits repayable after one year
___________________
(excluding working capital, loans, overdrafts, interest due on
___________________
loans unless funded, bank guarantee etc., and other short-term
arrangements) as reduced by: ___________________

tio
(a) aggregate of any investments (except in the case of ___________________
investment by an investment company whose principal ___________________
business is acquisition of shares, stock, debentures, or

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___________________
other securities).
___________________
(b) accumulated losses not written off.

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___________________
(c) preliminary expenses not written off.
___________________
Explanation II:

(a) Where the appointment of the managerial person is made in


ep
the year in which the company has been incorporated, the
effective capital shall be calculated as on the date of such
appointment.
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(b) In any other cases, the effective capital shall be calculated as


on the last date of the financial year preceding the financial
year in which the appointment of managerial person is made.
t fo

Perquisites
1. A managerial person shall be eligible to the following
perquisites which shall not be included in the computation of
No

the ceiling on the remuneration specified in the paragraph 1 of


this Section.
(i) Contribution to provident fund, superannuation fund or
annuity fund to the extent these either single or put
S,

together are not taxable under the Income Tax Act 1961.
(ii) Gratuity payable at a rate not exceeding half a month's
PE

salary for each completed year of service.


(iii) Encashment of leave at the end of the tenure.
U

Perquisites for expatriates


2. In addition to the perquisites specified in paragraph 2 of this
(c)

Section, an expatriate managerial person (including non-


resident Indians) shall be eligible to the following perquisites
Business Accounting

ale
170 which shall not be included in the computation of the ceiling
Notes on remuneration specified in paragraph 1 of this Section:
___________________
(a) Children's education allowance: In case of children

n/S
___________________ studying in or outside India, an allowance limited to a
___________________ maximum of ` 5,000 per month per child or actual
expenses incurred whichever is less. Such allowance is
___________________
admissible up to a maximum of two children.

tio
___________________
(b) Holiday passage of children studying outside India or
___________________ family studying abroad: Return holiday passage once in a
year by economy class or once in two years by first class to

uc
___________________

___________________
children and to the members of the family from the place
of their study or stay outside India, if they are not residing
___________________
in India with the managerial person.

rod
___________________
(c) Leave travel concession: Return passage for self and family
in accordance with the rules specified by the company
where it is proposed that the leave be spent in home
ep
country instead; anywhere in India.
Explanation: For the purpose of this part, family means the
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spouse, dependent children and dependent parents of the


managerial person.

Formula for Computation of Effective Capital `


Paid up Share Capital .................
t fo

+ Credit balance of Premium A/c. (securities) .................


+ Reserve & Surplus (excluding Revaluation Reserve) .................
+ Long-term Loans and Deposit repayable after one year .................
Total .................
No

– Investments
Accumulated losses .................
Preliminary expenses ................. .................
Effective Capital .................
S,

Check Your Progress


Fill in the blanks:
PE

1. The managerial remuneration of the managerial


personnel should not more than ………………. of the net
profit.
U

2. In case a company has no profit or its profits are


inadequate in any financial year, the company will pay
(c)

the minimum amount of remuneration to ………………. .


UNIT 11: Managerial Remuneration

ale
Remuneration to Directors 171
Notes
Activity
Remuneration to directors including managing directors, is
You___________________
and your group members
determined either by the Articles of Association or by a resolution

n/S
are required to develop an
or, if the articles so required, by a special resolution, passed by the ___________________
assignment on remuneration
company in general meeting subject to the provisions of the Section to directors.
___________________
309 of the Companies Act. Section 309 governs the remuneration of
___________________
directors, including managing directors or whole- time director of a

tio
public company and a private company which is a subsidiary of a ___________________

public company. Provisions of this section are as under: ___________________

(a) Remuneration to whole-time director or managing

uc
___________________
director: As per the provision of Section 309(3), a whole-time ___________________
director or a managing director may be paid remuneration

rod
___________________
either by way of a monthly payment or at a specified
percentage of the net profits of the company or partly by one ___________________

way and partly by the other. But except with the approval of
the Central Government, such remuneration shall not exceed:
ep
(i) 5% of the net profit for one whole-time or managing
director,
rR

(ii) 10% of the net profit for more than one whole-time
director.
(b) Remuneration of part-time directors: As per the provision
t fo

of Section 309(4) a part-time director (who is neither whole-


time nor managing director) may receive monthly, quarterly or
annual payment of remuneration with the approval of Central
Government or by way of commission, if a special resolution of
No

the company authorizes such payment. But except with the


approval of the Central Government, total remuneration shall
not exceed:
(i) 1% of the net profit of the company if the company has
S,

managing directors or whole- time directors or;


(ii) 3% of net profit of the company if the company has no
PE

manager, managing directors or whole-time director.


It is to be noted that these rates of 1% and 3% respectively can
be increased by the company by a special resolution in a
U

general meeting with the approval of the Central Government.


This special resolution will be valid for a period of five years.
(c)

(c) Director's Fees: In addition, a director may receive


remuneration by the way of a fee for each meeting of board of
Business Accounting

ale
172 directors or a committee thereof attended by him according to
Notes the Companies Act, but the government has decided that in
___________________ case of whole-time directors or managing directors, no sitting
fee will be payable. As per notification of the Central

n/S
___________________
Government dated, 27.8.1993 a company can pay fees up to `
___________________
2,000 to its each director for attending the meeting of board of
___________________ directors or a committee thereof. As stated earlier, director's

tio
___________________ fees a not included in the managerial remuneration for the
purpose of overall limit.
___________________
(d) Whole-time director or managing director shall not get

uc
___________________
any remuneration or commission from subsidiary
___________________
company: As per Section 309(6) a whole-time or managing
___________________ director who is in receipt of any commission from a company is

rod
___________________ not entitled to receive any commission or remuneration from
the subsidiary company of such company.
(e) As per Section 309(1) remuneration to a director will include
ep
any remuneration paid to him for services rendered by him in
any capacity except when:
(i) the services rendered by him are of a professional nature.
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(ii) In the opinion of the Central Government, the director


possesses the requisite qualifications for the practice of
the profession.
t fo

(f) The above-mentioned provision of Section 309 regarding the


remuneration of the managerial personnel will not be
applicable to a private company unless it is a subsidiary
company of a public company. [309(9)]
No

(g) As per Section 310 of the Companies Act, if a public company


or a private company, which is the subsidiary of a public
company, increases the remuneration payable to directors,
S,

such an increase requires the approval of Central Government,


except in the following cases:
PE

(i) if Schedule XIII is applicable and the increase is in


accordance with the conditions specified in that schedule
and
U

(ii) if the increase is in the fee payable for attending each


meeting of the board of directors or a committee thereof
(c)

and the increased rate does not exceed such sum as may
be prescribed.
UNIT 11: Managerial Remuneration

ale
173
(h) The net profit of the company for the purpose of calculating
Notes
director's remuneration would be computed as per the Activity
provisions of Sections 349 and 350 of the Companies Act. Collect recent updates on
___________________

n/S
remuneration to manager.
(i) As per Section 200, no company will pay its officers or ___________________

employees any remuneration free of any tax. ___________________

___________________
Check Your Progress

tio
___________________
State true or false:
___________________
1. As per the provision of Section 309(4) a part-time

uc
director may receive monthly, quarterly or annual ___________________

payment of remuneration with the approval of Central ___________________


Government.

rod
___________________
2. Director’s fees a not included in the managerial ___________________
remuneration for the purpose of overall limit.
ep
Remuneration to Manager
Provisions regarding remuneration to manager are given in the
Section 387 of the Companies Act 1956. According to this section, a
rR

company can pay the remuneration to a manager by the way of a


monthly payment or by way of a specific percentage of the net
profits of the company or partly by way of monthly payment and
t fo

partly by way of specific percentage of the net profits. The net


profit of the company is calculated according to Sections 349 and
350 of the Companies Act. The total remuneration to the manager
cannot exceed 5% of the net profit of the company, except with the
No

approval of the Central Government.

Determination of Net Profit for Managerial Remuneration


Determination of Net Profit of a public company for the purpose of
S,

calculating the managerial remuneration will be as per the


provision of the Section 349 and Section 350 of Indian Companies
Act. These provisions are summarized as under:
PE

1. The following items are added to the gross profit of the


company:
U

Bounties and subsidies received from any government or any


public authority constituted or authorized in this behalf, by
(c)

any government, unless and except in so far as the Central


Government otherwise directs.
Business Accounting

ale
174
2. The following items are not considered to calculate the net
Notes
profit of the company:
___________________
(a) Profit by way of premium on the issue of shares or

n/S
___________________
debentures of the company.
___________________
(b) Profits on the sale of forfeited shares.
___________________
(c) Profits in capital nature.

tio
___________________
(d) Profit arising from the sale of immovable property or fixed
___________________
assets, if company's business is not the sale and purchase
of such type of assets. In other words if the company is

uc
___________________

___________________ engaged in buying and selling of any assets of capital


nature, profit arised from such a sale is added to for gross
___________________

rod
profit of the company.
___________________
Under Section 350 if amount of sale of any such assets exceeds
the written down value thereof, credit shall be given for so
much of the excess as is not higher than the difference
ep
between the original cost of the fixed assets and its written
down value. For example- Gujarat Ltd. acquired fixed assets
for ` 80,000 two years ago and now its written down value is
rR

`60,000. The Company sold these assets for ` 85,000. In this


case, total profit is ` 25,000 (` 85,000-` 60,000) Profit of `
20,000 (difference of original cost and written down value of
t fo

the assets) will be added to gross profit and the excess of profit
of ` 5,000 (` 25,000 - ` 20,000) will be excluded in computing
the net profit for the purpose of remuneration.
3. The following items shall be deducted from the gross profit of
No

the company:
(a) all the usual working charges.
(b) bonus or commission paid or payable to any member of the
S,

company's staff or to any engineer, technician or person


employed or engaged by the company whether on a whole-
time or a part-time basis.
PE

(c) any tax notified by the Central Government as being in


the nature of a tax on the excess or abnormal profits.
U

(d) any tax on business profits imposed for special reason or


in special circumstances and notified by Central
(c)

Government in this behalf.


(e) interest on debentures issued by the company.
UNIT 11: Managerial Remuneration

ale
175
(f) interest on mortgages executed by the company and on
Notes
loans and advances secured by a charge on its fixed or
floating assets. ___________________

n/S
(g) interest on secured loans and advances. ___________________

___________________
(h) expenses on repairs if the repairs are not of capital nature.
___________________
(i) outgoings inclusive of contribution made to charitable and

tio
other funds not directly relating to the business of the ___________________
company or welfare of its employees. ___________________

(j) depreciation as per Section 350 of the Companies Act.

uc
___________________
Under this Section, the amount of depreciation is
___________________
calculated as per rates specified in the Schedule XIV

rod
___________________
(which is discussed in the chapter of Final A/cs) on the
written down value of the assets. The amount of ___________________
depreciation includes normal depreciation, which includes
extra and multiple shift allowance but excludes special
ep
depreciation, initial depreciation and any development
rebate. If any assets are sold, discarded, demolished or
destroyed before the expiry date of the assets, excess of
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W.D.V. of the assets over the sales proceeds of the assets


or scrap value of the assets as the case may be, is written
off in that financial year in which the assets are sold,
discarded or demolished. This excess of W.D.V. will be
t fo

computed as below:
Excess of W.D.V. = W.D.V. - sale proceeds - scrap value.
(k) the excess of expenditure over income which had arisen in
No

computing the net profit in accordance with the Section


349 of the Companies Act in any year which begins at or
after the commencement of this Act insofar as such excess
has not been deducted in any subsequent year preceding
S,

the year in which the net profits have to be ascertained.


(l) any compensation or damages to be paid by virtue of any
PE

legal liability including a liability arising from a breach of


contract.
(m) any sum paid by way of insurance against the risk of
U

meeting any liability such as referred to in clause (l); and


(n) debts considered bad and written off or adjusted during
(c)

the year of account.


Business Accounting

ale
176
4. But the following items shall not be deducted from the gross
Notes
profits of the company:
___________________
(a) the income tax and super tax payable by the company

n/S
___________________
under the Indian Income Tax Act, 1961 or any other tax
___________________ on the income of the company not covered under clauses
___________________ (c) and (d) above.

tio
___________________ (b) any compensation or damage paid by the company
voluntarily.
___________________
(c) loss of capital nature including loss on sale of undertaking

uc
___________________
or any part thereof not including any excess of written
___________________
down value over its sale proceeds or scrap value of any
___________________ excess of written down value of any assets sold, discarded,

rod
___________________ demolished or destroyed as this excess is written off
against P & L A/c.
Note:* The profit calculated as per above provision is considered
ep
profits for the purpose of remuneration to directors, managing
directors and manager. On the basis of this profit, the managerial
remuneration is computed.
rR

Check Your Progress


Fill in the blanks:
t fo

1. The …………………… of the company is calculated


according to Sections 349 and 350 of the Companies Act.
2. If the company is engaged in buying and selling of any
assets of capital nature, profit arised from such a sale is
No

added to for …………………… of the company.

Summary
S,

The remuneration which is paid to the managerial personnel


(directors, managing directors and managers) by the company is
called managerial remuneration. This remuneration is shown in
PE

the debit side of profit and loss account of the company. As per
Section 198 of the Companies Act 1956, these are several
restrictions on the managerial remuneration. Remuneration to
U

directors including managing directors, is determined either by the


Articles of Association or by a resolution or, if the articles so
(c)

required, by a special resolution, passed by the company in general


meeting subject to the provisions of the Section 309 of the
UNIT 11: Managerial Remuneration

ale
Companies Act. Section 309 governs the remuneration of directors, 177
including managing directors or whole- time director of a public Notes
company and a private company which is a subsidiary of a public ___________________
company. Provisions regarding remuneration to manager are given

n/S
___________________
in the Section 387 of the Companies Act 1956. According to this
section, a company can pay the remuneration to a manager by the ___________________

way of a monthly payment or by way of a specific percentage of the ___________________

tio
net profits of the company or partly by way of monthly payment
___________________
and partly by way of specific percentage of the net profits.
___________________

uc
Lesson End Activity ___________________

___________________
Visit this site http://www.lexvidhi.com/article-details/managerial-

rod
remuneration-under-companies-act-1956-26.html and prepare a ___________________

report on Managerial Remuneration Under Companies Act, 1956. ___________________

Keywords
ep
Managerial Personnel: The managerial personnel include the
director, managing director and manager.
rR

Managerial Remuneration: The remuneration paid to


Managerial Personnel is called managerial remuneration.
Remuneration: Remuneration is the total compensation that
t fo

an employee receives in exchange for the service they perform for


their employer.
Director: Directors are the representatives of the company. They
manage and control the company.
No

Questions for Discussion


1. What do you mean by managerial remuneration?
S,

Explain
2. How is the profit calculated for managerial remuneration?
PE

Describe in detail.
3. What are the provisions regarding the maximum limit of
managerial remuneration? Explain.
U

4. Determine the maximum remuneration available to the part-


time Directors and Managers of Babli and Bunti Ltd. under
(c)

Sections 309 and 387 of the Companies Act, 1956 from the
following particulars:
Business Accounting

ale
178
5. Before charging any such remuneration the Profit and Loss
Notes
A/c, showed a credit balance of ` 57,75,000 for the year ended
___________________
31st March, 2012 after taking into account of following

n/S
___________________ balances:
___________________ `

___________________ i. Capital Expenditure 13, 12,500


ii. Subsidiary received from Government 10, 50,000

tio
___________________
iii. Special Depreciation 1, 75,000
___________________
iv. Multiple Shift Allowance 2, 62,500
v. Bonus to foreign technicians 7, 87,500

uc
___________________

___________________ vi. Provision for Taxation 70, 00,000


___________________ vii. Compensation paid to an injured workman 1, 75,000

rod
viii. Ex-gratia payment to an employee 87,500
___________________
ix. Loss on sale of fixed assets 1, 75,000
x. Profit on sale of investment 5, 25,000
ep
Company is providing depreciation as per Section 350 of the
Companies Act, 1956.
rR

Further Readings

Books
t fo

T.S. Grewal, M.C. Shukla. “Advanced Accounts”. S. Chand, New


Delhi.
R.L. Gupta, M. Radhaswami. “Advanced Accountancy”. Sultan
Chand, New Delhi.
No

Dr. S.N. Maheshwari, Sharad, K. Maheshwari. “Financial


Accounting”. Vikas Publishing Co. Pvt. Ltd., New Delhi.
Pandikumar, M. P (2007). “Management Accounting, Excel Books”.
New Delhi.
S,

Web Readings
www.caclubindia.com › Discussion › Accounts › Others
PE

http://www.lexvidhi.com/article-details/managerial-remuneration-
under-companies-act-1956-26.html
www.svtuition.org/2009/10/how-to-calculate-managerial.html
U

http://www.indiankanoon.org/search/?formInput=managerial%20re
muneration
(c)

www.slideshare.net/gswapnil/managerial-remuneration-9648039
UNIT 12: Dividends & Dividends Declaration Out of Past & Current Profits

ale
Unit 12
179
Notes
Activity
Prepare a presentation
Dividends & Dividends
___________________
showing the Disposal of Profit.

n/S
___________________

Declaration Out of Past & Current ___________________

Profits ___________________

tio
___________________

Objectives ___________________

uc
After completion of this unit, the students will be aware of the following ___________________
topics:
___________________
\ Disposal of Profit and Divisible Profits

rod
___________________
\ Dividends
___________________
\ Declaration of Dividend Out of Reserve
\ Declaration of Dividend out of Capital Profit
\ Issue of Bonus Shares
ep
Introduction
rR

Dividend is that part of the profit which is divided among the


shareholders of the company. Dividend is divided among the
shareholders as per the legal provisions of the Company Act.
t fo

Dividend can be paid in cash or shares. For the declaration of


dividend and bonus among shareholders, a company must satisfy
the different conditions. In the present unit the legal provisions
and different conditions for the declaration of dividend are
No

discussed.

Disposal of Profit and Divisible Profits


The question of disposal, distribution or appropriation of profit
S,

arises only when a company earns the net profit. Under the
disposal of profit, we consider distribution of profit to shareholder
PE

in the form of dividend and bonus shares and transfer of profit into
adequate reserves and funds for keeping sound financial position of
the company.
U

Divisible Profits
(c)

Divisible profits are also known as profits available for dividends


for shareholders. In other words, net profits which can be
Business Accounting

ale
180
distributed among the shareholders are called divisible profits. In
Notes normal course, that profit is distributed among the shareholders as
___________________ dividend which has been calculated after deducting all expenses,
losses, depreciation on fixed assets, fall in the price of current

n/S
___________________
assets, taxation, past losses and transferring a reasonable amount
___________________ to reserve. Profit on revaluation of fixed assets and profit of
___________________ extraordinary nature should not be included into divisible profits.
In the absence of profit the company cannot declare the dividend.

tio
___________________

___________________
Provision of Section 205 of the Companies Act for the
ascertainment of divisible profit is as follows:

uc
___________________
1. For any financial year, dividend can be declared or paid by a
___________________
company out of the profit of the current year which have been
___________________ derived after considering the depreciation in accordance with

rod
___________________ the provision of Section 205(2), or

2. The company can make a payment or declared a dividend out


of the undistributed profits of the previous financial year
ep
which have been calculated after providing depreciation in
accordance with Section 205(2).

3. Dividend can be declared or paid by the company out of the


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aggregate of profit as mentioned in (1) and (2) above.

4. Dividend can be declared or paid out of subsidy provided by


the Central Government or state government for the payment
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of dividend.

5. If a company has failed to redeem its preference shares in


accordance the provision of the Section 80(A), it cannot, as
long as such failure continues, declare or pay any dividend on
No

its equity shares.

In order to understand the provisions of this section


completely, it is necessary to understand the following points:
S,

(a) Calculated of Depreciation

(b) Past Losses


PE

(c) Transfer of Profit to Reserve

(a) Calculated of Depreciation: Herewith, depreciation will be


U

provided as the provision of Section 205(2) of the


Companies Act, 1956 and the rate of depreciation will be
(c)

applicable as given in Part III of the Schedule XIV of the


Companies Act. The provision or Section 205(2) and Part
UNIT 12: Dividends & Dividends Declaration Out of Past & Current Profits

ale
III of the Schedule XIV have been discussed under the 181
heading of Profit and Loss Account of this chapter. Notes

(b) Past Losses: If a company suffers a loss in any financial ___________________

n/S
year after 28th December, 1960, the amount of loss or ___________________
amount of depreciation for that year, whichever is less,
___________________
must be set off against the profit of the company before
declaration of dividend. ___________________

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___________________
(c) Transfer of Profit to Reserve: Generally, the rules
regarding the disposal of profits are given in the Articles ___________________
of Association. As per Section 205(2A) of the Companies

uc
___________________
Act, before the declaration of dividend out of the current
___________________
year's profit, the company has to transfer such percentage
if its profit for the current year to the various reserves,

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___________________
not exceeding 10%, as may be prescribed. The Central
___________________
Government has prescribed the following percentages to
be transferred to Reserves:
ep
Minimum percentage of current
Rate of proposed dividend
profit to be transferred to reserves
(i) More than 10% but less 2.5%
than 12.5% of the paid up
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capital.
(ii) More than 12.5% but less 5%
than 15% of the paid up
capital
t fo

(iii) More than 15% but less 7.5%


than 20% of the paid up
capital
(iv) More than 20% of the paid 10%
up capital
No

Note: If the rate of the proposed dividend does not exceed, it is not
obligatory on a company to transfer any profit to its reserves. The
directors, however can exercise their discretion, and transfer some
amount to reserve from out of profit. But such transfer should not
S,

exceed the ceiling of 10% prescribed in the Act referred to above


where:
PE

(a) Reserve means free reserve


(b) Current profit means profit after tax
(c) Dividend means dividends on equity shares
U

Transfer of Higher Percentage: Although there is a ceiling of 10% of


(c)

profit to transfer reserve, a company may transfer a higher


percentage of profits to reserves in accordance with the rules made
Business Accounting

ale
182
by the Central Government for this purpose [Section 205(2A)].
Notes
Activity These rules are as follows:
Give___________________
the various provisions of
Indian Companies Act
(a) Where a dividend is declared, the minimum distribution of

n/S
___________________
governing the declaration and dividend equal to the average rate of the rates for the three
payment of dividend.
___________________ preceding years immediately proceeding the financial year.

___________________ (b) Where bonus shares have been issued in the financial year in
which the dividend is declared, or in the three years

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___________________
immediately proceeding the financial year, a minimum
___________________ distribution of dividend declared for the three years.

uc
___________________
However, the minimum distribution in the above two cases
___________________ need not to be ensured if net profits after tax have fallen by at
___________________ least 20% of the average net profits after tax of two preceding

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financial years.
___________________
(c) Where no dividend is declared, the amount proposed to be
transferred to its reserve from current profit should be lower
than the average amount of dividends to the shareholders
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declared by it over three preceding financial years.

Check Your Progress


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Fill in the blanks:


1. Dividend is divided among the …………………. as per
the legal provisions of the Company Act.
t fo

2. …………………. are also known as profits available for


dividends for shareholders.
No

Dividends
Dividend is that portion of divisible profit which is divided among
the shareholders of the company. After complying with the
provisions of the Companies Act and the Articles of Association the
S,

profit of the company is distributed to the shareholders by the way


of return on their investment in shares. The rate of dividend is
PE

decided by the board of directors in the annual general meeting of


the shareholders. The legal provisions regarding the dividend are
summarized below:
U

1. Dividend can be paid only out of profits. Payment of dividend


is ruled out if there is a loss except where the Central or State
(c)

Government has guaranteed the payment of dividends by the


company.
UNIT 12: Dividends & Dividends Declaration Out of Past & Current Profits

ale
183
2. Shareholders are entitled to claim the dividend only when it
Notes
has been declared by the company in the general meeting.
Shareholders can sue the company for the recovery of ___________________

n/S
dividend. ___________________

3. Dividend shall be payable only in cash, by cheque, draft or by ___________________


dividend warrant.
___________________

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4. In any manner the operations of Section 208 shall not be ___________________
affected by the provision of Section 205.
___________________
5. For the purpose of this section:

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___________________
(a) The word "Specified Period" used in this section will mean
___________________
the number of years at the end of which at least 95% of

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___________________
the original cost of the assets of the company would have
been provided for by way of depreciation, if depreciation ___________________
were to be calculated in accordance with provision of
Section 350.
ep
(b) Any dividend payable in cash may be paid by cheque or
warrant sent through the post directed:
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(i) To the registered address of any shareholder entitled


to the payment of the dividend; or
(ii) In the case of joint shareholder, to the registered
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address of that one of the joint shareholder, who is the


first named on the register of the member; or
(iii) To such person and to such address as the shareholder
or joint shareholder may have directed in writing.
No

6. Dividend is calculated at the recommended rate by the


directors on the paid up capital. If the Articles of Association
specifically permits, dividend can be declared on the nominal
value of shares.
S,

7. No dividend will be payable on calls-in-advance as it does not


have the nature of share capital and has a nature of advance.
PE

8. In the case of calls-in-arrear, dividend will be paid on the


amount actually paid by the shareholders. The company is,
however, authorized to make provision in the Articles of
U

Association prohibiting the payment of dividend to such a


shareholder.
(c)

9. Interim dividend can also be declared by the directors during


the financial year.
Business Accounting

ale
184
10. Dividend including interim dividend must be paid within 30
Notes
days of its declaration as per Section 93 of Companies
___________________
Amendment Act 2000. If company fails to pay the dividend

n/S
___________________ with 30 days, it has to pay interest @ 18% p.a., to the
___________________ shareholder as per Section 207.

___________________ 11. As per the provision of Section 205(C) of the Companies


(Amendment) Act, 1999, the Central Government shall be set

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___________________
up an Investor Education and Protection Fund. The following
___________________ amounts shall be deposited into this fund:

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___________________
(a) The balance lying in the unpaid Dividend Account of the
___________________ Company.
___________________ (b) The application money received by the company for the

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___________________ allotment of shares debentures or any other securities
which is now to be refunded.
(c) Matured deposits with companies.
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(d) Matured debentures with companies.
(e) The interest accrued on the amounts mentioned in the
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clauses (a) to (d) above.


(f) Grants and donations received by the companies for this
fund from the Central Government, State Governments or
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other institutions for the purpose of this fund.


(g) The interest or other income on the investment made from
this fund, by the companies.
The above mentioned (a) to (d) amounts shall be transferred to
No

this fund only if such amount is unpaid or unclaimed for seven


years. In case any claimant makes his claim within seven
years from the due date, this amount will not be transferred to
this fund. The amount of this fund will be utilized for the
S,

promotion of awareness among investors and for protecting the


interest in investor in accordance with the prescribed rules.
PE

Different Terms Relating to Dividend


Following are the different terms which are used in relation to
dividend:
U

1. Proposed Dividend: The dividend which is recommended for


(c)

the shareholders by the directors is called proposed dividend.


If this dividend is approved in the annual general meeting of
UNIT 12: Dividends & Dividends Declaration Out of Past & Current Profits

ale
the shareholders it is called final dividend. In the annual 185
general meeting declaration of final dividend cannot be more Notes
than the proposed dividend. However, final dividend can be ___________________
lesser than the proposed dividend. Proposed dividend is shown

n/S
___________________
in the debit side of Profit and Loss Appropriation Account and
in the liabilities side of the Balance Sheet. ___________________

___________________
2. Final Dividend: Final dividend is declared and approved at

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the annual general meeting. It is approved by the ___________________
shareholders by looking at the financial position and the ___________________
divisible profits of the company. Final dividend is declared

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___________________
only at the annual general meeting and not at the
extraordinary general meeting. Approval of the final dividend ___________________
is based on the recommendation of the directors of the

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___________________
company. After the declaration of final dividend, no further
___________________
dividend for that year can be declared. When a dividend is
declared, it becomes the debts of the company to the
registered shareholders.
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3. Interim Dividend: The dividend that is declared between
two annual general meetings is called interim dividend. In
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other words, it can be paid by directors to the shareholders at


any time before closing the final accounts. The Articles of
Association of the company empower the directors to declare
the interim dividend. Interim dividend is declared by the
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directors in the anticipation of sufficient profits to be made by


the company during the accounting period. Generally, the
interim dividend is declared after preparing the final accounts
of the first half of the year. If it is found that dividend is paid
No

by the directors without sufficient profit, directors will be


liable to make good the amount of such dividend as dividend
can be paid legally out of profit and not out of capital. No
interim dividend can be declared by the directors without
providing the depreciation for the full year, any accumulated
S,

losses and transfer to reserve.

Dividend can be paid by the directors by the mere passing of a


PE

resolution by the board of directors. There is no need of


approval of the shareholders. The resolution of the directors
for interim dividend does not create a debt between the
U

company and the shareholder, as it is always open to the


directors to subsequently rescind the resolution before the
payment of it.
(c)
Business Accounting

ale
186
Notes 4. Scrip Dividend: Before the passing of the Companies
Amendment Act 1960, some companies used to distribute
___________________
dividend in the form of shares or debentures or any other

n/S
___________________ securities of any other companies. These shares, debentures or
___________________ other securities may have been held by the shareholder as
investment. Dividend so paid was known as scrip dividend.
___________________
Generally, a shareholder had to bear a loss on such type of

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___________________ dividend (shares, debentures etc.) because amount of dividend
___________________
in the form of shares, debentures etc. was worthless for
shareholder. But nowadays, such type of unhealthy practice

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___________________
has been stopped by the Section 205 of the Companies
___________________ Amendment Act 1960 i.e. not dividend shall be payable except
in cash.
___________________

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___________________ 5. Unclaimed or Unpaid Dividend: When some shareholders
are unable to encash or claim the dividend warrants within 30
days from the date of declaration of the dividend amount,
dividend of such a shareholder is called unclaimed/unpaid
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dividend. There is a provision in Section 205(A) of the
Companies Amendment Act 2000 regarding such an
unclaimed/unpaid dividend, that the company shall within
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seven days, transfer such amount of dividend which remains


unpaid/unclaimed, to a special account. This account will be
called "Unpaid Dividend Account of .......... Company Ltd.
/Company Pvt. Ltd." This account can be held with any
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Scheduled Bank. If the company has not transferred the


amount of dividend to the above account, it has to pay interest
@12% p.a. on such amount. If the amount deposited in this
account and is not claimed or paid within seven years of its
No

deposit, the company shall transfer this amount to a fund


established u/S 205(C) of the Companies Amendment Act
2000. The same provision will also be applicable to interim
dividend. As per the provisions of this section the person who
S,

is entitled to get dividend may apply to the Central


Government. The Central Government for its own satisfaction
may demand company's certificate or may otherwise ensure
PE

that the applicant is entitled to receive the dividend. After the


Central Government is satisfied, it passes an order for the
payment of the related amount against security of such value
U

from the applicant. If the provision of this Section 205 is


violated as per Section 205(3A) as penalty of ` 5,000 per day
will be imposed on the company.
(c)
UNIT 12: Dividends & Dividends Declaration Out of Past & Current Profits

ale
187
6. Dividend on Preference Shares: Preferential shareholders
Notes
have been a preferential right in respect of dividend as
compared to the equity shareholder. They can claim dividend ___________________

n/S
only out of profit at a fixed rate on the nominal value of shares. ___________________
If nothing is stated, preference shares are always treated as
___________________
cumulative. If, due to inadequacy of profits they have not been
paid for some years, the whole of the dividend (including the ___________________

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arrears of dividend of past years) will be paid first to ___________________
preference shareholders before making any payment of ___________________
dividend to equity shareholder. But the holder of non-

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___________________
cumulative preference share cannot claim dividend in
subsequent years if their dividend is not paid due to ___________________
inadequacy of profit. Arrears of dividend of cumulative

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___________________
preference share are shown as a contingent liability by the
___________________
way of a footnote to the balance sheet. It may be noted that the
preference shareholders cannot compel the company to pay the
entire dividend (including arrears). They can only force the
ep
company to pay them before any dividend is paid to the equity
shareholder. If there are some participating preference shares,
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shareholders will have a right to share the balance of profits


with the equity shareholders. Herein, one more point is to be
noted that in case of inadequate profit, the company may pay
dividend on preference shares at a rate less than the fixed
t fo

rate. In this case, the company will not declare any dividend
on the equity shares.

Source of Dividend
No

As per Section 205, following are the sources of dividend from


which a company can declare and pay the dividend:
(i) Current year's profit after providing depreciation.
(ii) Previous years profit after providing depreciation.
S,

(iii) Aggregation of the above (i) & (ii)


(iv) Money provided by the Central or State Government for the
payment of dividend.
PE

Procedure of Dividend
The procedure of dividend can be understood by the following
U

steps:
(c)

1. After the preparation of final accounts, the rate of dividend is


proposed in the meeting of board of directors.
Business Accounting

ale
188
Notes 2. If the proposed of board of directors regarding dividend is
Activity
approved in the annual general meeting, the rate of dividend
Collect recent updates on
___________________
declaration of dividend out of
is declared.

n/S
___________________
reserve.
3. After the declaration of dividend, the dividend list is prepared.
___________________
4. With the help of the dividend list, dividend warrants are
___________________
prepared and sent to the registered addresses of the

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___________________ shareholders.
___________________
5. For the payment of dividend, the company opens a Dividend
Bank A/c with a Scheduled Bank.

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___________________

___________________ 6. After receiving the dividend warrants, the shareholders get


___________________ the payment from the banker of the company.

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___________________ Check Your Progress
Fill in the blanks
1. ……………….. is that portion of divisible profit which is
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divided among the shareholders of the company.
2. Dividend is calculated at the recommended rate by the
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……………….. on the paid up capital.

Declaration of Dividend Out of Reserve


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In case of inadequate of profits or absence of profit as per Section


205(A), a company can declare and pay dividend out of revenue
reserves (which were made during the years of heavy profit) to
maintain a uniform and steady rate of dividend. Only free and
No

uncommitted reserves can be utilized for the declaration of


dividend. But there are some restrictions which are given in the
Section 205(3A) of the Companies Act, on the utilization of these
reserves. If a company wants to utilize these reserves or post-
accumulated profit for the declaration of dividend, it will have to
S,

comply with the prescribed rules framed by the Central


Government which are known as Companies (Declaration of
PE

Dividend out of Reserve) Rules 1975. According to Rule 2 of these


rules, a company has to satisfy the following conditions:

(a) The rate of dividend declared should be 10% of the paid up


U

capital or average of rates of dividend which was declared and


paid by the company in the five preceding years to that year,
whichever is less.
(c)
UNIT 12: Dividends & Dividends Declaration Out of Past & Current Profits

ale
189
(b) The amount to be drawn from such reserve (accumulated past
Notes
profits) for the declaration of dividend should not be more
than 10% of the sum of paid up capital and free reserves. In ___________________

n/S
addition to this, the amount so drawn must first be utilized to ___________________
set off the losses incurred in those financial years for the
___________________
declaration and payment of dividend.
___________________
(c) The balance of reserve account after such withdrawal should

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not be less than 15% of its paid up capital. ___________________

___________________
Illustration

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___________________
(i) Calculated the maximum amount that can be distributed as
___________________
dividend for the year 2012 according to Companies
(Declaration of Dividend out of Reserve) Rules 1975 from the

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___________________
following data: ___________________
`
Paid up equity capital 25, 00,000
ep
Free Reserves 12, 50,000
Loss in 2012 1, 25,000
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Dividend
2000, 2008, 2009, 2010 & 2011.
declared in
15%, 12.5%, 16%, 13%, 13.5%.

(ii) Due to inadequacy of profits during the year, the company


t fo

proposes to declare dividend out of general reserves. From the


following particulars you are to ascertain the amount that can
be drawn applying the Companies (Declaration of Dividend
out of Reserve) Rules 1975:
No

(a) 17,500 8% Preference shares of ` 100


each fully paid 17, 50,000
(b) 7, 00,000 Equity shares of ` 10 each
S,

fully paid 70, 00,000


(c) General Reserve 21, 00,000
PE

(d) Securities Premium 3, 50,000


(e) Capital Reserve on revaluation
of assets 3, 50,000
U

(f) Credit balance of P&L A/c. 63,000


(g) Net Profit for the year 3, 75,000
(c)

(h) Average rate of dividend during the


last five year 15%
Business Accounting

ale
190
Notes Solution:

___________________ (a) Average Rate of Dividend:

n/S
___________________ 15 +12.5 +16 +13 +13.5
during the last five years = = 14%
___________________ 5

___________________ Condition of Rule 2 of the Companies (Declaration of Dividend


of Reserve) Rule, 1975 will be applicable for the declaration of

tio
___________________
dividend out of reserves:
___________________
First Condition: Average rate of dividend of the last five years

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___________________
i.e. 14% (calculated above) or maximum rate of dividend i.e.
___________________ 10% whichever is less can be declared for dividend. Here, 10%
___________________ is the lower rate.

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___________________ Second Condition: Maximum amount which can be withdrawn
for the declaration of dividend i.e. 10% of paid up Capital +
Free reserve.
ep
` 3, 75,000 first will be used to set off the losses of 2005.

Now amount left after writing off the losses for Dividend
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= (` 3, 75,000 - ` 1, 25,000) = ` 2, 50,000


Third Condition: After withdrawing the amount for dividend
i.e. ` 3, 75,000, the balance of reserve account should not be
2,500,000 × 15
t fo

less than 15% of paid up capital ( = 3,75000).


100
Here, the balance of the reserve a/c is (` 12, 50,000 - ` 3,
75,000) is more than ` 250,000.
No

Thus ` 2, 50,000 can be paid and declared as dividend.


2,50,000
Rate of Dividend = ×100 = 10%
25,00,000
S,

(b) Amount available for dividend on equity shares


`
PE

Credit balance of P & L A/c. 63,000


+ Net Profit for the year 3, 57,000
U

Total profit 4, 20,000


– 8% Dividend on Preference Shares 1, 40,000
(c)

Profit for Equity Shareholder 2, 80,000


UNIT 12: Dividends & Dividends Declaration Out of Past & Current Profits

ale
191
First Condition: Maximum rate of dividend i.e. 10% or average
Notes
Activity
rate 15% whichever is lower, will be declared the rate of
You___________________
and your group members
dividend. Thus, the rate of dividend will be 10%.

n/S
are required to develop an
70,00,000 × 10 ___________________
assignment on declaration of
Amount of Dividend = = ` 7,00,000
100 dividend out of capital profit.
___________________
Amount required for dividend = ` 7,00,000 – 2, 80,000 =
___________________
` 4,20,000

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___________________
Second Condition: Maximum amount which can be withdrawn
for the declaration of dividend i.e. 10% of paid up Capital + ___________________

Free reserve.

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___________________
Third Condition: After withdrawing the amount for dividend, ___________________
the balance of reserve account should not be less then 15% of
17,50,000 + 70,00,000 × 15

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___________________
paid up capital i.e. = 13,12,500.
100 ___________________
The balance left in the reserve account = 21, 00,000 - 4, 20,000
= ` 16, 80,000, which is more than 15% of the paid up capital.
ep
Thus, on the basis of above three conditions, 10% dividend can
be declared and paid.
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Check Your Progress


Fill in the blanks:
1. In case of inadequate of profits or absence of profit as
t fo

per Section 205(A), a company can declare and pay


dividend out of ………………….. to maintain a uniform
and steady rate of dividend.
2. The balance of reserve account after withdrawal should
No

not be less than ………………. of its paid up capital.

Declaration of Dividend out of Capital Profit


S,

Capital profits are those profits which are earned by the company
on the transactions not related to its normal course of business.
For example, profit on sale of fixed assets. Capital profit can be
PE

utilized for the payment of dividend only if:


(i) They have been realised in cash.
U

(ii) The Memorandum and Articles of Association permit the


payment of dividend out of capital profit.
(c)

(iii) Surplus remains after revaluation of all assets.


Business Accounting

ale
192
The following types of capital profit are not at all available for
Notes
dividend:
___________________
(i) Securities shares premium account.

n/S
___________________
(ii) Balance of profit after the reissue of forfeited shares.
___________________
(iii) Balance of capital redemption reserve account.
___________________
The following types of capital profit are also not available for

tio
___________________
dividend:
___________________
(a) Profit on sale of fixed assets

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___________________
(b) Profit on the redemption of debentures
___________________

___________________
(c) Pre-incorporation profits

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___________________ (d) Profit on redemption of debentures
(e) Profit on acquisition of building
Although there are several restrictions on the payment of dividend
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out of capital profit in the Companies Act, but no restriction will be
imposed in respect of the following uses-
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(i) Issue of bonus shares (fully paid).


(ii) Writing off capital losses and fictitious assets as preliminary
expenses, goodwill, discount or commission on the issue of
share or debentures.
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(iii) Providing for premium payable on redemption of preference


share/debentures.
(iv) Writing off losses on the revaluation of the assets of the
No

company.
It is to be noted that capital profits transferred to capital reserve
shall not be utilized for the payment of dividend. If the capital
profits are used for the declaration of dividend, those should not be
S,

transferred to capital reserves.


PE

Accounting Entries Regarding Dividend


1. When dividend is proposed/recommended by the directors:
Profit and Loss Appropriation A/c. Dr.
U

To Proposed Dividend A/c.


(c)

Note: If the balance in the P/L Appropriation A/c is not


sufficient for the payment of dividend, the directors may
UNIT 12: Dividends & Dividends Declaration Out of Past & Current Profits

ale
utilize the balance lying in the Dividend Equalization Reserve 193
or General Reserve. For this purpose, the required amount is Notes
transferred from these reserves to Profit and Loss ___________________
Appropriation A/c. Then the following entry will be passed

n/S
___________________
before passing the above entry:
___________________
Dividend Equalization Reserve A/c. Dr.
___________________
or

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___________________
General Reserve A/c. Dr.
___________________
To Profit and Loss Appropriation A/c.

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___________________
2. When dividend is declared after the approval of shareholder-
___________________
Proposed Dividend A/c Dr.

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___________________
To Dividend Payable A/c. ___________________

3. When amount is deposited in the Dividend Bank A/c for the


payment of dividend-
ep
Dividend Bank A/c. Dr.
To Bank A/c.
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4. When the amount of dividend is paid to the shareholder:


Dividend Payable A/c. Dr.
To Dividend Bank A/c.
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5. When there is some balance in the dividend payable account at


the end of the year, that is transferred to Unclaimed Dividend
A/c.
No

For the purpose the following entry will be passed:


Dividend Payable A/c. Dr.
To Unclaimed Dividend A/c.
S,

6. When unclaimed dividend becomes time-barred, it is


transferred to a Special A/c. For that entry will be:
PE

Unclaimed Dividend A/c. Dr.


To Dividend Bank A/c.
U

7. If unpaid dividend is not claimed by the shareholders within


seven years form the date of declaration, it is transferred of
Investor Education and Protection Fund A/c.
(c)
Business Accounting

ale
194
For that entry will be:
Notes

___________________
Unclaimed Dividend A/c. Dr.

n/S
___________________ To Unpaid Dividend Bank A/c.

___________________ Illustration

___________________ Lucky Limited has a credit balance of profit and loss account of
` 2,50,000 on 1st April 2012. The net profit for the year is

tio
___________________
` 15,50,000. During the year, a half-year's dividend was paid on
___________________
10% preference shares capital of ` 14,00,000. It was decided that
following appropriation be made:

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___________________

___________________ (i) Provision for taxation ` 7,80,000


___________________
(ii) Dividend equalization reserve account ` 50,000.

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___________________
(iii) To pay the final dividend on preference shares.
(iv) To pay the dividend 15% on the ` 20,00,000 equity capital.
ep
(v) Transfer to general reserve ` 40,000
(vi) Transfer to debentures redemption reserve ` 80,000.
rR

Prepare Profit and Loss Appropriation A/c and give journal entries
for payment of dividend. Tax is deducted on preference dividend @
10%.
Solution:
t fo

Profit and Loss Appropriation Account


(For the year ended 31st March, 2012)
Particulars ` Particulars `
No

To General Reserve 40,000 By Balance b/d


(last year balance) 2, 50,000
To Debentures: To Balance b/d
(current year balance) 15, 50,000
S,

Redemption Fund 80,000


To Proposed Equity dividend 3,00,000
To Dividend Equalization
PE

Reserve 50,000
To Dividend on Preference
share
Paid 70,000
U

Proposed 70,000 1, 40,000


To Provision for Taxation 7, 80,000
(c)

To balance c/d 4, 10,000


18, 00,000 18, 00,000
UNIT 12: Dividends & Dividends Declaration Out of Past & Current Profits

ale
Journal Entries in the books of Lucky Ltd. 195
Date Particulars L.F. ` ` Notes
At the Profit and Loss Appropriation A/c Dr. 70,000
___________________
end of

n/S
To Preference Dividend Payable 63,000
1st half
A/c ___________________
To Income Tax A/c. 7,000
___________________
(Being to declaration of Preference
Dividend for half year at tax deducted ___________________
at source).

tio
Dividend Bank A/c Dr. 63,000 ___________________
To Bank A/c. 63,000 ___________________
(Being opened a special account, for

uc
the payment of Preference Dividend) ___________________
Preference Dividend Payable A/c. Dr. 63,000
___________________
To Dividend Bank A/c. 63,000

rod
(Being the payment of Preference ___________________
Dividend)
___________________
Income Tax A/c. Dr. 7,000
To Bank A/c. 7,000
(Being payment of tax in the
ep
Government A/c)
At the Profit and Loss Appropriation A/c Dr. 3,70,000
end of
To Proposed Equity Dividend A/c 3, 00,000
2nd
rR

half. To Proposed Preference Dividend 70,000


A/c
(Being recommendation of equity and
preference dividend)
Proposed Equity Dividend A/c Dr. 3, 00,000
t fo

Proposed Preference Dividend A/c. Dr. 70,000


To Equity Dividend Payable A/c. 3, 00,000
To Pref. Dividend Payable A/c. 63,000
To Income Tax A/c. 7,000
No

(Being the declaration of equity


and preference dividend and tax
deducted at source on Preference
Dividend)
Dividend Bank A/c. Dr. 3, 63,000
To Bank A/c. 3, 63,000
S,

(Being opened a Special account for


the payment of dividend)
Dividend Bank A/c Dr. 3, 00,000
PE

Pref. Dividend Payable A/c Dr. 63,000


To Dividend Bank A/c 3, 63,000
(Being the payment of dividend)
U

Income Tax A/c. Dr. 7,000


To Bank A/c. 7,000
(Being payment of Income Tax)
(c)
Business Accounting

ale
196
Check Your Progress
Notes
Activity
Fill in the blanks:
Make an honest assessment
___________________
of your organisation and 1. …………………… are those profits which are earned by

n/S
___________________
prepare a brief write up about
the company on the transactions not related to its
the ___________________
issue of bonus shares in
your organization. normal course of business.
___________________
2. Capital profits transferred to capital reserve shall not be

tio
___________________ utilized for the payment of ……………………
___________________

Issue of Bonus Shares

uc
___________________

___________________ When a company has a large amount of accumulated profit in its


___________________ different revenue reserve and the company wants to distribute it to

rod
its shareholders in addition to regular dividend, such a distribution
___________________
is called 'bonus'. Bonus may be paid in the following ways:
(i) In case
ep
(ii) In the share capital:
(a) by the issue of new shares to the existing shareholders.
rR

(b) by making partly paid shares as fully paid shares.


(i) Bonus in Cash: When a company has a large accumulated
profit and a large amount in cash, it can pay bonus in cash. By
t fo

making the payment of bonus in cash, the position of working


capital should not be adversely affected. If there is a shortage
of liquid assets or there is requirement of working capital for
development in the future, cash payment of bonus may be
No

stopped. Cash bonus is paid only in that situation when the


company has earned a huge amount of profit in a particular
year and does not want to increase its rate of dividend or it is
not possible for the company to issue the bonus due to the limit
of authorized capital.
S,

(ii) Bonus in Shares: Payment of bonus into shares is also known


as capitalization of profit. In other words, conversion of
PE

accumulated profit or reserve into shares capital is the


capitalization of profit. A company can issue bonus shares into
two ways- (1) issue of fully paid bonus shares to the existing
U

shareholder. (2) By utilizing the bonus into making the partly-


paid shares into fully-paid shares. When new shares are
(c)

issued to pay the bonus to the existing shareholders the


number of shares increase and accumulated profits and
UNIT 12: Dividends & Dividends Declaration Out of Past & Current Profits

ale
reserves decrease. In the second case, when amount to bonus 197
is utilized to make the already issued partly paid shares into Notes
fully paid shares, paid up value of the existing shares ___________________
increases without increasing the number of shares and paying

n/S
___________________
the extra amount by the shareholder.
___________________
Sources of the Issued of Bonus Shares ___________________

tio
These sources are also known as the source of capitalization. They
___________________
are as follows:
___________________
(i) Credit balance of Profit and Loss A/c.

uc
___________________
(ii) General Reserve
___________________
(iii) Any other reserve made from profit

rod
___________________
(iv) Investment Allowance Reserve ___________________
(v) Development Rebate Reserve
(vi) Shares Premium
ep
(vii) Capital Redemption Reserve
(viii) Capital Reserve
rR

Here, it is to be noted that above Capital Redemption Reserve


shares premium and Capital Reserve can be utilized only for the
issue of fully paid bonus shares while the others can be used to
t fo

make partly paid shares into fully paid.

Advantage of the Issue of Bonus Shares


There are following advantages to a company due to the issue of
No

bonus shares-
(i) As the company does not have to pay the bonus in cash, the
liquidity position of the company does not affect.
S,

(ii) For the expansion of business, it is the cheapest method to


raise the capital.
PE

(iii) It is an easy method to reduce the high rate of dividend.


(iv) By the issue of bonus shares, the capital structure of the
company becomes more realistic.
U

Latest Guidelines for the Issue of Bonus Shares


(c)

After the abolition of Control of Capital Issue Act through


ordinance No. 9, in May 1992, new guidelines for bonus shares
Business Accounting

ale
198 have been issued by the Securities Exchange Board of India
Notes (Primary Market Department) vide its press release dated
___________________ 13.4.1994. These modified guidelines are as follows:

n/S
___________________ i. These guidelines are applicable to existing listed companies
___________________ which shall forward a certificate duly signed by the issuer and
duly countersigned by its statutory auditor or by a company
___________________
secretary in practice, to the effect that the terms and

tio
___________________ conditions for issue of bonus shares as laid down in these
___________________ guidelines have been complied with.
ii. Issue of bonus shares after any public right issue is subject to

uc
___________________

___________________
the condition that no bonus issue shall be made which will
dilute the value or right of the holder of debentures.
___________________
Convertible fully or partly.

rod
___________________
In other words, no company shall, pending conversion of
FCDs/PCDs, issue any shares by way of bonus, unless similar
benefit is extended to the holder of such FCDs/PCDs, through
ep
reservation of shares in proportion to such convertible part of
FCDs/PCDs. The shares so reserved may be issued at the time
of conversion(s) of such debentures on the same terms on
rR

which the bonus issues were made.


iii. The bonus issue is made out of free reserves built out of the
genuine profits or share premium collected in cash only.
t fo

iv. Reserves created by revaluation of fixed assets are not


capitalized.
v. The declaration of bonus issue, in lieu of dividend, is not made.
No

vi. The bonus issue is not made unless the partly-paid shares, if
existing, are made fully-paid up.
vii. The company:
S,

1. Has not defaulted in payment of interest or principal in


respect of fixed deposits and interest on existing
debentures or principal on redemption thereof; and
PE

2. Has sufficient reason to believe that is has not defaulted


in respect of the payment of statutory dues of the
employees, such as contribution to provident fund,
U

gratuity, bonus etc.


(c)

viii. A company which announces its bonus issue after the approval
of the Board of Directors must implement the proposal within
UNIT 12: Dividends & Dividends Declaration Out of Past & Current Profits

ale
a period of six months from date of such approval and shall not 199
have the option of changing the decision. Notes

ix. There should be a provision in the Articles of Association of the ___________________

n/S
company for capitalisation of reserves, etc. and if not the ___________________
company shall pass a resolution at its General Body Meeting
___________________
provision in the Articles of Association for capitalization.
___________________
x. Consequent to the issue of bonus shares, if the subscribed and

tio
___________________
paid up capital exceeds the authorized shares capital, a
resolution shall be passed by the company at its General Body ___________________
Meeting for increasing the authorized capital.

uc
___________________

Accounting Treatment Regarding Bonus Shares ___________________

rod
___________________
(A) When already issued partly paid shares are made fully
paid: ___________________

(i) On declaring the bonus:


Profit and Loss Appropriation A/c. Dr.
ep
Or
General Reserve A/c. Dr.
Or
rR

Any other Reverse Reserve A/c. Dr.


To Bonus to shareholders A/c.

(ii) On making the final call on existing shares:


t fo

Shares Final Call A/c Dr.


To Shares Capital A/c.

(iii) On adjusted the bonus with final call:


No

Bonus to Shareholder A/c. Dr.


To Shares Final Call A/c.

(B) When fully paid bonus shares are issued:

(i) On declaring the Bonus:


S,

Profit and Loss Appropriation A/c. Dr.


Or
PE

General Reserve A/c. Dr.


Or
Any other Reverse Reserve A/c. Dr.
To Bonus shareholder A/c.
U

(ii) On issuing the Bonus shares:


Bonus to shareholder A/c Dr.
(c)

To Share Capital A/c.


Business Accounting

ale
200
(C) When Bonus is paid in cash
Notes

___________________
(i) On declaring the bonus:
Profit and Loss Appropriation A/c Dr.

n/S
___________________
Or
___________________
General Reserve A/c. Dr.
___________________ Or

tio
___________________ Any other Reverse Reserve A/c. Dr.
___________________ To Bonus shareholder A/c.

uc
___________________
(ii) On the payment of bonus:
___________________ Bonus to shareholder A/c. Dr.
___________________
To Cash A/c.

rod
___________________
Illustration

Following were the balance in the books of Victory Company


ep
Limited as at 30th June, 2012:

(i) Authorised Capital: 1, 00,000 share of ` 100 each.


rR

(ii) Issued Capital: 80,000 shares of ` 90 per share paid up.

(iii) General Fund ` 36, 00,000


t fo

(iv) Profit and Loss A/c ` 16, 00,000

The following resolutions were passed on annual general


meeting of the company, which was held on 17th August,
No

2012:

(a) To pay ` 15 cash dividend for each share.

(b) To declare capital bonus @ ` 50 per share. It was used in


S,

making partly paid up share as fully paid and the


balance was used in issuing fully paid bonus shares at a
PE

premium of 60%.

(c) ` 2, 00,000 was to be paid as bonus to the employees of


the company. These resolutions were carried out.
U

Pass the necessary journal entries in the books of the


company.
(c)
UNIT 12: Dividends & Dividends Declaration Out of Past & Current Profits

ale
Solution: 201
Notes
Journal entries in the books of
Victory Company Limited ___________________

n/S
Date Particulars L.F. ` ` ___________________
(i) Profit and Loss Appropriation A/c Dr. 12, 00,000
___________________
To Dividend A/c 12, 00,000
(Being the declaration of dividend ___________________
on 80,000 shares @ ` 15 per share)

tio
(ii) General Reserve A/c Dr. 36, 00,000 ___________________
Profit and Loss Appropriation A/c Dr. 6, 00,000
To Bonus to shareholders A/c 40, 00,000 ___________________
To Staff Bonus A/c 2, 00,000

uc
___________________
(Being declaration of bonus to
shareholders and employees) ___________________
(iii) Dividend A/c Dr. 12, 00,000

rod
Staff Bonus A/c Dr. 2, 00,000 ___________________
To Bank A/c 14, 00,000
___________________
(Being the payment of bonus and
dividend)
(iv) Shares Final Call A/c Dr. 8, 00,000
ep
To Shares Capital A/c 8, 00,000
(Being final call due on 80,000
equity shares @ ` 10 each)
(v) Bonus to shareholder A/c Dr. 8, 00,000
rR

To Shares Final Call A/c 8, 00,000


(Being adjustment of bonus with
final call A/c.)
(vi) Bonus to shareholder A/c Dr. 32, 00,000
To Share Capital A/c 20, 00,000
t fo

To Share Premium A/c 12, 00,000


(Being issue of fully paid bonus
shares at a premium of 60%)

Check Your Progress


No

Fill in the blanks:


1. When a company has a large accumulated profit and a
large amount in cash, it can pay ……………….. in cash.
S,

2. Payment of bonus into shares is also known as


……………….. of profit.
PE

Summary
Dividend can be paid in cash or shares. For the declaration of
U

dividend and bonus among shareholders, a company must satisfy


the different conditions. Divisible profits are also known as profits
(c)

available for dividends for shareholders. In other words, net profits


which can be distributed among the shareholders are called
Business Accounting

ale
202 divisible profits. In normal course, that profit is distributed among
Notes the shareholders as dividend which has been calculated after
___________________ deducting all expenses, losses, depreciation on fixed assets, fall in
the price of current assets, taxation, past losses and transferring a

n/S
___________________
reasonable amount to reserve.
___________________
Dividend is that portion of divisible profit which is divided among
___________________
the shareholders of the company. After complying with the

tio
___________________ provisions of the Companies Act and the Articles of Association the
___________________ profit of the company is distributed to the shareholders by the way
of return on their investment in shares. In case of inadequate of

uc
___________________
profits or absence of profit as per Section 205(A), a company can
___________________
declare and pay dividend out of revenue reserves (which were
___________________ made during the years of heavy profit) to maintain a uniform and

rod
___________________ steady rate of dividend. Only free and uncommitted reserves can
be utilized for the declaration of dividend. Capital profits are those
profits which are earned by the company on the transactions not
related to its normal course of business. When a company has a
ep
large amount of accumulated profit in its different revenue reserve
and the company wants to distribute it to its shareholders in
rR

addition to regular dividend, such a distribution is called 'bonus'.

Lesson End Activity


t fo

Discuss the sources from which bonus shares can be issued by a


company. Briefly state the main guidelines issued by SEBI for the
issue of bonus shares.
No

Keywords
Divisible Profits: Divisible profits are also known as profits
available for dividends for shareholders. In other words, net profits
which can be distributed among the shareholders are called
S,

divisible profits.
Proposed Dividend: The dividend which is recommended for the
PE

shareholders by the directors is called proposed dividend.


Final Dividend: Final dividend is declared and approved at the
annual general meeting. It is approved by the shareholders by
U

looking at the financial position and the divisible profits of the


company.
(c)
UNIT 12: Dividends & Dividends Declaration Out of Past & Current Profits

ale
203
Interim Dividend: The dividend that is declared between two
Notes
annual general meetings is called interim dividend. In other words,
it can be paid by directors to the shareholders at any time before ___________________

n/S
closing the final accounts. ___________________

Bonus: When a company has a large amount of accumulated profit ___________________


in its different revenue reserve and the company wants to
___________________
distribute it to its shareholders in addition to regular dividend,

tio
___________________
such a distribution is called bonus.
___________________

Questions for Discussion

uc
___________________

___________________
1. Explain the term 'Dividend'.

rod
___________________
2. What do you mean by Divisional Profits?
___________________
3. What are the different sources of Dividend?
4. What are the different sources for the issue of bonus
ep
shares?
5. Lucky Limited has a credit balance of profit and loss account
of ` 2, 50,000 on 1st April 2012. The net profit for the year is `
rR

15, 50,000. During the year, a half-year's dividend was paid on


10% preference shares capital of ` 14, 00,000. It was decided
that following appropriation be made:
t fo

(i) Provision for taxation ` 7, 80,000


(ii) Dividend equalization reserve account ` 50,000.
(iii) To pay the final dividend on preference shares.
No

(iv) To pay the dividend 15% on the ` 20, 00,000 equity


capital.
(v) Transfer to general reserve ` 40,000
S,

(vi) Transfer to debentures redemption reserve ` 80,000.


Prepare Profit and Loss Appropriation A/c and give journal
PE

entries for payment of dividend. Tax is deducted on preference


dividend @ 10%.
6. Following were the balance in the books of Victory Company
U

Limited as at 30th June, 2012:


(i) Authorised Capital: 1, 00,000 share of ` 100 each.
(c)

(ii) Issued Capital: 80,000 shares of ` 90 per share paid up.


Business Accounting

ale
204
(iii) General Fund ` 36, 00,000
Notes

___________________
(iv) Profit and Loss A/c ` 16, 00,000

n/S
___________________ The following resolutions were passed on annual general
meeting of the company, which was held on 17th August, 2012:
___________________
(a) To pay ` 15 cash dividend for each share
___________________
(b) To declare capital bonus @ ` 50 per share. It was used in

tio
___________________
making partly paid up share as fully paid and the balance
___________________
was used in issuing fully paid bonus shares at a premium
of 60%.

uc
___________________

___________________ (c) ` 2, 00,000 was to be paid as bonus to the employees of the


___________________ company. These resolutions were carried out.

rod
___________________ Pass the necessary journal entries in the books of the company.

Further Readings
ep
Books
T.S. Grewal, M.C. Shukla. “Advanced Accounts”. S. Chand, New
rR

Delhi.
R.L. Gupta, M. Radhaswami. “Advanced Accountancy”. Sultan
Chand, New Delhi.
t fo

Dr. S.N. Maheshwari, Sharad, K. Maheshwari. “Financial


Accounting”. Vikas Publishing Co. Pvt. Ltd., New Delhi.
Pandikumar, M. P (2007). “Management Accounting, Excel Books”.
No

New Delhi.

Web Readings
http://beginnersinvest.about.com/od/dividendsdrips1/ss/dividends-
S,

and-dividend-investing-101_2.htm
http://www.cliffsnotes.com/study_guide/Dividends.topicArticleId-
PE

21248,articleId-21194.html
www.taxmann.com/taxmannflashes/articles/flashart23-12-
10_1.htm
U

www.icsi.edu/WebModules/Publications/SSONDIVIDEND(SS3).pd
f
(c)
UNIT 13: Amalgamation, Absorption & External Reconstruction

ale
Unit 13
205
Notes
Activity
What do you mean by
Amalgamation, Absorption &
___________________
amalgamation of companies?

n/S
Explain its objectives, merits
___________________

External Reconstruction and demerits.


___________________

___________________

tio
Objectives ___________________
After completion of this unit, the students will be aware of the following
___________________
topics:

uc
___________________
\ Amalgamation and Absorption of Companies
\ Reconstruction of Companies ___________________

\ Calculation of Purchase Consideration

rod
___________________
\ Accounting Treatment ___________________

Introduction
ep
In order to get the advantages of large scale business and to
abolish the cut-throat competition, two or more companies combine
rR

their undertakings. This combination of undertakings may be in


the form of amalgamation and absorption. In the chapter we
discuss the legal provisions which are considered at the time
preparation of accounts on the combination of business and
t fo

reconstruction of business.
The modern age is the age of competition and large-scale business.
In order to derive the economies of large scale production and to
eliminate or reduce the competition, two or more than two
No

companies engaged in the similar nature of business, may combine


their undertakings. Combination of the undertakings reduces the
duplication of expenditures, decreases the amount of risk of
competition and also reduces cost per unit of the production.
S,

Combination of the companies may be in the form of


Amalgamation, Absorption and Reconstruction of Companies.
PE

Amalgamation and Absorption of Companies


When two or more companies having similar nature of business
U

merge their businesses in order to form a new company, such a


merging is known as amalgamation of companies. In other words,
(c)

two or more existing companies will liquidate themselves and a


new company will be formed to take over the business of these
Business Accounting

ale
206 companies. For example, suppose there are two companies X
Notes Limited and Y Limited engaged in the similar nature of business.
___________________ In the case of amalgamation, these two companies will liquidate
themselves and a new company (assume X Y Ltd.) will be formed

n/S
___________________
to take over the business of these two existing companies.
___________________
According to Halsburry's Laws of England "Amalgamation is a
___________________
blending of two or more existing undertakings into one

tio
___________________ undertaking, the shareholder of each blending company becoming
___________________ substantially the shareholders in the company which is to carry on
the blended undertakings. There may be amalgamation either by

uc
___________________
transfer of two or more undertakings to a new company or by the
___________________
transfer of one or more undertakings to an existing company."
___________________

rod
Absorption of Companies
___________________
In absorption, an existing company takes over the business of one
or more existing companies, which dissolve their businesses. In
other words, no new company will be formed to take over the
ep
business of the liquidating companies. Only an existing company
will acquire the business of these companies. For example: If A
rR

Limited (an existing company) acquires the business of B Limited


(an existing company), it will be a case of absorption. In this case,
B Limited has to dissolve itself.
t fo

Objectives of Amalgamation & Absorption


1. To eliminate or reduce cut-throat competition.
2. To reap the economies of the production of goods and services
No

on a large scale.
3. To gain control over the market.
4. To gain the benefits of the service of the experts.
5. To promote research and development schemes.
S,

6. To derive the other advantage of the amalgamation.


PE

Types of Amalgamation
According to AS-14 for the purpose of accounting, the
amalgamation of companies is divided into two categories:
U

1. Amalgamation in the nature of merger.


(c)

2. Amalgamation in the nature of purchase.


UNIT 13: Amalgamation, Absorption & External Reconstruction

ale
Amalgamation in the Nature of Merger 207

Upon the satisfaction of the following conditions of AS-14, the Notes

amalgamation of the companies is considered as merger: ___________________

n/S
(i) All the assets and liabilities of the transferor company become, ___________________
after amalgamation, the assets and liabilities of the transferee
___________________
company.
___________________
(ii) Shareholders holding not less than 90% of the face value of the

tio
equity shares of the transferor company (other than equality ___________________

shares already held therein, immediately before the ___________________


amalgamation of the transferee company or its subsidiaries or

uc
___________________
their nominees) become equity shareholders of the transferee
___________________
company by virtue of amalgamation.

rod
___________________
(iii) The consideration for the amalgamation receivable may those
equity shareholders of the transferee company is discharged by ___________________
the transferee company wholly by the issue of equity shares in
the transferee company, except that cash may be paid in
ep
respect of any fractional shares.
(iv) The business of the transferee company is intended to be
carried on, after the amalgamation by the transferee company.
rR

(v) No adjustment is intended to be made to the book values of the


assets and liabilities of the transferor company when they are
incorporated in the financial statements of the transferee
t fo

company, except to ensure uniformity of accounting policies.

Amalgamation in the Nature of Purchase


If an amalgamation does not satisfy any one or more of the
No

conditions mentioned above for amalgamation in the nature of


merger, such an amalgamation is called the amalgamation in the
nature of purchases. For example, if X Ltd. purchases the business
of Y Ltd. with an intention not to continue the business of Y Ltd., it
S,

will be an amalgamation in the nature of purchase and not merger.

Merits of Amalgamation
PE

(1) After the amalgamation of two or more companies, the


prevailing competition among themselves is eliminated.
(2) On the amalgamation of two or more companies, certain
U

expenses are reduced.


(3) When two or more companies amalgamate themselves, it is
(c)

easy for them to control the market through the supply of


goods.
Business Accounting

ale
208
(4) If there is an amalgamation of two or more companies, there
Notes
will be more capital and the problem of finance will be
___________________ removed.

n/S
___________________ (5) After amalgamation of companies, there will be greater control
___________________ on the business.
(6) Production on a larger scale is possible through the
___________________
amalgamation of two or more companies.

tio
___________________
(7) In the case of amalgamation, it is possible to avail of the
___________________ services of experts otherwise, heavy remuneration has to be
paid to experts.

uc
___________________

___________________ (8) After the amalgamation of companies, distribution channel of


the products becomes easy.
___________________

rod
___________________ Demerits of Amalgamation
(1) Amalgamation of companies may give rise to problems of over-
capitalization.
ep
(2) Amalgamation of companies reduces the expenditure, cost and
price of the products of the bigger companies, smaller
businessmen therefore, cannot last for long when confronted
rR

by the bigger players.


(3) Upon increasing the size of the business after amalgamation,
managerial problems multiply.
t fo

(4) The possibilities of exploitation of customers by amalgamated


companies are manifold.
(5) There is also one more danger of monopoly by the
amalgamation of company.
No

(6) Increased production by the amalgamated companies may give


rise to problems of proper distribution and over-production.
(7) The event of non-cooperation between the managerial staff of
the amalgamated companies may retard the growth of the
S,

business.

Check Your Progress


PE

Fill in the blanks:


1. When two or more companies having similar nature of
business merge their businesses in order to form a new
U

company, such a merging is known as …………………


2. In …………………, an existing company takes over the
(c)

business of one or more existing companies, which


dissolve their businesses.
UNIT 13: Amalgamation, Absorption & External Reconstruction

ale
Reconstruction of Companies 209
Notes
Activity
Reorganization or rearrangement of the capital structure of a
Collect recent data
___________________ on
business unit is called reconstruction of the company. The

n/S
reconstruction of companies
objectives of the reconstruction of a company are not the same as and ___________________
prepare a presentation.
those of business combination. In the case of severe financial ___________________
problems as overcapitalization, heavy losses and over valuation of
___________________
fixed assets, reconstruction of the financial structure becomes

tio
necessary. Reconstruction of the financial structures of the ___________________

company is expressed to alter the rights and interest of the ___________________


shareholders, debenture-holders and creditors or outsider's

uc
___________________
liability. On the reconstruction of the company it may or may not
___________________
go into liquidation.

rod
___________________
Reconstruction of companies may be of two types:
___________________
(a) Internal Reconstruction
(b) External Reconstruction
ep
Internal Reconstruction
Internal reconstruction means the reorganization of the capital
rR

structure of a company without forming a new company and


without liquidating the existing company. Internal reconstruction
of a company is done to alter the share capital or to reduce the
share capital without going into liquidation. It means the
t fo

reorganized form of the company will run the business of the


existing company. The claims of the shareholders, creditors and
outsiders are adjusted towards the amount of writing off the losses
and fictitious assets. This is further discussed in the following
No

pages.

External Reconstruction
When the capital structure of a company is reorganized through
S,

the liquidation of the existing company and formation of the new


company, it is called external reconstruction. Thus, in the case of
PE

external reconstruction, one existing company will go into


liquidation and a new company will be formed in order to purchase
the business of the existing company. For example, when Ankit
Limited goes into liquidation and a new company Ankit Mohan
U

Limited is formed to purchase the business of Ankit Limited, it is a


case of external liquidation. In this way, the shareholders and
(c)

persons interested and business will be same in the newly formed


company as were in the old company.
Business Accounting

ale
210
The different features of the Amalgamation Absorption and
Notes
Activity
External Reconstruction are given in the following table:
Give___________________
the meaning of purchase
consideration and list the Basis of External

n/S
Amalgamation Absorption
___________________
different methods to calculate Difference Reconstruction
the purchase consideration. 1. Liquidation Two or more One or more One and only one
___________________ companies go into companies go into company goes into
liquidation. liquidation. liquidation.
___________________
2. Formation of A new company is Only the existing A new company is

tio
___________________ Company formed to take company acquires the New formed to
over the business acquire the business of liquidated company.
___________________ of the wound up the business of the
company. wound up company.
3. Shareholders The shareholders There will be the The shareholders of

uc
___________________
of the new shareholders of the the new company
___________________ company are purchasing company are those who were
those who were in only. in the old company.
___________________ the old company.

rod
4. Level of The level of the The economic status of The economic
___________________ Companies amalgamating the purchasing condition of the old
companies is company is, enhanced company is found to
generally same. in comparison to that be unsound, and a
of the liquidating. new company is
formed to rectify
ep
the situation.

Here, we shall deal with the accounting treatment of


amalgamation, absorption and external reconstruction of
rR

companies only, because there is quite similarity. Accounting


treatments of the internal reconstruction are discussed in the
following pages separately.
t fo

Check Your Progress


Fill in the blanks:
1. ……………….. of the capital structure of a business unit
No

is called reconstruction of the company.


2. ……………….. means the reorganization of the capital
structure of a company without forming a new company
and without liquidating the existing company.
S,

Calculation of Purchase Consideration


PE

The purchase consideration is that amount which is determined at


the time of amalgamation. In other words, it is that amount which
is payable by the transferee company (purchasing company) to the
U

transferor company (vendor company) for the purchase of business.


Purchase consideration may be paid in cash, shares, debentures or
(c)

other securities. As per Accounting Standard (AS)-14


"consideration is the aggregate of the shares and the other
UNIT 13: Amalgamation, Absorption & External Reconstruction

ale
securities issued and the payment made in the form of cash or 211
other assets by the transferee company to the shareholders of the Notes
transferor company." ___________________

n/S
Mode of Payment is generally decided by the mutual agreement ___________________
between Transferor Company and Transferee Company. Fair value
___________________
of the different elements of the consideration is also considered as
the market value of assets. It is to be noted that purchase ___________________

tio
consideration must be paid directly to the shareholders of the ___________________
transferor company. If any amount is directly paid to the creditors ___________________
or debenture-holders of the transferee company, it will not be

uc
___________________
included in the amount of purchase consideration.
___________________
The following methods are used to determine the amount of
purchase consideration:

rod
___________________

___________________
(a) Lump Sum Method
(b) Net Assets Method
ep
(c) Net Payment Method
(d) Intrinsic Worth Method or Share Proportion Method
rR

(a) Lump Sum Method: It is the simplest method among the


above four methods. Under this method, no calculation is
required. The amount of purchase consideration is clearly
given as a lump sum in the examination problems. For
t fo

example, if A Ltd. acquires the business of B Ltd., for ` 35,


00,000 will be the purchase consideration in lump sum.
(b) Net Assets Method: Under this method, the purchase
No

consideration is calculated by adding the agreed value of all


the assets which have been taken over by the transferee
(purchasing) company and deducting there from the total of
agreed value of those liabilities, which have been taken by the
transferee company.
S,

In the form of formula:


PE

Purchase consideration = Total of agreed value of assets taken


over - Total of agreed value of liabilities taken over.
At the time of calculating the purchase consideration by this
U

method, the students should consider the following points:


(i) Only those assets are aggregated which have been taken
(c)

over by the transferee company.


Business Accounting

ale
212
(ii) The fictitious assets and miscellaneous expenditure such
Notes
as preliminary expenses, debit balance of profits and loss
___________________
account etc., are never included in the total of assets.

n/S
___________________
(iii) In the absence of any contrary information, the book value
___________________ of the assets and liabilities taken by Transferee Company
___________________ is treated as agreed value.

tio
___________________ (iv) Only those liabilities are considered, which have been
taken over by the transferee company. In the absence of
___________________
contrary information, all the liabilities belonging to third

uc
___________________
party are assumed to be taken by the transferee company.
___________________
(v) Accumulated profits appearing in the liability sides are
___________________ not considered in calculating the consideration.

rod
___________________ (vi) Payments directly made to the debenture holders and
outside liabilities of the transferor company by the
transferee company are not considered.
ep
(c) Net Payment Method: Under this method, the purchase
consideration is calculated by aggregating the payments made
by the transferee company to the shareholders of transferor
rR

company in the form of cash, shares, debentures and agreed


value of assets given. There is a point for the students to be
noted that all the payments made by the transferee company
t fo

only to the shareholders of the transferor company are the


parts of purchase consideration. And the payments made by
the transferee company to the outside liabilities, creditors and
debenture holders of the transferor company are not
No

considered into the above aggregation of payments because it


is presumed that outside liabilities are taken over and paid by
the transferor company. If the liquidation expenses of the
transferor company are paid by the transferee company that
S,

must also be added in the purchase consideration. The


transferee company may issue the shares and debentures to
the transferee company at par at premium or a discount. In
PE

the absence of instruction, the transferee company must issue


the shares, to the transferor company at par in the case of
amalgamation of the companies in the nature of merger, and
U

at market price in case of amalgamation of companies in the


nature of purchase.
(c)

(d) Intrinsic Worth Method: Under this method, first of all the
intrinsic value of the shares of the transferor is calculated on
UNIT 13: Amalgamation, Absorption & External Reconstruction

ale
the basis of net assets. The net assets are calculated according 213
to net assets method. Therefore, purchase consideration Notes
Activity
calculated under this method becomes equal to the purchase Tom___________________
Company Limited agrees
consideration calculated under net assets method. To find out

n/S
to take over the business of
___________________
the intrinsic value of the shares, the net assets of the company Jerry Company Limited, the
consideration being the
are divided by the number of shares. After finding this value, ___________________
assumption of trade liabilities
the rate of exchange of shares between Transferor Company ` 62,500, the payment of the
___________________

tio
and Transferee Company is determined. If, in the examination cost of liquidation ` 2,500, the
___________________
redemption of the 'Y'
problem, the agreed values of the shares of both the companies
Debentures of ` 2,50,000 at a
___________________
are given, there is no requirement to calculate the intrinsic premium of 10%, the
values of the shares. Suppose there are two companies Ankit

uc
___________________
discharge of 'X' Debentures of
Limited and Shobhit Limited carrying on business in the same ` 5,00,000 at a premium of
___________________
8% by the issue of 10%
line of activities. Their capitals are `24, 00,000 and ` 8, 00,000
Debentures in the Tom

rod
___________________
(value of each share, ` 100). The two companies decided to Company Limited and the
amalgamate in Akshaye Limited. If each share of Ankit ___________________
payment of ` 10 per share in
Limited and Shobhit Limited is valued at ` 150 and ` 250 cash and exchange of 2 fully
paid ` 10 in Tom Co. Ltd., at
respectively for the purpose of amalgamation, then purchase the market price of ` 15 per
ep
consideration will be as follows: share for every share in the
Jerry Co Ltd. The share
Ankit Ltd. Shobhit Ltd. capital of the Jerry Company
rR

Ltd. consists of 25,000 shares


24,000 shares @ ` 150 each 36, 00,000 – of ` 25 each fully paid.
Calculate the purchase
8,000 shares @ ` 250 each – 20, 00,000 consideration by net payment
At the time of issuing the shares to the individual shareholders, method.
t fo

there may be fraction of shares. However, the fractional shares


cannot be issued by the company. In such a situation, the company
can issue the fractional certificate or pay cash for the fractions.
No

Check Your Progress


Fill in the blanks:
1. Under ………………. method, no calculation is required.
S,

2. Under ………………. method, first of all the intrinsic


value of the shares of the transferor is calculated on the
PE

basis of net assets.

Accounting Treatment
U

Let us discuss the:


z Journal Entries in the Books of Transferor Company
(c)

z Journal Entries in the Books of Transferee Company


Business Accounting

ale
214
Journal Entries in the Books of Transferor Company
Notes
In any of the conditions-either amalgamation in the nature of
___________________ purchase, in the nature of merger, absorption, or external

n/S
___________________ reconstruction-the transferor company has to wind up its business.
Hence all the accounts have to close in the same way as the
___________________
accounts of partnership firm are closed on dissolution. All assets
___________________
are disposed, liabilities are paid off and the surplus (if any) is

tio
___________________ distributed among its shareholders. Following are the journal
___________________ entries, which are passed in the books of Transferor Company:
(1) For transferring the assets taken over by the transferee

uc
___________________
company:
___________________
Realization A/c. Dr.
___________________

rod
To Various Assets A/c.
___________________
(Being the transfer of various assets to Realization A/c).
Note:
ep
(a) Various assets will be shown individually
(b) Assets will be shown at book value
(c) Fictitious assets and miscellaneous expenses will not be
rR

transferred to Realization A/c.


(d) If cash balance and bank balance are not taken over by
the transferee company, these will not be transferred to
t fo

the Realization A/c.


(2) For transferring the liabilities taken over by the purchasing
company:
No

Various liabilities A/c. Dr.


To Realization A/c.
(Being transfer of various liabilities to the Realization A/c)
Note:
S,

(a) All liabilities will be shown individually.


(b) Accumulated profits are not transferred to Realization A/c.
PE

(c) If the transferee company agrees to pay some liabilities


directly, such liabilities will not be transferred to the
realizations A/c.
U

(d) Those liabilities, which have not been taken by the


transferee company, will also not be transferred to the
(c)

Realization A/c.
UNIT 13: Amalgamation, Absorption & External Reconstruction

ale
215
(3) For recording the purchase consideration due:
Notes
Transferee Company A/c. Dr.
___________________

n/S
To Realization A/c.
___________________
(Being purchase consideration receivable) ___________________
(4) For selling the assets which are not taken over by the ___________________
transferee company:

tio
___________________
Bank or Cash A/c. Dr.
___________________
To Realization A/c.

uc
___________________
(Being the realization of assets) ___________________

(5) For liquidness expenses of the transferee company:

rod
___________________

(a) When the payment of liquidation expenses or realization ___________________


expenses is made by the transferor company itself.
Realization A/c. Dr.
ep
To Bank A/c.
(Being payment of liquidation expenses)
rR

(b) If liquidation expenses are borne and paid by the


transferee company, it would be better not to pass any
entry. Alternatively, the following two entries may be
t fo

passed:
(i) When expenses are paid:
Transferee Company A/c. Dr.
No

To Bank A/c.
(Being payment of liquidation expenses on the behalf
of Transferee Company)
(ii) When the expenses are reimbursed:
S,

Bank A/c. Dr.


PE

To Transferee Company's A/c.


(c) If the transferee company pays the liquidation expenses
with purchase consideration and not pay separately:
U

Realization A/c. Dr.


(c)

To Bank A/c.
(Being payment of Realization Expenses)
Business Accounting

ale
216
(6) For the discount or premium to the debenture-holders or
Notes
preference shareholders: At the time of amalgamation,
___________________
absorption and external reconstruction shares may be repaid

n/S
___________________ at premium or discount. Such a premium or discount is first
___________________ transferred to the realization account. Entries would be:

___________________ (a) For discount:

tio
___________________ Debenture-holders Account Dr.

___________________ Preference Shareholders Account Dr.


To Realization A/c.

uc
___________________

___________________ (Being transfer of discount to realization A/c)

___________________ (b) For Premium:

rod
___________________ Realization Account Dr.
To Debenture-holders A/c.
To Preference Shareholders A/c
ep
(Being transfer of premium to realization A/c)
(7) For gain or loss on the payment of liabilities not taken
rR

over: If there are some liabilities which are not taken over by
the transferee company, those will not be transferred to the
realization account. But if any profit or loss may occur on the
redemption of such liabilities, such a profit or loss will be
t fo

transferred to the realization account. Then, journal entries


would be:
(a) If there is loss:
No

Realization A/c. Dr.


To Relative Liability A/c
(Being transfer of loss on repayment of the liability)
S,

(b) If there is a profit:


Relative Liability A/c Dr.
PE

To Realization A/c
(Being transfer of profit on repayment of liability)
(8) For receiving the purchase consideration from
U

transferee company:
(c)

Bank A/c Dr.


Shares in Transferee Company A/c Dr.
UNIT 13: Amalgamation, Absorption & External Reconstruction

ale
217
Debentures in Transferee Company A/c Dr.
Notes
To Transferee Company's A/c
___________________

n/S
(Being receipt of purchase consideration in cash, shares
___________________
and debentures)
___________________
(9) For closing the realization A/c:
___________________
(a) On closing the Realization a/c if there is profit:

tio
___________________
Realization A/c Dr.
___________________
To Equity shareholders' A/c

uc
___________________
(Being transfer of profit on realization A/c to the equity ___________________
shareholder's A/c)

rod
___________________
(b) On closing the realization accounts, if there is a loss:
___________________
Equity shareholders' A/c Dr.
To Realization A/c
ep
(Being transfer of loss on Realization A/c to the equity
shareholder's A/c)
rR

(10) For transferring the fictitious assets and accumulated


losses:
Equity Shareholders' A/c Dr.
t fo

To Profit and Loss A/c


To Preliminary Expenses A/c
To Underwriting Commission A/c
No

To Discount on issue of Shares A/c


To Discount on issue of Debentures A/c
(Being transfer of fictitious assets and accumulated losses to
S,

shares to shareholders A/c)


(11) For transferring equity share capital and accumulated
PE

profits:
Equity Share Capital A/c Dr.
General Reserve A/c Dr.
U

Profit and Loss A/c Dr.


(c)

Capital Reserve A/c Dr.


To Equity shareholders capital A/c
Business Accounting

ale
218
(Being transfer of share capital and accumulated profits to
Notes
equity shareholders A/c)
___________________
(12) For the payment of debenture-holders:

n/S
___________________
(a) Debentures A/c Dr.
___________________
To Debenture-holders A/c
___________________
(Being transfer of debentures to debenture-holders A/c)

tio
___________________

___________________ (b) On payment:


Debenture-holders A/c Dr.

uc
___________________

___________________ To Bank A/c


___________________ To Debentures in Transferee company

rod
___________________ (Being payment of debenture-holders)
(13) For the payment of preference share capital:
(a) Preference shares Capital A/c Dr.
ep
To Preference Share Capital A/c
(Being transfer of preference share capital to preference
rR

shareholders A/c)
(b) On payment:
t fo

Preference Shareholders A/c Dr.


To Bank A/c
To Debentures in Transferee company
No

To Equity Shares in Transferee company


To Preference Shares in Transferee company
(Being payment of preferences shareholders in cash, shares
and debentures)
S,

(14) For the Final payment of equity shareholders:


PE

Equity shareholders A/c Dr.


To Bank A/c
To Equity Shares in Transferee Company
U

To Debentures in Transferee Company


(c)

(Being payment of equity shareholders)


UNIT 13: Amalgamation, Absorption & External Reconstruction

ale
Note: After passing this entry, not a single account would have 219
any balance. All the accounts will be closed. Notes

___________________
Journal Entries in the Books of Transferee Company

n/S
___________________
As per the Accounting Standard (AS)-14, there are two methods of
accounting for the amalgamation of companies in the books of ___________________

Transferee Company. These are given below: ___________________

tio
(a) Pooling of Interests Methods ___________________

(b) Purchase Method ___________________

uc
(a) Pooling of Interests Methods: When amalgamation is in the ___________________

nature of merger, this method of accounting is adapted. The ___________________


main features of the pooling of interests method are given

rod
___________________
below:
___________________
(1) In preparing the transferee company's financial
statements, the assets, liabilities and reserves (whether
capital or revenue or arising on revolution) of the
ep
transferor company should be recorded at their existing
carrying accounts and in the same form as at the date of
rR

amalgamation.
(2) The balance of the Profit and Loss Account of the
transferor company should be aggregated with the
corresponding balance of the transferee company, or
t fo

transferred to the general reserve, if any.


(3) The difference between the amount recorded as share
capital issued (plus any additional consideration in the
No

form of cash or other assets) and the amount of share


capital of Transferor Company should be adjusted in
reserves.
(4) If, at the time of amalgamation, the transferor and
S,

transferee companies have conflicting accounting policies,


a uniform set of accounting policies should be adopted
PE

following the amalgamation. The effects on the financial


statements of any changes in the accounting policies
should be reported in accordance with Accounting
Standard (AS)-5, Prior Period of Extraordinary Item and
U

Changes in Accounting Policies.


Accordingly, the following entries are passed in the books of
(c)

Transferee Company to incorporate the financial statements of


company:
Business Accounting

ale
220
1. For recording the purchase consideration:
Notes

___________________
Business Purchase A/c Dr.
To Liquidators of Transferor Company

n/S
___________________
(Being purchase consideration due to the liquidators of
___________________
Transferor Company)
___________________
2. For recording the assets, liabilities and reserves taken

tio
___________________
over:
___________________ Sundry Assets (Individually) A/c Dr.
To Sundry Liabilities (individually) A/c

uc
___________________

___________________ To Various Reserves A/c


___________________ To Business Purchase A/c

rod
___________________ (Being sundry assets, liabilities and reserves of transferor
company taken over)
Note:
ep
(a) All the assets and liabilities will be shown
individually at the book value.
rR

(b) The difference between debit and credit an account of


purchase consideration will be adjusted in the General
Reserve of the transferee company. If the credit side is
greater than the debit side, the following entry will be
t fo

passed.
Various Assets A/c Dr.
General Reserve (Balancing figure) A/c Dr.
No

To Various Liabilities A/c


To Reserve & Funds A/c
To Business Purchase A/c
3. For making the payment of purchase consideration to the
S,

liquidation of transferor company:


Liquidator of Transferor Company A/c Dr.
PE

To Bank A/c
To Debentures A/c
U

To Equity Share Capital A/c


To Preference Share Capital A/c
(c)

(Being discharge of purchase consideration in cash,


debentures and shares)
UNIT 13: Amalgamation, Absorption & External Reconstruction

ale
221
If shares or debentures are issued on discount, discount
Notes
account will also debited and if shares or debentures are
issued at premium, premium account will be credited in ___________________

n/S
the above entry. ___________________

4. For the payment of liquidation expenses of transferor ___________________


company:
___________________

tio
Goodwill/Liquidation Expenses A/c Dr. ___________________
To Bank A/c ___________________

(Being payment of liquidation expenses)

uc
___________________

5. For the payment of preliminary/formation expenses of the ___________________


transferee company:

rod
___________________
Preliminary Expenses A/c Dr. ___________________

To Bank A/c
(Being payment of preliminary expenses)
ep
6. For discharging the debentures of the transferor company:
Debentures of the Transferor Company A/c Dr.
rR

To Bank A/c
To Debentures of the Transferor Company
t fo

To Shares of the Transferor Company.


(Being discharges of debentures of the transferor
company)
No

(b) Purchase Method: Purchase method of amalgamation is


adapted by the transferee Company, when amalgamation is in
the nature of purchase. The following points are kept in mind
at the time of passing of accounting entries under this method:
S,

(1) In preparing the transferee company's financial


statements, the assets and liabilities of the transferor
company should be incorporated at their existing carrying
PE

accounts or, alternatively, the consideration should be


allocated to the individual identifiable assets and
liabilities on the basis of their fair values at the date of
U

amalgamation.
(2) The reserves (whether capital or revenue or arising on
(c)

revaluation) of the transferor company, other than the


Business Accounting

ale
222 statutory reserves, should not be included in the financial
Notes statements of the transferee company.
___________________
(3) Any excess of the amount of the consideration over the

n/S
___________________ value of net assets of the transferor company acquired by
___________________ the transferee company should be recognized in the
transferee company's financial statements as goodwill
___________________
arising on amalgamation. If the amount of the

tio
___________________ consideration is lower than the value of the net assets
___________________ acquired, the difference should be treated as capital
reserve.

uc
___________________

___________________
(4) The goodwill arising on amalgamation should be
amortised to income on a systematic basis over its useful
___________________
life. The amortization period should not exceed five years

rod
___________________ unless a somewhat longer period can be justified.
(5) Where the requirements of the relevant statute for
recording the statutory reserves in the books of the
ep
transferee company are complied with, statutory reserves
of the transferor company should be recorded in the
financial statements of the transferee company. The
rR

corresponding debit should be given to a suitable account


head (e.g. Amalgamation Adjustment Account), which
should be disclosed as a part of 'Miscellaneous
t fo

Expenditure' or other similar category in the balance


sheet. When the identity of the statutory reserves is no
longer required to be maintained, both the reserves and
the aforesaid account should be reversed.
No

Accordingly, the following journal entries are made in the


books of transferee company to incorporate the financial
statements of the transferor company:
1. For recording the purchase consideration:
S,

Business Purchase Account Dr.


PE

To Liquidator of Transferor Company


(Being purchase price due to the liquidator of the
transferor company)
U

2. For recording the assets, liabilities and reserves taken


over:
(c)

Sundry Assets (individually) A/c Dr.


UNIT 13: Amalgamation, Absorption & External Reconstruction

ale
223
To Sundry Liabilities (individually) A/c
Notes
To Various Reserve A/c
___________________

n/S
To Business Purchase A/c
___________________
(Being sundry assets, liabilities and reserves of Transferor ___________________
Company taken over)
___________________
(a) All the assets and liabilities will be shown

tio
___________________
individually at the book values.
___________________
(b) If debit side is greater than credit side, difference will

uc
___________________
be credited to the Capital Reserve A/c and if credit
side is greater than the debit side, difference will be ___________________
debited to the Goodwill A/c.

rod
___________________
3. For making the payment of purchase consideration to the ___________________
liquidator of the transferor company:
Liquidator of Transferor Company A/c Dr.
ep
To Bank A/c
To Debentures A/c
rR

To Equity Share Capital A/c


To Preference Capital A/c.
(Being discharge of purchase consideration in cash,
t fo

debentures and shares)


Note: If shares or debentures are issued on discount,
discount account will also be debited and if shares or
No

debentures are issued at premium, premium account will


be credited in the above entry.
4. For the payment of liquidation expenses of the transferor
company:
S,

Goodwill A/cDr.
To Bank A/c
PE

(Being payment of liquidation expenses)


5. For maintaining the statutory reserve:
U

Amalgamation Adjustment A/c Dr.


To statutory Reserve A/c
(c)
Business Accounting

ale
224
(Being incorporation of statutory reserves of the transferor
Notes
company)
___________________
6. For the payment of preliminary expenses:

n/S
___________________
Preliminary Expenses Account Dr.
___________________
To Bank A/c
___________________
(Being payment of preliminary expenses)

tio
___________________

___________________ 7. For the payment of various liabilities of the transferor


company:

uc
___________________
Various Liabilities A/c Dr.
___________________

___________________
To Bank A/c

rod
___________________ To Debentures A/c
To Share capital A/c
(Being payment of liabilities of the transferor company)
ep
8. For writing off the goodwill against Capital reserves:
Capital Reserve A/c Dr.
rR

To Goodwill A/c
(Being goodwill written off against capital reserves)
t fo

Check Your Progress


Fill in the blanks:
1. At the time of ……………………, absorption and
No

external reconstruction shares may be repaid at


premium or discount.
2. If there are some liabilities which are not taken over by
the transferee company, those will not be transferred to
S,

the ……………………
PE

Summary
In the modern age, to eliminate the cut throat competition, to reap
the economies of production at large scale, amalgamation and
U

absorption of companies are adopted. Amalgamation can be in the


nature of merger and in the nature of purchase.
(c)

Reconstruction of companies is the rearrangement of financial


structure of the company. It is of two types (i) Internal
UNIT 13: Amalgamation, Absorption & External Reconstruction

ale
Reconstruction and (ii) External Reconstruction As per AS 14 there 225
are two methods of accounting for amalgamation i.e. .Pooling of Notes
Interest Methods and Purchase Method. ___________________

n/S
Purchase consideration is the amount which is paid by the ___________________
transferee company to the transferor company on the
___________________
amalgamation. It is computed by (a) Lump Sum Method , (b) Net
Assets Method, (c) Net Payment Method and (d) Intrinsic Worth ___________________

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Method. At the time of Amalgamation of Companies, the inter- ___________________
company Owings/ transactions are eliminated. ___________________

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___________________
Lesson End Activity
___________________
“To eliminate the cut throat competition, to reap the economies of

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___________________
production of large scale, amalgamation and absorption of
___________________
companies are adopted.” Discuss in detail.

Keywords
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Amalgamation: When two or more companies having similar
nature of business merge their businesses in order to form a new
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company, such a merging is known as amalgamation of companies.


Absorption: In absorption, an existing company takes over the
business of one or more existing companies, which dissolve their
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businesses.
Internal Reconstruction: Internal reconstruction means the
reorganization of the capital structure of a company without
forming a new company and without liquidating the existing
No

company.
External Reconstruction: When the capital structure of a
company is reorganized through the liquidation of the existing
company and formation of the new company, it is called external
S,

reconstruction.
Accounting Treatment: Cancellation of the unissued shares
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capital does not require any journal entry in the books of the
company because it does not have any effect on the issued shares
capital.
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Questions for Discussion


(c)

1. What do you understand by purchase consideration? How is it


determined? Explain.
Business Accounting

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226
2. What do you mean by the term amalgamation? Explain any
Notes
four Objectives of it.
___________________
3. Define Amalgamation and give its merits and demerits.

n/S
___________________
4. What do you mean by Reconstruction of Companies? Explain
___________________
its different types.
___________________
5. Give a brief overview of calculation of purchase consideration.

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___________________

___________________
Further Readings

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___________________

___________________
Books
T.S. Grewal, M.C. Shukla. “Advanced Accounts”. S. Chand, New
___________________

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Delhi.
___________________
R.L. Gupta, M. Radhaswami. “Advanced Accountancy”. Sultan
Chand, New Delhi.
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Dr. S.N. Maheshwari, Sharad, K. Maheshwari. “Financial
Accounting”. Vikas Publishing Co. Pvt. Ltd., New Delhi.
Pandikumar, M. P (2007). “Management Accounting, Excel Books”.
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New Delhi.

Web Readings
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www.rkmvc.ac.in/evecol/dept/bcs/syl20092010/syllabus_sem4.pdf
http://www.scribd.com/doc/51198074/AMALGAMATION-
ABSORPTION-RECONSTRUCTION
http://www.scribd.com/doc/9295098/Amalgamation-Absorption-
No

and-External-Reconstructions
220.227.161.86/19017comp_sugans_pe2_ accounting_cp9_ 4.pdf
S,
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(c)
UNIT 14: Internal Reconstruction

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Unit 14
227
Notes
Activity
In how many ways the Share
Internal Reconstruction
___________________
Capital may be altered? Write

n/S
names.
___________________

___________________
Objectives
___________________
After completion of this unit, the students will be aware of the following

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topics: ___________________

\ Reconstruction of Companies ___________________


\ External Reconstruction

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___________________
\ Internal Reconstruction
___________________
\ Accounting Treatment for Reduction of Capital

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___________________

___________________
Introduction
Internal Reconstruction of the companies is the rearrange of the
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financial structure of the companies. In the internal reconstruction
of company, the alteration of share capital and reduction of share
capital are included. In the unit the procedure for these two and
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their accounting treatment is given.

Reconstruction of Companies
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The word reconstruction of a company implies the reorganization


of the financial structure of the company. It is different from
amalgamation and absorption. In the case of heavy losses, over
capitalization or several financial problems, the reconstruction of a
No

company is adopted to remove these defects and to reorganize the


financial structure. Thus term 'reconstruction of a company' is
used to reorganize the financial structure. During the
reconstruction of a company, several changes take place such as
S,

change in shareholders' rights and interests, debenture- holders'


rights, creditors' rights etc. Reconstruction of a company may be of
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two type’s viz., (a) External Reconstruction (b) Internal


Reconstruction.

External Reconstruction
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In the case of external reconstruction, an existing company goes


into liquidation and a new company is formed in order to buy its
(c)

business. Thus, shareholders of the old existing company become


the shareholders of the newly formed company.
Business Accounting

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228
Internal Reconstruction
Notes
In the case of internal reconstruction, the financial structure of a
___________________ company is reorganized without forming a new company and

n/S
___________________ liquidating an existing company. In order to avoid the tedious
affairs of forming a new company and liquidation of a company and
___________________
to avail of the tax advantages of set off past losses against future
___________________
profits, internal reconstruction of the company is adopted. In other

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___________________ words, internal reconstruction is adopted to alter the share capital
___________________ or to reduce the share capital. In the internal reconstruction the
reorganized form of the company runs the business of the existing

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___________________
company. The claims of the shareholders, creditors and outsiders
___________________ are adjusted towards the amount of writing off the accumulated
___________________ losses and fictitious assets. Thus, in the internal reconstruction,

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___________________
the following two are included:
1. Alteration of share capital
2. Reduction of share capital
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1. Alteration of Share Capital: According to Section 94 of the
Companies Act, a limited company having a share capital may,
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if so authorized by its Articles of Association, alter the capital


clause of its Memorandum of Association by the ordinary
resolution in the general meeting. These alterations do not
require the approval of the Company Law Board. Alteration in
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the capital clause may be in any of the following ways:


(a) Increase in its share capital by the issue of fresh shares of
such amount as it thinks expedient.
No

(b) Consolidation of all or part of its existing shares of smaller


denomination into shares of larger denomination.
(c) Conversion of all or part of its fully paid shares into stock
and vice-versa.
S,

(d) Sub-division of its shares or part of them of larger


denominations into smaller denominations.
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(e) Cancellation of those shares which have not been issued.


(a) Increase in Share Capital by Issue of Fresh Shares: A
limited company may increase its nominal or subscribed
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capital by making fresh issue of shares. To increase its


nominal capital, the company has to alter its capital
(c)

clause in its Memorandum of Association. On the passing


of the resolution for increasing of the nominal capital, the
UNIT 14: Internal Reconstruction

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Registrar of the Companies must be informed within 229
thirty days of passing such resolution. The offer for the Notes
issue of fresh shares must first be made to existing ___________________
shareholders in the proportion of their holdings, unless

n/S
___________________
the company has decided otherwise by a special resolution
or by an ordinary resolution approved by the Central ___________________

Government. If the existing shareholders fail to exercise ___________________

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their option within fifteen days, the Board of Directors
___________________
will be free to issue such shares.
___________________
Accounting treatment for the issue of such shares will be

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___________________
same as is adopted for the issue of new shares explained
earlier. ___________________

(b) Consolidation of Shares: As per Section 94 of the

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___________________

Companies Act, 1956, a limited company may consolidate ___________________


its shares of smaller denomination (value) into larger
denomination (value). Generally, consolidation is done
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when the value of shares is in very small amount.
On consolidation of shares, the amount of paid up share
capital remains at old figure, but the number of shares
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decreases.
For example: XYZ Limited having a share capital of
` 10, 00,000 divided into 1, 00,000 shares of ` 10 each on
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which ` 8 per share are paid up, resolve to consolidate 10


shares of ` 10 each into one share of ` 100. On
consolidation the paid up value of the shares will be same
but the number of shares will reduce.
No

On consolidation, the company will pass the following


journal entry:
Share Capital (` 10) Account Dr. 8, 00,000
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To Share Capital (` 100) Account 8, 00,000

(Being consolidation of 10 shares of ` 10 each, ` 8 paid up


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into one share of ` 100).


(c) Sub-Division of Shares: Section 94 of the Companies Act,
1956, also provides that a company may sub-divide its
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shares of larger amount into shares of smaller amount if


so authorised by the Articles of Association. If the shares
(c)

are not fully paid up, the proportion between the amount
Business Accounting

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230 paid and the amount unpaid on each reduced share must
Notes be the same as it was before sub-division.
___________________
On the sub-division of shares, the amount of paid up

n/S
___________________ capital remains the same, but the number of shares
___________________ increases.

___________________ For example: XYZ Limited having a share capital of `


10,00,000 divided into 10,000 equity shares of ` 100 each,

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___________________
resolves to split up one equity share of ` 100 each into 2
___________________ equity shares of ` 50 each. After sub-division, the company
will have the same amount of capital and it will pass the

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___________________

___________________
following journal entry:

___________________ Equity Share Capital (` 100) Account Dr. 10, 00,000

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___________________ To Equity Share Capital (` 50) Account 10, 00,000

(Being sub-division of 10,000 shares of ` 100 each into


20,000 shares of ` 50 each).
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(d) Conversion of Shares into Stock and Vice-Versa: As per
Section 94 of the Companies Act 1956, a company is also
allowed to convert its fully paid up shares into stock or to
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reconvert that stock into fully paid up shares. Stock is the


set of fully paid shares of a number merged into one fund
having equal value. It is a point to be noted that stock is
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always made from fully paid up share, it is never made


from partly paid up shares and shares cannot be
transferred into fractions, while stock can be transferred
into any fraction.
No

On the conversion of shares into stock, the shareholder


becomes stockholders. The stockholders have the same
rights, privileges and advantages as to dividends and
voting as were carried by the shares before conversion into
S,

stock took place. On conversion of shares into stock, the


work of maintaining register and issuing certificate is very
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simplified.
Accounting treatment: On conversion of fully paid up
shares into stock, the company has to pass the following
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journal entry:
Equity Share Capital Account Dr.
(c)

To Equity Stock Account


UNIT 14: Internal Reconstruction

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231
(Being conversion of fully paid up equity shares into
Notes
equity stock).
___________________
On the conversion of equity stock into fully paid up equity

n/S
shares, the above journal entry will be just reverse. ___________________

___________________
(e) Cancellation of Unissued Share Capital: As per Section
94(1) (e) of the Companies Act, 1956, a company is ___________________

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permitted to decrease the amount of its nominal capital by ___________________
cancellation of shares. Cancellation will be of those shares
___________________
which at the date of passing of the resolution for

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cancellation of shares in general meeting in that behalf ___________________

have not taken or agreed to be taken by any person and ___________________


thus diminish the amount of its nominal share capital.

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___________________
Diminution of share capital is different from the reduction
___________________
of share capital. Diminution of capital is unissued share
capital, while reduction of share capital is for
subscribed/paid up capital. For the reduction of capital,
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sanction of the court is mandatory while cancellation of
unissued capital does not require the sanction of court.
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Accounting Treatment: Cancellation of the unissued


shares capital does not require any journal entry in the
books of the company because it does not have any effect
on the issued shares capital.
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2. Reduction of Share Capital: Capital reduction of a company


takes place strictly in accordance with the legal provisions of
Section 100 to 105 of the Companies Act, 1956. If the company
is authorised by its Articles of Association, it may, by a special
No

resolution and on its confirmation by the court on petition,


reduce its shares capital by the following ways:
(a) Reducing or extinguishing the liability of shareholders in
S,

respect of share capital not paid up.


(b) Writing off or cancelling any paid up capital which is lost
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by available assets.
(c) Paying off paid up capital in excess of the requirements of
the company.
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(d) Any other method approved by the court.


As per Section 100, reduction (b) and (c) may be made either in
(c)

addition to or without extinguishing or reducing the liability of


shareholders for uncalled capital.
Business Accounting

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232
Any reduction of capital is dangerous for creditors, as issued
Notes
capital of a company represents the security on which the
___________________
creditors rely. Generally, companies do not call the full value of

n/S
___________________ shares at one time. The uncalled capital acts as a future security
___________________ for the creditors of the company. Therefore, any reduction in
___________________ capital reduces the security of the creditors. In such a situation
the creditors are entitled to object to the reduction. For this

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___________________
purpose the court shall settle a list of creditors and hear their
___________________
objections, if any, and on being satisfied that either the creditors
consent to the reduction or that their debts have been

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___________________

___________________ discharged or secured by the company, may confirm the


___________________
reduction on any terms it thinks fit. As per Sections 101 & 102

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the court may direct the company to add the words "and
___________________
reduced" to its name for a fixed period and to publish the
reasons for reduction for the information of the public.
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As per Section 103, the order of the court and minutes as approved
by the court have to be filed with the Registrar who will register
them and issue a certificate of registration which will be a
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conclusive evidence that everything is in order.

Reduction of capital is purely democratic and is decided by


securing the consent of the holders of at least three-fourth of the
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shares concerned in separate class meetings by means of special


resolution. If at least one-tenth of the issued shareholders are not
satisfied with the resolution of reduction of capital, they may apply
to the court within 21 days after the resolution is passed. In this
No

case the decision of the court will be final.

Following are some exceptional cases in which reduction may take


place without the sanction of the court:
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(a) when shares are forfeited by the company for non-payment of


calls on instalments.
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(b) when redeemable preference shares are redeemed in


accordance with the provisions of Section 80.

(c) when shares are surrendered to the company.


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(d) when the company cancels any share of its nominal capital
(c)

which has not been taken or agreed to be taken by any person.


UNIT 14: Internal Reconstruction

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233
Check Your Progress
Notes
Activity
Fill in the blanks:
On ___________________
the reconstruction of ABC
1. The term ……………….. is used to reorganize the