Accounts

Meaning
Accounting is often called the language of business. Its purpose is to communicate or report
the results of business operations and its various aspects.
It is the process of identifying, measuring and communicating economic information to permit
informed judgments and decisions by users of the information.
According to American Institute of Certified Public Accountants (AICPA), “Accounting is the

art of recording, classifying and summarizing in a significant manner and in terms of
money transactions and events which are, in part at least, of a financial character and
interpreting the results thereof.”
American Accounting Association (AAA) has defined accounting as “the process of
identifying, measuring and communicating economic information to permit informed
judgements and decisions by users of the information.”
On analyzing the above definitions the following characteristics of accounting emerges:
i. Accounting is the art of recording and classifying different business
transactions.
ii. The business transactions may be completely or partially of financial nature.
iii. Generally the business transactions are described in monetary terms.
iv. In accounting process, the business transactions are summarized and analyzed
so as to arrive at a meaningful interpretation.
v. The analysis and interpretations thus obtained are communicated to those who
are responsible to take certain decisions to determine the future course of
business.
Why Accounting is Important?

A businessman generally interested in knowing answers to the following questions:
 The types and amount of earnings.

 The types and amount of Expenses
 The amount of profit or loss, if any.
 The amount of capital and causes of increase and decrease.
 The nature and value of assets possessed by the business.
 The nature and value of liabilities.
 Customers who be in debt to the business and the amount in each case.
 Suppliers to whom the business has to make payments and the amounts in each case.
 Other facts for filing various returns for external use, like Income-Tax return, Sales-Tax
return etc.
Objectives of Accounting:
The following are the objectives of accounting:
a. To record the business transactions in a systematic manner.
b. To determine the gross profit and net profit earned by a firm during a specific period.
c. To know the financial position of a firm at the close of the financial year by way of
preparing the balance sheet
d. To facilitate management control.
e. To assess the taxable income and the sales tax liability.

Dr. Shishir Srivastava, GIHS 1
f. To provide requisite information to different parties, i.e., owners, creditors, employees,
management, Government, investors, financial institutions, banks etc.
Limitations of Accounting:
Accounting suffers from the following limitations:
i. Accounting information is expressed in terms of money. Non monetary events

or transactions, however important, are completely omitted.
ii. Fixed assets are recorded in the accounting records at the original cost, that is,
the actual amount spent on them plus all incidental charges. In this way the effect of
inflation (or deflation) is not taken into consideration. The direct result of this practice is
that balance sheet does not represent the true financial position of the business.
iii. Accounting information is sometimes based on estimates; estimates are often

inaccurate.
iv. Accounting information cannot be used as the only test of managerial

performance on the basis of more profits. Profit for a period of one year can readily be
manipulated by omitting such costs as advertisement, research and development,
depreciation and so on.
v. Accounting information is not neutral or unbiased. Accountants calculate income

as excess of revenues over expenses. But they consider only selected revenues and
expenses. They do not, for example, include, cost of such items as water or air pollution,
employee’s injuries, etc.
vi. Accounting like any other discipline has to follow certain principles, which in
certain cases are contradictory. For example current assets (e.g., stock of goods) are
valued on the basis of cost or market price whichever is less following the principle of
conservatism. Accordingly the current assets may be valued on cost basis in some year
and at market price in another year. In this manner, the rule of consistency is not followed
regularly.
Functions of Accounting
Various Functions of Accounting are:
a. Recording: Accounting records business transactions in terms of money. It is

essentially concerned with ensuring that all business transactions of financial nature are
properly recorded. Recording is done in journal, which is further subdivided into subsidiary
books from the point of view of convenience.
b. Classifying: Accounting also facilitates classification of all business transactions

recorded in journal. Items of similar nature are classified under appropriate heads. The
work of classification is done in a book called the ledger.
c. Summarizing: Accounting summarizes the classified information. It is done in a

manner, which is useful to the internal and external users. Internal users interested in
these informations are the persons who manage the business. External users of
information are the investors, creditors, tax authorities, labor unions, trade associations,
shareholders, etc.

d. Interpreting: It implies analyzing and interpreting the financial data embodied in final
accounts. Interpretation of the data helps the management, outsiders and shareholders in
decision making.
Different systems of Accounting
The following are the basic systems of Accounting:
i. Cash Basis Accounting: According to this system, only actual cash receipts
and payments are recorded in the books. The credit transactions are not recorded at all,
till actual cash is received or paid. Thus, if purchases are made in the year 2002 on credit
and payment for purchases is made in the year 2003, such purchases shall be considered
to be an expense of the year 2003 and shall not be recorded in the year 2002. This
system of accounting is mostly followed by non-trading organizations, professionals like
lawyers, doctors, chartered accountants, etc.
ii. Mercantile or Accrual System: According to this system, all the business
transactions pertaining to the specific period, whether of cash or credit nature, are
recorded in the books. This system of accounting is based on accrual concept, which
states that revenue is recognized when it is earned and expense is recognized when
obligation of payment arises. Actual movement of cash is irrelevant. Mercantile system of
accounting is widely followed by the industrial and commercial undertakings because it
takes into account the effects of all transactions already entered into.
iii. Mixed System: Mixed system is modified form of pure-cash-basis accounting.

Because of the fact that pure cash basis would result in balance sheet and income
statement with limited use, it necessitates the need of mixed accounting in which some
items (especially sales and period costs are treated on cash basis and some items
(especially product costs and long-lived assets) are treated on accrual basis.
Pure cash basis approach would change the cost of acquisition of inventories from the profit of
that year in which the acquisition costs are paid rather than in the year in which inventories are
sold. Similarly cost of acquisition of fixed assets would reduce the profits when paid in cash
rather than in later periods when these long-lived items are used, thus misleading the results of
financial operation.
ACCOUNTING PRINCIPLES
Definition and Explanation:
Accounting is the language of business. Affairs of a business unit are made understood to others
as well as to those who own or manage it through accounting information which has to be
suitably recorded, classified, summarized and presented.
In order to make this language to convey the same meaning to all people, it is necessary that it
should be based on certain uniform scientifically laid down standards. These standards are
termed as accounting principles. Accounting principles may be defined as those rules of action
or conduct which are adopted by the accountants universally while recording accounting
transactions. In the absence of common principles there will be a chaotic situation and every
accountant will have his own principles. Not only the utility of accounts will be less but these will
not be comparable even in the same business. Therefore, it become essential that common
principles should be followed for measuring business revenues and expenses.
Essential Features of Accounting Principles:

Accounting principles are accepted if they satisfy the following norms:
Usefulness:
A principle will be relevant only if it satisfies the needs of those who use it. The accounting
principles should be able to provide useful information to its users otherwise it will not serve the
purpose.
Objectivity:
A principle will be said to be objective if it is based on facts and figures. There should not be a
scope for personal bias. If the principle can be influenced by the personal bias of users, it will not
be objective and its usefulness will be limited.
Feasibility:
The accounting principle should be practicable. The principles should be easy to use otherwise
their utility will be limited.
Classification of Accounting principles:

Accounting principles can be classified into two kinds:
1. Accounting Concepts: The term concepts includes those basic assumptions or

conditions upon which accounting is based.
2. Accounting Conventions: The term "conventions" includes those customs or traditions
which guide the accountants while preparing the accounting statements.
Accounting Concepts:
The term concepts includes those basic assumptions or conditions upon which accounting is
based. The following are the important accounting concepts:
1. Business Entity Concept

2. Going Concern Concept
3. Money Measurement Concept
4. Cost Concept
5. Duel Aspect Concept
6. Accounting Period Concept
7. Matching Concept
8. Realisation / Realization Concepts
The explanation of these concepts are as follows:
Business Entity Concept:
In accounting, business is treated as separate entity from its owners. Accounts are prepare to
give information about the business and not about those who own it. a distinction is made
between business transactions and personal transactions. Without such a distinction, the affairs
of the business will be mixed up with the private affairs of the proprietor and the true picture of
the firm will not be available. The 'Business' and 'owner' are taken as two separate entities. The
accountant is interested to record transactions relating to business only. The private transactions
of the owner will be recorded separately and will have no bearing on the business transactions.
All the transactions of the business are recorded in the books of the business from the point of
view of the business as an entity and even the proprietor is treated as a creditor to the extent of
his capital.
The concept of separate entity is applicable to all of business organizations. For example, in
case of a sole proprietorship business or partnership business, though the sole proprietor or
partners are not considered as separate entities in the eyes of law, but for accounting purposes
they will be considered as separate entities. In the case of joint stock company, the business has
a separate legal entity than the shareholders. The coming and going shareholders don not affect
the entity of the business. Thus, the distinction between owner and the business unit has helped
accounting in reporting profitability more objectively and fairly. It has also led to the development
of 'responsibility accounting' which enables us to find out the profitability of even the different
sub-units of the main business.
Going Concern Concept:
According to going concern concept it is assumed that the business will exist for a long time to
come. Transactions are recorded in the books keeping in view the going concern aspect of the
business unit. A firm is said to be going concern when there is neither the intention nor necessary
to wind up its affairs. In other words, it should continue to operate at its present scale in the
future. On account of this concept the fixed assets are shown in the balance sheet at a
diminishing balance method i.e., going concern value. There is no need to show assets at market
value because these have been purchased for use in future and earn revenues and for sale
purpose. If the business is not to continue then market value will have significance. Since
business is to continue, fixed assets will be shown at cost less depreciation basis. It is due to the
concept that the fixed assets are depreciated on the basis of their expected life than on the basis
of market value. The concept also necessitates distinction between expenditure that will render
benefit over a long period and that whose benefit will be exhausted quickly, say within one year.
The going concern concept also implies that existing liabilities will be paid at maturity.
Money Measurement Concept:
Accounting to records only those transactions which can be expressed in terms of money.
Transactions or events which cannot be expressed in money do not find place in the books of
accounts though they may be very useful for the business. For example, if a business has got a
team of dedicated and trusted employees, it is definitely an asset to the business, but since their
monetary measurement is not possible, they are not shown in the books of business. It should be
remembered that money enables various things of diverse nature to be added up together and
dealt with. The use of a building and the use of clerical service can be aggregated only through
money values and not otherwise.
Cost Concept:
This concept is closely related to the going concern concept. According to this concept, an asset
in ordinarily recorded in the books at the price at which it was acquired i.e., at its cost price. This
cost serves the basis for the accounting of this asset during the subsequent period. The 'cost'
should not be confused with 'value'. It must be remembered that as the real worth of the assets
changes from time to time, it does not mean that the value of such an asset is wrongly recorded
in the books. The book values of the assets as recorded do not reflect their real value. They do
not signify that values noted therein are the values for which they can be sold. Though the assets
are recorded in the books at cost, in course of time, they are reduced in value on account of
depreciation charges. The idea that the transactions should be recorded at cost rather than at a
subjective or arbitrary value is known as cost concept. With the passage of time, the market
value of fixed assets like land and buildings vary greatly from their cost. These changes in the
value are generally ignored by the accountants and they continue to value them in the balance
sheet at historical cost. The principle of valuing the fixed assets at cost and not at market value is
the underlying principle in cost concept. According to them the current values alone will fairly
represent the cost to the entity. The cost principle is based on the principle of objectivity. There is
no room for personal assessment in showing the figures in accounting records. If subjectivity is
flowed in records the same assets will be valued at different figures by different individual. Every
body will have his own views about various assets. The cost concept is helpful in making truthful
records. The records becomes more reliable and comparable.
Dual Aspect Concept:
This is the basic concept of accounting. Modern accounting system is based on dual aspect
concept. Dual concept may be stated as "for every debit, there is a credit". Every transaction
should have two sided effect to the extent of same amount. For example, if A starts a business
with a capital of $10,000. There are two aspects of the transaction. On the one hand the
business has assets of $10,000 while on the other hand the business has to pay to the proprietor
a sum of $10,000 which is taken as proprietor's capital. This expression can be shown in the
form of following equation:
Capital (Equities) = Costs (Assets)

10,000 = 10,000
The term 'assets' denotes the resources owned by a business while the term 'equities' denotes
the claims of various parties against the assets. Equities are of two types. They are owners
equity and outsiders equity. Owner's equity (or capital) is the claim of the owner's against the
assets of the business while outsiders equity (liabilities) is the claim of outside parties against the
assets of the business. Since all assets of the business are claimed by someone (either owners
or outsiders), the total of assets will be equal to total of liabilities. Thus:
Equities = Assets
OR Liabilities + Capital =
Assets
Suppose if the business borrows $5000 from a bank, dual aspect of this transaction will be
Capital + Liabilities = Assets

A Loan
10,000 = 15,000
Thus the accounting Equation states that at any point of time the assets of any entity must be
equal (in monetary terms) to the total of owner's equity and outsider's liabilities. As a mater of fact
the entire system of double entry accounting is based on this concept.
Accounting period concept:
According to this concept, the life of the business is divided into appropriate segments for
studying the results shown by the business after each segment. Since the life of the business is
considered to be indefinite (according to going concern concept) the measurement of income
and studying financial position of the business according to the above concept, after a very long
period would not be helpful in taking proper corrective steps at the appropriate time. It is,
therefore, absolutely necessary that after each segment or time interval the businessman must
stop and see, how things are going on. In accounting such a segment or time interval is called
accounting period. It is usually of a year.
At the end of each accounting period and income statement/profit & loss Account and a Balance
Sheet are prepared. The income statement discloses the profit or loss made by the business
during the accounting period while Balance Sheet discloses the financial position of the business
as on the last day of the accounting period. While preparing these statements a proper distinction
has to be made between capital and revenue expenditure.
Matching concept:
The aim of business is to earn profit. In order to ascertain the profit the costs (expenses) are
matched to revenue. The difference between income from sales and costs of producing the
goods will be the profit. When business is taken as a going concern then it becomes necessary
to evaluate the performance periodically.
A correct statement of income requires a distinction between past, present and future
expenditures. A distinction between capital and revenue expenditure is also necessary. The
revenues and costs of same period are matched. In other words, income made by the business
during a period can be measured only when the revenue earned during a period is compared
with the expenditure incurred for earning that revenue. The question when the payment was
received or made is irrelevant.
Realization Concept:
This concept emphasises that profit should be considered only when realised. The question is at
what stage profit should be deemed to have accrued? Whether at the time of receiving the order
or at the time of execution of the order or at the time of receiving the cash? For answering this
question the accounting is in conformity with the law and Recognises the principle of law i.e., the
revenue is earned only when the goods are transferred. It means that profit is deemed to have
accrued when property i.e. goods passes to the buyer, viz., when sales are made.
Accounting Conventions:
The term "conventions" includes those customs or traditions which guide the accountants while
preparing the accounting statements. The following are the important accounting conventions.
1. Convention of Disclosure
2. Convention of Materiality
3. Convention of Consistency
4. Convention of Conservatism
Convention of Disclosure:
The disclosure of all significant information is one of the important accounting conventions. It
implies that accounts should be prepared in such a way that all material information is clearly
disclosed to the reader. The term disclosure does not imply that all information that any one
could desire is to be included in accounting statements. The term only implies that there is to a
sufficient disclosure of information which is of material in trust to proprietors, present and
potential creditors and investors. The idea behind this convention is that any body who want to
study the financial statements should not be mislead. He should be able to make a free
judgment. The disclosures can be in the way of foot notes. Within the body of financial
statements, in the minutes of meeting of directors etc.
Convention of Materiality:
It refers to the relative importance of an item or even. According to this convention only those
events or items should be recorded which have a significant bearing and insignificant things
should be ignored. This is because otherwise accounting will be unnecessarily over burden with
minute details. There is no formula in making a distinction between material and immaterial
events. It is a matter of judgment and it is left to the accountant for taking a decision. It should be
noted that an item material for one concern may be immaterial for another. Similarly, an item
material in one year may not be material in the next year.
Convention of Consistency:
This convention means that accounting practices should remain uncharged from one period to
another. For example, if stock is valued at cost or market price whichever is less; this principle
should be followed year after year. Similarly, if depreciation is charged on fixed assets according
to diminishing balance method, it should be done year after year. This is necessary for the
purpose of comparison. However, consistency does not mean inflexibility. It does not forbid
introduction of improved accounting techniques. If a change becomes necessary, the change and
its effect should be stated clearly.
Convention of Conservatism:
This convention means a caution approach or policy of "play safe". This convention ensures that
uncertainties and risks inherent in business transactions should be given a proper consideration.
If there is a possibility of loss, it should be taken into account at the earliest. On the other hand, a
prospect of profit should be ignored up to the time it does not materialise. On account of this
reason, the accountants follow the rule 'anticipate no profit but provide for all possible losses'. On
account of this convention, the inventory is valued 'at cost or market price whichever is less.' The
effect of the above is that in case market price has gone down then provide for the 'anticipated
loss' but if the market price has gone up then ignore the 'anticipated profits.' Similarly a provision
is made for possible bad and doubtful debt out of current year's profits.
Emerging Role of Accounting
Financial Accounting
Financial or traditional accounting consists of the classification, recording, and analysis of the
transactions of a business in a subjective manner according to the nature of expenditure so as to
enable the presentation at periodic intervals, of statements of profit or loss of the business and,
on a specified date, of its financial state of affairs. The day-to-day transactions journalized or
recorded in subsidiary books are posted in the various ledgers and at the end of the accounting
period, a Profit and Loss Account and a Balance Sheet are prepared. The emphasis is on the
ascertainment and exhibition of the profits earned or losses incurred by the business rather than
on the aspects of planning and control and decision making.
Financial accounting safeguards the interests of the business and its proprietors and other
connected with it by providing suitable accounts and information to various parties, such as the
shareholders or partners, present and prospective creditors and the Government. The accounts
are kept in a manner so as to meet the provisions of the Companies Act and to present correct
figures to income tax, excise and other authorities. These accounts show how gainfully the
resources of the business were employed.

Management Accounting
Management accounting includes all those accounting services by means of which assistance is
rendered to the management at all levels, in formulation of policy, fixation of plans, control of their
execution, and measurement of performance. Management accounting is primarily concerned
with the supply of information which is useful to the management in decision making for the
efficient running of the business and thus, in maximizing profit. Management account employs
various techniques, which include standard costing, budgetary control, marginal costing, break-
even and cost-volume-profit analysis, uniform costing and inter-firm comparison, ratio
accounting, internal audit, and capital project assessment and control.
Social Responsibility Accounting
Social responsibility accounting is a new phase in the development of accounting and owes its
birth to increasing social awareness, which has been particularly noticeable over the last two
decades or so. Social responsibility accounting widens the scope of accounting by considering
the social effects of business decisions, in addition to the economic effects. Several social
scientists, statesmen and social workers all over the world have been drawing the attention of
their governments and the people in their countries to the dangers posed to environment and
ecology by the unbridled industrial growth. The role of business in society is increasingly coming
under greater scrutiny. The management is being held responsible not only for efficient conduct
of business as expressed in profitability, but also for what it contributes to social well being and
progress. There is a growing feeling that the concepts of growth and profit as measured in
traditional balance sheets and income statements are too narrow to reflect the social
responsibility aspects of a business.
Human Resource Accounting
It is another new field of accounting which seeks to report and emphasize the importance of
human resources in a company’s earnings. It is based on the fact that the only real long lasting
asset which an organization possesses is the quality of the people working in it. This system of
accounting is concerned with ” the process of identifying and measuring data about human
resources and communicating this information to interested parties.”
How does management Accounting differs from Financial Accounting?

Explain briefly, how management accounting helps the management of a
company in making its decisions.
Financial or traditional accounting consists of the classification, recording, and analysis of the
transactions of a business in a subjective manner according to the nature of expenditure so as to
enable the presentation at periodic intervals, of statements of profit or loss of the business and,
on a specified date, of its financial state of affairs. The day-to-day transactions journalized or
recorded in subsidiary books are posted in the various ledgers and at the end of the accounting
period, a Profit and Loss Account and a Balance Sheet are prepared. The emphasis is on the
ascertainment and exhibition of the profits earned or losses incurred by the business rather than
on the aspects of planning and control and decision making.
Management accounting includes all those accounting services by means of which assistance is
rendered to the management at all levels, in formulation of policy fixation of plans and control of
their execution, and measurement of performance. Management accounting is primarily
concerned with the supply of information which is useful to the management in decision making
for the efficient running of the business and thus, in maximizing profit. Management account
employs various techniques, which include standard costing, budgetary control, marginal costing,
break-even and cost-volume-profit analysis, uniform costing and inter-firm comparison, ratio
accounting, internal audit, and capital project assessment and control.
Difference
 Financial accounting depicts the past position of the concern, while management
accounting stresses at future.
 Financial accounting keeps a record of very large number of daily business transactions
and prepares various financial statements according to accounting principles and
standards. In management accounting there is no such compulsion. It lays emphasis on
analysis and standards.
 Management accounting provides data to managers to help them in making decisions
about the future. To the contrary, financial accounting aims at meeting the requirements of
outside parties who have financial stake in the business.
 Financial accounting is mandatory for all joint stock companies and business
organizations but this is not the case with management accounting.
Definition and Explanation of Single Entry System:
It is difficult to define single entry system because, in fact, there exists no system like single
entry system. Broadly speaking, it is a defective double entry system. Any system that falls short
of complete double entry method is called single entry system. Under this method, sometimes
both the aspects of transactions are recorded, sometimes only one aspect is recorded or
sometime no aspects of transactions is recorded in the books. As a general rule under the single
entry practice only the personal aspects of the transactions are recorded and the nominal and
real aspects are omitted altogether. As the name implies, the single entry system does not take
into account the double affect of every transaction. The ledger contains only the personal
accounts of debtors and creditors, all impersonal accounts such as purchases, sales, wages,
carriage, rent etc., are not recorded. Thus the system does not consider the two fold aspect of
every transaction. In short single entry system may be called a mix of double entry, single entry
and no entry.
Single entry system may be defined as a system which does not strictly conform to the double
entry system of bookkeeping. Under this system what is found in practice is an intermixture of
single entry, double entry and no entry.
Defects/Limitations/Disadvantages of Single Entry System:
The limitations or defects or disadvantages of single entry system may be summed up as

follows:
1. Under this system only partial and incomplete record is maintained because two fold
aspects of transactions are generally ignored.
2. As the two fold aspects of every transaction are not recorded, a trial balance cannot be
drawn up to test the arithmetical accuracy of the records.
3. A nominal accounts are not maintained, a profit and loss account cannot be prepared for
want of information regarding the various income and expenditures.
4. As no real accounts are maintained the preparation of balance sheet is not possible.
Double Entry System of Bookkeeping:
The double entry system of bookkeeping owes its origin to an Italian merchant named Lucas
Pacioli who wrote the first book on double entry bookkeeping entitled "Decomputis et
Scripturis". It was published in Venice in 1544. All modern methods of accounting are simply
adaptation of the system invented by that ancient pioneer.

The double entry theory of bookkeeping can be defined as the system of recording transactions
having two fundamental aspects - one involving the receiving of a benefit and the other to giving
the benefit - in the same set of books.
In this theory, as the two fold aspects of each transaction are recorded, the name "double entry"
has been given to this system.
Every transaction involves two fold aspects e.g., an aspect of receiving and an aspect of giving.
One who receives is a debtor (Dr) and one who gives is a creditor (Cr). Under the double entry
system, both the aspects of giving and receiving are recorded in terms of accounts. The account
which receives the benefit is debited and the account which gives the benefit is credited. It is the
ultimate result of this system that every debit must have corresponding credit and vice versa and
on any particular day the total of the debit entries and the credit entries on the various accounts
must be equal.
Advantages of Double Entry System:
The main advantages of double entry theory of book keeping are as follows:
1. Trial balance can be drawn up on any day to prove the arithmetical accuracy of record.
2. The nominal sides of transactions being recorded: it is possible to prepare Trading and
Profit and Loss Account from which the Gross Profit and Net Profit made by the business
during a particular period can be easily ascertained.
3. As all personal accounts of debtors and creditors as well as real accounts are kept, it is
possible to prepare Balance Sheet.
4. The transactions being recorded in the most scientific and systematic way gives the most
reliable information of business.
5. It prevents fraud by rendering any alteration in any account more difficult.
6. It enables the trader to compare the different items, such as sales, purchases, opening
stock and closing stock of one period with similar items of preceding period and the trader
may thus know whether his business is progressing or not.
Disadvantages of Double Entry System:
The following are the main disadvantages of this system:
1. This system requires the maintenance of a number of books of accounts which is not
practical in small concerns.
2. The system is costly because a number of records are to be maintained.
3. There is no guarantee of absolute accuracy of the books of accounts inspite of agreement

of the trial balance.
Single Entry Versus Double Entry System of Bookkeeping:
Single entry system of bookkeeping which does not follow double entry system and as such,
does not record or give effect to the two fold aspect of each and every transaction. Under this
system of book keeping, generally a cash book and books to record personal accounts are only

maintained. It is not really a system because under this system there may be no record of the
some of the transactions and only partial record of some others. As such, single entry system of
book-keeping is not perfect and frauds and mistakes can hardly be detected. This system is
discussed in greater detail on Single Entry System Page. Proper results cannot be obtained by
its use.
Advantages of Double Entry Over Single Entry System:
1. In double entry system of bookkeeping as two fold aspect of each transaction is recorded
in the books, a trial balance can be prepared to prove the arithmetical accuracy of the
transaction. No trial balance can be prepared under single entry system and hence
accuracy of books cannot be proved.
2. In double entry system the risk of fraud or its non discovery is less. But under single entry
system chances of fraud or mistake remaining undetected are very high.
3. In double entry system a trading and profit and loss account can be prepared very easily.
The proprietor can know the profit earned or loss suffered by has business. Under single
entry system no trading and profit and loss account can be prepared scientifically and,
hence, the proprietor will have no firm idea of profit earned or loss suffered.
4. In double entry system a balance sheet can be prepared from the books of accounts. The
correctness of assets and liabilities can be proved. The balance sheet called statement of
affairs in a single entry system is prepared in an unsatisfactory manner. The assets and
liabilities are not proved from records. Hence the correctness of assets and liabilities
cannot be relied upon.
Interested Groups / Stake holders / Users of A/c Information
There are various parties interested in the financial statements. Accounting information is useful
to various internal & external users listed below:
 Shareholders: Since shareholders have invested in the company so they are interested
in the financial statements.
 Creditors: Creditors may be short-term or long-term. The main concern of the creditors is
focused on the credit worthiness of the firm and its ability to meet its financial obligations.
They are therefore concerned with the liquidity of the firm, its profitability and financial
soundness.
 Management: Management requires accounting information for planning, organizing, and
control purposes. The emphasis on efficient & effective management of organizations has
considerably extended the demand for accounting information.
 Employees: The importance of harmonious industrial relations between management &
employees cannot be over-emphasized. The employees have a stake in the outcomes of
several managerial decisions. Greater emphasis on industrial democracy through
employee participation in management decisions has important implication for the supply
information to employees. Matters like settlement of wages, bonus, & profit sharing rest on
adequate disclosure of relevant facts.
 Government: Government uses financial information for compiling statistics concerning
calculation of profitability, taxes, computation of national income, and determination of the
industrial growth.
 Stock Exchanges: Several stock exchanges also require accounting information for
listing of securities.
 Consumers & Others: Consumer organizations, media, welfare organizations and public
at large are also interested in condensed accounting information in order to appraise the
efficiency and social role of the enterprises in different sectors of the economy.
Role of Accountants
Role of Accountants in Modern Business Organization:

Accounting is an age-old profession. In old days of accounting, the main function of an
accountant was to maintain the records of the business. However over the years, the role of an
accountant has undergone a sea change. With the inception of joint stock company form of an
organization, the profession of accountancy has come to be recognized as one of the lucrative
professions. Accountants can be broadly divided into two categories namely, Accountants in
public practice and Accountants in employment. Accountants in public practice (practicing
chartered accountants) are members of the Institutes of Chartered Accountants of India. The
accountant renders valuable service to the society in the following manner:
1. Writing up Accounts for Preparing Financial Statements: Professional accountants

offer services for writing up accounts and preparing financial statements. By maintaining
proper books of accounts and records he assists management to a great extent in the field
of planning, decision-making and controlling. A systematic record also enables the
business to compare one year’s results with those of other years.
2. Audit of Accounts: Conducting of audit is one of the most important functions of a

professional accountant where his specialized training, skills and judgement are most
often called into play. Audit satisfies the users of financial statements that the accounting
information contained in these statements is true and reliable and that accounts have
been prepared in accordance with the accounting standards. It, thus, adds credibility to
financial statements prepared by the business. He also points out the shortcoming and
suggests ways to overcome them.
3. Role as Management Accountant: A management accountant helps the management

in planning and control of organizational activities and their performance evaluation.
4. Help to government, Revenue Department and Tax Payer: Chartered accountant

plays an important role in ensuring that the Government gets its proper share of taxes and
at the same time the tax payer is not exploited. Chartered accountant is instrumental in
preparing the financial statements of the enterprise. He also prepares the returns for tax
purposes. He also appears before the tax authorities on behalf of the taxpayer. He also
does the work of certification of documents in many cases.
5. Role as Cost Accountant: As a cost accountant, he maintains the costing records and
ascertains the cost of product or service. He provides costing information introduces cost
control and cost reduction methods and assists the management in fixing appropriate
selling prices.
6. Role in Merger, Liquidation, etc: The services or advice of chartered accountants are
frequently sought in the formation, merger or liquidation of limited companies. They are
called upon to undertake investigation for achieving greater efficiency in management and
find out the reasons for increase of decrease in profits. They act as executors and trustees
under a will or trust deed to carry out the administration of the estate or settlements.
Accounting Personnel
Finance is the life blood of business. Procuring financial resources and their judicious utilization
are the two important activities of financial management which is a specialized function. The
finance manager has to strike a balance between the current needs of the enterprise for cash
and the needs of the shareholders for adequate return. The financial management of a large
company is usually the responsibility of the finance director who may be in place of or in addition
to the controller. Often finance manager and controller are inter-changeable terms and only one
of these two positions may be found in a company. The finance manager is also concerned with

implementing the financial policy of the board of directors, managing liquidity, preparation of
budgets, administration of budgetary control system, managing profitability, etc.
Types of Accounts
ACCOUNTS
PERSONAL REAL NOMINAL
Natural Artificial Representa Expenses Incomes &

tive Natural & Losses Gains
Tangible Intangible
ACCOUNTING PROCESS
Subsidiary LEDGER
Transactions for a Books- Posting there
period entered in Journal from made to Real Account
m made to OR
Day-Book Personal Account
Nominal Account
Balance Sheet Real and
As on _____ Personal A/Cs
Transferred to
Capital+Liabilities
Balances of these
Nominal A/Cs A/Cs Transferred to
Assets
Closed to
Trial Balance
Here we check
mathematical
Trading & accuracy of
Dr. Shishir Srivastava, GIHS Profit & Loss 14
A/cs
Net Profit & Loss Account
Transferred to
Accounting Equation:
Definition and Explanation of Accounting Equation:
Dual aspect may be stated as "for every debit, there is a credit." Every transaction should have
twofold effect to the extent of the same amount. This concept has resulted in accounting
equation which states that at any point of time the assets of any entity must be equal (in
monetary terms) to the total of equities. In other words, for every business enterprise, the sum of
the rights to the properties is equal to the sum of the properties owned. The properties of the
business are called "assets". The rights to the properties are called "equities". Equities may be
sub-divided into two principle types: The rights of the creditors and the rights of the owners. The
equity of the creditors represents debts of the the business and are called liabilities. The equity of
the owner is called capital, or proprietorship or owner's equity.
The formula know as the accounting equation, thus arrived at is as follows:
Assets = Equities
OR
Assets = Liabilities + Proprietorship
Another method of demonstrating the mathematical relationship involves a simple variation in the form of
equation. Again it begins with the position that every business owns or has interest in certain assets. It also
owes certain amounts to its creditors. The difference between what it owns and what it owes represents the
owner's capital or proprietorship. Thus the original equation is changed into:
Assets - Liabilities = Proprietorship
Effects of Transactions on the Accounting Equation:
Each and every business transaction affects the elements of accounting equation. The effect is
shown by the use of (+) or (-) placed against the elements affected. Note particularly that the
equation remains in balance after each transaction. The accounting equation can be understood
with the help of the following example:
Example:
Transaction 1:
Mr. Riaz commences his business with cash $50,000. This is an example of investment of asset
in the business by the owner. The effect of this transaction on the accounting equation is that

cash asset is increased by $50,000 and the proprietorship (Riaz's capital) is also increased by
the same amount such as:

Cash Riaz, Capital
+ 50,000 = ---- + 50,000
Note that assets and equities increased by equal amounts
Transaction 2:
Purchased furniture on cash $10,000. This transaction effected accounting equation as the
increase in one new asset furniture and decreases in assets cash with the same amount. Thus

Cash Furniture Riaz, Capital
+ 50,000 = ---- + 50,000
- 10,000 + 10,000
40,000 + 10,000 = 50,000
Note that this transaction has affected assets side only and no change is made in equities side of
the equation.
Transaction 3:
Purchased merchandise for cash $10,000. This transaction will introduce a new element
(merchandise) on the assets side and decrease the cash by $10,000.

Cash Furniture Merchandise Riaz, Capital
+ 40,000 + 10,000 = ---- + 50,000
-10,000 -- + 10,000
30,000 + 10,000 = 50,000
Note that this transaction has affected assets side only and no change is made in equities side of
the equation.
Transaction 4:
Purchased merchandise on account (on credit) $5,000.

Cash Furniture Merchandise Creditors Riaz, Capital
+ 30,000 + 10,000 + 10,000 = + 50,000
+ 5,000 + 5,000
30,000 +10,000 + 15,000 = + 5,000 + 50,000
Note that this transaction has affected assets side and liabilities. Both the sides of equation has
increased with the same amount.
Transaction 5:
Sold merchandise for cash $2,000 cost of these merchandise were $1,500.

Cash Furniture Merchandise Creditors Riaz, Capital
+ 30,000 + 10,000 + 15,000 = + 5,000 + 50,000
+ 2,000 - 1,500 + 500 (Profit)
+ 32,000 +10,000 + 13,500 = + 5,000 + 50,500
Note that this transaction has affected assets side and also the proprietorship. Difference
between sales price and cost price is treated as profit and has been added to capital.
Transaction 6:
Sold merchandise on credit for $4,000 costing $3,000.

Cash Furniture MerchandiseDebtors Creditors Riaz, Capital
+ 32,000 + 10,000 + 13,500 = + 5,000 + 50,500
- 3,000 + 4,000 + 1,000
32,000 +10,000 + 10,500 + 4000 = + 5,000 + 51,500
Note that this transaction has affected assets side and also the proprietorship. Anew element
"debtors" has been introduced. Difference between sales price and cost price is treated as profit
and has been added to capital.
Transaction 7:
Paid $1,000 to creditors for merchandise purchased.

+ 32,000 + 10,000 + 10,500 + 4,000 = + 5,000 + 51,500
- 1,000 - 1,000
31,000 +10,000 + 10,500 + 4000 = + 4,000 + 51,500
Transaction 8:
Received cash from a debtor $ 1,000 whom a sale on credit was made earlier. This is an
example of collection from debtors. This transaction is an exchange of one asset for another. the
effect is on one side of the equation, i.e., asset side. Thus:

+ 31,000 + 10,000 + 10,500 + 4,000 = + 4,000 + 51,500
+ 1,000 - 1,000
32,000 +10,000 + 10,500 + 3000 = + 4,000 + 51,500

Transaction 9:
Paid salaries $1,000 in cash. This transaction affected the equation by decrease in a cash asset
and decrease in proprietorship (i.e., capital). Thus:

+ 32,000 + 10,000 + 10,500 + 4,000 = + 4,000 + 51,500
- 1,000 - 1,000
31,000 +10,000 + 10,500 + 3000 = + 4,000 + 50,500
Effects of all the transactions explained above are presented in the following table:
Assets = Liabilities +Proprietorship

+ +
Cash + Debtors Creditors + Riaz, Capital
Furniture Merchandise
1 + 50,000 +50,000
50,000 = +50,000
2 - 10,000 + 10,000
40,000 10,000 = +50,000

3 - 10,000 + 10,000
30,000 10,000 10,000 = +50,000

4 + 5,000 + 5,000
30,000 10,000 15,000 = 5,000 +50,000

5 + 2,000 - 1,500 + 500 (Profit)
32,000 10,000 13,500 = 5,000 +50,500

6 - 3,000 + 4,000 + 1,000 (Profit)
32,000 10,000 10,500 4,000 = 5,000 +51,500

7 - 1,000 - 1,000
31,000 10,000 10,500 4,000 = 4,000 +51,500

8 +1,000 1,000
32,000 + 10,000 + 10,500 + 3,000 4,000 +51,500

9 1,000 1,000
31,000 10,000 10,500 3,000 = 4,000 +50,500
The elements of the equation of Mr. Riaz that is,
Cash + Furniture + Merchandise + Debtors = Creditors + Capital

31,000 + 10,000 + 10,500 + 3,000 = 4,000 + 50,500
This may also be stated in vertical form as shown below:

EQUITIES ASSETS
Creditors $4,000 Cash $31,000
Capital $50,500 Debtors 3,000
Merchandise 10,500
Furniture 10,000
$54,500 $54,500
The presentation of the effects of transactions in tabular form is only a device which helps
beginners to understand the analysis of different types of transactions. It is not practically
feasible to record the effects of transactions in this form. The increases and decreases in the
various elements are recorded in the journal in a special technical form.
Capital and Revenue Expences

Difference between capital and revenue expenditures affects the fundamental principle of correct
accounting. Proper adjustments are necessary before preparation of the final accounts. All items
of capital and expenditure will find place in the balance sheet whereas all items of revenue
expenditure will be included in the profit and loss account. If any incorrect adjustment or
allocation is made between these expenditures, this will falsify the final results as disclosed by
the revenue account or the balance sheet.
Capital Expenditures
Expenditure means the amount spent. Any expenditure incurred for the following purposes is
capital expenditure:
1. For acquiring fixed assets such as land, building, plant and machinery, furniture and fitting
and motor vehicles. These assets should not be acquired with a view to resell them at a
profit but to retain in the business. The cost of fixed asset would include all expenditure up
to the asset becomes ready for use.
2. For making improvement and extensions to the fixed asset e.g., additions to buildings.
3. For increasing the earning capacity of a business or for reducing the cost of manufacture,
administration or distribution in a business e.g., expenditure incurred in removing the
business to a central locality or compensation paid to retrenched employee.
4. For raising capital monies for the business such as brokerage paid for arranging loans,
discount on issue of shares and debentures, underwriting commission etc.
All capital expenditures represent either an asset or liability and are shown in the balance sheet.
Examples of Capital Expenditures
The following is a list of the usual items of capital expenditures:
 Cost of goodwill.
 Cost of freehold land and building and the legal charges incurred in this connection.
 Cost of lease.

 Cost of machineries, plants, tools, fixtures, etc.
 Cost of trade marks, patents, copy rights, designs, etc.
 Cost of car, lorry etc.
 Cost of installation of lights and fans.
 Cost of any other assets acquired by way of equipment.
 Erection cost of plant and machinery.
 Cost of addition to existing assets.
 Structural improvements and alteration in the existing assets.
 Expenses for developments in case of mines and plantations.
 Expenses for administration incurred during construction and equipment of any industrial
enterprise.
 Expenses incurred in experimenting which finally result in the acquisition of a patent or

other rights.
Revenue Expenditures:
Expenditures will be treated as revenue expenditures if it is incurred for the following purposes:
1. Expenditure for purchasing floating assets i.e., assets meant for resale at a profit or for
being converted into saleable goods, such as the cost of goods, raw materials and stores.
2. Expenditures incurred by maintaining assets in proper working order e.g., repairs to plant
and machinery, building furniture and fittings etc.
3. Expenditures incurred for meeting day to day expenses of carrying on a business e.g.,
salaries, rent, rates, taxes, stationery, postage etc.
All revenue expenditures have to be deducted from the income earned by the firm. That is to say,
all revenue items will be taken to the profit and loss account.
Examples of Revenue Expenditures
The following is a list of the usual items of revenue expenditures:
 Expenses incurred for the ordinary administration and carrying on the business.
 Expenses for repairs, renewals and replacement of permanent assets.
 Cost of goods for resale.
 Cost of raw materials and stores acquired for consumption in course of manufacturing.
 Wages paid for manufacture of products for sales.

 Expenses for the manufacture and distribution of the finished goods.
 Loss from wear and tear and obsolescence of assets.
 Depreciation of lease.
 Interest on loans borrowed for business.
 Loss from sale of fixed assets.
 Fees for renewal of patent rights, etc.
 Up-keep and maintenance of motor car and van.
 Maintenance of fan and lights.
 Book value of assets discarded or totally damaged or destroyed by fire or other reasons.
Difference Between Capital and Revenue Expenditures:
Following is the difference between capital and revenue expenditures.
Capital Expenditures Revenue Expenditures

1 Its effect is long term i.e., it is not 1 Its effect is temporary, i.e., it is exhausted
exhausted within the current account within the current accounting year.
year. Its benefit is enjoyed in future year
or years also. In a word, its effect is
reduces gradually.
2 An asset is acquired or the value of an 2 Neither an asset is acquired nor the value
asset is increased as a result result of of an asset is increased.
this expenditure.
3 It does not occur again and again - it is 3 It occurs repeatedly - It is recurring and
non-recurring and irregular. regular.
4 Generally, it has physical existence i.e., it 4 It has no physical existence, i.e., it cannot
can be seen with eyes. be seen with eyes.
5 This expenditure improves the position of 5 This expenditure helps to maintain the
the concern concern
6 A portion of this expenditure is shown in 6 The whole amount of this expenditure is
the trading and profit and loss account or shown in trading and profit and loss
income and expenditure account as account or income and expense account.
depreciation. But deferred revenue expenditures and
prepaid expenses are not shown.
7 It appears in balance sheet until its 7 It does not appear in balance sheet.
benefit is fully exhausted. Deferred revenue expenditure,
outstanding expenditure, outstanding
expenses and prepaid expenses,
however, temporarily shown in the
balance sheet.
8 It does not reduce the revenue of the 8 It reduces revenue. Payment of salaries
concern. Purchase of fixed assets does to employees decreases revenue.
not effect revenue.

Capitalized or Deferred Revenue Expenditures:
Where a certain revenue expenditure incurred is of such a nature that its benefit is likely to be
spread over a certain number of years, or where it is of non-recurring and special nature and
large in amount, in such circumstances, instead of debiting the entire amount to the profit and
loss account of the year in which it has been incurred, it may be spread over a number of years,
a proportionate amount being charged to each year's profit and loss account. The remaining
portion of the expenditure is carried forward and is known as capital expenditure or deferred
revenue expenditure and is shown as an asset in the balance sheet. Item such as preliminary
expenses, cost of issue of debentures are examples that may be classified under this head.
Exceptions to General rules:
There are certain expenses which are usually of revenue in nature but under certain
circumstances they become capital expenditures. The following are the examples of expenses
which are usually revenue but under certain circumstances become capital.
Legal Charges:
These are, as a rule, revenue charges, but legal charges incurred in connection with the
purchase of a fixed asset are capital expenditures as they form an additional cost of the asset
acquired.
Wages:
Wages are ordinary a revenue expenditure. But in a manufacturing business where the firm's
own men are employed in making of fixed asset, the wages paid for such purpose would be
capitalized. For example if the firm's own men are employed in making extension to the factory
building or in erection of plant or manufacturing tools for own requirements. the wages and
salaries paid to the persons are not revenue but capital expenditures.
Brokerage and Stamp Duty:
Normally these are revenue expenditures, but brokerage paid on acquisition of a property and
stamp duty involved thereon can be capitalized.
Freight and Carriage:
This is revenue charge, but freight and carriage paid on newly acquired plant or fixed assets are
capital expenditures.
Advertising:
Ordinarily amount expended on advertising is revenue charge but the cost of special advertising
undertaken for the purpose of introducing a new line of goods may be capitalized.
Development Expense:
In concern like collieries, mines, tea, rubber etc., all expenses incurred during the period of
development are treated as capital.
Preliminary Expenses:

These are the expenses incurred in connection with the formation of a public company. These
expenses although are revenue in nature but are allowed to be capitalized and can be shown as
an asset in the balance sheet.
JOURNAL
The word "journal" has been derived from the French word "jour". Jour means day. So journal
means daily. Transactions are recorded daily in journal and hence it has been named so. It is a
book of original entry to record chronologically (i.e. in order of date) and in detail the various
transactions of a trader. It is also known Day Book because it contains the account of every day's
transactions.
Characteristics of Journal:
Journal has the following features:
1. Journal is the first successful step of the double entry system. A transaction is recorded
first of all in the journal. So the journal is called the book of original entry.
2. A transaction is recorded on the same day it takes place. So, journal is called Day Book.
3. Transactions are recorded chronologically, So, journal is called chronological book
4. For each transaction the names of the two concerned accounts indicating which is debited
and which is credited, are clearly written in two consecutive lines. This makes ledger-
posting easy. That is why journal is called "Assistant to Ledger" or "subsidiary book"
5. Narration is written below each entry.
6. The amount is written in the last two columns - debit amount in debit column and credit
amount in credit column.
Advantages of Journal:
The following arte the advantages of journal:
1. Each transaction is recorded as soon as it takes place. So there is no possibility of any

transaction being omitted from the books of account.
2. Since the transactions are kept recorded in journal, chronologically with narration, it can
be easily ascertained when and why a transaction has taken place.
3. For each and every transaction which of the two concerned accounts will be debited and
which account credited, are clearly written in journal. So, there is no possibility of
committing any mistake in writing the ledger.
4. Since all the debits of transaction are recorded in journal, it is not necessary to repeat
them in ledger. As a result ledger is kept tidy and brief.
5. Journal shows the complete story of a transaction in one entry.
6. Any mistake in ledger can be easily detected with the help of journal.
Objective of an Entry:
While recording transactions in journal the following two objects must be aimed at:
That each entry in the journal should be so clear that at any future time we may, without the aid
of memory, perceive the exact nature of the transactions.
That each transaction should be so classified that we may easily obtain the aggregate effect of
such transactions at the end of a certain period.
Narration of an Entry:
It is the remark or explanation put below each entry in the journal. The journal is a book of
original entry and all possible details have to recorded in connection with each and every
transaction entered there. The details are laid out in the form of a remark at the end of each
journal entry, which is called narration.
Format of Journal:
Date Particulars L.F.
Dr. Amount Cr. Amount
(1) (2) (3)
Column (1) is meant for writing the date of the transaction.
Column (2) is used for recording the names of the two accounts affected by
transactions.
Column (3) is meant for noting the number of the page of the ledger on on
which the particular account appears in that book.
Column (4) Shows the amount to be debited to the account named.
Column (5) Shows the amount to be credited to the account stated.
Rules of Journalising:
The act of recording transactions in journal is called journalising. The rules may be summarised
as follows:
Use two separate lines for writing the names of the two accounts concerned in each transaction.
write the name of the debtor or account to be debited in the first line and the name of the creditor
or the account to be credited in the next line
Write the name of the account to be debited close to the line starting the particulars column and
that of the account to be credited at a short distance from this line.
Use "Dr" after each debit item and "To" before each credit. The term "Cr." after a credit item is
unnecessary, as if one account is debtor, the other must be creditor.
To separate one entry from another a line is drawn below every entry to cover particulars column
only. The line does not extend to amount column.
Example 1:
On first January, 1991 A started business with capital of $20,000 and his transactions of the
month were as follows:
Jan.2 Purchased building for cash 8,000

Jan.8 Purchased goods from C 1,000
Jan.15 Sold goods for cash 500
Jan.20 Goods returned to C 100
Jan.22 Sold goods to R 400
Jan.25 R returned goods 25
Jan.31 Salaries paid for the month 200
Jan.31 Rent paid for the month 150
Solution:
Journal of A
Date Particulars L.F Debit Credit

Jan. 1 Cash Account ...Dr. 20,000
To Capital Account 20,000
(Capital introduced)
Jan 2. Building Account ...Dr. 8,000

To Cash Account 8,000
(Building purchased for cash)
Jan. 8 Purchases Account ...Dr. 1,000

To Sales Account 1,000
(Goods purchased on credit form C)
Jan. 15 Cash Account ...Dr. 500

To Sales Account 500
(Goods sold for cash)
Jan. 20 C ...Dr. 100

To purchases Returns Account 100
(Goods returned to C)
Jan. 22 R ...Dr. 400

(Goods sold on credit)
Jan. 25 Sales returns Account ..Dr. 25

To R 25
(Goods returned by him)
Jan. 31 Salaries Account ...Dr. 200

To Cash Account 200
(Salaries paid)
Jan. 31 Rent Account ...Dr. 150
To Cash Account 150
(Rent paid in cash)
30,375 30,375
Total

Capital Account:
The proprietor's account in the business books is called "capital account". Whenever the
proprietor invests money in the business, instead of giving credit to his name, capital account
should be credited.
Drawings Account:
Any cash or goods taken away by the proprietor for his personal use are called his drawings and
are debited to "Drawings Account". Drawings account like the capital account is personal account
of the proprietor.
Casts and Carry Forwards:
In bookkeeping casting means totaling. The first page of the journal will be cast by drawing a line
across the money column. The total of this page will be carried forward to the to the top of
second page. The total of the second page will be carried forward to the third page and so on
until the last page gives the final total.
When carrying forward the total of the one page to another, the words "carried forward" or
"carried over" should be written at the bottom of the first page and words "brought forward" the
top of the next page. The abbreviations c/f or c/o and b/f can also be used.
Compound Journal Entries:
When two or more transactions of the same nature take place on the same date, a compound
journal entry may be made instead of making separate entries for each transaction.
Trade Discount:
No entry is passed for trade discount. The purchases or sales should be recorded at net price
i.e., after deducting the trade discount from the list price.
Goods Given Away:
Sometimes goods are (a) given away as charity (b) taken by the proprietor for his private use (c)
distributed free as samples. Such goods are not sales. Therefore they are not credited to sales
account but are credited to purchases account because they reduce the amount of goods
purchased.
Example 2:
On first April 1991 a merchant started business with a capital of $15,000 and his transactions of
the month were as follows:
April 2 Purchased machinery for $7,000.

April 3 Bought furniture from S $300.
April 7 Purchased goods for cash $2,500
April 8 Sold goods to R & Sons $1,500
April 10 Bought goods from B, $1,000 and from C $2,000
April 12 Received cash from R & Sons $1,450, allowed him discount of $50.
April 15 Paid B cash $975, discount received $25.
April 16 Returned goods to C $500
April 17 Sold goods to Din Mohammad $800
April 20 Goods returned by Din Mohammad $200
April 21 Purchased from K goods of the list price of $600 subject to a 10 percent trade discount.

April 22 Paid C cash $1,500
April 25 Gave away a charity cash $50 and goods worth $30.
April 27 Distributed goods worth $200 as free samples and goods taken away by the proprietor
for personal use $100
April 28 Amount withdrawn by the proprietor for private use $200
April 31 Salaries paid for the month $500
Record these transactions in the journal.
Solution:
Journal
Date Particulars L.F Debit Credit

April 1 Cash Account ...Dr. 15,000
To Capital Account 15,000
(Capital introduced)
April 2 Machinery Account 7,000

(Machinery purchased)
April 3 Furniture Account 2,500

(Goods purchased for cash C)
April 7 Purchases Account 3,000

(Goods purchased for cash)
April 8 R & Sons 1,500

To Sales Account 1,500
April 10 Purchases Account 3,000

To B 1,000
To C 2,00
(Goods purchased on credit)
Cash Account 1,450

April 12
Discount 50
To R & Sons 1,500
(Cash received and discount allowed)
April 15 B 1,000
To Cash Account 975
To Discount account 25
(Salaries paid)
April 16 C 500
To Purchases Return Account 500
(Goods returned to C)
April 17 Din Mohammad 800

April 20 Sales Returns Account 200

To Din Mohammad 200
(Goods returned by him)
April 21 Purchases Account 540

To K 540
(Goods purchased on credit)
April 22 C 1,500
(Cash paid to C)
April 25 Charity Account 80

To Cash Account 50
To Purchases Account 30
(Cash and goods given in charity)
April 27 Free samples Account 200

Drawings Account 100
To Purchases Account 300
(Goods distributed free and taken by the proprietor for private
use)
April 28 Drawings Account 200

To Cash 200
(Cash drawn by the proprietor)
April 31 Salaries Account 500

To Cash Account 500
(Salaries paid in cash)
Note:
(a) In actual practice even the word "Dr." is not written after the name of the account to be
debited, because it is also implied.
(b) When writing the name of a personal account, it is not considered necessary to add the word
"account" after the name of the person.

Subdivision of Journal:
Though the principle of journalising all transactions, known as continental system of bookkeeping
is quite perfect in actual business but in a large business it is found inconvenient to Journalise
every transaction and sometime it becomes rather impossible for one man to Journalise
numerous transactions on a business in one journal. Therefore, the journal is sub-divided into
different journals known as the subsidiary books or books of prime entry or books of original
entry. These are the books in which are recorded the details of transactions as they take place
from day to day, in a classified manner.
In every trading concern, the transactions, however numerous they may be, can be grouped into
small number of classes. They consist chiefly of receipts and payments of cash, purchases and
sales of goods, returns of goods purchased and sold, bills receivable and bills payable. The
journal is divided in such a way that a separate book is used for each class of transactions.
The important subsidiary books used in modern business world are the following:-
1. Cash Book: It is used to record all cash receipts and payments.

2. Purchases Book: It is used to record all credit purchases.
3. Sales Book: It is used to record all credit sales
4. Purchases returns book: It is used to record all goods returned by us to our suppliers.
5. Sales Returns Book: It is used to record all goods returned to us by our customers.
6. Bills Receivable Book: It is used to record all accepted bills received by us.
7. Bills payable Book: It is used to record all bill accepted by us to our creditors.
8. Journal Proper: It is used for recording those transactions for which there is no separate
book.
All these subsidiary books are called books of original entry, as transactions in their original
form are entered therein.
Advantages of Different Journals: The advantages of having several books of original entry in
place of one journal may be stated to as follows:
1. It may be impossible to record each transaction into the ledger as it occurs. Subsidiary
books record the details of the transactions and therefore, helps the ledger to become
brief.
2. As similar transactions are recorded together in the same book, future reference to any of
them becomes easy.
3. The chance of fraudulent alteration in an account is reduced as the book of original entry
keeps records of the transactions in a chronological order.
4. The work of posting can be entrusted to several clerks at the same time and thus the
ledger of a large business can be written up much more quickly.
5. As each journal contains separately transactions of similar nature any desired analysis
can be made conveniently.

CASH BOOK
Definition and Explanation of Cash Book:
Cash book is a book of original entry in which transactions relating only to cash receipts and
payments are recorded in detail. When cash is received it is entered on the debit or left hand
side. Similarly, when cash is paid out the same is recorded on the credit or right hand side of the
cash book.
The cash book, though it serves the purpose of a cash book of original entry viz., cash journal
really it represents the cash account of the ledger separately bound for the sake of convenience.
It is more a ledger than a journal. It is journal as cash transactions are chronologically recorded
in it. It is a ledger as it contains a classified record of all cash transactions. The balances of the
cash book are recorded in the trial balance and the balance sheet.
Vouchers:
For Every entry made in the cash book there must be a proper voucher. Vouchers are documents
containing evidence of payment and receipts. When money is received generally a printed
receipt is issued to the payer but counterfoil or the carbon copy of it is preserved by the cashier.
The copy receipts are called debit vouchers, and they support the entries appearing on the debit
side of the cash book. Similarly when payment is made a receipt is obtained from the payee.
These receipts are known as credit vouchers. All the debit and credit vouchers are consecutively
numbered. For ready reference the number of the vouchers are noted against the respective
entries. A column is provided on either side of the cash book for this purpose.
Balancing Cash Book:
The cash book is balanced at the end of a given period by inserting the excess of the debit on
the credit side as "by balance carried down" to make both sides agree. The balance is then
shown on the debit side by "To balance brought down" to start the next period. As one cannot
pay more than what he actually receives, the cash book recording cash only can never show a
credit balance.
Format:
The following is the simple format of a cash book:
Date Particulars L.F. Amount Date Particulars L.F. Amount
Single Column Cash Book:

Single column cash book records only cash receipts and payments. It has only one money
column on each of the debit and credit sides of the cash book. All the cash receipts are entered
on the debit side and the cash payments on the credit side.

While writing a single column cash book the following points should be kept in mind:
1. The pages of the cash book are vertically divided into two equal parts. The left hand side
is for recording receipts and the right hand side is for recording payments.
2. Being the cash book with the balance brought forward from the preceding period or with
what we start. It appears at the top of the left side as "To Balance" or "To Capital" in case
of a new business.
3. Record the transactions in order of date.
4. If any amount of cash is received on an account, the name of that account is entered in
the particulars column by the word "To" on the left hand side of the cash book.
5. If any amount is paid on account, the name of the account is written in the particulars
column by the word "By" on the right hand side of the cash book.
6. It should be balanced at the end of a given period.
Posting:
The balance at the beginning of the period is not posted but other entries appearing on the debit
side of the cash book are posted to the credit of the respective accounts in the ledger, and the
entries appearing on the credit side of the cash book are posted to the debit of the proper
accounts in the ledger.
Format of the Single Column Cash Book:
Following is the format of the single column cash book:
Date Particulars L.F. Amount Date Particulars L.F. Amount
Example:
Write the following transactions in the simple cash book and post into the ledger:
1991
Jan. 1 Cash in hand 15,000 Solution:
" 6 Purchased goods for cash 2,000
Cash Book " 16 Received from Akbar 3,000
" 18 Paid to Babar 1,000
Date Particulars L.F.
" 20 Cash sales Amount Date Particulars4,000 L.F. Amount
1991 " 25 Paid for stationary 60
Jan. 1 To Balance b/d Paid for salaries 15,000 Jan. 6
" 30 By Purchases a/c 1,000 2,000
16 To Akbar " 31 Purchased office furniture
3,000 18 By Babar 2,000 1,000
20 To sales a/c 4,000 25 By stationary 60
30 By Salaries a/c 1,000
31 By Furniture a/c 2,000
By Balance c/d 15,940
22,000 22,000
15,940
To Balance b/d
Two Column Cash Book/Double Column Cash Book:

A double column cash book or two column cash book is one which consists of two separate
columns on the debit side as well as credit side for recording cash and discount. In many
concerns it is customary for the trader to allow or to receive small allowance off or against the
dues. These allowances are made for prompt settlement of accounts. In certain business almost
all receipts or payments are accompanied by such discounts and in order to avoid unnecessary
postings separate columns in the cash book are introduced to record the discounts received or
allowed. These discount columns are memorandum columns only. They do not form the discount
account. The discount column on the debit side of the cash book will record discounts allowed
and that on the credit side discounts received.
Posting:
The cash columns will be posted in the same way as single column cash book. But as regards
discount column, each item of discount allowed (Dr. side of the cash book) will be posted to the
credit of the respective personal accounts. Similarly each item of discount received will be posted
to the debit of the respective personal account. Total of the discount column on the debit side of
the cash book will be posted to the debit side of the discount account in the ledger and the total
of discount column on the credit side of the cash book on the credit side of the discount account.
The discount columns are not balanced like cash column of the tow column cash book.
Format of the Double Column Cash Book:
Debit Side Credit Side
DateParticulars V.N. L.F. DiscountCashDateParticularsV.N. L.F. DiscountCash
Example of Two Column Cash Book:

From the following transactions write up a two column cash book and post into ledger:
1991
Jan. 1 Cash in hand $2,000
" 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
" 25 Received from Salman $500; discount allowed $15
" 27 Paid Hussan & Sons $300.
" 28 Bought furniture for cash $100
" 31 Paid rent $100
Solution:
Cash Book
Date Particulars V.N. L.F. Discount Cash Date Particulars V.N. L.F. Discount Cash
1991 To Balance 2,000 1991 By Zahoor & 15 500

Jan.1b/d 10 200 Jan.5 Sons 300
" 7 To Riaz & 1,000 " 20 By purchase 300
" 12 Co. 15 500 " 27 a/c 100
" 25 To Sales " 28 By 100
a/c " 31 Hussan&Sons 2,400
To Salman 25 3,700 By Furniture 15 3,700
a/c
2,400 By Rent a/c
1991 By Balance
Feb1 c/d
To Balance
b/d
Three Column Cash Book:
A three column cash book or treble column cash book is one in which there are three
columns on each side - debit and credit side. One is used to record cash transactions, the
second is used to record bank transactions and third is used to record discount received and
paid.
When a trader keeps a bank account it becomes necessary to record the amounts deposited into
bank and withdrawals from it. Fir this purpose one additional column is added on each side of the
cash book. One of the main advantages of a three column cash book is that it is very helpful
to businessmen, since it reveals the cash and bank deposits at a glance
Writing a Three column Cash Book:
Opening Balance:
Put the opening balance (if any) on cash in hand and cash at bank on the debit side in the cash
book and bank columns. If the opening balance is credit balance (overdraft) then it will be put in
the credit side of the cash book in the bank column.
Cheque/Check or Cash Received:
If a cheque is received from any person and is paid into the bank on the same date it will appear
on the debit side of the cash book as "To a Person". The amount will be shown in the bank
column. If the cheque received is not deposited into the bank on the same date then the amount
will appear in the cash column. Cash received will be recorded in the usual manner in the cash
column.
Payment By Cheque/Check or Cash:
When we make payment by cheque, this will appear on the credit side "By a person" and the
amount in the bank column. If the payment is made in cash it will be recorded in usual manner in
the cash column.
Contra Entries:
If an amount is entered on the debit side of the cash book, and the exact amount is again
entered on the credit side of the same account, it is called "contra entry". Similarly an amount
entered on the credit side of an account also may have a contra entry on the debit side of the
same account.
Contra entries are passed when:
1. Cash is deposited into bank by office: It is payment from cash and receipt in bank.
Therefore, enter on credit side, cash column "By Bank" and on debit side bank column "To
Cash". The reason for making two entries is to comply with the principle of double entry
which in such transactions is completed and therefore, no posting of these items is
necessary. Such entries are marked in the cash book with the letter "C" in the folio column
2. Cheque/Check is drawn for office use: It is payment by bank and receipt in cash.
Therefore, enter on the debit side, cash column "To Bank" and on credit side, bank column
"By Cash".
Bank Charges and Bank Interest Allowed:
Bank charges appear on the credit side, bank column "Bank Charges." Bank interest allowed
appear on the debit side, bank column "To Interest".
Posting:
The method of posting three column cash book into the ledger is as follows:
1. The opening balance of cash in hand and cash at bank are not posted.
2. Contra Entries marked with "C" are not posted.
3. All other items on the debit side will be posted to the credit of respective accounts in the
ledger and all other items on the credit side will be posted to the debit of the respective
accounts.
4. As regards discounts the total of the discount allowed will be posted to the debit of the
discount account in the ledger and total of the discount received to the credit side of the
discount account.
Format of the Three Column Cash Book:
Dis- Dis-
DateParticularsV.N. L.F. CashBankDateParticularsV.N. L.F. CashBank
count count

Example of Three Column Cash Book:
On January 1, 1991 Noorani Stores cash book showed debit balance of cash $1,550 and bank $13,575.
During the month of January following business was transacted.
1991
Jan.1 Purchased office typewriter for cash $750; cash sales $315
" Deposited cash $500
" 4 Received from A. Hussan a cheque for $2,550 in part payment of his account
" 6 Paid by cheque for merchandise purchased worth $1,005
" 8 Deposited into bank the cheque received from A. Hussan.
" 10 Received from Hayat Khan a cheque for $775 in full settlement of his account and allowed him
discount $15.
" 12 Sold merchandise to Divan Bros. for $1,500 who paid by cheque which was deposited in the
bank.
" 16 Paid Salman $915 by cheque, discount received $5
" 27 Paid to Gulzar Ahmad by cheque $650
" 30 Paid salaries by cheque $1,750
" 31 Deposited into bank the cheque of Hayat Khan.
" 31 Drew from bank for office use $250.
You are required to enter the above transactions in three column cash book and balance it.
Solution:
Noorani Stores
Cash Book
Dis- V. Dis-
Date Particulars V.N. L.F. Cash Date Particulars L.F. Cash
count N. count
1991 To Balance 1,550 13,575 1991 By Office 750

Jan.1 b/d 1,315 Jan.1 Equip. C 500
" 1 To Sales a/c C 500 " 3 By Bank 1,005
" 3 To Cash a/c 2,550 " 6 By Purchases C 2,550
" 4 To A Hussan C 2,550 " 8 a/c 5 915
" 8 To Cash 15 775 " 16 By Bank 650
" 10 To Hayat 1,500 " 27 By Salman 1,750
" 12 Khan C 775 " 30 By Gulzar C 775
" 31 To Sales a/c C 250 " 31 By Salaries a/c C 250
" 31 To Cash " 31 By Bank 1,865 14,330
To Bank By Cash
15 6,440 18,900 By Balanced 5 6,440 18,900

1,865 14,330
c/d
Petty Cash Book:
In almost all businesses, it is found necessary to keep small sums of ready money with the
cashier or petty cashier for the purpose of meeting small expenses such as postage, telegrams,
stationary and office sundries etc. The sum of money so kept in hand generally termed as petty
cash and book in which the petty cash expenditures are recorded is termed as petty cash book.
In large business houses , the cashier has to handle every day a large number of receipts and
payments and if in addition to this he is further saddled with petty cash payments, his position
becomes embarrassing. Besides, it is most common to find with large commercial
establishments that all receipts and payments are made through bank. Since expenses like
postage, telegrams, traveling etc, cannot be made by means of cheques, the maintenance of a
small cash balance to meet these petty payments becomes all the more necessary.
A petty cash book is generally maintained on a columnar basis - a separate column being allotted
for each type of expenditure. The is only one money column on the debit side and all sum
received from time to time by the petty cashier from the chief cashier are entered in it. The credit
side consists of several analysis columns. Every payment made by the petty cashier is entered
on this side twice - Firstly it is recorded in the total column and then to the appropriate column to
which the expense is concerned. The total of the "total column" will naturally agree with the total
of all subsidiary columns. The difference between the total of the debit items and that of the "total
column" on the credit side at any time will represent the balance of the petty cash in hand and
this should tally with the petty cashier's actual holding of cash.
The posting from the petty cash book to the respective accounts in the ledger are made directly
in total at the end of every month or any other fixed period.
The Imprest System:
The more scientific method of maintaining petty cash so for introduced into practice is the
imprest system. Under this system a fixed sum of money is given to the petty cashier to cover
the petty expenses for the month. At the end of a month the petty cashier submits his statement
of petty expenses to the chief cashier. The chief cashier on the receipt of such statement refunds
to the petty cashier the exact amount spent by him during the month, thus making the imprest for
the next month the same as it was at the beginning of the current month.
It is to be noted that the amount of cash in the hands of the petty cashier is a part of the cash
balance, therefore it should be included in the cash balance when the latter is shown in the trial

balance and the balance sheet. It should also be kept in mind that petty cash book is not like the
cash book. It is a branch of cash book.
Advantages of Imprest System:
The main advantages of imprest system of petty cash are as follows:
1. A s the petty cashier has to produce to the chief cashier the petty cash book for
inspection, it acts as a healthy check on the petty cashier.
2. As the petty cashier has to account for his expenses, before he can draw further sums,
the petty cash book remains up to date.
3. As the petty cashier cannot draw as and when he likes, it prevents unnecessary
accumulation of cash in his hand thus the chances of defalcation of cash are minimised.
Format of the Petty Cash Book:
The following is the simple format of a petty cash book:
Printing
Amount Traveling
DateParticulars V.N. Total Postage and Cartage Misc.
Received Expenses
Stationary
Example:
Enter the following transactions in the columnar petty cash book of a cashier who was given $100 on
1st March, 1991 on the imprest system:-
1991
March 2 Paid for postage stamps 8
" 2 Paid for stationary 10
" 3 Paid for cartage 4
" 3 Paid for postage stamps 6
" 8 Paid for paper 1
" 12 Paid for cartage 6
" 18 Paid for trips to office peons 2
" 23 Paid for ink and nibs 4
" 25 Paid for Tiffin to office peons 6
" 26 Paid for train fair 5
" 28 Paid for bus fair 4
" 29 Envelops and letter heads 6
" 30 Printing address on above 4
" 31 Taxi fare to manager 10
Solution:
Amount Printing and Traveling
Date Particulars V.N. Total Postage Cartage Misc.
Received Stationary Expenses

$ 1991
$100 March1 To Cash
" 2 By Postage 8 8
" 2 By Stationary 10 10 4
" 3 By Cartage 4
" 3 By Postage 6 6
" 3 By Paper 1 1
" 12 By Cartage 6 6
2
" 18 By Tip to peon 2
" 23 By Ink & nibs 4 4
6
" 25 By Tiffin to Peon 6
" 26 By train fair 5 5
" 28 By bus fair 4 4
" 29 By Envelops et. 6 6
" 30 By printing 4 4
" 31 By Taxi fair 10 10
" 31 By balance c/d 24
100 100 14 25 10 19 8
24
April 1 To Balance b/d
76
" 1 To Cash
Purchases Day Book:

Purchases book or purchases day book is a book of original entry maintained to record credit
purchases. You must note that cash purchases will not be entered in purchases day book
because entries in respect of cash purchases must have been entered in the cash book. At the
end of each month, the purchases book is totaled. The total shows the total amount of goods
purchased on credit. Purchases book is written up daily from the invoices received. The invoices
are consecutively numbered. The invoice of each number is noted in the purchases book.
Ruling:
It is not ruled like the ordinary journal. The first column in this book is for date. In the second
column, the name of the supplier or the seller, quantity of each article bought, description of the
article, rate etc., are recorded. Sometimes a separate column to record the details of the
transactions is added in the purchases day book. The third column is for invoice number. The
fourth column is for ledger folio. The last column gives the total amount to the supplier.
Posting:
The total of the purchases book is posted to the debit of purchases account. Names of the
suppliers appear in the purchases book. These parties have supplied the goods. They are,
therefore, credited with the amount appearing against their respective names. The double entry
will thus be completed.
Format:
The following is the format of purchases day book:
Date Particulars Inv.No. L.F. Amount

Purchases Returns Book:
Purchases returns book is a book in which the goods returned to suppliers are recorded. It is
also called returns outward book or purchases returns day book. Goods may be returned
because they are of the wrong kind or not up to sample or because they are damaged etc. The
ruling of this book is absolutely the same as of purchases day book. The book and entries are
made therein just the same as those made in the purchases day book.
Posting:
The total of the purchases returns or returns outwards book is credited to returns outward
account or purchases return account (being the goods sent out). Individual suppliers to whom
goods are returned are debited (because they receive the goods).
Debit Note:
When the goods are returned to the suppliers, an intimation is sent to them through what is
known as a debit note. These debit notes serve as vouchers for these entries. A debit note is a
statement sent by a businessman to another person, showing the amount debited to the account
of the later. Debit notes are usually serially numbered and are prepared in the same form as that
of the invoice.
Form of the Debit Note:
Debit Note
Messrs Rehman & Sons Lahore,

Standard Road March 19, 1991.
Multan
To goods returned:
10 shirts at $12 120
10 pairs trousers at $20 200
Goods returned as per R/R No.........dated.......
320
E & O. E For Good Luck & Co.
Partner
Format of Purchases Returns Book:

The following is the format of purchases Returns book:
Date Particulars D/N L.F. Amount
Sales Day Book:


A sales book is also known as sales day book is a book of original entry in which are
recorded the details of credit sales made by a businessman. Total of sales book shows the total
credit sales of goods during the period concerned. Usually the sales book is totaled every month.
The sales day book is written up daily from the copies of invoices sent out.
Posting:
The total of the sales book is credited to sales account. Customers whose names appear in the
sales book are debited with the amount appearing against their names. Double entry is thus
completed.
Format of Sales Day Book:
The following is the format of sales day book:
Date Particulars Inv. No. L.F. Amount
Sales Returns Book:

Sales returns book is also called returns inwards book. It is used for recording goods returned
to us by our customers. The ruling of this books is exactly as for sales day book.
Posting:
The of the returns inwards book or sales returns book is debited to returns inwards account or
sales returns account. The customers who have returned the goods are credited with the amount
shown against their names.
Credit Note:
Customers who return goods should be sent a credit note. It is a statement sent by a business
to another person showing the amount credited to the account of the later. Credit notes are
serially numbered and are similar in form to the invoices. These are usually printed in red ink.
Credit notes issued to customers are vouchers for the entries appearing in the sales returns
book.
Form of Credit Note:

Messrs Ideal Traders, Peshawar Lahore,
Cr. in account with Messrs Good luck & Co.. Lahore March 19, 1991
By 100 shirt at $2 200
Goods returned as per I/No.........Dated.......
Dollars two hundred only
E. & O. E. For Good luck & Co.

Partner
Format of Sales Returns Book:

The following is the format of sales returns book:

Date Particulars C/N L.F. Amount
Bills Receivable Book:

Bills receivable book is used to record the bills received from debtors. When a bill is received,
details of it are recorded in the bills receivable book.
Posting:
In the ledger the account of the person from whom each bill is received is credited with the
amount of that bill and the periodical total of the book is posted to the debit of bills receivable
account.
the bills receivable book is ruled according to the requirements of a particular account.
Format of Bills Receivable Book:
The following is the format of bills receivable book:
(1) Bills Receivable Book

No. of From whom Where Due
Date Drawer Acceptor Term L.F. Amount Remarks
Bills received payable date
(2) Bills Receivable Book

Date From whom received Term Due date L.F. Amount
Bills Payable Book:
Bills payable book is used to record bill accepted by us. When a bill drawn by our creditor is
accepted particulars of the same are recorded in this book.
Posting:
In the ledger, the account of each person whose bill has been accepted is debited with the
amount of the bill. The monthly total of the bills accepted is credited to the bills payable account
ledger.
Format of Bills Receivable Book:
The following is the ruling and format of bills payable book:

(1) Bills Payable Book
To whom Where Due
Date Drawer Payee Term L.F. Amount Remarks
given payable date
(2) Bills Payable Book

Date To whom given Term Due date L.F. Amount
Journal Proper:
Journal proper is book of original entry (simple journal) in which miscellaneous credit
transactions which do not fit in any other books are recorded. It is also called miscellaneous
journal. The form and procedure for maintaining this journal is the same that of simple journal.
The use of journal proper is confined to record the following transactions:-
1. Opening entries
2. Closing entries
3. Transfer entries
4. Adjustment entries
5. Rectification entries
6. Entries for which there is no special journal
7. Entries for rare transactions
Opening Entries:
When a businessman wants to open the book for a new year, it is necessary to Journalise the
various assets and liabilities before the new accounts are opened in the ledger. The journal
entries so passed are called "opening entries". Suppose a businessman opens a new set of
books on January 1, 1991 with cash in hand $100, debtors $200, stock in trade $320, machinery
$700, furniture $150, bank loan $300, capital $1,070 the respective opening entry in the journal
will be:
Cash 100
Sundry debtors 200
Stock in trade 320
Machinery 700
Furniture & fitting 200
To Sundry creditors 150
To Bank loan 300
To Capital 1,070
(Being the incorporation of assets and liabilities at this date)
Closing Entries:
When the books are balanced at the close of the accounting period with a view to paper final
accounts it is necessary that balance of all the income and expenses accounts must be transferred to
trading and profit and loss account. The process of transferring balances to the trading and profit and loss
account at the end of year is called closing the books and entries passed at that time are called closing
entries. For example on 31st December, 1991 the balance in expenses accounts are: Salary $500; rent $200;
Stationary $50; legal charges $100; and income accounts are: commission received $50. These balance will
be recorded in profit and loss account though the following closing entries:
Profit and loss account 850

To Salary 500
To Rent 200
To Stationary 50
To Legal charges 100
(Being the closing entry)
Commission received account 50

To Profit and loss account 50
(Being the closing entry)
Transfer Entries:
When accounts are transferred from one account to another for combination of allied items, it is
necessary to pass transfer entry. For example, Drawings $500 is transferred from the drawings
account to the capital account to find out the net capital. The transfer entry will be passed as
follows:
Capital Account 500

To Drawings account 500
(Being the transfer entry)
Adjusting Entries:
Modification of the accounts at the end of an accounting period is called adjustments. If there be
any event affecting the related period of accounts but left out of the books, the same should be
incorporated in the books before the preparation of the final accounts. This is done by means of
adjusting entries through the journal proper. For example at the end of the year it is found that
rent $50 is outstanding. It is not recorded in the books. It will be taken into account by means of
adjusting entry which is as follows:
Rent account 50
To Outstanding rent account 50
(Being outstanding rent recorded)
Rectification Entries:
When an error is detected in the books, the same is rectified through an entry in the journal
proper; thus is called rectification entry. For example, it was detected that an expenditure of $
100 on repair to building was charged to building account. It is corrected through the following
entry in the journal proper:
Building repair account 100

To Building account 100
Entries of Which There is No Special Journal:
When a trader cannot record the entries in the above mentioned sub-journals, the same are
entered in the journal proper. The common transactions which cannot be recorded in any of the
book of original entry are:
 Distribution of goods as free sample.

 Distribution of goods as charity.
 Goods destroyed by fire.
 Goods stolen away by employees.
 Exchange of one asset for another asset etc.
Ledger:
When all the transactions of a given period have been journalised, the next thing is to classify
them according to the accounts affected. All similar transactions must be brought together. For
instance, all transactions relating to cash must be put in one place. Similarly, all transactions with
a customer or a supplier must be assembled at one place. The book in which this classification is
done is called the ledger.
The ledger is a book which contains a condensed and classified record of all the pecuniary
transactions of the business generally brought, transferred or posted from the books of original
entry.
Ledger is called the king of all books of accounts because all entries from the books of original
entry must be posted to the various accounts in the ledger. It should be noted that journal
contains a chronological record while ledger contains a classified record of all transactions.
Features of Ledger:
The following are the features of ledger.
1. It has two identical sides - left hand side and right hand side. The left hand side is called
debit side and right hand side is called credit side.
2. Debit aspects of all the concerned transactions is recorded on the debit side, while credit
aspect on credit side according to date.
3. The difference of the total of the two sides represent balance. The excess of debit side
over credit side indicates debit balance, while excess of credit side over debit side
indicates credit balance. If the total of the two sides are equal there will be no balance.

4. Usually balance is drawn at the year end and recorded on the deficit side to make the two
sides equal. This balance is known as closing balance.
5. The closing balance of the current year will be the opening balance of the next year.
Advantages of Ledger:
The following are the advantages derived from ledger:
1. It is the ledger through which successful application of double entry system of

bookkeeping is ensured. Each and every transaction is divided into two parts - receiver
and giver - and recorded in the two concerned accounts in ledger.
2. Transactions relating to different persons or concerns are recorded in the account of each
person or concern separately. As a result, complete and reliable information is available in
respect of each and every account.
3. Different types of income and expenses are recorded in different accounts separately. So,
it is possible to ascertain the amount of income and expenditure under each head and the
overall result at the year end through trading and profit and loss account.
4. Separate account is opened for each item of assets and liabilities. It is, therefore, possible
to ascertain the value of different assets and liabilities and the true financial position at the
year end through balance sheet.
5. Transactions being recorded primarily in journal and thereafter finally in ledger, the
possibility of errors and defalcations are remote.
6. Valuable information and statistics are collected from ledger and supplied to the
management to enable them to run the concern efficiently.
Difference Between Ledger and Journal:

The journal and the ledger are the most important books of the double entry system of
accounting. Following are the points of difference between these two types of books:
1. The journal is the book of first entry (original entry); the ledger is the book of second entry.
It is the goal where all the entries in the journal find their ultimate destination.
2. The journal is the book of chronological record; the ledger is the book for the analytical
record.
3. The journal, as a book of source entry, ordinarily has greater weight as legal evidence
than the ledger.
4. The unit of classification of data within the journal is the transaction; the unit of
classification of data within the ledger is the account.
5. The process of recording in the journal is called journalising; the process of recording in
the ledger is called posting.
Form of Ledger:
One account usually occupies one page in the ledger. But if the account is big one it may extend
to two or more pages. The pages of the ledger are vertically divided into two equal halves.
The left hand half or side is known as the debit (Dr.) side and the right hand half is the credit (Cr.)
side. Abbreviations "Dr." and "Cr." are put on the top left and right hand corners. Each half part is
further divided into four sections - (1) Date (2) Particulars (3) Folio (4) Amount, as follows:

Date Particulars J.F. Amount Date Particulars J.F. Amount
Method of Posting:
The act of separately transferring each entry from journal to the respective account in the ledger
is called posting. Posting consists of:
1. Recording the relevant amount on the left hand side of the account which according to
journal is to be debited.
2. Recording the amount on the right hand side of the account which, according to the
journal, is to be credited.
3. In the ledger account, the first entry on the debit side is preceded by the word "To" and the
first entry on the credit side is preceded by the word "By." The sign of ditto is placed before
the subsequent entries.
Folioing:
Folio means folded page of account books. Account books are usually made of sheers of paper
folded at the middle and vertically divided into two pages, each of which is called a folio. For
ready reference the pages of our books should be numbered in numerical order. When we post
the various entries from the journal into the ledger, we should write the ledger page in the ledger
folio column of the journal and the page of the journal in the journal folio column of the ledger.
This is known as folioing.
Example of Ledger and Preparing Ledger Accounts:

Journalise the following transactions and post them to the ledger accounts concerned:
1991
Jan. 1 Purchased goods for cash 2,000
Jan. 3 Sold goods to Karim 500
Jan. 10 Received from Karim 500
Jan. 15 Purchased machinery for cash 1,000
Jan. 20 Cash sales 300
Jan. 25 Sold goods to Rahim & Sons 600
Jan. 28 Received from Rahim & Sons 590
Discount allowed 10
Jan. 30 Paid Rent 50
Jan. 31 Paid Salaries 100
Solution:
Date Particulars L.F. Debit Credit
Jan. 1 Purchases Account 12 2,000
To Cash Account 13 2,000
(Goods purchased for cash)
Jan. 3 Karim 14 500

To Sales Account 15 500
Jan. 10 Cash Account 13 500

To Karim Account 14 500
(Cash received)
Jan. 15 Machinery Account 16 1,000

To Cash Account 13 1,000
(Machinery purchased)

(Goods sold for cash)
Jan. 25 Rahim & Sons 17 600


Discount Allowed 18 10
To Rahim & Sons 17 600
(Cash received, discount allowed)
Jan. 30 Rent Account 19 50

To Cash Account 13 50
(Rent paid)
Jan. 31 Salaries Account 20 100

To Cash Account 13 100
(salaries paid)
Total 5,650 5,650
LEDGER ACCOUNT
Purchases Account
1991.
Jan.1 To Cash a/c 30 2,000
Cash Account
1991. 1991.
Jan.10 To Karim 500 Jan.1 By Purchases a/c 30 2,000
Jan.20 To Sales a/c 30 300 By Machinery a/c 30 1,000
Jan.28 To Rahim & Sons 30 590 By Rent a/c 30 50
30 By Salaries a/c 30 100
Karim Account
1991. 1991.
Jan.1 To Sales a/c Jan.10 By Cash a/c
30 500 30 500
Sales Account
1991.
Jan.3 By Karim 30
By Cash a/c 30 500
By Rahim & Sons 30 300
600
Machinery Account
1991.
Jan.15 To Cash Account 30
1,000
Rahim & Sons Account

1991. 1991.
Jan.25 To Sales a/c Jan.28 By Cash a/c
30 600 By Discount a/c 590
10
Discount Account
1991.
Jan.28 To Rahim & Sons
30 10
Rent Account
1991.
Jan.30 To Cash a/c
30 50
Salaries Account
1991.
Jan.31 To Cash a/c
30 2,000
Preparing Trial Balance:

Having posted all the transactions into the ledger, it is necessary to check the correctness of the
work done before proceeding further. In order to test the arithmetical accuracy of our ledger we
should prepare a statement called trial balance.
A trial balance is a statement prepared by taking out the debit and credit balances of all accounts
appearing in the ledger.
Objectives and Advantages of Preparing a Trial Balance:
The following are the main objectives of preparing a trial balance.
1. Trial balance helps in knowing the arithmetical accuracy of the accounting entries. Trial
balance represents a summary of all ledger balances and, therefore, if the two sides of the
trial balance tally, it is an indication of this fact that the books of accounts are arithmetically
accurate.

2. Trial balance forms the basis for preparing financial statements such as income
statement / Trading and profit and loss account and balance sheet. In case, the trial
balance is not prepared, it will be almost impossible to prepare the financial statements.
3. The entire ledger is summarised in the form of a trial balance. Thus the position of a
particular account can be judged simply by looking at the trial balance.
Proof of Accuracy:
If the debit and credit totals of the trial balance are equal and also correspond with the total of
journal, we may be satisfied that the posting have been properly made and are arithmetically
accurate.
How to Prepare a Trial Balance - An Example:
The trial balance is usually prepared on a loose sheet of paper. The ruling of trial
balance is similar to that of a journal. We may prepare a trial balance in one of the
following forms:
1. Total Trial Balance Method

2. Balance Trial Balance Method
Total Trial Balance Method:
According to total trial balance method two sides of each ledger account i.e., debit
and credit side are added up and debit and credit totals so obtained are placed in the
debit and credit columns of the trial balance respectively. Thus we may draw the
following trial balance by taking out the debit side total and credit side total of each
account in the ledger.
Trial Balance
J.F Total Debits Total Credits

Ledger Account
$ $
Cash Account 12,453 8,436
Sundry Debtors Account 43,675 34,453
Sundry Creditors Account 23,654 31,298
Discount Account 430 550
Purchases Account 26,670 --
Sales Account -- 32,145
Machinery Account 10,000 --
Building Account 20,000 --
Capital Account -- 35,000
Rent Account 3,400 --
Wages Account 600 --
Salaries Account 1,000 --
1,141,882 1,141,882

One clear defect of this method is that mistakes may be committed more often while preparing
the trial balance, because large number of figures would be required to be enlisted. Thus, the
process becomes unwieldy and cumbrous.
Balance Trial Balance Method:
The task of preparing a trial balance under balance - trial balance method is much simplified.
There is well known axiom that if equals are subtracted from equals the remainders are equal.
On this assumption, in place of writing against each account the debit as well as the credit total
the balance alone is written. The difference between the two sides of an account is called the
balance. If the debit side of an account is greater than the credit side, the balance falls on the
debit side and is known as "debit balance." If the credit side of an account is greater than the
debit, the the balance is on the credit side and is called "credit balance."
Rules of Balancing Accounts: Rules of balancing each account is as follows:
1. Add up both sides of the account

2. Find out the difference in a separate slip.
3. Put the difference on the lighter side.
4. Add up both sides again.
5. Rule off.
The trial balance prepared above, if prepared with the balance of accounts will appear as under .
Trial Balance
J.F Dr. Balance Cr. balance

Ledger Account
$ $
Cash Account 4,017 --
Sundry Debtors Account 9,222 --
Sundry Creditors Account -- 7,644
Discount Account -- 120
Purchases Account 26,670 --
Sales Account -- 32,145
Machinery Account 10,000 --
Building Account 20,000 --
Capital Account -- 35,000
Rent Account 3,400 --
Wages Account 600 --
Salaries Account 1,000 --
74,909 74,909
The second method has the added advantages and is the one that is generally used. There are
comparatively less chances of committing errors. As the magnitude of figures is smaller the
process is not cumbrous. It does not appear to be unwieldy. Moreover, in a trial balance, the
exact position of any account on the date of trial balance can be determined at a glance.
Final Accounts
Having proved the arithmetical accuracy of ledger by means of trial balance we should proceed
to ascertain our profit or loss for a period, in order to determine the profit or loss of a business
and its financial position, final accounts at the end of a particular period are prepared. The term
"final accounts" means statements which are finally prepared to show the profit earned or loss
suffered by the firm and financial state of affairs of the firm at the end of the period concerned. In
order to know the profit or loss earned by a firm, income statement or trading and profit and loss
account is prepared. This statement is also called "statement of operations." While the financial
position is judged by means of preparing a balance sheet of the business. This statement is also
called "position statement" or "statement of financial condition". In this section of the website we
shall study the method of preparing these two statements.
The basis of these statements is trial balance. The trial balance includes all the accounts from
the ledger. the nature of which may be either, personal, real, or nominal. It should be noted that
from the trial balance only nominal accounts are transferred to the profit and loss account. The
real or personal accounts go to the balance sheet.
Trading Account:
A trading account is an account which contains, " in summarized form, all the transactions,
occurring, throughout the trading period, in commodities in which he deals" and which gives the
gross trading result. In short, trading account is the account which is prepared to determine the
gross profit or the gross loss of a trader.
Items of Trading Account:
The following items usually appear in the debit and credit sides of the trading account.
Debit Side Items:
1. The value of opening stocks of goods (i.e., the stock of goods with which the business
was started).
2. Net purchase made during the year (i.e., purchases less returns).
3. Direct expenses, if any.
Credit Side Items:
1. Total sales made during the period less the value of returns, i.e., net sales.
2. The value of closing stock of goods.
The difference between the two sides of the trading account represents either gross profit or
gross loss. Thus if the credit side is heavier that would mean that the trader has earned gross
profit i.e., the excess of selling price of the goods sold over their purchase price. If the debit side
is heavier it would mean that the trader has suffered gross loss i.e., purchase price of goods
exceeds the selling price.
The balance of trading account which represents either gross profit or gross loss is transferred to
profit and loss account.
Format of Trading Account (T or Account Form)

Trading Account
For the year ending .......20......
Dr. Cr.

To Opening stock ........ By Sales .........
To purchases ......... Less returns ......... .........
Less Returns ......... ........ By Closing stock .........
To Carriage inwards ......... By Gross loss transferred to
To Cartage ......... profit and loss account .........
To dock charges .........
To Wages .........
To Duty .........
To Freight .........
To Clearing charges .........
To Etc. Etc., .........
To Gross profit (Transferred
to profit and loss account) .........
Trading Accounts Items:
Now we shall discuss the items of trading account one by one.
Opening Stock:
In case of trading concerns it will consist of only finished goods or goods to be sold without
alteration. In manufacturing concerns, the opening stock will consist of three parts
(a). Stock of raw material.
(b). Stock of partly completed goods or work-in-progress.
(c). Stock of finished goods.
In case of new business there will be no opening stock.
Purchases:
This item includes both cash and credit purchases of goods bought with the object of sales.
Return Outwards or Purchases Returns:
It means the goods returned by a trader to his suppliers from out of his purchases. Return
outwards reduce the purchases. It is shown by way of deduction from purchases in the trading
account.
Discount on Purchases:
It is also shown by way of deduction from purchases in the trading account.
Sales:
This item includes total of both cash and credit sales of goods in which businessman deals in. It
is credited to trading account.

Returns Inwards or Sales Returns:
It means goods returned to a trader by his customers from out of goods sold to them. It is shown
by way of deduction from sales on the credit side, of the trading account.
Discount on Sales:
This account has always a debit balance and is shown by deduction from sales in the trading
account.
Direct Expenses:
Direct expenses are those expenses which are incurred to convert raw-materials into finished
goods or which may be regarded as a part of the cost of purchasing the goods. e.g., wages paid
by a manufacturer to construct furniture out of raw wood, the expenses incurred to bring goods
from the place of purchase to the business place of the trader etc. All the direct expenses are
charged to the trading account. The items usually included in the direct expenses are:
1. Wages: This item usually signifies some hourly, daily or piecework remuneration paid to
laborers. It is direct expenditure and should be charged to trading account.
2. Manufacturing or Productive Wages: This item usually signifies the wages of factory
workmen actually engaged in making or producing something. It is a direct charge on the
cost of manufacturer. It is debited to manufacturing account or trading account.
3. Carriage Inward: Carriage means conveyance charges of goods by land. Carriage inward
are the conveyance expenses incurred to bring the goods purchased in the godown or
shop. It is debited to trading account. In examination questions when the item only
"carriage" is given and is not expressly stated to be inward or outward, it should be
assumed to be inward and debited to trading account. The reason is that carriage on
goods is usually paid by the purchaser.
4. Cartage: The cartage charges on goods purchased are direct expenses and should be
debited to trading account.
5. Freight: Freight is the charge made for conveyance of goods by sea. Freight on goods
purchased is charged to trading account.
6. Customs Duty, Octroi Duty etc: When goods are purchased from a foreign country
import duty will be payable. When goods are received from another city, the municipal
corporation may charge octroi duty. All duties on goods purchased should be debited to
trading account.
7. Excise Duty: It is a tax levied by the government. If the duty is levied on production it will
be treated as manufacturing expenses and debited to trading account.
8. Stores Consumed: This item stores denote lubricating oil, tallow, grease, cotton and jute
waste, etc., required for running the machinery of manufacturing concern. The amount of
stores consumed is a direct expense and should be charged to trading account.
9. Motive Power: This item includes, coke, gas, water or electric energy consumed in
propelling the machinery. It is debited to manufacturing account in the absence of a
manufacturing account, it is debited to trading account.
10. Royalty: Royalty is an amount paid to a person for exploiting rights possessed by him it is
usually paid to patentee, author, or landlord for the right to use his patent, copyright or
land. If they are productive expenses, they are debited to manufacturing account; but in
the absence of a manufacturing account, they are debited to trading account.
11. Manufacturing Expense: All other expenses such as factory rent, factory insurance,
factory repair etc., are direct expenses and should be charged to trading account.
Closing Stock and its Valuation:
Closing stock represents the value of goods lying unsold in the hands of a trader at the end of a
trading period. The value of closing stock is ascertained by means of compilation of list of
materials, stores and goods actually in possession at the close of the trading period. This work is
known as taking the inventory. The inventory or lists of physical stock are then faired and valued.
The total of the lists will be closing stock. The closing stock is valued at cost or market price
whichever is lower. As this item materially affects the gross profit (or gross loss), it is essential
that all possible care should be taken to calculate the closing stock at a proper value.
The value of closing stock is taken into consideration only at the time of preparing the trading
account and not before. The trial balance is prepared before the preparation of the trading
account. Hence the closing stock does not appear in a trial balance. It is brought into account by
means of a journal entry debiting stock account and crediting the trading account.
Advantages of Trading Account:
The advantages of the trading account are as follows:
1. A trader can find out the gross profit and thereby can ascertain the percentage of profit he
has earned on the cost of goods sold. This percentage of gross profit may serve as his
ready guide for the adjustment of future sale price.
2. A trading account help a trader to compare his stock at open with that at the close. He can
further find out whether the purchases he has made during the period of account have
been judicious.
3. Once can compare the figure of sales with similar figure of the previous year and can find
out whether business is improving or declining.
4. If the gross profit disclosed by the trading account is less than expected, an enquiry can
be made into the cause responsible for the decline. And if the gross profit is more than
was expected, steps can be taken to maintain it.
Profit and Loss Account:

Profit and loss account is the account whereby a trader determines the net result of his
business transactions. It is the account which reveals the net profit (or net loss) of the trader.
The profit and loss account is opened with gross profit transferred from the trading account (or
with gross loss which will be debited to profit and loss account). After this all expenses and
losses (which have not been dealt in the trading account) are transferred to the debit side of the
profit and loss account. If there are any incomes or gains, these will be credited to the profit and
loss account. The excess of the gain over the losses is called the net profit and that of the loss
over the gain is called the net loss. The account is closed by transferring the net profit or loss to
capital account of the trader.

Format of the Profit and Loss Account:
Profit and Loss Account
For the year ended ..............
To Gross Loss xxxx By Gross Profit xxxx
To Salaries xxxx By Interest Received xxxx
To Rent xxxx By Discount Received xxxx
To Rent and Rates xxxx By Commission Received xxxx
To Discount Allowed xxxx By Other Receipts xxxx
To Commission Allowed xxxx By Etc., Etc. xxxx
To Insurance xxxx
To Bank Charges xxxx
To Legal Charges By Net Loss (transferred to capital
xxxx
To Repairs account of the trader) xxxx
xxxx
To Advertising xxxx
To Trade Expenses ex.
To Office Expenses
xxxx
To Bad Debts
xxxx
To Traveling Expenses
xxxx
To Etc., Etc.
xxxx
To Net Profit (transferred to capital
account of the trader)
xxxx
Profit and Loss Account in Statement Form/Income Statement:

Trading and profit and loss account/income statement may be prepared either in account form (T
form) or in report form (statement form). Trading and profit and loss account in both the forms
give the same information. The account or T form is traditional and is used widely but in recent
years many business houses prefer to present the profit and loss account/income statement in
the report form.
Explanation of Certain Items of Income Statement:
Income from sales: The total of all charges to customers for goods sold, both for cash and on
credit, is reported in this section. Sales returns and allowances and sales discounts are deducted
from the gross amount to yield net sales.
Cost of Goods Sold: Cost of goods sold refers to the cost price of goods which have been sold during a
given period of time. In order to calculate the cost of goods sold we should deduct from the total cost of
goods purchased the cost of goods at the end of the year. This can be explained with the help of following
formula/equation:
(Opening stock + Cost of goods purchased) - Closing stock = Cost of goods sold
Gross Profit: The excess of the net income from sales over the cost of goods sold is also called
gross profit on sales, trading profit or gross margin. It is as gross because all other expenses for
the period must be deducted from it to obtain the net profit or net income of the business.
Operating Expenses: The operating expenses also called operating costs of a business may be
classified under any desired number of headings and sub-headings. In small retail business it is
usually satisfactory to classify operating expenses as selling or general.

1. Expenses that are incurred directly in connection with the sale of goods are known as
selling expenses. selling expenses include salaries or the salesmen, store supplies used,
depreciation of the store equipment, and advertising.
2. Expenses incurred in the general administration of the business are known as
administrative expenses or general expenses. Examples of general expenses are office
salaries, depreciation of equipment, and office supplied used.
Net Profit from Operations: The excess of gross profit on sales over total operating expenses is
called net profit or net profit from operations. If operating expenses should exceed gross profit,
the excess is designated as net loss or net loss from operations.
Other Income: Minor sources of income are classified as other income or non-operating income.
In a merchandising business this category often include income from interest, rent, dividends and
gains from the sale of fixed assets.
Other Expenses: Expenses that cannot be associated definitely with the operations are
identified as other expenses or non-operating expenses. Interest expense that results from
financing activities and losses incurred in the disposal of fixed assets are examples of items
reported in this section.
The two categories of non-operating items, other income and other expenses, are offset against
each other on the profit and loss account. If the total of other income exceeds the total other
expenses, the excess is added to net profit from operations; if the reverse is true, the difference
is subtracted from net profit from operations.
Net Profit: The final figure on the profit and loss account is labeled as net profit (or net loss) or
net profit carried to balance sheet. It is the net increase in capital from profit making activities.
Balance Sheet:
A balance sheet is a statement drawn up at the end of each trading period stating therein all the
assets and liabilities of a business arranged in the customary order to exhibit the true and correct
state of affairs of the concern as on a given date.
A balance sheet is prepared from a trial balance after the balances of nominal accounts are
transferred to the trading account or to the profit and loss account. The remaining balances of
personal or real accounts represent either assets or liabilities at the closing date. These assets
ant liabilities are shown in the balance sheet in a classified form - the assets being shown on the
right side and the liabilities on the left hand side.
Grouping and Marshalling:
In a balance sheet assets and liabilities should be properly grouped and classified under
appropriate headings. The individual balance of each debtor's and creditor's account need not be
shown. Debtors and creditors should be shown in total. The grouping together of dissimilar
assets will make the balance sheet misleading.
The term marshalling means the order in which assets and liabilities are stated on the balance
sheet as the balance sheet exhibits the financial position of a concern even to a non technical
observer. It is of great importance that the different assets and liabilities should be arranged in
the balance sheet on certain principles. The balance sheet is generally marshaled in three ways:

1. The Order of Liquidity or Realizability:
According to this method assets are entered up in the balance sheet following the order in which
they can be converted into cash and the liabilities in the order in which they can be paid off. The
following is a format of a balance sheet based on this order:
Balance Sheet as at ..........

Liabilities Rs. Assets Rs.
Bills Payable Cash in hand
Loans Cash at Bank
Trade Creditors Investments
Capital Bills Receivables
Debtors
Stock (Closing)
Stores
Furniture & Fixtures
Plant & Machinery
Land & Buildings
2. The Order of Permanence:
This method is the reverse of the first method. Under this method the assets are stated according
to their permanency i.e., permanent assets are shown first and less permanent are shown one
after another. Similarly the fixed liabilities are stated first and the floating liabilities follow. The
following is a specimen of a balance sheet based on this order:
Balance Sheet as at ..........

Liabilities Rs. Assets Rs.
Capital Land & Buildings
Trade Creditors Plant & Machinery
Loans Furniture & Fixtures
Bills Payable Stores
Stock (Closing)
Debtors
Bills Receivables
Investments
Cash at Bank
Cash in hand
3. Mixed Order of Arrangement:
This method is the combination of the first two methods. Under this method the assets are
arranged in order of realisability and liabilities are arranged in order of permanence.
The first method is adopted by sol proprietors, firms and partnership concerns. The second
method is adopted by companies and the third method is adopted by banking concerns.
Objectives of the Balance Sheet:

The function of the correctly prepared balance sheet is to exhibit the true and correct view of the
state of affairs of any concern. In a balance sheet as the assets and liabilities are shown in
details after being properly valued, a trader can judge the position of his business from it.
Classification of Assets:
The properties and possessions of a business are called assets and they are classified into the
following classes:
Fixed assets:
Fixed assets are assets which are acquired not for sale but for permanent use in the business
e.g., land and buildings, plant and machinery, furniture etc. These assets help the business to be
carried on.
Current Assets Or Circulating Assets or Floating Assets:
Current assets denote those assets which are held for sale or to be converted into cash after
some time e.g., sundry debtors. bills receivables, stock of goods etc.
Liquid Assets:
Liquid assets are those assets which are with us in cash or easily converted into cash e.g., cash
in hand, cash at bank, investments etc.
Wasting Assets:
The assets that depreciate through "wear and tear", whose values expire with lapse of time or
that become exhausted through working are known as wasting assets. This is a sub-class of
fixed assets e.g., plant machinery, mines etc.
Intangible or Fictitious Assets:
There are assets which have no physical existence. Which can neither be seen with eyes not
touched with hands. These are called intangible assets or fictitious assets. They do not
represent any thing valuable. They include debit balance of profit and loss account, goodwill etc.
Contingent Assets:
A contingent asset is one which comes into existence upon the happening of a certain event. If
that event happens the asset becomes available, otherwise not. For example uncalled capital of
a limited company.
Outstanding Assets:
Expenses paid in advance i.e., prepaid expenses, and income earned but not received are
known as outstanding assets.
Classification of Liabilities:
The liabilities of a business are classified as follows:

Fixed Liabilities:
These are the liabilities which are payable immediately or in the near future. These liabilities are
payable after a long period. Long term loans, capital of the proprietor are the examples of such
kind of liabilities.
Current Liabilities:
These are the liabilities which are payable immediately or in the near future, such as creditors,
bank loans etc.
Contingent Liabilities:
Contingent liabilities are those liabilities which arise only on the happening of some event. The
event may or may not happen. Thus a contingent liability may or may not involve the payment of
money. Examples of contingent liabilities are:
1. Liabilities on bills discounted: In case the bill is dishonored by the acceptor, the holder
may be called upon to pay the amount to the discounter.
2. Liability under guarantee: In case the debtor fails to fulfill his obligation, the man who
has given a guarantee or surety have to make good the loss to the creditor.
3. Liability in respect of a pending suit: A suit pending against a person in a court is a

contingent liability because if the decision of the court goes against him, he may thereby
become liable to pay compensation.
Contingent liabilities are not recorded in the books not they are included in the balance sheet.
They are simply referred to by way of foot notes on the balance sheet.
Outstanding Liabilities:
Outstanding expenses and unearned income are examples of outstanding liabilities.
Distinction/Difference Between Trial Balance and Balance Sheet:

The following are the points of distinction/difference between trial balance and balance
sheet:
Trial Balance Balance Sheet
It is a list of balance extracted from the ledger It is a statement of assets and liabilities
accounts
It contains the balance of all accounts - real, It contains the balance of only those accounts
nominal and personal. which represents assets and liabilities.
It is prepared before the preparation of trading It is prepared after the preparation of trading
and profit and loss account. and profit and loss account.
It does not contain the value of the closing stock It contains the value of closing stock, which
of goods. appears on the assets side.
Expenses due but not paid and incomes due but Expenses due but not paid appear on the
not received do not appear in the trial balance liability side and income due but not received
appear on the asset side of the balance sheet.

Definition, Explanation and Characteristics of "Depreciation" or
"Accounting Depreciation":
Definition
The value of assets gradually reduces on account of use. Such reduction in value is known as
depreciation. Different authors have given different definitions of depreciation, such as:
"Depreciation may be defined as the permanent continuous diminution in the quality, quantity or
value on an asset." (By Pickles)
"Depreciation is the gradual permanent decrease in the value of an asset from any cause." (By
Carter)
"Depreciation may be defined as a measure of the exhaustion of the effective life of an asset
from any cause during a given period." (By Spicer & Pegler)
Depreciation is the diminution in intrinsic value of an asset due to use and/or the lapse of time."
(By Institute of Cost and Management Accountants, England)
"Depreciation is the reduction in the value of a fixed asset occasioned by physical wear and tear,
obsolescence or the passage of time." (Northcott & Forsyth)
"Depreciation is the diminution in the value of assets owing to wear and tear, effluscion of time,
obsolescence or similar causes." (Cropper)
From the above definitions, it follows that an asset gradually declines on account of use and
passage of time and this causes permanent reduction in the value and utility of asset. Such
reduction in the value or utility of asset is called depreciation. In other words, expired cost or
utility of asset is depreciation.
Characteristics of Depreciation:
Depreciation has the following characteristics:
1. Depreciation is charged in case of fixed assets only. e.g., building, plant and machinery,
furniture etc. There is no question of depreciation in case of current assets - such as
stock, debtors, bills receivable etc.
2. Depreciation causes perpetual, gradual and continual fall in the value of assets.
3. Depreciation occurs till the last day of the estimated working life of the asset.
4. Depreciation occurs on account of use of asset. In certain cases, however, depreciation

may occur even if the assets are not used, e.g., leasehold, property, patent, copyright etc.
5. Depreciation is a charge against revenue of an accounting period.
6. Depreciation does not depend on fluctuations in market value of assets.
7. The amount of depreciation of an accounting year cannot be determined precisely - it has

to be estimated. In certain cases, however, it may be ascertained exactly, e.g., leasehold
property, patent right, copyright etc.
8. Total depreciation of an asset cannot exceed its depreciable value (cost less scrap value).

Causes of Depreciation:
The main causes of depreciation may be divided into two categories, namely:
1. Internal Cause and

2. External Causes
Internal Causes:
Depreciation which occurs for certain inherent normal causes, is known as internal depreciation.
The main causes of internal depreciation are:
Wear and Tear:
Some assets physically deteriorate due to wear and tear in use. More and more use of an asset,
the greater would be the wear and tear. Physical deterioration of an asset is caused from
movement, strain, friction, erasion etc. An obvious example of this is motor car which rapidly
wears out. Other assets like this are building, plant, machinery, furniture, etc. The wear and tear
is general but primary cause of depreciation.
Depletion:
Some assets declines in value proportionate to the quantum of production, e.g. mine, quarry etc.
With the raising of coal from coal mine the total deposit reduces gradually and after sometime it
will be fully exhausted. Then its value will be reduced to nil.
External Causes:
Depreciation caused by some external reasons is called external depreciation. The main external
causes are as follows:
Obsolescence:
Some assets, although in proper working order, may become obsolete. For example, old
machine becomes obsolete with the invention of more economical and sophisticated machine
whose productive capacity is generally larger and cost of production is therefore less. In order to
survive in the competitive market the manufacturers must must install new machines replacing
the old ones. Again, it may happen that the articles produced by old machine are no longer
saleable in the market on account of change of habit and taste of the people. In such a case the
old machine, although in good working condition, must be discarded and the new one purchased.
Efflux of Time:
Some assets diminish in value on account of sheer passage of time, even though they are not
used e.g., leasehold property, patent right, copyright etc. Suppose we take a lease of a house for
10 years for $10,000. Its annual depreciation will be $1,000 (10,000/10), irrespective of the the
whether the house has been used or not. Because with the end of lease after 10 years, the
house will go out of possession.
Accident:
Assets may be destroyed by abnormal reasons such as fire, earthquake, flood etc. In such a
case the destroyed asset must be written off as loss and a new one purchased.

Need for Depreciation:
Ascertainment of True Profit or Loss:
Depreciation is a loss. So Unless it is considered like all other expenses and losses, true profit or
loss cannot be ascertained. In other words, depreciation must be considered in order to into out
true profit or loss of a business.
Ascertainment of True Cost of Production:
Goods are produced with the help of plant and machinery which incurs depreciation in the
process of production. This depreciation must be considered as a part of the cost of production of
goods. Otherwise, the cost f production would be shown less than the true cost. Sales price is
fixed normally on the basis of cost of production. So, if the cost of production is shown less by
ignoring depreciation, the sale price will also be fixed at low level resulting in a loss to the
business.
True Valuation of Assets:
Value of assets gradually decreases on account of depreciation, if depreciation is not taken into
account, the value of asset will be shown in the books at a figure higher than its true value and
hence the true financial position of the business will not be disclosed through balance sheet.
Replacement of Assets:
After sometime an asset will be completely exhausted on account of use. A new asset must then
be purchased requiring a large sum of money. If the whole amount of profit is withdrawal from
business each year without considering the loss on account of depreciation, necessary sum may
not be available for buying the new asset. In such a case the required money is to be collected
by introducing fresh capital or by obtaining loan or by selling some other assets. This is contrary
to sound commerce policy.
Keeping Capital Intact:
Capital invested in buying an asset, gradually diminishes on account of depreciation. If loss on

account of depreciation is not considered in determining profit or loss at the year end, profit will
be shown more. If the excess profit is withdrawal, the working capital will gradually reduce, the
business will become weak and its profit earning capacity will also fall.
Depreciation, Depletion and Amortization:

Depreciation:
The term depreciation is used with reference to tangible fixed assets because the permanent
continuing and gradual fall in book value is possible only in the case of fixed asset.
Depletion:
The term depletion is used for the depreciation of wasting assets such as mines, oil wells,
timber trees etc.
Amortization

The term amortization is used in respect of intangible assets like patents, copyrights, leasehold
and goodwill which are recorded at cost. Some intangible assets have limited useful life and are,
therefore, written off. The process of their writing off is called amortization.
Basic Factors of Determination of Depreciation:

For calculation depreciation the basic factors are:
1. The original cost of the asset.

2. The estimated working life of the asset or the number of years the asset is expected to
last.
3. The estimated residual or scrap value at the end of its life. It is the value which the asset
will fetch when discarded as useless.
4. The amount to be spent periodically for repairs and renewals. If the repairs necessary to
keep the asset in a proper state of efficiency are regularly carried out, the life of the asset
is prolonged and the amount of annual depreciation is proportionately lowered.
5. The possibility of the asset becoming obsolete. If there are great chances of
improvements being made in a particular asset on account of inventions, higher
depreciation should be written off such an asset.
METHODS FOR PROVIDING DEPRECIATION
Fixed Installment Method or Straight Line Method or Original Cost

Method of Depreciation:
Fixed installment method is also know as straight line method or original cost method.
Under this method the expected life of the asset or the period during which a particular asset will
render service is the calculated. The cost of the asset less scrap value, if any, at the end f its
expected life is divided by the number of years of its expected life and each year a fixed amount
is charged in accounts as depreciation. The amount chargeable in respect of depreciation under
this method remains constant from year to year. This method is also know as straight line method
because if a graph of the amounts of annual depreciation is drawn, it would be a straight line.
Formula:
The following formula or equation is used to calculate depreciation under this method:
Annual Depreciation = [(Cost of Assets - Scrap Value)/Estimated Life of Machinery]
Journal Entries:
The journal entries that will have to be made under this method are very simple. The journal
entries will be as under:
1. Depreciation account
To Asset account
(Being the depreciation of the asset)
2. Profit and loss account

To Depreciation account
(Being the amount of depreciation charged to Profit and Loss account)

These entries will be passed at the end of each year so long as the asset lasts. In the last year,
the scrap will be sold and with the amount that realised by the sale the following entry will be
passed:
3. Cash account
To Asset account
(Being the sale price of scrap realised.)
Advantages:
1. Fixed installment method of depreciation is simple and easy to work out

2. The book value of the asset can be reduced to zero.
Disadvantages:
1. This method, in spit of its being simplest is not very popular because of the fact that
whereas each year's depreciation charge is equal, the charge for repairs and renewals
goes on increasing as the asset becomes older. The result is that the profit and loss
account has to bear a light burden in the initial years of the asset but later on this burden
becomes heavier.
2. Interest on money is locked up in the asset is not taken into account as is done in some
other methods.
3. No provision for the replacement of the asset is made.
4. Difficulty is faced in calculation of depreciation on additions made during the year.
Scope of Application:
On account of the above mentioned advantages and disadvantages of fixed installment method,
it is generally applied in case of those assets which have small value or which do not require
many repairs and renewals for example copyright, patents, short leases etc.
Example:
On 1st January 1991 X purchased a machinery for $21,000. The estimated life of the machine is
10 years. After it its break up value will be $1,000 only. Calculate the amount of annual
depreciation according to fixed installment method (straight line method or original cost method)
and prepare the machinery account for the first three years.
Machinery Account
$ $
1991 Jan. 1 To Bank account 21,000 1991 Dec. 31 By Depreciation account 2,000
1991 Dec. 31 By Balance c/d 19,000
21,000 21,000
1992 Jan. 1 To Balance b/d 19,000 1991 Dec. 31 By Depreciation account 2,000
1991 Dec. 31 17,000
15,000 15,000
1993 Jan. 1 To Balance b/d 17,000 1991 Dec. 31 By Depreciation account 2,000
1991 Dec. 31 By Balance c/d 15,000
17,000 17,000

Diminishing Balance Method of Depreciation:
Diminishing balance method is also known as written down value method or reducing
installment method. Under this method the asset is depreciated at fixed percentage calculated
on the debit balance of the asset which is diminished year after year on account of depreciation.
Advantages of Diminishing Balance Method:
1. The strongest point in favor of this method is that under it the total burden imposed on
profit an loss account due to depreciation and repairs remains more or less equal year
after year since the amount after depreciation goes on diminishing with the passage of
time whereas the amount of repairs goes on increasing an asset grow older.
2. Separate calculations are unnecessary for additions and extensions, though in the first
year some complications usually arise on account of the fact that additions are generally
made in the middle of the year.
Disadvantages of Diminishing Balance method:
1. This method ignores the question of interest on capital invested in the asset and the
replacement of the asset.
2. This method cannot reduce the book value of an asset to zero if it is desired.
3. Very high rate of depreciation would have to be adopted other wise it will take a very long
time to write an asset down to its residual value
Scope of Application:
Diminishing balance method of depreciation is most suited to plant and machinery where
additions and extensions take place so often and where the question of repairs is also very
important. Written down value method or reducing installment method does not suit the case of
lease, whose value has to be reduced to zero.
Example:
On 1st January, 1994, a merchant purchased plant and machinery costing $25,000. It has been
decided to depreciate it at the rate if 20 percent p.a. on the diminishing balance method (written
down value method). Show the plant and machinery account in the first three years.
Plant and Machinery Account

$ $
Date Date
1994 1994
To Cash 25,000 By Depreciation 5,000*
Jan. 1 Dec. 31
" By Balance c/d 20,000
25,000 25,000
1995 1995
To Balance b/d 20,000 By Depreciation 4,000**
Jan. 1 Dec. 31
" By Balance c/d 16,000

20,000 20,000
1996 1996
To Balance b/d 16,000 By Depreciation 3,200***
Jan. 1 Dec. 31
By Balance c/d 12,800
16,000 16,000
Trend Percentage:
Horizontal analysis of financial statements can also be carried out by computing trend percentages.
Trend percentage states several years' financial data in terms of a base year. The base year equals
100%, with all other years stated in some percentage of this base.
Example:
Consider McDonald's Corporation, the largest global food service retailer, with more than 26,000
restaurants worldwide. McDonalds enjoyed tremendous growth during the 1990s, as evidenced by the
following data:
2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990
Sales(millions) $14,243 $13,259 $12,421 $11,409 $10687 $9,795 $8,321 $7,408 $7,133 $6,695 $6,640
Income(millions) $1,977 $1,948 $1,550 $1,642 $1,573 $1,427 $1,224 $1,083 $959 $860 $802
By simply looking at these data, one can see that sales increased every year. But how rapidly sales
have been increasing, and have the increases in net income kept pace with the increase in sales? It is
difficult to answer these questions by looking at the raw data alone. The increases in sales and the
increases in net income can be put into better perspective by stating them in terms of trend
percentages, with 1990 as the base year. These percentages (all rounded) appear as follows:
2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990
Sales 215% 200% 187% 172% 161% 148% 125% 112% 107% 101% 100%
Income 247% 243% 193% 205% 196% 178% 153% 135% 120% 107% 100%
The trend analysis is particularly striking when the data are plotted as above. McDonald's growth was
impressive through the entire 11-year period, but it was out paced by even higher growth in the
company's net income. A review of the company's income statement reveals that the dip in net
income growth in 1998 was attributable, in part, to the $161.6 million that McDonalds spent to
implement its "Made for you" program and a special charge of $160 million that related to a home
office productivity initiative.
Common Size Statements:

Common size statement is one that shows the items appearing on it in percentage form as well as
in dollar form.
Each item is stated as a percentage of some total of which that item is a part. Key financial changes
and trends can be highlighted by the use of common size statements.

Common size statements are particularly useful when comparing data from different companies. For
example, in one year, Wendy's net income was about $110 million, whereas McDonald's was $1,427
million. This comparison is somewhat misleading because of the dramatically different size of the two
companies. To put this in better perspective, the net income figures can be expressed as a
percentage of the sales revenues of each company, Since Wendy's sales revenue were $1,746 million
and McDonald's were $9,794 million, Wendy's net income as a percentage of sales was about 6.3%
and McDonald's was about 14.6%.
Example:
Balance Sheet:
One application of the vertical analysis idea is to state the separate assets of a company as
percentages of total sales. A common type statement of an electronic company is shown below:
Common Size Comparative Balance Sheet

December 31, 2002, and 2001
(dollars in thousands)
Common-Size Percentages
2002 2001 2002 2001
Assets
Current assets:
Cash $ 1,200 $ 2,350 3.8% 8.1%
Accounts receivable, net 6,000 4,000 19.0% 13.8%
Inventory 8,000 10,000 25.4% 34.5%
Prepaid expenses 300 120 1.0% 0.4%
------------ ------------ ----------- ------------
Total current assets 15,500 16,470 49.2% 56.9%
------------ ------------ ------------ ------------
Property and equipment:
Land 4,000 4,000 12.7% 13.8%
Building and equipment 12,000 8,5000 38.1% 29.3%
------------ ------------ ------------ ------------
Total property and equipment 16,000 12,500 50.8% 43.1%
------------ ------------ ------------ ------------
Total assets $ 31,500 $ 28,970 100.0% 100.0%
====== ====== ====== ======
Liabilities and Stockholders' Equity

Current liabilities:
Accounts payable $ 5,800 $ 4,000 18.4% 13.8%
Accrued payable 900 400 2.9% 1.4%
Notes payable, short term 300 600 1.0% 2.1%
------------ ------------ ------------ ------------
Total current liabilities 7,000 5,000 22.2% 17.3%
------------ ------------ ------------ ------------
Long term liabilities:
Bonds payable, 8% 7,500 8,000 23.8% 27.6%
------------ ------------ ------------ ------------
Total liabilities 14,500 13,000 46.0% 44.9%
------------ ------------ ------------ ------------
Stockholders' equity:
Preferred stock, $100, 6%, $100 liquidation value 2,000 2,000 6.3% 6.9%
Common stock, $12 par 6,000 6,000 19.0% 20.7%

Additional paid in capital 1,000 1,000 3.2% 3.5%
------------ ------------ ------------ ------------
Total paid in capital 9,000 9,000 28.6% 31.1%
Retained earnings 8,000 6,970 25.4% 24.1%
------------ ------------ ------------ ------------
Total stockholders equity 17,000 15,970 54.0% 55.1%
------------ ------------ ------------ ------------
$ 31,500 $ 28,970 100.0% 100.%
====== ====== ====== ======
*Each asset in common size statement is expressed in terms of total assets, and each liability and equity account is expressed in terms
of total liabilities and stockholders' equity. For example, the percentage figure above for cash in 2002 is computed as follows:
[$1,200 / $31,500 = 3.8%]
Notice from the above example that placing all assets in common size form clearly shows the relative
importance of the current assets as compared to the non-current assets. It also shows that the
significant changes have taken place in the composition of the current assets over the last year.
Notice, for example, that the receivables have increased in relative importance and that both cash
and inventory have declined in relative importance. Judging from the sharp increase in receivables,
the deterioration in cash position may be a result of inability to collect from customers.
The main advantages of analyzing a balance sheet in this manner is that the balance sheets of
businesses of all sizes can easily be compared. It also makes it easy to see relative annual changes in
one business.
Income Statement:
Another application of the vertical analysis idea is to place all items on the income statement in
percentage form in terms of sales. A common size statement of this type of an electronics company is
shown below:
Common-Size Comparative income statement

For the year ended December 31, 2002, and 2001
(dollars in thousands)
Common-Size Percentage
2002 2001 2002 2001

Sales $52,000 $48,000 100.0% 100.0%
Cost of goods sold 36,000 31,500 69.2% 65.6%
------------ ------------ ------------ ------------
Gross margin 16,000 16,500 30.8% 34.4%
------------ ------------ ------------ ------------
Operating expenses:
Selling expenses 7,000 6,500 13.5% 13.5%
Administrative expense 5,860 6,100 11.3% 12.7%
------------ ------------ ------------ ------------
Total operating expenses 12,860 12,600 24.7% 26.2%
------------ ------------ ------------ ------------
Net operating income 3,140 3,900 6% 8.1%
Interest expense 640 700 1.2% 1.5%
------------ ------------ ------------ ------------
Net income before taxes 2,500 3,200 4.8% 6.7%
Income tax (30%) 750 960 1.4% 2.0%
------------ ------------ ------------ ------------
Net income $ 1,750 $2,240 3.4% 4.7%
====== ====== ====== ======

*Note that the percentage figures for each year are expressed in terms of total sales for the year. For example, the percentage figure
for cost of goods sold in 2002 is computed as follows:
[($36,000 / $52,000) × 100 = 69.2%]
By placing all items on the income statement in common size in terms of sales, it is possible to see at
a glance how each dollar of sales is distributed among the various costs, expenses, and profits. And
by placing successive years' statements side by side, it is easy to spot interesting trends. For
example, as shown above, the cost of goods sold as a percentage of sales increased from 65.6% in
2001 to 69.2% in 2002. Or looking at this form a different view point , the gross margin percentage
declined from 34.4% in 2001 to 30.8% in 2002. Managers and investment analysis often pay close
attention to the gross margin percentage since it is considered a broad gauge of profitability. The
gross margin percentage is computed by the following formula:
Gross margin percentage = Gross margin / Sales
The gross margin percentage tends to be more stable for retailing companies than for other
service companies and for manufacturers. Since the cost of goods sold in retailing exclude fixed costs.
When fixed costs are included in the cost of goods sold figure, the gross margin percentage tends to
increase of decrease with sales volume. The fixed costs are spread across more units and the gross
margin percentage improves.
While a higher gross margin percentage is considered to be better than a lower gross margin
percentage, there are exceptions. Some companies purposely choose a strategy emphasizing low
prices and (hence low gross margin). An increasing gross margin in such a company might be a sign
that the company's strategy is not being effectively implemented.
Common size statements are also very helpful in pointing out efficiencies and inefficiencies that might
other wise go unnoticed. To illustrate, selling expenses, in the above example of electronics
company , increased by $500,000 over 2001. A glance at the common-size income statement shows,
however, that on a relative basis, selling expenses were no higher in 2002 than in 2001. In each year
they represented 13.5% of sales.
Ratio Analysis
Ratios simply means one number expressed in terms of another. A ratio is a statistical yardstick by
means of which relationship between two or various figures can be compared or measured.
Ratios can be found out by dividing one number by another number. Ratios show how one number is
related to another. It may be expressed in the form of co-efficient, percentage, proportion, or rate.
For example the current assets and current liabilities of a business on a particular date are $200,000
and $100,000 respectively. The ratio of current assets and current liabilities could be expressed as 2
(i.e. 200,000 / 100,000) or 200 percent or it can be expressed as 2:1 i.e., the current assets are two
times the current liabilities. Ratio sometimes is expressed in the form of rate. For instance, the ratio
between two numerical facts, usually over a period of time, e.g. stock turnover is three times a year.
Advantages of Ratios Analysis:

Ratio analysis is an important and age-old technique of financial analysis. The following are some of
the advantages / Benefits of ratio analysis:
1. Simplifies financial statements: It simplifies the comprehension of financial statements.

Ratios tell the whole story of changes in the financial condition of the business
2. Facilitates inter-firm comparison: It provides data for inter-firm comparison. Ratios
highlight the factors associated with with successful and unsuccessful firm. They also reveal
strong firms and weak firms, overvalued and undervalued firms.
3. Helps in planning: It helps in planning and forecasting. Ratios can assist management, in its
basic functions of forecasting. Planning, co-ordination, control and communications.
4. Makes inter-firm comparison possible: Ratios analysis also makes possible comparison of
the performance of different divisions of the firm. The ratios are helpful in deciding about their
efficiency or otherwise in the past and likely performance in the future.

5. Help in investment decisions: It helps in investment decisions in the case of investors and
lending decisions in the case of bankers etc.
Limitations of Ratios Analysis:

The ratios analysis is one of the most powerful tools of financial management. Though ratios are
simple to calculate and easy to understand, they suffer from serious limitations.
1. Limitations of financial statements: Ratios are based only on the information which has
been recorded in the financial statements. Financial statements themselves are subject to
several limitations. Thus ratios derived, there from, are also subject to those limitations. For
example, non-financial changes though important for the business are not relevant by the
financial statements. Financial statements are affected to a very great extent by accounting
conventions and concepts. Personal judgment plays a great part in determining the figures for
financial statements.
2. Comparative study required: Ratios are useful in judging the efficiency of the business only
when they are compared with past results of the business. However, such a comparison only
provide glimpse of the past performance and forecasts for future may not prove correct since
several other factors like market conditions, management policies, etc. may affect the future
operations.
3. Ratios alone are not adequate: Ratios are only indicators, they cannot be taken as final
regarding good or bad financial position of the business. Other things have also to be seen.
4. Problems of price level changes: A change in price level can affect the validity of ratios
calculated for different time periods. In such a case the ratio analysis may not clearly indicate
the trend in solvency and profitability of the company. The financial statements, therefore, be
adjusted keeping in view the price level changes if a meaningful comparison is to be made
through accounting ratios.
5. Lack of adequate standard: No fixed standard can be laid down for ideal ratios. There are no
well accepted standards or rule of thumb for all ratios which can be accepted as norm. It
renders interpretation of the ratios difficult.
6. Limited use of single ratios: A single ratio, usually, does not convey much of a sense. To
make a better interpretation, a number of ratios have to be calculated which is likely to
confuse the analyst than help him in making any good decision.
7. Personal bias: Ratios are only means of financial analysis and not an end in itself. Ratios
have to interpreted and different people may interpret the same ratio in different way.
8. Incomparable: Not only industries differ in their nature, but also the firms of the similar
business widely differ in their size and accounting procedures etc. It makes comparison of
ratios difficult and misleading.
FUND FLOW STATEMENT

Definition.
“The funds flow statement describes the sources from which additional funds were derived and the use to
which these funds were put.”
It indicates various methods by which funds are obtained during a particular period and the ways in which
these funds are employed. In simple words, it is a statement of sources and application of funds.
“A statement of sources and application of funds is a technical device designed to analyse the changes in
the financial condition of a business enterprise between two dates.”
In funds flow statement funds means working capital i.e. current assets – current liabilities. Flow of funds
It means changes in funds or change in working capital Source of fund It is any transaction that results in
an increase in working capital (inflow of funds) Application of funds It is any transaction that results in a
decrease in working capital (outflow of funds).
Importance Of Funds Flow Statement.
1. Helps in analysis of financial operations.
2. Helps in formulation of realistic dividend policy.
3. Helps in proper allocation of resources.
4. It acts as a future guide.
5. Helps in appraising the use of working capital.
6. It helps knowing the overall creditworthiness of firm.
7. It throws light on many questions of general interest. :
 Why dividend could not be declared in spite of available profits
 Why were the net CA lesser in spite of profits.
 What are the sources of repayment of debts
CASH FLOW STATEMENT

A Cash Flow Statement is similar to the Funds Flow Statement, but while preparing funds flow statement
all the current assets and current liabilities are taken into consideration. But in a cash flow statement only
those sources of funds are taken which provide cash and only the uses of cash are taken into consideration,
even liquid asset like Debtors and Bills Receivables are ignored.
A Cash Flow Statement is a statement, which summarises the resources of cash available to finance the
activities of a business enterprise and the uses for which such resources have been used during a particular
period of time. Any transaction, which increases the amount of cash, is a source of cash and any
transaction, which decreases the amount of cash, is an application of cash.
Cash flow statements have three distinct sections, each of which relates to a particular component -
operations, investing and financing - of a company's business activities:
Cash Flow from Operations: This is the key source of a company's cash generation. It is the cash that the
company produces internally as opposed to funds coming from outside investing and financing activities.
In this section of the cash flow statement, net income (income statement) is adjusted for non-cash charges
and the increases and decreases to working capital items - operating assets and liabilities in the balance
sheet's current position.
Cash Flow from Investing: For the most part, investing transactions generate cash outflows, such as
capital expenditures for plant, property and equipment, business acquisitions and the purchase of
investment securities. Inflows come from the sale of assets, businesses and investment securities. For
investors, the most important item in this category is capital expenditures (more on this later). It's generally
assumed that this use of cash is a prime necessity for ensuring the proper maintenance of, and additions to,
a company's physical assets to support its efficient operation and competitiveness.
Cash Flow from Financing: Debt and equity transactions dominate this category. Companies
continuously borrow and repay debt. The issuance of stock is much less frequent. Here again, for investors,
particularly income investors, the most important item is cash dividends paid. It's cash, not profits, that is
used to pay dividends to shareholders.
USES AND ADVANTAGES:
(i) Planning and Co-ordination of Financial Operations. Cash Flow Statement is useful is evaluating
Financial policies and current cash position. Since cash is the basis for carrying on operations, the Cash
Flow Statement prepared on an estimated basis for the next accounting period will enable the management
to plan and co-ordinate the financial operations probably. The management comes to know how much cash
is needed in the future and at what time and how can it be arranged-how much internally and how much
from outside. It is especially useful in preparing cash budgets.
(ii) A Control Device. Cash Flow statement is also a control device for the management. A comparison of
cash flow statement of previous year with the budget for that year would indicate to what extent the
resources of the enterprise were raised an applied according to the plan. Thus a comparison of original
forecast with actual results may highlights trends of movement that might otherwise go undetected.
(iii) Useful to internal Financial Management. Since it gives a clear picture of cash inflow from
operations (and not income flow of operation), it is, therefore, very useful to internal financial management
in considering the possibility of retiring ling-term debts, in planning replacement of plant facilities or in
formulating dividend policies.
(iv) Profit and Cash Positions. It enables the management to account for situation when business has
earned huge profits yet run without money or when it has suffered a loss and still has plenty of money at
the bank.
(v) Short-term Financial Decisions. Cash Flow Statement helps the management in taking short-term
financial decisions. Suppose, if firm wants to know its state of solvency after one month from to date, it is
possible only from Cash Flow analysis and not from Fund Flow Statement. Shorter the period, greater is
the importance of Cash Flow Statement.
Difference between Funds Flow Statement and Cash Flow Statement
Basis of Difference Funds Flow Statement Cash Flow Statement
1. Basis of Analysis Funds flow statement is based on Cash flow statement is based on
broader concept i.e. working narrow concept i.e. cash, which is only
capital. one of the elements of working capital.
2. Source Funds flow statement tells about Cash flow statement stars with the
the various sources from where the opening balance of cash and reaches to
funds generated with various uses the closing balance of cash by
to which they are put. proceeding through sources and uses.
3. Usefulness Funds flow statement is more Cash flow statement is useful in

useful in assessing the long-range understanding the short-term
financial strategy. phenomena affecting the liquidity of
the business.
4. Schedule of Changes In funds flow statement changes in In cash flow statement changes in
in Working Capital current assets and current current assets and current liabilities are
liabilities are shown through the shown in the cash flow statement
schedule of changes in working itself.
capital.
5. Causes Funds flow statement shows the Cash flow statement shows the causes
causes of changes in net working the changes in cash.
capital.
6. Principal of Funds flow statement is consonant In cash flow statement data obtained
Accounting with the accrual basis of on accrual basis are converted into
accounting. cash basis.

Statement of Affairs:

Correct final accounts of a business can be prepared in the records are maintained under the double
entry system . How every where the record is incomplete, and it is not all possible to complete it by
double entry, in such cases the final accounts can be only approximately prepared by means of a
statement of affairs. In appearance the statement of affairs is similar to a balance sheet. For this
purpose, two comparative statement of affairs are prepared - one at the commencement of the year
and other at the end of the year. The excess of the assets over the liabilities as shown by the
statement will represent the capital of the firm. If capital at the end shows an increase as compared
to the amount of capital at the start the difference will represent profit and if the capital at the end is
less than the capital at the beginning the difference will be loss. In this calculation, however, two
more factors should be taken into account.
1. Where fresh capital has been introduced into the business during the account period, the
closing capital may be taken to have been increased to that extent. To arrive at the true profit
or loss, therefore, the amount of fresh capital introduced is deducted from the closing assets
as determined under such circumstances.
2. Where drawings have been made by the proprietor during the accounting period, such
drawings reduce the amount of capital at the close. In order to calculate net profit, it is
necessary, therefore, that amount withdrawal should be added to the capital at the close
before deducting from it the capital at the beginning.
Formula:
Formula for determining the net profit is put as follows:
(Capital at the end + Drawings - Additional capital introduced) - Capital in the beginning
Example:
Rashid and Co. keeps his book on single entry system. his position on 1st January, 19991 was as
follows:
Cash in hand $200, cash at bank $3000; stock in trade $20,000; sundry debtors $8,500; furniture
$1,800; machinery $15,000; sundry creditors $22,000.
On 31st December, 1991 the financial position was as follows:
Cash in hand $300; cash at bank $2,000; machinery $27,000; furniture $1,500; sundry debtors
$14,000 stock in trade $19,000 sundry creditors $29,000.
During the year Rashid introduced a new capital of $5,000 and withdrew for his personal expenditure
$9,000.
From the above figures, prepare a statement showing the profit or loss made by him during 1991.

Solution:
Rashid & Co.

Statement of Affairs as at 1st January, 1991.
Liabilities $ Assets $
Sundry creditors Cash in hand
Capital (balancing figure*) 22,000 Cash at bank 200
26,500 Sundry debtors 3,000
Stock in trade 8,500
Furniture 20,000
Machinery 1,800
15,000
48,500 48,500
* 48,500 - 22,000
Rashid & Co.

Statement of Affairs as at 1st January, 1991.
Liabilities $ Assets $
Sundry creditors Cash in hand
Capital (balancing figure*) 29,000 Cash at bank 300
34,800 Sundry debtors 2,000
Stock in trade 14,000
Furniture 19,000
Machinery 1,500
27,000
63,800 63,800
* 63,800 - 29,000
Statement of Profit for the year ending 31st December, 1991.

Capital 31st December, 1991 34,800
Add drawings during the year 9,000
43,800
Less capital introduced during the year 5,000
38,800
Less capital as at 1st January, 1991 26,500
Net profit during the year 12,300
Difference Between Statement of Affairs and Balance Sheet:

Learning Objectives:
1. What is the difference between statement of affairs and balance sheet?
As real or property accounts are not maintained and also because a capital account does not exist
under the single entry system, a balance sheet cannot be prepares in the same way as is done under
the double entry system. However, in order to have an idea about the financial position on a
particular date information concerning the available assets and liabilities is gathered and a statement
is prepared setting in it assets and liabilities on the date; this statement is called a statement of
affairs. The assets and liabilities are set out in the form of a balance sheet. The excess of assets over
liabilities is shown as capital.
Balance sheet and statement of affairs may be distinguished as follows:
Statement of Affairs Balance Sheet

(1) It is a statement of assets and liabilities (1) It is statement of assets and liabilities
(including capital) prepared under the single (including capital) prepared under the double
entry system entry system.
(2) It is prepared partly from a trader's books, (2) It is prepared with data available from the
partly from other sources of information and books of accounts only.
sometimes from memory
(3) It is compiled from an incomplete books and (3) It is prepared from a set of books kept
information, the accuracy of which cannot be according to the double entry system, the
relied upon arithmetical accuracy of which can be
proved.

Accounts

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Meaning

According to American Institute of Certified Public Accountants (AICPA), “Accounting is the

Why Accounting is Important?

 The types and amount of earnings.

The following are the objectives of accounting:

a. To record the business transactions in a systematic manner.

d. To facilitate management control.

e. To assess the taxable income and the sales tax liability.

Accounting suffers from the following limitations:

i. Accounting information is expressed in terms of money. Non monetary events

iii. Accounting information is sometimes based on estimates; estimates are often

iv. Accounting information cannot be used as the only test of managerial

v. Accounting information is not neutral or unbiased. Accountants calculate income

Various Functions of Accounting are:

a. Recording: Accounting records business transactions in terms of money. It is

b. Classifying: Accounting also facilitates classification of all business transactions

c. Summarizing: Accounting summarizes the classified information. It is done in a

Dr. Shishir Srivastava, GIHS 2

Different systems of Accounting

The following are the basic systems of Accounting:

iii. Mixed System: Mixed system is modified form of pure-cash-basis accounting.

Definition and Explanation:

Essential Features of Accounting Principles:

Dr. Shishir Srivastava, GIHS 3

Classification of Accounting principles:

1. Accounting Concepts: The term concepts includes those basic assumptions or

1. Business Entity Concept

3. Money Measurement Concept

5. Duel Aspect Concept

6. Accounting Period Concept

8. Realisation / Realization Concepts

The explanation of these concepts are as follows:

Business Entity Concept:

Going Concern Concept:

Money Measurement Concept:

Dual Aspect Concept:

Capital (Equities) = Costs (Assets)

Capital + Liabilities = Assets

Accounting period concept:

Emerging Role of Accounting

Dr. Shishir Srivastava, GIHS 8

Social Responsibility Accounting

Human Resource Accounting

How does management Accounting differs from Financial Accounting?

Definition and Explanation of Single Entry System:

Defects/Limitations/Disadvantages of Single Entry System:

The limitations or defects or disadvantages of single entry system may be summed up as

Double Entry System of Bookkeeping:

Dr. Shishir Srivastava, GIHS 10

Advantages of Double Entry System:

5. It prevents fraud by rendering any alteration in any account more difficult.

Disadvantages of Double Entry System:

The following are the main disadvantages of this system:

3. There is no guarantee of absolute accuracy of the books of accounts inspite of agreement

Single Entry Versus Double Entry System of Bookkeeping:

Dr. Shishir Srivastava, GIHS 11

Advantages of Double Entry Over Single Entry System:

Interested Groups / Stake holders / Users of A/c Information

Role of Accountants in Modern Business Organization:

1. Writing up Accounts for Preparing Financial Statements: Professional accountants

2. Audit of Accounts: Conducting of audit is one of the most important functions of a

3. Role as Management Accountant: A management accountant helps the management

4. Help to government, Revenue Department and Tax Payer: Chartered accountant

Dr. Shishir Srivastava, GIHS 13