Financial Accounting - SUCM101

SUCM 101/
SUBT101/SUCR101/SUCC102
UNDERGRADUATE COURSE
B.COM. - GENERAL COMMERCE
FIRST YEAR
FIRST SEMESTER
PAPER - I
FINANCIAL ACCOUNTING
INSTITUTE OF DISTANCE EDUCATION

UNIVERSITY OF MADRAS
B.Com. - General Commerce PAPER - I
FIRST YEAR - FIRST SEMESTER FINANCIAL ACCOUNTING
WELCOME
Warm Greetings.
It is with a great pleasure to welcome you as a student of Institute of Distance

Education, University of Madras. It is a proud moment for the Institute of Distance education
as you are entering into a cafeteria system of learning process as envisaged by the University
Grants Commission. Yes, we have framed and introduced Choice Based Credit
System(CBCS) in Semester pattern from the academic year 2018-19. You are free to
choose courses, as per the Regulations, to attain the target of total number of credits set
for each course and also each degree programme. What is a credit? To earn one credit in
a semester you have to spend 30 hours of learning process. Each course has a weightage
in terms of credits. Credits are assigned by taking into account of its level of subject content.
For instance, if one particular course or paper has 4 credits then you have to spend 120
hours of self-learning in a semester. You are advised to plan the strategy to devote hours of
self-study in the learning process. You will be assessed periodically by means of tests,
assignments and quizzes either in class room or laboratory or field work. In the case of PG
(UG), Continuous Internal Assessment for 20(25) percentage and End Semester University
Examination for 80 (75) percentage of the maximum score for a course / paper. The theory
paper in the end semester examination will bring out your various skills: namely basic
knowledge about subject, memory recall, application, analysis, comprehension and
descriptive writing. We will always have in mind while training you in conducting experiments,
analyzing the performance during laboratory work, and observing the outcomes to bring
out the truth from the experiment, and we measure these skills in the end semester
examination. You will be guided by well experienced faculty.
I invite you to join the CBCS in Semester System to gain rich knowledge leisurely at
your will and wish. Choose the right courses at right times so as to erect your flag of
success. We always encourage and enlighten to excel and empower. We are the cross
bearers to make you a torch bearer to have a bright future.
With best wishes from mind and heart,
DIRECTOR
(i)
B.Com. - General Commerce PAPER - I
FIRST YEAR - FIRST SEMESTER FINANCIAL ACCOUNTING
COURSE WRITER
Dr. R. Panchalan
Professor in Commerce
I.D.E., University of Madras, Chennai - 600 005.
(Units 1 & 2)
Dr. M. Premavathi
Reader
Department of Commerce Queen Mary’s College, Chennai - 600 005.
(Units 3 & 4)
Dr. V.K. Somasundaram

Head, P.G. Department of Corporate Secretaryship
Bharathidasan Govt. Arts College for Women, Pondicherry - 605 003.
(Units 5 & 6)
Dr. E. Sankaralingam
Department of Commerce
Govt. Arts College, Nandanam, Chennai - 600 035.
(Unit 7)
Ms. A. Dhanalakshmi
Department of Commerce
SDNB Vaishnav College for Women, Chrompet, Chennai - 600 044
(Unit 8 & 9)
COORDINATION & EDITING
Dr. R. Panchalan
Professor in Commerce
I.D.E., University of Madras,
Chennai - 600 005.
© UNIVERSITY OF MADRAS, CHENNAI 600 005.
(ii)
B.Com. - GENERAL COMMERCE DEGREE COURSE
FIRST YEAR
FIRST SEMESTER
Paper - I
SYLLABUS
UNIT I
Preparation of Final Accounts of a Sole Trading Concern – Adjustments – Closing
Stock, Outstanding and Prepaid items, Depreciation, Provision for Bad Debts, Provision
for Discount on Debtors, Interest on Capital and Drawings .
UNIT II
Preparation of Receipt and Payments Accounts – Income and Expenditure Account
and Balance Sheet of Non Trading Organizations.
UNIT III
Account Current – Average Due Date – Sale or Return Account.
UNIT IV
Depreciation – Meaning, Causes, Types – Straight-Line Method – Written Down
Value Method – Insurance Claims – Average Clause (Loss of Stock only).
UNIT V
Single Entry – Meaning, Features, Defects, Differences between Single Entry and
Double Entry System – Statement of Affairs Method – Conversion Method.
(iii)
REFERENCE BOOKS:
1. R.L. Gupta & V.K Gupta – Advanced Accounting
2. T.S. Reddy & A.Murthy – Financial Account
3. Shukla & Grewal – Advanced Accounting
4. Jain & Narang – Financial Accounting
5. P.C.Tulsian – Financial Accounting
6. S.Parthasarathy & A.Jaffarulla – Financial Accounting
7. R.L Gupta & Radhaswamy – Advanced Accounting – Volume I
B.Com., DEGREE COURSE
FIRST YEAR
FIRST SEMESTER
Paper - I
SCHEME OF LESSONS
Sl.No. Title Page
1. Accounting Framework 1
2. Accounting Process 22
3. Final Accounts 51
4. Income & Expenditure Account 93
5. Average due date and Account current 105
6. Sale or Return Account 123
7. Depreciation, Provision and Reserves 136
8. Insurance Claims 165
9. Single Entry System 206
(iv)
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UNIT 1
ACCOUNTING FRAMEWORK
Learning Objectives
After studying this unit, you should be in a position to :
 explain the meaning and scope of accounting

 appreciate the objectives of accounting
 distinguish between book-keeping and accounting
 explain the systems of book-keeping
 describe the advantages and limitations of accounting
 appreciate the significance of accounting concepts and conventions.
Structure
1.1 Introduction
1.2 Meaning and Scope of Accounting
1.3 Objectives of Accounting
1.4 Distinction between Book-Keeping and Accounting
1.5 Branches of Accounting
1.6 Systems of Book-keeping
1.7 Systems of Accounting
1.8 Advantages and Limitations of Accounting
1.9 Accounting Concepts and Conventions
1.9.1 Basic Assumptions
1.9.2 Basic Accounting Principles
1.9.3 Modifying Principles
1.10 Summary
1.11 Key Words
1.12 Review Questions
1.13 Answers to Check Your Progress
1.14 Suggested Readings
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1.1 Introduction
In the past accounting had been generally treated as a function of recording and maintaining
financial records. At present, a lot of changes have taken place in the accounting function. The
role of accountant has gradually changed from that of mere recorder of transactions to that of
the member providing relevant information to people who make rational investment, credit and
similar decisions. Accounting is now considered as an information system and forms an integral
past of management information system. As an information system, it identifies, measures and
communicates the economic information of an organisation to its users to enable them to make
better decisions. Accounting is highly useful for both profit – oriented business and non-profit
organisations such as hospitals, schools and colleges, churches/temples etc. Accounting is
based on certain concepts and conventions. In this unit, you can learn the meaning, scope,
objectives the accounting concepts and conventions and the difference between book-keeping
and accounting.
1.2 Meaning and Scope of Accounting

American Accounting Association (AAA) defined Accounting as “the process of identifying,
measuring and communicating economic information to permit informed judgements and
decisions by users of the information”. This definition highlights the latest developments that
have taken place in the field of accounting. At present, accounting is considered as the language
of the business. It communicates what is going on and how things are going on in the business.
The definition given by the American Institute of certified public Accountants (AICPA) is
more popular. It brings out the clear meaning and functions of accounting. According to it
accounting is “ the art of recording, classifying and summarising in a significant manner and in
terms of money, transactions and events which are, in part atleast, of a financial character and
interpreting the results there of”.
Accounting can, therefore, be defined as “the process of identifying, measuring, recording

and communicating the economic events and results thereof to the users of the accounting
information”.
The analysis of the above definition brings out the following characteristics of accounting:
(a) Economic events
(b) Identification, measurement, recording, classifying and communicating

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(c) Organisation
(d) Users of accounting information
A. Economic Events
An economic event can be defined as occurence of economic consequence of an activity

related to a business entity. Economic events can be grouped into external and internal events.
External event involves the transfer or exchange of value between two or more entities. [An
entity means an economic unit that performs economic activities. An internal event is an economic
event that occurs entirely within an entity. Payment of rent to the landlord is an example of
external economic event. Because it is a transaction between one business entity and a landlord.
Supply of raw materials from the stores department to the manufacturing department is an
example of internal event.
B. Identification, Measurement, Recording and Communication

(i) Identification: In accounting all transactions are not recorded in the accounting
books. therefore, at the out set, we have to identify the events which are to be
recorded. Accounting records transactions and events which are having some
financial character. For instance, the efficiency of the management is not recorded
in financial accounts. But purchase of goods for sale and purchase of assets for
business use are recorded. Because these transactions are having financial
character.
(ii) Measurement: Financial accounts record only those transactions which can be
measured (i.e. quantified) in terms of money. The transactions (whatever may be
their level of importance), which cannot be quantified are not recorded in the books
of accounts. For instance, appointment of highly renowned person as Managing
Director in a organisation add values to it and may bring a lot of benefits to the
business. But, it is not recorded in the accounting books reason that it cannot be
quantified in terms of money value.
(iii) Recording: Once the economic events are identified and measured in financial
terms, the next stage is recording the events. Economic events are recorded in a
chronological order and in a systematic manner. The “Journal” is used to record the
financial transactions.
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(iv) Classifying: After recording the financial transactions in the ‘Journal’, they are
classified. Classification involves systematic analysis and grouping transactions of
entries of one nature at one place. The process of classification is done in the book
called “Ledger”. For example, there may be separate account heads for Rent paid,
Advertisement, Printing and Stationery etc. Accounts prepared under ledger provide
complete picture of the dealings for which account is prepared.
(v) Communication: The very purpose of accounting is to communicate the operating

results and financial position of the business to end-users of accounting information.
Therefore, after classifying the transactions with the help of ledger, a summary
statement is prepared. This process involves preparation of Trial Balance, and
financial statements [Income statement and Balance sheet]. Trial Balance is prepared
to check the arithmatical accuracy of posting transactions from ‘Journal’ to the
‘Ledger’. Financial statements consist of Income statement and Balance sheet.
Income statement popularly known as Profit and Loss Account reveals the net results
of operations of business. That is, it shows whether a business earns profit or incurs
loss. Balance sheet is prepared to know the financial condition of the business.
Nowadays, the basic functions of accounting are done with help of electronic data
processing devices. The accountant has to mainly concertrate on the interpretation aspects of
accounting. In fact, one can derive some meaningful conclusion from the accounting records
by systematic analysis and interpretation of data. Interpretation can be done by applying various
techniques such as comparative financial statements, ratio analysis, funds flow and cash flow
analysis etc.
C. Organisation
It is an entity that performs some economic activities with a profit or non-profit motive.
The economic activities can be carried out by choosing appropriate form of organisation to suit
the level of business operations.
D. Interested Users of Information
The main aim of accounting is to provide information to various individuals, groups and
institutions which are interested in the operations of a business. The users can be grouped
internal users and external users of accounting. A brief details about each of these users are
given below.
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1. Internal Users
The management of a business is the internal user of accounting information. The

management can be classified as top level, middle level and lower-level management. Top
level management is concerned with policy formulation and strategic planning. The middle
level management is concerned equally with operational planning and controlling. And, the
lower level management is concerned with implementation, execution and controlling operations.
Each level of management requires accounting information in order to perform their functions
efficiently and effectively. Accounting, by providing the required information helps the organisation
to reach its overall goals. Information is supplied through financial statements, cash flow
information, various types of production reports, budgets, performance reports etc.
2. External Users
Present and potential investors, short-term and long-term creditors, employees, customers,
the authorities are the important external users of accounting. External users can be further
classified into two groups: (i) those having direct interest and (ii) those having indirect interest in
the business. Present and potential investors, short-term and long term creditors are having
direct interest in the business. Investors (both present and potential) take investment decisions
on the basis of accounting information. Short term creditors decide about the credit worthless
of the firm and make decisions about level of credit to be given to the firm and long term
creditors decide about the long-term solvency position of the business. Employees of the
organisation are also having direct interest in the affairs of the business.
Tax authorities, regulatory agencies (i.e Registrar of Companies, Ministry of Finance,

Ministry of Commerce, Securities and Exchange Board of India ) stock exchange, customers
are the important external users having indirect and non-financial interest in the affairs of business.
Figure 1.1 shows the internal and external users of accounting information. The main sources
of information for external users are annual, half-yarly and quarterly financial reports of business.
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Figure 1.1
1.3 Objectives of Accounting

The following are the main objectives of accounting :
1. To maintain accounting records : You know human memory has certain limit. Today’s
organisations are complex in nature. Therefore, it is impossible for a human mind to keep in
memory all business transactions. Accounting helps to keep a systematic record of financial
transactions. Written records become evidence in a court of law whenever any dispute arise.
2. To ascertain operating results of business : Income statement (also called Profit and
Loss Account) is prepared from the accounting records at the end of an accounting period.
Income statement shows the profit or loss of the business. A business earns profit when its
revenue exceeds its expenses. Similarly, a business incurs loss when its expenses exceed the
revenue.
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3. To ascertain the financial position of business : In addition to Income Statement a business

prepares Balance Sheet. Balance sheet (also called position statements) is a statement of
assets and liabilities of business on a particular date. It shows the financial position of business.
One can evaluate the financial strengths and weakness of a firm with the help of balance sheet.
4. To facilitate rational decision making : We have seen there are various parties interested
in the affairs of business. Accounting aims to provide the required information to these parties
at the right time to enable them to take rational investment, credit and other type of decisions.
5. To protect business properties: Accounting provides information about what is going on in

business, how are activities carried out, who is responsible for a particular activity, etc. Therefore,
unjustified and unwarranted use of resources can be stopped and effective utilisation of resources
can be ensured.
Check Your Progress - A
State whether each of the following statements is ‘True’ or ‘False’.
i) Accounting is the language of the business.
ii) Accounting is useful only to the profit oriented business.
iii) Accounting records only transactions which are of a financial character.
iv) Income statement shows the financial position of a business on a particular

date.
v) The main objective of accounting is to ascertain the profit/loss and financial

position of the business.
1.4 Distinction between Book Keeping and Accounting

The terms book-keeping and accounting are used interchangeably by layman, but they
are different from each other. Book-keeping is mainly concerned with :
(i) identifying the transactions and events to be recorded;
(ii) measuring them in terms of money;

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(iii) recording them in the books of prime entry; and
(iv) posting them into ledger.
This work is often routine and clerical nature. On the other hand, accounting is concerned
with summarising the recorded data, analysis and interpretation of data, communicating the
operating results and financial position of the business to the interested parties of accounting.
As book-keeping is the primary activities of accounting, it becomes a part of accounting process.
As the work of book-keeper is routine and clerical in nature, he does not require specialised
knowledge and skills, whereas an accountant requires specialised knowledge, conceptual
understanding and analytical skill. Nowadays, the accountant takes part in management activities
also. He is involved in planning and controlling of economic resources of an enterprise.
1.5. Branches of Accounting

The branches of accounting are briefly explained below:
(i) Financial Accounting
It is mainly concerned with ascertaining the operating results and financial position of the
business. Financial statements (i.e. Income Statements and Balance Sheet) are prepared for
this purpose. Financial accounting aims to provide the needed information to the interested
parties, namely, management, present and potential investors, creditors, banks and financial
institutions who lend long term loans, employees, tax authorities, government regulating bodies,
etc.
(ii) Cost Accounting
It deals with the ascertainment of cost of product or service. Cost accounting provides to
the management detailed records and reports on costs and expenses associated with the
operations, mainly for cost control and decision making.
(iii) Management Accounting
It provides the necessary accounting information to the management for planning and
controlling of business operations and for taking decisions. Unlike the financial accounting
where the primary emphasis is to provide information to outsiders, management accounting
focuses on providing information for internal planning and control activities.
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1.6. Systems of Book-keeping

Book-keeping as explained earlier is the art of recording business transactions in a regular
and systematic manner. The recording of transactions can be done in any one of the following
systems.
(i) Single Entry System
(ii) Double Entry System.
These two systems of book-keeping are explained briefly below.
(i) Single Entry System
It is the defective system of double entry. Kohler defines single entry system as “a system
of book-keeping in which as a rule only records of cash and personal accounts are maintained,
it is always incomplete double entry, varying with circumstances.” Under this system only essential
records are maintained. Therefore, this system is not reliable and can be adopted only by small
business firms.
(ii) Double Entry System
This system recognises that every transaction has two aspects, namely, (i) the receiving
aspect and ii) giving aspect. The benefit receiving aspect is generally debited and the benefit
giving aspect is generally credited. Thus, as per this system, for every debit there will be an
equivalent credit. As the double entry system maintains complete records, it becomes more
reliable and helps to know the exact profit or loss and financial conditions of the business.
1.7 Systems of Accounting

Basically, there are two systems of accounting: (i) Cash system of accounting; and (ii)
Mercantile or accrual system of accounting. A brief details about these two systems are given
below:
(i) Cash System of Accounting
In this system of accounting, entries are made only when cash is received or paid. No
entry is passed when a payment or receipt is merely due. Most of Government system of
accounting is based on this system. Some professionals and even cooperative societies and
departmental stores also follow this system.
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(ii) Mercantile or Accrual System of Accounting
Under this system, records are made on the basis of amounts having become due for
payment or receipt. This system is considered a better one, since it takes into account the
effects of all transactions already entered into. This system also helps to present a meaningful
picture of profit earned or loss suffered and also the financial conditions of the firm.
1.8 Advantages and Limitations of Accounting

The following are the important advantages of accounting:
(i) The books of accounts serve as historical records. One can get information easily
from the accounting records.
(ii) Accounting provides the details of assets and liabilities of business. This helps the
business to have control over the assets. And also it facilitates the effective utilisation
of resources.
(iii) The operating results and financial position of the business can be ascertained with
the help of financial accounting.
(iv) It helps to provide various information to the parties who have interest in the affairs
of the business.
(v) Financial accounting helps to compare the performance of one firm with another.
Even the performance of a firm itself can be compared over different periods.
(vi) It helps to ascertain the value of business in the event of sale of business firm.
(vii) Accounting records are generally treated as evidence by Court in case if disputes.
Limitations of Accounting
Financial accounting suffers from certain limitations. The important ones are given below:
(i) Financial accounting fails to provide a complete picture of business. Because in

accounting only the transactions which are having financial character are recorded.
The other transactions even though they are important (like efficiency and
commitment of workforce, effective top management, etc.) are not recorded.
(ii) The data recorded in accounting is historical in nature. It ignores price level changes.
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(iii) The accounting conventions and personal judgments of accountants greatly

influences in recording accounting information. Because of that, the financial
statements prepared from them fails to provide the true and fair view of business.
(iv) Financial accounting provides information about the overall profitability of the
business. We cannot know the cost and profitability of different activities of business
separately.
1.9 Accounting Principles - Concepts and Conventions

We have seen in the earlier section that various parties take decisions on the basis of
information provided in the accounting. Therefore, the accounting information must be relevant,
reliable and comparable. To make accounting information relevant, reliable and comparable,
accounting profession follows certain accounting principles. These principles are called
“Generally Accepted Accounting Principles (GAAP)”. GAAP provides a set of guidelines to be
observed by accounting profession for preparing and reporting the financial information. It
makes the accounting information more relevant, reliable and comparable. The concepts and
conventions of accounting principles can be categorized into: Basic assumptions, Basic
Accounting principles and modifying principles. One should be familiar with these principles
to use and interpret financial statements correctly. In this section, you can learn the accounting
principles.
1.9.1. Basic Assumptions
Basic accounting assumptions are considered as foundation pillars on which the structure
of accounting is based. The following are four basic assumptions:
(a) Accounting Entry;
(b) Money Measurement;
(c) Going Concern; and
(d) Accounting period.

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These are discussed below:
(a) Accounting Entry Assumption
According to this assumption, a business is considered a distinct entity from its owners.
This enables the accountant distinguish between the transactions of the business and those of
owners. When the owner brings cash to the business, it is treated as capital and shown in the
liability side of the balance sheet. Similarly, when a owner withdraws cash from the business,
it is treated as drawings and deducted from capital. Accounting entity concept helps to know
the exact operating results and financial position of the business. It is applicable to all forms of
business organisations. For instance, in the sole trading concern, the law does not make
distinction between proprietor and the business. But, in accounting, these two are treated as
separate entities.
(b) Money Measurement Assumption
According to this assumption, only the transactions which can be expressed in monetary
terms are recorded in the books of accounts. The transactions whatever may be their level of
importance, which cannot be expressed in monetary terms are not recorded and reported in
accounting. For example, the smooth employer and employee relationship, efficient
management, committed and competent employees are vital for the success of any organisation.
But these are not recorded in accounting, because these cannot be expressed in terms of
money.
Monetary unit is supposed to provide a common yardstick to measure the financial

transactions and events of business. This makes the accounting records clear, simple,
comparable and understandable. However, one of the important assumptions is, it ignores
price level changes.
(c) Going Concern Assumption
It is also called ‘continuity assumption’. According to this assumption, a business is normally

viewed as a going concern, i.e., continues operation for an indefinite period unless there is
evidence to the contrary. It is because of this assumption, assets are shown in the balance
sheet on their cost price and distinctions are made between fixed assets and current assets,
short term liabilities and long term liabilities and capital and revenue expenditure. The going
concern assumption becomes invalid when a business is expected to fail and/or be liquidated.
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(d) Accounting Period Assumption
We have seen in the previous paragraph that accountants assume business to be in

activities in the foreseeable future. Truly speaking one can know the results of operations of
business at the time of closing down the business. But, the users of accounting cannot wait for
such a long period. Hence, the accountants make use of assumption of accounting period.
According to this assumption, the life span of the business enterprise is artificially split into
different time periods known as accounting period (quarterly, half yearly, annually, etc.) for the
preparation of financial statements. Normally, it is the practice to prepare the income statement
for a period of one year. But, the accounting period may be more or less than one year.
While preparing financial statements a distinction is made between capital and revenue
expenditure. The portion of capital expenditure which is consumed during the current period is
charged as an expense to income statement and the unconsumed portion is taken balance
sheet and shown in the asset side. It is also called ‘periodicity assumption’ or ‘time period
assumption’.
1.9.2. Basic Accounting Principles
Basic accounting principles are essentially, the general decision rules which govern the
development of accounting techniques. These principles refine the application of assumptions
discussed in the previous section. The following are the basic accounting principles developed
on the basis accounting assumptions:
(a) Duality (Dual Aspect Principe)
(b) Revenue Recognition Principle
(c) Historical Cost Principle
(d) Matching Principle
(e) Full Disclosure Principle
(f) Objectivity Principle
These are discussed below:

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(a) Duality Principle
Duality principle is the very basis of double entry system of book-keeping. According to
this principle, every business transaction has a dual effect. For instance, when A starts a
business with Rs.50,000/- on the one hand the business receives cash (asset) Rs.50,000/-. On
the other hand, the business has to pay a sum of Rs.50,000/- to the owner which is taken as
owner’s capital and shown in the liability side of the balance sheet. This can be expressed in
the form of following equation:
Capital (Equities) = Cash (Assets)
Rs.50,000/- = Rs.50,000/-
The above example clearly illustrates that every financial transaction affects two accounts.
In the above example, the two accounts affected are:
(i) Capital Account and
(ii) Cash Account.
The accounting equation is given below:
Liabilities + Owner’s Equity = Asset
Every financial transaction will affect the accounting equation and there will be increase
or decrease in both sides of the equation or increase or decrease in one side of the equation.
You take the previous example. In that the business owner’s equity of Rs.50,000 and
Cash balance (Asset) of Rs.50,000. Assume the business purchases furniture worth Rs.5,000
for cash and machinery worth Rs.15,000 on credit. Now, the accounting equation will be:
15000 + 50000 = 45000 + 5000 + 15000
(Liabilities) (Owner’s Equity) (Cash) (Furniture) (Machinery)
The accounting equation denotes the relationship of equities to assets. The governing
principle here “for every debit there is an equal and corresponding credit.”
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(b) Revenue Recognition Principle
This is also known as ‘realisation principle’. It helps in determining the amount and time
of recognising the revenues from the business activities. Revenues are the gross inflows of
cash, receivable or other considerations in the course of an enterprise from the sale of goods or
providing service to the customers. The revenue is considered earned in the period in which
the sale has taken place or services have been performed to the satisfaction of the customer
and the revenue has been received or becomes receivable. When goods are sold, the date of
placing the order of the date of receiving cash are irrelevant for recognition of revenues. The
date of passing the title of goods is relevant here for revenue recognition. Revenue recognition
principle is vital for determining incomes relating to an accounting period. It avoids the possibility
of inflating incomes and profits. However, there are few exceptions to this principle. For instance,
in case of contract accounts, the revenues may be recognized on the basis of cash received on
partially completed and certified works. Here payments are made on the basis of terms of
contract, which specify partial payment in relation to the work certified and completed. Similarly,
in case of hire purchase the ownership of the goods passes to the buyer only when the last
instalment is paid, but sales are presumed to have been made to the extent of instalments
received and instalments outstanding.
(c) Historical Cost Principle
As per this principle, all transactions should be recorded at their acquisition cost. When
an asset is purchased in business, it is entered on the accounting records at the acquisition
cost and this cost is basis for all subsequent accounting for the asset and in the subsequent
accounting periods. For example, if a business buys a plant and machinery for Rs.90,000 and
spent Rs.10,000 to bring and install the plant at factory premises, the asset would be recorded
in the books at Rs.1,00,000.
The historical cost principle does not mean that the asset will be always shown at cost. It
means the asset is recorded at acquisition cost at the time of purchase but it may systematically
be reduced to its value by charging depreciation. The important advantage of this principle is
that it is objective, verifiable and reliable.
(d) Matching Principle
According to this principle, the expenses incurred in an accounting period should be

matched with the revenues generated in that period. This principle disregards the timing and
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the amount of actual cash inflow or cash outflow and concentrates on the occurrence of revenues
and expenses. This calls adjustments to be made in respect of prepaid expenses, outstanding
expenses, accrued revenue and unaccrued revenues. Further, the cost of fixed assets used in
the operations of the business, known as depreciation is treated as expense of the period. The
matching principle by relating expenses to the associated revenues helps in ascertaining the
exact profit for the given period.
(e) Full Disclosure Principle
Financial statements should convey the time and fair view of operations and financial
status of business. For this, the financial statement must disclose all relevant and reliable
information. Full disclosure principle emphasises this point. According to this principle, all
those facts that are necessary for discharging the accountability and proper understanding of
the financial statements must be revealed. Information may be given in the main body of the
financial statements, schedules and annexures and the footnotes appended thereto. Suppose,
if any, incident took place after the balance sheet dates and is likely to affect the financial status
of the business unit, that must be also given in notes to financial statements. Thus, full disclosure
principle enables the users of accounting to take rational decisions.
(f) Objectivity Principle
According to this principle, the accounting data should be verifiable and free from personal
bias of accountants. In other words, in accounting only the transactions which have verifiable
supportive evidence are recorded. In historical costing, the accounting data are verifiable and
free from personal bias of accountant, because the transactions are recorded on the basis of
original documents which contain supportive evidence. The objective principle facilitates auditing
of accounts and eliminates unauthorised entries in the books of accounts and ensures reliability.
1.9.3 Modifying Principles
Generally, the financial statements are prepared keeping in view the basic principles and
assumptions discussed above. But, certain difficulties arise in the application of these principles
in some situations, which call for the modified application of accounting principles. These
modifying principles are given below:
(a) Cost-Benefit Principle
(b) Materiality Principle

17
(c) Consistency Principle
(d) Conservatism Principle
(e) Timeliness Principle
(f) Industry Practice
(a) Cost-Benefit Principle
According to this principle, the cost of applying an accounting principle should not exceed
its benefits. If the cost is more than benefits, it is better to modify the principle.
(b) Materiality Principle
The term materiality refers to the relative importance of an item. According to the materiality
principle, the material items should be focussed and presented in financial statements and the
immaterial ones should be ignored. An item/event is considered to be material if it is likely
relevant and the knowledge of which might influence the decision of the users of accounting
information. For example, stationery items such as pens, stapler, scissors, calculators, etc. are
treated as expenses (not as assets) and shown under the head of stationery expenses even
though these items are carried out to next year. The simple reason is that the values of these
items are immaterial. However, it is to be noted here that the materiality depends not only upon
the amount of item but also upon the size of the firm, level and nature of person, level of person/
department who makes the judgment about materiality.
(c) Consistency Principle
There should be consistency in the accounting practices from one period to another. For
example, if the company follows written down value method for providing depreciation, it should
be followed consistently year after year. Consistency facilitates comparison of accounting data
from one period to another.
Consistency does not mean that there should not be any changes in the accounting
practices. A business enterprise is free to adopt the improved accounting standards. But,
whenever there is any change in the accounting policies, the change and the effects of that
change must be informed to the users of accounting.
18
(d) Conservatism Principle
The future is uncertain. A business has to take various measures in order to play a safe
role. “Anticipate no profit but provide for all possible losses” is the mantra of conservatism
principle. The valuation of stock-in-trade at a lower cost (i.e. cost price or market price whichever
is less), creating provisions for doubtful and bad debts, etc. are based on the principle of
conservatism. In the situation of uncertainty and doubt, the business transactions should be
recorded in such a manner that the profits are not overstated. If you observe closely, you can
understand that this principle is in conflict with the principle of full disclosure. Nowadays, the
conservatism principle is being replaced by the prudence principle which insists that the
conservatism principle should be applied only in circumstances in which great uncertainty and
doubt exists.
(e) Timeliness Principle
According to this principle, information should be made available to the users of accounting
in time. For instance, the quarterly reports should be made available at the end of the quarter.
There is no use of providing quarterly reports on half-yearly basis.
(f) Industry Practice
The peculiar characteristics of an industry may require departure from the accounting
principles discussed above. Valuation of gold on the basis of market price, valuation of crops in
the agricultural industry or market value rather than at costs are examples of industry practice.
Check Your Progress - B
State whether the following statements are true or false:
(i) Full disclosure requires disclosure of insignificant information.
(ii) Accounting entity is recognised by law.
(iii) Assets are always equal to liabilities plus capital.
(iv) Income is excess of revenue over cost.
(v) Cost and expenses are same.
(vi) Income statement reports income on historical cost basis.

19
1.10 Summary
Accounting is the process of identifying, measuring, recording and communicating the
economic events and results thereof to the users of accounting information. It is now a days
considered as an information system and forms an integral part of management information
system. Accounting provides valuable information to different users of accounting. They can
be grouped into internal users and external users of accounting.
Accounting is different from book-keeping. Book-keeping is mainly concerned with the

maintenance of the books of account. Accounting is concerned with summarising, analysis
and interpretation and communicating the results to the management and other users of
accounting. There are two systems of book-keeping, namely, single entry system and double
entry system of book-keeping. Single system is incomplete system of double entry and under
this system only important accounts are maintained. Double entry system of book-keeping is
the perfect system of accounting. This system recognises that every transaction has two aspects,
viz., the receiving aspect and giving aspect.
Accounting profession follows certain accounting principles in order to make the accounting
information more relevant, reliable and comparable. These principles are called “Generally
Accepted Accounting Principles (GAAP)”. The accounting principles can be categorized into:
(i) basic assumptions, (ii) principles and (iii) modifying principles. Accounting entity, money
measurement, going concern, and accounting period are the assumptions of accounting. Duality,
revenue recognition, historical cost, matching, full disclosure and objectivity are the basic
accounting principles. Cost-benefit, materiality, consistency, conservatism, timeliness and
industry practice are the modifying principles of accounting.
1.11 Key Words

Entity : An economic unit that carries out economic activities.
Event : An event is a happening of consequences to a

business entity.
Short-term solvency : Ability of a firm to repay its short-term liabilities.
Long-term solvency : Ability of a firm to repay its long-term liabilities with

interest when the due comes.
20
Income Statement : It reveals the profit or loss of the business for the
accounting period.
Balance Sheet : Statement of assets and liabilities. It reveals the

financial position of the business at the end of
accounting period.
Revenue : It refers the inflow of cash or other asset received in

exchange for goods sold or services rendered to
customers.
Expense : The cost incurred in the process of earning revenue.
Assets : Resources owned by an enterprise that can be

expressed in monetary terms. Assets can be
classified as current assets and fixed assets.
Liabilities : The financial obligations or debts that the enterprise

must pay at some time in the future. Liabilities may
be classified as current and long-term liabilities.

1. What do you understand by Accounting? Explain its scope.
2. What are the objectives of Accounting?
3. List the different parties interested in accounting information. How are the accounting
information useful to them?
4. Explain the basic assumptions and principles of accounting.
5. Write short notes on:
(a) Materiality Principle
(b) Consistency Principle
(c) Conservatism Principle

21

A. (i) True; (ii) False; (iii) True; (iv) False; (v) True.
B. (i) False; (ii) False; (iii) True; (iv) False; (v) False.
1.14 Suggested Readings

(1) Maheswari. S.N., Introduction to Accounting, Vikas Publishing House, New Delhi.
(2) Gupta. R.L. and M. Radhaswamy, Advanced Accountancy, Sultan Chand & Sons,
New Delhi.
(3) Tulsian. P.C., Financial Accounting, Tata McGraw-Hill Publishing Co. Ltd., New Delhi.
(4) Shukla M.C., Grewal T.S., and Gupta S.C. Advanced Accounts, Volume I, S. Chand
& Co. Ltd., New Delhi. 55.
22
UNIT 2
ACCOUNTING PROCESS
Learning Objectives
After studying this unit, you should be in a position to :
 explain the meaning and classification of accounts
 discuss the rules of debit and credit
 describe the meaning of journal and the procedures for journalising the transactions
 list out sub-division of journal
 prepare the different types of cash books
 appreciate the need for preparing trial balance.
Structure
2.1. Introduction
2.2. Meaning and Classification of Accounts.
2.3. Rules of Debit and Credit
2.4. Journal
2.5. Ledger
2.6. Sub-division of the Journal
2.7. Cash Book
2.8. Trial Balance
2.9 Summary
2.10 Key Words

23
2.1 Introduction
In the previous unit, you have learn that the main purpose of accounting is to ascertain
the operating results and financial position of the business and communicating them to various
parties who have interest in the affairs of business. For this purpose, a business has to record
all its transactions systematically. In accounting, all transactions which are having some financial
nature or the transactions which can be measured in terms of money are recorded. Journal is
used to record the transactions. As the journal fails to reveal the net effect of transactions, a
Ledger Account is prepared. Ledger shows the net effect of transactions and also facilitates
the preparation of financial statements (i.e. Income Statement and Balance Sheet). Before
preparing the financial statements, Trial Balance is prepared. Trial Balance helps to check the
arithmetical accuracy of posting of transactions from Journal to the Ledger. In this unit, you can
learn in detail about the procedures for recording the transactions in the Journal, posting the
transactions from Journal to the Ledger and preparation of Trial Balance. You can also learn
about various types of cash books.
2.2 Meaning and Classification of Accounts
An account is a summarised records of all transactions relating to a particular person,

thing, an item of income or expense. It is prepared under a particular head. The left hand side
of the account is called ‘debit side’ and the right hand side is called ‘credit side’. Debit side is
indicated by ‘Dr.’ (abbreviation of Debit) and credit side is indicated by ‘Cr.’ (abbreviation of
Credit).
Accounts can be classified on the basis of:
(A) Traditional Approach, and
(B) Accounting Equation Approach.

24
A. Traditional Approach
According to traditional approach, accounts can be classified as (i) Personal Accounts,

(ii) Real Accounts and (iii) Nominal Accounts.
(i) Personal Accounts: These accounts relate to natural persons (examples: Raman’s
A/c, Suresh A/c, Kannan’s A/c, etc.), artificial persons (examples: Raman & Co’s A/
c, Suresh & Co’s A/c, etc.) and representative persons (examples: Outstanding
Expenses A/c and Accrued or Prepaid Incomes Accounts).
(ii) Real Accounts : These accounts relate to assets of the firm. Assets include both
tangible and intangible. Land, Machinery and Building are some examples of tangible
assets, Goodwill and Patent are examples for intangible assets.
(iii) Nominal Accounts : These accounts relate to expenses, losses, incomes and
gains. Salaries Account, Loss by Fire Account, Interest Received Account are some
examples of nominal accounts. Real and nominal accounts are called impersonal
accounts.
B. Accounting Equation Approach
According to accounting equation approach, accounts can be classified as:
(i) Assets Accounts
(ii) Liabilities Accounts
(iii) Capital Accounts
(iv) Revenue Accounts
(v) Expenses Accounts
A brief details about each of these accounts are given below:
(i) Assets Accounts: These accounts relate to tangible or intangible real assets.
(ii) Liabilities Accounts: These accounts relate to the financial obligations of an

enterprise towards outsiders.
(iii) Capital Accounts: These accounts relate to owners of an organisation.
(iv) Revenue Accounts: These accounts relate to the amount charged for the goods
sold or services rendered, or permitting others to use an organisation’s resources
yielding interest, royalty and dividend.
25
(v) Expenses Accounts: These accounts relate to the amount incurred or lost in the
process of earning revenue.
The classification of accounts is given in Figure 2.1
Accounts
On the basis of On the basis of

Traditional Classification Accounting Equation
Personal Impersonal Assets Liabilities Capital

Accounts Accounts Accounts Accounts Accounts
Revenue Expenses
Accounts Accounts
Real Accounts Nominal Accounts
Figure 2.1 Classification of Accounts
2.3 Rules of Debit and Credit

You have learnt the classification of accounts. In this section, you can learn the rules of
debit and credit. The Rules for Debit and Credit are given below:
(i) Rules for Debit and Credit
when the accounts are classified as Personal, Real and Nominal.

26
Types of Accounts Rules for Debit Rules for Credit
(a) Personal Accounts Debit the receiver Credit the giver
(b) Real Accounts Debit what comes in Credit what goes out
(c) Nominal Accounts Debit all expenses and Credit all gains and
losses profits
when the accounts are classified on the basis of Accounting Equation.
Types of Accounts Rules for Debit Rules for Credit
(a) Assets Accounts Debit the increase Credit the decrease
(b) Liabilities Accounts Debit the decrease Credit the increase
(c) Capital Accounts Debit the decrease Credit the increase
(d) Revenue Accounts Debit the decrease Credit the increase
(e) Expenses Accounts Debit the increase Credit the decrease
2.4 Journal
A Journal is a book in which all day to day transactions are recorded in the order in which
they occur (chronological order). It is also called a ‘Day Book’. All transactions are recorded
first in this book. Therefore, this book us also called ‘book of original entry’. The process of
recording a transaction in the Journal is called journalising. And, the entries made in the Journal
are called Journal entries. From the journal, postings are done to various accounts that took
place. The rules for journalising are given in the previous section. You should be familiar with
the rules at the time of journalising the transactions. The proforma of Journal is given in Figure
2.2.
27
Date Particulars L.F. Dr. Cr.

Rs. Rs.
Figure 2.2 Proforma of Journal

(a) Date Column: The date on which the transaction is entered is recorded in this
column. The year is written at the top of the column and in the next line the month
and date are written.
(b) Particulars Column: In this column, the name(s) of the account(s) to be debited
and the name(s) of the account(s) to be credited are entered. After this, a brief
explanation of the transaction (called narration) are given.
(c) L.F. (Ledger Folio) Column: In this column, the ledger page number containing
the relevant account is entered at the time of posting.
(d) Debit Amount Column: In this column, the amount to be debited is entered.
(e) Credit Amount Column: In this column, the amount to be credited is entered.
Now, let us discuss the important points relating to the journalising of transactions.
2.4.1 Meaning of Journalising
The process of recording a transaction in the journal is called journalising. The following
tips will help you to record the transactions correctly.
(i) Ascertain what accounts are involved in a transaction.
(ii) Ascertain what is the nature of the accounts involved.
(iii) Identify which rule of debit and credit is applicable for each of the accounts involved.
(iv) Note down which account is to be debited and which account is to be credited.
(v) The name of the account to be debited should be written close to the left hand side
along with the abbreviation ‘Dr’ in the ‘Particulars Column.’
28
(vi) The name of the account to be credited should be written in the next line preceded
by the word ‘To’ at a few spaces towards right in the ‘Particulars Column.’
(vii) Don’t forget to write narrations after writing the names of the accounts to be debited
and credited. The narration should be written in the next line in the ‘Particulars
Column.’
You can understand these points with the help of some examples.
Example 1
Paid cash to Kumar & Co. Rs.20,000.
In this case the two accounts involved are (i) Kumar and Co’s Account and (ii) Cash
Account. Kumar & Co.’s Account is a personal account and cash is a real account. Kumar &
Co. has received the benefit (Cash Rs.20,000) from business, therefore, it has to be debited as
per the first part of the rule for personal account ‘debit the receiver’. As cash has gone out from
the business, as per the second part of the rule of real account ‘credit what goes out’, the cash
account should be credited.
Example 2
Received Rs.1,000 as commission.
In this case, the two accounts involved are (i) Cash Account and (ii) Commission Account.
Cash is a real account. As cash comes in to the business as per the first part for rule of real
account ‘debit what comes in’, Cash Account should be debited. Commission Account is a
nominal account. Therefore, the rule of nominal account applies to this. As Commission received
is an income to the business, the second part of the rule for nominal accounts, ‘credit incomes
and gains’ applies to this. Therefore, income received should be credited.
Example 3
Paid Rs.10,000 for advertisement expenses.
In this case, the accounts affected are Cash Account and Advertisement Account.
Advertisement Account is a nominal account and cash is a real account. As per the first part of
the rule for nominal account ‘debit expenses and losses’, Advertisement Account will have to be
debited as it is expense to the business. Cash Account will have to be credited as per the
second part of the rule for real account.
29
2.4.2 Transactions Relating to Goods
The term goods refers to articles which are traded by a firm i.e. articles produced for sale
or articles bought for resale. For example, for stationery store stationery items such as pens,
pencils, note books are goods, for electrical stores, electronic items are goods, for a furniture
dealer, furniture items such as table, chair are goods. Articles bought for use in business are
treated as assets not as goods.
The transactions relating to goods include purchases, sales, purchase returns (return
outwards), sales returns (return inwards). As per the rule of accounting, for all transactions
relating to goods, we have to maintain only one account viz., Goods Account. But, in practice,
we are maintaining five separate accounts. These accounts are given below:
(i) Purchases Account
(ii) Sales Account
(iii) Returns Outwards Account or Purchase Returns Account
(iv) Returns Inwards Account or Sales Returns Account
(v) Stock Account
When goods are purchased, Purchases Account is debited. When goods are sold, Sales
Account is credited. Similarly, when goods are returned by our customers, Returns Inwards
(Sales Return Account) Account is debited and when we return goods to our suppliers we credit
Return Outwards (Purchase Returns Account). You have to note that there will be no Goods
Account at all. Maintaining Purchases Account, Sales Account, Purchase Returns Account and
Sales Returns Account will help to know the exact amount of goods purchased and sold and
also we can know the goods unsold (stock in trade).
2.4.3 Compound Journal Entry
When two or more transactions of the same nature takes place on the same day, instead
of passing several journal entries, we may pass single journal entry, such single journal entry is
termed as ‘compound journal entry’. You can understand better about compound journal entry
with the help of an example.
30
Example 4
Goods were sold on credit to Arun for Rs.5,000 and to Prakash for Rs.10,000 on 15 th
September 2005. Both of these transactions took place on the same day (i.e. on 15th September
2005) and are of the same nature (i.e. on credit). We can pass a compound journal entry for
recording both the transaction as follows:
Rs. Rs.
Arun’s Account Dr. 5,000

Prakash’s Account Dr. 10,000
To Sales Account 15,000
(Being goods sold on credit)
We can pass compound journal entry for passing a transaction which involves more than
two accounts. For instance, we paid cash to Kannan Rs.1,900 and he allowed us discount
Rs.100. This transaction involves Kannan’s Acount, Cash Account and Discount Received
Account. We can pass the following compound journal entry to record the above transaction.
Rs. Rs.
Kannan’s Account Dr. 2,000
To Cash Account 1,900
To Discount Received Account 100
(Being cash paid to Kannan and
discount received from him)
2.4.4 Transactions Relating to Cash Discount
In the above example, you might have observed that discount received is credited in the
account. Yes. Cash discount is entered in the books of accounts. Cash discount means a
reduction in the net amount due when a customer makes payment before due date cash discount
is allowed to him. It is a loss to the business, therefore, it should be debited. Similarly, when we
pay our supplier before the due date, the supplier allows discount to us. It is an income to the
business, therefore, it should be credited.
On the contru Entry, trade discount is not entered in the book. Trade discount means a
reduction in selling price allowed at the time of sale. The buyer pays only the net price (after
trade discount) and only the net amount is entered in the books of accounts. The amount of
31
trade discount is deducted from the invoice, whereas cash discounted is not deducted from the
invoice.
2.4.5 Opening Entry
A journal entry by means of which the previous year’s balances of various assets, liabilities
and capital are brought forward in the books of current accounting period is known as ‘Opening
Entry’. While passing an opening entry, all assets accounts are debited and all liabilities (including
the proprietor’s capital account) are credited.
Illustration 2.1
Journalise the following transactions:
2005
April 2 Started business with Rs.1,00,000 paid into Bank Rs.50,000.
3 Bought furniture for cash Rs.5,000
5 Bought goods for Rs.30,000
6 Sold goods for cash Rs.6,000
10 Bought typewriters for Rs.18,000 from the Remington Rand Inc. on credit
13 Sold goods to M/s Anand & Sons for Rs.10,000 on credit.
15 Bought goods from M/s Mahindra & Co. for Rs.20,000 on credit.
18 Paid telephone rent Rs.2,400 for one year.
22 Paid Rs.1,000 for advertisement
26 Sold goods to M/s S. Lall & Co. for Rs.8,000 for cash.
30 Paid salaries Rs.2,000
30 Paid rent Rs.1,000
30 Withdrew from bank Rs.3,000 for private use
30 Bought one delivery van for Rs.3,00,000 from the Delhi Motor Co. Payment
to be made by monthly instalments of Rs.20,000 each together with interest
at 18%. First instalment paid by cheque.
32
Solution
Journal

Rs. Rs.
2005
April 2 Cash Account Dr. 1,00,000
To Capital Account 1,00,000
(Cash brought into start
business)
2 Bank Account Dr. 50,000

(Cash deposited with Bank)
3 Furniture Account Dr. 5,000
(Furniture bought for cash)
5 Purchase Account Dr. 30,000
(Goods bought for cash)
6 Cash Account Dr. 6,000
(Goods sold for cash)
10 Typewriters Account Dr. 18,000
To Remington Rand Account 18,000
(Typewriters bought on credit)
15 Purchase Account Dr. 20,000

To M/s Mohindra & Co. Account 20,000
(Goods bought on credit as
per bill no… . dated . . . .)
18 Telephone Charges Account Dr. 2,400

(Charges in respect of
telephone paid in
advance for one year)
33
2005 13 M/s Anand & Sons Dr. 10,000

April To Sales Account 10,000
(Sale of goods on credit to
M/s Anand & Sons as per
invoice on . . . . )
22 Advertisement Account Dr. 1,000

(Amount paid for advertisement)
26 Cash Account Dr. 8,000

(Goods sold for cash)
30 Salaries Account Dr. 2,000

Rent Account Dr. 1,000
(Salaries and rent for the
month of April Paid in Cash)
30 Capital Account (or

Drawing A/c) Dr. 3,000
To Bank Account 3,000
(Amount withdrawn from bank
for private use)
30 Delhi Motor Co. Account Dr. 20,000

To Bank Account 20,000
(Amount paid to Delhi Motor
Co. through Cheque no. . . . .
dated . . . . . in pursuance
of agreement)
Total 5,76,400 5,76,400

34

1. What is Journal?
2. Distinguish between trade discount and cash discount.
3. Choose the correct answer by putting a tick at the number
(a) Sale of goods to Kumar should be debited to
(i) Kumar’s Account
(ii)Cash Account
(iii) Sales Account
(b) Goods returned by Ramesh should be credited to
(i) Goods Account
(ii) Ramesh’s Account
(iii) Return’s Inwards Account
(c) Wages paid to Ashok should be debited to
(i) Ashok’s Account
(ii)Cash Account
(iii) Wages Account
(d) Cash discount allowed by a creditor should be credited to
(i) Discount allowed account

35
(ii) Discount received account
(iii) Creditors account
(e) Purchase of building should be debited to
(i) Building’s Account
(ii)Purchase’s Account
(iii) Goods Account.
2.5 Ledger
After recording the transactions and events in the Journal, the next step is posting i.e.
transferring the transactions recorded in the Journal in the respective accounts opened in the
Ledger. A Ledger is the ‘principle book of entry’ which provides complete information about
various transactions relating to all parties and all items of asset, incomes and expenses. Ledger
is also called the ‘book of final entry’. Ledger provides complete information about all accounts
in one book and facilitates the preparation of final accounts. The format of a ledger account is
given in Figure 2.3.
Name of the Account
Dr. Cr.
Date Particulars Folio Amount Date Particulars Folio Amount

Rs. Rs.
Figure 2.3 Ledger

36
2.5.1 Posting into Ledger
The process of transferring the transactions recorded in the books of original entry in the
concerned accounts opened in the ledger is called posting. The following procedures are
followed while posting into ledger.
(i) Each journal entry has to be posted into all those accounts which have been debited
and credited in the journal entry.
(ii) Posting is made on the debit side of the account which has been debited in the
journal and the credit side of the account which has been credited in the journal.
(iii) The date of transaction is entered in the date column.
(iv) The page number of the Journal is recorded in the Folio column.
(v) The name of the account which had been credited in the journal is entered on the
debit side of an account in the particulars column with the word ‘To’ before the
name. And the name of the account which had been debited in the journal is entered
on the credit side of an account in the particulars column with the word ‘By’ before
the name.
(vi) The amount involved in the journal entry is entered in the amount columns of both
the accounts.
You can understand the procedures discussed above with the help of an example. Consider
the following journal entry.

Rs. Rs.
2005
Sep 20 Purchases a/c Dr. 10,000
To Bank a/c 10,000
(Being goods purchased)
The above journal entry when posted to the ledger accounts would appear as follows:
37
Purchase Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
Rs. Rs.
2005 To Bank 10,000 2005 By Balance c/d 10,000

Sep 20 Sep 30
10,000 10,000
Oct 1 To Balance b/d 10,000
You can notice that the purchases a/c has a debit balance
Bank Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
Rs. Rs.
2005 To Balance c/d 10,000 2005 By Purchases 10,000

Sep 30 Sep 20
10,000 10,000
Oct 1 By Balance b/d 10,000
2.5.2 Balancing Ledger Accounts
The process of ascertaining the difference between the total of debit amount column and
the total of credit amount column of a ledger account is called balancing. Balancing helps to
find out the net effect of all the transactions posted to an account. Generally, personal accounts
and real accounts are balanced. Nominal accounts are normally not balanced but closed by
transferring to Trading and Profit and Loss Account.
38
Illustration 2.2
Prepare Ledger Accounts for the following transactions in the Books of Imran:
2005 1 Commenced business with Cash 45,000 Rs.
June 1 Paid into bank 25,000
2 Goods purchased for cash 15,000
3 Purchase of furniture and payment by cheque 5,000
5 Sold goods for cash 8,500
8 Sold goods to Arvind Walia 4,000
10 Goods purchased from Amrit Lal 7,000
12 Goods returned to Amrit Lal 1,000
15 Goods returned by Arvind Walia 200
18 Cash received from Arvind Walia Rs. 3,760

and discount allowed to him Rs. 40
21 Withdrew from bank for private use 1,000
Withdrew from bank for use in the business 5,000
25 Paid telephone rent for one year 400
28 Cash paid to Amrit Lal in full settlement of his account 5,940
30 Paid for: Stationary Rs. 200
Rent Rs. 1,000
Salaries to staff Rs. 2,500

39
Solution
Cash Account
Dr. Cr.
Date Particulars L.F. Amount Date Particulars L.F. Amount
Rs. Rs.
June 1 To Capital a/c 45,000 June 1 By Bank a/c 25,000
June 5 To Sales a/c 8,500 June 2 By Purchases a/c 15,000
June 18 To Arvind Walio 3,760 June25 By Telephone
June 21 To Bank a/c 5,000 Rent a/c 400
June26 By Amrit Lal a/c 5,940
June30 By Stationery a/c 200
June30 By Rent a/c 1,000
June30 By Salaries a/c 2,500
June30 By Balance c/d 12,220
62,260 62,260
July 1 To Balance b/d 12,220
Capital Account
Dr. Cr.
Rs. Rs.
June 30 To Balance c/d 45,000 June 1 By Cash a/c 45,000
45,000 45,000
45,000 July 1 By Balance b/d 45,000
Bank Account
Dr. Cr.
Rs. Rs.
June 1 To Cash a/c 25,000 June 3 By Furniture a/c 5,000
June21 By Drawings a/c 1,000
June21 By Cash a/c 5,000
June30 By Balance c/d 14,000
25,000 25,000
40
Furniture Account
Dr. Cr.
Rs. Rs.
June 3 To Bank a/c 5,000 June30 By Balance c/d 5,000
5,000 5,000
Purchase Account
Dr. Cr.
Rs. Rs.
June 3 To Cash a/c 15,000 June 30 By Balance c/d 22,000
June10 To Amrit Lal 7,000
22,000 22,000
Sales Account
Dr. Cr.
Rs. Rs.
June30 To Balance c/d 12,500 June 5 By Cash a/c 8,500
June 8 By Arvind Walice 4,000
12,500 12,500
July 1 By Balance b/d 12,500
Arwind Walia Account

Dr. Cr.
Rs. Rs.
June 8 To Sales June15 By Returns Inwards 200
Account 4,000 June18 By Cash a/c 3,760
June18 By Discount a/c 40
4,000 4,000
41
Amrit Lal Account

Dr. Cr.
Rs. Rs.
June12 To Return Outwards 1,000 June10 By Purchases a/c 7,000
June28 To Cash a/c 5,940
June28 To Discount a/c 60
7,000 7,000
Returns Inwards Account
Dr. Cr.
Rs. Rs.
June15 To Arvind Walia 200 June30 By Balance c/d 200
200 200
July 1 To Balance c/d 200
Returns Outwards Account
Dr. Cr.
Rs. Rs.
July 1 To Balance b/d 1,000 June12 By Amrit Lal 1,000
1,000 1,000
Discount Account
Dr. Cr.
Rs. Rs.
June18 To Arvind Walia 40 June30 By Amrit Lal 60
June30 To Balance c/d 20
60 60
July 1 By Balance b/d 20
Drawings Account
Dr. Cr.
Rs. Rs.
June 21 To Bank a/c 1,000 June30 By Balance c/d 1,000
1,000 1,000
42
Telephone Rent Account

Dr. Cr.
Rs. Rs.
June 25 To Cash a/c 400 June30 By Balance c/d 400
400 400
July 1 To Balance b/d 400
Stationery Account
Dr. Cr.
Rs. Rs.
June 30 To Cash a/c 200 June30 By Balance c/d 200
200 200
July 1 To Balance b/d 200
Rent Account
Dr. Cr.
Rs. Rs.
June 30 To Cash a/c 1,000 June30 By Balance c/d 1,000
1,000 1,000
Salaries Account
Dr. Cr.
Rs. Rs.
June 30 To Cash a/c 2,500 June30 By Balance c/d 2,500
2,500 2,500
43
2.6 Sub-division of the Journal

When number of transactions are large, it is practically impossible to record all the
transactions through one journal. Therefore, generally firms maintain subsidiary books to record
transactions. Subsidiary books are also known as special journals or day books. The following
subsidiary books are generally used:
(i) Cash Book – It is used to record cash and bank transactions.
(ii) Petty Cash Book – It is used to record cash payments involving small amounts.
(iii) Sales Book – It is used to record credit sales.
(iv) Purchases Book – It is used to record credit purchases.
(v) Purchase Returns Book – It is used to record returns to suppliers.
(vi) Sales Returns Book – It is used to record returns from customers.
(vii) Bills Receivable Book – It is used to record acceptances received.
(viii) Bills Payable Book – It is used to record acceptances given.
(ix) Journal Proper – It is used to record transactions which cannot be entered in any of
the above specialised journals.
You can learn in detail the Cash Book.
2.7. Cash Book

All the transactions relating to cash receipts and cash payments are recorded in the Cash
Book. All cash receipts are recorded in the debit side and all payments are recorded in the
credit side of cash book. Cash book is a book of prime entry as well a ledger account.
Types of Cash Book
There are three types of Cash Book. These are:
(i) Single Column Cash Book
(ii) Two or Double Column Cash Book
(iii) Three or Triple Column Cash Book

44
2.7.1 Single Column Cash Book
This book is nothing but a cash account. It has one amount column on each side. All
cash receipts are recorded on the debit side and all cash payments are recorded on the credit
side. The format is given in Figure 2.4.
Single Column Cash Book

Dr. Cr.
Date Particulars LF Amount Date Particulars LF Amount

Rs. Rs.
Illustration 2.3
Enter the following transactions in Single Column Cash Book.
2005 Rs.
June 1 Cash in Hand 1,700
5 Paid to Murugan 300
Discount allowed by him 10
8 Purchased goods from Gopal & Co. for cash 400
10 Received from Ganesh 980
Discount allowed 20
16 Sold goods to Raj & Co. for cash 400
21 Paid to Aravind 295
Discount received 5
45
25 Paid wages 50
31 Paid to X & Co. in full settlement of his account which

shows a credit balance of Rs.400 390
31 Purchased furniture 200

(See solution at Page No. 42)
2.7.2 Two Column Cash Book
In this two-column cash book, two amount columns (one for cash and another for discount)
are maintained on each side. On the debit side all cash receipts and discount allowed to
debtors are recorded and on the credit side all cash payments and discount received from
creditors are recorded. The format of two-column cash book is given in Figure 2.5.
Cash Book with Discount Column

Dr. Cr.
Date Particulars L.F. Discount Cash Date Particulars L.F. Discount Cash
Rs. Rs. Rs. Rs.
Figure 2.5
46
Solution
Single Column Cash Book
Dr. Cr.
Date Particulars LF Amount Date Particulars LF Amount
2005 Rs. 2005 Rs.
Jan 1 To Balance b/d 1,700 Jan 5 By Murugan 300
Jan 10 To Ganesh 980 Jan 8 By Purchases 400
Jan 15 To Sales a/c 400 Jan 21 By Aravind 295
Jan 25 By Wages a/c 50
Jan 31 By X & Co. 390
By Furniture 200
By Balance c/d 1,445
3,080 3,080
To Balance b/d 1,445

47
Illustration 2.4
Record the following transactions of Sundar in Double Column Cash Book, with cash and
discount columns.
2005 Rs.
May 1 Cash Balance 30,000
2 Cash received on sale of furniture 3,000
4 Paid into Bank 2,000
5 Paid to Arul 1,000

Discount allowed by him 50
8 Paid salaries 800
10 Received from Mohan 3,000

Discount allowed to him 75
12 Goods sold for cash 4,000
14 Cash withdrawn for personal purpose 300
16 Received from Sathyamoorthy 10,000
Allowed to him discount 300
19 Paid to John 5,000

Discount received from him 50
20 Drew cheque for office use 200
28 Office rent paid 100

(See Solution at Page No. 44)
2.7.3 Three Column Cash Book
The cash book containing a bank column in addition to cash and discount columns can
be called three-column cash book. All cash receipts, deposits into bank and discount allowed
to debtors are recorded on the debit side. All cash payments, withdrawals from the bank and
discount received from creditors are recorded on the credit side. A three-column cash book
serves the purpose of Cash Account and Bank Account. Hence, there will be no need to open
these two accounts in the ledger.
48
Solution
Dr. Cash Book of Mr. Sundar (Double Column) Cr.
Date Particulars Discount Cash Date Particulars Discount Cash

Rs. Rs. Rs. Rs.
1.5.2005 To Balance b/d 30,000 4.5.2005 By Bank 2,000
2.5.2005 To Furniture 3,000 5.4.2005 By Arul 50 1,000
10.5.2005 To Mohan 75 3,000 8.5.2005 By Salaries 800
12.5.2005 To Sales 4,000 14.5.2005 By Drawings 300
16.5.2005 To Sathyamoorthy 300 10,000 19.5.2005 By John 50 5,000
20.5.2005 To Bank 200 28.5.2005 By Rent 100
31.5.2005 By Balance c/d 41,000
375 50,200 100 50,200
1.6.2005 To Balance b/d 41,000
Note: RN – Receipt No. VN – Voucher No. LF – Ledger No.

49
The format of three-column cash book is given in Figure 2.6.

Three Column Cash Book
Dr. Cr.
Date Particulars LF Discount Cash Bank Date Particulars LF Discount Cash Bank
Rs. Rs. Rs. Rs. Rs. Rs.
Figure 2.6
Illustration 2.5
Record the following transactions in the three column cash book of Vinod for the
month of June 2005.
2005 Rs.
June 1 Cash Balance 15,000
Bank Balance 30,000
4 Goods purchased for cash 5,000
5 Paid wages by cheque 3,000
6 Sold goods for cash 10,000
8 Received cheque from Anitha for Rs.9,900 in full settlement of
Rs.10,000 and deposited it in Bank
10 Paid Balu Rs.475 and was allowed discount Rs.25
15 Received Commission from Revathi 800
17 Paid Travelling expenses to Chitra 300
18 Deposited into Bank 10,000
20 Purchased goods by cheque 4,000
25 Sold goods to Dhanalakshmi on Credit 7,000
26 Received cash from Ray 5,000
Discount allowed to Ray 25
27 Received cheque from Dhanalakshmi 6,900 in full settlement
which is put into Bank
28 Withdrawn from Bank for office use 4,000
30 Purchased furniture by cheque 1,000
29 Withdrawn from Bank for personal use 200
30 Ramesh directly paid into Bank 1,000
30 Dhanalakshmi’s cheque dishonoured
50
Solution
Dr. Cash Book of Mr. Sundar (Three Column) Cr.
Date Particulars Discount Cash Bank Date Particulars Discount Cash Bank
1.6.2005 To Balance b/d 15,000 30,000 4.6.2005 By Purchases 5,000
6.6.2005 To Sales 10,000 5.6.2005 By Wages 3,000
8.6.2005 To Anitha a/c 100 9,900 10.6.2005 By Balu’s A/c 25 475
15.6.2005 To Commission 800 17.6.2005 By Travelling
18.6.2005 To Cash (c) 10,000 Expenses 300
26.6.2005 To Ray’s a/c 25 5,000 18.6.2005 By Bank (c) 10,000
27.6.2005 To DhanaLakshmi’s a/c 100 6,900 20.6.2005 By Purchases 4,000
28.6.2005 To Bank (c) 4,000 28.6.2005 By Cash (c) 4,000
30.6.2005 To Ramesh 1,000 29.6.2005 By Furniture 1,000
30.6.2005 By Drawings 200
30.6.2005 By DhanaLakshmi’s a/c 6,900
By Balance c/d 19.025 38,700
225 34,800 57,800 25 34,800 57,800
1.7.2005 To Balance b/d 19,025 38,700

51

1. State whether each of the following statements is True or False.
(i) Ledger is also called the book of final entry.
(ii) The process of recording transactions and events in the Journal is called
posting.
(iii) Balancing helps to ascertain the net effect of all transactions posted to an
account.
(iv) Writing narration is not necessary while posting into ledger accounts.
(v) Posting will be made on the credit side of the account that has been debited
in the Journal.
2. Choose the correct answer.
(i) Cash book records
(a) all receipts and payments
(b)all receipts only
(c) all payments only
(ii) The book which is used to record cash payments involving small amounts is
(a) Cash book
(b)Petty Cash Book
(c) Journal proper
(iii) Purchases journal is kept to record
(a) all purchases of goods
(b)all credit purchases of goods
(c) all credit purchases
(iv) Sales journal is kept to record
(a) all sale of goods
(b)all credit sales
(c) all credit sale of goods

52
(v) Journal proper is used for recording
(a) all credit purchases of fixed assets only
(b)returns of goods
(c) all such transactions for which no special journal has been kept
by the business.
2.8 Trial Balance

After posting the journal entries into the ledger and balancing all accounts, the next step
is preparing a Trial Balance. Trial balance is a statement in which debit and credit balances of
all the accounts in the ledger are shown. It aims to test the arithmetical accuracy of the books
of accounts.
Under the double entry system for every debit there is an equal and corresponding credit.
So, the total of debit balances in different accounts must be equal to the total of credit balances
and vice versa.
Trial balance tallies if both the aspects of each transaction are recorded correctly in the
ledger. However, the tally of trial balance does not mean that there is no error at all in the
preparation of ledger accounts. For example, complete omission of transactions, error of principle
wouldn’t affect the tally of trial balance. You can learn in detail about the errors which affect the
trial balance and errors which do not affect the trial balance in the later part of this study material.
There are two methods of preparing trial balance (i) Total method and (ii) Balance method.
Under the total method, the total of debits and credits of all accounts are shown in the trial
balance respectively in the debit and credit side of the trial balance. Under the balance method,
only balance of each account of ledger is shown in trial balance. This method is more popular
and widely used. Trial balance contains all the personal, real and nominal accounts. It helps in
the preparation of final accounts.
53
Illustration 2.6
Prepare Trial Balance on the basis of information given in illustration 2.2

Trial Balance
(As on 30th June 2005)
Particulars Debit Credit

Amount Amount
Rs. Rs.
Cash Account 12,220
Capital Account 45,000
Bank Account 14,000
Furniture Account 5,000
Purchases Account 22,000
Sales Account 12,500
Returns Inwards Account 200
Returns Outwards Account 1,000
Discount Account 20
Drawings Account 1,000
Telephone Account 400
Stationery Account 200
Rent Account 1,000
Salaries Account 2,500
Total 58,520 58,520
2.9 Summary
An account is a summarised record of all transactions relating to a particular person,
thing, an item of income or expense. It is prepared under a particular head. Accounts can be
classified on the basis of traditional approach and accounting equation approach. On the basis
of traditional approach, accounts can be classified as Personal Accounts, Real Accounts and
Nominal Accounts. On the basis of accounting equation, accounts can be classified as Assets
Accounts, Liabilities Accounts, Capital Accounts, Revenue Accounts and Expenses Accounts.
54
Journal is used to record the transactions of the business. After recording the transactions
in the journal, postings are done to the respective accounts opened in the Ledger. Ledger
provides complete information about all accounts in one book and facilitates the preparation of
final accounts. After this, Trial Balance is prepared to check the arithmetical accuracy of postings
to ledger accounts.
Cash Book, Petty Cash Book, Sales Book, Purchases Book, Purchases Returns Book,
Sales Returns Book, Bills Receivables Book, Bills Payables Book and Journal Proper are the
subsidiary books generally used in business. Cash Book can be classified as (i) Single Column
Cash Book, Two (Double) Column Cash Book and Three Column Cash Book. In single column
cash book, only cash account is prepared. In double column cash book, two columns, one for
cash and another for discount are opened. In three column cash book, three columns one for
cash, one for bank and one for discount are maintained.
2.10 Key Words

Journalising : The process of recording the transactions and events
in the Journal.
Posting : Transfer of transactions recorded in the Journal to

the Ledger.
Cash Discount : An allowance given by the creditor to the debtor for

making payment before the due date.
Trade Discount : An allowance given by the seller to the buyer on the

list price at the time of sale in order to motivate him
to buy at bulk.
Opening Entry : A journal entry passed at the beginning of an

accounting period to bring previous year’s balance
of assets, liabilities and capital.
Compound Entry : A journal entry involving more than two accounts.
Subsidiary Book : A special journal used for recording a particular

category of transactions such as purchases, sales,
etc.
55
Balancing : The process of ascertaining the difference between

the total of debit amount column and the total of credit
amount column of a ledger account.
Trial Balance : A statement showing the balances of each and every

account to verify whether the sum of the debit
balances is equal to the sum of credit balances.
2.11 Review Questions / Exercises

1. Explain the different rules for journalising the transactions with appropriate
illustrations.
2. Explain the procedures regarding posting of transactions in the ledger.
3. What is Trial Balance? Explain the objectives.
4. What do you mean by sub-division of Journal?
5. Enter the following transactions in a two column Cash Book and post it into the
ledger.
2005 Rs. 2005 Rs.

July July
1 Commenced business 16 Paid into Bank 10,000

with cash 50,000 18 Cash Sales 2,500
2 Bought goods for cash 28,000 20 Purchsed Stationery for

5 Received cash from him 2,000 Cash 250
7 Paid cash to Sanjay 2,900 23 Paid Suresh cash 3,900

Discount allowed by him 100 Discount allowed 100
10 Paid Wages 3,000 26 Received from Rajesh 1,900
14 Received from rajesh cash 950 Allowed him discount 100

Allowed him discount 50 30 Paid Salaries 2,000
Ans. (Dr. Balance Rs. 7,300 ; Discount - Dr. Rs. 150 and Cr. Rs. 200)
56
6. Record the following transactions in the Three Columnar Cash Book
Jan 1 Balance: Cash Rs. 500, and Bank (Cr.) Rs. 12,000.
“ 2 Invested additional capital of Rs. 12,000
“ 5 Deposited Rs. 8,000 in the bank
“ 8 Received from Roy Rs. 890, allowed him discount Rs. 5.
“ 12 Paid Rs. 1,200 top Ghose who allowed us discount of Rs. 30.
“ 15 Bought merchandise for cash Rs. 700.
“ 17 Sold merchandise for cash Rs. 1,000
“ 18 Purchased furniture by cheque Rs. 1,500
“ 19 Received a crossed cheque of Rs. 230 from Sundaram in full settlement of
the debt of Rs. 240.
“ 22 Paid commission Rs., 150 by cheque.
“ 25 Withdrew for personal use Rs. 300.
“ 26 Paid commission Rs. 150 by cheque
“ 27 Withdrew for personal use Rs. 300.
“ 29 Received dividend by an order cheque Rs. 30, deposited in the bank on the
same day.
“ 30 Cleared telephone bill Rs. 50.
“ Paid manager’s salary Rs. 350, rent Rs. 200, and wages Rs. 150.
Ans (Dr. Balance Cash : 3140 Bank : 18460 Discover Dr: 15 Cr : 30

A. 3 (a) ii, (b) ii, (c) iii, (d) ii, (e) i
B. 1 (i) True, (ii) False, (iii) True, (iv) True, (v) False.
2 (i) a, (ii) b, (iii) b, (iv) c, (v) c.

57
UNIT 3
FINAL ACCOUNTS
Learning Objectives
After going through this unit, you should be able to:
 explain the significance of preparing final accounts
 enumerate the items in respect of which adjustments are usualy made in the books of
account
 pass the required entries for various adjustments
 prepare the final accounts with adjustments.
Structure
3.1 Introduction
3.2 Adjustments
3.3 Preparation of Final Accounts
3.3.1 Trading Account
3.3.2 Profit and Loss Account
3.3.3 Balance Sheet
3.4 Illustrations
3.5 Summary
3.6 Key Words

58
3.1 Introduction
In the previous unit, you have learn the various process of accounting. You know the very
purpose of accounting is to ascertain whether a business earns profit or incurs loss and to
assess the financial conditions of the business. For this purpose, every businessman prepares
the Income statement (popularly known as Profit and Loss Account) and Balance Sheet. Final
Accounts are prepared from the statement of Trial Balance. In this unit, you can learn how to
pass adjustment entries and how to prepare final accounts.
3.2 Adjustments
Generally we assume that all expenses and incomes shown in the Trial Balance relate to
the current period. In practice, so many expenses and incomes relating to that period may not
be fully disbursed or received. Such transactions are adjusted before the books of accounts
are closed and the Final Accounts are prepared. In order to make suitable adjustments,
adjustment entries are passed. that the necessary adjustments are brought into books by
means of adjustment entries before the accounts are closed and Final Account are prepared.
Usually adjustments are required for the following items:
1. Closing Stock
2. Outstanding Expenses
3. Prepaid Expenses
4. Outstanding Income
5. Income Received in Advance
6. Depreciation
7. Bad Debts
8. Provision for Doubtful Debts
9. Provision for Discount on Debtors
10. Provision for Discount on Creditors
11. Interest on Capital
12. Interest on Drawings

59
We have seen how these adjustments are important to arrive at an accurate figure of the
actual profit or loss made during any particular period.
Closing Stock
It refers to the value of lying in stock in the business at the end of accounting period.
Stock should be valued at cost price or market price is lower.
The adjustment entry is :
Closing Stock A/c Dr.

To Trading A/c
Example
Trial Balance
As on December 18, 2004
Particulars Dr. Cr.

Rs. Rs.
Opening Stock (1.1.2004) 15,000
Adjustment: The Closing Stock was valued on 31.12.2004.
Solution
Rs. Rs.
Closing Stock A/c Dr. 22,000

To Trading A/c 22,000
(Being the Closing Stock brought into A/c)
Trading A/c
For the period ended 31.12.2004
Dr. Cr.
Particulars Rs. Particulars Rs.
To Opening Stock (1) 15,000 By Closing Stock (2) 22,000
60
Balance Sheet
Liabilities Rs. Assets Rs.
Closing Stock (3) 22,000
2. Outstanding Expenses
Expenses which have been incurred but not yet paid in an accounting period for which
final accounts are prepared are called outstanding expenses. Adjusting the outstanding expenses
helps to ascertain the exact profit for the accounting period.
The adjustment entry is :

Expenses A/c Dr. xxx
To Expenses Outstanding A/c xxx
Example
Trial Balance
Dr. Cr.
Particulars Rs. Rs.
Salary 1,000
Adjustment: Unpaid Salary Rs.300
Solution
Particulars Rs. Rs.
Salary A/c Dr. 300

To Outstanding Expenses A/c 300
(Being the outstanding salary adjusted)
Profit and Loss A/c

For the year ended December 31, 2004
Dr. Cr.
Particulars Rs. Rs. Particulars Rs. Rs.
Salary 1,000
Add: Outstanding 300 1,300
61
Balance Sheet
As at 31st December, 2004
Outstanding Liabilities 300
3. Prepaid Expenses
Expenses which have been paid in advance but relating to the future accounting period
are called as prepaid expenses. These expenses are also called as unexpired expenses.
The adjustment entry is:

Prepaid Expenses A/c Dr xxx
To Expenses A/c xxx
Trial Balance
As on 31st December, 2004
Particulars Dr. Cr.

Rs. Rs.
Telephone Rent 1,080
Adjustment: Annual Telephone Rent Rs.1,080 paid upto 31.03.2005.
Solution
Particulars Rs. Rs.
Prepaid Expenses A/c Dr. 270
To Telephone Rent A/c 270

(Being the prepaid telephone rent adjusted)
Profit and Loss A/c

For the year ended 31st December, 2004
Dr. Cr.
Telephone Rent 1,080
Less : Prepaid 270 810
62
Balance Sheet
Prepaid expenses 270
4. Outstanding Income
The income which has been earned but not received during the accounting period is
called outstanding income. It is also called as accrued income The adjustment entry is:
Accrued Income A/c Dr xxx
To Income A/c xxx
Trial Balance
as on 31st December, 2004
Particulars Dr. Cr.

Rs. Rs.
Interest on Investment 450
Adjustment: Interest @ 6% on Government Bonds of Rs.15,000/- for the last quarter was not
received.
Solution
Particulars Rs. Rs.
Outstanding Income Dr. 225

To Interest A/c 225
(Being the interest on Bonds for the last quarter adjusted)
Profit and Loss A/c

for the year ended 31st December, 2004
Dr. Cr.
By Interest Received 450
Add: Outstanding 225 675
63
Balance Sheet
Accured Income 225
Interest = Rs.15,000 x 6/10 x 3/12 = Rs.225.
5. Income Received in Advance

Income received during a particular period for the work to be done in future (period) is
called income received in advance. The adjustment entry is:
Income A/c Dr xxx
To Income received in advance A/c xxx
Trial Balance
Particulars Dr. Cr.

Rs. Rs.
Apprenticeship Premium Received

1,600
Adjustment: Apprenticeship Premium of Rs.1,200 was received on 7.1.2004.
Solution
Particulars Rs. Rs.
Apprenticeship Premium A/c Dr. 1,200

To Income received in advance A/c 1,200
(Being the premium received in advance adjusted)
64
Profit and Loss A/c

Dr. Cr.
Apprenticeship Premium 1,600
Less: Received in
Advance 1,200 400
Balance Sheet
Income received
in advance 1,200
6. Depreciation
A permanent decrease or reduction in the value of fixed asset can be called as depreciation.
Depreciation is a loss to the business. The adjustment entry is:
Depreciation A/c Dr xxx

To asset A/c xxx
Example
Trial Balance
Particulars Dr. Cr.
Rs. Rs.
Machinery A/c 12,000
Adjustment: Depreciate Machinery by 10% per annum.

Solution
Particulars Rs. Rs.
Depreciation A/c Dr. 1,200

To Machinery A/c 1,200
(Being the depreciation provided for)
65
Profit and Loss Account

Dr. Cr.
To Depreciation on
Machinery at 10% 1,200
Balance Sheet
Liabilities Assets
Rs. Rs. Rs Rs.
Machinery 12,000
Less: Depreciation 10% 1,200 10,800
10
Depreciation = Rs.12,000 x  Rs.1,200
100

Fill in the blanks
(i) Closing stock is valued at cost price or ..................... price whichever is lower.
(ii) Outstanding expenses are shown on the ................ side of the Balance sheet.
(iii) Prepaid expenses are shown on the ....................... side of the Balance sheet.
(iv) Income accrued but not received will be shown on the ................................ side
of the Balance sheet.
(v) Income received in advance will be shown on the ...................... side of the
Balance sheet.
(vi) Depreciation is provided on ........................ assets only.
7. Bad Debts
The debts which cannot be collected from debtors are called bad debts. Bad debts are
loss to the business. Therefore, they are debited into the profit and loss A/c and also deducted
from debtors in the balance sheet. the entry in the books of Debtors is
66
Bad debts A/c Dr. xxx
To Debtors A/c xxx
Trial Balance
Particulars Dr. Cr.

Rs. Rs.
Sundry Debtors 9,000
Bad Debts 1,100
Adjustment: Write off Rs.900 as Bad Debt.
Solution
Rs. Rs.
Bad Debts A/c Dr. 900
To Sundry Debtors A/c 900
(Being the amount written off as
bad and irrecoverable)
Profit and Loss A/c
Liabilities Rs. Rs. Assets Rs Rs.
To Bad Debts 1,100 Machinery 12,000

Add: Bad Debts
Written Off 900 2,000
2,000
67
Balance Sheet

Less: Bad Debts
Written Off 900 8,100
8. Provision for Doubt ful and Bad Debts

You have learnt that bad debts are loss to the business. In order to meet the bad debts
losses, a business should take some precautionary steps. Creating provision for bad debts and
doubtful debts is a precautionary measure. Generally is provided at certain percentage experience
adjustment entry is:
Profit and loss A/c Dr. xxx
To Provision for doubtful debts A/c xxx
It is deducted from existing debtors on assets side of Balance sheet.
Trial Balance
Particulars Dr. Cr.

Rs. Rs.
Book Debts 25,000
Adjustment: Create a provision for Doubtful Debts @ 15% on Book Debts.
Solution
Rs. Rs.
Profit & Loss A/c Dr. 3,750

To Provision for Doubtful Debts A/c 3,750
(Being the provision for Doubtful Debts created)
68
Profit & Loss A/c

Dr. Cr.
To Provision for
Doubtful Debts 3,750
Balance Sheet As at 31st December, 2004
Liabilities Assets
Rs. Rs. Rs Rs.
Book Debts 25,000

Less: Provision for
Doubtful Debts @ 15% 3,750 21,250
21,250
9. Provision for Discount on Debtors
A business provides cash discount to debtors to motivate them to make promt payment.
It is calculated at a certain percentage on good debtors. It is shown as a deduction from good
debtors on the asset side side of balance sheet and is debited to profit and loss accout. The
Adjustment entry is
Profit and loss A/c Dr. xxx
To Provision for discount on debtors A/c xxx
Trial Balance
Particulars Dr. Cr.
Rs. Rs.
Adjustment: Create a Reserve for Discount on Debtors @ 2%.

69
Solution
Rs. Rs.
Profit and Loss A/c Dr. 360
To Reserve for Discount on Debtors A/c 360

(Being the provision for Discount on Debtors created)
Profit and Loss A/c

Dr. Cr.
To Reserve for
Discount on Debtors 360
Balance Sheet

Less: Reserve for
Discount on Debtors
@ 2% 360 17,640
10. Provision for Discount on Creditors

A firm may except to receive cash discount from creditors for prompt payment. On the
basis of its expectations and past experience, it may create provision for discount on creditors.
It is calculated at a certain percentage on sundry creditors. The adjustment entry is:
Provision for distcout on creditors A/c Dr xxx
To profit and loss A/c xxx
It is shown as deduction from sundry creditors on the liability side of balance sheet and is
credited to Profit and Loss Account.
70
Example
Trial Balance
Particulars Dr. Cr.
Rs. Rs.
Trade Creditors 6,000
Adjustment: Create a Reserve for Discount on Creditors @ 1%.

Solution
Dr. Cr.
Reserve for Discount on Creditors A/c Dr. 60
To profit & Loss A/c 60
(Being the provision for discount on creditors created)
Profit and Loss A/c

For the year ended 31st December, 2004.
Dr. Cr.
Particulars Rs . Particulars Rs.
By Reserve for Discount
on Creditors 60
(Rs.6,000 x 1%)
Balance Sheet
Liabilities Assets
Rs. Rs. Rs Rs.
Creditors 6,000 Trade Creditors 6,000

Less :Reserve for
Discount on Creditors 60 5,940
71
11. Interest on Capital

A business may charge interest on capital at certain rate in order to ascertain its real profit
ability. Interest on capital is shown on the debited side of profit and loss account and is added to
the capital on the ability side of balance sheet. the adjustment entry is:
Interest on capital A/c Dr. xxx

To capital A/c xxx
Example
Trial Balance
As on 31st December 2004
Particulars Dr. Cr.

Rs. Rs.
Capital 1,00,000
Adjustment: Allow interest on capital at 5% per annum.
Solution
Rs. Rs.
Interest on Capital A/c Dr. 5,000
To Capital A/c 5,000
(Being the interest allowed on capital)
Profit and Loss A/c
For the year ended 31st December, 2004.
Dr. Cr.
Particulars Rs. Rs.
To Interest on capital 5,000
(Rs.1,00,000 x 5%)
Balance Sheet
Liabilities Assets
Rs. Rs. Rs Rs.
Capital 1,00,000
Add:Interest on
Capital 5,000 1,05,000
72
12. Interest on Drawings

When proprietor withdraws money from business for personal use, it is called as drawings.
A business may charge interest on drawings at a certain rate. It is and income to the business.
Therefore, it should be shown on the credited side of profit and loss account. And in the liabilities
side of balance sheet, it should be deducted from the capital account.
The adjustment entry is:

Capital A/c Dr xxx
To interest on drawings A/c xxx
Example
Trial Balance
Dr. Cr.
Particulars Rs. Rs.
Drawings and Capital 15,000 60,000
Adjustment: Charge Interest on Drawings at 5% per annum for six months.
Solution
Rs. Rs.
Drawings A/c Dr. 375
To Interest on Drawings 375
Profit and Loss A/c
Dr. Cr.
By Interest on Drawings 375
(Rs.15,000 x 5/100
x 6/12)
Balance Sheet
Liabilities Assets
Rs. Rs. Rs Rs.
Capital 60,000
Less: Drawings 15,000
45,000
Less: Interest on
Drawings (5%) 375 44,625
73
Example
Trial Balance of Sekar

Particulars Dr. Cr.

Rs. Rs.
Bad Debts 500
Reserve for Bad & Doubtful Debts (1.1.2004) 700
Adjustment: Provide provision for Doubtful Debts at 10% on Debtors. Create a Reserves for
Discount at 2% on Sundry Debtors.
Solution
Rs. Rs.
31.12.04 Profit & Loss A/c Dr. 1,500
To Reserve for Doubtful Debts A/c 1,500
(Being the provision for doubtful debts adjusted)
31.12.04 Profit & Loss A/c Dr. 270

(Being the provision for discount on debtors created)
Sekar’s Profit & Loss A/c

Dr. Cr.
To Reserve for
Doubtful Debts:
Bad Debts 500
Add: New Reserve 1,500
2,000
Less:Old Reserve 700 1,300
To Reserve for
Discount on
Debtors 270
Less:Old Reserve — 270
74
Balance Sheet of Mr. Sekar

Liabilities Rs. Assets Rs Rs.
Less: Reserve for

Doubtful Debts
@ 10% 1,500
13,500
Less: Reserve for

Discount on
Debtors @ 2% 270 13,230
 Bad Debts and Reserve for Bad Debts appears in the Trial Balance. Reserve for Doubtful
Debts shown in the Trial Balance is treated as Old.
New Reserve = Rs.15,000 x 10/100 = Rs.1,500
Bad Debts + New Reserve – Old Reserve
Rs.500 + Rs.1,500 – Rs.700 = Rs.1,300
 Provision for Doubtful Debts Rs.1,300 is debited in the P&L A/c. The new reserve for
Doubtful Debts Rs.1,500 shown in the Balance Sheet, assets side, which is deducted
from Sundry Debtors.
 Reserve for Discount on Debtors is calculated below:
Sundry Debtors – New Reserve for Doubtful Debts
Rs.15,000 – Rs.1,500 = Rs.13,500
Rs.13,500 x 2/100 = Rs.270
 Reserve for Discount on Debtors is calculated on the Sundry Debtor’s balance which we
get after deducting provision for Doubtful Debts from the Sundry Debtors.
 Reserve for Discount on Debtors is debited in the P & L A/c and subtracted from Sundry
Debtors.
75
Example
Trial Balance of Senthil
As at 31st December, 2004.
Solution
Particulars Dr. Cr.
Rs. Rs.
Bad Debts 200
Reserve for Doubtful Debts (1.1.04) 1,350
Reserve for Discount on Debtors (1.1.04) 275
Adjustment: Maintain the Reserve for Discount on Debtors @ 2% on Sundry Debtors.

Maintain the Provision for Doubtful Debts @ 10% on Sundry Debtors.
Solution
Rs. Rs.
Reserve for Doubtful Debts A/c Dr. 250
To Profit & Loss A/c 250
(being the excess reserve transferred
to Profit & Loss A/c)
Profit & Loss A/c Dr. 23

(being the excess Discount on Debtors
transferred to Profit & Loss A/c)
Profit and Loss A/c of Senthil

Dr. Cr.
To Bad Debts 200
(+) Reserve for doubtful
Debts 1400
(-) Old Reserve for 1600
doubtful debts 1350 250
76
Balance Sheet of Senthil

As at 31st December 2004

Rs.
Less Reserve for
Doubtful Debts
at 10% 1,400
12,600
Less Reserve for
Discount on
Debtors at 2% 252 12,348
 Reserve for Discount on Debtors should be calculated on the balance we get after deducting
Reserve for Doubtful Debts from the Debtors.
Sundry Debtors Rs.14,000

Less: Reserve for Doubtful Debts at 10% 1,400
12,600
Less: Reserve for Discount on Debtors 2% 252
12,348
 Calculation of new Reserve for Doubtful Debts:-
New Reserve (Rs.14,000 x 10/100) 1,400

Bad Debts + New Reserve – Old Reserve
Rs.200 + Rs.1,400 – Rs.1,350 250 (excess)
Usual entry should be reversed.
 Required new Reserve for Discount on Debtors
New Reserve = Rs.12,600 x 2/100 = 250
New Reserve – Old Reserve
Rs.252 – Rs.275 = Rs.23 (more reserve)
 Excess Reserve for Doubtful Debts Rs.250, Excess Reserve for Discount on Debtors
Rs.23 should be credited in P & L A/c.
New Reserve for Doubtful Debts, New Reserve for Discount on Debtors should be deducted
from the Debtors on the Balance Sheet.
77
3.3 Preparation of Final Accounts

The business transactions are first recorded in the Journal and then in the concerned
ledger accounts. The Trial Balance is extracted from the balances of ledger accounts to test
the arithmetical accuracy of Books of Accounts. If there are any errors in the books of accounts,
they need proper rectification. The primary aim of Book Keeping is to enable the businessman
to know clearly whether the business is progressing and to know the exact financial position of
the business. As such the businessman is interested in finding out two important facts.
(i) The profit earned or loss incurred by him during a given period.
(ii) The financial position of the business based on assets and liabilities on a given date.
To find out profit or loss, he prepared an account known as
“Trading & Profit and Loss A/c”.
To find out the exact financial position of the business, he prepares a statement known as
Balance Sheet.
The preparation of Trading, Profit and Loss A/c and Balance Sheet is known as the
“Preparation of Final Accounts”. In this section, you can learn how to prepare final accounts.
Method of Preparation
Based on the Trial Balance final accounts are prepared. The Trial Balance contains both
debit and credit balances of all ledger accounts.Look at figure 3.1 that explains you, which are
to items are taken to trading and proit and loss A/c and which are the items are taken to Balance
sheet.
Trial Balance
Debit Balance Credit Balances
Expenses Loss Assets Income Gains Liabilities
Trading, Balance Trading, Balance

Profit & Sheet Profit & Loss Sheet
Loss A/c A/c
Figure 3.1 Method of preparation

78
 Debit Balances of Trial Balance

The Debit Balances of Trial Balance denote assets or expenses or losses.
Expenses and Losses are transferred to Trading, P & L A/c.
Assets are transferred to Assets side of Balance Sheet.
 Credit Balances of Trial Balance
The Credit Balances of Trial Balance denote liabilities or incomes or gains.
Incomes, Gains are transferred to Trading, P & L A/c.
Liabilities are transferred to Liabilities side of Balance Sheet.
Profit & Loss Account

Profit and Losses are recorded in Profit & Loss A/c.
3.3.1 Trading Account

This account is constructed to find out the profitability of trading transactions of a business.
The difference between the selling price and the cost price of the goods is the gross earning of
the businessman. Such gross earning is known as “Gross Profit”. When the cost of buying
goods is more than the selling price, there is a gross loss.
To find out the gross profit, a Trading A/c is opened and all accounts relating to goods,
such as opening stock, purchases, purchase returns, sales and sales returns are transferred to
it.
Specimen
Trading A/c
For the year ended ..........
Dr. Cr.
To Opening Stock xxx By Sales xxx
To Purchases xxx Less: Sales Returns xx xxx
Less: Purchase
Returns xx xxx
To Manufacturing
Expenses xx By Closing Stock xx
To Expenses on
Purchases xx
To Gross Profit c/d xxx
(transferred to
Profit & Loss A/c)
xxxx xxxx
79
Advantages of Preparing a Trading Account

(i) It shows the Gross Profit or Gross Loss made after buying and selling of Goods.
(ii) It helps us in finding the ratio of Gross Profit to the turnover so that the selling price can be
fixed.
(iii) It helps us to find out the ratio of gross profit to the direct expenses so that unnecessary
expenses can be avoided.
(iv) It helps us to compare purchases, sales, returns, etc. of the current year with those of the
previous year.
3.3.2 Profit and Loss Account

You have learnt that Gross Profit or Gross Loss is found out by preparing a Trading
A/c. The Profit and Loss A/c is opened by the transfer of either the Gross Profit to its Credit side
or Gross Loss to its Debit side. The Profit and Loss A/c reveals the Net Profit or Net Loss during
the trading period.
We find a number of accounts showing expenses, losses, incomes and gains in a Trial
Balance. The manufacturing expenses, the expenses relating to purchases and bringing
expenses are all already transferred to Trading A/c. The remaining accounts showing expenses
and losses are transferred to debit side P & L A/c. The incomes and gains are transferred to
credit side of the P & L A/c.
When all expenses, losses, incomes and gains have been transferred to P & L A/c, this
accounts shows Net Profit or Net Loss. The Net Profit or Net Loss is transferred to Capital A/c.
Specimen
Profit & Loss A/c
For the year ended ..........
Dr. Cr.
To Indirect expenses xx By Gross Profit b/d xxx

(brought from
Trading A/c)
To Losses xx By Other Incomes xx
To Net Profit xxx By Gains x
(transferred to
Capital A/c)
xxxx xxxx
80
3.3.3 Balance Sheet

A Simple statement is drawn up at the end of each trading period with various assets and
liabilities. Such statement is called ‘Balance Sheet’. It is a statement of all those debit and
credit balances existing in the ledger after the preparation of Trading and Profit and Loss A/c.
Thus, Balance Sheet means a statement containing assets and liabilities and items which are
neither assets nor liabilities.
Advantage of Preparing Balance Sheet

It gives us information about
(i) The nature and value of assets,
(ii) The nature and extent of liabilities,

(iii) The businessman is solvent,
(iv) The soundness of business.
A Balance Sheet is divided into two sides:
(i) The left hand side is Liability Side
(ii) The right hand side is Assets side.
Specimen
Balance Sheet
As on ..........

Rs
The Balance Sheet is prepared at a specified date. It is true only on that date. It would
not have been true on the previous day or next day. This is due to the fact that even a single
transaction will change assets and liabilities. For example, on 1.1.2004 when we pay off our
creditors, the cash balance will reduce. Similarly, if we sell goods on 1.1.2004 for cash, this will
increase the cash balance and reduce the stock of goods.
The two sides of the Balance Sheet must agree, otherwise, there is definitely something
wrong.
81
Fill in the blanks
(i) Debts which are not able to recover from sundry debtors are termed as
................
(ii) Bad debts is a ........................... to the business.
(iii) Provision for bad and doubtful debts is deducted from ...................... in the
Balance sheet.
(iv) Provision for discount on creditors is deducted from ........................ in the

balance sheet.
(v) Interest on capital is .................... to the business.
(vi) Interest on drawings is shown on the ........................ side of profit and loss
Account.
3.4 Illustrations
For your better understanding we have given some Illustrations. In this section you go
through all the illustrations, that will help you to learn how to prepare final account. Let us take
the first illustration.
Illustration 1
The following is the Trial Balance of Mr. Prakash:-
Trial Balance
Debit Balances Rs. Credit Balances Rs.
Salary, Wages 5,000 Capital 2,25,000
Purchases 2,10,000 Discount Received 1,300
Sales 3,10,000
Dress and Clearing charges 8,000 Purchase Returns 5,000
Creditors 17,000
Legal and Accounts Exp. 3,000 Bank Over Draft 5,000
Sales Returns 11,000 Bills Payable 2,000
Cash at Hand 11,000 Loan 12,500
Opening Stock (1.1.2004) 16,000 Income from Investments 1,700
Advertisement 2,000
Land & Building 1,80,000
82
Plant & Machinery 60,000

Investments 6,000
Drawings 5,500
Debtors 50,000
Bills Receivable 12,000
5,79,500 5,79,500
Adjustment: Closing Stock (31.12.2004) Rs.40,000.

Prepare Final Account.
Solution
Adjustment Entry
Rs. Rs.
Closing Stock A/c Dr. 40,000
(Being the Closing Stock brought into account)
Prakash Trading, Profit and Loss Account

For the year ending 31st December, 2004
Dr. Cr.
To Opening Stock 16,000 By Sales 3,10,000

To Purchases 2,10,000 Less: Sales Returns 11,000 2,99,000
Less: Purchase
Returns 5,000 2,05,000
To Duty and By Closing Stock 40,000

Clearing Charges 8,000
To Gross Profit c/d 1,10,000
(transferred to
Profit & Loss
Account)
3,39,000 3,39,000
83
To Salary, Wages 5,000 By Gross Profit b/d 1,10,000

(transferred from
Trading A/c)
To Legal & By Discount Received 1,300
Accounts By Income from
Expenses 3,000 Investments 1,700
To Advertisement 2,000
To Net Profit
(transferred to
Capital A/c) 1,03,000
1,13,000 1,13,000
Balance Sheet of
Mr. Prakash
Liabilities Rs. Rs. Assets Rs.

Sundry Creditors 17,000 Cash at hand 11,000
Bills Payable 2,000 Investments 6,000
Bank Over Draft 5,000 Bills Receivable 12,000
Loan 12,500 Sundry Debtors 50,000
Capital 2,25,000 Closing Stock 40,000
Add: Net Profit 1,03,000 Land & Building 1,80,000
3,28,000
Plant & Machineries 60,000
Less: Drawings 5,500 3,22,500
3,59,000 3,59,000
84
Illustration 2
From the following Trial Balance and adjustments of Pandiarajan, prepare his Final
Accounts.
Particulars Dr. Cr.
Rs. Rs.
Stock (1.1.2004) 23,000
Cash at hand 1,850
Bank overdraft 9,500
Plant & Machinery 18,500
Sundry Creditors 11,750
Trade Expenses 375
Sales 1,35,000
Salary 2,250
Carriage outwards 350
Rent 950
Bills Payable 8,700
Purchases 1,19,670
Insurance 1,400
Business Premises 35,500
Commission 600
Capital 72,795
Carriage Inwards 1,500
2,38,345 2,38,345
Adjustments
(a) Closing Stock as on 31.12.2004 Rs.11,500.
(b) Rent Rs.200 is unpaid.
(c) Depreciation: 10% on Plant & Machinery and Business premises.
(d) Commission earned but not received amounts to Rs.300.
(e) Carry forward unexpired insurance on 500

85
Solution
Adjustment Entries
Dr. Cr.
Date Particulars L.F. Rs. Rs.
31.12.04
1) Closing Stock A/c Dr. 11,500
(Being the Closing Stock brought
into account)
2) Rent A/c Dr. 200

To Outstanding expenses A/c 200
(Being the unpaid rent adjusted)
3) Depreciation A/c Dr. 5,400

To Plant & Machinery A/c 1,850
To Business Premises A/c 3,550
(Being depreciation on plant and
machinery and on business premises
provided for)
4) Accrued Income A/c Dr. 300

To Commission A/c 300
(being the accrued commission
adjusted)
5) Prepaid Expenses A/c Dr. 500

To Insurance A/c 500
(Being the prepaid insurance adjusted)
86
Pandiarajan’s Trading, Profit & Loss A/c

Dr. Cr.
To Purchases 1,19,670 By Closing Stock 11,500
To Carriage inwards 1,500
To Gross Profit c/d

(transferred to
Profit & Loss A/c) 2,330
1,46,500 1,46,500
To Trade Expenses 375 By Net Profit b/d

(transferred from
To Salary 2,250 Trading A/c) 2,330
To Carriage outwards 350
To Rent 950 By Commission 600
Add: Outstanding
Rent 200 1,150 Add: Accrued 300 900
To Insurance 1,400
Less: Prepaid
Insurance 500 900 By Net Loss
(transferred to
To Depreciation: Capital A/c) 7,195
Plant &
Machinery 1,850
Business
Premises 3,550 5,400
10,425 10,425
87
Pandiyarajan’s
Balance Sheet
As on ...............
Liabilities Assets
Rs. Rs. Rs Rs.
Capital 72,795 Cash in hand 1,850
Less: Net Loss 7,195 65,600 Sundry Debtors 33,000
Rent payable 200 Closing Stock 11,500
Sundry Creditors 11,750 Prepaid Expenses:
Bills Payable 8,700 Insurance- 500
Bank Over Draft 9,500 Plant & Machinery 18,500
Less Depreciation 1,850 16,650
Business Premises 35,500

Less: Depreciation 3,550 31,950
Outstanding Commission 300

95,750 95,750
Illustration 3
The following is the Trial Balance of Mr. Rajangam
Particulars Dr. Cr.
Rs. Rs.
Capital & Drawings 20,500 2,05,000
Debtors & Creditors 1,00,500 48,900
Goods purchased and sold 2,40,500 4,01,000

Returns of Goods 20,500 30.500
Bills accepted and received 30,500 44,500
Cash balance 10,500
Heating and Lighting 10,500
Factory Wages 20,500
General Expenses 2,500
88
Machinery on 1.7.2004 1,00,500
Additions to Machinery on 1.10.2004 20,500
Furniture & Fixtures 30,500
Salaries 40,500
Loan to Madhavan 20,500
Dividend Received 2,000
Stock of Goods as on 1.1.2004 62,900
7,31,900 7,31,900
Adjustments
(i) Stocks on hand on 31.12.2004 – Rs.90,000; Stationery – Rs.450.
(ii) Goods destroyed but covered by insurance (not yet paid) – Rs.9,500.
(iii) General expenses includes stationery purchased for Rs.1,000/-
(iv) Interest @ 5% for due on loan to Madhan.
(v) Depreciate Machinery & Furniture by 10%.
(vi) Included in sales is Rs.5,000 being sale of fixtures, book value Rs.7,000. Depreciation
thereon to the date of sale is Rs.400.
(vii) The manager is entitled to get a commission of 10% on the profit before charging such
commission.
Prepare Final Accounts taking into account the above adjustments.
Solution
Adjustment Entries
Dr. Cr.
1) Closing Stock A/c Dr. 90,000

(Being the closing stock brought
into account)
89
2) Stock Destroyed A/c Dr. 9,500

(Being the entry to record the
stock destroyed)
3) Insurance Company A/c Dr. 9,500
To Stock destroyed A/c 9,500
(Being the claim admitted in full by the
insurance company)
4) Stationery A/c Dr. 1,000
To General Expenses A/c 1,000
(Being the entry to remove purchase
of stationery wrongly included in the
latter account)
5) Outstanding Debtors A/c Dr. 1,012.50
To Interest A/c 1,012.50
(Being the interest due on loan
advanced to Madan)
6) Depreciation A/c Dr. 7,113
To Machinery A/c 5,538
To Furniture A/c 1,575
(Being the depreciation on Machinery
and on furniture provided)
7) Commission A/c Dr. 12,285
To Outstanding Expenses A/c 12,285
(Being the commission due on Net
Profit, before charging such commission)
8) Sales A/c Dr. 5,000
To Furniture A/c 5,000
(Being the wrong entry removed)
Note
Furniture 30,500
(-) Book value of furniture sold 7,000
23,500
(-) Depreciation @ 10% for 6 months 1,175
(+) ADD Dep 400
Total. Dep 1575 21,925
90
92Rajangam
Profit and Loss A/c
Dr. Cr.
To Goods Purchased 2,40,500 Less Sales Returns 20,500
Less Purchase
Returns 30,500 2,10,000 3,80,500
To Factory Wages 20,500 Less: Sale of fixture 5,000
To Gross Profit c/d 1,81,600 3,75,500
(transferred to
P&L A/c) By Closing Stock 90,000
By Stock destroyed 9,500
4,75,000 4,75,000
To Heating & Lighting 10,500 By Gross profit b/d 1,81,600
To General Expenses 2,500 (transferred from Trading A/c)
Less: Purchase of
Stationery 1,000 1,500
To Stationery used By Dividend received 2,000
Stationery purchased 1,000
Less: Stock 450 550 By Outstanding Interest 1,013
To Salaries 40,500
To Loss on sale
of Fixture 1,600
(7,000-400-5000)
To Depreciation:
Machinery @ 10% 5,538
Furniture &
Fixtures 1,575 7,113
To Commission due
to Manager @ 10% 12,285
(1,22,850 x 10/100)
To Net Profit 1,10,565
(transferred to
Capital A/c)
1,84,613 1,84,613
91
Balance Sheet
Liabilities Rs. Rs. Assets Rs. Rs.

Rs. Rs. Rs. Rs.
Sundry Creditors 48,900 Cash Balance 10,500
Bills Accepted 44,500 Bills Received 30,500
Capital 2,05,000 Sundry Debtors 1,00,500
Add: Net Profit 1,10,565 Loan to Madhavan 20,500
3,15,565 Closing Stock 90,000
Less: Drawings 20,500 2,95,065 Stock of Stationery 450
Due from Ins. Co. 9,500
Machinery 1,00,500
Commission due to 12,285 Add: Additions 20,500

the Manager 1,21,000
Less: Depreciation 5,538 1,15,462
Furniture & Fixtures 30,500
Less: Book value of the

asset sold 7,000
23,500
Outstanding Debtors 1,013
4,00,750 4,00,750
3.5 Summary
Every business tries to known the progrees and position of the busineess. For this purpose,
he prepares the final accounts at the end of the accounting period. Final accounts consist of
trading and profit and loss Account and balance sheet. Trading Account reveals the gross profit
or loss of the business. Profit and loss Account reveals the net results of the operations of the
92
business. It shows the net profit or loss of the business. Balance sheet is prepared for a particular
date. It highlights the assets and liabilities of a concern on a given date thus, Balance sheet
helps to judge the financila position of the business while preparing final accounts we have to
make adjustments for some items. If such items are not adjusted, the final accounts will not
reveal the true and fair view of the performance of the business. Closing stock, outstanding
expenses, prepaid expenses, outstandings income, income received in advance, depreciation,
bad debts, Provision for doubtfu debts, provision for discount on debtors / creditors, interest on
capital and drawings are the important items which require adjustment.
3.6 Key Words

Fixed Assets : The assets which are procured for business use and from which
benefits are expected for long period.
Adjustments : All such items which need to be brought into books of accounts at
the time of preparing final accounts.
Drawings : Amount withdrawn by the owner for personal use.
Good Debtors : The amount of debtors remaining after providing bad and doubtful
debts.
Bad Debts : The debts which cannot be recovered from debtors.

A (i) Market (ii) liability (iii) Asset (iv) asset (v)liability (vi)fixed
B (i) Bad debts (ii) Loss (iii) Sundry debtors (iv) Sundry creditors
(v) an expense (vi) credit
93
UNIT 4
INCOME & EXPENDITURE ACCOUNT
Learning objectives
After studying this unit, you should be able to:
 define what is non-trading institutions
 explain the special features of receipt and payment account an income and expenditure
accounts
 prepare receipt and payment accounts and income and expenditure account.
Structure
4.1 Introduction
4.2 Special features of the Receipts and payments Accounts
4.3 Special features of Income and Expenditure Account
4.4 Illustrations
4.5 Summary
4.6 Key Words
4.1 Introduction
In the previous unit, you have learn the preparation of final accounts in case of trading
concerns, i.e., the concerns which are mainly involve in trading activities with the objective of
earning profit. You know there are some institutions functioning without involving in trading
activities but, rendering service with or without the objective of earning profit. These type of
institutions are called as non-trading institutions. Charitable institutions such as hospitals,
educational institutions, and clubs are examples of non-trading institutions.
94
The Non-Profit institutions like Schools, Hospitals, Sports Clubs, Libraries, Associations
to promote Arts and Charitable Institutions do not maintain all types of accounts. They do not
prepare Trial Balance at the end of the year. These organizations usually receive their incomes
by way of donations from the general public, subscriptions from members and grants from
governments. The amount so received will be utilized for the fulfilment of the aims and objects
for which they are constituted. The office bearers have to maintain the accounts in such a way
that at the end of the year, they will be able to explain what has been the income and how it has
been utilized.
Generally, these institutions maintain only cash book. When presented to its members,
in an account form, this summary is known as Receipts and Payments Account.
4.2 Special features of the Receipts and Payments Account

The important features of the receipts and payments Accounts are given below:
(i) The Receipts and Payments Account is nothing but a summary of the Cash Book.
(ii) It starts with the opening balance of cash in hand & bank and ends with the balance of
cash in hand & at bank at the end of the period.
(iii) It records all cash receipts and cash payments irrespective of the fact whether they are
capital or revenue items or whether they relate to the previous or future year.
(iv) It does not take cognizance of outstanding amounts of receipts or payments either at the
beginning or end of the period. In other words, only actual receipts and payments are
entered.
(v) It does not show either the final result to the effect whether the total income is more than
expenditure or vice versa or the financial position but only shows the cash positions.
For the purpose of knowing the excess of income over expenditure or vice-versa, it is
necessary to prepare an Income and Expenditure Account.
4.3 Special features of Income and Expenditure Account

The following are the special features of income and expenditure account:
(i) It is in the form of Profit and Loss Account.
(ii) It enters only Revenue, Incomes and Expenses.

95
(iii) The difference the two sides is either a surplus or deficit and this will be transferred to
capital fund in the Balance Sheet.
(iv) Expenses and Adjustments are adjusted to all figures relating to the current year whether
actually paid or not and received or not and
(v) Exclude all figures relating to previous or future years.
1. What do you understand by non-trading institutions?
............................................................................................................................
............................................................................................................................
............................................................................................................................
2. What is receipt and payment account?
............................................................................................................................
............................................................................................................................
............................................................................................................................
3. What is income and expenditure account?
............................................................................................................................
............................................................................................................................
............................................................................................................................
4. State whether each of the following statements is true or false.
(i) Receipts and payments account is a nominal account.
(ii) The receipts and payments account generally shows a debit

balance.
(iii) Income and expenditure a/c shows a balance of surplus or deficit.
(iv) Subscription received in advance during the accounting year is

an asset.
(v) Subscription in arrears are shown in the debit side of income and
expenditure a/c.
96
4.4 Difference between Receipts and Payments Account

and Income and Expenditure Account
Receipts & Payments A/c Income & Expenditure A/c
1) It is a summary of the Cash Book 1) It is a Revenue A/c (i.e. P & L A/c.)
2) It starts and closes with 2) It does not start with any Balance, as
Cash/Bank Balance. it is a Revenue A/c.
3) It shows all receipts on the Debit 3) It shows income on the Credit Side
side and all Payments on the and expenses on the Debit side.
Credit side.
4) It contains both Capital and 4) It contains only Revenue items.

Revenue Items
5) It includes receipts and payments 5) It includes items of the current period

relating to the current, preceding only whether received or not and paid
and succeeding periods. or not.
6) It does not take into account 6) It takes into account outstanding

outstanding expenses and expenses and outstanding incomes.
outstanding incomes.
7) It discloses the closing 7) It discloses the surplus or deficit

Cash/Bank Balance. which is transferred to the Capital
Fund.
8) It is not followed by a 8) It is followed by a Balance Sheet.

Balance Sheet.
Hints for preparing Income and Expenditure Account from

Receipts and Payments Account
(i) Take Revenue Expenditure and Revenue Incomes from Receipts A/c.
(ii) Make suitable adjustments regarding outstanding and prepaid expenses as well as accrued
incomes and incomes received in advance.
97
(iii) Provision should be made for depreciation on Fixed Assets.
(iv) Ignore the opening and closing cash and bank balances.
(v) Fees, Entrance Fees, Legacies, Donations, Subscriptions, Rent Receipts, Interest
Receipts, Grants, etc., are always taken as Revenue Incomes unless otherwise stated
specifically.
(vi) Life Membership Fees (i.e. Receipts of non-recurring nature) is always a capital item. It
should be added to the Capital Fund and not to be credited to the Income and Expenditure
Account.
(vii) If there is any special subscription for a specific purpose it should be shown under the
Liabilities side of the Balance Sheet, and expenses if any under that heading will be
shown as deduction there itself and will not appear in the Income and Expenditure A/c.
Similarly, Separate Party Fund, Special Fund and Reserve Fund are always capital items.
(viii) Proper adjustments should be made for Purchase of Materials and Closing Stock.
Fill in the blanks
(i) Receipts and payment a/c is a summary of ......................
(ii) Income and expenditure a/c is ............................. account.
(iii) ............................... takes into account outstanding expenses and outstanding

incomes.
(iv) Income and Expenditure Account is followed by a .........................
(v) Receipts and payments Account starts and closes with ............
balance.
98
4.5 Illustrations
Illustration 1
Given below the Receipts and Payments Account of State Bank Officers Association for
the year ended 31st December 2003.
Receipts Payments
Rs. Rs. Rs Rs.
To Donation Account 52,000 By Buildings 40,500

To Reserve Fund By Expenses incurred
(Life Members Fee for Matches 1,700
& Entrance fee
received) 5,000 By Furniture 2,600
To Expenses for the
Specific Matches 11,000 By Salaries 1,900
To Revenue Receipts: By Cricket 700
To Subscription (fees
including Rs.200 for
2002) 3,350 By Tennis 640
To Locker’s Rent 200 By Insurance (paid upto the
year ending Sept. 30, 2004) 480
To Interest on Securities 250 By Gardening 220
To Cricket 475 By Printing, etc. 170
To Tennis 450 By Telephone 340
To Billiards 225 By Sundries 150 4,600
To Sundries 150 5,100 By Investments (at cost) 20,000
By Balance 3,700
73,100 73,100
 Subscription fees outstanding for the year 2003 Rs.400
 Salaries unpaid for December 2003 Rs.260
From the details given prepare Income and Expenditure Account and Balance Sheet as
on 31st December 2003.
Notes
1. Capital Receipts and Payments are shown separately.
2. If a Special fund is created for a specific purpose then expenses relating to that should be
deducted from the fund in the Balance Sheet and should not be charged to Income and
Expenditure A/c.
3. Prepare Income & Expenditure A/c and Balance Sheet as usual.
99
Solution
State Bank Officers Association
Income and Expenditure Account
For the year ending 31st December, 2004.
Dr. Cr.
Receipts Rs. Rs. Payments Rs Rs.
To Salaries 1,900 By Subscription 3,350

Add: Outstanding 260 2,160 Less: Received in advance 200
To Cricket 700 3,150
To Tennis 640 Add: Outstanding 400 3,550
To Insurance 480 By Locker’s Rent 200
Less: Prepaid 360 120 By Interest on Securities 250
To Gardening 220 By Cricket 475
To Printing, etc. 170 By Tennis 450
To Telephone 340 By Billiards 225
To Sundries 150 By Sundries 150
To Excess of Income
Over Expenditure 800
5,300 5,300
State Bank Officers Association
Balance Sheet
Rs. Rs. Rs Rs.
Outstanding Creditors 260 Cash Balance 3,700
Subscriptions received
in advance 200 Investments 20,000
Sports Match Fund 11,000 Outstanding Debtors
Less: Expenses for subscriptions 400
incurred 1,700 9,300 Buildings 40,500
Capital Fund: Furniture 2,600
Donations 52,000 Prepaid Insurance 360
Life members fees 5,000
57,000
Add: Excess of
Income over 800 57,800
67,560 67,560
100
Illustration 2
The following is the Receipts and Payments Account of Mehrautli Club for the year ended
31st December 1997.
Cash in hand (1-1-97) 350 Bank Overdraft (1-1-97) 180
Subscription Salaries 670
1996 400 Printing and Stationery 50
1997 2,200 Furniture 1,000
1998 100 2700 Investment in Securities 1,500
Income from Entertainment 230 Balance on 31-2-97
Entrance Fee 450 Cash in Hand 170
Interest on Securities 560 Cash at Bank 900
Sale of old Furniture 180
(Book Value 150) 4,470 4,470
Prepare Income and Expenditure Account for the year ended 31st December, 1997 and the
Balance Sheet as on that date having due regard to the following additional information:
(i) The Club has 250 members paying an annual subscription of Rs. 10 each.
(ii) Salary Rs. 50 was outstanding on 1-1-97 and Rs. 60 is still payable for the year 1997.
(iii) The Club has furniture Rs. 2,650, Building Rs. 5,000 and investments Rs. 7,000 as on 1-
1-97
(iv) Depreciate Building and Furniture by 5% of their closing balances.
Solution
Income and Expenditure Account of Mehrauli Club
Expenditure Rs. Income Rs.
To Salaries 670 By Income from Entertainment 230
Less : Paid for 1996 50 By Entrance Fees 450
620 By Subscriptions 2,500
Add : Outstanding
for 1997 60 680 By Interest on Securities 560
To Printing 50 By Profit on sale of Furniture 30
To Depreciation on :
Building 250
Furniture 175
To Surplus 2,615
3,770 3,770
101
Balance Sheet
Capital Fund 15,170 Cash at Bank 900

Add Surplus 2,615 17,785 Cash in hand 170
Salary Outstanding 60 Building 5,000
Subscriptions Received Less: Depreciation 250 4,750
in advance 100 Furniture 3,500
Less : Depreciation 175 3,325
Subscriptions Accrued 300
Investments (Rs. 7,000+
Rs. 1,500) 8,500
17,945 17,945
Working Notes
Balance Sheet
As on 1st January, 1997
Bank Overdraft 180 Cash in hand 350

Salary Outstanding 50 Furniture 2,650
Capital Fund (b/f) 15,170 Building 5,000
Investments 7,000
Unpaid Subscriptions 400
15,400 15,400
Furniture Account
Dr. Cr.
To Balance b/d 2,650 By Cash A/c (Sales) 180
To Cash A/c (Puchases) 1,000 By Balance c/d 3,500
To Profit on sale 30
3,680 3,680
102
4.5 Summary
The institutions which function without involving in traidng activities but rendering service
with or without the objective of earning profit are called non-trading institutions. Non-trading
institutions do not maintain all types of accounts. Also they do not pepare Trial Balance at the
end of the accounting period. But, they prepare final accounts at the end, which include; (i)
Reeipts and Payments Account, (ii) Income and Expenditure Account and (iii)Balance Sheet.
Receipt and Paymenta Account is just a summary of cash transactions. It is a real account. All
cash receipts are recorded on the debit side while all cash payments are recorded on the credit
side. It does not consider whether the receipts and payments are capital nature or revenue
nature or whether they relate to the current year or not. Income and Expenditure Account is
similar to the Profit and Loss Account. It records all losses and expenses on its debit side while
all incomes and gains are recorded on its credit side. Income and expenditure account is a
nominal account. The difference of the two sides is either a surplus or deficit and this wil be
transferred to capital account in the Balance Sheet. The preparation to that of other institution.
The excess of asets over liabilitites is termed as Capital Fund or a General Fund.
4.6 Key Words

Non Trading Concerns : The institutions which do not involve in purchasing and seling
of goods but deal in services with or withtout objective of
making profit.
Capital Fund : The excess of assets over liabilities.
Legacy : It refers to the amount which are gets on account of a will.
Subscription : It is the amount received from members in a club. It is an
income to the club.

1) Which organizations prepare Income and Expenditure Account?
2) Explain the special features of Receipts and Payments Account?
3) Explain the special features of Income and Expenditure Account?
4) Distinguish between Receipts and Payments Account and Income and Expenditure
Account?
103
5) The Receipts and Payments Account and the Income and Expenditure Account of the
Bharathidasan Public Library for the year ended 31st December, 2003 were as follows:-
Receipts and Payments Account

Dr. Cr.
Receipts Rs. Rs. Payments Rs.
To Balance b/d 700 By Books Purchases 1,500

To Subscriptions: By Printing & Stationery 150
2002 400 By Salary 1,250
2003 3,500 3,900 By Advertisement 100
To Interest 400 By Miscellaneous Expenses 320
To Donation for special fund 150 By Balance c/d 2,220
To Rent:
2002 260
2003 130 390
5,540 5,540
Income and Expenditure Account

Dr. Cr.
Expenditure Rs. Income Rs.
To Insurance 120 By Interest 380

To Salary 1,300 By Subscriptions 3,800
To Miscellaneous Expenses 320 By Rent 260
To Depreciation of Building 750
To Printing and Stationery 150
To Advertisement 90
To Excess of Income
Over Expenditure 1,710
4,440 4,440
104
On enquiry you were told that the Library’s Assets as on 1.7.2003:
Rs. Rs.
Buildings 17,000 Books 15,000
Furniture 1,000 Investments 5,000
and that, there were no liabilities as on that date. You are asked to prepare the Balance
Sheet as at 31.12.2002 and 31.12.2003.
(Answer: Balance Sheet – 2002: Rs.39,360, Balance Sheet – 2003 : Rs.41,410)

A 4 (i) False
(ii) True
(iii) True
(iv) False
(v) False
B (i) Cash book
(ii) Revenue
(iii) Income and Expenditure A/c
(iv) Balance Sheet
(v) Cash / Bank balance

105
UNIT 5
AVERAGE DUE DATE AND ACCOUNT CURRENT
Learning Objectives
 Define average due date and account current
 Explain the different procedures to be adopted for calculating the average due date
and account current
 Compute average due date and account current.
 Explain the uses of average due date.
Structure
5.1 Introduction
5.2 Meaning of Average Due Date
5.3 Steps in the Computation of Average Due Date
5.4 Illustrations on Average Due Date
5.5 Account Current- Meaning
5.6 Methods for Calculating Number of Days
5.7 Methods for Calculating Interest
5.8 Illustrations on Account current
5.9 Summary
5.10 Key Words

106
5.1 Introduction
No business can be carried out without availing credit facilities. Credit facilities help both
the buyer and seller. The buyer can get goods or service without cash. The seller can motivate
the buyers to buy more; therefore, the sales can be increased rapidly. The undue delays in the
payment of credit seriously affect the credibility of the buyer. Similarly, the delays in payment
highly affect the working capital position of the seller. Therefore, the credit amount should be
paid to the vendor without affecting both the buyer and vendor. Average due date is concerned
with finding the due date is concerned with finding the date to repay the credit amount without
affecting both the parties. IN this unit, you can study the calculation of average due date and
account current.
5.2 Meaning of Average Due Date

Average due date is the date on which serval debts due on different dates can be paid by
a single payment without any loss of interest to the buyer (debtor) and the seller (creditor). In
other words, average due date is one on which the net amount payable can be settled without
causing loss of interest either to the borrower or the lender.
5.3 Steps in Computation of Average Due Date

1. Calculating due date for each payment
First we have to calculate the due date from the date and term of the bills given. Three
grace days must be added to arrive the due date, in case of term bills.
2. Selection of base date
3. Calculation of number of days
4. Find the product by multiplying the number of days with the amount of transaction
5. Find the total of the product
6. Apply the following formulae according to the situation.
(i) If amount is lent in installments and repaid in one settlement
Total of Product
Average Due Date  Base Date  days
Total of Amount
107
(ii) If amount is lent in lump sum and is repayable in installments
Total Days / Months/Years of Installment

Average Due Date  Base Date 
Number of Installment
(iii) For mutual transactions
Difference in Product
Difference in Amount
5.4 Illustrations on average Due Date

1. Mr.Kannan has accepted the following bills drawn by Mr. Raman, but now he wishes to
cancel these three bills and make a single payment. Calculate Average Due Date.
Bill No. Date of Drawing Amount (¹ ) Term
1 10.04.2016 3,000 92 days

2 12.06.2016 4,000 65 days
3 14.07.2016 6,000 30 days
Grace days to be added.
Solution:
Calculation of Due Date
Date of Bill Term Due Date*
10.04.2016 92 days 15.07.2016
12.06.2016 65 days 20.08.2016
14.07.2016 30 days 17.08.2016
*(after adding 3 grace days)

108
Calculation of average Due Date
Base Date: 15.07.2016
Due Date Number of Days from Amount (¹ ) Product

Base Date
15.07.2016 0 3,000 0
20.08.2016 33 (17+16) 6,000 1,98,000
17.08.2016 36 (17+19) 4,000 1,44,000
Total 13,000 3,42,000
Total of Product
Total Amount of Transaction
3,42,000
 15.07.2016 days
13,000
= 15.07.2016 + 26.3 days
= 15.07.2016 + 26 days
Average Due Date = 10.08.2016
2. Find the average Due Date.
Date of Bill Amount (¹ ) Term of Bill
04.01.2015 3,500 3 months
17.02.2015 5,000 4 months
26.03.2015 2,500 1 month
07.04.2015 4,000 5 months

109
Solution
Calculation of Due Dates
Date of Bill Due Date
04.01.2015 07.04.2015
17.02.2015 20.06.2015
26.03.2015 29.04.2015
07.04.2015 10.09.2015
Calculation of Average Due Date
Base Date: 07.04.2015
Due Date Number of Days Amount (¹ ) Product

from Base Date
07.04.2015 0 3,500 0
29.04.2015 22 2,500 55,000
20.06.2015 74 (23+31+20) 5,000 3,70,000
10.09.2015 156 4,000 6,24,000
(23+31+30+31+31+10)
Total 15,000 10,49,000
Total of Product
10,49,000
 07.04.2015  days
15,000
= 07.04.2015 + 69.9 days
= 07.04.2015 + 70 days

110
3. Mr.Ramakrishnan has four different bills with Mr.Akbar on different dates. He wishes to settle
in a single payment, in lieu of the four bills. Compute Average Due Date for him.
Due Date Amount (¹ )
30.04.2017 5,000
01.08.2017 2,000
31.10.2017 6,000
01.12.2017 5,000
Solution:
Calculation of Average Due Date
Base Date: 30.04.2017
Due Date Number of Days Amount (¹ ) Product

from Base Date
30.04.2017 0 5,000 0
01.08.2017 93(31+30+31+1) 2,000 18,6,000
31.10.2017 185(31+30+31+31+30+31) 6,000 11,10,000
01.12.2017 215(31+30+31+31+30+31+30+1) 5,000 10,75,000
Total 18,000 23,71,000
Total of Product
23,71,000
 30.04.2017  days
18,000
= 30.04.2017+ 132 days
Hint: Fraction of days to be rounded off to nearest value.

111
Check Your Progress – A

1. What is Average Due Date?
2. What is meant by maturity date of a bill?
3. Write a short note on Grace Days.
5.5 Account Current – Meaning

Account current is a statement which is given in the form of an account by one party to
another, duly setting out in chronological order the details of the transactions together with
interest.
According to Eric Kohler, “Account Current is any personal account on which specific
settlements are made”. Account current is a statement which is given in the form of an account
by one party to another, duly setting out in chronological order the details of the transactions to
gether with interest.
5.6 Methods for Calculating Number of Days

There are three methods for calculating number of days:
(a) Forward method The method is most common. The numbers of days are calculated
from the due date of the transaction to the date of settlement.
112
(b) Backward or époque method In case of this method the number of days are
counted from the opening date (i.e., the date of commencement of the account
current) of the account current to the due date of the transaction.
(c) Daily balance method The method is used by banks. Days are calculated from the
due date of a transaction to the due date of the next transaction.
5.7 Methods for Calculating Interest

The following methods are adopted for calculating interest.
1. Calculating interest on each item. The days are calculated from the date of the
transaction to the settlement date and interest is charged for the number of days so
called at agreed rate of interest.
2. Product Method: This is a modification of the first method. In place of making

separate calculations, the amount involved in each transaction is multiplied by the
number of days (or months) from its date to the date of settlement. Interest is
calculated on the balance of the products for one day (or month) and is put on the
side the sum of the products is more. However, if the rates of interest are different
for debits and credits, interest for debits and credits will have to be calculated
separately.
3. Epoque method: This method is the reverse of the first two methods. Interest is
computed from the opening date of the account current to the date of each
transaction. Thus, no interest is charged on the opening balance while interest for
the whole period will be charged on the closing balance.
Interest is calculated at the agreed rate on the balance of the products for one day
(or month) and entered on the side which has smaller product. In case rates of
interest are different for debits and credits, interest for each side will have to be
calculated separately.
4. Periodical Balance Method: The method is usually followed in banks. The balance
is struck after each transaction and is multiplied by the number of days up to the
next transaction. Interest is charged for one day on the difference of the products.
In case the rates of the interest are different for debits and credits interest will be
calculated for the debits of the products and the credits of the products separately.
113
The difference of the two amounts will be the amount of interest chargeable to or
receivable from the party concerned.
5. Red Ink Interest Method: Sometimes, the due date of a bill accepted may fall
beyond the closing date. In such a case, the days between due date and closing
date are marked in red ink in the days-column. The product of such transaction is
shown as minus product. So, it is called as Red Ink Interest method. The amount
marked in red ink is usually deducted from the products.
This occurs only in forward method but does not apply to or arise in époque method.
5.8 Illustrations on Account Current

Illustration 1
On 1st May 2010, Ravi owes ¹ 9,000 to Mahesh. The following transaction took place
between them till 31st December 2010, on which date, account current is to be prepared.
Date Particulars Amount

(¹ )
01.05.2010 Sales to Ravi 4,000
16.06.2010 Ravi paid Mahesh 2,000
01.08.2010 Goods sold by Ravi to Mahesh 6,000
01.09.2010 Sales to Ravi 8,000
01.11.2010 B/R accepted by Ravi for 1 month 6,000
01.12.2010 Cash received from Ravi 4,000
Prepare an account current to be sent to Ravi by Mahesh as on 31.12.2010. Interest is

charged at 12% p.a.
114
In the Books of Mahesh

Ravi in Account Current with Mahesh
Date Particulars Month/ Interest Amount Date Particulars Month/ Interest Amount
Days (¹ ) (¹ ) Days (¹ ) (¹ )
01.05.2010 To Balance 8 720 9,000 16.06.2010 By Cash 199 131 2,000

b/d Days
01.05.2010 To Sales 8 320 4,000 01.08.2010 By Purchase 5 300 6,000
01.09.2010 To Sales 4 320 8,000 04.12.2010 By B/R 27 53 6,000
31.12.2010 To Interest ….. 836 01.12.2010 By Cash 1 40 4,000

Month
31.12.2010 By Interest
(Contra) ….. 836 …..
By Balance
c/d
(Bal.fig) ….. ….. 3,836
1,360 21,836 1,360 21,836
01.01.2011 To Balance 3,836

b/d
Illustration 2
Ranjith had the following transaction with Keshav during the year 2012 for the period 1st
July 2012 to 31st December 2012.
Date Particulars Amount (¹ )

01.07.2012 Balance payable by Keshav 4,000
01.08.2012 Accepted Keshav’s bill for 1 month 3,000
10.08.2012 Cash received from Keshav 2,500
24.09.2012 Purchases from Keshav 2,000
15.10.2012 Goods returned to Keshav 500
01.11.2012 Sales to Keshav 3,000
115
Prepare account current, to be sent to Keshav by Ranjith on 31st December 2012, after
calculating interest @ 12% p.a.
Solution
In the Books of Ranjith
Keshav in Account Current with Ranjith
Date Particulars Amount Days Product Date Particulars Amount Days Product
(¹ ) (¹ )
01.07.2012 To Balance 4,000 184 7,36,000 10.08.2012 By Cash 2,500 143 3,57,,500
b/d
01.08.2012 To B/P 3,000 118 3,54,400 24.09.2012 By 2,000 98 1,96,000

(04.09.12 Purchases
due)
15.10.2012 To Returns 500 77 38,500 31.12.2012 By Balance ……. ……. 7,55,000

Of Product
01.11.2012 To Sales 3,000 60 1,80,000 31.12.2012 By Balance 6,248 ……. …….

c/d
To Interest
31.12.2012 On Balance 248
10,748 13,08,500 10,748 13,08,500
Illustration 3
Following transactions took place between A and B during the month of May 2009.
01.05.2009 Amount payable by B to A 5000

07.05.2009 Received acceptance of A to B for 1 month 2,500
11.05.2009 Goods sold to B 7,500
13.05.2009 A received cheque from B 7,500
16.05.2009 B sold goods to A 3,000
21.05.2009 A returned goods sold by B on 16.05.2009 500
116
You are required to make out an Account Current by products method to be rendered by
A to B on 30.06.2009, taking interest at 10% p.a.
Solution
In the Books of A
B in Account Current with A
(¹ ) (¹ )
01.05.2009 To Balance 5,000 61 3,05,000 13.05.2009 By Bank 7,500 48 3,60,000

B/d
To Bills
07.05.2009 Payable
(due
10.06.2009) 2,500 20 50,000 16.05.2009 By 3,000 45 1,35,000
purchase
11.05.2009 To Sales 7,500 50 3,75,000 30.06.2009 By

Balance …… …… 2,57,500
of Product
To Returns
21.05.2009 (16.05.2009) 500 45 22,500 30.06.2009 By
Balance
c/d 5,070.5
To Interest 70.5
30.06.2009 (2,57,500*
10/100*1/365)
15,570.50 7,52,500 15,570.50 7,52,500
Illustration 4
The details of transaction between Raghav and Madhav are given below.
01.01.2013 Amount due to Raghav 4,000
20.01.2013 Goods sold to Madhav 3,000
11.02.2013 Purchases from Madhav 2,500
08.03.2013 Cash received from Madhav 3,500

117
14.03.2013 Paid to Madhav 1,500
15.04.2013 Sales to Madhav with one month credit period 1,000
10.05.2013 Purchases by Raghav 1,500
20.06.2013 Raghav drew a bill on Madhav for 2 months 1,000
Prepare account current to be sent by Raghav to Madhav on 30th June 2013. Interest is
charged at 6% p.a.
Solution
In the Books of Raghav
Madhav in Account Current with Raghav
(¹ ) (¹ )
01.01.2013 To Balance 4,000 181 7,24,000 11.02.2013 By 2,500 139 3,47,500

B/d Purchase
20.01.2013 To Sales 3,000 161 4,83,000 08.03.2013 By Cash 3,500 114 3,99,000
14.03.2013 To Cash 1,500 108 1,62,000 10.05.2013 By 1,500 51 76,500

purchase
15.04.2013 To Sales 1,000 43 43,000 20.06.2013 By B/R 1,000 -54 -54,000

(Due Date (DueDate:
18.05.2013) 23.08.2013)
30.06.2013 To Interest 106 30.06.2013 By Balance …… ….. 6,43,000

on Balance of
of Products Products
(6,43,000 (Bal.fig.)
*6/100*
1/365)
30.06.2013 By Balance 1,106 ….. …..
c/d
(Bal.fig.)
9,606 14,12,000 9,606 14,12,000

118
Check Your Progress – B

1. What is Account Current?
2. What is Red Ink Interest?
3. State whether each of the following statements is ‘True ‘or ‘False’.
(i) Account Current and Current Account are not synonymous terms.
(ii) In case of Epoque Method the numbers of days are counted from the opening date
to the date of the transaction.
(iii) The problem of red ink interest arises when the due date of a transaction falls after
closing date of the account current.
(iv) Average Due Date is the date on which accounts are usually settled by the parties.
(v) While calculating Average Due Date, the due date of the any transaction can taken
as the basic date.
(vi) Payment on average due date results in loss of interest to the creditor.
5.9 Summary
Credit is inevitable in the business. Generally problems arise at the time of settlement of
the credit amount. Finding a mechanism benefitting both the debtor and creditor at the time of
settlement creates a win- win situation to both the parties. Average due date helps the debtor
and creditor to settle the credit without any loss to anyone.. Average due date is the date on
which serval debts due on different dates can be paid by a single payment without any loss of
interest to the buyer (debtor) and the seller (creditor). In other words, average due date is one
on which the net amount payable can be settled without causing loss of interest either to the
119
borrower or the lender. Account current is a statement which is given in the form of an account
by one party to another, duly setting out in chronological order the details of the transactions
together with interest. There are three methods for calculating number of days, namely, Forward
method, backward or époque method and daily balance method. Calculating interest on each
item, product method, époque method, periodical balance method are important methods used
for calculating interest. Sometimes, the due date of a bill accepted may fall beyond the closing
date. In such a case, the days between due date and closing date are marked in red ink in the
days-column. The product of such transaction is shown as minus product. So, it is called as
Red Ink Interest method. The amount marked in red ink is usually deducted from the products.
This occurs only in forward method but does not apply to or arise in époque method.
5.10 Key Words

Debtor, Creditor, Interest, Loss, Due Date, Grace Days, Credit, Settlement, Transaction

1. Explain the uses of calculating the average due date.
2. Enumerate the steps involved in calculating average due date.
3. Explain the methods of calculating number of days.
4. Describe the methods of preparing account current.
5. Explain the methods of preparing account current.
6. Distinguish between
(a) Forward Method and Backward Method in Account Current.
(b) Account Current and Current Account.
(c) Average Due Date and the Date of Settlement.
7. Calculate Average Due Date.

18.05.2012 3,000
23.07.2012 6,000
03.08.2012 5,000
31.08.2012 7,000
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8. Calculate Average Due Date of Mr.Vinod from the details of his transactions with
Mr. KarthiKesan.
Date Due Date Amount (¹ )
03.01.2000 06.02.2000 4,000
06.02.2000 09.04.2000 5,000
03.04.2000 06.05.2000 8,000
13.05.2000 15.06.2000 7,000
20.05.2000 22.06.2000 10,000
9. David owes the following bills to Murugan Compute Average Due Date and interest
to be paid, if David wants to make a single payment on 30th June 2013 with interest
@ 5% p.a.
10.03.2015 300
04.04.2015 1,000
30.04.2015 5,000
03.06.2015 1,000
10. Make out an Account Current to be rendered by Mohan to Suraya on 30.09.2012 in

respect of the following transactions appearing in the books of Mohan. Interest to
be taken at 15% p.a. Calculate interest to nearest rupees under Products method.
Date Transactions Amount (¹ )
01.07.2012 Debit balance b/f 1,300
05.07.2012 Sold goods to Surya 900
15.07.2012 Received cash from Surya 1,350
04.08.2012 Surya purchased goods 1,920
15.08.2012 Received cash from Surya 900
01.09.2012 Bought goods from Surya 2,100
01.09.2012 Paid cash to Surya 750
12.09.2012 Sold goods to Surya 960
15.09.2012 Paid cash to Surya 600
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11. Prepare an Account Current to be rendered to Vani by Mala as at 30th June 2013,
taking interest @ 5% p.a., adopting forward method.

01.01.2013 Purchases from Vani 2,240
10.01.2013 Accepted Vani’s bill for 2 months 1,000
15.02.2013 Paid to Vani 1,200
02.03.2013 Sales to Vani 5,500
15.08.2012 Received acceptance from Vani for one month 2,000
11.04.2013 Cash received from Vani 2,000
30.04.2013 Purchases from Vani(due at end of May) 2,400
11.05.2013 Sales to Vani 1,500
31.05.2013 Purchases from Vani (due on 10.06.2013) 2,200
15.06.2013 Sales to Vani 3,000
12. Keshav is in Account Current with Vishal and the following transactions take place
between them from 1st January 2016 to 30th April 2016.
Date Particulars Amount

(¹ )
01.01.2016 Balance due by Keshav 3,400
15.01.2016 Sales to Keshav 6,000
25.01.2016 Cash received from Keshav 2,000
10.02.2016 Received bills receivable due after 2 months 2,400
20.02.2016 Purchases by Keshav (due on 31.03.2016) 10,000
15.03.2016 Purchases by Keshav 4,000
31.03.2016 Cash paid by Keshav 4,000
15.04.2016 Sales to Keshav (due on 30.05.2016) 5,200

122
Prepare an account to be rendered by Vishal to Keshav on 30 th April 2016, calculating

interest at 6% p.a.
13. From the details provided regarding the transactions between P and Q for a period
of three months ending 31st March 2015, calculate the Interest to be paid @ 12%
p.a. in the books of P, under interest table method.
01.01.2015 Opening balance (Dr.) 5,000
11.01.2015 Sales by P 10,000
15.01.2015 Cash received from Q 10,000
16.02.2015 Purchases by Q 10,000
01.03.2015 Q paid cash 5,000

Check your Progress B, Question number 3 – (i) TL; (ii) T; (iii) T, (iv) F; (v) T; (vi) F
123
UNIT 6
SALE OR RETURN
Learning Objectives
Explain the meaning of sale or return
Give journal entries to various transactions on sale or return
List out various books maintained on sale or return
Structure
6.1 Introduction
6.2 Methods of Accounting Transaction on Sale or Return
6.3 Books to be Maintained on Sale or Return
6.4 Illustrations
6.5 Summary
6.6 Key Words
6.1 Introduction
Generally the goods are delivered or dispatched to the customers against their orders by
the sellers. This may sometime involve oral orders or after seeing the goods by the customers.
In this competitive business world, the sellers enable the customers with a additional facility of
choosing the goods after through verification or inspection with the choice of either retaining the
goods or returning to the seller. The customers are given some stipulated time within which
they may accept the goods or return. This type of sale is called “Sale or return” or “Sale on
approval” basis.
This kind of approach or add on facility will improve the quantum of sales and thereby the
profit. Mostly the sale or return transactions take place in routine business activities with regular
customers. Now in online transactions also, the customers have the choice of returning the
goods within the stipulated time period. Here, accounting transactions slightly vary because the
124
sale is not complete till the customer accepts the goods. Therefore, the nature of accounting
transactions in connection with ‘sale or return’ basis is dealt separately.
6.2 Methods of Accounting Transaction on Sale or Return

Based on the quantum of transactions in a year, the accounting entries are classified
under three heads as below.
1. When the business transactions are less in number
2. When frequent transactions take place
3. When the transactions are large in number
Accounting system for each type of business is explained below:
1) When transactions are very few
The following steps are taken
(a) When goods are sent they are recorded as sales.
(b) When goods are not approved and returned the entry is reversed.
(c) At the end of the accounting year if the confirmation has not been received then
goods with customers is to be deducted from sales and included in closing stock at
cost price.
2) When transactions are very frequent
The steps involved are:
(a) A Sale or Return day book is prepared on memorandum basis.
(b) In this book there are various columns. The transactions are recorded chronologically
(Datewise)
(c) On sending the goods they are recorded at sale value in the goods sent column.
(d) On getting the approval from the customer the goods are recorded in approval
column.
(e) When the goods are rejected the sale value of such goods is recorded in the goods
returned column.
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(f) Balance of goods is recorded in the balance column. This represents the value of
goods with the customers. This must be deducted from sales at sale price and
shown at cost price in the closing stock.
3) When the transaction is large in number
Because of the peculiarity of the system and large number of transactions an elaborate
accounting system is needed. This involves two important aspects.
(i) What are the books to be maintained?
(ii) How should the accounts are to be written?
6.3 Books to be Maintained on Sale or Return

Besides the normal subsidiary book the following additional books are to be maintained.
(a) Sale or Return day book. This is to record goods sent to customers on sale or
return basis.
(b) Sales and return book. This is to record both sales and returns.
(c) Sale or return ledger which maintained in addition to regular ledger (Katcha ledger)
this contains personal accounts and sale or return account in addition to the regular
ledger.
Recording: The important point to be noted here is the recording is done first in the sale
or return ledger. It is transferred to the regular ledger when the sale is completed.
(a) On sending the goods to customers on sale or return basis it is recorded in the sale
or return day book at sales value. The journal to be posted in the sale or return
ledger as:
Customer A/C Dr.

To Sale or return A/C
(For recording the dispatch of goods)
(b) On approval of the goods by the customer it is recorded in the goods approved
column of the ‘Sales and Return Book’. The transfer entry is posted from Sale or to
ledger Return ledger to regular ledger. The journal entries to be passed are:
126
(i) Customer’s A/C Dr. (regular ledger)
To Customer’s A/c (Sale or Return ledger)
(ii) Sale or Return A/C Dr. (Sale or Return ledger)
To Sales A/C (Regular ledger)
(c) On returning the goods by the customer the goods returned is entered in the goods
returned column of the sale and return book.
The journal entry to be recorded in the sale or return ledger.
Sale or Return A/C Dr.
To Customer’s A/c
(d) At the end of the accounting year the balance in ‘Sale or Return Account’ in the
‘Sale or Return ledger’ gives the stock in the hands of customers who have not
decided. This is to be treated as closing stock. This must be shown on the asset
side of Balanced Sheet and the credit side of Trading Account. Journal entry to be
passed:
Stock with customer’s A/C Dr.
To Trading A/C
6.4 Illustrations
When the number of transactions are few and rare
Illustration – 1
Ramu sells goods to his approved customers on ‘Sale or Return’ basis at a profit of 20%
on sales, treating as actual sales. On 15th December, goods costing Rs.1, 000/- were sent to
Usha Traders. No confirmation has been received from Usha Traders until 31st December.
Give the necessary journal entries in the book of Ramu.

127
Solution:
Journal Entries
Date Particulars Dr. Cr.

Rs. Rs
15th Usha Traders A/C Dr. 1,250

Dec. To Sales A/C 1,250
[Being the sales made with sales value
of Rs. 1,250 (cost=1,000 + Profit 20%
on sales) (25% on cost – 1,000*25/100)]
31st Sales A/C Dr. 1,250

Dec. To Usha traders A/C 1,250
[Being the cancellation of sale
Recorded earlier]
31st Stock with customers A/C Dr. 1,000

Dec. To Trading A/C 1,000
[Being stock at the end recorded with
the customers at cost price]
Illustration – 2
An automobiles company send out its cars to dealers on sale or return. All such transaction
are, however, treated like actual sales and are passed through the day book. Just before the
end of the financial year, two cars which had cost Rs.5, 500 each have been sent on sale or
return and have been debited to customers at Rs.7, 500 each. How would you adjust these
transaction for the purpose of the company’s Trading and Profit and Loss A/C and Balance
Sheet.
128
Solution
Journal Entries
Particular Rs. Rs.
(a) When goods sold:

Customers A/C Dr. 15,000
To Sales A/C [7,500x2] 15,000
(b) When the approval is pending:

Sales A/C Dr. 15,000
To Customers A/C 15,000
(c) Entry for stock at cost price:

Stock with Customers A/C Dr. 11,000
To Trading A/c [5,500x2] 11,000
Illustration 3
A trader sells his goods rarely to his customers on sale or return basis. He treats all such
transactions as actual sales at the time of dispatch. In the year 1995, he had dispatched goods
costing Rs.10,000 to Raju at a profit of 20% on cost and was passed through sales day book.
How would you adjust the transaction on December 31, 1995, if Raju’s case in pending?
[B.Com., M.S.U. April 1997]
Solution
Journal Entries
Particulars Rs. Rs
Raju A/C Dr. 12,000
To Sales A/C 12,000

Sales A/C Dr. 12,000
To Raju A/C 12,000
129

Stock with Customer’s A/c 10,000
To Trading A/C 10,000
Rs.
Let cost price = 100

(+) Profit 20
——
Selling price 120
——
If cost price is Rs.10, 000, Selling price = 10,000 x = Rs.12, 000
Illustration – 4
A cloth merchant casually sells goods to his approved customers on sale or return basis
treating all such transaction as actual sales at the time of dispatch. Just before the end of the
financial year some cloth costing Rs.2, 000 was sent to Manohar at 20% profit on sale and was
passed through the sales day book. How will you adjust transactions on 31 st December, if
consent of Manohar is pending?
[B.Com., Madras, April 1986]
Solution
Journal Entries
Particular Rs. Rs.

Manohar A/c Dr. 2,500
To Sales A/c 2,500

Sales A/c Dr. 2,500
To Manohar A/c 2,500

Stock with customer’s A/c Dr. 2,000
130
Rs.
Cost of goods sold 2,000
(+) 20% on sale is equal to 25% on cost 500

————
2,500
————
Illustration – 5
On 31st December goods at sale price of Rs.3,000 were lying with M/s Sexton & co. to
whom they were sold on sale or return basis and recorded as sale. Since no consent has been
received you are required to pass adjustment entries presuming goods were sent on approval
at a profit of cost plus 20%.
[B.Com., M.S.U. April 1997]
Solution
Journal Entries
Particular Rs. Rs.

Sexton & Co. A/c Dr. 3,000
To Sales A/c 3,000

Sales A/c Dr. 3,000
To M/s Sexton A/c 3,000
(c) Entry for Stock at cost price:

Stock with customers A/c Dr. 2,250
131
Calculation of stock at market price:
Rs.
Sale price of the goods 3,000

th
Less: Profit 20% or 1/5 on cost 500
Or 1/6th on sales (3,000x1/6) —————
Cost price of goods 2,500
Less: 10% Fall in the market price 250
————
2,250
————
Illustration – 6
A gas company sends out its gas stoves to dealers on sale or return. All such transactions
are, however treated like actual sales and are passed through the day book. Just before the
end of the financial year, 100 stoves, which had cost them Rs.150 each, have been sent to a
dealer on sale or return and have been debited to his account at Rs.200 each, out of which only
20 stoves are sold at Rs.220 each. Pass journal entries to adjust these transactions for the
purpose of preparing the final accounts for the year ended 31st December 1989.
[B.Com., Madras, April 1990]
Solution
Journal Entries
Particular Rs. Rs.
(a) Sales A/c Dr. 16,000

To Debtors Suspense A/c 16,000
[Being the cancellation of sales
(200x80)]
(b) Sundry debtors A/c Dr. 400

To Sales A/c 400
[Being the extra price adjusted
(20 stoves x Rs. 20)]
132
(c) Stock with customer’s A/c Dr. 12,000

[ Being the stock at cost price
(8 x Rs.150)]
Illustration – 7
B.S. Sends out goods on approval to a few customers and include the same in Sale
Account. On 31.03.1990, the stock in hand amounted to Rs.80,000 and the Sundry Debtors
balance stood at Rs.1,50,000 which include Rs. 10,000 for goods sent on approval against
which no intimation was received during the year. These goods were sent out 25% above cost
and were sent to R Rs.4,000 and B Rs.6,000.
On 20th April, B returned the goods and on 25th April R intimated of his intention to retain
the goods. Make adjustment entries and show how these items will appear in the Balanced
Sheet as on 31.03.1990 and show what entries would be made in April, 1990.
Solution
In the Books of B.S
Journal Entries
Date Particulars Rs. Rs.
1990 Sales A/c Dr. 10,000

Mar.31 To Debtors A/c 10,000
[Being the cancellation of the entry for goods sent
on sale or approval basis which were not
accepted]
Stock with customers (or sale or Return) A/c Dr. 8,000
[Being the cost of goods sent on sale or return
Basis and lying in the hands of customers]
133
Balance sheet (Extracts)
Rs. Rs.
Assets Side:
Sundry Debtors 1,50,000
Less: Debtors for sale or return basis 10,000
————— 1,40,000
Stock 80,000
Less: Stock on approval 8,000
————— 72,000
Journal Entries
Date Particulars Rs. Rs.
1990 Debtors A/c Dr. 6,000
Apr-20 To B A/c 6,000

[Being the return of goods sent on B on
Approval in the last financial year]
Apr-25 Debtors Dr. 4,000

To Sales A/c 4,000
Illustration 8
A gas company sends out of its gas stoves to dealers on sale or return. All such transactions
are, however treated like actual sales and are passed through the day book. Just before the
end of financial year, 100 stoves, which had cost them Rs.150 each, have been sent to a dealer
on sale or return and have been debited to his account at Rs.200 each; out of which only 20
stoves are sold at Rs.220 each. Pass journal entries to adjust these transactions for the purpose
of preparing the final accounts for the year ended 31st December 2000.
134
Journal entries
Particulars Dr. Rs. Cr. Rs.
Sales 16,000
To debtors suspense 16,000
Sundry debtors 400
To Sales 400
Stock with customer 12,000
To Trading 12,000
Check Your Progress

1. What do you understand by Sale or Return?
2. List the books to be maintained under Sale or Return.
6.5 Summary
Business people take various measures to boost the sale. Sale or return is one of the
methods used by the seller to motivate the buyer to buy the goods. Under Sale or Return, the
seller gives some options to the buyer to return the goods within the stipulated time, if the
goods are not as per terms and conditions. Accounting transactions slightly vary in sale or
return because the sale is not complete till the customer accepts the goods. Based on the
135
quantum of transactions in a year, the accounting entries are classified under three heads, viz;
(i) when the business transactions are less in number, (ii) when frequent transactions take
place, and (iii) when the transactions are large in number. A company has to maintain sales or
return book in addition to normal subsidiary book.
6.6 Key Words

Customers, Goods, Business Transactions, Subsidiary Books, Ledger.

1. Explain the uses of sale or return method.
2. Describe the methods of accounting transactions on sale or return
3. Bring out the books to be maintained on sale or return
4. Krishna sells goods to his customers on ‘Sale or Return’ ‘basis, at a profit of 25% on
sales, treating as actual sales. On 31st March, goods costing ¹ 5,000 were sent to
Suresh. No confirmation has been received from Suresh until 31st March.
Pass the necessary journal entries in the books of Krishna.
5. On 31st March, goods worth sale price of ¹ 13,000 were lying with Javith, to whom
they were sold on ‘Sale or Return ‘basis as sale. Since no consent has been received,
you are required to pass adjustment entries, presuming goods were sent on approval
at a profit of cost plus 25%. Present market price is 10% less than the cost price.
136
UNIT 7
DEPRECIATION, PROVISIONS AND RESERVES
Learning Objectives
 define the meaning of depreciation
 explain the objectives of providing depreciation
 discuss the causes of depreciation
 describe the methods of depreciation
 prepare the depreciations accounts under different methods
 explain the concept of reserve and provisions.
Structure
7.1 Introduction
7.2 Features of Depreciation
7.3 Objectives of Providing Depreciation
7.4 Causes of Depreciation
7.5 Factors to be Considered in Charging Depreciation
7.6 Methods of Depreciation
7.7 Reserves and Provisions
7.8 Summary
7.9 Key Words
7.10 Review Questions/Exercises

137
7.1 Introduction
You know thesedays business seriously attempts to ascertain the profitability of the
business periodically. For this purpose, the business matches the revenues earned with the
expenditure incurred during a particular accounting period. A business uses both fixed assets
and current assets to generate revenues. Fixed assets are those assets from which a business
expects benefits for a long period. The economic potential so consumed represents the expired
cost of a particular fixed assets. These expiried costs must be recovered from the revenue of
the business in order to know the exact profit for a particular accounting period. The expired
cost of the asset deducted from revenue can be called depreciation. In this unit, you can learn
the meaning of depreciation, causes, the various methods of computing depreciation.
7.2 Features of Depreciation

Depreciation implies a gradual, permanent and continuing fall in the value of a fixed asset
due to wear and tear, passage of time and obsolescence. It is a business loss and must be
regularly provided for out of the profits of the business.
The following are the main features of depreciation:
a) It is a continuous process.
b) Results in reduction of the book value of the asset.
c) It is a process of allocation of expired cost.
d) The reduction in the book value of the asset is permanent.
e) Normally a fair estimate of depreciation is made.
Depreciation is to be differentiated from other like Depletion, Amortisation and

Obsolescence. Depreciation is the accounting process of converting the cost of fixed assets to
expenses. This has a significant effect in determining and presenting the financial position and
the results of operations of a business organization.
Depletion is the accounting process of converting the cost of the natural resources to
expenses. Depletion is applied to the process of measuring and recording the exhaustion of
natural resources like ore deposits, oil wells etc. The difference between depletion and
depreciation is Depletion is the physical shrinkage or lessening of estimated available quantity
of the resources. Depreciation implies a reduction in the service capacity of an asset.
138
Amortisation is the accounting process of converting intangible assets to expenses. This

is used in connection with leaseholds, patents, copy rights, trade marks. Depreciation implies a
reduction in the service capacity of an asset.
Obsolescence refers to loss of usefulness arising from such factors as technological

changes, improvement in production methods, change in market demand for the product or
service output of the asset or other restrictions. So depreciation arises out of functional loss in
the physical condition of an asset but obsolescence is a loss of usefulness (asset becomes
useless) due to external conditions.
7.3 Objectives of Providing Depreciation

Depreciation is provided with various objectives. The important ones are given below:
i) To calculate correct profits: Depreciation is an invisible expenditure incurred by an

asset in earning profits and it must be debited to Profit and Loss Account. It is to be
provided for proper matching of revenues with expenses.
ii) To present the asset at its reasonable value: The charging of depreciation should
result in carrying forward that part of asset which represents the unexpired cost of expected
future service. In the absence of depreciation the assets in the Balance Sheet will not
disclose a true and fair view of the position. The assets are unnecessarily inflated.
iii) To facilitates replacement: Depreciation charged to the Profit and Loss Account is not
spent by the business. But it is retained with the object of replacing the asset.
iv) To increases cash resources: Dividend is to be declared only with the amount available
after charging depreciation. This saves cash resources of the organization and increases
its cash position.
v) To reduces tax liability: The tax rate for business is between 45% to 55%. This is charged
on profits after deducting depreciations as it is allowed as a deduction.
7.4 Causes of Depreciation

Depreciation is a permanent fall in the value of an asset. The causes of depreciation are
divided into (a) Internal causes, and (b) External causes.
Internal Causes: It arises due to the constant use of the asset. It is natural to the asset or
it may be the inherent quality of asset.
139
External Causes: It refers to operation of forces outside the asset itself.

Internal causes are (a) Wear and Tear, (b) Disuse, (c) Maintenance, and (d) Change in
production.
Wear and Tear: This arises due to constant use of asset. The loss of serviceability of the
asset due to continuous use.
Disuse: A machine may remain idle continuously for quite some time. They become
potentially less and less useful as time passes.
Maintenance: The serviceability of a machine deteriorates rapidly because of lack of

proper maintenance.
Change in Production: Either due to change in the product or change in technology of

production the asset cannot be adapted to the changes. Its future productivity is reduced.
Restricted Production: The policies of the government or shortage in the supply of

materials may restrict production. So the use of the asset is reduced.
Technological Progress: As a result of technical development new machines have been

developed that can perform more simply, quickly or more cheaply. As a usefulness of the old
machine may be seriously restricted or ceased altogether. Depletion is the exhaustion of natural
resources due to constant exploitation.
External Factors: External factors are obsolescence and Effluxion of time.
Obsolescence: It is induced by new invention, improvements, loss of demand due to

changes in fashion and due to changes in government requirements. So the asset goes out of
use or becomes obsolete.
Effluxion of Time: This means the decrease in the value of fixed assets as time elapses.
The term amortisation is generally used to indicate the fall in the value of assets like leasehold.
7.5 Factors to be Considered in Charging Depreciation
There are two important steps in charging of depreciation in accounts. They are : (a)
Calculation of the total amount of depreciation. (b) Spreading it over the economic life of the
asset. The calculation of total depreciation or its measurement is done by considering the
following factors:
(a) Total cost of the asset,

(b) Economic life of the asset, and
(c) Its residual value.
140
(i) Total Cost of the Asset : The price paid for the purchase of the assets plus
transportation, handling charges, transit insurance, installation expenses, repair costs. It exclude
financing charges on credit terms and interest on money borrowed to purchase the asset.
(ii) Economic Life of the Asset: This refers to the period of time during which the firms
expect to use the asset in the earning process. This life is shorter than its physical life as it is
subject to war and tear, the extent of use and passage of time. This may also be affected by
obsolescence, inadequacy and changing economic conditions. This may be expressed in terms
of time (months or years), output and units of measurement like kilometers or miles.
The determination of useful life is done by estimation and with the help of experts.
(iii) The Residual Value (Scrap or Salvage Value): This means the estimated sale
value of the asset at the end of its economic life. This is to be determined after deducting the
disposal and the removal cost, if any, Of installation or on subsequent occasion.
There are two methods of recording depreciation in the books:
(i) Charging depreciation to the asset, and
(ii) When provision for depreciation is maintained.
Charging Depreciation to the Asset

In this method there are two steps:
a. Charge depreciation to the Asset, and
b. Transfer of depreciation to the Profit and Loss Account useful life of the asset.
The Journal entries:
a. Depreciation A/c Dr.

To Asset A/c
(Entry for charging depreciation on asset)
b. Profit and Loss A/c Dr.

To Depreciation A/c
(Entry for the transfer of depreciation to Profit and Loss A/c)
141
1. What is depreciation?
............................................................................................................................
............................................................................................................................
............................................................................................................................
2 List out the main causes of depreciation.
............................................................................................................................
............................................................................................................................
............................................................................................................................
3. State whether each of the following statements is true or false:
(a) Depreciation is the process of apportionment of the cost of the asset over
its useful life.
(b) Depreciation facilitates the replacement of asset.
(c) Charging of depreciation increases tax liability of the business.
(d) The loss of value of the asset due to new invention, changes in technology,
loss of demand can be called obsolescence,
(e) Depreciation is calculated on current assets.
7.6 Method of Depreciation

There are various methods of charging depreciation. They are:
(i) Straight line method (ii) Reducing instalment method
(iii) Annuity method (iv) Sinking fund method
(v) Insurance policy method (vi) Revaluation method
(vii) Depletion method (viii) Machine hour method
The discussions confined to the first two methods in tune with the syllabus.
142
(i) Straight Line Method

A fixed proportizon of the original cost of the asset is written off each year. In other words,
a fixed and equal amount in the form of depreciation is written off during each accounting
period over the expected useful life of the asset.
The amount and the rate of depreciation is calculated as under:
Original cost of the asset - Residual value

a Amount of depreciation =
Expected useful life of the asset
Amount of depreciation
b. Rate of Depreciation = X 100
Original cost
Merits of this method are:
a. Easy to understand
b. Easy to calculate the amount and rate of depreciation.
c. On expiry of its useful life of the asset, Book value = Zero or Scrap value.
The demerits of their method are:
a. In reality the depreciation will be less in the initial years and may be greater in later years.
This is due to ageing of the assets. But this method of depreciation is not considering as
it charges depreciation uniformly. So it lacks realism in its approach.
b. The investment in asset ignores the calculation of interest.
c. Method not suitable to assets which render uniform service every year. Suitability: It is
suitable to those assets for whom the repair charges are less and possibility for
obsolescence is less.
Illustration 1
An asset is purchased for Rs. 25,000. Depreciation is to be charged annually according
to Straight Line method. The useful life of the asset is 10 years and the residual value is Rs.
5,000. Calculate the amount of depreciation and the rate of depreciation.
Solution
Cost of the asset - Scrap

Amount of Depreciation =
Life of the asset
25,000  5,000 20,000

   Rs.2,000
10 10
Depreciation 2,000
Rate of Depreciation = X 100  X100  8%
Cost of the asset 25,000
143
Illustration 2
A machine was purchased on 1st July, 2001 at a cost of Rs. 14,000 and Rs. 1,000 was
incurred on its installation. The depreciation is written off at 10 % on the original cost every year.
The account books are closed on 31st December every year. Machine was sold for Rs. 9,500 on
31st March 2004. Prepare Machinery Account for all the four years.
Solution
Machinery Account
Dr. Cr.
Date Particulars Rs. Date Particulars Rs.
2001 2001
July 1 To Bank A/c 15,000 Dec.31 By Depreciation A/c 750
10 6
(14,000+1,000) (15,000x x
100 12
31 By Balance c/d 14,250
15,000 15,000
2002 2002
Jan.1 To Balance b/d 14,250 Dec.31 By Depreciation 1,500
14,250 14,250
2003 2003
Jan.1 To Balance b/d 12,750 Dec.31 By Depreciation A/c 1,500

12,750 12,750
2004 2004
Jan.1 To Balance b/d 11,250 Mar.31 By Depreciation 375
15000 x 10/100 x 3/12
By Bank A/c 9,500
By P & L A/c (Balancing) 1,375

11,250 11,250
144
Illustration 3 (Sale of asset)

On 1.7.2002 ‘A’ Co. Ltd. Purchased a second hand machine for Rs. 20,000 and spent
Rs.3,000 on reconditioning and installing it. On 1.2.2003 the firm purchased a new machine for
Rs. 12,000. On 30.6.2004. Machinery purchased on 1.1.2003 was sold for Rs. 8,000 and on
1.7.04 fresh plant was installed at a cost of Rs. 15,000.
The company writes off 10% of the original cost of machinery each year. The accounts
are closed on 31st March. Prepare Machinery Account for 3 years.
Solution
Machinery Account
Dr. Cr.
2002 2003
July 1 To Bank A/c 20,000 March31 By Depreciation A/c
10 9
To Bank A/c 3,000 23,000 x x 1,725
100 12
10 3
12,000 x x 300
100 12
2003
Jan.1 To Bank A/c 12,000 By Balance c/d
On Machinery I 21,275
On Machinery II 11,700
35,000 35,000
2003 2004
April 1 To Balance b/d March31 By Depreciation A/c
Machinery I 21,275 On Machinery I 2,300
Machinery II 11,700 On Machinery II 1,200
By Balance c/d
On Machinery I 18,975
On Machinery II 10,500
32,975 32,975
145
2004 2004
April 1 To Balance b/d June 30 By Depreciation
10 3
Machinery I 18,975 12,000 x x 300
100 12
Machinery II 10,500
July 1 To Bank A/c 15,000 By Bank 8,000
By P & L A/c 2,200
(10,500-300-8,000)
2005
March31 By Depreciation A/c
Machinery I 2,300
Machinery III 1,125
By Balance c/d
Machinery I 16,675
Machinery III 13,875
44,475 44,475
(ii) Reducing Balance Method
(Other Name: Written Down value Method or diminishing balance method)
In this method the depreciation is charged on the basis of reduced value of the asset. The
amount of depreciation varies every year and it goes on decreasing as it is charged on the
carried over balance which is reducing.
Illustration 4
Motor cycle purchased on 1.1.2002 for Rs. 25,000 depreciated at 10 % on diminishing

balance method was sold on 31.12.2004 for Rs. 16,500. Prepare Motor Cycle account.
146
Solution
Motor Cycle Account
Dr. Cr.
1.1.02 To Cash 25,000 31.12.96 By Depreciation 2,500

25,000 25,000
1.1.03 To Balance b/d 22,500 31.12.03 By Depreciation 2,250
22,500 22,500
1.1.04 To Balance b/d 20,250 31.12.04 By Depreciation 2,025
By Cash 16,500
By P & L A/c 1,725
20,250 20,250
Illustration 5
Company purchased a machine on 1.1.2000 at a cost of Rs. 40,000 and spent Rs. 1,000
on its installation. Depreciation is written off at 10% on the Diminishing Balance. Accounts are
closed on 31 st December every year. Show machinery account for three years.
147
Solution
Machinery Account
Dr. Cr.
2000 2000
Jan. 1 To Bank A/c 41,000 Dec.31 By Depreciation A/c 4,100
10
(40,000+1,000) 41,000x
100
41,000 41,000
2001 2001
10
36,900x
100
36,900 36,900
2002 2002
10
33,210x
100
33,210 33,210
Difference between Straight Line Method and Written Down Value Method
You have learnt calculation of depreciation under both straight line method and written
down value method. You might have observed the differences betwee these two. The important
differences are given below:
i) Calculation: In SLM depreciation is calculated at a fixed percentage on the original cost

of asset. In WDV depreciation is calculated at a fixed percentage on Written Down Value
of the asset.
ii) Amount of Depreciation: Amount of depreciation remains fixed for every year in SLM
but in WDV it keeps on decreasing from year to year.
148
iii) Scrap Value: In SLM at the end of the life of the asset the written down value becomes
equal to scrap value or zero whereas in WDV at the end of useful life of the asset written
down value never becomes zero.
iv) Other Names: SLM known as fixed installment method or constant charge method as
the amount of depreciation is fixed. WDV is called as Diminishing Balance method or
Reducing Installment on depreciation is fixed. WDV is called as Diminishing Balance
method or Reducing Installment method. Depreciation keeps on decreasing every year
under this method.
v) Calculation: In SLM rate of depreciation can be calculated easily. In WDV rate of

depreciation calculation is difficult as it involves the use of logarithm tables.
vi) Depreciation and Repairs Mix: In SLM with the ageing of the asset repair increases but
depreciation decreases as against more depreciation and less repairs in the initial years.
So the total charge of both to Profit and Loss Account is almost the same.
vii) Suitability: SLM is suitable for assets in which repair changes are less and the possibility
for obsolescence is less. WDV is suitable for assets which are affected by technological
changes with more repairs with the passage of time.
Illustration 6 (Problem with both methods of depreciation)

On 1-4-1999, a company purchased a machinery for Rs. 1,00,000. On 1.10.99 additions
were made to the extent of Rs. 20,000. On 1.8.2001 further additions were made to the extent
of Rs. 12,800. On 30th Oct.2002 machinery whose original value was Rs. 16,000 on 1.4.99 was
sold for Rs. 12,000. The books of accounts were closed on 31 st March every year. Prepare
Machinery A/c from 1999 to 2003 in the books of X if depreciation is charged at 10%.
(i) On Original cost of the asset (SLM) (ii) On written value of the asset (WDV)
149
Solution
In the books of X
Machinery Account
Dr. Cr.
1999 2000
April 1 To Bank A/c 1,00,000 March31 By Depreciation A/c 10,000
1,00,000 1,00,000
2000 2001
April 1 To Balance b/d 90,000 March31 By Depreciation A/c
Oct. 1 To Bank A/c 20,000 Machinery I 10,000

Machinery II 1,000
By Balance c/d
Machinery I 80,000
Machinery II 19,000
1,10,000 1,10,000
2001 2002
Machinery I 80,000 Machinery I 10,000
Machinery II 19,000 Machinery II 2,000
Aug. 1 To Bank A/c 12,800 Machinery III 853

By Balance c/d
Machinery I 70,000
Machinery II 17,000
1,11,800 1,11,800
150
2002 2002
April 1 To Balance b/d Oct.30 By Bank A/c 12,000
Machinery I 70,000 (Sales of Asset)
Machinery II 17,000 By Depreciation A/c 933

Machinery III 11,947 (for 7 months)
Oct.30 To P & L A/c 1,733 2003

(profit on sale) March31 By Depreciation A/c
Machinery I 5,880
(70,000-11.200)@ 10%
Machinery II 2,000
Machinery III 1,280
March31 By Balance c/d

Machinery I 52,920
Machinery II 15,000
1,00,680 1,00,680
Working
Calculation of Profit on Sale
Rs. Rs.
Cost Price of the Asset on 1.4.99 16,000
Less: Depreciation @ 10% for 3 years, 1,600x3 4,800
Depreciation for 7 months in 2002 933 5,733
Book value on 1.10.2002 10,267
Sale Price 12,000-10.267 = Rs. 1,733 Profit

151
Written Down Value Method

Machinery Account
Dr. Cr.
1999 2000
April 1 To Bank A/c 1,00,000 April 1 By Depreciation A/c 10,000
1,00,000 1,00,000
2000 2001
April 1 To Balance b/d 90,000 March31 By Depreciation A/c
Oct. 1 To Bank 20,000 Machinery I 9,000
Machinery II 1,000
(for 6 months)
By Balance c/d
Machinery I 81,000
Machinery II 19,000
1,10,000 1,10,000
2001 2002
Machinery I 81,000 Machinery I 8,100
Machinery II 19,000 Machinery II 1,900
Aug. 1 To Bank A/c 12,800 Machinery III 853
By Balance c/d
Machinery I 72,900
Machinery II 17,100
1,12,800 1,12,800
2002 2002
Apr. 1 To Balance b/d Oct.30 By Bank A/c 12,000
Machinery I 72,900
Machinery II 17,100 By Dep., A/c 680
Machinery III 11,947 By Dep., A/c

152
Oct.30 To P & L A/c 1,016
Machinery I 6,124
Machinery II 1,710
2003 Machinery III 1,195
March 31 By Balance c/d
Machinery I 55,112
Machinery II 15,390
1,02,963 1,02,963
Working
Calculation of Profit on Sale

Rs. Rs.
Book Value of Machinery on 1.4.99 16,000
Less: Depreciation at 10% 1 Year 1,600

II Year 1,440
III Year 1,296
for 7 months on Oct. 30th 680
5,016
Book value on 30.10.2003 10,984
Sale Price 12,000
Less: Book value 10,984
Profit on Sale 1,016

153
Illustration 7
On 1st January 2002 the machinery account of Raman Brothers showed balance of Rs.
80,000 and provision for depreciation was presented at Rs. 36,000. On 1.1.2002 they decided
to sell a machine for Rs. 8,700. This machine was purchased for Rs. 16,000 in January 1998.
Prepare Provision for Depreciation account and Machinery account on 31 st December

2002 assuming the firm has been charging depreciation at 10% p.a. on Straight Line Method.
Solution
In the Books of Raman Brothers

Machinery Account
Dr. Cr.
1999 2000
Jan. 1 To Balance b/d 80,000 Jan.1 By Bank A/c (sale) 8,700
By Provision for
Depreciation A/c 6,400
By P & L A/c (Loss on sale) 900
80,000 80,000
Provision for Depreciation Account
Dr. Cr.
1999 2000
Jan. 1 To Machinery A/c 6,400 Jan.1 By Balance b/d 36,000
Dec. 31 To Balance c/d 36,000 Dec.31 By Depreciation 6,400
42,400 42,400
(a) This account will appear as the liability side of Balance Sheet during the life time of the
asset.
(b) In case of sale of asset provision for depreciation will be transferred to the Asset Account.
154
(iii) Annuity Method

The straight line method and written down value method ignore the interest factors. The
Annuity method takes into accout this factors. Under this method, depreciation is charged by
taking not only the cost of the asset but also the interest thereon at an accepted rate. The term
‘Interest’ here referes the interest which the business could purchase of asset would have been
invested in some other form of investment. The amout of depreciation is computed with the
help of annuity table.
(iv) Depreciation method or sinking Fund methods
According to this method, the amount of depreciation charged on the profit and loss
account is invested in some securities carrying a particular rate of interest. The interest received
from these securities are also invested along with the depreciation charged from period to
period. When the asset is completely written off or when the replacement is required the securities
are sold in the market and the amount so realised is utilised for replacing the old asset by new
one. Thus, this method helps the business to procure new asset when the life of old asset
expires.
(v) Insurance policy method
This is similar to the depreciation fund method. However, the amout charged in the form
of depreciation is not invested in securities, but used for paying premium to an insurance policy
taken for this purpose. When the policy mature (or at the end of specified period), the insurance
company pays the agreed amount. That amout can be utilised for purchasing a new asset.
(vi) Revaluation method
This is most appropriate method for providing depreciation on lease hold property. Under
this method the assets are revalued at the end of the accounting period. And later this is compared
with the value of the asset at the beginning of the year. The difference is treated as depreciation.
(vii) Depletion method
This method is suitable for mines, queries etc., where it is possible to estimate the total
output likely available. Depreciation is computed per unit of output.
155
(viii) Machine hour method

This method is suitable for charging depreciation on plant and machinery, air-crafts etc.,
It takes into account the running time of The asset for computng the amount of depreciation. It
is also called as service Hours Method.

1. Write a short note on straight line method of depreciation
............................................................................................................................
............................................................................................................................
............................................................................................................................
2. What do you understand by reducing balance of method of depreciation?
............................................................................................................................
............................................................................................................................
............................................................................................................................
3. State whether each of the following statements is True or False?
(a) In case of Straight line method (SLM) depreciation is charged evenly
every year throughout the effective life of the asset.
(b) Depreciation is charged on the book value of the asset each year in case
of diminishing balance method.
(c) The value of the asset can be reduced to zero under diminshing balance
method.
(d) Diminishing balance method is suitable method when the possibility of
obsolescence is less .
(e) The amount of depreciation goes on decreasing in case of straight line
method.
(f) The appropriate method for providing depreciation is revaluation method.
(g) Depletion method is unsuitable for charging depreciation in case of live
stock or loose tools.
(h) The interest lost on acquisition of an asset is taken into account in
calculating depreciation in case of Annuity method.
(i) In case of Insurance policy method, the depreciation is credited to the
Asset Account.
156
7.7 Reserves and Provisions
Let us discuss the meaning of reserve first.
Reserve
It is that part of profit which is retained in the business to meet some known or unknown
objects. It is not designed to meet any liability’ or contingency known to exist at the date of the
Balance Sheet. This refers profits retained in the business and used for meeting emergencies.
Its features are:
(a) It is an appropriation of profits.

(b) It is created out of current years profits or out of accumulated profits.
(c) It is created to meet known or unknown contingencies.
(d) It is not obligatory on the part of the management to create a reserve as it is a matter of
business policy.
Reserves are broadly classified into (a) Capital reserve, and (b) Revenue reserve.
Capital reserve : It does not include any amount regarded as free for distribution of profits. So
this is not available for distribution of dividend as it is of capital structure. This arises out of the
following:
(a) Profit on revaluation of assets and liabilities.

(b) Profits prior to incorporation of companies.
(c) Premium on issue of shares and debentures.
(d) Profit on sale of fixed assets.
(e) Profit on re-issue of forfeited shares.
These profits are used for writing off intangible assets, preliminary expenses, discount on
issue of shares and debentures, underwriting commission or to meet capital losses, Capital
reserve is created out of capital profits and used for writing off of capital losses. Reserve capital
is that portion of capital of a company that has set a side to be called up only on winding up of
the company.
Revenue reserve: Implies any reserve, which is not a capital reserve and this created by
transferring from Profit and loss appropriation account. The types of revenue reserve are: (a)
General Reserve, (b) Specific Reserve, (c) Secret Reserve, (d) Reserve fund, and (e) Sinking
fund.
157
General reserve : It is created by appropriation of profits. This reserves is not created with any
specific purpose. Normally this is used for meeting any unknown liability. This is created only
when sufficient profits are available. This is also known as free reserve.
The objects of creating free reserves are:
(a) To strengthen the liquid resources of the business.
(b) To make additional working capital.
(c) To meet any known/unknown liability or contingency.
(d) For equalize dividends in the lean years.
(e) To minimize the declaration of dividend in fat years.
Specific reserve: It is created for some specific purpose. It is created by debiting Profit and
Loss Appropriation Account. Normally it is available for the purpose of its creation. After meeting
the purpose it may be used for some other purpose.
Secret reserve: It is a reserve whose existence or the amount of which cannot be disclosed by
the balance sheet. This is created in those organization where public confidence is required.
Banking companies, Electricity companies and Insurance companies are some examples of
organisations in which secret reserves are created.
The objects of creating secret reserves are:
(a) To make the organization strong and stable.
(b) With the objects of concealing their presence from the eyes of competitors.
(c) To maintain uniform rate of dividend in all years.
The methods of creating secret reserves are:
(a) By providing excessive depreciation on assets.
(b) By making excessive provision.
(c) By evaluation of liabilities.
(d) By charging capital expenditure of the business as revenue.
Sinking Fund : This is created to have ready money after a particular period. The object is
either for the replacement of an asset or for the repayment of liability. Every year some amount
is charged or appropriated from the Profit and loss Account and is invested in outside securities.
158
At the end of the stipulated period the securities realized and with the available money
replacement of an asset or redemption of liability takes place.
The features of a sinking fund are:
(a) It is always specific, not general.
(b) It is created by setting aside a certain amount on yearly basis.
(c) It is created for specific object either for replacement of an asset or redemption of liability.
(d) Money set aside is invested in outside securities.
Provisions
Provisions are amount charged against revenue to provide for:
(a) Depreciation, renewal or reduction in the value of assets.
(b) Known liability, the amount which cannot be determined with substantial accuracy, and
(c) A disputed claim.
Difference between Reserves and Provisions

You have learnt the features of different types of reserve and provisions in the previous
paragraphs. Now you can learn the basic differences between reserves and provisions.
The differences between reserves and provisions are given below:

(a) Nature: Reserve is an appropriation of profit. Provision is a charge against profits.
(b) Object: Reserve is created to unforeseen liabilities and to strengthen the financial position
of the organization. Provision is created to meet a specific liability.
(c) Investment : Reserve can be invested outside the business. Provision cannot be invested
outside the business.
(d) Purpose: A reserve can be created with no specific purpose. A provision is to be created
with specific purpose.
(e) Creation: A reserve can be created only when there are profits. A provision is to be
charged ever! if there is no profit.
159
(f) Presentation: A reserve is presented in the liabilities side of Balance Sheet. A provision
can be presented on both sides of Balance Sheet.
(g) Profits: Reserve reduces divisible profits. Provision reduces net profits.
(h) Use: A reserve unused for a long time can be used for the issue of bonus shares or
declaration of dividend. A provision cannot be used as such.
Illustration 8
The following information was available from the books of accounts of an organisation.
Balance of Provision for Repairs and Renewals account on 31.3.2000 was Rs. 75,000
Actual repairs during the year ended 31-3-01 to Rs. 50,000 and 31-3-2002 Rs. 30,000.
The company makes an annual transfer of Rs. 40,000 to the Provision for Repairs
and Renewals account. Prepare the Provision for Repairs and Renewals account for the 31st
March 2001 and 2002.
Solution
Provision for Repairs and Renewals A/c
Dr. Cr.
1999 2000
Mar. 31 To Rep. & Ren. A/c 50,000 Apr.1 By Balance b/d 75,000
To Balance c/d 65,000 2001

Mar.31 By Profit and Loss A/c 40,000
1,15,000 1,15,000
2002 2001
Mar.31 To Rep. & Ren.A/c 30,000 Apr. 1 By Balance b/d 65,000

Mar.31 By Profit and Loss A/c 40,000
1,05,000 1,05,000
160
Illustration 9
On 1.1.2002, a Company had a bad debts provision of Rs. 14,000. Bad debts during the
year amounted to Rs. 11,000. The debtors amounted to Rs. 2,50,000. It is the practice of the
company to maintain a provision for bad debts at 5%. During the year 2003, 2004 bad debts
amounted Rs. 14,000 and Rs.5,200
Prepare necessary ledger account.
Solution
Dr. Cr.
1999 2000 ` Dec.31
To Sundries 11,300 Dec.31 By Provision for 11,300
Bad Debts
11,300 11,300
2003 2003
Dec.31 To Sundries 14,000 Dec.31 By Provision for 14,000
Bad Debts
14,000 14,000
2004 2004
Dec. 31 To Sundries 5,200 Dec.31 By Provision for 5,200
5,200 Bad Debts 5,200

Dr. Cr.
1999 2000
Dec.31 To Bad Debts 11,300 Jan.1 By Balance b/d 14,000
Dec.31 By Profit and Loss A/c 12,500
26,500 26,500
2003 2003
Dec.31 To Bad Debts 5,200 Jan.1 By Balance b/d 18,700
To Balance c/d 22,000 Dec.31 By Profit and Loss A/c 8,500
27,200 27,200
2003
Jan.1 By Balance b/d 22,000
161
7.8 Summary
Depreciation is a gradual, permanent and continous fall in the value of a fixed asset due
to wear and tear, passege of time and obsolescence. Depreciation is calculated to ascertain the
correct profit of the business. There are various causes of depreciation. The causes may be
classified as internal causes and external causes. Internal causes refer to causes that arise
due to constant use of asset. External causes refer to the operation of forces outside the asset
itself. There are various methods of charging depreciation. They are: (a)Straight line method,
(b) Annuity method, (d) Sinking fund method (e) Insurance policy method (f) Revaluation method
(g) Depletion method and (h) Machine hour method.
7.9 Key Words

Depreciation : It is a gradual, permanent and continous fall in the value of a fixed asset
due to wear and tear, passege of time and obsolescence.
Depletion : It is an accounting process of converting the cost of natural resources

to expenses.
Amortisation : It is the accounting process of converting intangible assets to expenses.

1. What are the causes of Depreciation?
2. What are the factors to be considered for charging depreciation?
3. How the profit/loss on sales of assets is calculated?
4. A company purchased a Machinery for Rs. 1,00,000. the useful life of the machinery is 10
years and the residual value is Rs. 20,000. Find out the rate of depreciation under straight-
line (Ans. Rs.8,000, 8%)
5. Machinery purchased on 1 st July 2000 at a cost of Rs. 14,000 and Rs. 1,000 was spent
on its installation. The depreciation is written off at 10% on original value every year. The
books are closed on 31 st December each year. The machine was sold for Rs. 9,500 on
31 st march 2003. Show Machinery A/c for all the year. (Ans:
Loss on sale Rs.250)
162
6. On 1.1.98, X Itd. Purchased a machine for Rs. 9,000 and spent Rs. 1,000 for erection
charges. After using the machine for 3 years, it was sold for Rs. 8,500. Depreciation is
charged
7. A firm purchased plant and machinery on 1 st July 2002 for Rs. 90,000 and incurred Rs.
10,000 on its erection expenses. Depreciation is written off at the rate of 10%. The firm
closes its books on 31 st december each year. show the machinery a/c upto 31 st dec.2004
under straight line method.
(Ans: Balance on 31 st Dec.2004 Rs.75,000)
8. On 1.1.2000, a company purchases machinery worth Rs. 1,00,000. On 1 st July 2001 it

buys additional machinery worth Rs. 50,000 and spends Rs. 5,000 on its erection. The
account are closed on 31 st December Annual depreciation 10%. Show the machinery A/
c for 3 years under straight line method.
(Ans: Depreciation Rs.10,000, Rs.12,750, & Rs.15,500)
Straight Line Method

9. An asset purchased for Rs.25,000. Depreciation is to be provided annually according to
straight line method. The useful life of the asset is 10 years and the residual value is Rs.
5,000. Calculate the rate of depreciation prepare asset account for first three years.
(Ans: 8%; Asset A/c Balance Rs. 19,000)
10. A machine was purchased for Rs. 30,000 on 1.1.2000. This is expected to last for 5
years. Estimated scrap value is Rs. 5,000. Calculate the rate of depreciation and the
amount of deprecation. Prepare the assets account for two years.
(Ans: Depreciation Rs.5,000; Rate of Depreciation 16.67%)
11. On 1.1.2003, the balance in machinery account was Rs.1,80,000. On 30-6-2003, a

machine was purchased for Rs.20,000. On 31-12-2003, a machine was sold for Rs.4,200,
which was purchased for Rs, 4,000 on 1.1.2003. On 31-12-2004, a machine purchased
on 1.1.2003 for Rs. 12,000 was sold for Rs. 8,000. Depreciation is to be provided at 10%
p.a. on S.L.M. Prepare Machinery Account for 2003 and 2004.
(Ans: Machinery Account Balance on 2004 Rs. 1,48,200)
I profit on Save of Ist machine Rs. 600 ii) IInd machine loss Rs. 1600
163
12. A company whose accounting year is the calendar year purchased on 1.4.2002, machinery
costing Rs.30,000. It purchased further machinery on 2 st October 2002 costing Rs.20,000.
Additions were on 1 st Ju2003. for Rs.10,000. On 1.1.2004 one-third of the machinery
installed on 1.4.2002 was sold for Rs.3,000. Prepare machinery account for three years
from 2002 to 2004. Depreciation is charged at 10% p.a.
(Ans: Loss on sale of Machinery Rs.5,250; Balance on 31.12.2000 Rs.38,500)
13. Mr. X purchased a second hand machine for Rs.8,000 on 1.4.2000. He spent Rs. 3,500
on repairs and installation. Depreciation is written off @ 10% on original cost. On
30.6.2003, the machine was found unsuitable and sold for Rs.6,500. Prepare the asset
account from 2000 to 2003 assuming that the accounts were closed on 31 st December
every year.
(Ans: Loss on sale Rs. 1,262.50)
Written Down Value Method
14. A company purchased a second hand plant for Rs. 30,000. It immediately spent on it
Rs.5,000. The plant was put to use on 1.1.97. After having used it for 6 years it was sold
for Rs. 15,000. You are required to prepare the plant account for all the six years providing
depreciation at 10% p.a. on W.D.M.
(Ans: 2002 Loss on Sale Rs.3,600)
15. Machinery Account Stood in the books of a company as:
Balance as at 1.1.2000 Rs.14,900. Purchase of machinery on 1.7.2000 Rs.4,400. Sale

of machinery on 1.10.2000 Rs. 1,000. The original cost of machinery sold was Rs. 6,000.
On 1.7.1997, depreciation was charged at 10% on W.D.V Prepare machinery account in
the books of the company for the year 2000. Account were closed on 31 st December
each year.
(Ans: Loss on Sale Rs.3,271)
16. A company acquired a machine on 1.4.2000 at a cost of Rs.40,000 and spent Rs.1,000
on its installation. The firm writes off depreciation at 10% on diminishing balance. The
books are closed on 31 st March each year. Show machinery account for 3 years.
(Ans: Balance on Machinery Account 29,889)

164
17. A company purchased a machinery for Rs.30,000 and immediately spent Rs.5,000 on
repairs. It was put to use on January 2000. In the third year, it was sold for Rs.15,000.
Prepare asset account for three years providing depreciation at 10% on diminishing
balance. Accounts are closed on 31 st December.
(Ans: Loss on sale Rs.3,600)
18. A company whose accounting year is the Financial year purchased on 1.4.2002 machinery
costing Rs.30,000. It purchased further machinery on 1.10.2002 costing Rs.20,000 and
on 1 st July 2003 costing Rs.10,000. On 1 st January 2004, one-third of the machinery
which was installed on 1.4.2002 become obsolete and sold for Rs.3,000. Show how
machinery account would in the books of the company assuming depreciation was charged
@ 10% p.a. on W.D.V.
Change in Method
19. The balance in the machinery account stood at Rs. 81,000 after providing depreciation
using written down value method at 10% for two years up to 31.3.2003. On this date it
was decided to change the method to original cost from the date of purchase at 10% p.a.
Prepare Machinery Account for 2001 – 02 to 2004-2005.

A. 3 (a) True (b) True (c) False (d) True (e) False
B. 3 (a) True (b) True (c) False (d) False (e) False
(f) True (g) True (h) True (i) False
165
UNIT 8
INSURANCE CLAIMS
Learning Objectives
After studying this unit, you should be able to :
 discuss the need of an undertaking to take a fire insurance policy
 compute the amount of loss of stock after a fire accident
 compute at the amount recoverable from the insurance company
 pass necessary accounting entries against a policy for loss of stock
 explain the meaning of certain accounting terms.
Structure
8.1 Introduction
8.2 Meaning and concepts
8.3 Need for Fire Insurance
8.4 Nature of Fire Insurance Claim
8.5 Type of Fire Insurance Policies
8.6 Computation of Total Stock and Claim
8.7 Factors that Affect the Amount of Claim for Loss of Stock
8.8 Accounting Entries for a Fire Claim
8.9 Illustrations
8.10 Summary
8.11 Key Words

166
8.1 Introduction
In the course of running the business, a businessman is exposed to a number of risks
such as fire, burglary, accidents, etc. Out of all these risks, the fire risk is the most dangerous.
In case it goes out of control, it may involve loss both in terms of property as well as human
lives. A prudent businessman secures himself against such losses by taking a proper insurance
policy. Such policy is usually taken for two types of losses: (i) Loss to the property such as
stock, plant, buildings, etc. and (ii) Loss of profits on account of dislocation of the business.
In the present unit, we are mainly concerned with estimating the amount of loss of stock on the
date of fire and arriving at the claim recoverable from the insurance company against the
stock loss on account of fire.
8.2 Meaning and Concepts

In order to understand this unit better, you should be familiar with some terms relating to
insurance. In this section, the important concepts are explained.
8.2.1 Insurance Contract

Under an insurance contract, one party, called insurer, undertakes to indemnify the losses
suffered by the other party, called insured, for some specified causes in consideration for a
fixed premium. The document that contains terms of insurance contract is called Insurance
Policy.
8.2.2 Types of Insurance

Insurance is basically of two types – Life Insurance and General Insurance. Life Insurance
Policy covers the life risk of the insured (or assured) up to the policy amount. General Insurance
means insurance other than Life Insurance. Sec 2(6B) of the Insurance Act defines ‘General
Insurance Business as fire, marine or Miscellaneous Insurance Business whether carried on
singly or in combination with one or more of them. An important feature of the General Insurance
Policy is that the insured gets compensation only in case of loss sustained by him due to
reasons specified in the policy.
8.2.3 Meaning of ‘Fire’

For purposes of insurance, fire means:
167
(i) Fire (whether resulting from explosion or otherwise) nor occasioned or happening through:
(a) Its own spontaneous fermentation or heating or its undergoing any process involving
the application of heat;
(b) Earthquake, subterraneous fire, riot, civil commotion, war, invasion, act of foreign
enemy, hostilities (whether war be declared or not), civil war, rebellion, revolution,
insurrection or military or usurped power:
(ii) Lightning
(iii) Explosion, not occasioned or happening through any of the perils specified in 1 (a)
above;
(a) of boilers used for domestic purposes only;
(b) of any other boilers or economizers on the premises;

(c) in a building not being any part of any gas works or gas for domestic purpose or
used for lighting or heating the building.
The policy of insurance covers any of the excepted perils by agreement. In certain cases,
some extra premium is payable by the insured. Usually, fire policies covering stock or other
assets do not cover explosion of boilers used for domestic purposes or other boilers or
economizers on the premise.
8.3 Need for Fire Insurance

Now you can learn the need for a fire insurance policy to a business man.
Fire, in the business premises of any firm, can damage a number of assets like stock,
buildings, furniture, fixtures, machinery etc. In addition, the normal working of a firm is affected
for a number of days or months, resulting in loss of sales and loss of profits. It is very difficult for
a business to replace all the destroyed assets and normalize its working without affecting its
working capital position and cash position. During such difficult times, external help is like a
boon to the business. All prudent business undertakings insure their stock and also other assets
against the risk of fire. They take appropriate insurance policy from a recognized company by
paying required premium. This enables the business to lodge claim, against insurance company
and receives sufficient funds to replace the
lost assets. Insurance companies investigate any claim made through experienced assessors’.
They evaluate the causes for fire and the actual loss through the damage. Based on the
assessor’s report, insurance company settles the claim made against it for loss due to fire.
168
8.4 Nature of Fire Insurance Claim

After understanding the purpose of fire insurance policy , let us know the purpose for
which claim is insured. An undertaking takes a fire insurance policy to cover the loss of:
(i) existing assets including stock, and (ii) prospective profit in consequence of fire. On
the occurrence of the loss the insured claims from the insurer for indemnification. The latter
then settles the claim in the light of experts i.e. (loss assessors’) report as to the circumstances
of the fire and the extent of damage. The claimer faces little difficulty in determining the claim
for loss of those items whose records are maintained by him. But complication arises over the
loss of (i) stock as usually no inventory record is kept, and (ii) post – fire profit due to sudden
distress of the firm.
8.5 Types of Fire Insurance Policies

Now let us come to know the types of policies issued by fire insurance companies.
There are two major types of policies issued by insurance companies: (i) Loss of stock
policies, and (ii) Loss of profits or consequential loss policies.
1. Who are the parties to an insurance contract?

.............................................................................................................................
.............................................................................................................................
.............................................................................................................................
2. Why should a businessman take a fire insurance policy?
.............................................................................................................................
.............................................................................................................................
.............................................................................................................................
3. When does an insurance company indemnify the loss of the insured?
.............................................................................................................................
.............................................................................................................................
.............................................................................................................................
169
8.6 Computation of Total Stock and Claim

Claim for loss of stock depends upon actual loss of stock due to fire. Actual loss of stock
is equal to “Total stock on the date of fire less stock saved of fire.” Therefore, in order to lodge
the claim, it is essential to calculate:
(i) Total stock in the shop on the date of fire, and
(ii) Stock salvaged or saved.
When fire occurs, some stock is completely destroyed, while some stock may be partially
damaged. This partially damaged stock is assessed by assessor of the insurance company
and the goods are usually allowed to be kept with the insured at an agreed value. These goods
are called “goods or stock salvaged.”
Total stock is equal to stock in the beginning plus purchases (from the beginning of
accounting year to the date of fire) less cost of goods or stock sold (from the beginning of
accounting year to the date of fire). Cost of stock sold is calculated by deducting gross profit
from sales. Thus, this may be just in the form of trading account as under.
Proforma Trading Account
Dr. Cr.
Rs. Rs. Rs.
To Stock in the beginning xxx By Sales xxx
To Purchases xxx
Less Returns outwards xxx

xxx By Stock on the date of fire xxx
(Balancing figure)
To Gross Profit xxx
xxx xxx
170
For the preparation of the above proforma trading account, figures for
(i) Stock in the beginning
(ii) Purchases and
(iii) Sales up to the date of fire
can be found out from the subsidiary books or accounts of the business.
Opening stock is the same as the closing stock of the last period. In case where all the
accounting records are destroyed by fire, then details can be collected from sources such as
income tax returns, copies of invoices from suppliers, bank statements, records of other parties
etc. Sometimes, even circulars may be sent to customers and suppliers to ascertain the amount
of purchases and sales. In examination questions sometimes, figures of purchases and sales
are not given but details about debtors and creditors are provided. With the help of these
details, students can prepare total debtors account and total creditors account to ascertain the
figures of credit sales and credit purchases respectively in the following manner:
Dr. Cr.
Rs. Rs.
To Balance (Opening) xxx By Bank xxx
To Sales (Balancing Figure) xxx By Return inwards xxx
By Discounts xxx
By Bad debts xxx
By Bills receivable xxx
By Balance c/d (closing) xxx
Total xxx Total xxx
Total Creditors Account

Dr. Cr.
Rs. Rs.
To Bank xxx By Balance (Opening) xxx
To Discount xxx By Purchases xxx
To Returns outwards xxx (Balancing figure)
To Bills Payable xxx
To Balance c/d (closing) xxx
Total xxx Total xxx
171
In the proforma trading account, gross profit can be calculated with help of sales and
rate of gross profit on sales or turnover which are given in the question. Rate of gross profit is
given sometimes on sales and sometimes on cost. In case it is given “on cost”, then it must be
converted to “on sale”. In case no rate is given, then it must be calculated by preparing the
trading account of the preceding year or years. The following formula is used for its calculation:
Gross Profit
Rate of gross profit on sales = ————————— X 100
Sales
When the insured files the claim with the insurance company and the insurance company
admits the claim after proper assessment and valuation, it makes payment for the loss claimed
and admitted. After making the payment, the insurance company has the same rights which the
insured had over the salvaged or saved stocks. These are subrogated to the insurers. In practice,
as said earlier, in determining the amount of the claim, credit is given for damaged or saved
stock.
8.7 Factors that affect the amount of Claim for Loss of Stock
The amount of claim for loss of stock to be filed with the insurance company depends on
two important factors. These two factors are explained briefly below:
8.7.1 Rate of Gross Profit

For determination of the loss of stock, the information regarding cost of sales is necessary.
This can be ascertained by deducting the amount of “gross profit” from the “sales” made by the
business. The rate of gross profit can be ascertained on the basis of the performance of the
business during the preceding 3-4 years. While calculating such rate of gross profit, any abnormal
factor affecting the rate of gross profit should be ignored. For example, , if certain damaged
goods had to be sold away at a price lower than the cost of sale of such goods, they need not
be considered for the purpose of determination of the rate of gross profit. More over, if the gross
profit percentage is showing a definite trend (for example, 5 percent in the first year, 10 percent
in the second year, 15 percent in the third year), it will be appropriate to use the weighted
average method for finding out the average rate of gross profit.
172
8.7.2 Average Clause

In order to discourage under-insurance, usually the “average clause” is inserted in all
contract of fire insurance. The object of inserting such a clause is to limit the liability of the
insurance company to that proportion of the actual amount of loss which the insured amount
bears to the actual value of the property. For example, stock worth Rs. 40,000 is insured only
for Rs. 30,000 and if the loss amounts to Rs.18,000 the claim admitted by the insurance company
will be as follows:
Amount of policy
Amount of claim = ———————————— x Actual loss of stock
Stock on the date of fire
= 30,000 x 18,000 = 13,500
40,000
It is to be noted that the average clause comes into play only if it is proved that loss
sustained by the insured is less than the sum insured. When the loss is more than the sum
insured, the insured can recover the whole amount in spite of the average clause.
8.8 Accounting entries for a Fire Claim

The following are the specimen journal entries to be passed in relation to loss of stock .
Distinction has to be made between stock fully destroyed without recovery value and
stock damaged with recovery value.
1. When claim is admitted by the insurance company.
Insurance Company a/c Dr. xxx

(Amount of claim admitted)
To Stock destroyed a/c xxx
To Stock damaged a/c xxx
(Being claim admitted for stock destroyed and damaged)
2. For actual cost of the stock destroyed and damaged.
Stock destroyed a/c Dr. xxx

Stock damaged a/c Dr. xxx
To Trading a/c xxx
( Being cost of stock destroyed and damaged due to fire)
173
3. When damaged goods are sold
Bank a/c Dr xxx

( Being sale of damaged goods )
Any balance in the stock destroyed and damaged accounts has to be transferred to profit
and loss a/c
4. Profit and loss a/c Dr xxx

To Stock destroyed a/c xxx
(Being net loss due to fire)
5. For receiving cash from insurance company
Bank a/c Dr xxx

To Insurance Company’s A/c xxx
(Being amount of claim received)

1. When is it easy for the claimer to determine the claim for loss of stock?
..............................................................................................................................
..............................................................................................................................
..............................................................................................................................
2. State the two major types of policies issued by the fire insurance
companies.
..............................................................................................................................
..............................................................................................................................
..............................................................................................................................
3. Why does an insurance company incorporate an average clause in a fire
insurance
..............................................................................................................................
..............................................................................................................................
..............................................................................................................................
174
8.9 Illustrations
When Gross Profit Ratio is given
Illustration 1
A fire occurred at the premises of a trader on 31.5.04 destroying a great part of his goods.
His stock at 1.1.04 was Rs.60, 000. The value of stock salvaged was Rs.13,500. The gross
profit on sales was 30% and sales amounted to Rs.1,53,000 from January to date of fire, while
for the same period the purchases amounted to Rs.1,03,500. Prepare a statement of claim.
Solution
Hints
(i) Calculate gross profit on sales with the gross profit rate given.
(ii) Bal. Fig. in the trading account is the stock on the date of fire.
(iii) Stock is fully insured. Do not apply average clause.
Memorandum Trading A/c for the period ended 31.5.04
Particulars Amount Particulars Amount

Rs. Rs.

“ Stock on the date of
fire (Bal. Fig.) 56,400
“ Purchases 1,03,500
“ Gross Profit c/d

(1,53,000 x 30%) 45,900
2,09,400 2,09,400
Claim for loss of stock

Rs.
Stock on the date of fire 56,400
Less: Stock salvaged 13,500
Claim to be lodged 42,900
175
Illustration 2
Calculate Insurance Claim from the following facts assuming that the insurers met their
liability under the policy on “Average basis “
A trader stock valued at Rs.40, 000 was totally destroyed. The stock in the gowdon was
insured for Rs.30, 000 subject to average clause. The balance of stock, left after fire, appeared
in the books at Rs.24, 000.
Solution
Hints
(i) Stock lost in fire given Rs.40, 000.
(ii) Stock left after fire given Rs.24, 000.
(iii) Therefore, stock on the date of fire is Rs. 64,000.
Amount of policy
Amount of claim = X Actual Loss of Stock
30,000
= x 40,000 = Rs. 18,750
64,000
Illustration 3
A fire occurred in the premises of Mr. Dheenadayalan on 15th of August 2005. A large
part of the stock was destroyed and Rs.7, 500 was realized for the salvage. For the period from
1st January 2005 to 15th August 2005, the following information is available :
(i) Purchases amounted to Rs 42,500
(ii) Sales amounted to Rs. 45,000
(iii) Stock on hand on 1st January 1995 was Rs.20,000 at cost price.
(iv) Goods costing Rs. 2,500 were taken by Mr. Dheenadayalan for his personal use.
The previous accounts revealed that the rate of gross profit was 33 1/3% on sale. The
insurance policy was for Rs. 25,000 and included an average clause. Prepare the statement of
claim to be made to the insurance company.
Solution
Hints
(i) Apply gross profit rate on sales.
(ii) Deduct salvage from the stock on the date of fire to arrive at actual loss of stock.
(iii) Apply average clause formula, for calculating amount of claim.
176
Memorandum Trading A/c for the period ending 15-8-2005

Rs. Rs.
To Opening Stock 20,000 By Sales 45,000
“ Purchases 42,500 “ Stock on the date of

Less: Drawings 2,500 40,000 fire (Balancing figure) 30,000
To Gross Profit
(45,000 x 33 1/3 / 100) 15,000
75,000 75,000
Calculation of actual loss of stock

Rs.
Less: Salvaged stock 7,500
Loss of stock 22,500
Amount of policy
25,000
= x 22,500 = Rs. 18,750
30,000
Illustration 4
A trader asks for your help in preparing an insurance claim in respect of stock in trade
destroyed by fire in his warehouse on June 1st 2005.
His books of accounts give the following information concerning trading account
transactions for the period January 1st to June 1st 2005.
Balance of stock, January 1st 2005 at cost Rs.26, 000

177
Rs.
Debtors on 1-1-2005 50,000

Debtors on 1-6-2005 80,000
Cash received from debtors 60,000
Discount allowed debtors 10,000
Cash Purchases 10,000
Cash paid to suppliers 67,000
Creditors on 1-1-2005 16,000
Creditors on 1-6-2005 18,500
The rate of gross profit on cost is 25%
Calculate the amount of claim taking into account the goods salvaged from the fire were
worth Rs.3, 000.
Solution
Hints: (i) Prepare Total Debtors account to calculate credit sales.
(ii) Prepare Total Creditors account to calculate credit purchases.
(iii) Prepare memorandum trading account by applying rate of gross profit on

total sales . The bal. figure gives the total stock on the date of fire.
(iv) Deduct salvage from the stock on the date of fire.
(v) As the policy amount is not given it is assumed that the stock is fully insured.
(1) Calculation of credit sales

Total Debtors A/c

Rs. Rs.
To Balance B/d 50,000 By Cash 60,000

“ Sales – Credit 1,00,000 “ Discount allowed 10,000
(Balancing figure)
“ Balance c/d 80,000
1,50,000 1,50,000
178
(2) Calculation of credit purchases

Total Creditors A/c

Rs. Rs.
To Cash 67,000 By Balance b/d 16,000
“ Balance c/d 18,500 “ Purchases – Credit

(Balancing figure) 69,500
85,500 85,500
(3) Calculation of stock on the date of fire
Memorandum Trading A/c for the period ending 1-6-96

Rs. Rs.
“ Purchases: “ Stock on the date 25,500

Cash 10,000 of fire (Balancing figure)
Credit 69,500 79,500
“ Gross Profit
(1,00,000 x 25/125) 20,000
1,25,500 1,25,500
(4) Calculation of amount of claim

Rs.
Less: Stock salvaged 3,000
Claim 22,500
179
Illustration 5
Batliboi & Co. have taken out a fire policy of Rs.80, 000 covering its stock in trade. A fire
occurs on 31st March 2005 and stock was destroyed with the exception of Rs.20,680 worth.
The following particulars are available from the books of accounts of the firm.
Rs.
Stock on January 1st 2005 30,000
Purchased to the date of fire 1,30,000
Sale to the date of fire 90,000
Commission paid to the purchase manager on purchases 2%
Carriage paid on purchases 800
Average gross profit on cost 50%
The policy was subject to average clause. You are require to arrive at the (i) Total loss of
stock and (ii) Amount of claim to be made against the insurance company.
Solution
Hints
(i) Gross profit rate is given on cost , therefore it should be converted to gross profit rate on
sales. One half on cost is equal to one third on sales .i.e by adding one to the denominator,
½ on cost is equal to 1/3 on sales .
(ii) The value of the stock on the date of fire is more than the policy value , hence average
clause is applied for calculating the claim amount.
180
Trading Account
(In the books of M/s Batliboi & Co.)
For the period ending 31st March 2005

Rs. Rs.

“ Stock on the date of fire
“ Purchases 1,30,000 (Balancing figure) 1,03,400
“ Commission on
Purchases – 2% on
Rs.1,30,000 2,600
To Carriage 800
“ Gross Profit—
(50% on cost or 1/3rd
of sales) 30,000
1,93,400 1,93,400
Claim for loss of stock

Rs.
Stock on the date of fire 1,03,400
Less: Salvage 20,680
Loss of Stock 82,720
Amountof Policy
Claim on average basis = x Actual loss of stock
80,000
= x 82,720
1,03,400
= Rs. 64,000
Though there is a loss of stock of Rs. 82,720 yet due to average clause in the policy, the
claim of Rs. 64,000 will be entertained.
181
When Gross Profit Ratio is not given
Illustration 6
A fire occurred in the premises of X Ltd. On 10.10.05. All stocks were destroyed except
to the extent of Rs. 6,200. From the following figures, ascertained the loss of stock suffered by
the company:
Rs.
Stock on 1.1.04 40,000
Purchases during 2004 1,45,000
Sales during 2004 2,00,000
Stock on 31.12.04 25,000
Purchases during 2005 upto the date of fire 1,52,200
Sales during 2005 upto date of fire 1,89,000
Solution
Hints
(i) Prepare previous year Trading account for finding out the gross profit.
(ii) Apply the gross profit ratio formula for finding out the rate of gross profit.
(iii) Now prepare memorandum trading account .Apply the gross profit rate so calculated
on the sales up to the date of fire.
Balancing figure of the memorandum trading account will give the stock on the date of
fire.
(iv) Deduct salvage from the stock on the date of fire to arrive at the claim amount.
(v) Since the policy amount is not given it is assumed that the stock is fully insured. Hence
the average clause formula is not applied to arrive at the claim.
182
(1) Calculation of Gross Profit Ratio

Trading A/c for the year ending 31.12.04

Rs. Rs.
“ Purchases 1,45,000 “ Closing Stock 25,000

2,25,000 2,25,000
Gross Profit
Gross Profit Ratio = x 100
Sales
40,000
= x 100 =20%
2,00,000
(2) Calculation of the value of stock on the date of fire

Memorandum Trading A/c from 1.1.05 to 10.10.05

Rs. Rs.

“ Stock on the date of
fire (Balancing figure) 26,000
“ Purchases 1,52,200

(1,89,000 x 20/100) 37,800
2,15,000 2,15,000
183
(3) Statement of claim

Rs.
Stock on date of fire 26,000
Less: Stock saved 6,200
Claim to be made 19,800
Illustration 7
The premises of a trading firm caught fire on 22.10.2005 and the stock was damaged.
The firm had made up accounts to 31st December.
Rs.
Stock in 31.12.2004 13,272
Stock on 31.12.2003 9,614
Purchase during 2004 45,258
Purchase from 1.1.2005 to the date of fire 34,827
Sales during 2005 52,000
Sales from 1.1.2005 to the date of fire 49,170

Additional Information
(a) In April 2005 goods which cost Rs.1,000 were given away for advertising purpose, no
entries being made in the books.
(b) During 2005, a clerk had misappropriated unrecorded cash sales. It is estimated that the
defalcation amounted to Rs.400.
(c) The rate of gross profit is constant.
From the above information, make an estimate of the stock on the date of fire.
Solution
Hints
(i) Calculate the gross profit ratio on sales for the previous year, by preparing trading account
of the previous year.
(ii) Prepare memorandum trading account and apply the gross profit rate on the sales upto
the date of fire, to arrive at the gross profit upto the date of fire, the balancing figure gives
the value of the stock upto the date of fire.
184
(iii) Since the policy amount is not given in the problem it is assumed that the stock is fully
insured.
(1) Calculation of Gross Profit Ratio

Trading A/c for the year ending 31.12.2004

Rs. Rs.
“ Purchases 45,258 “ Closing Stock 13,272

65,272 65,272
Gross Profit
Gross Profit Ratio = x 100
Sales
10,400
= x 100 = 20%
52,000
(2) Calculation of stock on the date of fire

Memorandum Trading A/c for the period ending 22.10.2005

Rs. Rs.

“ Purchases 34,827 Add: Cash sales
misappropriated 400 49,570
Less: Advertisement
Samples 1,000 33,827 By Stock on the date
of fire (Balancing figure) 7,443
To Gross Profit
(49,570 x 20%) 9,914
57,013 57,013
Therefore, Claims to be made: Rs. 7,443

185
Under Valuation of Stock
Illustration 8
Fire occurred on the premises of the Unfortunate Traders Ltd. On 4th May 1983. All the
stocks with the exception of Rs. 13,000 were destroyed by fire, From the following figures,
ascertain the loss suffered by the company:
Rs.
Stock on 1st January 1982 36,000
Stock on 31st December 1982 66,000
Purchases during 1982 4,80,000
Sales during 1982 6,00,000
Purchases during 1983 upto the date of fire 2,30,000
Sales during 1983 upto the date of fire 3,00,000
On 20th December 1982 also fire broke out and destroyed stock at genuine cost of
Rs.10,000. There was a practice in the firm to value stock at cost less 10%. But all of a sudden
they change this practice and valued stock on 31st December 1982 at cost plus 10%. The
amount of policy was Rs.40, 000 and claim was subject to an average clause.
Solution
Hints
(i) For finding the rate of gross profit , prepare trading account of 1982, the year immediately
preceding the year of fire.
(ii) Opening stock is undervalued by 10% so increase it.
(iii) Closing stock is overvalued by 10% so decrease it.
(iv) Record for loss by fire of previous year.
(v) Prepare memorandum trading account , by applying the rate of gross profit on sale on
stock up to the date of fire. Balancing figure will give the loss of stock on the date of fire.
(vi) Deduct salvage to arrive at the actual loss of stock.
(vii) Since the policy amount is less than the stock on the date of fire average clause is to be
applied in order to arrive at the actual claim on loss of stock.
186
(1) Calculation of rate of profit on sale

The Unfortunate Traders Ltd.
Trading A/c for the year ending 31st December 1982

Rs. Rs.
To Stock at cost price By Sales 6,00,000

(100/90 x Rs.36,000) 40,000 “ Stock at cost price
(100/110 x Rs.66,000) 60,000
“ Purchases 4,80,000 “ Loss by fire 10,000
“ Gross Profit 1,50,000

(Balancing Figure)
6,70,000 6,70,000
1,50,000
Rate of gross profit on sales = x 100 = 25%
6,00,000
(2) Calculation of loss of stock

Trading Account
For the period ending 4th May 1983.

Rs. Rs.
To Stock at cost price 60,000 By Sales 3,00,000
“ Purchases 2,30,000 “ Stock on date of fire

To Gross Profit
25% on Rs.3,00,000 75,000
3,65,000 3,65,000
Claim for loss of stock Rs.

187
Stock at the end 65,000
Less: Salvage 13,000
(3) Claim on Average basis
Amount of Policy
40,000
= x 52,000 = Rs. 32,000
65,000
Illustration 9
Rohit Industries Ltd. had taken out an insurance policy on stock for Rs.30,000 with an
average clause. On 15th July, 1982, there was a fire as a result of which the whole of the stock
with the exception of that valued at Rs.10, 000 was destroyed. From the following information,
ascertain the claim that can be lodged against the Insurance company:
Rs.
Stock on 1-1-1982 ( @ 10% less than cost) 27,000
Purchases from 1-1-1982 to 15-7-1982 90,000
Wages for the period 20,000
Sales for the period 1,30,000
The Company sells goods at cost plus 30%. Assuming that the claim as calculated by
you is settled by the Insurance Company, give Journal entries in the book of Rohit Industries
Ltd.
Solution
Hints
(i) Opening stock is under valued hence increase it.
(ii) Selling price is given as cost plus 30%
(iii) Assumption cost price is 100

188
add: profit 30
Selling price 130
30
(iv) Profit on sales = x 1,30,000 =Rs.30,000
130
(v) .The balancing figure shows stock on the date of fire.
(vi) Deduct salvage from stock on the date of fire to arrive at the actual loss.
(vii) Since the amount of policy is less than the value of stock on the date of fire average
clause is applied to calculate the amount of claim
(1) Statement Showing Computation of Amount of Claim

Rs.
Stock at cost on 1-1-1982 (Rs. 27,000 x 100/90) 30,000

Purchases from 1-1-1982 to 15-7-1982 90,000
Wages from 1-1-1982 to 15-7-1982 20,000
1,40,000
Less: Cost of sales for the period 1-1-1982 to 15-7-1982:
Sales Rs. 1,30,000
Less: Profit @ 30% on cost Rs. 30,000
1,00,000
Estimated cost of stock on 15-7-1982 40,000
Less: Cost of stock salvaged 10,000
Estimated cost of stock destroyed 30,000
(2) Applying the Average Clause

Amount of Policy
30,000
= x 30,000 = Rs. 22,500
40,000
Amount of claim will be for Rs.22, 500.

189
Journal Entries
Dr. Cr.
1) Stock Destroyed by fire account Dr. 30,000

To Trading account 30,000
(For cost of stock destroyed by fire)
2) Insurance Co.account Dr 22,500

To Stock destroyed by fire account 22,500
(For amount of claim admitted by the Co.)
3) Bank a/c Dr. 22,500

To Insurance Co Account. 22,500
(For receipt of claim)
4) Profit and loss account Dr. 7,500

To Stock destroyed by fire account 7,500
(For transfer of loss not recovered
from insurance Co.)
Illustration 10
The premises and stock of Karam Stores were totally destroyed by fire on 30th
January, 2005. From the account books and other records that were saved the following
information is available. The stock on hand has always been valued at 10% less than cost.
2002 2003 2004 2005

Rs. Rs. Rs. Rs.
Opening stock as valued 27,090 32,400 36,000 36,900
Purchases less Returns 74,900 80,000 81,000 6,000
Sales less Returns 1,20,000 1,32,000 1,40,000 12,000
Wages 17,400 16,400 23,600 2,000
Closing stock as valued 32,400 36,000 36,900

190
Prepare a statement of submission to the Insurance company in support of the claim for
loss of stock.
Solution
Hints
(i) Prepare trading accounts for the year 1999,2000 and 2001 to arrive at the rate of gross
profit ratio.
(ii) Find the average of the rate of gross profit so calculated .
(iii) Average gross profit is applied on the sales upto the date of fire.
(iv) Balancing figure of memorandum trading account is the stock on the date of fire.
(v) Since the policy amount is not given it is assumed the stock is fully insured, hence
average clause is not applied.
Percentage of gross profit on sales for each year(1999,2000 and 2001) should be calculated
to find out the average percentage of gross profit on sales to be applied to the current year.
Therefore , trading accounts for the last three years are prepared to ascertain the ratios of
gross profit for the last three years.
Trading Account of Karam Chand Stores


Rs. Rs.
To Opening Stock By Sales less Returns 1,20,000

(27,090x100/90) 30,100 “ Closing Stock
(32,400x100/90 ) 36,000
To Purchases less Returns 74,900
To Wages 17,400
To Gross Profit 33,600
1,56,000 1,56,000
33,600
% of gross profit on sales for the year 1999 is: x 100 = 28%
1,20,000
191

Rs. Rs.

(32,400x100/90) 36,000 “ Closing Stock
( 36,000x100/90 ) 40,000
To Purchases less
Returns 80,000
To Wages 16,400
1,72,000 1,72,000
39,600
1,32,000

Rs. Rs.

(36,000x100/90) 40,000
To Purchases less 81,000 “ Closing Stock

Returns (36,900x100/90 ) 41,000
To Wages 23,600
1,81,000 1,81,000
36,400
1,40,000
28%  30%  26%

Average percentage of gross profit = = 28%
3
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Trading Account of Karam Chand Store

Up to 30th January 2005

Rs. Rs.
To Opening Stock By Sales less Returns 12,000

(36,900x100/90) 41,000
To Purchases less “ Closing Stock

Returns 6,000 32,400x100/90 40,360
To Wages 2,000
To Gross Profit
(28% of Rs.12,000) 3,360
52,360 52,360
Stock worth Rs. 40,360 has been completely destroyed by fire, so claim for loss of stock
to be lodged is Rs. 40,360.
Poor Selling Line and Effect of Abnormal Happenings.
Sometimes, a business house purchases some products from the market or produces
products which are not sold as regular items or readily saleable items. Such items may be
partially or completely written off the stock. Such goods may be sold at a loss or at a rate of
profit which is different from that normally followed. When stock gets undervalued as a result of
such write off, it needs to be valued at normal figure other wise such items lost by fire will be
indemnified below cost. These items or products are known as abnormal items or items of poor
selling line.
Thus, the effect of abnormal happenings are:
(i) Variation in the practice of stock valuation,
(ii) Selling a part of goods (of poor selling line) either at a loss or at a rate of profit which is
different from that normally followed,
(iii) Charging productive or direct expenses as indirect expenses.

193
The effect must be nullified at the time of preparing the trading account for the calculation
of the rate of gross profit. This is necessary because the rate of gross profit has a direct impact
on the calculation of claim for loss of stock. If the rate of gross profit is high, then stock at the
end will also be more (because it is a balancing figure) and the claim from the insurance company
will be for higher amount. Therefore, insurance company is very particular about the rate of
gross profit used for the calculation of the amount of claim. The company wants that it must not
be higher than what it should be.
In practical questions, proforma trading account is prepared in the year of fire. The sale
of normal and abnormal items are separated and the gross profit determined individually. The
rate of gross profit is applied on normal sales only. If any allowance is to be given by the
insurance company on abnormal items or items of poor selling lines, then that is also added to
the normal stock on the date of fire.
Illustration 11
On 25th June, 2005 a fire broke out in the premises of Unlucky Co. All the stocks were
destroyed except some which were partly damaged and sold subsequently for Rs.7,900.
From the following particulars ascertain the claim to be submitted to the Insurance
Company assuming the policy was for Rs. 20,000.
Rs.
Stock as on 1st January, 2005 24,400
Purchases upto the date of the fire 73,000
Sales upto the date of the fire 97,000
Purchases during the year 2004 1,53,500
Sales during the year 2004 1,96,500
Stock as on 1st January 2004 18,500
The stock as on 1st January, 2004 included a special item valued Rs. 5,600 which was
sold at a profit of 20% on sales. A part of this item was sold in 2004 while the balance was sold
on 3rd May, 2005 for Rs.2500. Except for this item, the gross profit on all other items was at
uniform rate throughout the period.
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Solution
Hints
(i) Calculate the sale value of special item as per the information given.
(ii) Calculate the closing stock at cost of abnormal stock as per the information given.
(iii) Prepare trading account of the previous year columnar wise
(iv) Calculate gross profit ratio.
(v) Prepare memorandum trading account to arrive at the stock on the date of fire.
(vi) Since the stock on the date of fire is more than the policy amount apply average clause to
arrive at the claim to be lodged.
Trading Account of Unlucky Co.
For the year ending 31st December 2004
Particular Normal Abnormal Particulars Normal Abnormal

Items Items Items Items
Rs. Rs. Rs. Rs.
To Opening stock 12,900 5,600 By Sales 1,92,000 —-

(note 1) —- 4,500
To Purchases 1,53,500 —- By Closing Stock 22,400 —

(note 2) —- 2,000
To Gross Profit 48,000 900
2,14,400 6,500 2,14,400 6,500
Working notes
Note 1 Sales value of special item is calculated as follows:
Rs.
Cost of special item 5,600
Add: 25% profit on cost which is equivalent to 20% on sales 1,400

(5,600 x 25/100)
7,000
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Total Sales value of the special item 7,000
Less: Sale of special item in 2005 2,500
Sale of special item in 2005 4,500
Note 2: Cost of the sale of special item in 2005
Sale value 2,500
Less: 20% Profit included therein

( 2,500 x 20/100) 500
cost 2,000
Gross Profit on Normal Sales

Gross Profit on Normal Sales = x 100
Normal Sales
48,000
= Rs. x 100 = 25 %
1,92,000
Memorandum Trading Account of Unlucky Co.

Upto 25th June 2005
Particular Normal Abnormal Particulars Normal Abnormal

Items Items Items Items
Rs. Rs. Rs. Rs.
To Opening stock By Sales 94,500 2,500

on 1.1.2005 22,400 2,000 By Closing Stock 24,525
on 25.6.2005
To Purchases 73,000
To Gross Profit
(25% On Normal
sales & Balancing
figure in Case
of abnormal Items) 23,625 500
1,19,025 2,500 1,19,025 2,500

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Stock of goods lost

Rs.
Value of stock on the date of fire 24,525
Less: Sale of partly damaged stock 7,900
Applying the Average Clause
Amount of Policy
20,000
= x 16,625 = Rs. 13,558
24,525
Amount of claim will be for Rs.13,558.
Illustration 12
On 1st July, 2005 a fire took place in the Godown of Ram Kumar which destroyed all
stocks. Calculate the amount of insurance claim for stock from the following details:
Rs.
Sales in 2003 2,00,000
Gross Profit in 2003 60,000
Sales in 2004 3,00,000
Stock as on 1-1-2005 2,70,000
Purchases from 1-1-2005 to 30-6-2005 4,00,000
Sales from 1-1-2005 to 30-6-2005 7,20,000

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The following are also to be taken into consideration:
1. Stock as on 31st December, 2004 had been undervalued by 10 %
2. A stock taking conducted in March, 2002 had revealed that stocks costing Rs.80,000
were lying in a damaged condition. 50% of these stocks had been sold in May, 2005 at
50% of cost and the balance were expected to be sold at 40% of cost.
Solution
Hints
(i) Calculate rate of gross profit in 2000 with the given information.
(ii) Calculate rate of gross profit in 2001with the given information.
(iii) Calculate the average rate of gross profit for 2000 and 2001.
(iv) Calculate the gross loss on Abnormal stock.
(v) Amount of claim for loss of stock is total of normal and abnormal stock.
Calculation of Rate of Gross Profit in 2003

Rs.
Gross Profit as given 60,000
Sales in 2000 2,00,000
60,000
Rate of Gross Profit on Sales = x 100 = 30%
2,00,000
Calculation of Rate of Gross Profit in 2004 Rs
Gross Profit as given 60,000
Add: Profit to be increased due to increase in value of

Closing Stock (2,70,000 x 10/90) 30,000
Sales in 2001 3,00,000
Therefore, percentage of gross profit to sale (90,000/3,00,000 x 100) = 30%
30% (for 2000)  30% (for 2001)

Average Percentage of Gross Profit =
2
= 60/2 =30%
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Memorandum Trading Account

Upto 1st July, 2005
Particulars Normal Abnor- Total Partiular Normal Abnormal Total

Items mal Items Items
Items
To Opening By Sales 7,00,000 20,000 7,20,000

Stock
(Rs.2,70,000 2,20,000 80,000 3,00,000 “Gross Loss —— 44,000 44,000
X 100/90) (W.N:1)
To Purchases 4,00,000 —— 4,00,000 “Closing

Stock
(Balancing 1,30,000 16,000 1,46,000
figure)
“Gross Profit @ 2,10,000 —— 2,10,000

30% on
normal sales 8,30,000 80,000 9,10,000 8,30,000 80,000 9,10,000
Working Note 1
Calculation of Gross Loss on Abnormal Items
Cost of abnormal items 80,000
Cost of ½ of the abnormal items 40,000
Less: Value of sales @ 50% 20,000
Gross loss on 50% abnormal items 20,000
Add: 60% loss on balance of 50% goods (Rs.40,000 x 60/100) 24,000
Total gross loss on abnormal items

(20,000+24000) 44,000
Amount of claim for loss of stock is total of normal stock and abnormal stock, i.e.,
Rs.1,46,000.
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8.10 Summary
A fire in a business place destroys stock of goods. So it is in the interest of a business
unit to take a fire Insurance Policy to indemnify itself against the loss of stock. To lodge claim
for the loss of stock by fire, the value of stock - in – trade on the date of fire has to be estimated.
Trading account of the previous year may be referred to determine the gross profit ratio of the
last year. The balancing figure of the memorandum trading account will be the estimated value
of stock in hand on the date of fire. By deducting salvage from the stock in hand on the date of
fire the amount of claim for the loss of stock to be lodged with the insurance company can be
arrived at.
If stock in trade of the last year was not valued at cost, it should be adjusted to the cost to
ascertain the correct percentage of gross profit on sales to be applied to the current year. If
there is a poor selling line stock, such stock should be eliminated from the Trading account of
the last year to get the Gross profit ratio to be applied to the current year. Any sale of poor
selling line should also be deducted from the total sales to find out normal sales because gross
profit ratio is to be applied to the normal sales. The same procedure is to be followed for poor
selling line stock and sales in case of Memorandum Trading Account. When Gross Profit ratio
for number of years are given an average of these ratio may be ascertained for finding out the
Gross Profit Ratio to be applied to the current year, when the ratios show and increasing trend.
This rule is however not applicable when the Gross Profit Ratio is decreasing. When the total
stock is not fully insured then claim on average clause basis can be made.
8.11 Key Words

Average Clause : It is the clause which limits the liability of the insurer to that
proportion of actual loss which the insured amount bears to the
actual value of the asset insured.
Indemnity Period : The period beginning with the occurrence of the damage and
ending not later then twelve months thereafter during which the
results of the business will be affected in consequence of the
damage.
Salvage : Partially damaged stock is assessed by assessor of the

insurance company and the goods are usually allowed to be
kept with the insured at an agreed value. These goods are called
“Goods or Stock Salvaged”
200
Poor Selling Line : When stock gets undervalued as a result of s writing off, it needs
to be valued at normal figure other wise such items lost by fire
will be indemnified below cost These items or products are
known as abnormal items or items of poor selling line.

Fill in the blanks
1. The average clause in a loss of stock policy discourage———————.
2. The average clause in case of a loss of stock policy is applied when the value of stock on
the date of fire is more than the ————— ———— ———— ——
Value of Policy
3. Claim to be lodged = Value of stock destroyed x
-----------
4. Memorandum Trading Account is prepared to find out the value of ———— on the date
of fire.
Ans: 1. under insurance of stock; 2. amount of policy taken; 3. value of stock on the
date of fire; 4. stock.
Select the most appropriate answer

(i) The main objective of the average clause is to
(a) encourage full insurance,
(b) encourage under insurance,
(c) discourage full insurance.
(ii) In case of average clause the loss is suffered by both the insurer and the insured
(a) in the ratio of risk covered,
(b) in equal ratio,
(c) only by insurer.
(iii) A property worth Rs.20,000 is insured for Rs.15,000. It is completely destroyed by fire.
The policy contains an average clause. The loss to be born by the insurance company
will be
201
(a) Rs.15,000, (b) Rs.10,000, (c) Rs.20,000
Ans: (i) (a), (ii) (a), (iii) (a)
1.) What is the purpose of Fire Insurance ?
2.) Explain the significance of “Gross Profit Ratio” in relation to Loss of Stock claim.
3) What is average clause in a fire insurance policy ?
4) Explain the objective of “Average Clause” in a Fire Insurance policy.
5) Explain the procedure to ascertain stock on the date of fire. How do you compute the
claim for loss of stock?
6) What is average clause? What is its purpose? How do you compute claim for loss of
stock when there is average clause in the contract?
7) How do you deal with “Abnormal items” and “Abnormal practices” in computation of claim
for loss of stock?
Exercises
1. A fire occurred on 25th April 2002 in the premises of a company from the following particulars
ascertain the amount of claim to be lodged in case of loss of stock which was insured.
Rs.
Stock on 1-1-2002 2,50,000
Purchases from 1-1-2002 to date of fire 10,00,000
Wages 2,00,000
Manufacturing Expenses 1,00,000
Sales from 1-1-2002 to the date of fire 15,00,000
The gross profit ratio is 15%. The stock salvaged was estimated at Rs.57,500
(Ans: Closing Stock Rs.2,75,000 ; Claim Rs. 2,17,500)

202
2. A fire occurred in the premises of Mr. Patil on 31st March, 2002. From the following
particulars, ascertain the claim to be lodged.
Rs.
Stock on 1-1-2001 4,50,000
Purchases during the year 2001 18,55,000
Purchases Returns during the year 2001 15,000
Goods taken by Mr. Patil for his personal use during

the year 2001 10,000
Stock on 31-12-2001 6,30,000
Sales for the year 2001 20,60,000
Sales Returns during the year 2001 60,000
Purchases from 1-1-2002 to the date of fire 4,20,000
Sales from 1-1-2002 to the date of fire 4,95,000
Value of stock saved 99,000
Goods destroyed by fire during the year 2001 30,000
(Ans: Percentage of Gross Profit to Sales 19%;

Stock on the date of fire Rs.6,49,050;
Claim Rs.5,50,050)
3. A fire occurred in the business premises of Raghavan on 19-7-89. From the following
particulars ascertain the loss of stock and prepare a claim for insurance.
Rs.
Stock on 1-1-88 36,720
Stock on 31-12-88 32,400
Sales for 1988 2,16,000
Purchases for 1988 1,46,400
Purchases from 1-1-89 to 19-7-89 1,76,400
Sales from 1-1-89 to 19-7-89 1,80,000

203
The stocks were always valued at 90% of cost. The stock saved from fire was worth
Rs.21,600. The amount of the policy was Rs.75,600 there was an average clause in the policy.
(Ans: Gross Profit Rs.64,800; Gross Profit Ratio 30%

Stock on date of fire Rs.86,400; Actual loss of stock Rs.64,800
Claim under average clause Rs.56,700
4. Fire occurred in the premises of Mr. Paswan on 10th May 1996. In order to make a claim
on their fire policies in respect of the stock, they ask your advice and you are able to
obtain the following information.
Particulars 1993 1994 1995 1996

Rs. Rs. Rs. Rs.
Opening stock 16,000 15,000 16,000 18,000
Purchases 41,000 47,200 56,600 78,000
Sales 60,000 66,000 78,000 99,000
Closing stock 15,000 16,000 18,000 ?
The stock salvaged was Rs. 3,800. Compute the amount of claim.
(Ans: Year Gross Profit Gross Profit Ratio
1993 18,000 30%
1994 19,800 30%
1995 23,400 30%
Average Gross profit Ratio 30%
Stock on the date of fire Rs. 26,700; Claim Rs. 22,900)
5. A fire occurred on the premises of a merchant on 31st March, 2002, destroying the major
part of the stock. The stock was, however insured. The amount of the policy was Rs.76,000
and there was an average clause in the policy. The details about the year 31st December,
2001 together with available figures for 3 months of 2002 are given below:
204
2001 2002
(1.1.02 to 31.3.02)
Rs. Rs.
Stock on 1st January 87,000 73,200
Purchases 2,54,000 69,980
Sales 3,46,000 96,000
Variable Expenses (Direct) 9,600 3,680
Closing stock of 2000 includes an abnormal item (slow moving) taken at 75% of cost,
original cost being Rs.32,000. The normal stock on hand has always been valued at 10% less
than cost.
50% of the abnormal stock of 2000 was sold out in 2001 for Rs.14,000 and 50% of the
balance was sold out at Rs.10,000 in March, 2002. The rate of gross profit in 1999 and 2000
were 28% and 24% respectively. The stock salvaged was Rs.5,000.
Show the amount of the claim to be lodged to the Insurance Company in respect of the
loss of stock, mentioning any further factors which you consider should be taken into consideration
when preparing the claim.
Ans: Rate of gross profit 20%;
Opening stock on 1-1-2001— Normal stock at 90% is Rs.63,000
Normal stock at 100% is Rs.70,000
Abnormal stock 75% of Rs.32,000 is Rs.24,000
Closing stock on 31-12-2001—Normal stock at 90% is Rs.61,200
Normal stock at 100% is Rs.68,000
Abnormal stock 50% of Rs.32,000 valued at 75% is Rs.12,000
Abnormal stock 100% of Rs.12,000 is Rs.16,000
Closing Stock Rs.72,000 (Normal) ; Rs.8,000 (Abnormal)
Gross Profit Rs.16,340 (Normal) ; Rs.2,000 (Abnormal)

205
Assume Gross Profit Rate reduces by 1% for January 1st 2002 to 31st March 2002 i.e.,
(20% Minus 1%). Since Gross Profit reduces at a uniform rate of 4% Per annum)
Value of stock destroyed Rs.75,000
Average claim Rs.71,250

1. The insured and the insurer.
2. The damages caused by fire accident is so intense that a business man finds it difficult
to recover to normal business activities. Hence he takes a fire policy to normalize himself
at the earliest.
3 Those who are actually exposed to the damages on account of fire file their claims. The
insurance company indemnifies only those business men who have lost stock on account
of fire and not all those who have paid premium.
4. Only when the insured maintains proper books and records of the stock it is easy for the
claimer to determine the claim for loss of stock.
5. The two major types of policies issued by insurance companies are loss of stock policies
and loss of profits.
6. To avoid under insurance the average clause is included .

206
UNIT 9
SINGLE ENTRY SYSTEM
Learning Objectives
 explain, the meaning and concept of Single Entry System
 discuss the features of Single Entry System
 highlight the defects of Single Entry System
 differentiate between Single Entry and Double Entry System
 compute the profits as per Net Worth and Conversion Method.
Structure
9.1 Meaning and Concept
9.2 Salient features of Single Entry System
9.3 Defects of Single Entry System
9.4 Difference between Single Entry and Double Entry System
9.5 Ascertainment of Profit
9.5.1 Net Worth Method
9.5.2 Conversion Method
9.6 Illustrations
9.7 Summary
9.8 Key Words

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9.1 Introduction
In the Unit “Introduction to Accounting” you might have learnt that there are Double Entry
system and Single Entry System of accounting. Single entry system is nothing but the defective
double entry system. In this unit, you can learn in detail about the single entry system. Business
people, without systematic accounting knowledge, like small traders, medical practitioners and
other professionals follow this method. The term single entry is vaguely used to refer to any
method of maintaining accounts which does not conform to strict principles of double entry.
Single entry does not mean that there is only one entry for each transaction. In fact, single
entry is a combination of (a) Double Entry for some transactions like cash collected from debtors
(b) Single Entry for transactions like cash sales and (c) No Entry for transactions like depreciation.
In short, under single entry only personal accounts are recorded. In quasi single entry, personal
accounts, cash account and some subsidiary books are maintained. Thus, single entry refers
to crude accounting methods which do not record nominal accounts and most of the real accounts.
You can understand better the meaning of single entry system with the help of the following
definition. According to R.N. Carter, “Single Entry cannot be termed as a system, as it is not
based on any scientific system, like double entry system. For this purpose, single entry is now-
a-days known as preparation of accounts from incomplete records”. Kohler, in his “Dictionary
for Accountants” defines single entry system as “A system of book keeping in which as a rule
only records of cash and personal accounts are maintained. It is always incomplete double
entry, varying with the circumstances”.
9.2 Salient features of Single Entry System

The analysis of the above definition highlights the following features of single entry system:
(i) Absence of Uniformity: It is not a specific system governed by definite rules of operation.
It is highly flexible according to the capabilities of individuals maintaining the records.
(ii) Records Maintained : Usually personal accounts are fully written and cash book is
also maintained. Nominal accounts and most of the real accounts are completely
omitted.
iii) Mixing of Transactions: Business dealings as well as personal transactions are mixed
while writing the cash book.
208
(iv) Suitability: Sole traders, partnership firms and professionals who cannot afford a paid
book keeper usually follow this method to write their own accounts. Joint stock
companies have to follow double entry system under the provisions of the Companies
Act, 1956.
(v) Dependence: on Original Vouchers No entries are made for a large number of
transactions. For example, credit purchases and sales have to be ascertained from the
copies of invoices.
(vi) Finalisation of Accounts: Regular final accounts cannot be prepared. Profit or loss can
be ascertained in a crude way, which is not reliable
9.3 Defects of Single Entry System of Accounting

As pointed earlier in this unit, single entry system is the defective system of double entry.
It suffers from various defects. The following are the defects and limitations of single entry
methods.
(i) Insufficient: Records Except personal accounts and cash accounts, all other impersonal
accounts are left out. So, the accounts serve very little purpose.
(ii) Absence of Trial Balance: Trial Balance cannot be prepared for any period. Hence
arithmetical accuracy of the accounts cannot be verified.
(iii) Difficulty in ascertaining profit: Absence of record for expenses and incomes makes it
impossible to ascertain profit in a reliable way.
(iv) Difficulty in ascertaining Financial Position: In the absence of real accounts, balance
sheet cannot be prepared to assess the financial position of the business.
(v) Lack of Statistical Data: Statistical data relating to increase or decrease in sales,
purchases, different items of expenses, profits etc., cannot be obtained.
(vi) Encouragement to Fraud: Fraud, embezzlement etc., by employees cannot be detected.
(vii) Rectification of errors is difficult: There is no cross verification system like Trial Balance
to detect mistakes. So, rectification of errors is rare.
(viii) Value of business cannot be ascertained: It is difficult for the owners to assess the
value of goodwill of the business in the absence of proper records.
(ix) Planning and decision making are difficult: The owners cannot plan for future operations
and growth, etc., of the business in the absence of reliable information.
(x) Difficulty in getting institutional loans: Commercial banks do not accept incomplete
records as basis for extending credit.
(xi) Filing tax returns, preparing claims etc: Tax authorities may charge tax arbitrarily in
the absence of reliable records. Filing claims for loss of stock becomes difficult.
209
9.4 Difference between Single Entry and Double Entry System

Sl. Basis of Difference Double Entry Single Entry
No. System system
1. Recording of Both aspects of all In some cases, both
Transactions transactions are aspects, in some
recorded. others a single aspect or no aspect
is recorded.
2. Opening of Accounts: All personal, real and Only personal accounts
nominal accounts and cash account are
are opened. opened.
3. Preparation of Trial Balance can Trial Balance cannot be
Trial Balance be prepared. prepared.
4. Ascertaining Accurate profit or loss Profit or loss cannot be
profit or loss can be found, through found normally, in the
trading and profit absence of Trading and
and loss A/c. Profit and loss A/c.
5. Revealing Reliable Financial Balance Sheet cannot be
Financial Position: position can be found prepared. So, financial
through Balance Sheet. position is difficult to
ascertain.
6. Acceptability Acceptable for Income Not acceptable for
Tax and other tax taxation, claims,
purposes, for raising raising of loans. etc.
of bank loans etc.
7. Acceptable Evidence In case of disputes, The Accounting records
accounting records are not acceptable as
can be produced in evidence.
courts of law.
8. Utility Suitable for any type It can be followed by
of business of any size. small business men
who can exercise
personal control
over the business.
9. Internal check Internal check is Internal check is not
possible. possible.
210
1. What do you understand by single entry system of Accounting?
............................................................................................................................
............................................................................................................................
............................................................................................................................
2. What are the accounts are maintained under single entry system?
............................................................................................................................
............................................................................................................................
............................................................................................................................
3. List out any two differences between single entry and double entry system.
............................................................................................................................
............................................................................................................................
............................................................................................................................
9.5 Ascertainment of Profit

When business records are incomplete, profit or loss can be found through any one of
the following two methods. (i) Net worth Method and (Statement of affairs method) (ii) Conversion
Method. In this section you can learn ascertainment of profit under both method
9.5.1 Networth Method

This method is also called Statement of Affairs method because “Net Worth” is ascertained
with the help of Statement of Affairs. (i) Net Worth is the owners’ share of the assets, after
providing for outside liabilities. (ii) Difference between net worth at the beginning of the year
and at the end of the year represents profit or loss for the year because owners’ worth or share
in assets increases or decreases due to profit or loss respectively. Before ascertaining the
211
change in net worth which is the profit or loss, adjustment must be made for any drawings by
the owner or additional capital contributed by him.
The following five steps are to be followed for ascertaining profit or loss under net worth
method.
Step 1: Calculating opening captial

Opening capital can be found by preparing a statement of affairs at the beginning of the
year. A statement of affairs is just like a balance sheet. Assets are shown on the right hand
side and liabilities are shown on the left hand side of the statement of affairs. The difference
between both the sides represents “Opening Capital”.
Since full records are not maintained by the business, the assets and liabilities are
ascertained as follows:-
(a) Cash can be physically counted.

(b) Bank balance is obtained from the pass book.
(c) Stock is recorded through physical stock taking.
(d) Debtors and creditors are usually available from the list maintained by the business.
(e) Other assets can be listed out after an approximate valuation by the owners.
(f) Any other relevant data like outstanding expenses, accrued income should be listed
out from the owners’ memory.
Step 2: Ascertainment of drawings during the year

This is a difficult task is most of the cases because cash book may show a part of the
withdrawals only. Money may be used for personal purposes out of sale proceeds and the
balance only may be recorded in cash book or deposited in the bank. Still, the owners’ personal
estimate may help in arriving at the rough amount of the drawings.
Step 3: Ascertaining capital introduced during the year

Additional capital provided by the owner during the year may be in cash or in the form of
assets or goods. The total amount must be recorded, in whatever form it was brought in.
Step 4: Computing closing capital

Closing capital can be found by preparing a statement of affairs at the end of the year,
in the same way as opening statement was prepared. However, all adjustments relating to
depreciation, provision for doubtful debts etc., must be made in the closing statement of affairs
which were not necessary in the opening statement.
212
Step 5: Preparing Statement of Profit

Statement of profit is prepared as follows:
Statement of Profit or Loss for the year……..

Closing Capital xxxx
Add: Drawings xxxx
xxxx
Less: Additional Capital introduced xxxx
Less: Opening Capital xxxx xxxx
Net Profit/loss for the year xxxx
Illustration 1
Find out profit from the following data
Rs.
Capital at the beginning of the year 8,00,000

Drawing during the year 1,80,000
Capital at the end of the year 9,00,000

Capital introduced during the year 50,000
Solution
Statement of profit
Rs.
Closing Capital 9, 00, 000

Add: Drawing 1, 80, 000
10, 80, 000
Less: Additional Capital 50, 000
10,30, 000
Less: Opening Capital 8,00,000
Net Profit 2,30,000

213
Illustration 2
Mohan, a retail merchant commenced business with a capital of Rs.12,000 on 1.1.94.
Subsequently on 1.5.94 he invested further capital of Rs.5,000. During the year, he has withdrawn
Rs. 2,000 for his personal use. On 31.12.94. his assets and liabilities were as follows:-
Rs.
Cash at Bank 3,000
Debtors 4,000
Stock 16,000
Furniture 2,000
Creditors 5,000
Calculate the profit (or) loss made during the year 1994.
Solution
Calculation of Closing Capital
Statement of affairs of Mohan
As on 31.12.94
Creditors 5,000 Cash at Bank 3,000
Capital (Balancing figure) 20,000 Debtors 4,000
Stock 16,000
Furniture 2,000
25,000 25,000
Statement of Profit (or ) Loss for the year ended 31.12.94

Rs.
Closing Capital 20,000
Add: Drawings 2,000
22,000
Less: Additional Capital 5,000
17,000
Less: Opening Capital 12,000
Profit 5,000
214
Illustration 3
Mr. Mano keeps his books of accounts under single entry system. His financial position
on 31.12.90 and 31.12.91 was as follows:
1990 1991
Rs. Rs.
Cash 9,860 800
Stock in trade 38,520 57,020
Plant and Machinery 54,420 61,000
Bills Receivable — 16,480
Sundry Debtors 24,840 43,940
Sundry Creditors 72,040 80,000
Furniture 4,960 5,220
Drawings — 5,000
During the year he introduced additional capital of Rs.20,000.
From the above particulars prepare a statement of profit and loss of Mr. Mano for the year
ended 31.12.91.
Solution
Calculation of capital at the Beginning
Statement of affairs of Mano

As on 31.12.91

Sundry creditors 72,040 Cash 9,860
Capital (Balancing figure) 60,560 Stock in Trade 38,520
Plant and Machinery 54,420
Furniture 4,960
1,32,600 1,32,600
215
Calculation of capital at the end

Statement of affairs of Mano
As on 31.12.91
Sundry Creditors 80,000 Cash 800
Capital (Balancing figure) 1,04,460 Stock in Trade 57,020
Plant and Machinery 61,000
Furniture 5,220
Bills receivable 16,480

1,84,460 1,84,460
Statement of Profit/loss for the year ended 31.12.91
Rs.
Closing Capital 1,04,460

Add: Drawings 5,000
1,09,460
89,460
Profit made during the year 28,900
Illustration 4
Ramesh keeps his books on single entry basis. Prepare a statement of affairs as on
31.10.1992 and a statement of profit (or) loss for the period ending 31.10.1992.
Assets & Liabilities 1.11.91 31.10.92

Rs. Rs.
Bank Balance 560(Cr) 350(Dr)
Cash on Hand 10 50
Debtors 4,500 3,600
Stock 2,700 2,900
Plant 4,000 4,000
216
Ramesh had withdrawn Rs.2,000 during the year and had introduced fresh capital of
Rs.4,200 on 1.7.1992. A provision of 5% on debtors is necessary. Write off Depreciation on
Plant at 10% and Furniture at 15%. Interest on capital is to be allowed at 5%
Solution
Calculation of Opening Capital
Statement of affairs of Ramesh
As on 1.11.91
Bank O/D 560 Cash in hand 10
Capital (Balancing figure) 11,650 Debtors 4,500
Stock 2,700
Plant 4,000
Furniture 1,000
12,210 12,210
Calculation of Closing Capital

Statement of affairs of Ramesh
As on 31.10.92
Capital (Balancing figure) 11,170 Bank Balance (Dr) 350
Cash in Hand 50
Debtors 3,600
(-) 5% Provision 180 3,420
Stock 2,900
Plant 4,000
(-) 10% Depreciation 400 3,600
Furniture 1,000
(-) 15% Depreciation 150 850
11,170 11,170
217
Statement showing Profit/Loss for the period ended 31.10.92

Rs.
Add: Drawings 2,000
13,170
8,970
(+) Interest on Capital (11,650x5% ) 583
4,200 x 5/100 x 4/12 70 12,303
Loss 3,333
Illustration 5
The position of a businessman who keeps his books on Single entry was as under on
31.12.90 and 31.12.91.
Particulars 1990 1991

Rs. Rs.
Cash in Hand 400 480
Cash at Bank 6,000 2,500
Stock 6,500 5,000
Debtors 4,000 5,200
Furniture 300 350
He withdraws Rs.7,500 from business on 2.1.91 out of which he spent Rs.5,200 for
purchase of a motor truck for the business.
Adjustments
(a) Depreciation on closing balance of furniture and truck at 10%
(b) Write off Rs.220 as bad debts
(c) 5% Provision for bad and doubtful debts is needed.
Find out the profit or loss for the year.

218
Solution
Calculation of Opening Capital
Statement of affairs as on 31.12 90
Sundry Creditors 4,100 Cash in hand 400

Capital (Balancing figure) 13,100 Cash at bank 6,000
Stock 6,500
Debtors 4,000
Furniture 300
17,200 17,200
Calculation of closing capital
Statement of affairs as on 31.12.91

Capital (Balancing figure) 14,606 Cash at bank 2,500
Stock 5,000
Debtors 5,200
(-) Bad Debts 220
4,980
(-) 5% Provision
for bad debts 249 4,731
Furniture 350
(-)10%Depreciation 35 315
Motor truck 5,200
(-)10%Depreciation 520 4,680
17,706 17,706
219
Statement of profit (or) loss for the year ended on 31.12.91
Rs.
Add: Drawings (7,500-5,200) 2,300
16,906
Less: Opening capital 13,100
Net Profit 3,806
Illustration 6
Ram and Laxman are equal partners in a business in which the books are kept by single
entry. Their position on 1.7.94 was an under:
Rs. Rs.
Bills Payable 12,400 Cash in hand 540
Sundry Creditors 40,000 Cash at bank 27,760
Capital A/c Bills Receivable 9,200
Ram 1,60,000 Sundry Debtors 97,300
Laxman 1,60,000 Stock 67,600
3,20,000 Plant & Machinery 1,60,000
Furniture 10,000
3,72,400 3,72,400
On 30.6.95 the following was the state of affairs.
Rs. Rs.
Cash in hand 800 Cash at bank 31,600
Sundry Creditors 42,400 Stock 73,400
Sundry Debtors 1,32,600 Bills Payable 1,200
Plant & Machinery and Furniture are to be depreciated by 10%
Drawings: Ram: 20,000
Laxman: 16,000
Ascertain the profit for the year ended 30.6.95 and statement of affairs as on that date.
Prepare capital accounts of partners.
220
Solution
Statement of affairs of Ram & Laxman as on 30.6.95

Bills Payable 1,200 Cash at bank 31,600
Capital (Balancing figure) 3,65,400 Stock 73,400
Sundry Debtors 1,32,600
Plant & Machinery 1,60,000
Less:10%Depreciation16,000 1,44,000
Furniture 10,000
Less:10%Depreciation 1,000 9,000
4,09,000 4,09,000
Statement of Profit (or) Loss for the year ended 30.6.95
Rs.
Capital A/c on 30.6.95 3,65,400
(Ram + Laxman)
Add: Drawings:
Ram 20,000
Laxman 16,000 36,000
4,01,400
Less: Capital A/c on 30.6.94 [1,60,000 + 1,60,000] 3,20,000
Profit 81,400
Capital A/c
Particulars Ram Laxman Particulars Ram Laxman

Rs. Rs. Rs. Rs.
To Drawings 20,000 16,000 By Balance b/d 1,60,000 1,60,000
To Balance c/d 1,80,700 1,84,700 By Profit 40,700 40,700
2,00,700 2,00,700 2,00,700 2,00,700
By Balance b/d 1,80,700 1,84,700

221
9.5.2 Conversion Method

The process of collecting, computing and recording missing information along with the
available data in the incomplete books of a business is called “Conversion Method”. Once the
books are “ converted”, all future transactions can be recorded as per “double entry system “ .
Need for Conversion

The net worth method does not provide a clear picture of the operating results of a business.
It does not show sales, purchases, gross profit, operating expenses etc. So it is not possible to
make a meaningful analysis of the financial statements and initiate effective steps to improve
the financial position of the business. Conversion to double entry system enables a business to
avoid the harassment of taxation authorities and ensures better management of the business.
Steps to be Followed
Step 1 : Statement of affairs at the beginning of the year from which conversion is to be
effected should be prepared. The balance in the statement represents opening capital.
In problems, it may not be possible to complete the statement due to missing opening
balances like Debtors, Creditors, Stock . The statement should be prepared to the extent possible
and can be completed at a later stage.
Step 2 : Cash book with cash and bank columns or a single column should be prepared
. Careful scrutiny of bank pass book and enquiry relating to cash “takings” used by the owner
for personal expenses and payments are essential.
In problems, opening or closing cash or bank balances may be missing. The balance in
the cash book represents the missing figure. Cash book must be prepared even when the
opening and closing balances of cash and bank are given. Any shortage on the debit side can
be cash sales or additional capital introduced or sundry income. Shortage on the credit side can
be cash purchases or drawings or sundry expenses.
Step 3 : Bills receivables account, bills payables account, total debtors account and total
creditors account must be prepared. Preparation of these accounts can help in finding any
missing items like opening or closing debtors, opening or closing creditors, credit purchases
and sales etc. Total sales and total purchases can be found by adding cash and credit sales and
also cash and credit purchases. If opening or closing stock is missing, preparation of
memorandum trading account after ascertaining gross profit ratio can reveal the opening or
closing stock whichever is not given.
222
Step 4 : The opening statement of affairs can now be completed, by filling up any
missing figure and opening capital can be ascertained.
Step 5 : Appropriate journal entry should be passed in respect of assets and liabilities
included in the opening statement of affairs.
Step 6 : Real and nominal accounts must be written from the information recorded in the
cash book, total debtors account, total creditors account, etc. The double effect of every entry
must be posted to the ledger, opening new accounts wherever necessary.
Step 7 : All the accounts in the ledger must be balanced now and a trial balance should
be extracted.
Step 8 : From the trial balance and any other additional details, trading account, profit
and loss account and balance sheet must be prepared.
Note:Steps 5, 6, and 7 are not needed to solve examination problems.
Table 9.1
The following table shows the figures which are usually missing in problems and the
appropriate account from which they can be found.
Table 9.1: Clues for finding missing items
S. No. Missing items Appropriate account to find the items

1. Credit Sales
2. Opening debtors Total debtors account reveals any
3. Closing debtors one of the items as balancing figure.
4. Cash collected from debtors}
5. Credit Purchases
6. Opening creditors Total creditors account reveals an
7. Closing creditors one of the items as balancing figure.
8. Cash paid to creditors
9. Opening stock Memorandum trading account reveals
any one them, if gross profit ratio is
223
10. Closing stock known.

11. Opening bills receivable
12. Closing bills receivable Bills receivable account can reveal any
13. Bills receivable received one of the items as balancing figure.
14. Bills receivable collected
15. Opening bills payable
16. Closing bills payable Bills payables account can reveal any
17. Bills Payable issued one of the items as balancing figure.
18. Bills payable honoured
19. Opening cash or bank
20. Closing cash or bank
21. Cash sales
22. Cash purchases
23. Cash received from debtors Cash and Bank A/c can reveal any one
24. Cash paid to creditors of the missing items as balancing
25. Drawings figure.
26. Sundry expenses
27. Additional capital
28. Sundry income
Note: When opening or closing cash balances and also cash purchases or cash sales
are missing, it can be assumed that there are no cash sales or cash purchases unless some
other way is available to find them.
For the preparation of final accounts various items should be located from the information
given in the problem. In this process missing figures can be identified. Table 9.2 provides you
required ideas to locate the required information
224
Table 9.2: How to search for the required information

Final Accounts Item Where to find out
(1) Trading account (i) Opening stock Opening statement of

(debit side) affairs.
(ii) Purchases:
(a) cash purchases Payment side of cash

book.
(b) credit purchases (a) total creditors account
or
(b) other information.
(iii) Direct expenses, Payment side of cash book
such as wages, freight, and/or adjustments.
carriage, octroi, fuel &
power etc.
(2) Trading account (i) Sales:
(credit side) (a) cash sales (a) receipt side of
cash book
(b) credit sales (b) total debtors A/c
or other information.
(ii) Closing stock Closing balances or other
information.
(3) Profit & Loss (i) indirect expenses Payments side of cash
account (debit side) such as administrative book/or adjustments and
expenses, selling from other information.
expenses, distribution
expenses.
(ii) Expenses relating Total debtors account and/
to debtors such as or other information.
bad debts, discount
allowed etc.
(iii) Depreciation Comparison of opening &
closing value of assets or
Rate of depreciation given
in the adjustments.
225
(4) Profit & Loss (i) Gross Profit From Trading A/c
account (credit side) (ii) Income Received Receipts side of cash
book.
(iii) Income Receivable From adjustments
(5) Balance Sheet (i) Cash in hand and From receipts side of cash
(Assets) bank balance book or opening statement
of affairs.
(ii) Sundry debtors & By preparing debtors A/c

Bills receivable and Bills receivable A/c or
from closing balances
given or other information.
(iii) Fixed assets such From opening statement of

as Land, Buildings, affairs.
Machinery etc.
Any additions to fixed Payments side of cash

assets book.
(iv) Other assets From closing balances
(6) Balance Sheet (i) Opening capital From opening statement of
(Capital) affairs or from other
information.
(ii) Additional capital From receipts side of cash
book.
(iii) Net profit or Net loss From Profit & Loss A/c
Drawings (to be Payments side of cash
deducted from capital) book.
(7) Balance Sheet Bank overdraft Cash book
(Liabilities) Sundry creditors & By preparing creditors A/c
bills payable and Bills payable A/c or
from closing balances
Outstanding creditors From opening statement of
affairs and from other
adjustments.
226
Calculation of missing figures by preparing necessary ledger accounts

(i) Finding out Credit Sales or Closing Debtors:- A total Debtors account is to be prepared to
find out either missing credit sales or closing balance of debtors (sometimes cash received
from debtors or opening balance of debtors also) in the following manner.
Proforma of a Total Debtors A/c
Rs. Rs.
To Balance b/d By Cash received
(Opening balance) xxx (either given or
balancing figure)
To Bills receivable
(dishonoured) xxx By Bank
To Freight (charged) xxx By Bills receivable xxx
To Interest on overdue A/c xxx By Discounts xxx
To Cash (refund for return) xxx By Return inwards xxx
To Credit sales if given By Transfer to Creditors xxx
(if not given, balancing
figure is credit sales) xxx By Balance c/d (closing
balance) (either given
or balancing figure) xxx
xxxx xxxx
ii. Finding out credit purchases or closing creditors: A total Creditors Account is to be
prepared to find out either missing credit purchases or closing balance of creditors
(sometimes cash paid to creditors also) in the following manner:
Rs. Rs.
To Cash paid (either given By Balance b/d
or balancing figure) xxx (Opening balance) xxx
To Bank xxx By Cash (refund for
returns etc) xxx
To Bills Payable xxx
To Returns outwards xxx By Bills Payable dishonoured xxx
To Discounts received xxx By Credit purchases (either
Given or Bal Fig) xxx
To Allowances & rebates xxx
To Transfer from debtors xxx
To Balance c/d (Closing
Balance either given
Or balancing figure) xxx
xxxx xxxx
227
(iii) Finding out Bills Receivable: A Bills Receivable Account is to be prepared to ascertain
either missing opening or closing balance of bills receivable (sometimes Bills receivable
received from debtors also in the following manner:
Proforma of a Bills Receivable A/c
Rs. Rs.
To Balance b/d (opening By Cash (On presentation
balance) (either given of bills) xxxx
or balancing figure) xxxx
To Sundry debtors By Sundry debtors
(B/R received during (B/R dishonoured) xxxx
the year) (either given
or balancing figure) xxxx By Balance c/d (closing
balance) (either given
or Balancing figure) xxxx
xxxx xxxx
(iv) Finding Out Bills Payable: A Bills Payable Account is to be prepared to ascertain either
missing opening or closing balance of bills payable (sometimes Bills payable accepted
also ) in the following manner:-
Proforma of a Bills Payable A/c

Rs. Rs.
To Balance b/d (opening xxxx By Balance b/d (opening)
(either given or balancing
figure) xxxx
To CashTo Sundry creditors xxxx By Sundry creditors
(B/P dishonoured) (Bills accepted) (either
given or Balancing figure) xxxx
To Balance c/d (closing) xxxx
(either given or
balancing figure)
xxxx xxxx
(v) Finding out opening capital: An opening statement of affairs should be prepared to ascertain
opening balance of capital, without which closing balance sheet cannot be prepaid.
228
(vi) Finding out cash and bank balance:- A cash book should be prepared (in columnar form
if necessary) to ascertain eitheropening or closing balances of cash and bank. The cash
book should be prepared and scrutinized thoroughly even if the opening and closing
balances are given in order to find out missing figures. Such missing item can be any one
of the following items. i.e., cash sales, sundry income or capital introduced (if debit side of
cash book is shorter than credit side)
(OR)
Cash purchase, drawings, sundry expenses or cash missing (if credit side of cash book is
shorter than debit side).
Combined cash and bank closing balance may be given in some problems. In such
cases, either bank balance or cash balance should be found separately in another way (for
which information available). Then from combined balance the cash or bank balance found out
should be reduced to find the remaining balance.
1. What are the methods followed for ascertaining profits when business
records are incomplete?
............................................................................................................................
............................................................................................................................
............................................................................................................................
2. Do income tax authorities accept the profit or loss arrived at by conversion

method?
............................................................................................................................
............................................................................................................................
............................................................................................................................
3. Does net worth method provide a clear picture of the operating results
of a business?
............................................................................................................................
............................................................................................................................
............................................................................................................................
229
4. State whether each the following statements is ‘True’ or ‘False’
i. Joint stock companies can also adopt the single entry System.
ii. Trial balance cannot be prepared in case the books are maintained
according to Single Entry system.
iii. In order to determine the profit according to the Net Worth Method of
Sinlgle Entry system, the profit and loss account is prepared.
iv. Net profit according to Net Worth Method is equal to: Capital at the end
+ Drawings + Fresh Capital introduced - Capital in the beginning of the
accounting period.
v. The Statement of Affairs shows the financial position of the business on

a particualr date in the case of a single entry system.
vi. The amount of credit sales is determined by preparing a Total Creditors

Account.
9.6 Illustrations
Illustraton 7
Rajinikant commenced business as a cloth merchant on January 1, 2002 with a capital of
Rs. 10,000. On the same day he purchased furniture for cash Rs. 3,000. From the following
particulars obtained from his books kept by Single Entry, you are asked to prepare Trading.
Profit and Loss Account for the year ending December 31, 2002 and a Balance Sheet as on that
date.
Rs. Rs.
Sales (inclusive of cash Rs. 7,000) 17,000 Bad Debts written off 500
Purchases (inclusive of
cash Rs. 4000) 15,000 Rajinikant’s Drawings 1,200
Salaries of Staff 2,000
Business Expenses 700
Rajinikanth took cloth worth Rs. 500 from the shop for private use and paid Rs. 200 to his
son, but omitted to record these transactions in his books. On December 31, 2002 his Sundry
Debtors were Rs. 5,200 and Sundry Creditors, Rs. 3,600. Stock -in-trade on December 31,
2002 was Rs. 6,500.
230
Solution
Trading and Profit and Loss Account of Shri Rajinikanth
For the Year ended 31st December 2002
Rs. Rs.
To Purchases 15,000 By Sales 17,000
Less : Drawings By Closing Stock 6,500
(i.e., Cloth taken
from shop for
private use) 500 14,500
To Gross Profity c/d 9,000
23,500 23,500
To Salaries 2,000 By Gross Profit b/d 9,000
To Business Expenses 700
To Bad Debts 500
To Net Profit transferred
to Capital A/c 5,800
9,000 9,000
Balance Sheet of Shri Rajnikant
As on 31st December 2002
Creditors 3,600 Cash 2,800
Capital Account Debtors 5,200
As on 1-1-2002 10,000 Stock-in-trade 6,500
Less : Drawings Furniture 3,000
Cloth Taken 500
Cash given
to son 200
Cash
Drawings 1,200 1,900
8,100
Add : Net Profit for
the year 5,800 13,900
17,500 17,500
231
Working Note
Cash in hand on 31st December 2002 is not given. It has been calculated as follows:
Debtors account will have to be prepared to find out the cash received from debtors which
is not given in the problem. Similarly creditors account has to be prepared to ascertain the
amount of Cash paid to Creditors.
Sundry Debtors Account

Dr. Cr.
Rs. Rs.
To Credit Sales By Bad Debts 500
(Rs. 17,000 - Rs. 7,000) 10,000 By Cash (Balancing figure) 4,300
10,000 10,000
Dr. Sundry Creditors Account Cr.

Rs. Rs.
To Cash (Balancing figure) 7,400 By Credit Purchases
To Balance c/d 3,600 (Rs. 15,000 - Rs. 4,000) 11,000
11,000 11,000
Cash Account
Rs. Rs.
To Capital 10,000 By Furniture 3,000
To Sales (Cash) 7,000 By Cash Purchases 4,000
To Debtors as per Debtors A/c 4,300 By Drawings 1,200
By Salaries 2,000
By Business Expenses 700
By Drawings amoung
given to son 200
By Creditors
(as per Creditors A/c) 7,400
By Balance c/d
21,300 21,300
232
Illustration 8
Meharban keeping his books under Single Entry System has placed the following facts
before you.
a. His Statement of Affairs as at 1st January 2002;
b. A summary of cash transactions for the year 2002;
c. A list of remaining transactions for the year.
(i) Rs. Rs.
Bank Overdraft 25,000 Debtors 75,000
Creditors 50,000 Less: Provision 3,750 71,250
Bills Payable 3,000 Bills Receivable 18,000
Outstanding Stock 70,000
General Charges 2,000 Plant 50,000
Capital Account 1,52,000 Building 20,000
Cash in hand 2,750
2,32,000 2,32,000 (ii)
Rs. Rs.
To Balance on 1.1.2002 2,750 By Payment to Creditors 1,80,000
To Bills Receivable 50,000 By Cash Purchases 40,000
To Debtors 2,18,000 By Bills Payable 80,000
To Cash Sales 41,000 By Salaries 15,000
To Mrs. Meharban Loan 25,000 By Rent 9,000
By General Charges 4,500
By Drawings 5,400
3,36,750 3,36,750
(iii) Rs. Rs.
Total sales 4,02,500 Bills payable accepted
Total purchases 3,60,000 during the year 93,000
Discount allowed
to customers 1,000 Stock on 31-12-2002 85,000
Owing for outstanding
general charges 3,000
Discount Bad debts 2,000
allowed by creditors 2,000 Prepaid rent 1,800
Bills receivable as
at 31-12-2002 30,000
233
Provide 5% for doubtful debts and 2 ½% for discount on debtors. Depreciate building by
2% and plant by 10%.
You are required to prepare Trading and Profit and Loss Account and Balance Sheet of
Meharban from the above particulars.
Solution
Trading and Profit and Loss Account of Meharban

For the Year ending 31st December 2002
Dr. Particulars Rs. Particulars Rs Cr.
To Opening Stock 70,000 By Sales Cash 41,000
To Purchases : Credit 3,61,500 4,02,500
Cash 40,000
Credit 3,20,000 3,60,000 By Closing Stock 85,000
To Gross Profit c/d 57,500
4,87,500 4,87,500
To Salaries 15,000
To Rent 9,000 By Gross Profit b/d 57,500
Less: prepaid 1,800 7,200 By Discount received 2,000
To General Charges 4,500
Less: O/S last year 2,000
2,500
Add: O/S this year 3,000 5,500
To Discount allowed 1,000
To Bad Debts 2,000
Add: Provision for
Bad Debts (New) 7,675
9,675
Less: Existing
Provision 3,750 5,925
To Provision for
Discount on Debtors 3,646
To Depreciation:
Building – 2% 400
Plant – 10% 5,000 5,400
To Net Profit 15,829
59,500 59,500
234
Balance Sheet of Meharban as on 31st December, 2002

Liabilities Rs. Assets Rs
Outstanding General Cash in hand 2,850
Charges 3,000 Bills Receivable 30,000
Bills Payable (Note : 4) 16,000 Debtors (Note :1) 1,53,500
Creditors (Note: 3) 95,000 Less : Provision for
bad debts 7,675
1,45,825
Bank Overdraft 25,000 Less : Provision for
Mrs. Meharban Loan 25,000 discount 3,646 1,42,179
Capital Account: Stock 85,000
On 1.1.2002 1,52,000 Prepaid Rent 1,800
Less : Drawings 5,400 Plant 50,000
1,46,600 Less : Depreciation 5,000 45,000
Add : Net Profit 15,829 1,62,429 Building 20,000
Less : Depreciation 400 19,600
3,26,429 3,26,429
Working Notes
1) Calculation of Debtors as at 31-12-2002
Total Debtors Account
Particulars Rs. Particulars Rs
To Balance b/d 75,000 By Cash 2,18,000
To Credit Sales By Bills Receivable A/c
(Rs.4,02,500 – (Note : 2) 62,000
Rs.41,000) 3,61,500 By Discount Allowed 1,000
By Bad Debts 2,000
By Balance c/d 1,53,500
4,36,500 4,36,500
235
(2) Calculation of Bills Receivables Received during the year

Bills Receivable Account
Particulars Rs. Particulars Rs
To Balance c/d 18,000 By Cash 50,000
To Debtors A/c 62,000 By Balance c/d 30,000
(Balancing figure)
80,000 80,000
3) Calculation of Creditors as on 31-12-2002
Total Creditors Account
Rs. Rs.
To Cash 1,80,000 By Balance b/d 50,000
To Discount 2,000 By Total Credit Purchases 3,20,000
To Bills Payable A/c 93,000 (Rs.3,60,000 - Rs.40,000)
To Balance c/d
3,70,000 3,70,000
(4) Calculation of Bills Payable as on 31-12-2002
Bills Payable Account
Rs. Rs.
To Cash 80,000 By Balance B/d 3,000
To Balance c/d 16,000 By Total Creditors A/c 93,000

(Balancing figure)
96,000 96,000
Illustration 9
Satya Prakash does not maintain regular books but keeps only Memoranda office
transactions. He furnishes the following information for the year ended 30th September 2002.
(i) Total collections from debtors (in cash) Rs.1,50,000
(ii) Cash Sales (as gathered from cash sales invoices) Rs.96,000
236
(iii) The abstract of the Bank Account for the year ended 30th September, 2002 is as follows:
Rs. Rs.
To Cash deposited By Overdraft as on 1.10.2001 24,000
out of “ Interest and Bank Charges 450
collections 2,39,550 “ Personal Drawings 12,000
“ Salaries to staff 51,000
“ General Expenses 47,550
“ Payment to Creditors 90,000
“ Balance on30.9.2002 14,550
2,39,550 2,39,550
(iv) Other balance on 1st October 2001 are as follows:-
Rs.
Stock 54,000
Debtors 1,32,000
Furniture 6,000
Building 90,000
Creditors 48,000
Cash in hand 500
(v) He purchased an old scooter for Rs.6,000 on 1st July, 2002
(vi) Besides the cash balance with the cashier, the other balances as on 30th
September ,2002 .
Rs.
Stock 61,200
Debtors 1,80,000
Creditors 33,000
Prepare Trading and Profit and loss Account for the year ended 30th September,2002 and the
Balance Sheet as on that date after providing for depreciation at 10% p.a. on all fixed assets.
237
Solution
In the Books of Satya Prakash
Trading and Profit and Loss Account
for the year ending 30the September 2002
Rs. Rs.
To Opening Stock 54,000 By Sales
“ Purchases(Credit) 75,000 Cash 96,000
Credit 98,000
“ Gross profit c/d 2,26,200 By Closing Stock 2,94,000
61,200
3,55,200 3,55,200
To Salaries 51,000 By Gross Profit b/d 2,26,200
“ General Expenses 47,550
“ Interest and Bank
Charges 450
“ Depreciation on
Furniture 600
Building 9,000
Scooter 150 9,750
To Net Profit transferred
to capital a/c 1,17,450
2,26,200 2,26,200
Balance Sheet
As at 30.9.2002
Creditors 33,000 Cash in hand 950
Capital as on Cash at Bank 14,550
1.10.2001 W.N. 4. 2,10,500 Debtors 1,80,000
Add: Net Profit 1,17,450 Closing Stock 61,200
3,27,950 Furnitrue 6,000
Less: Less : Depreciation 600 5,400
Drawings 12,000 3,15,950 Scooter 6,000
Less: Depreciation 150 5,850
Building 90,000
Less : Depreciation 9,000 81,000
3,48,950 3,48,950
238
Working Notes
(1) Calculation of Credit Purchases
Creditors Account
Rs. Rs.
To Bank a/c 90,000 By Balance b/d 48,000
To Balance c/d 33,000 By Credit Purchases 75,000
1,23,000 (Balancing figure) 1,23,000
(2) Calculation of Credit Sales:
Debtors Account
Rs. Rs.
To Balance b/d 1,32,000 By Cash a/c 1,50,000
To Credit Sales 1,98,000 By Balance c/d 1,80,000
Balancing figure 3,30,000 3,30,000
(3) Calculation of cash in Hand on 30.9.2002
Cash Book
Receipts Rs. Payment Rs.
To Balance b/d 500 By Bank 2,39,550
“ Debtors 1,50,000 “ Scooter 6,000
“ Cash Sales 96,000 “ Balance c/d. 950
2,46,500 2,46,500
(4) Calculation of capital as on 1.10.2001

Statement of Affairs
As at 1.10.2001
Bank Overdraft 24,000 Cash in hand 500
Creditors 48,000 Debtors 1,32,000
Capital (Balancing figure) 2,10,500 Stock 54,000
Furniture 6,000
Building 90,000
2,82,500 2,82,500
239
Illustration 10
Shri Sikand, a small producer of machine parts, has supplied the following details of his
business transactions:
Rs. Rs.
Cash and Discount credited to Cash Drawings 1,500
Debtors 64,200 Cheques collected from Debtors 43,200
Discounts received 200 Drawings by Cheques 4,200
Expenses paid in cash 3,400 Cash in hand on 30.9.2002 2,200
Bad Debts 500 Discount allowed 700
Cash withdrawal from Bank 4,500 Chques paid to Creditors 53,400
Expenses paid by cheques 3,500 Total Sales 69,100
Cash collections from Debtor 20,300 Cash Purchases 2,100
Cash deposit in Bank 13,500 Cash paid to Credtors 6,300
As on 1.10.2001 As on 30.9.2002
Rs. Rs.
Debtors ? 15,000
Cash and Bank Balance 13,900 5,300
Stock 8,700 10,500
Plant 5,600 4,600
Creditors 6,000 9,400
Liabilities for Expenses 500 800
You are required to prepare Trading and Profit and Loss Account for the year ending 30.9.2002
and a Balance Sheet as at that date for Shri Sikand.
240
Solution
Trading and Profit and Loss Account of Shri Sikand
for the year ending 30th September, 2002
Rs. Rs.
To Opening Stock 8,700 By Sales
“ Purchases: Cash (W.N.I) 2,300
Cash 2,100 Credit 66,800 69,100
Credit 63,300 65,400 “ Closing Stock 10,500
“ Gross Profit 5,500
79,600 79,600
To Expenses
Cash 3,400
Cheques 3,500
6,900
Less: O/S last year 500 By Gross profit b/d. 5,500
6,400
Add: O/S this year 800 7,200 “ Discount received 200
To Discount Allowed 700 “ Net loss transferred to
Capital account 3,700
To Bad Debts 500
To Depreciation on plant 1,000
(5,600 - 4,600)
9,400 9,.400
Balance Shee of Shri Sikand
as on 30th September, 2002
Creditors 9,400 Cash in hand 2,200
Outstanding Expenses 800 Cash at Bank 3,100
Capital: As on Stock 10,500
1.10.2001 36,800 Debtors 15,000
Less : Drawings 5,700 Furniture 2,200
Net loss 3,700 9,400 27,400 Plant 5,600
37,600 37,600
241
Working Notes
(1) Calculation of cash sales
Particulars Cash Bank Particulars Cash Bank
Rs. Rs. Rs. Rs.
To Balance b/d. --- 10,000 By Expenses 3,400 3,500
(Bal. Fig.) “ Cash --- 4,500
In case of Bank) “ Bank 15,500 ---
(13,900 –
10,000) 3,900 --- “ Drawings 1,500 4,200
“ Bank / Cash 4,500 15,500 “ Creditors 6,300 53,400
“ Debtors 20,300 43,200 “ Purchases 2,100 ---
“ Cash Sales 2,300 --- “ Balance c/d. 2,200 3,100
(Balancing figure)
31,000 68,700 31,000 68,700 (2)

Calculation of opening balance of Debtors
Dr. Sundry Debtors Account Cr
Rs. Rs.
To Balance b/d. By Cash 20,300
(Bal. Fig.) 12,900 “ Bank 43,200
To Credit Sales “ Discount 700
Total Sales 69,100 “ Bad Debts 500
Less Cash “ Balance c/d. 15,500
Sales 2,300 66,800
79,700 79,700
(3) Calculation of opening balance of capital
Balance Sheet As at 1.10.2001
Creditors 6,000 Cash 3,900
Liabilities for Bank 10,000
ExpensesCapital 500 Debtors W.N.; 2. 12,900
(Balancing figure) 36,800 Stock 8,700
Furniture 2,200
Plant 5,600
43,300 43,300
242
(4) Calculation of credit purchases.

Creditors Account
Rs. Rs.
To Bank 53,400 By Balance b/d. 6,000
“ Cash 6,300 “ Credit Purchases
“ Discount 200 (Balancing figure) 63,300
“ Balance c/d 9,400
69,300 69,300
Illustration 11
Mr. PQ has a small trading business for which the following procedures are followed:
(1) All collections are deposited with the bank each day.
(2) All payments except petty expenses are made by cheques.
(3) To meet petty expenses a cheque of Rs.500 is withdrawn from bank on the 1st day of
each month.
(4) Mr. PQ makes personal drawings from the bank.
The following figures are available from Mr. PQ’s records:
1-1-202 31-12-2002
Cash in Hand 320 200
Balance in Bank 2,500 ——

Bank Overdraft — 5,000
Debtors 20,000 30,000
Stock of goods 10,000 30,000
Payment made to creditors

during the year —- 20,000
Sales made during the year —- 30,000
Creditors 20,000 30,000
Mr. PQ spent during the year Rs.200 from the office cash for his personal expenses.
Prepare Profit and Loss Account for the year ended 31-12-2002 and Balance sheet as on that
date from the above information.
243
Solution
Trading and Profit and Los Account of Mr. PQ
for the year ended 31-12-2002
Rs. Rs.
To Purchases (W.N.2) 30,000 By Closing Stock 30,000
To Gross Profit c/d. 20,000
60,000 60,000
To Sundry Expenses
(W.N.3) 5,920 By Gross Profit b/d. 20,000
To Net Profit transferred to
Capital A/c 14,080
20,000 20,000
Balance Sheet of Mr. PQ
As at 31-12-2002
Bank Overdraft 5,000 Cash in Hand 200
Sundry Creditors 30,000 Sundry Debtors 30,000
Capital A/c: Stock in Trade 30,000
As on 1-1-2002 (W.N.5)12,820
Add: Net Profit 14,080
26,900
Less: Drawings
(W.N.4) 1,700 25,200
60,200 60,200
Working Notes
(1) Calculation of Amount received from customers
Total Debtors Account
Rs. Rs.
To Balance b/d. 20,000 By Bank (Balancing figure) 20,000
To Sales 30,000 By Balance c/d. 30,000
50,000 50,000
244
(2) Calculation of Credit Purchases

Total Cresitors Account
Rs. Rs.
To Bank 20,000 By Balance b/d. 20,000
To Balance c/d. 30,000 By Credit Purchases
50,000 50,000
(3) Calculation of Sundry Expenses
Cash Account
Rs. Rs.
To Balance b/d. 320 By Drawings 200
To Bank (Amount withdrawn By Sundry Expenses
For 12 months @ Rs.500 6,000 By Balance c/d. 200
6,320 6,320
(4) Calculation of Amount of Drawings by Cheques
Bank Account
Rs. Rs.
To Balance b/d. 2,500 By Sundry Creditors 20,000
To Sundry Debtors 20,000 By Cash (Amount
withdrawn for
petty expenses 6,000
To Balance c/d.
(Overdraft) 5,000 By Drawings
27,500 27,500
Total drawings:
Cash drawings 200
Drawings by cheques 1,500
Total Drawings 1,700
245
(5) Calculation of Capital as on 1-1-2002

Balance Sheet As at 1-1-2002
Sundry Creditors 20,000 Cash in Hand 320
Capital (Balancing figure) 12,820 Cash at Bank 2,500
Stock in trade 10,000
32,820 32,820
9.7 Summary
Single entry does not mean that there is only one entry for each transaction. In fact,
single entry is a combination of (a) Double Entry for some transactions like cash collected from
debtors (b) Single Entry for transactions like cash sales and (c) No Entry for transactions like
depreciation. In pure single entry, only personal accounts are recorded. In simple single entry,
personal accounts and cash account are maintained. In quasi single entry, personal accounts,
cash account and some subsidiary books are maintained. Thus, single entry refers to crude
accounting methods which do not record nominal accounts and most of the real accounts.
Business people, without systematic accounting knowledge, like small traders, medical
practitioners and other professionals follow this method. Under single entry system profit or
loss can be found through any one of the following two methods. (i)Net worth Method
(Statement of affairs method) and (ii)Conversion Method.
9.8 Key Words

Net Worth : It is the same as net assets. It refers to the excess of the book
value of assets (other than fictitious assets) of an enterprise
over its liabilities.
Single Entry System : An incomplete double entry system varying with the
circumstances.

1. Explain the Single Entry System. Explain how the profit can be determined under this
system and also State its disadvantages.
246
2. Explain in detail the steps to be taken to convert a set of books kept under the Single
Entry System into the Double Entry System.
3. Discuss the limitations of Single Entry System.
4. What are the differences between Single Entry System and Double Entry System?
Choose the most appropriate answer

i. In the case of net worth method of single entry system, the net profit is ascertained by
(a) Preparing a Trading and Profit and Loss Account.
(b) Comparing the capital in the beginning and at the end of the accounting period.
(c) Adopting any other method.
ii. The capital in the beginning of the accounting year is ascertained by preparing
a/an
(a) Cash account.
(b) Opening Statement of Affairs.
(c) Total Creditors Account.
iii. The amount of opening stock can be ascertained by preparing a/an
(a) Memorandum Trading Account.
(b) Total Creditors Account.
(c) Opening Statement of Affairs.
iv. The closing balance in the Creditors Account can be ascertained from the
(a) Cash Account.
(b) Total Creditors Account.
(c) Balance Sheet at the end of the accounting period.
v. If the rate of gross profit is 25% of sales and the cost of goods sold is Rs.1,00,000 the
amount of gross profit will be
(a) Rs.25,000
(b) Rs.33,333
247
(c) Rs.20,000
vi. If the rate of groos profit is 20% on cost of goods sold and the sales are Rs.1,00,000, the
amount of gross profit will be
(a) Rs.20,000
(b) Rs.25,000
(c) Rs.16,667
Answer:- (i) (b); (ii) (b); (iii) (a); (iv) (b); (v) (b); (vi) (c)
From the information given below, calculate the required items:

a. Capital at the beginning of the year:
Capital at the end of the year Rs.70,000; drawings during the year Rs.10,000; Capital
introduced during the year Rs.5,000; Profit during the year Rs.20,000.
b. Sales
Cost of goods sold Rs.5,40,000; rate of profit 25% on sales.
c. Purchases
Creditors at the beginning of the year Rs.40,000; Closing creditors Rs.45,000; Cash paid
to creditors Rs.1,50,000; discount allowed by creditors Rs.5,000; returns outwards
Rs.8,000; acceptances given to creditors during the year Rs.50,000.
d. Purchases
Cost of goods sold Rs.8,00,000; Opening stock Rs.1,00,000; Closing stock Rs.1,20,000.
e. Cost of goods sold:
Sales Rs.8,40,000; rate of gross profit on cost 20%.
f. Stock at the end of the year:
Sales Rs.6,00,000; Opening stock Rs.50,000; Purchases Rs,5,00,000; Wages(productive)

Rs.10,000; Carriage inward Rs.7,000; rate of gross profit on cost 20%.
g. Bills received from customers:
Opening balance of B/R Rs.15,000; B/R endorsed in favour of creditors Rs.2,000; B/R
collected (i.e. honoured) Rs.8,000; B/R dishonoured Rs.1,000; Closing balance of B/R
Rs.20,000.
248
Answer:- (a) Rs.55,000; (b) Rs.7,20,000; (c) Rs.2,18,000; (d) Rs.8,20,000; (e) Rs.7,00,000;
(f) Rs.67,000; (g) Rs.16,000.
Exercises
1. A trader keeps his books by single entry system. During the year 2002 he kept a cash
book of which the following is an analysis:
Rs.
Received from Sundry Debtors 64,000

Additional capital introduced on 1.10.2002 8,000
Loan from Z at 16% p.a. on 1.7.2002 10,500
Paid to Sundry Creditors 57,700
General Expenses Paid 3,900
Salaries paid 3,000
Drawings 4,000
Deposits in the Bank during the year 50,000
Withdrawals from the Bank during the year 36,000
The following balances existed on 1.1.2002:-
Rs. Rs.
Sundry Debtors 15,300 Building 42,500
Sundry Creditors 11,500 Stock 21,800
Bank Overdraft 8,000 Cash Balance 600
The following balances existed on 31.12.2002:-
Rs. Rs.
Sundry Debtors 16,000 Stock 26,000
Sundry Creditors 11,900
Depreciate building @ 5% and provide interest on Z’s loan. Prepare Trading and Profit
and Loss Account for year ended 31st December 2002 and Balance Sheet as on that date.
249
Ans: Gross Profit Rs.10,800; Net Profit Rs.935; Balance Sheet Total Rs.88,875
2. The following facts have been ascertained from the records of Murali who maintains his
books of account under the single entry system:
Receipts for the year ended 31st March, 2002: Rs.

From Sundry debtors 88,125
Cash Sales 20,625
Paid in by Murali, the proprietor 12,500
1,21,250
Payments made during the year ended 31st March, 2002:
Rs.
New plant purchased 3,125
Drawings 7,500
Wages 33,625
Salaries 5,625
Interest paid 375
Telephone 625
Rent 6,000
Light and Power 2,375
Sundry expenses 10,625
Sundry creditors 38,125
1,08,000
It may be noted that Murali banks all receipts and makes all payments only by means of
cheques:
Assets and Liabilities As at As at
31st March, 2001 31st March, 2002
Rs. Rs.
Sundry Debtors 18,750 30,625
Bank 3,125 ?
Stock 31,250 15,625
Plant 37,500 36,575
250
From the above data, prepare the trading and profit and loss account for the year ended
31st March, 2002 and balance sheet as on that date.
Ans: Gross Profit Rs.33,875; Net Profit Rs.4,200; Balance Sheet Total Rs.99,200
3. X is a small trader. He maintains no book but only an account with a bank in which all
takings are lodged after meeting business expenses and his personal drawings and in
which payments for business purchases are passed through.
You are required to ascertain his trading results for the year ended 31st March, 2002 and
the financial position of the business as on that date from the following information supplied by
X.
(i) The bank statement shows deposits of Rs.12,030 and withdrawals of Rs.11,850.
(ii) Rs.1,000 had been placed in fixed deposit account on 31st December, 2000 at 8% p.a.
and withdrawn with interest on 30th June, 2001.
(iii) The assets and liabilities on 31st March, 2002 were : Stock Rs.2,100; Book Debts Rs.1,150;
Bank Balance Rs.320;
Furniture Rs.2,000; and Trade Creditors Rs.400.
(iv) In the absence of reliable information, estimates are supplied on the following matters:
(a) The stock and book debts have each increased by Rs.100 during the year;
(b) The trade creditors were Rs.200 on 1st April, 2001.
(c) During the year the personal expenses amounted to Rs.1,000 and business expenses
Rs.1,700.
Ans: Gross Profit Rs.1,840; Net Profit Rs.160; Balance Sheet Total Rs.5,570
4. The following is a summary of the Bank Account of Sri Debashish Poddar, a trader, for the
year 2002:
251
Bank Summary
Rs. Rs.
Balance, 1st January 2002 5,140 Payment to Trade Creditors 1,87,860
Cash sales and receipts on General Expenses 16,970

account of Credit Sales 2,43,720 Rent and Rates 7,710
Balance, 31st December 2002 1.180 Drawings 37,500
2,50,040 2.50.040
All business takings had been paid into the bank except Rs.21,180, out of which Poddar
paid wages amounting to Rs.12,800. He retained Rs.8,380 for private purposes.
The following information is obtained from the books:

31.12.01 31.12.02
Rs. Rs.
Stock-in-trade 24,300 31,500
Creditors (goods) 19,450 17,090
Debtors (goods) 22,400 26,900
Amount owing to a customer who
had overpaid his account 600 ——
Rates paid in advance 420 450
Creditors for general expenses 810 1,340
Furniture and Fittings 10,000 10,000
Discount received from trade creditors during 2002 amounted to Rs.1,500.
No discounts were allowed to customers.
The amount due to the customers who overpaid his account was set off against sales to
him in 2002.You are required:
a. To ascertain the balance of Poddar’s capital account as at 31st December, 2001, and
b. To prepare a Trading and Profit and Loss Account for the year 2002 and a Balance Sheet
as on 31st December, 2002. Ignore depreciation on Fixed Assets.
252
Ans: Gross Profit Rs.90,200; Net Profit Rs.53,720Balance Sheet Totals : as at 31.12.2001
– Rs.61,660as at 31.12.2002 – Rs.68,850
5. From the following information of M/s Pradip & Co., prepare Trading and Profit and Loss
Account for the year ended 31st March, 2002 and the Balance Sheet as on that date:
Liabilities and Assets 31-3-2001 31-3-2002

Rs. Rs.
Car 90,000 90,000
Furniture 10,000 10,000
Stock 70,000 90,000
Debtors 62,000 46,000
Bank 9,000 16,000
Creditors 60,000 ?
The following further informations are also available:
(i) M/s Pradip & Co., purchases goods for resale from manufactures who allow discount of
3% on goods purchased in excess of Rs.5,00,000 in a year. The discount for the year
ended 31st March, 2002 was Rs.12,480.
(ii) All goods are sold at a gross profit margin of 30% on selling price.
(iii) Bank statements for the year reveal the following payments:
Rs.
Creditors 9,03,520
Salaries 60,000
Car Expenses 23,000
Rent 30,000
Printing & Stationery 6,400
Rates and Taxes 3,000
Carriage Outward 18,600
Travelling Expenses 14,900
Delivery Van Purchase 1,70,000
253
Miscellaneous Expenses 9,580

Drawings 50,000
Depreciation on Car and Van @ 20% and Furnitue @ 10% is to be provided on balances
as on 31-3-2002.
Ans:Gross Profit Rs.3,84,000; Net Profit Rs.1,95,000; Balance Sheet Total Rs.3,86,000

A 2. Only personal accounts and cash accounts are maintained.
B. 1. Networth method or statement of affairs method and conversion method.
2. Income tax authorities accept the profit arrived by conversion method for the purpose
of taxation
3. No, it does not show sales, purchases, gross profit , operating expenses, etc.
4. (i) False (ii)True (iii) False (iv) False (v)True (vi) False
254
Model Question Paper

B.Com
Financial Accounting
Time: Three hours Maximum: 75 marks
Part A – (10x2 = 20 marks)
Answer any ten questions each in 50 words.
1. What do you mean by double entry book keeping?
2. Define Balance Sheet.
3. What is Suspense account?
4. Write short notes on Revaluation method.
5. What is meant by statement of affairs method?
6. What is Account current?
7. What is depreciation.
8. Journalise the following transactions:

2006 Jan. 10 Paid Rs. 500 as wages for installation of machinery.
Jan 15 Goods worth Rs. 2,000 were used by proprietor for own use.
9. From the following information, prepare Balance Sheet.
Rs.
Capital 5,00,000
Debentures 2,00,000
Assets 7,75,000
Other liabilities 1,00,000
Sundry creditors 50,000
Sundry debtors 1,00,000
Cash at bank 25,000
Profit 50,000
10. ‘A’ Ltd. purchased a machinery for Rs. 1,00,000 on 1.4.2009. The useful life of the
machinery is 10 years. Its residual value is Rs. 10,000. Find out the rate of
depreciation under Straight line method.
255
11. Find out profit from the following data:
Rs.
Capital at the beginning of the year 8,00,000
Capital at the end of the year 9,00,000
Drawings 1,80,000
Additional capital 50,000
12. How will the following appear in the expenditure side?
Rs.
Stock of sports materials on 1.1.99 3,000
Sport materials purchased during 1999 8,500
Stock of sports materials on 31.12.99 600
Part B – (5x5 = 25 marks)
Answer any five questions each in 250 words
13 Explain the limitations of single entry system.
14 A company acquired a machine on 1.1.88 at a cost of Rs. 40,000 and spent Rs.
1,000 on its installation. The firm writes of depreciation at 10% on the diminishing
balance. The books are closed on 31st December of each year. Show the Machinery
account for 3 years.
15. From the following information ascertain opening stock on 1-1-2006.Purchases

during the year 2006 Rs. 2,50,000 Sales during the year 2006 Rs. 3,25,000 Stock
on 31-12-2006 Rs. 60,000 Wages Rs. 3,000 Rate of gross profit on cost 25%
16. Journalise the following transactions :
(a) Business started with Rs. 2,50,000 and cash deposited with banks Rs.1,50,000
(b) Purchased machinery on credit from Rengan Rs.50,000
(c) Bought furniture from Ramesh for cash Rs.25,000
(d) Goods sold to Yesodha Rs.22,500

256
17. Prepare Receipts and payments account from the following details.
Rs.
Opening balance of cash 4,00,000
Received entrance fees 8,000
Subscription received : Current year 16,000
Previous year 1,600
Paid salaries 2,000
Paid for miscellaneous expenses 200
Rent paid 1,200
Purchase of cricket balls 500
Purchase of cricket bats 1,600
Paid stationery 100
18. From the following particulars find out net credit purchases:
Rs.
Opening balance of sundry creditors 40,000
Payment by cheques 2, 35,000
Payment by bills payable 25,000
Payment in cash 5,000
Discount received 2,500
Purchase returns 5,000
Closing balance of sundry creditors 47,500
19. From the information given below prepare Trading account
Rs.
Opening stock 2,00,000
Direct expenses 20,000
Purchases 3,00,000
Closing stock 1,00,000
Carriage inwards 10,000
Sales 8,00,000
Purchase returns 50,000
257
Part C – (3x10 = 30 marks)
Answer any three questions each in 500 words
20. What are the methods of computing depreciation? Explain their merits and demerits
21. A second hand machinery was purchased on 1.1.2000 for Rs. 30,000 and repair
charges amounted to Rs. 6,000. It was installed at a cost of Rs. 4,000. On 1st July
2001, another machine was purchased for Rs. 26,000. On 1st July 2002, the first
purchased machine was sold for Rs. 30,000. On the same day, one more machine
was bought for Rs. 25,000. On 31.12.2002, the machine bought on 1st July, 2001,
was sold for Rs. 23,000. Accounts are closed every year on 31st December.
Depreciation is written off at 15% p.a. Prepare the Machinery Account for the Three
years.
22. Ascertain the credit sales by preparing total debtors account from the following
information :
Rs.
Debtors as at 31.3.2002 28,000
Debtors as at 31.3.2001 24,000
Sales returns 1,000
Cash received from Debtors 74,800
Bills receivable drawn 26,000
Discount allowed 1,000
Bad debts 1,000
Cheque received from debtors 10,000
Bills receivable dishonoured 4,000
Cheques dishonoured 6,000
23. The following balances are extracted from the books of M/s. Chaitanya & co. on
31st December, 2008. You are required to give the necessary closing entries and
prepare Trading and Profit and Loss a/c for the year ended and a Balance sheet as
at that date.
258
Rs.
Capital 7,160
Rent and taxes 440
Creditors 7,860
Commission (cr.) 160
Bills payable 1,200
Returns inwards 520
Sales 20,000
Stationery 180
Carriage outward 580
Interest on capital 280
Commission (Dr.) 320
Stock on Jan 1.2008 400
Carriage inward 320
Bills receivable 1,800
Wages 1,120
Sundry debtors 12,000
Purchases 15,600
Trade expenses 80
Insurance 440
Office furniture 400
Return outwards 200
Cash in hand 200
Cash at bank 1,900
The closing stock was valued at Rs.10,000.
24. Take problem from sale or return
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SUCM 101/

INSTITUTE OF DISTANCE EDUCATION

It is with a great pleasure to welcome you as a student of Institute of Distance

With best wishes from mind and heart,

Dr. V.K. Somasundaram

COORDINATION & EDITING

© UNIVERSITY OF MADRAS, CHENNAI 600 005.

Sl.No. Title Page

4. Income & Expenditure Account 93

5. Average due date and Account current 105

6. Sale or Return Account 123

7. Depreciation, Provision and Reserves 136

8. Insurance Claims 165

9. Single Entry System 206

After studying this unit, you should be in a position to :

 explain the meaning and scope of accounting

1.2 Meaning and Scope of Accounting

Accounting can, therefore, be defined as “the process of identifying, measuring, recording

(a) Economic events

(b) Identification, measurement, recording, classifying and communicating

(d) Users of accounting information

An economic event can be defined as occurence of economic consequence of an activity

B. Identification, Measurement, Recording and Communication

(v) Communication: The very purpose of accounting is to communicate the operating

D. Interested Users of Information

The management of a business is the internal user of accounting information. The

Tax authorities, regulatory agencies (i.e Registrar of Companies, Ministry of Finance,

1.3 Objectives of Accounting

3. To ascertain the financial position of business : In addition to Income Statement a business

5. To protect business properties: Accounting provides information about what is going on in

Check Your Progress - A

State whether each of the following statements is ‘True’ or ‘False’.

i) Accounting is the language of the business.

ii) Accounting is useful only to the profit oriented business.

iii) Accounting records only transactions which are of a financial character.

iv) Income statement shows the financial position of a business on a particular

v) The main objective of accounting is to ascertain the profit/loss and financial

1.4 Distinction between Book Keeping and Accounting

(i) identifying the transactions and events to be recorded;

(ii) measuring them in terms of money;

(iii) recording them in the books of prime entry; and

(iv) posting them into ledger.

1.5. Branches of Accounting

(i) Financial Accounting

(ii) Cost Accounting

(iii) Management Accounting

1.6. Systems of Book-keeping

(i) Single Entry System

(ii) Double Entry System.

These two systems of book-keeping are explained briefly below.

(i) Single Entry System

(ii) Double Entry System

1.7 Systems of Accounting

(i) Cash System of Accounting

(ii) Mercantile or Accrual System of Accounting

1.8 Advantages and Limitations of Accounting

(i) Financial accounting fails to provide a complete picture of business. Because in

(iii) The accounting conventions and personal judgments of accountants greatly

1.9 Accounting Principles - Concepts and Conventions

1.9.1. Basic Assumptions

(a) Accounting Entry;

(b) Money Measurement;

(c) Going Concern; and

(d) Accounting period.