FINANCIAL ACCOUNTING AND ANALYSIS

INTRODUCTION:
Accounting is the language of business. Companies communicate their performance to outsiders and
evaluate the performance of their employees using information generated by the accounting system.
Learning the language of accounting is essential for anyone that must make decisions based on financial
information. Accounting is not an end in itself; it is a means to an end. It performs the service activity by
providing quantitative financial information that helps the users in making better business decisions.
Accounting also describes and analyses the mass of data of an enterprise through measurement,
classification, and summarization, and reduces that data into reports and statements, which show the
financial condition and results of operations of that enterprise. Accounting as an information system
collects processes and communicates information about an enterprise to a wide variety of interested
parties.

Definitions:

The American Accounting Association defines accounting as follows: “The process of identifying,
measuring and communicating economic information to permit informed judgements and decisions by
users of the information.”

American Institute of certified public Accountant defines accounting as “Accounting is an art of

recording, classifying and summarizing in a significant manner and in terms of money, transaction and
events which are, in part at least, of a financial character and interpreting the results thereof ”

The purpose of financial accounting statements is mainly to show the financial position of a business at a
particular point in time and to show how that business has performed over a specific period.

The three main financial accounting statements that help achieve this aim are:

(1) The profit and loss account (or income statement) for the reporting period
(2) A balance sheet for the business at the end of the reporting period
(3) A cash flow statement for the reporting period

A balance sheet shows at a particular point in time what resources are owned by a business (“assets”) and
what it owes to other parties (“liabilities”). It also shows how much has been invested in the business and
what the sources of that investment finance were.

Differences between Accounting and Book-Keeping:

Book keeping usually involves only the recording of business transactions (transactions) and is therefore,
just one part of the accounting process. Accounting on the other hand, involves the entire accounting
process, i.e. identification, measurement, recording, and communication. Now-a-days, much of the book
keeping function is performed by the computer and other machines
Objectives of Accounting
The basic objective of accounting is to provide information to the interested users to enable them to make
business decisions. The necessary information, particularly in the case of external users, is provided in the
basic financial statements: Profit and loss statement and Balance sheet.

Besides the above sources of information, the internal users, officers and staff of the enterprise, can obtain
additional information from the records of business. Thus the primary objectives of accounting can be
stated as:
 Maintenance of Records of Business transactions.
 Calculation of Profit or Loss
 Depiction of Financial Position.
 Provide Information to the Users

Maintenance of Records of Business :

First record, then pay; if there is an error, trace it from the records. Human memory is short. Even the
most brilliant executive or manager cannot accurately remember what he might have observed regarding
the daily operations. He need not strain his memory unnecessarily, if proper and complete records of all
business transactions are kept regularly. More-over, records can be used by different officials for different
decision-making purposes.

Calculation of Profit or Loss :

Earning profit is the main purpose for which a business is carried on. This information is available from
the profit and loss statement. Profit is calculated by deducting expenses from the associated revenues.
Profit is a measure of the performance of the enterprise.

Depiction of Financial Position

A balance sheet depicts the financial position of an enterprise. It is a statement of assets and liabilities. It
shows the resources (assets) owned by an enterprise and depicts the claims (liabilities) against the
resources. The balance of assets minus the external liabilities shows the capital (owner’s equity).

Provide Information to the Users

Generation of information is not an end in itself. It is a means to facilitate the dissemination of
information among different user groups. Therefore, communication of information is the essential
function of accounting.

Users of the Financial Statements

The most basic objective of financial accounting is preparation of general purpose financial statements,
which are financial statements meant for use by stakeholders external to the entity, who do not have any
other means of getting such information, i.e. people other than the management. These stakeholders
include

Investors and Financial Analysts:

Investors need the information to estimate the intrinsic value of the entity and to decide whether to buy,
hold or sell the entity's shares. Equity research analysts use financial statements to conduct their research
on earnings expectations and price targets.

Employee groups:
Employees and their representative groups are interested in information about the solvency and
profitability of their employers to decide about their careers, assess their bargaining power and set a target
wage for themselves.
Lenders:
Lenders are interested in information that enables them to determine whether their loans and the interest
earned on them will be paid when due.

Suppliers and other trade creditors:

Suppliers and other creditors are interested in information that enables them to determine whether
amounts owing to them will be paid when due and whether the demand from the company is going to
increase, decrease or stay constant.

Customers:
Customers want to know whether their supplier is going to continue as an entity, especially when they
have a long-term involvement with that supplier. For example, Apple is interested in long-term viability
of Intel because Apple uses Intel processors in its computers and if Intel ceases operations at once, Apple
will suffer difficulties in meeting its own demand and will lose revenue.

Governments and their agencies:

Governments and their agencies are interested in financial accounting information for a range of
purposes. For example, the tax collecting authorities are interested in calculating taxable income of the
tax-paying entities and finding their tax payable. The governments themselves are interested in efficient
allocation of resources and they need financial accounting information of different sectors and industries
to decide on federal and state budget allocation, etc. The bureaus of statistics are interested in calculating
national income, employment and other measures.

Public:
The public is interested in an entity’s contribution towards the communities in which it operates, its
corporate social responsibility updates, its environmental track record, etc.

The Accounting Cycle:

There are ten basic steps to the accounting cycle.
1. Collect Source Documents :
The very first step in the accounting cycle is to gather all the documents that are related to financial
transactions of the organization. These documents, called source documents, are things like receipts, bank
statements, checks and purchase orders. They are the items that describe what a transaction was for.

2. Analyze Transactions:
The second step in the accounting cycle is to analyze source documents. The purpose of this is to look
them over and then decide what effect they have had on company accounts.

3. Journalize Transactions :
The third step in the accounting cycle is to post entries into the journal for the analyzed transactions. A
journal is the book or electronic record that documents all the financial transactions of a company and the
accounts that are affected by each transaction. When a journal entry is made, the 'double-entry' rule is
used. This means that for every one transaction, at least two accounts are affected. There must be a debit
and a credit for each transaction, and the total of debits and credits must equal the amount of the
transaction. Journal entries are entered in chronological order, and debits are entered before credits.

4. Post Transactions:
The fourth step in the accounting cycle is to transfer information from the journal to the ledger. A ledger
is a book or an electronic record of all the accounts that a company has. These accounts are broken down
by account number and class. When the information from the journal is transferred to the ledger, it is
transferred to each account that was affected by a transaction.

5. Prepare an Unadjusted Trial Balance :

A trial balance is a list of all the company's accounts and their balance at the time that the trial balance is
prepared. An unadjusted trial balance is a trial balance that is prepared before adjusting entries are made
into accounts. This information comes directly from the ledger. The total debit balance and total credit
balance must be equal.

6. Prepare Adjusting Entries :

Adjusting entries are entries that are made in the journal and posted in the ledger. The purpose of these
entries is to bring account balances to the proper amounts. Not all accounts will have an adjusting entry.
Adjusting entries are made at the end of the accounting period, but not the end of the accounting cycle.

7. Prepare Trial Balance :

Remember, the trial balance is a list of all accounts and their balances after adjustments have been made.
This trial balance is prepared to check and make sure that the debits and credits equal after adjusting
entries are made. It is used to prepare the financial statements.

8. Prepare Financial Statements :

These are prepared in a specific order because information from one financial statement is often used in
preparing another financial statement. The order that the financial statements need to be prepared is:

a) Income Statement - This statement measures how well a company is performing financially
during a specific time period. If the company made money, then it had a net profit. If it lost
money, then it had a net loss.

b) Balance Sheet- A balance sheet also known as the statement of financial position tells about
the assets, liabilities and equity of a business at a specific point of time. It is a snapshot of a
business. A balance sheet is an extended form of the accounting equation. An accounting
equation is:
Assets = Liabilities + Equity
Assets are the resources controlled by a business, equity is the obligation of the company to its
owners and liabilities are the obligations of parties other than owners.

c) Statement of Cash Flows - A statement of cash flows is a financial statement which

summarizes cash transactions of a business during a given accounting period and classifies them
under three heads, namely, cash flows from operating, investing and financing activities. It shows
how cash moved during the period by indicating whether a particular line item is a cash in-flow
or cash out-flow.

9. Closing Entries:
Closing entries are journal entries made at the end of an accounting period which transfer the balances of
temporary accounts to permanent accounts. Closing entries are based on the account balances in an
adjusted trial balance.

Temporary accounts include:

Revenue, Income and Gain Accounts
Expense and Loss Accounts
Dividend, Drawings or Withdrawals Accounts
Income Summary Account
The permanent account to which balances are transferred depend upon the type of business. In case of a
company, retained earnings account, and in case of a firm or a sole proprietorship, owner's capital account
receives the balances of temporary accounts.

10. Post-Closing Trial Balance :

A post-closing trial balance is a list of balances of ledger accounts prepared after closing entries have
been passed and posted to the ledger accounts. Since the closing entries transfer the balances of temporary
accounts (i.e. expense, revenue, gain, dividend and withdrawal accounts) to the retained earnings account,
the new balances of temporary accounts are zero and therefore they are not listed on a post-closing trial
balance. However, all the other accounts having non-negative balances are listed including the retained
earnings account.

The preparation of post-closing trial balance is the last step of the accounting cycle and its purpose is to
be sure that sum of debits equal the sum of credits before the start of new accounting period. It provides
the openings balances for the ledger accounts of the new accounting period.
Generally Accepted Accounting Principles
The common set of accounting principles, standards and procedures that companies use to compile their
financial statements. GAAP are a combination of authoritative standards (set by policy boards) and
simply the commonly accepted ways of recording and reporting accounting information.
Accountants use generally accepted accounting principles (GAAP) to guide them in recording and
reporting financial information. GAAP comprises a broad set of principles that have been developed by
the accounting profession and the Securities and Exchange Commission (SEC). Two laws, the Securities
Act of 1933 and the Securities Exchange Act of 1934, give the SEC authority to establish reporting and
disclosure requirements. However, the SEC usually operates in an oversight capacity, allowing the FASB
and the Governmental Accounting Standards Board (GASB) to establish these requirements. The GASB
develops accounting standards for state and local governments.

The current set of principles that accountants use rests upon some underlying assumptions. The basic
assumptions and principles presented on the next several pages are considered GAAP and apply to most
financial statements. In addition to these concepts, there are other, more technical standards accountants
must follow when preparing financial statements. Some of these are discussed later in this book, but other
are left for more advanced study.

BASIC ACCOUNTING CONCEPTS

Accounting is a system evolved to achieve a set of objectives. In order to achieve the goals, we
need a set of rules or guidelines. These guidelines are termed here as “BASIC ACCOUNTING
CONCEPTS”. The term concept means an idea or thought. Basic accounting concepts are the
fundamental ideas or basic assumptions underlying the theory and profit of FINANCIAL
ACCOUNTING. These concepts help in bringing about uniformity in the practice of accounting.
In accountancy following concepts are quite popular.
1. Business Entity Concept:
In this concept “Business is treated as separate from the proprietor”. All the Transactions
recorded in the book of Business and not in the books of proprietor. The proprietor is also treated
as a creditor for the Business. In case this concept is not followed, affairs of the business will be
mixed with the personal transactions of the proprietor and the true picture of the business will not
be known. Even the proprietor is regarded as creditor to the extent of the capital contributed by
him to the business.
2. Going Concern Concept:
This concept relates with the long life of Business. The assumption is that business will continue
to exist for unlimited period unless it is dissolved due to some reasons or the other.it is for this
reason that fixed assets are recorded at original cost and are depreciated on the basis of their
expected life rather than on the basis of market value.

3. Money Measurement Concept:

In this concept “Only those transactions are recorded in accounting which can be expressed in
terms of money, those transactions which cannot be expressed in terms of money are not
recorded in the books of accounting”. Non-monetary events such as retirement of manager, sales
policy of management, working conditions of workers etc. cannot be recorded in accounting
books.
4. Cost Concept:
According to this concept, an asset is recorded at its cost in the books of account. i.e., the price
which is paid at the time of acquiring it. In balance sheet, these assets appear not at cost price
every year, but depreciation is deducted and they appear at the amount, which is cost, less
classification.

5. Accounting Period Concept:

Every Businessman wants to know the result of his investment and efforts after a certain period.
Usually one-year period is regarded as an ideal for this purpose. This period is called Accounting
Period. It depends on the nature of the business and object of the proprietor of business.

6. Dual Aspect Concept:

According to this concept “Every business
benefit aspect another one is giving benefit
where as the giving aspect is termed as
corresponding credit. The dual aspect is also
Capital + Liabilities = Assets
Capital = Assets –Liabilities
transactions has two aspects”, one is the receiving
aspect. The receiving aspect is termed as ‘Debit’;
“Credit”. Therefore, for every debit there will be
expressed in another form of equation as under.

7. Matching Cost Concept:

According to this concept “The expenses incurred during an accounting period, e.g., if revenue is
recognized on all goods sold during a period, cost of those good sole should also be charged to
that period.

ACCOUNTING CONVENTIONS
Accounting is based on some customs or usages. Naturally accountants are here to adopt that
usage or custom. They are termed as convert conventions in accounting. The following are some
of the important accounting conventions.

1. Convention of Full Disclosure:

According to this convention accounting reports should disclose fully and fairly the information.
They purport to represent. They should be prepared honestly and sufficiently disclose
information which is if material interest to proprietors, present and potential creditors and
investors. The companies act, 1956 makes it compulsory to provide all the information in the
prescribed form. Full disclosure does not mean disclosure of each and every item of information.
It only means disclosure of such information which is of significance to owners, investors and
creditors.

2. Convention of Materiality:
Under this convention the trader records important factor about the commercial activities. In the
form of financial statements if any unimportant information is to be given for the sake of clarity
it will be given as footnotes. Its means unimportant mattes should be either left out or merged
with other items.
3. Convention of Consistency:
It means that accounting method adopted should not be changed from year to year. It means that
there should be consistent in the methods or principles followed. Or else the results of a year
cannot be conveniently compared with that of another. If change becomes necessary the change
and its effect should be stated clearly.

4. Convention of Conservatism:
This convention is based on the policy of playing safe. According to this convention all possible
or expected losses should be provided for but unearned or unrealized profit should be left out.
This convention warns the trader not to take unrealized income into account. That is why the
practice of valuing stock at cost or market price whichever is lower is in vague. It takes in to
consideration all prospective losses but leaves all prospective profits.

Accounting System
There are two systems in Accounting. They are
1. Single Entry System 2. Double entry system

Single Entry System:

The system which does not totally follow the principles of double entry system is called single
entry system. Under this system complete record of each and every transaction is not maintained.
Under this method real and nominal accounts are not maintained. Transactions are recorded only
in cash book and only personal accounts are maintained. It is not proper to call it ‘system’
because it is not based on any scientific system like Double entry system.

Double Entry System:

According to this system every transaction has two aspects i.e. one part receiving and another
part is giving aspect. When we receive something, we give something else in return. This method
of writing every transaction in two accounts is known as ‘Double Entry System’. Every
transaction is divided into two aspects, debit and credit. One account is to be debited and another
account is to be credited for every transaction in order to have a complete record of the same.
Every transaction affects two accounts in opposite direction. A transaction has to be recorded in
two different accounts on opposite sides of an equal value. Both the accounts cannot be debited
or credited.

Classifications of Accounts:
An account is a summary of the record of all the transactions relating to a person, asset, expenses
or gain. It has two sides the left hand called the ‘debit’ side and the right hand side called ‘credit’
side. Accounts are broadly classified into two heads. They are
1. Personal Account and
2. Impersonal Account.
Impersonal account later divided into Real Account and Nominal Account
Personal Account:
It is related to persons with who a concern carries on business. They are
 Natural persons such as Raju, Rani, Suresh etc.
 Artificial persons such as Andhra Bank and Universal Trading Company etc.
 Representative personal accounts such as outstanding salaries, prepaid insurance accounts
etc.

Real Account:
Accounts relating to properties or assets of a trader are known as real accounts. It includes
tangible assets such as buildings, furniture, cash etc and also intangible assets such as good will,
trade-marks etc.

Nominal Account:
Accounts dealing with expenses, gains, losses, and incomes are called Nominal Account,
Example:- Wages, Salaries, Interest, Commission Received.

Journal Entries
Journal is books for recording daily transaction. All the business transactions are recorded in this
book in a chronological order. It is a book of prime, original or first entry, as all business
transactions are first recorded in the journal. Journals help in the preparation of accounts in the
ledger. The process of recording transaction in Journal is termed as ‘Journalising’. The journal is
rules as follows.
Format for Journal Entries:
Journal Entries in the books of XXX Company
Debit Credit
Date Particulars LF
Amount(Rs.) Amount(Rs.)
Column 1:
Date: the date on which the transaction has taken place is entered in the column.

Column 2:
Particulars: in the first line, the name of the account to be debited is written. The Word ‘Dr’ is
written at the end of the first line. In the second lime some space is left and the word ‘To’ is
written before the name of the account to be credited. Then the name of the account to be
credited is written. A brief explanation usually with the word ‘Being’ is written called ‘narration’
the narration explains the reason for debiting and crediting the particular accounts and helps one
to understand the nature and purpose of the journal entry at a future date.

Column 3:
L.F.: it stands for ‘Ledger Folio’. In this column the page number on which the various accounts
appear in the ledger are entered.

Column 4:
Debit (Amount): In this column the amount to be debited against the Debit account is written

Column 4:
Credit (Amount): In this column the amount to be credited against the Credit account is written.

ILLUSTRATION 1:

Journalize the following transactions in the books of Rama Krishna:

Particulars Amount
2012
July 1 Mr. Ram started business with cash 2,00,000
July4 Goods purchased for cash 20,000
July5 He deposited in bank 40,000
July7 Goods sold 15,000
July10 Purchased from Mr. Kamlesh on credit 25,000
July11 Furniture purchased 18,000
July12 Wages paid 4,000
July20 Interest received 500
July25 Cash paid to Mr.Kamlesh 25,000
July 30 Additional capital brought by Mr. Ram 50,000
Solution: Journal Entries in the Books of Ram Company

Date Particulars L.F Debit Credit

(Amount) Rs. (Amount) Rs.
July- 1-2012 Cash A/c Dr 2,00,000
To Capital A/c 2,00,000
(Being start of business by
Ram)
July -4- 2012 Purchase A/c Dr 20,000
To Cash A/c 20,000
(Being Purchased Goods for
Cash)
July -5-2012 Bank A/c Dr 40,000
To Cash A/c 40,000
(Being Deposit Cash into
Bank)
July -7-2012 Cash A/c Dr 15,000
To Sales A/c 15,000
(Being Sale of Goods in Cash )
July -10-2012 Purchase A/c Dr 25,000
To Kamlesh A/c 25,000
(Being Purchases goods on
credit from Kamlesh )
July-11-2012 Furniture A/c Dr 18,000
To Cash A/c 18,000
(Being Furniture Purchased)
July-12-2012 Wages A/c Dr 8,000
To Cash A/c 8,000
(Being Wages paid in Cash)
July- 20-2012 Cash A/c Dr 500
To Interest A/c 500
(Being Receipt of Interest )
July -25-2012 Kamlesh A/c Dr 25,000
To Cash A/c 25,000
(Being Payment of Credit
Purchases )
July -30-2012 Cash A/c Dr 50,000
To Capital A/c 50,000
(Being Introduction of
Additional Capital in Business )
ILLUSTRATION 2: Journalize the following transactions in the books of Ravi:

Particulars Amount
2008
March 1 Purchase of goods from ram 3, 20,000
March10 Paid rent for the month 2,000
March11 Purchase of Machine 1, 00,000
March12 Paid salaries 12,000
March15 Paid to ram 1, 00,000
March20 Sold goods to shyam 20,000
March25 Received from shyam 30,000
March31 Received cash from cash sales 2, 50,000
March31 Wages paid 5,000

Solution: Journal Entries in the Books of Ravi Company

Date Particulars L.F Amount(Dr) Amount(Cr)
Rs. Rs.
1-March-2008 Purchase A/c Dr 3, 20,000
To Ram A/c 3, 20,000
(Being purchased goods on credit
from Ram )
10-March-2008 Rent A/c Dr 2,000
To Cash A/c 2,000
(Being rent paid )
11-March-2008 Machine A/c Dr 1, 00,000
To Cash A/c 1, 00,000
(Being purchase of plant)
12-March-2008 Salaries A/c Dr 12,000
To Cash A/c 12,000
(Being salaries paid)
15-March-2008 Ram A/c Dr 1, 00,000
To Cash A/c 1, 00,000
(Being cash payment to Ram )
20-March-2008 Shyam A/c Dr 20,000
To Sales A/c 20,000
(Being goods sold on credit to
Shyam)
25-March-2008 Cash A/c Dr 30,000
To Shyam A/c 30,000
(Being Cash Received from shyam)
31-March-2008 Cash A/c Dr 2, 50,000
To Sales A/c 2, 50,000
(Being goods sold for cash)
31-March-2008 Wages A/c Dr 5,000
To Cash A/c 5,000
(Being wages paid)
Illustration:3 Following are the transactions in the month of January, 2009 of Mr. Prasad & Co:

Jan 1 Purchase goods worth Rs. 5,000 for cash

less 20% trade discount and 5% cash discount.
Jan 4 Purchase of goods from Bharat Rs. 5,000
Jan 12 Sold goods to Rohan on credit Rs. 600
Jan 18 Sold goods to Ram for cash Rs. 1000.
Jan 20 Paid salary to Ratan Rs. 2000
Jan 26 Interest received from Madhu Rs. 200
Jan 31 Sold goods for cash Rs. 500.
Jan 31 Withdrew goods from business for personal use Rs. 200
Solution: Journal Entries in the Books of Mr.Prasad & Co
Date Particulars L.F Amount(Dr) Amount(Cr)
Rs. Rs.
1-Jan-2009 Purchase A/c Dr 4,000
To Cash A/c 3,800
To Discount A/c 200
(Being Purchase of goods for
cash worth Rs. 5,000 and
allowed trade and cash
discount)
04-Jan-2009 Purchase A/c Dr 5,000
To Bharat A/c 5,000
(Being goods purchased from
Bharat)
12-Jan-2009 Rohan A/c Dr 600
To Sales a/c 600
(Being goods sold on Credit to
Rohan)
18-Jan-2009 Cash A/c Dr 1,000
To Sales A/c 1,000
(Being Goods sold on cash)
20-Jan-2009 Salary A/c Dr 2,000
To Cash A/c 2,000
(Being Salaries Paid)
26-Jan-2009 Cash A/c Dr 200
To Interest A/c 200
(Being Interest paid)
31-Jan-2009 Cash A/c Dr 500
To sales 500
(Being goods sold for cash)
31-Jan-2009 Drawings A/c Dr 200
To Purchases A/c 200
(Being goods withdrawn for
personal use )
 Ledgers
It is a book of final entry. All business transactions are first recorded in the journal and finally
recorded in the ledger. The process of transferring the transaction from journal to the ledger is
called posting. Ledger is the main or principal or most important book of the business .ledger is a
book where the various accounts pertaining to a particular person thing or service are grouped
together in one place in the form of an account. It contains accounts for all the persons with
whom the business deals, for all the assets or things held by the business and for all the expenses
incurred and incomes earned by the business. Ledger may be defined as a book which contains
records of all transaction permanently in a summariased and classified form.

The following are the guidelines for posting transactions in the ledger.

After the completion of Journal entries only posting is to be made in the ledger.
For each item in the Journal a separate account is to be opened. Further, for each new item
a new account is to be opened.
Depending upon the number of transactions space for each account is to be determined in
the ledger.
For each account there must be a name. This should be written in the top of the table. At
the end of the name, the word “Account” is to be added.
The debit side of the Journal entry is to be posted on the debit side of the account, by
starting with “TO”.
The credit side of the Journal entry is to be posted on the debit side of the account, by
starting with “BY”.
The journal entries should be posted to the ledger accounts in the order of their dates.

Format for Ledger Posting:

Dr. Cr.
Date Particulars JF Amount Date Particulars JF Amount
(Rs) (Rs)
Journalize the following transactions in the books of Ravi and post them into ledgers:
Particulars Amount
2008 March 1 Started business with cash 4,50,000
March 1 Purchase of goods from ram 3, 20,000
March10 Paid rent for the month 2,000
March11 Purchase of Machine 1, 00,000
March12 Paid salaries 12,000
March15 Paid to ram 1, 00,000
March20 Sold goods to shyam 20,000
March25 Received from shyam 30,000
March31 Received cash from cash sales 2, 50,000
March31 Wages paid 5,000
Solution: Journal Entries in the Books of Ravi Company
Date Particulars L.F Amount(Dr) Amount(Cr)
Rs. Rs.
1-March-2008 Cash A/c Dr 4,50,000
To Capital A/c 4,50,000
(Being business started with cash )
1-March-2008 Purchase A/c Dr 3, 20,000
To Ram A/c 3, 20,000
(Being purchased goods on credit)
10-March-2008 Rent A/c Dr 2,000
To Cash A/c 2,000
(Being rent paid )
11-March-2008 Machine A/c Dr 1, 00,000
To Cash A/c 1, 00,000
(Being purchase of plant)
12-March-2008 Salaries A/c Dr 12,000
To Cash A/c 12,000
(Being salaries paid)
15-March-2008 Ram A/c Dr 1, 00,000
To Cash A/c 1, 00,000
(Being cash payment to Ram )
20-March-2008 Shyam A/c Dr 20,000
To Sales A/c 20,000
(Being goods sold on credit to Shyam)
25-March-2008 Cash A/c Dr 30,000
To Shyam A/c 30,000
(Being Cash Received from shyam)
31-March-2008 Cash A/c Dr 2, 50,000
To Sales A/c 2, 50,000
(Being goods sold for cash)
31-March-2008 Wages A/c Dr 5,000
To Cash A/c 5,000
(Being wages paid)
 Ledger Posting

Dr. Cash Account Cr.

Date Particulars JF Amount Date Particulars JF Amount
(Rs) (Rs)
01-03- To Capital A/c 4,50,000 10-03- By Rent A/c 2,000
2008 2008
25-03 To Syam A/c 30,000 11-03 By Machine A/c 1,00,000
31-03- To Sales A/c 2,50,000 12-03 By Salaries A/c 12,000
2008 15-03 By Ram A/c 1,00,000
31-03-
2008 By Wages A/c 5,000
31-03-
2008 By Balance C/d 5,11,000
7,30,000 7,30,000
01-04- To Balance B/d 5,11,000
2008

Dr. Capital Account Cr.

Date Particulars JF Amount Date Particulars JF Amount
(Rs) (Rs)
31-03- To Balance C/d 4,50,000 01-03- By Cash A/c 4,50,000
2008 2008

4,50,000 4,50,000
01-04- By Balance B/d 4,50,000
2008

Dr. Purchase A/c Cr.

Date Particulars JF Amount Date Particulars JF Amount
(Rs) (Rs)
15-03- To Ram A/c 3,20,000 31-03- By Balance C/d 3,20,000
2008 2008

3,20,000 3,20,000
01-04- To Balance B/d 3,20,000
2008

Dr. Ram Account Cr.

Date Particulars JF Amount Date Particulars JF Amount
(Rs) (Rs)
01-03- To Cash A/c 1,00,000 01-03- By Purchase A/c 3,20,000
2008 2008

31-03- To Balance C/d 2,20,000

2008
3,20,000 3,20,000
01-04- By Balance B/d 2,20,000
2008
Dr. Rent Account Cr.
Date Particulars JF Amount Date Particulars JF Amount
(Rs) (Rs)
10-03- To Cash A/c 2,000 31-03- By Balance C/d 2,000
2008 2008

2,000 2,000
01.04- To Balance B/d 2,000
2008

Dr. Machine A/c Cr.

Date Particulars JF Amount Date Particulars JF Amount
(Rs) (Rs)
11-03- To Cash A/c 1,00,000 31-03- By Balance C/d 1,00,000
2008 2008

1,00,000 1,00,000
01.04- To Balance B/d 1,00,000
2008

Dr. Salaries Account Cr.

Date Particulars JF Amount Date Particulars JF Amount
(Rs) (Rs)
12-03- To Cash A/c 12,000 31-03- By Balance C/d 12,000
2008 2008

12,000 12,000
01-04- To Balance B/d 12,000
2008

Dr. Shyam Account Cr.

Date Particulars JF Amount Date Particulars JF Amount
(Rs) (Rs)
20 -03 To Sales A/c 20,000 25 -03 By Cash A/c 2,50,000
-2008 -2008
31-03-
2008 To Balance C/d 2,30,000
2,50,000 2,50,000
01-04- To Balance B/d 2,30,000
2008

Dr. Sales Account Cr.

Date Particulars JF Amount Date Particulars JF Amount
(Rs) (Rs)
31-03- To Balance C/d 2,70,000 25-03- By Shyam A/c 20,000
2008 2008
31-03- By Cash A/c 2,50,000
2008
2,70,000 2,70,000
01-04- To Balance B/d 2,70,000
2008
Dr. Wages Account Cr.
Date Particulars JF Amount Date Particulars JF Amount
(Rs) (Rs)
25-03- To Cash A/c 5,000 31-03- By Balance C/d 5,000
2008 2008

5,000 5,000
01-04- To Balance B/d 5,000
2008

Trail Balance
“Trail balance is a statement containing the balances of all ledger accounts, as at any given date,
arranged in form of debit and credit columns placed side by side and prepared with the object of
checking the arithmetical accuracy of ledger posting. The fundamental principle of double entry
system of book keeping is that every debit has a corresponding credit and vice versa of equal
moment. Therefore, the total of the debit balances must equal in aggregate to the total of the
credit balances when accounts are balances when accounts are balances.
A trail balance can be prepared in two ways. They are
1. Total Method
2. Balance Method

1. Total Method:
Under this method, the debit totals of each account shown in the debit and credit column of the
trail balance.

2. Balance Method:
Under this method, the difference of each account is extracted. If the debit side of an account is
bigger in amount than the credit side the difference is put in the debit column of the trail balance
and if the credit side is bigger, the difference is written on the credit column of train balance

How to prepare Trail Balance?

1. Accounts dealing with assets, expenses & losses will shown debit balance
2. Accounts dealing with liabilities, incomes and gain will show credit balance
3. ‘Sundry Debtors’ are the total amount due from various debtors and ‘Sundry Creditors”
are the total amount due to various creditors
4. Opening stock will show debit balance, generally closing stock will not appear in Trail
Balance
5. Reserves and provisions such as General Reserve, Provision for doubtful debts, reserve
for discount on debtors will show credit balance. However Reserve for Discount on
Creditors will show debit balance.
Problem 1:
From the following list of balance of Mr. X. Prepare a Trail Balance as on 30-06-2005
Particulars Amount Particulars Amount
Opening Stock 1,800 Wages 1,000
Sales 12,000 Bank Loan 440
Coal 300 Purchases 7,500
Repairs 200 Carriage 150
Income tax 150 Debtors 2,000
Land 600 Cash in hand 20
Plant 750 Machinery 180
Lighting 230 Creditors 800
Capital 4,000 Bills receivables 60
Office furniture 60 Office salaries 250
Patents 100 Good will 1500
Bank 510
6th , April set-3

Solution:
Trail Balance of Mr. X as on 30-06-2005
Debit (Rs.) Credit (Rs.)
Opening Stock 1,800
Wages 1000
Sales 12,000
Bank Loan 440
Coal 300
Purchases 7,500
Repairs 200
Carriage 150
Income tax 150
Debtors 2,000
Land 600
Cash in hand 20
Plant 750
Machinery 180
Lighting 230
Creditors 800
Capital 4,000
Bills receivables 60
Office furniture 60
Patents 100
Good will 1,500
Bank 510
Office salaries 250
17,300 17,300
Problem 2:
Prepare trail balance for the following information
Particulars Amount
Capital 1,00,000
Plant & Machinery 1,60,000
Sales 3,54,000
Purchases 1,20,000
Returns outwards 1,500
Returns inwards 2,000
Opening stock 60,000
Discount allowed 700
Discount Received 1,600
Bank Charges 150
Sundry Debtors 90,000
Sundry Creditors 50,000
Salaries 13,600
Manufacturing Wages 20,000
Carriage inwards 1,500
Carriage outwards 2,400
Provision for bad debts 1,050
Rent, rates and taxes 20,000
Advertisements 4,000
Cash 1,800
Bank 12,000
Closing stock 70,000

Particulars Debit Particulars Credit

Plant & Machinery 1,60,000 Capital 1,00,000
Purchases 1,20,000 Sales 3,54,000
Return inwards 2,000 Return outwards 1,500
Opening stock 60,000 Discount received 1,600
Discount allowed 700 Sundry Creditors 50,000
Sundry Debtors 90,000 Provision for bad debts 1,050
Salaries 13,600
Manufacturing wages 20,000
Carriage inwards 1,500
Carriage outwards 2,400
Rent, rates and taxes 20,000
Advertisements 4,000
Cash in hand 1,800
Bank 12,000
Bank Charges 150
508150 508150
 FINAL ACCOUNTS
One of the main objects of maintain Accounts is to findout the profit or loss made by the
business during a period and to ascertain the financial position of the business as on a given data.
In order to know the profit or loss made by the business trading and profit and loss account is
prepaid. The position of the business on the last date of the financial year will be reveled by the
balance sheet the trading and profit and loss account and balance prepare by the business man at
the end of the trading period are called final accounts.

TRADING ACCOUNT
Trading account is prepared mainly to know the profitability of the goods bought and sold by the
business man. It shows the result of trading that is buying and selling of goods called gross profit
or gross loss. The difference between sales and the cost of the goods sold is gross profit or gross
loss. Trading account is prepared in T form, just like any other account except the Date and
Journal Folio Columns are not provided. As the Trading Account shows the results of operation
over a period, the heading will be “Trading Account for year (or Period) ended… Opening
Stock, Purchases and other direct expenses are taken on the Debit side and Sales and Closing
Stock are taken on the Credit Side. The Balance between the two sides is Gross Profit or Gross
Loss. The excess of credit side over Debit side is called ‘Gross Profit’. And excess of Debit side
over Credit side is called ‘Gross Loss’. The ‘Gross Profit’ or ‘Gross Loss’ is transferred to Profit
and Loss Account.

PROFIT AND LOSS ACCOUNT

The profit and loss account is an account which shows the net profit or net loss of a business for
a particular period. All indirect expenses such as Administrative or Management Expenses,
Selling and Distribution Expenses, Financial Expenses and Other Expenses such as Depreciation
and provisions etc are taken on the Debits side. Gross profit and other items of incomes such as
Interest received, Discount received etc are taken on the credit side. The difference between two
sides is either Net Profit or Net Loss which is transferred to Capital Account. Trading and Profit
and Loss account will appear as follows
 The format of Trading and Profit and Loss Account

Trading account and Profit and Loss for the year ending of 31-12-XXXX
Particulars Amount Particulars Amount
To Opening Stock xxx By Sales xxx
To Purchases xxx Less Sales Returns xxx xxx
Less Returns xxx xxx
To Wages xxx By Closing Stock xxx
To Fuel & Power xxx
To Carriage Inwards xxx
To Coal, water xxx
To Octrai xxx
To Import Duty xxx
To Manufacturing xxx
Expenses xxx
To factory Lighting
To Gross Profit xxx
(Transfer to P & L A/C) Xxx xxx
To Gross Loss Xxx By Gross Profit xxx
To Salaries xxx By Rent Received xxx
To Rent xxx By Commission Received xxx
To Commission xxx By Interest received xxx
To Discount xxx By Other incomes xxx
To Insurance Premium xxx
To Telephone Expenses xxx
To Advertisements xxx
To Audit Fee xxx
To legal Fee xxx
To Interest on Loan xxx
To Carriage outwards xxx
To Bad debts xxx
To Provision for xxx
depreciation xxx
To Printing & Stationary xxx
To Postage & Telegram xxx
To General Expenses xxx
To Packing Expenses xxx
To Transportation Fee xxx
To Net Profit xxx
(Transfer to Balance Sheet)

xxx Xxx
 BALANCE SHEET
Balance sheet is prepared to know the financial position of business on a particular date. It is a
statement which shows the assets and liabilities of a business as on a particular date. It shows
what a business owns and what it owes. This statement is prepared from real and personal
account left after the nominal accounts are transferred to Trading and Profit and loss account.
Balance sheet is a “Statement” and not an “Account”. It does not have ‘Debit’ and ‘Credit’ sides.
It is divided into two sides i.e. left hand side and right hand side. The left hand side is called the
liabilities side and right hand side is called assets side. All the liabilities and capital are entered
on the liabilities side and all properties and assets are entered on the Assets side.

“A balance sheet is a statement with a view to measure exact financial position of a business at a
particular date.” ------ J. R. Botliboi

Format of Balance Sheet:

Balance Sheet of Mr. X as on the date of 32-12-XXXX

Liabilities Amount Assets Amount

Capital xxx Fixed Assets:
(+) Net Profit xxx Plant & Machinery
xxx (-) Depreciation xxx
(-) Net Loss xxx Furniture and fixtures
xxx (-) Depreciation xxx
(+) Interest on Capital xxx Land & Buildings
xxx (-) Depreciation xxx
(-) Drawing xxx Furniture
xxx (-) Depreciation xxx
(-)Interest on Drawingxxx xxx Motor Vehicles xxx

Reserve xxx Current Assets:

Long term loans xxx Sundry Debtors xxx
Bank Over Draft xxx (-) Bad Debt xxx
Cash in Hand xxx
Current Liabilities: Cash in Bank xxx
Sundry Creditors xxx Bills Receivable xxx
Bills Payable xxx Closing Stock xxx
Outstanding Expenses xxx Prepaid Expenses xxx

xxx xxx
 Adjustments
While preparing the Profit and Loss account for a particular period it is essential that expenses,
losses and incomes and gains relating only to that period are considered. We know that business
is a going concern. It has to be carried on indefinitely at the end of every accounting year. The
trader prepares the Trading and Profit and Loss account and Balance Sheet. While preparing
these financial statements, sometimes the trader may come across certain problems .The
expenses of the current year may be still payable or the expenses of the next year have been
prepaid during the current year. In the same way, the income of the current year still receivable
and the income of the next year have been received during the current year. Without these
adjustments, the profit figures arrived at or the financial position of the concern may not be
correct. As such these adjustments are to be made while preparing the final accounts.

The adjustments to be made to final accounts will be given under the Trial Balance. While
making the adjustment in the final accounts, the student should remember that “every adjustment
is to be made in the final accounts twice i.e. once in trading, profit and loss account and later in
balance sheet generally”. The following are some of the important adjustments to be made at the
time of preparing of final accounts:-

1. Closing Stock:-
(i) If closing stock is given in Trail Balance: It should be shown only in the balance sheet “Assets
Side”.
(ii) If closing stock is given as adjustment:

1. First, it should be posted at the credit side of “Trading Account”.

2. Next, shown at the asset side of the “Balance Sheet”.

2. Outstanding Expenses:-
(i) If outstanding expenses given in Trail Balance: It should be only on the liability side of
Balance Sheet.
(ii) If outstanding expenses given as adjustment:

1. First, it should be added to the concerned expense at the debit side of profit and loss
account or Trading Account.
2. Next, it should be added at the liabilities side of the Balance Sheet.

3. Prepaid Expenses:-
(i) If prepaid expenses given in Trial Balance: It should be shown only in assets side of the
Balance Sheet.
(ii) If prepaid expense given as adjustment:
 1. First, it should be deducted from the concerned expenses at the debit side of profit and
loss account or Trading Account.
2. Next, it should be shown at the assets side of the Balance Sheet.

4. Income Earned But Not Received [Or] Outstanding Income [Or] Accrued Income:-
(i) If incomes given in Trial Balance: It should be shown only on the assets side of the Balance
Sheet.
(ii) If incomes outstanding given as adjustment:

1. First, it should be added to the concerned income at the credit side of profit and loss
account.
2. Next, it should be shown at the assets side of the Balance sheet.

5. Income Received in Advance or Unearned Income:-

(i) If unearned incomes given in Trail Balance: It should be shown only on the liabilities side of
the Balance Sheet.
(ii) If unearned income given as adjustment:

1. First, it should be deducted from the concerned income in the credit side of the profit and
loss account.
2. Secondly, it should be shown in the liabilities side of the Balance Sheet.

6. Depreciation:-
(i) If Depreciation given in Trail Balance: It should be shown only on the debit side of the profit
and loss account.
(ii) If Depreciation given as adjustment

1. First, it should be shown on the debit side of the profit and loss account.
2. Secondly, it should be deduced from the concerned asset in the Balance sheet assets side.

7. Interest on Loan (or) Capital:-

(i) If interest on loan (or) capital given in Trail balance: It should be shown only on debit side of
the profit and loss account.
(ii) If interest on loan (or) capital given as adjustment:

1. First, it should be shown on debit side of the profit and loss account.
2. Secondly, it should add to the loan or capital in the liabilities side of the Balance Sheet.

8. Bad Debts:-
(i) If bad debts given in Trail balance: It should be shown on the debit side of the profit and loss
account.
(ii) If bad debts given as adjustment:

1. First, it should be shown on the debit side of the profit and loss account.
2. Secondly, it should be deducted from debtors in the assets side of the Balance Sheet.

9. Interest on Drawings:-
(i) If interest on drawings given in Trail balance: It should be shown on the credit side of the
profit and loss account.
(ii) If interest on drawings given as adjustments:

1. First, it should be shown on the credit side of the profit and loss account.
2. Secondly, it should be deducted from capital on liabilities side of the Balance Sheet.

10. Interest on Investments:-

(i) If interest on the investments given in Trail balance: It should be shown on the credit side of
the profit and loss account.
(ii) If interest on investments given as adjustments:

1. First, it should be shown on the credit side of the profit and loss account.
2. Secondly, it should be added to the investments on assets side of the Balance Sheet.
Example 1:
Trail Balance of Bharat is given below. Prepare the Trading Account and Profit and Loss
Account for the year ending 31st December, 2005 and Balance Sheet as on that date
Particulars Debit Rs. Credit Rs.
Drawings and Capital 10,550 1,19,400
Plant & Machinery 38,300
Sundry Debtors and Creditors 62,000 59,360
Wages 43,750
Purchases and Sales 2,56,590
Opening Stock 95,300
Salaries 12,880
Insurance 930
Cash at Bank 18,970
Interest on Loan 14,370
Discount allowed 4,870
Furniture 12,590
Loan Payable 79,630
Land & Buildings 43,990
6,15,090 6,15,090
Closing Stock was Values at Rs. 90,000 (Feb-08, set-2, Q7)

Solution:
Trading and Profit and Loss Account of Mr. Bharat at the end of the year 31 st December,
2005
Dr. Cr.
Particulars Amount Amount Particulars Amount Amount
To Opening Stock 95,300 By Sales 3,56,430
To Purchase 2,56,590
To Wages 43,750 By Closing Stock 90,000

To Gross Profit 50,790

(Transfer to P & L A/c
4,46,430 4,46,430

To Salaries 12,880 By Gross Profit 50,790

To Insurance 930
To Interest on Loan 14,370
To Discount 4,870

To Net Profit (Transfer to 17,740

Balance Sheet) 50,790 50,790
 Balance Sheet of Mr. Bharat as on the date of 31-12-2005
Liabilities Amount Amount Assets Amount Amount
Capital 1,19,400 Fixed Assets:
(+) Net Profit 17740 Plant & Machinery 38,300
1,37,140 Furniture 12,590
Drawing 10,550 Land & Buildings 43,990
1,26,590
Loan Payable 79,630 Current Assets:
Sundry Debtors 62,000
Current Liabilities: Cash in Bank 38,300
Sundry Creditors 59,360 Closing Stock 90,000
Suspense A/c 270

2,65,850 2,65,850

Example 2:
The following are the particulars of Ledger Account balances taken from the books of Bhaskar
for the year ending 31st March 2005. You are required to prepare Trading Account and Profit
and Loss Account and Balance Sheet as on that date
Particulars Debit Rs. Credit Rs.
Capital 1,00,000
Bills receivables and Bills Payable 4,00,000 7,00,000
Sundry Debtors and Creditors 75,000 50,000
Cash 15,000
Bank 25,000
Business Premises 2,50,000
Loan Payable 25,000
Opening stock 40,000
Purchase & Returns 60,000 8,000
Sales & Returns 37,000 2,75,000
Wages 35,000
Salaries 65,000
Rent, Taxes and rates 15,000
Depreciation 5,000
Furniture 78,000
Advertisement 58,000

11,58,000 11,58,000
Adjustments:
1. Closing Stock was Values at Rs. 80,000
2. Write off Bad Debts of Rs. 5,000 out of sundry debtors
3. Prepaid Insurance amounted Rs. 1,000 (Feb-08, set-3, Q7)
Solution:
Trading and Profit and Loss Account of Mr. Bhaskar at the end of the year 31st March,
2005
Dr. Cr.
Particulars Amount Amount Particulars Amount Amount
To Opening Stock 40,000 By Sales 2,75,000
To Purchase 60,000 37,000 2,38,000
Less: Returns 8,000 52,000
To Wages 35,000 By Closing Stock 80,000

To Gross Profit 1,91,000

(Transfer to P & L A/c 3,18,000 3,18,000

To Salaries 65,000 By Gross Profit 1,91,000

To Rent, Taxes and
Insurance 15,000
Less: Insurance 1,000 14,000
To Depreciation 5,000
To Advertisements 58,000
To Bad Debts 5,000

To Net Profit (Transfer to 44,000

Balance Sheet)
1,91,000 1,91,000

Balance Sheet of Mr. Bhaskar as on the date of 31-03-2005

Liabilities Amount Amount Assets Amount Amount
Capital 1,00,000 Fixed Assets:
(+) Net Profit 44,000 Furniture 78,000
1,44,000 Business Premises 2,50,000

Loan Payable 25,000 Current Assets: 75,000

Sundry Debtors 5,000 70,000
Current Liabilities: Less: Bad Debts 4,00,000
Sundry Creditors 50,000 Bills Receivable 15,000
Bills Payable 7,00,000 Cash in Hand 25,000
Pre-paid Insurance 1,000
Closing Stock 80,000
9,19,000 9,19,000
From the following Trail Balance of Mr. Surya & Co as on 31st December 2009. Prepare
the Trading Account, Profit and Loss Account and Balance Sheet as on date
Particulars Debit Rs. Credit Rs.
Capital 70,000
Purchases 40,000
Sales 75,000
Returns 1,000 2,000
Opening Stock 20,000
Wages 1,000
Coal , Power 1,500
Carriage Inwards 3,000
Salaries 2,000
Sundry Creditors 10,000
Sundry Debtors 15,000
Bills Payable 5,000
Bill Receivable 10,000
Plant & Machinery 7,500
Cash 27,000
Bank 15,000
Discount 500
Discount Received 2,000
Loans 5,000
Bank OD 5,000
Buildings 33,000

1,74,000 1,74,000
Adjustments:
1. Closing Stock Rs. 30,000
2. Bad Debts on Sundry Debtors Rs. 1,000
3. Depreciation on Buildings Rs. 3,000
4. Outstanding Salaries Rs. 500 (Nov-2010, Set-2, Q8)
Solution:
Trading and Profit and Loss Account of Mr. Surya & Co at the end of the year
31st December, 2005
Dr. Cr.
Particulars Amount Amount Particulars Amount Amount
To Opening Stock 20,000 By Sales 75,000
To Purchase 40,000 1,000 74,000
Less: Returns 2,000 38,000
To Wages 1,000 By Closing Stock 30,000
To Coal and Power 1,500
To Carriage Inwards 3,000

To Gross Profit
(Transfer to P & L A/c 40,500
1,04,000 1,04,000
To Salaries 2,000 By Gross Profit 40,500
Less: Outstanding Salaries 500 2,500 By Discount Received 2,000
To Bad Debts 1,000
To Depreciation 3,000
To Discount 500

To Net Profit (Transfer to 35,500

Balance Sheet)
42,500 42,500

Balance Sheet of Mr. Surya as on the date of 31-03-2005

Liabilities Amount Amount Assets Amount Amount
Capital 70,000 Fixed Assets:
(+) Net Profit 35,000 1,05,500 Buildings 33,000
Less: Depreciation 3000 30,000
Plant & Machinery 750
Loan Payable 5,000
Bank OD 5,000 Current Assets:
Sundry Debtors 15,000
Current Liabilities: Less: Bad Debts 1,000 14,000
Sundry Creditors 10,000 Bills Receivable 10,000
Bills Payable 5,000 Cash in Hand 27,000
Outstanding Salaries 500 Closing Stock 30,000
Suspense Account 2,500
1,33,500 1,33,500