Our earlier discussion on Balance Sheet and Profit & Loss Account has given us idea that

for any business there are only four Possibilities

Incomes Assets

Expenses Capital & Liabilities

Accrual System of Accounting & Double entry system of Accounting

As per Section 128 of the Companies Act, every company has to follow Double
entry system of accounting on accrual basis.

Double entry means every financial transaction is recorded at minimum to places.

Accrual system means all incomes for a particular period have to be recorded even
though money is not received in that year and all expenses have to be recorded
which are incurred in that year even though payment is not made in that year.
Double Entry System of Accounting

The Double-entry system of accounting or bookkeeping

means that for every business transaction, amounts must be recorded
in a minimum of two accounts. The double-entry system also
requires that for all transactions, the amounts entered as debits must be
equal to the amounts entered as credits.

For example when a machine is purchased of Rs.25,000 and payment

is made through cheque . Transaction will be recorded in two account
1.Machine because there is increase in Asset and 2. Bank Account
because Bank balance gone down because of payment made.
.
Accrual System of Accounting :

When transactions are recorded in the books of accounts as they occur

even if the payment for that particular product or service has not been
received or made, it is known as accrual based accounting. This method is
more appropriate in assessing the health of the organization in financial
terms

For example Company A purchased raw material of Rs.50,000 from

Company B against which company A has not yet made payment to
Company B.

Now even though payment is not made Rs.50,000 will appear as expense in
the books of Company A and Rs.50,000 will appear as Income ( Sales ) in
the books of Company B.
Generally Accepted Accounting Principles

While recording various business transactions under Financial Accounting

there are certain assumptions which are followed by all accountant and
are referred as accounting principles, concepts, conventions and rules. The
principles which are basic of theory and practice of accounting are as
below.

Business Entity Concept – It means there is clear cut separation between

business and the owners of the business. While recording transactions
accountant has to keep this in mind. For example, in case of proprietary
firm accounting process is carried out for the business and not for the
individual person who owns it. There should be clear cut separation
between business and owner.
Dual Aspect Concept – It means every business transaction has two aspects that means
when a person brings capital say of Rs.10,000/- in the business then we have to show
Rs.10,000/- as liability of the business ( as this amount I payable to the owner in future )
and Rs.10,000/- cash as an asset of the business.

Going Concern Concept – Considering the current financial health of the business It
assumes that business is going to be in existence for a long time in future.

Accounting Period Concept – as we have discussed in the first para that accounts are
prepared to know the profit or loss of the business. However we have to take a cut off
period to prepare those accounts to ascertain profit or loss and hence a period of 12
months i.e for one year .Hence Profit & Loss Account and Balance Sheet is prepared after
every 12 months to find out the business position and as per the Companies Act, 2013,
financial year is defined as 1st April to 31st March..
Cost Concept – This principle says that all assets particularly fixed assets
should be shown at cost in the books less depreciation. However now as
per Ind As, Company has to decide whether they want to show assts at
cost or at Fair Value .
Money measurement concept – The transactions which are expressed in
term of money only will find place in accounting for example a company
is having a very good team of very skilled workers will not find any place
in accounting.
Matching Concept – This concept proposes that to find out profit or loss
of a particular period we have to consider all the revenues and expenses
and cots for that period whether they have actually paid or not. For
example if accounting period is 1st April to 31st March then salary for the
month of March is to be considered in the same year even though it is
paid in the April of next year.
Accounting Conventions
Materiality

An important convention. As we can see from the application of accounting standards

and accounting policies, the preparation of accounts involves a high degree of
judgement. Where decisions are required about the appropriateness of a particular
accounting judgement, the "materiality" convention suggests that this should only be an
issue if the judgement is "significant" or "material" to a user of the accounts. The concept
of "materiality" is an important issue for auditors of financial accounts.
Consistency
Transactions and valuation methods are treated the same way from year to year, or
period to period. Users of accounts can, therefore, make more meaningful comparisons
of financial performance from year to year. Where accounting policies are changed,
companies are required to disclose this fact and explain the impact of any change.
Conservative Approach

Playing it safe . It tells accountants to err on the side of caution when

providing estimates for assets and liabilities. That means that when two
values of a transaction are available, the lower one should be favored. The
general concept is to factor in the worst-case scenario of a firm’s financial
future.
Accounting Cycle

• Identify Financial Transaction

• Make Journal Entries
• Prepare Ledger Accounts
• Prepare Trial Balance
• Make Adjustment Entries
• Prepare Financial Statements i.e Profit & Loss
Account and Balance Sheet
Debit /Credit Rule
Particulars Increase Decrease

Assets Debit Credit

Expenses & Losses Debit Credit

Capital & Liabilities Credit Debit

Incomes & gains Credit Debit

Examples of Assets
Assets
• Increase -----Debit
Property, Plant & equipment such as Land, Building, Warehouses,
Machinery , Furniture, Vehicles , Canteens, Internal Roads, Fencing, • Decrease---- Credit
Safety equipment
Capital Work in Progress

Intangible Assets such as Patents, Trade Mark, Copy Rights,

Goodwill, Soft wares , Licenses
Intangible Assets under Development

Non Current Investments

Deferred Tax Assets
Trade Receivables, Inventory of Raw Material, Work in Progress,
Finished Goods, Short Term Investments, Advance Tax Paid, Cash in
Hand, Cash at Bank
Examples of Expenses & Losses
• Raw Material consumed
• Purchase of stock in trade • Increase -----Debit
• Employee Cost • Decrease--- Credit
• Finance Cost
• Depreciation & Amortization
• Other Expenses ------ Power, Fuel, Electricity, Repairs &
Maintenance, Printing, Stationery, Telephone,
• Broad band, Travelling, Administration, Sub
Contracting , Research & Development
• Selling & Distribution, Advertisement, Royalty,
Branding,
• Audit Fees, Legal fees
• Loss on sale of assets, Loss on sale of Investments,
Provisions,
• Exceptional Items
Examples of Capital & Liabilities
Capital & Liabilities
Equity share Capital, Preference Share Capital
Reserves & Surplus/Other Equity
Bank Loans, Debentures
Long Term Provisions
Deferred Tax Liabilities
Current Liabilities such as Trade Payables, • Increase -----Credit
Outstanding Expenses, Advance from Customers
Current Tax Liabilities • Decrease---- Debit
Short Term Provisions
Examples on Incomes & gains
• Incomes & Gains • Increase ---Credit
• Revenue from Operations/Sales • Decrease-- Debit
• Dividend received,
• Interest Received
• Rent received
• Profit on Sale of Assets
• Profit on Sale of Investments
Identify Financial Transaction
As we have covered earlier that every transaction creates at least two accounts ( Double
Entry System ) . We have to find out the accounts involved in the transaction . Account
involved means either Asset or Expenses are involved or Liabilities or Incomes are involved .

For Example Company collected Rs.10,00,000 in Its Bank Account by way of Share capital
In this example two accounts are involved 1. Bank Account which is out asset and 2. Equity
Share Capital Account which is our liability

On the same logic let us find out different accounts involved in following Financial
Transactions

1. Company purchased a Building of Rs.10 Lacs and made payment through cheque
2. Company paid Rent of Rs.1,20,000 through cheque
3. Company received Rs.2 Lacs against sale of goods
4. Company has taken a loan of Rs.5 Lacs from Bank of India
Steps involved in making Journal Entries

• Find out different accounts involved in the transaction

• Find out Increase/Decrease in those accounts

• Accordingly give Debit or Credit to that account

Let us make journal entries from the above transactions - Company purchased a Building of
Rs.10 Lacs and made payment through cheque. In this transaction two accounts are involved
1 . Building Account 2. Bank Account

So when we purchase Building , there is increase in Asset so Debit to Asset Account i.e.
Building Account. And When payment is made through cheque , there is decrease in asset so
Bank Account Credit

Giving Debit to any account means putting the figure on left hand side of that account
Giving Credit to any account means putting the figure on right hand side of that account
Debit Building Account Credit

Date Particulars Amount Date Particulars Amount

 Debit Bank Account Credit
Date Particulars Amount Date Particulars Amount

2. Company paid Rent of Rs.1,20,000 through cheque In this transaction, as rent is paid there is
increase in Expense so Rent Account is to be debited and since payment is made through cheque
there is decrease in Bank balance i.e decrease in asset so Bank Account credit

Debit Rent Account Credit

Date Particulars Amount Date Particulars Amount
3. Company received Rs.2 Lacs against sale of goods - In this transaction Bank Account and Sales account ( which is our
income ) are involved- As there is increase in Bank Balance , Bank Account is to be debited and there is increase in Income
so Sales Account is to be credited

Debit Sales Account Credit

Date Particulars Amount Date Particulars Amount

4. Company has taken a loan of Rs.5 Lacs from Bank of India - In this transaction again Bank balance is increasing as we
are getting loan so increase in asset , Bank Account is to be debited and when loan is taken, liability of the business
increases so Loan Account is to be credited

Debit Loan from Bank Account Credit

Date Particulars Amount Date Particulars Amount

From the following transactions which have taken place during the year 2019-20, make journal entries and prepare
necessary Ledger Accounts

10th April, 2019 Company received Rs.30,00,000 in its Bank Account against issue of 3,00,000 Equity shares of the face
value of Rs.10 each

25th April, 2019 Company purchased a Building , consisting of Land , costing Rs.10 Lacs and Building costing Rs.4 Lacs and
paid through cheque

30th April, 2019 Company purchased Machinery costing Rs. 5,00,000and Furniture of Rs.1,00,000 and paid through
cheque

5th May, 2019 Company purchased material of Rs.3,50,000 and made payment through cheque

30th May, 2019 Company paid salary to the employees of Rs.50,000 through cheque

30th May, 2019 Paid through cheque all operating expenses such as power, electricity, repairs, maintenance of
Rs.1,10,000

14th June, 2019 Sold manufactured goods for Rs.6,00,000 and received money from customers through cheques