Unit 1 : Basics of Financial Accounting

Learning Objectives

After studying this unit you should be able to :

 Understand basic accounting terms & accounting concepts

 Understand different types of organization & their relevance in financial accounting

 Grasp significance of account principles, accounting standards & accounting policies &
their importance in preparing & presenting financial statements.
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1.1 Introduction

Financial statements are required not only for owners, but also for many outside parties.
Companies have to depend for funds on financial market, Financial Institutes (FIs) & in
many cases on Foreign Institutional Investors (FII).
These entities demand good accounting practices & procedures by companies
which ensure that financial statements give true & fair view of affairs of company. This
makes every management professional to know & follow good accounting practices. This
unit highlights conceptual frame work required for preparation, presentation and
understanding of financial statements.

1.2 Basic Accounting Terms

(A) Types of Profit

Profit is excess of revenue over the expenses to earn that revenue
Profit = Revenue – Expenses
Following are the types of profit
(i) Revenue profits
Profits earned by company in ordinary course of business
(ii) Capital profits
Profits realized from sale, transfer or exchange of assets of business not held
by co. for sale in ordinary course of business
(iii) Gross Profit (G.P. or G/P)
Excess of proceeds of goods & services sold during certain period over their cost
before taking into account administrative, selling & financing expenses
G.P. = ( Sales) – ( Cost of goods sold) i.e.[C.O.G.S.]
(C.O.G.S.) = ( Op. stock + purchases – Clo. stock)
+ ( Direct manufacturing expenses )
(iv) Operating Profit (E.B.I.T.) or (P.B.I.T.)
 Net profit arising from normal operations & non operating activities but without
considering interest expenses.
It is also referred as Profit or Earning Before Interest & Tax (PBIT or EBIT)
(PBIT) = (Sales)+(Other income)
- (C.O.G.S., Admin, selling & Depreciation Exp.)

(v) Net Profit (N.P. or Profit Before Tax i.e. P.B.T.)

Excess of revenue over expenses of business. Income tax is payable on this profit.

(vi) Profit After Tax (PAT):

Profit left after paying income tax. From this amount
- Dividend on preference shares is paid
- Dividend on equity shares is paid
- Remaining amount is kept as reserves of company
(also known as retained earnings)

(B) Types of Dividend

(i) Preference Dividend
Dividend paid to preference shareholders. It is paid before dividend is paid to equity
shareholders. Rate of this dividend is fix. It is paid out of P.A.T.
(ii) Equity Dividend
Dividend paid to equity shareholders. Rate of this dividend is not fix. It is paid out of
amount available after paying preference dividend & transfer to reserves.

(C) Types of Reserve

(i) Revenue Reserve
This is the reserve created out of revenue profits. This reserve can be used for any
purpose as desired by Board of Directors of company
(ii) Capital Reserve
It is a reserve created out of capital profits. It is not available for distribution as
dividend. This reserve can be used by management under the restrictions of
Companies Act 1956.

(D) Types of Liabilities

 Long Term Liabilities
(i) Equity Capital (Permanent Capital )
Capital collected by company from public.
Those who subscribe for capital are called equity shareholders or only
shareholders. Capital is divided in small denomination of Rs. 10 & each such
denomination is called as share. Thus if company has capital of Rs.50 crores then
there will be 5 crores equity shares. It is permanent capital of company.
Equity capital has following components:
(a) Authorized share capital is the capital with which company is registered.
 This amount is specified in memorandum of association . Company cannot
collect capital more than this e.g. company has authorized share capital of Rs.100
crores.
(b) Issued share capital is that part of authorized capital which is issued to public
for subscription e.g. issued capital is Rs. 70 crores.
(c) Subscribed share capital is that part of issued share capital which public has
agreed to subscribe e.g. subscribed capital is Rs.55crores.
(d) Paid-up share capital is that part of subscribed capital which public has actually
paid the amount for e.g. paid-up capital is Rs.50 crores. This is the actual capital
received by company

(ii) Preference capital (Long Term Capital )

This is a capital subscribed by preference shareholders which is to be repaid or
redeemed by company after specific period of time.
Features of preference shares are:
(a) They receive dividend ahead of equity shareholders
(b) Dividend is at fixed rate
(c) When company is liquidated they receive their capital ahead of equity
shareholders.

(iii) Debenture Capital (Long Term Capital )

It is a secured loan taken by company from public at large.
Generally company issues debenture of Rs.100 each. If investor subscribes for100
debentures, it means company has taken loan of Rs.10,000 from him. It is a
secured loan for specific period of time after which loan is repaid i.e. debentures
are repaid or redeemed by company.
During the period for which loan is taken co. must pay interest on debentures. If
company fails to pay interest or principal debenture holders can bring action
through court & company has to make the payment by selling the assets which are
secured against debentures. Many times company is wound up.

(iv) Term Loan (Long Term Capital)

It is a long term ( 5 to 10 years ) secured loan taken by company from banks or
Financial Institutions ( FIs ).

 Short Term Liabilities

Current Liabilities
These are the liabilities which are payable by company within one year & include
: Sundry Creditors, Bills Payable(B/P), Bank overdraft ( o/d), Short Term Loans
taken, Outstanding Expenses, Advances Received, Proposed Dividend, Provision
for Taxes.

 Contingent Liabilities
Liabilities which are contingent or dependent on happening or not happening
future events which are uncertain. They are not shown in balance sheet but are
shown as foot note below balance sheet.
(E) Types of Assets
(i) Fixed Assets
Assets held by company for purpose of producing goods or providing services.
These assets are not held for resale in ordinary course of business. Fixed assets
are of two types:
Tangible Fixed Assets: They have physical identity e.g. land, building, plant,
machinery, furniture, motor car etc.
Intangible Fixed Assets: They do not have physical identity.
e.g. .goodwill, patent. trademark, copy-right, know-how etc.
Depreciation is charged on these assets (other than on goodwill)

(ii) Current Assets

Assets which can be converted into cash within one year or consumed in
production or for rendering services in ordinary course of business & include :
Stock, Sundry debtors, Bills receivables (B/R), Short term loans given, Advances
paid, Pre-paid expenses, Bank & cash balance, marketable securities.

(iii) Investments:
These are the investments made by our company in shares, debentures of different
companies, Govt. securities, partnership firms & immovable properties.

(iv) Fictitious Assets

These are actually not assets but are shown as assets. They do not have any real value.
Items included in this group are losses of company, preliminary expenses & misc.
expenses not written off, loss on Issue of debentures/shares.

(F) Types of Expenses

(i) Revenue Expenditure

It is an expenditure incurred to generate revenue for a particular accounting period. It
is incurred in ordinary course of business & expires in same accounting period.
e.g. cost of goods sold, rent, salaries, commission paid etc. It is shown in income
statement

(ii) Capital Expenditure

Expenditure to acquire any tangible & intangible fixed assets for receiving future
benefits. Thus benefits arising out of capital expenditure last for more than one
financial year.
(iii) Deferred Revenue Expenditure
This is revenue expenditure by nature but its matching with revenue may be deferred
considering the benefits to be accrued in future. e.g. heavy expenditure on advertising.
So long as deferred revenue expenditures is not written off it is shown on asset side
under “Misc. expenditure not written off” as fictitious assets.

(G) General Accounting Terms

 1 Business
Exchange of goods &/or services for earning profit
2 Freight or Carriage inward
Transport charges paid by company to bring raw material from supplier to factory. It is
a direct expense.
3 Freight or Carriage outward
Transport charges paid by company to bring finished goods from factory to customer.
It is selling & distribution expense.
4 Trade Discount
Reduction granted by a supplier from list price of goods on business consideration
other than for prompt payment. It is not shown in books of accounts.
5 Cash Discount
Reduction granted to our company by supplier or by or company to customer from invoice price
in consideration of immediate payment or payment w Explained the
concept relating to
Accounting
Principles No Response Explained shortly the Concept Briefly explained the concept Fairly
explained the concept Fully explained the concept Explained the concept with examples
Explain the basic
purpose and
important terms in
Income Statement
and Balance Sheet No response Explained shortly the Concept of Financial Statements Briefly
explained the Concept of Financial statements Fairly explained the Concept of Financial
statements Explained the concept with examples Student exhibited complete grasped of the
concept.
Explain the basic
concepts and
Important terms
relating to Cost
Accounting No response Demonstrated basic understanding of the concept Explained the
concept with reasonable understanding Explained the concept with fair understanding Could
establish the significance relevance of the concept Explained the concept with practical
applicability
Apply the cost
information into
CVP analysis and
Budgeting
No response Explained but could not apply Explained but could not apply completely Applied
the concept with fair understanding Applied the concept with good understanding Explained the
concept with practical applicability
Domain
understanding of
the course –
Accounting for
Business Decision Could not answer the domain concepts related to ABD Could briefly answer
the domain concepts related to ABD Could reasonably answer the questions asked related to the
syllabus of ABD Could fairly answer the questions asked related to the syllabus OF ABD
Explained all the answers with reasonable knowledge Showed excellent level of domain
understandi
ithin stipulated period. It is shown in books of accounts.
6 Debit Note
It is a document sent by our company to supplier which indicates that balance in
supplier’s account is being reduced by amount of purchase returns or purchase
allowances.
7 Credit Note
It is a document sent by our company to customer which indicates that balance in
customer’s account is being reduced by amount of sales returns or sales allowance.
8 Bills Receivable(B/R)
It is a bill of exchange raised by our company on customer & accepted by him for the
amount due from him. It is shown as current asset of company.
9 Bills Payable(B/P)
It is a bill of exchange raised by supplier on our company & accepted by us for the
amount due to him. It is shown under current liabilities.
10 Provision
An amount written off or retained by way of providing for :
(a) Depreciation or
(b) Diminution in value of asset or
(c) Known liability amount of which cannot be determined with substantial accuracy.

11 Liquid Assets
Current assets other than pre-paid expenses & inventory. These assets can be easily
converted into cash.
12 Amortization
The gradual & systematic writing off of an asset or an account over an appropriate
period e.g. depreciation, preliminary expenses.
13 Sales Returns
Value of goods returned by customers to our company. It is also known as Returns
Inward.
14 Purchase Returns
Value of goods returned by our company to suppliers. It is also known as Returns
Outward.
15 Sundry Debtors
Customers of company to whom goods have been sold on credit.
16 Sundry Creditors:
Suppliers of company from whom goods have been purchased on credit.
17 Marketable Securities
Securities which can be easily converted into cash e.g. government securities short
term investment & other money market instruments. These are shown as current
assets.
18 Pre-paid expenses
 Payment for expenses in an accounting period the benefit of which will accrue in the
next accounting period. It is current asset.
19 Outstanding Expenses
Payment for expense not made in an accounting period the benefit of which accrues in
same accounting period. It is current liability.
20 Advance Received
It is an amount received by company from customer for which goods or services have
not been provided. It is current liability
21 Bad Debts
Debts owed to company which are considered to be irrecoverable. It is a loss to the
company & shown under selling & distribution expenses.
22 Bank Overdraft(O/D)
It is a limit specified by bank up to which company can have negative balance. Bank
charges interest on negative balance on day basis.
23 Solvency
Ability of company to pay its dues on due dates. When company cannot pay so it is
said to be insolvent.
24 Liquidity
Ability of company to generate cash as & when required.
25 Drawings
Capital withdrawn from business by the owner.

1.3 Forms of Business Organization :

There are four types of organization. While introducing accounting system it is important
to know the type, as requirements & acts applicable to each type for implementing
accounting system are different. Following are the types of organization:

Type of organization Features

Proprietary concern - Single owner

- Capital is provided by him
- Liability of owner is unlimited
- Provisions of Companies Act not applicable
- Tax audit applicable if turnover is more than
Rs. 40 lakhs
- No minimum capital requirement

Partnership firm - Owners- minimum 2 & maximum 20

(10 for banking business)
- Capital provided by partners
- Formed by partnership deed properly registered
- Profits & losses are shared in ratio agreed as per deed
- Liability of partners is joint, several & unlimited
 - Provisions of Companies Act not applicable
- Tax audit applicable if turn over is more than
Rs. 40 lakhs
- No minimum capital requirement

Pvt. Ltd. Co. - Owners: minimum 2 & maximum 50

(called shareholders or members)
- Capital provided by shareholders
- Formed as per procedure of Companies Act
- Liability of shareholder is limited to capital provided
by him.
- Provisions of Companies Act applicable
- Minimum capital required is Rs. 1 lakh

Public Ltd. Co. - Owners: minimum 7 & maximum any

(called shareholders or members)
- Capital provided by shareholders
- Formed as per procedure of Companies Act
- Liability of shareholder is limited to capital provided
by him.
- Provisions of Companies Act applicable
- Minimum capital required is Rs. 5 Lakhs

1.4 Meaning & Significance of Accounting

Meaning

a. Process of identifying, measuring & communicating economic information of company to

the users of this information for decision & control.

b. Book-keeping is a part of accounting & it is concerned merely with recording transactions

& keeping records.

c. Accounting mainly focuses on measurement, analysis, interpretation & use of economic

information by managers for making decisions & control activities.

d. As an information system it involves 3 stages.

i) Input : Economic events measured in financial terms
ii) Process : Recording, classifying, summarizing, analyzing & interpreting of input
information through computer.
iii) Output : Communication of information to the users

e. Accounting cycle involves following stages

i) Entering financial transactions in journal.
ii) Posting in ledger accounts
iii) Preparation of trial balance
 iv) End products – income statement & balance sheet

Significance

a. Records all business transactions timely & accurately.

b. Educates businessman to be systematic & accurate
c. Protects business from theft & dishonesty
d. Useful for control on cash flows
e. Highlights areas of excess expenses
f. Gives information for decision making & control
to all who are connected with business.
g. Useful for knowing profitability, solvency, & liquidity of co.
h. To know tax liability of co.
i. Useful for business valuation at the time of corporate restructuring
j. Provides evidence in court of law
k. Useful for SWOT analysis
l. Useful for strategy formulations
m. Tool for financial planning
n. Divisional performance measurement
o. Better cooperation & coordination

1.5 Users of Accounting Information

Users Use of Information
1. INVESTORS i) To know profitability of company
ii) To assess growth & survival of company
iii) To decide on quantum of investment
2. LENDERS i) To judge profitability
ii) To assess capacity of co. to pay interest & principal
iii) To assess long term survival of co.

3. CREDITORS i) To assure that their credit will be honored

ii) To judge credibility of form
iii) To judge continuity of business

4. CUSTOMERS i) To ensure continuous availability of product

ii) To know profitability of company
iii) To know credit policy of company
5. GOVT.AGENCIES i) To assess Excise duty/ Sales Tax/Income tax due from
company.
ii) To study wage structure of company for national wage
policy
iii) To know Import / Export for assessing net foreign
exchange earned by company.

6. EMPLOYEES i) To study profitability of company

 ii) To know expenses on employees by company
iii) To ensure continuity of business

1.6 Accounting Principles

Meaning:
i) Accounting principles are general rules derived for accounting procedures &
practices.
ii) Accounting principles must be followed for recording financial transactions & for
preparing financial statements of company.

Significance:
1. Separate Entity
i) Business is to be treated separate from its owners.
ii) Distinction must be made between personal & business transactions
iii) Assets & liabilities of business are different from that of owners.
iv) Applicable to all types of organization
Exs. (a) Money provided by owners is to be treated as capital of owners & regarded as
liability of firm.
(b) Drawings by owners are recorded by business i.e. capital withdrawn from
business.
2. Going Concern
i) Business entity has a continuity of life for indefinitely long period.
ii) Concept recognizes value of the assets & liabilities of the business on the basis
of their productivity & not on the basis of their current realizable value.
iii) As per this concept assets & liabilities of concern are shown in the form of
Balance sheet
iv) Concept helps other business units to make contracts with our business units for
business dealings in future.
v) Ex: prepaid expenses are recognized as assets since benefits will be utilized in
future when business will continue.

3. Money Measurement
i) In accounting all transactions are expressed & interpreted in terms of money
ii) Helps to express heterogeneous economic activities in terms of money
iii) Fact or event which cannot be expressed in money is not recorded in books of
accounts
iv) As per this concept fixed assets like land, machinery, furniture are expressed
in terms of money & not in terms of area or quantity.

4. Cost Concept
i) Asset is recorded at its cost in the books of accounts i.e. price which is paid at the
time of acquiring it.
ii) Asset when acquired is recorded at its cost price & gradually reduced by way
of depreciation.
 iii) Amount of depreciation is to be calculated on the basis of cost price & the
effective life of the asset.
iv)
v) The market value of the asset is not to be taken into account for the purpose of
valuation or depreciation of the asset.
vi) This method is closely related to the going concern concept method.

5. Accounting Period
i) Business is assumed to continue indefinitely as per going concern concept
ii) Business has to choose intervals for ascertaining financial position & the
operational results at each such interval, known as accounting period, which is
generally one year.
iii) In India every limited co. must publish its financial results two times- half
yearly & yearly. Many statutory bodies & financial institutions require many
companies to submit even quarterly results.
iv) Interested parties such as investors, creditors, shareholders etc. need periodical
reports to judge business performance & for decision making.
v) Concept is applicable to:
a Valuation of Assets & Liabilities
b Financial Analysis
c Revenue & Capital Expenditure
d Presentation of true & fair view of Financial Position
e Estimation of Profits
vi) Concept helps to measure income generated during specific accounting
period which also helps to distribute same periodically by way of dividend
vii) Concept recognizes the measurement of operating results of each period.
viii) Reveals clear demarcation of accrued or deferred items of incomes & expenses.
ix) The segregation of expenditure between capital & revenue arises from this
concept. Revenue item has benefit for one accounting period whereas capital
expenditure has benefit for more than one accounting period.

6 Dual Aspect
i) Every transaction has double effect – Receiving benefit & giving benefit
ii) Thus there will be double entry for each transaction
i.e. To every debit, there must be credit
iii) Accounting equation: Assets= Capital +Liabilities is based on this concept

7 Accrual Concept
i) Incomes & expenses should be recognized as & when they are earned or
incurred, irrespective of whether money is received or paid for any transaction.
ii) Companies Act 1956 provides that accrual concept has to be maintained
practically for all accounting purposes by all companies. Exs.:
iii) Rent paid for 15 months in first month of year in advance. In this case rent for
only 12 months should be recognized as expense for the year. Remaining 3
months rent should be treated as advance payment of rent for next year.
iv) Credit sales of year =Rs.20 lakhs
 Cash collected from debtors =Rs.15 lakhs
Sales of Rs.20 lakhs should be considered for finding income of firm & not
Rs.15 lakhs.

8 Matching Concept
i) Revenue earned in an accounting year is matched with all expenses incurred
during same period to generate that revenue.
ii) Exs:
(a) Depreciation for the year is the cost of asset to earn revenue for same year.
(b) Prepaid expenses are excluded to decide income of year
(c) Outstanding expenses are added to decide income of year
9 Prudence or Conservatism .
i) Prudence is the inclusion of a degree of caution in making estimates under
conditions of uncertainty.
ii)It states that :
 Anticipate no profits but provide for all possible losses
 Assets or incomes should not be overstated & liabilities or expenses should
not be understated
 Expected losses should be accounted for but not the anticipated gains

10 Realization
i) Governed by concept of prudence
ii) Revenue should only be brought into account when it is actually realized or
when there is certainty to realize revenue.
iii) EX: Provision for doubtful debts is excluded from sales and only that sale is
considered which business is certain to realize for knowing profit of business.

11 Materiality
i) It means relative importance.
ii) Whether a matter should be disclosed or not in the financial statement depends
on its materiality i.e. whether it is material or not.
iii) In the accounting sense an item is recorded only when it is considered to be
useful or important to the user of financial statement
iv) Amount may be material under one situation but immaterial under another
situation.
e.g. sale of Rs. 4 lakhs is material when turnover is Rs.40 lakhs but it is
immaterial when turnover is Rs.4,000 cr.
v) It is useful to management to avoid unnecessary wastage on time & money on
immaterial amounts.
vi) Material items should be separately disclosed in published financial statements,
whereas immaterial items may not be disclosed separately but may be
considered in a consolidated form

12 Consistency
i) Accounting methods, practices & policies used by business must be consistent
from one period to another period.
 ii) Gives confidence to the user of accounting information
iii) Useful for comparison of business performance year after year
(ii) Ex: Same method of depreciation i.e. either S.L.M. or W.D.V. should be
consistently used year after year.

13 Full Disclosure
i) Financial statements is a means of disclosing & not concealing.
ii) Financial statements must disclose all relevant & reliable information.
iii) Disclosure must be full, fair & adequate

Methods of Accounting

There are 2 methods of accounting

(a) Cash Method :

 Entries are made in Books of accounts only when cash is received or cash is paid.
 Receipt of income is treated as income when cash is received against it.
 Incurring an expenditure is recorded only when person pays cash for it.
E.g. Business has executed total sales of Rs. 12 lakhs out of this sale Rs. 2 lakhs is
executed in month of March & co. will receive amount in month of May then sales to
be recorded = Rs. 10 lakhs
 This system is followed by professionals such as doctors, lawyers, CAS etc.

(b) Mercantile or Accrual Method :

Entries are made in Books of A/cs when payment or receipts are merely due even
though not paid or received.
 There must be right to receive income & business must be sure to receive the same.
 Incurring of an expenditure is recorded when legal liability to pay arises or enjoyment
from such expenditure takes place.
 E.g. in the above case sales to be recorded = Rs. 12 lakhs
 This system is used by firms & limited cos.
 As per companies act all limited cos. must maintain their accounts as per this system
only.

1.11 Summary :
 Every subject has technical terms so also is for financial accounting . It is important to
grasp meaning of these terms so that understanding of subject becomes easy.

 There are 4 types of business organizations. Proprietary concern, partnership firm,

private limited company & public limited company. Former two have unlimited
liability, while later two have limited liability – At one end proprietary concern is
having single owner, at other end public limited co. can have unlimited no.of owners .
 Depending upon capital required & liability to be undertaken, particular organization
is formed. Each form requires different type of accounting system & method of
preparing financial statements.

 Accounting is the process of collecting, analyzing & conveying economic information

of any company to the users of this information for the decision making & control .
Accounting is useful to many aspects of business such as financial discipline,
formulation of different strategies & policies, fulfillment of legal requirements & so
on.

 Accounting information is required by owners, creditors, employees, customers &

investors of company to check whether their interests have been & will be taken care
by. Government also uses this information for taxation , foreign exchange earnings or
outgo & to study wage structure for particular company & industry .

 Accounting principles are required to be followed by companies to ensure correctness,

reliability & legality of financial statements.

 Accounting standards are prepared by ICAI. Applicable standards must be followed

by every organization, otherwise financial statements of company are not accepted
under companies Act & Income Tax Act.

 Company must follow accounting polices consistently so that financial statements

become reliable & acceptable by investors, Govt. & other interested parties.

 There are 2 methods of accounting. As per cash method transactions are recorded only
when amounts are received or paid by organization. On the other hand accrual method
requires that transactions must be recorded when they become due, even though
received or paid or not. While limited companies must use accrual method,
professionals like doctors or lawyers have to use cash method for statutory purposes.

1.12 Assignment Material

[A] Fill in the blanks

1. Profit is earned by company when ------------------------ exceeds ------------------

2. Revenue profit is earned when Co. sells ----------------------------------------------

& capital profit is earned when Co. sells ----------------------------------------------

3. Gross profit = Rs. 15,00,000

C.O.G.S. = Rs. 65,00,000
Sales = Rs. ------------

4. Sales = Rs. 175 Crs.

 Other Income = Rs. 5 Crs.
Admin. Expenses = Rs. 8 Crs.
Selling Expenses = Rs. 12 Crs.
Depreciation = Rs. 30 Crs.
C.O.G.S. = Rs. 100 Crs.
EBIT of Co. = Rs. ---------

5. P.A.T. = (P.B.T.) - (-----------)

6. P.A.T. = Rs. 60 Crs.
Pref. dividend = Rs. 2 Crs.
Equity dividend = Rs. 18 Crs.
Reserves of Co. = Rs. ---------------

7. P.A.T. = Rs. 40 Crs.

Equity dividend = Rs. 30 Crs.
Retention ratio of Co. = ---------- --- %

8. Company has received advance Rs. 30,000 from customer & given advance of Rs.
50,000 to supplier this means
a) Current Assets = ---------------------- (b) Current Liabilities = ------------------

9. Benefit from capital expenditure lasts for ---------------------------------------------

And from revenue expenditure lasts for -----------------------------------------------

10. Freight inward is a ---------------------------------------------------expense whereas

Freight outward is --------------------------------------------------------------expense

11. -------------- discount is shown in books of A/Cs but -------------- discount is not
Shown in books of A/Cs .

12. Amount which cannot be collected by Co. from customer due to Co.
is called -------------------------------
13. Debit note is given by -----------------------------------to -----------------------------
14. Bills receivable is raised by --------------------& accepted by -----------------------
15. Liquid assets = (Current Assets ) - ( -------------------------------------------------
16. Sales returns also known as --------------------------------------------------------- &
Purchase returns also known as --------------------------------------------------------

17. Sundry debtors are ------------------------------------------------------------ Assets &

Sundry Creditor are ----------------------------------------------------------Liabilities

18. For pre-paid expenses payment is made in -------------------accounting period &

Benefit is derived in -----------------------------------------------accounting period.
19. Co. sells goods worth Rs. 100 lakhs. of which Rs. 20 lakhs received immediately
This means Rs. 80 lakhs. are ----------------------------------------------------------

20. Bank overdraft means ------------------------------------------------- bank balance

21. When Co. cannot pay its dues it is said to be ----------------------------------------

22. Ability of Co. to generate cash as & when required is known a-------------------
23. Electricity bill payable in next month is -------------------------------------liability
24. ---------------------------dividend is after ------------------------------------dividend
25. Co. pays ------------------------ on shares & --------------------------on debentures
26. Debenture is ------------------------------ loan taken from ----------------------------
27. -----------------------------------Liabilities are not shown in balance sheet of Co.
28. Accounting cycle involves following stages :
a) -------------------------------------- (b) -------------------------------------------
c) -------------------------------------- (d) -------------------------------------------
29. Govt. uses accounting information for :
a) ---------------------------------------- (b) -----------------------------------------
c) -------------------------------------------

30. As per entity concept distinction must be made between ---------------------------

& ---------------------------------------------------- transactions

31. As per going concern concept assets & liabilities of company are shown in form of
----------------------------------------------------------------.

32. In accounting all transactions are ------------------------ & -----------------------in

Terms of money .
33. As per cost concept depreciation is to be calculated on basis of ------------------.

34. Assets = ----------------------------------- ( + ) -----------------------------------

35. As per prudence concept Co. should not anticipate------------------------------ but
Provide for ------------------------------------- .

36. As per companies Act 1956 Co. must maintain its accounts as per ---------------
Concept.

37. Credit sales of year = Rs. 20 lakhs

Cash collected from debtors = Rs. 15 lakhs
Income of Co. = ------------------------------------------------------------------------.

38. Depreciation is the example of --------------------------------------------- concept .

 39. Accounting methods , practices & policies used by Co. must be -----------------
from one period to another .

40. Indian Accounting Standards are prepared by ------------------------------------- .

41. As on today ------------------------------ Accounting Standards have been issued.

42. Every Co. must prepare --------------------------------------------------------- as per

Accounting Standards applicable to Co.

43. Accounting policies must be useful to present true & fair view
of -------------------------------------- of Co.

44. G.A.A.P. means --------------------------------------------------------------------------

45. U.S.A. Cos. operating in India have to prepare 2 sets of accounts .One as per
-------------------------- G.A.A.P. & Other as per ------------------------G.A.A.P.

46. As per cash method of accounting entries are made in books of A/cs only
When ----------------------------- is received or --------------------------- is paid

47. Cash method of accounting is used by ---------------------------------------------- .

48. Accrual method of accounting is used by -------------------------------------------.

49. Closing stock must be valued by company either at ----------------------------- or

------------------------------------- whichever is less

50. --------------------------------------- concept is useful for other business units to

make contracts with a company .
[Answers to Assignment

[A] Fill in the blanks

1 (Revenue, Expenses ), 2 (Goods &/or Services ), 3 ( Rs.80,000 ), 4 (Rs.30 Crs.),

5 ( Income Tax ), 6 ( Rs.40 Crs ), 7 ( 25% ) , 8 ( 50,000, 30,000), 9 (More than 1year,
Less than 1 year ), 10(Direct expenses, Selling & distribution) , 11 (Cash, Trade) , 12
(Bad debts), 13 ( Our Co. , supplier) 14(Seller , Buyer), 15 ( Inventory & pre-paid
expenses), 16(Returns Inward , Returns outward), 17 (Customers of Co., Suppliers of
Co.) , 18(This , Next ), 19(Receivables or debtors), 20 (Negative ), 21 (Insolvent), 22
(Liquidity ), 23 (Current), 24 (Equity, Preference), 25 (Dividend, Interest), 26 (Secured,
Public), 27 ( Contingent liabilities), 28 ( Journal, Ledger, Trial balance, Income statement
& balance sheet Final A/C) 29 (Taxation, Wage structure, Import / Exports by Co.), 30
(Personal, Business ), 31(Balance sheet ), 32 (expressed & interpreted.), 33 (Cost of
asset), 34(Capital(+)Liabilities), 35(Any profit, All losses), 36 (Accrual), 37 (Rs. 20
lakhs), 38(Matching), 39(Consistent), 40(ICAI), 41(29), 42 (Financial statements ),
 43(State of affairs), 44(Generally Accepted Accounting Principles), 45 (Indian USA),
46(Cash),47(Professionals), 48(Companies), 49(Cost market value), 50 (Going concern),

Unit 2 : Mechanics of Accounting.

Learning Objectives :

After studying this unit you will be able to :

 Understand significance of accounting equation
 Enter transactions in journal & subsidiary books
 Prepare various ledger accounts
 Check whether transactions entered in journal or ledger are correct by
preparing trial balance.
 Prepare final accounts i.e. Income statement & Balance sheet.
_________________________________________________________________________

2.1 Introduction

Accounting is a highly technical subject. Many rules, regulations & procedures are to be
followed for correct recording of business transactions. This unit deals with accounting
process, & specific system to be followed for recording transactions. It takes you through
four stages of accounting cycle viz. Journal, ledger, trial balance & final accounts.

2.2 Accounting Equation :

i) Financial accounting is based on accounting equation.
ii) It is based on dual aspect concept.
iii) Equation is : Capital + Liabilities = Assets
iv) With every transaction values of any of above or all of above changes but both
sides must be equal.

Example:

Transaction Equation
Capital + Liabilities = Assets
a) R started business with 5,20,000 + NIL = 5,00,000 + 20,000
Rs. 5 lakhs as bank (Bank) (Cash)
balance & cash Rs. 20,000
b) Took loan Rs. 1 lakh 5,20,000 + 1,00,000 = 6,00,000 + 20,000
c) Bought goods 5,20,000 + 1,00,000 = 3,00,000 + 20,000 + 3,00,000
Rs. 3,00,000 (Bank ) (Cash) (goods)
Illustration 1 :
Write accounting equation for each of the following transactions :
Date Transaction Amt. (Rs.)
1/4/2007 Ajay started business with bank balance Rs. 2,00,000 & cash Rs. 20,000
5/4 Purchased machinery by cheque Rs. 80,000
8/4 Purchased goods by cash Rs. 10,000
12/4 Sold goods (cost Rs. 4,000) by cash Rs. 5,000
15/4 Purchased goods by cheque Rs. 1,00,000
20/4 Purchased goods on credit Rs. 3,00,000
24/4 Sold goods (cost Rs. 60,000) on credit Rs. 80,000
28/4 Paid Rent by cheque Rs. 10,000
30/4 Paid salaries by cash Rs. 10,000

Solution :
Date Capital + Liabilities Assets
Capital + Creditors = Bank + Cash + Machinery + Stock +Debtors
1/4 2,20,000 = 2,00,000 + 20,000
5/4 2,20,000 = 1,20,000 + 20,000 + 80,000
8/4 2,20,000 = 1,20,000 + 10,000 + 80,000 + 10,000
12/4 2,21,000 = 1,20,000 + 15,000 + 80,000 + 6,000
15/4 2,21,000 = 20,000 + 15,000 + 80,000 + 1,06,000
20/4 2,21,000 + 3,00,000 = 20,000 + 15,000 + 80,000 + 4,06,000
24/4 2,41,000 + 3,00,000 = 20,000 + 15,000 + 80,000 + 3,46,000 + 80,000
28/4 2,31,000 + 3,00,000 = 10,000 + 15,000 + 80,000 + 3,46,000 + 80,000
30/4 2,21,000 + 3,00,000 = 10,000 + 5,000 + 80,000 + 3,46,000 + 80,000

Explanation :
Date Explanation
1/4 Ajay has introduced capital Rs. 2,20,000 Capital ↑
Business has bank balance Rs. 2,00,000 Asset ↑
Business has cash balance Rs. 20,000 Asset ↑
5/4 Machinery increased by Rs. 80,000 Asset ↑
Bank balance decreased by Rs. 80,000 Asset ↓
8/4 Purchased goods i.e. stock increased by Rs. 10,000 Asset ↑
Cash decreased by Rs. 10,000 Asset ↓
12/4 Profit it is added to capital
when goods of Rs. 4,000 are sold for
Profit = (5,000 – 4,000) = Rs. 1,000 Liability ↑
Cash increased by Rs. 5,000 Asset ↑
Stock decreased by Rs. 4,000 Asset ↓
15/4 Bank balance decreased by Rs. 1,00,000 Asset ↓
Stock increased by Rs. 1,00,000 Asset ↑
20/4 Creditors increased by Rs. 3,00,000 Liability ↑
Stock increased by Rs. 3,00,000 Asset ↑
24/4 Sundry Debtors increased by Rs. 80,000 Asset ↑
Stock decreased by Rs. 60,000 Asset ↓
 Profit = [ 80,000 - 60,000 ]
Hence capital increased by Rs. 20,000 Liability ↑
28/4 Bank balance decreased by Rs. 10,000 Asset ↓
Rent is expenses which is a loss
Hence capital decreased by Rs. 10,000 Liability↓
30/4 Cash balance is decreased by Rs. 10,000 Asset ↓
Capital (Loss) is decreased by Rs. 10,000 Liability ↓
NOTE that :
1. One asset may increase & other asset may decrease by same amount
2. Asset may increase/ decrease & liability or capital may increase/decrease by same
amount.
3. When there is profit capital increases by amount of profit
4. When there is loss / expenses capital decreases by amount of loss / expenses
5. After every transaction both sides of equation must be equal.

) Journal:
(i) Word journal means a daily record of business transactions
(ii) It is a book of original or prime entry. Every transaction is first recorded in Journal &
from Journal it is posted into Ledger.
(iii) Recording transactions in journal is called as journalizing or journal entry.
(iv) Journal is called subsidiary book of A/Cs because it is merely written for Ledger
posting.
(v) For journalizing following rules are applied:
Asset increase Debit (Dr.) Asset A/C
Asset decrease Credit (Cr.) Asset A/C
Liability/Capital increase Credit (Cr.) Liability/Capital A/C
Liability/Capital decrease Debit (Dr.) Liability/Capital A/C
When there is income Credit (Cr.) Income A/C
When there is loss/expense Debit (Dr.) Loss/Expense A/C
(vi) Significance to management:
 Gives detail information of business transactions.
 Useful for day to day control on expenses
 Useful for locating & preventing errors
 Brings financial discipline in organization

a) Trade Discount ( T.D. ) : It is a discount offered by co. to its dealer on M.R.P. This is
the profit of the dealer. T.D. never appears in books of A/Cs.
b) Cash Discount (C.D.) : It is a discount offered by Co. to it’s customers for making prompt
payment by them. It is calculated after T.D. & is shown in books of A/Cs.
When Co. gives C.D. it is “discount Allowed A/C” & is always Dr.
When Co. receives C.D. it is “discount received A/C” & is always Cr.
c) When shares or securities of other company are purchased sold them add / deduct
brokerage amount & debit / credit the entire amount to investment A/C

b) Subsidiary Books:
 Practically for every business there are large no. of transactions. It is tedious and
impractical to record all transactions in one journal. It is therefore essential to classify the
transactions in a convenient manner & record them in separate journals. This sub-
division of journal is called subsidiary books.

Name of subsidiary book Used to record

Sales Day Book Credit sales
Sales return or Returns inward book Goods returned by customer
Purchase Day Book Credit purchases
Purchase return or Returns outward book Goods returned to supplier
Bills Receivable (B/R) book Bills raised by co.& accepted by customer
Bills Payable(B/P) book Bills raised by supplier & accepted by co.
Cash book All cash receipts & cash payments
Journal Proper Any transaction which can’t be recorded
in any of the above books
Advantages of subsidiary books:
i) Accounting work can be divided amongst no. of clerks
ii) Particular person acquires efficiency & speed in handling particular journal
iii) Time of accounting process is reduced
iv) Facilitates audit work as different auditors can check different books.

) Ledger :

a) Meaning of Account(A/C):

i) It is a basic block of any accounting system.

ii) It is a standard format used to maintain record for each individual item.
iii) It facilitates preparation of periodical financial statements & provides a continuous
check on the accuracy of recording of transactions.
iv) Account exists for: Assets, Liability, Owners capital, Revenue & Expenses
v) Account is used to record increase or decrease in above items resulting from
business transactions
vi) Account has following components:
- Account title
- Place to write debit & credit amounts
- Dates & descriptive notations
- Cross reference to other accounting records
vii) The words “ To (Name of A/C)” means to make entry on left side of A/C. On this
side word debit (Dr) is written on top just below title of A/C.
viii) The words “ By (Name of A/C)” means to make entry on right side of A/C. On this
side word credit (Cr) is written on top just below title of A/C.
ix) When Dr side is more than Cr side we say Debit balance & difference is written on
Cr side.
x) When Cr side is more than Dr side we say Credit balance & difference is written on
Dr side.
FINAL ACCOUNTS
In the double entry system every entry has its corresponding credit and debit. It follows, that at
any given point of time, the posting from Journal, day books and cash book to the ledger is
completed, the debit balances standing in all the ledgers including the cash book will equal the
credit balances. At the end of the financial period (or at some other date) these balances are
extracted and a schedule is prepared in journal form is called a Trial Balance. Thus the total of
debit balances appearing in the Trial Balance must agree with the total of credit balances of
appearing in the Trial Balance. The next stage after posting accounts to the ledger is the
preparation of a Trial Balance. The debit and credit balances of accounts are entered in this
statement. The total of the debit and the total of the credit side must agree. An agreement
indicates reasonable accuracy of the accounting work. The trial balance helps in ascertaining
arithmetical accuracy of the ledger accounts, location of errors and in the preparation of financial
statements.

Objects of preparing Trial Balance :

1. It forms the very basis on which final accounts are prepared.
2. It helps in knowing the balance on any particular account in the ledger.
3. It is used as a test of arithmetical accuracy.

Errors disclosed by the Trial Balance :

A Trial Balance will not agree on account of the following errors :
(i) Wrong posting of entries i.e. A debit entry of Rs. 1,000 for purchase of furniture wrongly
posted as Rs. 100 in the account.
(ii) Omission of posting of debit or credit e.g. A debit entry of Rs. 1,000 for purchase of furniture
is not posted at all.
(iii) Duplication of posting e.g. when debit entry of Rs. 1000 for purchase of furniture has been
posted twice in the account.
(iv) Wrong side of posting e.g. when debit entry is posted on the credit side or credit entry is
posted on the debit side, e.g. when a debit entry of Rs. 1000 is posted on the credit side, i.e. when
debit entry of Rs. 1000 is posted on the credit side and vice versa.
(v) Errors in casting the totals of debit or credit side of the Trial Balance.
(vi) Wrong transfer of balances in the Trial Balance.
(vii) Omission of entering the balance of account in the Trial Balance.
(viii) Balance of cash book omitted to be recorded in the Trial Balance.
(ix) Wrong balancing of account.
(x) Errors in the total or posting or entries of subsidiary book.
(xi) Wrong carry forward of balance in the various books, i.e. day books, cash book, etc.

Errors not disclosed by Trial Balance

The following errors do not affect the agreement of the Trial Balance :
(i) Errors or omission ; omission to record any transaction
(ii) Posting of wrong amount both debit and credit side of the account
(iii) Error made in posting of debit or credit entry is compensated by an identical error of equal
amount. These errors are known as compensating errors.
(iv) Errors made in posting a transaction on the correct side of wrong account.
(v) Recording a transaction twice erroneously. These are known as errors of duplication.
(vi) Errors of principle – when the accounting principle is disregarded e.g. a capital item as
revenue item and vice versa, i.e. purchase of furniture posted to Purchases Account.

The prime objective of accounting is to ascertain how much profit or loss a business organisation
has made during any accounting period and to determine its financial position on a given date.
Preparing final accounts or financial statements serve this purpose. After the preparation of Trial
Balance, the next level of work in accounting is called “Final
Accounts” level. Preparation of Final Accounts involves the following:
Preparation of a Trading Account
Preparation of a Profit & Loss Account and
Preparation of a Balance Sheet

TRADING ACCOUNT
Trading Account is prepared to know the outcome of a trading operation. Trading
Account is made for calculating the gross profit or gross loss of a business establishment during
an accounting period, which is generally a year. In accounting gross profit means overall profit.
Gross profit is the difference between net sale proceeds of a particular period and the cost of the
goods actually sold. Since gross profit means overall profit, no deduction of any sort, i.e. general,
administrative or selling and distribution expenses is made. Gross Profit is said to be made when
the sale proceeds exceeds the cost of goods sold. On the contrary, if the cost price of the goods is
more than the selling price, then there will be a gross loss.

PROFIT AND LOSS ACCOUNT

The Profit & Loss Account can be defined as a report that summarizes the revenues and expenses
of an accounting period. It displays the revenues recognized for a specific period and the cost
and expenses charged against these revenues, including write-offs (e.g. depreciation and
amortization of various assets) and taxes. The objective of the income statement is to explain to
the managers and investors whether the company made or lost money during the period being
reported. It takes into consideration all remaining indirect (normal and abnormal) expenses and
losses related to or incidental to business. These operating and non-operating expenses are
charged to Profit & Loss Account and shown to the debit side of the account. After transferring
the Gross Profit or Gross Loss from the Trading Account to the Profit & Loss Account, the
sources of other incomes are shown on the credit side of the Profit & Loss Account, It also
includes the non-trading income.

BALANCE SHEET
A Balance Sheet or statement of financial position is a summary of the financial balances of a
sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity
are listed as of a specific date, such as the end of the financial year. It is a statement of assets and
liabilities, which helps us to establish the financial position of a business enterprise on a
particular date, i.e. on a date when financial statements or final accounts are prepared or books of
accounts are closed.
______________________________________________________________________________

EXERCISES:

a. Show the accounting equation for the following

transactions
a) Started business with cash Rs. 20 lakhs
b) Deposited Rs. 12 lakhs in the Bank
c) Purchased goods on credit Rs. 7 lakhs
d) Sold goods on credit Rs. 5 lakhs
e) Paid salaries Rs. 2 lakhs
f) Received interest income of Rs. 1 lakh
g) Taken a Bank loan Rs. 3 lakhs
h) Purchased machinery and furniture for Rs. 8 lakhs and 2 lakhs

2) Journalize the following transactions and prepare a Cash Account

a) Started business with cash Rs. 15 lakhs, machinery Rs. 7 lakhs and furniture Rs. 50,000 and
Land Rs. 30,00,000
b) Purchased goods worth Rs. 9 lakhs for 5% cash discount.
c) Sold goods costing Rs. 2 lakhs at 10% above invoice price and allowed 5% trade discount and
2% cash discount.
d) Paid salaries, rent and taxes Rs. 120000 and 200000
e) Received commission Rs. 40,000 and interest Rs. 70,000
f) Purchased shares of Ace India for Rs. 1 lakh
g) Cash stolen from office Rs. 25,000
h) Goods destroyed by fire Rs. 2,00,000
i) Sold piece of land costing Rs. 1,80,000 for Rs. 2,00,000
j) Sold shares of Ace India for Rs. 1,50,000

3) From the following particulars prepare a Trial Balance as on 30th September 2013 :
Stock 1st October 2012 Rs. 1,380, Debtors Rs. 2,960, Creditors Rs. 1,580, Capital Account 1st
Oct. 2012 Rs. 4,100, Drawings Rs. 1,200, Bills Receivable Rs. 770, Bad Debt written off Rs.
190, Provision for Bad and Doubtful Debts Rs. 160, Bills Payable Rs. 470, Wages & Salaries Rs.
1,920, Purchases Rs. 6,580, Sales Rs. 10,670, Bank Rs. 580, Cash Rs. 40, Rent, Rates &
Insurance Rs. 330, Sales Returns Rs. 410, Purchases Returns Rs. 280, Fixtures & Fittings Rs.
550, General Expenses Rs. 200, Discounts allowed Rs. 520, Discounts Recd. Rs. 370.

4) Journalise the following transactions and post them to Ledger and balance the accounts. Also
prepare a Trial Balance as on 30th April 2013.

April 1 Ravi started business with Rs. 15,000 of which Rs. 4,000 were borrowed at 15% p.a.
from Shri Sashi.
2 Purchased goods worth Rs. 4,000 from Anant at 2% trade discount.
3 Cash sales to Madan Rs. 1,200.
6 Credit sales to Salvi Rs. 2,000 less trade discount 2%.
9 Paid cash Rs. 1,950 to Anant and received discount of Rs. 10
12 Received Rs. 1,950 from Salvi in full settlement of his dues.
14 Returned goods of the price of Rs. 100 to Anant.
16 Paid into bank Rs. 5,000.
18 Issued a cheque for Rs. 1,000 to Anant on account.
19 Purchased goods of Rs. 2,000 from Anant.
22 Sold foods costing Rs. 1,000 at 25% profit to Ratan.
22 Received commission Rs. 800 from S & Co.
24 Received a cheque for Rs. 395 from Ratan & he was allowed discount Rs. 5.
25 Ratan returned goods of Rs. 50.
30 Paid Interest on loan Rs. 50 to Sashi.
30 Paid Salaries Rs. 2,000 out of which Rs. 1,200 paid by cheque.
30 Paid into Bank Rs. 500.
30 Paid Office Rent by cheque Rs. 300.

5) Enter the following transactions in the subsidiary books and post them into ledger and
prepare a Trial Balance for 2013.
1 Dec. Mr. X started a business 1,00,000
5 Dec. Purchased furniture from Vikram Furniture for 20,000
7 Dec. Purchased goods for cash 15,000
10 Dec. Purchased goods from AB & Co. for Rs. 30,000. Trade Discount 20%
12 Dec. Opened a bank account by depositing 25,000
14 Dec. Sold goods for cash 15,000
15 Dec. Purchased Stationery for Rs. 1,000 from Sayyed Stationery Mart
18 Dec. Sold goods to Yusuf 5,000
20 Dec. Goods returned by Yusuf 400
21 Dec. Payment to AB & Co. by cheque 5,000
22 Dec. Purchased goods on Credit from Ramesh & Co. for 20,000
23 Dec. Returned goods to Ramesh & Co. worth 2,000
23 Dec. Paid Electricity Bill for 400
29 Dec. Cash Sale for 5,000
30 Dec. Withdraw Rs. 2,000 for private use from Bank.

6) Correct the following entries.

a) Sale or goods Rs.1200 to Mr. Kumar has been entered in the sales book as Rs. 1100.
b) Machinery purchased for Rs. 11500 from XYZ Co. Ltd has been entered in the Purchases
book.
c ) Payment of the proprietor's personal expenses Rs. 450 has been debited to the General
Expenses A/c.
d) The Returns Inwards book has been overcast by Rs. 150.
e) Discount allowed to M/s ABC Rs. 35 has not been entered in the cash book but the full
amount (including discount) has been credited to M/s ABC
f) Sale of old typewriter Rs. 275 has been passed through the sales book.

7) Classify the following as revenue or capital expenditure:

a) An piece of land was purchased for construction of shed amounting to Rs. 7,00,000 and Rs. 1
0 000 was paid for land rent.
b) Rs. 1, 50,000 was spent on advertising for the introduction of a new product in the market, the
benefit of the market which will be divided for five years.
c) Constructed additional floor to an existing building costing Rs. 11, 00,000 and replaced all the
doors and windows of the entire building amounting to Rs. 5, 00,000.
d) Purchased machinery costing Rs. 12, 00,000 and paid Rs. 1, 00,000 as installation charges and
Rs. 50,000 as overhauling charges.
e) Acquired technical know how costing Rs. 3, 00,000.

1) Differentiate between:
a) Financial Accounting and Cost Accounting
b) Trial Balance and Balance Sheet
c) Capital Expenditure and Revenue Expenditure
d) Non current and current assets

10) From the following information prepare Raj Trading and Profit and Loss Account for the
year end 31st March, 2013
Rent Rs. 6000 Discount earned Rs. 1000
Carrriage inwards Rs. 3,000 Travelling expenses Rs. 5,000
Commission Rs. 3,000 Wages Rs. 10,000
Salesman salary Rs. 9,000 Purchases Rs. 1,17,000
Opening stock Rs. 24,000 Bad debts Rs. 1000
Sundry expenses Rs. 8,000 Closing stock Rs. 49,000
Interest Rs. 2,000 Warehouse expenses Rs. 4,000
Sales Rs. 2,60,000 Salaries Rs. 12,000
Returns Inward Rs. 4,500 Return outwards Rs. 65,00
Royalties Rs. 7,500 Goods lost by theft Rs. 8,000
Loss by theft Rs. 15,00 Goods distributed as Rs. 5,000
samples
Depreciation Rs. 6,000 Trade expenses Rs. 4,000
Rent received Rs. 8,000 Sundry income Rs. 7,000
Dividend received Rs. 4,000 Printing and stationary Rs. 25,00
Factory rent Rs. 10,000

11) From the following information prepare Trading account, Profit and Loss account and
Balance sheet for the year ended 31st March, 2013
Particulars Dr Particulars Cr
Salaries 15,500 Sales 2,10,000
Discount 1,300 Returns 4,000
Rent 2,200 Interest 12,000
Opening stock 77,000 Creditors 13,000
Purchases 1,29,000 Dividends 9,400
Wages 11,800 Commission 10,400
 Drawings 15,000 Capital 1,20,000
Returns 2,800
Debtors 15,500
Machinery 80,000
Bank 18,000
Cash 10,700
Adjustments
i) Outstanding salaries and rent were Rs. 2500 and Rs. 4200
ii) Prepaid wages were Rs. 3200
iii) Interest earned but not received was Rs.4150
iv) Dividends earned but not received Rs. 2100
v) Commission received but not earned was Rs. 450
vi) Closing stock was valued at Rs. 98,000
vii) Bad debts written off Rs. 6,000 and maintain RDD @5% on debtors and reserve for
discount on debtors @2%
viii) Goods worth Rs. 12,000 destroyed by fire and insurance company admitted claim for
Rs. 10,000
ix) Distributed goods worth Rs. 6,000 as free samples

Balance Sheet
Balance Sheet is one of the reports of a financial statement which provides the financial
condition on a given date. An entity’s balance sheet provides a lot of information which
can be used to analyse the financial stability and business performance. The balance
sheet is a report version of the accounting equation that is balance sheet
equation where the total of assets always is equal to the total of liabilities plus
shareholder’s capital.
Assets = Liability + Capital
Investors and creditors generally look at the balance sheet and infer as to how
efficiently an entity can use its resources and assess the value of their investments. The
three important sections of any balance sheet are:

 Assets – This is a resource owned by an entity to produce positive economic

value.
 Liabilities – This provides a list of debts an entity owes to others.
 Capital or Equity- This is the amount invested by the shareholders

Importance of Balance Sheet

Balance sheet analysis can reveal a lot of important information about a company’s
performance. Importance of balance sheet is listed below:
  It is an important tool used by outsiders such as investors, creditors, and other
stakeholders to understand the financial health of an entity.
 It is a tool to measure the growth of an entity. This can be done by comparing the
balance sheet of different years.
 It is an essential document that must be submitted to the bank or investors to
obtain a business loan.
 It helps stakeholders to understand the business performance and liquidity
position of the entity.
 It enables decision making regarding expansion projects and meet unforeseen
expenses.
 If the entity is funding its operations with profit or debt, it can be known by
analysing the balance sheet.

Vertical Company Format of Balance Sheet

PART I — BALANCE SHEET
Name of the Company…………………….
Balance Sheet as at ………………………
(Rupees in…………)

Particulars Note Figures as at the Figures as at the

No. end of current end of the previous
reporting period reporting period
1 2 3 4

I. EQUITY AND LIABILITIES

(1) Shareholders’ funds
(a) Share capital
(b) Reserves and surplus
(c) Money received against share
warrants
(2) Share application money pending
allotment
(3) Non-current liabilities
(a) Long-term borrowings
(b) Deferred tax liabilities (Net)
(c) Other Long term liabilities
(d) Long-term provisions
(4) Current liabilities
 (a) Short-term borrowings
(b) Trade payables
(c) Other current liabilities
(d) Short-term provisions
TOTAL LIABILITES

II. ASSETS
Non-current assets
(1)        (a) Fixed assets
(i) Tangible assets
(ii) Intangible assets
(iii) Capital work-in-progress
(iv) Intangible assets under
development
(b) Non-current investments
(c) Deferred tax assets (net)
(d) Long-term loans and advances
(e) Other non-current assets
(2) Current assets
(a) Current investments
(b) Inventories
(c) Trade receivables
(d) Cash and cash equivalents
(e) Short-term loans and advances
(f) Other current assets
  TOTAL ASSETS
See accompanying notes to the Financial Statements.

Vertical Company Format of Profit and

Loss Account

PART II – STATEMENT OF PROFIT AND LOSS

Name of the Company…………………….
Profit and loss statement for the year ended ………………………
(Rupees in…………)
   Particulars Note No. Figures as at the Figures as at the
end of the previous
end of current reporting period
reporting period
  1 2 3 4
I Revenue from operations   xxx xxx
II Other income   xxx xxx
III Total Revenue (I + II)   xxx xxx
IV Expenses:      
Cost of materials consumed Xxx Xxx
 
Purchases of Stock-in-Trade    
  Xxx Xxx
Changes in inventories of
finished goods work-in-    
progress and Stock-in-Trade Xxx Xxx
 
   
Employee benefits expense
Finance costs    
     
Depreciation and amortization
expense xxx Xxx
   
Other expenses
 
Total expenses
V Profit before exceptional and   xxx xxx
extraordinary items and tax
(III - IV)
VI Exceptional items   xxx xxx
VII Profit before extraordinary   xxx xxx
items and tax (V - VI)
VIII Extraordinary items   xxx xxx
IX Profit before tax (VII- VIII)   xxx xxx
X Tax expense:      
(1) Current tax Xxx Xxx
(2) Deferred tax Xxx Xxx
XI Profit (Loss) for the period   xxx xxx
from continuing operations
(VII-VIII)
XII Profit/(loss) from   xxx xxx
discontinuing operations
XIII Tax expense of discontinuing   xxx xxx
operations
 XIV Profit/(loss) from   xxx xxx
Discontinuing operations
(after tax) (XII-XIII)
XV Profit (Loss) for the period   xxx xxx
(XI + XIV)
XVI Earnings per equity share:      
(1) Basic Xxx Xxx
(2) Diluted xxx xxx

CHARACTERISTICS OF A COMPANY

The main characteristics of a company are :

1. Incorporated association. A company is created when it is registered under the Companies
Act. It comes into being from the date mentioned in the certificate of incorporation. For forming
a public company at least seven persons and for a private company at least two persons are
persons are required. These persons will subscribe their names to the Memorandum of
association and also comply with other legal requirements of the Act in respect of registration to
form and incorporate a company, with or without limited liability.

2. Artificial legal person. A company is an artificial person. Negatively speaking, it is not a

natural person. It exists in the eyes of the law and cannot act on its own. It has to act through a
board of directors elected by shareholders. But for many purposes, a company is a legal person
like a natural person. It has the right to acquire and dispose of the property, to enter into contract
with third parties in its own name, and can sue and be sued in its own name.
3. Separate Legal Entity : A company has a legal distinct entity and is independent of its
members. The creditors of the company can recover their money only from the company and the
property of the company. They cannot sue individual members.
4. Perpetual Existence. A company is a stable form of business organization. Its life does not
depend upon the death, insolvency or retirement of any or all shareholder (s) or director (s). Law
creates it and law alone can dissolve it. Members may come and go but the company can go on
for ever.
5. Common Seal. As was pointed out earlier, a company being an artificial person has no body
similar to natural person and as such it cannot sign documents for itself. It acts through natural
person who are called its directors. But having a legal personality, it can be bound by only those
documents which bear its signature. Therefore, the law has provided for the use of common seal,
with the name of the company engraved on it, as a substitute for its signature. Any document
bearing the common seal of the company will be legally binding on the company. A company
may have its own regulations in its Articles of Association for the manner of affixing the
common seal to a document.
6. Limited Liability: A company may be company limited by shares or a company limited by
guarantee. In company limited by shares, the liability of members is limited to the unpaid value
of the shares.
7. Transferable Shares. In a public company, the shares are freely transferable.
The right to transfer shares is a statutory right and it cannot be taken away by a provision in the
articles. However, the articles shall prescribe the manner in which such transfer of shares will be
made and it may also contain bona fide and reasonable restrictions on the right of members to
transfer their shares.
8. Separate Property : As a company is a legal person distinct from its members, it is capable of
owning, enjoying and disposing of property in its own name. Although its capital and assets are
contributed by its shareholders, they are not the private and joint owners of its property. The
company is the real person in which all its property is vested and by which it is controlled,
managed and disposed of.