Unit 1 Merged

2nd Semester Accounts | UNIT 1
INTRODUCTION TO ACCOUNTING
Introduction
The main aim of a business is to earn profit. For earning profit, the businessman will either
purchase the goods in one market at a certain price and sell it in another market at higher price
or will convert the raw materials into finished products or sell it to the different customers at a
price which will give him some percentage of profit on cost of production. However he will be
anxious at the end of the year to find out whether his goods taken together have been sold at a
profit or at a loss and what is the financial position on a particular date. Moreover in big
business information is required for planning, control, evaluation of performance and decision
making. This information can be provided only when business transactions are recorded,
classified and summarized properly.
In order to achieve the above purposes it would be necessary to record business transactions
according to well devised system. Book-keeping (in elementary stage) and accounting (in
advanced stage) is the name given to such a system.
Meaning of BOOK-KEEPING
Bookkeeping is the recording of financial transactions. Transactions include sales, purchases,

income, receipts and payments by an individual or organization. Bookkeeping is usually
performed by a bookkeeper. The purpose of bookkeeping is to keep the management and the
owners informed about the financial health of the company. Book-keeping, in this way, may
be defined as the science and art of identifying and recording accounting transactions
systematically in the proper books of accounts.
“Book- keeping is the art of recording business transactions in a systematic manner.” A.H.
Rosenkamph.
“Book- keeping is the science and art of correctly recording in books of account all those
business transactions that result in the transfer of money or money’s worth.” R.N.Carter
“Book-keeping is the art of recording in the books of accounts the monetary aspect of
commercial or financial transactions.” North Cott
Objectives of Book- keeping:
□ Book- keeping provides a permanent record of each transactions.

□ Soundness of a firm can be assessed from the records of assets and abilities on a
particular date.
□ Entries related to incomes and expenditures of a concern facilitate to know the profit
and loss for a given period.
IHM Notes Site | Hotel Accounts | 2nd Semester

□ It enables to prepare a list of customers and suppliers to ascertain the amount to be

received or paid.
□ It is a method gives opportunities to review the business policies in the light of the past
records.
□ Amendment of business laws, provision of licenses, assessment of taxes etc are based
on records.
Meaning of ACCOUNTING
The systematic recording, reporting, and analysis of financial transactions of a business.

The person in charge of accounting is known as an accountant, and this individual is typically
required to follow a set of rules and regulations, such as the Generally Accepted Accounting
Principles. Accounting allows a company to analyze the financial of the business, and look at
statistics such as net profit. Thus accounting is a wider term and
includes the recording, classifying and summarising of business transactions in term of
money, the preparation of financial reports, the analysis and interpretation of these reports
for the information and guidance of management.
The main purpose of accounting is to ascertain profit or loss during a specified period, to
show financial position of the business on a particular date and to have control over the
firm‘s property. Accounting is a discipline which records, classifies, summarises and
interprets financial information about the activities of a concern so that intelligent
decisions can be made about the concern.
The American Accounting Association defines accounting as: "the process of

identifying, measuring and communicating economic information to permit informed
judgments and decisions by users of the information!
The American Institute of Certified Public Accountants (AICPA) has defined the Financial
Accounting as “the art of recording, classifying and summarizing in a significant manner in
terms of money transactions and events which in part, at least of a financial character and
interpreting the results thereof.”
In the words of Smith and Ashburne, “accounting is a means of measuring and

reporting the results of economic activities.”
In the opinion of Bierman and Derbin, “Accounting may be defined as the identifying,
measuring, recording and communicating of financial information.”
From the above the following attributes of accounting emerge:
a) It is the art of recording business transactions.

b) It is the art of classifying business transactions.
c) The transactions or events of a business must be recorded in monetary terms.

d) It is the art of summarising financial transactions.
i. It is the art of analysis and interpretation of these transactions.
ii. The results of such analysis must be communicated to the persons who are to make
decisions or form judgements.
Objectives of ACCOUNTING
Accounting is an information system that measures business activities, processes

information into reports and communicates the reports to decision makers. A key product
of this information system is a set of financial statements—the documents that report
financial information about an entity to decision makers. The main objects of accounting
are:
1. To ascertain whether the business operations have been profitable or not - Accounting
helps is ascertaining the net profit earned or loss suffered on account of carrying the
business. This is done by keeping a proper record of revenues and expenses of a
particular period. The profit and loss account is prepared at the end of a period and if
the amount of revenue for the period is more than the expenditure incurred in earning
that revenue, there is said to be a profit. In case the expenditure exceeds the revenue,
there is said to be a loss.
2. To ascertain the financial position of the business - The profit and loss account
gives the amount of profit or loss made by the business during a particular period.
However, it is not enough. The businessman must know about his financial position
i.e., where he stands; what he owes and what he owns? This objective is served by
the balance sheet or position statement.
3. Top generate information - Accounting these days has taken upon itself the task of
collection, analysis and reporting of information at the required points of time to the
required levels of authority in order to facilitate rational decision making.
Functions of ACCOUNTING
The main functions of accounting are:
1. Systematic record of business transactions - The primary function of accounting is to

keep a systematic record of financial transaction - journalisation, posting and
preparation of final statements. The purpose of this function is to report regularly to
the interested parties by means of financial statements.
2. Protecting the property of the business - The second function of accounting is to

protect the property of business from unjustified and unwanted use. The accountant
thus has to design such a system of accounting which protect its assets from an

unjustified and unwanted use.
3. Communicating results to interested parties - Accounting is the language of business.

Various transactions are communicated through accounting. There are many parties -
owners, creditors, government, employees etc, who are interested in knowing the
results of the firm. The fourth function of accounting is to communicate the results to
interested parties. The accounting shows a real and true position of the firm of the
business.
4. Compliance with legal requirements - The another function of accounting is to devise

such a system as will meet the legal requirements. Under the provision of law, a
business man has to file various statements e.g., income tax returns, returns for sales
tax purpose etc. Accounting system aims at fulfilling the requirements of law.
Accounting is a base, with the help of which various returns, documents, statements
etc., are prepared.
Branches of ACCOUNTING
1. General Accounting or Financial Accounting - is concerned with the recording of

transactions for a business or other economic unit and the periodic preparation of statements
from these records.
2. Cost Accounting - emphasizes the determination and the control of costs particularly the
costs of manufacturing processes and of the manufactured products.
Management Accounting
3. Management Accounting - concerned with the application of appropriate techniques and
concepts in processing the historical and projected economic data of an entity, to assist
management in setting up reasonable economic objectives and in making rational decisions
towards the attainment of these objectives.
DISTINCTION BETWEEN BOOK-KEEPING AND ACCOUNTING
Book-keeping is recording of the financial transactions of a business in a methodical manner

so that information on any point in relation to them may be quickly obtained. A book-keeper
may be responsible for keeping all the financial records of a business or only a minor segment
such as maintenance of the customer‘s accounts in a departmental store.
On the other hand, Accounting is primarily concerned with the design of the system of
records, the preparation of reports based on the recorded data, the interpretation of the
reports and finally communicating the results of the interpretation to persons who are
interested in such results.
The main difference between Book-keeping and Accounting are as follows:

Bookkeeping Accounting
Accounting is abstract and theoretical. It is

Bookkeeping is routine work and is largely concerned
concerned with development and
maintenance of with the "why", in other words the reason or
accounting records. It is the "how" of
accounting. justification for any action that‘s implemented.
Bookkeeping is a part of accounting. It is Accounting is a four-stage process of

mainly a recording,
mechanical aspect of recording, classifying classifying, summarizing and the interpretation
and of the
summarising transactions. financial statements.
The process of bookkeeping does not require Accounting uses bookkeeping information to
any interpret
the data and then compiles it into reports to
analysis. present to
management.
It records incoming transactions (received They usually deliver the business results in the
payments form of
from customers, etc.) and outgoing reports. Management can see whether the
transactions company is
(paying for specific bills on the correct time, successful or not and with the help of the
etc). analysis they
can see where the problems come from in case
of
negative results.
There are two basic kinds of bookkeeping: The accounting department also does
single preparations of a
entry bookkeeping and double entry
bookkeeping. Company’s budgets and plans loan proposals.
Advantages of ACCOUNTING
The following are the main advantages of accounting:

□ Assistance to management: Accounting provides information to the management to
enable it to do its work properly. Such information helps in the Planning, Decision
making and controlling.

□ Comparative study: A systematic record enables a business to compare one year's

results with those of other years and locate significant factors leading to the change if
any.
□ Evidence in the court: Systematic record of transactions is often treated by the courts
as good evidence.
□ Replacement of memory: it provides records which will furnish information as
and when desired and thus it replaces human memory.
□ Settlement of taxation liability: if accounts are properly maintained it will be of
great assistance to the businessman in settling the income tax and sale tax liability.
□ Sale of business: accounts help in ascertaining the proper purchase price in case
the businessman is interested to sell his business.
Disadvantages of ACCOUNTING
□ Financial accounting is of historical nature: Net effect of transactions is recorded

in financial accounting which has happened in past. These accounts is just
postmortem of all events of business in past .These record does not help for future
planning and other managerial decisions.
□ Financial accounting deals with overall profitability: Accounts of business are made
by a way which shows only overall profitability .It does not shows net profit per product
, or per department or according to job.
□ Absence of full disclosure of facts: In financial accounting we record only those

activities and transactions which we can show or describe in money. There are many
other facts of business which are non financial and non monetary like efficient
management, demand of products of firm , good relations in industry , good working
environments which can not be known by financial accounting .
□ Financial reports are interim report of business: Financial statements made by

financial accounting is the interim report of firm‘s all business work but financial
position and profitability which are shown in it is not fully true . Due to adopting cost
concept, all transactions are recorded on it real cost but by changing in the time; it is
the need of time to adjust cost of assets and liabilities according to inflation of market.
□ Incomplete knowledge of costs: From cost point of view, financial accounting is

incomplete. In financial accounting, accountant does not calculate each and every
product‘s total cost. So, financial accounting does not help to determine the price
of product of business.
□ No provision of cost control: Financial accounting does not help business

organization for controlling the cost. Because, there is no provision of controlling cost
in it. In financial accounting, we write cost, if we paid any expenses. Thus there is no
provision of improvement in financial accounting. Except this, there is no any other

way to inspect all expenses.
□ Financial statements are affected from personal judgment: Many events of

financial statements are affected from personal judgment of accountant. Method of
calculating depreciation, rate of provision of doubtful debts and stock valuation
method are decided by accountant. Thus, financial statements do not show true and
fair view of business.
Basic Accounting Terms:
i. Business Transactions: It is an economic event that relates to a business entity. It can

be a purchase of goods, collection of money, payment to creditors for goods and
expenses. An event must be capable of being measured in monetary terms and related
to business enterprise in terms of economic consequence.
ii. Assets: These are economic resources of an enterprise that can be usefully expressed in
monetary terms. Assets are things of value used by the business in its operations. For
example, Departmental Store owns a fleet of trucks, which is used by it for delivering
food stuff; the trucks, thus, provides economic benefits to the enterprise.
iii. Capital: Investment by the owners for the use in the firm is known as capital. Owner‘s
equity is the
ownership claim on total assets. It is equal to total assets minus total

external liabilities: E=A-L this is also called residual interest. Owner's
equity is equal to capital.
iv. Sales: Sales are total revenues from goods sold and/or services sold or provided to
customers. Sales may be cash sales or credit sales.
v. Revenues: These are the amounts the business earns by selling it products or providing
services to customers. These are called 'sales revenues'. Other items and sources of
revenues common to many businesses are: sales, fees, commission, interest, dividends,
royalties, rent received, etc.
vi. Expenses: These are costs incurred by a business in the process of earning revenues.
Generally, expenses are measured by the cost of assets consumed or services used
during an accounting period. The usual items of expenses are: depreciation, rent, wages,
salary, interest, costs of heat, light and water, telephone, etc.
vii. Expenditure: Expenditure is the amount of resources consumed. Usually, it is of long

term in nature. Therefore, its benefit is to be derived in future. For example: capital
expenditure.

viii. Loss: Loss is the gross decreases in the assets or gross increases in the liabilities. It is
the excess of expenses over revenues. It represents reduction in owners' equity due to
inability of the firm to recover the assets used in the business. For example, a firm
spends Rs. 70,000 and generates revenue of Rs. 60,000 there is a loss of Rs. 10,000
which represents non-recovery of assets consumed in doing business.
ix. Income: Income is the increase in the net worth of the organization either from business
activity or other activities. Income is a comprehensive term, which includes profit also.
In accounting income is the positive change in the wealth of the firm over a period of
time.
x. Profit: Profit is the excess of revenues over expenses during an accounting year. It
increases the owner‘s equity.
xi. Gains: Gain is the change in the equity (net worth) arising from change in the form and
place of goods and holding of assets over a period of time whether realized or
unrealized. It may either be of capital nature or revenue nature or both.
xii. Drawings: It is the amount of cash or other assets withdrawn by the owner for his
personal use.
xiii. Purchases: Purchases are total amounts of goods procured by a business on credit and
for cash, for use or sale. In a trading concern, purchases are made of merchandise for
resale with or without processing. In a manufacturing concern, raw materials are
purchased, processed further into finished goods and then sold. Purchases may be cash
purchases or credit purchases.
xiv. Stock: Stock (inventory) is a measure of something on hand-goods, spares and other
items-in a business. It is called stock on hand. In a manufacturing company, closing
stock comprises raw materials, semi-finished goods and finished goods on hand on the
closing date. Similarly, opening stock (beginning inventory) is the amount of stock at
the beginning of the accounting year.
xv. Debtors/Accounts Receivable: Debtors (accounts receivable) are persons and/or other
entities who owe to an enterprise an amount for receiving goods and services on the
credit.
xvi. Creditors/Accounts Payable: Creditors (accounts payable) are persons and/or other
entities who have to be paid by an enterprise an amount for providing the enterprise
goods and/ or services on credit.
ACCOUNTING PRINCIPLES

There are general rules and concepts that govern the field of accounting. These general rules—
referred to as basic accounting principles and guidelines—form the groundwork on which more
detailed, complicated, and legalistic accounting rules are based. For example, the Financial
Accounting Standards Board (FASB) uses the basic accounting principles and guidelines as a
basis for their own detailed and comprehensive set of accounting rules and standards.
The phrase "generally accepted accounting principles" (or "GAAP") consists of three important
sets of rules: (1) the basic accounting principles and guidelines, (2) the detailed rules and
standards issued by FASB and its predecessor the Accounting Principles Board (APB), and (3)
the generally accepted industry practices.
GAAP is exceedingly useful because it attempts to standardize and regulate accounting

definitions, assumptions, and methods. Because of generally accepted accounting principles
we are able to assume that there is consistency from year to year in the methods used to prepare
a company's financial statements. And although variations may exist, we can make reasonably
confident conclusions when comparing one company to another, or comparing one company's
financial statistics to the statistics for its industry. Over the years the generally accepted
accounting principles have become more complex because financial transactions have become
more complex.
Accounting Principles can be classified into two categories:
I. Accou
nting
concepts,
II.
Accounting
conventions.
ACCOUNTING PRINCIPLES
ACCOUNTING CONCEPTS ACCOUNTING CONVENTIONS
i. Business entity i. Consistency

ii. Money measurement ii. Full Disclosure
iii. Going concern iii. Conservation
iv. Cost iv. Materiality
v. Dual aspect
vi. Accounting period

vii. Matching
viii. Realization
ix. Objective evidence
ACCOUNTING CONCEPTS
i. Business Entity Concept: The accountant keeps all of the business transactions of a
sole proprietorship separate from the business owner's personal transactions. For legal
purposes, a sole proprietorship and its owner are considered to be one entity, but for
accounting purposes they are considered to be two separate entities.
ii. Monetary measurement: Money is the only practical unit of measurement that cane
be employed to achieve homogeneity of financial data, so accounting records only those
transactions which can be expressed in terms of money.
iii. Going concern: This accounting principle assumes that a company will continue to exist
long enough to carry out its objectives and commitments and will not liquidate in the
foreseeable future. If the company's financial situation is such that the accountant believes
the company will not be able to continue on, the accountant is required to disclose this
assessment. The going concern principle allows the company to defer some of its prepaid
expenses until future accounting periods.
iv. Cost Concern: From an accountant's point of view, the term "cost" refers to the amount
spent when an item was originally obtained, whether that purchase happened last year or
thirty years ago. For this reason, the amounts shown on financial statements are referred to
as historical cost amounts. Because of this accounting principle asset amounts are not
adjusted upward for inflation. In fact, as a general rule, asset amounts are not adjusted to
reflect any type of increase in value. Hence, an asset amount does not reflect the amount
of money a company would receive if it were to sell the asset at today's market value.
v. Dual aspect: according to this concept, every financial transaction involves a two-fold
aspect, (a) yielding of a benefit and (b) the giving of that benefit. For example: if a
business has acquired some asset, it must have given up some other asset such as cash
or the obligation to pay for it in future.
vi. Accounting period concept: This accounting principle assumes that a company will
continue to exist long enough to carry out its objectives and commitments and will not
liquidate in the foreseeable future. If the company's financial situation is such that the
accountant believes the company will not be able to continue on, the accountant is required
to disclose this assessment. The going concern principle allows the company to defer some
of its prepaid expenses until future accounting periods.

vii. Matching concept: This accounting principle requires companies to use the accrual basis
of accounting. The matching principle requires that expenses be matched with revenues.
For example, sales commissions‘ expense should be reported in the period when the sales
were made (and not reported in the period when the commissions were paid). Wages to
employees are reported as an expense in the week when the employees worked and not in
the week when the employees are paid.
viii. Realization concept: Under the accrual basis of accounting, revenues are
recognized as soon as a product has been sold or a service has been performed, regardless
of when the money is actually received. Under this basic accounting principle, a company
could earn and report $20,000 of revenue in its first month of operation but receive $0 in
actual cash in that month. For example, if ABC Consulting completes its service at an
agreed price of $1,000, ABC should recognize $1,000 of revenue as soon as its work is
done—it does not matter whether the client pays the $1,000 immediately or in 30 days.
ix. Objective evidence concept: Objectivity cannotes reliability, trustworthiness and

verifiability, which means that there is some evidence in ascertaining the correctness of
the information reported. Evidence should be such which will minimize the possibility of
error and intentional bias or fraud.
ACCOUNTING CONVENTIONS
I. Convention of Consistency: Accountants are expected to be consistent when applying

accounting principles, procedures, and practices. Same accounting principles, rules and
conventions should be used i.e. these should not change from one year to another. The
results of different years will be comparable only when accounting rules are
continuously adhered to from year to year.
II. Convention of full Disclosure: according to this convention, all accounting

statements should be honestly prepared and to that end full disclosure of all
significant information should be made. All information which is of material interest
to proprietors, creditors and investors should be disclosed in accounting statements.
III. Convention of Conservatism: it is a policy of caution or playing safe and had its origin
as a safeguard
against possible losses in the world of uncertainty. It compels the businessman to

wear a ―risk-proof‖ jacket, for the working rule is: “anticipate no profits, but
provide for all possible losses.”
IV. Convention of Materiality: Whether something should be disclosed or not in the

financial statements will depend on whether it is material or not. Materiality depends
on the amount involved in the transaction.

ACCOUNTING EQUATION
The whole of the financial accounting is based on the accounting equation. This can be stated
to be that for a firm to operate resources are required and that these resources are to be supplied
to the firm by someone. The equation that is the foundation of double entry accounting. The
accounting equation displays that all assets are either financed by borrowing money or paying
with the money of the company‘s shareholders.
Thus, the accounting equation is: Assets = Liabilities + Shareholder Equity (capital).
The balance sheet is a complex display of this equation, showing that the total assets of a
company are equal to the total of liabilities and shareholder equity. Any purchase or sale by an
accounting equity has an equal effect on both sides of the equation, or offsetting effects on the
same side of the equation. The accounting equation is also written as:
Liabilities = Assets –
Shareholder Equity and
Shareholder Equity =
Assets – Liabilities.
Rules of Accounting Equation
1. Regarding Assets
Increases in assets are debits and decreases in assets are credits.
2. Regarding Liabilities
Increases in liabilities are credits and decreases in liabilitites are debits.
3. Regarding Capital
Increases in capital are credits and decreases in capital are debits.
4. Regarding Expenses
Increases in expenses are debits and decreases in expenses are credits.
5. Regarding Incomes or Profits

Increases in Income or Profits are credits and decreases in Incomes or Profits are debits.

DOUBLE ENTRY SYSTEM
The double entry system is based on “ Dual concept ” which states “for ebery debit ,there is a
credit”. Every transaction has two sided effects to the same extent and both the effects are
recorded under double entry system.
Double Entry system seeks to record every transaction in money or money’s worth in its double
aspect – the receipt of a benefit by one account and the surrender of alike benefit by another
account, the former entry being to the debit of the account receiving the later to the credit of
the account surrendering.
The most scientific and reliable method of accounting is the Double Entry System. One must
have a clear conception of the nature of the transaction to understand the double-entry system.
Every transaction involves two parties or accounts – one account gives the benefit and the other
receives it.
It is called a dual entity of transaction.
In every transaction, the account receiving a benefit is debited and the account giving benefit
is credited.
The process of keeping account accepting this dual entity i.e. debiting one account for a definite
amount of money and crediting the other account for the same amount is called a double-entry
system.
Every transaction affects the accounting equation of a business. Dual change may take place
between two assets.
For example, machinery purchase in cash.
Here machinery account receives the benefit and the cash account gives the benefit or the
amount of decrease in cash will give an increase of machinery for the same amount.
Again this change may take place between two liabilities.
For example; to meet up the claim of a creditor taking a long-term loan.
Here long-term liability is credited abolishing the short term liability of creditor. Besides, this
change may take place between assets and liabilities.
For example; furniture purchased on credit.
Here asset is debited for a particular amount and at the same time, an equal amount of liability
is also credited.
Since every transaction brings changes in assets for an equal sum of money or asset and liability
or liabilities, the transactions are to be recorded according to a double-entry system to know
the accurate, position of assets and liabilities of a business concern.
If accounts are maintained under a double-entry system two accounts are affected.
One is debited and another is credited. This is the main principle of the double-entry system.
Mr. Angel invested cash Rs20,000 in his business as capital. This transaction involves two
accounts – Cash Account and Capital Account – Angel. For this transaction asset-cash
increases for rs.20,000 on one side and on the other side liability increases for Rs.20,000 as
capital which is the claim of the owner.
This transaction is to be recorded debiting cash and crediting capital accounts. If the
transactions are not recorded in two accounts proper results are not reflected.
Furniture purchased for Rs. 2,000. This transaction involves two accounts – a furniture account

and a cash account.

For this transaction cash decreases for Rs. 2,000 and furniture increases by $2,000. Here, the
furniture account is debited and the cash account is credited for Rs2,000 cash.
In another way, the transaction changes only. An element of accounting equation i.e., A = L +
P.
It is clear from the above discussion that every transaction is to be recorded in two accounts –
one is debited and the other is credited.
The main principle of double-entry system is that for every debit there is a corresponding credit
for an equal amount of money and for every credit there is a corresponding debit for an equal
amount of money; i.e. for every transaction one account is debited for the amount of transaction
and the other account is credited for the equal amount of money.
Therefore, it can be said that the system under which every transaction is accounted in two
accounts for the equal amount of money debiting one and crediting the other ignoring no
account is called a double-entry system.
Every debit must have a corresponding credit and Vice – Versa. Double-entry Book-Keeping
is a system by which every debit entry is balanced by an equal credit entry.
A double-entry bookkeeping system is a set of rules for recording financial information in a

financial accounting system in which every transaction or event changes at least two different
nominal ledger accounts. It was first codified in the 15th century by Luca Pacioli. In deciding
which account has to be debited and which account has to be credited, the golden rules of
accounting are used.
This is also accomplished using the accounting equation: Equity= Assets − Liabilities.
The accounting equation serves as an error detection tool. If at any point the sum of debits for
all accounts does not equal the corresponding sum of credits for all accounts, an error has
occurred. It follows that the sum of debits and the sum of the credits must be equal in value.
Characteristics of double-entry system are stated below;
Two parties: Every transaction involves two parties – debit and credit. According to the main
principles of this system, every debit of some amount creates corresponding credit or every
credit creates the corresponding debit for the same amount.
Giver and receiver: Every transaction must have one giver and one receiver.
Exchange of equal amount: The amount of money of a transaction the party gives is equal to
the amount the party receives.
Separate entity: Under this system business is treated as a separate entity from the owner.
Here the business is considered as a separate entity.
Dual aspects: Every transaction is divided into two aspects. The left side of the transaction
debit and the right side is credit.
Results: Under double entry system totality of debit is equal to the totality of credit. In it
ascertainment of the result is easy.
Complete accounting system: Double entry system is a scientific and complete accounting

system.
Through this system, the account is kept completely and no party is ignored. In fine it can be
said that every transaction must possess these characteristics.
If there is an exception to this complete information will not be available in the books of
accounting. As a result, the main objective of accounting will be frustrated.
Types of Accounts
Every business transaction has two aspects i.e., when we receive something and when we give
something else in return. For e.g. when we purchase goods for cash, we receive goods and give
cash in return. This method of writing every transaction in two accounts is known as Double
entry system of accounting. Of the two accounts one account is given debit while the other
account if given credit with an equal amount.
ACCOUNTS
Personal Accounts Impersonal

Accounts
Personal Artificial Representative Real Nominal
Accounts person‘s person‘s

Accounts Accounts
Tangible real Intangible real
Accounts Accounts
□ Personal Account: - When a transaction is involved with a person or firm it is known

as Personal account such as Mr. Roy, Bose & sons, ABC Ltd.co. etc.
Natural Person’s account: Human Beings/Name of the persons are natural
persons like Ram, Shyam, Hira lal etc.
Legal or artificial person : A person created by law is called legal person or
artificial person. The name of companies like Reliance Industries Ltd, Ram Lal and
sons, Hira lal and brothers are examples of Legal Persons.
Representative personal account : Outstanding payment to persons are termed
as representative personal e.g. outstanding salary to Ram ,Outstanding rent to landlord.

□ Nominal Account: - All recurring expenses/incomes are known as Nominal Account,

such as salary, Rent, Interest etc.
□ Real Account: - Such type of accounts relate to assets i.e. both tangible and intangible
assets, such as Machinery, Furniture, building, goodwill, etc.
Tangible Assets : the assets that can be touched and felt physically.few
examples of Tangible Real accounts are ; Machinery, Furniture, Land and
Building.
Intangible Assets : The assets that cannot be touched or felf physically.Few
examples of real accounts are goodwill, patent and trademark etc.
Rules of the Double Entry System

There are separate rules of the double entry system in respect of personal, real and nominal
accounts which are discussed below:
□ In case of Personal Account - Debit the receiver and Credit the giver.
□ In case of Nominal Account- Debit all expenses and losses and Credit all income
and liabilities.
□ In case of Real Accounts - Debit what comes in and credit what goes out.
Advantages of Double entry system
The following are the main advantages of Double entry system.

□ A complete record of the financial transactions is maintained.
□ Gives accurate information
□ Arithmetical accuracy of the account books can be tested
□ Helpful in preventing frauds and errors
□ Helpful in ascertaining profit or loss of a particular period
□ Financial position can be ascertained
□ Makes Helpful in filing accurate claim for loss of stock
Disadvantages of Double entry system
The following are the main disadvantages of this system:

□ Number of books have to be maintained which is not suitable for small concerns
□ System is very costly
□ No guarantee of absolute accuracy of books
□ Only qualified person can record the transaction.
Example 1.
1. Opened a bank account in State Bank of India with an amount of Rs. 4, 80,000.
Analysis of transaction: This transaction increases the cash at bank (assets) and decreases cash
(asset) by Rs. 4, 80,000.

2. Bought furniture for Rs. 60,000 and cheque was issued on the same day.
Analysis of transaction: This transaction increases furniture e (assets) and decreases bank
(assets) by Rs. 60,000.
3. Bought plant and machinery for the business for Rs. 1, 25,000 and an advance of Rs.
10,000 in cash is paid to M/s Ramjee Lal.
Analysis of transaction: This transaction incr eases plant and machinery (assets) by Rs. 1,
25,000, decreases cash by Rs. 10,000 and increases liabilities (M/s Ramjee lal as creditor)
by Rs. 1, 15,000.
4. Goods purchased from M/s Sumit Traders for Rs. 55,000. Analysis of transaction: This
transaction increases goods (assets) and increases liabilities (M/s Sumit Traders as
creditors) by Rs. 55,000.
5. Goods costing Rs. 25,000 sold to Rajani Enterprises for Rs. 35,000. Analysis of transaction:
This transaction decreases stock of goods (assets) by Rs. 25,000 and increases assets (Rajani
Enterprises as debtors Rs. 35,000) and capital (with the profit of Rs. 10,000)
The final equation as per the above analysis table can be summarised in the form of a balance
sheet as under:

In terms of accounting equation A = L + C

Rs. 6,80,000 = Rs. 1,70,000 + Rs. 5,10,00
Account Title
(Left Side) (Right Side)
Rules of Debit and Credit

All accounts are divided into five categories for the purposes of recording the transactions: (a)
Asset (b) Liability (c) Capital (d) Expenses/Losses, and (e) Revenues/Gains.
Two fundamental rules are followed to record the changes in these accounts:
(1) For recording changes in Assets/Expenses (Losses):
I. “Increase in asset is debited, and decrease in asset is credited.”
II. “Increase in expenses/losses is debited, and decrease in expenses/ losses is credited.”
(2) For recording changes in Liabilities and Capital/Revenues (Gains):
I. “Increase in liabilities is credited and decrease in liabilities is debited.”
II. “Increase in capital is credited and decrease in capital is debited.”
III. “Increase in revenue/gain is credited and decrease in revenue/gain is debited.”
The rules applicable to the different kinds of accounts have been summarized in the following
chart

JOURNAL
Journal is a daily record of business transactions. It is also called a 'Day Book' and is used for
recording all day today transactions in the order in which they occur. It is a book of prime entry
(also called book of original entry) because all transactions are recorded first in this book. The
process of recording a transaction in the journal is called 'Journalising' and the entries made in
this book are called journal entries.
PERFORMA OF JOURNAL:
Date Particulars L.F. Dr. Cr.

Amount(Rs.) Amount(Rs.)
The Journal is divided into five columns. The first column is used for writing the date of the
transaction. It is customary to write the year at the top of the column only once and then in the
next line the month and date are written.
The second column called 'Particulars' column. The names of the two accounts affected by the
transaction are to be recorded in this column. The name of the account to be debited is written
first. The abbreviation 'Dr,' for debit is also written against the name of the account to be
debited. It is written on the same line very close to the L. F. column. In the next line, the name
of the account to be credited is written. It is always preceded by the word 'To'. It is not necessary
to write 'Cr.' against the name of the account to be credited. In the next line, a brief description
of the transaction is also given within brackets. It is called 'Narration'. After writing the
narration a line is drawn in the particulars column to separate one entry from the other.
The third column L. F. (Ledger Folio) is meant for writing the page number of the ledger where
the concerned account appears. This column is filled at the time of posting into the ledger. The
fourth and the fifth columns are meant for recording the amounts with which the two accounts
have been affected, the amount to be debited is entered in the debit amount column against the
name of the account debited, and the amount to be credited is entered in the credit amount

column against the name of the account credited. Both the amounts will always be equal.
Transactions relating to goods:
The term goods refer to articles which are traded by the firm i.e., articles bought for resale. For
example, for a book-seller books are goods, for an electrical store fans and other electrical
items are goods, for a furniture dealer table and chairs are goods. Articles bought, for using
them in business are not to be treated as goods. They may be fixed assets or consumables and
are to be treated as such in books of account.
The transactions relating to goods include purchases, sales, purchases returns and sales returns.
Normally, as per rules, when goods are bought you will debit the Goods Account and when
they are sold you will credit the Goods Account. Similarly, when goods are returned by your
customer you will debit the Goods Account and when you return goods to the suppliers, you
will credit the Goods Account. In other words, for all transaction relating to goods you will
maintain only one account viz., Goods Account.
i) Purchases Account - for recording all purchases of goods
ii) Sales Account - for recording all sales of goods
iii) Returns Onwards Account or Purchases Returns Account - for recording

goods returned to suppliers
iv) Returns Inwards Account or Sales Returns Account - For recording goods returned by
customers
v) Stock Account -for goods in stock (unsold goods) as at the end of the year
Thus, when goods are purchased you will debit the Purchases Account and when they are sold
you will the credit the Sales Account. Similarly, when goods are returned by your customers
you will debit the Returns Inwards Account (or Sales Returns Account) and when you return
goods to the suppliers you will credit Returns Outwards Account (or Purchases Returns
Account). There will be no Goods Account at all. This helps in ascertaining the amount of
purchases and sales more quickly and correctly.


Example :






LEDGER
The Journal is just a chronological record of all business transactions. It does not provide all
information regarding a particular item at one place. This makes it difficult to know the net
effect of various transactions affecting a particular item. For example, if you want to know the
amount due to a particular supplier or the amount due from a particular customer, you will have
to go through the whole journal. To overcome this difficulty, we maintain another book called
'Ledger'. In this book we open separate accounts for each item and all transactions related to a
particular item as recorded in journal are posted in the concerned account. For example, all
transactions related to a particular supplier, say Mohan, are posted to Mohan's Account.
Similarly, all cash payments and cash receipts can be posted to Cash Account. Thus, you will
have no problem in knowing the amount due to Mohan or the balance in Cash Account, and so
on. ,
Thus, ledger is a book where all accounts relating to different items are maintained and into
which all journal entries must be posted. In fact, ledger is the principal book of entry which
provides complete information about various transactions relating to all parties and all items of
asset, incomes and expenses. Some persons have even suggested that we should record all
transactions directly into ledger and do away with Journal. But, it is not advisable because in
that case we will not have any date-wise record of the transactions and the details thereof. Such
record is considered necessary for future reference.
Posting into Ledger
The journal entries form the basis for recording in the ledger accounts, and the process of
entering transaction in the ledger is called 'Posting'. When a journal entry has to be posted in
the concerned ledger accounts, the following procedure is adopted.

1. Every Journal entry will have to be posted into all those accounts which have been
debited and credited in the journal entry. For example, for cash sales, Cash Account is
debited and Sales Account is credited in the journal. When this entry is posted in the
ledger, it must be posted in Cash Account as well as in Sales Account.
2. Posting will be made on the debit side of the account which has been debited in the
journal, and the credit side of the account which has been crediting the journal. In case
of the above example of cash sales, posting will be made on the debit side of Cash
Account, as it has been debited in journal and the credit side of Sales Account, as it had
been credited in the journal.
3. Whether the posting is made on the debit side or the credit side, first of all the date of
the transaction (as given in the journal) will be entered in the date column. The method
of recording the date in the ledger account is the same as in the journal.
4. While posting on the debit side of an account in the particulars column, we shall write
the name of the account which had been credited in the journal and add the word 'To'
before the name. Similarly, while posting on the credit side of an account, we shall
write the name of the account which has been debited in the journal and add the word
'By' before the name. In case of the above example, we shall write 'To Sales A/c' in the
particulars column on the debit side of Cash Account, and 'By Cash A/c' in the
Particulars Column on the credit side of the Sales Account.
5. The journal entries contain 'narration'. But it is not required in the ledger accounts.
Similarly, there is no need to draw a line between the two entries in an account as is
done in the journal. Note that posting in the ledger account is considered complete only
when both the debit and the credit aspects of all journal entries have been posted.
6. In the folio column, we shall mention the page number of the journal where concerned
journal entry appears. At the same time, the page number of the ledger accounts will be
entered in the 'L, F.' column in the journal so as to complete the cross reference.
7. The amount involved in the journal entry shall be entered in amount columns of both
the accounts.
Balancing Ledger Accounts
Whenever one wants to know the net effect of various transactions in a particular account, we
have to work out its balance, Balance is the difference between the totals of the debit and the
credit side of an account. The process of finding out the balance is known as balancing. The
procedure for balancing is as follows:

i) Total the two sides of an account.
ii) Find out the difference between the totals of the,two sides.
iii) Put the difference in the amount column of the side showing less total.
iv) If the difference is entered on the debit side, write against it in the particulars column 'To
Balance c/d' (c/d stands for carried down). In case the difference is entered on the credit side,
write against it in the particulars column 'By Balance c/d'.
v) Now, total both the sides and you will find that both the totals are equal,
vi) The closing balance (balance c/d) is going to be the opening balance for the subsequent
period, The opening balance is shown on the next date in the account by writing 'To Balance
b/d' (b/d stands for brought down) or 'By Balance b/d' as the case may be.
Note that if the closing balance was on the debit sides, the opening balance would be shown
on the credit side and if the closing balance was shown on the credit side, the opening balance
would be shown on the debit side. In fact, an account is said to have a debit balance if its debit
side total is bigger and a credit balance if its credit side total is bigger. Thus, the opening
balance is shown according to the nature of the balance i.e.,
the debit balance on the debit side and the credit balance on the credit side.
vii) Sometimes the totals of the debit side and the credit side of an account are equal. It implies
that the account has nil balance. In such a situation the account is said to have closed having
no closing and opening balances.
Advantages/ Uses of Ledger

Or
Why Ledger is Prepared
The ledgers are prepared to know the following :

1. Preparation of Trial Balance:
It is not possible to prepare a Trial Balance without ledgers. Because, a Trial Balance is
prepared by taking up the ledger accounts balance. Moreover, arithmetical accuracy is not
possible.

2. Presenting Final Position:
We know that final account can only be prepared from a Trial Balance (i.e., Trading Account,
Profit and Loss Account and Balance Sheet). Thus, if we do not get the ledger accounts
balance from a Trial Balance, it is impossible for us to prepare final accounts.
3.Application of Double Entry System:
Double Entry System is completed only when we post the journals to different ledger
accounts.
2. . Determining Results of Each Account:
The results of each account can be obtained from the ledger on the basis of Double Entry
principles.
3. Maintaining Classified Accounts Indirect Advantages:
The particulars of classified accounts may be revealed after recording in ledger account
properly.
4. . Presenting Statistical Information:

The ledger accounts with their respective balances are the sources of statistical
information which are used by the management while decision-making.
5. Collecting Information:
The ledger may be called the collection or storeroom of various transactions.
6. Present Financial Position:
The financial position of an enterprise (i.e., after preparing final account) can only be
known if we maintain ledger account properly.

Example :



SUBSIDIARY BOOKS
Journal is a book of prime entry in which all transactions are to be recorded first. But, in
practice, the number of transactions happens to be so large that it becomes difficult to record
them in one book. Hence, the journal is sub-divided into a number of special journals, called
subsidiary books.
Subsidiary Books are those books of original entry in which transactions of similar nature are
recorded at one place and in chronological order. In a big concern, recording of all transactions
in one Journal and posting them into various ledger accounts will be very difficult and involve
a lot of clerical work.
This is avoided by sub-dividing the journal into various subsidiary journals or books. The
subdivisions of journal into various subsidiary journals for recording transactions of similar
nature are called as ‘Subsidiary Books.’
In practice, the journal is sub-divided in such a way that a separate book is used for each
category of transactions which are repetitive in nature and are sufficiently large in number. In
any large business the following subsidiary books are generally used:
Purchases (Journal) Book

All credit purchases of goods are recorded in the purchases journal whereas cash purchases are
recorded in the cash book. Other purchases such as purchases of office equipment, furniture,
building, are recoded in the journal proper if purchased on credit or in the cash book if
purchased for cash. The source documents for recording entries in the book are invoices or bills
received by the firm from the supplies of the goods. Entries are made with the net amount of
the invoice. Trade discount and other details of the invoice need not be recorded in this book.
The monthly total of the purchases book is posted to the debit of purchases account in the
ledger. Individual suppliers accounts may be posted daily.
Purchases Return (Journal) Book
In this book, purchases return of goods are recorded. Sometimes goods purchased are returned
to the supplier for various reasons such as the goods are not of the required quality, or are
defective, etc. For every return, a debit note (in duplicate) is prepared and the original one is
sent to the supplier for making necessary entries in his book. The supplier may also prepare a
note, which is called the credit note. The source document for recording entries in the purchases
return journal is generally a debit note. A debit note will contain the name of the party (to
whom the goods have been returned) details of the goods returned and the reason for returning
the goods. Each debit note is serially numbered and dated.

Sales (Journal) Book
All credit sales of merchandise are recorded in the sales journal. Cash sales are recorded in the
cash book. The format of the sales journal is similar to that of the purchases journal explained
earlier. The source document for recording entries in the sales journal are sales invoice or bill
issued by the firm to the customers. The date of sale, invoice number, name of the customer
and amount of the invoice are recorded in the sales journal. Other details about the sales
transaction including terms of payment are available in the invoice. In fact, two or more than
two copies of a sales invoice are prepared for each sale.
The book keeper makes entries in the sales journal from one copy of the sales invoice. The
format of the sales joournal is shown in figure 4.8. In the sales journal, one additional column
may be added to record sales tax recovered from the customer and to be paid to the government
within the stipulated time. Periodically, at the end of each month the amount column is total
led and posted to the credit of sales account in the ledger.
Sales Return (Journal) Book

This journal is used to record return of goods by customers to them on credit. On receipt of
goods from the customer, a credit note is prepared, like the debit note referred to earlier. The
difference between the credit not and the debit note is that the former is prepared by the seller

and the latter is prepared by the buyer. Like the debit note, the credit note is also prepared in
duplicate and contains detail relating to the name of the customer, details of the merchandise
received back and the amount. Each credit note is serially numbered and dated. The source
document for recording entries in the sales return book is generally the credit note.
Cash Book
Cash book is a book in which all transactions relating to cash receipts and cash payments are
recorded. It starts with the cash or bank balances at the beginning of the period. Generally, it
is made on monthly basis. This is a very popular book and is maintained by all organisations,
big or small, profit or not-forprofit. It serves the purpose of both journal as well as the ledger
(cash) account. It is also called the book of original entry. When a cashbook is maintained,
transactions of cash are not recorded in the journal, and no separate account for cash or bank
is required in the ledger.
Journal Proper
A book maintained to record transactions, which do not find place in special journals, is known
as Journal Proper or Journal Residual. Following transactions are recorded in this journal:
1. Opening Entry: In order to open new set of books in the beginning of new accounting year
and record therein opening balances of assets, liabilities and capital, the opening entry is made
in the journal.
2. Adjustment Entries: In order to update ledger account on accrual basis, such entries are made
at the end of the accounting period. Such as Rent outstanding, Prepaid insurance, Depreciation
and Commission received in advance.
3. Rectification entries: To rectify errors in recording transactions in the books of original
entry and their posting to ledger accounts this journal is used.
4. Transfer entries: Drawing account is transferred to capital account at the end of the
accounting year. Expenses accounts and revenue accounts which are not balanced at the time
of balancing are opened to record specific transactions. Accounts relating to operation of
business such as Sales, Purchases, Opening Stock, Income, Gains and Expenses, etc. and
drawing are closed at the end of the year and their Total/balances are transferred to Trading
and Profit and Loss account by recording the journal entries. These are also called closing
entries.
5. Other entries: In addition to the above mentioned entries in the point’s number 1 to 4,
recording of the following transaction is done in the journal proper:
(i) At the time of a dishonor of a cheque the entry for cancellation for discount received or
discount allowed earlier
(i) Purchase/sale of items on credit other than goods.

(ii) Goods withdrawn by the owner for personal use.

(iii)Goods distributed as samples for sales promotion.
(iv)Endorsement and dishonor of bills of exchange.
(v) Transaction in respect of consignment and joint venture, etc.
(vi)Loss of goods by fire/theft/spoilage.
Bills Receivable Journal: It is used for recording bills of exchange and promissory notes
received from the debtors.
Bills Payable Journal: It is used for recording bills of exchange and promissory notes accepted
by the business in favour of creditors.

Advantages of Subsidiary Books

The following are the advantages of having a number of subsidiary books:
i) Classification of transactions becomes automatic: As there is a separate book for

each type of transactions, the trapactions of same nature are automatically brought
at one place. For example, all credit purchases of goods are recorded Subsidiary
Books: Cash Book in the Purchases Book.
ii) Reference becomes easy: If any reference is required, it can be traced easily by
referring to the appropriate subsidiary book. You do not have to go through all the
transactions recorded in the journal.
iii) Facilitates division of work: The division of journal into various subsidiary books
facilitates division of work among many persons. This, in turn, facilitates prompt
recording of transactions and saves a lot of time.
iv) More particulars: More details about the transactions can be given-in subsidiary
books than would be possible in one book.
. v) Responsibility can be fixed: The work of maintaining a particular book can be entrusted
to a particular person. He will be responsible for keeping it up-to-date and in order.
vi)Facilitates checking: When the Trial Balance does not agree, the location of errors will be
relatively easy.






Cash Book
Cash Book
Cash book is a book in which all transactions relating to cash receipts and cash payments are
recorded. It starts with the cash or bank balances at the beginning of the period. Generally, it
is made on monthly basis. This is a very popular book and is maintained by all organisations,
big or small, profit or not-for-profit. It serves the purpose of both journal as well as the ledger
(cash) account. It is also called the book of original entry. When a cashbook is maintained,
transactions of cash are not recorded in the journal, and no separate account for cash or bank
Advantages of Cash Book
A cash book has simplified the entry cash transactions for accounting purpose to a great extent.
Following are the various other benefits of maintaining a cash book:
Traces Mistakes: The balance of the cash book can be verified by matching it with the actual
cash in hand; thus, mistakes and errors can be easily detected.
Daily Record: The cash transactions are recorded promptly in a cash book daily, which helps
in maintaining a regular record of the cash receipts and payments.
Ascertain Receipts and Payments: The cash receipts and the payments made in cash on a
specific date can be easily determined with the help of a cash book.

Identifies Default: Any default, theft, failure in payment or cash evasion can be easily
identified while verifying the cash book balance with the actual cash balance.
Determines Cash in Hand: It provides a clear picture of the remaining balance or cash in hand
left with the organization.
Saves Time, Cost and Labour: Recording the cash transactions first in a journal and then
posting it in the cash account of the ledger is a hefty task.
A cash book initiates creating of a single book of accounts and thus saves a lot of time, efforts
and expense incurred while preparing these two separate books.
Types of Cash Book
A cash book varies based on its complexity and the needs and requirements of the business.
Following are the two major categories into which a cash book can be bifurcated:
General Cash Book
The cash book, which serves as a journal for the first recording of the cash transactions and
also replaces the cash account in a ledger, is called a general cash book.
It is further subdivided into three different categories:

Single column Cash Book
The single column cash book records all cash transactions of the business in a chronological
order, i.e., it is a complete record of cash receipts and cash payments. When all receipts and
payments are made in cash by a business organisation only, the cash book contains only one
amount column on each (debit and credit) side.
Double Column Cash Book
This type of cashbook has two columns, viz., cash column and discount column.
Usually cash discount is allowed or received when payment is made. So, it is necessary
to record this fact at the same place where the cash transaction is recorded.
This type is similar to Simple Cash Book, except that one additional column on each
side is provided for recording cash discount. As discount is a nominal account, discount

allowed being a loss is shown on the debit side and discount received being a gain is
shown on the credit side.\
Three Column Cash Book.
In modern times, banking habit has become so widespread and is so convenient and safe that a
large number of payments of big concerns are made and received through cheques. In such
cases, the Cash Book with bank column in addition to the cash and discount columns is found
convenient. Such type of cashbook is known as three-column cashbook. In such a Cash Book,
cash columns and bank columns represent cash a/c and bank a/c respectively.

Contra Entries:
When a transaction affects both the sides of the Cash Book, such a transaction is entered on
both the sides and is called as contra entry. For example, when cash is deposited into bank, it
is entered in the debit side of the Cash Book by writing “To Cash” and entering the amount in
the bank column.
The other entry is on the credit side by writing “By Bank” and entering the amount in the Cash
column.
When the cash is withdrawn from the bank, the reverse entry is made, i.e., by writing “To
Bank” in the debit side and entering the amount withdrawn in the cash column and the other
entry is on the credit side by writing “By Cash” and entering the amount in the bank column
of the Cash Book. Entering the letter “C” in the L.F. column indicates such entries.
As the double entry is complete for such transactions in the Cash Book itself, no further posting
Rules for recording transactions in the Cash Book:
1. All items of cash receipts are entered in the cash column of the receipt side; cash payments
in the payment side. Discount allowed on the debit side and discount received on the credit side
of the Cash Book [in the discount columns].
2. When cheques are received from customers and deposited immediately they are entered in
the bank column of the Cash Book [debit side]. If they are sent to the bank at a later date, it
becomes deposit of money into bank and, therefore, a ‘contra’ entry.
It is shown on the bank column on the debit side and cash column on the credit side.
2. If cheques are received by the business and endorsed to creditors, they are taken into
cash columns as cash receipt and cash payment.
Illustration 3:
Enter the following transactions in a three-column Cash Book and find out the balances
as on 16th January, 2002:

Illustration 4:
Make out a Cash Book with discount, cash and bank columns.


Solution:
Problem 1:
On April 1, 2017, Hassan Sajjad Store Cash Book showed debit balances of Cash Rs. 1,550
and Bank Rs. 13,575. During the month of April following business was transacted. You are
required to prepare Cash Book?
April 2017
02 Purchased Office Type-Writer for Cash Rs. 750; Cash Sales Rs. 1,315.
07 Deposited Cash Rs. 500 to bank.
10 Received from A. Hussain a check for Rs. 2,550 in part payment of his account (not
deposited).

16 Paid by check for merchandise purchased worth Rs. 1,005.

20 Deposited into Bank the check received from A. Hussain.
22 Received from customer a check for Rs. 775 in full settlement of his accounts (not
deposited).
24 Sold merchandise to sweet Bros. for Rs 1,500 who paid by check which was deposited
into bank.
26 Paid creditor a Salman Rs. 915 by check.
28 Deposited into Bank the check of customer of worth Rs. 775 was dated 22nd April.
29 Paid wages by cash Rs. 500 and salary Rs. 1,000 by bank.
30 Drew from Bank for Office use Rs. 250 and Personal use Rs. 150.
Solution:
Problem 2:

From the following particulars make cash book of Ghulam Fatima Trading Co. for the month
of November, 2016:
1. Cash balance (Cr) Rs. 2,000; Bank balance Rs. 40,000.

4 Cash sales Rs. 3,700; Credit sales Rs. 1,800 would be received at near future.
6 Paid Ahmed & Bros. by cash Rs. 500; Received cash by debtors Rs. 1,800.
12 Paid to vendor by means of check worth Rs. 2,700.
13 Paid Utility bills in cash Rs. 250; Bought goods by check Rs. 750.
19 Drew from Bank for office use Rs. 160; Personal withdrawal of cash Rs. 1,000.
20 Received a check from Hamid Rs. 2,700 and deposited into the bank.
21 Received by check from Munir Rs. 1,360; Discount Rs. 140 (not deposited).
25 Cash sales Rs. 2,100; Paid wages by bank Rs. 1,500.
28 Deposited Munir’s check into bank.
29 Payment by check to Anees for Rs. 17
30 Munir’s check has been dishonored and return by bank.
Solution

Problem 3:
Enter the following transactions in the Cash Book with Cash, Bank and Discount column for
A R Khan and Co. for December, 2016 (all figures in Rupees):

Petty Cash Book
In every organisation, a large number of small payments such as conveyance, cartage, postage,
telegrams and other expenses (collectively recorded under miscellaneous expenses) are made.
These are generally repetitive in nature. If all these payments are handled by the cashier and
are recorded in the main cash book, the procedure is found to be very cumbersome. The cashier
may be overburdened and the cash book may become very bulky. To avoid this, large
organisations normally appoint one more cashier (petty cashier) and maintain a separate cash
book to record these transactions. Such a cash book maintained by petty cashier is called petty
cash book. The petty cashier works on the Imprest system. Under this system, a definite sum,
say Rs. 2,000 is given to the petty cashier at the beginning of a certain period. This amount is
called imprest amount. The petty cashier goes on making all small payments out of this imprest
amount and when he has spent the substantial portion of the imprest amount say Rs.1,780, he

gets reimbursement of the amount spent from the head cashier. Thus, he again has the full
imprest amount in the beginning of the next period. The reimbursement may be made on a
weekly, fortnightly or monthly basis, depending on the frequency of small payments. (In
certain cases, the petty cash system is operated through the main cash book itself. In such
instances, the petty cash book is not maintained independently.) The petty cash book generally
has a number of columns for the amount on the payment side (credit) besides the first other
amount column. Each of the amount columns is allotted for items of specific payments, which
are most common. The last amount column is designated as ‘Miscellaneous’ followed by a
‘Remarks’ column. In the miscellaneous column those payments are recorded for which a
separate column does not exist. In the ‘Remarks’ the nature of payment is recorded. At the end
of the period, all amount columns are totaled. The total amount column l shows the total amount
spent and to be reimbursed. On the receipt (debit) side, there is only one amount column.
Columns for the date, voucher number and particulars are common for both receipts and
payments.
Imprest System:
Under the imprest system, a fixed amount say Rs. 5,000 is given to the petty cashier for
incurring small and petty expenses. This amount is called imprest money. The petty cashier
makes all the payments for which he is authorized out of the imprest amount. After a specific
period or as soon as he exhausts the full imprest amount, whichever is earlier, he gets
reimbursement for the actual amount spent by him from the main cashier.
Thus at the beginning of the next period he once again has the full imprest amount. Keeping in
view the quantum of amount involved and frequency of transactions, reimbursement of amount
is made on a weekly, fortnightly, monthly basis. Sometimes the petty cash system is operated
through the main cash book and in that case petty cash book is not maintained independently.
Advantages:
(i) Reduces the labour:
Petty cash book is based on the division of labour and works on imprest system; hence, it
reduces the work and labour of main cashier.

(ii) Controls irregular expenses:
One of the famous principles of management is ‘control by exception’ which means that if one
person tries to control everything, he may end up controlling nothing. Based on this principle,
a petty cashier is appointed who can control the irregular expenses. In the absence of petty
cashier, it is very difficult to watch and control the necessities of incurring any expenses.
(iii) Main cash book does not become over bulky:
Petty cash book helps to keep the main cash book in a compact form because numerous entries
for small and petty items are recorded in the petty cash book itself.
(iv) Quick payment possible:
In petty cash book, payments for petty items are recorded. Though they are small, yet they are
essential. Sometimes they are so urgent that they cannot wait for approval of the higher
authority. In that case quick payment is required and this can be made by the petty cashier.
Types of Petty Cash Books:
There are the two methods of preparing petty cash book:
(i) Simple Petty Cash Book
(ii) Analytical Petty Cash Book or Columnar Petty Cash Book
I. Simple Petty Cash Book:
In simple petty cash book there is one column each for recording of receipt of cash from the
main cashier and for payment of petty expenses. ‘Date’ and ‘Particulars’ column is same for
receipts and payments. In the ‘C.B. Folio’ column, page number of cash book in which payment
to petty cashier is made is to be recorded.
In the particular column heads of the items are to be mentioned. In ‘V .No’ column, voucher
number of the transactions are recorded. ‘L.F.’ column shows where the posting of these items
have been made in respective ledgers. ‘Amount’ column shows the money value of the
transactions.

The format of simple petty cash book is as under:
II. Analytical Petty Cash Book:
Analytical Petty Cash Book or Columnar Petty Cash Book is different from the simple petty
cash book in the sense that in this type of petty cash book, an analytical presentation of cash
payment is made. All petty payments are to be classified into different heads and different
columns are maintained.
The format of the analytical petty cash book is as under:

Explanations to the Various Columns & Balancing the Analytical Petty Cash Book:
Receipts are recorded in one amount column on the receipts (debit) side known as ‘Amount
Received’ column. However, for recording receipts and payments the column for date, voucher
number and particulars are common. For recording petty expenses, petty cash book has one
column on the payment (credit) side which is known as ‘Total Amount’ column.
In this column total of various expenses paid by same voucher and on the same day are recorded
at one place. The total amount column is followed by number of columns for recording the
heads of items which are most common in the business enterprise.
After allotting the columns to most common heads, one column is allotted for recording
miscellaneous items which are known as “Miscellaneous’ column. Payments for which a
separate column does not exist are recorded in this column.
The last column is allotted for ‘Remarks’. The nature of payments is recorded in this column.
All amount columns are totaled at the end of the period. The total amount spent and the amount
reimbursed shall be shown in the total amount column.
Illustration 3: (Petty Cash Book)
Sharma Sports Goods Co. follows the imprest system of petty cash under which, Rs 6,000 was
handed over to the petty cashier as on 1st March 2011.
The expenses during the month were as follows:


Problem 4:
Prepare Petty Cash Book on imprest system from the following particulars for Minha Shukat
Ltd.
September 2016
1. Received for petty cash payments Rs. 1,000
4. Paid for stationery Rs. 140
9. Paid for postage Rs. 80
10. Paid for printing charges Rs. 150
11. Paid for carriage Rs. 125
17. Paid for telegrams Rs. 25
20. Purchased envelops Rs. 30
21. Paid for coffee to office staff Rs. 30
22. Paid for office cleaning Rs. 50
30. Paid to Faiza Munir Rs. 200


BANK RECONCILATION STATEMENT
The bank pass book indicates the amount paid into the bank and the amount withdrawn there
from. The pass book balance on any given date must be the same as the balance shown by the
bank column of the cash book on the same date. But in actual practice the bank pass book
balance seldom agree with the balance shown by the bank column of the cash book. This
happens when some of the transactions appear in the cash book but not in the pass book or in
the pass book but not in the cash book.
The specimen of the Pass book can be as follows:
Name…………… Account No……………

Address…………….
CURRENT ACCOUNT WITH CENTRAL BANK
Date Particulars Dr. Cr. Balance Accountant‘s

Withdrawals Deposits Dr. or Cr. Amount Initials
Reasons for the Difference in two Balances
The reasons for the difference in the balances shown by the two books may be following:
a) Cheques issued but not yet presented for payment: When cheques are issued, the
entry in the cash book is made immediately. It is possible that at the time when the
balance of two books are being compared, some of the cheques might have been issued
but might not have been presented for payment, thus causing a disagreement between
the two balances.
b) Cheques paid into the bank but not yet cleared: The customer‘s account is credited
by the bank only when the cheques are cleared. It is possible that when the cash book
is compared with pass book some of the cheques deposited by the concern may remain

uncollected.
c) Interest allowed by the bank: Bank might have credited the account of the customer
with the interest and may have made the entry in the pass book. It is possible that the
entry in respect of such interest may not have been made by the customer in the bank
column of the cash book thus causing a disagreement between the two balances.
d) Interest and bank charges debited by bank: The bank debits the account of the
customer by way of interest on overdraft. It also debits the account the account of the
customers by way of incidental charges and collection charges. As soon as these
charges are made the bank debits the customer‘s account. But the entries in the cash
book are made by the customer only when he receives the bank statement or pass book.
e) Interest, dividend etc. collected by the bank: Sometimes interest on government
securities or dividend on shares is collected by the bank and is credited to customer‘s
account. If the entries for these do not appear in the cash book, the balance will differ.
f) Direct payment by the bank: Sometimes understanding instructions from the client,
certain payments like insurance premium, club fees etc. are made by the bank. The
entries in the cash book and pass book may be on different dates.
g) Direct payment into the bank by a customer: Sometimes our customers deposit
money direct into the account in the bank, the corresponding entry for which may not
appear in the cash book due to delay in necessary instructions by the customers.
Difference Caused by errors : Sometimes the difference between the two balances may be
accounted for by an error on the part of the bank or an error in the cash book of the business.
This causes difference between the bank balance shown by the cash book and the balance
shown by the bank statement.
(a) Errors committed in recording transaction by the firm Omission or wrong recording of
transactions relating to cheques issued, cheques deposited and wrong totalling, etc. committed
by the firm whilerecording entries in the cash book cause difference between cash bookand
passbook balance.
(b) Errors committed in recording transactions by the bank Omission or wrong

recording of transactions relating to cheques deposited and wrong totalling, etc.

committed by the bank while posting entries in the passbook also cause differences
between passbook and cash book balance
Definition of Bank Reconciliation Statement
The statement which is prepared for verifying and reconciling the bank balances, shown
by the cash book and the pass book on a certain date and incorporates the reasons of
disagreement between them is called a Bank Reconciliation Statement.
Utility of Bank Reconciliation Statement
1. It gives an authentic proof of the accuracy of the cash book and the pass book balances.
2. Entries in both the books are automatically checked.
3. The cash book may be made up to date by recording some hitherto unknown entries.
4. It helps to detect any mistake in the cash book or the pass book.
5. The reconciliation statement will also indicate any undue delay in the clearance of
outstation cheques.
Example: On November 30,1987, the cash book of Mr. Sharma showed a bank balance
of Rs. 28,000. A comparison of the cash book with the pass book, revealed the
following.
1. Cheque deposited but not collected by Rs. 20,000.

2. Interest on investments collected by the bank as per standing instructions, appearing
in the pass book only, Rs. 2,000.
3. Cheques for a total amount of Rs. 80,000 were issued during the month of November.
Of these, cheques for Rs. 65,000 only were presented for payment by the end of the
month.
4. The bank has made a direct payment of Rs. 1,000 towards insurance premium,
as per the standing instructions. This payment has not yet been recorded in the
cash book.
5. A customer has made a direct deposit of Rs. 5,000 in the bank account. There was
no corresponding entry for this in the cash book.
6. Bank charges appearing only in the pass book Rs. 150.
7. A debit of Rs. 2,000 in respect of dishonoured cheque (this ,was discounted earlier)
appear in the pass book only.

8. A cheque of Rs. 3,000 deposited in the bank, was entered twice in the cash book.
From the above particulars, prepare a Bank Reconciliation Statement as on November 30,1987
and ascertain the pass book balance as on that date.

CAPITAL EXPENDITURE
Capital expenditure occurs when a business gets a long term advantage due to that expenditure.
It is usually incurred for accusation of an asset. These expenditures do not occur in the regular
day to day transactions of the business. Common examples:
□ Purchase of furniture, office building etc.
□ Purchase of additional furniture or machinery
□ Expenditure incurred in connection with the purchase of a fixed asset. For example,
carriage paid of machinery purchased.
□ Purchase of patent right, copy rights etc

REVENUE EXPENDITURE
Expenditure which is not for increasing the value of fixed assets, but for running the business
on a day to day basis, is known as revenue expenditure. Routine repairs are revenue
expenditures because they are charged directly to an account such as Repairs and Maintenance
Expense. Even significant repairs that do not extend the life of the asset or do not improve the
asset (the repairs merely return the asset back to its previous condition) are revenue
expenditures.
DEFFERED REVENUE EXPENDITURE
Sometimes, some expenditure is of revenue nature but its benefit likely to be derived over a
number of years. Such expenditure is called deferred revenue expenditure. The two examples
of deferred revenue expenditure and their treatment in final accounts are as explained below:
1: When a new firm enters in to market, it undertakes special advertising campaign on which
it spends heavy amount. The benefit of this expenditure will certainly come in some future
years. Hence it will not be justified to charge this expenditure only in the profit and loss account
of the year in which it incurred. This expenditure must be spread over the period over which
the benefit is likely to lose. Suppose this expenditure will cover 3 years. Hence 1/3 of the
expenditure must be charged to each year Profit and Loss Account.
2: Sometimes even a big loss, arising from an accident or other unforeseen circumstances, may
be spread over 3 or 4 years instead of being charged off wholly against the revenues of the year
in which the loss is actually suffered. The loss of building because of an earthquake may be
treated on this manner. This type of loss is treated as revenue expenditure. It may be note here
that the amount which has not been charged off to the profit and loss account is shown in the
balance sheet as a sort of asset.

TRIAL BALANCE
After posting the journal entries into the ledger and balancing all accounts, we prepare a statement called
Trial Balance. This statement shows the balances of all the accounts which appear in the ledger. The debit
balances are shown in one column and the credit balances in the other. It is usually prepared just before
preparing the final accounts. The purpose is to check the arithmetical accuracy of the books of account.
Under the Double Entry System for every debit there is an equal and corresponding credit. So, the total of
debits given to different accounts must be equal to the total of credits given to different accounts. Similarly,
the total of debit balances in different accounts must be equal to the total of credit balances in different
accounts. Now if the Trial balance tallies i.e., the total of its debit balances column is equal to the total of
its credit balances column, it would mean that both the aspects of each transaction have been correctly
&corded in the ledger. If, however, the two totals do not tally it implies that some errors have been
committed while posting the transactions into ledger.
There are two methods of preparing the Trial Balance: (i) Totals Method, and (ii) Balances Method. Under
the first method we show the totals of each side of an account in the Trial Balance. The debit side total of
an account is shown h the debit column of the Trial Balance and the credit side total of the account in the
credit column. Under the second method we show only the balances of each account in the Trial Balance.
The second method is more convenient and commonly used because it eliminates all those accounts which
have nil balance.
Definition of Trial Balance
According to J.R.Batliboi, ―Trial Balance is a statement prepared with the debit and credit balances of
ledger accounts to verify the arithmetical accuracy of the books.‖

PERFORMA OF TRIAL BALANCE
Name of the Firm……
Trial Balance as on……
S.No. Name of the Ledger account L.F. Dr. Cr.
Steps in Making of Trial Balance
In order to prepare a trial balance following steps are taken:
• Ascertain the balances of each account in the ledger.
• List each account and place its balance in the debit or credit column, as the case may be. (If an account
has a zero balance, it may be included in the trial balance with zero in the column for its normal balance).
• Compute the total of debit balances column.
• Compute the total of the credit balances column.
• Verify that the sum of the debit balances equal the sum of credit balances.
If they do not tally, it indicate that there are some errors. So one must check the correctness of the balances
of all accounts. It may be noted that all assets expenses and receivables account shall have debit balances
whereas all liabilities, revenues and payables accounts shall have credit balances.
Objectives of Preparing the Trial Balance
The trial balance is prepared to fulfill the following objectives:

1. To ascertain the arithmetical accuracy of the ledger accounts.
2. To help in locating errors.
3. To help in the preparation of the financial statements. (Profit & Loss account and Balance Sheet).
To Ascertain the Arithmetical Accuracy of Ledger Accounts : As stated earlier, the purpose of preparing
a trial balance is to asceitain whether all debits and credit are properly recorded in the ledger or not and that
all accounts have been correctly balanced. As a summary of the ledger, it is a list of the accounts and their
balances. When the totals of all the debit balances and credit balances in the trial balance are equal, it is
assumed that the posting and balancing of accounts is arithmetically correct. However, the tallying of the
trial balance is not a conclusive proof of the accuracy of the accounts. It only ensures that all debits and the
corresponding credits have been properly recorded in the ledger.
To Help in Locating Errors :When a trial balance does not tally (that is, the totals of debit and credit
columns are not equal), we know that at least one error has occured. The error (or errors) may have occured
at one of those stages in the accounting process: (
totalling of subsidiary books,
➢ posting of journal entries in the ledger,
calculating account balances,
➢ carrying account balances to the trial balance, and
➢ totalling the trial balance columns.
It may be noted that the accounting accuracy is not ensured even if the totals of debit and credit balances
are equal because some errors do not affect equality of debits and credits. For example, the book-keeper
may debit a correct amount in the wrong account while making the journal entry or in posting a journal
entry to the ledger. This error would cause two accounts to have incorrect balances but the trial balance
would tally. Another error is to record an equal debit and credit of an incorrect amount. This error
would give the two accounts incorrect balances but would not create unequal debits and credits. As a result,
the fact that the trial balance has tallied does not imply that all entries in the books of original record
(journal, cash book, etc.) have been recorded and posted correctly. However, equal totals do suggest that
several types of errors probably have not occured.

To Help in the Preparation of the Financial Statements : Trial balance is considered as the connecting
link between accounting records and the preparation of financial statements. For preparing a financial
statement, one need not refer to the ledger. In fact, the availability of a tallied trial balance is the first step
in the preparation of financial statements. All revenue and expense accounts appearing in the trial balance
are transferred to the trading and profit and loss account and all liabilities, capital and assets accounts are
transferred to the balance sheet.
Advantages (Objectives of Trial Balance)
1. It ensures that the transactions recorded in the books of accounts have identical debit and credit amount.
2. Balance of each ledger account has been computed correctly.
3. Balance of each and every ledger account has been transferred accurately and on the correct side of the
sheet on which trial balance has been prepared.
4. The debit and the credit columns of trial balance have been added up correctly.
5. Preparation of final accounts is not possible without preparing trial balance first.
6. Agreed trial balance is a prima facie evidence of the arithmetical accuracy of the accounting
books maintained.
7. Errors which are revealed by preparing trial balance (listed below) are rectified even before the
preparation of final accounts.
Trial Balance Limitations - Shortcomings of trial balance

An agreed trial balance does not prove by itself that :
1. All transactions have been correctly analyzed and recorded in proper accounts. For example wages
paid for installation of fixed asset might have wrongly been debited to wages account.
2. All the transactions have been recorded and nothing has been omitted.
3. Certain types of errors remain undetected even after the preparation - of trial balance.
Thus it is quite well known and said that "agreement of trial balance is not the conclusive proof of the
accuracy of the books maintained."

Errors revealed by (the preparation of) trial balance
If trial balance does not agree, the disagreement may be due to :
(1) Omission to post an amount into ledger: If an item is not posted from journal or subsidiary book to
ledger, two sides of trial balance shall not agree, e.g., if goods sold on credit to A are recorded properly in
sales book but not debited to A's account' in ledger, the debit side of trial balance shall fall short.
(2) Omission to post an amount in trial balance: It is natural if balance 'of an account is not recorded
in trial balance the two sides of trial balance shall not agree which is an indication of error in accounts.
(3) Wrong totaling or balancing of ledger account: If any account in the ledger is wrongly
totaled or balanced, then also the trial balance shall not agree.
(4) Wrong totaling of subsidiary books: If the total of any subsidiary book is wrongly cast, it would
cause a disagreement in the trial balance, e.g., if purchase book totaled Rs. 2,500 instead of 2,050, the
debit side of the trial balance shall exceed the credit side by Rs. 450.
(5) Posting on the wrong side: When an item is by mistake posted on the wrong side of the ledger account
it would cause disagreement in the trial balance, e.g., if Rs. 200 have been allowed as discount and while
posting into discount account the amount has been credited to discount account. It will result in a
difference of Rs. 400 in two sides of trial balance.
(6) Posting of wrong amount: If wrong amount is posted in one of the two accounts while posting, it
would immediately cause disagreement of trial balance e.g. goods worth Rs. 690 have been sold to 'X' but
'X's account has been debited with Rs. 960. It will increase the debit side of trial balance by Rs. 270.
Errors not revealed by (the preparation of) trial balance
Normally four types of errors are not revealed by mal balance. So two sides of trial balance will although
agree, even then our accounts may not be free from errors. Such errors are :

(1) Errors of omission
If a transaction is not recorded in books of original entry then both debit and credit effects of the transaction
will be omitted and trial balance shall not be effected, e.g. goods sold to John worth Rs. 1,000. The entry
is not recorded in the books at all, it means neither John's account is debited nor sales account has been
credited. As both sides have been effected by equal amount so the mal balance shall agree.
(2) Errors of commission

These errors are the result of carelessness of accounting staff and in some of the cases such errors do
not effect the totals of mal balance, e.g. wrong recording in the books of original entry or posting to
wrong account with correct amount and correct side e.g. goods sold for cash worth Rs. 1,000 but Cash
Nc debited with Rs. 100 and sales credited with identical amount.
(3) Compensating errors
Such errors neutralize the effect of the errors committed earlier. When one error is committed which
affects the total of mal balance but in the mean time another error of opposite effect is committed which
neutralizes the effect of earlier error, e.g. forgetting to post Rs. 500 on the debit side of a certain account
may be compensated by under posting of Rs. 500 on the credit side of some other account or by over
posting of Rs. 500 in debit side of some other account.
(4) Errors of Principle
Whenever any income or expenditure is not properly allocated between capital and revenue, the mistake
so made is called a mistake of principle, e.g. if furniture purchased is debited to purchases account,
building sold is credited to sales account, wages paid for installation of machinery debited to wages
account, then the error of principle is committed; the trial balance shall remain unaffected by such errors
How to Prepare a Trial Balance - An Example:
The trial balance is usually prepared on a loose sheet of paper. The ruling of trial balance is similar to

that of a journal. We may prepare a trial balance in one of the following forms:
(i) Totals Method

(ii) Balances Method
(iii) Totals-cum-balances Method
1. Total Method:
According to total trial balance method two sides of each ledger account i.e., debit and credit side are
added up and debit and credit totals so obtained are placed in the debit and credit columns of the trial
balance respectively. Thus we may draw the following trial balance by taking out the debit side total and
credit side total of each account in the ledger.
Ledger Account J.F Total Debits Total Credits

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

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

2. Find out the difference in a separate slip.
3. Put the difference on the lighter side.
4. Add up both sides again.
5. Rule off.

Trial Balance
Ledger Account J.F Dr. Balance Cr. balance

Rs. Rs.
Cash Account 4,017 --
Sundry Debtors Account 9,222 --
Sundry Creditors Account -- 7,644
Discount Account -- 120
Purchases Account 26,670 --
Sales Account -- 32,145
Machinery Account 10,000 --
Building Account 20,000 --
Capital Account -- 35,000
Rent Account 3,400 --
Wages Account 600 --
Salaries Account 1,000 --
74,909 74,909
Totals-cum-balances Method : This method is a combination of totals method and balances

method. Under this method four columns for amount are prepared. Two columns for writing
the debit and credit totals of various accounts and two columns for writing the debit and credit
balances of these accounts. However, this method is also not used in practice because it is time
consuming and hardly serves any additional or special purpose.
Types of errors
1. Errors of Principle: When a transaction is recorded against the fundamental principles

of accounting, it is an error of principle.
For eg; a revenue expenditure is treated as capital expenditure
2. Clerical errors: these errors can be subdivided as follows:

a) Errors of Omission: when a transaction is partially or wholly not recorded in

the books, it is an error of omission.
b) Errors of Commission: when an entry is incorrectly recorded either wholly or

partially incorrect posting, calculation, casting or balancing. Some of the errors
of commission effect the trial balance whereas others not.
c) Compensating errors: Sometimes an error is counter balanced by another error

in such a way that it is not disclosed by the trial balance. Such errors are called
compensating errors.
RECTIFICATION OF ERRORS
Rectification of Errors
From the point of view of rectification, the errors may be classified into the following two
categories :
(a) errors which do not affect the trial balance.
(b) errors which affect the trial balance.
This distinction is relevant because the errors which do not affect the trial balance usually take
place in two accounts in such a manner that it can be easily rectified through a journal entry
whereas the errors which affect the trial balance usually affect one account and a journal entry
is not possible for rectification unless a suspense account has been opened. Such errors are
rectified by passing a nullifying entry in the respective account as explained before under
Rectification of Errors which do not affect the Trial Balance
These errors are committed in two or more accounts. Such errors are also known as two sided
errors. They can be rectified by recording a journal entry giving the correct debit and credit to
the concerned accounts.

Examples of such errors are – complete omission to record an entry in the books of original
entry; wrong recording of transactions in the book of accounts; complete omission of posting
to the wrong account on the correct side, and errors of principle.
The rectification process essentially involves:
• Cancelling the effect of wrong debit or credit by reversing it; and
• Restoring the effect of correct debit or credit.
For this purpose, we need to analyses the error in terms of its effect on the accounts involved
which may be:
(i) Short debit or credit in an account ; and/or

(ii) Excess debit or credit in an account.
Therefore, rectification entry can be done by:
(i) debiting the account with short debit or with excess credit,
(ii) crediting the account with excess debit or with short credit.
Rectification of Errors Affecting Trial Balance
The errors which affect only one account can be rectified by giving an explanatory note in the
account affected or by recording a journal entry with the help of the Suspense Account.
Suspense Account is explained later in this chapter. Examples of such errors are error of
casting; error of carrying forward; error of balancing; error of posting to correct account but
with wrong amount; error of posting to the correct account but on the wrong side; posting to
the wrong side with the wrong amount; omitting to show an account in the trial balance.
An error in the books of original entry, if discovered before it is posted to the ledger, may be
corrected by crossing out the wrong amount by a single line and writing the correct amount
above the crossed amount and initialing it. An error in an amount posted to the correct ledger
account may also be corrected in a similar way, or by making an additional posting for the
difference in amount and giving an explanatory note in the particulars column. But errors
should never be corrected by erasing or overwriting reduces the authenticity of accounting
records and give an impression that something is being concealed. A better way therefore is by
noting the correction on the appropriate side for neutralizing the effect of the error.

Every businessman is interested in finding the true profit and the financial position at the close
of the trading year. But inspite of the best efforts of the accountant certain errors are committed
in the recording of the transactions which affect the final accounts of the concern. It, therefore
becomes utmost important for the accountant to locate such errors and rectify them so that the
correct profit and the financial position may be ascertained.
The objectives of rectification of the errors are as follows:
a) Preparing correct accounting records.

b) Ascertaining correct profit or loss for the accounting period.
c) Exhibiting the true financial position of the concern.
Rectification
All types of errors in accounts can be rectified at two stages:
a. Before the preparation of the
final accounts
b. . After the preparation of final
accounts
The following methods may be used for the rectification of the errors:
1. By striking off wrong figure and replacing it by a correct one. For example, the
cashier pays Rs. 1,015 for the purchase of goods but by mistake he writes Rs.1,510 in
the cash book.
2. By passing a journal entry. This method of rectification of errors is followed in case

of those errors which take place in two accounts.

EFFECT OF ERRORS ON FINAL ACCOUNTS
1. Errors effecting Profit and loss account
If the errors lie in the nominal accounts then only the net profit will be effected. Errors in
these accounts will either increase or decrease the net profit.
How the errors or their rectification effect the profit – following rules are helpful in
understanding it:
a) If because of an error a nominal account has been given some debit the profit will
decrease or losses will increase, and when it is rectified the profits will increase and
the losses will decrease.
b) If because of an error the amount is omitted from recording on the debit side of a
nominal account- it results in increase of profits or decrease in losses. The
rectification of this error shall have reverse effect, which means the profit will be
reduced and losses will be increased.
c) Profit will increase or losses will decrease if a nominal account is wrongly credited.
With the rectification of this error, the profits will decrease and losses will increase.
d) Profits will decrease or losses will increase if an account is omitted from posting in
the credit side of a nominal or goods account. When the same will be rectified it
will increase the profit or reduce the losses.
2. Errors effecting balance sheet only
If an error is committed in a real or personal account, it will effect assets, liabilities, debtors
or creditors of the firm and as a result it will have its impact on balance sheet alone, because
these items are shown in balance sheet only and balance sheet is prepared after the profit
and loss account has been prepared. So if there is any error in cash account, bank account,
asset or liability account it will effect only balance sheet.



FINAL ACCOUNTS WITH SIMPLE ADJUSTMENTS
In practice, however, you are always required to make some adjustments while preparing the final accounts. It is
because there may be many expenses and incomes relating to the current year which are still to be brought into
the books of account. Then there may be certain items recorded in current year's books which actually relate to
the previous year or the next year. Unless such items are duly
Adjusted in the books of account, the final accounts will not reveal the true and fair view of the state of affairs of
the business.
Treatment of Adjustments in Final Accounts
There are several items which need adjustment at the time of preparing the final accounts. Some of the important
and common adjustments are listed below:
1 Closing Stock
2 Outstanding or Accrued Expenses
3 Prepaid or Unexpired Expenses
4 Outstanding or Accrued Incomes
5 incomes received in Advance (Unearned Income)
6 Depreciation
7 interest on Capital
8 Interest on Drawings
9 Interest on Loan
10 Bad Debts
11 Provision for Bad Debts
12 Provision for Discount on Debtors
13 Provision for Discount on Creditors
14 Manager's Commission
15 Abnormal Loss
16 Drawing of Goods by the Proprietor

PROVISIONS AND RESERVES
Business firms maintain their accounts as going concerns on the assumption that the business will continue to
exist indefinitely, hence, at the end of each accounting year, they must also take into account the future
contingencies and the requirements of funds before determining the amount of net profit available for distribution
among the owners. Provisions and reserves actually relate to the future needs for which a part of the current
earning has to be set aside. In this unit you will learn about the meaning of provision and reserve, the difference
between provision and reserve, and also the various types of reserves which are usually created before distribution
of profits.
PROVISION
There are certain expenses/losses which are related to the current accounting period but amount of which is not
known with certainty because they are not yet incurred. It is necessary to make provision for such items for
ascertaining true net profit. For example, a trader who sells on credit basis knows that some of the debtors of the
current period would default and would not pay or would pay only partially. It is necessary to take into account
such an expected loss while calculating true and fair profit/loss according to the principle of Prudence or
Conservatism. Therefore, the trader creates a Provision for Doubtful Debts to take care of expected loss at the
time of realisation from debtors. In a similar way, Provision for repairs and renewals may also be created to
provide for expected repair and renewal of the fixed assets. Examples of provisions are:
➢ Provision for depreciation;
➢ Provision for bad and doubtful debts;
➢ Provision for taxation; • Provision for discount on debtors; and
➢ Provision for repairs and renewals.
It must be noted that the amount of provision for expense and loss is a charge against the revenue of the current
period. Creation of provision ensures proper matching of revenue and expenses and hence the calculation of true
profits. Provisions are created by debiting the profit and loss account. In the balance sheet, the amount of
provision may be shown either:
➢ By way of deduction from the concerned asset on the assets side. For example, provision for doubtful debts
is shown as deduction from the amount of sundry debtors and provision for depreciation as a deduction from
the concerned fixed assets.

➢ On the liabilities side of the balance sheet alongwith current liabilities, for example
provision for taxes andprovision for repairs and renewals
Accounting Treatment for Provisions

The accounting treatment of all types of provisions is almost similar. Therefore, the accounting treatment is
explained here taking up the case of provision for doubtful debts. As already stated that when business
transaction takes place on credit basis, debtors account is created and its balance is shown on the asset-side of
the balance sheet. These debtors may be of three types:
➢ Good Debtors are those from where collection of debt is certain.
➢ Bad Debts are those debtors from where collection of money is not possible and the amount of credit
given is a certain loss.
➢ Doubtful Debts are those debtors who may pay but business firm is not sure about the collection of full
amount from them. In fact, as a matter of business experience, some percentage of such debtors are not
likely to pay, hence treated as doubtful debts. To consider this possible loss on account of non-payment
by some debtors, it is a common practice (and necessary also) to make a suitable provision for doubtful
debts at the time of ascertaining true profit or loss. The provision for doubtful debts is usually calculated
as a certain percentage of the total amount due from sundry debtors after deducting/writing-off all known
bad debts. Provision for doubtful debts is also called ‘Provision for bad and doubtful debts’. It is created
by debiting the amount of required provision to the profit and loss account and crediting it to provision
for doubtful debts account.
➢ For creating a provision for doubtful debts the following journal entry is recorded:
Profit and Loss A/c Dr. (with the amount of provision)
To Provision for doubtful debts A/c
RESERVE
The term reserve refers to the amount set aside out of profits and other surplus which are not designed to meet
any liability or diminution in value of assets known to exist at the date of the Balance Sheet. The Indian
Companies Act has not given any clear definition of the term 'Reserve'. It states, however, that "the expression
'reserve' shall not include any amount written off or- retained by way of providing for depreciation, renewal or

diminution in value of an asset, or retained by way of providing for any known
liability. In other words, any amount set aside out of profits to meet unexpected future losses and liabilities is
called reserve. Not only that if any amount retained by way of providing for any known liability in excess of the
amount actually needed for thepurpose, shall also be treated as reserve and not a provision.
The basic purpose of creating a reserve is to provide for unexpected losses in future and also retain profits
within business (not distribute them to the owners or shareholders) to provide funds for expansion of the
business. Most well managed companies make it a point not to distribute the whole of their profits to the
shareholders. They retain good portion of their profit in the form of general reserve (also called contingency
reserve). This also enables them to pay dividend even during the year when the profits are low or there are
losses.
Reserves are created by debiting their amounts to the Profit and Loss Appropriation Account. But reserve is not
a compulsory charge on profits. It is purely voluntary and is regarded as an appropriation of profits. It means that
reserve represents an undistributed portion of net profit and not a loss or expense which ought to have been
charged before calculating the net profit, as is done in case of the provisions.
Reserve Fund: The term 'reserve fund' is used for the amount of reserve which has been invested in outside
securities. The instructions given in the Companies Act for the preparation of Balance Sheet, the word 'fund‘ in
relation to any reserve can be used only when such reserve is specifically represented by earmarked investments.
Examples of Reserve fund are employees' welfare fund, pension fund, gratuity fund, debenture redemption fund,
etc. If, however, the amount of reserve is being utilized by the business itself and not invested in some outside
securities, it cannot be called reserve fund.

DIFFERENCE BETWEEN PROVISION AND RESERVE
TYPES OF RESERVES
To have a clear understanding of the nature and purpose of reserves we may classify them into diffrent
categories as follows:

pen Reserves:
There are two ways of creating reserves: (1) by debiting the amount to Profit and Loss Account and clear 1 y
showing it in the Balance Sheet in one form or the other, and (2) by undervaluation of assets or over providing
for losses. The first category of reservescan be easily identified from the financial statements and are termed as
open reserves. The second category of reserves cannot be identified by the reader of financial statements. They
are known only to the management. Such reserves are called 'secret reserves'
Open reserves are further classified as capital reserves and revenue reserves depending on the nature of profit
out of which they are created.
Capital Reserves:
A reserve created out of capital profits is called 'Capital Reserve'. Capital profits may arise on account of
revaluation or sale of fixed assets. In case of companies the following items are also regarded as capital profits.
i) Credit balance left in Forfeited Shares Account after the re-issue of such shares,
ii) Premium received on issue of shares on debentures,
iii) Profit realised on the purchase of company‘s own debentures from the market, and
iv) Profits made prior to incorporation.
It is also to fits cannot normally be used for a distribution of dividends land therefore are transferred to capital
reserve. If at all the company, at some stage, wants to utilize capital reserve for the distribution of dividends, it
has to satisfy certain specified conditions.
Revenue Reserves:
Any reserve other than capital reserve can be called a revenue reserve. Revenue reserves are usually created out
of business profits which are available for distribution of dividends. They are meant for specific purposes or
general purposes and are accordingly known as specific reserves or a 'general reserve'. The specific purposes for
which they are usually created are dividend equalization (known as dividend equalization reserve), redemption
of debenture (known as debenture redemption fund), workmen's compensation (known as worker‘s compensation

fund); etc. A general reserve, on the other hand, is meant for meeting the unforeseen
contingencies and to strengthen the financial position of the business. All these reserves are debited to the Profit
and Loss Appropriation Account and shown on the liabilities side under the head ‗Reserves and Surplus'. As a
matter of fact, they reflect the undistributed profits of the business.
Distinction between Capital Reserve and Revenue Reserve:
The capital reserves and revenue reserves differ in many respects. The main points of distinction are as follows:
Sinking Fund: A sinking fund is a specific reserve created with the object of providing funds for the redemption
of long term liabilities like redeemable debenture. It is created by setting aside a fixed sum out of profits every
year for a definite period. Such a sum is invested at a compound interest so that at the end of the period, the annual
amounts with accumulated interest will be sufficient to discharge the liability. If, for example, a company has to
redeem debentures worth Rs, 1, 00,000 at the end of ten years, it may set aside certain amount of profits every
year and invest it in some securities carrying certain rate of interest. The interest earned every year is also re-
invested. At the end of ten years, the total amount of investment (including interest) will be equal to the amount
needed for redemption i.e., Rs. l, 00,000). The securities are then sold and the amount so realized is used for the
redemption of the debenture. The amount of yearly installment can be determined by reference to the sinking fund
table. The same is debited to Profit and Loss Appropriation Account and credited to the Debenture Redemption

Fund.
Dividend Equalization Fund: This fund is created by setting aside a portion of distributable profits during
prosperous years as a provision for lean period so that company is able to declare usual dividend even if
sufficient profits are not there. The amount representing this fund need not be invested in outside securities.
Even if there is no specific dividend equalization fund, a company can always use its reserves, if any, for the
purpose of equalizing dividends.
Investment Fluctuation Fund: This is a reserve created to provide for the loss by way of fluctuation in the
values of investments made by the company in outside securities. This is generally provided by banks and
insurance companies who invest huge funds in government securities.
Workman's Compensation Fund: Under Workmen Compensation Act, the workers are entitled to certain
amount of compensation in case of accidents in the factory. When an accident takes place, the amount of
compensation involved may be heavy. Hence, in order to avoid such loss being charged to the Profit and Loss
Account of the year in which it occurs, the companies set aside a portion of profits every year and create &special
fund for this purpose. It is called, 'Workmen's Compensation Fund'. As and when some compensation is paid,
the same can be debited to this fund.
Secret Reserves: The term 'Secret Reserve' is applied to a reserve, the existence of which does not appear on
the face of the Balance Sheet. When secret reserves exist, the financial position of the business is better than
what may appear on the face of the balance sheet.
The main purpose of creating secret reserve is to reduce the disclosed profit so that during bad period this
hidden profit, or a portion of it, may be merged into the earnings and thus help in equalizing the dividends.
Methods of creating Secret Reserves: Secret Reserves may be created in one of the following ways:
i) Writing off excessible depreciation

ii) Undervaluation of closing stock
iii) Charging capital expenditure to Profit and Loss Amount
iv) Making excessive provision for bad and doubtful debts

v) Showing contingent liabilities as actual liabilities
vi) Retaining appreciating assets at cost price
Merits and Demerits:
Creation of secret reserves, within certain limits, is justifiable on the ground of expediency and prudence. Secret
Reserves enable the business to meet extra-ordinary losses without the same being disclosed and thus prevent the
provisions and Reserves public confidence being shaken. The concealment of huge profits is also essential in
order to prevent competition from other firms.
Despite certain merits, the following objections are raised against the practice of creating secret reserves.
i) Secret Reserves prevent the financial statements from showing the true and fair position of the business. The
Profit and Loss account charged with fictitious amount in respect of excessive depreciation, doubtful debts, or
repairs etc, fails to disclose the true profits. Similarly, when the value of certain asset is understated or some
liabilities are overstated, the Balance Sheet cannot be said to represent the true state of affairs of the business.
Thus, the financial statements become unreliable.
ii) The shareholders cannot assess the value of their holding correctly.
iii) Management can conceal its inefficiency by making use of secret reserves.
iv) It permits misuse of secret reserves for personal gain by managers. Sometimes the management, or those
close to them, having knowledge of wilful suppression of net profits, may indulge in certain malpractices in the
stock markets.
Before the enactment of the Companies Act, 1956, there were no restrictions on the creation of secret reserves.
But, at present such reserves cannot be created by a company because the auditor has to certify that the Balance
Sheet of the company gives a true and fair view of the state of affairs of the company. In case some secret reserves
have been created, the auditor cannot give such a report without disclosing the extent of such reserves.

Manufacturing Accounts
For manufacturing organizations, manufacturing accounts will be needed in addition to a trading and profit and
loss accounts. This will be for internal purposes/ use in the company. In place of purchases we will instead have
the cost of manufacturing the goods. For a manufacturing business the manufacturing costs are divided into the
following types:
i) Direct material costs
Direct material costs are those materials used directly in the manufacture of products i.e. materials that can be
identified in the final products. E.g. in the manufacture of tables, direct materials consists of timber, nails, glue
etc.
ii) Direct labour costs
These are wages paid to those who are directly involved in the manufacture of a product e.g. in the manufacture
of tables; direct labour consists of wage paid to those workers who saw, shape of join the piece of timber into
table.
iii) Direct expenses
These are expenses that must be incurred in the manufacture of a product. That is, they can be directly allocated
a particular unit of a product e.g. live charges for a special equipment used in the process of manufacture, royalties.
Note: The sum of all the direct costs is known as prime costs
iv) Indirect manufacturing costs / factory overheads
These are any other expenses (apart from the direct costs) for items being manufactured. E.g. cleaners‘ wages,
factory rents, depreciation of plant and equipment, factory power and lighting
Therefore, prime cost + indirect manufacturing costs = PRODUCTION COSTS

v) Administrative Expenses

These are expenses that are administrative in nature, that is, expenses incurred in the process of panning,
controlling and directing the organization. e.g. office rents, office electricity, depreciation of office machinery,
secretarial salaries.
vi) Selling and distribution expenses
These are expenses incurred in the process of selling, promoting and distributing the goods manufactured. E.g.
advertising expenses, carriage outwards, depreciation of motor van, salesmen salaries etc.
vii) Finance Costs
These are expenses such as bank charges, discount allowed.
Format of the financial statements
Manufacturing account part
This is debited with the production cost of goods completed during the accounting period:
It consists of: Direct materials
▪ Direct labour
▪ Direct expenses
▪ Indirect manufacturing costs.
It also includes adjustments for work in progress (goods that are part- completed at the end of a period).
STEPS
1. Add opening stock of raw materials to purchases and subtract the stock of raw materials. This is to get the
cost of materials used during the period.
2. Add in all the direct costs to get the prime costs

3. Add all the indirect manufacturing costs.
4. Add the opening stock of WIP and subtract the closing stock WIP to get the production cost of all goods
completed in the period. This is because WIP cannot be sold and therefore should not be included in the
trading account.
5. The manufacturing account when completed shows the total that is available for sale during the period.
This will be used in trading account in place for purchases.
Final accounts of a manufacturer

1. Manufacturing accounts – used to determine the cost of production.
2. Trading account- Used to determine the gross profit on trading. 3

After studying the form of Manufacturing Account as given above and the Manufacturing
Account as prepared above, you will observe the following points:
I. All items of expenses have been shown on the debit side and income from scrap on the
credit side.
II. The heading of Manufacturing Account, as in case of Trading Account, indicates the
name of the firm and the period of which it is prepared.
III. Opening and closing stocks of rqw materials have been adjusted in the cost of raw
materials Consumed on the debit side itself.
IV. Opening stock of work-in-progress has been shown on tht: debit side and closing work-
in-progress on the credit side.
V. Expenses on purchases of raw materials have been shown on the debit side separately.
They are adjusted in the cost of raw materials consumed.
VI. Cost of production has been shown on the credit side which makes the totals on both
sides equal. Thus, cost of production is the excess of the debit side total over the credit
side total.

TRADING ACCOUNT
A trading account is an account which contains, "in summarized form, all the transactions,
occurring, throughout the trading period, in commodities in which he deals" and which gives
the gross trading result. In short, trading account is the account which is prepared to determine
the gross profit or the gross loss of a trader.
Items of Trading Account:
The following items usually appear in the debit and credit sides of thetradingaccount.
Debit Side Items:
1. The value of opening stocks of goods (i.e., the stock of goods with which the business
was started).
2. Net purchase made during the year (i.e., purchases less returns).
3. Direct expenses, if any.
Credit Side Items:

1. Total sales made during the period less the value of returns, i.e., net sales.
2. The value of closing stock of goods.
The difference between the two sides of the trading account represents either gross profit or
gross loss. Thus if the credit side is heavier that would mean that the trader has earned gross
profit i.e., the excess of selling price of the goods sold over their purchase price. If the debit
side is heavier it would mean that the trader has suffered gross loss i.e., purchase price of goods
exceeds the selling price.
The balance of trading account which represents either gross profit or gross loss is transferred
to profit and loss account.

Format of Trading Account (T or Account Form):

Trading
Account
For the year
ending....... 20......
Dr. Cr.
........ By .........
To Opening stock Sales
.........
To purchases Less returns ......... .........
......... .........
Less Returns ........ By Closing stock
By Gross loss
To Carriage inwards ......... transferred to
To Cartage ......... profit and loss account .........
.........
To dock charges
To Wages .........
To Duty .........
To Freight .........
To Clearing charges .........

To Etc. Etc., .........

To Gross profit
(Transferred to
profit and loss account) .........
Trading Accounts Items:
Now we shall discuss the items of trading account one by one.
1. Opening Stock: In case of trading concerns it will consist of only finished goods or
goods to be sold without alteration. In manufacturing concerns, the opening stock will
consist of three parts:
➢ Stock of raw material
➢ Stock of partly completed goods
➢ Stock of finished goods
In case of new business there will be no opening stock.
2. Purchases: This item includes both cash and credit purchases of goods bought with the
object of sales.
3. Return Outwards or Purchases Returns: It means the goods returned by a trader to

his suppliers from out of his purchases. Return outwards reduce the purchases. It is
shown by way of deduction from purchases in the trading account.
4. Discount on Purchases: It is also shown by way of deduction from purchases in the

trading account.
5. Sales: This item includes total of both cash and credit sales of goods in which
businessman deals in. It is credited to trading account.
6. Returns Inwards or Sales Returns: It means goods returned to a trader by his

customers from out of goods sold to them. It is shown by way of deduction from sales
on the credit side, of the trading account.

7. Discount on Sales: This account has always a debit balance and is shown by deduction
from sales in the trading account.
8. Direct Expenses: Direct expenses are those expenses which are incurred to convert
raw-materials into finished goods or which may be regarded as a part of the cost of
purchasing the goods. e.g., wages paid by a manufacturer to construct furniture out of
raw wood, the expenses incurred to bring goods from the place of purchase to the
business place of the trader etc. All the direct expenses are charged to the trading
account. The items usually included in the direct expenses are:
a) Wages: This item usually signifies some hourly, daily or piecework remuneration paid
to laborers. It is direct expenditure and should be charged to trading account.
b) Manufacturing or Productive Wages: This item usually signifies the wages of factory
workmen actually engaged in making or producing something. It is a direct charge on
the cost of manufacturer. It is debited to manufacturing account or trading account.
c) Carriage Inward: Carriage means conveyance charges of goods by land. Carriage

inward are the conveyance expenses incurred to bring the goods purchased in the
godown or shop. It is debited to trading account. In examination questions when the
item only "carriage" is given and is not expressly stated to be inward or outward, it
should be assumed to be inward and debited to trading account. The reason is that
carriage on goods is usually paid by the purchaser.
d) Cartage: The cartage charges on goods purchased are direct expenses and should be
debited to trading account.
e) Freight: Freight is the charge made for conveyance of goods by sea. Freight on goods
purchased is charged to trading account.
f) Customs Duty, Octroi Duty etc: When goods are purchased from a foreign country
import duty will be payable. When goods are received from another city, the municipal
corporation may charge octroi duty. All duties on goods purchased should be debited

to trading account.
g) Excise Duty: It is a tax levied by the government. If the duty is levied on production it
will be treated as manufacturing expenses and debited to trading account.
h) Stores Consumed: This item stores denote lubricating oil, tallow, grease, cotton and
jute waste, etc., required for running the machinery of manufacturing concern. The
amount of stores consumed is a direct expense and should be charged to trading
account.
i) Motive Power: This item includes, coke, gas, water or electric energy consumed in
propelling the machinery. It is debited to manufacturing account in the absence of a
manufacturing account, it is debited to trading account.
j) Royalty: Royalty is an amount paid to a person for exploiting rights possessed by him
it is usually paid to patentee, author, or landlord for the right to use his patent, copyright
or land. If they are productive expenses, they are debited to manufacturing account; but
in the absence of a manufacturing account, they are debited to trading account.
k) Manufacturing Expense: All other expenses such as factory rent, factory insurance,
factory repair etc., are direct expenses and should be charged to trading account.
Closing Stock and its Valuation:
Closing stock represents the value of goods lying unsold in the hands of a trader at the end of
a trading period. The value of closing stock is ascertained by means of compilation of list of
materials, stores and goods actually in possession at the close of the trading period. This work
is known as taking the inventory. The inventory or lists of physical stock are then faired and
valued. The total of the lists will be closing stock. The closing stock is
valued at cost or market price whichever is lower. As this item materially affects the gross
profit (or gross loss), it is essential that all possible care should be taken to calculate the closing
stock at a proper value.
The value of closing stock is taken into consideration only at the time of preparing the trading

account and not before. The trial balance is prepared before the preparation of the trading
account. Hence the closing stock does not appear in a trial balance. It is brought into account
by means of a journal entry debiting stock account and crediting the trading account.
Closing Entries for Trading Account:
Closing entries are those which are passed at the end of each financial period for the purpose
of transferring the various revenues items to the trading and profit and loss account and thus
the nominal accounts are closed. I preparing a trading account, the opening stock, purchases,
sales, returns both inwards and outwards, direct expenses and closing stock are transferred to
it by means of journal entries as follows:
1. Trading Account
To Purchases Account
To Returns Inwards Account
To Direct Expenses Account
(wages, carriage etc.) (Being the
transfer of the latter accounts to the
former.)
2. Sales Account
Returns
Outward
Account To
Trading
Account
(Sales etc., transferred to trading account)

3. Closing Stock Account

To Trading Account
(Being to record closing stock)
Advantages of Trading Account:
The advantages of the trading account are as follows:
1. A trader can find out the gross profit and thereby can ascertain the percentage of profit
he has earned on the cost of goods sold. This percentage of gross profit may serve as
his ready guide for the adjustment of future sale price.
2. A trading account help a trader to compare his stock at open with that at the close. He
can further find out whether the purchases he has made during the period of account
have been judicious.
3. Once can compare the figure of sales with similar figure of the previous year and can
find out whether business is improving or declining.
4. If the gross profit disclosed by the trading account is less than expected, an enquiry can
be made into the cause responsible for the decline. And if the gross profit is more than
was expected, steps can be taken to maintain it.

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

For the year ended..............
To Gross Loss xxxx By Gross Profit xxxx
To Salaries xxxx By Interest Received xxxx
To Rent xxxx By Discount Received xxxx
To Rent and Rates xxxx By Commission Received xxxx
To Discount Allowed xxxx By Other Receipts xxxx

To Commission Allowed xxxx By Etc., Etc. xxxx
To Insurance xxxx
To Bank Charges xxxx By Net Loss (transferred to capital

xxxx
To Legal Charges xxxx account of the trader)
To Repairs Xxxx
To Advertising Xxxx
To Trade Expenses ex.
To Office Expenses xxxx
To Bad Debts xxxx
To Traveling Expenses xxxx
To Etc., Etc. xxxx
To Net Profit (transferred to capital

account of the trader)

xxxx
Closing Entries for Profit and Loss Account:
The following usual entries are passed at the end of each trading period.
1. Transferring all expenses or losses:

Profit and loss account
To each of the various
expenses or losses
(This entry will close the
expenses accounts)
2. Transferring all items of gains etc:
Various nominal accounts

(representing ains) To
Profit and loss account
(This entry will close all the remaining nominal accounts)
3. Transferring net gain to capital account:

Profit andloss account To Capital account
(This entry closes the P & L account)
4. Transferring net loss to capital account:
Capital account
To Profit and loss account
(This entry closes the P & L account)

CLOSING STOCK
You know that all goods purchased or produced during the year are not completely sold-out by
the end of the year. Some goods always remain unsold as at the end of the which are called
'Closing Stock'. The Closing Stock does not usually appear in the Trial Balance. It is mostly
given in the form of additional information. Since Gross Profit or loss cannot be worked out
without accounting for the closing stock it is brought into books by means of the following
adjustment entry.
Closing Stock A/c Dr.

To Trading A/c
The closing stock is treated in the final accounts as follows:

i. On the credit side of Trading Account: shown as a separate item, and
ii. On the assets side of the Balance Sheet: shown as a separate
item under Current Assets.
OUTSTANDING EXPENSES
Outstanding expenses are those expenses which have been incurred during the current
accounting year but have not been paid till the end of the year. They are also called 'expenses
accrued'. The common examples of such expenses are the salaries, wages and rent for the last
month of the accounting year paid in the first month of the next year. Since they remained
unpaid as at the end of accounting year, no entry might have been passed in the books of
account. So, they must be taken into account while preparing the Trading and Profit and Loss
Account otherwise it will not reveal the correct amount of profit or loss. The following
adjustment entry is passed in respect of outstanding expenses.
Concerned Expense A/c Dr.

To Outstanding Expenses A/c
The outstanding expenses will be treated in final accounts as follows:
I. Added to the concerned expenses in the Trading and Profit and Loss Account, and

II. Shown on the liabilities side of the Balance Sheet as a

separate item under Current Liabilities.
PREPAID EXPENSES
Sometimes, the benefit of some expenses will be available not only in the current accounting
year but also during the next year. That portion of expense the benefit of which is yet to be
received is called 'prepaid expense'. It is also called 'unexpired expense'. Examples of such
expenses are unexpired insurance, interest paid in advance, etc. In such situations it is necessary
to find out the unexpired portion and adjust it in the concerned expense. The following
adjustment entry is passed in respect of the prepaid expenses:
Prepaid Expenses A/c Dr.

To Concerned Expense Alc
The Prepaid expenses will be treated in financial accounts as follows:

i. Subtracted from the concerned expense in the Trading
and Profit and Loss Account, and
ii. Shown on the assets side of the Balance Sheet as a separate

ACCRUED INCOME
Accrued Incomes are those incomes which have been earned during the current accounting
year but have not been received till the end of the year. They are also called 'outstanding
incomes' or 'incomes earned but not yet received'. Examples of such incomes are commission
receivable, income on investments due but not yet received, etc. The following adjustment
entry is passed in respect of accrued income.
Accrued Income A/c Dr.

To Concerned Income A/c

The Accrued income is treated in final accounts as follows:
I. Added to the concerned income in the Profit and Loss Account, and
II. Shown on the asset side of the Balance Sheet as a separate
INTEREST ON DRAWINGS
In case interest is allowed to the proprietor on his capital, it is a usual practice to also charge
interest on his drawings. Interest on drawings will be a gain for the business and the following
adjustments entry is passed to bring it into the books of account.
Capital A/c or Drawings A/c Dr.

To Interest on Drawings A/c
Interest on Drawings is treated in final accounts as follows:

I. On the credit side of Profit and Loss Account: shown as a separate item, and
II. Deducted from Capital on the liabilities side of Balance Sheet.

Preparing Balance Sheet

All the account of assets, liabilities and capital are shown in the balance sheet. Accounts of
capital and liabilities are shown on the left hand side, known as Liabilities. Assets and other
debit balances are shown on the right hand side, known as Assets. There is no prescribed form
of Balance sheet, for a proprietary and partnership firms. (However, Schedule VI Part I of the
Companies Act 1956 prescribes the format and the order in which the assets and liabilities of
a company should be shown). The horizontal format in which the balance sheet is prepared is
shown in the figure 9.7.



DEPRICIATION
When the benefit of expenditure is available beyond the accounting year (for one or more
years) such expenditure is treated as capital expenditure and it often results in acquisition of
an asset. Since many accounting years are likely to receive benefits on account of the use-of
such an asset, the cost of investment must necessarily be allocated over the period of its useful
life and charged to the Profit and Loss Account. Allocation of the appropriate amount to each
period is called depreciation which represents the expired portion of the cost of an asset.
Pickles defined depreciation as "the permanent and continuous diminution in the quality,
quantity or value of an asset."
According to IGMA (Institute of Cost and Management Accounts, London) terminology,

"Depreciation is the diminution in intrinsic value of the asset due to use and/or lapse of time.‖
Thus, depreciation refers to that part of the cost of fixed asset which has expired on account
of its usage and or the passage of time. It is thus the 'lost usefulness', 'expired utility', or
'reduction in the intrinsic value' of a fixed asset. Depreciation is charged on almost all fixed
assets, possible exceptions being land, antiques, etc. Usually the value of land and antiques
appreciates over a period of time, because they do not have finite economic life as in the case
of machinery or furniture.
CAUSES OF DEPRICIATION
The causes of depreciation can be stated as follows:
1. Wear and tear: Wearing out of the asset on account of its constant use is called wear
and tear. This causes a definite reduction in the value of the asset and is regarded as
the main source of depreciation.
2. Lapse of Time: Normally, the passage of time also causes some reduction in the value
of fixed assets because as they become old their value stands reduced. That is why the
depreciation is usually charged on time basis. In case of certain assets like least patents,
etc., the value decreases with passage of time as they generally have a fixed number of
years of legal life. For example, a building is taken on lease for a period of 10 years

costing Rs. 1, 00,000. The yearly depreciation of lease will amount to Rs. 10,000 (1/10
of Rs. 1, 00,000) and charged as such to the Profit and Loss Account every year.
3. Obsolescence: 'The acquisition of an improved model may render the existing machine
obsolete. As the new machine performs the same operation more quickly and/or more
economically existing machine is said to have become out of date or obsolete. This
causes a drastic reduction in the value of existing machinery and the amount of
depreciation is bound to be heavy.
4. Depletion: Some assets arc of a wasting character. For example mines, quarries, oil
wells etc. Due to continuous extraction of materials the natural resources get depleted.
Depreciation, in case of such assets is often computed on the basis of actual depletion.
For example, a coal mine has the coal deposits of 200 million tons. In the first year we
extract 10 m tons of coal. The depreciation in the first five years shall amount to 10/200
of the cost of mine.
METHODS FOR PROVIDING DEPRICIATION
I. Fixed Instalment Method: This method is also called 'equal instalment method' or
'straight line method'. Under this method, a fixed and equal amount is charged as
depreciation every year during the life time of an asset. When this amount of
depreciation is presented on a graph paper it would show a straight line parallel to the
X-axis, and hence the alternative name 'straight line method'. This method writes off
a fixed percentage of the original cost of the asset every year so that the asset is
reduced to zero or its salvage value at the end of its working life. The annual amount
of depreciation to be charged under this method can be calculated with the help of the
following formula :

II. Diminishing Balance Method: Under this method, though the rate of depreciation is
fixed, it is calculated on the written down value of the asset. Consequently the amount
of depreciation to be charged goes on reducing from year to year. For example, a
machine was purchased on January 1, 1986 for Rs. 10,000. It is to be depreciated at
15% per annum under the diminishing balance-method. In this case, the depreciation
for 1986 would be Rs. 1,500 (15% of 8500), for 1987 it would be Rs. 1,275 (15% of
8,500), and for1988 it would work out as Rs. 1,084 (15% of 7,225). Thus you will
notice that the annual depreciation goes on reducing. Hence, it is also known as
'reducing instalment method'. This method is considered better than the fixed
instalment method because with reducing instalrnents of depreciation the combined
effect of repairs and depreciation will be more or less uniform throughout the life of
the asset.
Need for Depreciation

The need for providing depreciation in accounting records arises from conceptual, legal, and
practical business consideration. These considerations provide depreciation a particular
significance as a business expense.
Matching of Costs and Revenue
The rationale of the acquisition of fixed assets in business operations is that these are used in
the earning of revenue. Every asset is bound to undergo some wear and tear, and hence lose
value, once it is put to use in business. Therefore, depreciation is as much the cost as any
other expense incurred in the normal course of business like salary, carriage, postage and
stationary, etc. It is a charge against the revenue of the corresponding period and must be
deducted before arriving at net profit according to ‘Generally Accepted
Consideration of Tax
Depreciation is a deductible cost for tax purposes. However, tax rules for the calculation of
depreciation amount need not necessarily be similar to current business practices,
True and Fair Financial Position
If depreciation on assets is not provided for, then the assets will be over valued and the
balance sheet will not depict the correct financial position of the business. Also, this is not
permitted either by established accounting practices or by specific provisions of law.
Compliance with Law
Apart from tax regulations, there are certain specific legislations that indirectly compel some

business organizations like corporate enterprises to provide depreciation on fixed assets.


CAPITAL AND REVENUE EXPENDITURE
ACCOUNTING FOR NON-PROFIT ORGANISATIONS
We come across organisations which are not engaged in business activities. Their objective is not to make
profits but to serve. Examples of such organisations are: schools, hospitals, charitable institutions, welfare
societies, clubs, public libraries, resident welfare association, sports club etc. These are called Not-for-
Profit Organisations (NPOs). These organisations provide services to their members and to the public in
general. Their main source of income is membership fees, subscription, donation, grant-in-aid, etc. As the
money is involved in the activities of these organisations, they also maintain accounts. These organisations
prepare certain statements to ascertain the results in financial terms of their activities for a particular period
say, one year.
Characteristics of Not-for-profit organisations (NPOs):

Following are the main characteristics or the salient features of Not for Profit organisations (NPOs):
1. The objective of such organisations is not to make profit but to provide service to its members and to the
society in general.
2. The main source of income of these organisations is not the profit earned from purchase and sale of
goods and services but is admissions fees, subscriptions, donations, grant-in-aid, etc.
3. These organisations are managed by a group of persons elected by the members from among themselves.
This group is called managing committee.
4. They also prepare their accounts following the same accounting principles and systems that are followed
by business for profit organisations that are run with an objective to earn profits:
The type of financial statements that are generally prepared by Not-for Profit Organisations (NPOs) are:
1. Receipts and Payments Account
2. Income and Expenditure Account

3. Balance Sheet
The receipts and payments account is the summary of cash and bank transactions which helps in the
preparation of Income and expenditure Account and the Balance Sheet.
Income and Expenditure A/c is similar to Profit and Loss Account. NPOs usually prepare the Income and
Expenditure Account and balance Sheet with the help of Receipts and Payments Account.
RECEIPTS AND PAYMENTS ACCOUNT–MEANING AND NEED:
Like any other organisations Not-for-Profit Organizations (NPOs) also maintain cash book to record cash
transactions on day to day basis. But at the end of the year they prepare a summary of cash transactions
based on the cash-book. This summary is prepared in the form of an account. It is called Receipts and
Payments account. All cash receipts and payments are recorded in this account whether these belong to
current year or next year or previous year. All receipts and payments are recorded in this account whether
these are of revenue nature or capital nature. As it is an account so it has the debit side and the credit side.
All receipts are recorded on its debit side while all payments are shown on the credit side. This account
begins with opening cash or/and bank balance. Closing balance of this account is cash in hand and or cash
at bank/overdraft. Items in this account are recorded under suitable heads.
Following are the main features of Receipts and Payments Account:

1. It is prepared at the end of the year taking items from the cash book.
2. It is the summary of all cash transactions of a year put under various heads.
3. It records all cash transactions which occurred during the year concerned irrespective of the period they
relate to i.e. previous/current/next year.
4. It records cash transactions both of revenue nature and capital nature.

5. Like any other account it begins with opening balance and ends with closing balance.
Need for preparing Receipts and Payments Account:

As most of the transactions of Not-for-Profit Organisations are for cash, the Receipts and Payments Account
shows most of the items at one place.
As it is in a summary form, it gives an idea of large number of transactions at a glance. It contains

accounting information under various heads. So it gives information item wise for the accounting year. It
shows the closing cash or/and bank balance, this cash/Bank balance is taken to the Balance Sheet.
The Receipts and Payments Account serves the purpose of trial balance and becomes the basis of preparing
financial statements i.e. Income and Expenditure Account and Balance sheet for the organisation. Very
small Not-for-Profit Organisations (NPOs) prepare only Receipts and
Payments Account.
As the name itself suggests, Receipts and Payments Account is an account which has two sides, the debit
side and the credit side. All receipts are written on the debit side and payments on the credit side. It has a
definite format which is given below:
Format of Receipts and Payments Account:

Receipts and Payments Account
For the year ended on................

SPECIFIC ITEMS OF RECEIPTS AND PAYMENTS ACCOUNT:
1. Subscription: It is a regular payment made by the members to the organisation. It is generally

contributed annually. It is one of the main sources of income. It appears on the debit side i.e. Receipts side
of the Receipts and Payments Account. Apart from amount for current year, it may include amount
pertaining to previous year or advance payment for next years.
2. Entrance fees or Admission fees: Whenever a person is admitted as a member of the organisation
certain amount is charged from him/her to give him/her admission. This is called entrance fee or admission
fee. It is an item of income and is shown on the debit side of the Receipts and Payments Account.
3. Life membership fees: Membership, if granted to a person for the whole life, special fee is charged
from him/her, this is called life membership fees. It is charged once in the life time of a member. It is a

capital receipt for the organisation.
4. Endowment fund: It is a fund which provides permanent means of support for the organisation. Any
contribution towards this fund is an item of capital receipt.
5. Donation: Donation is the amount received from some person, firm, company or any other body by way
of gift. It is also an important item of receipt. It can be of two types:
(a) Specific donation: It is a donation received for a specific purpose.

Examples of such donations are: donation for library, donation for
building, etc.
(b) General donation: It is a donation which is received not for some specific purpose. It can be of two
types:
(i) General donation of big

amount (ii) General donation of
small amount
6. Legacy: It is the amount which is received by organisations as per the will of a deceased person. It is
treated as a capital receipt.
7. Sale of old newspapers/periodicals and sports material: Old newspapers used/condemned sport
material is sold and fetches some money. It is a source of revenue. It is taken to the debit of Receipts and
Payments account.
8. Purchase of fixed assets: Assets such as building, machinery, furniture, books etc. are purchased for
the organisation. These are items of capital expenditure. These are shown on the credit side i.e. the payment
side of Receipts and Payments Account.
9. Payment of honorarium: This is another item of payment. This is an amount paid to persons who are

not the employees of the organisation but take part in the management of the organisation. Remuneration
paid to them is called honorarium. For example, payment made to the secretary of the club as honorarium.
This is a payment of revenue nature.
10. Purchase of consumable items: Items such as stationery, sports material, drugs and medicines etc. are
called consumable items. Payments are regularly made by Not-for-Profit Organisation (NPO). These are
shown on the payment side. Payments are made for rent, salary, and insurance, office expenses etc. which
are payments made as revenue expenditure by both businesses for profit and not for Profit Organisations
(NPOs).
Preparation of Receipts and Payments Account:

Following are the steps followed to prepare Receipts and Payments A/c :
□ At first the cash and bank balance carried forward from the last year is written on its debit side. In
case there is bank overdraft at the beginning of the year, enter the same on the credit side of this
account.
□ The amounts are written under relevant heads such as subscription, donations etc. on the receipts
side and salary, rent, purchase of sports equipment, books etc. on the Payment side.
□ The amounts comprise of only cash and all cash received or paid during the period for which
Receipts and Payments Account is prepared. No distinction is made between the items of revenue
nature or capital nature and whether these belong to current year, previous year or the coming year.
Finally, this account is balanced by deducting the total of the credit side i.e. the total payments from the
total of the debit side i.e. total receipts and is put on the credit side as ‗balance c/d‘.
It shows the closing cash and Bank balance which is written on the asset side of the Balance sheet of the
concerned organisation.


The Income and Expenditure Account:
The Income and Expenditure account is a revenue account of a Not-for-Profit entity, like a charitable or
cultural society, educational institutions, hospitals, sports club etc. It is a type of income statement similar
to profit and loss of other business organizations. The income and expenditure account is prepared on the
basis of some principles, which are applicable in the preparation of profit and loss account. Fund based
expenses are first matched against the income arising/accrued from the same fund. Fund based expenses
cannot be in excess of the income accrued from the fund however a transfer may be made from general
fund to the specific fund to set off the deficit.
Any surplus arising on the income of a firm has to either accumulate in the fund itself or is to be disposed
off as for the specific provisions. Items of revenue nature alone are dealt with in this account but they are
not confined to actual cash transacted during the accounting period. Gains whether received or accrued are
credited and expenses and loses whether paid or incurred are debited to the Income and Expenditure
Account. Any advance receipt of income on payment or expense is duly adjusted. After due adjustment of
accruals, prepayments, provisions, depreciation etc, the final balance of the account represent an excess of
income over expenditure which is called surplus. When the expenditure is in excess over the income then
the balance is called deficit.
[Incomes- Expenditures = Surplus], [Expenditures-Income = Deficit].
Preparation of Income and Expenditure Account:

Following steps are involved in the preparation of the Income and Expenditure Account:
1. It is generally prepared in ‗T‘ form with revenue expenditure on the debit side (left hand side) and
revenue income on the credit side (right hand side). It follows the rules given below:
Debit Expenditure || Credit Income
2. This account can also be prepared in a vertical form where in incomes are first shown and added
up. There after, the expenditures are presented and added up. From the totals of the income s the

totals of expenditure are deducted to ascertain surplus or deficit.
3. The Income and Expenditure account does not start with any opening balance, because it is prepared
to ascertain only the current year‘s surplus or deficit. The previous year‘s surplus or deficit is
therefore, not relevant.
4. This account shows only the revenue items and hence the capital items are not recorded. For
example building owned by a sport club should not be taken into consideration.
5. In this account only the expenses and incomes of the particular current accounting year are shown.
Hence, the revenue receipt and payment pertaining to the pervious year(s) and future year(s) should
be suitably or all to be adjusted. Similarly, outstanding expenses and accrual incomes pertaining to
the previous accounting year of which the income and expenditure account is being prepared must
be included in the total of the expenses and incomes.
6. The closing balance of this account shows surplus i.e. excess of revenue income and revenue
expenses. The surplus is added to and the deficit is deducted from the ‗Not-for-Profit‘
organization‘s ‗capital fund‘.
Items of Income and Expenditure Account:
Revenue Expenditure: It generally refers to the revenue expenses paid and due for a particular year and
non-cash losses. It can be shown as follows in the form of an equation.
Revenue Expenditure = Revenue Payments made during the year + (outstanding revenue payments of the
year + prepaid revenue payments of the year at the beginning of the year) -
(Outstanding revenue payments in the beginning of the year + prepaid revenue payments at the end of the
year)
Revenue Income: It refers to the revenue receipts accruing during a particular year. Therefore;

Revenue Income = Revenue Receipt during the year + (accrued revenue receipt at the end of the year +
revenue receipts received in advance at the beginning of the year) - (accrued revenue receipts in the
beginning of the year + revenue receipts received in advance at the end of the year) + gain on sale of fixed
assets.

The format of Income and expenditure account is given below:
Income and Expenditure Account

For the year ended.....
Expenditure Rs. Income Rs.
To Salaries and Wages *** By Subscription ***

To Rent, rates and taxes *** By Entrance fees(only revenue
To Printing and Stationary *** portion) ***
To Postage and Telegraphs *** By General Donations ***
To Communication expenses *** By Life Membership fees (only
To Electricity & Water Charges revenue portion) ***
To Honorarium *** By Interest on Investment ***
To Insurance *** By Sale of Refreshments ***
To Repairs and Maintenance *** By Rent for use of hall ***
To Travelling expenses *** By Hire of Ground ***
To Entertainment Expenses *** By Lockers Rent ***
To Tournament Expenses *** By Advertisement in Journals ***
To Meeting Expenses *** By Grant from Govt. ***
To Audit Fee *** By Sale of tickets ***
To Newspapers & Magazines *** By Tournament Collections ***
To Depreciation *** By Sale of Old Newspapers ***
To Sports Material Consumed *** By Sale of grass ***
To Surplus(excess of income By Miscellaneous Incomes ***
over expenditure) *** By deficit (excess of expenditure
over income) ***
***
*** ***

Balance Sheet for Not-for-Profit Organization
Balance sheet of a nonprofit organisation (NGO) is important financial document which shows financial
position of that nonprofit organisation. So, In a nonprofit, the name of this financial statement is also
called the statement of financial position.
In the balance sheet of nonprofit organisation, difference between total assets and total liabilities will be
shown as net assets because there is no equity share capital in nonprofit organisation and there is also no
shareholder of this organisation. This net assets will be the donation fund which is issued by its donors.
The performa Balance Sheet of a Not-for-Profit organization is given below:

Preparation of Balance Sheet
The following procedure is adopted to prepare the Balance Sheet:
1. Take the Capital/General Fund as per the opening balance sheet and add surplus from the Income and
Expenditure Account. Further, add entrance fees, legacies, life membership fees, etc. received during the
year.
2. Take all the fixed assets (not sold/discarded/or destroyed during the year) with additions (from the
Receipts and Payments account) after charging depreciation (as per Income and Expenditure account) and
show them on the assets side.
3. Compare items on the receipts side of the Receipts and Payments Account with income side of the
Income and Expenditure Account. This is to ascertain the amounts of: (a) subscriptions due but not yet
received:
(b) Incomes received in advance; (c) sale of fixed assets made during the year; (d) items to be capitalized
(i.e. taken directly to the Balance Sheet) e.g. legacies, interest on specific fund investment and so on.
4. Similarly compare, items on the payments side of the Receipt and Payment Account with expenditure
side of the Income and Expenditure Account. This is to ascertain the amounts if: (a) outstanding expenses;
(b) prepaid
expenses; (c) purchase of a fixed asset during the year; (d) depreciation on fixed assets; (e) stock of
consumable items like stationery in hand; (f) Closing balance of cash in hand and cash at bank as, and so
on.




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2nd Semester Accounts | UNIT 1

Bookkeeping is the recording of financial transactions. Transactions include sales, purchases,

Objectives of Book- keeping:

□ Book- keeping provides a permanent record of each transactions.

IHM Notes Site | Hotel Accounts | 2nd Semester

□ It enables to prepare a list of customers and suppliers to ascertain the amount to be

The systematic recording, reporting, and analysis of financial transactions of a business.

The American Accounting Association defines accounting as: "the process of

In the words of Smith and Ashburne, “accounting is a means of measuring and

From the above the following attributes of accounting emerge:

a) It is the art of recording business transactions.

IHM Notes Site | Hotel Accounts | 2nd Semester

d) It is the art of summarising financial transactions.

i. It is the art of analysis and interpretation of these transactions.

Accounting is an information system that measures business activities, processes

1. Systematic record of business transactions - The primary function of accounting is to

2. Protecting the property of the business - The second function of accounting is to

IHM Notes Site | Hotel Accounts | 2nd Semester

unjustified and unwanted use.

3. Communicating results to interested parties - Accounting is the language of business.

4. Compliance with legal requirements - The another function of accounting is to devise

1. General Accounting or Financial Accounting - is concerned with the recording of

DISTINCTION BETWEEN BOOK-KEEPING AND ACCOUNTING

Book-keeping is recording of the financial transactions of a business in a methodical manner

The main difference between Book-keeping and Accounting are as follows:

IHM Notes Site | Hotel Accounts | 2nd Semester

Accounting is abstract and theoretical. It is

Bookkeeping is a part of accounting. It is Accounting is a four-stage process of

The following are the main advantages of accounting:

IHM Notes Site | Hotel Accounts | 2nd Semester

□ Comparative study: A systematic record enables a business to compare one year's

□ Financial accounting is of historical nature: Net effect of transactions is recorded

□ Absence of full disclosure of facts: In financial accounting we record only those

□ Financial reports are interim report of business: Financial statements made by

□ Incomplete knowledge of costs: From cost point of view, financial accounting is

□ No provision of cost control: Financial accounting does not help business

IHM Notes Site | Hotel Accounts | 2nd Semester

way to inspect all expenses.

□ Financial statements are affected from personal judgment: Many events of

Basic Accounting Terms:

i. Business Transactions: It is an economic event that relates to a business entity. It can

ownership claim on total assets. It is equal to total assets minus total

vii. Expenditure: Expenditure is the amount of resources consumed. Usually, it is of long

IHM Notes Site | Hotel Accounts | 2nd Semester

IHM Notes Site | Hotel Accounts | 2nd Semester

GAAP is exceedingly useful because it attempts to standardize and regulate accounting

Accounting Principles can be classified into two categories:

ACCOUNTING CONCEPTS ACCOUNTING CONVENTIONS

i. Business entity i. Consistency

IHM Notes Site | Hotel Accounts | 2nd Semester

IHM Notes Site | Hotel Accounts | 2nd Semester

ix. Objective evidence concept: Objectivity cannotes reliability, trustworthiness and

I. Convention of Consistency: Accountants are expected to be consistent when applying

II. Convention of full Disclosure: according to this convention, all accounting

against possible losses in the world of uncertainty. It compels the businessman to

IV. Convention of Materiality: Whether something should be disclosed or not in the

IHM Notes Site | Hotel Accounts | 2nd Semester

Rules of Accounting Equation

5. Regarding Incomes or Profits

IHM Notes Site | Hotel Accounts | 2nd Semester

DOUBLE ENTRY SYSTEM

IHM Notes Site | Hotel Accounts | 2nd Semester

and a cash account.

A double-entry bookkeeping system is a set of rules for recording financial information in a