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Unit -2

INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS)

Introduction to Accounting Standards:

Financial Statements provide inputs for most business and economic decisions.

However, when these statements are not transparent and reliable, it could have a

huge negative impact on growth of business enterprises, and economy at large.

Hence it is essential to regulate the accounting process that helps in preparing

financial statements. In order to provide transparency, consistency, comparability,

adequacy and reliability of financial reporting, it is essential to standardise the

accounting principles and policies. Accounting standards provide a framework and

standard accounting policies so that the financial statements of different enterprises

become comparable.

Meaning of Accounting Standards:

According to ICAI, Accounting standards are “written documents, policies, procedures

issued by expert accounting body or government or other regulatory body covering the

aspects of recognition, measurement, treatment, presentation and disclosures of

accounting transactions in the financial statement.”

In short, an accounting standard may be regarded as a sort of law- a guide to action, a

settled ground or basis of conduct or practice, of accounting.

The accounting Standards deal with the issues of:

a. Recognition of events and transactions in the financial statements;

b. Measurement of these transactions and events;

c. Presentation of these transactions and events in the financial statements in a

manner that is meaningful and understandable to the reader; and

d. The disclosure requirements which should be there to enable the public at large

and the stakeholders and the potential investors in particular, to get an insight

into what these financial statements are trying to reflect and thereby facilitating

them to take prudent and informed business decisions.

Need for Accounting Standards:


a) In order to avoid the variance which may arise between the accounting principles

and accounting practices and also to find uniformity among various diverse

underlying principles of accounting.

b) Comparison between two firms is possible if both of them maintain the same

principle, otherwise proper comparison is not possible. For example, if A company

follows the FIFO method of valuation of stock whereas firm B follows the LIFO

method for valuing stock, the comparison between the two firms becomes useless.

The same is possible only when both of them follow identical method of valuing

closing stock.

c) To find uniformity in accounting practice while formulating financial reports and

make consistency and proper comparison of data which are contained in financial

statements for the users of accounting information.

d) To maintain fairness, consistency and transparency in accounting practices which

will satisfy the users of accounting.

e) To resolve potential conflicts of financial interest among the various external groups

that use and rely upon published financial statements.

f) Accounting standards reduce the accounting alternatives in the preparation of

financial statements within the bounds of rationality, thereby ensuring comparability

of financial statements of different enterprises. Thus, accounting standards can be

seen as providing an important mechanism to help in the resolution of potential

financial conflicts interest between the various important groups in society.

g) To harmonise accounting policies and practices followed by different business

entities so that the diverse accounting practices adopted for various aspects of

accounting can be standardised.

Objectives of Accounting Standards:

1.To standardise the diverse accounting policies

2.To eliminate the extent possible non comparability of financial statements

3.To increase the reliability of financial statements

4.To increase the arithmetical accuracy of financial statements


5.To understand accounting treatment in financial statements

6.To provide a set of standard accounting policies, valuation norms and

disclosure requirements

Significance or advantages of Accounting Standards:

The specific advantages of accounting standards to the user group are:

1. They would be useful to investors in judging the yield and risk involved in alternative

investments in different companies and different countries.

2. The standards enable the public accountants (the Chartered Accountants in India)

to deal with their clients by providing rules of authority to which the accountants

have to adhere, in their job of preparing the financial statements on a true and fair

basis. This makes the accountants ensure commitments and integrity in the

profession.

3. Accounting standards raise the standards of auditing itself in its task of reporting on

the financial statements.

4. Government officials, tax authorities and other find accounting reports produced in

accordance with established standards to be reliable and acceptable.

5. Financial statements thus produced will be reliable documents for the purpose of

analysis and interpretation by analysts, researchers and consultants for economic

forecasting and planning.

Limitations of Accounting Standards:

The following are some of the limitations of setting of accounting standards:

1.Alternative solutions to certain accounting problems may each have arguments to

recommend them. Therefore, the choice between different alternative accounting

treatments may become difficult.

2.There may be a trend towards rigidity and away from flexibility in applying the

accounting standards.

3.Accounting Standards cannot override the statute. The standards are required to be

framed within the ambit of prevailing statutes.

Accounting standards in Indian context:


In India, Accounting Standards are issued by the Accounting Standards Board of the

Institute of Chartered Accountants of India in consultation with the National Advisory

Committee on Accounting Standards. The Institute of Chartered Accountants of India,

recognising the need to harmonise the diverse accounting policies and practices at

present in use in India, constituted the Accounting Standards Board (ASB) on 21st

April, 1977.

The scope and functions of Accounting Standards Board are:

a. To formulate Accounting Standards so that such standards may be established by

the council of the Institute in India, while formulating the accounting standards, ASB

will take into consideration the applicable laws, customs, usages and business

environment.

b. To support the objectives of International Accounting Standards Committees (IASC)

as the institute is one of the members of IASC. ASB will give due consideration to

International Accounting Standards while formulating the Accounting Standards to

the extent possible in the light of the conditions are practices prevailing in India.

c. To propagate the Accounting Standards and persuade he concerned parties to

adopt them in the preparation and presentation of financial statements.

d. To issue guidance notes on the Accounting Standards and give clarifications on

issues arising therefrom.

e. To review the Accounting Standards at periodical intervals.

INTRODUCTION TO IFRS:

Multinational and global companies across the world prepare financial statements for

each country in which they did business, in accordance with each country’s GAAP. In

order to reduce this burden of preparing multiple sets of financial statements need for

uniform International accounting standards was felt. As a result, International

Accounting Standards Committee (IASC) was constituted to issue International

Accounting Standards. It operated from 1973 to 2001, when it was restructured to

become International Accounting Standards Board (IASB). IASC when it lasted for 27

years had issued 41 accounting standards. At the time of establishment of IASB they
agreed to adopt the revised set of standards issued by IASC. But any standards to be

published after that, would follow series known as International Financial Reporting

Standards (IFRS- Standards issued by IASB).

MEANING OF IFRS:

IFRS is an acronym for International Financial Reporting Standards and covers full set

of principles and rules on reporting of various items, transactions or situations in the

financial statements. Often they are referred to as “principles based” standards

because they describe principles rather than dictate rigid accounting rules for

treatment of certain items.

In simple words, IFRS are a set of International accounting standards, stating how

particular types of transactions and other events should be reported in the financial

statements. They are the guidelines and rules set by IASB which the company and

organisation can follow while preparing their financial statements.

IFRS are designed as a common global language for business affairs so the company

accounts are understandable and comparable across international boundaries.

Components of IFRS:

IFRS comprises the following components:

1. International Accounting Standards (IASs) issued by IASC

2. International Financial Reporting Standards (IFRSs) issued by IASB

Both IAS and IFRS are standards themselves that prescribe rules or accounting

treatments for various individual items or elements of financial statements. IASs are

the standards issued before 2001 and IFRSs are the standards issued after 2001.

There used to be 41 standards named IAS 1, IAS 2, etc.., however, several of them

were superseded, replaced or just withdrawn.

3. Interpretations originated from Standing Interpretations Committee (SIC)

4. Interpretations originated from the International Financial Reporting Interpretations

Committee (IFRICS)

SICs and IFRICs are interpretations that supplements IAS/IFRS standards. SIC

were issued before 2001 and IFRIC were issued after 2001. They deal with more
specific situations not covered in the standard itself, or issues that arose after

publishing of certain IFRS.

OBJECTIVES OF IASB:

1.To achieve convergence in accounting standards around the world

2.To develop a single set of high quality, understandable, enforceable and

globally accepted International Financial Reporting Standards (IFRS)

(previously International Accounting Standards (IASs))

3.To develop financial reporting standards that provide a faithful portrayal of an

entity’s financial position and performance in its financial statements

4. Those standards should serve investors and other market participants in

making informed resource allocation and other economic decisions

5.The confidence of all users of financial statements in the transparency and

integrity of these statements is critically important for the effective functioning of

capital markets, efficient capital allocation, global financial stability and sound

economic growth

6.To provide guidance on IFRS

7.To promote the use of those standards

The main advantages to India by converging with IFRS are as follows:

a) Common basis of comparison: Most of the countries of the European Union have

switched over to IFRS. If companies in India also switched over to IFRS, it would

make transitions and dealings with companies of other countries who operate under

IFRS much easier. It would also give stock holders and other interested parties a

common basis of comparability.

b) Clarity and productivity: Under IFRS, financial makers use their own professional

judgement as to how to handle a specific transaction. This will lead to less time

being spent trying to follow all rules that are coupled with rule based accounting.

c) Consistent financial Reporting Basis: A consistent financial reporting basis would

allow a multinational company to apply common accounting standards with its

subsidiaries worldwide which would improve internal communication, quality of


reporting and group decision making.

IFRS also expected to result in better quality of financial reporting due to consistent

application of accounting principles and improvement in reliability of financial

statements. These are very consistent, reliable and easy to adopt ensuring better

quality of financial reporting.

d) Quality information: It is expected that the adoption of IFRS will be beneficial to

investors and other users of financial statements, by reducing the cost of comparing

alternative investments and increasing the quality of information. The companies

are also expected to benefit, as investors will be more willing to provide financing.

e) Improved access to international capital markets: Many Indian entities are

expanding and making significant acquisitions in the global market for which large

amount of capital is required. The majority of the stock exchanges require financial

information prepared under IFRS.

f) Lower cost of capital: Migration to IFRS will lower the cost of raising funds, as it will

eliminate the need for preparing dual sets of financial statements. It will also reduce

accountant’s fees abolish risk premiums and will enable access to all major capital

markets as IFRS is globally acceptable.

INDIAN ACCOUNTING STANDARDS (Ind AS):

These are a set of accounting standards notified by the Ministry of Corporate Affairs

which are converged with International Financial Reporting Standards (IFRS). These

accounting standards are formulated by Accounting Standards Board of Institute of

Chartered Accountants of India. With India deciding to converge with IFRS and not to

adopt IFRS, Ind AS is certainly the way forward for Indian Companies.

Convergence with IFRS means that India would not be following the IFRS as issued

by the IASB but would issue its own accounting standards in sync with the

International Financial Reporting Standards. And these synced Indian Accounting

Standards are popularly referred to as ‘Ind-AS’.

List of Indian Accounting Standards:

The Accounting Standards Board of the Institute of Chartered Accountants of India


has issued the following Accounting Standards:

AS 1 – Disclosure of Accounting policies

AS 2 – Valuation of Inventories

AS 3 – Cash Flow Statement

AS 4 – Contingencies and Events Occurring after the Balance Sheet Date

AS 5 – Net Profit or Loss for the period, Prior Period Items and Changes in

Accounting Policies

AS 6 – Depreciation Accounting

AS 7 – Construction Contracts (revised 2002)”’

AS 8 – Accounting for Research and Development (AS-8 is no longer in force

since it was merged with AS-26)

AS 9 – Revenue Recognition

AS 10 – Accounting for Fixed Assets

AS 11 – The Effects of Changes in Foreign Exchange Rates (revised 2003),

AS 12 – Accounting for Government Grants

AS 13 – Accounting for Investments

AS 14 – Accounting for Amalgamations

AS 15 – Employee Benefits (revised 2005)

AS 16 – Borrowing Costs

AS 17 – Segment Reporting

AS 18 – Related Party Disclosures

AS 19 – Leases

AS 20 – Earnings Per Share

AS 21 – Consolidated Financial Statements

AS 22 – Accounting for Taxes on Income.

AS 23 – Accounting for Investments in Associates in Consolidated Financial

Statements

AS 24 – Discontinuing Operations

AS 25 – Interim Financial Reporting


AS 26 – Intangible Assets

AS 27 – Financial Reporting of Interests in Joint Ventures

AS 28 – Impairment of Assets

AS 29 – Provisions, Contingent` Liabilities and Contingent Assets

AS 30 – Financial Instruments: Recognition and Measurement and Limited

Revisions to AS 2, AS 11 revised 2003), AS 21, AS 23, AS 26, AS 27, AS 28

and AS 29

AS 31 – Financial Instruments: Presentation

AS 32 – Financial Instruments: Disclosures

IND AS is also known as Indian Accounting Standards or Indian version of IFRS. Indian AS or IND
AS is used in the context of Indian companies.
Let us look at some of the points of difference between the IFRS and IND AS.

IFRS IND AS

Definition

IFRS stands for IND AS stands for


International Financial Indian Accounting
Reporting Standards, Standards, it is also
it is an internationally known as India
recognised accounting specific version of
standard IFRS

Developed by

IASB (International MCA (Ministry of


Accounting Standards Corporate Affairs)
Board)

Followed by
144 countries across Followed only in India
the world

Disclosure

Companies complying Such a disclosure is


with IFRS have to not mandatory for
disclose as a note that companies complying
the financial with Indian
statements comply Accounting Standards
with IFRS or IND AS

Financial Statement Components

It includes the It includes the


following following:

1. Balance Sheet
1. Statement of
financial position 2. Profit and loss
account
2. Statement of profit
and loss 3. Cash flow statement
3. Statement of 4. Statement of
changes in equity for changes in equity
the period
5. Notes to financial
4. Statement of cash statements
flows for the period
6. Disclosure of
accounting policies

Balance Sheet Format

Companies complying Companies complying


with IFRS need have with IND AS need
specific guidelines for have no such
preparing balance requirements for
sheet with assets and balance sheet format,
liabilities to be but the guidelines are
classified as current defined for presenting
and non-current balance sheet
Meaning:

Depreciation is a decline in the book value of depreciable assets due to wear and

tear, constant use and expiry of time during the estimated useful life of the asset.

Causes of Depreciation

1. By constant use.

2. By the expiry of time.

3. By accident.

4. By depletion.

5. By permanent fall in the market price.

Importance/need of providing depreciation:-

● For ascertaining the true profit or loss.

● For providing a true and fair view of the financial position.

● To ascertain the accurate cost of the product.

● To provide funds for the replacement of assets.

● For avoiding overpayment of income tax.

Factors determining the amount of Depreciation:-

1. The total cost of the asset.


2. The estimated useful life of assets.
3. Estimated scrap value.

Methods of providing or allocating depreciation:-

1. Straight-line method

2. Written down value method

3. Annuity method

1. Straight-line method
Depreciation is charged at a fixed percentage on the original cost of the asset. The amount of
depreciation remains equal from year to year and as such the method is also known as the ‘Equal
instalment method'.

(Accounting treatment)

Following entries are passed in this method:

1. Entry for purchase of asset:-

Asset a/c

To Bank a/c

2. Entry for providing depreciation at the

end of each year:-

Depreciation a/c

To asset a/c

3. Entry for the amount realized on the sale

of asset:-

Bank a/c

To asset a/c

4. Entry in case of loss on sale of asset:-

Profit /loss a/c

To asset a/c

5. Entry in case of profit on the sale of

asset:-

Asset a/c

To profit and loss a/c

WRITTEN DOWN VALUE METHOD

Under this method, the value of assets goes on diminishing year after year, the amount of depreciation
charged every year also goes on declining.

For example, if a machine is purchased for Rs.20,000 and depreciation is to be charged at 10% p.a.
according to written down value method the depreciation will be charged as:

● Ist year

10% of 20,000 = 2,000


● 2nd year

20,000-2,000 = 18,000

10% of 18,000 = 1,800

● 3rd year

18,000 - 1,800 = 16,200

10% of 16,200 = 1,620

And so on…

Difference between the straight-line method and written down value method.

Provision

Provision can be described as an amount kept aside to cover a known expense/liability in the future This
is the fund that is to be put aside by a company/organisation to cover the anticipated losses in the
future.

Example:-

1. Provision for depreciation.

2. Provision for bad debts.

3. Provision for discount on debtors.


Difference between provision and reserves:

JOURNAL

Introduction to Journal

Meaning, Characteristics, Advantages, Format and Limitations of a Journal

Meaning of a Journal:

According to M.J. Keeler, “A Journal is a chronological record of financial transactions of a

business.”

It is book of prime entry or original entry in which all the business transactions are recorded the

first in the sequence in which the transactions had actually occurred.

Meaning of Journalising:

According to Rowland, “The process of recording the transactions into journal is called

Journalising.”
Characteristics:

1.It is a chronological record of financial transactions of a business.

2.It is a book of original entry which records all the details of transactions from various source

documents.

3.It records both the aspects of a transaction i.e., debit and credit using Double Entry System of

Book Keeping.

4.It gives complete details of a transaction in one entry.

5.It forms the base for recording or transferring the journalised transactions to the individual

accounts known as Ledger Accounts.

6.Since, all the transactions are recorded for the first time in a Journal, it is correctly known as a

Book of Original Entry.

Advantages:

1.It provides complete accounting information in a chronological order.

2.It reduces the chances of errors in the accounting records since the amount debited can be

verified with the amount of corresponding credit.

3.It provides a base for recording or transferring the entries in the individual ledger accounts.

4.It helps in locating the errors in case of disagreement of Trial Balance.

5. It provides with the description of transaction that has been recorded that helps identify reason

for the record.

Types of Journal Entries:

Simple Journal Entry: It is the type of entry in which only two accounts are affected where one

account is debited and another account is credited with an equal amount.

Compound Journal Entry: It is the type of entry in which more than two accounts are affected

i.e., one or more accounts are debited and/or one or more accounts are credited or vice versa.
Format: Following is the format of a Journal along with the explanation for each head:

Date: Date of the transaction is entered in the first column. This date is entered only once

unless and until there is change in the date of transaction. It should be entered in a proper

sequence.

Particulars: Each business transaction has two accounts- debit and credit. In the first line of

the particular column, name of the debit account is written along with word “Dr.” at the end. In

the second line, start with the word “To” and after some space from the margin, the name of the

credit account is written.

Narration: Explanation of the transaction is provided within the brackets after each journal

entry is called narration.

Ledger Folio: All journal entries are posted later into the ledger accounts. The page number or

folio number of the ledger is recorded in the L.F. column of the journal. Till then, the column

remains blank.

Debit: The amount of the account being debited is written in this column.

Credit: The amount of the account being credited is written in this column.

Limitations:

1.As the numbers of transactions in a business are large, journal becomes bulky and voluminous

and therefore is not suitable in case of such large volume of transactions.

2.It is considered as a difficult process as recording of journal entries requires proper

identification of accounts and correct compliance of the accounting concepts and conventions.

3.Cash transactions are usually recorded in a separate book called ‘cash book’. Those
transactions are not recorded in journal.

4.After recording journal entries, separate ledger account is required to be prepared for individual

account balances. Therefore, a Journal can never be used as a substitute to ledger.

Meaning, Advantages and Accounting for Discount and Rebate:

Discount: It is the amount of reduction in the price of goods and/or services or a reduction in the

total amount payable for such goods or services. Such discount is further classified as Trade

Discount and Cash Discount:

Trade Discount:

Meaning: It is a reduction in the prices of the goods allowed by the seller to the buyer for

buying goods of certain quantity or value (bulk purchase discount). When such discount is

allowed, Purchases and Sales are recorded in the books at their net value i.e., Purchases –

Trade Discount and Sales – Trade Discount respectively. Such trade discount is allowed on

sale of goods, therefore, it is allowed on both cash and credit sales. GST is applied at the net

value of sale.

Advantages:

i. It improves sales by encouraging the purchaser to buy larger quantities.

ii. It reduces the purchase cost of the purchaser and therefore, can be used as a tool to

face competition.

iii. It increases the profit margin for the retailers and helps them earn more profits by

making sales at list price.

iv. Differential pricing may be followed by reseller as it enables them to sell at different

prices without even reprinting the catalogues or changing the price given in the articles.

Cash Discount:

Meaning: It is allowed for timely payment of the amount. Such amount is recorded in the

books for which it is treated as an expense by the party allowing such discount and income

for the party receiving such discount.

Advantages:

i. It helps the seller of the goods realise the payment promptly as it encourages the

debtors to make the payment within a specified period.


ii. It reduces the bad debts and improves cash inflow of the business.

iii. It enables sale of goods at lower prices by way of better cash discount.

Rebate:

Meaning: It is a reduction in the price of the goods after the goods have been sold for reasons

other than that for allowing trade discounts (goods sold when delivered turned to be of lower

quality). It is offered and allowed on sales completed in the past.

Definition of Ledger:

Ledger is a book which contains various accounts. In simple words, ledger is a set of accounts.

It includes all accounts of the business enterprise whether Real, Nominal or Personal. Ledger

may be kept in any of the following two forms: Bound Ledger; and Loose Leaf Ledger. It is

common to keep the ledger in theform of loose-leaf cards these days instead of keeping them

in bounded form. This helps in posting transactions particularly when mechanized system of

accounting is used. Interestingly, nowadays, mechanized system of accounting is preferred

over the manual system of accounting.

Posting Process:

The term ‘Posting„ means transferring the debit and credit items from the Journal to their

respective accounts in the ledger. It is important to note that the exact names of accounts

used in the Journal should be carried to the ledger. For example: If in the Journal, Salary

Account has been debited, it would not be correct to debit the Outstanding Salary Account in

the Ledger. Therefore, the correct course would be to use the same account in both the

Journal and Ledger.

Ledger posting may be done at any time. However, it must be completed before the annual

financial statements are prepared. It is advisable to keep the more active accounts posted up

to date. The examples of such accounts are the cash account, personal accounts of various

parties, etc.

The Ledger posting may be made by the book-keeper from the Journal to the Ledger by any of

the following methods:

1.He may take a particular side first. For example, he may take the debits first and make the

complete postings of all debits from Journal to the Ledger.


2.He may take a particular account first and post all debits and credits relating to that account

appearing on one particular page of Journal. He may then take some other account and

follow the same procedure.

3.He may complete posting of each journal entry before proceeding to the next entry.

It is advisable to follow the last method. Further, one should post each debit and credit item

as it appears in the Journal.

The Ledger Folio (L.F.) column in the Journal is used at the time when debits and credits are

posted to the Ledger. The page number of the Ledger on which the posting has been done is

mentioned in the L.F. Column of the Journal. Similarly a folio column in the Ledger can also

be kept where the page from which posting has been made from the Journal. Thus, these are

cross references in both the Journal and theLedger. A proper index must be maintained in the

Ledger giving the names of the accounts and the page number. A specimen of Ledger is given

below:

Rules Regarding Posting:

The following rules must be observed while posting transactions in the Ledger from the

Journal:

i) Separate accounts should be opened in the Ledger for posting transactions relating to

different accounts recorded in the Journal. For example, separate accounts may be opened for

sales, purchases, sales returns, purchases returns, salaries, rent, cash, etc.

ii) The concerned account which has been debited in the Journal should also be debited in the

Ledger. However, a reference should be made of the other account which has been credited
in the Journal. For example, for salaries paid, the salaries account should be debited in the

Ledger, but reference should be given of the Cash Account which has been credited in the

Journal.

iii) The concerned account, which has been credited in the Journal; should also be credited in

the Ledger, but reference should be given of the account, which has been debited in the

Journal. For example, for salaries paid, Cash Account has been credited in the Journal. It will

be credited in the Ledger also, but reference will be given of the Salaries Account in the

Ledger.

Thus, it may be concluded that while making posting in the Ledger, the concerned account

which has been debited or credited in the Journal should also be debited or credited in the

Ledger, but reference has to be given of the other account which has been credited or debited

in the Journal, as the case may be.

Illustration:

Journalize the following transactions, post them in the Ledger and balance the accounts as on

31st March, 2006.

1. Ram started business with a capital of Rs. 10,000.

2. He purchased goods from Mohan on account for Rs. 2,000.

3. He paid cash to Mohan for Rs. 1,000.

4. He sold goods to Suresh on account for Rs. 2,000.

5. He received cash from Suresh for Rs. 3,000.

6. He further purchased goods from Mohan on account for Rs. 2,000.

7. He paid cash to Mohan for Rs. 1,000.

8. He further sold goods to Suresh on account for Rs. 2,000.

9. He received cash from Suresh for Rs. 1,000

Solution:
It is to be noted that the balance of an account is always known by the side which is greater.

For example, in the above illustration, the debit side of the Cash Account is greater than the

credit side by Rs. 12,000. It will be therefore said that Cash Account is showing a debit

balance of Rs. 12,000. Similarly, the credit side of the Capital Account is greater than debit

side by Rs. 10,000. It will be, therefore, said that the Capital Account is showing a credit balance of Rs.
10,000.

Meaning & Definition of Trial Balance:

Trial balance is a statement which shows the balanes in the accounts maintained in the Ledger

and Cash Book balances, i.e. Cash and Bank Balances.

According to J.R.Batliboi – “A Trial Balance is a statement, prepared with the debit and

credit balances of the Ledger Accounts to test the arithmetical accuracy of the books.”

According to Carter – “A Trial Balance is the list of debit and credit balances, taken out

from the Ledger. It also includes the balances of cash and bank taken from the Cash Book.”

Trial Balance is prepared after having posted the Journal entries into the Ledger and balancing

the Accounts.

To conclude, a Trial Balance is a summary of all the ledger balances existing as on aparticular

date.

In case, the various debit balances and the credit balances of the different accounts are taken

down in a statement, the statement so prepared is termed as a ‘Trial Balance„. In other words,

Trial Balance is a statement containing the various ledger balances on a particular date.

Objectives of Preparing a Trial Balance:

(i) Checking of the arithmetical accuracy of the accounting entries

As indicated above, Trial Balance helps in knowing the arithmetical accuracy of the

accounting entries. This is because according to the dual aspect concept for every debit, there

must be an equivalent credit. Trial Balance represents a summary of all ledger balances and,

therefore, if the two sides of the Trial Balance tally, it is an indication of this fact that the

books of accounts are arithmetically accurate. Of course, there may be certain errors in the

books of accounts in spite of an agreed Trial Balance. For example, if a transaction has been

completely omitted, from the books of accounts, the two sides of the Trial Balance will tally,
in spite of the books of accounts being wrong. This has been discussed in detail later in a

separate Chapter.

(ii) Basis for financial statements

Trial Balance forms the basis for preparing financial statements such as the Income Statement

and the Balance Sheet. The Trial Balance represents all transactions relating to different

accounts in a summarized form for a particular period. In case, the Trial Balance is not

prepared, it will be almost impossible to prepare the financial statements as stated above to

know the profit or loss made by the business during a particular period or its financial

position on a particular date.

(iii) Summarized ledger

It has already been stated that a Trial Balance contains the ledger balances on a particular

date. Thus, the entire ledger is summarized in the form of a Trial Balance. The position of a

particular account can be judged simply by looking at the Trial Balance. The Ledger may be

seen only when details regarding the accounts are required.

A Trial Balance contains mainly five columns:

a) Serial Number

b) Heads of Account

c) Ledger Folio (L.F.)

d) Debit Balance

e) Credit Balance

Characteristics or Features of Trial Balance:

1. It is a list of balances of Ledger Accounts and Cash Book.

2. It is not a part of the Double Entry System of Book Keeping. It is a result of Double Entry

System of Book Keeping. It is only a working paper.

3. It can be prepared on any date if the accounts are balanced.

4. It verifies the arithmetical correctness of posting from Journal to the Ledger.

5. It is not a conclusive proof of the accuracy of the books of account since some

compensating errors are not shown (disclosed) by Trial Balance.

6. It is helpful in preparation of Trading Account, Profit and Loss Account and the Balance Sheet.
Preparation of Trial Balance:

There are Three methods of constructing a trial Balance: -

1. Total Methood: - Uner this method, total amount of debit side of each ledger account is

shown on the debit side of the Trial Balance. Similarly, total amount of credit side of

each ledger account is shown on the credit side of the Trial Balance. After this, amount

of debit and credit side items of the Trial Balance are totaled. The total of debit column of

Trial Balance showed agree with the total iof credit column in the Trial Balance.

However, this method is not widely used in practice.

Requirement: - A Trial Balance under this method can be prepared immediately after the

completion of posting to the ledger.

2. Balance method: - Under this method Trial Balance is prepared by showing the

balances of different accounts in the ledger. All the accounts showing debit balance in

the ledger are put on the debit side of Trial Balance. Similarly, the accounts showing

credit balance are put on its credit side. If, however, an account shows no balance (i.e.,

when debit and credit side totals of account are equal), the account is not shown in the

Trial Balance. After this, the debit and credit columns of the Trial Balance are totaled. If

the total of both debit and credit amounts are equal, it is said that the Trial Balance has

agreed. This is most wided used method in practice for preparing a Trial Balance.

Requirement: - This method can be followed only when all the ledger accounts have been

balanced.

Format of Total Balance


Accounting Treatment of Closing Stock in Trial Balance:-

1. Generally, Closing stock does not appear in the Trial Balance because a separate

account for this is not opened in the General Ledger.

2. Closing stock is shown in the adjustment below the Trial Balance.

3. If the adjustment entry regarding ‘Closing Stock’ has already been passed then

‘Closing Stock’ will be shown in the debit column of the Trial Balance.

Accounting Treatment of Opening Stock in Trial Balance: -

1. Opening Stock is shown in the debit side of the Trial balance.

2. If the Cost of goods sold in given in Trial Balance and ‘Opening Stock’ as well as

‘Closing Stock’ are also given, then in that case:

a) Cost of Goods Sold will be shown in the debit column of Trial Balance

b) Closing Stock will be shown in the debit column of Trial Balance.

c) Opening Stock will not be shown in Trial Balance.

3. Total-cum-Balances Method: - This method is a combination of balances method and totals

method. So under this method four columns are provided for amount. Two columns for showing

the debit and credit balances of various accounts and two columns for showing the debit and

credit totals of various accounts.

This method is also not used in practice, the reason being it istime consuming and

hardly serves any special purpose.

Rule :

All Assets, Expenses and Losses Account will show debit balance

All Liabilities, Capital and Incomes/gains will show credit balance.


double-entry system of bookkeeping
“Every business transaction that involves money has two aspects’’ and these two-fold aspects of a business
transaction give rise to the double-entry bookkeeping system. A double-entry system is a complete system of
recording the financial transactions of a business.
Under this system, preparing a profit or loss account and balance sheet can help in determining the actual
financial position of the business.

Characteristics of the double-entry system


• Affecting two accounts
A business transaction affects two accounts where one is debited and the other is credited. Certain
transactions may affect more than two accounts but the amount that is debited or credited must be equal.
• Following certain rules, while recording transactions
Various rules need to be followed while debiting or crediting the account. It does not mean that any account
is debited or credited. Debits and credits are made following specified rules.
• Preparation of trial balance
As one account is debited and the other is credited, all debits must be equal to all the credits. This ensures
the arithmetical accuracy of the accounting records of the business.

Advantages of Double-entry System


• Scientific system
This system of bookkeeping is more scientific because transactions are recorded according to specified rules.
• A complete record of business transactions
Under this system, there are three accounts, i.e., personal accounts, real accounts, and nominal accounts
that help record both aspects of transactions.
• Preparation of trial balance
As per this system, arithmetical accuracy can be checked by preparing a trial balance as the debit amount
must be equal to the credit amount.
• Knowledge of the financial position of the business
Separate accounts are prepared for each transaction and businessmen can understand the financial position
of their business at the end of the accounting period, so this system provides the true and exact financial
position of the business.
• Legal approval
Joint-stock companies, banks, and insurance companies are required to maintain their accounts as per the
double-entry system. Books maintained through this system are reliable as per the companies and various
other acts.
Disadvantages of the double-entry system
• Less economical
As there are a large number of books that need to be maintained under this system, some specialised
professionals are required, which makes this system less economical.
• Difficult to apply rules
It is quite complex to apply the rules of debit and credit. Proper financial knowledge, training, and education
are required to have command over the rules of this system.
• Types of errors that are not disclosed
In this system, only arithmetic accuracy can be checked by preparing a balance sheet. However, errors of
omission, commission, principle, and compensation are not disclosed by this system.

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