Fundamental of Accounts Final Book-2018

IFA – Indian Financial Academy www.ifaindia.
org
FUNDAMENTAL
OF ACCOUNTS
Classes at
209, 2nd floor, Sharda Niketan,
Near Deepali Chowk, Pitampura, Delhi,
110034
Behind every good Business is a great Accountant 1

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Phone: 011-47014601, 9899982600

www.ifaindia.org
TOPICS PAGE NO.
CHAPTER-1
INTRODUCTION

TO ACCOUNTING
3
CHAPTER-2
ACCOUNTING
TERMS 4

CHAPTER-3
ACCOUNTING
STANDARD
ERROR!
BOOKMARK NOT
DEFINED.

CHAPTER-4
BUSINESS
TRANSACTION –
VOUCHER 4
CHAPTER-5
ACCOUNTING

EQUATION 4
CHAPTER -6
ACCOUNTING
PROCEDURES –
RULES OF DEBIT
AND CREDIT 4

CHAPTER-7
JOURNAL 4
CHAPTER -8
TRADE DISCOUNT
AND CASH
DISCOUNT 4

CHAPTER -8
TRADE DISCOUNT
AND CASH
DISCOUNT ERROR!
BOOKMARK NOT
DEFINED.

CHAPTER -9
SPECIAL
PURPOSE BOOKS
I – CASH BOOK 4
CHAPTER -10
BANK

RECONCILIATION
STATEMENT 4
CHAPTER -11
DEPRICIATION 4
CHAPTER-13
ACCOUNTING
FOR SHARE
CAPITAL 4

Chapter Introduction to Accounting

1
MEANING OF ACCOUNTING
According to American Institute of Certified Public Accountants
“Accounting is the art of Recording, Classifying and Summarizing in a significant manner and in
terms of money, transactions and events which are, in part at least, of a financial character, and
interpreting the results thereof.”
According to American Accounting Association
“Accounting is the process of identifying, measuring and communicating economic information to

permit informed judgement and decisions by the users of the information. According to this
definition, “Accounting is a processing system, whose input is financial transaction and output is
financial statements communicating various information to various interested groups”.
ACCOUNTING PROCESS
The procedure of accounting includes generating financial information and their use. Accordingly
the following steps are taken in accounting:
 Recording – This is the basic function of accounting. Accounting consists of recording business
transactions and events in a systematic way in Journal etc.
 Classifying – Classifying means grouping the transactions of same nature at one place. This is
done by preparing appropriate accounts in Ledger. For example, all transactions relating to cash
would be recorded in the Cash Account.
 Summarising – Summarising involves the preparation of financial statements i.e. Trial Balance;
Profit and Loss Account; Balance Sheet and Cash Flow Statement. Summarising helps in
conveying economic information to various parties interested in them.
 Analysing – The term Analysis means methodical classification of the data given in the financial
statements.

 Interpreting – It is concerned with explaining the meaning and significance of the relationship
as established by the analysis of accounting data.
 Communicating – It is concerned with the transmission of summarised, analysed and
interpreted information to the end users to enable them to make balanced decisions. This is
done through accounting reports.
Accounting process
Communicating Financial transactions

To the Users or events
Recording
Analysis and Journal
Interpretation 1. Cash books
2. Purchases book
3. Sales book
4. Purchases returns book
5. Sales returns book
6. Bills payable book
Summarizing 7. Bills receivable book
Trial balance 8. Journal proper
Trading and profit and loss account
Balance Sheet
Classifying
(Posting into ledger)
BRANCHES OF ACCOUNTING

1. Financial Accounting: It is the original form of Accounting. Basically, it is concerned with the
recording and classifying, analyzing, summarizing and interpreting of financial transactions and
events and communicating the results, derived there from to the users of the financial
statements.
2. Management Accounting: As the name suggests, it is the accounting for management. This
accounting provides useful information to management to discharge their functions. The
management accounting covers various areas, such as financial accounting, cost accounting,
budgetary control, inventory control, statistical methods, internal auditing, etc.
3. Cost Accounting: it is mainly concerned with the determination of the cost of each product so
that the reasonable selling price of the product may be determined. The purpose of this branch
is of accounting is to ascertain the cost, to control the cost and to communicate the information
to the decision maker.
4. Social Responsibility Accounting: Now a days, this new branch of accounting has also been
developed. It is the accounting of social aspect of business. It is the process of identifying and
measuring the social effects of the business decisions and communicating to the users of
accounts and society.
5. Human Resource Accounting: Human Resource Accounting is an attempt to identity, quantity

and report investments made in human resources of an organization.
BOOK KEEPING, ACCOUNTING AND ACCOUNTANCY

Meaning of Book Keeping
Book keeping is a branch of knowledge that educates us as to how financial records are to be
maintained, Book keeping is a part of accounting and is concerned with the recording of financial
data in the books of accounts, it is the process by which a record of financial transactions is
maintained.

Accounting
Accounting is an art of recording, classifying and summarizing the financial data and interpreting the
results there of. Thus, accounting is a wider concept than Book keeping, Book keeping is a part of
accounting.
Basis of Book-Keeping Accounting
Distinction
Scope It involves recording of transaction of It involves recording analysis and

accounts. It does not cover preparation interpretation of business
of final accounts. transactions. It covers preparation
of final accounts.
Stage It is the primary stage and it is done It is the secondary stage and
first. begins after book-keeping.
Knowledge It does not require special knowledge It requires special knowledge and
and ability. It is done by clerical i.e. ability. It is done by qualified and
junior staff. senior staff.
Interest Outsiders do not have any interest in it. Various groups including outsiders
have interest in it.
Nature It is complementary to accounting It is not complementary to book-

keeping.
Branch There is no branch of Book-Keeping. It has several branches like

financial, cost, management
accounting etc.
Financial Financial position of the business Financial position of the business is

position cannot be ascertained. ascertained on the basis of the
accounting reports.
Base/Language It constitutes as a base for accounting. It is considered as a language of

the business.

OBJECTIVES OF ACCOUNTING
Following are the objectives of accounting:
1. Systematic recording of transactions: – Accounting keeps a systematic record of financial
transactions. There is a limit to human memory and therefore, a systematic record of all
transactions is essential for every business. These recorded transactions are later on classified
and summarized logically for the preparation of financial statements and for their analysis and
interpretations
2. Ascertainment of operational profit or loss – Accounting helps in ascertaining the net profit
earned or loss suffered by the business. It is done by preparing Profit and Loss Account.
3. Ascertainment of the financial position of the business – Every businessman desires to
know about his financial position i.e. where he stands; what he owns and what he owes. This is
served by the Balance Sheet. Balance Sheet is a statement of assets and liabilities of the
business on a particular date.
4. Communication of results – Another function of accounting is to communicate the results to
interested groups viz., investors, employees, creditors etc.
5. To facilitate rational decision-making – Accounting facilitates rational decision-making by
providing relevant data.
6. (6)To meet legal requirements – The next function of accounting is to devise such a system as will
meet the legal requirements
Functions of Accounting
The main functions of accounting are as follows:
1. Measurement: Accounting measures past performance of the business entity and depicts its
current financial position.
2. Forecasting: Accounting helps in forecasting future performance and financial position of the
enterprise using past data.
3. Decision-making: Accounting provides relevant information to the users of accounts 'to aid
rational decision-making. .

4. Comparison & Evaluation: Accounting assesses performance achieved in relation to targets

and discloses information regarding accounting policies and contingent liabilities which play an
important role in predicting, comparing and evaluating the financial results.
5. Control: Accounting also identifies weaknesses of the operational system and provides
feedbacks regarding effectiveness of measures adopted to check such weaknesses.
6. Government Regulation and Taxation: Accounting provides necessary information to the
government to exercise control on the entity as well as in collection of tax revenues.
LIMITATIONS OF ACCOUNTING
Following are the limitations of accounting:
1. Only monetary transactions – Accounting records only those transactions which can be
measured in terms of money. Transactions and events howsoever important they may be, do
not find a place in the accounts if they cannot be measured in terms of money.
2. Assets at cost – Assets are recorded at their cost and not at their market price. Hence financial
statements fail to show real worth of the business.
3. Personal Judgement – Adoption of various accounting policies depends on the personal
judgement of the accountant. As a result, financial statements may not be objective and
comparable.
4. Not Exact – Accounting information is sometimes based on estimates. Hence the financial
statements do not reflect the true position of the business.
5. Not a good tool for management – Accounts record the past fact which does not help the
management for decision-making. Accounts do not provide for evaluation of business policies
and plans.
.
USERS OF ACCOUNTING INFORMATION
Users of accounting information may be categorized into internal users and external users.
Internal users
i. Owners: Owners contribute capital in the business and thus are exposed to maximum risk.
Naturally, they are interested in knowing the profit earned or loss suffered by the business
besides the safety of their capital. The financial statements give the information about profit or
loss and financial position of the business.

ii. Management: The management makes extensive use of accounting information to arrive at
informed decisions such as determination of selling price, cost controls and reduction,
investment into new project, etc.
iii. Employees and Workers: Employees and workers are entitled to bonus at the year end,
which is linked to the profit earned by an enterprise. Therefore, the employees and workers are
interested in financial statements. Beside the financial statements also reflect whether the
enterprise has deposited its dues into the provident fund and employee’s state insurance, etc., or
not.
External users
I. Banks and Financial Institutions: Banks and financial institutions are an essential part of any
business as they provide loans to the businesses. Naturally, they watch the performance of the
business to know, whether it is making progress as projected to ensure the safety and recovery of
the loan advanced. They assess it by analyzing the accounting information.
II. Investors and potential investors: Investment involves risk and also the investors do not have
direct control over the business affairs. Therefore, they rely on the accounting information available
to them and seek answers to the questions such as –what is the earning capacity of the enterprise
and how safe is their investment?
III. Creditors: Creditors are those parties who supply goods or services on credit. It is a common
business practice that a large amount of supplier’s remains invested in credit sales. Before granting
credit, creditors satisfy themselves about the credit worthiness of the business, the financial
statements help them immensely in making such an assessment.
IV. Government and its authorities: The government makes use of financial statements to compile
national income accounts and other information. The information so available to it enables them to
take policy decisions. Government levies varied taxes such as excise duty, VAT, service tax and
income tax. These government authorities assess the correct tax dues from an analysis of financial
statements.
V. Researchers: Researchers use accounting information their research work.
VI. Consumers: Consumers require accounting information for establishing goods accounting control
so that cost of production may be reduced with the resultant reduction of the prices of products they
buy. Sometimes, information to fix fair prices so that consumers and producers are not exploited.

VII. Public : They want to see the business running since it makes substantial contribution to the
economy in many ways, employment of people, patronage to suppliers, etc. thus, financial
accounting provides useful financial information to various user groups for decision – making.
SYSTEMS OF ACCOUNTING
The systems of recording transactions in the books of accounts are classified into two types:
1. Double entry system; and
2. Single entry system.
ROLE OF ACCOUNTING
The role of accounting has been changing with the change in economic environment and increasing
societal demands, at present, accounting plays the following different roles:
1. Role of language: In a popular sense accounting has been referred to as ‘the language of
businesses because of its role in maintaining and processing all relevant financial information that
an entity requires for its managing and reporting purposes. The basic function of a language is to
serve as a means of communication. Accounting also serves this function. It communicates the
results of business operations to various parties who have some stake in the business, proprietor,
creditors, investors, etc.
2. Role of information system: Accounting as an information system, collects and communicates
financial information about an enterprise to the interested parties. However, accounting information
relates to past transactions and is quantitative and financial in nature, it ignores qualitative
information (like quality of management, quality of labor force) and non – financial information.
These limitations of accounting must be considered while making use of accounting information.
3. Role of Historical Record: Usually, Accounting supplies information in the form of profit and loss
account and balance sheet at the end of the year. So the information provided is historical in nature.

Chapter Accounting Terms

2
1. Assets: - Assets are properties of the business that help it to earn revenue. Assets are the
resources which result in economic benefits to the business. Assets are the resources which result
in economic benefits to the business. Assets are not meant for sale. They are maintained by the
business because they increase the operational efficiency of the business. In other words, anything
which will enable the firm to get cash of a benefit in the future is an asset. In the words of Finny and
miller, “Assets are future economic benefits, the rights, which are owned or controlled by an
organization or individual.” Amount owed by debtors, stock of goods, cash, furniture, machines,
building, etc, are a few examples of assets.
Assets can be classified to be:

I. Fixed Assets: fixed Assets are those assets which are purchased for the purpose of operating the
business and not for resale. Examples of Fixed Assets are land, building, machinery, furniture, etc.
II. Current Assets : current Assets are those assets of a business which are kept for short –term with
a purpose to convert Assets are those assets of a business which are kept for current Assets are
unsold goods, debtors, bills receivables, bank balance , etc.
III. Tangible Assets: Tangible Assets are those assets which have physical existence; they can be
seen and touched. Examples of Tangible Assets are land, building, plant and machinery, computer,
etc.
IV. Intangible Assets: Intangible Assets are those assets which do not have any physical form they
cannot be seen and touched. Examples of intangible Assets are goodwill, trademarks, patents, etc.
V. Wasting Assets: Wasting assets are those assets which are natural resources consumed during
the process of use. Examples of wasting assets are mines, quarries, etc.
2. Liabilities: Liabilities are the amounts which a business firm owes to others (other than
proprietors). Liabilities are also known as creditors. Liabilities mean the amount which the business
owes to outsiders, that is, excepting the proprietors. In the words of Finny and Miller, “Liabilities are

debts, they are amounts owed to creditors,” Thus, the claims of those who are not owners are called
Liabilities. This can be expressed as:
Liabilities = Assets - Capital
In business, transactions are recorded taking business to be an entity distinct from its owners. Thus,
capital invested by the proprietors is a liability but an internal liability. On the other hand, external
liability is a liability that is payable to outsiders, other than the proprietors.
External liability arises because of credit transactions or loans raised. Examples of liabilities are
creditors, bank overdraft, bills payable, outstanding liabilities.
Liabilities can be classified into the following:
 Long–Term liabilities: These are those liabilities which are payable after a long-term, (generally
more than a year). Examples of Long-Term Liabilities are long-term loans, debentures, etc.
 Current Liabilities: These are liabilities which are payable in the near future (generally within a
year). Examples of current Liabilities are creditors, bank overdrafts, bills payable, short-term loans,
etc.
3. Capital: Capital means the amount (in terms of money or assets having money value) which
the proprietor has invested in the business and can claim from it. For the firm, it is a liability towards
the owner. It is so because the owner is treated separate from the business. Capital is also known
as owner’s Equity, proprietorship and net worth. Owner’s Equity means owner’s claim against the
assets of the business. It will always be equal to assets less liabilities. This can be expressed as:
Capital = Assets – Liabilities
4. Expense: Expense is the amount spent in order to produce and sell the goods and services
which produce the revenue. “Expense is the cost of the use of things or the services for the purpose
of generating revenue.” Examples of Expense are payment of salaries, wages, rent, etc.
5. Income: Income is the profit earned during a period of time. In other words, the difference
between revenue and expense is called Income. For example, goods costing Rs. 15,000 are sold

for Rs. 21,000, the cost of goods sold, Rs. 15,000 is expense, the sale of goods, Rs. 21,000 is
revenue and the difference, Rs. 6,000 is income. It can, therefore, be expressed as:
Income = Revenue – Expense

6. Expenditure: Expenditure is the amount spent or liability incurred for the value received.
Expenditure is a payment (or a money sacrifice) for a benefit received. Expenditure may be
categorized into:
 Capital Expenditure: Capital Expenditure is the amount spent in purchasing assets which will give
benefits over a number of accounting periods. It means expenditure incurred to acquire fixed assets
of its improvement. Examples of capital Expenditure are purchase of machinery to manufacture
goods say auto parts, purchase of furniture of computers to conduct business. Capital Expenditure
is shown on the assets side of the balance sheet.
 Revenue Expenditure: Revenue Expenditure is the amount spent to purchase goods and services
that are consumed during the accounting period. Revenue expenditure does not increase the
earning capacity but it maintains the earning capacity in the current year. Revenue Expenditure is
shown on the debit side of the profit and Loss Account.
7. Revenue: Revenue means the amount, which as a result of operations, sale of goods or
services, is added to the capital. “Revenue is an inflow of assets, which results in an increase in the
owner’s equity.” Examples of Revenue are receipts from sale of goods, rent, commission, etc,
Revenue differs from income. Sale of goods and services is revenue and cost of sale of goods and
services is expense. The difference between revenue and expense is income.
8. Debtor: A person who owes amount to the enterprise generally on account of credit sales of
goods is called a Debtor. R or example, when goods are sold to a person on credit that person is
called a Debtor. Because he owes the account to the enterpr4ise. The amount due is known as
debt.

9. Creditor: A person to whom an enterprise owes amount on account of credit purchases of

goods of services is called a creditor. FOR EXAMPLE, Mohan is a creditor of a firm when goods are
purchased on credit from him.
10. Goods: They refer to items forming part of the Stock-in-Trade of an enterprise, which are
purchased of manufactured with a purpose of selling. In other words, they refer to the products in
which an enterprise is dealing. For an example enterprise dealing in home appliances such as T.V.
fridge, A.C. etc, these are goods, similarly for a stationer, stationery is goods, whereas for others, it
is an item of expense (not purchases). An enterprise may purchase assets for use in furtherance of
business or stationery for use in the business, but they are not purchases of ‘goods’ but fixed asset
and expense respectively.
11. Cost: It is the amount of expenditure incurred on or attributable to a specified article, product or
activity.
12. Gain: It is a profit that arises from transactions which are incidental to business such as sale of
investments of fixed assets at more than their book values. The term gain is used to indicate
increase in capital from incidental transactions. Gain may be operating gain or non–operating gain.
13. Stock or inventory: Stock is the tangible property held by an enterprise for the purpose of sale
in the ordinary course of business or for the purpose of using it in the production of goods meant for
sale of services to be rendered. Stock may be opening stock or closing stock. In case of a trading
concern it comprises of closing stock in Hand or the amount of goods which are lying unsold at the
end of an accounting period. In case of a manufacturing concern, closing stock comprises raw
materials, work –in – progress (semi- finished goods ) and finished goods in hand on the closing
date. Similarly, opening stock (beginning inventory) is the amount of stock at the beginning of the
accounting period. Stock is classified in the balance sheet as a current asset; the stock is valued on
the basis of “cost or market prices whichever is lower” principle.
14. Purchase: The term purchase is used only for purchase of goods. Goods are those things
which are purchased for resale or for producing the finished products which are also to be sold. The

term ‘purchased for cash are called cash purchases but if goods are purchased of credit, it is
referred to ass credit purchases.
 Purchases Returns: Goods purchased may be returned due to any reason, say, they are not as per
specifications of are defective. Goods returned are known as purchases returns or Returns outward.
15. Sale: This term is used for the sale of only those goods dealt by the firm. The term ‘sales’
includes both cash and credit sales. When goods are sold for cash, they are cash sales but if goods
are sold and payment is not received at the time of sale, it is referred to as credit sale
 Sales Returns: goods sold when returned by the purchaser are termed as sales return inwards.
16. Loss: A loss is an excess of expenses of a period over its related revenues which may arise
from normal business activities. It decreases the owner’s equity. It also refers to money or money’s
worth lost (or cost incurred) against which the firm receives no benefit, cash of goods lost in theft, It
also arises from events of non –recurring nature, loss on sale of fixed assets.
17. Profit: It is the surplus of revenues of a business over its costs; profit is normally categorized
into gross profit and net profit.
 Gross profit: Gross profit is the difference between sales revenue and the proceeds of goods sold
and/or services rendered over its direct cost.
 Net profit: Net profit is the profit made after allowing for all expenses. In case expenses are more
then the revenue, it is Net Loss.
18. Voucher: Voucher is an evidence of a business transaction. Examples of voucher are cash
memo, Invoice or Bill, Receipt Debit/Credit Notes, etc.
19. Discount: When customers are allowed any type of reduction in the prices of goods by the
business, it is called a discount. When some discount is allowed in the prices of goods on the basis
of sales, it is called a Trade Discount but when debtors are allowed some discount in prices of the
goods for timely payment, it is called a cash discount.
20. Transaction: The term transaction means a financial event entered by the parties and entered
in the books of account. In the words of L.C.Copper, “A person’s dealings in money or money’s

worth are termed as transactions.” It is a financial event, which can be expressed in terms of money
and brings change in the financial position of an enterprise. It is concerned with two parties involving
the transfer of exchange of goods of services. Examples of a transaction are sale of goods,
purchases of goods, receipt from debtors, payment made to creditors, purchase of sale of fixed
assets, payment of dividend, etc.
21. Characteristics of a Transaction

 It is concerned with money or money’ worth of gods of services.
 It arises out of the transfer of exchange of goods or services.
 It brings about a change in the financial position (assets and liabilities) of a business concern.
 It has an effect on the accounting equation of any business firm.
 It has dual aspects or sides- ‘receiving’ (Debit) and ‘giving’ (Credit) of the benefit.
In other words, every transaction has two sides –one side is ‘receiving’ and the other side is ‘giving’
the benefit.
A transaction may be a cash transaction or a credit transaction. When the amount is
transacted immediately on entering into a transaction it is a cash transaction and promise to pay
later, it is a credit transaction. Transactions may be external (between a business entity and a
second party, for example, goods sold on credit to Z) or internal (does not involve second party,
depreciation charged on machiner
21 Drawings: It is the amount of money or the value of goods which the proprietor takes for his
domestic or personal use. Drawing reduces the investment (or capital) of the owners.
22 Account: Account is a summarized record of relevant transactions at one place relating to a

particular head. It records not only the amount of transactions but also their effect and direction.
23. Books of Account: Books of accounts refer to journal and Ledger in which transactions are
recorded.
24. Entry: A transaction and event when recorded in the books of accounts is known as an entry

25. Debit: An account has two parts debit and credit. The left side is the debit side while the right
side is the credit side. If an account is to be debited. Then the entry is posted to the debit side of the
account .In such an event, it is said that the account is debited.
26. Credit: Credit is the right side of an account. In an account is to be credited, and then the entry
is posted to the credit side of the account. In such an event, it is said that the account is credited.
27. Proprietor: The person who makes the investment and bears all the risks connected with the
business is called the proprietor.
28. Receivables: the term ‘receivables’ includes the outstanding amount due from others.
Sometimes, a debtor may accept a bill of exchange, which is payable after a given period. Such a
bill is known as Bill Receivable. Sometimes, a debtor promises to pay the specific amount in
writing after a specified period. Such a promise is known as a promissory note and is recorded as
note receivable. The term-accounts receivable includes trade debtors as well as bills receivable and
promissory notes receivable. The term receivable includes all the amounts due from others.
29. Payable: the term ‘payable’ include the amounts due to others. Accounts payable includes trade
creditors as well as bills payable and promissory notes payable. The term payable includes all the
amounts due to other.
30. Bill Receivable: Bill Receivable means a bill of exchange accepted by a debtor the amount of
which will be received on the specified date.
31. Bill payable: Bill payable means a bill exchange, the amount of which will be payable on the
specifies date.
32. Depreciation: Depreciation is a fall in the value of an asset because of usage or with passage
of time or obsolescence or accident.
33. Cost of goods sold: Cost of goods sold is the direct costs of the goods or services sold.

34. Bad Debts: Bad Debt is the amount that has become irrecoverable. It is a business loss and is
debited to profit and loss account.
35. Insolvent: insolvent is a person or enterprise which is not in a position to pay its debts.
36. Solvent: solvent is a person or enterprise which is in a position to pay its debts.
37. Book value: this is the amount at which an item appears in the books of accounts or financial
statements.
38. Balance sheet: it is a statement of the financial position of an individual or enterprise as at a

given date, which exhibits its assets, liabilities, capital, reserves and other account balances at their
respective book values.
39. Entity: An Entity means an economic unit which performs economic activities (Reliance,
industries, Bajaj Auto, Maruti, and TISCO). Business entity means a specifically identifiable
business enterprise like ITC Ltd., Hira Jewelers, etc. An accounting system is always devised for a
specific business entity (also called Accounting Entity).
IMPORTANT TERMS TO REMEMBER
1. Capital - Amount invested by owner in the business.

2. Liability - Amount to be given to the outsiders.
3. Assets - Things owned by the business.
4. Debtors - Persons from whom business has to take money.
5. Creditors - Persons to whom business has to pay money.
6. Proprietor - Owner of business.
7. Drawings - Money or Goods used by proprietor for personal
use.
8. Transaction - Any business event to be recorded.
9. Entry - Record to be made in books for any transaction.
10. Stock - Goods lying unsold with the business on a

particular date.
11. Expense - Amount spent to produce and sell the goods.
Chapter- Business Transaction

4 Voucher
VOUCHER
VOUCHER is a. a piece of substantiating evidence; a proof; or, b. a written record of
expenditure, disbursement, or completed transaction; or, c. a written authorization or certificate,
especially one exchangeable for cash or representing a credit against future expenditures.
Source Document
SOURCE DOCUMENTS are the primary documents used when forwarding an argument or making
a presentation of fact.
A document is paperwork, recording and evidencing of a transaction or an event. In
accounting, such documents are known as ‘source documents’ because these documents are the
first evidence of a transaction having taken place. The source documents contain the information
with respect to the transaction based on which accounts are debited or credited with the transacted
amount
We can now define a source document as “A source document is a written document
containing details thereof and prepared at the time of a transaction.”
A source document is of prime importance in accounting because accounting is based on factual
financial information, evidence. For example, a cash memo showing cash sale, an invoice showing
sale of goods on credit, bills of purchases showing purchase of goods on credit, l a receipt made out
by the receiver for cash received , etc. these documents are called source documents and are
evidence in support of a transaction. They are also sometimes referred to as supporting document.
Let us now discuss the most common source documents.

Cash Memo: The definition of cash memo is a document that a seller passes to a buyer at the time
of a specific purchase of goods or services. It is the equivalent of an invoice and is only used to
record transactions that are paid for using cash, rather than bank transactions or checks.
A cash memo will contain the following information:
• Date of purchase
This is vital as the date of the purchase enables the transaction to be placed in the correct month of
the business accounts.
• Details of goods or service sold
This shows the amount of items purchased, or the service provided, so that the amounts can be
tracked easily in the future.
• Price of items sold
The price of individual items is included on a cash memo. There are also sub-totals for totals of the
same item, as well as the final total of the transaction that took place.
• Name and address of seller
This is vital as the finances of the company may be checked in the future, and this enables those
auditing the accounts to be able to cross-reference the two companies, and will ensure that both
companies have placed the cash sale/purchase through their books.
• Name and address of buyer
As with the above point, this is vital to cross-reference the transaction, if this is needed.
A cash memo is recognized as a legal document, in the same way that an invoice is. The only
difference is that the cash memo is for any transaction that is paid for in cash. An invoice can also

be used in this respect, but many companies find it easier to differentiate between cash sales and
those paid for at a later date.
Invoice or Bill: Definition:

An invoice is a bill sent by a provider of a product or service to the purchaser. The invoice
establishes an obligation on the part of the purchaser to pay, creating an account receivable.

The usual sections in an invoice include:
 Date
 Names and addresses of customer and supplier
 Contact names
 Description of items purchased, either products or services
 Terms of payment. For example, the provider might specify "net 30 days," which means that
the entire amount is due within 30 days.
Also Known As: Bill
An invoice or bill is a commercial document issued by a seller to the buyer, indicating the products,
quantities, and agreed prices for products or services the seller has provided the buyer. An invoice
indicates the buyer must pay the seller, according to the payment terms. The buyer has a maximum
amount of days to pay these goods and are sometimes offered a discount if paid before.
The term invoicing is also used to refer to the act of delivering baggage to a flight company in an
airport before taking a flight.In the rental industry, an invoice must include a specific reference to the
duration of the time being billed, so rather than quantity, price and discount the invoicing amount is
based on quantity, price, discount and duration. Generally speaking each line of a rental invoice will
refer to the actual hours, days, weeks, months, etc being billed.
Invoice is a statement which contains the under mentioned details compulsorily.
1. Invoice Number
2. Invoice date
3. Name and address of the person making the invoice ( Seller of goods and service)
4. Name and address of the person to whom invoice is made. ( Buyer of goods and service)
5. Description of goods / services involved

6. Applicable rates and taxes with percentages
7. Rate of the goods / services
8. Quantity of the goods and services
9. Quality or any other specifications
10. Price / Value of the goods and services
11. Invoice must be signed by the person making it
12. Terms and conditions of making the payment
Formats
BILL OF SALE
STATE OF _____________
COUNTY OF _____
KNOW ALL MEN BY THESE PRESENTS:
That in the consideration of _________________ Dollars and ___________ Cents ($_______)
In hand paid by _______________________ hereinafter referred to as buyer, the receipt of which

sum is hereby acknowledged and the undersigned does bargain, sell and convey to the said buyer
the following described property:
Year/Make/Model:
VIN:
As is, and does hereby covenant and agree to warrant and defend the sale of said Property unto
said buyer against any lawful claims and demands of all and every person or persons whatsoever.

(This property is sold as accepted and is not guaranteed.).
THIS AGREEMENT made and entered into on this the _______ day of January 09, by and between
______________ and ____________________.
____________________
WITNESS:
______________________
SIGNATURE OF OWNER:

Receipt: A receipt is a written acknowledgment of having received an item of a specific value. Most
receipts or vouchers will have an outline of the purchase, the date of purchase, the value of the
purchase and any/all information by the seller.
The original copy is handed over to the party tendering the payment and the duplicate is kept for
record. This source document contains details regarding the date, amount, name of the party and
the nature of the payment. A specimen of a receipt is given below:
Your NGO Name

RECEIPT
VOUCHER No. 0001
Office: Date:
Currency:
Received From Description Amount Budget Code
Total
Cash/Cheque Received By:

(delete as applicable)
Received From:
Attach paperwork to this voucher
Your NGO Name

RECEIPT
VOUCHER No. 0002
Office: Date:
Currency:

Received From Description Amount Budget Code
Total
Cash/Cheque Received By:

(delete as applicable)
Received From:
Attach paperwork to this voucher
Pay –In –Slip:
Negotiable Instrument Cheque / Demand Draft / Pay Order is a popular mode of payment. After
receiving such instruments, they are deposited with the Banks. This is the stage where our Pay-In-
Slip system provides you the assistance in process improvement to optimize the usage of
resources.
In Maintain Bank Transactions Sessions' of Baan ERP Finance module, user can enter only the
receipt amount of the instrument. If one were to look at the above process, we can characterize that
No data gets recorded for the instruments and inquiries are not available.
Pay-In-Slip cannot be generated.
Acknowledgement receipt to the customer cannot be given.
More time is consumed in manual entries of the instruments and maintaining records.

Status of cleared, dishonoured, re-deposited and cancelled cheques is not available.

Our Pay-In-Slip product provides a wide spectrum of features, which covers all the above needs
along with other value added parameters like.
Exclusively designed for Baan ERP users in Indian environment.
Sixty seconds of transaction entry through this system can save your time and cost up to 50-60%,
depending upon the volume of pay-in-slip transactions of your business.
Post-dated instruments can be entered, and pay-in-slip cab be printed as per the date of the
instrument.
Pay-In-Slip can be generated as and when required.
Duplicate instrument entry is restricted.
Acknowledgement Receipt to the customer is generated along with the receipt number. More than
one receipt series is possible for the offices at different locations.
Re-deposit of dishonoured instruments or to accept a new instrument in place of dishonoured

cheque, is possible.
Instrument status can be maintained.

Bank Acknowledgement for Pay-In-Slip can be recorded.
Pick up date can be changed [if required].

This source document relates to bank transactions. A pay –in –slip is a form available from a bank
for depositing cash and Cheque, etc., in a bank account. It has a counterfoil which is returned to the
depositor with cashier’ signature, as receipt. Now – as – days, banks usually place a box in which
Cheque along with the filled pay-in –slips can be dropped. In such cases, counterfoils are not

signed. The counterfoil or the pay-in-slip gives details regarding the date and the amount (in cash or
Cheque) deposited. A specimen of a pay-in-slip is given below:
1.
Debit Note:
What is an 'Debit Note'?
Debit Note proves that a debit entry has been made to a debtor's or creditor's account. A customer
or supplier can be debited for variety of reasons such as purchase return, wrong quantity or quality
of product, rate difference, discount, commission, etc.
When goods are returned to the supplier, a Debit Note is made out of his name. But if you want to
record the stock also (in case of Purchase Return) then you must enter 'Purchase Return' voucher
'Purchase'.
For rest of the cases (where stock is not affected) you can prepare a Debit Note.
DEBIT NOTE:
DEBIT NOTE No. 25/2007
Shyam Trading Corporation

10,Asaf Ali Road

New Delhi 110011
Date: 19th November, 2007
To
Kirloskar Electric Co. Ltd.
Bombay -Pune Highway
Pune, Maharashtra
We have debited your account as follows:

Goods Rs.
Returned
Motor 15 HP 25,000
1Pice Pump 10,000
1Piece 35,000
Electric
For Shyam Trading Corporation
2. Credit Note: A credit note or credit memorandum (memo) is a commercial document issued
by a seller to a buyer. The seller usually issues a Credit Memo for the same or lower amount than
the invoice, and then repays the money to the buyer or sets it off against a balance due from other
transactions.

It can also be a document from a bank to a depositor to indicate the depositor's balance is being
increased because of an event other than a deposit, such as the collection by the bank of the
depositor's note receivable.
For example, if a customer returns goods previously invoiced, a credit note d is issued or the
customer is allowed further discount, or the customer has returned the goods. The effect of a credit
note is that the amount of the customer’s indebtedness is reduced or, if it is already settled, to
enable the customer to purchase goods to the value of credit without further payment. A specimen
of a Credit Note is given on next page:
Debit/ Credit Note
No. Date:
M/s
………………………………………………………………………………………………..
Descriprion Amount
We have Credited to your account towards commission against following invoices

for the period from April to march 09 1,500.00
Tax -
G Total 1,500.00
(Rupees one thousand five hundred only)

For X Y Z Limited
Auth. Signatory
DEBIT NOTE
Credit Note No.25/2007
Kirloskar Electrical Co. Ltd.

Bombay-Pune Highway
Pune, Maharashtra
Date: 19th November, 2007
To
Shyam Trading Corporation
10,Asif Ali Road
New Delhi 110 011
We have Credited your account as follows:
Goods returned Rs.

1 Piece Electric Motor 15 HP 25,000
1Piece Pump 10,000
35,000
For Kirloskar Electric Co. Ltd.
Cheque: Definition of a Cheque ↓
"Cheque is an instrument in writing containing an unconditional order, addressed to a banker, sign

by the person who has deposited money with the banker, requiring him to pay on demand a certain
sum of money only to or to the order of certain person or to the bearer of instrument."
Different Kinds / Types of Cheques ↓

1. Bearer Cheque
When the words "or bearer" appearing on the face of the cheque are not cancelled, the cheque is
called a bearer cheque. The bearer cheque is payable to the person specified therein or to any
other else who presents it to the bank for payment. However, such cheques are risky, this is
because if such cheques are lost, the finder of the cheque can collect payment from the bank.
2. Order Cheque
When the word "bearer" appearing on the face of a cheque is cancelled and when in its place the
word "or order" is written on the face of the cheque, the cheque is called an order cheque. Such a
cheque is payable to the person specified therein as the payee, or to any one else to whom it is
endorsed (transferred).
3. Uncrossed / Open Cheque

When a cheque is not crossed, it is known as an "Open Cheque" or an "Uncrossed Cheque". The
payment of such a cheque can be obtained at the counter of the bank. An open cheque may be a
bearer cheque or an order one.
4. Crossed Cheque
Crossing of cheque means drawing two parallel lines on the face of the cheque with or without
additional words like "& CO." or "Account Payee" or "Not Negotiable". A crossed cheque cannot be
encashed at the cash counter of a bank but it can only be credited to the payee's account.
5. Anti-Dated Cheque
If a cheque bears a date earlier than the date on which it is presented to the bank, it is called as
"anti-dated cheque". Such a cheque is valid upto six months from the date of the cheque.
6. Post-Dated Cheque
If a cheque bears a date which is yet to come (future date) then it is known as post-dated cheque. A
post dated cheque cannot be honoured earlier than the date on the cheque.
7. Stale Cheque

If a cheque is presented for payment after six months from the date of the cheque it is called stale
cheque. A stale cheque is not honoured by the bank.

VOUCHER
Meaning
1. A piece of substantiating evidence; a proof.
2. A written record of expenditure, disbursement, or completed transaction.
3. A written authorization or certificate, especially one exchangeable for cash or representing a
credit against future expenditures.
tr.v. vouch·ered, vouch·er·ing, vouch·ers
1. To substantiate or authenticate with evidence.
2. To prepare a voucher for: properly vouchering each transaction.
3. To issue a voucher to: a company that vouchers employees when the payroll cannot be met.
Different examples of vouchers

 a document serving as evidence for some claimed transaction, as the receipt or expenditure of
money) Brit a ticket or card serving as a substitute for cash a gift voucher
 a person or thing that vouches for the truth of some statement, etc.
 (Government, Politics & Diplomacy) any of certain documents that various groups of British
nationals born outside Britain must obtain in order to settle in Britain
A voucher is a document providing evidence of a business transaction. It flows from the above
definition that whenever a transaction takes place, evidence to that effect is also established. Such
evidences are source documents. Examples of source documents are cash memo, invoice or bill,
receipt, pay-in –slip, Cheque and debit and credit notes, etc. on the basis of source documents, a
voucher derailing the accounts that are debited and credited is prepared.
Types of vouchers
Vouchers may be categorized into:
1. Source vouchers or source documents or supporting vouchers; and
2. Accounting vouchers.
Source vouchers or source documents or supporting vouchers: Each time a company makes
a financial transaction, some sort of paper trail is generated. That paper trail is called a source
document. If a small business writes a check out of its checking account for office supplies, for
example, the source document is the check along with the receipt for office supplies.

Source vouchers or source documents or supporting vouchers are documents which come into
existence when a transaction taken place. Examples of this are issue of cash memo on cash sale,
issue of credit memo (invoice) on credit sale, issue of rent receipt on receipt of rent and so on.
These vouchers generally follow a business transaction. If In any situation the supporting voucher
for a transaction cannot be made available, then it has to be created or generated. For instance, if
taxi driver. In such a case, the person making the payment should generate the supporting voucher.
Features of source voucher

(i) It is a written document.
(ii) It contains complete details of the transaction.
(iii) It is a proof of a transaction having taken place.
(iv) It is generally for a business transaction.
(v) It is signed by the maker.
Accounting vouchers: The various vouchers prepared for accounting receipts and issue
transactions are summarised below.
RECEIPTS:
Stores received are accounted for either on Receipt Vouchers or on certified Receipt Vouchers.
Receipt vouchers are used to account for stores received from other establishments/ units/ Depots
etc., based on quantities shown in their respective issue vouchers. Thus, in respect of each Receipt
Voucher, there will be a corresponding issue Voucher from the consignor. However, stores received
direct either by local purchase or by central purchase etc., are accounted for on Certified Receipt
Voucher (CRV). CRVs are also used for accounting surpluses found in stock taking. Thus, CRVs
are used when there are no corresponding issue vouchers or when no departmental consignors are
involved.
ISSUES:
All transactions relating to issues (Free issues, Payment issues, Loan issues) will be supported by
issue vouchers. The vouchers will show separately, where prescribed, serviceable, repairable and
unserviceable articles except articles of clothing and necessaries, which will be conditioned as
either serviceable (new) part worn or unserviceable. As in the case of receipts, issues are also
accounted mainly either on Issue Vouchers (IVs) or Certified Issue Vouchers (CIVs). Issue vouchers

are made based on indents / demands etc., and will always have a corresponding receipt voucher
of the consignee. Unlike Ivs, CIVs are made to account for Final issues like issues for consumption,
issues on payment etc.,
we can say that an ‘accounting voucher’ is a written document containing an analysis of business
transactions for accounting and recording purposes, prepared by the accountant on the basis of
supporting vouchers and signed by another authorized person.
Features of accounting voucher. Features of an accounting voucher are:
(i) It is a written document.
(ii) It is prepared on the basis of evidence of the transaction.
(iii) It is an analysis of a transaction.
(iv) It is prepared and signed usually by an accountant and countersigned by the authorized
signatory.
(v) In the case of cash/bank voucher, it is a receipt.
Types of accounting vouchers: Accounting vouchers are of two types,

1. Cash vouchers; and
2. Non – Cash vouchers or Transfer Voucher
Let us discuss them in detail.
1. Cash Vouchers: Cash vouchers refer to the voucher prepared at the time of receipt or payment
of cash and includes receipt and payment through Cheque.
Cash voucher can be of the following two types namely (1) credit voucher and (2) Debit voucher
a) Credit voucher: credit vouchers are prepared when cash is received. Cash may be received
against
 Sale of goods,
 Sale of fixed assets,
 Sale of investments,
 Receipts from debtors, and
 Withdrawal from bank, etc.
The credit voucher gives the following information:

1. Name and address of the organization.

2. Date of preparing the voucher.
3. Accounting voucher number
4. Title of the account credited.
5. Net amount of the transaction.
6. Narration, a brief description of the transaction.
7. Signature of the person preparing it.
8. Signature of the authorized signatory.
9. Supporting voucher number.
b) Debit vouchers: Debit vouchers are prepared when payment is made. Payment may be made
against
 Expenses,
 Purchases of goods,
 Purchase of fixed assets,
 Payment to creditors,
 Deposits into bank,
 Drawings, etc.
A Debit voucher gives the following information:
2. Date and address of the organization.
3. Accounting voucher number.
4. Title of the account debited.
5. Net transaction amount.
10. A document in lieu of the supporting voucher.
2. Non – Cash Vouchers or Transfer Vouchers: Non –cash vouchers refer to vouchers prepared
for transactions not involving cash. Examples of these are invoice or Bills, Debit and Credit Notes,

etc. non-cash vouchers are prepared for the transactions of credit sale, credit purchase, goods
retuned (both inwards and outwards), rectifying the mistakes, etc.
A Non –Cash voucher gives the following information:

2. Date of preparing voucher.
3. Accounting voucher number.
4. Title of the account debited.
Title of the account credited.

5. Net transaction amount.

Chapter-5 ACCOUNTING EQUATION

5
MEANING OF AN ACCOUNTING EQUATION

An Accounting Equation is a formula of accounting which shows the assets and liabilities of a firm
are equal. An accounting equation is based on the dual aspect concept of accounting. In the dual
aspect concept, a transaction has a two – sided effect, that is, on the assets. The total clams (those
of outsiders and of the proprietors) will always equal the total assets of the firm. The claims, also
known as equities, are of two types:
1. Owner’s equity or capital; and
2. Liabilities or amounts due to outsiders (outsider’s equity).
We can express it as:
Assets = Equities (Total Claims)
Or
Assets= Liabilities + Capital
Or
Liabilities = Assets- Capital
Or
Capital = Assets - Liabilities

The above relationship is usually known as the Accounting Equation or the balance sheet equation.
The Accounting Equation is the basis for double entry system of accounting. An accounting

equation always holds true with every change that occurs due to a transaction taking place. It is
because of this reason that it is based on the dual aspect concept of accounting which holds that for
every debit or credit there is equal credit or debit.
A transaction may affect either both sides of the equation by the same amount or one side of the
equation only, by both increasing and decreasing it by equal amounts.
Transactions from the accounting equation viewpoint, can be divided into two,
1. Transactions affecting two items; and
2. Transactions affecting more than two items.
Let us discuss them in detail.

1) Transactions affecting two items: As the title suggests, these are those transactions that
affect two items. Such transactions have 9 possible combinations; 4 affecting the opposite side of
the balance sheet and 5 affecting the same side of the balance sheet.
Transactions affecting opposite side are:

(i) Increase in asset, increase in liability: for example, credit purchases and loan from bank. Credit
purchases increase asset (stock) and also increase liability (creditor). Similarly, loans from bank
increase asset (cash) and also increase liability (loan).
(ii) Decrease in liability, decrease n asset: For example, payment to creditor. It decreases liability
(creditor) and also reduces asset (cash or bank)
(iii) Increase in asset, increase in owner’s equity: For example, introduction of capital by the
proprietor. It increases asset (cash or bank) and also liability (capital).
(iv) Decrease in owner’s capital, decrease in asset: For example, drawings by the proprietor. It
decreases liability (capital) and also asset (cash or bank).
Transactions affecting same side but in opposite direction are:

(i) Increase in asset, decrease in another asset: For example, cash purchases or receipt from
debtors. It increases one asset (goods and cash or bank, respectively) and decreases another
asset (cash or bank and debtors).

(ii) Decrease in liability, increase in another liability: For example, settlement of creditor by issue of
bill of exchange. It decreases a liability (creditor) and also increases another liability (bill of
exchange).
(iii) Decrease in owner’s equity item, increase in owner’s another equity item: For example, issue of
bonus shares. It decreases reserves and increases share capital.
(iv) Decrease in owner’s equity item, increase in liability: For example, it decreases reserves and
increases liability to pay dividend.
(v) Decrease in liability, increase in owner’s equity item: For example, redemption of debentures by
conversion into shares.
2. Transactions affecting more than two items: Some transactions affect more than two items of
a balance sheet. For example, when a sale is made in cash for Rs. 30,000 reduces asset (stock of
goods); plus profit (Rs. 5,000). Cost of goods (Rs. 25,000) reduces asset (stock of goods); cash in
bank increases by Rs. 30,000 and the owner’s capital increases by the profit (Rs. 5,000). It should
be noted that profit increases the owner’s capital and loss decreases it.
Effect of Transactions on Accounting Equation

We shall now discuss the procedure to workout an Accounting Equation:
1. Analyze the transaction in terms of such variables as assets, liabilities, capital, revenues and
expenses.
2. Decide the effect of the transactions in terms of increase or decrease on variables mentioned in
1.
3. Record the effect on the relevant side of the equation.
Now, let us take a few transactions to show how the accounting equation is always maintained.
Suppose Rakish starts business and the following successive changes or transactions take place:
1. He commences his business with Rs. 20,000 in the form of capital. The equation stands as follows:
Assets = Liabilities + Capital

Rs. 20,000 = 0 + 20,000

2. The business purchases furniture for Rs. 500 in cash. The effect of this transaction is that the
amount of cash in hand is lower by Rs. 500, but a new asset of the same amount has been
acquired leaving the total assets unchanged. The equation will now appear as follows:

Cash + Furniture
Old Balance 20,000 + 0 = 0 + 20,000
New Transaction - 500 + 500 = 0 + 0
New Balance 19,500 + 500 = 0 + 20,000
It shall be seen that the total assets remain equal to liabilities plus capital.
3. The business purchases goods for Rs. 1,000, for cash. In this transaction also, Cash balance
will be lower by Rs. 1,000 and another asset, stock of goods, has come into existence, but the
total of assets remains unchanged. The equation will be as follows:
Cash + Furniture + Stock
Old Balance 19,500 + 500 + 0 = 0 + 20,000
New Transaction -1,000 + 0 + 1,000 = 0 + 0
New Balance 18,500 + 500 + 1,000 = 0 + 20,000
4. The business purchases goods for Rs. 2,000 on credit. Because of these transaction, the stock
of goods increased by Rs. 2,000 making the total assets rs. 22,000. the equation will be as
follows:
Cash + Furniture + Stock
Old Balance 18,500 + 500 + 1000 = 0 + 20,000
New Transaction 0 + + 2000 = 2000 + 0
New Balance 18,500 + 500 + 3,000 = 2000 + 20,000

5. The business sells goods on credit for Rs. 4,000; the cost of goods is rs. 2,500. Here also, on
account of this credit transaction, the Accounting Equation is maintained, because asset,
debtors, has come into existence to the extent of Rs. 4,000. But the stock of goods will be
reduced only by Rs. 2,500, being the cost of goods sold. The net increase in assets, Rs. 1,500,
rs. 4,000 – Rs. 2,500 (profit) will be added to the

Cash + Furniture + Stock + Debtors Creditors + Rajesh’s
Old Balance 18,500 + 500 + 3000 + 0 = 2000 + 20,000
New Transaction 0 + 0 -2500 + 4000 = 0 +
1500
New Balance 18,500 + 500 + 500 + 4000 = 2000 + 21,500
6. The business pas Rs. 100 for rent and rs. 200 for salaries. The cash balance will now be
reduced by Rs. 300; there is no asset to show for this ; hence, the capital will be reduced by this
amount, as shown below:
Old Balance 18,500 + 500 + 500 + 4000 = 2000 + 21,500
New Transaction -300 + 0 + 0 + 0 = 0 -
300
New Balance 18,200 + 500 + 500 + 4000 = 2000 + 21,200
7. Rakesh withdraws Rs. 2,000 for personal use. The cash balance will now reduce by Rs. 2,000
and capital will also reduce by the same amount. The new Accounting Equation will be as
follows
Old Balance 18,200 + 500 + 500 + 4000 = 2000 + 21,200
New Transaction -2000 + 0 + 0 + 0 = 0 - 2000
New Balance 16,200 + 500 + 500 + 4000 = 2000 + 19,200

As seen above, one can take any number of transactions; the total of assets will always be equal to
the total of liabilities and the capital. The last equation stated above can also be presented in the
form of a statement called the Balance sheet. It is given below:
BALANCE SHEET OF………

As at ………….
Liabilities Amount Assets Amount
Creditors 2,000 Cash 16,200

Capital 21,200 Furniture 500
Less: Drawings 2,000 19,200 Stock 500
Debtors 4,000
21,200 21,200
The Balance sheet shows the sources from which funds have been obtained – the left-hand side
does that; in the above case, Rs. 2,000 have been obtained from outsiders and Rs. 19,200 have
been contributed by the proprietor. The other side known as asset side shows how the funds stand
invested.
A conclusion apparent from the transactions given above is that every transaction has a double
sided effect. In other words, the dual aspect concept will always hold good. A reduction of increase
in an asset will have a corresponding effect on liabilities or capital.
This is because of the rule that every receiver is a giver and every giver is a receiver.
RULES FOR ACCOUNTIG EQUATIONS

1. Capital: when capital is increased, it is credited (+) and when some
part of the capital is withdrawn, drawings are made, it is debited (-). Interest on capital is an
expense for the business, and thus, profit is reduced by the amount and since interest on

capital is an income for the owner it is added to capital. So the net effect of this transaction is nil
on capital. Interest on drawings is a profit for the business therefore added to profit and thus,
capital. Since it is a loss/expense for the owner thus, is deducted from capital. Assets and
Liabilities will not be affected by interest on capital and interest on drawings.
2. Revenue: owner’s equity (capital) is increased by the amount of

revenue.
3. Expenses: owner’s equity (capital is decreased by the amount of

expenses.
Income is the profit earned during a period of time. Profit increases the owner’s equity (capital)
and loss decreases the owner’s equity (capital)
4. Outsider’s equity: when liabilities are increased, outsiders’ equities are credited (+) and when
liabilities are decreased, outsiders’ liabilities are debited (-)
5. Assets: if there is an increase in assets, the increase is debited (+) in the asset account. If
there is decrease in assets, the decrease is credited (-) in the asset account.
6. It is possible that when one asset increases, the other asset decreases, purchase of furniture
for cash. Thus, furniture increases and cash decreases.
7. It is possible that one asset decreases, the other asset increases sale of furniture for cash.
Thus, cash increases and furniture decreases.
8. It is possible that when one liability increases, the other liability decreases, on dishonor of bills
payable, the bills payable account is debited and the creditor’s account is credited. Thus,
creditors increase and the amount of bills payable also decrease.
9. It is possible that one liability decreases and the other liability increases, creditors were made
payment by accepting bills payable. Thus, creditor’s decrease and bills payable increase.

10. It is possible that when an asset increases, liability also increases, furniture is purchased on
credit. Thus, furniture increases and the amount of creditors also increase.
11. It is possible that when an asset decreases, liability also decreases, cash paid to creditors,
also decreases.
12. Effect of outstanding expenses (outstanding salary): increase in liabilities and decrease in
capital.
13. Accrued income: increase in asset and increase in capital.
14. Income received in advance: increase in asset (as cash) and increase in liabilities.
15. An increase in an asset, without a corresponding increase in liability or a corresponding

decrease in another asset, means an increase in capital. Conversely, an increase in liability
without a corresponding increase in asset, or a corresponding decrease in another liability,
indicates decrease in capital.
Illustration 1. Show the effect of the following transactions on the accounting equation:
1. Ram started business with cash 50,000

2. purchased goods on credit 4,000
3. purchased goods for cash 1,000
4. purchased furniture for cash 500
5. withdrew for private use 700
6. paid rent 200
7. Received interest 100

8. sold goods on credit (cost Rs. 500) 700

9. paid to creditors 400
10. paid salaries 200
11. Rent outstanding 200
12. Bought furniture for personal use 2,000
Solution:
No. Transactions Assets = liabilities + Capital
Rs. Rs.
1. Ram started business with cash
Rs. 50,000 50,000 = 0 + 50,000
2. Purchased goods on credit for Rs. +4,000 = 4000 + 0
4,000 54,000 = 4,000 + 50,000
3. +1,000
New equation - 1,000 = 0 + 0
Purchased goods for cash for Rs. 54,000 = 4,000 + 50,000
1,000 500
- 500 = 0 + 0
4. New equation 54,000 = 4,000 + 50,000
- 700 = 0 + -
5. Purchased furniture for cash for Rs. 700
500
53,300 = 4,000 +
6. New equation 49,300
Withdrew cash for private use Rs. - 200 = 0 + -
7. 700 200

8. New equation 53,100 = 4,000 +

Paid for rent Rs. 200 (note 1) 49,100
+ 100 = 0 + +
New equation 100
9. Received interest Rs. 100
53,200 = 4,000 + 49,200
10. New equation -500
Sold goods costing Rs. 500 (note +700 = 0 + +
2) 200
11. 53, 400 = 4,000 +
New equation 49,400
Paid to creditors rs.400 - 400 = -400 +
12. 0
New equation
53000 = 3600 +
Paid salaries Rs. 200 49,400
-200 = 0 + -
New equation 200
Rent outstanding for Rs. 200
52800 = 3600
New equation + 49,200
Bought furniture for personal use 0 = 200 + -200
Rs. 2000
52,800 = 3800 + 49000
New equation - 2000 = 0 + -2000
50,800 = 3800 + 47000
Accounting Equation: Assets = Liabilities + capital

Illustration 2. If the capital of a business is RS. 70,000 and liabilities are of RS. 40,000 calculate
the total assets.

Solution:
Capital + Liabilities = Total Assets
RS. 70,000 + RS. 40,000 = Total Assets
Total Assets = 1, 10,000
Illustration 3. A commenced his cloth business on Ist April, 2008 with a capital of RS. 30,000. on
31st march, 2009 his assets were worth RS. 50,000 and liabilities of RS. 10,000. Find out his closing
capital and profits earned during the year.
Solution:
Capital + Liabilities = Total Assets
Capital + RS. 10,000 = RS. 50,000
Closing capital = RS. 50,000 – RS. 10,000 = RS. 40,000
Profit = Closing capital – Opening capital
= RS. 40,000 – RS. 30,000 = RS. 10,000.
Illustration 4. X has the following assets and liabilities as on 31st march, 2009. Ascertain his capital.
Cash RS. 25,000; Bank RS. 47,500; Debtors RS. 18,000; Creditors RS. 22,000: plant and
Machinery RS. 80,000; Building RS. 2, 00,000; Furniture RS. 24,000; Bills Receivable RS. 56,500
Bills Payable RS. 23,500.
Solution:
Or Capital = (Cash + Bank + Debtors + Plant and Machinery + Building + Furniture + Bills
Receivable)-
(Creditors + Bills Payable)
= RS. (25,000 + 47,500 + 18,000 + 80,000 + 2, 00,000 + 24,000 + 56,500) –
RS. (22,000 + 23,500)
= RS. (4, 51,000 – 45,500) = RS. 4, 05,500.
Illustration 5. Calculate the total equity if:

(i) Owner’s equity in the beginning is RS. 60,000.

(ii) Equity of creditors at the end is RS. 50,000
(iii) Revenue during the period is RS. 70,000
(iv) Expenses during the same period are RS. 65,000
Also calculate the amount of owner’s equity at the end.

Solution:
Total Equity = Owner’s Equity + Creditors’ Equity
= (Opening Owner’s Equity + Revenue – Expenses) + Creditors’ Equity
= (RS. 60,000 + RS. 70,000 – RS. 65,000) + RS. 50,000.
= (RS. 65,000 + RS. 50,000 = RS. 1, 15,000.
Owner’s Equity = RS. 65,000.
Illustration 6. X started a business on 1st April, 2008 with a capital of RS. 50,000 and a loan of RS.
25,000 borrowed from y. on 31st march, 2009 his assets were RS. 1,50,000. Find out his capital as
on 31st march, 2009 and profit made or loss incurred during the year 2008 – 09.
Solution:
Closing Capital = Closing Assets – Closing Liabilities
= RS. 1, 50,000 – RS. 25,000 = RS. 1, 25,000
Profit = Closing Capital – Opening Capital
= RS. 1, 25,000 – RS. 50,000 = RS. 75,000.
Illustration 7: x started a business on 1st April, 2008 with a capital of RS. 50,000 and a loan of RS.
25,000 borrowed from y. During 2008-2009, he had introduced additional capital of RS. 25,000 and
had withdrawn RS. 15,000 for personal use. On 31st March, 2009 his assets were RS. 1,50,000. find
out his capital as on 31st march, 2009 and profit made or loss incurred during the year 2008-09.
Solution:
Closing Capital = Closing Assets – Closing Liabilities (Y’s Loan)
= RS. 1, 50,000 – RS. 25,000 = RS. 1, 25,000
Profit = Closing Capital + Drawings – Additional Capital – Opening Capital
= RS 1, 25,000 + RS. 15,000 – RS. 25, 000 – RS. 50,000
= RS. 65,000

Illustration 8. on 31st March, 2009, the total assets and external liabilities were RS. 1, 00,000 and
RS. 3,000 respectively. During the year, the proprietor had introduced additional capital of RS
10,000 and had Withdrawn RS. 6,000 for personal use. He made a profit of RS. 10,000 during the
year. Calculate capital as on 1st April, 2008,
Solution:
Closing Capital = Closing Assets – Closing External Liabilities
= Rs. 1, 00,000 – Rs 3,000 = Rs. 97,000
Opening Capital = Closing Capital + Drawing – Additional Capital – Profits

= Rs. 97,000 + Rs. 6,000 – Rs. 10,000 – Rs. 10,000
= RS. 83,000.
Accounting equation can be understood with the help of effects of different transactions also. This
will be clarified by the following illustration:
Illustration 9. Give an example for each of the following types of transactions:

(i) Increase in one asset, decrease in another asset.
(ii) Increase in asset, increase in liability.
(iii) Increase in asset, increase in owner’s capital.
(iv) Decrease in asset, decrease in liability.
(v) Decrease in asset, decrease in owner’s capital.
(vi) Decrease in liabilities, increase in owner’s capital
(vii) Increase in one liability, decrease in another liability.
(viii) Increase in liabilities, decrease in owner’s capital.
Solution:
(i) Purchase of furniture for cash – increase in furniture and decrease in cash.
(ii) Purchase of furniture on credit – increase in furniture and increase in liability.
(iii) Capital introduced by proprietor – increase in cash and increase in capital.
(iv) Payment to creditors – decrease in cash and decrease in creditors.
(v) Cash withdrawn by proprietor – Decrease in cash and decrease in capital.
(vi) Conversion of partner’s loan into capital – increase in capital and decrease in loan.

(vii) Bills payable accepted – increase in bills payable and decrease in creditors.
(viii) Outstanding expenses provided – increase in creditors for outstanding expenses and
decrease in capital.
Practical Problem
Question. Shahs started a business with:
Cash 2,00,000
Goods 1,20,000
Machine 80,000
b). He purchased goods for cash 50,000
c). He sold goods (costing Rs 20,000) 25,000
d). He purchased goods from Ravi 70,000
e). He paid cash to Ravi in full settlement 69,000
f). He sold goods to Vikas (costing Rs 54,000), 60,000
g). He received prompt payment from Vikas & discount allowed 2,000 58,000
h). Salaries paid by him 40,000
i). Rent outstanding 4,000
j). Prepaid insurance 1,000
k). Commission received by him 3,000
l). Amount withdrawn by him for personal use 30,000
m). Interest on capital invested by him 2,000
n). Depreciation charged on Machinery 8,000
o). Purchased goods from Sandeep 1, 70, 000

Chapter Accounting Procedures – Rules of

6 Debit and credit
DOUBLE ENTRY SYSTEM

Double entry System means the recording of both the aspects – receiving of values and giving of
values – of each transaction. These two aspects are distinguished in terms of Debit and Credit. Dr.
is symbol for Debit and Cr. is a symbol for Credit. An account is capable of receiving and giving of
values. When an account receives a value or benefit, it is debited and when it gives a value or
benefit, it is credited.
Advantages of Double Entry System

1. It provides a check upon the arithmetical accuracy of the clerical work.
Since every debit has a corresponding credit, the total debits at any time must equal total credits in
terms of rupee amounts.
2. From the personal accounts, the amount due to and due by each person, with Whom the business
deals, can at any time be ascertained.
3. The information supplied by the books is not limited to personal accounts (i.e. accounts of debtors
and creditors) only; the impersonal accounts furnish additional information in respect of assets of
the business.
4. The balances of nominal accounts can be collected together in Trading and Profit and loss account
which disclose the result of the operations i.e. the gross profit or gross loss accounts and net profit
or net loss for any given period.
5. By means of a balance sheet in which balances of accounts representing capital, assets and
liabilities are recorded, the financial position of the business.
6. The double entry system with its system of counter facilitates the detection of errors and frauds
Account
An account is a summarized record of transactions at one place relating to a particular head. It
records not only the amount of transactions but also their effect and direction.

An account is divided into two parts, debit and credit. It is usually in a ‘T’ form and the commonly
used layout of an account is as follows:
Dr. NAME OF THE ACCOUNT, WAGES ACCOUNT Cr.

Date Particul J.F. Amount Date Partic J.F. Amount
ars ulars
Date Name of Page or Amount Date of Name Page or Amount

of The Reference the The Of the reference Of the
The other Number of transacti transactio Other Number of transacti
Trans account The on n Accoun the on
action subsidiary t subsidiary
Book, where book, where
the entry the entry
was first was first
recorded, recorded,
cash book cash book
Note the following points about the layout of this account:

 The name of the account is written at the top.
 The account is divided into two identical halves, separated by a thick voucher
 The left hand side is called the ‘debit’ side (‘debit’ is abbreviated as ‘Dr’
 The right hand side is called the ‘credit’ side (‘credit’ is abbreviated as )
 The date, the date of the transaction is entered in the date column.
 In the ‘particulars’ column, the name of the other account involve transaction is entered.
 The ‘folio’ or journal Folio (J.F.) column is used as a referencing system original entry was
recorded in the journal book.
 In the last column, the amount transacted is written.
This is illustrated below by taking imaginary amounts:
Dr. Cr.

Increases Rs. Decreases Rs.

Opening Balance 1,00,00 Payments for purchases 56,000
Cash sale of Goods 0 Payments to Creditors 20,000
Receipts from Debtors 50,000 Wages and salaries 16,000
Receipts from commission 70,000 Rent 10,000
Sale of Fixed Assets 20,000 Postage 2,000
Rent 30,000 Cartage 1,000
5,000 Closing Balance 1,70,000
2,75,00 2,75,000
0
What we have to do is to palace the increases in cash on the left hand side and the decreases on
the right hand side. It can also be said that the receiving account is debited and the giving
account is credited.
The closing balance has been ascertained by deducting the total of payments, Rs. 1,0 5,000 from
the total of the left hand side, Rs. 2, 75,000.
MEANING OF DEBIT AND CREDIT

In simple words, debit refers to the left side of an account and credit refers to the right side of an
account. In the abbreviated form Dr. Stands for debit and Cr. stands for credit. An item recorded on
the debit side of an account is said to be debited to the account and a balance resting on the debit
side of an account is said to be debited to the account and a balance resting on this side is said to
be a debit balance. A debit entry signifies that value has flowed to the named account; payment to a
creditor signifies that payment has been made for the goods purchased from him. Thus, his account
is debited.
An item recorded on the credit side of an account is said to be credited to the account and the
balance resting on this side is said to be a credit balance. A credit entry signifies that value has
flown from the source indicated by the name of the account; receipt of cash from a debtor signifies
that debtor has made payment for the goods purchased by him. Thus. His account is credited. Debit
and credit are simply additions to or subtractions from an account.

RULES OF DEBIT AND CREDIT

Under double entry system of book keeping each transaction has two aspects. One aspect is the
receiving or incoming aspect. This is also known as the ‘debit’ aspect’ another aspect is giving or
outgoing aspect. This is also known as the ‘credit’ aspect. Debit and credit aspects of a transaction
form the basis of double entry system.
Debit and credit are simply additions to or subtractions from an account. We have discussed that by
deducting the total of liabilities from the total of assets, the capital can be ascertained, as indicated
by the accounting equation:
Assets = Liabilities + capital
Or
Assets - Liabilities = capital
We have also discussed that if there is any change on one side of the equation, there is bound to be
a similar change on the other side of the equation or among items comprised in it. This is due to the
dual aspect effect of the transactions and will become clear from the following illustration:
Transactions Total Liabilities Owner’s

assets capital
1. StartedbusinesswithcasRs.20,000Borrowed Rs. +20,000 +20,000

10,000 +10,000 +10,000
2. Withdrew cash from business Rs. 5,000 -5,000 -5,000
3. Loan repaid to the extent of Rs. 5,000 -5,000 -5,000
Balance 20,000 5,000 15,000

The above method is suitable only if the number of transactions is small. But if the number is large,
a different procedure – of putting increases and decreases in different columns – will be useful and
this will also yield significant information. The transactions given above are shown below according
to this method:
Total assets = Liabilities + Owner’s capital
Increase Decreas Decrease Increase Decrease Increase

e
1. 20,000 20,000
2. 5,000 5,000
3. 2,000
4. 2,000 1,000
1,000
Total 15,000 3,000 1,000 5,000 2,000 10,000
Balanc 12,000 4,000 8,000
e
In accounting, the general tradition followed is as follows:

1. increases in assets are recorded on the left hand side and decreases on the right hand side; and

2. In the case of liabilities and capital, increases are recorded on the right hand side and decreases on
the left hand side.
From the above examples, the following rules can be derived:

(i) When there is an increase in the amount of an asset, its account is debited; on the contrary,
the account will be credited if there is a reduction in the amount of the asset concerned: Let
us take an example to clarify this. Suppose, furniture worth Rs. 800 is purchased, the furniture
account will be debited by Rs. 800 since the asset has increased by this amount. Later, if furniture
worth Rs. 300 is sold, the reduction will be recorded by crediting the furniture account by Rs. 300.
(ii) If the amount of liability increases, the increase will be entered on the credit side of the
liability account, the account will be credited: similarly, the liability account will be debited if
there is a reduction in the amount of the liability. Suppose, a firm borrows Rs. 5,000 from Mohan.
Mohan’s account will be credited since Rs. 5,000 is now owed to him. If later the loan is repaid,
Mohan’s account will be debited since the liability no longer exists.
(iii) An increase in the owner’s capital is recorded by crediting the capital account: suppose,
the proprietor introduces additional capital, the capital account will be credited. If the owner
withdraws some money, the capital account will be debited.
(iv) Profit leads to increase and loss to reduction in the capital: according to the rule mentioned
in above profits, revenue may be directly credited to the capital account and expenses and
losses may be similarly debited.
However, it is more useful to record all incomes, gains, expenses and losses separately. By doing
so, very useful information becomes available regarding the factors which have contributed to the
year’s profits or losses. Later, the net result of all these is ascertained and adjusted in the capital
account.
Since incomes and gains increase capital, the rule is to credit all gains and incomes and since
expenses and losses decrease capital, the rule is to debit all expenses and losses in the concerned
accounts. Of course, if there is a reduction in any income or gain the concerned account will be
debited; similarly for any reduction in an expense or loss, the concerned account will be credited.

The rules given above can be summarized as:
(i) Increases in assets are debits; decreases are credits.

(ii) Increases in liabilities are credits; decreases are debits.
(iii) Increases in owner’s capital are credits; decreases are debits.
(iv) Increases in expenses are debits; decreases are credits
(v) Increases in revenues or incomes are credits; decreases are debits.
It should be noted that an increase in assets is something favorable to the firm but an increase in
expenses is not so, even though in both the cases, the fact remains that the increase will be
recorded on the debit side. Similarly, increase in liabilities is, of course, not favorable but an
increase in revenue is favorable. Nonetheless, both will be recorded on the credit side. Thus, the
terms ‘debit’ and ‘credit’ should not be taken to mean respectively favorable and unfavorable things
– they merely describe the two sides of an account. In other words, both debit and credit may
represent either increase or decrease depending upon the nature of an account.

Rules of debit and credit

Assets = Liabilities + capital + profits – Losses
(1) Assets (2) Liabilities
Debit Credit Debit Credit

Increase (+) Decrease (-) Decrease (-) Increase (+)
(3) Capital
Debit Credit
Decrease (-) Increase (+)
(5) Revenue
(4) Expenses
(Loss)
Debit Credit
Debit Credit Decrease (-) Increase (+)
Increase (+) Decrease (-)
These rules can be explained in another manner:

(i) Suppose, Ram and Mohan go to see a cricket match and Ram purchases tickets for himself and for
Mohan. Ram has thus placed Mohan under a debt and can be said to have done a creditable thing.
Next time, Mohan purchases tickets for Ram and himself; forgetting for a moment the earlier
incident, Mohan earns a credit and Ran suffers a debit. From this, one rule of accounting can be
developed – one who receives should be debited and one who gives, credited. So, debit the
receiver and credit the giver.
(ii) Let us consider transactions relating to things like cash, goods, etc. in any business, receipts and
payments are entrusted to the ashier. If the above rule is followed, he will be debited on every

transaction (when cash is received) and credited (when cash is paid). But, he is receiving and
paying cash for the firm. Therefore, it will be more appropriate to title the account as cash account.
Likewise, transactions relating to goods received (purchases) should be debited to the purchases
account and goods out (sale) should be credited to the sales account. From this, the second rule
can be developed ‘Debit what comes in and credit what goes out’.
(iii) There are other transactions in a business that relate to nominal accounts. Suppose a clerk
personal account should be debited since he has received cash. If we do so, the clerk’s personal
account should be debited since he has received cash. If we do so, the account will indicate that he
owes us money whereas it is not so – he is not going to return this money since he has already
rendered the requisite service. It would be better to recognize this from the very beginning and style
the account as salary account to show that so much money has been paid out on account of
salaries. Whenever money is paid because of an expense, the debit should be to an account
showing the nature of the expense and not to the personal account of the receiver.
Suppose, we place some money in a fixed deposit in a bank and later receive interest. According to
rule (1) the bank should be credited since it has paid cash. Interest received is an income for the
business; therefore, it would be better to credit the amount to an account (interest Received
Account) showing that it is an income. When cash is received on account of an income or gain, the
credit should be to an account indicating the fact.
CLASSIFICATION OF ACCOUNTS
Accounts can be classified in two ways:
1. Traditional classification
2. Modern classification
1. Traditional classification of accounts

This is a very old system of classifying accounts. Under this system, accounts are classified into two
groups as shown below:

Accounts
Personal Impersonal
Natural Artificial Representative Real Nominal
Personal Accounts: Accounts which relate to persons, individuals, firms, companies, etc., debtors
or creditors are personal accounts. Examples of personal accounts are the account of Ram & co., a
credit customer, or the account of jhaveri & co.
A supplier of goods. A capital account is the account of the proprietor and, therefore, is also
personal but adjustments on account of profits and losses are made in it. Similarly, a drawing
account is also a personal account. The main purpose of preparing a personal account is to
ascertain the balance due to of due from persons or organizations.
Personal accounts can be classified into three categories:

(i) Natural personal accounts: the term ‘natural persons’ means persons who are creations of god.
For example, Ram’s account, Asha’s account, etc.
(ii) Artificial personal accounts: These accounts include accounts of corporate bodies or institutions
which are recognized as persons in business dealings. For example the account of a limited
companies, the account of a club or a cooperative society, etc.
(iii) Representative personal accounts: these are accounts which represent a certain person or a
group of persons. For example, if rent is due to the landlord, an outstanding rent account will be
opened in the books. The outstanding rent accounts represents the landlord to whom the rent is
payable.

Rule of Debit and Credit – Debit the receiver, Credit the giver.
Impersonal Accounts: accounts which are not personal such as machinery account, cash account,
rent account, etc., are termed as ‘impersonal accounts’. These can be further sun-divided into two
accounts:
(i) Real Accounts: Real accounts are the accounts which relate to tangible of intangible assets of
the firm (excluding debtors). Examples of tangible assets are: land, buildings, investments, plant
and machinery, stock or cash in hand. Examples of intangible assets are: goodwill, patents and
trademark.
Rule of Debit and Credit - Debit what comes in, Credit what goes out.
(ii) Nominal (or revenue/expense) accounts: accounts which relate to expenses, losses, gains,
revenue, etc., are termed as nominal accounts. Sales account and commission received
account, The net result of all the nominal accounts is profit or loss which is transferred to the
capital account
Rule of Debit and Credit – Debit all expenses and losses, Credit the incomes and gains.
Note: When some prefix of suffix is added to a nominal account, it becomes a personal account.
The table given below explains the above rule:
Nominal account Personal account

Interest A/c Outstanding interest A/c, interest received in advance A/c, prepaid interest
Ac
Rent A/c Outstanding rent A/c, prepaid rent A/c
Salary A/c Outstanding salaries A/c, prepaid salaries A/c
Commission A/c Outstanding commission A/c, prepaid commission A/c
Rules of Debit and Credit (Traditional) at a Glance
Types of account Account to be debited Account to be credited

I. Personal A/c Receiver Giver
II. Real A/c What comes in What goes out
III. Nominal A/c Expense and loss Income and gain

Illustration 1. Classify the following under personal, real and nominal accounts:
(i) Capital Introduced
(ii) Drawings A/C
(iii) Cash Received
(iv) Interest Paid
(v) Discount Received
(vi) Bank A/C
(vii) Bank Overdraft
(viii) Bad Debts Written Off
(ix) Outstanding Salaries
(x) Prepaid Rent
(xi) Purchases A/C
(xii) Sales A/C
(xiii) Carriage Inwards
(xiv) Bad Debts Recovered
(xv) Interest Accrued A/C
(xvi) Goodwill
(xvii) Plant And Machinery
(xviii) Leasehold Property
Personal accounts Real accounts Nominal accounts

Capital introduced Cash received Interest paid
Drawings A/c Goodwill Discount received
Bank A/c Plant and machinery Bad debts written off
Bank overdraft Leasehold property Purchases A/c
Outstanding salaries Sales A/c
Prepaid rent Sales A/c
Interest accrued A/c Carriage inwards
Bad debts recovered

Illustration 2. State the nature of account (personal, real or nominal) and show which will be
debited and which will be credited:
1. Rent Paid
2. Rent Received
3. Interest Received
4. Machinery Purchased
5. Building Sold
6. Goods Purchased
7. Discount Allowed
8. Capital Introduced
9. Goods Sold
Solution:
Account Nature of account Debited/Credited
Rent paid A/c Nominal Debited

Rent received A/c Nominal Credited
Interest received A/c Nominal Credited
Machinery A/c Real Debited
Building A/c Real Credited
Purchases A/c Nominal Debited
Discount allowed A/c Nominal Debited
Capital A/c Personal Credited
Sales A/c Nominal Credited
Illustration3. From the following transactions, state the nature of accounts and state which account
will be debited and which account will be credited:
I. Mr. Mohan started business with RS. 5, 00,000 in cash.
II. Purchased goods for cash RS. 1,00,000
III. Sold goods for cash RS. 1,50,000
IV. Received interest from Ram in cash RS. 500.
V. Sold goods to Ashok for RS. 60,000

VI. Purchased furniture for cash RS. 50,000

VII. Paid wages RS. 20,000.
Solution: ANALYSIS OF TRANSACTIONS

Transactions Accounts Nature of Debit Credit Reason
involved account RS. RS
Mr. Mohan started Cash Real 5,00,000 Incoming
business Capital personal 5,00,000 giver
With RS. 5,00,000 in cash
Purchased goods for cash Purchases Nominal 1,00,000 Expenses
RS. 1,00,000 cash real 1,00,000 Outgoing
Sold goods for cash RS. Cash sales Real 1,50,000 Incoming
1,50,000 nominal 1,50,000 income
Received interest from Cash Real 500 Received

Ram in cash RS. 500 Interest nominal 500 income
Sold goods to ashok for Ashok’s Personal 60,000 Receiver

RS. Sales nominal 60,000 income
60,000
Purchased furniture for Furniture Real 50,000 Incoming

cash cash Real 50,000 outgoing
RS. 50,000.
Paid wages RS. 20,000 Wages cash Nominal 20,000 Expenses

real 20,000 outgoing
NATURE OF ACCOUNTS
(provision for depreciation account; provision for doubtful debts)

Provision for depreciation account is credited by the amount of depreciation on fixed assets for
an accounting year. When this method is followed fixed assets are shown at their original cost
in the books of account. In the balance sheet, fixed asset is shown at original value less
provision for depreciation. For example, provision for depreciation on machinery is shown by
way of deduction from original cost. Alternatively, machinery accounts shown at its original cost
in the assets side and provision for depreciation is shown in the liabilities side of the balance
sheet.
Illustration 4. Analyze the following transactions, state the nature of accounts and state which
account. Will be debited and which account credited according to the traditional approach:
1. Dinesh started business with cash RS. 5,00,000
2. Borrowed from naresh for cash RS. 1,00,000
3. Purchased furniture for RS. 20,000 in cash from Raj furniture house
4. Purchased furniture from Delhi safe for RS. 30,000
5. Purchased goods for cash RS. 15,000
6. Purchased goods from Mahesh RS. 30,000
7. Sold goods for cash to Karim RS. 25,000
8. Sold goods to Shyam on credit RS. 30,000
9. Cash received from Shyam RS. 20,000
10. Cash paid to Mahesh RS. 10,000
11. Deposited cash into bank RS. 50,000 for opening an account.
12. Withdrew cash for personal use RS. 5,000
13. Withdrew cash from bank for office use RS. 10,000
14. Received a Cheque from shyam RS. 5,000
15. Deposited shyam’s Cheque next day.
16. Paid Mahesh by Cheque RS. 10,000
17. Paid salary to staff RS. 20,000
18. Paid rent by Cheque RS. 6,000
19. Paid interest on loan RS. 5,000
Transactions Account Nature of How Affected Debit Credit

Involved Account
Dinesh started Cash Real Cash is 5,00,000
business with Capital Personal coming in
cash. Dinesh is the 5,00,000
giver
Of cash.
Borrowed from Cash loan Real Cash is 1,00,000
naresh. from Personal coming in. 1,00,000
Naresh Naresh is the
giver
Purchased Furniture Real Furniture is 20,000
furniture for RS. Cash Real coming in.
20,000 in cash Cash is going 20,000
out.
Purchased Furniture Real Furniture is 40,000
furniture from Cash personal coming in.
Delhi safe for Delhi safe is
RS. 40,000. giver 40,000
Purchased Purchases Nominal Goods come 15,000
goods for cash (note 1) in. purchase is
RS. 15,000 Cash (note 2) Real an expense.
Cash is going 15,000
out.
Purchased Purchases Nominal Goods come 30,000
goods from in. purchase is
Mahesh RS. Mahesh Personal an expense.
30,000 Mahesh is 30,000
giver.
Sold goods for Cash Real Cash is 25,000
cash to Karim Sales Nominal coming in.
RS. 25,000 Sales are an 25000

income.
Sold goods to Shyam Personal Shyam is the 30,000
shyam on credit Sales (note3) Nominal receiver.
RS. 30,000 Sales are an
income. 30,000
Cash received Cash Real Cash is 20,000
from shyam Rs. coming in.
20,000. Shyam PERSONAL Shyam is the 20,000
giver.
Cash paid to Mahesh Personal Mahesh is the 10,000
Mahesh RS. Cash receiver.
10,000 Real Cash is going 10,000
out.
Deposited cash Bank Personal Bank is the 5,0000
into bank RS. receiver.
50,000 Cash Real Cash is going 5,0000
out.
Withdrew cash Drawing Personal Dinesh is the 5,000
for Cash Real receiver.
Personal use Cash is going 5,000
RS. 5,000 out.
Withdrew cash Cash Real Cash is 10,000
from bank for coming in.
office use RS. Bank Personal Bank is the 10,000
10,000. giver.
Received a Cash Real Cash (in the 5,000

Cheque from (note4) form of a
shyam RS. Shyam personal Cheque) is
5,000 coming in. 5,000
shyam is the

giver.
Deposited Bank Personal Bank is the 5,000
shyam’s receiver.
Cheque next Cash Real Cash(in the
day. form of a
Cheque ) 5,000
Is going out.
Paid Mahesh by Mahesh Personal Mahesh is the 10,000
Cheque RS. Bank Personal receiver. Bank
10,000 is the giver. 10,000
Paid salary to Salary Nominal Salary is an 20,000
staff RS. 20,000 Cash Real expense.
Cash is going 20,000
out.
Paid rent by Rent Nominal Rent is an 6,000
Cheque RS. Bank Personal expense.
6,000 Bank is the 6,000
giver.
Paid interest on Interest on Nominal Lender is the 5,000
loan RS. 5,000 loan Real receiver.
Cash Cash is going 5,000
out.
Note:-
1. Purchases: It refers to purchase of goods for resale, and not the purchase of asset.
2. In cash purchases, the seller’s name is not considered. Similarly in cash sales, the purchaser’s
name is not considered.
3. Sales: It refers to the sale of goods which forms a part of the stock – in – trade of the business firm.
The sale of old assets are not ‘sales’ in the accounting meaning of that word.

4. When a Cheque is received from a customer but is not deposited into the bank on the same date,
the Cheque is first treated as cash received. Afterwards,
BALANCING AN ACCOUNT
At the end of each month of year of on any particular day, it may be necessary to ascertain the
balance in an account. This is not difficult process. Let me illustrate this point. Suppose a person
has bought goods worth RS. 1,000 and has paid only RS. 850; he owes RS. 150 and that is the
balance in his account. To ascertain the balance in any account the two sides are totaled and the
difference ascertained. The difference is the balance. If the credit side is larger than the debit side, it
will be a credit balance. In the other case, it will be a debit balance. The credit balance is written on
the debit side as ‘to balance carried down or ‘by balance b/d ‘. After this, the two sides will be equal.
The totals are written on the two sides opposite one another with one line above and two lines
below, like this: Than the credit balance is written on the credit side as ‘by balance brought down’ or
‘by balance b/d’. This is the opening balance for the new period. The debit balance similarly is
written on the credit side as ‘by balance carried down’. The totals then are written on the two sides
as shown above and the debit balance written on the debit side as, ‘to balance brought down’ or ‘to
balance b/d’ as the opening balance for the new period. It should be noted that nominal accounts
are not balanced. In fact, the balances in them are transferred to the profit and loss account.
Accounts related to goods purchases account, sales account, purchases and sales return) are
transferred to the trading account balances of direct expenses account are also transferred to the
trading account. Only personal and real accounts ultimately show balances. In other words, account
balances in the nature of assets and liabilities appear in the balance sheer, which are not closed,
but carried forward to the next accounting period.
SIGNIFICANCE OF DEBIT AND CREDIT IN ACCOUNTS

1.Personal accounts: Accounts recording business transactions with persons and other business
enterprises are called the personal accounts .They are necessitated by credit transactions, that is ,
when the transaction is not settled in cash immediately. Persons to whom the goods have supplied
goods on credit or have advanced loans to the business enterprise are called the creditors.
Personal accounts, in practice, may be of following types:

Natural person accounts : such as the accounts of the proprietor, suppliers or receivers of goods
or money etc., in the name of natural persons such as Sachin’s Account Ray’s Account, Anu’s
Account etc.
Artificial or legal person accounts : such as the accounts of legal entities in the nature of limited
companies accounts (e.g., Brook Bond India Ltd. Hindustan Lever Limited); partnership firm’s
accounts(e.g. Kumar and Co.); accounts of Government agencies (e.g. Hyderabad sports club)
Groups or representative personal accounts: In the account books, the accounts are opened
in the names of individual persons (or parties), natural and legal.
The sum due to these employees or workers is aggregated in one common account, the
title of which is usually: salaries outstanding or wages outstanding account. This account is a
personal account representing a group of employees or workers.
Impersonal accounts: Accounts of business transactions which do not affect persons – natural or
artificial – but affect the business enterprise are called the impersonal accounts.
These are divided into two classes:

2. Real accounts: Debit in real account indicates purchase of an asset. Any further debit in real
account means more acquisition of the asset and this will increase the value.
Any credit in real account indicates that some part or whole of the asset has been sold off. This will
reduce the value of asset.
3. Nominal accounts: Debit in nominal accounts indicates that expenditure has been incurred or
some loss has taken place or some income has diminished by the amount of debit. Any expenditure
on account of rent, salary, commission, interest is incurred, these accounts should be debited.
SIGNIFICANCE OF VARIOUS BALANCES

Some accounts show debit balances and some credit. These balances bear special importance as
follows:
1. Credit balance of the capital account discloses how much money is due to the owner of the
business of how much money the owner has invested in the business.
2. Debit balance of cash account shows how much money the businessman has kept in cash.

3. Credit balance of discount received account shows discount received by the businessman and
debit balance of discount allowed account shows discount allowed by the business for the
prompt payment of amount due arising out of sale. But debit balances of other expenses show
how much expenses have been incurred by the businessman in his business, salary, rent, etc.
So, we can briefly say that (a) a debit balance is either an asset (cash, bank, etc.) Of an expense
(salary, rent, etc.); and (b) A credit balance shows the income earned or liability or the amount
invested by the proprietor.
Illustration 5. Open a ‘T’ shape account for furniture and write the following transactions on the
proper side:
1. Furniture purchased 50,000

2. Furniture sold – costing 10,000
3. Furniture again purchased 15,000
4. Old furniture discarded 5,000
5. Depreciation on furniture 3,000
Solution:
Dr FURNITURE ACCOUNT Cr
Increase (+) RS. Decrease (-) RS.
Cash – furniture purchased 50,000 Cash – sale of furniture 10,000

Cash – furniture purchased 15,000 Furniture discarded 5,000
Depreciation 3,000
Balance c/d 47,000

65,000 65,000
Illustration 6. Write the following transactions on Debtor’s account, creditor’s account and cash
account:-

1. Cash sales 50,000

2. Sold goods to x on credit 80,000
3. Cash received from x 56,000
4. Purchased goods from y on credit 44,000
5. Paid to y 30,000
6. Cash purchases from y 16,000
Dr. Cash account Cr.

Sales 50,000 Y (creditor ) 30,000
X (Debtor) 56,000 Purchase 16,000
Balance c/d 60,000

1,06,000 1,06,000
Dr. X (Debtor‘s account) Cr.

Sales 80,000 Cash 56,000
Balance c/d 24,000

80,000 80,000
Dr. Y (Creditor’s account) Cr.

Decrease (-) RS. Increase (+) RS.
Cash 30,000 Purchases 44,000
Balance c/d 14,000

44,000 44,000

Illustration 7. From the following particulars, prepare the account of Budhi Raja, the proprietor of a
business:
(i) Capital introduced
(ii) Drawings made by him
(iii) Further capital introduced
(iv) Profits for the period
Balance the same and explain what the closing balance indicates.
Dr. BHUDIRAJA’S CAPITAL ACCOUNT CR.

Particulars RS. Particulars RS.
To drawings a/c 6,500 By cash a/c – capital 30,000

To balance c/d 53,000 By cash a/c – capital 22,000
By profit and loss a/c 7,500
59,500 59,500
By balance b/d 53,000
NOTE: proprietor’s capital account has a credit balance of RS. 53,000 which indicates that the
business owes him this amount.
PRACTICAL PROBLEMS
1. Following accounts are being maintained in the books of shri ashok. Classify them under
personal, real and nominal accounts.
A. Land
B. Investments,
C. Building,
D. Interest received,
E. Salary,
F. Excise duty
G. Bank overdraft,
H. Debtors,

I. Creditors,
J. Purchases returns,
K. Bad debts
L. Capital
M. Drawings
N. Depreciation.
O. Motor vehicles,
P. Freight
Q. Wages.
R. Goodwill
S. Return inwards.
T. Repairs.
2. Classify the following into assets, liability, capital, revenue, expense :

(I) Plant & Machinery;(Ii) Bank Loan; (Iii) Sales; (Iv) Rent; (V) Discount Received; (Vi) Carriage
Inwards; (Vii) Carriage Outwards; (Viii) Purchases; (Ix) Bills Payable (X) Wages; (Xi) Advance
Income; (Xii) Accrued Income; (Xiii) Goodwill; (Xiv) Furniture And Fixture; (Xv) Outstanding
Expenses; (Xvi) Capital.
[Assets – (I), (Xii), (Xiii), (Xiv), Liability – (Ii), (Ix), (Xi), (Xv); Capital – (Xvi) Revenue – (Iii), (V)
Expenses – (IV), (VI), (Vii), (X),]
3. On which side will the increase in the following accounts will be recorded? Also, mention
the nature of the account:
(i) Furniture A/C
(ii) Mohan (Proprietor)
(iii) Salary A/C
(iv) Purchases A/C
(v) Sales A/C
(vi) Interest Paid A/C
(vii) Sohan (Creditor)
(viii) Ram (Debtor)

[According To ,Modern Approach – (I) Debit (Assets); (Ii) Credit (Liability); (Iii) Debit (Expenses );
(Iv) Debit (Expenses); (V) Credit (Revenues); (Vi) Debit (Expenses); (Vii) Credit (Liability); (Viii)
Debit (Assets) And Traditional Approach – (I) Debit (Real); (Ii) Credit (Personal); (Iii) Debit
(Nominal); (Iv) Debit (Real ); (V) Credit (Real); (Vi) Debit (Nominal) (Vii) Credit (Personal); (Viii)
Credit (Personal)]
4. Open a ‘T’ shape account of creditor ‘rakesh’ and write the following transactions on the
proper side:
(i) Goods purchased from Rakesh on credit 50,000
(ii) Goods returned to Radesh for 5,000
(iii) Paid to Rakesh 20,000
(iv) Purchased goods from Rakesh on credit 10,000
[Debit side (ii) and (iii) credit side: (i) and (IV)]
5. Classify the following under the three types of accounts (real, nominal or personal);
(i) Drawings
(ii) Cash
(iii) Outstanding salaries
(iv) Prepaid insurance premium
(v) Depreciation
(vi) Loan
(vii)Capital a/c
[Real a/c – (ii) nominal a/c – (v); personal a/c – (I); (iii); (IV); (VI); (vii);]
6. Analyses the following transactions, state the nature of accounts and state which account
will be debited and which account credited;
(i) Lal started business with a cash of RS. 3,00,000
(ii) Purchased furniture for RS. 75,000 in cash from shanty furniture house.
(iii) Purchased goods for cash RS. 55,000
(iv) Sold goods for cash to pal rs. 35,000
(v) Sold goods to Om on credit RS. 60,000
(vi) Deposited cash in bank RS. 70,000 for opening an account.
(vii)Received a Cheque from Om rs. 20,000

(viii) Deposited Om’s Cheque the next day.

(ix) Borrowed from sohan RS. 1,00,000
(x) Purchased furniture from haryana safe rs. 50,000
(xi) Paid interest on loan RS. 10,000
(xii)Paid rent by Cheque RS. 4,000
(xiii) Paid salary to staff RS. 14,000
(xiv) Withdrew cash for personal use RS. 5,000

Chapter- JOURNAL JOURNAL

7
The business transaction are recorded in the books of accounts which are customarily, divided into
two classes (i) journal and (ii) ledger. Ledger is called ‘principal book’ of accounts as all the
accounting information can be secured from this book. Journal helps the posting of entries into the
ledger accounts; it is therefore, also known as ‘subsidiary book’.
Meaning of a Journal: Transactions are written, as they occur, on the basis of the source
documents, a voucher are prepared indicating the accounts to be debited or credited. They are
recoded in a systematic manner in a book known as the journal. A journal is that primary book of
accounts in which transactions are originally recorded in a chronological order, as they occur.
An entry made in the journal is called a journal entry.
The process of recording a transaction in a journal is known as journalizing.
The transfer of journal entry to a ledger account is called posting.
CHARACTERISTICS OF A JOURNAL
1. A journal contains day-to –day transactions in a chronological order.
2. It is a basic book of original entry in which transactions are analyses before they are posted in
the ledger.
3. It records both the debit and credit aspects of a transaction by using the double entry system of
book keeping
4. A journal is a record which shows the complete detail of a transaction in one entry.
5. Journalizing means recording a transaction in the journal and the form in which it is recorded is
known as a journal entry.
Form of a journal: The form of a journal is given below:
Date Particulars L.F. Dr. Amount Cr. Amount

IMPORTANT CONSIDERATIONS
1. If a transaction relates to purchase of sale of goods and the name of the seller of purchaser is
given and it is not stated as a cash transaction, it is treated as a credit transaction. For example,
‘goods sold to Mohan’ means that it is a credit transaction. But ‘goods sold to Mohan in cash’
means that it is a cash transaction. Accordingly, the cash account is debited and the sales
account is credited.
2. If a transaction related to purchase or sale and the name of the seller or purchaser is not given,
it is treated as a cash transaction. For example. Goods sold for RS. 10,000.
3. In nominal account, even If the name of the party receiving or making payment is given, it is still
treated as a cash transaction. Personal account will not be opened. For example, if a salary of
RS. 5,000 are paid to Ranjan, the transaction will not be recorded in the account of Ranjan,
instead the salary Account and cash account will be affected.
4. Introduction of funds in the business by the proprietor known as capital is credited to his capital
account whereas withdrawal in cash or by way of goods for his personal use is debited to
drawings account.
Recording in journal: Transactions are recorded in the journal on the basis of source documents
following the reels of debit and credit. Let us take few examples to understand how a transaction is
recorded.
Illustration 1. Transactions of Ramesh for April are given below. Journalize them.
April 1 2009 Ramesh started business with cash 1,00,000
April 2 Paid into bank 70,000
April 3 Bought goods for cash 5,000
April 4 Drew cash from bank for office 1,000
April 13 Sold to Krishna goods on credit 1,500
April 20 Bought from shyam goods on credit 2,250
April 24 Received from Krishna 1,500
April 28 Paid shyam cash 2,150
discount allowed by him 100
April 30 Cash sales for the month 8,000

April 30 Paid rent 500

April 30 Paid salary to ram 3,000
Date Particular L.F. Dr. (amount ) Cr. (amount)

April 1, Cash a/c Dr. 1 1,00,000
2009 To capital 4 1,00,000
(being the amount invested by
Ramesh in the business as
capital )
April 2 Bank a/c Dr. 5 70,000
To cash a/c 1 70,000
(being the amount paid into the
bank )
April 3 Purchases a/c Dr. 7 5,000
To cash 1 5,000
(being the goods purchased for
cash )
April 4 Cash a/c Dr. 1 1,000
To bank a/c 5 1,000
(being the cash withdrawn from
the bank )
April 13 Krishna Dr. 9 15,00
To sales a/c 7 15,00
(being the goods bought from
shyam on credit )
April 20 Purchases a/c Dr. 7 2,250
To shyam 10 2,250
(being the goods bought from
shyam on credit )

To Krishna 9 1,500
(being the cash received from
Krishna )
April 28 Shyam Dr. 10 2,250
To cash a/c 1 2,150
To discount received a/c 12 100
(being the goods sold for cash)
April 30 Rent a/c Dr. 15 500
Salaries a/c Dr. 10 3,000
To cash a/c 1 3,500
(being the amount paid for rent
and salary )
1,95,000 1,95,000
Notes:
1. Discount may be allowed when a payment is made. Discount may be received when payment is
received. Discount allowed is an expense for business so it should be debited and discount
received is a gain so it should be credited.
2. A combined or compound entry is passed since rent and salary to Ram has been paid in cash
on the same day.
Illustration 2. Journalese the following transactions:
Jan 1 2009 Started business with cash 50,000

Jan 3 Paid into bank 40,000
Jan 5 Sold goods to Mohan 22,000
Jan 9 Goods returned by Mohan 2,000
Jan 11 Goods purchased from shyam 31,000

Jan 15 Goods returned to shyam 1,500

Jan 18 Purchased goods from Ram on which he allowed 10% trade 10,000
discount
Jan 22 Received a V.P.P for goods 1,000
Jan 22 Sent a peon to collect it who paid as cartage 50
Jan 30 Paid interest on loan 500
Solution:
Date Particulars L.F. Dr. (amount) Cr. (amount)
Jan. 1 Cash a/c Dr. 50,000
To capital a/c 50,000
(being the business started with cash
Jan 3 Bank a/c Dr. 40,000
To cash a/c 40,000
(being the amount deposited into the bank)
Jan 5 Mohan Dr. 22,000
To sales a/c 22,000
(being the goods retuned by Mohan )
Jan 9 Sales returns a/c Dr. 2,000
To Mohan 2,000
(being the goods retuned by Mohan )
Jan 11 Purchase a/c Dr. 31,500
To shyam 31,500
(being the goods returned by Mohan)
Jan 15 Shyam Dr. 1,500
To purchases retunes a/c 1,500
(being the goods returned to shyam )
Jan 18 Purchases a/c Dr. 9,000
To Ram 9,000
(being the goods purchased from Ram at

10% trade discount )

Jan 22 Purchase a/c Dr. 1,000
To cash a/c 1,000
(being the V.P.P. received )
Jan 22 Cartage a/c Dr. 50
To cash a/c 50
(being the paid cartage)
Jan 30 Interest on loan a/c Dr. 500
To cash a/c 500
(being the payment of interest on loan)
1. Simple entry: a simple entry is one in which only two accounts are affected, one account is
debited and another is credited with an equal amount. The entries in illustration 1 above are
examples of single entry.
2. Compound entry: a compound entry is one in which two or more accounts are debited and or
more accounts are credited or vice versa. For example, a debt of rs. 5,000 due from satish has
been discharged by receipt of only rs. 4,850 cash and by rs. 150 allowed as discount. The
combined entry passed will be:
The transaction affects three accounts as follows:

Cash a/c Real a/c cash a/c (Rs. 4,850) to be debited because
cash is coming is coming into business.
Discount allowed a/c Nominal a/c discount allowed (Rs. 150) to be debited
because it is a Loss for business.
Satish personal a/c satish’s a/c (Rs. 5,000) to be credited
because he is the giver of the amount.
The entry for the transaction is a compound entry as follows:
Cash a/c Dr. 4,850
Discount allowed a/c Dr. 150
To satish 5,000
Entries of some specific transactions

1. Bed debts: in a business, if an amount is not realized or is partially realized on account of credit
sales, then the amount not realized is a loss termed as bad debt. The following journal entries are
passed in such a case:
(i) when the amount is irrecoverable:
Bad debts a/c Dr.
To Debtor’s personal a/c
(ii) When a part of the bad debt is recoverable: when a debtor becomes bankrupt, he is unable to
pay his total debt; the unrealized amount is a loss to the business.
The journal entry passed is:
Cash /bank a/c Dr. [With the amount received]

Bad Debts a/c Dr. [With the amount which is not recovered]
To Debtor’s personal a/c [Total amount of debtor]
2. Bad Debts Recovered: sometimes a debtor whose had been earlier written off as ‘Bad Debts’ pay
some amount. The amount so received is a gain to the business because the amount was earlier
written off as a loss. The entry of bed debts recovered is :
Cash / bank a/c Dr.

To bad debts recovered a/c

(i) Sohan is declared insolvent. Received from his official Receiver a first and final dividend of 60
paisa in the rupee on a debt of Rs. 1,000
(ii) Mohan who owed Rs. 2,000 has failed. He pays a compensation of 50 paisa in the rupee.
(iii) Received cash for a bad debt written off last year Rs. 700.
In the books of………….Journal

Date Particulars L.F. Dr. Cr. (amount )

(amount )
(i) Cash a/c Dr. 600
Bad debts a/c Dr. 400
To sohan 1,000
(being a cash dividend of 60 paisa
in the rupee out of his debt of Rs.
1,000 received from sohan on his
insolvency)
(ii) Cash a/c Dr. 1,000
Bad debts a/c Dr. 1,000
To Mohan 2,000
(being a cash composition of 50
paisa in the rupee received firm
Mohan out of a debt of Rs. 2,000)
(iii) Cash a/c Dr. 700
To Bad debts Recovered a/c 700
(being cash received on account
of recovery of a bad debt which
was previously written off )
3. Cash withdrawn or goods taken by proprietor for personal use: the following entry is
passed:
Drawings a/c Dr.
To cash a/c (if cash is withdrawn)
To purchases a/c (if goods are taken by proprietor for personal use)
Note: if the proprietor withdraws cash of takes goods from the business for his personal use; it is
called Drawings. The amount or cost of goods so withdrawn is debited to the Drawing account and
credited to the cash /purchase account. It is not treated as a sale but as a decrease in purchase as
no profit is earned on such goods.

4. Banking Transactions: Businesses have a banking account through which they make and
receive most of the payments. Payment by Cheque, Cheque received withdrawal of cash from
bank, deposit into bank, bank charges charged by bank and interest charged on overdraft by bank,
etc, are examples of banking transactions. If the books of accounts show a debit balance in the
bank account, it means that much amount is lying deposited in the bank. And if the books of
accounts show a credit balance in the bank account, it means that much amount is overdrawn and
is payable to the bank.
At the time of recording banking transactions, the following important considerations should be
borne in mind:
1. A bank account is a personal account and rule of debit and credit for a personal account, debit the
receiver and credit the giver’ will apply. Whenever a deposit is made in a bank, the bank account is
debited and whenever a withdrawal is made, the bank account is credited.
For example, cash deposit into the bank increases the bank balance. Thus, the bank account is
debited. Cash withdrawal from the bank reduces the bank balance. Thus, the bank is credited.
2. If a Cheque is received and is not deposited in the bank on the same day, it is debited to cash
account taking it to be cash. When the Cheque is deposited, on the day it is received, bank account
is debited instead of cash account.
Let us take the journal entries relating to banking transactions:
S.No. Transaction Entry Reason

1. Cash deposited for opening an Bank a/c Dr. Debit the receiver.
account To cash a/c Credit what goes out.
2 Cash withdrawn Cash a/c Dr. Debit what comes in.
To Bank a/c Credit the giver.
3 Cash with drawn for personal use Drawing a/c Dr. Debit the receiver.
To Bank a/c Credit the giver. In this
case, receiver is the
proprietor. Drawings are
reduced from his capital.

4 Payment by Cheque to a creditor Rakesh Dr. Debit the receiver.

(say vikas ) To Bank a/c Credit the giver.
5 Payment by draft to a creditor Vikas Dr. Debit the receiver.
(say vikas ) Bank charges a/c Dr. Debit all expenses and
To Bank a/c losses. Credit the giver.
6 Payment of expenses Expenses a/c Dr. Debit all expenses and
7 Charges paid to or charged by Bank Bank charges a/c Dr. Debit all expenses and
8 Cheque or draft received from a Bank a/c Dr. Debit the receiver.
debtor (say Rahul ) and deposited into To Rahul Credit the giver.
bank the same day
9 Cheque /draft received from debtor Cash a/c Dr. Debit what comes in.
Ankur) and not deposited into bank To Ankur Credit the giver.
the same day
10 Above Cheque/draft deposited into Bank a/c Dr. Debit the receiver.
the bank To cash a/c Credit what goes out.
11 Deposited Cheque dishonored Ankur Dr. When a Cheque
(say or Ankur ) To Bank a/c received from a debtor
is dishonored, he again
becomes a debtor and
the personal account of
the debtor will be
debited. Bank a/c will be
credited.
12 Interest charged by the bank Interest a/c Dr. Interest is an expense.
To Bank a/c Bank balance decrease.

13 Interest allowed by the bank Bank a/c Dr. Bank balance has
To Interest increased. Interest is our
Received a/c income.
14 Bank makes payment on firm’s behalf Insurance premium a/c Insurance premium is an
(say insurance premium ) Dr. expense so it should be
To Bank a/c debited. Bank balance
has decrease.
15 Bank collection by bank on our behalf Bank a/c Dr. Debit the receiver.
(say dividend ) To dividend a/c Credit what goes out or
cash has reduced.
16 Repayment of bank loan by issue of Bank loan a/c Dr. Debit the receiver.
Cheque To cash a/c Credit what goes out or
cash has reduced.
17 Repayment of bank loan by issue of Bank loan a/c Dr. Liability has deceases.
Cheque To Bank a/c Bank balance has also
reduced.
18 Transfer of funds from one account to Bank a/c Dr. Bank balance of account
another To Bank a/c has increased and bank
balance of account
decreased.
Jan.1 Paid into bank for opening a current account 20,000

Jan. 2 Withdrawn for private expenses 1,000
Jan. 3 Withdrawn from bank 3,000
Jan.4 With drawn from bank for private use 2,000
Jan.5 Placed on fixed deposit account at bank by 5,000
transfer from current account

Solution: Journal
DATE PARTICULER L.F. DR. (amount ) Cr. (amount)

Jan. 1 Bank a/c Dr. 20,000
To cash a/c 20,000
(being the cash deposited onto
the bank )
Jan.2 Drawing a/c Dr. 1,000
To cash a/c 1,000
(being the cash withdrawn for
personal use)
Jan.3 Cash a/c Dr. 3,000
To bank a/c 3,000
Jan.4 Drawing a/c Dr. 2,000
To bank a/c 2,000
(being the cash withdrawn from
bank for personal use)
Jan.5 Fixed deposit a/c Dr. 5,000
To bank a/c 5,000
(being the transfer from current
account to fixed deposit account
)
Jan.10 Purchases a/c Dr. 2,500
To bank a/c 2,500
(being goods purchased and
payment made through
Cheque )
5. Goods given as charity: The amount of purchases is reduced with the value of goods given as
charity. It is so because if goods are used for purposes other than sale, the amount of such

goods is reduced from purchases, credited to the purchases account. The following entry is
passed:
Charity a/c Dr.

To purchases a/c
6. Discount: A reduction in amount, whether to encourage more purchases or prompt payment is

called a Discount. A discount may be classified into: (i) Trade Discount; and (ii) cash Discount.
(i) Trade Discount: Trade Discount is an allowance made to a customer if he purchases goods of
certain quantity or amount. The discount so allowed is reduced from the sale value and the sale
or purchase is recorded in the books at the net value, net of trade discount. For examples, B
sells goofs to C worth RS. 1,000 and allows him 10% discount. Net sale therefore, is RS. 900. B
shall record the sale and C shall record the purchase at RS. 900
(ii) Cash Discount: cash discount is an allowance to encourage prompt payment of the amount due.
Cash discount, received or allowed, is recorded separately in the books. Cash discount allowed
is debited to discount allowed account while discount received is credited to discount received
account.
Trade discount and cash discount are discussed in detail in a separate chapter.
Illustration 5. Record the following transactions in a journal:
(I) With drawn goods for personal use (cost RS. 500, sales price RS. 700)?
(II) Goods worth RS. 500 given as charity.
(III) Received RS. 975 from Hare in full settlement of his account for RS. 1,000
(IV)Paid RS. 1,400 to Guri in cash in full settlement of his account for RS. 1,500.
(V) A Cheque for RS. 5,000 received from Rajib deposited into bank were returned dishonored.
Solution:
Date Particulars L.F. Dr. Cr.
(amount ) (amount )
(i) Drawings a/c Dr. 500
To purchases a/c 500
(being the goods withdrawn for personal use)

(ii) Charity a/c Dr. 500

(being goods given as charity )
(iii) Cash a/c Dr. 975
Discount a/c Dr. 25
To hari 1000
(being the amount received from hari an allowed
him discount)
(iv) Guri a/c Dr. 1,500
To cash a/c 1,400
To discount Received a/c 100
(being the amount paid in full settlement)
(v) Rajib a/c Dr. 5,000
To bank a/c 5,000
(being the Cheque deposited into bank retuned
dishonored )
7. Distribution of goods as free samples: To increase sales sometimes goods are distributed as
free samples. It is a part of the advertisement expense, hence, it is debited to the advertisement
account and deducted from purchases:
Advertisement a/c Dr.
To purchases a/c
8. Loss by theft or fire: In both the cases, it is loss of goods and loss to business. The following
entry is passed:
Loss by theft or fire a/c Dr.
To purchases a/c
Note: Loss by fire account is debited because the loss incurred represents an increase in expense
and the purchase account is credited because the purchase decreases.

(i) In case goods were insured:

Insurance co. Dr.
To loss by theft or fire a/c
(ii) When the full amount of claim is received from the insurance company:
Bank a/c Dr.
To insurance co.
(iii) When the insurance company does not accept full claim :
Bank a/c Dr.
Profit and loss a/c Dr.
To insurance co.
Illustration 6. Journalese the following:

(i) Goods worth rs. 500 were used by the proprietor for domestic purposes.
(ii) Rs. 200 due from hari is bad debts.
(iii) Goods uninsured worth rs. 3,000 were destroyed by fire.
(iv) Goods damaged by fire rs. 1,000 were destroyed by fire and insured by a insurance co.
(v) Goods costing rs. 500 given as charity (sales price rs. 600)
(vi) Paid landlord rs. 1,500 for rent. One third of the premises are occupied by the proprietor for his
own residence.
(vii) Sold household furniture for rs. 5,000 and paid the money into business cash.
Solution: JOURNAL
Date Particulars L.F. Dr. (amount) Cr.
(amount)
(i) Drawings a/c Dr. 500
(being the goods used for domestic purpose )
(ii) Bad debts a/c Dr. 200
To Hari 200
( being the bad debts written off )

(iii) Loss by fire a/c Dr. 3,000

To purchases a/c 3,000
(being the goods destroyed by fire )
(iv) Loss by fire a/c Dr. 1,000
To purchase a/c 1,000
( being the goods destroyed by fire )
Insurance co. Dr. 1,000
To loss by fire a/c 1,000
(Being the insurance claim lodged with the
insurance co.)
Bank a/c Dr. 800
Profit and loss a/c Dr. 200
To insurance co. 1,000
(v) Charity a/c Dr. 500
(being the goods distributed as charity )
(vi) Rent a/c (2/3rds of RS. 1,500) Dr. 1,000
Drawing a/c Dr. 500
To cash a/c 1,500
rd
(being rent paid to landlord, 1/3 of the
premises occupied by the proprietor for
personal residence )
(vii) Cash a/c Dr. 5,000 5,000
To capital a/c
(Being the introduced cash for capital)
9. Purchase and sale of assets :
On purchase of asset:
Asset a/c Dr.
To cash /Bank a/c
To supplier’s a/c
On sale of asset:
Cash/bank a/c Dr.

Purchaser’s a/c Dr.

To asset a/c
10. Expenditure on the installation of machinery and on the construction of building:

Machinery as building is the assets of a business. Any expenditure incurred on carriage and
installation of machinery, freight, wages paid for the installation, etc., is treated as ‘capital
expenditure’ and is debited to the Machinery account. In other words, all expenses incurred on the
purchases of an asset (except goods) increases the ultimate cost of the asset for the buyer. These
should, therefore, be debited to the particular asset account and not to any expense account.
Similarly, any expenditure incurred for the construction of buildings such as purchase of
construction materials and payment of wages should also be treated as capital expenditure and are
debited to the building account.
11. Sales Tax: At the time of sale, sales tax is also collected from the customers. Sales tax so
collected must be deposited in the government account on the due date. Sales tax collected is a
liability; therefore, it should be credited in a separate account. Journal entry passed in such
instances is;
(i) Cash /Debtors a/c Dr.
To sales a/c
To sales tax a/c
(ii) At the time of depositing sales tax in the government account, the entry passed is:
Sales tax a/c Dr.
To cash /Bank a/c
12. Value added tax (vat): in most of the states, sales tax has been replaced by value added tax. It
is similar to sales tax except for the fact the t vat paid on liability payable to the government. Journal
entries passed are:
(i) When VAT is paid at the time of purchases:

Purchases a/c Dr.
VAT paid a/c Dr.
To cash /Bank a/c creditor

(ii) When VAT is collected at the time of sale:

Cash /Bank a/c Debtor Dr.
To sales
To VAT collected a/c
(iii) When VAT is paid to the government:
(a) VAT collected a/c Dr.

To VAT paid a/c
(b) VAT collected a/c Dr.
To cash /Bank a/c
Illustration 7. Journalese the following transactions in the books of Ranjan:

(i) Paid RS. 5,000 in cash as wages on installation of machinery.
(ii) Sold goods to Krishna at his list price RS. 20,000, Trade Discount 10% and cash discount
5%. He paid the amount on the same day and availed the cash discount
(iii) Supplied goods costing RS. 6,000 to Mohan, issued invoice at 10% above cost less 5% Trade
discount.
(iv) Sold goods costing RS. 40,000 to ashok for cash at a profit of 25% on cost less 20% Trade
discount and charged 8% sales tax and paid cartage RS. 200 (not to be charged from the
customer).
(v) Sold goods costing RS. 40,000 to Mohan at a profit of 20% on sales less 20% Trade discount
and charged 8% sales Tax and paid cartage RS. 200 (to be charged from the customer).
(vi) Goods were distributed from stock as free sample value Rs. 2,500 a part of an advertising
campaign.
(vii) Anjan, a customer, returned goods invoiced at RS. 2,000, they being defective.
Date Particulars L.F. Dr. (amount) Cr.

(amount)
(i) Machinery a/c Dr. 5,000
To cash a/c 5,000
(being the wages paid on installation of a

machinery)
(ii) Cash a/c Dr. 17,100
Discount allowed a/c Dr. 900
To sales a/c 18,000
(being goods worth RS. 20,000 Sold At
10% Trade Discount And 5% Cash
Discount)
(iii) Mohan Dr. 6,270
To sales a/c 6,270
(being goods supplied worth RS. 6,600)
(IV) Cash a/c Dr. 43,200
To sales a/c 40,000
To sales tax a/c 3,200
(being goods sold for cash )
Cartage outward a/c Dr. 200
To cash a/c 200
(being the cartage paid )
Mahan Dr. 43,400
To sales a/c 40,000
To sales tax a/c 3,200
To cartage outward a/c 200
(being the cartage paid )
Cartage outward a/c Dr. 200
To cash a/c 200
(being the cartage paid)
(vi) Advertisement a/c Dr. 2,500
To purchases a/c 2,500
(being goods distributed as free samples )
(vii) Return inwards a/c Dr. 2,000
To Anjan 2,000
(being the goods returned by Anjan)

Installation charge is a capital expenditure, so it is debited to the machinery account.
Notes:
1. Trade discount is not shown separately in the books of account.
13.Sundry or miscellaneous expenses: often petty expenses such as for refreshment, postage,
conveyance, etc., are incurred in a business. It is not desirable to record such expenses in a
separate account of each expense. These expenses are generally debited in one account, sundry
expenses account the journal entry passed is :
Sundry expenses a/c Dr.

To cash a/c
14.Outstanding expenses: outstanding expenses are the expenses that relate to the current year
but have not been paid till the year end.
Example: wages for the year ending 31 st march, 2009 are rs. 6,000. Out of this, rs. 500 for the
month of March, 2009 have been paid in April, 2009. Since, rs. 500 as on 31st march, 2009 is yet to
be paid it should be recorded in the books by passing the following journal entry:
Wages a/c Dr. 500

To outstanding wages a/c 500
15. Prepaid expenses: Normally payment of certain expenses like – insurance, rent of shop, etc.,
are paid in advance. Such expenses are termed advance or prepaid expenses.
Example: on 1st July, 2008, RS. 1,200 were paid as insurance premium for the shop for the whole
year. Final accounts have to be prepared on 31st march, 2009 it means advance payment has been
made for the period 1st April, 2009 to 30th June, 2009. Since, payment relating to the period 1 st April,
2009 to 30th June, 2009 relates to the next year, it should be recorded in the books for the year
ended 31st March, 2009 as prepaid expenses. Journal entry passed is:

RS. RS.
Prepaid Expenses a/c Dr. 300

(Prepaid insurance premium a/c
In the above example)
To cash a/c 300
Note: prepaid insurance premium a/c is an asset.
16. Depreciation: Due to continuous use of foxed assets, value of these assets decreases every
year. This diminution in value is called depreciation. This is a trading loss. The following journal
entry is passed for recording depreciation :
Depreciation a/c Dr.

To Assets a/c
17. Interest on capital and drawings: interest on capital is a loss for business. Therefore, the
interest account is debited and the capital account credited with the amount of interest. If owner of
business draws any amount for his personal use from business, it is called drawings. Due to
drawings, the capital of the business is reduced. In case interest is charged on drawings, the capital
of the business is reduced. In case interest is charged on drawings, it is a gain for the business. For
these, drawings account is debited and interest on drawings account credited.
18. Income Tax : for a sole proprietorship, income tax is treated as drawings of the proprietor
because it is neither loss, nor an expense or the business.
a. When income tax is paid;
Income tax a/c dr.
To cash /bank a/c
b. For treated drawings of the proprietor;

Drawings a/c Dr.
To income tax a/c

Note: In a partnership firm and joint stock companies, income tax shall be paid by the partnership
firm and joint stock companies, respectively.
Illustration 8. Journalese the following transactions in the books of Ram:

(i) Beena who owed RS. 1,500 are declared insolvent and 65 paisa in a rupee is received as final
dividend from her estate.
(ii) Sold goods to Leela list price RS. 2,000 Trade Discount 10% and cash discount 5% she paid the
amount on the same day.
(iii) Rent due to landlord RS. 500.
(iv) Goods worth RS. 10,000 were destroyed by fire.
Solution:
Date Particulars L.F. Dr. Cr.
(amount ) (amount)
(i) Cash a/c (RS. 1500 × 65/100) 975
Dr. 525
Bad debts a/c (RS. 1,500 × 35/100) 1,500
Dr.
To Beena
(being65paise in a rupee is received from Beena
in full settlement )
(ii) Leela 1,800
Dr. 1,800
To sales a/c (RS. 2,000- 10% of RS. 2,000)
(Being cash received from Leela on credit at 10%
trade discount)
Cash a/c 1,710
Dr. 90
Discount allowed a/c (5/100*RS. 1,800) Dr. 1,800
To Leela
(being cash received from Leela at 5% cash
discount )

(iii) Rent a/c 500

Dr. 500
To rent outstanding a/c
(being rent outstanding during the year)
(iv) Goods lost by fire a/c Dr 10,000
To purchase a/c 10,000
(being goods lost by fire )
OPENING ENTRY
Business firms close their books of account at the end of each year and start a new set of books at
the beginning of each New Year. The first entry in the journal is to record the closing balances of
individual assets and liabilities of the previous year. These balances become the opening balances
of the New Year. The entry passed to record the closing balances of the previous year is called the
opening entry. The balance sheet prepared at his end of the year reflects the closing balances of
each asset and liability and forms the basis for this opening entry. While passing an opening entry
all assets accounts are debited and all liabilities accounts are credited. The following example will
make it clearer:
Balance sheet
Liabilities RS. (amount ) Assets RS. (amount )
Mahendra & sons 5,600 Cash in hand 430
Capital 20,000 Cash at bank 2,675
Debtors 7,795
Closing stock 9,000
Machinery and 6,000
equipment
25,600 25,600
Advantages of a journal: Advantages of a journal are:

(i) Journal Reduces the possibility of Error
(ii) Journal provides an Explanation of the Transaction :
(iii) Journal provides a chronological record of all transactions.

SUB- DIVISION OF JOURNAL

Journal is the primary book of accounts in which the transaction is first recorded. As the business
grows so dies the number of transaction. And if all the transactions are first recorded in the journal,
it will become very voluminous and this, difficult to handle. Also, distribution of work will become
difficult. Therefore, journal is sub-divided into subsidiary journal books. These are:
(i) Cash Book - to record cash and bank transactions.
(ii) Purchase Book - to record credit purchases of goods dealt in or used in manufacturing.
(iii) Purchases Return Book – to record return of purchased goods.
(iv) Sales Book - to record credit sale of goods dealt in.
(v) Sales Return Book - to record return of goods sold.
(iv)Bills Receivable Book - to record bills received.
(vii) Bills Payable Book - to record bills payable.
(viii) Journal Proper - to record all other transactions that are not recorded in any of the
above sub-
Journals.
We shall discuss the sub-journals in a subsequent chapter.
LEDGER
Meaning of a ledger: earlier, we discussed the term account. In an account transactions of one
nature are posted or summarized. All the accounts put together constitute a ‘Ledger’. A ledger may
be defined as a “book or register which contains, in a summarized and classified form, a permanent
record of all transactions. It is the most important book of accounts, since the trial balance is drawn
from it and from the trial balance, financial statements are prepared. Hence, the ledger is called the
principal book.
Utility of a ledger: A ledger is the principal book of account which contains all information regarding
business transactions. It is difficult to prepare the final accounts in the absence of a ledger as it
provides necessary information regarding various accounts. Personal accounts in a ledger show
how much money the firm owes to its creditors and the amounts it has to recover from its debtors.
The real accounts show the values of properties and also the value of stock. Nominal accounts
reflect the sources of income and also the amount spent on various items. The financial position of
the business can be ascertained easily at any time with the help of a ledger.

Form of a ledger account: The form of this account was explained in an earlier chapter. For
convenience, the form of account is repeated here.
NAME OF THE ACCOUNT, WAGES ACCOUNT

Date Particulars Folio Amount Date Particulars Folio Amount
Date of the Name of Page of Amount of Date of Name of Page or Amount of
Transactio the other reference the the the other reference the
n account number of transaction transactio account number of transaction
subsidiary n subsidiary
book, book,
where the where the
entry was entry was
first first
recorded, recorded,
cash cash
book book
Posting the entries

The process of transferring the information contained in a journal to a ledger is called posting.
The following procedure is followed for pasting the debit and credit aspect of the transaction
recorded in a journal
(i) Posting of account debited in a journal entry: the steps to be followed are:
First: Identify in the ledger the account to be debited.
Second: Enter the date of the transaction in the ‘date’ column on the debit side of the account.
Third: Write the name of the account which has been credited in the respective entry in the
‘particulars’ column on the debit side of the account as ‘To (name of account credited)’
Fourth: Record the page number of the journal where the entry exists in the journal folio (j.f.)
column
Fifth: Enter the relevant amount in the ‘Amount’ column on the debit side.
(ii) Posting an account credited in a journal entry: The steps to be followed are:
First: Identify in the ledger the account to be credited.

Second: Enter the date of the transaction in the ‘Date’ column on the credit side.
Third: Write the name of the account which has been debited in the respective entry in the
‘particulars’ column on the credit side of the account as ‘By (name of account debited)’
Fourth: Record the page number of the journal where the entry exists in the journal folio (J.F.)
column.
Fifth: Enter the relevant amount in the ‘Amount column on the credit side.
Use of the words ‘To’ and ‘By’: it is costmary to use the word ‘To’ with accounts which appear on
the debit side of a ledger account. Similarly, the word ‘By’ is used with accounts which appear on
the credit side of a ledger account. The words ‘To’ and ‘by’ do not have any specific meaning.
Modern accountants therefore, ignore the use of these words.
BALANCING OF ACCOUNTS
Balance of an account is the difference between the debit and credit totals of an account. After
posting all transactions, accounts are balanced every year of after a certain period to ascertain the
net effect of entries in the accounts. Balancing an account means that the two sides of account are
totaled and the difference in total of the two sides is written on the side whose total is short. For
example, if the total of the credit side is more than the debit side of any account the difference of
account will be recorded as Balance c/d o the debit side and vice versa on the credit side. If the total
of the debit side of any account is greater that account will reveal a debit balance and if total of
credit side of any account is greater it will show a credit balance. The debit balance is then written
on the debit side as ‘To balance brought down’ of ‘To Balance b/d’ which is the opening balance for
the new period. The credit balance is then written on the credit side as ‘By Balance b/d; this is the
opening balance for the new period. The total of the debit and credit sides of some accounts may be
equal. Those accounts will not show any balance. The concept of balancing is illustrated in the
following diagram:
Types of accounts that are balanced: Normally, personal accounts and real accounts are
balanced. Nominal accounts are not balanced but are closed by transfer to trading of profit and loss
account at the end of the accounting year.
The ledger accounts based on journal entries in illustration 1 will be opened as follows:

LEDGER
CASH ACCOUNT
Dr. Cr.
Date Particulars J.F. RS. Date Particulars J.F. RS.
2009 2009
April 1 To capital a/c 1,00,000 April 2 By bank a/c 70,000
April 4 To bank a/c 1,000 April 3 By purchase 5,000
April 24 To Krishna 1,500 April 28 a/c 2,150
April 30 To sales a/c 8,000 April 30 By shyam 500
April 30 By rent a/c 3,000
April 30 By salaries a/c 29,850
1,10,500 By balance c/d 1,10,500
29,850
May 1 To balance b/d
Capital account
TRIAL BALANCE
Meaning of Trail Balance: After posting the transactions in the accounts and balancing them. A
statement is prepared to show separately the debit and credit balances. Such a statement is known
as trial balance. It may also be prepared by listing each and every account and entering in separate
columns the totals of the debit and credit sides. Whichever way it is prepared, the totals of the two
columns should agree. An agreement indicates reasonable arithmetical accuracy of the accounting
work. If the two sides do not agree. There is definitely some error or errors. It must by remember
that equalizing the two sides of a trial balance is not the sole and conclusive proof of the complete
correctness of accounting work.
Objects of a trial balance

A trial balance is a list of accounts showing debit balances and credit balances. If the trial balance
agrees it proves:

(i) that the accounts are arithmetically accurate;

(ii) that both aspects of all the transactions have been correctly recorded; and
(iii) That both debit and credit entries are passed in the ledger.
A Trial balance facilitates the preparation of final accounts, the trading account, the profit and loss
account and the balance sheet.
Methods of preparing a trial balance
There are two methods of preparing a trial balance:
1. totals method: In this method, the total of debit and credit sides of the ledger accounts,
excluding the closing balances are shown in the trial balances
2. Balance method: In this method, only the closing balances of the ledger accounts are shown.
Illustration 9. Journalese the following transactions, post them in ledger accounts and balance
them:
2009
April 1 Kamal started business with cash ………………………………….. 1,00,000
April 2 Bought goods for cash ……………………………………………... 30,500
April 3 Opened bank account with cash …………………………………… 50,000
April 4 Sold goods for cash ………………………………………………... 40,000
April 7 Bought goods from surya on credit ………………………………... 30,000
April 10 Sold goods to rekesh on credit …………………………………….. 25,000
April 15 Purchased plant and machinery and payment is made by Cheque 16,000
April 19 Paid to surya in cash ………………………………………………. 10,000

April 21 Received loan from Anil and deposited the same into bank ………. 8,000
April 23 Goods Retuned to surya ……………………………………………. 1,000
April 26 Withdrew from bank for personal use. ……………………………. 5,000
April 27 Paid to Surya by Cheque. …………………………………………... 8,000
April 29 Received cash from radish ………………………………………… 1,0000
April 30 Purchased stationery for cash ……………………………………… 200
April 30 Paid wages and salaries ……………………………………………. 10,000
Solution:
Date Particular L.F. Dr. (amount ) Cr.
(amount)
2009 Cash a/c Dr. 1,00,000
April 1 To capital a/c 1,00,000
(being business started with capital of RS. 1,00,000
brought in cash)
April 2 Purchases a/c Dr. 30,500
To cash a/c 30,500
(being goods purchased for cash )
April 3 Bank a/c Dr. 50,000
to cash a/c 50,000
(being a bank account opened by depositing cash
into bank)
April 4 Cash a/c Dr. 40,000
To sales a/c 40,000

(being goods sold for cash )

April 7 Purchases a/c Dr. 30,000
To surya 30,000
(being goods purchased on credit from surya)
April 10 Rakesh a/c Dr. 25,000
To sales a/c 25,000
(being goods sold to radish on credit )
April 15 Plant and machinery a/c Dr. 16,600
To Bank a/c 16,600
(being plant and machinery purchased by Cheque )
April 19 Surya Dr. 10,000
To returns outwards a/c 10,000
(being amount paid to surya in cash )
April 21 Bank a/c Dr. 8,000
To Anil’s loan a/c 8,000
April 23 Surya a/c Dr. 1,000
To Bank a/c 1000
(being amount paid to surya by Cheque )
April 26 Drawing a/c Dr. 5,000
To Bank a/c 5,000
(Being amount withdrawn from bank for personal
use )
April 27 Surya a/c Dr. 8,000

To bank a/c 8,000
(being amount paid to surya by Cheque )
April 29 Cash a/c Dr. 10,000
To Rakesh 10,000
(being cash received from rakesh )
April 30 Stationery a/c Dr. 200
To cash a/c 200

(being stationery purchased for cash )

April 30 Wages and salaries a/c Dr. 10,000
To Cash a/c 10,000
LEDGER
CASH ACCOUNT
Dr. Cr. Cr.
Date Particular J.F Dr. Amount Date Particular J.F. Cr.
. . Amount
2009 2009
April 1 To Capital a/c 1,00,000 April 2 By purchases a/c 30,500
April 4 To Sales a/c 40,000 April 3 By Bank a/c 50,000
April 29 To Rakesh 10,000 April 19 By Surya 10,000
April 30 By tationery a/c 200
April 30 By Wages and 10,000
salaries a/c
April 30 By Balance c/d 49,300
1,50,000 1,50,000
49,300
1 May To Balance b/d
CAPITAL ACCOUNT
Dr.
Cr.
Date Particulars J.F. Amount Date Particular J.F. Amount
2009 2009
April 30 To balance c/d 1,00,000 April 1 By cash a/c 1,00,000
1,00,000 1,00,000

1,00,000
May 1 By balance b/d
PURCHASES ACCOUNT
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
2009 2009
April 2 To cash a/c 30,500 April 30 By balance c/d 60,500
April 7 To surya 30,000
60,500 60,500
May 1 To Balance b/d 60,500
BANK ACCOUNT
Dr. Cr.
Date Particular J.F. Amount Date Particular J.F. Amount
2009 2009
April 3 To cash a/c 50,000 April 15 By plant and 16,600
April 21 To anil’s loan a/c 8,000 machinery a/c 5,000
April 26 By drawings a/c 8,000
April 27 By surya 28,400
58,000 April 30 By balance c/d 58,000
May 1 To Balance b/d 28,400

SALES ACCOUNT
Dr. Cr
Date Particulars J.F. Amount Date Particular J.F. Amount
2009 2009
April 30 To balance c/d 65,000 April 4 By cash a/c 40,000
April 10 By Rakesh 25,000
65,000 65,000
May 1 By balance b/d 65,000
SURYA
Dr. Cr.
2009
2009 To cash a/c 10,000 April 7 By purchases 30,000
April 19 To returns 1,000 a/c
April 23 outwards a/c 8,000
To Bank a/c 11,000
April 27 To balance a/c
April 30 30,000 30,000

May 1 11,000
By balance b/d
RAKESH
Dr. Cr.
2009 2009
April 10 To sales a/c 25,000 April 29 By cash a/c 10,000
April 30 By balance c/d 15,000
25,000 25,000
May 1 To balance b/d 15,000

PALNT AND MACHINERY ACCOUNT
Dr. Cr.
2009 2009
April 15 To bank a/c 16,600 April 30 By balance c/d 16,600
16,600 16,600

ANIL’S LOAN ACCOUNT

Dr. Cr.
2009 2009
April 30 To balance c/d 8000 April 21 By bank a/c 8,000
8,000 8,000
8,000
May 1 By balance b/d
RETURN OUTWARDS ACCOUNT
Dr. Cr.
2009 2009
April 30 To balance c/f 1,000 April 23 By surya 1,000
1,000 1,000
May 1 By balance b/d 1,000
DRAWINGS ACCOUTNT
Dr. Cr.
2009 2009
April 26 To bank a/c 5,000 April 30 By balance c/d 5,000
5,000 5,000

STATIONERY ACCOUNT
Dr. Cr.
2009 2009
April 30 To cash a/c 200 April 30 By balance c/d 200
200 200
May 1 To balance b/d 200

WAGES AND SALARIES ACCOUNT
Dr. Cr.
2009 2009
April 30 To cash a/c 10,000 April 30 By balance c/d 10,000
10,000 10,000
Distinction between journal and ledger

Point of distinction Journal Ledger
1. Nature of book It is a book of primary entry. It is a book of final entry.
2. Basis for preparation Primary documents(such as Journal is the basis for
vouchers, receipts, etc.) are the recording transactions in the
basis for recording transaction in ledger.
the journal
3. Stage of recording Recording in the journal is the Recording in the ledger is the
first stage. second stage.

4. Object It is prepared to record all It is prepared to see the net

transactions in chronological effect of various transactions
order. affecting of particular account.
5. Format Journal has five columns: Ledger has four identical
1. Date 2. Particulars, 3. columns on debit and credit
Ledger folio, 4. Debit amount, 5. side; 1. Date, 2. Particulars, 3.
Credit amount. Folio, 4. Amount.
6. Balancing Journal is not balanced. All ledger accounts (except
nominal account) are balanced
in the ledger.
7. Process The process of recording in Ledger serves as the basis for
journal is called journalizing. the preparation of final
accounts.
8. Basis of preparation of Formal directly does not serve Ledger serves as the basis for
final accounts as basis for the preparation of the preparation of final
final accounts. accounts.
TRIAL BALANCE
Meaning of trial balance: After posting the transactions in the accounts and balancing them, a
statement is prepared to show separately the debit and credit balances. Such a statement is known
as trail balance. It may also be prepared by listing each and every account and entering in separate
columns the totals of the debit and credit sides. Whichever way unit is prepared, the totals of the
two columns should agree. An agreement indicates reasonable arithmetical accuracy of the
accounting work. It the two sides do not agree, there is definitely some error or errors. It must be
remembered that equalizing the two sides of a trial balance is not the sole and conclusive proof of
the completer correctness of accounting work.
OBJECTS OF A TRIAL BALANCE

A trial balance is a list of accounts showing debit balances and credit balances, if the trial balance
agrees it proves:
i. That the accounts are arithmetically accurate;

ii. That both aspects of all the transactions have been correctly recorded; and
iii. That both debit and credit entries are passed in the ledger.
A trial balance facilitates the preparation of final accounts, the trading account, the profit and loss
account and the balance sheet.
Methods of preparing a trial balance
There are two methods of preparing a trial balance;
i. Totals method: In this method, the total of debit and credit sides of the ledger accounts,
excluding the closing balances are shown in the trial balance.
ii. Balance method: In this method, only the closing balances of the ledger accounts are shown.
Illustration 10. From the following transactions of M/s. Wise and Active, wrote up the Journal in
proper form, post the ledger and take out a Trial balance:
2009
Jan 1 Assets: cash in hand RS 200: cash at bank RS. 6,800; Stocks of goods RS.
4,000;
Machinery Rs 10,000;Furniture Rs. 1,000; M/s. Narain Bros. owe RS.1,500;
M/S.B.K. Bros. owe RS 2.500. Liabilities: Loan RS, 5,000; sum owing to
Jacob Bros. ltd., RS. 2,000
Jan.2 Bought goods on credit from Samuel &Co. 1,000
Jan.3 Sold goods for cash to Dhiraj &Co. 400
Jan.4 Sold goods to Narain Bros. on credit 1,000
Jan.5 Received from Narain Bros. in full settlement of amount due on january1 1,450
Jan.6 Payment made to Jacob Bros. Ltd. by cheque; 975
they allowed discount 25
Jan.9 Old Furniture Sold for cash 100
Jan.10 Bought goods for cash 750
Jan.11 B.K.Bros. paid by Cheque; Cheque deposited in the bank 2,500
Paid cash 100
Jan. 13 Bought goods from Jacob bros. ltd. 1,000
Paid carriage on these goods 50
Jan. 16 Received Cheque from Narain bros. and the Cheque deposited in bank 950

Discount allowed to them 50

Jan. 17 Paid Cheque to Jacob bros. ltd. 1,000
Jan. 18 Bank intimates that Cheque of Narain bros. has been retuned unpaid 1,000
Jan. 19 Sold goods for cash to kay bros. 600
Jan. 21 Cash deposited in bank 500
Jan. 24 Paid municipal taxes in cash 100
Jan. 25 Borrowed from urania investment co. ltd. for erecting own premises. Money
deposited with bank for the time –being 10,000
Jan. 27 old newspapers sold 20
Jan. 28 paid for advertisements 100
Jan. 31 paid rent by Cheque 150
Jan. 31 paid salaries for the month 300
Jan. 31 drew out of bank for private use 250
Jan. 31 Narain bros. becomes insolvent, a dividend of 50p. in the rupee is received
an old amount, written off as bad debt in 2007 is recovered
Solution
IN THE BOOKS OF M/S WOSE AND ACTIVE

JOURNAL
Date Particular l.f. Dr. Amount Cr. Amount
2009
Jan. 1 Cash a/c Dr. 2 200
Bank a/c Dr. 3 6,800
Stock a/c Dr. 4 4,000
Machinery a/c Dr. 5 10,000
Furniture a/c Dr. 6 1,000
Narain bros. Dr. 7 1,500
B.K. bros. Dr. 8 2,500
To loan a/c 9 5,000
To Jacob bros. 10 2,000

To capital a/c 1 19,000

(Being the assets and liabilities brought forward from
last tear, capital found by deducting liabilities from
assets (rs. 26,000-rs. 7,000)
Jan. 2 Purchase a/c Dr. 4 1,000

To Samuel & co. 11 1,000
(Being goods purchased from Samuel &co. as per
their bill no. dated ……)
To sales a/c 4 400
(Being goods sold for cash to Dhiraj & co. as per
cash memo no……)
Jan. 4 Narain bros. Dr. 7 1000
(Being goods sold to Narain & bros. as per invoice
no dated………..)
Jan. 5 Cash a/c Dr. 2 1,450
Discount Allowed a/c Dr. 13 50
To Narain bros. 7 1,500
(being the amount of RS. 1,450 received in payment
for a debt of RS. 1,500 hence discount allowed is
RS. 50)
JAN. 6 Jacob Bros. ltd. Dr. 10 1,000
To Bank a/c 3 975
To Discount received a/c 13 25
(being the amount paid by Cheque[out of bank ] to
Jacob bros. ltd. Who allowed discount of RS. 25)
To furniture a/c 6 100
( being sale of old furniture, payment received in
cash)

Jan. 10 Purchases a/c Dr. 4 750

To cash a/c 2 750
(Being purchases of goods for cash as per voucher
no...)
Jan. 11 Bank a/c Dr. 3 2,500
To B.K. Bros. 8 2,500
(Being the cheque received firm b.k. bros. and
deposited inn bank )
Jan. 11 Repairs a/c Dr. 15 100
To Cash a/c 2 100
(Being the amount paid for repairs to machinery as
per repairs bill no…dated ….)
Jan. 13 Purchases a/c Dr. 4 1,000
To Jacob Bros. ltd. 10 1,000
(Being foods purchased from Jacob bros. ltd. as per
their bill no. Dated…)
Jan. 13 Cartage a/c Dr. 16 50
To Cash a/c 2 50
(Being the amount paid for cartage on goods bought
from Jacob bros. ltd.)
Jan. 16 Bank a/c Dr. 3 950

Discount allowed a/c Dr. 13 50
To Narain & bros. 1,000
(Being the cheque received and deposited in bank;
discount allowed RS. 50)
Jan. 17 Jacob Bros. ltd. Dr. 10 1,000
To Bank a/c 3 1,000
(Being the amount paid by Cheque to Jacob bros.
ltd.)

Jan. 18 Narain Bros. a/c Dr. 7 1,000

To Bank a/c 3 950
To Discount allowed a/c 13 50
(Being the Cheque received from Narain bros.
returned dishonored, They are debited with the full
amount due to us; bank credited with RS. 950
because the previous debit had to be cancelled;
discount account credited because the discount
allowed previously will be written back.)
To Sales a/c 4 600
(Being goods sold fro cash as per cash memo no….)
Jan. 21 Bank a/c Dr. 3 500
To Cash a/c 2 500
(being cash sent to bank )
Jan.24 Municipal taxes a/c Dr. 17 100
To Cash a/c 2 100
(being the amount paid as tax)
Jan. 25 Bank a/c Dr. 3 10,000
To loan a/c 9 10,000
(Being the amount borrowed from urania investment
co. ltd.)
To Sundry receipts a/c 18 20
(being the income derived by sale of old newspapers
)
Jan. 28 Advertisement a/c Dr. 19 100
To Cash a/c 2 100
(Being the advertisements paid for as per bill no…)
Jan. 31 Rent a/c Dr. 20 150
To Bank a/c 3 150

(Being the account paid as rent by Cheque no….)

Jan. 31 Salaries a/c Dr. 22 300
To Cash a/c 2 300
(Being salaries paid for the month )
Jan. 31 Capital a/c Dr. 1 250

To Bank a/c 3 250
(Account drawn out of bank by the proprietor for
private use)
Bad debts a/c Dr. 21 500
To Narain bros. 7 1,000
(Being half the sum due from Narain bros. received
in cash and the other half written off as being
irrecoverable )
To Bad Debts recovered a/c 21 150
(Being the sum previously treated as lost, now
recovered –it is a gain,)
Ledger accounts
M/s. wise and active
CAPTIAL ACCOUNT
Dr. Cr.
2009 2009
Jan. 31 To bank a/c 250 Jan. 1 By balance b/d 19,000
Jan. 31 To balance c/d 18,750
19,000
19,000

Feb. 1 By balance b/d 18,750
CASH ACCOUNT
Dr. Cr.
2009 2009
Jan 1 To balance b/d 11 200 Jan. 10 By purchases a/c 10 750
Jan 3 To sales a/c 11 400 Jan. 12 By repairs a/c 12 100
Jan 5 To Narain bros. 12 1,450 Jan. 13 By cartage a/c 12 50
Jan 9 To furniture a/c 12 100 Jan. 21 By bank a/c 13 500
Jan 19 To sales a/c 12 600 Jan. 24 By municipal tax a/c 13 100
Jan 26 To sundry 20 Jan. 28 By advertisement 13 100
receipts a/c 13 500 Jan. 31 a/c 13 300
Jan 31 To barain bros. 13 Jan. 31 By salaries a/c 13 1,520
Jan 31 To bad debts 150 By balance c/d
Recovered a/c 13 3,420 3,420
17,425
Feb 1 To balance b/d
BANK ACCOUNT
Dr. Cr.

2009 2009
Jan 1 To balance b/d 11 6,800 Jan. 6 By Jacob bros. ltd. 12 975
Jan 11 To b.k. bros. 12 2,500 Jan 17 By Jacob bros. ltd. 12 1,000
Jan 16 To Narain bros. 12 950 Jan 18 By Narain bros. 13 950
Jan 21 To cash a/c 13 500 Jan 31 By rent a/c 13 150
Jan 25 To loan a/c 13 10,000 Jan 31 By capital a/c 13 250
Jan 31 By balance c/d 17,425
20,750 20,750
Feb 1 To balance b/d 17,475
MACHINERY ACCOUNT
Dr. Cr.
2009 2009
Jan. 1 To balance b/d 11 10,000 Jan. 31 By balance b/d 10,000
10,000 10,000
10,000
Feb. To balance b/d
1
FURNITURE ACCOUNT
Dr. Cr.
2009 2009
Jan. 1 To balance b/d 11 1,000 Jan. 9 By cash a/c 11 100
Jan. 31 By balance c/d 900

1,000
1,000
Feb. 1 To balance b/d

900
STOCK ACCOUNT
Dr. Cr.
2009 2009
Jan. 1 To balance b/d 11 4,000 Jan. By balance c/d 11 4,000
31
Feb. To balance b/d 4,000
1
PURCHASE ACCOUNT
Dr. Cr.
Date Particular J.F. Amount Date Particular J.F Amount
.
2009 2009
Jan. 6 To Samuel &co. 11 1,000 Jan. 31 By balance c/d 2,750
Jan. 10 To cash a/c 12 750
Jan. 13 To Jacob bros. 12 1,000
ltd.
2,750 2,750
Feb. 1 2,750
To balance b/d
SALES ACCOUNT

Dr. Cr.
Date Particular J.F Amount Date Particular J.F. Amount
.
2009 2009
Jan. 31 To balance c/d 2,000 Jan. 3 By cash a/c 11 400
Jan. 4 By barain bros. 11 1,000
Jan. By cash a/c 13 600
19
2,000 2,000
By balance b/d 2,000

Feb. 1
NARAIN BROS.
Dr. Cr.
2009 2009
Jan.. 1 To balance b/d 11 1,500 Jan. 5 By cash a/c 12 1,450
Jan. 4 To sales a/c 11 1,000 Jan. 5 By discount
Jan. 18 To bank a/c 13 950 Jan.16 allowed a/c 12 50
Jan. 18 To discount 50 Jan.16 By bank a/c 12 950
allowed a/c Jan.31 By discount
allowed a/c 12 50
By cash a/c 11 500
By bad debts a/c 21 500

3,500 3,500
B.K. BROS.
Dr. Cr.
2009 2009
Jan. 1 To Balance b/d 2,500 Jan. By Balance b/d 11 2,500
11
LOAN ACCOUNT
Dr. Cr.
.
2009 2009
Jan. 31 To Balance c/d 15,000 Jan. 1 By Balance b/d 1 5,000
Jan. 25 By Bank a/c 13 10,000
15,000 15,000
Feb. 1 By Balance b/d 15,000
JACOB BROS. LTD.

Dr. Cr.

2009 2009
Jan. 6 To Bank a/c 12 950 Jan. 1 By Balance b/d 11 2,000
Jan. 6 To discount Jan. 13 By Purchase a/c 12 1,000
received a/c 12 50
Jan. 17 To Bank a/c 1,000
Jan. 31 To Balance 1,000
c/d 3,000 3,000
Feb. 1 By balance b/d 1,000
SAMUEL & CO.
Dr. Cr.
2009 2009
Jan. 31 To Balance c/d 1,000 Jan. 2 By Purchase 11 1,000
a/c
Feb. 1
By Balance 1,000
b/d
DISCOUNT ALLOWED ACCOUNT

Dr. Cr.
2009 2009
Jan. 5 To Narain bros. 12 50 Jan. 18 By Narain bros. 13 50
Jan. 16 To Barain bros. 12 50 Jan. 31 By balance c/d 50
100 100
Feb. 1 To balance b/d 50

DISCOUNT RECEIVED ACCOUNT

Dr. Cr.
2009 2009
Jan. 31 To balance 25 Jan. 6 By Jacob bros. 12 25
c/d ltd.
25
Feb. 1
By balance b/d
REPAIRS ACCOUNT
Dr. Cr.
2009 2009
Jan. 11 To cash a/c 12 100 Jan. 31 By balance c/d 100
100
100
Feb. 1 To balance b/d
CARTAGE ACCOUNT
Dr. Cr.
2009 2009
JAN. 13 To cash a/c 12 50 Jan. 31 By balance c/d 3 50
MUNICIPAL TAXES ACCOUNT

Dr. Cr.
2009 2009
To balance b/d 100
SUNDRY RECEIPTS ACCOUNT

Dr. Cr.

2009 2009
Jan. 31 To balance c/d 20 Jan. 27 By cash a/c 13 20
Feb. 1 By balance b/d 20
ADVERTISEMENT ACCOUNT
Dr. Cr.
2009 2009
RENT ACCOUNT
Dr. Cr.


.
2009 2009
Jan. 31 To bank a/c 13 150 Jan. 31 By balance c/d 150
SALARES ACCOUNT
Dr. Cr
Date Particular J.F. Amount Date Particular J.F Amount
.
2009 2009
Jan. 31 To cash a/c 300 Jan. 31 By balance c/d 300
Feb. 1 T balance b/d 300
BAD DEBTS ACCOUNT

Dr. Cr.
2009 2009
Jan. 31 To Narain bros. 13 500 Jan. 31 By balance c/d 500

BAD DEBTS RECOVERED ACCOUNT

Dr. Cr.
2009 2009
Jan. 31 To balance c/d 150 Jan. 31 By cash a/c 150
By balance b/d 150
TRIAL BALANCE
As at January, 31, 2009
S. no Name of account L.F. Dr. (amount ) Cr. (amount )

1. Capital a/c 18,750

2. Cash a/c 1,520
3. Bank a/c 17,425
4. Machinery a/c 10,000
5. Furniture a/c 900
6. Stock a/c 4,000
7. Purchases a/c 2,750
8. Sales a/c 2,000
9. Loan a/c 15,000
10. Jacob bros. ltd. 1,000
11. Samuel & co. 1,000
12. Discount allowed a/c 50
13. Discount received a/c 25
14. Repairs a/c 100
15. Cartage a/c 50
16. Municipal taxes a/c 100
17. Sundry receipts a/c 20
18. Advertisement a/c 100
19. Rent a/c 150
20. Salaries a/c 300
21. Bad debts a/c 500
22. Bad debts recovered a/c 150
37,945 37,945
Question 1. Enter the following transactions in the journal of m/s Karim bros., post to the ledger and
prepare a trial balance;
2009
April 1 Assets: Cash in hand ……………………………………………… 20,000
Cash at bank ………………………………………………… 35,000

Stock ………………………………………………………… 15,000

Furniture…………………………………………………….. 4,500
Debtors: Poonam …………………………………………… 20,000
Sonu………………………………………………………. 10,000
Liabilities: Ashok ………………………………….……………… 13,500
Pankaj…………………………………………………… 21,500
April 4 Purchased goods from Pankaj……………………………… 5,000
April 7 Paid Ashok by Cheque in full settlement of his account …………… 13,000
April 10 Sold goods to Poonam ……………………………………………… 11,000
April 12 Purchased goods from Ashok …………………………………… 15,000
April 15 Sold goods to Sonu…………………………………………… 6,000
April 18 Received Cheque from Poonam ……………………………… 24,500
April 25 Allowed her discount ………………………………………… 1,500
April 27 Paid for stationery ……………………………………………… 1,200
April 30 Paid rent by chaque ……………………………………………… 3,500
Paid salaries ………………………………………………………… 6,000
(Trial Balance- Rs 128000)
2. Journalese the following transactions, post to the ledger and prepare a trial balance to check its
arithmetical accuracy:
2009 RS. RS.
April 1 Commenced business April 21 Paid cash for trade
with cash 18,000 Expenses 15
April 2 Deposited into bank 5,000 April 22 Sold goods to radhey
April 3 Bought goods for cash 2,500 April 23 shyam 2,338
April 5 Bought goods of shyam Received from jagdish
Lal 7,320 April 25 chand 2,000
April 10 Sold goods for cash 1,630 Allowed him discount 50
April 11 Paid cash into bank 2,500 April 27 Paid shyam Lal cash on
April 13 Bought furniture for cash 300 April 28 account 2,000
April 15 Sold goods to vinod 1,280 April 29 Cash sales 300
April 16 Received cash from vinod 1,232 Paid cash for stationery 17

Allowed him discount 48 April 30 Paid cash for

April 17 Paid shyam Lal cash 1,000 miscellaneous expenses 16
discount allowed 25 April 30 Bought goods from Ram &
April 18 Paid wages 18 co. 1,683
April 20 Sold goods to jagdish Withdrew cash for private
chand 3,600 expenses 150
[Total Trial Balance(Balance Method) Rs 33151]

3. Journalise the following transactions in the books of Basu:
a). Basu sold goods to Chowdhary for Rs. 750
b). Received Commission Rs. 400
c). Bank paid Rs. 300 directly for insurance premium of Basu.
d).Cash Deposited into Bank Rs. 5,000
e). Withdrawn cash from Bank for personal expenses 850.
4. Journalise the following transactions:

a). Purchased goods for Rs. 30,000 at 20% trade discount.
b). Goods taken away for personal use Rs. 500.
c). Goods Destroyed by fire Rs. 1000.
d). Goods given as Charity Rs 800.
e). Goods distributed as free samples Rs 400
f). Goods Eaten by Rats Rs 300
g). Goods given to Employees as part of their Salary as a part of food for Work Programme Rs
2000.
h). Goods stolen for Rs. 1,200 ; insurance claim admitted in full.
5. Journalise: .
a). Paid by cheque insurance premium Rs. 400
b). Paid by cheque life insurance premium Rs. 500

c). Bought goods from R and co. for rs. 7,000, accepted their
bill for rs. 1,500 and gave them a cheque for the balance.
d).Sold goods to Rita Agencies for rs. 6,000, received their Acceptance for Rs. 2,000 and Balance in
Cash
e). Returned goods to Sujata 500.
f). Chandra Returned goods to us. 150.
g). Bought from Lata cosmetics for Propreitor’s wife Rs. 40
h). Paid Reema by Cheque Rs. 35,000
Discount Received 200
i). Received Cash from Samita Rs. 4,900
Discount allowed 100
j). Paid House Tax Rs. 2,000
6. Journalise:
1. Started business with cash by T 15,000
2. Bought goods for cash 1,000
3. Bought goods from A 3,000
4. Sold to B 4,000
5. Paid A on account 2,000
6. Bought goods from P for cash 7,000
7. Received from B cash in full settlement 3,880
8. Returned to P goods worth 200
9. Paid salaries 700
10. Received from G a fifty rupee note and gave him the change for it
11. Commission received on sale of other goods 500
12. Deposited with the bank 2,000
13. Paid rent by cheque 100
14. withdrawn for personal use goods Rs. 300; cash Rs. 200 500
7. Jounarlise:
1. Business started with cash 8,000 and plant & machinery 3,000.
2. Stock purchase for sale (cash purchase)= 3,000, credit purchase = 5,000

3. Wages paid 120,000(including 20,000 of future year).

4. Salary paid 200,000 but due 110,000.
5. Sale made for cash 600,000 & on credit 800,000.
6. Depreciation 10 percent on plant & machinery.
7. Goods costing 20,000 destroyed by fire.
8. Payment made to creditor of 200,000 at 10 percent discount
DISTINCTION BETWEEN TRADE DISCOUNT AND CASH DISCOUNT

Basis Trade Discount Cash Discount
1. Nature It is allowed on a certain quantity being It is allowed on payment
purchased. being made on or before
a certain date.
2. Recording Trade discount is not recorded separately Cash discount is
in the books of account. recorded separately in
the books of account.
3. Deduction from The amount of the trade discount is It is not deducted from
invoice deducted from the invoice. the invoice.
4. Nature of It is allowed both on credit and cash It is allowed only on
transaction transaction payment.
5. Consideration The consideration for allowance is The consideration for
purchases. allowance is payment.
6. Relation It is related t sale and purchase of goods. It is related to payment.
ADVANTAGES OF CASH DISCOUNT

To the seller
1. He gets the amount within specified time because it is allowed to encourage a debtor to pay
within a specified period.
2. The possibility of bad debts is reduced.
3. Prompt payment saves the trader from some clerical work, maintaining of debtors’ accounts.
4. It improves the cash inflow of the business which can be better utilized.

To the Buyer
1. Early payment results in higher cash discount, this, increasing income.
2. Better cash discount earning enables selling of goods at lower prices.
ADVANTAGES OF TRADE DISCOUNT

1. It improves sales by encouraging the purchaser to buy large quantities.
2. It reduces the purchase cost of the purchaser and thus, increases profit margins.
3. A change in the rate of trade discount may be used as a tool to face competition
4. Different prices can be charged to regular customers and occasional customers.
5. It enables the retailer to sell at the ‘list’ price and at better profit.
6. It is an easy method of making changes in prices without reprinting catalogues or changing the
price given in the articles.
Answer to question
1. State whether the following statements are True or False:
(i) Discount allowed on purchases by customers is Trade Discount.
(ii) Discount allowed to customers on payment is cash discount.
(iii) Cash sale, involving Trade Discount and cash Discount, only cash Discount is shown
separately in the cash Book.
(iv) Trade Discount is shown separately in the books of account.
(v) Cash Discount is shown as deduction from invoice price.
2. Fill in the blanks with appropriate words:

(i) ……………Discount is allowed to encourage timely payment.
(ii) ……………Discount is allowed to encourage large purchases.
(iii) ……………Discount is shown separately in the books of account.
(iv) ……………Discount is not shown separately in the books of account.
(v) ……………Discount is not reduced from the invoice price.
(vi) ……………Discount is reduced from the invoice price.
(vii) Cash Discount is allowed @10% on Rs. 15,500; the amount paid will be
………….

(viii) Catalogue price is Rs. 500. Trade discount allowed @ 10% will be ……….. And
cash discount @ 5% will be ………….

Chapter Special purpose books i – cash book

8
In the previous chapter we discussed that business transactions are first recorded in a journal and
then posted into a ledger. In practice, the numbers of business transactions are large and it
becomes difficult, if not impossible, to number of business transactions are large and it becomes
difficult, if not impossible, to record all of them in one book of prime entry. For example, in a
business, most of the transactions may relate to receipt and payment of cash, sale of goods and
their purchase. It is convenient to maintain a separate register for each such class of transactions –
one for receipts and payments of cash, one for purchase of goods and one for sale of goods. A
register of this type is called a book of original entry o9r of prime entry – it is a special form of a
journal, a sub- division of it. For transactions recorded in such books there will be no journal entry.
The system by which transactions of a class are first recorded in a book, specially meant for it, and
then posted into a ledger is called the practical system of accounting.
SYSTEM OF ACCOUNTING.
These books of original or prime entry are also called a special journal or subsidiary books since
ledger accounts are prepared on their basis and without this process of ledger pasting, a trial
balance cannot be drawn. The ledger is thus called the principal book.
SUBSIDIAUY BOOKS OR SUB-DIVISION OF JOURNAL

We has discussed earlier that it is practically difficult to record all the transactions in only one book
of prime entry. For convenience, the journal is divided into a number of subsidiary books. These
are:
1. Cash book: To record receipt and payments of cash, including receipts into and payments out
of the bank.
2. Purchases book: To record credit purchases of goods dealt in or of the materials ands stores
required in the factory.
3. Sales book: To record the credit sales of goods dealt in by the firm.

4. Purchases returns book: To record the returns of goods and materials previously purchased
on credit.
5. Sales returns book: To record the returns of credit sales made by customers.
6. Bills receivable book: To record the receipts of promissory notes or hundis from various
parties.
7. Bills payable book: To record the issue of promissory notes or hundis to other parties.
8. Journal proper: To record the transactions which cannot be recorded in any of the seven books
mentioned above.
Advantages of subsidiary books

The use of subsidiary books has the following advantages:
(i) Division of work: since in the place of one journal there are many subsidiary books, accounting
work can be divided among a number of persons.
(ii) Specialization and efficiency: when the same work is handled by a particular person for a
considerable time, he acquires full knowledge e of it and becomes efficient in handling it. Thus,
accounting work is done more efficiently.
(iii) Saving of time: various accounting processes can be undertaken simultaneously because of the
use of number of books. This leads to the work being completed quickly.
(iv) Availability of information: since a separate book is kept for each class of transactions,
information relating to each class is available at one place.
(v) Facility in checking: when the trial balance does not agree, location of error or errors is
facilitated by the existence of separate books. Even the commission of errors and frauds can be
checked by the use of various subsidiary books.
(vi) Responsibility: Division of work results in assigning a particular job to a particular person. If an
error is committed in recording, responsibility can be easily fixed.
CASH BOOK
Cash book is a book of prime entry in which cash and bank transactions of a business are recorded
in a chronological order. It is necessary and useful for a business to continuously know the cash or
bank balance on hand. Cash receipts are recorded on the debit side of the cash book and cash
payments on the credit side. A balance is struck by deducting the total cash payments from the total

cash receipts to know the cash in hand. The number of cash transactions in a firm is generally
large; therefore, it becomes convenient to have a separate cash book to record such transactions.
Features of cash book

1. Only cash transactions are recorded on the cash book.
2. Cash and Cheque receipts are recorded in the debit side and all cash and Cheque payments
are recorded in the credit side.
3. It records only one aspect of the transaction, cash.
4. Cash and bank transactions are recorded in the cash book in a chronological order, in order
they take place.
5. It performs the function of both journal and the ledger at the same time.
CASH BOOK – A SUBSIDIARY BOOK ANDS A PRINCIPAL BOOK

Cash transactions are recorded in the cash book and on the basis of such a record, ledger accounts
are prepared. Therefore, the cash book is a subsidiary book. But, the cash book itself serves as the
cash account and the bank account. As a matter of fact, the balances are entered in the trial
balance directly. The cash book therefore is part of the ledger also. Hence, it is also treated as a
principal book. The cash book is, thus, both a subsidiary book and a principal book.
KINDS OF CASH BOOKS

There are three types of cash books:
(i) Simple cash books or single column cash books: For recording cash transaction only.
(ii) Two – column cash book (cash book with cash, and bank column): For recording cash and bank
transactions.
(iii) Three – column cash book (cash book with cash, bank and discount columns): For recording
cash and bank transactions involving loss or gain on account of discount.
In addition to the main cash book, firms sometimes also maintain a petty cash book but that is
purely a memorandum book. On the basis of the information provided by the petty cash book,
journal entries are made.
Following the syllabus, single column, two-column and petty cash books shall be discussed in
this chapter.

(1) Simple cash book

A simple cash book looks like an account, with one account column on each side. The lift- hand side
records receipts of cash and the right – hand side, the payments. Hence, it is also called a single
column cash book. The ruling is as follows:
SIMPLE CASH BOOK
Dr. Receipts Payments
Date Particulars V.NO. L.F. Amount Date Particular V.NO L.F. Amount
s
Receip ts S ide Payme nts Sid e
In the column for:
(i) Date: Date of transaction is written.
(ii) Particulars: The name of the account under which cash has been received or payment has been
made is written. In an existing business, cash book starts with the opening balance of cash
written on the receipt side as ‘To balance b/d’
(iii) Voucher No. (V. No.): the document supporting a transaction is called a voucher. There are two
types of cash voucher: (1) Receipt voucher, and (2) payment voucher. Generally, a voucher has
a serial number which is written in this column.
(iv) Ledger folio (L.F.): Records the page number in the ledger where the relevant account will be
found.
(v) Amount: The amounts received are to written on the Debit side and paid are written on the credit
side.
Balancing a cash book: A cash book is balanced like any other account. The receipts column is
always bigger than the payment column. The difference is written on the credit side as ‘By Balance
c/d’. The totals are then entered in the two columns opposite one another and then on the debit
side, the balance is written as ‘To Balance b/d’ to show the cash balance in hand at the beginning of
the next period.
Simple cash book or single column cash book – some observations

1. When a cash book is maintained, a cash account is not opened in the ledger.
2. Cash book is balanced just like any other account.
3. It does not record (a) non – cash transactions, (b) Cheque received or given, and (c) cash
discount allowed and received.

4. When an entry is passed in a simple cash book, corresponding entry is passed in the ledger. For
instance, if x pays Rs. the receipt (or debit) entry is passed in the cash book and Ram’s account
is credited in the ledger.
5. Cash book always shows a debit balance, cash in Hand, because cash paid can not exceed
cash in hand.
Illustration 1. Enter the following transactions in a simple cash book:
2009
Jan. 1 Cash in hand 12,000
Jan. 5 Received from Ram 3,000
Jan. 7 Paid rent 300
Jan. 8 Sold goods 3,000
Jan.10 Paid shyam 7,000
Jan. 27 Purchased furniture 2,000
Jan. 31 Paid salaries 1,000
Solution:
In the books of ……
CASH BOOK
Date Particulars L.F. Amount Date Particulars L.F. Amount
2009 2009
Jan. 1 To balance b/d 12,000 Jan. 7 By Rent A/c 300
Jan. 5 To Ram 3,000 Jan. By shyam 7,000
Jan. 8 To sales A/c 3,000 10 By Furniture A/c 2,000
Jan. By salaries A/c 1,000
27 By balance c/d 7,700
18,000 Jan. 18,000
To balance b/d 7,700 31
Jan.
31
Can a cash book show credit balance?
Cash column in the cash book can not show a credit balance because cash payments can not
exceed cash receipts. At best, it can show nil balance when total cash receipts are equal to total

payments. But a cash book with bank column may show a credit balance so far as bank column is
concerned.
Ledger posting from single column cash book: the posting of the debit and credit sides of cash
book is carried out as follows:
Pasting of Debit side of cash book: The receipts are recorded on the debit side of the cash book
and to complete the process of dual aspect concept they are posted to the credit side of the
respective ledger account by writing ‘By cash’. For example, the entry for cash received from
Mahesh (see illustration 3) on 30th April, is posted to Mahesh’s account from the debit side of cash
book as follows:
MAHESH
Dr. Cr.
Date Particulars L.F. Amount Date Particulars L.F. Amount
2009
April 30 By cash A/c 45,000
By discount allowed a/c 2,500
Illustration 2. Enter the following transactions in a single column cash book:

2009 Rs.
April 1 Cash in Hand 5,000
April 2 Cash sales 10,000
April 4 Received from pravin on account 3,000
April 5 Purchased goods 6,000
April 7 Loan given to Mohan 2,000
April 8 Sold goods to sohan in cash 8,000
April 10 Purchased furniture 4,000
April 12 Purchased postal stamps 500
April 14 Sold goods to Ram on credit 4,500
April 15 Salary paid to accountant 500
April 18 Purchased goods 2,500
April 19 Paid freight 200

April 20 Withdrew for personal use 1,000

April 22 Received commission 2,000
April 24 Paid to shyam 2,500
April 27 Received form Mohan 2,000
April 29 Paid to Girish 1,000
April 30 Rent paid 800
Solution:
Date Particular L.F. Rs. Date Particular L.F. Rs.
2009 2009
April 1 To balance b/d 5,000 April 5 By purchase a/c 6,000
April 2 To sales a/c 10,000 April 7 By Mohan (loan ) 2,000
April 4 To pravin 3,000 April 10 By furniture a/c 4,000
April 8 To sales a/c 8,000 April 12 By postal stamps a/c 500
April 22 To commission a/c 2,000 April 15 By salaries a/c 500
April 27 To Mohan 2,000 April 18 By purchases a/c 2,500
April 19 By freight a/c 200
April 20 By drawing a/c 1,000
April 24 By shyam 2,500
April 29 By Girish 1,000
April 30 By rent a/c 800
April 30 By balance a/c 9,000
30,000 30,000

(2) Two – column cash book (cash book with cash and bank column)
A Two – Column cash Book or Double Column Cash Book is a Cash Book with two columns on
each side; one each to record cash transactions and bank transactions, deposit two chaque or
cash, issue of Cheque and withdrawal of cash, account and bank account.
A bank account is a personal account and while recording transactions in the bank column of the
cash book, the golden rule of Debit and Credit applicable to personal account should be followed
‘Debit the receiver and Credit the giver’. Thus, for cash deposited into the bank column of the cash
Book. Similarly, for cash withdrawn or cheque issued- the bank would be the giver therefore; it
would be credited in the bank column of the cash Book.
A Two – Column Cash Book (cash Book with cash and Bank Column) enables us to keep both the
cash and bank account side by side which enables us to quickly know the cash and bank balance.
The ruling of a Two- Column Cash Book is as follows:
Date Particular L.F. Cash Bank Date Particular L.F. Cash Bank
s
R eceipt s si de p aymen ts s ide
Two – column or double column cash book – some observations

While maintaining a two-column cash book, the following points should be noted:
(i) While commencing a new business, capital is introduced in the business. The amount is written
in the cash column if cash is introduced and in the bank column if it is directly put into the bank
with the explanation; to capital account’. If a new cash book is started for an existing business,
the opening balance is written as: ‘to balance b/d’.
(ii) All receipts are written on the receipts side; cash in the cash column and Cheque in the bank
column. In the particulars column, the name of the account under which the payment has been
received is written.
If a Cheque or draft is deposited in the bank on the same day, the amount is if a Cheque or draft
received from customers is not deposited in the bank on the same day, they are included in cash
and the amount is written in the cash column of the debit side. On the day of deposit into the bank,
the amount is written in the bank column of the debit side and in the cash column of the credit side.

Example: On 27th March, 2009 a Cheque is received from Mohan for Rs. 10,000. However, the
Cheque is deposited into the bank On 31st March, 2009.
CASH BOOK (DOUBLE COLUMN)

Date Particular L.F. Cash Bank Date Particulars L.F. Cash Bank
2009 2009
To Mohan 10,000 By bank A/c c 10,00
c 10,000
March 27 March 31
To cash A/c 0
March 31
(iii) All payments are written on the payments side, cash payments in the cash column and
payments by Cheque in the bank column.
In fact, if by a transaction the bank balances increases, the bank column is debited and if the
balance decreases, the bank column is credited.
(iv) Contra Entry: Some transactions are recorded in a two – column cash book which relate to both
cash and bank, balance of one will decrease and the other will increase due to such
transactions or vice versa. Such transactions are entered on both sides of the cash book. Such
entries are known as contra entries: let us take an example to understand it better.
Against such entries, the letter’s’ should be written in the L.F. column to indicate that these are
contra transactions and are not posted into the ledger account.
Note: If initially Cheque received are entered in the cash column as then sent to the bank, the entry
will be as if cash has been sent to the bank.
(v) If a Cheque sent to the bank is dishonored, the bank is not able to collect the amount, the
uncollected amount is entered in the bank column on the credit side eighth the name of the
Cheque issuing party in the particulars column. In other words, when a Cheque is received from
a customer and deposited into the bank for collection but ultimately returned dishonored, the
customer’s account is debited and the bank account credited.
(vi) On the contrary, if any Cheque issued by the firm is not paid on presentation, it is entered in the
bank column on the debit side with the name of the party to whom the Cheque was issued.

(vii)A Cheque received may be given to some other party, endorsed. On receipt, it is entered in the
cash column on the debit side. On endorsement, the amount is written in the cash column on
the credit side.
Example: On 26th December, 2008 a Cheque was received from R.K. Gupta & co. for Rs. 10,000.
on 29th December, 2008 a Cheque was received from R.K. Gupta & co. for Rs. 10,000. on 29 th
December, 2008 it was endorsed in favor of K.B. & Co.
CASH BOOK (DOUBLE COLUMN)

Date Particulars L.F. Cash Bank Date Particulars L.F. Cash Bank
2008 To R.K. Gupta 2008
Dec.26 & co. 10,000 Dec. 29 By K.B. & co. 10,000
(viii) Cheque or drafts deposited by customers directly into the bank are entered in the bank
column on the debit side.
(ix) Whenever the firm avails a bank service, it has to pay a charge for the service called bank
charges. It is written on the credit side of the cash book and the called bank charges. It is
written on the credit side of the cash book and the amount is entered in the bank column.
(x) Cash discount allowed or received is recorded by way of a journal entry.
Balancing
Cash columns are balanced in the same manner as in the case of a simple cash book. The process
is similar for balancing the bank column. It is possible, however, that the bank may allow the firm to
withdraw more than the amount deposited. If the bank allows the firm to withdraw more than the
amount deposited. If the bank allows the firm to withdraw more than the balance, it is called an
overdraft. In such a case, the total of the bank column on the credit side will be bigger than the one
on the debit side. The difference is written on the debit side as ‘To Balance c/d Then the totals are
written on the two sides opposite one another. The balance is then entered on the credit side
mentioning ‘By Balance b/d’

Usually, payments into the bank will exceed the withdrawals or payments out the bank. Then the
bank columns are balanced just like the cash columns. In other words, the bank columns will show
a ‘debit balance’.
Let us explain the opening of a Two – Column cash book with the help of the following
Illustration 3. Record the following transactions in a Double Column Cash Book with cash ands
Bank column and balance the book on January 31, 2009
Date Particulars Amount Date Particular Amou
nt
2009 2009
Jan. 1 Cash balance 100 Jan. 16 Bought goods 600
Jan. 1 Bank balance 1,450 Jan. 19 Paid shyam by Cheque 370
Jan. 1 Cash received from sale Discount received from
Of shares 6,000 him 30
Jan. 2 Paid into bank 5,000 Jan. 20 Drew from bank 300
Jan. 3 Purchased goods from Jan. 22 Cash drawn from bank for
m/s Agarwalla for personal use 200
Rs. 1,200 and paid by 1,200 Jan. 24 Cash sales 170
Cheque Jan. 27 Received from Sharma 1,800
Jan. 4 Paid wages 250 Allowed him discount 200
Jan. 5 Received from Mohan a Jan. 28 Deposited cash into bank 1,500
Jan. 8 Cheque for Rs. 980 in full Jan. 28 Gave Cheque for cash
settlement of a claim of purchase 200
Rs. 1,000 Jan. 30 Paid rent by cheque 200
Jan14 Mohan’s Cheque

deposited into bank
Paid for stationery 150

Solution:
IN THE BOOKS OF …
TWO – COLUMN CASH BOOK
DATE PARTICULAR L.F. CASH BANK DATE PARTICULARS L.F. CASH BANK
S
2009 2009
JAN. 1
To balance 100 1,450 JAN 2 By bank a/c C 5,000
JAN. 1
b/d 6,000 JAN 3 By purchases a/c 1,200
JAN. 2
JAN. 5 To investment C 5,000 JAN 4 By wages a/c 250
JAN. 8 a/c 980 JAN 8 By bank a/c C 980
To cash a/c C 980 JAN 14 By stationery a/c 150
JAN.20
To Mohan C 300 JAN 16 By purchases a/c 600
JAN. 24
(Cheque) 170 JAN 19 By shyam 370
JAN.27 To cash a/c 1,800 JAN 20 By cash a/c C 300
JAN. 28 To bank a/c C 1,500 JAN 22 By drawings a/c 200
To sales a/c JAN 28 By bank a/c C 1,500
To Sharma JAN 28 By purchases a/c 200
To cash a/c JAN 30 By rent a/c 200
JAN 31 By balance c/d 870 6,460
9,350 8,930 9,350 8,930
Feb.1 870 6,460
To balance
b/d
Notes: 1. Discount allowed Rs. 20 to Mohan, Rs. 200 to Sharma and discount received Rs. 30
from shyam shall be posted in the respective ledger accounts through journal entries.

2. It is mentioned in the question that the Cheque received from Mohan on 5 th January was
deposited into the bank on 8th January. The date of receipt of the Cheque and the date of deposit of
Cheque are different. Therefore, it is to be recorded first in the cash column by debiting the cash
account and crediting Mohan’s account. At the time of deposit on 8th January, the Bank account
debited and cash account credited. It will be treated as a contra entry.
Bank Overdraft
Many a times, a firm enjoys overdraft facility from a bank. It means the firm can overdraw from its
bank up to the limit allowed by the bank. Amount withdrawn in excess of its own money in the bank
is known as a bank overdraft. A bank overdraft is shown as a credit balance meaning thereby that
the business has to pay that amount to the bank. If a business has a credit bank balance at the
beginning of a period, it is recorded on the credit side of the cash Book as ‘By Balance b/d’. at the
end of the period, at the time o0f balancing the bank column, if it is found that debit side total is
short (overdraft), the bank column is balanced by entering ‘To Balance c/d, in the bank column on
the debit side of the Cash Book. In the beginning of the following year, it is entered on the credit
side of the cash Book as ‘By Balance c/d’.
Illustration 4. Enter the following transactions of M/s. premier Trading company is cash book with
Two columns (cash and Bank column). Balance the cash book as on 31st December, 2008:
Date Particulars Amount Date Particular Amount

2008 2008
Dec. 1 Cash in Hand 4,000 Dec. 15 Cheque received
Dec. 1 Bank overdraft 1,000 from chandulal of
Dec. 3 Received a Cheque Rs. 2,400 as
from Ram Lal on allowed him
account Rs. 290 and Dec. 20 discount Rs. 100 100
allowed him discount Issued a cheque
Dec. 7 Rs. 40 Dec. 26 for petty cash
Ram Lal’s Cheque Paid to Gupta by
Dec. 10 deposited into bank Cheque Rs. 920
Withdrew from the 800 as discount

Dec. 12 bank for office use 600 Dec. 28 received Rs. 30 900
Paid bills payable by Made cash sales
Cheque
Solution:
In the Books of M/s. Premier trading company
TWO – COLUMN CASH BOOK
Date Particulars L. Cash Bank Date Particulars L.F. Cash Bank
F.
2008 2008
Dec. 1 To balance - Dec. 1 By balance b/d - 1,000
c/d 4,000 Dec. 7 By bank A/c C 290
Dec. 3 To Ram Lal C 290 Dec. 10 By cash A/c C 800
Dec. 7 To cash A/c C 290 Dec. 12 By Bills
Dec. 10 To Bank A/c 800 Payable A/c 600
Dec. 15 To chandulal 2,400 Dec. 20 By petty cash A/c 100
Dec. 28 To sales A/c 900 Dec. 26 By Gupta 920
Dec. 31 To balance 730 Dec. 31 By balance c/d 5,700
c/d
5,990 3,420
5,990 3,420
2009
5,700 … Jan. 1 By balance c/d … 730
2009 To balance
Jan. 1 b/d
Note: It is mentioned in the question that the cheque received from Ram Lal on December 3 was
deposited into bank on December 7. Therefore, it is to be recorded first in the cash column by
debiting the cash account and credit Ram Lal. At the time of deposit on December 7, the Bank
account is to be debited and the cash account credited. It will be treated as a contra entry.

More than one Bank Account: If a firm has more than one bank account, the bank column is
suitably divided to record bank transactions through different banks separately. For example, if a
business enterprise has two bank accounts, one with the state Bank of India (SBI) and another with
the Punjab National Bank (PNB), the bank column on debit side as well as credit side can be
divided as follows:
Illustration 5. From the following particulars, prepare a cash book with suitable columns:
2009
March 1 Cash in Hand 8,500
Bank balance with state Bank of India (SBI) 25,000
overdraft with Punjab national bank (PNB) 17,500
March 3 Cash sales 7,000
March 5 Paid salary to staff by Cheque on SBI 10,000
March 8 Cheque received from Anil deposited with PNB 9,000
March 10 Cash deposited into SBI 5,000
March 12 Amount transferred from SBI to PNB by Cheque 3,000
March 15 Cash withdrew from SBI 8,000

SOLUTION:
Date Particula L. Cas Bank Date Particul L. Cash Bank
rs F. h SBI PNB ar F. SBI PNB
(Amt) (Amt) (Amt) (Amt )
2009 25,000 2009

Mar.1 To 8,50 Mar. By 17,50
balance 0 1 balance 10,000 0
Mar.3 b/d b/d C
To sales C 7,00 5,000 9,000 Mar. By C 5,000 3,000
Mar. A/c C 0 5 salaries C 8,000
8 To Anil Mar. A/c
Mar. To cash 3,000 10 By SBI 9,000
10 A/c Mar. By PNB 18,50
To SBI 12 By 0
Mar. To SBI 5,500 Mar. cash
12 A/c 8,00 15 A/c
Mar. To 0 Mar. By
15 Balance 23,5 30,000 17,500 15 balance 23,50 30,000 17,50
Mar c/d 00 c/d 0 0
15
18,5 9,000 5,500

00 Mar.
To 16
balance
b/d
Mar. By
16 Balanc
e b/d

In the books of
CASH BOOK
Ledger posting of Two – column Cash Book: In order to complete the double entry of
transactions that have been recorded in the Two – Column cash book, the transactions are posted
into the respective Ledger Accounts.
Posting of the Receipts side: Transactions written on the debit side of the cash Book are posted
to the credit side on the Ledger Accounts. In the ‘particulars column, of the Ledger, ‘By Cash
Account ‘is written for cash transactions and ‘By Bank Account’ for bank transactions. Amount of the
transaction is written in the ‘Amounts Column’ ‘Contra entries’, transactions between cash and bank
are not posted into the Ledger.
Posting of the payment side: Transactions written on the credit side of the cash Book are posted
to the debit side in the Ledger Accounts. In the ‘Particulars Column’ of the Ledger, ‘To cash
Account’ is written for cash transactions and ‘To Bank Account’ for bank transactions. Amount of the
transaction is written in the ‘Amounts Column’ ‘contra entries’ are not posted into a Ledger. The
posting process is illustrated below:
(1) Three – Column cash Book

A column for discount when added to the existing Two Column Cash Book makes a ‘Three- Column
cash Book’. The columns for discount are not balanced but each side is totaled. The total so
ascertained is posted to the Discount Account, the total of the discount column on the credit side of
a cash Book is posted to the credit of discount Received account and the total of the discount
column on the debit side of the cash Book is posted to the debit of the discount Allowed Account.
PETTY CASH BOOK

In a business besides large payments, a number of small payments, such as for conveyance,
stationery, cartage, etc., have to be made. If all these payments are recorded in the cash book, it
will become unwieldy. Also, the main cashier will be overburdened with work. Therefore, it is usual
for firms to appoint a person as ‘petty cashier’ and to entrust the task of making small payments,
say, below Rs. 250, to him. Of course, he is reimbursed for the payments made. The respective
accounts are debited.

Petty cash book is used for the purpose of recording petty cash expenses. It is prepared by petty
cashier. It acts as the petty cash Account in which details of the receipts and payments of petty
cash are entered.
Recording of petty cash
Petty cash given to the petty cashier for small payments is recorded on the credit side of the cash
Book as ‘By petty cash A/c’ and is posted to the debit side of the petty cash Account in the Ledger.
SYSTEM OF PETTY CASH

Petty cash Book may be maintained by ordinary system or by imprest system.
In cash of Ordinary System of petty Cash, Petty Cashier is given a certain amount of cash and after
spending the whole of that amount, he submits the account to the Head Cashier.
Imprest system of petty cash Book

It is convenient to entrust a definite sum of money to the petty cashier at the beginning of a period
and to reimburse him for the payments made at the end of the period. Thus, he will again have the
fixed amount at the beginning of the new period. Such a system is known as the ‘Imprest system of
petty cash’.
Advantages of Imprest system of petty cash

(i) Control over Mistakes: The petty cash Book is checked by the cashier at regular intervals so that
a mistake, if committed, is soon rectified.
(ii) Control over petty expenses: Petty expenses are kept within the limits of Imprest since the petty
cashier can never spend more than the available petty cash.
(iii) Control over Fraud: Under this system defalcation of cash can be minimized since the petty
cashier is not allowed to draw cash as and when he desires.
Types of petty cash Books

Following are the two types of petty cash books:
1. Simple petty cash Book
2. Analytical petty cash Book

1. Simple petty cash Book: A simple petty cash book is identical with a cash side cash book any
cash which the petty cashier receives will be recorded on the left hand side cash column (debit
column) and any cash which he pays out will be recorded on be written in the same date and
particulars column.
A specimen form of a simple petty cash book is given below:
SIMPLE PETTY CASH BOOK

Amount Received Cash book Date Particulars Voucher no. Amount
Folio paid
Money Received … … … … …
Money paid
Illustration 6. From the following information, write up a simple petty cash Book for the 1 st week of
April, 2009:
Date Particular Amount
2009
April 1 Received Rs. 4,000 from chief cashier for petty cash
April 2 Bought postage stamps 200
April 4 Paid bus fare 120
April 5 Purchased stationery for office use 1,000
April 6 Paid for milk and sugar for office tea 600
April 7 Paid window cleaner 80
Solution:
SIMPLE PETTY CASH BOOK
Amount Cash Book Date Particular Voucher Amount
Received Folio No. paid

2009
4,000 April 1 To cash A/c
April 2 By postage A/c 200
April 4 By Traveling Expenses A/c 120
April 5 By stationery A/c 1,000
April 6 By office Expenses A/c 600
April 7 By Miscellaneous Exp. A/c 80
By balance c/d 2,000
4,000 4000
2. Analytical petty cash Book: An Analytical petty cash book has two sides; the left hand side is
used for recording receipts of cash (which will be only from the main cashier) and right hand side,
which is used for recording payments. In the Analytical petty cash Book, a separate column is
provided for recording a particular item of expenditure, postage, stationery, traveling, advertisement,
etc. a column is usually provided for ‘sundries’ to record infrequent payments. When a petty
expense is recorded on the right hand total payment column, the same amount is immediately
recorded in the appropriate expense column. At the end of a particular period, the entire analysis
(expenses) column are added and posted to the debit side of the respective accounts.
Under the Imprest system of petty cash, the new petty cash is reimbursed at the end of each week
or month or specific period with the exact amount of moony spent. The petty cashier begins the
period with the same amount of money – the Imprest amount. A specimen analytical petty cash
book is given below:
ANALYTICAL PETTY CASH BOOK

Receipts Date Voucher Particulars Total Convince Cartage Stationery Post Sundries
No. Payment (amount And age
) courier

Balancing the petty cash Book

A petty cash Book is balanced at the end of the month or a specified period. The columns for
payments and expenses are totaled and the total equals the total in the ‘Total payment column’.
Thereafter, the petty cash book is balanced. The method of balancing the petty cash book is the
same as that of a simple cash Book.
Look at the following illustration. It will help you understand how a petty cash book is opened and
balanced.
Illustration 6. Prepare an Analytical petty cash book on the Imprest system from the following:
2009
Jan. 1 Received Rs. 1,000 for petty cash
Jan. 2 Paid bus fare 5
Jan. 2 Paid cartage 25
Jan.3 Paid for postage and telegrams 50
Jan. 3 Paid wages for casual laborers 60
Jan.4 Paid for stationery 40
Jan. 4 Paid auto charges 20
Jan. 5 Paid for repairs to chairs 150
Jan. 5 Bus fare 10
Jan. 5 Cartage 40
Jan. 6 Postage and telegrams 70
Jan. 6 Conveyance charges 30
Jan. 6 Cartage 30
Jan. 6 Stationery 20
Jan. 6 Refreshment to customers 50
See Solution on next page.

Posting the petty cash book
Posting in the ledger form the petty cash book is done at the end of the period, month or quarter as
the cash may be. There are two methods of posting from the petty cash book:

(i) petty cash book as a memorandum book: In such a situation, the total of various expenses from
the petty cash book is debited to the concerned accounts at the end of the period and credit is
given to the cash Account with the actual expenditure incurred. The account advanced by the
chief cashier to the petty cashier is recorded by him as a memorandum by way of note in the
cash book itself. This method is not followed usually.
(ii) Petty cash is considered as a part of the double Entry System: The method is very popular.
Under this method, petty cash transactions are recorded on the basis of the following entries:
(a) When money is advanced to the petty cashier
Petty cash A/c Dr.
To cash A/c
Solution.
In the Books of….

PETTY CASH BOOK

And telegram
Conveyance
Receipts
Voucher
Particulars
Stationery
Payment
Sundries
Rs
Postage
Cartage
Wages
Total
Date
2009
1,000 Jan. 1 To cash A/C
1 1 By conveyance A/C 5 5
2 2 By cartage A/C 25 25 50
3 By postage and telegrams A/C 50 60
3 4 By wages A/C 60
5 By stationery A/C 40 40 150
4 6 By conveyance A/C 20 20
7 By repairs of furniture A/C 150
5 8 BY conveyance A/C 10 10
9 By cartage A/C 40 40 70
10 By postage ands Telegrams 70
6 11 A/c 30 30
12 By conveyance A/C 30 30
13 By cartage A/C 20 20
14 BY STATIONERY A/C 50
By general Expenses A/C
600 65 95 60 120 60 200
400
1000 6 By Balance c/d 1000
400
600
8 To Balance b/d
To Cash A/c

Note: Expenses occurring casually are entered into the sundries column and thereafter into the
correct account. On 8th January, the petty cashier will get Rs. 600 so that his cash balance is Rs.
1,000 again.
(b) on submission of accounts by the petty cashier
Expenses A/c Dr.
To petty cash A/c
(Each expense is to be debited separately with the expenditure incurred during the
period as shown by the petty cash book.)
Thus, in the Ledger, there is a petty cash account as well as separate Expenses
Accounts for each of the expenses.
In illustration 6, the journal entry and the relevant accounts will be as follows:
(Amount ) (amount)
Conveyance a/c Dr. 65
Cartage a/c Dr 95
Stationery a/c Dr 60
Postage and telegrams a/c 120
Dr 60
Wages a/c Dr 150
Repairs a/c Dr 50
General expenses a/c Dr 600
To petty cash a/c
Journal entry (if required) for cash handed over to the petty casher will be passed as follows:
Petty cash A/c Dr. Rs. 1,000

To cash A/c Rs. 1,000

Dr. CONVEYANCE ACCOUNT Cr.

2009
Jan. 6 To petty cash A/c 65
Dr CARTAGE ACCOUNT Cr.

2009
Dr. STATIONERY ACCOUNT Cr.

2009
Dr. PASTAGE AND TELEGRAMS ACCOUNT Cr.

2009
Dr. WAGES ACCOUNT Cr.

2009
Dr REPAIRS ACCOUNT Cr.

Date Particulars J.F. Amount Date Particulars J.F Amount
.
2009

Dr. GENRAL EXPENSES ACCOUNT Cr

Date Particulars J.F. Amount Date Particulars J.F Amount
.
2009

2009 2009
Jan. 1 To cash A/c 1,000 Jan. 6 By conveyance a/c 65
Jan. 8 To cash A/c 600 Jan. 6 By cartage a/c 95
Jan. 6 By stationery a/c 60
Jan. 6 By postage and
telegrams a/c 120
Jan. 6 By wages a/c 60
Jan. 6 By repairs a/c 150
Jan. 6 By general expenses a/c 50
Jan. 8 By balanced c/d 1,000
1,600 1,600
Jan. 9 To balance 1,000

b/d
Advantages of Petty Cash Book

The advantages of maintaining a petty cash Book are:
(i) Time saving: saves the chief cashier’s time.
(ii) Labor saving: saving of labor in writing up the cash book and posting into the Ledger.
(iii) Control: it provides control over small payments.
(iv) Convenience in preparing Ledger Accounts: the totals ate only taken to post them into the
Ledger. No unnecessary detail is to be given. Hence, it is convenient to post these directly into the
ledger

1. You are required to prepare a single column cash Book from the following transaction:
2009 (Amount)
April 1 Mr. ashok commenced business with cash 3,50,000
April 2 Bought goods for cash 22,000
April 6 Purchased goods from Gupta & co. on credit 20,000
April 8 Cash sales 75,000
April 10 Paid rent 1,200
April 18 Purchased building 3,00,000
April 21 Sold goods for cash 9,900
April 22 Sold goods to Vijay on credit 20,000
April 25 Paid salaries 10,000
April 28 Paid wages 5,500
April 30 Received from Vijay 12,000
[Cash Balance – Rs 108200]
2. As an accountant, enter the following transactions in the single column cash book:
2009
April 1 Balance from the last month 1879
April 2 Received cash from S.K.Agarwal 3400
April 4 Purchased a radio set for private use 1000
April 5 Purchased goods for cash 1500
April 6 Cash sales 1860
April 6 Paid wages 150
April 8 Received from Mukesh Chand 1000
April 9 Paid Naresh Chand in full settlement of his account of Rs. 250 225
April 12 Paid for V.P.P. of goods from Chandigarh 243
April 13 Sent money order to satish chand 150
April 13 Money order commission 2
April 14 Krishan chand paid cash to us 1236

Discount allowed 13
April 18 Cash purchases 290
April 21 Paid for general expenses 14
April 24 Received from Anand prakesh 280
April 28 Paid for stationery 25
April 30 Paid water bill 10
April 30 Paid for charity 5
April 30 Purchased a transistor for his son 200
Ans.[Cash Balance- 5841]

Two – Column cash Book (cash book with cash and bank column)
3. Record the following transactions in a Double Column Cash Book with cash and Bank
Column and balance the book on 31st January , 2009:
2009 Amt. Amt.

Jan. 1 Cash in Hand 567 Jan.17 Purchased a motor
Jan. 1 Cash at bank 12,675 Car and paid by Cheque 5,250
Jan. 2 Deposited in bank 500 Jan.17 Paid by Cheque to Dand 367
Jan. 5 Received from A 790 Received discount 3
And allowed discount 10 Jan.19 Withdrew from bank for office
Jan. 7 Purchased furniture for use 250
cash 250 Jan.22 Purchased goods for cash 350
Jan. 8 Paid to B by Cheque and 745 Jan.25 Paid establishment
Received discount 5 Expenses through bank 450
Jan13 Received from C by Jan.31 Paid rent in cash 50
Cheque And deposited
into bank 500
Jan15 Cash sales 785
Jan15 Deposited into bank 1,000

Ans. Cash Balance-Rs 242; Bank Balance-Rs 7623

4. Record the following transactions in a suitable cash book and find out the cash and bank
balances:
2009 (Amount)
Jan. 1 Cash in Hand 5,000
Jan. 1 Bank overdraft 1,000
Jan. 2 Paid wages 1,500
Jan. 3 Deposited into bank 2,000
Jan. 4 Cash sales 7,500
Jan. 5 Sold goods for Cheque which was deposited in bank 5,000
on the same day
Jan. 6 Purchased goods from Hari on credit 4,000
Jan. 7 Drew from bank for personal use 1,000
Jan. 8 Paid to Hari on account 3,500
Jan. 9 Received from Ram, who owes Rs. 5,000, Rs.
2,000only on account
Ans. Cash in Hand-Rs 7500, Bank Balance Rs 5000

Analytical petty cash Book
5. From the following information, prepare an Analytical petty cash Book:
2009 (Amount)
April 1 Received for cash payment 2,000
April 2 Paid for postage 160
April 5 Paid for stationery 100
April 8 Paid for advertisement 200
April 12 Paid for wages 80
April 16 Paid for carriage 60
April 20 Paid for conveyance 88
April 25 Paid for traveling expenses 320
April 27 Paid for postage 48
April 28 Paid for office cleaning 40
April 29 Paid for telegram 80
April 30 Sent registered notice to landlord 19

Ans.
6. The following transactions took place during the will ending 29 th may, 2009. how will you record
them in the petty cash Book which was maintained with a weekly ‘float’ of Rs. 300?
2009
May 23 Postage 40
May 24 Casual labour 50
May 24 Taxi hire 60
May 26 Writing pads and registers 80
May 27 Cartage 20
May 28 Bus fare 30
Chapter Bank Reconciliation Statement

9
MEANING OF A BANK RECONCILIATION STATEMINT

Money deposited into a bank is recorded in the bank column of a two-column cash Book on the
debit side while withdrawals are recorded on the credit side.
The bank also maintains an account of the customer in its books of account. Deposits made by the
customer are recorded on the credit side of the customer’s account and withdrawals on the debit
side. A copy of it is also given to the customer for his knowledge in the form of a pass Book or a
statement of account.

As the same transactions relating to deposits and withdrawals made during a period are recorded in
both the cash Book and the pass book, the balance shown by the two records at the end of a period
should agree.
But, sometimes the two balances differ. If the two balances differ, it becomes necessary to know the
reasons for the difference. A statement showing the reasons or causes of differences is prepared.
This statement is known as a Bank Reconciliation Statement.
A bank reconciliation statement is prepared on a particular date to reconcile the bank balance in the
cash book with the balance as per the bank pass book or bank statement by showing reasons for
differences between the two.
CAUSES OF DIFFERENCE BETWEEN CASH BOOK ASN PASS BOOK BALANCES

Balances as per books of accounts and pass book may differ under some situations. We can
broadly classify these situations into three categories:
1. Difference Due to Timing: There is always a time gap between recording a transaction in the
books of accounts and their being recorded by the bank. For example, a Cheque issued is
recorded in the books of accounts immediately but the bank will record it when it is presented for
payment. Similarly, a Cheque deposited is recorded in the books of account immediately
whereas the bank grants credit on the clearing of the Cheque. Thus, there is always a time gap
between the two. So, if a bank reconciliation statement is prepared in between the two dates,
differences will exist.
2. Transactions Recorded by the Bank: sometimes transactions are recorded by the banks,
which are not known to the accountholder. For example, interest charged or allowed, bank
charges, transfer of balance from one account to another. The account holder comes to know
about it after receiving the bank statement. Such transactions in the bank statement lead to a
difference between the cash book and the bank statement balances.
3. Errors: Errors may be committed by the bank of the accountant, and these errors leas to
difference in the balance of cash book and book statement. For example, wrong balance may be
carried forward by the accountant, a transaction may not have been recorded in the cash book,
or a transaction may have been wrongly recorded in another account.
The bank balance as per the cash book will not agree with ht balance as per the bank statement
under the above discussed situations. The reasons for the disagreement can be:

1. Cheque issued but not yet presented for payment: When a Cheque is issued for payment,
an entry in the cash book is recorded immediately. But the entry is recorded by the bank only
when the Cheque is presented for payment. There will, thus, be a gap of row days between the
entry in the cash Book and in the pass book. If the bank reconciliation statement is prepared on
a date between the issue of Cheque and its presentation to the bank for payment, a difference
will arise. Let us take an example for better understanding. Suppose, a Cheque of Rs. 2,000 is
issued on December 27, 2008 which is presented to the bank on January 2, 2009. The issue of
Cheque will be the pass book on January 2, 2009. On December 31, 2008. The cash book
balance will be less by Rs. 2,000 due to this reason.
2. Cheque paid into the bank but not yet cleared: Cheque sent to the bank is recorded in the
bank column on the debit side of the cash book. But banks credit the customer’s account when
they have received the payment from the other bank – in other words, when the Cheque and the
credit given by the bank. Therefore, a difference will arise on a particular date in the bank
balance as per the books and the bank.
For example, a Cheque of Rs. 1,000 is deposited into the bank on march 30, 2009 which is
collected by the bank on April 4, 2009. now, if the balances on march 31, 2009 are compared, the
cash book balance will be higher by Rs. 1,000
3. Interest credited by the bank but not recorded in the cash book: if the bank allows interest
to a customer, it credits the customer’s account and his balance would increase. But the
customer will made the corresponding entry in the cash book at the end of the month or when
he comes to know about this. Until then, the balance as per the pass book would be more then
the balance as per the cash book.
4. Bank charges and interest charged by bank but not Entered in the book: Bank renders
certain services to its customers for which it charges an amount known as bank charges.
Similarly, bank provides overdraft facilities for which it charges interest. As soon as these
charges are made, the bank debits the customer’s account in its books and thus reduces the
bank balance. But the customer comes to know about them only when he receives the bank
statements or pass book and then he credits the bank account in his cash book. Until then, the
balance as per the pass book would be less than the balance as per the cash book.
5. Interest and dividends collected by the bank: Sometimes investments are left in the safe
custody of the bank. The bank collects interest or dividend on the due dates and credits them to
the customer’s account. The bank then sends the necessary information to this effect to the

customer. Naturally, the customers record it in their pass book. The entries in the pass book and
in the cash book may thus be on different dates. Until then, the balance as per the pass book
would be more than the balance as per the cash book.
6. Direct payments by the bank: The bank may be given standing instructions for certain
payments such as for insurance premium. When the bank makes such payments, it immediately
debits the customer’s account. In theirs case also the customer may come to know of the
payment only on perusing the pass book. Entries in the pass book and in the cash book will thus
be on different dates.
7. Direct payment into the bank by a customer: if a payment is received by the bank directly, it
will be recorded in the customer’s account and also in the pass Book. The account holder may
come to know of the amount on a later date only when he peruses the pass book.
8. Dishonor of a Bill Discounted with the Bank: if the bank is not able to receive payment on
promissory notes discounted by it, it will debit the customer’s account together with any charges
that it may have incurred. The customer will naturally record the entry only when he peruses the
pass book. But till such entry is recorded, the balances shown by cash book and pass book will
differ.
9. Bill collected by the Bank on behalf of the customer: if goods are sold, the documents may
be sent through the bank. If the bank is able to collect the amount, it will credit the customer’s
account. The customer may me the entry only on receiving the pass book on a later date.
10. Errors and omissions: Errors and Omissions either in the cash book or in the pass book
would cause disagreement between the balance as per the cash book and the balance as per
the pass book. It may be possible that while recording the transactions in the cash book, a
Cheque of Rs. 1,000 deposited into the bank is recorded as Rs. 10,000. Similarly, the bank may
also commit a mistake while recording the transactions in the pass book. For example, a
Cheque collected on behalf of Mohan is entered in the account of Mahesh. Such errors would
also lead to differences in the balances between the cash book and the pass book.
NEED AND IMPORTANCE OF A BANK RECONCILIATION STATEMENT

A Bank Reconciliation statement is needed and is important because of the following reasons:
1. It brings out any errors that may have been committed either in the cash book or in the pass
book.
2. Any undue delay in the clearance of Cheque will come to light at the time of reconciliation.

3. Regular reconciliation discourages the staff from embezzlement.

4. Reconciliation helps the management check the accuracy of entries recorded in the cash book
and keeps track of claque, etc., which may have been sent to the bank for collection.
Ascertaining the reasons or causes of the Difference in the balance: The causes of the
difference are ascertained when items in the pass book and in the cash book are compared. To
illustrate this, we give below an extract from a pass book and the bank columns in the cash book.
PASS BOOK
M/s. tall & short, Lajpat Nager, New Delhi 110024 in account in Punjab National Bank, MCC,
Defense Colony, New Delhi.
PASS BOOK
Date Particulars Withdrawals Deposits Dr. or Balance
Rs. Rs. Cr. Rs.
2009
Jan. By cash 40,000 Cr. 40,000
Jan. To furniture dealers Ltd. 6,000 Cr. 34,000
Jan. To Das & co. 12,500 Cr. 21,500
Jan. By J.johnson & co.’s Cheque 35,00 Cr. 25,000
Jan. To Roy & james 10,000 Cr. 15,000
Jan. By B. Babu & Cheque 7,600 Cr. 22,600
Jan. By cash 3,000 Cr. 25,600
Jan. To cash 5,000 Cr. 20,600
Jan. To premium paid as per Cr. 24,900
standing Instruction 2,500 Cr. 22,400
Jan. By J. Raj & BROS. 4,300 Cr. 22,300
Jan. To bank charges 100
Jan. By interest collected on Cr. 24,300
Government securities
2,000

CASH BOOK (BANK COLUMNS ONLY )

Date Particulars Rs. Date Particulars Rs.
2009 2008
Jan. 2 To cash 40,000 Jan. 2 By furniture dealers 6,000
Jan. 8 To J.Johnson & co. 3,500 Jan. 2 ltd. 10,000
Jan. 10 To B. Babu & co. 7,600 Jan. 4 By Roy & James 12,500
Jan. 16 To cash 3,000 Jan. 17 By Das & co. 7,300
Jan. 20 To J.Raj & Bros. 4,300 Jan. 20 By K. Nagpal & co. 5,000
Jan. 22 To M.Mohan & co. 10,500 Jan. 25 By cash 7,800
Jan. 31 To N. Nandy & sons 3,400 Jan. 25 By B. Babu & co. 23,700
By balance c/d
72,300 72,300
Feb. 1 To balance b/d 23,700
PREPARING A BANK RECONCILIATION STATEMENT

A Bank reconciliation statement is prepared by starting with one of the balances the pass book
balance or the cash book balance. Then the causes that lead to the difference are classified into:
(a) entries that have been made in the cash Book but not in the pass Book; and
(b) entries that have been made in the pass book but not in the cash book.
The starting balance is then adjusted by noting how the balance would have changed if the same
entries were made in the two books.
 If we start Bank Reconciliation Statement With favorable balance (Dr. Balance) as per Cash
Book, we determine the items that have led to the difference in the balances of cash Book and
pass Book. Thereafter, each item of difference is analyzed to ascertain whether each item has
led to increase or decrease in the cash Book balance.

Items of differences which have led to decreased Cash Book balance (Cheque issued but not
presented for payment, interest credited by bank but not recorded in the cash Book, etc.) are added
to the cash Book balance.
Similarly, items of differences which have led to increased Cash Book balance Cheque deposited
but not credited by bank, bank charges charged by the bank, etc.) is deduction from the Cash
Book Balance?
 If we start Bank Reconciliation Statement with unfavorable or bank overdraft (Cr. Balance )
as per Cash Book, then we ascertain whether each item causing difference has led to increase
or decrease in the overdraft Cash Book balance (Cheque issued but not presented for payment,
interest credited by bank, etc. )are deducted from overdraft cash Book balance.
Similarly, items of differences which have led to decreased overdraft cash Book balance (Cheque
deposited but not credited by bank, bank charges charged by bank, etc.) are added to the overdraft
Cash Book balance.
The deduction and addition of above amount, lead us to the balance as per Pass Book.
 If we start Bank Reconciliation Statement with Favorable balances (Cr. Balance) as per Pass
Book, we determine the items that have led to the differences in the two balances. Thereafter,
each item causing difference is analyzed whether it has led to increase or decrease in the
balance as per pass Book.
Items of difference which have led to increased pass Book balance (Cheque issued but not
presented for payment, interest credited by bank, etc.) are deducted from the Pass Book balance.
Similarly, items of differences which have led to decreased pass Book balance Cheque
deposited but not credited, bank charges charged by bank, etc.) are added to the pass Book
balance.
The adjustments of above amounts lead us to the balance as per Cash Book.
 If we start Bank Reconciliation statement with unfavorable or bank overdraft (Dr. Balance) as
per Pass Book, we determine the items that have led to the differences in the two balances.
Thereafter, each item causing difference is analyzed whether it has led to increase or decrease
in balance as per pass Book.

Items of differences which have led to increased overdraft pass Book balance (claque deposited but
not credited, bank charges charged by bank, etc.) are deducted from the overdraft pass Book
balance.
Similarly, items of differences which have led to decreased overdraft Pass Book balance
(Cheque issued but not presented for payment, interest credited by bank, etc.) are added to the
overdraft pass Book balance.
The adjustments of above amounts lead us to the balance as per cash Book.
Apart form the above; the following points should also be borne in mind, while preparing this
statement:
1. Date: The date on which the Bank Reconciliation Statement is prepared.]
2. Balance: Which balance is the basis of bank reconciliation? In this regard it should also be
remembered that:
a. Balance as per Cash Book means the balance as per the bank column of the Cash Book,
b. A debit balance or favorable balance in the Cash Book means that the amount is lying deposited
in the bank,
c. A credit balance in the Cash Book means overdraft, there is an excessive withdrawal of that
amount,
d. A credit balance or favorable balance as per the Pass Book means that the amount is lying
deposited in the bank, and
e. A debit balance as per the Pass Book means an overdraft has been made by the customer. In
other words, the customer is a debtor to the bank for the amount equal to the debit balance of
the pass Book.
Besides this, the following facts should also be remembered:
(a) Debiting any item in the cash Book increases the Cash Book balance and crediting decreases it.
(b) Debiting any item in the Pass Book decreases the Pass Book balance or increases the overdraft
balance and crediting increases the balance or decreases the overdraft balance.
Preparation of Statement: After deciding which entries are to be added to the balance of the
concerned book and which entries are to be subtracted, we should prepare the Bank Reconciliation
Statement in a statement form. Continuing with our previous example, the Bank Reconciliation
Statement can be prepared by (a) taking the balance as per Pass Book as the starting point or (b)
taking the balance as per the Cash Book as the starting point.

BANK RECONCILIATION STATEMENT

As at 31st January, 2009
(a) When balance as per Pass Book is taken as the starting point.
Particular Rs.
Balance as per pass Book (Cr.) 24,300
Add. Cheque paid in but not yet credited:
M. Mohan & Co.
10,500 13,900
N. Nandy & Co. 3,400
Add. Premium paid and bank charges entered in the 2,600
Pass Book but not yet entered in the Cash Book 40,800
Less: Cheque issued but not yet presented for payment:

K. Nagpal & Co. 7,300 15,100
B. Babu & Co. 7,800
25,700
Less: interest credited by bank but not yet recorded in the cash book 2,000
Cash Book
23,700
Balance as per Cash Book (Dr.)
Or
(b) When balance as per cash Book is taken as the starting point.
Particular Rs.

Balance as per Cash Book (Dr.) 23,700

Add : Cheque issued but not yet presented for payment:
K. Nagpal & Co. 7,300
B. Babu & Co. 7,800 15,100
Add : interest credited in the pass Book, but not yet entered
in the Cash Book 2,000
40,800
less: Cheque paid in but not yet credited:

M. Mohan & Co. 10,500
N. Nandy & Co. 13,900
3,400 26,900
2,600
Less: premium paid and bank charges recorded in the pass Book but not yet
recorded in the Cash Book 24,300
Balance as per pass Book (Cr.)

Alternative presentation
An alternative presentation of a Bank Reconciliation Statement is also possible. Two columns are
given, one to record items that reduce the balance (minus column). Balances as per Cash Book or
Pass Book are written as the starting balance as follows:
1. Debit balance of the Cash Book is written in the ‘plus’ column.
2. Credit balance of the Cash Book is written in the ‘minus’ column.
3. Debit balance of the Pass book is written in the ‘minus’ column.
4. Credit balance of the pass book is written in the ‘plus’ column.
Having written the amounts for causes of difference, the two columns are totaled and the difference
ascertained. The difference is written in the column having the shorter total. The difference is the
balance as per the Cash Book, if balance as per pass Book is taken as the starting balance and it is
balance as per Pass Book, if balance as per Cash Book is taken as the starting balance. The
statement given above is redrawn below:

BANK RECONCILATION STATEMENT

As at 31st January, 2009
(a) When balance as per Pass Book is taken as the starting point.
Particular Plus Minus items
items Rs.
Rs
.
Balance as per pass Book 24,300
Cheque paid in but not yet cleared:
M. Mohan & Co. 10,500
N. Bandy & Co. 3,400 13,900
Premium paid and bank charges recorded
In the pass Book but not yet recorded in the Cash Book 2,600
Cheque issued but not yet presented for payment:
B. Babu & Co. 7,800 15,100
Interest recorded in the pass Book but not yet recorded in the
Cash Book 2,000
17,100
Balance as per cash Book (Rs. 40,800- Rs. 17,100) 23,700
40,800 40,800
Or
(b) When balance as per Cash Book is taken as the starting point.
Particulars Plus items Minus items
Rs. Rs.

Balance as per cash book 23,700

Cheque issued but not yet presented for payment:
B. Babu & Co. 7,800 15,100
Interest recorded in the pass Book but not yet recorded in the 2,000
Cash Book
Cheque deposited but not yet cleared:
M. Mohan & Co. 10,500 13,900
N. Nandy & Co. 3,400
Premium paid and bank charges recorded in the pass Book but 2,600
not 16,500
Recorded in the cash Book 24,300
Balance as per Pass Book (Rs. 40,800-Rs. 16,500) 40,800 40,800
A Bank Reconciliation Statement may be prepared taking either balance as per Cash Book or
balance as the bank (pass Book) as the base and thereafter adjusting differences between the two.
The balances, the basis for preparing a Bank Reconciliation Statement may be:
(i) Favorable balance as per Cash Book; or
(ii) Favorable balance as per Pass Book; or
(iii) Overdraft (unfavorable) balance as cash Book ; or
(iv) Overdraft (unfavorable) balance as per Pass Book.
Let us discuss how a Bank Reconciliation Statement is prepared under each of the above
situations.
CASE 1. WHERE FAVOURABLE BALANCE AS PER CASH BOOK IS GIVEN.
A favorable balance as per Cash Book means a debit balance in the books of account, balances
lying deposited in the bank. When the balance (favorable) as per cash book is taken as a basis to
arrive at the balance as per Pass Book, adjustments are made for the differences as have been

discussed above. Let us discuss individual items of differences and the basis why these items are
added to or deducted from the Cash Book balance.
Items of Differences Reasoning

Added to cash Book Balance
(i) Cheque issued but not presented for payment The amount is added to the balance
because to had been earlier deducted from
the cash Book balance at the time of its
recording but has not been deducted by the
bank because they have not been presented
for payment.
(ii) Cheque deposited by a creditor directly into the It is added because the balance as per the
bank bank already stands increased but it has not
been added to the cash book balance
because the deposit is not recorded in the
cash book. Adding the amount will bring it at
par with balance as per the pass book.
(iii) Interest allowed by the bank It is added because the balance as per the
bank already stands increased but it has but
par with the balance as per the pass Book.
(iv) Dividend collected It is added because the balance as per the
bank already stands increased but it has not
par want the balance as per the pass book
(v) Bills of exchange realized It is added because the balance as per the
Or bank already stands increased but it has not

Cash directly deposited into the bank but not been added to the cash book balance
recorded in the cash book. because the deposit is not recorded in the
cash book adding the amount will bring it at
par want the balance as per the pass Book.
(vi) Wrong credit granted by the bank It is added because the balance as per bank
already stands increased but is not added to
the cash book balance. Adding the amount
will bring it at par with balance as per the
pass Book. But remember, that entry is not
recorded in the books of account for wrong
credit granted by the bank.
(vii) Cheque deposited but not recorded It is added because bank balance stands
increased but cash book balance does not.
Adding the amount to cash Book balance
will bring it at par with balance as per pass
book.
Deducted from cash Book Balance
(viii) Cheque deposited but not collected (credited) The amount is deducted because the cash
by bank Book balance stands increased but the bank
has not given credit because it has not given
credit because it has not collected it.
Deducting the amount will bring the balance
at par with the pass Book balance.
(ix) Cheque or Bill of Exchange dishonored It is deducted because the cash book
balance stands increased but the balance as
per the bank has not increased because the
Cheque or bill of exchange deposited has
not been collected.
(x) Bank charges charged The bank has debited the account by the
charges, thus, the balance as per the bank
stands reduced. Had it been recorded in the

cash book, the balance as per the cash

book would also have been reduced.
(xi) Interest charged The bank has debited the account by the
charges, thus, the balance as per the bank
stands reduced. Had it been recorded in the
cash book, the balance as per the cash
book would also have been reduced.
(xii) Direct payment by the bank as per standing It is deducted because the balance as per
order, life insurance premium paid the bank is reduced. Had it been also
recorded in the cash book, the cash book
balance would also have been reduced.
(xiii) Wrong debit by the bank It is deducted because the balance as per
the bank is reduced on recording. Deducting
the amount form the balance as per the
cash book will bring the balance as par with
the balance as per the bank. But remember
that entry is not recorded in the books of
account for wrong debits made by the bank.
(xiv)Chaque recorded but not deposited It is deducted because the cash book
balance stands increased with the account.
But the bank will increase the balance upon
receipt of the Cheque and its clearance.
Deducting the amount will bring the
balances at par.
Illustration 1. The bank column of a cash book showed a debit balance of Rs. 49,000 on June 30,
2009. Entries in the cash Book and the pass book were compared and the following differences
were noticed:
(i) Cheque of shyam Rs. 9,000 and of Mohan Rs. 15,000 were deposited but were not collected
up to June 30,2009
(ii) Ramesh, a creditor, deposited a Cheque of Rs. 8,000 directly into the bank.

(iii) Bank allowed an interest of Rs. 500.

(iv) Cheque for Rs. 10,000 issued to Radhey shyam was not presented for payment.
(v) Bank debited the account by Rs. 6000, being insurance premium.
(vi) Bank debited the account by Rs. 100, being bank charges.
You are required to prepare a Bank Reconciliation Statement as on June 30, 2009.
Solution:
As at June 30, 2009
Particulars Amount Amount
Details (Rs.) (Rs.)
Balance as per cash Book (Dr.) 49,000
Add : cheque directly deposited by Rajesh 8,000
Interest allowed by bank 500
Cheque issued but not presented for payment 10,000 18,500
Less: Cheque deposited but not yet cleared: 67,500

Shyam 9,000
Mohan 15,000 24,000
Insurance premium paid by bank 6,000
Bank charges debited 100 30,100
Illustration 2. From the following particulars, prepare a Bank Reconciliation Statement showing
balance as per the Bank pass Book on 31st march, 2009.
The Cheque from shri Morarji Dalal Rs. 2,500, shri Dinkar Tapase Rs. 3,000 and shri Baliram
Gidwani Rs. 2,400 were deposited into account in March 2009 but were credited by the bank in April
2009.
The Cheque issued to shri M. Kher Rs. 3,000 shri Natverlal Mehta Rs. 5,000 and shri Dayabhai
Desai Rs. 3,000 in March, 2009 and were presented for payment in April 2009.

A Cheque for Rs. 1,000 which was received from a customer was entered in the bank column of the
cash Book in March, 2009 but the same was paid into bank in April, 2009.
The pass Book shows a credit of Rs. 2,500 for interest and a debit of Rs. 500 for bank charges. The
balance (Dr.) as per Cash Book was Rs. 1, 80,000 whereas the pass Book showed a credit balance
of Rs. 1, 84,100.
Solution:
As at march 31, 2009
Particular Rs.
Balance as per cash Book (Dr.)
Less: Cheque deposited into the bank but not yet cleared:
Morarji Dalal 2,500
Dinkar Tapase 3,000
Baliram Gidwani 2,400 7,900
1,72,100
Less : Cheque debited in the cash Book but not deposited 1,000
1,71,100
Less: Bank charges charged in the pass book but not yet recorded
In the cash Book 500
1,70,600
Add: claque issued but not yet presented for payment:
M. Kher 3,000
Natverlal Mehta 5,000
Dayabhai Desai 3,000 11,000
Add: interest credited in the pass Book but not yet recorded in the 2,500
Cash Book 1,84,100
Balance as per Bank pass Book (Cr.)

CASE: 2. WHEN FAVOURABLE BALANCE AS PER PASS BOOK IS GIVEN.
Favorable balance as per pass Book means a credit balance in the pass Book, balance lying
deposited in her bank. When the balance (favorable) as per pass Book is taken as the basis to
arrive at the balance as per cash Book, adjustments are made for the differences as have been
discussed above. Let us discuss individual items of differences and the basis why these items are
added to or deducted from the pass Book balance.
Items of differences Reasoning

Added to pass Book balance
(i) Cheque deposited but not collected The amount is added because the cash
(credited ) by bank Book balance already stands increased. By
adding the amount, the balance will come
at par with the cash Book balance.
(ii) Deposited Cheque or Bills Receivable The amount is added because the amount
dishonored of deposit already stands added to the
balance of the cash Book but on dishonor,
the amount is not deducted from the Cash
Book balance. By adding the amount, the
balance will come at par with the cash
book balance
(iii) Bank charges charged by bank but The amount is added because the balance
recorded in the Cash Book of the bank is reduced but the cash Book
balance is not as it is not recorded. By
adding the amount the balance will come at
par with the cash Book balance.
(iv) Interest charged by bank not recorded in The amount is added because the balance
the cash Book of the bank stands reduced but the cash

Book balance is not as it is not recorded.

By adding the amount, the balance will
come at par with the cash Book balance.
(v) Direct payment by bank as per standing The amount is added because the balance
instruction, say for insurance premium as of the bank is reduced but the cash
Book balance is not as it is not recorded.
By adding the amount, the balance will
come at par with the cash Book balance.
(vi) Bill payable paid by bank not recorded The amount is added because the pass
in the cha Book book balance stands reduced but, cash
Book balance is not reduced. By adding
the amount, the balances will come at par.
(vii) Wrong debit by bank The amount is added because the balance
of the is reduced by the cash Book balance
is not reduced. By adding the amount, the
balance will come at par with the cash
Book balance.
(viii) Cheque recorded in cash Book but not The amount is added because, if the
deposited cheque had been deposited, the balance of
the bank would have been equal to that of
the cash book.
Deducted from the pass Book Balance

(ix) Cheque issued but not presented for The amount is deducted because if the
payment Cheque had been presented for payment,
the balance would have been reduced and
the two balances would have been the
same.
(x) Cheque deposited directly into bank by a The amount is deducted because the entry

creditor is not recorded in the cash Book, the

cashbook balances would have increased.
Had it been recorded the two balances
would have matched.
(xi) Interest allowed by bank not recorded in The amount is deducted because the entry
the Cash Book is not recorded in the cash Book, eth Cash
Book balance would have increased. Had it
been recorded the two balances would
have matched.
(xii) Dividend collected The amount is deducted because the entry

is not recorded in the cash Book, the Cash
Book balance would have increased, had it
have matched
(xiii) Bill of exchange realized The amount is deducted because the entry
is not recorded in the cash Book, the Cash
have matched.
(xiv) Wrong credit granted by bank The amount is deducted because the entry
is not recorded in the Cash Book, the Cash
been recorded the two balanced would
have matched.
(xv) Cheque deposited into bank, It is deducted because it has not been
recorded in the cash Book. It means Cash
Book balance is lower by that amount,

Illustration 3. On 31st March, 2009 the pass Book of a trader showed a credit balance of Rs.
15,650 whereas the Cash Book showed a debit balance of Rs. 15,200. the reasons for the
differences were:
(i) Cheque issued to Roshan for Rs. 6,000 and to Daniel for Rs. 3,840 were not presented for
payment.
(ii) Bank charged Rs. 350 for bank Charges.
(iii) Nitesh directly deposited Rs. 8,160 into the bank account of the trader which was not entered in
the Cash Book.
(iv) Two Cheque one from shyam for Rs. 5,150 and another from Kailash for Rs. 12,500 were
collected by bank in the first week of April, 2009 although they were banked on 25 th March,
2009.
(v) Interest allowed by bank Rs. 450.
Prepare a Bank Reconciliation Statement as on 31st March, 2009
Solution:
As at 31st March, 2009
Particular Amount details Amount details
Rs. Rs.
Add: Cheque sent to bank for collection but not yet collected:
Shyam 5,150
Kailash 12,500 17,650
Bank charges debited by the bank 350 18,000
33,650
Less : Cheque issued but not yet presented for payment:
Roshan 6,000
Daniel 3,840 9,840
Cheque directly deposited in bank 8,160
Interest allowed by bank 450 18,450

Balance as per cash Book (Dr.) 15,200
Illustration 4. Prepare Bank Reconciliation Statement from the following particulars on 30 th

June, 2006
bank statement showed a favorable balance of Rs. 9,214.
(i) On 29th June, 2006 the bank credited the sum of Rs. 1,650 in error.
(ii) Certain Cheque, valued at Rs. 4,500 issued before 29th June, 2006 were not cleared.
(iii) A hire purchase payment of Rs. 950, made by a standing order was not entered in the Cash
Book.
(iv) A cheque of Rs. 600 received, deposited and credited y bank, was accounted as a receipt in the
cash column of the Cash Book.
(v) Other Cheque for Rs. 8,500 were deposited in June but Cheque for Rs. 6,000 only were cleared
by the bankers.
Solution:
As on 30th June, 2006
Rs. Rs.
Less: Bank credited in error 1,650
Chequ3e issued but not cleared 4,500
Add: A hire purchases payment of Rs. 950. made by a standing
order was not entered in the Cash Book 950
Less: cheque deposited into bank, was accounted as receipt in 600
the cash column of the cash Book
Add: Cheque deposited but not cleared (Rs. 8,500 – Rs. 6,000) 2,500
Balance as per Cash Book (Dr.) 5,914

12,664 12,664
CASH: 3. WHEN OVERDRAFT (UNFAVOURABLE) BALANCE AS PER CASH BOOK IS GIVEN.
Overdraft (unfavorable) balance as per the Cash Book means credit balance in the Cash Book, an
amount has been overdrawn and is payable to the bank. When the balance (unfavorable) as per the
Cash Book is taken as the basis to arrive at the balance as per the pas Book, adjustments are
made for the differences as have been discussed in the foregoing paragraphs. Let us discuss
individual items of differences and the basis why these items are added to or deducted from the
unfavorable cash book balance.
Items of Difference Reasoning
Added to cash Book Balance
(i) Cheque deposited but not collected The amount is added to the overdraft amount
(credited) by bank because the bank has not credited the amount to the
account. Thus, the Cash Book shows a lower
overdraft balance compared to the overdraft balance
of the bank.
(ii) Cheque recorded in Cash Book but The amount is added to the amount of overdraft
not sent to bank because the Cheque have not been deposited
although they have been recorded in the Cash Book.
In effect, the overdraft
(iii) Bank charges charged by bank The amount is added to the overdraft balance
not recorded in the Cash Book because the bank has debited the account and in
effect increased the overdraft balance. If the amount
had been recorded in the Cash Book, the overdraft
balance of the Cash Book would have increased.
(iv) Interest charged by bank is not The amount is added to the overdraft balance
recorded in the Cash Book because the bank has debited the account and in
effect increased the overdraft balance. If the amount

had been recorded in the Cash Book, the overdraft

(v) Direct payment by bank as per The amount is added to the overdraft balance
standing instruction, say payment of because the bank has debited the account and in
insurance premium effect increased the overdraft balance. If the amount
had been recorded in the cash Book, the overdraft
(vi) Wrong debit by bank The amount is added to the overdraft balance
because the bank has debited the account and in
effect increased the overdraft balance. Adding the
amount will bring the overdraft balance of the Cash
Book at par with the bank.
(vii) Cheque issued but not recorded The amount is added to the overdraft balance
in Cash Book because the unrecorded cheque presented to the
bank has increased the overdraft balance as per the
bank. Had it been recorded in the Cash Book, the
overdraft balance as per the cash Book would have
increased?
(viii) Deposited Cheque or Bills The amount is added to overdraft balance because
receivable dishonored at the time of deposit overdraft balance was reduced.
Overdraft balance will increase and therefore, will
come at par with balance as per bank.
Deducted from the Cash Book The amount is deducted from the overdraft cash
Balance Book balance because the issue of Cheque so
(ix) Cheque issued but not presented recorded in the Cash Book, in effect the overdraft
for payment Cash Book balance stands increased. The Cheque
so issued are not presented for payment, meaning,
the bank has not debited the amount. Thus, the
overdraft balance of the bank is lower or the credit

balance of the bank balance.

(x) Cheque deposited directly into the The amount is deducted because the amount is
bank by a creditor credited by the bank in effect the overdraft balance in
the bank stands decreased. Since the Cheque
directly deposited are not recorded in the Cash
Book, the overdraft Cash Book balance is higher
than the bank balance.
(xi) Interest allowed by bank not The amount is deducted because the amounts
recorded in the Cash Book credited by the bank in effect the overdraft balance
stands decreased. The cash Book shows higher
overdraft balance because the credit for interest is
not recorded.
(xii) Dividend collected The amount is deducted because the amount is
credited by the bank; in effect the overdraft balance
stands decreased. Cash Book shows a higher
overdraft balance because the credit for interest is
not recorded
(xiii) Wrong credit granted by bank The amount is deducted because the amount is
credited by the bank; in effect the overdraft balance
stands decreased. Cash Book sows a higher
overdraft balance because the credit is not recorded.
(xiv)Cheque deposited but not The amount is deducted because the amount is
recorded in the cash Book credited by the bank, in effect, the overdraft balance
stands decreased. The Cash Book shows a higher
overdraft balance because the Cheque deposited
are not recorded, the overdraft balance is both
decreased.
Illustration 5. Prepare a Bank Reconciliation Statement from the following particulars:

Over draft as per Cash Book. 1,80,000

Overdraft as per Pass Book. 2,13,900
Cheque deposited into the bank but n entry passed in the Cash Book. 3,000
Cheque received and entered into Cash Book but not sent to the bank. 10,000
Credit side of the bank column castled short. 1,000
Insurance premium paid directly by the bank under standing order. 5,000
Bank charges entered in the Cash Book twice. 100
Cheque received returned by bank but no entry passed. 4,000
Cheque; issued’ returned on technical grounds. 3,000
Bill discounted dishonored. 40,000
Bills receivable directly collected by the bank. 20,000
Solution:
Particular Amount Amount
details Rs.
Overdraft as per Cash Book (Cr.) 1,80,000
Add: Cheque received and recorded in the Cash Book but not 10,000
sent to the bank
Credit side of the bank column castled short 1,000
Insurance premium paid directly by the bank 5,000
Cheque received retuned by the Bank 4,000
Bill discounted dishonored 40,000 60,000
2,40,000
less : cheque deposited into the bank but no entry was passed in
the Cash Book 3,000
Bank charges entered twice in the Cash Book 100
Cheque ‘issued’ returned on technical grounds 3,000
Bill directly collected by bank 20,000
26,100

overdraft as per pass Book (Dr.) 2,13,900
Illustration 6. From the following particulars ascertain the balance that would appear in the Bank
Pass Book of A on 31st March, 2009:
(i) The bank overdraft as per Cash Book on 31st March, 2009 Rs. 63,400.
(ii) Interest on overdraft for 6 month ending 31st March, 2009. Rs. 1,600 entered in the Pass Book.
(iii) Bank charges of Rs. 300 for the above period are debited in the Pass Book.
(iv) Cheque issued but not cashed period to 31st March, 2009, amounted to Rs. 11,680.
(v) Cheque paid into the bank but not cleared before 31st March, 2009, were for Rs. 21,700
(vi) Interest on investments collected by the bank and credited in the Pass Book, Rs. 12,000
Note: In this illustration the point to note is that the opening balance is an overdraft. Hence, items
which increase the balance at bank will be deducted from the overdraft since money deposited will
reduce the overdraft. Similarly, items which reduce the balance at bank will be added to the
overdraft.
Solution:
BANK RECONCILIATION STATEMENT as at 31st march, 2009
Particular Rs.
Overdraft as per Cash Book (Cr.) 63,400
Add: Interest debited in the Pass Book but not yet
Entered in the Cash Book 1,600
Bank charges debited in the Pass Book but not yet
entered in the Cash Book 300
Add: Cheque paid in but not yet credited by the bank 21,700 23,600
87,000
Less : Cheque issued but not yet presented 11,680

Interest collected and credited by the bank but
Not yet entered in the Cash Book 12,000 23,680

Overdraft as per Pass Book (Dr.) 63,320
The above illustration can also be presented with the two columns using the ‘plus’ and ‘Minus’
method.
(Rs.) (Rs.)
Overdraft as per Cash Book (Cr.) 63,400
Interest debited in the pass Book but not yet entered in 1,600
the cash Book 11,680
Cheque issued but not yet presented 21,700
Cheque paid in but not yet credited by the bank 300
Bank charges 12,000
Interest collected and credited by the Bank in the Pass 23,680
Bank
But no yet entered in the Cash Book 63,320
87,000 87,000
Overdraft as per Pass Book (Dr.) (Rs. 87,000-Rs.
23,680)
CASH: 4. WHERE OVERDRAFT BALANCE AS PER PASS BOOK IS GIVEN.
Overdraft (Unfavorable) balance as per Pass Book means debit balance in the bank, amount
overdrawn or payable to the bank. When an overdraft balance (unfavorable) as per Pass Book is
taken as the basis of arriving at the balance as per Cash Book, adjustments are made for the
differences as have been discussed in the foregoing paragraphs. Let us discuss individual items of
differences and the basis why these items are added to or deducted form the unfavorable Pass
Book balance:
Items Reasoning
Added to the Pass Book Balance

(i) Cheque issued but not presented for The amount is added to the balance because of
payment the Cheque had been presented for payment,
the overdraft balance as per the bank would
have increased.
(ii) Cheque deposited directly in the bank by a The amount is added because the bank has
creditor credited the account and in effect the overdraft
balance stands reduced. In the Cash Book is
shown.
(iii)interest allowed by bank not recorded in the The amount is added because the bank has
Cash Book credited the account and in effect the overdraft
balance stands reduced. Since the deposit is not
recorded in the Cash Book, higher overdraft
balance in the Cash Book is shown.
(iv) Dividend collected The amount is added because the bank has
credited the account and in effect the overdraft
(v) Bill of exchange realized The amount is added because the bank has
credited the account and in effect the overdraft
(vi) wrong credit granted by the bank The amounts added because the bank shows a
lower overdraft balance due to wrong credit.
Adding the amount will increase the overdraft
balance as per the bank.
(vii) Cheque paid into bank but not recorded in The amount is added because the bank shows a
Cash Book lower overdraft balance due to this credit. Adding
the amount will increase the overdraft balance as

per the bank.

Deducted from the pass Book Balance The amount is deducted from the overdraft
(viii) claque deposited but not collected balance because if the Cheque had been
collected and credited to account by the bank, it
would have reflected a lower overdraft balance.
(ix) Cheque recorded in Cash Book but not The amount is deducted from the overdraft
sent for collection balance because if the Cheque had been
collected and credited to account by the bank, it
would have reflected a lower overdraft balance.
(x) Cheque of Bill of Exchange dishonored The amount is deducted from the overdraft
balance because the amount not realized by the
bank is debited to the account, thus in effect,
reflecting a higher overdraft balance. At the
same time. The amount has not been recorded
in the Cash Book, thus reflecting a lower
overdraft balance.
(xi) Bank charges charged The amount is deducted form the overdraft
balance because the amount has been debited
to the account resulting in a higher overdraft
balance. At the same time, the amount is not
recorded in the Cash Book thus reflecting a
lower overdraft balance.
(xii) Interest charged The amounts deducted from the overdraft
recorded in the Cash Book thus, reflecting a
(xiii)Direct payment by bank as per standing The amount is deducted from the overdraft
instruction insurance premium paid balance because the amount has been debited


(xiv) Wrong debit by bank The amount is deducted from the overdraft
Illustration 7. From the following particulars prepare a Bank Reconciliation Statement as on 31 st

March, 2009,
(i) Balance as per Pass Book on 31st March, 2009 overdrawn Rs. 8,000.
(ii) Cheque drawn on 25th March, 2009 but not collected till April 2008 Rs. 1,500, Rs. 500 and Rs.
800.
(iii) Interest on bank overdraft not entered in Cash Book Rs. 200.
(iv) Outstation cheque Rs. 3,000 deposited into bank but collected in April 2009.
(v) Rs. 1,000 Insurance premium paid by bank as per the trader’s standing order has not been
entered in the Cash Book.
(vi) Chamber of Commerce fee Rs. 300 paid by bank for traders but not recorded in the Cash Book.
(vii)Collection charges of Rs. 100 charged by the bank but not entered in the Cash Book.
Solution:
As at 31st march, 2009
Particular Amount Amount
Details (Rs.) (Rs.)

Balance as per pass Book (Dr.) 8,000

Add: Cheque issued but not yet presented for payment 2,800 2,800
10,800
Less: interest charged by the bank, not recorded in the

Cash Book 200
Cheque sent for collection but not yet collected by the
bank 3,000
Insurance premium paid by the bank
Fee of chamber of commerce paid by the bank but not 1,000
recorded in the Cash Book 300 4,600
Collection charged by the bank 100
Balance as per Cash Book (Cr.)
6,200
Illustration 8. My bank Pass Book for Account No. 1 shows an overdraft of Rs. 6,500 on 31 st
March, 2009. this does not agree with the Cash Book balance. From the following particulars
ascertain the Cash Book balance:
Cheque amounting to Rs. 15,000 were paid into the bank in March out of which, it appears, only
chouse amounting to Rs. 4,500 were credited by bank. Cheque issued during March amounted in
all to Rs. 11,000. out of these Cheque for Rs. 3,000 were unpaid on 31 st March, 2009. the bank has
wrongly debited Amount No. 1 with Rs. 500 in respect of a cheque drawn on Account No.2. the
Account stands debited with Rs. 150 for interest and with Rs. 30 for bank charges. The bank has
paid the annual subscription of Rs. 100 to my Club according to my instructions. The entries for
interest charges and subscription have not yet been made in the Cash Book.

Solution:
BANK RECONCILIATION STATEMENT (account no. 1)
As at 31 st March, 2009
Particulars Plus Minus
Items Items
Rs. Rs.
Overdraft as per pass Book (Dr.) 6,500
Cheque paid into the bank but not entered in the Pass
Book (Rs. 15,000- Rs. 4,500) 10,500
Cheque issued but not yet presented
Wrong debit it Account No. 1 instead of Account No. 2 500
Payment for charged made and entered in the pass
Book but not yet entered in the Cash Book:
Interest 150
9,500
Bank changes 30
1,780
Subscription 100 280
11,280 11,280
BANK RECONCILIATION STATEMENT WITH ADJUSTED (CORRECTED)

CASH BOOK BALNCE
Bank reconciliation statement is prepared generally without adjusting (corrected) the Cash Book
during the different months of the financial year. At the end of the financial year, the Cash Book
must be adjusted (corrected) for the entries that should have been incorporated but have not been
incorporated, before preparing the Bank Reconciliation Statement. It is so because; otherwise
correct balances (including cash balance) will not be reflected in the Balance Sheet. Following
procedure is to be followed for ascertaining the adjusted (corrected) Cash Book Balance.

Step 1: Draw up a Cash Book having Bank column only. If favorable balance (Dr. balance) as per
Cash Book is given, write down the balance on the debit side of the Cash Book. if unfavorable
balance or overdraft as per Cash Book is given, write down the balance on the credit side of the
Cash Book.
Step 2: Pass entries in the Cash Book in respect of the following items:
(a) Amount recorded in the Pass Book but not yet recorded in the Cash Book, omission in the Cash
Book, bank charges, interest charged on overdraft, interest allowed by bank, dividend/interest
/bills receivable directly collected by the bank, direct payment by bank under standing
instructions from customers.
(b) Rectifying entries in respect of errors committed in the Cash Book, chaque issued but recorded
in cash or discount column, Cheque issued recorded in bank column for wrong amount, over or
under cash of bank column, error in balancing the bank column, errors in carry forward or
brought forward bank balance.
At this point, on arrives at the Adjusted Cash Book Balance.
Step 3: The adjusted balance of the Cash Book is taken as starting point. A Bank Reconciliation
Statement is prepared listing the causes of differences and arriving at the balance as per Pass
Book. It is prepared as has been discussed earlier in the Chapter. In other rewords, add to Cash
Book balance if there is more in the Pass Book and deduct form the Cash Book balance if there is
less into the Pass Book.
Illustration 26. You are given the following particulars:

(i) Debit balance in the bank column as per the Cash Book on 31st March 209 was Rs. 50,000.
(ii) Cheque and drafts deposited into the bank but not collected Rs. 5,000
(iii) Cheque of Rs. 10,000 were issued but not presented for payment.
(iv) Bank charges of Rs. 50 for expenses which were not yet entered in the Cash Book.
(v) Interest on investment Rs. 3,000 was collected by the bank but not entered in the Cash Book.
Pass the necessary entries in the Cash Book and then prepare a Bank Reconciliation Statement on
31st March, 2009.
Solution:

ADJUSTED CASH BOOK

(BANK COLUMN ONLY)
Date Particulars L.F. Rs. Date Particulars L.F. Rs.
2009 2009
March 31 To balance b/d 50,000 March 31 By Bank Charges A/c 50
March 31 To interest on March 31 By Balance c/d 52,950
Investment A/c 3,000
53,000 53,000

As at 31 st march, 2009
Particulars Rs.
Balance as per Pass Book (Dr.) 52,950
Add: Cheque issued but not yet presented for payment 10,000
62,950
Less: Cheque and drafts deposited into bank but not yet collected 5,000
Balance as per Pass Book (Cr.) 57,950
BANK RECONCILIATION STATEMENT – AT A GLANCE

Particulars Cash Book – Starting Pass Book –
Balance Starting Balance
Normal Overdraft Normal Overdraft
Balance Balance
(Dr. (Cr. (Cr. (Dr.
Balance Balance ) Balance Balance )
) )

1. Cheque issued but not yet presented for + - - +

payment. - + + -
2. Cheque deposited into Bank but not yet + - - +
collected. _ + + -
3. Interest allowed by Bank but not entered in
the Cash Book. + - - +
4. bank charges not entered in the Cash Book - + + -
5. Direct deposit into the bank by a customer.
6. Direct payments from the bank not entered + - - +
in the Cash Book.
7. direct collections made by the bank not - + + -
entered in the Cashbook
8. Cheque issued and payment received by the _ - - +
creditor but entered in the Cash Book.
9. cheque paid into the bank but omitted to be - + + -
entered in the Cash Book
10. Dishonor of a cheque and bill discounted - + + -
with the bank.
11. Cheque entered in the Cash Book but not
sent to the bank.

BRS ASSIGNENT
1. Mr. x opened a bank account on mar, 2001, prepare a BRS from the cash book &
pass book for the month of mar. 01 given below:
Cash Book (Bank Column)
1-3-2001 To Cash 1,000 5-3-2001 By X & CO. 1,000
3-3-2001 To A& co 2,000 8-3-2001 By Y & CO. 2,500
10-3-2001 To B& co 5,000 20-30-2001 By C& co. 4,000
15-3-2001 To C& co 4,000 (Cheque dishonored )
30-3-2001 To D& co 7,000 25-3-2001 By salaries 1,000
31-3-2001 By Z& co. 3,500
By Bal c\d 7,000
19,000 19,000
1-4-2001 To Bal b/d 7,000
Pass Book for the month of mar. 2001

Date particulars With drawl Deposit Amount of Nature of
(Dr) (Cr) Balance Balance
1-3-2001 Cash - 1,000 1,000 Cr
5-3-2001 Clearing –A&co. - 2,000 3,000 Cr
10-3-2001 Clearing – x & co. 1,000 - 2,000 Cr
12-3-2001 Clearing – B & co. - 5,000 7,000 Cr
13-3-2001 Clearing – Y & co. 2,500 - 4,500 Cr
17-3-2001 Clearing – C & co. - 4,000 8,500 Cr
18-3-2001 Dishonor of cheque of c & co. 4,020 - 4,480 Cr
25-3-2001 Ramlal – C & co. 1,000 - 3,480 Cr
31-3-2001 Locker’s Rent 400 - 3,080 Cr
Cheque deposited but nit credited for rs. 7,000 dishonor charges charged by bank rs 20 not
recorded in CBP

2 The following is the cash book & pas book of Chetan for the month of June 2001 and July 2001:
Dr Cash Book (Bank column only) Cr

1-6-2001 To Balance b/d 5,000 4-6-2001 By cash a/c 2,000
10-6-2001 To sales a/c (ravi) 2,000 16-6-2001 By shashi a/c 3,000
11-6-2001 To Cash a/c 1,200 19-6-2001 By nikki a/c 1,000
19-6-2001 To Ramesh a/c 2,000 20-6-2001 By dhruv a/c 1,500
29-6-2001 To Subhash a/c 1,800 25-6-2001 By swati a/c 2,500
30-6-2001 To Satinder a/c 1,000 30-6-2001 By Balance c/d 4,000
14,000 14,000
Pass Book
Date Particulars Amount (Dr.) Amount (Cr.) Dr or Cr Balance
1-7-2001 Balance b/d 3,700 Cr 3,700
3-7-2001 Subhash a/c 1,800 Cr 5,500
4-7-2001 Satinder a/c 1,000 Cr 6,500
6-7-2001 Poonam a/c 4,500 - Cr 4,500
10-7-2001 Bank charges 500 - Cr 4,000
15-7-2001 Swati a/c 2.500 - Cr 1,500
18-7-2001 Rakesh a/c - 2,000 Cr 3,500
22-7-2001 Predeep a/c - 1,500 Cr 5,000
28-07-2001 Sunil a/c 1.000 - Cr 4,000
Prepare BRS for the month of June, 2001

Chapter - DEPRICIATION
10
MEANING
Depreciation means a fall in the value of an asset because of usage or with efflux of time or due to
obsolescence or accident. Every fixes asset looses its value, once it is put to use. Let us consider
some important definitions of Depreciation. These are:
Having considered the above definitions, we can now define Depreciation as a part of the cost of
fixed asset which has expired on account of its usage and /or lapse of time. In other words, it is
reduction in the value of a fixed asset.
Here, it is important to note that Depreciation is charged on all fixed assets except land. The reason
is that unlike other fixed assets like machinery and furniture, it does not have a finite economic life.
CHARACTERISTICS OF DEPRECIATION
The above definition brings to light the characteristics of Depreciation as follows:
1. Depreciation is a reduction in the book value of fixed assets.
2. it reduces the book value of the asset but not its market value.
3. The reduction in the book value of an asset is permanent, gradual and continuing nature. When
the book value is reduced, it is not possible to restore its original cost.
4. Depreciation is a continuing process because the book value is reduced either due to use or
with the passage of time.
5. it takes place gradually unless there is a quick physical deterioration or obsolescence due to
technological developments.
6. It is not the process of valuation of asset; it is a process of allocation of cost of the asset to the
period of its life.
7. The term Depreciation is used only for tangible fixed assets. This term is not used in the case of
wasting and fictitious assets such as depletion of natural resources and amortization of goodwill
respectively.
DEPRECIATION AND OTHER RELATED CONCEPTS

Sometimes the terms depletion, obsolescence, amortization, etc., are used inter-changeably with
Depreciation. But, these terms are used in different contexts. Therefore, let us understand the
distinction between Depreciation and such other related concepts.
(i) Depreciation and Depletion :The term ‘depletion’ is used in respect of the extraction of natural
resources like quarries, mines, etc., that reduces the availability of the quantity of material or
asset. Depreciation refers to a reduction in the value of all kinds of fixed assets arising from their
wear and tear.
(ii) Depreciation and Obsolescence: Obsolescence refers to decrease in usefulness caused on
account of the asset becoming out of date, old fashioned, etc. depreciation, as stated earlier, is
a loss in the value of an asset generally arising on account of wear and tear. So, obsolescence
is regarded as one of the causes of Depreciation.
(iii) Depreciation and Amortization: The distinction between Depreciation and Amortization is that
‘amortization’ refers to writing off of the proportionate value of the intangibles such as goodwill,
copyright, patents, etc., while ‘depreciation’ refers to the writing off of the expired cost of the
tangible assets like, machinery, building, furniture, etc.
CAUSES OF DEPRECIATION
The main causes of Depreciation are:
(i) Use of Assets: Constant use of asset leads to its wear and tear and thus falls in value.
(ii) Efflux of Time: Some assets have a definite life period like lease; on the expiry of the life, the
asset will cease to exist. Other assets, like plant and machinery may not have a definite life; in
their case the life is estimated.
(iii) Obsolescence: If a better machine comes in the market, old machines may have to be
scrapped even though they are capable of being used. It is a reduction in the usefulness of the
asset.
(iv) Accidents: Accidental loss may be permanent but is not continuing and gradual.
Of the above, only (i) and (ii) factors are considered relevant to Depreciation. Factors (iii) and
(iv) are considered only when that occurs; they do not happen to all assets. It should be noted
that when we talk of Depreciation, we think only of fixed assets.
ACCOUNTING CONCEPT OF DEPRECIATION

The Accounting Concept of Depreciation means to distribute the cost of fixed assets over its
estimated life in a reasonable manner. Accounting to this concept, in an accounting period,
diminution in the value of assets can be charged to that accounting period. Annual Depreciation in
the value of assets is like an expense which is due to use of assets in business functions and thus,
is a charge on profits. Therefore, this is an expense like other expenses. Its provision is not optional
but mandatory. If we do not deduct any expense from the income of an accounting period, the profit
and loss account will not show correct profit or loss. As Depreciation is also an expense which
refers to the cost of the use of fixed assets, it must be deducted from the incomes of that accounting
period. Therefore, there should be a regular provision for Annual depreciation.
OBJECTIVES OR NEED FOR PROVIDING DEPRECIATION

The above discussion shows that the need for providing a reasonable amount of Depreciation
over the useful life of an asset arises for the following purposes:
(i) To Ascertain the Correct profit or Loss: The first objective is to ascertain the correct profit or
loss. If Depreciation is ignored, the loss that is occurring (though not being paid for in cash) in
respect of fixed assets will be ignored. The loss will suddenly loom large when the asset
becomes useless or valueless. Looking at it from another point of view, when gods are produced
it involves use of fixed assets- the reduction in their value should be treated like another cost for
production of the goods. Depreciation should, therefore, be debited to the profit and loss
account before profit is ascertained.
(ii) To show a true and Fair View of the Financial Position: Depreciation, if not charged. would
result in assets being stated at a higher value. As a result of this the position statement (Balance
sheet) would not present a true and fair view of the financial position.
(iii) To show the Assets at its Proper Value: Another objective is to show the fixed assets in the
Balance sheet at their proper value. To continue to show them at cost, when their value has
fallen because of wear and tear will be improper – it will tantamount to painting a financial
picture better than it is. If Depreciation is not allowed, the Balance sheet would fail to show the
true financial position. Therefore, Depreciation must be accounted for in order to present the
assets at their proper value.
(iv) To Retain, out of profits, Funds for Replacement: The forth objective of Depreciation is to
retain, out of profit, funds for replacement of assets. The amounts debited in the profit and loss
account are retained in the business (no payment is made like other expenses). These are

available for replacement of the asset when its life is over. Funds would not be collected for this
purpose without accounting for depreciation.
(v) Compliance of Legal Provisions: It is necessary to charge Depreciation to comply with the
provisions of the companies Act and the income tax Act.
FACTORS OR BASIS OF PROVIDING DEPRECIATION

Factors for calculating the amount of Depreciation are:
(i) Original (Historical) Cost of the Asset: Cost will include all expenses incurred like freight and
installation charges up to the point the asset is ready for use.
Original Cost = Purchase price +Freight +Installation Cost
(ii) The Estimated Residual or Scrap Value at the End of its Life: Residual value is an estimated
sale value of the asset at the end of its economic life to the firm. Difference between the cost
and residual or scrap value is the amount written off over the useful life of the asset.
Amount to be Written off = Cost of Asset – Residual or scrap Value
(iii) Estimated effective or Commercial Life or the Legal Life Whichever is shorter: Physical life
is not important – an asset may still exist physically but may not be capable of producing goods
at a reasonable cost. If, for instance, assets can work for twenty years but is likely to lose its
commercial value within ten years, its life for the purpose of accounting should be considered as
only ten years.
Depreciation therefore, is provided each year so that the book value of the asset is reduced to its
estimated scrap value at the end of its useful life.
A student to do well should note the following:
1. If the rate of Depreciation is given with the words per annum (15% per annum) and
(a) the date of acquisition is given - Depreciation be charged only for the period for which the
asset is held.
(b) the date of acquisition is not given – Depreciation be charged for the full year and a note
explaining it be Given.
2. If the rate of Depreciation is given - Depreciation be charged for the full without the words
per annum, 15% year
METHODS OF RECORDING DEPRECIATION

In the books of account, Depreciation can be recorded by any of the two methods, (i) when
Depreciation is charged to the assets account; and (ii) when provision for Depreciation
/Accumulated Depreciation Account is created.
Let us discuss the two methods in detail.
When Depreciation is Charged to Assets Account: Under this method, Depreciation is directly
charged to the Asset Account; provision for Depreciation Account is not maintained. The
Depreciation Account is closed by transferring to the profit and Loss Account. In the Balance sheet
asset is shown at it’s written down value cost less Depreciation Provided to date). The original cost
of an asset and the total amount of Depreciation that has been provided (to date) cannot be
ascertained from the Balance Sheet when this method is followed. The journal entries for charging
Depreciation and transferring it to profit and Loss Account are:
1. Depreciation A/c Dr. [with the amount of Depreciation]
To Asset A/c
(being Depreciation on assets charged)
2. profit and loss A/c Dr. [for closing of Depreciation Account]
To Depreciation A/c
(being the Depreciation transferred to profit and Loss A/c)
When provision for Depreciation/Accumulated Depreciation Account is Created: Under this

method, provision for depreciation account is maintained.
Every year, Depreciation charged is credited to the provision for Depreciation Account. At the year-
end, in the Balance Sheet, the asset will continue to appear at the original cost and the total amount
of Depreciation provided will be shown in the provision for Depreciation Account. Thus, the original
coat of the asset and the total amount of Depreciation charged can be known from the Balance
sheet. For purposes of depiction, provision for Depreciation may be deducted from the cost of asset
and the balance is shown in the outer column. Alternatively, asset may be depicted at the original
cost on the asset side and provision for Depreciation may be depicted on the liabilities side. The
entries for Depreciation are:
1. Depreciation A/c …Dr. [With the amount of

Depreciation]

To provision for Depreciation A/c

(being the Depreciation on assets charged)
2. Profit and loss A/c …Dr. [For closing of Depreciation

Account]
To Depreciation A/c
(being the Depreciation transferred to profit and Loss A/c)
Let us take an example to understand how the asset account appears in the books of accounts and
how asset is depicted in the Balance sheet under the two methods:
Example: The cost of an asset is Rs. 1, 20,000. It is estimated to have a scrap value of Rs. 20,000
at the end of its useful life of 10 years. The asset was purchased on 1 st April, 2007. The firm closes
its accounts on 31st March, every year. The asset will be depicted in the Balance sheet as on 31 st
March, 2009 as follows:
First Method
BALANCE SHEET
As on 31st March, 2009
Liabilities Rs. Assets Rs.
Asset (note 2)
1,10,000 1,00,000
Less: Depreciation for 2008-09
10,000
ANNUAL Depreciation by straight Line Method

Note:
1. Under straight Line Method, an equal amount of Depreciation is charged every year during the
economic life of an asset so as to reduce the cost of asset to its residual value at the end of its
economic life.
2. Annual Depreciation as per Note 1 = Rs. 10,000 Depreciation charge for 2007 – 08 = Rs.
10,000. Book value of Asset as on 1st April, 2008 = Rs. 1, 20,000 – Rs. 10,000 = Rs. 1, 10,000.

Dr. ASSET ACCOUNT

Date Particulars Rs. Date Particular Rs.
2007 2008
April 1 To bank A//c 1,20,00 March 31 By Depreciation 10,000
0 March 31 A/c 1,10,000
By Balance C/d
2008 1,12,00 2009 1,20,000
April 1 To Bank A/c 0 March 31
March 31 By Depreciation
1,10,00 A/c 10,000
0 By Balance c/d 1,00,000
1,10,000
Second Method
BALANCE SHEET
As on 31 st March, 2009
Asset (Original Cost)
1,20,000 1,00,000
Less : provision for Depreciation
20,000
(Note2)
Notes: 1.

Dr. ASSET ACCOUNT Cr.

Date Particular Rs. Date Particulars Rs.
2007 2008
April 1 To Bank A/c 1,20,000 March 31 By Balance c/d 1,20,000
2008 2009
April 1 To Balance b/d 1,20,000 March 31 By Balance c/d 1,20,000
. Dr. PROVISION FOR DEPRECIATION ACCOUNT Cr

2008 2008
March 31 To Balance c/d 10,000 March 31 By Depreciation A/c 10,000
2009 2008
March 31 To Balance c/d 20,000 April 1 By Balance b/d 10,000
2009
March 31 By Depreciation A/c 10,000
20,000 20,000
IMPORTANT POINTS RELATING TO DEPRECIATION ON ADDITION TO FIX

TO FIXED ASSETS AND DEPRECIATION ON ASSET SOLD
 Depreciation on Addition to Fixed Assets

1. If the rate of Deprecation with the words ‘per annum’ is given (say 20% p.a.)And the date of
purchase of assets is given, Depreciation should be charged from the date of purchase to the
last date of accounting period.

2. If the rate of Depreciation without the words ‘per annum’ (say 20%) is given, Depreciation should
be charged for the full accounting period irrespective of the date of purchase of the asset.
3. when question specifically states that Depreciation is to be charged for full year, when an asset
is purchased, then Depreciation should be charged for the full year irrespective of the date of
purchase of the asset.
Depreciation on Assets sold

1. If an asset is sold Depreciation should be charged on the asset from the beginning of the
accounting period in which asset is sold to the date of the sale of asset.
2. If the question specifically stated states that full year’s Depreciation is to be charged when the
asset is sold, Depreciation should be charged for the full year on the asset sold.
3. If the question specifically states that Depreciation is to be ignored when the asset is sold,
Depreciation should not be charged on the asset sold for the year in which it is sold.
Difference between provision for Depreciation account is not maintained (Net Method) and
Provision for Depreciation Account is maintained (Gross Method)
Basis Net Method Gross Method

1. Assets shown in Balance Assets are shown at book value Assets always appear at
sheet minus Depreciation written off original cost minus total
during the year. Depreciation provided from
the date of purchase to the
date of Balance sheet.
2. Preparation of Asset account Asset Account is shown at book Asset Account always
value minus Depreciation written appears at original cost year
off during the year. after year.
3. Information No information about Information about original
accumulated Depreciation. cost of the asset and total
amount of Depreciation
(accumulated depreciation)
can be obtained from the
Balance sheet.

METHODS OF DEPRECIATION
The amount of Depreciation for the year is computed using various methods. But the two main
methods for computing Depreciation are:
1. Fixed percentage on Original Cost of Fixed Instilment of Straight Line Method; and
2. fixed percentage on Diminishing Balance or Reducing Instilment Method or Written – Down
Value Method.
1. Straight Line Method

Under this method, a suitable percentage of original cost of the asset is written off every year. It
means that the amount of Depreciation is uniform from year to year. Suppose, if an asset costs Rs.
20,000 and 10% Depreciation is thought proper, Rs. 2,000 would be written off every year. The
assumption in this cas3e is that the life is 10 year as that at the end of 10 years there will be no
scrap or residual value. In this method, the amount to be written off every year is arrived at as
under:
Important Note: It may also be expressed as a percentage of the original cost. If the life is 10
years, we may say that the Depreciation is 10% of the cost every year. Therefore, if the cost is Rs.
20000, the depreciation will be Rs 2000 per annum. In the first year the asset may have been used
for a part of the year in that case only a proportionate amount will be provided as Depreciation.
Suppose in the above case the asset is installed on 1st April and the accounts are closed on 31st
December for the year will be Rs. 1,500, i.e. Rs 2000×9/12
Merits of the straight line method the merits of the method are
(i) It is a simple methods of calculating Depreciation
(ii) In this method assets can be depreciated up to the estimated scrap value of zero value
(iii) In this method it is easy to know the amount of depreciation
(iv) Every year, the profit and loss Account is debited by the same amount of depreciations so there
is the same effect on the profit and loss account every year
Demerits of the straight line method Line method: Demerits of this method are:
(i) There is no arrangement of interest on capital invested in assets in this method.
(ii) With the passage of time, work efficiency of assets decrease and repair expenses increase. In
comparison to earlier years, in latter years, there are more loads on the profit and Loss Account.

(iii) Sometimes in this method, the book value of assets becomes zero; still the assets are used in
the business.
It is important to note that:
1. The amount of Depreciation is same every year.
2. if the rate of Depreciation is given, Depreciation is computed on the original cost.
3. if the asset is purchased in between the year, Depreciation is charged for the part of the year,
the asset is used.
Illustration 1. A firm bought machinery for Rs. 1, 80, 000 on 1 st January, 2008 and Rs. 20,000 is
spent on its installation. Its life was estimated to be 5years. Its estimated scrap value at the end of
the period was Rs. 10,000. Find out the amount of annual Depreciation and rate of Depreciation.
Solution:
Determination of the amount of Depreciation:
Illustration 2. Ram Bros. acquired a machine on 1 st July, 2006 at a cost of Rs. 1, 40,000 and spent
Rs. 10,000 on its installation. The firm writes off Depreciation at 10% of the original cost every year.
The books are closed on 31st December every year. Show the Machinery Account and Depreciation
Account for three years.
Solution:
Dr. MACHINERY ACCOUNT Cr.
2006 2006
July 1 To Bank A/c 1,40,000 Dec. 31 By Depreciation A/c 7,500
July 1 To Bank A/c – (Rs.
installation 10,000 Dec.31 1,50,000×10/100×6/12) 1,42,500
expenses 1,50,000 By Balance c/d 1,50,000
2007 2007
Jan. 1 1,42,500 Dec. 31 15,000
To Balance b/d Dec. 31 By depreciation A/c 1,27,500
1,42,500 By Balance c/d 1,42,500

2008 2008
Jan. 1 1,27,500 Dec. 31 15,000
To Balance b/d 1,27,500 Dec. 31 By Depreciation A/c 1,12,500
By Balance c/d
1,27,500
2009
Jan. 1 1,12,500
To Balance b/d
Dr. DEPRECIATION ACCOUNT Cr.

2006 2006
Dec. 31 To Machinery A/c 7,500 Dec. 31 By profit and Loss 7,500
A/c
2007 2007
Dee. 31 To Machinery A/c 15,000 Dec. 31 15,000
By profit and Loss
2008 2008 A/c
Dec. 31 To Machinery A/c Dec. 31 15,000
15,000
By profit and Loss
A/c
Note: First year (2006) Depreciation will be charged for 6 months since the machinery was
purchased on July 1, 2006.
Sale of an Asset: An asset may be sold before the end of its useful life due to obsolescence,
inadequacy, etc. the sale proceeds may not be equal to the written down value of the asset. If the
sale proceeds are a case of profit on sale of asset, on the contrary, if the sale proceeds are less
than the written down value of the asset on the date of sale, it is a case or loss on sale of the asset.
Profit or loss on sale of asset should be transferred to profit and Loss account.

As and when the asset is sold, the following entries are recorded:
1. on the date of sale of the asset:
Cash /Bank /Party’s A/c …Dr. [sale price]
To Asset A/c
(Being the asset sold)
2. Precision for Depreciation Account is transferred to the asset A/c because it is no
longer required to be
Carried. The entry is:
Provision for Depreciation A/c …Dr. [Amount of provision for depreciation
a/c]
To Asset a/c
(being the provision for depreciation transferred to Asset A/c)
Note: This entry will be passed when provision for Depreciation Account is
maintained.
3. If profit is earned on sale:
Asset A/c …Dr.
To profit and Loss A/c
(Being the profit on sale of asset transferred to profit and Loss A/c)
4. In case of loss:
Profit and Loss A/c …Dr.
To Asset A/c
(Being the loss on sale of asset transferred to profit and Loss A/c)
Illustration 3. A company purchased machinery for Rs. 20,000 on 1 st January, 2006. The
machinery is depreciated at 10% p.a. on the original cost. On 1st July, 2008, the machinery was sold
for Rs. 12,000

Solution:

2006 2006
Jan. 1 To Bank A/c 20,000 Dec. 31 By Depreciation A/c
-10% on Rs. 20,000 2,000
Dec. 31 By Balance c/d 18,000
20,000 20,000
2007 2007
Jan. 1 To Balance b/d 18,000 Dec. 31 By Depreciation A/c
-10% on Rs. 20,000 2,000
Dec. 31 By Balance c/d 16,000
18,000 18,000
2008 2008
Jan. 1 To Balance b/d July 1 By Depreciation A/c
16,000
-For 6 month
1,000
July 1 By Bank A/C
12,000
July 1 By profit and Loss A/C
- loss on sale of
3,000
Machinery
16,000 16,000
If a separate account is maintained for provision of Depreciation, the credit balance in the account
will be transferred to the credit side of the asset account. The balance in the asset account will then
indicate profit or loss on sale of asset; this will be transferred to the profit and Loss Account.

In this case, the solution to the previous illustration will be as follows:

2006 2006
Jan. 1 To Bank A/c 20,000 Dec. 31 By Balance c/d 20,000
20,000 20,000
2007 2007
Jan. 1 To Balance b/d 20,000 Dec. 31 By Balance c/d 20,000
20,000 20,000
2008 2008
20,000
Jan. 1 To Balance b/d July 1 By provision for Depreciation
5,000
July 1 By Bank A/c – sale
12,000
July 1 By profit and Loss A/c – Loss on
3,000
Sale of Machinery
20,000 20,000
PROVISION FOR DEPRECIATION ACCOUNT

2006 2006
Dec. 31 To Balance c/d 2,000 Dec. 31 By Depreciation A/c
2,000 (10%of Rs. 20,000) 2,000
2007 2007 2,000
Jan. 1 To Balance c/d 4,000 Jan. 1 By Balance b/d
4,000 Dec. 31 By Depreciation A/c

(10%of Rs. 20,000) 2,000
4,000

2008 2008
July 1 To Machinery A/c 5,000 Jan. 1 By Balance b/d 4,000
- Transferred Jan. 1 By Depreciation A/c
(10%of 20,000for 1,000
6month)
5,000 5,000
2. Written Down Value Method

Under this method, Depreciation is charged at a fixed trade on the reducing balance (cost less
Depreciation) every year. In other words, a fixed rate on the written down value of the asset is
charged as Depreciation every year over the expected useful life of the assets. A percentage known
as rate of Depreciation is applied to the book value and not to the cost of the asset.
Suppose, the cost of the asset is Rs20, 000 and the percentage to be written off each year are 10.
in the first year, the amount of Depreciation will be Rs. 2,000; this will reduce the book value to Rs.
18,000. Next year, the Depreciation amount will be Rs. 1,800, 10% of Rs. 18,000. Thus every year
the Depredation amount will go on reducing.
Rate of depreciation can be determined on the basis of cost, scrap value and useful life of the asset
as follows:
Merits of the written Down Value Method:

(i) There is same weight age on profit and loss Account of Depreciation and repair expenses.
(ii) Practically, this method is easier.
(iii) On the expansion and increase in assets, the Depreciation can be computed easily by this
method.
(iv) This method is accepted under the Income –tax Act.
Demerits of the written down value Method:
(i) In this method, the value of assets can never be zero.
(ii) It is a difficult task to ascertain the proper rate of Depreciation.
(iii) In this method also, there is no provision of interest on capital invested in use of assets.

Sale of an Asset: The procedure on sale of an asset is the same as has been discussed under (1)
above. The illustration or Ram Bros. (illustration 2) is worked out below following this method.

2006 2006
July 1 To Bank 1,40,000 Dec. 31 By Depreciation A/c 7,500
July 1 To Bank (installation 10,000 Dec. 31 By Balance c/d 1,42,500
Expenses ) 1,50,000 1,50,000
2007 2007
Jan. 1 1,42,500 Dec. 31 By Depreciation A/c 14,250
To Balance b/d Dec. 31 By Balance c/d 1,28,250
1,42,500 1,42,500
2008 2008
Jan. 1 Dec. 31 By Depreciation A/c
1,28,250 12,825
To Balance b/d Dec. 31 By Balance c/d
1,15,425
1,28,250
2009
1,28,250
Jan. 1
1,15,425
To Balance b/d
Continuing the example and assuming that the machinery was sold on March 31, 2009 at Rs.
95,000.


2009 2009
Jan. 1 To Balance b/d 1,15,425 March By Bank – sale 95,000
31 By Depreciation A/C
March (10% on Rs. 1,15,425 for 3
31 months ) 2,886
By profit and loss A/c 17,539

- loss on sale of Machinery
March (Balancing Figure )
31
1,15,425 1,15,425
Difference between straight line Method and written Down value Method
Basis Straight Line Method Written Down Value Method

1. Depreciation charge Depreciation is calculated on Depreciation is calculated on
the original cost of a fixed the diminishing balance or
asset. written down value of a fixed
asset.
2. Amount of Depreciation The amount of Depreciation The amount of Depreciation
remains the same for all years. reduces year after year.
3. Zero Balance At the expiry of the working life The balance in the asset
of the asset, the balance in the account will not reduce to zero.
asset account reduces to zero.
4. Cost of Depreciation and The combined cost on account The combined cost on account
Repairs of Depreciation and repairs is of depreciation and repairs
lower in the initial years and remains, more or less, equal
higher in the later years. throughout the period.
5. Suitability This method is more suitable This method is suitable for such
for assets which get assets which require more and

depreciated on account of more repairs in the later years

expiry of working life of the of their working life.
asset.
6. Calculation – Easy or It is easy to calculate the rate of It is difficult to calculate the rate
Difficult Depreciation. of depreciation.
PRACTICAL PROBLEMS
1. a). A Machine was acquired on 1st April , 2003 for Rs. 15,000. The cost of installation being
Rs. 1,000. It is expected that its scrap value at the end of its working life will be Rs. 2,000.
Write up the machine account for the first two years under diminishing balance method and
S.LM. Charging 10% depreciation. Assume that the financial year is followed.
b). Solomon purchases a machine for Rs. 1, 00, 000on 1 January, 2,000. Its Estimated useful
life is 5 years and Scrap Value Rs. 10,000. It is decided to write off Depreciation under
Straight Line Method. Pass necessary journal entries for five years and Open necessary
accounts in the ledger for the same period. The accounting period ends on 31 st March every
year
2. On 1st April, 2005, sohan Lal & sons purchased a plant coating Rs. 60,000. Additional plant was
purchased on 1st October, 2005 for 40,000 and on 1 st July, 2006, for Rs. 20,000. On 1 st January,
2007, one –third of the plant purchased on 1st April, 2005 was found to have become obsolete and
was sold for Rs. 6,000.
Prepare the plant Account for the first three years in the books of sohan Lal & sons. Depreciation is
charged @ 10%p.a. on straight Line method. Accounts are closed on 31st December each year.
Ans. Loss on Sale of Plant-Rs 10500, Balance as on 31.12.2007-Rs. 77000
3. The following balances appear in the book of x Ltd. As on 1 st April, 2001. Machinery Account =
Rs. 5, 00,000 Provision for Depreciation Rs. 2, 25,000
The machinery is depreciated at 10% p.a. on the fixed installment method. The accounting year
being
April – March. On 1st October, 2001 machinery which was purchased on 1 st July, 1998 for Rs. 1,
00,000 was sold for Rs. 42, 00 and on the same date a fresh machine was purchased for Rs. 2,

00,000 Prepare the Machinery account and provision for Depreciation Account for the year 2001-
2002[loss on sale of Machinery – Rs. 25,500, Balance of Machinery A/c – Rs. 6, 00,000]
Ans. Loss on Sale of Machinery-Rs 25500, Balance of Machinery A/c-Rs 600000.
4. On 1st October, 1999, the Sahara Transport company purchased a truck for Rs. 4, 00,000.
on 1st April, 2001, this truck was involved in an accident and was completely destroyed and Rs. 3,
00,000 were Received from the insurance company in full settlement. On the same date another
truck was purchased by the company for Rs. 5, 00,000. The company writes off 20% Depreciation
per annum on written down value Method and closes its books on 31 st December every year. Give
the Truck Account from 1999 to 2001 [Balance of Truck A/c – Rs. 4, 25,000; profit on sale of Truck
–Rs. 11,200]
Ans. Balance of Truck A/c Rs 425000, Profit on Sale of Truck Rs 11200
5. Sharma & co. whose books are closed on 31st December, 2005 purchased machinery for
Rs. 1, 50,000 on 1st January, 2005, and 2005: Additional machinery was acquired for Rs. 50,000 on
1st July, 2005. Certain machinery which was purchased for Rs. 50,000 on 1 st July, 2005 was sold for
Rs. 40,000 on 30th June, 2007. Prepare the Machinery account and accumulated Depreciation
Account for all the years up to the Year ending 31 st December, 2007. depreciation is charged 10%
p.a. on straight line method.
Also show the Machinery Disposable account.
Ans. Neither Profit nor loss on sale or machinery, Balance of Machinery A/c (Dec 31,2007) Rs
150000, Accumulated Depreciation A/c Rs 45000.

FINANCIAL STATEMENTS
Chapter (FINAL ACCOUNTS)
11 TRADING ACCOUNT, PROFIT AND
LOSS ACCOUNT AND BALANCE

SHEET
FINANCIAL STATEMENTS
Meaning
At the end of the financial year or at the end of the accounting period, financial statements are
prepared to know profit or loss and also the financial position of the business. These statements are
presented to users of accounting information for decision – making. A complete set of Financial
statements includes(i) a Balance Sheet, (ii) a Profit and Loss Account, and (iii) schedules and notes
forming part of balance sheet, and profit and loss account in many countries, Financial statements
also include a statement of changes in financial position (which may be presented as cash flow
statement or funds flow statement).
Financial statements are prepared from the Trial Balance drawn taking the ledger balance and cash
Book balances. The trial Balance testes the arithmetical accuracy of the entries effected. On being
satisfied by this, the owner or the business lids to know the ultimate results of operation the
business,
1. How much profit the business has earned in a particular period (generally one year)? Profit and
Loss Account (income statement) shows the financial position on a particular date.
2. What is the financial position of the business at the end of a particular period (generally one
year)? Balance Sheet (position Statement) shows the financial position on a particular date.
These two Financial Statements are the ‘Final Accounts’. They are the end product of Financial
Accounting.
CLASSIFICATION OF CAPITAL AND REVENUE ITEMS

We have discussed that a business prepares a profit and Loss Account to ascertain whether it has
earned profit or incurred loss and the Balance Sheet to know the financial position as at the end of a
period. Both are prepared on the basis of a Trial Balance which is a compendium of the final
position of all ledger accounts. There is a set rule that all the accounts appearing in the Trial
Balance are transferred either to the profit and Loss Account or to the Balance Sheet. Few
enterprises also prepare Trading Account in addition to profit and Loss Account which item of the
Trial Balance is transferred to the profit and Loss Account and which to the balance sheet depends
on whether it is a capital expenditure or a revenue expenditure. Revenue expenditure is transferred
to the Trading and profit and loss account and capital Expenditure to the Balance sheet under fixed
assets. We have to follow this basis while preparing the profit and loss account and the Balance
sheet. If we wrongly transfer an item of capital nature treating it as of revenue nature or vice versa,
then neither profit and loss account will reveal the correct profit or loss nor the Balance sheet will
reflect the true and fair financial position of the business. It is therefore, necessary to understand
and classify correctly whether an item appearing in the trial balance is of a capital or revenue
expenditure. Thereafter, the item should be transferred to the final accounts accordingly. There are
certain rules governing the classification of expenditure and receipt between capital and revenue.
Let us clearly understand these rules or basis.
CAPITAL EXPENDITURE
Capital Expenditure is the amount spent by an enterprise on purchase of fixed assets that are used
in the business to earn income and are not intended for resale. Fixed assets p9urchased may be
tangible or intangible.
Capital Expenditure yields benefit over a period extending beyond the accounting period. The
following types of expenditure are usually treated as Capital Expenditure:
(i) Expenditure which results in acquiring or bringing into existence an asset or advantage
or enduring benefit: An asset means anything which can be used for a long time, like a
building. All money spent in acquiring an asset is a part of capital Expenditure.
(ii) Expenditure in connection with the purchase, receipt or installation of fixed assets: All
expenses in addition to the purchase price incurred for making the asset ready for use are
added to the cost of the asset and thus are capital Expenditure. Expenses of this type are
wages paid to workers for erecting machinery, the cost of the platform on which the machinery

will be fixed, overhaul of second-hand machinery purchased, interest on the loan raised to
purchases a fixed asset, etc. it is to be noted that expenses incurred after the assets have been
put to use are not capital Expenditure.
(iii) Expenditure for the extension of or improvement in fixed asset: If because of any
expenditure the profit –earning capacity increases, through lowering costs or increasing
output, the expenditure will be a capital Expenditure.
(iv) Expenditure incurred to acquire the right to carry on business: The expenses necessary for
either establishing the business like preliminary expenses for floating a company or obtaining
license are capital Expenditure. Similarly, the cost of a patent, that is the right to produce certain
goods in a certain manner, are capital Expenditure – only the initial expenditure is capital;
renewal fee is revenue expenditure.
(v) Expenditure incurred to acquire a tangible asset: Even if the asset does not prove to be
profitable, the expenditure on it is a capital Expenditure.
(vi) Legal charges incurred: Legal expenses incurred in connection with acquiring or defending
suits for protection fixed assets, rights, etc., are also capital Expenditure. Capital Expenditure is
debited to a fixed account which appears in the Balance Sheet.
Revenue Expenditure: Revenue Expenditure is the amount spent on running a business. In short,
an expenditure which is not capital can be considered as Revenue Expenditure. The benefit of
Revenue Expenditure is exhausted in the accounting period in which it is incurred. Examples of
such expenses are:
(i) Expenses incurred in the day-to –day running of the business such as rent, salaries, wages,
power, fuel, etc.
(ii) Expenses incurred for upkeep of fixed assets.
(iii) Expenses incurred on purchase of stock of materials and goods to the extent that these are
used up during the year; the remaining amount will be an asset.
(iv) Depreciation or the expired cost of fixed assets.
We have discussed the basis for distinguishing capital Expenditure from Revenue Expenditure.
However, students should not think that the distinction is easy. Suppose, a cinema house converts
its ordinary screen into a cinemascope screen. Is the expenditure capital or revenue? Since, the
seating capacity has not increased; the expenditure should be treated as only Revenue
Expenditure. But now there is a greater chance for the house being full more often; profits will thus

increase and therefore the expenditure may be treated as capital Expenditure. In fact, there is truth
in both the views.
The under mentioned expenses appear to be revenue expenses but they are actually capital:
1. Expenses incurred on the repairs and whitewashing for the first time on the purchase of an old
building, since these expenses are necessary to make the building usable:
2. wages paid to workers to produce a tool to be used by the factory itself or to fix a machine;
3. Expenses incurred in connection with the purchase of land or buildings, such as fees paid to the
lawyer or registration expenses: and
4. Interest on loan rose to acquire an asset up to the point of time it is ready for use.
Having gone through the bases governing the classification of capital and revenue expenditures, let
us try to point out differences between the two in a more orderly manner.
Differences between capital Expenditure and Revenue expenditure

Basis Capital Expenditure Revenue Expenditure
1. Purpose It is incurred for acquisition of It is incurred for conduct of business.
fixed assets for use in business.
2. Capacity It increases the earning capacity It is incurred for earning profits.
of the business.
3. Period Its benefit extends to more than Its benefit extends to only one year.
one year.
4. Debited It is debited to an asset account. It is debited to an expense account.
5.Nature of It is a real account. It is a nominal account.
account
6. Depiction It is shown in the Balance sheet. It is part of the Trading or profit and Loss
Account.
7. Examples (a) Cost of plant and Machinery. (a) Depreciation on plant and Machinery.
(b) Cost of land and Building. (b) Rent.
(c) Cost of Furniture and fixtures. (c) Repairs, insurance.

Improper considerations in the Determination of capital Expenditure and Revenue

Expenditure
Whether any expenditure is capital or revenue should be determined only after considering the
nature of the expenditure. One should not be guided by some of the issues discussed above.
To know whether any expenditure is a Capital Expenditure or Revenue Expenditure, some issues
are immaterial. One should not rely on them. These are:
(i) An Amount of payment: Usually the amount involved in capital expenditure is grater than in
Revenue Expenditure. But it does not mean that if the amount is small, it is certainly a Revenue
Expenditure and if the amount is big it is certainly a capital Expenditure.
(ii) Payment – periodic or Lump – sum: Usually the payment of capital expenditure is made at a
time in lump-sum. For example, the purchase or land; while revenue expenditures are paid
periodically, such as, salary. Here again, it should not be concluded that if payment is made
repeatedly, it is a Revenue Expenditure only. It may also be possible that payment for an asset
purchased (which is a capital expenditure), be made in fixed installments.
(iii) Source of payment: Mostly the payment of Capital Expenditure is made out of the capital while
Revenue Expenditure is paid out of revenue receipt. But it should not be considered as a
general rule that expenses paid out of the capital are capital expenditures and ex0peses paid
out of revenue reci3epts are always Revenue Expenditure.
(iv) Its nature in the Hands of Recipient: To decide whether any expenditure is a capital Expenditure
or Revenue Expenditure, it is useless to see that the payment for the recipient is an item of
revenue or an item or expenditure. It may be quite possible that any item, which is an item of
revenue for the payee, is an item or capital for the payer. For example, for a sewing machine
manufacturer, the amount received from sale of sewing machine is a revenue receipt but for a
tailor, who purchases this machine, it is a capital expenditure.
Illustration 1. State whether the following items of expenditure are of capital or revenue natures:
(i) A second – hand car was purchased for a sum of Rs. 50,000. A sum of Rs. 10,000 was spent on
its overhauling.
(ii) Rs. 2,500 paid for the installation of a new machine.
(iii) Repairs for Rs. 5,000 necessitated by negligence.
(iv) Cost of annual taxes paid and the annual insurance premium paid on the car mentioned above.
(v) Cost of air conditioning of the office of the General Manager.

Solution:
(i) The total expenditure of Rs. 60,000 should be taken as a capital Expenditure. The sum of Rs.
50,000 was spent on a capital asset while another Rs. 10,000 was spent for making the capital
asset fit for use.
(ii) Cost of installation the new machine should be capitalized because the amount. Spent is up to
the point when the asset is ready for use.
(iii) Repair charges are Revenue Expenditure since it is for maintaining an asset and not for
improving the asset.
(iv) Annual taxes and annual premium, paid on the car are Revenue Expenditure because they do
not add to the value of the car and their benefit will be exhausted within the year.
(v) This is capital Expenditure because the benefit of this expenditure will be available for a number
of years.
Deferred Revenue Expenditure: It is that class of Revenue Expenditure which is incurred during
an accounting period but, the benefit arising out of it extends beyond that accounting period. Such
expenditure is unusually larger than the normal expenditure under the head. An example of this is
large expense; say on advertising a new product. The expenditure so incurred will certainly give
benefit in the periods beyond the accounting period in which the expenditure was incurred. It will
thus, be proper to spread the expenditure over a period and not charge the entire amount to the
profit and Loss Account for the year in which the expense is incurred.
It may be noted that the amount which has not been charged to the profit and loss account is shown
in the balance sheet as an asset.
Sometimes even a large loss, arising from an accident or other unforeseen circumstances, may be
spared over three or four years instead of being charged wholly against the revenues of the year in
which the loss is actually suffered. The loss of a building because of an earthquake may be treated
in the s manner. This type of loss is also treated as a deferred Revenue Expenditure.
A deferred Revenue Expenditure is a fictitious asset: Although it appears on the assets side of the
Balance Sheet, it is not really an asset to the business.
Illustration 2. State with reasons whether the following are capital or Revenue Expenditure:
(i) Custom duty paid on import of machinery.
(ii) Wages paid in connection with the erection of new machinery.

(iii) Rs. 5,000 spent on repainting the factory.

(iv) Repairs Rs. 2,000 necessitated by negligence of an operator of machine.
(v) Rs. 10,000 paid for electricity bill.
Solution:
(i) Custom duty paid on import of machinery should be treated as capitals Expenditure because it
is in connection with the acquisition of a new asset.
(ii) Wages paid in connection with the erection of new machinery should be treated as capital
expenditure because it is in correction with the acquisition of a now assets.
(iii) Rs. 5,000 spent on repainting the factory should be treated as a reserve Expenditure because it
has been incurred to maintain the factory building.
(iv) Repairs Rs. 2,000 necessitated by negligence of an operator of machine should be treated as
Revenue Expenditure since it is not going to improve the asset (machine) in any way.
(v) Rs. 10,000 paid for electricity bill should be treated as Revenue Expenditure because it is a part
of operating cost.
CAPITAL RECEIPTS AND REVENUE RECEIPTS

Receipts are the opposite of expenditure. Just like expenditure, a clear distinction between capital
receipts and revenue receipts is also necessary.
Capital Receipts: Capital Receipts are the amounts received in the form of additional capital
introduced in the business. Loans received, it increases the business liability. Hence, it cannot be
treated as revenue. Sale of any fixed asset reduces fixed assets hence, the amount received is not
revenue earned in the normal course of the business. In fact, capital Receipts do not affect the profit
or loss of the business. They either increase the liabilities or reduce the assets. Hence, these are
shown in the Balance sheet only.
Revenue Receipts: These are the amounts received in the normal and regular course of the
business mainly through sale of goods and services. An important feature of Revenue Receipts is
that the amount received does not need to be returned to any one. All such receipt is Revenue
Receipts and is treated as incomes. Hence, these are shown on the credit side of the profit and
Loss Account.

Distinction between capital Receipt and Revenue Receipt

Capital Receipts Revenue Receipts
1. It is the amount realized by sale of It is the amount realized by sale of goods or rendering of
fixed assets or by issue of shares or services.
debentures or by secured or unsecured
loans taken.
2. It is an item of balance sheet. It is an item of trading and profit and loss account
3. Capital Receipts are normally of non Revenue receipts are normally or recurring nature.
– recurring nature.
4. Capital receipts are receipts which Revenue receipts are obtained in the course of normal
are not obtained in course of normal trading operations.
business activities.
5. Capital receipts are normally not Revenue receipts net of revenue expenses and expired
available for payment as profit to the portion of capital expenditure/deferred revenue
owner or the business. expenditure are available for distribution to the owner or
the business.
FINAL ACCOUNTS
Final Accounts mean the Financial Statements prepared consequent to the drawing of Trial
Balance. Financial Statements include:
1. Trading and profit and Loss Account or income Statement; and
2. Balance Sheet.
INCOME STATEMENT
An income Statement is a summary of accounts that affects the profit or loss of an enterprise. Many
accounts shown in the trial balance relate to expenditure or income. These accounts either increase
or decrease the profit. Accounts that increase the profit are shown on one side while accounts that
decrease the profit, losses and expenses are shown on the other side. The statement so prepared
is known as an income statement.
An Income Statement has two parts, namely,
1. Trading Account: It reveals gross profit or gross loss, and
2. Profit and Loss Account: It reveals net profit or net loss.

Let us discuss these in detail.
TRADING ACCOUNT
Meaning
Trading Account is the first stage in the process of preparing final accounts. Trading Account shows
the gross profit or gross loss during an accounting year. Its main components are sales, services
rendered in the credit side and cost of such sales or services rendered in the debit side.
Fractures of Trading Account
1. It is the first stage in the preparation of final accounts of a trading concern.
2. It records only net sales and direct cost of goods sold.
3. The balance of this account discloses the gross profit or gross loss.
4. The balance of this account is transferred to the profit and Loss Account.
Purpose of the Trading Account

The Trading Account is prepared to know gross profit or gross loss during the accounting period.
This account is based on matching the selling price of goods and services with the cost of goods
sold and services rendered.
Contents of a Trading Account

Items shown on the Debit side of the Trading Account
1. Opening stock: refers to the Closing stock of the previous year, which has been entered in the
opening stock account through an opening entry. Therefore, it will be found in the Trial Balance.
This item is usually put as the first item on the debit side of the Trading Account. Of course, in
the first year of a business there will be no opening stock. In case or a trader, the opening stock
consists of different types of finished goods. For the manufacturing concern, the opening stock
consists of raw materials, work-in – process and finished goods.
2. Purchases and purchase Returns. The purchases account will show a debit balance, showing
the gross amount of purchases made of the materials. This refers to the goods purchased, both
cash and credit purchases, for resale. Remember, the purchases of assets which are meant for
permanent use in business such as machinery, furniture, etc., are not included in the purchases.
The purchase Returns Account will show a credit balance showing the returns of materials to the

suppliers. On the debit side of the trading account, the net amount is shown as indicated below
(with assumed figure):
To purchases 3, 00,000
Less: purchases Returns 10,000
2, 90,000
Besides the purchases returns, the following entries should also be deducted:
(a) Goods taken by the proprietor for his personal use.
(b) Goods given as charity
(c) Goods given by way of samples.
Let us discuss some issues relating to purchases for more clarity of the subject:
1. Drawing of material made by the owner are recorded in the books by debiting the drawings
Account and crediting the purchases Account
2. Goods received on consignment are recorded separately from purchases. They are not included
in the amount of purchases because these goods are not owned by the firm.
3. Purchases of plant, furniture, stationery, etc., are also recorded separately.
4. Sometimes it happens that some goods are purchased in the last days of the year and the firm
receives it but these are not recorded in the account books. In such a situation, before preparing
the Trading Account, such purchase is also recorded in the books. This amount is debited in the
purchases Account and credited in the Seller’s Account.
5. If goods purchased are in transit, it is necessary to record them too. This amount is debited to
‘Goods-in – Transient Account and credited to seller’s Account. In the Balance Sheet, ‘Goods –
in – Transit Account’ is shown on the assets side and seller’s Account on liabilities side. The
Trading Account remains unaffected by such type of purchases.
6. Adjusted purchases: When the business firms adjust their opening and closing stocks by
preparing purchases Account, the following entries are passed:
(a) For Adjustment of Opening Stock:
Purchases A/c …Dr.
To Opening Stock A/c
(b) For Adjustment of Closing Stock:

Closing Stock A/c …Dr.

To Purchases A/c
If these adjustments are made, there will be no opening stock in the Trial Balance. The amount in
the ‘Adjusted Purchases Account’ is shown on the debit side of the Trading Account and the amount
of closing stock on the assets side of the Balance Sheet.
Adjusted purchases = Net Purchases + opening stock – closing stock
3. Direct Expenses: Direct Expenses are those expenses which are incurred on the goods
purchased till they are brought to the place of business for sale. Examples of such expenses are
fright inward, insurance, customs (import) duty, clearing charges, octroi duty, cartage, etc. in a
manufacturing business, besides the above, expenses incurred for purposes of production such
as wages, power and fuel, factory rent, etc. are also Direct Expenses.
Let us discuss direct expenses individually.
(i) Carriage or Freight or Cartage Inwards: It is the cost of bringing materials to the firm’s go down
and making them available for use. If any freight or carriage is paid on any asset, like
machinery, it is added to the cost of the asset and not debited to the Trading Account.
(ii) Manufacturing wages: Wages paid to workers in the factory, including stores, are debited to the
Trading Account; if any amount is outstanding it must be brought into the books so that the full
wages for ht period are charged to the Trading Account. If any amount is spent on the making of
an asset, the amount is added to the cost of the asset; and debit to the Trading Account is
reduced to that extent.
But the difficulty arises when wages are clubbed with salaries (an indirect expense) and the Trial
Balance includes a single amount for ‘wages and salaries’. In such a situation it is assumed the at
the item includes the salaries of the supervisory staff in the factory itself. Therefore, the amount is
shown in the Trading Account. But, if the item in the Trial Balance is shown as ‘salaries and wages’,
it is shown in the profit and Loss Account. It is assumed that the item includes the wages of office
staff only.
(iii) power and Fuel: The cost of coal used in the boiler or electricity consumed in running the
machines is included under this head of accounts. Expenses incurred including not paid,
outstanding expenses are debited to the Trading Account.

(iv) Factory Lighting: Electricity consumed for providing light for running the factory is debited to the
Trading Account. If there is a common meter for the office and the factory, the total bill should be
appropriately divided between the two – only the portion relating to the factory is debited to the
Trading Account; the other portion will be debited to the profit and Loss Account
(v) Factory Rent and Rates: The rent paid for the factory premises as well as the municipal taxes
(which are called rates) or charged for water, etc., are debited to the Trading Account. If the
office and the factory are in the same premises, the total rent rates have to be suitably
apportioned
(vi) Duty on Purchases: Any duty paid in connection with the purchases of goods is debited to the
Trading Account.
(vii)Royalties are the payments which are made for acquiring the right to use patents. It is treated as
direct expenses if it is based on the number of unit produced.
(viii) Consumable stores: These are incurred to keep the machine in right condition and
include engine oil, cotton waste, soft soap, oil grease and waste, consumed in a factory.
Stores consumed during the year = opening Balance in stores + purchases of stores during the
year – closing Balance of Stores.
Items shown on the credit side of the trading account
1. Sales and sales Returns: The sales account always has a credit balance, indicating the total
sales made during the year. The sales returns account has always a debit balance, showing the
total of the amount of goods returned by customers.
The net of the two amounts is called ‘net sales’ and is entered on the credit side of the Trading
Account.
It must be understood that the sales Tax or Value Added Tax (VAT) charged is not a part of the
sales revenue. Sales Tax or VAT charged is to be deposited with Government. However, if sales
are inclusive of tax, the tax amount must be deducted from the sales amount.
2. Closing stock: Closing stock refers to the stock of unsold goods at the end of the current
accounting period. Usually there is no account to show the value of goods lying in the go down at
the end of the year. However, to correctly ascertain the gross profit, the Closing stock must be taken
and valued.
The following entry is recorded to incorporate the closing stock in the books:
Closing Stock A/c …Dr.

To Trading A/c
As a result the closing stock appears both on the credit side of the trading account and on the asset
side of the balance sheet.
Note: In this case the closing stock appears outside the Trial Balance.
It is also possible to pass the following entry:
Closing stock A/c ….Dr.
To Purchases A/c
The effect of this entry is to reduce the debit in the purchases Account; the stock account is then not
entered in the Trading Account. It will then appear in the Trial Balance and the closing stock will be
shown on the asset side of the Balance sheet. According to the convention of conservatism, stock is
valued at its cost or its market price, net realizable value, Whichever is lower?
Let us take an example. Suppose, an article worth Rs. 100 is purchased. If this article is not sold out
up to the end of the year, its value will be taken as Rs. 100 at the time of valuation of the closing
stock, notwithstanding the fact that its sales prove is more than Rs. 100 at the end of the year. But if
at that time the sales price of this article is Rs. 95 only, in such a situation, its value will be taken as
Rs. 95 only. But remember, dead articles are not included in the closing stock.
In case of a trading business. The closing stock consists of different types of finished goods. In case
of a manufacturing concern, the closing stock consists of raw materials, work-in – progress and
finished goods.
Closing stock means only raw material or unsold finished goods or those things which are traded by
the firm. Therefore, the balances of items like stationery and other sundry goods of office use are
not included in the closing stock but are shown separately.
Balancing of Trading Account

Gross profit or Gross Loss: After recording the above items in the respective sides of the Trading
Account. The balance is calculated to ascertain gross Profit or Gross Loss. If the total of the credit
side is more than that of the debit side, the excess is gross profit.
If the total of the debit side is more than that of the credit side, the excess is Gross Loss. Gross
profit is transferred to the credit side of the profit and Loss Account and Gross Loss is transferred to
the debit side of the profit and Loss Account.

Closing Entries for Trading Account

Preparation of a trading Account requires recording entries to transfer the balances of accounts of
all the concerned items to the Trading Account. These entries are called closing Entries as after
recording the entries these accounts are closed. The following closing Entries are passed to give
effect of such transfer of balances:
(i) For the items of Debit Side:

Trading A/c Dr.
To opening stock A/c
To purchases A/c
To Direct Expenses A/c
(ii) For the item of credit side:

Sales A/c Dr.
Closing stock A/c Dr.
To Trading A/c
(iii) For Gross Profit :

Trading A/c Dr.
(iv) For Gross Loss:

Profit and Loss A/c Dr.
To Trading A/c
Format of a Trading Account

A general format of a Trading Account is given below:
Particulars Rs. Particulars Rs.

To opening stock … By sales

To purchases … Less: Return inwards
Less: Return outwards … … …
… … By closing stock ….
To Direct Expenses … By Abnormal Loss of stock …
To Wages and salaries … By *Gross Loss transferred to
To Freight inwards … P&L A/c
To Carriage inwards …
To Cartage inwards …
To * Gross profit transferred to
P&L A/c
illustration 3. Prepare a trading Account for the year ending March 31, 2008 from the
following balances as at March 31, 2009:
Rs.
st
Stock (1 April, 2008) 10,000
Wages 5,000
Sales (inclusive of sales Tax) 1, 70,000
Return outwards 8,000
Freight 500
Purchases 1, 00,000
Carriage inwards 1,000
Return inwards 5,000
Sales Tax paid 15,000
Octroi Duty 2,500
Closing stock as on March 31, 2009 was valued at Rs. 20,000.
Solution:
TRADING ACCOUNT
For the year ending March 31, 2009


To opening stock 10,000 By sales A/c
To purchases A/c 1,00,000 1,70,000
Less: Return outwards 8,000 92,000 Less : sales Tax
To wages 5,000 15,000 1,50,000
To carriage inwards 1,000 1,55,20
To freight 500 0 20,000
To octroi Duty 2,500 Less: Return inwards
To profit and Loss A/c (Gross profit) 59,000 5,000
By closing stock
1,70,000 1,70,000
JOURNAL
Date Particulars L.F. Dr. (Rs.) Cr. (Rs.)
2009
March 31 Trading A/c Dr. 1,24,000
To opening stock A/c 10,000
To purchases A/c 1,00,000
To Return inwards A/c 5,000
To wages A/c 5,000
To carriage inwards A/c 1,000
To Freight A/c 500
To octroi Duty A/c 2,500
(Being transfer of accounts to the debit side of
the Trading account)
March 31 Sales A/c Dr. 15,000
To sales Tax A/c 15,000
(Being transfer of sales tax paid to the sales
Account ) 1,55,000

March 31 Sales A/c Dr. 8,000

Return outwards A/c Dr. 1,63,000
To Trading A/c
(being transfer of sales (net of sales tax) and
purchases return to trading account) 20,000
March 31 Closing stock A/c Dr. 20,000
To Trading A/c
(Being recording of closing stock ) 59,000
March 31 Trading A/c Dr. 59,000
(Being transfer of gross profit to the profit and
Loss Account)
Illustration 3. Prepare a Trading Account for the year ending March 31, 2009 from the following
balances as at March 31, 2009:
Rs.
Stock (April 1,2008) 10,000
Sales 2,00,000
Purchases 2,00,000
Carriage Inwards 1,500
Freight Inwards 2,500
Sales Returns 5,000
Clearing Charges 11,000
Purchases Returns 2,500
Carriage Outwards 3,000
The closing stock of goods as at March 31, 2009 is Rs. 20,000.

Solution:
TRADING ACCOUNT
For the year ending march 31, 2009
To opening stock 10,000 By sales A/c 2,00,000
To purchases A/c 2,00,000 Less: Returns 5,000 1,95,000
Less: Returns 2,500 1,97,500 By closing stock 20,000
To carriage inwards 1,500 By Gross Loss
To freight inwards 2,500 transferred to profit and 7,500
To clearing charges 11,000 Loss A/c
2,22,500 2,22,500
Point to Remember
1. Trading Account shows gross profit or Gross Loss.
2. Gross profit can be presented in the form of an equation as follows:
Gross profit = Net sales – cost of Goods sold
Where (i) net sales = cost of Goods sold
(ii) Cost of goods sold = opening stock + Net Purchases +Direct
Expenses – Closing Stock
(iii) Net purchases = Total purchases – purchases Returns.
Gross profit is usually ascertained by preparing Trading Account.
3. Carriage inwards is debited to the Trading Account and Carriage Outwards to the
profit and Loss Account.
4. Return inwards are deducted from sales whereas Return Outwards Are deducted
from the purchases in the Trading account.

PROFIT AND LOSS ACCOUNT

Meaning
The next step after preparing the Trading Account, is preparing the profit and Loss Account. Profit
and Loss Account is prepared to calculate the net profit or net loss of the business for a given
accounting period.
“A profit and Loss Account is an account into which all gains and losses are collected in order to
ascertain the excess of gains over the losses or vice versa.” – prof. carter
The profit and Loss Account starts with the credit from the Trading Account in respect of gross profit
(or debit if there is gross loss). Thereafter, all indirect expenses and loosed are debited to the profit
and Loss Account. It means all those expenses or incomes which have not been debited or credited
to the Trading Account are debited or credited in the profit and loss account. Indirect expenses
include all administrative, selling and distribution expenses such as salaries, rent and taxes,,
postage, and stationery, insurance, depreciation, interest paid, office lighting, advertising, packing,
carriage outwards, etc. losses include items like loss by fire, loss by theft, etc. if there is any income
and gain beside the gross profit, it will also be transferred to the credit of the profit and loss account.
The difference of the two sides of this account is either net profit and loss account. The difference of
the two sides of this account is either net profit and loses. If the total of the credit side exceeds the
total of the debit side, the difference represents the net profit. In a reverse situation, the difference
will represent net loss. This difference (net profit or net loss) is transferred to the capital account of
the proprietors. Net profit increases the capital or net loss decreases the capital.
Features of profit and loss account

1. It is the second stage in the preparation of the final accounts.
2. It related to a particular accounting period and is prepared at the end of that period.
3. Accrual basis of accounting is followed in the preparation of this account.
4. This account is credited with the gross profit and income from other sourced and debited with
indirect expenses and losses.
5. The balance of this account is the net profit or net loss.
6. The capital of the owner is increased or decreased by the balance of this account (Net profit or
Net Loss)
Form of profit and Loss Account

Look at the following form. It shows various expenses, losses, incomes, etc., which usually appear
in the profit and Loss Account:

For the year ending on….
Particular Rs. Particulars Rs.

To Gross Loss transferred … By Gross Profit transferred form

From Trading A/c Trading A/c
To salaries … By Rent …
To Rent, rates and Taxes … By Discount Received …
To Stationery and printing … By Commission Earned …
To postage and Telegrams … By Interest …
To Audit Fees … By Bad Debts Recovered …
To Legal Charges … By Income form Investment …
To Telephone Expenses … By Dividends on shares …
To insurance Premium … By miscellaneous Revenue Gains …
To Business Promotion … By income from any other source …
Expenses … By Nit Loss (transferred to Capital …
To Repairs and Renewals … A/c)
To Depreciation …
To Interest …
To sundry Trade Expenses …
To conveyance …
To Charity …
To Bank Charges …
To Office Expenses …
To Establishment Expenses …
To General Expenses …
To Loss in Exchange …
To License Fee …
To Brokerage …
To Car Running and …
Maintenance …
To office Lighting …
To Loss by Fire, Theft …
To Commission …
To Advertisement …
To Freight and Carriage …
Outward …

To Distribution Expenses
To Bad Debts
To Net profit transferred to
Capital A/c
Need: The need for preparing a profit and Loss account can briefly be summed up as under:
(i) To Ascertain Net Profit or Net Loss: The profit and Loss Account provides information about the
net profit or net loss earned or suffered by the business during the accounting period.
(ii) Comparison with the previous year’s profit: The profit amount ascertained by the profit and Loss
Account for the accounting period can be compared with that of the previous year’s profit. It
helps in ascertaining whether the business is being conducted efficiently or not.
(iii) Control over Expenses: An analysis of the various expenses included in the profit and Loss
Account and their comparison with the expenses of the previous period helps in taking steps for
effective control over the expenses.
Items of profit and Loss Account
Accounting to present day thinking, it is desirable that the profit and Loss Account should be
prepared in such a manner as to enable the reader to form a correct view about the profit earned or
loss suffered by the firm during the period together with other significant factors.
Expenses and losses shown on the debit side of the profit and Loss Account can be classified as
follows:
(i) Administration and office Management Expenses: Administration expenses include the
following:
(i) Establishment Expenses or Charges; (ii) Office salaries; (iii) office Rent and Rates; (iv) Lighting;
(v) printing and stationery; (vi) postage and Telephone charges; (vii) Legal Expenses; (viii) Audit
Fee and (ix) General or Trade Expenses.
(ii) Selling and Distribution Expenses: These will comprise the following:
(i) salesman’s salaries and Commission; (ii) commission of Agents; (iii) Advertising; (iv)
warehousing Expenses; (v) packing Expenses; (vi) Freight and carriage on sales; (vii) Export
Duties; (viii) Maintenance of Vehicles for distribution of goods and their running expenses; (ix)
insurance of Finished Goods, stock and goods in Transit and (x) Bad Debts.
(iii) Financial Expenses: These are those expenses which are incurred in respect of arranging
finance for business. Financial Expenses include the following expenses:

(i) Interest on Loan; (ii) Interest on Capital and (iii) Discount Allowed.
(iv)Abnormal Losses: Abnormal Loss such as stock loss by fire not covered by insurance, loss on
sale of fixed assets, loss by theft, cash defalcation, etc., may occur during the accounting period.
Abnormal Losses are treated as extraordinary expenses and debited and shown separately in the
profit and Loss Account.
Following expensed of not appear in the profit and Loss Account:

1. Domestic expenses o the proprietor or partners as they are personal expenses.
2. Drawing in the form of cash, goods by the proprietor or partner.
3. Personal income tax as life insurance premium paid by the firm on behalf of the proprietor or
partners. If income tax appears in the Trial Balance of a sole proprietorship concern, it is treated
as drawings and deducted from capital.
Income and items of profit which are shown on the credit side of profit and loss account can be
divided into the following groups:
(i) Income from Main Business: These refer to those profits and incomes which are received from
the operations of the main business. This includes the following types of profits and incomes:
(i) Gross profit, (ii) profit on Consignment, (iii) profit on joint venture, and (iv) commission
Receivable, etc.
(ii) Financial and other incidental income: Income received from other sources except the main
function of the business comes under this category. These include:
(i) Interest on Fixed Deposits, (ii) Income from Investment, (iii) Rent Received, (iv) Interest on
Drawings, and (v) Discount Received.
Balances of the profit and Loss Account

Net profit or Net Loss: The balance in the profit and Loss Account represents the net profit or net
loss. If the credit side is more than the debit side, it shows net profit. If the debit side is more than
the credit side, it shows net loss. Both (Net Profit or Net Loss) are transferred to the capital Account
Difference between Trading Account and Profit and Loss Account

Basis Trading Account Profit and Loss Account

1. Relation Trading account is a part of profit Profit and loss account is the main
and Loss account. account.
2. Nature The gross profit or gross loss is The profit and loss account is
ascertained form the trading prepared to ascertain the net profit
account. or nit loss or the business.
3. Transfer of Balance The balance of the trading The balance of the profit and loss
account is transferred to the profit account is transferred to the
and loss account. capital account of the proprietor.
4. Items Items shown in the trading Items like indirect expenses
account are purchases, sales, related to sales, distribution,
stock, direct expenses, etc. admin8istration, finance, etc., are
shown in the profit and loss
account.
Explanation Regarding certain items of profit and Loss Account

1. Salary: Salary is an indirect expense. The combined salaries and wages Account is also treated
as an indirect expense and, therefore, it is transferred to the profit and Loss Account. As profited
out earlier, a combined wages and salaries account is treated as a direct expense and
transferred to the Trading Account.
2. Depreciation : Depreciation is a decrease in the value of an asset due to wear and tear, use or
lapse of time, it is treated as business expense and is charged to the profit and Loss Account
3. Discount: Discount Allowed account and Discount Received Account should be shown
separately on the debit side and credit side of the profit and Loss Account respectively.
4. Loss by fire: Loss of goods by fire is a loss to the business. It is debited to the profit and Loss
Account.
5. Insurance: generally, assets are insured to cover the risk of loss. Insurance premium is treated
as a business expense and debited to the profit and loss account.
6. Bad Debts and Bad Debts Recovered: When a customer does not pay the is a loss to the
firm. Therefore, the Bad Debts Account is debited, which later on is written on the debit side in
the profit and Loss Account.

If later the amount is recovered, it is traded as a gain; it is not credited to the party paying it; it is
credited to Bad Debts Recovered Account. It is written on the credit side in the profit and Loss
Account
Closing Entries in respect of the profit and Loss account: Entries that are to be recorded in the
journal for preparing the Trading and Profit and Loss Account, that is, for transferring the various
accounts to these two accounts, are known as closing Entries. To complete the profit and Loss
Account, the under – mentioned three Closing Entries are necessary:
(a) For items to be debited to the Profit and Loss Account this account is debited and the
various accounts concerned are credited. For example, salaries account, rent account, interest
Account are closed by transferring their balances to the debit side of profit and Loss Account. The
entry is:
Profit and Loss A/c Dr.
To Salaries A/c
To Rent A/c
To interest A/c
(b) Items of income or gain such as interest Received Account, Miscellaneous Income Account
are closed by transferring their balances to the credit side of the profit and Loss Account. The entry
passed is :
Interest Received A/c Dr.
Miscellaneous Income A/c Dr.
To Profit and Loss A/c
(c) At this stage the profit and Loss Account shows net profit or net loss. Both are transferred to
the capital Account. In case of net profit, when the credit side id bigger than the debit side, the
entry is:
Capital A/c Dr.
To profit and loss A/c

C. wanchoo
TRADING ACCOUNT
For the year ended March 31, 2009
Particular Rs. Particular Rs.
To stock 2,000 By sales 50,000
To purchases 15,000 By closing stock 2,700
To wages 10,000
To Fuel and power 3,000
To Factory Lighting 200
To Gross Profit transferred to
profit and Loss A/c 22,500
52,500 52,500

To salaries 7,000 By Gross profit
To Discount Allowed 500 transferred from Trading
To Advertising 5,000 A/c 22,500
To Sundry office expenses 4,000 By Discount Received 300
To Net profit transferred to capital 6,000
A/c
22,800 22,800

Illustration 3. From the following information prepare the profit and Loss Account of a sole
proprietor for the year ended March 31, 2009:
Rs.
Gross Profit 2,00,000
Salaries and Wages 10,000
Commission Allowed 5,000
Commission Received 2,500
Interest paid 3,500
Interest Received 2,000
Freight Outwards 750
Discount Allowed 250
Discount Received 1,250
Dividend Received 1,900
Rent Paid 3,000
Rent Received 8,000
Bad Debts Recovered 6,000
Brokerage Paid 1,500
General Expenses paid 9,000
Miscellaneous Incomes 7,000
Depreciation on Machines 6,000
Postage and Telegrams 4,000


To Salaries and Wages 10,000 By Gross Profit 2,00,000
To Commission Allowed 5,000 By Commission
To Interest Paid 3,500 Received 2,500
To Carriage Outwards 1,250 By Interest Received 2,000
To Freight Outwards 750 By Discount Received 1,250
To Discount Allowed 250 By Dividend Received 1,900
To Rent Paid 3,000 By Rent Received 8,000
To Brokerage paid 1,500 By Bad Debts Recovered 6,000
To General Expenses 9,000 By Miscellaneous
To Depreciation on Machines 6,000 incomes 7,000
To postage and Telegrams 4,000
To Net profit transferred to 1,84,400
Capital A/c
2,28,650 2,28,650
Points to Remember
1. Salaries: Salaries are paid for the services of the employees and
are debited to the profit and Loss Account being an indirect
expense. Direct salaries, salary of the factory manger, salary of the
purchase manager, foreman, are of course debited to the Trading
Account
2. Salaries and wages: when wages are included in salaries, shown
in the salaries and wages account, they are treated indirect expenses
and are taken to the profit and Loss Account. On the other hand,
wages and salaries are treated as direct expenses and debited to the
Trading Account

Illustration 4. From the following information of a trader prepare his profit and Loss Account for the
year ended March. 31, 2009:
Particulars Rs. particulars Rs.
Gross Profit 2,26,500 Salaries and wages 12,000
Discount Received 17,000 Discount Allowed 3,000
Commission Received 7,000 Interest Received 2,000
Fire insurance Paid 6,000 Commission paid to salesman 14,000
Interest Paid 5,000 Freight outwards 15,000
Rent Paid 14,000 Rent Received 12,500
Printing and Stationary 7,500 Entertainment Expenses 8,000
Postage and Telegram 5,500 Sales Promotion Expenses 4,250
Bad Debts 3,250 Audit Fees 8,500
Depreciation on Machines 5,000 Miscellaneous income 12,900
Carriage Outwards 4,100 Repairs and Maintenance 3,400
Traveling expenses 6,500 Water and Electricity Charges 3,000
Packing expenses 10,500 (Office)
Bank charges 1,900 Telephone Expenses 6,000
Loss by Fire 3,500 Gain on sales of Machine 600
Loss on sale of Furniture 4,000 Income from Investments 11,500
Dividend Received on 6,250 Loss by Theft 1,000
shares Legal Expenses 11,250
Advertising and publicity 9,000
Expenses
Solution:


To Salaries and wages 12,000 By Gross Profit 2,62,500
To Discount Allowed 3,000 By Discount Received 17,000
To Commission paid 14,000 By Interest Received 2,000
To Fire insurance 6,000 By Commission Received 7,000
To Interest paid 5,000 By Rent Received 12,500
To Fright Outwards 15,000 By Miscellaneous Income 12,900
To Printing and Stationery 7,500 By Gain on sale of Machine 600
To Rent Paid 14,000 By Income from investments 11,500
To Entertainment Expenses 8,000 By Dividend Received on shares 6,250
To Postage and Telegrams 5,500
To sales promotion expenses 4,250
To Bad Debts 3,250
To Audit Fees 8,500
To Depreciation on Machines 5,000
To carriage outwards 4,100
To Repairs and Maintenance 3,400
To Traveling Expenses 6,500
To water and Electricity charges
(office) 3,000
To Packing Expenses 10,500
To Telephone Expenses 6,000
To Bank Charges 1,900
To Loss by Fire 3,500
To Loss by Theft 1,000
To Loss on sale of Furniture 4,000
To Legal Expenses 11,250
To Advertising and Publicity
Expenses 9,000
To Net profit transferred to capital
Account 1,57,100

Distinction between Gross Profit and Net profit

Gross profit Net profit
1. Gross profit = sales – cost of Goods sold Net profit = Gross Profit + All other incomes –
indirect Expenses and Losses
2. It is ascertained from the Trading Account. It is ascertained from the Profit and Loss
Account.
3. Gross profit is transferred to profit and Loss Net profit is transferred to the Capital Account.
Account
4. It does not include any income from other It may include income from other sourced.
sources.
5. It does not depend on the amount of net profit. It depends on the amount of gross profit.
6. Amount of Gross profit depends on the Amount of Net Profit depends on the valuation
valuation of stock. Increase in the value of stock of assets other than stock. For example,
will increase the gross profit. Similarly, reduction provision for doubtful debts, depreciation, etc.
in the value of closing stock will reduce the gross
profit.
OPERATING PROFIT AND NET PROFIT

Profit may be divided into two, (i) Operating Profit and (ii) Net Profit
Operating Profit is the excess of gross profit over operating expenses. Gross profit is the excess of
net sales revenue over cost of goods sold. Operating expenses includes office and administrative
expenses, selling and distribution expenses, cash discount allowed, interest on bills payable and
other short-term debts, bad debts and so on.
Net sales mean cash sales +credit sales – sales return.
Operating Profit = Net Sales – Operating Cost
= Net Sales – (Cost of Goods Sold + Administration and office Expenses + Selling
and Distribution
Expenses) Or

Operating Profit = Net Profit +Non-Operating Expenses – Non-Operating Income

Net Profit mean the excess of revenue (whether operating or non – operating) over expenses and
losses (whether operating or non-operating).In other word, net profit is arrived by deducting
operating expenses from operating profit as well as non-operating profit. Expenses which are
incidental or indirect to the main operations of the business are called Non – Operating Expenses.
They include interest on loan, charities and donations, loss on sale of fixed assets, extraordinary
losses due to theft, and loss by fire and so on. Similarly, non-operating incomes are added while
computing the net profit. Non-operating incomes include, receipt of interest, rent, dividend, profit on
sale of fixed assets, etc.
Illustration 5. Compute Operating profit and Net Profit from the following particulars:
Rs. Rs.
Gross Profit 4,40,000 Interest on Loan 22,000
Carriage Outwards 4,800 Interest on Investments 2,800
Advertising 12,000 Printing and stationary 3,600
Salaries 1,78,000 Loss on sale of Furniture 35,000
Rent and Taxes 62,000 General Expenses 1,400
Lighting 15,000 Donation 5,100
Insurance charges 2,400 Rent Received 6,000
Bad Debts 1,500 Loss by Fire 20,000
Audit Fees 2,000 Gain on sale of Machine 50,000

Gross profit
Less : selling and Distribution Expenses:
Advertising 12,000
Bad Debts 1,500 18,300
Less: Office and Administrative Expenses:
Salaries 1,78,000
Rent and Taxes 62,000
Lighting 15,000
Insurance Charges 2,400
Audit Fees 2,000
Printing and Stationery 3,600
General Expenses 1,400 2,64,400 2,82,700
Operating Profit 1,57,300
add: non – operating incomes:
Interest on Investments 2,800
Rent Received 6,000
Gain on sale of Machine 50,000 58,800
2,16,100
Less: Non – Operating incomes:
Interest on Loans 22,000
Loss on Sale of Furniture 35,000
Donation 5,100
Loss by Fire 20,000 82,100
Net profit 1,34,000
Solution:
BALANCE SHEET

The next step after preparing the Trading and profit and Loss Account is preparing the Balance
Sheet. A Balance Sheet is prepared from the Real Accounts and Personal Accounts. The
Balance Sheet may be defined as “A statement which sets out the assets and liabilities of a firm or
an institution as at a certain date.” In the words of Francis R. Stead, “A Balance Sheet is a screen
picture of the financial position of a going business at a certain moment.” It is a statement which
reports the property owned by the enterprise and the clams of the creditors and owners against
these properties. It shows the status of the business as at a given moment of time, in so far as
accounting figures can show its status.
The purpose of preparing the Balance sheet is to ascertain the financial position of a business, to
know what the business owes and what it owns on a certain date. This is why the Balance Sheet
has the heading: Balance sheet as at… as against the heading of Trading Account and Profit and
Loss Account which usually is for a year. Since even a single transaction will make a difference to
some of the assets or liabilities, the Balance Sheet is true only at a particular point of time. That is
the significance of the words ‘as at’.
Need: A Balance Sheet is prepared with a view to measure the true financial position of a business
at a particular point of time. It is a device to show the financial position of a business in a systematic
and standard form. It is a screen picture of the financial position of the business. Through it the
position of the business, at a particular point of time, can be understood at a glance. Just as a
doctor will feel the pulse of a person and know whether he is enjoying good health or not, in the
same manner by looking at the Balance sheet one can know whether the firm is solvent or not. If the
assets exceed liabilities it is solvent; in the other case, it would be insolvent. It may serve as the
basis for determining purchase consideration of the business.
The debit and credit balance of those Ledger accounts not close by transfer to the Trading and
Profit and Loss Account are shown in the Balance Sheet. The debit balances are shown on the
‘Assets’ side and credit balances are shown on the ‘liabilities’ side. It will be observed that the
undetermantioned account have not been closed even after preparation of the profit and Loss
Account and the transfer of the net profit to the Capital Account
Cash in Hand 440 Debit Balance
Cash at Bank 1,000 Debit Balance
Capital A/c (opening Balance Rs. 10,000+Net Profit Rs. 6,300) 16,300 Credit Balance
Machinery A/c 6,000 Debit Balance
Furniture and Fittings A/c 1,360 Debit Balance

Sundry Debtors 8,500 Debit Balance

Sundry Creditors 3,700 Credit Balance
Stock A/c 2,700 Debit Balance
Looking at these accounts, one would know the various assets – cash in hand, cash at bank,
furniture, etc. – that the firm possesses and the amount that are owing as liability- to sundry
creditors – and to the proprietor as capital. The capital, of course, will be the difference between the
total of the assets and liabilities. In other words, the total of assets should always be equal to the
total of the liabilities. You have already learnt this equality as ‘accounting equation’. The assets and
liabilities and capital are usually presented in a statement called the Balance sheet. This is given
below for the accounts mentioned above.
BALANCE SHEET
As at March 31, 2009
Sundry Creditors 3,700 Cash in Hand 440
Capital 16,300 Cash at Bank 1,000
Sundry Debtors 8,500
Stock 2,700
Furniture and Fittings 1,360
Machinery 6,000
20,000 20,000
The assets are shown on the right – hand side and the liabilities and capital on the left – hand side.
Form of Balance sheet: The usual items found in the Balance sheet of a firm are given below:
BALANCE SHEET OF …

As at….
Sundry or Trade Creditors Cash in Hand including petty …
Bills Payable … Cash …
Bank Overdraft … Cash at Bank …
Employees provident Fund … Bills Receivable …
Loans (cr.) … Sundry Debtors / Book debts …
Mortgage … Loans (Dr.) …
Reserves or Reserve fund … Closing stock …
Capital Loose Tools …
… Investments …
Add: Interest on Capital … Furniture and Fitting …
Net profit … Plant and Machinery …
Lend and Buildings …
… Freehold/Leasehold Land …
Less: Drawings … Business Premises …
Income Tax … Patents and Trade Marks, etc. …
Interest on Drawings … goodwill
Net Loss …
Characteristics
The Balance Sheet has certain characteristics which should be noted. These are:
(i) It is prepared at a particular date and not for a particular period.
(ii) It is prepared after the preparation of the Profit and Loss Account; this is the reason why the
profit and Loss Account (including the Trading Account) and the Balance Sheet are together called
the Final Account.
(iii) It shows the financial position of a business as a going concern.
(iv) The Balance Sheet is not an account but only a statement of assets and liabilities. On the left-
hand side, the liabilities of the business are shown whereas on the right- hand side the assets of the
business appear.

(v) The total of the asset side must be equal to the total of liabilities side; the two sides of the
Balance Sheet must have the same totals. If this is not the case, there is certainly an error
somewhere.
Distinction between Balance sheet and Trial Balance

Basis Balance sheet Trial Balance
1. Purpose The purpose is to portray the The purpose is to establish the
financial position. arithmetical accuracy of the
books of account.
2. Information about profits It provides information as to the No such information is possible
profitability and financial from the Trial Balance.
position of the firm
3. Necessity It is essential to prepare a Though desirable, it may be
Balance sheet to complete the possible to dispense with its
accounting process. preparation.
4. Headings The two sides are headed as The two columns are headed
assets and liabilities. as debit and credit
5.Coverage Only personal and real In the Trial Balance all
accounts appear in the Balance accounts must be written; no
sheet. account can be left out.
6. Closing stock This Account appears in the Normally, a closing stock does
Balance Sheet. not figure in the Trial Balance.
7. Period Normally, it is prepared only at A Trial Balance is prepared
the end of the trading period. normally every month and
whenever desired.
8. Adjustment A Balance Sheet cannot be A Trial Balance can be
prepared without making prepared at any stage, without
adjustments for outstanding even making adjustments.
and prepaid items and without
taking into account all events
and transactions for the year.

Grouping and Marshalling (Arrangement) of Assets and Liabilities

The assets and liabilities should be shown in a certain order in the Balance sheet. Therefore, they
should be arranged in certain groups and in a particular order. This is called Grouping and
Marshalling of the Balance sheet. Thus, ‘Grouping’ means putting items of a similar nature under a
common heading. The arrangement of assets and liabilities in a particular order in the Balance
sheet is called Marshalling.
Before we discuss the arrangement of assets and liabilities in the balance sheet, let us first
understand what assets and liabilities mean. The term ‘assets’ denote the economic resources
(property) of the business and includes all current and fixed assets. There are discussed
subsequently. The term ‘liabilities’ denote all claims against the assets of the business and include
those of the outsiders (creditors) or those of the owners of the business. Assets and liabilities are
shown in the Balance sheet either in the order of liquidity or in the order of permanence.
(i) In the order of Liquidity: Liquidity means the facility with which the assets may be converted into
cash; those assets which are most difficult to convert into cash are written last. Liabilities are to be
shown first as short-term liabilities and then as long-term liabilities and last of all as capital.
According to this arrangement, the form of a Balance Sheet is as follows:
BALANCE SHEET OF ….
As at………

Bills Payable … Cash in Hand …

Sundry Creditors … Cash at Bank …
Bank Overdraft … Bills Receivable …
Loans … Debtors …
Capital Closing Stock …
Opening Balance … Investment …
Add: Net Profit … Furniture …
… Plant and Machinery …
Less: Drawings … Land and Building …
Goodwill …
(ii) In order of permanence: Assets, which are to be used permanently in the business and are not
meant to be sold, are written first. Assets, which are most liquid such as cash in hand, are written
last. Liabilities may also be shown according to their performance arrangement. In this method, first
show the capital, then long-term liabilities and the last of all short – term liabilities like amounts due
to suppliers of goods or bills payable. The form of a Balance sheet under such an arrangement
would be as follows:
BALANCE SHEET OF …
As at…
Capital : Goodwill …
Opening Balance Land and Buildings …
… Plant and Machinery …
Add: Net profit … Furniture …
… … Investment …
Less: Drawings Closing stock …
… … Debtors …
Loans … Bills receivable …
Bank Overdraft … Cash at Bank …

Sundry creditors … Cash in Hand …

Bills payable …
Some of the assets may be capable of being sold easily like investment in government securities or
shares of some companies. They should be treated as liquid or permanent according to the
intention of the firm.
One should also note that the order in which the assets and liabilities of a company are to be shown
is described by the companies Act.
Classification of Assets and Liabilities
As already discussed a Balance sheet is prepared to show the financial position of a business
concern, this financial statements shows the various types of assets and liabilities.
BALANCE SHEET
Liabilities Assets
Fixed or Long –Term Liabilities Fixed Assets
Current or short – Term Liabilities Investments
Owner’s Funds (capital ) Current Assets
It is desirable that in a Balance sheet various types of assets and liabilities should be shown
separately and prominently. This would give meaningful and logical information. We shall now
discuss the nature of various types of Assets and Liabilities.
The Assets given above in the Balance sheet are divided into two parts as follows:
1. Fixed Assets: Fixed Assets that are acquired for continued use and are not meant for resale,
though later it may be decided to sell a particular asset. They may be tangible like land, building,
plant and Machinery, furniture and fixtures, etc... or intangible like goodwill, patents, etc.
Fixed Assets may be: (i) Tangible and (ii) Intangible.
(i) Tangible Fixed Assets refers to those fixed assets which can be seen and touched, Land
and Building, plant and machinery, Furniture and Fixture, etc.
(ii) Intangible Fixed Assets refer to those fixed assets which are not in a physical form, they can
neither be seen nor touched, goodwill of a firm or the know-how which it possesses, patents, trade
marks, etc.

Note: Fixed assets are valued at cost less depreciation.

Investments*: Investments represent capital expenditure on purchase of shares, debentures,
bonds, etc., to earn interest, dividend and other benefits.
*investment is shown separately in the Balance sheet.
Distinction between Tangible Assets and intangible Assets

Basis Tangible Assets Intangible Assets
1. Physical Existence Tangible assets are generally Intangible assets are fixed
defined as assets having a assets having no physical
physical existence. existence.
Example: Land and Building, Example: Goodwill, patents,
plant and Machinery etc. Trademarks, etc.
2. Fixed Vs. Current Tangible assets can be fixed or Intangible assets usually fall in
current, stock. the category of fixed assets.
3. Depreciation Or Amortization Fixed tangible assets are Intangible assets are
depreciated. amortized.
4. Risk Of Loss These assets may be lost due These assets cannot be lost
to fire. due to fire.
5. Acceptance In Security Lender accepts such assets as Lenders usually do not accept
security for providing loan. these assets as security for
providing loan.
There is another category called Fictitious Asset which is not represented by anything concrete.
The examples of fictitious assets are: Advertisement Suspense, preliminary Expenses, Discount on
Issue of shares or Debentures, profit and Loss Account (Debit Balance), etc. thus, these include
deferred revenue expenditure not yet written off.
2. Current Assets: These are those assets of the business which are kept temporarily for resale or
for converting into cash. These are assets which are likely to be realized within a period of one year
or during the normal operating cycle. A business earns profit by sale of these assets but not by
keeping them in hand. Examples are: unsold finished goods, amount received from debtors, bills

receivables, bank balance, and cash in hand, etc. these assets are temporary and may change.
These are also called floating or circulating assets. These are those assets on which any trade
depends for the payment of current liabilities. In current assets except closing stock, all the assets
are called quick assets. These include cash, bank balance, bills receivable, debtors and readily
marketable securities.
Distinction between fixed assets and Current Assets

Basis
1. Nature These are long lasting These are short-term resources
resources of a business. of a business.
2. Purpose of Holding These assets are used to These assets are realized in
operate the business and to cash or consumed during the
earn profits. normal operating cycle of
business.
3. Valuation These assets are valued at cost These assets are valued at
less depreciation. cost or market price whichever
less is.
4. Sources of Finance These assets are acquired out These assets are acquired out
of long-term funds of the of short- term funds of the
business. business.
5. Subject to change These assets are not usually These assets are usually
subject to change. subject to change.
6. Profit on sale The profit on sale of these The profit on sale of these
assets is a capital profit. assets is a revenue profit.
Liabilities are shown in Balance Sheet on the left-hand side. They may be divided as follows:
(i) Long –Term Liabilities or Fixed Liabilities: These liabilities are not payable by the business in the
next year. They mainly include ling-term loans as even for ten or fifteen years or amount of
debentures, etc. funds from this source are used for purchase of fixed assets.
(ii) Current Liabilities: These are liabilities payable by the business within a year. Example is: trade
creditors, bills payable, expenses outstanding, bank over-draft, etc.

(iii) Owner’s Funds: the amount owing to the proprietors as capital is a class by itself: it will include
undistributed profits and reserves also. It is equal to the net assets of the business and is
defined as the difference between assets and liabilities.
Contingent Liabilities: A contingent Liability is a liability that becomes payable on the happening of
an event. In case. The event does not happen, no amount is payable. Such liabilities are not shown
in the Balance sheet; they are revealed by way of a note. The following are the examples of
contingent liabilities:
(i) Liabilities in Respect of Bills Discounted: If the firm got its bills receivable discounted with the
bank the primary liability will be that of the acceptor. If the acceptor does not pay, then and only
then is the firm liable.
(ii) Guarantee for Loan: If the firm had stood surety for a loan, it may be liable to pay the amount if
the other person fails to meet his obligation.
(iii) Disputed Claims: If some other r party has lodged a claim against the firm, the firm will be liable
to pay if the claim succeeds.
Now look at the following illustration it shows how the Trading and Profit and Loss Account and the
Balance Sheet are prepared from a given Trial Balance.
Illustration 6. From the following Trial Balance, prepare a Trading and a profit and Loss Account for
the year ending 31st March, 2009 and a Balance sheet as on that date:
Rs. Rs.
Debit Balances Rent, Rates and Taxes 800
Sundry Debtors 1,500 Salaries 2,000
Stock 1st April, 2008 5,000 Drawings 2,000
Land and Building 10,000 Purchases 10,000
Cash in Hand 1,600 Office Expenses 2,500
Cash at Bank 4,000 Plant and Machinery 5,700
Wages 3,000 Credit Balance
Bills Receivable 2,000 Capital 25,000
Interest 200 Interest 600
Bad Debts 500 Sundry creditors 7,000

Repairs 300 Sales 17,000

Furniture and fixtures 1,500 Bills payable 4,000
Depreciation 1,000
On 31st March, 2009 the stock was valued at Rs. 10,000

Solution:
TRADING AND PRIFIT AND LOSS ACCOUNT

For the year ending 31st March, 2009
Particulars Amount Particulars Amount
To Opening Stock 5,000 By Sales 17,000
To purchases 10,000 By Closing Stock 10,000
To wages 3,000
To Gross profit
transferred to Profit and 9,000
Loss a/c 27,000 27,000
200 By Gross Profit 9,000
To interest 500 transferred from Trading
To Bad Debts 300 A/c 600
To Repairs 1,000 By interest
To Depreciation 800
To Rent , Rates and 2,000
Taxes 2,500
To Salaries 2,300
To Office Expenses
To Net profit transferred 9,600 9,600
to Capital A/c
BALANCE SHEET
As at 31st March, 2009

Liabilities Amount Assets Amount

Current Liabilities Current Assets
Sundry Creditors 7,000 Cash in Hand 1,600
Bills Payable 4,000 Chas at Bank 4,000
Bills Receivable 2,000
Capital 11,000 Sundry Debtors 1,500
Opening Balance 25,000 Closing stock 10,000
Less: Drawings 2,000
Fixed Assets 19,100
23,000 Furniture and Fixtures 1,500
Add: Net Profit 2,300 Plant and Machinery 5,700
Land and Building 10,000
25,300
17,200
36,300 36,300
Illustration 7. The following is the Trial Balance of Ram Chandra on 31st March, 2009. Draw the
final accounts from the balances there from:
TRIAL BALANCE
st
As at 31 March, 2009
Particulars Dr. (Rs.) Cr. (R.)

Capital 1,50,000
Stock (1st April, 2008) 30,000
Cash at Bank 10,000
Cash in Hand 5,000
Machinery 1,00,000
Furniture 13,000
Purchases 2,00,000
Wages 50,000
Carriage 33,000
Salaries 70,000
Discount Allowed 4,000
Discount Received 5,000
Advertising 50,000
Office Expenses 40,000
Sales 5,00,000
Sundry Debtors 90,000
Sundry Creditors 40,000
6,95,000 6,95,000
Value of Closing Stock as at 31st March, 2009 was Rs. 50,000.
Solution:
TRADING AND PROFIT AND LOSS ACCOUNT OF RAM CHANDRA
For the year ended 31st march, 2009

Particulars Rs. particular Rs.

To Opening Stock 30,000 By Sales 5,00,000
To Purchases 2,00,000 By Closing Stock 50,000
To Wages 50,000
To Carriage 33,000
To Gross profit c/d 2,37,000
5,50,000 5,50,000
To salaries 70,000 By Gross Profit b/d 2,37,000

To Discount Allowed 4,000 By Discount Received 5,000
To Advertising 50,000
To Office Expenses 40,000
To Net Profit transferred to Capital A/c 78,000
2,42,000 2,42,000
BALANCE SHEET OF RAM CHANDRA

As at 31 st March, 2009
Current Liabilities Current Assets
Sundry Creditors 40,000 Cash in Hand 5,000
Capital Cash at Bank 10,000
Opening Balance 1,50,000 Sundry Debtors 90,000
Add: Net profit 78,000 2,28,000 Closing Stock 50,000
Fixed Assets
Furniture 13,000
Machinery 1,00,000
2,68,000 2,68,000
Preparation of simple Final Account (without Adjustments)

1. Prepare the Trading and Profit and loss Account and Balance Sheet of Jagat Shah as on 31 st
March 2009 from the following balances:
Rs.
Capital (cr.) 3,600
Machinery 700
Sales 8,200
Purchases 4000
Sales Returns 100
Stock on April 1, 2008 1000

Drawings 400
Wages 1000
Carriage Inwards 50
Salaries 600
General Expenses 200
Rent 500
Purchases Returns 50
Debtors 3000
Cash 400
Carriage Outwards 200
Advertising 200
Creditors 500
The Closing Stock was valued at Rs. 2,000.

[Gross profit –Rs. 4,100; Net Profit –Rs. 2,400; Balance sheet Total –Rs. 6,100]
2.From the following balances, prepare the Trading and profit and Loss Account and Balance sheet:
Debit Balance Rs. Debit Balance (Contd.) Rs.
Machinery 3,500 Rent 450

Debtors 2,700 Sundry Expenses 200

Drawings 900 Carriage 150
Purchase 9,500 Credit Balances:
Wages 5,000 Capital A/c 10,000
Bank 1,500 Creditors 1,400
Stock Opening 2,000 Sales 14,500
Closing Stock was Rs. 300

[Gross Loss – Rs. 1,850; Net Loss – Rs. 2,500; Balance sheet- Rs. 8,000]
3.The following Trial Balance is extracted from the books of a merchant on 31st March, 2009:
Debit Balances: Rs. Debit Balance (contd.): Rs.
Furniture and Fittings 640 Taxes and Insurance 1,250
Motor vehicles 6,250 General Charges 782
Building 7,590 Salaries 3,300
Bad Debts 125 Credit Balances:
Sundry debtors 3,800 Capital 12,890
Stock on 1st April , 2008 3,460 Bills Payable 200
Purchases 5,575 Sundry Creditors 2,500
Sales Returns 200 Sales 15,450
Advertising 450 Bank Overdraft 2,850
Interest 118 Purchases Returns 125
Cash in Hand 650 Commission 175
Stock in hand on 31st March, 2009 was Rs. 3,250. From the above, prepare the Trading and profit
and Loss Account for the year ended 31st March, 2009 and Balance sheet as on that date.
[Gross profit –Rs. 9,590; Net Profit – Rs. 3,740; Balance sheet Total –Rs. 22,180]
4.John smith carries on business as a cigar manufacturer. Prepare his profit and Loss Account and
Balance Sheet from the following balance as on 31st March, 2009:

Rs Rs
Capital 6,000 Boxes, Labals,etc 500
Withdrawals (Drawings) 1,000 Rates and Taxes 40
Sales 10,000 Bill Receivable 30
Tobacco (bought ) 2,000 Insurance 150
Loan or Mortgage(Cr.) 1,000 Carriage 10
Machinery and plant 1,500 Incidental expenses 200
Land and Building 2,000 Stock ,1st April ,2008 2,000
Creditors 500 Cash at bank 1,250
Wages 5,000 Cash in Hindi 50
Debtors 1,500
Stock on 31st March, 2009, Rs. 1,500
[Gross Profit, Rs. 1,900; Net Profit, Rs. 1,600 Balance Sheet Total – Rs. 8,100]
5.The following balances were extracted from the books of Harish Chandra on 31st March 2009:
Rs. Rs.
Capital 24,500 Loan sales 7,880
Drawing 2,000 Purchases 65,360
General Expenses 2,500 Purchases 47,000
Buildings 11,000 Motor Car 2,000
Machinery 9,340 Reserve Fund(Cr.) 900
Stock 16,200 Commission (Cr.) 1,320
Power 2,240 Car Expenses 1,800
Taxes and Insurance 1,315 Bills payable 3,850
Wages 7,200 Cash 80
Debtors 6,280 Bank Overdraft 3,300
Creditors 2,500 charity 105
Bad Debts 550
st
Stock on 31 March, 2009 was valued at Rs. 23,500.
Prepare the final accounts for the year ending 31st March, 2008.
[Gross Profit – Rs. 16,220; Net profit –Rs. 11,270, Balance sheet Total – Rs. 52,200]
Chapter RECTIFICATION OF ERRORS

13
Errors and their Rectification Trial Balance and Computers or commit errors while recording and
posting transactions. These are called‘Accounting Errors’. So accounting errors are the errors
committed by persons responsible for recording and maintaining accounts of a business firm in the
course of accounting process. These errors may be in the form of omitting the transactions to
record, recording in wrong books, or wrong account or wrong totalling and so on. Accounting errors
can take the following forms:
 l Omission of recording a business transaction in the Journal or Special purpose Books
 l Not posting the recorded transactions in various books of accounts to the respective accounts
in ledger
 l Mistakes in totalling or in carrying forward the totals to the next page
 l Mistake in recording amount wrongly, writing it in a wrong account or on the wrong side of the
account.
Again there may be two types of accounting errors
(i) That cause the disagreement of trial balance
(ii) That do not affect the agreement of Trial Balance.
Locating Errors
It is obvious that if there are errors they must be located at the earliest. After locating the errors,
they are to be rectified. In accounting also once it is
established there are some accounting errors these need to be located and detected as early as
possible. How to locate the errors?
Steps to be taken to locate the accounting errors can be stated as follows:
(A) When the Trial Balance does not agree

(i) Check the columnar totals of Trial Balance

(ii) Check that the balances of all accounts (including cash and bank balances) in the ledger have
been written and are written in the correct column of trial balance i.e. debit balance in the debit
column and credit balance in the credit column.
(iii) Find the exact figure of difference with trial balance and see that:
Trial Balance and Computers errors and their Rectification
(a) No account of a similar balance has been omitted to be shown in the Trial Balance or
(b) A balance amount which is half of the amount of difference amount but is written on the
wrong side of the trial Balance.
(iv) Recheck the totals of Special Purpose Books.
(v) Check the balancing of the various accounts in the ledger.
(vi) If difference is still not traced, check each and every posting from the Journal and various
Special Purpose Books, one by one in the ledger.
(B) When the Trial Balance agrees.
You have already learnt that if the totals of the two amount columns of trial balance tally it is no
conclusive proof of the accuracy of accounts. There
may still be some accounting errors. These errors may not be immediately traced but may be
detected at much later stage. These are rectified as and when detected.
Following are the errors which don’t affect the trial balance :
(i) Omission to record a transaction in a journal or in a Special Purpose Book. For example,
goods purchased on credit but are not recorded in the Purchases Book at all.
(ii) Recording a wrong amount of an item in journal or in a Special Purpose Book. For example,
sale of Rs. 2550 on credit entered in the Sales Book as Rs.5250.
(iii) Posting the correct amount on the correct side but in wrong account. For example, cash
received from Jagannathan was credited to Vishvanathan.
(iv) An item of Capital Expenditure recorded as an item of Revenue Expenditure and vice-a-versa.
For example, Repairs to Building was debited to Building A/c.

QUESTION 1
Do the following errors affect the trial balance or do not affect the trial balance? Write ‘Yes’ if it
affects and ‘No’ if does not affect.
1. Sold goods of Rs.3200 to Anil Nayar, but it is not entered in the SaleBook.
2. Purchased goods of Rs.2400 from Simran and is correctly entered the Purchases Book but
posted to the credit of her account in the ledger as Rs.3400.
3. Total of the Purchases Book is incorrect.
4. An amount of repair to building is debited to Building Account.
2 CLASSIFICATION OF ACCOUNTING ERRORS
Various accounting errors can be classified as follows :
A. On the basis of their nature
(a) Errors of omission
(b) Errors of commission
(c) Errors of principle
B. On the basis of their impact on ledger accounts
(a) One sided errors
(b) Two sided errors.
A. On the basis of their nature

(a) Errors of omission

As a rule, a transaction is first recorded in books of accounts. However, accountant may not record it
at all or record it partially. It is called an error of omission. For example, goods purchased on credit
are not recorded in Purchases Book or discount allowed to a customer was not posted Discount A/c
in the ledger. In the first case it is a complete omission.
Therefore, both debit and creditare affected by the same amount. Therefore, it does not affect the
Trial Balance. The second example is the example of partial omission. It affects only one account i.e.
Discount A/c. Therefore it affects Trial Balance.
(b) Errors of commission
When the transaction has been recorded but an error is committed in the process of recording, it is
called an error of commission. Error of commission can be of the following types:
(i) Errors committed while recording a transaction in the Special Purpose books. It may be :
 l Recording in the wrong book for example purchase of goods from Rakesh on credit is
recorded in the Sales Book and not in the Purchases Book.
 l Recording in the book correctly but wrong amount is written. For example, goods sold to
Shalini of Rs.4200 was recorded in the Sales Book as Rs.2400
 In the above two cases two accounts are affected by the same amount, debit of one and the
credit of the other. Therefore, trial balance will not be affected.
(ii) Wrong totalling : There may be a mistake in totalling Special Purpose Book or accounts. The
totalled amounts may be less than the actual amount or more than the actual amount.
First is a case of undercasting and the other of overcasting. For example, the total of Purchases
Book is written as Rs.44800 while actual total is Rs. 44300, the total of Sales Day Book is
written as Rs.52500 while it is Rs.52900. It is a case of an error affecting one account hence it
affects trial balance.
(iii) Wrong balancing : While closing the books of accounts at the end of the accounting period, the
ledger accounts are balanced. Balance is calculated of the totals of the two sides of the
account. It may be wrongly calculated. For example, the total of the debit column of Mohan’s
A/c is Rs.8600 and that of credit column is Rs.6800. The balance calculated is as Rs.1600

while the actual balance is Rs.1800. It has affected one account only, therefore, the Trial
Balance gets affected.
(iv) Wrong carry forward of balances or totals : Totals or balances are carried forward to the next
page. These may be carried forward incorrectly. For example, the total of one page of the
Purchases Book. of Rs.35,600 is carried to next page as Rs.36500.Again the error affects one
account only. Therefore, Trial Balance gets affected.
(v) Wrong Posting : Transactions from the journal or special purpose books are posted to the
respective accounts in the ledger. Error may be committed while carrying out posting. It may
take various forms such as, posting to wrong account, to the wrong side of the account or
posted twice to the same account. For example goods purchased of Rs.5400 from Rajesh
Mohanti was posted to the debit of Rajesh Mohanti or posted twice to his account or posted to
the credit of Rakesh Mohanti. In the above examples, only one account is affected because of
the error therefore, Trial Balance is also affected.
(C) Compensating Errors
Two or more errors when committed in such a way that there is increase or decrease in the debit
side due to an error, also there is corresponding decrease or increase in the credit side due to
another error by the same amount. Thus, the effect on the account is cancelled out. Such errors are
called compensating errors. For example, Sohan’s A/c is debited by Rs 2500 while it was to be
debited by Rs 3500 and Mohan’s A/c is debited by Rs 3500 while the same was to be debited by Rs
2500. Thus excess debit of Mohan’s A/c by Rs.1000 is compensated by short credit of Sohan’s A/c
by Rs.1000. As the debit amount and the credit amount are equalised, such errors donot affect the
agreement of Trial Balance, but the fact remains that there is still an error.
(d) Error of Principle

Items of income and expenditure are divided into capital and revenue categories. This is the basic
principle of accounting that the capital income and capital expenditure should be recorded as capital
item and revenue income and revenue expenditure should be recorded as revenue item. If
transactions are recorded in violation of this principle, it is called error of principle i.e. the capital item
has been recorded as revenue item and revenue item is recorded as capital item. For example, Rs.

5000 spent on the repairs of building is debited to Building A/c while it should have been debited to
Repair to Building A/c. It is a case of error of principle because expenditure on repairs of building is a
revenue expenditure, while it has been debited to Building A/c taking it as an item of capital
expenditure. As both the sides i.e. credit as well as debit remain affected, the trial Balance also is not
affected by such errors.
B. On the basis of impact on ledger accounts
Errors may affect one side i.e. either debit or credit side of an account or its two sides i.e. both debit
and credit thus errors may be divided as:
(b) Two sided errors
Accounting errors that affect only one side of an account which may be either its debit side or credit
side, is called one sided error. The reason of such error is that while posting a recorded transaction
one account is correctly posted while the corresponding account is not correctly posted. For
example, Sales Book is overcast by Rs.1000. In this case only Sales A/c is wrongly credited by
excess amount of Rs.1000 while the corresponding account of the various debtors have been
correctly debited. Another example of one sided error is Rs 2500 received from Ishita is wrongly
debited to her account. In this case, only Ishita’s account is affected, amount in the cash-book is
correctly written. This type of mistake does affect the trial balance.
(b) Two sided errors
The error that affects two separate accounts, debit side of the one and credit side of the other is
called two sided error. Example of such error is purchase of machinery for Rs.1000 has been
entered in the Purchases Book. In this case, Purchases A/c is wrongly debited while Machinery A/c
has been omitted to be debited. So two accounts i.e. Purchases A/c and the Machinery A/c are
affected.
QUESTIONS 2

Following are the accounting errors. Write against each error the type i.e. error of omission, error of
principle, compensatory error, error of commission as per the nature of error:
(i) Purchase of Furniture is entered in the Purchase Book (Error of ............)
(ii) Repairs of building is debited to Building A/c. (Error of ............)
(iii) Sales Book is totalled Rs 15000 instead of its 14600. (Error of ............)
(iv) Mohan’s A/c was to be debited by Rs 4500 and Sohan A/c was to be debited by Rs. 5500 while
Mohon’s A/c was debited by Rs. 5500 and that of Sohan’s A/c by Rs. 4500. (Error of ............)
3 RECTIFICATION OF ACCOUNTING ERRORS
By now you must have understood well that every business enterprise prepares its financial
statements to provide information of profit earned or loss incurred by it during an accounting period
and its financial position on the relevant date. This information will be most useful only if the
information is accurate. How can the business concern achieve this objective if there are number of
errors in the accounting? Your immediate response will be that errors in accounts should be
detected at the earliest and be corrected before preparing the financial statements. It should be
clear in your mind that the errors should never be rectified by erasing or overwriting because it will
encourage manipulations and frauds in accounts.In accounting practice there are some definite
methods to rectify the accounting errors. These are based on accounting practices and procedures.
Rectification of errors using these methods is called rectification of accounting errors. So it is a
process of rectification. It is generally done by passing an entry to nullify the effect of error.Methods
of rectification of accounting errors Before preparing Trial Balance
(i) instant correction
(ii) correction in the affected account After preparing Trial Balance
Before preparing Trial Balance

(i) Instant correction
If the error is detected immediately after making an accounting entry, it may be corrected by neatly
crossing out the wrong entry and making the correct entry and the accountant should put his initials.
For example, an amount of Rs. 3500 is written as Rs. 5300. This can be corrected as 3500.
(ii) Correction in the affected accounts.
In case error is detected on a date later than the date on which the transaction was recorded but
before the Trial Balance, the rectification will be made by making a correction in the affected account
. A few Illustrations of accounting errors corrected by this method are as follows :
Illustration 1
Purchases book is overcast for the month of July, 2006 by Rs 8000.
Solution.
Accounts Affected
The total of the Purchase Book is posted to the debit of Purchase A/c. Therefore Purchase A/c is
affected.
Rectification:
To nullify the effect of the error, the entry of Rs 8000 will be made on the credit side of the Purchase
A/c. With the words written as. “The amount of Purchase Book is overcast for the month of July
2006.”
Illustration 2
A sum of Rs 1200 paid to Ashok has been wrongly credited to his account.
Solution.
Accounts affected
Ashok A/c is affected because his account has been credited instead of being debited.
Rectification
In this case Ashok A/c is to be debited to nullify the effect of its being wrongly credited at the same
time it is to be debited for cash payment.
Illustration 3

Purchase of furniture of Rs 5000 was entered in the Purchases Book.
Solution.
Accounts affected
Furniture Account and Purchases account have been affected. Furniture Account has been omitted
to be debited while Purchases account is wrongly credited.
Rectification
In this case Purchases account is credited to nullify as it is wrongly credited as furniture account is
debited in it was to be debited but was omitted.
Illustration 4
Amount of Rs 15000 received from Govind was credited to Har Govind.
Solution.
The two accounts affected are Govind’s A/c which is not credited and Har Govind’s A/c which is
wrongly credited.
Rectification entry in Journal is :
Har Govind A/c Dr 15000
To Govind A/c 15000
(Amount received from Govind wrongly credited to Har Govind is now rectified.)
Illustration 5
Following are some accounting errors. Rectify them by making journal entries :
(i) Sales for Rs.20000 made to Malvika was not entered in the Sales Book.
(ii) Salary of Rs.7500 paid to Accountant Raman was debited to his personal account
(iii) Old furniture sold for Rs.2800 was entered in the Sales Book.
(iv) Carriage paid Rs.500 on purchase of a Machine was debited to Carriage A/c

(v) Cash Rs.50000 paid to the creditor Atulya Ghosh was debited to Praful Ghosh’s A/c
Solution :
Journal.
Date Particulars Amount
Malvika Dr 20000
To Sales A/c 20000
(Sale to Malvika omitted to be entered in Sales Book is corrected)
(ii) Salary A/c Dr 7500
To Raman 7500
(Salary paid to Raman was debited to his personal account is now corrected)
(iii) Sales A/c Dr 2800
To Furniture A/c 2800
(Old furniture sold was entered in the sales Book is now corrected)
(iv) Machine A/c Dr 500
To Carriage A/c 500
(Amount paid for carriage on purchase of machine is debited to carriage A/c is now corrected)
(v) Atulya Ghosh Dr 50000
To Praful Ghosh 50000
(Amount paid to Atulya Ghosh was debited to Praful Ghosh is corrected)
QUESTIONS 3

1. Cash received from Ashok Rs 2500 were posted to his account asRs.5200. Accountant erased
amount of Rs 5200 and wrote Rs 2500 in its place. Is he justified in doing so?
2. Accountant corrected an error of writing Rs 7200 instead of Rs 5200 in the following manner, is
he justified to do so?Rs 7200 Rs 5200
3. Total of the Sales Book was overcast by Rs 1000. Accountant corrected the error in the following
manner :Amount as per Sales Book Rs.1000On which side of the Sales A/c he should write the
above amount?
4. Wages paid of Rs.1200 were omitted to be recovered in the Cash Book. What journal entry will
be made to rectify the error?
4 RECTIFICATION OF ERRORS THROUGH SUSPENSE
ACCOUNT
You have learnt that the Trial Balance prepared at the end of a period by the business concern must
agree. It means the sum of its debit column and sum of credit column should agree. But if the totals
do not agree the difference amount is written in a new account. This account is called Suspense
Account. If the total of the debit side of the Trial Balance is more than the total of its credit side, the
difference amount will be written in Suspense A/c on its credit side i.e. Suspense A/c is credited and
vice-aversa. You have also learnt that the two sides of the Trial Balance do not agree because there
is some error or errors in the accounts, which is reflected in the Suspense Account. Thus, Suspense
A/c is a summarised account of errors.
Opening of a Suspense Account is a temporary arrangement. As soon as the error that has led to
Suspense Account is rectified, this account will disappear. One point needs to be noted that
Suspense A/c is the result of one sided errors. So one sided errors are corrected through Suspense
A/c. Completing the double entry when an error is corrected by placing the correct amount on the
debit of the proper account, the credit is placed in Suspense Account or vice-a-versa. For example,
Gopal’s Account was debited short by Rs.100. The error will be rectified through Suspense A/ c by
debiting Gopal A/c and crediting Suspense A/c by Rs.100.
Journal entry for the same is as follows :
Gopal Dr. 100

To Suspense A/c 100
(Gopal’s A/c debited short is now corrected)
Similarly, while correcting as one sided error the proper account is credited with the correct amount,
the debit is placed in the Suspense A/c. For example, Sales Book for December, 2006 is undercast
by Rs. 500. The error will be rectified by debiting Suspense A/c and crediting Sales A/c.
Journal Entry for the same will be as follows :
Suspense A/c Dr 500
To Sales A/c 500
(Sales Book undercast is rectified)
Illustration 6
Following are some accounting errors. Rectify the same through SuspenseA/c.
(i) Purchases Book has been overcast by Rs.200
(ii) Goods purchased from Manohar of Rs.2500 has been posted to the debit of his account.
(iii) Cash of Rs.4500 paid to Munish was credited to Manish.
(iv) Discount Rs.100 allowed to Anthony was not debited to discount account.
Solution.
(i) Accounting effect
 Purchase A/c has been debited in excess by Rs.200
 Rectification : Purchase A/c is credited by Rs.200 and Suspense A/c is
 debited by Rs.200.
 Journal entry
 Suspense A/c Dr 200
To Purchases A/c 200

(Purchase Book overcast is now corrected)
(ii) Accounting effect
Manohar A/c has been debited by Rs.2500 instead of it being credited by the same amount.
Rectification
Manohar A/c is credited by Rs.5000
Journal Entry
Suspense A/c Dr 5000
To Manohar A/c 5000
(Goods purchased from Manohar debited to his account is now corrected)
(iii) Accounting effect
Manish A/c is credited by Rs. 4500 while Manish A/c was to be debited by the same amount.
Rectification. Manish A/c is to be debited by Rs. 4500 and Manish A/c is also be debited by Rs.
4500 and Suspense A/c to be credited by Rs. 9000
Journal Entry :
Manish Dr 4500
Munish Dr 4500
To Suspense A/c 9000
(Cash paid to Munish was wrongly credited to Manish, now corrected)
(iv) Accounting effect
Discount A/c is omitted to be debited by Rs.100. This account is debited and Suspense A/c is
credited.
Journal Entry

Discount A/c Dr 100
To Suspense A/c 100
(Discount allowed is notdebited to discount A/c.)
Illustration 7
Rectify the following accounting errors through Suspense Account by making journal entries :
1. Purchase of goods from Mohit for Rs2500 was entered in the Sales Book, however Mohit’s
Account was correctly credited.
2. Cash received from Anil a debtor Rs3200 was correctly entered in the Cash Book but was
omitted to be posted to his account.
3. Sales Book was overcast by Rs1500.
4. Cash of Rs4000 paid to Hanif was credited to Rafique A/c as Rs1400.
5. The total of Purchase Returns Book of Rs3150 was carried forward as Rs1530.
6. Namita was paid cash Rs6500 but Sumita was debited by Rs6000.
Solution
Particulars Amount
1. Purchase A/c Dr 2500
Sales A/c Dr 2500
(Purchase of good was entered in the the sale book now corrected)
2. Suspense A/c Dr 3200
To Anil A/c 3200
(Anil’s account omitted to be credited now rectified
3. Sales A/c Dr 1500

(Sales Book overcast is corrected)
4. Hanif A/c Dr 4000
Rafique A/c Dr 1400
(Cash paid to Hanif was wrongly credited to Rafique the error is now rectified)
5. Suspense A/c Dr 1620
To Purchase Returns A/c 1620
(Purchase Return Book is undercaste is now rectified)
6. Namita A/c Dr 6500
To Sumita A/c 6000
To Suspense A/c 500
(Cash paid to Namita Rs 6500 was debited to Sumita by Rs 6000 is the error is rectified)
Rectification of two sided Errors Error which affects two different accounts on the same sides or
different sides is called two sided error.
Illustration 8
Furniture purchased from M/s Furniture House on 15th January, 2006 for Rs 5000 was wrongly
entered in the Purchases Book.
Solution
Accounts affected are Furniture A/c which is omitted to be debited and Purchase A/c which is
wrongly debited.
Rectification through Journal Entry
Furniture A/c Dr 5000
To Purchase A/c 5000

(Furniture purchased wrongly entered in the Purchases Book now corrected)
QUESTIONS .4
Answer the following in one sentence :
1. When is Suspense A/c opened?
_______________________________________________________
_______________________________________________________
2. When does Suspense A/c disappear?
_______________________________________________________
_______________________________________________________
3. What are two sided errors?
_______________________________________________________
_______________________________________________________
4. What type of errors are rectified through Suspense A/c?
_______________________________________________________
_______________________________________________________
TERMINAL QUESTIONS
1. State the meaning of Accounting Errors.
2. Explain the following types of errors with suitable examples:
(a) Error of omission
(b) Compensating errors
(c) Error of principle

3. A businessman has prepared trial balance of his business firm that has agreed? He is satisfied
that now there are no accounting errors. Do you agree with him? If not list the errors that do not
affect the agreement of the trial balance.
4. When is a suspense Account opened? How are errors rectified through Suspense A/c?
5. Rectify the following errors :
(i) Goods purchased on credit for Rs.8200 not recorded in the Purchases Book.
(ii) Purchase Returns Book is overcast by Rs.1000.
(iii) Salary of Rs.3200 paid to Gopal the accountant was debited to his personal account
(iv) Sales to Shakila of Rs.2400 was posted to her account
(v) Cash received from Suresh Rs.2000 was not entered in the books.
6. Rectify the following errors :
(i) Purchases Book is undercast by Rs.1500
(ii) Sales Return Book is overcast by Rs.1000
(iii) Sales Book is added short by Rs.100
(iv) The total of Purchases journal of Rs.7580 has been posted to Purchases Account as
Rs.5780
(v) The total of the page of Sales journal of Rs.24750 was carried to next page as Rs.027450
7. Pass necessary journal entries to rectify the following errors :
(i) Sale of an old machine for Rs.4500 was posted to Sales account
(ii) Rent of proprietors residence of Rs.12000 was posted to Rent Account.
(iii) A credit to Brij Mohan of Rs.6750 was posted to his account as Rs.4750
(iv) Furniture purchased from M/s Decorates for Rs.22500 was entered in the Purchases
Book
(v) Salary paid to the accountant Sushil Gupta of Rs.6500 was debited to his personal
Account.

8. The Book keeper of a firm found that his trial balance did not agree. Its credit total exceeded the
debit total by Rs.2850. He placed theamount in Suspense A/c and subsequently found the
following errors.
(i) A credit item of Rs.3490 has been debited to his personal Account as Rs.4390.
(ii) A sum of Rs.2650 written off as depreciation on machine has not been posted to Depreciation
A/c.
(iii) Goods of Rs.5300 sold were returned by the customer and were taken into stock before
closing the books but were not entered in the books.
(iv) Rs.4800 due from Lakhan Pal which had been written off as bad debt in a previous year was
unexpected recorded and had been posted to the personal account of Lakhan Pal.
(v) Sales Book is undercast by Rs.1500.
(vi) Rs.4000 withdrawn for domestic use by the proprietor was debited to General Expenses A/c.
(vii) Machine Purchased from Machine Mart for Rs.18000 were entered in the Purchases Book.
(viii) Cash paid Rs.1200 to Lakshman was credited to Ram as Rs.2100.

Interview Questions
Q.1 What is accounting

Q.2 Rent is direct income or indirect income
Q.3 What is individual capital account.
Q.4 If u sale an asset for Rs.1000, which shows the book value of 8600. what will be the journal
entry?
Q.5 If our provision of taxation of particular year 23000/- and on that year we paid advance tax
20000/-then how we adjust this both amount.......
Q.6 what is the difference between reserves & provisions and accumulated reserves & surplus
Q.7 Preliminary expenses incurred in the year october 2012 month 5 laks which accounted in
asset side as ''preliminary expenses''... in year end march 2013, in 5 laks how much amount
should take for preliminary expenses written off..?
Q.8 what is difference between trail balance and balance sheet
Q. 9 What is Bills of Exchange? How is it negotiable instrument?
Q. 10 Tell us Assets as well as liabilities bal.

Fundamental of Accounts Final Book-2018

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IFA – Indian Financial Academy www.ifaindia.

Behind every good Business is a great Accountant 1

Phone: 011-47014601, 9899982600

TOPICS PAGE NO.

Behind every good Business is a great Accountant 2

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Behind every good Business is a great Accountant 5

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Chapter Introduction to Accounting

According to American Institute of Certified Public Accountants

According to American Accounting Association

“Accounting is the process of identifying, measuring and communicating economic information to

Behind every good Business is a great Accountant 12

Communicating Financial transactions

Behind every good Business is a great Accountant 13

5. Human Resource Accounting: Human Resource Accounting is an attempt to identity, quantity

BOOK KEEPING, ACCOUNTING AND ACCOUNTANCY

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Scope It involves recording of transaction of It involves recording analysis and

Nature It is complementary to accounting It is not complementary to book-

Branch There is no branch of Book-Keeping. It has several branches like

Financial Financial position of the business Financial position of the business is

Base/Language It constitutes as a base for accounting. It is considered as a language of

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Behind every good Business is a great Accountant 16

4. Comparison & Evaluation: Accounting assesses performance achieved in relation to targets

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Chapter Accounting Terms

Assets can be classified to be:

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Liabilities = Assets - Capital

Capital = Assets – Liabilities

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Income = Revenue – Expense

Income = Revenue – Expense

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9. Creditor: A person to whom an enterprise owes amount on account of credit purchases of

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21. Characteristics of a Transaction

22 Account: Account is a summarized record of relevant transactions at one place relating to a

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38. Balance sheet: it is a statement of the financial position of an individual or enterprise as at a

IMPORTANT TERMS TO REMEMBER

1. Capital - Amount invested by owner in the business.

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Chapter- Business Transaction

Let us now discuss the most common source documents.

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• Details of goods or service sold

• Price of items sold

• Name and address of seller

• Name and address of buyer

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Invoice or Bill: Definition:

That in the consideration of ___________ Dollars and _ Cents ($___)