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Basic Concepts of Financial Accounting

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TOPICS

Forms of Business Organizations


Accounting Terminologies
Types of Accounting Methods
Dual Entry System
Types of Accounts with examples
Debit & Credit Rules for different Accounts
Accounting Cycle
Journal
Ledger
Trial Balance
Income Statement
Balance Sheet
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OBJECTIVES

To get an overview of basics of Financial Accounting


To understand basic terminologies of Accounting
To understand the two types of Accounting
To understand different types of Accounts and their corresponding rules
for Debit & Credit
To Understand each components of the Accounting Cycle (i.e. Journal,
Ledger, Trial Balance, Income Statement & Balance Sheet)

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Forms of Business Organization


Proprietorship
Proprietorship

Partnership
Partnership

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Corporation
Corporation

Accounting
is the

Accounting
Accounting

art of

Recording
Recording
Classifying
Classifying

the
theresults
resultsto
tohelp
help
users
usersmake
makebetter
better
decisions.
decisions.

Interpreting
Interpreting

Summarizing
Summarizing
Presenting
Presenting
the financial
aspect and

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Accounting
Recording means entering the financial transactions in
journals.
Classifying means posting the transactions from journals to
ledger
Summarizing means to prepare the Trial Balance.
Presentation means setting out the financial data in a
systematic manner in the form of Statements ( i.e. Profit &
Loss and Balance Sheet).
Interpretation means to understand the financial statements
for the user to make appropriate decisions.
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Foundation of Accounting Systems


Indian Accounting Standards encompass the conventions, rules,
and procedures for determining acceptable accounting practices at
a particular time.
Institute of Chartered Accountants of India (ICAI) is primarily
responsible for evaluating, setting, or modifying IAS in India.

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Users of Accounting Information


Internal Users

External Users

Lenders

Consumer Groups Managers

Shareholders External Auditors


Customers
Governments

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Officers
Internal
Auditors

Sales Staff
Budget
Officers
Controllers

Users of Accounting Information

Lenders: Whether the firm (borrower) can repay the money?


Shareholders: Whether to buy, hold, or sell stocks?
Governments: Whether the firm pay all due tax?
Customers: Whether the firm can exist to provide post-sale services?
External Auditors: Whether the financial statements are prepared
according to IAS?
Accounting provides the relevant information for internal decision
makers.

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Accounting Terminologies
Assets: Assets are the properties or resources which are owned by the
business entity.
Ex: Land, building, machinery, cash etc. owned by the business.
Liabilities: Liabilities are the debts owed by the business to the
outsiders.
Ex: Amount due to suppliers, Loan from bank.
Capital: Capital represents owners claim or share in the assets of the
business. In common sense, Capital is the amount invested by the
proprietor in his business.
Drawings: Drawing means the amount of cash or any asset withdrawn
by the owner of the business for his personal or domestic use.

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Accounting Terminologies
Expense: Expenses are the amounts spent on purchasing, manufacturing
and selling of goods and services.
Ex: Salary, Rent, Wages, Telephone bills paid etc.
Revenue: Revenue represents the cash generated by sale of goods or by
rendering services.
Ex: Sale proceeds of goods, Rent earned, Consulting fees etc.
Accounting Year: Accounting year is generally a period of 12 months
during which the accounts are maintained.
An accounting year may be a calendar year (i.e. from 1 st January to
31st December) or any financial year (i.e. from 1 st April to 31st
March) or any other period of year.
The Profit or Loss of a business are ascertained after the close of
every accounting year.
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Accounting Methods
CASH BASIS
The Cash Method of accounting records revenue when cash is
received, and records expenses when cash is paid.
Ex: Magazine Subscription
ACCRUAL BASIS
The accrual method records revenue when they are earned and
records expenses when they are actually incurred.

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Dual Entry System


The term Double-entry system means the method of recording
of two-fold aspects of a transaction.

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Accounting Cycle
Financial
Transactions

Posting to Ledger
Accounts

Taking out Trial


Balance

Preparing P & L and


Balance Sheet
Statement
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Accounting Process

Entering Into
Journals

Accounting Terminologies
Journal: Journal is a book of original entry where transactions are
entered in sequence of their occurrence date wise.
Ledger: Ledger is a book of final entry containing all the accounts of
the business. The accounts are the classified records of all the
transactions prepared on the basis of journals.
Posting: Posting is the process of transferring the entries of the
transactions from journals to the ledger accounts.
Trial Balance: Trial Balance is the list of all debit and credit balances of
accounts taken out from the ledger at any given date.

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Accounting Terminologies
P & L Account: It is a summarized revenue account which shows net
profit or loss made by a business during the year.
Balance Sheet: Balance sheet is the statement of assets and liabilities
prepared with a view to ascertain the financial position of the business
as on a specified date.

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Accounting Terminologies
Goods: It includes all commodities, articles or products which are
purchased for the purpose of resale.
Purchases:
The term Purchases means goods purchased for resale.
Any goods purchased for office use is not regarded as purchases.
It may be treated as an Asset or office expense depending upon the
use of such goods
Ex: If a furniture dealer buys tables, chairs etc. for trading purpose,
it will be treated as Purchases.
But if they are purchased for use in the office, it will be treated as an
Asset.
It should be noted that Purchases are treated as expenses for
accounting purpose.
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Accounting Terminologies
Sales:
The term Sales means goods sold for cash or on credit.
Note: Sales doesnt include sale of any asset.
It may be treated as an Asset or Revenue depending upon the use
of such goods.
Ex: If a furniture dealer sells tables, chairs etc. for trading purpose,
it will be treated as Sales.
But if he sells the office furniture's in use, then it will be treated as
an
Asset.
It should be noted that Sales are treated as Revenue for
accounting purpose.

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Accounting Terminologies
Purchases Returns (or Returns Outwards):
It means the goods which were purchased being returned to the
suppliers.
Goods may be returned for reasons such as poor quality, damage
by bad packing etc.
The amount of goods returned reduces the purchases.
Sales Returns (or Returns Inwards):
It means the goods which were sold to customers are now returned
for the same reasons stated above.
The amount of such returns reduces the sales.

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Accounting Terminologies
Debtor:
Debtor is a person who owes any amount to another person.
Ex: If we sell goods to Mr. X on credit, he becomes our debtor.
Creditor:
Creditor is a person to whom any amount is owed by other person.
Ex: If we purchase goods from Mr. Y on credit, he becomes our
creditor.

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Accounting Terminologies
Accounts Payable:
Accounts payable is money owed by a business to its suppliers
shown as a liability.
Ex: If we purchase goods on credit, then we make use of Accounts
Payables instead of Cash account.
Accounts Receivables:
Accounts receivables is money yet to be received by a business
from its customers shown as a asset.
Ex: If we sell goods on credit, then we make use of Accounts
Receivables instead of Cash account.

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Accounting Terminologies
Account:
Account means the record of transactions in a summarized form
pertaining to a particular person or a particular asset or a particular
expense or income.

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Every Account has:


An Increase Side, and
A Decrease Side
But, Some Accounts
Increase on the Debit
Side(Left Side)
And, Some Accounts
Increase on the Credit
Side(Right Side)
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5 Rules of Debits and Credits

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Rule #1
ASSET ACCOUNTS

Increase on
Debit Side

Dr.

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Cr.

Decrease on
Credit Side

Rule #2
LIABILITY ACCOUNTS

Decrease on
Debit Side

Dr.

Cr.

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Increase on
Credit Side

Rule #3
CAPITAL ACCOUNTS

Decrease on
Debit Side

Dr.

Cr.

Increase on
Credit Side

JUST LIKE
LIABILITY ACCOUNTS
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Rule #4
REVENUE ACCOUNTS

Decrease on
Debit Side

Dr.

Cr.

Increase on
Credit Side

JUST LIKE
LIABILITY & CAPITAL
ACCOUNTS
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Rule #5
EXPENSE ACCOUNTS

Increase on
Debit Side

Dr.

Cr.

+
JUST LIKE
ASSET ACCOUNTS
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Decrease on
Credit Side

Rule #1
ASSET ACCOUNTS

Increase on
Debit Side

Dr.

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Cr.

Decrease on
Credit Side

Example
PURCHASED OFFICE SUPPLIES FOR $800 CASH

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Step #1
Name the accounts affected:

CASH

OFFICE
SUPPLIES

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Step #2
Determine Classification of Accounts

AS

ASS
ET

CASH

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SE

OFFICE
SUPPLIES

Step #3
Now that we know the classification, we can identify
increase and decrease sides.

CASH
DR.

OFFICE SUPPLIES

CR.

DR.

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CR.

PURCHASED OFFICE SUPPLIES FOR $800 CASH

Did Office Supplies


Increase or Decrease
in this transaction?

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INCREASED

OFFICE SUPPLIES
DR.

+
$800

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CR.

PURCHASED OFFICE SUPPLIES FOR $800 CASH

What about Cash?


Increase or Decrease
in this transaction?

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DECREASED

CASH
DR.

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CR.

$800

DEBITS = CREDITS
OFFICE SUPPLIES
DR.
CR.

$800

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CASH
DR. CR.

$800

Rule #2
LIABILITY ACCOUNTS

Decrease on
Debit Side

Dr.

Cr.

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Increase on
Credit Side

Example
PURCHASED EQUIPMENT ON ACCOUNT FOR
$3,000.

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Step #1
Name the accounts affected:

ACCOUNTS

EQUIPMENT

PAYABLE

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Step #2
Determine Classification of Accounts

AS
SE
T

LIA
BI

LIT
Y
ACCOUNTS
PAYABLE

EQUIPMENT

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Step #3
Now that we know the classification, we can identify
increase and decrease sides.

EQUIPMENT
DR.

CR.

ACCOUNTS PAYABLE
DR.

CR.

+
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PURCHASED EQUIPMENT ON ACCOUNT FOR


$3,000.

Did Equipment
Increase or Decrease
in this transaction?

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INCREASED

EQUIPMENT
DR.

$3000

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CR.

PURCHASED EQUIPMENT ON ACCOUNT FOR


$3,000.

ACCOUNTS PAYABLE?
Increase or Decrease
in this transaction?

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INCREASED

ACCOUNTS PAYABLE
DR.

CR.

$3000

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DEBITS = CREDITS
EQUIPMENT
DR.
CR.

$3000

ACCOUNTS PAYABLE
DR. CR.

$3000

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Rule #3
CAPITAL ACCOUNTS

Decrease on
Debit Side

Dr.

Cr.

Increase on
Credit Side

JUST LIKE
LIABILITY ACCOUNTS
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Example
MARY ADAMS, THE OWNER, INVESTED $25,000 IN
THE BUSINESS

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Step #1
Name the accounts affected:

CAPITAL

CASH

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Step #2
Determine Classification of Accounts

O
EQ WN
U ER
IT S
Y

ASS

ET
CASH

CAPITAL

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Step #3
Now that we know the classification, we can identify
increase and decrease sides.

CAPITAL
DR.

CASH

CR.

DR.

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CR.

MARY ADAMS, THE OWNER, INVESTED $25,000 IN


THE BUSINESS

Did Capital
Increase or Decrease
in this transaction?

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INCREASED

M. ADAMS, CAPITAL
DR.

CR.

$25,000

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MARY ADAMS, THE OWNER, INVESTED $25,000 IN


THE BUSINESS

CASH?
Increase or Decrease
in this transaction?

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INCREASED

CASH
DR.

$25,000

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CR.

DEBITS = CREDITS
CASH
DR. CR.

$25,000

M. ADAMS, CAPITAL
DR. CR.

$25,000

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Rule #4
REVENUE ACCOUNTS

Decrease on
Debit Side

Dr.

Cr.

Increase on
Credit Side

JUST LIKE
LIABILITY & CAPITAL
ACCOUNTS
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Example
MARY PERFORMED SERVICES AND RECEIVED
$4,500 IN CASH

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Step #1
Name the accounts affected:

CONSULTING
FEES

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CASH

Step #2
Determine Classification of Accounts

RE
VE

NU
E

ASS

ET
CASH

CONSULTING
FEES
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Step #3
Now that we know the classification, we can identify
increase and decrease sides.

CASH

CONSULTING FEES
DR.

CR.

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DR.

CR.

MARY PERFORMED SERVICES AND RECEIVED


$4,500 IN CASH

Did Consulting Fees


Increase or Decrease
in this transaction?

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INCREASED

CONSULTING FEES
DR.

CR.

$4,500

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MARY PERFORMED SERVICES AND RECEIVED


$4,500 IN CASH

CASH?
Increase or Decrease
in this transaction?

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INCREASED

CASH
DR.

$4,500

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CR.

DEBITS = CREDITS
CASH
DR. CR.

CONSULTING FEES
DR. CR.

$4,500

$4,500

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Rule #5
EXPENSE ACCOUNTS

Increase on
Debit Side

Dr.

Cr.

+
JUST LIKE
ASSET ACCOUNTS
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Decrease on
Credit Side

Example
MARY ADAMS PAID HER ASSISTANT $750 IN WAGES

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Step #1
Name the accounts affected:

WAGES

CASH

EXPENSE

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Step #2
Determine Classification of Accounts

EXP

AS

ENS
E

SE

CASH

WAGES
EXPENSE
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Step #3
Now that we know the classification, we can identify
increase and decrease sides.

WAGES EXPENSE
DR.

CR.

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CASH
DR.

CR.

MARY ADAMS PAID HER ASSISTANT $750 IN WAGES

Did Wages Expense


Increase or Decrease
in this transaction?

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INCREASED

OFFICE SUPPLIES
DR.

$750

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CR.

MARY ADAMS PAID HER ASSISTANT $750 IN WAGES

What about Cash?


Increase or Decrease
in this transaction?

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DECREASED

CASH
DR.

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CR.

$750

DEBITS = CREDITS
WAGES EXPENSE
DR.
CR.

$750

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CASH
DR. CR.

$750

How to apply the Rules????


Firstly, find out which are the two accounts affected
in the transaction
Secondly, find out to which class the above two
accounts belong.
Thirdly, find out whether the account value
increases or decreases.
Lastly, write the particular account to be debited
and the account to be credited.

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Extra Examples:
Gagan commenced business with Rs. 100,000.
Cash Account

Capital Account

Asset Account

Capital Account

Increases

Increases

Debit Cash Account

Credit Capital Account

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Extra Examples: (Contd..)


Purchased goods from Mr. Abhishek Rs. 10,000 for cash.
Purchases Account

Cash Account

Expense Account

Asset Account

Increases

Decreases

Debit Purchases Account

Credit Cash Account

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Extra Examples: (Contd..)


Purchased goods from Mr. Ankit Rs. 20,000 on Credit.
Purchases Account

Ankits Account

Expense Account

Liability Account

Increases

Increases

Debit Purchases Account

Credit Ankits Account

NOTE: Accounts Payables is an account which indicates the liability


that needs to be paid off in the near future.
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Extra Examples: (Contd..)


Paid Cash Rs. 8000 to Mr. Ankit on account.
Ankits Account

Cash Account

Liability Account

Asset Account

Decreases

Decreases

Debit Ankits Account

Credit Cash Account

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Extra Examples: (Contd..)


Returned goods worth Rs. 1000 to Mr. Ankit.
Ankits Account

Purchases Returns Account

Liability Account

Expense Account

Decreases

Decreases

Debit Ankits Account

Credit Purchases Returns


Account

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Extra Examples: (Contd..)


Purchased furnitures from Mr. Anil Rs. 3000 on Credit.
Furnitures Account

Anils Account

Asset Account

Liability Account

Increases

Increases

Debit Furnitures Account

Credit Anils Account

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Extra Examples: (Contd..)


Purchased machinery for cash Rs. 5000.
Machinery Account

Cash Account

Asset Account

Asset Account

Increases

Decreases

Debit Furniture Account

Credit Cash Account

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Extra Examples: (Contd..)


Returned machinery due to a serious defect in the design.
Cash Account

Machinery Account

Asset Account

Asset Account

Increases

Decreases

Debit Cash Account

Credit Furniture Account

NOTE:
Here, we assume that the Supplier returns the amount immediately.
If the supplier doesnt returns the amount immediately, then the
offset account will be Accounts Receivables.
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Extra Examples: (Contd..)


Sold goods to Mr. Jitender Rs. 15,000 for cash
Cash Account

Sales Account

Asset Account

Revenue Account

Increases

Increases

Debit Cash Account

Credit Sales Account

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Extra Examples: (Contd..)


Sold goods to Mr. Akhtar Rs. 9000 for credit
Akhtars Account

Sales Account

Asset Account

Revenue Account

Increases

Increases

Debit Akhtars Account

Credit Sales Account

NOTE: Accounts receivables is an account which has future


economic benefit, that is why it is regarded as asset account.
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Extra Examples: (Contd..)


Received cash Rs. 4000 from Mr. Akhtar on account.
Cash Account

Akhtars Account

Asset Account

Asset Account

Increases

Decreases

Debit Cash Account

Credit Akhtars Account

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Extra Examples: (Contd..)


Mr. Akhtar returned goods worth Rs. 500.
Sales Returns Account

Akhtars Account

Revenue Account

Asset Account

Decreases

Decreases

Debit Sales Returns Account

Credit Akhtars Account

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Extra Examples: (Contd..)


Mr. Jitender returned defective goods worth Rs. 1000.
Sales Returns Account

Cash Account

Revenue Account

Asset Account

Decreases

Decreases

Debit Sales Account

Credit Cash Account

NOTE:
Here, we assume that the amount is returned immediately.
If the company doesnt returns the amount immediately, then the
offset account will be Accounts Payables.
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Extra Examples: (Contd..)


Paid Salary Rs. 7000 to Accountant.
Salary Account

Cash Account

Expense Account

Asset Account

Increase

Decreases

Debit Salary Account

Credit Cash Account

NOTE:
Here, we assume that the salary is paid as on date.
If the company doesnt pays the amount as on date, then the offset
account will be Salary Payables which will be a Liability Account.
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Extra Examples: (Contd..)


Paid Landlord, office rent Rs. 5000
Rent Account

Cash Account

Expense Account

Asset Account

Increase

Decreases

Debit Rent Account

Credit Cash Account

NOTE:
Here, we assume that the rent is paid as on date.
If the company doesnt pays the rent amount as on date, then the
offset account will be Rent Payables which will be a Liability
Account.
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Extra Examples: (Contd..)


Paid wages Rs. 1500
Wages Account

Cash Account

Expense Account

Asset Account

Increase

Decreases

Debit Wages Account

Credit Cash Account

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Extra Examples: (Contd..)


Received interest on bank deposit Rs. 1200
Cash Account

Interest Account

Asset Account

Revenue/Income Account

Increases

Increases

Debit Cash Account

Credit Wages Account

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Extra Examples: (Contd..)


Withdrawn cash Rs. 1000 for personal expenses.
Drawings Account

Cash Account

Capital Account

Asset Account

Decreases

Decreases

Debit Drawings Account

Credit Cash Account

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Extra Examples: (Contd..)


Borrowed Bank Loan of Rs. 10,000
Cash Account

Bank Loan Account

Asset Account

Liability Account

Increases

Increases

Debit Cash Account

Credit Bank Loan Account

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Banking Transactions
Business concerns generally deposit their excess cash into
bank. It is for the sake of safety and also the bank provides
some facilities to the depositors.
Whenever cash is required it can be withdrawn from bank
and even the payments can be made to others through
cheques.
The other parties may also make payments to us by means
of cheques drawn on their banks.
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Extra Examples: (Contd..)


Deposited cash into bank Rs. 5,000.
Bank Account

Cash Account

Asset Account

Asset Account

Increases

Decreases

Debit Bank Account

Credit Cash Account

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Extra Examples: (Contd..)


Withdrawn from bank for office use Rs. 1,000.
Cash Account

Bank Account

Asset Account

Asset Account

Increases

Decreases

Debit Cash Account

Credit Bank Account

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Extra Examples: (Contd..)


Paid Mr. Ankit on account by cheque Rs. 2,000
Ankits Account

Bank Account

Liability Account

Asset Account

Decreases

Decreases

Debit Ankits Account

Credit Bank Account

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Extra Examples: (Contd..)


Received Cheque from Mr. Akhtar on Account Rs. 3,000
Cash Account

Akhtars Account

Asset Account

Asset Account

Increases

Decreases

Debit Cash Account

Credit Akhtars Account

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Extra Examples: (Contd..)


Deposited the above cash into bank.
Bank Account

Cash Account

Asset Account

Asset Account

Increases

Decreases

Debit Bank Account

Credit Cash Account

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Journal Format
Date

Particulars

L.F.

Dr.

Cr.

NOTE: L.F means Ledger folio or page number of ledger. (Similarly,


in ledger, page number of journal is mentioned for cross reference.
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Journal Entries
Jan 1, 2013: Borrowed from Mr. B cash Rs. 10,000
Jan 3, 2013: Paid Rs. 6,000 to Mr. B on Account.
Journal Entries
Date

Particulars

Jan 1, 2013

Cash Account
To Mr. Bs Account

10,000

Mr. Bs Account
To Cash Account

6,000

Jan 3, 2013

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L.F.

Dr.

Cr.
10,000
6,000

Ledger Format
Name of the Account
Debit
Date

Particulars

Credit
J.F.

Amount

Date

Particulars

J.F.

Amount

NOTE: J.F means Journal folio or page number of Journal.


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Posting

Journal Entries

Date

Particulars

Jan 1, 2013

Cash Account
To Mr. Bs Account

10,000

Mr. Bs Account
To Cash Account

6,000

Jan 3, 2013

L.F.

Dr.

Cr.
10,000
6,000

Cash Accounts
Date

Particulars J.F Amount

Jan 1, To Mr. Bs
2013 Account

10,000

Date

Particulars

Jan 3,
2013

By Mr. Bs A/c

J.F

Amount
6,000

Mr. Bs Accounts
Date

Particulars J.F Amount

Jan 3, To Cash
2013 Account

6,000

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Date

Particulars

Jan 1,
2013

By Cash A/c

J.F

Amount
10,000

T Accounts
ACCOUNT NAME

CASH
Dr.

Cr.
SHAPED
LIKE a T

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BALANCING T ACCOUNTS
CASH
10,000

BALANCE 4,000

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16,000

Balance is
written on
side with
larger
total

Accounting Terminologies
Debit Balance:
If the total amount of debit side of an account is higher than that of
the credit side, the difference amount is called the Debit Balance.
Credit Balance:
If the total amount of credit side of an account is higher than that of
the debit side, the difference amount is called the Credit Balance.

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Format of Trial Balance


GlobalMinds Advisory Services Pvt. Ltd.
Trial Balance
April 30, 20-Sl. No

Account Title

HEADING should include:


Name of the Company
Title of Document Trial Balance
Date of the Trial Balance
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Debit Balance

Credit Balance

It Balances!!!
Debits = Credits

Format of Profit & Loss Account


Profit and Loss Account for the year ending .
Expenses/ Loss

Total

Amount Revenue/Profit

XXXX

Total

Amount

XXXX

NOTE:
The result of P& L Account may be either: Net Profit or Net Loss.
The Net Profit is shown on the debit side and the Net Loss on the
credit side.
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Format of Balance Sheet


Balance Sheet as on ..
Liabilities

Total

Amount Assets

XXXX

Total

NOTE:
The Balance Sheet, when totaled up, should tally.
It means, the total of both the sides must be equal.
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Amount

XXXX

Example

NOTE:
Please refer the word document for complete flow of transactions
from the Journal to Balance Sheet.

Microsoft Word
Document

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QUESTIONS

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