ACCOUNTING RECORDS &

SYSTEMS
• Recordkeeping Fundamentals
• Accounting is something best learned by doing;
• Debit-and-Credit Mechanism (detailing about the
transactions);
• The Account : A device used for calculating the
net changes of an item (by recording all
increases and decreases of the item together for
a period – and then calculating net changes)
 Recordkeeping Fundamentals….
1. Permanent Accounts: maintained for
various items of the Balance sheet
– at the end of the accounting period
each account is balanced;
- these balances are reported as closing
balance for this accounting period &
transferred as opening balance in the
next accounting period.
 Recordkeeping Fundamentals….
2. Temporary Accounts: established for each
revenue and expense item of an Income
Statement…& these are recorded in their
respective accounts as the period progress…
- procedure creates a “sort as you go” routine
for the transactions instead of allowing them to
be sorted out at the end of the period…
- at the end of the accounting period, all of the
temporary accounts are summed up to one
“net income amount”, which is then entered
into Retained Earnings Account.
 Recordkeeping Fundamentals….
• The Ledger: It is a group of accounts –the
accounts for balance sheet and income
statement items are often referred to as
‘General Ledger’ accounts;
• a holdover from the manual system in
which these accounts are recorded in a
bound book called as a ‘Ledger’.
 CLASSIFICATION OF
COMMONLY USED ACCOUNTS
• Assets – Fixed & Current
• Liabilities – Long-term & Short-term
• Owners’ Equity – Capital, Retained earnings
(Revenues & Expenses)
• Each of the above accounts is numbered to form
the ‘Chart of Accounts’
Assets: Liabilities:
Equipments 103 Creditors 201
Inventory 109 Expenses:
Cash 113 Advertisement 509
 DOUBLE ENTRY SYSTEM
• Every transaction must be recorded with
equal debits and credits and the total of
debits must be equal to total of credits.
• Left hand side of any account is arbitrarily
called ‘Debit Side’ (dr.) and the right hand
side is called ‘Credit Side’ (cr.).
• Standard form of an account:
Date Explanation Ref. Dr. Cr. Bal.
• ‘T Form’ of Account
 DEBIT & CREDIT RULES
• Pacioli based his procedure on the
fundamental equation:
• Assets = Liabilities + Owners’ Equity
• Arbitrarily decided that asset accounts must
increase on ‘left hand’ or ‘debit side’;
• Rules:
1. In order for debits to equal credits;
2. In order to maintain the fundamental equation,
rules for liabilities and owners’ equity accounts
have to be the opposite from those for assets.
 DEBIT & CREDIT RULES
• A = L + OE or, A = L + OE + RE
• Or, A = L + OE + (Rev. - Exp.)
• Or, A = L + OE - Drawings+ Rev. -Exp.
• A + D + E = L + OE + R
• Debit to Increase Credit to Increase
(LHS) (RHS)
• Credit to Decrease Debit to Decrease
(RHS) (LHS)
DEBIT & CREDIT RULES……..

• Or, A & E L, OE & R

• To increase Debit Credit
• To Decrease Credit Debit
 DEBIT & CREDIT RULES
• Type of Increase Normal
Accounts Recorded by Balance
• Asset Debit Debit
• Liability Credit Credit
• Owner’s Equity:
Share Capital Credit Credit
Dividend Debit Debit
Revenue Credit Credit
Expense Debit Debit
 The Accounting Process
(Accounting Cycle)
1. Analysis of transactions – deciding which
accounts to be debited & which to be credited;
2. Journalizing original entries;
3. Posting is the process of recording changes in
the ledger accounts exactly as specified by the
journal entries;
4. Adjusting entries at the end of accounting
period – journalized and posted in the same
way as original entries;
5. Journalizing & posting of Closing entries;
6. Preparation of Financial Statements.
 JOURNAL ENTRY EXAMPLE
• Date Particulars Ref Debit Credit
200X Rs. Rs.
Jan.1 Cash 2 50,000 -
Share Capital 1 - 50,000
(Cash invested in the business)

Jan.15 Inventory 9 11,000 -

Cash 2 - 9,000
Acct.s Payable 13 - 2,000
(Purchase of inventory on part payment)
 Transferring Journal to Ledger
• Locate in the ledger the debit account in the
journal entry.
• Enter date of the transaction in the Ledger.
• Enter Ref. column in the Ledger, the page no. of
journal from which entry is being posted.
• Enter in the debit column of the ledger the
amount of debit as shown in the journal.
• Enter in the ref. column of the journal the
account no. to which the debit was posted.
• Repeat the above for credit side posting.
 BALANCING THE LEDGER

• It refers to closing of the Ledger account

with the difference between the total of left
side and right side amounts in the account
at any particular time.
 TRIAL BALANCE
• A list of all accounts in the general ledger
with their balances reflected either in ‘dr.’
or in ‘cr.’ column.
1. It shows whether the equality of debits
and credits has been maintained;
2. It provides a convenient summary
transcript of the ledger records as a
basis of making the adjusting and closing
entries.
 ERROR IDENTIFICATION
• If trial balance total does not agree,
following errors may be taking place:
1. A debit may be posted in an account as
a credit or vice-versa;
2. An account balance may be computed
incorrectly;
3. Amount of an account balance may be
recorded incorrectly.
 CORRECTING ERRORS

1. Identify Correct Entry;

2. Pass Correct Entry & Compare;
3. Pass an additional correcting error entry
to neutralize the effect.
Example: A repair Expense was erroneously debited to
equipment on July 27; error was discovered on July 31.

• Erroneous Entry:
27/7 Equipment ………….500
Cash …………………….500
• Correct Entry:
27/7 Repair Expense……500
Cash ……………………500
• Correcting Entry:
31/7 Repairing Expense……500
Equipment………………….500
 The Adjusting & Closing Process
• ADJUSTING ENTRIES: End-of-period
entries that assign the financial effects of
implicit transactions to the appropriate
time periods;
• Because some events that affect
concerned accounts are not evidenced by
documents associated with original
entries.
 Features of Adjusting Entries
1. Every adjusting entry affects both a
balance sheet account (i.e. asset or
liability) and an Income Statement (i.e.
revenue or expense).
2. Adjusting entries never affect the cash
account since adjustments are needed
when transactions affect the revenue or
expenses of more than one accounting
period.
 Continuous Transactions
• Most adjusting entries are made in connection with
continuous transactions;
• 1st Method:
• Expenditure is originally recorded as an asset – at the
end of the accounting period, the inventory asset
account is adjusted by subtracting the cost of inventory
consumed (Expense).
• 2nd Method:
• The expenditure of inventory is originally recorded in an
expense account (instead of inventory). The remaining
inventory at the end is subtracted from expense and then
shown as an asset.
 Transactions result in Deferrals
• Deferrals: It is a delay of the recognition
of expenditure or revenue already
received – Concerned with past cash
receipts and payments.

• Expl: Prepaid Expenses & unearned

revenue.
 Transactions result in Accruals
• Accruals: Recognition of an expense that
has not been paid or of revenue that has
not been received – Concerned with
future cash receipts and payments.
• Expl.: Salaries of employees neither
billed nor paid.
 Types of Adjusting Entries…..
1. PREPAID EXPENSES
• Recorded costs to be apportioned among
two or more accounting periods.

• By the end of the period, the portion of

these services that has been consumed
during the period has become an expense
and the unused portion represents an
asset
 PREPAID EXPENSES…….
• Expl.: Inventory, prepaid expenses etc.

• Insurance protection, originally recorded

as prepaid insurance for Rs.7,200 of which
Rs.3,000 becomes an expense for the
current period.

• Analysis:Increase in Insurance expense

and decrease in prepaid expense.
 PREPAID EXPENSES…….
• Rule: Increase in expense is recorded by a
debit and decrease in asset is recorded by
a credit.

• Insurance Expense Prepaid Insurance

3,000 7,200 3,000
 2. Unrecorded / Accrued /
Outstanding Expenses
• These expenses were incurred during the
period, but no record of them has yet been
made (Expense Payable).
• Expl.: RS.5,000 of wages earned by an
employee during the period, but not yet
paid to the employee.
• Analysis: Increase in Wage Expense &
Increase in the liability of Accrued/
Outstanding Wages.
 Unrecorded / Accrued /
Outstanding Expenses……….
• Rule: Increase in expense has to be
debited& Increase in liability has to be
created.

• Wages Expense Accrued Wages

5,000 5,000
 3. Unearned Revenue/ Revenue
Received in Advances
• Recorded revenues to be apportioned
among two or more accounting periods.

• These amounts were initially recorded in

one account, and at the end of the
accounting period must be properly
divided between a revenue and a liability
account.
 Unearned Revenue………
• Expl.: Rent collected during the period and
recorded as rent revenue – Rs.7,500 of
which, Rs.6,000 is applicable to the next
period and hence is a liability at the end of
the current period.
• Analysis: Liability (Unearned rent revenue)
decreased. Revenues (Rent revenue
earned) increased.
 Unearned Revenue………
• Rule: Decrease in liability is recorded by a
debit and increase in revenue is recorded
by a credit.

• Rent Rev. Earned Unearned Rent Rev

1,500 1,500 7,500
 4. UNRECORDED/ACCRUED
REVENUES
• These revenues were earned during the
period but no record of them has yet been
made.
• Expl.:Rs.1,200 of interest earned by the
entity during the period but not yet
received.
• Analysis: Increase in asset (Interest
Receivable) and increase in revenue
(Interest Revenue).
 ACCRUED REVENUES………
• Rule: Increase in asset is recorded by a
debit and increase in revenue is recorded
by a credit.

• Interest Receivable Interest Revenue

1,200 1,200
 5. Depreciation
• Portion of long-lived asset costs that has
become expense during an accounting
period.

• Factors: 1.Service life of asset, 2. Residual

Value, 3. Cost of the asset along with
additional maintenance expenses.
 Depreciation Methods
1. Straight Line Method (SLM)
Original Cost – Estimated Scrap
Estimated useful life
(Amount of Depreciation is fixed)
2. Written Down Value Method
1 - n Estimated Scrap Value
Original Cost
(Depreciation Rate is fixed)
 Depreciation Methods……
• Sum of the Year Digit method (SYD)
• Rate of Depreciation =
(n/SYD) = for the first year
{(n-1)/SYD} = for the second year
{(n-2)/SYD} = for the third year
• SYD = 1+2+3+……….+n
• Rate is applied to the net cost.
 Example
• A Construction company purchased an
earthmoving equipment for Rs.20,00,000,
expected to have an useful life of 6 years,
or 15,000 hours with an estimated residual
value of Rs.2,00,000 at the end of the
time. The equipment logged 2,000 hours
in the first year.
• Compute depreciation expenses under
various methods.
 Amortization
• Business acquires intangible assets viz. patents,
copyright, trademark, goodwill by paying large
sums of money – Unexpired cost.
• Expiration of these costs (similar to depreciation)
is known as Amortization.
• Amortization is always on straight line basis.
• Intangible assets are amortized over a
reasonably short period (as it is difficult to
determine the useful life precisely).
 Accounting Treatment of
Depreciation
1. Amount of depreciation is debited to
Depreciation Expense.
2. A separate account called ‘Accumulated
Depreciation’ is credited for the amount
allocated to the period instead of making a
direct credit to the asset account.
3. The ‘Accumulated Depreciation’ is a contra
asset account (this is reported as a deduction
from related asset account in the balance
sheet.
 Example
• Rs.3,500 is the depreciation expense for
furniture.
• Analysis: Depreciation expense increased,
concerned asset decreased through
accumulated depreciation.
• Entry: Increase in expense is recorded by a
debit and decrease in asset is recorded by a
credit to contra-asset account – accumulated
Depreciation, concerned asset.
 Example………
• Depn. Expense Acc.Depn.,Furniture
3,500 3,500

• Depreciation is recorded in the Income

Statement as expense.

• Furniture will be shown in the B/S as:

Furniture………….. 35,000
Less, Accumulated Depn… 3,500 31,500
 Reasons………
• GAAP requires separate disclosure of:

1. Original cost of entity’s depreciable

assets;

1. Depreciation that has been accumulated

on these assets from the time they were
required until the date of Balance sheet.
 6. BAD DEBTS
• Arises because of credit sales.
• Such a state initially is recorded as: Debit
Accounts Receivable, Credit Sales Revenue.
• But when bad debts occur, another entry must
be made to show that:
• Amount debited to A/R does not represent the
amount of the additional asset and that O.E. has
not in fact increased by the amount of sale.
 Accounting Treatment
1. Direct Write-Off Method: Amounts that are
believed to be bad are subtracted from A/R
and same accounts are shown as expenses in
Income Statement.

• Entry: Debit Bad Debt Expense

Credit Accounts Receivable

• This method, however, requires that specific

uncollectible accounts be identified, which is
not usually possible.
 Accounting Treatment………
2. Allowance Method: Here, the total amount of
uncollectible accounts is first estimated to be
shown under ‘Bad Debts Expense A/c’ in the
Income statement.
• Then, the estimate is shown as a Contra Asset
in the B/S in the form of ‘Allowance for
Doubtful Debts Account’.
• Entry: Debit Bad Debts Expense
Credit Allowance for Doubtful Debts A/C
 Accounting Treatment………
• Bad Debts Exp. Allow. for Doubtful Debt
300 300

• In the Balance sheet:

Accounts Receivable-10,000
Less, Allow. for Doubtful Debts- 300
Accounts Receivable Net - 9,700
 Accounting Treatment………
• Now, if a company decides a specific customer
is never going to pay the amount owed, then:

• Entry:
Debit Allowance for doubtful debts…50
Credit Accounts Receivable ………..50

• This entry does not have any effect on Bad Debt

Expense or on income of the period in which
account is written off.
 CLOSING ENTRIES
• Journal entries designed to transfer the
balances in revenue and expense
accounts at the end of an accounting
period to a balance sheet equity account.
• Temporary accounts are closed now by
transferring their balances to Income
Summary or Profit & Loss account.
• Permanent accounts are also closed to
extract their balances to prepare B/S.
 Closing Revenue & Expenses
(Temporary Accounts)
1. Transferring Revenue Accounts
Debit All revenue accounts
Credit Profit & Loss A/c or Income Summary
2. Transferring Expenses Accounts
Debit Profit & Loss A/c or Income Summary
Credit All expenses accounts
 Closing Revenue & Expenses
(Temporary Accounts)…….
3. Balance of Profit & Loss a/c transferred to
Retained Earnings or Profit & Loss
Appropriation Account.
(i) If net profit:
Debit Profit & Loss Account
Credit Retained Earnings Account
(ii) If net loss:
Reverse entry
 Closing Revenue & Expenses
(Temporary Accounts)………
4. Closing Dividend Account ( Having Debit
Balance)
Debit Retained Earnings Account
Credit Dividend Account
5. Now all temporary accounts relating to
revenue expenses, dividend have zero
balance & ready to be used for next
accounting period.
 Accounts after closing
• All temporary accounts have now zero
balances & balances of permanent
accounts are carried forward to next
period.
• Post-Closing Trial Balance: Accuracy
check for all permanent accounts and
temporary accounts to be reflected in the
balance sheet.
 Steps in formation of accounting
records
• Identify transactions
• Analyze & record them in journals
• Ledger posting
• Trial Balance
• Preparing Adjusting & Closing entries
• Worksheet
• Income Summary & Balance sheet
• Transfer entries
Completion of Accounting cycle
• After passing the adjusting and closing
entries, accountants accommodate them
through Work Sheet.
• Proforma Worksheet
• Accounts Trial balance Adjustments Adjusted TB P&L A/c B/S
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
 Steps to prepare Worksheet
1. Enter the A/c balances in Trial balance column, in
adjustments column & in Adjusted Trial balance
column.

2. Enter each account in the Adjusted T.B. column to

either P&L or B/S column.

3. Total P&L A/c and B/S columns & enter the Net profit
or loss as a balancing figure in both pairs of columns.
Total the four columns with the balancing figure
included.
 PREPARING FINANCIAL
STATEMENTS
1. After preparing the work sheet, the
adjusting entries must be entered in the
general journal & posted to the ledger
accounts.
2. Next, closing entries should be designed
to transfer the balances in revenue and
expenses accounts to P&L account.
3. Balancing P&L A/c to identify Net profit
or loss for the accounting period.