Ravi Dholakiya

Roll no. 18

Financial Accounting

Accounting Cycle and Statements

of Financial Information

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ACCOUNTING CYCLE AND STATEMENTS
OF FINANCIAL INFORMATION

ACCOUNTING CYCLE

BALANCE SHEET

PROFIT AND LOSS ACCOUNT

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1. Transaction analysis
2. Recording transactions in journal books
3. Posting them in ledger books
4. Preparation of trial balance
5. Recording adjustment entries in journal book
6. Closing entries in respect of nominal accounts
7. Preparation of financial statements, namely, Profit and loss account,
Profit and loss appropriation account and Balance sheet.

In the case of existing firms, the accounting cycle starts

with opening entries of all liabilities and asset account
balances of the preceding period.
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 Accounting cycle refers to the procedural aspects of
accounting records.
(6) Preparation of
Final
(1) Transaction
Statements
Analysis
P&L A/c
and B/s

(5) Closing (2) Posting in

entries ledger books

(3) Preparation
(4) Adjustment
of
Entries
Trial Balance

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 An account is a book-keeping device to record
increases and decreases in each specific
asset or liability item.

It has two sides divided by a vertical line from the

centre, giving it the appearance of alphabet
‘T’ and is, therefore, referred to as
‘T’-account.

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Format 1: Journal Book
Journal book is a chronological record of transactions and is known
as the book of original or first entry.
Date Particulars L.F. Dr. Amount Cr. Amount

Format 2: Ledger Book

Ledger book provides details (by listing increases as well as decreases)
of each account.
Date Particulars J. Dr. Amount Date Particulars J. Cr. Amount
F. F.

Posting is the process of transferring entry from journal to ledger.

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 Conventionally, the left side of an account is known as the
debit (abbreviated Dr.) side and the right side as the
credit (abbreviated Cr.) side. The account balance
is always of the higher side.

It is reasonably safe to assume that debtors have debit balance.

Debtors are assets. Therefore, all assets have debit balances.

Liabilities are opposite of assets and, therefore,

have credit balances.

Profits and revenue/income items are liabilities (as payable to the

owners), hence, have credit balances.

Conversely, expenses and loss items have debit balances.

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 Meaning of Debit and Credit for Asset and
Expenses Account
Any Asset Account Any Expense Account

Debit for increase (+) Debit for increase (+)

Credit for decrease (-) Credit for decrease (-)

Meaning of Debit and Credit for Liability and

Revenue Account

Any Liability Account Any Revenue Account

Debit for decrease (-) Debit for decrease (-)

Credit for increase (+) Credit for increase (+)

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 Temporary Accounts Permanent Accounts

1 2 3
Nominal Personal Real

Natural Notional Tangible Intangible

Person Person Assets Assets

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Nominal Account
Debit all expenses and losses and Credit all
revenues, incomes and gains.

Personal Account
Debit the receiver and Credit the giver.

Real Account
Debit what comes in and credit what goes out.

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 Trial balance is a statement which contains the account
names along with the balances in each account at a
given point of time. It shows debit balances in one
column and credit balances in another column.
Tallying of the two sides of trial balance is a signal of
arithmetic accuracy of records made in accounting
books (journal and ledger).

Format 3: Trial Balance

Ledge account Dr. Balance Cr. Balance

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IT IS IMPORTANT TO NOTE THAT THE AGREEMENT OF THE TRIAL
BALANCE IS NOT A CONCLUSIVE PROOF OF ACCURACY. THE
REASON IS THAT TRIAL BALANCE FAILS TO DISCLOSE/DETECT
THE FOLLOWING TYPES OF ERRORS.

Errors of Omission
Error of omission arises from omission of a
transaction from the journal.
Errors of Principle
Errors of principle arises from treatment of revenue
expenditure as capital expenditure and vice-versa.
Errors of Compensation
Errors of compensation result from offsetting of one
error by another error.

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 There are two systems of keeping accounting
records.

1. Maintaining records in two books only

(i) General journal and
(ii) General ledger

2. Maintaining records in multiple books, namely,

Special journals books.

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 Maintaining accounting records based on special
journals is more advantageous. Its three
major advantage are:
i. There is less work load involved in journalising
and posting.

ii. It facilitates division of labour among employees

working in accounts section of the firm.

iii. It can relatively furnish more accurate information

and more promptly.

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 Special Journals
Format 4: Sales Book
Date Particulars L.F. Invoice Details Amount

Format is the same for sales returns book, purchase returns book.

Format 5: Cash Book

Receipts Payments
Date Particulars L.F. Amount Date Particulars L.F. Amount

Discount column can also be inserted on both side (before amount).

Format 6: Bank Book

Deposits Withdrawals
Date Particulars L.F. Amount Date Particulars L.F. Amount

In case company uses one bank book and operates with more than
one bank, there will be additional amount columns
(for each additional bank) on both sides.
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SPECIAL LEDGER

Posting procedure from Special journals to

Special ledger

1. Sales Book
Total of credit sales book is posted to the credit side of the
sales account and debit side of the individual debtors
account.

2. Sales Returns Book

The sales returns book total is posted to the debit side of
the sales return account and credit side of the debtor’s
account.
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3. Purchase Book
The total of purchase book is posted to the debit side
of the purchase account and credit side of the
individual creditors account .
4. Purchase Returns Book
The purchase returns book total is posted to the
credit side of the purchase return account and debit
side of the account of the supplier.
5. Cash Book and 6. Bank Book
Post items appearing on debit side of cash book and
bank book to the credit side of various relevant
accounts of special ledgers and general ledgers and
vice-versa.
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Adjustment Entries
Adjustment entries record outstanding expenses, expenses
paid in advance and income in arrears, depreciation etc.

Closing Entries
Closing entries are entries that close all revenue and
expense accounts by transfer to profit and loss account.

Opening Entries
Opening entries are recorded to transfer all assets and
liabilities from the previous year to the current year.

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 © Tata McGraw-Hill Publishing Company
3.Opening Entry (1st April, 2008) Limited, Management Accounting

Date Particulars Dr. Amount Cr. Amount

1st Land and building account Dr. Rs 5,00,000
April Plant and machinery account Dr. 9,95,000
Furniture account Dr. 98,000
Closing stock account Dr. 2,00,000
Cash account Dr. 2,74,100
Bank account Dr. 3,50,000
Rent paid in advance account Dr. 1,200
Sundry debtors account Dr. 25,000
  To Capital account Rs 21,00,000
  To Wages payable account 500
  To Sundry creditors account 2,00,000
  To P&L appropriation account 1,20,550
  To Dividends account 21,000
  To Provision for bad and doubtful debts
account 1,250
(Various assets and liabilities brought
forward from the previous accounting
year recorded)
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 Balance Sheet – Account Form
The Hypothetical Ltd. Balance Sheet as on March 31, 2008.
Liabilities and owner’s Amount Assets Amount
equity
Share capital Fixed assets
  Equity   Land, buildings, plants, etc.
  Preference   Less: depreciation
Reserves and surplus   Investments (at cost)
Long–term loans Current assets
Debentures   Inventory
Mortgages   Debtors
Current liabilities and provisions:   Cash and bank
  Bills payable   Advance deposits etc.
  Creditors   Other assets
  For goods  
  For expenses
Customer’s advance
Unclaimed dividend
Provision for dividend

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 Balance Sheet – Report Form
The Hypothetical Ltd. Balance Sheet as on March 31, 2008.

Assets, Liabilities and owner’s equity Amount

Fixed assets
Land, building, plant, machinery, etc.
Less: depreciation
Investments (at cost)
Current assets
Inventory
Debtors
Cash and bank balance
Advance deposits, etc.
Less current liabilities and provisions
Bills payable
Creditors:
   For goods
   For expenses
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(Contd.)
Customer’s advances
Unclaimed dividend
Provision for dividend
Provision for taxation
Net current assets
Other assets
Total net assets
Financed by
Share capital
Reserves and surpluses
Shareholder’s equity
Non–current liabilities
Debentures
Mortgages
Total obligations

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Profit and loss account portrays the operations of a firm during an
accounting period. Normally, the P&L A/c is divided into four parts:

(1) Manufacturing account (with an objective to determine

cost of goods manufactured).
(2) Trading account (to know gross profit margin).
(3) Profit & Loss A/c (to indicate earnings before interest and
taxes (EBIT)/operating profit, net profits before taxes and
after taxes).
(4) P&L Appropriation A/c (showing utilisation of profits
earned).

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 © Tata McGraw-Hill Publishing Company
Limited, Management Accounting
Manufacturing Account
Format 7:  Manufacturing Account of Hypothetical Limited (for the period …)
Particulars Dr. Particulars Cr. Amount
Amount
To Cost of direct raw materials used: By Sale of scrap
Opening stock By Closing stock of work-in-process
Add purchases (including freight) By Cost of goods manufactured(balancing
Less closing stock figure) transferred to Trading A/c  
To Work-in-process (opening stock)
To Direct labour cost
To Other direct expenses
To Manufacturing expenses:
Factory rent
Factory insurance
Fuel and power
Depreciation of plant and machinery
Repairs/maintenance of machinery
Consumable stores
Indirect labour cost (salary of
supervisors, foreman, factory manager)
Other manufacturing expenses (specify)

Note: In case the cost of goods manufactured (of finished output) is lower than
purchase/buy cost from market, production department is efficient.

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 Profit & Loss Account

Format 8:  Trading Account of Hypothetical Limited (for the period …)

Dr. Cr.
Particulars Particulars
Amount Amount
To Cost of goods sold: By Sales revenue
Opening stock of finished (Gross)
goods Less Returns
Add production cost*
(transferred from
manufacturing A/c)
Less closing stock of
finished goods
To Gross profit (balancing
figure) transferred to P&L
A/c
*Purchase costs (including freight) are used in the case of trading/non-
manufacturing firms; in such firms, goods purchased are sold without
any further processing.

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 Profit & Loss Account
Format 9: Profit & Loss A/c of Hypothetical Limited (for the period …)
Dr. Cr.
Particulars Particulars
Amount Amount
To Administrative expenses: By Gross profit
Office salary By Operating profit
Office insurance By Other incomes:
Office rent Interest received
Depreciation on office Dividend received
equipments & furniture Commission received
Office electricity bills Discount received
Office stationary and postage Other incomes
(specify)
Office telephone, fax and
internet
Office traveling expenses
Other office expenses (specify)
To Selling expenses:
Advertising
Salesman salaries
Salesman commission
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 (Contd.)
Bad debts
Add provision for bad and doubtful
debts  created during current year
Less provision created during last
year
Freight/Carriage on goods sold
Depreciation of deliver vans
(used to deliver goods at buyer
place)
Cost of free samples distributed
Other selling expenses (specify)
To Operating profit/EBIT
(balancing figure)
To Financial expenses:
Interest on borrowings
Bank charges By EBIT
Amortisation cost of raising funds  
Other expenses (specify)  
To Profit before taxes  
To Provision for taxes  
To Net profit after taxes By Profit before taxes

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Format 10:  Income Statement of Hypothetical Limited (for the period …)

Particulars Amount
Revenues:
Gross sales revenue
Less returns
Less operating expenses:
Cost of goods sold
Administrative expenses (specify each)
Selling expenses (specify each)
Operating profit/EBIT
Other incomes (specify each)
Less non-operating expenses:
Financial expenses (specify each)
Profit before taxes
Less provision for taxes
Net profit after taxes
Less appropriations:
Dividends (proposed)
General reserve
Others appropriations (specify each)
Retained earnings (out of current year profit)
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 © Tata McGraw-Hill Publishing Company
P&L Appropriation Account
Limited, Management Accounting

Profit and loss appropriation account deals with the

use/appropriation of profits
Format 11: P&L Appropriation Account of Hypothetical Limited
(for the period …)
Dr. Cr.
Particulars Particulars
Amount Amount
To Statutory reserve By Net profit
To General reserve after taxes
To Long-term assets
replacement reserve  
To Dividend (proposed)  
To Dividend equalisation  
reserve  
To Other reserves  
(specify)  
To Balance (representing
retained earnings out
of current year profits
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