BASICS OF ACCOUNTINGContents Introduction to accounting... Introduction .. Meaning of accounting Functions of accounting...esene eet Accounting Cycle. Book-keeping, accounting and accountancy Objectives of accounting. Sub-disciplines within accounting. nancial accounting Cost accounting. Management accounting... Accounting is an art as well as science ‘Advantages of accounting. Disadvantages of accounting... Types of Accounting Information ... Basic accounting terms... Accounting principles. Bases of accounting... Accounting equation ...ssisicnenstinneutinnninanenisnenensienieieiniinnnasinenanaensnesnnennsaneiee LT Rules of debit and credit Journal Ledger Subsidiary books .. 9 2 1 5, Cash book. 10 6 Trial balance and rectification of errors 58 Financial statement of sole proprietorship .. pe.Introduction to accoun ng Introduction Atend of each year, every business wants to know how much profit they have earned or losses ‘occurred, how much stock they have in their warehouse, how much is business liabilities, how much is owed to them and by whom, ete. * So many other such questions which a businessman wants to know on a daily, monthly or annual basis. * Inorderto attain such information, itis essential to keep a complete and systematic record of each FATHER OF ACCOUNTING Luca Pacioli Meaning of accounting “Accounting is the art of recording, classifying and summarising in a significant manner and in terms of money, transactions and events, which are, in part atleast, of a financial character, and interpreting the result thereof.” — American Institute of Certified Public Accountants Functions of accounting 1. Identifying: Identifying the business transactions of a financial character from the source documents such as invoice, agreements, cash memos etc. and measure them in terms of money. pe.22. Recording: The next function of accounting is to keep a systematic record of all business transactions, which are identified in chronological order of their occurrence in the journal or subsidiary books. 3. Classifying: Classification of the recorded business transactions so as to group the transactions of similar type at one place. i., in ledger accounts. In order to verify the arithmetical accuracy of the accounts, trial balance is prepared. 4. Summarising: The classified information available from the trial balance is used to prepare profit and loss account and balance sheet in a manner useful to the users of accounting information. 5. Analysing: It establishes the relationship between the items of the profit and loss account and the balance sheet. The purpose of analysing is to identify the financial strength and weakness of the business. It provides the basis for interpretation. 6. Interpreting: It is concerned with explaining the meaning and significance of the relationship so established by the analysis. Interpretation should be useful to the users, so as to enable them to take correct decisions. 7. Communicating: The results obtained from the summarised, analysed and interpreted information are communicated to the interested parties. Accounting Cycle Het from when the transaction occurs, to its representation on the financial statements, to closing. the accounts. One of the main duties of a bookkeeper is to keep track of the full accounting cycle from start to finish. The cycle goes on continued till the business ends. Peart areata Pe ar Sans Beoucics ca 3- General CEs ers pe.31. Transactions- the first task of accounting is to identify the transactions of financial character and measure them in terms of money. Transactions may include a debt payoff, any purchases or acquisition of assets, sales revenue, or any expenses incurred. 2. Journal Entries- With the transactions set in place, the next step is to record these entries in the company’s journal in chronological order. In debiting one or more accounts and crediting one or more accounts, the debits and credits must always balance. 3. Posting to the General Ledger (GL) -The journal entries are then posted to the general ledger where a summary of all transactions to individual accounts can be seen. Trial Balance - At the end of the accounting period (which may be quarterly, monthly, or yearly, depending on the company), a total balance is calculated for the accounts. 5. Financial Statements- The balance sheet, income statement, and cash flow statement can be prepared using the correct balances. Book-keeping, accounting and accountancy * Identifying Book * Measuring keeping pbisasasba * Classifying ‘Summarizing * Analyzing * Interpreting © Communicating Accounting Book-Keeping — Book-keeping is recording the business transaction of monetary aspects in books of accounts. It is mainly concerned with record keeping or maintenance of books of accounts. It includes identifying, measuring, recording and classifying functions of accounting. The book-keeping function is routine and clerical in nature and can be performed by a person having limited knowledge of accounting. ‘Accounting - Accounting is considered as a system which collects and processes financial information ofa business. Accounting starts where bookkeeping ends. It includes summarising, analysing, interpreting and communicating functions of accounting. pe. 4Accountancy - Accountancy refers to a systematic knowledge of accounting, concerned with the principles and techniques which are applied in accounting. Accountancy is collection of theory and practices of accounting. Basis Book-keeping ‘Accounting Objective To maintain systematic To ascertain the net results and the records of transactions of __| financial position of the business financial nature Phase Itis the recording phase of __| itis the summarizing phase of an an accounting system accounting system Stage It is a primary stage and It is secondary stage which begins basis for accounting where the book-keeping process ends. Skills required It is routine in nature and _| Itis analytical in nature and require does not require any special | special skill or knowledge skill or knowledge Who performs It is done by junior staff Itis done by senior staff called called book keepers accountants Objectives of accounting The following are the main objectives or utility of accounting: 1. Keep systematic record of business transaction- The main objective of accounting is to keep complete record of business transactions according to specified rules. Complete record of business transactions helps to avoid the possibility of omission and frauds. For this purpose, all the business transactions are first of all recorded in journal or subsidiary books and then posted into ledger. 2. Calculate profit or loss — The second main objective of accounting is to ascertain the net profit earned on loss suffered on account of business transactions during a particular period. For this purpose trading and profit & loss account of the business is prepared at the end of each accounting period. 3. Toascertain the financial position of the business - After preparing the profit & loss account a statement called balance sheet is prepared which shows the assets and their values on one hand and liabilities and capital on the other. A balance sheet is actually a screen picture of financial position of the business. 4, To provide information to various parties- The objective of the accounting is to communicate the accounting information to various interested parties like owners, creditors, banks, government etc. pe.SSub-disciplines within accounting Financial accounting Financial accounting assists in keeping a systematic record of financial transactions, the preparation and presentation of financial reports in order to arrive at a measure of organisational success and financial soundness. The financial accounting is useful for ascertaining profit or loss made for a given period and financial position at the end of the given period and also the sources and uses of cash for the given period. Cost accounting Cost accounting assists in analysing the expenditure for ascertaining the cost of various products manufactured or services rendered by the firm. It also helps in controlling the costs and providing necessary costing information to management for decision-making. Management accounting Management accounting draws the relevant information mainly from financial accounting and cost. accounting which helps the management in budgeting, assessing profitability, taking pricing decisions, capital expenditure decisions and so on. Accounting is an art as well as science Accounting, like science follows a systematic and organized path to understand the economic status of an entity. Science is obtaining knowledge by a systematic pattern including observation, study, practice, experiments and investigation. Like Science, Accounting requires gaining knowledge about the economic status of an entity by systematic study. An accountant finalizes the economic results by identifying, analyzing, classifying using the method of double entry book-keeping system. So, Accounting is a science that comprises of rules, principles, concepts, conventions and standards in science. Artis the application of techniques and methods. Accounting is an art because it presents the financial findings by following and implementing universally accepted principles (GAAP). Artis the study of application of scientific method to practical use. Accounting is an art as the established rules and principles of accounting are applied to bookkeeping process of an economic entity. pe. 6Advantages of accounting ‘* Protecting business assets ‘* Facilitates settlement of tax liabilities: A systematic accounting record immensely helps settlement of taxes as it is good evidence of the correctness of transactions. ‘© Replaces memory: A systematic and timely recording of transactions obviates the necessity to remember the transactions. The accounting record provides the necessary information. ‘* Facilitates comparative study: A systematic record enables a businessman to compare one year’s results with those of other years and locate significant factors leading to the change, if any. ‘* Facilitates loans: Loan is granted by the banks and financial institutions on the basis of growth potential which is supported by the performance. Accounting makes the information available with respect to performance. ‘* Facilitates sale of business: If someone desires to sell his business, the accounts maintained by him will enable the ascertainment of the proper purchase price. Disadvantages of accounting ‘© Accounting ignores the qualitative element: Since accounting is confined to monetary matters only, qualitative elements like the quality of staff, industrial relations and public relations are ignored. Pe.7© Accounting may lead to window dressing: The term window dressing means manipulation of accounts in a way so as to conceal vital facts and present the financial statements in a way to show a better position than what itis actually. ‘* Accounting is based on historical costs: Accounting often uses historical costs to measure the values. This fails to take into consideration factors such as inflation, price changes, etc. This skews the relevance of such accounting records and information. This is one of the major limitations of accounting. ‘* Accounting is not fully exact: Although most of the transactions are recorded on the basis of evidence such as sale or purchase or receipt of cash, yet some estimates are also made for ascertaining profit or loss. Examples of this are providing depreciation on the basis of the estimated Useful life of an asset, possible bad debts, the probable market price of the stock of goods, etc. Types of Accounting Information Information relating to profit or surplus: The income statement i.e., profit and loss account makes available the accounting information about the profit earned or loss incurred as a result of business operations or otherwise during an accounting period. Information relating to financial position: The position statement, i information available about the financial position of the entity. In the case of not-for-profit organisation, the difference between assets and liabilities is termed as ‘General Fund.’ ., the balance sheet makes the Information about cash flow: Cash flow statement is a statement that shows flow, both inflow and outflow, of cash during a specific period. It is of immense use as many decisions such as payment of liabilities, payment of dividend and expansion of business etc., are based on the availability of cash. pe.8Basic accounting terms Capital: refers to the amount invested by the proprietor in a business enterprise. Capital is also known as ~ Owner's Equity /Net Worth/ Net Assets Asset: jability + Capital Drawings: any cash or value of goods withdrawn by the owner for personal use or any private payments made out of business funds. Liabilities: It refers to the amount which the firm owes to outsiders. Example: Unpaid wages, Creditors, etc. Classification of liabilities Internal: which business entity has to pay to the proprietor or owners. External: which a business entity has to pay to outsiders. Also classified as: - Non- current liabilities (to be paid after more than 1 year) - Current liabilities (to be paid within 1 year) Case Study: Mr. X invests Rs.10000 in his business and takes a loan of Rs.25,000 from SBI Bank for a period of 10 years. Then he buys goods worth Rs.2000 from Mr. Y on credit for 2 months. Internal Liability: Rs.10000 External li Rs.25000 Non- current liability: Rs.25000 Current Liability: Rs.2000 Distinction between business transaction and event A Business Transaction is an economic activity of the business that changes its financial position. (The change should be capable of being expressed in terms of money) An event is the result of a transaction. Example: Ram purchased goods worth Rs.2 lacs and sold them for Rs.2.5 lacs. Thus, he earned a profit of Rs.50 thousand. Transactions - Economic activity of purchasing goods, selling goods. Event - Profit of Rs 50,000 earned due to the transactions taking place. peoAssets: Assets are valuable resources owned by businesses that are acquired at a measurable money cost. Example: Cash, Land, Furniture, etc. Classification of assets (1) Non - Current Assets: ‘* Held for continued use in business for producing goods and services; and Not meant for resale urniture, Land & Building, Tangible assets - which have a physical existence. (Cash, Computer) Intangible assets — do not have a physical existence. (Patents, Goodwill) (2) Current assets (Floating assets/ Circulating assets) * Meant for sale or * Converted into cash within 1 year. \ebtors, Stock, Bills receivables (3) Fictitious/ Nominal Assets: Fictitious assets are those assets which are neither tangible assets nor intangible assets but represent loss or expenses yet to be written off. Eg: Debit balance of P&L, deferred revenue expenditure. Expenditure: any disbursement of cash or transfer of property or incurring liability for the purpose of acquiring assets, goods or services. jon between Capital and Revenue Expenditure Capital expenditure Revenue expenditure It is incurred in acquiring or improving permanent _| It is a routine expenditure incurred in the normal assets which are not meant for resale. It may add _| course of business and includes cost of sales and to value of an existing asset. maintenance of fixed assets. Itis normally a non-incurring outlay. It is generally a recurring outlay. Leads to increase in earning capacity of the It maintains the earning capacity of the business business, It is shown in the balance sheet. It is shown in trading and profit & loss account. Pe. 10It provides benefit over several years. A small part_| itis consumed within an accounting year i.e., is charged to profit & loss account as depreciation | provides benefit for a single year only. The entire and the rest appears in the balance sheet. amount is charged to profit & loss account. It does not appear in the balance sheet. Expense: It is a value that has expired during the accounting period. An expense is charged to profit and loss account. Income: Income is the pr earned during a period of Income = Revenue ~ Expense Profit: It is the excess of revenue of a business over its costs. Gain: It is a profit of irregular or non-recurrent nature. For example, profit on the sale of a fixed asset or investment. excess of expenses of a period over its related revenues which may arise from normal ies. It decreases the owner's equity. Case: Following transactions were reported during an accounting reported for Mr. B’ s business of furniture. Transactions Term ‘a._Sold goods worth Rs.50, 000 to MrX__| Sales b._ Theft of cash from office Loss c._ Rs.2,000 earned by selling goods Revenue worth Rs.10,000 for Rs.12,000 ‘d. Machinery (costing Rs.25,000) sold | Gain for Rs.28,000 Terms related to trade pe. 11Buying of goods in which the business deals Purchases Purchased goods returned to the suppliers Purchase Return / Returns Outwards Transfer of ownership of goods or services to customers Sales for a price Sold goods returned by the customers Sale Return / Returns Outwards Distinction between stock and inventory Stock refers to the value of goods which are purchased for reselling and which are lying unsold at the end of the accounting period. Inventory is a wider term which includes stock also. Inventory includes: 1. Inventory of raw material 2. Inventory of semi-finished goods 3. Inventory of finished goods 4. Inventory of stock Bills receivable: An accounting term for bills of exchange drawn on debtors or received by way of endorsement from them. The amount specified in such a bills receivable at a future date. Bills payable: an accounting term for bills of exchange accepted in favour of creditors. The amount specified in such a bill is payable at a future date. Debtors: Persons or firms to whom goods have been sold or services rendered on credit and payment has not been received from them. They owe some amount to the business. Creditors: Persons or firms from whom goods have been purchased or services procured on credit and payment has not been made to them. Some amount is still owing to them. Bad debts: the amount that has become irrecoverable from a debtor. It is debited to P&L account as an expense. Insolvent: a person or an enterprise which is not in a position to pay its debts. Discount: rebate or allowance given by the seller to the buyer. It is of 2 types: pe. 12(i) Trade discount: at a fixed percentage on the list or catalogue price of the goods. Not recorded in the books of accounts (deducted in the invoice from the gross value of goods) (ii) Cash Discount: for making prompt payment. It is always recorded in the books of accounts. A gp ples BASIC ACCOUNTING PRINCIPLES Accounting Principles - Financial statements are the product of a process in which a large volume of data about aspects of the economic activities of an enterprise are accumulated, analysed and reported. This process should be carried out in conformity with generally accepted accounting principles. These principles represent the most current consensus about how accounting information should be recorded, what information should be disclosed, how it should be disclosed, and which financial statement should be prepared. The general acceptance of an accounting principle usually depends on its usefulness, objectiveness and feasibility. Generally Accepted Accounting Principles (GAAP) Generally Accepted Accounting Principles (GAAP) are basic accounting principles and guidelines which provide the framework for more detailed and comprehensive accounting rules, standards and other industry-specific accounting practices. *Accounting «Industry-specific Standards usually | accounting practices issued by the ‘to cover unusual premier accounting scenarios body of the country -Basic accounting principles/guidelines Separate Business Entity Concept - In accounting we make a distinction between business and the owner. All the books of accounts records day to day financial transactions from the view point of the business rather than from that of the owner. For instance, when a person invests Rs. 1 lakh into a business, it will be treated that the business has borrowed that much money from the owner and it will be shown as a ‘capital’ in the books of accounts of business. Similarly, if the owner withdraws some amount from the business, then it is shown as drawings in the books of accounts of business. pe. 13Money Measurement Concept - In accounting, only those business transactions are recorded which can be expressed in terms of money. In other words, a fact or transaction or happening which cannot be expressed in terms of money is not recorded in the accounting books. This concept imposes two limitations: Use of money implies that we assume stable or constant value of rupee Dual Aspect Concept - Financial accounting records all the transactions and events involving financial element. Each of such transactions requires two aspects to be recorded. The recognition of these two aspects of every transaction is known as a dual aspect analysis. According to this concept every business transaction has dual effect. For example, if a firm sells goods of Rs. 10,000 this transaction involves two aspects. One aspect is the delivery of goods and the other aspect is immediate receipt of cash {in the case of cash sales). Going Concern Concept - The business entity is assumed to be a going concern, i.e, it will continue to operate for an indefinite amount of time. This assumption is important because if the business entity were to liquidate in the near future, it would have to restate its assets and liabilities in the accordance with the. actual amount that could be realised or payable as the case may be so as to reflect the true financial Position of the entity. Accounting Period Concept - This concept requires that the life of the business should be divided into appropriate segments for studying the financial results shown by the enterprise after each segment. A year is the most common interval on account of prevailing practice, tradition and government requirements. Some firms adopt financial year of the government, some other calendar year. Historical Cost Concept - According to this concept an asset is ordinarily entered on the accounting records at the price paid to acquire it. For example, if a business buys a plant for Rs. 5 lakh the asset would be recorded in the books at Rs. 5 lakh, even if its market value at that time happens to be Rs. 6 lakh. The cost concept does not mean that all assets remain on the accounting records at their original cost for all times to come. The asset may systematically be reduced in its value by charging ‘depreciation’. pe. 14Matching Concept - This concept requires the revenue for a particular period to be matched with its corresponding expenditure so as to show the true profit for the period. This means that if you owned a store and spent money to purchase items for your inventory, you wouldn't record that expense until you sold the items for revenue. ‘Accrual Concept - Accrual concept is the most fundamental principle of accounting which requires recording revenues when they are earned and not when they are received in cash and recording expenses when they are incurred and not when they are paid. Example - A business records its utility bills as soon as it receives them and not when they are paid, because the service has already been used. The company ignores the date when the payment will be made. Difference between accounting concepts and conventions ‘Accounting concept ‘Accounting convention ‘Accounting concepts refers to the rules of accounting which are to be followed, while recording business transactions and preparing final ‘Accounting conventions implies the customs or practices that are widely accepted by the accounting bodies and are adopted by the firm to accounts. work as a guide in the preparation of final accounts. Materiality Convention — Materiality concept states that items of small significance need not be given strict theoretically correct treatment. For example, an ordinary calculator costing Rs. 100 may last for ten years. However, the effort involved in allocating its cost over the ten year period is not worth the benefit that can be derived from this operation. The cost incurred on calculator may be treated as the expense of the period in which it is purchased. It should be noted that an item material for one party may be immaterial for another. Itis a matter of judgement and common sense. Conservatism Convention - All anticipated expenses or losses will need to be accounted for but all potential income or gains should not be recorded until actually earned/received. Examples include - ‘Valuing the stock in trade at market price or cost price whichever is less’ and ‘making the provision for doubtful debts on debtors in anticipation of actual bad debts’. pe. 15Consistency Convention - The convention of consistency requires that once a firm decided on certain accounting policies and methods and has used these for some time, it should continue to follow the same methods or procedures for all subsequent similar events and transactions unless it has a sound reason to do otherwise. For example, if depr tion is charged on fixed assets according to straight line method, this method should be followed year after year. Disclosure Conve : This principle state that the financial statement should be prepared in such a way that it fairly discloses all the material information to the users, so as to help them in taking a rational decision, Bases of accounting BASES OF ACCOUNTING CASH BASIS ACCRUAL BASIS Incomes are recorded when they are received and expenses are recorded when they are paid Incomes are recorded when they are earned or acccrued, whether received or not. Similarly, expenses are recorded when they are due, whether pi Examples Cases Base of Accounting 1. Received sales order in May 2017 Recorded: Received payment in Aug 2017 May 2017 — Accrual Base ‘Aug 2017 - Cash Base 2. Expenses paid @ Rs. 1000 per month as rent for 15 months up to June 2018 Recorded: 12,000 ~ Accrual Base 15,000 - Cash Base pe. 16Cash basis PNW) eC eece tects Cree) 2. This basis of accounting is suitable ase ue tnt eRe ete eee eer Sue eRe ECR) CR ce ena ac Peetu nenctas 2. It does not follow the matching ane eaireertars Accrual basis ONC} PRS Recetas GTS Ree ues neo 2. It discloses correct profit or lo: Eee nen neue POS ane cs DIENT le as cash basis MN ee Rg cot isnot possible Accounting equation Prior to understanding an accounting equation, itis essential to know about a Balance Sheet (in a simple T format) Example to understand the basics of accounting equation Kapil started a business of shoes. He invested Rs.80 lacs of his own and borrowed Rs.20 lacs from Sunil @ 7% p.a. From this amount he bought a shop worth Rs40 lacs. He spent on furnishing Rs.10 lacs. He bought some stock of shoes worth Rs.30 lacs and balance he deposited in bank. The above position can be expressed as: Pe. 17BALANCE SHEET CAPITAL & AMOUNT (Rs) SETS, AMOUNT (Rs.) LIABILITIES Capital '80,00,000 Cash at Bank 20,00,000 Stock of shoes 30,00,000 Liabilities Furniture 10,00,000 {Loan from Sunil) _} 20,00,000 Shop premises 40,00,000 [Total 1. 3,90,00,000 yoo Also, it can be expressed in the form of an accounting equation: [Assets___ [= [Liabilities 1,00,00,000 20,00,000 Meaning Accounting Equation signifies that the assets of a business are always equal to the total of capital and liabilities. ASSETS = LIABILITIES + CAPITAL A business transaction will result in the change in either of the total assets, liabilities or capital of the firm and even after the change the assets will be again equal to the total of capital and liabilities. Continuing with the previous examples Shoes of Rs.5 lacs were sold to a retailer (Ram) on credit. Assets = Liabilities + Capital [_cash_] stock [Debtors [Furniture] shop [= [Loan] [20lacs] 25lacs] Stacs | 10lacs [adlacs| | 20lacs_ [| 80 lacs _| ASSETS = [uasiuries | Pe. 18Rules of debit and credit Meaning of debit and credit All accounts are divided into two sides. The left side of an account is called Debit side (Dr.) and the right side of account is called Credit side (Cr.) Rules of debit or credit in respect of the various categories of accounts Asset A/c Dr. ASSET A/c cr Increase in asset will be recorded ‘Amount (Rs.) Decrease in asset will be recorded ‘Amount (Rs.) con this side con this side Liability A/c Or. LIABILITY A/c cr Decrease in liability will be recorded on this side Capital A/c Dr. will be recorded on this side Decrease in capital ‘Amount (Rs.) Increase in liability will be recorded ‘on this side CAPITAL A/c ‘Amount (Rs.) Increase in capital will be recorded on this side ‘Amount (Rs.) cr ‘Amount (Rs.) pe. 19Revenue or Income A/c Dr. REVENUE OR INCOME A/c Decrease in gains | Amount (Rs.) Increase in gains and income will be and income will be recorded on this recorded on this side side cr ‘Amount (Rs.) Loss or Expense A/c Dr. LOSS OR EXPENSE A/c cr Increase in losses] Amount (Rs.) Decrease in losses ] Amount (Rs.) and expenses will and expenses will be recorded on be recorded on this side this side [ Natural persons Zz Personal accounts Artificial persons 5 i l s Representative Ss persons < I z Real 2 Impersonal 0 accounts Nominal Pe. 20Personal, Real and Nominal Accounts ‘Account Type Description Examples, Rule 1. Personal Relate to A/cofErnstand | “Debit the individual, firm, | Young, Bank A/c, | Receiver and company oran —_| A/c of Rohan Credit the Giver” institution. 2. Real Things whose Cash A/c, “Debit what comes value can be Furniture A/c, in and Credit what determined in Goodwill A/c goes out” terms of money and which are the properties of the business. 3. Nominal | Accounts of all__| Salaries paid, “Debit the expenses and incomes. Rent paid Classification of Personal Accounts: Interest received, expenses and losses and Credit incomes and ‘Account Type Description Examples ] Natural Personal ‘Accounts of human Debtors A/c, Proprietor’s beings Capital A/c ‘Artificial Personal Such accounts don’t have | Limited Company's A/c, physical existence as Bank A/c human beings but they work as personal accounts. Representative Personal | Represents a particular person or group of persons. Accrued Interest A/c, Unearned Commission Alc Classification of Real Accounts: ‘Account type. Description Examples Tangible ‘Accounts of those things | Land A/c, Building A/c, which can be touched, —_| Stock A/c felt, measured, purchased, sold etc. intangible ‘Such things which can’t | Goodwill A/c, Patents be touched, but, of ‘Alc, Copyrights A/c course their value can be measured in terms of money. pe. 21Note: When any word (as a prefix or suffix) is added to a Nominal A/c, it becomes a Personal A/C Example: Interest A/C: Nominal A/c Interest Outstanding A/C: Personal A/c Journal Meaning The books in which transactions are recorded for the first time from a source document are called ‘Book of Original Entry’. Journal is one of the basic books of original entry in which transactions are originally recorded in a chronological order according to the principles of double entry system. After Journal, transactions are entered in Ledger. The process of recording a transaction in a journal is known as Tn The transfer of journal entry to a ledger account is called posting Format of Journal Date [Particulars LF [Amount fpmount [Account to be debited xx Dr. X Account to be credited (Narration) The various columns of journal are explained in details below: Date This column is used to write the date of the business transaction. Different date formats are used in different countries. Different formats of date are: 15.03.2001, 03.15.2011, 15 March 2021 etc. pe. 22Particulars or Details Column In this column the names of the two connected accounts are written in two consecutive lines - in the first line the name of account debited and in the second line the name of account credited. The world "Dr." is used at the end of the name of account debited. It is not necessary to place the word "Cr." after the name of the credited account, because if one account is Dr. It follows that the other account must be Cr. Ledger Folio (L.F) In this column, the number of the ledger page is written to which the amount is posted Amount The debit amount is written in the first "amount" column against the name of account debited and the credit amount in the second "amount" column against the name of account credited. All the columns, except the Ledger Folio column are completed at the time Cee Ue eae Puce es Rules for Journalizing How a transaction is recorded in journal, is discussed below: Suppose the transaction is: Purchased furniture from Mr. A on 10.01.20 for Rs.16,000, for cash Here furniture accounting is debited and cash account is credited. Date Particulars LF {amount ‘Amount 10.01.20 Furniture A/c woreernseens DI 16,000 Cash A/c 16,000 (Being the furniture purchased against the cash) Simple Entry and Compound Entry Simple entry - Every transaction effect two accounts - one is debited and another account is credited. Thus, in recording a transaction in a journal one account is debited and another account is credited. This type of entry is called simple entry. pe. 23Compound entry - The entry in which more than one account is debited or more than one account is credited, is known as compound entry. Three or more accounts are connected with a compound entry. Example of Simple Entry For example, on 10.04.20 we bought furniture from S. The entry is: Date Particulars LF [Amount Amount 10.04.20 Furniture A/C.nnnnnnnnmnnnnDF: | [10,000 sac 10,000 (Being furniture purchased on credit) Example of Compound Entry For example, on 16.05.20 we paid Rs. 1,000 on account of salaries and Rs.600 on account of rent. For this the entry will be: Date Particulars LF [Amount ‘Amount 16.05.20 Salary A/C. 11,000 Rent A/C. 600 Cash A/C 10,000 (Being salaries and rent) Here two accounts have been debited and the entry involves three accounts. Hence, it is a compound entry. Personal Books and Business Books It should be noted here that no private transactions of the proprietor can be recorded in the books of business. On the other hand, no transactions of the business can be recorded in the books of its proprietor. But the transactions in between proprietor and business must be recorded in the books of both the proprietor and business. If these rules are not strictly followed, the books of account will fail to disclose the true result of business. We are concerned with the books of business, not with the private books of proprietor. Transactions between the business and its proprietor are recorded in the following two accounts: Capital Account The money with which proprietor starts his business is called capital. When proprietor brings capital in the business, it is recorded in capital A/C. Capital account is in fact the personal account of the proprietor. So, itis a personal account. The proprietor has given the benefit to the business through introduction of capital. So, proprietor's account A/C, i.e., capital account will be credited. From the viewpoint of pe. 24bookkeeping the introduction of capital to the business by proprietor means that the proprietor lends the money to his business and the business becomes indebted to him. The proprietor is regarded as a special or internal creditor to the business. Example: Mr. R started a business with Rs.20,000 Date Particulars LF [Amount [Amount 16.05.20 Cash A/C... 20,000 Capital A/C |20,000 (Being capital brought in) Drawings If the proprietor draws any money or takes goods from his business for his personal use, it will be recorded in drawings A/C. Drawings A/C is the personal account of the proprietor, so it is classified as the personal account. Proprietor receives benefit when he withdraws money or goods from business. So, the proprietor’s account i.e., drawing is debited. Example: Date Particulars LF [Amount {Amount 16.05.20 Drawings A/C Ia |2,000 Cash A/C 2,000 (Being amount withdrawn by proprietor) Entries of some specific transactions Cash Discount The manufacturers and whole sellers frequently grant cash discount to their debtors who will pay their debts before due date for goods purchased by them on credit. The seller regards it a "cash discount" or "sale discount" or "discount allowed". The buyer calls the discount as "purchase discount" or "discount received". Trade Discount This discount is allowed by wholesaler or manufacturer to the retailer at a fixed percentage on the listed price of goods. It is allowed when goods are manufactured in bulk. No separate entry is passed for the trade discount, as it is deducted from the invoice of the goods. pe. 25Da ner eee UC Reams ee alee lO Meee ered EU EU Ru rime uke ela eC Bad Debts When the goods are sold on credit to a customer, and if the amount becomes irrecoverable, the amount is called as bad debts. For recording it, bad debts is debited and customer account is credited. Bad Debts A/c Dr. To debtor’s personal A/c Bad Debts Recovered Sometimes, it happens if the bad debts previously written off are subsequently recovered. In such case: Cash A/c Dr. To Bad Debts Recovered A/c Outstanding Expenses Sometimes, there are some expenses which are yet to be paid at the end of the accounting period, they are called as Outstanding Expenses Expenses A/c Dr. To Outstanding expenses A/c Prepaid Expenses These are those expenses which are related to the next accounting year but paid in advance during the current year. Prepaid Expenses A/c Dr. To Expenses A/c Depreciation Itis the gradual decrease in the value of an asset due to wear and tear and passage of time. Depreciation A/c Dr. To Asset A/c Pe. 26Accrued Income The income which has been earned but not yet received is called accrued income. Accrued income/c Dr. To income A/c Income received in advance Income received but not earned during the accounting period is called income received in advance. Income A/c Dr. To income received in advance A/c Purchase and sale of fixed asset Fixed asset includes land, building, plant, machinery, furniture etc. When fixed asset is purchased, the asset account is debited. It is not debited to purchases account as fixed asset is not for the purpose of sales. Similarly, when fixed asset is sold, itis credited to asset account and not sales account. ‘* On purchase of asset for cash Asset A/c Dr. To cash A/c ‘* On purchase of asset on credit Asset A/c Dr. To suppliers A/c © Onsale of asset for cash Cash A/c Or. To assets A/c ‘* Onsale of asset on credit Purchaser A/c Dr. To assets A/c Expenditure on installation of Machinery Any expenditure incurred on the carriage and installation of machinery is treated as capital expenditure and included in the cost of the machinery. Asset A/c Or. To cash A/c Transactions related to goods Drawings of Goods pe. 27Drawings A/c Dr. To Purchases A/c Goods given away as charity Charity A/c Dr. To Purchases A/c Goods distributed as samples Advertisement expenses A/c Or. To Purchases A/c Loss of Goods by theft or fire Loss by Theft A/c Dr. Loss by Fire A/c Or. To Purchases A/c In case goods were insured Insurance Company A/e Dr. To Loss by Theft or Fire A/c If full claimed amount is received Bank A/c Dr. To Insurance Company A/c When stock is not insured Profit and Loss A/c Dr. To loss by theft/fire A/c Opening Entry Business firms close their books of accounts at the end of each year and start a new set of books in the beginning of each new year. The first entry in 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. While passing the opening entry all the assets are debited and capital and liabilities are credited. If capital is not given, total liabilities are deducted from total assets. Example of Journal Journalise the following transactions: 2020 Feb. 3 X commenced business with a capital of Rs.15,000 05 Purchased good Rs.6,000 07 Purchased goods on credit from S & Co. Rs.3,000 10 Purchased furniture Rs.2,400 1 Sold goods Rs.3,900 15 Sold goods on credit to D Rs.2,250 Pe. 2820 Paid salaries Rs.960 25 Received commission Rs.75 26 Returned goods to S & Co. Rs.600. 27 Returned goods by D Rs.450 28 Received from D Rs.1,500 Paid to $ & Co. Rs.1,800 X withdrew from business Rs.900 Charged depreciation on Rs.240 Borrowed from K Rs.1,500 Solution: Journal (Date [Particular [LF Amount [Amount \2020, \Feb. |cash A/C Dr. {15,000 3 Capital 15,000 |(Being capital brought in) |S [Purchases A/C Dr. {6,000 Cash A/C 6.000 |(Being goods purchased for cash) 7 [Purchases A/C Dr. [3,000 S&Co.A/C '3,000 Pegeeebententionsa cree 10 Furniture A/C Dr. [2,400 Cash A/C \2,400 |(Being furniture purchased for cash) a1 [cash A/C Dr. 3,900 Sales A/C {3,900 [Being goods sold for cash) 15D Bros. A/C Dr. [2,250 Sales A/C 2,250 \(Being goods sold on credit to D) 20 [Salaries A/C Dr. {60 Cash A/C {960 pe. 29(Being salaries paid) 25 |cash yc Dr. Commission A/C (Being commission received) 26 |S&Co.A/C Dr. Purchases A/C Return (Being goods returned to S & co.) 127. |Sales Returns A/C Dr. D Bros. A/C (Being goods returned by D Bros.) 28 \casha/c Dr. DBros. A/C (Being amount received from D Bros.) ff S&co.arc Dr. Cash A/C (Being amount paid to $ & Co.) [Drawings a/c Dr. Cash A/C (Being amount paid to S & Co.) |" [Depreciation A/C Dr. Furniture A/C fee ) fr [cash ave Or. KA/C (Being amount borrowed from K) pe. 30Ledger The journal provides a complete listing of the daily transactions of a business, but it does not provide information about a specific account in one place. For example, to know how much cash balance we have, the accounting clerk would have to check all the journal entries in which cash is involved which is very difficult. To avoid this difficulty, the debit and credit of journalized transactions are transferred to ledger accounts. Thus, all the changes for a single account are located in one place - in a ledger account. This, makes it easy to determine the current balance of any account. Standard Form of Ledger Account: To understand clearly as to how to write the accounts in ledger, the standard form of an account is given below with two separate transactions: Date [Particulars .R [Amount [Date [Particulars LR Amount ‘2005 [200s Dec. 17 |Cash A/C 1,200 Dec. 17. [Purchases A/C \2,000 Posting Procedure: Transferring information i.e., entries from journal to ledger accounts is called posting. The procedure of posting from journal to ledger is as follows: 1. Locate the ledger account from the first debit in the journal entry. 2. Record the date in the date column on the debit side of the account. The date is the date of transaction rather than the date of the posting. 3. Record the name of the opposite account (account credited in entry) in the particular (also known as. reference column, description column etc.) column. 4, Record the page number of the journal in the journal reference (J.R) column from where the entry is being posted. 5. Record the amount of the debit in the "amount column" 6. Locate the ledger account for the first credit in the journal and follow the same procedure. Balancing An Account: The difference between the two sides of an account is its balance. The balance is written on the lesser side to make the two sides equal. The process of equalizing the two sides of an account is known as balancing. The rules for balancing an account are stated as below: 1. Add up the amount columns of both the sides of an account and write the totals in a separate slip of paper. 2. Find out the difference of the two totals. 3. Write down the difference on the lesser side of the account. 4. Now total up both the sides and write the totals and draw double 5, Again write the difference on the opposite side below the double line. 1es under them. pe. 31If the debit side of an account is heavier, its balance is known as debit balance. and if the credit side of an account is heavier its balance is known as credit balance. If the two sides are equal, that account will show zero balance. The rules for determining the balance is as follows: Total Total Total It may be noted that at the time of balancing an account debit balance is placed on the credit side and debit More than total credit credit More than total debit debit Total credit = Debit balance Credit balance Nil bi nce credit balance on debit site. This balance is known as closing balance. What is closing balance in this year, is the opening balance of the next year. Examp! le: Enter the following transactions in journal and post them into ledger: 2018 Jan. 1 Mr. Javed started business with cash Rs.100,000 2 He purchased furniture for Rs.20,000 3 He purchased goods for Rs.60,000 5 He sold goods for cash Rs.80,000 6 He paid salaries Rs.10,000 Solution: Journal |Date Particular LF Amount Amount 2018 Jan. [Cash A/C 9 100,000 1 | Capital u 100,000 (Being capital brought in) 2 (Furniture 13 20,000 AIC. Dr. 9 20,000 Cash A/C \(Being furniture purchased for cash) 3° Purchases A/C.. 15 60,000 Cash A/C 9 60,000 |(Goods purchased for cash) 5 |Cashasc. 9 80,000 sales A/C ay 80,000 \(sold goods for cash) 6 [Salaries A/ 19 10,000 Cash A/C Return 9 10,000 \(salaries paid) pe. 32Ledger Cash Account (No.9) Date Particular JR Amount | Date Particulars SR Amount 20018 2018 Jan.1 [Capital A/C 100,000 |Jan.2 [Furniture A/C 20,000 Jan. [Sales A/C 80,000 — [Jan.3 [Purchases A/C 60,000 Jan.6 (Salaries A/C 10,000 Balance c/d 90,000 Total 180,000 [Total 180,000 Capital Account (No.11) Date| Particular | J.R | Amount |Date| Particulars |J.R | Amount 2018 2018 Jan.6 [Balance c/a 100,000 _[Jan.1 |Cash A/C i 100,000 Total 100,000 {Total 100,000 Furniture Account (No.13) Date Particular JR Amount Date Particulars IR ‘Amount 2018 2018 Jan.2 [Cash A/C 1 | 20,000 _ {ian.6 [Balance c/d 20,000 Total 20,000 Total 20,000 Purchases Account (No.15) Date Particular JR | Amount |Date| Particulars .R | Amount 2018 2018 Jan.3 cash AIC 1 60,000 Jan.6 Balance c/d 60,000 Total 60,000 Total 60,000 pe. 33Sales Account (17) Date Particular | J.R | Amount | Date Particulars 4R | Amount 2018 2018 Jan.6 [Balance c/d 80,000 Jan.5 |Cash A/C 1 80,000 Total 80,000 ‘Total 80,000 ies Account (19) Date Particular [J.R | Amount |Date Particulars JR | Amount 2018 2018 Jan.6 \Cash A/C 1 | 10,000 _ |Jan.6 [Balance c/d 10,000 Total 10,000 Total 10,000 DISTINCTION BETWEEN BOOKS OF ORIGINAL ENTRY AND LEDGER Basis Books of original entry Ledger Recording of transactions Transactions are entered for the first time in these books, they are also referred to as books of Transactions are entered in Journal or Subsidiary Books are later transferred to the Ledger. primary entry. Thus, ledger is also called a They are also referred to as book of final entry. books of primary entry. Narrations Narrations are recorded. Narrations are not recorded. Order of transactions Transactions are entered in Transactions are entered in chronological order. analytical order. Final Accounts Final accounts can’t be Final accounts can be prepared prepared with the help of books | with the help of Ledger of original entry. balances. ‘Accuracy ‘Accuracy of these books can’t | Accuracy of the Ledger be tested. Accounts is tested by preparing a Trial Balance. Process of recording Journalising Posting entries. CLOSING OF ACCOUNTS. 1. Personal Accounts Ifa personal account shows a debit balance, On the contrary, if a personal account shows a credit balance, it in¢ indicates the amount owing from him. ates the amount owing to him.2. Real Accounts Method of closing the Cash A/c and the accounts of all other assets is the same as that of personal accounts. When balanced, these will always show debit balances. 3. Nominal Accounts These accounts do not require balancing. As the main purpose of opening such accounts is to ascertain the net profit or loss of the firm, all such accounts are transferred to the trading and profit and loss account of the firm at the end of the financial period. Subsidiary books If the size of business is small, then it is possible to enter every transaction in Journal only, but if the size of business is large, itis no longer possible to enter every transaction in one book only. Therefore, Journal is divided into sub-parts, known as Special Journals. Therefore, following subsidiary books are prepared: pe. 35Purchase book All credit purchases of goods are recorded in the purchases journal whereas cash purchases are recorded in the cash book. Other purchases such as purchases of office equipment, furniture, building, are recoded in the journal proper if purchased on credit or in the cash book if purchased for cash. The source documents for recording entries in the book are invoices or bills received by the firm from the supplies of the goods. The format of the purchases journal Date Invoice no. Name of supplier LF. | Amount The monthly total of the purchases book is posted to the debit of purchases account in the ledger. Individual supplier’s accounts may be posted daily. Books of Kanika Electronics Purchase Book Date Invoice no. _| Name of supplier LE. | Amount 2017 ‘Aug 04 3250 Neema Electronics 182,000 ‘Aug 10 3260 Pawan electronics 31,050 Aug 18 4256 Northern Electronics 3,06,250 ‘Aug 26 3294 Neema Electronics 54,000 ‘Aug 29 3281 Pawan Electronics 38,700 Aug 31. 6,12,000 Books of Kanika Electronics Neema Electronics Dr. cr. Date | Particulars | JF. | Amount | Date Particulars JF. | Amount 2017 ‘Aug 04 Purchases 182,000 ‘Aug 26 Purchases 54,000 Pawan Electronics Dr. cr. Date | Particulars | J.F. | Amount | Date Particulars LF. [Amount 2017 ‘Aug 10 Purchases 31,050 Aug 29 Purchases 38,700 Pe. 36Northern Electronics Or. cr. Date | Particulars | J.F. | Amount | Date Particulars JF. [Amount 2017 Aug 18 Purchases 3,06,250 Purchases Account Dr. cr. Date Particulars JF. [Amount Date | Particulars | J.F. | Amount 2017 ‘Aug 31 | Sundries as per 6,12,000 Purchases Journal Purchase return book In this book, purchases return of goods are recorded. Sometimes goods purchased are returned to the supplier for various reasons such as the goods are not of the required quality, or are defective, etc. For every return, a debit note (in duplicate) is prepared and the original one is sent to the supplier for making necessary entries in his book. The supplier may also prepare a note, which is called the credit note. Books of Kanika Electronics Purchase Return Book Date Debit note | Name of supplier LF. | Amount no. Neema Electronics 13,200 Neema Electronics Account Or. cr. Date Particulars JF. Amount Date Particulars J.F. | Amount Purchases return 13,200 Purchases Return Account Or. oe Date Particulars J.F. | Amount Date Particulars J.F. | Amount Sundries as per 13,200 purchase returns book pe. 37Sales book All credit sales of merchandise are recorded in the sales journal. Cash sales are recorded in the cash book. The format of the sales journal is similar to that of the purchases journal explained earlier. The source document for recording entries in the sales journal are sales invoice or bill issued by the firm to the customers. Date Invoiceno. _| Name of customer LF. | Amount 2017 Apr 6 178 Raman traders 4,850 Apr 09 180 Nutan Enterprises 21,000 Apr 28 209 Raman traders 85,000 Apr 30 1,10,850 Raman Traders Account Dr. cr. Date Particulars JF. [Amount [| Date | Particulars | JF. | Amount 2017 Apr 06 | Sales 4,850 Apr 28 | Sales 85,000 Nutan Enterprises Account or. cr. Date Particulars F.| Amount | Date | Particulars | Jf. | Amount 2017 Apr 01 | Sales 21,000 Sales Account or. cr. Date Particulars | J.F.| Amount | Date Particulars LF. | Amount 2017 Apr 30 | Sundries as per 1,10,850 sales book Sales return book This journal is used to record return of goods by customers to them on credit. Date Credit no. Name of customer LF. | Amount Raman traders 2,100 pe. 38Raman Traders Account Dr. Cr. Date Particulars J.F. | Amount Date Particulars JF. | Amount Sales Return 2,100 Sales Return Account Dr. cr. Date Particulars | J.F. | Amount Date Particulars JF. | Amount Sundries as per 2,100 sales return book Journal proper Entries recorded in journal proper are: Opening Entry: In order to open new set of books in the beginning of new accounting year and record therein opening balances of assets, liabilities and capital, the opening entry is made in the journal. Adjustment Entries: In order to update ledger account on accrual basis, such entries are made at the end of the accounting period. Such as Rent outstanding, Prepaid insurance, Depreciation and Commission received in advance. Rectification entries: To rectify errors in recording transactions in the books of original entry and their posting to ledger accounts this journal is used. Transfer entries: Drawing account is transferred to capital account at the end of the accounting year. Expenses accounts and revenue accounts which are not balanced at the time of balancing are opened to record specific transactions. Accounts relating to operation of business such as Sales, Purchases, Opening Stock, Income, Gains and Expenses, etc., and drawing are closed at the end of the year and their Total/balances are transferred to Trading and Profit and Loss account by recording the journal entries. These are also called closing entries. Other entries: In addition to the above-mentioned entries, recording of the following transaction is done in the journal proper: ‘© Purchase/sale of items on credit other than goods. ‘* Goods withdrawn by the owner for personal use. Goods distributed as samples for sales promotion. Endorsement and dishonour of bills of exchange. Transaction in respect of consignment and joint venture, etc. Loss of goods by fire/theft/spoilage. pe. 39Cash book It plays a dual role. It is both a book of original entry as well as a book of final entry. All cash transactions are primarily recorded in it as soon as they take place; so, itis a journal (a book of original entry/subsidiary book). On the other hand, the cash aspect of all cash transactions is finally recorded in the Cash Book (no posting in Ledger); so, a Cash Book is also a Ledger (a book of final entry/Principal Book). When a cashbook is maintained, transactions of cash are not recorded in the journal, and no separate account for cash or bank is required in the ec TYPES OF CASH BOOKS Single Column Cash Book The single column cash book records all cash transactions of the business in a chronological order, i.., itis a complete record of cash receipts and cash payments. When all receipts and payments are made in cash bya business organisation only, the cash book contains only one amount column on each (debit and credit) side. as Colac telcos 1. Non-cash transactions 2. Cheques received or given 3. Cash discount allowed or received Format of single column cash book Cash Book Or. cr. Date Receipts LF. | Amount Date Payments LF. | Amount 1. Date: Date for the transaction is written 2. Particulars: The name of the account under which the cash has been received or payment has been made is written. Cash book starts with the opening balance of cash written on the receipts side as “To balance b/d”. A new business will not have an opening balance. pe. 403. Ledger Folio (L.F.): It records the page number in the ledger where the amount has been posted in the account. 4, Amount: The amounts received are written on the debit side and the amounts paid are written on the credit side. Posting in single column cash book The left side of the cash book shows the receipts of the cash whereas the right side of the cash book shows all the payments made in cash. The accounts appearing on then debit side for the cash book are credited in the respective ledger accounts because cash has been received in respect of them. Similarly, all the account names appearing on the credit side of the cash book are debited as cash/cheque has been paid in respect of them. Balancing of single column cash book A cash book is balanced like any other account. The receipts column is always bigger than the payments column. The difference is written on the credit side as ‘By balance c/d’. Example Enter the following transactions in the cash book of Mr. Jamil: 2018. Rs. Jan.1 Mr. Jamil started business with cash 2,00,000 Jan. 3 Bought goods for cash 1,40,000 Jan. 5 Paid for stationary 2,000 Jan.7 Sold goods for cash 80,000 Jan. 10 Paid for trade expenses 2,000 Jan. 11 Sold goods for cash 20,000 Jan. 14 Received cash from Mr. Asif 10,000 Jan. 15, Paid cash to Mr. Qadir 20,000 Jan. 18 Withdrew cash for personal use 6,000 Jan. 22 Bought goods for cash 40,000 Jan. 25 Sold goods for cash 90,000 Jan. 27 Paid for electricity bill 4,000 Jan. 31 Paid salary 10,000 Jan. 31 Paid rent 3,000 Solution: Single Column Cash Book of Mr. Jamil pe. 41Date | Particulars Date | Particulars “Amount (Rs.) 2018 2018 Jan. | Capital A/C Jan. | Purchases A/C 140,000 1 3 Jan.7 | Sates A/C Jan. | Stationery A/C 2,000 = Jan. | Sales A/C Jan. | Trade expenses 2,000 11 10 Jan. | Mr ASIFA/C Jan. | Mr. Qadir A/C 20,000 14 15 Jan. | Sales A/c Jan. | Drawing A/C 6,000 25 18 Jan. | Purchase A/C 40,000 2 Jan. | Electricity A/C 4,000 27 Jan. | Salary A/C 10,000 31 Jan. | Rent A/C 3,000 31 Jan, | Balance ¢/d 173,000 31 400,00 Feb. | Balance b/d 1 Double Column Cash Book In this cash book, there are two columns on each side, one column for recording cash transactions and the other column for recording bank transactions. Format of double cash book Dr. cr. Date Receipts Date Payments | LF. Bank Contra Entry In any account we can only have one half of a double entry. An account cannot be debited and credited at the same time. For example, when we sell goods for cash, cash received will be recorded on the debit side of Cash Book and the goods sold will be posted on the credit side of Sales Account. pe. 42But in Double Column Cash Book, we have two accounts, Cash A/c and the Bank A/c, so it is possible to have both a debit entry and a credit entry at the same time. For example, cash of Rs.5,000 is deposited into the bank. In this transaction both Bank A/c and Cash A/c are involved and they will be recorded on both sides of Double Column Cash Book i.e., on the debit side in bank column and on the credit side in cash column ‘Thus, a transaction in which Cash A/c and Bank A/c are involved, is recorded on both the sides of Double Column Cash Book, it is called "contra entry”, In recording such a transaction, the letter "C", is written in 'LF.' column because both aspects of the transactions are recorded and there is no need to post them into the ledger. Example Enter the following transactions in a double column cash book/two column cash book. 2018 Rs. March 1 Cash in hand 80,000 March 1 Bank Balance 120,000 March 3 Received a cheque from Osman 24,000 March 4 Deposited Osman's cheque with bank - March 8 Withdrawn from bank for business use 20,000 March 10 Goods sold for cash 30,000 March 15 Goods bought for cash 80,000 March 18 Goods sold for cash 60,000 March 20 Paid Rahim by cheque 26,000 March 30 Deposited into bank 16,000 March 31 Paid salary in cash 10,000 March 31 Paid rent by cheque 6,000 Solution: pe. 43Double Column Cash Book Date | Particulars | V | U/] Cash Rs. | Bank Rs. | Date | Particulars | v[ t/] Cash Rs. | BankRs. /\F iG N N = 2018 Balance b/d 80,000 | 120,000 | Mar. | Bank A/c 24,000 1 4 3 | Osman A/c 24,000 8 | Cash A/c iC 20,000 4 | Gashaye c 24,000 | 15 | Purchase 80,000 Alc 8 | Bank A/c | 20,000 18 | Cash A/c | 16,000 10 | Sales A/c 30,000 20 | Rahim A/c 26,000 18 | Sales A/c 60,000 31 _| Salary A/e 10,000 30_| Cash A/c e 16,000 | 31__| Rent A/c 6,000 31_| Balance ¢/d 84,000 | 108,000 214,000 | 160,000 214,000 _| 160,000 ‘Apr 1 | Balance b/d 84,000 | 108,000 Three column cash book The triple column cash book (also referred to as three column cash book) is the most exhaustive form of cash book which has three money columns on both receipt (Dr) and payment (Cr) sides to record transactions involving cash, bank and discounts. A triple column cash book is usually maintained by large firms which make and receive payments in cash as well as by bank and which frequently receive and allow cash discounts Format of triple column cash book Page No:__ Dr. (Receipts) CASH BOOK Cr. Payments) Discount: The amount of discount allowed is recorded on debit side and the amount of discount received is recorded on credit side in discount column. The totals of debit column and credit column are posted to discount allowed account and discount received account respectively. pe. 44Note: All other columns are similar to the double column cash book. Petty Cash It is another Cash Book which is maintained, generally, in large business concerns to reduce the burden of ‘Main Cash Book’, in which numerous transactions involving petty (small) amounts are recorded. For this purpose, a Petty Cashier is appointed by the Chief Cashier. The Chief Cashier advances a sum of money to the Petty Cashier to enable him to meet petty expenses for a fixed period. The Petty Cashier will record this amount on the Debit Side of the Petty Cash Book while the Chief Cashier will record the same amount on the Credit Side of the Main Cash Book. Imprest system of petty cash book Under this system, a definite sum, say Rs.2,000 is given to the petty cashier at the beginning of a certain period. This amount is called imprest amount. The petty cashier goes on making all small payments out of this imprest amount and when he has spent the substantial portion of the imprest amount say Rs.1,780, he gets reimbursement of the amount spent from the head cashier. Thus, he again has the full imprest amount in the beginning of the next period. The reimbursement may be made on a weekly, fortnightly or monthly basis, depending on the frequency of small payments. The balance of the Petty Cash Book will be shown on the asset side of balance sheet as “Cash in hand” at the end of the year. Example From the following particulars prepare a Petty Cash Book under Imprest System. 2018 Jan. 1. Received from the Chief Cashier as imprest cash Rs.400. Jan. 2. Paid Taxi hire Rs.20. Jan. 3. Paid postage Rs.28 and stationery Rs.60. Jan. 4, Purchased stationery Rs.48. Jan. 5. Paid telegram charges Rs.28 and bus fare Rs.4. Jan. 6. Bought postage stamps Rs.96. Jan. 7. Paid Rs.72 for repairs of typewriter. Solution: Petty cash book pe. 45‘Amount | Date V. | Total | Traveling | Postag | Station | Office | Misc. Received No| Rs. | Expenses esRs. | eryRs. | Expenses Expenses Rs. a Rs. Rs. Rs. 400 | 2018 | Cash Received Jun. 1 Jun. | Taxi hire A/c 20 20 2 Jun. | Postage A/c 28 28 3 Jun. | Stationery A/e 60 60 BI Jun. | Stationery A/c 48 48 4 Jun. | Telegram A/c 28 28 BI Jun. | Bus fare A/c 4 4 5 Jun. | Postage A/c 96 96 6 Jun. | Repairs A/c 72 2 7 356 | 24 152 | 108 2 Balance c/d 44 400 400 44 | Jun. | Balance b/d 8 356 Cash received Trial balance and rectification of errors Meaning of trial balance Atrial balance is a statement showing the balances, or total of debits and credits, of all the accounts in the ledger with a view to verify the arithmetical accuracy of posting into the ledger accounts. Format of trial balance pe. 46Trial Balance of ...... as on March 31, 2014 ‘Account Title Purpose of Trial Balance 1. To check the equality of debits and cre 2. To help in preparation of final accounts. 3. To locate errors. 4, To obtain a summary of ledger accounts. ~ an arithmetical or mathematical test of accuracy. If the trial balance agrees we may reasonably assume that the books are correct. On the other hand, if it does not agree, it indicates that the books are not correct - there are mistakes somewhere. There are however, a few types of errors which the trial balance cannot detect. In other words, the trial balance will agree in spite of the existence of those errors. Methods of Preparing Trial Balance There are two methods for the preparation of trial balance. These methods are: 1. Total or gross trial balance 2. Balance or net trial balance Total or Gross Trial Balance Under this method the two sides of all the ledger accounts are totalled up. The total of debit side and credit side of each account is then placed on “debit amount" column and “credit amount" column respectively of a list. Finally, the two columns are added separately to see whether they agree of not. Balance or Net Trial Balance Under this method, first of all the balances of all ledger accounts are drawn. Thereafter, the debit balances and credit balances are recorded in "debit amount" and "credit amount" column respectively and the two columns are added separately to see whether they agree or not. pe. 47Example Enter the following transactions in journal and post them into the ledger and also prepare a trial balance. 2018 Jan. Jan. Jan. Jan. Jan. eewne Mr. X started business with cash Rs.80,000 and furniture Rs.20,000. Purchased goods on credit worth Rs.30,000 from Y. Sold goods for cash Rs.16,000. Sold goods on credit to $ for Rs.10,000 Cash received from § Rs.9,800 in full settlement of his account. Solution: Journal Date Particulars i DR. 2018 Amount (Rs.) 13. Cash a/c 80,000 Furniture A/C 20,000 Capital A/c (Owner invested cash and furniture) Purchases Account y {Bought goods on credit) Cash A/C sales A/C (Sold goods for cash) sa/c sales A/C {Sold goods on credit) Cash A/C Discount A/C sac (Cash received and discount allowed) cr. Amount (Rs.) pe. 48Ledger Cash Account Date | Particulars [ iF | Amount | Date | Particulars | JF [Amount Jan1 | Capital a/c 80,000 | Jan31 | Balance 1,05,800 cfd jan3_| Sales a/c 16,000 Jan8 Sa/c ‘9,800 1,05,800 1,05,800 Feb1 | Balance 105,800 b/d Furniture Account Date | Particulars | JF [ Amount | Date | Particulars | JF | Amount Jan 1 | Capital a/c 20,000 | Jan31 | Balance 20,000 cfd 20,000, 20,000 Feb1 | Balance 20,000 b/d Capital Account Date | Particulars | JF | Amount | Date | Particulars | JF | Amount yan 31 | Balance 1,00,000 | Jana | Casha/e 80,000 c/d Jan | Furniture 20,000 a/c 1,00,000 1,00,000 Feb1 | Balance 1,00,000 b/d pe. 49Purchases Account Date | Particulars | JF [ Amount | Date | Particulars [JF [Amount Jan2 | Ya/e 30,000 | Jan31 | Balance 30,000 cfd 30,000 30,000 Feb1 | Balance 30,000 b/d Y Account (No.13) Date | Particulars [ JF [ Amount | Date | Particulars [JF | Amount Jan 31 | Balance 30,000 | Jan2 | Purchases 30,000 old afc 30,000 30,000 Feb1 | Balance 30,000 b/d Sales Account Date | Particulars [ JF [ Amount | Date | Particulars [JF [_ Amount Jan 31 | Balance 40,000 | Jan3 | Casha/c 16,000 od van | Safe 10,000 40,000 40,000 Feb1 | Balance 40,000 b/d ‘S$ Account Date | Particulars | JF | Amount | Date | Particulars [JF [Amount jan4 | Sales a/c 10,000 jan8 | Cash a/c 9,800 Jan8 | Discount 200 afc 10,000 10,000 pg. 50Discount Account (No.19) Date | Particulars | JF [ Amount [ Date | Particulars | JF [Amount yan8 | Sa/c 200 | Jan31 | Balance 7200 od 200 200 Febi | Balance 200 b/d Trial Balance (Balances method) S.No. ‘Account Name _ Debit Credit 1 [Cash Account 105,800 2 _ [Furniture Account 20,000 3 |Capital Account - 100,000 4 — [Purchases Account 30,000 5__{y Account = 30,000 6 [Sales Account - 26,000 7 {SAccount = 8 [Discount Account - [Total 156,000 1,56,000 an account shows zero balance, it is not necessary to record it in trial balance. Types of errors Types of errors Errors of Errors of Errors of Compensating omission ‘commission principle errors Errors of omission pe. 52‘The errors of omission may be committed at the time of recording the transaction in the books of original entry or while posting to the ledger. These can be of two types: (i) error of complete omi (ii) error of partial omission When a transaction is completely omitted from recording in the books of original record, itis an error of complete omission. For example, credit sales to Mohan Rs. 10,000, not entered in the sales book. When the recording of transaction is partly omitted from the books, it is an error of partial omission. If in the above example, credit sales had been duly recorded in the sales book but the posting from sales book to Mohan’s account has not been made, it would be an error of partial omission. Errors of commission These are the errors which are committed due to wrong posting of transactions, wrong totalling or wrong balancing of the accounts, wrong casting of the subsidiary books, or wrong recording of amount in the books of original entry, etc. For example: Raj Hans Traders paid Rs.25,000 to Preetpal Traders (a supplier of goods). This transaction was correctly recorded in the cashbook. But while posting to the ledger, Preetpal’s account was debited with Rs.2,500 only. This constitutes an error of commission. Such an error by definition is of clerical nature and most of the errors of commission affect in the trial balance. Errors of principle Accounting entries are recorded as per the generally accepted accounting principles. If any of these principles are violated or ignored, errors resulting from such violation are known as errors of principle. An error of principle may occur due to incorrect classification of expenditure or receipt between capital and revenue. Examples: ‘* Amount spent on additions to the buildings should be treated as capital expenditure and must be debited to the asset account. Instead, if this amount is debited to maintenance and repairs account, it has been treated as a revenue expense. This is an error of principle. * Ifacredit purchase of machinery is recorded in purchases book instead of journal proper or rent paid to the landlord is recorded in the cash book as payment to landlord, these errors of principle. These errors do not affect the trial balance. Compensating errors When two or more errors are committed in such a way that the net effect of these errors on the debits and credits of accounts is nil, such errors are called compensating errors. Example: Shyam’s account was debited with Rs.100 instead of Rs.1000 while Ram's account was debited with Rs.1000 instead of Rs.100. Thus, Shyam’s account which was debited by Rs.900 less was compensated by another error in Ram’s account, whose account was debited excess of Rs.900. pe. 52From another point of view, errors may be divided into two categories: Errors affecting Trial Balance 1, Posting only one aspect of the journal entry in the ledger 2. Posting a journal entry on the wrong side of an account 3. Wrong totalling of the subsidiary books 4. Posting the correct amount in one account and wrong amount in another account 5. Wrong totalling or balancing of the ledger account 6. Omission in writing the balance of an account in the trial balance 7. Writing balance in the wrong column of trial balance 8. Totalling the trial balance wrongly Errors not affecting Trial Balance 1. Errors of complete omission Transaction remains altogether unrecorded either in Journal or in Subsidiary books. 2. Compensating Errors Effect of one error is neutralized by the effect of some other error. 3. Errors of Principle ‘Some fundamental principle of accounting is violated while recording a transaction. Suppose on the purchase of a typewriter, office expenses account is debited, the trial balance will still agree 4. Errors of Posting in wrong account While posting from the books of ori ial entry, posting is made to a wrong account but on the correct side. 5, Recording both the aspects of a transaction twice in the books of accounts Case study (for errors) Mr. Roy is a furniture dealer. Some of the transactions undertaken through the year are as follows: pe. 53Transactions Errors Affect Trial Balance Total of purchase book was added Rs Error of commission Yes 2,000 in excess due to wrong calculations Dining table was sold to Ram. Error of commission Yes Ram’s A/c was credited by Rs 20,000. Rs 10,000 spent on repairs of old Error of Pripciple No machinery debited to Machinery A/c Sold study table to Shyam for Rs 15,000 _| Errors of Omission No but was omitted to be recorded in the books. Rs 5,000 received from Rahul was posted | Error of commission Yes on the credit side of Rahul’s A/c twice but correctly entered in Cash Book Purchased wood from Mr X for Rs 10,000. | Error of commission Yes Credited Mr X with Rs 1000 Sold a bed for Rs 40,000 but cash A/c was | Error of omission Yes not debited Purcahse book was overcast byRs1,000 | Compensating Errors | No and Purchase Returns book was overcast by Rs 1,000 Sale of table to Meena for Rs 5000 has_—_| Errors of Commi No been entered in the Journal as Rs 500 Rectification of errors From the point of view of rectification, the errors may be classified into the following two categories: (a) errors which do not affect the trial balance. {b) errors which affect the trial balance. Res ication of errors which do not affect the | balance (Two sided errors) ‘These errors are committed in two or more accounts. Such errors are also known as two sided errors. They can be rectified by recording a journal entry giving the correct debit and credit to the concerned accounts. pe. 54Examples of such errors are — complete omission to record an entry in the books of original entry; wrong recording of transactions in the book of accounts; complete omission of posting to the wrong account on the correct side, and errors of principle. Such errors are rectified by passing a rectifying entry. The procedure for rectification for such errors is explained with the help of following examples: {a) Credit sales to Mohan Rs. 10,000 were not recorded in the sales book. This is an error of complete omission. Its affect is that Mohan’s account has not been debited and Sales account has not been credited. Accordingly, recording usual entry for credit sales will rectify the error. Mohan’s a/c Dr. 10,000 To sales a/c 10,000 (b) Credit sales to Mohan Rs. 10,000 were recorded as Rs. 1,000 in the sales book. This is an error of commission. Mohan’s a/c To sales a/c Correct entry Mohan’s a/c lshould have been To sales a/c Rectifying entry | Mohan’s a/c To sales a/c (c) Credit sales to Mohan Rs.10,000 were recorded as Rs. 12,000. This is an error of commission. Wrong entry Mohan’s a/c 12000 Tosales a/c 12000 Correct entry should have been | Mohan’s a/c 10000 Tosalesa/c 10000 Rectifying entry Sales a/c 2000 To Mohan’s a/c _2000 (d) Credit sales to Mohan Rs.10,000 was correctly recorded in the sales book but was posted to Ram's account, pe. SSRam’s a/c To sales a/c Mohan’s a/c To sales a/c Rectifying entry | Mohan’s a/c To Ram’s a/c (e) Rent paid Rs.2,000 was wrongly shown as payment to landlord in the cash book Wrong entry Tandlord a/c To cash a/c Correct entry Rent a/c should have been | To casha/c Rectifying entry _ | Rent a/c Tolandlord a/c Rectification of errors affecting trial balance (one sided errors) The errors which affect only one account can be rectified by giving an explanatory note in the account affected or by recording a journal entry with the help of the Suspense Account. Rectification of errors before preparation of the trial balance If the one-sided errors come into notice before preparing the trial balance, they should be rectified by debiting the concerned account for short debit or excess credit and by crediting the concerned account for short credit or excess debit. Examples: Shyam’s account was credited short by Rs.190. This will be rectified by an ad the credit side of his account as follows: ional entry for Rs.190 on Shyam’s Account Dr. cr. Date Particulars | J.F. | Amount Date Particulars JF. | Amount Difference in 190 amount posted short 0 wn. Pe. 56The purchases book was undercast by Rs.1,000. The effect of this entry is on purchases account (debit side) where the total of purchases book is posted Purchases Account Dr. cr. Date | Particulars LF. | Amount | Date Particulars JF. | Amount Under casting 1,000 purchases book for the month of.... in of errors after preparation of trial balance One sided errors will be rectified by passing the journal entry either debiting or crediting the suspense account, Suspense account Sometimes, in spite of best efforts some errors are not located and due to which Trial Balance does not tally. In such a situation, to avoid delay in preparing the Final Accounts, the difference in the Trial Balance is placed to a newly opened account known as ‘Suspense Account’ and the Trial Balance tallies. Later, when errors are detected, rectification entries are passed. When all the errors are rectified, the account will close. But if suspense account shows balance, it will be shown on the Asset debit balance and if it has credit balance, then le of the Balance sheet if it has. is shown on Liabilities side. Examples 1) Credit sales to Mohan Rs.10,000 were not posted to his account. This is an error of partial omission committed while posting entries of the sales book. Wrong entry Mohan’s a/c To sales a/c Correct entry Mohan’s a/c should have been To sales a/c Rectifying entry | Mohan’s a/c To suspense a/c 2) Purchases book overcast by Rs.1,000 Suspense a/c 1,000 Pe.57To purchases a/c 1,000 Financial statement of sole proprietorship Meaning Financial Statements are the summaries of the accounts of a business enterprise and shows the profitability and financial position at the end of the accounting period. It includes at least two basic statements: A) Trading and & Profit and Loss Account B) Balance Sheet ‘Trading Account It is prepared for calculating the gross profit or gross loss arising out of the trading activities of a business. Format of a Trading Account Trading Account or (For the year ended...) x. Particulars | Amount Poxtisars Ament By Sales OK Boreas vex | 7% | Let Return ward bom | Xx By Closing stock Xx Less Ratu Ourwords tuna) | xx to ee Xe | py Gros Los Xx To Carriage inwards | Xxx ToFreight wards/cortage | Xxx To Gross Profit c/d Xxx All expenses which relate to either purchase of raw material or manufacturing of goods are recorded in the Trading account. All such expenses are called ‘Direct Expenses’. Examples of direct expenses: Carriage or freight inwards Manufacturing wages Power and fuel Factory lighting Factory rent and rates Royalties Consumable stores pe. 58Calculation of Cost of Goods Sold: Cost of Goods Sold = Opening stock + Net Purchases + Direct Expenses ~ Clo: Cost of Goods Sold = Sales ~ Gross Profit Case: Calculate Net Sales and Gross Profit from the following information: Cost of Goods Sold Rs.1,00,000 Gross Profit 20% on Sales Solution: Sales will be 1,00,000 x (100/80) = Rs.1,25,000 Gross Profit = Sales ~ Cost of Goods Sold s.1,25,000 ~ Rs.1,00,000 Rs.25,000 Profit and loss account Trading account only shows gross profit earned as a result of buying and selling goods. However, there are other expenses also which must be included to get the net profit, for this Profit and Loss Account is prepared All Distribution, office, selling, administrative and miscellaneous expenses like, interest on loan, interest on capital etc. are included in Profit and Loss Account. A Profit & Loss A/c 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. Name of Business Profit and Loss Account for the year ended ec ry eri cory To gross loss b/d XXX By gross profit b/d XXX To Salaries XXX By rent from tenant XXX To rent, rates and taxes XXX By discount received XXX To printing & stationery XXX By dividend on shares XXX To lighting XXX By interest on investments XXX To travelling expense XXX By commission received XXX To insurance XXX By bad debts recovered XXX To establishment expenses XXX By misc receipts XXX pe. 59To legal charges XXX By profit on sale of assets XXX To audit fees XXX By net loss (t/f to capital a/c) XXX To telephone charges XXX To postage & telegram XXX To general expenses XXX To advertisement XXX To bad-debts XXX To packing charges XXX To delivery van expenses XXX To commission XXX To depreciation XXX To bank charges XXX To loss on sale of assets XXX To net profit (t/f to capital a/c) XXX Balance sheet A Balance Sheet is a statement at a particular date showing on one side the trader's property and possessions and on the other hand the liabilities. Balance sheet contains all the Assets and Liabilities to show the exact financial position of the business. It is, known as Balance Sheet because it shows the balances of ledger accounts which are left open after transferring all the nominal accounts to Trading & Profit & loss Account. Balances of all the Real and Personal Accounts are grouped together and shown in Balance Sheet as Assets and Liabilities. Marshalling of Assets and Liabilities in Balance Sheet ‘The assets and liabilities must be shown in such a manner that the financial position of the business can be assessed through it easily and quickly. Thus, an arrangement shown in the balance sheet. Such an arrangement is called marshalling of assets and liabilities. There are three methods of marshall 1. Permanency Preference Method 2. Liquidity Preference Method Permanency Preference Method Pe. 60Under this method, the assets and liabilities are shown in balance sheet in the order of their permanence. In other words, the more permanent the assets and liabilities, the earlier they are shown. Balance Sheet as on.. Liabilities Fixed Liabilities: Long term loans (Current r | } | | | | | Sundry creditors Bills payable | Bank overdraft Outstanding expenses | | | | | | Assets Fixed Assets: Good will Patent Land Building Plant & Machinery Furniture & Fixtures Current Assets: Investment Stock Sundry debtors Bills receivable Prepaid expenses Cash at bank Cash in hand Lig ty Preference Method Under this method, assets and liabilities are shown in order of their liquidity. The more liquid the assets, the earlier are they shown. Pe. 61Balance Sheet as on..... Liabilities Assets (Current Liabilities: Liquid Assets: Sundry creditors Cash at bank Bills payable Cash in hand Bank overdraft Outstanding expenses [Current Assets: Fixed Liabilities: Investment Stock Capital Sundry debtors Reserves Bills receivable Long term loans Prepaid expenses Fixed Assets: Good will Patent Land Building Plant & Machinery Furniture & Fixtures Classification of Assets 1. Non-current Assets: Acquired for continuous use and last for many years. Example: Furniture, Motor Vehicles etc. 2. Current Assets: Either in the form of cash or can be easily converted into cash within 1 year of the date of Balance Sheet. Example: Accrued Income, Closing stock etc. Classi ition of. bi 1. Non-Current/ Long-term Liabilities Liabilities which are to be paid after 1 year or more. Example: Debentures, Public Deposits, etc. ies 2. Current or Short-term liabilities Liabilities which are expected to be pi within 1 year of the date of the Balance Sheet. pe. 62Example: Bank overdraft, Bills Payable etc. 3. Contingent Liabilities They are liabilities which will become payable only on the happening of some specific event, otherwise not. Example a. Liabilities for bill discounted b. Liabilities in respect of a suit pending in a court of law . Liability in respect of a guarantee given for another person. ***Contingent li 's are not shown in the Balance Sheet but as a footnote below the Balance Sheet Pe. 63