BASICS OF ACCOUNTING

Contents
Introduction to accounting...............................................................................................................................2
Introduction................................................................................................................................................. 2
Meaning of accounting.................................................................................................................................2
Functions of accounting............................................................................................................................... 2
Accounting Cycle.......................................................................................................................................... 3
Book-keeping, accounting and accountancy................................................................................................4
Objectives of accounting.............................................................................................................................. 5
Sub-disciplines within accounting................................................................................................................ 6
Financial accounting................................................................................................................................. 6
Cost accounting........................................................................................................................................ 6
Management accounting......................................................................................................................... 6
Accounting is an art as well as science.........................................................................................................6
Advantages of accounting............................................................................................................................ 7
Disadvantages of accounting........................................................................................................................7
Types of Accounting Information................................................................................................................. 8
Basic accounting terms.................................................................................................................................... 9
Accounting principles..................................................................................................................................... 13
Bases of accounting........................................................................................................................................ 16
Accounting equation...................................................................................................................................... 17
Rules of debit and credit................................................................................................................................ 19
Journal............................................................................................................................................................ 22
Ledger............................................................................................................................................................ 31
Subsidiary books............................................................................................................................................ 35
Cash book....................................................................................................................................................... 40
Trial balance and rectification of errors......................................................................................................... 46
Financial statement of sole proprietorship.....................................................................................................58

pg. 1
 Introduction to accounting
Introduction
 The main objective of every business is to earn profit.

 At end 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, etc.

 So many other such questions which a businessman wants to know on a daily, monthly or annual
basis.

 In order to attain such information, it is essential to keep a complete and systematic record of each
and every business transaction entered into during the year.

Meaning of accounting
Accounting is the process of identifying, recording, classifying, summarising, interpreting and
communicating financial information of business to its users for judgement and decision making.

“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.
pg. 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.e., 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
The accounting cycle is the holistic process of recording and processing all financial transactions of a
company, 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.

pg. 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.
4. 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

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
of a business. Accounting starts where bookkeeping ends. It includes summarising, analysing,
interpreting and communicating functions of accounting.

pg. 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 It is the recording phase of It is 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 It is 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 It is 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. To ascertain 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.

pg. 5
 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.

Art is the application of techniques and methods. Accounting is an art because it presents the financial
findings by following and implementing universally accepted principles (GAAP).

Art is 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.

pg. 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.
pg. 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 it is 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.e., the balance sheet makes the
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.’

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.

pg. 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

Assets = Liability + 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 liability: 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.

pg. 9
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

Eg: Furniture, 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.
Eg: Debtors, 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.

Distinction between Capital and Revenue Expenditure

Capital expenditure Revenue expenditure

It is incurred in acquiring or improving It is a routine expenditure incurred in the normal

permanent assets which are not meant for course of business and includes cost of sales and
resale. It may add to value of an existing asset. maintenance of fixed assets.
It is 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.

pg. 10
 It provides benefit over several years. A small part It is 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 profit earned during a period of time.

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.

Loss: A loss is excess of expenses of a period over its related revenues which may arise from normal
business activities. It decreases the owner’s equity.

Case: Following transactions were reported during an accounting reported for Mr. B’ s business of
furniture.

pg. 11
Terms related to trade

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 bill is 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.

pg. 12
Discount: rebate or allowance given by the seller to the buyer.
It is of 2 types:

(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.

Accounting principles
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.

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.

pg. 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:

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.

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.

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’.

pg. 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.

Difference between accounting concepts and conventions

Accounting concept Accounting convention

Accounting concepts refers to the rules of Accounting conventions implies the customs or
accounting which are to be followed, while practices that are widely accepted by the
recording business transactions and preparing final 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.

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.

pg. 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.

Disclosure Convention: 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

pg. 16
Advantages and disadvantages

Cash basis Accrual basis

Advantages
Advantages
1. It is very simple as adjustment
enteries are not required 1. It shows a complete picture of
financial transactions of the business
2. This basis of accounting is suitable
for those enterprises where most of 2. It discloses correct profit or
the transactions are on cash basis loss and also exhibits true
financial
position of an enterprise

Disadvantages
1. It does not give a true and fair Disadvantages
view of the profit or loss abd the
financial 1. It is not as simple as cash basis
position of an enterprise 2. A quick appraisal of the profit/loss
2. It does not follow the is not possible
matching principle of

Accounting equation
Prior to understanding an accounting equation, it is 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:

pg. 17
Meaning
Accounting Equation signifies that the assets of a business are always equal to the total of capital and
liabilities.

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

pg. 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

pg. 19
 Natural persons

Personal accounts Artificial persons

Classification of accounts

Representative
persons

Tangible
Real
Impersonal
Intangible
accounts
Nominal

pg. 20
pg. 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 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.

pg. 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.

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.

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.

pg. 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:

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:

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,
it is 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
pg. 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

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:

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.

pg. 25
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
It is 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
pg. 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, it is 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

 On sale of asset for cash

Cash A/c Dr.
To assets A/c

 On sale 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 Dr.
To cash A/c

Transactions related to goods

Drawings of Goods

pg. 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 Dr.
To Purchases A/c

Loss of Goods by theft or fire

Loss by Theft A/c Dr.
Loss by Fire A/c Dr.
To Purchases A/c

In case goods were insured

Insurance Company A/c 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
11 Sold goods Rs.3,900
15 Sold goods on credit to D Rs.2,250
pg. 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 S & Co. Rs.1,800
X withdrew from business Rs.900
Charged depreciation on Rs.240
Borrowed from K Rs.1,500

Solution:

Journal

pg. 29
[Type here]

pg. 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:

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 lines under them.
5. Again write the difference on the opposite side below the double line.

pg. 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:

It may be noted that at the time of balancing an account debit balance is placed on the credit side and 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.

Example:
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
Solution:6 He paid salaries Rs.10,000

pg. 32
pg. 33
DISTINCTION BETWEEN BOOKS OF ORIGINAL ENTRY AND LEDGER

CLOSING OF ACCOUNTS

1. Personal Accounts
If a personal account shows a debit balance, it indicates the amount owing from him.
On the contrary, if a personal account shows a credit balance, it indicates the amount owing to him.
pg. 34
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, it is 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:

pg. 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

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

Books of Kanika Electronics

Neema Electronics
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
2017
Aug 04 Purchases 1,82,000
Aug 26 Purchases 54,000

Pawan Electronics
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
2017
Aug 10 Purchases 31,050
Aug 29 Purchases 38,700

pg. 36
 Northern Electronics
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
2017
Aug 18 Purchases 3,06,250

Purchases Account
Dr. Cr.
Date Particulars J.F. 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

Neema Electronics Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
Purchases return 13,200

Purchases Return Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
Sundries as per 13,200
purchase returns book

pg. 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.

Raman Traders Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
2017
Apr 06 Sales 4,850
Apr 28 Sales 85,000

Nutan Enterprises Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
2017
Apr 01 Sales 21,000

Sales Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. 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.

pg. 38
 Raman Traders Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
Sales Return 2,100

Sales Return Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. 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.

pg. 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, it is 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).

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.e., it is a
complete record of cash receipts and cash payments. When all receipts and payments are made in cash by
a business organisation only, the cash book contains only one amount column on each (debit and credit)
side.

Format of single column cash book

Cash Book
Dr. Cr.
Date Receipts L.F. Amount Date Payments L.F. 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.

pg. 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

pg. 41
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 L.F. Cash Bank Date Payments L.F. Cash 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.
pg. 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 'L.F.' 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:

pg. 43
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

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.
pg. 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

pg. 45
 Trial balance and rectification of errors
Meaning of trial balance
A trial 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

pg. 46
 Trial Balance of …… as on March 31, 2014

Purpose of Trial Balance

1. To check the equality of debits and credits - an arithmetical or mathematical test of accuracy.
2. To help in preparation of final accounts.
3. To locate errors.
4. To obtain a summary of ledger accounts.

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.

pg. 47
Example
Enter the following transactions in journal and post them into the ledger and also prepare a trial balance.

2018
Jan. 1 Mr. X started business with cash Rs.80,000 and furniture Rs.20,000.
Jan. 2 Purchased goods on credit worth Rs.30,000 from Y.
Jan. 3 Sold goods for cash Rs.16,000.
Jan. 4 Sold goods on credit to S for Rs.10,000
Jan. 8 Cash received from S Rs.9,800 in full settlement of his account.

Solution:

Journal

pg. 48
 Ledger
Cash Account

Furniture Account

Capital Account

pg. 49
pg. 50
Types of errors

pg. 51
Errors of omission
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 omission
(ii) error of partial omission

When a transaction is completely omitted from recording in the books of original record, it is 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.
 If a credit 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
pg. 52
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.

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 original 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:

pg. 53
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.

Rectification of errors which do not affect the trial 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.

pg. 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.

(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

To sales a/c 12000
Correct entry should have been Mohan’s a/c 10000
To sales a/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.

pg. 55
(e) Rent paid Rs.2,000 was wrongly shown as payment to landlord in the cash book

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 additional entry for Rs.190 on
the credit side of his account as follows:

Shyam’s Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount

Difference in 190
amount posted
short on ……

pg. 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 J.F. Amount Date Particulars J.F. Amount

Under casting 1,000

purchases book for
the month of …..

Rectification 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 side of the Balance sheet if it has
debit balance and if it has credit balance, then it 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.

2) Purchases book overcast by Rs.1,000

Suspense a/c 1,000

pg. 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

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

pg. 58
Calculation of Cost of Goods Sold:
Cost of Goods Sold = Opening stock + Net Purchases + Direct Expenses – Closing stock 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 × (100/80) = Rs.1,25,000 Gross

Profit = Sales – Cost of Goods Sold
= Rs.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 .....

Particulars Amt Particulars Amt

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

pg. 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 is made in which assets and liabilities are
shown in the balance sheet. Such an arrangement is called marshalling of assets and liabilities. There are
three methods of marshalling:
1. Permanency Preference Method
2. Liquidity Preference Method

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Permanency Preference Method

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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.

Liquidity 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.

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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.

Classification of Liabilities
1. Non-Current/ Long-term Liabilities
Liabilities which are to be paid after 1 year or more.
Example: Debentures, Public Deposits, etc.

2. Current or Short-term liabilities

Liabilities which are expected to be paid within 1 year of the date of the Balance Sheet.
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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.
Examples:
a. Liabilities for bill discounted
b. Liabilities in respect of a suit pending in a court of law
c. Liability in respect of a guarantee given for another person.

***Contingent liabilities are not shown in the Balance Sheet but as a footnote below the Balance Sheet.

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