HABIB PUBLIC SCHOOL

PRINCIPLES OF ACCOUNTING

BUSINESS

: Business is any legal activity to earn profit.

ACCOUNTING

: Accounting is an art of recording, classifying, summarizing business

transactions and interpreting their results into final accounts.
ACCOUNTING EQUATION
Assets = Capital + Liabilities
Fixed Assets + Current Assets = Capital + Current Liabilities + Long-term Liabilities
Working Capital

Fixed Assets + Currents Assets - Current Liabilities = Capital + Long-term Liabilities

Net Assets

Capital Employed

The prime function of accounting is to provide the information basis for action.
In bookkeeping, posting a transaction means making the second entry of a double
entry transaction.
An accounting period is any twelve month period.
The part of accounting that is concerned with recording data is known as
bookkeeping.

DEFINITION/TERMS
Assets:
Assets are resources owned by the business. There are two types of assets:
i.Non-Current Assets:Assets with normal life of more than one year are known as noncurrent assets. These assets are costly and there are rare changes in
these. At the time of purchase our intention is to use them in
business, not to resell. Examples are Land, Building, Plant,
Machinery, Furniture, Fixture, Fitting, Electrical Equipments and
Vehicles etc.
ii.Current Assets :
Assets with normal life of less than one year are known as current
assets. These are not very costly and there are frequent changes in
these. Examples are Inventory, Trade Receivables, Prepayments,
Cash at Bank and Cash in Hand etc.
Expenses:
Expenses are cost or value of goods and services that has been used to obtain revenue.
Expenses are charged to profit and loss account.
Drawings:
Drawings are cost or value of personal expenditures of the owner.
Liabilities:
Liability is amount owing to suppliers. There are two types of liabilities.
i.
Non-Current Liabilities : Liabilities that do not have to be paid within one year and
we have more than one year time to pay them are known as
non-current liabilities. Example is Loan.
ii.
Current Liabilities
: Liabilities which are to be paid within one year. Examples
are trade payables, rent accrued and electricity payable etc.
PREPARED BY:
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HABIB PUBLIC SCHOOL

PRINCIPLES OF ACCOUNTING

Income/Sales:
Income or sales is value of goods and services that has been supplied to customers. Sales and
operating incomes are transferred to trading account whereas non operating incomes are
transferred to profit and loss account.
Capital:
Capital is actual investment of the owner in the business.
Purchases:
Purchase is value or cost of goods purchased for reselling purpose. Purchases are transferred
to trading account.
Returns Inwards/Sales Returns:
Returns inwards are sold goods returned to us by our customers. Value of returns inwards is
deducted from sales in trading account.
Returns Outwards/Purchases Returns:
Returns outwards are purchased goods returned by us to our suppliers. Value of returns
outwards is deducted from purchases in trading account.
Note: Trade Payable sends a credit note to trade receivable or trade receivable sends debit
note to supplier for confirmation of returns.
Discount Allowed:
Discount allowed is rebate given to customers when they pay us. Discount allowed is treated
as an expense and charged to profit and loss account.
Discount Received:
Discount received is rebate given by our supplier when we pay them. Discount received is
treated as an income and is added to gross profit or operating profit.
Carriage Inwards:
Carriage inwards is transport cost on goods purchased. It is part of purchases and added to
purchases in trading account.
Carriage Outwards:
Carriage outwards is transport cost on goods sold. This is treated as an expense and charged
to profit and loss account.
Increase in Inventory: i) Purchase of additional goods.
ii) Goods returned to the business which were previously sold.
Decrease in Inventory: i) Sale of goods.
ii) Goods returned by the business which were previously bought.

PREPARED BY:
MUHAMMAD ASAD ALI

HABIB PUBLIC SCHOOL

Book-keeping

PRINCIPLES OF ACCOUNTING

Accounting

Transactions

Recording of transactions To
examine
these
in books of original entry.
recorded transactions in
order to find out their
accuracy.

Posting

To make posting in ledger

To
examine
this
posting in order to
ascertain its accuracy.

Total and Balance

To make total of the

amount in journal and
accounts of ledger. To
ascertain balance in all the
accounts.

To prepare trial balance

with the help of
balances of ledger
accounts.

Income Statement Preparation of trading,

and Balance Sheet Profit & loss account and
balance sheet is not book
keeping

Preparation of trading,
profits and loss account
and balance sheet is
included in it.

Rectification of
errors

These are not included in These are included in

book-keeping
accounting.

Special skill and It does not require any It requires special skill
knowledge
special skill and knowledge and knowledge.
as in advanced countries
this work is done by
machines.
Liability

A book-keeper is not liable An accountant is liable

for accountancy work.
for the work of bookkeeper.

PREPARED BY:
MUHAMMAD ASAD ALI

HABIB PUBLIC SCHOOL

PRINCIPLES OF ACCOUNTING

ACCOUNTING CONCEPTS

TABLE/SUMMARY/SNAPSHOT OF ACCOUNTING CONCEPTS/CONVENTION

Accounting period
Concept

Accrual Concept /
Matching

Business Entity

Consistency Concept

Dual Aspect Concept

Going Concern Concept

Historical Cost Concept

Also known as Time Period where business operation can be
divided into specific period of time such as month, a quarter or a
year (accounting period)

Final accounts are prepared at the end of the accounting period,
i.e. one year. Internal accounts can be prepared monthly,
quarterly or half yearly.


Requires all revenues and expenses to be taken into account for
the period in which they are earned and incurred when
determining the profit / (loss) of the business. The net profit /
(loss) is the difference between the revenue EARNED and the
expenses INCURRED and not the difference between the revenue
RECEIVED and expenses PAID.


Also known as Accounting Entity convention which states that the
business is an entity or body separate from its owner. Therefore
business records should be separated and distinct from personal
records of business owner.


According to this convention, accounting practices should remain
unchanged from one period to another. For example, if
depreciation is charged on fixed assets according to a particular
method, it should be done year after year. This is necessary for
purpose of comparison.


Double entry system. For every debit, there is a credit entry of an
equal amount.


The business will follow accounting concepts and methods on the
assumption that business will continue its operation to the
foreseeable future or for an indefinite period of time.


Business should report its activities or economic events at their
actual costs. For example, fixed assets are recorded at their cost in
account except for land which can be revalued due to appreciation

PREPARED BY:
MUHAMMAD ASAD ALI

HABIB PUBLIC SCHOOL

PRINCIPLES OF ACCOUNTING

Materiality Concept

The accountant should attach importance to material details and
ignore insignificant details otherwise accounting will be burdened
with minute details. Only items that are deemed significant for a
given size of operation.



Money Measurement
Also known as Monetary unit. Transactions related to the
Concept
business, and having money value are recorded in the books of
accounts. Events or transactions which cannot be expressed in
term of money do not find a place in the books of accounts.



Objectivity and
Objectivity is following rules of the industry and based on
Subjectivity
objective evidence and subjectivity is to follow ones own rules
and methods.



Prudence / Conservatism Take into account unrealized losses, not unrealized profits/gains.
Assets should not be over-valued, liabilities under-valued.
Concept
Provisions are example of prudence or conservatism concept. Also
under this prudence/conservatism concept, stock/inventory is
value at lower of cost or market value. This concept guides
accountants to choose option that minimize the possibility of
overstating an asset or income.



Real substance takes over legal form namely we consider the
Substance Over Form
economic or accounting point of view rather than the legal point
of view in recording transactions.

Realization Concept

Revenue is recognized when goods are sold either for cash or
credit namely the debtor accepts the goods or services and the
responsibility to pay for them.

PREPARED BY:
MUHAMMAD ASAD ALI

HABIB PUBLIC SCHOOL

FORMATS

PRINCIPLES OF ACCOUNTING

General Journal
Date

Particulars

Folio

20X5

Dr

Cr

General Ledger

Date
20X5

Particulars

Folio

Dr

Date

20X5

Particulars

Folio

Cr

PREPARED BY:
MUHAMMAD ASAD ALI

HABIB PUBLIC SCHOOL

PRINCIPLES OF ACCOUNTING

Trading and Profit & Loss Account (Basic)

Particulars

Sales

xxx

Cost of Goods Sold

Opening Stock

xxx

Purchases

xxx

Carriage Inwards

xxx

Cost of Goods available for Sale

Closing Stock

xxx
xxx
(xxx)

Gross Profit

(xxx)
xxx

Other Expenses
Rent & Rates Expense

xxx

Insurance Expense

xxx

Electricity Expense

xxx

Bank Charges

xxx

Plant Repair

xxx

Wages & Salaries

xxx

Repair & Maintenance

xxx

Sundry Expenses

xxx

Net Profit

(xxx)
xxx

PREPARED BY:
MUHAMMAD ASAD ALI

HABIB PUBLIC SCHOOL

PRINCIPLES OF ACCOUNTING

Balance Sheet (Basic)

Particulars

Fixed Assets
Premises

xxx

Furniture & Fixtures

xxx

Motor Vans

xxx

xxx

Current Assets
Closing Stock

xxx

Debtors

xxx

Prepaid Expenses

xxx

Cash at Bank

xxx

Cash in Hand

xxx
xxx

Current Liabilities
Creditors

(xxx)

xxx
xxx

Financed By
Capital

xxx

Net Profit

xxx
xxx

Drawings

(xxx)

xxx

8.2 A balance sheet is a financial statement that summarises the position at the end of a period. It contains all the balances on the accounts held in the accounting books at that time. As it is prepared
after the Trading and Profit and Loss Account, all the accounts have already been balanced off. All
we do with the balance sheet is lift the balances carried forward from the accounts and place them
in an appropriate position in the statement.

PREPARED BY:
MUHAMMAD ASAD ALI

HABIB PUBLIC SCHOOL

PRINCIPLES OF ACCOUNTING

Trading and Profit & Loss Account (Advanced)

Particulars

Sales
Returns Inwards
Cost of Goods Sold
Opening Stock
Purchases
Carriage Inwards
Damaged Goods (N-1)
Returns Outwards
Stock Drawings (N-2)

xxx
(xxx)

xxx

xxx
xxx
xxx
(xxx)
(xxx)
(xxx)

Cost of Goods available for Sale

Closing Stock

xxx
xxx
(xxx)

Gross Profit
Other Incomes
Discount Received
Bad Debts Recovered
Profit on Disposal of Fixed Assets
Provision for Doubtful Debts (Reduction)

(xxx)
xxx

xxx
xxx
xxx
xxx

xxx
xxx

Other Expenses
Rent, Rates & Insurance
Wages & Salaries
Damaged Goods (N-3)
Repair & Maintenance
Bad Debts
Provision for Doubtful Debts (Increase)
Loss on Disposal of Fixed Assets
Provision for Depreciation
Sundry Expenses
Net Profit

xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx

(xxx)
xxx

EXPLANATORY NOTES
N-1 : Goods damaged due to fire, flood or stolen by theft.
N-2 : Goods taken by owner for own use.
N-3 : Amount of damaged/stolen goods not covered by insurance.

PREPARED BY:
MUHAMMAD ASAD ALI

HABIB PUBLIC SCHOOL

10

PRINCIPLES OF ACCOUNTING

Balance Sheet (Advanced)

Fixed Assets
Premises
Provision for Depreciation

xxx
(xxx)

xxx

Furniture & Fixtures

Provision for Depreciation

xxx
(xxx)

xxx

Motor Vans
Provision for Depreciation

xxx
(xxx)

xxx

Particulars

Current Assets
Closing Stock
Debtors
Provision for Doubtful Debts

xxx

xxx
xxx
(xxx)

Prepaid Expenses
Insurance Claim (N-1)
Cash at Bank
Cash in Hand

xxx
xxx
xxx
xxx
xxx
xxx

Current Liabilities
Creditors
Wages Owing
Bank Overdraft

xxx
xxx
xxx

(xxx)

xxx
xxx

Financed By
Capital
Net Profit
Drawings

xxx
xxx
xxx
(xxx)

xxx

Long-Term Liabilities
Loan

xxx

xxx

EXPLANATORY NOTES
N-1 : Amount of damaged/stolen goods covered by insurance.

PREPARED BY:
MUHAMMAD ASAD ALI

BA10_C07.qxd 16/12/04 11:22 am Page 80

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11

PRINCIPLES OF ACCOUNTING

Review questions
7.1

From the following trial balance of A Moore, extracted after one years trading, prepare a trading and profit and loss account for the year ended 31 December 20X6. A balance sheet is not required.
Trial Balance as at 31 December 20X6

Sales
Purchases
Salaries
Motor expenses
Rent
Insurance
General expenses
Premises
Motor vehicles
Debtors
Creditors
Cash at bank
Cash in hand
Drawings
Capital

Dr

Cr

190,576

119,832
56,527
2,416
1,894
372
85
95,420
16,594
26,740
16,524
16,519
342
8,425
345,166

138,066
345,166

Stock at 31 December 20X6 was 12,408.

(Keep your answer; it will be used later in Question 8.1)

7.2

From the following trial balance of B Lane after his first years trading, you are required to
draw up a trading and profit and loss account for the year ended 30 June 20X8. A balance sheet is
not required.
Trial Balance as at 30 June 20X8

Sales
Purchases
Rent
Lighting and heating expenses
Salaries and wages
Insurance
Buildings
Fixtures
Debtors
Sundry expenses
Creditors
Cash at bank
Drawings
Vans
Motor running expenses
Capital

Dr

Cr

265,900

154,870
4,200
530
51,400
2,100
85,000
1,100
31,300
412
15,910
14,590
30,000
16,400
4,110
396,012

114,202
396,012

Stock at 30 June 20X8 was 16,280.

(Keep your answer; it will be used later in Question 8.2)

PREPARED BY:
MUHAMMAD ASAD ALI

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12

PRINCIPLES OF ACCOUNTING

7.3A From the following trial balance of B Morse drawn up on conclusion of his first year in business, draw up a trading and profit and loss account for the year ended 31 December 20X8. A balance sheet is not required.
Trial Balance as at 31 December 20X8

General expenses
Business rates
Motor expenses
Salaries
Insurance
Purchases
Sales
Car
Creditors
Debtors
Premises
Cash at bank
Cash in hand
Capital
Drawings

Dr

Cr

305
2,400
910
39,560
1,240
121,040

235,812
4,300
11,200
21,080
53,000
2,715
325
23,263
23,400
270,275

270,275

Stock at 31 December 20X8 was 14,486.

(Keep your answer; it will be used later in Question 8.3A)

7.4A Extract a trading and profit and loss account for the year ended 30 June 20X8 for
G Graham. The trial balance as at 30 June 20X8 after his first year of trading was as follows:

Equipment rental
Insurance
Lighting and heating expenses
Motor expenses
Salaries and wages
Sales
Purchases
Sundry expenses
Lorry
Creditors
Debtors
Fixtures
Shop
Cash at bank
Drawings
Capital

Dr

Cr

940
1,804
1,990
2,350
48,580

382,420
245,950
624
19,400
23,408
44,516
4,600
174,000
11,346
44,000
600,100

194,272
600,100

Stock at 30 June 20X8 was 29,304.

(Keep your answer; it will be used later in Question 8.4A)

PREPARED BY:
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13

PRINCIPLES OF ACCOUNTING

7.5 Henry York is a sole trader who keeps records of his cash and bank transactions in a threecolumn cash book. His transactions for the month of March were as follows:
March
1
4
6
8
10
11
14
18
23
24
26
28
31

Cash in hand 100, Cash at bank 5,672

York received a cheque for 1,246 from W Abbot which was paid directly into the bank.
This represented sales.
Paid wages in cash 39
Sold goods for cash 152
Received cheque from G Smart for 315, in full settlement of a debt of 344; this was
paid directly into the bank.
Paid sundry expenses in cash 73
Purchased goods by cheque for 800
Paid J Sanders a cheque of 185 in full settlement of a debt of 201
Withdrew 100 from the bank for office purposes
Paid wages in cash 39
Sold goods for cash 94
Paid salaries by cheque 230
Retained cash amounting to 150 and paid the remainder into the bank

Required:
(a)
(b)

Enter the above transactions within T-accounts and bring down the balances.
Assuming no opening debtors, creditors or stock, prepare a trading and profit and loss
account for the month of March.

Review questions
8.1

Complete question 7.1 by drawing up a balance sheet as at 31 December 20X6.

8.2

Complete question 7.2 by drawing up a balance sheet as at 30 June 20X8.

8.3A

Complete question 7.3A by drawing up a balance sheet as at 31 December 20X8.

8.4A

Complete question 7.4A by drawing up a balance sheet as at 30 June 20X8.

8.5

G. Hope started in business on 1 July 20X0, with 40,000 capital in cash. During the first year
he kept very few records of his transactions.
The assets and liabilities of the business at 30 June 20X1 were:

Freehold premises
76,000
Mortgage on the premises
50,000
Stock
24,000
Debtors
2,800
Cash and bank balances
5,400
Creditors
7,600

PREPARED BY:
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BA10_C08.qxd 16/12/04 11:23 am Page 90

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14

PRINCIPLES OF ACCOUNTING

During the year, Hope withdrew 9,000 cash for his personal use but he also paid 6,000 received
from the sale of his private car into the business bank account.
Required:
From the above information, prepare a balance sheet showing the financial position of the business at 30 June 20X1 and indicating the net profit for the year.

8.6A

The following information relates to A Traders business:

Assets and liabilities at

Fixtures
Debtors
Stock
Creditors
Cash
Balance at bank
Loan from B Burton
Motor vehicle

1 January 20X9

18,000
4,800
24,000
8,000
760
15,600
6,000

31 December 20X9

16,200
5,800
28,000
11,000
240
4,600
2,000
16,000

During the year, Trader had sold private investments for 4,000 which he paid into the business
bank account, and he had drawn out 200 weekly for private use.
Required:
Prepare a profit and loss account for the year ending 31 December 20X9 and a balance sheet as at
that date.

PREPARED BY:
MUHAMMAD ASAD ALI