Contents

Unit – 1.............................................................................................................4
Introduction................................................................................................4
Need of Accounting......................................................................................4
Development of Accounting...........................................................................5
Definitions and Functions of Accounting...........................................................5
Objectives of Accounting..............................................................................7
Accounting as Science or Art.........................................................................8
Book-keeping, Accounting and Accountancy....................................................9
Bookkeeping............................................................................................9
Accounting................................................................................................9
Accountancy.............................................................................................9
End Users of Accounting Information............................................................11
Limitations of Accounting.............................................................................12
Accounting Concepts...................................................................................14
Accounting Conventions..............................................................................16
Unit – 2...........................................................................................................17
The Accounting Equation.............................................................................17
Branches of Accounting...............................................................................17
Rules of debit and credit..............................................................................19
Journal and Journalising Process..................................................................20
Meaning of Journal...................................................................................20
Cash Book.................................................................................................21
Kinds of Cash Books.................................................................................21
Kinds of Cash Book..........................................................................................21
1] Simple Cash Books..............................................................................22
2] Two Column Cash Books......................................................................22
3] Three Column Cash Books....................................................................22
4] Petty Cash Book..................................................................................23
Preparation of Ledger................................................................................23
Trial Balance..............................................................................................24
Preparation of Trial Balance........................................................................24
Steps in the preparation of trial balance........................................................24
Types of Errors..........................................................................................26
Error which Effect only One Account................................................................26
Error which Effect Two or more Accounts..........................................................26
 Bank Reconciliation Statement.....................................................................26
Steps in Preparation of Bank Reconciliation Statement.....................................26
Why do we need to Prepare Bank Reconciliation Statement?.............................27
Bill of Exchange.........................................................................................28
Features of Bill of Exchange........................................................................28
Types of Bill of Exchange...........................................................................28
Advantages of Bill of Exchange....................................................................28
In the above-mentioned bill of exchange format, Kunal Singh is the drawer as well as the
payee of the bill.......................................................................................29
Parties of Bill of Exchange..........................................................................29
Importance of Promissory note in Bill of Exchange.............................................30
Promissory Note.......................................................................................30
Parties to a Promissory Note.........................................................................30
Unit – 3...........................................................................................................31
FINAL ACCOUNTS?.....................................................................................31
WHY THIS NAME – FINAL ACCOUNTS?............................................................31
PREPARATION OF FINAL ACCOUNTS.............................................................31
Form of Final Accounts............................................................................32
MEANING AND NEED OF ADJUSTMENT ENTRIES..............................................32
ADJUSTMENTS IN FINAL ACCOUNTS..............................................................33
Accounting Treatment:................................................................................33
CLOSING ENTRIES......................................................................................40
Unit – 4...........................................................................................................41
COMPANY : AN INTRODUCTION.....................................................................41
COMPANY–MEANING AND CHARACTERISTICS.................................................41
TYPES OF COMPANIES................................................................................43
SHARES-MEANING AND ITS KINDS.................................................................45
PRIVATE PLACEMENT OF SHARES.................................................................47
ISSUE OF SHARES TO PROMOTERS...............................................................48
PROCEDURE OF ISSUE OF SHARES...............................................................49
Issue of Shares...........................................................................................52
ISSUE OF SHARES AT PREMIUM....................................................................54
ISSUE OF SHARES AT DISCOUNT...................................................................57
CALLS IN ADVANCE AND CALLS IN ARREARS.................................................58
Question Bank..................................................................................................60
Unit 1........................................................................................................60
Unit 2........................................................................................................61
Unit 3........................................................................................................62
 Unit 4........................................................................................................63
Web References link..........................................................................................64
NPTEL Lectures Link..........................................................................................65
MUTIPLE CHOICE QUESTIONS...............................................................................66
Unit – 1
Introduction
Abusiness enterprise engages itself in a number of activies, primarily in
terms of money, with a view to making profit and keeping it as a going concern
for an indefinite period of time. Abusiness enterprise of even medium size deals
with many customers, many employees and many suppliers and deals in
many business transactions. It is impossible to operate even a medium sized
business just by remembering the details of business transactions occuring
therein. That is why there is a saying “ First record and then pay. If errors, look
what books say”.

A systematic and upto date record of varied and numemous business

transactions, is therefore quite essential to obtain the required information in
respect of profit and loss, assets and liabilities and capital of business and also
to exercise control over various items of expenditure. Accounting plays a key
role in serving this purpose.

Need of Accounting
Accounting has rightly been termed as the language of business. The
basic function of a language is to serve as a means of communication.
Accounting also serves this function. It communicates the results of business
operation to various parties who have some stake in the business viz the
proprietor, creditor, investors, government and other agencies. Though
accounting is generally associated with business yet it is not only business which
make use of accounting. Persons like housewives, government and other
individuals also make use of accounting. For example, in case the housewife
records her transactions regularly, she can collect valuable information about
the nature of her receipts and payments. For example she can find out the
total amount spent by her during a period on different items say milk, food,
education, entertainment etc. Similarly she can find the source of her receipt
as salary, rent from property, cash gifts from her relatives thus at the end of
the period she can see for herself about her financial position i.e. what she
owes and what she owns. This will help her in planning her future income and
expenses (or making out a budget) to a great extent.
The need for accounting is all the more greater for a person who is
running a business. He must know: - (i) what he owns (ii) who he owes (iii)
whether he has earned a profit or suffered a loss onaccount of running a
business (iv) what is his financial position i.e. whether he will be in a position
to meet all his commitments in the near future or he is in the process of
becoming a bankrupt.
Development of Accounting
Accounting is as old as money itself. In India, Chanakya in his
Arthashastra has emphasized the existence and need of proper accounting and
auditing. However, the modern system of accounting owesits origin to Pacoili
who lived in Italy in the 18th century. In those earlydays the business
organizations and and transactions were not so complex due to their being
small and easily manageable by the proprietor itself. Things have changed fast
during the past 50 years. The evident of industrial revolution has resulted n
large scale production, cut throat competition and widening of the market. In
the early stages accounting developed as a result of the needs of the business
firms to keep track of their relationship with outsiders, listing of their assets
and liabilities. In recent years changes in technology have also brought a
remarkable change in the field of accountancy. The whole concept of
accounting has changed. “it has come to be recognized as a tool for mastering
the various economic problems with the business organization mayhave to
face..it systematically writes the economic history of the organization. It
provides informationthat can be drawn upon by those responsible for decision
affecting the organization's future. Its history is mostly written in quantitative
terms. It consists partly offiles of data, partlyof reports summarizing various
portions of these data, and partly of the plans established by the management
to guide its operations”.
Definitions and Functions of Accounting
In 1941, the American Institute of Certified Public Accountants (AICPA)
defined accounting as follows “Accounting is the art ofrecording, classifying and
summarizing in significant manner andin terms of money, transactions and
events which are, in part, at least a financial character and interpreting the
results there of”.
In 1966, the American accounting association (AAA) defined accounting
as follows:
a) “Accounting is the process of identifying, measuring and
communicating economic information to permit informed
judgments and decisions by the users of the information”.
b) In 1970, the Accounting Principle Board (APB) of American
Institute of Certified Public
Accountants enumerated the functions of accounting as follows:
c) “The function of accounting is to provide quantitative information,
primarily of financial nature, about economic entities, that is
needed to be useful in making economic decisions”.
 d) Thus accounting may be defined as the process of recording,
classifying, summarizing, analyzing and interpreting the financial
transactions and communicating the result thereof to the persons
interested in such information.
The analysis of the definition brings out the following functions of
accounting:
4 Recording: This is basic function of accounting. It is essentially
concerned with not only ensuring that all business transactions of
financial character are in fact recorded but also that they are
recorded in an orderly manner. Recording is done in the book
of”Journal”. This book may be further sub divided into various
subsidiary books such as cash journal (for recording cash
transactions), purchases journal( for recording credit purchase of
goods) sales journal (for recording credit sales of goods), etc…
the number of subsidiary books to be maintained will be
according to the nature and size of the business.
5 Classifying: It is concerned with the systematic analysis of the
recorded data, with a view to keeping group transactions or
entries of one nature at one place. The work of classification is
done in the book termed as 'ledger”. This book contains different
pages of different accounts heads under which all financial
transactions of similar nature are collected. For example there
may be separate account heads for travelling expenses, printing
and stationary, advertising etc.
6 Summarizing: This involves presenting the classified data in a
manner which is understandable and useful to the internal as well
as external end users of accounting statements. The process leads
to the preparation of the following statements: (i) Trial balance,
(ii) Income statement, and (iii) Balance sheet.
7 Dealing with financial transactions: Accounting records only
those transactions and events in terms of money which are of
financial character. For example, if a company has got a team of
dedicated and trusted employees, it is of great use to the
business but since it is not of a financial character and capable of
being expressed in terms of money, it will not be recorded in the
books of business.
 8 Analyzing and interpreting: This is the final function of
accounting. The recorded financial data is analyzed and interpreted
in a manner that the end users can make a meaningful judgment
about the financial conditions and profitability of the business
operations. The data is also used for preparing the future plan and
framing of policies for executing such plans.
9 Communicating: The accounting information after being
meaningfully analyzed and interpreted has to be communicated in
a proper form and manner to the proper person. This is done
through preparation and distribution of accounting reports,
which includes, besides the usual income statement and the
balance sheet, additional information in the form of accounting
ratios, graphs, diagrams, fund flow statement etc...
Objectives of Accounting
The following are the main objectives of accounting:
i. To keep systematic records. Accounting is done to keep a
systematic record of financial transactions. In the absence of
accounting there would have been terrific burden on human
memory which in most cases would have been impossible to bear.
ii. To protect business properties. Accounting provides
protection to business properties from unjustified and
unwarranted use. This is possible on account of accounting by
supplying the following information to the managers or the
proprietors:
a. The amount of the proprietor's fund invested in the business
b. How much the business has to pay to the others.
c. How much the business has to recover from the others.
d. How much the business has in the form of (a) fixed
assets; (b) cash in hand; (c) cash at bank; (d) stock of
raw materials, work in progress and finished goods.
Information about the above matters helps the proprietor in
assuring that the funds of the business are not unnecessarily kept idle or
under-utilized.
iii. To ascertain the operational profit or loss. Accounting helps in
ascertaining the net profit earned or loss suffered on account of
carrying the business. This is done by keeping a proper record of
 revenues and expenses of a particular period. The profit and loss
account is prepared at the end of a period and if the amount of
revenue for the period is more than the expenditure incurred in
earning that revenue there is said to be a loss.
Profit and loss account will help the management, investors,
creditors etc. in knowing whether running the business has proved to be
remunerative or not. In case it has not proved to be remunerative or
profitable, the cause of such a state of affairs will be investigated and
necessary remedial steps will be taken.
iv. To ascertain the financial position of business. The profit and loss
account gives the amount of profit and loss made by the business
during a particular period. However, it is not enough. The
businessman must know his financial position i.e. where he
stands, what he owes and what he owns. This objective is served
by Balance Sheet or Position Statement. The Balance Sheet is a
statement of assets and liabilities of the business on a particular
date. It serves as barometer for ascertaining the financial health
of the business.
v. To facilitate rational decision making. Accounting these days has
taken upon itself the task of collection, analysis and reporting of
information at the required points of time to the required levels of
authority in order to facilitate rational decision making. The
American Accounting Association has also stressed this point while
defining the term 'accounting' when it says that accounting is “the
process of identifying, measuring and communicating economic
information to permit informed judgments and decisions by users
of the information.” Of course, this is by no means an easy task.
However the accounting bodies all over the world and particularly
the International Accounting Standards Committee have been
trying to grapple with this problem and have achieved success in
laying down some basic postulates on the basis of which the
accounting statements have to be prepared.
Accounting as Science or Art
Any organized knowledge based on certain principles is a 'science'.
Accounting is also a science. It is an organized knowledge based on scientific
principles which have been developed as a result of study and experience. Of
course accounting cannot be termed as a perfect science like physics or
chemistry where experiments can be carried and perfect conclusions can be
drawn. It a social science depending much on human behavior and other social
and economic factors.
Art is the technique which helps us in achieving our desired objective.
Accounting is definitely anart.
The American Institute of Certified Public Accountants also defines accounting
as” the art of recording, classifying and summarizing the financial transactions”.
Accounting helps in achieving the desired objectives of maintaining proper
accounts i.e.… to know the profitability and the financial position of the business
by maintaining proper accounts.
Book-keeping, Accounting and Accountancy
These three are sometimes considered as synonyms. However, there is
fundamental difference amongst bookkeeping and accounting and accountancy.
Bookkeeping
Bookkeeping is mainly concerned with record keeping or maintenance of
books of accounts. The maintenance of books of accounts include the following
four activities
1. Identifying the transactions of financial nature from amongst the
various transactions.
2. Measuring the identified transactions in terms of money.
3. Recording the identified transactions in the books of original entry.
4. Classifying them into ledger.
The bookkeeping function is routine and clerical in nature and can be
performed by persons having limited knowledge of accounting. At present this
function is increasingly done by computers.
Accounting
Accounting starts where book keeping ends. It includes the following
activities:
1.Summarizing the classified data in the form of profit and loss account
and balance sheet etc.
2. Analyzing and interpreting the summarized results. In other words,
drawing the meaningful information from profit and loss account
and balance sheet.
3.Communicating the information to the
interested parties. Thus the accountant’s
work goes beyond the work of a book
keeper.
 Accountancy
Accountancy refers to a systematic knowledge of accounting concerned
with the principles and techniques which are applied in accounting. It tells us
how to prepare books of accounts, how to summarize the accounting
information and how to communicate it to the interested parties. According to
Kohler,' accountancy refers to the entire body of theory and practice of
accounting.'
End Users of Accounting Information
Accounting information is used by various groups of people who have
contact with business enterprise. They use accounting information in order to
satisfy some of their varied needs for information. The various users are as
follows:
1. Proprietors: A business is done with the objective of making
profit. Its profitability and financial soundness are, therefore,
matters of prime importance to the proprietors who have invested
their money into the business
4. Managers: Managers need financial information to run the business
entity in an efficient manner and take effective decisions on behalf
the owners of the business.
5. Creditors: Creditors are the persons who have extended credit to
the company. They are also interested in the financial statements
because they will help them in ascertaining whether the
enterprise will be in a position to meet its commitment towards
them both regarding payment of interest and the principal.
6. Prospective investors: A person who is contemplating an
investment in a business will like to know about its profitability
and financial position. Astudy of the financial statement will help
him in this respect.
7. Government: The government is interested in the financial
statement of business enterprise on account of taxation, labor
and corporate laws, if necessary; government can ask its officials
to examine the accounting records of the business.
 8. Employees: The employees are interested in the financial
statements on account of various profit sharing and bonus
schemes.Their interest may further increase in case they purchase
shares of the companies in which they are employed.
9. Citizens: An ordinary citizen may be interested in the accounting
records of the institutions with which he comes in contact in daily
life example bank, temple, and public utilities such as gas,
transport and electricity companies. In a broader sense, he is also
interested in the accounts of the government company, a public
utility company etc...As a voter and a tax payer.
10.Researcher: Accounting information being a mirror of financial
performance of the business enterprise, is of immense value to
the research scholars who want to make an in depth study of the
financial operations of the enterprise.
Limitations of Accounting
As discussed above, accounting provides information about the
profitability and financial soundness of the concern to the owners and the
interested parties. In addition, it provides various other valuable information
also. However accounting has certain limitations which must be kept in mind
while using such informations. These limitations are as follows:
1. Based on accounting concepts and conventions: Accounts
are prepared on the basis of number of accounting concepts and
conventions. Hence, the profitability and the financial position
disclosed by it may not be realistic. For example, fixed assets are
shown in the business as per going concern concept. This means
that fixed assets are shown at their cost and not at their market
price
.The value realized on their sales may be more or less then the value stated in
the balance sheet. Similarly, on account of convention of conservatism, the profit
and loss account does not disclose the true profit of the business because future
losses are provided for where as future profits are ignored.
11. Influenced by personal judgment: Accounting is not an exact
science and accountant has to exercise his personal judgment in
respect of various items. For example, it is extremely difficult to
predict with any degree of accuracy the actual useful life of an
asset which is needed for calculating depreciation. Different
personas are bound to have different opinions in respect of such
 things and hence it will result in ascertainment of different figures
of profit and loss of a business by different persons. Hence the
figures of profit cannot be taken as exact figures.
12. Incomplete information: Accounting statements provide only the
incomplete information because the actual profit or loss of a
business can be known only when the business is closed down.
13. Omission of qualitative information: Accounts contain
information which can be expressed in terms of money. Qualitative
aspects of the business unit are completely omitted from the
books as these cannot be expressed in monetary terms. Thus
changes in management, reputation of the business, cordial
relations between management and labor, firm's ability to develop
new product, efficiency of management, satisfaction of firm's
customers etc. which have the vital bearing on the firm's
profitability are all ignored and omitted from being recorded
because all of these events are qualitative in nature.
14. Based on historical cost: Accounts are prepared on the basis
of historical cost (i.e. the original cost) and as such the figures
given in financial statements do not show the effect of changes in
price level. The asset remain undervalued in many cases
particularly land and building. The outcome of this practice is that
balance sheet values of the asset are not helpful in estimating the
true financial position of the business.
15. Affected by window dressing: The accounts are manipulated,
so that the financial statements may disclose a more favorable
position than the actual position. For example, the purchase made
at the end of the year may not be recorded or the closing stock
may be overvalued. Hence correct decision cannot be taken on
the basis of such financial statements.
16. Unsuitable for forecasting: Financial accounts are only a
record of past events. Continuous changes take place in the
demand of the product, policies adopted by the firm, the position
of the competitors etc. as such; the financial analysis based on the
past events may not be of much use for forecasting.
 Accounting Concepts

The most important concepts of accounting are as follows:

 Business Entity Concept
 Money Measurement Concept
 Going Concern Concept
 Cost Concept
 Dual Aspects Concept
 Accounting Period Concept
 Matching Concept
 Accrual Concept
 Objective Evidence Concept

The first two accounting concepts, namely, Business Entity Concept and Money
Measurement
Concepts are the fundamental concepts of accounting. Let us go through each one of them
briefly:

Business Entity Concept

According to this concept, the business and the owner of the business are two different
entities. In other words, I and my business are separate.

Money Measurement Concept

According to this concept, “we can book only those transactions in our accounting record
which can be measured in monetary terms.”

Going Concern Concept

Our accounting is based on the assumption that a business unit is a going concern. We
record all the financial transaction of a business in keeping this point of view in our mind
that a business unit is a going concern; not a gone concern. Otherwise, the banker will not
provide loans, the supplier will not supply goods or services, the employees will not work
properly, and the method of recording the transaction will change altogether.
The concept of going concern does not work in the following cases:
 If a unit is declared sick (unused or unusable unit).
 When a company is going to liquidate and a liquidator is appointed for the same.
 When a business unit is passing through severe financial crisis and going to wind up.

Cost Concept
It is a very important concept based on the Going Concern Concept. We book the value of
assets on the cost basis, not on the net realizable value or market value of the assets based on
the assumption that a business unit is a going concern. No doubt, we reduce the value of
assets providing depreciation to assets, but we ignore the market value of the assets.
The cost concept stops any kind of manipulation while taking into account the net realizable
value or the market value. On the downside, this concept ignores the effect of inflation in the
market, which can sometimes be very steep. Still, the cost concept is widely and universally
accepted on the basis of which we do the accounting of a business unit.
Dual Aspect Concept
There must be a double entry to complete any financial transaction, means debit should be
always equal to credit.

Accounting Period Concept

The life of a business unit is indefinite as per the going concern concept. To determine the
profit or loss of a firm, and to ascertain its financial position, profit & loss accounts and
balance sheets are prepared at regular intervals of time, usually at the end of each year. This
one year cycle is known as the accounting period. The purpose of having an accounting
period is to take corrective measures keeping in view the past performances, to nullify the
effect of seasonal changes, to pay taxes, etc.
Based on this concept, revenue expenditure and capital expenditure are segregated.
Revenues expenditure are debited to the profit & loss account to ascertain correct profit or
loss during a particular accounting period. Capital expenditure comes in the category of
those expenses, the benefit of which will be utilized in the next coming accounting periods
as well.
Accounting period helps us ascertain correct position of the firm at regular intervals of time,
i.e., at the end of each accounting period.

Matching Concept
Matching concept is based on the accounting period concept. The expenditures of a firm for
a particular accounting period are to be matched with the revenue of the same accounting
period to ascertain accurate profit or loss of the firm for the same period. This practice of
matching is widely accepted all over the world.

Accrual Concept
As stated above in the matching concept, the revenue generated in the accounting period is
considered and the expenditure related to the accounting period is also considered. Based on
the accrual concept of accounting, if we sell some items or we rendered some service, then
that becomes our point of revenue generation irrespective of whether we received cash or
not. The same concept is applicable in case of expenses. All the expenses paid in cash or
payable are considered and the advance payment of expenses, if any, is deducted.
Most of the professionals use cash basis of accounting. It means, the cash received in a
particular accounting period and the expenses paid cash in the same accounting period is the
basis of their accounting. For them, the income of their firm depends upon the collection of
revenue in cash. Similar practice is followed for expenditures. It is convenient for them and
on the same basis, they pay their Taxes.
Objective Evidence Concept
According to the Objective Evidence concept, every financial entry should be supported by
some objective evidence. Purchase should be supported by purchase bills, sale with sale
bills, cash payment of expenditure with cash memos, and payment to creditors with cash
receipts and bank statements. Similarly, stock should be checked by physical verification
and the value of it should be verified with purchase bills. In the absence of these, the
accounting result will not be trustworthy, chances of manipulation in accounting records
will be high, and no one will be able to rely on such financial statements.
 Accounting Conventions

We will discuss the following accounting conventions in this section:

 Convention of Consistency
 Convention of Disclosure
 Convention of Materiality
 Conservation of Prudence
 Unit – 2
The Accounting Equation
Let us discuss the accounting equation, which keeps all the business accounts in balance.
We will create this equation in steps to clarify your understanding of this concept. In order
to start a business, the owner usually has to put some money down to finance the business
operations. Since the owner provides this money, it is called Owner’s equity. In addition,
this money is an Asset for the company. This can be represented by the equation:

ASSETS = OWNER’S EQUITY

If the owner of the business were to close down this business, he would receive all its
assets. Let’s say that owner decides to accept a loan from the bank. When the business
decides to accept the loan, their Assets would increase by the amount of the loan. In
addition, this loan is also a Liability for the company. This can be represented by the
equation:

Assets = Liabilities + Owner’s Equity

Now the Assets of the company consist of the money invested by the owner, (i.e. Owner’s
Equity), and the loan taken from the bank, (i.e. a Liability). The company’s liabilities are
placed before the owners’ equity because creditors have first claim on assets. If the business
were to close down, after the liabilities are paid off, anything left over (assets) would belong
to the owner.

Dual aspect concept

The dual aspect concept states that every business transaction requires recordation in two
different accounts. This concept is the basis of double entry accounting, which is required by
all accounting frameworks in order to produce reliable financial statements. The concept is
derived from the accounting equation, which states that:
Assets = Liabilities + Equity
The accounting equation is made visible in the balance sheet, where the total amount of
assets listed must equal the total of all liabilities and equity. One part of most business
transactions will have an impact in some way on the balance sheet, so at least one part of
every transaction will involve either assets, liabilities, or equity.
Branches of Accounting
In order to satisfy needs of different people interested in the accounting
information, different branches of accounting have developed. They can be
broadly classified into three categories
17. Financial accounting: It is the original form of accounting. It is
mainly confined to the preparation of financial statements for the
use of outsiders like shareholders, debenture holders, debtors,
creditors, bank and financial institutions. The financial statements
i.e. the profit and loss account and the balance sheet, show the
manner in which the business operations of the business have
been conducted during the specified period.
18. Management Accounting: It is accounting for the management
i.e. accounting which provides necessary information to the
management for discharging its functions. According to Chartered
Institute of Management Accountants, London, “Management
accounting is the formation of policies and in planning and control of
the operations of the undertaking.” It covers all the arrangements and
combinations or adjustments of orthodox information to provide the
chief executive with the information from which he can control the
business.
19. Cost accounting: The main purpose of cost accounting is to
ascertain total cost and per unit cost of goods produced and
services rendered by a business. It also estimates the cost in
advance and helps the management in exercising strict control
over cost.
Rules of debit and credit
Journal and Journalising Process
Every business organization carries various transactions throughout
the day. Some transactions are similar, many are different. Hence, it
is not possible to keep all the journalising process in mind without
recording it. All these transactions are important and therefore can’t
be avoided or omitted. So, to avoid any mistake or omission, all these
transactions are recorded in books. Journalising is the traditional form
of keeping track of happenings in the organization.
Meaning of Journal
Journal is the book of prime entry also called the book of original
entry. That is, a transaction is first entered here and is the most
important book of accounts. The transactions are recorded
systemically and in chronological order.
They are entered to show which accounts should be debited or
credited. Recording of transactions in “Journal” is called
as “Journalising the entries”
“Journal” is derived from the Latin word ‘Jour’, which means ‘a day’.
The transactions are first entered here and it is then subsequently
posted to another account book called as “Ledger”.
Importance of Journal
 Information recorded in the journal which certainly serves as a
proof or evidence in the court of law.
 It provides the base for ledger posting and also for cross-checking
of entries posted.
 It maintains the detailed record of transactions in the form of
narration, written immediately after passing the entry hence is
provides a highlight of the transaction done.
 Because the transactions are recorded in chronological order it is
useful for easy reference in the future.
Journalising Process
Journalising refers to recording business transactions systematically
and in a summarised form in the journal. It means a process of
entering the twofold effects of transactions in the form of debt and
 credit in the journal.

Cash Book
Kinds of Cash Books
A cash book is like a subsidiary book. It is a special book that will record only one type of
transactions – cash transactions. In an organization thousands of cash transactions occur in a
year and journalizing them all is tedious work. And so companies maintain cash books. Let us
look at the three types of cash books and their functions.

Kinds of Cash Book

A cash book is both a ledger and a journal for all the cash transactions of a company since it
performs the function of both. It records all cash receipts on the debit side and all the cash
payments of the company on the credit side. Let us now look at the three main kinds of cash
book a company may maintain.

1] Simple Cash Books

This is also known as a Single Column Cash Book. This cash book will only record cash
transactions. The cash coming in (receipts) will be on the left and the cash payments will be on
the right. And since we will record all cash transactions here there is no need for a
cash ledger account.
Now since there is only one column we do not record bank transactions in this cash book. Any
discounts given will also not feature here. We will record bank and discount transactions in
their separate ledger accounts.
Cash books are balanced quite frequently. In fact, most companies balance their cash book
daily. One important point to remember is that the cash book can never have a credit balance.
Cash books only show a debit balance.

2] Two Column Cash Books

Here instead of one column, we have an additional column for discounts. So along with the
cash transactions, we will also record the discounts in the same cash book. So both discounts
received and the discount that is given is recorded here. If any organization is in a general
practice of giving or receiving discounts this is the preferable option.
Discount is a nominal account – so the discount is given (loss) is on the debit side and discount
received (profit) is on the credit side. At the end of the period, we balance both columns and
transfer the closing balances.

3] Three Column Cash Books

 This cash book has the cash, the discount and additionally the bank columns in it. Since the
development of banking most firms, these days prefer to deal in cheques or other such bills of
exchange. And so having a bank column in your cash book makes things concise and simpler
to understand.
So when you receive a cheque and you deposit it in the bank the same day you make the entry
in the bank column (the debit side in this case). But say you send the cheque later (not the same
day) then this will be a contra entry. A contra entry is transactions that happen between a cash
account and a bank account. Ultimately your Cash & Bank balance remains the same, the
money just moves around.

4] Petty Cash Book

In a firm, there are usually cash transactions happening in all the departments. These we will
record in one of the above formats of cash books. But there are many cash transactions
happening for very small amounts. Sometimes there are dozens of such transactions that occur
in just one day. These are known as petty transactions. Examples are expenses for postage,
stationery, traveling, food bills, etc.
So since the number of such transactions tends to be very high we maintain a separate cash
book for them – the petty cash book. Such a cash book is maintained by the petty cashier (who
in most cases also handles the petty cash).

Q: Prepare a two column cash book from the following entries

i. Cash in Hand – 15000

ii. Received from ABC – 4800; Discount – 200
iii. Goods bought for cash 1500
iv. Cash paid to LMN – 2400; Discount – 100

Preparation of Ledger
Business organizations need to write and prepare ledger account
wherein all the transactions of are recorded permanently under
different heads of accounts.
As per accounting principle, the transactions just after their
occurrence are recorded in the primary book of account – journal in
chronological order of dates with explanations.
But it is not possible to determine the complete results of transactions
from the journal.
How to Write and Prepare Ledger Account
So, the 5 simple steps for writing and preparing ledger are;
 Drawing the Form: Get pen and paper, start drawing the ledger
account.
 Posting: Transactions from journal to respective ledger account.
 Folioing: Put the page number for a journal entry on the ledger
account’s folio column.
 Castin: Separating debit and credit amount.
 Balancing: Find the difference between debit and credit to get
debit or credit balance of the account.

Trial Balance
A trial balance is a bookkeeping worksheet-like account that reflects
all the credit and debit balances of all the ledger accounts. Once we
prepare this statement, we can prepare the final accounts of the
company on the basis of this trial balance.

One other important use of the trial balance is that it can determine
the arithmetic accuracy of the accounts. So if both columns of the
trial balance tally, we can be reasonably assured of the accuracy of
the accounts. It does not ensure that the accounts are free of all
errors but it can at least establish mathematical accuracy.

Preparation of Trial Balance

Preparation of trial balance is the third step in the accounting
process. First, we record the transactions in the journal. And then we
post them in the general ledger. Then we prepare a trial balance to
verify that the debit totals equal to the credit totals.

Steps in the preparation of trial balance

To prepare a trial balance we need the closing balances of all the
ledger accounts and the cash book as well as the bank book. So
firstly every ledger account must be balanced. Balancing is the
difference between the sum of all the debit entries and the sum of all
the credit entries.
Then prepare a three column worksheet. One column for the account
name and the corresponding columns for debit and credit balances.
Fill out the account name and the balance of such account in the
appropriate debit or credit column
Then we total both the debit column and the credit column. Ideally,
in a balanced error-free Trial balance these totals should be the
same
Once you compare the totals and the totals are same you close the
trial balance. If there is a difference we try and find and rectify
errors. Here are some cases that cause errors in the trial balance
A mistake in transferring the balances to the trial balance
Error in balancing an account
The wrong amount posted in the ledger
Made the entry in the wrong column, debit instead of credit or vice
versa
Mistake made in the casting of the journal or subsidiary book

Rules for Preparation of Trial Balance

While preparation of trial balances we must take care of the following
rules/points
1] The balances of the following accounts are always found on the
debit column of the trial balance
 Assets
 Expense Accounts
 Drawings Account
 Cash Balance
 Bank Balance
 Any losses

2] And the following balances are placed on the credit column of the
trial balance
Liabilities
 Income Accounts
 Capital Account
 Profits
There are broadly two methods for the Preparation of Trial Balance.
They are

Total Method: Here the totals of the credit and debit columns of the
ledger accounts are transferred to the Trial Balance. The closing
balance is of no concern
Balance Method: Here only the closing balance is transferred to the
Trial Balance on the relevant credit or debit column.
Financial accounting deals with recording and maintaining every monetary
transaction of an organization. However, sometimes, a few entries might be either
incorrect or used at the wrong place. In financial accounting, the process of
correcting such mistakes is known as Rectification of Errors.
Types of Errors
Two most common types of errors, which are usually occurred at the time of
preparation of Financial Statements are discussed below.

Error which Effect only One Account

 Omission of posting of balance in a Trial Balance.

 Error of carried forward of balance.
 Error of casting and posting.

Error which Effect Two or more Accounts

The nature of errors, which occur during the preparation of Financial Statements
are −

 Error of posting in wrong account.

 Error of principle.
 Error of omission.

Bank Reconciliation Statement

Two different firms prepare a cash record and bank statement. A firm records transactions in
the cash book.  A bank issues a bank statement every month.
However, a third party prepares the Bank Reconciliation statement. It compiles the errors they
both make.

Steps in Preparation of Bank Reconciliation Statement

Check for Uncleared Dues

Step 1: First of all, compare the opening balances of both the bank column of the cash book as
well as the bank statement. The two can be different in terms of uncleared dues like un-
presented or un-credited cheques from the previous month.

Compare Debit and Credit Sides

Step 2: Start by comparing the credit side of the bank statement to the debit side of the bank
statement. Also, compare the credit side of the cash book to the debit side of the cash book.
The two must be equal in both documents. Tick the columns if you can’t find any error.
Check for Missed Entries
Step 3: Analyse entries in the bank column of the cash book as well as in checkbook. Look for
records that have been missed to be posted in the bank column of the cash book. Make a
separate list of all such items and list them in cash book.
Correct them
Step 4:  Correct the errors present in the cash book, if any.
Revise the Entries
Step 5: Calculate the balance after revising the updated cash book’s bank column.
Make BRS Accordingly
Step 6: Prepare Bank Reconciliation Statement accordingly. Make sure to add the updated
version of records.
Add Un-presented Cheques and Deduct Un-credited Cheques
Step 7: Banks are not aware of Un-presented cheques because the beneficiary doesn’t get the
cheque. It is the case when the business firm forgets to deliver the signed cheque to the issued
name.
This situation leads to the addition of the cheque amount in the bank statement.
On the other hand, cheques which beneficiary has not yet collected are called un-credited
cheques. These must be deducted.
Make Final Changes
Step 8: Make all the final adjustments and check for bank errors in the bank statement and the
firm’s errors in the cash book. During heavy transaction days, firms or banks may make
mistakes in noting entries.
The process removes those errors. Although it consists of fine work, reconciliation becomes a
helping hand at hard times (large transaction days).
Left-Hand Side Equal to the Right-Hand Side
Step 9: The results from both the documents i.e. bank statement and cash book must match
with each other.
Why do we need to Prepare Bank Reconciliation Statement?
A bounced cheque leads to a fall in one’s reputation in the eyes of the bank. This may lead to
future misunderstandings for a firm’s relationship with Banks.
Moreover, it may also lead to delays in monetary help responses from bank side. Therefore,
reconciliation helps to tackle these mistakes and maintain a healthy official relationship. BRS
offers several other advantages to a business firm:
Detects Errors
A bank reconciliation statement helps to locate errors. After locating errors, firms can
easily remove them.
Tracking Interest and Fees
The bank might add interest payments or deduct service fees from the account without
prior notice. The additions or deletions are visible directly in the bank statement. A bank
reconciliation statement helps in managing these changes.
Detecting Fraud
Suppose, an employee handles the bank account for the firm. Apparently, the transaction
history is clearly visible to the manager of the business by reading the reconciliation
statement. Hence, no chances of fraud are entertained.
Bill of Exchange
According to the Negotiable Instruments Act 1881, ‘a bill of exchange is defined as an
instrument in writing containing an unconditional order, signed by the maker, directing a certain
person to pay a certain sum of money only to, or to the order of a certain person or to the
bearer of the instrument.’

Features of Bill of Exchange

 It is important to have a bill of exchange in writing

 It must contain a confirm order to make a payment and not just the request
 The order should not have any condition
 The bill of exchange amount should be definite
 Fixed date for the amount to be paid
 The bill must be signed by both the drawee and the drawer
 The amount stated on the bill should be paid on-demand or on the expiry of a fixed time
 The amount is paid to the beneficiary of the bill, specific person, or against a definite
order

Types of Bill of Exchange

 Documentary Bill- In this, the bill of exchange is supported by the relevant documents
that confirm the genuineness of sale or transaction that took place between the seller
and buyer.
 Demand Bill- This bill is payable when it demanded. The bill does not have a fixed date
of payment, therefore, the bill has to be cleared whenever presented.
 Usance Bill- It is a time-bound bill which means the payment has to be made within the
given time period and time.
 Inland Bill- An Inland bill is payable only in one country and not in any other foreign
country. This bill is opposite to foreign bill.
 Clean Bill- This bill does not have any proof of a document, so the interest is
comparatively higher than the other bills.
 Foreign Bill- A bill that can be paid outside India is termed as a foreign bill. Two
examples of a foreign bill are an export bill and import bill.
 Accommodation Bill- A bill that is sponsored, drawn, accepted without any condition is
known as an accommodation bill.
 Trade Bill- This kind of bill is specially related only to trade.
 Supply Bill- The bill that is withdrawn by the supplier or contractor from the government
department is known as the supply bill.

Must Read: Accounting for Bills Exchange

Advantages of Bill of Exchange

 Legal Document- It is a legal document, and if the drawee fails to make the payment it
will be easier for the drawer to recover the amount legally.
  Discounting Facility- The bill bearer has to wait till the due date of the bill to receive
the payment and it from the bank before its due date.
 Endorsement Possible- This bill of exchange can be exchanged from one individual to
another for the adjustment of the debt.

Bill of Exchange Format

In the above-mentioned bill of exchange format, Kunal Singh is the drawer as well as the payee
of the bill.

Parties of Bill of Exchange

A bill of exchange has three parties:
(1) Drawer:

 The drawer is the maker of a bill of exchange.

 The bill is signed by Drawer.
 A creditor who is entitled to receive payment from the debtor can draw a bill of
exchange.

(2) Drawee:

 Drawee is the person upon whom the bill of exchange is drawn.

 Drawee is the debtor who has to pay the money to the drawer.
 He is also known as ‘Acceptor’.

(3) Payee:

 The payee is the person to whom payment has to be made.

 The payee may be the drawer himself or a third party.
Importance of Promissory note in Bill of Exchange
According to the Negotiable Instruments Act 1881, the meaning of promissory note is ‘an
instrument in writing (not being a banknote or a currency note), containing an unconditional
undertaking signed by the maker, to pay a certain sum of money only to or to the order of a
certain person, or to the bearer of the instrument. However, according to the Reserve Bank of
India Act, a promissory note payable to bearer is illegal. Therefore, a promissory note cannot be
made payable to the bearer.’

Promissory Note
The promissory note is defined as an instrument in writing (not being a banknote or a currency
note), containing an unconditional undertaking signed by the maker, to pay a certain sum of
money only to or to the order of a certain person, or to the bearer of the instrument.

Parties to a Promissory Note

There Are Two Parties to a Promissory Note:
(1) Maker OR Drawer:

 Maker is the person who makes or draws the promissory note.

 Who promises to pay a certain sum as specified in the promissory note.
 He is also called the ‘Promisor’.

(2) Payee:
 The payee is the person in whose favour the promissory note is drawn.
Unit – 3

FINAL ACCOUNTS?
The term ‘Final Accounts’ is a broader term. The three following financial statements
are prepared for the preparation of final accounts:
(i) Trading account: It shows gross profit/loss of the business.
(ii) Profit & loss account: It shows the net profit/loss of the business.
(iii) Balance sheet: It shows the financial position of the business.
Out of the above three statements, trading, profit & loss accounts are prepared,
together, and balance sheet is prepared, independently. Here, it is very necessary to
remember that these accounts are not prepared in the ledger rather than on the
plain sheets or papers. Theses papers are filed for future reference.
The method of preparing these accounts is different from other accounts like
personal, real, nominal accounts.

WHY THIS NAME – FINAL ACCOUNTS?

As stated above, the term ‘final accounts’ refer to trading account, profit & loss
account and balance sheet. Balance sheet is a statement but even then it is included
in final accounts. Now, here the question arises that why they are named final
accounts?
Every businessman is, ultimately, interested to know the final result of the
business. These are called final accounts because they are the last accounts,
prepared at the end of the year. They serve the ultimate purpose of keeping
accounts. Their purpose is to analyze the effect of various incomes and expenses
during the year and the resultant profit or loss.
Trading, profit & loss account and balance sheet, all these three together,
are called as final accounts. Final result of trading is known through Profit
and Loss Account. Financial position is reflected by Balance Sheet. These
are, usually, prepared at the close of the year hence known as final accounts.

PREPARATION OF FINAL ACCOUNTS

Final balances of all the accounts in the ledger are transferred to trial balance. From
trial balance, expenses and income accounts are transferred to trading account and
profit and loss account.
Accounts, with balances, which are to be carried forward to the next year, are shown
in the balance sheet. The balance sheet constitutes the final stage of accounting.
Final accounts have to be prepared, every year, in every business. Trading and
profit & loss accounts are prepared, after all the accounts have been completely
written and trial balance is extracted. Before preparing final accounts, it becomes
necessary to examine whether all the expenses and incomes for the year for which
accounts are prepared have been duly provided for and included in the accounts.
Circumstances and items are common where adjustments, at the end of the
accounting period, are to be made. In such items, no cash is involved hence no
record has been kept till year-end.
Form of Final Accounts: There is a standard format of final accounts only in
the case of a limited company. There is no fixed prescribed format of financial
accounts in the case of a proprietary concern and partnership firm.

Transactions

Trading & Profit & Loss Account

Balance Sheet

Journal

Trial Balance

Ledger

Cycle of Final Accounts

MEANING AND NEED OF ADJUSTMENT ENTRIES

Sometimes, it is seen that after preparation of trial balance, but, prior to preparation
of final accounts, it may be noticed some business transactions have been,
completely or partially, omitted to be recorded or entered wrong. Besides this, there
are some incomes or expenses, which are
related to the next year but have been received or paid during the current year.
Before preparing trading and profit & loss accounts, adjustment entries are necessary
in these accounts.
Transactions omitted relate to the current year must be entered in books. If
a transaction entered is not related to the current year, fully or partly, that
portion of income or expense must be excluded. This process is made
through adjustment entries in the books of accounts. If we ignore to make
the necessary adjustments, the trading, profit & loss accounts do not show
the true profit or loss and in consequence balance sheet fails to depict true
financial position of the business. This situation defeats the very purpose
of final accounts. Hence, adjustment entries play an important role in
presenting correct picture of accounts.

ADJUSTMENTS IN FINAL ACCOUNTS

Final Accounts are prepared, normally, for a complete period. It must be kept in mind
that expenses and incomes for the relevant accounting period are to be taken, while
preparing final accounts. If an expense has been incurred but not paid during the
period, a liability for the unpaid amount should be created, before finding out the
operating result and financial position of a concern. In order to prepare the final
accounts on mercantile system of accounting, all expenses and incomes relating to
the period, whether incurred or not, received or not, should be brought into the
books. For doing this, a concern is required to pass certain entries at the end of the
year to adjust the various items of incomes and expenses. Such entries are called
adjusting entries.
Accounting Treatment: Trading and Profit and Loss and Balance sheet,
together, are called as final accounts. Item appearing in the trial balance appears
only once in final accounts, either on the debit or credit. Any adjustment entry
requires two postings, debit and credit for the same amount. Important point is
students should do the posting (debit and credit) in the concerned accounts,
simultaneously. Care is to be exercised that the amount is the same for the total
debit and credit.
The following are the important adjustments, which are, normally made at the
end of accounting period.

 Closing Stock
Every concern prepares a list of unsold goods at the end of the period and puts value
against it. It is to be remembered that stock is valued at cost or market price,
whichever is less.
Closing Stock appears below the Trial Balance as an adjustment entry:
Normally, closing stock appears as an adjustment entry in the problem and is given
at the end of the trial balance. For example, if the value of stock at the end of the
period is Rs. 30,000 and is shown below the trial balance, then the following
adjusting entry will be passed:
Closing Stock A/c … Dr 30,000
To Trading Account 30,000
 The two-fold effect of this entry will be:
(i) Stock will have a debit balance. Being a real account, it will be shown
on the assets side of the Balance Sheet.
(ii) Closing stock will be shown on the credit side of the Trading Account.
Closing Stock appearing in Trial Balance: Sometimes, opening and closing stock are
adjusted through purchases. In this case, closing stock (debit balance) appears in the
Trial Balance. Closing stock, under this case, will not be shown on the credit side of the
Trading Account but will be shown on the assets side of to Balance Sheet only.
Remember, any entry appearing in the Trial Balance appears only once either on the
debit side or credit side, depending on the nature of the transaction. Closing stock is a
real account, hence appears on the assets side of the balance sheet.

 Outstanding Expenses
There are certain expenses, which have been incurred but not paid. These expenses
are called outstanding expenses. For example, salary to the clerk Rs. 10,000 is due
for the month of December. Books are closed at the end of December. In order to
bring this transaction into accounts, the following adjustment entry will be passed:
Salary Account …..Dr. Rs. 10,000
To Outstanding Salary A/c. Rs.
10,000 The two fold effect of this entry will be:
(i) Outstanding salary will be added to salary, if any, on the debit side of
Profit & Loss
Account.
(ii) Outstanding Salary Account, being personal and having credit balance,
will be shown on the liabilities side of the Balance Sheet.

 Prepaid or Unexpired Expenses

Those expenses which have been paid, in full, but their utility or benefit has not
expired during the accounting period are called prepaid or unexpired expenses. In
other words, amount has been paid even for the period subsequent to the balance
sheet date. For example, annual premium Rs. 12,000 is paid on 1 st July, where
accounting year closes on 31st December. Rs. 6000 will be insurance paid in advance.
To bring this into account, the following adjusting entry will be passed:
Prepaid Insurance Premium Account…..Dr. Rs. 6,000
To Insurance Premium Rs. 6,000
The double effect of this adjusting entry will be:
(i) Prepaid insurance will be deducted from the insurance premium on the
debit side of the Profit & Loss Account.
(ii) Prepaid insurance, being personal account and having debit balance,
will be shown on the assets side of the Balance Sheet.

 Accrued Income
Income earned but not received during the accounting period is called
accrued Income.
Suppose, the interest on investments shown in the trial balance is Rs. 19,500.
The adjustment may run like this. Interest @10% is due on investments of Rs.
10,000 for 6 months, though accrued, has not been yet been received.
 This interest Rs. 500 will be accrued income. In order to bring this into account,
the following adjusting entry will be passed:

Accrued Interest on Investments Account …..Dr. Rs. 500

To Interest on Investment Account Rs. 500
The two fold effect of this entry will be:
(i) Interest on Investment account (accrued interest) will be added to the
interest account on the credit side of the profit & loss account.
(ii) Accrued interest, being personal account and having debit balance,
will be shown on the debit side of the Balance Sheet.

 Unearned Income or Income Received in Advance

Sometimes, the amount received in respect of an income during the year pertains,
partially, to the next year. Suppose a landlord corrects rent for one quarter, in
advance, and closes his account on 30th June each year. Suppose, a tenant has
occupied a house on 1st June and pays Rs. 1,800 as rent for 3 months. The landlord
must not treat the whole of the rent received as income for the current year. Two
months’ rent pertains to the next year and should be credited to the Profit and Loss
Account of next year. This will ensure that the income for the current year is not
overstated. The required entry is:
Rent Account ….Dr. Rs. 1,200
To Rent Received in Advance Account Rs. 1,200
The Rent Received in Advance Account will be transferred to the Rent Account in
the next year.
This principle should be applied to all incomes, which pertain wholly, or partially to
the next year. Other examples can be the fees received from students, before the
summer vacation or subscription received in respect of a magazine. The fees
applicable to the period after the close of the accounting year or the subscription for
copies, to be supplied after the end of the year, should be credited to unearned
income account by debit to the account of the students’ fees or the subscription. This
will ensure that the income for the current year is not overstated.

 Depreciation
The value of fixed assets goes on reducing year by year because of wear, tear and
efflux of time. This fall in the value should be treated as a loss or expense, to be
considered before profit or loss is ascertained. The value to be shown in the Balance
Sheet must also be, suitably, reduced. To continue to show it at the old figure will be
overstating the assets. Depreciation is usually computed on the basis of the life of the
assets. Suppose, a machine costs Rs. 1,00,000 and has a life of 5 years. Then,
th
each year 1/5 of the cost, i.e., Rs. 20,000 should be treated as an expense; only
the remaining amount is to be shown in the balance sheet. The entry is:
Depreciation Account …Dr. 20,000
To Machinery Account 20,000
Depreciation is debited to the Profit & Loss Account. In the final accounts, the item
will figure as shown below:

Depreciation appearing in Trial Balance: In this case, depreciation entry has,

already, been passed, before preparation of the trial balance. In that case only, the
Depreciation Account will figure in the trial balance itself. The concerned asset will
appear at its reduced value since the amount of the depreciation would have been
credited to it. In such a case, no further adjustment will be necessary; the
Depreciation Account will be transferred to the debit of the Profit & Loss Account like
other expenses.
Again, it is reminded if any entry appears in the trial balance, only once it appears in
the financial statements. Here, it appears in profit & loss account. Only Adjustment
involves two entries.
Pro rata depreciation: While computing depreciation, the period for which the asset
is used should be kept in mind. Suppose, a machine is purchased on 1 st January,
2008 for Rs. 10,000 and another machine is purchased on 30 th June, 2008 for Rs.
6,000: the rate of depreciation is 10%. Accounts are closed at the end of the calendar
year. The depreciation for 2008 will be Rs. 1,300 as shown below:
Rs.
On Rs. 10,000 for one year @10% 1,000
On Rs. 6,000 for six months @10% 300
1,300
Treatment in case of Loose Tools: In some cases like loose tools, depreciation is
arrived at by comparing the value on two dates. Suppose loose tools were valued
at Rs. 2,300 on 1st January, 2008 and at Rs. 2,100 on 31st December, 2008, the
depreciation will be Rs. 200.

 Interest on Capital
The proprietor may wish to ascertain his profit, after considering the interest for the
amount invested in the firm. Suppose, the capital is Rs. 2,00,000 and the rate of
interest is 5%. Then, the interest will be Rs. 10,000. It will be treated like other
expenses and debited to the Profit and Loss Account; the amount will also be
credited to the Capital Account. The entry is:
Interest on Capital Account …Dr. 10,000
To Capital Account 10,000

In the final statements of account, the item will appear as shown below:

 Interest on Drawings
The proprietor may also realize that when he draws money for private use, the firm
loses interest as funds for business are reduced. Therefore, the proprietor’s capital
may be debited with the interest on the money drawn by him. Interest will depend on
the amount and the date of withdrawal concerned. In absence of information about
the date of drawings, it should be assumed that the drawings were made, evenly,
throughout the year; therefore, interest should be charged for six months on the full
amount. Suppose, capital is Rs. 2,00,000 and the total drawings are Rs. 10,000.
The rate of interest is 6% on the drawings.
The average amount of drawings on which interest is to be charged is Rs. 5,000.
So, interest @ 6% on drawings Rs. 5,000 will be Rs. 300. The entry to be passed is:
Interest on Drawings ...Dr. Rs. 300
To Profit & Loss Account Rs. 300
It will be shown as follows:
Drawings and Interest on drawings are reduced from Capital account.

 Interest on Loan
Interest must be paid on loans, whether there is profit or loss. It is calculated by
reference to the rate of interest agreed to be paid by the firm. Suppose a loan of
Rs. 20,000 is taken on 1st May 2008 at 18%, if the accounts are closed on 31 st
December, the interest for the year will be Rs. 2,400 i.e., Rs. 20,000 × 18/ 100 × 8/
12. The amount of the interest, if not paid, is to be credited to the Outstanding
Interest Account. The debit entry will be to the Interest on Loan Account. The entry
is:
Interest on Loan Account ….Dr. Rs. 2,400
To Outstanding Interest Account Rs. 2,400
The item will figure as follows in the final accounts:

 Classification of Debtors
Once goods are sold on credit, debtors appear in accounts. In place of debtors, bills
receivable may also appear. Debtors and bills receivable represent the amounts to
be received by the firm for the credit sales made. All debtors and bills receivable
may not be realizable. Where recovery is impossible, those amounts are to be written
of as bad debts. Against likely bad debts, provision is required to be made. Both bad
debts and provision for bad debts reduce the profits of the firm.
Classification of Debtors

Good Dettors Doubtful Debtors Bad Debtors

Fully Realizable Partly Realizable & No Chance of

Debts Partly Unrealizable Recovery
Debts

 Bad Debts
Credit sales have become a must these days and bad debts occur, when there are
credit sales. Bad Debt is a loss to the business and a gain to the debtor. The following
journal entry should, therefore, be passed in the event of a debt becoming bad.
Bad Debts A/c Dr.
To Debtor’s Personal A/c

 Provision for Bad and Doubtful Debts

Prudent accounting principle is to make provision for expected losses
and not to take credit for expected profits.
All credit sales would not be realized in the year in which the sales are made.
Sales may be made in one year and actual realizations may happen in the
succeeding year. A firm, therefore, makes provision at the end of the accounting year,
for likely bad debts, which may happen during the course of the next year. The
simple reason is all collections do not occur in the same year in which sales are
made. Some sales are likely to become bad in the course of the next year. So, the
proper course would be to charge such likely bad debts in that accounting year in
which sales have been made, since, the profit on such sales has been considered in
the year in which the sales have been made.
The following journal entry is passed for creating a provision for bad debts.
Profit & Loss A/c Dr.
 To Provision for Bad and Doubtful Debts
The provision for bad debts is charged to the Profit & Loss Account and is
deducted from debtors in the Balance Sheet.
Calculation of Provision for Bad and Doubtful Debts: Normally, problem
states the % of Provision for Bad and Doubtful Debts. On which amount of
debtors, this % of Provision for Bad and Doubtful Debts is to be
calculated?
 From debtors, first deduct total bad debts from debtors. Bad debts are
that amount, appearing in the trial balance and any further provision
that may be required in the adjustment for bad debts.
 On the balance amount of debtors only, Provision for Bad and Doubtful
Debts is to be calculated. Reason is simple. Once, debt becomes bad, it
would be written off. So, bad debts amount is already excluded from
debtors. The balance amount of debtors is only good debts, expected
to be realized. Even this amount may not be totally recoverable and
for this reason only, Provision for Bad and Doubtful Debts would be
created.

Provision for Bad and Doubtful Debts is to be calculated on that amount of debtors, after
deducting bad debts. Provision for Bad and Doubtful Debts is not to be calculated on
the total amount of debtors.
The provision for bad debts created at the end of the accounting year is carried
forward to the next year. At the end of the next year, suitable adjusting entry is
passed for keeping the provision for doubtful debts at an appropriate amount to be
carried forward.
Accidental Losses
Stock of goods may also be destroyed or damaged by fire, etc. As a result, the value
of the closing stock will be lower than otherwise. This will reduce the amount of the
gross profit and, in turn, net profit, automatically. It is always better to ascertain the
gross profit, which would have been earned, in absence of the loss since this enables
the firm to judge its trading operations, properly. This will be possible if the amount of
the loss of goods is credited to the Trading Account and debited to the Profit and Loss
Account. By this entry, the increases in the gross profit will be neutralized by the
debit to the Profit and Loss Account and thus the net profit will not be affected.
The entries to be passed, say, in case of fire, are as follows:
Loss of goods by Fire Account ……Dr.
To Trading Account.
If there is an insurance policy to cover the goods concerned, part or the whole
amount of loss may be admitted by the insurance company. The amount received or
agreed to be paid by the insurance company will be credited to the Loss of Goods by
Fire Account. The remaining amount only will be transferred to the Profit and Loss
Account as a write off as this would be the final loss due to accident.
(ii) Profit and Loss Account …..Dr.
To Loss of goods by Fire Account

 Commission Payable on Net Profits

Sometimes, Company may provide an incentive to the manager in the form of
commission on profits to improve profitability of the company. Suppose the profit earned
by the firm is Rs. 80,000, without considering the commission; commission is 5%. The
commission will be then Rs. 4,000. The profit will be reduced to Rs. 76,000. The entry
to be passed will be to debit the Profit and Loss Account and credit the Commission
Payable Account. This account will be a liability and shown in the balance sheet.
Sometimes, commission may be on the net profits of the company. If the rate of
the commission is 5%, then the profit remaining after the commission should be Rs.
100. In such an event, the profit before the commission should be Rs. 105. In other
words, commission is Rs. 5 out of every Rs. 105 profit, before the commission.
The formula to calculate the commission in such a situation is: 5/105 × Profits
before the commission.

CLOSING ENTRIES
‘Closing Entries’ are essential to ascertain the correct operating results. Accounts
relating to expenses and incomes are to be closed to find out the operating profit. So,
balances in the expenses and income accounts have to be transferred to Trading and
Profit and Loss Accounts. Process of closing expenses and income accounts is done
through closing entries.
Unit – 4

COMPANY : AN INTRODUCTION
You may have come across the name of organisation with suffix
limited (Ltd.), for example Hindustan Motors Ltd. or Hindustan
Aeronautics Ltd. etc. Have you ever thought what does this indicate?
Names of organisations with Ltd. indicate that these are forms of
oganisations which are different from sole proprietorship or
partnership. These are called joint stock companies.
As you know that the sole proprietorship and partnership forms of
business organisations could not meet the growing needs of huge
capital and managerial skills required for increased scale of business
and growing economic activities. The liability of owner/owners of
these organisations is unlimited. In order to overcome these problems
a new form of business organisation known as ‘company’ came into
existence.
In this lesson, we shall study about company, its features and the
methods of raising capital through issue of shares.

Company : An Introduction

COMPANY–MEANING AND CHARACTERISTICS

A company is a voluntary association of individuals formed to carry
on business to earn profits or for non profit purposes. These persons
contribute towards the capital by buying its shares in which it is
divided. A company is an association of individuals incorporated as a
company possessing a common capital i.e. share capital contributed
by the members comprising it for the purpose of employing it in some
business to earn profit.
As per Companies Act 1956, a company is formed and registered
under the Companies Act or an existing company registered under
any other Act”.
Characteristics of a Company
Following are the main characteristics of a company:
 Artificial Legal Person : A company is an artficial person as it is
created by law. It has almost all the rights and powers of a natural
person. It can enter into contract. It can sue in its own name and can
be sued.
 Incorporated Body : A company must be registered under
Companies Act. By virtue of this, it is vested with corporate
personality. It has an identity of its own. Although the capital is
contributed by its members called shareholders yet the property
purchased out of the capital belongs to the company and not to its
shareholders.
 Capital Divisible into Shares : The capital of the company is
divided into shares. A share is an indivisible unit of capital. The face
value of a share is generally of a small denomination which may be of
` 1, ` 2, ` 5, ` 10, ` 25 or ` 100 etc.
 Transferability of Shares : The shares of the company are easily
transferable. The shares can be bought and sold in the stock market.
 Perpetual Existence : A company has an independent and
separate existence distinct from its shareholders. Changes in its
membership due to death, insolvency etc. does not affect its existence
and its continuity.
 Limited Liability : The liablity of the shareholders of a company
is limited to the extent of face value of shares held by them. No
shareholder can be called upon to pay more than the face value of the
shares held by them. At the time of winding up, if necessary, the
shareholders may be asked to pay the unpaid value of shares.
 Representative Management : The number of shareholders is so
large and scattered that they cannot manage the affairs of the
company collectively. Therefore they elect some persons among
themselves to manage and administer the company. These elected
representatives of shareholders are individually called the ‘directors’
of the company and collectively the Board of Directors.
 Common Seal : A common seal is the official signature of the
company. Any document bearing the common seal of the company is
legally binding on the company.
Nature of Company
In the beginning, the size of business firms were very small. Sole
proprietorship was therefore, the usual form of business organisation.
Later on partnership become popular when the size of business firms
increased. But sole proprietorship and partnership could not meet the
growing demand of big size business because of their limitations such
as limited capital, limited managerial ability, unlimited liability and
other drawbacks. Therefore, in the present days of business world, it
is only the Joint stock company form of business organisation which
proved to be useful.
A company is a voluntary association of persons formed for some
common purpose, with capital divisible into parts, known as shares
and with a limited liability. It is created by law and is known as an
artificial person with a perpetual succession and a common seal. It has
a separate legal entity.

TYPES OF COMPANIES
Companies can be classified under the following heads:
1. On the basis of formation.
2. On the basis of liability.
3. On the basis of ownership.
1. On the basis of Formation
On the basis of formation companies can be categorised as :
(a) Statutory Company : A company formed by a Special Act of
parliament or state legislature is called a Statutory Company. Reserve
Bank of India, Industrial Financial Corporation of India, Life
Insurance Corporation of India, Delhi State Finance Corporation are
some of its examples.
(b) Registered Company : A company formed and registered under
the Companies Act, 1956 or earlier Companies Acts is called a
Registered Company. The working of such companies is regulated by
the provisions of the Companies Act.
2. On the basis of Liability
On the basis of liabilty, companies can be categorised as:
(a) Company Limited by Shares : The liability of the member of
such company is limited to the face value of shares held by him/her.
(b) Company Limited by Guarantee : The liabilty of each member
of such company is limited to the extent of guarantee undertaken by
the member. It may arise in the event of it being wound up.
(c) Unlimited Company : The company not having any limit on the
liability of its members, is called an unlimited company. Liability in
such a case extends to the personal property of its shareholders. Such
companies do not use the word ‘limited’ at the end of their name.
(d) Company Under Section 25 : A company created under section-
25 is to promote art, culture and societal aims. Such companies need
not use the term limited at the end of their name. Punjab, Haryana,
Delhi chambers of commerce, etc. are the examples of such
companies.
3. On the basis of Ownership
On the basis of ownership, companies can be catagorised as :
(a) Private Company : A private company is one which by its
Articles of Association :
(i) restricts the right of members to transfer its shares;
(ii) limits the number of its members to fifty (excluding its past and
present employees);
(iii) prohibits any invitation to the public to subscribe to its shares,
debentures.
(iv) The minimum paid up capital of the company is one lakh rupees
(` 100000).
The minimum number of shareholders in such a company is two and
the company has to add the words ‘private limited’ at the end of its
name. Private companies do not involve participation of public in
general.
(b) Public Copmpany : A company which is not a private company
is a public company. Its Articles of association does not contain the
above mentioned restrictions.
Main features of a public company are :
(i) The minimum number of members is seven.
(ii) There is no restriction on the maximum number of members.
(iii) It can invite public for subscription to its shares.
(iv) Its shares are freely tansferable.
(v) It has to add the word ‘Limited’ at the end of its name.
(vi) Its minimum paid up capital is five lakhs rupees (` 500,000).
(c) Government Company : A Government company is one in
which not less than 51% of its paid up capital is held by (1) Central
Government or (2) State Government, or (3) partly by Central
Government and partly by State Government. Example of a
Government company is Hindustan Machine Tools Limited, (HMT)
State Trading Corporation (STC). Minerals and metals trading
corporation (MMTC).
(d) Foreign Company : A foreign company is one which is
incorporated outside India but has a place of business in India, for
example Philips, L.G, etc.
(e) Holding Company and Subsidiary Company : A holding
company is a company which controls another company (called
subsidiary company) either by acquiring more than half of the equity
shares of another company or by controlling the composition of Baord
of Directors of another company or by controlling a holding company
which controls another company.
(f) Listed Company and Unlisted Company : A company is
required to file an application with stock exchange for listing of its
securities on a stock exchange. When it qualifies for the admission
and continuance of the said securities upon the list of the stock
exchange, it is known as listed company. A company whose securities
do not appear on the list of the stock exchange is called unlisted
company.

SHARES-MEANING AND ITS KINDS

A joint stock company divides its capital into units of equal
denomination. Each unit is called a share. These units i.e. shares are
offered for sale to raise capital. This is termed as issuing shares. A
person who buys share/shares of the company is called a shareholder
and by acquiring share or shares in the company he/she becomes one
of the members of the company.
Thus, a share is an indivisible unit of capital. It expresses the
proprietory relationship between the company and the shareholder.
The denominated value of a share is its face value. The total capital of
a company is divided into number of shares.
Kinds of Shares
According to the Companies Act, a company can issue the following
types of Shares:
(i) Preference Shares (ii) Equity Shares
(i) Preference Shares : A preference share is one which carries
following preferential rights over other type of shares called equity
shares in regard to the following :
 Payment of dividend
 Repayment of capital at the time of winding up of the company.
Characteristics of Preference Shares
i. Such type of shareholders have priority in the payment of
dividend before any other class of shareholders get their payment of
dividend.
ii. The rate of dividend of such shares are pre-determined.
(ii) Equity Shares : All shares which are not preference shares are
equity shares. Holders of these shares receive dividend out of the
profits of the company after the payment of dividend has been made
to the preference shareholders.
Characteristics of Equity Shares
i. Its dividend rate can change from year to year.
ii. Dividend on Equity shares is paid after the payment of dividend
to preference shareholders.
iii. In the event of winding up of company the repayment of capital
to equity shareholder is made at last.
iv. They are real owners of the company.
Equity shareholders have the right to elect directors of the company.
Equity shares are the permanent source of capital.
SHARE CAPITAL–MEANING AND ITS TYPES
A joint stock company estimates its future capital requirements. The
amount of the capital is mentioned in the capital clause of the
Memorandum of Association registered with the Registrar of the
Companies. Total capital is divided into a number of small indivisible
units of fixed amount and each such unit is called a share. A share is
nothing but a part in the share capital of the company. As the total
capital of the company is divided into shares, the capital of the
company is called share capital. Share capital of the company is
divided into following categories:
 Nominal/Authorised/Registered Capital : It refers to the
maximum amount of share capital which a company is
authorised to issue as per its Memorandum of Association.
 Issued Capital : Issued capital is that part of the authorised
capital which the company offers to public, that may include
vendors, for subscription or purchase. A company may issue its
 entire authorised capital or may issue it in parts from time to
time as per the needs of the company. It means and includes the
nominal value of shares issued by the company for (a) cash, and
(b) consideration other than cash to (i) promoters of a company,
and (ii) others.
 Subscribed Capital : It is that part of issued capital which is
taken up or subscribed by those who are offered for
subscription. Company may receive application for equal to,
more than or less than shares issued. This capital can be equal to
or less than the issued capital. The portion of nominal value of
the issued share capital which is actually paid (or subscribed) by
the shareholders forms part of the subscribed capital.
 Called up Capital : It is that part of the issued/subscribed capital
which is called up by company to pay on the allotted shares and
is to be paid by the shareholders. The portion of the issue price
of the shares which a company has demanded or called from
shareholders is known as called up capital
 Uncalled Capital : Uncalled Capital is that portion of the
issued/subscribed capital that is not called up by the company on
the shares allotted.
 Paid up Capital : It is the portion of called up capital which has
been paid by the shareholders, to calculate the paid up capital,
the amount of instalments in arrears is deducted from the called
up capital.
 Unpaid Capital : That part of the called up capital which has
been called but has not been paid by the shareholders is called
unpaid capital. i.e. calls-in- arrears.
 Reserve Capital : Company may keep some part of its share
capital uncalled and keep in reserve to be called only in case of
need at the time of its winding up. This is known as Reserve
capital. For this, a special resolution will have to be passed by
the company. Thus, it is that portion of the uncalled capital
which a company has decided to call only in case of liquidation
of the company.

PRIVATE PLACEMENT OF SHARES

According to Section 81 (1A) of Companies Act, 1956 private placement of
shares implies issue and allotment of shares to a selected group of persons.
A private company limited by shares is prohibited by the Companies
Act from issue of shares for public subscription. It also need not file a
statement in lieu of prospectus. Its shares are issued privately to a
small number of persons known as promoters or
related to them by family connections. This is an easy way of raising
capital which involves less legal formalities. However, a public
company can also raise the capital by placing the shares privately and
without inviting the public for subscription. Such Private Placement
requires special resolution to be passed by the company or consent of
Central Government. An underwriter or broker finds clients who wish
to buy shares. Since, no public offer is made, there is no need to issue
prospectus. Statement in lieu of prospectus should be filed with
registrar of companies in such a case.
Accounting treatment of private placement is similar to the public
subscription.

Salient Features of Private Placement are as follows :

i. The company needs to prepare a draft prospectus known as
“Statement in lieu of Prospectus” and must file with the registrar
atleast 3 days before the allotment of shares or debentures.
ii. Private Placement of shares and debentures is carried only in the
case where the company does not want to raise capital through public
subscription.
iii. In the case of private placement of shares the allotees will not
sell their shares for a minimum period of 3 years from the date of
allotment. This period is known as lock-in period.

ISSUE OF SHARES TO PROMOTERS

Promoters are those persons, firms or companies, who promote the
company. They are entrusted with the work of the formation of the
company. Promoters are paid remuneration for their services. This
remuneration can be paid in the form of shares also. In such cases
companies issue shares to their promoters without payment. The
journal entry to be passed is as under :
Goodwill A/c Dr.
To Share Capital A/c
Goodwill A/c is debited on the assumption that promoter’s function
has resulted in forming the company into profitable unit.
Alternatively, conservative treatment is as under : Preliminary Exp. /
Incorporation Costs A/c Dr.
To Share Capital A/c
Incorporation costs A/c should be written off against P/LAccount as
early as possible.

PROCEDURE OF ISSUE OF SHARES

Face value of a share is the par value of the share. It is also known as the
Nominal value or denomination of a share. To issue shares a company follows a
definite procedure which is controlled and regulated by the Companies Act and
Securities Exchange Board of India (SEBI). There are different ways of issue of
shares which may be:
(A) For consideration other than cash
(B) For cash

Issue of Shares
(A) ISSUE OF SHARES FOR CONSIDERATION OTHER THAN
CASH
Sometimes shares are issued to the promotors of the company in lieu
of the services provided by them during the incorporation of the
compnay. The issue price of these shares is normally debited to
‘Goodwill A/c’ and journal entry is made as follows:
Goodwill A/c Dr.
To Share Capital A/c
In case a company does not have sufficient funds for the purchase of
fixed assets or for payment to creditors it may offer and allot its
shares to vendors/ creditors in lieu of cash. Any allotment of shares
against which cash is not to be received is called ‘issue of shares for
consideration other than cash’. For example building is purchased and
payment is made by issuing shares.
In case of purchase of assets like building, machinery, stock of
materials, etc. the following journal entry is made :
1. Assets A/c Dr.
To Vendors/Creditors A/c (Assets purchased)
2. Vendors/Creditors A/c Dr.
To Share Capital A/c
(Issue of shares of `…….each fullly paid up)
(B) ISSUE OF SHARES FOR CASH
In general, shares are issued for cash. The company may call the share
money either in one instalment or in two or more instalments. But
company always collects this money through its bankers.
(i) Receipt of Share Money in One Instalment : The company may
receive the share money in one instalment along with application. In
this case the following journal entries are made in the books of the
company
1. On Receipt of Application Money
Bank A/c Dr.
To Share Application A/c
(Application money received on ….shares of `…each)

Issue of Shares

2. On transferring the Application Money

Share Application A/cDr.
To Share Capital A/c
(Application money transferred to share capital A/c)
(ii) Share Money Received in Two or More Instalments : Instead of
receiving payment in one instalment i.e. at the time of application the
company collects it in two or more instalments. The first, instalment
which the appplicants have to pay along with the applications for
shares is known as application money. On the allotment of shares the
allottees are required to pay the second instalment which is termed as
allotment money. If the company decides to call the share money in
more than two instalments the other instalment is/are termed as call
money (i.e. first-call, second call or final call).
In the above case the transactions are recorded in journal as given
below :
(a) On Receipt of Application Money
Bank A/c Dr.
To Share Application A/c
(Receipt of share application money for …. Shares @ `.. per share)
(b) On Allotment of Shares : After receiving the application for
shares within the prescribed time, the Board of Directors of the
company proceed to allot shares. On allotment of shares the
application money is transferred to Share Capital A/c. For this the
following journal entry is made :
Share Application A/cDr.
To Share Capital A/c
(Share application for …. Shares @ `… per share transferred to share
capital A/c)
Allotment Money Becoming Due and Received
On the allotment of shares the amount receivable on the next
instalment i.e. on allotment becomes due. The following entry is made
for recording the amount due:
(i) Allotment money becoming due
Share Allotment A/c Dr.
To Share Capital A/c
(Share allotment money due on …. shares @` ... per share)
(ii) Receipt of allotment money
On the receipt of share allotment money the following journal entry is
made: Bank A/c Dr.
To Share Allotment A/c
(Receipt of the amount due on allotment of … shares)
Calls on Shares
After the receipt of application and allotment money the money that
remains unpaid can be called up by the company as and when
required. Thus a call is a demand made by the company asking the
shareholders to remit the called up amount on shares allotted to them.
The company may demand the remaining money in more than two
instalments. The amount called after the allotment is known as call
money. There may be one or more calls, depending on the fund
requirements of the company. When only one call is made and Call
Money is Due :
Share First and Final Call A/c Dr.
To Share Capital A/c.
(Call money due on …. share @ ` … per share).
Receipt of Call Money
The following journal entry is made for receipt of call money: Bank
A/c Dr.
To Share First & Final call A/c
(call money due on … shares @ ` ... per share received)
Note : If the company makes more than one call the same accounting
treatment is followed for recording the second call or third call money
due and their receipt. The last call made is termed as final call.

Issue of Shares

(i) Under Subscription : The issue is said to have been under

subscribed when the company receives applications for less number
of shares than offered to the public for subscription. In this case
company is not to face any problem regarding allotment since every
applicant will be alloted all the shares applied for. But the company
can proceed with allotment provided the subscription for shares is at
least equal to the minimum required number of shares termed as
minimum subscription.
(ii) Over Subscription : When company receives applications for
more number of shares than the number of shares offered to the public
for subscription it is a case of over subscription. A company cannot
allot more shares than what it has offered. In case of over
subscription, company has the following options :

Option I
(i) Rejection of Excess Applications and Money Returned : The
company may reject the applications for shares in excess of the shares
offered for issue and a letter of rejection is sent to such applicants. In
this case the application money received from these applicants is
refunded to them in full. The journal entry made is as follows:
Share Application A/cDr.
To Bank A/c
(Application money on … shares refunded to the applicants)
(ii) Excess application money adjusted towards sums due on
allotment. Journal entry made is :
Shares Application A/c Dr.
To Share Allotment A/c
(Excess application money adjusted towards sums due on allotment)
If the application money received on partially accepted applications is
more than the amount required for adjustment towards allotment
money, the excess money is refunded. However, if the Articles of the
company so authorise, the directors may retain the excess money as
calls in advance to be adjusted against the call/ calls falling due later
on and the following entry is made :
Share Application A/cDr.
To Call-in-advance A/c
(The adjustment of excess share application money retained as call-in-
advance in respect of ... shares)

Issue of Shares Option II

Partial Acceptance of Applications
In some cases the company accepts the applications for subscription
partially. It means that the company does not allot the full number of
shares applied for. For example if an applicant has applied for 5000
shares and is allotted only 2000 shares, then the applications is said to
have been partially accepted. The company may evolve some formula
of accepting applications partially or making proportionate allotment/
the Prorata allotment which means that the applicants are allotted
shares proportionately. In such a case the company adjusts the excess
share money received on application towards share allotment money
due on partially accepted applications. The journal entry recording the
adjustment of application money towards share allotment money, is as
under :
Share Application A/cDr.
To Share Allotment A/c
(Share application money transferred to Share Allotment Account in
respect of ... shares)
Illustration 2
The Full Health Care Ltd has offered to public for subscription 20000
shares of ` 100 each payable as ` 30 per share on application, ` 30 per
share on allotment and the balance on call. Applications were
received for 30000 shares. Applications for 5000 shares were rejected
all together and application money was returned. Remaining
applicants were alloted the offered shares. Their excess application
money was adjusted towards some due on allotment. Calls were made
and duly received. Make journal entries in the books of the company.
ISSUE OF SHARES AT PREMIUM
A company can issue its shares at their face value. When company
issues its shares at their face value, the shares are said to have been
issued at par. Company can also issue its shares at more than or less
than its face value i.e, at ‘Premium’ or at ‘Discount’ respectively.
When shares are issued at premium or at discount an accounting
treatment different from shares issued at par is required. Let us
discuss issue of shares at premium.
Issue of Shares at Premium
If a company issues its shares at a price more than its face value, the
shares are said to have been issued at Premium. The difference
between the issue price and face value or nominal value is called
‘Premium’. If a share of ` 10 is issued at ` 12, it is said to have been
issued at a premium of ` 2 per share. The money received as premium
is transferred to Securities Premium A/c. A company issues its shares
at premium only when its financial position is very sound. It is a
capital gain to the company. The Premium money may be demanded
by the company with application, allotment or with calls.
The Companies Act has laid down certain restrictions on the
utilisation of the amount of premium.
According to Section 78 of this Act, the amount of premium can be
utilised for :
(i) Issuing fully-paid bonus shares;
(ii) Writing off preliminary expenses, discount on issue of shares
and debentures, underwriting commission or expenses on issue;
(iii) Paying premium on redemplion of Preference shares or
Debentures;
(iv) By Back of Shares.
Further, the company may demand the total amount of premium in
more than one instalment. In case the company doesn’t specify the
particular call with which Securities Premium is to be paid it is
supposed to be called at the time of Allotment.
Accounting Treatment of Premium on Issue of Shares
Following is the accounting treatment of Premium on issue of shares :

(a) Securities Premium Collected with Share Application Money :

If the Securities premium is collected on application and the company
has taken decision about the allotment of shares, the following journal
entry is made :
Share Application A/cDr.
To Securities Premium A/c
(The amount of Securities premium received on application
of the alloted shares is transferred to Securities Premium A/c)
(b) Premium Collected with Allotment Money or Calls : If the
company decides to demand the premium with share Allotment or/and
share call money, the journal entry made is :
Share Allotment A/c Dr.
Or/and
Share Call A/c Dr.
To Securities Premium A/c
(Adjustment of share premium due on……shares @ `…….per share.)
Dislosure of Share Capital in Company’s Balance Sheet (Vertical
form)
According to schedule V1, Part I of the companies Act 1956, the
Share Capital of a company is shown in the Balance Sheet as given
below.
Balance Sheet of a Company (an extract)
as at ........................

Particulars Note `
I. Equity and Liabilities
(1) Shareholders Funds
(a) Share Capital
(b) Reserves and Surplus
(c) Money received against share accounts
(2) Share Application Money Pending Allotment

Note : On the face of the Balance Sheet only so much information

should be disclosed as is required and the remaining should be
disclosed in the Notes to Accounts.
I. Equity and Liabilities
There are broadly two headings shown on the Equity and Liabilities
side. First, being the equity, i.e., liability of the company towards
shareholders. It is termed as Shareholders’ Funds. It includes Share
Capital, Reserves and Surplus and Money received against share
warrants. Second, being liability of the company towards the
outsiders. It is termed as Liabilities.
1. Shareholders’ Funds
(a) Share Capital : It is the first item under shareholders’ funds.
Details required to be shown are :
i.  Authorised Share Capital : Authorised Share Capital is stated
in the Memorandum of Association and is divided into different
categories such as equity share capital and perference share capital. It
is the amount of share capital that a company is authorised to issue
under each category. It is shown by way of information in the notes
attached to the Balance Sheet. The above information is shown for
information only, i.e., it is not added to liability.
• Issued Share Capital : It is that part of the authorised share
capital which the company has issued for subscription up to the
authorised share capital which the company has issued for
subscription up to the date of Balance Sheet. It includes a number and
classes (Equity or Preference) of shares and their face value, etc.
• Subscribed Share Capital : It is that part of issued share capital
which has been subscribed by the applicants.
• Called-up Share Capital: It is that part of the issued share capital
that has been called-up to be paid by the company.
• Paid-up Share Capital : It refers to that part of subscribed share
capital which has been paid-up by the subscriber towards share
capital.

(ii) If a company has issued different types of Equity and Preference

shares, detail of each type of shares is given.
(iii) Amount of Calls-in-Arrear is shown as deduction from called-up
capital or ‘subscribed capital’ to ascertain the paid-up capital of the
company and shown as liability in the Balance Sheet.
Calls-in Arrear from Directors and Officers of the company have to
be disclosed.
(iv) Forfeited shares amount, i.e., amount originally paid up is
shown by adding it to subscribed capital. But in case of profit on
reissue of forfeited shares, it is transferred to Capital Reserves.
It is to be noted that details regarding share capital or in fact, any item
of Balance Sheet and Statement of Profit and Loss is to be given in
the notes.
(b) Reserve and Surplus : Reserve and Surplus include following
items and are shown separately :
(i) Capital Reserves
(ii) Capital Redemption Reserve
(iii) Securities Premium Reserve
(iv) Debentures Redemption Reserve
(v) Revaluation Reserves
(vi) Share Options Outstanding Account
(vii) Other Reserves (to specify the nature and purpose of each
reserve)
(viii) Balance in the statement of Profit and Loss after appropriations
towards proposed dividend and transfer to reserves. In case, Reserves
and Surplus has a balance under the head, profit (surplus) or loss
(deficit) for the year is added to it. Thereafter, appropriation is made
by transfer to reserves or for provision for dividend.
If the balance after transfer of profit to the existing balance results in
negative figure, it is shown under Reserves and Surplus as a negative
amount. It means it is deducted to arrive at the total reserves.

ISSUE OF SHARES AT DISCOUNT

When the issue price of share is less than the face value, shares are
said to have been issued at discount. For example if a company issues
its shares of ` 100 each at
` 90 each, the shares are said to be issued at discount. The amount of
discount is
` 10 per share (i.e. ` 100 – ` 90). Discount on issue of shares is a loss
to the company.
Section 79 of Companies Act 1956 has laid down certain conditions
subject to which a company can issue its shares at a discount. These
conditions are as follows :
(i) At least one year must have elapsed from the date of
commencement of business;

(ii) Such shares are of the same class which has had already been
issued;

(iii) The company has sanctioned such issue by passing a resolution

in its General meeting and the approval of the court is obtained.
(iv) Discount should not be more than 10% of the face value of the
share and if the company wants to give discount more than 10%, it
will have to obtain the sanction of the Central Government.
Accounting Treatment of Shares Issued at Discount
The amount of discount is generally adjusted towards share allotment
money and the following journal entry is made:
Share Allotment A/c Dr.
Discount on issue of shares A/c Dr.
To Share Capital A/c
(Allotment money due on….shares @ ` ……per share after allowing
discount @ ` per share)

CALLS IN ADVANCE AND CALLS IN ARREARS

If a shareholder pays any amount to company before it is demanded, it
is called Call- in-Advance. This amount is put in a separate account
known as Calls-in-Advance A/c. This amount is not shown as capital
of the company, till such time the company makes a demand from all
the shareholders. Call-in-Advance A/c is shown on the liabilities side
of the Balance Sheet. For example if a company issued shares of ` 10
on which it has already called ` 5. Against the uncalled portion of ` 5
per share the company makes a call ` 3 per share, the entry for call
money due will be made only for ` 3 per share. Now suppose a
shareholder pays ` 5 per share including the uncalled amount of ` 2
per share along with the call money, it means he has paid
` 2 per share in advance, which will be credited to calls in Advance
A/c. The company is required to pay interest on this amount @ 6% till
the date of its appropriation.

Following journal entry is made for calls-in-advance.

Bank A/c Dr.
To Calls-in-Advance A/c
(Calls in advance received on…….shares @ ` …….per share)
Appropriation of calls-in-Advance A/c say in the final call Journal
entry will be :
Calls-in-Advance A/c Dr.
To Share Final call A/c (Calls in advance amount adjusted)
For interest given on Calls-in-Advance ournal entry will be :
Interest on calls-in-Advance A/c Dr.
To Bank A/c
(Interest paid on the amount of Call-in-Advance)
Calls in Arrears
When the company sends notice to the shareholders to pay allotment
and /or call money, it has to be paid by them within the specified time
period. If it is not paid by any one or more of the shareholders, the
unpaid amount becomes arrears due from them. Such arrears are
transferred to an account termed as Calls-in-Arrears A/c. The
company is authorised to charge interest on calls-in-Arrears @ 5%
p.a. for the intervening peroid. (The period between date of non-
receipt of the due amount and the date of actual receipt of the due
amount).

Issue of Shares Accounting Treatment

The following jounal entry is made to record Calls-in-Arrears:
Calls-in-Arrears A/c Dr.
To Share Allotment/Call A/c
(Share allotment/ Call money not received on …. shares)

When the unpaid balance is received later on the following journal

entry is made: Bank A/c Dr.
To Calls in Arrears A/c
(Amount due on allotment/ call remaining unpaid now received
on…… shares.)
The company may charge interest on the amount of calls in arrears at
a given rate from the date of amount due till it is paid journal entry
will be
Bank A/c Dr.
To Interest on calls in arrears A/c.
Question Bank

Unit 1

20. Define Book keeping.

21. Define accounting.
22. What do you mean by single entry system of book keeping ?
23. What do you mean by double entry system of Book keeping ?
24. Define accounting principle.
25. List out the four characteristics of accounting principle.
26. What do you mean by accounting concept ?
27. What do you mean by accounting convention ?
28. Define accounting equation.
29. What do you mean by accounting cycle ?
30. What is journal ?
31. What do you mean by journal entry ?
32. What do you mean by journalising ?
33. What is narration ?
34. What do you mean by simple journal entry ?
35. What do you mean by compound journal entry ?
36. State the steps involved in accounting cycle.
37. What is an account ?
38. What is a ledger ?
39. State the differences between the journal and ledger.
40. What is meant by debtors ledger.
41. What is meant by creditors ledger
42. What do you mean by general ledger.
43. What is meant by “posting”.
44. Explain the need for accounting.
45. State the objectives of book keeping.
46. State the advantages of book keeping.
47. State the differences between book keeping and accounting.
48. Explain the various accounting concepts.
49. Explain the various accounting conventions.
50. Examine the relationship of accounting with various other disciplines.
51. Explain the role of Accountant in a society.
Unit 2
1. State the limitations of recording transactions in the Journal.
2. What do you mean by Practical system or English system of book keeping,
3. List out the various subsidiary books.
4. State the advantages of subsidiary books.
5. What do you mean by purchase book ?
6. What is a purchase returns book ?
7. What is a debit note ?
8. What do you mean by credit note ?
9. What is meant by sales book.
10. What is a sales return book ?
11. What is bills receivable book ?
12. What is a bills payable book ?
13. What is a Journal proper
14. What do you mean by a cash book ?
15. Mention three objects of cash book .
16. Mention two methods of maintaining a cash book.
17. Give the proforma of a simple cash book.
18. What do you mean by a cash receipt journal ?
19. What do you mean by a cash payment Journal ?
20. Distingush between a cash receipt journal and cash payment journal.
21. List out the various types of cash book
22. What do you mean by petty cash book ?
23. What is imprest ?
24. Mention two types of petty cash book.
25. What do you mean by contra entry ?
26. What is a petty cash book ? How is it maintained ?
27. Explain the imprest system of petty cash.
28. What is the object of cash book ? Further, explain the imprest system of petty cash.
29. What is a petty cash ? How is it best recorded in the books of account ?
30. What is a three column cash book ? What is its advantage ?
31. How is posting done from the cash book ?
32. State the points of similarities between a journal and a cash book.
33. “A cash book is both a Journal and a ledger” Do you agree. Explain.
34. What is a cash receipt Journal. Give a ruling of a cash receipt Journal.
35. What is a cash payment Journal. Give a ruling of a cash payment Journal ?
36. What is a simple cash book. How is it balanced ?
37. What do you mean by a two column cash book ? How is it balanced ?
Unit 3
1. Mention the three components of the final accounts of a sole trader.
2. What do you mean by Trading account ?
3. What do you mean by Gross profit ?
4. What do you mean by profit & loss account ?
5. What do you mean by net profit ?
6. What do you mean by manufacturing account ?
7. Distinguish between a manufacturing account and a Trading account.
8. Distinguish between a trading account and a profit and loss account .
9. Give four examples of Financial expenses.
10. Give four examples of Administrative expenses.
11. Give four examples of selling and distribution on expenses.
12. Mention four items of income which appear on the credit side of profit & loss a/c.
13. What do you mean by balance sheet ?
14. State four features of balance sheet.
15. How are assets arranged in balance sheet ?
16. What do you mean by Marshalling of assets and liabilities in balance sheet ?
17. What do you mean by capital expenditure ?
18. What do you mean by revenue expenditure ?
19. Why it is necessary to classify expenditure into capital and revenue at the time of preparing a balance
sheet ?
20. What do you mean by capital receipt ?
21. What do you mean by a revenue receipt ?
22. Distinguish between a revenue receipt and a capital receipt.
23. What do you mean by outstanding expenses ? How is it treated in preparing final accounts ?
24. What do you mean by prepaid expense ? How is it treated in preparing final accounts?
25. What do you mean by accrued expenses ? How is it treated in preparing final accounts ?
26. What do you mean by income received in advance? How is it treated in preparing final accounts ?
27. What do you mean by Depreciation ? How is it treated in preparing final accounts ?
28. What do you mean by bad debts? How is it treated in preparing final accounts ?
29. What do you mean by reserve for doubtful debts accounts ? How is it treated while preparing final
accounts ?
30. What do you mean by reserve for discount an debtors ?
31. What do you mean by provision for discount on creditors ?
32. What do you mean by interest on capital ? How is it treated in preparing final accounts ?
33. What do you mean by interest on drawings ? How is it treated in preparing final accounts ?
34. Give the proforma of a trading account of a trader.
35. Give a proforma of a manufacturing a/c of a trader.
36. Give a proforma for a profit & loss account of a trader.
37. Give a proforma of a balance sheet of a trader.
38. What is depreciation ?
39. What is depletion ?
40. What is obsolescence ?
41. What is “straight line method” of charging depreciation ?
42. What do you mean by “diminishing balance method” ?
43. Give the meaning of “Revaluation method” of depreciation.
44. What is “Annuity method” of depreciation ?
45. What is “Sinking fund ” method of depreciation ?
46. What is “Insurance policy method” of depreciation ?
47. Write a note on “ Machine hour method” of depreciation ?
48. Why is correct valuation of inventory essential ?
49. What is the basic principle involved while valuing inventories ?
50. Briefly explain the following methods of inventory valuation :FIFO (b) LIFO (c) Average Price.
51. What are the principal methods of inventory valuation suggested in Accounting Standard-2 (Revised).
52. Briefly explain the meaning of “cost” in relation to inventory valuation.
Unit 4
1. Define a Company.
2. State the Characteristics of a Company.
3. What do you mean by Authorised Capital ?
4. What do you mean by Issued Capital ?
5. What do you mean by Subscribed Capital ?
6. What do you mean by called up Capital ?
7. What do you mean by paid-up Capital ?
8. What is a Reserve Capital ?
9. Define Shares.
10. What do you mean by preference Shares ?
11. What are the types of preference Shares ?
12. What do you mean by Equity Shares ?
13. What do you mean by issue of Shares at par ?
14. What do you mean by issue of Shares at Premium ?
15. What do you mean by issue of shares at discount ?
16. What do you mean by cells in advance ?
17. What do you mean by forfeiture of Shares ?
18. Define Debentures.
19. How do you treat undimmed dividend while preparing final accounts of the Company ?
20. What is meant by interim Dividend ?
21. What do you mean by contingent liability ?
22. How would you treat miscellaneous expenses while preparing final accounts of a company ?
 Web References link
https://www.accountingcoach.com/accounting-basics/explanation

https://www.udemy.com/course/basic-accounting-and-bookkeeping-for-beginners-and-startups/

https://www.coursera.org/courses?query=basic%20accounting

https://www.guru99.com/accounting.html
NPTEL Lectures Link

https://youtu.be/kIgBgbnOAvI

https://youtu.be/P9JIBbZas3w

https://youtu.be/jhtVVJxbPU0
 MUTIPLE CHOICE QUESTIONS
__is the art of recording, classifying, and summarizing in a significant manner, and in
terms of money transactions and events which are in part at least, of a financial
character and interpreting the results thereof.
a) Journal Entry
b) Ledger
c) Accounting
d) None
Any form of accounting which enables a business to be conducted more efficiently can be regarded as
___ accounting.
a) Financial
b) Management
c) Cost
d) None
4. Inflation accounting is also called ___
a) Revaluation
b) Replacement
c) None
d) All
5.A process of accounting where revenue and expense recognition would occur when
cash is received and disbursed is called ___
a) Cash
b) Accrual
c) None
d) a & b

6) ___ they are the present obligations arising from past events. It also arises when
an asset is created or acquired.
a) Asset
b) Liabilities
c) Equity
d) All

7) ___ is an increase in economic benefits during the accounting period in the form
of inflows or enhancements of assets or a decrease in liabilities, thereby increasing
equity and net worth.
a) Income
b) Equity
c) Expenses
d) None

8) ___ is a residual interest in the assets after deducting liabilities

a) Income
b) Equity
c) Expenses
d) None
9) ___ concept implies that each transaction and event must be expressible in
monetary terms
a) Money measurement
b) Business Entity
c) Going Concerned
d) None

10) ___ implies that a business unit is separate and distinct from the person who
owns or controls it
a) Money measurement
b) Business Entity
c) Going Concerned
d) None

11) ___concept tells that to recognize revenue it has to be realized.

a) Accrual concept
b) Matching concept
c) Realization concept
d) None

12) The conventions, concepts, rules, and procedures that together make up accepted
accounting practice at any given time are called ___
a) AICPA
b) GAAP
c) GAPA
d) None of the above

13) ___ is the after-tax cash flow generated by a business minus the cost of the
capital it has deployed to generate that cash flow.
a) EVA
b) GAAP
c) AICPA
d) None of the above

14) Prepaid Insurance A/cis ___ A/c

a) Real
b) Personal
c) Nominal
d) None

15) Outstanding wages A/c is ___ A/c

a) Personal
b) Real
c) Nominal
d) None

16) Bad Debts A/c is ___ A/c

a) Real
b) Personal
c) Nominal
d) None

17) The___ accounting system provides a system of checks and balances

a) Single Entry
b) Financial Entry
c) Double Entry
d) Triple Entry

18) It means that cash is received by the business from the proprietor. It results in
the immediate receipt of cash
a) Antony commenced business with Rs 10,000
b) Bought goods for cash rs 2,000
c) Charged commission to Chander rs 100
d) Sold goods for cashrs1000

19) Debt may be of ___ types

a) 3
b) 2
c) 5
d) None

20) Creditor may be ___ types

a) 3
b) 2
c) 4
d) 5

21) ___ is a brief explanation to a journal entry, given below the journal entry,
within brackets
a) Narration
b) Ledger
c) Credit
d) Debit

22) ___ is written in a ledger A/c at the time of its closing to indicate that the
balance in that A/c has been carried down to the next period.
a)c/f
b) c/d
c) b/d
d) b/f

23) A cashbook, which is used to record both cash and bank transactions, is referred
to as a ___ column cash book.
a) 1
b) 2
c) 3
d) 4

24) ___ provides internet technology to navigate the vast resources available in the
market.
a) WWW
b) Internet
c) Intranet
d) None

25) ___ are devices that allow direct data entry into the computer without doing any
manual data entry.
a) Standard Programmes
b) Scanner
c) Flow Charts
d) None

26) ___ helps in conducting business electronically with the help of internet
technology.
a) Parity Bit
b) E-Commerce
c) Computer Checks
d) None

27) Mines quarries is the example of ___ assets

a) Fictitious assets
b) Liquid assets
c) Intangible assets
d) wasting assets

28) Which of the following accounts is prepared to find out the cost of production?
a) Manufacturing account
b) Trading account
c) Profit and Loss account
d) Balance Sheet
29) Sale proceeds of fixed assets are a
a) Capital profit
b) Revenue profit
c) Capital receipt
d) Revenue receipt

30) Preliminary expenses are an example of

a) Capital expenditure
b) Revenue expenditure
c) Deferred Revenue expenditure
d) Capital loss

31) Petty Cashbook is prepared to

a) Meet the requirements of small business
b) Meet the small expenses paid in cash
c) Cover small and miscellaneous incomes
d) All of the above

32) Who draws B/E?

a) Debtor
b) Bank
c) Fixed asset
d) Creditor

33) Commerce is ___

a) Industry and trade
b) Trade and aids to trade
c) Industry and business
d) Industry and aids to trade

34) In the double-entry system, every business transaction affects

a) Two sides of the same account
b) The same side of two accounts
c) Two accounts only
d) Two or more accounts

35) The concept of conservatism takes into account

a) All expected income and losses
b) All expected income but no losses
c) All expected losses but no expected income
d) None

36) Financial position of the business means

a) Position about profits and losses
b) Position about incomes and expenses
c) Position about liquid funds
d) What the business owes to others and what it owns at a given point in time

37) A Bank Reconciliation Statement is a

a) Part of Pass Book
b) Part of Cash Book
c) Statement prepared by the bank
d) Statement prepared by the customer

38) Income from the sale of scrap is usually shown in

a) Profit and Loss account
b) Trading account
c) Manufacturing account
d) A11 of the above

39) Sales to Ram Rs. 450 posted to his account as Rs. 550 would affect
a) Sales account
b) Ram’s account
c) Cash account
d) None

40) Trial Balance contains the balances of

a) All real and personal accounts
b) All personal and nominal accounts
c) All nominal and real accounts
d) All accounts

41) The book value of old furniture was Rs. 1,500. It was sold for Rs. 500. The
difference is a ___.
a) Revenue expenditure
b) Revenue loss
c) Capital expenditure
d) Capital loss

42) Which of the following expenses will be shown in the Profit and Loss Account?
a) Wages
b) Carriage inwards
c) None of the above
d) Both (a) and (b) above

43) Overcasting of Purchases Journal would affect

a) Sales Account only
b) Purchases Account only
c) Supplier’s Account and Purchases Account
d) Sales Account and Purchases Account

44) Salary paid to Rehman was recorded in the Cashbook as payment to Rehman.
This is an error of
a) Omission
b) Commission
c) Compensating error
d) Principle

45) According to the money measurement concept, which transaction will be

recorded in the books of the account?
a) Health of manager
b) Quality of goods
c) Value of building
d) Qualifications of employees

46) Revenue is said to be realized when

a) The sale is made
b) Goods are manufactured
c) Cash is received
d) Sale is made and cash is received

47) Discount allowed on the issue of shares is an example of

a) Capital loss
b) Capital expenditure
c) Revenue expenditure
d) Deferred revenue expenditure

48) Repair incurred for using a second-hand car purchased recently

a) Capital expenditure
b) Revenue expenditure
c) Capital loss
d) Deferred revenue expenditure

49) Sales are equal to

a) Cost of Goods Sold + Gross Profit
b) Cost of Goods Sold – Gross Profit
c) Gross Profit – Cost of Goods Sold
d) Cost of Goods Sold – Stock
50) Interest in drawings is regarded as
a) Expenditure for the business
b) Loss for the business
c) Gain for the business
d) Liability for the business