LEARNING OBJECTIVES:

(i) To learn the basics of accounting, accounting, concepts and conventions.

(ii) To analyse accounting standards Globally.

LEARNING OUTCOMES:

(i) Understand the Financial reporting and interpreting the financial data.

(ii)Read and Understand the Annual Report.

INTRODUCTION

Accounting is a system meant for measuring business activities, processing of information

into reports and making the findings available to decision-makers. The documents, which
communicate these findings about the performance of an organisation in monetary terms, are
called financial statements. Usually, accounting is understood as the Language of Business.
However, a business may have a lot of aspects which may not be of financial nature. As such, a
better way to understand accounting could be to call it The Language of Financial Decisions. The
better the understanding of the language, the better is the management of financial aspects of
living. Many aspects of our lives are based on accounting, personal financial planning,
investments, income-tax, loans, etc. We have different roles to perform in life-the role of a student,
of a family head, of a manager, of an investor, etc. The knowledge of accounting is an added
advantage in performing different roles. However, we shall limit our scope of discussion to a
business organisation and the various financial aspects of such an organisation.

CHAPTER - 1
PRINCIPLE OF ACCOUNTING AND STANDARDS

Structure
1.0 Introduction
1.1 Unit objectives
1.2 Origin and growth of accounting
1.3 Meaning of accounting
1.3.1 Attributes of accounting
 1.3.2 Definition of Accounting
1.5 Nature of Accounting
1.5.1 Accounting as a service activity
1.5.2 Accounting as a profession Accounting is very much a profession.
1.5.3 Accounting as a social force
1.5.4 Accounting as a language
1.5.5 Accounting as science or art
1.5.6 Accounting as an information system
1.6 Objectives of Accounting
1.6.1 Identification and recording of transactions
1.6.2 Ascertainment of results
1.6.3 Ascertainment of financial affairs
1.6.4 Keeping accounts of cash
1.6.5 Control over assets and liabilities
1.6.6 Controlling money defalcation and cost
1.6.7 Providing economic data
1.6.8 Helping tax fixation
1.6.9 Determination and evaluation of policy
1.6.10 Testing the arithmetical accuracy of accounts
1.6.11 Acceptability to others
1.6.12 Creation of values and accountability
1.6.13 Following legal bindings and prohibition
1.7 Advantages of Accounting
1.7.1 Complete and Systematic Record
1.7.2 Determination of Selling Price
1.7.3 Valuation of the Business
1.7.4 Helps in Raising Loan
1.7.5 Evidence in Court of Law
1.7.6 Incompliance of Law
1.7.7 Inter-Firm or Intra-Firm Comparison
1.7.8 Facilitates Audit
1.7.9 Effective Management
1.8 Limitations of Accounting
1.8.1 Ignores qualitative aspects of transactions
1.8.2 Biased accounting information
1.8.3 Ignorance about the present value of business
1.8.4 Inexactness
1.9 Types of Accounting
1.9.1 Financial accounting
1.9.2 Management accounting
1.9.3 Cost accounting
1.10 Types of Accounts
1.10.1 Real Accounts
1.10.1.1Golden rule for real accounts
1.10.2 Personal Accounts
1.10.2.1Natural personal accounts
1.10.2.2Artificial personal accounts
 1.10.2.3Representative personal accounts
1.10.2.4Golden rule for personal accounts
1.10.3 Nominal Accounts
1.10.3.1Golden rule for nominal accounts
1.11 Methods of Accounting
1.11.1 Financial Accounting
1.11.2 Management Accounting
1.11.3 Cost Accounting
1.11.4 Public Accounting
1.11.5 Government Accounting
1.11.6 Forensic Accounting
1.11.7 Tax Accounting
1.11.8 Project Accounting
1.11.9 Social Accounting
1.12 Methods of Accounting System
1.12.1 Single entry system
1.12.1.1Incomplete Records
1.12.1.2No Reconciliation
1.12.1.3Possibility of Fraud
1.13 Double Entry System
1.13.1. Debit and Credit
1.13.2 Advantages of double entry system of book-keeping
1.13.2.1 Scientific
1.13.2.2 Systematic
1.13.2.3Complete
1.13.2.4 Accuracy
1.13.2.5 Profit or Loss
1.13.2.6 Financial Position
1.13.2.7 Control
1.13.2.8 Decision Making
1.14 Further Reading

1.0 INTRODUCTION

Accounting can be considered the language of business. Mastery of accounting primarily

rests in ability to critically think through and synthesize the information as it applies to a given
situation. You should approach the learning of accounting the same way you would approach
learning a foreign language; It will take time and practice to ensure you remember the concepts.
There are a number of sub-disciplines that fall under the umbrella of "accounting,” but in this
course, we will be focused on financial accounting. Accounting as a business discipline can be
viewed as a system of compiled data. The word data should not be confused with "information.”
In terms of accounting, "data” should be viewed as the raw transactions or business activity that
happens within any business entity. . The word information should be viewed as the
communicated results of the data as it has happened in the business within a specified period of
time. This information is used by decision makers to support how they determine specific courses
of action within the business. This course introduces you to financial accounting in preparation
for more advanced business topics within the business major. Recording financial information in
a standard format allows managers, investors, lenders, stakeholders, and regulators to make
appropriate decisions regarding their respective interests. In this course, the formats of focus will
be identified as the Income Statement, the Balance Sheet, Statement of Cash Flows, and Statement
of Shareholders' Equity. In this course, you will learn how to compile and analyze these financial
statements, determine the value of a firm, and compare the firm to its competitors.
______________________________________________________________________________
1.1 UNIT OBJECTIVES

After reading this lesson, you should be able to

➢ Define accounting and trace the origin and growth of accounting.
➢ Distinguish between book-keeping and accounting.
➢ Explain the nature and objectives of accounting.
➢ Discuss the branches, role and limitations of accounting
_________________________________________________________________________
1.2 ORIGIN AND GROWTH OF ACCOUNTING

Accounting is as old as money itself. However, the act of accounting was not as developed
as it is today because in the early stages of civilisation, the numbers of transactions to be recorded
were so small that each businessman was able to record and check for himself all his transactions.
Accounting was practised in India twenty three centuries ago as is clear from the book named
"Arthashastra" written by Kautilya, King Chandragupta's minister. This book not only relates to
politics and economics, but also explains the art of proper keeping of accounts. However, the
modern system of accounting based on the principles of double entry system owes it origin to
Luco Pacioli who first published the principles of Double Entry System in 1494 at Venice in Italy.
Thus, the art of accounting has been practised for centuries but it is only in the late thirties that
the study of the subject 'accounting' has been taken up seriously.
__________________________________________________________________________
1.3 MEANING OF ACCOUNTING

The main purpose of accounting is to ascertain profit or loss during a specified period, to
show financial condition of the business on a particular date and to have control over the firm's
property. Such accounting records are required to be maintained to measure the income of the
business and communicate the information so that it may be used by managers, owners and other
interested parties. Accounting is a discipline which records, classifies, summarises and interprets
financial information about the activities of a concern so that intelligent decisions can be made
about the concern. The American Institute of Certified Public Accountants has defined the
Financial Accounting as "the art of recording, classifying and summarising in as significant
manner and in terms of money transactions and events which in part, at least of a financial
character, and interpreting the results thereof". American Accounting Association defines
accounting as "the process of identifying, measuring, and communicating economic information
to permit informed judgements and decisions by users of the information.

1.3.1 Attributes of accounting

(i) Recording: It is concerned with the recording of financial transactions in an orderly manner,
soon after their occurrence In the proper books of accounts.

(ii) Classifying: It Is concerned with the systematic analysis of the recorded data so as to
accumulate the transactions of similar type at one place. This function is performed by
maintaining the ledger in which different accounts are opened to which related transactions are
posted.

(iii) Summarising: It is concerned with the preparation and presentation of the classified data in
a manner useful to the users. This function involves the preparation of financial statements such
as Income Statement, Balance Sheet, Statement of Changes in Financial Position, Statement of
Cash Flow, and Statement of Value Added.

(iv)Interpreting: Nowadays, the aforesaid three functions are performed by electronic data
processing devices and the accountant has to concentrate mainly on the interpretation aspects of
accounting. The accountants should interpret the statements in a manner useful to action. The
accountant should explain not only what has happened but also (a) why it happened, and (b)
what is likely to happen under specified conditions.

1.3.2 Definition of Accounting

According to the American Institute of Certified Public Accounts (AICPA) “ Accounting

is the art of recording, classifying and summarizing in a significant manner and in terms of money
transactions and events which are of financial character and interpreting results thereof”.

This definition highlights in a logical sequence the different steps in the accounting process and
some important attribute of the accounting.

The first step in the cycle of accounting is to identify transactions that will find place in
books of accounts. Transactions having financial impact only are to be recorded. E.g. if a
businessman negotiates with the customer regarding supply of products, this will not be
recorded. The negotiation is a deal which will potentially create a transaction and will have
exchange of money or money’s worth. But unless this transaction is finally entered into, it will
not be recorded in the books of accounts.

Secondly, the recording of the business transactions is done based on the Golden Rules of
accounting (which are explained later) in a systematic manner. Transaction of similar nature are
grouped together and recorded accordingly. e.g. Sales Transactions, Purchase Transactions, Cash
Transactions etc. One has to interpret the transaction and then apply the relevant Golden Rule to
make a correct entry thereof.

Thirdly, as the transactions increase in number, it will be difficult to understand the

combined effect of the same by referring to individual records. Hence, the art of accounting also
involves the step of summarizing them. With the aid of computers, this task is simplified in
today’s accounting world. The summarization will help users of the business information to
understand and interpret business results.

Lastly, the accounting process provides the users with statements which will describe
what has happened to the business. Remember the two basic questions we talked about, one to
know whether business has made profit or loss and the other to know the position of resources
that are used by the business. It can be noted that although accounting is often referred to as an
art, it is a science also. This is because it is based on universally applicable set of rules. However,
it is not a pure science as there is a possibility of different interpretation.

1.4 DISTINCTION BETWEEN BOOK-KEEPING AND ACCOUNTING

Book-keeping is a part of accounting and is concerned with the recording of transactions

which is often routine and clerical in nature, whereas accounting performs other functions as
well, viz., measurement and communication, besides recording. An accountant is required to
have a much higher level of knowledge, conceptual understanding and analytical skill than is
required of the book-keeper. An accountant designs the accounting system, supervises and
checks the work of the book-keeper, prepares the reports based on the recorded data and
interprets the reports. Nowadays, he is required to take part in matters of management, control
and planning of economic resources.
Although in practice Accountancy and Accounting are used interchangeably yet there is
a thin line of demarcation between them. The word Accountancy is used for the profession of
accountants - who do the work of accounting and are knowledgeable persons. Accounting is
concerned with recording all business transactions systematically and then arranging in the form
of various accounts and financial statements. And it is a distinct discipline like economics,
physics, astronomy etc. The word accounting tries to explain the nature of the work of the
accountants (professionals) and the word Accountancy refers to the profession these people
adopt.

1.5 NATURE OF ACCOUNTING

The various definitions and explanations of accounting has been propounded by different
accounting experts from time to time and the following aspects comprise the nature of
accounting:
1.5.1 Accounting as a service activity
Accounting is a service activity. Its function is to provide quantitative information,
primarily financial in nature, about economic entities that is intended to be useful in making
economic decisions, in making reasoned choices among alternative courses of action. It means
that accounting collects financial information for the various users for taking decisions and
tackling business issues. Accounting in itself cannot create wealth though, if it produces
information which is useful to others, it may assist in wealth creation and maintenance.

1.5.2 Accounting as a profession Accounting is very much a profession.

A profession is a career that involve the acquiring of a specialised formal education before
rendering any service. Accounting is a systematized body of knowledge developed with the
development of trade and business over the past century. The accounting education is being
imparted to the examinees by national and international recognised the bodies like The Institute
of Chartered Accountants of India (ICAI), New Delhi in India and American Institute of Certified
Public Accountants (AICPA) in USA etc. The candidate must pass a vigorous examination in
Accounting Theory, Accounting Practice, Auditing and Business Law. The members of the
professional bodies usually have their own associations or organisations, where in they are
required to be enrolled compulsorily as Associate member of the Institute of Chartered
Accountants (A.C.A.) and fellow of the Institute of Chartered Accountants (F.C.A.). In a way,
accountancy as a profession has attained the stature comparable with that of lawyer, medicine or
architecture.

1.5.3 Accounting as a social force

In early days, accounting was only to serve the interest of the owners. Under the changing
business environment the discipline of accounting and the accountant both have to watch and
protect the interests of other people who are directly or indirectly linked with the operation of
modern business. The society is composed of people as customer, shareholders, creditors and
investors. The accounting information/data is to be used to solve the problems of the public at
large such as determination and controlling of prices. Therefore, safeguarding of public interest
can better be facilitated with the help of proper, adequate and reliable accounting information
and as a result of it the society at large is benefited.

1.5.4 Accounting as a language

Accounting is rightly referred the "language of business". It is one means of reporting and
communicating information about a business. As one has to learn a new language to converse
and communicate, so also accounting is to be learned and practised to communicate business
events. A language and accounting have common features as regards rules and symbols. Both are
based and propounded on fundamental rules and symbols. In language these are known as
grammatical rules and in accounting, these are termed as accounting rules. The expression,
exhibition and presentation of accounting data such as a numerals and words and debits and
credit are accepted as symbols which are unique to the discipline of accounting.

1.5.5. Accounting as science or art

Science is a systematised body of knowledge. It establishes a relationship of cause and
effect in the various related phenomenon. It is also based on some fundamental principles.
Accounting has its own principles e.g. the double entry system, which explains that every
transaction has two fold aspect i.e. debit and credit. It also lays down rules of journalising. So we
can say that accounting is a science. Art requires a perfect knowledge, interest and experience to
do a work efficiently. Art also teaches us how to do a work in the best possible way by making
the best use of the available resources. Accounting is an art as it also requires knowledge, interest
and experience to maintain the books of accounts in a systematic manner. Everybody cannot
become a good accountant. It can be concluded from the above discussion that accounting is an
art as well as a science.

1.5.6 Accounting as an information system

Accounting discipline will be the most useful one in the acquisition of all the business
knowledge in the near future. You will realise that people will be constantly exposed to
accounting information in their everyday life. Accounting information serves both profit-seeking
business and non-profit organisations. The accounting system of a profit-seeking organisation is
an information system designed to provide relevant financial information on the resources of a
business and the effect of their use. Information is relevant and valuable if the decision makers
can use it to evaluate the financial consequences of various alternatives. Accounting generally
does not generate the basic information (raw financial data), rather the raw financial data result
from the day to day transactions of the business. As an information system, accounting links an
information source or transmitter (generally the accountant), a channel of communication
(generally the financial statements) and a set of receivers (external users).
1.6 Objectives of Accounting

The Main objectives of accounting are maintaining a complete and systematic record of
all transactions and analyzing the financial position of a business. Every individual or a business
concern is interested to know the results of financial transactions and their results are ascertained
through the accounting process. A businessman can ascertain the operating results and financial
position of his business at any time through Accounting.

16.1 Identification and recording of transactions

The primary object of accounting is to identify the financial transactions and to record
these systematically in the books of accounts. As a result, the true nature of each and every
transaction is known without much exercise of memory. With this end in view the transactions
are primarily recorded in general and in a special journal and later on permanently various
accounts are kept in the ledger.

1.6.2 Ascertainment of results

Every business concern is interested to know its operating results at the end of a particular
period. The amount of profit or loss for a particular period of a business concern can be
ascertained by preparing income statement with the help of ledger account balances of revenue
nature. Surplus or deficit of revenue for a particular period of a non-trading concern can also be
ascertained by preparing income and expenditure account or statement.

1.6.3 Ascertainment of financial affairs

Ascertainment of debts-liabilities, property, and assets i.e. total financial affairs of an
organization at a particular date is another important object of Accounting.
Financial affairs of a concern at a particular date can be ascertained by preparing a balance
sheet. The balance sheet is the statement of assets and liabilities of a concern at a particular date.

1.6.4 Keeping accounts of cash

Cash book is a prominent book of the books of accounts. Cash receipts and cash payments
are accounted for in this book. A number of daily cash receipts, payments, cash in hand and cash
at the bank can be known from this book. Fraud, forgery, and misappropriation of money are
reduced by keeping cash book scientifically and accurately.

1.6.5 Control over assets and liabilities

For running a business successfully a businessman is to acquire various assets like land,
building, machinery etc. He is to face various debts and liabilities like accounts payable, notes
payable, loan, bank overdraft etc. side by side with die acquisition of assets. The actual position
of these debts-liabilities, property, and assets can be ascertained through the proper keeping of
accounts. A businessman can take the right steps for controlling the quantity of assets decrease
and liability increase.

1.6.6 Controlling money defalcation and cost

Prevention of money defalcation through fraud and forgery and controlling of the cost of
a concern are also the main objects of Accounting. Prevention of money defalcation and cost
control become easier if accounts are kept scientifically.

1.6.7 Providing economic data

Another noble object of Accounting is to provide the concerned parties with all economic
information preparing financial statements and reports etc. in time.

1.6.8 Helping tax fixation

Accounts prepared on the basis of accepted accounting principles in considered reliable
to the income tax and VAT authorities for easy determination and settlement of tax and VAT.

1.6.9 Determination and evaluation of policy

The object of Accounting is to help the management in determining and evaluating the
management policies in running the business successfully by supplying necessary, information,
interpreting and analyzing the financial statements.

1.6.10 Testing the arithmetical accuracy of accounts

One of the main objects of scientific methods of accounting is to make sure that accounts
have been kept in a proper way. The arithmetical accuracy of accounts kept in the ledger can be
assured by preparing a trial balance. Agreement of a trial balance is the proof of the arithmetical
accuracy of accounts. The advantage in taking loan’s Due to insufficiency of capital, borrowing
capital from outsiders is felt necessary to run a business. Loan givers are not willing to give a loan
without knowing the financial position of a business. Financial statement of a business concern
reflects the solvency or loan repayment capability of that concern.

1.6.11 Acceptability to others

Banks or financial institutions are interested to know the accurate financial position of a
business concern for sanctioning loans. On the other hand, government or other authorities may
also ask about the financial position of a business concern for various reasons. In these cases the
accounts maintained in a disciplined way become easily acceptable to the interested institutions
or authorities.

1.6.12 Creation of values and accountability

The object of accounts maintained in an acceptable way is to create higher values among
individuals and organizations and thereby creating awareness in preventing money defalcation,
misappropriation of fund and cost control by ensuring transparency and accountability.

1.6.13 Following legal bindings and prohibition

As all kinds of business organizations have to abide by some legal bindings and prohibitions,
they are to maintain their accounts accurately.

1.7 Advantages of Accounting

1.7.1 Complete and Systematic Record

Accounting is based on generally accepted principles and a scientific way of presentation
of business transactions in books of accounts. As such, accounting is a complete and systematic
recording of all business transactions. The limitations of humans, that they cannot keep all
transactions in mind, is overcome by accounting because each and every business transaction can
be recorded and analyzed through same.
1.7.2 Determination of Selling Price
The main function of the management is decision making. Accounting helps and guides
the management to take decisions in respect of determining selling price, deduction of cost,
increase in sales etc.

1.7.3 Valuation of the Business

In case of sale of business or conversion of one business into another, true and fair value
of the business is calculated. Through accounting, the correct picture can be depicted in Balance
Sheet and as such the purchase price can be determined. Balance Sheet shows the value of assets
& liabilities of the business which can be used to calculate its net worth.

1.7.4 Helps in Raising Loan

For further expansion, business must have sufficient funds. Sometimes, due to paucity of
funds business cannot do well. In those cases further funds can be raised by taking loan from
some financial institutions like banks, IDBI, ICICI etc. These financial institutions lend money on
the basis of profitability and soundness of the business enterprise. The profitability and
soundness can be measured by the Trading and Profit & Loss Account and Balance Sheet, the
final results of books of accounts.

1.7.5 Evidence in Court of Law

The business transactions are recorded in the books of accounts supported by
authenticated documents viz. vouchers etc. Thus, the accounts can be used as evidence in the
court of law.

1.7.6 Incompliance of Law

Every business has to deal with various government departments like income tax, sales
tax, custom and excise etc. Various periodic returns are to be filed with these departments.
Accounting helps in preparation and filing of such returns.

1.7.7 Inter-Firm or Intra-Firm Comparison

Trading and Profit & Loss Account shows net profit earned or net loss sustained by the
business. If the accounts are maintained properly, records relating to various expenses, sales,
gross profit and net profit etc. can be compared.
 As such, accounting helps in inter- firm and intra-firm comparison. Comparison of
accounts of two different enterprises for the same year is known as inter-firm comparison and
comparison of two different periods for the same business enterprise is known as intra-firm
comparison. The performance of the business enterprise is then compared with the
predetermined goals and shortcomings, if any, can be rectified accordingly.

1.7.8 Facilitates Audit

Depending upon the size, nature and type of business, certification of books of accounts,
known as audit, is mandatory. Audit certificate issued by the auditor on the accounts is a clean
chit to organization which proves that there are no irregularities in the organization.

1.7.9 Effective Management

Accounting facilitates proper feed back to the management. As such, it helps the
management in planning as well as control of different activities of the business enterprise. It also
helps the management to evaluate the performance of the business enterprise and takes timely
action to remove the shortcomings in the management.

1.8 LIMITATIONS OF ACCOUNTING

1.8.1 Ignores qualitative aspects of transactions

Business Transactions which are of monetary nature only find a place in accounting.
Transactions which not related to money do not find a page in accounting. It ignores qualitative
elements like management reputation, employee morale, labour strike etc.
1.8.2 Biased accounting information

Another limitation of accounting results are based on the information provided to it. The
management may be biased and feed manipulative data to confirm its point view. An accountant
can reveal the result of business, as wanted by the owners of the business. This may be done by
erasing certain accounts, increasing or diminishing the amounts of specific accounts, under-
estimating or over-estimating the value of assets. For example, a purchase of furniture has
appeared as a purchase of goods this will reduce the profit.

1.8.3 Ignorance about the present value of business

 While keeping the books of accounts of an ongoing concern i.e., the business will be
carried on for an indefinite period. With this standard in view, we show the value of our assets
in the balance sheet at its book value, not at the market value. Sometimes certain assets might be
valueless in the market but yet we keep on showing it in the books of accounts. Hence, accounting
fails to reveal the present value of the business concern.

1.8.4 Inexactness

Accounting evaluates profit or loss of the business on the basis of the real and planned
estimates. Accountants make the valuation of the stock, determine the method of depreciation
and maintain various provisions in any way, they like. Different firms have their own different
methods of providing depreciation and valuation of the stock. Hence, the results of the business
will change with the adjustment in the practice.

1.9 TYPES OF ACCOUNTING

The financial literature classifies accounting into two broad categories, viz, Financial
Accounting and Management Accounting. Financial accounting is primarily concerned with the
preparation of financial statements whereas management accounting covers areas such as
interpretation of financial statements, cost accounting, etc. Both these types of accounting are
examined in the following paragraphs.
1.9.1 Financial accounting

As mentioned earlier, financial accounting deals with the preparation of financial

statements for the basic purpose of providing information to various interested groups like
creditors, banks, shareholders, financial institutions, government, consumers, etc. Financial
statements, i.e. the income statement and the balance sheet indicate the way in which the activities
of the business have been conducted during a given period of time. Financial accounting is
charged with the primary responsibility of external reporting. The users of information generated
by financial accounting, like bankers, financial institutions, regulatory authorities, government,
investors, etc. want the accounting information to be consistent so as to facilitate comparison.
Therefore, financial accounting is based on certain concepts and conventions which include
separate business entity, going concern concept, money measurement concept, cost concept, dual
aspect concept, accounting period concept, matching concept, realization concept and
conventions of conservatism, disclosure, consistency, etc. All such concepts and conventions
would be dealt with detail in subsequent lessons.

The significance of financial accounting lies in the fact that it aids the management in
directing and controlling the activities of the firm and to frame relevant managerial policies
related to areas like production, sales, financing, etc. However, it suffers from certain drawbacks
which are discussed in the following paragraphs. The information provided by financial
accounting is consolidated in nature. It does not indicate a break-up for different departments,
processes, products and jobs. As such, it becomes difficult to evaluate the performance of different
sub-units of the organisation. Financial accounting does not help in knowing the cost behaviour
as it does not distinguish between fixed and variable costs. The information provided by financial
accounting is historical in nature and as such the predictability of such information is limited.
The limitations of financial accounting, however, should not lead one to believe that it is
of no use. It is the basic foundation on which other branches and tools of accounting analysis are
based. It is the source of information, which can be further analysed and interpreted according to
the tailor-made requirements of decision-makers.

1.9.2 Management accounting

Management accounting is ‘tailor-made’ accounting. It facilitates the management by

providing accounting information in such a way so that it is conducive for policy making and
running the day-to-day operations of the business. Its basic purpose is to communicate the facts
according to the specific needs of decision-makers by presenting the information in a systematic
and meaningful manner. Management accounting, therefore, specifically helps in planning and
control. It helps in setting standards and in case of variances between planned and actual
performances, it helps in deciding the corrective action. An important characteristic of
management accounting is that it is forward looking. Its basic focus is one future activity to be
performed and not what has already happened in the past. Since management accounting caters
to the specific decision needs, it does not rest upon any well-defined and set principles. The
reports generated by a management accountant can be of any duration– short or long, depending
on purpose. Further, the reports can be prepared for the organisation as a whole as well as its
segments.

1.9.3 Cost accounting

One important variant of management accounting is the cost analysis. Cost accounting
makes elaborate cost records regarding various products, operations and functions. It is the
process of determining and accumulating the cost of a particular product or activity. Any
product, function, job or process for which costs are determined and accumulated, are called cost
centres. The basic purpose of cost accounting is to provide a detailed breakup of cost of different
departments, processes, jobs, products, sales territories, etc., so that effective cost control can be
exercised. Cost accounting also helps in making revenue decisions such as those related to
pricing, product-mix, profit-volume decisions, expansion of business, replacement decisions, etc.

The objectives of cost accounting, therefore, can be summarized in the form of three
important statements, viz, to determine costs, to facilitate planning and control of business
activities and to supply information for short- and long-term decision. Cost accounting has
certain distinct advantages over financial accounting. Some of them have been discussed
succeeding. The cost accounting system provides data about profitable and non-profitable
products and activities, thus prompting corrective measures. It is easier to segregate and analyse
individual cost items and to minimize losses and wastages arising from the manufacturing
process. Production methods can be varied so as to minimize costs and increase profits. Cost
accounting helps in making realistic pricing decisions in times of low demand, competitive
conditions, technology changes, etc. Various alternative courses of action can be properly
evaluated with the help of data generated by cost accounting. It would not be an exaggeration if
it is said that a cost accounting system ensures maximum utilization of physical and human
resources. It checks frauds and manipulations and directs the employer and employees towards
achieving the organisational goal.

1.10 TYPES OF ACCOUNTS

There are mainly three types of accounts in accounting: Real, Personal and Nominal accounts
1.10.1 Real Accounts

➢ All assets of a firm, which are tangible or intangible, fall under the category “Real
Accounts“.

➢ Tangible real accounts are related to things that can be touched and felt physically. Few
examples of tangible real accounts are building, machinery, stock, land, etc.

➢ Intangible real accounts are related to things that can’t be touched and felt physically.
Few examples of such real accounts are goodwill, patents, trademarks, etc.

1.10.1.1 Golden rule for real accounts

➢ Debit what comes in

➢ Credit what goes out

1.10.2 Personal Accounts

These accounts are related to individuals, firms, companies, etc. A few examples of
personal accounts include debtors, creditors, banks, outstanding/prepaid accounts, accounts of
credit customers, accounts of goods suppliers, capital, drawings, etc.

1.10.2.1 Natural personal accounts

This type of personal accounts is the simplest to understand out of all and includes all of
God’s creations who have the ability to deal, who, in most cases, are people. E.g. Kumar’s A/C,
Adam’s A/C, etc

1.10.2.2 Artificial personal accounts

Personal accounts which are created artificially by law, such as corporate bodies
and institutions, are called Artificial personal accounts. E.g. Pvt Ltd companies, LLCs, LLPs,
clubs, schools, etc.

1.10.2.3 Representative personal accounts

 Accounts which represent a certain person or a group directly or indirectly. E.g. Let’s say
that wages are paid in advance to an employee – a wageprepaid account will be opened in the
books of accounts. This wages prepaid account is a representative personal account indirectly
linked to the person.

1.10.2.4 Golden rule for personal accounts

➢ Debit the Receiver
➢ Credit the Giver

1.10.3 Nominal Accounts

Accounts which are related to expenses, losses, incomes or gains are called Nominal
accounts. The dictionary meaning of the word “nominal” is “existing in name only” and the
meaning remains absolutely true in accounting sense too, because nominal accounts do not really
exist in physical form, but behind every nominal account money is involved. E.g. Purchase A/C,
Salary A/C, Sales A/C, Commission received A/C, etc.

The final result of all nominal accounts is either profit or loss which is then transferred
to the capital account.

1.10.3.1 Golden rule for nominal accounts

➢ Debit all expenses and losses

➢ Credit all Incomes and Gains

1.11 METHODS OF ACCOUNTING

There are several types of accounting that range from maintaining records, auditing to
preparing income tax returns. Accounting professional trend to specialize in one of these field as
their career option as accountant.

1.11.1 Financial Accounting

 Under this accounting, primary focus is towards accuracy of financial data towards
external reports. Accounting professionals with specialized in external reporting requires in-
depth knowledge on accounting framework like IFRS (International Financial Reporting
Standards), GAAP (Generally Accepted Accounting Principles), or government standards of the
country such as Securities and Exchange Commission of USA, Securities and Exchange Board of
India, etc. There is likewise regulator track, which requires join awareness of management and
financial accounting. Financial accounting is one of the common branches of accounting.

1.11.2 Management Accounting

These branches of accounting are maintained by companies only for internal purposes.
It’s in-depth information about company rather than the information available to the public. This
information is use by an organisation to control and define strategic goals. Data may be used to
structure budget planning, forecasts, organisation goals. Such types of accounting are maintained
purely for the purpose of companies management strategic decisions.

1.11.3 Cost Accounting

Management accounting is further divided into cost accounting. Main purpose to

maintain a cost accounting technique is to control and monitor effective cost of production. Such
branches of accounting are mostly preferred by manufacturing companies for controlling and
maintaining costs.

1.11.4 Public Accounting

Under this type of accounting, primary objective is to examine the financial statements
and supporting documents of client companies. This assures that financial proclamations
collected by customers genuinely exhibit financial position of an entity. Professionals who are
involved in public accounting required in-depth knowledge on accounting frameworks and
reviewing type of personality to become an audit partner.

1.11.5 Government Accounting

It’s one of the branches of accounting system which manages funds uniquely. It is also
known as federal accounting. Time to time disbursement of cash for various expenditures offered
on account of governmental services. These services are requested by a government entity.
Governmental Accounting also maintains accounts for public sector companies. This financial
and performance overview assist government in budgetary and various other decisions,
Professionals need to have various different skill sets and specialized accounting within this area
to accomplish government accounting.

1.11.6 Forensic Accounting

These types of accounting techniques are followed for examining and investigating
disputed or lawsuit cases. Forensic Accounting plays a role of witnesses in courts of law for
financial criminal or financial disputes cases. These accounting assess financial effect of loss or
detection of financial fraud. Specialized forensic accountants are hired for cases like damage
claims, insurance claims, suspect fraud and claims, business valuations or any other finance
related matters.

1.11.7 Tax Accounting

All tax related matters are categorized into Tax Accounting. It is represented by the
assessment rules recommended by the countries tax laws. Tax accounting rules, standards and
principles are different than financial statement prepared for public reviews. Professionals with
tax accountants then perform adjustments into financial statements with implementing standards
and principles of tax accounting described under countries tax laws. This information is
afterwards used for tax estimation and tax planning.

1.11.8 Project Accounting

Under these branches of accounting, financial reports and financial statements are been
prepared to track the progress of the project. One of the main components of project management
is to maintain project accounting. This will assist management in various decision making steps.
Project accounting is the specialized branch of management bookkeeping focusing primarily on
success of new launched projects. Those companies who want to keep track on projects rely on
Project accounting for example: construction projects, road projects, bridge projects, rail projects,
etc.

1.11.9 Social Accounting

A corporate Social Responsibility Reporting or Sustainability Accounting term refers to

social branches of accounting. Primarily objective of organization’s behind implementing social
accounting is to track environmental reports. Organization looks forward for social and ecological
environmental reports. Social accounting is a new types of accounting followed by organizations
these days. It is still under phases of improvement. Considering growing awareness about
environment among public has lead organizations to maintain such kind of accounts.

1.12 METHODS OF ACCOUNTING SYSTEM

Basically all methods of accounting are classified under two categories:

1. Single entry system

2. Double entry system
1.12.1 Single entry system

Single entry accounting systems record only one side of every transaction, this happens
because they use one entry to record every transaction. Therefore single entry system does not
use nominal and real accounts. The emphasis is on cash and accounts receivable. Single entry
system is used by small firms that have just started business. Such firms do not have the resources
that are required to put up a full-fledged accounting system in place. Hence they begin with a
single entry accounting system. However as and when their business grows most firms are
compelled to adopt the double entry system. This is because the single entry system is highly
inefficient and can be used only by sole proprietors when the scale of business is very small and
the transactions to be undertaken are not very complicated.

1.12.1.1Incomplete Records

The biggest problem with single entry bookkeeping system is that of incomplete records.
Single entry system records only transactions that the firm is undertaking with external parties.
There are numerous transactions within the firm that are of vital importance and need a place in
the financial statements. However, the single entry system ignores these needs and gives
incomplete information to the management.

1.12.1.2No Reconciliation

Single entry accounting system does not have provisions for reconciliation of accounts.
This means that the system does not have inbuilt error detection. Therefore, if a clerk is doing the
task of making entries in the book, the system may be prone to clerical errors. This could lead to
management having insufficient information or no information when they have to make
decisions.

1.12.1.3Possibility of Fraud

Single entry accounting system is highly prone to frauds and embezzlement. There is only
one book of account rather than an elaborate accounting system. Hence, the internal checks are
few. In fact they are non-existent. The person making the accounts could single handily
manipulate the books of accounts and misappropriate the resources of the firm.

1.13 DOUBLE ENTRY SYSTEM

Accounting is an art of recording, classifying and summarizing the transactions of financial

nature measurable in terms of money and interpreting the results thereof. Two methods for
accounting are Single Entry System and Double Entry System. Mostly, we convert to Double Entry
for better accounting purposes. Double Entry System of accounting deals with either two or more
accounts for every business transaction. For instance, a person enters a transaction of borrowing
money from the bank. So, this will increase the assets for cash balance account and simultaneously
the liability for loan payable account will also increase. It’s a fundamental concept encompassing
accounting and book-keeping in present times. Every financial transaction has equal and opposite
effect in at least two different accounts.

Equation can be: ASSETS = LIABILITIES + EQUITY

Double entry system records the transactions by understanding them as a Debit items or
Credit Items. A debit entry in one account gives opposite effect in another account by credit entry.
This means that the sum of all Debit accounts must be equal to the sum of Credit accounts. This
method of accounting and book-keeping results in the accurate depiction of financial statements,
thus, it also lowers the rate of errors by detecting them on a timely basis.
1.13.1. Debit and Credit

Debits and Credits are essentials to enter data in a double entry system of accounting and
book-keeping. While posting an accounting entry, an entry on the left side of the account ledger is a
debit entry and right side entry is a credit entry.

Finally, to complete an entry the total of the Debit side and the Credit side should be equal.
All debits do not always equate to increase the account nor do all credits equate to decrease the
accounts. A debit entry might increase one account and at the same time decrease another account.

➢ The word Debit is derived from Latin word Debitum means Due for that. In short, the benefit
receiving aspect of a transaction is known as debit.

➢ The word Credit is derived from the Latin word Creder which means Due to that. The benefit
giving aspect of a transaction is known as credit.

The abbreviations Dr for debit and Cr for Credit are usually used.

1.13.2 Advantages of double entry system of book-keeping

1.13.2.1 Scientific

The double-entry book-keeping system is a scientific system of book-keeping. Double-entry

system has its own set of principles and rules. Under those principles and rules, two aspects of
every financial transaction are recorded.

1.13.2.2 Systematic

A systematic technique is followed in recording financial transaction in double-entry book-

keeping system. It records financial transactions in a systematic and chronological order with
suitable narration of the financial transaction.

1.13.2.3Complete

Double-entry system is a complete system of book-keeping. It records not only each and every
financial transaction, but also each aspect of the transaction.
1.13.2.4 Accuracy

Double-entry book-keeping system is based on the double-entry principle which means '
for every debit amount there is a corresponding credit amount'. Such a method of debit and
credit can help ensure arithmetical accuracy of the recordings of financial transactions.

1.13.2.5 Profit or Loss

Double-entry book-keeping system helps to ascertain the true profit or loss of a business
by preparing the profit and loss account for a given period.

1.13.2.6 Financial Position

Double-entry book-keeping system also helps to reveal information about the financial
position of the business by preparing a statement called balance sheet.

1.13.2.7 Control

Double-entry book-keeping system keeps a detailed record of financial transactions.

Therefore, the recording of financial transactions in books provides necessary information for the
purpose of costs control.

1.13.2.8 Decision Making

Double-entry book-keeping system communicates financial information that

is necessary for taking decisions by a business. Double-entry book-keeping system also
provides necessary information to different users such as owners, managers and creditors for
their decision making purposes.

1.14 ANSWER TO “CHECK YOUR PROGRESS”

1. What is accounting?
2. What are the objectives of Accounting?
3. What is Book-Keeping?
4. What do you understand by Debit and Credit?
5. Describe the three kinds of personal Accounts?
6. What is accounting? What is the need for it?
7. Explain the steps in process of Accounting in detail
8. Briefly describe various Branches of Accounting.
9. Explain the methods of Accounting

1.15 FURTHER READING

1.
S.N.Maheswari, Advanced Accountancy
2.
R.L.Gupta, Advanced Accountancy
3.
T.S.Reddy and A.Murthy, Financial Accounting
4.
M.C.Sukhla and T.S.Gfrewal, Advanced Accounting
CHAPTER –II
BASIC ACCOUNTING CONCEPTS AND CONVENTIONS
Structure

2.0 Introductions
2.1 Unit objectives
2.2 Accounting concepts and conventions
2.2.0 Theory Base of Accounting
2.2.1 Theory Base of Accounting: Basic Concepts
2.2.1.1 Business Entity Concept

2.2.1.2 Money Measurement Concept

2.2.1.3 Going Concern Concept
2.2.1.4 Accounting Period Concept
2.2.1.5 Cost Concept
2.2.1.6 Dual Aspect Concept
2.2.1.7 Revenue Recognition (Realization) Concept
2.2.1.8 Matching Concept
2.2.1.9 Full Disclosure Concept
2.2.1.10Consistency Concept
2.2.1.11Conservatism Concept
2.2.1.12Materiality Concept
2.2.1.13Objectivity Concept
2.3 Accounting conventions
2.3.1 Convention of Disclosure
2.3.2 Convention of Consistency
2.3.3 Convention of Conservatism
2.3.4 Convention of Materiality
2.4 Accounting standards
2.4.1 Advantages of accounting standard
2.4.2 Disadvantages of accounting standard
2.5 Indian accounting standards
2.5.1 Introduction to Indian Accounting Standards
2.5.2 Benefits of Indian Accounting Standards
2.5.2.1 Wider acceptability
2.5.2.2 Comparability of Financials
 2.5.2.3 Changes in standards as per economic situations
2.5.2.4 Attracts Foreign Investment
2.5.2.5 Saves financial statement preparation cost
2.5.2.6 Indian Accounting Standards Applicability
2.6 Check your answer to questions

2.0 INTRODUCTION

A widely accepted set of rules, conventions, standards, and procedures for reporting
financial information, as established by the Financial Accounting Standards Board are called
Generally Accepted Accounting Principles (GAAP). These are the common set of accounting
principles, standards and procedures that companies use to compile their financial statements.
GAAP are a combination of standards (set by policy boards) and simply the commonly accepted
ways of recording and reporting accounting information. GAAP is to be followed by companies
so that investors have a optimum level of consistency in the financial statements they use when
analyzing companies for investment purposes. GAAP cover such aspects like revenue
recognition, balance sheet item classification and outstanding share measurements.

2.1 UNIT OBJECTIVES

➢ Introduction
➢ Meaning of accounting principles
➢ Features of accounting principles
➢ Necessity of accounting principles
➢ Basic accounting concepts and Conventions

2.2 ACCOUNTING CONCEPTS AND CONVENTIONS

The accounting information is published in the form of financial statements. The three basic
financial statements are :

(i) The Profit & Loss Account that shows net business result i.e. profit or loss for a certain
periods
 (ii) The Balance Sheet that exhibits the financial strength of the business as on a particular
dates

(iii) The Cash Flow Statement that describes the movement of cash from one date to the
other.

As these statements are meant to be used by different stakeholders, it is necessary that the
information contained therein is based on definite principles, concrete concepts and well accepted
convention.

Accounting principles are basic guidelines that provide standards for scientific accounting
practices and procedures. They guide as to how the transactions are to be recorded and reported.
They assure uniformity and understandability. Accounting concepts lay down the foundation for
accounting principles. They are ideas essentially at mental level and are self-evident. These
concepts ensure recording of financial facts on sound bases and logical considerations.
Accounting conventions are methods or procedures that are widely accepted. When transactions
are recorded or interpreted, they follow the conventions. Many times, however, the terms-
principles, concepts and conventions are used interchangeably.

Professional Accounting Bodies have published statements of these concepts. Over years,
many of these concepts are being challenged as outlived. Yet, no major deviations have been
made as yet. Path breaking ideas have emerged and the accounting standards of modern days do
require companies to record and report transactions which may not be necessarily based on
concepts that are in vogue for long. It is essential to study accounting from the basic levels and
understand these concepts in entirety.

2.2.0 Theory Base of Accounting

All the stakeholders of the accounting information of any firm, require it to be accurate,
reliable and most importantly, comparable. This can be achieved only if there is uniformity in
accounting policies and rules that are followed by various firms. This consistency is essential
throughout the process of accounting, right from identification to summarizing and reporting of
the information. Hence, the need for a theory base of accounting is evident. The theory base of
accounting includes principles, concepts, rules and guidelines, which are developed over a period
of time to bring consistency to the process of accounting and better its utility to its stakeholders.
 In addition to this, ICAI (Institute of Chartered Accountants of India), the regulatory body
for standardization of accounting policies in India, has issued a set of accounting standards,
which are expected to be abided by all, for the purpose of bringing consistency in the accounting
practices.

Theory Base of Accounting: Generally Accepted Principles

The Generally Accepted Accounting Principles (GAAP) refer to the rules or guidelines
adopted for recording and reporting of business transactions, in order to bring uniformity and
consistency in the preparation and the presentation of financial statements. These principles of
accounting are not static in nature and are constantly influenced by the social, legal and economic
environment surrounding the firms and the system.

2.2.1 Theory Base of Accounting: Basic Concepts

There concepts are primarily the fundamental ideas underlying the theory base of
accounting and hence can be considered as broad working rules for all accounting activities.
These concepts are as under:

2.2.1.1 Business Entity Concept

The concept of business entity states that a firm or business is a distinct entity from its
owners. Hence, for the purpose of accounting, the business and its owners are treated as two
different persons. Therefore, when an owner brings in capital into the business, it is treated as a
liability of the business. Also, the accounting records are made from the point of view of the firm
and not the owner. Likewise, the personal assets and liabilities of the owners are not to be
considered while reporting for the business.

2.2.1.2 Money Measurement Concept

The concept of money measurement relates to those transactions of a business, which can
be recorded in terms of money in the books of accounts. The records of the same are to be kept
not in physical, but monetary units alone. All the assets are hence shown in monetary terms for
accounting purposes. There are some limitations to this concept. Owing to the changes in prices,
the value of money does not remain consistent over time. As this change does not reflect in the
books of accounts, the accounting data does not show a true and fair view of the actual scenario.
2.2.1.3 Going Concern Concept
This concept states that a business firm will carry on its business for an indefinite period
of time and would not be liquidated at any pre-decided point of time. In simple terms, it will go
on forever. This is an important concept as it offers the fundamental basis for projecting the value
of assets in the balance sheet.

This assumption regarding the continuity of the business necessitates us to charge from
the revenue (for any asset bought and used), only that part of the asset which has been consumed
or used, and the remaining is carried forward to the next year. If the continuity assumption did
not exist, the whole cost of the asset would have been charged from the revenue of the year in
which it was purchased.

2.2.1.4 Accounting Period Concept

Accounting period is the span of time at the end of which, the financial statements of a
firm are prepared, to assess its profits and losses, and to understand the position of its assets and
liabilities. This is essential for easy availability of information to the users of the accounting
information in a timely manner. Therefore, the financial statements are prepared at regular
intervals, usually a period of one year. In certain cases, interim statements to are prepared if need
be.

2.2.1.5 Cost Concept

This concept necessitates that all the assets must be recorded in the books of accounts at
the price at which they were purchased, which includes the cost incurred for acquisition,
transportation and installation (along with any other costs required to make the assets fit for use).
The cost concept is historical in nature as the respective amount pertaining to the asset is paid on
the date of acquisition and does not change year after year. This brings in objectivity in the records
as the costs are easily verifiable from the purchase documents. The market value basis, in contrast,
is more complex since the value keeps changing, thus making comparisons between different
periods difficult. The negative side to this concept is that the true worth of the business is not
clear and this may lead to hidden profits.

2.2.1.6 Dual Aspect Concept

This concept highlights that every transaction has a two-fold effect and hence, must be
recorded at two places. In simpler words, at least two accounts are will be involved in the
recording of any transaction. This is also referred to as duality principle, which can be simplified
as:

Assets = Liabilities + Capital

Therefore, the assets of a business are always equal to the sum of owners’ capital and
outsiders’ claims. This equation ensures that the equality on both sides is maintained. This
concept forms the core of the Double Entry System of Accounting.

2.2.1.7 Revenue Recognition (Realization) Concept

This concept necessitates that revenue from any business transaction should be recorded
only when it is realized. Revenue is the gross inflow of cash arising from the sale of goods and
services and any use of the enterprise’s resources yielding interest, royalties or dividends.
Revenue is realized when a legal right to receive arises (that is, when goods are sold or services
are rendered). Thus, credit sales are considered to be revenue on the day the sale is made, and
not when the money is transferred.

2.2.1.8 Matching Concept

For assessment of the profits earned or the losses incurred, expenses are deducted from the
revenue of a particular period. The matching concept says that the expenses incurred in any
accounting period must be matched with the revenues of the same period. Thus, the revenues
and the expenses incurred to earn these revenues must belong to the same time period. Like
revenues, an expense is considered to be incurred, not when the money is paid but when the asset
has been used to generate revenues.

2.2.1.9 Full Disclosure Concept

The accounting information provided by financial statements has many stakeholders like
investors, creditors, debtors, etc. These statements therefore need to make full and fair disclosure
of all the information which may be relevant to any of the stakeholders to make any financial
decisions. This enables its users to make correct assessment about the risks, opportunities and the
overall financial soundness of the enterprise.

2.2.1.10Consistency Concept
The accounting information from the financial statements is used for inter-firm and intra-
firm comparisons. Therefore, the accounting policies and practices compulsorily need to be
consistent over a period of time. This helps in eliminating personal bias and assists in
achievement of comparable results.

2.2.1.11Conservatism Concept
This concept states that a conscious effort should be made for ascertaining the income of
a firm in order to ensure that the profits are not overstated or understated. Hence, this concept
mandates that the profits should not be recorded unless realized and the losses should be
anticipated and recorded henceforth. This is necessary for dealing with uncertainty and
protecting the interests of creditors against unwanted distribution of firm’s assets.

2.2.1.12Materiality Concept
This concept necessitates that the books of accounts should only focus on the materialistic aspect.
All immaterial information should be ignored. The materiality of a fact depends on its nature and
the money involved. Any fact is considered material if its knowledge influences the decisions of
its users. All such materialistic information must be disclosed for the facilitation of its users.

2.2.1.13Objectivity Concept
This concept requires the recording of transactions to be highly objective. Hence, each transaction
must necessarily be supplemented with the required documents for verification purposes. This
helps in verifying the actual costs of assets via means of the documents. Ascertaining assets’
market value is difficult, and hence, using market value basis will lead to compromising on the
information’s objectivity.

2.3 ACCOUNTING CONVENTIONS

Conventions in accounting have been evolved and developed to bring about uniformity
in the maintenance of accounts. Conventions denote customs or traditions or usages which are in
use since long. To be clear, these are nothing but unwritten laws. The accountants have to adopt
the usage or customs, which are used as a guide in the preparation of accounting reports and
statements. These conventions are also known as doctrine.

Following are the important accounting conventions in use:

2.3.1 Convention of Disclosure
This convention requires that accounting statements should be honestly prepared and all
significant information should be disclosed therein. That is, while making accountancy records,
care should be taken to disclose all material information. Here the emphasis is only on material
information and not on immaterial information. This convention assumes greater importance in
respect of corporate organisations where the management is divorced from ownership. That is
why forms of Balance Sheet and Profit and Loss accounts are prescribed in Schedule VI of the
Companies Act, 1956; so that significant information may not be left out to be disclosed.

The purpose of this convention is to communicate all material and relevant facts of
financial position and the results of operations, which have material interests to proprietor,
creditors and investors. Sometimes, there may be time gap between the preparation of Balance
Sheet and its publication and if there are material events — bad debts, destruction of plant or
machinery etc., which occurred in the time gap, may also be known to users proprietors, creditors
etc. In short, full disclosure of all relevant facts in accounts is a necessity in order to make
accounting record useful. Therefore, full disclosure is a very healthy convention, and is
important.

2.3.,2 Convention of Consistency

Rules and practices of accounting should be continuously observed and applied. In order
to enable the management to draw conclusions about the operation of a company over a number
of years, it is essential that the practices and methods of accounting remain unchanged from one
period to another. Comparisons are possible only if a consistent policy of accounting is followed.
If there are frequent changes in the treatment of accounts there is little or no scope for reliability.
Comparison of accounting period with that in the past is possible only when the convention of
consistency is adhered to. According to Anthony, “the consistency requires that once a company
had decided on one method, it will treat all subsequent events of the same character in the same
fashion unless it has a sound “reason to do otherwise.”

This convention plays its role particularly when alternative accounting practice is equally
acceptable. Moreover, consistency serves to eliminate personal bias. But if a change becomes
desirable, the change and its effect should be clearly stated in the financial statements. Accounts
should lend themselves easily to comparisons and contrasts. This convention increases accuracy
and comparability of accounting information for prediction or decision making. This convention
does not prohibit changes. If there is any change, its effect should be clearly stated in the financial
statements.

2.3.3 Convention of Conservatism

“Anticipate no profit and provide for all possible losses” is the essence of this convention.
Future is uncertain. Fluctuations and uncertainties are not uncommon. Conservatism refers to the
policy of choosing the procedure that leads to understatement as against overstatement of
resources and income. The consequences of an error of understatement are likely to be less serious
than that of an error of overstatement. For example, closing stock is valued at cost or market price
whichever is lower. This is a convention of caution or playing safe and is adhered to while
preparing financial statements. Showing a position better than what it is, is not permitted.
Moreover, it is not proper to show a position substantially worse than what it is.

Following are the examples:

(a) The value of an asset should not be overestimated.

(b) The value of a liability should not be underestimated.

(c) The profit should not be overestimated.

(d) The loss should not be underestimated.

Such conservatism is generally accepted to present a true and fair value of business in the
financial statements.

2.3.4 Convention of Materiality:

American Accounting Association defines the term materiality as “An item should be
regarded as material if there is reason to believe that knowledge of it would influence the decision
of informed investor.” It refers to the relative importance of an item or event. Materiality of an
item depends on its amount and its nature. Theoretically, all items, large or small, should be
treated alike. Materiality convention implies that the economic significance of an item will to
some extent affect its accounting treatment. Materiality in its essence is of relative significance. In
the sense that some of the unimportant items are either left out or included with other items. For
instance, acquisition of items like fountain pen, stapler, pin cushion, punching machine etc., can
be treated as part of assets, when considering their durability and span of life. But, it is not
necessary to maintain separate ledgers. Such low cost items can be treated as expense for the
period. Therefore, unimportant items are either left out or merged with other items. The reason
for this different treatment lies in the magnitude of their amount. The dividing line between
material and immaterial varies according to the company, the circumstances of the transactions
and economic significance. It should also be noted that an item considered to be material for one
business firm, may be immaterial for another firm.

Similarly, an item of material in a year may not be material in the subsequent years.
Similarly, most of the companies publish their financial statements in whole rupees round figures,
by ignoring paise. Omission of paise is immaterial, i.e., insignificant when figures appear in lakhs.
In short, all material information should be disclosed that is necessary to make the financial
statements clear and understandable.

2.4 ACCOUNTING STANDARDS

Accounting standard is a method or an approach established and issued by recognized

expert accountancy body. It is used in preparing financial statement viz., Profit & Loss Account
and Balance Sheet of various concerns operating different fields. The main purpose of
formulating accounting standard is to standardize the diverse accounting policies with views
eliminating to the extent possible the incomparability of information provided in financial
statements within or across the organization. So that the users of aforesaid statements don’t get
confused while evaluating the results to take various decisions viz., to subscribe in equality
shares, or subscribe in debenture of that concern. To discuss on whether such standards are
necessary in present days it will be beneficial to go through the advantages and disadvantages
which they are said to provide.

2.4.1 ADVANTAGES OF ACCOUNTING STANDARD

1. It provides the accountancy profession with useful working rules.

2. It assists in improving quality of work performed by accountant.
3. It strengthens the accountant’s resistance against the pressure from directors to use accounting
policy which may be suspected in that situation in which they perform their work.
4. It ensures the various users of financial statements to get complete crystal information on more
consistent basis from period to period.
5. It helps the users compare the financial statements of two or more organisaitons engaged in
same type of business operation.

2.4.2 DISADVANTAGES OF ACCOUNTING STANDARD

1. Users are likely to think that said statements prepared using accounting standard are infallible.
2. They have been derived from social pressures which may reduce freedom.
3. The working rules may be rigid or bureaucratic to some user of financial statement.
4. The more standards there are, the more costly the financial statements are to produce.

Accounting Title of Accounting Standard

Standard No.
Mandatory Standards
AS-1 Disclosure of Accounting Policies
AS-2 Valuation of Inventories(Revised)
AS-3 Cash Flow Statement
AS-4 Contingencies and Events Occurring after the Balance Sheet Date
AS-5 Net Profit or Loss for the Period, Prior Period Items and Change in
Accounting Policies
AS-6 Depreciation Accounting
AS-7 Construction Contracts
AS-8 Accounting for Research and Development (withdrawn)
AS-9 Revenue Recognition
AS-10 Accounting for Fixed Assets
AS-11 Effects of Changes in Foreign Exchange Rates
AS-12 Accounting for Government Grants
AS-13 Accounting for Investments
AS-14 Accounting for Amalgamation
AS-15 Employee Benefits
AS-16 Borrowing Costs
AS-17 Segment Reporting
AS-18 Related Party Disclosure
AS-19 Accounting for Leases
AS-20 Earnings Per Share
AS-21 Consolidated Financial Statements
AS-22 Accounting for Taxes on Income
AS-23 Accounting for Investment in Associates in Consolidated Financial
Statements
AS-24 Discontinuing Operations
AS-25 Interim Financial Reporting
AS-26 Intangible Assets
AS-27 Financial Reporting of Interest in Joint Venture
 AS-28 Impairment of Assets
AS-29 Provisions, Contingent Liabilities and Contingent Assets
Non-Mandatory Standards
AS-30 Financial Instruments: Recognition and Measurement
AS-31 Financial Instruments: Presentation
AS-32 Financial Instruments: Disclosures

This standard deals with disclosure of significant accounting policies followed in the
preparation and presentation of the financial statements and is mandatory in nature. The
accounting policies refer to the specific accounting principles adopted by the enterprise.

Proper disclosure would ensure meaningful comparison both inter/intra enterprise and
also enable the users to properly appreciate the financial statements. Financial statements are
intended to present a fair reflection of the financial position financial performance and cash flows
of an enterprise.

Areas involving different accounting policies by different enterprises are:

• Methods of depreciation, depletion and amortization
• Treatment of expenditure during construction
• Treatment of foreign currency conversion/translation.
• Valuation of inventories
• Treatment of intangible assets
• Valuation of investments
• Treatment of retirement benefits
• Recognition of profit on long-term contracts
• Valuation of fixed assets
• Treatment of contingent liabilities

2.5 INDIAN ACCOUNTING STANDARDS

2.5.1 Introduction to Indian Accounting Standards

Indian Accounting Standards is converged standards for IFRS (International Financial

Reporting Standards). Ind AS are documents and policies that provide principles for recognition,
measurement, treatment, presentation and disclosures of accounting transactions in the Ind AS
financial statements.
 For example: Ind AS 16 on Property, Plant and Equipment (PPE) will provide principles
on the criteria on the basis of which PPE is recognised, what all cost will form part of PPE, how
to treat those cost and how to present PPE in the financial statement and relevant disclosures. Ind
AS are prepared keeping IFRS in mind, in actual these are IFRS in their converged form.There are
41 Ind AS notified till now.

2.5.2 Benefits of Indian Accounting Standards

2.5.2.1 Wider acceptability

Since Indian AS are converged form of IFRS which are widely acceptable and will give
confidence to the user of financial statements.

2.5.2.2 Comparability of Financials

Financial statements prepared using Ind AS are easily comparable with the financial statements
prepared by companies of other countries.

2.5.2.3 Changes in standards as per economic situations

Principles of Ind AS are revised/modified in case there is any major change in economy.
Ind AS 29 is ‘Financial Reporting in hyperinflationary Economies’ which deals with situations
related to inflation.

2.5.2.4 Attracts Foreign Investment

Adopting Ind AS may attract foreign investors to invest in Indian Companies as that will
ensure better comparability with similar companies across the globe.

2.5.2.5 Saves financial statement preparation cost

For multinational companies, it will be beneficial as it will be able to use the same
accounting standards in all the markets in which they operate. This will save preparation costs of
aligning financial statements of Indian company with other operations.

2.5.2.6 Indian Accounting Standards Applicability

Indian Accounting Standards are applicable to specified category of companies is as
follows:
Mandatory requirement: Companies are required to follow Indian Accounting Standard from
Financial year 2015-2016. For Financial year 2018-19, following is the limit for companies
required to follow Indian Accounting Standards:
1. 1. Companies whose equity or debt securities are listed or are in the process of being listed on
any stock exchange in India or outside India;
2. Unlisted companies having net worth of Rs. 250 crore or more; and
3. Holding, subsidiary, joint venture or associate companies of companies covered in point (1)
and (2) above.

Non-Banking Financial Companies (NBFCs)

1. NBFCs having net worth of rupees five hundred crore or more;
2. Holding, subsidiary, joint venture or associate companies of
2018-19 companies covered under point (1) above.

1. NBFCs whose equity or debt securities are listed or in the process

of listing on any stock exchange in India or outside India and
2019-2020 having net worth less than Rs. 500 crore;
2. NBFCs, that are unlisted companies, having net worth of Rs. 250
crore or more but less than Rs. 500 crore; and
3. Holding, subsidiary, joint venture or associate companies of
companies covered under point (1) and (2) above.

Voluntary applicability:
Company may voluntarily apply Indian accounting standards (Ind AS).

Requirement to follow Accounting Standards:

Corporate entities are required to follow standard of accounting (Ind AS where
applicable) while preparing its financial statements as per Section 129 of the Companies Act, 2013.

In case of conflict between Act and Indian Accounting standards:

In case there is any conflict between provisions of any applicable Act and
Indian Accounting Standard (Ind AS), the provisions of the Act shall prevail to that extent.

2.6 CHECK YOUR ANSWER TO QUESTIONS

1. What do you understand by basic accounting principles, postulates, concepts and

conventions?
2. What are the characteristics of Accounting concepts and conventions?
3. What is mean by accounting standard? What is the main objective of accounting standard?
4. Explain the utility of Accounting Standards.

CHAPTER-3
 THE ACCOUNTING CYCLE- BOOKS AND RECORDS

Structure

3.1 Journal
3.2 Ledger
3.2.1 Relationship between Journal and Ledger
3.2.2 Utility of a Ledger
3.2.3 Ledger Posting
3.2.3.1 Procedure for ledger Posting
3.2.3.2 Balancing of an Account
3.3 Subsidiary books
3.3.0 Learning Objectives
3.3.1 Introduction
3.3.2 The different subsidiary books and their purposes
3.3.3 Benefits of specific journals
3.3.4 Advantages of Subsidiary Books
3.3.4.1 Saving of Clerical Labour
3.3.4.2 Division of Clerical Work
3.3.4.3 Minimizes Frauds
3.3.4.4 Facilitates Further Reference

3.1 JOURNAL

A journal is often referred to as Book of Prime Entry or the book of original entry. In
this book transactions are recorded in their chronological order. The process of recording
transaction in a journal is called as ‘Journalisation’. The entry made in this book is called a
‘journal entry’.

Example: From the following transactions, identify the nature of accounts involved and state
which account will be debited and which account will be credited?

ACCOUN TYPE OF DEBIT/ CREDIT

S. TRANSACTIO TS ACCOUNT
No N INVOLVE
. D
Mr. Anil started Cash Account Real Personal Debit
1. business with ` Capital Incomings
60,000. Account Credit Giver
Purchased goods for Purchases Nominal Real Debit
2. cash ` A/c Cash Expenses
25,000. Account Credit
 Outgoings

Cash Real Nominal Debit

3. Sold goods for cash ` Account Incomings
20,000. Sales Credit
Income
Purchased goods from Purchases i.e. good Real Real Debit Exp
4. Mr. Bansal for cash ` the A/c Cash Credit Outgoings
10,000. Account
Sold goods to Mr. Charles Sales A/c Personal Debit Receiver Credit
5. Charles ` 8,000 on Nominal Income
credit.
6. Furniture A/c Cash Real Real Debit Incomings
Credit Outgoings
Purchased furniture for Account
` 6,000
Rent Account Cash Nominal Debit Expenses
7. Account Real Credit Outgoings
Paid rent ` 1,500
Wages A/c Cash Nominal Debit Expenses
8. Account Real Credit Outgoings
Paid wages
Purchased goods from Purchases A/c Ajit Nominal Debit Expenses
9. Ajit on credit Personal Credit giver
Cash Account Real Debit incomings
10. Dividend A/c Nominal Credit Income
Dividend received
Cash Account Real Real Debit incomings
11. Machinery A/c Credit Outgoings
Machinery sold
Salaries A/c Nominal Debit Expenses
12. Personal Credit given
Outstanding for Outstanding
salaries Salaries A/c

The specimen of a journal book is shown below.

Date Particulars L.F.No. Voucher Debit Credit

No. (Rs.) (Rs.)

Details about the Journal

(i) Date Column: This column contains the date of the transaction.
(ii) Particulars: This column contains which account is to be debited and which account is to be
credited. It is also supported by an explanation called narration.
(iii) Voucher Number: This Column contains the number written on the voucher of the respective
transaction.
(iv)Ledger Folio (L.F.): This column contains the folio of the ledger, where the transaction is
posted.
(v) Dr. Amount and Cr. Amount: This column shows the financial value of each transaction. The
amount is recorded in both the columns, since for every debit there is a corresponding and equal
credit.

All the columns are filled in at the time of entering the transaction except for the column
of ledger folio. This is filled at the time of posting of the transaction to ‘ledger’. This process is
explained later in this chapter.

Example: As per voucher no. 32 of Raja Brothers, on 12.06.2016 goods of Rs.60,000 were
purchased. Cash was paid immediately. Ledger Folios of the Purchase A/c and Cash A/c are 6
and 18 respectively. Journal entry
Date Particulars L.F. Vouc Debit Credit
No. her (Rs.) (Rs.)
No.
Purchase A/C Dr 60,000
12-06-2016 To Cash A/C 60,000
( Being goods purchased for cash)

Illustration 01

Journalise the following transactions of Shree Ltd of 2016

Rs.

Jan. 1 Mohan started business with cash 80,000

Jan. 6 purchased goods from Ram on credit 30,000
Jan. 8 sold goods on cash 6,000
Jan. 15 Bought Furniture from Raja for cash 8,000
Jan. 18 Paid Salary to manager 6,500
Jan. 20 Paid Rent to land lord in cash 1,000

Solution

Journal Entries in the Books of Shree Ltd

 Date Particulars L.F Debit Credit
Rs Rs.
2016 Cash A/C Dr 80,000
January To Shree Capital’s A/C 80,0000
1 (Being commencement of new Business with
capital of Rs.80,000)
6 Purchases A/C Dr 30,000
To Ram A/C 30,000
(Being goods purchased from Ram on credit
basis)

8 Cash A/C Dr 6,000

To Sales A/C 6,000
(Being goods sold on cash basis)
15 Furniture A/C Dr 8,000
To Cash A/C 8,000
(Being furniture purchased on cash basis from
Mr.Raja)
18 Salary A/C Dr 6,500
To Cash A/C 6,500
(Being salary paid to Manager)
20 Rent A/C Dr 1,000
To Cash A/C 1,000
(Being Rent paid to Landlord)

Illustration: 02

Journalise the following transactions in the books of Mr.Jayan

2017, April
1. He started business with a capital of Plant Rs.10,000, Bank Rs. 8,000,
Stock Rs.12, 000
2. Bought furniture for resale Rs. 5,000
Bought furniture for Office decoration Rs. 3,000
3. Paid rent for Rs. 2,000
8. Sold furniture out of those for resale Rs. 6,000
12. Paid Salary to Mr. X for Rs. 1,200

15. Purchased goods from Mr. Mukherjee for cash Rs. 3,000
18. Sold goods to Mr. Sethu on credit for Rs. 8,000
20. Mr. Sethu returned goods valued Rs.1,000
22. Received cash from Mr. Sethu of Rs. 6,500 in full settlement
 28. Bought goods from Mr.Nambi on credit for Rs. 5,000
30. Returned goods to Mr. Nambi of Rs. 500 and paid to Mr. Bose Rs. 4,000 in full
settlement.

Solution

Journal Entries in the Books of Mr.Jayan

Date Particulars L.F Debit Credit

Rs Rs.
2017 Plant A/C Dr 10,000
April Bank A/C Dr 8,000
1 Stock A/C Dr 12,000
To Capital A/C 30,000
(Being commencement of new Business with
Plant, Bank balance and Stock)
2 Purchases A/C Dr 5,000
To Cash A/C 5,000
(Being purchased furniture for resale)
2 Furniture A/C Dr 3,000
To Cash A/C 3,000
(Being furniture purchased for Office
purpose)
3 Rent A/C Dr 2,000
To Cash A/C 2,000

(Being rent paid for office Buildings)

8 Cash A/C Dr 6,000

To Sales A/C 6,000
(Being sold furniture out of those resale)
12 Salary A/C Dr 1,200
To Cash A/C 1,200
(Being salary paid to Mr.X)
15 Purchases A/C Dr 3,000
To Cash A/C 3,000
(Being goods purchased for cash)
18 Sethu A/C Dr 8,000
To Sales A/C 8,000
(Being goods sold to Mr.Sethu on Credit
basis)

20 Sales Returns A/C Dr 1,000

To Sethu A/C 1,000
(Being sold good returned by Mr.Sethu )
22 Cash A/C Dr 6,500
 Discount allowed A/C Dr 500
To Sethu A/C 7,000
(Being Cash received from Mr.Sethu Rs.6,500
and allowed discount of Rs.500 to him)
28 Purchases A/C Dr 5,000
To Nambi A/C 5,000
(Being goods purchased from Mr.Nambi on
credit basis)
30 Nambi A/C Dr 500
To Purchase Returns A/C 500
( Being purchased part of materials returned
to Mr.Nambi)
30 Nambi A/C Dr 4,500
To Cash A/C 4,000
To Discount earned A/C 500
( Being full settlement of Nambi’s account
Rs.4000)

Please observe the convention of entry. Accounts to be debited are written first
with ‘Dr’ as a suffix, and accounts to be credited are written subsequently with a prefix
‘To’.

➢ Purchases Account: This is opened for goods purchased on cash and credit.
➢ Sales Account: This account is opened for the goods sold on cash and credit.
➢ Purchase Returns Account or Return Outward Account: This account is opened
for the goods returned to suppliers.
➢ Sales Returns Account or Return Inward Account: This account is opened for the
goods returned by customers.

Exercise

1. Journalize the following transactions in the books of Nithish and Co.,

Rs.
2018, June 1 Started business with a capital of 60,000
2 Paid into bank 30,000
4 Purchased goods from Srinath on credit 10,000
6 Paid to Arun 4,920
8 Cash Sales 20,000
12 Sold to Ravi 5,000
15 Purchased goods from Bharat on credit 7,500
18 Paid salaries 4,000
20 Received from Prem allowed him discount 20
25 Withdrew from bank for office use 5,000
28 Withdrew for personal use 1,000
 30 Paid Anil by cheque 3,000

2. Journalise the following transactions of Mr.Gopal, Chennai.2017

Rs.
January, 1 Mr.Gopal started business with cash 16,000
2 He bought goods for cash 10,000
4 Sold goods for cash 200
5 Received cash from Mano 720
10 Paid into Bank 6,000
12 Paid to Rajesh 430
15 Sold goods for cash 3,000
17 Paid for stationary 30
19 Paid for office furniture 370
20 Received from Mohan Doss 1,360
24 Paid for advertising 180
26 Purchased postage stamps 16
29 Paid Rent 200
31 Paid Electricity Charges 30

3.2 LEDGER

Ledger is the main book or principal book of account. The entries into ledger accounts
travel through the route of journal and subsidiary books. The ledger book contain all accounts
viz. assets, liabilities, incomes or gains, expenses or losses, owner’s capital and owner’s equity.
The ledger is the book of final entry and hence is a permanent record. There is a systematic way
in which transactions are posted into a ledger account. Once the transactions are posted for an
accounting period, the ledger accounts are balanced (i.e. the difference between debit side and
credit side is calculated). These balances are used to ultimately prepare the financial statement
like Profit and Loss A/c and Balance Sheet. The ledger may also be divided as General ledger
and Sub-ledgers. While the General Ledger will have all ledger accounts, the sub-ledgers will
have individual accounts of customers and suppliers. If there are 10 customers, the general ledger
will not have 10 individual accounts for each customer. Instead, these 10 customer account will
exist in what is called as ‘Receivables or Debtors Ledger’ and the general ledger will have only
one account that represents the customers. This is named as Debtors Control Account. Similar is
the case of supplier accounts. Such sub-ledgers are necessary for better control over individual
accounts. Also, this will avoid the general ledger from becoming too big, especially when number
of customers and suppliers is large.
Journal is a daily record of all business transactions. In the journal all transactions relating
to persons, expenses, assets, liabilities and incomes are recorded. Journal does not give a complete
picture of the fundamental elements of book keeping i.e. properties, liabilities, proprietorship
accounts and expenses and incomes at a glance and at one place.
Business transactions being recurring in nature, a number of entries are made for a
particular type of transactions such as sales, purchases, receipts and payments of cash, expenses
etc., throughout the accounting year. The entries are therefore scattered over in the Journal. In
fact, the whole Journal will have to be gone through to find out the combined effect of various
transactions on a particular account.
In case, at any time, a businessman wants to know:
i) How much he has to pay to the suppliers/creditors of goods?
ii) ii) How much he has to receive from the customers?
iii) What is the total amount of purchases and sales made during a particular period? iv)
How much cash has been spent/incurred on various items of expenses such as salaries,
rent, carriage, stationery etc?
v) what is the amount of profit or loss made during a particular period?
vi) What is the financial position of the unit on a particular date?

The above mentioned information cannot be easily gathered from the journal itself
because the details of such information is scattered all over the journal. It is thus of dire need to
get a summarized/grouped record of all the transactions relating to a particular person, or a thing
or an expenditure to take managerial decisions. The mechanics of collecting, assembling and
summarizing all transactions of similar nature at one place can better be served by a book known
as 'ledger' i.e. a classified head of accounts. Ledger is a principal book of accounts of the
enterprise. It is rightly called as the 'King of Books'. Ledger is a set of accounts. Ledger contains
the various personal, real and nominal accounts in which all business transactions of the entity
are recorded. The main function of the ledger is to classify and summarize all the items appearing
in Journal and other books of original entry under appropriate head/set of accounts so that at the
end of the accounting period, each account contains the complete information of all transaction
relating to it. A ledger therefore is a collection of accounts and may be defined as a summary
statement of all the transactions relating to a person, asset, expense or income which have taken
place during a given period of time and shows their net effect.

3.2.1 Relationship between Journal and Ledger

Journal and Ledger are the most useful books kept by a business entity. The points of
distinction between the two are given below:
1. The journal is a book of original entry where as the ledger is the main book of account.
2. In the journal business transactions are recorded as and when they occur i.e. date-wise.
However posting from the journal is done periodically, may be weekly, fortnightly as per the
convenience of the business.
3. The journal does not disclose the complete position of an account. On the other hand,
the ledger indicates the position of each account debit wise or credit wise, as the case may be. In
this way, the net position of each account is known immediately.
4. The record of transactions in the journal is in the form of journal entries whereas the
record in the ledger is in the form of an account.

3.2.2 Utility of a Ledger

The main utilities of a ledger are summarized as under:
(a) It provides complete information about all accounts in one book.
(b) It enables the ascertainment of the main items of revenues and expenses
(c) It enables the ascertainment of the value of assets and liabilities.
(d) It facilitates the preparation of Final Accounts.
The specimen of a typical ledger account is given below.
Dr Cr
Date Particulars J.F Amount Date Particulars J.F Amount
Rs. Rs.

3.2.3 Ledger Posting

 Posting refers to the process of transferring debit and credit amounts from the Journal or
subsidiary books to the respective heads of accounts in the ledger. Journal will have at a minimum
of one debit and one credit for each transaction. The ledger will have either a debit or a credit for
each account used in the Journal. Posting may be done daily, weekly fort nightly or monthly
according to the convenience and requirements of the business, but care should be taken to
complete it before the preparation of annual financial statements.

3.2.3.1 Procedure for ledger Posting

The following rules should be followed while posting business transactions to respective
accounts in the ledger from the journal:
i) Enter the date and year of the transaction in the date column.
ii) Open separate account in the ledger for each person, asset, revenue, liability, expense,
income and loss appearing in the Journal. iii) The appropriate/relevant account debited in the
Journal will be debited in the ledger, but the reference should be given of the other account which
has been credited.
iv) Similarly, the account credited in the Journal should be credited in the ledger, but the
reference has to be given of the other account which has been debited in the Journal.
v) The debit posting should be prefixed by the word 'To' and credit posting should be
prefixed by the word 'By'.
vi) In the Journal Folio (J.F.) column the page number of the book of original entry
(Journal) is entered. This is explained with the following example:
Illustration 01: Goods sold to Raja for Rs. 1000 on credit on Ist April 2017. Record this
transaction in the journal and the ledger.
Solution: The journal entry will be
Date Particulars L.F. Debit Credit
No. (Rs.) (Rs.)
2017 Raja’s A/C Dr 10,000
April-1 To Sales A/C 10,000
( Being goods sold to Mr.Raja on credit)
 The above journal entry will appear in the ledger in two accounts as follows. On the debit
side of Raja's Account, we will write "To Sales Account" and on the credit side of Sales Account
we will write "By Raja's Account".
Raja’s A/C
Dr Cr
Date Particulars J.F Amou Dat Particulars J.F Amou
nt e nt
Rs. Rs.
2017
April 1 To Sales A/C 10,000

Sales A/C
Dr Cr
Date Particulars J.F Amount Date Particulars J.F Amou
Rs. nt
Rs.
2017 2017
April-1 April-1 By Raja’s A/C 10,000

Posting of Compound Journal Entry

When a single entry is passed to record more than one transaction, it is known as a
compound journal entry. However, it will be treated as several separate entries while posting.
The following example will make the point clear:
Illustration: 02
Rs.
2016 December 31 Purchased stationary 1,000
Paid salary 7,000
Paid wages 600
Paid rent 1,200
Pass the necessary journal entry and prepare ledger accounts
Solution: The Journal entry will be

Date Particulars L.F. Debit Credit

No. (Rs.) (Rs.)
2016 StationaryA/C Dr 1,000
December-31 Salary A/C Dr 7,000
WagesA/C Dr 600
Rent A/C Dr 1,200
To Cash A/C 9,800
( Being cash paid for the above items)

The Ledger posted as under:

Stationary A/C
Dr Cr
Date Particulars J.F Amount Date Particulars J.F Amount
Rs. Rs.

2016 To Cash A/C 1,000

Dec-31

Salary A/C
Dr Cr
Date Particulars J.F Amount Date Particulars J.F Amou
Rs. nt
Rs.
2016 To Cash 7,000
Dec-31 A/C

Wages A/C
Dr Cr
Date Particulars J.F Amou Date Particulars J.F Amou
nt nt
Rs. Rs.
 2016 To Cash A/C 600
Dec-31

Rent A/C
Dr Cr
Date Particulars J.F Amount Date Particulars J.F Amou
Rs. nt
Rs.
2016 To Cash A/C 1,200
Dec-31

Cash A/C
Dr Cr
Date Particulars J.F Amount Date Particulars J.F Amou
Rs. nt
Rs.
2016 ByStationary A/C 1,000
BySalary A/C 7,000
Dec-31
ByWages A/C 600
ByRent A/C 1,200

3.2.3.2 Balancing of an Account

After transferring the entries from Journal to the ledger, the next stage is to ascertain the
net effect of all the transactions posted to relevant account. When the posting is completed, most
of the accounts may have entries on both sides of the accounts i.e. debit entries and credits entries.
The process of finding out the difference between the totals of the two sides of a Ledger account
is known as balancing and the difference of the total debits and the total credits of accounts is
known as balance.
If the total of the credit side is bigger than the total of the debit side, the difference is
known as credit balance. In the reverse case, it is called debit balance.
 Steps for Balancing Ledger Account Ledger accounts may be balanced as and when it is
required. The balances of various accounts are ascertained as under:
1. Make the total of both sides of an account in a worksheet.
2. Write down the higher amount on the side obtained e.g. if the total of the debit side is
6,000 and the credit side is 5,500, the amount Rs. 6,000 is first inserted in the total on the debit
side.
3. Also write down the same total on the other side of the account i.e. the total of Rs. 6,000
is written against the total on the credit side also.
4. Find out the difference between the two sides of the account. In this example debit side
is more than credit side; therefore, there is a debit balance of Rs. 500.
5. This debit balance of Rs. 500 is to be shown as "By Balance c/d" in the account on the
credit side.
6. Finally, the amount of the closing balance should be brought down as the opening
balance at the beginning of the next day. Remember that if the opening balance is not written on
the next day, the balancing is incomplete.

Balancing of different accounts

Balancing is done either weekly, monthly, quarterly, biannually or annually, depending
on the requirements of the business concern.
Personal Accounts: Personal accounts are balanced regularly to know the amounts due
to the persons or due from the persons. A debit balance of this account indicate that the person
concerned is a debtor of the business concern and a credit balance indicates that he is a creditor
of the business concern. If a personal account shows no balance at all, it means that the amount
due to him or due from him is settled in full.
Real Accounts: Real accounts are generally balanced at the end of the accounting year
when final accounts are prepared and always show debit balances. But, bank account may show
either a debit balance or a credit balance.
Nominal Accounts: In fact, nominal accounts are not balanced, as they are to be closed by
transferring them to the final accounts i.e. Trading and Profit and Loss Account.

Enter the following transactions in the Journal of Ramesh, and post them to the Ledger. 2018
 Jan. 1 Assets in hand: Cash Rs. 630; Cash at Bank Rs. 23,100
Stock of goods Rs. 26,400; M. & Co., Rs. 6,750
Liabilities: Marathi & Co. Rs. 3,880; Ram & Sons Rs. 3000
2. Received a cheque from M. & Co. in full settlement Rs.6,650
4. Sold goods to Chand & Sons on credit 1,440 Carriage paid 35 Sold goods to G. &
Co. for cash Rs.3,120
5. Brought goods from Ram & Sons on credit 4,000 Paid Marathi & Co. by cheque
in full settlement Rs.3,800
6. Bought goods from Chatterjee Rs.6,300
13. Returned goods to Chatterjee (not being up to specifications) Rs.300
16. Goods used personally by proprietor Rs.50
17. Sold goods to M. & Co Rs.5,000
20. Cheque received from Chand & Sons Rs.1,440
22. Bank advises Chand & Sons cheque returned unpaid
24. Cash deposited with bank Rs.2,000
27. Cheque sent to Chatterjee (Discount allowed Rs. 150) Rs.5,850 "
31. Paid salaries 600 Paid rent Rs.300
Drew for personal use out of bank Rs.500
Solution
Journal entries in the books of Mr.Ramesh
Date Particulars L.F.No. Debit Credit
(Rs.) (Rs.)
2018, CashA/C Dr 630
January BankA/C Dr 23,100
1 Stock of Goods A/C Dr 26,400
M&Co., A/C Dr 6,750
To Maruthi & Co., A/C 3,880
To Ram & Sons A/C 3,000
To Ramesh’s CapitalA/C 50,000
(Being balances of various assets & liabilities
brought forward)
2. BankA/C Dr 6,650
Discount Allowed A/C Dr 100
To M & Co., A/C
(Being a cheque received from M. & Co. & 6,750
Discount allowed)
4. Chand & Sons A/C Dr 1,440
To Sales A/C
(Being goods sold on credit) 1,440

4. Carriage outwards A/C Dr 35

To Cash A/C 35
(Being the carriage paid)

4. Cash A/ C Dr 3,120
To Sales A/C 3,120
(Being goods sold for cash)
5. Purchases A/ C Dr 4,000
To Ram & Sons A/C 4,000
(Being goods purchased on credit)

5. Maruthi & Co., A/c Dr 3,880

To Discount earned A/C 80

To Bank A/C 3,800
(Being payment made to Marathi & Co. in full
settlement & discount received)

6. Purchases A/ C Dr 6,300
To Chatterjee A/C 6,300
(Being goods purchased on credit)

13. Chatterjee A/ C Dr 300

To Purchase Returns A/C 300
(Being goods returned to Chatterjee)

16. Drawings A/ C Dr 50
To Purchases A/C 50
(Being goods withdrawn for personal use)

17. M. & Co., A/ C Dr 5,000

To Sales A/C 5,000
(Being goods sold on credit)

20. Bank A/ C Dr 1,440

To Chand & Sons A/C 1,440
(Being a cheque received from Chand & Sons)

22. Chand & Sons A/C Dr 1,440

To Bank A/C 1,440
(Being the cheque of Chand & Sons
dishonoured)
 24. Bank A/C Dr 2,000
To Cash A/C 2,000
(Being cash deposited into bank)

27. Chatterjee A/c Dr 6,000

To Discount earned A/C 150
To Bank A/C 5,850
(Being payment made to Chatterjee and
discount received)

31. Salaries A/c Dr 600

To Cash A/c 600
(Being salaries paid)

31. Rent A/c Dr 300

To Cash A/c 300
(Being rent paid)
31. Drawings A/ C Dr 500
To Cash A/C 500
(Being cash withdrawn from bank for
personal use)

Ledger of Ramesh
1. Capital A/C
Dr Cr
Date Particulars J.F Amount Date Particulars J.F Amount
Rs. Rs.
2018 To Balance C/d 50,000 2018 By Balance 50,000
Jan-01
Jan.3 50,000 B/f 50,000
1
50,000
Feb-
01 By Balance
b/d
2. Stock of goods A/C
Dr Cr
Date Particulars J.F Amou Date Particulars J.F Amou
nt nt
 Rs. Rs.
2018 To Balance B/f 26,400 2018 By Balance c/d 26,400
Jan.1 Jan-31
26,400 26,400
Feb-1 To Balance b/d 26,400

3. Cash A/C
Dr Cr
Date Particulars J.F Amou Date Particulars J.F Amou
nt nt
Rs. Rs.
2018 To Balance B/f 630 2018
Jan.1 3,120 Jan-04 Bycarriage 35
To Sales Jan-24 outwards 2,000
04 Jan-31 By Bank A/C 600
Jan-31 By Salary 300
3,750 Jan-31 By Rent 815
815 By Balance c/d 3,750
To Balance b/d

Feb-1

4. Bank A/C
Dr Cr
Date Particulars J.F Amou Date Particulars J. Amou
nt F nt
Rs. Rs.
2018,Jan To Balance B/f 23,100 2018
-1 To M & Co., 6,650 Jan-05 By Maruthi & Co., 3,800
02 To Chand & Sons 1,440 Jan-22 By Chand & Sons 1,440
20 To Cash 2,000 Jan-31 By Chatterjee 5,850
24 Jan-31 By Drawings 500
Jan-31 By Balance c/d 21,600
33,190 33.190
Feb-1 To Balance b/d 21,600

5. M & Co., A/C

Dr Cr
Date Particulars J.F Amou Date Particulars J.F Amou
nt nt
 Rs. Rs.
2018,Jan -1 To Balance B/f 6,750 2018
17 To Sales 5,000 Jan-01 By Bank 6,650
Jan-02 By Discount 100
Allowed
Jan-31 5,000
By Balance c/d
Feb-1 11,750 11,750
To Balance b/d 5,000

6. Maruthi & Co., A/C

Dr Cr
Date Particulars J.F Amou Date Particulars J.F Amou
nt nt
Rs. Rs.
2018 2018 By Balance B/f 3.880
Jan.0 To Bank 3,800 Jan-01
5 ToDiscount 80
Received 50,000 3,880
05

Ram & Son’s A/c

Dr Cr
Date Particulars J.F Amou Date Particulars J.F Amou
nt nt
Rs. Rs.
2018 2018
Jan.3 Jan-1 By Balance B/f 3,000
To Balance c/d 7,000
1 05 By Purchases 4,000
7,000
7,000

Feb- By Balance B/d 7,000

01

7. Chand & Son’s A/c

Dr Cr
Date Particulars J.F Amou Date Particulars J.F Amou
nt nt
Rs. Rs.
 2018 To Sales 1,440 2018
Jan.0 Jan-1 By Bank 1,440
4 To Bank 1,440 05 By Balance c/d 1,440
22 2,880
2,880
To Balance b/d 1,440
Feb-
01

8. Chatterjee's Account
Dr Cr
Date Particulars J.F Amou Date Particulars J.F Amou
nt nt
Rs. Rs.
2018 2018
Jan.1 To Purchase Returns 300 Jan-06 By Purchases 6,300
3 To Bank 5,850
27 To Discount received 150
27
6,300 6,300

9. Purchases A/C
Dr Cr
Date Particulars J.F Amou Date Particulars J.F Amou
nt nt
Rs. Rs.
2018 2018
Jan.0 To Ram & Sons 4,000 Jan-16 By Drawings 50
5 To Chatterjee's 6,300 31 By Balance c/d 10,250
06 10,300 10,300

To Balance b/d 10,250

Feb-
01
 10. Sales A/C
Dr Cr
Date Particulars J.F Amou Date Particulars J.F Amou
nt nt
Rs. Rs.
2018 2018
Jan Jan-4 By Chand & 1,440
31 To Balance b/d 9,560 04 Sons 3,120
17 By Cash 5,000
9,560 By M. & Co., 9,560
9,560
Feb 01

11. Discount Allowed A/C

Dr Cr
Date Particulars J.F Amou Date Particulars J.F Amou
nt nt
Rs. Rs.
2018 2018
Jan.0 To M.& Co., 100 Jan
2 31 By Balance c/d 100
100 100

To Balance b/d 100

Feb-
01

12.Discount Earned A/C

Dr Cr
Date Particulars J.F Amou Date Particulars J.F Amou
nt nt
 Rs. Rs.
2018 2018
Jan.3 To Balance C/d 230 Jan - By Maruthi A/c 80
1 05 By Chatterjee's 150
230
27 230
By Balance B/d
230
Feb-
01

13.Carriage Outwards A/C

Dr Cr
Date Particulars J.F Amou Date Particulars J.F Amou
nt nt
Rs. Rs.
2018 2018
35 Jan
Jan.0 To Cash 31 By Balance c/d 35
4 35 35

35
To Balance b/d
Feb-
01

14. Purchase Returns A/C

Dr Cr
Date Particulars J.F Amou Date Particulars J.F Amou
nt nt
Rs. Rs.
 2018 2018
Jan.3 To Balance c/d 300 Jan
1 13 By Chatterjee's 300
300 300

Feb- By Balance b/d 300

01

15. Drawings A/C

Dr Cr
Date Particulars J.F Amou Date Particulars J.F Amou
nt nt
Rs. Rs.
2018 2018
50 Jan
Jan.1 To Purchases A/C 500 31 By Balance c/d 550
6 To Bank A/C 550 550
31

To Balance b/d 550

Feb-
01

16. Salaries A/C

Dr Cr
Date Particulars J.F Amou Date Particulars J.F Amou
nt nt
Rs. Rs.
2018 2018
Jan
Jan.0 To Cash A/C 600 31 By Balance c/d 600
3 600
31 600

To Balance b/d 600

Feb-
01
 17.Rent A/C
Dr Cr
Date Particulars J.F Amou Date Particulars J.F Amou
nt nt
Rs. Rs.
2018 2018
Jan
Jan To Cash A/C 300 31 By Balance c/d 300
31 300
300

Feb- To Balance b/d 300

01

Exercise:01

Pass necessary journal entries and post them in the appropriate Ledger Accounts of Kamal
for the month of March 2017:
1. Started business with Rs. 2, 00,000 in the bank and Rs. 40,000 cash
1. Bought shop fitting Rs. 40,000 and a van Rs. 60,000, both paid by cheque.
2 .Paid rent by cheque Rs. 5,000.
3 .Bought goods for resale on credit from Zakir & Co. Rs. 50,000
5. Cash sales Rs. 5,000
8. Paid wages of assistant in cash Rs. 1,000.
10. Paid insurance by cheque Rs. 500
12. Cash sales Rs. 8,000
15. Goods returned to Zakir & Co. Rs. 6,000.
17. Paid Zakir & Co. Rs. 30,000 by cheque
24. Bought stationery and paid in cash Rs. 500.
25 Cash sales Rs. 15,000
27. Paid Rao & Co. Rs. 14,000 by cheque. 3
31. Paid Rs. 20,000 into the bank
Short Questions
1. What is meant by Journal ? Enumerate the steps in journalising.
 2. Define ledger. Explain the procedure for balancing a ledger account.
3. What is meant by posting? How is posting made from the journal in the ledger? Explain
with suitable examples.

3.3 SUBSIDIARY BOOKS

3.3.0 Learning Objectives

The main objective of this lesson is to make the students learn about the preparing of a
Subsidiary Books and their relevance in accounting process while preparing the financial
statements or books of accounts of an organization.

3.3.1 Introduction

Subsidiary Books are those books of original entry in which transactions of similar nature
are recorded at one place and in chronological order. In a big concern, recording of all transactions
in one Journal and posting them into various ledger accounts will be very difficult and involve a
lot of clerical work. This is avoided by sub-dividing the journal into various subsidiary journals
or books. The subdivisions of journal into various subsidiary journals for recording transactions
of similar nature are called as ‘Subsidiary Books.’

3.3.2 The different subsidiary books and their purposes

1. Purchases Day Book – for recording credit purchase of goods only. Cash purchase or assets
purchased on credit are not entered in this book.

2. Sales Day Book – for recording credit sales of goods only. Assets sold or cash sales are not
recorded in this book.

3. Purchases Returns Book – for recording the goods returned to the suppliers when purchased
on credit.

4. Sales Returns Books – for recording goods returned by the customers when sold on credit.

5. Bills Receivable Book – for recording the bills received [Bills Receivables] from customers for
credit sales.
6. Bills Payables Book – for recording the acceptances [Bills Payables] given to the suppliers for
credit purchases.

7. Cash Book – for all receipts and payments of cash.

8. Journal Proper – for recording any transaction which could not be recorded in the above-
mentioned subsidiary books. For example, assets purchased or sold on credit and opening entry
etc., are entered in this book.

When numbers of transactions are large, it is practically impossible to record all the
transactions through one journal because of the following reasons:
(a) The system of recording all transactions in a journal requires
(i) Writing down of the name of the account involved as many times as the transactions
occur; and
(ii) An individual posting of each account debited and credited and hence, involves the
repetitive journalizing and posting labour.
(b) Such a system does not provide the information on a prompt basis.
(c) Such a system does not facilitate the installation of an internal check system since only one
person can handle the journal.
(d) The journal becomes bulky and voluminous.

To overcome the shortcomings of the use of the journal only as a book of original entry,
the journal is sub-divided into special journals. It is subdivided in such a way that a separate book
is used for each category of transactions, which are repetitive in nature and are sufficiently large
in number. Subsidiary books refer to the journals meant for specific transactions of similar nature.

The proforma and number of special journals vary according to the requirements of each
enterprise. In any large business, the following special journals are generally used:
Name of the Special Journal Specific transactions to be recorded
I. Cash Journal
(i) Single column Cash book Cash transactions
(ii) Double Column cash book Cash and discount transactions
(iii) Triple Column Cash book Cash, bank and discount transactions
 (iv) Petty cash book Petty cash transactions

II. Goods Journal

(i) Purchase book Credit purchase of goods
(ii) Sales book Credit sales of goods
(iii) Sales returns book Goods returned by those customers to
whom goods were sold on credit
Goods returned to those suppliers
(iv) Purchase returns book
from whom goods were purchased on
credit

III. Bills Journal

(i)Bills Receivables Bills receivable drawn
(ii) Bills Payable Bills payable accepted
IV. Journal proper Transactions not covered elsewhere

3.3.3 Benefits of specific journals

The benefits of using special journals are as under:

(a) Facilitates: The accounting work can be divided among many persons.

(b) Permits the installation of internal check system: The accounting work can be divided in
such a manner that another person automatically checks the work of one person. With the use of
internal check, the possibility of occurrence of error/fraud may be avoided.
(c) Permits the use of specialized skill: The accounting work requiring specialized skill may be
assigned to a person possessing the required skills. With the use of a specialized skill, prompt,
economical and more accurate supply of accounting information may be obtained.

(d) Time and labour saving in journalizing and posting: For instance, when a Sales Book is kept,
the name of the sales account will not be required to be written down in the Journal as many
times as the sales transactions occur and at the same time, sales account will not be required to
be posted again and again since, only a periodic total of sales book is posted to the sales account.
3.3.4 Advantages of Subsidiary Books
The following are the advantages of Subsidiary books or Special journal:

3.3.4.1 Saving of Clerical Labour

Subsidiary books effect considerable saving of clerical labour in postings and narration.
Transactions of any one class such as credit purchases, credit sales, cash transactions etc., are
recorded through separate subsidiary journals and there is no need for giving narration. For
example, by recording the transactions in the Purchase Day book 50% of the labour in postings is
saved. The periodical total of this book is to be debited to the Purchases a/c. Only the personal
accounts of the suppliers are to be credited.

3.3.4.2 Division of Clerical Work

As separate journals are used for recording the transactions of each particular type, the
division of clerical labour amongst several office clerks becomes possible. This makes speedy
record of day-to-day transactions practicable.

3.3.4.3 Minimizes Frauds

These books make possible the introduction of internal check system under which the
system of rotation of writing up books can be adopted. This helps minimizing errors and
detecting frauds.

3.3.4.4 Facilitates Further Reference

As transactions of similar nature are grouped together in a separate book, the further
reference to any particular item is considerably facilitated.

3.5 CHECK YOUR ANSWER TO QUESTIONS

1. What are the Stages in the Accounting Cycle?

2. Briefly describe the four stages in the accounting Cycle.
3. What are Subsidiary books? Explain the purpose of each one of them
4. What is meant by posting? How is posting made from the journal in the ledger? Explain
with suitable examples.
5. What do you understand by subsidiary books? Describe the purpose of preparing such
books.
 CHAPTER – IV
TRIAL BALANCE & FINAL ACCOUNTS

Structure

4.1. Trial balance

4.1.1 Course objective
4.1.2 Introduction
4.1.3 Objectives of preparing trial balance
4.1.4 Limitations of trial balance
4.1.5 Methods of preparation of trial balance
4.1.6 A specimen of the Trial Balance is given as follows
4.2 Final Accounts 102 - 114

4.2.0 Learning Objectives

4.2.1 Introduction
4.2.2 Trading Account
4.2.3 Profit and loss Account
4.2.4 Balance sheet
4.2.5 Objectives of Final 1accounts
4.2.6 Significant adjustment transactions and their effects on final accounts
4.2.6.1 Closing Stock
4.2.6.2 Outstanding Expenses
4.2.6.3 Prepaid Expenses
4.2.6.4 Accrued Incomes
4.2.6.5 Advance Incomes
4.2.6.6 Depreciation
4.2.6.7 Bad Debts and Provision for Bad Debts
4.2.6.8 Interest on Capital
4.2.6.9 Interest on Loan

4.1 TRIAL BALANCE

4.1.1 Course objective

After reading this lesson, you should be able to (a) Define Trial Balance and explain the
methods of preparation of Trial Balance. (b) Preparation of trading, profit and loss account and
balance sheet.

4.1.2 Introduction
 A Trial Balance is a two-column schedule listing the titles and balances of all the accounts
in the order in which they appear in the ledger. The debit balances are listed in the left-hand
column and the credit balances in the right-hand column. In the case of the General Ledger, the
totals of the two columns should agree. We, now, know the fundamental principle of double entry
system of accounting where for every debit, there must be a corresponding credit. Therefore, for
every debit or a series of debits given to one or several accounts, there is a corresponding credit
or a series of credits of an equal amount given to some other account or accounts and vice-versa.
Hence, according to this principle, the sum total of debit amounts must equal the credit amounts
of the ledger at any date. If the various accounts in the ledger are balanced, then the total of all
debit balances must be equal to the total of all credit balances. If the same is not true then the
books of accounts are arithmetically inaccurate. It is, therefore, at the end of the financial year or
at any other time, the balances of all the ledger accounts are extracted and are recorded in a
statement known as Trial Balance and finally totalled up to see whether the total of debit balances
is equal to the total of credit balances. A Trial Balance may thus be defined as a statement of debit
and credit totals or balances extracted from the various accounts in the ledger books with a view
to test the arithmetical accuracy of the books. The agreement of the Trial Balance reveals that both
the aspects of each transaction have been recorded and that the books are arithmetically accurate.
If both the sides of Trial Balance do not agree to each other, it shows that there are some errors,
which must be detected and rectified if the correct final accounts are to be prepared. Thus, Trial
Balance forms a connecting link between the ledger accounts and the final accounts.
4.1.3 Objectives of preparing trial balance
The following are the main objectives of preparing the trial balance:
(i) To check the arithmetical accuracy of books of accounts: According to the principle
of double entry system of book-keeping, every business transaction has two aspects, debit
and credit. So, the agreement of the trial balance is a proof of the arithmetical accuracy of
the books of accounts. However, it is not a conclusive evidence of their accuracy as there
may be certain errors, which the Trial Balance may not be able to disclose.

(ii) Helpful in preparing final accounts: The trial balance records the balances of all the
ledger accounts at one place which helps in the preparation of final accounts, i.e. Trading
and Profit and Loss Account and Balance Sheet. But, unless the trial balance agrees, the
 final accounts cannot be prepared. So, if the trial balance does not agree, errors are located
and necessary corrections are made at the earliest, so that there may not be unnecessary
delay in the preparation of the final accounts.

(iii) To serve as an aid to the management: By comparing the trial balances of different
years changes in figures of certain important items such as purchases, sales, debtors etc.
are ascertained and their analysis is made for taking managerial decisions. So, it serves as
an aid to the management.

4.1.4 Limitations of trial balance

The following are the main limitations of the Trial Balance:
(i) Trial Balance can be prepared only in those concerns where double entry system
of accounting is adopted.
(ii) Though trial balance gives arithmetic accuracy of the books of accounts but
there are certain errors, which are not disclosed by the trial balance. That is why it is said
that trial balance is not a conclusive proof of the accuracy of the books of accounts.

(iii) If trial balance is not prepared correctly then the final accounts prepared will
not reflect the true and fair view of the state of affairs of the business. Whatever
conclusions and decisions are made by the various groups of persons will not be correct
and will mislead such persons.

4.1.5 Methods of preparation of trial balance

A trial balance can be prepared by the following two methods:

1. Total method: In this method, the debit and credit totals of each account are
shown in the two amount columns (one for the debit total and the other for the credit
total).

2. Balance Method: In this method, the difference of each amount is extracted. If

debit side of an account is bigger in amount than the credit side, the difference is put in
 the debit column of the Trial Balance and if the credit side is bigger, the difference is
written in the credit column of the Trial Balance.

4.1.6 A specimen of the Trial Balance is given as follows

Trial Balance of ABC Ltd. as on 31st March 2018

Serial Name of the Account Debit Credit
No. Rs. Rs.
1. Capital A/C - XXX
2. Drawings A/C XXX -
3. Interest on Capital A/C XXX -
4. Interest on Drawings A/C - XXX
5. Salaries, Rent and all types of office and admin.Exp XXX -
6. All type of Provisions and reserves A/C - XXX
7. All type of Current and fixed Assets A/c XXX -
8. All type of fixed liabilities and current liabilities A/c - XXX
9. Bad debts XXX
10. Provision for Bad debts - XXX
11. Opening and closing stocks XXX
Of the two methods of the trial balance preparation, the second is usually used in
practice because it facilitates the preparation of the final accounts.

Illustration 1: The following Trial Balance has been prepared wrongly. You are
asked to prepare the Trial Balance correctly.

Name of Accounts Debit Balances Credit Balances

Rs. Rs.
Cash in hand - 7,000
Purchase returns 8,000 -
Wages 8,000 -
Establishment Expenses 12,000 -
Sales Returns - 7,000
Capital 12,000 -
Carriage outwards - 2,000
Discount received 1,200 -
Commission earned 800 -
Machinery - 20,000
Stock - 10,000
Debtors 8,000 -
Creditors - 12,000
Sales - 44,000
Purchases 1,28,000 -
Bank Overdraft - 1,14,000
Manufacturing expenses 14,000 -
Loan from Mr.Arun 14,000 -
Carriage inward 1,000 -
Interest on Investment - 1,000
Total 2,17,000 2,17,000

Solution: 01
Correct Trial Balance of ABC Ltd as on 31st March 2018
Name of Accounts Debit Balances Credit Balances
Rs. Rs.
Cash in hand 7,000 -
Purchase returns - 8,000
Wages 8,000 -
Establishment Expenses 12,000 -
Sales Returns 7,000 -
Capital - 12,000
Carriage outwards 2,000 -
Discount received - 1,200
Commission earned - 800
Machinery 20,000 -
Stock 10,000 -
Debtors 8,000 -
Creditors - 12,000
Sales - 44,000
 Purchases 1,28,000 -
Bank Overdraft - 1,14,000
Manufacturing expenses 14,000 -
Loan from Mr.Arun - 14,000
Carriage inward 1,000 -
Interest on Investment - 1,000
Total 2,17,000 2,17,000

Illustration 2:

Prepare Trial Balance as on 31-12-2018 from the books of Shri.Rao Ltd.,

Name of the Accounts
Rs.
Opening stock 10,000
Salaries 5,000
Bills payable 5,000
Cash in hand 12,000
Bank overdraft 4,000
Debtors 15,000
Cash at Bank 18,000
Sales 80,000
Wages 1,000
Prepaid Insurance 2,500
Depreciation on Plant 8,000
Capital 60,000
Creditors 10,000
Loan from Krishana 25,000
Discount allowed 700
Accrued interest payable 5,000
Purchases 30,000
Reserve for Bad debts 1,200
Trade Expenses 500
Outstanding salaries 2,000
Plant and Machineries 90,000
Outstanding interest on overdraft 500

Solution: 02

Trial Balance of Sri Rao as on 31-12-2018

Name of the Accounts Debit Credit

Rs. Rs.
Opening stock 10,000 -
 Salaries 5,000 -
Bills payable - 5,000
Cash in hand 12,000 -
Bank overdraft - 4,000
Debtors 15,000 -
Cash at Bank 18,000 -
Sales 80,000
Wages 1,000 -
Prepaid Insurance 2,500 -
Depreciation on Plant 8,000 -
Capital - 60,000
Creditors - 10,000
Loan from Krishana - 25,000
Discount allowed 700 -
Accrued interest payable - 5,000
Purchases 30,000 --
Reserve for Bad debts - 1,200
Trade Expenses 500 -
Outstanding salaries - 2,000
Plant and Machineries 90,000 -
Outstanding interest on overdraft - 500
Total 1,92,700 1,92,700

Exercise: 01
Prepare Trial Balance as on 31-3-2018 from the books of Mr. Vasu

Particulars Rs. Particulars Rs.

Capital 2,49,000 Drawings 24,000

General Expenses 98,210 Building 78,000

Machinery 1,18,680 Stock ( 1-4-2017) 1,32,400

Wages 14,400 Insurance 2,610

Bad debts 1,100 Creditors 5,000

Sales 3,30,720 Loan (Cr) 75,000

Commission 5,500 Purchases 2,10,800

Bills payable 7,700 Reserve Fund 15,000

 Bank O/D 28,600 Cash in hand 25,320

Exercise: 02

Journalize the following transactions in the books of Nithish and Co., prepared ledger and
Trial balance
Rs.

2016,
June 1 Started business with a capital of 60,000
2 Paid into bank 30,000
4 Purchased goods from Srinath on credit 10,000
6 Paid to Arun 4,920
8 Cash Sales 20,000
12 Sold to Ravi 5,000
15 Purchased goods from Bharat on credit 7,500
18 Paid salaries 4,000
20 Received from Prem allowed him discount 20
25 Withdrew from bank for office use 5,000
28 Withdrew for personal use 1,000
30 Paid Anil by cheque 3,000

Short Questions
1. What do you mean by a Trial Balance? Discuss the objectives and methods of preparing a Trial

Balance.

2. Is the agreement of Trial Balance a conclusive proof of the accuracy of books of accounts? If

not, what are the errors, which remain undetected by the Trial Balance?

3. In case of disagreement of the Trial Balance in what order you would follow to locate the errors?
 4.2 FINAL ACCOUNTS

4.2.0 Learning objectives

This lesson will make you familiar with preparation of
* Trading Account.
* Manufacturing Account.
* Profit and Loss Account.
* Balance Sheet.
* Final accounts giving effect to adjustments.

4.2.1 INTRODUCTION

After the completion of preparing Trial Balance, Final Accounts are prepared to ascertain the
net result i.e. profit or loss and the financial position of the business. In other words, a business
can find out the profit or loss made by the business through the final accounts. They are prepared
at the close of the accounting period with the help of trial balance. It is the final step of accounting
circle which includes:

1. Trading Account. , 2. Profit and Loss Account and 3.Balance Sheet.

4.2.2 TRADING ACCOUNT

Trading account is prepared for calculating the gross profit or gross loss arising or
incurred as a result of the trading activities of a business. In other worlds, it is prepared to show
the result of manufacturing, buying and selling of goods. If the amount of sales exceeds the
amount of purchases and the expenses directly connected with such purchases, the difference is
termed as gross profit. On the contrary, if the purchases, and direct expenses exceed the sales, the
difference is called gross loss. A Trading Account records the amount of purchases of goods and
also the expenses which are incurred in bringing that commodity to a saleable state. IN other
words, all expenses which relate to either purchase of raw material for manufacturing of goods
are recorded in the Trading Account. All such expenses are called ‘Direct Expenses’. According
to J.R. Batliboi, “The Trading Account shows the results of buying and selling of goods. In
preparing this account, the general establishment charges are ignored and only the transactions
in goods are included.”
 4.2.3 PROFIT AND LOSS ACCOUNT

Trading account only discloses the gross profit earned as a result of buying and selling of
goods. However, a businessman has to incur a number of expenses which are not taken to trading
account. Hence, a businessman is more interested in knowing the net profit earned or net loss
incurred during the year. As such, a Profit & Loss Account is prepared which contains all the
items of losses and gains pertaining to the accounting period. According to Prof. Carter, “A Profit
& Loss Account is an account into which all gains and losses are collected, in order to ascertain
the excess gains over the losses or vice-versa”.

4.2.4 BALANCE SHEET

After ascertaining the net profit or loss of the business enterprise, the businessman would
also like to know the exact financial position of his business. For this purpose a statement is
prepared which contains all the Assets and Liabilities of the business enterprise. The statement
so prepared is called a Balance Sheet because it is a sheet of balances of ledger accounts which are
still open after the transfer of all nominal accounts to the Trading and Profit & Loss Account.
Balances of all the personal and real accounts are grouped as assets and liabilities. Liabilities are
shown on the left hand side o the Balance Sheet and assets on the right hand side.

Definitions: A Balance Sheet has been defined as follows:

In the words of Karlson, “A business form showing what is owed and what the proprietor is
worth, is called a Balance Sheet.”

According to A. Palmer, “The Balance Sheet is a statement at a particular date showing on

one side the trader’s property and possessions and on the other hand the liabilities.”

In case of manufacturing concern, a separate manufacturing account must be prepared before

preparing trading account. Final accounts are prepared mainly for following two objectives.

1. To ascertain the net result i.e. profit or loss made by the business firm during the
accounting period.
2. To know the financial position of the business i.e. assets and liabilities of the business as
on given date.
 The net result of the business operation is disclosed by the profit and loss account and the
financial position of the business is shown by the balance sheet.

The final account is the final process of accounting. It is an accounting process, which is
prepared at the end of the given period of time. It is prepared to know the amount of profit or
loss and financial position of the business. The amount of profit or loss of the business during the
year is determined by preparing trading and profit and loss accounts. The financial position of
the business on a particular date is determined by preparing the balance sheet. Thus, final
accounts are the combination of trading account, profit and loss account and balance sheet.

The following are the main definitions of final account: -

“Final account is the account, which is prepared at the end of the given year or period, to
see the profit and loss position as well as the financial position of a going concern for the period
given.” – S. Mukherjee

“Final accounts consist of trading account, profit and loss account and balance sheet. The
trading account shows the gross profit or gross loss, net profit or net loss is calculated from profit
and loss account and the balance sheet is prepared to know the position of assets and liabilities.”
– O. P. Gupta

4.2.5 OBJECTIVES OF FINAL ACCOUNTS

The following are the main objectives of final accounts: -

• To determine gross profit and the net profit of the business during the year.
• To present the true financial position of the business on a given date.
• To make effective control on financial activities of the business.
• To make a summary presentation of all the financial transactions.
• To communicate the operating results and financial position of the users.
• To help in making a different financial decision to the users of accounting information.

The items that appear in the trial balance have a single effect in the final accounts but the
transactions, which appear outside the trial balance, have a dual effect. The transactions, which
do not appear in the trial balance, are to be noted as adjustments. The adjustment transactions
represent such items of incomes and expenditures, which relate to the current year and have not
yet been brought into the book of accounts. Such financial transactions are adjusted after the
preparation of trial balance. The adjustment helps to determine the actual net profit and financial
position of the business.

Every adjustment has a dual effect. The possible effects are as follows: -

1. Trading account and balance sheet or

2. Profit and loss account and balance sheet or
3. Trading account and profit and loss account.

4.2.6 SIGNIFICANT ADJUSTMENT TRANSACTIONS AND THEIR EFFECTS ON FINAL

ACCOUNTS

4.2.6.1 Closing Stock

The unsold items of goods remained in the store at the end of the accounting year is called
closing stock. It is an asset of the business. It is shown on the asset side of the balance sheet and
credit side of the trading account.

4.2.6.2 Outstanding Expenses

Expenses incurred but not yet paid are called outstanding expenses. They are the liabilities
of the business. These are shown on the liabilities side of the balance sheet and added to the
concerned item on the debit side of the trading or profit or loss account.

4.2.6.3 Prepaid Expenses

Prepaid expenses are those expenses that are paid in advance. They are assets of the
business. These are shown on the assets side of the balance sheet and deducted from the
concerned item on the debit side of the trading or profit and loss account.

4.2.6.4 Accrued Incomes

 Accrued incomes are those incomes that are earned but not yet received. They are the
assets of the business. These are shown on the assets side of the balance sheet and added to the
concerned item on the credit side of the profit and loss account.

4.2.6.5 Advance Incomes

The incomes, which are not earned but received in advance, are called advance incomes.
They are the liabilities of the business. These are shown on the liabilities side of the balance sheet
and deducted from the concerned item on the credit side of the profit or loss account.

4.2.6.6 Depreciation

The permanent decrease in the value of fixed assets due to continuous use is called
depreciation. It is the loss of the business. It is deducted from the concerned asset on the asset
side and shown on the debit side of the profit or loss account.

4.2.6.7 Bad Debts and Provision for Bad Debts

The uncollectible or irrecoverable amount of debtors is known as bad debts. The amount
of provision, which is created for uncollectible debtors is called provision for bad and doubtful
debts. These are losses of the business. It is deducted from debtors on the assets side of the balance
sheet and shown on the debit side of the profit or loss account.

4.2.6.8 Interest on Capital

The amount of interest, which is allowed on capital, is known as interest on capital. It is

an expense. It is added to the amount of capital in the balance sheet and shown on the debit side
of the profit or loss account.

4.2.6.9 Interest on Loan

It is the amount of interest, which is allowed on the loan. It is an expense. It is shown on

the liabilities side of the balance sheet and debited to the profit and loss account.

Illustration: 01
Trading Account:

Trading account is prepared to know the result of manufacturing and trading activities:
Ex: Prepare a Trading Account from the following particulars for the year ended March 31, 2017.
Opening Stock 56,250
Purchases 157500
Sales 405000
Wages 45000
Solution:
Trading Account for the year ended March 31, 2017
Particulars Amount Particulars Amount
To Opening Stock 56,250 By Sales 4,05,000
To Purchases 1,57,500
To Wages 45,000
To Gross Profit 1,46,250
4,05,000 4,05,000

Illustration: 02

Profit and Loss Account:

Profit and loss account is prepared to know the result of the business in the term of net
profit. Prepare Profit and Loss Account for the year ended 31st March, 2010 from the following
particulars:

Rs. Rs.
Gross profit 90,500 Discount allowed 600
Trade expenses 2,400 Lighting 4,100
Rates and taxes 1,200 Interest on investment 500
Carriage outwards 7,500 Commission received 600
Salaries 13,600 Bad debts 1,000
Postage and telegram 2,400 Discount (Cr.) 600
Rent 9,000 Interest on loan 1,800
Legal charges 2,000 Stable expenses 1,600
Audit fee 2,400 Export duty 2,200
Depreciation 2,000 Miscellaneous receipts 200
Donation 500 Unproductive wages 2,100
General expenses 1,500 Travelling expenses 3,500
Selling expenses 4,000
Solution:
Profit and Loss Account
(for the year ended 31st March 2010)
Particulars Amount Particulars Amount
To Trade expenses 2,400 By Gross profit b/d 90,500
To Carriage outwards 7,500 By commission received 600
To Salaries 13,600 By Discount 600
To Postage and telegram 2,400 By Miscellaneous receipts 200
To Rent 9,000 By interest on investment 500
To Rates and taxes 1,200
To Legal charges 2,000
To Audit fee 2,400
To Depreciation 2,000
To Donation 500
To General Expenses 1,500
To Selling expenses 4,000
To Discount allowed 600
To Lighting 4,100
To Bad Debts 1,000
To Interest on loan 1,800
]To Stable expenses 1,600
To Export duty 2,200
To Unproductive wages 2,100
To Traveling expenses 3,500
To Net Profit transferred to capital 27,000
account) 92,400 92,400

Illustration: 03

From the following figures prepare Trading and Profit and Loss Account for the year ended 31 st
March, 2010 and a Balance Sheet as on that date:

Capital 86,800
Drawing 15,000
Investments 14,000
Cash 8,000
Rent and Insurance 3,000
Opening Stock 36,600
Purchases 1,86,000
 Sales 3,05,000
Sales return 5,000
Wages 22,000
Carriage 4,200
Bad debts 700
Bad debts provision 2,100
Sundry debtors 40,400
Sundry creditors 25,700
Furniture 8,000
Plant and machinery 50,000
Salaries 11,000
Advertisement 4,400
Goodwill 6,000
Freight 6,300
Commission (Cr.) 1,000

Adjustments :
1. Stock on 31st march 2010 was Rs. 31,500
2. Salary and wages for March 2010 were unpaid.
3. Rent outstanding amounted to Rs. 600 and insurance unexpired amounted to Rs. 400.
4. Commission amounting to Rs. 200 has been received in advance.
5. Write off Rs. 400 as bad debts, create provision for doubtful debts at 5% on sundry debtors
and provide 2% provision for discount on debtors and creditors.
6. Depreciate furniture and plant and machinery by 10%.

Solution:
Trading and Profit and Loss Account
For the year ending 31st March 2010

Particulars Amount Particulars Amount

To Opening Stock 36,600 By Sales 3,05,000
To Purchases 1,86,000 Less : Sales Return 5,000 3,00,000
To Wages 22,000 By Closing Stock 31,500
Add : Outstanding 2,000 24,000
To Carriage 4,200
To Freight 6,300
To Gross Profit c/d 74,400
3,31,500 3,31,500
To Bad Debts 700 By Gross Profit b/d 74,400
Add : Further Bad Debts 400 By Commission 1,000
New Provision 2000 Less : Unearned 200 800
3100 By Provision for Discount on
Less : Old Provision 2100 1,000 Creditors 514
To Provision for Discount on debtors 760
To Salary 11,000
Add: Salaries outstanding 1,000 12,000
To Advertisement 4,400
To Rent and Insurance 3,000
Add : Outstanding Rent 600
3600
Less :Prepaid Insurance 400 3200
To Depreciation on
Furniture 800
Plant and Machinery 5,000 5,800
To Net Profit transferred to
Capital A/c 48,554
75,714 75,714

Balance Sheet (As on 31st March, 2010)

Liabilities Amount Assets Amount

Salaries outstanding 1,000 Cash 8,000
Wages outstanding 2,000 Sundry Debtors 40,400
Outstanding Rent 600 Less : Bad Debts 400
Unearned commission 200 40,000
Creditors 25,700 Less : New Prov. for
Less : Prov.for discount 514 25,186 Bad Debts. 2,000
Capital 86,800 38000
Add : Net Profit 48,554 Less : Prov. for discount 760 37240
1,35,354 Closing Stock 31,500
Less : Drawing 15,000 1,20,354 Insurance Prepaid 400
Investment 14,000
Furniture 8,000
 Less : Depreciation 800 7,200
Plant and Machinery 50,000
Less : Depreciation 5,000 45,000
Goodwill 6,000
1,49,340 1,49,340

Exercise: 01

Prepare a Trading Account from the following particulars for the year ended 31st March, 2011
Rs. Rs.
Opening Stock 30,000 Wages 18,000
Purchases 1,00,000 Carriage on purchases 3,000
Sales 2,05,000 Manufacturing Exp. 20,000
Factory rent 10,000 Custom Duty 4,500
Purchases returns 3,000 Gas, Fuel and power 12,000
Sales returns 5,000 Dock charges 3,000

Exercise: 02

From the following trial balance of Raj & Co. prepare trading and profit and loss A/c for
the year ending 31st March 2011 .

Debit Balance Amount Credit Balance Amount

Stock 16,000 Sundry Creditors 20,000
Purchases 55,000 Purchases returns 1,000
Sales Returns 2,000 Sales 1,03,000
Carriage 3,500 Commission 4,500
Wages 12,500 Capital 56,000
Salaries 10,000 Bills Payable 8,500
Printing and stationery 3,400 Bank Loan 20,000
Trade expenses 2,000
Cash in hand 3,500
Bills receivables 8,000
Sundry Debtors 22,000
Land and buildings 30,000
Plant and machinery 20,000
Drawings 8,000
Furniture and fixtures 10,600
 Rent and taxes 6,500

Exercise: 03

Following is the Trial Balance of Rama & Co. for the year ending 31st December 2010. Prepare
Trading and Profit and Loss Account and Balance Sheet:

Name of Account Dr. Balance Cr.Balance

Drawing and Capital 4.000 23,000
Furniture 8,000 -
Apprentice Premium - 1,000
Machinery 20,000 -
Bad debts 350 -
Provision for bad debts - 500
Sundry debtors and Creditors 8,200 5,000
Stock on January 1, 2010 7,400 -
Purchases and sales 75,000 1,05,000
Bank overdraft - 2,600
Sales return and purchase returns 500 400
Advertisement 2,400 -
Interest 200 -
Commission - 400
Cash in hand 1,650 -
Taxes and Insurance 3,200 -
Carriage and Freight 1,500 -
Salaries 5,500 -

Adjustments:
The following adjustments are to be made :
(i) Stock in hand on 31st December 2010 was value Rs. 8,250/-
(ii) Salary is paid at Rs. 500 for month.
(iii) Tax outstanding Rs. 300 and insurance is prepaid Rs 400.
(iv) Write off furniture bad debts Rs. 200 and create provision for bad debts on debtors at
5%.
(v) Apprentice Premium Rs. 300 is related to 2011.
(vi) Commission Accrued Rs. 100.
Ans.: Gross Profit. 29250, Net Profit: 18300 and B/S 46000

Exercise: 04
From the following trial balance of Mr. M.G. Ravi prepare the trading and profit and Loss
Account and the Balance Sheet as on 31st March 2016.
Particulars Rs. Particulars Rs.
Cash in hand 4,800 Capital 2,00,000
Cash at Bank 19,200 Sundry Creditors 1,20,000
Stock (1.4.2015) 1,44,000 Bills payable 1,22,400
Furniture 8,000 Sales 10,40,000
Machinery 2,40,000 Return outwards 16,000
Sundry Debtors 1,28,000 Commission earned 8,800
Purchases 7,20,000
Return inwards 40,000
Bad Debts 4,000
Salaries 64,000
Rent 28,800
Wages 88,000
Discount 7,200
Commission 5,600
Trade Expenses 3,200
Cycle 2,400
Total 15,07,200 Total 15,07,200

Adjustments:
1. Closing stock was Rs.192,000
2. Depreciation on Machinery @ 20 %, Furniture @ 10 % and Cycle @ 5 %.
3. Outstanding Salaries Rs.12,000
4. Provide 5 % on Sundry Debtors for Bad Debts and 1 % provision for discount on Sundry
Creditors
5. Interest on Capital @ 5 % to be provided.
Exercise: 05

From the following Trial balance of Thiru. Rehman on 31st March 2017, Prepare Trading
and Profit and loss A/c and Balance Sheet taking into account the adjustments.
Debit Balance Rs. Credit Balances Rs.
Land and Buildings 42,000 Capital 62,000
Machinery 20,000 Sales 98,780
Patents 7,500 Return Outwards 500
Stock on 1-4-2016 5,760 Sundry creditors 6,300
Sundry Debtors 14,500 Bills payable 9,000
Purchases 40,675
Cash in hand 540
Cash at bank 2,630
Return Inwards 680
Wages 8,480
Fuel and power 4,730
Carriage on Sales 3,200
Carriage on Purchases 2,040
Salaries 15,000
General Expenses 3,000
Insurance 600
Drawings 5,245
Total 1,76,580 Total 1,76,580

The following adjustments are to be made:

(i) Stock on 31-3-2017 Was Rs.6,800

(ii) Salary outstanding Rs.1,500,
(iii) Depreciate machinery @ 10% and patents@20%
(iv) Create a provision of 2% on debtors for bad debts.