JOURNALISING TRANSACTIONS:

Accounting cycle involves the following stages:

1. Recording of transactions: done in the book termed as journal.

2. Classifying the transactions: done in the book ledger.
3. Summarizing the transactions: includes preparation of the trial balance, profit and
loss account and balance sheet.
4. Interpreting the results: involves computation of ratios, ABC analysis etc to know
the liquidity, profitability and solvency of the business.

JOURNAL:

Journal records all daily transaction of a business into the order in which they occur. A
journal is the books of original records. The process of recording transactions in a journal is
termed as Journalizing. Journal is referred as the book of original entry or prime entry.
Performa of journal:

Date Particulars L.F Debit Rs Credit Rs

Date: the date on which the transaction was entered.

Particulars: the details regarding accounts which have to be debited and credited
L.F: ledger folio. The relevant ledger folio is entered here.
Debit: the amount to be debited.
Credit: the amount to be credited.

RULES OF DEBIT AND CREDIT:

The transactions in the journal are recorded on the basis of the rules of the debit and credit.
Business transactions may be classified into 3 categories:
  Transactions relating to persons.
 Transactions relating to properties and assets
 Transactions relating to incomes and expenses.

On this basis it become necessary for the business to keep on account of

 Each person with whom it deals
 Each property or asset which the business owns
 Each item of income or expense.

Accounts may be classified into three

1. PERSONAL ACCOUNTS
2. REAL ACCOUNTS
3. NOMINAL ACCOUNTS

PERSONAL ACCOUNTS:

It includes the accounts of persons with whom the business deals. These accounts are of
three types.
1. Natural personal accounts: Natural persons are the persons who are creation of god.
Eg Raman‘s account, Mohan‘s account
2. Artificial personal accounts: this involves the accounts of corporate bodies or
institutions e.g. account of government, account of co-operative society, account of a
limited company.
3. Representative personal accounts: these are accounts represent a certain person or a
group of persons. e.g if the rent is due to a landlord, an outstanding rent account will
be opened in the books. It represents the account of the landlord to whom the rent is
to be paid.

RULE

DEBIT THE RECEIVER

CREDIT THE GIVER
E.g. If cash has been paid to Anil, the account of Anil will be debited.

REAL ACCOUNTS:
Real accounts may be two types:

Tangible real accounts: these relate to the items which can be touched, felt, measured etc.
e.g. cash account, building account furniture account etc. Bank account is a personal account,
since it represents the account of the banking company – an artificial person.

Intangible real accounts: these relate to the items which cannot be touched, felt, measured
etc e g patents account, goodwill account etc.

RULE:
DEBIT WHAT COMES IN
CREDIT WHAT GOES OUT
E.g. If building has been purchased for cash building account should be debited and cash
account credited.

NOMINAL ACCOUNTS:

It includes accounts of all expenses, losses, incomes and gains. E.g. rent account, salaries
account etc.

RULE

DEBIT ALL EXPENSES AND LOSSES

CREDIT ALL INCOMES AND GAINS

E.g. rent paid, rent account should be debited and cash should be credited.

Note: when a prefix or suffix is added to a Nominal account, it becomes a personal

account. E.g. rent prepaid account, outstanding rent account, and outstanding salaries
account.
2 American Approach

According to this approach, in order to understand the rules of debit and credit, transactions are
divided into the following five categories.

(i) Transactions relating to owner, e.g. capital.

(ii) Transactions relating to other liabilities, e.g. supplier of goods, bankers etc.

(iii) Transactions relating to assets, e.g. land, building, plant, machinery, cash, goodwill,
trademarks

(iv) Transactions relating to expenses, e.g. wages, salaries, commission, discount, purchase of
goods.

(v) Transactions relating to revenues, e.g. sale of goods, interest received, dividend received, rent
received etc.

The rules of debit and credit in relation to these accounts are given below.

For capital account: Debit means decrease and credit means increase. This means that if

by a transaction the capital of the proprietor increases, for e.g., introduction of capital, profit of
the year etc., the capital account will be credited and if the capital decreases, for e.g., withdrawal
of capital, loss of the year on any capital account will be debited.

For any liability account: Increase in liability means credit and decrease in liability means
debit. This means that if because of a transaction there is increase in a liability than liability
account will be credited and if there is decrease in liability than that concerned liability account
will be debited.

For any asset account: Debit means increase and credit means decrease. This means that if due
to a transaction there is increase in the value of an asset than the concerned asset account will be
debited and if there is decrease in the value of an asset than the concerned asset account will be
credited.

For any expense account: Increase means debit and decrease means credit. This means that if
by a transaction there is increase in the account of expense the expense account is debited and if
there is decrease than expense account will be credited.

For any revenue account: Debit means decrease and credit means increase. Thus means that if
by transactions, the total of the revenue decreases then the concerned revenue account will be
debited and if the amount of revenue increases then the concerned revenue account will be
credited.
These rules can be easily understood with the help of the following table.

Name of the Account Debit Credit

Capital Decrease Increase
Liability Decrease Increase
Revenue & Gains Decrease Increase
Assets Increase Decrease
Expenses Increase Decrease

Important Points:

 If a transactions relates to sales or purchases of goods and the name of the seller or
purchaser is given and it is not stated as a cash transaction, it is considered to be a credit
transaction.

 If a transactions relates to sales or purchases of goods and the name of the seller or
purchaser is given along with cash it is taken as cash transaction.

 If a transactions relates to sales or purchases of goods and the name of the seller or
purchaser is not given it is considered as a cash transaction.

Capital and Drawings It is important to note that business is treated as a separate entity from
the business man. All transactions of the business have to be analysed from the business point of
view and not from the proprietor‘s point of view. The amount with which a trader starts the
business is known as Capital. The proprietor may withdraw certain amounts from the business
to meet personal expense or goods for personal use. It is called Drawings.

Life Insurance premium and Income tax paid is treated as Drawings as it is a personal
expense not business expense

Specific Transactions

Bad Debts -When the goods are sold to a customer on credit and if the amount becomes
irrecoverable due to his insolvency or for some other reason, the amount not recovered is called
bad debts. For recording it, the bad debts account is debited because the unrealised amount is a
loss to the business and the customer‘s account is credited.
Bad Debts Recovered- Some times, it so happens that the bad debts previously written off are
subsequently recovered. In such case, cash account is debited and bad debts recovered account is
credited because the amount so received is a gain to the business.

Discount: A discount may be classified into:

 Trade Discount
 Cash Discount

Trade Discount :Trade discount is an allowance or concession granted by the seller to the buyer,
if the customer purchases goods above a certain quantity or above a certain amount. The amount
of the purchase made, is always arrived at after deducting the trade discount, ie., only the net
amount is considered. For example, if the list price (price prescribed by the manufacturers or
wholesalers) of a commodity is Rs.100, and trade discount granted by manufacturer to the
wholesaler is 20% then cost price of the commodity to the wholesaler is Rs.80. Trade discount is
not recorded in the books. They are used for determining the net price.

Cash Discount: Sale of goods on credit is a common phenomenon in any business. When goods
are sold on credit the customers enjoy a facility of making payment on some date in the future. In
order to encourage them to make the payment before the expiry of the credit period a deduction
is offered. The deduction so made is known as Cash Discount

If both Trade and Cash discount are allowed, Trade Discount is allowed first and
thereafter, cash discount is allowed.

Expenditure on the installation of Machinery and on construction of Building : Any

Expenditure incurred on carriage and installation of Machinery is capital expenditure and
debited to Machinery Account.

Compound Entries
Sometimes there are a number of transactions on the same date relating to one particular
account or of one particular nature. Such transactions may be recorded by means of as single
journal entry instead of passing several journal entries. Such entry regarding a number of
transactions is termed as compound journal entry.

SUB DIVISION OF JOURNAL

All business transactions are to be recorded first recorded in the journal. In big business concerns
recording of transactions in one journal is inconvenient to handle and delay in collecting
information required. So the journal divided into many subsidiary books.

Journal may be classified into two types

1. Special journal: it means a journal which is meant a special purpose
2. General journal
Special journal may be again classified into three.
 Cash journal
 Goods journal
 Bills journal
Cash journal may be of two types:
1. Cash receipts journal
2. Cash payments journal
Goods journal may be of four types:
1. Purchases journal
2. Sales journal
3. Purchase returns journal
4. Sales returns journal
Bills journal may be of two types:
1. Bills receivable journal
2. Bills payable journal

i) Cash journal: it is meant for recording all cash transactions It may be further classified into
cash receipts journal and cash payments journal. Cash receipts journal records all cash receipts
and cash payments journal records all cash payments.

ii) Goods journal: it is meant for recording all transactions that relating to goods. It may further
classified into the following categories:

 Purchase journal: it is meant for recording all credit purchases of goods. Cash purchases
are recorded in cash journal.

Difference between Purchase Book and Purchase Account

Purchase Book Purchase Account

All credit Purchases of goods are recorded in All credit and cash Purchases of goods are
this book recorded in this book.
 It is a part of sub- journal or subsidiary Books It is a part of ledger .

It has no debit and credit Columm like a It has debit and credit coulmms ,as it is a
ledger , because format is different from that of part of ledger.
a ledger
Purchase day book‘s total amount is Purchase account‘s total is transferred to
transferred to purchases Account trading account.

 Sales journal: it records all credit sales of goods. Cash sales of goods are to recorded in
cash journal.

Sales Book Sales Account

All credit Sales of goods are recorded in this All credit and cash sales of goods are
book recorded in this book.
It is a part of sub- journal or subsidiary Books It is a part of ledger .

It has no debit and credit Columm like a It has debit and credit coulmms ,as it is a
ledger , because format is different from that of part of ledger.
a ledger
Sales day book‘s total amount is transferred to Sales account‘s total is transferred to trading
purchases Account account.

 Purchase returns journal: it records all returns of goods purchased on credit. It is also
known as returns outward journal.

Generally Goods are returned to the suppliers due to defective goods or some other reason. A
note , known as DEBIT NOTE is given to the supplier together with the goods returned , stating
that their account is debited for the goods returned. It contains the date of return, quantity and
value , supplier‘s name and the reasons for such return.

 Sales returns journal: It records all return of goods sold on credit. It also known as
return inwards journal.

When goods are returned by the customer, a document is prepared called Credit Note and send
it to the customer to intimate that his account has been credited.

iii) Bills Journal: The journal is meant for recording all bills of exchange or promissory notes
received or issued by the business. It can be classified into two categories
  Bills receivables journal: it is meant for recording all bill of exchange or promissory
notes received by the business from its debtors.

 Bills payable journal: it is meant for recording all bill of exchange or promissory notes
issued by the business from its creditors.

GENERAL JOURNAL

It is also known as journal proper. It is meant for recording such transactions which do not
occur frequently in the business.

Examples of such transactions are:

Opening entries: when a new set of books is started, the old accounts have to be brought
forward in the beginning of the year from the last year‘s books.

Closing entries: at the end of accounting year, the nominal accounts are closed by transferring
them to trading account or profit and loss account. The entries passed for this purpose are termed
as closing entries.

Adjustment entries: at the end of the accounting year, adjusting entries are to be passed for
outstanding /prepaid expenses, accrued income etc. these entries are termed as adjustment
entries.

Transfer entries: transfer entries are required for transferring one account to the other. Entries
for such transfer are passed in the general journal.

Rectification entries: it rectifies the errors which might have been committed in the books of
account. The necessary rectifying entry will be passed in the general journal.

CASH JOURNAL:

Cash journal or cash book is meant for recording cash transactions. It is very important
because
 The number of cash transactions is quite large in every business.
 The chances of fraud being committed regarding cash are higher as compared to other
assets.
 Cash is the nerve centre of every business.
Types
1. Simple (single column) cash book
2. Double (two column) cash book
3. Three columnar cash book

Triple Columm Cash Book

Contra Entries: A particular type of transaction when recorded on both sides of the cash
book on the same day is known as contra entry. Contra Entries are made under the
following circumstances:

1. Cash Deposited into bank – Bank A/c Dr.

To Cash A/c

2. Cash withdrawn from bank- Cash A/c Dr.

To bank
Guidelines while preparing Triple Columm Cash book

 For cheque received from debtors/parties

 All Receipts on the debit side of the cash book

 All payments are in the credit side of the cash Book

For cheques received from debtors/ parties

A. Cheque received and deposited the same into bank immediately

Bank A/c Dr.

To Debtors
B. Cheque received and deposited the same into bank in subsequent date :
I The date when received : cash A/c Dr.
To Debtors A/c
Ii Then the date when sent to bank for collection
Bank A/c Dr.
To cash A/c
C. Cheque received and problem remains silent . it may be assumed that the cheque
was received and deposited into bank immediately.
D. Cheque Received and endorsed to some other party
 The date when received : Cash A/c Dr.
To Debtors A/c
The date when endorsed : Party‘s A/c Dr.
To cash A/c

When cash book is maintained , cash account is not opened in the ledger

PETTY CASH BOOK

Petty cash book is maintained by the business to record petty cash expenses of the business such
as postage, cartage, stationary, cleaning charges etc these are usually termed as petty cash
payments. A proper re cord for such payments is necessary because in a big business the number
of petty payments is large.

 These payments recur at regular intervals

 It is usually not possible (impracticable) to issue a cheque in payment of any of them.
 Person receiving payment may be an employee of the business

A petty cashier is appointed by the business to make payments of all such

petty expenses. He works under the supervision of the Chief cashier, who advances money in the
beginning of every month/ quarter to meet petty cash expenses. At the end of the month /quarter
the petty cashier submits a statement of account of the expenses incurred by him during the
month/quarter and gets a fresh advance.

IMPREST SYSTEM

The method of dealing with petty cash payments which is generally adopted in the Imprest
system. According to this system, a fixed amount is advanced to the petty cashier at the
beginning of the period by the chief cashier. He submits his accounts at the end of the period and
the chief cashier after examining his accounts gives him a fresh advance equivalent to the
amount spent by him. Thus at the beginning of the period (month/quarter) the petty cashier has a
fixed balance. The amount so advanced to him in termed as Imprest or float.

Advantages

 The money in the hands of the petty cashier is limited to the Imprest amount
 The periodical reimbursements are the actual expenses paid.
 The chief cashier by handing over a fixed sum, is relieved as petty disbursements
 The main cash book is not unnecessarily burdened with the large number of small items
  The regular check of the petty cash book creates a sense of responsibility in the petty
cashier

DIFFERENCE BETWEEN PURCHASE ACCOUNT AND PURCHASE JOURNAL

PURCHASE JOURNAL:
 Purchase journal is used to record the purchases of goods on credit. It is also known as
purchases book or bought day book. It has columns of date of purchase, invoice number,
name of the party, ledger folio and amount of purchases. The posting is done in the
personal accounts daily from the purchases book. At the end of a week/month, the total of
the purchases book is debited to the purchase account in the ledger.
 Thus a business transaction must fulfill the following two conditions before it is entered
in the purchase book
 The credit purchases involving no payment of cash on the spot.
 The articles, goods, or merchandise purchased are meant for sale and not as a property or
asset of the
 Business.
Format of Purchases journal

Date Invoice Particulars L.F Amount Amount

No. Rs Rs

PURCHASE ACCOUNT is an account in which all inventory purchases are recorded; used
with the periodic inventory method. Purchase account has two sides debit side and a credit side.

Ledger
Ledger is a book which contains various accounts. In other words, ledger is a set of accounts.
Thus, ledger is a book in which the monetary transactions of a business are posted in the form of
debits and credits. It may be kept in any of the two forms.
 Bound Ledger
 Loose leaf ledger

It is common to keep ledger in the form of loose leaf cards these days. This helps in posting
transactions when mechanised system of accounting is used and nowadays almost all the
business organisations, whether big or small, use computerised system of accounting.

Relationship between ledger and journal/ Difference between ledger and journal
The journal and the ledger are the most important books of the double entry system of
accounting. Their relationship can be expressed as follows.

1) The journal is the book of first entry (original entry); the ledger is the book of second
entry.
2) The journal is the book of chronological record; the ledger is the book for the analytical
record.
3) The process of recording in the journal is called journalising; the process of recording in
the ledger is called posting.

Posting

Posting is the process of transferring entries from a journal to a ledger book

Example:

2012

Aug., 31 Paid salary to Karan Rs. 5,000

Journal
Date Particulars L.F. Debit Credit
2012 Salary A/c Dr. 5,000
Aug., 31 To Cash A/c 5,000
(Being salary paid )

Ledgers

Salary A/c

Dr. Cr.

Date Particulars L.F. Amount Date Particulars L.F. Amount

2012 To Cash A/c 5,000
Aug.,
31
 Cash A/c

Dr. Cr.

Date Particulars L.F. Amount Date Particulars L.F. Amount

2012 By Salary A/c
Aug., 31

Balancing of an account

The technique of finding out the net balance of an account, after considering the totals of both
debits and credits appearing in the accounts is known as ‗Balancing the Account‘. The balance is
put on the side of the account which is smaller and a reference is given that it has been carried
forward or carried down (c/f or c/d) to the next period. On the other hand, in the next period a
reference is given that the opening has been brought forward or brought down (b/f or b/d) from
the previous period.

Problem: Pass the journal entries and post them to ledger.

Aug. 1. Arjun commenced a business with a capital of Rs.1,00,000
Aug. 2. Bought goods for Rs. 20,000
Aug. 8. Bought goods from Sultan for Rs. 10,000
Aug. 10. Received Rs. 1,000 for rent
Aug. 16. Paid wages Rs. 200
Aug. 21 Sold goods for cash Rs. 10,000
Aug. 22. Sold goods to Nidhi Rs. 2,000
Aug. 31 Withdrew for personal use Rs. 1,000

Trial balance

Trial balance is a statement containing the various ledger balances on a particular date. In case,
the various debit balances and credit balances of the different accounts are taken down in a
statement, the statement so prepared is termed as a trial balance.

Objectives and significance of preparing trial balance

1) Trial balance provides a summary of all transactions.

 2) It helps in preparation of final accounts. i.e. trading account, profit and loss account and
balance sheet.
3) Trial balance helps in detecting errors.
4) Trial Balance can be prepared on a particular date or for a particular period to check the
accuracy of the transactions entered.

Limitations of trial balance

1) It does not guarantee that all transactions have been correctly posted in proper accounts.
2) If a trial balance has not been prepared accurately, the final accounts prepared from such
trial balance would not be reliable.
3) All the errors are not disclosed by trial balance.

Error that are not disclosed by the trial balance

1) Errors of omission- An error of omission is when a transaction is completely omitted from

the accounting records. As the debits and credits for the transaction would balance, omitting it
would still leave the totals balanced.
2) Errors of commission –Such errors include errors on account of wrong balancing of an
account, wrong posting, wrong carry forwards, wrong totalling etc. This error may or may not
affect trial balance.
3) Errors of principle- It is committed in those cases where a proper distinction between
revenue and capital items is not made.
4) Compensating errors-Compensating errors are multiple unrelated errors that would
individually lead to an imbalance, but together cancel each other out. In other words, these
errors compensate each other

Methods of preparation of trial balance

1) Total Method-The trial balance is prepared by taking into consideration the totals of each
side of various accounts without balancing them in the form of debit and credit balances
respectively.
2) Balance Method-Every ledger account is balanced and only the balance of the ledger account
is carried to the trial balance.
3) Total and balance method-In case of this method, the trial balance contains both the totals
of both sides of the respective accounts as well as their final balances.
Classification of Expenditure

1) Capital Expenditure-Capital expenditure means an expenditure which has been incurred

for the purpose of obtaining a long term advantage for the business. It includes assets acquired
for the purpose of earning income. Expenditure incurred for improving assets, increasing the
earning capacity of the business and extending an existing asset are also capital expenditure.
An expenditure may be said to be capital expenditure if it fulfills any of the following
characteristics:

 Purchase of permanent asset or fixed asset

 That asset is for use in business and not for immediate sale
 Expenditure gives benefit more than one year
 Purchase may be for the improvement of the existing asset or additions or extensions in
order to increase the earning capacity of the business.
 Expenditure which brings assets in working condition and to present location

Examples:

a) Acquisition of new assets.

b) Expenditure in connection with or incidental to the purchase or installation of an asset

d) Additions and extensions to existing assets.

e) Betterment of fixed assets or improvement of an asset

h) Cost of financing a fixed asset.

2) Revenue Expenditure

Revenue expenditure consists of expenditure incurred in one period of the accounting, the full
benefit of which is enjoyed in that period only. It includes all expenses which arise in normal
course of business. The benefit of such expenditure is for a short period.

 Expenses relating to maintain fixed assets

 Expenses occurring in normal day to day activities of business enterprises.
 To maintain productivity and earning capacity ( and not to increase) of firms.
 Income is normally earned from this revenue expenditure.
 Benefits are less than one year

Examples:

a) Purchase of raw materials for conversion into finished goods.

b) Selling and distribution expenses, establishment expenses, administrative costs, financial costs
etc.

c) Depreciation of plant, machinery and equipment.

d) Expenses incurred in order to maintain the existing fixed assets in an efficient and workable
state.

3) Deferred Revenue Expenditure

Deferred Revenue Expenses are those expenses, the benefit of which may be extended to a
number of years, say 3 to 5 years. These are to be charged to profit and loss account, over a
period of 3 to 5 years depending upon the benefit accrued.

Examples:

a) Expenditure wholly paid in advance.

b) Expenditure partly paid in advance
c) Expenditure in respect of service rendered which for any reason is considered as an asset.
For example, cost of experiments etc.
d) Amounts representing losses of exceptional nature, e.g., property confiscated in a foreign
country.

Difference between capital expenditure and revenue expenditure

Capital expenditure Revenue expenditure

Capital expenditure is incurred for acquisition Revenue expenditure is incurred for day to
of fixed assets. day operations of the business.
Capital expenditures are non recurring in Revenue expenditures are recurring in
nature. nature.
Capital expenditures give benefit over a The benefit of revenue expenditure is
number of years. received in the year in which expenditure is
incurred.
Capital expenditure is shown on the assets side Revenue expenditure is shown either in
of balance sheet. trading account or in profit and loss
Account.

Classification of Receipts

1) Capital Receipts-Capital receipts are derived from activities which are not part of the
normal trading activities of the business. E.g., capital introduction, sale proceeds of fixed
assets. These receipts affect the balance sheet

2) Revenue Receipts-Any receipt which is not a capital receipt is a revenue receipt.

Revenue receipts are the one which affect the profitability of the company. They appear
in the credit side of trading account or profit and loss A/c, e.g, sale of goods.
Revenue expenditure that becomes capital expenditure

The following are some of the circumstances under which an expenditure which is usually of a
revenue nature may be taken as an expenditure of a capital nature.

1) Repairs-When a second hand asset is purchased, the expenditure incurred for immediate
repairs of such an asset to make it fit for use are taken as capital expenditure.

2) Wages-Wages paid for erection of a new plant or wages paid to workers engaged in
construction of a fixed asset are taken as expenditure of a capital nature.

3) Legal charges- Legal charges incurred in connection with purchase of fixed assets should be
taken as capital expenditure.

4) Transport charges-Transport charges incurred for new assets are taken as capital
expenditure.

5) Interest on capital-Interest on capital paid during the construction of works, buildings or

plants are taken as capital expenditure.

Types of Losses

1) Capital loss-It is the loss which does not arise during the normal course of running the
business. E.g., machine costing Rs. 10,000 purchased for use in the business is sold for Rs.
8,000. It is the capital loss.

2) Revenue loss-Theses losses arise during the normal course of running of the business because
of fall in the value of the current assets of the business. E.g,, loss on account of bad debts, loss on
account of destruction of goods by fire etc.

Difference between capital expenditure & capitalized expenditure

The difference between capital expenditure and capitalized expenditure is, the capital
expenditure is directly identified with the cost of fixed assets while capitalized expenditures are
added to the cost of fixed assets to increase its total cost.

Revenue Recognition

Meaning of revenue-The Institute of Chartered Accountants of India (ICAI) defines revenue as

―the gross inflow of cash, receivables or other consideration, arising out of activities of an
enterprise from the sale of goods, from the rendering of services and from the use by others, of
enterprise resources yielding interest, royalties and dividends.‘
Recognition of revenue

The problem of revenue recognition is related to its timings. There are two viewpoints prevailing
on this issue. One view is based on accrual concept while the other on cost concept.

Guidelines for revenue recognition

Accountants have formulated at least four guidelines according to which revenue should be
recognized in the books of accounts.

1) The business enterprise has performed substantial portion of its duty.

2) The revenue can be objectively determined.
3) The earning process has been substantially completed.
4) The amount ultimately collectible on bills receivables or from debtors has been received,
and an estimate can be made for the bad debts.

Recognition at the point of sale

In most of the cases where the firms are engaged in manufacturing and selling goods or services,
revenue is recognized at the time of sale of products or performance of the services. This method
of recognized revenue is called the complete sale or market test.

Exceptions to sales basis

There are certain exceptions to the revenue recognition at the point of sale. These are:

1) Proportionate or percentage of completion method-In long term construction

contracts, the most widely used practice is to apply percentage of completion method, in
which a portion of total contract price is recognized as revenue of each accounting
period, on the basis of reasonable estimate of work completed
2) Instalment method-Under this method, there is always some uncertainty as to the
collection of instalments and therefore revenue are recognized only when the cash is
actually collected on instalments and not before.
3) Recognition at completion of production process-Such is the case when the firms are
engaged in the production of precious metals. Revenues may be recognized when goods
are produced.
Final Accounts

Is quite natural that the businessman is interested in knowing whether his business is
running on Profit or Loss and also the true financial position of his business. The main aim of
Bookkeeping is to inform the Proprietor, about the business progress and the financial position at
the right time and in the right way. Preparation of Final accounts is highly possible only after the
preparation of Trial Balance.

Final Accounts
Trading & Profit and Loss A/c Balance sheet
1. Trading and Profit and Loss A/c is prepared to find out Profit or Loss.
2. Balance Sheet is prepared to find out financial position a if concern.
Trading and P&L A/c and Balance sheet are prepared at the end of the year or at end of the
part. So it is called Final Account.
Revenue account of trading concern is divided into two-part i.e.
1. Trading Account and
2. Profit and Loss Account.

1.5 TRADING ACCOUNT

Trading refers buying and selling of goods. Trading A/c shows the result of buying and
selling of goods. This account is prepared to find out the difference between the Selling prices
and Cost price. If the selling price exceeds the cost price, it will bring Gross Profit. For example,
if the cost price of Rs. 50,000 worth of goods are sold for Rs. 60,000 that will bring in Gross
Profit of Rs. 10,000. If the cost price exceeds the selling price, the result will be Gross Loss. For
example, if the cost price Rs. 60,000 worth of goods are sold for Rs. 50,000 that will result in
Gross Loss of Rs. 10,000. Thus the Gross Profit or Gross Loss is indicated in Trading Account.

Items appearing in the Debit side of Trading Account.

1. Opening Stock: Stock on hand at the commencement of the year or period is termed as the
Opening Stock.
2. Purchases: It indicates total purchases both cash and credit made during the year.
3. Purchases Returns or Returns out words: Purchases Returns must be subtracted from the
total purchases to get the net purchases. Net purchases will be shown in the trading account.
4. Direct Expenses on Purchases: Some of the Direct Expenses are.
i. Wages: It is also known as Productive wages or Manufacturing wages.
ii. Carriage or Carriage Inwards:
iii. Octroi Duty: Duty paid on goods for bringing them within municipal limits.
iv. Customs duty, dock dues, Clearing charges, Import duty etc.
v. Fuel, Power, Lighting charges related to production.
vi. Oil, Grease and Waste.
vii. Packing charges: Such expenses are incurred with a view to put the goods in the
Saleable Condition.

Items appearing on the credit side of Trading Account

1. Sales: Total Sales (Including both cash and credit) made during the year.
2. Sales Returns or Return Inwards: Sales Returns must be subtracted from the Total Sales to
get Net sales. Net Sales will be shown.
3. Closing stock: Generally, Closing stock does not appear in the Trial Balance. It appears
outside the Trial balance. It represents the value of goods at the end of the trading period.

BALANCING OF TRADING ACCOUNT

The difference between the two sides of the Trading Account indicates either Gross Profit
or Gross Loss. If the total on the credit side is more, the difference represents Gross Profit. On
the other hand, if the total of the debit side is high, the difference represents Gross Loss. The
Gross Profit or Gross Loss is transferred to Profit and Loss A/c.

Closing Entries of Trading A/c

Trading A/c is a ledger account. Hence, no direct entries should be made in the trading
account. Several items such as Purchases, Sales are first recorded in the journal and the posted to
the ledger. The Same accounts are closed by the transferring them to the trading account. Hence
it is called as closing entries.

Advantages of Trading Account

1. The result of Purchases and Sales can be clearly ascertained
2. Gross Profit ratio to Sales could also be easily ascertained. It helps to determine Price.
3. Gross Profit ratio to direct Expenses could also be easily ascertained. And so, unnecessary
expenses could be eliminated.
4. Comparison of trading account details with previous years details help to draw better
administrative policies.

1.6 PROFIT AND LOSS ACCOUNT

Trading account reveals Gross Profit or Gross Loss. Gross Profit is transferred to credit
side of Profit and Loss A/c. Gross Loss is transferred to debit side of the Profit Loss Account.
Thus Profit and Loss A/c is commenced. This Profit & Loss A/c reveals Net Profit or Net loss at
a given time of accounting year.
Items appearing on Debit side of the Profit & Loss A/c

The Expenses incurred in a business is divided in two parts. i.e. one is Direct expenses are
Recorded in trading A/c., and another one is Indirect expenses, which are recorded on the debit
side of Profit & Loss A/c. Indirect Expenses are grouped under four heads:

1. Selling Expenses: All expenses relating to sales such as Carriage outwards, travelling
Expenses, Advertising etc.,
2. Office Expenses: Expenses incurred on running an office such as Office Salaries, Rent, Tax,
Postage, Stationery etc.,

3. Maintenance Expenses: Maintenance expenses of assets. It includes Repairs and Renewals,

Depreciation etc.

4. Financial Expenses: Interest Paid on loan, Discount allowed etc., are few examples for
Financial Expenses.

Item appearing on Credit side of Profit and Loss A/c.

Gross Profit is appeared on the credit side of P & L. A/c. Also other gains and incomes of
the business are shown on the credit side. Typical of such gains are items such as Interest
received, Rent received, Discounts earned, Commission earned

The combined item of wages and salaries appears in the trial balance it will be debited to
trading account.

The combined item of salaries and wages would be debited to profit and loss account .

BALANCE SHEET
Trading A/c and Profit & Loss A/c reveals G.P. or G.L and N.P or N.L respectively,
Besides the Proprietor wants
i. To know the total Assets invested in business
ii. To know the Position of owner‘s equity
iii. To know the liabilities of business.

Definition
The Word ‗Balance Sheet‘ is defined as ―a Statement which sets out the Assets and
Liabilities of a business firm and which serves to ascertain the financial position of the same on
any particular date.‖On the left hand side of this statement, the liabilities and capital are shown.
On the right hand side, all the assets are shown. Therefore the two sides of the Balance sheet
must always be equal. Capital arrives Assets exceeds the liabilities.

OBJECTIVES OF BALANCE SHEET:

1. It shows accurate financial position of a firm.

2. It is a gist of various transactions at a given period.
3. It clearly indicates, whether the firm has sufficient assents to repay its liabilities.
4. The accuracy of final accounts is verified by this statement
5. It shows the profit or Loss arrived through Profit & Loss A/c.

ASSETS:

Assets represent everything which a business owns and has money value. Assets are always
shown as debit balance in the ledger. Assets are classified as follows.
1. Tangible Assets:
Assets which can be seen and felt by touch are called Tangible Assets. Tangible Assets are
classified into two:
a. Fixed Assets: Assets which are durable in nature and used in business over and again
are known as Fixed Assets.
e.g. land and Building, Machinery, Trucks, etc.
b. Floating Assets or Current Assets: Current Assets are i. Meant to be converted into
cash, ii. Meant for resale, iii. Likely to undergo change e.g. Cash, Balance, stock,
Sundry Debtors.
2. Intangible Assets: Assets which cannot be seen and has no fixed shape. E.g., goodwill,
Patent.
3. Fictitious assets: Assets which have no real value and will appear on the Assets side of B/S.are
known as Fictitious assets:
E.g. Preliminary expenses, Discount or creditors.

LIABILITIES:
All that the business owes to others are called Liabilities. It also includes Proprietor‘s
Capital. They are known as credit balances in ledger.
Classification of Liabilities:
1. Long Term Liabilities: Liabilities will be redeemed after a long period of time 10 to 15 years
E.g. Capital, Long Term Loans.
2. Current Liabilities: Liabilities, which are redeemed within a year, are called Current
Liabilities or short-term liabilities E.g. Trade creditors, B/P, Bank Loan.
3. Contingent Liabilities: Liabilities, which have the following features, are called contingent
liabilities. They are:
a. Not actual liability at present
b. Might become a liability in future on condition that the contemplated event occurs.
E.g. Liability in respect of pending suit.

Difference between Trial Balance and balance sheet

The trial balance is an internal document—it stays in the accounting department. It is a listing of
all of the accounts in the general ledger (balance sheet accounts and income statement accounts)
and their respective balances as of a specified point in time, such as June 30, 2006. The purpose
of the trial balance is to document that the total amount of account balances with debit balances
is equal to the total of amount of account balances with credit balances.

The balance sheet is a financial statement that reports the dollar amounts of assets, liabilities,
and stockholders‘ equity at a specified point, such as June 30, 2006. Since it is a financial
statement, it will be distributed outside of the accounting department. As a result, it should be
prepared in accordance with generally accepted accounting principles.

Common Adjustments

ADJUSTMENTS
1. Outstanding Expense/ Yet to be Paid/ Expense Due:
Add the amount with respective item and it will appear on the Liability side of the Balance
Sheet. (Add & Liability)
2. Prepaid Expense/ Paid in advance/ Unexpired Expenditure:
Deduct the prepaid amount with the respective amount and it will appear on the Asset side of the
Balance Sheet. (Deduct & Assets)
3. Accrued Income/ Yet to be received:
Add the amount with the respective amount and it will appear on the Assets side of the Balance
Sheet. (Add & Assets)
4. Income received in advance:
Deduct the amount with the respective amount and it will appear on the Liability side of the
Balance Sheet. (Add & Liability)
5. Depreciation:
Calculate the depreciation amount and it will appear on the Profit & loss A/c Debit side and it
will be deducted from the concerned assets.
6. Interest on capital:
Calculate the interest on capital and write it on the Profit & Loss A/c Debit side. Again this
amount should be added with capital in Liability side.
7. Interest on Drawings:
Calculate the interest on drawings and write it on the Profit & Loss A/c Credit side. Again this
amount should be deducted from capital along with drawings.
8. Interest on Loan/ Overdraft:
Calculate the amount and write it in the Profit & Loss A/c Debit side. Again this amount will be
added with loan/overdraft in the Liability side of the Balance Sheet.
9. Interest on Investment/ Fixed Deposit:
Calculate the accrued interest and write it on the Profit & Loss A/c Credit side. Again this will
be added with investment/fixed deposit in the Assets side of the Balance Sheet.
10. Bad Debt:
(A) If the Bad debt appears only in the trial balance, then it will appear on the Profit & Loss
A/c Debit side.
(B) If the Bad debt appears only in the adjustment, then it will appear on the Profit & Loss A/c
Debit side and again it will be deducted from Sundry debtors in Assets side.
(C) If the Bad debt appears in two places such as trial balance as well as Adjustment, then both
amount should be added and written on the Profit & Loss A/c Debit side and Adjustment Bad
debt amount will be deducted from Sundry debtors in the Assets side.
11. Doubtful Debt/ Bad Debt Provision/ Bad Debt Reserve/ Bad and Doubtful Debt:
(A) It the Doubtful debt appears only in the trial balance, then it will appear on the Profit &
Loss A/c Credit side. (Old Provision)
(B) If the Doubtful debt appears only in the Adjustment, then it will appear on the Profit &
Loss A/c Debit side and again it will be deducted from the Sundry debtors. (New Provision)
(C) If the doubtful debt appears in both the trial balance as well as in the Adjustment, then the
trial amount is considered as Old Provision and the Adjustment as New Provision.
If the New provision is greater than that of (New – Old), write it on the Profit & Loss A/c
Debit side and New provision is deducted from debtors on the Balance Sheet Assets side.
If the Old provision is greater than that of (Old – New), write it on the Profit & Loss A/c
Credit side and New provision is deducted from debtors on the Balance Sheet Assets side.
12. Discount on Debtors:
(A) It the Discount on Debtors appears only in the Trial balance, then it will appear on the
Profit & Loss A/c Credit side. (Old Provision)
(B) If the Discount on Debtors appears only in the Adjustment, then it will appear on the Profit
& Loss A/c Debit side and again it will be deducted from the Sundry debtors. (New Provision)
(C) If the Discount on Debtors appears in both the trial balance as well as in the Adjustment,
then the trial balance amount is considered as Old Provision and the Adjustment as New
Provision.
If the New provision is greater than that of (New – Old), write it on the Profit & Loss A/c
Debit side and New provision is deducted from debtors on the Balance Sheet Assets side.
If the Old provision is greater than that of (Old – New), write it on the Profit & Loss A/c
Credit side and New provision is deducted from debtors on the Balance Sheet Assets side.

13. Discount on Creditors:

(A) If the Discount on Creditor appears only in the Question, then it will appear in the Profit
& Loss A/c Credit side.
(B) If the Discount on Creditor appears only in the Adjustment, then it will appear in the
Profit & Loss A/c Credit side and it will be deducted from the Creditors in the Balance Sheet
Liabilities side.
14. Goods withdrawn for Personal use : Owner takes away some goods from the business for
his personal use , he records withdrawals at cost price.
Goods so taken are deducted from purchases on the debit side of the trading A/c and deducted
from the capital on the liabilities side.
15 Goods distributed as free Samples – Journal Entry is
Advertisement A/c Dr.
To purchases A/c
Advertisement as an expense will be shown on the debit side of the and Goods so taken are
deducted from purchases on the debit side of the trading A/c
16. Abnormal Losses- Sometimes stock –in trade is lost due to fire or theft . If the firm inures
the stock in trade , then the loss can be good made good fully or partly by Insurance company
A. When the claim on the loss on account of loss is fully recoverable from the insurance
Company
Trading Account is credited with the gross amount of stock lost by fire or theft
Insurance claim is an asset will be shown on the assets side of the balance sheet.
When the claim on the loss on account of loss is partly recoverable from the insurance
Company
Trading Account is credited with the gross amount of stock lost by fire or theft
Profit and loss account is debited with the amount not recovered.
Insurance claim is an asset will be shown on the assets side of the balance sheet
When the claim on the loss on account of loss is not recoverable from the insurance
Company
Trading Account is credited with the gross amount of stock lost by fire or theft
Profit and loss account is debited with the amount on account of loss on fire
17. Manager‘s Commission – It is a common practice to pay managers commission on net profit
. There is no difficulty in its computation if the commission is payable as a percentage of net
profit before charging such commission.
Manager‘s commission – Rate*Profit before commission/100
If the commission is payable at a fixed percentage after charging such commission ,
Manager‘s Commission – Rate*Profit before commission/(100+Rate )
Manager commission will be appeared in the Profit & Loss Account – Debit side and Liabilities
side of the Balance Sheet.