Processing Transactions

Accounts Classification
• An account is a formal record of a particular type of
transaction expressed in money- Kohler’s Dictionary of
Accountants
• An account is prepared for each type of asset, liability,
owner(s) equity, revenue and expense.
• Natural Person’s a/c-proprietor’s account, supplier’s
account, receiver’s account etc
• Artificial person’s ac/c- any limited company’s account,
bank account, insurance company’s account, any firm’s
account, any club’s account, etc.
• Representative a/c- Salary outstanding, rent prepaid,
interest outstanding, interest received in advance.
• Tangible a/c- land, building, furniture, cash etc.
• Intangible a/c- goodwill, trade marks, patent rights etc.
• Nominal a/c- - salary is paid to the employees, rent is
paid to the landlord, wages paid
Systems of accounting
Double Entry System
• The single entry system appears to be time-saving and economical but it is unscientific as under
this system some transactions are not recorded at all whereas some other transactions are
recorded only partially.
• Business organisations if follow this system, prepare only cash book and personal accounts of debtors/
creditors. Therefore complete record maintenance is not possible and trial balance cannot be prepared. It is
based on scientific principles and is, therefore, used by most of the business houses. The system
recognises the fact that every transaction has two aspects and records both aspects of each and
every transaction. Under this system, in every transaction an account is debited and some other
account is credited.
• Double entry system means a double effect of a transaction on the business. It means that every debit have a
corresponding credit, with an equal amount. This further means that two accounting entries need to be passed
in the books of accounts, to record each financial transaction. In simple terms it means that every transaction
have equal and opposite effects in two separate accounts.
 Rules of Debit/ Credit
• The left hand side of an account is called the debit side; while the right hand side is called the credit side.
An entry on the left side of an account is called a debit entry, or merely a debit, an entry on the right side is
called a credit entry or credit. The act of recording an entry on the left side of an account is called debiting
the account; and recording an entry on the right side of an account is called crediting the account. The
difference between the total debits and total credits is the account balance. Double entry system means the
recording of both the aspects i.e. debit and credit.
• The accounts are divided into five heads: Asset, Liability, Capital, Expenses/Losses and Income/Gains.
 IMPORTANT NOTE: ANALYSING TRANSACTIONS FOR RECORDING
If the three fundamental rules described above are kept in mind, it would be possible to record all the
transactions correctly. Follow these simple steps to record all the transactions:
– Identify the two accounts involved in the transaction.
– Find out the type of account for both the accounts involved in the transaction.
– Apply the rules of debit and credit.
For example, payment of salary is a transaction. It involves Salary Account and the Cash Account. Salary
Account is a nominal account whereas the Cash Account is a real account. Salary is an Expense. Rule of
Nominal Accounts says “Debit all expenses and losses”. So, Salary Account will be debited. Whereas rule
of real accounts says credit what goes out. Here cash is going out. So, Cash Account will be credited
 Illustration 1:
From the following transactions, identify the nature of accounts involved and state which account will be debited and which account will
be credited?

    ACCOUNTS TYPE OF DEBIT/ CREDIT

S. No. TRANSACTION INVOLVED ACCOUNT
  Mr. Anil started business with Rs. Cash Account Real Personal Debit (Incomings) Credit
1. 60,000. Capital Account (Giver)
  Purchased goods for cash Rs. Purchases A/c Real Real Debit (Incomings) Credit
2. Rs. 25,000. Cash Account (Outgoings)
  Sold goods for cash Rs. 20,000. Cash Account Real Real Debit (Incomings) Credit
3. Sales A/c (Outgoings)
  Purchased goods from Mr. Bansal for cash Purchases A/c Real Real Debit (Incomings) Credit
Rs.10,000. Cash Account (Outgoings)
4.
  Sold goods to Mr. Charles Rs. 8,000 on credit. Charles Sales Personal Real Debit (Receiver) Credit
5. A/c (Outgoings)
6. Purchased furniture for Rs.Rs. 6,000 Furniture A/c Real Real Debit (Incomings) Credit
Cash Account (Outgoings)
  Paid rent Rs. 1,500 Rent Account Nominal Real Debit (Expenses) Credit
7. Cash Account (Outgoings)
    Wages A/c Cash Nominal Real Debit (Expenses) Credit
8. Paid wages Account (Outgoings)
 
MAINTAINING ACCOUNTS UNDER DOUBLE ENTRY
SYSTEM

• It is clear that the every transaction carried out by the business, have a dual effect on the business, debit and
credit, with the same amount. This debit and credit of the account are presented in the form of a “T Account”.
T Account is an individual account depicting the increase or decrease in that particular account only. It is
prepared horizontally. With Debit on the left side, whereas Credit on the right side. The difference between
the two sides is known as the Account Balance.
 Accounting Equation
All business transactions are recorded as having a dual aspect. At any point of time, a firm will possess things
which may either be sold or converted into cash or which may be later used for a fairly long time. All these
things are called assets. The proprietor of the business brings capital into the business out of which the
business (a separate entity) purchases assets for its use. Thus, the amount of the assets of a business is
equal to the amount of capital contributed by the proprietor of the business. Thus, Capital = Assets.

In case the capital contributed by the proprietor is insufficient, the business takes borrowing from other
parties or outsiders. These parties may give loan or allow credit facilities at the time of purchase of goods.
The money which is owed to outsiders and which has to be paid, sooner or latter are called liabilities. For
example: Loans, Bank Overdraft, Creditors, Bills Payable, and Outstanding Expenses etc. On the one hand,
the loan given by the outside parties increases the assets of the business, on the other hand, claims of
creditors and lender of money on the assets of the business increase.

Hence, the sum of uses of funds = sources of funds

Therefore, Capital + Liabilities = Assets; or
Capital = Assets — Liabilities.
This equation is known as accounting equation. This equation is based on the concept that for
every debit, there is an equivalent credit. The entire system of double entry book-keeping is
based on this concept.
Example: Suppose A starts a business with a capital of Rs. 50,000, immediately the firm will have Rs.
50,000 as cash as asset and at the same time the firm will owe to the owner Rs. 50,000 which is taken as
the proprietor’s capital. Thus,
Capital (Rs. 50,000) = Assets Rs. 50,000 (Cash).
If the firm purchases furniture worth Rs. 10,000 out of the money provided by A, the situation will be:
Capital (Rs. 50,000) = Cash (Rs. 40,000) + Furniture (Rs. 10,000).
Subsequently, if the business borrows Rs. 15,000 from a bank, the position will be as follows:
Capital (Rs. 50,000) + Bank loan (Rs. 15,000) = Cash (Rs. 55,000) + Furniture (Rs. 10,000).
Accounting Cycle
• 1) Analysing the source documents: the first step is to analyse the documents with respect to each transaction.
Before recording the transactions, it is the responsibility of the person recording the transactions, to check for the
evidence/proof for that transaction, either in the form of invoice or bank statement. Thereby, fulfilling the objective
evidence concept.
• 2) Recording in Journal: the next step is the preparation of journal. Also known as book of original entry,
maintains a chronological record of all the monetary transactions, which took place in an accounting year.
• 3) Posting from Journal to Ledger: after preparing the journal, a ledger account is maintained where the
information about all the accounts is kept. A ledger account shows the two sided effect of each transaction. For
example: all the information regarding the increase and decrease in cash is recorded under the ledger to update the
cash accounts.
• 4) Preparation of Trial Balance: a trial balance shows a list of all the accounts with their respective balances. All
the ledger accounts are listed in the trial balance with their amounts, and are totalled up so that the sum total of debit
equals the sum total of credit. Such information helps in the preparation of the final accounts.
• 5) Preparation of Financial Statements: after the preparation of the trial balance, and cross checking that the debit
and credit totals are equal, the final step includes the preparation of the final accounts, which helps in predicting the
financial position, solvency and effective working of any enterprise.
Journal
• Journal is the book of primary entry in which every transaction is recorded before being posted into
the ledger. It is that book of account in which transactions are recorded in a chronological (day to
day) order. In modern times, besides the main journal, specialized journals are maintained to record
different type of transactions. The process of recording transaction in a journal is termed as
journalizing. A journal is generally kept on a columnar basis. Journalizing is the root of accounting.
 
SPECIMEN OF JOURNAL
In the Books of …………..
Journal Entries
Date Particulars L.F. Debit Amount Credit Amount
(Rs) (Rs)

(i) (ii) (iii) (iv) (v)

• The following procedure is followed for passing journal entries-
– Analyze each transaction in terms of accounts affected. As a rule every transaction has at least two accounts.
– Find out the type of accounts affected in a transaction i.e. personal, real or nominal.
– Apply the rules of debit and credit to each type of accounts involved.
– The debit and credit accounts must be equal. Sometimes, a journal entry may have more than one debit or
more than one credit. This type of journal entry is called compound journal entry. Regardless of the number of
debits or credits in a compound journal entry, the aggregate amount of debits should be equal to the aggregate
amount of credits.
– For a business, journal entries generally extend to several pages, hence, totals of debit and credit amount
columns are cast at the end of each page. Against the debit and credit total at the end of a page, the words,
‘Total c/f’ (c/f - indicates carried forward) are written in the particulars column. The debit and credit totals are
then written in the beginning of the next page in the amount columns and against them the words ‘Total b/f’ (b/f -
indicates brought forward) are written in the particulars column. On the last page ‘Grand Total’ is casted.
 Ledger
• Ledger is the principal book of accounts where similar transactions relating to a particular person or
property or revenue or expense are recorded. In other words, it is a set of accounts. It contains all
accounts of the business enterprise whether real, nominal or personal. The main function of a
ledger is to classify or sort out all the items appearing in the journal or other subsidiary books under
their appropriate accounts so that at the end of the accounting period each account will contain the
entire information of all the transactions relating to it in a summarized or condensed form.
• The term ‘Posting’ means transferring the debit and credit items from the journal to their respective accounts

Rules of Posting
•The names of accounts used in the journal carried to the ledger should be exactly the same.
•Separate accounts should be opened in the ledger for posting transactions relating to different accounts recorded in the
journal.
•The concerned account which has been debited in the journal should also be debited in the ledger and the account which
has been credited in the journal, should also be credited in the ledger i.e., but a reference should be given of the other
account.
•It is customary to use the words ‘To’ and ‘By’ while making posting in the ledger. The words ‘To’ is used with the accounts
shown on the debit side of the ledger account while the word ‘By’ is used with accounts which appear on the credit side of
the ledger account.
•In the folio column, the page number of the journal from where the entry is transferred to ledger account is written.
•The date of the transaction is written on the date column.
• ADVANTAGES OF DOUBLE ENTRY SYSTEM:
• Scientific in nature: the double entry system, records the transactions, keeping in mind the own set of framed
rules and principles, hence it can be said that double entry system is scientific in nature.
• Systematic: it can be termed to be systematic, as the transactions are recorded in a chronological order, i.e. as
and when they occur.
• Accurate: the accounts prepared on the basis of double entry, are accurate as for every debit there is an equal
credit with the same amount, hence maintains a mathematical accuracy.
• Helps in ascertaining profit/ loss: with the help of profit and loss account, a true picture of the profits and loss
can be ascertained.
Illustration 2:From the following transactions of M/s Malice & Brothers, prepare a journal,
post the entries in ledger accounts.

• Excel
Compound Entries
•  A compound journal entry is one that affects three or more accounts. In other words, it’s an entry
that debits or credits at least three accounts in the general ledger.
• A compound entry is actually a combination of two or more simple journal entries but instead of recording
numerous separate journal entries, it is better to merge multiple journal entries of a single accounting event
into a single compound entry because it saves time and keeps the related debits and credits in one place in the
journal.
• On Jan 1, 20X3 Company T purchased a computer costing $1,000 from a supplier and issued a check of
$3,400. The excess amount fully settles a previous amount owed by the company to the supplier.
• Since the total payment of $3,400 comprised of $1,000 for computer and the remaining $2,400 for past
payable, this transaction may be recorded in two separate journal entries:
• Debit Equipment and Credit Cash for $1,000 each; and
• Debit Payables and Credit Cash for $2,400 each.

Date Account Debit Credit

Jan 1, 20X3 Equipment 1,000
Accounts Payable 2,400
Cash 3,400
E.g- EXCEL
2014
• June 1 Karthik commenced business with Rs.20,000.
• June 2 Paid into bank Rs.5,000.
• June 3 Purchased Plant worth Rs.10,000 from Modi & Co.
• June 4 Purchased goods worth Rs. 5,000 form Anwar.
• June 6 Goods worth Rs.4,000 sold to Anbu
• June 8 Sold goods worth Rs.2,000 for cash.
• June 10 Goods returned by Anbu Rs.50.
• June 15 Paid rent Rs.250.
• June 18 Withdrawn from bank for office use Rs. 2,500.
• June 20 Paid Salaries Rs.1,800.
• June 25 Withdrawn for personal use Rs.250.
• June 26 Goods returned to Anwar Rs.100.
• June 27 Paid for office furniture Rs.1,500 by cheque.
• June 28 Received Rs.3,900 cash from Anbu and discount allowed Rs.50.
• June 29 Paid Anwar on account Rs.4,800 and discount allowed by him Rs.100.
Trial Balance
• A trial balance is a report that lists the balances of all general ledger accounts of a company at a certain point in
time.  It is primarily used to identify the balance of debits and credits entries from the transactions recorded in the
general ledger at a certain point in time.
• A trial balance includes a list of all general ledger account totals. Each account should include an account number,
description of the account, and its final debit/credit balance.

Advantages of Trial Balance

•Arithmetical accuracy
Given the nature of double entry system, every transaction will result in two entries of equal and opposite nature. Hence
at any point in time all debit ledger totals will match to credit ledger totals. Since Trial Balance lists all the accounts as
on a particular date, the debit total of a trial balance must match to the credit total. Therefore a Trial Balance is an
indicator of the Arithmetical accuracy of the books of accounts.
Bird’s-eye view
A trial balance is a summary sheet listing all ledges and balances. Hence it provides a bird eye view of the accounting
transactions of an organization.
•Prerequisite for preparation of Financial statements
An organization needs to know profit or loss and financial position at year end. And thus to prepare financial statements,
Trial Balance is prerequisite. All stakeholders also need this information. It is the first step towards closure of accounts
for a particular period.
Preparation of Final Accounts
• interested in knowing the overall financial position of the concern
• Final accounts, also known as financial statements are a set of systematically presented and chronologically recorded accounts,
which reveals the financial position of the concern at the end of accounting year.
• can be classified into two heads: Manufacturing Concern and Non Manufacturing Concern.
• Manufacturing Concern: are concerned with the purpose of manufacturing the goods and then selling them to the customers.
They do not borrow the items from outside for reselling them in the market, instead produce them on their own.
• Non-Manufacturing Concern: are involved in the process of selling only. They are not engaged in the process of manufacture,
but simply purchase the goods from outside, and sell them to the customers, without changing the original form of the goods.
They are not attached to the manufacturing business.
• Final accounts of manufacturing business entities include the preparation of manufacturing accounts, trading accounts, profit &
loss account and balance sheet. Whereas, final accounts of non- manufacturing concern includes the preparation of trading
accounts, profit & loss accounts and balance sheet.
• The only difference between the two concerns is the additional preparation of Manufacturing Account in case of Manufacturing
Business Entities. Manufacturing account is prepared to know the costs involved in the process of manufacturing the finished
goods. And the balance of the manufacturing account can be transferred to the trading account. The preparation of rest of the
accounts (i.e. the Trading Account, Profit and Loss account, and Balance Sheet) remains the same, both for the manufacturing as
well as the non manufacturing concerns.
 BALANCE SHEET PREPARATION

• The Balance Sheet, also known as the position statement, is a statement which highlights the financial position of the enterprise. It
depicts the position of the assets and liabilities of the firm, by recording them. It is in accordance with the accounting equation.
• Assets = Liability + Capital
The three important sections of any balance sheet are:
• Assets – This is a resource owned by an entity to produce positive economic value.
• Liabilities – This provides a list of debts an entity owes to others.
• Capital or Equity- This is the amount invested by the shareholders
• Purpose:
• 1. The financial position is revealed at the end of an Accounting Year- a tool to measure the growth of an entity. This can be done by
comparing the balance sheet of different years. enables decision making regarding expansion projects and meet unforeseen expenses
• 2. It is an essential document that must be submitted to the bank or investors to obtain a business loan.
• 3. The assets and liabilities are presented in an elaborate manner- helps stakeholders to understand the business performance and
liquidity position of the entity.
• 4. The solvency position of the concern can be judged easily- tool used by outsiders such as investors, creditors, and other
stakeholders to understand the financial health of an entity
• 5. The opening entries of the next financial year depend on the figures from the previous year balance sheet.
Format of Balance Sheet
• The new format of the balance sheet is also called “vertical format
balance sheet” and it lists the equities and liabilities on the top
followed by the assets at the bottom.- EXCEL
 Manufacturing and Trading Account Preparation

• In case of manufacturing concerns financial statements are titled ‘Manufacturing, Trading, and
Profit and Loss Account’ and ‘Balance Sheet.’
• Manufacturing concerns prepares manufacturing account before trading account, manufacturing
account shows cost of production which is transferred to trading account to ascertain gross profit
or loss. This is necessary because they have to ascertain cost of goods manufactured, gross profit
and net profit.
• PURPOSE OF MANUFACTURING ACCOUNT
• The main purpose of manufacturing account is to show:
• i. Cost of goods manufactured; and
• ii. Major items of costs such as raw material consumed, productive wages, direct and indirect
expenses of production.
Trading Account Preparation
• In case of trading concerns financial statements are prepared under the headings ‘Trading and
profit and loss account’ and ‘Balance sheet
 Elements of cost
Prime cost Overheads

Direct Direct Direct

Material labor expenses
Indirect Indirect Indirect
Material Labour Expense

Factory Office & Selling & distribution

Overheads administration overheads o
overheads
• Raw Material − Raw material is used to produce products and there may be opening
stock, purchases, and closing stock of Raw material. Raw material is the main and
basic material to produce items.
• Work-in-Progress − Work-in-progress means the products, which are still partially
finished, but they are important parts of the opening and closing stock. To know the
correct value of the cost of production, it is necessary to calculate the correct cost of it.
• Finished Product − Finished product is the final product, which is manufactured by the
concerned business and transferred to trading account for sale.
• Raw Material Consumed (RMC) − It is calculated as.
• RMC = Opening Stock of Raw Material + Purchases - Closing Stock
• Cost of Production − Cost of production is the balancing figure of Manufacturing
account.

• COP = Direct Materials Used + Direct Labor Used + Manufacturing Overhead

+ Beginning Work in Process (WIP) Inventory – Ending Work in Process (WIP)
Inventory
• DMU=Opening Stock of RM+ Purchases of RM- Closing Stock of RM
• Opening Stock − Unsold closing stock of the last financial year is appeared in debit
side of the Trading Account as “To Opening Stock“ of the current financial year.
• Purchases − Total purchases (net of purchase return) including cash purchase and
credit purchase of traded goods during the current financial year appeared as “To
Purchases” in the debit side of Trading Account.
• Direct Expenses − Expenses incurred to bring traded goods at business
premises/warehouse called direct expenses. Freight charges, cartage or carriage
charges, custom and import duty in case of import, gas, electricity fuel, water, packing
material, wages, and any other expenses incurred in this regards comes under the
debit side of Trading Account and appeared as “To Particular Name of the Expenses”.
• Sales Account − Total Sale of the traded goods including cash and credit sales will
appear at outer column of the credit side of Trading Account as “By Sales.” Sales
should be on net releasable value excluding Central Sales Tax, Vat, Custom, and
Excise Duty.
• Closing Stock − Total Value of unsold stock of the current financial year is called as
closing stock and will appear at the credit side of Trading Account.
• COGS= Opening stock+ Net Purchases- Closing Stock
• Gross Profit − Gross profit is the difference of revenue and the cost of
providing services or making products. However, it is
calculated before deducting payroll, taxation, overhead, and other
interest payments. Gross Margin is used in the US English and carries
same meaning as the Gross Profit.
• Gross Profit = Sales - Cost of Goods Sold
• Operating Profit − Operating profit is the difference of revenue and the
costs generated by ordinary operations. However, it is
calculated before deducting taxes, interest payments, investment
gains/losses, and many other non-recurring items.
• EBIT or Operating Profit = Gross Profit - Total Operating Expenses
• Net Profit − Net profit is the difference of total revenue and the total
expenses of the company. It is also known as net income or net
earnings.
• Net Profit = Operating Profit - (Taxes + Interest)
• Gross Profit = Net Sales – Cost of goods Sold Net Sales = Sales – Sales return

• Cost of goods sold = Sales – Gross profit Or

• Cost of Sales = Opening Stock + Net purchases + Direct Expenses – Closing Stock

• Net purchases = Purchases – Purchases Return

• Gross Loss = Cost of goods sold – Net Sales
 Profit and Loss Statement Preparation
• The purpose and the importance of preparing profit and loss account is as under:

1. Knowledge of net profit or net loss: The purpose of preparing profit and loss account is to ascertain the amount of net profit
or loss. This is the actual profit available to the proprietor and credited to his capital account.
2. Ascertain ratio between net profit and sales: After getting net profit from profit and loss account. It is matched with the net
sale to calculate net profit ratio. This ratio is compared with the desired net profit ratio and if there is any short coming, that
will be removed. This ratio can also be compared with the ratio of previous years and effective future line of action can be
taken.
3. Calculation of expenses ratio to sale: This ratio can be calculated by compare it with desired expenses ratio and with the ratio
of previous years. It will always be in the interest of the firm that the expenses ratio should be the minimum.
4. Comparison: The actual performance of the business is available with the profit and loss account as regards net profit,
individual expenses and individual income. Helps in comparison of actual performance with our planned performance, identify
weakness and try to remove them.
5. Maintaining provision and reserves: Certain reserves and provisions are to be maintained to meet the future uncertainties.
The amount of provisions, reserves and funds to be maintained depends upon net profit earned by the firm. It is necessary to
prepare profit and loss account to determine the net profit, so that effective provision for uncertain future could be maintained.
6. Determining future line of action: The organization can adopt future line of action on the basis of the information available
from profit and loss account regarding net profit and other expenses.
• Manufacturing concern- EXCEL
• Trading Concern- EXCEL
ADJUSTMENTS ENTRIES
• The preparation of the accounts is not error free, but certainly includes some sort of error either due to human
mistakes or due to some technical fault in recording. The error may be in the form of either partially omitting any
entry or error in updating certain revenue and expense accounts
• As the name suggest, adjustment entries (also known as correcting entries) means entries passed in order to adjust
some unadjusted accounts. These are the journal entries passed/ prepared at the end of accounting year, in order to
meet up the matching principle of accounting. The matching principle of accounting states that there should be a
match between the expenses and the revenues in one accounting year. In simple terms it means that the expenses
incurred need to be matched up to the same accounting period in which the revenue was earned by paying those
expenses.

• 1) These entries are passed so as to depict the correct net profit and net loss in the profit and loss account.
• 2) To depict the true financial position of the business.
• 3) To match up the expenses paid with the revenue earned by paying such expenses in the same accounting period.
• 4) To find out the actual amount payable to the outsider as well as the correct expenses incurred.

• E.g- EXCEL