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Ch. 1 Accounting Concepts and Conventions Ch.2 Basic accounting terminologies, Classification of accounts Journal, Subsidiary books, Ledger.

Ch.3 Secondary books-Ledger, Trial balance, Final accounts of Sole traders Book-keeping The term book keeping refers to maintaining of books of accounts. A transaction means an act of exchange of things or services between the two parties. Book keeping is concerned only with monetary transactions. Books of accounts is a book which is maintained to record day to day business transactions. Definitions: According to J. R. Batliboy Book keeping is the art of recording business dealings in a set of books. Book keeping is a systematic method of recording the financial transactions in the books of accounts. Objectives: 1. Book keeping is a permanent record and provides the necessary and reliable information. 2. In enables a trader to ascertain what he owes to others and what others owe to him, the value of various classes of property and the profit earned and the loss sustained in business. 3. Book keeping is essential to meet the requirements of the certain laws like the Bankruptcy Act, Income Tax Act, Sales tax etc. 4. To know the profits or loss suffered by the business. 5. To know the cash in hand and cash at bank at any time. Accountancy: Definition: The American Institute of Certified Public Accounts has defined accounting as the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character and interpreting the results thereof. Distinction between Book keeping and Accountancy: Book Keeping Accountancy Concerned with only recording of Concerned with the preparations of business transactions in the the financial statements from the

subsidiary books Includes journalizing, posting, totaling and balancing of various accounts Repetitive type of work

book keeping records. Includes making of adjustments, rectification of errors, preparation of trading and profit and loss account and balance sheet, etc. Needs sufficient knowledge of accounting principles and imaginations.

Basic Accounting Terminologies:


1. Transactions: An act of exchange the things or services between two parties

is called transaction. The transactions are classified as Monetary and Nonmonetary. The transactions in which money (Cash/Cheque ) is used as a medium of exchange of goods and services are called monetary transactions. Only monetary transactions are recorded in the books of accounts. The transactions which are not using money as a medium of exchange are called non monetary transactions. Eg. Barter system. The transaction relating to business are called Business transactions which are divided as cash and credit transactions. 2. Cash Transactions: Cash transactions are those transactions in which payment or receipt of cash/cheque is involved at the time of effecting transactions. 3. Credit Transaction: In case of credit transaction cash/cheque is not paid at the time of effecting the transaction but for payment some time is allowed. If in a transaction, the name of person/trader is given and no mention is made, whether it is a cash or credit transaction, it is to be treated as credit transaction. 4. Debit: The receiving aspect is known as Debit. It is abbreviated as Dr. Debit is derived from the Latin word Debitur which means Debtor. The left hand side of an account is called as debit side. The amount recorded on the left hand side is called debit (Dr). Debit balance means the total of Debit side is greater than the total of Credit side of an account. 5. Credit: The giving aspect is known as Credit. It is abbreviated as Cr. Credit is derived from the Latin word Credere which means Creditor. The right hand side of an account is called as credit side. The amount recorded on the right hand side is called credits (Cr). Credit balance means the total of Credit side is greater than the total of Debit side of an account. 6. Goods: The term goods mean the things, articles, products, merchandise, etc in which a trader trades. The term purchases , sales, purchase return and sales return are related to goods. 7. Stock: The balance of unsold/unused goods lying in the business is called stock or inventory. The stock at the beginning of certain period is called

opening stock and the stock at the closing of certain period is called closing stock. The last years closing stock is a next years opening stock. Stock is having debit balance. Closing stock is always valued at cost or market price whichever is less. 8. Assets: The term assets mean the total possessions of business. An asset is any right or thing that is owned by a business. It is valuable resources owned by a business which have been acquired at measurable money cost. Assets include land, buildings, equipment and anything else a business owns that can be given a value in money terms for the purpose of financial reporting. All the assets are having debit balance. The assets are classified as Fixed assets, Current assets, Investment and Other assets. Fixed Assets/ Long Term Assets: The assets which are purchased or acquired by the business to increase the productivity and not for resale such as building, plant and machinery, land etc are termed as fixed assets. A fixed asset is an asset of a business intended for continuing use. A "fixed asset" is an asset which is intended to be of a permanent nature and which is used by the business to provide the capability to conduct its trade. Fixed assets must be classified in a company's balance sheet as Tangible and Intangible,

"Tangible Fixed Assets" means the assets which have a physical existence and generate goods and services and are shown net of depreciation. It include plant & machinery, land & buildings, furniture, fixtures and fittings, motor vehicles and IT equipment. They are shown in the balance sheet in accordance with the cost concept , at the cost at what they are purchased. The cost of these assets is allocated divided over their useful life. On these assets yearly depreciation is charged i.e. reduction in the value of the assets due to its wear and tear which is shown by way of deduction from the respective cost of the asset in the balance sheet. Salvage or residual value means the amount realized by the sale of the discarded asset at the end of its useful life. "Intangible Fixed Assets" reflect the exclusive rights of the firm. Intangible fixed assets do not generate goods and services directly. Intangible assets are those fixed assets which cannot be seen or touched or felt. They are not necessarily valueless. These assets confer certain exclusive rights on their owners. Intangible assets are also written off over a period of time. The written off balance is transferred to profit and loss account debit side. It

include goodwill, patents, trademarks, copyrights and brands - although they may only be included if they have been "acquired". Goodwill is the reputation, brand, image of the company/firm. Patents confer exclusive rights to use an invention; Copyrights relate to production and sale of literary, music and artistic works; Trade mark represent exclusive rights to use certain name , symbols, labels, designs etc. Fictitious Assets: are valueless assets (useless trade marks) or expenses treated as assets like preliminary expenses. Preliminary expenses means the expenses which are incurred to establish a company/ expenses incurred at the time of formation of company. Investments: Investment represents funds in the securities of another company. The investment may be short term (less than a year) and long term marketable securities. The purpose of investment is either to earn a return/interest/profit or and to control another company. Investments are shown in the balance sheet at lower of the cost or the market price. Market value is shown in the parenthesis. Current Assets/ Short Term Assets/ Floating Assets: Current assets are short term in nature. It refers to the assets which either held in the form of cash or are expected to be realized in cash within one year. Current assets are also called as liquid assets (except stock). Current assets are those that form part of the circulating capital of a business. They are replaced frequently or converted into cash during the course of trading in a short period. The most common current assets are inventory/ stock, trade debtors, bills receivable, short term marketable securities and cash. Liquid assets are those current assets which are already in cash form or which can be readily converted into cash such as government securities etc.
9. Liabilities: The term represents the total amount payable by business to

others. It is defined as the claims of outsiders against the firm. All the liabilities are having credit balance. of the firm. The liability may short term and long term. Long term liability means borrowings in the from banks, financial institutions or through bonds/debentures/mortgages for more than a year. Current or Short term liability means short term borrowing in the form of purchase of goods or services on credit for less than one year period. It includes

creditors, bills payable, tax payable, outstanding expenses, accounts payable, accured expenses and deferred income.. 10. Contingent Liability: It is the liability which can not be treated as actual liability at present because it depends upon happening or not happening of certain events in future, whether it is a liability or not. It is shown by way of foot note to balance sheet on the liabilities simply as information. 11. Capital: What ever money or moneys worth a proprietor brings into his business from his private property is called capital in the business. Capital is a personal account. Capital is always have credit balance as owner is the giver of the capital. Assets Liabilities = Capital 12. Drawings: If a proprietor uses business cash or business assets for his personal use, it is termed as drawings of the proprietor. Drawing is amount or goods withdrawn by the proprietor from the business for his personal use. It is always having debit balance as it is personal account and owner is the receiver. 13. Debtor: A person who owes something to the business is a debtor. Debtor is a person who receives services /purchases goods on credit from the business. Debtor is a current asset. Debtor account always has a debit balance as debtor is the receiver. 14. Creditor: A person from whom the business owes something is a creditor. He/she is a person who sells goods on credit or provides services on credit. Creditor is a current liability. It is always has credit balance as creditor is the giver. 15. Expenditure: means spending of money or incurred an obligation to pay at a later date. For expenses paid in cash or a promise to pay the money in the future. Expense means an expenditure whose benefit is enjoyed and finished immediately. For eg. Payment of wages , rent , salaries, lighting etc. 16. Capital Expenditure: Expenditure incurred in acquiring fixed assets like land, building, etc. for using them in business and not for resale. The cost of fixed assets includes all expenditure necessary up to the time the asset is ready for use. The capital expenditure signifies expenditure which increases quantity of fixed assets, results in the replacement of fixed assets and increase productivity. For example : purchase of long term /fixed assets, cost of stand by and servicing equipment, legal charges and stamp duty for acquisition of a property etc. 17. Revenue Expenditure: Any expenditure incurred for maintaining fixed assets in good working condition and for meeting the day to day expenses to carry the business is treated as revenue expenditure. Revenue expenditure are expenses which benefit one accounting year. Revenue expenses are occur in

one accounting year and expensed/written off against the revenues of the same year. They are recurring nature. For example: salaries, wages, rent, lighting, postage, stationery, obsolescence cost , depreciation , interest on loan etc. 18. Deferred Revenue Expenditure: The expenditure which provides benefits more than one accounting year know as deferred revenue expenditure. For example research and development expenditure, advertisement for launching new product etc. 19. Income: means receipt of cash or equivalent without it having to be returned to any one. Eg. Sales , commission received, interest received. 20. Voucher: is the written record and evidence of a transaction. 21. Cash Discount: Discount is nothing but the concession .In any business purchases and sales of goods are required to be made on credit terms therefore to recover the amount from debtors in time cash discount is given. Cash discount is an allowance given on sales price to encourage prompt payment of cash. Cash discount appears in the books of account. 22. Trade discount: This discount is given by wholesaler to retailer. It is given on catalogue price/invoice price/price list. As this discount is allowed at the time of purchase or sale the value of good purchased or sold is recorded in the books after deducting the amount of trade discount from the invoice price. Therefore trade discount does not appear in the books of account. 23. Goodwill: Goodwill is defined as the benefit arising from reputation and named earned in the market. It is an extra value attached to an established business over and above the value of its tangible assets. It is an intangible asset. It is recorded on the asset side in the balance sheet. 24. Solvent person: A person whose assets are more than or equal to liabilities is called solvent person. 25. Insolvent person: A person whose liabilities are more than his assets are called insolvent. 26. Account: An account is a systematic and summarized record of all day to day business transactions relating to persons, items or things and income and expenses of the business. It is also called as T form of account as it is divided into two parts the left hand side is called debit and right hand side is called credit side, the two sides are divided by a vertical line in between which looks alphabet T. An account is book keeping device to record increase and decrease in each specific asset or liability item. 27. Bad Debts: The amount which is not recoverable from debtors is called bad debts. It is a loss and has debit balance. It is debited to profit and loss account as it is a loss. Accounting Concepts and Conventions:

Accounting concepts are basic assumptions or conditions on which the science of accounting is based. Accounting conventions includes those customs and traditions which guide the accountant while preparing the accounting statement. 1. Separate Entity Concept: This concept implies that a business unit is separate and distinct from the persons who are owners of business. This concept is necessary to know the effect of the each business transaction on the operation of business and not on the owners of business. According to this concept personal transactions cannot be mixed with business transactions. 2. Money Measurement Concept: If the results of operations of a business entity are to be properly accounted for, they need to be expressed and recorded in common units of measurement. For the purpose of accounting the common economic value of assets and liabilities is expressed in monetary terms rather than in any other physical dimension. Only monetary transactions are recorded in the books at the time they takes place. 3. Cost Concept: Under this concept the fixed assets are shown at cost price less depreciation and not at the realizable value. Due to this concept there remains consistency. If it is decided to record fixed assets at their present value it would become necessary to change the value practically every day and this would affect financial position and would introduce degree of instability in the accounts. In the case of current assets, the question of cost concept does not crop up as they are to be converted to cash with in a short period- their cost and present worth are nearly the same. 4. Consistency: According this convention, the policy once adopted should not generally be changed- it should be consistently, followed from one period to another. If there is inconsistency in the policies followed or the methods adopted in would render comparison of figures difficult and meaningless. 5. Conservatism: While recording business transactions the accountants follow the rule Anticipate no profit but provide for all possible losses. On this basis the stock is valued at cost or market price which ever is lower. 6. Going Concern Concept: According to this concept it is always presumed that the business is having a perpetual succession. It assumes that the business entity would continue to operate indefinitely. It has uninterrupted existence with continuing activity till such time it is legally liquidated. In the absence of this concept it would not be possible for anybody to enter into the contracts with the business organization. 7. Realization Concept: The concept answers the question as to when and how the revenue is recognized. Sales revenue is considered as recognized when sales are effected during the accounting period irrespective of the fact

whether cash is received or not. The realization concept revolves around the determination of the point of time when revenues are earned. 8. Accrual Concept: According to this concept the expenses accrued but not paid in cash as also revenues earned but not received in cash are also to be taken in to account. Only those revenues and those expenses are to be considered which relate to the period under consideration irrespective of the fact whether they are received or paid in cash or not. 9. Dual Aspect Concept: In each transaction there are two concepts, i.e. two fold effects are required to be recorded. Modern or double entry system of accounting is based on two aspects of every transaction. There is two fold effect for every transaction .In other words every debit has corresponding credit and every credit has corresponding debit. 10. Disclosure Convention: According to this convention, accounting report should fully and fairly disclose the information they intend to represent. They should be honestly prepared and should disclose all material information to proprietors, present and potential creditors and investors. 11. Materiality Convention: Materiality means relative importance. Materiality refers to what is significant and what is insignificant. It will not be worthwhile to record every minute detail in accounting as it will be cumbersome and uneconomical. The material concept essentially relates to the time, effort and cost of accounting in relation to usefulness of the data generated whether it would influence the decision of informed investors. Materiality of an item depends upon the amount and the nature of item.

Double Entry System: Every business transaction has two aspects i.e. receiving & giving. Thus for each transaction minimum two entries are required to be made and hence this system is termed as Double Entry System. The principle of double entry system is Every Debit has a corresponding Credit & Every Credit has corresponding Debit. Advantages of Double Entry System: 1. From the balances of personal accounts it can be easily ascertained as to how much a trader owes to others and how much others owe to him. 2. The balances of real accounts show the value of properties possessed. 3. The balances of nominal accounts indicate incomes, gains, expenses and losses. 4. A trial balance can be prepared by taking debit balances under one column and credit balances under the other. 5. From trial balance a trader can prepare a Trading and Profit & Loss A/c to find out profit or loss and a Balance Sheet showing the financial position. 6. Comparison of various items like purchases, sales etc. of the two different years can be done to know the trends. 7. Any errors made in recording the transaction can be easily traced. 8. A possibility of fraud is reduced. The manner of recording transactions in an account is Asset Account Account Debit Credit Increase Decrease Liability Account Debit Decrease Debit Credit Decrease Increase Expense Account Debit Credit Increase Decrease Income Account Capital Credit Increase

Debit Credit Decrease Increase

JOURNAL JOURNAL is a book of prime entry/ Basic entry/ Original entry/ Trial entry/ Primary entry. This means that as soon as a transaction takes place, it is recorded in the Journal. The transactions are first recorded in the journal in a chronological (serial) order and then they are posted into the ledger. Journal is derived from French word Jour means Day. Journal serves the purpose of permanent accounting record. However, to reduce the pressure on Journal, it is sub divided into several subsidiary books which are also books of prime entry. Journalising refers to the process of recording the transactions. The following steps are involved in recording a transaction in Journal.
I. Identify the two aspects involved in a transaction: According to the

principle of double entry, every transaction has minimum two aspects. These two aspects are the two accounts involved in the transaction. The first step in recording a transaction in Journal is to identify these two aspects. The following examples will clarify the point. Goods purchased for cash: This transaction involves two aspects, i.e. goods come in and cash goes out. Goods sold for cash: The two aspects involved are goods are going out and cash is coming in. Goods purchased for credit: Here goods come in and the supplier from whom they are purchased becomes a creditor as there is no outflow of cash. Deposited cash in the bank: Cash going out i.e. cash balance reduces and bank balance increases are the two aspects of this transaction.

Business commenced with cash: In this transaction, cash comes in and the proprietor who has invested the money becomes the creditor of the business. II] Identify the Accounts affected in a transaction: As mentioned above, in each and every transaction, there are minimum two aspects involved as per the principle of the double entry. These aspects are called as Accounts. It is necessary to identify the accounts involved in a transaction and thereafter the type of accounts affected so that passing of a journal entry will be possible. The identification of accounts affected in a transaction is illustrated in the following illustration. Illustration 1: From the following transactions, prepare a statement showing the two aspects of each transaction and also the accounts affected in them. i. ii. iii. iv. v. vi. vii. viii. ix. x. A commenced business with his own cash. Opened an account in a bank and deposited amount in the same. Goods purchased for cash Purchased office furniture and paid the amount by cheque. Paid for office expenses Paid for stationery Sold goods on credit to B Purchased goods on credit from C Withdrawn from bank for office use Sold goods for cash

The following chart is made to show the aspects involved and the accounts affected in each of the above transaction. Sr. Transaction Aspects Involved Accounts

No. 01

A commenced business with his own cash.

Cash comes in the business Proprietor is the giver of the cash

Affected Cash A/c Capital Account of the Proprietor Bank A/c Cash A/c Purchases A/c * Cash A/c Furniture A/c

02

Opened an account in a bank and deposited amount in the same. Goods purchased for cash

Bank balance increases Cash balance decreases as the cash goes out Goods come in Cash goes out Furniture comes in Bank balance is reduced cheque Office Expenses are incurred Cash is paid

03

04

Purchased office furniture and paid the amount by cheque.

as the payment is made by Bank A/c Office Expenses A/c Cash goes out Stationery A/c Cash A/c Sales A/c # Bs A/c Purchases

05

Paid for office expenses

06

Paid for stationery

Stationery expenses are incurred Cash is paid Goods go out B becomes the debtor as the amount is recoverable from him in the future Goods come in

07

Sold goods on credit to B

08

Purchased goods on

credit from C

C becomes the creditor as the amount is payable to him Cash comes in

A/c * Cs A/c Cash A/c

09 10

Withdrawn from bank for office use Sold goods for cash

Balance at bank is reduced Bank A/c Cash A/c Cash comes in Goods go out Sales A/c #

* In accounting, whenever any trading goods are purchased, the Purchases Account is affected rather than Goods A/c. In fact the Purchases Account is for the decentralization of the Goods Account. There are several transactions in a business, which affect the goods. There are purchases, sales, purchases returns and sales returns. If all these transactions are recorded through the Goods Account, it will be extremely difficult to find out Purchases, Sales, Purchase Returns and Sales Returns as all transactions connected with the goods account will be clubbed in this account. Hence due to decentralization the burden on the Goods Account will be reduced and so in case of trading goods purchases, the Purchases Account will be affected. [Trading goods mean the goods in which the proprietor is trading, for example, if a person is trading in stationery, purchase of stationery will be the purchases of trading goods. On the other hand, if a stationery merchant is purchasing furniture for his own shop, it will not be the purchases of trading goods and hence in such cases the purchases account will not be affected. # In case of sale of trading goods, the Sales Account is affected due to the reason mentioned above.

III] Classification of Accounts/ Types of Accounts: For recording a journal entry, it is necessary to decide the account to be debited and account to be credited. For doing this, it is necessary to classify the accounts and then apply the rule for debit and credit. Accounts are classified as shown in the following chart. Account (A/C)

Personal

Impersonal /Non Personal _______________________ Real & Nominal

Rules: 1. For personal Accounts: Debit the receiver Credit the giver 2. For Real Accounts: Debit what comes in Credit what goes out 3. For Nominal Accounts: Debit Expenses and losses Credit incomes and gains

A] Personal Accounts: These accounts include accounts of individuals, firms, limited companies, banks, insurance companies, co-operative societies, educational institutions etc. Personal accounts deals with a. Natural persons: means dealing with alive /real persons. Eg. Ram, Sunita, Kamala, Bosh etc.

b. Artificial persons: It relates to corporate bodies, firms, companies,

institutions which have legal existence. Eg. Bajaj, Sinhgad institute, Tata, KEM hospital , ABC firm etc. c. Representative persons: It represents outstanding expenses (unpaid) and accrued or prepaid expenses or income relating to persons. Eg. Outstanding salaries, Outstanding rent, Prepaid insurance etc. The Rule for debit and credit for a personal account is as follows. Debit the Receiver and Credit the Giver. This means that the personal account which is receiving benefit should be debited while the personal account which is giving the benefit should be credited. Thus if cash is paid to A by a proprietor, As Account will be debited in the books of the Proprietor while is cash is received from B, Bs account will be credited in the books of the Proprietor. B] Impersonal /Non Personal Accounts: It is not personal but related to goods, articles , expenses and incomes and profits or losses. As shown in the chart, these accounts are further sub divided into Real and Nominal. Both these types of accounts are discussed in the following paragraphs. I] Real Account: Accounts relating to various classes of properties or things such as building, furniture, machinery, cash etc are called real accounts. The accounts of Assets are included in this category. For example, accounts of assets like Land and Building, Plant and Machinery, Furniture, Vehicles, Electrical Fittings are included in the category of Real Accounts. Similarly accounts of intangible assets like Goodwill, Patents and Copyrights, Trade Marks also come in this category. The rule for debit and credit in this type of account is as follows. Debit what comes in and Credit what goes out. This means that the asset coming in the business should be debited while the asset going out should be credited. This if furniture is purchased by paying cash, the furniture account will be debited as the furniture is coming in and cash account should be credited as the cash is going out.

II] Nominal Account: All accounts other than Personal and Real are included in this type. In other words, accounts of expenses and losses as well as accounts of incomes and gains are included in the category of nominal accounts. For example, accounts of salary, wages, printing and stationery, rent, discount allowed, trade expenses, carriage inwards and outwards etc are nominal accounts as all of them are expenses. On the other hand accounts like discount received, rent received, interest received are also nominal accounts as they are transactions of income. Similarly accounts of losses like loss on fire, loss due to fraud etc are also nominal accounts. The rule of debit and credit in case of the nominal accounts is as follows. Debit all expenses and losses and credit all incomes and gains. The classification of accounts and the application of rule of debit and credit is shown in the following illustration. Illustration: 2: From the following transactions, prepare a table showing the accounts affected, the type of the account and the account to be debited and credited with the reasons thereof. i. ii. iii. iv. v. vi. vii. viii. ix. x. B started business with own cash and also with furniture. Purchased goods and paid cash for the same. Opened an account with bank and deposited cash in the same. Paid for stationery. Wages paid Sold goods to C on credit Purchased goods from Z on credit. Paid for carriage inwards Paid for sundry expenses Sold goods for cash.

Solution: The following chart is prepared to show the required things in the same.

Sr. No.

Accounts Affected

Type of

Debit Credi

Reason

Accounts / t Debit Debit Credi t Debit Credi t Debit Credi t Debit Credi t Debit Credi t Debit Credi t Debit Credi t Debit Credi

I] Cash Account II] Furniture Account III] Bs Capital Account I] Purchases Account II] Cash Account.

Real Real Personal Nominal Real Personal Real Nominal Real Nominal Real Personal Nominal Nominal Personal Nominal Real

Debit what comes in Debit what comes in Credit the giver Debit all expenses & losses Credit what goes out Debit the receiver Credit what goes out. Debit all expenses & losses Credit what goes out. Debit all expenses & losses Credit what goes out. Debit the receiver Credit all incomes & gains. Debit all expenses & losses Credit the giver Debit all expenses & losses

I] Banks Account II] Cash Account

I] Stationery Account II] Cash Account

I] Wages Account II] Cash Account

I] Cs Account II] Sales Account

I] Purchases Account II] Zs Account

I] Carriage Inwards Account II] Cash Account

Credit what goes out

I] Sundry Expenses Account II] Cash Account

Nominal Real Real Nominal

Debit Credi t Debit Credi t

Debit all expenses & losses Credit what goes out Debit what comes in Credit all incomes & gains

10

I] Cash Account II] Sales Account

IV] Recording a Journal Entry: After deciding the account to be debited and credited in a transaction, the nest step is to record the Journal Entry for that transaction. A Journal entry is recorded in the following manner. The process of recording the transaction in the journal is called journalizing. Transaction: Salaries paid Rs.50000 Journal Entry: Date 01 Particulars Salaries Account Dr. To Cash A/c [Being the salaries paid] The following features of Journal can be noted from the above illustrative entry.
There are five columns for a Journal. The first column is for date of the

L.F. Debit Rs. 50,000

Credit Rs. 50,000

transaction. The second column is for writing the details of the transaction. When transaction is written, the account, which is debited has to come first and so Salaries Account which is debited comes first. To indicate that it is debited, the word Dr [Approved short form for the word Debit] is written

against the Salaries Account. The account, which is credited in the transaction comes below the account which is debited. Since it is implied that when one account is debited the other one is credited, the word credit is not written against the Cash Account. The next column is of L.F., which indicates Ledger Folio. This is the page number of the Ledger on which each of the two accounts, i.e. Salaries and Cash, appear. In the illustration this column is kept blank since there is no mention of the Ledger Folio. The remaining two columns are for writing the amount and the amount is to be written against each of the two accounts in the appropriate column. This means that as the Salaries account is debited, the amount is shown against the account in the debit column and Cash account is credited so that the amount is shown against it in the credit column. Amounts in debit and credit columns are the same. A Journal entry is not completed without narration, which is a brief explanation of the transaction. Narration is written in the bracket below each Journal entry so that in the future easy reference of the transaction can be find out. Though no particular format of narration is there, it is to be written in brief and normally started with the works as either For or Being. After the period for which, the Journal is maintained is over, totals of the Debit and Credit column are taken and then the Journal for that particular period is closed. Journal is a book of primary entry and after recording the transaction in a Journal, the same is taken to the Ledger, which is the book of secondary entry. If all the transactions are recorded in Journal, the size of the same will be unmanageable and any future references will be extremely difficult. To overcome this difficulty, Journal is sub-divided into several books, which

are called as Subsidiary Books and only those transactions, which cannot be recorded in subsidiary books are recorded in Journal. This reduces the burden on Journal to a great extent. SUBSIDIARY BOOKS:
1. INTRODUCTION: In the previous chapter, we have discussed about the

principles and rules for passing a journal entry. The Journal is a book of prime entry, which means that as soon as a transaction takes place, it is recorded in the journal. However as the number of transactions is very large, if all these transactions are recorded in a journal, the size of this book will be unmanageable and any future reference will be extremely difficult. Therefore to reduce the pressure on journal, it is divided into a number of books, which are called as subsidiary books and depending on the nature of a transaction, it is recorded in an appropriate book. Thus considerable number of transactions is taken out of journal and only those transactions, which cannot be recorded anywhere else due to their nature are recorded in the journal. These subsidiary books are also books of prime entry and after recording transactions in them, the transaction is posted in the ledger. The various types of subsidiary books and the method of recording of transactions in them are discussed in the following paragraphs.
2. VARIOUS SUBSIDIARY BOOKS: The following subsidiary books are

maintained for sub-dividing a journal. Subsidiary Books

Purchase Book Book

Sales Book

Return Books

Cash Book B/R Book B/P

Purchase Return

Sales Return

These books are discussed in detail in the following paragraphs. A] Purchase Book: This book is maintained to record certain type of transactions of Purchases of goods. The type of transactions are, purchases of trading goods made on credit basis only are recorded in this book. Trading goods mean the goods in which the firm or the proprietor is trading. Thus a trader who is trading in furniture will have furniture as trading goods. Similarly a trader who is trading in stationery will have stationery as trading goods. But if a trader in stationery purchases furniture for his shop, the furniture purchases will not be purchases of trading goods as he is not trading in furniture. The other condition is that the purchases made on credit basis only are recorded in the Purchase Book. Thus if there is a purchase of trading goods for cash, it will not find place in the Purchase Book. It will be recorded in the Cash Book, which is also a subsidiary book. The format of Purchase Book is as follows. PURCHASE BOOK Date Name of Supplier Description of Goods Total Invoice Number L.F. Amount Rs. xxx

The transactions are recorded in the Purchase Book date wise and at the end of the month, the total of Purchase Book is taken. The total is then posted to the ledger accounts ie. Purchases account debit side as To, sundries as per purchase book B] Sales Book: In this book, the transactions of sales of trading goods made on credit only are recorded. Thus it has similarity with the Purchase Book in the sense only the transactions of sales of trading goods made on credit are recorded in the Sales Book. In other words, if a transaction of sale is of non trading goods or a transaction of sale of trading goods made for cash is not recorded in the Sales Book. The format of Sales Book is given below. SALES BOOK Date Name of Customer Description of Goods Total Invoice Number L.F. Amount Rs. xxx

Like Purchase Book, the total of the Sales Book is taken at the end of a month and posted to the Sales Account credit side as By sundries as per Sales book. C] Purchase Return Book/ Return Outward Book: Sometimes, it may so happen that the goods purchased from supplier are required to be returned to him. This may be due to delivery of wrong quality or quantity, late delivery, goods received in damaged condition and so on. The details of such goods returned to the supplier are recorded in the Purchase Return Book, which is also called as Return Outward Book. In transactions of return, the supplier is sent a debit note, which means that his account is debited in the books of the firm/proprietor so that the amount payable to him is reduced. The debit note number is shown in the Purchase Return Book. The format of this book is as follows.

PURCHASE RETURN BOOK Date Name of Supplier Description of Goods Debit L.F. Note Number Amount Rs.

Total

xxx

The total of this book at the end of the month is taken and posted in the Purchase Return account credit side as By, Sundries as per purchase return book. D] Sales Return Book/ Return Inward Book: This book is used to record the transactions of return of goods made by the customer by the firm/proprietor. Customers return goods due to several reasons like quality not as per the specifications, delivery of either excess or less quantity than ordered, late delivery etc. Customers are sent Credit Note Number in such cases, which indicates that their account is credited in the books of the firm and hence the amount receivable from them is reduced. The number of the credit note is mentioned in the Sales Return Book, which is also called as Return Inward Book. The format of this book is given below. SALES RETURN BOOK Date Name of Customer Description of Goods Credit Note Number L.F . Amount Rs.

Total

xxx

The total of this book, which is taken at the end of the month, is posted to the Sales Return account on the debit side as To, Sundries as per Sales return book.

E] Cash Book/Cash Account: There are several cash transactions in a business. There are several items of cash receipts and cash payments. All these transactions are recorded in the book called as Cash Book. It is prepared to record all transactions in cash or by cheques. Cash book and cash account both are same as the format of cash book is in the form of ledger. There are two sides to a Cash Book, the left hand is the Receipts side and the right hand side is the Payment side. All cash receipts are recorded on the receipts side while all payments are recorded on the payment side. The difference between the two sides is the cash balance, i.e. available cash on hand at the end of the month. This closing cash balance is then brought forward as opening cash balance in the subsequent month. Petty cash book is prepared to record all cash transactions of petty expenses. There are various types of cash book, which are discussed below. I] Simple Cash Book: A simple cash book has only one column for amount on each of the two sides, i.e. receipts and payments. There are no other columns for recording discounts and bank transactions. Hence this cash book is called as a simple cash book. The format of this cash book is as follows. Cash Book Receipts Date Particulars To, L.F. Amount Date Rs. By, Particulars L.F . Payments Amount Rs.

II] Two Column Cash Book: [Cash and Discount Column]: In this type, there are two columns for amount on Receipts and Payment sides and they are for amount and discount. The discount column on the debit side represents the discount allowed while the discount column on the credit side represents the discount received. At the end of the month, while the amount column is balanced, the

discount column is not balanced and only the totals on the debit and credit side are shown. The format of this cash books is as follows. Cash Book [Two Columns] Receipts Date Particulars L.F . To, Discount Amount Date Particulars L.F Rs. Rs. By, . Payments Discount Amount

Note: In the two column cash book as shown above, there can be a column for Bank Column instead of Cash Column for recording the bank transactions. Rest of the things remain the same. III] Cash Book with three columns, Cash, Bank and Discount: This is called as three column cash book. The three columns are provided for recording amounts of discount, cash receipts and payments and receipts and payments through cheque, i.e bank transactions. The format of this type of cash book is as follows. Cash - Book [Three Columns] Receipts Payments Date Particulars L.F . To, Discount Cas h By, Bank Date Particulars L. F Discount Cas h

Ban

In this Cash Book, the discount received is recorded on the debit side while the discount allowed is recorded on the credit side. At the end of a particular month, the balance cash and amount column is ascertained while the discount column is

not balanced. Only the total of the debit side and credit side of the discount column is taken without computing the balance. F] Bills Receivable Book: This book is maintained to record various transactions regarding the bill of exchange, i.e. Bills Receivable. Bills receivable is the part of debtors, the amount which firm is going to receive for a bill accepted by drawee. The bills which have been drawn by the businessman but accepted by the other party are known as bills receivable. G] Bills Payable Book: For recording the transactions of Bills Payable, this book is maintained. All the transactions relating to acceptance of bills are recorded in this book. It is part of creditors, the amount which is accepted by firm. H] Journal Proper: Transactions, which cannot be recorded in any of the books due to their nature, are recorded in the Journal, which is called as Journal Proper. Some examples of such transactions are given below. Goods distributed as free samples. Goods withdrawn for personal use.
Purchase of non trading goods i.e. assets on credit. Sale of non-trading goods i.e. assets on credit etc

LEDGER LEDGER: Ledger is a book of Secondary entry/ Principal or Final entry. This means that before a transaction is posted to the ledger, it has already been recorded in

either the journal or any of the subsidiary books. Ledger is a book in which several accounts are opened and all transactions concerning that account are recorded there. Ledger shows the net effect under one particular head relating to the similar transaction which has take place in a particular period. It is also called as T form of account as the format of ledger is like alphabet T and the account is divided into two parts the left hand side is called debit and the right hand side is called credit. For example, in ledger, Cash Account will show all the transactions involving either cash coming in or cash going out. Similarly in Purchases Account, all transactions relating to the purchases will be shown. Same is the case with accounts like Sales, Personal Accounts and also accounts of assets and properties. Thus while the objective of journal or any of the subsidiary books is to record the transaction as soon as it takes place, the object of ledger account is to bring together all transactions connected with that account so that at the end of a particular accounting period, the balance can be ascertained. The concept of balance is discussed later in this topic.
1. FORMAT OF LEDGER ACCOUNT: A ledger is opened in the following

T form. Dr. Cr. Date Particulars To, POSTING: J.F. Amount Rs.

Title of the account /Ledger Account

Date

Particulars By,

J.F. Amount Rs.

The process of transferring all the debit and credit items from the journal into ledger is called ledger posting.

Thus, from the above format it will be clear that the ledger account has the following features. Each ledger account has two sides, debit and credit. Entries are made either on the debit side or credit side depending on whether the concerned account is debited or credited in the journal entry. The word To is used as connecting word while passing an entry on the debit side while the word By is used as connecting word while passing an entry on the credit side of the ledger account. After completing all the entries in a particular accounting period, a ledger account is to be balanced for closing the same. This means totals of amounts recorded on both sides are taken and the difference in the amounts is put on the side, which has lesser amount than the other one. This difference is known as balance. For closing a ledger account the wordings used is To/By Balance c/d or c/f [c/d = carried forward, c/f = carried forward] If there is no difference between the amounts on the debit and credit side, it is said that the ledger account is squared up.
A ledger account, which is closed at the end of an accounting period, is to be

re-opened at the beginning of the next accounting period. Thus a ledger account at the end of June, i.e. on 30th June, is to be re-opened on the first day of July. For this the balance carried forward at the end of June is to be brought forward. For example, in case of a particular account if the balance is carried forward Rs.10000 and on the credit side is to be brought forward on the opposite side at the commencement of the next month. [Illustrated in the numerical example]. The wordings used for re-opening an account are either Balance b/f or Balance b/d [b/f = brought forward, b/d = brought down]

Balancing is done in case of all ledger accounts except in case of nominal accounts. TRIAL BALANCE TRIAL BALANCE: A trial balance is the list of all ledger account balances segregated into debit and credit balances. After preparing the ledger accounts, their balances are ascertained and they are divided into debit and credit balances. A ledger account shows a debit balance if the debit side total amount is more than the total amount of the credit side. On the other hand if the credit side total is more than that of the debit side, the account shows credit balance. In other words, if the balance of the ledger account is carried down on the credit side, it shows debit balance and if the balance is carried down on the debit side, it shows credit balance. After ascertaining the balance, a list is prepared showing the accounts and the balances shown either as debit or credit. This is the Trial Balance, which is an important document as it is used for preparing the final accounts, i.e. Trading and Profit and Loss Account and Balance Sheet. A Trial Balance tallies, which means that the total of the debit side is equal to the total credit side. If it tallies, it is an indication of mathematical accuracy. However, even if tallies, it is not a guarantee that there are no errors. There are certain types of errors, in spite of which the Trial Balance tallies. However tallying of the Trial Balance is a sign of mathematical accuracy. FINAL ACCOUNTS: FINAL ACCOUNTS/ FINANCIAL STATEMENT:

1. INTRODUCTION: The basic objective of financial accounting is to find out the results of an accounting year in the form of profit or loss and financial position of the business. For this there is a need that all business transactions should be recorded properly in the books of accounts so that at the end of the year, a summary of them can be prepared to find out the results of the accounting year. The accounting cycle, which is shown in the chapter number one, is shown here again for better understanding. Transaction Entry Books of Prime Entry Journal & Subsidiary Books Books of Secondary Entry Ledger Trial Balance Final Accounts Trading Account Profit & Loss Account Balance Sheet

As shown by the accounting cycle, the preparation of final accounts is at the end of the accounting cycle. 2. Final Accounts include the following accounts and statement. A] Trading Account is prepared to find out the gross profit or gross loss. B] Profit and Loss Account is prepared to find out the net profit or net loss.

C] Balance Sheet, which is not an account, but a statement showing Assets and Liabilities on a particular day. All these are discussed in detail in the following paragraphs. A] TRADING ACCOUNT: This account is prepared to find out the Gross Profit or Gross Loss for a particular year. The gross profit or gross loss is the difference between the Sales and the Cost Of Goods Sold. The cost of goods sold is computed as given below. Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses Closing Stock The opening and closing stocks mentioned above represent the unsold stock of finished goods. Direct expenses includes expenses like carriage inwards, customs duty, octoi, freight, coal, gas and water etc. The format of this account is as follows. TRADING ACCOUNT OF Mr.XYZ FOR THE YEAR ENDED ---Dr. Cr. Particulars To Opening Stock To Purchases Less: Purchase Returns To Wages Amount Amount Particulars Rs. Rs. By Sales Less: Sales Returns By Closing Stock By Gross Amount Rs. Amount Rs.

Loss Transferred to Profit and Loss Account To Carriage Inwards To Customs Duty To Octroi To Coal, Gas and Water To Factory Expenses To Gross Profit Transferred to Profit and Loss Account Total Total

B] PROFIT AND LOSS ACCOUNT: The objective of this statement is to find out the Net Profit or Net Loss for a particular year. The net profit or net loss is computed by deducting from the all expenses other than those taken in the Trading Account and adding all other income like interest received, rent received, discount received and so on. The net profit or not loss is the final figure of profit or loss of a business organization. The format of this account is given below. PROFIT AND LOSS ACCOUNT OF Mr. XYZ FOR THE YEAR ENDED ----

Dr. Cr. Particulars To Gross Loss transferred from Trading Account To Salaries To Printing and Stationery To Postage and Telephone To Rent Amount Amount Rs. Rs. By Gross Profit transferred from Trading Account By Interest By Dividend By Sundry Income By Net Loss transferred to Balance Sheet To Discount To Advertising To Traveling Expenses To Bad Debts To Carriage Outwards To Depreciation on Fixed Assets To Miscellaneous Expenses To Net Profit transferred to Balance Sheet Particulars Amount Amount Rs. Rs.

Total

Total

Note: The items of expenditure and income shown on the debit and credit side of the Profit and Loss Account is not the exhaustive list of all the items of expenditure and income. It is an indicative list given for illustrative purpose. C] Balance Sheet: Balance Sheet is a statement showing Assets and Liabilities of a business organization on a particular day. There is no particular format of Balance Sheet prescribed for a proprietorship or partnership organization. However while writing the items on the liabilities side and assets side, a particular order is normally followed. For example, on liabilities side, the first item is always the Capital Account of the proprietor while on the asset side, Fixed Assets are normally taken in the beginning and then other assets. For a limited liability company, i.e. joint stock company, the Companies Act 1956 has prescribed a format as given in the schedule Vith of the Companies Act. According to this Act, a balance sheet can be prepared either in vertical form or a horizontal form. Generally balance sheet and profit and loss account of a limited liability company are shown in vertical form. The format of balance sheet is given below. BALANCE SHEET OF Mr. XYZ AS ON ---------Liabilities Assets Particulars Capital Add: Net Profit Amount Amount Rs. Rs. Land and Building Assets Amount Amount Rs. Rs.

OR Less: Net Loss Less: Drawings Add: Interest on Capital Sundry Creditors

Less: Depreciation

Plant and Machinery Less: Depreciation Furniture Less: Depreciation Motor Vehicles Less: Depreciation Investments Sundry Debtors Less: Further Bad Debts Bills Receivables Closing Stock Patents and Trade Marks Cash in hand Bank Balance Income Due But Not Received

Loan

Bills Payable

Bank Overdraft Expenses Due But Not Paid [Outstanding expenses] Income Received In Advance

Expenses paid in advance [Prepaid Total Expenses] Total

Note: In the Trading Account, Profit and Loss Account and Balance Sheet, the list of items shown is not exhaustive but just illustrative.

ILLUSTRATIONS:
1. From the following Trial Balance, prepare Trading Account, Profit and Loss

Account for the year ended 31st March 2009 and a Balance Sheet as on that date of Mr. X Trial Balance As On 31st March 2009 Trial Balance Capital Account Sales Land and Building Furniture Equipments Opening Stock Purchases Debit Rs. 2000000 1000000 1200000 800000 3500000 Credit Rs. 3500000 7500000

Salaries Postage and Telephone Cash and Bank Balance Sundry Creditors Sundry Debtors Total

500000 300000 900000 500000 1300000 11500000 11500000

The closing stock as on 31st March 2009 was Rs.900000 Solution: Trading Account of --For The Year Ended 31st March 2009 Dr. Cr Particulars Amou nt Rs. To Opening Stock To Purchases To Gross Profit transferred to Profit & Loss Account Total 410000 0 840000 Total 0 8400000 Amoun t Rs. 80000 By Sales 0 350000 By Closing 0 Stock Particulars Amoun Amount t Rs. 7500000 900000 Rs.

Profit and Loss Account of --For The Year Ended 31st March 2009

Dr. Cr. Particulars Amou nt Rs. To Salaries Amoun t Particulars Amoun Amount t Rs. 4100000

Rs. Rs. 50000 By Gross Profit 0 transferred from Trading Account

To Printing & Stationery 0 To Net Profit transferred to Balance Sheet Total 330000 0 410000 Total 0 4100000 30000

Balance Sheet Of ---As On 31st March 2009 Liabilities Assets Particulars Capital Add: Net Amount Rs. 3500000 3300000 Amount Rs. Land and 6800000 Building Particulars Amount Rs. Amount Rs. 2000000

Profit Creditors

500000

Furniture Equipments Sundry Debtors Closing Stock Cash & Bank

1000000 1200000 900000 1300000 900000 7300000

Total

7300000

Balance Total

ADJUSTMENTS IN ACCOUNTS: Normally in preparing the final accounts of a business organization certain adjustments are required to be made. These adjustments are due to the following reasons. 1. Certain information, which is required for the preparation of final accounts, may be available after the preparation of trial balance. For example, information about any expenditure due but not paid may not be available on the date of closing of the accounts, similarly the information regarding the bad debts may be available after the closing the accounts. This information is to be included in the final accounts, otherwise the financial statements will not show a true and fair view of the financial condition of the business. For incorporation of this information, it is necessary to pass adjustment entry and carry on necessary adjustments in the financial statements. 2. Sometimes there can be some errors taking place while preparing the trial balance. For example, there may be some omission of some of the transactions or a transaction may be recorded twice. There can be some errors of posting also when posting in the ledger is made either of the wrong amount or on the wrong side or wrong amount on the wrong side. This needs to be corrected and for that adjustment entry is required.

3. There are some appropriations out of profit. For example in case of limited companies, there can be transfer to reserves or there can be proposed dividend. These appropriations are to be recorded in the financial statements through adjustment entries. The common adjustments along with their treatment in the accounts are discussed in the following paragraphs. It should be remembered that every adjustment has minimum two effects. 1] Outstanding Expenses / Expenses Due But Not Paid / Unpaid Expenses: On the date of closing of the books of accounts, certain expenses may have become due but they may not have been paid in cash. For example, on 31st March 2009, salaries for March 2009 may not have been paid. Due to the non payment of the salary, it is not recorded in the books and consequently do not appear in the trial balance from which, the final accounts are prepared. However if this salary is not taken into consideration, the profit/loss disclosed by the Profit and Loss Account will not be true as according to the accrual principle, an expenditure for the current year should be taken into current years account even if it is not paid in cash. Therefore such outstanding expenses are to be taken into consideration by way of the following adjustment. A] The amount of such outstanding expenses is to be added in the concerned item of expenditure either in the Trading Account or Profit and Loss Account, depending on the item of the expenditure. For example, if it is wages it will be taken in the Trading Account, while if it is salary it will be taken in the Profit and Loss Account and so on. B] The amount of such expenditure is to be paid in the future and till it is paid it is to be shown as liability on the LIABILITIES side of the Balance Sheet. The Journal entry for recording this transaction is as follows. (Particular) Expenses A/c Dr.

To Outstanding Expenses A/ Note: Particular Expenses means the concerned expense. For example, is it is salary outstanding, salary account will be debited, if wages are outstanding, wages account will be debited and so on. 2] Prepaid Expenses / Expenses Paid In Advance / Unexpired Expenses: Exactly opposite of the outstanding expenses are the expenses paid in advance or also called as prepaid expenses or unexpired expenses. Sometimes expenses are to be paid in advance for the future period. For example, insurance is to be paid in advance or sometimes rent may be paid in advance. These expenses are actually paid and hence their entry is made in the books of accounts and hence they are shown in the trial balance. However if they are shown in the final accounts without any adjustments it will mean that next years expenses are shown in the current years accounts and the profit/loss shown will be true, though the Balance Sheet at the end will tally. Therefore the following adjustments are to be made. A] Deduction from the concerned expense either in the Trading Account or the Profit and Loss Account. B] Showing the item of expense as an asset on the asset side of the Balance Sheet. The journal entry for recording this adjustment is as follows. Prepaid Expenses A/c Dr. To Particular Expense A/c 3] Depreciation on Fixed Assets: Fixed Assets are those assets, which are acquired not for resale but are acquired for being used in the business and improve the earning capacity of the business. Due to constant use and wear and tear, the utility value of the assets is reduced and this is called as the depreciation. The depreciation is provided on the books according to one of

the several methods available for the same. The effects in the accounts are as follows. A] Amount of depreciation is debited to the Profit and Loss Account B] It is deducted from the concerned asset in the Balance Sheet of the firm. The Journal entry for this adjustment is as follows. Profit and Loss Account Dr. To Depreciation Account. 4] Income Outstanding/ Income Due But Not Received: It was discussed in the first adjustment that there can be certain expenses, which are not paid though they have become due in the relevant accounting year. The accounting treatment of the same has also been discussed. Now, we have to discuss the income, which has become due but not received due to a particular reason. The same principle that is followed for recording the outstanding expenses is followed here. The income, which has been due but not received due to some reason should be taken into account because it is relevant for the current year. The two effects of this adjustment are as follow. I] Add in the particular item on the credit side of the Profit and Loss Account II] The amount of the outstanding income is to be shown on the asset side of the Balance Sheet. The journal entry for recording this adjustment is as follows. Outstanding Income A/c Dr. To Particular Income A/c [For example, if it is interest receivable, it will be outstanding interest account debited and credited to interest account] 5] Pre-received Income / Income Received In Advance: Sometimes, it so happens that certain type of income is received in advance. Actually it is due for the next year but it is received in advance in the current year itself. If no adjustments are made for this, the profits for the current year will be distorted as

the next years income is included in the current years accounts. Therefore the following effects are given to this adjustment. I] Income received in advance is deducted from the concerned item of income. Thus if rent is received in advance, the amount of rent received in advance is deducted from the amount of rent on the credit side of the Profit and Loss Account. II] Income received in advance is treated as a liability as any income received without being due, is a liability and hence shown on the liability side of the Balance Sheet of the organization. The journal entry for this transaction is as follows. Particular Income Account Dr. To Income Received In Advance Account. 6. Bad Debts: Bad Debts is the amount of irrecoverable debt. In the course of business, as a part of the policy credit is granted to customer to pay the money. Thus there are sales on credit basis and the amount of such sale is expected to receive within the credit period allowed to the customer. However sometimes, the customer to whom such sales are made, may not pay the money and in the future he may not be able to pay the money at all. This may be due to reasons like bankruptcy, closure of business, death of the customer and so on. The result is that the concerned amount is written off as bad debts. The amount of bad debts known to the proprietor during the course of business gets recorded in the books of accounts and is carried to the trial balance through the regular accounting chain. The amount of such bad debts is shown on the debit side of the Profit and Loss Account and this is the only effect of this item. However, adjustment entry is required for the bad debts which have come to the notice of the proprietor after the trial balance is prepared. There will be two effects of this adjustment. These two effects are as follows.

I] The amount is debited to the Profit and Loss Account. If bad debts are already given in the trial balance, the amount will be added in the bad debts already given in the trial balance. II] The amount will be deducted from the Sundry Debtors in the Balance Sheet. However the point to be noted that the above two effects are for the bad debts given in the ADJUSTMENT and not in the trial balance. Amount of bad debts given in the trial balance is to be recorded in the Profit and Loss Account debit side and there will not be two effects for the same. The Journal entry for this transaction is as follows. Bad Debts A/c Dr. To Sundry Debtors A/c 7] Reserve / Provision for Bad and Doubtful Debts: The word reserve and provision has different meanings in accounting. However since the accounting treatment for both is same in this case, the terms have been used interchangeably. Creation of reserve or provision for bad and doubtful debts is according to the principle of conservatism. Every year, it is expected that some of the amount of debt may not be recovered by the firm. In the course of business, goods are sold on credit. This amount is recoverable according to the credit period. But if a debtor becomes bankrupt or closes down his business, he may be unable to pay the amount. In such cases, there are Bad Debts, which in fact is the irrecoverable amount of the debt. Every year some of the amount of the debtors may become bad and hence a provision is created in the accounts. The accounting treatment of this adjustment is as follows. I] The amount of reserve/provision to be created on debtors at the end of the year is added in the bad debts on the debit side of the profit and loss account. From this amount, the amount of reserve/provision for bad and doubtful debts already given in the profit and loss account is to be deducted.

II] The amount of provision for bad and doubtful debts created in the current year only is to be deducted from sundry debtors in the balance sheet. The journal entry for creating a provision/reserve for bad and doubtful debts is as follows. Profit and Loss Account Dr To Provision/Reserve for Bad and Doubtful Debts. The accounting treatment of this adjustment is illustrated in the following illustration. Illustration: The Trial Balance of a firm shows the following. Particulars Provision for bad and doubtful debts Bad Debts 18000 Debit Rs. Credit Rs. 30000

The adjustment to the account provides that, i. ii. Write off additional bad debts of Rs.13000 Create a provision on Sundry Debtors @ 5%. The amount of Sundry Debtors is Rs.750000 The accounting adjustments will be as follows. Profit and Loss Account for the year ended Dr. Cr. Particulars To Bad Debts: Amount Amount Rs. 18000 Rs. Particulars Amount Amount

Add: Additional Bad Debts [New Bad Debts] Add: New Provision for Bad and 36850 --------13000

Doubtful Debts 67850

Less: Old Provision for Bad and Doubtful Debts

30000

37850

In the Balance Sheet, the Sundry Debtors will be shown in the following manner. Balance Sheet [Asset side only] Particulars Sundry Debtors Less: Additional Bad Debts Less: New Provision for Bad and Doubtful Debts 676150 Amount Rs. 750000 37000 713000 36850

8] Discount on Debtors: In order to encourage early payment, the debtors may be allowed some cash discount as an incentive. The discount allowed to debtors is actually a loss suffered by the firm. The accounting treatment for the same is as follows. I] The amount of discount allowed to debtors is shown on the debit side of the Profit and Loss Account. II] The amount is deducted from Sundry Debtors in the Balance Sheet. It should be noted that before computing the amount of discount allowed to debtors, the bad debts and provision/reserve for bad and doubtful debts given in the adjustments should first be deducted from debtors. The journal entry for the discount on debtors is as follows. Discount on debtors A/c Dr. To Sundry Debtors A/c The discount on debtors account is ultimately transferred to the Profit and Loss Account. 9] Discount on Creditors: Creditors of the firm allow discount to the firm in order to provide an incentive for early payment. This discount allowed by creditors is a gain for the business and the two effects of this transaction are as follows. I] The amount of discount allowed by creditors is credited to the profit and loss account as it is a gain for the firm. II] The amount of discount is deducted from creditors from the Balance Sheet of the firm as the amount payable to them is reduced. The journal entry for this transaction is as follows. Sundry Creditors A/c Dr. To Discount on Creditors A/c Ultimately the discount on creditors allowed to creditors is transferred to the Profit and Loss Account.

10] Unrecorded Credit Sales: Sometimes there is an omission regarding recording a transaction like credit sales. This may happen in the last month of the accounting year, where the goods sold are adjusted in the stock but the entry is not passed in the books. In such case, the following two effects are to be given for this adjustment. I] The amount of the unrecorded credit sales is added in the amount of sales in the Trading Account. II] Amount of Sundry Debtors will be increased by the amount of unrecorded credit sales as their receivable amount will increase. The journal entry for this transaction is as follows. Sundry Debtors A/c Dr. To Sales A/c It should be noted that the amount of provision for bad and doubtful debts as well as the amount of discount on debtors should be computed after adding the amount of unrecorded sales in the sundry debtors. 11] Unrecorded Credit Purchases: Credit purchases made during the year may be omitted to be recorded in the books of accounts. Therefore an adjustment is to be made in the accounts otherwise the profit/loss shown by the financial statements will not be true. The two effects for this adjustment are as follows. I] The amount will be added in the purchases on the debit side of the Trading Account. II] The amount will also be added in the amount of Sundry Creditors on the liabilities side of the Balance Sheet. The journal entry for the recording of this transaction is as follows. Purchases A/c Dr. To Sundry Creditors A/c

12] Goods Destroyed By Fire: There may be loss due to fire taking place at the office or the warehouse of the firm. If these goods are insured and the insurance company has admitted a claim but of lesser amount than the amount of loss the effects of this transaction will be as follows. I] The amount of claim admitted by the Insurance Company will be shown as receivable in the Balance Sheet on the Asset side. II] The difference between the amount of the goods destroyed and the claim admitted is a net loss and will be debited to the Loss By Fire Account on the debit side of the Profit and Loss Account. III] The amount of goods destroyed will be credited to Goods Destroyed by Fire Account and will be shown on the credit side of the Trading Account. The Journal entry for recording this transaction will be as follows. Insurance Company A/c Dr. Loss By Fire A/c Dr. To Goods Destroyed by Fire A/c 13] Goods Withdrawn For Personal Use: A proprietor or a partner of a firm may withdraw some goods from the business for his private use. The effects of this transaction are as follows. I] The amount is credited to the Trading Account. II] It is added in the drawing account of the proprietor or the partner. If drawing account is not given, the amount will be deducted from the Capital Account. The journal entry for this is as follows. Drawings Account Dr. To Goods Withdrawn For Personal Use A/c 14] Goods Distributed As Free Samples: This is part of advertising as the goods are distributed as free samples as a part of the promotion program. The two effects of this transaction are as follows.

I] The amount is debited to the Advertisement Account and is shown on the debit side of the Profit and Loss Account. II] Trading Account is credited with the amount of goods distributed as free samples. Journal entry for this is as follows. Advertisement Account Dr. To Goods Distributed As Free Samples Account. 15] Interest on Capital: If the proprietor or partners are allowed interest on their capital investments, this adjustment will be required. Interest on capital is paid by the business firm to the proprietor or partners and hence it is an item of expenditure for the firm. It is called as an appropriation out of profits. The amount of capital is increased by the amount of interest. The two effects of this adjustment are therefore as follows. I] Amount of interest of capital is debited to the Profit and Loss Account II] This amount is added in the capital account of the proprietor. 16] Interest on Drawings: While the interest on capital is allowed by a firm to its proprietors or partners, the interest on drawings is charged from the proprietor or partners by the firm. Drawings is the amount of goods/cash withdrawn by the proprietor/partners for their personal use. The two effects of this adjustment are as follows. I] Amount of interest on drawings is credited to the Profit and Loss Account as it is a gain for the firm. II] This amount is added in the drawings of the proprietor/partner. Journal entry for recording this transaction is as follows. Drawings A/c Dr. To Interest on Drawings A/c

17] Installation Charges of Plant and Machinery: Purchase of Plant and Machinery is a capital expenditure like the purchase of any other asset. Any expenditure incurred on installation of machinery such as wages paid to the workers for such purpose is also a capital expenditure. If there is an error of principle and such expenditure is treated as a revenue expenditure, this adjustment is required. For example, if wages paid for the installation of plant and machinery is debited to the wages account instead of the plant and machinery account, adjustment will be required. The two effects of such an adjustment are as follows. I] Deduction from the concerned revenue expenditure. For example, if wages paid for the installation of plant and machinery are debited to the wages account, the amount of such wages is deducted from the wages account. II] Amount deducted like this is added in the cost of plant and machinery account as it is a capital expenditure. Journal entry for this adjustment is as follows. Plant and Machinery A/c Dr. To Concerned Revenue Expenditure A/c Depreciation on plant and machinery will be computed after adding the amount of such installation expenditure. 18] Writing off an Asset: Fixed Assets are depreciated as per the relevant rules in various Laws. However an intangible asset is to be written off over a period of time. The accounting treatment for such an adjustment is similar to that of the depreciation. The adjustment has the following effects. I] Amount written of, is debited to the Profit and Loss Account. II] The amount is deducted from the concerned asset. Journal entry for recording such transaction is as follows. Profit and Loss A/c Dr. To Concerned Asset A/c

19] Appropriations out of profits: In case of limited companies, there are several appropriations. Some of them are as follows. Transfer to Reserves Payment of Dividend The respective amounts are debited to the Profit and Loss Account, appropriation section and then the second effect is to show it in the Balance Sheet under appropriate headings. 20] Hidden Adjustments/ Adjustments with in the trial balance: Some adjustments are not given explicitly but are implicit from the information given in the Trial Balance. For example, in the trial balance it may be mentioned that loan of a particular amount is given by the firm. The rate of interest is given and the date of giving the loan is also given. In such cases, the amount of interest due is to be computed and compared to the amount of interest paid and mentioned in the trial balance. There may have been some amount of interest due but not paid and hence adjustment for outstanding interest payable will have to be made as mentioned in the first adjustment.