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Trial Balance What? Why?

When?
What is a Trial Balance
The Trial Balance is a statement of ledger account balances as on a particular instance.

Trial Balance of M/s Wearall Textlies as on 31st March 2006


Particulars

L/F

Debit
Amount
(in Rs)

Opening Stock
Textile Purchases
Wages
Octroi

63,650
22,56,000
3,25,000
1,78,200

Salaries
Rent
Printing and Stationery
Advertisements
Cash
Office Building
Capital
Bank
Motor Vehicles
Sundry Creditors
Sales
P/L Appropriation
Sundry Debtors
Machinery

1,04,000
1,26,000
74,650
86,000
26,000
4,23,450

Total

Credit
Amount
(in Rs)

2,50,000
1,19,000
2,10,000
1,80,000
36,86,000
6,52,950
2,08,000
5,69,000
47,68,950

47,68,950

Why is a Trial Balance prepared?


The trial balance is prepared to check/ensure the arithmetical accuracy of accounting. Though not a conclusive proof,
the agreement of the trial balance is a prima facie evidence of the absence of mathematical errors.
This is the most important purpose for which the trial balance is prepared.

Isn't Trial Balance made for enabling preparation of Final Accounts?


No, not at all.
Preparation of Trial Balance is not an act that forms a part of the activities involved in the regular accounting cycle.
Since Final Accounting can be completed without the preparation of the Trial Balance, we can say that enabling the
preparation of final accounts is not the purpose of the trial balance.
final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,adjustments

When is a Trial Balance prepared?


The trial balance is generally prepared at a time when all the ledger accounts are balanced like at the end of the
accounting period.

Theoretically, the trial balance can be prepared as and when needed.


The practical difficulty in preparing the trial balance as and when needed is the requirement of the balances of all the
ledger accounts within the organisational accounting system. Different ledger accounts are balanced at different time
intervals based on the information needs of the organisation. Say in a typical organisation Cash a/c is balanced daily,
Expenses, Creditor and Debtor accounts are balanced on a monthly basis, Asset accounts are balanced annually etc.
The ledger account balances relating to all ledger accounts would not be available ready hand at any given instance.
Year ending is one such instance when the balances are derived.

Computerised Accounting
In mechanised (computerised) accounting systems, trial balance is a statement that can be automatically derived as
and when needed.

Accounting Cycle Absence of Preparation of Trial


Balance
Preparation of a trial balance is not an act which forms a part of the activities involved in the accounting cycle.
The Accounting Cycle (activities involved)

Begins with opening the books of accounts for an accounting period by recording the opening entry;

Journal in the books of M/s Amonaya Metals for the period from 1st January 2007 to ____
Date

V/R
No.

1st January

Particulars
Assets a/c
To Liabilities a/c
To Capital a/c

L/F
Dr

Debit Amount Credit Amount


(in Rs)
(in Rs)

[For bringing the balances in the various ledger


accounts at the end of the previous accounting
period into books.]

This is the journal entry that supports the posting To Balance b/d and By Balance b/d in the various ledger
accounts.

Recording the various transactions all through out the accounting period;

Balancing the ledgers as and when needed and finally at the end of the accounting period;

Recording the transactions for making up the final accounts

1.

Making the Trading a/c

2.

Closing the Trading a/c by transferring the balance in it to Profit & Loss a/c

3.

Making the Profit and Loss a/c

4.

Closing the Profit and Loss a/c by transferring the balance in it to Capital a/c (or Profit and Loss
Appropriation a/c)

Preparing the Balance sheet (A statement of balances in all the ledger accounts that remain after making up
and closing the Trading and Profit & Loss a/c.)

The accounting cycle ends with recording the closing entry for closing the books of accounts.

Journal in the books of M/s Amonaya Metals for the period from 1st Jan to 31st Dec 2007
Date

V/R
No.

31st December

Particulars
Liabilities a/c
Capital a/c
To Assets a/c

L/F
Dr

Debit Amount
(in Rs)

Credit
Amount
(in Rs)

[For carrying the balances in the various


ledger accounts at the end of the accounting
period to the subsequent accounting period.]

This is the journal entry that supports the posting To Balance c/d and By Balance c/d in the various ledger
accounts.

Final Accounting : Use of


Journal/Ledger
Final Accounting deals with all the ledger account balances at the end of the accounting period in one way or the
other.

All the Nominal accounts that represent direct expenses and direct incomes are closed by transfer to the
Trading a/c.
For this at least two journal entries are recorded.

The Trading a/c is closed by transferring its balance to the Profit and Loss a/c.
For this a journal entry is recorded.

All the Nominal accounts that represent indirect expenses, losses and indirect Incomes are closed by
transfer to the Profit and Loss a/c.
For this at least two journal entries are recorded.

The Profit & Loss a/c is closed by transferring its balance to either the Capital a/c or Profit & Loss
Appropriation a/c.
For this a journal entry is recorded.

All the remaining accounts are listed out in the Balance Sheet.
A closing entry is recorded in relation to this, though it is not directly related to preparing the balance sheet.

If the Final Accounting is to be done in a systematic manner, then all the journal entries mentioned above are to be
recorded and all the ledger accounts that are affected by those transactions are to be posted to and updated. That
would result in the making up of the Trading a/c and Profit and Loss a/c. The balance sheet is prepared by drawing
up a statement of ledger account balances carried forward through the closing entry.
final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,adjustments

Final Accounting : Use of Trial Balance : Avoiding


Journal/Ledger

In manual accounting, the Trading a/c, Profit & Loss a/c and the Balance Sheets can also be prepared using the
information in the Trial Balance avoiding the act of journalising the transactions involved in final accounting.
This is done by showing each item in the ledger accounts (Trading, P/L a/c) or the statement (Balance Sheet) where
it would be ultimately appearing had the actual procedure been adopted. This would have the same affect as
recording the journal and posting into the ledger.

Example
The balance in the Carriage Inwards a/c (direct expenditure) is transferred to the Trading a/c by recording a Journal
entry. By this, the Carriage Inwards a/c would get closed (its balance becomes zero) and the Trading a/c would get
debited with that balance. In preparing the Trading a/c the balance in the Carriage Inwards a/c can be ascertained
from the Trial Balance and shown on the debit side of Trading a/c.

Reduction of Work involved in Manual Accounting


Since not recording the related journal entries makes no difference as far as final accounting is concerned, in almost
all cases in manual accounting, the process of recording the journal entries required for final accounting and
updating the ledger is bypassed to reduce the burden of the work involved.

Information in Trial Balance To be dealt with only


once
In making up final accounts using the information in the Trial Balance, we should ensure that each item of
information (representing a ledger account balance) should be dealt with only once.
In final accounting each piece of information can appear either on the debit or credit sides of the Trading a/c or
"Profit & Loss a/c" or on the assets or liabilities side of the "Balance Sheet".
Each item from the Trial Balance should be dealt with only once in Final Accounting.

Interpreting the items in the Trial Balance


A statement for interpretation of the various ledger account balances in the above trial balance

Trial Balance of M/s Wearall Textlies as on 31/03/06 Statement of Analysis


Account
Opening Stock
Textile Purchases
Wages
Octroi
Salaries
Rent
Printing and Stationery
Advertisements
Cash
Office Building
Capital
Bank

Description
Direct Expenses
Direct Expenses
Direct Expenses
Direct Expenses
Indirect
Expenses
Indirect
Expenses
Indirect
Expenses
Indirect
Expenses

Account
Type
Nominal
Nominal
Nominal
Nominal
Nominal
Nominal
Nominal
Nominal
Real
Real
Personal
Personal

Balance
Nature
Debit
Debit
Debit
Debit
Debit
Debit
Debit
Debit
Debit
Debit
Credit
Debit

Where
Trading
a/c
Trading
a/c
Trading
a/c
Trading
a/c
P/L a/c
P/L a/c
P/L a/c
P/L a/c

Which
Side

Amount

Debit
Debit
Debit
Debit
Debit
Debit
Debit
Debit
Assets
Assets
Liabilities
Assets

63,650
22,56,000
3,25,000
1,78,200
1,04,000
1,26,000
74,650
86,000
26,000
4,23,450
2,50,000
1,19,000

Motor Vehicles
Sundry Creditors
Sales
P/L Appropriation
Sundry Debtors
Machinery

Asset
Asset
Liability
Liability/Asset
Asset
Liability
Direct Incomes
Accumulatd
Profit
Asset
Asset

Real
Personal
Nominal
Spl.
Nominal
Personal
Real

Debit
Credit
Credit
Credit
Debit
Debit

B/S
B/S
B/S
B/S
B/S
B/S
Trading
a/c
B/S
B/S
B/S

Assets
Liabilities
Credit
Liabilities
Assets
Assets

2,10,000
1,80,000
36,86,000
6,52,950
2,08,000
5,69,000

Making up the Final Accounts


Final Accounting using the information in a Trial Balance involves nothing more than putting the right items in the
right places i.e. on the appropriate side of Trading a/c, Profit and Loss a/c or the Balance Sheet.

Dr

Trading and Profit & Loss a/c [For the year ending 31/03/06]
Particulars

To
To
To
To
To

Opening Stock
Textile Purchases
Wages
Octroi
Gross Profit

Amount

Particulars

(in Rs)

63,650
22,56,000
3,25,000
1,78,200
8,63,150

By Sales

36,86,000
To
To
To
To
To

Salaries
Rent
Printing and Stationery
Advertisements
Net Profit

1,04,000
1,26,000
74,650
86,000
4,72,500

Cr

Amount
(in Rs)

36,86,000

36,86,000
By Gross Profit

8,63,150

8,63,150

8,63,150

Balance Sheet of M/s Wearall Textlies as on 31st March 2006


Liabilities

Amount

Assets

Amount

Capital
2,50,000
Sundry Creditors
1,80,000
P/L Appropriation
11,25,450
[6,52,950 + 4,72,500]

Cash
Bank
Office Building
Motor Vehicles
Sundry Debtors
Machinery

26,000
4,23,450
1,19,000
2,10,000
2,08,000
5,69,000

15,55,450

15,55,450

Care in dealing with Profit and Loss Appropriation a/c (or


Capital a/c)

The balance in the "Profit & Loss Appropriation a/c" as shown in the Trial Balance represents the balance carried
forward from the previous accounting period (i.e. year ending 31st March 2005).
The Profit and Loss a/c relating to the current period is closed by transfer its balance to the "Profit & Loss
Appropriation a/c"

Dr

Profit and Loss Appropriation a/c


Date

Particulars

31/03/06 To Bal c/d

Total

J/F

Amount

Date

(in Rs)

11,25,450

Cr

Particulars

J/F

31/03/06 By Bal b/d


31/03/06 By Net Profit

Total

11,25,450

01/04/06 By Balance b/d

Amount
(in Rs)

6,52,950
4,72,500
11,25,450

11,25,450

Therefore, while showing the information (balance) relating to the Profit & Loss Appropriation a/c in the Balance
sheet, care should be taken to make appropriate adjustment to the balance on account of the transfer of balance
from the Profit and Loss a/c.
The balance that appears in the balance sheet is not the one that appears in the trial balance, but the one that takes
into consideration the adjustment on account of current periods profit or loss also.
If the balance in Profit and Loss a/c is transferred to the Capital a/c, then such a care should be taken with regard to
the Capital a/c balance.

Trial Balance used in Final Accounting : When


Prepared?
The Trial Balance is a statement of ledger account balances as on a particular date (instance).
Final Accounting is done towards the end of the accounting period.
The trial balance that we consider in the preparation of final accounts is the one that is prepared towards the end of
the accounting period i.e. on the last day of the accounting period.

Transactions after the Trial Balance


Date
There might be a number of accounting transactions which might not have been taken into consideration by the time
the Trial Balance has been prepared.
Some of the reasons for the presence of such transactions are

Transactions which do not occur in the normal course of business


There are a number of transactions relating to the business which do not occur in the normal course of business.
These transactions unless deliberately recorded do not get into the books of accounts.

Examples for such transactions


i. Stock taken away by the proprietor for personal use
ii. Abnormal loss of stock

Transactions which have to be recorded only towards the end


There are a number of transactions relating to the business which have to be recorded only at the end of the
accounting period. If the trial balance has been prepared before all such transactions into consideration have been
taken into consideration, then they stay unrecorded in the books of accounts.
i. Depreciation on Assets
ii. Expenses - Outstanding/Prepaid
iii. Incomes - Outstanding/Pre-received

Transactions relating to Error Rectifications


The agreement of a Trial Balance is not a conclusive proof of absence of errors in accounting. Even in case where the
trial balance agrees, there may still be errors existing in the books of accounts.
These errors if identified subsequent to the preparation of the Trial Balance, need to be rectified which needs journal
entries to be passed for rectification.

What are
Adjustments?
The transactions which have not yet been journalised, appended to the trial balance are what we call adjustments.
Thus we can say that Adjustments are transactions relating to the business which have not been journalised by the
end of the accounting period.

Illustration
Trial Balance of M/s Azaya Traders" as on 30th June 2006.
Particulars
Opening Stock
Purchases
Salaries
Wages
Carriage Inwards
Trading Charges
Carriage Outwards
Rent received
Cash
Capital
Bank (Overdraft)
Comission
Creditors

L/F

Debit
Amount
(in Rs)

Credit
Amount
(in Rs)

86,000
11,36,000
1,53,000
18,000
26,900
64,000
52,500
1,78,300
62,500
3,44,700
37,980
42,780
2,68,000

Sales
Debtors
Machinery

Total

15,48,700
2,56,000
4,80,000
23,77,680

23,77,680

Adjustments
The following additional information is available
1. A Machine purchased on credit from M/s Ramsay Machine Tools for Rs. 2,00,000 is not yet recorded in
the books.
2. Wages to the extent of Rs. 43,000 are incorrectly recorded as Salaries.
The additional information presented after the trial balance contains information relating to accounting transactions,
which are to be identified from the wordings.
final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,adjustments

Why are they called Adjustments? Why not Additional


Transactions?
Since adjustments are also transactions relating to the business, we need to bring them into the accounting books by
journalising them.
The trial balance is used for final accounting, so as to eliminate a lot of physical work (in manual accounting) in the
form of recording transactions for making up final accounts, posting them into respective ledger accounts, balancing
of ledger accounts effected by these transactions.
Therefore even for the purpose of bringing the transactions represented by the adjustments into books a method has
been designed which would not require us to record these transaction, post them and balance the ledger accounts
affected. This method incorporates the effect of the transactions into the final accounts without having to go through
the regular process of recording, posting, balancing etc.

Accounting for the Transactions


Recording the transactions represented by adjustments normally would result in the existing balance in the affected
ledger accounts to either increase or decrease.

Transaction
Wages to the extent of Rs. 43,000 are incorrectly recorded as Salaries.
This represents an error of principle whereby an expenditure that was to be debited in a particular account has been
debited to another account.
To bring the effect of this transaction into books, the journal entry to rectify this error has to be recorded.

Journal/Ledger

Hide/Show

Journal in the books of M/s Azaya Traders for the year ending 30th June 2006
Date

V/R
No.

30/06/06

Particulars

L/F

Wages a/c
To Salaries a/c

Dr

Debit Amount
(in Rs)

Credit
Amount
(in Rs)

2,00,000
2,00,000

[For the transfer of wages erroneously


treated as salaries from the "salaries a/c" to
the "Wages a/c".]

Dr

Salaries a/c
Date

Particulars

30/06/06 To Bal b/d

J/F

Amount
(in Rs)

1,53,000

Date

Cr
Particulars

30/06/06 By Wages
30/06/06 Bal c/d

J/F

1,53,000
01/07/06 To Balance b/d

Dr

Amount
(in Rs)

43,000
1,10,000
1,53,000

1,10,000

Wages a/c
Date

Particulars

30/06/06 To Salaries a/c

J/F

Amount
(in Rs)

43,000

Date

Cr
Particulars

30/06/06 By Bal c/d

43,000
01/07/06 To Balance b/d

J/F

Amount
(in Rs)

43,000
43,000

43,000

The Method of Adjustment


This method involves identification of the effect and making mathematical adjustments in the figures that we
consider in final accounting (i.e. at the time of showing them in the Trading a/c or Profit & Loss a/c or the Balance
Sheet.).

Effect of the Transaction


The effect of the journal entry to be recorded in the above case can be analysed as

A. () From Salaries on the debit side of P/L a/c


The Salaries a/c which already has a debit balance is credited which will result in a decrease in the
existing debit balance.
To bring the effect of this transaction, the amount involved in the transaction (Rs. 43,000) is deducted
from the Salaries a/c balance (Rs. 1,53,000) shown on the debit side of the "Profit & Loss a/c".

B. (+) To Wages on the debit side of Trading a/c


The Wages a/c which already has a debit balance is debited resulting in an increase in the existing
debit balance.

To bring the effect of this transaction, the amount involved in the transaction (Rs. 43,000) is added to
the Wages a/c balance (Rs. 18,000) shown on the debit side of the "Trading a/c".
These are the adjustments to be made to bring the affect of the above transaction into the books of accounts.

Why call them Adjustment? Why not Additional Transactions?


Since the affect of these transactions is incorporated by mathematical adjustments, they are called Adjustments
rather than just Additional Transactions.

To make the Adjustment Know the Journal


Entry
Adjustments are transactions relating to business which have not yet been journalised.
Therefore, to make the adjustments one should have an idea of the journal entry related to the transaction indicated
by the adjustment.
If we know the Journal entry, we can identify the effect of the same on the ledger accounts and thus be able to
identify the adjustments to be made.
The adjustments are made at the time of making up the final accounts within the three parts that make up the final
accounting, i.e. the "Trading a/c", "Profit & Loss a/c" and the "Balance Sheet".

Illustration
Problem
Draw up the final accounts from the following trial balance and the additional information that follows it.

Trial Balance of M/s Azaya Traders" as on 30th June 2006.


Particulars
Opening Stock
Purchases
Salaries
Wages
Carriage Inwards
Trading Charges
Carriage Outwards
Rent received
Cash
Capital
Bank (Overdraft)
Comission
Creditors
Sales
Debtors
Machinery

L/F

Debit
Amount
(in Rs)

Credit
Amount
(in Rs)

86,000
11,36,000
1,53,000
18,000
26,900
64,000
52,500
1,78,300
62,500
3,44,700
37,980
42,780
2,68,000
15,48,700
2,56,000
4,80,000

Total

23,77,680

23,77,680

The following additional information is available


1.

A Machine purchased on credit from M/s Ramsay Machine Tools for Rs. 2,00,000 is not yet recorded in the
books.

2.

Wages to the extent of Rs. 43,000 are incorrectly recorded as Salaries.

Illustration Working
Notes
An analysis of the various ledger accounts in the trial balance would enable us to decide what to be done with each
item in the trial balance.

Trial Balance of M/s Azaya Traders as on 30/06/06 Statement of Analysis


Account

Description

Opening Stock
Purchases
Salaries
Wages
Carriage Inwards
Trading Charges
Carriage Outwards
Rent received
Cash
Capital
Bank (Overdraft)
Comission
Creditors
Sales
Debtors
Machinery

Direct Expenses
Direct Expenses
Indirect
Expenses
Direct Expenses
Direct Expenses
Indirect
Expenses
Indirect
Expenses
Indirect Incomes
Asset
Liability
Liability
Indirect Expense
Liability
Direct Incomes
Asset
Asset

Account
Type

Balance
Nature

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

Debit
Debit
Debit
Debit
Debit
Debit
Debit
Credit
Debit
Credit
Credit
Debit
Credit
Credit
Debit
Debit

Where
Trading
a/c
Trading
a/c
P/L a/c
Trading
a/c
Trading
a/c
P/L a/c
P/L a/c
P/L a/c
B/S
B/S
B/S
P/L a/c
B/S
B/S
B/SB/S

What
Side

Amount

Debit
Debit
Debit
Debit
Debit
Debit
Debit
Credit
Assets
Liabilities
Liabilities
Debit
Liabilities
Credit
Assets
Assets

86,000
11,36,000
1,53,000
18,000
26,900
64,000
52,500
1,78,300
62,500
3,44,700
37,980
42,780
2,68,000
15,48,700
2,56,000
4,80,000

An analysis of the additional transactions would enable us to identify what is to be done to incorporate their effect in
accounting.
1.

A Machine purchased on credit from M/s Ramsay Machine Tools for Rs. 2,00,000 is not yet recorded in the
books.

Entry
Dr. Machinery a/c
Cr. Ramsay Machine Tools a/c

2.

Detailed Explanation Hide/Show

Effect
1. (+) To Machinery a/c on the Assets side of the Balance Sheet
2. (+) To Ramsay Machine Tools a/c on the Liabilities side of the Balance
Sheet

Journal in the books of M/s Azaya Traders for the year ending 30th June 2006
Date

V/R
No.

30/06/06

Particulars

L/F

Machinery a/c
To M/s Ramsay Machine Tools a/c

Dr

Credit
Amount
(in Rs)

Debit Amount
(in Rs)

2,00,000
2,00,000

[For the value of machine purchased on


credit.]

Dr

Machinery a/c
Date

Particulars

30/06/06 To Bal b/d


To Ramsay
Machine Tools

J/F

Amount

Date

(in Rs)

4,80,000
2,00,000

Cr
Particulars

30/06/06 By Bal c/d

J/F

6,80,000
01/07/06 To Balance b/d

Dr

Particulars

30/06/06 To Bal c/d

6,80,000

6,80,000

6,80,000

J/F

Amount

Date

(in Rs)

2,00,000

Cr
Particulars

30/06/06 By Machine a/c

J/F

2,00,000

Amount
(in Rs)

2,00,000
2,00,000

01/07/06 By Balance b/d

2,00,000

Wages to the extent of Rs. 43,000 are incorrectly recorded as Salaries.

Entry
Dr. Wages a/c
Cr. Salaries a/c
4.

(in Rs)

Ramsay Machine Tools a/c


Date

3.

Amount

Effect
1. (+) To Wages a/c on the Debit side of the Trading a/c
2. () From Salaries a/c on the Debit side of the Profit and Loss a/c

Detailed Explanation Above

final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,adjustments

Illustration
Solution
Making up the final accounts would involve nothing more than putting the items from the trial balance in the right
places i.e. in either the "Trading a/c" or "Profit and Loss a/c" or the "Balance Sheet" and making subsequent
adjustments.

Dr

Trading and Profit & Loss a/c of M/s Azaya Traders for the year ending 30/06/06
Particulars

To Opening Stock
To Purchases

Amount

Amount

(in Rs)

(in Rs)

Particulars

86,000 By Sales
11,36,000

Amount

Amount

(in Rs)

(in Rs)

Cr

15,48,700

To Wages
(+) Salary (Tr)

18,000
43,000

To Carriage Inwards
To Gross Profit

61,000
26,900
2,38,800
15,48,700

To Salaries
() Tr. to Wages

1,53,000
43,000

To Trading Charges
Carriage Outwards
To Comission
To Net Profit

15,48,700

By Gross Profit
1,10,000 By Rent Received
64,000
52,500
42,780
1,47,820

2,38,800
1,78,300

4,17,100

4,17,100

Balance Sheet of M/s Azaya Traders as on 30th June 2006


Liabilities
Capital
(+) Net Profit
Bank (Overdraft)
Creditors
(+) Due to M/s Ramsay

Amount
3,44,700
1,47,820
2,68,000
2,00,000

Amount

Assets

Cash
4,92,520 Debtors
37,980 Machinery
(+) New Machine

Amount

Amount
62,500
2,56,000

4,80,000
2,00,000

6,80,000

4,68,000
9,98,500

9,98,500

The effect of the additional transactions (adjustments) are incorporated into the accounts by mathematical
adjustments wherever needed.

Adjustments to be Dealt with at least


Twice
Dual Entity Concept
Every transaction relating to business has its effect on two elements.
Adjustments are transactions relating to the business which are yet to be journalised. We call them adjustments for
the reason that they are dealt with by making mathematical adjustments to the figures of ledger account balances
instead of passing the regular journal entries.
Therefore, in making mathematical adjustments we have to ensure that we are adjusting the two elements that are
affected by the transaction.
Each item from the adjustments should be dealt with at least twice in Final Accounting.
Where an item appears in the trial balance it is to be dealt with only once and where an adjustment is being dealt
with it is to be dealt with at two or more places depending on the number of elements effected by the transaction.

Adjusting more than two accounts


In most of the cases, the journal entry for recording the transaction given as adjustments is a simple entry involving
two accounts (one being debited and the other being credited). However, in some cases, a complex entry involving
more than two elements (accounts) is needed to record the additional transactions. In such cases more than two

accounts may have to be adjusted.

Valuation of Assets Direct


Expenses
Asset Valuation Principle
The value of an asset includes all the expenses incurred before bringing the asset into usable condition.

Direct Expenditure
In financial accounting, we use the term Direct Expense in relation to assets.
Any expenditure that goes into the value of an asset is identified as Direct Expenditure for that asset.

Assets Treatment of Direct Expenses


All the expenses incurred in relation to an asset before bringing the asset into usable condition would form direct
expenses for the asset
All the direct expenses in relation to an asset are to be made part of the value of the asset i.e. are to be capitalised.

Example
If a machine is purchased at Delhi and brought to Tenali for use, then all the expenses incurred before bringing the
machine into working mode (usable condition) like transportation charges from Delhi to Tenali, Unloading Charges at
Tenali, Installation Charges etc., should be considered to be part of the value of the machine.
These expenses should not be debited to the respective expenditure accounts, but should be debited to the
Machinery a/c. The Machinery a/c balance which indicates the value of the asset would be the sum of the cost of the
machine, the transportation charges, unloading charges, installations charges, etc..

Is Stock an
Asset?
Dual nature of Stock
Purchases : During the Accounting Period
Whenever we purchase stock/goods we debit the Purchases a/c (Nominal account). This implies that we treat the
amount spent on purchasing stock as an expenditure.
Such a treatment is adopted all throughout the year.

Asset : At the end of the Accounting Period


At the end of the accounting period, while preparing the final accounts we treat stock an asset and show it in the
Balance Sheet on the assets side.
Thus we can say that stock has dual nature. All throughout the year the amount spent on it is expenditure and only
for the moment the balance sheet is prepared it is an asset.

Valuation of Stock Based on the Principle for Valuation of Assets


Since Stock is an asset, its valuation should also be made based on the principle for valuation of assets.
The value of stock should include all the expenses incurred before bringing stock into usable condition.

Usable Condition for Stock Being ready for Sale


Considering the Stock used in sale, the usable condition for stock would mean getting it ready for sale i.e. it being
finally set up in the show case or sale area.

Value of Stock
All the expenses incurred on the stock till it is placed in the sales area would form direct expenses for the stock and
should be treated as a part of the value of stock.
In situations where it would be difficult/impossible to collect all the expenses in detail, this idea is modified to mean
the expenses incurred before that stage till which point it would be convenient to collect information.

Direct Expenses for Stock used in Trading


Business
In relation to a trading business, the stock used for sale would be an asset.
The usable condition for that stock would be, it being placed ready for sale in the showroom.
Therefore, the direct expenses in relation to this stock would be all the expenses incurred before placing it in the
show room or any other relevant place ready for sale.
Conventionally, expenses like Wages, Carriage Inwards (carriage on purchases), Octroi, Excise, Duties etc., Stock
purchased, etc. are treated as direct expenses apart from the actual cost of the goods purchased which is revealed
by the "Purchases a/c".
It is not a rule that only these form direct expenses. Any expenditure that would have been incurred in relation to
stock before it is made ready for sale would form direct expenditure for the stock.
final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,adjustments

Cost of Goods
Sold
Cost of Goods Sold = Value of the Goods Sold
The cost of goods sold is a term used to indicate the value of the goods sold.
This value is needed to identify the amount of basic/core (gross) profit made by the organisation

Gross Profit = Sales Cost of Goods Sold


Illustrative Explanation
Consider the following data relating to an organisation.
1.

Opening Stock at the beginning of the accounting period, Rs. 20,000.

2.

Purchases of goods/stock during the accounting period : Rs. 2,48,000.

3.

Direct expenses incurred :Rs. 54,000.

4.

Unsold stock at the end of the accounting period valued at Rs. 36,000.

5.

Value of Stock used for other purposes Rs. 14,000.

Particulars

Amount

Opening Stock

(+) a) Purchases (Cost Value)


b) Direct Expenses

20,000
2,48,000
54,000

Total Value of Goods


() a) Closing Stock (Value)
b) Stock Unused for Trading

Amount

3,02,000
3,22,000

36,000
14,000

Cost of Goods Sold

50,000
2,72,000

The formula for calculating the value of Cost of Goods Sold based on the above calculations can be written as

Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses


Closing Stock Stock Unused for trading
Stock Unused for Trading
Stock with the organisation may have been used for purposes other than trading. The value of such stock unused for
trading purposes has to be deducted from the total value of stock so as to arrive at the value of cost of goods sold.
Some such instances

Goods being taken away by the proprietor for personal purposes;


Stock used in building up an asset;
Stock used for advertisement purposes;
Normal loss of stock;
Abnormal loss of stock;
Stock used up for other types of businesses (like consignments, branches, joint ventures etc)

Do we need Cost of Goods Sold to find Gross


Profit
Gross Profit = Sales Cost of Goods Sold
By definition Gross Profit = Sales Cost of Goods Sold (1)
To obtain the value of gross profit we need the figures of cost of goods sold and sales.

Bypassing finding Cost of Goods Sold


Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses Closing Stock Stock Unused for trading
Substituting this in (1) we get,
Gross Profit =

Sales (Opening Stock + Purchases + Direct Expenses Closing Stock Stock Unused for
trading)

= Sales Opening Stock Purchases Direct Expenses + Closing Stock + Stock Unused for trading
=

(Sales + Closing Stock + Stock Unused for trading) (Opening Stock + Purchases + Direct
Expenses)

Thus we do not specifically need to calculate the value of cost of goods sold for finding gross profit, only its affect is
to be brought into account.
Such an ascertainment of Gross Profit is done in the Trading and Profit and Loss account.

Dr

Trading a/c
Particulars

To Opening Stock
To Purchases
To Direct Expenses

Amount
(in Rs)

Cr
Particulars

Amount
(in Rs)

By Sales
By Stock Unused
By Closing Stock

"Purchases a/c" is a nominal account with a debit balance and is a direct expenditure (for stock).
Since Purchases a/c is closed by transfer to the Trading a/c, it appears on the debit side of Trading a/c.
Transferring a debit balance from one account to a second results in the second
account being debited and the first account being credited.
Thus, all the accounts representing the figures that are added to purchases appear on the debit side

"Sales a/c" is a nominal account with a credit balance and is a direct income.
Since Sales a/c is closed by transfer to the Trading a/c, it appears on the credit side of Trading a/c.
Transferring a credit balance from one account to a second results in the second
account being credited and the first account being debited.
Thus, all the accounts representing the figures that are added to sales appear on the credit side

Finding Cost of Goods Sold in such cases


Cost of goods sold is a figure that is not straight away available in the books of accounts used in financial accounting.
That figure can be obtained either from the "Trading a/c" or by preparing a separate ledger account to specific
account which gives the information relating to the cost of goods sold.
final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,adjustments

Ascertaining Cost of Goods Sold from Trading


a/c
Each ledger account serves one or more informational needs of the organisation. The Trading a/c gives the
information relating to the Gross Profit made by the organisation. It can also be used to derive the information
relating to the "Cost of Goods Sold".

Ascertaining Cost of Goods Sold


Cost of Goods Sold = (Opening Stock + Purchases + Direct Expenses) (Closing Stock + Stock Unused for trading)

The "Trading a/c" with this information posted to it would be

Dr

Trading a/c
Particulars

To Opening Stock
To Purchases
To Direct Expenses

sub-total

Amount

Particulars

(in Rs)

20,000
2,48,000
54,000

Cr

By Closing Stock
By Stock Unused

sub-total

3,22,000

Amount
(in Rs)

36,000
14,000
50,000

The trading account before crediting sales would have a greater total on the debit side and thus has a debit balance.
That debit balance represents the cost of goods sold.
Thus, to ascertain the cost of goods sold, we need to balance the "Trading a/c" without crediting sales.
The Sales a/c can be subsequently transferred to the Trading a/c to ascertain the Gross Profit.

Dr

Trading a/c
Particulars

To Opening Stock
To Purchases
To Direct Expenses

Amount

Particulars

(in Rs)

20,000
2,48,000
54,000

Cr

By Closing Stock
By Goods Unused
By Cost of Goods Sold c/d

3,22,000
To Cost of Goods Sold b/d
To Gross Profit

2,72,000
1,08,000

Amount
(in Rs)

36,000
14,000
2,72,000
3,22,000

By Sales

3,80,000

3,80,000

3,80,000

If such a two stage Trading a/c is prepared, we would be able to ascertain the Cost of Goods Sold as well as Gross
Profit from the Trading a/c itself.

Ascertaining Cost of Goods Sold by Mathematical Calculations


The Trading a/c is generally prepared only as a single stage account as follows

Dr

Trading a/c
Particulars

To
To
To
To

Opening Stock
Purchases
Direct Expenses
Gross Profit

Amount
(in Rs)

20,000
2,48,000
54,000
1,08,000

Cr
Particulars

By Sales
By Goods Unused
By Closing Stock

4,30,000

Amount
(in Rs)

3,80,000
14,000
36,000
4,30,000

To obtain the value of cost of goods sold from this we use the definition for gross profit.
Cost of Goods Sold = Sales Gross Profit [Since Gross Profit = Sales Cost of Goods Sold]
= Rs. 3,80,000 Rs. 1,08,000
= Rs. 2,72,000

Finding Cost of Goods Sold using Goods Consumed


a/c
The value of Cost of Goods Sold can also be obtained specifically, by maintaining a separate account for the purpose.
This may be named "Goods Consumed a/c" (any other indicative name may be used).
The basic purpose of accounting is derivation of information and the more
the information we need, the more the accounting heads we need to
maintain.
The Goods Consumed a/c is nothing but the first part of the trading account where it was balanced twice.

Dr

Goods Consumed a/c


Particulars

To Opening Stock
To Purchases
To Direct Expenses

Amount

Particulars

(in Rs)

20,000
2,48,000
54,000

By Goods Unused
By Closing Stock
By Trading a/c

3,22,000

Cr
Amount
(in Rs)

14,000
36,000
2,72,000
3,22,000

The balance in the Goods Consumed a/c represents Cost of Goods sold. This account is closed by transferring the
balance to the Trading a/c.

Dr

Trading a/c
Particulars

To Goods Consumed
To Gross Profit

Amount

Particulars

(in Rs)

2,72,000
1,08,000
3,80,000

Cr

By Sales

Amount
(in Rs)

3,80,000
3,80,000

Cost of Goods Consumed


If the balances in the ledger accounts representing direct expenses are not transferred to the "Goods Consumed a/c"
but are transferred to the "Trading a/c", then the balance from the "Goods Consumed a/c" cannot be called cost of
goods sold (value of goods sold).
It just represents the cost of goods consumed. To obtain the cost of goods sold from this, the direct expenses have
to be added to this.

Goods used within the Organisation have to be valued at


Cost
The stock that is used within the organisation (stock drawn by the proprietor for own purposes, stock used for
building an asset, stock used for advertisement purposes, etc.,) have to be valued at cost.
This is for the reason that if such usages are recorded at a value which includes an element of profit, the transaction
when recorded would generate a profit, which would amount to making a profit out of a transaction with oneself.

Principle of Mutuality One cannot make a profit out of a transaction with oneself

Illustrative Explanation
Consider the following data relating to an organisation which started its operations on 28th December 2006:

Opening Stock :: Nil;


Purchases :: Rs. 1,20,000;
Direct Expenses :: Rs. 30,000
Sales :: Nil
Stock used by the organisation internally Rs. 20,000 (Valued at Cost).
Generally Sales are made by adding 25% profit to cost

Closing Stock :: ?
The accounting period ends on 31st December 2006.
Value of Closing Stock with the Organisation = Total Value of Stock Value of Stock used up internally
= Purchases + Direct Expenses Rs. 20,000
= (Rs. 1,20,000 + Rs. 30,000) Rs. 20,000
= Rs. 1,30,000
Sales value of the stock used within the organisation = Cost + 25% of Cost
= Rs. 20,000 + 25% of Rs. 20,000
= Rs. 20,000 + Rs. 5,000
= Rs. 25,000

Stock used up internally recorded at Sales Value


Dr

Trading a/c
Particulars

To Purchases
To Direct Exp.
To Gross Profit

Amount

Amount

(in Rs)

(in Rs)

Cr
Particulars

Amount

Amount

(in Rs)

(in Rs)

1,20,000 By Sales
30,000 By Stock used
5,000 By Closing Stock
1,55,000

25,000
1,30,000
1,55,000

There is no commercial activity (no sales), there is no scope for earning profits. But the Trading a/c reveals a Gross
Profit of Rs. 5,000 which is on account of the stock used up internally being recorded at sales value.
Such profit generation is inappropriate for the reason that in using up stock within the organisation, the organisation
is not conducting a transaction with an outside party.
Thus to avoid profit generation in such cases, the stocks so used are to be valued at cost.

Stock used up internally recorded at Cost

Dr

Trading a/c
Particulars

Amount

Amount

(in Rs)

(in Rs)

To Purchases
To Direct Exp.
To Gross Profit

Cr
Particulars

Amount

Amount

(in Rs)

(in Rs)

1,20,000 By Sales
30,000 By Stock used
Nil By Closing Stock
1,50,000

20,000
1,30,000
1,50,000

The Trading a/c would reveal no profit when the stock used up internally is valued at cost.

Finding Value of Closing Stock from


Sales
We may be able to ascertain what is left out if we know what has been sold. This logic may be applied in finding the
value of closing stock. However, to know this, we need to ascertain the value of cost of goods sold.
i.

Gross Profit = Sales Cost of Goods Sold

ii.

Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses Closing Stock

iii.

Gross Profit = Sales (Opening Stock + Purchases + Direct Expenses Closing Stock) [From (i) and (ii)]
= Sales Opening Stock Purchases Direct Expenses + Closing Stock

iv.

Closing Stock = Opening Stock + Purchases + Direct Expenses + Gross Profit Sales [From (iii)]

To use this relation to obtain the value of closing stock, we need the information relating to Gross Profit. All other
information in this relation is readily available from the accounting records.

Gross Profit
Ratio
Ratio : Percentage
Ratio is a comparison between two numerical quantities of the same kind.
Ratio between two quantities is expressed in the form a : b
or

a
b

, where "a" and "b" do not have a common factor.

Percentage = Ratio 100

Gross Profit Ratio


Gross Profit Ratio is the ratio of Gross Profit to Net Sales Value or Cost of Goods Sold.

To Sales
Gross Profit Ratio =

Gross Profit
Net Sales

Gross Profit as a % of Sales =

Gross Profit
Net Sales

100

(Or)= Gross Profit Ratio (to Sales) 100

To Cost of Goods Sold


Gross Profit

Gross Profit Ratio =

Cost of Goods Sold

Gross Profit as a % of Cost of Goods Sold =

Gross Profit
Cost of Goods Sold

100

(Or)= Gross Profit Ratio (to Cost) 100

Inter-Relationship between the two Ratios


The Gross Profit Ratio (to Sales) and Gross Profit Ratio (to Cost of Goods Sold) are interrelated and one can be
obtained if the other is known.

Finding GP Ratio (to Cost) when GP Ratio (to Sales) is known


Gross Profit = Sales Gross Profit Ratio (to Sales)
=xy
= xy
Cost of Goods Sold = Sales Gross Profit
= x xy
= x (1 y)
Gross Profit Ratio (to Cost) =
=
=

Gross Profit
Cost of Goods Sold
xy
x (1 y)
y
(1 y)

Given Gross Profit Ratio (to Sales) is 0.25 y = 0.25


Therefore, Gross Profit Ratio (to Cost) =
=
=
=

y
(1 y)
0.25
(1 0.25)
0.25
0.75
1
3

= 0.33
Gross Profit (as a % to Cost) = Gross Profit Ratio (to Cost) 100
= 0.33 100
= 33

1
3

Let the data on 100 scale be represented by 'm'. y =


Gross Profit Ratio (as a % of Cost) =

100

m
100

Show/Hide

(1 y)
m
100

(1

100

100

m
100

100 m

100

100
m

100

100 m

100 m
25

100 25
25

=
=

100
3

= 33

Gross Profit Ratio (to Cost) =

y=

100

75

1
3

1
a

y
(1 y)
1
a

(1

1
=

a
a1
a

=
=

1
a

a
a1

1
a1

Given Gross Profit Ratio (to Sales) =

1
4

100

100

Therefore, Gross Profit as a % of Cost =

Let the data be represented by

100 m

100

a=4

100

100

Gross Profit Ratio (to Cost) =

a1
1

41
1

Gross Profit (as a % to Cost) = Gross Profit Ratio (to Cost) 100
1

100

= 33

Finding GP Ratio (to Sales) when GP Ratio (to Cost) is known


Gross Profit = Cost of Goods Sold Gross Profit (to Cost of Goods Sold)
=pq
= pq
Sales = Cost of Goods Sold + Gross Profit
= p + pq
= p (1 + q)
Gross Profit Ratio (to Sales) =
=
=

Gross Profit
Net Sales
pq
p (1 + q)
q
(1 + q)

Therefore, Gross Profit Ratio (to Sales) =


=
=
=

q
(1 + q)
0.2
(1 + 0.2)
0.2
1.2
1
6

Gross Profit (as a % to Sales) = Gross Profit Ratio (to Cost) 100
=

1
6

= 16

100
2
3

Let the data on 100 scale be represented by 'n'. q =

Gross Profit as a % of Sales =

q
(1 + q)

100

n
100

Show/Hide

n
100

100

(1 +

100

n
=

100

100

100 + n
100

=
=

100

100
100 + n

100

100

100 + n

Therefore, Gross Profit as a percentage of Saes =

=
=
=

n
100 + n
20
100 + 20
20
120
1
6

Let the data be represented by

Gross Profit Ratio (to Sales) =

q=

1
b

q
(1 + q)
1
b

(1 +

1
=

b
b+1
b

=
=

1
b

b
b+1

1
b+1

Given Gross Profit Ratio (to Sales) is


Gross Profit Ratio (to Sales) =

1
b+1

1
5

b=5

100

100

100

= 16 2/3%
1

100

=
=

1
5+1
1
6

Gross Profit Ratio (as a % to Sales) = Ratio 100


1

100

= 16

Frequently used conversions


Hundred Scale
As a % of Cost

20

As a % of Sales 16

25 33

2
3

20

50

25

33

66

1
3

2
3

40

100

50

One Scale
As a % of Cost

0.2

0.25 0.333

As a % of Sales 0.166 0.20

0.25

0.5

0.666

0.333

0.4

0.5

Inverse
As a % of Cost

As a % of Sales

final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,adjustments

Gross Profit is generally NonUniform


The gross profit earned by an organsation is in almost all cases not a figure that can be easily derived (without the
availability of the value of closing stock). Deriving the value of closing stock would be far easier than deriving the
value of gross profit made (based on sales).

Variety of Products being Sold


The organisation may be selling a number of products with different selling prices and different rates of gross profits.
In such cases, if the gross profit figure is to be ascertained from the sales figure, sales records should be maintained

so as to give the sales details relating to each product with a distinct Gross Profit %. This would involve a lot of work
and would be impractical, more so where there are a large number of products being dealt with.

Variations in Sale Prices


The prices charged to customers are dependent on a number of factors like the market conditions, the immediate
competition existing in the market, the loyalty of the customers etc.
Depending on the market conditions, some times the prices may be varied instantaneously.
Depending on the customer to whom the product is being sold, the prices may be varied (a discount may be given to
loyal customers) etc.
In such a situations there would not be uniformity in the Gross profit percentage and it would be near to impossible
to ascertain the gross profit made using the sales figures.
Since using the figure of gross profit to ascertain the value of closing stock available in the organisation is not a
feasible idea, we look at other methods for finding out the value of closing stock.

How is the Value of Closing Stock


Ascertained?
Physical Stock
Closing stock is the stock/goods unsold at the end of the accounting period.
The details relating to the physical stock would be readily available with the organisation only if the inventory records
are being maintained by the organisation. In other cases the physical stock would have to be ascertained by stock
taking.

Stock Value
There is no specific ledger account in financial accounting that would give us the information relating to the value of
closing stock ready hand.
The value of closing stock is available ready hand only if inventory records are being maintained that too from the
inventory records.
The value of Closing Stock is ascertained by Physical Verification of Stock on the last day of the
accounting period and its valuation at Cost or Market Price (Net Realisable Value) whichever is
lesser
This is the most common method for valuing the closing stock.
The information relating to the value of closing stock is not regularly required by the organisation. It is however
required at the end of the accounting period for the purpose of evaluation of the Cost of Goods Sold.

Convention of
Conservatism
Net Realisable Value of Stock
For the purpose of Valuation of closing Stock, Market Price implies Net Realisable Value/Rate and not the Selling

Price.
Net Realisable Value of stock is the net sale realisation excluding all the expenses directly and exclusively relatable to
the sale (Sale commission, Brokerage etc) from the Sale Realisation.
Therefore, in trying to ascertain the Market Price to be used for valuation, care should be taken to ensure that such
expenses are deducted from the sales price to ascertain the net realisable value of stock.

Convention of Conservatism
By the Convention of Conservatism we take into consideration all those
expenses and losses of which we are aware, even if they relate to the
subsequent accounting periods.
The act of valuing closing stock at cost or market price is based on the "Convention of Conservatism".

Convention of Conservatism : Valuation of Closing Stock :


Illustration
Following is the "Trading a/c" relating to an organisation, wherein the Closing Stock has been recorded at cost.

Dr

Trading a/c
Particulars

To
To
To
To

Opening Stock
Purchases
Direct Expenses
Gross Profit

Amount
(in Rs)

20,000
2,48,000
54,000
94,000
4,16,000

f
i
n
a
l
,
a
c
c
o
u
n
t
s
,
f
i
n
a
n
c
i

Cr
Particulars

By Sales
By Closing Stock

Amount
(in Rs)

3,80,000
36,000

4,16,000

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Closing Stock details


The closing stock is made up of

Batch N :: 600 units valued at Rs. 36/unit with a total value of Rs. 21,600
Batch M :: 600 units valued at Rs. 24/unit with a total value of Rs. 14,400
Total 1,200 units with a total value of Rs. 36,000
Value here implies cost + direct expenses

The selling prices and the related expenses are

Batch N :: Rs. 50/unit


Batch M :: Rs. 50/unit [Regular price]
Batch M :: Rs. 25/unit [Current price]
This stock represents an outdated model of the product and the present market conditions would enable
the stock to be sold only at a price of Rs. 25 per unit.

The sales of all stocks are made through a dealer who would charge a commission of 10% of the sale
proceeds.

Cost and Net Realisable Values of Closing Stock


From the available data, Closing stock can be valued at two different rates. Cost and Market Price (Net Realisable
Rate).

600

units [Batch N]
i. Cost = Rs. 36/unit.
ii. Market Price = Rs. 50/unit.

iii. Expenses directly relatable to sale = Rs. 5/unit


(10% of selling price = Rs. 50/unit 10%).
iv. Net Realisable Value = Rs. 45/unit
[Market Price (Rs. 50/unit) Expenses relatable to sale (Rs. 5/unit)]

600

units [Batch M]
i. Cost = Rs. 24/unit.
ii. Market Price = Rs. 25/unit.

iii. Expenses directly relatable to sale = Rs. 2.50/unit


(10% of selling price = Rs. 25/unit 10%).
iv. Net Realisable Value = Rs. 22.50/unit
[Market Price (Rs. 25/unit) Expenses relatable to sale (Rs. 2.50/unit)].

Valuation of Closing Stock based on Convention of Conservatism


600

units [Batch N]

Cost = Rs. 36/unit. Net Realisable Rate = Rs. 45/unit.


Since Cost < Net Realisable Value, the goods are to be valued at cost.
Value of 600 units is Rs. 21,600 (600 units Rs. 36/unit)

600

units [Batch M]

Cost = Rs. 24/unit. Net Realisable Rate = Rs. 22.50/unit.


Since Net Realisable Value < Cost, the goods are to be valued at the net realisable value.
Value of 600 units is Rs. 13,500 (600 units Rs. 22.50/unit)

Value of Closing stock if valued at cost = Rs. 14,400 (600 units Rs. 24/unit)
The Closing Stock should be valued therefore at Rs. 35,100 (Rs. 21,600 + 13,500).

Trading a/c
If value of Closing Stock is taken based on the Convention of Conservatism, the Trading a/c would be

Dr

Trading a/c
Particulars

To
To
To
To

Opening Stock
Purchases
Direct Expenses
Gross Profit

Amount

Particulars

(in Rs)

20,000
2,48,000
54,000
93,100

Cr

By Sales
By Closing Stock

4,15,100

Amount
(in Rs)

3,80,000
35,100

4,15,100

The Gross profit has gone down by Rs. 900 since closing stock is considered at a lesser value.

Role of Convention of
Conservatism
The convention of conservatism asks us to take into consideration all those expenses and losses relating to the
subsequent periods of which we are aware.

Future Losses
Where the Net realisable value of stock is less than its cost, the organisation may incur a loss.
In the above case, the organisation may have to incur a loss of Rs. 900 [Rs. 14,400 (cost) Rs. 13,500 (net
realisable value)].

When?
This loss would have to be borne by the organisation if it sells the stock at the net realisable rate.
Since it is the end of the accounting period, such a sale at such a price, if at all it takes place, would be in the
subsequent accounting period.
Thus, the organisation may have to incur this loss in the future.

Is the loss for sure?


The loss may have to be incurred in the future only if the stock has to be sold at Rs. 25 per unit (which gives a net
realisation of Rs. 22.50).
We may consider such a loss a certainty in cases where the stock is required to be sold at the lower price on account
of it becoming obsolete, losing demand etc.
Bu where the lower market rate is on account of normal market fluctuation and if the rates go up in the subsequent
period and the product can be sold at a higher price, this loss need not be incurred.

How is the loss


absorbed?
Based on the Convention of Conservatism, the loss though it may have to be incurred in the future period, is
absorbed in the current period itself, since its information is known.
This will be the case where the lower valuation is on account of conditions which are certain (obsolete goods,
demand going down etc).

Crediting a Nominal a/c implies gain


The value of closing stock is credited to the "Trading a/c". By the principle of credit in relation to nominal accounts
(Credit all Incomes and Gains), we can assume the value to indicate a gain.
Reducing the value of closing stock would therefore amount to reducing the credit made to the Trading a/c, which
would be reducing the gain. Debiting an amount is an equivalent of deducting the amount from the opposite side i.e.
the credit side. Therefore, reducing the gain is the same as taking in additional loss.
Therefore, the loss is absorbed by considering the value of closing stock at a lesser value i.e. the net realisable
value. [In the above example, by considering the closing stock at the lower value, the estimated loss of Rs. 900
relating to the subsequent accounting periods has been absorbed in the current period itself.]

Value of Closing Stock = Value of Opening Stock of the


Subsequent Period
The Closing Stock a/c relating to an accounting period and the Opening Stock a/c relating to the subsequent
accounting period represent the same account. Therefore, the value of the closing stock at the end of the accounting
period and the opening stock at the beginning of the subsequent accounting period are the same.

Closing Stock a/c


The "Closing Stock a/c" is a real account and is created at the last moment of the accounting period.
It represents Stock as an asset. The balance in the "Closing Stock a/c" is carried forward to the next accounting
periods.

Opening Stock a/c


The account that we name "Closing Stock a/c" is renamed "Opening Stock a/c" at the beginning of the next
accounting period while bringing the values of assets and liabilities into the books of accounts with the help of an
"Opening Entry".
This "Opening Stock a/c" is treated as an equivalent of a Nominal account.
Like other nominal accounts it is closed at the end of the accounting period. It is closed by transfer to the "Trading
a/c" since it goes into the value of cost of goods sold.

Note
The value of Opening and Closing stocks relating to a particular accounting period do not mean the same. They are
two indicated by distinct ledger accounts - Opening stock by "Opening Stock a/c" which is a nominal account and
Closing stock by "Closing Stock a/c" which is a Real account.
They may or may not have the same values.

Recording the Value of Closing


Stock
The valuation of closing stock and recording of the value of closing stock in the books are two different aspects.
After ascertaining the value of the closing stock, it is to be brought into the books of accounts.
The basic purpose of accounting is derivation of information and the more information we need
the more the accounting heads we need to maintain.
For each additional piece of information that we intend to derive from the books of accounts, we create and use an
additional ledger account.
Thus, to derive the information relating to Closing Stock we maintain a real account by name "Closing Stock a/c".
The "Closing Stock a/c" gives the information relating to the value of the stock (as an asset) unsold at the end of the
accounting period.

Recording
The value of closing stock is not available ready hand in the books of accounts. It is specifically ascertained at the
end of the accounting period by physical verification of stock and its valuation at cost or market price whichever is
lower.
Thus, by recording the journal entry for Closing Stock, we are in effect bringing the value of Closing Stock into
books.

Debit : Closing Stock a/c


Accounts representing assets are real accounts and show a debit balance. Since by recording the journal entry for
bringing the value of closing stock into books, we are creating an asset by name "Closing Stock a/c" we debit that
account.
[Closing Stock a/c Real a/c Debit what comes in.]

Credit :
There are three possible variations in the account to be credited for recording the value of closing stock.
i.

Trading a/c

ii.

Goods Consumed a/c

iii.

Purchases a/c

The ledger account to be credited is dependent on which account is used to reflect the value of cost of goods sold as
well as the time of recording the entry.

Recording Closing Stock Crediting Trading


a/c

Total value of goods = Opening Stock + Purchases + Direct Expenses.

Particulars

Amount

Opening Stock

Amount
20,000

(+) a) Purchases (Cost Value)

2,48,000

b) Direct Expenses

54,000

Total Value of Goods

3,02,000
3,22,000

() a) Closing Stock (Value)

36,000

b) Stock Unused for Trading

14,000

Cost of Goods Sold

50,000
2,72,000

Direct Incomes/Expenses transferred to Trading a/c


At the end of the accounting period, the balances (amounts) in all the ledger accounts which represent expenses
which go into the value of goods/stock (direct expenses), are closed by transfer to the "Trading a/c".
This would result in the "Trading a/c" being debited with the total value of goods/stock. Show/Hide

Dr

Trading a/c
Particulars

To Opening Stock
To Purchases
To Direct Expenses

Amount

Cr
Particulars

(in Rs)

Amount
(in Rs)

20,000
2,48,000
54,000
3,22,000

3,22,000

Revealing/Reflecting Cost of Goods Sold


To reflect/reveal the cost of goods sold, the value of closing stock is to be deducted from the total value of goods.
Thus the value of closing stock has to be credited to the "Trading a/c" which has the total value of goods/stock
existing in it as a debit balance. Show/Hide

Dr

Trading a/c
Particulars

To Opening Stock
To Purchases
To Direct Expenses

Amount
(in Rs)

20,000
2,48,000
54,000

Cr
Particulars

By Cost of Goods Sold c/d


By Closing Stock

3,22,000
To Cost of Goods Sold b/d

Amount
(in Rs)

2,86,000
36,000
3,22,000

2,86,000

Journal/Ledger
The Journal entry for recording the value of closing stock in such a case would be

Journal in the books of M/s ___ for the period from ____ to ____
Date

V/R
No.

Particulars

L/F Debit Amount


(in Rs)

Credit
Amount

(in Rs)
31st Dec

Closing Stock a/c


To Trading a/c

Dr

36,000
36,000

[For recording the value of Closing Stock in


the books.]

Dr

Closing Stock a/c


Particulars

To Trading a/c

Amount

Particulars

(in Rs)

36,000

Cr

By Bal c/d

36,000

Dr

(in Rs)

36,000
36,000

Trading a/c
Particulars

To
To
To
To

Amount

Opening Stock
Purchases
Direct Expenses
Gross Profit

Amount
(in Rs)

20,000
2,48,000
54,000
94,000

Cr
Particulars

By Sales
By Closing Stock

4,16,000

Amount
(in Rs)

3,80,000
36,000

4,16,000

final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,adjustments

Recording Closing Stock Crediting Goods Consumed


a/c
Where the organisation intends to specifically identify the cost of goods consumed, a separate ledger account by
name "Goods Consumed a/c" may be created and used for that purpose.

Direct Expenses transferred to Goods Consumed a/c


At the end of the accounting period, the balances (amounts) in all the ledger accounts which represent expenses
which go into the value of goods/stock (direct expenses), are closed by transfer to the "Goods Consumed a/c".
This would result in the "Goods Consumed a/c" being debited with the total value of goods/stock. Show/Hide

Dr

Goods Consumed a/c


Particulars

To Opening Stock
To Purchases
To Direct Expenses

Amount
(in Rs)

Particulars

Cr
Amount
(in Rs)

20,000
2,48,000
54,000
3,22,000

3,22,000

Revealing/Reflecting Cost of Goods Sold


To reflect/reveal the cost of goods sold, the value of closing stock is to be deducted from the total value of goods.
Thus the value of closing stock has to be credited to the "Goods Consumed a/c" which has the total value of

goods/stock existing in it as a debit balance. Show/Hide

Dr

Goods Consumed a/c


Particulars

To Opening Stock
To Purchases
To Direct Expenses

Amount

Amount

Particulars

(in Rs)

20,000
2,48,000
54,000

Cr
(in Rs)

By Trading a/c (?)


By Closing Stock

2,86,000
36,000

3,22,000

3,22,000

Journal/Ledger
The Journal entry for recording the value of closing stock in the books would be

Journal in the books of M/s ___ for the period from ____ to ____
Date

V/R
No.

31st Dec

Particulars

L/F

Closing Stock a/c


To Goods Consumed a/c

Dr

Debit Amount
(in Rs)

Credit
Amount
(in Rs)

36,000
36,000

[For recording the value of Closing Stock in


the books.]

Dr

Goods Consumed a/c


Particulars

To Opening Stock
To Purchases
To Direct Expenses

Amount

Particulars

(in Rs)

20,000
2,48,000
54,000

By Trading a/c (?)


By Closing Stock

3,22,000

Cr
Amount
(in Rs)

2,86,000
36,000
3,22,000

The balance in the "Goods Consumed a/c" represents the cost of goods sold and is transferred to the "Trading a/c" to
ascertain the Gross Profit.

Dr

Trading a/c
Particulars

To Goods Consumed
To Gross Profit

Amount

Particulars

(in Rs)

2,86,000
94,000

Cr

By Sales

3,80,000

Amount
(in Rs)

3,80,000
3,80,000

Balance in Goods Consumed a/c not representing Cost of


Goods Sold
The balancing figure in the "Goods Consumed a/c" transferred to the "Trading a/c" does not represent cost of goods
sold, in the following cases

Direct Expenses Transferred to Trading a/c

Where the direct expenses have been transferred to the Trading a/c instead of the Goods Consumed a/c, the
balancing figure in Goods Consumed a/c does not represent cost of goods sold.

Dr

Goods Consumed a/c


Particulars

To Opening Stock
To Purchases

Amount

Particulars

(in Rs)

20,000
2,48,000

By Trading a/c (?)


By Closing Stock

2,68,000

Cr
Amount
(in Rs)

2,32,000
36,000
2,68,000

Cost of Goods Sold implies the total value of goods sold which includes both cost of the goods (represented by
purchases a/c balance) and direct expenses related to the goods.
Since Direct Expenses have not been debited to Goods Consumed a/c, the balancing figure represents the value of
goods sold excluding direct expenses thereon.

Dr

Trading a/c
Particulars

To Direct Expenses
To Goods Consumed
To Gross Profit

Amount

Particulars

(in Rs)

54,000
2,32,000
94,000

Cr

By Sales

Amount
(in Rs)

3,80,000

3,80,000

3,80,000

Recording Closing Stock


Valuation of closing stock is independent of the accounting treatment. Closing Stock can be credited to either the
Trading a/c or the Goods Consumed a/c.
The only precaution to be taken would be in interpreting the balancing figure value. It should not be considered as
Cost of Goods Sold.
However, in such cases, it would be more appropriate to record the value of closing stock through the Trading a/c
where the value includes both cost and direct expenses.

Exception
Recording Closing Stock through Goods Consumed a/c would be rational if its value does not include any part of the
direct expenses incurred during the current period which have been debited to the Trading a/c.

Opening Stock transferred to Trading a/c


Where the balance in "Opening Stock a/c" has been transferred to the Trading a/c instead of the Goods Consumed
a/c, the balancing figure in Goods Consumed a/c may not represent Cost of Goods Sold.

Dr

Goods Consumed a/c


Particulars

To Purchases
To Direct Expenses

Amount
(in Rs)

2,48,000
54,000
3,12,000

Particulars

By Trading a/c (?)


By Closing Stock

Cr
Amount
(in Rs)

2,66,000
36,000
3,12,000

The balance in the Goods Consumed a/c transferred to the Trading a/c represents the value of goods that have been

purchased and sold away during the current period.


This does not include the value of opening stock that might also have been sold away. Thus this balance, cannot be
called "cost of goods sold" though it represents value.

Dr

Trading a/c
Particulars

To Opening Stock
To Goods Consumed
To Gross Profit

Amount

Amount

Particulars

(in Rs)

20,000
2,66,000
94,000

Cr
(in Rs)

By Sales

3,80,000

3,80,000

3,80,000

Recording Closing Stock


Valuation of closing stock is independent of the accounting treatment. Closing Stock can be credited to either the
Trading a/c or the Goods Consumed a/c.
The only precaution to be taken would be in interpreting the balancing figure value. It should not be considered as
Cost of Goods Sold.
However, in such cases, it would be more appropriate to record the value of closing stock through the Trading a/c
where the total value is debited ultimately.

Exception
Recording Closing Stock through Goods Consumed a/c would be rational closing stock includes only that stock which
has been purchased during the current accounting period.
This would be the case where the quantity of closing stock is less than the quantity purchased during the current
period and stock is being used up on FIFO basis.

Recording Closing Stock Crediting Purchases


a/c
Where the following conditions exist, we can credit "Purchases a/c" with the value of closing stock.

Closing stock is physically relatable to the stock that has been purchased during the current period.
[This would be the case where FIFO method is adopted for physical usage of stock]

There are no direct expenses in relation to the stock purchased during the current period
(Or)
The value of closing stock does not include the direct expenses incurred during the current period

Journal/Ledger
The Journal entry for recording the value of closing stock in the books would be

Journal in the books of M/s ___ for the period from ____ to ____
Date

V/R
No.

31st Dec

Particulars
Closing Stock a/c

L/F
Dr

Debit Amount
(in Rs)
36,000

Credit
Amount
(in Rs)

To Purchases a/c

36,000

[For recording the value of Closing Stock in


the books.]

Dr

Purchases a/c
Date

1st31st

Particulars

To Cash/Bank/Crs

J/F

Amount
(in Rs)

2,48,000

Cr

Date

Particulars

31/12/05 By Closing Stock


31/12/05 By Trading a/c

Amount

J/F

(in Rs)

36,000
2,12,000

2,48,000

Dr

Trading a/c
Particulars

To
To
To
To

2,48,000

Opening Stock
Purchases
Direct Expenses
Gross Profit

Amount

Particulars

(in Rs)

20,000
2,12,000
54,000
94,000

Cr

By Sales

3,80,000

Amount
(in Rs)

3,80,000

3,80,000

Conventional use
Technically we can credit the value of closing stock to Purchases a/c only when the above conditions are satisfied.
The use of "Trading a/c" or "Goods Consumed a/c" for crediting the value of closing stock, is possible only if the
journal entry for brining the value of closing stock into books is being recorded at the time of preparation of final
accounts.
Where we are recording the value of closing stock in the accounting books before the preparation of final accounts, it
is a convention that we credit "Purchases a/c" (on account of the absence of "Trading a/c" or "Goods Consumed a/c"
for use).
final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,adjustments

Closing Stock a/c : Opening Stock a/c


The "Closing Stock a/c" and the end of an accounting period and the "Opening Stock a/c" at the beginning of the
subsequent accounting period represent the same account.

At the End of an Accounting Period


The closing balances in all the ledger accounts are carried forward to the subsequent accounting periods.
Every ledger posting should have a journal support.
The journal entry that supports the carry forward of balances in ledger accounts is called the "Closing Entry".

Closing Entry
The journal entry for closing the books of accounts during an accounting period

Journal in the books of M/s ___ for the period from ____ to ____
Date

V/R
No.

31st Dec

Particulars

L/F

Creditors a/c
Bank Loan a/c
Profit & Loss Appropriation a/c
Capital a/c
To Closing Stock a/c
To Cash a/c
To Debtors a/c
To Furniture a/c

Dr
Dr
Dr
Dr

Debit Amount
(in Rs)

Credit
Amount
(in Rs)

48,000
63,000
54,000
1,00,000
36,000
42,000
1,26,000
61,000

[For the balances in the ledger accounts


carried forward to the next accounting
period.]

Closing Balance Sheet


The closing Balance Sheet is a statement of balances that are carried forward to the subsequent accounting periods.

Balance Sheet of M/s ______ as on the Last Day


Liabilities

Amount

Capital
Profit & Loss Appropriation
Creditors
Bank Loan

1,00,000
54,000
48,000
63,000

Assets
Cash
Closing Stock
Debtors
Furniture

2,65,000

Amount
42,000
36,000
1,26,000
61,000
2,65,000

At the beginning of the Subsequent Accounting Period


The opening balances in all the ledger accounts are brought forward from the previous accounting periods. Every
ledger posting should have a journal support and the journal entry that supports the brining forward of balances in
ledger accounts is called the "Opening Entry".

Opening Balance Sheet


The opening balance sheet of an accounting period and the closing balance sheet of the previous period are the
same. This is something that is not specifically prepared.

Balance Sheet of M/s ______ as on the First Day


Liabilities

Amount

Capital
Profit & Loss Appropriation
Creditors
Bank Loan

1,00,000
54,000
48,000
63,000
2,65,000

Assets
Cash
Closing Stock
Debtors
Furniture

Amount
42,000
36,000
1,26,000
61,000
2,65,000

Opening Entry
The opening entry is based on the opening balance sheet.

Journal in the books of M/s ___ for the period from ____ to ____
Date

V/R
No.

31st Dec

Particulars
Cash a/c
Opening Stock a/c
Debtors a/c
Furniture a/c
To Capital a/c
To Profit & Loss Appropriation a/c
To Bank Loan a/c
To Creditors a/c

L/F
Dr
Dr
Dr
Dr

Debit Amount
(in Rs)

Credit
Amount
(in Rs)

42,000
36,000
1,26,000
61,000
1,00,000
54,000
63,000
48,000

[For the opening balances in the various


ledger accounts brought forward into the
books of accounts from the previous
accounting period.]
Where the Opening Entry is being recorded, the phrase "Closing Stock" is replaced by the phrase "Opening Stock".

Closing Stock Adjustment during Final


Accounting
The value of closing stock is ascertained through physical verification of the stock and its valuation at cost or market
price whichever is lesser.
Thus recording the entries for brining in the value of closing stock into books may not be complete by the time trial
balance is drawn up.
If the value of closing stock is not available (or is not recorded) by the time of making up the trial balance at the end
of the accounting period, it would appear as a part of the transactions appended to the trial balance which are to be
adjusted.
Adjustment is bringing in the effect of the transactions through mathematical operations of addition and subtraction.
The adjustments to be made can be found out by ascertained the net effect of the journal entries to be recorded.
In adjusting the value of closing stock we consider the entry for recording the same to be the one where the Trading
a/c or Purchases a/c is credited.

Where the closing stock is recorded by crediting its value to the Trading a/c

Entry
Dr. Closing Stock a/c
Cr. Trading a/c

Effect
1. (+) Show the Value of Closing Stock on the Assets side of the Balance Sheet
2. (+) Show the Value of Closing Stock on the Credit side of Trading a/c

Where the closing stock is recorded by crediting its value to Purchases a/c

Entry
Dr. Closing Stock a/c

Effect
1. (+) Show the Value of Closing Stock on the Assets side of the Balance Sheet

Cr. Purchases a/c

2. () Deduct the Value of Closing Stock from Purchases on the Debit side of
Trading a/c

Where the closing stock is recorded by crediting Goods Consumed a/c

Entry

Effect

Dr. Closing Stock a/c


Cr. Goods Consumed a/c

1. (+) Show the Value of Closing Stock on the Assets side of the Balance Sheet
2. (+) Show the Value of Closing Stock on the Credit side Goods Consumed a/c

This assumption is generally avoided, where the value of closing stock has to be dealt with as an
adjustment.

Closing Stock in Trial Balance


Interpretation
Where "Closing Stock a/c" is present in the Trial Balance, it is an indication of the Journal entry for recording the
value of closing stock has already been recorded.

Dealing with Closing Stock a/c


The "Closing Stock a/c" represents an asset and is thus a Real account.
Since an item appearing in the "Trial Balance" has to be dealt with only once based on its nature, the Closing Stock
a/c appearing in the trial balance is shown on the assets side of the Balance Sheet.
The balance in all the real accounts is carried forward to the subsequent accounting periods. All such accounts whose
balances are carried forward to the subsequent accounting periods are listed in the Balance Sheet as at the end of
the accounting period. Thus all the real account balances are shown on the assets side of the balance sheet.

What was the Journal Entry used?


The Journal entry used for recording the value can be identified/assumed depending on what ledger accounts are
present in the Trial Balance

Trading a/c appears in the Trial Balance


Trial Balance of M/s ___ " as on 30th June 2005
Particulars
Opening Stock a/c
Purchases a/c

Closing Stock a/c

Trading a/c

L/F

Total

Debit
Amount
(in Rs)

Credit
Amount
(in Rs)

20,000
2,48,000
36,000
36,000

xxx

Where Closing Stock a/c and Trading a/c appear in Trial Balance

xxx

Dr. Closing Stock a/c


Cr. Trading a/c

The entry used for recording the value of closing stock.

Trading a/c does not appear, but Purchases a/c appears in the Trial Balance
Trial Balance of M/s ___ " as on 30th June 2005
Particulars

L/F

Opening Stock a/c


Purchases a/c

Closing Stock a/c

Debit
Amount
(in Rs)

Credit
Amount
(in Rs)

20,000
2,12,000
36,000

Total

xxx

xxx

Where Closing Stock a/c and Purchases a/c appear in Trial Balance
Dr. Closing Stock a/c
Cr. Purchases a/c

The entry used for recording the value of closing stock.

Both Trading a/c and "Purchases a/c" do not appear in the Trial Balance
Trial Balance of M/s ___ " as on 30th June 2005
Particulars

L/F

Debit
Amount
(in Rs)

Goods Consumed

Closing Stock a/c

Total

Credit
Amount
(in Rs)

2,32,000
36,000

xxx

xxx

Where Purchases a/c and Trading a/c do not appear in the Trial Balance and

Where Closing Stock a/c and Goods Consumed a/c appear in Trial Balance
Dr. Closing Stock a/c
The entry used for recording the value of closing stock.
Cr. Goods Consumed a/c

Purchases and Sales Return


a/c's
Each ledger account provides one or more pieces of information. To enable derivation of additional information
relating to returns of goods/stock, we record the transactions relating to purchase returns as well as sales returns
using Purchase Returns a/c and Sales Returns a/c respectively.

Purchases Returns a/c


Purchase Returns a/c is a nominal account. It provides the information relating to the value of goods/stock returned
to the seller from whom the stock has been purchased.
Being a nominal account, this account is closed at the end of the accounting period.

Sales Returns a/c


Sales Returns a/c is a nominal account. It provides the information relating to the value of goods/stock returned by
the buyers to whom the stock has been sold.
Being a nominal account, this account is closed at the end of the accounting period.

Gross Purchases and Gross Sales


The Purchase Returns a/c and the Sales Returns a/c provide information relating to returns only.
Since returns are recorded separately using these accounts, the Purchases a/c and Sales a/c give the information
relating to the Gross Purchases and Gross Sales.

Need for information relating to Net Values


Along with the information relating to the returns and the gross values, the organisation needs the information
relating to the net values i.e. the net purchases and net sales made by it.
There are two methods adopted for deriving the information relating to Net Purchases and Net Sales.

By Setting off related Ledger account balances.


By Transferring the balance in the returns accounts to Trading a/c and making adjustments thereon.
This information is generally derived at the end of the accounting period. However, it can be derived as and when
needed, by deducting the balance in the returns account from the balance in the main account.
final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,adjustments

Finding Net Purchases/Sales by Setting off related Ledger


Account Balances

SET OFF Setting off of ledger accounts is clubbing two accounts with opposite balances. In
setting off ledger account balances, we close the account with the lower balance by transferring
it to the account with a higher balance.

Finding Net Purchases


The Purchases a/c carries a debit balance and the Purchase Returns a/c carries a credit balance. At the end of the
accounting period, the two accounts are set off i.e. the Purchase Returns a/c is closed by transfer to the Purchases
a/c.
Transfer of a credit balance from one account to a second would result in the second account
being credited and the first account being debited.
The balance remaining in the Purchases a/c would thus represent net purchases. While closing the purchases
account at the end of the accounting period, this balance is transferred to the Trading a/c

Journal/Ledger

Show/Hide

Journal in the books of M/s __ for the period from ____ to _____
Date

V/R
No.

March 31st

Particulars

L/F

Purchase Returns a/c


To Purchases a/c

Dr

Debit Amount
(in Rs)

Credit
Amount
(in Rs)

80,000
80,000

[For transferring the balance in the purchase


returns account to the purchases account to
derive the net purchases]

Dr

Purchase Returns a/c


Particulars

To Purchases a/c

Amount

Particulars

(in Rs)

80,000

Amount
(in Rs)

By
By

80,000

Dr

Cr

80,000

Purchases a/c
Particulars

To
To

Amount

Cr
Particulars

(in Rs)

5,80,000

By Purchase Returns a/c


By Trading a/c

Amount
(in Rs)

80,000
5,00,000
5,80,000

Finding Net Sales


The Sales a/c carries a credit balance and the Sales Returns a/c carries a debit balance. At the end of the accounting
period, the two accounts are set off i.e. the Sales Returns a/c is closed by transfer to the Sales a/c.
Transfer of a debit balance from one account to a second would result in the second account
being debited and the first account being credited.

The balance remaining in the Sales a/c would thus represent net sales. While closing the Sales account at the end of
the accounting period, this balance is transferred to the Trading a/c

Journal/Ledger

Show/Hide

Journal in the books of M/s __ for the period from ____ to _____
Date

V/R
No.

March 31st

Particulars

L/F

Sales a/c
To Sales Returns a/c

Dr

Debit Amount
(in Rs)

Credit
Amount
(in Rs)

72,500
72,500

[For transferring the balance in the sales


returns account to the sales account to
derive the net sales]

Dr

Sales Returns a/c


Particulars

Amount

Particulars

(in Rs)

To
To

Cr

By Sales a/c

(in Rs)

72,500

72,500

Dr

Amount

72,500

Sales a/c
Particulars

To Sales Returns a/c


To Trading a/c

Amount

Particulars

(in Rs)

72,500
7,51,500

Cr

By
By

Amount
(in Rs)

8,24,000

8,24,000

Information in Trading a/c


If this method is adopted for deriving the value of net purchases and sales, the Trading a/c would not display
information relating to returns and would contain postings as To Purchases a/c on the debit side and the By Sales a/c
on the credit side.

Dr

Trading a/c
Particulars

To
To
To
To
To
To

Opening Stock
Purchases
Wages
Octroi
Carriage Inwards
Gross Profit

Amount
(in Rs)

40,000
5,00,000
45,000
32,000
15,000
2,40,500
8,27,500

Cr
Particulars

By Sales
Closing Stock

Amount
(in Rs)

7,51,500
76,000

8,27,500

Transferring balances in Purchases/Sales Returns a/c to


Trading a/c

The Purchase Returns a/c and the Sales Returns a/c being nominal accounts are closed at the end of the accounting
period by transfer to the Trading a/c (instead of to the Purchases a/c and Sales a/c respectively).
The Purchase Returns a/c carries a credit balance and the "Sales Returns a/c" carries a credit balance.

Journal
The journal entries for closing these accounts by transfer to the trading account would be

Journal in the books of M/s __ for the period from ____ to _____
Date

V/R
No.

March 31st

Particulars

L/F

Purchase Returns a/c


To Trading a/c

Dr

Debit Amount
(in Rs)

80,000

72,500

Credit
Amount
(in Rs)
80,000

[For transferring the balance in the purchase


returns account at the end of the accounting
period to the trading account]
March 31st

Trading a/c
To Sales Returns a/c

Dr

72,500

[For transferring the balance in the sales


returns account at the end of the accounting
period to the trading account]

Posting in Trading a/c


The "Trading a/c" with these journal entries posted:

Dr

Trading a/c
Particulars

To
To
To
To
To
To
To

Opening Stock
Purchases
Sales Returns
Wages
Octroi
Carriage Inwards
Gross Profit

Amount
(in Rs)

40,000
5,80,000
72,500
45,000
32,000
15,000
2,40,500
9,80,000

Cr
Particulars

By Sales
By Purchase Returns
Closing Stock

Amount
(in Rs)

8,24,000
80,000
76,000

9,80,000

We cannot derive the information relating to Net Purchases and Net Sales by just Posting the entries to the Trading
a/c.
final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,adjustments

Adjustment in Trading a/c : Information relating to Net


Purchases/Sales
Since the information relating to Net Purchases and Net Sales is not revealed by just transferring the balances in the
returns accounts to the Trading a/c we need to make adjustments to derive that information.

Net Purchases
Posting (showing) an amount on the credit side of an account is an equivalent of deducting the
amount from an item on the debit side.
Thus the Purchase Returns a/c balance instead of being shown on the credit side is deducted from Purchases a/c
balance on the debit side of the Trading a/c, thereby giving the figure of Net Purchases in the Trading a/c itself.

Net Sales
Posting (showing) an amount on the debit side of an account is an equivalent of deducting the
amount from an item on the credit side.
Thus, the Sales Returns a/c balance instead of being shown on the debit side would be deducted from Sales a/c on
the credit side of the Trading a/c, thereby giving us the figure of Net Sales in the Trading account itself.

Deriving from the Trading a/c


Dr

Trading a/c
Particulars

To Opening Stock
To Purchases
() Pur. Returns
To
To
To
To

Wages
Octroi
Carriage Inwards
Gross Profit

Amount

Amount

(in Rs)

(in Rs)

5,80,000
80,000

Cr
Particulars

40,000 By Sales
() Sales Returns
5,00,000 Closing Stock
45,000
32,000
15,000
2,40,500
8,27,500

Amount

Amount

(in Rs)

(in Rs)

8,24,000
72,500

7,51,500
76,000

8,27,500

Such an adjustment would not affect the figure of gross profit.

Revenue
Income, turnover, revenue are terms used synonymously to mean the amount of money that an organisation
receives from its activities like sale of products, providing services to customers etc. Depending on the nature of the
organisation and the type of activity it is involved in the revenue streams are varied
Sale or Products, Providing Services are the activities most common to business organisations. Taxes, Duties, Fees
etc are the major sources of revenue for Governments. Donations, Grants, Subscriptions, etc are some of the
sources of revenue for non-profit organisations.

The terms Revenue and Sales or Turnover are interchangeably used. This makes sense only when sales are

expressed in terms of value and not in terms of quantity.


Gross Revenue and Net Revenue are terms which are indicative of Gross Sales and Net Sales after setting

off sales returns

Revenue would be meaningful only when it is expressed in relation to a period. Say the revenue is Rs. 5
crores is would not make much sense unless we express the period involved.
final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,adjustments

Saying the revenue for the last month is Rs. 5 Crores does sound meaningful.

Top Line and Bottom Line


Revenue is often referred to as top line since it is the first item that we consider in preparing the income
statements or accounts. On the Credit Side of the Trading account we find sales generally towards the top
as the first or second item.
Similarly Net Profit (revenue left after deducting all expenses) is termed "Bottom Line". In the Profit and
Loss account, Net Profit/Loss is the last item that appears towards the end.
Even in an income statement (which is nothing but the Trading and Profit & Loss a/c prepared in a form
suitable for financial analysis) we start by considering the gross sales (i.e. gross revenue) and end with
arriving at the net profit.

Revenue Recognition
Revenues are
realized when goods and services are exchanged for cash or receivables (debtors).

realizable when assets received in exchange for goods and services are readily convertible to cash or
receivables (debtors).

earned when the duties to be entitled to compensation are performed.

Recognising revenue implies the act that would make the organisation consider that they have earned the revenue
involved in the transaction. Based on when the revenue is recognised there are two
types of accounting systems (1) Cash Basis of Accounting and (2) Accrual Basis or final,accounts,financial,account
Mercantile System of Accounting
ing,trading,profit,loss,account,
balance,sheet,trial,balance,wor
1.Cash Basis Accounting
k,sheet,adjustments
Under cash basis accounting revenues are recognized and earned only when cash is received irrespective
of when and how the services were performed or goods delivered.
To put it in different terms, the cash basis of accounting asks you to take into consideration all those
incomes/gains that have been received in cash or other assets and expenses/losses that have been paid
out in cash or other assets during the accounting period in consideration.

2.Accrual or Mercantile Basis Accounting


Under accrual or mercantile basis accounting, revenues are recognized and earned when they are realized
or realizable irrespective of when the cash is received.
To put it in different terms, the accrual basis of accounting asks you to take into consideration all those
incomes/gains and expenses/losses pertaining to the accounting period for which you are trying to
ascertain the profits and losses irrespective of whether the incomes are received in cash or not and the

expenses are paid out in cash or not.

3.Hybrid System of Accounting


This is not a system of accounting on its own. It is a combination of the Cash Basis Accounting and
Accrual Basis Accounting. This system is based on the concept of conservatism.
Under the hybrid system of accounting, incomes are recognised as in Cash Basis Accounting i.e. when
they are received in cash and expenses are recognised on accrual basis i.e. during the accounting period
in which they arise irrespective of when they are paid.

What Basis/system to follow?


The basis of accounting to be followed is dependent on the attitude and outlook of the organisation. If organisations
have a conservative attitude, they may adopt the hybrid system of accounting.
The traditional accounting systems used to adopt the cash basis of accounting. Organisations which are to abide by
the various regulations imposed by the various acts under which they are regulated are mostly required to adopt the
Mercantile System of Accounting which is supposed to reveal the information relating to the organisation in a more
appropriate manner than the cash basis of accounting.

Conversion from One System to Another


In practice we consider only the Cash and Accrual bases as the systems of accounting. As such, conversion implies
converting from cash basis of accounting to the mercantile basis of accounting and vice versa.
For the purpose of deriving each piece of information, a ledger account is created. The more the information we
need, the more the accounting heads we need to maintain.
Conversion

From Cash Basis to Accrual/Mercantile Basis would require the following information to be brought into the

books of accounts.
From Mercantile/Accrual Basis to Mercantile Basis would require the following information to be written off
from the books of accounts.

1.Expenses Outstanding [ Creditors]


The amount of expenses that have been incurred but have not yet been
paid out.

final,accounts,financial,account
ing,trading,profit,loss,account,
balance,sheet,trial,balance,wor
k,sheet,adjustments

Separate ledger accounts may be used for each distinct expenditure (like outstanding salaries a/c, Rent
payable a/c, Interest unpaid a/c etc.) or a single account may be used in place of all these (like
outstanding expenses a/c or creditors for expenses a/c).

Creditors !!! (for expenses)


When an expenditure is outstanding it amounts to a liability for the organisation. It may have to be paid
to a person or an organisation. Any person or organisation to whom we owe money is called a creditor. As
such, the "outstanding expenditure a/c" is a personal account in the nature of a creditor. Since it is

indicative of a creditor, it carries a credit balance and has to be shown on the liabilities side of the balance
sheet.
The creditors for expenses are cleared in the subsequent periods by paying them out.

2.Expenses Prepaid [ Debtors]


The amount of expenses that have not yet been incurred but have been paid out in advance.
Separate ledger accounts may be used for each distinct expenditure (like Advance salaries a/c, Rent
prepaid a/c, Interest paid in advance a/c etc.) or a single account may be used in place of all these (like
Prepaid expenses a/c or expenses paid in advance a/c).

3.Incomes Receivable [ Debtors]


The amount of incomes (revenue) that have arisen and have not yet been received.
Separate ledger accounts may be used for each such income (like Interest Receivable a/c, Commission
Due a/c, etc.) or a single account may be used in place of all these (like Incomes Still Receivable a/c).

4.Incomes Pre-received [ Creditors]


Incomes that have not yet arisen but have been received in advance.
Separate ledger accounts may be used for each such income (like Interest received in advance a/c,
Commission Pre received a/c, etc.) or a single account may be used in place of all these (like Pre-received
Incomes a/c or Incomes received in advance a/c).

Any Nominal Account Head prefixed or suffixed by the terms


outstanding, prepaid, pre-received, still receivable, etc.,
indicates a personal account and not a nominal account.
Depending on the nature of the balance in the account, it is
an equivalent of either a creditor or a debtor.
Conversion from Cash Basis to Accrual Basis
To convert the accounting system from cash basis to accrual basis from a particular point of time, one
needs to identify the values attributable to the accounts of the nature as described above and bring them
into the books of accounts, which would take care of the adjustments to be made in the books for the
incomes/expenses relating to the past periods. From thereon, the incomes and expenses have to be
recorded on accrual basis.
The ledger accounts to be brought into the books of accounts are personal accounts and are an equivalent
of either debtors or creditors. Brining the ledger accounts equivalent to debtors would amount to brining
in an undisclosed asset into the books, which would result in a gain. Brining the ledger accounts
equivalent to creditors would amount to brining in an undisclosed liabilities into the books, which would
result in a loss. A ledger account by name "Profit and Loss Adjustment a/c" is used to record thess gains
or losses.

Journal Entries

Hide/Show

Journal in the books of M/s _____ for the period from _____ to _____
Date

V/R
No.

31/12/05

Particulars

L/F

Profit & Loss Adjustment a/c


To Expenses Outstanding a/c

Dr

Credit
Amount
(in Rs)

Debit Amount
(in Rs)

26,000

16,400

11,100

5,200

26,000

[For brining the expenses outstanding to be


paid into the books of accounts.]
31/12/05

Expenses Prepaid a/c


To Profit & Loss Adjustment a/c

Dr

16,400

[For brining the expenses paid in advance


into the books of accounts.]
31/12/05

Profit & Loss Adjustment a/c


To Incomes Pre-received a/c

Dr

11,100

[For brining in the amount of incomes


received in advane into books of accounts.]
31/12/05

Incomes Receivable a/c


To Profit & Loss Adjustment a/c

Dr

5,200

[For brining the incomes receivable into the


books of accounts.]

Ledger Accounts

Hide/Show

Dr

Expenses Outstanding a/c


Date

Particulars

31/12/05 To Bal c/d

J/F

Amount
(in Rs)

26,000

Date

Cr
Particulars

31/12/05 By P/L
Adjustment.

J/F

26,000

(in Rs)

26,000
26,000

31/12/05 By Balance b/d

Dr

Amount

26,000

Expenses Prepaid a/c


Date

Particulars

J/F

31/12/05 To P/L Adjustment

Amount
(in Rs)

16,400

Date

Cr
Particulars

31/12/05 By Bal c/d

J/F

16,400

Dr

Incomes Pre-received a/c


Particulars

J/F

(in Rs)

16,400
16,400

31/12/05 To Balance b/d

Date

Amount

16,400

Amount
(in Rs)

Date

Cr
Particulars

J/F

Amount
(in Rs)

31/12/05 To Bal c/d

11,100

31/12/05 By P/L
Adjustment.

11,100

11,100
31/12/05 By Balance b/d

Dr

11,100

11,100

Incomes Receivable a/c


Date

Particulars

J/F

31/12/05 To P/L Adjustment

Amount

Date

(in Rs)

5,200

Cr
Particulars

31/12/05 By Bal c/d

J/F

5,200
31/12/05 To Balance b/d

Dr

Amount
(in Rs)

5,200
5,200

5,200

Profit & Loss Adjustment a/c


Date

Particulars

31/12/05 To Out. Exp.


31/12/05 To Pre-rec. Inc.

J/F

Amount

Date

(in Rs)

26,000
11,100

Particulars

Cr
J/F

31/12/05 By Prepaid Exp.

31/12/05 By Inc. receivable


By P/L Appropr.

37,100

Amount
(in Rs)

16,400
5,200
15,500
37,100

The overall gain or loss revealed by the "P/L Adjustment a/c" is written off to the "P/L Appropriation a/c"
or the "Capital a/c", depending on where the accumulated profits of the previous periods have been
transferred.
These would bring in all the adjustments needed for the various accruals, outstandings and prepaids that
have not been taken into consideration in the previous periods on account of not having received the cash
relating to the same.

Conversion from Accrual Basis to Cash Basis

To convert the accounting system from accrual/mercantile basis to cash basis from a particular point of
final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,adjustments
time, one needs to identify the accounts of the nature as described above and write them off from the
books of accounts, which would take care of the adjustments to be made in the books for the
incomes/expenses relating to the past periods. From thereon, the incomes and expenses have to be
recorded on cash basis.

The ledger accounts to be written off from the books of accounts are personal accounts and are an
equivalent of either debtors or creditors. Writing off the ledger accounts equivalent to debtors would
amount to writing off an existing asset in the books, which would result in a loss. Writing off the ledger
accounts equivalent to creditors would amount to writing off an existing liability in the books, which would
result in a gain. A ledger account by name "Profit and Loss Adjustment a/c" is used to record these losses
or gains.

Journal Entries

Hide/Show

Journal in the books of M/s _____ for the period from _____ to _____
Date

V/R
No.

31/12/05

Particulars

L/F

Expenses Outstanding a/c


To Profit & Loss Adjustment a/c

Dr

Credit
Amount
(in Rs)

Debit Amount
(in Rs)

31,650

18,700

13,650

8,750

31,650

[For writing off the expenses outstanding to


be paid, recorded as a liability, from the
books of accounts.]
31/12/05

Profit & Loss Adjustment a/c


To Expenses Prepaid a/c

Dr

18,700

[For writing off the expenses paid in


advance, recorded as an asset, from the
books of accounts.]
31/12/05

Incomes Pre-received a/c


To Profit & Loss Adjustment a/c

Dr

13,650

[For writing off the amount of incomes


received in advance, recorded as a liability,
from books of accounts.]
31/12/05

Profit & Loss Adjustment a/c


To Incomes Receivable a/c

Dr

8,750

[For writing off the incomes receivable,


recorded as an asset, from the books of
accounts.]

Ledger Accounts

Hide/Show

Dr

Expenses Outstanding a/c


Date

Particulars

31/12/05 To P/L
Adjustment.

J/F

Amount
(in Rs)

31,650

Date

Cr
Particulars

31/12/05 By Bal b/d

J/F

31,650

Dr

(in Rs)

31,650
31,650

Expenses Prepaid a/c


Date

Particulars

31/12/05 To Bal b/d

J/F

Amount
(in Rs)

18,700

Date

Cr
Particulars

31/12/05 By P/L
Adjustment

18,700

Dr

Amount

Incomes Pre-received a/c

J/F

Amount
(in Rs)

18,700
18,700

Cr

Date

Particulars

31/12/05 To P/L
Adjustment.

J/F

Amount
(in Rs)

13,650

Date

Particulars

31/12/05 By Bal b/d

J/F

13,650

Dr

(in Rs)

13,650
13,650

Incomes Receivable a/c


Date

Particulars

31/12/05 To Bal b/d

J/F

Amount
(in Rs)

8,750

Date

Cr
Particulars

J/F

31/12/05 By P/L Adjustment

8,750

Dr

Amount
(in Rs)

8,750
8,750

Profit & Loss Adjustment a/c


Date

Particulars

31/12/05 To Prepaid Exp.


31/12/05 To Inc. receivable
31/12/05 To P/L Appropr.

J/F

Amount
(in Rs)

18,700
8,750
17,850

Date

Particulars

31/12/05 By Out. Exp.


31/12/05 By Pre-rec. Inc.

45,300

Amount

Cr
J/F

Amount
(in Rs)

31,650
13,650
45,300

The overall gain or loss revealed by the "P/L Adjustment a/c" is written off to the "P/L Appropriation a/c" or
the "Capital a/c", depending on where the accumulated profits of the previous periods have been
transferred.

These would bring in all the adjustments needed for the various accruals, outstandings and prepaids that
have been taken into consideration in the previous periods on account of not having received the cash
relating to the same.

Income/Profits
The profits relating to a particular accounting period are revealed by the "Profit & Loss a/c" relating to that period.
The profits are derived by transferring the ledger account balances in the nominal accounts to the "Trading a/" or
"Profit & Loss a/c" as the case may be.
The basis of accounting followed i.e. cash basis or mercantile basis would decide the amount of incomes/expenses in
relation to the accounting period. Since the figure of profit is dependent on the incomes/expenses, we can say that
the figure of profit would vary depending on the method of accounting being followed by the organisation.

Finding Income under a System given Income under the other


Many a times, in problem solving, we would be required to identify the income under the Mercantile basis accounting
from the income under cash basis account.

We know that the information relating to outstanding expenses, expenses paid in advance, pre-received incomes,
outstanding incomes receivable is to be dealt with in changing the accounting system from Cash to Mercantile or vice
versa from a particular point of time. The same accounts are to be dealt with in finding the income under one system
given the income under the other system of accounting. Moreover, we should understand that these accounts are to
be dealt along with the respective income/expenses accounts and not in isolation.

Adjusting Expenditure
Consider an expenditure like Salary. Within an accounting period, salary is expended as well as paid. The
amount of salary paid can be identified from the amount of cash paid or cheques issued towards salaries.
The amount of salary expended i.e. the expenditure on account of salary relating to the current
accounting period can be identified by making appropriate adjustments for outstanding and prepaid
salaries both at the beginning and ending of the accounting period.

o Opening Expenses Outstanding


This represents the amount of expenditure that has been outstanding at the beginning of the
accounting period.
This would have to be cleared by paying out the amount in the current period. Therefore, the
cash paid in the current period towards the expenditure is assumed to include this outstanding
amount also (unless there is an indication to the contrary).
Thus to find the expenditure relating to the current period only, this amount has to be deducted
from the Cash Paid for the expense during the current period.

o Opening Expenses Prepaid


This represents the amount of expenditure that has been paid in advance during the previous
period. The prepaid expenses account shows a debit balance at the end of the previous
accounting period. It is an equivalent of a debtor and is treated as an asset. During the current
accounting period, this account is closed by transferring the balance to the expenditure account.
Thus to find the expenditure relating to the current period only, this amount has to be added to
the Cash Paid for the expense during the current period.

o Closing Expenses Outstanding


This represents the amount of expenditure relating to the current accounting period that has not
yet been paid.
Thus to find the expenditure relating to the current period only, this amount has to be added to
the Cash Paid for the expense during the current period.

o Closing Expenses Prepaid


This represents the amount of expenditure relating to the subsequent accounting periods that
has been paid in advance during the current accounting period.
Thus to find the expenditure relating to the current period only, this amount has to be deducted
from the Cash Paid for the expense during the current period.

Date

Particulars

J/F

01/01/05 To Bal b/d

1st_31st To Cash/Bank a/c


31/12/05 To Bal c/d

Amount
(in Rs)

15,425
2,48,000
45,300

Date

Particulars

01/01/05 By Bal b/d


1st_31st By P/L a/c
31/12/05 By Bal c/d

J/F

3,08,725
01/01/06 To Bal b/d

23,750

Dr

Amount
(in Rs)

18,200
2,66,775
23,750
3,08,725

01/01/06 By Bal b/d

45,300

Expenditure a/c
Date

Particulars

31/12/05 To Bal c/d

J/F

Amount
(in Rs)

Date

Cr
Particulars

01/01/05 By Bal b/d


45,300

J/F

3,08,725

(in Rs)

18,200

3,08,725
01/01/06 By Bal b/d

Dr

Amount

45,300

Expenditure a/c
Date

Particulars

01/01/05 To Bal b/d

J/F

Amount
(in Rs)

Date

Cr
Particulars

Amount
(in Rs)

15,425
31/12/05 By Bal c/d
3,08,725

01/01/06 To Bal b/d

J/F

23,750
3,08,725

23,750

Opening Outstanding vs Prepaid


The "Expenditure Outstanding a/c" is a personal account with a credit balance and is an equivalent of a
creditor (a liability). Creditors are cleared by paying out the amount due. Thus the oustandings of the
previous periods may be paid out in full or in part during the subsequent periods.
The "Expenditure Prepaid a/c" is a personal account with a debit balance and is an equivalent of a debtor
(an asset). Debtors are normally liquidated by paying realising the amounts due from them. But, the
prepaid expenditure is not an asset that is liquidated by realising it in cash. It is liquidated by absorbing
(writing off) the asset as an expenditure during the subsequent periods.

Adjusting Incomes
Consider an income like Interest. Within an accounting period, interest is earned as well as received in
cash. The amount of interest received can be identified from the amount of cash/cheques received
towards interest. The amount of interest earned i.e. the income on account of salary relating to the
current accounting period can be identified by making appropriate adjustments for outstanding and prereceived interest both at the beginning and ending of the accounting period.

o Opening Income Receivable

This represents the amount of income that has been outstanding and still receivable at the
beginning of the accounting period.
This would be cleared by realising the amount in the current period. Therefore, the cash received
in the current period towards the income is assumed to include this outstanding amount also
(unless there is an indication to the contrary).
Thus to find the income relating to the current period only, this amount has to be deducted from
the Cash received towards the income during the current period.

o Opening Income Pre-received


This represents the amount of income that has been received in advance during the previous
period. The pre-received income account shows a credit balance at the end of the previous
accounting period. It is an equivalent of a creditor and is treated as a liability. During the current
accounting period, this account is closed by transferring the balance to the income account.
Thus to find the income relating to the current period only, this amount has to be added to the
Cash received for the income during the current period.

o Closing Income Receivable


This represents the amount of income relating to the current accounting period that has not yet
been received.
Thus to find the income relating to the current period only, this amount has to be added to the
Cash received towards the income during the current period.

o Closing Income Pre-received


This represents the amount of income relating to the subsequent accounting periods that has
been received in advance during the current accounting period.
Thus to find the income relating to the current period only, this amount has to be deducted from
the Cash received towards the income during the current period.

Particulars
Cash Received during the Current Period
(+) Opening Income Pre-received
Closing Income Receivable

() Opening Income Receivable


Closing Income Pre-received
Income relating to the current period

Amount

Amount
1,32,500

8,125
5,245
6,850
3,750

13,370
1,45,870
10,600
1,35,270

The
adjustment
relating
to
the
incomes
can
be
summarised
as
follows:
Cash
Received
+
Opening
Income
Pre-received

Opening
Income
Receivable
+ Closing Income Receivable Closing Income Pre-received = Income.
Using the above relation, either the cash received (which would be the income to be considered in cash
basis accounting) or the income pertaining to the current period (which would be the income to be

considered under the mercantile basis accounting) can be found.

Deriving the Information using the Ledger a/c's


Dr

Hide/Show

Income Pre-received a/c


Date

Particulars

01/01/05 To Income a/c


31/12/05 To Bal c/d

J/F

Amount
(in Rs)

8,125
3,750

Date

Cr
Particulars

01/01/05 By Bal b/d


31/12/05 By Income a/c

J/F

11,875

(in Rs)

8,125
3,750
11,875

01/01/06 By Balance b/d

Dr

Amount

3,750

Income Receivable a/c


Date

Particulars

01/01/05 To Bal b/d


31/12/05 To Income a/c

J/F

Amount
(in Rs)

6,850
5,245

Date

Cr
Particulars

01/01/05 By Income a/c


31/12/05 By Bal b/d

J/F

12,095
01/01/06 To Balance b/d

Dr

Amount
(in Rs)

6,850
5,245
12,095

5,245

Income a/c
Date

Particulars

01/01/05 To Inc. Rec a/c


1st_31st To P/L a/c
31/12/05 To Inc. Pre. a/c

J/F

Amount
(in Rs)

6,850
1,35,270
3,750

Date

Cr
Particulars

01/01/05 By Inc. Pre. a/c


1st_31st By Cash/Bank
31/12/05 a/c
By Inc. Rec. a/c

J/F

1,45,870

Dr

Amount
(in Rs)

8,125
1,32,500
5,245
1,45,870

Income a/c
Date

Particulars

01/01/05 To Bal b/d


1st_31st To P/L a/c
31/12/05 To Bal c/d

J/F

Amount
(in Rs)

6,850
1,35,270
3,750

Date

Cr
Particulars

01/01/05 By Bal b/d


1st_31st By Cash/Bank
31/12/05 a/c
By Bal c/d

J/F

1,45,870

Dr

Amount
(in Rs)

8,125
1,32,500
5,245
1,45,870

Income a/c
Date

Particulars

01/01/05 To Bal b/d

J/F

Amount
(in Rs)

Date

Cr
Particulars

J/F

Amount
(in Rs)

6,850
31/12/05 By Bal c/d

5,245

01/01/06 To Bal b/d

Dr

5,245

Income a/c
Date

Particulars

31/12/05 To Bal c/d

J/F

Amount
(in Rs)

Date

Cr
Particulars

J/F

Amount
(in Rs)

01/01/05 By Bal b/d

8,125

01/01/06 By Bal b/d

3,750

3,750

Opening Receivable vs Received in Advance


The "Income Receivable a/c" is a personal account with a debit balance and is an equivalent of a debtor
(an asset). Debtors are normally liquidated by realising the amounts due from them. Thus the Incomes
receivable relating to the previous periods may be realised in full or in part during the subsequent periods.
The "Income Pre-received a/c" is a personal account with a credit balance and is an equivalent of a
creditor (a liability). Creditors are cleared by paying out the amount due to them. But, the pre-received
income is not a liability that is cleared by paying out in cash. It is cleared by absorbing (writing off) the
liability as an income during the subsequent periods.

A Nominal Account with a balance represents a personal


account. It is an equivalent of a debtor (debit balance) or a
creditor (credit balance) depending on the nature of
balance.
Statement for Finding Income under Mercantile System
Particulars

Amount

Profit/Income under Cash Basis Accounting


(+) Opening Expenses Outstanding
Opening Incomes Pre-received
Closing Expenses Prepaid
Closing Incomes Receivable

() Opening Expenses Prepaid


Opening Incomes Receivable
Closing Expenses Outstanding
Closing Incomes Pre-received
Profit/Income under Mercantile/Accrual Basis Accounting

2,48,000
18,200
8,125
23,750
5,245
15,425
6,850
45,300
3,750

Statement for Finding Income under Cash System


This statement is just the converse of the above statement.

Amount

55,320
3,03,320

49,775
2,53,545

Particulars

Amount

Profit/Income under Mercantile/Accrual Basis Accounting

(+) Opening Expenses Prepaid


Opening Incomes Receivable
Closing Expenses Outstanding
Closing Incomes Pre-received

() Opening Expenses Outstanding


Opening Incomes Pre-received
Closing Expenses Prepaid
Closing Incomes Receivable
Profit/Income under Cash Basis Accounting

Amount
2,53,545

15,425
6,850
45,300
3,750
18,200
8,125
23,750
5,245

49,775
3,03,320

55,320
2,48,000