Accounting Basics for Managers

Accounting for Managers 9
Unit-1: Accounting: Introduction

Notes
Structure
1.1 Introduction
1.2 What is Accounting ?
1.4 Financial Accounting Steps
1.5 Double Entry System of Accounting
1.6 Generally Accepted Accounting Principles, Conventions And Concepts
1.7 Accounting Concepts
1.8 Conventions
1.9 Accounting Principles in India
1.10 Usefulness of Accounting
1.11 Various users of Financial Statements
1.12 Branches of Accounting
1.13 Limitation of Financial Accounting
1.14 Summary
Objectives
 Objective of this unit of the study material is to familiarize the students
basics of accounting terms and expressions. In this explanation of
accounting basics, and throughout the study material , these notes will often
omit some accounting details and complexities in order to present clear and
concise explanations
1.1 Introduction
This explanation of accounting basics will introduce you to some basic accounting
principles, accounting concepts, and accounting terminology. Once you become familiar
with some of these terms and concepts, you will feel comfortable navigating through
these notes and other notes as well. Some of the basic accounting terms that you will
learn include revenues, expenses, assets, liabilities, income statement, balance sheet,
and statement of cash flows. You will become familiar with accounting debits and
credits as we show you how to record transactions. You will also see why two basic
accounting principles, the revenue recognition principle and the matching principle,
assure that a income statement reports profitability.
The first printed treatise of bookkeeping in the world is the “Summa de Arithmetica,
Geometria, Proportioni et Proportionalita” written by Luca Pacioli. The treatise was
published in Venice in 1494, and was reprinted at Toscolano in 1523. This work is one
of the most important books on mathematics and has had an enormous impact on the
field of accounting ever since.
1.2 What Is Accounting ?

1. All of us do some accounting, often without realizing it. It is a part of out life.
Let us say you realize suddenly, one morning, that you needed to buy a book
urgently. You ask one of your parents for the money. ‘But’ the parent says, “What
happened to the money I gave last week?” You either recollect how you spent it or
if you believe in being systematic and have noted it in your diary you explain how
the money was spent. You are ‘accounting’ for the money given to you. When
a housewife tries to note down her household expenses, strike the balance she
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10 Accounting for Managers
has on hand at the end of the month, or determines how much she needs for the
expenses which would arise, she is ‘accounting’ for the money she withdrew or was
Notes given to run the household.
2. In business, however, it is a more urgent matter. The student may not be
questioned by his parents or the housewife may just meet her expenses as and when
they come without bothering to find out how much she spent, but in business it is a
must. You cannot run a business unless you know how much you owe outsiders and
how much outsiders owe you. And when you invest money in a business as an
owner wouldn’t you like to know whether you’ve recovered it, increased it or lost it?
1.3 Definition of Accounting
Accounting has been defined by the american accounting association committee as:
“the process of identifying, measuring and communicating economic information to
permit informed judgments and decisions by users of the information”. This may be
considered as a good definition because of its focus on accounting as an aid to decision
making.
The american institute of certified and public accountants committee on terminology

defined accounting as:
“Accounting is the art of recording, classifying and summarizing, in a significant
manner and in terms of money, transactions and events which are, in part at least,
of a financial character and interpreting the results thereof ”. of all definitions available,
this is the most acceptable one because it encompasses all the functions which the
modern accounting system performs.
Objectives and Scope of Accounting

Let us go through the main objectives of Accounting:
 To keep systematic records: Accounting is done to keep systematic record of

financial transactions. The primary objective of accounting is to help us collect financial data
and to record it systematically to derive correct and useful results of financial statements.
 To ascertain profitability: With the help of accounting, we can evaluate the profits
and losses incurred during a specific accounting period. With the help of a Trading and Profit
& Loss Account, we can easily determine the profit or loss of a firm.
 To ascertain the financial position of the business: A balance sheet or a

statement of affairs indicates the financial position of a company as on a particular date. A
properly drawn balance sheet gives us an indication of the class and value of assets, the
nature and value of liability, and also the capital position of the firm. With the help of that, we
can easily ascertain the soundness of any business entity.
 To assist in decision-making: To take decisions for the future, one requires

accurate financial statements. One of the main objectives of accounting is to take right
decisions at right time. Thus, accounting gives you the platform to plan for the future with the
help of past records.
 To fulfill compliance of Law: Business entities such as companies, trusts, and

societies are being run and governed according to different legislative acts. Similarly, different
taxation laws (direct indirect tax) are also applicable to every business house. Everyone has
to keep and maintain different types of accounts and records as prescribed by corresponding
laws of the land. Accounting helps in running a business in compliance with the law.

In simple words, ‘Accounting’ merely means, ‘reckoning’. In an organisational
context too, ‘Accounting’ has more or less the same meaning. In technical terms,
the process of accounting involves recording, classifying and summarizing of past
events and transactions of financial nature, with a view to enabling the user of
accounts to interpret the resulting summary.
Difference between Accounting and Book-keeping: There exists a difference

between the terms ‘accounting’ and ‘bookkeeping’. Accounting is broader in scope than
bookkeeping, which is merely concerned with orderly record keeping. Going beyond
the narrow confines of bookkeeping, accounting involves analysis and judgment at different
stages such as recording of transactions, classification, summarization and interpretations
Accounting vs. Accountancy: Body of knowledge (consisting of principles,

postulates, assumptions, conventions, concepts and rules) governing the science of
recording classifying and analyzing financial transactions is accounting. Whereas the
practice and art of the science of accounting is termed as accountancy.
1.4 Financial Accounting- Steps

Accounting in business can be referred as Financial Accounting , consists of
creation of financial information and the consequent use of such information.
1. Creation. It entails three steps namely Recording, Classifying and Summarizing

which are dealt below:
(a) Recording: Commences when a business transaction occurs and it has been
quantified. Records of all these transactions are maintained in the order in
which they occur. Recording is based on four fundamental questions:
(i) What to record: All the events and transactions which effect the business
have to be recorded in accordance with the principal of accountancy. As money is
the common unit of measurement all such events are to be expressed in monetary
terms, and thus those which do not facilitate such transaction will not be recorded.
(ii) When to record: Accounting is historical in nature because of which the recording
is to be effected only after the occurrence of the subject transaction. Therefore,
sale of goods cannot be registered in the Books of Account of a shop when
the goods are merely intended to be sold on receipt of order for firm demand
items but only after such sale is complete and the property in the goods have been
transferred to the buyer. There are a few exceptions to this rule like the instance of
Provisions etc. which will be discussed later.

(iii) How to record: As mentioned above, the Double Entry Book-keeping System
is the practical base of accountancy. Entries are passed in the Journal Book
and the entries are called Journal Entries. Some of the business firms may not Notes
follow the Journal Entry System. They may follow the subsidiary book system .
(iv) Value at which it is to be recorded: All the ingredients of the financial
statements are to be assigned appropriate values. Money is the scale of
measurement in accounting and we can measure only those which can be
translated into monetary terms.
(b) Classifying: Refers to the rational segregation of the recorded information

into related groups so as to make the record useful. The Book containing
such classified information is called the Ledger Book consisting of a number
of accounts. For example, all the receipts forming inflows and the payments
forming outflows are grouped to ascertain the net cash/bank position of the
business. The arrangement in this case is better known as the Cash Book.
The mechanism for classification is to open accounts called ledger accounts.
(c) Summarizing: After the Recording and Classification phases are complete
the accounts containing relevant information in the Ledger Book are to be
balanced and the balances listed. The Statement giving names of theses
accounts and their respective balances is called the Trial balance. On the basis
of the Trail Balance the summaries are generated to provide information about
the Profit/Loss and the Position of the Business.
(d) Reporting: The reporting of these summaries is done through Financial

Statements. Financial Statements can be defined to include the Balance Sheet,
the Profit and Loss Account etc .
1.5 D o u b l e Entry System Of Accounting

Earlier, organisations used to maintain accounts in the single entry system which
recognizes only cash transactions. But now, accounts are invariably maintained in the
double entry system which recognizes both cash and credit transactions. Accounts are
maintained on accrual basis under this system. Accrual System means a cost incurred
(i.e. accrued) is duly accounted for irrespective of whether it is paid or not during that
period. In addition, all transaction are supposed to have dual aspect- debit aspect and a
credit aspect. Each monetary happening is referred as Transaction. We will see more of
debits and credits later. Since the system records both the debit and credit aspects of a
transaction. It is known as double entry system.
1.6 Generally Accepted Accounting Principles, Conventions And

Concepts
There are general rules and concepts that govern the field of accounting. These
general rules—referred to as basic accounting principles and guidelines—form the
groundwork on which more detailed, complicated, and legalistic accounting rules are
based :
The phrase “generally accepted accounting principles” (or “GAAP”) consists of
three important sets of rules: (1) the basic accounting principles and guidelines, (2)
the detailed rules and standards issued by FASB(Financial Accounting Standards
Bureau) and its predecessor the Accounting Principles Board (APB), and (3) the
generally accepted industry practices. If a company distributes its financial statements
to the public, it is required to follow generally accepted accounting principles in the
preparation of those statements. Further, if a company’s stock is publicly traded, federal
law requires the company’s financial statements be audited by independent public
accountants. Both the company’s management and the independent accountants must
certify that the financial statements and the related notes to the financial statements
Notes have been prepared in accordance with GAAP. GAAP is exceedingly useful because
it attempts to standardize and regulate accounting definitions, assumptions, and
methods. Because of generally accepted accounting principles we are able to assume
that there is consistency from year to year in the methods used to prepare a company’s
financial statements. And although variations may exist, we can make reasonably
confident conclusions when comparing one company to another, or comparing
one company’s financial statistics to the statistics for its industry. Over the years the
generally accepted accounting principles have become more complex because financial
transactions have become more complex. In India , Institute of Chartered Accountants
of India (ICAI) is entrusted with responsibility of preparing and issuing accounting
standards. Accounting principals can be classified as accounting concepts and
conventions. Important conventions and concepts are discussed below
1.7 Accounting Concepts

Some of concepts which are very important from the point of view of understanding
are discussed below:
1. Money Measurement Concept. In financial accountancy, a record is made only of

information that can be expressed in monetary terms. Recording, classification and
summarization of business transactions requires a common unit of measurement
which is taken as money. Thus, if a certain event, no matter how significant for the
health or even existence of the business, cannot be measured in monetary terms,
such an event is not recorded in accounting. For example, the posting out of
the CEO of the company, even though it has far reaching consequences for the
business, is not accounted for, since no monetary measurement of the event is
feasible.
2. Cost Concept. Cost Concept implies that in accounting, all transactions are
generally recorded at cost, and not at market value. For example, if a piece of land
is acquired for Rs.01 lakh, it would continue to be shown in the balance sheet at Rs.
01 lakh, even when the market value of the land rises to say Rs. 02 lakh.
3. Going Concern Concept

The concept deals with the quality of long lasting status of the business enterprise irrespective
of the owners’ status, whether he is alive or not. This concept is known as concept of longterm
assets. The fixed assets are bought in the intention to earn profits during the season of
the business. The assets which are idle during the slack season of the business retained for
future usage, in spite of that those assets are frequently sold out by the firm immediately
after the utility leads to mean that those assets are not fixed assets but tradable assets.
4. Business Entity Concept. Less understood however is the accounting entity of a

business as distinct from its owners. It is in accordance with this concept that when
owner brings capital into the business, the business in turn is deemed to owe the
capital to the owner.
5. Accounting period Concept.

The life period of the business is of a long span which is classified into the operating
periods which are smaller in duration. The accounting period may be either calendar
year of Jan.-Dec. or fiscal year of April-Mar. The operating periods are not equivalent
among the trading firms. This means that the operating period of one firm may be
shorter than the other one. The ultimate aim of the concept is to nullify the deviations of
the operating periods of various traders in the trading practice. According to the
Companies Act, 1956, the accounting period should not exceed more than 15 months.

6. Realization Concept. Realization concept deals with the point in time at which
revenue may be deemed to be realized or when a sale can be said to have taken Notes
place. For example in bakery , orders may be obtained at time 01 , which may be
accepted at time 02, the work towards the production of the order may commence
at time 03, the production process completed at time 04, the goods dispatched at
time 05, and the cash received at time6 and so on. At which time can one say
that the revenue is realized, or a sale is made? Normally revenue is said to be
realized when efforts rendered are rewarded either in cash (or kind) or in the form
of a promise of reward some time in future. Thus, in the above case , revenue is
normally recognized only when breads are transferred and a reward or promise of
reward is forthcoming.
7. Cost Concept. From an accountant’s point of view, the term “cost” refers to the
amount spent (cash or the cash equivalent) when an item was originally obtained,
whether that purchase happened last year or thirty years ago. For this reason, the
amounts shown on financial statements are referred to as historical cost amounts.
Because of this accounting principle asset amounts are not adjusted upward for
inflation. In fact, as a general rule, asset amounts are not adjusted to reflect any
type of increase in value. Hence, an asset amount does not reflect the amount of
money a company would receive if it were to sell the asset at today’s market value.
(An exception is certain investments in stocks and bonds that are actively traded on
a stock exchange.) If you want to know the current value of a company’s long-term
assets, you will not get this information from a company’s financial statements you
need to look elsewhere, perhaps to a third-party appraiser.
1.8 Conventions
Following are important conventions.
1. Full Disclosure. If certain information is important to an investor or lender using
the financial statements, that information should be disclosed within the statement
or in the notes to the statement. It is because of this basic accounting principle
that numerous pages of “footnotes” are often attached to financial statements. As
an example, let’s say a company is named in a lawsuit that demands a significant
amount of money. When the financial statements are prepared it is not clear
whether the company will be able to defend itself or whether it might lose the
lawsuit. As a result of these conditions and because of the full disclosure principle
the lawsuit will be described in the notes to the financial statements. A company
usually lists its significant accounting policies as the first note to its financial
statements.
2. Conservatism. This principle emphasizes that revenues are to be recognized only

when they are reasonably certain and expenses are to be recognized as soon as
they are reasonably possible. If a situation arises where there are two acceptable
alternatives for reporting an item, conservatism directs the accountant to choose
the alternative that will result in less net income and/or less asset amount.
Conservatism helps the accountant to “break a tie.” It does not direct accountants
to be conservative. Accountants are expected to be unbiased and objective.
3 Consistency. There are several ways of treating an event that may be recorded in
the accounts. The consistency concept requires that once an business organisation
has decided on one method, it will treat all subsequent events of the same
character in the same fashion unless it has a sound reason to change the method
of treatment of that event. For an example in a club , if the expenditure on account
of salary to the barman is being debited to bar account, next year , just assuming
that bar will not have sufficient profit such expenditure should not be debited to
messing account.

4 Materiality. Because of this basic accounting principle or guideline, an

Notes accountant might be allowed to violate another accounting principle if an amount
is insignificant. Professional judgment is needed to decide whether an amount
is insignificant or immaterial. An example of an obviously immaterial item is the
purchase of a Rs 150 printer by a highly profitable multi-million dollar company.
Because the printer will be used for five years, the matching principle directs the
accountant to expense the cost over the five-year period. The materiality guideline
allows this company to violate the matching principle and to expense the entire cost
of Rs 150 in the year it is purchased. The justification is that no one would consider
it misleading if Rs 150 is expensed in the first year instead of Rs 30 being expensed
in each of the five years that it is used. Because of materiality, financial statements
usually show amounts rounded to the nearest rupee, to the nearest thousand, or to
the nearest lakhs depending on the size of the company.
1.9 Accounting Principles In India

In order to bring uniformity in terminology, approach and presentation of accounting
results, the Institute of Chartered Accountants of India has been entrusted with the
task of issuance of accounting standards in India. The institute has issued about 29
accounting standards till date and now is on the task of convergence of accounting
standards with other accounting bodies in the world.
Because the material covered here is considered an introduction to the topic of

accounting principles, there are many complexities not presented.
1.10 Usefulness Of Accounting

Usefulness of Accounting Information To Users General speaking, ‘Accounting is
concerned with the collection, analysis and communication of economic information’ .
People need economic information to help them to make decision and judgment about
business. Operating an accounting system is to recognize and record transaction
implies that all economic events in the business, from payment of wage to the purchase
of a subsidiary company, are entered into the system, which is organised to minimize
the possibility of resources being misused. Accounting can be seen as an important
part of the total information system within a business. User, both inside and outside
the business require to ensure that resources are allocated in an efficient and effective
manner and require economic information to make base decision. Following are
important uses of accounting.
1. How good or bad is the financial condition of the business?
2. Has the business activity resulted in a profit or loss?
3. How well the different departments of the business have performed in the past?
4. Which activities or products have been profitable?
5. Out of the existing products which should be discontinued and the production of
which commodities should be increased.
6. Whether to buy a component from the market or to manufacture the same?
7. Whether the cost of production is reasonable or excessive?
8. What has been the impact of existing policies on the profitability of the business?

9. What are the likely results of new policy decisions on future earning capacity of the
business? Notes
10. In the light of past performance of the business how it should plan for future to
ensure desired results ?
11. Above mentioned are few examples of the types of questions faced by the users
of accounting information. These can be satisfactorily answered with the help of
suitable and necessary information provided by accounting.
12 Besides, accounting is also useful in the following respects :-

(a) Increased volume of business results in large number of transactions and
no businessman can remember everything. Accounting records obviate the
necessity of remembering various transactions.
(b) Accounting record, prepared on the basis of uniform practices, will enable a
business to compare results of one period with another period.
(c) Taxation authorities (both income tax and sales tax) are likely to believe the
facts contained in the set of accounting books if maintained according to
generally accepted accounting principles.
(d) Cocooning records, backed up by proper and authenticated vouchers are good
evidence in a court of law.
(e) If a business is to be sold as a going concern then the values of different
assets as shown by the balance sheet helps in bargaining proper price for the
business.
1.11 Various Users Of Financial Statements

There are many interested parties in accounting documents and statements such as
owners, management, creditors, taxation authorities etc as discussed below. Various
Accounting statements such as Income Statements, Balance Sheet and Cash flow etc
provide such information.
1. Shareholders or owners: They are interested in knowing the probability of the

business and the assets and liabilities of business to be calculated in their capital
wealth.
2. Management: They are interested in all information relating to business to frame

future policies and strategies.
3. Potential investors: They are interested in knowing the past and current
performances of the firm so that they can conclude about their investment in the
firm.
4. Creditors: They are always interested in the accounting information on day to day
activities of the business and its constant progress.
5. Employees: They are interested in the good running of the business, its
probability and prosperity.
6. Government: Government keeps a watch in its business to collect tax, to know the
fulfillment of social obligations of the business, etc.
7. Researchers: They acquire the information to do academic research.

1.12 Branches Of Accounting

Notes To meet the ever increasing demands made on accounting by different interested the
various branches have come into existence. These are being discussed below :
1. Financial Accounting. The object of financial accounting is to ascertain the result

(profit or loss) of business operations during the particular period and to state the
financial position (Balance Sheet) as on a date at the end of the period. Financial
accounting refers to accounting refers to accounting for revenues, expenses,
assets, and liabilities. It involves the basic accounting processes of recording,
classifying, and summarizing transactions of financial nature.
2. Cost accounting. is the branch of accounting dealing with the recording,

classification, allocation, and reporting of current and prospective costs. The object
of cost accounting is to find out the cost of goods produced or services rendered by
a business. It also helps the business in controlling the costs by indicating avoidable
losses and wastes.
3. Management Accounting. The object of management accounting is to supply

relevant information at appropriate time to the management to enable it to take
decision and effect control. Managerial accounting is the branch of accounting
designed to provide information to various management levels in the hospitality
operation for the purpose of enhancing controls.
Are Tax Prepares Accountants?

Although We often hear tax preparers being called Accountants, technically
speaking they are not. In the early 1900s accountants usually filled out the relatively
simple forms as one of their duties. Today, with the tax preparation industry becoming a
specialty all its own and the tax laws becoming increasingly complex, tax preparation is
a totally different field populated by thousands of individuals that have never performed
bookkeeping or accounting. Most are educated individuals who know how to organise
tax data and how to enter it on the tax forms. Their title is “Tax Preparer”. Of course,
there are those, including a fraction of CA’s, who do perform all three tasks. Again,
because “Accountant” is the most recognized title, it’s the one of choice by most such
professionals
1.13 Limitations Of Financial Accounting

Advantages of accounting discussed in this section do not suggest that accounting is
free from limitations. Following are the limitations:
1. Financial accounting permits alternative treatments. Accounting is based on

concepts and it follows “ generally accepted principles” but there exist more than
one principle for the treatment of any one item. This permits alternative treatments
with in the framework of generally accepted principles. For example, the closing
stock of a business may be valued by anyone of the following methods: FIFO (First-
in- First-out), LIFO (Last-in-First-out), Average Price, Standard Price etc., but the
results are not comparable.
2. Financial accounting does not provide timely information. It is not a limitation

when high powered software application like HiTech Financial Accenting are used
to keep online and concurrent accounts where the balance sheet is made available
almost instantaneously. However, manual accounting does have this shortcoming.
3. Historical Information. Financial accounting is designed to supply information

in the form of statements (Balance Sheet and Profit and Loss Account) for a
period normally one year. So the information is, at best, of historical interest and

only ‘post-mortem’ analysis of the past can be conducted. The business requires
timely information at frequent intervals to enable the management to plan and take Notes
corrective action. For example, if a business has budgeted that during the current
year sales should be Rs 12,00,000 then it requires information whether the sales
in the first month of the year amounted to Rs 10,00,000 or less or more?
4. Time Interval. Traditionally, financial accounting is not supposed to supply

information at shorter interval less than one year. With the advent of computerized
accounting now a software like HiTech Financial Accounting displays monthly profit
and loss account and balance sheet to overcome this limitation.
5. Subjectivity. Financial accounting is influenced by personal judgments’

Convention of objectivity’ is respected in accounting but to record certain events
estimates have to be made which requires personal judgment. It is very difficult to
expect accuracy in future estimates and objectivity suffers. For example, in order
to determine the amount of depreciation to be charged every year for the use of
fixed asset it is required estimation and the income disclosed by accounting is not
authoritative but ‘approximation’.
6. Financial accounting ignores important non-monetary information.

Financial accounting does not consider those transactions of non- monetary
in nature. For example, extent of competition faced by the business,
technical innovations possessed by the business, loyalty and efficiency of the
employees; changes in the value of money etc. are the important matters in
which management of the business is highly interested but accounting is not
tailored to take note of such matters. Thus any user of financial information
is, naturally, deprived of vital information which is of non-monetary character.
In modern times a good accounting software with MIS and CRM can be most
useful to overcome this limitation partially.
7. Financial Accounting does not provide detailed analysis. The information

supplied by the financial accounting is in reality aggregates of the financial
transactions during the course of the year. Of course, it enables to study the overall
results of the business the information is required regarding the cost, revenue
and profit of each product but financial accounting does not provide such detailed
information product- wise. For example, if business has earned a total profit of say,
Rs 5,00,000 during the accounting year and it sells three products namely petrol.
diesel and mobile oil and wants to know profit earned by each product Financial
accounting is not likely to help him unless he uses a computerized accounting
system capable of handling such complex queries. Many reports in a computer
accounting software like Hi-Tech Financial Accounting which are explained
with graphs and customized reports as per need of the business overcome this
limitation.
8. Financial Accounting does not disclose the present value of the business. In
financial accounting the position of the business as on a particular date is shown
by a statement known as ‘Balance Sheet’. In Balance Sheet the assets are shown
on the basis of “Continuing Entity Concept. Thus it is presumed that business has
relatively longer life and will continue to exist indefinitely, hence the asset values
are ‘going concern values.’ The ‘realized value’ of each asset if sold to-day can’t be
known by studying the balance sheet.
1.14 Summary
Accounting is a process of recording, classifying, summarizing and interpreting
business transaction. The primary purpose of accounting is to provide relevant financial

information to owners, investors, creditors, employees and other stakeholders. Financial

Notes statements are systematic and meaningful summarization of underlying data recorded
and classified through accounting process. For recording the transactions one must be
aware of accounting principles and rules of recording. While principles are discussed in
this chapter, rules of recording transactions will be discussed in the subsequent chapter.
Principles may include various accounting concepts , conventions and Generally
Accepted Accounting Principles (GAAP). Accountancy has various branches such as
Financial Accounting, Management Accounting and Cost Accounting. Most important
accounting concepts are : Money Measurement, Cost, Time Period , Separate Entity
, Realisation, Duality etc to name a few . GAAP when enforced by statutory body
can be known by name as Accounting Standards. Accountancy is useful for various
reasons such as performance, comparison and financial position etc but also suffers
from various limitations such as historical , subjective and can disclose only monetary
transactions etc.
Check Your Progress

1. The process of accounting involves,———————, classifying and summarizing of
past occurrences of financial nature.
2. Cost concept implies that in accounting, all transactions are generally recorded
————— and not at————————.
3. Total Liabilities = ———————— + External Liability.
4. —————————————————— issues accounting standards in India.
State True or False

5 Cost concept implies that all transactions are recorded at market cost.
6. Business Entity concept states that the accounting entity of a business is separate
from its owner .
7. The Institute of standards of India issues the Accounting Standards
Questions and Exercises

1. Define Accounting. How it is different from Accountancy and Book-keeping?
2. Explain various steps in the process of Accounting.
3. What do you understand by Accounting Principles? Explain some of them under
various categories.
4. Explain the usefulness of accounting process and its limitations.
5. Explain in brief about various branches of accounting.
Further Readings
1. Accounting for Managers . Maheshwari and Maheshwari. Vikas publication.
2. Financial Accounting . Meigs and Meigs. Mcgraw Hills Inc.
3. Introduction to Accountancy. T S Grewal. S Chamd & Co Ltd
4. Advanced Accounting, Sehgal Ashok, Sehgal Deepak .Taxman Allied Services (P)
Ltd., New Delhi
5. Advanced Accountancy, Jain S.P., Narang K.L..Kalyani Publishers, Ludhiana.
6. Advanced Accounts, Shukla M.C., Grewal T.S.: S. Chand & Company Ltd., New
Delhi.
7. Advanced Accountancy, Gupta R.L., M. Radhaswamy: Sultan Chand & Sons, New
Delhi.
8. Financial Accounting, Tulsian. Tata McGraw-Hill, New Delhi.

Unit-2: Double Entry System And Journalizing
Structure
2.1 Introduction
2.2 Double Entry System of Financial Accounting
2.3 Rules for Transaction Recording
2.4 Types of Accounts
2.5 Rules for Transaction
2.6 Alternate Rule
2.7 Types of Transaction
2.8 Recording of Transaction
2.8.1 Steps for Recording
2.9 Journalising
2.9.1 Journal
2.9.2 Journal Entry
2.9.3 Simple and Compound Entry
2.10 Summary
Objectives
 Objective of this chapter is to introduce the students about double entry system and also familiarise them with
process of journalising.
2.1. Introduction
The books of accounts of Business are to be maintained as per “Double Entry System”. Which means for every
monetary transaction which is to be recorded , will be two aspects. One needs to be debited and the other one
needs to be credited. The double Entry System and the different terms used therein are briefly described in this unit.
2.2 Double Entry System Of Financial Accounting

1. Earlier, organizations used to maintain accounts in the single entry system which recognizes only cash
transactions. But now, accounts are invariably maintained in the double entry system which recognizes both
cash and credit transactions. Accounts are maintained on accrual basis under this system. Accrual System means
a cost incurred (i.e. accrued) is duly accounted for irrespective of whether it is paid or not during that period. In
addition, all transaction are supposed to have dual aspect- debit aspect and a credit aspect. Each monetary
happening is referred as Transaction. We will see more of debits and credits later. Since the system records
both the debit and credit aspects of a transaction. It is known as double entry system. Business transactions
have twofold effect. Recording of both aspects of a transaction is called Double Entry system of Accounting.
2. Accounting Equation. In last unit, It was stated that, under the duality concept that sources of funds must always
Liabilities + Owners’ Equity = Assets
equal to uses of funds and from this equality was derived the fundamental accounting equation:

Total Liabilities = Total Assets (or)
Owners’ Equity + Outside Liability = Assets
3. You may have heard someone say “the books are in balance” referring to a
business concern’s accounting records. This refers to the use of the double-
entry system of accounting, which uses equal entries in two or more accounts to
record each business transaction. Because the rupee amounts are equal we say
the transaction is “in balance.” Double-entry accounting follows one simple rule,
called the accounting equation. It is a simple algebraic equation, expressed as an
equality. E = MC2 OOPS! That’s not it. It is reproduced again.
Liabilities + Owners’ Equity = Assets
Another way to think about it
everything we own = who provided the financing
4. Where assets refer to resources which are owned by business enterprises,

liabilities are debts payable to parties external to business and capital means the
amount payable to owner of the business enterprise. Revenues are the receipts in
general course of the business and expenditure are the outflow of cash incurred
to generate the revenue or purchase the fixed asset. Any expenditure not able to
generate the revenue or any reduction in value of fixed assets is referred as loss.
Profit is the excess of revenue over expenditure or increase in value of an asset or
some other benefit accruing to the business.
5. Sources of Fund. It was also evident from the earlier discussions that any of the
following is a source of funds
(a) Incurring Liability (including owners’ equity).
(b) Earning Revenue.
(c) Making Profits.
It stands to reason that a decrease in liability, revenue or profit must be a use of

funds being the opposite of a source.
6. Uses of Fund. Similarly, any of the following is a use of funds:
(a) Acquiring Assts.
(b) Incurring Expenses.
(c) Incurring Losses.
7. Also a decrease in assets, expenses or losses must be a source of funds, being the
opposite of a use.
8. Thus, no matter what event transpires in the business , it must be possible to

capture that event in the balance sheet in such a way that the liabilities (sources)
and assets (uses) remain equal. For instance, consider the following examples in
isolation. You will see after each transaction if Balance Sheet is prepared it will have
Assets = Liabilities. Though Balance sheet is prepared at the end of the accounting
period but each transaction during the period will have the perennial effect on the

Assets and Liabilities. In nut shell , if balance sheet is prepared even after each
transaction it will tally. Following are some transactions which will prove the equation
right.
Transaction 1
A Business is started with a capital of Rs. 10,000 brought in cash. The above event
gives rise to a cash balance of Rs. 10,000 which being an increase in an asset (namely cash),
is a use. At the same time, the business now owes Rs. 10,000 to the owner who invests
the capital in it, so that the owners’ equity in the business is Rs.
10,000. This being a liability of the business towards owner becomes a source. Thus, the
balance sheet of the business (if prepared after the transaction) at the end of the above
event would look as follows:
Liabilities (Source) Assets (Uses)

Owners’ Equity Rs. 10,000 Cash Rs. 10,000
Transaction 2
Now assume that in the above business concern, Fixed Assets worth Rs. 8000 are
bought for cash. The above event would make the balance sheet look as follows:
Liabilities (Sources) Rs Assets (Uses)

Owners’ Equity 10,000 Fixed Assets 8,000
10,000 Cash 2,000
10,000
It is clear from the above that the purchase of fixed assets is the use (being an
increase on an asset), whereas the decrease in the cash balance is a source (being a
decrease in an asset).
Transaction 3
Machinery is purchased for Rs.4, 000 by taking a loan from bank for the purpose.
The balance sheet would now look as follows:

Loan 4,000 Cash 2,000
Furniture 4,000
14,000 14,000
Transaction 4
Goods worth Rs.1, 500 are purchased for cash. The balance sheet gets modified to:

Loan 4,000 Cash 500
Furniture 4,000
Stock (Inventory) 1500
14,000 14,000
In this case, the inventory build-up is the use, whereas the cash depletion is the
source.
Transaction 5
Now assume that Rs.1, 000 worth of goods from the inventory are sold for Rs.1, 200
on cash. On account of the sale made, revenue worth Rs.1, 200 is realized. Whatever

revenue is earned by the business, it must owe that revenue to the owners. Thus
Notes revenue may be regarded as increasing the owners’ equity. Similarly, the cost of the
goods sold in this case is Rs.1, 000. This expense must ultimately be borne by the
business concern, so that the expense may be viewed as decreasing the owners’ equity

Add: Revenue 1,200 Cash 1,700
Less: Expenses- 1,000 Furniture 4,000
10,200 Stock (Inventory) 500
Loan 4,000
14,000 14,000
Also, it can be observed that following the above sale, the owners’ equity (Capital)
has gone up from Rs.10, 000 at the time of inception of the business, to Rs.10, 200
after the above sale was made. This increase in owners’ equity is clearly the profit
made by the business during the period (similarly in the above case, had Rs.1, 000
worth of goods been sold for Rs.800 instead, the balance sheet would indicate an
owners’ equity (Capital) of Rs.9, 800 indicating thereby a loss of Rs.200).
2.3 Rules For Transaction Recording

Since ‘Source’ and ‘Uses’ are relatively longer words, as in Chemistry, they can
be replaced by short symbols. The accepted symbol for sources is Cr. and that for
uses is Dr. These symbols are purely incidental and could well have been switched or
entirely changed without any loss in generality whatsoever. However, the symbol Cr. is
commonly pronounced as ‘CREDIT’ and the symbol Dr as ‘DEBIT’. In accounting, the
terms CREDIT and DEBIT are merely two different sounds and do not have the same
implications as they have in English Language.
Thus increase in liabilities, revenue or profits being sources of funds are all called
‘Cr’ items. Similarly, increase in assets, expenses and losses being uses of funds are
called ‘Dr’ items. This may be expressed by the following matrix.
Increase Decrease
Liability, revenue and Profit CR= Source DR= Use
Asset, Expense and Loss DR= Use CR= Source
A funny accounting story (yes, there are accountant jokes)

A young accountant often asked his boss for advice in writing journal entries. The
boss would always open his desk drawer, look at something for a moment and then tell
the young accountant how the make the correct journal entry. This went on for many
years. Finally the old accountant was ready to retire. The younger accountant asked the
old man, “I don’t know what I’m going to do without you. Whenever I’ve had a question
you always knew the answer. What will I do when you’re gone? And what’s in your desk
drawer? Every time I ask for advice you look in there?”
The old accountant took the younger one into his office and opened his desk drawer.
There was a 3” x 5” index card. It said: “Debits on the Left, Credits on the Right”.
2.4 Types Of Accounts

22. As explained earlier, grouping of similar transaction is known as classification
and the format in which the information is captured is called Accounts. The book in

which various account are maintained is called ledger book.
Notes
1. Classification of Accounts. Accounts can be classified into personal, real and
nominal accounts.
(a) Personal Account. These include the accounts of the persons with whom the
organization deals. These can be further classified into the following categories:
(i) Natural personal account. Means Accounts of living persons. (E.g., Ram a/c,
Vijay a/c).
(ii) Artificial personal account. Accounts of corporate bodies or institutions

created under low like account of a company, society, firm etc.
(iii) Representative personal account. These are the accounts, which represent
dues to certain person or group of persons. E.g., when rent is due to landlord,
an outstanding rent account is opened in the books.
(b) Real accounts
(i) Tangible Real Account. These are those which relate to such things which can
be touched, felt and measured e.g. cash account, building account etc.
(ii) Intangible Real Account. These accounts represent the things that can not
be touched. However they can be measured in terms of money e.g. patent,
goodwill etc.
(c) Nominal Account These accounts are opened in the books of account to
record transactions relating to income and expenses under various categories
like interest a/c, salary a/c, TA/DA, telephone rental etc.
2. Various types of accounts are explained here by means of a diagram also.
2.5 . Rules For Accounting

1. Personal Account. Debit the receiver, credit the giver.
2. Real Account. Debit what comes in, credit what goes out.

3. Nominal Account. Debit all expenses & losses and credit all incomes & gains.
Notes
2.6 Alternate Rule
From the matrix at Para 2.3 above, the simplified rule of Debit and Credit can be
derived from there. That is:
1. All Assets, Expenses and Losses are debited when they increase; they are credited
when they decrease.
2. All Liabilities, revenues and Profits are credited when they increase; they are
debited when they decrease.
Example -1
Identify the elements affected by the transaction given below and also state the
nature of the elements
1. Ibrahim a sole proprietor Commenced business with a capital of Rs. 2,00,000.

2. Bought Furniture for cash Rs. 20,000.
3. Paid Rent to the shop owner Mr. Murugan Rs. 5,000.
4. Paid cash into bank Rs. 1,50,000
5. Bought Goods for cash Rs. 10,000 from M/s Shamir Jain & Co.,
6. Bought Goods on credit from M/s Ramdas & Bros. for Rs. 10,000.
7. Sold goods for cash Rs. 12,000 to Mr. Naryan Tiwari
8. Bought Machinery from M/s Boolani Machinery and paid by cheque Rs.
25,000.
9. Sold goods on credit to Mr. Natekar for Rs. 8,000
10. Paid weekly wages to workers Rs. 5,000
11. Paid M/s Ramdas and Brothers by cheque Rs. 5,000
12. Received from Mr. Natekar Rs. 2,000
13. Received commission from M/s Orion Traders for giving a trade lead Rs. 500.
Solution
1. Commenced Business with a Capital of Rs. 2,00,000.
Capital a/c Cash a/c

↓ ↓
Person Tangible aspect/Asset
↓ ↓
Personal a/c Real a/c
2. Bought Furniture for cash Rs. 20,000.

Furniture a/c Cash a/c
↓ ↓
Tangible aspect/Asset Tangible aspect/Asset
↓ ↓
Real a/c Real a/c

3. Paid Rent to the shop owner Mr. Murugan Rs. 5,000.
Notes
Rent Paid a/c Cash a/c
↓ ↓
Expenditure Tangible aspect/Asset
↓ ↓
Nominal a/c Real a/c
Payee name irrelevant in Recording Expenses Incurred

The amount paid to Mr. Murugan is towards the rent of the shop and therefore it
would result in the organisational expenditure on rent increasing by Rs. 2,000. Though
it is given to Mr. Murugan, the shop owner, it should not be interpreted as cash paid to
Mr. Murugan. The information relating to the expenditure on account of rent is normally
recorded using the account head Rent Paid a/c. However, the payee name would be
considered where an outstanding amount has been recorded earlier
4. Paid cash into bank Rs. 1,50,000

Cash a/c Bank a/c
↓ ↓
Tangible aspect/Asset Organisation
↓ ↓
Real a/c Personal a/c
5. Bought Goods for cash Rs. 10,000 from M/s Shamir Jain & Co.,
Cash a/c Goods/Stock a/c
↓ ↓
↓ ↓
Real a/c Real a/c
6. Bought Goods on credit from M/s Ramdas & Bros. for Rs. 10,000.
M/s Ramdas & Bros. a/c Goods/Stock a/c
↓ ↓
Organisation Tangible aspect/Asset
↓ ↓
7. Sold goods for cash Rs. 12,000 to Mr. Naryan Tiwari.

Cash a/c Goods/Stock a/c
↓ ↓
↓ ↓
Real a/c Real a/c
8. Bought Machinery from M/s Boolani Machinery and paid by cheque Rs.
25,000.
Bank a/c Machinery a/c
↓ ↓
Organisation Tangible aspect/Asset
↓ ↓

Cash Purchase of Machinery

Notes Machinery being a tangible aspect is an asset. The information relating to machinery
is identified using the account head Machinery a/c. Since it is an asset/tangible aspect
it is a Real account. The fact that Machinery has been purchased from M/s Boolani
Machinery is irrelevant here since there is no time gap between the transactions
of purchase of machinery and payment for it. Since a cheque is issued, the amount
available in the bank is reduced and not cash. Therefore Bank a/c is affected by the
transaction.
9. Sold goods on credit to Mr. Natekar for Rs. 8,000.

Goods/Stock a/c Mr. Natekar a/c
↓ ↓
Tangible aspect/Asset Person
↓ ↓
Real a/c Personal a/c
10. Paid weekly wages to workers Rs. 5,000

Cash a/c Wages Paid a/c
↓ ↓
Tangible aspect/Asset Expenditure
↓ ↓
Real a/c Nominal a/c
Wages Paid - Recording the Expenditure
Wages paid is expenditure. Generally, the information relating to this expenditure is
maintained using the accounting head Wages Paid a/c.
11. Paid M/s Ramdas and Brothers by cheque Rs. 5,000.

M/s Ramdas & Bros. a/c Bank a/c
↓ ↓
Organisation Organisation
↓ ↓
Personal a/c Personal a/c
Cheque Payment
Since the payment is made by cheque the amount available in the bank would be
reduced i.e. Bank a/c would be affected and not Cash a/c.
12. Received from Mr. Natekar Rs. 2,000

Mr. Natekar a/c Cash a/c
↓ ↓
Person Tangible aspect/Asset
↓ ↓
13. Received commission from M/s Orion Traders for giving a trade lead Rs. 500.
Commission Received a/c Cash a/c
↓ ↓
Income Tangible aspect/Asset
↓ ↓
Nominal a/c Real a/c
Recording Income Received-
Commission received is income. Generally, the information relating to this income is
maintained using the accounting head Commission Received a/c.

2.7 Typpe Of Transactions
There are three general types of transactions and entries. Notes
1. Routine, daily operating events - represents over 99% of all transactions.
2. Occasional events involving major assets, liabilities and owners’ equity

transactions.
3. Adjusting and Closing entries - made to prepare statements and close the
books at the end of the year.
2.8 Recording Of Transaction

As explained earlier, in business organization two methods are being followed for
recording the transactions. In first method, daily business transactions are recorded in a
book called Journal. The journal is called ‘Book of original entry’. All the transactions are
first entered in the journal in the order of their occurrence. Recording of entries in the
journal is known as journalizing. With the growth in business, and consequent increase
in the number of transactions, it became difficult to record all the transactions in the
journal. Therefore, to facilitate recording of similar transactions, large concerns maintain
special journal also known as subsidiary books. The method of recording through
subsidiary book is explained diagrammatically.
2.8.1 Steps in Recording Transaction

It involves two steps analyze the transaction and identity the two accounts that are
being affected by the transaction.
1. Ascertain the nature of the accounts involved as real, personal or nominal. If

alternate rule is to be applied than it is to be identified whether they are assets/
liabilities or profit/loss as the case may be.
2. Determine which rule of debit and credit is applicable for each of accounts involved.
If alternate rule is to be applied than matrix to be referred.
3. Ascertain the account to be debited and the account to be credited.
Example 2:
1. M/S X & Co received Rs. 1,000 from Y as advance for purchase of items on
05-01-2008. Recording the transaction in the books of M/s X & Co will involve
following steps.

(a) Step1: The two accounts involved in the above transaction are (i) money being
received and (ii) the person paying the amount Y.
Notes
(b) Step2: The natures of the accounts are (i) Real account and (ii) Personal
account respectively. As per alternate rule (i) is asset and (ii) is liability
(c) Step3: First Method.

(i) The rule applicable to real account is debit what comes in and credit what goes
out’. In the given transaction, cash is coming in, therefore debit cash account.
(ii) The rule applicable for personal account is ‘debit the receiver and credit the
giver’. In the above transaction, Y is the giver, therefore it has been credited in
the books of accounts of M/S X & Co.
(d) Step3: Alternate Method

(i) The rule applicable to assets as per matrix is assets are debited when they
increase. In the case, cash in getting increased so ‘Cash Account’ is debited.
(ii) The rule for liabilities is they are credited when they increase. In this case,
advance payment from Y is a liability till the time the good or services is not
delivered. The liability is getting created (increased) hence it is credited.
Example 3:
1. Let us apply the rules of debit and credit for a few sample transactions after
ascertaining dual aspects. Transactions and their duality aspects are enumerated
on the next page.
These are entered in the books of accounts of M/S Harish Ltd.
Translations Aspects Ac- Reason for the Debit Ac- Reason for the Credit
count count
Debit- Credit-
ed
ed
M/S Harish Aspect 1: Bank B a n k 1. Bank a/c is personal Capital 1. Capital a/c is personal
Kumar account has a/c a/c. The rule ‘debit the a/c a/c. it represents Mr
started with been credited receiver and credit the Harish as owner. The rule
capital of Rs with Rs giver’ applies. Since ‘debit the receiver and
50,000 at 50,000 Aspect bank is receiver from credit the giver’ applies.
Baroda. 2 : M/S Harish M/S Harish Kumar, it Since Mr Harish Kumar
Kumar has will be debited in M/S is giver to M/S Harish
become liable Harish Kumar‘s books of Kumar , it will be credited
to pay to the accounts. in M/S Harish Kumar ‘s
owner Harish 2. If alternate rule is to be books.
Kumar Rs applied then Bank is an 2. If alternate rule is to be
50,000 known Asset. Increase in As- set applied then capital is Li-
as Capital will be debited in M/S ability. Increase in Liability
Harish Kumar’s books. will be credited
M/S Harish Aspect 1 : C a s h 1. Cash a/c is a Real M/S X 1. M/S X’s a/c is a
Kumar cash of Rs. a/c a/c. The rule of ‘Debit a/c Personal a/c. It is giver
Received 5,000 is what comes in’ applies. to M/S Harish Kumar .
Rs. 5,000 received. 2. Cash a/c is an Asset The rule of Credit the giver
from Mr X Aspect 2 The a/c. If alternate rule is to applies.
on account amount is be applied then increase 2. If alternate rule is to
of advance given in Asset will be debited. be applied then advance
payment for by M/S X. from M/S X is a Liability
goods. till the commitment is met.
Increase in Liability will be
credited.

M/S Harish Aspect 1 Inven- 1. Inventory a/c or pur- M/S Va- 1. M/S Varieties a/c is a
Kumar Pur- Goods of Rs. t o r y chases a/c is a Real a/c. r i e t i e s Personal a/c. The rule of
chased Rs. 6,000 are re- a / c The rule of ‘Debit what a/c Credit the giver applies. Notes
6,000 worth ceived. Aspect ( P u r - comes in applies. 2. If alternate rule is to
of goods from 2 The goods c h a s - 2. Increase in stock is be applied then purchase
M/S Varieties are purchased es a/c) an increase in Asset. If from depot is a Liability
Faridabad on from M/S alternate rule is to be till the time payment is
credit Varieties on applied then increase in made. Increase in Liability
credit. Asset will be debited. will be credited. Hence
M/S Varieties a/c will be
credited.
M/S Harish Aspect 1 S a l - 1. Salaries a/c is a Nom- Bank 1. Bank a/c is personal
Kumar has payment of an a r i e s inal a/c. The rule of Deb- a/c a/c, the rule of Credit the
paid the expense of Rs. a/c it all expenses’ applies giver applies.
salaries of 15,500 .2. Increase in expen- 2. If alternate rule is to be
Rs. 1,500 to Aspect 2 Bank diture will amount to in- applied then decrease in
its staff for balance is crease in expenditure. Bank will amount to reduc-
the month reduced by As per alternate rule in- tion in asset. Decrease in
through bank Rs. 15,500 crease in expenditure is asset will be credited.
transfer. to be debited as it will re-
duce the owner’s equity.
Note : These transactions are entered in the books of accounts of M/S Harish Kumar
2.9 Journalising/Recording
By analysing a transaction (i.e. its proof), we identify the two elements affected by
the transaction and then the nature of the elements. We then decide which element is
to be debited and which is to be credited by applying the rules of debit and credit. In
actual practice, accounting starts with writing the journal. This act of writing the Journal
is called RECORDING or JOURNALISING. Journalising (or Recording) is writing down
the information relating to an accounting transaction that is relevant in accounting into
the accounting records (generally in a specific format) based on the principles of debit
and credit.
2.9.1 Journal
The General Journal is called the book of original entry. A journal is a
chronological record of transactions - they are in date order. Each entry is called
a journal entry, and represents a different business transaction. Each transaction is
recorded once, and only once. All journal entries follow the rules of debit and credit.
Format of Journal is given below :
Journal of —————————————
Date V/R No. Particulars L/F Debit Amount Credit Amount

(in Rs) (in Rs)
Information in Journal
 Heading
The heading gives the following information:
 The organisation whose accounting transactions are being recorded
 The period relating to which the journal entries are recorded.
 Date

Date of recording the transaction.

Notes
To ensure that the accounting system is functional and useful, transactions are
recorded as and when they happen (at least on the date on which they occur).
Therefore assume that the date here is the date of the transaction and not the date
of recording the transaction.
 V/R No » Voucher/Receipt Number
 A Voucher is a document which is made when a payment is made
 A Receipt is a document which is made when an amount is received.
Vouchers and receipts form proof of transactions. [There may be other forms of
documents like sales invoices, debit notes, credit notes etc., which also form proof of
transactions. Please ignore them for now.]
They are generally numbered and have identifications like voucher number, receipt
number etc., on them. These numbers are entered in this column to have a cross
reference to the proof of the transaction based on which that journal entry is being
recorded.
Note that we do not find statements like “Paid cash to Mr. Shyam” etc. in the
accounting records. The documents which form proofs of transactions are the ones
which enable to interpret the transactions in such a way.
 Particulars
This is the column where the actual account heads (the one to be credited and the
one to be debited) are written.
 Debit Account :
The account to be debited is shown on the first line and is aligned to the left of
the column. The element name i.e Account Head starts with a Capital Letter and is
succeeded by the letters “a/c”.
The word “Dr” (read as detor {debtor - b silent}) is written on the same line, aligned
to the right.
 Credit Account :
The account to be credited is shown on the second line preceded by the word “To”
and is succeeded by the letters “a/c”.
The line starting with “To” is indented (i.e. the first letter of the name of the Account
that is Debited and the letter “T” do not fall in the same vertical line). “T” always lies to
the right of the first letter of the account head that is debited.
We do not find the use of the letters “Cr” on this line or anywhere in the entry.
 Narration
[ Being the amount ....]

The sentence that appears below the lines containing the Account Heads that are
Debited and Credited is called the narration for the journal entry. Notes
The narration is a brief explanation for the entry. It includes certain details in relation
to the transaction. The purpose of the narration is to enable anyone who reads it to get
a preliminary idea of why the entry is being recorded. If the information in the narration
does not provide the required detail, one can always refer the Voucher/Receipt (which
is the actual proof for the transaction journalised through that entry) using the relevant
voucher/receipt number recorded relating to that entry.
 L/F » Ledger Folio
The Ledger is a record that follows the journal. Each element (Account Head) has its
own distinct page (folio) in the ledger.
“Ledger Folio” is the page number in the ledger record, where the information shown
in the journal entry has been carried to. This information is distinct for each account
head.
The Ledger Folio information will enable tracking of flow of information from the
journal to the ledger.
 Debit amount
This is the amount relating to the element (account head) that is being debited. This
generally is the transaction value. The amount is written in the same line as Debit entry
i.e. in vertical alignment with it. The currency related to the amounts is written in the
column header itself.
 Credit amount
This is the amount relating to the element (account head) that is being credited. This
generally is the transaction value. The amount is written in the same line as Credit entry
i.e. in vertical alignment with it.
2.9.2 Journal entries

1. These should be made contemporaneously with the event they are recording,
or reasonably soon after the event. Keep in mind that a journal is a chronological record
of events. A contemporaneous writing is one that takes place at the same time as the
event. This is the best time to record an event, because the facts and details are still
fresh in our minds. Necessary documents, conversations, calculations, etc., are readily
available to create a correct record of the event. If we wait too long, the event will be
much more difficult to reconstruct. In a legal sense, a contemporaneous writing carries
much more weight than a writing made at a later date. And a writing carries much more
weight than a mere recollection of events, months or years after the event has taken
place. The courts recognize that people’s memories about events are much clearer
right after the event has taken place. As to the sale of real estate, state laws require
a contemporaneous writing, to establish the exact terms and conditions of the sale. In
contract law, this is called a “meeting of the minds,” and must be present for a valid
contract to exist.
2. We will use verifiable, tangible evidence whenever it exists. Tangible evidence

has physical existence – we can touch it, fold, staple, copy and file the document. We
will look for a check, invoice, purchase order, contract or other business document that
is a record of the event, a confirmation of payment received and goods delivered, etc.
These documents become the back-up documentation for our journal entry.

2.9.3 Simple Vs Compound Journal Entry

Notes
1. A journal entry involving only 2 Account Heads (elements) is called a simple
journal entry. One of the elements/accounting heads is debited and the other credited.
We have till now seen the simple journal entries. A journal entry involving more than 2
Account Heads (Elements) is called a compound/combined journal entry. Example of
compound journal entry is as follows :
2. The compound/combined entries should not be interpreted to mean that more

than 2 elements are effected in a single/simple accounting transaction. A compound/
combined entry is a journal entry derived by combining two or more simple journal
entries. Theoretically a compound/combined entry can always be broken down into the
constituent simple journal entries. However such a breakdown would be a bit difficult in
case of complex compound entries. Writing a compound/combined entry in place of two
or more simple entries reduces the task involved in recording the transactions.
3. More about Combined Journal Entry. A complex compound/combined Journal

Entry is a journal entry involving more than 3 Account Heads (elements) in which there
are multiple debits and multiple credits.
Example - 4
1. Consider a person starting business by bringing in his personal assets and
liabilities into the business. [The separate entity concept says that the owner is alien
to business. Thereby the owner can give or take from the business.] .Mrs. Raju
Commenced business by bringing in the following assets and liabilities of hers as her
capital contribution.
(a) Cash Rs. 50,000.
(b) Motor Car Rs. 1,00,000
(c) Furniture Rs. 20,000
(d) Bank Loan (payable) Rs. 50,000
Based on the value of assets and liabilities contributed, we would be able to assess
his capital contribution.
Value of Assets brought in
= Rs. 50,000 (Cash) + Rs. 1,00,000 (Motor Car) + Rs. 20,000 (Furniture)

= Rs. Rs. 1,70,000
Notes
Value of Liabilities brought in
= Rs. 50,000 (Bank Loan)
Value of Net Assets brought in
= Value of Assets brought in “ Value of Liabilities brought in
= Rs. 1,70,000 “ Rs. 50,000
= Rs. 1,20,000
Solution
1. The amount of Capital contributed by Mrs. Raju is nothing but the value of Net
Assets brought in by her. The transaction relating to the assets and liabilities brought in
by Mrs. Raju can be broken up into 4 simple transactions.
 Brought in Cash Rs. 50,000 towards Capital.
[Cash a/c and Capital a/c are the two elements effected]
 Contributed Motor Car worth Rs. 1,00,000 towards Capital
[Motor Car a/c and Capital a/c are the two elements effected]
 Contributed Furniture worth Rs. 20,000 towards Capital
[Furniture a/c and Capital a/c are the two elements effected]
 The business accepted to take over the responsibility of paying up Mrs. Rajus
Bank Loan Rs. 50,000
[Capital a/c and Bank Loan a/c are the two elements effected]
2. In the first three transactions, Mrs. Raju stands in the position of benefit giver.
Therefore, Capital a/c (which represents the owner i.e. Mrs. Raju) is to be credit. In
case of Bank Loan, which is a liability, the benefit is derived by Mrs. Raju, since the
responsibility of her liability is being taken over by the organisation. Therefore, Capital
a/c (which represents the owner i.e. Mrs. Raju) is to be debited.
3. In analysing a transaction to arrive at the simple journal entry, it should be

possible to support both the debit as well as credit with reasoning. However in some
cases, the reasoning trying to support both the debit and credit becomes too complex a
thought. Even in such cases explaining one (either the debit or credit) would be simple.
In such situations, after identifying the two elements (Account Heads) effected by the
transaction, we analyse only the element whose analysis is simple and decide whether
it should be debited or credited. What should be done with the second element is
thereafter decided automatically without thinking of analysis.
4. The above transaction can be recorded using simple journal entries as given
under

Notes
4. The same transactions can be recorded using a complex compound/combined

journal entry as
Journal of M/S —————————————————

Notes
Example – 5
Journalise the following transaction
Jun Acquired the running business of Max, for cash Rs. 50, 000 by taking over
5th: the following assets and liabilities at values stated against them:
Stock of Goods Rs. 15,000; Cash 25,000; Furniture Rs. 10,000; Debtors
Rs. 7,000;
6th: Machinery Rs. 8,000 & Creditors Rs. 15,000.
7th: Opened a bank account with Rs. 5,000
8th: Bought goods worth Rs. 6, 000 from Usha & Co. & paid half the amount in
cash.
14th: Sold to Bee & Co. goods worth Rs.5,000 and a cheque received for the due
16th: Sold private car for Rs. 4,000 and bought a new one with the proceeds for
business plus Rs. 5,000 from office cash.
18th: Bought furniture worth Rs. 4,000 of which, those worth Rs. 1,000 are for
office decoration and the balance for stock.
19th: Sold goods to Arial & Co. Rs. 8,000 and to Wheel & Co. 7,000
20th: Payment made to Credtiors Rs. 4,500
25th: Cash received from Debtors Rs. 5,800
30th: Paid Rent by cheque Rs. 2,500
Commission received Rs. 3,000

Notes Vr Debit Credit

Date Particulars UF No Amount Amount
(In Rs) (In Rs)
June Goods/Stock ale Dr - 15,000
5th Fumiture ale Dr - 10,000
Debtors ale Dr - 7,000
Machinery ale Dr - 8,000
Cash ale Dr - 25,000
To Creditors ale - 15,000
To Capital ale - 50,000
[Being the amount of assets and
liabilities acquired from Mr. Max,
ide bill no:_ dated:_]
Note:Capital = Assets - Liabilities
6th Bank ale Dr - 5,000

To Cash ale - 5,000
[Being the amount of cash deposited
into bank vide bill no:- dated:_]
7th Goods/Stock ale Dr - 6,000

To Cash ale - 3,000
To Usha & Co. ale - 3,000
[Being the value of stock purchased
rom M/s. Usha & Co on credit and
paid half the amount in cash vide bill
no:_ dated:_]
8th Bank ale Dr - 5,000

To Goods/Stock ale - 5,000
[Being the value of stock sold to M/s.
Bee & Co. and received amount due
by cheque no:_ dated:_J
14th Carafe Dr - 9,000

To Capitl ale - 4,000
To Cash ale - 5,000
[Being the amount of car purchased
lfrom private cash and business cash
ide vocher no:_ dated:_]
16th Goods/Stock ale Dr - 3,000

Fumiture ale Dr - 1,000
To Cash ale - 4,000
[Being the amount of fumiture
purchased for office decoration and
or stock vide bill no:- dated:_]
18th rial & Co. ale Dr - 8,000

heel & Co. ale -
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Notes
2.10 Summary
45. Financial Accounting is based on the double entry system of accounting
which recognizes dual aspects of a transaction, known as debit and credit. It follows
the principle that “ every debit has corresponding credit”. Debit items represent use of
fund and credit item represent use of fund. Transactions can be recoded in two ways
. In the first method every transaction is recoded in the journal . The process is called
Journalising. The process follows certain rules and ultimate outcome of these rules is
every debit has corresponding credit. Alternatively, instead of passing journal entry for
each transaction , they are grouped on the basis of their nature in one of the various
books : Cash Book, Sales Book , Purchases Book, etc and only residual transactions
are recoded in the Journal Proper .
Check Your Progress

1. The basic accounting equation is Assets = Liabilities + .
2. A business’s net income is eventually recorded in the following account:
3. The financial statement with a structure that is similar to the accounting equation is
the .
4. The financial statement that reports the portion of change in owner’s equity
resulting from revenues and expenses during a specified time interval is the
5. Books of accounts of business are to be maintained as per ———————

system.

6. Double Entry system recognises both —————— and ———————————

Notes — transactions.
True/False
7 Interest a/c, salary a/c, TA/DA etc. are examples of real a/c.
8. Normally revenue is said to be realised when efforts rendered are rewarded either
in cash or in the form of promise
9. Drawing account is nominal a/c.
10 Wages paid on installation of machinery should be debited to Machinery account.
Questions and Exercises

1. Describe the alternate rule of ‘Credit’ and ‘Debit’ as per matrix of increase and
decrease of fund.
2. Explain steps in recording transaction
3. Explain equation of duality concept
4. Recognize two side of double entry in following transactions along with account
name which is required to be debited/credited.( in the books of accounts of M/S
XYZ ) :
(a) Paid Rent in cash Rs.5000/-.
(b) Sold goods on credit to M/S ABC .
5. Mrs. Raju Commenced business by bringing in the following assets and liabilities
of hers as her capital contribution. Journalise the transaction in simple entry format
and complex entry format.
(c) Cash Rs. 50,000.
(d) Motor Car Rs. 1,00,000
(e) Furniture Rs. 20,000
(f) Bank Loan (payable) Rs. 50,000 .
6 Mr. Nirmal has the following transactions in the month of April. Write Journal Entries
for the transactions . You can date in logical manner.
(a) Commenced business with a capital of Rs. 1,00,000 .
(b) Purchased goods from Veeru for Rs. 20,000 .
(c) Purchased Goods for Cash Rs. 15,000 .
(d) Purchased Goods from Abhiram for cash Rs. 9,000 .
(e) Bought Goods from Shyam on credit Rs. 12,000 .
(f) Sold goods worth Rs. 15,000 to Tarun .
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(g) Sold goods for cash Rs. 20,000 .
Notes
(h) Sold goods to Utsav for cash Rs. 6,000 .
(i) Sold goods to Pranav on credit Rs. 17,000 .
(j) Returned goods to Veeru Rs.3,000 .
(k) Goods returned from Tarun Rs. 1,000 .
(l) Goods taken by the proprietor for personal use Rs. 1,000 .
(m) Bought Land for Rs. 50,000 .
(n) Purchased machinery for cash Rs. 45,000 .
(o) Bought computer from Intel Computers for Rs. 25,000 .
(p) Cash sales Rs. 15,000 .
(q) Cash purchases Rs. 22,000 .
(r) Bought furniture for proprietor’s residence and paid cash Rs. 10,000.
Further Readings
1. Accounting Principles . Robert N Anthony.
2. Accounting For Managers. Maheshwari and Maheshwari.
3 Introduction to Accountancy.T S Grewal. S Chand & CO.
Delhi.
5. Financial Accounting, Tulsian. Tata McGraw-Hill, New Delhi

Unit-3: Preparation of Ledger

Notes
Structure
3.1 Introduction
3.2 Ledger Account : Balance
3.3 Ledger Posting
3.3.1 Steps in Ledger Posting
3.4 Balancing the Account
3.4.1 Sub Totals
3.4.2 It is debit Balance or Credit Balance ?
3.5 When to Balance?
3.6 What idea does the Ledger Balance give?
3.7 Balancing Frequency
3.8 Carried Forward and Brought Forward
3.8.1 Carried Forward
3.8.2 Brought Forward
3.9 Comprehensive Example On Journal And Ledger Preparation
3.10 Summary
Objectives
 The objective of this unit is make student aware of the classification process
from Journal. And also make them aware of how to balance the accounts in
ledger and how to interpret the account balances
3.1 Introduction
1. The basic purpose of Accounting is derivation of information. The target to be
achieved through the whole process of accounting is to collect all the information
relating to an element at a single place. This is achieved by preparing the ledger.
Each Ledger Account provides information relating to an element. By information
we mean the accounting information. The ledger account provides all the
accounting information relating to an element at a single place and is called king of
all the accounting books. Apart from this there is some other information that can
be derived from the ledger account.
2. Ledger contains a classified summary of all transaction recorded in Cash Book and
subsidiary books or Journal. It is the main book of account. Ledger is also called
principal book as final information pertaining to the financial position of a business
emerges only from the accounts. Other books like the Cash Book, Purchases Book
etc facilitate the preparation of accounts or the ledger and hence are known as
subsidiary books or books of original entry. Though the cash book has a unique
position, it contains the two accounts of cash and bank itself and hence it is a part
and parcel of the ledger also. The cash book therefore, is both a book of original
entry as well as a principal book. Ledger looks like the following:
Account
Dr Cr
Date Particular Folio Amt Rs. Date Particular Folio Amt Rs.

3. An alternative to the above ruling is the following:
Notes
Date Particulars Folio Dr. Amount Rs. Cr. Amount Rs. Balance Rs.
4. In an account, a reference is made to the original entry in the Cash Book/

Purchase/Sales Book or Journal etc, by entering the relevant page number in the “
Folio” column.
3.2 Ledger Account : Balance

The ledger account collects all the debits and credits made in relating to an account
head at a single place. From this information another key information called the ledger
account balance can be obtained. Debit and credit are two actions of opposing nature.
A debit in an account and a credit in the same account result in the amounts getting set
off against each other. What would be left in the account is the difference (balance) of
the two amounts after set off. This difference is what we call the balance of the ledger
account.
3.3 Ledger Posting

The process of transferring entries from the Cash Book/ subsidiary books to the
ledger is called ledger posting. A separate account is opened in ledger for each
account. All the debit entries and credit entries are duly entered.
3.4.1 Steps in Ledger Posting

1. Debit Side Posting. First of all the opening entry has to be posted. The opening
entry for various assets/expenditures should be posted by writing ‘To Balance b/f’
on the debit side of the relevant account. Enter the date of the transaction on the
debit side of the relevant account.
(a) The title of the account to be credited proceeded by the word “To” is entered in
the particulars column.
(b) In ‘Folio’ column, page number of the subsidiary book /Cash Book/Journal on
which the transaction is written.
(c) Amount column records the amount mentioned in the subsidiary book/Cash
Book/Journal against title of the account under consideration.
(d) It is to be noted that due to dual aspect of accounting the account debited in
cash/bank column will result in crediting the other account by writing ‘by cash/
bank’. Similarity, for all credit expenditures, purchase of assets the respective
expenditure/asset a/c will be debited after writing the same in respective
subsidiary book.
2. Credit Side Posting. Similarly, liabilities/incomes/revenues accounts should be

posted by writing ‘By Balance b/f ‘on the credit side of the relevant account. For
posting of the account to be credited, above mentioned steps are followed but with
one difference. Now the recording is done on the credit side of the account and
in the particulars column title of the amount to be debited is preceded by the word
“By”.

Example 1:
Notes 7. Suppose one NPF purchased Furniture of Rs 600/- on credit from X Ltd.
(a) In this case, Furniture will be debited stating,
“To X Ltd 600”
(b) The account of X Ltd will be credited saying,
“By Furniture Account 600”
3.4 Balancing The Accounts

After the posting has been completed, accounts are balanced. That is to say the
difference in the total of the two sides is ascertained. If the debit side is bigger than
credit side, the difference is known as “debit balance” and likewise, if the credit side is
bigger, the difference is “credit balance”. The difference is inserted in the shorter side,
saying, “To (or By) Balance carried down or (c/d)” and then the two sides comes equal.
The total then is written on both the sides opposite each other and the account is ruled
off. Then the balance is written on its side (debit balance on the debit side and credit
balance on credit side) as to (or By Balance) at the beginning of new period. In setting
off, we always assume that the greater sum is being set off from the smaller one. Thus
the ledger account balance is also interpreted as
1. Debit side total “ Credit side total (if debit side total is greater) .
2. Credit side total “ Debit side total (if Credit side total is greater).
Mathematically, the balance is the absolute difference between the credit side total
and the debit side total.
Ledger Account Balance = [Debit side total “ Credit side total]
3.5.1 Sub Totals

Conventionally, the totals of the postings on the debit side (sum of debit side item
values) or on the credit side (sum of credit side item values) are not shown in a ledger
account. To enable a student to understand the concept of balancing a ledger account,
we have shown them and named them sub-totals. Till you get accustomed to the
concept of ledger account balancing, add up the items and show the total as sub-totals
(at least with a pencil). It makes things easier for you. Following example will make this
aspect more clear.
Example -2
Dr Cash A/C Cr

3.4.2 It is debit Balance or Credit Balance ?
Since the balance is obtained by setting off the sum of debit side amounts and sum Notes
of credit side amounts, we can say that what remains is related to the greater sum. The
nature of the balance is related to the greater sum.
1. If the total of the debit side is greater, the ledger account has a debit balance
2. If the total of the credit side is greater the ledger has a credit balance.
In the example given above , the total of the debit side is 2,14,500 and that of credit
side is 1,90,000. The balance in this Ledger account is 24,500 (2,14,500 “ 1,90,000).
Since the debit side total is greater than the credit side total , the balance in this
Ledger account is a debit balance. .This ledger account has a debit balance of 24,500.
3.5 When To Balance ?

The ledger account is balanced periodically. In general, there are ledger accounts
that are balanced daily, weekly, monthly, annually. There is no cut right rule or principle
to specify the period for which a particular ledger account should be balanced. For
what period a ledger account is to be balanced is something that is dependent on the
information that we wish to derive from the account and the frequency at which we wish
to derive it. The period for which balancing should be done can be better understood by
looking at the information that the balance itself represents.
3.6What Idea Does The Ledger Balance Give?

1. Explanation for the information provided by the ledger account balance of some
accounts.
(a) Cash a/c. Cash a/c being a real account, is debited whenever cash comes
into the organisation (receipts) and is credited whenever cash goes out of
the organisation (payments). Thus, the amount of balance in Cash a/c should
give an idea of the amount of cash available with the organisation. [Since
you cannot pay cash without having it, let us assume that receipts are always
greater than payments.] Cash balance is an information that may be needed
frequently. So, we find it a general practice that businesses assesses the
amount of cash on a daily basis at the end of the day at least. Amount of cash
balance can be known by balancing the Cash a/c. Thus we can say that Cash
a/c is balanced daily (at the end of the day).
(b) Wages Paid a/c Wages paid a/c is a nominal account. It is debited whenever
Wages are paid. Assume that wages are being paid daily. Say, the organisation
needs the information relating to the weekly expenditure on wages. What
should it do? Balance the Wages Paid a/c on a weekly basis. The balance at
the end of the first week indicates the first weeks expenditure. The balance at
the end of the second week indicates the cumulative expenditure for the first
two weeks. Deducting the balance at the end of the first week from this would
give the expenditure for the second week.
(c) Furniture a/c Furniture a/c being a Real account, is debited whenever
Furniture comes in (bought) and is credited whenever Furniture goes
out (scrapped, sold, damaged etc). Assume that Furniture is purchased
occasionally. Organisations wish to know the value of their assets at least once
a year, generally towards the end of the year. What should be done to obtain
this information annually? Balance the Furniture a/c at the end of the year.

(d) Mr. Ibrahim a/c. Mr. Ibrahim a/c being a personal account, is debited whenever
Notes he receives some benefit (buys goods on credit) from the organisation and
is credited whenever he gives some benefit (pays money, returns goods
purchased etc) to the organisation. Say the organisation needs the information
relating to the balance due from Mr. Ibrahim (debtor) on a monthly basis. What
should be done? Balance Mr. Ibrahim’s a/c at the end of every month. [The
ledger balance gives the amount due and the nature of balance lets us know
whether the amount is due to him or due from him.]
The information may also be obtained as and when needed by balancing the
account at that point when the information is needed
3.7 Balancing Frequency

Frequency means number of occurrences within a given time period. The frequency
of balancing (i.e. how many times a ledger account is balanced in a time period [say a
year]) is dependent on the information needs of the organisation
3.8 Carried Forward And Brought Forward

3.8.1 Carried Forward
It means transfer from one time period to the next. It is Synonym to Carried Down.
Consider Cash a/c and assume that it is being balanced on a daily basis. At the end
of a day, the cashier would be left with a certain amount of cash (how much is what
is indicated by the balance in the Cash a/c). What would he do with that cash?. He
would take it over to the next working day. This explains the use of the phrase Carried
Forward or Down. We say that the balance is carried forward to the next day or the
balance is carried down to the next day. (Or) more specifically,
We say that the balance is carried forward from the end of a day to the beginning of
the next day.
Where do we use/show this (appear) in the Ledger Account
1. Following are important points
(a) The phrase “Balance c/d” or “Balance c/f” is written immediately after the sub-
total.
(b) It is written on the side with the lesser total.
(c) It is prefixed by “To” or “By” depending on which side it is being written
(d) After writing down the balance being carried down or carried forward, if you
add up the two sides starting from the sub-totals, the totals on the two sides
would be the same. This is identified as the total for each side of the ledger
account.
(e) The higher of the two totals (sub-totals) is written (in the amount column) as
the final total of the two columns.
(f) The difference between the two sub-totals (i.e. the balance) is then written on
the side having the shorter total.
(g) This would make the total of the two sides equal to the higher amount.
(h) Against the balance that is recorded, write the phrase “Balance c/d”, prefixed
with
(i) “By” if it falls on the credit side (making it By Balance c/d)
(Or)
(ii) “To” if it falls on the debit side (making it To Balance c/d).
3.8.2. Brought Forward.
it means transfer from the past time period to the current. It is Synonym to Brought Notes
Down. Consider Cash a/c and assume that it is being balanced on a daily basis. At the
end of a day, the cashier would be left with a certain amount of cash (how much is what
is indicated by the balance in the Cash a/c). What would he do with that cash?. He
would take it over to the next working day. At the beginning of the next day, what would
the cashier say? I have brought down yesterdays cash balance. This explains the use
of the phrase Brought Forward or Down. We say that the balance is brought forward
from the previous day or the balance is brought down from the previous day.
(Or) more specifically, We say that the balance is brought forward to the beginning of
the day from the end of the previous day
3. Where do we use/show this (appear) in the Ledger Account
(a) The phrase “Balance b/d” or “Balance b/f” is written immediately after the
Totals.
(b) It is written on the side with the higher sub-total.
(c) It is prefixed by “To” or “By” depending on which side it is being written.
(d) Sub totals are optional.
Following example will make all the aspects discussed above more clear.
Example - 3
Dr Cash a/c Cr
3.9 Comprehensive Example On Journal And Ledger Preparation

Example -4
1. Record the following transactions in a Journal and then post the entries into
the ledger.
(a) 15th June: Ibrahim a sole proprietor Commenced business with a capital of
Rs. 2,00,000.
(b) 17th June: Bought Furniture for cash Rs. 20,000.
(c) 17th June: Paid Rent to the shop owner Mr. Murugan Rs. 5,000.
(d) 18th June: Paid cash into bank Rs. 1,50,000
(e) 18th June: Bought Goods for cash Rs. 10,000 from M/s Shamir Jain & Co.,
(f) 18th June: Bought Goods on credit from M/s Ramdas & Bros. for Rs. 10,000.
(g) 19th June: Sold goods for cash Rs. 12,000 to Mr. Naryan Tiwari

(h) 20th June: Bought Machinery from M/s Boolani Machinery and paid by cheque
Rs. 25,000.
Notes
(i) 21st June: Sold goods on credit to Mr. Natekar for Rs. 8,000
(j) 21st June: Paid weekly wages to workers Rs. 5,000
(k) 24th June: Paid M/s Ramdas and Brothers by cheque Rs. 5,000
(l) 24th June: Received from Mr. Natekar Rs. 2,000
(m) 24th June: Received commission from M/s Orion Traders for giving a trade
lead Rs. 500.
Solution

Ledger
[Books of Mr. Ibrahim] Notes
Dr Cash a/c Cr
Amount Amount
Date Particulars J/F Date Particulars J/F
(In Rs) (In Rs)
15/06/05 To Capital a/c By Furniture a/c
19/06/05 To Goods/Stock By Rent Paid
24/06/05 a/c -
2,00,000 17/06/05
a/c -
20, 000
24/06/05 To Mr. Natekar -
12,000 17/06/05
By Bank a/c -
5, 000
- 2,000 18/06/05 - 1,50,000
a/c By Goods/Stock
To Commission
18/06/05
a/c
- 10,000
- 500 21/06/05 - 5,000
Received By Wages Paid
a/c a/c
sub-total 2,14,500 sub-total 1,90, 000
25/06/05 By Balance c/d - 24,500
Total 2,14,500 Total 2,14,500
25/06/05 To Balance b/d - 24,500
Capital a/c
Amount Amount
(In Rs) (In Rs)
15/06/05 By Cash a/c - 2,00,000
sub-total 0 sub-total 2,00,000
25/06/05 To Balance c/d - 2,00,000
Total 2,00,000 Total 2,00,000
25/06/05 By Balance b/d - 2,00, 000
Furniture a/c
Amount Amount
Data Particulars J/F Data Particulars J/F
(in Rs) (in Rs)
17/06/05 To Cash ale - 20,000
sub-total 20,000 sub-total 0
25/06/05 By Balance c/d - 20,000
Total 20,000 Total 20,000
25/06/05 To Balance b/d - 20,000
Rent Paid a/c
Amount Amount
(in Rs) (in Rs)
17/06/05 To Cash ale - 5,000
25/06/05 By Balance c/d - 5,000
25/06/05 To Balance b/d - 5,000
Bank a/c
Amount Amount
Date Particulars J/F Date PartlcuIars J/F
(In Rs) (In Rs)
18/06/05 To Cash a/c - 1 ,50,000 20/06/05 By Machinery a/c - 25,000
24/06/05 By M/s Ramdas
& Bros. ale - 5,000
sub-total 1,50,000 sub-total 30,000
25/06/05 By Balance c/d - 1,20,000
Total 1,50,000 Total 1,50,000
25/06/05 To Balance b/d - 1 ,20,000
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Goods/Stock ale
Notes
Date Particulars J/F Amount
(In Rs)
(In Rs)
18/06/05 To Cash ale - 10,000 19/06/05 By Cash ale - 12,000
1 B/06/05 By M/s 21/06/05 By Mr. Natekar - 8,000
Ramdas - 10,000 ale
& Bros. ale
sub-total 20,000 sub-total 20,000
M/s Ramdas & Bros. a/c

(in Rs)
(in Rs)
24/06/05 To Bank a/c - 5,000 18/06/05 By Goods/Stock - 10,000

ale
25/06/05 To Balance - 5,000

c/d
25/06/05 By Balance b/d - 5,000
Machinery a/c,

(In Rs)
Date PartlcuIars J/F Amount
(In Rs)
20/06/05 To Bank a/c - 25,000
25/06/05 By Balance c/d - 25,000
25/06/05 To Balance b/d - 25,000
Mr Natek ar a/c
(in Rs)
(in Rs)
21/06/05 To Goods/Stock ale - 8,000 24/06/05 By Cash a/c - 2,000
25/06/05 By Balance c/d - 6,000
25/06/05 To Balance b/d - 6,000
Wages Paid a/c

(In Rs)
(In Rs)
21/06/05 To Cash a/c - 5,000
25/06/05 By Balance c/d - 5,000
25/06/05 To Balance b/d - 5,000

Notes
3.10 Summary
The ledger, sometimes known as the nominal ledger, is the main accounting record
of a business which uses double-entry bookkeeping. It will usually include accounts
for such items as current assets, fixed assets, liabilities, revenue and expense items,
gains and losses. Each General Ledger is divided in two sections. The left hand side
lists debit transactions and the right hand side lists credit transactions. This gives a ‘T’
shape to each individual general ledger accounting. The balance sheet and the income
statement are both derived from the general ledger. Each account in the general ledger
consists of one or more pages. The general ledger is where posting to the accounts
occurs. Posting is the process of recording amounts as credits, (right side), and
amounts as debits, (left side), in the pages of the general ledger. Additional columns to
the right hold a running activity total.
Check Your Progress

1. The wrtiting of balance at the end of the month as “ By Balance c/d” denotes
………………..Balance.
2. Ledger is also called ………………Principal Book.
3. The process of transferring entries from the Cash Book/ subsidiary books to the
ledger is called …………………….
4. Balances of the various accounts are used in preparing ……………….
Questions and Excercises

1. What is Ledger ? how it is balanced.
2. Distinguish the ledger from Journal.
2. Do the ledger posting of all examples and questions of the last chapter from
journalised transactions.
Further Readings
1. Accounting Principles. Robert N Anthony.
2. Accounting For Managers. Maheshwari and Maheshwari. .
3. Introduction to Accountancy.T S Grewal. S Chand & CO.
Delhi.
5. Financial Accounting, Tulsian. Tata McGraw-Hill, New Delhi
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Unit-4: Practical System- Preparing Cash Book And

Notes Bank Reconciliation Statement
Structure
4.1 Introduction – Cash Book
4.2 Format of Cash Book
4.3 More about Cash Book
4.3.1 Special Book
4.3.2 Contra Entries
4.4 Balancing the Cash Book
4.5 What is Bank Reconciliation Statement
4.6 Reasons of difference between Bank Balance as per Cash Book and Pass
Book
4.7 The Reconciliation Statement
4.7.1 Advantage of preparing BRS
4.7.2 Steps in Preparing BRS
4.7.3 Format of BRS
4.8 Summary
Objectives
The Objectives of this unit is to give fair idea about
 How to prepare the Cash Book.
 How to reconcile the balance of Cash Book and Pass Book and to know the
importance of reconciliation process.
4.1 Introduction – Cash Book

The cash book is meant to record all cash/bank transactions whatever be their
nature if subsidiary book system is followed. It is divided into two sides, the left hand
side (called debit side) for receipts of cash and the right hand side (called credit) for
payments. All receipts are debited and payments are credited in cash column. This is
done because cash is real a/c and the rule ‘debit what comes in and credit what goes
out’ applies. Since in today’s Business Concern, transactions with or through Bank are
even more numerous than strictly cash transaction, each side has two columns one
to record cash transactions and the other to record Bank transactions. Payments into
the Bank are entered on the left hand side (debit side) , payments out of Bank a/c are
entered on the right hand side(credit side). This is because bank a/c is personal a/c and
the rule ‘debit the receiver and credit the giver’ applies.
4.2 Format Of Cash Book

Ruling of a typical two column Cash Book is given here under:-
Dr Cr
Date Particular’s Ledger Foli Cash Bank Date Particulars Ledger Folio Cash Bank
Note : Cash and Bank Balances will be shown in two different coumns both the sides.

The opening balance of cash in hand and at Bank is written first of all as “To Balance
brought down” or just “To Balance b/d”. At the end of the period concerned the two Notes
columns on both the sides are totalled. The debit side cash column will always be
higher than the credit side cash column. The difference represents actual cash in hand
and should tally with the amount in the cashier’s hand. Usually, the debit side bank
column is always bigger than the credit side bank column. The difference will mean so
much balance at the Bank. But sometimes a Bank allows a person an Overdraft (OD)
i.e., he can draw more than he has deposited. In such a case, the credit side Bank
column will total more than the debit side Bank column. (If the debit side is heavier,
the difference is a debit balance and if the credit side is heavier, the difference is a
credit balance). Difference is put on the shorter side (opposite side) by writing:” To (or
by) balance carried down (c/d)”. Then the two sides are totalled, same figure appearing
on both the sides. In the cash book of the new period, one will begin with the closing
balance of the previous period which would become the opening balance of the new
period.
4.3 More About Cash Book

4.3.1 Special Book.
Cash Book is special Journal in which all cash and bank transaction are recorded
directly. Cash Book shows the cash receipts and the cash payments and it should not
be confused with profitability. The Cash Book resembles a ledger with the debit and
credit sides, and the balance represents cash on hand at the end of the accounting
period/sub-period or any particular occasion. Cash account is not opened separately,
when a Cash Book is maintained because Cashbook serves the purpose of the ledger
also. In other words, Cashbook is the book of first entry for all such transactions and the
ledger accounts for cash in hand and cash at bank.
4.3.2 Contra Entries.

1. If a transaction affects cash account and bank account only, entry for recording the
transaction is called a contra entry. Contra entries are corresponding entries made
on the opposite sides (both) of the cash book. They have to be written on both sides
as both sides (cash and bank a/c) are in the book itself. They are made on the
following occasions:
(a) When a cheque is presented to Bank and money is collected-payment entry in

the bank column and receipt entry in the cash column.
(b) When a cheque held as cash is sent for deposit to Bank-Payment entry in the
cash column and receipt entry in the Bank column.
(c) Cheques issued are returned and fresh cheques issued in lieu – Receipt entry
in the Bank column and payment entry in the Bank column.
(d) When cash is given in lieu of cheque – payment entry in cash column and
receipt entry in cash column.
(e) The sign used for contra entry C/…. is made red ink in the ledger folio column
and serially numbered during the month.
4.4 Balancing of Cash Book.

Cash book is to be ruled off and balanced on the occasions and the balance carried
forward to the next month and on the next page in the similar way what has been
discussed about balancing the account in the ledger. Cash and Bank balances are to be
separately balanced. Discount column is not to be balanced.

Example 1 - Cash Book-

Notes 8. A example of preparing Cash Book from cash/bank transactions is given below :
The following transactions of M/s Kempapura Ltd Bangalore for the month of Jan
05 in the Cash Book. The Cash Book is required to be balanced for on 11Jan 05 on the
occasion of knowing the cash balance.
Date Transactions Amount
1 2 3
01 Opening Balance Cash Rs 950
Bank Rs. 65,000
Withdrew from Bank Rs. 2,000
Advance to Maanger, KP Singh Cash for Petty Exps Rs. 1,000
02 Purchase of Stationery For cash Rs. 1,000
03 Bought Sofa set for the Business Concern and paid by Rs. 10,000
Cheque
04 Bought Music System and Paid by Cheque Rs. 10,000
05 KP Singh cleared his advance by Submitting a bill for
Rs. 900/- and Cash Refund Rs. 100/-
07 Purchased manure, seeds, pots etc for garden for Cash Rs. Rs. 500
08 Purchased Bath-room Requisites for Cash Rs. 250
10 Purchased goods Rs. 8,000
11. Withdrawn from Bank Rs. 4,000
Note. Use imaginary receipt numbers, vouchers numbers, cheque numbers and
ledger folios.

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4.5 What is Bank Reconcilation Statement

The Bank Reconciliation Statement (BRS) is an aid used to ensure the accuracy
of transactions appearing in the bank columns of the cashbook. Such transactions
can be verified through an external record, namely, the bank statement or pass book
received periodically from the banker. While the Business Concern keeps a record of
its transactions through the bank column in the Cashbook, the banker in turn maintains
the bank's transaction with the Business Concern in his ledger. An extract from this

ledger showing details of the transactions during a specified period is sent at frequent
Notes intervals by the bank of the Business Concern and this extract is referred to as a bank
statement or pass book. Ideally speaking if both the side transactions are happening
instantly, then the balances in Cash Book and Bank’s Pass Book for the same Business
Concern should be in agreement but it normally does not happen . Let’s see why?
4.5 Reasons For Difference Between Bank Balance as Per

Cashbook and Passbook
1. The relationship between the customer and the banker is that of a creditor and
a debtor. So, if the bank column of the Cashbook shows a debit balance as on a
specified date the bank statement should show an equal amount of credit balance
as on that date vice versa. However, the balances shown by the two independent
records may not always agree due to the following:
(a) Cheques issued by the Business Concern to its suppliers or other parties may
not have been presented for payment.
(b) Cheques received from customers and deposited may not have been collected
and credited by the banker.
(c) Deposits may have been directly made into the bank account of the Business.
(d) Collection charges, service charges and interest on overdraft charged by the
banker.
(e) Interest and other incomes directly credited by the bank.
(f) Wrong entries made by the Business Concern in the Cash Book or errors
committed by the bank in its ledger.
(g) Omission of entries in the two sets of books.
(h) Dishonour of cheques deposited in the bank.
The effect of one of these entries is explained below.
Example 2
1. Cheques issued but not presented for payment: When a cheque is issued
to a third party, it is entered in the Cash Book by crediting the Bank account
resulting in reducing the bank balance in the business’s books. But bank
debits the business concern’s account only when the cheque is presented by
that third party. So, till it is presented and paid for, the bank passbook shows
more balance than shown by the depositor’s Cashbook.

Notes
2. So, balance as per bank statement or passbook is Rs 2, 000 less than the
balance in the Cashbook.
4.7 The Reconciliation Statement

1. On receipt of the bank statement or on updating the passbook, a comparison
of the entries in the Cashbook with those appearing in the bank statement will help in
identifying the items causing the difference in the two balances. While the difference
due to the reasons enumerated in para 2 (a) and (b) above will be eliminated in the
near future (that is, creditors will soon present their cheques for payment and Business
Concern’s cheques will be collected by the bank in due course), the difference due
to items 2 (c) and (h) can be eliminated only if such items are recorded in the cash
Book. After these adjustments have been recorded a statement will be prepared to
reconcile the balance as shown by the Cashbook with that shown by the passbook.
This statement is referred to a BRS. The BRS is thus an additional tool available to
check the accuracy of the bank columns of the Cash Book.
4.7.1 Advantages of Bank Reconciliation Statement (BRS)

1. Following are the steps for preparing BRS:
(a) Error Detection.
(b) Delay in collection gets revealed in time.
(c) Completion of Cash Book as BUSINESS CONCERNs gets information about
bank charges, cheques dishonoured, direct payments and direct receipts etc.
(d) Chances of embezzlement are reduced.
4.7.2 Steps in preparation of BRS
1. Steps of preparing BRS can be as follows:
(a) Take the Cashbook and passbook balance as starting point.
(b) Adjust the start point amount as per information given and analyse its impact
on the other balances.
(c) After adjusting all the difference or errors, the balance as per the other book
is obtained. If the final balance is positive, it denotes favourable balance (Dr.
Balance as per Cashbook or credit balance as per the passbook). However, if
the final balance is negative, it denotes the unfavourable balance or overdraft.
(Cr. Balance as per Cashbook or debit balance as per passbook).
4.7.3 Format of BRS

The following table summarizes the impact of various difference and errors on the
starting balance. This template will help you in practicing preparing BRS by following
steps as enumerated above.

Notes
Example – 3.
1. DLF Golf Course, New Delhi shown an overdrawn position of Rs 3732 on 31
March 2005. Detailed examination of two records revealed following. Analyse the
following and prepare BRS.
(a) A cheque of Rs. 1,560 received from R Bhatia had been credited in the name
of another customer’s a/c ( R K Parashar).
(b) The debit side of his own book had been undercast by Rs.300.
(c) A cheque for Rs. 182 drawn in payment of electricity charges had been
entered in Cashbook as Rs. 128 but was shown correctly in bank statement.
(d) A cheque for Rs.210 from Deepinder Singh having been paid into bank, was
dishonoured and shown as such in Bank Statement, although no entry relating
to dishonouring of the cheque had been made in the Cashbook.
(e) The bank had debited a cheque for Rs. 126 to Golf Course a/c. It should have
been debited to one customer a/c (A K Bassy).
(f) An interest credit of Rs. 90 on Golf Course has been directly collected by the
bank, but no entry has been made in the Cash Book.
(g) A cheque for Rs.1, 080 deposited in the bank on 31.3.2001 had not been
credited by the bank.
(h) Interest of Rs. 228 had been directly debited by bank but the same was not
recorded in Cashbook.
Notes
Prepare a Bank Reconciliation Statement after necessary amendments in the
Cashbook as on 31st March, 2001.
Solution
Bank Reconciliation Statement On 31 St March 2005
4.8 Summary
Knowing about the Cash Book is very important as cash and Bank Balance is the
life blood of the business. Even the Business is not following subsidiary book system
a hybrid system is followed and Cash Book is maintained. Similarly, Knowing about
BRS is important for the benefits mentioned. After you adjust the balance per bank to
be the true balance and after you adjust the balance per books to also be the same true
balance, you have reconciled the bank statement. Most accountants would simply say
that you have done the bank reconciliation .
Check Your Progress

1. The cash book is meant to record all ……………transactions whatever be their
nature.
2. Cashbook is the book of first entry for ……….. transactions and the ledger accounts
for ………….. and ……………..
3. In three column Cash Book the ……………………column is not balanced.
4. The ……………….column of the cash book can only have the debit balance.
5. Contra entries are ……………to be recorded in the ledger.
True or False
6. The cash book can only be balanced at the month end.
7. All receipts are written on the credit side of the cash book.
8. Bank Statement and Bank Reconciliation Statement are the same.
9. BRS helps in detecting/ruling out the frauds beside facilitating the follow up actions.

10. BRS is prepared by only profit making organisations.

Notes
Questions and Excercises
1. What is Cash Book ? What is its Format? How it is Prepared?
2. What are the Contra Entries? Are they posted to Ledger?
3. Enter the following transactions in Cash Book of M/s Barkat & Co

2008 April 1 Cash in hand Rs 237 ; Balance at Bank Rs 200.
April 2 Received from KK Ent cash Rs 590.
April 4 Cash Sales Rs 134
Paid salaries for March by cash Rs 200.
April 5 Paid BK Bose by cheque Rs 300.
Cash Purchases Rs 60
April 8 Cash Sales Rs 112
Paid Cartage Rs 12
April 10 Paid rent Rs 10
April 14 Deposited into Bank Rs 300.
April 30 Paid Wages Rs 72.
4. From the following particulars prepare a Bank Reconciliation Statement as on 31st

March, 2007 of CD & Associates.
Rs.
(a) Balance as per Cash Book 11,600
(b) Cheques issued but not presented for payment upto 31st March, 2007 4,000
(c) Cheques sent for collection but not collected upto 31st March, 2007 3,000
(d) The Bank had wrongly debited the firm’s account by Rs. 400
which was rectified by them in April, 2007
(e) Interest on securities Rs. 800 collected by the Bank direct credited by the
Bank to the firm’s Account within 31st March, 2007 but not entered in the Cash
Book.
5. The Bank Balance as per Bank Statement of Sen & Co. as on 31st March, 2003
showed a Credit Balance of Rs. 19,500. On comparison with the Cash Book the
following points were noted: 8+8=16 (a) Cheques of Rs. 15,900 deposited on
29.03.2003 but cheque of Rs. 9,500 credited by the Bank on 3.4.2003. (b) Cheque
of Rs. 5,900 deposited with the Bank on 24.3.2003 but not recorded in the Cash
Book. (c) As per out standing order Bank paid on our Account Telephone Bill Rs.
2,500 and Electric Bill of Rs. 1,200 for the month of February, 2003, intimation
for the same cam on 2.4.2003. (d) Cheque of Rs. 16,000 issued to creditors by
31.3.2003 but cheque of Rs. 6,200 was presented by 31.3.2003. (e) Bank has
debited our account Rs. 500 for issuing cheque books from time to time but not
recorded in the Cash Book. (f) A cheque of Rs. 2,000 deposited with the Bank on
12.2.2003 but the Bank has credited Rs. 1,970 on 16.3.2003. (g) Bank has credited
out Account by Rs. 1,200 on account of interest on Fixed Deposit but not recorded
in the Cash Book. Make necessary corrections in the Cash Book and prepare Bank
Reconciliation Statement.

Further Readings
1. Accounting Principles. Robert N Anthony. Notes
2. Accounting For Managers. Maheshwari and Maheshwari. .
3. Introduction to Accountancy.T S Grewal. S Chand & CO.
Delhi.
5. Financial Accounting, Tulsian. Tata McGraw-Hill, New Delhi.

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Accounting for Managers 9

Unit-1: Accounting: Introduction

1.2 What Is Accounting ?

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1.3 Definition of Accounting

The american institute of certified and public accountants committee on terminology

Objectives and Scope of Accounting

 To keep systematic records: Accounting is done to keep systematic record of

 To ascertain the financial position of the business: A balance sheet or a

 To assist in decision-making: To take decisions for the future, one requires

 To fulfill compliance of Law: Business entities such as companies, trusts, and

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Difference between Accounting and Book-keeping: There exists a difference

Accounting vs. Accountancy: Body of knowledge (consisting of principles,

1.4 Financial Accounting- Steps

1. Creation. It entails three steps namely Recording, Classifying and Summarizing

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(b) Classifying: Refers to the rational segregation of the recorded information

(d) Reporting: The reporting of these summaries is done through Financial

1.5 D o u b l e Entry System Of Accounting

1.6 Generally Accepted Accounting Principles, Conventions And

1.7 Accounting Concepts

1. Money Measurement Concept. In financial accountancy, a record is made only of

3. Going Concern Concept

4. Business Entity Concept. Less understood however is the accounting entity of a

5. Accounting period Concept.

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2. Conservatism. This principle emphasizes that revenues are to be recognized only

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4 Materiality. Because of this basic accounting principle or guideline, an

1.9 Accounting Principles In India

Because the material covered here is considered an introduction to the topic of

1.10 Usefulness Of Accounting

1. How good or bad is the financial condition of the business?

2. Has the business activity resulted in a profit or loss?

4. Which activities or products have been profitable?

6. Whether to buy a component from the market or to manufacture the same?

7. Whether the cost of production is reasonable or excessive?

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12 Besides, accounting is also useful in the following respects :-

1.11 Various Users Of Financial Statements

1. Shareholders or owners: They are interested in knowing the probability of the

2. Management: They are interested in all information relating to business to frame

7. Researchers: They acquire the information to do academic research.

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1.12 Branches Of Accounting

1. Financial Accounting. The object of financial accounting is to ascertain the result

2. Cost accounting. is the branch of accounting dealing with the recording,

3. Management Accounting. The object of management accounting is to supply

Are Tax Prepares Accountants?

1.13 Limitations Of Financial Accounting

1. Financial accounting permits alternative treatments. Accounting is based on

2. Financial accounting does not provide timely information. It is not a limitation

3. Historical Information. Financial accounting is designed to supply information

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4. Time Interval. Traditionally, financial accounting is not supposed to supply

5. Subjectivity. Financial accounting is influenced by personal judgments’

6. Financial accounting ignores important non-monetary information.

7. Financial Accounting does not provide detailed analysis. The information

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information to owners, investors, creditors, employees and other stakeholders. Financial

Check Your Progress

3. Total Liabilities = ———————— + External Liability.