Account and Finance Research PDF

Accounting and Finance
Comprehensive Assignment
Prepared by:
Mirza Farrukh Baig
Submitted to:
ABASEEN
Institute of Medical & Modern Sciences
(AIMMS)
Q1. Describe ‘Basic concept of Accounting’?
Accounting concept refers to the basic assumptions and rules and principles which work as the
basis of recording of business transactions and preparing accounts.
The main objective is to maintain uniformity and consistency in accounting records. These
concepts constitute the very basis of accounting. All the concepts have been developed over
the years from experience and thus they are universally accepted rules. Following are the
various accounting concepts that will be discussed in the following sections:
 Business entity concept

 Money measurement concept
 Going concern concept
 Accounting period concept
 Accounting cost concept
 Duality aspect concept
 Realization concept
 Accrual concept
 Matching concept
Business Entity Concept:

This concept assumes that, for accounting purposes, the business enterprise and its owners are
two separate independent entities. Thus, the business and personal transactions of its owner
are separate. For example, when the owner invests money in the business, it is recorded as
liability of the business to the owner. Similarly, when the owner takes away from the business
cash/goods for his/her personal use, it is not treated as business expense. Thus, the accounting
records are made in the books of accounts from the point of view of the business unit and not
the person owning the business. This concept is the very basis of accounting. Let us take an
example. Suppose Mr. Ahmed started business investing Rs100,000. He purchased goods for
Rs40,000, Furniture for Rs20,000 and plant and machinery of Rs30,000. Rs10,000 remains in
hand. These are the assets of the business and not of the owner. According to the business
entity concept Rs100,000 will be treated by business as capital i.e. a liability of business towards
the owner of the business. Now suppose, he takes away Rs5,000 cash or goods worth Rs5,000
for his domestic purposes. This withdrawal of cash/goods by the owner from the business is his
private expense and not an expense of the business. It is termed as Drawings. Thus, the
business entity concept states that business and the owner are two separate/distinct persons.
Accordingly, any expenses incurred by owner for himself or his family from business will be
considered as expenses and it will be shown as drawings.
Accounting & Finance Prepared by Mirza Farrukh Baig

SIGNIFICANCE
The following points highlight the significance of business entity concept:
 This concept helps in ascertaining the profit of the business as only the business
expenses and revenues are recorded and all the private and personal expenses are
ignored.
 This concept restraints accountants from recording of owner’s private / personal
transactions.
 It also facilitates the recording and reporting of business transactions from the business
point of view
 It is the very basis of accounting concepts, conventions and principles.
Money Measurement Concept

This concept assumes that all business transactions must be in terms of money that is in the
currency of a country. In our country such transactions are in terms of rupees. Thus, as per the
money measurement concept, transactions which can be expressed in terms of money are
recorded in the books of accounts. For example, sale of goods worth Rs.200,000, purchase of
raw materials Rs.100,000, Rent Paid Rs.10,000 etc. are expressed in terms of money, and so
they are recorded in the books of accounts. But the transactions which cannot be expressed in
monetary terms are not recorded in the books of accounts. For example, sincerity, loyalty,
honesty of employees is not recorded in books of accounts because these cannot be measured
in terms of money although they do affect the profits and losses of the business concern.
Another aspect of this concept is that the records of the transactions are to be kept not in the
physical units but in the monetary unit. For example, at the end of the year 2006, an
organization may have a factory on a piece of land measuring 10 acres, office building
containing 50 rooms, 50 personal computers, 50 office chairs and tables, 100 kg of raw
materials etc. These are expressed in different units. But for accounting purposes they are to be
recorded in money terms i.e. in rupees. In this case, the cost of factory land may be say Rs.12
crore, office building of Rs.10 crore, computers Rs.10 lakhs, office chairs and tables Rs.2 lakhs,
raw material Rs.30 lakhs. Thus, the total assets of the organization are valued at Rs.22 crore
and Rs.42 lakhs. Therefore, the transactions which can be expressed in terms of money is
recorded in the accounts books, that too in terms of money and not in terms of the quantity.
SIGNIFICANCE
 The following points highlight the significance of money measurement concept:

 This concept guides accountants what to record and what not to record.
 It helps in recording business transactions uniformly.

 If all the business transactions are expressed in monetary terms, it will be easy to
understand the accounts prepared by the business enterprise.
 It facilitates comparison of business performance of two different periods of the same
firm or of the two different firms for the same period.
Going Concern Concept

This concept states that a business firm will continue to carry on its activities for an indefinite
period of time. Simply stated, it means that every business entity has continuity of life. Thus, it
will not be dissolved in the near future. This is an important assumption of accounting, as it
provides a basis for showing the value of assets in the balance sheet; For example, a company
purchases a plant and machinery of Rs.100,000 and its life span is 10 years. According to this
concept every year some amount will be shown as expenses and the balance amount as an
asset. Thus, if an amount is spent on an item which will be used in business for many years, it
will not be proper to charge the amount from the revenues of the year in which the item is
acquired. Only a part of the value is shown as expense in the year of purchase and the
remaining balance is shown as an asset.
SIGNIFICANCE
 The following points highlight the significance of going concern concept;

 This concept facilitates preparation of financial statements.
 On the basis of this concept, depreciation is charged on the fixed asset.
 It is of great help to the investors, because, it assures them that they will continue to get
income on their investments.
 In the absence of this concept, the cost of a fixed asset will be treated as an expense in
the year of its purchase.
 A business is judged for its capacity to earn profits in future.
Accounting Period Concept

All the transactions are recorded in the books of accounts on the assumption that profits on
these transactions are to be ascertained for a specified period. This is known as accounting
period concept. Thus, this concept requires that a balance sheet and profit and loss account
should be prepared at regular intervals. This is necessary for different purposes like, calculation
of profit, ascertaining financial position, tax computation etc. Further, this concept assumes
that, indefinite life of business is divided into parts. These parts are known as Accounting
Period. It may be of one year, six months, three months, one month, etc. But usually one year is
taken as one accounting period which may be a calendar year or a financial year.

Year that begins from 1st of January and ends on 31st of December’, is known as ‘Calendar
Year’. The year that begins from 1st of April and ends on 31st of March of the following year, is
known as financial year
As per accounting period concept, all the transactions are recorded in the books of accounts for
a specified period of time. Hence, goods purchased and sold during the period, rent, salaries
etc. paid for the period are accounted for and against that period only.
SIGNIFICANCE
 It helps in predicting the future prospects of the business.

 It helps in calculating tax on business income calculated for a particular time period.
 It also helps banks, financial institutions, creditors, etc to assess and analyze the
performance of business for a particular period.
 It also helps the business firms to distribute their income at regular intervals as
dividends.
Accounting Cost Concept

Accounting cost concept states that all assets are recorded in the books of accounts at their
purchase price, which includes cost of acquisition, transportation and installation and not at its
market price. It means that fixed assets like building, plant and machinery, furniture, etc are
recorded in the books of accounts at a price paid for them. For example, a machine was
purchased by XYZ Limited for Rs.500,000, for manufacturing shoes. An amount of Rs.1,000 were
spent on transporting the machine to the factory site. In addition, Rs.2,000 were spent on its
installation. The total amount at which the machine will be recorded in the books of accounts
would be the sum of all these items i.e. Rs.503,000. This cost is also known as historical cost.
Suppose the market price of the same is now Rs 90,000 it will not be shown at this value.
Further, it may be clarified that cost means original or acquisition cost only for new assets and
for the used ones, cost means original cost less depreciation. The cost concept is also known as
historical cost concept. The effect of cost concept is that if the business entity does not pay
anything for acquiring an asset this item would not appear in the books of accounts. Thus,
goodwill appears in the accounts only if the entity has purchased this intangible asset for a
price.
SIGNIFICANCE
 This concept requires asset to be shown at the price it has been acquired, which can be
verified from the supporting documents.
 It helps in calculating depreciation on fixed assets.

 The effect of cost concept is that if the business entity does not pay anything for an
asset, this item will not be shown in the books of accounts.
Duality Aspect Concept

Dual aspect is the foundation or basic principle of accounting. It provides the very basis of
recording business transactions in the books of accounts. This concept assumes that every
transaction has a dual effect, i.e. it affects two accounts in their respective opposite sides.
Therefore, the transaction should be recorded at two places. It means, both the aspects of the
transaction must be recorded in the books of accounts. For example, goods purchased for cash
has two aspects which are (i) Giving of cash (ii) Receiving of goods. These two aspects are to be
recorded. Thus, the duality concept is commonly expressed in terms of fundamental accounting
equation:
Assets = Liabilities + Capital
The above accounting equation states that the assets of a business are always equal to the
claims of owner/owners and the outsiders. This claim is also termed as capital or owners’ equity
and that of outsiders, as liabilities or creditors’ equity. The knowledge of dual aspect helps in
identifying the two aspects of a transaction which helps in applying the rules of recording the
transactions in books of accounts. The implication of dual aspect concept is that every
transaction has an equal impact on assets and liabilities in such a way that total assets are
always equal to total liabilities. Let us analyze some more business transactions in terms of their
dual aspect:
1. Capital brought in by the owner of the business, the two aspects in this transaction are:
(i) Receipt of cash
(ii) Increase in Capital (owners’ equity)
2. Purchase of machinery by cheque, the two aspects in the transaction are
(i) Reduction in Bank Balance
(ii) Owning of Machinery
3. Goods sold for cash, the two aspects are
(i) Receipt of cash
(ii) Delivery of goods to the customer

4. Rent paid in cash to the landlord, the two aspects are
(i) Payment of cash
(ii) Rent (Expenses incurred).
Once the two aspects of a transaction are known, it becomes easy to apply the rules of
accounting and maintain the records in the books of accounts properly. The interpretation of
the Dual aspect concept is that every transaction has an equal effect on assets and liabilities in
such a way that total assets are always equal to total liabilities of the business.
SIGNIFICANCE
 This concept helps accountant in detecting error.

 It encourages the accountant to post each entry in opposite sides of two affected
accounts.
Realization Concept
This concept states that revenue from any business transaction should be included in the
accounting records only when it is realized. The term realization means creation of legal right to
receive money. Selling goods is realization, receiving order is not. In other words, it can be said
that:
Revenue is said to have been realized when cash has been received or right to receive cash on
the sale of goods or services or both has been created.
Let us study the following examples:
(i) N.P. Jeweler received an order to supply gold ornaments worth Rs.500,000. They supplied
ornaments worth Rs.200,000 up to the year ending 31st December 2005 and rest of the
ornaments were supplied in January 2006.
(ii) Bansal sold goods for Rs.100,000 for cash in 2006 and the goods have been delivered during
the same year.
(iii) Akshay sold goods on credit for Rs.50,000 during the year ending 31st December 2005. The
goods have been delivered in 2005 but the payment was received in March 2006.
Now, let us analyze the above examples to ascertain the correct amount of revenue realized for
the year ending 31st December 2005.
(i) The revenue for the year 2005 for N.P. Jeweler is Rs.200,000. Mere getting an order is not
considered as revenue until the goods have been delivered.
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(ii) The revenue for Bansal for year 2005 is Rs.100,000 as the goods have been delivered in the
year 2005. Cash has also been received in the same year.
(iii) Akshay’s revenue for the year 2005 is Rs.50,000, because the goods have been delivered to
the customer in the year 2005. Revenue became due in the year 2005 itself. In the above
examples, revenue is realized when the goods are delivered to the customers.
The concept of realization states that revenue is realized at the time when goods or services are
actually delivered.
In short, the realization occurs when the goods and services have been sold either for cash or
on credit. It also refers to inflow of assets in the form of receivables.
SIGNIFICANCE
 It helps in making the accounting information more objective.

 It provides that the transactions should be recorded only when goods are delivered to
the buyer.
Accrual concept
The meaning of accrual is something that becomes due especially an amount of money that is
yet to be paid or received at the end of the accounting period. It means that revenues are
recognized when they become receivable. Though cash is received or not received and the
expenses are recognized when they become payable though cash is paid or not paid. Both
transactions will be recorded in the accounting period to which they relate. Therefore, the
accrual concept makes a distinction between the accrual receipt of cash and the right to receive
cash as regards revenue and actual payment of cash and obligation to pay cash as regards
expenses. The accrual concept under accounting assumes that revenue is realized at the time of
sale of goods or services irrespective of the fact when the cash is received. For example, a firm
sells goods for Rs 55,000 on 25th March 2005 and the payment is not received until 10th April
2005, the amount is due and payable to the firm on the date of sale i.e. 25th March 2005. It
must be included in the revenue for the year ending 31st March 2005. Similarly, expenses are
recognized at the time services provided, irrespective of the fact when actual payment for
these services are made. For example, if the firm received goods costing Rs.20,000 on 29th
March 2005 but the payment is made on 2nd April 2005 the accrual concept requires that
expenses must be recorded for the year ending 31st March 2005 although no payment has
been made until 31st March 2005 though the service has been received and the person to
whom the payment should have been made is shown as creditor. In brief, accrual concept
requires that revenue is recognized when realized and expenses are recognized when they
become due and payable without regard to the time of cash receipt or cash payment.
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SIGNIFICANCE
 It helps in knowing actual expenses and actual income during a particular time period.
 It helps in calculating the net profit of the business.
Matching concept
The matching concept states that the revenue and the expenses incurred to earn the revenues
must belong to the same accounting period. So once the revenue is realized, the next step is to
allocate it to the relevant accounting period. This can be done with the help of accrual concept.
Let us study the following transactions of a business during the month of December, 2006 (i)
Sale: cash Rs.2,000 and credit Rs.1,000 (ii) Salaries Paid Rs.350 (iii) Commission Paid Rs.150
(iv) Interest Received Rs.50 (v) Rent received Rs.140, out of which Rs.40 received for the year
2007 (vi) Carriage paid Rs.20 (vii) Postage Rs.30 (viii) Rent paid Rs.200, out of which Rs.50
belong to the year 2005 (ix) Goods purchased in the year for cash Rs.1,500 and on credit Rs.500
(x) Depreciation on machine Rs.200 Let us record the above transactions under the heading of
Expenses and Revenue.
In the above example expenses have been matched with revenue i.e (Revenue Rs.3,150-
Expenses Rs.2,900) This comparison has resulted in profit of Rs.250. If the revenue is more than
the expenses, it is called profit. If the expenses are more than revenue it is called loss. This is
what exactly has been done by applying the matching concept. Therefore, the matching
concept implies that all revenues earned during an accounting year, whether received/not
received during that year and all cost incurred, whether paid/not paid during the year should
be taken into account while ascertaining profit or loss for that year.
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SIGNIFICANCE
 It guides how the expenses should be matched with revenue for determining exact
profit or loss for a particular period.
 It is very helpful for the investors/shareholders to know the exact amount of profit or
loss of the business.

Q2. What do you know about ‘Record Keeping’? Give details.
One of the main parts of accounting is recordkeeping or bookkeeping. Recordkeeping is the
process of recording transactions and events in an accounting system. Since the principles of
accounting rely on accurate and thorough records, record keeping is the foundation accounting.
A brief history of record keeping

As soon as records could be documented, thousands of years ago, wealth and taxes were
recorded. Early writing on papyrus or stone showed the amount that tenants of wealthy
landholders paid as taxes for living on the owner’s land. Governments issued taxes and
recorded receipt of the taxes and payments made for expenditure. Bookkeeping is based on
principles set in a text written in excess of five hundred years ago. The double entry system of
bookkeeping was first used by the merchants in Venice, Italy. A friar, Luca Pacioli, published a
mathematics book in 1494. One chapter referred to the double entry system used by the
merchants. He stated that for ‘every credit there must be a corresponding debit’ and also
mentioned the merchants’ use of journals, ledger accounts and a trial balance. Also stated was
the separation of the five groups of accounts used today: the assets, liabilities, income, expense
and capital accounts. The text also referred to the ‘cash’ and ‘accrual’ methods of accounting.
Pacioli stated that a successful merchant needed three basic but important things to operate a
business diligently: 1. a surplus cash fund and the availability of credit 2. the ability to arrange
business transactions in debits and credits in an orderly way 3. to have the services of a ‘sharp’
bookkeeper. Double entry bookkeeping was so simple that it was immediately adopted by
businesses of that time and this strengthened the position of bookkeepers as important
financial contributors to the industry. The principles of double entry bookkeeping continue
today.
Accounts
General ledger accounts are used for sorting and storing the company’s transactions. Examples
of accounts include Cash, Account Receivable, Accounts Payable, Loans Payable, Advertising
Expense, Commissions Expense, Interest Expense, and perhaps hundreds or thousands more.
The amounts in the company’s general ledger accounts will be used to prepare a company’s
financial statements such as its balance sheet and income statement. Within the general ledger,
a corporation’s accounts are usually organized as follows:
BALANCE SHEET ACCOUNTS
 Assets
o Current assets
o Long-term investments
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o Property, plant and equipment
o Other assets
 Liabilities
o Current liabilities
o Noncurrent liabilities
o Deferred credits
 Stockholders’ equity
o Paid-in capital
o Retained earnings
o Treasury stock
INCOME STATEMENT ACCOUNTS
 Operating revenues
 Operating expenses
 Non-operating revenues and gains
 Non-operating expenses and losses
The balance sheet accounts are known as permanent or real accounts since these accounts are
not closed at the end of the accounting year. Instead, the balances are carried forward to the
next accounting year. (If the company had Cash of $987 at the end of the accounting year, it will
begin the next accounting year with Cash of $987.) The income statement accounts are known
as temporary or nominal accounts since these accounts are closed at the end of the accounting
year. In other words, the balances in the accounts for revenues and expenses will not carry
forward to the next accounting year. Instead, the balances in these accounts are closed by
transferring the end-of-year balances to Retained Earnings. Since the income statement
accounts will begin each accounting year with zero balances, they will report the company’s
year-to-date revenues and expenses. A list of all of the individual balance sheet and income
statement accounts that are available for recording transactions is the chart of accounts. The
chart of accounts can be expanded as more accounts become necessary for improved reporting
of transactions.
Journals
Under a manual system (and in many bookkeeping textbooks) transactions are first recorded in
journals and from there are posted to accounts. Hence, journals were defined as books of
original entry. In manual systems, there were special journals (or day books) such as a sales
journal, purchases journal, cash receipts journal, and cash payments journal. With bookkeeping
software the need for these special journals has been reduced or eliminated. However, the
general journal is still needed in both manual and computerized systems in order to record
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adjusting entries and correcting entries. The following entry shows the format that is used in
the general journal:
Ledgers
In addition to the general ledger (which contains general ledger accounts), manual bookkeeping
systems often had subsidiary ledgers. The details in a subsidiary ledger’s accounts should add
up to the summary amounts found in the related general ledger account. Subsidiary ledgers
were common for the following general ledger accounts: Accounts Receivable, Accounts
Payable, Inventory, and Property, Plant and Equipment. When a subsidiary ledger is used, the
respective general ledger account is referred to as a control account.
Debits and Credits

The words debit and credit are similar to the words used 500 years ago when double-entry
bookkeeping was documented by an Italian monk. Today you should think of debit and credit as
follows:
 debit indicates that an amount should be entered on the left side of an account
 credit indicates that an amount should be entered on the right side of an account
In short, debit means left, credit means right.
An increase in an asset account is recorded with a debit amount. In other words, the amount
should be entered on the left side of the account. (Three examples of asset accounts are Cash,
Accounts Receivable, and Equipment.)
A decrease in an asset account is recorded with a credit amount. In other words, the amount
should be entered on the right side of the account.
To illustrate an increase and a decrease in asset accounts let’s assume that a company pays
cash for equipment which has a cost of $20,000. The company should record a debit of $20,000
in its asset account Equipment (since this asset increased) and it should record a credit of
$20,000 in its asset account Cash (since this asset decreased).
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Expenses are recorded as debit amounts.
When a company pays $1,000 for its monthly rent, a debit of $1,000 needs to be entered in the
account Rent Expense (and a credit of $1,000 needs to be entered in the asset account Cash).
Revenues are recorded as credit amounts.
To record a cash sale of $700, the account Sales needs a credit entry of $700, and the account
Cash needs a debit entry of $700.
An increase in a liability account is recorded with a credit entry. In other words, the amount
will be entered on the right side of the account. (Two examples of liability accounts are
Accounts Payable and Loans Payable.)
A decrease in a liability account is recorded with a debit.
To illustrate an increase and decrease in liability accounts let’s assume that a company signs a
promissory note to a supplier to replace its $5,000 accounts payable. A debit of $5,000 is
entered in Accounts Payable (since this liability decreased) and a credit of $5,000 is recorded in
Loans Payable (since this liability increased).
An increase in a stockholders’ equity account is recorded with a credit entry. In other words,
the amount will be entered on the right side of the stockholders’ equity account. (Two
examples of stockholders’ equity accounts are Common Stock and Retained Earnings.)
A decrease in a stockholders’ equity account is recorded as a debit. For example, the dividends
declared by a corporation will mean a debit is recorded in the Retained Earnings (and a credit to
another account).
The following is a summary of debits and credits and their effect on the general ledger
accounts:
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Double-entry bookkeeping
Double-entry bookkeeping (or double-entry accounting) means that every transaction will
result in entries in two (or more) accounts. A minimum of one amount will be a debit (entered
on the left side of the account) and at least one amount must be a credit (entered on the right
side of the account). In other words, every transaction must have the total of the debits equal
to the total of the credits.
To illustrate double entry, let’s assume that a person invests $100,000 in exchange for 10,000
shares of the common stock of a new corporation. The corporation will debit the asset account
Cash for $100,000 and will credit the stockholders’ equity account Common Stock for $100,000.
(We are assuming that the stock does not have a par or stated value.)
For a second example, let’s assume that the company has utilized a consultant at a cost of
$3,000 with the amount due in 30 days. The company will debit Consulting Expense for $3,000
and will credit Accounts Payable for $3,000.
If every transaction is recorded with the debit amounts equal to the credit amounts and there
are no posting or math errors, the total of all of the account balances with debit balances will
be equal to the total of all of the account balances with credit balances.
Trial balance
The trial balance is an internal document that lists any account in the general ledger which has
a balance. If an account has a debit balance, the balance is entered in the column that is
headed “debit.” If an account has a credit balance, the balance is entered in the column that is
headed “credit.” Each column is summed and the total of the debit column should be equal to
the total of the credit column. If the totals are identical, we say that the trial balance is “in
balance.”
When bookkeeping was done manually there were usually errors in writing, posting, and
tabulating amounts and balances. Hence, the trial balance was routinely prepared in order to
detect and correct the incorrect account balances. However, today’s software is written/coded
to prevent such errors from occurring. As a result, it is usually assumed that a trial balance from
a reliable computerized system is in balance.
Bookkeeping equation
The bookkeeping equation (or accounting equation) for a corporation is:
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This equation must always be in balance under the double-entry bookkeeping method.
The bookkeeping equation is also helpful in understanding debits and credits. For example,
asset accounts normally have debit balances (and assets are increased with a debit entry).
Recall that the term debit means the left side of an account. As you look at the bookkeeping
equation you see that assets are also on the left side of the equal sign.
Note that liabilities are on the right side of the bookkeeping equation. Recall that earlier we
said that liability accounts normally have credit balances (balances on the right side of the
account).
Stockholders’ equity accounts are on the right side of the bookkeeping equation and these
accounts will also have credit balances. Since the stockholders’ equity account Retained
Earnings will normally have a credit balance it is logical that:
 revenues will have credit balances since revenues will cause Retained Earnings (and
therefore stockholders’ equity) to increase, and
 expenses will have debit balances since expenses cause Retained Earnings (and
stockholders’ equity) to decrease.
Your understanding of bookkeeping will be enhanced if you keep in mind that:
 revenues cause stockholders’ equity to increase, and

 expenses cause stockholders’ equity to decrease.
In effect the income statement is providing details on how the corporation’s operations had
caused stockholders’ equity to change. (There are also other transactions that will cause
stockholders’ equity to change such as issuing additional shares of stock, declaring dividends,
and other transactions.)
Accrual method vs. cash method

The accrual method is the best bookkeeping or accounting method for: measuring a company’s
net income for any accounting period, and for the complete reporting of assets, liabilities, and
stockholders’ equity.
The reasons that the accrual method is better than the cash method are: revenues and the
related assets will be reported when they are earned (and not when the cash is received), and
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expenses and the related liabilities will be reported when the expenses actually occur (and not
when the cash is paid).
Hence, the accrual method results in more complete and accurate income statements and
balance sheets.
Adjusting entries
Adjusting entries are necessary to bring a company’s records up-to-date under the accrual
method. For example, a business expense may have occurred but it may not have been
recorded as of the end of the accounting period. Another transaction may have been recorded,
but the amount needs to be expensed over two or more accounting periods.
Adjusting entries almost always involve:
 an income statement account, and

 a balance sheet account.
For example, if an expense occurred but it was not recorded as of the end of the accounting
period, an adjusting entry is needed to:
 debit an expense account, and

 credit a liability account.
Adjusting entries are typically dated as of the last day of an accounting period. In this way, the
adjustments will be included in the amounts reported in the company’s balance sheet and
income statement. (The accounting period could be a year, quarter, month, or other period of
time.)
The concepts behind adjusting entries are:
 match expenses with revenues when there is a cause and relationship effect,
 report expenses in the accounting period in which they are used up or expire, and
 report the correct amount of assets, liabilities and stockholders’ equity as of the end of
an accounting period.
Adjusting entries – accruals

Accruals or accrual-type adjusting entries pertain to:
 expenses (and the related payables or liabilities) that have been incurred but not yet
recorded
 revenues (and the related receivables) that have been earned but not yet recorded
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 losses (and the related liabilities) that occurred but have not yet been recorded
Common expenses that will need an accrual-type adjusting entry (or need to be accrued)
include:
 electricity used
 wages earned by hourly-paid employees
 interest on debt
Adjusting entries – deferrals/prepayments

A deferral or prepayment-type adjusting entry is needed when a transaction has been recorded
but the amount involves more than one accounting period. A classic example is a payment on
December 1 for six months of property insurance. Part of the payment needs to be expensed
during the month of December and part of the payment needs to be deferred to the balance
sheet until it is expensed in the following year.
The company’s payment on December 1 poses a similar bookkeeping problem for the insurance
company that receives the payment. One month of the payment is part of the insurance
company’s revenues for December while the remainder needs to be deferred to the balance
sheet until it is earned and reported as revenues in the following year.
As with all adjusting entries, the concept is to get the expenses and revenues matched
 have each period’s income statement report the proper amount of revenues
 have each period’s income statement report the proper amount of expenses
 have each balance sheet report the proper amount of assets, liabilities and
stockholders’ equity
This means that at the end of each accounting period the unexpired insurance premiums paid
by a company will be reported as a current asset. The insurance company that has received the
insurance premiums will report the unearned amount as a current liability.
Adjusting entries – other

Depreciation is an example of an adjusting entry under the category of other. Depreciation is
similar to a deferral in that a transaction (such as the purchase of equipment to be used in a
business) has been recorded but the cost will be expensed over several accounting periods. The
adjusting entry will include:
 a debit to the income statement account Depreciation Expense, and

 a credit to the balance sheet account Accumulated Depreciation.
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Another example in the “other” category of adjusting entries involves Accounts Receivable.
Instead of waiting to learn of a specific uncollectible account receivable, a company could
anticipate that some of its receivables will not be collected. In this situation the company
estimates the amount and:
 debits Bad Debts Expense, and

 credits Allowance for Doubtful Accounts.
This adjusting entry is preferred by accountants but is not allowed for U.S. income taxes.
(Accountants believe that entering an estimated expense or loss in its accounting records is
better than ignoring the likelihood that some accounts will not be collected in full.)
Reversing entries
Reversing entries are usually associated with accrual-type adjusting entries. Accrual-type
adjusting entries were made because:
 the company had incurred an expense but had not yet received the invoice or other
documentation, or
 the company had earned revenues but had not yet billed the customer
Accounts payable
Accounts payable could refer to:
 the general ledger liability account

 the bill paying department in a large company, or
 the process of reviewing vendor invoices and other bills to be certain they are legitimate
Often the three-way match is used as part of the accounts payable process. This technique
requires that the following information be compared and reconciled:
 the vendor invoice

 the company’s purchase order, and
 the company’s receiving report
Only after the three-way match is completed and any differences reconciled is a vendor invoice
approved for payment.
Vendor invoices and receiving reports that are not fully matched as of the last day of the
accounting period also need to be reviewed as this information may require that an accrual-
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type adjusting entry be recorded. Accrued expenses are usually reported in a liability account
that is separate from Accounts Payable.
The account Accounts Payable is usually reported as the first or second item in the current
liability section of the company’s balance sheet.
Accounts receivable
Accounts receivable result when a company has sold goods or has provided services on credit.
This means that the customer or client is allowed to pay 10 days, 30 days, 60 days, etc. after the
goods or services have been delivered.
Delivering goods or services on credit could lead to Bad Debts Expense if the customer or client
cannot pay the total amount owed. Therefore, a company needs to review the credit
worthiness of its customers and potential customers before transferring goods or providing
services on credit.
An aging of accounts receivable is a report that sorts the company’s existing accounts
receivable according to their invoice dates. The aging shows the amount of each receivable that
is current (not past due), 1-30 days past due, 31-60 days past due, 61-90 days past due, and so
on.
Bank reconciliation
The bank reconciliation is also known as the bank statement reconciliation or bank rec. Its
purpose is to determine an organization’s true amount of cash. (Cash includes bank accounts.)
For instance, the amount of cash shown in a company’s general ledger account (or in an
individual’s check register) may not be the true amount if the bank had recently charged the
bank account for a service charge, loan payment, a deposited check that was returned because
of insufficient funds, etc.
For a business, it is possible that neither 1) the bank statement balance, nor 2) the company’s
general ledger account balance is the true balance. The bank reconciliation process that we
prefer adjusts both the balance per the bank statement and the balance per the general ledger
to the one true amount.
Any adjustments to the balance per the general ledger will need a journal entry in order to get
the correct amounts into the general ledger. (Since every journal entry will affect two or more
accounts, the bank rec is important for accurate financial statements.)
For good internal control of an organization’s assets, the bank reconciliation should be
prepared by someone who does not write checks, process deposits, make entries in the cash
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account, etc. The idea is to separate duties so that one person cannot easily misuse or embezzle
the organization’s money.
Petty cash
Petty cash or petty cash fund refers to a relatively small amount of currency and coins on hand
in order to pay small amounts such as postage, cost of emergency supplies, parking, etc. The
petty cash fund is established by writing a company check (say $200) which will be coded to
credit Cash and debit a new general ledger account Petty Cash. Next, one person should be
designated as the petty cash custodian. The petty cash custodian is responsible for the $200
and is required to document any payments. Therefore, at all times the petty cash custodian
should have cash and receipts that will total $200. (When the Petty Cash account is a constant
$200 balance, it is said to be imprest.)
When the currency and coin is low and also at the end of each accounting period the petty cash
fund needs to be replenished. This means getting the cash back to the general ledger amount of
$200. This is achieved by submitting a check request for the difference between the $200
needed and the actual cash on hand. Hopefully, the documentation equals that difference and
should be attached to the check request. If the documentation does not equal the amount of
cash needed, the difference is debited or credited to an account such as Cash Short or Over (a
miscellaneous income statement account).
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Q3. Explain System of Accounting and Basic Terminologies?
Accounting is not as one dimensional as it sometimes seems to people. It also has a few
systems and types, which allows the accountant to choose the system most suitable for
his organization. Here we will look at two systems of accounting – single entry and double
entry. And we will also learn about the two bases of accounting – cash basis and accrual basis.
Systems of Accounting
Systems of accounting refer to the two systems of recording the financial transactions in the
books of accounts. These two systems are the single entry system and the double or dual entry
system. Let us learn about both in brief.
Single Entry System

This system is also known as pure entry system. It does not follow the traditional dual recording
format. Instead, in a single entry system, only a Cash Book will be maintained. All cash
transactions will be recorded in the Cash Book. No other Ledgers find a place in this system.
All transactions of personal nature are simply recorded in a rough book.
As you can notice, this method is not very scientific. So it is rarely used in the modern days. We
use the single entry system only to prepare final accounts from records that are incomplete for
some reason. Some other salient features of the single entry system are,
 Since only one cash book is kept, personal and business transactions will be recorded
together
 Real and Nominal accounts will be ignored by this system
 Profit or Loss can be ascertained but we cannot represent the financial position of the
organization
 No trial balance is prepared, so arithmetical accuracy of accounts cannot be verified
Double Entry System

This is the more traditional and conventional system for recording transactions in financial
accounting. This is a scientific method which has some rules and principles which must be
followed. The basic essence of the double entry system is that every transaction will affect two
accounts. This is known as the debit and credit rule – every credit entry, there must be a
corresponding debit entry.
The double entry system is the one widely used and recognized in the accounting world. Some
salient features of this system are,
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All three types of accounts are maintained in this system – real, nominal and personal
 The arithmetic accuracy of the financial records are verified by preparing the trial
balance
 The system does not have many modifications.
 It allows for the preparation of the balance sheet which will reflect the financial position
of the organization
Easy to detect frauds and errors in this double entry system
Basis of Accounting
This deals with the timing of the revenue recognition, i.e. when should the revenue be
recognized in the books of accounts. There are two approaches to this dilemma – cash basis of
accounting and accrual basis of accounting. Let us take a brief look at both.
Cash Basis of Accounting

This is the simpler, uncomplicated approach. Under the cash system of accounting
an income will only be recorded when it comes in. So an income will be earned when it is
received in cash by the organization. And similarly, the expenses will also be recorded only
when they are actually made.
So take for example the organization pays the salary of its employees for the month of June on
the 3rd of July. This salary expense will thus be recorded in July, although the expense is for the
period of June. Similarly, say the organization made a credit sale on 5th August. They received
the payment on 11th October, so this sale will be recorded on this date.
Accrual Basis of Accounting

Accrual basis is the more logical and scientific approach to accounting. This is the method most
organizations chose to adopt, as it gives a more fair representation of the financial position of
the company.
In the accrual system, the revenues and expenses are recognized in the time period in which
they occur, not when the money actually comes in. So the income will be recorded if it is
earned irrespective of whether the payment has come in or not. And the expense is recorded
when it becomes due, irrespective of whether it has been paid.
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So in accrual system, all incomes and expenses – cash items and non-cash items (like
prepaid/outstanding expenses and accrued/advance income) will be taken into account. And
the final accounts will be a true representation of the organization’s financial position.
Basic Terminologies of Accounting

ACCOUNT
An account is a record used to properly classify the activity recorded in the General Ledger.
ACCOUNT BALANCE
An account balance is the sum of debit entries minus the sum of credit entries in an account. If
positive, the difference is called a debit balance; if negative, a credit balance.
ACCOUNTING
Accounting is recording and reporting of financial transactions, including the origination of the
transaction, its recognition, processing, and summarization in the financial statements.
ACCOUNTS PAYABLE
Accounts Payable is an amount owed by the business for delivered goods or completed
services. Accounts Payable is a liability.
ACCOUNTS R ECEIVABLE
Account Receivable is an amount owed to the business from a completed transaction of sales or
services rendered. Accounts Receivable is an asset.
ACCRUAL BASIS
Accrual basis is a method of accounting that recognizes revenue when earned, rather than
when collected and expenses when incurred rather than when paid.
ASSET
An asset is what the business owns. For example- land, property, buildings, equipment, cash in
bank accounts, other investments and accounts receivable.
AUDIT
An audit is a formal examination and official endorsement of the accuracy of the financial
statements of the business by an independent certified public accountant (CPA). Based on rules
the college is required to have an audit performed each fiscal year.
BALANCE SHEET
A Balance Sheet is a summary report of the business assets, liabilities and fund balance (net
assets) on a specific date.
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BUDGET
A budget is an estimate of activity for a fiscal year or period. A budget can be created for a
department or a project.
COST OF GOODS SOLD
Cost of Goods Sold (CGS) is the cost of items purchased for resale. For example-the bookshop
purchases textbooks to sell in the bookshop.
CREDIT
A credit is an entry on the right side of a double-entry accounting system that represents the
reduction of an asset or expense or the addition to a liability or revenue.
DEBIT
A debit is an entry on the left side of a double-entry accounting system that represents the
addition of an asset or expense or the reduction to a liability or revenue.
EXPENSE
An expense is funds paid by the business, for example-paychecks to employees,
reimbursements to employees, payments to vendors for goods or services.
FINANCIAL S TATEMENTS
Financial Statements are a series of reports showing a summary view of the various financial
activities of the business at a specific point in time. Each statement tells a different story about
the financial activity of the business.
FISCAL YEAR
A fiscal year is a period of 12 consecutive months chosen by an entity as its accounting period
which may or may not be a calendar year.
FIXED ASSET
A fixed asset is any tangible item with a useful life of more than one year and a unit cost of PKR
5,000 or more, for example buildings and major equipment. A fixed asset is an asset.
GENERAL LEDGER
The general ledger is the collection of all asset, liability, fund balance (net assets), revenue and
expense accounts.
INCOME S TATEMENT
An Income Statement is a summary report that shows revenues and expenses over a specific
period of time, typically a month, quarter or fiscal year.
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J OURNAL ENTRY
A journal entry is a group of debit and credit transactions that are posted to the general ledger.
All journal entries must net to zero so debits must equal credits.
LIABILITY
A liability is what the business owes. For example-loans, taxes, payables, long term debt from a
bond issue.
NET INCOME (LOSS)
Net Income (loss) is the amount the business, a department or a project made or lost for a
specific period of time in order to arrive at this number take total revenues minus total
expenses.
SUBSIDIARY LEDGER
A subsidiary ledger is a group of accounts containing the detail of debit and credit entries.
Example is detail information contained in Accounts Payable.
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Q4. What is the difference between ‘Single and Double Entry Record Keeping’?
Every business transaction has an effect on two different accounts like if we purchase
something then it will affect the two people one is the receiver(buyer) and another is the
giver(Seller) or if we pay any expense there will also be affected to two people one is the
receiver of the payment and another is the giver. But In the single entry system, we record only
one effect of the business transaction in the books of accounts and in the double entry system,
we will record both the effect of the business transaction in the books.
Chart of Difference between Single Entry and Double Entry:
Basis of Difference Single Entry System Double Entry System

In the Single Entry system of In Double Entry system of
bookkeeping, only one effect of the bookkeeping, only both or all effects
Overview
transaction is recorded which is of the transaction is recorded in the
related to our business. books of accounts.
To know or remember the cash, To know every financial term of the
Object
debtors and creditor balance only. business entity.
It is an incomplete system of It is the complete system of
Type of Recording
recording the transactions. recording the transactions.
In this system, here is very easy to In this system, here is difficult to
record fraud entry of transactions record fraud entry of transactions
Fraud Because you are not showing the Because you are showing the
second affected account by the second affected account by the
same transaction. same transaction.
It is very hard to identify the error in It is easy to identify the error in the
Error
the books. books.
All accounts are considered in this
Only account related to persons and
Accounts Included method. Like the person, real and
cash are included.
nominal.
Acceptance by Taxation It is not accepted by the taxation
It is accepted.
department department.
It requires a lot of labor and time to It is easy to find out the Profit and
Profit/loss for the year calculate the Profit/loss for the year. Loss for the Year.
This system is suitable for only a

Suitable It is suitable for all type of business.
very small business.
Cost of This system does not require any This system does require any cost
Implementation cost of implementation of implementation.
Only Owner of the Business can
All related Parties can use this
use this system because it is not
Users system because all books are
maintained on the particular
maintained on the standard formats.
standard.
Reconciliation of Reconciliations of accounts are not Reconciliations of accounts are
accounts possible. possible.
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Conclusion
A person of little accounting knowledge can maintain records as per single entry system, but
due to some shortcomings in this system, double entry system has been evolved. Almost all the
countries of the world have adopted double entry system for maintaining accounting records.
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Q5. Discuss in details the ‘Classification of Accounting’.
In accounting, the accounts are classified using one of two approaches – modern approach
or traditional approach. We shall describe modern approach first because this approach
of classification of accounts is used in almost every advanced country. The use of traditional
approach is very limited.
Modern approach
According to modern approach, the accounts are classified as asset accounts, liability accounts,
capital or owner’s equity accounts, withdrawal accounts, revenue/income accounts and
expense accounts.
1. ASSET ACCOUNTS:
Assets are things or items of value owned by a business and are usually divided into tangible or
intangible. Tangible assets are physical items such as building, machinery, inventories,
receivables, cash, prepaid expenses and advance payments to other parties. Intangible assets
normally include non-physical items and rights. Examples of intangible assets include goodwill,
trademarks, copyrights, patent rights and brand recognition etc.
A separate account for each tangible and intangible asset is maintained by the business to
record any increase or decrease in that account.
2. LIABILITY ACCOUNTS :
Liabilities are obligations or debts payable to outsiders or creditors. The title of a liability
account usually ends with the word “payable”. Examples include accounts payable, bills
payable, wages payable, interest payable, rent payable and loan payable etc. Besides these, any
revenue received in advance is also a liability of the business and is known as unearned
revenue. For example, a marketing firm may receive marketing fee from its client for the
forthcoming quarter in advance. Such unearned revenue would be recorded as a liability as long
as the related marketing services against it are not provided to the client who has made the
advance payment.
3. CAPITAL OR OWNER ’S EQUITY ACCOUNTS :
Capital is the owner’s claim against the assets of the business and is equal to total assets less all
liabilities to external parties. The balance in capital account increases with the introduction of
new capital and profits earned by the business and decreases as a result of withdrawals
and losses sustained by the business.
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In sole proprietorship, a single capital account titled as owner’s capital account or simply capital
account is used. In partnership or firm, each partner has a separate capital account like John’s
capital account, Peter’s capital account etc. In corporate form of business there are many
owners known as stockholders or shareholders and the title capital stock account is used to
record any change in the capital.
4. WITHDRAWAL ACCOUNTS :
Withdrawals are cash or assets taken by a business owner for his personal use. In sole
proprietorship and partnership, an account titled as drawings account is used to account for all
withdrawals. In corporate form of business withdrawals are more systematic and usually
termed as distributions to stockholders. The account used for recording such distributions is
known as dividend account.
5. REVENUE OR INCOME ACCOUNTS:
Revenue is the inflow of cash as a result of primary activities such as provision of services or
sale of goods. The term income usually refers to the net profit of the business derived by
deducting all expenses from revenue generated during a particular period of time. However, in
accounting and finance, the term is also used to denote all inflows of cash resulted by those
activities that are not primary revenue generating activities of the business. For example, a
merchandising company may have some investment in an oil company. Any dividend received
from Oil Company would be termed as dividend income rather than dividend revenue. Other
examples of income include interest income, rent income and commission income etc. The
businesses usually maintain separate accounts for revenues and all incomes earned by them.
6. EXPENSE ACCOUNTS :
Any resource expended or service consumed to generate revenue is known as expense.

Examples of expenses include salaries expense, rent expense, wages expense, supplies expense,
electricity expense, telephone expense, depreciation expense and miscellaneous expense.
Traditional approach
According to traditional approach, the accounts are classified into four types – personal
accounts, real accounts, nominal accounts, and valuation accounts. A brief explanation of each
is given below:
1. PERSONAL ACCOUNTS :
The accounts related to real persons and organizations are classified as personal accounts.
Examples of personal accounts include John’s account, Peter’s account, Procter and
Gamble’s account, Vibrant Marketing Agency’s account and City bank’s account etc. The
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business keeps a separate account for each individual and organization for the purpose of
ascertaining the balance due from or due to them.
2. REAL ACCOUNTS:
Real accounts are accounts related to assets or properties (both tangible and intangible) owned
by a business enterprise. A separate account for each asset is maintained to account for
increases and decreases in that asset. Examples of real accounts include cash account,
inventory account, investment account, plant account, building account, goodwill account,
patent account, copyright account etc.
3. NOMINAL ACCOUNTS :
The accounts related to incomes, gains, expenses and losses are classified as nominal accounts.
These accounts normally serve the purpose of accumulating data needed for preparing income
statement or profit and loss account of the business for a particular period. Examples of
nominal accounts include sales account, purchases account, wages account, salaries account,
interest account, rent account, gain on sale of fixed assets account and loss on sale of fixed
assets account etc.
4. VALUATION ACCOUNT :
Valuation account (also known as contra account) is an account used to report the carrying
value of an asset or liability in the balance sheet. A popular example of valuation account is the
accumulated depreciation account. Companies maintaining fixed assets in the books of
accounts at their original cost also maintain an accumulated depreciation account for each fixed
asset. In balance sheet, the balance in the accumulated depreciation account is deducted from
the original cost of the asset to report it at its book value or carrying value. Another example of
valuation account is allowance for doubtful accounts. In balance sheet, the balance in
allowance for doubtful accounts is deducted from the total receivables to report them at their
net realizable value or carrying value.
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Q6. What do you know about ‘Flow of Transactions’? Give details.
The Flow of Transactions
Occurrence of an Event
The Voucher
General Journal
General Ledger Cash / Bank Book
Trial Balance Profit & Loss Account Balance Sheet
EVENT
Event is the happening of anything but in accounting we discuss monetary events
MONETARY EVENTS
If the financial position of a business is change due to the happening of event that Event is
called Monetary Event
THE VOUCHER
Voucher is documentary evidence in a specific format that records the details of a transaction.
It is accompanied by the evidence of transaction.
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THE GENERAL JOURNAL
The Journal is used to record financial transactions in chronological (day-to-day) order. All
vouchers were first recorded in books of accounts. It was also called the Book of Original Entry
or Day Book. But in present day accounting and especially with the introduction of computers
for accounting, this book is not in use any more.
GENERAL LEDGER – T HE ‘T’ ACCOUNT

Ledger – is a book that keeps separate record for each account (Book of Accounts). The Account
or Head of Account is systematic record of transactions of one type. An account in its simplest
form is a T-shape and looks like this:
A STANDARD GENERAL LEDGER

Since the ledger keeps record of transactions that affect one head of account, therefore, it
should provide all the information that a user may need. Usually the ledger is required to
provide following information:
 Title of account
 Ledger page number, called Ledger Folio / Account Code
 Date of transaction
 Voucher number
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A STANDARD GENERAL LEDGER
RECORDING FROM VOUCHER TO GENERAL LEDGER
COMPLETING THE RECORDING – BOTH EFFECTS
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A SIMPLE PRESENTATION OF A RECORDED TRANSACTION IS AS UNDER:
The Ledger Balance

In the earlier lecture, we have discussed that in order to have the total figure in respect of each
head of expense/income, asset/liability, we need to maintain different accounts. We had also
said that each account may have figures on the debit as well as on the credit side. Therefore,
the difference between the debit and the credit sides, known as the BALANCE, would represent
the required total of the particular account.
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The total of all balances on the Debit side is ALWAYS equal to the total of all balances on the
Credit side. This is called the balancing of books of accounts. We will study about this concept
at a later stage. The balance may be written out after every transaction in a third column or
calculated at the end of a specific time period (an accounting period). A Debit balance is shown
without brackets and a Credit balance is shown in brackets (XYZ).
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Q7. What are the Basic Books of Accounting? Explain.
There are two main books of accounts, Journal and Ledger. Journal used to record the
economic transaction chronologically. Ledger used to classifying economic activities according
to nature.
Types of Journals
Special Journals are used in large business organizations, where it is found inconvenient to
journalize every transaction in one journal. Therefore, the journal is sub-divided into different
journals known as the subsidiary books. The journal is divided in such a way that a separate
book is used for each class of transactions The basic books of accounts used in modern business
world are the following:
Purchases Day Book / Purchase Journal

Purchases book or purchases day book is a book of original entry maintained to record credit
purchases. You must note that cash purchases will not be entered in purchases day book
because entries in respect of cash purchases must have been entered in the Cash Book. At the
end of each month, the purchases book is totaled. The total shows the total amount of goods
purchased on credit. Purchases book is written up daily from the invoices received. The invoices
are consecutively numbered. The invoice of each number is noted in the purchases book.
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Sales Day Book / Sales Journal
A sales book is also known as sales day book in which are recorded the details of credit sales
made by a businessman. Total of sales book shows the total credit sales of goods during the
period concerned. Usually the sales book is totaled every month. The sales day book is written
up daily from the copies of invoices sent out.
Return Inward Book / Sales Return

Sales returns book is also called returns inwards book. It is used for recording goods returned to
us by our customers. Customers who return goods should be sent a credit note. It is a
statement sent by a business to customer showing the amount credited to the account.
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Return Outward Book / Purchase Return
Purchases returns book is a book in which the goods returned to suppliers are recorded. It is
also called returns outward book or purchases returns day book. Goods may be returned
because they are of the wrong kind or not up to sample or because they are damaged etc.
When the goods are returned to the suppliers, intimation is sent to them through what is
known as a debit note. These debit notes serve as vouchers for these entries. A debit note is a
statement sent by a businessman to vendor, showing the amount debited to the account.
General Journal
The transactions other than the transactions recorded in cash receipts journal, cash payment
special, purchase journal, sales journal etc. are recorded in journal proper or general journal.
For example;
Purchase of assets on credit, the stock of goods at the year-end, rectification of errors,
adjustment of accounts etc. are recorded in journal proper.
Therefore, the journal, wherein the transactions which cannot be directly recorded in a
particular journal are recorded, is called journal proper.
In the journal proper generally, the following transaction is recorded;
OPENING ENTRY:
The journal entry which is passed at the beginning of the current year for recording assets and
liabilities of the previous year is called opening entry.
CLOSING ENTRY:
The journal entries, which are passed to close the periodical expenses and income transferring
them to the income statement, are called closing entries. That is all income – expense accounts,
sales-purchase accounts, and profit- loss accounts are closed through transfer to the income
statement.
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ADJUSTMENT ENTRY:
The journal entry through which accrued expenses and income and advance income, expenses,
depreciation, specific provisions etc. are adjusted is called adjustment entry.
RECTIFICATION ENTRY:
The entry, through which errors in accounts are rectified, is called rectification entry.
TRANSFER ENTRY:
The entry which is made for transferring fund from one account to another account is called
transfer entry.
CREDIT PURCHASE AND SALE OF ASSETS:
The entry which is needed for recording transactions relating to credit purchase and sale of
assets is called credit purchase and sale of assets entry. For example, Furniture purchased from
Sonargaon Furniture for $5,000.
OTHER ENTRY:
Entries which cannot be recorded in another journal.
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Q8. What is “Financial Statements”? Give complete introduction.
Definition
Financial statements are reports prepared by a company’s management to present the financial
performance and position at a point in time. A general-purpose set of financial statements
usually includes a balance sheet, income statements, statement of owner’s equity, and
statement of cash flows. These statements are prepared to give users outside of the company,
like investors and creditors, more information about the company’s financial positions. Publicly
traded companies are also required to present these statements along with others to
regulatory agencies in a timely manner.
What Does Financial Statements Mean?

Financial statements are the main source of financial information for most decision makers.
That is why financial accounting and reporting places such a high emphasis on the accuracy,
reliability, and relevance of the information on these financial statements.
Financial statements, also called financial reports, refer to such statements as contain financial
information of an enterprise. Thus, these statements are collection of data presented strictly
according to logical and consistent accounting principles. They are overall general purpose
entity statements as they report financial position and operating result of an entire business at
the end of accounting period.
The financial statements are the end products of financial accounting which contain
summarized periodical reports of the financial and operative data accumulated by the firm in its
books of accounts, known as the General Ledger. As a matter of fact, these statements reflect
the totals of the summary of the books of account.
The basic purpose of preparing financial statements is to convey to owners, creditors and the
general public about financial position of the enterprise. They are used as basis for decisions by
all those interested in the enterprise. Thus, the management may review the company’s
progress to-date and decide upon the courses of action to be taken in future on the basis of
information contained in the financial statements.
Creditors may choose to extend, maintain or restrict credit, stockholders may judge prospects
for their investments and elect to sell or continue ownership and the general public may
appraise the effectiveness of the economic unit from which it buys goods or services.
Anatomy of Financial Statements:

Financial statements comprise two major statements, viz., Balance Sheet and Income
Statement. These statements are the record of operating performance with its impact on
financial position and progress of the enterprise. Cash Flow Statement and Statement of
Changes in Equity are also comes under the umbrella of ‘Financial Statements’.
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1. Balance Sheet:
The balance sheet, also called statement of financial position, shows the assets, liabilities and
capital as on a particular date. It indicates what the firm owns and how these assets are
financed in the form of liabilities or ownership interest. Thus, the balance sheet delineates the
firm’s holdings and obligations.
It presents a bird’s eye view of the financial status of the firm. It is a summary of changes which
have occurred since the last statement was compiled. In short, the balance sheet is nothing but
a snapshot of the financial condition of the firm.
How the Balance Sheet is structured?
Balance sheets, like all financial statements, will have minor differences between organizations
and industries. However, there are several “buckets” and line items that are almost always
included in common balance sheets. We briefly go through commonly found line items under
Current Assets, Long-Term Assets, Current Liabilities, Long-term Liabilities, and Equity.
Current Assets
Cash and Equivalents
The most liquid of all assets, cash, appears on the first line of the balance sheet. Cash
Equivalents are also lumped under this line item and include assets that have short-term
maturities less than three months or assets that the company can liquidate on short notice,
such as marketable securities. Companies will generally disclose what equivalents it includes in
the footnotes to the balance sheet.
Accounts Receivable
This account includes the balance of all sales revenue still on credit, net of any allowances for
doubtful accounts (which generate a bad debt expense). As companies recover accounts
receivables, this account decreases and cash increases by the same amount.
Inventory
Inventory includes amounts for raw materials, work-in-progress goods, and finished goods. The
company uses this account when it reports sales of goods, generally under cost of goods sold in
the income statement.
Non-Current Assets
Plant, Property, and Equipment (PP&E)
Property, Plant, and Equipment (also known as PP&E) capture the company’s tangible fixed
assets. This line item is noted net of depreciation. Some companies will class out their PP&E by
41

the different types of assets, such as Land, Building, and various types of Equipment. All PP&E is
depreciable except for Land.
Intangible Assets
This line item includes all of the companies’ intangible fixed assets, which may or may not be
identifiable. Identifiable intangible assets include patents, licenses, and secret formulas.
Unidentifiable intangible assets include brand and goodwill.
Current Liabilities
Accounts Payable
Accounts Payables, or AP, is the amount a company owes suppliers for items or services
purchased on credit. As the company pays off their AP, it decreases along with an equal amount
decrease to the cash account.
Current Debt/Notes Payable
Includes non-AP obligations that are due within one year’s time or within one operating cycle
for the company (whichever is longest). Notes payable may also have a long-term version,
which includes notes with a maturity of more than one year.
Current Portion of Long-Term Debt
This account may or may not be lumped together with the above account, Current Debt. While
they may seem similar, the current portion of long-term debt is specifically the portion due
within this year of a piece of debt that has a maturity of more than one year. For example, if a
company takes on a bank loan to be paid off in 5-years, this account will include the portion of
that loan due in the next year.
Non-Current Liabilities
Bonds Payable
This account includes the amortized amount of any bonds the company has issued.
Long-Term Debt
This account includes the total amount of long-term debt (Excluding the current portion, if that
account is present under current liabilities). This account is derived from the debt schedule,
which outlines all of the company’s outstanding debt, the interest expense, and the principal
repayment for every period.
Shareholders’ Equity
Share Capital
This is the value of funds that shareholders have invested in the company. When a company is
first formed, shareholders will typically put in cash. For example, an investor starts a company
42

and seeds it with $10M. Cash (an asset) rises by $10M, and Share Capital (an equity account)
rises by $10M, balancing out the balance sheet.
Retained Earnings
This is the total amount of net income the company decides to keep. Every period, a company
may pay out dividends from its net income. Any amount remaining (or exceeding) is added to
(deducted from) retained earnings.
Importance of the Balance Sheet
The balance sheet is a very important financial statement for many reasons. It can be looked at
on its own, and in conjunction with other statements like the income statement and cash flow
statement to get a full picture of a company’s health.
4 important takeaways include:
1. Liquidity – Comparing a company’s current assets to its current liabilities provides a

picture of liquidity. Current assets should be greater than current liabilities so the
company can cover its short-term obligations. The Current Ratio and Quick Ratio are
examples of liquidity financial metrics.
2. Leverage – Looking at how a company is financed indicates how much leverage it has,
which in turn indicates how much financial risk the company is taking. Comparing debt
to equity and debt to total capital are common ways of assessing leverage on the
balance sheet.
3. Efficiency – By using the income statement in connection with the balance sheet it’s
possible to assess how efficiently a company uses its assets. For example, dividing
revenue into fixed assets produces the Asset Turnover Ratio to indicate how efficiently
the company turns assets into revenue. Additionally, the working capital cycle shows
how well a company manages its cash in the short term.
4. Rates of Return – The balance sheet can be used to evaluate how well a company
generates returns. For example, dividing net income into shareholders’ equity
produces Return on Equity (ROE), and dividing net income into total assets
produces Return on Assets (ROA), and dividing net income into debt plus equity results
in Return on Invested Capital (ROIC).
2. Income Statement:
The Income Statement is one of a company’s core financial statements that show their profit
and loss over a period of time. The profit or loss is determined by taking all revenues and
subtracting all expenses from both operating and non-operating activities.
43

The income statement is one of three statements used in both corporate finance
(including financial modeling) and accounting. The statement displays the company’s revenue,
costs, gross profit, selling and administrative expenses, other expenses and income, taxes paid
and net profit, in a coherent and logical manner.
Basis of preparation
Income statement is prepared on the accruals basis of accounting.
This means that income (including revenue) is recognized when it is earned rather than when
receipts are realized (although in many instances income may be earned and received in the
same accounting period).
Conversely, expenses are recognized in the income statement when they are incurred even if
they are paid for in the previous or subsequent accounting periods.
Income statement does not report transactions with the owners of an entity.
Hence, dividends paid to ordinary shareholders are not presented as an expense in the income
statement and proceeds from the issuance of shares is not recognized as an income.
Transactions between the entity and its owners are accounted for separately in the statement
of changes in equity.
Components
Income statement comprises of the following main elements:
Revenue
Revenue includes income earned from the principal activities of an entity. So for example, in
case of a manufacturer of electronic appliances, revenue will comprise of the sales from
electronic appliance business. Conversely, if the same manufacturer earns interest on its bank
account, it shall not be classified as revenue but as other income.
Cost of Sales
Cost of sales represents the cost of goods sold or services rendered during an accounting
period.
Hence, for a retailer, cost of sales will be the sum of inventory at the start of the period and
purchases during the period minus any closing inventory.
44

In case of a manufacturer however, cost of sales will also include production costs incurred in
the manufacture of goods during a period such as the cost of direct labor, direct material
consumption, depreciation of plant and machinery and factory overheads, etc.
You may refer to the article on cost of sales for an explanation of its calculation.
Other Income
Other income consists of income earned from activities that are not related to the entity's main
business. For example, other income of an entity that manufactures electronic appliances may
include:
 Gain on disposal of fixed assets

 Interest income on bank deposits
 Exchange gain on translation of a foreign currency bank account
Distribution Cost
Distribution cost includes expenses incurred in delivering goods from the business premises to
customers.
Administrative Expenses
Administrative expenses generally comprise of costs relating to the management and support
functions within an organization that are not directly involved in the production and supply of
goods and services offered by the entity.
Examples of administrative expenses include:
 Salary cost of executive management

 Legal and professional charges
 Depreciation of head office building
 Rent expense of offices used for administration and management purposes
 Cost of functions / departments not directly involved in production such as finance
department, HR department and administration department
Other Expenses
This is essentially a residual category in which any expenses that are not suitably classifiable
elsewhere are included.
Finance Charges
Finance charges usually comprise of interest expense on loans and debentures.

45

The effect of present value adjustments of discounted provisions are also included in finance
charges (e.g. unwinding of discount on provision for decommissioning cost).
Income tax
Income tax expense recognized during a period is generally comprised of the following three
elements:
 Current period's estimated tax charge

 Prior period tax adjustments
 Deferred tax expense
Prior Period Comparatives
Prior period financial information is presented alongside current period's financial results to
facilitate comparison of performance over a period.
It is therefore important that prior period comparative figures presented in the income
statement relate to a similar period.
For example, if an organization is preparing income statement for the six months ending 31
December 2013, comparative figures of prior period should relate to the six months ending 31
December 2012.
Purpose & Use
Income Statement provides the basis for measuring performance of an entity over the course of
an accounting period.
Performance can be assessed from the income statement in terms of the following:
 Change in sales revenue over the period and in comparison to industry growth
 Change in gross profit margin, operating profit margin and net profit margin over the
period
 Increase or decrease in net profit, operating profit and gross profit over the period
 Comparison of the entity's profitability with other organizations operating in similar
industries or sectors
Income statement also forms the basis of important financial evaluation of an entity when it is
analyzed in conjunction with information contained in other financial statements such as:
 Change in earnings per share over the period
46

 Analysis of working capital in comparison to similar income statement elements (e.g.
the ratio of receivables reported in the balance sheet to the credit sales reported in
the income statement, i.e. debtor turnover ratio)
 Analysis of interest cover and dividend cover ratios
3. Cash Flow Statement:
Cash Flow Statement, presents the movement in cash and bank balances over a period. The
movement in cash flows is classified into the following segments:
 Operating Activities: Represents the cash flow from primary activities of a business.
 Investing Activities: Represents cash flow from the purchase and sale of assets other
than inventories (e.g. purchase of a factory plant)
 Financing Activities: Represents cash flow generated or spent on raising and repaying
share capital and debt together with the payments of interest and dividends.
4. Cash Flow Statement:
Statement of Changes in Equity, also known as the Statement of Retained Earnings, details the
movement in owners' equity over a period. The movement in owners' equity is derived from
the following components:
 Net Profit or loss during the period as reported in the income statement
 Share capital issued or repaid during the period
 Dividend payments
 Gains or losses recognized directly in equity (e.g. revaluation surpluses)
 Effects of a change in accounting policy or correction of accounting error
47

Q9. Elaborate ‘Vouchers and Posting to Ledger Accounting’?
Voucher
A document that serves as an evidence for a business transaction is called a Voucher.

Sometimes, mistakenly seen as just a bill or receipt; it can actually have many other forms.
It is not the appearance of it that matters it just needs to act as an evidence of a transaction.
When a transaction is entered, the evidence of that transaction is also confirmed. A
voucher helps in recording expenses or a liability and further helps in its payment.
They are also called source documents as they help in identifying the source of a transaction.
A few examples of vouchers include bill receipts, cash memos, pay-in-slips, checks, an invoice, a
debit or credit note.
FORMAT AND TEMPLATE OF VOUCHER (I NVOICE)
Invoice
Client Name xxxx Your company’s name

Company xxxx Company Address
Company Address xxxx Post Code
Post Code xxxx Country
Country xxxx
Date:
mm/dd/yy
Invoice Details
Invoice no. 6666 Terms 60 days

Payment Due
PO no. 3102 mm/dd/yy
By
Description Rate Quantity Amount

Item 1 80.00 1 80.00
Item 2 154.00 2 308.00
Gross Total 388.00
48

Different Types of Vouchers
1. Source Vouchers
2. Accounting Vouchers
SOURCE VOUCHERS
Documents which are created at the time when a business enters into a transaction are called
source vouchers, for example, rent receipts, bill receipts at the time of cash sales, etc.
They are expected to contain complete details of a transaction duly signed by the maker and
act as evidence of the transaction.
ACCOUNTING VOUCHERS
This type of a voucher basically analyzes a business transaction from the accounting standpoint
and is used for recording purposes.
These are commonly prepared by accountants on the basis of supporting vouchers and
approved by a different individual. They are further subdivided into two, cash and non-cash
vouchers.
Examples of cash type
 Credit vouchers
 Debit vouchers
Examples of the non-cash type
 Debit note
 Credit note
 Invoices
Posting to the Ledger – The Classifying Phase
After journal entries are made, the next step in the accounting cycle is to post the journal
entries into the ledger.
Posting refers to the process of transferring entries in the journal into the accounts in
the ledger. Posting to the ledger is the classifying phase of accounting.
An accounting ledger refers to a book that consists of all accounts used by the company, the
debits and credits under each account, and the resulting balances.
49

While the journal is referred to as Books of Original Entry, the ledger is known as Books of Final
Entry.
THE POSTING PROCESS
Let us illustrate how accounting ledgers and the posting process work using the transactions we
had in the previous lesson. Click here to see the journal entries we will be using.
Let's start.
Take transaction #1 first.
Now, go to the ledger and find the accounts. Post the amounts debited and credited to the
appropriate side. Debits go to the left and credits to the right. After posting the amounts, the
cash and capital account would look like:
Explanation: First, we posted the entry to Cash. Cash in the journal entry was debited so we
placed the amount on the debit side (left side) of the account in the ledger. For Mr. Gray,
Capital, it was credited so the amount is placed on the credit side (right side) of the account.
And that's it. Posting is simply transferring the amounts from the journal to the respective
accounts in the ledger.
Note: The ledger accounts (or T-accounts) can also have fields for account number, description
or particulars, and posting reference.
Let's try to post the second transaction.
After posting the above entry, the affected accounts in the ledger would look like these:
50

There was a debit to Taxes and Licenses so we posted that in the left side (debit side) of the
account. Cash was credited so we posted that on the right side of the account.
Notice that after posting transaction #2, we now can get a more updated balance for each
account. Cash now has a balance of $9,630 ($10,000 debit and 370 credit). Nice, right? Post all
the other entries and we will be able to get the balances of all the accounts.
GENERAL LEDGER E XAMPLE
A general ledger contains accounts that are broad in nature such as Cash, Accounts Receivable,
Supplies, and so on. There is another type of ledge which we call subsidiary ledger. It consists of
accounts within accounts (i.e., specific accounts that make up a broad account).
For example, Accounts Receivable may be made up of subsidiary accounts such as Accounts
Receivable – Customer A, Accounts Receivable – Customer B, Accounts Receivable – Customer
C, etc.
Okay – let's go back to the general ledger. In the above discussion, we posted transactions #1
and #2 into the ledger. If we post all 15 transactions (click here to see the entries) and get the
balances of each account at the end of the month, the ledger would look like this:
51

After all accounts are posted, we can now derive the balances of each account. So how
much Cash do we have at the end of the month? As shown in the ledger above, the company
has $7,480 at the end of December.
How about accounts receivable? Accounts payable? You can find them all in the ledger.
Note: The above is a simplified and theoretical example of a ledger. In reality, companies have a
lot more than 15 transactions! They may have hundreds or even thousands of transactions in
one day. Imagine how lengthy the ledger would be. Worse, imagine the work needed in posting
that many transactions manually.
52

Because of technological advancements however, most accounting systems today
perform automated posting process. Nonetheless, the above example shows how a ledger
works.
53

Q10. What are ‘Fixed Assets & Depreciation’? Give details.
A fixed asset is a long-term tangible piece of property or equipment that a firm owns and uses
in its operations to generate income. Fixed assets are not expected to be consumed or
converted into cash within a year. Fixed assets most commonly appear on the balance sheet
as property, plant, and equipment (PP&E). They are also referred to as capital assets.
How a Fixed Asset Works

A company's balance sheet statement consists of its assets, liabilities, and shareholders' equity.
Assets are divided into current assets and noncurrent assets, the difference for which lies in
their useful lives. Current assets are typically liquid assets which will be converted into cash in
less than a year. Noncurrent assets refer to assets and property owned by a business which is
not easily converted to cash. The different categories of noncurrent assets include fixed assets,
intangible assets, long-term investments, and deferred charges.
A fixed asset is bought for production or supply of goods or services, for rental to third parties,
or for use in the organization. The term “fixed” translates to the fact that these assets will not
be used up or sold within the accounting year. A fixed asset typically has a physical form and is
reported on the balance sheet as property, plant, and equipment (PP&E).
When a company acquires or disposes of a fixed asset, this is recorded on the cash flow
statement under the cash flow from investing activities. The purchase of fixed assets represents
a cash outflow to the company, while a sale is a cash inflow. If the value of the asset falls below
its net book value, the asset is subject to an impairment write-down. This means that its
recorded value on the balance sheet is adjusted downward to reflect that its overvalued
compared to the market value.
When a fixed asset has reached the end of its useful life, it is usually disposed of by selling it for
a salvage value, which is the estimated value of the asset if it was broken down and sold in
parts. In some cases, the asset may become obsolete and may no longer have a market for it,
and will, therefore, be disposed of without receiving any payment in return. Either way, the
fixed asset is written off the balance sheet as it is no longer in use by the company.
Key Takeaways;
 Fixed assets are items, such as property or equipment, a company plans to use over the
long-term to help generate income.
 Fixed assets are most commonly referred to as property, plant, and equipment (PP&E).
 Current assets, such as inventory, are expected to be converted to cash or used within a
year.
 Noncurrent assets besides fixed assets include intangibles and long-term investments.
54

 Fixed assets are subject to depreciation to help represent the lost value as the assets are
used, while intangibles are amortized.
Special Considerations
Fixed assets lose value as they age. Because they provide long-term income, these assets are
expensed differently than other items. Tangible assets are subject to periodic depreciation, as
intangible assets are subject to amortization. A certain amount of an asset's costs is expensed
annually. The asset's value decreases along with its depreciation amount on the company's
balance sheet. The corporation can then match the asset's cost with its long-term value.
How a business depreciates an asset can cause its book value—the asset value that appears on
the balance sheet—to differ from the current market value at which the asset could sell. Land
cannot be depreciated unless it contains natural resources, in which case depletion would be
recorded.
Fixed Assets vs. Current Assets

Both current assets and fixed assets appear on the balance sheet, with current assets meant to
be used or converted to cash in the short-term (less than one year) and fixed assets meant to
be utilized for the longer-term (greater than one year). Current assets include cash and cash
equivalents, accounts receivable, inventory, and prepaid expenses. Fixed assets are
depreciated, while current assets are not.
Fixed Assets vs. Noncurrent Assets

Fixed assets are a noncurrent asset. Other noncurrent assets include long-term investments
and intangibles. Intangible assets are fixed assets, meant to be used over the long-term, but
they lack physical existence. Examples of intangible assets include goodwill, copyrights,
trademarks, and intellectual property. Meanwhile, long-term investments can include bond
investments that will not be sold or mature within a year.
Benefits of Fixed Assets

Information about a corporation's assets helps create accurate financial reporting, business
valuations, and thorough financial analysis. Investors and creditors use these reports to
determine a company's financial health and to decide whether to buy shares in or lend money
to the business. Because a company may use a range of accepted methods for recording,
depreciating, and disposing of its assets, analysts need to study the notes on the
corporation's financial statements to find out how the numbers were determined.
Fixed assets are particularly important to capital-intensive industries, such as manufacturing,

that require large investments in PP&E. When a business is reporting persistently negative net
cash flows for the purchase of fixed assets, this could be a strong indicator that the firm is in
growth or investment mode.
55

Examples of Fixed Assets
Some of a manufacturer's fixed assets include:
 Land, land improvements, buildings

 Machinery and equipment
 Trucks, automobiles
 Furniture and fixtures
 Computer systems
Fixed assets can include buildings, computer equipment, software, furniture, land, machinery,
and vehicles. For example, if a company sells produce, the delivery trucks it owns and uses are
fixed assets. If a business creates a company parking lot, the parking lot is a fixed asset. Note
that a fixed asset does not necessarily have to be "fixed" in all sense of the word. Some of these
types of assets can be moved from one location to another, such as furniture and computer
equipment.
What is Depreciation?
In accounting terms, depreciation is defined as the reduction of recorded cost of a fixed asset in
a systematic manner until the value of the asset becomes zero or negligible.
Examples of fixed assets are buildings, furniture, office equipment, machinery etc. A land is the
only exception which cannot be depreciated as the value of land appreciates with time.
Depreciation allows a portion of the cost of a fixed asset to the revenue generated by the fixed
asset. This is mandatory under the matching principle as revenues are recorded with their
associated expenses in the accounting period when the asset is in use. This helps in getting a
complete picture of the revenue generation transaction.
An example of Depreciation – If a delivery truck is purchased a company with a cost of Rs.

100,000 and the expected usage of the truck are 5 years, the business might depreciate the
asset under depreciation expense as Rs. 20,000 every year for a period of 5 years.
There three methods commonly used to calculate depreciation. They are:
1. Straight line method

2. Unit of production method
3. Double-declining balance method
Three main inputs are required to calculate depreciation:

56

1. Useful life – this is the time period over which the organization considers the fixed asset
to be productive. Beyond its useful life, the fixed asset is no longer cost-effective to
continue the operation of the asset.
2. Salvage value – Post the useful life of the fixed asset, the company may consider selling
it at a reduced amount. This is known as the salvage value of the asset.
3. The cost of the asset – this includes taxes, shipping, and preparation/setup expenses.
Unit of production method needs the number of units used during production. Let’s take a look
at each type of Depreciation method in detail.
Types of depreciation
1) STRAIGHT-LINE DEPRECIATION METHOD

This is the simplest method of all. It involves simple allocation of an even rate of depreciation
every year over the useful life of the asset. The formula for straight line depreciation is:
Example – Suppose a manufacturing company purchases a machinery for Rs. 100,000 and the
useful life of the machinery are 10 years and the residual value of the machinery is Rs. 20,000
Annual Depreciation expense = (100,000-20,000) / 10 = Rs. 8,000
Thus the company can take Rs. 8000 as the depreciation expense every year over the next ten
years as shown in depreciation table below.
57

2) UNIT OF PRODUCTION METHOD
This is a two-step process, unlike straight line method. Here, equal expense rates are assigned
to each unit produced. This assignment makes the method very useful in assembly for
production lines. Hence, the calculation is based on output capability of the asset rather than
the number of years.
The steps are:
Step 1: Calculate per unit depreciation:
Per unit Depreciation = (Asset cost – Residual value) / Useful life in units of production
Step 2: Calculate the total depreciation of actual units produced:
Total Depreciation Expense = Per Unit Depreciation * Units Produced
Example:
ABC Company purchases a printing press to print flyers for Rs. 40,000 with a useful life of
180,000 units and residual value of Rs. 4,000. It prints 4,000 flyers.
Step 1: Per unit Depreciation = (40,000-4,000)/180,000 = Rs. 0.2
Step 2: Total Depreciation expense = Rs. 0.2 * 4,000 flyers = Rs. 800
So the total Depreciation expense is Rs. 800 which is accounted. Once per unit depreciation is
found out, it can be applied to future output runs.
3) DOUBLE DECLINING METHOD

This is one of the two common methods a company uses to account for the expenses of a fixed
asset. This is an accelerated depreciation method. As the name suggests, it counts expense
twice as much as the book value of the asset every year.
The formula is:
58

Accumulated depreciation is the total depreciation of the fixed asset accumulated up to a
specified time.
Example:
On April 1, 2012, company X purchased an equipment for Rs. 100,000. This is expected to have
5 useful life years. The salvage value is Rs. 14,000. Company X considers depreciation expense
for the nearest whole month. Calculate the depreciation expenses for 2012, 2013, 2014 using a
declining balance method.
Useful life = 5
Straight line depreciation percent = 1/5 = 0.2 or 20% per year
Depreciation rate = 20% * 2 = 40% per year
Depreciation for the year 2012 = Rs. 100,000 * 40% * 9/12 = Rs. 30,000
Depreciation for the year 2013 = (Rs. 100,000-Rs. 30,000) * 40% * 12/12 = Rs. 28,000
Depreciation for the year 2014 = (Rs. 100,000 – Rs. 30,000 – Rs. 28,000) * 40% * 9/12 = Rs.
16,800
Depreciation table is shown below:
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Depreciation for 2016 is Rs. 1,120 to keep the book value same as salvage value.
Rs. 15,120 – Rs. 14,000 = Rs. 1,120 (At this point the depreciation should stop).
Why should small businesses care to record depreciation?

So now we know the meaning of depreciation, the methods used to calculate them, inputs
required to calculate them and also we saw examples of how to calculate them. Let’s find out
as to why the small businesses should care to record depreciation.
As we already know the purpose of depreciation is to match the cost of the fixed asset over its
productive life to the revenues the business earns from the asset. It is very difficult to directly
link the cost of the asset to revenues, hence, the cost is usually assigned to the number of years
the asset is productive.
Over the useful life of the fixed asset, the cost is moved from balance sheet to income
statement. Alternatively, it is just an allocation process as per matching principle instead of a
technique which determines the fair market value of the fixed asset.
Accounting entry – DEBIT depreciation expense account and CREDIT accumulated depreciation
account.
If we do not use depreciation in accounting, then we have to charge all assets to expense once
they are bought. This will result in huge losses in the following transaction period and in high
profitability in periods when the corresponding revenue is considered without an offset
expense. Hence, companies which do not use the depreciation expense in their accounts will
incur front-loaded expenses and highly variable financial results.
60

Final Notes
Depreciation is an important part of accounting records which helps companies maintains their
income statement and balance sheet properly with the right profits recorded. Using a
good business accounting software can help you record the depreciation correctly without
making manual mistakes.
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Accounting and Finance

 Business entity concept

Business Entity Concept:

Accounting & Finance Prepared by Mirza Farrukh Baig

The following points highlight the significance of business entity concept:

Money Measurement Concept

 The following points highlight the significance of money measurement concept:

Accounting & Finance Prepared by Mirza Farrukh Baig

Going Concern Concept

 The following points highlight the significance of going concern concept;

Accounting Period Concept

Accounting & Finance Prepared by Mirza Farrukh Baig

 It helps in predicting the future prospects of the business.

Accounting Cost Concept

Accounting & Finance Prepared by Mirza Farrukh Baig

Duality Aspect Concept

Assets = Liabilities + Capital

(i) Receipt of cash

(ii) Increase in Capital (owners’ equity)

2. Purchase of machinery by cheque, the two aspects in the transaction are

(i) Reduction in Bank Balance

(ii) Owning of Machinery

3. Goods sold for cash, the two aspects are

(i) Receipt of cash

(ii) Delivery of goods to the customer

Accounting & Finance Prepared by Mirza Farrukh Baig

(i) Payment of cash

(ii) Rent (Expenses incurred).

 This concept helps accountant in detecting error.

Let us study the following examples:

Accounting & Finance Prepared by Mirza Farrukh Baig

 It helps in making the accounting information more objective.

Accounting & Finance Prepared by Mirza Farrukh Baig

Accounting & Finance Prepared by Mirza Farrukh Baig

Accounting & Finance Prepared by Mirza Farrukh Baig

A brief history of record keeping

BALANCE SHEET ACCOUNTS

Accounting & Finance Prepared by Mirza Farrukh Baig

INCOME STATEMENT ACCOUNTS

Accounting & Finance Prepared by Mirza Farrukh Baig

Debits and Credits

In short, debit means left, credit means right.

Accounting & Finance Prepared by Mirza Farrukh Baig

Revenues are recorded as credit amounts.

A decrease in a liability account is recorded with a debit.

Accounting & Finance Prepared by Mirza Farrukh Baig

Accounting & Finance Prepared by Mirza Farrukh Baig

Your understanding of bookkeeping will be enhanced if you keep in mind that:

 revenues cause stockholders’ equity to increase, and

Accrual method vs. cash method

Accounting & Finance Prepared by Mirza Farrukh Baig

Adjusting entries almost always involve:

 an income statement account, and

 debit an expense account, and

The concepts behind adjusting entries are:

Adjusting entries – accruals

Accounting & Finance Prepared by Mirza Farrukh Baig

Adjusting entries – deferrals/prepayments

Adjusting entries – other

 a debit to the income statement account Depreciation Expense, and

Accounting & Finance Prepared by Mirza Farrukh Baig

 debits Bad Debts Expense, and

 the general ledger liability account