Chapter -1 – Introduction to the concept of business

Concept of business – Any activity to make profit. Whenever a person or two or more persons are coming together and
involves themselves into any activity with an object to make some profit. To get profit means earnings are more than what
they have invested into the business. In practice we can see number of people are buying some goods on wholesale basis
and are selling it at retail with an object of making profit. For example Mr.Sanjay who is buying bed sheets from Solapur
on whole sale basis and selling in Pune on retail basis. There are different types and combinations of businesses but for
understanding purpose we can divide the business activities in Trading , Manufacturing and service providers.

Trading business– In trading, the businessman buys goods in bulk and sells the same goods to his customers in retail.
Here the businessman is not making any changes/process on the goods. For example Vinayak Medicals, Mahalaxmi
Jwellers, Nirmiti Furnitures are the examples of traders where the owner of the business is buying the ready made goods
and selling it again to his customers.

Manufacturing activities includes buying of raw material , processing it to convert into finished goods with the use of
machines and workers and then to sell into the market. For Example Reliance Industries Ltd, Tata Motors Ltd etc. Here in
comparing with trading business, number of transactions are on higher side, more workers are required, more assets are
required for the business such as factory building, machines, tools, equipments etc .

Service provider – In such type of business, customers are getting different types of services such as Bank of India,
Kingfisher Airlines, Infosys Technologies Ltd, Ludhiyana Roadways , TNT Courier Services etc. In such type of
businesses goods are not produced however the owner is providing different services to the customers. In service industry
huge factory building, machines are not required but manpower is the basic asset of the business.

Forms of Business Organizations

All the above different business can be managed under various forms of business organizations. Mainly there are three
types of business organizations

1. Sole Proprietorship – Sole proprietor is the only owner of the business. He invests his personal funds as the initial
capital of the business. He takes all the decisions of his business and he is responsible for all the profits and losses of the
business. For example Mr.Ganesh is having a Pan shop, Mr.Salim is having a garage, Mr.Agarwal is having a business of
exporting readymade garments.

Advantages of Sole Proprietorship- Owner of the business is in full control of the business. He takes all the decisions of
the business. Decisions can be very fast. He enjoys all the profits

Disadvantages – There is limitation to introduce capital for the business. One person can not be expert in various business
areas such as finance, marketing, production etc. If there are losses to the business the owner has to suffer the losses. He
has to make the losses good by bringing money from his personal property. Sole Proprietor has no separate legal entity.

Partnership Firms- When two or more persons are coming together to do a business it is a partnership firm. All the
partners are bringing capital into the business and accordingly profit and losses can be shared among the partners. Since
there are two or more partners, everybody is having expertise to deal with various business areas such as finance,
marketing, production etc.

Comparing to Sole proprietor, decisions relating to the business are taken by all the partners with consultation so more
time is involved in decision making process. If there are losses all the partners have to suffer the losses and like sole
proprietor, Partnership firms are also do not have a separate legal status. If there are losses to the business all the partners
have to suffer the losses and have to make the losses good by bringing money from their personal property. However
recently a new concept of “ Limited Liability Partnership” is introduced where liability of the partners is limied.

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Company – Company form of organization is totally different form of organization. Here minimum two and maximum
50 members in case of private company and minimum seven members and maximum with no limit can come together to
do any legal business. They have to register and complete the legal formalities with the Government ( Registrar of
Companies ) to take permission and then they can start the business. Every member has to share in capital of the business
that is why the capital is called share capital. The owners of the company are called Equity shareholders. Every
shareholder is having voting right according to his share holding ( generally one share one vote ). Profits of the business
can be distributed among the shareholders which is called dividend. Shareholders will appoint different persons from
different fields to manage the business who are called “Directors” of the Company. To run the business, specific powers
are with the directors and specific powers are with the owners of the company i.e. equity shareholders.

Companies are mainly divided in Private Companies and Public Companies. Private Companies are those companies
which are privately managed and have number of restrictions to raise the funds from public. Public money is not involved
in private companies and that is why number of provisions under the Companies Act are not applicable to Private
Companies. Public Companies on the other hand can mobilize funds from public at large. Public Companies are further
divided into Listed Public Companies and Unlisted Public Companies. Listed Public Companies means those companies
who have executed agreement with the stock exchange and shares of such companies are available for trading through that
stock exchange say BSE, NSE say Tata Motors Limited, Infosys Technologies Limited, Bajaj Auto Limited. Unlisted
Public Companies means those Public companies who have not yet issued shares to the public and their shares are not
listed on the stock exchange say Tata Sons Limited, Krishidhan Seeds Limited.

Comparing to Sole proprietor and Partnership firm, under company form of organization more capital can be brought in to
the business. Any outsider can be appointed who is expert in a specific area as employee of the company. All the
properties of the business are in the name of the company and not the owners of the company. Shareholders are
contributing towards share capital as per the agreed amount per share. Once this amount is paid they are not liable to pay
further amount. Even if the company is having huge losses, shareholders are not liable to make good the loss of the
company.( Limited Liability ).Another important advantage under company form of organization is equity shareholders
can at any time sell their shares to any interested party and can get their money back .

Exercise –
Explain the concept of “ business”

What are the different types of business?

What are the features of different types of businesses ?

Which are the different forms of business organization ?

Explain the advantages and disadvantages of different types of business organization

What is the limit of minimum and maximum number of members for Private Company and a Public company?

What is the meaning of “Dividend” ?

Who are directors of a company ?

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Chapter - 2

Basic objects of any business – All the business houses as mentioned above are doing their business with the object of
making profit and that is why it is up most necessary for them to know whether we are running the business at profit or
loss and what is the position about the assets i.e properties of the business and liabilities of the business i.e various
amounts which business has to pay to outsiders.

To understand and to achieve the above objects of the business, it is necessary to record each every transaction relating to
the business which is called accounting. It is necessary to record all the transactions whether they are big or small, such as
purchases and sales made for the business and also a transaction where even ten rupees are involved.

Financial Accounting-

To record each and every transaction of the business where funds are involved is called Financial Accounting i.e
recording of transactions relating to finance. Financial Accounting considers all the transactions which can be expressed
in terms of money. In case of a manufacturing company, transactions includes buying of raw material, buying of land,
constructing building, factory sheds, purchase and installation of machines, processing the raw material with the use of
machines and workers, advertisement, selling the finished goods , recovery from the customers, payment to suppliers of
raw material etc. Recording of all such transactions where funds are involved is called Financial Accounting. To achieve
the object of the business, owner must know the profit or loss from the business and whether this profit is sufficient or not.
For this purpose Profit & Loss Account is to be prepared where all the revenues from the business are to be considered
and all the expenses for the same are to deducted so as to calculate profit or loss. Similarly to know the position of assets
and liabilities, Balance sheet is to be prepared. In short for any business the transactions recorded will come under either
of the following headings

1. Revenues/ Income of the business 2. Expenses of the business 3. Assets of the business 4. Liabilities of the
business.

Assets of the Business – Assets or properties of the business means with the use of those assets business can generate
benefits in future. Assets means what business owns. Such as land ,building, plant, machinery, furniture, vehicles, amount
receivable from customers, stock lying in stores etc. Assets or properties can be converted in to cash at any point of time.

Liabilities - Liabilities are what business owes to others. What business has to pay. For example capital received from
the owners, bank loans or any other loans, amounts payable to suppliers of raw material, workers are examples of
liabilities of the business. Liabilities are mainly divided in two – first owners equity and second other liabilities.

Revenue Expenditure
We observe here that we have to put revenue receipts/incomes ( income from business) on one hand and all expenses on
the other hand so as to calculate profit or loss. Another important point is expenses what we have to record are recurring
in nature and are of day to day expenses. These are the expenses where no any asset is created. In fact benefit from this
expenses is already received by the business i.e. different parties involved have already provided the services to the
business against which business has to pay. For example material is received from supplier, workers have worked or the
business, space is occupied by the business so rent is paid Electricity and telephone services are received by the business
etc. These expenses are called Revenue Expenses. These expenses are routine expenses and will be repeated again and
again during the year. Revenue expenses will appear only in Profit & Loss Account.

Following are some examples of revenue expenses /recurring expenses for a hotel business

1. Food and beverages 2. Salary to staff 3. Licensing and fees 4. Electricity and water 5. Fuel, coal and gas
6. Washing and cleaning 7. Linen and uniform expenses 8. Painting and Decoration 9. Repairs and maintenance
10. Laundry expenses 11. Various taxes 12. Crockery expenses 13. Advertisement 14. Audit fees 15. Computer
maintenance 16. Books and newspaper 17. Depreciation on Fixed assets etc.

So depending upon the business and product, revenue expenses will be different.
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Following are some examples of revenue expenses for a manufacturing business

1. Material consumed 2. Store & spares 3. Salaries, wages, bonus 4. Contribution to Provident other fund and staff
welfare 5. site expenses and labour charges 6. Freight and transport 7. Travel and conveyance 8. Insurance
9. Rent 10. Power & Fuel 11. Repairs and Maintenance 12. testing charges 13. Communication expenses
14. Advertisement 15. Bad debts and Provision for doubtful debts 16. Sales commission 17. Loss on sale of fixed
assets 18. Foreign exchange fluctuation loss/gain 19. Misc. Expenses 20. Depreciation on Fixed Assets 21. Audit
fees 22. Legal expenses etc

Following are some examples of revenue expenses for a Software business

1. Software Development Expenses which includes salary and allowances, contribution to Provident and other funds,
Travel expenses, sub-contractor charges, software purchase, computer consumables, post contract support services etc.
2. Salary and allowances, contribution to Provident and other funds to other staff 3. Power & fuel 4. Rent,
5. Telephone 6. Printing and stationery 7. Office maintenance 8. Insurance 9. Advertisement 10. Legal and
Professional fees 11. Depreciation on Fixed Assets etc

Following are some examples of revenue expenses for a banking business

1. Interest paid on deposits 2. Interest paid on funds borrowed from RBI 3. Other interest 4. Salary to staff
5. Insurance 6. Rent 7. Communication expenses 8. Advertisement 9. Depreciation on Fixed Assets 10. Audit
fees 11. Legal expenses 12. Repairs and Maintenance etc

Revenue Receipts

Similarly all receipts for a year we have to show in Profit & Loss Account are from day to day operations of the business
For example for a manufacturing company income generated from sale of goods manufactured. In case of software
companies, software development fees is the major income, For a Bank, major income is Interest earned on loans, interest
earned on balance with RBI etc. All revenues which are earned for that particular period are treated as revenue
receipts/income. Apart from main business activity there can be income from other sources such as dividend received,
interest received on investments, profit on sale of fixed assets/investments, rent received etc. All income for the year
either from business activities or from other sources is shown in Profit & Loss Account for that year

Capital Expenditure

For any business, certain assets are required with the use of which income can be generated such as land, building,
machinery, vehicles, furniture etc. For example for a manufacturing business only workers and raw material is not
required but land, factory building, machines are required to convert the raw material in to finished goods. Money spend
by the business on such types of assets is called Capital Expenditure. The most important point is Capital expenditure
will not appear in Profit & Loss account and will be presented directly under Balance sheet. The logic is very simple
as the above mentioned assets are being used and giving benefits to the business ( by using it for manufacture ) for next so
many years and not only for the year in which they are purchased.

Capital Receipts - For capital expenditure i.e. to buy fixed assets, long term funds are required. Business can collect
those funds by way of capital or loans taken from banks, or accepting deposits which are called Capital Receipts. Capital
receipts are directly shown in Balance sheet and they will not appear in Profit & Loss Account.

In short any transaction relating to the business will come under the following four categories

1. Revenue Expenses 2. Capital Expenses( assets ) 3. Revenue Receipts 4. Capital Receipts (Long term Liabilities )

Revenue receipt and Revenue expenses are covered under Profit & Loss Account and Capital receipts and Capital
expenditure are covered under Balance Sheet.

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Example- Mr.A who is trading in furniture, has given the following information
Sales for the year Rs.1,00,000 , Material purchased Rs.60,000, Rent paid Rs. 5,000, Salary paid to employees Rs.10,000,
Electricity Bills paid Rs.2,000, Advertisement Rs.10,000, Telephone Bill paid Rs.1,000.

In the above example profit made by the business is Rs.12,000 where the revenues are Rs.1,00,000 and expenses are
Rs.88,000. Here sales for the year are shown and expenses for the year are considered. When we are recording all the
sales on daily basis then we get the total sales figure. Similarly expenses are recorded as and when they are incurred so as
to calculate total expenses for the full year . Profit & Loss Account always show revenues and expenses for a particular
period that is why heading for the Profit & Loss Account is “ for the year ended on ”

Here it is important to note that Profit & Loss Account shows all revenues from the business whether actually received or
not . For example out of total sales of Rs.1,00,000, customers have paid Rs.65,000 and for remaining amount of
Rs.35,000, they have promised to pay the amount in future. Similarly all the revenue expenses will be shown in Profit &
Loss Account whether they have actually paid or not. This system of accounting is called Accrual system of accounting .

If we put figures in the above example, Profit & Loss Account will look like as
Profit & Loss Account
Particulars Amount Particulars Amount
Material 60,000 Sales 1,00,000
Salary 10,000
Rent 5,000
Electricity 2,000
Advertisement 10,000
Telephone Expenses 1,000
Profit 12,000
Total 1,00,000 Total 1,00,000

Profit & Loss Account shows the transactions for the year say from 1 st April to 31st March. All the sales made during this
period will be clubbed and can be shown as total sales under Profit & Loss Account, similarly total of all expenses for the
year will appear under profit & Loss Account.
Balance Sheet shows the position of assets and liabilities on the last day of the year. i.e what business owes to the others
and what business owns on the last day of the year.

Income Tax authorities requires the records for tax purposes from the period 1 st April to 31st March every year. That is
why maximum businesses keeps their records for the period 1st April to 31st March every year so that there is no need to
keep separate records for tax and accounts.

Example – From the following balances of various accounts on the last day of the year i.e. 31 st March, 2009 . Prepare a
Balance sheet
Land & building Rs.1,20,000, Machinery – Rs.80,000, Furniture Rs.20,000, Sales for the year Rs.4,50,000 , Vehicles –
Rs.40,000 , Amount receivable from customers ( Debtors) – Rs.15,000, Cash & Bank balance Rs. 35,000, Share Capital –
2,00,000, Reserve & surplus ( profit ) – 40,000, Loan from Bank – Rs.60,000, amount payable to suppliers of raw material
( Creditors ) Rs.10,000

Balance sheet as on 31st March, 2009

Liabilities Amount Assets Amount
Share Capital 2,00,000 Land & Building 1,20,000
Reserves & Surplus 40,000 Machinery 80,000
Bank Loan 60,000 Furniture 20,000
Creditors 10,000 Vehicles 40,000
Debtors 15,000
Cash & Bank balance 35,000
Total 3,10,000 Total 3,10,000
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While preparing Balance sheet, we have considered sales for the year because it is revenue from the business and will be
part of Profit & Loss Account.

Exercise -1-

A company engaged in hotel business and has given the following transactions which have taken place during the year

Sales for the year – Rs.5,00,000, Food & beverages expenses – Rs.2,50,000, Electricity & water expenses – Rs10,000,
Washing & cleaning expenses – Rs.25,000, Linen & uniform expenses – Rs.20,000, Laundry expenses – Rs.12,000, Audit
fees – Rs.3,000, Purchase of Machine – Rs.2,25,000, crockery expenses –Rs.5,000. Calculate profit /loss for the year

Exercise – 2 – Information for a manufacturing company is given, state whether the following items are coming under
Asset, liability, revenue or expenditure

1. Salary paid 2. Cash in hand 3. sales 4. loan from bank 5. share capital 6. amount receivable form customers 7.
amount payable to suppliers 8. amount paid in advance to suppliers 9. Land & Building 10. printing & stationery

1. 2. 3. 4.

5. 6 7 8

9. 10

Exercise -3 – The total Assets of a business are Rs.87,000 , share capital is Rs.53,000 what is the amount of liability?

Exercise – 4 – Share capital of a company is twice of its liabilities. The total assets of the company are Rs.81,000. what is
the amount of liability ?

Exercise – 5

On 1st April, 2008, Mr.Ramesh stared a real estate agency under the name Ramesh Real Estate Agency Private Limited by
depositing Rs.1,00,000 in the companies bank account. The activities resulted in the following revenue and expenses

Commission Income – Rs.1,35,000, Salary expenses – Rs.25,000, Electricity charges – Rs.3,000, Rent Expenses –
Rs.36,000, Advertisement –Rs.20,000. The assets and liabilities of the business on 31 st March, 2009 are Cash – Rs.95,000,
Debtors – Rs.40,500, office Equipments – Rs.30,000. Creditors- Rs.2,500, Loans payable – Rs.12,000.

What is the meaning of Financial Accounting ?

Why it is necessary to record all business transactions ?

What is the meaning of Profit & Loss Account ?

What is the meaning of Balance sheet ?

Explain the meaning of “ Assets “ and “ Liabilities”

Explain the meaning of Capital Expenditure with example

Explain the meaning of Revenue expenditure with example

Explain the meaning of Revenue receipt and Capital receipt

6
Chapter - 3

We have seen that Financial Accounting is necessary to find out profit or loss for the business. Under Financial
Accounting Profit & Loss Account and Balance sheet is prepared. They are collectively called Financial Statements.

Features of Financial Accounting

• Financial Accounting is historical accounting . It records the transactions which have already taken place.

• Financial Accounting considers only monetary transactions. Financial Accounting records only those transactions
which can be expressed in terms of money.

• Financial Accounting is a legal requirement. Keeping of records for business transactions, getting them audited
are the requirements, particularly for company form of business organization.

• Financial Accounting is for outsiders. Outsiders such as Govt, Banks, Suppliers, Investors, shareholders are
interested in Financial accounting and financial results and that is why uniformity is ensured so that comparison
is possible between financial performance of two different entities.

• Financial statements are available at a particular point of time after the expiry of the accounting period for
example Balance sheet as on 31st March, 2009 can be available after this date.

• Financial Accounting gives the result of the business as a whole. It does not give the details about the individual
departments, job wise information etc. Even though now a days segment reporting etc are introduced, it is
applicable only to limited companies.

Generally Accepted Accounting principles ( GAAP )

While recording various business transactions under Financial Accounting there are certain assumptions which are
followed by all accountant and are referred as accounting principles, concepts, conventions and rules. The principles
which are basic of theory and practice of accounting are as below.
Business Entity Concept – It means there is clear cut separation between business and the owners of the business. While
recording transactions accountant has to keep this in mind. For example, in case of proprietary firm accounting process is
carried out for the business and not for the individual person who owns it. There should be clear cut separation between
business and owner.
Dual Aspect Concept – It means every business transaction has two aspects that means when a person brings capital say
of Rs.10,000/- in the business then we have to show Rs.10,000/- as liability of the business ( as this amount I payable to
the owner in future ) and Rs.10,000/- cash as an asset of the business.
Going Concern Concept – It assumes that business is going to be in existence for a long time in future. Because of this
assumption we have to valuate all assets and liabilities at a cost price less depreciation and not at market price.
Accounting Period Concept – as we have discussed in the first para that accounts are prepared to know the profit or loss
of the business. However we have to take a cut off period to prepare those accounts to ascertain profit or loss and hence
a period of 12 months i.e one is a period decided for this purpose. Hence Profit & Loss Account and Balance Sheet is
prepared after every 12 months to find out the business position.
Cost Concept – It proposes that assets should be shown at cost in the books less depreciation.
Money measurement concept – The transactions which are expressed in term of money only will find place in
accounting for example a company is having a very good team of very skilled workers will not find any place in
accounting.
Matching Concept – This concept proposes that to find out profit or loss of a particular period we have to consider all the
revenues and expenses and cots for that period whether they have actually paid or not. For example if accounting period is
7
1st April to 31st March then salary for the month of March is to be considered in the same year even though it is paid in the
April of next year.

Now if we see the above mentioned assumptions while preparing accounts, first we have to assume that business is
separate from its owner, we have to fix a period for which we have to record the transaction etc.

With the above assumptions we have to consider certain traditions or customs which are called conventions while
preparing accounts
Materiality – Consider only those transactions which are having material/ significant impact on the profitability of the
business.
Consistency – The accounting policies which are now following, follow it for the next periods also then only you can
compare the financial statements for different periods.

Case – 1- Mr.Anand after completing his MBA, started his own furniture business under the name Anand Plywoods. He
introduced Rs.2,00,000 towards capital by way of cash. He purchased a plot of Rs.75,000 and constructed a shed of
Rs.25,000. During the year he approached a bank and takes a loan of Rs.50,000 @ 10% interest, Sale for the year were
made for Rs.2,50,000 and following expenses were incurred and paid

Purchase of stock Rs. 1,50,000, Wages & Salaries Rs.20,000, Electricity – Rs.2,500, Advertisement Rs.15,000 and
delivery expenses Rs.4,500.

1. Explain the capital expenditure and revenue expenditure involved in the first year of business

2. Explain the capital receipts and revenue receipts which are involved in the first year

3. Prepare Profit & Loss Account and Balance sheet of the sole proprietor. Ignore depreciation and tax.

4. Discuss various generally accepted accounting principles followed while preparing the Profit & Loss Account and
Balance sheet.

Solution
Profit & Loss Account for the year
Particulars Amount Particulars Amount
Purchases 1,50,000 Sales 2,50,000
Wages & Salaries 20,000
Electricity 2,500
Advertisement 10,000
Delivery Expenses 4,500
Interest on Loan 5,000
Profit for the year 58,000
Total 2,50,000 Total 2,50,000

Balance Sheet as on
Liabilities Amount Fixed Assets Amount
Capital 2,00,000 Plot 75,000
Add: Profit 58,000 Shed 25,000
2,58,000 Current Assets
Bank Loan 50,000 Cash & Bank 2,08,000
Total 3,08,000 Total 3,08,000

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 Cash Account
Amount Fixed Assets Amount
Capital 2,00,000 Plot 75,000
Sales 2,50,000 Shed 25,000
Bank Loan 50,000 Purchases of material 1,50,000
Expenses 42,000
Closing balance 2,08,000
Total 5,00,000 Total 5,00,000

GAAP followed – 1. Business Entity concept 2. Money measurement concept 3. Double Effect concept 4. Cost
Concept 5. Accounting year concept.

Case -2 - Mr. Sanjay is M.D. of a private company having business of ready made garments. He was going through the
records of the business and found the following transactions for the first year which ended on 31st March, 2009

1. Introduced Rs.5,00,000 as share capital of the business

2. Purchase of premises for the shop of Rs.2,60,000
3. Material purchased on cash basis Rs.1,00,000
4. Salary paid to staff Rs.24,000
5. Cash Sales Rs.1,80,000
6. Material purchased on credit Rs.20,000
7. Credit sales Rs.24,000
8. Interest free Loan taken from directors Rs.50,000
9. Telephone, Electricity bill paid for the shop Rs.12,000

On 31st March, his accountant informed him that salary for the month of march of Rs.12,000 to staff is not yet paid and
material costing Rs.8,000 is still lying in the shop on 31st March, 2009 and depreciation is to be charged @5% on shop
building. Ignore tax

Prepare the Income statement and Balance sheet of the business and also discuss the Generally Accepted Accounting
Principles followed by the business.
Profit & Loss Account for the year ended on 31st March, 2009
Particulars Amount Particulars Amount
Purchases on cash basis 1,00,000 Cash Sales 1,80,000
Purchases on credit basis 20,000 Credit sales 24,000
Salaries 24,000 Closing stock 8,000
Add: outstanding 12,000 36,000
Telephone & Electricity 12,000
Depreciation on shop 13,000
Profit for the year 31,000
Total 2,12,000 Total 2,12,000

Balance Sheet as on
Liabilities Amount Fixed Assets Amount
Capital 5,00,000 Premises less Depreciation 2.47,000
Add: Profit 31,000 Current Assets
5,31,000 Stock 8,000
Loan from friend 50,000 Debtors 24,000
Creditors 20,000 Cash & Bank 3,34,000
Outstanding salary 12,000
Total 6,13,000 Total 6,13,000

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 Cash Account
Amount Fixed Assets Amount
Capital 5,00,000 Premises 2,60,000
Sales 1,80,000 Purchases of material 1,00,000
Loan from Director 50,000 Salary 24,000
Telephone & Electricity 12,000
Closing balance 3,34,000
Total 7,30,000 Total 7,30,000

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Chapter - 4
Contents of Company Balance sheet

Equity Share Capital. As per the provisions of the Companies Act, 1956 equity shareholders are owners of the company
and they are having specific rights such as voting rights whenever any decision is taken with the approval of the
shareholders.( on the basis of one share one vote ). They are also having other rights such as right to attend general
meetings of the company, right to receive dividend, right to inspect the statutory registers of the company etc. However
equity shareholders are unsecured i.e they don’t have any right on assets of the company to receive their amount given to
the company. Similarly at the time of liquidation ( closing down the business ) of the company equity shareholders are
having last priority to get their funds from the liquidator of the company. even though they are owners of the company
they can not decide the rate of dividend it is the Board of Directors who decides whether to declare and pay any dividend
or not. At the outset we can conclude that equity shareholders are owners of the company with limited rights with lot of
risk towards their investment made in the company. As far as business is concern the amount which is received from
equity shareholders for the business is liability because business has to pay this amount to the equity shareholders hence
Equity Capital is the first item shown as liability of the business. In the Balance sheet equity capital is shown under
following headings

Authorized Capital – This is the maximum amount of capital company can raise from the investors. For example –
1,00,000 equity shares of Rs.10 each.

Issued capital – This is the amount out of Authorized capital which company has offered to the investors by way of
offering no. of shares. For example – 80,000 equity shares of Rs.10 each

Subscribed Capital – This is the amount of capital, investors have agreed to pay to the company – For example - 70,000
equity shares of Rs.10 each

Called Up Capital – This the amount of capital out of subscribed capital which company has called up ( demanded ) from
the investors i.e shareholders. For example 70,000 equity shares of Rs.10 each amount called up Rs.5 per share

Paid Up Capital – This is the amount shareholders have paid to the company. For example out of 70,000 equity shares
company has received Rs.5 on 69,500 shares and on 500 shares only Rs.3 per share. i.e calls are in arrears of Rs. 2 per
share on 500 shares. So paid up capital is Rs.3,47,500 + Rs.1,500. ( i.e Paid up capital – Calls in arrears Rs.3,50,000 –
Rs.1,000)

If there is any amount because if forfeiture of shares it has to be added to the Paid up capital. In the Balance sheet paid up
capital has to be shown in the outer column.

A Company can issue its shares at a premium i.e a share having face value of Rs.10/- will be issued at price say Rs.12/-.
In this situation, amount towards face value will be shown under Share Capital account and Rs.2 per share under share
premium account.

A Company can issue its shares at discount i.e a share having a face value of Rs10/- will be issued at Rs 9/- per share. In
this situation, amount towards face value of Rs.10 will be shown under Share Capital Account and rs.1 per share under
Misc. Expenses not written off under Asset side.

Preference Shareholders – Preference shareholders are less risky than equity shareholders. They get dividend from the
company at a predetermined rate. Company has to pay dividend to the preference shareholders and then to equity
shareholders. At the time of liquidation of the company, to get the funds from the company, preference shareholders get
priority over equity shareholders .

Preference shareholders are not owners of the company. They don’t have any voting rights means they are not the part of
decision making process. They are having voting rights only under specific circumstances where their interest is affected.
Like equity shareholders they are also unsecured. They get the dividend only when there is profit to the company.
Company can issue preference shares to mobilize the funds and can repay them after a specific predetermined period. As
11
far as business is concern the amount which is received from preference shareholders for the business is liability because
business has to pay this amount to the preference shareholders hence Preference Capital is the item shown as liability of
the business after Equity Capital.

Sometimes a company issues convertible preference shares where after a specific period, preference shares gets converted
into equity shares.

A Company can issue its shares at a premium i.e a share having face value of Rs.10/- will be issued at price say Rs.12/-.
In this situation, amount towards face value will be shown under Share Capital account and Rs.2 per share under share
premium account.

A Company can issue its Preference shares at discount i.e a Preference share having a face value of Rs10/- will be issued
at Rs 9/- per share. In this situation, amount towards face value of Rs.10 will be shown under Share Capital Account and
Rs.1 per share under Misc. Expenses not written off under Asset side.

Sometimes a company will redeem the preference shares at a premium i.e a Preference share of a face value of Rs.10 will
be repaid at the rate of Rs.11/-. In this situation, amount towards additional amount paid i.e Rs.1 will be shown under
Misc. Expenses not written off under Asset side.

Reserves & Surplus – A company out of its profits keeps aside certain amount for future which are called “Reserves”.
Reserves are divided in two – Revenue reserves and Capital Reserves.

Revenue Reserve are those reserves which are created out of the profits generated from the main business activity
( operating activities ) of the company whereas Capital Reserves are those reserves which are created out of profits
generated from other ( non-operational ) activities. For example in case of a manufacturing company, any reserve created
from the profit generated from the manufacturing activity is revenue reserve and if company has sold any asset during the
year at profit then it is a capital reserve.

When a company keeps aside any amount from profits without any specific reason it is called General Reserve.

When a company issues its shares at a price more than its face value, the excess amount collected is called share premium.
For example recently Reliance Power issued its equity shares of a face value of Rs.10 per share issued the shares at
Rs.430 per share to retail investors, the excess amount i.e Rs.420 per share is share premium. All the amount coming
under Reserves are considered as part of owners funds that is why they are included in shareholders equity.

When a company transfers any amount from profits to reserves it is only through book entry, no funds are involved. Profit
is to be reduced by the amount and reserve has to be increased by that amount.

Secured Loans – Under secured loans , major item is debentures. Debentures means loan taken by the company from the
investors for its business. Company has to pay interest on the debentures at a pre determined rate whether there is profit or
not. In case of secured debentures, at the time of accepting money, company gives its fixed assets such as land, buildings
as security to the debenture holders. In case company is not able to pay interest and principle loan amount, debenture
holders have every right to sell off the assets to recover their dues.

Comparing to Equity shareholders and Preference shareholders , debenture are less risky because they are secured that is
why rate of interest on debentures is lower comparing to equity and preference dividend. They do not have any voting
rights. After a specific period company can pay back the amount taken from the debenture holders. Like Preference
shares, a company can issue convertible debentures means after specific period debentures gets converted into equity
shares. Interest accrued and due on debentures is shown with the principle amount under the liability side whereas interest
accrued but not due will appear under Current liabilities.

Like debentures, under Secured Loan Category , Term loans taken from the banks and financial institutions are covered.
Like debentures, company has to pay interest on the loan taken irrespective of the profitability. Company has to accept
12
certain terms and conditions put by the bankers. Sometimes bankers appoints their representative on the Board of the
company. Interest accrued and due on term loans is shown with the principle amount under the liability side whereas
interest accrued but not due will appear under Current liabilities.

Interest paid to debenture holders and to the bankers is treated as expenditure for the business under the head finance
expenses which reduces profit and ultimately tax.

Unsecured Loans – Under this heading company accepts money from investors as fixed deposit or loans from other
companies which are unsecured means company is not giving any asset as security for the repayment.

All the above alternative sources available to the company to mobilize the funds for the business are long term sources.
Company uses this money for the business for a long term period say 5 to 10 years even more than that. When these
parties gives money to the business, they expects return i.e either dividend or interest from the company which is called
cost of capital. i.e amount paid by the company to these parties for the usage of funds. The basic difference is that interest
payment made to debenture holders or banker is treated as expenditure of the business which reduces profits and whereas
dividend payment to equity shareholders and preference shareholders is appropriation of profit which is paid after
payment of tax which will not save tax of the company.

Current Liabilities & Provisions – Like long term liabilities as discussed above there are certain current liabilities which
are created due to the day to day activities of the company. Company has to pay off such type of liabilities in one year. It
includes Creditors, Bills payables, outstanding expenses, short term borrowings from the banks such as bank overdraft,
cash credit. Company has to make certain provisions considering the likely payments such as Provision for taxation,
provision for PF, gratuity, advances received from customers, etc.

In the net shell balance sheet liability side is divided in two parts 1) Long term liabilities which consist of share capital,
reserves and surplus, secured loans and un secured loans and 2) short term liabilities which includes Current Liabilities
and provisions.

Balance Sheet – Asset side

The fist item under Balance sheet asset side is Fixed Assets. Fixed assets are those assets with the use of which company
carry on its business. Fixed assets are mainly divided in two – tangible fixed assets and in tangible fixed assets. Tangible
assets are land, building, plant, machinery, vehicles, furniture having physical existence where as intangible assets consist
of patents, trade marks, copy rights, goodwill etc which are by way of rights.

Since tangible fixed assets are giving benefits to the company for a longer period and not just one year in which they are
purchased. The purchase value of the asset is spread over the life time of that asset. Every years portion is called
depreciation which is treated as expenditure for that year. For example when a machine is purchased for Rs.1,00,000 life
of which is 10 years, the amount of Rs.1,00,000 is spread over a period of ten years since company is going to use the
asset for ten years. Thus every years portion will be Rs Rs.10,000 which is called depreciation and will be treated as
expenditure for that year. Thus at the end of first year balance sheet will show machine value as Rs.1,00,000 – Rs.10,000
= Rs.90,000 and income statement for the year will show expenditure of Rs.10,000/-

Like tangible fixed assets, money spent to acquire/ generate intangible assets is also required to spread over a number of
years. This is called amortization.

Investments - Second heading under asset side is Investments. Company can invest the surplus funds in various
securities like equity shares, debentures, mutual funds. Investments are shown in the Balance Sheet at purchase price and
market price in the brackets.

Current Assets & Loans and Advances – Like fixed assets, business requires certain assets for its day to day operations.
These assets are called current assets. For example in case of a manufacturing company the process is purchase of raw
material, conversion of raw material in to finished goods with the use of machines and workers and then selling the
finished goods in the market either on cash or credit basis. So the assets which can be generated are raw material, work in
13
progress, finished goods, debtors, cash in hand, cash at bank etc. Current assets are those assets which can be convertible
in to cash or cash equivalent assets in a period of one year without reduction in its value.
Current assets includes cash in hand, cash at bank, stock, debtors, bills receivables, prepaid expenses, advance paid to
suppliers, advance tax paid, various deposits kept with various authorities etc. Current assets are to be supported by
Current liabilities which are short term liabilities of the business. Investment in current assets is called gross working
capital of the company and Current assets – Current liabilities is called Net working Capital

Misc.Expenses ( to the extent not written off ) - Under this heading we have to show expenses incurred at the time of
formation of the company, discount allowed on issue of shares, debentures, premium paid while redemption of preference
shares, debentures etc which has to be spread over in next few years and has to be recovered from every years profit.

Format of Balance Sheet

Liabilities Amount Assets Amount

Fixed Assets
Share Capital Goodwill
Equity Share Capital Patents
Preference Capital Land & Building
Reserves & Surplus Plant & Machinery
General Reserve Furniture
Capital Reserve Vehicles
Share Premium Account Investments
Profit & Loss Account Long Term Investments
Secured Loans Current Assets and Loans
Debentures plus interest And Advances
accrued and due
Term Loans plus interest Stock
accrued and due
Unsecured Loans Debtors/ Bills Receivables
Deposits Cash in Hand & at Bank
Inter Corporate Dep. Prepaid expenses
Current Liabilities & Short term investments
Provisions Inter Corporate Deposits
Sundry Creditors Advance Tax paid
Bills Payables Loans to group companies
Outstanding Expenses Deposits kept with various
authorities
Provision for Taxation Misc. Expenses to the extent
not written off
Proposed Dividend Preliminary expenses
Bank Overdraft/ cash credit Issue expenses
Provision for PF
Interest accrued but not due
Total Total

14
Chapter - 5
Steps involved in preparation of Profit & Loss Account and of Balance Sheet

We have already seen that Profit & Loss Account shows the profit or loss for the business. This Profit & loss Account is
divided in two parts left hand side and right hand side. Left hand side of the account is called Debit side which shows all
the revenue expenses and losses for the business where as right hand side is called Credit side which shows all incomes
and gains for the business. The items which are coming under Profit & Loss Account depends on the business. For a
manufacturing company , trading company and a service provider company, items are different.

For a manufacturing company along with opening balances of stock, all revenue expenses such as raw material consumed,
consumption of stores and spare parts, power & fuel, repairs to machinery, building, rent, depreciation on fixed assets,
wages paid, insurance, other factory expenses, office expenses, selling expenses, are shown on the left hand side of the
account whereas sales and closing stock are shown on the right hand side of the account.

For a Trading Company opening stock, Purchases along with all office and selling expenses are shown on left hand side
whereas Sales and closing stock on right hand side of the Profit & Loss Account.

Depending upon the business of the company Profit & Loss Account will give information about trading activities or
manufacturing activities so as to calculate profit or loss.

Profit & Loss Account for a Trading Company

Debit Credit
Particulars Amount Particulars Amount
Opening Stock 35,000 Sales 11,55,000
Purchases 5,50,000 Closing stock 25,000
Gross Profit ( Balancing figure ) 5,95,000
Total 11,80,000 Total 11,80,000
Office Expenses 2,00,000 Gross Profit brought 5,95,000
forward
Selling Expenses 1,60,000 Other Income 30,000
Finance Expenses ( Interest ) 20,000
Depreciation on assets 40,000
Provision for Tax 70,000
Net Profit after Tax 1,30,000
Total 6,20,000 Total 6,20,000

Since it is a trading business , there will be no factory related expenses

Profit & Loss Account for a Manufacturing Company

Debit Credit
Particulars Amount Particulars Amount
Opening Stock of raw material, WIP 35,000 Closing stock of raw 25,000
and FG material, WIP and FG
Purchases of Raw material 5,50,000
Wages paid 1,00,000 Cost of Production 7,65,000
Power & Fuel 40,000 ( Balancing figure )
Consumable stores 15,000
Manufacturing expenses 25,000
Depreciation on manufacturing assets 25,000
Total 7,90,000 Total 7,90,000
Cost of Production ( Brought 7,65,000 Sales 11,55,000
forward)
Office Expenses 1,00,000 Other Income 25,000
15
Selling Expenses 95,000
Finance Expenses 20,000
Provision for Tax 70,000
Profit after Tax ( Net profit ) 1,30,000
Total 11,80,000 Total 11,80,000

Net profit made by the company along with earlier accumulated balance will be distributed to various reserves, as
dividend etc and will be shown under Profit & Loss Appropriation Account

Profit & Loss Appropriation Account

Debit Credit
Proposed Dividend 25,000 Opening Balance ( last year ) 0
Transfer to reserve 40,000 Net profit for the year brought 1,30,000
forward
Balance transferred to 65,000
Balance sheet
Total 1,30,000 Total 1,30,000

Here the ultimate figure of Profit is transferred to Balance sheet under Reserves & Surplus. However some times there
can be loss also in such case either the loss can be deducted from the earlier balance of Profit & Loss Account or it
can be shown on Balance sheet asset side under separate heading of Profit & Loss Account.

There is no specific format under Companies Act for preparation of Profit & Loss Account and hence there is liberty to
prepare and present Profit & Loss Account. It can also be prepared under vertical format. All listed companies are
preparing Profit & Loss Account in Vertical format .

Vertical Format with imaginary figures

Particulars Amount in Amount in
rupees rupees
Gross Sales 12,00,000
Less: Excise Duty 45,000
Net Sales 11,55,000
Add: Other Income 25,000
Total Income 11,80,000
Less: Expenditure
Raw Material consumed
Opening stock of Raw material( WIP,FG) 35,000
Add: Purchase of Raw material 5,50,000
Less: Closing stock of Raw material ( WIP,FG) 25,000 5,60,000
Less: Employee cost 1,25,000
Less: Factory , Office and Selling Exp. 2,35,000
Profit before Depreciation, Interest and Tax 2,60,000
Less: Depreciation 40,000
Profit before Interest and Tax 2,20,000
Less: Interest 20,000
Profit before Tax 2,00,000
Less: Provision for Tax 70,000
Profit after Tax ( Net Profit ) 1,30,000
Less: Transfer to Reserves 40,000
Less: Proposed Dividend 25,000
Balance transferred to Balance sheet 65,000

16
Similarly Balance sheet is divided in two parts , left hand side is Liability side where all the amounts which business owes
to outsiders are shown including owners capital and on right hand side all the amounts the business owns i.e assets or
properties of the business.

Important Concepts under Financial Accounting

Double Entry System of Accounting

Basic assumption under double entry system of accounting is that every business transaction has two elements means
when business receives something it has to pay something. For example when the business pays the rent it gets the
benefit of using the place for the business but at the same time cash goes out of the business. Similarly when goods are
sold goods are going out from the business however cash is coming in to the business.

Cash System of Accounting

Under this system of accounting expenses are considered to be expenses only when they are paid for and income is are
considered as income only when they are actually received. This system is generally used for non-profit making
organizations.

Mercantile System of Accounting

Under this system of accounting, expenses are considered as expenses during the period to which they are pertain
similarly incomes are considered as income during the period to which they are pertain. Whether expenses are actually or
incomes actually received is not important. For example Telephone expenses incurred during April to March are say
Rs.6,000 and amount paid is Rs.5,000, under this system of accounting we have to consider the amount of Rs.6,000.

Steps involved in preparation of Balance Sheet and Profit & Loss Account

• Making of journal entries

• Preparation of Ledger Accounts
• Preparation of Trial Balance
• Consideration of adjustments, closing entries
• Preparation of Balance Sheet & profit & Loss Account

How to make journal entries -This step is for recording of basic transaction in the books. For example capital introduced,
purchases made, wages paid etc. while recording the transactions they can be divided in three heads of accounts. We also
have to keep in mind that under double entry system of accounting every transaction affects on minimum two accounts

1.Real Account which is for assets.

2.Personal Account which is for parties which are associated with the business such as banks, creditors, debtors, Owners
(Capital accounts) etc
3. Nominal Account i.e. the accounts which are not coming under either Real Account or Personal Account. These
accounts are of expenses and incomes and profits and losses.

The rules for recording the transactions are -For Real Account – such as land, building, plant, machinery, furniture,
vehicles, cash

Rule – Debit – What comes in to the business

Credit – What goes out of the business

17
For Personal Account such as suppliers, customers, bankers

Rule – Debit – the receiver ( who has received something from the business )
Credit – the giver ( who has given something to the business )

For Nominal Accounts – such as salaries, wages, telephone expenses, printing, stationery etc

Rule – Debit – all expenses and losses of the business

Credit – all profits and gains of the business

Giving debit to any account means nothing but putting the figure on the left hand side of that account and giving
credit to any account means putting the figure on the right hand side of that account.

As mentioned earlier under double entry system of accounting , from every transaction there can be minimum two
accounts which are generated/affected and they are from the above three heads i.e Real Account, Personal Account and
Nominal Account.

While recording any transaction, we have to put one figure on either left hand side or right hand side of the account,
means we have to give either debit or credit for the particular item. this procedure is called making Journal entries. For
every transaction debit and credit amount should be the same.

For this purpose first we have to find out the accounts which can be generated/affected from every transaction

Example No.1-

The transaction is - machinery purchased for Rs.10,000 by paying cash

Here the accounts which are created from this transaction are machinery account and cash account.

After finding out the account then we have to check each of them whether it is a Real Account, Personal Account or
Nominal Account. In our example both machinery and cash are Real Account.

Finally we have to apply the rules of debit and credit.

In the above example both machinery and cash are Real Accounts so the rule is-

give Debit to What comes in to the business and give Credit to what goes out of the business. Here machinery is coming
into the business since it is purchased and cash is going out of the business ( for payment ) so Machinery Account is to be
debited and Cash account is to be credited.

Example No.2-

If transaction is payment of Rs.5,000 made to suppliers by paying cash

Here the accounts which are created from this transaction are Suppliers account and cash account.

In this example Suppliers account is a Personal account and cash is Real Accounts so the rule for Personal Account is
Debit the Receiver
Credit the Giver

18
Here Supplier has received cash from the business so we have to give him debit in the books and cash is a real account
where the rule is give Debit to What comes in to the business and give Credit to what goes out of the business. Since
cash is going out of the business we have to give credit to Cash Account by the same amount.

Example No.3

Rent of Rs.2,000 paid through cheque

Here the accounts which are created from this transaction are Rent Account and Cash Account.
In this example Rent Account is a Nominal Account and Bank is a Personal Accounts so the rule for Nominal Account is
Debit – all expenses and losses of the business and Credit – all profits and gains of the business. Since rent paid is
expenditure of the business we have to give debit to Rent Account

Since Bank Account is a Personal Account the rule is Debit the Receiver and Credit the Giver. Here our Banker has made
payment on our behalf i.e banker has given Rs.2,000 on our behalf so we have to give credit the Bank Account.
Ledger Posting - After making journal entry we have to post the above facts to the ledger accounts. Ledger Account
shows all transactions for a particular item. The objective of ledger accounts is convenience. Suppose the accountant has
to check the amount paid for electricity for the month of October. Now instead of checking all the transactions ( journal
entries ) it is better for the accountant to check the information at Electricity Expense account. Every accountant has to
open various ledger accounts according to the nature of expenditure. If we continue the example number 1 where we have
given debit to Machine Account and credit to Cash Account, we have to put the figure on left hand side of Machinery
account and right hand side of cash account. Which will look like as

Machinery Account
(Debit side) (Credit side)
Date Particulars Amount Date Particulars Amount

To Cash Rs.10,000

Cash Account
(Debit side) (Credit side)
Date Particulars Amount Date Particulars Amount

By Machinery Rs.10,000

Let us consider another example where the transaction is Telephone bill of Rs.500 paid. Here the two accounts which are
generated are Telephone Expenses Account and Cash Account. Now Telephone Expense is a Nominal Account and cash
is Real Account.
For Nominal Account, rule is Debit all expenses and losses and Credit all incomes and gains. Since telephone expenses is
our expenditure we have to give Debit to Telephone Expenses Account and since Cash is a Real Account and which is
going out we have to Credit to Cash Account.

19
 Telephone Expenses Account
(Debit side) (Credit side)
Date Particulars Amount Date Particulars Amount

To Cash Rs.500

Cash Account
(Debit side) (Credit side)
Date Particulars Amount Date Particulars Amount

By Telephone Exp. Rs.500

Trial Balance
Trial Balance as the name indicates tries to balance between debit and credit totals. i.e. total of all debits must be equal to
all credits. After posting all the transaction in the above manner to related accounts for the whole year or a specific period,
we have to close the ledger accounts. While closing the accounts we will get the balancing figures. For example when we
are paying rent of Rs.2,000 every month, Debit side of Rent Account will show Rs.24,000/- at the end of the year. This
amount of Rs.24,000 first will go to Trial Balance debit column and then to Profit & Loss Account as total rent paid
during the year. Similarly if we have purchased machinery of Rs.10,000 and at the end of the year we have charged
depreciation of Rs.2,000 for its use then we will get Rs.10,000 on debit side of Machinery Account and Rs.2,000 on credit
side and a balancing figure of Rs.8,000 which is the balance of Machinery account at the end of the year. Here we can
say that Machinery Account is having a debit balance of Rs.8,000 i.e. debit side is more by Rs.8,000 than credit side.
Ultimately we have to take balances of all the ledger accounts either debit or credit and have to prepare the Trial Balance
where total debit must be equal to total credit..
On the Trial Balance we have to make adjusting entries such as valuation of closing stock, charging of depreciation on
fixed assets, making of provisions at the end of the year etc and then finally we have to prepare Trading, Profit & Loss
Account and Balance Sheet.
Other important concepts

Closing stock
This indicates the amount of stock in hand at the end of the year i.e on the Balance sheet date. Closing stock is valued at
cost or market price whichever is less. As a first effect, closing stock is shown on the credit side of the Profit & Loss
Account and as a second effect, on the asset side of the Balance sheet.

Journal Entry
Closing stock A/s Debit
Profit & loss A/c Credit

Depreciation
Depreciation is an expenditure for normal wear and tear ( usage ) of a fixed asset. The simple logic is when a company
purchases any fixed asset say a machine for Rs.10 lacs and the life of the machine is 10 years, company is going to use
this machine for next 10 years so the total expenditure on machine i.e Rs.10 lacs we have to divide for 10 years so every
we have to show depreciation as expenditure of every year of Rs.1 lac. So as a first effect depreciation is to be shown as
20
expenditure to the debit side of Profit & Loss Account and as a second effect we have to deduct the amount of
depreciation from the value of the asset shown on asset side.

Journal Entry
Depreciation A/c Debit
Fixed Asset A/c Credit

Outstanding Expenses
This indicates the amount of expenditure pertaining to the relevant period which are not paid during the said period.
According to mercantile system of accounting, we have to add the amount in corresponding expenses even though they
are not paid and as a second effect we have to show it as a current liability on the liability side of the Balance sheet

Journal Entry
Expenses A/c Debit
Outstanding Expenses Credit

Prepaid Expenses
This indicates the amount pertaining to next period is paid in advance in this year. So a s a first effect we have to reduce
the amount from expenses and as a second effect we have to show it as current asset under the Balance sheet asset side.

Journal Entry
Prepaid Expenses Debit
Expenses Account Credit

Accrued Income
This indicated the amount of income for the current year but not received. Accordingly as a first effect we have to add
this amount in current years income and as a second effect as current asset under the asset side of the Balance sheet.

Journal Entry
Accrued Income Debit
Income Account Credit

Income received in Advance

This indicates the amount of income for the next period received during the current period. Accordingly first we have to
reduce current years income and as second effect we have to it as liability under current liabilities on liability side of the
Balance sheet.

Journal Entry
Income A/c Debit
Income received in advance Credit

Bad debts
This is the amount which is not recoverable from the customer to whom goods are sold on credit. Accordingly assuming it
as a loss to the business, we have to reduce the income for the current year and as a second effect we have to reduce the
balance of debtors from the asset side of Balance sheet.

Journal Entry
Bad debts A/c Debit
Debtors A/c Credit

Provision for Bad debts

There is always possibility that some customers are not paying the bills. So management has to make provision for bad
debts by reducing the current years profit and as a second effect we have to reduce the balance of debtors from the asset
side of Balance sheet.
21
 Journal Entry
Profit & Loss A/c Debit
Debtors A/c Credit

Let us consider one example to understand how to give and credit to any account

Example
Mr.Ganesh left his job as carpenter and started a company under name Woodcraft Private Limited. The transactions for
the business for September are as follows

Date Particulars Debit Credit

Sept.1 Started business by depositing Rs.1,00,000 in the bank account of the
company for 10,000 equity shares of Rs.10 each
Sept.5 Purchased equipments for cash of Rs.12,000
Sept.10 Received Rs.18,600 for remodeling a kitchen
Sept.14 Paid cash of Rs.2,000 in cash for advertisement
Sept.17 Received Rs.11,200 for furnishing an office room
Sept.23 Billed customers for work done other than on cash terms Rs.15,000
Sept.25 Paid wages to assistant Rs.10,000 in cash
Sept28 Paid electricity bill Rs.500 in cash
Sept.29 Received partial payment from customers billed on Sept.23, Rs.4,800
Sept.30 Declared and paid dividend of Rs.2500

Let us consider one example where we are covering all the steps to prepare a Balance Sheet and Profit & Loss Account

Problem No.1
From the following particulars of Rivolta Auto Trading Private Limited, make journal entries, ledger accounts, Trial
Balance and Final accounts

Started business by introduction of a share capital of Rs.1,00,000

Opened a Bank Account with Vijaya Bank and deposited Rs.35,000
Purchased goods from M/s Ajay Trading Company on credit for Rs.20,000
Sold goods to Vijay & Sons on credit of Rs.14,000
Paid to Ajay & Sons by cheque of Rs.19,500 in full settlement
Received Rs.13,000 from Vijay & Sons in full settlement by a cheque
Purchased furniture of Rs.10,000 and paid the amount by cheque
Paid Rs.3,000 for traveling of the director in cash
Sold goods of Rs. 10,000 to Ganesh Auto Pvt Ltd for cash
Goods purchased from Akanksha Steels Ltd of Rs.8,0000 against cash
Cash deposited in Vijaya bank Rs.5,000.
Salary paid in cash Rs.2,000

Additional information – Value of stock on 31st March, 2008 is Rs.17,000

Depreciation is to be charged @2% on furniture
Telephone bill of Rs.1,500 for the month of march is not yet paid

Journal entries

1. Cash Account Debit Rs.50,000

Share Capital Account Credit Rs.50,000
22
2. Vijaya Bank Account Debit Rs.35,000
Cash Account Credit Rs.35,000

3. Purchases Account Debit Rs.20,000

Ajay Trading Company Account Credit Rs.20,000

4. Vijay & Sons Account Debit Rs.14,000

Sales Account Credit Rs.14,000

5. Ajay Trading Company Account Debit Rs.20,000

Vijay Bank Credit Rs.19,500
Discount Account Credit Rs. 500

6. Vijaya Bank Account Debit Rs.13,000

Discount Account Debit Rs. 1,000
Vijay & Sons Account Credit Rs.14,000

7. Furniture Account Debit Rs.10,000

Vijaya Bank Credit Rs.10,000

8. Traveling Expenses Account Debit Rs. 3,000

Cash Account Credit Rs. 3,000

9. Cash Account Debit Rs.10,000

Sales Account Credit Rs. 10,000

10. Purchases Account Debit Rs.8,000

Cash Credit Rs.8,000

11.Vijaya Bank Debit Rs.5,000

Cash Account Credit Rs.5,000

12. Salary Account Debit Rs.2,000

Cash Account Credit Rs.2,000

Ledger Accounts in the books of the company

Cash Account
(Debit side) (Credit side)
Date Particulars Amount Date Particulars Amount

23
 Vijaya Bank Account
Date Particulars Amount Date Particulars Amount

Share Capital Account

Date Particulars Amount Date Particulars Amount

Purchases Account
Date Particulars Amount Date Particulars Amount

Sales Account
Date Particulars Amount Date Particulars Amount

24
 Traveling Expenses Account
Date Particulars Amount Date Particulars Amount

Salary Account
Date Particulars Amount Date Particulars Amount

Telephone Expenses Account

Date Particulars Amount Date Particulars Amount

Discount Account
Date Particulars Amount Date Particulars Amount

Depreciation Account
(Debit side) (Credit side)
Date Particulars Amount Date Particulars Amount

25
 Ajay Trading Co Account
Date Particulars Amount Date Particulars Amount

Vijay & Sons Account

Date Particulars Amount Date Particulars Amount

Furniture Account
(Date Particulars Amount Date Particulars Amount

Outstanding Expenses Account

Date Particulars Amount Date Particulars Amount

After closing all ledger accounts we have to complete the third step i.e.Trial Balance. On every account there is either
debit balance or credit balance. If debit side ( left hand side ) is more than credit side( right hand side ) it means the
account is having debit balance for the differential amount and vice versa. Here we have to balance between debit and
credit side on trial basis that is why it is called Trial Balance

Trial Balance
Name of the account Debit Credit
Cash
Vijaya Bank account
Purchases
Sales
Traveling Expenses

26
Salary
Telephone expenses
Depreciation
Discount
Share Capital
Furniture
Outstanding expenses
Total

Profit & Loss Account

Particulars Amount Particulars Amount

Rivolta Auto Trading Private Limited

Balance Sheet
Liabilities Amount Assets Amount

27