1.

ACCOUNTING

Accounting is one of the most important subjects studied under the commerce stream. It
is often referred to as the language of business.

In the modern age, the scope of business has widened. Production and sales are conducted on
a large scale due to the division of labour, specialisation, and scientific management. A
seller’s customers are spread throughout the country. Usually, goods are sold for cash, but to
boost sales, credit transactions have also increased.

The human memory is limited, making it difficult to remember all business transactions. To
overcome this limitation, the practice of recording transactions began, which gave birth to
Book-keeping. With the development of business, book-keeping also evolved. Different
methods of book-keeping were used in different regions and periods.

It can be said that book-keeping is the foundation upon which the entire structure of
modern accountancy is built.

1.2 Importance and Meaning of Accounting

When a businessperson considers expanding their business, additional capital is required.

This capital can be obtained from banks or investors in the form of loans. However, before
granting a loan or investing money, banks and investors want to assess the financial position
of the business. This information can only be provided if all business transactions have been
properly recorded in the books of accounts and the financial statements have been prepared
accurately.

Each business entity is also connected to the government. The government levies sales tax on
sales, income tax on earnings, and excise duty on certain products. In order to calculate these
taxes accurately, it is essential to record all transactions of the year. This is made possible
only through proper accounting practices.

The modern era is also known as the age of Joint Stock Companies. Most goods are produced
and sold by such companies. In these companies, shareholders (owners) and managers
(executors) are different individuals. Hence, it becomes crucial to maintain proper records of
all business transactions to preserve the confidence of shareholders in management. The
Companies Act also includes legal provisions for proper accounting practices.

Every business is established with the aim of earning a profit. Therefore, at the end of each
year, every businessman wants to know whether they have earned a profit or incurred a loss.
Accounting is essential in business for the following reasons:

1. To know the assets and liabilities of the business.

2. To determine the amount receivable from debtors and payable to creditors.
3. To ascertain the incomes and expenditures of the business.
4. To compare the business results of the current year with previous years.
5. To understand the causes of an increase or decrease in capital and to determine the
actual amount of capital at the end of each year.
To obtain this kind of information, it is necessary to keep a complete and systematic record of
every business transaction.

From the above interpretation, we conclude that “Accounting is an important and useful
subject. It is a tool to measure business progress.” In earlier times, accounting was
primarily used to determine the profit or loss of a business and its financial position at year-
end. However, today, accounting is considered an essential part of the management
information system.

Prof. Robert N. Anthony has defined accounting as:

“Nearly every business enterprise has an accounting system. It is a means of collecting,

summarising, analysing, and reporting in monetary terms, information about business
operations.”

Smith and Ashburn have provided a detailed definition of accounting:

“Accounting is the science of recording and classifying business transactions and events,
primarily of a financial character, and the art of making significant summaries, analysis, and
interpretations of these transactions and events, and communicating the results to the persons
who must make decisions based on that information.”

Based on the above definitions, we can say:

“Accounting is a discipline that records, classifies, summarises, and interprets financial

information about the activities of a business firm. This information is used by owners,
managers, and other stakeholders for decision-making.”

Accounting Cycle

The accounting cycle is a complete sequence of steps that begins with the recording of
business transactions in the books of original entry and ends with the preparation of final
accounts, along with the analysis and interpretation of financial information.

Steps Involved in the Accounting Cycle:

1. Journalizing
The accounting cycle begins with the recording of business transactions in the journal
or subsidiary books. This is the process of entering transactions in chronological
order.
2. Ledger Posting
Transactions recorded in the journal are posted to their respective ledger accounts.
This process is also known as classifying the transactions.
3. Ledger Balancing
To make the classified data understandable and useful, the ledger accounts are
balanced or closed at the end of a specific period.
4. Trial Balance
A trial balance is prepared to check the mathematical accuracy of the ledger. It lists
the debit and credit balances of all ledger accounts.
 5. Income Statement
The Trading and Profit & Loss Account is prepared to ascertain the profit or loss of
the business during the accounting period.
6. Position Statement (Balance Sheet)
A Balance Sheet is prepared to show the financial position of the business at the end
of the accounting period. It reflects the assets, liabilities, and capital of the business.
7. Interpretation and Analysis
The financial statements are analyzed and interpreted to provide meaningful insights
to interested parties like proprietors, managers, banks, creditors, and employees. This
helps them assess the profitability and financial health of the business.

Duration of the Accounting Cycle:

• The accounting cycle typically covers one full year, also known as the accounting
year.
• It can start from 1st January to 31st December, or from 1st April to 31st March of
the following year, depending on the organization.
• The same steps are repeated every year to maintain consistency in financial
reporting.

Book-Keeping and Accountancy

Generally, the terms book-keeping, accountancy, and accounting are used interchangeably.
However, there are significant differences between them. Therefore, it is essential to
understand their meanings clearly.

Book-Keeping

The word Book-keeping is a combination of two words: Book and Keeping.

• In accountancy, Books of Accounts are the records in which business transactions are
entered.
• Keeping refers to recording these transactions in a proper and systematic manner.

Book-keeping involves recording daily business transactions that are often routine in nature.
It enables a trader or businessman to determine profit, loss, and the financial position of the
business at any given point in time.

Objectives of Book-Keeping:

1. To maintain a permanent and accurate record of each transaction of the business.

2. To ascertain the combined effect of all transactions made during an accounting
period on the financial position of the business.
Historical Background:

• Book-keeping has been in practice since ancient times.

• Fra Luca Pacioli is known as the father of modern Book-keeping.
• His book "De Computis et Scripturis" was first published in 1494 in Venice, Italy.
• This work introduced the Double Entry System of Book-keeping, which is still in
use today, although it has evolved significantly over time.

Definitions of Book-Keeping:

1. North Cott: "Book-keeping is the art of recording in the books of accounts the
monetary aspect of commercial or financial transactions."
2. R.N. Carter: "Book-keeping is the science and art of correctly recording in the books
of accounts, all those transactions that result in the transfer of money or money’s
worth."
3. A.J. Favell: "Book-keeping is the recording of the financial transactions of business
in a methodical manner so that information at any point in relation to them may be
quickly obtained."

Key Features:

• Book-keeping is the art of identifying, recording, and maintaining business

transactions regularly and systematically.
• It provides a permanent record from which various business-related details can be
retrieved easily and quickly.
• The work is typically performed by a book-keeper or clerk.
• In developed countries, book-keeping tasks are often done using accounting software
or machines.
• It involves using standard accounting books such as the Journal, Ledger, Cash
Book, Purchase Book, Sales Book, etc.
• Interpretation of business results is not part of book-keeping; that comes under
accountancy.

Accountancy

Accountancy goes beyond book-keeping. It includes:

• Identifying,
• Recording,
• Classifying,
• Summarising, and
• Interpreting business transactions.

Purpose:

Accountancy provides a complete picture of a business's financial health and helps in

decision-making by presenting meaningful financial information to various stakeholders
such as owners, managers, investors, creditors, and government bodies.
While book-keeping is focused only on recording transactions, accountancy includes the
analysis and interpretation of these records to evaluate performance and plan for the future.

1 Accountancy

Accountancy begins where book-keeping ends. While book-keeping focuses on the

recording of transactions, accountancy goes further to analyze, interpret, and present
financial information in a useful manner. It requires specialized knowledge and analytical
skills, typically performed by trained accountants.

Definition of Accountancy

• Accountancy is defined as the art and science of re-arranging the accounts and
records maintained by a book-keeper, preparing financial statements based on
those records, and interpreting their effects on the business.
• In simpler terms, "The practice and art of the science of accounting is known as
Accountancy."

Accountancy Process

The procedure of accountancy involves the following sequential steps:

1. Identifying the Business Transactions

Only those transactions that are expressed in monetary terms and are supported by
valid documents or vouchers are recorded in the books of accounts.

▪ Examples: Purchase/sale of goods, cash receipts/payments, wages, salaries, etc.

▪ Non-monetary but important events like employee relations, strikes, or
competitor activities are not recorded as they cannot be measured in money.

2. Recording the Transactions

▪ In small businesses: Transactions are first recorded in a Journal.

▪ In large businesses: Transactions are recorded in Subsidiary Books (Cash
Book, Purchases Book, Sales Book, etc.) due to the high volume of entries.
▪ The number and type of subsidiary books used depend on the size and
nature of the business.

3. Classifying the Transactions

Classification involves grouping similar transactions together and posting

them to respective accounts.

This process is done in the Ledger, where each account (e.g., Cash A/c, Rent
A/c, Sales A/c, etc.) is maintained separately.

This step helps in understanding the impact of specific types of transactions

over a period.
 4. Summarising the Transactions

• Summarising means presenting the classified data in a concise and understandable

form for stakeholders.
• It involves:

▪ Balancing ledger accounts.

▪ Preparing the Trial Balance.
▪ Creating Final Accounts such as:
▪ Trading Account
▪ Profit & Loss Account
▪ Balance Sheet

• These statements provide insights into the profitability and financial position of the
business.

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5. Interpreting the Transactions

At the end of the accounting year, the final accounts and other financial statements are
prepared and presented in such a way that they provide relevant financial information to
various stakeholders. These include:

• Business owners
• Managers
• Creditors
• Investors
• Banks
• Employees
• Government departments

This step helps stakeholders to assess profitability and the financial position of the
business, enabling sound decision-making.

Definition of Accountancy

Accountancy can be defined as:

"The art of identifying business transactions of financial character, recording them

effectively, classifying, summarizing, and interpreting their results."

Definition of Accounting

In 1941, the American Institute of Certified Public Accountants (AICPA) defined

accounting as:
“The art of recording, classifying, and summarising in a significant manner and in
terms of money, transactions and events which are, in part at least, of a financial
character, and interpreting the results thereof.”

According to Smith and Ashburne:

“Accounting is the science of recording and classifying business transactions and

events—primarily of a financial nature—and the art of making significant summaries,
analyses, and interpretations of those transactions and events, and communicating the
results to persons who must make decisions or form judgments.”

Importance of Accounting

In the modern business world, accounting is not just for recording transactions or knowing
profit and loss. Its role has expanded to provide useful, timely, and accurate financial
information to multiple interested parties such as:

• Owners and shareholders

• Creditors and banks
• Managers and employees
• Customers and suppliers
• Government departments
• Stock exchanges
• Legal professionals and consultants

This evolution has made accounting a dynamic discipline with wide applicability.

Difference Between Accounting, Accountancy, and Book-Keeping

Concept Definition
Book- The process of recording business transactions in the books of accounts.
Keeping
Accountancy Involves the classification, summarisation, and interpretation of financial
data recorded through book-keeping.
Accounting A broader field that includes book-keeping, accountancy, financial
reporting, analysis, and communication of results.

Book-Keeping is a part of Accountancy, and Accountancy is a part of the broader field of

Accounting.
Nature of Modern Accounting

Modern accounting includes various specialized fields that address the diverse informational
needs of internal and external users. It is a structured system that involves:

• Principles
• Standards
• Concepts
• Conventions
• Rules

These guide the systematic recording, classification, analysis, and interpretation of

financial transactions.

Branches of Accounting

Due to the expansion of business activities and the growing need for specialized information,
accounting has evolved into several branches, including:

1. Financial Accounting
o Focuses on recording transactions and preparing final accounts for external
users.
o Provides profit/loss and financial position information.
2. Cost Accounting
o Deals with recording, classifying, and analyzing costs incurred in production.
o Helps in cost control and decision-making.
3. Management Accounting
o Provides internal financial information to assist management in planning,
controlling, and decision-making.
4. Tax Accounting
o Involves preparation of accounts in accordance with tax laws.
o Focuses on tax liability computation and compliance.
5. Government Accounting
o Maintains accounts for public sector and government organizations.
o Follows specific rules and formats prescribed by the government.

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Important Branches of Accounting
Accounting has evolved into several branches to serve the specific needs of different users.
Below is a structured overview of the major branches of accounting:

1. Financial Accounting

Purpose:
To record business transactions and prepare financial reports to determine profit/loss and the
financial position of a business.

Key Components:

• Journal: Daily records of all transactions.

• Ledger: Accounts classification.
• Trial Balance: A list of all accounts with debit and credit balances to check
mathematical accuracy.
• Final Accounts:
o Trading Account
o Profit & Loss Account
o Balance Sheet

Objective:
To provide information to external stakeholders such as investors, creditors, and government
authorities.

2. Cost Accounting

Purpose:
To determine and control the cost of production and services, thereby improving efficiency
and profitability.

Key Techniques:

• Cost Sheet: Statement showing various cost elements.

• Job and Contract Costing: Costing of individual jobs or contracts.
• Process Costing: Used for mass production processes.
• Operating Costing: Applicable to services like transport, hospitals, etc.

Benefits:

• Helps in cost control

• Aids in decision-making related to pricing and profitability
3. Management Accounting

Purpose:
To provide internal financial information for managerial decision-making, policy formation,
and performance evaluation.

Key Tools:

• Ratio Analysis: Evaluating financial health using key financial ratios.

• Break-Even Point Analysis: Determining when the business will start earning profit.
• Standard Costing: Comparing actual costs with standard costs to find variances.
• Financial Statement Analysis: Examining the balance sheet and income statement
for insights.

Uses:

• Planning and forecasting

• Policy formulation
• Performance measurement

4. Tax Accounting

Purpose:
To calculate and manage a business's tax obligations by adhering to government laws and
regulations.

Key Areas:

• Sales Tax
• Income Tax
• Wealth Tax
• Excise Duty

Note:
Although financial accounting helps in preparing taxable income, tax accounting involves
special adjustments, tax deductions, exemptions, and compliance with specific provisions of
taxation laws.

5. Government Accounting

Purpose:
To maintain financial records for public funds and government expenditures, ensuring
transparency and accountability.
Key Components:

• Budget: Estimated income and expenditure for the fiscal year.

• Consolidated Fund: Main account of the government for all revenue receipts and
expenses.
• Contingency Fund: Emergency fund used for unforeseen expenditures.
• Public Account: Includes all public money other than those under the Consolidated
Fund.

Requirement:
Mandated under constitutional and statutory provisions for all government bodies.

Chart View: Major Branches and Tools of Accounting

Branch Tools/Techniques
Financial Accounting Journal, Ledger, Trial Balance, Final Accounts
Cost Accounting Cost Sheet, Job Costing, Process Costing, Operating Costing
Management Ratio Analysis, Break-Even Analysis, Standard Costing,
Accounting Analysis
Tax Accounting Income Tax, Sales Tax, Wealth Tax, Excise Duty
Government Budget, Consolidated Fund, Contingency Fund, Public
Accounting Account

1.8 Government Accounting and Social Responsibility Accounting

(5) Government Accounting

The Central Government, State Governments, and local bodies also undertake accounting
work, which is known as Government Accounting. It differs from financial accounting in its
objectives and structure. Government accounting explains and maintains the budget and
various other types of accounts such as:

• Consolidated Fund
• Contingency Fund
• Public Account

Its primary focus is on tracking public expenditures and revenues to ensure accountability
and transparency in government financial operations.

(6) Social Responsibility Accounting

Businesses operate within society and benefit from the infrastructure and facilities it
provides. As such, businesses have responsibilities towards society. Social Responsibility
Accounting is the process of identifying, measuring, and communicating the contributions of
a business to the social environment.
Key areas of contribution include:

• Providing employment, especially to underprivileged groups

• Supporting public utility programs
• Environmental and ecological protection
• Ensuring product quality, safety, and durability
• Enhancing customer satisfaction

Techniques have been developed in this branch of accounting to measure both the cost of
these contributions and the benefits delivered to society.

Financial Accounting

The American Institute of Certified Public Accountants (AICPA) defines financial

accounting as:

“The art of recording, classifying, and summarising in a significant manner and in terms of
money, transactions and events which are, at least in part, of a financial character, and
interpreting the results thereof.”

Financial Accounting is central to every business. It involves properly recording business

transactions (bookkeeping) and then classifying and summarizing them into financial
statements to evaluate business performance and financial position.

Thus, Financial Accounting is the combination of:

• Bookkeeping – the systematic recording of transactions

• Accountancy – the classification, summarization, and interpretation of that data

The aim of financial accounting is to determine the financial results of business activities
over a specified period. This book first covers Bookkeeping and then moves on to
Accountancy.

Relation between Bookkeeping and Accountancy

The terms Bookkeeping and Accountancy are often used interchangeably, but there are
important distinctions:

• Bookkeeping is the foundation of accountancy. According to Prof. Anthony:

“Accountancy includes Bookkeeping.”

 • In small businesses, one person may handle both bookkeeping and accountancy.
However, in larger businesses, these functions are separated due to scale and
complexity.
• Bookkeeping involves the systematic recording of financial transactions. It is
considered a routine, clerical task.
• Accountancy, on the other hand, involves:
o Designing the system of recording
o Preparing financial statements
o Interpreting financial information for decision-making
• Accountancy requires a higher level of knowledge and conceptual understanding,
and is generally performed by trained accountants.

Thus, while bookkeeping is typically done by clerks or accounting software, accountancy

is performed by professionals with deeper analytical and interpretive skills.

Difference Between Book-keeping and Accountancy

[Link] Basis of Book-keeping Accountancy

Difference
1. Origin It is the first step of It is the second step of financial
financial accounting. accounting.
2. Objective To record original business To determine net profit/loss and
transactions. financial position through final
accounts.
3. Scope Limited to recording in Broader scope — includes Trial
Journals, Subsidiary Books, Balance, Adjustments, Final
and Ledgers. Accounts, and their interpretation.
4. Knowledge Does not require specialized Requires trained professionals,
Requirement knowledge. Typically done such as Chartered Accountants.
by clerks or machines.
5. Timing Transactions are recorded Begins after bookkeeping. Final
daily, as they occur. accounts are prepared at the end
of the year.
6. Principles Follows general accounting Applies own principles for
Applied principles uniformly across presenting and interpreting
firms. financial information; may vary
across firms.
7. Financial Does not reflect financial Reveals the financial position,
Position position. Supports the work including profit/loss, assets, and
of accountancy. liabilities.
8. Adjustments Does not include Includes adjustment entries and
and Errors adjustments or error rectification of errors.
rectification.
9. Final Accounts Does not include final Includes the preparation of final
accounts. accounts.
Conclusion:
Book-keeping and Accountancy are distinct yet interdependent. It is rightly said,
“Accountancy begins where Book-keeping ends.”
Book-keeping lays the foundation, while accountancy completes the structure by
summarizing, analyzing, and interpreting the data.

Objectives / Functions of Accounting

In the modern era, accounting has become a subject of practical importance for all types of
organizations—whether they are trading firms, manufacturing companies, banks,
insurance agencies, transport enterprises, or government bodies.

Numerous stakeholders such as owners, shareholders, creditors, banks, government

authorities, and employees rely on accounting information. Hence, accounting serves
several key objectives:

1. Systematic Record of Transactions

• The primary objective of accounting is to record all business transactions in a

systematic and organized manner.
• Transactions are first recorded in the Journal or Subsidiary Books and then
transferred to the Ledger.

2. Ascertainment of Profit or Loss

• At the end of an accounting period, accounting helps in calculating the profit or loss
incurred by the business.
• This is done through the preparation of the Trading Account and Profit & Loss
Account.

3. Determination of Financial Position

• Accounting helps determine the financial health of a business by preparing the

Balance Sheet, which shows assets and liabilities.

4. Information to Stakeholders

• Accounting provides reliable and timely information to internal and external users,
such as:
o Owners
o Investors
o Creditors
o Government departments
o Financial institutions
5. Facilitates Decision-Making

• By providing insight into the business's financial status, accounting assists

management in making strategic decisions like expansion, investment, or cost
control.

6. Compliance with Legal Requirements

• Accounting ensures compliance with tax laws, company laws, and government
regulations by maintaining accurate and complete records.

7. Helps in Comparative Study

• It allows for comparison of current performance with past results, helping identify
growth trends or shortcomings.

8. Detection and Prevention of Errors and Frauds

• Systematic record-keeping helps in identifying errors, omissions, and frauds early.

Importance of Accounting Information System

An Accounting Information System (AIS) plays a critical role in modern business

organizations. It not only streamlines accounting processes but also enhances decision-
making and strategic planning. The key importance of AIS is as follows:

1. Integration with Other Sub-Systems

• AIS integrates accounting with other organizational sub-systems such as

finance, production, HR, and logistics.
• This leads to greater accuracy and speed in delivering financial
information to users.

2. Support in Corporate Decision-Making

• By incorporating data related to social responsibility, human resource

management, and environmental performance, AIS supports informed
strategic decision-making at the corporate level.

3. Connectivity with Functional Information Systems

• AIS connects seamlessly with other information systems such as:

Production systems
▪
Marketing information systems
▪
Personnel and HR systems
▪
Research and Development systems
▪
This interconnectedness promotes a holistic view of the organization.
▪
4. Comprehensive Organizational Insight
 AIS provides both internal (e.g., managers, employees) and external (e.g.,
investors, creditors, regulators) stakeholders with a complete picture of the
organization’s financial and operational status.

Qualitative Characteristics of Accounting Information

To serve its purpose effectively, accounting information must not only be accurate but also
useful to its users. This usefulness is defined by certain qualitative characteristics, which
are essential for enhancing the decision-making capability of the information.

1. Reliability

▪ The information must be accurate, verifiable, and free from bias or

error.
▪ It should represent what it purports to represent faithfully.
▪ For example, audited financial statements enhance the reliability of
reported data.

2. Relevance
o Information should be pertinent to the decision-making needs of users.
o It must help in predicting future outcomes or confirming past evaluations.
o Timely financial data about costs, revenues, and profitability are relevant for
managerial decisions.
3. Understandability
o The information should be presented clearly and concisely, making it
understandable to users with a reasonable knowledge of business and
economic activities.
o Complex data should be supported with explanations or notes to enhance
clarity.
4. Comparability
o Users must be able to compare financial information over time (intra-firm)
and across different firms (inter-firm).
o This requires consistency in applying accounting policies and standards.
o For example, if depreciation methods are consistently applied, comparisons
across years become meaningful.
Users of Accounting Information

Accounting information is useful for a wide variety of users. These users can be broadly
classified into two categories:

(a) External Users with Direct Financial Interest

These include:

• Investors (existing and potential): They use financial information to decide whether
to buy, hold, or sell ownership interests based on the profitability and financial
stability of the business.
• Creditors (e.g., banks, lenders, debenture holders, financial institutions): They
assess the creditworthiness of the business and the associated risks before granting
loans or extending credit facilities.

These users rely primarily on financial statements and reports to make informed decisions.

(b) External Users with Indirect Financial Interest

These users are not directly involved in the business but still rely on its financial information:

• Government authorities (Department of Company Affairs, Registrar of Companies,

Income Tax and Sales Tax Departments)
• Labour unions (to negotiate wages and benefits)
• Customers and suppliers (to evaluate the continuity and stability of the business)
• Stock exchanges, trade associations, and researchers

These stakeholders use financial reports to ensure compliance, support policymaking, protect
their interests, and assess the firm’s overall health.
 Accountancy: A Science or an Art?

There is an ongoing debate on whether accountancy should be classified as a science or an

art. In reality, it possesses elements of both.

Accountancy as a Science:

• It follows a systematic body of knowledge, governed by established principles,

concepts, and rules (such as GAAP or accounting standards).
• These rules ensure consistency and objectivity in recording business transactions.
• However, unlike natural sciences (like Physics or Chemistry), accountancy does not
establish cause-and-effect relationships in a strict sense. It is better considered a social
science.

Accountancy as an Art:

• It involves the skillful application of accounting rules and principles in real-life

business scenarios.
• Interpreting financial data, making judgments, and presenting meaningful results
require experience and professional competence.

Conclusion: Accountancy is both a science and an art. The scientific aspect provides a
structured foundation, while the artistic aspect enables practical application and
interpretation. Both are essential to achieve the objectives of accounting.

Advantages of Accounting

Accounting offers several advantages, especially to business owners, by helping them make
informed decisions and maintain financial discipline.

(A) Advantages to Businessmen:

1. Systematic Recording of Transactions:

o Accounting ensures that all business transactions (real, nominal, and personal)
are recorded in a complete and organized manner, creating a permanent
record for future reference.
2. Replacement of Human Memory:
o In large businesses, it is impossible to remember every transaction.
Accounting acts as an external memory system, storing all financial activities
in structured formats.
3. Access to Important Information:
o Business owners can obtain timely data on:
▪ Total purchases and sales
▪ Outstanding receivables and payables
▪ Income and expenditure breakdowns
4. Ascertainment of Financial Results:
o At the end of each financial year:
▪ Trading Account helps determine gross profit.
 Profit & Loss Account reveals net profit or loss.
▪
Balance Sheet presents the financial position of the business,
▪
including assets and liabilities.
5. Knowledge of Business Position:
o Through accounting, the owner can assess:
▪ Whether the business is profitable
▪ What the financial health is (assets vs. liabilities)
▪ Areas requiring improvement or further investment

In summary: Accounting is a powerful tool that helps in planning, controlling, and

evaluating business operations efficiently.

(A) Advantages to the Businessman

(6) Reference in Future:

When the work of a trader is recorded in the books of accounts, the businessman can present
the old ledgers as references in the future. These books of accounts can be treated as business
evidence and used in courts as valid proof, provided they are maintained properly.

(7) Comparative Study:

When business transactions are recorded regularly and systematically, the business results of
different years can be easily compared. This comparative analysis helps in making informed
decisions for the future.

(8) Check on Errors and Frauds:

When business transactions are recorded systematically in the books of accounts, the chances
of errors are minimized. Moreover, accounting helps in checking frauds related to stock and
cash, making it easier to manage the business efficiently.

(9) Helpful in Management:

Managers require various kinds of information to run the business effectively. These vital
pieces of information are provided by the Accounts Department. Therefore, a good Accounts
Department plays a significant role in effective management.

(10) Helpful in the Sale of Business:

If accounts are properly maintained, it becomes easier to determine the purchase price when
the businessman intends to sell the business. Proper accounts increase the credibility and
value of the business in the eyes of potential buyers.

(B) Advantages to Consumers

(1) Proper Price Determination:

A manufacturer can determine the accurate cost of a product through adequate and complete
record-keeping. This further helps in setting a fair price, ensuring the product is available to
consumers at a reasonable cost.

(2) Quality Goods:

An indirect advantage of efficient accounting is the improved quality of goods. When the
Accounts Department functions effectively, it leads to better management and control, which
ultimately results in higher-quality products for consumers.

(C) Advantages to the Government

(1) Financial Assistance:

The government provides financial assistance such as subsidies and grants to business firms.
These benefits can only be availed if business transactions are properly recorded, thus
highlighting the importance of accounting in gaining from government schemes.

(2) Knowledge of Financial Position of the Country:

Accounting allows the government to assess the commercial and industrial progress of the
country through the data of various trades. This is possible only when all business units
maintain proper accounts.

(3) Granting Licences:

Proper accounting records help the government in issuing import, export, and production
licenses to enterprises, as it reflects their financial and operational credibility.

(4) Framing Commercial Laws:

Accounting plays a role in the framing and amending of various commercial laws such as the
Companies Act, the Monopolies and Restrictive Trade Practices Act, and the Consumer
Protection Act.

(5) Tax Assessment:

Traders are required to pay various taxes such as Sales Tax, Income Tax, GST, etc. These
taxes can be properly assessed only if business transactions are recorded accurately in the
books of accounts. Government officers rely on these records for assessment purposes. Thus,
both businessmen and the government benefit from proper accounting.

(6) Settlement of Disputes:

Properly maintained accounts serve as good evidence in courts and are useful in settling
commercial disputes.

(D) Advantages to Employees

(1) Control and Regulation:

It is crucial in business to assign work to employees according to a systematic plan.
Accounting helps determine how many employees can be hired at a fixed wage, thereby
assisting in workforce planning. The Accounts Department thus indirectly controls employee
management through proper financial records.

(2) Increase in Salary and Bonus

Accounting also helps in determining employee salaries, bonuses, and other forms of
compensation. With the growing trend of employee participation in management, the
importance of accounting has gained further significance. Accurate financial data supports
fair and transparent remuneration decisions.

(E) Other Advantages

(1) Helpful in Planning

Managers need estimates related to purchases, sales, expenses, costs, and cash flows for the
upcoming year in order to create effective business plans. These forecasts and estimates are
generated by the Accounts Department through proper accounting procedures.

(2) Helpful in Decision-Making

Every businessperson must take important decisions related to production, pricing, and sales
strategies. For example:

• Should the selling price be reduced to increase sales?

• Should gifts be offered with the product?

The data required to make such decisions is provided by the Accounts Department through
well-maintained financial records.

(3) Helpful in Borrowing

For expanding the business, additional capital may be required. Banks and investors need to
assess the financial health of a business before approving loans. This financial status is best
reflected through proper accounting records and financial statements.

(4) Determination of Goodwill

Goodwill is an intangible asset and can be determined using accounting records from
previous years. Accurate accounting helps in objectively calculating the reputation and brand
value of a business.

(5) Helpful in Partnership

In a partnership firm:

• A new partner can evaluate the firm's financial condition through its accounts.
• An outgoing partner can assess the value of his share in the business.

Since partnerships involve multiple stakeholders, mutual trust is essential. Proper accounting
ensures transparency and trust among partners.
(6) In Large Scale Business

In the modern economy, most products are produced and distributed on a large scale. As
business activities expand, they become complex. Accounting helps in maintaining control
and coordination across large-scale business operations.

(7) In Case of Insolvency

If a businessman fails to pay his debts, he is declared insolvent. In such a case, creditors may
pressurize or harass him. However, if the businessman has maintained proper records of all
business transactions, he can seek protection from the court. The court uses accounting
records to verify claims and declare insolvency if appropriate.

(8) Assessment of Progress

By analyzing data on profits and losses, assets and liabilities, purchases and sales, and
income and expenditures over several years, a business can assess its overall progress. Such
an assessment is only possible through effective accounting.

In conclusion, accounting is essential for running a business efficiently, planning future

policies, improving employee performance, complying with government regulations, and
serving consumers better. The importance of accounting continues to grow with the
complexity of modern business.

Limitations of Accounting
Despite its many advantages, accounting has certain limitations. A person using accounting
data should be aware of these constraints:

(1) Incomplete Information

Accounting only records those events and transactions that can be expressed in monetary
terms. Several critical aspects of business success and financial health are not captured in
accounting records, such as:

• Managerial efficiency
• Government regulations and policies
• Economic conditions of the country
• Market competition
• Changes in consumer preferences
• Popularity and productivity of employees

Although these factors significantly impact the business, they cannot be measured or
recorded in monetary terms and are therefore excluded from accounting systems. This leads
to incomplete financial information for decision-making.
(2) Influence by Personal Judgement

In accounting, several estimates and assumptions are made at the end of the accounting year
to determine the net profit or loss. For example:

• Estimating the useful life and scrap value of an asset for charging depreciation
• Estimating bad debts
• Valuing closing stock, provisions, etc.

These estimates are often influenced by the personal judgment, preferences, or biases of the
accountant. As a result, the final accounting outcomes may vary from person to person,
affecting the objectivity of financial results.

(3) Realisable Value of Business is Not Shown

The Balance Sheet prepared at the end of the year shows the value of assets at their original
(historical) cost, not their current market or realisable value.
Thus, the actual worth of the business—what it would fetch if sold—is not reflected in the
Balance Sheet, making it difficult to assess the real-time value of the enterprise.

(4) Complete Control on Frauds is Impossible

Accounting can verify the arithmetic accuracy of books of accounts, but it cannot
completely eliminate the possibility of fraud.
For example, the net profit shown in the Profit & Loss Account can be manipulated by
inflating or deflating the closing stock, among other tactics. Therefore, even accurate-
looking books can conceal financial misconduct.

(5) Manipulations in Accounts

If the owner or management includes personal preferences or interests in financial records,

the accounting results will be biased and misleading.
Such manipulations compromise the reliability of the accounts and distort the true financial
picture of the business.

(6) Does Not Provide Timely Information

Final accounts are usually prepared only at the end of the accounting year. Hence, they
reflect historical data and past performance.
However, business managers often need real-time information for decision-making and
planning. Accounting does not always provide up-to-date data, making it less effective for
daily or short-term business decisions.
 THEORY BASE OF ACCOUNTING,
ACCOUNTING TERMINOLOGY, AND
ACCOUNTING STANDARDS
Nowadays, every business is generally associated with several individuals and institutions
such as creditors, banks, insurance companies, employees, investors, tax departments,
shareholders, and the government etc.

Therefore, it is essential that financial statements are prepared according to certain rules,
procedures, and conventions. These rules and conventions are known as “Generally
Accepted Accounting Principles” (GAAP).

Accounting is the Language of Business:

Different accountants prepare the accounts of different enterprises. If each accountant

prepares financial statements using their own methods without following generally accepted
principles, the accounts will not be reliable and the results will not be accurate.

Hence, to ensure uniformity, comparability, and reliability in financial reporting,

adherence to GAAP is necessary.

Accounting: A Simple Understanding

Accounting is a subject that involves a systematic and organized way of recording financial
transactions. The main goal is to make accounting understandable to everyone. To achieve
this, accounting follows standardized terminology, language, principles, and elements.
These essential components include:

• Accounting Principles
• Accounting Concepts
• Accounting Conventions

1. Accounting Principles

Like all other sciences—whether natural or social—accounting is also based on certain

principles and rules. To study accounting properly, it is important to understand these
principles.

The American Institute of Certified Public Accountants (AICPA) defines a principle as:

“A general law or rule adopted or professed as a guide to action; a settled ground or basis of
conduct or practice.”
Need for Accounting Principles

It is important to adopt principles in accounting because:

• We need a proper way to record business transactions.

• The accounting system must be universally acceptable and understandable.

These principles are generally accepted by accountants all over the world and are called
Generally Accepted Accounting Principles (GAAP). They have been developed based on
years of experience and evolving business needs.

Accounting principles are not rigid. They may change over time due to:

• Government regulations
• Opinions of professional institutions like the Institute of Chartered Accountants of
India (ICAI)

The aim is to make financial statements more meaningful and useful.

Features of Accounting Principles

1. Clarity and Simplicity: They should be clear and easy to understand.

2. Based on Facts: They must reflect the true financial position of a business.
3. Consistency: They should be suitable for regular and consistent use.

2. Types of Accounting Principles

Accounting principles are known by different terms, such as:

• Concepts
• Assumptions
• Conventions
• Postulates

For study purposes, they are generally grouped into three categories:

1. Basic Concepts or Assumptions

2. Basic Principles
3. Modifying Principles or Conventions
3. Accounting Concepts or Assumptions

Concepts are basic assumptions that are accepted and followed by all accountants. A concept
is a thought or idea that guides our actions in a systematic way.

“Concepts denote logical consideration and a notion which is generally and widely accepted.”

Importance of Accounting Concepts

Accounting concepts form the foundation of the accounting process. They help in:

• Selecting an appropriate accounting system.

• Accurately recording business transactions.

According to the International Accounting Standards Committee (IASC) and the

Institute of Chartered Accountants of India (ICAI), some of the key accounting concepts
include:

Let me know if you’d like me to continue with the explanation of the main accounting
concepts like:

• Business Entity Concept

• Money Measurement Concept
• Going Concern Concept
• Cost Concept
• Dual Aspect Concept
• Realization Concept
• Accrual Concept
• Matching Concept

1. Accounting Period Concept

(Also called the Accounting Year Concept)

• The life of a business is indefinite, i.e., it continues forever.

• However, to calculate profit or loss, businesses must evaluate financial results
periodically, typically every year.
• This fixed time duration is known as the Accounting Period.
• An accounting period can be:
o A calendar year: from 1st January to 31st December, or
o A financial year: from 1st April to 31st March of the following year.
• Accounting is carried out on a yearly basis throughout the world using this concept.
• If a business is started during the year, its first accounting period will be less than a
year, but it will still close its accounts:
o On 31st December, if it follows the calendar year
o On 31st March, if it follows the financial year
 According to the Companies Act, all companies must adopt the financial year (1st April –
31st March) as their accounting year.

The Income Tax Act also makes it mandatory to use the financial year as the accounting
year.

2. Business Entity Concept

• This concept says that a business is separate and distinct from its owner(s).
• The business should maintain its own set of books, separate from the personal records
of the owner.
• All transactions are recorded from the point of view of the business, not the owner.

For example:

• When the owner invests money in the business, it is recorded as Capital (the business
owes it to the owner).
• When the owner withdraws cash or goods for personal use, it is recorded as Drawings
(the owner owes it back to the business).

• The Balance Sheet shows the financial position of the business, not the owner.
• The Companies Act also confirms that a company has a legal identity separate from
its owners.

This concept applies to all forms of business — sole proprietorships, partnerships, and
companies.

3. Going Concern Concept

• According to this concept, it is assumed that the business will continue to operate
for an indefinite period into the future.
• Because of this assumption, fixed assets like land, building, plant, and machinery are
recorded at cost minus depreciation, and not at their market value.

If the business was expected to shut down soon, assets would be shown at market (realisable)
value instead.

• Why this concept is important:

o It allows long-term agreements with suppliers, creditors, and investors.
o Encourages people to invest in shares or debentures, and provide long-term
loans.
o It enables classification of assets into:
▪ Current Assets (short-term)
▪ Fixed Assets (long-term)
o And classification of liabilities into:
 ▪ Short-term liabilities
▪ Long-term liabilities

For example:

• Prepaid insurance (which has no immediate resale value) is shown as an asset,

because it will benefit the business in the future.

• If an expense is made for an item that will benefit the business over several years (like
advertising), it is treated as a Capital Expenditure and spread over multiple years.

Summary

Concept Meaning Importance

Accounting Business transactions are recorded Helps in calculating periodic
Period for a fixed time (usually 1 year) profits and losses
Business Business and owner are treated as Ensures proper recording of
Entity separate entities business-only transactions
Going Business will continue to operate in Allows long-term planning,
Concern the future contracts, and asset classification

(4) Money Measurement Concept

According to this concept, only those business transactions are recorded in the books of
accounts which can be expressed in monetary terms. Recording of transactions in
monetary terms makes them meaningful.

For example, if it is said that an electronics business is started with 25 televisions, 10 fridges,
10 washing machines, 20 two-in-one transistor radios, and 9 vacuum cleaners, then this
information will be meaningless from the accounting perspective because it does not tell us
the amount of capital invested in the business.

On the contrary, if it is said that the electronics business is started with ₹3,00,000, then it
becomes meaningful and useful for accounting purposes.

It is clear from this concept that qualitative and emotional factors of business are not
recorded. For example:

• Efficiency of managers
• Quality of products
• Government policies
• Changes in consumer taste
• Strikes or labour unrest
Although these factors have a deep impact on business operations, they are not recorded in
accounts because they cannot be expressed in monetary terms.

Due to the money measurement concept, a uniformity is maintained in the presentation of all
information, which makes addition, subtraction, and comparison easy. In India, the rupee is
used as the unit of account.

Significance of Accounting Concepts

Every business should follow the above-stated concepts while recording its transactions.
These concepts are considered the basic pillars of accounting. Every concept is important,
and if any one of them is ignored, the work of accounting will become meaningless, and the
data will not be comparable.

Use of these concepts is not optional, but compulsory.

Basic Accounting Principles

Basic accounting principles are those which are static and do not change over time. These
principles include:

1 Principle of Revenue Recognition (or Realisation Principle)

This is an important principle used to measure the income of the business. According to this
principle, revenue is recognised as earned when it is accrued, not necessarily when cash is
received. Revenue does not mean the receipt of cash, but rather the right to receive cash.

This principle helps determine:

• When the revenue is considered earned

• To which period the revenue belongs

Revenue recognition can be done on the following bases:

(a) Sales Basis

On the sales basis, revenue is recognised at the time the goods are transferred to the
buyer, and the buyer becomes legally liable to pay for the goods.

Example:
A firm receives an order for goods worth ₹9,000 on 1st March. The goods are dispatched on
15th March. The revenue is recognised on 15th March, because the ownership of goods was
transferred on that date—even if the payment is received later, say, on 5th April.
(b) Cash Basis

On this basis, revenue is recognised only when cash is actually received. This method is
used when there is uncertainty in receiving payment.

Example:
In the hire purchase system, goods are sold on credit and there may be doubt about receiving
full payment. Therefore, revenue is recognised only for the instalments actually received.

(c) Production Basis

In this method, revenue is recognised at the time of production of goods, especially when
production is the key milestone rather than sale.

This method is generally adopted in construction businesses, where revenue is recognised

proportionally based on the percentage of work completed.

Only those events which have historical certainty are recorded in accounting. Contingent
or uncertain events are not recorded. This is why revenue is generally recognised either:

• At the time of actual payment, or

• When the buyer becomes legally liable to make the payment.

2 Principle of Expenses
The Principle of Expenses deals with the recognition and recording of business expenses in
financial accounts. An expense includes the following:

1. Cost of goods sold (COGS)

2. Selling and distribution expenses
3. Other indirect expenses such as carriage, commission, salaries, depreciation, etc.
4. Decrease in the value of fixed assets (e.g., depreciation)

Key Point:
Expenses are recognised not when they are paid, but when they are incurred, i.e., when
they contribute to generating revenue.

This is important for accurate calculation of profit or loss.

Expense vs Cost

There is a difference between cost and expense:

• Cost is the total amount spent to acquire or produce an asset.

• Expense is the portion of that cost that is charged to a specific accounting period.

For example, if a plant is purchased for ₹5,00,000 and its useful life is 10 years, then
depreciation of ₹50,000 per year will be recorded as an expense in the profit and loss account
each year. The rest of the cost is allocated over the remaining useful life of the plant.

3. Principle of Matching Revenue with Expenses

(Matching Principle)
This principle states that:

“Revenue of a particular period must be matched with the expenses incurred to earn
that revenue.”

This helps in correctly calculating the profit or loss for that period.

According to this principle:

Profit = Revenue of the period − Expenses of the same period

If:

• Revenue > Expenses, it results in Profit

• Expenses > Revenue, it results in Loss

While applying the matching principle, the following rules are followed:

1. All expenses related to the period must be included, whether they are paid or still
outstanding.
2. Prepaid expenses (relating to future periods) should be excluded.
3. All revenue earned during the period must be included, whether received or
accrued.
4. Income received in advance (for future periods) must be excluded.
5. Losses arising during the period must also be recorded.

Adjustments:

To apply this principle properly, adjustment entries are passed at the end of the accounting
year for:

• Outstanding expenses
 • Prepaid expenses
• Accrued income
• Unearned income
• Provisions for doubtful debts

4. Principle of Full Disclosure

This principle states that:

“All relevant and material information must be fully and fairly disclosed in the financial
statements.”

This ensures transparency and helps stakeholders make informed decisions.

Who benefits from this principle?

Various users of financial statements:

• Owners
• Creditors
• Investors
• Employees
• Tax authorities
• Government agencies
• Banks and financial institutions

Application of Full Disclosure:

1. Different types of expenses (manufacturing, selling, administrative, etc.) should be

shown under separate headings instead of being grouped together.
2. Footnotes and notes to accounts must be added to explain:
o Market value of investments
o Methods of stock valuation
o Methods of depreciation
o Contingent liabilities, pending court cases, guarantees, etc.

Example:
The Indian Companies Act provides a specific format for the Balance Sheet to ensure full
disclosure. Additional notes and annexures must be attached for items that cannot be shown
directly in the financial statements.
5. Principle of Dual Aspect (Duality Principle)
This is one of the most fundamental principles of accounting and is the basis of the Double
Entry System.

According to this principle:

“Every business transaction affects at least two accounts — if one account is debited,
another must be credited for the same amount.”

It ensures that the accounting equation remains balanced at all times.

Accounting Equation:

Assets=Liabilities+Capital\text{Assets} = \text{Liabilities} +
\text{Capital}Assets=Liabilities+Capital

This equation shows that:

• Everything the business owns (assets) is financed either by what it owes (liabilities)
or by what the owner has invested (capital).

Example:

If a business receives ₹1,00,000 cash from the owner:

• Cash (Asset) increases → Debit

• Capital increases → Credit

Thus, both sides of the equation remain equal, demonstrating financial equilibrium.

This principle is also called the Balance Sheet Concept, because the Balance Sheet is
prepared based on this dual aspect — ensuring equal totals on both sides.

6. Principle of Verifiability and Objectivity

According to this principle:

Every transaction recorded in the books of accounts must be supported by

documentary evidence.

These documents may include:

• Receipts
• Bills
• Invoices
• Cash memos
• Salary slips
• Wages registers
 • Agreements
• Business correspondence
• Vouchers

These vouchers serve as proof for the occurrence of a transaction. Even auditors use them to
verify the accuracy of accounts.

Objectivity

The principle of objectivity means that:

• Accounting information should be free from personal bias—whether from

management or accountants.
• Subjective judgments must be avoided.

Accounting should be based on verifiable and factual evidence. Where physical documents
are not available (e.g., stock valuation, provision for doubtful debts, depreciation), a uniform
accounting policy should be applied to ensure consistency.

Example:
While providing for doubtful debts or calculating depreciation, standard accounting estimates
and methods are used even though these items don't have direct invoices or receipts.

7. Principle of Historical Cost

According to this principle:

All assets should be recorded in the books of accounts at their original cost (cost of
acquisition).

This cost includes:

• Purchase price of the asset

• Additional expenses (installation, delivery, transportation, etc.) required to make the
asset ready for use

Key Features:

• The market value of assets is not recorded.

• Assets are not adjusted for appreciation or depreciation in market value.
• Over time, the book value of an asset is reduced using depreciation, and shown in
the balance sheet as:

Asset Value=Historical Cost−Accumulated Depreciation\text{Asset Value} =

\text{Historical Cost} - \text{Accumulated
Depreciation}Asset Value=Historical Cost−Accumulated Depreciation
Example:

If a building is purchased for ₹5,00,000:

• It will be recorded at ₹5,00,000 in the books.

• Even if its market value increases or decreases, this will not affect the books.
• Depreciation will be charged yearly and the reduced value will appear in the Balance
Sheet.

Limitations:

Assets for which no monetary payment is made will not be recorded:

• Business reputation (goodwill developed internally)

• Skilled workforce
• Favourable location
• Technical know-how

These may help in profit-earning, but since they are non-monetary and unverifiable, they
are not recorded.

Advantage of Historical Cost:

It is objective and verifiable, reducing bias or manipulation in financial reporting.

Modifying Principles (Accounting Conventions)

Sometimes, strict accounting principles are modified to suit the practical conditions of
business. These are called modifying principles or accounting conventions.

One major modifying principle is the:

1) Principle of Materiality

This principle is an exception to the Principle of Full Disclosure.

According to the Principle of Materiality, items or information that are insignificant and do
not affect decision-making can be ignored or disclosed in brief.

Meaning of “Material”:

Information is considered material if:

• Its inclusion or omission would affect the decision of a reasonable investor or user of
the financial statements.
According to the American Accounting Association:

“An item should be regarded as material if there is a reason to believe that knowledge of it
would influence the decision of an informed investor.”

Application Examples:

• If a company gives debentures worth ₹1,00,000 as collateral for a loan of ₹70,000:

o The loan is recorded in the books.
o The collateral security (debentures) is mentioned in a footnote or note to
accounts, not in the main Balance Sheet.
• If the closing stock of stationery (e.g., pens, staplers, ink) is very small, it may not be
shown in the Balance Sheet individually. Instead, all such items are recorded under a
single head like "Stationery".
• There's no need to open separate accounts for petty items like paper clips,
envelopes, or ink refills.

Conclusion:

The Principle of Materiality allows the simplification of accounts by:

• Avoiding unnecessary complexity

• Focusing only on items that impact users’ decisions

This helps accountants manage large volumes of data efficiently while still maintaining
accuracy.

According to the Principle of Materiality:

Only information that is significant and relevant should be recorded and disclosed in
financial statements.

Key Points:

• Recording immaterial (insignificant) items wastes time and money.

• As per the Indian Companies Act, there is a provision that:
o Amounts may be recorded to the nearest rupee, leaving out fractions
(paise)—because such small amounts are immaterial.
• Minor items (e.g., small stationery, small tools, or petty expenses) are often recorded
in aggregate rather than individually.

In essence, this principle helps businesses focus on relevant data and maintain efficiency in
accounting.

2) Principle of Consistency
According to the Principle of Consistency:

The same accounting methods and policies should be followed consistently every year.
Purpose:

• To ensure that Profit and Loss Accounts and Balance Sheets of different years are
comparable.
• Consistency helps users analyze trends and performance over time.

Applications:

1. Depreciation of fixed assets should use the same method each year (e.g., Straight
Line Method or Reducing Balance Method).
2. Valuation of closing stock should follow the same rule annually.
3. Provisions for doubtful debts should be calculated using a consistent method.

Exception:

• Consistency does not mean rigidity.

• If better accounting methods are available due to changing conditions, the
accountant can change the method.
o However, any such change must be clearly disclosed (e.g., in footnotes or
notes to accounts) so that users can properly compare results across years.

Example: If depreciation was calculated using the Straight-Line Method earlier and is
changed to Written Down Value method this year, it must be mentioned in the financial
statements.

3)Principle of Conservatism (or Prudence)

The Principle of Conservatism says:

"Anticipate all possible losses, but do not anticipate gains."

This principle is used to avoid overstatement of income or assets and to safeguard against
future uncertainties.

Key Examples:

1. Closing stock is valued at cost or market price, whichever is lower.

2. Investments are also valued at cost or market price, whichever is lower.
3. Investment Fluctuation Fund is created to cover possible losses.
4. Depreciation is properly charged on fixed assets, even if their market value increases.
5. Provision for doubtful debts is created, anticipating possible bad debts.
6. Joint Life Insurance Policies are shown at surrender value, not at the premium
paid.

Effects:

• Profit and Loss Account shows lower profit than it may actually be.
 • Balance Sheet may understate assets and overstate liabilities.
• This may lead to creation of secret reserves.

Therefore, this principle should be used cautiously to avoid manipulation.

4)Principle of Timeliness
This is a modern principle of accounting.

It emphasizes that transactions should be recorded promptly and accounting information

should be available without delay.

Purpose:

• To ensure accounting information is available to managers and stakeholders in time,

so that it is still useful for decision-making.

Applications:

1. Final accounts should be prepared promptly at the end of every accounting year.
2. Many companies now prepare semi-annual financial statements to get quicker
insights.
3. In banks and financial institutions, daily cash counting and accounting is a practical
application of this principle.

In short, accounting work should not be postponed—daily operations should be recorded on

the same day to maintain relevance and accuracy.

Principle of Industry Practice

• This principle allows variation in accounting methods to suit the special nature of
a particular industry.
• Certain industries have unique transactions or reporting needs that differ from
standard accounting norms.
• Example:
o In the agricultural industry, crops are valued at market price instead of cost,
as prices fluctuate heavily.
o In the construction industry, percentage of completion method is often used
instead of waiting until the project is finished.

Principle of Substance Over Form

• This principle states that transactions should be recorded based on their economic
substance rather than just their legal form.
• It focuses on true financial reality instead of the mere wording of legal documents.
 • Example:
o If a company sells an asset but has an agreement to buy it back immediately,
the substance is that the company still controls the asset — so it should not be
recorded as a sale in the books.
o Leases that transfer all risks and rewards of ownership are recorded as finance
leases, even if legally described as an operating lease.

Summary Table

Principle Key Focus Area Example/Application

Materiality Ignore immaterial Record amounts to the nearest rupee, not paise
information
Consistency Use same methods Same depreciation method; comparable P&L
every year and Balance Sheet across years
Conservatism Expect losses, ignore Stock/investments valued at lower of cost or
gains market value
Timeliness Record transactions at Daily cash count in banks; quarterly/half-yearly
the right time final accounts

Accounting Terminology

Accounting terminology is a set of specialized terms used in the field of accounting for
recording, classifying, and summarizing business transactions. Understanding these terms
ensures accurate bookkeeping and financial reporting.

1. Account – Definition

An Account is a systematic record of all financial transactions related to a specific asset,

liability, equity, income, or expense item.

• It tracks increases and decreases in a particular category.

• Recorded in the ledger.
• Can be classified as Asset, Liability, Equity, Income, or Expense accounts.

T-Account Format

An account is visually represented in the form of a "T", called a T-account, with:

• Left Side → Debit (Dr)

• Right Side → Credit (Cr)
[Link] and Liabilities
I. Assets

Assets refer to the resources owned by a business that have economic value and are expected
to provide future benefits. They can be broadly classified as follows:

(a) Tangible Assets

• These are assets that have a physical existence and can be seen or touched.
• Examples:
o Cash
o Furniture
o Machinery
o Building
o Tools
o Stock
• They are typically used in the operation of the business to generate income.

(b) Intangible Assets

• Assets that do not have a physical form, i.e., they cannot be seen or touched.
• They may or may not have monetary value, but they still contribute to the profit-
earning capacity of the business.
• Examples:
o Goodwill
o Patents
o Trademarks
o Copyrights
o Prepaid Expenses
• These cannot usually be sold in the open market but are often critical to a business’s
value.

(c) Liquid Assets

• Assets that can be easily converted into cash within a short period (generally
within a year).
• These do not include stock or prepaid expenses.
• Examples:
o Cash in hand
 o Cash at bank
o Sundry debtors (after provision for doubtful debts)
o Bills receivable

(d) Fictitious Assets

• These are not real assets; they do not represent any tangible or intangible benefit.
• Shown on the balance sheet only due to accounting conventions.
• They are expenses or losses that are yet to be written off.
• Examples:
o Preliminary expenses
o Discount on issue of shares and debentures
o Underwriting commission
o Debit balance of Profit & Loss A/c
• They are gradually amortized over time and removed from the balance sheet.

(e) Wasting Assets

• Assets that decrease in value over time due to their nature or use.
• Their value diminishes as they are exploited for natural resources.
• Examples:
o Mines
o Oil wells
o Quarries
o Leasehold properties

II. Liabilities

Liabilities are the financial obligations of a business, representing amounts owed to

outsiders (excluding the owner). They arise from loans, credit purchases, or services received.
(a) Fixed Liabilities (Long-term Liabilities)

• These are liabilities that are payable after a long period, typically more than one
year.
• They usually relate to loans or borrowings taken for the long-term growth of the
business.
• Examples:
o Debentures
o Long-term loans from banks or financial institutions

(b) Current Liabilities

• These are short-term obligations, payable within a year.

• Examples:
o Creditors
o Bills Payable
o Bank Overdraft
o Short-term loans
o Outstanding expenses
• Note: Fixed liabilities become current liabilities in the year in which they fall due for
repayment.

(c) Contingent Liabilities

• These are potential liabilities, which may or may not arise depending on the
outcome of a future event.
• They are not recorded in the Balance Sheet as actual liabilities but are disclosed as
footnotes.
• Examples:
o Bills receivable discounted from a bank
o Court cases pending for liability
o Guarantees given for loans
• If the contingent event occurs, these liabilities will then become actual liabilities.

3. Capital

The amount invested by the proprietor (owner) in a business in the form of cash, goods, or
any other asset is called capital. This is the amount with which assets are purchased and the
business starts operating. Capital is also known as owner's equity or net worth.

• Profits earned by the business increase the capital.

 • Losses incurred in business decrease the capital.

Formula to calculate Capital:

Capital = Total Assets – External Liabilities

Classification of Capital

1. Fixed Capital
Capital invested in fixed assets is known as fixed capital.
Examples: Building, Machinery, Furniture, etc.
2. Floating or Circulating Capital
Capital invested in current assets is known as floating or circulating capital.
Examples: Stock, Debtors, Prepaid expenses, etc.
3. Working Capital
This is the part of capital used for daily operations of the business.

Formula to calculate Working Capital:

Working Capital = Current Assets – Current Liabilities

It is the surplus of current assets over current liabilities and ensures the smooth
day-to-day running of business operations.

4. Drawings

• When the proprietor withdraws cash or goods from the business for personal or
domestic use, it is called drawings.
• Even expenses incurred for personal use (e.g., using business car for personal travel)
are considered drawings.
• Drawings are always deducted from the capital, and it reduces the owner’s equity.

In accounting:

• Capital Account records the owner’s investments in the business.

• Drawings Account records the owner’s withdrawals from the business.

At the end of the accounting year, the amount in the Drawings Account is subtracted from
the Capital Account.

5. Revenue
In accounting, revenue refers to the income generated from business operations. Revenue
increases the owner’s capital.

Examples of Revenue:

• Sale of goods and services

• Receipt of rent
• Interest income
• Commission
• Dividend

Revenue includes all incomes which are earned regularly or from business operations.

6. Expenses

Expenses refer to the costs incurred in order to earn revenue. They represent the value of
resources used in the business operations and lead to a reduction in capital.

As per Finney and Miller:

"Expense is the cost of use of things or services for the purpose of generating revenue."

Types of Expenses:

1. Cost of Goods Sold (COGS) – The cost involved in producing or purchasing goods
sold by the business.
2. Operating Expenses – Such as salaries, rent, commission, electricity, transportation,
etc.
3. Depreciation – Reduction in the value of fixed assets like machinery, buildings, etc.,
due to wear and tear or usage over time.

Basic Accounting Terms

7. Loss

• A loss is an expense that does not result in any benefit for the business.
 • In contrast to general expenses that help in earning profits (like rent, salaries, etc.), a
loss occurs due to unexpected events.

Examples of Losses:

• Loss by fire
• Theft
• Accidental damage
• Loss in value of assets

These losses reduce profit or capital, and are not recoverable.

8. Goods

• Goods refer to the items a business buys or manufactures to sell and earn a profit.

Examples:

• In a cloth shop: Textile materials are goods.

• In a stationery shop: Books and pens are goods.
• In a furniture shop: Tables, chairs, etc., are goods.

If a business buys something for its own use, it is not treated as goods.
Example: If a cloth merchant buys furniture for shop use, it’s not goods; it’s an asset.

Types of Transactions Involving Goods:

(a) Purchases

• Buying of goods for resale is called Purchases.

o If paid in cash → Cash Purchases
o If bought on credit → Credit Purchases
• In accounting, “Purchases” refer only to goods, not to assets like machinery or
furniture.

(b) Sales

• Selling of goods is called Sales.

o If sold for cash → Cash Sales
o If sold on credit → Credit Sales
• Like purchases, “Sales” means only sale of business goods, not assets.

(c) Purchase Returns (Returns Outward)

• When goods purchased are returned back to the supplier, it's called Purchase
Returns.
(d) Sales Returns (Returns Inward)

• When sold goods are returned by the customer, it's called Sales Returns.

9. Stock

• Stock refers to unsold goods available in the business at a specific date.

Types of Stock:

(a) Opening Stock:

• Stock available at the beginning of the year (i.e., closing stock of the previous year).

(b) Closing Stock:

• Stock left unsold at the end of the year.

Valuation Rule:

Stock is valued at cost price or market price, whichever is lower.

For Manufacturing Businesses, stock includes:

1. Raw materials
2. Semi-finished goods
3. Finished goods

10. Debtors

• Debtors are people or firms to whom the business has sold goods on credit.
• They owe money to the business.

Example:

• If goods worth ₹5,000 are sold on credit to Sanjay, he becomes a debtor until he
pays.
• Shown on the asset side of the Balance Sheet.

11. Creditors

• Creditors are people or firms who have sold goods to the business on credit.
• The business owes money to them.
Example:

• If you buy goods worth ₹10,000 on credit from Mohan Traders, they are your
creditors.
• Shown on the liability side of the Balance Sheet.

12 Creditors

For example, goods worth Rs. 2,000 purchased on credit from Saleem – he will be called a
creditor until the business repays the amount. The amount of creditors is shown on the
liabilities side of the Balance Sheet.

13 Bad Debts

That portion of debtors' amount which becomes irrecoverable is called Bad Debts. This
means the amount which debtors fail to pay, or when there is no hope of repayment of the
loan. It generally occurs when the financial condition of a debtor deteriorates, or he dies, or
he is declared insolvent.

14 Discount

Any kind of concession offered in payments to either encourage prompt payment or to

boost sales is known as a Discount. It is of two types:

(a) Cash Discount

Cash discount is allowed to customers for making quick payments. It is generally expressed
as a percentage. This type of discount is recorded along with the cash payment entry.
Cash discount is a nominal account:

• It is debited when allowed to a customer.

• It is credited when received from a supplier.

(b) Trade Discount

Trade discount is given by the seller to buyers at a fixed percentage on the list price of the
goods, with the objective of increasing sales.
No separate accounting entry is passed for trade discount, as it is deducted directly from the
invoice or cash memo.
It is provided to all buyers, irrespective of whether the purchase is made in cash or on credit.
15 Books of Accounts

The books in which business transactions are recorded systematically are called Books of
Accounts.
Examples include:

• Journal
• Ledger
• Cash Book
• Subsidiary Books

16 Balance Sheet

A Balance Sheet is a financial statement prepared at the end of the financial year to present
the financial position of the business.
It shows:

• Assets
• Liabilities
• Capital

Preparation of the Balance Sheet is legally mandatory.

17 Entry

The act of recording a business transaction in the Journal or in the Subsidiary Books is
called an Entry.

18 Posting

The process of transferring entries from the Journal or Subsidiary Books to the Ledger is
known as Posting.

19 Proprietor

The person who:

• Invests capital
• Manages the business
• Bears the risk
 • Owns the profit/loss of the business
is called a Proprietor.
He can be:

1. A Sole Trader
2. A Partner
3. A Shareholder

20 Vouchers

Documents that serve as proof of business transactions are called Vouchers.

Examples include:

• Receipts
• Invoices
• Cash memos
• Salary bills
• Purchase documents

Vouchers serve two purposes:

1. Assist in accounting
2. Aid in verification during audit

These are also called Source Documents, as they provide detailed information about
business transactions including their:

• Nature
• Amount
• Time
• Parties involved

Advantages of Source Documents:

1. They serve as written evidence of business transactions.

2. They can be referred to in the future for clarity.
3. They help confirm the supply upon receiving an order.
4. They form the basis for posting entries in different accounts.

21 Debit and Credit

Every account has two sides:

• Left side is called the Debit side.

• Right side is called the Credit side.
When a business transaction is recorded:

• An entry on the debit side is known as a debit entry.

• An entry on the credit side is called a credit entry.

22 Turnover

The total amount of goods sold during a specific period (including both cash and credit
sales) is called Turnover. It is also referred to as Total Sales.

23 Insolvent

A person who is unable to pay his liabilities in full and is legally declared insolvent by a
court. This means their liabilities are greater than their assets.

24 Solvent

A person or business that can pay all its liabilities in full is called Solvent.

25 Business Transaction

A business transaction involves an exchange of goods, services, or money that can be

measured in monetary terms (such as rupees, dollars, etc.).

Business transactions result in a change in the financial position of the business – affecting
assets, liabilities, or capital.

Types of Business Transactions:

1. Cash Transactions – Paid in cash at the time of exchange.

2. Credit Transactions – Payment is made at a future date.

Classification:

• External Transactions: Involve two independent parties (e.g., sale of goods to a

customer).
• Internal Transactions: Occur within the business itself (e.g., charging depreciation).

26 Losses

A loss means a situation where the business receives no benefit in return.

Losses are of two types:

1. Operational Loss: When expenses exceed revenues.

 Example: Revenue = Rs. 2,00,000; Expenses = Rs. 2,20,000 ⇒ Loss = Rs.
o
20,000.
2. Non-operational Loss: Loss from accidents, fire, theft, etc.

Note: Losses differ from expenses – expenses usually provide some benefit, while losses do
not.

27 Gains

A gain is a monetary benefit or profit earned from a business transaction.

Example:

• A building costing Rs. 5,00,000 is sold for Rs. 6,00,000.

• Gain = Rs. 1,00,000.

Gains can be of:

• Capital Nature (e.g., sale of fixed assets)

• Revenue Nature (e.g., profit from daily operations)

28 Receivables

Receivables are amounts due to the business from outsiders excluding debtors.

Examples:

• Bills Receivable
• Duty Drawback
• Government subsidies

Some sources consider both sundry debtors and bills receivable together as Receivables.

29 Payables

Payables are amounts the business owes to outsiders, other than sundry creditors.

Examples:

• Bills Payable
• Outstanding expenses
• Promissory notes

According to some, sundry creditors and bills payable together form Payables.

30 Expenditure

Any payment (in cash or other form) made to acquire goods, services, or assets is called
expenditure.
It refers to the outflow of money for a benefit received and may be of two types:

(a) Capital Expenditure

Expenditure made to:

• Acquire fixed assets, or

• Increase the value of existing fixed assets.

Examples:

• Purchase of land
• Construction of a building

Capital

Capital is the amount invested by the proprietor in a business in the form of cash, goods, or
any other form. It is the financial base of the business used to acquire assets and begin
operations. Capital is also referred to as owner's equity or net worth. Any profit earned in
the business increases the capital, while losses reduce it.

The formula for calculating capital is:

Capital = Total Assets – External Liabilities

Classification of Capital

1. Fixed Capital:
Capital invested in fixed assets like buildings, machinery, furniture, etc., is called
fixed capital. These assets are not meant for resale and are used in the production
process over a long period.
2. Floating or Circulating Capital:
Capital invested in current assets like stock, debtors, prepaid expenses, etc., is called
floating or circulating capital. These assets keep changing their form and are
converted into cash during the course of business operations.
3. Working Capital:
This is the part of capital used for the daily operations of the business. It is calculated
as:

Working Capital = Current Assets – Current Liabilities

A surplus of current assets over current liabilities indicates the availability of working
capital.
Drawings

Drawings refer to the cash or goods withdrawn by the proprietor from the business for
personal or domestic use. Even the personal use of business assets is considered drawings.
Drawings are made against the possible profit and reduce the capital of the business.

• Capital Account and Drawings Account are personal accounts of the proprietor.
• When the proprietor invests in the business, the amount is recorded in the Capital
Account.
• When the proprietor withdraws assets or cash, the amount is recorded in the Drawings
Account.
• At the end of the year, drawings are subtracted from capital.

Revenue

In accounting, revenue refers to the income that arises from business transactions and leads
to an increase in owner's equity. It includes:

• Income from the sale of goods and services.

• Other recurring incomes like:
o Rent received
o Interest
o Commission
o Dividends

Revenue represents the total inflow of economic benefits during a given period from normal
business activities.

Expenses

Expenses are the costs incurred in order to generate revenue. They represent the consumption
of goods and services for business purposes and lead to a reduction in capital.

According to Finney and Miller:

“Expense is the cost of use of things or services for the purpose of generating revenue.”

Common types of expenses include:

1. Cost of Goods Sold (COGS)

o This includes the cost of raw materials, direct labor, and other direct expenses
related to production.
2. Operating Expenses
o Salaries, commission, rent, selling and distribution expenses, utility bills, etc.
3. Depreciation on Fixed Assets
 o Reduction in the value of fixed assets due to wear and tear or obsolescence.

Reveue Expenditure

Revenue expenditure is any expenditure whose benefits are fully received within the
accounting period. These are recurring in nature and necessary for running daily business
operations.

• It is debited to the Trading Account or Profit & Loss Account.

• These expenditures do not result in the acquisition of long-term assets.

Examples:

• Payment of wages and salaries

• Rent paid
• Repairs and maintenance
• Stationery and office supplies
• Utility bills
 BOOK OF ORIGINAL ENTRY :
JOURNAL
The books of accounts in which business transactions are recorded for the first time are called
“Books of Original Entry”. Journal is one of them. With the increase in size of business, the
number of business transactions also increases. It is very difficult for human beings to
remember all the cash and credit transactions. Therefore, to overcome this difficulty, the book
of original entries, Journal, is prepared. Afterestablishing the Book-keeping system, the work
of accountancy can be started in two ways. One way is to open a Memorandum book in
which all business transactions are recorded immediately upon completion, so that we do not
forget them. Afterwards, Journal is prepared from the Memorandum book. And the second
way is to start the work of accounting from the vouchers of the business transactions,
and it is called the Voucher system.

Memorandum Book
It is also called a waste or rough book. It is kept by those businessmen who have a large
number of transactions. No rule is followed while preparing this book. Only transactions are
recorded orderly on their happening. The memorandum book is not a book of accounts.
Entries are not made in the form of debit and credit in it. It is easy to prepare a Journal from
the memorandum book. There may be many transactions with one firm in a day. All these
transactions of the day can be recorded by one entry in the Journal.

It checks the number of entries. It also acts as an evidence in case of any doubt. There
are various types, such as Stock Register, Salary Register and a Rough Book (Kachhi
Bahi), Share Register etc.

Source Documents

A document which becomes the basis for recording a transaction in the books of accounts is
called a source document. The accounting process starts with identifying the transaction to be
recorded in the books of accounts and preparing the source documents. A source document
provides necessary information about the amount, the parties involved, and the nature of the
transaction. It also acts as written documentary evidence of the transaction that has taken
place. Hence, the correctness of a transaction recorded can be verified with the help of a
source document, because entries in the books are always made from the source documents.

According to the Verifiability and Objectivity of Evidence Principle of Accounting, each

transaction recorded in the books of accounts should have adequate written and authentic
proof to support it. These documents are also required for audit and tax assessments. They
also serve as legal evidence in case of a dispute.

Following are some common source documents:

(i) Cash Memo
(ii) Cash Receipts
(iii) Invoice or Bill
(iv) Debit Note and Credit Note
(v) Pay-in-slip
(vi) Cheque
(vii) Bills Receivable and Bills Payable
(viii) Wage Sheet
(ix) Agreements
(x) Correspondence, etc.

Journal
The word Journal is derived from the French word “Jour” which means a day. Journal,
therefore, means a daily record of business transactions. Journal is the primary book of
accounts in which business transactions are recorded in chronological and systematic order in
the form of debit and credit, either from the memorandum book or from the source
documents.

Journal is a book of original entry because all business transactions are first entered in this
book and then posted to the ledger at any convenient time. The form in which it is recorded is
called a Journal Entry, and the process of recording or entering a transaction in the Journal is
known as Journalising.

Though we may post the business transactions in the Ledger directly from the memorandum
book or from the vouchers, this may lead to omission or commission, because the accounts to
be debited and credited are scattered in the ledger. Therefore, for every type of business, it is
better to record every business transaction in the Journal so that the ledger can be prepared
from it. According to some persons, the use of the Journal has decreased due to the use of
accounting machines and computers. But there are many entries, such as opening entries,
closing entries, adjustment entries, transfer entries, and rectification entries, which are still
passed through the Journal.

Definition of Journal

1. “A Journal is a book employed to classify or sort out transactions in a form

convenient for their subsequent entry in the ledger.” — L.C. Cropper
2. “The Journal or ‘Daily Record,’ as originally used, was a book of prime entry in
which transactions were copied, in order of date, from a memorandum or waste book.
The entries, as they were copied, were classified into debits and credits so as to
facilitate their being correctly posted afterwards in the ledger.” — Carter
3. “Journal means a Day Book, Diary, or Log Book. It is called the prime subsidiary
book of the double-entry system.” — Roland

The process of recording the transactions in the Journal is called Journalising.

Objectives and Importance of Journal

1. Complete Record: A complete record of each business transaction is maintained in

the Journal. Along with each entry, the summarised narration of the transaction is also
written, which gives necessary information about the transaction.
 2. Correct Knowledge: Every transaction is recorded in the Journal by dividing it into
two parts — debit and credit — which helps in knowing the transaction correctly.

3. Helpful in Ledger Posting: Though Ledger can be prepared directly from the
vouchers, it is better to prepare it from the Journal. It makes the work clearer and
easier, and the chances of errors are also reduced.
4. As a Proof: Journal can be used as a reference in case of omission or to settle
business disputes. It is compulsory to prepare it in France, Italy, Germany, and
Russia, though the work may also be done through accounting machines and
computers.

Book-keeping is an art of recording business transactions on the basis of a particular system

so that the accounting objectives can be achieved. When we select the Double Entry System
for book-keeping, then the primary entries are made in an organised manner in the Journal.
Before we study the process of Journalising, it is essential to understand the meaning of an
account and the rules of journalising.

Account

An Account is a summarised statement in which all transactions relating to a particular

person, a particular asset, or a particular head of income or expense are recorded at one place.
Its simple form is a “T”-shape. It has two sides — the left side is called the Debit side and the
right side is called the Credit side. Accounts are maintained in a book called the Ledger. Each
item has a separate account, and the book in which all accounts are maintained is called the
Ledger.

According to Carter:

“An account is a ledger record in a summarised form, of all the transactions that have taken
place with the particular person or things specified.”

Features of an Account

An account has the following features:

1. A separate account is maintained to record the transactions relating to each person,

asset, and revenue or expense item.
2. All transactions related to an item are recorded in a summarised manner in an
account.
3. An account is a well-organised and summarised statement.

Classification of Accounts

To record business transactions in the books of accounts, it is essential to have knowledge of

various types of accounts. There are two main classifications of accounts: Traditional and
Modern.

Traditional Classification of Accounts

 1. Personal Accounts: Accounts which are in the name of a person, firm, institution,
company, or corporation are called personal accounts.
Examples: Ram’s A/c, State Bank of India’s A/c, Tata Motors Ltd. A/c, etc.
2. Real Accounts: Accounts that record transactions relating to the assets of a business
are called real accounts.
Examples: Cash A/c, Goods A/c, Furniture A/c, Building A/c, etc.
3. Nominal Accounts: Accounts relating to incomes, expenses, profits, and losses are
called nominal accounts.
Examples: Rent A/c, Salaries A/c, Discount A/c, Bad Debts A/c, Interest A/c, etc.

Modern Classification of Accounts

(A) Personal Account

Accounts which are opened in the name of a particular person, firm, institution, company, or
corporation, etc., are called personal accounts.
Examples: Account of Lala Ram Mohan, Account of Goyal Brothers, Account of Hindustan
Lever Ltd., Account of Ambala Municipal Committee, etc.

Accounts relating to outstanding and prepaid items, such as Outstanding Salary A/c,
Prepaid Rent A/c, are also treated as personal accounts. Some scholars do not think it proper
to use the word “Account” with personal accounts, but in practice we use it in the ledger as
— Account of ________. For example: Account of Lala Ram Mohan, Account of Goyal
Brothers, etc. There is no fixed rule for this.

Personal accounts are of three types:

1. Natural Personal Accounts: Accounts relating to individual human beings are called
natural personal accounts.
Examples: Account of Mohan, Account of Sohan, Account of Sharad, etc.
2. Artificial Personal Accounts: Accounts relating to firms, institutions, companies,
corporations, etc., which are not natural persons, are called artificial personal
accounts.
Examples: Account of S.A. Jain College, Account of Rotary Club, Account of Jain
Brothers, Account of State Bank of India, etc.
3. Representative Personal Accounts: Accounts relating to outstanding and prepaid
items are called representative personal accounts. For example, if we have not paid
the wages of workers for the last two months, the workers will become creditors of
the business because they have already provided services. But since the return for
their services has not been paid, the wages of the workers will be shown collectively
in an account. This account will be a personal account as it represents all the workers
collectively.
Examples: Outstanding Wages A/c, Outstanding Salary A/c, Commission Received in
Advance A/c, Prepaid Insurance A/c, etc.
From the above explanation, it is concluded that all accounts relating to natural persons,
artificial persons, and outstanding or prepaid expenses or revenues are called Personal
Accounts.

Capital and Drawings Accounts are also personal accounts because they record the
transactions relating to the owner of the business. Representative personal accounts are not
personal accounts of the first degree. They are actually nominal accounts by nature, but when
they remain unpaid or are received/paid in advance, they become representative personal
accounts, representing creditors or debtors.

Personal Accounts

Personal Accounts can also be classified as Debtors’ Personal Accounts and Creditors’
Personal Accounts.

(B) Impersonal Accounts

Accounts other than personal accounts are called impersonal accounts. They are not related
to persons.

Impersonal accounts are of two types:

(a) Real Accounts
(b) Nominal Accounts

(a) Real Accounts

Accounts which are related to the assets of the business are called real accounts. In other
words, the accounts of all those things which really exist, whose value can be measured in
money, and which are owned by the business are termed real accounts. Every business owns
various types of assets, and a separate account is opened for each asset.

Some people treat only the tangible items as real accounts, which is not proper. Real accounts
are of two types:

1. Tangible Real Accounts: Accounts relating to assets which can be touched, seen, and
transferred are called tangible real accounts.
Examples: Cash A/c, Stock A/c, Furniture A/c, Machinery A/c, Building A/c, etc.

Modern accountants classify tangible real accounts into two groups:

o Cash Account: Every business, whether small or large, has cash transactions
which are recorded in Cash A/c. Since cash transactions are more frequent
than other types of transactions, a separate ledger is used for this account,
known as the Cash Book. (Note: Bank A/c is treated as a personal account
because it is related to a banking company.)
o Other Assets Accounts: Various types of assets are used to run the business
properly. The accounts relating to these assets are tangible real accounts.
Examples: Stock A/c, Furniture A/c, Machinery A/c, Building A/c, etc.
2. Intangible Real Accounts: Assets which cannot be touched or which do not have
physical existence are called intangible assets. Accounts relating to them are
 intangible real accounts.
Examples: Goodwill A/c, Trademarks A/c, Patents A/c, Copyright A/c, etc.

(b) Nominal Accounts

Accounts relating to transactions having no physical existence are called nominal accounts.
These accounts are used to define the nature of transactions, i.e., income or expense.

For example: rent, wages, interest, discount, carriage, etc. are terms of payment and are paid
in cash. Cash is a real account, while rent, wages, interest, discount, and carriage are nominal
accounts, as they represent only the nature of transactions.

• In reality, we pay cash, but we say rent paid, wages paid, etc.
• Similarly, when we receive cash, we say rent received, dividend received, etc.

Thus, all accounts relating to income, profit, or revenue, and loss or expense are termed as
nominal accounts.

In short: Accounts of income and gains, and accounts of expenses and losses are called
nominal accounts.

Nominal accounts are of two types:

1. Revenue Accounts
2. Expenses Accounts

(i) Revenue Accounts

Revenue is the money received or earned from the sale of goods and services, or from assets,
dividend, interest, rent, and commission received. These are nominal accounts because
although the actual receipt is in cash (a real account), the receipt is represented by the head
for which it is received.

For example: Dividend Received, Interest Received, Rent Received. These increase the assets
and capital of the business.

ii) Expenses Accounts: Many expenses are incurred to run a business, such as production,
salary to employees, wages, interest, rent, operating expenses, etc. In addition to it, losses are
incurred many times in a running business, e.g., damage due to theft, fire, etc. These are
recorded in expenses accounts. They reduce the capital and assets.

If business has paid an advance payment, it is not treated as an expense, but such item is
treated as a personal account.

1. Commission Account
o Prepaid Commission A/c
 o Outstanding Commission A/c
o Unexpired Commission A/c
o Commission received in advance A/c
2. Rebate on Bill Discounted A/c
3. Interest Account
o Prepaid Interest A/c
o Outstanding Interest A/c
o Accrued Interest A/c
o Interest received in advance A/c
4. Premium received in advance A/c
5. Outstanding Rent A/c
o Rent received in advance A/c
6. Outstanding Salaries A/c
7. Subscription received in advance A/c
8. Insurance Account
o Unexpired Insurance A/c

Classification of Accounts on the basis of Accounting Equation

Modern accountants classify the accounts on the basis of fundamental elements. It is called
classification on the basis of Accounting Equation or Balance Sheet. This classification is
as under:

1. Assets Accounts: Accounts relating to the economic sources of business are called
assets accounts. These are owned by the business such as – Cash A/c, Debtors A/c,
Goods A/c, Furniture A/c, Machinery A/c, Building A/c, etc.
2. Liabilities Accounts: Accounts relating to the liabilities of the business except capital
are called liabilities accounts. Such as – Creditors A/c, Bank Overdraft A/c, Loan A/c,
Outstanding Expenses A/c, etc.
3. Capital Accounts: Accounts relating to the owner of the business are called capital
accounts.
4. Revenue Accounts: Accounts relating to the incomes or gains of a business are called
revenue accounts. e.g., Commission received A/c, Interest received A/c, Rent received
A/c, Dividend received A/c, etc.

Description of Rules

To understand the proper use of the above-discussed rules, their description is essential.

1. Personal Accounts

Rule: “Debit the Receiver, Credit the Giver.”

It means that the account of a person who gets the benefit is debited, while the account of
another person who surrenders the benefit is credited.
Example:

• Paid to Ram → Ram is the receiver, so his account is debited. Cash is paid, so the
Cash A/c is credited.
• Received from Shyam → Cash is received from Shyam. Shyam is the giver, so his
account is credited, and cash coming into the business means Cash A/c is debited.

(Cash A/c being a Real A/c, to debit or credit it, we apply the rule of Real Account.)

Summary Table:

DEBIT CREDIT
The Receiver The Giver

Short Form:

• Debit = Debit the Receiver

• Credit = Credit the Giver

2. Real Accounts

Rule: “Debit what Comes in, Credit what Goes out.”

Real items such as cash, furniture, goods, machinery, and other assets, when acquired by the
business, their accounts are debited. On the other hand, when they are sold or transferred out
of the business, their accounts are credited.

In case of Cash A/c, which is also a Real A/c:

• All receipts are debited

• All payments are credited

Real Accounts are debited or credited along with the Personal and Nominal Accounts.

Summary Table:

DEBIT CREDIT
What Comes in What Goes out

Short Form:

• Debit = Debit what Comes in

• Credit = Credit what Goes out
3. Nominal Accounts

“Debit all expenses and losses, Credit all income and gains.”

For example – Paid Salary and Wages.

Salary and Wages are expenses, so both are debited respectively. These expenses are paid in
cash, therefore the Cash Account is credited (being a Cash A/c).

Received Interest. Here interest is an income, thus Interest Account is credited and Cash A/c
is debited.

It must be remembered that when a Nominal Account is converted into a Personal Account, it
also becomes a Personal A/c. In other words, we can say if any word (as a prefix or suffix) is
added with “Account” then it becomes a Personal A/c.

DEBIT CREDIT
All Expenses and Losses All Incomes and Gains

Illustration 2 (Application of Rules)

Q. State the type of account and show which account will be debited or credited?

1. Cash withdrawn
2. Capital introduced
3. Building purchased
4. Goods sold
5. Rent paid
6. Interest received

Solution:

[Link]. Account Type of Account Transaction Nature Effect

1 Drawings Personal Withdrawn Receiver Debited
2 Capital Personal Introduced Giver Credited
3 Building Real Purchased Comes in Debited
4 Sales Real Sold Goes out Credited
5 Rent Nominal Paid Expenses Debited
6 Interest Nominal Received Income Credited

Procedure of Journalising

A Journal is prepared from memorandum books or business vouchers. “Journal is the

starting point of Double Entry System.”
We must start the work of book-keeping in the following steps:

1. Nature of Transaction: First of all, we have to see the transaction from the business
point of view i.e., whether it has taken place or not, and whether liabilities have arisen
or not from the legal point of view. We must study the effect of transaction on the
business.
2. Selection of two aspects of accounts:
The two aspects of accounts which are going to be affected by the transaction are
selected.
3. To know type of accounts:
To know the type of accounts involved in the transaction, whether they are personal,
real, or nominal.
4. To determine the effect of accounts:
After the classification of accounts, the effect of accounts is determined i.e., whether
the transaction makes us a receiver or giver, items are coming in or going out, and
whether it is the case of expenses and losses or incomes and gains.
5. Application of rules:
After knowing two aspects of accounts, their types, and effects, we make use of
prescribed rules to debit or credit the concerned accounts.

Example:
While preparing a journal, one must remember that each transaction has two
aspects—debit and credit. Both aspects can never be debit alone or credit alone.
Application of rules can be understood with the following examples.

Personal Account
Accounts relating to persons such as individuals, firms, institutions, companies,
corporations, etc., are personal accounts.
Rule for personal accounts is:
“Debit the receiver, Credit the giver.”
(a) When a transaction involves both the personal accounts:
In such a case, the receiver is debited and the giver is credited.
Example: A Dhoop Factory having its headquarters at Kurukshetra has two
branches—one at Ambala City and another at Ambala Cantt. The branch at Ambala
City sells out its whole stock and, on the directions of the head office, receives goods
from Ambala Cantt. Branch. In the books of the head office, the account of Ambala
City Branch will be debited and the account of Ambala Cantt. Branch will be credited,
because both are personal accounts. Hence, the receiver's account is debited and the
giver's account is credited.
(b) When a transaction involves two different accounts (one personal and
another real or nominal):
In such a situation, we have to judge whether the person is receiver or giver. If he is a
receiver, his account will be debited, and if he is a giver, his account will be credited.
The rule applicable to the second account depends upon its type—whether it is a real
account or a nominal account.
Example: “Rs. 1,000 paid to Basant.” This transaction involves personal and cash
accounts. Basant is a receiver, therefore his account will be debited. Cash, being a real
account, goes out on payment, so it will be credited.
 Real Account
These accounts are related to assets.
Examples: Cash A/c, Stock A/c, Furniture A/c.
Rule applicable to real accounts is:
“Debit what comes in, Credit what goes out.”
(a) When a transaction involves both real accounts:
Example: “Furniture purchased for cash.”
This involves two accounts—Furniture A/c and Cash A/c. Both are real accounts.
Furniture comes in, while cash goes out. Thus, Furniture A/c is debited and Cash A/c
is credited.

Rules of Accounts & Journal Entries

1. When a Transaction Involves Real + Personal/Nominal Account

• Rule for Real Account: Debit what comes in, Credit what goes out.
• Rule for Personal Account: Debit the receiver, Credit the giver.
• Rule for Nominal Account: Debit all expenses & losses, Credit all incomes & gains.

Examples:

• Cash paid to Ramesh →

o Ramesh A/c (Personal – receiver) → Debit
o Cash A/c (Real – going out) → Credit
• Paid Rent →
o Rent A/c (Nominal – expense) → Debit
o Cash A/c (Real – going out) → Credit

2. Nominal Account

• Deals with incomes, expenses, losses, gains.

• Rule: Debit all expenses/losses, Credit all incomes/gains.

Examples:

• Paid Salary → Salary A/c (Expense → Dr.), Cash A/c (Cash out → Cr.)
• Received Commission → Cash A/c (Cash in → Dr.), Commission A/c (Income →
Cr.)
3. Cash Account (Special Real Account)

• Treated under Real Account rules.

• Rule: Debit all receipts, Credit all payments.

Examples:

• Cash Purchases → Purchases A/c (Goods in → Dr.), Cash A/c (Cash out → Cr.)
• Cash Sales → Cash A/c (Cash in → Dr.), Sales A/c (Goods out → Cr.)

4. Format of Journal

Name of the Firm

Journal Entries

Date Particulars L.F. Debit (₹) Credit (₹)

YYYY/MM/DD A/c to be debited …… Dr. Amount Amount
To A/c to be credited

5. Explanation of Columns

1. Date → Record the date of transaction. Year & month written once at beginning of
page.
2. Particulars → Names of accounts affected.
o First line → Debit account (with “Dr.” at the end).
o Second line → Credit account (with “To”).

Table of Mr. Amrit Lal for the month of April 2004

Transactions Analysis

Date Type of Aspect Affected Rule Debit Credit

Account Applied
April Started business Cash A/c (Real) Debit what Cash A/c Dr. To Capital
1 with Cash comes in A/c
Capital A/c Credit the
(Personal) giver
April Paid Rent Rent A/c Debit all Rent A/c Dr. To Cash
2 (Nominal) expenses A/c
Cash A/c (Real) Credit what
goes out
April Purchased Purchases A/c Debit what Purchases A/c To Cash
3 Goods (Real) comes in Dr. A/c
Cash A/c (Real) Credit what
goes out
 April Sold Goods Cash A/c (Real) Debit what Cash A/c Dr. To Sales
4 comes in A/c
Sales A/c (Real) Credit what
goes out
April Paid Rent Rent A/c Debit Rent A/c Dr. To Cash
5 (Nominal) expenses A/c
Cash A/c (Real) Credit what
goes out
April Received from Cash A/c (Real) Debit what Cash A/c Dr. To Raman
6 Raman comes in A/c
Raman A/c Credit the
(Personal) giver
April Paid to Ram on Ram A/c Debit the Ram A/c Dr. To Cash
7 account (Personal) receiver A/c
Cash A/c (Real) Credit what
goes out
April Sold Goods Cash A/c (Real) Debit what Cash A/c Dr. To Sales
8 comes in A/c
Sales A/c (Real) Credit what
goes out
April Paid Drawings Drawings A/c Debit the Drawings A/c To Cash
9 (Personal) receiver Dr. A/c
Cash A/c (Real) Credit what
goes out
April Bought Furniture A/c Debit what Furniture A/c To
10 Furniture (Real) comes in Dr. Purchases
A/c
April Deposited Cash Bank A/c Debit the Bank A/c Dr. To Cash
11 in Bank (Personal) receiver A/c
Cash A/c (Real) Credit what
goes out
April Paid Commission A/c Debit Commission To Cash
12 Commission (Nominal) expenses A/c Dr. A/c
Cash A/c (Real) Credit what
goes out

Journalising

• Journalising is the act of entering transactions in a Journal.

• It means recording business transactions in such a way that they can be easily
transferred into the Ledger.
• A Journal Entry is an entry recorded in the Journal which analyses a business
transaction in terms of Debit and Credit.
• We follow the Principles of Double Entry System while journalising.

Points to consider while Journalising:

1. Identify the accounts affected.

 2. Determine their type (Real, Personal, Nominal).
3. Apply the debit and credit rules.
4. Pass the Journal Entry.

Name of Firm: Mr. Amrit Lal

Journal Entries — April 2004

Date Particulars L.F. Debit (₹) Credit (₹)

Apr 1 Cash A/c Dr. 10,000
To Capital A/c 10,000
(Started business with cash)
Apr 2 Purchases A/c Dr. 4,000
To Cash A/c 4,000
(Cash purchases)
Apr 3 Cash A/c Dr. 3,000
To Sales A/c 3,000
(Goods sold for cash)
Apr 4 Purchases A/c Dr. 5,000
To Ram A/c 5,000
(Purchased goods from Ram — credit)
Apr 5 Rent A/c Dr. 500
To Cash A/c 500
(Paid shop rent)
Apr 6 Salaries A/c Dr. 500
To Cash A/c 500
(Paid salary to servant)
Apr 7 Furniture A/c Dr. 1,000
To Dhiman A/c 1,000
(Purchased furniture from Dhiman — credit)
Apr 18 Ram A/c Dr. 2,000
To Cash A/c 2,000
(Paid to Ram on account)
Apr 21 Cash A/c Dr. 2,000
To Sales A/c 2,000
(Goods sold — treated as cash sale)
Apr 25 Postage A/c Dr. 500
To Cash A/c 500
(Postage stamps purchased)
Apr 26 Drawings A/c Dr. 500
To Cash A/c 500
(Cash withdrawn for personal use)
Apr 29 Loss by Theft A/c Dr. 1,000
To Purchases A/c 1,000
(Goods lost by theft)
Apr 30 Bank A/c Dr. 1,000
 To Cash A/c 1,000
(Opened a bank account — cash deposited)
Apr 30 Cash A/c Dr. 10,000
To Haryana Financial Corporation Loan A/c 10,000
(Loan borrowed from HFC — cash received)

Points to be Remembered in the Procedure of Journalising

1. Name of Journal
The firm for which the Journal is being prepared, along with the name of the month,
must be written at the top of the Journal, as:
JOURNAL
of M/s Ashoka Enterprises
for the month of ………
2. Use of Debit and Credit Signs
o In the Journal, the name of the account to be debited is written first. It starts
from the line of the Date column. At the end of the name of the account, near
the Debit Amount column, the sign “Dr.” is written.
o The sign of Credit “Cr.” is not written at the end of the credited account. The
credit entry starts with the word “To”, after leaving a gap of about half an inch
from the Date column.
3. Personal Account
The word Account is not used at the end of a personal account. Instead, it may be used
before the name of the person in the form of — “Account of Kashika.”
4. Narration
After every journal entry, a brief narration of the transaction is written. Narration acts
as proof in the future to explain why and how the accounts were debited and credited.
5. Line of Demarcation
After recording the entries and narration relating to a transaction in the Journal, a line
of demarcation is drawn to separate one journal entry from the next. The next entry
should be recorded after leaving a line’s gap.
6. Writing Amount Correctly
o The Debit and Credit amounts should be written in their respective columns
and on the correct line.
o A comma should be used after the figures of thousands, lakhs, etc.
o If there are paise in the amount, they should be shown. If there are no paise,
then “.00” should be written in place of paise, or a dash (—) may be used.
7. Totalling
o The Journal should be totalled at the end of each page. Write “Totals Carried
Forward (C/F)” or “Totals Carried Over (C/O)” at the bottom of the page.
o On the next page, these totals should be brought forward at the top and written
against “Total Brought Forward (B/F)” or “Total Brought Over (B/O).”
o At the end of the Journal, the words “Grand Total” should be written in the
particulars column.
o Totals of Debit and Credit columns must always be equal, written in a straight
line, and double underlined in red ink.
8. Proprietor’s Accounts
Business and proprietor are considered separate entities. Accounting is done for the
business only, not for the proprietor. Therefore, no account is opened in the
proprietor’s name. Instead, two accounts are maintained — Capital A/c and
Drawings A/c.
9. Credit Purchases and Sales
o When the name of a person is mentioned in purchase or sales transactions, it
indicates a credit transaction.
o If the word Cash is written along with the name, it is treated as a cash
transaction.
o Purchase or sale of other assets (like Machinery, Furniture, etc.) is not entered
in Purchases or Sales A/c. Instead, it is entered directly under the name of the
asset.
o If neither the name of a person nor the word Cash is used, the transaction is
treated as a cash transaction.
10. Journalising Rule
A complete journal entry of a transaction must be recorded at one place. A transaction
should not be split — recorded partly on one page and partly on the next page. That is
incorrect.
 LEDGER

Accountancy includes identifying, recording, classifying, summarising and interpreting the

business transactions. Financial transactions are first of all recorded in the books of original
record i.e. Journal and Subsidiary books. The next step is to classify them in proper accounts.
Classification means to collect or record the transactions relating to a particular account at
one place. For this purpose, a separate book is used which is called a Ledger. Ledger is a
book which contains all accounts of the business whether Personal, Real or Nominal.

B. Meaning, Utility and Importance of Ledger

The main objective of accountancy is to provide information, such as— (1) How much
amount is to be received or paid to other businessmen, (2) How much goods have been
purchased or sold during a particular period, (3) How much expenses were incurred on
various items and how much income was received from different items, (4) How the changes
took place in Assets, Liabilities and Capital etc. These informations cannot be collected from
the Journal, because in it transactions are recorded in chronological order, instead of
recording the transactions of similar nature at one place. For example, if we want to know
how much money is due towards our customer ‘Rattan and Co.’, then we have to check the
whole Journal of that period and if subsidiary books are there, then we have to know about
total credit sales made to him from the Sales Book, the goods returned by him, if any, from
the Sales Returns Book, and the amount received from him, if any, from the Cash Book. All
these informations so collected can tell us the outstanding amount from Rattan & Co. But in
Ledger, all these informations are recorded at one place in the form of the ‘Account of Rattan
and Co.’ and we can know the outstanding amount very easily from his account.

In short, Ledger is a principal book of accounts and a businessman cannot work without it.
Separate accounts for each individual, institution, asset, liability, income and expense are
opened in the ledger. Thus, Ledger is a collection of different accounts which completes the
double entry of transactions. It is also called the book of final entry in which all transactions
are recorded in a classified manner, so that business information can be collected easily and
as per requirement to present their changes and effects on the Balance Sheet.

Ledger
The ledger is the most important and useful book of accounts. It is the destination of entries
recorded in the journal. Final accounts are prepared at the end of the year with the help of
balances of ledger accounts. Different financial results can be extracted from the final
accounts.
Important Definitions of Ledger
1. “Ledger is the chief book of accounts.” – Rolland
2. “The book of accounts in which the transactions of a business concern are kept
in a classified and permanent form is called the ledger.” – L.C. Cropper
3. “Ledger is the chief book of accounts and it is in this book that ultimately all the
business transactions find their place under their respective accounts in a duly
classified form.” – R. Batliboi
4. “The ledger is defined as a book in which all the accounts of a business concern
are kept for permanent record so that the up-to-date position of any account can
easily be known.” – William Pickles

Account and the Ledger

The statement that records the transactions at one place relating to a particular person, asset,
income, or expense etc., is known as an account.

In other words, the term ledger is the name given to the manner in which the information
relating to a particular item is set out. It is also called account because both are implied in
each other. Hence, ledger = account, account = ledger.

Simple Form of an Account

A simple form of an account is ‘T-form’.

• It has two sides: Debit side and Credit side.

• One side is the receiver and the other side is the giver.
• The balance of each account presents the net effect of all the transactions relating to
that account.

Relation Between Journal and Ledger

In double entry system, Journal and Ledger are the two main books of accounts. For
complete and efficient accounting of business, both are essential as they attain different
objectives.

• Journal is the chronological record.

• Ledger is the analytical record of business transactions.
• Journal is a prime recording.
• Ledger is a derived recording.
Differences Between Journal and Ledger

Basis Journal Ledger

Nature It is the book of original entry. It is the book of final entry.
Form of Transactions are recorded in a Transactions are recorded in a
record descriptive manner. summarised manner.
Order Entries are made in chronological Entries are made analytically.
order.
Permanency Being original entry, it is a Being the final entry, it is a
temporary recording. permanent record.
Trial Balance A Trial Balance cannot be prepared Trial Balance is prepared on the
with its help. basis of it.
Final Final Accounts cannot be prepared Final Accounts are prepared with
Accounts with its help. its help.
Basis It is the basis of preparing a ledger. It is prepared on the basis of a
journal.

Advantages of Ledger
Ledger is one of the most important books of accounts in accounting. All transactions
recorded in the Journal or Subsidiary Books are finally posted into the Ledger under
different heads of accounts. It helps in knowing the financial position of the business and in
preparing final accounts. The main advantages of the Ledger are:

1. Knowledge of Business Results

• In the ledger, separate accounts are maintained for every item of transaction such as
assets, liabilities, income, and expenses.
• This makes it easy to know the overall results of the business.
• Such information cannot be obtained directly from the journal or subsidiary books.

2. Preparation of Trial Balance

• Ledger balances are used to prepare the Trial Balance.

• This helps in checking the arithmetical accuracy of accounts.

3. Preparation of Final Accounts

• Every businessman must prepare final accounts at the end of the year. Ledger helps in
this process because:
o (a) It fulfils government requirements.
o (b) It reveals net profit or loss of the business.
o (c) It shows the financial position (assets, liabilities, and capital).
4. Knowledge of Incomes and Expenses

• Since each income and expenditure item has a separate ledger account, it is easy to
know:
o The amount of income earned from a particular source.
o The expenses incurred on a particular item.

5. Overcoming the Limitations of Journal

• The journal records transactions chronologically but does not give a summarized
picture.
• The ledger classifies all transactions under proper heads and provides a complete
description in a summarized form.
• Thus, it fulfils the objectives not served by the journal.

Format of Ledger
A ledger account is generally prepared in a T-Form.

• Left side is Debit (Dr.)

• Right side is Credit (Cr.)

At the top, the account’s name is written. Each side has four columns:

1. Date – Date of the transaction.

2. Particulars – Name of the corresponding account. The word “To” is used on the
debit side and “By” on the credit side.
3. Journal Folio (LF) – Reference to the journal page where the transaction is first
recorded.
4. Amount – Value of the transaction.

Use of “To” and “By” in Ledger

While making postings in the ledger, on the debit side of every account the word “To” and
on the credit side the word “By” shall be used before the name of the account. To understand
the meaning of “To” and “By,” we have to read the words Debit and Credit respectively
along with them.

• To means “from” (i.e., Dr. means Debtor).

• By means “to” (i.e., Cr. means Creditor).
Example:

Cash Account

Date Partriculars L.F. Amount Date Particulars L.F. Amount

2025 To Sales A/c 5000 2025 By Purchases 2500
A/c
July 1 July 2

• On the debit side: “To Sales A/c” is written. It means Sales A/c is the Debtor of Cash
A/c i.e. cash is being received from Sales A/c.
• On the credit side: “By Purchases A/c” is written. It means Purchases A/c is the
Creditor of Cash A/c i.e. cash is being paid to Purchases A/c.

Rules and Principles Regarding Posting

According to the Double Entry System, each transaction affects at least two accounts: one
account is debited and another account is credited.
Posting is the process of classifying the transactions account-wise and recording them in the
Ledger from the Journal or Subsidiary Books.

Thus, while posting, the following rules and principles should be kept in mind:

1. Ledger Account has two sides—Debit and Credit.

Each side has four columns: Date, Particulars, J.F. (or L.F.), and Amount.
2. Debit side is marked by Dr. at the top of the left side and Credit side is marked by
Cr. at the top of the right side of the account.
3. All postings on Debit side start with “To” and on Credit side with “By.”
4. The name of the account is mentioned at the top of the Account. This is called the
opening of an account.
Example: Ram Kumar & Co. (Kurukshetra), Ram Kumar & Co. (Jind).
5. The account relating to which we are making posting (i.e., the posting relating to the
account) never appears in the same account.
Example: In Cash A/c, “To Cash A/c” or “By Cash A/c” will never appear.
6. It is not compulsory to write A/c after the name of a personal account.
7. The account in which posting is being made:
o If it has been debited in the Journal, then postings will be made on its Debit
side and in the Particulars column the name of the account which has been
credited in the Journal will appear.
o If it has been credited in the Journal, then postings will be made on its
Credit side and in the Particulars column the name of the account which has
been debited in the Journal will appear.

8. The account in which the credit side posting is being made, if it has been credited in
the Journal, then posting is made in its Credit side of the Ledger.
 In the Particulars column, the name of the account which has been debited in the
Journal will appear.

9. J.F. and L.F. Column

• In the Journal, the J.F. (Journal Folio) column bears the page number of the Journal
where the concerned entry has been made.
• In the Ledger, the L.F. (Ledger Folio) column records the page number of the Ledger
where the concerned account appears.
• Sometimes the columns are left blank, and students can tick the column when the
page number is not given.

Posting in the Ledger from Journal

Every transaction is recorded in the Journal after classifying it into Debit and Credit. This
makes it easy to post into the Ledger from the Journal.

Steps of Posting:

1. First, the account which has been debited in the Journal is posted.
Example:

Cash A/c Dr. 10,000

To Capital A/c 10,000
(Being business started with cash)

o Here, Cash A/c is debited.

o Thus, in the Ledger, Cash A/c will be opened first.
o On its Debit side, the posting will be made as: To Capital A/c.

Ledger Format:

Cash Account

Date Partriculars L.F. Amount Date Particulars L.F. Amount

2025 To capital A/c 10000

July 1

Next, the account which has been credited in the Journal is posted.

o Here, Capital A/c is credited.

 o So, in the Ledger, Capital A/c will be opened.
o On its Credit side, the posting will be made as: By Cash A/c.

Capital Account

Date Partriculars L.F. Amount Date Particulars L.F. Amount

By Cash A/C 10,000

Illustration – Ledger Posting from Journal

Transactions (July 1998):

1. Haveli Ram started a business with cash ₹10,000

2. Purchased goods for cash ₹9,000
3. Sold goods to Sardari Lal for cash ₹2,500
4. Paid rent of the shop ₹900
5. Purchased goods from Banarsi Dass for cash ₹500

Solution: Journal Entries

Date Particulars Debit (₹) Credit (₹)

July 1 Cash A/c Dr. 10,000
To Capital A/c 10,000
(Being business started with cash)
July 1 Purchases A/c Dr. 9,000
To Cash A/c 9,000
(Being cash purchases)
July 1 Cash A/c Dr. 2,500
To Sales A/c 2,500
(Being goods sold for cash)
July 2 Rent A/c Dr. 900
To Cash A/c 900
(Being rent paid)
July 2 Purchases A/c Dr. 500
To Cash A/c 500
(Being cash purchase from Banarsi Dass)
Grand Total 18,500 18,500
Ledger Posting

Cash Account

Date Particulars J.F Amount Date Particulars J.F. Amoun

. t
1998 To Capiital A/C 10000 1998 By Purchases A/C 5000

July 1 July 1
July 1 To Sales A/C 2500 July 2 By Rent A/C 500
July 2 By Purchases A/c 500

Capital Account

Date Particulars J.F Amount Date Particulars J.F. Amoun

. t
1998 By Cash A/C 10,000

July 1

Purchases Account

Date Particulars J.F Amount Date Particulars J.F. Amoun

. t
1998

July 1 To Cash A/C 5,000

July 2 To Cash A/C 500

Sales Account

Date Particulars J.F Amount Date Particulars J.F. Amoun

. t
1998 By Cash A/C 2,500

July 1

Rent Account

Date Particulars J.F Amount Date Particulars J.F. Amoun

. t
1998 To Cash A/C 500

July 2
 Bank reconciliation statement

Introduction
As discussed in the previous chapter, nowadays most businessmen have their accounts in the
bank and think it better to transact through cheque. Bank transactions are recorded either in
the bank columns of the three-column Cash Book or in the Bank A/c of the ledger.

The bank also opens a separate account for each business firm in its ledger and enters all the
transactions in it. On opening a bank account, the bank hands over a Pass Book to the account
holder through which bank officials supply a copy of the firm's account in the bank's ledger.
So, the bank Pass Book is a copy of transactions which took place between the business firm
and the bank.

Since all the bank transactions are recorded in the bank columns of the Cash Book and Pass
Book, the balance of the two books must tally with each other. At any time, the bank balance
shown by these two should be the same because the same bank transactions are recorded in
both. But in actual practice, the balance of the bank column of the Cash Book does not tally
with the balance of the Pass Book. To tally the bank balances of both the books (Cash Book
and Pass Book), a Bank Reconciliation Statement is prepared.

“Bank Reconciliation Statement is a statement which is prepared to reconcile the difference

between the bank balance shown by the Cash Book and the Pass Book.”

Main Points Regarding Bank Reconciliation Statement

1. There are some cases when, with the Cash Book, a separate Bank A/c is maintained in
the ledger. Generally, the businessman who opens a bank account keeps a three-
column Cash Book to record bank transactions. Because Bank A/c is related to the
Cash Book, while preparing the Bank Reconciliation Statement the bank balance is
generally named as the Cash Book balance.
2. Bank Reconciliation Statement can be prepared at any time, but generally it is
prepared at the end of the month.
3. Bank Reconciliation Statement is prepared by the businessman.
4. The balance of the bank column of the Cash Book and that of the Pass Book may not
agree, but they are correct at their places.
5. Bank Reconciliation Statement can be prepared starting with the bank balance of the
Cash Book as well as starting with the balance of the Pass Book. When it is prepared
with the Cash Book balance, then the closing balance will be Pass Book balance and
vice versa.
6. The bank is a debtor of a customer and credits the account with the amount he
deposits while debits the account with the amount he withdraws. Therefore, the items
debited in the Cash Book are credited in the Pass Book and vice versa. The debit
balance of the Cash Book will be the credit balance of the Pass Book.
7. Debit balance of the Cash Book and credit balance of the Pass Book are recorded in
the Plus Amount Column of the Bank Reconciliation Statement. The bank overdraft
 (credit balance of the Cash Book and debit balance of the Pass Book) is shown in the
Minus Amount Column.

B. Causes of difference between Cash Book balance and Pass Book balance

As discussed earlier, it is clear that the Bank Reconciliation Statement is prepared to match
the balances of the Cash Book and the Pass Book. Generally, the balances of the Cash Book
and the Pass Book do not agree with each other. When the Cash Book is recorded in a proper
way and the bank has also recorded the transactions properly, then the question arises: why is
there a difference? Why do the balances of the Cash Book and Pass Book not agree? The
answer is that it can be due to the following reasons:

(1) Cheques issued but not yet presented for payment: When cheques are issued by a
businessman to any of his creditors, the entry in the Cash Book is made immediately. This
reduces the Cash Book balance by the said amount. But it is not necessary that the creditor to
whom the cheque was issued may present the cheque for payment on the same date.
Moreover, the bank takes 7 to 10 days to make the payment of outstation cheques. The bank
will not debit the account till the cheque is presented for payment. So the balances of the
Cash Book and Pass Book do not agree.

(2) Cheques deposited but not credited/collected/cleared: Those cheques which are
received from customers, when deposited in the bank, their amount is recorded on the debit
side of the Cash Book. It increases the bank balance of the Cash Book. It takes time to collect
the payments on these cheques. The bank will not credit their amount to the account of the
depositor until they are collected. Hence, the balances of the Cash Book and Pass Book will
not agree.

(3) Interest credited or debited by bank: Bank allows interest on our deposits which is
credited to our account. It increases our bank balance in the Pass Book. But its information is
supplied only on the entry in the Pass Book, so no entry is passed in the Cash Book. Thus, the
balance of the Pass Book will be more. Similarly, bank charges and interest on overdrafts are
debited in our account. It will reduce the balance in the Pass Book or increase overdraft in the
Pass Book. Due to lack of information, the Cash Book does not show these entries at the
same time.

(4) Bank charges: Bank debits the customer’s account with incidental charges and collection
charges for the operation of the current account and for other services rendered by the bank
on the request of the customer. It reduces the balance of the Pass Book. Such information is
received only when entered in the Pass Book. This is also a reason for the difference between
the two balances.

(5) Payments made by the bank on behalf of the customer: Sometimes, a busy
businessman instructs his banker to make various business and personal payments on time.
The bank acts accordingly and debits these payments in the Pass Book. But until the
businessman receives the information, no entry is made in the Cash Book. Hence, the
balances of the Cash Book and Pass Book do not agree.
(5) Payments made by the bank on behalf of the customer: The bank makes payments
accordingly and debits the account of the customer with the amount of payments made. It
again reduces the balance of the Pass Book. The businessman comes to know about it only
when he receives a copy of his account (i.e., entry in the Pass Book). Hence, it is also one of
the reasons that the two balances of Cash Book and Pass Book, although properly maintained,
do not agree with each other.

(6) Collections made by the bank on behalf of the customer: Generally, the bank collects
various amounts under standing instructions of the customer and credits them in his account,
e.g., dividend on shares, interest, etc. It increases the balance in the Pass Book. Such entries
are made in the Cash Book only when known through the Pass Book. That is why the
balances of the Cash Book and Pass Book do not tally.

(7) Dishonouring of Bills of Exchange and Cheques: It is also one of the reasons for
disagreement of balances of Cash Book and Pass Book. The bills of exchange or cheques
deposited by the customer in the bank for collection may be dishonoured. As they are already
debited in the Cash Book but are not credited by the bank in the customer’s account, it
increases the balance of the Cash Book but makes no addition in the Pass Book. Thus, the
balances of the two disagree.

(8) Direct deposit into the bank by the debtors: Sometimes debtors deposit money directly
into our bank account. Hence, the balance of the Pass Book increases and does not agree with
the balance of the Cash Book.

(9) Wrong entries in Cash Book or Pass Book: Errors committed in the total of either the
Cash Book or the Pass Book may also lead to disagreement of balances, such as omission in
the Cash Book or Pass Book, e.g., cheque debited in the Cash Book but omitted to be banked,
or wrong credit in place of debit, etc.

(10) Cheques deposited into the bank without recording in Cash Book: Sometimes
cheques received are deposited into the bank without entering them in the Cash Book. It
increases the balance of the Pass Book and thus does not agree with the balance of the Cash
Book.

Above-stated facts make it clear that there are certain reasons due to which the balances of
the Cash Book and Pass Book do not agree with each other.

C. Need and Importance of Bank Reconciliation Statement

It is essential for the businessman to prepare a Bank Reconciliation Statement due to the
following reasons:

(1) For locating errors and omissions: The preparation of the Bank Reconciliation
Statement helps in locating the errors and omissions that may have been committed either in
the Cash Book or in the Pass Book. This helps in rectification of errors.

(2) For reducing the chances of embezzlement: Periodic preparation of the Bank
Reconciliation Statement reduces the chances of embezzlement by the clerical staff of the
firm and even that of the bank. For example, a cheque debited in the Cash Book but not
deposited in the firm’s account.

(3) For completing the Cash Book: For example, the entries relating to bank charges,
interest allowed or charged by the bank, direct payments by the bank on standing instructions,
etc., will be recorded in the Pass Book, but there is no entry in the Cash Book because these
entries are known only through the Pass Book. Therefore, a Bank Reconciliation Statement
helps in the completion of the Cash Book.

(4) For knowing the bank balance: By preparation of the Bank Reconciliation Statement,
the businessman becomes sure about the bank balance. It helps him in making further
transactions through the bank.

Procedure of Preparing Bank Reconciliation Statement

1. A Bank Reconciliation Statement can be prepared at any time when we receive the
Pass Book from the bank.
2. On receiving the Pass Book, the businessman tallies the bank balance of the Cash
Book with the balance shown in the Pass Book.
3. In case of differences, items appearing in both the books are checked and ticked.
4. Unticked items in both the books are causes of difference.
o With the help of these unticked items, a statement of reconciliation is
prepared.
5. While preparing the statement:
o Debit balance of bank column of Cash Book OR
o Credit balance of Pass Book is shown in the Plus Amount column.
6. In case of Overdraft:
o Credit balance of Cash Book OR
o Debit balance of Pass Book is shown in the Minus Amount column.
7. The remaining procedure is the same in both cases (normal balance or overdraft).
8. The effect of given transactions is ascertained on the balance of whichever book is
given (Cash Book or Pass Book).
o Example: If the balance of the Cash Book is given, then for each transaction
we check whether it increases or decreases the balance of the Cash Book.
▪ If it increases the balance → The amount is deducted.
▪ If it decreases the balance → The amount is added.
9. While preparing the Bank Reconciliation Statement, the effect of all transactions is
ascertained on a particular date.
10. Finally, the amount of each item to be added or deducted is shown as per the
following table:
 Transaction When Cash Book When Pass Book
Balance is Given Balance is Given
Cheques issued but not presented for + –
payment
Cheques deposited but not credited by – +
Bank
Cheques issued but not recorded in – +
Cash Book
Cheques recorded in Cash Book, but – +
not deposited
Cheques deposited but dishonoured – +
Cheques sent for collection, not yet – +
collected by Bank
Bank charges and interest debited by – +
Bank
Interest credited (allowed) by Bank + –
Direct deposits by customers in our + –
bank account
Interest and dividends collected by + –
Bank
Bills collected by Bank, not entered in + –
Cash Book
Bills discounted with the Bank, but – +
dishonoured
Direct payments made by Bank on our – +
standing instructions
Interest on overdraft charged by Bank – +

Specimen of Bank Reconciliation Statement

Bank Reconciliation Statement
As on …………

Particulars Plus Amount Minus Amount

Important Note:

• If Overdraft is given (Cash Book or Pass Book), it will be written in the Minus
Amount column.
• If Plus Amount total > Minus Amount total → Balance (favorable).
• If Minus Amount total > Plus Amount total → Overdraft (unfavorable).
Preparation of Bank Reconciliation Statement by Debit Balance of
Bank Column of Cash Book
Items to be Added

1. Cheques issued but not presented for payment

o Recorded in Cash Book (credit side) → reduces Cash Book balance.
o Pass Book remains unchanged (cheques not yet presented).
o Therefore, add to Cash Book balance.
2. Cheques deposited but not recorded in Cash Book
o Bank has credited the customer’s account.
o No entry in Cash Book → shows lesser balance.
o Therefore, add to Cash Book balance.
3. Interest allowed by bank
o Bank credits interest on deposits → increases Pass Book balance.
o Not recorded in Cash Book.
o Therefore, add to Cash Book balance.
4. Interest and dividend collected by bank
o Bank credits these amounts directly to account → increases Pass Book
balance.
o Not yet in Cash Book.
o Therefore, add to Cash Book balance.
5. Amount directly deposited by customers
o Direct deposits increase Pass Book balance.
o Cash Book remains unchanged.
o Therefore, add to Cash Book balance.

Items to be Deducted

1. Cheques sent for collection but not yet credited by bank

o Entry already made in Cash Book (debit side) → increases Cash Book
balance.
o Bank credits only after collection → Pass Book still shows lesser balance.
o Therefore, deduct from Cash Book balance.

(2) Cheques sent to the bank for collection but dishonoured

Sometimes cheques deposited in the bank are dishonoured. These are already entered
on the debit side of the Cash Book, but no entry will appear in the Pass Book
because the cheque has bounced. As a result, the Cash Book shows a higher balance
than the Pass Book.
Therefore, while preparing the Bank Reconciliation Statement (BRS), the
dishonoured cheque amount must be deducted from the Cash Book balance.
(3) Bank charges and commission debited by the bank
Banks often debit charges and commission directly in the Pass Book. These expenses
are not immediately recorded in the Cash Book. As a result, the Pass Book balance
becomes lower than the Cash Book balance.
 Hence, while preparing BRS, bank charges and commission should be deducted
from the Cash Book balance.

(4) Direct payment made by the bank on standing instructions

Sometimes the bank makes payments directly on behalf of the customer, for example,
insurance premiums, rent, or subscriptions, as per standing instructions. These
payments reduce the Pass Book balance, while the Cash Book remains unchanged
until recorded.
Therefore, such amounts should be deducted from the Cash Book balance while
preparing BRS.

(5) Cheques issued but not recorded in the Cash Book

In some cases, cheques are issued and the bank debits the customer’s account
(recorded in the Pass Book) but the entry is not made in the Cash Book. This causes
the Pass Book balance to fall while the Cash Book balance remains higher.
Hence, while preparing BRS, such cheque amounts should be deducted from the
Cash Book balance.

From the following information, prepare a Bank Reconciliation Statement as on 31st

December to reconcile the balance as per Cash Book with the balance as per Pass Book:

1. Balance as per Cash Book is Rs. 3,200.

2. Cheques issued but not presented for payment amounted to Rs. 1,780.
3. Cheques deposited into the bank but not yet credited amounted to Rs. 860.
4. Dividend collected directly by the bank is Rs. 100.
5. Bank charges debited by the bank are Rs. 20.
6. Cash Book was undercast on the payment side by Rs. 100.

Particulars Amount (Rs.) Amount (Rs.)

Balance as per Cash Book 3,200
Add: Cheques issued but not presented for payment 1,780
Less: Cheques deposited into bank but not yet credited 860
Add: Dividend collected by Bank 100
Less: Bank charges debited by Bank 20
Less: Cash Book undercast on the payment side 100
Balance as per Pass Book 4,100
Total 5,080 5,080
Question:

From the following particulars, prepare a Bank Reconciliation Statement as on 31st

December, 1998:

1. Balance as per Cash Book (Dr) – Rs. 3,800

2. Cheques issued but not presented for payment – Rs. 2,000
3. Cheques deposited for collection but not collected up to 31.12.1998 – Rs. 1,600
4. Bank wrongly debited our account (rectified after 31.12.1998) – Rs. 200
5. Balance as per Pass Book (Dr) – Rs. 4,000

Prepare the Bank Reconciliation Statement.

1) Bank Reconciliation Statement

As on 31st December, 1998

Particulars Plus Amount Minus Amount

(Rs.) (Rs.)
Balance as per Cash Book (Dr) 3,800
Cheque issued but not presented for payment 2,000
Cheque deposited for collection but not collected upto 1,600
31.12.98
Bank wrongly debited our account (rectified after 200
31.12.98)
Balance as per Pass Book (Dr) 4,000
Totals 5,800 5,800
 Cash Book

A Cash Book is a book of accounts in which all cash transactions are recorded. Every
business, whether big or small, has many cash transactions. To record these properly, a
separate Cash Book is maintained. The Cash Book is as important in business as the ledger.

The need for a separate Cash Book arises due to the following objectives:

1. To make payments of expenses on time, such as salary, rent, and insurance.

2. To make timely payments to creditors.
3. To maintain proper liquidity, i.e., the ability of the business to make payments.
4. To prevent misuse or misappropriation of cash.

The Cash Book is very important in business because every transaction eventually involves
cash. Therefore, it is essential to keep a separate book to record all cash transactions.

Cash Book

Cash Book helps the trader to ascertain the daily cash balance—how much cash was at the
beginning, how much cash is received, how much cash is paid, and the final balance at the
end. Cash Book is a principal book of accounts, because after maintaining a Cash Book, there
is no need to open a Cash Account in the ledger.

As there are a large number of cash transactions in every business, it is not convenient to
record them in the Journal and then post them into the ledger. So, it is convenient to record
them in a separate book. The format of the Cash Book is similar to the ledger, i.e., it has two
sides. All receipts are posted on the debit side and all payments are posted on the credit side.
Cash Book is an asset account, so it always has a debit balance.

Definition of Cash Book

1. “Cash Book is a book of original entry, the object of which is to record all receipts
and payments of money.” — Carter
2. “Cash Book fulfils the functions of both a ledger account and a book of original entry,
in which all cash transactions are entered as they occur.” — B.G. Bickery
3. “Cash Book is used for recording the receipts and payments of money, whether in
coins, notes, cheques, and bank drafts etc.” — Andrew Munero

Cash Book — Subsidiary Book or Principal Book

In every business, the number of cash transactions is more than other transactions. If they are
recorded in the Journal, then the number of entries in the Journal and Ledger will increase.
Thus, a separate book is kept to record cash transactions, which is called the Cash Book.

Cash Book is both a primary book as well as a principal book. It is a subsidiary book
because all the cash transactions are recorded in it at the first instance. Cash Book is also a
principal book because, after maintaining it, a separate Cash Account is not maintained in the
ledger. Therefore, “Cash Book is both a Subsidiary Book and a Principal Book.” In other
words, the Cash Book fulfils the functions of both a Journal and a Ledger account.

Difference between Cash Book and Cash Account

No doubt, Cash Book and Cash Account are substitutes. There is no need to prepare both of
these, because both serve the same purpose. In both, cash transactions are recorded date-wise
in order of their occurrence. Both of these enable a businessman to know the cash balance of
the firm. Both are used to record cash receipts and payments. However, there are some
differences between the two, as follows:

Basis Cash Book Cash Account

1. Nature It is a separate book maintained to It is an account in the Ledger.
record the cash transactions.
2. Opening When cash transactions are recorded in When cash transactions are
of Cash the Cash Book, there is no need to open recorded in the Journal, there is a
Account a separate Cash A/c in the ledger. necessity to open a Cash A/c in
the ledger.
3. Posting It is a book of original entry; therefore, Cash A/c is maintained in the
all cash transactions are first recorded in ledger and posting into this
it and then posted to different accounts account is done from the Journal.
in the ledger.

Cash Book as a Journal and a Ledger

Sometimes a question arises whether Cash Book is a Journal or a Ledger? It is a Journal,

because cash transactions are recorded in it for the first time from the source documents, and
from there these are posted to the respective accounts in the ledger.

Cash Book is also a Ledger, because it serves the purpose of a Cash A/c also. When a Cash
Book is prepared, no separate Cash A/c is opened in the Ledger. Hence, Cash Book is both a
Journal and a Ledger, and is called a journalised ledger.

Similarities between Cash Book and Journal

1. In both the books, transactions are recorded for the first time from the source
documents.
 2. In both the books, transactions are recorded date-wise and in chronological order, i.e.,
as and when they take place.
3. In both the books, we have a Ledger Folio (L.F.) column.
4. From both the books, transactions are posted to the relevant accounts (except Cash
Account) in the ledger.

Similarities between Cash Book and Ledger

1. The format of the simple Cash Book is similar to the format of the Ledger.
2. In both the books, the words “To” and “By” are used for recording transactions.
3. When a Cash Book is maintained, there is no need to open a Cash A/c in the Ledger.
4. Both the books are balanced.

Cash Book Always Shows a Debit Balance

It should be noted that the total of the debit side of the Cash Book always exceeds the credit
side. This is because a businessman cannot pay more than what he has got. If money is paid
by borrowing from someone, it will first be recorded on the debit side (receipt side) and only
then will it be shown on the credit side (payment side). Hence, the simple Cash Book or the
Cash columns of two- or three-column Cash Books always show a debit balance, but can
never show a credit balance.

Types of Cash Book

Every business differs from others as regards its size, nature, and requirements. The business
can maintain the following types of Cash Books:

1. Simple Cash Book

2. Two-Column Cash Book
3. Three-Column Cash Book
4. Petty Cash Book

Each business firm uses only one type of Cash Book out of the first three, while the Petty
Cash Book is used to record petty (small) expenses only. Generally, the Simple Cash Book
is the most widely used.

Simple Cash Book

It is also called a single-column Cash Book. It is the simplest form of Cash Book. Such a
book is generally kept by retailers. It contains only a cash column. It also works as a Cash
Account. In practice, its debit side is also called the receipt side, and its credit side is called
the payment side.

Specimen of Simple Cash Book

Columns of a Simple Cash Book

1. Date:
This column records the date of each transaction on the day it occurs. The year and
month are written only once on a page.
2. Particulars:
In this column, the name of the account is written in which the second aspect of the
transaction is posted.
o All receipts are recorded on the debit side.
o All payments are recorded on the credit side.
o Each entry starts with “To” on the debit side and with “By” on the credit side.
3. Ledger Folio (L.F.):
After recording the cash transactions in the Cash Book, they are posted to the Ledger.
This column shows the page number of the Ledger on which the concerned account
appears.
4. Amount:
This column records the amount of each transaction. In Cash Book, cash includes
coins, rupees, cheques, bank drafts, and negotiable instruments accepted by banks.

Points to Remember while Writing a Simple Cash Book

1. Cash A/c is a Real Account, so it follows the rule:

o Debit all receipts, credit all payments
o Or simply: Debit what comes in, credit what goes out.
2. Like an account, the Cash Book also bears “Dr.” on the left corner and “Cr.” on the
right corner.
3. Debit entries start with “To”, and credit entries start with “By.”
4. The debit side total of a Simple Cash Book is always larger, meaning it always
shows a debit balance.
5. If there is an opening balance, it is written on the debit side as “To Balance b/d.”
6. The balance of the Simple Cash Book must match the actual cash in hand (imprest
cash).
7. The Cash Book is balanced, while other subsidiary books are only totalled.
8. In practice, the Cash Book is balanced daily, but in examination questions, it is
usually balanced monthly.
9. While balancing, the difference is recorded on the credit side as “By Balance c/d” to
make both sides equal. On the first day of the next month, this balance is brought
down on the debit side as “To Balance b/d.”
10. After preparing the Cash Book, a separate Cash Account is not opened in the
Ledger, since the Cash Book itself acts as a Cash Account.
Question:

From the following particulars, prepare a Bank Reconciliation Statement (Overdraft Case)
as on 30th June, 2004:

1. Credit balance as per Cash Book (Overdraft) – Rs. 1,800

2. Cheque issued but not presented for payment – Rs. 360
3. Cheque deposited into bank but not collected – Rs. 770
4. Interest on overdraft charged by bank – Rs. 30
5. Customer directly deposited into our Bank Account – Rs. 500
6. Bank paid electricity bill as per standing instruction – Rs. 200
7. Bank charges – Rs. 25
8. Receipt side of Cash Book overcast – Rs. 1,000
9. Balance as per Pass Book (Overdraft) – Rs. 2,965

Prepare the Bank Reconciliation Statement.

2) Bank Reconciliation Statement (Overdraft case)

As on 30th June, 2004

Particulars Plus Amount (Rs.) Minus Amount (Rs.)

Credit balance as per Cash Book (Overdraft) 1,800
Cheque issued but not presented for payment 360
Cheque deposited into bank but not collected 770
Interest on overdraft charged by bank 30
Customer directly deposited into our Bank A/c 500
Bank paid electricity bill as per standing instruction 200
Bank charges 25
Receipt side of Cash Book overcasted 1,000
Balance as per Pass Book (Overdraft) 2,965
Totals 3,825 3,825