ACCOUNTING

Meaning and Scope of Accounting:

Accounting is the language of business. The basic function of a language is to serve as a means of
communication. Likewise, accounting communicates the results of business operations to various parties
who have some stake in the business, viz. the proprietor, creditors, investors, government and other
agencies.

Accounting is associated with business, but it is not only the business that makes the use of accounting.
Persons like housewives, government and other individuals also make use of accounting.

Thus, the need of accounting for a person is to know:

1. What he owns?

2. What he owes?

3. Whether he has earned a profit or, suffered a loss on accounting of running a business?

4. What is his financial position? Whether he will be in a position to meet all his commitments in
the near future or, he is in the process of becoming a bankrupt.

Definition of Accounting:

Accounting is as old as money itself. In India, Chanakya in his Arthashastra has emphasized the existence
and need of proper accounting and auditing. However, the modern system of accounting owes its origin to
Pacoili, who lived in Italy in the 18th century. Since then, the concept of accounting and the role of
accountant have undergone a revolutionary change. The change is particularly noticeable during the last
fifty years.

Earlier, accounting was considered simply as a process of recording business transactions and the role of
accountant as that of record-keeper. However, accounting is now considered to be a powerful tool of
management providing vital information concerning the organization’s future and thus accounting today
considered as an information system rater than a mere recording system.

Thus, accounting may be defined as “the process of recording, classifying, summarizing, analyzing and
interpreting the financial transactions and communicating the results thereof to the persons interested in
such information”.
Steps of Accounting:

The following are the important steps to be adopted in the accounting process (depicted in Figure 1.1):

1. Recording: Recording is the primary function of accounting. It involves recording of all the
business transactions in an orderly manner for the purpose of future record or reference. It is done
in a book referred to as “Journal”. This may be further sub-divided into various subsidiary books
such as cash journal, purchase journal, sales journal, etc.

2. Classifying: Classification is concerned with the systematic analysis of the recorded data, with a
view to group transactions or, entries of one nature at one place. The work of classification is
done in book termed as “Ledger”. This book contains different pages for individual account heads
under which all financial transaction of similar nature are collected. For example, there may be
separate account heads for travelling expenses, printing and stationary, advertising, etc.

3. Summarizing: This involves presenting the classified data in a manner which is understandable
and useful to the internal as well as external end-user of accounting statements. This process leads
to the preparation of Trail Balance, Income Statement (Profit and Loss Account) and Balance
Sheet.

Dealing with financial transactions: Accounting records only those transactions and events in terms of
money which are of financial character. Transactions which are not of a financial character are not
recorded in the book of accounts.

4. Analyzing and Interpreting: The summarized data are further analyzed and interpreted in a
manner that the end-users can make a meaningful judgment about the financial condition and
profitability of the business operation. The data is also used for making the future plans and
framing of policies for executing such plans. This involves computation of various accounting
ratios, etc., to know about the liquidity, solvency and profitability of business.

Analysis means establishment of relationship between the items of the profit and loss account and
the balance sheet. The purpose of analyzing is to identify the financial strength and weakness of
the business. It provides the basis for interpretation. For example, all the items relating to
‘Current Assets’ are put at one place while all the items relating to ‘Current Liabilities’ are put at
another place.

Interpreting means explaining the meaning and significance of the relationship so established by
the analysis. Interpretation should be useful to the users, so as to enable them to take correct
decisions.
 Passing of
reverse
Preparation of entities Economic
Financial event/business
statements transaction

Preparation
Transaction
of Trial
analysis i.e., asset,
Balance
liblity, capital,
revenue, and
expenses

Posting to Record in
Ledger memorandum
, rough or
waste book
Journalizing
transactions in
books of original
entry

Figure 1.1 Accounting Process

5. Communicating: The accounting information after being meaningfully analyzed and interpreted
has to be communicated in a proper form and manner to proper person. This is done by
preparation and distribution of accounting reports like: Income statement, Balance sheet, Graphs,
Diagram, Fund Flow Statements, Cash Flow statements, etc. This basically depends upon the
imagination and innovative ability of the accountant.

Functions of Accounting:

From the definition and analysis of the above the main functions of accounting can be summarized as:

1. Keeping systematic record of business transactions.

2. Protecting properties of the business.

3. Communicating the results to various parties interested in or connected with the business.

4. Meeting legal requirements.

Objectives of Accounting:

1. To keeps systematic records.

2. Providing suitable information with an aim of safeguarding the interest of the business and its
proprietors and others connected with it.
3. To emphasis on the ascertainment and exhibition of profits earned or losses incurred in the
business.
 4. To ascertain the financial position of the business as a whole.
5. To ensure accounts are prepared according to some accepted accounting concepts and
conventions.
6. To comply with the requirements of the Companies Act, Income Tax Act, etc.
7. To facilitate rational decision making.

Book-keeping and Accounting:

Bookkeeping may be defined as "the art of recording the business transactions in the books of accounts in
a systematic manner." A person who is responsible for and who maintains and keeps a record of the
business transactions is known as Bookkeeper. His work is primarily clerical in nature.

On the other hand, Accounting is primarily concerned with the recording, classifying, summarizing,
interpreting the financial data and communicating the information disclosed by the accounting records to
those persons interested in the accounting information relating to the business.

In general, the differences between book-keeping and accounting is portrayed in the Table 1.1.

Table 1.1 Differences between book-keeping and accounting

Sl. Basis of
Book-keeping Accounting
No. Distinction

1. Scope Recording and maintenance of It is not only recording and maintenance of

books of accounts. books of accounts but also includes
analysis, interpreting and communicating
the information.

2. Stage Primary stage Secondary stage.

3. Objective To maintain systematic records of To ascertain the net result of the business
business transactions. operation.

4. Nature Often routine and clerical in Analytical and executive in nature.

nature.

5. Responsibility A book-keeper is responsible for An accountant is also responsible for the

recording business transactions. work of a book-keeper.

6. Supervision The book-keeper does not An accountant supervises and checks the
supervise and check the work of work of the book-keeper.
an accountant.

7. Staff involved Work is done by the junior staff of Senior staff performs the accounting work.
the organization.
Is Accounting “a science” or “an art:

Any organized knowledge based on certain basic principles is ‘science’. Accounting is also a science. It is
an organized knowledge based on scientific principles which have been developed as result of study and
experience. Of course, accounting cannot be termed as a “perfect science” like Physics or Chemistry
where experiments can be carried and perfect conclusions can be drawn. It is a social science depending
much on human behavior and other social and economic factors. Thus, perfect conclusions cannot be
drawn. Some people, therefore, though not very correctly, do not take accounting as a science.

Art is the technique which helps us in achieving our desired objective. Accounting is definitely an art.
The American Institute of Certified Public Accountants also defines accounting as “the art of recording,
classifying and summarizing the financial transactions.” Accounting helps in achieving our desired
objective of maintaining proper accounts, i.e., to know the profitability and the financial position of the
business, by maintaining proper accounts.

Accounting and Economics:

Economics is concerned with rational decision making regarding the efficient use of scare resources for
satisfying the human works. Accounting is considered to be a system which provides appropriate
information to the Management for taking rational decisions.

Moreover, the basic objective of management of a business organization is to maximize the wealth of its
owners. This is also the objective of economics. Efficient use of scare resources results in maximizing the
wealth of a nation.

Thus, accounting and economics both have a similarity in the sense that both seek the optimum utilization
of resources of the firm on the nation.

Limitations of Accounting:

1. Accounting provides only limited information because it reveals the profitability of the concern
as a whole.

2. Accounting considers only those transactions which can be measured in terms of money or
quantitatively expressed. Qualitative information is not taken into account.

3. Accounting provides limited information to the management.

4. Accounting is only historical in nature. It provides only a post mortem record of business
transactions.
Branches of Accounting:

The main function of accounting is to provide the required information for different parties who are
interested in the welfare of that enterprise concerned. In order to serve the needs of management and
outsiders various new branches of accounting have been developed. The following are the main branches
of accounting:

1. Financial Accounting.

2. Cost Accounting.

3. Management Accounting.

Financial Accounting: Financial Accounting is prepared to determine profitability and financial position
of a concern for a specific period of time.

Cost Accounting: Cost Accounting is the formal accounting system setup for recording costs. It is a
systematic procedure for determining the unit cost of output produced or service rendered.

Management Accounting: Management Accounting is concerned with presentation of accounting

information to the management for effective decision making and control.

Basic Accounting Terms:

1) Transactions: Transactions are those activities of a business, which involve transfer of money or
goods or services between two persons or two accounts. For example, purchase of goods, sale of
goods, borrowing from bank, lending of money, salaries paid, rent paid, commission received and
dividend received. Transactions are of two types, namely, cash and credit transactions.

a) Cash Transaction is one where cash receipt or payment is involved in the transaction.
For example, When Ram buys goods from Kannan paying the price of goods by cash
immediately, it is a cash transaction.

b) Credit Transaction is one where cash is not involved immediately but will be paid or
received later. In the above example, if Ram, does not pay cash immediately but promises
to pay later, it is credit transaction.

2) Proprietor: A person who owns a business is called its proprietor. He contributes capital to the
business with the intention of earning profit.

3) Capital: It is the amount invested by the proprietor/s in the business. This amount is increased by
the amount of profits earned and the amount of additional capital introduced. It is decreased by
 the amount of losses incurred and the amounts withdrawn. For example, if Mr. Anand starts
business with Rs.5,00,000, his capital would be Rs.5,00,000.

4) Assets: Assets are the properties of every description belonging to the business. Cash in hand,
plant and machinery, furniture and fittings, bank balance, debtors, bills receivable, stock of
goods, investments, Goodwill are examples for assets.

Assets can be classified into tangible and intangible.

a) Tangible Assets: These assets are those having physical existence. It can be seen and
touched. For example, plant & machinery, cash, etc.

b) Intangible Assets: Intangible assets are those assets having no physical existence but
their possession gives rise to some rights and benefits to the owner. It cannot be seen and
touched. Goodwill, patents, trademarks are some of the examples.

5) Liabilities: Liabilities refer to the financial obligations of a business. These denote the amounts
which a business owes to others, e.g., loans from banks or other persons, creditors for goods
supplied, bills payable, outstanding expenses, bank overdraft etc.

6) Drawings: It is the amount of cash or value of goods withdrawn from the business by the
proprietor for his personal use. It is deducted from the capital.

7) Debtors: A person (individual or firm) who receives a benefit without giving money or money’s
worth immediately, but liable to pay in future or in due course of time is a debtor. The debtors are
shown as an asset in the balance sheet. For example, Mr. Arul bought goods on credit from Mr.
Babu for Rs.10, 000. Mr. Arul is a debtor to Mr. Babu till he pays the value of the goods.

8) Creditors: A person who gives a benefit without receiving money or money’s worth immediately
but to claim in future, is a creditor. The creditors are shown as a liability in the balance sheet. In
the above example Mr. Babu is a creditor to Mr. Arul till he receives the value of the goods.

9) Purchases: Purchases refers to the amount of goods bought by a business for resale or for use in
the production. Goods purchased for cash are called cash purchases. If it is purchased on credit,
it is called as credit purchases. Total purchases include both cash and credit purchases.

10) Purchases Return or Returns Outward: When goods are returned to the suppliers due to
defective quality or not as per the terms of purchase, it is called as purchases return. To find net
purchases, purchases return is deducted from the total purchases.
11) Sales: Sales refers to the amount of goods sold that are already bought or manufactured by the
business. When goods are sold for cash, they are cash sales but if goods are sold and payment is
not received at the time of sale, it is credit sales. Total sales include both cash and credit sales.

12) Sales Return or Returns Inward: When goods are returned from the customers due to defective
quality or not as per the terms of sale, it is called sales return or returns inward. To find out net
sales, sales return is deducted from total sales.

13) Stock: Stock includes goods unsold on a particular date. Stock may be opening and closing stock.
The term opening stock means goods unsold in the beginning of the accounting period. Whereas
the term closing stock includes goods unsold at the end of the accounting period. For example, if
4,000 units purchased @ Rs. 20 per unit remain unsold; the closing stock is Rs.80, 000. This will
be opening stock of the subsequent year.

14) Revenue: Revenue means the amount receivable or realized from sale of goods and earnings
from interest, dividend, commission, etc.

15) Expense: It is the amount spent in order to produce and sell the goods and services. For example,
purchase of raw materials, payment of salaries, wages, etc.

16) Income: Income is the difference between revenue and expense.

17) Voucher: It is a written document in support of a transaction. It is a proof that a particular

transaction has taken place for the value stated in the voucher. It may be in the form of cash
receipt, invoice, cash memo, bank pay-in-slip etc. Voucher is necessary to audit the accounts.

18) Invoice: Invoice is a business document which is prepared when one sell goods to another. The
statement is prepared by the seller of goods. It contains the information relating to name and
address of the seller and the buyer, the date of sale and the clear description of goods with
quantity and price.

19) Receipt: Receipt is an acknowledgement for cash received. It is issued to the party paying cash.
Receipts form the basis for entries in cash book.

20) Account: Account is a summary of relevant business transactions at one place relating to a
person, asset, expense or revenue named in the heading. An account is a brief history of financial
transactions of a particular person or item. An account has two sides called debit side and credit
side.
 ACCOUNTING PRINCIPLES
We know that accounting is the language of business through which normally a business house
communicates with the outside World. In order to make this language intelligible and commonly
understood by all, it is necessary that it should be based on certain uniform scientifically laid down
standards. These standards are termed as accounting principles.

Accounting principles (or Accounting standards) may be defined as those rule of action adopted by the
accountants universally while recording accounting transactions. These accounting principles can be
classified into two categories:

1. Accounting Concepts or, Accounting Postulates.

2. Accounting Conventions.

Accounting Concepts: Accounting concept refers to the basic assumptions and rules and principles
which work as the basis of recording of business transactions and preparing accounts. The main objective
is to maintain uniformity and consistency in accounting records. These concepts constitute the very basis
of accounting. All the concepts have been developed over the years from experience and thus they are
universally accepted rules. The following are the important accounting concepts:

1. Business Entity Concept;

2. Dual Aspect Concept;

3. Accounting Period Concept;

4. Going Concern Concept;

5. Accounting Cost Concept;

6. Money Measurement Concept;

7. Matching Concept;

8. Realization Concept;

9. Accrual Concept;

10. Rupee Value Concept.

Accounting Conventions (Standards): An accounting convention refers to common practices which are
universally followed in recording and presenting accounting information of the business entity. They are
followed like customs, tradition, etc. in a society. Accounting conventions are evolved through the regular
and consistent practice over the years to facilitate uniform recording in the books of accounts. Accounting
Conventions help in comparing accounting data of different business units or of the same unit for
different periods. These have been developed over the years. The most important conventions which have
been used for a long period are:

1. Convention of Disclosure.

2. Convention of Conservatism.

3. Convention of Consistency.

4. Convention of Materiality.

ACCOUNTING CONCEPTS

1. Business Entity Concept: It is also known as Separate Entity Concept. This concept assumes that,
for accounting purposes, the business enterprise and its owners are two separate independent entities.
Thus, the business and personal transactions of its owner are separate. For example, when the owner
invests money in the business, it is recorded as liability of the business to the owner. Similarly, when
the owner takes away from the business cash/goods for his/her personal use, it is not treated as
business expense. Thus, the accounting records are made in the books of accounts from the point of
view of the business unit and not the person owning the business. This concept is the very basis of
accounting.

Let us take an example. Suppose Mr. Sahoo started business investing Rs.100000. He purchased
goods for Rs.40000, Furniture for Rs.20000 and plant and machinery of Rs.30000. Rs.10000 remains
in hand. These are the assets of the business and not of the owner. According to the business entity
concept Rs.100000 will be treated by business as capital i.e. a liability of business towards the owner
of the business.

Now suppose, he takes away Rs.5000 cash or goods worth Rs.5000 for his domestic purposes. This
withdrawal of cash/goods by the owner from the business is his private expense and not an expense of
the business. It is termed as Drawings. Thus, the business entity concept states that business and the
owner are two separate/distinct persons. Accordingly, any expenses incurred by owner for himself or
his family from business will be considered as expenses and it will be shown as drawings.

Significance

The following points highlight the significance of business entity concept:

a) This concept helps in ascertaining the profit of the business as only the business expenses and
revenues are recorded and all the private and personal expenses are ignored.
 b) This concept restraints accountant from recording of owner’s private/personal transactions.

c) It also facilitates the recording and reporting of business transactions from the business point of
view.

d) It is the very basis of accounting concepts, conventions and principles.

2. Dual Aspect Concept: Dual aspect is the foundation or basic principle of accounting. It provides the
very basis of the double entry book keeping in the books of accounts. This concept assumes that
every transaction has a dual effect, i.e. it affects two accounts in their respective opposite sides.
Accordingly for every debit there is an equal and corresponding credit. Therefore, the transaction
should be recorded at two places. It means both the aspects of the transaction must be recorded in the
books of accounts. For example, goods purchased for cash has two aspects which are (i) Giving of
cash (ii) Receiving of goods. These two aspects are to be recorded.

Thus, the duality concept is commonly expressed in terms of fundamental accounting equation:

Capital + Liabilities = Assets

(or)

Assets = Equities (Capital)

The term Capital refers to funds provide by the proprietor of the business concern. On the other hand,
the term liability denotes the funds provided by the creditors and debenture holders against the assets
of the business. The term assets represent the resources owned by the business. For example, Mr.
Thomas starts business with cash of Rs. l00000 and building of Rs.500000, and then this fact is
recorded at two places; Assets Accounts and Capital Account. In other words, the business acquires
assets of Rs.600000 which is equal to the proprietor's capital in the form of cash of Rs.100000 and
building worth of Rs.500000. The above relationship can be shown in the form of accounting
equation:

Capital + Liabilities = Assets

Rs.100000 + Rs.500000 = Rs.600000

The knowledge of dual aspect helps in identifying the two aspects of a transaction which helps in
applying the rules of recording the transactions in books of accounts. The implication of dual aspect
concept is that every transaction has an equal impact on assets and liabilities in such a way that total
assets are always equal to total liabilities.

Let us analyze some more business transactions in terms of their dual aspect:
 1) Capital brought in by the owner of the business

The two aspects in this transaction are:

a) Receipt of cash

b) Increase in Capital (owners’ equity)

2) Purchase of machinery by cheque

The two aspects in this transaction are:

a) Reduction in Bank Balance

b) Owning of Machinery

3) Goods sold for cash

The two aspects in this transaction are:

a) Receipt of cash

b) Delivery of goods to the customer

4) Rent paid in cash to the landlord

The two aspects in this transaction are:

a) Payment of cash

b) Rent (Expenses incurred).

Once the two aspects of a transaction are known, it becomes easy to apply the rules of accounting and
maintain the records in the books of accounts properly.

The interpretation of the Dual aspect concept is that every transaction has an equal effect on assets
and liabilities in such a way that total assets are always equal to the total liabilities of the business.

Significance

The following points highlight the significance of the business entity concept:

a) This concept helps accountants in detecting errors.

b) It encourages the accountant to post each entry on opposite sides of two affected accounts.

3. Accounting Period Concept: According to this concept, income or loss of a business can be
analyzed and determined on the basis of suitable accounting period instead of wait for a long period.
Thus, this concept requires that a balance sheet and profit and loss account should be prepared at
 regular intervals. This is necessary for different purposes like, calculation of profit, ascertaining
financial position, tax computation etc.

Further, this concept assumes that, indefinite life of business is divided into parts. These parts are
known as Accounting Period. It may be of one year, six months, three months, one month, etc. But
usually one year is taken as one accounting period which may be a calendar year or a financial year.

Year that begins from 1st of January and ends on 31st of December, is known as Calendar Year. The
year that begins from 1st of April and ends on 31st of March of the following year, is known as
financial year.

As per accounting period concept, all the transactions are recorded in the books of accounts for a
specified period of time. Hence, goods purchased and sold during the period, rent, salaries etc. paid
for the period are accounted for and against that period only.

Significance

a) It helps in predicting the future prospects of the business.

b) It helps in calculating tax on business income calculated for a particular time period.

c) It also helps banks, financial institutions, creditors, etc to assess and analyze the performance
of business for a particular period.

d) It also helps the business firms to distribute their income at regular intervals as dividends.

4. Going Concern Concept: It is also known as Continue of Activity Concept. This concept assumes
that a business firm will continue to carry on its activities for an indefinite period of time. In other
words, under this assumption, the enterprise is normally viewed as a going concern and it is not likely
to be liquidated in the near future and will be continued throughout the life. This assumption implies
that while valuing the assets of the business on the basis of productivity and not on the basis of their
realizable value or the present market value, at cost less depreciation till date for the purpose of
balance sheet. It is useful in valuation of assets and liabilities, depreciation of fixed assets and
treatment of prepaid expenses.

Further, it provides a basis for showing the value of assets in the balance sheet; For example, a
company purchases a plant and machinery of Rs.100000 and its life span is 10 years. According to
this concept every year some amount will be shown as expenses and the balance amount as an asset.
Thus, if an amount is spent on an item which will be used in business for many years, it will not be
proper to charge the amount from the revenues of the year in which the item is acquired. Only a part
 of the value is shown as expense in the year of purchase and the remaining balance is shown as an
asset.

Significance

The following points highlight the significance of going concern concept;

a) This concept facilitates preparation of financial statements.

b) On the basis of this concept, depreciation is charged on the fixed asset.

c) It is of great help to the investors, because, it assures them that they will continue to get
income on their investments.

d) In the absence of this concept, the cost of a fixed asset will be treated as an expense in the
year of its purchase.

e) A business is judged for its capacity to earn profits in future.

5. Accounting Cost Concept: Accounting cost concept states that all assets are recorded in the books of
accounts at their purchase price, which includes cost of acquisition, transportation and installation and
not at its market price. It means that fixed assets like building, plant and machinery, furniture, etc are
recorded in the books of accounts at a price paid for them. For example, a machine was purchased by
XYZ Limited for Rs.500000, for manufacturing shoes. An amount of Rs.1000 was spent on
transporting the machine to the factory site. In addition, Rs.2000 was spent on its installation. The
total amount at which the machine will be recorded in the books of accounts would be the sum of all
these items i.e. Rs.503000. This cost is also known as Historical Cost. Suppose the market price of
the same is now Rs 90000 it will not be shown at this value. Further, it may be clarified that cost
means original or acquisition cost only for new assets and for the used ones, cost means original cost
less depreciation. The cost concept is also known as historical cost concept. The effect of cost concept
is that if the business entity does not pay anything for acquiring an asset this item would not appear in
the books of accounts. Thus, goodwill appears in the accounts only if the entity has purchased this
intangible asset for a price.

Significance

a) This concept requires asset to be shown at the price it has been acquired, which can be
verified from the supporting documents.

b) It helps in calculating depreciation on fixed assets.

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

6. Money Measurement Concept: This concept assumes that all business transactions must be in terms
of money, that is, in the currency of a country. In our country such transactions are in terms of rupees.
Thus, as per the money measurement concept, transactions which can be expressed in terms of money
are recorded in the books of accounts. For example, sale of goods worth Rs.200000, purchase of raw
materials Rs.100000, Rent Paid Rs.10000 etc. are expressed in terms of money, and so they are
recorded in the books of accounts.

But the transactions which cannot be expressed in monetary terms are not recorded in the books of
accounts. For example, sincerity, loyality, honesty of employees, skill of the supervisor, product
policies, planning, and employer-employee relationship cannot be recorded in books of accounts
because these cannot be measured in terms of money although they do affect the profits and losses of
the business concern.

Another aspect of this concept is that the records of the transactions are to be kept not in the physical
units but in the monetary unit. For example, at the end of the year 2006, an organization may have a
factory on a piece of land measuring 10 acres, office building containing 50 rooms, 50 personal
computers, 50 office chairs and tables, 100 kg of raw materials etc. These are expressed in different
units. But for accounting purposes they are to be recorded in money terms i.e. in rupees. In this case,
the cost of factory land may be say Rs.12 crore, office building of Rs.10 crore, computers Rs.10
lakhs, office chairs and tables Rs.2 lakhs, raw material Rs.30 lakhs. Thus, the total assets of the
organization are valued at Rs.22 crore and Rs.42 lakhs. Therefore, the transactions which can be
expressed in terms of money is recorded in the accounts books, that too in terms of money and not in
terms of the quantity.

Significance

a) This concept guides accountants what to record and what not to record.

b) It helps in recording business transactions uniformly.

c) If all the business transactions are expressed in monetary terms, it will be easy to understand
the accounts prepared by the business enterprise.

d) It facilitates comparison of business performance of two different periods of the same firm or of
the two different firms for the same period.
7. Realization Concept: Realization Concept is also known as Revenue Recognition Concept. This
concept states that revenue from any business transaction should be included in the accounting
records only when it is realized. The term realization means creation of legal right to receive money.
Selling goods is realization, receiving order is not.

In other words, it can be said that:

Revenue is said to have been realized when cash has been received or right to receive cash on the sale
of goods or services or both has been created.

Let us study the following examples:

a. N.P. Jeweller received an order to supply gold ornaments worth Rs.500000. They supplied
ornaments worth Rs.200000 up to the year ending 31st December 2005 and rest of the ornaments
was supplied in January 2006.

b. Bansal sold goods for Rs.100000 for cash in 2006 and the goods have been delivered during the
same year.

c. Akshay sold goods on credit for Rs.50000 during the year ending 31st December 2005. The goods
have been delivered in 2005 but the payment was received in March 2006.

Now, let us analyze the above examples to ascertain the correct amount of revenue realised for
the year ending 31st December 2005.

a. The revenue for the year 2005 for N.P. Jeweller is Rs.200000. Mere getting an order is not
considered as revenue until the goods have been delivered.

b. The revenue for Bansal for year 2005 is Rs.1,00,000 as the goods have been delivered in the year
2005. Cash has also been received in the same year.

c. Akshay’s revenue for the year 2005 is Rs.50,000, because the goods have been delivered to the
customer in the year 2005. Revenue became due in the year 2005 itself. In the above examples,
revenue is realized when the goods are delivered to the customers.

The concept of realization states that revenue is realized at the time when goods or services are
actually delivered. In short, the realization occurs when the goods and services have been sold either
for cash or on credit. It also refers to inflow of assets in the form of receivables.

Significance

1) It helps in making the accounting information more objective.

 2) It provides that the transactions should be recorded only when goods are delivered to the
buyer.

8. Accrual Concept: The meaning of accrual is something that becomes due especially an amount of
money that is yet to be paid or received at the end of the accounting period. It means that revenues are
recognized when they become receivable. Though cash is received or not received and the expenses
are recognized when they become payable though cash is paid or not paid. Both transactions will be
recorded in the accounting period to which they relate. Therefore, the accrual concept makes a
distinction between the accrual receipt of cash and the right to receive cash as regards revenue and
actual payment of cash and obligation to pay cash as regards expenses.

The accrual concept under accounting assumes that revenue is realized at the time of sale of goods or
services irrespective of the fact when the cash is received. For example, a firm sells goods for Rs
55000 on 25th March 2005 and the payment is not received until 10th April 2005, the amount is due
and payable to the firm on the date of sale i.e. 25th March 2005. It must be included in the revenue
for the year ending 31st March 2005.

Similarly, expenses are recognized at the time services provided, irrespective of the fact when actual
payment for these services is made. For example, if the firm received goods costing Rs.20000 on 29th
March 2005 but the payment is made on 2nd April 2005 the accrual concept requires that expenses
must be recorded for the year ending 31st March 2005 although no payment has been made until 31st
March 2005 though the service has been received and the person to whom the payment should have
been made is shown as creditor.

In brief, accrual concept requires that revenue is recognized when realized and expenses are
recognized when they become due and payable without regard to the time of cash receipt or cash
payment.

Significance

1) It helps in knowing actual expenses and actual income during a particular time period.

2) It helps in calculating the net profit of the business.

9. Matching Concept: The matching concept states that the revenue and the expenses incurred to earn
the revenues must belong to the same accounting period. So once the revenue is realized, the next step
is to allocate it to the relevant accounting period. This can be done with the help of accrual concept.
Let us study the following transactions of a business during the month of December, 2006.

a. Sale : cash Rs.2000 and credit Rs.1000

 b. Salaries Paid Rs.350

c. Commission Paid Rs.150

d. Interest Received Rs.50

e. Rent received Rs.140, out of which Rs.40 received for the year 2007

f. Carriage paid Rs.20

g. Postage Rs.30

h. Rent paid Rs.200, out of which Rs.50 belong to the year 2005

i. Goods purchased in the year for cash Rs.1500 and on credit Rs.500

j. Depreciation on machine Rs.200

Let us record the above transactions under the heading of Expenses and Revenue.

Expenses Amount (Rs.) Revenue Amount (Rs.)

1. Salaries 350 1. Sales

2. Commission 150 Cash 2000

3. Carriage 20 Credit 1000 3000

4. Postage 30 2. Interest received 50

5. Rent Paid 200 3. Rent received 140

Less for 2005 (50) 150 Less for 2007 (40) 100

6. Goods purchased

Cash 1500

Credit 500 2000

7. Depreciation on machine 200

Total 2900 Total 3150

In the above example expenses have been matched with revenue i.e., (Revenue Rs.3150-Expenses
Rs.2900). This comparison has resulted in profit of Rs.250. If the revenue is more than the expenses,
it is called profit. If the expenses are more than revenue it is called loss. This is what exactly has been
done by applying the matching concept. Therefore, the matching concept implies that all revenues
 earned during an accounting year, whether received/not received during that year and all cost
incurred, whether paid/not paid during the year should be taken into account while ascertaining profit
or loss for that year.

Significance

1) It guides how the expenses should be matched with revenue for determining exact profit or loss
for a particular period.

2) It is very helpful for the investors/shareholders to know the exact amount of profit or loss of the
business.

10. Rupee Value Concept: This concept assumes that the value of rupee is constant. In fact, due to
inflationary pressures, the value of rupee will be declining. Under these situations financial statements
are prepared on the basis of historical costs not considering the declining value of rupee. Similarly
depreciation is also charged on the basis of cost price. Thus, this concept results in underestimation of
depreciation and overestimation of assets in the balance sheet and hence will not reflect the true
position of the business.

ACCOUNTING CONVENTIONS

1. Convention of consistency: The convention of consistency means that same accounting principles
should be used for preparing financial statements year after year. A meaningful conclusion can be
drawn from financial statements of the same enterprise when there is comparison between them over
a period of time. But this can be possible only when accounting policies and practices followed by the
enterprise are uniform and consistent over a period of time. If different accounting procedures and
practices are used for preparing financial statements of different years, then the result will not be
comparable.

Generally a businessman follows the under mentioned general practices or methods year after year.

i. While charging depreciation on fixed assets or valuing unsold stock, once a particular method is
used it should be followed year after year so that the financial statements can be analyzed and
compared provided the depreciation on fixed assets is charged or unsold stock is valued by using
particular method year after year. This can be further clarified as: in case of charging depreciation
on fixed assets accountant can decide to adopt any one of the methods of depreciation such as
diminishing value method or straight line method.
 ii. Similarly, in case of valuation of closing stock it can be valued at actual cost price or market price
or whichever is less. However precious metals like gold, diamond, minerals are generally valued
at market price only.

Types of consistency: There are three types of consistency namely :

a. Vertical consistency (Same organization) : It is to be found within the group of inter-related

financial statements of an organization on the same date. It occurs when fixed assets have
been shown at cost price and in the interrelated income statement depreciation has also been
charged on the historical cost of the assets.

b. Horizontal consistency (Time basis) : This consistency is to be found between financial

statements of one entity from period to period. Thus, it helps in comparing performance of
the business between two years i.e. current year with past year.

c. Dimensional consistency (Two organizations in the same trade) : This consistency is to be

found in the statements of two different business entities of the same period. This type of
consistency assists in making comparison of the performance of one business entity with the
other business entity in the same trade and on the same date.

Therefore, as per this convention the same accounting methods should be adopted every year in preparing
financial statements. But it does not mean that a particular method of accounting once adopted can never
be changed. Whenever a change in method is necessary, it should be disclosed by way of footnotes in the
financial statements of that year.

Significance

1) It facilitates comparative analysis of the financial statements.

2) It ensures uniformity in charging depreciation on fixed assets and valuation of closing stock.

2. Convention of full disclosure: Convention of full disclosure requires that all material and relevant
facts concerning financial statements should be fully disclosed. Full disclosure means that there
should be full, fair and adequate disclosure of accounting information. Adequate means sufficient set
of information to be disclosed. Fair indicates an equitable treatment of users. Full refers to complete
and detailed presentation of information. Thus, the convention of full disclosure suggests that every
financial statement should fully disclose all relevant information. Let us relate it to the business. The
business provides financial information to all interested parties like investors, lenders, creditors,
shareholders etc. The shareholder would like to know profitability of the firm while the creditor
would like to know the solvency of the business. In the same way, other parties would be interested in
 the financial information according to their requirements. This is possible if financial statement
discloses all relevant information in full, fair and adequate manner.

Let us take an example. As per accounts, net sales are Rs.150,000, it is important for the interested
parties to know the amount of gross sales which may be Rs.200,000 and the sales return Rs.50,000.
The disclosure of 25% sales returns may help them to find out the actual sales position. Therefore,
whatever details are available, that must be honestly provided. Additional information should also be
given in the financial statement. For example, in a balance sheet the basis of valuation of assets, such
as investments, inventories, land and building etc. should be clearly stated. Similarly, any change in
the method of depreciation or in making provision for bad debts or creating any reserve must also be
shown clearly in the Balance Sheet. Therefore, in order to achieve the purpose of accounting, all the
transactions of a business and any change in accounting policies, methods and procedures are fully
recorded and presented in accounting.

To ensure proper disclosure of material accounting information, the Companies Act 1956, under
schedule VI has provided a format for the preparation of Profit and Loss account and Balance Sheet
of a company. It is necessary for every company to follow this format. The regulatory bodies like
Securities and Exchange Board of India (SEBI) has also made compulsory for complete disclosures
by registered companies.

Significance

1) It helps in meaningful comparison of financial statements of the different business units. This can
also help in the comparison of financial statements of different years of the same business unit.

2) This convention is of great help to investor and shareholder for making investment decisions.

3) The convention of full disclosure presents reliable information.

3. Convention of materiality: The convention of materiality states that, to make financial statements
meaningful, only material fact i.e. important and relevant information should be supplied to the users
of accounting information. The question that arises here is what a material fact is. The materiality of a
fact depends on its nature and the amount involved. Material fact means the information of which will
influence the decision of its user.

For example, a businessman is dealing in electronic goods. He purchases T.V., Refrigerator, Washing
Machine, Computer etc. for his business. In buying these items he uses larger part of his capital.
These items are significant items; thus should be recorded in books of accounts in detail.
 At the same time to maintain day to day office work he purchases pen, pencil, match box, scented
stick, etc. For this he will use very small amount of his capital. But to maintain the details of every
pen, pencil, match box or other small items is not considered of much significance. These items are
insignificant items and hence they should be recorded separately. Thus, the items that are
significantly important in recording the details are termed material facts or significant items. The
items that are of less significance are immaterial facts or insignificant items. Thus according to this
convention important and significant items should be recorded in their respective heads and all
immaterial or insignificant transactions should be clubbed under a different accounting head.

Significance

1) It helps in minimizing errors in calculation.

2) It helps in making financial statements more meaningful.

3) It saves time and resources.

4. Convention of conservatism: This convention is based on the principle that “Anticipate no profit,
but provide for all possible losses”. It provides guidance for recording transactions in the books of
accounts. It is based on the policy of playing safe in regard to showing profit. The main objective of
this convention is to show minimum profit. Profit should not be overstated. If profit shows more than
actual, it may lead to distribution of dividend out of capital. This is not a fair policy and it will lead to
the reduction in the capital of the enterprise.

Thus, this convention clearly states that profit should not be recorded until it is realized. But if the
business anticipates any loss in the near future, provision should be made in the books of accounts for
the same. For example, valuing closing stock at cost or market price whichever is lower, creating
provision for doubtful debts, discount on debtors, writing off intangible assets like goodwill, patent,
etc. The convention of conservatism is a very useful tool in situation of uncertainty and doubts.

Significance

1) It helps in ascertaining actual profit.

2) It is useful in the situation of uncertainties and doubts.

3) It helps in maintaining the capital of the enterprise.

 JOURNALIZING TRANSACTIONS
The word Journal comes from the French word “Jour”, meaning “day”. A journal is a historical record of
business transactions, which records day-to-day transactions of a business in the order in which they
occur. A Journal may, therefore, be defined as a book containing a chronological record of transactions.

It is the book in which the transactions are recorded first under a double-entry system. Thus, Journal is the
book of original record since every transaction is recorded firstly in the journal.

The process of recording transactions in a Journal is termed as Journalizing. The general performance of
Journal is shown as follows:

JOURNAL

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

(1) (2) (3) (4) (5)

Column 1 (Date): The date of the transaction on which it takes pale is written in this column.
Column 2 (Particulars): In this column, the name of the accounts to the debited is written first, then the
names of the accounts to be credited and lastly, the narration (i.e. a brief explanation of
transaction) are entered.
Column 3 (L.F.): L.F. stands for Ledger Folio which means page of the ledger. The transactions entered
in the Journal are later on posted to the Ledger. The relevant Ledger Folio is entered here.
Column 4 (Dr. Amount): In this column, the amount to be debited against the ‘Dr.’ Account is written
along with the nature of currency.
Column 5 (Cr. Amount): In this column the amount to be credited against the ‘Cr.’ Account is written
along with the nature of currency.

Advantages of Using Journal:

Journal is used because of the following advantages:

 A journal contains a permanent record of all the business transactions.

 The journal provides a complete chronological (in order of the time of occurrence) history of all
business transactions and the task of later tracing of some transactions is facilitated.
 Complete information relating to one single business transaction is available in one place with all
its aspects.
  The transaction is provided with an explanation technically called a narration.
 Use of the journal reduces the possibility of an error when transactions are first recorded in this
book.
 The journal establishes the quality of debits and credits for a transaction and reconciles any
problems. If a business purchases a bicycle, it is necessary to decide whether the bicycle
represents ordinary goods or machinery. Further any amount paid is debited to bicycle account
and credited to cash account.
 The use of journals avoids omission or duplication of transactions or parts of transaction. Without
the journal the accountant would be forced to got to the individual account to enter debits and
credits. Therefore it is possible for accountant to miss part of a transaction, duplicate all or part of
a transaction or incorrectly record debits and credits. Even with the Journal, it is still possible to
omit transactions and make other errors. However, the Journal reduces these problems.
 Once a transaction is recorded in the journal, it is not necessary to post it immediately in the
ledger accounts. In this, way, the journal allows the delayed posting.

In connection with the journal, the following points are to be remembered:

 For each transaction, the exact accounts should be debited and credited. For that, the two accounts
involved must be identified to pass a proper journal entry.
 Sometimes, a journal entry may have more than one debit or more than one credit. This type of
journal entry is called compound journal entry. Regardless of how many debits or credits are
contained in a compound journal entry, all the debits are entered before any credits are entered.
The aggregate amount of debits should be equal to the aggregate amount of credits.
 For a business, journal entries generally extend to several pages. Therefore, the total are cast at
the end of each page, against the debit and credit columns, the following words and written in the
particular column, which indicates, carried forward (of the amount on the next page) “Total c/f”.
 The debits and credits totals of the page are then written on the next page in the amount columns;
and opposite to that on the left, the following words are written in the particulars column to
indicate brought forward (of the amount of the previous page) “Total b/f”. This process is
repeated on every page and on the last page; “Grand Total” is cast.
 CLASSIFICATION OF ACCOUNTS

ACCOUNTS

Personal Account Impersonal Account

Natural Artificial Representative Real Account Nominal Account

Personal Personal Personal
Account Account Account

Expenses and Incomes and

Losses Gains

Tangible Real Intangible

Account Real Account
 [ENGINEERING ECONOMY] MODULE 1

 Personal Accounts:
Accounts which are related with accounts of individuals, firms, companies are known as personal
accounts. The personal accounts may further be classified into three categories:

 Natural Personal Accounts: The term ‘Natural Person’ means persons who are creation of
God. Accounts of individuals relating to natural persons such as Akhil’s A/c, Rajesh’s A/c,
Sohan’s A/c are Natural Personal Accounts.

 Artificial Personal Accounts: Accounts of corporate bodies, companies, or institutions

which are recognized as person in business dealing are termed as Artificial Personal
Accounts. For example, accounts of Reliance Industries Ltd; Lions Club, M/s Sham &
Sons, National College account are come in category of Artificial Personal Accounts.
These exist only in the eyes of law.
 Representative Personal Accounts: The accounts which represent a certain person or a
group of persons. For example, if the rent is due to the landlord, an outstanding rent
account will be opened in the book of account. Similarly, for salaries due to the employees
(not paid), an outstanding salaries account will be opened. The outstanding rent account
represents the account of the landlord to whom the rent is to be paid while the outstanding
salaries account represents the accounts of the persons to whom the salaries have to be
paid. All such accounts are, therefore, termed as Representative Personal Accounts.

RULE:
DEBIT THE RECEIVER
CREDIT THE GIVER

For example, if cash has been paid to Ram, the account of RAM will have to be debited.
Similarly, if cash has been received from Mohan, the account of Mohan will have to be credited.

 Real Accounts:
Real accounts are the accounts related to assets/properties. These may be classified into tangible
real account and intangible real account.

 Tangible Real Accounts: Tangible Real Accounts are those accounts which are related to
such things which can be touched, felt, measured, etc. For example, building, plant,
machinery, cash, furniture etc. are tangible real accounts.

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 Intangible Real Accounts: Intangible Real Accounts are those accounts which are related
to such things which cannot be touched. For example, goodwill, trademarks, copyrights,
franchisees, Patents etc.

RULE:
DEBIT WHAT COMES IN
CREDIT WHAT GOES OUT

For example, if building has been purchased for cash, building account should be debited while
cash account should be credited.

 Nominal Accounts:
The accounts relating to income, expenses, losses and gains are classified as nominal accounts.
For example, Wages Account, Rent Account, Interest Account, Salary Account, Bad Debts
Accounts. These accounts are opened in the books to simply explain the nature of the
transactions. In actual, they do not really exist. However, in the absence of such information, it
may be difficult for the person concerned to explain how the cash at his disposal was utilized.

RULE:
DEBIT ALL EXPENSES AND LOSSES
CREDIT ALL GAINS AND INCOMES

NOTE: Both Real Accounts and Nominal Accounts come under the category of Impersonal Accounts. It
should be noted that when some Prefix or Suffix is added to Nominal Account, it becomes a Personal
Account. Table shows some such accounts.

S. No. Nominal Account Personal Account

1. Rent Account Rent Prepaid Account, Outstanding Rent Account.
2. Interest Account Outstanding Interest Account, Interest Prepaid Account.
3. Salary Account Outstanding Salary Account, Prepaid Salary Account.
4. Insurance Account Outstanding Insurance Account, Prepaid Insurance Account.
5. Commission Account Outstanding Commission Account, Prepaid Commission Account.

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JOURNALIZING

Journalizing is the process of recording journal entries in the Journal. It is a systematic act of entering the
transaction in a day book in order of their occurrence i.e., date-wise or event-wise. After analyzing the
business transactions, the following steps in journalizing are followed:

1) Find out what accounts are involved in business transaction.

2) Ascertain what is the nature of accounts involved?
3) Ascertain the golden rule of debit and credit is applicable for each of the accounts involved.
4) Find out what account is to be debited which is to be credited.
5) Record the date of transaction in the “Date Column”.
6) Write the name of the account to be debited very near to the left hand side in the ‘Particulars Column’
along with the word ‘Dr’ on the same line against the name of the account in the ‘Particulars Column’
and the amount to be debited in the ‘Debit Amount column’ against the name of the account.
7) Record the name of the account to be credited in the next line preceded by the word ‘To’ at a few
space towards right in the ‘Particulars Column’ and the amount to be credited in the ‘Credit Amount
Column’ in front of the name of the account.
8) Record narration (i.e. a brief explanation of the transaction) within brackets in the following line in
‘Particulars Column’.
9) A thin line is drawn all through the particulars column to separate one Journal entry from the other
and it shows that the entry of a transaction has been completed.

Illustration 1: How will you classify the following into personal, real and nominal accounts?

(i) Investments (ix) Indian Bank Ltd.

(ii) Freehold Premises (x) Capital Account
(iii) Accrued Interest (xi) Brokerage Account
(iv) Punjab Agro Industries Corporation (xii) Toll Tax Account
(v) Janata Allied Mechanical Works (xiii) Dividend Received Account
(vi) Salary Accounts (xiv) Royalty Account
(vii) Loose Tools Accounts (xv) Sales Account
(viii) Purchases Account

Solution:
1) Real Account: (i), (ii), (vii), (viii), (xv).
2) Nominal Account: (vi), (ix), (xi), (xii), (xiii), (xiv)
3) Personal Account: (iii), (iv), (v), (x)

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 [ENGINEERING ECONOMY] MODULE 1

Illustration 2: From the following transactions find out the nature of account and also state which
account should be debited and which account should be credited.

1) Rent paid 7) Outstanding for salaries

2) Salaries paid 8) Telephone charges paid
3) Interest received 9) Paid to Suresh
4) Dividends received 10) Received from Mohan (Proprietor)
5) Furniture purchased for cash 11) Lighting
6) Machinery sold

Solution:

S. No. Transaction Accounts Involved Nature of Accounts Debit/Credit

1. Rent paid Rent A/c Nominal A/c Debit
Cash A/c Real A/c Credit
2. Salaries paid Salaries A/c Nominal A/c Debit
Cash A/c Real A/c Credit
3. Interest received Cash A/c Real A/c Debit
Interest A/c Nominal A/c Credit
4. Dividends received Cash A/c Real A/c Debit
Interest A/c Nominal A/c Credit
5. Furniture purchased for Furniture A/c Real A/c Debit
cash
Cash A/c Real A/c Credit
6. Machinery sold Cash A/c Real A/c Debit
Machinery A/c Real A/c Credit
7. Outstanding for salaries Salaries A/c Nominal A/c Debit
Outstanding salaries A/c Personal A/c Credit
8. Telephone charges paid Telephone charge A/c Nominal A/c Debit
Cash A/c Real A/c Credit
9. Paid to Suresh Suresh A/c Personal A/c Debit
Cash A/c Real A/c Credit
10. Received from Mohan Cash A/c Real A/c Debit
(Proprietor)
Capital A/c Personal A/c Credit
11. Lighting Lighting A/c Nominal A/c Debit
Cash A/c Real A/c Credit

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 [ENGINEERING ECONOMY] MODULE 1

Illustration 3: Journalize the following transaction for the month of January, 2018.
Ram started a business with a capital of ₹20,000 on January 1, 2018. He purchased furniture for cash
₹5,000 on January 5, 2018. He paid rent for business premises ₹2,000 on January 10, 2018. He purchased
goods on credit of ₹2,000 from Suresh on January 20, 2018.

Solution:

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

2018 Cash A/c Dr. 20,000
Jan. 1
To Capital A/c 20,000
(Being commencement of business)
2018 Furniture A/c Dr. 5,000
Jan. 5
To Cash A/c 5,000
(Being purchase of furniture)
2018 Rent A/c Dr. 2,000
Jan. 10
To Cash A/c 2,000
(Being payment of rent)
2018 Goods A/c Dr. 2,000
Jan. 20
To Suresh A/c 2,000
(Being purchase of goods on credit)

1) Ram started a business with a capital of ₹20,000 on January 1, 2018.

Ram is natural person and, therefore, his account is a Personal Account. Cash Account is a tangible
asset and, therefore, it is a Real Account. As per the rules of Debit and Credit, applicable to Personal
Accounts, Ram is the giver and, therefore, his account, i.e., Capital Account should be credited. Cash
is coming in the business and, therefore, as per the rules applicable to Real Accounts, it should be
debited.

The words put within brackets “Being commencement of business” constitute the narration for the
entry passed, since, they narrate the transaction.

2) He purchased furniture for cash for ₹5,000 on January 5, 2018.

The two accounts involved in this transaction are the Furniture Account and the Cash Account. Both
are Real Accounts. Furniture is coming in and, therefore, it should be debited while cash is going out
and, therefore, it should be credited.

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 [ENGINEERING ECONOMY] MODULE 1

3) He paid rent for business premises ₹2,000 on January 10, 2018.

In this transaction, two accounts involved are the Rent Account and the Cash Account. Rent Account
is Nominal Account. It is an expense and, therefore, it should be debited. Cash Account is a Real
Account. It is going out of the business and, therefore, it should be credited.

4) He purchased goods on credit of ₹2,000 from Suresh on January 20, 2018.

The two accounts involved in the transaction are those of Suresh and Goods. The account of Suresh is
a Personal Account while that of Goods is a Real Account. Suresh is the giver of goods and,
therefore, his account should be credited while Goods are coming in the business and, therefore,
Goods Account should be debited.

GOODS ACCOUNT:

The term goods include articles purchased by the business for resale. Goods purchased by the business
may be returned back to the supplier. Similarly, goods sold by the business to its customers can also be
returned by the customers back to the business due to certain reasons. In business, it is desired that a
separate record be kept of all sale, purchase and return of goods. Hence, Goods Accounts can be classified
into the following categories:

1) Purchases Account. The account is meant for recording all purchases of goods. Goods "come in" on
purchasing of goods and, therefore, the purchases Account is debited on purchase of goods.

2) Sales Account. The account is meant for recording of selling of goods. The goods "go out" on selling
of goods, and therefore, on sale of goods, the Sales Account is credited.

3) Purchases Returns Account. The account is meant for recording return of goods purchased. The
goods "go out" on returning of goods to the suppliers and, therefore, the account should be credited
on returning goods purchased.

4) Sales Returns Account. The account is meant for recording return of goods sold, by the customers.
The goods "come in" and, therefore, the Sales Returns Account should be debited on return of goods.

The above classification of Goods Accountꞏ can be shown in the form of the following chart:

GOODS
ACCOUNT

Purchases A/c Sales A/c Purchases Return A/c Sales Return A/c
Goods come in Goods go out Goods go out Goods come in
(Dr.) (Cr.) (Cr.) (Dr.)

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COMPOUND JOURNAL ENTRY:

Sometimes there are a number of transactions on the same date relating to one particular account or of one
particular nature. Such transactions may be recorded by means of a single journal entry instead of passing
several journal entries. Such entry regarding recording a number of transactions is termed as a
“Compound Journal Entry”.

It may be recorded in any of the following three ways:

i) One particular account may be debited while several other accounts may be credited.
ii) One particular account may be credited while several other accounts may be debited.
iii) Several accounts may be debited and several other accounts may also be credited.

Illustration 4: Pass a compound Journal entry in each of the following cases:

1) Payment made to Ram ₹1,000. He allowed a cash discount of ₹50.
2) Cash received from Suresh ₹800 and allowed him ₹50 as discount.
3) A running business was purchased by Mohan with the following assets and liabilities.
Cash ₹2,000; Land ₹40,000; Furniture ₹1,000; Stock ₹2,000; Creditors ₹1,000; and Bank
Overdraft ₹2,000.

Solution:
Sl. No. Particulars L.F. Debit (₹) Credit (₹)
1. Ram A/c Dr. 1,050
To Cash A/c 1,000
To Discount A/c 50
(Being payment made to Ram ₹1,000 and he
allowed ₹50 as discount)
2. Cash A/c Dr. 800
Discount A/c Dr. 50
To Suresh 850
(Being cash received from Suresh ₹800 and
discount allowed ₹50)
3. Cash A/c Dr. 2,000
Land A/c Dr. 40,000
Furniture A/c Dr. 1,000
Stock A/c Dr. 2,000
To Creditors 1,000
To Bank Overdraft 2,000
To Capital A/c 42,000
(Being commencement of business by Mohan
by taking over a running business)

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 [ENGINEERING ECONOMY] MODULE 1

1) The total of payment due to Ram was ₹ 1,050. A payment of ₹1,000 has been made to him and he
allowed a discount of ₹50. This means by paying ₹1,000, a full credit for ₹1,050 has been obtained.
The account of Ram is a Personal Account, and therefore, it has been debited as he is the receiver.
The cash has gone out of the business and, therefore, Cash Account being a Real Account, has been
credited. Discount Account is a Nominal Account; getting discount is a gain to the business and,
therefore, it has been credited.

2) Suresh was to pay sum of ₹850. He paid ₹800 and he was allowed a discount of ₹50. It means by
paying ₹800 only, Suresh could get a full credit of ₹850. The Cash Account is a Real Account and,
therefore, it has been debited since cash is coming in. Discount Account is a Nominal Account; it has
been debited since it is a loss to the business. Suresh is the giver. His account being a Personal
Account, it has been credited by ₹850.

3) It is not necessary that a person should start business only with cash. He may bring the assets into the
business or he may purchase' a running business. Mohan in the present case has purchased the assets
of some other business. The net assets (i.e., assets-liabilities taken over) will be the capital of Mohan.
The business is getting various assets and, therefore, the assets accounts have been debited. The
business creates certain liabilities in the form of creditors, bank overdraft, and, therefore, these
accounts have been credited. Mohan's Account, i.e., his Capital Account has been credited the
balance since it represents the capital brought in by him.

Illustration 5: Journalize the following transactions for the month of Dec. 2017.

Dec. 1: Ajit started business with Cash ₹40,000.

Dec. 3: He paid into the Bank ₹2,000.
Dec. 5: He purchased goods for cash ₹15,000.
Dec. 8: He sold goods for cash ₹6,000.
Dec. 10: He purchased furniture and paid by cheque ₹5,000.
Dec. 12: He sold goods to Arvind ₹4,000.
Dec. 14: He purchased goods from Amrit ₹10,000.
Dec. 15: He returned goods to Arnrit ₹5,000.
Dec. 16: He received from Arvind ₹3,960 in full settlement.
Dec. 18: He withdrew goods for personal use ₹1,000.
Dec. 20: He withdrew cash from business for personal use ₹2,000.
Dec. 24: He paid telephone charges ₹1,000.
Dec. 26: Cash paid to Amrit in full settlement ₹4,900.

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Dec. 31: Paid for stationary ₹200, rent ₹500 and salaries to staff ₹2,000.
Dec. 31: Goods distributed by way of free samples ₹1,000.
Solution:
Date Particulars L.F. Debit (₹) Credit (₹)
Dec. 1 Cash A/c Dr. 40,000
To Capital A/c 40,000
(Being commencement of business)
Dec. 2 Bank A/c Dr. 20,000
To Cash A/c 20,000
(Being cash deposited in the Bank)
Dec. 5 Purchases A/c Dr. 15,000
To Cash A/c 15,000
(Being purchase of goods for cash)
Dec. 8 Cash A/c Dr. 6,000
To Sales A/c 6,000
(Being goods sold for cash)
Dec. 10 Furniture A/c Dr. 5,000
To Bank A/c 5,000
(Being purchase of furniture paid by cheque)
Dec. 12 Arvind Dr. 4,000
To Sales A/c 4,000
(Being goods sold)
Dec. 14 Purchases A/c Dr. 10,000
To Amrit 10,000
(Being purchase of goods from Amrit)
Dec. 15 Amrit Dr. 5,000
To Purchases Return A/c 5,000
(Being goods returned to Amrit)
Dec. 16 Cash A/c Dr. 3,960
Discount A/c Dr. 40
To Arvind 4,000
(Being cash received from Arvind in full
settlement and allowed him ₹40 as discount)
Dec. 18 Drawing A/c Dr. 1,000
To Purchases A/c 1,000
(Being withdrawal of goods for personal use)
Dec. 20 Drawing A/c Dr. 2,000
To Cash A/c 2,000
(Being cash withdrawal from the business for
personal use)
Dec. 24 Telephone Expenses A/c Dr. 1,000
To Cash A/c 1,000
(Being telephone expenses paid)

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Dec. 26 Amrit Dr. 5,000

To Cash A/c 4,900
To Discount A/c 100
(Being cash paid to Amrit and he allowed
₹100 as discount)
Dec. 31 Stationary Expenses A/c Dr. 200
Rent A/c Dr. 500
Salaries A/c Dr. 2,000
To Cash A/c 2,700
(Being expenses paid)
Dec. 31 Advertisement Expenses A/c Dr. 1,000
To Purchases A/c 1,000
(Being distribution of goods by way of free
samples)

Illustration 6: Pass the Journal entries for the following transactions.

1. Ram started business by introducing the following assets:

Cash ₹10,000
Furniture ₹20,000
Plant ₹30,000
Goods ₹20,000
2. He purchased goods of the invoice value of ₹10,000 at 10% trade discount from Suresh.
3. He supplied goods costing ₹1,000 to Ramesh at an invoice price of 10% above cost at a trade
discount of 5%.
4. He installed further machinery of ₹20,000 and paid wages for installation ₹2,000. The machinery
was supplied by M/s Surya Brothers.
5. He purchased stationery for business purposes ₹500.
6. He sold goods to Sidharth for ₹5,000.
7. He withdrew goods for personal use costing ₹5,000 (sale value ₹6,000).
8. He distributed goods costing ₹2,000 (sale value ₹2,500 as free samples).
9. Sidharth became insolvent and the whole money due from him was considered as a bad debt.
10. He sold goods for cash ₹20,000.
11. Salaries paid ₹10,000 after deduction ₹1,000 as income tax, ₹1,500 as employee’s share of
provident fund but before employer’s share of provident fund ₹1,500.
12. Amount due from Sidharth earlier written off bad debts recovered in full.
13. Amount paid to Suresh ₹8,500 in full satisfaction.
14. Income tax liability of Ram ₹1,000 paid in cash.

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Solution:
Sl. No. Particulars L.F. Debit (₹) Credit (₹)
1. Cash A/c Dr. 10,000
Furniture A/c Dr. 20,000
Plant A/c Dr. 30,000
Purchases (Goods) A/c Dr. 20,000
To Ram’s Capital 80,000
(Being commencement of businesses with
cash and other assets)
2. Purchases A/c Dr. 9,000
To Suresh 9,000
( Being purchase of goods from Suresh)
(Invoice price ₹10,000 less Trade Discount
10%)
3. Ramesh Dr. 1,045
To Sales A/c 1,045
(Being goods sold invoice price of ₹1,100
less Trade Discount of 5%)
4. Machinery A/c Dr. 22,000
To Cash A/c 2,000
To Surya Brothers 20,000
(Being cost of machinery purchased
₹20,000; installation charges incurred
₹2,000)
5. Stationery A/c Dr. 500
To Cash A/c 500
(Being stationary purchased for business
purposes)
6. Siddhartha Dr. 5,000
To Sales A/c 5,000
(Being sale of goods to Siddhartha)
7. Drawings A/c Dr. 5,000
To Purchases A/c 5,000
(Being goods withdrawn for personal use)
8. Advertisement A/c Dr. 2,000
To Purchases A/c 2,000
(Being goods distributed by way of free
samples)
9. Bad Debits A/c Dr. 5,000
To Siddhartha 5,000
(Beings money due from Siddhartha
written off as bad debts)
10. Cash A/c Dr. 20,000
To Sales A/c 20,000
( Being sale of goods for cash)

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11. Salaries A/c Dr. 14,000

To Cash A/c 10,000
To Tax Deducted at Source 1,000
To Employees Provident Fund 3,000
(Being payment of salary after deduction
of tax at source and employer’s and
employees contribution to Provident Fund)
12. Cash A/c Dr. 5,000
To Bad Debits Recovered A/c 5,000
(Being amount earlier written off as bad
debts and now recovered)
13. Suresh Dr. 9,000
To cash A/c 8,500
To Discount A/c 500
(Being amount paid to Suresh and earned
₹500 as cash discount)
14. Drawings A/c Dr. 1000
To Cash A/c 1,000
(Beings Income tax paid)
1,78,045 1,78,045

OPENING ENTRY:

In case of a running business, the assets and liabilities appearing in the previous year’s balance sheet will
have to be brought forward to the current year. This is done by means of a journal entry which is termed
as “Opening Entry”.

All Assets Accounts are debited while all Liabilities Accounts are credited. The excess of assets over
liabilities is the proprietor’s capital and is credited to his Capital Account.

Illustration 7: Pass the Opening Entry on January 1, 2018 on the basis of the following information taken
from the business of Mr. Sunil:

(i) Cash in Hand ₹2,000

(ii) Sundry Debtors ₹6,000
(iii) Stock of Goods ₹4,000
(iv) Plant ₹5,000
(v) Land and Buildings ₹10,000
(vi) Sundry Creditors ₹10,000

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Solution:
Date Particulars L.F. Debit (₹) Credit (₹)
2018 Cash A/c Dr. 2,000
Jan. 1 Sundry Debtors A/c Dr. 6,000
Stock A/c Dr. 4,000
Plant A/c Dr. 5,000
Land and Buildings A/c Dr. 10,000
To Sundry Creditors 10,000
To Capital A/c (balancing figure) 17,000
(Being balances brought forward from the
last year)
27,000 27,000

Illustration 8: Joumalise the following transactions in the books of a trader.

1. Opening entries on Jan. 1, 2016.
Debit Balances:
Cash in hand ₹8,000; Cash at Bank ₹25,000; Stock of Goods ₹20,000; Furniture ₹2,000; Building
₹10,000; Sundry Debtors: Vijay ₹2,000, Anil ₹1,000, and Madhu ₹2,000.
Credit Balances:
Sundry Creditors: Anand ₹5,000; Loan from Bablu ₹10,000.
2. Jan. 1: Purchased goods worth ₹5,000 for cash less 20% trade discount and 5% cash discount.
3. Jan. 4: Received ₹1,980 from Vijay and allowed him ₹20 as discount.
4. Jan. 6: Purchased goods from Bharat ₹5,000.
5. Jan. 8: Purchased plant from Mukesh for ₹5,000 and paid ₹100 as cartage for bringing the plant to
the factory and another ₹200 as installation charges.
6. Jan. 12: Sold goods to Rahim on credit ₹600.
7. Jan. 15: Rahim became an insolvent and could pay only 50 paise in a rupee.
8. Jan. 18: Sold goods to Ram for cash ₹1,000.
9. Jan. 20: Paid salary to Ratan ₹2,000.
10. Jan. 21: Paid Anand ₹4,800 in full settlement.
11. Jan. 26: Interest received from Madhu ₹200.
12. Jan. 28: Paid to Bablu interest on loan ₹500.
13. Jan. 31: Sold goods for cash ₹500.
14. Jan. 31: Withdrew goods from business for personal use ₹200.

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Solution:
Sl.
Date Particulars L.F. Debit (₹) Credit (₹)
No.
1. 2016 Cash A/c Dr. 8,000
Jan. 1 Bank A/c Dr. 25,000
Stock A/c Dr. 20,000
Furniture A/c Dr. 2,000
Building A/c Dr. 10,000
Vijay Dr. 2,000
Anil Dr. 1,000
Madhu Dr. 2,000
To Anand 5,000
To Bablu’s Loan A/c 10,000
To Capital A/c 55,000
(Being balance brought forward from last year)
2. Jan. 1 Purchases A/c Dr. 4,000
To Cash A/c 3,800
To Discount A/c 200
(Being purchase of goods for cash worth ₹5,000
allowed 20% trade discount and 5% cash
discount on ₹4,000)
3. Jan. 4 Cash A/c Dr. 1,980
Discount A/c Dr. 20
To Vijay 2,000
(Being cash received from Vijay, allowed ₹20 as
cash discount)
4. Jan. 4 Purchases A/c Dr. 5,000
To Bharat 5,000
(Being purchase of goods from Bharat)
5. Jan. 8 Plant A/c Dr. 5,300
To Mukesh 5,000
To Cash A/c 3,00
(Being purchase of plant for ₹5,000 and payment
of ₹100 as cartage and ₹200 as installation
charges)
6. Jan. 12 Rahim Dr. 600
To Sales A/c 600
(Being sale of goods to Rahim)
7. Jan. 15 Cash A/c Dr. 300
Bad Debit A/c Dr. 300
To Rahim 600
(Being cash received from Rahim after his being
declared as an insolvent. 50% of the amount due
has been received and the rest has been taken as
a bad debt)

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8. Jan. 18 Cash A/c Dr. 1,000

To Sales A/c 1,000
(Being goods sold for cash)
9. Jan. 20 Salary A/c Dr. 2,000
To Cash A/c 2,000
(Being salary paid)
10. Jan. 21 Anand Dr. 5,000
To Cash A/c 4,800
To Discount A/c 200
(Being cash paid to Anand and he allowed ₹200
as discount)
11. Jan. 26 Cash A/c Dr. 200
To Interest A/c 200
(Being receipt of interest)
12. Jan. 28 Interest on loan A/c Dr. 500
To Cash A/c 500
(Being payment of interest on loan)
13. Jan. 31 Cash A/c Dr. 500
To Sales A/c 500
(Being goods sold for cash)
14. Jan. 31 Drawings A/c Dr. 200
To Purchases A/c 200
(Being goods withdrawn for the personal use)
Total 96,900 96,900

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LEDGER
LEDGER:

Ledger is a book which is contains various accounts. In other words, it is a set of accounts. It contains all
the types of accounts of business enterprise whether Personal, Real or Nominal. It may be kept in any of
the following two forms:
i) Bound Ledger.
ii) Loose- leaf Ledger.

POSTING:

The term “Posting” means transferring the debit and credit items from the Journal to their respective
accounts in the Ledger.

The posting may be done by the book-keeper from the Journal to the Ledger by any of the following
methods:

1) He may take particular side first. For example, he may take debit first and make the complete
postings of all debits from Journal to the Ledger.

2) He may take a particular accounts and post all debits and credits relating to that account opening
on one particular page of Journal.

3) He may complete posting of each Journal entry before proceeding to the next Journal entry. [It is
Preferred]

The Ledger folio (L.F.) column in the Journal is used at the time when debits and credits are posted to the
Ledger. The page number of the Ledger on which the posting has been done is mentioned in the ledger
folio (L.F.) column of the Journal. Similarly, a folio column in the Ledger can also be kept where the
page from when posting has been done from the journal may be mentioned. Thus, there are cross
references in both the Journal and the Ledger.

Also, a proper index should be maintained in the Ledger by giving the names of the accounts and the
page numbers.

RELATIONSHIP BETWEEN JOURNAL AND LEDGER:

1) The transactions are recorded first-of-all in the Journal and then they are posted to the Ledger.
Thus Journal is the book of first or original entry, while the Ledger is the book of second entry.

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2) Journal records transactions in a chronological order, while the Ledger records transactions in an
analytical order.

3) Journal is more reliable as compared to the Ledger since it is the book in which the entry is
passed first-of-all.

4) The process of recording transactions in Journals in termed as “Journalizing” while the process
of recording transactions in Ledger is called as “Posting”.

RULES REGARDING POSTING:

The following rules should be observed while posting transactions in the Ledger from the Journal:

1) Separate accounts should be opened in the Ledger for posting transactions relating to different
accounts recorded in the Journal. For example, separate accounts may be opened for sales,
purchases, sales returns, purchases returns, salaries, rent, cash, etc.

2) The concerned account which has been debited in the Journal should also be debited in the
Ledger. However, a reference should be made of the other account which has been credited in the
Journal. For example, for salaries paid, the salaries account should be debited in the Ledger, but
reference should be given of the Cash Account which was has been credited in the Journal.

3) The concerned account, which has been credited in the Journal should also be credited in the
Ledger, but reference should be given of the account, which has been debited in the Journal. For
example, for salaries paid, Cash Account has been credited in the Journal. It will be credited in
the Ledger also, but reference will be given of the Salaries Account in the Ledger.

4) It is customary to use words ‘To’ and ‘By’ while making posting in the Ledger. The word ‘To’ is
used with the accounts which appear on the debit side of a Ledger Account. Similarly, the word
‘By’ is used with accounts which appear on the credit side of a Ledger Account.

GENERAL PERFORMA OF LEDGER ACCOUNT:

Dr. Cr.
Date Particulars (₹) Date Particulars (₹)

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Illustration 9: Journalize the following transactions and post them into the Ledger:

i) Ram started business with a capital of ₹10,000.

ii) He purchased furniture for cash ₹4,000.
iii) He purchased goods from Mohan on credit ₹2,000.
iv) He paid cash to Mohan ₹1,000.

Solution:

JOURNAL

Sl. No. Particulars L.F. Debit (₹) Credit (₹)

1. Cash A/c Dr. 10,000
To Capital A/c 10,000
(Being Commencement of Business)
2. Furniture A/c Dr. 4,000
To Cash A/c 4,000
3. Purchase A/c Dr. 2,000
To Mohan 2,000
4. Mohan Dr. 1,000
To Cash A/c 1,000

LEDGER
Cash Account
Dr. Cr.
Sl. No. Particulars (₹) Sl. No. Particulars (₹)
1. To Capital A/c 10,000 1. By Furniture A/c 4,000
2. By Mohan 1,000
Capital Account
Dr. Cr.
Sl. No. Particulars (₹) Sl. No. Particulars (₹)
1. By Cash A/c 10,000
Furniture Account
Dr. Cr.
Sl. No. Particulars (₹) Sl. No. Particulars (₹)
1. To Cash A/c 4,000
Purchase Account
Dr. Cr.
Sl. No. Particulars (₹) Sl. No. Particulars (₹)
1. To Mohan 2,000

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Mohan
Dr. Cr.
Sl. No. Particulars (₹) Sl. No. Particulars (₹)
1. To Cash A/c 1,000 1. By Purchase A/c 2,000

BALANCING OF AN ACCOUNT:

In business, there may be several transactions relating to one particular account. In Journal, these
transactions appear on different pages in a chronological order while they appear in a classified form
under that particular account in the Ledger. At the end of a period (say, a month, a quarter or a year), the
businessman will be interested in knowing the position of a particular account. This means, he should
total the debits and credits of the account separately and find out the net balance.

Thus, the technique of finding out the net balance of an account, after considering the totals of both debits
and credits appearing in the account is known as “Balancing the Account”'.

The balance is put on the side of the account which is smaller and a reference is given that it has been
carried forward or carried down (c/f or c/d) to the next period. On the other hand, in the next period, a
reference is given that the opening has been brought forward or brought down (b/f or b/d) from the
previous period.

Illustration 10: Journalize the following transactions, post them in the Ledger and balance the accounts
on 31st January.

1. Ram started business with a capital of ₹10,000.

2. He purchased goods from Mohan on credit ₹2,000.
3. He Paid cash to Mohan ₹1,000.
4. He sold goods to Suresh ₹2,000.
5. He received cash from Suresh ₹3,000.
6. He further purchased goods from Mohan ₹2,000.
7. He paid cash to Mohan ₹1,000.
8. He further sold goods to Suresh ₹2,000.
9. He received cash from Suresh ₹1,000.

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Solution:

JOURNAL
Sl.
Particulars L.F. Debit (₹) Credit (₹)
No.
1. Cash A/c Dr. 10,000
To Capital A/c 10,000
(Being Commencement of Business )
2. Purchase A/c Dr. 2,000
To Mohan A/c 2,000
(Being Purchase of Goods on Credits)
3. Mohan Dr. 1,000
To Cash A/c 1,000
(Being Payment of Cash to Mohan)
4. Suresh Dr. 2,000
To Sales A/c 2,000
(Being Goods sold to Suresh)
5. Cash A/c Dr. 3,000
To Suresh 3,000
(Being Cash received from Suresh)
6. Purchase A/c Dr. 2,000
To Mohan 2,000
(Being Purchase of Goods from Mohan)
7. Mohan Dr. 1,000
To Cash A/c 1,000
(Being Payment of Cash to Mohan)
8. Suresh Dr. 2,000
To Sales A/c 2,000
(Being Goods sold to Suresh)
9. Cash A/c Dr. 1,000
To Suresh 1,000
(Being Cash received from Suresh)
TOTAL 24,000 24,000

LEDGER
Cash Account
Dr. Cr.
Date Particulars (₹) Date Particulars (₹)
To Capital A/c 10,000 By Mohan 1,000
To Suresh 3,000 By Mohan 1,000
To Suresh 1,000 Jan. 31 By Balance c/d 12,000
14,000 14,000
Feb. 1 To Balance b/d 12,000

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Capital Account
Dr. Cr.
Date Particulars (₹) Date Particulars (₹)
Jan. 31 To Balance c/d 10,000 By Cash A/c 10,000
10,000 10,000
Feb. 1 By Balance b/d 10,000
Purchases Account
Dr. Cr.
Date Particulars (₹) Date Particulars (₹)
To Mohan 2,000 Jan. 31 By Balance c/d 4,000
To Mohan 2,000 4,000
4,000
Feb. 1 To Balance b/d 4,000
Mohan
Dr. Cr.
Date Particulars (₹) Date Particulars (₹)
To Cash A/c 1,000 By Purchase A/c 2,000
To Cash A/c 1,000 By Purchase A/c 2,000
Jan. 31 To Balance c/d 2,000 4,000
4,000
Feb. 1 By Balance b/d 2,000

Suresh
Dr. Cr.
Date Particulars (₹) Date Particulars (₹)
To Sales A/c 2,000 By Cash A/c 3,000
To sales A/c 2,000 By Cash A/c 1,000
4,000 4,000
Sales Account
Dr. Cr.
Date Particulars (₹) Date Particulars (₹)
Dec. 31 To Balance c/d 4,000 By Suresh 2,000
4,000 By Suesh 2,000
4,000
Feb. 1 By Balance b/d 4,000

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TRIAL BALANCE
Trial Balance is a statement that contains various debit balances and the credit balances of the different
accounts of a particular period. Thus, the two sides of the Trial Balance tally. It means the books of
accounts are arithmetically accurate.

Objects of Preparing a Trial Balance:

i) Checking of the arithmetical accuracy of the accounting entries.

ii) Basis for financial statements.
iii) Summarized ledger.

Methods of Preparation of a Trial Balance:

A Trial Balance may be prepared according to any of the two methods:

1) Total Method. In case of this method after totaling each side of the ledger account, the respective
debit and credit totals of the ledger accounts are transferred to the respective sides of the trial
balance. Thus, in case of this method, the trial balance can be prepared soon after totaling various
accounts and the time taken in balancing the account is saved to that extent. This method is not
generally followed since it does not help in preparation of financial statements.
2) Balance Method. According to this method, every ledger account is balanced and only the
balance of the ledger account is carried forward to the trial balance. This method is generally used
since the preparation of the financial statements where only balances are to be taken.
3) Total and Balance Method. This method combines the first two methods explained above. In
case of this method, the trial balance contains both the totals of both sides of the respective
accounts as well as their final balances. This method has the advantage that it helps in immediate
location of a mistake incurred, if any in the balancing the account However, it has disadvantage
of increasing the workload of the staff.

Illustration 11 Prepare (a) ledger accounts and (b) the trial balance according to (i) Total method (ii)
Balance method and (iii) Total and balance method on the basis of transactions given in Illustration 4.7.

(i) Total Method:

TRIAL BALANCE
(as on 31st January, 2016)
Particulars Debit (₹) Credit (₹)
Cash A/c 11,980 11,400

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Interest A/c 200

Bank A/c 25,000
Stock A/c 20,000
Furniture A/c 2,000
Building A/c 10,000
Vijay 2,000 2,000
Anil 1,000
Madhu 2,000
Anand 5,000 5,000
Capital A/c 55,000
Babu’s Loan A/c 10,000
Purchases A/c 9,000 200
Discount A/c 20 400
Bharat 5,000
Plant A/c 5,300
Interest on Loan A/c 500
Mukesh 5,000
Sales A/c 2,100
Rahim 600 600
Bad Debts A/c 300
Salary A/c 2,000
Drawing A/c 200
TOTAL 96,900 96,900

(ii) Balance Method:

TRIAL BALANCE
(as on 31st January, 2016)
Particulars Debit (₹) Credit (₹)
Cash A/c 580
Interest A/c 200
Bank A/c 25,000
Stock A/c 20,000
Furniture A/c 2,000
Building A/c 10,000
Anil 1,000
Madhu 2,000
Capital A/c 55,000
Babu’s Loan A/c 10,000
Purchases A/c 8,800
Discount A/c 380
Bharat 5,000

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Plant A/c 5,300

Interest on Loan A/c 500
Mukesh 5,000
Sales A/c 2,100
Bad Debts A/c 300
Salary A/c 2,000
Drawing A/c 200
TOTAL 77,680 77,680

(iii) Total and Balance Method:

TRIAL BALANCE
(as on 31st January, 2016)
Total Method Balance Method
Particulars
Debit (₹) Credit (₹) Debit (₹) Credit (₹)
Cash A/c 11,980 11,400 580
Interest A/c 200 200
Bank A/c 25,000 25,000
Stock A/c 20,000 20,000
Furniture A/c 2,000 2,000
Building A/c 10,000 10,000
Vijay 2,000 2,000
Anil 1,000 1,000
Madhu 2,000 2,000
Anand 5,000 5,000
Capital A/c 55,000 55,000
Babu’s Loan A/c 10,000 10,000
Purchases A/c 9,000 200 8,800
Discount A/c 20 400 380
Bharat 5,000 5,000
Plant A/c 5,300 5,300
Interest on Loan A/c 500 500
Mukesh 5,000 5,000
Sales A/c 2,100 2,100
Rahim 600 600
Bad Debts A/c 300 300
Salary A/c 2,000 2,000
Drawing A/c 200 200
TOTAL 96,900 96,900 77,680 77,680

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Trial balance for Illustration 10:

(i) Total Method:

TRIAL BALANCE
(as on 31st January)
Particulars Debit (₹) Credit (₹)
Cash A/c 14,000 2,000
Capital A/c 10,000
Purchases A/c 4,000
Mohan A/c 2,000 4,000
Suresh A/c 4,000 4,000
Sales A/c 4,000
TOTAL 24,000 24,000

(ii) Balance Method:

TRIAL BALANCE
(as on 31st January)
Particulars Debit (₹) Credit (₹)
Cash A/c 12,000
Capital A/c 10,000
Purchases A/c 4,000
Mohan A/c 2,000
Suresh A/c
Sales A/c 4,000
TOTAL 16,000 16,000

(iii) Total and Balance Method:

TRIAL BALANCE
(as on 31st January)
Total Method Balance Method
Particulars
Debit (₹) Credit (₹) Debit (₹) Credit (₹)
Cash A/c 14,000 2,000 12,000
Capital A/c 10,000 10,000
Purchases A/c 4,000 4,000
Mohan A/c 2,000 4,000 2,000
Suresh A/c 4,000 4,000
Sales A/c 4,000 4,000
TOTAL 24,000 24,000 16,000 16,000

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FINAL ACCOUNTS
We know that the accuracy of the books of accounts is determined by means of preparing a Trial Balance.
With the accuracy of the accounts, every businessman is interested in knowing about two more facts.
They are:

(i) Whether he has earned a profit or suffered a loss during the period covered by the Trial Balance.
(ii) Where does he stand now? In other words, what is his financial position?

The determination of the Profit or Loss is done by preparing a Trading and Profit and Loss Account (or an
Income Statement). While the financial position is judged by means of preparing a Balance Sheet of the
business.

The two statements together, i.e., Income Statement and the Balance Sheet, are termed as Final Accounts.
As the term indicates, Final Accounts means accounts which are prepared at the final stage to give the
financial position of the business.

TRADING AND PROFIT AND LOSS ACCOUNT:

The Trading and Profit and Loss Account is a final summary of such accounts which affect the profit or
loss position of the business. In other words, the account contains the items of Incomes and Expenses
relating to a particular period. The account is prepared in two parts: (i) Trading Account, and (ii) Profit
and Loss Account.

Trading Account
Trading Account gives the overall result of trading, i.e., purchasing and selling of goods. In other words,
it explains whether purchasing of goods and selling them has proved to be profitable for the business or
not.

It takes into account on the one hand the cost of goods sold and on the other the value for which they have
been sold away. In case the sales value is higher than the cost of goods sold, there will be a profit, while
in a reverse case, there will be a loss.

The profit disclosed by the Trading Account is termed as Gross Profit; similarly the loss disclosed by the
Trading Account is termed as Gross Loss.

 Opening and Closing Stocks:

At the end of the accounting year, a trader may be left with certain unsold goods. Such stock of goods
with a trader unsold at the end of the accounting period is termed as Closing Stock. Such a stock will
become the Opening Stock for the next period.

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While calculating the amount of profit or loss on account of trading, a trader will be to take such Opening
and Closing Stocks into consideration. This will be clear with the help of the following illustration.

Illustration 12: From the following data, calculate the profit made by a trader in 2016.

Sl. No. Particulars ₹

1. Stock of goods on 01/01/2016 10,000
2. Purchases during the year 40,000
3. Purchases returns during the year 5,000
4. Sales during the year 60,000
5. Sales returns during the year 10,000
6. Stock of goods on 31/12/2016 15,000
Solution:
Particulars Amount (₹) Amount (₹)
Sales 60,000
Less: Sales Returns 10,000
Cost of goods sold 50,000
Opening stock 10,000
Add: Net Purchases ₹(40,000-5,000) 35,000
45,000
Less: Closing Stock 15,000 30,000
Gross Profit 20,000

 Expenses on Purchases:

It may be noted that the trader has to incur various types of expenses for purchasing of goods as well as
for bringing them to his shop for sale. Such expenses may include brokerage or commission paid to
agents for purchase of goods, cartage or carriage charges for bringing the goods to the trader's shop,
wages paid to coolies for transportation of goods etc. All such expenses increase the cost of the goods
sold and hence they have also to be included in the cost of purchasing the goods.

Therefore, the cost of goods sold will be calculated as follows:

COST OF GOODS SOLD = OPENING STOCK + NET PURCHASES + EXPENSES ON

PURCHASING OF GOODS - CLOSING STOCK

Cost of goods sold calculated as above will then be compared with the net sales to find out the amount of
profit or loss made by the business. This will be clear with the following Illustrations.

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Illustration 13: Calculate the amount of the profit made by the trader with the help of data given in
Illustration 12, if the wages, carriage charges etc. incurred for bringing the goods to the trader's shop
amount to ₹5,000.

Solution:
Particulars Amount (₹) Amount (₹)
Sales 60,000
Less: Sales Returns 10,000
Cost of goods sold 50,000
Opening stock 10,000
Add: Net Purchases ₹ (40,000-5,000) 35,000
Carriage charges 5,000
50,000
Less: Closing Stock 15,000 35,000
Gross Profit 15,000

Note: The term ‘merchandise’ is also used for the term 'goods'.

 Equations for Preparing Trading Account:

GROSS PROFIT = SALES – COST OF GOODS SOLD

COST OF GOODS SOLD = OPENING STOCK + PURCHASES + DIRECT EXPENSES
– CLOSING STOCK
⸫ GROSS PROFIT = SALES – (OPENING STOCK + PURCHASES + DIRECT
EXPENSES – CLOSING STOCK)
OR, GROSS PROFIT = (SALES + CLOSING STOCK) – (OPENING STOCK +
PURCHASES + DIRECT EXPENSES)

Note: ‘Direct Expenses’ include those expenses which have been incurred in purchasing the goods,
bringing them to the business premises and making them fit for sale. Such as: Carriage charges, Octroi,
Import duty, Expenses for seasoning the goods, Commission or brokerage, wages, etc.

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 General Performa of Trading Account:

Trading A/c for the period ending ………….

Dr. Cr.
Particulars (₹) Particulars (₹)
To Opening stock ………… By Sales ………..
To Purchases ……….. Less: Returns ……….. …………
Less: Returns ……….. ………… By Closing stock …………
To Direct expenses …………
To Gross profit c/d ………… By Gross loss c/d …………

Illustration: Prepare the Trading Account of Mr. Ramesh for the year ending 31st December 2007 from
the data as follows:

Particulars (₹) Particulars (₹)

Purchases 10,000 Wages 4,000
Purchase Return 2,000 Carriage Charges 2,000
Sales 20,000 Stock on 01/01/2007 4,000
Sales Return 5,000 Stock on 31/12/2007 6,000
Solution:

Trading A/c for the year ending 31/12/2007

Dr. Cr.
Particulars (₹) Particulars (₹)
To Opening Stock 4,000 By Sales 20,000
To Purchases 10,000 Less: Sales Return 5,000 15,000
Less: Purchases Return 2,000 8,000 By Closing Stock 6,000
To Wages 4,000
To Carriage charges 2,000
To Gross Profit c/d 3,000
21,000 21,000

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Profit and Loss Account

The Trading Account simply tells about the gross profit or loss made by the businessman on purchasing
and selling of goods. It does not consider the order of operating expenses incurred by him during running
the business. For example, he must maintain an office for getting orders and executing them, taking
policy decisions and implementing them; all such expenses are charged to the profit and loss account.

The general Performa of the profit and loss account:

Profit and Loss A/c for the year ending ………….

Dr. Cr.
Particulars (₹) Particulars (₹)
To Gross Profit b/d ………. By Gross Loss b/d ……….
To Salaries ………. By Discount received ……….
To Rent ………. By Net Loss transferred to the ……….
Capital A/c
To Commission ……….
To Advertisement ……….
To Bad Debts ……….
To Discount ……….
To Net Profit transferred to the ……….
Capital A/c
………. ……….

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Illustration: From the following balances taken from the Trial balance of Shri Suresh. Prepare a Trading
and Profit & Loss Account for the year ending 31st December 2006.

Particulars Dr. (₹) Cr. (₹)

Stock on 01/01/2006 2,000
Purchases and Sales 20,000 30,000
Return 2,000 1,000
Carriage 1,000
Cartage 1,000
Rent 1,000
Interest received 2,000
Salaries 2,000
General expenses 1,000
Discount 500
Insurance 500

Solution:

Trading and Profit & Loss A/c for the year ending 31/12/2006

Dr. Cr.
Particulars (₹) Particulars (₹)
To Opening stock 2,000 By Sales 30,000
To Purchases 20,000 Less: Return 2,000 28,000
Less: Return 1,000 19,000 By Closing stock 5,000
To Carriage 1,000
To Cartage 1,000
To Gross Profit c/d 10,000
33,000 33,000
To Rent 1,000 By Gross Profit b/d 10,000
To Salaries 2,000 By Interest 2,000
To General expenses 1,000 By Discount 500
To Insurance 500
To Net Profit transferred to the 8,000
Capital A/c
12,500 12,500

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Manufacturing Account

It is basically prepared by the manufacturer in order to ascertain the cost of manufacturing of the goods.
The general Performa of the Manufacturing A/c is shown below:

Manufacturing A/c for the year ending ………….

Dr. Cr.
Particulars (₹) Particulars (₹)
To Work-in-progress (Opening) ………. By Work-in-progress (Closing) ……….
To Raw Material Consumed: By Sale of scrap ……….
Opening Stock ………. By Cost of Production of ……….
Finished Goods During the
Add: Purchases of Raw ……….
Materials Period Transferred to the
Trading A/c
Less: Closing stock of ………. ……….
Raw materials
To Direct or Productive Wages ……….
To Factory Overheads:
Power & Fuels ……….
Repair of Plant ……….
Depreciation on Plant ……….
Factory Rent ……….
………. ……….

Balance Sheet
After preparing the Manufacturing, Trading, and Profit & Loss account, a businessman would like to
know the financial proposition of his business. For this purpose, he prepares a statement of his assets and
liabilities as on a particular date. Such a statement is termed as “Balance Sheet”. Thus, Balance Sheet is
not an account but only a statement containing the assets and liabilities of a business on a particular date.

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Illustration: From the following Trail Balance, prepare the Manufacturing A/c, Trading A/c, and Profit
& Loss A/c for the year ending 31st March 201S9 and the Balance Sheet as of the date.

Particulars Debit (₹) Credit (₹)

Shri Banker’s Capital A/c 41,000
Shri Banker’s Drawing A/c 6,100
Shri Banker’s Loan A/c 4,000
Sundry Creditors 45,000
Cash in Hand 250
Cash at Bank 4,000
Sundry Debtors 40,500
Patents 2,000
Plant & Machinery 20,000
Land & Buildings 26,000
Purchase of Raw Materials 35,000
Raw Materials as on 01/04/2018 3,500
Work-in-Progress as on 01/04/2018 2,000
Finished Stocks as on 01/04/2018 18,000
Carriage Inwards 1,100
Wages 27,000
Salary of Works Manager 5,600
Factory Expenses 3,400
Factory Rent & Taxes 2,500
Royalties (Paid on Sale) 1,200
Sales (less returns) 1,23,400
Advertising 3,000
Office Rent & Insurance 4,800
Printing & Stationery 1,000
Office Expenses 5,800
Carriage Outwards 600
Discount 1,400 2,100
Bad Debts 750
Total 2,15,500 2,15,500
st
The stocks of 31 March 2019 were as follows:

(₹)
Raw Materials 4,000
Work-in-Progress 4,500
Finished Stocks 28,000

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Solution:
Manufacturing A/c for the year ending 31/03/2019
Dr. Cr.
Particulars (₹) Particulars (₹)
To Work-in-progress (Opening) 2,000 By Work-in-progress (Closing) 4,500
To Raw Materials Consumed: By Transfer to Trading A/c (cost 71,600
of finished goods produced)
Opening Stock of Raw 3,500
Material
Add: Purchase of Raw 35,000
Material
38,500
Less: Closing Stock of 4,000 34,500
Raw Material
To Carriage Inward 1,100
To Wages 27,000
To Salaries of Works Manager 5,600
To Factory Expenses 3,400
To Factory Rent & Taxes 2,500
76,100 76,100
Trading and Profit & Loss A/c for the year ending 31/03/2019
Dr. Cr.
Particulars (₹) Particulars (₹)
To Opening Stock of Finished 18,000 By Sales 1,23,400
Goods
To Manufacturing A/c (cost of 71,600 By Closing Stock 28,000
finished goods produced)
To Gross Profit c/d 61,800
1,51,400 1,51,400
To Royalties 1,200 By Gross Profit b/d 61,800
To Advertising 3,000 By Discount received 2,100
To Office Rent & Insurance 4,800
To Printing & Stationery 1,000
To Office Expenses 5,800
To Carriage Outwards 600
To Bad Debts 750
To Discount Allowed 1,400
To Net Profit transferred to the 45,350
Capital A/c
63,900 63,900

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Balance Sheet as on 31/03/2019

(Claim against the business) (Resources acquired by the business)
Liabilities (₹) Assets (₹)
Sundry Creditors 45,000 Current Assets:
Mrs. Banker’s loan 4,000 Cash in Hand 250
Capital A/c Cash at Bank 4,000
Balance on: Sundry Debtors 40,500
01/04/2018 41,000 Closing Stocks:
Net Profit 45,350 Raw Materials 4,000
86,350 Work-in-Progress 4,500
Less: Drawings 6,100 80,250 Finished Goods 28,000 36,500
Fixed Assets:
Patents 2,000
Plant & Machinery 20,000
Land & Buildings 26,000
1,29,250 1,29,250

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