Unit – I
Introductory Terms
First of all, you should understand the meaning of some terms which will be frequently used.
1. Business: It is an activity which involves exchange of goods/services with the intention of earning income and profit.
2. Business Transactions: It refers to any transaction, dealing or event which involves transfer of money or money’s worth between two parties.
3. Expenditure: It means spending of money or incurring an obligation to pay at a later date. Expenditure may be of capital nature (that is, leading to acquisition of an asset) or of revenue nature (that is where the benefit from it will soon be exhausted).
4. Expense: It means an expenditure whose benefit is enjoyed and finished immediately or almost immediately.
5. Cash Transaction: When payment for business activity is made immediately, it is called cash transaction.
6. Non-Cash Transaction: A non-cash transaction is a business transaction where there is no payment or receipt of cash either immediately or at a future date. Example: Depreciation, Bad Debts etc.
7. Proprietor: The owner of business is called proprietor. He invests capital in the business with the intention of earning profit.
8. Capital: It is the amount invested by the proprietor in the business. It is always equal to assets minus liabilities. It is also called owners’ equity.
9. Drawings: it is the value of cash or goods withdrawn from the business by the owner for his personal use.
10. Debtors: A debtor is a person who owes money to the business. 11. Creditors: A creditor is a person to whom the business owes money.
12. Assets: Assets refer to any properties or things owned by a business concern including the amounts due to it from others. Examples: Buildings, Machinery, Stock, Cash and Bank balances, Investments etc.
13. Liabilities: The term ‘Liabilities’ refer to debts or amounts due from a business to others either for money borrowed or for goods or assets purchased on credit or services received without making immediate payment. These include bank loan or overdraft, trade creditors, outstanding expenses etc.
14. Debt: The amount due from a debtor is called Debt.
15. Brought Down (b/d): This term is written in the ledger to show the opening balance in any account. It suggests that the account has been brought down from the previous period. 16. Carried Down(c/d): This is written in the ledger account at the time of closing the account.
DEFINITIONS OF ACCOUNTING
those transactions and events, and communicating the results to persons who must make decisions or form judgements.”
Smith and Ashburn
“Accounting is the art of recording, classifying and summarising in significant manner and in terms of money, transactions and events which are, in part at least, of a financial character and interpreting the results there of.”
American Institute of Certified Public Accountants
Objectives of Accounting
The following are the main objectives of accounting:
i. Keeping Systematic Records: Accounting is done to keep a systematic record of financial transactions.
ii. Protecting and Controlling Business Properties: Accounting helps in seeing to it that there is no unauthorised use or disposal of any assets or property belonging to the firm, because proper records are maintained. Accounting will furnish information about money due from various persons and money due to various parties. The firm can see that all amounts due to it are recovered in due time and that no amount is paid unnecessarily
iii. Ascertaining the operational profit or loss: Accounting is used to show the results of the activities in a given period, usually a year, i.e. to show how much profit has been earned or how much loss has been incurred. This is done by keeping a proper record of revenues and expenses of a particular period.
iv. Ascertaining the financial position of the business: balance sheet is prepared to ascertain the financial position of the firm at the end of a particular period. It shows the value of the firms possessions and the amount the firm is owing to others.
v. Facilitating rational; decision making: Accounting has taken upon itself the task of collection, analysis and reporting of information at the required point of time to the required levels of authority in order to facilitate rational decision making.
USERS OF ACCOUNTING INFORMATION:
i. Proprietors: The primary aim of accounting is to provide necessary information to the owners related to his business.
ii. Managers: In large business organisations and in corporations, there is separation of ownership and management functions. The management of such business are more concerned with accounting information because it is they who are answerable to the owners.
iii. Prospective investors: The person who is contemplating an investment in a business will like to know about its profitability and financial position. They derive these information from the accounting reports of the concern.
heavily upon accounting statements for determining the acceptability of a loan application.
v. Government: The government is interested in the financial statements of a business enterprise on an account of taxation, labour and corporate laws.
vi. Employees: Employees are interested in financial statements on accounts because their wages increase and payment of bonus depend on the size of the profit earned.
vii. Regulatory agencies: various government departments and agencies such as company law board, registrar of companies, tax authorities etc.use accounting reports not only as the basis for tax assessment but also in evaluating how well various business organizations are operating under regulatory legislation.
viii. Researchers: Accounting data are also used by the research scholars in their research in accounting theory as well as business affairs and practices.
SYSTEMS OF ACCOUNTING:
Basically there are two systems of accounting
i. Cash System of Accounting: In this system of accounting entries are made only when cash is received or paid. No entry is made when a payment or receipt is merely due. It may not treat any revenue to have been earned or even sales to have taken place unless cash is actually paid by the customers. Government system of accounting is mostly on the cash system. Professional people also record their income on cash basis, but while recording expenses they take into account the outstanding expenses also.
ii. Accrual System of Accounting: This is also known as mercantile system of accounting. It is a system in which accounting entries are made on the basis of amounts having become due for payment or receipt. Accrual basis of accounting, attempts to record the financial effects of the transactions, events, and circumstances of an enterprise in the period in which they occur rather than recording them in period(S) in which cash is received or paid by the enterprise. It recognises that the buying, producing, selling and other economic events that affect enterprise‘s performance often do not coincide with the cash receipts and payments of the period. The purpose of accrual basis accounting is to relate the revenue in terms of cost so that reported net income measures an enterprise’s performance during a period instead of merely listing its cash receipts and payments. Apart from income measurements, accrual basis of accounting recognise assets, liabilities or components of revenues and expenses for amounts received or paid in cash in the future.
ACCOUNTING PRINCIPLES, CONCEPTS AND CONVENTIONS
Accounting principles have been defined as “the body of doctrines commonly associated with the theory and procedure of accounting, serving as an explanation of current practices and as a guide for the selection of conventions or procedures where alternatives exist”.
i. Accounting concepts ii. Accounting conventions Accounting Concepts:
i. Business Entity Concept: Accountants assume that an enterprise is separate from its owners. It is treated to have a distinct accounting entity which controls the resources of the concern and is accountable there for. Accounts are kept for a business entity as distinguished from the persons associated with it. They will record transactions between the owner and the firm; for instance, when capital is provided by the owner, the accounting record will show that the firm as having received so much money and as owing it to the proprietor. This concept is based on the sense that proprietors entrust resources to the management; the management is expected to use these resources to the best advantage of the firm and to account for the resources placed at its disposal. The concept of separate entity is applicable to all forms of business organisations.
ii. Money Measurement Concept: Only those transactions and events as can be interpreted in terms of money are recorded. Events or transactions which cannot be expressed in money do not find place in the books of account though they may be very useful for the business. iii. Cost Concept: Transactions are entered in the books of account at the amount actually
involved. The personal views of people are not considered as the basis for making the record.
iv. Going Concern Concept: According to this concept it is assumed that the business will continue for a fairly long time to come. Transactions are, therefore, recorded in such a manner that the benefits likely to accrue in future from money spent now or the further consequences of events occurring now are taken into consideration. It is on this basis that a clear distinction must be made between assets and expenses. It is because of this concept that fixed assets are recorded at their original cost and are depreciated in a systematic manner without reference to their current realisable value. However, if it is certain that the business will last only for a limited period; the accounting record will keep the expected life in view, probably treating all expenditure, capital and revenue alike.
v. Dual Aspect Concept: Every transaction entered into by a firm or institution will have two aspects; if any event occurs, it is bound to have double effect.
vi. Realisation Concept: According to this concept revenue is recognised when a sale is made. Consequently unless money has been realised, i.e. either cash has been received or a legal obligation to pay has been assumed by the customer no sale can be said to have taken place and no profit can be said to have arisen. It prevents business firms from inflation their profits by recording sales and incomes that are likely to accrue i.e. expected incomes or gains are not recorded.
ACCOUNTING CONVENTIONS
The term ‘accounting conventions’ refer to the customs or traditions which are used as a guide in the preparation of accounting reports and statements. The following are the important accounting conventions in use.
i. Consistency: According to this convention the accounting practice should remain unchanged from one period to another. It requires that working rules once chosen should not be changed arbitrarily and without notice of the effects of change to those who use the accounts.
ii. Disclosure: Apart from statutory requirements good accounting practice also demands that significant information should be disclosed in financial statements. Such discloses can also be made through footnotes. Purpose of this convention is to communicate all material and relevant facts concerning financial position and results of operations to the users.
iii. Conservatism: Financial statements are usually drawn up on a conservative basis. Anticipated profits are ignored but anticipated losses are taken into account while drawing the statements. Valuing inventory at cost or market price whichever is less and creating provision for doubtful debts are the good examples of the application of this convention. iv. Materiality: According to this convention, the accountant should attach importance to
material details and ignore insignificant details in the financial statements. This is because otherwise accounting will be unnecessarily overburdened with minute details.
Book-keeping and Accounting
Book-keeping and accounting are often used interchangeably but they are different from each other. Book-keeping is mainly concerned with recording of financial data relating to the business operations in a significant and orderly manner. It is the science and art of correctly recording in books of account all those business transactions that result in the transfer of money or money’s worth. It is mechanical and repetitive. This work is usually entrusted to junior employees f accounts section of a business house.
Accounting is a broader and more analytical subject. It includes the design of accounting systems which the book-keepers use, preparation of financial statements, audits, cost studies, income-tax work and analysis and interpretation of accounting information for internal and external end-users as an aid to taking business decisions. This work requires more skill, experience and imagination. The larger the firm, the greater is the responsibility of the accountant. It can be said that accounting begins where book-keeping ends. Book-keeping provides the basis for accounting.
Double Entry System
There are two systems of keeping records i.e. (i) single entry system and (ii) double entry system.
system in every transaction an account is debited and some other account is credited. The crux of accountancy lies in finding out which of the two accounts are affected by a particular transaction and out of these two accounts which account is to be debited and which account is to be credited.
Merits of Double Entry System
i. It keeps a complete record of business transactions. Both personal accounts and impersonal accounts are kept. The entire information regarding the value of assets and profits earned during the year can be easily obtained.
ii. It provides a check on the arithmetical accuracy of the both of accounts, since every debit has corresponding credit to it and vice-versa.
iii. The detailed profit and loss account can be prepared to show profits earned or loss suffered during any given period.
iv. The system makes possible the comparison of purchases as well as sales, expenditure, income etc. of a current year with those of the previous years, thus enabling a businessman to control his business activities.
v. The balance sheet can be prepared at any specified point of time or any date showing the actual amount of assets, liabilities and capital.
vi. The system being a scientific one, it prevents commission of fraud and if a fraud is committed it can be easily detected.
vii. The accurate details with regard to any account can be easily obtained.
Accounts
An account is an individual record of a person, firm, or thing, an item of income or an expense. According to Kohler’s Dictionary for Accountants, an account has been defined as a formal record of a particular type of transaction expressed in money.
Classification of Accounts
Accounts are broadly classified into two classes: (i) Personal Accounts and (ii) Impersonal Accounts. The latter are further sub-divided into a) Real Accounts and b) Nominal Accounts. Thus all accounts can be classified into Personal, Real and Nominal Accounts.
Personal Accounts: Personal accounts are the accounts relating to persons with whom the business deals. Such accounts can take the following forms:
i. Natural person’s accounts: e.g. Mohan’s Account, Sheena’s Account, Raj’s Account etc. ii. Artificial person’s or body of person’s account: e.g. Bank Account, Firm Account,
Company Account, Club Account etc.
iii. Representative personal accounts: e.g. Outstanding Wages Account, Prepaid Rent Account, Unexpired Insurance Account etc.
Real Accounts: Real Accounts may be of the following types:
ii. Intangible Real Accounts: These accounts represent such things which cannot be touched. Of course they can be measured in terms of money e.g. Goodwill Account, Trade Mark Account, Patent Account etc.
Nominal Account: Accounts of incomes, expenses, gains and losses are called nominal accounts. Interest received, wages, salaries, rent, postage, profit and loss are such items, and a separate account is opened for each of these items.
Basic Accounting Rules
Personal Accounts
Debit The Receiver
Credit The Giver
Real Accounts
Debit What comes in
Credit What goes out
Nominal Accounts
Debit Expenses and Losses
Credit Incomes and Gains
Illustration 1
From the following transactions , state the nature of account and also state which account will be debited and which account will be credited:
a) X started business with cash b) Paid wages
c) Purchased goods for cash
d) Purchased goods from Amar on credit e) Purchased machinery for cash
f) Interest paid g) Dividend received h) Machinery sold
s.n o
accounts affected
nature of account
effect on business accounts dr./cr. a) cash a/c
capital a/c
real a/c personal a/c
cash comes in proprietor is the giver
dr. cr. b) wages a/c
cash a/c
nominal a/c real a/c
wages is an expense cash goes out
dr. cr. c) purchases a/c
cash a/c
real a/c real a/c
goods comes in cash goes out
dr. cr. d) purchases a/c
amar’s a/c
real a/c personal a/c
goods comes in amar the giver
dr. cr. e) machinery a/c
cash a/c
real a/c real a/c
machinery comes in cash goes out
dr. cr. f) interest a/c
cash a/c
nominal a/c real a/c
interest is an expense cash goes out
dr. cr. g) cash a/c
dividend a/c
real a/c nominal a/c
cash comes in dividend is a gain
dr. cr. h) cash a/c
machinery a/c
real a/c real a/c
cash comes in machinery goes out
dr. cr. i) salaries a/c
outstanding salaries a/c
nominal a/c personal a/c
salary is an expense salaries have to be paid
dr. cr.
JOURNAL
The journal is the book of prime entry in which every transaction is recorded before being posted into the ledger. It is that book of account in which transactions are recorded in a chronological ( day to day ) order.
A Specimen ruling of a journal is as under:
Date Particulars L.F Debit Amount ( Rs.)
Credit Amount (Rs.)
(i) (ii) (iii) (iv) (v)
(i) Date : The date on which the transaction took place is entered in this column. The year is written on the top, then the date column is divided in two parts, the first part is used for writing the month and second part is used for writing the date.
the word ‘To’ is written before the name of the account to be credited. Then the name of the account to be credited is written. A brief explanation , usually beginning with the word ‘Being’ is written called ‘narration’. The narration explains the reason for debiting and crediting the particular accounts and helps one to understand the nature and purpose of the journal entry at a future date. To separate one entry from another, a line is drawn below every entry to cover particular column only. The line does not extend to other columns.
(iii) L.F : Stands for Ledger Folio’. In this column the page numbers on which the various accounts appear in the ledger are entered.
(iv) Debit Amount: In this column , the amount to be debited against the debit account is written.
(v) Credit Amount : In this column, the amount to be credited against the credit account is written.
Illustration 2
Journalise the following transactions: 2007
April, 1 Rajesh stars business with cash 20,000 April, 2 He buys goods for cash 15,000 April, 4 He buys goods from Malhotra on credit 6,000 April, 5 Furniture is purchased for cash 1,000
April, 9 Cash sales made 1,500
April, 11 Goods sold on credit to Satya Dev 4,000 April, 16 Payment made to Malhotra 6,000
April, 19 Cash sales 4,300
April, 21 Purchases of stationery for cash 20 April, 25 Sales on credit to Yusuf 1,770 April, 30 Rent for the month paid in cash 500
Journal Entries
Date Particulars L.F. Debit Credit Amount Amount 2007 Cash a/c ...Dr. 20,000
April, 1 To Rajesh’s capital a/c 20,000 ( being cash brought in by
Rajesh as his capital )
_______________________________
April,2 Purchases a/c ...Dr. 15,000
To cash a/c 15,000
( being goods purchased for cash) _______________________________
April,4 Purchases a/c ...Dr. 6,000
To Malhotra 6,000
( being goods purchased on credit) _______________________________
April,5 Furniture a/c ...Dr. 1,000
Cash a/c 1,000
( being furniture purchased for cash) _______________________________
April,9 Cash a/c ...Dr. 1,500
To sales a/c 1,500
(being cash sales made )
_____________________________
April,11 Satya Dev ...Dr. 4,000
To sales a/c 4,000
( being goods sold on credit )
_______________________________
April,16 Malhotra a/c ...Dr. 6,000
To cash a/c 6,000
( being payment made to Malhotra ) _______________________________
April,19 Cash a/c ...Dr. 4,300
To sales a/c 4,300
( being cash sales made )
_______________________________
April,21 Stationery a/c ...Dr. 20
To cash a/c 20
( being stationery purchased for cash) _______________________________
April,25 Yousuf ...Dr. 1,770
To sales a/c 1,770
April,30 Rent a/c ...Dr. To cash a/c
( being rent paid in cash )
500
500
Illustration 3:
Give journal entries for the following.
1. Raju commenced business with Rs. 1,00,000 2. Purchased furniture for cash Rs. 50,000
3. Purchased machinery from Mahesh on credit Rs. 40,000 4. Received cash from Goyal Rs. 80,000 on account. 5. Paid rent to landlord Rs. 5,000
Journal Entries in the books of Raju
Date Particulars L.F Debit
Amount (Rs.)
Credit Amount
(Rs.) ?
1
2
3
4
5
Cash a/c ...Dr. To Capital a/c
(being capital brought into business)
1,00,000
50,000
40,000
80,000
5,000
1,00,000
50,000
40,000
80,000
5,000 Furniture a/c ...Dr
To Cash a/c
( being furniture purchased for cash )
Machinery a/c ...Dr. To Mahesh a/c
( being machinery purchased from Mahesh on credit)
Cash a/c ...Dr. To Goyal
(being cash received from Goyal )
Rent a/c ...Dr. To cash a/c
( being rent paid to landlord )
Illustration 4
Journalise the following transactions.
2007
Jan 1. pankaj commenced business with a capital of Rs. 5,00,000
5. Purchased goods from Krishna on credit Rs. 1,00,000
7. Sold goods to Rama on credit Rs. 80,000
9. Purchased goods from Manish for cash Rs. 50,000
12. Sold goods for cash to Sailesh Rs. 8,500
15. Purchased machinery from Ajay Engg. Co.
Payment made by cheque Rs. 20,000
18. Issued cheque to Krishna Rs. 75,000
1. Received interest from Ashok Rs. 500
22. Cash withdrawn from bank for office use 20,000
24. Amount withdrawn from bank for personal use 8,000
27. Took loan from Rajiv Varma 1,50,00
29. Cash withdrawn from office for personal use 10,000
30. Goods withdrawn for personal use 20,000
31. Paid rent to landlord by cheque 6,000
JOURNAL
Date Particulars L.F Debit
Amount (Rs.)
Credit Amount
(Rs.) 2007
Jan 1
2
5
Cash a/c Dr. To Capital a/c
( being cash brought into business as capital )
5,00,000
4,00,000
1,00,000
5,00,000
4,00,000
1,00,000 Bank a/c Dr.
To cash a/c
( being cash deposited in bank)
Goods/ Purchases a/c Dr. To Krishna a/c
7 9 12 15 18 20 22 24 27 29 30 31 80,000 50,000 8,500 20,000 75,000 500 20,000 8,000 1,50,000 10,000 20,000 6,000 80,000 50,000 8,500 20,000 75,000 500 20,000 8,000 1,50,000 10,000 20,000 6,000 Rama a/c Dr.
To Goods / Purchases a/c
( being goods sold to Rama on credit )
Goods / Purchases a/c Dr. To cash a/c
( being goods purchased for cash )
Cash a/c Dr. To Goods/ Purchases a/c
( being goods sold for cash)
Machinery a/c Dr. To Bank a/c
( being machinery purchased payment made by cheque)
Krishna a/c Dr. To Bank a/c
( being interest received )
Cash a/c Dr. To Interest a/c
( being cash withdrawn from bank for office use)
Cash a/c Dr. To Bank a/c
( being cash withdrawn from bank for personal use )
Drawings a/c Dr. To Bank a/c
( being amount withdrawn from bank for personal use)
Cash a/c Dr. To Rajiv Varma Loan a/c
( being loan taken from Rajiv Varma )
Drawings a/c Dr. To cash a/c
(being cash taken for personal use )
Drawings a/c Dr. To Goods a/c
(being goods withdrawn for personal use)
Rent a/c Dr. To Bank a/c
RECORDING OF TRANSACTIONS
Accounting Process
Following are the successive steps which are in practice, taken to record transactions:
a) Entering transactions in Subsidiary Books, i.e. Journalising.
b) Preparation of ledger accounts on the basis of records in subsidiary books, i.e. Posting. c) Balancing of ledger accounts.
d) Preparation of Trial Balance.
e) Preparation of Final Accounts ; Trading Accounting, Profit and Loss Account, in the case of trading concerns and Manufacturing Account, Trading Account and Profit and Loss Account in the case of manufacturing concerns.
f) Preparation of Balance Sheet.
Ledger -- Principal Book of Accounts
The ledger is the principal book of accounts where similar transactions relating to a particular person or thing are recorded. In other words, it is a set of accounts. It contains all accounts of the business enterprise whether real, nominal or personal. The main function of a ledger is to classify or sort out all the items appearing in the journal or other subsidiary books under their appropriate accounts so that at the end of the accounting period each account will contain the entire information of all the transactions relating to it in a summarised or condensed form.
The following is the specimen ruling of the standard form of ledger account.
Date Particulars J.F. Amount(Rs.) Date Particulars J.F. Amount (Rs.)
The following are the important features of the ledger account:
I. The ledger account is divided into two sides – the left hand side is known as debit side while the right hand side is known as credit side. The abbreviations ‘Dr.’ And ‘ Cr.’ Are placed at the top left and right hand corners respectively. This is more by custom than under any law. II. The name of account is written in the middle of the account.
III. J.F. denotes folio or page number on which its journal entry may be found.
The term ‘posting ‘ means transferring the debit and credit items from the journal to their respective accounts in the ledger.
i. Separate accounts should be opened in the ledger for posting transactions relating to different accounts recorded in the journal.
ii. The concerned account which has been debited in the journal should also be devited in the ledger i.e. the debit of the journal entry is posted to the debit side. However, a reference should be made of the other account which has been debited in the journal.
iii. The concerned account which has been credited in the journal, should also be credited in the ledger i.e. the credit of the journal entry is posted to the credit side, but a reference should be given of the other account which has been debited in the journal.
iv. It is customary to use the words ‘To’ AND ‘ By’ while making posting in the ledger. The words ‘To’ is used with the accounts shown on the debit side of the ledger account while the word ‘By’ is used with accounts which appear on the credit side of the ledger account. v. In the folio column, the page number of the journal from where the entry is transferred to
ledger account is written.
vi. The date of the transaction is written on the date column.
Balancing Ledger Accounts
Balancing of an account means the process of equalising the two sides of an account by putting the difference on the side where amount is short. Where the debit side of an account exceeds the credit side then the difference is put on the credit side, and the account is said to have a debit balance. This balance is brought down on the debit side while opening the account. Similarly, where the credit side of an account exceeds the debit side, the difference is put on the debit side, and the account is said to have a credit balance. This is also brought down on credit side while opening the account. The following steps are followed for balancing the account:
i. Total the amounts of debit and credit entries in the account.
ii. If the debit and credit sides are equal then there is no balance. The account stands automatically balanced or closed.
iii. If the debit side total is more , put the difference on the credit side amount column, by writing the words in particulars column “ By Balance c/d “. If the credit side total is more, put the difference on the debit side amount column by writing the words in the particular column “ To Balance c/d “.
iv. After putting the difference in the appropriate side of the account , add both sides of the account and draw a thin line above and below the total.
v. Bring down the debit balance on the debit side by writing the words in particular column “To Balance b/d “. Similarly bring down the credit balance on the credit side by writing the words in the particulars column “ By Balance b/d”.
either a liability or a gain. If such balance relates to Personal Account, it is a creditor, if it relates to Nominal Account, it is a gain or income. Real Accounts usually shows debit balance. In case there is a credit balance in a Real Account, it reflects loss on sale of the asset. It may be noted that when Nominal Accounts are balanced on the last day of an accounting year their balance are not carried down but are transferred to Trading and Profit and Loss Account.
Illustration 5
Record the following transactions in the Journal and post them into Ledger of Mr. Aditya Raj:
2008
March 1 Purchase of goods from Ramautar 3,20,000 March 10 Paid rent for the month 2,000 March 11 Purchase of Plant 1,00,000
March 12 Paid salaries 12,000
March 15 Paid Ramautar 1,00,000
March 20 Sold goods to Shyam 20,000 March 25 Received from Shyam 30,000 March 31 Received cash from cash sales 2,50,000
March 31 Wages paid 5,000
Journal Entries in the books of Aditya Raj
Date Particulars L.F.
Debit Amount
(Rs.)
Credit Amount
(Rs.) 2008
Mar-01 Purchases a/c 3,20,000
To Ramautar 3,20,000
( being purchase of goods on credit )
Mar-10 Rent a/c 2,000
To Cash a/c 2,000
( being payment of rent )
Mar-11 Plant a/c 1,00,000
To Cash a/c 1,00,000
( being purchase of plant )
Mar-12 Salaries a/c 12,000
To Cash a/c 12,000
( being payment of salaries )
Mar-15 Ramautar a/c 1,00,000
To Cash a/c 1,00,000
( being payment to Ramautar )
Mar-20 Shyam a/c 20,000
To Sales a/c 20,000
( being goods sold on credit )
Mar-25 Cash a/c 30,000
To Shyam a/c 30,000
( being receipt of cash )
Mar-31 Cash a/c 2,50,000
To Sales a/c 2,50,000
( being cash sales made )
Mar-31 Wages a/c 5,000
To Cash a/c 5,000
(being payment of wages )
LEDGER
CASH ACCOUNT
Date Particulars J.F.
Debit
Rs. Date Particulars J.F.
Credit Rs.
2008 2008
Mar-25 To Shyam 30,000 Mar-10 By Rent a/c 2,000 Mar-31 To Sales a/c 2,50,000 Mar-11 By Plant a/c 1,00,000 Mar-12 By Salaries a/c 12,000 Mar-15 By Ramautar a/c 1,00,000 Mar-31 By Wages a/c 5,000 Mar-31 By Balance c/d 61,000
2,80,000 2,80,000
2008
Apr-01 To Balance b/d 61,000
PURCHASES ACCOUNT
Date Particulars J.F.
Debit
Rs. Date Particulars J.F.
Credit Rs. 2008
Mar-01 To Ramautar 3,20,000 Mar-31 By Balance c/d 3,20,000
3,20,000 3,20,000
2008
RAMAUTAR'S ACCOUNT
Date Particulars J.F.
Debit
Rs. Date Particulars J.F.
Credt Rs. 2008
Mar-15 To Cash a/c 1,00,000 Mar-01 By Purchase a/c 3,20,000 Mar-31 To Balance c/d 2,20,000
3,20,000 3,20,000
Apr-01 By Balance b/d 2,20,000
RENT ACCOUNT
Date Particulars J.F.
Debit
Rs. Date Particulars J.F.
Credt Rs. 2008
Mar-10 To Cash a/c 2,000 Mar-31 By Balance c/d 2,000
2,000 2,000
2008
Apr-01 To Balance b/d 2,000
PLANT ACCOUNT
Date Particulars J.F.
Debit
Rs. Date Particulars J.F.
Credt Rs. 2008
Mar-11 To Cash a/c 1,00,000 Mar-31 By Balance c/d 1,00,000
1,00,000 1,00,000
2008
Apr-01 To Balance b/d 1,00,000
SALARIES ACCOUNT
Date Particulars J.F.
Debit
Rs. Date Particulars J.F.
Credt Rs. 2008
Mar-12 To Cash a/c 12,000 Mar-31 By Balance c/d 12,000
12,000 12,000
2008
Apr-01 To Balance b/d 12,000
SHYAM'S ACCOUNT
Rs. Rs. 2008
Mar-20 To Sales a/c 20,000 Mar-31 By cash a/c 30,000 Mar-31 To Balance b/d 10,000
30,000 30,000
Apr-01 By Balance b/d 10,000
SALES ACCOUNT
Date Particulars J.F.
Debit
Rs. Date Particulars J.F.
Credt Rs. 2008
Mar-01 To Balance b/d 2,70,000 Mar-20 By Shyam 20,000 Mar-31 By Cash a/c 2,50,000
2,70,000 2,70,000
Apr-01 By Balance b/d 2,70,000
WAGES ACCOUNT
Date Particulars J.F.
Debit
Rs. Date Particulars J.F.
Credt Rs. 2008
Mar-31 To Cash a/c 5,000 Mar-31 By Balance c/d 5,000
5,000 5,000
Apr-01 To Balance b/d 5,000
Subsidiary Books of Account
As stated earlier journal is a book of primary entry. It means all business transactions are to be first recorded in the journal. However, in big business houses recording of all transactions in one journal will not only be inconvenient but also cause delay in collecting the information required. The journal is, therefore, sub-divided into many subsidiary books. The sub-divisions of journal into various subsidiary journals, recording transactions of similar nature are called subsidiary books.
Advantages:
1. Sub-division of the Journal into subsidiary books will make the recording work easy and quick.
2. It helps in the division of labour as accounting work may be divided among a number of clerks.
4. There is a substantial reduction of clerical work.
The following are the special journals or subsidiary books:
1. Purchase Book 2.Sales Book 3. Purchase Returns Book 4. Sales Returns Book
5. Bills Receivable Book 6.Bills Payable Book 7. Cash Book 8. Journal Proper
1. Purchases Book
Purchases Book , only credit purchases of goods in trade are made. Cash Purchases will be entered in the Cash Book. Credit purchases of say office equipment, will be entered in the journal.
Illustration 6
The purchases of a firm are as follows:
10th May, 2007 from Moonlite & Co., Mumbai:
50 Electric bulbs of 100wt. Each @ Rs. 8 each.
5 Coolers @ Rs. 400 each.
Moonlite & Co. Mumbai allows trade discount @ 10% ( Trade discount is an allowance made by suppliers for bulk purchases ).
On 15th May, 2007 a type writer from Office Equipment Co. For Rs. 3,200 on credit.
On 18th May, 2007 from Prakash Chand & Sons, Surat:
10 toasters @ Rs. 100 each. Prakash Chand & Sons, Surat, allows Trade Discount @ 15%.
On 20th May, 2007 100 cut-outs @ Rs. 5 each from Electric & Co. For Cash.
Date Particulars
Invoice No
Ledger Folio
Details Rs.
Amount Rs.
May-10 To Moonlite & Co., Mumbai
each
5 coolers @ Rs. 400each 2000
2400
Less trade discount 10% 240 2,160
May-18 To prakash Chand & Sons, Surat 1,000
10 Toasters @ Rs. 100 each 150 850
3,010
Note: The purchases on 15th May will be journalised and that on 20th May will be entered in the Cash
Book.
Sales Book
In Sales Book, only credit sales of goods in trade are recorded. It is maintained on the lines similar to those on which Purchase Book is maintained. In ‘ Particular Column ‘ the name of the customers along with details of the goods sold to them are recorded. Sales Book is prepared on the basis of copies of invoices sent to customers. To post Sales Book, the accounts of the customers are individually debited with respective amounts at the end of every month. Sales Account is credited with the monthly total of the Sales Book.
Cash Sales will be entered in the Cash Book; credit sale of various assets or investments will be journalised.
Illustration 7
From the following transaction s write up the Sales Day Book of X &Co.
Jan. 1 Sold to Premier Traders 100 bags of sugar @ Rs. 650 per bag, less trade discount @ 5%
Jan. 10 Sold to R&Co. 10 bags of milk powder @ Rs. 500 per bag, less trade discount @ 10%
Jan 20 Sold to Tea King (P) Ltd. 10 Chest C.T.C Tea @ Rs.2,000 per Chest. Less trade discount @10%
Jan 29 Sold old office furniture on credit to Modern Furniture for Rs. 2,500.
` Sales Book
Date Particulars
Invoice No
Ledger Folio
Details Rs.
100 bags of sugar @ Rs.650 per bag. 65,000
Less: Trade discount @5% 3,250 61,750
Jan-10 R & Co
10 bags of milk powder @ Rs.500 per
bag 5,000
Less: Trade Discount @ 10% 500 4,500
Jan-20 Tea King (P) Ltd.
10 Chest C.T.C. tea @ Rs. 2,000 per
chest 20,000
Less: Trade discount @ 10% 2,000 18,000
Note: Sale of old furniture to be passed through Journal Proper.
3. Purchases Returns Book ( Return Outwards Book )
It record the returns of trade items purchased on credit. When goods are returned a Debit Note is made out and sent to the party to whom the goods are returned. The ruling of this book is as follows:
` Purchase Returns Book
Date Particulars
Debit Note No
Ledger Folio
Amount Rs.
The account of eash supplier mentioned in the Purchases Return Book is debited in the ledger with its respective amount with the words “ To Purchases Return Account”. The monthly total of this book is credited to the Purchases Return Account with the words “ By Sundries as per Purchases Returns Book “.
4. Sales Returns Book ( Returns Inward Book )
The book is kept to record the returns of goods on credit on receipt of the goods. The firm prepares a Credit Note in the name of the customers and sends its original copy to the customer. Entries are made from the credit note into the Sales Returns Book. The ruling of the sales returns book is as follows:
` Sales Returns Book
Date Particulars
Credit Note No
Ledger Folio
Each Customer’s Account is credited with the amount of goods returned by him with the words “ By Sales Returns Account”. The Sales Returns Account in the ledger gets the debit with the monthly total of Sales Returns Book with the words “ To Sundries as per Sales Returns Book “.
Credit Note: When the seller receives back goods from the purchaser along with a “Debit Note” the seller has to acknowledge the same by sending a “ Credit Note “ conforming the acceptance of the debit note.
5. Bills Receivable Book
Bills are of two types . Bills Receivable and Bills Payable. These arise in settlement of accounts between creditors and debtors. A bill is an order given by a creditor to his debtor to pay a certain sum of money to or to the order of a specified person on a specified date.
Bills drawn by the trader and duly accepted by his debtors are called Bills Receivable. These are entered in a separate book called ‘Bills Receivable Book’.
6. Bills Payable Book
This book is maintained to record all transactions relating to Bills Payable i.e. bills drawn by the creditors and accepted by the trader in settlement of accounts.
As and when a bill is accepted by the trader, all the particulars of the bill are entered in the Bills Payable Book.
7. Journal Proper
Journal Proper is used for recording only those transactions which cannot be recorded in any other subsidiary book. It is generally used for recording the following types of transactions.
Opening entries, Rectifying entries, Transfer entries, Adjustment entries, Closing entries etc.
8.Cash Book
In every business there will be a large number of cash transaction i.e. Receipts and Payments of cash. So it is necessary to maintain a separate subsidiary book for recording the cash transactions. The separate subsidiary book maintained for recording cash transactions is called the Cash Book.
Cash Book is a book of prime, or first entry, because all cash transactions are first recorded in the Cash Book. It is also a book of ‘final entry’ (i.e. ledger ) as cash book itself serves as cash account and bank account. Separate Cash account and Bank account are not opened.
1. To find out the total cash receipts and cash payments during a particular period 2. To know the cash and bank balance at any time without the physical counting of
cash and verification of pass book.
3. To verify the correctness of cash in hand and cash at bank.
Types of Cash Book
1. Simple Cash Book or Cash Book with only Cash column. 2. Two – column or Cash Book with Cash and Discount columns. 3. Three-column or Cash Book with Cash, Discount and Bank columns.
Simple Cash Book or Cash Book with only Cash column.
A simple cash book makes a record of only cash transactions. It is like an ordinary cash account. It is maintained by small business concerns. It has two sides- (i) Debit side or left hand side and (ii) Credit side or right hand side. The Debit side is used for recording cash receipts and credit side is used for recording cash payments. A single-column Cash book is ruled as follows:
Dr.
Cash Book
Cr. Date Particulars L.F. Amount(Rs.) Date Particulars L.F. Amount(Rs.)
Two – column or Cash Book with Cash and Discount columns
This Cash Book is an extension of simple cash book. Under this method and an additional column is provided both on debit side and credit side for recording discount allowed and discount received. A two-column cash book is ruled as follows:
Dr.
Tw o column cash book
Cr.
Date Particulars L.F
Discount (Rs.)
Cash
(Rs.) Date Particulars L.F
Discount (Rs.)
Cash (Rs.)
Illustration 8
Record the following transactions in a Two-Column Cash Book.
Jan. 1 cash balance 500
Jan.5 cash sales 4,000
Jan.10 paid into bank 3,000
Jan.12 Received cash from Satish ( in full settlement of his debt of Rs. 1,500 ) 1,480
Jan.14 Cash paid to Mehta ( discount allowed Rs.30 ) 770
Jan.16 Received cash from Sinha ( discount allowed 15 ) 585
Jan.22 paid cash to Ram Mohan 415
Jan.27 cash purchases 300
Jan.29 paid salaries 2,000
Jan.31 drew cheque for office use 800
Dr.
Two column
cash book Cr.
Date Particulars
L . F
Disco unt (Rs.)
Cash
(Rs.) Date Particulars
L . F
Disco unt (Rs.)
Cash (Rs.) 2007
Jan-01 To Balance b/d 500 Jan-10 By Bank a/c 3,000 Jan-05 To Sales a/c 4,000 Jan-14 By Mehta a/c 30 770 Jan-12 To Satish a/c 20 1,480 Jan-22 By Ram Mohan a/c 15 415 Jan-16 To Sinha a/c 15 585 Jan-27 By Purchases a/c 300 Jan-31 To Bank a/c 800 Jan-29 By Salaries a/c 2,000 Jan-31 By Balance c/d 880
35 7365 45 7365
Feb-01 To Balance b/d 880
Three-column or Cash Book with Cash, Discount and Bank columns.
The cash book which contains bank column in addition to discount and cash column is called Three column cash book. In this book one important point to be noted i.e. “Contra Entries”.
Contra Entries: If cash is deposited in the bank , it should be entered in the bank column on the debit side as ‘To Cash ‘ and again on the credit side as ‘ By Bank ‘ . If cash is withdrawn from Bank for office use, it should be entered in cash column on the debit as ‘To Bank’ and again on the credit side
Three column cash book
Da te
Particu lars
L. F
Discount (Rs.)
Cash (Rs.)
Bank (Rs.)
Da te
Particu lars
L. F
Discount (Rs.)
Cash (Rs.)
Bank (Rs.)
Illustration 9
On 1st July,2007 the columnar cash book of Mitra showed that he had Rs. 200 in his cash box
and that there was a bank overdraft of Rs.800. During the day the following transactions took place: Cash withdrawn from bank for office use 1,000
Paid in salaries in cash 300
cash paid to Harish & Co 650
Drawings in cash made by Mitra for household expenses 100
Received from Guha in full settlement of an account of Rs. 1,000, Rs. 180 in
Cash and cheque of Rs. 800. The cheque was immediately deposited in bank .
Bank returns a cheque of Rs. 990, received from Kulu & Sons in full settlement of Rs. 1,000
1. Paid rent by cheque 150
Cash deposited with bank 600
From above information prepare three columnar cash book.
Date Particulars L . F Disco unt(R s.) Cash (Rs.) Bank
(Rs.) Date Particulars L . F Dis cou nt( Rs.) Cash (Rs.) Bank (Rs.)
2007 2007
Jul-01 To Bal. b/d 200
Jul-01 By Bal. b/d 800
To Bank C 1,000 By Cash C 1,000
To Guha 20 180 800 By Salaries 300
To Sales 650
By Harish &
Co. 650
To Cash C 600 By Drawing 100
To Bal.c/d 1540
By Kulu &
Sons 10 990
By Rent 150
By Bank C 600 By Bal.c/d 380
20 2030 2940 10 2030 2,940
Jul-02 To Bal. b/d 380
Jul-02 By Bal. b/d 1540
PETTY CASH BOOK
Petty Cash Book is kept to record petty cash expenses. It is maintained by separate cashier called Petty Cashier. In this book the petty cashier records cash received by him from time to time to meet petty expenses. He does not receive money from any other person or for any other purpose. In petty cash, expenses are recorded and analysed in petty cash book. For purposes of analysis, it has a number of columns.
Petty cash book may be treated either as a part of the double entry system or merely as a memoranda book. If the former course is adopted, each payment to petty cahier is shown on the credit side of the main cash book which is considered to have been balanced by a debit entry in the petty cash book. The two entries are folioed against each other completing the double entry aspects. Payments recorded in the petty cash book are directly posted to the different nominal account. Of course, entries for expenses are made only with the periodical totals of expenses under various heads. If the latter course is adopted, for amounts paid to petty cashier, petty cash account in the ledge is debited besides entering the amounts ( paid to petty cashier ) on the credit side of the main cash book and recording the amount in the petty cash book. Periodically, different nominal accounts are debited and the petty cash account is credited in ledger for expenses recorded in petty cash book.
The balance in the petty cash account shows cash lying with the petty cashier.
Imprest System
etc. and these transactions are recorded in a separate book called petty cash book. This book is maintained by the petty cashier.
Under the imprest system of maintaining petty cash, the petty cashier is given a certain sum of money at the beginning of the fixed period ( e.g. a month/ fortnight ) which is called float. The amount of float is so fixed that it may be adequate to meet petty expenses for which he is authorised and records them in his cash book. At the end of such period, the petty cashier submits the account of the amount spent by him during the period, and the cashier gives him cash equal to the spent amount so that the petty cashier begins the next period with the fixed amount of float.
The advantages of the imprest system are as follows:
1. It saves the time of the chief cashier.
2. Petty cashier is not allowed to keep idle cash with him if the float is found to be more than adequate; its amount will be immediately reduced. This reduces the chances of misuse of cash by the petty cashier.
3. As the sum of float is small, it does not provoke the person in charge of it or other in the office to misappropriate it.
4. The record of petty cash is checked by the cashier, periodically, so that a mistake if committed is soon rectified.
5. It enables a great saving to be effected in the posting of small items to the ledger accounts. 6. The system trains young staff to handle money responsibilities.
Illustration 10
Prepare an analytical petty cash book from the following information.
Petty Cash Book is maintained on the basis of imprest system . On 20th Mar. 2007 the petty cashier
had with him Rs. 32.80. He received Rs. 67.20 to make up the expenses of the previous week. During the week the following expenses were met by the petty cashier:
Rs-Ps
Mar.20 Bus fare 0.60
Mar.21 Revenue stamps 8.50
Cold drinks for customers 2.20
Mar.22 Cartage 4.25
Mar.24 Cooli 1.00
Telegram charges 7.60
Refreshment for customers 5.20
Mar.25 Repairs to furniture 10.00
Tax charges 8.70
Cloth for dusters 7.40
Tea for customers 2.00
Analytical Petty Cash Book
Amt.
Received Date Particulars
V. No
Amt.
paid Cartage&Cooli P&T
Conve y.
Cust . Ent.
Sundrie s
2007
32.8 Mar-20 To Bal.b/d
67.2 Mar-20 To Cash
Mar-20 By Bus Fare 0.6 0.6
Mar-21 By Rev.Stamps 8.5 8.5
Mar-21
By Cold Drinks for
cutomers 2.2 2.2
Mar-22 By Cartage 4.25 4.25
Mar-24 By Cooli 1 1
Mar-24 By Telegram charges 7.6 7.6
Mar-24
By Refreshment to
customers 5.2 5.2
Mar-25 By Repairs to Furniture 10 10
Mar-25 By Taxi charges 8.7 8.7
Mar-25 By Post Cards 9 9
Mar-25 By Cloth for dusters 7.4 7.4
Mar-25 By Tea for Customers 2 2
66.45 5.25 25.1 9.3 9.4 17.4
By Bal. c/d 33.5
100 100
33.55 Mar-27 By Bal. b/d
TRIAL BALANCE
“Trial Balance is a statement containing the balance of all ledger accounts, as at any given date, arranged in form of debit and credit column placed side by side and prepared with the object of checking the arithmetical accuracy of ledger postings “. The fundamental principle of double entry system of book-keeping is that every debit has a corresponding credit and vice-versa of equal amount. Therefore, the total of the debit balance must equal in aggregate to the total of the credit balances when accounts are balanced. The aggrement of the trial balance signifies that both the aspects of each transaction have been recorded and that the books are arithmetically correct. If the trial balance does not agree, it suggests that there are some errors which must be detected and rectified before the final accounts can be prepared.
The main function of Trial Balance is that it acts as a device to check the arithmetical accuracy of the accounting process, it shows the ledger posting have been properly made and balance in each account in computed correctly. It acts as a starting point for the preparation of final accounts.
A trial balance can be prepared by any one of the following methods.
1. Total Method:
Under this method, the debit and credit totals of each account are shown in the debit and credit columns of the trial balance.
2. Balance Method:
Under this method, the difference of each account is extracted. If the debit side of an account is bigger in amount than the credit side the difference is put in the debit column of the trial balance and if the credit side is bigger, the difference is written on the credit column of Trial Balance.
Points to be noted for the preparation of Trial Balance:
1. Account dealing with assets, expenses & losses will show debit balance.
2. Accounts dealing with liabilities, incomes and gain will show credit balance.
3. ‘Sundry Debtors ‘ is the total amount due from various debtors and ‘ Sundry Creditors’ is the total amount due to various creditors.
4. Opening stock will show debit balance, generally closing stock will not appear in Trial Balance.
A table of the accounts appearing in trial balance on debit and credit side is given below
Debit Balance
Credit Balance
Personal
Accounts
Personal
Accounts
Sundry Debtors
Sundry Creditors
Bank Balance
Bank Overdraft
Loans or Advances given
Loan taken or Mortgage
loan
Drawings a/c
Capital a/c
Prepaid expenses
Outstanding Expenses
Real Accounts
Real Accounts
(a) Dealing with goods
Sales Account
Purchase Account
Return Outwards Account
Opening Stock
Nominal
Accounts
Returns Inwards
All incomes &
gains
(b) Assets
Interest Received
Land & Building
Rent Received
Plant &
Machinery
Commission Received
Furniture
Discount
Received
Investments
Reserves & Provisions
Goodwill
Provision for Doubtful
Debts
Nominal
Accounts
Provision for Discount on Debtors
All expenses and losses
General Reserve., etc
Salaries
Rent& Taxes
Carriage
Advertising
Bad Debts., etc
Mr. Kumar furnishes the following balance as on 31
stMar. 2007. You are required to
prepare a Trial Balance with the following information.
Particulars
Rs.
Particulars
Rs.
Interest on Capital
24,000 Salaries
1,28,000
Creditors
6,00,000 Capital
8,00,000
Discount received
23,000 Drawings
2,46,000
Loan
1,74,000 Machinery
3,00,000
Purchase returns
40,000 Bills payable
20,000
Sales returns
6,000 Furniture
6,00,000
Advertisement
1,63,000 Debtors
5,00,000
Commission received
20,000 Bank loan
2,00,000
Rent
10,000 Patents
60,000
Purchases
19,00,000 Opening stock
12,00,000
Sales
32,60,000
You are required to prepare a Trial Balance with the following information.
Trial Balance
As on 31st Mar. 2007
Particulars Debit Balance Credit Balance Interest on Capital 24,000
Creditors 6,00,000
Discount received 23,000
Loan 1,74,000
Purchase returns 40,000
Sales returns 6,000
Advertisement 1,63,000
Commission received 20,000
Rent 10,000
Purchases 19,00,000
Salaries 1,28,000
Capital 8,00,000
Drawings 2,46,000
Machinery 3,00,000
Bills payable 20,000
Furniture 6,00,000
Debtors 5,00,000
Bank loan 2,00,000
Patents 60,000
Opening stock 12,00,000
Sales 32,60,000
FINAL ACCOUNTS
At the end of every accounting period , which is mostly a year , accounts are prepared to ascertain net profit earned or net loss incurred during the period. These accounts are referred to as Final Accounts. Usually Trading and Profit and Loss Account also which shows the cost of manufacture of goods produced during the period. Every concern prepares a statement called Balance Sheet which sets out assets on the right hand side and liabilities including capital on the left hand side at amounts which they stand at the end of the accounting period. Balance Sheet is not an account but when one talks of final accounts, one may be referring to balance sheet also.
Capital and Revenue Expenditure
Before discussing the preparation of final accounts, it is essential to understand clearly the distinction between the capital and revenue expenditure. Capital expenditure is that expenditure which results in acquisition of an asset or which results in an increase in the earning capacity of a business. Another test of a capital expenditure is that the benefit of such an expenditure lasts for a long period of time. Obvious examples of capital expenditure are money paid for land , buildings, machinery, furniture, patents, etc.
Distinction between an capital expenditure and revenue expenditure
I. Capital expenditure is incurred in acquiring or improving permanent assets which are not meant for resale. But revenue expenditure is a routine expenditure incurred in the normal course of business and includes cost of sales as also the upkeep of fixed assets etc.
II. Capital expenditure seeks to improve the business but revenue expenditure purposes to maintain the earning capacity of the business.
III. Capital expenditure is normally a non-recurring outlay but revenue expenditure is usually a recurring item.
IV. Capital expenditure produces benefits over several years. Hence only a small part is charged to income statement as depreciation and the rest appears in the balance sheet. But revenue expenditure is consumed within an accounting year and the entire amount is charged to the ( current year’s ) income statement. Hence it does not appear in the balance sheet. Deferred revenue expenditure is however an exception to this rule.
Deferred Revenue Expenditure
Deferred Revenue expenditure is revenue in character but— I. The benefit of which is not exhausted in the same year, or II. Is applicable either wholly or in part of the future years, or
III. Is accidental and heavy and it is not prudent to charge against the profit of one year. Capital and Revenue Receipts
In order to ascertain profit made by a business, revenue expenses are deducted from the revenue receipts. Capital receipts and expenditure have no bearing on the profit or loss for the accounting period.
Distinction between Capital Receipt and Revenue Receipts
Capital Receipts Revenue Receipts
Amount realised by sale of fixed assets or by issue of shares or debentures is capital receipt.
Amount realised by sale of goods or rendering services is always revenue receipt.
A receipt in substitution of a source of income is a capital receipt.
A receipt is substitution of an income is a revenue receipt.
Amount received for surrender of certain rights under an agreement is a capital receipt, because a capital asset is being given up in the form of these rights.
Amount received as compensation under an agreement for the loss of future profits is a revenue receipt.
Instead of lump sum payment if the payment is received in instalments it is a capital receipt.
If an income is received in lump sum it is a revenue receipt.
Amount realised from the sale of capital assets or investment is capital receipt.
Amount realised from the sale of assets kept for resale is revenue receipt.
Capital and Revenue Profits
While preparing the final accounts, distinction has to be made between capital profits and revenue profits. Revenue profits are earned in the ordinary course of business. They appear in the Profit and Loss Account and are available for distribution as profit , or for creating reserves and funds, or for being used in the business. However, capital profits, are those which are earned as a result of selling some fixed assets, or in connection with raising capital for the firm.
Capital and Revenue Losses
Revenue losses are the losses which arise during the normal course of business whereas capital losses are those which occur when selling fixed assets or raising share capital.
Treatment of capital losses is not different from that of capital profits. Just as capital profits are not shown in Profit and Loss Account. They are shown in the balance sheet on asset side. As and when capital profit arise, capital profits are gradually written off against them. If however, capital losses are huge, the common practice is to spread them over a number of years and charge a part thereof to Profit and Loss Account, to each such year. But if they are negligible, they are debited to Profit and Loss Account of the year in which they occur.
Main Principles of Preparing Trading and Profit and Loss Account
The following principles must be kept in mind while preparing these accounts:
I. Only revenue receipts, i.e. sale proceeds and other incomes should be entered. II. Only revenue expenses together with losses should be taken into account.
IV. All expenses and incomes relating to the period concerned should be considered even if the expenses has not yet been paid in cash or the income has not yet been received in cash. V. While preparing Trading and Profit and Loss Account distinction must be made between the
personal expenses of the proprietor or partners and the expenses relating to the firm. All expenses of the proprietor or partners must not be debited to the Trading and Profit and Loss Account.
Trading Account
Trading account is the comparison of sales and purchase. This account is prepared to determine the amount of gross profit or gross loss on sales.
Proforma of Trading Account
Trading Account
(For the year ending...)
Particulars Rs. Particulars Rs.
To Opening stock xxxxxx By Sales xxxxxx
To Purchases xxxxxx Less: Sales returns xxx Xxxxxxx Less: Purchase returns xxxx xxxxxxx By Closing stock Xxxxx To Wages & Salaries Xxxx By Gross Loss (if any ) Xxxx To Carriage inwards Xxx (Transferred to P/L a/c)
To Cartage Xxx
To Freight Xxx
To Light power & Heating in Xxx Factory
To Consumable stores Xxx To Gross profit xxxxx
(Transferred to P/L a/c) xxxxxxxx Xxxxxxxx
Profit & Loss Account
Profit & Loss Account is the second part of Trading & Profit & Loss Account. Trading Account depicts the gross profit which is the difference of sales and cost of sale. Thus the gross profit can not treated as net profit while the businessman wants to know how much net profit he has earned from the operating activities during a period. For this purpose P&L a/c is prepared keeping in mind all the operating and non-operating incomes and losses of the business. In the debit side all the expenses and losses are disclosed and in the credit side all incomes are disclosed. The excess of credit side over debit side is called net profit while the excess of debit side over credit side shows net loss. Net profit increases the net worth of the business, therefore, it is added to the capital of owner. Net loss decreases the net worth of business so it is subtracted from capital.
Profit & Loss Account
For the year ending...
Dr. Cr.
Particulars Rs. Particulars Rs.
To Gross loss (if any ) Xxxx By Gross profit (transferred from Xxxx
transferred from Tradin a/c Trading a/c Xxxx
To Staff salaries Xxxx By Discount received Xxxx
To Office Rent Xxxx By Commission received Xxxx
To Office lighting and heating Xxxx By Dividend Xxxx To Printing & Stationery Xxxxx By Interest received Xxxx
To Bank charges Xxxx By Rent from tenant Xxxx
To Insurance Xxxx By Interest from bank Xxxx
To Telephone charges Xxxxx By Interest on drawings Xxxx To Legal expenses Xxxxx By Profit on sale of investment Xxxx To Repairs Xxxxx By Provision for discount on
To Postage & Stamps Xxxx creditors Xxxx
To Trade expenses Xxxx By Bad debts recovered Xxxx
To Establishment expenses Xxxx By Profit on sale of assets Xxxxx
To Audit fees Xxx By other incomes Xxxx
To Charity & Donations Xxxx By Net Loss ( if any ) Xxxx To Management expenses Xxxx transferred to capital a/c
To Depreciation on Xxx
Land & Buildings Xxx
Plant & Machinery Xxx
To Directors fee Xxx
To Interest on loan Xxxx
To Interest on capital Xxxx
To Sales Tax Xxxx
To Advertisement Xxx
To Bad Debts Xxxx
To Agents' commission Xxxx To Travelling expenses Xxxx To Free samples distributed Xxx To Warehouse expenses Xxx
To Packing expenses Xxxx
To Brokerage Xxx
To Distribution expenses Xxxx To Delivery van expenses Xxx To Provision for bad & doubtful debts Xxx To Entertainment expenses Xxx
To Carriage outwards Xxx
To Licence fees Xxxx
To Net Profit ( transferred to capital a/c) Xxxx
Xxxx Xxxx
Manufacturing Account
If in the business some goods are being manufacturing along with the trading activities, a manufacturing account is also prepared. In the case of trading activities ( selling and purchasing of goods ) only, the Trading and Profit and Loss account is prepared to compute the net profit . In case there is a manufacturing unit in the business with the trading , such a businessman’s income statement will include:
(i) Manufacturing Account (ii) Trading Account (iii) Profit and Loss Account
Manufacturing Account is prepared to know the results of manufacturing unit i.e. cost of production. This account is prepared before the trading account. The balance of this account is transferred to Trading Account. The proforma of Manufacturing Account is given hereunder:
Manufacturing Account
For the year ending...
Particulars Rs. Particulars Rs.
To Opening stock By Closing stock xxxxx Raw materials xxx Raw materials xxxx
Work in progress xxx xxxxx Work in Progress xxxx By Sale of scrap
xxxxx To Purchase of materials xxx xxxxx Less: Returns xxx xxxxx By Cost of production Xxxxxx To Manufacturing wages xxxxx (transferred to Trading a/c )
To Factory expenses xxxxx To Stores Consumed xxxxx To Factory rent xxxxx To Electricity xxxxx To Depreciation on plant xxxxx To Repairs of plant xxxxx To works Manager's salary xxxxx To Coal and fuel xxxxx To Other factory expenses xxxxx
xxxxxxxx Xxxxxxxx
Illustration12
From the following particulars prepare a Manufacturing Account for the year ended 31st mar. 2007.
Purchase of raw materials 39,58,500 Stock on 31st mar.2007:
Raw materials 3,63,000 Work in progress 3,00,000 Production wages 6,00,000 Factory expenses 5,52,000 Purchase expenses 1,80,000
Import duty 60,000
Stock on 1st April, 2006:
Raw material 1,20,000 Work in progress 90,000 Return outwards 25,500 Sale of scrap 6,000 Depreciation on plant 1,50,000 Carriage inwards 31,500 Repairs to machines 30,000
Manufacturing Account
Particulars Rs. Particulars Rs. To opening stock By sale of scrap 6,000 raw materials 1,20,000 By closing stock:
work in progress 90,000 materials 3,63,000 To purchases 39,58,500 work in progress 3,00,000 less:returns 25,500
To productive wages
39,33,000 By cost of production 50,76,000 6,00,000 ( transferred to trading a/c )
To factory expenses 5,52,000 To purchase expenses 1,80,000 To import duty 60,000 To carriage inwards 30,000 To depreciation 1,50,000 To repairs to machines 30,000
57,45,000 57,45,000
Illustration 13
From the following information , prepare a manufacturing account for the year ending 31st
Dec. 2007.
Particulars Amount (Rs.) Stock on 1.1.2007:
Raw materials 8,000
work in progress 20,000 Manufacturing wages 40,000 purchase of raw materials 1,20,000
factory rent 20,000
carriage of raw materials 12,000 salary of works manager 8,000 depreciation on plant 8,000
closing stock on 31st Dec. 2007 were as follows:
raw materials 20,000
work in progress 16,000
Manufacturing Account
Particulars Rs. Particulars Rs. To opening stock : By closing stock:
raw materials 8,000
raw materials 20,000
work in progress 20,000 28,000
work in progress
16,000 36,000
To purchases 1,20,000 By cost of production 2,00,000 To Carriage on raw materials 12,000 ( transferred to trading a/c )
To depreciation on plant 8,000 To manufacturing wages 40,000 To factory rent 20,000 To salary to works manager 8,000
2,36,000 2,36,000
Illustration 14
Ascertain Gross profit from the following :
Particulars Rs.
opening stock 20,000
closing stock 30,000
Purchases 80,000
purchase returns 2,000
Sales 1,60,000
sales returns 3,000
carriage inwards 2,000 carriage outwards 4,000 freight duty and clearing charges 5,000
rent and taxes 3,500
Dr. Cr.
Particulars
Amt.
(Rs.) Particulars Amt. (Rs.)
To opening stock 20,000 By sales 1,60,000
To purchases 80,000 less: returns 3,000 1,57,000 To purchase returns 2,000 78,000 By closing stock 30,000 To carriage inwards 2,000
charges
To Gross profit 82,000
1,87,000 1,87,000
Illustration 15
Prepare trading and profit and loss account for the year ending 31.12.2007
Particulars Rs. Particulars Rs.
Capital 30,
