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1 LESSON 1 INTRODUCTION TO ACCOUNTING STRUCTURE: 1.1 Introduction 1.2 Objectives of Accounting 1.3 Uses of Accounting Information 1.4 Principles of Accounting 1.4.1 Accounting Concepts 1.4.2 Accounting Conventions 1.5 Some Important Terms used in Book – Keeping 1.6 Summary 1.7 Key Words 1.1 INTRODUCTION: Accounting can be defined as, `an art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least of a financial character, and interpreting the result thereof.” Accounting, which involves recording, classifying and summarizing the transactions of financial nature in order to compute the results and financial position of the business. Accounting facilitates external reporting to the owners or shareholders, potential investors, trade creditors, creditors for expenses, banks and financial institutions, management and employees, society, Income-tax department, academicians, and other interested parties. As this branch of accounting is based OBJECTIVES: To explain the meanings and importance of accounting To know the utility of accounting information to various stakeholders To know the principles which guide the preparation and reporting of accounting statements To familiarize with the frequently used words in accounting

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LESSON 1 INTRODUCTION TO ACCOUNTINGOBJECTIVES: To explain the meanings and importance of accounting To know the utility of accounting information to various stakeholders To know the principles which guide the preparation and reporting of accounting statements To familiarize with the frequently used words in accounting

STRUCTURE:1.1 Introduction 1.2 Objectives of Accounting 1.3 Uses of Accounting Information 1.4 Principles of Accounting 1.4.1 1.4.2 Accounting Concepts Accounting Conventions

1.5 Some Important Terms used in Book Keeping 1.6 Summary 1.7 Key Words 1.1 INTRODUCTION: Accounting can be defined as, `an art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least of a financial character, and interpreting the result thereof. Accounting, which involves recording, classifying and summarizing the transactions of financial nature in order to compute the results and financial position of the business. Accounting facilitates external reporting to the owners or shareholders, potential investors, trade creditors, creditors for expenses, banks and financial institutions, management and employees, society, Income-tax department, academicians, and other interested parties. As this branch of accounting is based

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on historical or past data, it is described as the post-mortem of financial transactions. In Financial Accounting all the transactions of financial nature are recorded in a book called Journal in chronological order or in order of their occurrence, then classified in another book called Ledger and finally summarized into a schedule called Trial Balance, from which an Income statement is prepared to know the results of the transactions of financial nature in a business firm as on a particular date and the same are analyzed with the help of the tools of financial analysis, such as, comparative and common size financial statements, trend analysis, Ratio analysis, fund flow analysis and cash flow analysis. These days, Double Entry System of Accounting is followed by every Corporate and also most businesses which are organized in forms other than Corporate. Hence the subsequent discussion in this chapter and latter chapters would be on Double Entry System of Book Keeping. 1.2 OBJECTIVES OF ACCOUNTING: Accounts are maintained 1. To have a permanent record of all mercantile transactions. 2. To maintain records of incomes, expenses and losses in such a way that the net profit or net loss for any selected period may be readily ascertained. 3. To keep records of assets and liabilities in such a way that the financial position of the undertaking at any point of time may be readily ascertained. 4. To enable the review and revision of policies in the light of past experience brought to light by analyzing and interpreting records and reports. 1.3 USERS OF ACCOUNTING INFORMATION: The importance of accounting is to provide meaningful information about a business enterprise to those persons who are directly or indirectly interested in the performance and financial position of business enterprise. Such persons may include owners, creditors, investors, employees, government, public, research scholars and the managers.

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1.

Owners:

The owners of a business furnish capital to be used for the purpose of business. They are interested to know whether the business has earned a profit or loss during a particular period and also its financial position on a particular date. They want accounting reports in order to have an appraisal of past performance and also for an assessment of future prospects. 2. Creditors:

The creditors include suppliers of goods and services, bankers and other lenders of money. They are interested in the financial stability of the concern before making loans or granting credit. They look to the ability of the business to pay interest and principal as and when it becomes due for payment. They also look to the trends of earnings as it ultimately affects the solvency of a concern. 3. Investors:

Investors look not only the earning capacity of business but also its financial strength and solvency before deciding whether to subscribe or not for the shares in a Company. They are interested in steady and good return on their capital, the safety of their capital and appreciation in the value of the shares. 4. Employees:

Employees are interested in earning capacity of a concern as their salaries, bonus and pension schemes are dependent on this factor. They have a permanent stake in the business and in order to have an assurance of steady employment they are very much interested in the stability of the organization. 5. Government:

Government is interested in accounting statements and reports in order to see the performance of a particular unit, its cost structure and income in order to impose tax and excise duty.

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6.

Public:

The public as consumers is interested in accounting statements in order to know whether control is exercised on production, selling and distribution expenses in order to reduce the prices of goods they buy. They can also judge whether the economic resources of the concern are being utilized for the benefit of the common man or not. 7. Research Scholars:

Such persons are interested in accounting statements and reports in order to get data for proving their thesis on which they are working and hence to complete their research projects. 8. Managers:

The managers of an enterprise need accounting information for planning, control, evaluation of performance and decision-making. Their main responsibility is to operate the business so as to obtain maximum return on capital employed without causing any detriment to the interest of the stakeholders. 1.4 PRINCIPLES OF ACCOUNTING: Accounting is a system evolved to achieve a set of objectives. The objective being able to communicate accounting information, to its users. In order to achieve the goals, we need a set of rules or guidelines. These guidelines are termed here as Basic Accounting Principles. In order to ensure authenticity, and comparability in the matter of recording and interpretation of Accounts, Accounting Principles are followed. Concepts and Conventions. conventions. 1.4.1 ACCOUNTING CONCEPTS: These Principles can be divided into The following few paragraphs deal with these concepts and

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The term `concepts includes those basic assumptions or conditions upon which the science of accounting is based. The following are the important accounting concepts. The term Concept means an idea or thought. Basic Accounting Concepts are the fundamental ideas or basic assumptions underlying the theory and practice of financial accounting. 1. Separate Entity Concept:

Business is treated separate from the proprietor. All the transactions are recorded in the books of business and not in the books of the proprietor. The proprietor is treated as a creditor for the business. When he contributes capital he is treated as person who has invested his amount in the business. Therefore, capital appears in the liabilities of balance sheet of the Organisation. The concept of separate entity is applicable to all forms of business organizations. For example, in case of a partnership business or sole proprietorship business, though the partners or sole proprietor are not considered as separate entities in the eyes of law, but for accounting purposes they will be considered as separate entities. The major effects of this concept are that: a) b) c) 2. Financial position of the business can be easily found out. Earning capacity of business can be easily ascertained. The personal affairs of the owners are not mixed up with that of the business Going Concern Concept:

The assumption is that business will continue to exist for unlimited period of time. There is neither the intention nor the necessity to liquidate the particular business venture in the foreseeable future. On account of this concept, the accountant while valuing the assets does not take into account sale value of assets. Moreover, he charges depreciation on fixed assets on the basis of their expected lives rather than on their market values. 3. Money Measurement Concept:

Only those transactions are recorded in accounting which can be expressed in terms of money. Measurement of business in terms of money helps in understanding the state of affairs of the business in a much better way. For example if a business owns Rs.10,000 of cash, certain

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quantity of raw materials, two factories, 1,000 square feet of building space etc. These amounts cannot be added together to produce a meaningful total of what the business owns. However, if these items are expressed in monetary terms such as Rs.10,000 of cash, Rs.12,000 of raw materials, Rs.2,00,000 of factories, and Rs.50,000 of building, all such items can be added and much more intelligible and precise estimate about the assets of the business will be available. The transactions which cannot be expressed in monetary terms fall beyond the scope of accounting. This is also a limitation of accounting. For example, if a business has got a team of dedicated and trusted employees, it is definitely an asset to the business but since their monetary measurement is not possible, they are not shown in the books of the business 4. Cost Concept:

According to this concept, an asset is recorded at its cost in the books of account, i.e., the price which is paid at the time of acquiring it. This concept is mainly applicable for fixed assets. Current assets are not affected by it. Cost concept has the advantage of bringing objectivity in the preparation and presentation of financial statements. In the absence of this concept the figures shown in the accounting records would have depended on the subjective views of a person. However, on account of continued inflationary tendencies the preparation of financial statements on the basis of historical costs, creates problems of credibility in judging the financial position of the business. This is the reason for the growing importance of inflation accounting. 5. Accounting period Concept:

According to this concept, the life of the business is divided into appropriate time periods for studying the results shown by the business after each segment. This is because though the life of the business is considered to be indefinite (according to going concern concept), the measurement of income and studying the financial position of the business after a very long period would not be helpful in taking proper corrective steps at the appropriate time. It is therefore, absolutely necessary that after each segment or time interval the businessman must

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`stop and `see back, how things are going. In accounting such a time period or time is called `accounting period. It is usually one year. Every business wants to know the result of his investment and efforts after a certain period. Usually one-year period is regarded as an ideal for this purpose; it may be 6 months or 2 years also. This concept helps financial position and earning capacity of one year may be compared with another year and also in planning and increasing the efficiency of business. 6. Dual Aspect Concept:

This is the basic concept of accounting. According to this concept every business transaction has a dual effect. The two fold aspects are Receiving of benefit and Giving of equivalent benefit. For example, if A starts a business with a capital of Rs.10,000. There are two aspects of the transaction. On the one hand the business has asset of Rs.10,000 while on the other hand the business owes to the proprietor a sum of Rs.10,000 which is taken as proprietors capital. This expression can be shown in the form of following equation: Capital (Equities) = Cash (Assets) 10,000 = 10,000 The term `assets denotes the resources owned by a business while the term Equities denotes the claims of various parties against the assets, Equities are of two types. They are owners equity and outsiders equity. Owners equity (or capital) is the claim of owners against the assets of the business while outsiders equity (or liabilities) is the claim of outside parties such as creditors, debenture-holders against the assets of the business. total of liabilities, thus: Equities = Assets OR Liabilities + Capital = Assets In the example given above, if the business purchases furniture worth Rs.5,000 out of the money provided by A, the situation will be as follows: Since all assets of the business are claimed by someone (either owners outsiders), the total of assets will be equal to

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Equities =Assets Capital Rs.10,000 = Cash Rs.5,000 + Furniture Rs.5,000 Subsequently if the business borrows Rs.30,000 from a bank, the new position would be as follows: Equities = Assets Capital Rs.10,000 + Bank Loan Rs.30,000 = Cash 35,000 + Furniture Rs.5,000. The term `accounting equation is also used to denote the relationship of equities to assets. The equation can be technically stated as for every debit, there is an equivalent credit. As a matter of fact the entire system of double entry book-keeping is based on this concept. 7. Matching Concept:

Every businessman is eager to make maximum profit at minimum cost. Hence, he tries to find out revenue and cost during the accounting period. In order to ascertain the profit made by the business during a period, it is necessary that `revenues of the period should be matched with the costs (expenses) of the period. The term `matching means appropriate association of related revenues and expenses. In other words, surplus made by the business during a period can be measured only when the revenue earned during a period is compared with the expenditure incurred for earning the revenue. On account of this concept, adjustments are made for all outstanding expenses, accrued incomes, prepaid expenses and unearned incomes, etc., while preparing the final accounts at the end of the accounting period. 8. Realization Concept:

According to this concept revenue is recognized when a sale is made. Sale is considered to be made at the point when the property in goods passes to the buyer and he becomes legally liable to pay and not when the actual payment is made. For example, A places an order with B for supply of certain goods yet to be manufactured. On receipt of order, B purchases raw materials, employs workers, produces the goods and delivers them to A. A makes payment on receipt of

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goods. In this case the sale will be presumed to have been made not at the time of receipt of the cash for the goods but at the time when goods are delivered to A.

9.

Accounting Equivalence Concept:

The proprietor provides funds for acquisition of assets. Hence the assets owned by the business must be equal to the funds provided by the proprietor. Funds provided by the proprietor are called equity. Hence accounting equivalence concept is: Assets = Equities In addition to own funds, money is borrowed which is known as liability. Therefore assets are acquired through equity and liability. Therefore, accounting equation is: Assets = Owners Equity + liabilities 10. Objective Evidence Concept:

This concept relates with the verification of accounting record with Objective evidence. Objective evidence means study of those documents and vouchers on the basis of which accounting record has been made. This helps a lot in auditing of accounts and Account remains free from error and fraud due to existence of vouchers, documents etc. 1.4.2 ACCOUNTING CONVENTIONS: The term `convention includes those customs or traditions which guide the accountant while preparing the accounting statements. The following are the important accounting conventions:

Convention of Consistency Convention of Conservatism. Convention of Full Disclosure.

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Convention of Materiality.

1. Convention of Consistency: Continuance of same practice for number of years indicates consistency. Whatever accounting practice has been adopted in one year, the same should be continued in future years also. If depreciation is charged on fixed assets according to diminishing balance method, it should be done year after year. This is necessary for the purposes of comparison. However, consistency does not mean inflexibility. It does not forbid introduction of improved accounting techniques. If better method is found, it must be followed, but a note for making a change must be in the accounts. The biggest advantage of this convention is that it facilitates comparison of one years accounts with other years. 2. Convention of Conservation: Future is uncertain. Though projections may be made about future events, no one can forecast future with perfect certainty in business. Therefore some arrangement or provision is made to meet future uncertainties. Every sincere businessman makes an estimate of future losses and then some provision for it e.g., provision for bad debts is made. However, businessmen mostly ignore the items of future profits. This tendency is termed as conservatism. Therefore, the common accounting practices are: o Do not consider any income or gain till the same is realized in cash. o Create or make a provision for future expected losses and contingencies on the basis of past experience. The convention of conservatism has become target of serious criticism these days especially on the ground that it goes against the convention of full disclosure. It also gives room to the accountant to create secrete reserves (e.g. by creating excess provision for bad and doubtful

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debts, depreciation etc.), and the financial statements do not depict a true and fair view of state of affairs of the business.

3.Convention of Full Disclosure: Accounting records and statements should be honest and materially informative, Exclusion of material facts makes them incomplete and unreliable. This convention is gaining more importance because most of big businesses are run in the form of joint stock companies where ownership is divorced from management. The Companies Act, 1956, not only requires that Income Statement and Balance Sheet of a company must give a true and fair view of the state of affairs of the company but it also gives the prescribed forms in which these statements are to be prepared. The practice of appending notes to the accounting statements (such as about contingent liabilities or market value of investments) is pursuant to the convention of full disclosure. This is done to benefit the proprietor and all those outsiders who are interested in assessing the efficiency of financial position of the business unit. 4.Convention of Materiality: Materiality means relative importance. Whether a matter should be disclosed or not in the financial statements depends on its materiality, i.e., whether it is material or not. According to this convention accounting record should be made of all material facts. Immaterial items may either be clubbed with material items and then recorded or these may be ignored. For example purchase of a waste paper basket, might amount to purchase of a capital asset, since this lasts for more than a year, but by virtue of the amount involved, it is better treated as revenue expenditure. Thus, the term `materiality is a subjective term. The accountant should regard an item as material if there is reason to believe that knowledge of it would influence the decision of the informed investor.

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1.5 SOME IMPORTANT TERMS USED IN BOOK KEEPING: Before you get into the specifics of Accounting, you should be familiar with some of the terms which are generally used in Accounting. A few of them are given below: Business Transactions: Any exchange of money or moneys worth is called business transaction. Events like purchase and sale of goods, receipts and payments of cash for services or on personal accounts are the examples of transactions. When payment for business activity is made immediately, it is called cash transaction, but when the payment is postponed to a future date, it is called a credit transaction. Debtor: A debtor is a person who owes something to the business Creditor: A creditor is a person to whom something is owing, by the business. Debit and Credit: To debit an account means to enter the transaction on the debit side of that account. To credit an account means to enter the transaction on the credit side of that account. Capital: It is the amount invested by the proprietor in the business. For the business, capital is a liability towards the owner. Sometimes it is called `owners equity i.e. owners claim against the assets. Owners equity or capital is always equal to assets minus liabilities. Drawing: It is the value of cash or goods withdrawn from the business by the owner for his personal use. Goods: It includes all commodities or articles in which a trader deals.

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Assets: These are the material things or possessions or properties of the business including the amounts due to it. Examples are Cash and Bank balances, Land and Building, Plant and Machinery etc. Liabilities: The term liabilities denote the amounts which the business owes to others such as loan from bank, creditors for goods supplied, for outstanding expenses etc. Accounts: An account is a summary of the record of all the transactions relating to a person, asset, expense or gain. It has two sides-the left hand side called the debit side and the right hand side called the credit side.

Accounts are of three types Personal, Real and Nominal accounts: Personal Accounts: These are the accounts of natural persons (such as Rams accounts, Gopals account) artificial persons (such as Uday Ltd., Syndicate Bank,) and representative personal account (such as Prepaid Insurance account, outstanding salary account) with whom the trader deals) Real Accounts: Accounts relating to properties or assets of a trader are known as real accounts. It includes tangible assets such as building, furniture, cash etc., and also intangible assets such as goodwill, trade marks, patent rights Nominal Accounts: Accounts dealing with expenses, losses, gains and incomes are called Nominal Accounts, e.g. salaries account, wages account, commission account etc. Real and Nominal Accounts are also called Impersonal accounts because they do not affect any particular person but affect business in general. 1.6 SUMMARY:

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Accounting can be defined as, `an art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least of a financial character, and interpreting the result thereof. Accounting is a system evolved to achieve a set of objectives. The objective is to communicate accounting information to its users. In order to achieve the goals, we need a set of rules or guidelines. These guidelines are termed here as Accounting Principles. The importance of accounting is to provide meaningful information about a business enterprise to those persons who are directly or indirectly interested in the performance and financial position of business enterprise. Such persons may include owners, creditors, investors, employees, government, public, research scholars and the managers. 1.7 KEY WORDS: Double Entry System of Book Keeping Going Concern Concept Cost Concept Dual Aspect Concept Realization Concept Objective Evidence Concept Convention of Conservatism. Convention of Materiality. Try yourself: 1. Explain the principles of Accounting. 2. Discuss important Accounting Concepts 3. Explain the significance of Accounting conventions. 4. Who are the users of Accounting information? FURTHER READINGS: Jain S.P. and Narang, K.L., .Advanced Accountancy, Kalyani Publishers Mukherjee & Khan, Modern Accountancy, Tata Mcgraw Hill Separate Entity Concept Money Measurement Concept Accounting period Concept Matching Concept Accounting Equivalence Concept Convention of Consistency Convention of Full Disclosure.

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LESSON 2 ACCOUNTING CYCLE - I STRUCTURE OBJECTIVES:Explain importance of Journal, be able to record transactions in STRUCTURE: the journal Know the importance of Ledger, be able to do the ledger posting, and Balance the accounts Describe the importance and utility of Subsidiary books. Prepare the trial balance

STRUCTURE:2.1 Introduction 2.2 Journal 2.3 Ledger 2.4 Subsidiary Books- Division Of Journal 2.5 Trial Balance 2.6 Accounting Cycle 2.7 Summary 2.8 Key Words

2.1 INTRODUCTION: As discussed in the first chapter, businesses aim at earning profit. Entities which do not have profit earning as an objective also aim to be financially viable. Therefore, earning a profit or being viable is an important objective which is pursued by all organizations. However, it is not possible to ascertain whether operations have been viable or not, unless a proper record of all the transactions is kept in a systematic way.

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Maintaining such a systematic record of all transaction is called book-keeping and when such record-keeping moves on to classifying and summarizing, preparation of final reports and interpretation, we call it accounting. In India, Accounting had been practised as far back as Mauryan Dynasty times which we can see from Kautilyas Artha Shastra. However, the present day accounting has its origins in Luco Paciolis Double Entry System of Accounting. In this chapter, we shall learn to journalise, and post it into the ledger. The two steps mark the beginning of the Accounting cycle. 2.2 JOURNAL :

Journal is the book wherein a business transaction is first written or recorded and therefore it is also known as book of Original Entry. In the French language Jour means day. Journal therefore is a book where day to day transactions are written. written followed by January 2, January 3 and so on. Journal is written chronologically i.e., it is written date wise, for example; transaction relating January 1 are first Journal has columns for Date, Particulars, Ledger Folio, Debit and Credit. The format is as follows:

Date 1999 Jan 1 1999 Jan 2 1999 Jan 3

Particulars

LF

Debit Amount

Credit Amount

In the date column, date of the transaction is recorded, in the particulars column details relating to the accounts affecting the transaction are recorded. Both the debit and credit aspects of the transaction are recorded. The Amounts column relating to the debit and credit are placed side by side. Each transaction entered in the Journal is known as Journal Entry and the act of entering or writing the transaction in the Journal is known as journalizing. A Journal Entry is written in a specific form in which account relating to debit is written in the

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first line and Account relating to Credit is written in the second line. While writing the second line a little space is left and then written as given under.

Date

Particulars Ravis A/c To Cash Dr.

LF

Debit Amount 5000

Credit Amount 5000

Each Journal entry is followed by a narration given in brackets. Narration is the explanation about the journal entry. For E.g.: Date Particulars Ravis A/c To Cash (Paid Cash to Ravi) LF Dr. Debit Amount 5000 Credit Amount 5000

While Journalizing the transaction the rules of journalizing need to be followed. The rules of journalising accounts are as follows: Personal Accounts (A/cs relating to persons Real Accounts (A/cs relating to assets) Debit the Receiver Debit what comes in expenses Credit the giver Credit what goes out and Credit all incomes and gains

Nominal Accounts Debit all (A/cs relating to expenses, losses losses, income and gains) STEPS TO BE FOLLOWED:

1) Identify the accounts being affected in the transaction. 2) Categorize them into real, nominal and personal 3) Apply the relevant rules of debit and credit

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However, in order to journalize it is very important that you should be to identify and classify the accounts into proper categories. You should know the category into which a particular account falls. For example you should know whether Capital Account is a personal account, nominal account or a real account, only then you can apply the rule related to that category. Consider, Cash since it is a real account you should apply the rules relating to real account. And again take Rent since we know that it is a nominal account rules of debit and credit relating to nominal accounts need to be applied while journalising the transactions. Personal Accounts relate to Accounts relating to persons. Persons could mean individuals, business organization, a sole proprietary concern, partnership firm, and so on. It could be a bank, an educational, institution, a hospital or any institution. The term person includes a natural person as well as an artificial person. Real accounts relate to assets. They could be land, building, motor car, machinery, furniture, cash, goodwill, patents and so on. Assets could be Tangible or intangible. Examples of intangible assets could be good will, patents, trade and so on. Nominal accounts relate to expenses, losses, incomes and gains. For eg: Rent, Interest, Salary. Having understood the meaning of a journal, the rules of journalizing, the style of writing a journal entry, the format of a journal, the various type of accounts, we shall now try to enter or write sample business transactions into a Journal. January 1, 2005 Ravi Started business with Cash Rs.50000 In this business transaction it is obvious that Cash A/c is affected. We see that Cash is being brought into the business. So the first account that is affected is Cash and the other is the Personal A/c of the owner which is called as Capital. Now since Cash is a real account the rules of debit and credit relating to Real accounts need to be applied. And the rule is debit what comes in and credit what goes out. We see here that cash is coming into the business and so we need to debit the Cash A/c.

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The other account affected is the Capital A/c. Capital being a personal account, the rule of personal a/cs need to be applied. And the rule is debit the receiver and credit the giver. Here the owner of the business is supplying or giving capital to the business. It may be noted that business unit is separate from the owner. Therefore we credit the capital a/c of the owner. So the journal entry will be written thus: Date Jan 1, 2005 Particulars LF Cash A/c Dr. To Capital A/c (Being Capital brought in) Debit Amount 50000 Credit Amount 50000

If the name is not given it may be written as Cash A/c Dr. To Capital Account. January 2, 2005 Bought Furniture Rs.2000 In this transaction you see that one of the accounts is Furniture, the other being Cash. How do you know that Cash is the other account. It is because you cannot buy anything without paying. If you have bought furniture it means that you have paid for it. Suppose you feel that it could be a credit transaction. Then it may be remembered that if it were a credit transaction, the name of the concern, selling on credit would be given. Since it is not given we may safely assume that the two accounts affected in this transaction are Furniture A/c and Cash A/c. Analysis: After identifying that the two accounts Furniture and Cash are Real accounts

apply the rules of real accounts. Furniture is coming into the organization, debit it. Credit the cash a/c since it is going out of the organization. Date Jan 2,2005 Particulars Furniture A/c LF Dr. Debit Amount 2000 Credit Amount 2000

To Cash A/c (Being Furniture purchased)

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January 3, 2005 Rent paid Rs. 1000 The accounts affected here are Rent and Cash. While Rent is a nominal account (since it is an expenditure) Cash is a real A/c. Treat Rent as per nominal account rule. Debit all expenses, rent should therefore be debited. As per Real A/c Rules Credit what goes out, therefore credit cash account. Date Jan 3, 2005 Particulars Rent A/c To Cash A/c (Being the rent paid) LF Dr. Debit Amount 1000 Credit Amount 1000

It may be noted here, that to whom the Rent is paid is not so important when Cash has changed hands. Now having understood the procedure of writing business transactions in a Journal, it is now the time to get thorough with it. Therefore the following illustrations: (1) Brought into business Cash Rs.50000, Land Rs.100000, building Rs.250000, Furniture Rs.20000, Machinery Rs.200000 Date Feb 1, 2005 Particulars Cash A/c Dr. Land A/c Dr. Building A/c Dr. Furniture A/c Dr. Machinery A/c Dr. To Capital A/c (Being Capital Brought in) LF Debit Amount 50000 100000 250000 20000 200000 Credit Amount

620000

It may be noted that in Double Entry System of book-keeping, Debit = Credit therefore sum of all debits (6,20,000) should be equal to a single credit in the above transactions. Incidentally it may be noted that an entry where there are more than one debit or one credit it is called combined or a composite entry.

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(2) Purchases Rs.30000 Date Feb 2, 2005 Particulars LF Purchases A/c Dr. To Cash A/c (Being purchases made or goods purchases) Debit Amount 30000 Credit Amount 30000

When goods are purchased they may also be referred to as purchases. That is the reason we have debited it as purchases rather than as goods. (3) Purchases from Mohan Raj Rs.45,000 Date Feb 3, 2005 Particulars Purchases A/c LF Dr. Debit Amount 45000 Credit Amount 45000

To Mohan Raj A/c (Purchases on credit from Mohan Raj)

Note: It may be noted here that while in the previous entry Cash has been credited, here Mohan Rajs name has been credited. Thats because it is a credit transaction (so understood because the name of the person has been given). In this case cash has not gone out Mohan Rajs A/c is a personal account and since Mohan Raj has given the goods and the rule is credit the giver therefore his name has been credited. (4) Purchases from Mohan Raj for Cash Rs.35000 Date Feb 4, 2005 Particulars LF Purchases A/c Dr. To Cash A/c (Being the purchases made on Cash) Debit Amount 35000 Credit Amount 35000

Note: How does one know that it is a Cash transaction because it so mentioned. Although the name of the person transacting is given it is clearly mentioned that it is a Cash transaction and so Mohan Rajs name recedes into the background. It is not to be recorded.

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(5) Sales Rs. 25000 Date Feb 5, 2005 Particulars Cash A/c LF Dr. Debit Amount 25000 Credit Amount 25000

To Sales A/c (Being Cash Sales made)

(6) Sale made to Ravi Rs.15000 Date Feb 5, 2005 Particulars Ravis A/c To Sales A/c (Being Sales Credit to Ravi) made LF Dr. on Debit Amount 15000 Credit Amount 15000

(7) Sale made to Ravi Rs.20000 for Cash Date Feb 6, 2005 Particulars Cash A/c LF Dr. Debit Amount 20000 Credit Amount 20000

To Sales A/c (Being Cash Sales made to Ravi for Cash) (8) Machinery purchased Rs.60000 Date Feb 7, 2005 Particulars Machinery A/c To Cash A/c (Being Purchased) LF Dr. Machinery Debit Amount 60000

Credit Amount 60000

It may be noted here that debit is given to machinery and although it is a purchase, purchases a/c is not debited; because the name of the asset that is machinery is specified and it is to be differentiated from Purchases or Goods meant for resale.

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(9) Sale of Land Rs.500000 Date Feb 8, 2005 Particulars Cash A/c To Land A/c (Being Sale of Land) LF Dr. Debit Amount 50000 Credit Amount 50000

(10) Cash Withdrawn for Office Use Rs.30000 Date Feb 9, 2005 Particulars LF Cash A/c Dr. To Bank A/c (Being Cash withdrawn from Bank for Office use) Debit Amount 30000 Credit Amount 30000

(11) Cash withdrawn for personal use Rs.10000 Date Feb 9, 2005 Particulars Drawings A/c LF Dr. Debit Amount 10000 Credit Amount 10000

To Bank A/c (being Cash withdrawn for personal use)

Note: The above drawings are meant for personal use of the entrepreneur and not for office, so Cash is not entering the Office, therefore Cash is not entered as a debit instead drawings is to be debited, because to that extent the owner owes to the business. (12) Rent paid Rs. 750 Date Feb 10, 2005 Particulars Rent A/c To Cash A/c (Rent paid) (13) Rent paid to Shyam Rs.8000 Date Feb 11, 2005 Particulars Rent A/c To Cash A/c (Rent paid) LF Dr. Debit Amount 8000 Credit Amount 8000 LF Dr. Debit Amount 750 Credit Amount 750

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In the above transaction although name is given since Rent A/c is more important, which is an expense; therefore rent is debited. (14) Interest Received Rs.2000 Date Feb 11, 2005 Particulars Cash A/c LF Dr. Debit Amount 2000 Credit Amount 2000

To Interest A/c (Being Interest Received)

(15) Commission Received Rs. 1500 Date Feb 13, 2005 Particulars Cash A/c LF Dr. Debit Amount 1500 Credit Amount 1500

To Commission A/c (Being Commission Received) (16) Interest on Capital Rs.800 Date Feb 15, 2005 Particulars Interest on Capital A/c Dr. To Cash A/c (Being Interest paid on Capital) 2.3 LEDGER: LF Debit Amount 800

Credit Amount 800

Ledger is a book where account wise information is documented. While the Journal gives data in chronological form, the ledger gives account wise information. All the transactions related to a particular account are put at one place. For e.g., if you would like to know the transactions you carried out with your customer Ravi you need not search throughout the journal to trace out transactions relating to Ravi instead you go to ledger and locate Ravis A/c thereon and find all the transactions relating to Ravi. It is more useful than the day to day information provided in the journal. Ledger is the second stage in the Accounting cycle. From the journal transfer is made into the ledger under various heads of account. This process of transfer is known as Ledger posting.

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HOW IS LEDGER POSTING DONE: Various accounts which are found affected in the journal are opened in the ledger. An account is in T form. On either side of the account debit and credit aspects are shown. The name of the account is given on the top. The debit aspects relating to the account are recorded on the left side, while Credit aspects are recorded on the right side as shown below: Name of the Account Debit side Credit side

On debit side, To is used as a prefix of the account while on the credit side the word By is prefixed. A look at the Format shall further clarify this: NAME OF THE ACCOUNT Dr. Date Particulars JF Dr. side To Name of the A/C Amount Rs. Date Particulars JF Cr. Side By Name of the A/c Cr. Amount Rs.

Now let us post some Journal entries into the ledger. Example:1 JOURNAL Date 1.10.2005 2.10.2005 3.10.2005 Treatment: Particulars Cash A/c Dr. To Capital (Being capital brought in) Purchases A/c Dr. To Cash (Being purchase made) Cash A/c Dr. To Sales (Being Sales made) JF Amount 1,00,000=00 15,000=00 20,000=00 Amount 1,00,000=00 15,000=00 20,000=00

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LEDGER CASH A/C Dr. Date Particulars JF Amount Rs. 100000 20000 Date Particulars JF Cr. Amount Rs. 15000

1st Oct To Capital 2005 3rd Oct To Sales 2005 CAPITAL A/C Dr. Date Particulars JF

2nd Oct By Purchases 2005

Cr. Amount Rs. Date Particulars JF Amount Rs. 100000

1st Oct By Cash 2005

PURCHASES A/C Dr. Date Particulars JF Amount Rs. 15000 Date Particulars JF Cr. Amount Rs.

2nd Oct To Cash 2005

SALES A/C Dr. Date Particulars JF Amount Rs. Date Particulars JF Cr. Amount Rs. 20000

3rd Oct By Cash 2005

It may be noted from the above that in the first transaction cash A/c is showing a debit balance. Therefore in the Cash A/c the transaction is written on the debit side. It may be noted that

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when the name of the account having the credit balance is written Viz: in the Cash A/c it is written as To Capital Account. Whereas in the capital account which shows credit balance it is written as By Cash A/c on the credit side. In the second transaction purchases A/c is showing a debit balance and therefore in the purchases A/c the transaction is written on the debit side as To Cash A/c. Whereas in the Cash A/c which is showing credit balance it is written as By purchases. In the third transaction Cash A/c is showing a debit balance and therefore on the debit side of the cash account it is written as To Sales, while in the Sales A/c it is recorded as By Cash. From the above three transactions it is seen as to how ledger posting or transfer of transaction is made from the journal to the ledger. Example: 2 Journalise the following transactions and post them in the Ledger: Capital brought in Rs.50,000 Purchases Rs.10,000 Purchases from Ravi Rs.5,000 Sales Rs. 8,000 Sales to Mohan Rs.7,000 JOURNAL Date Particulars Cash A/c LF Dr. Dr. 50,000 Cr. 50,000 10,000 10,000

To Capital A/c (Being Capital brought in) Purchases A/c Dr. To Cash A/c (Being purchases made for Cash)

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Mohan A/c To Sales A/c (Being Cash Sales made) Cash A/c To Sales A/c (Being Cash Sales made) Purchases A/c To Ravi A/c

Dr.

7,000 7,000

Dr.

8,000 8,000

Dr.

5,000 5,000

(Purchases made on Credit) CASH A/C Dr. Date Particulars To Capital To Sales Total Amount 50000 8000 58000 Date Particulars By Purchases By Balance C/d Total Cr. Amount 10000 48000 58000

CAPITAL A/C Dr. Date Particulars Amount To Balance C/d 50000 Total 50000 Date Particulars By Cash Total Cr. Amount 50000 50000

PURCHASES A/C Dr. Date Particulars To Cash To Ravi Total Amount 10000 5000 15000 Date Particulars By Balance c/d Total Cr. Amount 15000 15000

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SALES A/C Dr. Date Particulars To balance c/d Total Amount 15000 15000 RAVI A/C Dr. Date Particulars To Balance c/d Total Amount 5000 5000 Date Particulars By Purchase Total Cr. Amount 5000 5000 Date Particulars By Cash By Mohan Total Cr. Amount 8000 7000 15000

MOHAN A/C Dr. Date Particulars To Sales Total Amount 7000 7000 Date Particulars By Balance c/d Total Cr. Amount 7000 7000

A brief explanation of how the above entries are posted in the ledger is given below: In the first transaction we see that Cash A/c is showing a debit balance. Therefore in the Cash A/c we write To Capital A/c on the debit side. Capital A/c is showing a credit balance therefore on the credit side of the capital a/c we write By Cash. Similarly in the second transaction purchases a/c is showing a debit balance and so on the debit side of purchase a/c we write To Cash and since cash a/c is showing credit balance we write By purchases in the Cash A/c. The other transactions are also posted on the same lines. In the above manner all the transactions in the journal are referred to and transactions relating to a particular account are written under that particular head. After such posting is done the debit and the credit side are totaled up separately to find out which side is heavier. If the debit side of an account is more than that the credit side of that particular account it is said to possess debit balance. If the credit side is heavier the account is said to have credit balance.

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It is very important to know which side of the account is heavier, because it explains the position of the account. For eg: Consider the following Cash A/c.CASH A/C. Dr Cr.

Date

Particulars To Balance B/d To Sales To Ravi To Commission Total

Amount 30000 15000 8000 3000 56000

Date

Particulars By Purchases By Salaries By Rent By Interest Total

Amount 10000 2000 3000 5000 20000

We see in the above account that the Debit side has total of Rs.56,000 whereas the credit side has a total of Rs.20000. It is obvious that the debit side is heavier by Rs.36,000. Therefore it is said that the Cash A/c has a debit balance, the balance being Rs.36000. Debit balance in the Cash A/c (Rs.36000) implies that in the Cash A/c there is still a balance of Rs.36000 and it is carried down (C/d) to the next period. Thats why it is written as By Balance C/d. In the beginning of the next period it is written as to Balance B/d meaning to say that balance has been brought down from the previous period. Suppose you are closing the account on 31st January, the balance is carried down on that day and is shown as an opening balance in the next period. Look at the account shown hereunder: CASH A/C Dr. Date Particulars To Balance B/d Jan 2005 To Sales To Ravi To Commission Total 1.2.05 To Balance b/d Amount 30000 15000 8000 3000 31.1.05 56000 36000 Date Particulars By Purchases Jan 2005 By Salaries By Rent By Interest By Balance C/d Total Cr. Amount 10000 2000 3000 5000 36000 56000

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What do Debit and Credit Balances mean: 1. If a personal account shows a debit balance it means that the person is a debtor which means he has to pay money to the firm. If it shows a credit balance he has to receive money from the firm. 2. If Real accounts show debit balance it means that the firm owns property or asset to the extent of balance in the account 3. If a nominal account shows a debit balance it means than an expense or loss to that extent has been incurred by the firm and vice versa. Posting of a compound entry: Consider the following Compound Entries and try to understand how these are posted. Ex:1 Cash A/c Furniture A/c To Capital Account (Being Capital brought in the form of Cash) We see that there are two debits for one credit in such a case three accounts are opened. Cash A/c, Furniture A/c and Capital A/c. Cash A/c shows a debit against the credit of capital account. Furniture A/c also shown a debit against the credit of Capital A/c which shows a Credit balance has two details: the Cash A/c and Furniture A/c. Therefore in the Cash A/c since it is showing the debit balance, on the debit side of the Cash A/c it is written as To Capital. In the Furniture A/c which is also showing debit balance it is written as To Capital Rs.40000. In the Capital A/c which has two debits it is written as By Cash Rs.10000 and By Furniture Rs.40000. Please examine the following accounts. Dr. Dr. Rs.10000 Rs.40000 Rs.50000

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CASH A/C Dr. Date Particulars To Capital Amount 10000 Date Particulars By Purchases Cr. Amount 10000

FURNITURE A/C Dr. Date Particulars To Capital Amount 40000 CAPITAL A/C Dr. Date Particulars Amount Date Particulars By Cash By Furniture 2.4 SUBSIDIARY BOOKS - DIVISION OF JOURNAL Journal is the book of original entry or the main book where in business transactions are entered in a chronological order. But when the transactions are too many, quick location of a particular transaction may not be easily done. Therefore, Journal is divided into 8 parts or eight subsidiary books viz: 1000 40000 Cr. Amount Date Particulars By Purchases Cr. Amount 10000

1) Cash Book 2) Purchases Book 3) Sales Book 4) Purchase Returns 5) Sales Returns 6) Bills Receivable 7) Bills payable 8) Journal proper

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Thus subsidiary books are parts or sub-divisions of a journal. The following paragraphs explain more about the individual Subsidiary Books. CASH BOOK The Cash Book records transactions dealing with receipts and payments of cash. The Format is given below: CASH BOOK Date Receipts L/F Amount Rs. Date Receipts L/F Amount Rs.

Here it may be seen that a Cash Book looks like a Cash Account. The Cash Book is different from other subsidiary books since it is two sided. It records two aspects, the receipts aspect as well as the payments aspect. It serves both the purpose of a journal and also a ledger. PURCHASES BOOK The Purchase Book records all the Credit purchases, the Voucher No. Invoice No the Name of the Creditor and then amount of Purchases are given. The Format of the Purchase Book is given below:

PURCHASE BOOK Date Name of the Creditor L/F Invoice No. Amount in Rs.

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SALES BOOK The Sales Book, also called the Day Book, records all the Credit Sales. The Voucher No. the Name of the Debtor and the amount of sales are recorded. The format of the Sales Book is given below:

SALES BOOK Date Name of the Debtor L/F Invoice No. Amount in Rs.

PURCHASE RETURNS BOOK The Purchase Returns Books records all the Returns made out of Credit Purchases. The format of the purchase returns is given below.

PURCHASE RETURNS BOOK Date Debit No. Name L.F. Amount in Rs.

Debit Note: It is a note made out in duplicate. The duplicate copy is kept for office record and the original one is sent to the seller. The partys account is debited with the amount written in the purchase returns book. SALES RETURNS BOOK Sales Returns Book shows the goods returned by the customers to whom goods have been sold. The format of the sales return book is given below:

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SALES RETURNS BOOK Date Credit Note. Name L.F. Amount in Rs.

Credit note is also like a debit note. It is also made out in duplicate. The duplicate copy is kept for office record.

BILLS RECEIVABLE BOOK Bills Receivable Book records the amounts receivable against Bills or exchange by the business receivable lying with us. The format of the Bills Receivable Book is given below:

BILLS RECEIVABLE BOOK Date Drawee Tenure Payable at Due Date

BILLS PAYABLE BOOK The Bills payable book records all the bills payable by the business. The format is given below. BILLS PAYABLE BOOK Date Drawer/Payee Tenure Payable at Due Date

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JOURNAL PROPER: This books makes a record of certain special entries like opening Entries, Closing entries, adjustment entries and rectification entries, transfer entries, Entries relating to dishonour of promissory notes withdrawal of goods by the proprietor for personal use or loss of goods by theft, fire etc., Credit purchase of Sale of assets; Bad debts etc., Those transactions which cannot be entered in any of the seven specific subsidiary books, get entered in the Journal Proper. 2.5 TRIAL BALANCE:

The fundamental principle of Double Entry System of Book Keeping is that for every debit there must be a corresponding credit. It follows, therefore, that the sum total of debit amounts should equal the sum total of credit amounts of ledger at any date. Trial Balance is a statement of all the debit and credit balances. It is basically prepared to check the arithmetical accuracy. It is prepared from the balances obtained from the Ledger. However, it may be noted that the agreement of the Trial balance is not a conclusive proof of accuracy. Although it points out certain errors, several errors may remain undetected even after the preparation of the trial balance.

TRIAL BALANCE THE LINK: The agreement of the Trial Balance reveals that both the aspects of each transaction have been recorded and that the books are arithmetically accurate. If the Trial Balance does not agree, it shows that there are some errors, which must be detected and rectified before the final accounts are prepared. Thus, Trial balance forms a connecting Link between the ledger accounts and the final accounts. It is the third stage in the accounting cycle.

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A specimen of Trial Balance is given below: TRIAL BALANCE OF _______________ AS ON: _____________ S.No. Name of the Accounts Dr. Balance Cr. Balance

As already said the trial balance may agree and yet there may be some errors. The following types may remain undetected, even after the tallying of Trial Balance.

i) ii) iii) iv) v)

Omission of an entry in a subsidiary book A wrong entry in a subsidiary book Posting an item to the correct side but in the wrong account Compensating errors Errors of principle

PREPARATION OF TRIAL BALANCE: Let us take a small example to understand and how a trial balance is prepared. From the following balances taken from the ledger of Sri Ltd., prepare a trial balance as on 31-3-2004:

Opening Stock Traveling Expenses Rent & Taxes Salaries & Wages Freight out wards Discount received Commission paid Bank Account Sundry debtors Trade creditors

24000 775 1050 3145 130 220 216 12054 13600 10000

Carriage inwards Returns inwards Sales Purchases Disallowed Capital Account Drawings Account Bills receivable Bills payable Closing stock

100 1200 42000 31500 450 57000 9000 16000 4000 31600

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TRIAL BALANCE OF SRI LTD.,AS ON 31-03-2004 Debit Balances Rs. 24000 774 1050 3144 130 100 1200 42000 31500 450 220 216 12054 13600 10000 57000 Total 9000 16000 1,13,220 1,13,220 Credit Balances Rs.

Opening Stock Travelling Expenses Rent & Taxes Salaries & Wages Freight outwards Bills payable Carriage Inwards Returns Inwards Sales Purchases Discount allowed Discount received Commission paid Bank account Sundry debtors Trade creditors Capital account Drawings account Bills receivable

4000

Note: Closing stock is already included in Purchases and therefore should not be shown in the Trial Balance. It should be given as an adjustment while preparing Final Accounts.

2.6 ACCOUNTING CYCLE: Ledger Journal Final Accounts The accounting cycle shows that a business transaction is first entered into Journal, the book of original entry. From there it is transferred or posted to the Ledger. From the Ledger Trial Balance

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Balances a Trial Balance is prepared. Trial balance is a statement of debits and credits. From these balances the Final Accounts are prepared. Thus it may be remembered that the Accounting Cycle starts with Journal and ends with the Final Accounts. At the Journal stage documentation of the Business transactions is done, while at the Ledger stage account wise information is obtained and summarized and at the Trial Balance stage List of Debit and Credit balances is obtained to check the arithmetical accuracy and at the final accounting stage the profit or loss position of the business is found out. 2.7 SUMMARY: Maintaining a systematic record of all transaction is called book-keeping and when such record-keeping moves on to classifying and summarizing, preparation of final reports and their interpretation, we call it accounting. Journal is the book wherein a business transaction is first written or recorded and therefore it is also known as book of Original Entry. Steps to be followed while journalizing are: Identify the accounts being affected in the transaction; Categorize them into real, nominal and personal and; apply the relevant rules of debit and credit. Ledger is a book where account wise information is documented. While the Journal gives data in chronological form, the ledger gives account wise information. transactions related to a particular account are put at one place . Journal is the book of original entry or the main book where in business transactions are entered in a chronological order. But when there are too many transactions, Journal is divided into 8 parts or eight subsidiary books. Thus subsidiary books are parts or sub-divisions of a journal. Trial Balance is a statement of all the debit and credit balances. It is basically prepared to check the arithmetical accuracy. It is prepared from the balances obtained from the Ledger. All the

2.8 KEY WORDS:Journal Narration Nominal Account Ledger Journalising Real Account Personal Account Ledger Posting

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Balancing Credit Balance Trial Balance Try Yourself:

Debit Balance Subsidiary Books

1. Journalize the following transactions in the books of Mr. Joy. April 1, 2004 April 2, 2004 April 3, 2004 April 5, 2004 April 6, 2004 April 7, 2004 April 8, 2004 April 9, 2004 April 10, 2004 April 11, 2004 April 15, 2004 2. Bank A/c Dr. Discount Dr. To Bills Receivable Post the above entries. Capital brought in Rs. 100000 Bought Machinery Rs. 50000 Purchased Good Rs. 25000 Sales Rs. 10000 Sales to Shalom Rs. 15000 Purchases from Princy Rs. 20000 Received to Divya Rs. 15000 Received Interest Rs.5000 Received Commission Rs.3000 Bought Furniture from Teja Ltd on Credit Rs. 10000 Paid Salaries Rs.5000 56000 500 5500

3. Given below is a Cash account, point out whether Cash book shows Debit or Credit. CASH A/C Dr. Date 1.1.04 15.1.04 20.1.04 Particulars To Balance B/d To sales To Ramya Total Amount 8000 2000 1000 11000 Date 17.1.04 19.1.04 31.1.04 Particulars By Purchases By Rent By Balance C/d Total 3000 1000 7000 11000 Cr. Amount

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4. From the following balances prepare the Trial Balance of MJS Ltd. Purchases 1,57, 500 Sales 2,10,000 Return Inwards 6,000 Carriage Inwards 500 Freight Outwards 650 Salaries & Wages 15,720 Rent & Taxes 5,260 Traveling Expenses 3,870 Opening Stock 1,20,000 Discount allowed 2,250 Discount received 1,100 Commission paid 1,080 Bank account 60,270 Sundry Debtors 68,000 Trade Creditors 50,000 Capital Account 2,85,000 Drawings Account 45,000 Bills Receivable 80,000 Bills Payable 20,000 Closing stock 1,58,000 5. What is Journal? 6. What are the various types of accounts? 7. Explain the rules of Journalising. 8. Classify the following accounts. a. Capital b. Cash c. Furniture d. Salaries e. Goodwill 9. What do you mean by ledger posting 10. If a personal account is showing a debit balance, what does it indicate 11. Cash Book records all ----------------------- transactions. 12. Purchases Book records ---------------------. 13. Adjustment entries are written in --------------------.

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14. Omission of an entry in a Subsidiary book affects the agreement of Trial Balance.(Yes/ No) 15. Compensating Errors go undetected by The Trial Balance.(Yes/ No)

Answers: 1. Date April 1, 2004

JOURNAL OF Mr. Joy Particulars Cash A/c To Capital A/c (Being Capital Brought) Dr. Debit Rs. 100000 Credit Rs. 100000

April 2, 2004

Machinery A/c To Cash A/c (Being purchase of Machinery)

Dr.

50000 50000

April 3, 2004

Purchases A/c To Cash A/c (Being Goods purchased)

Dr.

25000 25000

April 5, 2004

Cash A/c To Sales A/c (Being Sales made)

Dr.

10000 10000

April 6, 2004

Shalom A/c To Sales A/c

Dr.

15000 15000

(Being Credit Sales made to Shalom) April 7, 2004 Purchases A/c To Princy A/c (Being Credit purchases made) Dr. 20000 20000

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April 8, 2004

Cash A/c To Sales A/c (Being Sales made)

Dr.

15000 15000

April 9, 2004

Cash A/c To Sales A/c (Being Sales made)

Dr.

5000 5000

April 10, 2004 Cash A/c To Commission A/c (Being Commission received) April 11, 2004 Furniture A/c To Teja Ltd A/c (Furniture purchased on Credit) April 15, 2004 Salaries A/c To Cash A/c (Being Salaries paid)

Dr.

3000 3000

Dr.

10000 10000

Dr.

5000

5000

2. Dr. Date Particulars To Receivable

BANK A/C Cr. Amount Bills 5000 Date Particulars Amount

DISCOUNT A/C Dr. Date Particulars To Bills receivable Amount 500 Date Particulars Cr. Amount

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BILLS RECEIVABLE A/C Dr. Date Particulars Amount Date Particulars By Bank By Discount 4. Total of Trial Balance Rs 5,66,100. 8. (a) Personal A/c, (b) Real A/c, (c) Real A/c, (D) Nominal A/c (e) Real A/c. 11. Cash 12. Credit Purchases 13. Journal Proper 14. Yes 15. Yes 5000 500 Cr. Amount

FURTHER READINGS:Jain S.P. and K.L. Narang, Fundamentals of Accounting, Kalyani Publishers Jawaharlal, Financial Accounting, Wheeler Publishing Nitin Balwani, Accounting and Finance for Managers, Excel Books

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LESSON 3 ACCOUNTING CYCLE-II (FINAL ACCOUNTS)OBJECTIVES To be able to appreciate the need for preparation of Final Accounts. To be able to prepare the Trading A/c To be able to prepare the Profit and Loss A/c To be able to prepare the Balance Sheet

STRUCTURE:3.1 Introduction 3.2 Capital and Revenue Items 3.3 Profit & Loss Account 3.4 Balance Sheet 3.5 Adjustments 3.6 Summary 3.7 Key Words

3.1 INTRODUCTION:

The final stage in the accounting cycle is the preparation of final accounts. It is common knowledge that the ultimate objective of maintaining accounts is to find out profit or loss position and also the financial position of the organization concerned.

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Final accounts are prepared from the debit and credit balances of the trial balance. statement of assets and liabilities known as the balance sheet. 3.2 CAPITAL AND REVENUE ITEMS:

Final

accounts are constituted of the profit and loss account (also called Income Statement) and a

It may be noted that before preparing final accounts a distinction needs to be made between capital and Revenue items. While the revenue items are to be shown in the Profit & Loss A/c. The Balance Sheet records all capital items in the form of the assets and liabilities as on a particular date.

Capital Expenditure

Revenue Expenditure

1) Amount spent on acquiring permanent 1) Amount spent on the conduct of asset business and maintenance of capital assets

2) The expenditure adds to the revenue 2) This Expenditure may not do so earning capacity of the business 3) May add to the value of an existing asset 3) Revenue Expenditure does not add to any value to net asset 4) shown in the balance sheet 4) Shown in the trading or profit and loss account

3.3 PROFIT & LOSS ACCOUNT: As already stated profit and loss A/c shows the net income or net expenditure position of the business organisation. It consists of two parts namely: Trading A/c and (2) Profit and Loss A/c. The preparation of the main profit and loss account begins with the Trading Account and ends with the Profit and Loss account. While Trading Account records the balances which are

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directly related to the manufacturing the product, the profit and loss account records the expenses and incomes and expenses, profits and losses which are related to the business but not directly related to the making of the product saleable. TRADING ACCOUNT: There is a distinction even between the Trading account and Profit and Loss A/c. The trading accounts obtains gross profit or loss. On the debit side, items relating to opening stock, purchases, wages, carriage, wages, fuel & power, manufacturing expenses, coal, water and gas, motive power, octroi, import duty, custom duty, consumable, foreman/work managers salary, Royalty on manufactured goods are taken; That is the cost of good sold is obtained. On the credit side, sales, closing stock etc are taken. That is the value of net sales is obtained. The difference between the sales and cost of goods sold gives the gross profit / loss position of the concerned firm. PROFORMA OF TRADING A/C Trading A/c for the year ending : _________ Particulars Amount Rs. Dr. To Opening Stock To Purchases To Carriage on purchases Less: Purchase Returns To Wages To Fuel and Power To Coal, Gas and Water To Factory Rent To Gross Profit C/d Total Total By Closing stock By Sales Less: Sales Returns Particulars Amount Rs. Cr.

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PROFIT AND LOSS A/C: The profit and loss account is prepared in order to find out the net profit / loss position of the concern. The expenses and incomes taken in the profit and loss account are of indirect nature and include the following:Proforma of Profit And Loss A/C Amount By gross profit brought down Rs. By Interest Received By Discount Received By Commission Received By Rent from Tenants By Income from Investments By Apprentice premium By Interest on debentures By Income from any other sources By Miscellaneous Revenue receipts By Net loss transferred to Capital A/c

To gross loss brought down Amount To Office Salaries Rs. To Expenses To Advertisement To Traveling Salaries To Expenses incurred on commission To Bad Debts To Godown Rent To Export Expenses To Carriage outwards To Bank charges To Agents commission To Rent, Rates and Taxes To Heating and Lighting To selling and distribution expenses To Printing and Stationery To Postage and Telegram To Telephone Charges To Legal charges To Audit fees To Insurance To General Expenses To Depreciation To Repairs & Maintenance To Discount allowed To Interest on capital To Interest on loans To Discount on bills discounted To Extraordinary expenses To Loss by Fire (Not covered by Insurance) To Net profit transferred to capital A/c

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3.4 BALANCE SHEET: A balance sheet shows the financial position of a business on a certain fixed date. The financial position of any concern/organization is shown by its assets on a given date and its liabilities on that date. The excess of assets over liabilities represents the capital which serves as a pointer to the financial condition of the concern. It may be noted that a balance sheet is not an account but a mere statement of assets and liabilities on a particular date. The left hand side of the balance sheet shows all the liabilities while the right side displays the Assets position. The specimen proforma of a balance sheet is given below: BALANCE SHEET OF _________________ COMPANY AS ON : _____________ LIABILITIES CURRENT LIABILITIES: Bills payable Sundry creditors Bank Overdraft LONG TERM LIABILITIES: Loan from Bank Loan from Wife FIXED LIABILITIES: Capital Rs. ASSETS LIQUID ASSETS: Cash in Hand Cash at Bank FLOATING ASSETS: Sundry Debtors Investments Bills Receivable Stock in Trade Prepaid Expenses FIXED ASSETS: Machinery Building Furniture & Fixtures Motor Car INTANGIBLE ASSETS: Goodwill Patents Copyright Licenses FICTITIOUS ASSETS: Advertisement Miscellaneous Expenses Profit & Loss A/c TOTAL TOTAL Rs.

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In the reverse order of preference the Balance Sheet may be prepared as follows: BALANCE SHEET LIABILITIES 1. Fixed Liabilities 2. Long Term liabilities 3. Current Liabilities ASSETS 1. Fictitious Assets 2. Intangible Assets 3. Fixed Assets 4. Floating Assets 5. Liquid Asset TOTAL: TOTAL:

Thus it goes to say, that the items in the balance sheet may be marshaled either in the order of permanence or liquidity. Example: From the following balances of XYZ Ltd on 31.3.2004 you are required to prepare the Trading and Profit and Loss Account and a Balance sheet as on that date: Amount Rs. Stock on April 1 Bills Receivable Purchases Wages Insurance Sundry Debtors Carriage Inwards Commission (Dr) Interest on capital Stationery Returns inward Capital 1000 4500 39000 2800 1100 30000 800 800 700 450 1300 17900 Commission (Cr) Return Outward Trade Expenses Office Fixtures Cash withdrawal Cash at bank Rent and Taxes Carriage outward Sales Bills payable Creditors Closing stock Amount Rs. 400 500 200 1000 500 4750 1100 1450 50000 3000 19650 25000

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TRADING & PROFIT AND LOSS A/C OF XYZ LTD FOR THE YEAR ENDING : 31-3-2004 Particulars To Opening Stock Amount Rs. Dr. 1000 Particulars By 50000 Less: Returns 1300 By Closing Stock Sales: 48700 I/W 25000 Amount Rs. Cr.

To purchases: 39000 Less: Returns outward 500 To wages To Carriage I/w To Gross Profit C/d

38500 2800 800 30600 73700 By Gross Profit B/d By Commission

73700 30600 400

To Insurance 1100 To Commission 800 To Interest on Capital 700 To Rent and Taxes 1100 To Carriage O/w 1450 To net profit transferred to 25200 Capital A/c TOTAL 31000 BALANCE SHEET OF XYZ LTD AS ON: 31.3.2004 LIABILITIES Creditors Bills payable Capital: Add: Net profit Rs. 19650 3000 17900 25200 43100

TOTAL

31000

ASSETS Cash in hand Cash at Bank Bills receivable Stock Sundry debtors Office Fixtures TOTAL

Rs. 500 4750 4500 25000 30000 1000 65750

TOTAL

65750

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3.5 ADJUSTMENTS: Bits of information which are received/discovered after the preparation of Trial Balance have to be accommodated into financial statements. They are, therefore called adjustments. It may be remembered that sometimes adjustments thus need to be made in the final accounts. Since the adjustments are given after the trial balance is prepared, they have to be given the two fold effect. Once they appear in the trading/profit and loss account and the second time in the balance sheet. These adjustments enable the firm to make its accounts fall in line with the matching and such other concepts whichmake the final statements of account to reflect the true and fair view of the affairs of the business. given below: Closing Stock: This may be shown on the credit side of the Trading account and the Second time on the asset side of the balance sheet. Outstanding Expenses: These are expenses due to be paid but not paid. These expenses should be added to the amounts already paid and shown in the trading account or the profit and loss account depending upon whether it is a direct expenditure or indirect expenditure. For Eg: outstanding wages should be added to Wages in Trading account and if it is outstanding salary should be added to Salary account in the profit and loss account. The second effect is that should it should be shown on the liability side of balance sheet. Prepaid (Unexpired) Expenses: These are expenses paid in advance and therefore should be deducted from the respective expenditure on the debit side of Trading and profit and loss a/c and then shown on the asset side of the balance sheet. For instance if insurance is prepaid, it should be deducted from Insurance on the debit side of profit and loss account and should be shown on the asset side of the Balance sheet as prepaid insurance. Treatment for some of the adjustments is

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Accrued Income: That income which has been earned but not received during the accounting year is called accrued income. Such income needs to be added to the respective income on the credit side of the profit and loss and again on the asset side of the balance sheet. Income Received In Advance: Income received but not earned during the accounting year is known as Income received in Advance. This should be deducted from the respective income in the profit and loss a/c and should be shown in the balance sheet as a liability. Depreciation: This is reduction in the value of the fixed Asset and is usually calculated as a percentage of the assets. The amount of depreciation is shown on the debit side of profit and loss account and is to be deducted from the respective asset value in the balance sheet. Bad Debts: Debts which cannot be recovered or become irrecoverable are called bad debts. Since this is a loss for the business it is shown on the debit side of the Profit and Loss account and deducted from Sundry Debtors on the asset side of the Balance sheet. Interest on Capital: This is calculated as a percentage on capital and is shown on the debit side of Profit and Loss account and added to capital on the liability side of the Balance sheet. Interest on Drawings: The two fold effect of this adjustment is that it will be shown on the credit side of profit and loss account and is added to the amount of drawings on the liability side of the Balance sheet. Provision for Doubtful Debts: This is a provision maintained to meet doubtful debts. It is usually calculated as a percentage on sundry debtors and is shown on the debit side of profit and loss account and is deducted from sundry Debtors on the asset side of the Balance sheet. Provision for Discount on Debtors: In order to encourage prompt payment, discount is given to debtors. To meet the expenses of discount a provision is maintained on debtors. This provision, known as Discount on Debtors

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is shown on the debit side of the profit and loss account and is deducted from sundry debtors on the asset side of the balance sheet. Provision for Discount on Creditors: This is calculated as a percentage on creditors and is shown on the credit side of Profit and Loss account and is deducted from sundry creditors on the liability side of the Balance sheet. Deferred Revenue Expenditure: Advertisement expenditure is the best example for deferred revenue expenditure. A huge amount may be spent on advertisement in a single year but the benefits of such advertisements may be spread over the ensuing years too. Therefore only a part of such expenditure will be written off each year. The written off expenditure is shown on the debit side of profit and loss account and the unwritten part of the expenditure is shown on the asset side. Such unwritten off portions of deferred revenue expenditure from fictitious assets. Managers Commission:

Managers Commission may be given at a certain percentage (say 5%) on the net profit (say Rs.50000) before charging such commission; In such a case commission is calculated as follows: Net Profit x Rate of Commission = 50000 x 5/100 = Rs.2500 But sometimes it is given as after charging such commission, In such a case commission is calculated as given below: Profit x % of commission -----------------------------100 + % of commission 50000 x 5 -----------100 + 5 =Rs. 2380.95

This commission needs to be put on the debit side of the profit and loss account and is shown as a liability in the Balance sheet.

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Reserve Fund: Reserve is created out of profit and loss account. It is shown on the debit side of profit and loss account and is also shown on the liability side of the Balance sheet.

Example: From the following Trial Balance of Priya Industries Ltd., prepare Final Accounts after making the necessary adjustments for the year 31-12-2005

TRIAL BALANCE Debit Balances Freehold Land Loose Tools Plant and Machinery Sundry Debtors Cash at bank Opening Stock: 1.1.2005 Insurance Bad Debt Bills Receivable Purchases Cash in hand Rent, Rates etc Interest Wages Trade Expenses Salaries Repairs Carriage Inwards Discount Amount Rs. 35000 5600 45500 18200 11000 10500 300 560 5400 50000 560 1300 250 10700 1560 875 350 290 Mortgage Loans Bills payable Sales Creditors Discount Capital Credit Balances Amount Rs. 20000 3400 121500 15600 175 40000

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Drawings Suspense A/c

2500 80 200675 200675

Adjustments: a) Insurance unexpired to the extent of Rs.90 b) Salaries and Rent are outstanding to the extent of Rs.140 and 60 c) Loose tools are revalued at Rs.4500 d) Allow Interest on capital @ 5% p.a. e) Make a reserve of 5% Debtors for doubtful debts f) Closing stock was valued at Rs.30000 on 31.12.2005 TRADING & PROFIT AND LOSS A/C OF XYZ LTD FOR THE YEAR ENDING : 31-3-2004 Particulars Amoun t Rs. Dr. 50000 50000 10700 350 79950 151500 1560 140 1300 60 1700 By Discount received 1360 150 250 5560 210 175 Particulars Amount Rs. Cr. 121500 30000

To Opening Stock To Purchases To Wages To Carriage Inwards To Gross Profit C/d TOTAL To Salaries Add: O/S Salaries To Rent, Rates etc Add: O/S Rent To Trade Expenses To Interest To Bad Debts To Insurance Less: Prepaid

By Sales By Closing Stock

151500 By Gross Profit b/d 79950

300 90

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To RBDD 910 To Interest on Capital 2000 To Loose Tools Written off 1100 To Repairs 875 To Discount allowed 290 To Net Profit Transferred to Capital A/c 70720 TOTAL: 80125 80125

BALANCE SHEET OF PRIYA INDUSTRIES AS AT 31-12-2005 LIABILITIES Creditors Bills Payable Outstanding Expenses: Salaries Rent Mortgage Loan: Capital Less: Drawings Add: Net Profit 40000 2500 37500 70720 110220 Interest on Capital 2000 140 60 200 Sundry 18200 Less: 910 Closing Stock Prepaid Insurance Suspense Balance Freehold Land Plant & Machinery Loose Tools 149920 35000 45500 4500 149920 A/c 30000 90 (Dr) 80 RBDD Debtors 17290 Rs. 15600 3400 ASSETS Cash in Hand Cash at Bank Bills Receivable Rs. 560 11000 5400

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Note on Bad Debts, RBDD and Reserve for Discount on Debtors Bad Debts imply Debts which can not be received. That is out of Debtors this part of the amount is not going to be received. It is a loss. Therefore it should be shown on the debit side of profit and loss account. If Bad debts are given in the adjustments also, such bad debts should be added to the bad debts given in the trial balance and also shown on the debit side of the profit and loss a/c The New Bad debts or bad debts given in the adjustments should be deduced from the Sundry debtors and then the balance of sundry debtors should be shown on the asset side of the balance sheet. Example TRIAL BALANCE Debit Balances Rs. 50000 1000 Credit Balances Rs.

Sundry Debtors Bad Debts

Adjustment: Bad Debts to be further provided Rs.500

Treatment Profit and loss A/c (Debit Side) Amount Rs. To Bad Debts Add: New Bad Debts 10000 500 1500 Amount Rs.

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Balance Sheet LIABILITIES Rs. ASSETS Sundry Debtors Less: New Bad Debts 50000 500 49500 Rs.

Reserve for Bad and Doubtful Debts: Doubtful Debts imply debts which have not yet become bad but may not be recovered when Credit Sales are made, usually a percentage of debtors fail to pay. In order to meet the loss arising out of such bad and doubtful debts a provision is created. This is known as Reserve for Doubtful Debts or Provision for Doubtful debts. This is calculated on Sundry debtors. Reserve for Doubtful Debts (RBDD) if given in the Trial balance, should be shown on the debit side of Profit and loss a/c If RBDD is given in the adjustments also then there are two ways of showing it. The simple one is show the New RBDD on the credit side of Profit and loss Account and deduct the new RBDD from the Debtors in the balance sheet while showing the balance given in the trial balance on the debit side of the profit and loss account. The other method is compare the New RBDD with the old RBDD. If new RBDD is more the difference between the old and the new is put on the debit side of Profit and Loss A/c and the new RBDD is deducted from the Sundry Debtors. If the New RBDD is less then, the difference is shown on the Credit side and the new RBDD is deducted from Sundry Debtors. Example TRIAL BALANCE Debit Balances Rs. 50000 1500 Credit Balances Rs.

Sundry Debtors RBDD Bad Debts

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Adjustment: Create a reserve for Doubtful Debts @ 5% Treatment Method: 1 Profit and loss A/c Dr. Rs. To RBDD (old) 1500 By RBDD (New @ 5% on 50000 2500 Cr. Rs.

Balance Sheet

LIABILITIES

Rs.

ASSETS Sundry Debtors Less: 2500 RBDD 50000

Rs. (New) 47500

Method: 2 Profit and loss A/c Dr. Rs. To RBDD (New) 2500 Less: Old 1500 1000 Cr. Rs.

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Balance Sheets LIABILITIES Rs. ASSETS Sundry Debtors Less: 2500 RBDD 50000 (New) 47500 Rs.

Example where New Bad Debts provision and also Reserve for Discount on Debtors need to be maintained. TRIAL BALANCE Debit Balances Rs. 50000 500 1000 Credit Balances Rs.

Sundry Debtors Bad Debts Bad Provision (RBDD)

Adjustments: 1) Create further Bad Debts Rs.500 2) Create a reserve for bad and doubtful debts @ 5% on Sundry debtors 3) Create a reserve for discount on debtors @ 2% Treatment: Profit and loss A/c Dr. Rs. To RBDD (Old) To Bad Debts Add: New 500 500 1000 1000 By RBDD @ 5% Cr. Rs. 2475

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To Reserve for Discount on Debtors @ 2% 940

Balance Sheet LIABILITIES Rs. ASSETS Sundry Debtors Less: Bad Debts Rs.49500 47025 Less: Reserve For Discount 940=50 on drawings @ 2% on 47025 46084=50 50000 500 49500 on 2475 Rs.

Less RBDD @ 5%

We thus come to the end of the accounting cycle, by preparing the final statement of accounts, that is the Profit and Loss Account and the Balance Sheet together with the adjustments emanating from the additional pieces of information after the preparation of the Trial Balance. We may here recall the Accounting Cycle we explained to ourselves in Lesson 2. ACCOUNTING CYCLE: Ledger Journal Final Accounts The accounting cycle shows that a business transaction is first entered into Journal, the book of original entry from there it is transferred or posted to the Ledger. From Ledger Balances of the Trial Balance is prepared. Trial balance is a statement of debits and credits. From these balances the Final Accounts are prepared. It may be thus remembered that the Accounting Trial Balance

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Cycle starts with Journal and ends with the Final Accounts.

At the Journal stage

documentation of the Business transactions is done, while at the Ledger stage account wise information is obtained and summarized and at the Trial Balance stage List of Debit and Credit balances is obtained to check the arithmetical accuracy and at the final accounting stage the profit or loss position of the business concern is ascertained.

3.6 SUMMARY: The final stage in the accounting cycle is the preparation of final accounts. It is common knowledge that the ultimate objective of maintaining accounts is to find out operating results and also the financial position of the organization concerned. Final accounts are prepared from the trial balance. Final accounts consist of the profit and loss account (also called Income Statement) and a statement of assets and liabilities known as the balance sheet. Distinction needs to be made between capital and Revenue items. Profit and loss A/c shows the net income or net expenditure position of the business organisation. It consists of two parts namely: (1) Trading A/c and (2) Profit and Loss A/c. The preparation of the main profit and loss account begins with the Trading Account and ends with the Profit and Loss account. While Trading Account records the balances which are directly related to the manufacturing the product, the profit and loss account records the expenses and incomes and expenses, profits and losses which though related to the business are not directly related to the making of the product saleable. A balance sheet shows the financial position of a business on a certain fixed date. The financial position of any concern/organization is shown by its assets on a given date and its liabilities on that date. The excess of assets over liabilities represents the capital Bits of information which are received/discovered after the preparation of Trial Balance have to be accommodated into financial statements. They are, therefore called adjustments. Since the adjustments are given after the trial balance is prepared, they have to be given the two fold effect. These adjustments enable the firm to make its accounts fall in line with the matching and such other concepts to make the final statements of account to reflect the true and fair view of the affairs of the business.

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3.7 KEY WORDS: Final Accounts Profit & Loss Account Balance Sheet Outstanding Expenses Accrued Income Depreciation Interest on Capital Interest on Drawings Provision for Discount On Creditors Reserve Fund Try yourself: 1. The following is the Trial balance of Seema as on 31st December 2005: ] Debit Balances Drawings Sundry Debtors Cash in Hand Interest Opening Stock Cash at Bank Land and Buildings Sales Returns Bad Debts Purchases Carriage Inwards Establishment Charges Rent Advertising Rs. 10000 80000 5000 6000 15000 10000 100000 5000 6000 150000 4000 9000 5000 15000 Credit Balances Capital Sundry Creditors Loand Sales Purchase Returns Discount Bills Payable Provision for Bad Debts Rs. 100000 60000 40000 220000 8000 2000 15000 5000 Capital and Revenue Items Trading Account Closing Stock Prepaid (Unexpired) Expenses Income Received In Advance Bad Debts Provision for Doubtful Debts Provision for Discount on Debtors Deferred Revenue Expenditure

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Office Expenses Wages Bills Receivable Total Additional Information:

9000 15000 6000 450000 Total 450000

a) The stock on hand on kDecember 31, 2005 is Rs.30000 b) Outstanding rent is Rs.1000 c) Prepaid Wages are Rs.2000 d) Bad debts provision is to be maintained at 5 per cent of closing debtorws You are required to prepare Trading and Profit and Loss Account for the year ending 31st December, 2005 and a balance sheet as on that date.

FURTHER READINGS:Jain S.P. and K.L. Narang, Fundamentals of Accounting, Kalyani Publishers Jawaharlal, Financial Accounting, Wheeler Publishing Nitin Balwani, Accounting and Finance for Managers, Excel Books

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LESSON 4 FINANCIAL STATEMENT ANALYSISOBJECTIVES: Explain the meaning and nature of Financial Statements Describe the objectives and types of Financial Statements Recognize the importance and limitations of Financial Statements Understand the meaning and importance of Financial Analysis Prepare Comparative and Common size Financial Statements and interpret them; and Calculate the Trend Percentages and interpret them.

STRUCTURE:4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 Introduction Meaning and nature of Financial Statements Objectives and types of Financial Statements Importance and uses of Financial Statements Limitations of Financial Statements Meaning of Financial Statement Analysis Types and importance of Financial Analysis Techniques of Financial Analysis Comparative Financial Statement Analysis

4.10 Common size Financial Statement Analysis 4.11 Trend Analysis 4.12 Limitations of financial analysis 4.13 Summary 4.14 Key words

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4.1 INTRODUCTION: In the previous lesson you have understood the preparation of trading account, profit and loss account and balance sheet. The financial statements viz., the Balance sheet and Profit and loss account are the end products of the accounting process. The accounting system of a firm becomes the basis for financial information. The accounting system helps to measure, compare, analyze and communicate financial data to various interested parties for making rational decisions. Understanding the nature of financial statements, their form, content and factors that affect them in projecting the true and fair view of financial position is the basic foundation for analysis of financial statements.

4.2 MEANING AND NATURE OF FINANCIAL STATEMENTS:

Meaning of Financial statements: Financial statements are the basic and formal means through which the company communicates financial information to various parties. Financial statements serve the varied needs of internal and external parties like owners, employees, management, creditors, investors etc. According to American Institute of Certified Public Accountants (AICPA) Financial statements are prepared for the purpose of presenting a periodical review or report on progress made by the management and deal with the status of investment in the business and the results achieved during the period under review. Financial statements are prepared for the purpose of disclosing the financial position of the business concern at a point of time and also operating results during the period under review. Thus, these are, in one sense, the periodical reports about the progress made by the management of the business concerns.

Nature of Financial Statements The data contained in the financial statements are the combined results of recorded facts, accounting conventions, postulates and personal judgment used in the application of

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accounting principles. Therefore, it is clear that the financial statements are composed of data, which are of a combination of: Recorded facts Accounting conventions adopted to facilitate accounting techniques Postulates or assumptions made Personal judgment of the accountants in using or applying a particular convention or postulates. The financial statements are used by investors and financial analysts to measure the firms performance in order to make investment decisions, so, they should be prepared with utmost care and contain as much information as possible. The financial statements have to be prepared in conformity with the GAAP.

4.3 OBJECTIVES OF FINANCIAL STATEMENTS: A financial statement shows both the performance and the financial position of the concern. These statements are the primary source of information on the basis of which conclusions are drawn about the profitability and financial position of the concern. The basic objective of financial statements is to furnish information required for decision making. The Accounting Principles Board of America (APB) states the following objectives of financial statements. To provide adequate, reliable and periodical information about economic resources and obligations of a business firm to external parties who have a limited access to gather data. To provide useful financial data to evaluate the firms earning capacity and future potential. To supply information which is useful for judging managements ability to utilize the resources of the firm effectively To disclose, to the extent possible other information related to the financial statements that is relevant to the users of these statements. To disclose, significant policies, concepts, methods followed in the accounting process.

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To report the activities of the business concern which are affecting the society and accounting for them To provide information to investors and creditors for predicting, evaluating potential funds in terms of amount, time and uncertainty

4.3.1 TYPES OF FINANCIAL STATEMENTS: Financial statements generally refer to two statements viz., Income statement or Profit and loss account and Balance sheet. Income statement shows only revenue receipts and revenue payments which are of nominal nature. Balance sheet shows all the balances which are of capital nature. The statement which shows total of assets and liabilities is known as Balance sheet. As per Generally Accepted Accounting Principles (GAAP), financial statements include the following. The position statement or balance sheet The income statement or profit and loss account A statement of changes in owners equity and A statement of changes in financial position

The two major financial statements i.e., balance sheet and income statement are required for external reporting and also for in