Basic Accountancy

CHAPTER 1

Introduction to Accounting

LEARNING OBJECTIVES

After studying this chapter, you will be able to:

● state the meaning of and need for accounting;

● appreciate the relevance of accounting as an informationsystem and its sub-systems;

● identify internal and external users of accountinginformation;

● distinguish between book keeping and accounting;

● explain objectives, role and limitations of accounting.

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For centuries, accounting had beengenerally confined to the financialrecord keeping functions of theaccountant. The role of an accountanthas gradually changed from that of themere recorder of transactions to thatof the member providing relevantinformation to the decision-makingteam. Accounting is now regarded asan information system and formsintegral part of managementinformation system. As an informationsystem, it collects data andcommunicates economic informationabout a business enterprise or otherentity to a wide variety of personswhose decisions and actions arerelated to the activity. This chapter,therefore, deals with accounting as aninformation system.

1.1 Meaning of Accounting

In 1941, the American Institute ofCertified Public Accountants (AICPA)defined accounting as the art ofrecording, classifying, and summa-rizing in a significant manner and interms of money, transactions andevents which are, in part, at least, of afinancial character, and interpretingthe results thereof.

With greater economicdevelopment, the meaning of the termaccounting gradually became broader.In 1966 the American AccountingAssociation (AAA) defined Accountingas: The process of identifying,measuring and communicatingeconomic information to permitinformed judgments and decisions byusers of the information.

Further, in 1970 the AccountingPrinciples Board of AICPA stated thatthe function of accounting is to providequantitative information, primarilyfinancial in nature, about economicentities, that is intended to be usefulin making economic decisions.

Accounting can, therefore be definedas: The process of identifying,measuring, recording and communi-catingthe economic events are considered interms of economic and businesstransactions of the organization tointerested users of the information.

The above definition contains fouressential characteristics of theaccounting:

● Economic events● Identification, measurement,

recording, and communication● Organization● Interested users of information

1.1.1 Economic Events

An economic event has been defined asa happening of consequence to a businessentity. Economic events are classifiedinto external and internal types.

An external event, involves thetransfer or exchange of something ofvalue between two or more entities. Itis called a transaction. The followingare some examples of transactions:

● Sale of shoes by Allen CooperShoe Company to customers.

● Rendering services to customersby Samsung Limited.

● Payment of wages to employeesby Maruti Udyog Limited.

● Payment of monthly rent to thelandlord.

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● Purchase of raw materials by anenterprise from some otherbusiness enterprise.

● Purchase of ticket from anairline.

An internal event is an economicevent that occurs entirely within oneenterprise, e.g. supply of raw materialor equipment by the stores departmentto the manufacturing department.

1.1.2 Identification, Measurement,Recording andCommunication

Identification: It means determiningwhat to record, i.e., to identify eventswhich are to be recorded. It involvesobserving activities and selecting thoseevents that are considered to be theevidence of economic activity. Further,these events should be related to abusiness organization. The businesstransactions and other economicevents are evaluated for consideringwhether it has to be recorded as anaccounting transaction. The value ofhuman resources, changes inmanagerial policies or change inpersonnel are important but none ofthese items are recorded in financialaccounts. However, when a companymakes a cash sale or purchase, it isrecorded in the books of accounts.

Measurement: It means quantification(including estimates) of businesstransactions into financial terms byusing monetary unit, i.e. rupees andpaise, as a measuring unit. If an eventcannot be quantified in monetaryterms, it is not considered forrecording in financial accounts. Thasis why important items like the

appointment of a new managingdirector, signing of contracts orchanges in personnel are not shownin the books of accounts.

Recording: Once the economic eventsare identified and measured infinancial terms, they are recorded ina chronological order and systematicmanner. An item should be written inboth words and numbers. Theamount should be included in thetotals of the books of account. Theaccountant also clarifies bysummarizing these items.

Communication: The economic eventsare classified, measured and recordedin a order that the pertinent informa-tion is generated and communicatedin a certain form to management andother internal and external users. Theinformation is communicated throughpreparation and distribution ofaccounting reports. The most commonreports are in the form of financialstatements (Balance Sheet and Profitand Loss Statement).

The accounting informationsystem should be designed in such away that the right information iscommunicated to the right person atthe right time. Reports can be daily,weekly, monthly, or quarterly,depending upon the needs of the user.An important element in thecommunication process is theaccountant’s ability and responsibilityto interpret the reported information.This is done by analyzing andexplaining the meaning, uses andlimitations of reported data with thehelp of the ratios, percentages etc.

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1.1.3 Organization

It is an entity performing businessactivities which can be for a profit ornot-for-profit motive. The activities canbe organized by choosing appropriateform of organization to suit the levelof business operations. It can eitherbe sole-tradership, partnership,company, cooperative society or boardsuch as Cantonment board, Municipalboard, Cricket board.

1.1.4 Interested Users ofInformation

Different categories of users needdifferent kinds of information formaking decisions. The users can bedivided into two broad groups: internalusers, external users.

Internal users are the persons whomanage the business, i.e. manage-ment at the top, middle, and lowerlevels. Their requirement ofinformation is different because theymake different types of decisions. Thetop level is more concerned withstrategic planning; the middle level isconcerned equally with operationalplanning and control; and the lowerlevel is considered more withexecution and controlling operations.Information is supplied on differentaspects, e.g. cash resources, saleestimates, result of operations,financial position, sources andapplication of funds (figure 1.1).

External users are the persons otherthan internal users (officers and staff

concerned with decision-making in abusiness organization) come in thegroup of external users. Externalusers can be divided into two groups:(a) those having direct interest; and(b) those having indirect interest in abusiness organization. The mainsources of information for externalusers are annual, half-yearly, andquarterly reports of businessorganizations. These reports state thefinancial position and performance,and give the auditors reports,director’s report and other infor-mation. Half-yearly and quarterlyfinancial reports are unaudited.Besides these reports, the externalusers can access the websites ofcompanies and stock exchanges toobtain updated performance reportsand current decisions of the boarddirectors.

● External users having directfinancial interest: Investors andcreditors-present and potential-are the external users havingdirect interest. Investors(owners), on the basis ofquantities of information, decideabout buying, holding or sellinginvestments in a businessentity. Creditors (banks,financial institutions, debentureholders and other lenders),evaluate the risk of grantingcredit or lending money to aparticular businessorganization on the basis ofaccounting and otherinformation obtained about that


Accounting process and its users

Identificationof

Economic events(transactions)

Measurement(quantity)

Rs. and paise

Recording(record, classify, and

summarize)

Communication

(Prepare (Analyze andAccounting Interpret)Reports) External users

Internal users

Management at Direct Interest Indirect interestall levels

Office and Present and Potential Regulatory Agenciesother staff Investors Tax Authorities

Customers CustomersLabour UnionsTrade AssociationsStock ExchangesPublic

Fig. 1.1: Accounting Process and Users of Accounting Information

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organization.● External users having indirect

financial and non-financialinterest: Tax authorities,regulatory agencies (such asDepartment of company affairs,Registrar of joint stockcompanies, SecuritiesExchange Board of India),customers, labour unions, tradeassocia-tions, stock exchangesand others are indirectlyinterested in the company’sfinancial strength, its ability tomeet short-term and long-termobligations, its future earningpower, etc. for making variousdecisions.

1.2 Types of AccountingInformation

Since times immemorial, accountinghas been the primary source ofgenerating information about the dayto day working and future planning ofthe organization. The accountant hasperformed this role. Much of therecording function in today’sorganization is computerized. This hasbeen possible due to the advances inthe field of information technology,which has made accounting activitiespossible just in time.

From the definition of accounting,it is clear that the social role ofaccountant is that of informationscientist. Insofar as business entitiesare concerned, a distinction is

normally made between financialaccounting and managementaccounting. Financial accountingdeals with recording and analysis offinancial results of transactions as ameans of arriving at a measure oforganization’s success and financialsoundness. Financial accountinginformation relates to the past periodand is essentially monetary in nature.However, its decision-usefulness islimited. Management accounting isconcerned with the activity ofproviding information (financial andnon-financial) to enable managementto take decisions about operations ofbusiness. Management accountingdraws all financial informationfrom financial accounting. Besides,it develops other information(quantitative and qualitative, financialand non-financial), which is futuristicin character and relevant for decision-making in the organization. Thus, itincludes estimates, forecasts of sales,cash flows, purchase requirements,manpower needs, pollution data,health and safety data aboutemployees, product and plants.Further, financial accountinginformation serves the stewardshipfunction while managementaccounting aids in internal decision-making by management. Therefore,financial accounting is a sub-systemof accounting information system(AIS), which in turn is part ofmanagement information system


InformationConsists of

Non-quantitative InformationQuantitativeInformation

Consists of

Accounting Non-AccountingInformation Information

Consists of

Operating Financial ManagementInformation Reporting Accounting

Fig. 1.2: Types of Accounting Information

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(MIS).Stewardship

A person who manages property orfinancial affair of other person(s) iscalled steward. When such a personpresents his account to anotherwhose property or financial affairshe manages is called stewardshipaccountability. The profit and lossaccount and balance sheet are partof stewardship reporting bymanagers (Board of directors) to theshareholders and creditors.

Box 1.1

Information is the processed data,fact or any observation that adds tothe knowledge. A singular datum suchas 1000 is no information, but 1000units of finished goods is informationbecause it indicates the position ofstock at hand. We can summarize theinformation as follows (figure 1.2)

1.3 Accounting as an InformationSystem

Earlier, the accounting work was�

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entirely manual and accountingdepartment used to take excessivelylong time in processing thetransactions and generating theaccounting reports. The moderntechnology has enabled the accountingdepartment in: (i) eliminating theredundancy, (ii) reducing the numberof people involved in processing oftransaction by removing theunnecessary control points, and (iii)automated posting of transaction fromelectronic voucher to ledger, preparingthe trial balance, profit and lossaccount and balance sheet. Theaccounting information system isdivided into following sub-systems( figure 1.3 and figure 1.4)

1.3.1 Cash sub-system

It deals with the receipt and paymentof cash both physical cash andelectronic fund transfer. Electronicfund transfer takes place without

having the physical cash entry or exitby using the credit cards or electronicbanking.

1.3.2 Sales and accountsreceivable sub-system

It deals with recording of sales,maintaining of sales ledger andreceivables. It generates periodicreports about sales, collections made,overdue accounts and receivablespositions as also ageing schedule ofreceivables/debtors.

1.3.3 Inventory sub-systemIt deals with the recording of differentitems purchased and issuedspecifying the price, quantity and date.It generates the inventory positionsand valuations reports.

1.3.4 Accounts payable sub-system

It deals with the purchase andpayments to creditors. It provides forordering of goods, sorting of purchase

Personnel

Fig. 1.3 : Interaction of Accounting Information System

Research andDevelopment

Accounting

Marketing

Administration

Budget

InventoryControl

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Production

Engineering

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Fig. 1.4 : Accounting Information System

expenses and payment to creditors. Italso generates periodic reports aboutthe performance of suppliers,payments schedule and position ofcreditors.

1.3.5 Payroll accounting sub-system

It deals with payment of wages andsalary to employees. A typical wagereport details information about basicpay, dearness pay, dearness allo-wance, other allowances and bonusand deductions from salary and wageson account of provident fund, loans,advances, taxes and other charges.The system generates reports aboutwage bill, overtime payment andpayment on account of leaveencashment, etc.

1.3.6 Fixed assets accounting sub-system

It deals with the recording of purchase,

addition, deletion, usage of fixed assetssuch as land and building, machineryand equipment, etc. It also generatesreports about the cost, depreciationbook value of different assets.

1.3.7 Costing sub-system

It deals with the ascertainment of costof goods produced. It has linkages withother accounting sub-systems forobtaining the necessary informationabout cost of material, labour andother expenses. This system generatesinformation about the changes in thecost that take place during the periodunder review.

1.3.8 Budget sub-system

It deals with the preparation of budgetfor the coming financial year as wellas comparison with the current budgetof the actual performances.

The foregoing discussion brings

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out clearly that systems perspectiveenables one to see that accounting isone sub-system interacting with thewhole organization. The different sub-systems of an organizational entitycould be operating system, financialsystem, accounting system, personnelsystem and marketing system.Accounting as an integral part ofmanagement information system,interacts not only with all theseinternal sub-systems but also with theexternal environment havinggovernment, lenders, consumers andother sub-systems of socio-economicenvironment. This manner of viewingthe organization makes accountingsystem most important for thefollowing reasons:

● The accounting informationsystem is the only one, whichenables management andexternal information users toget a picture of the wholeorganization.

● Accounting information systemlinks other important informa-tion systems such as marketing,personnel, research anddevelopment and production insuch a manner that theinformation of other sub-systemis ultimately expressed infinancial terms to facilitatefinancial planning.

● Non-financial information insuch areas as social respon-sibility and human resource areintegrated with accountinginformation so as to permitcorporate decision-making.

● The integration of accountingwith other sub-systems leads togreater accuracy and higherspeed in the delivery ofinformation to the users.

1.4 Qualitative Characteristics ofAccounting Information System

The objective of accounting is toprovide information about thefinancial position, performance andchanges in financial position of anenterprise that is useful to wide rangeof users in making economic decisions.To be useful the accountinginformation must possess thecharacteristic of reliability, relevance,understand-ability and comparability.

1.4.1 Reliability

Information is said to be reliable if itis free from error and bias andfaithfully represents what it seeks torepresent. Information must bebelieved and depended upon by theusers for a given purpose. To ensurethat information is reliable, itmust be verifiable, neutral andfaithful in representing the economiccondition.

1.4.2 Relevance

Information is said to be relevant if itinfluences the decisions. To berelevant, information must beavailable in time, must help inprediction, and help in feedback.

1.4.3 Understandability

The accounting information must


possess the quality of economicsignificance to the user, i.e. tounderstand the content and signifi-cance of financial statements andreports. The qualities that distinguishbetween good and bad communicationin a message are fundamental to theunderstandability of the message. Amessage is said to be communicatedwhen it is interpreted by the receiverof the message in the same sense inwhich the sender has sent.

1.4.4 Comparability

The quality of information that enablesusers to identify changes in the economicphenomena over a period of time,between two or more entities. Accountingreports should be comparable across thefirms to identify similarities anddifferences. To be comparable,accounting reports must belong to aperiod, use common unit of measure-ment and common format of reporting.

1.5 Difference between Book Keeping and Accounting

Book keeping usually involves only therecording of business transactions(transactions) and is therefore, justone part of the accounting process.Accounting on the other hand, involvesthe entire accounting process, i.e.identification, measurement, recor-ding, and communication. Now-a-days, much of the book keepingfunction is performed by the computerand other machines.

1.6 Objectives of Accounting

The basic objective of accounting is toprovide information to the interested

users to enable them to make businessdecisions. The necessary information,particularly in the case of externalusers, is provided in the basic financialstatements: Profit and loss statementand Balance sheet

Besides the above sources ofinformation, the internal users,officers and staff of the enterprise, canobtain additional information from therecords of business. Thus the primaryobjectives of accounting can be statedas :

● Maintenance of Records ofBusiness transactions.

● Calculation of Profit or Loss● Depiction of Financial Position.● Provide Information to the Users

1.6.1 Maintenance of Records of Business

First record, then pay; if there is anerror, trace it from the records.Human memory is short. Even themost brilliant executive or managercannot accurately remember whathe might have observed regardingthe daily operations. He need notstrain his memory unnecessarily, ifproper and complete records of allbusiness transactions are keptregularly. More-over, records can beused by di f ferent of f ic ials fordif ferent decision-makingpurposes.

1.6.2 Calculation of Profit or Loss

Earning profit is the main purpose forwhich a business is carried on. Thisinformation is available from the profitand loss statement. Profit is calculatedby deducting expenses from the

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associated revenues. Profit is ameasure of the performance of theenterprise.

1.6.3 Depiction of Financial Position

A balance sheet depicts the financialposition of an enterprise. It is astatement of assets and liabilities. Itshows the resources(assets) owned byan enterprise and depicts the claims(liabilities) against the resources. Thebalance of assets minus the externalliabilities shows the capital (ownersequity).

1.6.4 Provide Information to the UsersGeneration of information is not anend in itself. It is a means to facilitatethe dissemination of informationamong dif ferent user groups.Therefore, communication of infor-mation is the essential function ofaccounting. Accounting information iscommunicated in the form of reports,statements, graphs and charts to theinternal and external users who needit in different decision situations.

Internal users: The officers and staffof an enterprise need useful and timelyinformation for making different typesof business decisions. A majorobjective of accounting is to providemanagement with relevant and reliableinformation. For example, some of thequestions a manager might ask are:

● How much profit did thecompany make during the lastaccounting period?

● Is the return to share holdersadequate? How can it beimproved?

● Does the company have enoughcash on hands to pay debtswhen they fall due? What arethe projected cash needs in thenext quarter?

● Which are the most profitableproducts?

● What is the cost of manufac-turing each product?

● Which costs exceed the budget?● How much money should

be borrowed to expand thebusiness?

External users: The outside users havelimited authority, ability or resourcesto obtain information. Unlike internalusers, they have to rely on financialstatements (Balance sheet, Profit andLoss statement) as their principalsource of information about anenterprise’s economic activity.Primarily the external users areinterested in the following:

● The amount and the time whenthey are likely to receive cashin the future from dividend,interest etc.

● Reliable information abouteconomic resources (assets) andobligations (liabilities) of abusiness enterprise in order toevaluate its strengths andweaknesses, and its financialposition in general.

● Information about the perfor-mance and the earning powerof the business enterprise.


● Any other information relevantto the users needs.

1.7 Role of Accounting

Accounting is not an end in itself; it isa means to an end. It performs theservice activity by providingquantitative financial information thathelps the users in making betterbusiness decisions. Accounting alsodescribes and analyses the mass ofdata of an enterprise throughmeasurement, classification, andsummarization, and reduces that datainto reports and statements, whichshow the financial condition andresults of operations of that enterprise.Accounting as an information systemcollects, processes and communicatesinformation about an enterprise to awide variety of interested parties.

1.8 Limitations of Accounting

Accounting records relate to the pasttransactions, which provide fairly goodaccount of the economic activity of thebusiness enterprise. However, fromdecision-making viewpoint we needinformation, which relates not only topast but also about present andfuture. Financial accounting makesprovision for financial information butit does not provide non-financialinformation such as behavioural andsocio-economic. If the objective ofaccounting reports is to influence thebehaviour through decision-makingthen it must provide the dataconcerning the behaviour andoutcome of human activity to facilitateperformance evaluation. Therefore, the

accounting information does not fullymeet different types of information-requirements of varied decisionmaking situations. Accountingprovides stewardship information andnot decisional information.

1.9 Basic Terms in Accounting

1.9.1 Financial Statements

There are two basic financialstatements which are prepared by anenterprise: (1) Profit & Loss Statement,and (2) Balance Sheet.

1.9.2 Accounting Equation

The three components of a balancesheet can be stated in the form offollowing basic accounting equation—

Assets = Liabilities + Capital (ownersequity)Rs.50,000=Rs.10,000+Rs.40,000

This equation tells at a glance thatthe resources of this enterprise totalRs. 50,000 and these assets arefinanced by two sources — Rs.10,000by the creditors(liabilities), also knownas outsiders claims, and Rs.40,000 bythe owner (capital), also known asowner equity.

1.9.3 Business Transactions

It is an economic event that relates toa business entity. It can be a purchaseof goods, collection of money, paymentto creditors for goods and expenses.An event to be a transaction mustpossess the quality of economicsubstance, relate to business andaffect the economic results. In otherwords, an event must be capable of

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being measured in monetary termsand related to business enterprise interms of economic consequence.

1.9.4 Assets

These are economic resources of anenterprise that can be usefullyexpressed in monetary terms. Assetsare things of value used by thebusiness in its operations. Forexample, Departmental Store owns afleet of trucks, which is used by it fordelivering food stuff; the trucks, thus,provides economic benefits to theenterprise. This item will be shown ofthe asset side of the balance sheet ofDepartmental Store. Assets can bebroadly classified into two types : FixedAssets and Current Assets.

● Fixed Assets are assets held ona long term basis, such as land,buildings, machinery, plant,furniture and fixtures. Theseassets are used for doingbusiness and not for re-sale innormal course of operation.

● Current Assets are assets heldon a short term basis such asdebtors (account receivable),bills receivable (notes receivable),stock (inventory),temporaryinvestment in securities, cashand bank balances. Normallythe short term refers to anaccounting year.

1.9.5 Liabilities

These are the obligations or debts thatthe enterprise must pay in money orservices at sometime in the future.

They, therefore, represent creditors,claims against assets of the firms. Bothsmall and big businesses find itnecessary to borrow money at sometime or the other, and to purchasegoods on credit. Super Bazaar, forexample, purchases goods forRs.10,000 on credit for a month fromFast Foods Products Company on 25December 2001. If the balance sheetof Departmental stores is prepared asat 31 December 2001, Fast FoodProducts Company will be shown ascreditors (accounts payable) on theliabilities side of the balance sheet. Ifthe departmental store also takes aloan for a period of three years fromDelhi State Cooperative Bank Ltd., thiswill be shown as a liability in thebalance sheet of the Departmental

Stores.

● Long term liabilities are thosethat are usually payable after aperiod of one year, for example,a term loan from financialinstitution or debentures(bonds) issued by the company.

● Short term liabilities areobligations that are payablewithin a period of one year,for example, creditors (accountspayable), bills payable (notespayable), cash credit overdraftfrom a bank for a short period.

1.9.6 Capital

Investment by the owners for the usein the firm is known as capital. Fromthe accounting equation given earlier,it can easily be found that the capital


is Rs.40,000. Owners equity is theownership claim on total assets. It isequal to total assets minus totalexternal liabilities: E=A-L This is alsocalled residual interest. Owner’s equityis equal to capital.

1.9.7 Sales

Sales are total revenues from goodssold and/or services sold or providedto customers. Sales may be cash salesor credit sales.

1.9.8 Revenues

These are the amounts the businessearns by selling it products orproviding services to customers. Theseare called ‘sales revenues’. Other itemsand sources of revenues common tomany businesses are: sales, fees,commission, interest, dividends,royalties, rent received, etc.

1.9.9 Expenses

These are costs incurred by a businessin the process of earning revenues.Generally, expenses are measured bythe cost of assets consumed or servicesused during an accounting period. Theusual items of expenses are: depre-ciation, rent, wages, salary, interest,costs of heat, light and water,telephone, etc.

1.9.10 Expenditure

Expenditure is the amount ofresources consumed. Usually, it is oflong term in nature. Therefore, itsbenefit is to be derived in future. Forexample, capital expenditure.

1.9.11 Loss

Loss is the gross decreases in theassets or gross increases in theliabilities. It is the excess of expensesover revenues. It represents reductionin owners’ equity due to inability of thefirm to recover the assets used in thebusiness. For example, a firm spendsRs. 70,000 and generates a revenueof Rs. 60,000, there is a loss of Rs.10,000 which represents non-recoveryof assets consumed in doing business.

1.9.12 Income

Income is the increase in the net worthof the organization either frombusiness activity or other activities.Income is a comprehensive term,which includes profit also. Inaccounting income is the positivechange in the wealth of the firm over aperiod of time.

1.9.13 Profit

Profit is the excess of revenues overexpenses during an accounting year.It increases the owners equity.

1.9.14 Gains

Gain is the change in the equity (networth) arising from change in the formand place of goods and holding of assetsover a period of time whether realized orunrealized. It may either be of capitalnature or revenue nature or both.

1.9.15 DrawingsIt is the amount of cash or other assetswithdrawn by the owner for hispersonal use.

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1.9.16 PurchasesPurchases are total amounts of goodsprocured by a business on credit andfor cash, for use or sale. In a tradingconcern, purchases are made ofmerchandise for resale with or withoutprocessing. In a manufacturingconcern, raw materials are purchased,processed further into finished goodsand then sold. Purchases may be cashpurchases or credit purchases.

1.9.17 StockStock (inventory) is a measure ofsomething on hand-goods, spares andother items-in a business. It is calledstock on hand.

In a trading concern, the stock onhand is the amount of goods whichhave not been sold on the date on whichthe balance sheet is prepared. This isalso called closing stock (endinginventory). In a manufacturingcompany, closing stock comprises rawmaterials, semi-finished goods andfinished goods on hand on the closing

date.Similarly, opening stock

(beginning inventory) is the amountof stock at the beginning of theaccounting year.

1.9.18 Debtors/Accounts Receivable

Debtors (accounts receivable) arepersons and/or other entities who oweto an enterprise an amount forreceiving goods and services on thecredit. The total amount due from suchpersons and/or entities on the closingdate is shown in the balance sheetas the sundry debtors (accountreceivables) on the asset side.

1.9.19 Creditors/Accounts Payable

Creditors (accounts payable) arepersons and/or other entities who haveto be paid by an enterprise an amountfor providing the enterprise goods and/or services on credit. The total amountstanding due to such persons and/orentities on the closing date, is shownon the balance sheet as sundry creditors(accounts payable) on the liability side.

SUMMARY WITH REFERENCE TO LEARNING OBJECTIVES

1. Meaning of accounting as an information system

Accounting as an information system is the process of identifying, measuring,recording and communicating the economic events of the organization to interestedusers of the information.

2. Users of accounting information

Accounting plays a significant role in society by providing information tomanagement at all levels and to those having direct financial interest in theenterprise, such as present and potential investors and creditors. Accountinginformation is also important to external users such as regulatory agencies, taxauthorities, customers, labour unions, trade associations, stock exchanges andothers.


3. Difference between book keeping and accounting

Book keeping involves only the recording of business transactions, while accountinginvolves identifying, measuring, recording, processing and communication offinancial information.

4. Objectives of accounting

The primary objective of accounting is to:

● maintain records of business;● calculate profit or loss;● depict the financial position; and● make information available to various groups and users.

5. Role of accounting

Accounting is not an end in itself. It is a means to an end. It plays the role of:

● providing service to the users;● describing, analyzing and reducing a mass of data into reports statement that

show the finan-cial status and performance results of an enterprise; and● an accounting information system.

6. Basic terms in accounting

● Assets are the economic resources of an enterprise that can be expressedin monetary terms.

● Liabilities are obligations or debts that an enterprise must pay in money orservices at sometime in the future.

● Capital is investment by the owners for use in the firm. It is equal to totalassets minus total liabilities.

● Revenues are the amount a business earns by selling its products orproviding services to the customers.

● Expenses are the costs incurred by a business in the process of earningrevenue.

● Purchases are the total amount of goods procured by business on creditand for cash, for use, or sale.

● Sales are total revenues from goods sold and/or services provided tocustomers.

● Stock is the measure of something on hand-goods, spares and other itemsin a business.

● Debtors (account receivables) are persons or entities who owe to an enterprisean amount for receiving goods and services on credit.

● Creditors (accounts payables) are persons or entities who have to be paid byan enterprise an amount for providing the enterprise goods and services oncredit.

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EXERCISES

Objective Type Questions

1. Determine whether the following are assets, liabilities, revenue, or expensesor none of them:

(i) Sales(ii) Debtors (accounts receivable)(iii) Creditors (accounts payable)(iv) Salary paid to manager

2. Which of the following statements is not an objective of accounting?

(i) To provide information about the enterprises assets, liabilities andcapital.

(ii) To provide information on the personal assets and liabilities of theowner of enterprise.

(iii) To maintain records of business.(iv) To provide information about the performance of the enterprise.

3. The information provided in the annual financial statement of an enterprisepertains to :

(i) Individual business enterprise(ii) Business industries(iii) The economy as whole(iv) None of the above

4. Do the following events represent business transactions? (State True or False)

(i) An employee dismissed from the job.(ii) The owner of the business withdraws cash from the business for his

personal use Rs. 500.(iii) Goods are purchased on credit Rs. 1,000 from Y.(iv) A perspective employee is interviewed.(v) Goods ordered for delivery next month.(vi) The owner of the firm dies.(vii) Land is purchased for cash Rs. 5,00,000.

Short Answer Questions

5. Explain the meaning of accounting?6. Distinguish between book keeping and accounting?7. List the main objectives of accounting.8. What is primary reason for the business students and others to familiarize

themselves with the accounting discipline?9. Which decision makers use accounting information?10. What information do the users need?11. Define assets, liabilities and capital?12. How will you define revenues and expenses?


13. Describe the role of accounting?14. What accounting information system will be needed by the following:

(i) A newspaper vendor.(ii) A newspaper distributor.(iii) A newspaper publisher.

Essay Type Questions

15. Define accounting and explain its features.16. What is accounting information system? What are the qualitative

characteristics of accounting information?17. Explain the objectives of accounting? What are the limitations of accounting

information?18. Explain the sub-systems of the accounting information system?19. Distinguish between the scope and objectives of the following accounting

information sub-systems?

(i) Financial accounting information sub-system.(ii) Managerial accounting information sub-system.

20. Explain the following sub-systems of an accounting information system:

(i) Budget sub-system.(ii) Payables and Receivables sub-system.

Check-list of Key Letters/Words

1. (i) Revenue(ii) Debtors(iii) Liability(iv) Expenses

2. (ii)

3. (i)

4. (i) No(ii) Yes(iii) Yes(iv) No(v) No(vi) No(vii) Yes

42 ACCOUNTANCY

CHAPTER 3

Origin and Recording of Transaction

LEARNING OBJECTIVES


● state and explain the meaning of source documents;

● apply the accounting equation to explain the effect oftransactions;

● record the transactions using rules of debit and credit;

● explain the double entry book keeping system;

● explain the journal and record the transactions;

● appreciate the need for special purpose books and recordthe transactions therein;

● explain ledger and post the journal entries to ledgeraccounts, and balance it;

● explain the meaning and need of bank reconciliation andprepare it;

● ascertain the correct bank balance.

43ORIGIN AND RECORDING OF TRANSACTION

Accounting process starts withidentifying the transactions to berecorded in the books of accounts. Inthe earlier chapters, the generalprinciples involved in the recordingand measurement of accountingtransactions were discussed. In thischapter, we will discuss the process ofrecording the transactions. The firststep involves identifying thetransactions to be recorded andpreparing the source documents. Wewill begin with explaining the meaningof source documents and then thesteps involved in recording thetransactions.

3.1 Source Documents

A document which becomes the basisfor recording a transaction in the booksof accounts is called source document.Source document provides thenecessary information about thenature of transaction and the amountinvolved. It also acts as a writtendocumentary evidence of thetransaction that has taken place.Thus, the correctness of a transactionrecorded can be verified with the helpof a source document. There arevarious types of business documents,like, vouchers, invoices, cash memos,and bill receipts, etc., which constitutesource documents. There must be asource document for each entry to berecorded in the books of accounts.Even for internal events likedepreciation charged, materials issuedto production department formanufacturing of finished goods, thesource documents are prepared.

Source document, thus, can besaid to initiate the accounting process.The transaction is to be recorded inthe books of accounts by looking at theeffect it has on accounting equation.

3.2 Accounting Equation

Accounting equation states theequality of debits and credits. The leftside of the equation represents Assets(Debit) and right side representsLiabilities and Owners’ Equity (Credit).The relationship of assets on the leftside and liabilities and owners’ equityon the right side in the equation formis known as ‘Accounting Equation’ asgiven below:Assets (A) = Liabilities (L) + Owners’

Equity (E)

The above equation can be statedin any of the following forms:

A = L +E

or A - L = E

or A - E = L

or A - L - E = 0

Since the components of balancesheet are depicted in the accountingequation, it is also called as ‘BalanceSheet Equation’. The owners’ equityrepresents the amount invested byowners in the business plus retainedearnings.

Let us take for example, Mr. Jacobstarted his business by introducingRs.1,00,000 into the business. Theassets purchased are Land Rs. 30,000;Buildings Rs.20,000, FurnitureRs.5,000, inventory for Rs.20,000, andRs.20,000 are deposited into the bank

44 ACCOUNTANCY

account. Then the accounting equation will represent this situation as below:

Cash + Bank + Land + Buildings + Furniture + Inventory = Owners’ Equity 5,000 + 20,000 + 30,000 + 20,000 + 5,000 + 20, 000 = 1,00,000

This can be presented in the form of Balance Sheet as below:

Transaction 1:

On 1 April, Mr. Mohan brings Rs. 1,00,000 as his capital. The position as on 1 April will be as under:

Assets = Liabilities + Owners’ Equity (Capital)

(Rs.) (Rs.) (Rs.)

Cash1,00,000 = 0 + 1,00,000

Balance Sheet of Mr. Jacob as at _____________–––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––—–––––––

Amount Amount––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––—––––––––

(Rs.) (Rs.)Capital (Owners’ Equity) 1,00,000 Land 30,000

Buildings 20,000Furniture 5,000Inventory 20,000Cash at Bank 20,000Cash in Hand 5,000

–––––––––––– ––––––––––Total: 1,00,000 1,00,000 –––––––––––– ––––––––––

In the above balance sheet, the totalassets are equal to the capital (amountinvested by the owner). Since, thebusiness has not yet started itsactivities and has not earned anyprofits, the equity is still Rs.1,00,000.In case, any profits are earned, it willincrease owner’s equity. On the otherhand, if the business suffers anylosses, it will decrease owners’ equity.

3.3 Analysis of Transactions

An event that affects assets, liabilitiesor owners’ equity is called a transac-tion. Each transaction is to be recordedin the books of accounts in chrono-

logical order. We need to analyze eachtransaction to ascertain its effect ondifferent elements of accountingequation which will help us to decidewhich account is to be debited andwhich account is to be credited.

The transaction analysis, asexplained above, reveals the effect onassets, liabilities, and owners’ equity.After each transactions’ effect is takeninto consideration, the equation stillremains balanced i.e., A = L + E.

We will analyze some transactionsand its effect on different elements andwill observe that the accountingequation always remain balanced.


Transaction 2:On 2 April, Mr. Mohan purchased land for Rs. 35,000 for cash.

Assets = Liabilities + Owner’s Equity

Cash + Land = Liabilities + (Capital)Rs. Rs. Rs. Rs.

Old Bal. 1,00,000 + 0 = 0 + 1,00,000

Effect ofTransaction 2 -35,000 + 35,000

New Balance 65,000 + 35,000 = 0 + 1,00,000

Transaction 3:On 30 April paid Rs. 23,000 on completion of building constructed by contractor


Cash + Land + Building = Liabilities + (Capital)Rs. Rs. Rs. Rs. Rs.

Old Balance 65,000 + 35,000 = 0 + 1,00,000


New Balance 42,000 + 35,000 + 23,000 = 0 + 1,00,000

Transaction 4:On 3 May purchased furniture for Rs. 4,000


Cash + Land + Building + Furniture = Liabilities + (Capital)Rs. Rs. Rs. Rs. Rs. Rs.

Old Balance 42,000 35,000 23,000 0 1,00,000

Effect ofTransaction 4 - 4,000 + 4,000

New Balance 38,000 + 35,000 + 23,000 + 4,000 = 0 + 1,00,000

Transaction 5:On 8 May purchased stock for Rs. 18,000 for cash


Cash + Land + Building + Furniture + Inventory = Liabilities + CapitalRs. Rs. Rs. Rs. Rs. Rs. Rs.

Old Balance 38,000 35,000 23,000 4,000 = + 1,00,000


New Balance 20,000 + 35,000 + 23,000 + 4,000 + 18,000 = 0 + 1,00,000

46 ACCOUNTANCY

Transaction 6:On 10 May Deposited Rs. 15,000 in bank account opened in the name of business.


Cash + Land + Building + Furni- + Inven- + Bank = Liabi- + Capitalture tory lities

Rs. Rs. Rs. Rs. Rs. Rs. Rs. Rs.

Old 20,000 35,000 + 23,000 + 4,000 + 18,000 = 0 + 1,00,000Balance

Effect of - 15,000 + 15,000 =Transac-tion 6

NewBalance 5,000 + 35,000 + 23,000 + 4,000 +18,000 + 15,000 = 0 + 1,00,000

Transaction 7:On 11 May purchased goods on credit for Rs. 3,000 from Bright & Co.

Owners’ Equity

Cash + Land + Building +Furniture +Inventory + Bank = Creditors + (Capital)Rs. Rs. Rs. Rs. Rs. Rs. Rs. Rs.

Old Bal. 5,000 + 35,000 + 23,000 + 4,000 + 18,000 + 15,000 = 0 + 1,00,000

Effect ofTransac + 3,000 = 3,000tion 7

NewBalance 5,000 + 35,000 + 23,000 + 4,000 +21,000 + 15,000 = 3,000 + 1,00,000

Summary of effect of transactions on assets, liability and equity of Mohan Enterprises

Assets = Liabilities + Owners’(Rs.) (Rs.) Equity

(Rs.)

Transac- Cash + Land + Building + Furniture + Inven- + Bank = Creditors + Capitaltion No. tory

1 1,00,000 0 1,00,0002 - 35,000 + 35,0003 - 23,000 + 23,0004 - 4,000 + 4,0005 - 18,000 + 18,0006 - 15,000 + 15,0007 + 3,000 + 3,000

Balance 5,000 + 35,000 + 23,000 + 4,000 + 21,000 + 15,000 = 3,000 + 1,00,000

Illustration 1 Given below are the transactions and their effect on the accounting equationof M/s Fair Traders for the month of April 2001.


Solution

Transaction 1:

On 1 April Mr. Gaurav starts his business under the name ‘Fair Traders’ and investsRs.4,00,000 as his capital. This transaction increases cash (assets) and Gaurav’s capital(owners’ equity) by Rs. 4,00,000.

The position as on 1 April will be as under:

Assets = Liabilities + Owners’ (Rs.) (Rs.) Equity

(Rs.) Cash Capital

Effect of Tr. 1 4,00,000 4,00,000

Transaction 2:

On 2 April bank account was opened and Rs. 3,00,000 were deposited in it.This Transaction increases Bank (assets) and decreases cash (assets) by Rs. 3,00,000

Cash + Bank = Liabilities + Owners’ EquityRs. Rs. Rs. Rs. (Capital)

Old 4,00,000 0 4,00,000Balance

Effect of Tr.2 – 3,00,000 + 3,00,000 =

NewBalance 1,00,000 + 3,00,000 = 0 + 4,00,000

Transaction 3:

On 5 April Purchased furniture for Rs. 48,000 payment made by cheque. This transaction increasesfurniture (assets) and decreases cash (assets) by Rs. 48,000.

Cash + Bank + Furniture = Liabilities + Owners’ EquityRs. Rs. Rs. Rs. Rs. (Capital)

Old Balance 1,00,000 + 3,00,000 4,00,000

Effect of Tr.3 – 48,000 + 48,000 =

New Balance 1,00,000 + 2,52,000 + 48,000 = 0 + 4,00,000

Transaction 4:

On 7 April purchased goods costing Rs. 76,000 payment made through bank.

This transaction increases inventory (assets) and decreases cash at bank (assets) by Rs. 76,000.

Cash + Bank + Furniture + Inventory = Liabilities + Owners’Rs. Rs. Rs. Rs. = Rs. Equity (Capital) Rs.

Old Balance 1,00,000 + 2,52,000 + 48,000 + = + 4,00,000

Effect of Tr. 4 – 76,000 – – + 76,000 =

New Balance 1,00,000 + 1,76,000 + 48,000 + 76,000 = 0 + 4,00,000

48 ACCOUNTANCY

Transaction 5:

On 10 April purchased goods for Rs. 56,000 on credit from Honest Traders.

This transaction increases inventory (assets) and creditors (liabilities) by Rs. 56,000.

Cash + Bank + Furniture + Inventory = Liabilities + Owners’Rs. Rs. Rs. Rs. Rs. Equity (Capital) Rs.

Old Balance 1,00,000 + 1,76,000 + 48,000 + 76,000 = 0 4,00,000

Effect of Tr. 5 + 56,000 = 56,000 +

New Balance 1,00,000 + 1,76,000 + 48,000 + 1,32,000 = 56,000 + 4,00,000

Transaction 6:

On 12 April sold goods for Rs. 18,000 (costing Rs. 14,200) to Mr. Hira Lal on credit.

This transaction increases debtors (assets) by Rs. 18,000, inventory (assets) by Rs. 14,200 and increasesprofit (owners, equity) by Rs. 3,800.

Cash + Bank +Furniture + Inventory + Debtors = Creditors + Owners’Rs. Rs. Rs. Rs. Rs. Rs. Equity (Capital) Rs.

Old 1,00,000 +1,76,000 + 48,000 + 1,32,000 + = 56,000 + 4,00,000

BalanceEffect of Tr. 6 – 14,200 + 18,000 = + 3,800

NewBalance 1,00,000 +1,76,000 + 48,000 +1,17,800 + 18,000 = 56,000 + 4,03,800

Transaction 7:

On 14 April paid M/S Honest Traders Rs. 36,000 on his account by cheque on 14 April.

This transaction decrease cash at Bank (assets) and creditor (liabilities) by Rs. 36,000.


Old Balance 1,00,000 + 1,76,000 + 48,000 + 1,17,800 + 18,000 = 56,000 + 4,03,800

Effect of – 36,000 + = – 36,000 +Tr. 7

NewBalance 1,00,000 +1,40,000 + 48,000 +1,17,800 + 18,000 = 20,000 + 4,03,800

Transaction 8:

On 18 April Goods sold for Rs. 23,800 (costing Rs. 19,000) on cash on 18 April.This transaction increases cash (assets) by Rs. 23,800, decreases inventory (assets) by Rs. 19,000 andincreases profit (owners’ equity) by Rs. 4,800.



Old 1,00,000 +1,40,000 + 48,000 + 1,17,800 + 18,000 = 20,000 + 4,03,800Balance

Effect of + 23,800 – 19,000 4,800Tr. 8

NewBalance 1,23,800 +1,40,000 + 48,000 + 98,800 + 18,000 = 20,000 + 4,08,600

Transaction 9:

On 21 April received cheque for Rs. 18,000 from Mr. Hira Lal.

This transaction increases cash at bank (asset) by Rs. 18,000 and decreases another asset (amount duefrom customer, debtor) by Rs. 18,000


Old 1,23,800 + 1,40,000 + 48,000 + 98,800 + 18,000 = 20,000 + 4,08,600Balance

Effect of 18,000 – 18,000Tr. 9

NewBalance 1,23,800 +1,58,000 = 48,000 = 98,800 + 0 = 20,000 + 4,08,600

Transaction 10:On 27 April paid the balance amount in cash to M/s Honest Traders.

This transaction reduces cash (assets) by Rs. 20,000 and liabilities (amount due to supplier, credit) byRs. 20,000.

Cash + Bank + Furniture + Inventory + Debtors = Creditors + Owners’Rs. Rs. Rs. Rs. Rs. Rs. Equity (Capital) Rs.

Old 1,23,800 + 1,58,000 + 48,000 + 98,800 + 0 = 20,000 + 4,08,600Balance

Effect of – 20,000 = – 20,000Tr. 10

NewBalance 1,03,800 +1,58,000 + 48,000 + 98,800 + 0 = 0 + 4,08,600

Illustration 2

Show the impact of following transactions on the accounting equation and check whether the equationremains balanced or not:

1. Umesh commences business with Rs. 1,00,000.2. Purchased land for Rs. 24,000.3. Constructed building at a cost of Rs. 25,000 paid in cash.4. Purchased furniture for Rs. 5,000.5. Purchased goods for Rs. 8,000 on cash.6. Purchased goods for Rs. 13,000 on credit from M/s Prem Traders.7. Sold goods for cash Rs. 18,000 costing Rs. 12,600.

50 ACCOUNTANCY

8. Paid salary Rs. 2,000 to Salesman.9. Paid Rs. 7,000 to M/s Prem Traders on account.10. Paid Insurance premium on buildings Rs. 500.

Solution:

Summary of Effects of Transactions on Accounting Equation:

Transa- Cash + Land + Building + Furniture + Inventory + Debtors = Creditors + Owners’ction No. Rs. Rs. Rs. Rs. Rs. Rs. Rs. Equity Rs.

(Current 1,00,000 1,00,000Position)2 - 24,000 + 24,000New Bal. 76,000 24,000 = 1,00,0003 - 25,000 25,000New Bal. 51,000 24,000 25,000 = 1,00,0004 - 5,000 5,000New Bal. 46,000 24,000 25,000 5,000 = 1,00,0005 - 8,000 8,000New Bal. 38,000 24,000 25,000 5,000 8,000 = 1,00,0006 13,000 13,000New Bal. 38,000 24,000 25,000 5,000 21,000 = 13,000 1,00,0007 + 18,000 - 12,600 + 5400New Bal. 56,000 24,000 25,000 5,000 8,400 = 13,000 1,05,4008 - 2,000 - 2,000New Bal. 54,000 24,000 25,000 5,000 8,400 = 13,000 1,03,4009 - 7,000 - 7,000New Bal. 47,000 24,000 25,000 5,000 8,400 = 6,000 1,03,40010 - 500 - 500

New Bal. 46,500 + 24,000 + 25,000 + 5,000 + 8,400 = 6,000 + 1,02,900

account is defined and the rules of debitand credit are explained in the contextof the accounting equation.

3.4.1 Definition of an Account

To record every transaction, oneaccount is debited and the otheraccount is credited. An account is aformal record of all transactionsrelating to changes in a particular item.Transactions of similar nature arebrought together at one place in anaccount which are opened in a bookcalled ledger.

3.4 Rules of Debit and Credit

The terms, debit and credit, inaccounting indicate whether thetransactions are to be recorded on theleft hand side or right hand side of theaccount. Every transaction involves giveand take aspect. The debit representstake aspect and credit the give aspectin a transaction. For example, whenfurniture is purchased for cash, thenfurniture represents take aspect andcash represents give aspect. Thus,furniture is debited and cash iscredited. In the following paragraphs,


3.4.2 Rules of Debit and Credit

The basic rule of debit and credit areas follows:

● Any increase on the left handside of the equation is a debit.

● Any decrease on the left handside of the equation is a credit.

● Any increase on right hand sideof the equation is a credit.

● Any decrease on the right handside of the equation is a debit.

As discussed earlier, the profit andloss will change the owners’ equity. Theprofit or loss represents the netdifference between revenues andexpenses. Therefore, the basicaccounting equation discussed earliercan be expanded in the followingmanner:

Assets = Liabilities + Capital + Revenues - Expenses

where, Capital + Revenue - Expenses = Owners’ Equity

The debit and credit for differentelements of the accounting equationwill represent increase or decrease inthese elements as given below.

Elements of Debit CreditAccounting Equation

Assets Increase DecreaseLiabilities Decrease IncreaseCapital Decrease IncreaseRevenues Decrease IncreaseExpenses Increase Decrease

It is clear from the table given abovethat debit may represent increase insome elements while decrease in otherelements. Similarly, credit mayrepresent increase in some elementswhile decrease in other elements.

3.5 Double Entry Book Keeping

The recording of transactionsconsidering the debit and credit aspectis known as double entry book keepingsystem. The different books in which

The effect of these rules on different accounts is shown below:(1) (2)Debit Assets Credit Debit Liabilities Credit

Increase (+) Decrease (-) Decrease (-) Increase (+)

(3) (4)Debit Capital Credit Debit Revenues Credit

Decrease (-) Increase (+) Decrease (-) Increase (+)

(5) (6)Expenses Owners Equity (3+4+5)

Debit Credit Debit Credit

Increase (+) Decrease (-) Decrease (-) Increase (+)(Expenses, (InvestmentLosses, by Owners,Distribution Revenues,to Owners) Gains)

→

→

→

→

→

→

→

→

→ →

→

→

52 ACCOUNTANCY

the transactions are recorded arediscussed below:

3.5.1 Books of Original Entry

The book in which the transaction isrecorded for the first time is calledjournal or book of original entry. Thesource document, as discussed earlier,is required to record the transactionin the journal.

The transactions are recorded inchronological order in journal and thenneed to be posted to ledger. In thefollowing paragraphs, we will discuss theprocess of journalizing and posting thetransactions. There are few types oftransactions which occur repetitively inthe business. For economic reasons,instead of recording all the transactionsin journal, the similar transactions arerecorded separately in subsidiary books.The following are the books of originalentry normally used by the enterprises.

● journal● cash book● other day books–

● purchases book● sales book● purchase returns book● sales returns book● bills receivables book● bills payables book

3.5.2 Journal

In this book the transactions arerecorded in the chronological order inwhich they take place. Since, thetransactions are recorded first time, itis called book of original entry. Theprocess of recording transactions in thejournal is called journalizing. Eachtransaction is separately recorded afterdetermining the particular accounts tobe debited and credited. The first columnin a journal is date column which showsthe date on which the transactionrecorded against it took place. In theparticulars column the account to bedebited is written in the first line startingfrom the left hand corner of this column.In the second line the account to becredited is written leaving sufficientmargin on the left side. After writingthese two accounts, within the bracketsa brief explanation of the transaction(also called narration) is given. Theexplanation can be in simple words andthere is no need to start the narrationwith the word being which was a practiceearlier. The journal provides date wisecomplete record of transactions alongwith the documentary evidence availableto prove the occurrence of thetransactions. Following is the format ofthe journal showing the recording of thetransaction, such as, “Rs. 500 paid toMr. Ali on 1 April 2001”.

JOURNAL

Date Particulars L.F. Debit CreditAmount (Rs.) Amount (Rs.)

1 April Ali A/c Dr. 500.002001

Cash A/c 500.00(Paid Rs. 500 to Ali)


At the time of the posting to theledger, we need to write the Ledger Folio(in the computerized accounting thetraditional ledger folio is referred to asReference Number. Besides eachaccount has its code number.) in theledger where the entry is posted in theL.F. column. The ledger folio (LF) columnin the manual system of accounting isfilled in at the time of posting of thesetransactions in ledger only.Some examples of journalizing thetransactions are given below:

Illustration 3. Journalize the followingtransactions:

Transaction 1: On 1 April 2001 Mr.Mohan brings Rs.1,00,000as his capital.

Transaction 2: On 2 April 2001 Mr.Mohan purchases landfor Rs. 35,000 for cash.

Transaction 3: On 30 April 2001 paid Rs.23,000 on completion ofbuil-ding constructed bycontractor.

Transaction 4: On 3 May 2001 purchasedfurniture for Rs. 4,000.

Transaction 5: On 8 May 2001 purchasedstock for Rs.18,000 forcash.

Transaction 6: On 10 May 2001 Depo-sited in bank accountopened in the name ofbusiness Rs.15,000.

Transaction 7: Purchased goods on 11May 2001 from Brightand Co. on credit forRs. 3,000.

Solution JOURNAL

Date Particulars L.F. Debit CreditAmount

2001 (Rs.) (Rs.)

1 April Cash A/c Dr. 1,00,000 Mohan’s Capital A/c 1,00,000(Mohan invested capital in the firm)

2 Land A/c Dr. 35,000 Cash A/c 35,000(Land purchased for cash)

30 Buildings A/c Dr. 23,000 Cash A/c 23,000(Paid to contractor on completion ofconstruction of building)

3 May Furniture A/c Dr. 4,000 Cash A/c 4,000(Purchased furniture for cash)

8 Purchases A/c Dr. 18,000 Cash A/c 18,000(Purchased goods in cash)

Balance c/f 1,80,000 1,80,000

54 ACCOUNTANCY

Illustration 4: Analyze and Recordthe Journal entries relating totransactions given below:

Tr. Date ParticularsNo.

1 2002 Mr. Gaurav started1 April business by investing

Rs.4,00,000.2 1 April Deposited Rs.3,00,000

in the bank accountopened in the nameof business.

3 3 April Purchased fur -niture for Rs.48,000,payment made bycheque.

4 8 April Purchased goodscosting Rs.76,000against paymentmade by cheque.

5 10 April Purchased goodsfrom Honest Tra-ders on account forRs. 56,000.

6 12 April Sold goods to M/sHira Lal forRs. 18,000 (costingRs. 14,200) on

account (on credit).7 15 April Paid to Honest

Traders Rs.36,000by cheque.

8 18 April Goods sold forRs. 23,800 (costingRs.19,000) on cash.

9 22 April Received cheque forRs.18,000 fromHira Lal.

10 26 April Paid the balanceamount (Rs.20,000)to M/s HonestTraders by cheque.

Solution

Analysis of transactions:

Transaction 1: This transactionincreases cash (asset) and Gaurav’sCapital (owners’ equity) byRs. 4,00,000.

Transaction 2: This transactionincreases cash at bank (asset)and decreases cash (asset) byRs. 3,00,000Transaction 3: This transactionincreases furniture (asset) anddecreases cash (asset) by Rs. 48,000.

Total b/f 1,80,000 1,80,000

10 Bank A/c Dr. 15,000 Cash A/c 15,000(Deposited cash in newly opened

Bank Account) 11 Purchases A/c Dr. 3,000

Bright & Co 3,000(Purchased goods on credit fromBright & Co.)

Total 1,98,000 1,98,000


Transaction 4: This transactionincreases inventory (asset) anddecreases cash at bank (asset) byRs. 76,000Transaction 5: This transactionincreases inventory (asset) andcreditors (liabilities) by Rs. 56,000.Transaction 6: This transactionincreases sales (revenue) by Rs. 18,000and debtors (asset) by Rs. 18,000. Onfurther analysis cost of goods sold(expenses) increases by Rs.14,200,profit by Rs. 3,800 and debtors (asset)by Rs. 18,000.Transaction 7: This transactiondecrease cash at bank (asset) and

creditor (liability) by Rs. 36,000.Transaction 8: This transactionincreases cash (asset) by Rs. 23,800,decreases inventory (asset) byRs.19,000 and increases profit(owners’ equity) by Rs. 4,800.Transaction 9: This transactionincreases cash at bank (asset) byRs.18,000 and decremes Debtors(asset) by Rs.18,000.Transaction 10: This transactiondecreases cash at bank (asset) byRs. 20,000 and liability (creditors) byRs. 20,000.

The transactions are recorded injournal as under:

JOURNAL

Date Particulars L.F. Debit CreditAmount Amount

2000 Rs. Rs.

April 1 Cash A/c Dr. 4,00,000 Gaurav’s capital A/c 4,00,000(Gaurav invested capital in the firm)

April 1 Bank A/c Dr. 3,00,000 Cash A/c 3,00,000(Cash deposited in newly openedBank Account)

April 3 Furniture A/c Dr. 48,000 Bank A/c 48,000(Furniture purchased and payment madeby cheque)

April 8 Inventory A/c1 Dr. 76,000 Bank A/c 76,000(Inventory purchased on payment by cheque)

April 10 Inventory A/c Dr. 56,000 Honest Traders A/c 56,000[Inventory purchased fromM/s Honest Traders on account (credit)]

Total c/f 8,80,000 8,80,000

56 ACCOUNTANCY

Total b/f 8,80,000 8,80,000

April 12 Hira Lal A/c Dr. 18,000 Sales A/c 18,000[sold goods to Hira Lal on account (credit)]

April 12 Cost of goods sold A/c2 Dr. 14,200 Inventory A/c 14,200(cost of goods sold transferred to inventory)

April 15 M/s Honest Traders Dr. 36,000 Bank A/c 36,000(cheque given to M/s Honest Traders)

April 18 Cash A/c Dr. 23,800 Sales A/c 23,800(goods sold for cash)

April 18 Cost of goods sold A/c Dr. 19,000 Inventory A/c 19,000(cost of goods sold transferred to inventory)

April 22 Bank A/c Dr. 18,000 M/S Hira Lal A/c 18,000(Received cheque from Hira Lal)

April 26 M/S Honest Traders A/c Dr. 20,000 Bank A/c 20,000(cheque given to M/s Honest Traders)

Total 10,29,000 10,29,000

Note: 1 Inventory purchased may be debited to purchases account also.2 In real life, we do not ascertain the cost of goods sold, each time a sale is made.

Therefore, we do not need to pass this entry individually each time a sale is made.

3.5.3 Ledger

The ledger is the main book ofaccounting system. It containsdifferent accounts where transactionsrelating to that account are recorded.

A ledger is a collection of all theaccounts, debited or credited, in thegeneral journal and various specialjournals. A ledger may be in the formof a bound register, or cards, orseparate sheets may be maintained ina loose leaf binder. In the ledger, each

account is opened preferably on aseparate page or card.

● Utility

A ledger is very useful and is ofthe utmost importance in anyorganization. The relationship ofthe firm in respect of aparticular account on a givendate can be ascertained onlyfrom the ledger. For example, ifthe management wants to know,on a particular date, the amount


due from a certain customer, orthe amount the firm has to payto a particular supplier, suchinformation can be found onlyin the ledger. Such informationis very difficult to ascertain fromjournal. Since, in a journal, thetransactions are recorded inchronological order, it defiesclassification. This problem isobviated by the ledger whichhelps the classification oftransactions relating to aparticular account in such amanner that it helps obtainingnecessary information about theaccount which is used fordecision-making. For easyposting and location, accountsare opened in the ledger in somedefinite order. For example, theymay be opened in the sameorder as they appear in the Profitand Loss Account and BalanceSheet. In the beginning, anindex is also provided. For easyidentification, in big organi-zations, each account is alsoallotted a code number.

● Format

The ledger account isconventionally in ‘T’ shape and,thus, sometimes called ‘T’

account. The left side of the Taccount is called the debit sideand the right side is called thecredit side. In other words, alldebits will be recorded on theleft side and all credits will berecorded on the right side. Eachside of the account has fourcolumns to record necessarydetails of each transaction asshown below:

According to this format the columnswill contain the information as givenbelow:

Column InformationNo.

(1) The date on which a transactionis recorded.

(2) Particulars relating to atransaction.

(3) In journal folio column (JF), areference is made to the pagenumber of the book of originalentry.

(4) The amount related to thetransaction is entered in thiscolumn.

An account is debited or creditedaccording to the rules of debit andcredit already explained in respect ofeach category of account.

Dr. Account Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount(1) (2) (3) (4) (1) (2) (3) (4)

(Rs.) (Rs.)

Fig. 3.1 : Format of an Account

58 ACCOUNTANCY

● In the ‘particulars column’ write thename of the account through whichit has been debited in the journal.For example, when X paysRs. 50,000 in cash as his capital,cash is debited and X’s capital iscredited in the journal. In theledger, cash account will debited(left hand side) by writing “X’scapital A/c” in the particularscolumn. This signifies that increasein capital has resulted by inflow ofcash into the business. In thesimilar way, capital account will becredited (right hand side) by writing‘Cash A/c’ in the particularscolumn to signify that cashcontribution has been made to raisethe capital (owners’ equity)

● Enter the page number of the journalin the J.F. column and write the pagenumber of the ledger where the entryis posted in the L.F. column injournal (you may recall this columnwas left blank when entry wasoriginally recorded in the journal).

● Enter the amount in the relevantamount column (debit or credit).

It may be noted that the sameprocedure is follow for entering creditentries in the ledger. An account isopened only once in the ledger and theentries relating to a particular accountare posted on the debit or credit side,as the case may be.

Illustration 5

Transactions journalized earlier on page55 (Illustration 4) are posted in theledger in various accounts as givenbelow: (J.F. numbers have been omitted)

3.5.3 Classification of Ledger AccountsWe have seen earlier that all ledgeraccounts are put into five categories,viz., assets, liabilities, capital, revenuesand expenses. All permanent accountsare balanced and carried forward tothe next accounting period. Thetemporary accounts are closed at theend of the accounting period bytransfer to the Trading and Profit LossAccount. All permanent accounts willappear in the Balance Sheet. Thus, allassets, liabilities and capital accountsare permanent accounts and allrevenues and expenses accounts aretemporary accounts. This classifi-cation is also relevant for preparingfinancial statements.

3.6 Posting from JournalPosting is the process of transferringentries from books of original entry tothe ledger. In other words, postingmeans grouping of all the transactionsin respect to a particular account atone place for meaningful conclusionand to further the accounting process.Posting may be done daily, weekly,fortnightly or monthly, according to theconvenience and requirements of thebusiness. The complete process ofposting from the journal to the ledgerhas been discussed below:

● Locate the account to be debited orcredited in the ledger as entered inthe journal.

● If an account is to be debited/credited, enter the date of thetransaction in the date column onthe debit/credit side.


Solution

BOOKS OF GAURAVCash Account

Dr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount2002 (Rs.) 2002 (Rs.)

April Gourav’s 4,00,000 April 2 Bank 3,00,0001 Capital18 Sales 23,800

Bank AccountDr. Cr.


April 2 Cash 3,00,000 April 1 Furniture 48,00022 Hira Lal 18,000 8 Inventory 76,000

15 Honest Traders 36,00026 Honest Traders 20,000

Inventory AccountDr. Cr.


April 8 Bank 76,000 April Cost of goods 14,20010 Honest Traders 56,000 12 sold

18 Cost of goods 19,000sold

Sales AccountDr. Cr.


April12 Hira Lal 18,00018 Cash 23,000

Cost of Goods Sold AccountDr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount2002 (Rs.) (Rs.)

April12 Inventory 19,80018 Inventory 14,200

60 ACCOUNTANCY

Honest Traders Account

Dr. Cr.


April April15 Bank 36,000 10 Inventory 56,00026 Bank 20,000

Hira Lal’s Account

Dr. Cr.


April April12 Sales 18,000 22 Bank 18,000

Furniture Account

Dr. Cr.


April3 Bank 48,000

3.7 Special Purpose Books

The process of recording thetransactions in the journal and thenposting to ledger accounts, asexplained above, requires each andevery transaction to be recorded firstand then posted to ledger accounts. Ifwe try to analyze the transactions, wemay find that more than 95 per centof the transactions relate to cash(bank), purchase, sales, purchasereturns, sale returns, bills receivedand bills accepted. Since these fewtypes of transactions constitute bulk

of the total transactions, we can savetime and efforts by recording them inseparate books rather than firstrecording in the journal and thenindividually posting to ledger accountseach entry separately. The booksmaintained to record thesetransactions separately are calledspecial purpose journal or day books.In the following paragraphs, we willdiscuss these special purpose books.

3.7.1 Cash BookCash book is used to record thosetransactions that involve either receipt


or payment of cash. It serves thepurpose of journal as well as ledger(cash) account. Since cash book isconsidered as book of original entry,cash transactions are recorded in cashbook and not in the journal. Since it isalso a ledger account, posting to cashaccount is not required. This impliesthat for all the transactions recordedin cash book, only one posting isrequired, unlike in case of entriesrecorded in journal, where twopostings are required.

The amount column in the cashbook may be more than one dependingupon the needs of the organization. Ifthe organization has only cashtransactions, cash book with singleamount column on either side ismaintained. This is usually referred toas ‘simple cash book’. However, this isa remote possibility in today’s world,where we can think even of personaltransactions purely in cash becauseof security and legal considerations thetransactions have to be routed throughbanking system. This requires additionof one more amount column on thatcash and bank transaction may

be recorded separately andsimultaneously.

● Simple Cash BookWhen all receipts and paymentsare in cash only, the cash bookcontains only one column oneach (debit and credit) side. Itis called simple cash book orsingle column cash book. Aformat of simple cash book isgiven in (Fig. 3.2).

Illustration 6 : Record the followingtransactions in cash book:

April 2002

1 Gurdev Singh bringsRs. 5,00,000 into business ascapital

2 Purchased land & building forRs. 3,50,000 (land Rs. 1,30,000and buildings Rs. 2,20,000)

13 Purchased furniture for cashRs. 5,000

18 Purchased inventory for CashRs, 20,000

19 Purchased personal Computerfor Cash Rs, 30,000

30 Opened bank A/c by depositingRs. 20,000

.

Page_______

Dr. Receipts Payments Cr.

Date Particulars L.F. Amount Date Particulars L.F. Amount (Rs.) (Rs.)

Fig. 3.2 : Format of Simple Cash Book

62 ACCOUNTANCY

Solution

CASH BOOK OF GURDEV SINGHPage ______


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

2001 (Rs.) 2001 (Rs.)April Gurdev’s 5,00,000 April1 Capital 2 Land 1,30,000

2 Buildings 2,20,00013 Furniture 5,00018 Inventory 20,00030 Computer 30,00030 Bank 20,000April Balance c/f 75,00030

Total 5,00,000 Total 5,00,000

Note: Explanation for each transaction and documentary evidence is recorded, thoughomitted here.

● Double Column Cash BookIn the above illustration,Rs. 20,000 were deposited in thebank on 30 April 2001. This isto be noted that this transactionis a banking transaction. Solong as, we don’t have multipletransactions with the bank,single cash book will suffice.However, the real life is different.We have more transactionsthrough the bank whichrequires the ascertainment ofcash position both, in hand andat bank, this necessitates theaddition of one more column oneither side in the cash book tofacilitate the recording ofbanking transactions of thebusiness. A businessmangenerally opens an account witha bank which may either besavings bank account (in case

of proprietary business, currentaccount) or a term depositaccount. Usually a business-man prefers to maintain acurrent account which providesthe facility of routing the largevolume of transactions. In thecurrent account, a customercan deposit and withdrawmoney without any restriction.Banks do not allow any intereston the balance in currentaccount but charge a smallamount, called bank charges,for the services rendered.

For depositing cash/cheques in thebank account, a voucher (pay-in-slip)has to be filled up, which is availablefrom the bank. It contains a counterfoilwhich is returned to the customer(depositor) with the signature of thecashier, as a receipt. The bank issues


blank cheque forms usually free ofcharge up to a certain limit, to theaccount holder for withdrawing money.The depositor writes the name of theparty to whom payment is to be madeafter the words ‘pay’ printed on thecheque. Cheque forms have theprinted word ‘bearer’, which meanspayment is to be made to the person

whose name has been written after thewords ‘pay’ or the ‘bearer’ of thecheque. When the word ‘bearer’ isstruck off by drawing a line, the chequebecomes an order cheque. It meanspayment is to be made only to theperson whose name is written on thecheque or to his order after properidentification.

Date ....................

Pay.............................................................................................................................

...............................................................................................................OR BEARER

RUPEERS ................................................................................ Rs.

A/c No L.F INTLS

STATE BANK OF INDIA N.C.E.R.T, NEW DELHI - 110 016 MSBL/221

||”556242||” 110002078||: 10

Fig. 3.3 : Format of a cheque

Fig. 3.4 : Format of Pay-in-slip

cpr [kkrk tek iphZ [email protected] BANK PAY-IN-SLIP CASH/TRANSFER

Hkkjrh; LVsV cSad@STATE BANK OF INDIA

'kk[kk [kkrk Ø-......................BRANCH A/C NO.

fnukad/DATE .................................... 20FOR THE CREDIT OF THESAVINGS BANK ACCOUNT OF ...........................................................

..............................................osQ cpr [kkrs esa tek djus osQ fy,A

jksdM+@pSdksa dk fooj.k jkf'k/AMOUNT

DETAILS OF CASH/CHEQUES #-/Rs. iS-/P.

#- 'kCnksa esa@Rs, IN WORDS

jksdM+ vf/dkjh@ jksdfM+;k ikldÙkkZ vf/dkjh@ CASHIER CASH OFFICER/ #-@Rs.

PASSING OFFICER

fVIi.kh&varj.k fy[krksa dks olwyh osQ ckn tek fd;k tk;sxkANOTE-Transfer Instruments will be credited after realisation.

fVIi.kh% Ñi;k udn] cSad ij vkgfjr fy[krksa lek'kks/u fy[krksa vkSj vU; LFkkuksa osQ fy[krksa osQ fy, vyx ifpZ;ksa dk iz;ksx djsa ANOTE: Use separate slips for depositing cash, instruments drawn on bank, clearing instruments and outstation instruments.

cpr [kkrk tek iphZ Hkkjrh; LVsV cSad [email protected] BANK PAY-IN-SLIP STATE BANK OF INDIA CASH/TRANSFER

'kk[kk fnukad ..........................................BRANCH DATE ..........................20

FOR THE CREDIT OF THE [kkrk cgh [kkrk Ø-SAVINGS BANK ACCOUNT OF ........................................................... LEDGER ACCOUNT NUMBER

..............................................osQ cpr [kkrs esa tek djus osQ fy,A

vnkdÙkkZ cSad 'kk[kk pSd Ø- jksdM+@CASH jkf'k/AMOUNT

DRAWN ON BANK BRANCH CHEQUE NO. uksV@NOTES #-/Rs. iS-/P.

#- 'kCnksa esa@Rs, IN WORDS

jksdfM+;[email protected] jksdfM+;k jksdM+ vf/dkjh@ lwph cgh tekdÙkkZ osQ oqQy #-/Total Rs.

lkj.kh Ø- CASHIER ikldÙkkZ vf/dkjh@ Ø- gLrk{kjCASHIER'S/ CASH OFFICER/ JOTTING DEPOSITED BYTRANSFER PASSING BOOK NO. (SIGNATURE)

SCROLL NO. OFFICER

fVIi.kh&varj.k fy[krksa dks olwyh osQ ckn tek fd;k tk;sxkA NOTE-TRANSFER INSTRUMENTS WILL BE CREDITED AFTER REALISATION.

X500X100X50

X20X10X5X2X1

flDosQ/Coins

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vkjú

,iQ@R

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980

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- 51

003

64 ACCOUNTANCY

“A/c Payee only”. A bearer cheque canbe passed on by mere delivery. An ordercheque can be transferred byendorsement and delivery. Endor-sement means the writing of instructionsto pay the amount of the cheque to aparticular person and then signing it.This is done on the back of the cheque.

When the number of banktransactions is large, as discussedearlier, it is better if transactions relatingto both, cash and bank, are recorded inthe same cash book. Similar to cashtransactions, all bank receipts arerecorded on the left side of the cash bookunder bank column. Payments throughbank are recorded on the right side ofthe cash book under bank column.Contra Transactions It is a transactionwhich is recorded on both sides of thecash book but in different columns. Cashdeposited in bank is recorded on thereceipts (debit) side of bank column andpayments on (credit) side of cash column.When cash is withdrawn from the bankfor business purposes, the transactionis recorded on receipts (debit) side underthe cash column and payments (credit)side under the bank column. Thus,whenever for business purposes, thecash is deposited into or withdrawn fromthe bank, both aspects of thetransaction are recorded in the cashbook itself. These being contra entries,the word ‘c’ is written in the L.F. columnindicating that these entries are not tobe posted to any other ledger account.

When a cheque is received, it maybe deposited into the bank on the sameday or it may be deposited on anotherday. In case it is deposited on the same

Cheques are generally crossed inpractice. The payment of a crossedcheque cannot be made direct to theparty on the counter. It is to be paidonly through a bank. A cheque is saidto be crossed when two paralleltransverse lines are drawn across thecheque. The following are the varioustypes of crossing providing differentdegrees of safety to the payment.

Fig. 3.5 : Crossing of Cheque

In case of an ‘A/c Payee only”crossing, the amount of the cheque canbe deposited only in the account of theperson whose name appears on thecheque. It is called general crossing.When the name of the bank is writtenbetween two parallel lines, it becomesa special crossing and the payment canbe made only to the bank whose namehas been specified.

A cheque can be transferred by thepayee (the person in whose favour thecheque has been drawn) to anotherperson, (not very common throughpractice in real life) if it is not crossed as

& C

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Not N

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iable

A/c Pa

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Stat

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ia


day the amount is recorded in the bankcolumn of the cash book on thereceipts side. If the cheque is depositedon another day, in that case, on thedate of receipt it is treated as cashreceived and hence recorded in thecash column on receipts side. On thedate of depositing the cheque into thebank, entry for deposit will be passed,i.e. the amount will be recorded on thereceipts side in bank column and onthe payments side in the cash column.This is a contra entry.

If a cheque is dishonoured andintimated, the bank will return thedishonoured cheque, and debit thefirm’s account. On receipt of suchcheque/intimation from the bank, thefirm should make an entry on thecredit side of the cash book by enteringthe amount of the dishonoured chequein the bank column and the name ofthe party (from whom the cheque wasreceived) in the particulars column.This entry will restore the positionprevailing before the receipt of the

cheque from the party and its depositin the bank. Dishonour of a chequemeans return of the cheque unpaid,generally due to insufficient funds inthe party’s account with the bank.

If the bank debits the firm onaccount of interest, commission orother charges for bank services, theentry will be made on the credit sidein bank column. If the bank creditsthe firm’s account for direct collectionof interest, dividends, etc. the entry willbe made on the receipts (debit) side ofthe cash book in the bank column.

The bank column is balanced inthe same way as the cash column.However, in the bank column, theremay be credit balance also because ofoverdraft taken from the bank.Overdraft is a situation when cashwithdrawn from the bank exceeds theamount of cash deposited. The formatand entries in the two-column cashbook are illustrated below:

Illustration 7

Enter the following transactions in the double column cashbook of Mr. RakeshKhurana and balance it.

2002 AmountMay (Rs.)1 Opening balance: Cash in hand 8,500

Cash at bank 27,5002 Paid to petty cashier 5,0002 Sold goods for cash 3,5002 Paid to Mr. Arup Ghosh by cheque 7,5003 Received cheque from Mr. Robert 9,0006 Received cheque from Mr. Javed 12,0008 Purchased goods for cash 5,0008 Paid rent by cheque 5,0009 Withdrew cash from bank 5,000

66 ACCOUNTANCY

10 Sold goods for cash 7,50015 Purchased stationery for cash 2,00020 Sold goods for cash 13,50021 Deposited cash in bank 20,00024 Withdrew cash for personal use 3,00031 Paid salaries by cheque 18,000

SolutionCash Book (Double Column-Cash and Bank) of Mr. Rakesh Khurana


Date Particulars L.F. Cash Bank Date Particulars L.F. Cash Bank2002 Amount Amount Amount Amount

(Rs.) (Rs.) (Rs.) (Rs.)

May 1 Balance b/f 8,500 27,500 May 2 Petty cash 5,0002 Sales 3,500 2 Mr. Arup Ghosh 7,5003 Mr. Robert 9,000 8 Purchases 5,0006 Mr. Javed 12,000 8 Rent 5,0009 Bank C 5,000 9 Cash C 5,00010 Sales 7,500 15 Stationery 2,00020 Sales 13,500 21 Bank C 20,00021 Cash C 20,000 24 Rakesh’s 3,000

drawings31 Salaries 18,000

Balance c/f 3,000 33,00038,000 68,500 38,000 68,500

1 July Balance b/f 3,000 33,000

Note: Receipt/Voucher numbers have been omitted.

3.7.3 Petty Cash Book

In every organization, a large numberof small payments, such as, forconveyance, cartage, postage,telegrams and other expenses(collectively recorded undermiscellaneous expenses) are made.These are generally repetitive innature. If all these payments arehandled by the cashier and arerecorded in the main cash book, theprocedure is found to be verycumbersome. The cashier may beoverburdened and the cash book maybecome very bulky. To avoid this, large

organizations normally appoint onemore cashier (petty cashier) andmaintain a separate cash book torecord these transactions. Such a cashbook maintained by petty cashier iscalled petty cash book.

The petty cashier works on theimprest system. Under this system, adefinite sum, say Rs. 5,000, is givento the petty cashier at the beginningof a certain period. This amount iscalled imprest money. The pettycashier goes on making all smallpayments out of this imprest amount,and when he has spent the substantialportion of the imprest amount say


Rs. 4,780, he gets reimbursement ofthe amount spent from the maincashier. Thus, he again has the fullimprest amount in the beginning of thenext period. The reimbursement maybe made on a weekly, fortnightly ormonthly basis, depending on thefrequency of small payments. Incertain cases, the petty cash systemis operated through the main cashbook itself. In such instances, the pettycash book is not maintainedindependently.

The petty cash book generally hasa number of columns for the amounton the payment side (credit) besidesthe first total amount column. Eachof the other amount columns isallotted for items of specific payments

which are most common. The lastamount column is designated as‘Misce-llaneous’ followed by a‘Remarks’ column. In themiscellaneous column thosepayments are recorded for which aseparate column does not exist. In theremarks column the nature of paymentis recorded. At the end of the period,all amount columns are totaled. Thetotal amount column will show thetotal amount spent and to bereimbursed. On the receipt (debit) side,there is only one amount column.Columns for the date, voucher numberand particulars are common for bothreceipts and payments. The format andentries in the petty cash book areillustrated below:

Amount Date Voucher Particulars Total Postage Cartage Refreshments Misc. RemarksReceived No. Amo- Ex-

unt pense

Rs. Rs. Rs. Rs. Rs. Rs.

Fig.3.6 : Format of peatty cash book

Illustration 8

A petty cashier is paid Rs. 3,000 as imprest money on Monday, January 1,2002. During the month his expenses were as under:

January Voucher Particulars of Payment AmountNo. (Rs.)

1 1 Taxi fare for manager 1252 Courier charges for the letters dispatched 753 stationery purchased 1854 Cartage 455 Refreshments 95

4 6 Courier charges 507 Cartage 35

68 ACCOUNTANCY

January Voucher Particulars of Payment AmountNo. (Rs.)

8 taxi fare 1859 Refreshments 175

11 10 Taxi fare 15011 Revenue stamps purchased 5012 Cartage 4513 Refreshments 115

18 14 Conveyance 8515 Refreshments 12516 Stationery 125

25 17 Taxi fare 14518 Cartage 9519 Courier charges 7520 Refreshments 65

31 21 Courier charges 4522 Refreshments 7523 Office cleaning expenses 175

Record the above transactions inthe petty cash book (see solution onpage 69).

3.7.4 Balancing of Cash Book

On the left side, all cash transactionsrelating to cash receipts (debits) andon the right side, all transactionsrelating to cash payments (credits) areentered date-wise. When a cash bookis maintained, a separate cash accountin the ledger is not opened. The cashbook is balanced in the same way asan account in the ledger. But it maybe noted that cash book will alwaysshow debit balance since cashpayments can never exceed cashavailable (opening balance of cash plusreceipts during the period).

The source document for cashreceipts is generally the receipt issued

by the cashier. For payment, anydocument, invoice, bill, receipt, etc. onthe basis of which payment has beenmade will serve as a source documentfor recording transactions in the cashbook. When payment has been made,all these documents, popularly knownas vouchers, are given a serial numberand filed in a separate file for futurereference and verification.

3.8. Posting from Cash Book

The left side of the cash book showsreceipts of cash in the cash column oramount deposited in the bank in thebank column from various sources. Allthose accounts through which cash/bank has been debited are opened inthe ledger.

All the accounts appearing on thedebit side of the cash book are credited


70 ACCOUNTANCY

because cash/cheque has beenreceived in respect of them. Thus, ifon the debit side of the cash book, anentry ‘sales Rs. 3,500’ appears, itmeans that goods have been sold forcash. Therefore, in the ledger, salesaccount will be credited by writing,‘Cash Rs. 3,500’ in the relevantcolumns.

The right side of the cash bookshows all the payments made in thecash or through the bank indicatingitems of payment which are to be postedin the respective account by writing‘cash/bank A/c’ in the particularscolumn on the left hand side.

It may be noted that the cash bookserves the purpose of ledger, for cashand bank transactions. Therefore,cash bank account are not opened inthe ledger. All entries marked ‘C’(being contra entries as explained

earlier) are ignored while posting fromthe cash book to the ledger. Theseentries represent debit and creditaspect in the cash book itselfsignifying the completion of doubleentry process.

Posting from the petty cash bookis made at the end of the month. Totalsof various expense columns including‘miscellaneous column’ of the pettycash book are posted to the debit sideof the concerned ledger accounts onthe last day of the month as sundries,indicating that all petty amounts forthe month have been put together. Theledger folio number is written for everytotal expense amount to indicate thatthe entry has been posted in the ledger.In the J.F. column of the ledgeraccount, the page number of the pettycash book is written for cross/futurereference purposes.

Illustration 9

Post the transactions recorded in the double column cash book appearing onpage 66 at illustration 7


Date Particulars J.F. Amount Date Particulars J.F. Amount (Rs.) 2002 (Rs.)

May 2 Cash 3,500 10 Cash 7,500 20 Cash 13,500

Arup Ghosh AccountDr. Cr.


May 2 Bank 7,500


Purchases AccountDr. Cr.


May 8 Cash 5,000

Robert AccountDr. Cr.


May 3 Bank 9,000

Javed AccountDr. Cr.


May 6 Bank 12,000

Stationery AccountDr. Cr.


May Cash 2,00015

Rent AccountDr. Cr.


May 18 Bank 5,000

Rakesh’s Drawings AccountDr. Cr.


May Cash 3,00024

Petty Cash AccountDr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount (Rs.) (Rs.)

May 2 Cash 5,000

72 ACCOUNTANCY

Salaries AccountDr. Cr.


May Bank 18,00031

3.9 Other Day Books

When there are large number oftransactions of the similar type, thefirm can maintain a special journal forrecording transactions of similarnature in one book only. In that case,transactions of repetitive nature suchas purchases, sales, purchasesreturns, sales returns are recorded inspecial journals and the remainingtransactions are recorded in thejournal called the general journal.Special journals are also called daybooks.

Special journals are explainedbelow. (Cash book has already beenexplained).

3.9.1 Purchases Journal (Book)

All credit purchases of merchandiseare recorded in the purchases journal,cash purchases are recorded in thecash book. Other purchases such aspurchase of office equipment,furniture, building, are recorded in thegeneral journal if purchased on creditor in the cash book if purchased forcash. The source documents forrecording entries in the books ofaccounts are invoices or bills receivedby the firm from the suppliers of thegoods. Entries are made with the netamount of the invoice. Trade discountand other details of the invoice need

not be recorded in this book. Theformat of the purchases journal is thesame as that of the general journalexcept that one more column (credit)for the invoice number is added afterthe date column, while one amountcolumn is deleted. The monthly totalof the purchases book is posted to thedebit of Purchases Account in theledger. Posting to the credit side ofindividual suppliers’ account may bemade daily.

The format and preparation of thepurchases journal with imaginaryentries is illustrated below:

Illustration 10

Record the following transactions inthe purchases journal

Date Transactions2002 Purchased from BrightApril1 Enterprises, 1000 kg. of

chemical ‘X’ @ 28.4 per kg.

7 Purchased from Ali Brothers, 200kg. of chemical ‘Y’ @ Rs. 25 perkg. and 500 kg. of chemical ‘Z’ @Rs. 60.4 per kg.

14 Purchased from Robert Stores,100 kg. of chemical ‘X’ @ Rs. 28.4per kg., 200 kg. of chemical ‘Z’ @Rs. 60.4 per kg. and 100 kg. ofchemical ‘M’ @ Rs. 39.8 per kg.

15 Purchased from Nathan Traders,


Solution

Purchases Journal

Date Particulars Voucher L.F. Details AmountNo. (Rs.) (Rs.)

1.4.02 M/s Bright Enterprises vide invoiceNo…… 1000 kg. of chemical ‘X’ @ 28.4 28,400 28,400per kg.

7.4.02 M/s Ali Brothers vide invoiceNo….. 200 kg. of chemical ‘Y’ @ Rs. 25 5,000per kg. 500 kg. of chemical ‘Z’ @ Rs. 60.4 30,200 35,200per kg.

14.4.02 M/s Robert Stores vide invoiceNo….. 100 kg. of chemical ‘X’ @ Rs. 28.4 2,840per kg. 200 kg. of chemical ‘Z’ @ Rs. 60.4 12,080per kg. 100 kg. of chemical ‘M’ @ Rs. 39.8 3,980 18,900per kg.

15.4.02 M/s Nathan Traders vide invoiceNo….. 50 kg. of chemical ‘W’ @ Rs. 31.6 1,580per kg. 800 kg. of ‘X’ @ 28.4 per kg. 22,720 24,300

18.4.02 M/s Hazi Traders vide invoiceNo……. 500 kg. of chemical ‘W’ @ Rs. 31.6 15,800 15,800per kg.

21.04.02 M/s Narain Brothers vide invoiceNo……. 248 kg. of chemical ‘Y’ @ Rs. 25 6,200per kg. 500 kg. of chemical ‘X’ @ Rs. 28.4 14.200 20,400per kg.

Total 1,43,000

50 kg. of chemical ‘W’ @ Rs. 31.6per kg. and 800 kg. of ‘X’ @ 28.4per kg.

18 Purchased from Hazi Traders 500kg. of chemical ‘W’ @ Rs. 31.6 per kg.

21 Purchased from Narain Brothers248 kg. of chemical ‘Y’ @ Rs. 25per kg. and 500 kg. of chemical‘X’ @ Rs. 28.4 per kg.

74 ACCOUNTANCY

Posting from the Purchases DayBook

Posting to suppliers accounts is donedaily to their respective accounts withthe relevant amounts on the credit sideby writing ‘Purchases A/c” in theparticulars column.

The total of the purchases DayBook is periodically posted to the debitof the purchases account as ‘sundries’,

normally on a monthly basis. However,if the number of transactions is verylarge, the total may be done and postedat some other convenient time intervalsuch as daily, weekly or fortnightly.

Illustration 11

Post the transactions recorded in thepurchases journal as given inIllustration 10 on page 73.

The above entries are posted into the ledger account of individual supplies as under:

Bright Enterprises AccountDr. Cr.


April 1 Purchases 28,400

Ali Brothers AccountDr. Cr.



Robert Stores AccountDr. Cr.



Solution:



April 1 Sundries 1,43,000


Nathan Traders AccountDr. Cr.



Hazi Traders AccountDr. Cr.



Narain Brothers AccountDr. Cr.



3.9.2 Sales Journal (Book)

All credit sales of goods are recorded inthe sales journal. The format of thesales journal is similar to that of thepurchases journal explained earlier.The source documents for recordingentries in the sales journal are salesinvoices or bills issued by the firm. Thedate of sale, invoice number, name ofthe customer and amount of the invoiceare recorded in the sales journal. Otherdetails about the sales transactionincluding terms of payment areavailable in the invoice. In fact, two or morethan two copies of a sales invoice areprepared for each sale. The book keepermakes entries in the sales journal fromone copy of the sales invoice. Periodically,at the end of each month the amountcolumn is totaled and posted to the creditof sales account in the ledger. Postingto the debit side of individual custo-mers’ accounts may be made daily.

The format and preparation of thesales journal is illustrated:

Illustration 12

Record the following transactions inthe sales journal:

Date Transactions

2002 Sold to Sunaina TradingApril 2Company, 20 musical alarm

clocks @ Rs. 150 per piece and15 wall clocks @ Rs. 70 per piece

3 Sold to Asha Enterprises, 20wall clocks @ Rs. 70 per pieceand 20 deluxe wall clocks @Rs. 105 per piece.

5 Sold to Mehboob Stores, 20economy alarm clocks @Rs. 60 per piece and 13super -deluxe wall clocks @Rs. 200 per piece.

11 Sold to Ram Prakash & Co., 30wall clocks @ Rs. 70 per piece

76 ACCOUNTANCY

Solution

Sales Book (Journal)

Date Particulars Invoice L.F. Details Amount2000 No. (Rs.) (Rs.)

Apr 2 M/s Sunaina Trading Co. 20 musical alarm clocks @ 3,000 Rs. 150 per piece 15 wall clocks @ Rs.. 70 per piece 1,050 4,050

Apr 3 M/s Asha Enterprises 20 wall clocks @ Rs. 70 per piece 1,400 20 deluxe wall clocks @ Rs.. 105 per piece 2,100 3,500

Apr 5 M/s Mehboob Stores 20 economy alarm clocks @ Rs. 60 1,200 per piece 13 super-deluxe wall clocks @ Rs.. 200 2,600 3,800 per piece

Apr 11 M/s Ram Prakash & Co. 30 wall clocks @ Rs.. 70 per piece 2,100 2 super-deluxe wall clocks @ Rs. 200 400 2,500 per piece

Apr 14 M/s Dorjee & Co. 20 wall clocks @ Rs. 70 per piece 1,400 17 super-deluxe wall clocks @ Rs. 200 3,400 4,800 per piece

Apr 27 M/s John & Co. 30 economy alarm clocks @ Rs. 60 1,800 per piece 2,400 4,200 16 musical alarm clocks @ Rs. 150 per piece

Total 22,850

and 2 super-deluxe wall clocks@ Rs. 200 per piece

14 Sold to Dorjee & Co., 20 wallclocks @ Rs. 70 per piece and 17super-deluxe wall clocks @Rs. 200 per piece

27 Sold to John & Co., 30 economyalarm clocks @ Rs. 60 per pieceand 16 musical alarm clocks @Rs. 150 per peice

Posting from the Sales JournalFrom the sales journal, entries are postedto the debit of customers’ accounts keptin the ledger on daily basis. The salesjournal is totaled generally on monthlybasis, and the total is credited to salesaccount accordingly. However, dependingupon the need, the sales journal may betotaled more frequently, say on weeklyor fortnightly basis.


Illustration 13

Post the transactions recorded in the sales journal in Illustration 12 onpage 76.



April Sundries 22,850

Sunaina Traders’ AccountDr. Cr.


Apr 2 Sales 4,050

Asha Enterprises AccountDr. Cr.


Apr 3 Sales 3,500

Mehboob Stores AccountDr. Cr.


Apr 5 Sales 3,800

Ram Prakash & Company AccountDr. Cr.


Apr 11 Sales 2,500

Dorjee & Company AccountDr. Cr.


Apr 14 Sales 4,800

John & Company AccountDr. Cr.


Apr 27 Sales 4,200

78 ACCOUNTANCY

3.9.3 Purchases Returns Journal (Book)

In this book, goods returned tosupplier and recorded. Sometimes,goods purchased are returned to thesupplier for various reasons such as,the goods are not of the requiredquality, or are defective, etc. For everyreturn, a debit note (in duplicate) isprepared. The original note is sent tothe supplier for making necessaryentries in his book and the duplicatecopy is retained.. The supplier mayalso prepare a note which is called thecredit note. The source document forrecording entries in the purchasesreturns journal is generally a debitnote. A debit note will contain thename of the seller (to whom the goodshave been returned), details of thegoods returned and the reason forreturning the goods. Each debit note

is serially numbered and dated. Theformat of the purchases returnsjournal is also similar to that of thepurchases journal. The format andpreparation of the purchases returnsjournal are illustrated below:

Illustration 14

Record the following transactions inthe purchases returns journal:

Date Transactions

2002 Returned to Bright Enterprises,Apr 3 10 kg. of chemical ‘X’ purchased on

April 1 @ Rs. 28.4 per kg.18 Returned to Ali Brothers, 5 kg. of

chemical ‘X’ purchased on April 7 @Rs. 60.4 per kg.

24 Returned to Hazi Traders, 10 kg. ofchemical ‘W’ purchased on April 18@ Rs. 3.16 per kg.

25 Returned to Narain Brothers 10 kg.of chemical ‘Y’ purchased on April21, @ Rs. 25 per kg.

Solution:

Purchases Returns Book (Journal)


Apr 3 M/s Bright Enterprises 10 kg. of chemical ‘X’ purchased on 284 284 April 1 @ Rs. 28.4 per kg.

Apr 18 M/s Ali Brothers 5 kg. of chemical ‘X’ purchased on 302 302 April 7 @ Rs. 60.4 per kg.

Apr 24 M/s Hazi Traders 10 kg. of chemical ‘W’ purchased on April 18 @ Rs. 3.16 per kg. 316 316

Apr 25 M/s Narain Brother 10 kg. of chemical ‘Y’ purchased on April 21, @ Rs. 25 per kg. 250 250

Total 1,152


Posting from the Purchases Returns(Returns Outward) JournalThe posting from the purchasesreturns journal requires that thesuppliers’ individual accounts aredebited with the amount of returnsand the purchases returns account iscredited on periodical basis, as is done

in the case of posting from the salesjournal.

Illustration 15

Post the transactions recorded in thePurchases Returns Journal inIllustration 14 on page 78.

Solution:

Purchases Returns AccountDr. Cr.


April Sundries 1,152

Bright Enterprises AccountDr. Cr.


Apr 3 Purchase 284Returns

Ali Brothers AccountDr. Cr.


Apr Purchase 30218 Returns

Hazi Traders AccountDr. Cr.



Narain Brothers AccountDr. Cr.



80 ACCOUNTANCY

3.9.4 Sales Returns Journal (Book)

This journal is used to record salesreturns from customers to whom thegoods were sold credit. On receipt ofgoods from the customer, a credit noteis prepared, like the debit note forpurchase returns referred to earlier.The difference between the credit noteand the debit note is that the formeris prepared by the seller and the latteris prepared by the purchaser. Like thedebit note, the credit note is alsoprepared in duplicate and containsdetails relating to the name of thecustomer, details of the merchandisereceived back and the amount. Eachcredit note is serially numbered anddated. The source document forrecording entries in the sales returnsbook is generally the credit note. The

format of the sales returns journal issimilar to that of the purchases returnjournal.

The format and preparation of thesales returns journal are illustratedbelow:

Illustration 16

Record the following transactions inthe Sales Returns journal

Date Transactions

2002 Returned by Sunaina TradingApril Co. 2 musical alarm clocks sold8 on April 3 @ Rs. 150 per piece11 Returned by Mehboob Stores,

3 economy alarm clocks sold onApril 11 @ Rs. 60 per piece

14 Returned by Ram Parkash & Co.4 wall clocks sold on April 11 @Rs. 70 per piece.

Solution:

Sales Returns Book (Journal)


April 8 M/s Sunaina Trading Co. 2 musical alarm clocks sold onApril 3 @ Rs. 150 per piece 300 300

11 M/s Mehboob Stores 3 economy alarm clocks sold onApril 11 @ Rs. 60 per piece 180 180

14 M/s Ram Prakash & Co. 4 wall clocks sold onApril 11 @ Rs. 70 per piece 280 280

Total 760


Posting from the Sales Returns(Returns Inward) Journal

The posting from the sales returnjournal requires that the customer’saccount be credited with the amountof returns and the sales returnsaccount be debited with the periodicaltotal in the same way as is done in thecase of posting from the purchasesjournal.

Illustration 17

Post the transactions recorded in theSales Returns Journal in illustration16 on page 80.

3.9.5 Bills Receivable Book

The sales on credit may be made onan open account system or the sellermay insist on the buyer to accept thebill for the value of goods purchased.A bill in such a case, is bill receivablefor the seller, whereas, bills payablefor the purchaser. If the bills arereceived against credit sales, the sellermay record the bills so received in aseparate book which helps in gettingthe full information about the bills. Theformat of Bills Receivable Book is givenin Fig. 3.7. We will discuss more aboutthis in the chapter on bills of exchange.

Solution

Sales Returns Account

Dr. Cr.


Apr Sundries 760

Sunaina Trading Co. AccountDr. Cr.


April 3 Sales Returns 300

Mehboob Stores AccountDr. Cr.


April 11 Sales Returns 180

Ram Parkash & Co. AccountDr. Cr.


Apr 14 Sales Returns 280

82 ACCOUNTANCY

3.9.6 Bills Payable Book

When the bills are more commonlyaccepted to acknowledge debt, it is betterto maintain the record of bills acceptedin a separate book. The format of BillsPayable Book is given in figure 3.8.

3.10 Balancing of Accounts

Accounts in the ledger are periodicallybalanced, generally at the end of theaccounting period, with the objectiveof ascertaining the precise position ofthe business firm with regard to them.

Balancing of an account meansthat the two sides are totaled and thedifference between them is insertedon the side which is shorter in orderto make their totals equal. The words‘balance c/d or c/f ’ are writtenagainst the amount of the differencebetween the two sides. The amountof balance is brought down in the next

accounting period indicating that it isa continuing account, till finallysettled or closed.

In case, the debit side exceeds thecredit side, the difference is written onthe credit side and is called a debitbalance. If the credit side exceeds thedebit side, the difference between thetwo appears on the debit side and iscalled credit balance.

The balancing of an account isillustrated below with the help of anillustration explaining the completeprocess of recording the transaction,posting to ledger and balancing theaccount.

Illustration 18

Record the following transactions inthe books of Ranganathan, post it toledger accounts and balance theaccounts.

No. Date Date From Drawer Acceptor Where Term Due Ledger Amount Cash Remarksof Received of Whom pay- Date Folio BookBill bill Received able Folio

Fig.3.7 : Format of Bills Receivable Book

No. Date To Drawer Payee Where Term Due Ledger Amount Date Cash Remarksof of bill whom payable date folio paid bookBill given folio

Fig.3.8 : Specimen of Bills Payable Book


Date Transactions

2002 Ranganathan bringsApril 1 Rs.5,00,000 as his capital.1 Deposited Rs.4,50,000 in a

newly opened bank account.2 Rented a shop by paying

security deposit of Rs.1,00,000and rent for April Rs.5,000.

10 Furniture & fittings installedfor Rs.38,000. Payment madeby cheque.

15 Purchased goods for Rs.65,000on cash, payment made by cheque.

18 Purchased goods for Rs.18,000

from Sunshine Enterprises oncredit.

21 Purchased stationery forRs.1,800 on cash

22 Paid cash Rs.1,500 for printingand distribution of pamphlets.

29 Purchased goods Rs.37,500 oncash payment made by cheque.

30 Paid Rs.6,000 for flowers,refreshments and rent forchairs on account of openingceremony.

30 Goods sold on cash forRs. 7,650.

Solution

JOURNAL


2000 (Rs.) (Rs.)

April 1 Cash a/c Dr. 5,00,000 Capital a/c 5,00,000(Ranganathan invests capital in the firm)

1 Bank a/c Dr. 4,50,000 Cash a/c 4,50,000(Cash deposited in a newly openedbank account)

2 Security Deposit a/c Dr. 1,00,000Rent Expense a/c 5,000 Bank a/c 1,05,000(paid sec. deposit & rent for current month)

10 Furniture & Fitting a/c Dr. 38,000 Bank a/c 38,000(Furniture & Fittings installed in the shop)

15 Purchases a/c Dr. 65,000 Bank a/c 65,000(purchased goods on cash)

18 Purchase a/c Dr. 18,000 Sunshine Enterprises a/c 18,000(purchased goods on credit)

Total c/f 11,76,000 11,76,000

84 ACCOUNTANCY

Total b/f 11,76,000 11,76,000

21 Stationery a/c Dr. 1,800 Cash a/c 1,800(purchased stationery on cash)

24 Advertisement Expense a/c Dr. 1,500 Cash a/c 1,500(paid for printing & dist. of pamphlets)

29 Purchases a/c Dr. 37,500 Bank a/c 37,500(purchased goods on cash)

30 Opening Ceremony Expense a/c Dr. 6,000 Cash a/c 6,000(paid expense on opening of shop)

30 Cash a/c Dr. 7,650 Sales a/c 7,650(cash sales made)

Total 12,30,450 12,30,450

Cash AccountDr. Cr.


Apr 1 Capital 5,00,000 April 1 Bank 4,50,00030 Sales 7,650 21 Stationery 1,80030 Opening cere- 6,000 24 Advertising 1,500

mony Expense Expense30 Balance c/f 48,350

5,07,650 5,07,650

Capital AccountDr. Cr.


Apr 30 Bal. c/f 5,00,000 April 1 Cash a/c 5,00,000

5,00,000 5,00,000


Bank AccountDr. Cr.


April Cash a/c 4,50,000 April 2 Security deposit 1,00,0002 Rent expense 5,000

10 Furniture & fittings 38,00015 Purchases 65,00029 Purchases a/c 37,50030 Balance c/f 2,04,500

4,50,000 4,50,000

Rent Expense AccountDr. Cr.


Apr 2 Bank a/c 5,000 April 30 Bal. c/f 5,000

5,000 5,000

Security Deposit AccountDr. Cr.


Apr 2 Bank a/c 1,00,000 April 30 Bal. c/f 1,00,000

1,00,000 1,00,000

Furniture & Fittings AccountDr. Cr.


Apr Bank a/c 38,000 April 30 Bal. c/f 38,000

110 38,000 38,000



Apr 15 Bank a/c 65,000 April 30 Bal. c/f 1,20,50018 Sunshine 18,000

Ent. a/c29 Bank a/c 37,500

1,20,500 1,20,500

86 ACCOUNTANCY

Sunshine Enterprise AccountDr. Cr.


Apr 30 Balance c/f 18,000 April 18 Purchases 18,000

18,000 18,000

Stationery AccountDr. Cr.


Apr 21 Cash 1,800 April 30 Bal. c/f 1,800

1,800 1,800

Advertisement AccountDr. Cr.



1,500 1,500

Opening Ceremony Expenses AccountDr. Cr.



6,000 6,000



Apr 3 Balance c/f 7,650 April 30 Cash 7,650

7,650 7,650

3.11 Bank Reconciliation StatementIt is generally experienced that the bankbalance shown by the cash book doesnot tally with, pass book balance orbalance shown by the statement of

account provided by the bank. Since thebalance shown by cash book is normallydifferent from the balance shown by thepass book/statement of account, thereis a need to reconcile the two balance.This is facilitated by the preparation of


cheques with the bank, itimmediately debits the bankcolumn in the cash book. Butthe bank will credit the firm’saccount only after thesecheques have been collectedthrough the clearing process.The collection generally takes afew days. In the case ofoutstation cheques, this gapmay be longer. In theintervening period this will leadto a difference between the bankbalance as shown by the cashbook and the balance shown bythe bank pass book.

● Interest credited by the bank

If the interest is credited by thebank but the advise has notbeen communicated to thecustomer, this will result intodifference because the bank hascredited the amount to thecustomers’ account but it hasnot yet been recorded in thecash book.

● Interest and expenses chargedby the bank

The bank charges interest onoverdrafts, and commission,etc., for the services rendered tothe customer. These are calledbank charges which are debitedto the customer’s account fromtime to time. But the customerwill record these in the cashbook either on receiving advicefrom the bank in this regard orwhen customer obtains updated

bank reconciliation statement (BRS).Also, there is a need to ascertain thecorrect bank balance. The traditionalbank reconciliation statement does nothelp in ascertainment of correct bankbalance. We can modify the statementto meet the twin objectives.

It is a statement prepared to showthe items of difference between theitems shown in the pass book/statement and bank column of thecash book. The causes of differencesbetween the two balances arediscussed below:

● Cheques issued but not yetpresented for paymentWhen a cheque is issued to aparty, it is immediatelyrecorded in the cash book in thebank column and will reducethe bank balance as shown inthe cash book. However, bankwill debit the firm’s accountonly when bank makes thepayment. But there is a gapbetween the issue of a chequeand its presentation to thebank. In the intervening period,there will be difference betweenthe bank balance shown by thecash book and the balanceshown by the bank pass bookon account of unpresentedcheques. This leads to differencebetween the two balances to theextent of the amount of chequesissued but not presented.

● Cheques paid into the bank butnot yet collected

When a firm deposits the

88 ACCOUNTANCY

pass book/statement. In theintervening period, the twobalances will differ.

● Credits by the bank without theknowledge of the firm

The bank, under the instructionof the customer may collectdirectly dividend/interest on theinvestments made by the firm.The bank credits the firm’saccount immediately on receiptof such amounts, but the firmwill make entries in thecashbook only after receivingintimation in this regard. Thisleads to the difference betweenthe two balances till suchamounts are recorded in thecashbook.

● Direct deposits made by parties

The debtors of the customermay directly pay in the bank.This will result in immediateincrease in the bank balance.The firm will record this onlywhen intimation in this regardis received, and thus, will leadto the difference between thetwo balances till such amountsare recorded in the cashbook.

● Direct payments made by thebank on behalf of the customer

An account holder may giveinstructions to the bank tomake certain payments such asinsurance premium, on hisbehalf. The bank will debit theparty’s account, as and when,the payment, are made, but thefirm will be able to record these

transactions in the cash bookonly when receives updatedpass book/statement.

● Dishonour of a bill discounted/cheque deposited with the bank

Occasionally, the customerdiscounts a bill of exchangebefore its maturity with thebank. If, on the due date, sucha bill is not honoured by theacceptor, the bank will debit thecustomer’s account. Thecustomer will record entries inthis regard only on receivingintimation from the bank.Similarly, if the chequedeposited is not collected by thebank, this will also lead todifference in the two balances.

● Errors and omissions

An error or omission either onthe part of the customer or thebank will cause the differencebetween the bank balanceshown by the cash book and thebalance shown by the bank passbook. A dif ference on thisground can be eliminated whenthe error/omission is detected.A cheque may be recorded twicein the bank column (once whileit was received and again whenit was deposited into the bank).This will increase the bankbalance in cash book due toerror of recording a receipttwice. A bank may, also commitan error by wrongly debitingthe customers’ account onpresentation of a cheque which


belongs to some other account.Till such errors are rectified, thetwo balances will not reconcile.

3.11.1 Need and Importance

It is essential to tally the bank balanceshown by the cash book with thebalance shown by the bank pass bookand, in case of any difference, toidentify the reasons for the difference.This is possible only by preparing abank reconciliation statement. Theimportance of this statement lies in thefact that it ensures that the bankbalance shown by the cash book isreconciled with that of the bank passbook. In the absence of a bankreconciliation statement, the customercannot be sure of the correctness ofthe bank balance depicted by the cashbook. Hence, periodic preparation ofthe bank reconciliation statement isessential.

3.11.2 Preparation of the Bank Reconciliation Statement

As already stated, the traditional bankreconciliation statement is prepared toreconcile the bank balance shown inthe cash book with the balance shownby the bank pass book. Beforepreparing the bank reconciliationstatement, items appearing in thebank pass book are checked and tickedwith the items appearing in the cashbook. All such items which remainunticked in both the books — cashbook and bank pass book — are listedaccording to the nature of theirdif ference. The first item in the

statement is the balance as per cashbook or pass book. Then theadjustments are required to be madeto this balance for the items listedabove (leading to the dif ferencebetween the two balances given in3.11). The adjusted balance if equal tothe balance as per pass book or cashbook, the two are reconciled. Followingsteps may be initiated to prepare thebank reconciliation statement:

● To prepare the BRS obtain thebalance of Cash Book and PassBook which is the first item.

● Add the cheques issued but notyet presented to the cash bookbalance.

● Subtract the cheques depositedbut not yet collected/dishonoured from the cash bookbalance.

● Add the interest credited by thebank.

● Subtract interest and expensescharged by the bank.

● Add direct collection made bythe bank.

● Add direct deposits made by thedebtors.

● Subtract direct payments madeby the bank.

● Add/subtract errors oromissions in the cash book andpass book.

Any error/omission in cash bookresulting in decrease in balance or in passbook resulting in increase in balance areadded. On the other hand, if such errors/omissions result in increase in cash bookbalance or decrease in pass book balanceare subtracted.

90 ACCOUNTANCY

Date Particulars Amount Amount(Rs.) (Rs.)

Balance as per xx or Xx1

Cash Book

Add Cheques issued but xnot yet presented

Less Cheques depositedbut not yet collected

Less Bills/cheques deposited Xbut dishonoured

Add Interest credited xby bank

Less Interest & expenses Xcharged by bank

Add Direct deposits by xcustomers

Less Direct payments Xmade by bank

Add Errors/omissions in xcash book/pass book

Less Errors/omissions in Xcash book/pass book

Balance as per pass book x1 x(Balancing Figure)

Total xx or xx

1 The bank overdraft is recorded in this column.

Fig. 3.9 : Format of Bank Reconciliation Statement

Generally, the bank reconciliationstatement is prepared after passingadjustment entries in respect of itemsrelating to errors and omissions. If thisis done, the bank reconciliationstatement will show only twocategories of items:

● cheques deposited but not yetcollected;

● cheques issued but not yetpresented for payment;

● Bank charges;● Direct payments made by bank;

and● Direct collections by bank.

The preparation of the bankreconciliation statement is illustratedbelow:

Illustration 19

The following particulars relate to thebusiness of Akram on March 31, 2002.

Amount(Rs.)

Balance as shown by 20,000cash bookBalance as shown by the 22,000bank pass bookCheques issued but not yet 8,000presented for paymentCheques deposited but not 6,000yet collected

Solution

Bank Reconciliation Statement of Akram on31 March 2002.(Starting with bank pass book balance)

Amount Amount(Rs.) (Rs.)

Balance as per 22,000bank pass book

Add: Cheques deposited 6,000but not yet collected

Less: Cheques issued but not 8,000yet presented for paymentBalance as per bank book 20,000

Total 28,000 28,000

→

→

→


Bank Reconciliation Statement of Akram on31March 2002.(Starting with cash cash balance)


Balance as per Cash book 20,000Less: Cheques deposited 6,000

but not yet collectedAdd: Cheques issued but 8,000

not yet presented forpaymentBalance as per bank 22,000pass book

Total 28,000 28,000

Illustration 20

The bank pass book of Messers Bose &Co. showed a balance of Rs. 45,000 on31 May 2002. Cheques issued before 31May 2002, amounting Rs. 25,940, hadnot been presented for encashment. Twocheques of Rs. 3,900 and Rs. 2,350 weredeposited into the bank on 31 May butthe bank gave credit for the same inJune. There was also a debit in the passbook of Rs. 2,500 in respect of a chequedishonoured on May 31. Prepare areconciliation statement as on May31, 2002.

Solution

Bank Reconciliation Statementas on 31 May 2002.


Balance as per 45,000bank pass bookAdd: Cheques deposited

before 31 Maybut credited bythe bank in JuneCheque No………… 2,350Cheque No………… 3,900

Balance c/f 51,250

Balance b/f 51,250

The amount of a 2,500cheque dishonouredand not adjusted inthe cash book

Less: Cheques issued but 25,940not yet presented before31 MayBalance as per cash book 27,810

Total 53,750 53,750

Illustration 21

On 31 March 2002, Rohan’s passbook showed a balance of Rs.48,000to your credit. On 29 March 2002,Rohan had issued chequesamounting to Rs.34,500, of whichcheques amounting to Rs.5,700 haveso far been presented for payment.A cheque for Rs.5,400 paid by Rohaninto the bank on 29 March has notyet been credited in the pass book.He had also received a cheque forRs. 3,480 which, although enteredby him in the bank column of thecash book, was not deposited in thebank. On 29 March a cheque forRs.3,750, received by him was paidinto the bank and the same wascredited by the bank in his accountbut was not entered in the cashbook. The bank credited interestamounting to Rs. 555 and debitedRs.30 for bank charges. The cashbook shows bank balance asRs. 23,805.

Draw up a reconciliation statementto reconcile the bank balance shownby Rohan’s cash book with the balanceshown by the bank pass book.

92 ACCOUNTANCY

Solution

Bank Reconciliation Statementas on 31 March 2002


Balance as per 48,000bank pass book

Add: Cheques paid in 5,400but not yet creditedby the bankCheques not banked, 3,480though entered inthe cash book

Bank charges debited 30but not adjusted inthe cash Book

Less: Cheques issued 28,800*but not presented

Cheques deposited 3,750in bank but not enteredin the cash Book

Interest credited by 555the bank but notentered in the cash book

Balance as per cash book 23,805

Total 56,910 56,910

* (cheques issued but not presented = Rs. 34,500 Rs.- 5,700 = Rs.28,800)

Illustration 22

From the following particulars, you arerequired to ascertain the bank balanceas would appear in the cash book ofM.S. Swaroop as on 31 October 2002.

1. The bank pass book showed anoverdraft of Rs. 66,000 on31 October.

2. Interest of Rs.5,000 on overdraftup to 31 October 2002, has beendebited in the bank pass book,

but it has not been entered inthe cash book.

3. Bank charges debited in the bankpass book amounted to Rs.140.

4. Cheques issued, prior to31October 2002 but notpresented till that date,amounted to Rs. 46,000.

5. Cheques paid into the bankbefore 31 October but notcollected and credited up to thatdate, were for Rs.10,000.

6. Interest on Investments collectedby the bankers and credited inthe bank pass book amountedto Rs.7,200.

Solution

Bank Reconciliation Statementas on 31 October 2002.

Amount Amount(+) (Rs.) (-) (Rs.)

Overdraft as per 66,000bank pass book

Add: Interest on overdraft 5,000debited in the passbook but not enteredin the cash book

Add: Bank charges debited 140in the pass book

Add: Cheques paid into 10,000the bank, but notyet collected bank

Less: Cheques issued 46,000but not presented

Less: Interest on investments 7,200credited by the bankbut not adjusted inthe cash book

Bank overdraft as 1,04,060per cash book

Total 1,19,200 1,19,200


3.11.3 Correct Bank Balance

Bank reconciliation statementprepared, as stated above, helps inreconciling the cash book and passbook balance. But, at the year end weneed to record the correct bankbalance in the balance sheet. BankReconciliation Statement prepared inthe traditional way does not help inthis respect, since, neither cash bookbalance nor pass book balance can betaken as the correct bank balance.There is a need to ascertain correctbank balance. Because some of thereceipts/payments may be missingfrom these books and errors if any,need to be rectified, therefore, we needto look at the entries/errors recordedin both the statements, and otheravailable information to compute thecorrect bank balance.

Since, traditional Bank Reconcili-ation helps in reconciling the twobalances only, but not in ascertainingthe correct bank balance to be reportedin the balance sheet. We need to followan approach, whereby, the twinobjectives are achieved, i.e. reconcilingfor the reason that the certaintransactions recorded by the bankhave got to be effected in the bankbalance shown by the cash book andother corrections need to be made. Ifthe correct bank balance computedfrom pass book balance and cash bookbalance is same, the reconciliation isautomatically done. For showing thecorrect bank balance, the journalentries are required to be passed formaking adjustments shown in thestatement prepared on the basis of

cash book balance. This will bring thecash book balance to the correctamount.

Steps for computing correct bankbalance

● Scrutinize the receipts recordedin the cash book to ask thequestion, whether it is actuallya receipt or not? If Yes, noadjustment is required, if no,subtract this amount from thecash book balance.

● Find out the receipts recordedin the pass book but not in thecash book and ask thequestion whether it is actuallya receipt or not? If yes, add tothe cash book balance, if no,then no adjustment isrequired.

● Scrutinize the paymentsrecorded in the cash book to askthe question, whether it isconstitutes a payment or not, ifyes, no adjustment is required,if no, add this amount to thecash book balance.

● Find out the payments recordedin the pass book but notrecorded in the cash book andask the question whether itconstitutes a payment or not, ifyes, subtract this from the cashbook balance, if no, then noadjustment is required.

● For any errors and omissions incash book, adjustment isrequired to be made whereas forerrors or omissions in pass bookno adjustment is required.

94 ACCOUNTANCY

For reconciliation, as well as,ascertainment of correct bank balanceby using the pass book balance,following steps are required:

Repeat these steps to arrive at thecorrect bank balance as per pass bookby repeating the process discussedabove by scrutinizing the entries inpass book & comparing with the cashbook. If the correct cash balancearrived at as per cash book and passbook is same, the two statements arereconciled.

Illustration 23

Reconcile the balance as per cashbook and pass book and computethe correct cash balance of M/sBose & Co. from the informationgiven in illustration 21 on page 92.

Solution

Computation of Correct Bank Balance

Particulars Amount Amount(Rs.) (Rs.)

Balance as per Pass Book 48,000

Add Cheques not yetcollected by bank 5,400

Less Cheques yet notpresented to bank 28,800Correct Bank Balance 24,600

Total 53,400 53,400


Balance as per Cash Book 23,805Add Cheque deposited

into bank but notentered in cash book 3,750

Add Interest creditedby bank 555

Balance c/f 28,110

Balance b/f 28,110

Less Cheque not yetdeposited into bankbut entered incash book 3,480

Less Bank charges 30Correct Bank Balance 24,600

Total 28,110 28,110

Since, the correct bank balance asper pass book and cash book is same,the two balances are reconciled.

Illustration 24Reconcile the balance as per cash bookand pass book and compute thecorrect bank balance of Rohan fromthe information given in Illustration 22on Page 92.

SolutionComputation of Correct Bank Balance


Balance as per Cash 1,04,060*Book (overdraft)Less Interest charged

on overdraft 5,000Less Bank charges 140Add Interest collected

by bank 7,200Correct Bank 1,02,000OverdraftTotal 1,09,200 1,09,200


Balance as per 66,000Pass Book (overdraft)Less Cheques issued but not yet 46,000

presented to bankAdd Cheques deposited 10,000

but not yet collectedCorrect Bank 1,02,000overdraft

Total 1,12,000 1,12,000* The balance of cash book is taken from the solution to Illustration 22.


Illustration 25

Journalizing & Posting of transactions andBalancing of ledger accounts.

Mr. Murli Manohar started a new business.During the first month of operations, thefollowing transactions took place.

2002 transactionsApril 1 Mr. Murli Manohar paid Rs.5,00,000

in cash as capital.

1 Deposited in Bank Rs.4,50,000.1 Paid cheque for purchase of office

equipment for Rs.60,000.2 Purchased a second hand car

Rs.1,60,000 for office use, Amountpaid by cheque.

2 Paid by cheque Rs.9,000 cash for aone-year insurance policy on the car.

8 Purchased goods on account for atotal of Rs.1,10,000.

15 Sold goods for Rs.72,000, amountreceived by cheque.

17 Paid by cheque to creditorsRs.80,000 for supply of goods.

28 Sold goods on credit for Rs.40,000.30 Cash withdrawn from bank Rs. 5,000

for personal use.30 Paid by cheque Rs.7,500 as salary to

an assistant employed on April 1,2002.

Record the transactions in the journal, postthem to ledger accounts and balance theaccounts.

Solution

Books of Murli ManoharJOURNAL


2000 (Rs.) (Rs.)

April 1 Cash a/c Dr. 5,00,000 Capital a/c 5,00,000 (Capital investment in the business)

1 Bank a/c Dr. 4,50,000 Cash a/c 4,50,000 (deposited into Bank)

1 Office equipment a/c Dr. 60,000 Bank a/c Dr. 60,000 (Purchased Office equipment for cash)

2 Office Car a/c Dr. 1,60,000 Bank a/c 1,60,000 (Purchased office car for cash)

2 Insurance for Car a/c Dr. 9,000 Bank a/c 9,000 (paid insurance premium for car for one year)

Total c/f 11,79,000 11,79,000

96 ACCOUNTANCY

Total b/f 11,79,000 11,79,000

Purchases a/c Dr. Creditors a/c 1,10,000 (Purchased goods on credit)

15 Bank a/c Dr. 72,000 Sales a/c 72,000 (Sold goods for cash)

April 17 Creditors a/c Dr. 80,000 Bank a/c 80,000 (Paid cash to creditors)

28 Debtors a/c Dr. 40,000 Sales a/c 40,000 (Sold goods on credit)

30 Drawings a/c Dr. 5,000 Bank a/c 5,000 (withdraw cash for private use)

30 Salary a/c Dr. 7,500 Bank a/c 7,500 (Paid salary)

Total 14,93,500 14,93,500

Cash Account

Dr. Cr.


Apr 1 Capital 5,00,000 Apr 1 Bank 4,50,00030 Drawing 5,00030 Bal. c/f 45,000

5,00,000 5,00,000

Capital Account

Dr. Cr.


Apr 30 Bal. c/f 5,00,000 Apr 1 Cash 5,00,000

5,00,000 5,00,000


Bank AccountDr. Cr.


Apr 1 Cash 4,50,000 Apr 1 Office 60,0002 Equipment

15 Sales 72,000 Office Car 1,60,0002 Insurance for Car 9,00017 Creditors 80,00030 Salary 7,50030 Bal. c/f 2,55,500

5,22,000 5,22,000

Office Equipment AccountDr. Cr.


Apr 1 Bank 60,000 Apr 30 Bal. c/f 60,000

60,000 60,000

Office Car AccountDr. Cr.


Apr 2 Bank 1,60,000 Apr 30 Bal. c/f 1,60,000

1,60,000 1,60,000

Insurance for Car AccountDr. Cr.



9,000 9,000



Apr 8 Creditors 1,10,000 Bal. c/f 1,10,000

1,10,000 1,10,000

98 ACCOUNTANCY

Creditors AccountDr. Cr.


Apr 17 Bank 80,000 Apr 8 Purchases 1,10,00030 Bal. c/f 30,000

1,10,000 1,10,000



Apr 30 Bal. c/f 1,12,000 Apr 15 Bank 72,00028 Debtors 40,000

1,12,000 1,12,000

Debtors AccountDr. Cr.


Apr 28 Sales 40,000 Apr 30 Bal. c/f 40,000

40,000 40,000

Drawings AccountDr. Cr.


Apr 30 Cash 5,000 Apr 30 Bal. c/f 5,000

5,000 5,000

Salary AccountDr. Cr.



7,500 7,500


Illustration 26

Reconciliation of cash book and passbook balance and ascertain of correctbank balance.

The bank balance shown by pass bookof Rustomjee Trading Company wasRs.59,280 whereas the cash book showsthe balance of cash at bank as Rs.61,890.The following differences were locatedwhile comparing the transactionsrecorded in the cash book and pass bookof Rustomjee Trading Company:

Rs.

(i) Cheques deposited but not 18,500yet collected by bank

(ii) A cheque from Fancy 4,200Stores dishonoured

(iii) A bill discounted with the 5,000bank earlier was dishonouredwhen presented on maturity

(iv) Cheques issued but not 21,500yet presented

(v) Bank charges 750

(vi) Amounts deposited by 3,800customers directlyinto the bank

(vii) Collection of interest & 1,820dividends by bank

(viii) Direct payments made by 1,780the bank

(ix) A cheque issue from 2,500personal account of Rustomjeedebited to firm’s account

(x) A cheque deposited into 3,000the bank and collected butnot recorded in the cash book

Required

● Reconcile the balance as percash book and balance as perpass book.

● Compute the correct bankbalance and reconcile the twobalances.

Solution (i)Bank Reconciliation Statement


Balance as per Cash Book 61,890i) Less Cheque deposited but not yet collected 18,500ii) Less Cheque dishonoured 4,200iii) Less Bill discounted earlier dishonoured 5,000iv) Add Cheques issued but not yet presented 21,500v) Less Bank charges 750vi) Add Direct deposits by customers into the bank account 3,800vii) Add Collection by bank 1,820viii) Less Direct payments by bank 1,780ix) Less Cheque wrongly debited to bank account 2,500x) Add Cheque deposited but not recorded in cash book 3,000

Balance as per Pass Book 59,280

Total 92,010 92,010

100 ACCOUNTANCY

Solution (ii)Computation of Correct Bank Balance


Balance as per Cash Book 61,890Less Cheque deposited but dishonoured 4,200Less Bill discounted earlier dishonoured 5,000Less Bank charges 750Add Direct deposits into the bank account 3,800Add Direct collection by bank 1,820Less Direct payments by bank 1,780Add Cheque collected by bank but not recorded 3,000

Correct bank balance 58,780

Total 70,510 70,510

Balance as per Pass Book 59,280Add Cheques deposited but not yet collected 18,500Less Cheques issued but not presented 21,500Add Cheque wrongly debited to the account 2,500

Correct Bank Balance 58,780

Total 80,280 80,280


1. Meaning of Source DocumentsVarious business documents such as invoice, bills, cash memos, vouchers, whichform the basis and evidence of a business transaction recorded in the books ofaccount are called source documents.

2. Meaning of Accounting Equation

A statement of equality between debits and credits signifying that the assets of abusiness are always equal to the total of liabilities and owner’s equity.

3. Rules of Debit and Credit

An account is divided into two sides. The left side of an account is known as Debitand the right side is known as Credit. The rules of Debit and Credit depend on thenature of an account. Debit and Credit both may represent either increase or decrease,depending on the nature of an account. These rules are summarized below:

Nature (Type) of an Account Debit Credit

Assets Increase DecreaseLiabilities Decrease IncreaseOwner’s equity (Capital) Decrease IncreaseRevenues Decrease IncreaseExpenses Increase Decrease


4. Description of Double Entry Book KeepingA system of accounting in which every transaction is recorded considering the debitand credit aspect. In this system of accounting every transaction affects at leasttwo accounts on the opposite sides.

5. Meaning of Books of Original EntryThose books in which a transaction is recorded for the first time from a sourcedocument. The following are the important books of original entry:

● Journal – Basic book of original entry.● Cash Book – A book used to record cash receipts and payments.● Petty Cash Book – A book used to record small cash payments.● Purchases Journal (Book) – A special journal (day book) in which only credit

purchases are recorded.● Sales Journal (Book) – A special journal (day book) in which only credit

sales are recorded.● Purchases Returns Journal (Book) – A special journal (day book) in which

returns of merchandise purchased on credit are recorded.● Sales Returns Journal (Book) – A special journal (day book) in which returns

of merchandise sold on credit are recorded.● Bills Receivable Book – A special book to record detailed infor-mation relating

to bills received.● Bills Payable Book – A special book to record the detailed information about

bills accepted.

6. Meaning of LedgerA book containing all the accounts to which entries are transferred from the booksof original entry.Posting – A process of transferring entries from books of original entry to the ledger.Balancing of account – Ascertaining the balance of an account after totaling all thedebits and credits for a given period.

7. Meaning of Bank Reconciliation StatementA statement prepared to reconcile the bank balance as per cash book with thebalance as per bank pass book or statement, by showing the items of differencebetween the two accounts.

8. Correct Bank Balance

TERMS INTRODUCED IN THE CHAPTER

Source document Day booksAccounting equation Purchases journalDebit Sales journalCredit Purchases returns journalAccount Sales returns journalDouble entry book keeping LedgerBooks of original entry PostingJournal Balancing of accountCash book Bank reconciliation statementPetty cash book

102 ACCOUNTANCY

EXERCISES

Multiple Choice Questions

1. The journal is a book of:(i) Only cash transactions(ii) Original entry(iii) Credit sales and purchases(iv) Secondary entry

2. The ledger is a book of:(i) Original entry(ii) Secondary entry(iii) All Cash transactions(iv) Petty cash transactions

3. The purchases journal contains:(i) All purchases(ii) All purchases of merchandise(iii) Credit purchase of merchandise(iv) Cash purchase of merchandise

4. Which of the following is correct?(i) Capital = Asset + Liabilities(ii) Assets = Liabilities - Capital(iii) Liabilities = Capital + Assets(iv) Capital = Assets - Liabilities

5. Recording of transaction in the journal is called:(i) Posting(ii) Journalizing(iii) Tallying(iv) Casting

6. Writing of transactions in the ledger is called:(i) Costing(ii) Balancing(iii) Journalizing(iv) Posting

7. When a firm maintains a cash book, it need not maintain:(i) Sales journal(ii) Purchases journal(iii) General journal(iv) Cash account in the ledger


8. The source document for recording entries in the purchases returns journalis generally:

(i) A credit note(ii) An invoice(iii) A bill(iv) A debit note

9. Double Column Cash Book records:(i) Only cash transactions(ii) All transactions(iii) Cash purchase and cash sales transactions(iv) Cash and bank transactions

Fill in the Blanks

1. The source documents provide information about the nature of the __________and the _____________ involved in it.

2. The accounting equation is a statement of ___________ between the debitsand credits.

3. An account is a formal record of _____________ in items of ___________ nature.4. The left side of an account is known as ______________ and the right side as

_______________.5. In double entry book keeping, every transaction affects at least two

_____________.6. The debit and credit both may represent either ______________ or _____________

in an account balance.7. The journal is the basic book of ______________ entry.8. recording of transactions in the journal is called ______________.9. When cash book is maintained, the transactions of cash are not recorded in

the ________________.10. the word(c) against an entry in the cash book signifies that this entry is not

to be _______________ to the ledger.11. The petty cashier generally works on ___________ system.12. In the purchases journal, all ____________ purchases of merchandise are

recorded.13. In the sales journal, all ____________ sales of merchandise are recorded.14. The process of transferring entries from books of original entry to the ledger

is called _____________.15. Assets are always equal to liabilities plus ________________.


1. Explain the meaning of source documents with examples.2. Explain the meaning of the accounting equation.3. Justify the statement that the Accounting Equation (A = L+C) holds good

under all circumstances. Give atleast three transactions to show that theequality condition holds three goods.

4. Describe two basic purposes of source documents.5. What is owner’s equity? Give an equation for calculating owner’s equity.

104 ACCOUNTANCY

6. Give two transactions that will:(i) Increase an asset and increase a liability.(ii) Increase an asset and decrease another asset.(iii) Decrease an asset and decrease capital.7. Explain the rules of debit and credit.8. Explain the meaning of double entry book keeping.9. What are the books of original entry?10. What is a general journal?11. Why is a journal sub-divided?12. What is a special journal? Give a specimen of such a journal showing at

least five entries.13. Explain that the cash book is a journal as well as a ledger account.14. What do you understand by a ‘contra entry’?15. What do you understand by ‘petty cash book’?16. Explain the meaning and utility of a cash book.17. What is the meaning of an account?18. What is the purpose of a ledger?19. Explain the rules of debit and credit.

20. On which side of the account are the following decreases recorded

(i) Assets(ii) Liabilities(iii) Owner’s equity(iv) Revenues(v) Expenses

21. Indicate the nature (debit or credit) of normal balance in the followingaccounts:

(i) Cash(ii) Accounts receivable (debtors)(iii) Accounts payable (creditors)(iv) Furniture(v) Merchandise(vi) Capital(vii) Miscellaneous expenses(viii) Rent payable(ix) Salaries paid

22. List the various subsidiary (special) journals.23. At the time of recording a transaction in the general journal, should the

account(s) to be credited or debited be entered first?24. Explain the meaning of posting.25. Explain the meaning and purpose of the Ledger Folio (L.F.).26. What is a bank reconciliation statement? Why is the preparation of the

bank reconciliation statement necessary?27. Explain the reasons on account of which the balance as shown by the bank

pass book does not agree with the balance as shown by the bank column ofthe cash book.



1. What is the purpose of each subsidiary journals? Give specimen of thepurchases journal and sales journal with four imaginary entries.

2. How is a bank reconciliation statement prepared? Prepare a bankreconciliations statement with imaginary figures.

3. Explain the procedure of recording the journal entries in a journal. Givespecimen of a journal with five transactions recorded in it.

4. Explain the procedure of posting journal entries from the subsidiary books.

Problems

1. Show the accounting Equation on the basis of the following transactions:

Rs.(i) Ram Started business with cash 50,000(ii) Purchased goods from Shyam on credit 20,000(iii) Sold goods to Sohan costing Rs. 3,000 for cash 3,600

2. Develop the accounting Equation from the following transactions:

Rs.(i) Mohan commenced business with cash 50,000(ii) Purchased goods for cash 30,000(iii) Purchased goods on credit 20,000(iv) Sold goods (cost Rs. 10,000) for cash 12,000(v) Bought furniture on credit 2,000(vi) Paid cash to a creditor 15,000

3. Anil had the following transactions:

(i) Commenced business with cash Rs. 50,000(ii) Purchased goods for cash Rs. 20,000 and credit Rs. 30,000(iii) Sold goods for cash Rs. 40,000 costing Rs. 30,000(iv) Rent paid in Cash Rs. 500(v) Rent outstanding Rs. 100(vi) Bought furniture for Rs. 5,000 on credit(vii) Bought refrigerator for personal use for cash Rs. 5,000(viii) Purchased building for cash Rs. 20,000

Use the accounting equation to show the effect of the above transactions onhis assets, liabilities and capital and show the final Accounting Equation.

4. How will the following items be dealt with while preparing the bank columnof the cash book:

(i) Paid into bank Rs. 2,000(ii) Withdrew from bank for office use Rs. 3,000(iii) Withdrew from bank for private use Rs. 1,500

106 ACCOUNTANCY

5. Prepare a two-column cash book from the following transactions and postthem to appropriate ledger accounts:

2002 March Rs.1 Cash balance 7,0002 Bank balance (Dr.) 1,00,0003 Cash sales 60,0006 Rent paid by cheque 24,0008 Cash deposited in bank 60,00010 Wages paid 1,00010 Rent paid 1,80012 Received cheque from Ram 8,00014 Goods purchased on cash 4,00016 Withdrawn from bank for office use 20,00018 Issued cheque to Hari 14,00020 Withdrawn cash for personal use 4,00022 Received cheque from Shyam and deposited in bank 10,00024 Shyam dishonoured the cheque 10,00026 Furniture purchased and cheque issued 6,00029 Received interest on investments by cheque 3,00030 Paid salaries in cash 4,800

6. Enter the following transactions in the petty cash book. The imprest isRs. 5000.

2002 March Rs.1 Chowkidar’s wages 1,8002 Pencils purchased 608 Postage stamps 40012 Courier charges 45014 Cartage 15015 Scooter fare to assistant 7516 Cleaning expenses 18520 Taxi fare to manager 17524 Refreshment for customer 12025 Writing pads and registers 18027 Bus fare to peon 2028 Cartage 21029 Postage stamps 21029 Courier charges 22030 Purchase of 4 tube lights 13531 Cleaning expenses 110

7. M.S. Brothers carry on business as cloth dealers. From the following, writeup, their purchases book for January, 1988:

1989 January3 Purchased on credit from Ambika Mills:

100 meters long cloth @ Rs. 30 per meter


50 meters shirting @ Rs. 50 per meter8 Purchased for cash from Arvind Mills:

50 meters muslin @ Rs. 40 per meter15 Purchased on credit from India Textiles Ltd.

120 meters suiting @ Rs. 100 per meter100 meters shirting @ Rs. 60 per meter

20 Purchased Laser printer on credit fromBharat Computers Ltd. for Rs. 12,800.

8. From the following particulars, prepare the sales book of Akbar & Co., whodeals in furniture:

June, 19895 Sold on credit to Anand & Co.:

10 tables @ Rs. 30020 Chairs @ Rs. 150

10 Sold to Bannerji & Co. on credit:5 almirahs @ Rs. 1,5005 stools @ Rs. 100

20 Sold old typewriter -for Rs. 600 to Mohan and Co. on credit.25 Sold to Ram Lal & Bros. on credit

5 tables @ Rs. 5001 revolving chair @ Rs. 600

9. Enter the following transactions of Anil & Co. in the proper books:

July, 19895 Sold on credit to Sethi & Co.:

10 electric irons @ Rs. 255 electric stoves @ Rs. 15

8 Purchased on credit from Hari & Sons:25 heatres @ Rs. 4010 water heaters @ Rs. 20

10 Purchased for cash from Mohan & Co.10 electric kettles @ Rs. 30

15 Sold to Gopal Bros. on credit:10 heaters @ Rs. 505 water heaters @ Rs. 25

18 Returned to Hari & Sons:5 heaters, being defective

20 Purchased from Kohli & co.:10 toasters @ Rs. 2010 water heaters @ Rs. 30

26 Gopal Bros. returned one water heater as defective

10. Sangma Traders maintain General journal, Double column cash book (cashand bank), Purchases journal, and Sales journal to record the transactions.Record the following transactions in the proper books.

108 ACCOUNTANCY

(i) Ram started business with cash Rs.1,50,000. (ii) He depositedRs. 1,30,000 in a newly opened bank account. (iii) He purchased goodsfor cash Rs. 8,000. (iv) He purchased goods for Rs.10,000, paymentwas made through bank. (v) He withdrew Rs 2,000 from the bank foroffice use. (vi) He withdrew Rs.1,000 from the bank for personal use.(vii) He sold goods for cash Rs.15,000 out of this he again depositedRs.12,000 in the bank. (viii) He paid salary in cash Rs.200. (ix) Hegave a cheque for rent Rs.300. (x) Sold goods on account to Y, Rs.8,000.(xi) Purchased goods on account from X, Rs. 5,000. (xii) Sold goods forcash Rs.1,000. (xiii) Purchased goods from Z for cash Rs.2,500.(xiv) Purchased goods for cash Rs.2,800. (xv) Cash paid to X, Rs.3,000.(xvi) Cash received from Y, Rs.1,600. (xvii) Machinery purchased forcash Rs 20,000. (xviii) Machinery purchased from Anil on account Rs30,000. (xix) Sold a machine to Satish for cash Rs.5,000. There was aloss on sale of Rs.1,000. (xx) Interest earned Rs.5,400. (xxi) Interestpaid Rs.1,200.

11. From the following particulars, prepare a bank reconciliation statement toascertain the correct bank balance as on 31 March 2002:

The following cheques were paid into the firm’s current account in March2002, but were credited by the bank in April 2002:

A Rs. 2,500; B Rs. 3,500; and C Rs. 1,900.The following cheques were issued by the firm in March, 2002 and werecashed in April 2002:P Rs. 2,500; Q Rs. 4,500; and R Rs. 4,000.

A cheque for Rs.1,000 which was received from a customer was entered inthe bank column of the cash book in March 2002, but the same was paidinto the bank in April 2002.

The pass book shows a credit of Rs.2,500 for interest and a debit ofRs.1,000 for bank charges.

The balance as per cash book was Rs.1,80,000 and as per pass bookRs.1,83,600 on 31 March 2002.

12. The bank pass book of Mr. X showed an overdraft of Rs. 33,575 on31 March 2002 and the bank overdraft as per cash book was Rs. 30,295.On going through the pass book, the accountant found the following:

(i) A cheque of Rs.1,080 deposited on 28 March was dishonoured. Therewas no entry in the cash book about the dishonour of the cheque until31 March.

(ii) Bankers had credited his account with Rs. 2,800 for interest collectedby them on his behalf; the same has not been entered in his cashbook.


(iii) Cheques amounting to Rs. 7,500 were not yet collected by bank as on31 March.

(iv) Out of cheques amounting Rs. 7,800 drawn by him on 27 March acheque for Rs. 2,500 was encashed on 3 April.

Prepare bank reconciliation statement on 31 March 2002. Also ascertainthe correct bank balance.

13. From the following particulars, prepare a bank reconciliation statementshowing the balance as per bank pass book on March 31, 2002:

The following cheques were paid into the firm’s bank account in March2002, but were credited by the bank in April 2002:

Rs.S.M. Bannerjee 2,000S.P. Gupta 3,100R.A. Kalra 1,800

The cheque were issued by the firm in March 2002, but were presented forpayment in April 2002:

Rs.A.P. Sharma 4,000N.A. Dua 5,000S.B. Agarwal 3,420

The cheque for Rs. 1,000 which was received from a customer in fullsettlement of his account was entered in the bank column of the cash bookin March 2002 but the same was paid into the bank in April 2002.

The bank balance as per cash book was Rs.19,900 on 31 March 2002.

14. On 31 December 2001, your cash book showed cash at bank Rs. 5,435 andbank pass book showed a credit balance of Rs. 15,010. Before that date,you had issued cheques amounting to Rs. 12,000 but they were notpresented for payment. A cheque for Rs. 1,500 paid by you into the bankwas not credited. On December 31, 2001, you had also received a chequefor Rs. 1,100, which, though entered in the cash book, was not paid intothe bank. Besides, there was an entry of Rs. 175 for interest to your credit.Draw up a bank reconciliation statement to determine the correct bankbalance.

110 ACCOUNTANCY

15. Prepare a bank reconciliation statement and ascertain correct bank balancefor the following particulars as on 31 March 2002:

Rs.Balance as per pass book 5,750Balance as per cash book 4,750Cheques issued but not presented for 2,100payment till, March 31Cheques paid into the bank but not yet cleared 1,200Interest allowed by the bank but no entry 200appeared in the cash bookBank charges not entered in to cash book 100

16. From the following particulars, prepare a bank reconciliation statement toascertain the correct bank balance as on 31 December 2001:

Rs.Cash at bank 25,798Balance as per pass book as per cash book 19,820The following cheques were issued by thefirm in December but were presented for

payment in January 2002:

Sh. Rajni Deshmukh 6,840Sh. C.D. Patel 7,068Sh. D. Natarajan 4,535

The following cheques were sent to the bank for collection in December but were credited in the account in January 2002:

Rs.Sh. Rajesh 3,200Sh. Mukesh 6,750Sh. Kamaljeet 5,340

The customer directly deposited in the firm’s account Rs. 3,200. The bankpaid Rs. 400 insurance premium which was not entered in the cash book.The bank credited interest to the account Rs. 85.

The bank debited the account for charges Rs. 60.

17. On 31 March 2002, the cash book India Traders showed, in the bank column,a debit balance of Rs.1,140 and the pass book of India Traders showed adebit balance of Rs.2,820. On checking the entries in the cash book withthe bank pass book, it was ascertained that cheques forRs.18,700 were paid into the bank in the month of March. Cheques forRs.10,800 were realized till March 31 and a cheque of Rs.1,800 was returneddishonoured but it was not recorded in the cash book. Out of cheques forRs.12,700 issued in March, cheques encashed upto 31 March were to the


amount of Rs.7,300. Another cheque for Rs.1,300 was entered in the cashbook in March but was sent to the bank in April 2002. The bank has debitedRs. 120 for interest and Rs. 40 for bank charges.

(Hint: The cash book shows cash at bank, whereas, the pass book showsbank overdraft)

18. Prepare a bank reconciliation statement to ascertain the correct bankbalance as on 31 March 2002, from the following particulars:

Rs. 750 paid by the bank for insurance premium under a standing order ofthe account holder had not been entered in the cash book.

A customer paid Rs.2,400 directly into the bank account but advice fromthe bank was not received till 31 March.

Out of cheques issued for Rs.9,800 in March, cheques of Rs.4,300 onlywere cashed before 31 March.

Cheques of Rs.16,400 were paid into the bank in March out of them, chequesof Rs.8,200 were credited in April and one of Rs.700 was returneddishonoured.

An amount of Rs.1,200 paid into the bank was not entered in the cashbook.

Rs.400 collected by the bank as interest on investment was not entered inthe cash book.

There was a credit in the pass book of Rs.240 for interest and a debit of Rs.70 for bank charges. These amounts did not find a place in the cash book.The balance as shown by the pass book on 31 March 2002, was Rs.18,000and by cash book Rs.17,980.

19. The following information is provided relating to transactions recorded incash book and pass book of Divakar Enterprises:

1. Balance as per the bank statement dated 31 March 2002, wasRs. 8,900 and as per cash book was Rs.7,980.

2. Deposit of Rs.2,600 on 31 March was not included in the bankstatement.

3. Cheques issued but not presented as of 31 March totaled Rs.2,100.

4. The bank erroneously debited for a cheque of Janta Trader’s Accountfor Rs.400.

5. During March, the bank credited the account with the proceeds of acheque for Rs.2,020 that it received directly from Janta Traders.

6. Service and collection charges for the month amounted to Rs.200.

Reconcile the two balances and ascertain correct bank balance as on 31March 2002.

112 ACCOUNTANCY

ANSWERS

Multiple Choice

1. (ii) 6. (iv)2. (ii) 7. (iv)3. (iii) 8. (iv)4. (iv) 9. (iv)5. (ii)

Fill in the blanks

1. Transaction, amount 9. journal2. Equality 10. posted3. Changes, similar 11. imprest4. debit, credit 12. credit5. accounts 13. credit6. increase, decrease 14. posting7. original 15. owner’s equity8. journalizing

Exercises

1. Asset Rs. 70,600 = Liabilities Rs. 20,000+Owners’ Equity Rs. 50,6002. Assets Rs. 59,000 = Liabilities Rs. 7,000+ Owners’ Equity Rs. 52,0003. Assets Rs. 89,500 = Liabilities Rs. 35,100+ Owners’ Equity Rs. 54,4005. Balance Cash Rs. 11,400. Bank (Dr.) Rs. 1,07,0006. Petty cash balance Rs. 5007. Total of purchases book Rs. 23,5008. Total of sales book Rs. 17,1009. Total of sales book Rs. 95; Purchases book Rs. 1,700; Returns outwards

book Rs. 200; Returns inwards book Rs. 25.11. Correct bank balance Rs. 1,81,50012. (i) Overdraft as per cash book Rs. 30,295 (ii) Correct bank overdraft Rs. 28,575

13. Balance as per bank pass book Rs. 24,42014. Correct bank balance Rs. 4,51015. Correct bank balance Rs. 4,85016. Correct bank balance Rs. 22,64517. Correct Overdraft Rs. 2,12018. Correct bank balance Rs. 20,70019. Correct bank balance Rs. 9,800

CHAPTER 4

Trial Balance and Rectification of Errors

LEARNING OBJECTIVES


● state the meaning of trial balance;

● check the accuracy of accounting records;

● prepare the trial balance;

● identify the nature of balances in various accounts;

● state the different types of errors;

● detect and rectify errors; and

● appreciate the need for preparing suspense account.

114 ACCOUNTANCY

In the previous chapters, you havelearnt how to record and classify thetransactions in the various accountsalong with balancing there of. Allbalances of the accounts are listed ina statement, called trial balance. It isa summary statement of all balances.This summary of balances enables usto check the arithmetical accuracy ofthe transactions recorded in the ledgeraccounts. Since every debit has acorresponding credit, the total of debitsshould be equal to the total of creditsin the trial balance. This chapterexplains the meaning and process ofpreparation of trial balance. It isfollowed by a discussion of differenttypes of errors and their rectification.

4.1 Meaning of Trial Balance

A trial balance is a summary ofbalances of all accounts recorded in

the ledger. The format of trial balancein given in fig. 4.1.

Trial Balance of ……… as on 31st March 2002

Account Account DebitCode Title Amount Amount

Rs. Rs.

Fig. 4.1 : Showing Format of a Trial Balance

The trial balance is prepared at theend of a chosen period which mayeither be monthly, quarterly, half-yearly or annually or as and whenrequired. Since, every debit shouldhave a corresponding credit as per therules of the double entry system, thetotal of the debit and credit balancesshould tally. In case there is adifference, one has to check thecorrectness of the balances brought

Trial Balance as at 31 March 2002

Account Account Title Debit CreditCode Amount Amount

Rs. Rs.

001 Cash 45,000002 Capital 5,00,000003 Bank 2,05,500004 Office Equipment 60,000005 Office Car 1,60,000006 Insurance of Car 9,000007 Purchases 1,10,000008 Creditors 30,000009 Sales 1,12,0000.10 Debtors 40,0000.11 Drawings 5,0000.12 Salary 7,5000

Total 6,42,000 6,42,000

Fig. 4.2 : Trial Balance for Illustration 25 Chapter 3 on page 95

115TRIAL BALANCE AND RECTIFICATION OF ERRORS

forward from the respective accounts.This type of checking of accounts leadsto ascertainment of arithmeticalaccuracy of the balances of variousaccounts in a summarized form.Besides checking the arithmeticalaccuracy, trial balance also aims atascertaining the correctness of thenature of balances in relation to thetype of account. All assets, expenses,receivables shall have debit balances.Similarly, all liabilities, revenues,payables will have credit balances(figure 4.2).

4.2 Objectives of Preparing a Trial Balance

In order to provide a summarystatement view of the balances ofvarious accounts, we need to preparethe trial balance. This also indicatesthe correct nature of the balances ofvarious accounts. A trial balance isprepared to fulfill the followingobjectives:

● check the arithmetical accuracyof the ledger accounts;

● help in locating errors; and● provide a basis for preparing the

financial statements.

These objectives are explained indetail hereunder:

4.2.1 To Check the Arithmetical Accuracy of Accounts

A trial balance is prepared to checkwhether all debits and thecorresponding credits are properlyrecorded in the ledger or not. Whenthe totals of all the debits and credits

in the trial balance are equal, it isassumed that the posting andbalancing of ledger accounts isarithmetically accurate.

4.2.2 To Help in Locating Errors

Whenever the trial balance does nottally, the accountant know that errorshave crept in at the stage of recording,posting, balancing, or transfer ofbalances. The accountant, at thisstage, is faced with the problem oferrors. It is immaterial whether theamount of difference is small or large.Even a small amount of differencerequires careful attention to be paidto achieve accuracy in accounts.Once the errors are detected andlocated, these are rectified and thenthe corrected trial balance isprepared.

4.2.3 To Provide a Basis for the Preparation of Financial

Statements

Since the balances of all accountsappear in the trial balance, it providesa basis for the preparation of thefinancial statements. A tallied trialbalance, therefore becomes the firststep in the preparation of financialstatements.

All revenues and expensesaccounts from trial balance, aretransferred to the trading and profitand loss account. All assets,liabilities and capital accounts alongwith the balance of the profit and lossaccount are shown in the balancesheet.

116 ACCOUNTANCY

4.3 Detection of Errors Revealedby the Non-agreement of TrialBalance

If the trial balance does not tally, theaccountant should initiate thefollowing steps to detect and locate theerrors:

● Recast the totals of debit andcredit columns of the trialbalance.

● Compare the account head/titleand amount appearing in thetrial balance, with that of theledger to detect any difference inamount or omission of anaccount.

● Compare the trial balance of thecurrent year with that of theprevious year to check additionsand deletions of any accountsand also verify whether there isa large difference in amount,which is neither expected norexplained.

● Re-do and check the correctnessof balances of individualaccounts in the ledger.

● Re-check the correctness of theposting in accounts from thebooks of original entry.

● If the difference between thedebit and credit columns isdivisible by two, there is apossibility that an amount equalto one-half of the difference mayhave been posted to the wrongside of another ledger account.For example, if the total of thedebit column of the trial balanceexceeds by Rs.1,500, it is quitepossible that a credit item of

Rs.750 may have been wronglyposted in the ledger as a debititem. To locate such errors, theaccountant should scan all thedebit entries of an amount of Rs.750.

● The difference may also indicatea complete omission of aposting. For example, thedifference of Rs.1,500 givenabove may be due to omissionsof a posting of that amount onthe credit side. Thus, theaccountant should verify all thecredit items with an amount ofRs.1,500.

● If the difference is a multiple of9 or divisible by 9, the mistakecould be due to transposition offigures. For example, if a debitamount of Rs. 459 is posted asRs.954, the debit total in thetrial balance will exceed thecredit side by Rs. 495 (i.e. 954-459 = 495). This difference isperfectly divisible by 9. Amistake due to wrong placementof the decimal point may also bechecked by this method. Thus,a difference in trial balancedivisible by 9 helps in checkingthe errors for a transposemistake.

4.4 Preparation of the Trial Balance

The first step in the preparation of thetrial balance is to balance all ledgeraccounts. This is done after posting ofall the entries from books of originalentry to the ledger. Balancing of anaccount is done by putting the


Account Name of the Account Debit CreditCode Amount Amount

Rs. Rs.

Capital Account ✔Fixed Asset Accounts:

● Land and Buildings ✔● Plant and Machinery ✔● Equipment ✔● Furniture and Fixtures ✔

Current Asset Accounts:● Cash in Hand ✔● Cash at Bank ✔● Accounts Receivables ✔● Bills Receivable ✔● Stock of Raw Materials ✔● Work in progress ✔● Stock of Finished goods ✔● Purchases ✔● Carriage inwards ✔● Carriage outwards ✔● Sales ✔● Sales Returns ✔● Purchase Returns ✔

● Interest paid ✔● Commission/Discount received ✔● Salaries ✔● Long term loan ✔● Bills Payable ✔● Accounts payable ✔● Outstanding Salaries ✔● Prepaid Insurance ✔● Outstanding interest earned ✔● Advances from Customers ✔● Drawings ✔● Reserves and Surplus ✔● Provision for bad and doubtful debts ✔

Total xxx xxx

Fig. 4.3 : Illustrative Trial Balance

difference between the two sides of anaccount on the side, which is short.This leads to the equalization of twosides of an account. A trial balance hasfour columns. The first column is theaccount code/number, the second

column is the title/name of theaccount, the third and fourth columnsare the debit and credit columnsrespectively where the amount ofbalance of each account is entered. Itis shown in fig. 4.3.

118 ACCOUNTANCY

SolutionBooks of Asha General Stores

Cash Book

Receipts Payments

Cash - 001,Bank- 002

Date Particulars L.F. Cash Bank Date Particulars LF Cash Bank2002 (Rs.) (Rs.) 2002 (Rs.) (Rs.)

Jan 1 Capital 25,000 Jan 1 Purchases 10,000 –1 Loan from father 50,000 Jan 1 Bank 20,000 –1 Sales 7500 Jan 2 Purchases 30,000 –

Total c/f 82,500 – Total c/f 60,000

Illustration 1

Ajay started a small general store andagreed to pay a rent of Rs.500 p.m.His uncle provided him with somefurniture for the shop.He invested hispersonal savings of Rs. 25,000 and hisfather gave him Rs.50,000. He namedhis shop as Asha General Store. Theshop was inaugurated on 1 January2002. As Ajay is educated he wantedto run his business in a professionalway. He requested his friend Anand toprepare books of account for the shop.The following were the transactions ofthe stores in the first week:

January 2002

1 Purchased goods worthRs.10,000 from GaneshEnterprises by paying cash.Made cash sales of Rs.7,500 topeople who attended the inaugu-ration. Opened an account withUnited Bank of India by depo-siting Rs.20,000.

2 Made payment of Rs.2,000 to acaterer who supplied refresh-ments during the inaugurationceremony. Cash purchasesmade for Rs.30,000.

3 Purchased goods worth Rs.35,000from Subhash and Co. payingRs.5,000 cash and remaining oncredit with a promise to pay in30 days. Made a sale to Rajaramfor Rs.8,000 on account. Cashsales were also made for Rs.26,000.

4 Paid license fees of Rs.400.Rent Rs.500. Purchases worthRs.7,500. Made cash sales forRs.9,600

5 Made a payment to Subhashand Co., Rs.5,000 by cheque.Paid postage Rs150. Withdrewfor personal use Rs.7,000.Sales to Mary Export HouseRs.47,600. Cash sales were forRs.3,300

6 Paid electricity charges Rs.550and Rs.250 to Raja who agreedto clean the shop and alsoworked as a shop assistant.

7 Purchased furniture and fittingsfrom Lokesh Enterprises oncredit for Rs. 36000.

Record the above transactions invarious subsidiary books and postthem to the relevant ledger accountsand prepare the trial balance afterbalancing the various ledger accounts.


Jan Total b/f 82,500 – Jan Total b/f 60,000

1 Cash 20,000 2 Business 2,000expenses

3 Sales 26,000 3 Purchases 5,0004 Sales 9,6005 Sales 3,300 4 License fee 400

4 Rent 500Purchases 7,500

5 Subhash & Co. 5,000Postage 150Drawings 7,000Electricity 550Wages 250Balance c/f 38,050 15,000

1,21,400 20,000 1,21,400 20,000

Journal Proper

Date Particulars L.F Debit Credit Amount Amount

2002 Rs. Rs.

Jan 2 Furniture & 36,000FixturesLokesh 36,000Enterprises(Purchasedfurniture)

Total 36,000 36,000

Purchases Book

Date Particulars L.F Amount2002 Rs.

Jan 3 Subhash and Co. 30,000

30,000

Sales Book

Date Particulars L.F Amount2002 Rs.

Jan 3 Rajaram 8,000Jan 5 Mary Export 47,600

House55,600

Capital Account 003Dr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount2002 Rs. 2002 Rs.

Jan1 Cash 25,000

Drawings Account 004Dr. Cr.


Jan 5 Cash 7,000

120 ACCOUNTANCY

Purchases Account 005

Dr. Cr.


Jan 1 Cash 10,000 3 Jan Balance c/f 82,500Jan 3 Subhash & Co. 30,000 31 Dec

(creditors)Jan2 Cash 30,000Jan3 Cash 5,000Jan4 Cash 7,500

82,500 82,500

Loan Account 006Dr. Cr.


Jan 1 Cash 50,000

Subhash and Company Account 007Dr. Cr.


Jan 5 Bank 5,000 Jan 2. Purchases 30,00031 Dec Balance c/f 25,000

30000 30000

Mary Export House Account 008Dr. Cr.


Jan 5 Sales 47,600 Dec 31 balance c/f 47,6000

47,6000 47,6000

Electricity Account 009Dr. Cr.


Jan 6 Cash 550


Postage Account 010Dr. Cr.


Jan 5 Cash 150

License Fees Account 011Dr. Cr.


Jan 4 Cash 400

Wages Account 012Dr. Cr.


Jan 6 Cash 250

Furniture Account 013

Dr. Cr.


Jan 2 Lokesh 36,000Enterprises

Lokesh Enterprises 014Dr. Cr.


Jan 2 Furniture 36,000& Fitting

Sales Account 015Dr. Cr.


31 Dec Balance c/f 1,02,000 Jan 1 Cash 7,500Jan 3 Cash 26,000Jan 4 Rajaram 8,000Jan 4 Cash 9,600Jan 5 Cash 3,300Jan 5 Mary Export 47,600

House1,02,000 1,02,000

122 ACCOUNTANCY

Rent Account 017Dr. Cr.


Jan 4 Cash 500

Rajaram Account 018Dr. Cr.


Jan 3 Sales 8,000

Trial Balance of Asha General Stores as on 7 January 2002

Account Account Debit CreditTitle Amount Amount

Rs. Rs.

01 Cash 38,05002 Bank 15,00003 Capital 25,00004 Drawings 7,00005 Purchases 82,50006 Loan A/c 50,00007 Subash and company 25,00008 Mary Export House 47,60009 Electricity 550010 Postage 150011 License 400012 Wages 250013 Furniture and fittings 36,000014 Lokesh Enterprises 36,000015 Sales 1,02,000016 Business expenses 2,000017 Rent 500018 Rajaraman 8,000

Total 2,38,000 2,38,000

Illustration 2Following balances of ledger accountshave been obtained from which you arerequired to prepare a trial balance:Cash Rs.41,733; Expenses Rs.12,150;

Sales Rs.1,46,616; Fixed AssetsRs.12,000; Purchases Rs 1,10,850;Accounts Receivables Rs.24,436;Capital Rs. 50,000; Creditors Rs.8,553;Merchandise Rs 4,000.


Solution

Account Title Debit CreditAmount AmountRs. Rs.

Cash 41,733Expenses 12,150Fixed Assets 12,000Sales 1,46,616Purchases 1,10,850Accounts 24,436ReceivableMerchandise 4,000Capital 50,000Creditors 8,553

Total 2,05,169 2,05,169

4.5 Errors

The trial balance is prepared to checkthe arithmetical accuracy of accounts.If the trial balance does not tally, itimplies that there are arithmeticalerrors in the accounts which requirelocation, detection and rectificationthereof. Even if the trial balance tallies,there may still exist some errors. Thereare two types of errors: (a) errors whichare not revealed by the trial balance,and (b) errors which are revealed bythe trial balance. Errors may happenat any of the following stages of theaccounting cycle.

A. At Recording Stage1. Errors of principle2. Errors of omission3. Errors of commission

B. At Posting Stage1. Error of omission

i. Completeii. Partial

2. Error of commissioni. Posting to wrong account

ii. Posting on the wrong sideiii. Posting of wrong amount

C. Balancing Stage1. Wrong totaling2. Wrong balancing

D. Preparation of Trial Balance1. Error of Omission2. Error of Commission

i. Taking wrong amountii. Taking wrong accountiii. Taking to the wrong side

Errors can be classified into thefollowing four categories on the basisof the nature of errors and explainedhere under.

i. Errors of commissionii. Errors of omissioniii. Errors of principleiv. Compensating (offsetting)

errors.

4.5.1 Errors of Commission

These errors by definition, are ofclerical nature. These errors may becommitted at the time of recordingand/or posting. At the time ofrecording, the wrong amount may berecorded in journal which will becarried throughout. Such errors willnot affect the agreement of the trialbalance. These errors may also becommitted at the time of posting, byway of posting wrong amount, to thewrong side of an account or in thewrong account. The errors resulting inposting to wrong account will not affectagreement of trial balance, whereas,other errors of posting will resultingdisagreement of trial balance. Forexample, an amount of Rs.10,000

124 ACCOUNTANCY

received from customer (Debtor) iscorrectly recorded on the debit side ofthe cash book but while posting, thecustomer’s account is credited withRs.1,000. This is an error, which iscommitted at the time of posting, byposting wrong amount to the account.This will result in disagreement of trialbalance, since, the credit total of thetrail balance will be short by Rs. 9,000.

4.5.2 Errors of Omission

The errors of omission may becommitted at the time of recording thetransaction in the books of originalentry or while posting to the ledger. Anomission may be complete or partial.Such errors are known as errors ofomission. For example, Machinerypurchased for Rs. 50,000 by issuing acheque is recorded first in the creditside of cash book, in the bank column.Suppose it is not posted to the debit ofmachinery account, it is an error ofpartial omission. The trial balance willnot tally. Suppose the transaction isnot entered in the cash book and henceignored completely, this is a case ofcomplete omission. It means as if thetransaction has not taken place at all.It will not affect the trial balance andhence the trial balance will tally. Thisis true only in case of completeomission.

4.5.2 Errors of Principle

Accounting entries are recorded as perthe generally accepted accountingprinciples. If any of these principles areviolated or ignored, errors resultingfrom such violations are known as

errors of principle. As an illustration,Periodicity principle requiresmaintaining proper distinctionbetween capital and revenue items. Anerror of principle may occur due toincorrect classification of expenditureor receipts between capital andrevenue. This is very importantbecause it will have an impact onfinancial statements. It may lead tounder/over stating of income or assetsor liabilities, etc. For example, amountspent on additions to the buildingsshould be treated as capital expen-diture and must be debited to the assetaccount. Instead, if this amount isdebited to maintenance and repairsaccount, it is treated as a revenueexpense. This is an error of principle.Since instead of asset account, i.e.buildings, the maintenance andrepairs account (expense) is debited,the trial balance will still tally butwould not be correct as per generallyaccepted accounting principles.

Such errors are not disclosed bythe trial balance. This will result inunderstating of income due to extracharge under maintenance and repairsaccount and understating the value ofbuildings in the balance sheet.

4.5.4 Compensating Errors

When two or more errors arecommitted in such a way that the neteffect of these errors on the debits andcredits of accounts is nil, such errorsare called compensating errors. Theydo not effect the tallying of the trialbalance. For example: In a credit saletransaction, the sales account is


credited in excess by say, Rs.5,000 andsimilarly the suppliers account in caseof a credit purchase is understated byRs.5,000, this is a case of two errorscompensating for each others effect.It is to be noted that extra credit to thesales account is offset by lower creditto the creditor’s account, both beingcredit balance. Since, one plus is setoff by the other minus, the net effectof these two errors being ofcompensating nature and do not affectthe agreement of trial balance.

4.6 Classification of Errors - for the Purpose of Rectification

From the point of view of rectification,errors are classified into twocategories:

● Errors which affect the trialbalance; and

● Errors which do not affect thetrial balance.

4.6.1 Errors which Affect the Agreement of Trial Balance

These errors are due to the mistakehaving being committed on the oneside of the account. They may happenat any of the stages of the accountingprocess, like recording, posting,balancing, etc. such errors can berectified by giving an explanatory noteor by passing a journal entry with thehelp of a special account calledsuspense account. The nature andtreatment of suspense account isdiscussed later in this chapter.Examples of this group of errors are:errors of partial omission; error ofcasting (totaling); error of carrying

forward; error of balancing; error ofposting to the correct account but withwrong amount; error of posting to thecorrect account but on the wrong side;posting to the wrong side with thewrong amount and omitting to showan account in the trial balance.

4.6.2 Rectification

An error in the books of original entryif discovered before posting to theledger, may be corrected by crossingout the wrong amount by a single lineand writing the correct amount abovethe struck off amount and putting aninitial at the place.

An error in an amount posted tothe correct ledger account may also becorrected in a similar way or by makingan additional posting for the differencein amount and giving an explanatorynote in the particulars columnprovided that trial balance is notprepared. But errors should never becorrected by erasing. Crossing/Erasures reduce the authenticity ofaccounting records and give animpression that something is beingconcealed or manipulated.

Examples

● Under casting in the sales book(less total) by Rs.1,000. Sincethe total of sales journal isposted to sales account in theledger, only the sales account iscredited by an amount whichis lower by Rs.1,000. Theindividual customer accountswill be posted correctly to theirdebit side. To rectify this error,

126 ACCOUNTANCY

sales account is credited by anadditional amount of Rs.1,000with the comment in theparticulars column as follows:

“Mistake in totaling the salesjournal on page ….”

Errors committed while carryingforward or balancing can also berectified in this manner.

● An amount of Rs.6,300 for creditpurchases from Ashok on16.4.2001, correctly entered inthe purchases journal, but whileposting, his account has beencredited with Rs.3,600, thusunder crediting his account byRs.2,700.In this case since the entry hasbeen made correctly in thepurchases journal, posting tothe purchases account may beassumed to be free of errors.Therefore, the error is only inAshok’s account. This can berectified by entering additionalcredit of Rs.2,700 in his accountwith the comment in theparticular column as “Mistakein posting on 16.4.2001”.

● A credit sale of Rs.7,500 to Ajayon 1.8.2001 is wrongly creditedto his account. In this case, Ajayis a debtor, his account shouldhave been debited. Since it wascorrectly entered in the salesjournal, there is not an error inthe sales account. Therefore, theerror is only in Ajay’s account.This error can be rectified bydebiting his account with

Rs.15,000 (the amount of erroris double because instead ofdebit to Ajay’s account, hisaccount was wrongly creditedwith Rs.7,500. Thus, there is aneed for debiting his account bydouble the original amount ofRs.7,500, i.e. Rs.15,000 withthe explanation “ Mistake inposting on 1.8.2001”.

The above stated procedure forcorrection is applicable in assituation when trial balance hasnot been drawn, but, errors aredetected. However, all theseerror are generally rectified bythe use of suspense accountafter the trial balance isprepared and tallying it throughsuspense account.

4.6.3 Errors which do notaffect the trial balance

Errors which do not affect the trialbalance are committed in two or moreaccounts. They can be rectified bypassing a journal entry giving thecorrect debit and credit to theconcerned accounts. These correctingentries can be recorded in the journalproper. Examples of these errors are:omission to pass an entry in the booksof original entry; wrong amount oftransaction recorded in the journal,complete omission of the posting ofaccounts in the ledger. Examples ofthese errors are:

● Complete omission at therecording stages of thetransaction in the books of


original entry;● Recording of the transaction

with the wrong amount in thebooks of original entries;

● Complete omission of postingof a transaction;

● Errors of principle;● Posting of correct amount on the

correct side but to a wrongaccount.

Examples

A payment of Rs.25,000 made to asupplier Classic Enterprises is wronglyrecorded as payment to ClassicTraders. Suppose that the followingentry has been made and posted:

Debit CreditAmount Amount

Rs. Rs.

Classic Traders A/c Dr. 25,000 Bank A/c(Transaction wrongly 25,000recorded )

Here, instead of Classic Enter-prises the account of Classic Tradershas been wrongly debited. Thecorrecting entry will be:


Rs. Rs.

Classic Enterprises A/c Dr. 45,000 Classic Trader A/c 45,000(to correct the wrong debit)

When posted to the respectiveaccounts, this primal entry wouldnullify the effect of the earlier error.

We have learnt earlier that errorsof principle also do not affect the

tallying of the trial balance. Forexample, purchase of machinery oncredit for Rs.50,000 is debited toPurchases account. Actually, theMachinery account which is of acapital nature should have beendebited instead of Purchases account,which is a revenue account, thoughthe suppliers account is properlycredited. To correct this error, thefollowing journal entry will be passed.


Rs. Rs.

Machinery A/c Dr. 50,000 Purchases A/c 50,000

4.7 Suspense Account

In spite of best efforts, locating errorsis not an easy task and may take sometime. Unless detected and located,errors cannot be corrected. To avoiddelay in the preparation of financialstatements, the amount of differenceof the trial balance is temporarily putin an account called “SuspenseAccount” so as to tally the trial balanceby putting the difference on the shorterside. When all errors are located andrectified, the suspense account wouldclose automatically. But in case somebalance still remains in the suspenseaccount, due to non location of errors,it will be shown in the balance sheeton the asset side in case of debitbalance and on the liabilities side incase of credit balance.

4.7.1 Utility of Suspense Account

The main use of suspense account is

128 ACCOUNTANCY

Solution:Books of Indu Journal

Date Particulars Debit CreditAmount Amount

Rs. Rs.

2001 Purchases A/c Dr. 500April 1 Suspense A/c 500

(being Purchases Day Book total undercast by Rs.500, now rectified)

Sales A/c Dr. 5,000 Suspense A/c 5,000(Sales Day Book, total overcast byRs.5,000, now rectified)

Office Equipment A/c Dr. 3,645 Suspense A/c 3,645(Office equipment was under debitedby Rs.3,645, now rectified)

to facilitate the preparation of financialstatements. Later on errors affectingthe trial balance are located,rectification entries are passedthrough the suspense account.

4.7.2 Preparation and Treatment of Suspense Account

The following example highlights howa suspense account is used to rectifythe errors.

Illustration 3

Indu prepared a Trial balance of hershop for the year ended on 31 March2001. The debit total of the trialbalance was short by Rs.9,145. Shetransferred the deficiency to asuspense account. In April 2001, aftera close examination, she found the

following errors:(i) Purchases day book for

September 2000 was under castby Rs.500.

(ii) Sales day book of November2000, was overcast by Rs.5,000

(iii) A second hand computerpurchased for office use forRs.4,050 was recorded in theoffice equipment account asRs.405.

(iv) A bill drawn by her forRs.20,000 was not entered inthe bills receivable book.

(v) A machinery purchased forRs.50,000 was entered in thePurchases day book.

Pass the necessary journal entriesto rectify the above errors to help Induin finalizing her trial balance.


2001 Bills Receivable A/c Dr. 20,000April 1 Sundry Debtors A/c 20,000

(Bill drawn completely omitted in thebooks, now recorded)

Machinery A/c Dr. 50,000 Purchases A/c 50,000(Purchases account wrongly debitedinstead of machinery account, now rectified)

Total 79,145 79,145

Suspense Account

Dr. Cr.

Date Particulars Amount Date Particulars Amount2001 Rs. 2001 Rs.

March Balance b/f 9,145 Apr 1 Purchases A/c 50031 (balancing Sales 5,000

figure in the Office 3,645trial balance) Equipment

9,145 9,145

Illustration 4

The trial balance of Anand Dealersprepared on 31 December 2000 did nottally. The difference was placed in thesuspense account on the debit side Rs.39,180. A detailed examination of hisbooks revealed the following mistakes:

(i) A payment of Rs.20,000 to Johnwas posted to the credit of hisaccount.

(ii) Goods returned by Amrita aregular customer for Rs.5,800was posted to the credit of salesaccount

(iii) Charges on renovation to theslow windows of the shop ofRs.23,640 was debited to thefurniture and fixtures account

as Rs.32,460.(iv) A payment received from Rohan

for Rs.49,240 was credited toRoshan’s account.

(v) Glass purchased for showwindows from Aftab supplierson a credit for Rs.38,450 wasrecorded in the purchases daybook. At the time of posting,their account was credited withRs.34,850.

You are required to correct theabove mistakes by passing thenecessary rectifying errors in theGeneral journal and find out amountthat was transferred to suspenseaccount where the trial balance did nottally.

130 ACCOUNTANCY

Solution

Date Particulars Debit CreditAmount Amount

Rs. Rs.

2001, John’s A/c Dr. 40,000Dec 31 Suspense A/c 40,000

(being wrongly credited, now rectified)

Sales return A/c Dr. 5,800Sales A/c Dr. 5,800

" Suspense A/c 11,600(being sales account wrongly creditedand sales returns account not debited,now rectified)

Suspense A/c Dr. 8,820 " Furniture & Fixtures A/c 8,820

(being furniture & fixture credited wrongly,now rectified)

Roshan’s A/c Dr. 49,240 " Rohan A/c 49,240

(being correction of wrong entry in Roshan’saccount by correctly crediting Rohan)

1.Furniture and Fixture A/c Dr. 38,450 " Purchases A/c 38,450

(being purchases account wrongly debited,now stands corrected)

2.Suspense A/c Dr. 3,600 " Aftab A/c 3,600

(being wrong posting to Aftab’s account,now rectified)

Total 1,51,100 1,51,100

Suspense AccountDr. Cr.


April 1Furniture & Fixtures 8,820 March 31 John 41,800

Dec. Aftab 3,600 Sales Returns 5,80031 Balance b/f 39,180 Sales 5,800

51,600 51,600


Terms Introduced in this Chapter

● Trial Balance● Errors of Commission

● Errors of Omission● Compensating Errors● Errors of Principle● Suspense Account


1 Meaning of Trial Balance

A statement showing the extract of the balances, either credit or debit of variousaccounts in the ledger.

2 Objectives of Trial Balance

● to check the arithmetical accuracy of the ledger accounts;● to help in locating errors;● to provide a basis for preparing the financial statements.

3 Preparation of Trial Balance

A Trial Balance has four columns, the first column contains account code, thesecond column is for the title of the account, the third column is for writing thedebit balance and the final column is where the credit balance of the account in theledger is written.

4 Types of Errors

There are four types of errors:

● Errors of Commission

Errors caused due to wrong recording of a transaction, wrong posting, wrongtotaling, wrong balancing, etc.

● Errors of Omission

Errors caused due to omission of recording a transaction either fully orpartially in the books of accounts.

● Errors of Principle

Errors caused due to ignoring the accounting principles which may leadto wrong classification or identification of receipts and payments betweenrevenue and capital receipts and revenue expense and capitalexpenditure.

● Compensating Errors

Two or more errors committed in such a way that they nullify the effect ofeach other on the debits and credits.

132 ACCOUNTANCY

5 Rectification of Errors

Errors affecting only one account can be rectified by giving an explanatory note orby passing a journal entry. Errors which affect two or more accounts are rectifiedby passing a journal entry.

6 Meaning and Utility of Suspense Account

An account in which the difference in a trial balance is put temporarily till suchtime that errors are located and rectified. It facilitates the preparation of provisionalfinancial statements even when the trial balance does not tally.

7 Disposal of Suspense Account

When all the errors are located and rectified by passing the necessary journal entries,the suspense account automatically stands disposed off.

EXCERCISES

1. Fill in the Blanks

(i) Errors of principle ____________ affect the Trial Balance.(ii) The equality of ___________ and ___________ of the Trial Balance does

not mean that the individual accounts are also _________(iii) All ______________ and ______________ accounts appearing in the Trial

Balance are transferred to the Trading and Profit and Loss Account.(iv) If the Trial Balance does not ___________ it indicates that some

___________ have been committed.(v) A Suspense Account facilitates the ____________ of financial statements

even when the ___________ has not tallied.

2. Multiple Choice Questions

(a) Which of the following errors will not affect the Trial Balance?(i) Wrong balancing of an account(ii) Writing an amount in the wrong account but on the correct side(iii) Wrong totaling of an account(iv) None of the above

(b) Which of the following errors is an error of omission?

(i) Sale of Rs.500 was written in the purchases journal(ii) Wages paid to Mohan have been debited to his account.(iii) The total of the sales journal has not been posted to the Sales Account(iv) None of the above

(c) Purchase of office furniture for Rs.3,400 has been debited to GeneralExpenses Account. It is:

(i) An error of commission(ii) An error of omission


(iii) An error of principle(iv) None of the above

(d) Which of the following errors will affect the Trial Balance Account?

(i) Repair to buildings have been debited to buildings.(ii) The total of purchases journal is Rs.1,000 short.(iii) Freight paid on new machinery has been debited to the Freight

account(iv) None of the above

(e) Errors of commission do not allow:

(i) Correct totaling of the Balance Sheet(ii) Correct totaling of the Trial Balance(iii) The Trial Balance to agree(iv) None of the above

(f) The preparation of a Trial Balance helps in:

(i) Locating errors of complete omission(ii) Locating errors of principle(iii) Locating errors of commission(iv) None of the above

(g) Which of the following errors is an error of principle

(i) Rs. 500 received from Ganpat has been debited to his account(ii) Purchase of Rs.1,000 has been entered in the sales journal(iii) Repairs to buildings have been debited to Buildings Account(iv) None of the above

(h) Which of the following errors is an error of principle

(i) Rs.500 received from Rakesh has been debited to his account(ii) Sales of Rs.1,000 has been entered in the Purchases journal(iii) Repairs to Machinery have been debited to Machinery Account(iv) None of the above

(i) The type of account with a normal credit balance is:

(i) An asset(ii) A drawing(iii) A revenue(iv) An expense

(j) The form listing the balances and the title of the accounts in theledger on a given date is the :

(i) Income statement(ii) Balance Sheet(iii) Retained earnings statement(iv) Trial Balance

134 ACCOUNTANCY

3. Indicate whether the following accounts will have ‘debit’ or ‘credit’ balances:

(i) Sales Returns(ii) Carriage Inwards(iii) Purchases(iv) Outstanding Wages(v) Capital Account(vi) Machinery(vii) Goodwill(viii) Cash in Hand(ix) Cash at Bank(x) Bills Payable.


4. State the meaning of trial balance?5. What is the purpose of preparing trial balance?6. What is the purpose of preparing Suspense account?7. Explain compensating errors and give two examples of such errors?8. Explain errors of principle and give two examples of such errors?9. Explain the limitations of the Trial Balance.10. Name the errors that do not affect the agreement of Trial Balance.


11. Explain the meaning and Objectives of the Trial Balance.12. What is a Trial Balance? Name the errors which affect the Trial Balance?13. If a Trial Balance tallies, can it be concluded that there are no errors?

Why?14. Explain errors of omission and give two examples of such errors with

measures to rectify them.15. Explain errors of commission and give two examples of such errors with

measures to rectify them.

Problems

16. Give rectifying journal entries for the following errors:(i) A sale of goods to Mohit amounting to Rs.2,500 has been wrongly

passed through the purchases book.

(i) Rs. 15,000 paid for Furniture purchased has been charged toPurchases Account.

(i) A cheque for Rs.15,000 received from Ram K. Gupta was dishonoredand has been posted to the debit of Sales Returns Account.

(i) An amount of Rs.400 due from Mukesh which was written off as abad debt was unexpectedly recovered and was posted to the personalaccount of Mukesh.

(i) Rs. 12,000 paid by cheque for a printer was charged to the OfficeExpense Account instead of Office Equipment account.


17. Rectify the following errors:

(i) Rs. 700 allowed as Trade in allowance has been credited to SalesAccount.

(ii) Rs. 1,000 paid as rent to the landlord was debited to the Landlord’sAccount.

(iii) Materials from the store for Rs.1,000 and wages of Rs.400 had beenused in making tools and implements for use in the factory but noadjustments were made in the books.

(iv) The purchases book was overcast by Rs.100.(v) A sale of Rs.500 to Gupta & Co. was credited to its account.

18. Rectify the following errors:

(i) Wages paid for the Construction office were debited to Wages Account,Rs.15,000

(ii) Cartage paid for the newly purchased Furniture, Rs.100 charged tothe Cartage Account

(iii) Furniture purchased on credit from Babu Ram for Rs.3,000 recordedas Rs.300

(iv) Wages paid Rs.2,550 were posted in the Wages Account as Rs.2,505(v) Purchases from Mamata Rs.1,002 were omitted from the books.

19. The trial balance of a book-keeper shows an excess of debits over creditsby Rs.361. This difference is placed in the Suspense Account. Later, thefollowing errors were discovered.

(i) A credit item of Rs.2490 has been debited to The personal account ofDinesh as Rs.4290

(ii) Rs.9000 paid for Furniture bought has been charged to PurchasesAccount

(iii) A discount allowed to Ramesh has been credited to him as Rs.1450in place of Rs.1540

(iv) The total of the returns inward book was Rs.10 short.(v) A cheque for Rs.100 for miscellaneous expense was not posted to

Miscellaneous Expenses Account.

You are required to rectify the errors through Suspense Account andprepare the Suspense Account.

20. Rectify the following errors

(i) The total of sales book was overcast by Rs.200.(ii) Rs.4,000 paid for Furniture purchased has been charged to Office

Equipment Account.(iii) Rs.450 paid to Ramesh was debited to Rameshachar’s Account.(iv) A sum of Rs.300 paid to Shyam Lal, the clerk, was debited to his

personal account.(v) Rs.150 paid for regular maintenance for the building was debited to

the Building Account.

136 ACCOUNTANCY

21. Rectify the following errors

(i) The total of purchases book was undercast by Rs.900(ii) Goods invoiced Rs.2,500 and entered in the sales book on December

25 were returned on December 29. Although taken into stock onDecember 31, no entry was passed in the books.

(iii) Discount allowed to Bharat Bhushan of Rs.150 was not entered inthe discount account though posted to the credit of his personalaccount.

(iv) A payment of Rs.1,720 to Girish was debited to his account asRs.1,270.

(v) A sum of Rs.320 written off for depreciation on an asset has not beenposted to the Depreciation Account.

(vi) Total of debit column of journal proper was short on the debit byRs.360

22. The Trial Balance of New Delhi Dealers as on 31 March 1999, showed adifference, and on scrutiny, the following discrepancies were observed.

(i) A sales bill for Rs.8,750 was wrongly debited to the customer’s accountas Rs.7,850.

(ii) Sales to Santosh of Rs.4,000 was entered in the sales return bookbut was correctly debited to Santosh.

(iii) Bill received from Inderjeet Singh of Rs. 5,000 was entered in thebills payable book.

(iv) An amount of Rs.6,800 owing by a customer had been omitted fromthe list of Sundry Debtors.

(v) Goods bought from M. Kamlesh for an amount of Rs.6,400 has beencredited to his account as Rs. 8,400.

(vi) Rs.987.90 received from Mushtaq was entered in the cash book asRs.990.87.

Give journal entries rectifying the above errors.

23. Will you rectify the following errors?

(i) Rs.900 paid for the telephone bill of the telephone at the proprietor’sresidence was debited to Telephone Expense Account.

(ii) Cash sales of Rs. 1,200 to Manohar was correctly entered in theCash Book but was wrongly posted to account of Mohan

(iii) Rs. 1,500 spent on repairs of a machine was debited to MachineryAccount.

(iv) The amount of Rs.1,200 written off as bad debt, was recovered andwas credited to Ramesh’s personal account.

(v) Rs.2,000 included in the wages account was spent on the constructionof a cycle shed in the factory.

(vi) An amount of Rs.1,200 withdrawn by the proprietor for his personaluse has been debited to the Trade Expenses Account.


24. Rectify the following errors:(i) A customer Suresh, returned goods of the value of Rs.700 which

were not recorded in the books.(ii) The debit side of Radhey Lal, a debtor, is overcast by Rs.7,000.(iii) A cheque of Rs.1,400 received from Rajneesh & Sons was dishonored

and debited to Allowances Account.(iv) A fax machine purchased for the office for Rs.6,200 was entered in

the purchases book.(v) Purchase of goods from Sushil & Co. for Rs.3,800 was entered in the

sales book as Rs. 4,800.(vi) A credit sale to P.Mathur of Rs. 10,000 has been wrongly passed

through the purchases book.(vii) Rs. 250 being the total discount allowed to debtors has been posted

to the credit of Discount Received Account.

ANSWERS

Fill in the Blanks

(i) do not(ii) debit, credit, accurate(iii) revenue, expense(iv) tally, errors(v) preparation, trial balance

Multiple Choice

(i). (b); (ii). (c); (iii). (c); (iv). (b); (v). (c); (vi). (c); (vii). (c); (Viii). (c); (ix).(c); (x). (d).

Debit or Credit Balance

(i). Credit; (ii) debit; (iii) debit; (iv) credit; (v) debit;(vi) debit; (vii) debit; (viii) debit; (ix) debit; (x) credit.

138 ACCOUNTANCY

CHAPTER 5

Depreciation Provisions and Reserves

LEARNING OBJECTIVES


● explain the meaning of depreciation and other similarterms;

● state the need for providing depreciation and identify itscauses;

● compute depreciation according to different methods (interms of Accounting Standard VI);

● record transactions relating to depreciation anddisposition of assets;

● define ‘Provision’ and ‘Reserves’ and distinguish betweenthem;

● discuss the different type of ‘Provisions’ and ‘Reserves’ andthe accounting thereof.

139DEPRECIATION PROVISION AND RESERVES

Depreciation, provisions and reservesare two separate topics, therefore, theyare being presented as two differentsections. First section deals withdepreciation and section two dealswith provisions and reserves.

SECTION I

Depreciation

This section of the chapter deals withthe determination of the cost of fixedassets; the allocation of this cost toappropriate accounting periods; thedisposal of assets, and accountingtreatment thereof according to theAccounting Standard VI of the Instituteof Chartered Accountants of India. Inthe preparation of financialstatements, depreciation on fixedassets has a special significance. It liesin the fact that depreciation involvesrelatively large amounts as expenses,which are crucial for the ascertainmentof net profit and determination of thebalances of fixed assets, which are tobe shown in the balance sheet.Depreciation, in general, is concernedwith the manner in which capitalexpenditure gradually converts intorevenue expense for calculating netincome over a period of time.

5.1 Meaning of Depreciation

Depreciation may be described as apermanent, continuing and gradualshrinkage in the book value of fixedassets. It is the cost of assetsconsumed in business.

The Accounting Standard VI,which lays down guidelines for

depreciation accounting, defines thedepreciation as follows:

“Depreciation is a measure of thewearing out, consumption or other lossof value of a depreciable asset arisingfrom use, effluxion of time orobsolescence through technology andmarket changes. Depreciation isallocated so as to charge fairproportion of depreciable amount ineach accounting period during theexpected useful life of the asset.Depreciation includes amortization ofassets whose useful life is pre-determined.”

Thus, the subject matter ofdepreciation, or its base, are‘depreciable’ assets which:

● “are expected to be used duringmore than one accountingperiod;

● have a limited useful life; and● are held by an enterprise for use

in production or supply of goodsand services, for rental toothers, or for administrativepurposes and not for thepurpose of sale in the ordinarycourse of business.”

Further, depreciation is theallocation of ‘depreciable amount’which is the “Historical Cost,” or otheramount substituted for historical costless estimated salvage value.

Another point in the allocation ofdepreciable amount is the ‘expecteduseful life’ of an asset. It has beendescribed as “either (i) the period overwhich a depreciable asset is expectedto be used by the enterprise, or (ii) thenumber of production or similar units

140 ACCOUNTANCY

expected to be obtained from the useof the asset by the enterprise.”

According to AccountingTerminology Bulletin No.1 of theCommittee on Accounting Proceduresof American Institute of Certified PublicAccountants depreciation accountingis, “ A system of accounting which aimsto distribute cost, or other tangiblevalue, of capital asset, less salvage ifany, over the estimated useful life ofthe unit (which may be a group ofassets) in a systematic and rationalmanner. It is a process of allocationand not of valuation”.

The analysis of the foregoingdefinition derives one to conclude thatdepreciation is the cost of doingbusiness representing consumptionof facilities and loss in value forproduction decisions.

5.2 Depreciation and Analogous Terms

There are some terms-like depletion,obsolescence and amortization, whichare also used in connection withdepreciation. This has been due to thesimilar treatment given to them inaccounting on the basis of similarityof their outcome, since they representthe expiry of the usefulness of differentassets.

5.2.1 Depletion

It refers to the process of estimatingand recording the periodic charges tooperations owing to the exhaustion ofnatural resource such as oil, coal orstanding timber. The main difference

between depletion and depreciation isthat the former is concerned with theutilization of a bundle of economicresources, but the latter relates to theusage of an asset. In spite of this, theresult is erosion in the volume ofnatural resources and expiry of theservice potential. Therefore, depletionand depreciation are given similaraccounting treatment.

5.2.2 Obsolescence

It refers to a state of an existing assetbecoming out of date on account of theavailability of a better model due toimprovements in technology or changesin demand pattern. Obsolescence isthe outcome of events external to theasset, which significantly reduces thenet economic value of the physicaloutput, provided by it. However,depreciation is physical deteriorationthat arises from change in asset itself,e.g., an engineer can observe changesin machine’s output per period with thepassage of time like reduced machinespeed, more frequent breakdowns orhigher scrap rates. Yet their end-resultis the same, i.e., the shortening of theirestimated useful life, for being puttogether for accoun-ting treatment.

5.2.3 Amortization

It is often used as a general term towrite off intangible assets such aspatents, copyrights, franchises,leasehold mines which have entitle-ment to use for a specific contractedtime. The procedure for amortization orperiodic write off, of a portion of the cost


of intangible assets is the same as forrecording depreciation of fixed assets.

5.3 Need for Depreciation

The need for providing depreciation inaccounting records arises fromconceptual, legal, and practicalbusiness considerations. Theseconsiderations impart to depreciationa particular significance as a businessexpense.

5.3.1 Matching of Costs and Revenue

The rationale of the acquisition of fixedassets in business operations is thatthese are used in the earning ofrevenues. Every asset is bound toundergo some wear and tear, and lossin value, once it is put to use inbusiness. Therefore, consumption ofthe value of an asset is as much anexpense as any other expense incurredin the normal course of business likesalary, carriage, postage andstationary, etc. It is a charge againstthe revenues of the correspondingperiod before arriving at net profitaccording to ‘generally acceptedaccounting principles’.

5.3.2 Consideration of Tax

Depreciation is deductible expense fortax purposes. This helps in reducingthe tax liability of the entity. Therefore,tax authorities make their own rulesfor the calculation of depreciation.These rules need not necessarily besimilar to current business practicesor regulations other than taxation.

5.3.3 Fair Financial Position

If depreciation on assets is notprovided for, then the assets will beover valued and the balance sheet willnot depict the correct financial positionof the business. Also, this is notpermitted either by establishedaccounting practices or by specificprovisions of law.

5.3.4 Recording the True Impact of an Expense

Depreciation is a device for maintai-ning a proper record of capital andrevenue expenditure of a businessentity. This becomes quite clear whenan outright purchase of an asset iscompared with taking of an asset onhire rent or fee which is charged againstperiod’s revenue assuming for at netprofit. Therefore, purchase of an assetindirectly implies that the asset hasbeen given on hire by capital to revenue.Recording of this crucial expense goesa long way in providing more completeinformation for the computation ofproduct cost of goods manufactured.

5.3.5 Compliance with Law

Apart from tax regulations, there arecertain specific legislations thatindirectly compel some businessorganizations like corporate enter-prisesto provide depreciation on fixed assets.

5.4 Factors Affecting Depreciation

These have been very cogently spelt outas part of the definition of depreciationin the Accounting Standard VI and arebeing elaborated here.

142 ACCOUNTANCY

5.4.1 Wear and Tear

Wear and tear means deterioration,and the consequent diminution in itsvalue, arising from its use in businessoperations for earning of revenue. Itreduces the asset’s technicalcapitalizes to serve the purpose for,which it has been meant. Anotheraspect of wear and tear is the physicaldeterioration. A asset deterioratessimply with the passage of time, eventhough they are not being put to anyuse. This happens especially when theassets are exposed to the rigours ofnature like weather, winds, rains, etc.

5.4.2 Expiration of Legal Rights

Certain categories of assets lose theirvalue after the agreement governingtheir use in business comes to an endafter the expiry of pre-determinedperiods. Examples of such assets arepatents, copyright, leases, etc. whoseutility to business is extinguishedimmediately upon the removal of legalbacking to them.

5.4.3 Obsolescence

Obsolescence is another factor leadingto depreciation of fixed assets. Inordinary language, obsolescencemeans the fact of being “out of date”.Obsolescence has reference to anexisting asset becoming out of date anaccount of the availability of better typeof asset. It arises form such factors as:

● technological changes;● improvements in production

methods;● change in market demand for

the product or service output ofthe asset, and

● legal or other description.

5.5 Determinants of Depreciation

The determination of deprecationfocusses on the parameters involvingcost, estimated useful life and probablesalvage value — in estimating itsamount.

5.5.1 Cost of Asset Installed

The cost of the asset generally includesits purchase price plus all theexpenditure required to secure title toit and to get it ready for operationaluse. Thus, the cost of land alsoconsists of legal charges, broker’s feesand transfer taxes; the cost of buildingas well comprises permit fee,engineering fees, remodelling costs; thecost of machinery is represented byadditional expenses of transportation,installation and all other costsincurred in putting it into a positionto start its operations. Similarly, whenan old plant is acquired, allexpenditures incurred in bringing it toits full operational level — paintoverhauling, replacement parts, etc-are treated as cost of the asset.Forexample, a pressing machine waspurchased for Rs.10,000 at 2 per centdiscount net condition. Rs.250 werepaid for its transportation to theworkshop site, Rs. 150 was the wiringcost incurred on it and specialfoundation for it required anexpenditure of Rs. 220. The cost of themachine for use in operations wouldinclude following:


Rs RsPurchase price 10,000Less 2% cash discount 200Net purchase price 9,800Add installation costs:Transportation 250Wiring 150Special foundation 220 620

Total cost of the asset 10,420

The journal entry for the purchase ofmachine would be:

Rs. Rs.

Machinery A/c Dr. 10,420 Cash/Bank A/c 10,420(Cash purchase ofmachine)

5.5.2 Estimated Useful Life

Depreciation denotes the cost of anasset allocated to accounting periodeither according to a time-boundprogramme or as per productioncapacity of the asset. The estimateduseful life of the asset is of criticalimportance as a determinant ofdepreciation. Useful life of the assetis represented by the number ofyears of estimated serviceable lifespan of an asset. Thus, if an assetis expected to last for ten yearsbefore completely losing itsusefulness for business operations,its useful life is taken to be ten years.The useful life of a depreciable assetis shorter than its physical life andis:

● pre-determined by legal orcontractual limits, such as,expiry dates of leases;

● directly governed by extractionor consumption;

● dependent on the extent of useand physical deteriorations onaccount of wear and tear whichagain depends on operationalfactors, such as, the number ofshifts for which the asset is tobe used, repairs and mainte-nance policy of the enterprise, etc.

Determination of the useful life ofthe asset is a matter of estimation.These days such estimates areprovided by the supplier of the assethimself to the buyer at the time ofpurchase. Such estimation is moredifficult for an asset using new-technology or used in production of anew-product due to rapidity ofinventions and innovations. In the caseof internally generated assets,depreciation is provided on thepeculiar operational features of theasset concerned or standard operatingpolicies of the enterprise in thisconnection by using management’sestimate about the life of an asset.

5.5.3 Estimated Salvage Value

When the useful life of the asset comesto an end, it may either become entirelyvalue less or may fetch a very smallamount when sold in the market asscrap. The value of the asset that is sorealized is referred to as ‘Residual’,‘Breakup’ or ‘Salvage’ value.’Determination of the residual value isnormally a difficult matter. If such avalue is considered insignificant, it isgenerally regarded as nil. In case theresidual value is likely to be significant,it is estimated at the time of

144 ACCOUNTANCY

acquisition/ installation or at the timeof the subsequent revaluation ofassets. It is mostly regarded thatexperience alone will enable a businessto arrive at a salvage value factor.

5.6 Methods of Depreciation

The depreciation to be provided forduring an accounting year is thefunction of depreciable amount andthe method of allocation. For this, twomethods are mandated by law andenforced by professional accountingpractice in India, these are the StraightLine Method and Written Down ValueMethod. These methods are discussedhereunder:

5.6.1 Straight Line Method

This is the earliest and one of the mostwidely used methods of providingdepreciation. It is based on theassumption of equal usage of the assetover its entire useful life. This is alsocalled Straight Line Method for thereason that if the amount ofdepreciation and corresponding timeperiod is plotted on a graph, it willresult in a straight line (figure 5.1). Itis also called fixed installment methodbecause the annual charge ofdepreciation remains constant fromyear to year over the useful life of theasset. According to this method, afixed and an equal, amount is chargedas depreciation in every accountingperiod during the life-time of an asset.The amount annually charged todepreciation is such that it reduces theoriginal cost of the asset to its scrapvalue, at the end of its serviceable life.

The depreciation to be provided underthis method is computed by using thefollowing formula:

Depreciation = Acquisition Cost of Asset - EstimatedAmount Scrap Value

Estimated Life of the Asset

Total amount of depreciation to beprovided would be equal to cost ofacquisition less scrap value. Rate ofdepreciation, under straight linemethod is the per cent of the portionof depreciation to the total cost of theasset to be provided during the usefullifetime of the asset. Rate of depre-ciation is calculated as follows:

Annual Depreciation Amount ∞ 100 =

Depreciation Cost of Assets

Fig 5.1: Showing straight line depreciationwhen plotted on a graph

5.6.2 Written Down Value Method

Under this method, depreciation ischarged on the book value of the asset.Since book value keeps on reducingby the annual charge of depreciation.It is also known as reducing balancemethod. This method involves theapplication of a predeterminedproportion/percentage of the bookvalue of asset at the beginning of every

Rate of

Straight Line Depreciation

0

2000

4000

6000

1 2 3 4 5

Life of Asset

Dep

reci

atio

n

Series1


accounting period, so as to reduce theasset to its break-up value at the endof its useful life.

Thus, the rate of depreciationremains fixed but the amount ofdepreciation charged on the asset goeson diminishing with the passage oftime. This is due to the reason that apre-determined percentage is appliedto a gradually shrinking balance on theasset account every year. Under thismethod, large amount is recovered asdepreciation charge in the earlier yearsthan in the later years.

Rate of Depreciation

Under Written Down Value Method,the rate of depreciation is computed byusing the following formula:

Rate of Depreciation = [ 1- n S ] × 100 (in percentage) C

Where : n = expected useful lifes = scrap valuec = cost of an asset.

Box 1: Computation of rate of depreciation under written down value method

Illustration 1

Nagi Company Ltd purchased a coldstorage plant for Rs 2,50,000 on 1

January 2001.Depreciation is to beprovided annually according tostraightline method. The useful life ofthe plant is 10 years and its scrap valueafter 10 years is estimated to beRs.10,000. Compute the amount ofdepreciation to be charged every year andalso calculate the rate of depreciation.

SolutionAnnual Depreciation Amount: Acquisition Cost of Asset - Estimated Scrap Value= –––––––––––––––––––––––––––––––––––––––––––––

Estimated Life of the Asset

Rs. 2,50,000 - Rs.50,000 = –––––––––––––––––––––––––––

10 = Rs. 20,000Rate of Annual Depreciation Amount × 100 = ––––––––––––––––––––––––––––––––––Depreciation Acquisition Cost

Rate of Depreciation

= Rs. 2,40,000×100/2,50,000

= 9.6%

Illustration 2Gourav Bros. acquired a machine on1 July 1990, at a cost of Rs.28,000 andspent Rs.2,000 on its installation. Thefirm writes off depreciation at 10% ofthe original cost every year. The booksare closed on 31 December every year.Show the Machinery Account andDepreciation Account for three years.

Solution:

Books of Gourav Bros Machinery AccountDr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. AmountRs. Rs.

1990 1990

July 1 Bank 28,000 Dec 31 Depreciation 1,500July 1 Bank 2,000 Balance c/f 28,500

Installation Dec 3130,000 30,000

146 ACCOUNTANCY

1991 1991Jan 1 Balance b/f 28,500 Dec 31 Depreciation 3,000

Balance c/f 25,50028,500 Dec 31 28,500

1992 1992Jan 1 Balance b/f 25,500 Dec 31 Depreciation 3,000

Dec 31 Balance c/f 22,50025,500 25,500

1993Jan 1 Balance b/f 22,500

Depreciation AccountDr. Cr.


Dec 31 Machinery 1,500 Dec 31 Profit & Loss 1,5001991 1991Dec 31 Machinery 3,000 Dec 31 Profit & Loss 3,0001992 1992Dec 31 Machinery 3,000 Dec 31 Profit & Loss 3,000

Solution

Books of Raj Washing House Washing Equipment AccountDr. Cr.


Jun. 1 Bank 2,00,000 Dec 31 Depreciation 20,000Balance c/f ` 1,80,000

2,00,000 2,00,002000 2000Jan 1 Balance b/f 1,80,000 Dec 31 Depreciation 22,000

Bank 20,000 Balance c/f 1,78,000

2,00,000 2,00,0002001 2001Jan 1 Balance b/f 1,78,000 Dec 31 Depreciation 22,000

Balance c/f 1,56,000

1,78,000 1,78,000

Illustration: 3Raj Washing House purchasedwashing equipment for Rs. 2,00,000on 1 January 1999. On 1 January2000, an additional machinery waspurchased for Rs.20,000. Prepare the

asset account in the book of RajWashing House for three years,providing depreciation at 10% p.a.using straight line method. The firmclose its book on 31 December everyyear.


Book Value of Machine = Rs. 50,000- Rs.13,750= Rs. 36,250

Depreciation for II year = Rs.36,250 x 27.5(31 Dec 2002) 100

= Rs.9968.75Book value of machine = Rs. 36,250 - Rs. 9968.75

= Rs. 26,281.25Depreciation for III year = Rs. 26,281.25 x 27.5(31 Dec 2003) 100

= Rs. 7,227.34Book value of machine = Rs. 26,281 - Rs. 7,227.34

= Rs. 19,053.91Calculation of Rate ofDepreciation:Rate of depreciation = [ 1- n S ] × 100

c= 1-10 2,000 × 100 50,000= .275 = 27.5%1

Illustration 5

(Written Down Value Method)

Atul Transport Company purchases atruck for a sum of Rs. 2,00,000 on1 January 2001. It charges 20%depreciation per annum according tothe written down value method. Thetruck was sold on 1 July 2002 for asum of Rs. 1,60,000. You are requiredto prepare the Truck Account for2001-2002.

Working NotesCalculation of Amount of Depreciation:

I Year: 10% on Rs 2,00,000 Rs. 20,000II Year: Depreciation on equipment Rs. 20,000Purchased on 1 January

1999 10% on Rs 20,000 Rs. 2,000addition made on 1 Jan 2000

Rs. 22,000Illustration 4

(Rate of Depreciation Written DownValue Method)

On 1 January 2001, Shivam PrintingPress purchased a printing machinerycosting Rs. 50,000. Its scrap value isRs. 2,000 and expected life is 10 Years.It is decided to depreciate printingmachinery by written down valuemethod for initial 3 years.

Calculate the rate of depreciationunder this method and show thewritten down value (book value) at theend of the year.

SolutionDepreciation for I year = Rs.50,000 x 27.5(31 Dec 2001) 100

= 13,750

Solution

Books of Atul Transport CompanyTruck Account

Dr. Cr.


July 1 Bank 2,00,000 Dec 31 Depreciation 40,000Dec 31 Balance c/f ` 1,60,000

2,00,000 2,00,0002002 2002Jan 1 Balance b/f 1,60,000 Jul 31 Bank (sale 1,60,00

Proceed)Dec 31 P&L (Profit 16,000 Depreciation 16,000

on Sale) (for 6 Months)

1,76,000 1,76,000

148 ACCOUNTANCY

5.7 Straight Line Method andWritten Down Value Method:A Comparative Description

5.7.1 Annual Charge of Depreciation

Under straight-line method ofdepreciation, a fixed portion of assetis written down annually with respectto the original cost. Thus, a fixedamount is charged every year duringthe life-time of an asset. Under writtendown value method the charge ofdepreciation declines every year withrespect to book value becausedepreciation is charged on the bookvalue and not on the original costwhich is a reducing base.

5.7.2 Basis of Charge

This basis of charge under straightline method is the cost ofacquisition/original cost of the assetwhereas the basis of charge is underwritten down value method bookvalue of the asset.

5.7.3 Charge on Profit and Loss Account

Under straight line method charge toprofit and loss account in respect ofdepreciation and repairs are puttogether as unequal charge againstincome because of the constantamount of depreciation charge duringthe useful life of the asset whereas inwritten down method such charge toprofit & loss account remains equalbecause of amount of depreciationbeing reduced in the later years andrepairs cost increases due to declinein efficiency and wear and tear of theasset due to advancing age of the asset.

5.7.4 Deferment

In straight line method, it is notpossible to defer the tax liabilitywhereas in written down method taxliability can be deferred (but during theentire life span of an asset tax liabilityremains the same in both themethods). See figure 5.2 .

S. Basis Straight Line Method Written DownNo. Value Method

1. Annual Charge of It is constant It declines withDepreciation respect to book value

2. Basis of Charge It is based on cost of It is based on written downacquisition value

3. Charge to Profit Charge will go on Charge remains almostand Loss Account increasing year after uniform over years

year

Deferment of Tax It is not possible It is possible

Fig. 5.2 : Comparison of Straight Line Method and Written Down Value Method


Illustration 6

(Comparative Presentation of Methods)Vishal Plastics acquired a machine on1 July 1998 at a cost of Rs.1,00,000on 31 March 2001. The machine wassold for Rs.55,000. You are requiredto prepare machinery account and

depreciation account in the books ofthe firm according to both the straightline and the written down valueassuming the rate of depreciation is 10%.Methods: The account are balancedon 31 December every year on itsinstallation.

Solution

Books of Vishal PlasticsMachinery Account

Dr. Cr.

Date Particulars S.L.M. W.D.V. Date Particulars S.L.M. W.D.V.Amount Amount Amount Amount Rs. Rs. Rs. Rs.

1998 Bank 1,00,000 1,00,000 1998 Depreciation 5,000 5,000Jul 1 (Purchase) Dec 31 for 6 months

Dec 31 Balance c/f 95,000 95,000

1,00,000 1,00,000 1,00,00 1,00,0001999 1999Jun 1 Balance b/f 95,000 95,000 Dec 31 Depreciation 10,000 9,500

Dec 31 Balance c/f 85,000 85,500

95,000 95,000 95,000 95,0002000 2000Jan 1 Balance b/f 85,000 85,000 Dec 31 Depreciation 10,000 8,500

Dec 31 Balance c/f 75,000 76,500

85,000 85,000 85,000 85,0002001 2001Jan 1 Balance b/f 75,000 76,500 Mar 31 Bank-Sale 55,000 55,000

PriceMar 31 Depreciation 2,500 1912

for 3 monthsMar 31 Profit and 17,500 19,588

Loss Account(Loss on Sale)

75,000 76,500 75,000 76,500

● SLM = Straight Line Method

● WDV = Written Down Value Method

150 ACCOUNTANCY

Journal entries under this recordingtechnique are as follows:

Purchase of Asset (Year of purchase) Asset A/c Dr. Bank/Supplier A/c(Cash or credit purchase of asset)

Depreciation Charged (Every Year)to an Asset Depreciation A/c Dr. Asset A/c(Depreciation provided on asset)

Transfer of Depreciation (Every Year)as Business Expense Profit and Loss Account A/c Dr. Depreciation A/c(Depreciation debited toprofit and loss account)

Sale of Asset as Scrap (Year of Sale) Bank A/c Dr. Asset A/c(Asset sold as scrap)

Closure of Asset Account (At End)

5.8 Methods of Recording Depreciation

There are two types of arrangement forkeeping record of depreciation on fixedassets viz:

● depreciation is directly charged tothe asset account; and

● depreciation annually providedand accumulated in a separateaccount, especially maintained forthe purpose.

5.8.1 Depreciation on Asset Account

According to this arrangement,depreciation is provided by beingcredited to the asset account everyyear. That is, the depreciation, as abusiness expense, is transferred toProfit and Loss Account.

It is possible that, after an asset hasbeen completely depreciated and its scrapvalue is realized, some balance might beleft on the asset account. Such a balanceis debited or credited, as the case maybe, to Profit and Loss Account denotingprofit or loss on sale of the asset.

If there is ProfitAsset A/c Dr.

P&L A/c

If there is LossProfit and Loss A/c Dr.

Asset A/c

Balance Sheet Presentation

Throughout the period of its servicetenure, the asset is listed in the balancesheet at its book value at the beginningof every year, less depreciation providedon it at the end of the year.

5.8.2 Depreciation Accumulated on a Separate Account

This method is designed to accumulatedepreciation provided in an asset on aseparate account generally called‘Depreciation Provision’ or ‘Accumu-lated Depreciation’. Such accumu-lation of depreciation enables that theasset account need not be disturbedin any way and it continues to beshown at its original cost over thesuccessive years of its useful life.

There are some basic charac-teristics of this method of recordingdepreciation, which must be focused upon”

● asset account continues toappear at its original cost yearafter year of its service tenure.

● depreciation is accumulated ona separate account instead of


being adjusted into the asset accountat the end of the accounting period.

● recording mechanism has to beused together with the twomethods of providing depreciationbecause it is only a mode ofaccounting representation.

The pattern of journal entries forthis method of recording depreciationis as follows:

denotes either under provision orexcess provision as the case may be,in respect of depreciation on the asset.It is, therefore, transferred to profit andloss account.

Balance Sheet Presentation

Asset is shown at its original cost inthe balance sheet throughout itsserviceable life and the balance on theaccumulated depreciation account isshown as a deduction from its originalcost. This representation in thebalance sheet is more informative as itgives both the original cost of, the assetand the depreciation accumulated upto the date on the asset account.

Illustration 7

(Methods of Recording Depreciation)

On 1 January 1998, Max GB Limited,whose accounting year ends on31 December, purchased ten machinesof Rs.2,000 each. On 31 March 1999,one machine was sold for Rs.1,600 and,on 30 September 2000 another machinewas sold for Rs.1,500. A new machinewas purchased on 30 June 2001 for Rs.2,400. The Company has adopted thepractice of providing depreciation at 10per cent per annum on original cost ofmachines. You are required to preparethe necessary ledger accountsincorporating the above transactions ofmachines, and providing appropriatedepreciation on them, where:

● depreciation is written offthrough machinery account

● depreciation is accumulated ona separate account

Purchase of Asset (Time ofpurchase)

Asset A/c Dr. Bank/Supplier A/c(Cash or credit purchaseof asset)

Depreciation Provided andAccumulated (Every year) Depreciation A/c Dr. Accumulated Depreciation A/c(Depreciation provision accu-mulated on a separate account)

Depreciation as Business Expense (End of year) Profit and Loss Dr. Account A/c Depreciation A/c(Depreciation charged toprofit and loss)

Retirement of Asset (Year ofretirement)

Accumulated Depreciation A/c Dr. Asset A/c(Transfer of accumulateddepreciation to asset)

Sale of Asset as Scrap (Year of sale) Bank A/c Dr. Asset A/c(Scrap value of asset realized)

Closure of Asset Account

Some balance is normally left on theasset account after an asset has beencomplety depreciated and its scrapvalue is realized. Such a balance

152 ACCOUNTANCY

Solution

1. Depreciation written off to machinery account

Books of Max GB LimitedMachinery Account

Dr. Cr.


1998 1998July 1 Bank 20,000 Dec 31 Depreciation 20,0001

(Purchase) Dec 31 Balance c/f 18,000

20,000 20,000

1999Jan 1 Balace b/f 18,000 Mar 31 Bank (sale) 1,600

Mar 31 P&L (Loss on 1502

Sale)Mar 31 Depreciation 50Dec 31 Depreciation 1,800

Balance c/f 14,400

18,000 18,000

2000Jan 1 Balance b/f 14,400 Mar 31 Bank (Sale) 1,500Sep 30 Profit & Loss 50 Dec 31 Depreciation 1,750

Dec 31 Balance c/f 11,200

14,450 14,450

2001Jan 1 Balance b/f 11,200 Dec 31 Depreciation 1,720Jun 30 Bank 2,400 Dec 31 Balance c/f 11,880

(Purchase)

13,600 13,600

Working Notes:

Calculation of Depreciation amount for 1998

On Rs. 20,000 at 10 per cent for 1 year Rs. 2,0001

(a) Loss on Sale of First Machine

Original Cost of Machine Sold Rs. 2,000

Less depreciation provided:

1998 - On Rs. 2,000 at 10% for one year Rs. 2001999 - On Rs. 2,000 10% for 3 months Rs. 50 Rs. 250Book value on 31 March 1999 Rs. 1,750Less scrap value on sale Rs. 1,600

Loss on sale Rs. 1502


(b) Depreciation amount for 1999:

On Rs. 18,000 (Rs. 20,000) at 10 per cent for year Rs. 1,800On Rs. 2,000 at 10 per cent for three months Rs. 50

Total Rs. 1,850

(c) Profit on sale of second machine

Original cost of machine sold Rs. 2,000Less depreciation provided:1998 - Rs. 2,000 at 10% for 1 year Rs. 2001999 - Rs. 2,000 at 10% for 1 year Rs. 2002000 - Rs. 2,000 at 10% for 9 months Rs. 150 Rs. 550Book value on 30 September 2000 Rs. 1,450Less scrap value on sale Rs. 1,500

Profit on sale Rs. 50

(d) Depreciation amount of 2000

On Rs. 16,000 (Rs. 20,000 - Rs. 4,000) at 10% for 1 year Rs. 1,600On Rs. 2,000 at 10% for 9 months Rs. 150

Total Rs. 1,750

(e) Depreciation amount for 2001

On Rs. 16,0001 at 10% for 1 year Rs. 1,600On Rs. 2,400 at 10% for 6 months Rs. 120

Total Rs. 1,720

II. Depreciation Accumulated on a Separate Account

Machinery AccountDr. Cr.


1998 1998July 1 Bank 20,000 Balance c/f 20,000

(Purchase)20,000 20,000

1999 1999Jan 1 Balance b/f 20,000 Mar 31 Bank (sale) 1,600

Mar 31 Accumulated 250Depreciation(Transfer)

Mar 31 P&L (Loss on 150Sale)

Mar 31 Balance c/f 18,000

20,000 20,000

154 ACCOUNTANCY

Jan 1 Balance b/f 18,000 Mar 31 Bank 1,500Sep 30 Profit & Loss 50 Dec 31 Accumulated 550

on Sale Dec 31 (Transfer) 16,000

18,050 18,0502001Jan 1 Balance b/f 16,000 2001 Balance c/f 18,400Jun 30 Bank Purchase 2,400 2001

18,400 18,400

Books of Max GB LimitedDepreciation Account

Dr. Cr.


1998 1998July 31 Balance c/f 2,000 Dec 31 Profit and Loss 2,000

(Provision)

2,000 2,000

1999 1999Mar 31 Machines- 250 Balance b/f 2,000

Transfer Dec 31 Provision & 1,850Dec 31 Balance c/f 3,600 Loss

Dec 31 (Provision)

3,850 3,850

2000 2000Sep 30 Machine- 550 Jan 1 Balance b/f 3,600Dec 31 Transfer Dec 31 Profit & Loss 1,750

Balance c/f 4,800 (Provision)

5,350 5,350

2001 2001Dec 31 Balance c/f 6,520 Jan 1 Balance b/f 4,800

Profit & Loss 1,720Dec 31 (Provision)

6,520 6,520

5.9 Asset Disposal AccountAsset disposal account is designed toprovide a complete and clear view ofall the transactions involved in the sale

of an asset under one account head.The concerned variables are theoriginal cost of the asset, depreciationaccumulated on the asset up to date,


sale price of the asset, value of theparts of the asset used for retained, ifany, and the resultant profit or losson disposal. The balance of thisaccount is transferred to the profit andloss account.

An important point about assetdisposal account is that it is of atemporary nature and has to be closedas soon as its purpose is achieved.Therefore, it has to be prepared everytime an asset is sold, as its balance isnot carried over.

The journal entries required foroperating the Asset Disposal Accountare as follows:

Transfer from Asset Account

Asset Disposal A/c Dr.Asset A/c

(Transfer from asset account for sale)

Transfer of Depreciation Provision AccountDepreciation Provision/Accumulated

Depreciation A/c Dr.Asset Disposal A/c

(Balance of depreciation provision transferred)

Sale of AssetBank A/c Dr.

Asset Disposal A/c(Sale of asset)

Retained Parts of AssetStores/New Asset A/c Dr.

Asset Disposal A/c(Value of retained parts brought into account)

Closure of Asset Disposal Account

Asset disposal account mayultimately show a debit or creditbalance depending upon the detailsentered in it. The debit balance on theaccount would indicate either loss on

disposal, or inadequacy of depreciationprovided, and would be dealt with asfollows:

Profit and Loss A/cAsset Disposal A/c Dr.

(Loss on disposal transferred toprofit and loss a/c)

The credit balance of theaccount, may be taken either asprofit on disposal or excessiveprovision of depreciation on asset,and would be closed by the followingJournal entry:

Asset Disposal A/cProfit and Loss A/c Dr.

(Profit on disposal transferred toprofit and loss a/c)

Illustration 8:

(Disposal of Assets)

On 1 January 1999, Nagi Bros.purchased six machineries forRs. 15,000 each.

Depreciation at the rate of 10 percent on original cost of machines hasbeen provided and accumulated on‘Depreciation Provision Account’.

On 1 January 2000, one machinewas sold for Rs.12,500 and, on1 January 2001, a second machinewas also sold for Rs.13,000.

An improved model with a cost ofRs.28,000 was purchased on 1 July2000 and the arrangement forproviding depreciation was kept to bethe same as for older machines.

You are required to show ofMachinery A/c, Depreciation Provisionand Asset Disposal A/c.

156 ACCOUNTANCY

Machinery Disposal AccountDr. Cr.


2000 2000Jan 1 Machine 15,000 Jan 1 Depreciation 1,500

(Purchase) ProvisionJan 1 Bank 12,500

Profit & LossJan 1 (loss on sale) 1,000

15,000 15,000

2001Depreciation

Jan 1 Machinery 15,000 Jan 1 Provision 3,000(transfer)

Jan 1 Profit and Loss 1,000 Jan 1 Bank (sale price) 13,000(gain on sale)

16,000 16,000

Solution

Books of Nagi BrosMachinery Account

Dr. Cr.


1999 1999Jan 1 Bank 90,000 Dec 31 Balance c/f 90,000

(Purchase)

90,000 90,000

2000Jan 1 Balance b/f 90,000 2000

Bank 28,000 Jan 1 Machine Disposal 15,000(Purchase) (transfer)

Dec 31 Balance c/f1,03,000

1,18,000 1,18,000

2001 1,03,000 2001Jan 1 Balance b/f Jan 1 Machine Disposal 15,000

(transfer)Dec 31 Balance c/f 88,000

1,03,000 1,03,000


Depreciation Provision AccountDr. Cr.


1999 1999Dec 31 Balance c/f 9,000 Dec 31 Depreciation 9,0001

9,000 9,000

2000 2000Jan 1 Machine 1,500 Jan 1 Balance b/f 9,000

Disposal(Transfer)

Dec 31 Balance c/f 16,400 Dec 31 Depreciation 8,9002

17,900 17,900

2001 2001Jan 1 Machine 3,000 Jan 1 Balance b/f 16,400

Disposal(transfer)

Dec 31 balance c/f 22,200 Dec 31 Depreciation 8,8003

25,200 25,200

Working Notes:

Calculation of Amount of Depreciation amount

1999

10% on Rs. 90,000 for one year Rs. 9,0001

2000

10 % on Rs. 75,000 for one year Rs. 7,50010 % Rs 28,000 for six months Rs. 1,400

Rs. 8,9002

2001

10 % on Rs. 60,000 (Rs. 75,000-Rs. 15,000)for one year Rs. 6,00010 % on Rs 28,000 for one year Rs. 2,800

Rs. 8,8003

II Loss on sale of First MachineOriginal Cost on 1 January 1999 Rs. 15,000Less Depreciation at 10%for the year Rs. 1,500

Book Value on 1st January 2000 Rs.13,500

Sale Price Realized Rs. 12,500

Loss on Sale Rs. 1,0004

III Profit on Sale of Second MachineOriginal Cost on 1 January 1999 Rs.15,000Less Depreciation at 10% fortwo year Rs. 3,000

Book Value on 1 January 2001 12,000

Sale Price Realized Rs. 13,000

Profit on Sale 1,0005

Illustration 9

On 1.4.2001, following balancesappeared in the books on M/s AnilTraders: Furniture accountRs. 20,000, Provision for Depreciationon Furniture Rs. 12,000.On 1.10.2001a part of furniture purchased forRs.8,000 on 1.4.99 was sold forRs.3,000. On the same date a new

158 ACCOUNTANCY

furniture costing Rs.12,000 waspurchased. The depreciation wasprovided @ 10% p.a. on original costof the asset and no depreciation was

charged on the asset in the year ofsame. Prepare furniture account,provision for depreciation on furnitureaccount for the year ending 31.3.2002.

Solution:

Books of Anil TradersFurniture Account

Dr. Cr.


Apr 1 Balance c/f 20,000 Oct 1 Bank 3,000Oct 1 Bank 12,000 Oct 1 Provision 1,600

Oct 1 Loss on Sale 3,400Mar 31 Balance b/f 24,000

32,000 32,000

Depreciation Provision Account

Dr. Cr.


Apr 1 Furniture 1,600 Apr 4 Balance c/f 12,000

2002 2002

May Balance c/f 12,200 May 31 Depreciation 1,80031

13,800 13,800

Illustration 10

(Asset Disposal Account)

Solve problem 3, if asset disposal

account is to be prepared alongwith furniture account andprovis ion for depreciat ion onfurniture account.


Solution:

Books of Anil TradersFurniture Account

Dr. Cr.


2001 2001Apr 1 Balance c/f 20,000 Oct 1 Furniture 8,000

Disposal A/c

2001 2002

Oct 1 Bank 12,000 Mar 31 Balance c/f 24,000

32,000 32,000

Depreciation Provision AccountDr. Cr.


2001 2001Oct 1 Furniture 1,600 Apr 1 Balance c/f 12,000

disposal

2002 2002

May Balance c/f 12,200 May 31 Depreciation 1,80031

13,800 13,800

Furniture Disposal AccountDr. Cr.


2001 2001Oct 1 Furniture 8,000 Oct 1 Depreciation 1,600

Bank 3,000Profit & Loss(loss on sale) 3,400

8,000 8,000

160 ACCOUNTANCY

Illustration 11 (Loss by Fire)

On 1.1.98, Neha Ltd purchased fromM/s Varun Bros plant costing2,00,000 on instalment basis payableas follows:

On 1.1.98 50,000On 1.7.98 50,000On 1.1.99 50,000On 1.1.00 50,000

The company spent Rs. 5,000 ontransportation and installation of theplant. It was decided to provide fordepreciation on straightline method.For this purpose, the useful life of the

plant was estimated at 5 years. It wasalso estimated that at the end of theuseful life, realizable value of the plantwould be Rs.6,000 (Gross) anddismantling cost of the plant, to be paidby the company was estimated at Rs.1,000. The plant was destroyed by fireon 31-12-01 and an insurance claimof Rs. 25,000 was admitted by theinsurance company. Prepare plantAccount, Accumulated DepreciationAccount, Plant Disposal Account andLoss on Sale of Plant assuming thatthe company closes its books on31 December every year.

Books of Neh LtdPlant Account

Dr. Cr.


1998 1998Jan 1 M/s Varun Bros. 2,00,000 Dec 31 Balance c/f 2,05,000

Bank 5,000

2,05,000 2,05,000

1999 1999Jan 1 Balance b/f 2,05,000 Dec 31 Balance c/f 2,05,000

2,05,000 2,05,0002000 2000Jan 1 Balance b/f 2,05,000 Dec 31 Balance c/f 2,05,000

2,05,000 2,05,0002001 2001Jan 1 Balance b/f 2,05,000 Dec 31 Plant Disposal 2,05,000

2,05,000 A/c 2,05,000


Accumulated Depreciation Account

Dr. Cr.


1998 1998Dec Balance c/f 40,000 Dec 31 Depreciation 40,00031 A/c

40,000 40,000

1999 1999Dec Balance c/f 80,000 Jan 1 Balance c/f 40,00031 Dec 31 Depreciation 40,000

80,000 80,000

2000 Balance c/f 1,20,000Dec Jan Balance c/f 80,00031 Dec 31 Depreciation 40,000

1,20,000 1,20,000

2001 2001Dec Plant Dis- 1,60,000 Jan 1 Balance b/f 1,20,00031 posal A/c Dec 31 Depreciation 40,000

1,60,000 1,60,000

Plant Disposal AccountDr. Cr.


2001 2001Dec Plant 2,05,000 Dec 31 Accumulated 1,60,00031 Depreciation

Insurance Co, 25,000Profit & Loss 20,000(Loss on Sale)

2,05,000 2,05,000

Loss on Sale AccountDr. Cr.


1998 1998Dec 31 Plant Disposal 20,000 Dec 31 Profit and Loss 20,000

20,000 20,000

162 ACCOUNTANCY

SECTION II

Provisions and Reserves

In the previous section, we haddiscussed about depreciation accoun-ting and this section deals withProvisions and Reserves.

Every business enterprise,irrespective of its form of organization,likes to conduct its operations in aprudent manner so as to be able tomeet all eventualities — both expectedand unexpected. This is done, amongother things, by making provisions,and creating reserves, at the time ofthe preparation of financial statements.

5.10 Meaning of Provisions

The term ‘provision’ means an amount,which is: written off, or retained, byway of providing for depreciation,renewals, diminution in the value ofassets; or retained by way of providingfor any unknown future liability ofwhich the amount cannot bedetermined with reasonable accuracy.

Oviously, where the amount of aliability is known, or can beascertained, a definite liability shouldbe created, e.g., liability foroutstanding interest. Examples ofprovisions are provision for doubtfuldebts, provision for depreciation,provision for repairs, provision fordiscount on debtors, provision fortaxation, provision for legal damageslikely to arise from a pending suit.Provision is a charge against the profitof the year and hence, it is debited toprofit and loss account beforecalculating the net profit for the year,

and is shown in the balance sheet afterthe certain liabilities on the liabilityside. It is to be noted that provisionhas to be made irrespective of the factwhether a firm make a profit or not,othervise it leads to breach ofprudential business behaviour.

5.11 Meaning of Reserves

Reserve means amount set aside outof profits (as calculated by the profitand loss account) or other surpluseswhich are not meant to cover anyliability, contingency, commitment orlegal requirement. Thus, reservecovers the case of amount which isneither a liability nor a provision. Itis allocation of the profit and not acharge against the current revenues.It, in fact, belongs to the proprietorsover and above the capital contributedby them. In case amount equal to areserve is invested in outsidesecurities, it is called ‘Reserve Fund’but the absence of this conditionsentitles it to be called simply ‘reserve’.When it is called fund and meant for agiven purpose, it is called “SpecificReserve”, otherwise “General Reserve”.

Examples of reserves are CapitalReserve, General Reserve, ContingencyReserve, Dividend Equalization Reserve,Debenture Redemption Fund, etc.

5.12 Importance of Provisions and Reserves

A business firm in general, and acorporate enterprise in particular mayconsider it proper to set up somemechanism to protect itself from theconsequences of known liabilities and


losses it may be required to bear infuture. It may also regard it as moreappropriate in certain cases to reducethe amount that can be drawn by theproprietors as profit in order toconserve business resources to meetcertain significant demands for themin future. An example of such ademand is the much-neededexpansion in the scale of businessoperations. This is presented as thejustification for the role of provisionsand reserves in business activities andin accounting.

The amount so set aside may bemeant for the purpose of:

● fulfilling some specificrequirements like repairs andrenewals of an asset;

● meeting a future liability or loss;● strengthening the general

financial position of anundertaking;

● redeeming a long-term liabilitylike debentures.

5.13 Distinction

The identification and understandingof the precise scope of ‘provisions’ and‘reserves’ require explanation ofdif ferences between them forclarification of their respective roles inbusiness and in accounting.

5.13.1 Purpose

A provision is created for some specificliability in view but reserve is meantto meet the future legal obligations orinvestment requirements of businessfor development.

5.13.2 Mode of Creation

A provision is a charge against profitand loss account of the year and has tobe created even when profits are notexpected. A reserve is an appropriationof profits and can be made out of eitherprofits earned during a year or from alreadyexisting surplus, e.g. contingency reserve.

5.13.3 Presentation in Balance Sheet

A provision is generally presented asa deduction from the item for which ithas been created on the asset side ofthe balance sheet or as a liability aftercurrent liabilities as part of externalequities. Reserve is listed as distinctitem on the liabilities side of thebalance sheet.

5.13.4 Utilization

Very rigid restrictions are enforced inpractice on the use of provisions inbusiness operations to make themadhere to the purpose for which theyhave been meant. Contrary to this, thebalance of general reserve, or anyaccount of such a nature, is alwaysavailable for any bonafide requirementsof business. However, reserves createdunder specific legal obligations such as“Capital Redemption Reserve orDebenture Redemption Reserve” is to beused within the framework of the law only.

5.13.5 Identification with Operations

A provision is made for meeting aparticular liability or likely loss on aspecific item. Therefore, they cannotbe distanced from business operations

164 ACCOUNTANCY

and their investment outside thebusiness is just not possible. Reserves,being of a general nature, can beinvested outside the business to avoidthe possibility of their non-availabilityin the event of need as well as to earnsome additional income with their help.However, outside investment ofreserves by business is not mandatoryin all situations.

5.13.6 Inter Transfers

Provision cannot directly be trans-ferred to any reserve but reserves,where required, can be transferred toprovisions to boost their balances.

5.13.7 Support for Profit Distribution

The severely restrictive rules governingprovisions do not make it possible forthem to provide a helping hand in asgenuine a business need as distributionof profits to proprietors. However, thebalances on reserves are freelyavailable, and are commonly used, fordistribution of profits especially in thecase of corporate enterprises.

5.13.8 Demonstration Effect

The maintenance of provisions createsa distinct impression of the entity’saffairs having been looked after in abusiness like manner with due carebeing taken of asset values as part ofthe exercise of conservation of resources.All this is in conformity with manage-ment’s accountability of stewardshipaccounting. On the other hand, thecreation of reserves build a positiveimage of the enterprise in general, and

its management in particular, for theirprudent and progressive financialpolicies. It is of far reaching significancefrom the viewpoint of long-terminterests of the undertaking inattracting long-term investors.

5.14 Types of Provisions

The number of provisions maintainedby a business undertaking dependsupon its requirements, which aregoverned by the volume, range andnature of its operations. Generally, abusiness firm creates and maintainsprovisions for taxations, repairs andrenewals, depreciation, discount ondebtors, bad and doubtful debts. Butprovision for doubtful debts andprovision for discount on debtors hasbeen discussed at appropriate stagesin concerned chapters of the book.

5.14.1 Provision for Doubtful DebtsWhen business transaction take place oncredit basis, debtors may be of three types:

● Good Debtors are those fromwhere collection of debt is certain.

● Bad Debts are those debtorsfrom where collection of moneyis not possible and the amountof credit is a loss.

● Doubtful Debts are those whomay pay but firm is not sureabout cent per cent collectionfrom them. In fact, as a matterof business experience, somepercentage of such debtors arenot likely to pay, hence treatedas doubtful debts.

When it is certain that a debt willnot be recovered, the amount is written


off as bad debts. But it is also likelythat some of the remaining debts maynot be recovered in full. This will be aloss to the business. Hence, it is acommon practice to make a suitableprovision for doubtful debts at the timeof ascertaining the profit or loss. Thebalance sheet will not show the trueposition of sundry debtors. Theprovision for doubtful debts is usuallycalculated as a certain percentage ofthe total amount due from sundrydebtors after writing off all known baddebts. Provision for doubtful debts isalso called ‘Provision for Bad Debts’, or‘Provision for Bad and Doubtful debts’.Such a provision is made by debitingthe amount of doubtful debts to theprofit and loss account and creditingthe account of provision for doubtfuldebts. Thus, the journal entry forcreating such a provision is as follows:

Profit and Loss A/c Dr. Provision for Doubtful Debts A/c

The bad debts arising during theyear are first written off from the‘provision for doubtful debts’ account.In doing so, the opening balancestanding to the credit of the provisionfor doubtful debts account may not besufficient to meet the current amountof bad debts as also the requirements offuture doubtful debts. This deficit is tobe provided for at the end of the year bya charge to the profit and loss account.In case, the annual amount provided foris to be adjusted for any unused surplusrepresenting credit balance.

The following are the journalentries required when the provision for

bad debts exists in the books:

For writing off further bad debts givenoutside the trial balance:

Bad Debts A/c Dr.Sundry Debtors A/c

For transferring the total bad debts to theprovision for Bad Debts Account:

Provision for Doubtful Debts A/c Dr.Bad Debts A/c

For debiting the Profit and Loss Accountwith the amount of new provision plus theexcess of bad debts over the old provision:

Profit and Loss A/c Dr.Provision for Doubtful Debts A/c

For crediting the Profit and Loss Accountwith excess of the old provision over thetotal bad debts plus new provision, if any:

Provision for Doubtful Debts A/c Dr.Profit and Loss A/c

Illustration 12

(Provision for Doubtful Debts)

An extract of trial balance on31 December 2001 is given below:

Name of the Account Debit CreditAmount AmountRs. Rs.

Sundry Debtors. 80,000Bed Debts 4,000Provision of Bad Debts 7,000

Additional Information:

● Bad Debts proved bad but notrecorded amounted to Rs. 5,000

● Provision to be maintained at 10%of Debtors.

Prepare necessary accountingentries for writing off the bad debts andcreating the provision for doubtfuldebts account.

166 ACCOUNTANCY

Solution

Dr. Journal Cr.

Date Particulars L.F Amount AmountRs. Rs.

Dec 31 Bad Debts A/c Dr. 5,000Sundry Debtors 5,000

(Bad Debts written off)Dec 31 Provision for Doubtful Debts A/c Dr. 9,000

Bad Debts A/c 9,000(Bad Debts written off)

Dec 31 Profit and Loss A/c Dr. 9,500Provision for Doubtful Debts1 9,500

(Charged short-fall and provisionfor doubtful debts)

Total 23,500 23,500

Provision for Bad and Doubtful Debts AccountDr. Cr.


2001 2001

Dec Bad Debts 9,000 Jan 1 Balance b/f 7,00031Dec Balance c/f 7,500 Dec 31 P & L 9,50031

16,500 16,500

Bad Debts AccountDr. Cr.


2001 2001

Dec Balance c/f 4,000 Dec 31 Provision for 9,00031 Bad andDec Sundry 5,000 Doubtful Debts31 Debtors

9,000 9,000


Profit and Loss Account for the year ended 31 December, 2001Dr. Cr.


Provision for 9,500Bad andDoubtful debts

Balance Sheet as at 31 December, 2001*

Assets Amount Liability AmountRs. Rs.

Sundry Debtors 80,000Less: Bad Debts 5,000

75,000Less: Provision 7,500 67,500for Bad and Doubtful Debts

*Relevant items onlyWorking Notes

Provision for Doubtful Debts 7,500

required to be maintained

Add: Short fall of the

current provision:

Opening Balance 7,000

Less Bad Debts (9,000) 2,000

9,000

5.13.2 Provision for Discount on Debtors.

In practice, business enterprises allowcash discount to their customers. Thetenure of the cash discount periodmay spilt-over into the followingaccounting year for the sales madeduring the current year. This requiresa provision to be made on debtors. andis treated as a loss for the current year.The accounting treatment is givenhereunder;

Accounting Treatment

Discount is allowed to debtor:Discount Allowed A/c Dr.

Debtors A/c

Discount allowed transferred to P&L A/cProfit and Loss A/c Dr.Provision for Discount on Debtors A/c

Total bad debts transferred toprovision for doubtful debts.

Provision for Discount onDebtors A/c Dr.

Discount Allowed A/c

Illustration 13

(Provision for Discount on Debtors)Following is the extract of Trial Balanceas at March 31, 2001

Name of Account Debit CreditAmount (Rs) Amount (Rs)

Sundry Debtors 2,50,000 Discount Allowed 2,000

Provision for Discount 1,500 Allowed

168 ACCOUNTANCY

Additional information

● Provision for Discount Allowed is to be maintained at 2%.

Solution

Journal

Dr. Cr.

Date Particulars J.F. Debit CreditAmount Amount

Rs. Rs.

2001

March Provision for Discount on Debtor A/c Dr. 2,00031 Discount Allowed A/c 2,000

(Discount Allowed written off)

March Profit and Loss A/c Dr. 5,50031 Provision for Discount on Debtors A/c 5,5001

(Provision for discount on debtors)

Total 7,500 7,500

Discount Allowed AccountsDr. Cr.


2001 Balance b/f 2,000 2001 Provision for 2,000Mar Mar Discount on31 31 Debtors

2,000 2,000

Provision for Discount on Debtors AccountsDr. Cr.


200 2000Mar Discount 2,000 Apr 1 Balance b/f 1,50031 Allowed 2001

Mar Balance c/f 5,000 Mar 31 Profit & Loss 5,500

7,000 7,000


Profit and Loss Account for the year ended March 31, 2001Dr. Cr.


Provision for 5,500Discount onDebtors

Balance Sheet as at 31 March 2001

Assets Amount Liability Amount Rs. Rs.

Debtors Rs. 2,50,000LessProvision for Rs. 5,000Discount onDebtors 2,45,000

5.14 Types of Reserves

Reserves are broadly of two types—Capital Reserve and Revenue Reserve

5.14.1 Capital Reserve

‘Capital Reserve’ is an accountingmechanism for conserving profits. Theamount so set apart as ‘CapitalReserve’ imparts an element of stabilityto the over all finances of a businessenterprise. Capital reserve arises eitheras a gain on sale of long-term assetsor an settlement of liabilities. Again ofcapital nature may also arise due tothe basic transaction of being of capitalnature. For example: sale of equityshares at a premium. Further,allocation of revenue reserve may bemade to capital reserve due to legalobligations. Capital reserve does notinclude any free balance that might beused for the distribution of profits. It

Working Notes

Provision for discount on debtors: Rs.

Provision required for discount 5,000allowed on debtors

Discount Allowed 2,000

Less

Opening Balance of Provision 1,500for discount allowed

500

Provision to be charged to Profit 5,500and Loss Account

Alternative Calculation: Rs.

Provision required for discount on 5,000debtoRs. as on March 31, 2001

Add Discount Allowed during the 2,000year as per Trial Balance

Total amount received 7,000

Less Provision for discount of 1,500debtors. as per Trial Balance

Provision to be charged to Profit and 5,500Loss account for theYear ended March 31, 2001

170 ACCOUNTANCY

clearly stated in the balance sheeteither in its body itself or by way of afoot-note to the financial statements.This is due to the reason that thereare rigid restrictions, both laid downby law and enforced by accountingstandards, on the use of capitalreserve.

5.14.2 Revenue Reserves

Revenue reserves are created out ofrevenue profit which are usuallydistributable profits. All distributableprofits are not always available forpaying dividend since a certainamount may be required to be keptaside either by law (minimum) or as amanagerial decision (higher amount)for business needs. It is only after thisthat profit will be available fordistribution by way of dividend.Examples of revenue reserves are:

● General Reserve● Dividend Equalisation Reserve● Debenture Redemption Reserve

(only after complete redemp-tionof those debenture under whosetrust deed this reserve werecreated).

is this crucial factor alone which tendsto provide the much-needed financialstability to an corporate undertaking.

Capital reserve comes into existencefrom out of the capital profits arising from:

● profits emerging from therevaluation of fixed assets afterobserving all restrictions;

● profits accruing on the sale offixed assets;

● profits from the re-issue of shareonce forfeited by a company’s

● issue of shares at premium● profits arising at the time of

amalgamation and absorption ofcompanies

● profit prior to incorporation of acompany;

● Creation of capital RedemptionReserve upon the redemptionpreference shares.

Capital reserves, always havecredit balance which are shown on theliabilities side of the balance sheet.Whenever this reserve is utilized,capital reserve account is debited. Itis also required that the manner ofthe utilization of capital reserveduring an accounting period must be

5.15 Distinction between Revenue Reserve and Capital Reserve

Basis Revenue Reserve Capital Reserve

Creation It is created out of revenue It is created out of capitalprofits gains and revenue profits.

Distribution of Dividend It can be used for distribution It can not be used for cashof dividends. dividend distribution.

Objective Its objective is to strengthen It is created for meeting thethe financial position, meeting legal requirements orunforeseen contingencies or accounting practice.some specific purpose.

Usage It can be used for revenue as It can only be used for settingas well as capital purposes of capital loss or other purposes specified by law


General Reserve

A general reserve is a retention of aportion of revenue profits for theimprovement of the overall financialstatus of an enterprise and to improveits health in general.

An important point about generalreserve is that it is a salient feature ofcorporate finance. The creation andmaintenance of general reserve helpsin realizing certain well recognizedpurposes especially from the viewpointof financial management.

● Improvement of the generalfinancial position of thebusiness by conservingresources, which would haveotherwise been frittered awayat the expense of prudentmanagement.

● Arrangement for meetingunforeseen and abnormal lossesirrespective of their nature.

● Providing avenues for thefurther expansion of businessoperations.

General reserve is created by debitingthe profit and loss appropriationaccount and crediting general reserveaccount. The latter account is placedon the liabilities side of the balancesheet. When the balance on thisaccount is used for any purpose,general reserve account is debited.Any such use of general reserve has tobe stated in some way in the balancesheet. A number of provisions havebeen included in the companies Act forthe regulation, creation and utilizationof general reserve. This underlines the

importance attached to it in thefunctioning of corporate enterprises. Aword of caution about the commonlyperceived role of general reserve isnecessary. General reserve is widelyregarded as a means of strengtheningthe overall financial position of thebusiness entity. However, this dependsupon the proper valuation of the assetsand liabilities of the business. In caseassets and liabilities are properlyvalued, the balance on general reserveis indicative of the financial health ofan enterprise but it is not so in theabsence of this vital condition.

Specific Reserves

A business undertaking in contem-porary times is involved in a range ofbusiness activities in pursuance of itsgoal of creating value of the organi-zation. Some of the of contingencysituations can be looked after andfinancially managed by the creation ofprovisions for known or expectedcontingencies. Management may aswell like to provide a second line ofdeface against some of these contin-gencies as a measure of abundantcaution. A specific reserve is createdfor a given purpose. It cannot be usedfor any other purpose except for whichthey are created. There can possiblybe any number of reserves in business,every one of them characterized bysome peculiar feature dictated by thespecific purpose which they are meantto serve. However, there is an undercurrent of common characteristicsshared by them.

172 ACCOUNTANCY

● They are sharply focussed fromthe viewpoint of their usebecause they are built up forsome specific purpose or theother.

● A business-like approach to themanagement of these reservesmay require that their balancesbe invested outside the business.

All specific reserves are presentedon the liabilities side of the balance

sheet, as they are credit balances.When any specific reserve is utilized,the amount drawn upon is debitedto the account of the reserveconcerned. The reserves are creditedat the time of the preparation offinancial statements by allocationsdecided to be made to them bymanagement and the correspondingcredit is given to profit and lossappropriation account.


● Depreciation● Depletion● Obsolescence● Amortization● Salvage value/ Residual value/ Scrap value● Written down value/Reducing value/Diminishing value● Straight line/Fixed Instalment● Asset Disposal● Accumulated Depreciation


1. Meaning of Depreciation

Depreciation is a permanent and gradual diminution in the value of an asset causedby usage and effluxtion of time.

2. Factors Affecting Depreciation

● Wear and Tear● Expiration of legal rights● Obsolescence

3. Determinants of Depreciation

● Cost of asset installed● Estimated useful life● Estimated salvage value

4. Accounting Treatment

The accounting treatment is designed to record all transactions of purchaseand sale of an asset and charging of depreciation with the objective of reducingthe value of an asset to zero or its residual value as the case may be.


5. Methods of Calculating Amount of Depreciation—

● Straight Line method: Under this, the fixed amount is charged as depreciationevery year during the lifetime of asset.

● Written Down Value Method: In this method, a fixed percentage is applied tothe book value of an asset at the beginning of every accounting period,rather than the original cost.

6. Methods of Depreciation

There are two methods of recording depreciation in the books of accounts

● By maintaining a provision for depreciation account● Without maintaining a provision for depreciation account.

7. Asset Disposal Account

This account prepared to provide a complete and clear view of all the vari-ables involvedin the sale of an asset.

8. Provision

It is an amount written off or retained by way of providing depreciation, renewals,diminution in the value of assets and for known liabilities. It is a charge onprofits and must for the ascertain-ment of true profits of business.

9. Reserve

It is allocation of profit. It is an amount set aside out of profits and is meant tostrengthen, the general financial position of a business enterprise.

10. Types of Reserves

● Capital reserve: It is a mode for retaining profits in business, which are notavailable for distribution as dividends. It is always a credit balance.

● General reserve: It means retention of a portion of profit, not for any particularpurpose, but for the improvement of overall financial position of an enterprise.

11. Types of Provisions

● Provision for doubtful debts: This provision is made on certain percentage oftotal debtors appearing in the trial balance. It is meant for the recovery ofdoubtful overdue account.

● Provision for discount on debtors: This provision is also made on debtors andis treated as a loss for the current year.

EXERCISES

I Multiple Choice Questions

(a) Depreciation arises due to:

(i) Physical wear and tear of the asset

(ii) Fall in the market value of asset

(iii) Fall in the value of money

(iv) None of these

174 ACCOUNTANCY

(b) Under diminishing balance method of charging depreciation, it:

(i) Increase every year(ii) Decrease every year(iii) Constant every year(iv) None of these

(c) Under straight line method, depreciation is calculated on:

(i) Written down value(ii) Original cost(iii) Cost less scrap value(iv) Original Cost less scrap value.

(d) The term depletion is used for:

(i) Fixed assets(ii) Intangible assets(iii) Natural resources(iv) None of these

(e) Resources are the items of:

(i) current liabilities(ii) owners equity(iii) long-term liabilities(iv) none of these

2. Fill in the blanks

(i) Depreciation represents a__________________ in the value of fixedassets.

(ii) Scrap value of an asset means the ___________ that it fetched on saleat the end of its ______________.

(iii) The assumption underlying the fixed instalment method ofdepreciation is that of ___________________ of the asset over differentyears of its useful life.

(iv) Capital reserve are those which are generally not distributedas________________.

(v) The purpose of reserve is generally to ___________ the financial positionof a business enterprise.

3. True and False

(i) Depreciation can not be provided increase of loss, in a financial year.(ii) Under written down value method, depreciation is charged on the

original cost of the asset.(iii) Provision are the charges against profits for all apprehended losses.(iv) Capital reserves are freely distributed as profits.(v) All reserves appear on the liability side of the balance sheet.


4. Define depreciation?5. What are the factors effecting depreciation?


6. Why should depreciation on fixed assets be brought into account?7. Explain, in brief, the determinants of providing depreciation?8. What is the purpose of capital reserves?9. What is provision for doubtful debts? Why it is created?


10. Define depreciation as per Accounting Standard VI? Explain the need andsignificance of providing depreciation?

11. Explain the determinants of providing depreciation?12. Name and explain different types of provisions? Also write their accounting

treatment?13. State the meaning of reserves? Explain the different types of reserves?14. Distinguish between:

(i) Provision and Reserve(ii) Capital Reserve and Revenue Reserve

Problems

Q. 15On 1 Jan 2001, Alpha Fabrics Limited purchased a machine for Rs.52,000 andspent Rs. 3,000 on its carrige and Rs.1,000 on its erection. On the date ofpurchase it was estimated that the effective life of the machine will be 10 yearsand after 10 years it scrap value will be Rs. 6,000.Prepare Machine Account and Depreciation Account for four year. Depreciationis charged on Straight Line basis Account are closed on 31 Dec each year.

Q. 16Dinesh Garments purchased a machinery on 1 April 1997 for Rs.80,000. On1 July 1997 another machinery costing Rs.2,00,000 was purchased. Themachinery purchased on 1 April 1997 was sold on 30 September 2001 forRs.9,850. The company charges depreciation @ 15% per annum on straight linemethod. You are required to prepare machinery account for the years 1997-98to 2001-02.

Q. 17ACC Ltd purchased a machinery costing Rs. 60,000 on 1 April 1999. Anothermachinery costing Rs. 40,000 was acquired on 1 Oct 1999. On 1 July 2000,another machinery for Rs. 20,000 was purchased. On 1 Jan 2001, one third ofthe machinery , which was installed on 1 April 1999 became obsolete and wassold for Rs. 6,000. Prepare machinery account as it would appear in the booksof accounts. The depreciation is provided at 10% p.a. on straight line basis. Thebooks are closed on 31 March every year.

Q. 18Excel Company Limited has a debit balance in its machinery account Rs. 15,000(Original Cost of Rs. 50,000) as on 1 Jan 2000. On 1 April 2000, it purchased amachinery costing Rs.30,000. It further purchased machinery on 1 Oct 2000costing Rs. 20,000. On 1 Jan 2001, machinery purchased on 1 April 2000 becameobsolete and was sold for Rs. 2,000 and on 1 July 2001, an additional machinerywas purchased for Rs.10,000. Show how machinery account would appear in

176 ACCOUNTANCY

the books of Excel Company. The machinery is depreciated on Straight linebasis @ 10% p.a. Calculate the value of machinery as on 31 Dec 2000. Thebooks are closed on 31 December every year.

Q. 19Nagi Road Transport Corporation (NRTC) purchased 25 Mini buses atRs. 2,00,000 each on 1 April 2000. On 1 Oct 2002, one of the buses met with anaccident and was completely destroyed. Insurance Co. paid Rs. 90,000 in fullsettlement of the claim. On the same day, NRTC purchased a used Mini-Bus forRs. 1,00,000 and spent Rs. 20,000 on its overcharging. Prepare Mini-Bus Accountfor 3 year ending on 31 Dec 2002. The depreciation is charged @ 20% on Straightline basis.

Q. 20Nandan Milk Foods Ltd. purchased the dairy machinery for Rs. 15,00,000 on1 April 1995. The cost of installation was Rs. 1,00,000. On 1 July 1995, underits expansion programme, the company purchased old machinery from GopalMilk Foods, which was under the process of winding off for Rs. 8,00,000. Thecompany charges depreciation of the @ 10% p.a. on straight line basis. On1 Jan 1996, it was found that machinery purchased from Gopal Milk Foods wasnot working effectively. Therefore, the company decided to sell it off forRs. 4,00,000. On the same date a new machinery cost Rs. 20,00,000 waspurchased. Your are required to prepare machinery account, for the year 1995-96to 1998-99. The books of accounts are closed on 3 March every year.

Q. 21Amrit Raj Data Processing Company whose accounting year is a calendar year.purchased on 1 April 1990, a data processing unit costing Rs. 30,000. On1 Oct 1990, it made additions to it costing Rs. 20,000 and on 1 July 1991 costingRs. 10,000. On 1 Jan 1992, a part of data processing unit installed on 1 April1990 became obsolete and was sold for Rs. 3,000. The asset is depreciated onwritten down value @ 10% p.a. Prepare the asset account and show the balanceas on 1 Jan 1993.

Q.22On 1 Jan 1980, Aroma Fabricators purchased two machines for Rs. 60,000 and40,000 respectively. On 1 Jan 1981 another machine was purchased forRs. 1,00,000. On 1 Jan 1982, the machine purchased on 1.1.80 for Rs. 60,000got out of order and a new machine costing Rs. 1,20,000 was purchased aftersurrendering the old machine which got out of order and paying cash Rs. 30,000.On 1 Jan 1983 the machine which was purchased on 1 Jan 1981 for Rs. 10,00,00was destroyed by fire and insurance company paid Rs. 60,000 only.Depreciation is charged @ 10% p.a on written down value basis. Show themachinery account for 1980, 1981, 1982, 1983. Also prepare machinerydisposal account and machinery lost by fire account. The books are closed on31 December eveary year.

Q. 231.1.2001 Madras Printing House purchased ten machines of Rs. 1,80,000. On30.6.2002, it acquired another machine at a cost of Rs. 30,000. On 31.3.2003,


one of the machines purchased on 1.1.2001 had become obsolete and wasdisposed off for Rs. 2,500. Rs. 500 was paid as commission on sale of the machine.It was replaced by a new machine costing Rs. 20,000. Show machinery accountfrom 2001 onwards it–

● Depreciation @ 10% on Straight line method● Depreciation @ 10% on Written Down Value method

Q.24The following information relates to the business of Maharaja Enterprises forthe year ended Dec 31, 2001.

a. A debit balance on the Plant and Machinery account on Jan 1, 2001Rs.26,840.

b. During the year 2001, three machines standing in the books at Rs.1,286were sold for Rs.600.

c. On April 1,2001 new machine costing Rs.5,880 were purchased and wereinstalled by the manufacturer’s workman at an expenditure of Rs. 216 (i.e.wages Rs. 174 and materials Rs. 42).

d. It is the practice of the business to write-off 15% depreciation to all additionsto the plant during a year and 20% to all old plants. Prepare the Plant andMachinery account as it would appear on Dec 31, 2001.

Q. 25A Limited Company purchased machinery for Rs. 40,000 on 1 Jan 1987. Themachinery was depreciated at 10% p.a. on Straight line basis. On 31 March1989, the machinery was sold for Rs. 35,000. Give the machinery account incompany’s books if the depreciation provision account is maintained.

Q. 26Jinney soaps Ltd. Purchased a truck on 1 April 1998 for Rs. 5,00,000. On 1July 1999 an other truck was purchased for Rs. 5,50,000. On 1 Oct 2001, thetruck purchased on 1 April 1998 met with an accident the claim for Rs. 1,50,000.The company charges depreciation @ 20% on written down value basis andmaintain of provision for depreciation account. Prepare turck account, provisionfor deprecation on truck account, truck disposal account.

Q. 27A firm write off 95% of the cost of machinery acquired over a period of tenyears under Straight line method, remaining 5% as estimated scrap value.Full depreciation is written off even if the machinery is in use only for par ofa year. On Dec 31, 1997, the original cost of the machinery in use was asfollows:

● Purchased in 1987 or earlier Rs. 1,20,000● Purchased in 1989 Rs. 40,000● Purchased in 1993 Rs. 30,000

A machine acquired in 1993 at a cost of Rs. 15,000 was sold for Rs. 5,000. Onthe same date, new machinery was acquired for Rs. 45,000. Prepare theMachinery Account for the year 1998 in books of the firm, the accounts beingclosed every year on Dec 31.

178 ACCOUNTANCY

Q. 28 Pass the necessary Journal entries and clearly show the working notes separately.


Rs. Rs.

Debtors 40,000Bad Debts 2,000Discount Allowed 1,000Provision for Doubtful Debts 2,500Provision for discount on DebtoRs. 900

Additional information

It is desired to create a provision for Bad and Doubtful debts at 5% on Debtors andProvision for discount on debtors at 20%.

Q. 29From the following, pass the journal entries, prepare the necessary ledger accounts,also show how these items will appear in Profit and Loss account and BalanceSheet.

Extract of Trial Balance as on 31 Dec 2002.


Rs. Rs.

Bad debts 1,200Sundry Debtors 1,02,000Bad Debts provision 1.1.2002 3,650

Additional Information

● Write off further bad debts Rs. 2,000● Provide for doubtful debts at 10% on sundry debtors

ANSWERS

1. Multiple Choice

a. (i) , b. (ii), c. (ii), d. (iii), e. (ii)

2. Fill in the Blanks

(i) Diminution,(ii) Amount or Value,(iii) Equal usage ,(iv) Dividends,(v) Strengthen ,(vi) Allocation, Creation


3. True and False

(i) False(ii) False(iii) True(iv) False(v) True

Problems

15. Depreciation amount Rs. 5,000Balance of Machinery Account 36,000

16. Loss on sale Rs.1,50,150Balance of Machinery Account Rs. 1,41,500

17. Loss on Sale Rs.10,500Balance of Machinery Account Rs. 84,500

18. Balance of Machinery Account Rs. 31,00019. Loss on Bus Destroyed Rs. 10,000

Balance of Bus Account Rs. 4,74,00020. Loss on Sale Rs. 3,00,000

Balance of Machinery Account Rs. 2,10,00021. Loss on Sale Rs. 5,325

Balance on 1 Jan 1993, Rs. 39,33022. Balance of Machinery Account Rs. 97,200

Loss by fire Rs. 21,00023. SLM- Loss on Sale Rs. 11,950

Balance of Machinery Account Rs. 1,57,400WDV- Loss on Sale Rs. 12,215Balance of Machinery Account Rs. 1,62,248

24. Balance of Machinery Account Rs. 25,626 approx25. Provision for Depreciation Rs. 9,000

Profit on Sale Rs. 40,000Balance of Machinery Account Rs. 40,000

26. Balance of Truck Account Rs. 4,25,0750.27. Balance of Machinery account Rs. 54,675 approx28. Provision for doubtful debts Rs. 1,500

Provision on discount on Debtors Rs. 86029. Amount Debited to P&L account Rs. 9,550

Net Debtor Shown in Balance Sheet Rs. 90,000

180 ACCOUNTANCY

CHAPTER 6

Bills of Exchange

LEARNING OBJECTIVES


● state the meaning of bill of exchange and promissory note;

● describe features of bill of exchange and promissory note;

● identify the parties to a bill of exchange and a promissorynote;

● distinguish between a bill of exchange and a promissorynote;

● explain the meaning of different terms involved in thebill transaction, i.e. term of bill and days of grace, date ofmaturity, bill after date, negotiation, endorsement,discounting of bill, dishonour and noting of bill, insolvencyof acceptor, retirement and renewal of a bill; and

● record accounting transactions of bills of exchange.

181BILLS OF EXCHANGE

Goods can be sold or bought for cashor on credit. When goods are sold orbought for cash, payment is received/made immediately .On the other handwhen goods are sold/bought on creditthen payment is deferred to a futuredate. In such a situation, instrumentsof credit are used through which thebuyer assures the seller that thepayment shall be made according tothe agreed conditions as stated in theinstrument of credit. The instrumentsof credit in India have been in use sincetime immemorial and are popularlyknown as Hundies .The hundies arewritten in Indian languages. Now-a-days these instruments of credit arecalled as bills of exchange orpromissory notes. The most importantpoint about these instruments is thatthey contain an unconditional orderto pay a certain amount on an agreeddate in case of bills of exchange andan unconditional promise to pay acertain sum of money on a certain datein case of promissory notes. Theseinstruments in India are governed bythe Indian Negotiable Instruments Act1881.

6.1 Meaning of Bills of Exchange

According to the Negotiable Instru-ments Act 1881, a bill of exchange isdefined as an instrument in writingcontaining an unconditional order,signed by the maker, directing acertain person to pay a certain sum ofmoney only to, or to the order of acertain person or to the bearer of theinstrument. The following features ofa bill of exchange emerge out on the

basis of this definition.

● A bill of exchange must be inwriting and not oral.

● It is an order to make payment.● The order to make payment is

unconditional.● The maker of the bill of

exchange must sign it.● The payment to be made must

be certain.● The date on which payment is

made must also be certain.● The bill of exchange must be

payable to a certain person.● The amount mentioned in the

bill of exchange is payable eitheron demand or on the expiry of afixed period of time.

● It must be stamped as per therequirement of law.

According to the Negotiable Instru-ments Act, a bill of exchange isgenerally drawn by the creditor on hisdebtor. It has to be accepted by thedebtor or someone else on his behalf.It is called a draft before its acceptance.Therefore, one of the underlyingfeatures of a bill of exchange is that ithas to be accepted either by the personupon whom it is drawn or by someoneelse on his/her behalf. For example,Amit sold goods to Rohit on credit forRs.10,000 for three months. If agreedso, Amit can draw a bill of exchangeupon Rohit for Rs. 10,000 payable afterthree months. Before it is accepted byRohit it will be called a draft. It willbecome a bill of exchange only whenRohit writes the word “accepted” on itand puts his signature to commu-nicate the acceptance.

182 ACCOUNTANCY

6.1.1 Parties to a Bill ofExchange

There are three parties to a bill ofexchange:

● Drawer is the maker of the billof exchange. A seller/creditorwho is entitled to receive moneyfrom the debtor can draw a billof exchange upon the buyer/debtor. The drawer after writingthe bill of exchange has to signit as maker of the bill.

● Drawee is the person uponwhom the bill of exchange isdrawn. Drawee is purchaser ofthe goods upon whom the billof exchange is drawn. The daweehas to write the word “accepted”if he accepts to make thepayment given in the bill on thedue date and has to put hissignatures on it. After thedrawee of a bill has signed hisassent on the face of the bill, heis called the acceptor and thisprocess is called acceptance. Abill of exchange becomes a legaldocument after acceptance andbinds the drawee to honour thebill on the due date. Acceptancehowever may be general orqualified. The general accep-tance requires signatures of theacceptor only without statingany conditions, thereto. However,mention of a bank or a specifiedplace of payment or partpayment thereof, makes theacceptance qualified.A qualified acceptance varies theexpress terms of the bill as

originally drawn and thereby thedrawer can refuse to considerthe bill as accepted. Sometimesthe bill of exchange may beaccepted by another person onbehalf of the drawee. Forexample a bill of exchangedrawn by Ram upon Shyam maybe accepted by Ghanshyam.

● Payee is the person to whom thepayment is made. The drawer ofthe bill himself will be the payeeif he keeps the bill with him tillthe date of its payment. Thepayee may change in thefollowing situations.

● In case the drawer has got thebill discounted, the person whohas discounted the bill willbecome the payee;

● In case the bill is transferred infavour of a creditor of the drawerthen the creditor will become thepayee.

Normally, the drawer and the payeeis the same person. Similarly, thedrawee and the acceptor is normallythe same person.

For example, Mamta sold goodsworth Rs.10, 000 to Jyoti and drewa bill of exchange upon her for thesame amount payable after threemonths. Here Mamta is the drawerof the bill and Jyoti is the drawee. Ifthe bill is retained by Mamta forthree months and the amount ofRs.10,000 is received by her on thedue date than Mamta will be thepayee.

If Mamta gives away this bill to hercreditor, Ruchi then Ruchi will be the


payee.If Mamta gets this billdiscounted then the banker willbecome the payee.

In the above mentioned bill ofexchange, Mamta is the drawer and

Mamta New DelhiRs.10,000 1 April 2002

Three months after date pay to me or my order, the sum of Rupees Ten Thousandonly, for value received.

Accepted(Signed) (Signed)Jyoti Mamta1.4.2002 196, Karol Bagh73-B, Mahipalpur New DelhiNew Delhi 110 037

ToJyoti73-B, MahipalpurNew Delhi 110 037

Fig. 6.1 : Showing the specimen of bills of exchange

the bearer”.However, according to the Reserve

Bank of India Act, a promissory notepayable to bearer is illegal. Therefore,a promissory note cannot be made

Stamp

Jyoti is the drawee. Since Jyoti hasaccepted the bill she is the acceptor.Suppose in place of Jyoti the bill isaccepted by Ashok then Ashok willbecome the acceptor.

6.2 Promissory Note

According to the Negotiable Instru-ments Act 1881, “a promissory note isdefined as an instrument in writing(not being a bank note or a currencynote), containing an unconditionalundertaking signed by the maker, topay a certain sum of money only to orto the order of a certain person, or to

payable to the bearer. This definition suggests that when

a person gives a promise in writing topay a certain sum of money uncon-ditionally to a certain person oraccording to his order then thedocument is called as a promissorynote.

Following features of a promissorynote emerge out of the above definition.

● It must be in writing.● It must contain an unconditional

promise to pay.● It must be signed by the maker.● The maker must be a certain

184 ACCOUNTANCY

person.● The person to whom payment is

to be made must also be certain.● The sum payable must also be

certain.

● It should be properly stamped.

A promissory note does not requireany acceptance because the maker ofthe promissory note himself promisesto make the payment.

Ashok Kumar Rs.30,000 New Delhi

1 April 2002

Three month after date I promise to pay Sh. Harish Chander or order asum of Rupees Thirty Thousand only for value received.

ToHarish Chander Ashok Kumar24, Ansari Road 2, Dariba KalanDarya Ganj Chandani ChowkNew Delhi 110 002 Delhi 110 006

Fig. 6.2 : Showing specimen of a promissory note

Stamp

6.2.1 Parties to a Promissory Note

There are two parties to a promissorynote:

● Maker or Drawer is the personwho makes or draws thepromissory note to pay a certainamount as specified in thepromissory note. He is alsocalled the promisor.

● Drawee/Payee is the person inwhose favour the promissorynote is drawn. He is called thepromisee. Generally, the draweeis also the payee, unless, it is

otherwise mentioned. In theabove specimen of promissorynote, Ashok Kumar is thedrawer or maker who promisesto pay Rs.30,000 and HarishChander is the drawee or payeeto whom payment is to be made.If Harish Chander transfersthis promissory note in favourof Rohit then Rohit will becomethe payee. Similarly, if HarishChander gets this promissorynote discounted from the bankthen the bank will become thepayee.


6.3 Distinction between a Bill ofExchange and a PromissoryNote

Both a bill of exchange and apromissory note are instruments ofcredit and are similar in many ways.However, there are certain basicdifferences between the two (fig. 6.3).

6.4 Advantages

The bills of exchange as instrumentsof credit are used frequently inbusiness because of the followingadvantages.

● Frame for Relationship: A bill ofexchange represents a device,which provides a framework forenabling the credit transactionbetween the seller /creditor andbuyer/debtor on an agreedbasis.

● Certainty of Terms and Conditions:The creditor knows the timewhen he would receive themoney so also debtor is fullyaware of the date by which hehas to pay the money. This isdue to the fact that terms andconditions of the relationshipbetween debtor and creditorsuch as amount required to bepaid; date of payment; interestto be paid, if any; place ofpayment are clearly mentionedin the bill of exchange.

● Convenient Mode of Credit: A billof exchange enables the buyerto buy the goods on credit andpay after the period of credit.However, the seller of goods evenafter extension of credit can get

payment immediately either bydiscounting the bill with thebank or by endorsing it in favourof a third party.

● Conclusive Proof: The bill ofexchange is a legal evidence ofa credit transaction implyingthereby that during the courseof trade buyer has obtainedcredit from the seller of thegoods, therefore, he is liable topay to the seller. In the event ofrefusal of making the payment,the law requires the creditor toobtain a certificate from theNotary to make it a conclusiveevidence of the happening.

● Easy Transferability: A debt canbe settled by transferring a billof exchange through endor-sement and delivery.

6.5 Maturity

When a bill of exchange or a promi-ssory note is not payable on demand,the payment is deferred to the date ofmaturity of the instrument. It is thedate on which the instrument becomesdue for payment. In arriving at thematurity date three days, known asdays of grace, must be added to thedate on which the instrument ispayable. Thus, if a bill dated March 5is payable 30 days after date it fallsdue on April 7, i.e. 33 days after March5. However, if it were payable onemonth after date, the due date wouldbe April 8, i.e. one month and 3 daysafter March 5. But where the date ofmaturity is a public holiday, theinstrument will become due on the

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S. Basis Bills of Exchange Promissory NoteNo

1 Drawer It is drawn by the creditor

2 Order or It contains an order toPromise make payment

3 Parties There can be there parties to it,viz. the drawer, the acceptor andthe payee.

4 Acceptance It requires acceptance by thedrawee or someone else on hisbehalf.

5 Payee Drawer and payee can be thesame party

6 Liability Liability of the drawer issecondary and the liability of theacceptor is primary.

7 Notice In case of its dishonour duenotice of dishonour is to be givenby the holder to the drawer

8 No. of copies One copy of a bill of exchange isprepared in case of a local billand three copies are preparedin case of a foreign bill.

9 Revenue Stamps are not required to Stamps be fixed on the bills of exchange

payable on demand otherwisestamps would be necessary.

It is drawn by the debtor

It contains a promise to makepayment.

There are only two parties to it.The drawer or the maker whodraws the promissory note andsigns it and the payee to whomthe amount is payable.

It does not require anyacceptance.

Drawer cannot be the payee ofit.

The liability of the drawee isprimary.

No notice needs to be given in caseof its dishonour.

Only one copy is prepared in boththe cases.

Stamps have to be fixed on alltypes of promissory notes.

Fig. 6.3 : Distinction between Bills of Exchange and Promissory Note

preceding business day. In this case if8 April (maturity) is a public holidaythen the 7 April will be the maturitydate. When an emergent holiday isdeclared under the NegotiableInstruments Act 1881, by the

Government of India which mayhappen to be the date of maturity of abill of exchange, then the date ofmaturity will be the next working dayimmediately after the holiday. Forexample, the Government declared a


holiday on April 5, which happened tobe the day on which a bill of exchangedrawn by X upon Y for Rs.20,000became due for payment. Since 5 Aprilhas been declared a holiday under theNegotiable Instruments Act, therefore,April 6 will be the date of maturity forthis bill.

6.6 Negotiability

Negotiability means that the holder ofthe instrument can transfer the title.Bills of exchange and promissory notesare negotiable instruments within themeaning of Section 13 of NegotiableInstruments Act 1881, however in caseof promissory note the negotiation isrestricted, but it does not render it tothe status of not-negotiable instru-ment. This implies that a bill ofexchange can be transferred bynegotiation but a promissory notecannot be. However, this is subject tothe condition that the holder acquiresthem–

● without notice of defect in thetitle of the transferor, i.e. in goodfaith,

● for a consideration, and● before maturity.

If these conditions are met, it doesnot matter if the title of the transferorwas defective. Thus, if Rakesh steals abill of exchange and transfers it toRajesh who is not aware of Rakesh’smode of acquiring the bill and he takesit over for value and before the date ofits maturity, Rajesh will be entitled toget payment on the bill of exchange.However, if the words ‘or order’ areomitted from the bill, it cannot be

negotiated and becomes payable to theperson named therein and to himalone. Bills of exchange and promi-ssory notes can be passed on from oneperson to another by endorsement anddelivery. If a bill of exchange or apromissory note is dishonoured, thatis if payment is not made on the duedate by the drawee, the amount ofbill can be claimed from any of theprevious endorsers.

6.7 Endorsement of Bill

Any holder may transfer a bill unlessits transfer is restricted, i.e. the bill hasbeen negotiated containing wordsprohibiting its transfer.

The bill can be initially endorsedby the drawer by putting his signaturesat the back of the bill along with thename of the party to whom it isbeing transferred. The act of signingand transferring the bill is called‘endorsement’.

6.7.1 Effects of Endorsement

● Once an endorsement has beenmade, the person endorsing thebill is called an ‘endorser’. Theperson to whom the bill isendorsed is known as an‘endrosee’ and the bill is said tohave been ‘endorsed’.

● After a bill has been endorsedand delivered to a third person(endorsee), it would becomepayable to him instead oforiginal holder (endorsee). Theendorsee may again endorse itin favour of a fourth person(unless endorsement is restricted)

188 ACCOUNTANCY

and this may continue to anyextent till the date of maturity.

● An unrestricted endorsementprovides a mechanism forsettling the business payments.

6.7.2 Types of Endorsement

A bill may be endorsed in any one ofthe following ways:

● Blank Endorsement : It requiressignatures to be put by thetransferor, as follows:

Signed“Raja Ram”

This makes the bill transferable bymere delivery.

● Special Endorsement: Specialendorsement necessitates wri-ting the name of the party inwhose favour the property rightsof the bill are endorsed underthe signature of the endorser. Suppose Vishal & Co wantsto endorse a bill in favour ofArun & Co., it will be shown atthe back of the bill as follows.

“Pay Arun & Co. or order” Vishal & Co.

Official Signatory or Stamp

● Restricted Endorsement: This isan endorsement in favour of adefinite person, and to himalone. This restricts furtherendorsement of the bill. This isexpressed as follows:

“Pay Rakesh only”SignedAjay

● Endorsement Sans Recourse(i.e. Without recourse): Theendorsement of the bill in thismanner enables the endorser torelieve himself from the liabilityto all subsequent endorseesindicated by the word “SansRecourse” added to the signa-tures. This is generally made bypersons who acts in a repre-sentative capacity as agents andnot as principal. The endorse-ment is done in the following way;

“Pay Varun or order”SignedAnkit

Sans Recource

● Facultative Endorsement: Thisis the endorsement by whichthe endorser waives some of therights to which he is entitled.The right which is given up isclearly stated as a part of theendorsement itself. The endorse-ment is effected in the followingmanner:

“Pay Aleem or orderNotice of dishonour waived”

SignedRaja Ram

The implication of this is that thenotice of dishonour need not be givenby the endorsee before demanding thepayment from the endorser.

6.8 Accounting Treatment

For the person who draws the bill ofexchange and gets it back, after its due


acceptance, it becomes a billreceivable. For the person who acceptsit, the same becomes bills payable.In case of a promissory note for themaker it is a bills payable and for theperson in whose favour the promissorynote is drawn it is a note receivable.Bills/Notes receivables are assets andBills/Notes payables are liabilities.

Bills and Notes are usedinterchangeably.

6.8.1 Books of ReceiverA bill receivable can be treated in thefollowing four ways by its receiver.

● He can retain it till the date ofmaturity, and(i) get it collected on date of

maturity directly, or(ii) get it collected through the

banker.● He can get the bill discounted

from the bank.● He can endorse the bill in favour

of his Creditor.● He can pledge the bill receivable

as a security for obtaining cashcredit and overeraft facilities.

The accounting treatment in thebooks of receiver under all the fouralternatives is given below under theassumption that the bill is dulyhonoured on maturity by the acceptor.

1. (a) When the bill of exchange isretained by the receiver withhim till the date of its maturity,the following journal entriesare passed.

On receiving the billBills Receivables A/c Dr.

Debtors. A/c

On maturity of the bill

Cash/Bank A/c Dr. Bills Receivable A/c

(b) When the bill of exchange isretained by the receiver with himand sent to bank for collection afew days before maturity.

For sending the bill for collection

Bills sent for collection A/c Dr. Bills Receivable A/c

(c) On receiving the advice from thebank that the bill has beencollectedBank A/c Dr. Bills sent for collection A/c

1. When the receiver gets the billdiscounted from the bank.

On receiving the bill

Bills Receivable A/c Dr.Debtors. A/c

On discounting the billBank A/c Dr.Discount A/c Dr.

Bills Receivable A/cOn maturity

No Entry

Since the bill becomes the property ofthe bank, therefore, the bank willcollect the amount of the bill from theacceptor and no journal entry will bepassed in the books of the receiver.

2. When the bill is endorsed by thereceiver in favour of his Creditor–

On receiving the bill

Bills Receivable A/c Dr. Debtor’s A/c

On endorsing the bill

Creditor A/c Dr. Bills Receivable A/c

On maturityNo Entry

190 ACCOUNTANCY

Since the bill has been transferred infavour of the creditor, therefore thecreditor becomes its owner and willreceive the payment on maturity.Hence, no entry will be passed in thebooks of the receiver.

3. For pledging the bills receivables asa security for obtaining cash creditand overdraft facilities:

Pledging of the bill is a legal-cum-financial arrangement with thebank, whereby the bank authorizesthe customer to make withdrawalsup to a specific amount. This factis noted as a marking on theaccount of the customer in thebank’s ledger and no journal entryis required until the customeractually withdraws the money.However, such a pledged bill isalways collected through the bankonly because bank has the firstright to claim the amount of thebill. The journal entries to bepassed for this are as follows:

On Pledging the billNo Entry

On Maturity

(i) Bills sent for collection A/c Dr. Bills Receivable A/c

(ii) Bank A/c Dr. Bills sent for collection A/c

6.9 Books of Acceptor/Promissor

The following journal entries arepassed in the books of the acceptorunder all the four circumstancesdiscussed above.

On accepting the billCreditor’s A/c Dr. Bills payable A/c

On maturity of the billBills payable A/c Dr. Bank A/c

The journal entries in the books ofthe drawer and the acceptor under allthe four cases have been given in theform of a table for better understanding.

1. When the drawer retains the bill with him till the date of its maturity and gets thesame collected directly.

Transaction Books of Books ofCreditor/Drawer Debtor/Acceptor

Sale/Purchase of Debtor’s A/c Dr. Purchase A/c Dr.goods Sales A/c Creditor’s A/c

Receiving/Accepting Bills Receivable A/c Dr. Creditor’s A/c Dr.the bill Debtor’s A/c Bills Payable A/c

Collection of the bill Cash/Bank A/c Dr. Bills Payable A/c Dr. Bills Receivable A/c Dr. Cash/Bank A/c


2. When the bill is retained by the drawer with him and sent to bank for collection afew days before maturity.




Sending the bill Bills sent for collection A/c No Entryfor collection Bill Receivable A/c Dr.

On Receiving the Bank A/c Dr. Bills Payable A/c Dr.bank advice that the Bill sent for collection A/c Bank A/cbill has been collected

3. When the drawer gets the bill discounted from the bank.




Discounting the bill Bank A/c Dr.Discount A/c Dr. No Entry Bill Receivable A/c

On maturity of the No Entry Bills Payable A/c Dr.bill Bank A/c

4. When the bill is endorsed by the drawer in favour of his creditor.




Endorsing the bill Creditor’s A/c Dr. No Entry Bill Receivable A/c

On maturity of the No Entry Bills Payable A/c Dr.bill Bank A/c

192 ACCOUNTANCY

5. When the bill is pledged as security for obtaining cash credit and overdraft facilities.




Sending the bill for Bill sent for collection A/c Dr. No Entrycollection Bill Receivable A/c

When bill is collected Bank A/c Dr. Bills Payable A/c Dr.Bills sent for collection Bank A/c

Illustration 1

Amit sold goods for Rs. 20,000 to Sumiton Credit on 1 Jan 2002. Amit drew abill of exchange upon Sumit for thesame amount for three months. Sumitaccepted the bill and returned it toAmit. Sumit met his acceptance onmaturity. Pass the necessary journalentries in the books of Amit and Sumitunder the following circumstances.

(i) Amit retained the bill till thedate of its maturity.

(ii) Amit discounted the bill @ 12 %p.a. from his bank.

(iii) Amit endorsed the bill to hisCreditor Ankit.

(iv) On 31 March 2002 Amit sentthe bill for collection to its bank.On 5 April 2002 bank advisedwas received.

Solution Books of AmitJournal

(i) When the bill was retained till its maturity.

Date Particulars L.F Debit CreditRs. Rs.

2002Jan1 Sumit’s A/c Dr. 20,000

Sales A/c 20,000(Sold goods to Sumit’s on credit)

Jan 1 Bills Receivable A/c Dr. 20,000 Sumit’s A/c 20,000 (Received Sumit’s acceptancepayable after three months)

Apr 4 Bank A/c Dr. 20,000 Bills Receivable A/c 20,000(Sumit met his acceptance on maturity)

Total 60,000 60,000


(ii) When the bill was discounted from the bank.

Journal


Rs. Rs.

2002Mar 1 Summit's A/c Dr. 20,000

Sales A/c 20,000(Sold goods to Sumit)

Mar 1 Bills Receivable A/c Dr. 20,000 Sumit’s A/c 20,000(Received Sumit’sacceptance for three months)

Mar 1 Bank A/c Dr. 19,400Discount A/c Dr. 600 Bills Receivable 20,000(Sumit’s acceptancediscounted with the bank)

Total 60,000 60,000

(iii) When Amit endorsed the bill in favour of his creditor Ankit.

Journal


Rs. Rs.

2002Jan 1 Sumit's A/c Dr. 20,000

Sales A/c 20,000(Sold goods to Sumit on Credit)

Jan 1 Bills Receivable A/c Dr. 20,000 Sumit’s A/c 20,000(Received Sumit’sacceptance for three months)

Jan 1 Ankit’s A/c Dr. 20,000 Bills Receivable A/c 20,000(Sumit’s acceptanceendorsed in favour of Ankit)

Total 60,000 60,000

194 ACCOUNTANCY

(iv) When the bill was sent for collection by Amit to the bank.

Journal


Rs. Rs.

2002Jan 1 Sumit’s A/c Dr. 20,000

Sales A/c 20,000(Sold goods to Sumit on credit)

Jan 2 Bills Receivable A/c Dr. 20,000 Sumit’s A/c 20,000(Received Sumit’sacceptance for three months)

Mar 31 Bills sent for collection A/c Dr. 20,000 Bills Receivable A/c 20,000(Bills sent for collection)

Apr 5 Bank A/c Dr. 20,000Bills sent for collection A/c 20,000(Bills sent for collection collectedby the bank

Total 80,000 80,000

The following Journal entries will be made in the books of Sumit under all the fourcircumstances.

Journal


Rs. Rs.

2002Jan 1 Purchases A/c Dr. 20,000

Amit’s A/c 20,000(Purchases goods from Amit on credit

Jan 1 Amit’s A/c Dr. 20,000 Bill’s Payable A/c 20,000(Accepted bill drawn by Amit payableafter three months)

Apr 4 Bills Payable A/c Dr. 20,000 Bank A/c 20,000(Met acceptance maturity

Total 60,000 60,000


his creditor Poonam in full settlementof her debt of Rs. 8,250. On 15 MayPoonam discounted the bill with herbank @ 12% p.a. On the due dateDeepak met the bill. Pass thenecessary journal entries in the booksof Ramesh, Deepak, Poonam.

Illustration 2

On 15 March 2001 Ramesh sold goodsfor Rs.28,000 to Deepak on credit.Deepak accepted a bill of exchangeDrawn upon him by Ramesh payableafter three months. On 15 AprilRamesh endorsed the bill in favour of

Solution

Books of RameshJournal


Rs. Rs.

2001Mar 15 Deepak A/c Dr. 8,000

Sales A/c 8,000(Sold goods to Deepak on Credit)

Mar 15 Bills Receivable A/c Dr. 8,000 Deepak A/c 8,000(Received Deepak’sacceptance for 3 months)

Apr 15 Poonam’s A/c Dr. 8,250 Bill Receivable A/c 8,000 Discount Received A/c 250

(Bill endorsed in favour of Poonamin full Settlement of herdebt of Rs. 8,250

Total 24,250 24,250

196 ACCOUNTANCY

Books of DeepakJournal


Rs. Rs.

2001Mar 5 Purchase A/c Dr. 8,000

Ramesh A/c 8,000(Purchased goods on creditfrom Ramesh)

Mar 5 Ramesh’s A/c Dr. 8,000 Bills Payable A/c 8,000(Accepted Ramesh’s draftpayable after 3 months)

June 18 Bills Payable A/c Dr. 8,000 Bank A/c 8,000(Met the acceptance in favourof Ramesh on maturity)

Total 24,000 24,000

Books of PoonamJournal


Rs. Rs.

2001May 15 Bills Receivable A/c Dr. 8,000

Discount Allowed A/c Dr. 250 (Ramesh’s A/c 8,250(Ramesh endrosed Deepak’sacceptance in our favour fordischarge has debt of Rs. 8,250in full settlement)

May 15 Bank A/c Dr. 7,920 Discount allowed A/c Dr. 80 Bills Receivable A/c 8,000

Total 16,250 16,250


6.10 Dishonour of a BillBill is said to have been dishonouredwhen the acceptor fails to meet hiscommitment on the date of maturity.In this situation liability of the acceptorcomes into being again. Therefore theentries made on the receipt of the billshould be reversed. For example Anjureceived bill of exchange accepted byManju, which was dishonoured. Theentries of dishonour will be as followsin the books of Anju (receiver) :

When the bill was kept by Anju withher till maturity

Manju’s A/c Dr. Bill Receivables A/cWhen the bill was endorsed by Anju

in favour of SandhyaManju’s A/c Dr.

Sandhya’s A/cWhen the bill was discounted by Anju

with his bankManju’s A/c Dr. Bank A/c

When the bill was sent for collectionby Anju

Manju’s A/c Dr. Bill sent for collection A/c

Illustration 3

On 1.1.2002 Shieba sold goods to Vishalfor Rs.10,000 and drew upon him a billof exchange for 2 months. Vishalaccepted the bill and returned it toShieba. On the date of maturity the billwas dishonoured by Vishal. Pass thenecessary journal entries in the followingcases in the books of Shieba and Vishal.

● When the bill was kept by Shiebatill the date of its maturity.

● When the bill was discountedby Shieba from his bankimmediately @ 12% p.a.

● When the bill was endorsed byShieba in favour of his creditorLal Chand.

● When the bill was sent forcollection to the bank.

(i) When the bill was kept by Shieba till its maturity

Solution Books of SheibaJournal


Rs. Rs.

2002Jan 1 Vishal’s A/c Dr. 10,000

Sales A/c Dr. 10,000(Sold goods to Vishal)

Jan 1 Bills Receivable A/c Dr. 10,000 10,000 Vishal’s A/c (Received Vishal’s acceptance)

Vishal’s A/c Dr. 10,000 Bills Receivables A/c 10,000

Feb 4 (Vishal dishonoured his acceptance)

Total 30,000 30,000

198 ACCOUNTANCY

(ii) When the bill was discounted by Shieba

Journal


Rs. Rs.


Sales A/c Dr. 10,000(Sold goods to Vishal)

Jan 1 (Bills Receivable A/c) Dr. 10,000 Vishal’s A/c 10,000 (Received Vishal’s acceptance)

Jan 1 Bank A/c Dr. 9,800 Discount A/c Dr. 200Bills Receivable A/c 10,000(Vishal’s Bill discounted)

Mar 4 Vishal’s A/c Dr. 10,000 Bank A/c 10,000(Discounted bill dishonouredby Vishal)

Total 40,000 40,000

(iii) When the bill was endorsed by Shieba to Lal Chand

Journal


Rs. Rs.


Sales A/c 10,000(Sold goods to Vishal)

Jan 1 Bills Receivable A/c Dr. 10,000 Vishal’s A/c 10,000(Receivable Vishal’s acceptance

Jan 1 Lal Chand’s A/c Dr. 10,000 Bills Receivable A/c 10,000(Vishal’s acceptance endorsed infavour of Lal Chand)

Mar 4 Vishal’s A/c Dr. 10,000 Lal Chand’s A/c 10,000(Endorsed bill dishonoured by Vishal)

Total 40,000 40,000


The following entires will be passed in the books of Vishal in all the four cases

Books of Vishal Journal


Rs. Rs.


Shieba’s A/c 10,000(Purchased goods from Shieba)

Jan 1 Shieba’s A/c Dr. 10,000 Bills Payable A/c 10,000(Accepted Shieba’s draft)

Mar 4 Bills Payable A/ Dr. 10,000 Shieba’s A/c 10,000(Acceptance in favour ofShieba dishonoured)

Total 30,000 30,000

6.11 Noting Charges

A bill of exchange should be dulypresented for payment on the date ofits maturity. Acceptor is absolved ofhis liability if the bill is not dulypresented. Proper presentation of thebill means that it should be presentedon the date of maturity to theacceptor during business workinghours. To establish beyond doubtthat the bill was dishonoured, despiteits due presentation, it has gotpreferably to be “noted” by ‘NotaryPublic’. Therefore, ‘Noting’ authen-ticates the facts of dishonour. Forproviding this service, a fees ischarged which is called “NotingCharges”.

The following facts are generallynoted by the Notary:

● Date, fact and reasons ofdishonour,

● If the bill is not expresslydishonoured, the reasons whyhe treats it as dishonoured,and

● The amount of noting charges.

The entries for noting charges inthe drawers books will be as follows:

When Drawer himself paysAcceptor’s A/c Dr. Cash A/c

Where endorsee paysAcceptor’s A/c Dr. Endorsee A/c

200 ACCOUNTANCY

When the bank pays on discounted billAcceptor’s A/c Dr. Bank A/c

When the bank pays in the event ofsending the bill for collection to thebank

Acceptor’s A/c Dr. Bank A/c

It may be kept in mind thatwhosoever pays the noting charges,ultimately these have to be borne by theacceptor. That is why the acceptor isinvariably debited in the drawer’s books.This is because he is responsible for thedishonour of the bill and hence, he hasto bear these expenses. For recording thenoting charges in his books, the acceptoropens ‘Noting Charges Account’. Hedebits the noting charges account andcredit’s the drawer’s account.

Noting charge A/c Dr. Drawer’s A/c

Illustration 4

A sold goods for Rs.15,000 to B andimmediately draw a bill upon him on1.1.2002 payable after 3 months. Onmaturity the bill was dishonoured andRs. 50 were paid by the holder of thebill as noting charges. Pass thenecessary journal entries in the booksof A and B under the following cases:

● When the bill was kept by A tillits maturity.

● When the bill was discounted byA with his bank immediately @12% p.a.

● When the bill was endorsed byA in favour of his creditor C.

Solution

Books of AJournal

(i) When the bill was retained by A


Rs. Rs.

2002Jan 1 B’s A/c Dr. 15,000

Sales A/c 15,000(Sold goods to B)

Jan 1 (Bills Receivable A/c) Dr. 15,000 B’s A/c 15,000 (Received B’s acceptance)

Apr 4 B’s A/c Dr. 15,050 Bills Receivable A/c 15,000 Cash A/c 50(B dishonoured his acceptance andpaid Rs. 50 as noting charges)

Total 45,050 45,050


(ii) When the bill was discounted with the bank

Journal


Rs. Rs.

2002Jan 1 B’s A/c Dr. 15,000


Jan 1 (Bills Receivable A/c) Dr. 15,000 B’s A/c 15,000 (Received B’s acceptance payableafter three months)

Jan 1 Bank A/c Dr. 14,550Discount A/c Dr. 450 Bills Receivable A/c 15,000(B’s acceptance discounted)

Apr 4 B’s A/c Dr. 15,050 Bank A/c 15,050(B dishonoured his acceptance onmaturity and bank paid notingcharges)

Total 60,050 60,050

(iii) When the bill was endrosed to C

Journal


Rs. Rs.

2002Jan 1 B’s A/c Dr. 15,000


Jan 1 Bills Receivable A/c Dr. 15,000 B’s A/c 15,000 (Received B’s acceptance)

Jan 1 C’s A/c Dr. 15,000 Bills Receivable A/c 15,000(C’s acceptance dishonoured)

Apr 4 B’s A/c Dr. 15,050 C’s A/c 15,050(B dishonoured disacceptance and Cpaid Rs. 50 as noting charges)

Total 60,050 60,050

202 ACCOUNTANCY

The following Journal entires will be made in the books of B in all the three cases

Books of B Journal


Rs. Rs.

2002Jan 1 Purchase A/c Dr. 15,000

A’s A/c 15,000(Purchased goods from A)

Jan 1 A’s A/c Dr. 15,000 Bills Payable A/c 15,000 (Accepted A’s draft)

April 4 Bills Payable A/c Dr. 15,000Noting charges A/c Dr. 50 A’s A/c 15,050(Acceptance in favourof a dishonoured)

Total 45,050 45,050

6.12 Renewal of the Bill

Sometimes the acceptor of the bill findsit difficult to meet the obligation of thebill on maturity. He may therefore,approach the drawer with the requestto renew the existing bill, which maybe exceeded to by the drawer. If it is sothe old bill is to be cancelled and thefresh bill with new terms of paymentis to be drawn and duly accepted anddelivered. Since, cancellation of the billis mutually agreed upon, noting of thebill is not required.

The acceptor may have to payinterest to the drawer for the extendedperiod of credit. The interest is paid incash or may be include in the amountof new bill. Sometimes, the original billmay be cancelled partly for a new billand partly for cash. For example, a bill

of Rs.10,000 may be cancelled on acash payment of Rs.3000 and onacceptance of a new bill for the balanceof Rs.7000 plus interest as agreedbetween the parties.

The journal entries in the books ofthe drawer and the acceptor will be thesame as that of dishonour of bill. Cashpaid by the acceptor towards interestis treated as income. However, ifinterest is not paid in cash the drawerin his books debits the acceptor andcredits the interest account. Theacceptor debits the interest and creditsthe drawer’s account in his books.

The journal entries for thecancellation of the old bill, for interestand for the drawal / acceptance of thenew bill in the books of the drawer andacceptor have been given below:


Transaction Books of Drawer Books of Acceptor

Cancellation Acceptor’s A/c Dr. Bills Payable A/c Dr.of old bill Bills Receivable A/c Drawer’s A/c

Interest Acceptor’s A/c Dr. Interest A/c Dr. Interest A/c Drawer’s A/c

New Bill Bill Receivable A/c Dr. Drawer’s A/c Dr. Acceptor’s A/c Bills Payable A/c

Illustration 5

On 1.2.2002 Ravi sold goods to Mohanfor Rs.18,000, Rs.3,000 were paid byMohan immediately and for thebalance he accepted a three monthsbill drawn upon him by Ravi. On thedate of maturity of the bill Mohanrequested Ravi to cancel the old bill

and draw a new bill upon him for aperiod of 2 months. He further agreedto pay interest in cash to Ravi @ 12%p.a. Ravi agreed to Mohan’s requestand cancelled the old bill and drew anew bill. The new bill was met onmaturity by Mohan. Pass the Journalentries in the books of Ravi and Mohan.

Solution

Books of RaviJournal


Rs. Rs.

2002Feb 1 Mohan’s A/c Dr. 18,000

Sales A/c 18,000(Sold goods to Mohan)

Feb 1 Cash A/c Dr. 3,000Bills Receivable A/c Dr. 15,000 Mohan’s A/c 18,000(Received Rs. 3000 in cash from Raviand an acceptance for the balance)

May 4 Mohan’s Account Dr. 15,000Cash A/c Dr. 300 Bills Receivable A/c 15,000 Interest A/c 300(Cancelled old bill and Ravi paidRs 300 as interest

Balance c/f 51,300 51,300

204 ACCOUNTANCY

Balance b/f 51,300 51,300

May 4 Bills Receivable A/c Dr. 15,000 Mohan’s A/c 15,000(Received new acceptancefrom Mohan)

July 7 Bank A/c Dr. 15,000 Bills Receivable A/c 15,000(Mohan met his new acceptance)

Total 81,300 81,300

Books of MohanJournal


Rs. Rs.

2002Feb 1 Purchases A/c Dr. 18,000

Ravi A/c 18,000(Purchased goods from Ravi)

Feb 1 Ravi’s A/c Dr. 18,000 Cash A/c 3,000 Bills Receivable A/c 15,000(Received cash from Ravi &his acceptance)

May 4 Bills Payable A/c Dr. 15,000Interest A/c Dr. 300 Ravi A/c 15,000 Cash A/c 300(Old bill cancelled by Ravi andpaid Rs. 300 as interest)

May 4 Ravi’s A/c Dr. 15,000 Bills Payable A/c 15,000(Accepted new bill drawn by Ravi)

July 7 Bills payable A/c Dr. 15,000Bank A/c 15,000(Met acceptance of the newbill on maturity)

Total 81,300 81,300


Illustration 6

On 15.1.2002 Sachin sold goodsRs. 30,000 to Narain and drew uponthe later a bill for the same amountpayable after 3 months . The bill wasaccepted by Narain. The bill wasdiscounted by Sachin from his bankfor Rs.29,250 on 31.1.2002. Onmaturity of the bill Narain requestedSachin to cancel the bill . He further

agreed to pay Rs. 10,500 in cashincluding Rs.500 interest and accepta new bill for two months for theremaining Rs.20,000. The new bill wasendorsed by Sachin in favour of hiscreditor Kapil for settling a debt ofRs.20,800. The new bill was duly metby Narain on maturity. Pass thenecessary journal entries in the booksof Sachin and Narain.

SolutionBooks of Sachin

Journal


Rs. Rs.

2002Jan 15 Narain A/c Dr. 30,000

Sales A/c 30,000(Sold goods to Narain)

Jan 15 Bills Receivable A/c Dr. 30,000 Narain A/c 30,000Bills Receivable A/c(Received Narain’s acceptance)

Jan 31 Bank A/c Dr. 29,250Discount A/c Dr. 750 Bills receivable A/c 30,000(Narain’s Acceptance discountedwith bank)

April 19 Narain’s A/c Dr. 30,500 Bank A/c 30,000 Interest A/c 500(Narain’s acceptance cancelled)

April 19 Bank A/c Dr. 10,500Bills Receivable A/c Dr. 20,000 Narain A/c 30,500(Received cash from Narain and anew acceptance for the balance)

April 19 Kapil A/c Dr. 20,800 Bills Received A/c 20,000 Discount Received A/c 800Narain’s acceptance endorsed infavour of Kapil and he alloweddiscount)

Total 1,71,800 1,71,800

206 ACCOUNTANCY

6.13 Retiring of BillThere are instances when a bill ofexchange is arranged to be retiredbefore the due date by mutualunderstanding between the drawer andthe drawee. This happens when theacceptor of the bill has funds at hisdisposal and makes a request to thedrawer to accept the payment of thebill before its maturity. If the holderagrees to do so, the bill is said to havebeen “retired”.

6.13.1 Effects of Retiring

The retiring of a bill draws a curtainon the bill transactions before theexpiry of its normal term.

To encourage the retirement ofthe bill, the holder allows somediscount called “Rebate on retiredbills” for the period between date ofretirement and maturity. The rebateis calculated at a certain rate ofdiscount.

Books of NarainJournal


Rs. Rs.


Sachin A/c 30,000(Purchased goods from Sachin)

Jan 15 Sachin A/c Dr. 30,000 Bills Payable A/c 30,000(Accepted Sachin’s draft)

Bills Payable A/c Dr. 30,000Apr 19 Interest A/c Dr. 500

Sachin A/c 30,500(Cancelled old bill & Sachin chargedinterest)

Apr 19 Sachin A/c Dr. 30,500 Bank A/c 10,500 Bills Payable A/c 20,000(Paid Sachin and accepted a newdraft for the balance)

Jul 22 Bills Payable A/c Dr. 20,000 Bank A/c 20,000(Met new acceptance on maturity)

Total 1,41,000 141,000



Rs. Rs.

2001Jan 1 B’s A/c Dr. 10,000


Jan 1 Bills Receivable A/c Dr. 10,000 B’s A/c 10,000(Received B’s acceptance for threemonths)

Mar 4 Cash A/c Dr. 9,950Rebate on bills A/c Dr. 50 Bills Receivable A/c 10,000(B tried his acceptance and rebateallowed to him)

Total 30,000 30,000

6.13.2 Accounting Treatment

The accounting treatment on theretirement of a bill is similar to theaccounting treatment when a bill ishonoured by the acceptor on the duedate in the ordinary course. The onlydifference between the two relates tothe granting of rebate. The followingJournal entries are passed.

Books of the HolderCash A/c Dr.Rebate on Bills A/c Dr. Bills Receivables A/c

(Acceptor retired his acceptance andallowed rebate)

Books of the AcceptorBills Payable A/c Dr. Cash A/c Rebate on bills A/c(Acceptance retired and rebate received)

Illustration 7

A sold goods Rs.10,000 to B on1.1.2001 and immediately draw a billon B for the same amount B acceptedthe bill and returned it to A. On March4, 2001 B retired his acceptance underrebate of 6% per annum.

Record these transactions in thebooks of A and B by passing Journalentries and prepare the necessaryledger accounts.

Books of AJournal

208 ACCOUNTANCY

B’s Account

Dr. Cr.

Date Particulars J.F Amount Date Particulars J.F AmountRs. Rs.

2001 Sales 10,000 2001 Bills Receivable 10,000Jan 1 Jan1

10,000 10,000

Bill Receivable AccountDr. Cr.


2001 B’s A/c 10,000 2001 Cash 9,950Jan 1 Mar 4 Rebate on Bills 50

10,000 10,000

Books of BJournal


Rs. Rs.


A’s A/c 10,000(Purchased goods from A)

Jan 1 A’s A/c Dr. 10,000 Bill’s Payable A/c 10,000(Accepted A’s draft payable afterthree months)

Mar 4 Bills Payable A/c Dr. 10,000 Cash A/c 9,950 Rebate on Bills A/c 50(Acceptance in favour of A retired andrebate received)

Total 30,000 30,000


A’s AccountDr. Cr.


2001 2001Jan 1 Bills Payable 10,000 Jan 1 Purchases 10,000

10,000 10,000

6.14 Insolvency

A person may find himself in asituation when his liabilities exceed therealizable value of his assets and failsto honour his commitments. In sucha situation, he may approach the courtfor declaring him insolvent. If the courtaccept his request, the debtor isdeclared as ‘insolvent’ and theadministrator is appointed by the courtfor realizing the assets and settlementof liabilities. If realized value of assetsis less than the total claim the creditorare paid proportionately. The portionof unpaid liabilities is called bad debts/deficiency from the view point ofcreditor (drawer of the bill) and fromthe view point of the acceptorrespectively.

The following will be the journalentries for this in the books of debtorand creditor.

Books of CreditorBank A/c Dr.Bad Debts A/c Dr. Debtor’s A/c

Books of DebtorCreditor’s A/c Dr. Bank A/c Deficiency A/c

Illustration 8

X sold goods Rs.10,000 to Y on 1.1.2001and drew upon him a bill for the sameamount of three months. Y accepted thebill and returned it to X. On the samedate X got the bill discounted with hisbank at 10% per annum.

Bills Payable AccountDr. Cr.


2001 2001Jan 1 Cash 9,950 Jan 1 A’s A/c 10,000

Rebate on Bills 50

10,000 10,000

210 ACCOUNTANCY

The bill was dishonoured on thedue date and the bank paid Rs. 50 asnoting charges. X agreed to accept asum of Rs. 5,300 in cash from Y andagreed to draw two new bills on Y. onefor Rs. 3,000 for two months and theother for Rs. 2,000 for three monthsin full satisfaction of his claim.

Y accepted the bills and returnedterm to X.

X endorsed the first bill to Z andthe same was duly paid on maturity.

The second bill was dishonouredas Y became insolvent and a dividendof 25 paise in the rupees was receivedfrom his estate.

Pass necessary journal entries torecord these transactions in the booksof X and Y and prepare Y’s account inthe books of X and X’s account in thebooks of Y.

Books of XJournal


Rs. Rs.

2001Jan 1 Y’s A/c Dr. 10,000

Sales A/c 10,000(Sold goods to Y)

Jan 1 Bills Receivable A/c Dr. 10,000 Y A/c 10,000(Received Y’s acceptance)

Jan 1 Cash A/c Dr. 9,750Discount A/c Dr. 250 Bills Receivable A/c 10,000Y’s acceptance discount with bank)

Jan 1 Y’s A/c Dr. 10,050 Bank A/c 10,050(Y dishonoured his acceptance onmaturity and back paid Rs. 50 asnoting charges

April 4 Cash A/c Dr. 5,300 Y’s A/c 5,300(Partial payment received from Y)

April 4 Y’s A/c Dr. 250Interest A/c 250(Interest for the entendedperiod debited to Y)

April 4 Bill Receivable A/c Dr. 5,000Y’s A/c 5,000(Received two acceptance from Y)

Balance c/f 50,600 50,600


Apr 4 Balance b/f 50,600 50,600

Apr 4 Z’s A/c Dr. 3,000 Bills Receivable A/c 3,000(Y’s acceptance endorsed in favour of Z)

Jul 7 Y’s A/c Dr. 2,000 Bills Receivable A/c 2,000(Y dishonoured the second bill)

Jul 7 Cash A/c Dr. 500Bad Debts A/c Dr. 1,500 Y’s A/c 2,000(A dividend of 25 paise in a rupee received fromY’s estate and the balance written off as bad debts)

Total 57,600 57,600

Y’s Account

Dr. Cr.


2001 2001

Jan 1 Sales 10,000 Jan 1 Bills Receivable 10,000

Apr 4 Cash 10,050 Apr 4 Cash 5,300

Apr 4 Interest 250 Apr 4 Bill Receivables 5,000

Jul 7 Bills Receivable 2,000 Jul 7 Cash 500

Jul 7 Bad Debts 1,500

22,300 22,300

212 ACCOUNTANCY

Books of YJournal


Rs. Rs.

2001 Purchases A/c Dr. 10,000Jan 1 X’s A/c 10,000

(Purchased goods from X)

Jan 1 X’s A/c Dr. 10,000 Bills Payable A/c 10,000 (Accepted X’s draft)

Apr 4 Bills Payable A/c Dr. 10,000Noting Charge A/c Dr. 50 X’s A/c 10,050 (Acceptance in favour of X dishonoured)

Apr 4 X’s A/c Dr. 5,300 Cash A/c 5,300 (Partial Payment made to X)

Apr 4 Interest A/c Dr. 250 X’s A/c 250 (Interested on extended Credit period allowed to X)

Apr 4 X’s A/c Dr. 5,000 Bills Payable A/c 5,000 (Accepted two drafts of X)

Jun 7 Bills Payable A/c Dr. 3,000 Cash A/c 3,000 (Met acceptance in favour of X on maturity)

Jul 7 Bills Payable A/c Dr. 2,000 X’s A/c 2,000 (Acceptance in favour of X dishonoured on becoming Insolvent)

Jul 7 X’s A/c Dr. 2,000 Cash A/c 500 Deficiency A/c 1,500(Dividend of 25 paise a rupee paid to X’saccount transferred to insolvent account)

Total 42,600 42,600


X’s AccountDr. Cr.


2001 2001Jan 1 Bills Payable 10,000 Jan 1 Purchases 10,000Apr 4 Cash 5,300 Apr 4 Bills Payable 10,000Apr 4 Bills Payable 5,000 Apr 4 Noting Charges 50Jul 4 Cash 500 Apr 4 Interest 250Jul 4 Deficiency 1,500 Jun 7 Bills Payable 2,000

22,300 22,300

Bills Receivable Book

No. Date Date From Drawer Acceptor Where Term Due Ledger Amount Cash Remarksof Received of whom Payable Date Folio Book

Bill Bill received Folio

Fig. 6.4 : Showing specimen bills receivable book

6.15 Bills Receivable and BillsPayable Books

When large number of bills are drawnand accepted, their recording bymeans of journal entry for everytransaction relating to the bills becomea very cumbersome and timeconsuming exercise. It is thenadvisable to record them separately inspecial subsidiary books—the billsreceivables in the Bills Receivable Bookand the bills payable in the BillsPayable Book. The reason for the useof subsidiary books for recording billtransaction is the same as that in thecase of other subsidiary books for cash,purchases, sales and the like.

An important point in connectionwith these subsidiary books for billtransactions is that they do not recordthe entire range of transactionsrelating to the bills, e.g., endorsement,dishonour, discounting, cancellation,retirement, etc. a part from a passingreference for these aspects.

6.15.1 Bills Receivable Books

It has been designed as a summary ofinformation regarding a duly acceptedbill received by a drawer. All the detailsof the bill-date, acceptor’s name,amount, term, place of payment, etc.are entered in the bills receivable bookfor presentation and further reference.

214 ACCOUNTANCY

The proforma of a bills receivablebook is given on page 213.

The bills receivable book, like anyother subsidiary book, is totaledperiodically. This total is debited to the“Bills Receivable Account” where as theaccount of every individual debtor formwhom the bills received is credited inthe ledger. The bills receivable accountis the account of an asset and wouldalways have debit balance. Thisbalance on any date would representthe amount of bills receivableunmatured and on hand.

6.15.2 Bills Payable Book

It is maintained like a bills receivablebook. It is meant to record all thedetails, relating to the bills acceptedby a person or a party, which areretained for being use in the future, incase of need. The proforma of a billspayable book is given in (Figure 6.5).

The postings from this books areto the debit of the account of everycreditor to whom acceptance has beengiven and the periodical total of thebooks is credited to the ‘Bills PayableAccount’ in the ledger.

The Bills Payable Account,representing as it does the liability ofthe acceptor in respect of bills acceptedby him, always has a credit balance, ifany. The credit balance of this accounton any particular date must be thesame as the total amount worth of billspayable yet to be presented forpayment as ascertained from the billspayable book.

Illustration 9

Enter the following transactions in theBills Receivable and Bills Payablebooks maintained by a trader and postthem in the ledger as well:

2002Jan 7

Received from S. Mitra bill dulyaccepted for Rs. 1,325 dated January4, payable three months after date.

Jan 9

Accepted S.Warden’s draft for Rs. 970at two months.

Jan 13Pradhan drew on the trader at threemonths’ date and the same wasaccepted for Rs. 390.

Bills Payable Book

No. Date of To Drawer Payee Where Term Due Ledger Amount Date Cash Remarksof Bill whom Payable Date Folio Paid Book

Bill given Folio

Fig. 6.5 : Showing specimen bills payable


Bills Receivable Book

No. Date Date of From Drawer Acceptor Where Term Due Ledger Amount Cash Re-of Received Bill whom payable Date Folio Rs Book marks

Bill received Folio

2002 2002 2002

1 Jan 7 Jan 4 S. Mitra Self S. Mitra Bombay 3 month Apr 17 1,325

2 Jan 15 Jan 14 R. Rakesh “” R. Rakesh Amritsar 1 month Feb 17 250

3 Jan 21 Jan 21 G. Ghosh “” G. Ghosh Calcutta 2 month Mar 24 310

4 Jan 22 Jan 17 D. Dhiman D. Dhiman A. Vakil Bombay 3 month Apr 20 200

5 Jan 23 Jan 23 D. Kanga Self K. Kanga Bangalore 1 month Feb 26 300

6 Jan 27 Jan 20 C. Shah M. Meyers P. Parson Madras 2 month Mar 23 350

Total : Rs. 2,735

Jan 14

Drew on R.Rakesh at one month for Rs.250 and he accepted the draft next day.

Jan 18

Gave acceptance at two months forRs. 420 to S.Parkar.

Jan 21

Received from G.Ghosh his acceptancefor Rs. 310 at two months.

Jan 22

Received from D. Dhiman, A. Vakil’sacceptance for Rs. 200 at three monthsfrom Jan 17.

Jan 23

K.Kanga accepted my draft at onemonth for Rs. 300.

Jan 27

Received from C.Shah bill for Rs. 350dated January 20, accepted by P.Parson and drawn by M. Meyers.,payable two months after date.

Jan 31

Gave acceptance for Rs. 215 at onemonth to A. Roberts.

Bills Payable Book

No. Date To whom Drawer Payee Where Term Due Ledger Amount Date Cash Remof of given Payable Date Folio Paid Book arks

Bill Bill Folio

2002 2002

1 Jan 9 S. Warden S. Warden – 2 month Mar 12 970

2 Jan 13 Pradhan Pradhan – 3 month Apr 16 390

3 Jan 18 S. Parkar S. Parkar – 2 month Mar 21 420

4 Jan 31 A. Roberts A. Roberts – 1 month Mar 3 215

Total : Rs. 1,995

216 ACCOUNTANCY

S.Mitra’s AccountDr. Cr.


2002 2002Jan 1 Sales 1,325 Jan 7 Bills 1,325

Receivable

1,325 1,325

R. Rakesh’s AccountDr. Cr.


2002 2002Jan 14 Sales 250 Jan 15 Bills 250

Receivable

250 250

G. Ghosh’s AccountDr. Cr.



Receivable

310 310

D. Dhiman’s AccountDr. Cr.



Receivable

200 200


K. Kanga’s AccountDr. Cr.



Receivable

300 300

C. Shah’s AccountDr. Cr.



Receivable

350 350

Bill Receivables AccountDr. Cr.


2002 2002Jan 31 Sundries 2,735 Jan 31 Balance c/f 2,735

2,735 2,735

S. Warden’s AccountDr. Cr.


2002 2002Jan 9 Bill Payable 970 Jan 9 Purchases 970

970 970

218 ACCOUNTANCY

Pradhan’s AccountDr. Cr.


2002 2002Jan 13 Bill Payable 390 Jan 13 Purchases 390

390 390

S. Parkar’s AccountDr. Cr.


2002 2002Jan18 Bill Payable 420 Jan 18 Purchases 420

420 420

A. Robert’s AccountDr. Cr.


2002 2002Jan31 Bill Payable 215 Jan 31 Purchases 215

Receivable

215 215

Bill Payables AccountDr. Cr.


2002 2002Jan 31 Balance c/f 1,995 Jan 31 Sundries 1,995

Receivable

1,995 1,995

Note : The drawings and acceptance of a bill always pre-supposes some background of sale or purchasetransaction. Therefore, in posting bill transactions from the two books to the accounts of deb-tors and creditors, it has been necessary sales and purchases have been effected.


Illustration 10

On 1 Jan 2002 Vinay sold goods to Ravifor Rs. 8,000 and drew four bills ofexchange on him. The first forRs. 1,500 for one month the second forRs. 1,000 for two months. The third forRs. 2,000 for three months and thefourth for Rs. 3,500 for four months.Ravi accepted the bills and returned the

same to Vinay.The second bill wasdiscounted with the bank on 4 Jan at12% p.a and on the same day the thirdbill was endorsed to Ahmad. The firstbill was sent for collection on 30 Jan.On 4 Feb the bank informed that thebill had been collected. All the bills weremet by Ravi on maturity.Pass journalentries in the books of Vinay and Ravi.

Books of VinayJournal


Rs. Rs.

2002 Ravi A/c Dr. 8,000Jan 1 Sale A/c 8,000

(Sold goods to Ravi on Credit)

Jan 1 Bill Receivable A/c Dr. 8,000 Ravi A/c 8,000(Four bills of Rs. 1,500, Rs. 1,000,Rs. 2,000 & Rs. 3,500 payable after onetwo, three, and four months respectivelyaccepted by Ravi)

Jan 4 Bank A/c Dr. 980Discount A/c Dr. 20 Bill Receivable A/c 1,000(Second bill discounted)

Jan 4 Ahmad A/c Dr. 2,000 Bills Receivable A/c 2,000(Third bill endorsed in favour of Ahmad)

Jan 30 Bills sent for collection A/c Dr. 1,500Bills Receivable A/c 1,500(First bill collected by Bank)

Feb 4 Bank A/c Dr. 1,500 Bills sent for collection A/c 1,500(First bill collected by Bank)

May 3 Bank A/c Dr. 3,500 Bills Receivable A/c 3,500(Fourth bill met by Ravi on marutity)

Total 25,500 25,500

220 ACCOUNTANCY

Books of VinayJournal


Rs. Rs.

2002 Purchases A/c Dr. 8,000Jan 1 Vinay A/c 8,000

(Purchase goods on credit from Vinay)

Jan 1 Vinay’s A/c Dr. 8,000 Bills payable A/c 8,000(Accepted four bills drawn by Vinay)

Feb 3 Bill Payable A/c Dr. 1,500 Bank A/c 1,500(Met first acceptance in favour of Vinayon maturity)

Mar 3 Bill payable A/c Dr. 1,000 Bank A/c 1,000(Met 2nd acceptance in favour ofVinay on maturity

Apr 3 Bills payable A/c Dr. 2,000 Bank A/c 2,000(Met 3rd acceptance in favourof Vinay on maturity)

May 3 Bills Payable Dr. 3,500 Bank A/c 3,500(Met 4th bill in favour of Vinay onmaturity)

Total 24,000 24,000

Illustration 11

Ashok sold goods Rs. 14,000 toBishan on 30 October 2001 and drewthree bills for Rs.2,000, Rs.4,000 &Rs. 8,000 payable after two, three,and four months respectively. Thefirst bill was kept by Ashok with himtill maturity. He endorsed the secondbill in favour of his creditor Chetan.The third bill was discounted on 3December 2001 at 12% p.a. The firstand second bills were duly met onmaturity but the third bill was

dishonoured and the bank paid Rs.50as noting charges. On 8 March 2002Bishan paid Rs. 4,000 and notingcharges in cash and accepted a newbill at two months after date for thebalance plus interest Rs.100. Thenew bill was met on maturity byBishan.You are required to give thejournal entries in the books of bothAshok and Bishan and prepareBishan’s account in Ashok’s booksand Ashok’s account in Bishan’sbooks.


Books of AshokJournal


Rs. Rs.

2001 Bishan Dr. 14, 000Oct. 30 Sales A/c 14,000

(Sold goods to Bishan on Credit)

Oct. 30 Bills Receivable A/c Dr. 14,000 Bishan 14,000(Received three acceptances from Bishan.First for Rs. 2,000 payable after twomonths, second for 4,000 payable afterthree months and the third for Rs. 8,000payable after four months)

Oct. 30 Chetan A/c Dr. 4,000 Bills Receivable A/c 4,000(Endorsed second bill in favour ofcreditor Chetan)

Dec. 3 Bank A/c Dr. 7,760Discount A/c Dr. 240 Bills Receivable A/c 8,000(Third bill discounted at 12% p.a)

2002 Bank A/c Dr. 2,000Jan. 2 Bills Receivable A/c 2,000

(Bishan met his first acceptance on due date)

March 3 Bishan Dr. 8,050 Bank A/c 8,050(Bishan dishonoured his third acceptanceand bank paid Rs. 50 as noting charges

March 8 Cash A/c Dr. 4,050 Bishan 4,050(Cash Received from Bishan)

March 8 Bishan Dr. 100 Interest A/c 100(Interest charged from Bishan for theextended period

March 8 Bills Receivable A/c Dr. 4,100 Bishan 4,100(Received new acceptance from Bishanfor 2 months)

May Bank A/c Dr. 4,10012 Bills Receivable Account 4,100

(Bishan met his new acceptance on maturity)

Total 62,400 62,400

222 ACCOUNTANCY

Bishan’s AccountDr. Cr.


2001 2001Oct 30 Sales 14,000 Oct 30 Bills Receivable 14,0002002 2002Mar 3 Bank 8,050 Mar 9 Cash 4,050Mar 9 Interest 100 Mar 9 Bills Receivable 4,100

22,150 22,150

Books of BishanJournal


Rs. Rs.

2001 Purchases A/c Dr. 14,000Oct 30 Ashok A/c 14,000

(Purchases goods on credit from Ashok)

Oct 30 Ashok A/c Dr. 14,000 Bills payable A/c 14,000(Accepted three drafts of Ashok, the firstfor Rs. 2,000 payable after 2 months,second for Rs. 4,000 payable after 3months & 3rd for Rs. 8,000 payableafter 4 months

2002Jan. 2 Bills payable A/c Dr. 2,000

Bank A/c 2,000(Met first acceptance for Rs. 2,000in favour of Ashok)

Feb 2 Bill Payable A/c Dr. 4,000 Bank A/c 4,000(Met second acceptance for Rs. 4,000 infavour of Ashok on maturity)

Balance c/f 34,000 34,000


Balance b/f 34,000 34,000

Mar 3 Bill payable A/c Dr. 8,000Noting charges A/c Dr. 50 Ashok 8,050(Third acceptance in favour of Ashokdishonoured and noting charges Rs. 50)

Mar 8 Ashok Dr. 4,050 Cash A/c 4,050(Paid to Ashok Rs. 4,000 plus notingcharges)

Mar 8 Interest A/c Dr. 100Ashok 100(Interest allowed to Ashok)

Mar 8 Ashok Dr. 4,100 Bills payable A/c 4,100(New draft of Ashok for twomonths accepted)

Mar 12 Bills payable A/c Dr. 4,100 Bank A/c 4,100(Met new acceptance for Rs. 4,100in favour of Ashok on maturity)

Total 54,400 54,400

Ashok’s AccountDr. Cr.


2001 2001Oct 30 Bills payable 14,000 Oct 30 Purchases A/c 14,000

2002 2002Mar 8 Cash A/c 4,050 Mar 3 Bills Payable 8,000

Noting charges 50

Mar 8 Bills payable 4,100 Mar 8 Interest 100

22,150 22,150

224 ACCOUNTANCY

Illustration 12

Sunil receives three promissory notesfrom Anil, dated 1 January 2000 for 3months. One bill is for Rs. 3,000, thesecond is for Rs. 4,000 and the thirdis for Rs.5,000. The second bill is

immediately endorsed in favour of Ajitand on 4 January 2000 the third billis discounted with the bank forRs.4,700. Pass the entries in Sunil’sjournal assuming (i) the bills are meton maturity, and (ii) they aredishonourned.


Rs. Rs.

2000Jan 1 Bills Receivable A/c Dr. 12,000

Anil’s A/c 12,000(Three promissory notes for Rs. 3,000,Rs. 4,000 and Rs. 5,000received from Anil)

Jan 1 Ajit’s A/c Dr. 4,000 Bills Receivable A/c 4,000(The bill for Rs. 4,000 received from Anil,now endorsed in favour of Ajit

Jan 4 Bank A/c Dr. 4,700Discount A/c Dr. 300 Bills Receivable A/c 5,000(The bill for Rs. 5,000 discounted withthe bank for Rs. 4,700, i.e. at adiscount of Rs. 300)

(i)April 4 On maturity, suppose the bills are met:

Cash / Bank A/c Dr. 3,000 Bill Receivable A/c 3,000(Cash / Cheque received in respect of thebill for Rs. 3,000 held till maturity

(ii)April 4 On maturity, suppose the bills are

dishonoured: Anil’s A/c Dr. 3,000Bills Receivable A/c 3,000(The bill for Rs. 3,000 dishonoured by Anil

Balance c/f 27,000 27,000

Books of SunilJournal


Balance b/f 27,000 27,000

April 4 Anil’s A/c Dr. 4,000Ajit’s A/c 4,000(Dishonour of Anil’s promissory note forRs.4,000 which was endorsed infavour of Ajit)

April 4 Anil’s A/c Dr. 5,000Bank A/c 5,000(Dishonour of Anil’s promissory note forRs. 5,000 which was discountedwith bank)

Total 36,000 36,000

SolutionBooks of Aashirwad

Journal


Rs. Rs.

2000Jan 1 Bills Receivable A/c Dr. 10,000

Aakarshak’s A/c 10,000(The Bill of exchange receivedfrom Aakarshak)

Jan 1 Prateek’s A/c Dr. 10,000 Bills Receivable A/c 10,000(The bill of exchange receivedfrom Aakarshak, endorsed to Prateek)

Balance c/f 20,000 20,000

Illustration 13

Aashirwad draws on Aakarshak a Billof exchange for 3 months forRs. 10,000 which Aakarshak acceptson 1st January 2000. Aashirwardendorses the bill in favour of prateek.Before maturity Aakarshakapproaches Aashirwad with the

request that the bill be renewed for afurther period of 3 months at 18 percent per annum interest. Aashirwardpays the sum to Prateek on the duedate and agrees to the proposal ofAakarshak. Pass journal entries in thebooks of Aashirwad, assuming that thesecond bill is duly met.

226 ACCOUNTANCY

Balance b/f 20,000 20,000

Apr 4 Aakarshak’s A/c Dr. 10,000 Prateek’s A/c 10,000(Cancellation of the bill of exchangereceived from Aakarshak nowwith Prateek)

Apr 4 Prateek’s A/c Dr. 10,000 Bank A/c 10,000(Payment of the amount due to Prateek)

Apr 4 Aakarshak’s A/c Dr. 450 Interest A/c 450(Interest due from Aakarshak onRs. 10,000 for 3 months at 18% p.a.)

Apr 4 Bills Receivable A/c Dr. 10,450 Aakarshak’s A/c 10,450(The new bill recieved from Aakarshak forthe amount due for him.)

July 7 Bank A/c Dr. 10,450 Bills Receivable A/c 10,450(The amount received from Aakarshak inrespect of the renewed bill.)

Total 61,350 61,350

Illustration 14

Ankit owes Nikita a sum of Rs.6,000.On 1 April,2000 Ankit gives apromissory note for the amount for 3months to Nikita who gets itdiscounted with her bankers forRs.5,760. On the due date the bill isdishonoured, the bank paid Rs.15 asnoting charges. Ankit then pays

Rs.2,000 in cash and accepts a bill ofexchange drawn on him for thebalance together with Rs.100 asinterest. This bill of exchange is for 2months and on the due date the billis again dishonoured, Nikita paidRs.15 as noting charges. Draft thejournal entries to be passed inNikita’s books.


SolutionBooks of Nikita

Journal


Rs. Rs.

2000Apr Bills Receivable A/c Dr. 6,000

Ankit’s A/c 6,000(Ankit’s promissory note received insettlement of his account)

Apr 1 Bank A/c Dr. 5,760Discount A/c 240 Bills Receivable A/c 6,000(Ankit’s promissory note discountedfor Rs. 5,760)

July 4 Ankit A/c Dr. 6,015 Bank A/c 6,015(The promissory note dishonoured byAnkit the amount of the bill and thenoting charges recoverable from Ankitand payable to Bank)

Jul 4 Cash A/c Dr. 2,000 Ankit’s A/c 2,000(The amount received from Ankit)

Jul 4 Ankit’s A/c Dr. 100 Interest A/c 100(Interest due from Ankit for thesecond bill)

Jul 4 Bills Receivable A/c Dr. 4,115 Ankit’s A/c 4,115(Ankit’s acceptance for 2 months insettlement of amount due)

Sep 7 Ankit’s A/c Dr. 4,115 Bills Receivable A/c 4,115(The dishonour by Ankit of his acceptance)

Sep 7 Ankit’s A/c Dr. 15 Cash A/c 15(Payment of noting charges, recoverablefrom Ankit

Total 28,360 28,360

228 ACCOUNTANCY

Illustration 15

Mohit sends his promissory note for3 months to Rohit for Rs. 6,000 onMay 1, 2000. Rohit gets it discountedwith his bankers. at 18 per centperannum on 4 May. On the due date thebill is dishonoured, the bank payingRs.10 as noting charges. Rohit agreesto accept Rs. 2,170 in cash (Rs. 130for noting charges and interest) and

another promissory note for Rs.4,000at 2 months. On the due date, Mohitapproaches Rohit again and asks forrenewal of the bill for a further periodof 3 months. Rohit agrees to therequest, provided Mohit pays Rs.200as interest in cash. This last bill ispaid on maturity. Draft journalenteries in the books of Mohit andRohit.

SolutionBooks of Mohit

Journal


Rs. Rs.

2000May 1 Rohit’s A/c Dr. 6,000

Bills Payable A/c 6,000(The amount of the promissory notesent to Rohit)

Aug 4 Bills payable A/c Dr. 6,000Noting Charges A/c Dr. 10 Rohit’s A/c 6,010(The dishonour of the promissory noteand Rs. 10 being payable as notingcharges to Rohit

Aug 4 Interest A/c Dr. 120 Rohit’s A/c 120(Interest due to Rohit for part renewalof the promissory note)

Aug 4 Rohit’s A/c Dr. 6,130 Bills Payable A/c 4,000 Cash A/c 2,130(Payment of Rs. 2,130 in cash and a newpromissory note For Rs. 4,000 sent toRohit to Settle his account)

Oct 7 Bills Payable A/c Dr. 4,000 Rohit’s A/c 4,000(Cancellation of the bill due today)

Balance c/f 22,260 22,260


Balance b/f 22,260 22,260

Oct 7 Interest A/c Dr. 200 Rohit’s A/c 200(The amount due as interest to Rohiton the renewed bill)

Oct 7 Rohit’s A/c Dr. 4,200 Cash A/c 200 Bills Payable A/c 4,000(Payment to Rohit of Rs. 200 in cash andthe promissory note sent to him)

2001 Bills Payable A/c Dr. 4,000Jan 10 Cash A/c 4,000

(Payment made to meet the bill due this day)

Total 30,660 30,660

Books of RohitJournal

Dr. Cr.


Rs. Rs.

2000May 1 Bill Receivable A/c Dr. 6,000

Mohit’s A/c 6,000(Mohit’s promissory note receivedthis day)

May 4 Bank’s A/c Dr. 5,730Discount A/c Dr. 270 Bills Receivable A/c 6,000(The discounting of the promissory note byMohit at 18% on Rs. 6,000 for 3 months)

Aug 4 Mohit’s A/c Dr. 6,010 Bank A/c 6,010(The dishonour of the promissory noteby Mohit Rs. 10 being charged by bankfor noting charges)

Aug 4 Mohit’s A/c Dr. 120 Interest A/c 120(The amount agreed to be paid as interestby Mohit)

Balance c/f 18,130 18,130

230 ACCOUNTANCY


Rs. Rs.

Balance b/f 18,130 18,130

Aug 4 Cash A/c Dr. 2,130Bill Receivable A/c Dr. 4,000 Mohit’s A/c 6,130(Cash and promissory note received fromMohit for the amount due from him)

Oct 7 Mohit’s A/c Dr. 4,000 Bills Receivable A/c 4,000Cancellation of Mohit’s promissory note

Oct 7 Mohit’s A/c Dr. 200 Interest A/c 200(The amout due from Mohit as interest)

Oct 7 Cash A/c Dr. 200Bills Receivable A/c Dr. 4,000 Mohit’s A/c 4,200(Cash and promissory note receivedfrom Mohit)

2001 Cash / Bank /A/c Dr. 4,000Jan 10 Bills Receivable A/c 4,000

(Mohit met his acceptance on maturity)

Total 36,660 36,660

Illustration 16

Journalize the following transactionsin the books of J. Jaggi:

(a) Our acceptance to M. Madan forRs. 3,000 retired before duedate, rebate allowed Rs.45.

(b) K. Kaku’s acceptance forRs.4,000 renewed for a furtherperiod of 3 months, interestcharged at 15 per cent.

(c) Our acceptance to P. Swamy forRs.8,000 renewed for 3 monthson the condition that Rs.2,000is paid in cash immediately andthe remaining balance to carry

out interest at 18 per cent.(d) D. Dutt’s promissory note for

Rs.7,000 which we had endorsedin favour of P. Mukerjeedishonoured. P. Mukerjee paidRs.10 as noting charges. We payP. Mukerjee by cheque and acceptfrom D. Dutt another bill for theamount due plus interest, Rs.315.

(e) Our promissory note in favourof A. Alam for Rs. 2,150 whichwe pay by cheque.

(f) Our promissory note forRs.5,000 in favour of Patelsettled by sending him Tanna’sacceptance for Rs.5,000


SolutionBooks of J. Jaggi

Journal


Rs. Rs.

Bills Payable A/c Dr. 3,000 Bank A/c 2,955 Discount A/c 45(The amount paid and discount receivedon retirement of our acceptance beforedue date)

K. Kaku’s A/c Dr. 4,000 Bills receivable A/c 4,000(The Cancellation of K. Kaku’s acceptancein order to renew it)

K. Kaku’s A/c Dr. 150 Interest A/c 150(Interest due on renewal of bill for threemonths rate of interest being 15%)

Bills Receivable A/c Dr. 4,150 K. Kaku’s A/c 4,150(K. Kaku’s acceptance for the amount due)

Bills Payable A/c Dr. 8,000 P. Swamy’s A/c 8,000(Cancellation of our acceptance toP. Swamy prior renewal)

Interest A/c Dr. 270 P. Swamy A/c 270(Interest due to P. Swamy for hisreadiness to accept a new bill for theamount due which after paying Rs 2,000cash, will be Rs. 6,000)

P. Swamy’s A/c Dr 8,270 Cash 2,000 Bills Payable A/c 6,270(Settlement of P. Swamy’s account bypaying him cash Rs. 2,000 and thebalance by a bill of exchange)

Balance c/f 27,840 27,840

232 ACCOUNTANCY

Balance b/f 27,840 27,840

D. Dutt’s A/c Dr. 7,010 P. Mukerjee’s A/c 7,010(Dishonour of D. Dutt’s acceptance whichwas sent to P. Mukerjee who claimsanother Rs. 10 for noting charges)

P. Mukerjee’s A/c Dr. 7,010 Bank A/c 7,010(Amount paid to P. Mukerjee)

D. Dutt’s A/c Dr. 315Interest A/c 315

(Interest due from D. Dutt for renewalof his acceptance)

Bills Receivable A/c Dr. 7,325 D.Dutt’s A/c 7,325(Acceptance received from D. Dutt)

Bills Payable A/c Dr. 2,500 Noting Charge A/c Dr. 10 A. Alam A/c 2,510(A. Alam for dishonoured bill and notingcharges)

Bills Payable A/c Dr. 5,000 Bills Receivable A/c 5,000(Tanna’s acceptance of Rs. 5,000 sent toPatel settlement of own acceptance tohim for Rs. 5,000)

Total 59,520 59,520

dates. The first bill was duly met. Butdue to some temporary financialdifficulties, C failed to honour hisacceptance for Rs.20,000 on the duedate and the bank had to pay Rs.20 asnoting charges. However, on 14 August2000 it was agreed between C and Dthat D would immediately pay Rs.8,020in cash and accept a new bill at three

Illustration: 17

On 12 May 2000 C sold to D goods forRs. 36,470 and drew upon the lattertwo bills of exchange; One forRs.16,470 at one month and the otherfor Rs.20,000 at three months. Daccepted both the bills.

On 5 June 2000 C sent both thebills to his bank for collection on due


months for Rs.12,480 which includedinterest for postponement of partpayment of the dishonoured bill. Cimmediately sent the new acceptanceto its bank for collection on duedate.On 1October 2000 D approached

C offering Rs.12,240 for retirement ofhis acceptance. C acceded to therequest.

Pass journal entries for all the above-mentioned transactions and prepareledger accounts in the books of C.

Books of CJournal


Rs. Rs.

2000

May 12 D’s A/c Dr. 36,470 Sales A/c 36,470(Sales to D)

May Bills Receivable A/c Dr. 36,47012 D’s A/c 36,470

(two acceptance received from D; one forRs 16,470 at one month and the otherfor Rs. 20,000 at three months)

Jun 5 Bills Sent for Collection A/c Dr. 36,470 Bills Receivable A/c 36,470(D’s acceptance sent to bank forcollection on due date)

2000Jun 15 Bank A/c Dr. 16,470

Bills sent for collection A/c 16,470(D’s Acceptance for Rs. 16,470 collectedby bank on due date)

Aug 14 D’ A/c Dr. 20,020 Bills sent for collection A/c 20,020(Dishonour of D’s acceptance earlier sentto bank for collection; bank beingcredited for noting charges paid by it)

Aug 16 D’s A/c Dr. 480 Interest A/c 480(Interest agreed to be paid by D for post-ponement of part payment of the bill)

Balance c/f 1,46,380 1,46,380

234 ACCOUNTANCY

Balance b/f 1,46,380 1,46,380

Aug 16 Bank A/c Dr. 8,020Bills Receivable A/c Dr. 12,480 D’s A/c 20,500(Cash and new acceptance receivedfrom D in settlement of his account)

Aug 19 Bill sent for collection A/c Dr. 12,000Interest A/c Dr. 480 Bill Receivable A/c 12,480(D’s new acceptance sent to bank forcollection on due date)

Oct 14 Bank A/c Dr. 12,000Rebate A/c Dr. 480 Bills sent for collection A/c 12,480(Retirement by D of his acceptance forRs. 12,480 for rebate of Rs. 240)

Total 1,91,840 1,91,840

D’s AccountDr. Cr.


2000 2000May 12 Sales 36,470 May 12 Bills Receivable 36,470Aug 14 Bills Sent for 20,000 Aug 16 Bank 8,020

Collection Aug 16 Bill Receivable 12,480Aug 14 (Dishonour 20

of Bill)Aug 16 Bank 480

Interest

56,970 56,970


Bills Receivable AccountDr. Cr.


2000 2000May12 D’s 36,470 June 5 Bills sent for 36,470

collection

May 16 D’s 12,480 Aug 16 Bills sent for 12,000collection

Interest 480

48,950 48,950

Bills sent for collectionDr. Cr.


2000 2000Jun 5 Bills Receivable 36,470 Jun 5 Bank 16,470Aug 16 Bills Receivable 12,000 Aug 14 D’c 20,000

Oct 1 Bank 12,240Oct 1 Rebate 240

48,950 48,950


(a) Drawer: A person who makes or draws a bill.

(b) Drawee: A person on whom the bill is drawn for its acceptance by him.

(c) Payee: A person in whose favour a bill is Drawn.

(d) Bill Receivable: A bill is a bill receivable for a person who has to receive thepayment on the due date.

(e) Bill Payable: A bill is a bill payable for one who has to pay it on the due date.

(f) Drawing of a Bill: When a creditor writes and signs an unconditional orderon the debtor to make payment, the former is said to have drawn a bill.

(g) Acceptance of a Bill: When the drawee puts his signature on the draft receivedby him, he is said to have accepted the bill.

(h) Payment of a bill: When the amount of the bill is realized on the due date, itis said to have been paid off.

236 ACCOUNTANCY


1. Bill of Exchange as an Instrument

A bill of exchange is a device by which the purchaser or debtor in a credit transactionis not required to make immediate payment but satisfies the seller or creditor byaccepting in writing the liability to pay the amount due from him.

2. Meaning of Bill of Exchange and Promissory Note

A bill of exchange is a written acknowledgement of debt given by one person toanother, incorporating all the terms and conditions of payments.A promissory noteis an undertaking in writing given by the debtor to the creditor to pay the latter acertain sum of money in accordance with the conditions stated therein.

3. Difference between a Bill and a Note

(a) A bill is prepared by the creditor and accepted by the debtor; a note isprepared by the debtor.

(b) There are three parties to a bill; there are only two parties to a note.(c ) A bill requires acceptance to acquire financial status; a note in itself has

financial status.

4 Features and advantages of a bill

(a) A bill is a written unconditional order; it is signed by the creditor and acceptedby the debtor; the amount of the bill is payable either on demand or at afixed or determinable future time; the amount is payable either to the beareror a specified person or to the order of the latter.

(b) Advantages

A frame for relationship; certainty of terms and conditions; convenience for debtor;financing facility for creditor; conclusive proof; means of remittance; easytransferability.

EXERCISES

Q. 1 Fill in the blanks:

(i) A bill of exchange is a _______________________ instrument.(ii) A bill of exchange is drawn by the ___________upon his ____________.(iii) A promissory note is drawn by_______________in favour of his ____________.(iv) There are ________________parties to a bill of exchange.(v) There are ________________parties to a promissory note.(vi) drawer and _____________can be the same parties in case of a bill of exchange.(vii) drawer and ___________can not be the same parties in case of a promissory note.(viii) A bill of exchange requires _____________________.(ix) A promissory note does not require_____________.(x) According to the provision of Reserve Bank of India Act, a promissory note

cannot be made payable to ___________________.


(xi) Meeting a bill of exchange by the acceptor before the date of its maturity iscalled______________.

(xii) Bills of exchange in Indian language are called as___________.(xiii) The process of transferring the owners hip of the bill is called_______________.(xiv) _______________days of grace are added in the terms of the bill to calculate the

date of its________________.(xv) The act of non-payment of the amount of the bill on its due presentation is

called _________of the bill.(xvi) If the date of maturity of a bill is on holiday then the bill will mature on

_____________day.(xvii) If the date of maturity of a bill of exchange is declared as a holiday by the

Government of India under the negotiable instruments act then the bill willmature on _____________day.


Q.2 Define a bill of exchange?Q.3 What is meant by a promissory note?Q.4 Give the meaning of negotiable instruments.Q.5 What is meant by maturity of a bill of exchange?Q.6 What is meant by dishonour of a bill of exchange?Q.7 Name the parties to a bill of exchange.Q.8 Name the parties to a promissory note.Q.9 What is meant by acceptance of a bill of exchange?Q.10 Give the meaning of ‘Noting’ of a bill of exchangeQ.11 What is meant by renewal of a bill of exchange?Q.12 Give the Performa of a bills receivable book.Q.13 What is meant by retirement of a bill of exchange?Q.14 Give the Performa of a bills payable book.Q.15 What is meant by insolvency?Q.16 Give the meaning of rebate.Q.17 Give the Performa of a bill of exchange.


(i) Distinguish between a bill of exchange and a promissory note.(ii) Briefly explain the effects of dishonour and noting of a bill of exchange.(iii) Explain briefly the procedure of calculating the date of maturity of a bill of

exchange?(iv) What is meant by due presentation of a bill of exchange? Explain briefly.(v) Briefly explain the purpose and benefits of retiring a bill of exchange to the

debtor and the creditor.(vi) Explain briefly the difference between dishonour of a bill of exchange and

renewal of a bill of exchange.(vii) Describe briefly the purpose and advantages of maintaining of a bills

receivable book.(viii) Briefly explain the benefits of maintaining a bills payable book.

238 ACCOUNTANCY

Problems

Q.9 On 1.1.2002 Rao sold goods Rs. 10,000 to Reddy. Half of the payment wasmade immediately and for the remaining half Rao drew a bill of exchange uponReddy payable after 30 days. Reddy accepted the bill and returned it to Rao. On thedue date Rao presented the bill to Reddy and received the payment.

Journalize the above transactions in the books of Rao and Reddy. PrepareReddy’s account in the books of Rao and Rao’s account in the books of Reddy.

Q. 10 On 1.1.2002, Shankar purchased goods from Parvati for Rs. 8,000 andimmediately drew a promissory note in favour of Parvati payable after 3 months.On the date of maturity of the promissory note, the Government of India declaredholiday under the Negotiable Instrument Act 1881. Since, Parvati was unawareabout the provision of the Law regarding the date of maturity of the bill, she handedover the bill to her lawyer, who duly presented the bill and received the payment.The amount of the bill was handed over by the lawyer to Parvati immediately. Passthe necessary Journal entries in the books of Parvati and Shankar.

Q. 11 Vishal sold goods for Rs. 7,000 to Manju on 5 Jan 2002 and drew upon hera bill of exchange payable after 2 months. Manju accepted Vishal’s draft and handedover the same to Vishal after acceptance. Vishal immediately discounted the billwith his bank @12% p.a. On the due date Manju met her acceptance. Journalizethe above transactions in the books of Vishal and Manju.

Q. 12 On 1 Feb 2002, John purchased goods for Rs.15,000 from Jimmi. Heimmediately made a payment of Rs. 5,000 by cheque and for the balance acceptedthe bill of exchange drawn upon him by Jimmi. The bill of exchange was payableafter 40 days. Five days before the maturity of the bill, Jimmy sent the same to hisbank for collection. The bank duly presented the bill to John on the due date andaccordingly informed Jimmi. Pass the necessary Journal entries in the books ofJohn and Jimmi. Prepare John account in the books of Jimmi and Jimmi accountin the books of John.

Q13 On 15 Jan 2002, Kartar Sold goods for Rs. 30,000 to Bhagwan and drew uponhim three bills of exchange of Rs. 10,000 each payable after one month, two month,and three months respectively. The first bill was retained by Kartar till its maturity.The second bill was endorsed by him in favour of his creditor Ratna and the thirdbill was discounted by him immediately @ 6% p.a. All the bills were met by Bhgwan.Journalize the above transactions in the books of Kartar and Bhagwan. Also prepareledger account in books of Kartar and Bhagwan.

Q. 14 On 4 Jan 2002 Arun sold goods for Rs. 30,000 to Sunil. 50% of the paymentwas made immediately by Sunil on which Arun allowed a cash discount of 2%.For the balance Sunil drew a promissory note in favour of Arun payable after 20days. Since, the date of maturity of bill was a public holiday, Arun presented thebill on a day, as per the provisions of Negotiable Instrument Act which was met bySunil.

State the date on which the bill was presented by Arun for payment andJournalize the above transaction in the books of Arun and Sunil.


Q. 15 Darshan sold goods for Rs. 40,000 to Varun on 8.1.2002 and drew uponhim a bill of exchange payable after two months. Varun accepted the bill andreturned the same to Darshan. On the due date the bill was met by Varun. Passthe necessary Journal entries in the books of Darshan and Varun in the followingcircumstances.

● When the bill was retained by Darshan till the date of its maturity.● When Darshan immediately discounted the bill @ 6% p.a. with his bank.● When the bill was endorsed immediately by Darshan in favour of his creditor

Suresh.● When three days before its maturity, the bill was sent by Darshan to his

bank for collection .

Q. 16 Bansal Traders allow a trade discount of 10% on the list price of the goodspurchased from them. Mohan traders, who runs a retail shop made the followingpurchases from Bansal Traders.

Date Amount21.12.2001. 1,00026.1.2.2001 1,20028.1.2.2001 2,00031.12.2001 5,000

For all the purchases Mohan Traders drew promissory notes in favour of BansalTraders payable after 30 days. The promissory note for the sale of 21.12.2001 wasretained by Bansal Traders with them till the date of its maturity. The promissorynote drawn on 26.12.2001 was discounted by Bansal Traders from their bank at12% p.a. The promissory note drawn on 28.1.2.2001 was endorsed by Bansal Tradersin favour of their creditor dream soaps in full settlement of a purchase amountingto Rs. 1,900. On 25.1.2002 Bansal Traders sent the promissory note drawn on31.12.2001 to their bank for collection. All the promissory notes were met by MohanTraders.

Pass the necessary journal entries for the above transactions in the books ofBansal Traders and Mohan Traders and prepare Mohan Traders account in thebooks of Bansal Traders and Bansal Traders account in the books of Mohan Traders.

Q.17 Narayanan purchased goods Rs. 25,000 from Ravinderan on 1.2.2002.Ravinderan drew upon Narayanan a bill of exchange for the same amount payableafter 30 days. On the due date Narayanan dishonoured his acceptance.

Pass the necessary journal entries in the books of Ravinderan and Narayananin following cases.

● When the bill was retained by Ravinderan with him till the date of its maturity.● When the bill was discounted by Ravinderan immediately with his bank @

6% p.a.● When the bill was endorsed of his creditor Ganeshan.● When the bill was sent by Ravinderan to his bank for collection a few days

before it maturity.

Q. 18 Ravi sold goods for Rs. 40,000 to Suders han on Feb 13, 2002. He drew fourbills of exchanges upon Sudershan. The first bill was for Rs. 5,000 payable after

240 ACCOUNTANCY

one month. The second bill was for Rs. 10,000 payable after 40 days; the third billwas for Rs. 12,000 payable after three months and fourth bill was for the balanceamount payable after 19 days. Sudershan accepted all the bills and returned thesame to Ravi. Ravi discounted the first bill with his bank at 6% p.a. He endorsedthe second bill to his creditor Mustaq for the full settlement of a debt of rs. 10,200.The third bill was kept by Ravi with him till the date of maturity. Five days beforethe maturity of the fourth bill, Ravi sent the bill to his bank for collection. All thefour bills was dishonoured by Sudershan on maturity. Sudershan settled Ravi’sclaim in cash three days after the dishonour of each bill along with interest @ 12%p.a. for the terms of the bills.

You are requested to pass the necessary journal entries in the books of Ravi,Sudershan, Mustaq and bank for the above transaction.

Also prepare Sudershan account and Mustaq account in the books of Ravi.

Q19 On I Jan Neha sold goods for Rs. 20,000 to Muskan and drew upon her a billof exchange payable after two months. One month before the maturity of the billMuskan approached Neha to accept the payment against the bill at a rebate @ 12%p.a. Neha agreed to the request of Muskan and Muskan retired the bill under theagreed rate of rebate.

Journalize the above transactions in the books of Neha and Muskan.

Q 20 On 15 Jan 2002 Raghu sold goods worth Rs. 35,000 to Devendra and drewupon the latter three bills of exchanges. The first bill was for Rs. 5,000 payableafter one month, the second bill was for Rs.10,000 payable after two months andthe third bill was for Rs. 20,000 payable after three months. Raghu endorsed thefirst bill in favour of his creditor Dewan in full settlement of a debt of Rs. 5,200. Thesecond bill was discounted by Raghu @ 6% p.a. and the third bill was retained byRaghu with him till the date of maturity. Devendra dishonoured the bill on maturityand the bank paid Rs. 30 as noting charges. The second bill was also dishonouredon maturity and the bank paid Rs. 50 as noting charges. Four days before thematurity of the third bill Raghu sent the same for collection to his bank. The thirdbill was also dishonoured by Devendra and the bank paid Rs. 200 as noting charges.Five days after the dishonour of the third bill Devendra paid the entire amount dueto Raghu along with interest Rs.1,000 for this purpose Devendra obtained a shortterm loan from his bank.

You are requested to pass the necessary journal entries in the books of Raghu,Devendra and Dewan and prepare Devendra’s account in Raghu’s books and Raghu’saccount in Devendra’s account.

Q.21. Vimal purchased goods Rs. 25,000 from Kamal on 15.1.2.2001 and accepteda bill of exchange drawn upon him by kamal payable after two months. On the dateof the maturity the bill was duly presented for payment. Vimal dishounoured thebill.

Pass the necessary journal entries in the books of Kamal and Vimal when.

● The bill was retained by Kamal till the date of its maturity.● The bill was immediately discounted by Kamal with his bank @ 6% p.a.● The bill was endorsed by Kamal in favour of his creditor Sharad.● A five days before its maturity the bill was sent by Kamal to his bank for

collections.


Q. 22 Abdula sold goods to Tahir on 17.1.2002 for Rs. 18,000. He drew a bill ofexchange for the same amount on Tahir for 45 days. On the same date which Tahiraccepted the bill and returned to Abdulla. On the due date Abdulla presented thebill to Tahir which was dishonoured. Abdulla paid Rs. 40 as noting charges. Fivedays after the dishonour of his acceptance Tahir settled his debt by making apayment of Rs.18,700 including interest and noting charges.

Pass the necessary journal entries in the books of Abdulla and Tahir . Also prepareTahir’s account in the books of Abdulla and Abdulla’s account in the books ofTahir.

Q 23 Asha sold goods worth Rs.19,000 to Nisha on 2 March 2002. Rs. 4,000 werepaid by Nisha immediately and for the balance she accepted a bill of exchangedrawn upon her by Asha payable after three months. Asha discounted the billimmediately with her bank. On the due date Nisha dishonoured the bill and thebank paid Rs. 30 as noting charges.

Pass the necessary journal entries in the books of Asha and Nisha.

Q 24 On 2 Feb 2002, Verma purchased from Sharma goods for Rs.17,500. Vermapaid Rs.2,500 immediately and for the balance gave a promissory note to Sharmapayable after 60 days. Sharma immediately endorsed the promissory note in favourof his creditor. Gupta for the full settlement of a debt of Rs. 15,400. On the due dateof the bill Gupta presented the bill to Verma which the latter dishonoured andGupta paid Rs. 5,000 noting charges. On the same date Gupta informed Sharmaabout the dishonour of the bill. Sharma settled his debt to Gupta by cheque for Rs.15,500 which. Include noting charges and interest. Verma settled Sharma’s claimby cheque for the same amount.

Pass the necessary journal entries is the bank of Sharma, Gupta and Vermafor the above transaction and prepare Verma’s and Gupta’s account in the books ofSharma. Sharma’s account in the books of Verma. And also Sharma’s account inthe books of Gupta.

Q. 25 Lilly sold goods to Mathew on 1.3.2002 for Rs. 12,000 and drew upon Mathewa bill of exchange for the same amount payable after two months. Lilly immediatelydiscounted the bill with her bank at 9% p.a. The maturity date of the bill was a nonbusiness day (holiday), therefore, Lilly had to present the bill as per the provisionsof the Indian Instruments Act 1881.The bill was dishonoured by Mathew and Lillypaid Rs.45 as noting charges. Mathew settled the claim of Lilly five days after thedishonour of the bill by a cheque, which include interest @ 12% for the term of thebill.

Journalize the above transactions in the books of Lilly and Mathew and prepareMathew’s account in the books of Lilly’s and Liily’s account in the books of Mathew.

Q. 26 Kapil purchased goods for Rs. 21,000 from Gourav on 1.2.2002 and accepteda bill of exchange drawn by Gourav for the same amount. The bill was payable afterone month. On 25.2.2002 Gourav sent the bill to his bank for collection. The billwas duly presented by the bank. Kapil dishonoured the bill and the bank paid Rs.100 as noting charges.

Pass the necessary journal entries for the above transactions in the books ofKapil and Gourav.

242 ACCOUNTANCY

Q. 27 On 14.2.2002 Rashmi sold goods Rs. 7,500 to Alka. Alka paid Rs. 500 incash and for the bank balance accepted a bill of exchange drawn upon her byRashmi payable after two months. On 10.4.2002 Alka approached Rashmi to cancelthe bill since she was short of funds. She further requested Rashmi to acceptRs. 2,000 in cash and draw a new bill for the balance including interest Rs. 500.Rashmi accepted Alka’s request and drew a new bill for the amount due payableafter 2 months. The bill was accepted by Alka. The new bill was duly met by Alka onmaturity.

Pass the necessary journal entries in the books of Rashmi and Alka and preparedAlka’s account in the books of Rashmi’s and Rashmi’s account in the books ofAlka’s.

Q. 28. Nikhil sold goods for Rs. 23,000 to Akhil on 1.12.2001. He drew upon Akhila bill of exchange for the same amount payable after 2 months. Akhil accepted thebill and sent it back to Nikhil. Nikhil discounted the bill immediately with his bank@ 12% p.a. On the due date Akhil dishonoured the bill of exchange and the bankpaid Rs. 100 as noting charges. Akhil requested Nikhil to draw a new bill upon himwith interest @ 10% p.a. which agreed. The new bill was payable after two monthsa week before the maturity of the second bill Akhil requested Nikhil to cancel thesecond bill. He further requested to accept Rs. 10,000 in cash immediately anddraw a third bill upon him including interest of Rs. 500. Nikhil agreed to Akhil’srequest. The third bill was payable after one month. Akhil met the third bill on itsmaturity. Pass the necessary journal entries in the books of Nikhil and Akhil andalso prepare Akhil’s account in the books of Nikhil and Nikhil’s account in thebooks of Akhil.

Q 29. On 1 Jan 2002 Vibha sold goods worth Rs. 18,000 to Sudha and drew uponthe latter a bill of exchange for the same amount payable after two months. Sudhaaccepted Vibha’s draft returned the same to Vibha after acceptance. Vibha endorsedthe bill immediately in favour of her creditor Geeta. Five days before the maturity ofthe bill Sudha requested Vibha to cancel the bill since she was short of funds. Shefurther requested to draw a new bill upon her including interest of Rs. 200. Vibhaaccepted Sudha’s request. Vibha took the bill from Geeta by making the paymentto her in cash and cancelled the same. Then she drew the new bill upon Sudha asagreed. The new bill was payable after one month. The new bill was duly met bySudha on maturity. Pass the necessary journal entries in the books of Vibha.

Q. 30 On 1.1.2002 Adhikari sold goods Rs. 37,000 to Bhandari. On the same dayhe drew upon Bhandari a bill of exchange payable after two months. A week beforethe maturity of the bill Bhandari requested Adhikari to cancel the old bill and drawupon him a new bill including interest of Rs.1,500. Adhikari agreed to Bhandari’srequest and cancelled the old bill. Adhikari drew a new bill with interest Rs. 1,500payable after one month. The bill was duly accepted by Bhandari.On the maturityof the second bill Bhandari became insolvent and a dividend of 50 paise in a rupeewas received from his estate.

Pass the necessary journal entries in the books of Adhikari and Bhandariaccount and prepare Bhandari account in the books of Adhikari and Adhikariaccount in the books of Bhandari.


Q. 31 On 12.10.2001 Arun sold goods Rs. 50,000 to Kapil for which the latteraccepted four bills of Rs. 12,500 each. Payable after one month, 1.5 months, 2months and 3 months respectively. The second bill was sent for collection. Thethird bill was endorsed in favour of Vishal and the fourth bill was discounted byArun with his bank @ 12% per annum. The first bill was met on the due date. Asregards the second bill, Kapil approached Arun on 25 November 2001, paid him Rs.2,500 in cash and requested him to draw a new bill for the balance together withinterest @ 12% per annum. The term of the new bill was one month and it was dulypaid on maturity. The third bill was also duly met by Kapil. On maturity on 15.1.2002Kapil was disclosed insolvent and only 50 paise in a rupee were recovered from hisestate.

Pass necessary journal entries in the books of Aurn and Kapil and prepareKapil’s account in Arun ledger and Arun’s account in Kapil ledger.

Q. 32 Here under are the following transactions in the books of Radhe Shyam.

(i) Raj Kumar acceptance in our favour Rs. 5,000 was duly met on maturity.(ii) Our acceptance Rs. 7,000 in favour of Rs. 4,500 was duly met on maturity.(iii] Paramjeet acceptance in favour of Jaipal Rs. 3,000 endorsed in our favour

was duly met on maturity.(iv] Our acceptance in favour of L.Kumar endorsed in favour of Kiran Rs.

12,000 was duly met on maturity(v) Ashok’s acceptance for Rs. 3,800 in our favour discounted with the bank

was dishonoured and the bank paid Rs. 50 as noting charges.(vi] Gourav’s acceptance for Rs. 5,500 in favour of Varun. Endorsed in our

favour was dishonored on maturity and we paidrs. 120 as noting charges.(vii) We retired on acceptane Rs.7,000 in favour of Pramod one month before

maturity under a rebate of 12% per annum.(viii) Arun acceptance in our favour Rs. 9,000 endorsed in favour Mahender

was dishonoured by Mahinder and he paid Rs. 200 as noting charges.Arun settled his debt by paying a cheque for the amount due includinginterest Rs. 500

(ix) Neha acceptance in our favour for Rs. 8,000. She was remembered for afurther period of two months. Neha agreed to pay interest Rs. 500 incash.

(x) On his becoming insolvent Vishal could not fully meet an acceptance ofRs.12,000 and a final dividend of 60 paise in a rupee was received fromhis estate.

Q. 34 Sukumari sold goods for Rs. 21,000 to Jayant on 1.1.2002 and drew uponJayant a bill of exchange payable after one month. On 29 Jan 2002 Jayant requested.Sukumari to cancel the bill drawn on 1.1.2002. He further requested her to acceptRs. 7,000 in cash which included Rs. 2,000 for interest and draw a new bill for thebalance payable after two months. This bill was endorsed by Sukumari in favour ofher creditor Bhagwati. Bhagwati duly presented the bill to Jayant on its maturityand which was dishonored Bhagwati paid Rs.100 as noting charges. Jayant againrequested Sukumari to accept Rs. 2,000 in cash and draw upon him another bill ofexchange payable after one month including interest for Rs. 500. Sukumari acceptedJayant’s request and drew the third bill which was accepted by Jayant. On the

244 ACCOUNTANCY

maturity of the new bill, Jayant became insolvent and a claim of 60 paise in a rupeewas received from him.

Journalize the above transaction in the books of Sukumari and Jayant andprepare Jayant’s account in the book of Sukumari and Sukumari account in theJayant ledger.

Q. 35 On 15 April 2001 Anil sold goods to Bijoy for Rs. 30,000. Bijoy paid Rs.30,000in cash and accepted three bills of exchange for the remaining amount. The firstbill was fro Rs. 7,000 payable after one month the second bill was for Rs. 8,000payable after two months and the third bill was for Rs. 9,000 payable after threemonths.

On 20 April 2001, Anil endorsed the first bill to his creditor Cristopher in finalsettlement of his account of Rs.7,200. He discounted the second bill with his bankat a discount of Rs. 100. Anil retained the third bill with his till the date of itsmaturity.

The first bill was met on maturity. The second bill was dishonoured on its duepresentation by cristopher and cristopher paid Rs. 100 as noting charges. Anilcharged Rs. 200 for interest and drew upon Bijoy a fourth bill for the amount duepayable after three months. Bijoy accepted it and returned it to Anil. The third billwas also met on maturity but before the due date of the fourth bill Bijoy becomeinsolvent and only 40 recovered from him.

Give journal entries to record the above transaction in the bill of Anil and Bijoyand prepare Bijoy’s account in Anil’s books and Anil’s account in Bijoy’s books.

Q. 36 Following was the position of debtor and creditor of Gautam as on 1.1.2002.

Debtors Creditors

Rs. Rs.

Babu 5,000 -Chanderkala 8,000 -Kiran 13,500 -Anita 14,000 -Anju - 5,000Sheiba - 12,000Manju 6,000

The following transactions took place in the month of Jan 2002:

Jan 2Drew on Babu at two months after date at full settlement Rs. 4,800. Babu acceptedthe bill and returned it on 5.1.2002.

Jan 4Babu’s bill discounted for Rs. 4,750.

Jan 8Chanderkala sent a promissory note for Rs. 8,000 payable three months after date.

Jan 10Promissory note received from Chanderkala discounted for Rs. 7,900.


Jan 12Accepted Sheiba Draft for the amount due payable two months after date.

Jan 22Anita sent his promissory note payable after two months.

Jan 23Anita’s promissory note endorsed in favour of Manju.

Jan 25Accepted Anju’s Draft payable after three months.

Jan 29Kiran sent Rs. 2,000 in cash and a promissory note for the balance payable afterthree months.

Record the above transactions in the proper subsidiary books.

Check-list of key letters/words

ANSWERS

(i) Negotiable

(ii) Drawer, Drawee

(iii) Maker, Payee

(iv) Three

(v) Two

(vi) Payee

(vii) Payee

(viii) Acceptance

(ix) Acceptance

(x) Bearer

(xi) Returning of a bill

(xii) Hundi

(xiii) Endorsement

(xiv) 3, Maturity

(xv) Dishonour

(xvi) Preceding working day

(xvii) Next working day

CHAPTER 7

Financial Statements

LEARNING OBJECTIVES

After studying the chapter, you will be able to:

● state the meaning of financial statements;

● appreciate the uses of financial statements;

● state the meaning of gross profit, operating profit and net profit;

● describe the need for Profit and Loss Account and Balance Sheet;

● develop the skill of grouping and marshalling of assets andliabilities;

● record the accounting treatment of adjustments required to bemade for different outstanding, prepaid, accrued and advancepayments of items of incomes and expenses;

● understand and explain the adjustments regarding bad debts,provision for bad debts, provision for discount on debtors,manager’s commission, abnormal loss, goods sent for approvaland in transit; and

● develop the skill of preparing Profit and Loss Account andBalance Sheet of a sole proprietorship firm.

ACCOUNTANCY248

The procedure of recording thetransactions in the subsidiary books, theirledger posting and preparation of trialbalance have been described in precedingchapters. In this chapter we will discussthe concepts and steps involved in thepreparation of financial statements.Preparation of financial statements is thelast step of the accounting cycle. You mayrecall that the transactions recorded in theaccounting books are posted into therelevant ledger accounts. The balances ofledger accounts are checked for accuracyby preparing the trial balance. For thispurpose these balances are posted in thetwo column of the trial balance. Debitbalance in the debit column and creditbalance in the credit column. Having donethis, the next stage is set to prepare Profitand Loss Account and Balance Sheet,collectively referred to as financialstatements.

One of the objectives of accounting isto find out the profit earned or losssustained by the firm during a givenperiod of time and its financial position ata given point of time. For this purpose, thefirm prepares the following financialstatements.

● Profit & Loss Account, and● Balance Sheet

Profit and Loss Account is also knownas income statement. It is prepared todetermine the profit earned or losssustained by the business enterpriseduring a period of time. Generally, in thelarge size organisations only one accountis prepared and gross profit, operatingprofit and net profit is ascertained bypreparing Profit and Loss Account.Whereas in small-size organizations, this

account is bifurcated into two parts viz.trading account and profit and lossaccount. Trading account is prepared toascertain gross profit whereas Profit andLoss Account is prepared to ascertainoperating profit and net profit.

Balance Sheet is also known as theposition statement, which is prepared todetermine the position of assets andliabilities of the business at a given pointof time.

7.1 Profit and Loss Account

Profit and Loss Account is prepared todetermine the profit earned or losssustained by the business enterpriseduring the accounting period, usually, asa business custom the profit is ascertainedin three stages:

● Ascertainment of gross profit● Ascertainment of operating profit● Ascertainment of net profit

Gross Profit: Gross Profit is the excessof revenue over direct cost. In order toascertain gross profit, revenue implies saleof goods or rendering services and costimplies the cost of goods sold or servicesrendered. The excess of such revenue overcost directly related thereto is called grossprofit. It is also called gross margin. Whenthe result of this computation is negative,it is referred to as gross loss. Gross Profit isthe overall result of trading, i.e. purchasingand selling of goods. It is ascertained toknow whether selling of goods and orrendering of services to customers hasproved profitable for the business or not.Gross profit , therefore, is the differencebetween net sales revenues and cost ofsales. The cost of goods sold and servicesrendered is called cost of sales.

FINANCIAL STATEMENTS 249

Cost of goods sold or cost of servicesrendered is the material consumed andexpenses related thereto during anaccounting year. Material consumed iscalculated by subtracting the amount ofclosing stock for the total of opening stockand net purchases for the year. Inmanufacturing firms and retailingbusiness, it is often called cost of goods sold.It can be shown in the form of an equationas follows:

Gross Profit =Net Sales – Cost of Goods Sold

Where, Cost of Goods Sold = Opening Stock +Net Purchase + Direct Expenses – Closing Stock

Here, net sales means total sales lesssales returns. Cost of goods sold can becalculated as follows:

Particulars AmountRs.

Opening Stock ***Add: Net Purchases ***Add: Direct Expenses ***Cost of goods available for sale ***Less: Closing Stock ***Cost of goods sold ***

Illustration IFrom the following figures calculate theamount of Gross profit earned by Vinod,

a bookseller, for the year ending 31 March2002.

Cash sales Rs.5,00,000; Credit salesRs.2,00,000; Sales returns Rs. 5,000; Costof books sold during the year Rs. 6,00,000.

Solution

Gross profit = Net Sales – Cost of goods soldNet Sales = Total Sales – Sales Return

= Cash sales + Credit sales – Sales return= Rs.5,00,000 + Rs.2,00,000 – Rs.5,000= Rs.6,95,000

Gross Profit = Rs.6,95,000 – Rs.6,00,000= Rs.95,000

Illustration 2

From the following balances extractedfrom the books of Haryana Handloomsfor the year ending 31 March 2002.Calculate the amount of Gross Profit.

Opening stock Rs. 1,00,000; Netpurchase Rs. 20,00,000; Direct expensesRs. 50,000; Net sales during the yearRs. 30,00,000. Closing stock Rs. 1,50,000.

Illustration 3Calculate the amount of gross profit/grossloss from the following infor-mationcompiled from the books of Shudh Desi

Statement of Gross Profit or Gross Loss of Haryana Handlooms for the year ending 31st March 2002.

Particulars Amount AmountRs. Rs.

Net Sales 30,00,000Less:

Opening Stock 1,00,000+ Net Purchases 20,00,000+ Direct Expenses 50,000

Cost of goods available for sale 21,50,000Less: Closing Stock 1,50,000Cost of goods sold 20,00,000

Gross Profit 10,00,000

ACCOUNTANCY250

Ghee for the year ended 31 March 2002.Opening Stock of Ghee Rs. 10,000;

Purchase of Ghee during the year

Rs. 95,000; Direct Expenses incurredRs. 15,000; Closing stock of Ghee Rs. 20,000and Sales Rs. 80,000.

SolutionStatement of Gross Profit or Gross Loss of Shudh Desi Ghee

for the year ending 31st March 2002


Sales 80,000Less:

Opening Stock 10,000+ Purchases 95,000+ Direct Expenses 15,000

Cost of Ghee available for sale 1,20,000Less: Closing Stock 20,000

Cost of Ghee sold 1,00,000

Gross Loss 20,000

Illustration 4From the following balances extractedfrom the books of M/s Lovely Sweets,calculate the amount of gross profit earnedduring the year ended 31 March 2001:Opening stock Rs.18,000; Cash purchases

Rs. 2,40,000; Credit purchases Rs.6,99,000;Cash Sales Rs.3,70,000; Credit SalesRs.11,87,000; Wages Rs.90,000; SalariesRs.1,20,000; Closing stock Rs.27,000. Salesreturns Rs.12,000 and Purchases ReturnsRs.8,000, Wages Rs.90,000.

Solution

Statement of Gross Profit of M/S Lovely Sweets for the year ending 31 March 2001


Net Sales 15,45,0002

Less:Opening Stock 18,000

+ Net Purchases 9,31,0001

+ Direct Expenses: Wages 90,000

Cost of goods available for sales during the year 10,39,000Less: Closing Stock 27,000

Cost of goods sold during the year 10,12,000

Gross Profit 5,33,000


Working Notes

Total Sales = Cash Sales + Credit Sales= Rs.3,70,000 + Rs. 11,87,000= Rs.15,57,000

Net Sales = Gross Sales – Sales Return= Rs.15,57,000 – Rs.12,000= Rs. 15,45,0002

Total Purchases = Cash Purchases+ CreditPurchases

= Rs.2,40,000 +Rs. 6,99,000= Rs. 9,39,000

Net Purchases = Total Purchases – PurchasesReturns

= Rs.9,39,000 –Rs. 8,000= Rs. 9,31,0001

● Operating Profit: It is the profitearned through the normaloperations and activities of thebusiness. Operating profit is theexcess of operating revenue overoperating expenses. Whilecalculating operating profitextraneous transactions andexpenses of a purely financialnature are not taken into account.Operating profit is the profit beforeinterest and tax. Similarly, nonoperating expenses or losses suchas loss by fire, etc. are also not takeninto account. Operating profit canbe calculated as follows:

Operating Profit = Gross Profit – OperatingExpenses

or

Operating Profit = Gross Profit – (AdministrationExpanses + Selling & Distribution Expenses).

Illustration 5

Calculate the amount of operating profitfrom the following balances obtained formthe books of Hind Traders: Net sales

Rs.5,00,000; Cost of goods sold Rs.3,00,000;Operating expenses Rs.1,20,000.

Solution

Calculation of operating profitOperating Profit = Gross Profit – Operating

Expenseswhere,Gross Profit = Net Sales – Cost of goods sold

= Rs.5,00,000 –Rs. 3,00,000= Rs.2,00,000

Operating profit = Rs.2,00,000 –Rs. 80,000= Rs.1,20,000

Illustration 6

Calculate the amount of operating profitfrom the following balances obtained fromthe books of M/S Raj Nath & Sons for theyear ended 31 March 2002. Opening stockRs.20,000; Net purchases Rs.4,60,000; Netsales Rs.8,00,000; Direct expensesRs.48,000; Selling and distributionexpenses Rs. 42,000; Administrationsexpenses Rs.33,000; Loss due to fireRs.15,000 Closing Stock Rs. 50,000.

Solution

Operating Profit = Gross Profit – OperatingExpenses

= Rs.3,22,000 – Rs.75,000= Rs.2,47,000

Working Notes

Cost of Goods Sold = Opening Stock + Net Purchases+ Direct Expenses – Closing Stock

= Rs.20,000 + Rs.4,60,000 + Rs.48,000 –Rs. 50,000

= Rs.4,78,000

Gross Profit = Net Sales – Cost of Goods Sold= Rs.8,00,000 –Rs. 4,78,000= Rs.3,22,000

Operating Expenses = Selling & Distribution Expenses+ Administration Expenses

= Rs.42,000 + Rs.33,000= Rs.75,000.

ACCOUNTANCY252

● Net Profit : It is the differencebetween the operating profit lessnon-operating expenses plus non-operating incomes. When from theoperating profit we deduct nonoperating expenses like interest andadd to it nonoperating incomeslike gain on sale of fixed assets, etc.the resultant is the net profit. Netprofit can be calculated with thehelp of the following equation.

Net Profit : Operating profit – Non operating expenses + Non-operating incomes

Non-operating expenses includeexpenses of extraneous nature and financialexpenses like, interest, tax, loss on sale offixed assets, etc. Similarly non-operatingincomes include such incomes which are notdue to the operations of the business forexample, gain on sale of fixed assets, interestreceived on investments, commissionreceived, rent received, etc. such incomesare the result of the nonoperating activitiesof the business.

Alternatively, net profit can also becalculated with the help of the followingequations:Net Profit = Net Sale + Non-operating incomes – (Costof good sold + Operating expenses + Non- operatingexpenses)

Illustration 7

Operating profit earned by a firm duringthe year was Rs. 80,000. Its non-operatingexpenses were Rs.30,000 and non-operating incomes were Rs.5,000.Calculate the amount of net profit earnedby the firm.

Solution

Net Profit = Operating profit – Non-operating expenses + Non-operating incomes

= 80,000 – 30,000 + 5,000

= Rs. 55,000

Illustration 8Sales of an enterprise during the yearended 31st March 2002 was Rs.3,20,000.Its sales returns were Rs.20,000; OpeningStock (1 April 2001) Rs.50,000; Purchasesmade by the firm during the year Rs.1,00,000; Cartage Rs.5,000; Wages duringthe year Rs.15,000; Closing stock on 31December 2002 was Rs.20,000; Salaries paidduring the year Rs.12,000; Loss on sale offurniture Rs.1,000; Gain on sale of oldmachinery Rs.3,000. During the year, thefirm paid Rs.2,000 as interest on loan andRs.20,000 as income tax. Calculate Grossprofit, Operating profit and Netprofit earned during the year ended 31March 2002.

Solution :


Sales 3,20,000Less Sales Returns 20,000 3,00,000Opening stock 50,000Purchases 1,00,000Cartage 5,000Wages 15,000

Bal c/f 1,70,000


Dr. Cr.

Particulars Amount Particulars AmountRs. Rs.

Opening stock *** Sales ***Purchases *** Less Sales Returns ***Less Returns *** ____ *** ***

Direct Expenses: Closing stock ***Wages *** Gruss Loss if any c/fCartage ***Fuel ***Royalty ***Packaging ***Material ____ ***Gross Loss if any b/f *Gross profit c/f ***Operating Expenses: Gross profit b/f * ***Administrative *** operating loss of any c/fSelling Exp ***Distribution Exp ***____ ***

Operating profit c/f ***operating lon if any b/fNon operating Expenses:Interest *** Operating profit b/f ***Tax *** ____

*** Non-operating incomes ***Net Profit transferred to *** Other incomes ***Capital Account *** Net loss for transferred to ***

capital Account

7.1.1 Proforma of Profit and Loss Account

Profit and Loss account of ————— for the year ended ————— (Date) (Name of the firm)

Balance b/f 1,70,000

Less Closing stock 20,000

Gross profit 1,50,000Less: Operating expenses 12,000Operating profit 1,38,000

Less: Non-operating expenses:

Loss on sale furniture 1,000 Interest 2,000 Income tax 20,000 23,000

1,15,000Add Non Operating Income Gain on sale of machinery 3,000

Net Profit 1,12,000

.Fig. 7.1: Proforma of Profit and Loss Account

* Only one item appears in profit and loss account

ACCOUNTANCY254

7.1.2 Relevant terms in Profit andLoss Account

(i) Items on the debit side● Opening Stock: It is the stock of

goods in hand at the beginning ofthe accounting year. This is thestock of goods which is carriedforward from the previous yearand remains unchanged during theyear and appears in the trialbalance at the end of the year. Inthe P &L account it appears on thedebit side because it forms the partof cost of sales for the currentaccounting year.

● Purchases : This account in the trialbalance shows total purchases (cashas well as credit) made during theyear. It is shown on the debit side.Goods which are returned tosuppliers are termed as purchasereturns. Purchases returns areshown by the way of deduction formpurchases. Net Purchases meansTotal Purchases – Purchases Returns.

● Direct Expenses: In case of tradingconcerns, all expenses incurred onpurchases of goods and bringingthem in saleable conditions arecalled direct expenses. However, incase of manufacturing concerns,cost of conversion of raw materialinto finished products also frompart of direct expenses. Directexpenses include the following:

(a) Wages/Direct Wages ProductiveWages: These include wages paid tothe workers who are directly engagedin the production, wages paid to theworkers for loading, unloading andproduction of goods.

(b) C a r r i a g e / C a r t a g e / F r e i g h t /CarriageInwards/Cargo Expenses/Shipping: These Expense are the itemsof transport expenses which are met forbringing the material purchased to thebusiness place. All these items fallunder the category of direct expenses.

(c) Import Duty/Customs Duty: Whengoods are imported, import duty,customs duty or dock charges, etc.have to be paid. Since, these arerelated to purchases of goods forresale purpose these are included indirect expenses.

(d) Fuel/Power/Gas/Water: Theseitems are used in the productionprocess and hence are included indirect expenses.

(e) Royalty: It is the amount paid to theowner for using his rights. Forexample, the royalty is paid by the‘Lesse’ of a coal mine to its owner fortaking out the coal from the coal mine.Similarly, royalty is paid to the ownerof a patent for the use of patent right.It is to be noted that when royalty ispaid on the basis of production it istreated as direct expense. In contractto this when royalty is based on salesrevenue such as in book publishingbusiness it is to be considered asindirect expense.

(f) Packaging Material and PackagingCharges: Cost of packaging materialand packaging charges used in theproduct are direct expenses.

● Gross Loss: Gross Loss if any asshown is the first stage of P&Laccount becomes the first item tobe debited to Profit and LossAccount.


● Salaries: These include salaries paidto the administration, godown andwarehouse staff for the servicesrendered by them for running thebusiness. These are of indirectnature. In case of partnership firmssalaries may be allowed to thepartners as per the provision of thepartnership agreement. In thenormal course of business,employees are paid net salariesafter deduction of all dues to theorganization. It is to be noted thatthe amount of salary to be shownon the debit side of profit and lossaccount is the gross amount of thesalary (including deduction ofIncome tax, Provident fund andGratuity ).If salaries are paid afterdeduction of Income Tax orProvident Fund, then these shouldbe added back to get thegross figures of salaries to bedebited to the Profit and LossAccount. If salaries are paid in kind byproviding certain facilities to theemployees such as rent freeaccommodation, meals, uniform,medical facilities than the monetaryvalue of such facilities should beregarded as salaries and the sameshould be debited to the Profit andLoss Account.

● Rent, Rates and Taxes: Theseinclude office and godown rent,municipal rates and taxes.However, factory rent, rates andtaxes should be debited to Profitand Loss Account. If rent is paidafter deduction of some tax at

source then the same should beadded back to calculate the totalamount of rent. This total (Grossrent) is debited to Profit and LossAccount.

● Interest: Interest paid on loans,bank overdraft, renewal of bills ofexchange, etc. is an expense and isdebited to the Profit and LossAccount.

● Commission: Commission paid orpayable on business transac-tionsundertaken through the agents isan item of expense and is debitedto Profit and Loss Account.

● Repairs: Repairs and smallrenewals/replacements relating toplant and machinery, furniture,fixtures, fittings, etc. for keepingthem in working condition areincluded under this head. Suchexpenditure is debited to Profitand Loss account. However, itshould be noted that any expen-diture on repairs and renewalswhich increases the businesscapacity is an expenditure ofcapital nature and is debited to theconcerned asset account, e.g.expenditure on renewals of thebuilding of a Cinema Hallresulting into increase in itscapacity will be debited to thebuilding account and not to theProfit and Loss Account.

● Depreciation: It is an expensearising out of use due to wear andtear, lapse of time. This is theestimated value of assets consumedduring the period and is debited tothe profit and loss account.

ACCOUNTANCY256

● Miscellaneous Expense: Thoughexpenses are classified and bookedunder different heads, but certainexpenses being of small amountclubbed together and are calledmiscellaneous expenses. In normalusage these expenses are called“Sundry Expenses” or “TradeExpenses.”

If the total of the credit side of theProfit and Loss Account is morethan the total of the debit side, thedifference is the net profit as per thebooks of accounts of the businessfirm for the period of which theProfit and Loss Account is beingprepared. On the other hand, if thetotal of the debit side is more thanthe total of the credit side, thedifference is the net loss sustainedby the business firm. Net profit ornet loss so computed is transferredto the capital account in case of soleproprietorship and partnershipfirms. Net profit increases theowner’s equity and net lossdecreases it.

(ii) Items on the Credit side

● Sales: Sales account in trial balanceshows gross total sales (cash as wellas credit) made during the year. Itis shown on the credit side of thetrading account. Goods returnedby customers are called returninwards and are shown asdeduction from total sales.

Net Sales means Total Sales –Sales Return

● Closing Stock: It represents thevalue of unsold goods lying in thestock at the end of the accountingperiod. At the end of the year a listof the items remaining unsold isprepared and its value is put.Closing stock is valued at lower ofcost or net realizable value. It isshown on the credit side of theProfit and Loss Account.

● Besides this, gains and incomes arealso recorded in the Profit and LossAccount. Examples are Rentreceived, Dividend received,Interest received, Discountreceived, Bad debts recovered, etc.

7.1.3 Closing EntriesThose entries which are made during thepreparation of financial statements are calledclosing entries. All items of revenue andexpenses appearing in the trial balance aretransferred to Profit and Loss Account bypassing the following entries.

● Opening stock account, Pur-chaseaccount, Wages account, CarriageInward account and Direct expensesaccount are closed by transferring tothe debit side of the Profit and LossAccount. This is done by passing thefollowing entry.

Profit and Loss a/c Dr.Opening Stock a/cPurchases a/cWages a/cCarriage Inwards a/cAll other direct expenses a/c


● The Purchases Returns or Return outwards account is closed by transferring itsbalance to the purchases account.

The following entry is passed for this purpose

Purchase returns a/c Dr.Purchases a/c

● Same way, the sales return or returns inwards account is closed by transferringits balance to the sales account as follows.

Sales a/c Dr.Sales returns a/c

● The sales account is closed by transferring its balance to the credit side of theProfit and Loss Account by means of the following entry.

Sales a/c Dr.Profit and Loss a/c

● Items of expenses, losses, etc. are closed by means of the following entries.

Profit and Loss a/c Dr.

Expenses (Individually) a/cLosses (Individually) a/c

● Items of incomes, gains, etc. are closed by means of the following entries.

Incomes (Individually) Dr.Gains (Individually) Dr.

Profit and Loss a/c.

● Transfer of net profit or net loss.

(i) For transfer of net profit.

Profit and Loss a/c Dr.Capital a/c.

or

For transfer of net lossCapital a/c Dr.

Profit and Loss a/c

ACCOUNTANCY258

Illustration 9

Given below is the trial balance of Shri Hari Prakash. Pass the necessary closing entriesand prepare the Profit and Loss account of Shri Hari Prakash for the year ended 31March 2002.

Trial Balance of Hari Prakash as on 31st March 2002

Particulars Debit CreditAmount Amount

Rs. Rs.

Stock as on 1.4.2001 50,000

Sales 2,90,000

Sales returns 10,000

Purchases 2,45,000

Purchase Returns 5,000

Carriage Inwards 4,000

Carriage Outwards 6,000

Wages 12,000

Salaries 18,000

Printing and Stationery 900

Discount allowed 900

Discount received 600

Depreciation 3,000

Building 2,08,100

Insurance Premium 600

Trade Expenses 5,000

Capital 2,72,900

Accounts Receivables 20,000

Accounts Payables 15,000

5,83,500 5,83,500

Closking Stock on 31.3.2002 Rs. 65,000


Solution

Shri Hari PrakashJournal

Date Particulars L.F Debit Amount Credit Amount2002 Rs. Rs.

March 31 Profit and Loss a/c Dr. 3,21,000 Stock a/c 50,000 Purchases a/c 2,45,000 Sales Returns a/c 10,000 Carriage Inward a/c 4,000 Wages a/c 12,000(Closing entry for opening stock,purchases, sales returns, carriageinwards and wages)

March 31 Closing Stock a/c Dr. 65,000Sales a/c Dr. 2,90,000Purchase Returns a/c Dr. 5,000 Profit and Loss a/c 3,60,000(Closing only for closing stock,Sales & Purchase Returns)

March 31 Profit and Loss a/c Dr. 34,400 Carriage outwards a/c 6000 Salaries a/c 18,000 Printing and Stationery a/c 900 Discount allowed a/c 900 Depreciation a/c 3,000 Insurance premium a/c 600 Trade expenses a/c 5,000(Closing entry for Carriage outwards,Salaries, Printing and Stationery,discount allowed, depreciation,insurance premium and tradeexpenses

March 31 Discount received a/c Dr. 600 Profit and Loss a/c 600(closing entry for discount received)

March 31 Profit and Loss a/c Dr. 5,200 5,200 Capital a/c(Net profit transferred to Capital a/c)

ACCOUNTANCY260

Profit and Loss Account of Shri Hari Prakash for the year ended 31st March 2002

Dr. Cr.


Opening Stock 50,000 Sales 2,90,000Purchases 2,45,000 Less Returns 10,000 2,80,000Less Returns 5,000 2,40,000 Closing Stock 65,000Carriage Inwards 4,000Wages 12,000Gross Profit c/f 39,000

3,45,000 3,45,000

Carriage Outwards 6,000 Gross Profit b/f 39,000Salaries 18,000 Discount Received 600Printing and Stationery 900Discount Allowed 900Depreciation 3,000Insurance Premium 600Trade Expenses 5,000Net Profit (transferred 5,200to capital account)

39,600 39,600

7.2 Balance Sheet

In order to know the position of assets andliabilities of the business, a statement isprepared which is called Balance Sheet.This statement contains the informationregarding assets and liabilities of businessat a particular point in time at a particulardate.

The Balance Sheet has two sides. Onthe left hand side the ‘liabilities’ of thebusiness and on the right hand side the‘assets’ of the business are shown.

7.2.1 Proforma of the BalanceSheet

There is no prescribed form of the BalanceSheet for a proprietary and partnershipconcern, however, schedule VI Part I of

The Companies Act 1956 prescribes theformat and the order in which the assetsand liabilities of a company should beshown. In the case of a sole tradershipform of business enterprise and apartnership firm the assets and liabilitiesof a business can be shown in any order.It is the narration of balances carriedforward for those assets whose value is tobe realized or liabilities to be paid of inthe future. Being a sheet of balances, it iscalled a Balance Sheet.

The assets and liabilities can bearranged in the Balance Sheet in any of thefollowing orders.

● Marshalling of Assets & Liabilities(i) Order of liquidity(ii) Order of permanence


(i) Order of liquidity: When anenterprise decides to show theassets and liabilities in order ofliquidity then the assets which aremore readily convertible into cashare shown first followed by theassets which cannot be so readilyconverted into cash and so on.Similarly, the liabilities which arepayable immediately are shownfirst followed by the liabilitieswhich are to be paid later on andso on. In essence the principle ofarrangements of items is fromliquidity to fixidity. The Performaof the Balance Sheet in order ofliquidity is given in Fig. 7.2:

(ii) Order of Permanence: When anenterprise follows the order of

permanence to show its assets andliabilities in the Balance Sheetthen the most permanent assetsare shown first followed by the lesspermanent assets and so on.Similarly, the long term liabilitiesare shown first followed by themedium-term liabilities and short-term liabilities. We can say that theorder of permanence is just thereverse of the order of liquidity.

(Arrangement of assets and liabilitieseither in order of liquidity or permanenceis also called Marshalling of Assets andLiabilities).

The proforma of the Balance Sheetshowing the assets and liabilities in orderof permanence is given in Fig. 7.3.

Fig. 7.2: Proforma of Balance Sheet as per the order of permanence

Balance Sheet of ................................ as at .....................

Liabilities Amount Assets AmountRs. Rs.

Current Liabilities: - Current Assets -Bills Payable - Cash in hand -Sundry Creditors - Cash at Bank -Short-term loan - Prepaid Expenses -Outstanding Expenses - Bills Receivables -Bank overdraft - Sundry Debtors -Owner’s Equity (capital) - Finished goods -Long term loans - Work-in-progress -

Raw Material -Closing stock: -

Fixed Assets -Goodwill -Land -Building -Furniture -

-...... .........

ACCOUNTANCY262

7.2.2 Important items of theBalance Sheet

The following are the important items ofliabilities and assets which find place inBalance Sheet.Liabilities: The term ‘liabilities’ denotesclaims against the enterprise as a separateentity. The term ‘equity’ is moreappropriate than the term ‘liabilities’. Theterms ‘equity’ stands both for owners(owners claims) as well as for the outsidersequity (outsiders claims). Liabilities can bedivided into two categories as follows.

(i) Current Liabilities(ii) Long-term Liabilities

(i) Current Liabilities: The liabilitieswhich are payable within a periodof one year from the date of theBalance Sheet either out of theexisting current assets or bycreating new current assets arecalled current liabilities. Theimportant items of currentliabilities are given below:(a) Accounts payable which

includes bills payable andtrade creditors.

(b) Outstanding expenses are theexpenses for which the firmhas availed the services but thepayment has not been made.

(c) Bank overdraft: is moneydrawn over the balance.

(d) Short-term loan: are loans frombanks and other sources whichare payable within one year ofthe preparation of the BalanceSheet.

(e) Advances received: These are themoney received by the business

for the services to be rendered orgoods to be supplied in the nearfuture.

Long Term Liabilities: All liabilities otherthan the current liabilities. Long termliabilities usually are payable after oneyear of the date of the Balance Sheet. Theimportant items of long term liabilities arelong-term loans, owner’s equity (capital).Assets: The term ‘Assets’ denotes theresources acquired by the business eitherfrom the funds made available by theowners or by the creditors of the business.These include all rights or propertieswhich an enterprise owns. Some of theexamples of assets are cash, cash at bank,investments, stock, bills receivable,debtors, land, building, plant andmachinery, trade marks, patent right, etc.All the assets of a business enterprise canbe classified into the following categories.

(a) Current Assets: The assets which areacquired with the intention ofconverting them into cash during thenormal business operations of theenterprise. Current assets includecash and other resources which arereasonably expected to be realizedin cash or sold during the normaloperating cycle of the business, e.g.cash, cash at bank, stock of rawmaterials, work-in-progress, andfinished goods, bills receivable,debtors, short-term investments,prepaid expenses, etc.

(b) Liquid Assets: Those current assetswhich can be immedia-telyconverted into cash are calledliquid assets. These assets includecash, bank balance, debtors,receivable, etc.


Books of JaiJournal


March 31 Profit & Loss a/c Dr. 2,24,500Opening stock a/c 5,000Purchases a/c 1,95,000Wages a/c 14,000Return Inwards a/c 6,500Carriage Inwards a/c 4,000

(Closing entry for opening stock,purchases, returns Inwards carriageinwards)

March 31 Sales a/c Dr. 2,50,000Returns outwards Dr. 25,000Closing Stock Dr. 17,500 2,92,500

Profit & Loss a/c(Closing entry for sales, returnsoutwards closing stock)Profit and Loss a/c Dr. 27,500

Insurance a/c 5,500Commission Paid a/c 4,000

Total c/f 5,17,000 5,17,000

(c) Fixed Assets: These are the assetswhich are acquired for use forrelatively long period for carryingout the business of the enterprises.Such assets are not acquired for thepurpose of resale, e.g. land,building, plant and machinery,furniture and fixtures, etc. sometimes the term ‘Fixed Block’ or‘Block Capital’ is also used forthem.

(d) Intangible Assets: These are suchassets which cannot be seen ortouched, e.g. goodwill, patents,trademarks, etc. are some examplesof intangible assets.

Illustration 10

The following balances were extracted fromthe books of Jai on 31 March 2002. You are

required to pass the necessary closing entriesand prepare Profit and Loss Account and aBalance Sheet as on 31st March 2002.

Opening Stock Rs. 5,000, Commission(Cr.) Rs. 2,000; Bills Receivable Rs. 22,500;Returns outward Rs. 2,500; PurchasesRs. 1,95,000; Trade Expenses Rs. 1,000;Wages Rs. 14,000; Insurance Rs. 5,500;Debtors Rs. 1,50,000; Carriage Inwards Rs.4,000; Commission (Dr.) Rs. 4,000; Intereston capital Rs. 3,500; Stationary Rs. 2,250;Returns Inwards Rs. 6,500; Office Fixturesand Furniture Rs. 20,000; Cash in hand Rs.20,000; Cash at Bank Rs. 55,000; Rent andRates Rs. 7,250; Carriage outwardsRs. 3,250; Sales Rs. 2,50,000; Bills PayableRs. 15,000; Creditors Rs. 79,250; Capital Rs. 1,52,750

Closing stock on 31 March 2002 wasvalued as Rs.17,500.

ACCOUNTANCY264

Total b/f 5,17,000 5,17,000

Interest on capital a/c 3,500Stationary a/c 2,250Trade expenses a/c 1,000Rent & Taxes a/c 7,250Carriage outwards a/c 4,000

(Closing entry for indirect expenses)

Commission Received a/c Dr. 2,000Profit and Loss a/c 2,000

(Closing entry for commission received)

Profit and Loss a/c Dr. 20,000 20,000Capital a/c

(Net profit earned during year

5,66,500 5,66,500

Profit and Loss Account of Jai for the year ended 31 March 2002Dr. Cr.


Opening Stock 5,000 Sales 2,50,000Purchases 1,95,000 Less Returns 6,500 2,43,500Less Returns 2,500 1,92,500

Closing Stock 17,500Wages 14,000Carriage inwards 4,000Gross Profit c/f 45,500

2,61,000 2,61,000

Insurance 5,500 Gross Profit b/f 45,500Commission Paid 4,000 Commission Received 2,000Interest on Capital 3,500Stationary 2,250Trade Expenses 1,000Rent & Taxes 7,250Carriage Outwards 4,000Net Profit 20,000

47,500 3,08500


Illustration 11: From the following information extracted from the books ofM/s Pragati Printers. Pass the necessary closing entries, prepare a Profit and Loss Accountand a Balance Sheet.


Opening Stock 12,500 Sales 1,89,000

Depreciation 7,000 Commission Received 2,000

Capital 1,71,300

Carriage Inwards 700 Creditors 17,500

Furniture 8,000 Bills Payables 5,000

Carriage Outwards 500 Return outwards 13,800

Plant & Machinery 2,00,000

Cash 8,900

Salaries 7,500

Debtors 19,000

Discounts 1,500

Bills Receivable 17,000

Wages 16,000

Sales Returns 14,000

Purchases 86,000

3,98,600 3,98,600

Closing stock on 31-3-2002 was Rs 45,000


Creditors 79,250 Cash in hand 20,000Bills Payable 15,000 Cash at Bank 55,000Capital 1,52,750 Bills Receivable 22,500Add Net Profit 20,000 Debtors 1,50,000

closing stock 17,500172750 Office Furniture & 20,000

Fixture

2,67,000 2,67,000

Balance Sheet of Sai as at 31 March 2002

ACCOUNTANCY266

Books of Pragati PrintersJournal


March 31 Profit and Loss a/c Dr. 1,29,200Opening stock 12,500Purchase 86,000Carriage Inwards 700Wages 16,000Sales Returns 14,000

(Closing entry for opening stock,purchases, carriage inwards, wages,sales returns)

March 31 Sales a/c Dr. 1,89,000Closing stock a/c Dr. 45,000Returns outwards a/c Dr. 13,800

Profit and Loss a/c 2,47,800(Closing entry for sales, closingstock return outwards)

March 31 Profit and Loss a/c Dr. 16,500Carriage outwards 500Salaries 7,500Discount 1,500Depreciation 7,000

(Closing entry for carriage outwards,salaries and discount allowed)

March 31 Commission a/c Dr. 2,000Profit and Loss 2,000

(Closing entry for commission receivable)

March 31 Profit and Loss a/c Dr. 1,04,100Capital a/c 1,04,100

(Net profit earned during year)4,99,600 4,99,600


Profit and Loss Account of Pragati Printers for the year ended 31-3-2002


Opening Stock 12,500 Sales 1,89,000Purchase 86,000 -Returns 14,000 1,75,000- Returns 13,800 72,200 Closing stock 45,000Carriage Inwards 700Wages 16,000Gross profit c/f 1,18,600

2,20,000 2,20,000

Carriage outwards 500 Gross profit b/f 1,18,600Salaries 7,500 Commission Received 2,000Discount 1,500Depreciation 7,000Net Profit 1,04,100

1,20,600 2,20,600

Balance Sheet of Pragati Printers as on 31.3.2002


Capital 1,71,300 Plants and Machinery 2,00,000Net Profit 1,04,100 2,75,400 Furniture 8,000

Closing stock 45,000Creditors 17,500 Debtrors 19,000Bills Payable 5,000 Bills Receivable 17,000

Cash 8,900

2,97,900 2,97,900

7.3 Final Account with Adjustments

● While preparing Profit and LossAccount all the expenses andincomes of the year of which theaccount is being prepared shouldbe taken into consideration. Itmeans if an expense has beenincurred during the accountingperiod but has not been paid,liability for the unpaid accountshould be created. Similarly, if an

income has been earned but has notbeen received the same must alsobe taken into account at the time ofpreparing the final accounts. Allexpenses and incomes should beadjusted through the books ofaccounts by passing journal entries.Such entries, which are required tobe, passed at the end of theaccounting period are calledadjustment entries. These

ACCOUNTANCY268

adjustments generally relate to thefollowing items:

● Closing stock;● Outstanding expenses;● Prepaid expenses;● Accrued or outstanding

incomes;● Incomes received in advance or

incomes not earned butreceived;

● Depreciations;● Bad Debts;● Provision for doubtful debts;● Provision for discount on

debtors● Interest on capital;● Differed Revenue expenditure● Loss of stock by fire;● Reserve Fund;● Goods distributed as free

samples;● Manager’s commission;● Goods on sale on approval

basis, etc.

(i) Closing Stock-(Inventory): Itrepresents the value of unsold goodslying in the stores at the end of theaccounting period. The adjustment

regarding closing stock have thefollowing effects:(a) Closing stock will be shown on

the asset side of the BalanceSheet.

(b) The Profit and Loss Accountwill be credited with theamount of closing stock.

Closing stock of a year becomes theopening stock of the next year and will beshown in the trial balance of the nextperiod.

Some times opening and closingstocks are adjusted through purchasesaccount. In such a situation there will beno opening stock in the trial balance.Adjusted purchases and closing stock(Debit balance) will be given in the trialbalance. Adjusted purchases will be takenon the debit side of the profit and lossaccount and closing stock will be shownon the asset side of the balance sheet. Here,it should be noted that closing stock willnot be shown on the credit side of theprofit and loss account as closing stock hasalready been adjusted through purchasesaccount. The two types of situations havebeen made clear with the help of thefollowing:

Books of MohanTrial Balance as on 31.3.2002

Particulars Debit Amount Credit AmountRs. Rs.

Opening stock 50,000Purchases 1,90,000 2,40,000Sales

2,40,000 2,40,000

Closing stock on 31.3.2002 was Rs. 70,000.*Relevant items only


In this case the closing stock has beengiven outside the trial balance. The

different items will appear in the finalaccounts as follows;

Profit and Loss Account Books of Mohan for the year ending 31.3.2002Dr. Cr.


Opening stock 50,000 Sales 2,40,000Purchases 1,90,000 Closing stock 70,000Gross profit c/f 70,000

3,10,000 3,10,000

Net profit transferred to 70,000 Gross profit b/f 70,000capital account

2,40,000 2,40,000

Balance Sheet as at 31.3.2002

Biabilities Amount Assets AmountRs. Rs.

Capital 70,000 Closing stock 70,000

70,000 70,000

When the opening and closing stock are adjustedthrough the purchases account, it is done by passingthe journal entries given below.

In this case the adjusted purchases will indicate thegoods conumed and the items in the Profit and LossAccount will appear as follows.

Books of MohanJournal


Purchases a/c Dr. 50,000 Opening stock a/c 50,000(Opening stock adjusted through purchases)

Stock a/c Dr. 70,000 Purchases a/c 70,000(Closing stock adjusted through purchases)

ACCOUNTANCY270

(ii) Outstanding Expenses: Out-standingexpenses are those expenses whichhave been incurred but have notyet been paid during theaccounting period for which thefinal accounts are being prepared.This generally, happens in case ofsuch business expenses, whichaccrue from day to day businessoperations, but which are recordedonly when they are paid, e.g.wages, salary, rent, interest, etc.Some of such expenses mayremain unpaid at the end of theaccounting period. For example,the salaries for the month of March2002 for the year ended 31.3.2002have not been paid. These areoutstanding salaries. In order to

ascertain the true profit earned orloss sustained during the yearended 31.3.2002 and the positionsof the assets and liabilities of thebusiness as on 31.3.2002. It isnecessary that such outstandingsalary must be taken into account.The following adjustment journalentry will be passed for suchoutstanding expenses.

Expenses a/c Dr. Outstanding Expenses a/c

Outstanding expenses as a result of theabove entry will be added to theconcerned expenses and will also beshown on the liability side of the BalanceSheet.

Books of MohanProfit and Loss Account as on 31.3.2002

Particulars Debit Amount Particulars Credit AmountRs. Rs.

Purchases 1,70,000 Sales 2,40,000 Gross profit c/f 70,000

2,40,000 2,40,000

Net profit transferred tocapital account 70,000 Gross profit b/f 70,000

70,000 70,000

Balance sheet as at 31.3.2002


Capital 70,000 Closing stock 70,000

70,000 70,000


Illustration 12

The following are the extracts from theTrial Balance of Ram as on 31.3.2002

Trial balance as on 31.3.2002


Rs. Rs.

Salaries 20,000Wages 10,000Rent 15,000Interest 7,000


(a) Salaries @ Rs. 2,000 per months for twomonths was outstanding

(b) Wages Rs 3,000 were outstanding

(c) Interest on a loan of Rs. 1,00,000 @ 6% p.a.was outstanding for two months.

(d) Rent Rs 2,000 was outstanding for 3months. You are required to pass thenecessary adjustment entries and showhow the above items will appear in theProfit and Loss Account of Ram.

Journal

Date Particulars Debit Amount Credit AmountRs. Rs.

2002March 31 Salary a/c Dr. 4,000

Wages a/c Dr. 3,000Rent a/c Dr. 2,000Interest a/c Dr. 1,000 Outstanding salary 4,000 Outstanding wages 3,000 Outstanding Rent 2,000 Outstanding Interest 1,000(Adjustment entry for outstandingsalaries, wages rent and interest)

March 31 Profit and loss a/c Dr. 13,000 Wages a/c 13,000(Closing entry for wages)

March 31 Profit and Loss a/c Dr. 49,000 Salaries 24,000 Interest 8,000 Rent 17,000(Closing entry for salaries, interestand rent)

ACCOUNTANCY272

Profit and Loss Account for the year ended 31.3.2002

Particulars Debit Particulars CAmountAmount Amount

Rs. Rs.

Wages 10,000+ Outstanding Wages 3,000

13,000Salaries 20,000+ Outstanding Salaries 4,000

24,000Rent 15,000+ Outstanding Rent 2,000

17,000Interest 7,000+Outstanding Interest 1,000

8,000

Balance Sheet as at 31.3.2002


Outstanding wages 3,000Outstanding salaries 4,000Outstanding rent 2,000Outstanding interest 1,000

(iii) Prepaid Expenses: Expenses whichhave been paid in advance arecalled pre-paid expenses. These arethe expenses which have been paidin the accounting year for whichfinal accounts are being preparedbut they belong to the next year.For example, during theaccounting year ended 31.3.2002insurance premium for the yearended 30.6.2002 might have beenpaid. It means insurance premiumfor three months has been paid inadvance. In order to ascertain theamount of profit earned or losssustained only the expenses

relating to the accounting periodshould be charged to the profit andloss account and the expenses paidin advance should be carriedforward to the next year. Thefollowing adjustment journal entrywill be made for an expense paidin advance.

Prepaid Expenses a/c Dr. Expenses a/c

The effects of the above entry will bethat to the extent of the prepaid expense theconcerned expense will reduce and pre-paidexpense being asset will be shown on theassets side of the Balance Sheet.


Illustration 13Following are the extracts from the Trial Balance of Ashok for the year ended 31-3-2002.

Trial Balance of Ashok as on 31.3.2002


Insurance 15,000Rates and Taxes 7,500Rent 6,000

* Relevant Items only


(a) Insurance premium Rs 2,500 has been paid in advance for the next year.(b) Rates and Taxes Rs 1,250 have been paid in advance for the next year.(c) Rs. 1,000 rent has been paid in advance.

You are required to pass the necessary adjustment and closing entries for theabove items in the books of Ashok and show how these items will appear in the finalaccounts.

Books of Ashok Journal

Date Particulars L.F. Debit Amount Credit Amount2002 Rs. Rs.

March 31 Prepaid Insurance Premium a/c Dr. 2,500Prepaid Rates & Taxes a/c Dr. 1,250Prepaid Rent a/c Dr. 1,000 Insurance Premium a/c 2,500 Rates and Taxes a/c 1,250 Rent a/c 1,000(Adjustment entry for prepaidinsurance premium prepaid rates &taxes and for prepaid rent)

March 31 Profit and Loss a/c Dr. Insurance Premium a/c 23,750 Rates & Taxes a/c 12,500 Rent a/c 6,250(Closing entry for insurance premium, 5,000rates and taxes and rent) 28,500 28,500

ACCOUNTANCY274

(iv) Accrued or Outstanding Incomes:These are the incomes which havebecome due during the accountingyear but which have not beenreceived by the business enterpriseso far. In order to ascertain thecorrect amount of profit earned orloss sustained by the firm adjust-ment for such incomes must bemade. The following adjustmentjournal entry is passed in the booksfor such items.Accrued income /Outstanding income Dr.

Income A/c

A distinction should be made betweenaccrued income and outstanding income.Both have been earned but have not yetbeen received. However, accrued income

is the income, which has not yet becomedue to the business whereas outstandingincome is the income, which has alreadybecome due to the business. For example,suppose the firm has given a loan of Rs.1,00,000 at 12% and the interest is to bereceived monthly; if the interest for onemonth Rs 1,000 has not been received thanthis will be termed as outstanding interest(income). But sometimes interest ispayable on a definite date. Suppose thefirm has purchased Rs. 1,00,000 12%debentures of a company and the interestis payable six monthly on 30 June and 31December then interest for the year ended31-3-2002 for the three months from. Janto March has been earned but will becomedue for payment on 30 June only. Thisinterest is accrued interest.

Profit and Loss Account for the year ended 31.3.2002Dr. Cr


Insurance Premium 1,500- Prepaid Premium 2,500

12,500

Rent & Taxes 7,500- Prepaid Rent & Taxes 1,250

6,250Rent 6,000- Prepaid Rent 1,000

5,000

Balance Sheet of Ashok as on 31.3.2002


Prepaid Insurance Premium 2,500Prepaid Rent & Taxes 1,250Prepaid Rent 1,000


Books of NehaJournal

Date Particulars L.F. Debit Amount Credit AmountRs. Rs.

2002March 31 Outstanding interest a/c Dr. 3,000

Interest on 9% Loan a/c 3,000(Outstanding interest on 12%loan for 3 months)

March 31 Accrued interest a/c Dr. 4,500 Interest on 12% Debenture a/c 4,500(Accrued interest on 12% debenturefor 3 months)

March 31 Interest on 9% Loan a/c Dr. 12,000 Profit and Loss a/c 12,000(Closing entry for interest on 9% loan)

March 31 Interest on 12% Debentures a/c Dr. 18,000 Profit and Loss a/c 18,000(Closing entry for interest on 9% debenture)

37,500 37,500

Illustration : 14

The following balances have been extracted from the Trial Balance of Neha ason 31.3.2002.


12% Loan 1,00,0009% Debenture of T ltd. (interest payable on 2,00,00030 June and 31 December)Interest Received on 12% Loan upto 31.12.2001. 9,000Interest on 9% 13,500

* Relevant Items only

Pass the necessary adjustment entries for outstanding interest and accrued interestand show how these items will appear in the Profit and Loss Account and Balance Sheetof Neha.

ACCOUNTANCY276

(vi) Incomes Received in Advance:Sometimes a firm receives certainincomes against whom corres-ponding services have not beenrendered by it during theaccounting year. Such incomes arecalled incomes received in advanceor unearned incomes. Whilepreparing the Profit & LossAccount for the year such incomesare not taken into account so as tocertain the true profit or loss.Following adjustment entry ispassed for Incomes received inadvance.

Income a/c Dr. Income Received in Advance a/c

The effect of the above entry will bethat to the extent of incomes received in

advance the total incomes will decreaseand income received in advance areliabilities and will be shown on the liabilityside of the Balance Sheet.

Illustration: 15

From the following balances extractedfrom the Trial Balance of Raghu on 31March 2002. You are required to pass thenecessary adjustment entry and closingentry and show how these items willappear in the final accounts.

Trial Balance as on 31.03.2002

Particulars Debit CreditRs. Rs.

Rent Received for 12 months 24,000 ending 30.06.2002

Profit and Loss Account of Neha for the year ended 31-3-2002

Dr. Cr.


Interest on 12% LoanReceived 9,000+Outstanding 3,000 12,000

Interest on 9% /DebenturesReceived 13,500Accrued 4,500 18,000

Balance Sheet of Neha as on 31.3.2002


Outstanding interest on 12% 3,000Loan

Accrued interest on 9% 4,500Debentures


(vii) Depreciation:Depreciation is an expense andhence to calculate the true profitearned or the loss sustained by thebusiness depreciation should betaken into account. Depreciation isthe decrease in the value of an assetdue to use, passage of time, wearand tear, accidents, obsolesince, etc.

Books of RaghuJournal


March 31 Rent a/c Dr. 6,000 Rent Received in advance a/c 6,000(Rent for three months received inadvance adjusted)

March 31 Rent a/c Dr. 18,000 Profit & Loss a/c 18,000(Closing entry for rent)

24,000 24,000


Dr. Cr.


Rent 24,000Less:Received in Advance 6,000 18,000

Balance Sheet of Raghu as at 31.03.2002


Rent Received in advance 6,000

The following journal entry is passedfor charging depreciation.

Depreciation a/c Dr. Fixed Assets a/c

Illustration : 16

The following extracts have been obtainedfrom the Trial Balance of Darshan for theyear ended 31.03.2002.

ACCOUNTANCY278



Rs. Rs.

Building 5,00,000Plant 1,00,000Furniture 50,000

6,50,000 6,50,000

* Relevant items only


(a) Charged Depreciation on building @ 5% p.a.(b) Charged Depreciation on plant @10% p.a.(c) Charged Depreciation on furniture @15% p.a.

You are required to pass the necessary adjustment and closing entries fordepreciation in the books of Darshan.

Books of DarshanJournal


March 31 Depreciation a/c Dr. 42.500 Building a/c 25,000 Plant a/c 10,000 Furniture 7,500(Depreciation Charged)

Profit and Loss Account Dr. 42,500 Depreciation a/c(Closing entry for Depreciation)

85,000 85,000

Profit and Loss Account for the year ended 31.03.2002.Dr. Cr.


Depreciation: Building 25,000 Plant 10,000 Furniture 7,500

42,500


While providing depreciation itshould be kept in mind that depreciationshould be charged on the asset for thatperiod of time for which it was used bythe business during the accounting period.For example, if the accounting period of afirm ends on 31 March of the year and afixed asset was purchased on 1 July of theprevious year then depreciation on thisasset should be charged only for the periodbetween 1 July of the previous year to 31March of the current year, i.e. for 9 monthsonly. Similarly, when the asset is soldduring the course of the year thendepreciation on such an asset should becharged only upto the date on which it wassold. For example if an asset is sold on 30September and the accounting year of thefirm ends on 31 March of the next yearthen depreciation will be charged for theperiod 1 April to 30 September i.e., for 6months only.

Illustration 17

Following are the extracts from the TrialBalance of Vishal as on 31.03.2002.



Rs. Rs.

Building 10,00,000

Plant & Machinery 2,00,000

12,00,000



(a) Charged Depreciation on buildingand plant & machinery @ 10% and20%p.a. respectively.

(b) Building costing to Rs. 5,00,000 waspurchased on 01.01.2001.

Pass necessary journal entries forproviding depreciation and closing entriesfor the same. Also show how these itemswill be shown in the Final Accounts ofVishal.

Balance Sheet of Darshan as on 31.03.2002


Building 5,00,000Less: Depreciation 25,000

4,75,000Plant 1,00,000Less: Depreciation 10,000

90,000Furniture 50,000Less: Depreciation 7,500

42,500

6,07,500 6,07,500

ACCOUNTANCY280

Books of VishalJournal


2002 Depreciation Account Dr. 1,15,000March 31 Building 75,000

Plant & Machinery 40,000(Charged Depreciation onbuilding @10% p.a., and on plant &machinery @20% p.a.)

2002 Profit and Loss Account Dr. 1,15,000 1,15,000March 31 Depreciation

(Closing entry for Depreciation)

2,30,000 2,30,000

Profit and Loss Account of Vishal for the year ended 31.03.2002Dr. Cr.


DepreciationBuilding 75,0000sPlant & Mach. 40,000 1,15,000

Balance Sheet of Vishal as on 31.03.2002


Building 10,00,000Less: Depreciation 75,000

Plant & Mach. 2,00,000 9,25,000Less: Depreciation 40,000 1,60,000

10,85,000 10,85,000

Working Notes

Calculation of Depreciation on Building:

On Rs.5,00,000 @10% p.a.for one year.

On Rs.5,00,000 building purchasedo n 01.01.2001 for six months

Total Depreciation: Rs.75,000

000,50.Rs100

10000,00,5.Rs =×=

000,25.Rs2

1

100

10000,00,5.Rs =××=


(viii) Bad Debts : These days large numberof credit sales transac-tions take place.Despite due care in estimating creditworthiness of the buyer, he may notmake the payment on the due datedue to financial constraints. If thesefinancial constraints lead to default inpayment, such amount becomesirrecoverable. In such a situation itamounts to bad debts. The followingentry is passed in this context.

Bad Debts a/c Dr. Debtors a/c

Illustration: 18Following are the extracts from the TrialBalance of Ajanta for the year ended31.03.2002.



Rs. Rs.

Sundry Debtors 10,000

*Relevant items only


Suresh a debtor became insolvent and itwas found on 31.03.2002 that out of the totaldebt of Rs.400 only Rs.100 will be recoveredfrom him.

You are required to pass the necessaryadjustment and closing entries for theabove items and show how the same willappear in the Profit & Loss Account andBalance Sheet of Ajanta.

Books of AjantaJournal


March 31 Bad Debts Account Dr. 300 Debtor (Mr. Suresh) 300(Bad Debts written off)

March 31 Profit and Loss Account Dr. 300 Bad Debts Account 300(Closing entry for Bad Debts)

600 600

Profit and Loss Account as on 31.03.2002.Dr. Cr.


Bad Debts 300

ACCOUNTANCY282

The total of the Bad Debts written offduring the year are shown in the trialbalance, whereas the bad debts which haveto be written off on the date of thepreparation of final accounts are notshown in the trial balance. The bad debtswhich are written off on the date of thepreparation of the trial balance will havea dual effect. Firstly it will increase thetotal amount of the bad debts written off

Trial Balance of Akbar as on 31.03.2002


Debtors 2,00,000Bad Debts 5,000

Additional Information writen off furtherbad debts Rs.1,000.

Pass the necessary adjustment entry and

closing entry for the above items and showhow these items will be shown in the finalaccounts of Akbar.

Books of AkbarJournal


March 31 Bad Debts a/c Dr. 1,000 Debtor a/c 1,000(Written off further Bad Debts)

March 31 Profit and Loss a/c Dr. 6,000 Bad Debts a/c 6,000(Closing entry for Bad Debts)

7,000 7,000

Balance Sheet of Ajanta as at 31.03.2002


Debtors 10,000Less: Bad Debts 300

9,700 9,700

and secondly it will reduce the amountof debtors to the extent of this amount. Ithas been illustrated with the help of thefollowing illustration.

Illustration 19

The following balances have beenextracted from the Trial Balance of Akbaras on 31.03.2002.


(ix) Provision for Doubtful Debts:According to the principle ofprudence, while recording businesstransactions all expected lossesshould be taken into consideration.Since, it is not possible to accuratelyknow the amount of bad debts, it isdesirable to make a reasonableestimate of such loss likely to arisein the next accounting year andmake a provision for the same. Theprovision for bad debts is createdby debiting profit and loss accountand crediting provision for baddebt account. The following journalentries passed in this context.Profit and Loss a/c Dr. Provision for Bad Debts

Provision for bad debts is a liabilityand is shown either on the liability side of

the balance sheet or as a deduction fromthe debtors on the asset side of the balancesheet.

Illustration 20

The following balance has been extractedfrom the Trial Balance of Amit as on 31-3-2002.

Trial Balance of Amit as on 31-3-2002


Rs. Rs.

Debtors 20,000


Additional Information: Create aprovision of 5 per cent on debtors.

Profit and Loss Account for the year ended 31.03.2002.Dr. Cr.


Bad Debts 5,000Add Further Written off 1,000

6,000

Balance Sheet of Ajanta as on 31.03.2002


Debtors 2,00,000Less Further BadDebts Written off 1,000 1,99,000

1,99,000 1,99,000

ACCOUNTANCY284

SolutionBooks of Amit

Journal


March 31 Profit and Loss a/c Dr. 1,000 Provision for bad debts 1,000



Provision for Bad Debts 1,000

Balance Sheet of of Amit as at 31-3-2002


Debtors 20,000Less: Provision 1,000 19,000

Illustration : 21

Following are the extracts from the Trial Balance of Sonam as on 31.3.2001.

Trial Balance of Sonam as on 31-3-2001


Rs. Rs.

Sundry Debtors 1,50,000Bad Debts 5,000


amount of Rs. 7,000 due from him wasirrecoverable.

(b) Create a provision of 8 per cent for badand doubtful debts.

Pass the necessary journal entry forcreating the provision and show how it

will appear in the Profit and Loss accountand Balance Sheet of Amit.

Additional Information:(a) After preparing the trial balance it

was discovered that a debtor. Sunilhad become insolvent and the entire

Dr. Cr.



March 31 Bad Debts a/c Dr. 7,000 Sunil 7,000(Irrecoverable amount from sunilwritten off as bad debts)

March 31 Profit and Loss a/c Dr. 12,000 Bad Debts 12,000(Closing entry for bad debts)

March 31 Profit and Loss a/c Dr. 11,440 Provision for Bad Debts 11,440(Credit provision for bad debts @8% of debtors)

Profit and Loss account for the year ended 31.3.2001


Bad Debts 12,000Provision for bad debts 11,440

Balance Sheet of Sonam as on 31.3.2002


Debtors 1,50,000Less:Further 7,000Bad Debts ––––––

1,43,000

Less:Provision for 11,440 1,31,560Bad Debts

You are required to pass the necessary adjustment and closing entries and showhow these items will appear in the final account of Sonam.

When provision for bad debts existsthan the bad debts during a year arewritten off out of the existing provision

and afterwards the new provision iscreated. This has been made clear with thehelp of the following illustration.

ACCOUNTANCY286

Trial Balance as on 31-3-2002

Particulars L.F. Debit Amount Credit AmountRs. Rs.

Debtors 90,000Bad Debts 5,000Provision for Bad debts 6,000


Illustration 22Following are the extracts from the trial balance of Nagi & Sons as on 31.3.2002.

Additional InformationCreate a provision of 10% for bad anddoubtful debts.

You are required to pass the necessaryadjustment and closing entries in thebooks of Nagi & Sons also show how theseitems will appear in their final accounts.

Nagi and SonsJournal


March 31 Provision for bad debts a/c Dr. 5,000 Bad Debts 5,000(Bad debts written off)

March 31 Profit and Loss a/c Dr. 8,000 Provision for bad debts 8,000(created provision for bad debtsequal to 10% of the detors)

Provision for Bad Debts Account

Dr. Cr.


Bad debts 5,000 Balance b/f 6,000Balance c/f 9,000 Profit and Loss 8,000

14,000 14,000


Profit and Loss Account as on 31.3.2002Dr. Cr.


Provision for Bad Debts 8,000

Balance Sheet of Nagi & Sons as at 31-3-2002


Debtors 90,000Less: Provision 9,000 81,000

Illustration 23

Following are the extracts from the Trial Balance of Harish Chander as on 31.3.2002.

Trial Balance of Harish Chander as on 31.3.2002.


Debtors 2,00,000Bad Debts 10,000Provision for bad debts 8,000



(a) Write off further bad debts Rs. 2,000.(b) Create a provision of 5% for bad debts

You are required to pass the necessary

Books of Harish ChanderJournal


March 31 Bad Debts a/c Dr. 2,000 Debtors a/c 2,000(further bad debts written off)

March 31 Provision bad debts a/c Dr. 12,000 Bad Debts 12,000(Bad Debts transferred to provision forbad debts account)

March 31 Profit and Loss a/c Dr. 13,900 Provision for bad debts 13,900(Created a provision of 5% for bad debts)

journal entries regarding the above itemsand also show how these items will appearin the Profit and Loss account and BalanceSheet of Harish Chander. Also prepareprovision for bad debts account.

ACCOUNTANCY288

Provision for Bad debts AccountDr. Cr.


Bad Debts 12,000 Balance b/f 8,000Balance b/f 9,900 Profit and Loss a/c 13,900

21,900 21,900

Balance Sheet of Harish Chander as on 31.3.2002


Debtors 2,00,000Less Further 2,000Bad Debts ––––––––

1,98,000Less Provision 9,900 1,88,100

(ix) Provision for Discount on Debtors: Tomotivate the debtors to make promptpayments discount may be allowed tothem. Since the debtors for the currentaccounting year may be collected in thenext accounting year, hence aprovision for discount on such debtorsat a certain percentage may have to bemade. This provision is created bypassing the following journal entry.

Profit and Loss a/c Dr. Provision for discount on debtors a/c

It should be noted that the provision fordiscount on debtors will be created only ongood debtors, i.e. debtors who intend to

make payment. In other words it will bemade after deducting further bad debts andprovision for bad debts from the debtors. Theforgoing discussion makes it clear thatdebtors are either good, doubtful and bad.Provision for discount is made on goodsdebtors which are arrived at by deductingbad debts given outside the Trial Balance andthe provision for bad and doubtful debtsrequired to be made at the end of the year.

Illustration 24

Following are the balances extracted fromthe Trial Balance of Thomas as on31.3.2002.


Particulars Debit CreditAmount Rs. Amount Rs.

Debtors 93,000Bad debts 5,000



Additional Information(a) Write of further bad debts Rs. 3,000(b) Create a provision for bad debts @5% on debtors and a provision for discount on

debtors @ 2.5% of debtorsPass necessary journal entries for the above items and show how these items will

appear in the final accounts of Thomas.

SolutionBooks of Thomas

Journal

Particulars L.F. Debit Amount Credit AmountRs. Rs.

Bad Debts a/c Dr. 3,000 Debtors a/c 3,000(Further bad debts written off)Profit and Loss a/c Dr. 8,000 Bad Debts a/c 8,000(closing entry for bad debts)Profit and Loss a/c Dr. 4,500 Provision for doubtful debts a/c 4,500(created provision for doubtful debts on debtorsremaining after writing off further bad debts)Profit and Loss a/c Dr. 2,137.50 Provision for discount on debtor a/c 2,137.50(Create provision for discount on debtorsremaining after writing off bad debts and

provision for bad debts)

Profit and Loss account for the year ended 31.3.2002Dr. Cr.


Bad Debts 8,000Provision for bad debts 4,500Provision for discount on debtor 2,137.50

Balance Sheet of Thomas as at 31.3.2002


Debtors 93,000Less:Further Bad Debt 3,000

90,000Less:Provision bad debt 4,500

85,500Less:Provision forDiscount on debtors 2,137.50

83,362.50

ACCOUNTANCY290

Books of ZaferDr. Bad Debts Account Cr.


Balance b/f 5,000 Provision for doubtful debts 10,000Debtors 5,000

10,000 10,000

Discount AccountDr. Cr.


Balance b/f 2,000 Provision for discount on debtors 2,500Debtors 500

2,500 2,500

Provision for Doubtful Debts AccountDr. Cr.


Bad Debts 10,000 Balance b/f 7,000Balance c/f 19,450 Profit and Loss 22,450

29,450 29,450

Illustration 25

The following balances have beenextracted from the trial balance of Zafaras on 31.3.2002.

Trial Balance of Zafar as on 31.3.2002


Rs. Rs.

Debtors 2,00,000Bad debts 5,000 Provision for bad debts 7,000 Provision for discount 1,000Discount 2,000



(a) Write off further bad debtsRs. 5,000

(b) Additional discount allowedRs. 500

(c) Create a provision of 10% for baddebts and a provision of 5% fordiscount on debtors.

Prepare Bad Debts account, DiscountAccount, Provision for bad debts account,provision for discount account and alsoshow how these items will appear in theProfit and Loss account and Balance Sheetof Zafar.


Provision for Discount on Debtors AccountDr. Cr.


Discount 2,500 Balance b/f 1,000Balance c/f 9,252.50 Profit and Loss 10,752.50

11,725.50 11,752.50

Profit and Loss account for the year ended 31.3.2002Dr. Cr.


Provision for doubtful debts.Bad debts 5,000AddFurther bad debts 5,000

10,000Add:New provision 19,450

29,450Less:Old Provision 7,000 22,450Provision for discounton debtorsDiscount 2,000Add:Additional Discount 500

2,500Add:New Provision 9,252.5

11,725.5Less:Old Provision 1,000 10,725.50

Balance Sheet of Zafar as at 31.3.2002


Debtors 2,00,000Less:Further bad debts 5,000

1,95,000LessAdditional Discount 500

1,94,500Less:Provision forBad Debts 19,450

1,75,050Less:Provision forDiscount 9,252.50 1,65,797.50

ACCOUNTANCY292

(xii)Interest on Capital: Money investedby the proprietor in the business iscalled capital. In order to determinethe true profit earned by thebusiness it is necessary that intereston capital should be deducted fromit which the proprietor could haveotherwise earned. Interest oncapital is an expenses for thebusiness and hence is debited toprofit and loss account, at the sametime it increases the capital of theowner. The following journal entryis passed for interest on capital.

Interest on capital a/c Dr. Capital a/c

Interest on capital is allowed on capitalin the beginning of the year. However, iffurther capital is introduced by the ownerthan interest on it is allowed from the dateof its introduction till the end of theaccounting year.

Illustration 26

Yogesh started his business on 1 April 2000with a capital Rs. 2,00,000. On 1.7.2000. Heintroduced further capital Rs.1,00,000.interest on capital is allowed at @ 6% perannum. Yogesh closes his books on 31March every year. Calculate interest oncapital and pass necessary adjustment andclosing entry for the same.

(xiii) Interest on Drawings: Drawings isthe amount withdrawn by theowner for his personal use. Wheninterest on capital is allowed theninterest on drawings of theproprietor should also be chargedfrom him. Interest on drawings is anincome for the enterprise and it

reduce the capital of the proprietor.Interest on drawings should becharged for the period for whichdrawings have been made by theproprietor in the accounting year, i.e.from the date on which the moneyis withdrawn till the date on whichthe accounting year of the firm

Books of YogeshJournal


March 31 Interest capital a/c Dr. 16,500 Capital 16,500(allowed interest on capital onRs. 2,00,000 for one year and onRs. 1,00,000 for amount @ 6% p.a.)

March 31 Profit and Loss a/c Dr. 16,500 Interest on capital 16,500(closing entry for interest capital)


closes. The following journal entryis passed for interest on drawing.

Capital a/c Dr. Interest on Drawings a/c

Illustration 27

Ravi had withdrawn Rs. 10,000 on 1 July2002 and Rs, 15,000 on 1 Sept 2002 fromhis business. He closes his books on 31March every year. Calculate interest onRavi’s drawings and pass necessaryjournal entry for the same, also pass thejournal closing entry for interest ondrawing. Interest on drawing is to becalculated @ 12% p.a.

(xiii) Deferred Revenue Expenditure: Theexpenditure incurred in the initialstages but the benefits of which areavailable in subse-quent years alsois called deferred revenueexpenditure. Such expenditure isspread over the years equallyduring which benefits will beavailable, e.g. an expenditure of Rs.20,000 on advertisement whosebenefits will be available for 5 yearswill be spread equally over theyears. Every year Rs. 20,000 ÷= 4,000 will be charged to the profitand loss account and the balanceof such expenditure is shown as anasset in the balance sheet.

Working Notes:

Calculation of interest on drawings

On Rs. 10,000 for 9 months = 10,000 * 9/12 * 12/100 = 900

On Rs. 15,000 for 7 months = 15,000 * 7/12 * 12/100 = 1,050

Total interest on drawings 1,950

Books of RaviJournal


March 31 Capital a/c Dr. 1,950 Interest on Drawing 1,950(Changed interest on Ravi’s drawing)

March 31 Interest on drawing Dr. 1,950 Profit and Loss a/c 1,950(Closing entry for interest on drawing)

Solution

ACCOUNTANCY294

Illustration 28Deepak spent Rs.50,000 on advertise-menton 1 April 2001. The benefits of theadvertisement are expected to be available

for 5 years. Pass the necessary journal entryfor the same and show how advertisementwill be shown in the final accounts ofDeepak.

Solution

Books of DeepakJournal


2001 Advertisement a/c Dr. 50,000April 1 Bank 50,000

(paid for depreciation)

2002 Profit and Loss a/c Dr. 10,000April 1 Advertisement 10,000

(Depreciation for one year transferredto P&L account)

Profit and Loss Account for the year ended 31.3.2002Dr. Cr.


Advertisement 10,000

Balance Sheet of Deepak as at 31.3.2002


Advertisement (Deferred) 40,000

(xv) Loss of stock by fire: In the business lossof goods may occur due to fire. Thetreatment of loss of goods due to firewill depend upon the fact whether thegoods lost due to fire have beeninsured or not. The following journalentries will be passed:

(i) Loss by fire a/c Dr. Purchases a/c

(ii) Insurance claim a/c Dr. Profit and Loss a/c Dr.

Loss by fire a/c


Illustration 29

The physical stock verification showedthat goods costing Rs. 18,000 weredestroyed by fire during the year, but noentries have been made in the books ofaccount for the same. You are requestedto pass the necessary journal entries ineach of the following cases.

(a) Stock was completely uninsured.(b) Stock was fully insured and the

insurance company admitted fullclaim.

(c) Stock was partly insured and theinsurance. Company admitted aclaim ofRs. 10,000 only. The firm closed itsbooks on 31.3.2002.

Journal


March 31 Profit and Loss a/c Dr. 18,000 Trading a/c 18,000(When stock was completely uninsured)

March 31 Insurance company account a/c Dr. 18,000 Trading a/c 18,000(loss of goods due to fire and the fullclaim admitted by the insurance company

March 31 Insurance company a/c Dr. 10,000Profit and Loss a/c Dr. 8,000 Trading a/c 18,000(Loss of goods due to fire Rs. 18,000and the insurance company admittedthe claim of Rs. 10,000 only

Note: Trading account: The upper part of the profit and loss account.It is prepared by small trading organisations.

(xvi)Goods sent on approval: Sometimesgoods are sold to the customers onapproval basis. If they approve thegoods it will become sale. If thesegoods are laying with thecustomers on the last day of theaccounting year, and these can beyet returned by the customers thenthe same should be treated as stocklying with the customers. Thefollowing journal entries will bemade.

(a) Sales a/c Dr. Debtor a/cThe above entry is passed with the sale price ofthe goods.

(b) Stock a/c Dr. Trading a/c

This entry is passed with cost price of the goods.

Illustration 30

A firm sent goods Rs10,000 to itscustomers on a sale or return basis and hasincluded this amount in its sales. The

ACCOUNTANCY296

approval of the customer was not receivedtill the close of the accounting year. Theprice of goods include a profit of 30% on

sales. You are required to pass thenecessary journal entries.

Solution :

Journal


Sales a/c Dr. 10,000 Customers a/c 10,000(Cancellation of goods sent onapproval taken as sale)

Stock on approval a/c Dr. 7,000 Trading a/c 7,000(Stock lying with the customer forapproval at cost)

(xvii)Goods distributed as free sample:Sometimes in order to promote thesale of goods, some of the goods aredistributed as free samples. Thecost of such goods is included inthe advertisement expenses and tothis extent stock of goods at handwill be less. The following journalentry will be pasted for goodsdistributed as free samplesAdvertisement a/c Dr.

Purchases a/c

(xviii) Manager’s Commission: Some-times, a manager employed by abusiness enterprise may beallowed commission as apercentage of the net profit.Commission as a percentage of thenet profit may be before or aftercharging such commission. In theabsence of any infor-mation, it isassumed that commission is

allowed as a percentage of the netprofit before charging suchcommission.

Suppose the net profit of a businessamounts to Rs. 84,000 before chargingcommission. The manager is allowed acommission of 5% on the net profit beforecharging such commission. In this case, hiscommission would be:

5/100 × 84,000 or Rs. 4,200

if, in the above case, the manager isallowed commission on the net profit aftercharging such commission, thecomputation of his commission would beas follows;Let net profit after charging commission be Rs. 100.Commission Rs. 5 (5% of Rs. 100)

Net profit before charging commissionRs. 100 + 5 = Rs. 105Commission payable to the managerRs. 5/105 × 84,000 = 4,000


The manager’s commission will beadjusted in the books by passing thefollowing entry:Manager’s commission a/c Dr.

Outstanding commission a/c(Commission payable to the manager provided for)

The manager’s commission accountwill be closed by transferring it to theProfit and Loss account.

The following journal endtry will bePassed:

Profit and Loss a/c Dr Manager’s Commission.

The outstanding commission willappear on the liabilities side of the BalanceSheet.

Illustration 31

From the following Trial Balance of Mr.Arun as on 31 March 2002 pass thenecessary adjustment and closing entriesand prepare Profit and Loss account andBalance Sheet.

He furnishes you the following information:

(i) Closing stock on 31 March 2002 is Rs. 16,000(ii) Machinery and patents are to be depreciated @ 10% p.a. and 20% p.a. respectively.(iii) Salaries amounting to Rs. 2,000 were unpaid.(iv) A provision fo1r bad and doubtful debts is to be created to the extent of 5% on

debtors.

Particulars Debit Amount Credit AmountRs. Rs. Rs.

Cash in hand 1,500Cash at bank 7,000Purchases 70,000Sales 1,20,000Return inwards 600Returns outwards 700Wages 10,400Power & Fuel 7,000Carriage outward 3,000Carriage inward 4,000Stock (April 1,2001) 12,000Building 40,000Machinery 35,000Patents 10,000Salaries 14,000General expenses 3,000Drawings 10,000Capital 80,000Account receivable 40,000Account payable 60,000Bills payable 6,800

2,67,500 2,67,500

ACCOUNTANCY298

SolutionBooks of Arun

Journal

Adjusting Entries Particulars Debit Credit2002 Amount (Rs.) Amount (Rs.)

March 31 Depreciation a/c Dr. 5,500 Machinery a/c 3.500 Patents a/c(Amount written off as depreciation onmachinery @ 10% p.a. and on patents @ 20% p.a.)

March 31 Salaries a/c Dr. 2,000 Outstanding a/c 2,000(Amount of salary unpaid on March 31,2002)

March 31 Profit and Loss a/c Dr. 2,000 Provision for bad and doubtful debts a/c 2,000(Amount of provision required to themaintained for bad and doubtful debts)

Closing Entries2002

March 31 Profit and Loss a/c Dr. 1,04,000 Stock a/c 12,000 Purchases a/c 70,000 Wages a/c 10,400 Power a/c 7,000 Carriage inwards a/c 4,000 Return inwards a/c 600(The transfer of balances of variousaccounts to the Profit and Loss a/c)

March 31 Sales a/c Dr. 1,20,000 Returns outwards a/c 700 Profit and Loss a/c 1,19,300(Transfer of balances of the salesaccount and Returns outwards account)

March 31 Profit and Loss a/c Dr. 27,500 Carriage outward a/c 3,000 Salaries a/c 16,000 General expenses a/c 3,000 Depreciation a/c 5,500(Transfer of various expenses accounts tothe profit and loss account)

March 31 Profit and Loss a/c Dr. 3,200 Capital a/c 3,200(Transfer of net profit to the capitalaccount)

March 31 Capital a/c Dr. 10,000 Drawing a/c 10,000(Transfer of drawings to the capitalaccount)


Profit and Loss Account for the year ending 31st March 2002Dr. Cr.


Opening Stock (1.4.2001) 12,000 Sales 1,20,000Purchases 70,000 LessLess Return inwards 600 1,19,400Return outward 700 69,300 Closing stock 16,000Wages 10,400Power 7,000Carriage inwards 4,000Gross profit c/f 32,700

1,35,400 1,35,400

Depreciation:Machinery 3,500Patents 2,000 5,500 Gross profit b/f 32,700

Salaries 1,4000Add:Outstanding salaries 2,000 16,000Carriage outwards 3,000General expenses 3,000Provision for bad & doubtful debts 2,000Net profit (transferred to the 3,200capital account)

32,700 32,700

Balance Sheet as at 31st March 2002


Outstanding expenses Cash in hand 1,500Salaries 2,000 Cash at bank 7,000Bills payable 6,800 Sundry Debtor 40,000Account Payable 60,000 Less

Provision for badCapital 80,000 and doubtful debts 2,000 38,000Add Net Profit 3,200

83,200 StockPatents 10,000

Less drawing 10,000 73,200 Less depreciation 2,000 8,000

Machinery 35,000Less depreciation 3,500 31,500Building 40,000

Closing Stock 16,000

1,42,000 1,42,000

ACCOUNTANCY300

Illustration 32Kohli’s Group is the proprietor of a large business of cotton price goods. The followingTrial Balance was prepared form his books as on 31 March 2002

Trial Balance as on 31 March 2002

Debit Balance Amount Credit Balance Amount Rs. Rs.

Land and Building 40,000Purchases 3,26,700Return inwards 2,500Traveling expenses 6,900Printing and stationery 1,600Cash at bank 30,795Discount allowed 1,800Misc. Expenses 18,620Sundry debtors 64,000Postage 800Furniture 8,000Cash in hand 5,900Motor car 16,000Investment (market value Rs. 14,000) 12,000Drawings 10,000Bills receivable 4,800Stock (1.4.2001) 63,680

Interest on bank loan 3,000Salaries (including advanceRs. 1,500) 22,000Establishment Expenses 1,595Carriage inwards 3,000Advertisements 16,000

Sales 4,68,100Income from investments 99012% Bank Loan secured on 40,000fixed assets (no movementduring the year)Capital 80,000Bills payable 2,600Sundry creditors 63,100Return outwards 3,700Discount received 1,200

The following further information wasobtained:

(i) Stock as on 31 March 2002 was Rs.1,20,000,

(ii) Sundry debtors include a sum ofRs. 3,000 due from Mr. Varun andsundry creditors include a sum ofRs. 4,000 due to Mr. Arun,

(iii) The reserve for doubtful debts isto be maintained @ 10% onsundry debtors and reserve fordiscount on debtors and discounton creditors are to be created@ 5%,

(iv) Bills receivable include adishonored bill for Rs. 600,

(v) Stock worth Rs. 10,000 destroyedby fire on 25.2.2002 in respect ofwhich the insurance companyadmits claim for only Rs. 7,500,

(vi) The manager of Kohli’s Groupsis entitled to a commission of 10%of Net Profit calculated aftercharging such commission

(vii) 3/4 of the Advertisement Expensesis to be carried forward.

(viii) 2.5% of the Net Profit is to becarried to Reserve Fund.

(ix) Depreciation to be charged on● Land & Building @ 2.5%,● Furniture @ 10%, and● Motor Car @ 20%.


You are required to prepare the Profit and Loss a/c for the year ended 31 March2002 and to draw up the Balance Sheet as on that date.

SolutionKohli’s Group

Profit and Loss Accountfor the year ending 31 March 2002

Dr. Cr.


Opening stock 63,680 Sales 4,68,100Purchases 3,26,700 Less Return 2,500 4,65,600Less Return 3,700 3,23,000

Loss by fire 10,000Carriage 3,000 Closing stock 1,20,000Gross profit c/f 2,05,920

5,95,600 5,95,600

Traveling expenses 6,900 Gross profit b/f 2,05,920Printing & Stationary 1,600 Income from investment 990Discount 1,800 Discount Received 1,200Misc. Expenses 18,620 Reserve for Discount on 3,005Postage 800 Creditors

Interest on Bank loan 3,000Add Outstanding 1,800 4,800

Establishment Expenses 1,595Salaries 22,000Less Prepaid 1,500 20,500Advertisement 16,000Less Prepaid 12,000 4,000Loss on fire 2,500Provision forDoubtful debts 6,160Add: ProvisionFor discount on 2,772 8,932DebtorsDepreciation on :Land and Building 1,000Furniture 800Motor car 3,200 5,000

Manager commission 12,188 1,34,068 × 10 110Net Profit 1,18,833Reserve Fund 3.047 1,21,880

2,11,115 2,11,115

( )

ACCOUNTANCY302

Sundry creditor (afteradjustment the amountof Varun as debtor Rs. 3,000)

60,100

Less:Reserve for Discount on creditors @ 5% 3,005 57,095

Bills payable 2,600Bank loan 40,000capital 80,000Add: Net Profit 1,18,833

1,98,833

Less Drawing 10,000 1,88,833

Outstanding interest on 1,800bank loanReserve fund 3,047Manager’s commission 12,188outstanding

3,05,563

Balance Sheet as at 31 March 2002


Cash in hand 5,900Cash at bank 30,795Sundry debtors 64,000

Less: Amount dueFrom Arun adjusted 3,000As he being a creditor

61,000

Add: Bill Dishonored 600

61,600

Less: Provision forDoubtful debts 6,160

55,440

Less: Provision forDiscount 2,772 52,668

Bills receivable 4,800Less Bills Dishonored 600 4,200

Investment 12,000Furniture 8,000Less Depreciation 800 7,200

Motor Car 16,000Less Depreciation 3,200 12,800

Land and Building 40,000Less Deprecation 1,000 39,000

Advertisement (carried 12,000forward)Insurance claim 7,500Prepaid salary 1,500Closing Stock 1,20,000

3,05,563


1. Meaning usefulness and types of Financial Statements

After the agreement of the trial Balance, a business enterprise proceeds to prepare financialstatements. Financial statements are the statements which present periodic reports on theprocess of a business enterprises and the results achieved during a given period.

Financial statements include Profit and Loss Account, Balance Sheet and other statementsand explanatory notes which form part thereof. Information provided by financial statementsis useful to management to plan and control the business operations. Financial statementsare also useful to creditors, shareholders and employees of the enterprise.

2. Meaning, need and preparation of Profit and Loss Account

The Profit and Loss account highlights the profit earned or loss sustained by the businessentity in the course of business operations during a given period.

The need for preparing the Profit and Loss Account is to ascertain the net results of businessoperations during a given period. Analysis of the Profit and Loss accounts is helpful incontrolling expenses which are incurred in running a business enterprise.

● Depreciation● Discount allowed● Discount received● Cash● Trade expenses● Factory expenses● Financial statements● Fixed assets● Freight● Gross loss● Gross profit● Grouping and Marshalling● Income Tax● Interest on capital● Interest on drawings● Net loss● Net profit● Order of liquidity● Order of performance● Revenue expenditure● Revenue receipt● Salaries● Sales● Sales returns


● Accrued income● Accounts payable● Accounts receivable● Adjusting entries● Bad debts● Balance Sheet● Bank overdraft● Bills payable● Bills receivable● Capital● Capital expenditure● Capital receipts● Carriage inwards● Carriage outward● Cash at bank● Closing entries● Closing stock● Manager’s commissions● Current assets● Currents liabilities● Purchases returns● Rent● Return inward● Return outward● Revenue expenditure


ACCOUNTANCY304

The profit and loss account shows the items of revenue expenses and losses on thedebit side while items of gain and gross profit are shown on the credit side. For the preparationof the profit and loss account, closing entries are passed to transfer balances of account ofitems of expenses and gain. Net profit or net loss shown by the Profit and Loss Account istransferred to the capital account.

3. Meaning, Characteristic, need and structure of the Balance Sheet

The Balance Sheet is a statement of assets and liabilities of a business enterprise and showsthe financial position at a given date. Information contained in a Balance Sheet is true onlyon that date.

The Balance Sheet is a part of the Final Accounts. But it is not an account; it is only astatement. In a Balance Sheet the totals of assets and liabilities are always equal. It portraysthe accounting equation.

A Balance Sheet has to be prepared to know the financial position of the business; andthe nature and values of its assets and liabilities.

All the accounts which have not been closed till the preparation of the Profit and Lossaccount are shown in the Balance Sheet. Assets and liabilities shown in the Balance Sheetare marshaled in order of liquidity or order of permanence.

Q.1. Objective Type Questions

In each of the following questions tick mark (v) the correct answer out of the choices given:

I. The following items appear in Amits Trial Balance:Outstanding Wages Rs. 1,500.It will appear in:(a) Profit and Loss Account(b) Balance Sheet(c None of the above

II. Returns inwards are deducted from:(a) Sales(b) Purchases(c) Returns outward

III. Income tax paid by Mr. Arun amounts to Rs.2,000.The accounting treatment is:(a) To be credited to the Profit and Loss Account(b) To be ignored altogether(c) To be deducted from capital(d) To be debited to the Profit and Loss a/c


IV Bimal’s Trial Balance shows the following item:Opening stock Rs. 30,000(a) Debited to the Profit and Loss Account(b) Deducted from the closing stock in the Balance Sheet(c) None of the above

V. Ajits Trial Balance contains the following information:Bad debts Rs. 2,000Provision for Bad debts Rs. 2,500It is desired to make a provision for bad debts of Rs 3,000 at the end of the year.

The amount to be debited to the Profit and Loss Account is:(a) Rs. 3,000(b) Rs. 4,500(c) Rs. 2,500(d) Rs. 5,000(e) Rs. 7,500

VI. Mohan’s trial balance provides you the following information:Bad debts Rs. 800Provision for bad debts Rs. 3,000It is desired to maintain a provision for bad debts of Rs.2,000The accounting treatment of these adjustments is:(a) Rs 1800 to be debited to the Profit and Loss Account(b) Rs. 200 to be credited to the Profit and Loss Ac count(c) Rs. 200 to be debited to the Profit and Loss Account(d) Rs. 4,200 to be debited to the Profit and Loss Account

VII. Govind’s Trial Balance contains the following information:Discount allowed Rs. 500Provision for discount on debtors Rs. 1,000

The amount to be debited to the Profit and Loss Account is:(a) Rs. 1,200(b) Rs. 3,200(c) Rs. 700(d) Rs. 2,200

VIII. Dines trial balance contains the following information:Discount received Rs. 1,000Provision for discount on creditors Rs. 1,500It is desired to maintain a provision for discount on creditors at Rs.1,000.

ACCOUNTANCY306

The account to be credited to the Profit and Loss Account is:(a) Rs. 1,500(b) Rs. 3,500(c) Rs. 1,000(d) Rs. 500

IX. Bishan’s capital on January 1,1988 Rs. 50,000Interest on drawings Rs. 2,000Interest on capital Rs. 5,000Drawings Rs. 20,000Profit for the year Rs. 10,000

His capital at the end of the year is:(a) Rs. 67,000(b) Rs. 43,000(c) Rs. 47,000(d) Rs. 69,000

X. Yogesh’s trial balance contains the following information:Bad debts Rs. 3,000Provision for bad debts Rs. 4,000Sundry debtors Rs.25,000

It is desired to create provision for bad debts at 10% on sundry debtors at the end ofthe year.Sundry debtors will appear in the Balance Sheet at a figure of:(a) Rs. 22,500(b) Rs. 21,000(c) Rs. 18,000(d) Rs. 15,500(e) Rs. 23,500

XI. Chetan’s trial balance contains the following information:Bad debts Rs. 4,000Discount allowed Rs. 2,000Provision for discount on debtors Rs. 2,200Provision for bad debts Rs. 4,500Sundry debtors Rs.50,000

At the end of the year, it is desired to maintain a provision for bad debts atRs. 4,000 and provision for discount on debtors at Rs, 2,000.


Sundry debtors will appear in the Balance Sheet at a figure of:(a) Rs. 44,000(b) Rs. 38,000(c) Rs. 44,700(d) Rs. 31,300

XII. Baijnath’s trial balance as on March 31,2000, contains the following information:Bank loan Rs. 50,000(12% rate of interest)Interest paid Rs. 5,000Interest debited to the Profit and Loss Account is:(a) Rs. 6,000(b) Rs. 5,000(c) Rs. 5,500(d) Rs. 1,000

Q. 2 State whether the following expenditure is capital or revenue and why? Give reasonsfor your answers:(a) Expenditure incurred on repairs and whitewashing at the time of purchase of an

old building in order to make it usable.(b) Expenditure incurred to provide one more exit in a cinema hall in compliance

with a government order.(c) Registration fees paid at the time of purchase of a building(d) Expenditure incurred in the maintenance of a tea garden which will produce tea

after four years.(e) Depreciation charged on a plant.(f) The expenditure incurred in erecting a platform on which a machine will be fixed.(g) Advertising expenditure, the benefits of which will last for four years.

Long Answer Questions

Q.3 What are Financial Statements? What information do they provide?Q.4 What are closing entries? Give four examples of closing entries?Q.5 What is a Balance Sheet? What are its characteristics? What is the need of preparing

a Balance Sheet?Q.6 Explain the rationale of preparing a Balance Sheet. How does it differ from a Trial

Balance?Q.7 What do you understand by ‘Grouping and Marshalling of Assets and Liabilities’?

Explain the ways in which a Balance Sheet may be Marshalled.Q.8 Distinguish between

(i) Capital and Revenue Expenditure(ii) Capital and Revenue Receipts

ACCOUNTANCY308

Q.9 Explain the rationale of making adjustments at the time of preparing the Final Accounts?Mention any three important adjustments that are made for the preparation of theProfit and Loss Account.

EXERCISESSimple Final Accounts

Q 10 The Trial Balance of Mr. Brown shows the following balances on March 31, 2000.

Debit Balance Amount (Rs.)

Purchase 70,000Sales returns 5,000Opening stock 20,000Discount allowed 2,000Bank charges 500Salaries 4,500Wages 5,000Freight-in 4,000Freight-out 1,000Rent, Rates & Taxes 5,000Advertising 6,000Cash in hand 1,000Plant & Machinery 50,000Sundry debtors 60,000Cash at bank 70,000

2,41,000

Credit Balances

Capital account 56,000Sales 1,50,000Purchase returns 4,000Discount received 1,000Sundry creditors 3,000

2,41,000

The closing stock was valued at Rs. 30,000. You are required to prepare the Profit and LossAccount for the year ending 31 March 2000, and the Balance Sheet as on that date.

Q.11 From the following Trial Balance extracted from the books of Mohinder Singh, preparethe Profit and Loss Account for the year ending March 31, 2000 and the Balance Sheetas on that date.


Q. 12 The following balances were extracted from the books of Mr. Brijesh Chandra onMarch 31, 2001.

Debit balances Credit balances

Amount (Rs.) Amount (Rs.)

CapitalBuilding 80,000Machinery 70,000Furniture 15,000Stock 50,000Power 10,000Wages 70,000Carriage 8,000Rent & rates 12,000Insurance 5,000Salaries 35,000Bank charges 1,000Income tax 2,000Bad debts 5,000

Debit balances Credit balances


Capital 20,000 1,89,000Drawings 80,000Plant and Machinery 70,000Sundry debtors 50,000Sundry creditors 1,10,000PurchasesPurchases returns 7,000Sales 2,20,000Sales returns 10,000Wages 40,000Cash in hand 5,000Cash at bank 10,000Salaries 30,000Repairs 8.000Stock 45,000Rent 10,000Manufacturing expenses 7,000Bills receivable 12,000Bills payable 20,000Bad debts 5,000Carriage 9,000Furniture 15,000

4,86,000 4,86,000

Closing stock was valued at Rs. 50,000.

ACCOUNTANCY310

Commission received 9,000Purchases 1,50,000Sales 3,40,000Bills receivable 20,000Bills payable 30,000Bank overdraft 20,000Cash in hand 2,000Purchases returns 10,000Sales returns 15,000

5,50,000 5,50,000

The closing stock was valued at Rs. 60,000. You are required to prepare the Profit andLoss Account for the year ending March 31 2001 and the Balance Sheet as on the date.

Q.13 The following balances are extracted from the books of Rameshwar Prasad onMarch 31, 2001.

Debit Balances Amount (Rs.)

Building 50,000Furniture & fittings 10,000Bad debts 2,500Sundry debtors 50,000Stock (January 1, 1988) 40,000Purchases 1,20,000Sales returns 5,000Advertising 9,000Interest 5,000Cash in hand 2,000Taxes and insurance 4,000General charges 3,000Salaries 1,000Bills receivable 9,000Cash at bank 5,000

3,26,000

Credit Balances Amount (Rs.)

Capital 60,000Bills payable 7,000Sundry creditors 30,000Sales 2,20,000Purchases returns 4,000Commission 5,000

3,26,000


Closing stock on March 31, 2002 was Rs. 20,000. From the above, prepare the Profitand Loss Account for the year ending March 31, 2002 and the Balance Sheet as on thatdate.

Q.14 The balances are extracted from the books of Mr. Chetan as on 31 March 2002:


Plant & Machinery 90,000Purchases 2,00,000Sales returns 10,000Opening stock 70,000Bank charges 2,000Sundry debtors 80,000Salaries 40,000Wages 50,000Carriage inward 10,000Carriage outward 8,000Rent, rates & taxes 12,000Advertisement 15,000Cash in hand 5,000Discount 5,000Furniture 6,000Building 20,000

80,000

6,98,000


Capital 1,80,000Sales 3,70,000Purchase returns 20,000Discount 10,000Sundry creditors 90,000Bank overdraft 20,000Outstanding wages 8,000

6,98,000

The closing stock was valued at Rs.80,000. Prepare the Profit and Loss Account for theyear ending 31 March 2002 and the Balance Sheet as on that date.

ACCOUNTANCY312

Final Accounts with Adjustments

Q.15 From the following Trial Balance, prepare the Profit and Loss Account forthe year ending 31 March 2002 and the Balance Sheet as on that date.

Debit Balances Credit BalancesAmount (Rs.) Amount (Rs.)

Salaries 25,000Taxes and insurance 6,000Cash in hand 5,000General expenses 7,000Furniture 15,000Scooter 8,000Building 50,000Capital 90,000Bad debts 4,000Machinery 68,000Provision for bad debts 5,000Debtors 80,000Creditors 90,000Opening stock 40,000Purchases 1,00,000Sales 2,10,000Bank overdraft 20,000Returns 15,000Advertising 10,000Interest 14,000Commission 4,000

4,37,000 4,37,000

The following adjustments are to be made:

(1) Stock on March 31, 2002 was Rs. 50,000

(2) Depreciate building at 5%, furniture and machinery at 10% and scooter at 20%.

(3) Rs.1000 is due for interest on overdraft.

(4) Insurance account to Rs.1,000 is prepared.

(5) Provision for bad debts is to be maintained at 5% on debtors.


Q.16 The following is the Trial Balance of Mr. Ashoka as on 31 March 2002.


Land & building 70,000Plant & Machinery 60,000Loose tools 10,000Bills receivable 15,000Opening stock 50,000Purchases 1,40,000Sales 2,00,000Wages 40,000Carriage 5,000Salaries 25,000Rent & rates 5,000Discount allowed 4,000Cash at bank 7,000Cash in hand 1,000Debtors 80,000Bad debts 4,000Furniture 20,000Advertising 8,000Returns 15,000 12,000Capital 1,50,000Creditors 97,000

5,59,000 5,59,000

Adjustments

(i) Closing stock on 31 March 2002 was valued at Rs. 70,000

(ii) Depreciate plant and machinery at 10%; loose tools at 20%; furniture at 10%

and land and building at 5%.

(iii) Make a provision for discount on debtors @2% and a provision for bad anddoubtful debts at 5% on debtors.

You are requested to prepare Profit and Loss account and Balance Sheet.

ACCOUNTANCY314

Q.17 From the following balances for the year ending 31 March 2002 and additional Information, prepare the Profit and Loss Account and Balance Sheet of M/s Paul & Sons.


Capital 57,000Purchases 90,000Purchases returns 5,000Sales 1,70,000Sales returns 2,000Building 50,000Opening stock 30,000Debtors 50,000Creditors 40,000Furniture 15,000Wages 20,000Rent 5,000Sales tax payable 6,500Commission Received 4,000Insurance 3,000Salaries 10,000Bad debts 1,5000Provision for bad debts 3,000Cash in hand 1,000Cash at bank 8,000

2,85,500 2,85,500


(1) Closing stock was valued at Rs. 20,000

(2) Provide depreciation on building @5% p.a. and furniture @10% p.a.

(3) Further bad debts Rs. 1000

(4) Make provision for bad debts at 5%


Q.18 From the following Trial Balance extracted from the books of Narendra Kumar preparethe Profit and Loss Account for the year ending 31 March 2002 and a Balance Sheetas on that date.


Capital 81,000Drawings 10,000Plant & Machinery 60,000Debtors 40,000Creditors 45,000Purchases & Sales 80,000 1,40,000Returns 4,000 5,000Wages 15,000Cash in Hand 1,000Cash at Bank 6,000Salaries 10,000Repairs 4,000Rent 4,500Stock 20,000Manufacturing, expenses 5,000Bills receivable 10,000Bad debts 1,000Provision for bad debts 1,500Carriage 2,000

2,72,500 2,72,500

The following adjustments are made:

(1) Closing stock was valued at Rs.30,000

(2) Depreciate plant and machinery @ 10% p.a.

(3) Allow interest on capital @ 5% p.a.

(4) Rent paid in advance Rs. 500.

ACCOUNTANCY316

Q.19 The following balances were extracted from the books of Chand Ram on31 March 2002


Drawings 20,000 Capital 1,00,000Purchases 1,30,000 Sales 2,50,000Sales returns 20,000 Purchases returns 15,000Stock 50,000 Provision for bad debts 4,000Sundry debtors 70,000 Sundry creditors 80,000Rates and insurance 2,000 Bills payable 10,000Discount 1,000 Rent received 5,000Wages 40,000 3,000Building 60,000Carriage 5,000Office expenses 5,000Printing and stationery 2,000Postage and telegrams 1,000Cash in hand 1,000Cash at bank 5,000Furniture 10,000Salaries 2,000Bills receivable 20,000

4,47,000 4,67,000

Adjustments

(1) Closing stock was valued at Rs.40,000.

(2) Additions to building amounting to Rs.10,000 were made on June 30.2001.

This has been recorded in the book. Depreciate building @ 10% p.a.

(3) Increase the bad debts provision by Rs. 1000.

You are required to prepare the Profit and Loss Account for the year ending31 March 2002 and the Balance Sheet as on that date.


Q.20 The following is the Trial Balance of Mr. Gopal Das as on 31 March 2002.


Purchases 1,12,000Returns inward 10,000Rent 27,500Wages 40,000Salaries 38,500Office expenses 4,000Insurance (paid for the year 4,800 ending March 31 2002)Stock 35,000Plant & Machinery 60,000Furniture 20,000Cash in hand 4,000Cash at bank 9,000Sundry debtors 80,000Capital 1,50,000Loan 28,000Sales 2,00,000Sundry creditors 50,000Outstanding wages 4,000Returns outward 12,000Bad debts 3,200Provision for bad debts 4,000

4,48,000 4,48,000


(1) Closing stock was valued at Rs. 40,000.

(2) Maintain provision for bad debts at 6% on sundry debtors.

(3) Depreciate plant & machinery @ 10% p.a. and furniture @ 20% p.a.

Expenses for rent and salaries are uniform throughout the year and those for Marchhave not been paid.

You are required to prepare the Profit and Loss Account for the year ending 31 March 2002,and a Balance Sheet as on that date.

ACCOUNTANCY318

Q.21. The following is the Trial Balance of Anwar Ali as on 31 March 2002.


Plant & Machinery 1,00,000 Sales 4,00,000Furniture & fixtures 30,000 Bills payable 30,000Stock 80,000 Sundry creditors 66,000Debtors 90,000 Provision for bad debts 5,000Cash in hand 10,000 Returns outward 10,000Cash at bank 20,000 Discount received 6,000Wages 70,000 Capital 1,70,000Purchases 1,80,000Bills receivable 12,000Returns inward 20,000Drawings 30,000Rent 15,000Factory lighting 5,000Telephone charges 2,000Insurance 4,000Advertising 10,000Bad debts 4,000Discount allowed 5,000

6,87,000 6,87,000


(1) Closing stock was valued at Rs. 70,000:

(2) Rent due but not paid Rs. 1,000.

(3) Unexpired insurance Rs. 500.

(4) Provision for bad and doubtful debts to be increased to Rs.6000.

(5) Provide for 2% discount on debtors and creditors.You are required to prepare the Profit and Loss Account for the year ending 31 March2002 and the Balance Sheet as on that date.


Q.22. Mohan Singh has extracted the following trial balance from his books as onMarch 31, 2000.


Bills receivable 16,000Cash 7,000Petty cash 1,000Land & buildings 30,000Opening stock 40,000Salaries 12,000Debtors 50,000Wages 40,000Cash at bank 12,000Capital 1,00,000Rent 8,000Office lighting 4,000Power 8,000Advertising 9,000Creditors 70,000Purchases 2,00,000Postage and telegrams 1,000Sales 3,10,000Discount 7,000General expenses 5,000Drawings 30,000

4,80,000 4,80,000

You are required to prepare the Profit and Loss Account for the year ending March 31, 2000,and the Balance Sheet as on that date, after taking into account the following additionalinformation:

1. Closing stock at market price as on March 31, 2000 was Rs. 80,000. However, its costwas Rs. 60,000.

2. Allow interest on capital at 5% p.a.

3. Depreciate land and building by 10%.4. Write off bad debts amounting to Rs. 5,000.

5. Create a provision for bad debts at 10% of debtors.

(Hint: Closing stock is valued at cost following the principle cost or market price,whichever is less.)

ACCOUNTANCY320

Q.23 The following balances have been extracted from the books of QualityStores as on 31 March 2002.


Furniture 15,000Capital 1,00,000Cash in hand 4,000Opening stock 50,000Purchases 1,60,000Fixed deposit with bank 10,000Drawings 30,000Bad debts 6,000Provision for bad debts 7,000Salaries 30,000Carriage inwards 10,000Insurance 6,000Rent 13,000Debtors 90,000Sales 3,00,000Creditors 50,000Advertising 20,000Printing and stationery 6,000General expenses 7,000

4,57,000 4,57,000


1. Closing stock was valued at Rs. 40,000.

2. Depreciate furniture by 20% p.a.

3. Rent paid for the accounting year ending March 31, 2002 amounted to Rs.12,000.4. Increase the provision for bad debts by Rs.1,000.

5. 50% of the expenses for advertising are to be carried forward to the next year.


Q.24. An inexperienced clerk. Moti Lal prepared the following Trial Balance as onMarch 31, 2001.

Debit Balances Credit Balances


Capital 68,000 Building 50,000Loan at 10% 60,000 Furniture 10,000Creditors 30,000 Plant 40,000Bills receivable 12,000 Debtors 50,000Returns outward 6,000 Bills payable 11,000Carriage outward 4,000 Commission received 5,000Sales 1,50,000 Opening stock 30,000

Wages 15,000Salaries 12,000Rent & rates 10,000Printing & stationery 4,000Purchases 80,000Interest on loan (Paid 5,000upto 31st October)Returns inward 5,000Carriage inward 3,000

3,30,000 3,30,000

Prepare the correct Trial Balance, Profit and Loss Account for the year ending 31 March 2001and the Balance Sheet as on that date after taking the following adjustments into account:

1. Closing stock was valued at Rs. 40,000.2. Depreciate building and furniture by 10% and plant by 15%.3. Outstanding salaries amounted to Rs.1,000.4. Write off bad debts of Rs. 1,000.

ACCOUNTANCY322

Q. 25. The following is the Trial Balance of Radha Krishna on 31 March 2001.


Cash in hand 1,000Cash at bank 17,000Sundry debtors 56,000Stock on 1.1.2001 41,000Furniture & equipment 30,000Land & building 1,20,000Sundry creditors 48,000Loan on mortgage 50,000Capital 1,00,000Drawings 12,000Sales 4,50,000Sales returns & allowances 5,000Rent receivable 6,000Purchase 2,80,000Purchase returns & allowances 4,000Transportation inward 4,000Salaries 54,000Advertising 20,000Interest on loan 3,000Insurance premium 8,000Utilities expenses 7,000

6,58,000 6,58,000

Adjustments

1. Insurance premium is for the year ending 31 March 2001.2. Depreciation to be provided on furniture and equipment at 5% and on land and

building at 2%.3. Interest on loan is 12% p.a. and is unpaid for six months.4. Stock in hand on March 31, 2001 is Rs. 24,000.


Q.26. From the following Trial Balance of Aziz Ahmed, prepare the and Profit andLoss Account and Balance Sheet as on March 31, 2001.


Cash in hand 950 Sales 1,38,000Bills receivable 7,600 Return outward 2,800Purchases 74,500 Trade creditors 12,300Opening stock 14,450 Rent from sublet 6,500Return inwards 1,700 Discount 800Carriage 3,500 Capital 50,000Wages 8,000 Bank overdraft 10,000Drawings 24,000 Bad debts reserve 700Power 3,600General expenses 4,200Salaries 14,000Debtors 16,800Manufacturing expenses 4,200Insurance 1,800Rent 11,000Plant & machinery 24,000Furniture & fittings 7,000Bad debts 5,00

2,21,800 2,21,800

The following adjustments are necessary:

1. The closing stock was Rs.8,700.2. Rent is paid for 11 months but is received for 13 months3. Insurance is paid for the year ending March 31, 2001. Further, bad debts amounted

to Rs.800 and provision is made at 5% on debtors for doubtful debts.4. Interest on bank overdraft was outstanding Rs.250.

ACCOUNTANCY324

Q.27. From the following Trial Balance and the accompanying additional data of Ashokprepare Profit and Loss Account for the year ending March 31, 2001 and a BalanceSheet as on that date.


Cash at bank 22,900Accounts receivable 40,650Merchandise inventory 61,100Stores equipment 38,500Office equipment 20,800Accumulated depreciation 12,225Stores equipment 9,250Office equipment 38,600Accounts payable 32,000Salaries 85,000Capital 24,000Drawings 3,57,000SalesSales & returns 4,120Purchases 2,12,400 2,720Purchase returnsDelivery expenses 12,200Selling expenses 1,200Office expenses 18,000Rent expenses 8,400Insurance expenses 7,750

5,04,820 5,04,820

Adjustments

1. Merchandise inventory on 31.3.2001 is Rs.56,300.

2. Depreciation for current year – Stores equipment Rs.3,100.

3. Depreciation for current year – Office equipment rs.2,700.

4. Rs.1,600 for rent is due but not paid.

5. A typewriter of the value of Rs.5,000 purchased during the year is included in thepurchases.


Q.28. From the following ledger balances extracted at the close of a trading year endedMarch 31, 2001, prepare a Profit and Loss Account and Balance Sheet as on that dateafter giving effect to the under mentioned adjustments:


Capital Account 1.4.2000 80,000 Printing and stationery a/c 1,250Stock Account 1.4.2000 18,000 Rates & taxes a/c 3,350Net purchases 1,20,000 Travelling expenses a/c 750Net sales 1,80,000 Business premises 55,000Carriage outward account 4,500 Furniture and fixtures 12,500Wages account 6,300 Bills receivable 13,000Salaries account 15,500 Bills payable a/c 12,500Rent account 11,600 Sundry debtors 30,000Freight inward 4,400 Sundry creditors 25,800Fir insurance premium 1,800 Packing machinery 24,500Bad debts account 2,100 Loan a/c 50,000Discount a/c (Dr) 500 Cash in hand 1,250

Cash at bank 3,500Proprietors withdrawals 18,000

Adjustments to be made for the current period are:

1. Stock in hand on March 31, 2001 Rs.27,000.

2. Fire insurance premium include Rs.600 paid on July 17,2000, to run for oneyear from July 1.1.2000 to June 2001.

3. Depreciate: Business premises by 5%. Furniture and fixtures by 10% and packingmachinery by 10%.

4. Further bad debts amounted to Rs.1,000. Create a reserve on debtors for doubtfuldebts at 5% and for discount at 2%.

5. Create a reserve on creditors for discounts at 2%.

6. Interest on loan for one year has accrued at 12%.

ACCOUNTANCY326

Q.29. The following is the Trial Balance of Rajesh as on 31st March 2002

Particulars Debit CreditAmount (Rs.) Amount (Rs.)

Capital 1,00,000Drawings 10,000Plant and Machinery 50,000Stock 25,000Purchases 90,000Return Inward 2,000Return outward 1,000Furniture & Fixture 10,000Freight 2,000Rent, rate & taxes 5,000Printing and stationery 1,000Trade expenses 1,200Bad debts 1,500Provision for doubtful debts 2,000Sundry debtors 20,000Sundry creditors 30,000Bills receivable 27,000Bills payable 7,700Discount 1,000Wages & salaries 5,000Cash in hand 6,000Cash at bank 12,000Sales 1,28,000

2,68,700 2,68,700


1. The closing stock on 31st March 2002, is Rs. 40,0000

2. Provision for doubtful debts is to be maintained at 5% on sundry debtors

3. Provide for depreciation on furniture and fixtures and plant & machinery @ 10%p.a.

4. Machinery costing Rs. 20,000 was purchased on Sep 1, 20015. A fire occurred on 31st March 2002, and stock of the value of Rs. 7,000 was destroyed.

It was fully insured and the insurance company admitted the claim in full.

You are required to prepare Profit and Loss Account for the year ending 31st March2002 and a Balance Sheet as on date.


Q. 30 The Following Trial Balance is extracted from the books of Gaurav Kumar on 31March 2002.

Particulars Debit CreditAmount (Rs.) Amount (Rs.)

Salaries 30,000General expenses 7,800Taxes and insurance 12,200Sundry debtors 41,000Stock 40,000Purchases 82,000Wages 4,000Sales 1,50,000Bank overdraft 10,000Commission 3,000Advertising 8,000Interest 3,000Furniture 10,000Building 80,000Motor vehicles 60,000Capital 1,22,000Sundry creditor 47,500Bad debts 2,000Provision for bad debts 2,500Loan 45,000

3,80,000 3,80,000

The following adjustment are to be made:

1. Stock on hand on 31st March 2002 was estimated to be Rs. 35,0002. Depreciation

Building @ 5% p.a.Furniture @ 10% p.a.Motor vehicles @ 20% p.a.

3. Rs. 1,500 is due for interest on loan4. Insurance amounting to Rs. 1,200 is prepaid5. One third of the commission received is in respect of work to be done next year.6. Write off further Rs. 1,000 as bad debts and provision for bad debts is to be made

equal to 5% on sundry debtors.

Prepare Profit and Loss account for the year ending 31st March 2002 and a BalanceSheet as on the date.

ACCOUNTANCY328

Q.31. The following is the Trial Balance of Raj Cloth House as on 31st March 2002.

Debit Balances Credit Balances


Drawings 12,000 Capital 1,00,000Sundry debtors 70,000 Sundry creditors 85,000Cash in hand 3,000 Loan 40,000Interest 2,000 Sales 1,60,000Stock 40,000 Purchases returns 8,000Cash at bank 9,000 Discount 2,000Bad debts 4,000 Bills payable 10,000Land & building 90,000 Rent received 3,000Sales returns 7,000 Provision for bad debts 5,000Purchases 1,20,000Carriage outward 2,000Carriage inward 3,000Establishment charge 14,500Rates, taxes & insurance 4,000Advertisement 6,000General expenses 5,000Wages 10,000Bills receivable 11,500

4,13,000 4,13,000


1. The stock in hand on March 31st, 2002 is valued at Rs. 60,0002. Prepaid insurance amounted to Rs. 5003. Depreciation land and building at 5% p.a.4. Bad debts provision is to be increased by Rs. 1,0005. Provide for the manager’s commission at 5% on the net profits after charging such

commission.

You are required to prepare Profit and Loss Account for the year ending 31st March2002 and a Balance Sheet as on that date.

Q. 32 The following is the Trial Balance of Nagi’s Ltd., as on 31st March 2000. You arerequested to prepare the Profit and Loss Account for the year ended 31st March 2000and Balance Sheet as on that date after making the necessary adjustments.


ParticularsDebit CreditAmount (Rs.) Amount (Rs.)

Sundry DebtorsSundry CreditorsOutstanding Liability for ExpenseWagesCarriage OutwardsCarriage InwardsGeneral ExpensesCash DiscountBad debtsMotor carPrinting and StationaryFurniture and FittingsAdvertisementInsuranceSalesmen’s CommissionPostage and TelephoneSalariesRates and TaxesDrawingsCapital AccountPurchasesSalesStock on 1-4-99Cash at BankCash in Hand


1. Stock on 31st March 2000 was valued at Rs 7,25,0002. A Provision for Bad and Doubtful Debts is to be created to the extent of 5 per cent

on Sundry Debtors.3. Depreciation:

Furniture and Fittings by 10%Motor-Car by 20%

4. Nagi’s Ltd, had withdrawn goods worth Rs. 25,000 during the year.5. Sales include goods worth Rs. 75,000 sent out to Vishal & Company on approval

and remaining unsold on 31st March 2000. The cost of goods was Rs. 50,000.6. The Salesmen are entitled to a Commission of 5% on total sales.7. Debtors include Rs. 25,000 bad debts

5,00,000——-

55,0001,00,0001,10,000

50,00070,00020,00010,000

2,40,00015,000

1,10,00085,00045,00087,50057,500

1,60,00025,00020,000

…..15,50,000

….2,50,000

60,00010,500

36,30,500

2,00,000

14,43,000

19,87,500

36,30,500

ACCOUNTANCY330

8. Printing and Stationary expenses of Rs. 55,000 relating to 1998-1999 had notbeen provided in the year .

9. Purchases include purchase of Furniture worth Rs. 50,000

Q. 33 From the following Trial Balance of Mr. Subhash prepare Profit and LossAccount for the year ended 31 March 2001 and Balance sheet as on that dueafter giving effect to the under mentioned adjustments:

Drawings 3,250 Bad Debts 400Stock (1-4-98) 17,445 Patents & Patterns 500Return Inwards 554 Cash 62Carriage Inwards 1,240 Discount Allowed 330Deposit with Anand Gupta 1,375 Wages 754Carriage Outwards 725 Capital 15,000Loan to Ashok @5% 1,000 Returns outwards 840given on 1-4-98Rent 820 Interest on Loan to Ashok 25Purchases 12,970 Rent Outstanding 130Debtors 4,000 Creditors 3,000Goodwill 1,730 Provision for Doubtful Debts 1,200Advertisement Expenses 954 Sales 27,914

Adjustments

1. The Manager of Mr. Subhash is entitled to commission @ 10% of the Net Profitcalculated after charging such commission.

2. Increase Bad Debts by Rs. 600. Make provision for doubtful debts 10% andProvision for Discount on Debtors 5%

3. Stock valued at Rs. 1,500 destroyed by fire on 25-3-2001 but the Insurance andCompany admitted a claim for Rs. 950 only and paid it in April 2001

4. Rs. 200 out of the Advertisement Expenses are to be carried forward to thenext year.

5. The value of closing stock is Rs. 18,792.

Q. 34 The following Trial Balance was extracted from the books of Bilal as on 31st

December 2002.

Debit Balance Rs. Credit Balance Rs.

Plant and Machinery 20,000 Capital 80,000Manufacturing Wages 34,500 Sundry creditors 44,500Salaries 15,850 Bank loan 15,000Furniture 10,000 Purchase creditors 1,740Freight on Purchases 1,860 Sales 2,50,850Freight on Sales 2,140 Provision for bad debts 2,000Building 24,000


Motor car 12,000Purchases 1,02,000Sales returns 3,100Bad debts 1,400Interest and Bank charges 400Cash at Bank 4,200Cash in Hand 1,120Manufacturing expenses 9,500Insurance and Tax 4,250Goodwill 25,000General Expenses 8,200Factory Fuel and Power 1,280Sundry Debtors 78,200Factory Lighting 950Opening Stock 34,200

Prepare Profit and Loss Account for the year ended 31st December 2002 and the BalanceSheet as on that date taking into consideration the following information:

a. Stock in hand on 31st December 2002 was valued at Rs. 30,500b. Depreciation plant and machinery by 10%

Furniture by 5%Motor car by Rs. 1,000

c. Bring provision for bad debts to 5% on Sundry debtorsd. A commission of 1% on the gross profit is to be provided for work managere. A commission of 2% on net profit (after charging the Works Manager Commission)

is to beCredited to the General Manager.

Q. 35 The following is the Trial Balance of M/s Kohli’s Agencies as on 31st 2002. PrepareProfit and Loss Account for the year ended 31st March 2002 and a Balance Sheet as onthat date:

Capital 15,000 1,00,000Buildings 18,000Drawings 7,500Furniture and Fittings 25,000Motor van 900Loan from Mr. Arun @ 12% Interest 15,000Interest paid on above 900Sales 1,00,000Purchase 75,000Opening stock 25,000Establishment Expenses 15,000Wages 2,000

ACCOUNTANCY332

Insurance 1,000 7,500Commission 10,000Sundry Debtor and Creditors 28,100Bank balance 20,000

2,32,500 2,32,500

Adjustment

a. The value of closing stock on 31st March 2002 was Rs 2002 was Rs. 32,000b. Outstanding wages Rs. 5,00c. Prepared Insurance Rs. 300d. Commission received in advance of Rs. 800e. Allow interest on Capial @ 10% p.a.f. Depreciation building by 2.5% Furniture and Fitting by 10% and Motor van by 10%g. Charge interest on Drawings Rs. 500h. Balance of interest due on the loan in also to be provide for.

Q. 36 From the following Trial Balance prepared from the books of Laxmi Narayan on 30th

June 2002, prepare Profit and Loss Account and a Balance Sheet on that date:

Laxmi Narain’s Capital and Drawings 10,550 1,19,400Bills Received 9,500Purchases and Sales 2,56,590 3,56,430Return Inwards 2,780Opening Stock 89,680Commission 5,640Plant and Machinery 28,800Salaries 11,000Traveling Expenses 1,880Debtors (including Mohan for dishonoredcheque of Rs. 1,000) 62,000Stationary 2,000Telephone charges 1,370Interest and Discount 5,870Bad Debts 3,620Fixture and Fittings 8,970Creditors 56,6306% loan 20,000Wages 40.970Cash in hand 530Cash at bank 18,970Insurance (including premium of Rs. 300 p.a.paid up to 31st Dec. 2002) 400Rent and taxes 5,620

5,61,100 5,61,100


Adjustments

1. Stock in trade on 30th June 2002 was Rs. 1,28,9602. Write off half of Mohan’s cheque3. Create provision of 5% on Debtors4. Manufacturing wages include Rs. 1,200 for erection of machine purchased last year.5. Depreciate Plant and Machinery by 5% and Fixture and Fitting by 10% per year6. Commission accrued Rs. 6007. Interest on loan for the last two months is not paid.

Q. 37 From the following Trial Balance of Mr. Ram, prepare Profit and Loss Account forthe year ended 31st December 2002 and a Balance Sheet as at that date taking intoconsideration the following adjustments:

a. Closing Stock Rs. 9.500b. One quarter of insurance premium falls in next yearc. Provide 10% depreciation on furnitured. Loan to X carries 8% interest per yeare. Loan from Y carries 6% interest per yearf. Goods worth Rs 500 have been taken by the proprietor for private useg. Provide 5% for bad and doubtful debtsh. Salaries include salary to the Proprietor @ Rs. 200 per month

Debit balance Rs. Credit balance Rs.

Stock on 1-1-2002 6,000 Capital 40,000Salaries 6,000 Return outwards 500Drawings 6,000 Loan from Y 5,000Carriage inwards 1,000 Rent outstanding 100Carriage outwards 500 Creditors 13,000Return inwards 800 Outstanding Expenses 1,900Loan to X 3,000 Bad Debts Provision 1,000Rent 1,200 Discount 300Goodwill 5,000 Sales 73,700Wages 100 Rent by subletting 500Insurance premium 600Bank 8,500Purchases 60,000Debtors 30,000Advertisements 3,000Bad debts 500Discount 600Cash 200Furniture 3,000

ACCOUNTANCY334

Q.38 From the following Trial Balance and other particulars given prepare Profit and LossAccount for the year ended 31st December 2002 and a Balance Sheet as on that date:

Capital and Drawings 10,00,000Personal Debts 1,00,000Balance at Bank 1,000Motor Vehicle at cost less depreciation 1,76,000Debtors and Creditors 1,48,000Printing and Stationary 2,96,000 2,32,000Purchases and Sales 6,600Opening Stock 24,00,000 31,60,000Bad Debts provision 2,40,000 5,000Bad debts 11,400Free hold premises at cost 8,00,000Repairs and Premises 47,600General Reserve 2,00,000Proprietor’s Remuneration 20,000Wages and Salaries 2,29,000Delivery expenses 99,000Administration Expenses 1,31,000Rates and Taxes 15,000 124,000Profit and Loss (Last year)

47,21,000 47,21,000

Adjustments

1. Stock in hand as on 31 December 2002 Rs. 2,80,0002. Depreciation motor vehicles by Rs. 74,0003. Sundry Creditors include a claim for damages of Rs. 20,000 made last year and dur-

ing this year settled for Rs. 15,1004. Unpaid wages Rs. 1,6005. Rates paid in advance Rs. 3,0006. Provision for bad debts is to be reduced to Rs. 3,5007. The item of repairs to Premises includes Rs. 20,000 which has to be capitalized8. Stock of stationary in hand Rs. 2,200

Answers


I (c) Balance SheetII (a) SalesIII (c) to be deducted from the capital in the Balance Sheet.IV (a) Deleted to the Trading accountV (c) Rs. 2500


VI (b) Rs. 200 to be credited to Profit and Loss AccountVII (a) Rs. 1,200VIII (d) Rs. 500IX (b) Rs. 43,000X (a) Rs. 22,500XI (a) Rs. 44,000XII (a) Rs. 6,000

Problems

10. Net Profit Rs. 62,000Balance Sheet Rs. 1, 48,000

11. Net Profit Rs. 3,000Balance Sheet Rs. 2,42,000

12. Net profit Rs. 58,000Balance Sheet Rs. 2,47,000

13. Net Profi0t Rs. 49,000Balance Sheet Rs. 1,46,000



16. Net Profit Rs. 64, 980Balance Sheet Rs. 3, 13,980


18. Net Profit Rs. 19, 950Balance Sheet Rs. 1,40,000


20. Net profit Rs. 38,600Balance Sheet Rs. 1,99,000




24. Corrected Trial Balance Rs. 3,30,000Net Profit Rs. 18,000Balance Sheet Rs. 1,89,000


ACCOUNTANCY336

26. Net Profit Rs. 13,850Balance Sheet Rs. 63,900

27. Net Profit Rs. 58.400Balance Sheet Rs. 1,59,600












CHAPTER 8

Accounting for Financial Statements ofNot-for-Profit Organizations

LEARNING OBJECTIVES


● state the meaning of Not-for-profit organizations.

● differentiate between Not-for-profit and other businessorganizations.

● explain the concept of fund accounting.

● understand the fund-based accounting entities.

● understand the types and mode of receipts, payments andtransfers by Government.

● prepare receipt and payment account.

● prepare financial statements of Not-for-profit organizations.

ACCOUNTANCY338

Accounting is always done with respectto an entity. An accounting entity may bean individual such as a sole proprietor, adoctor, a lawyer or a chartered accountant.An accounting entity may also be a groupof persons such as a Hindu UndividedFamily, a Partnership Firm, a Joint StockCompany, a Cooperative Society, a Club,a Hospital, School, etc. On the basis of theobjectives to be achieved accountingentities can be divided into two categories.These are: (i) Entities for profit, and (ii)Not-for-profit entities (See Exhibit 8.1).Entities for profit: The objective of suchentities is to conduct business and earnprofit. These entities include manufac-turers, wholesalers, retailers, serviceproviders such as transporters, bankers,insurance agencies, and professionals suchas doctor’s lawyer, engineers, architects,professional advisors, etc.Not-for-profit entities: The objective ofsuch entities is to provide services to thepeople without any intentions to seekprofit. The main objective of these entitiesmay be social, educational, religious,cultural or charitable. These entities maybe in the form of sports club, social orliterary club, religious institutions,libraries, hospitals, educational institu-tions, professional bodies, societies andcharitable institutions like orphanagehomes, and old age homes.

Some not-for-profit entities such assports and recreation clubs exist with theprimary objective of providing services toits members. These may consist one ormore sub entity, which may undertaketrading in order to add the income frommemberships, subscriptions, donationsand grants. For example, a cricket club, a

not-for-profit organization may run arestaurant as a sub entity of cricket clubto earn profit and the same fund may beused for the furtherance of the objectivesof the club.

So far you have studied aboutaccounting of the transactions of BusinessOrganizations, which are profit-makingand follow accrual system of accounting.This chapter seeks to explain the conceptsand procedures of accounting followed bynot-for-profit organizations. Not-for-profit organizations follow usually theCash system of accounting and partly theAccrual system of accounting and hence,the system is hybrid in nature or ModifiedAccrual Accounting. This chapter isdivided into two parts. Part I dealswith Accounting for GovernmentalOrgani-zations and Part II dealswith Non-Governmental Not-for-ProfitOrganizations.

8.1 Concept of Not-for-ProfitOrganizations

The primary reason of the existence of not-for-profit organizations is the existence ofmany social and political groups withinour present-day society, which provideservice and carry on activities in theinterest of society. Thus, the interest ofsociety is considered to be of primeimportance because it is desirable to makeavailable certain services whicheconomically and physically challengedpeople cannot afford, but are required tobe provided for the empowerment of thedeprived people or for promotion ofcertain activities, which cannot be pursuedindividually. The not-for-profit organi-zations grow in any society with the

STATEMENTS OF NOT-FOR-PROFIT ORGANIZATIONS 339

growth of its collective socialconsciousness, which propels the peopleto ameliorate the hardships and sufferingsof the common people. It is for thesereasons that during the last decade a largenumber of Non-GovernmentalOrganizations (NGOs) have flourished. Anot-for-profit organization does notrestrict itself from earning surplus fromits activities. Rather such surplus is usedfor the furtherance of the activitiesemanating from the objectives for whichthe organization was created.

Not-for-profit organizations are thoseorganizations, which operate with thepurpose of achieving the objectives forwhich they are created and not necessarilyfor profit motive. It can be defined as “anentity that provides, without profit, aservice beneficial to society and that hasan equity interest that cannot be sold ortraded.” According to Emerson O. Henke,the term “without profit” in case of Not-for-profit organizations is not intended toimply that such an organization cannotplan or realize profit, but it implies thatthe activities pursued are not solely

governed by the profit motive. Hence, innormal course of activities a Not-for-profitorganization can have excess of revenuesover expenditure, called surplus. Whensuch addition takes place to the net assets,it is used to implement and enlarge theservices of the organization. Equity toNot-for-profit organizations is providedby membership contributions, alloca-tions, contributions, grants or membershipsolicitations. It is to be noted that this istrue only in c ase of Non-GovernmentalNot-for-profit organizations such as clubs,hospitals, colleges, sports-boards (such asCricket Control Board), Museums,Temples, Gurudwaras, Wakf Boards andChurches. In case of Not-for-profitorganizations in Government sector(Universities, Research Institutions,Scientific Institutions, MunicipalCorporations) do not have equity inthe same sense as that in the caseof commercial enterprises. Since there isno equity in Government sector,financing is done through tax-collections,surpluses from Public enterprises andborrowings.

ENTITIES

COMMERCIAL ENTITIES

MANUFACTURINGMININGFARMING/FISHINGTRADINGAGENCY SERVICESFINANCING, Banking, InsurancePROFESSIONALS

NOT-FOR-PROFIT ENTITIES

GOVERNMENTAL NON-GOVERNMENTAL• CENTRAL• STATE• LOCAL• UNIVERSITIES• INSTITUTIONS• COLLEGES• SCHOOLS

• TRUSTS• HOSPITALS• CLUBS• RELIGIOUS

INSTITUTIONS• PRIVATE

EDUCATIONALINSTITUTIONS

→ →

→

→ →

(Contd. at Page 440)

ACCOUNTANCY340

PRIMARY MOTIVES is carry on the above mentionedactivities and thereby bring financial gain to theowner(s)

PROPRIETORSHIP or interest of the owner(s) orowners equity represents the proprietors investmentin the business which consists of the original moneyput into the business plus the profits not withdrawn

RESULT OF ENTITY’S ACTIVITIES is profit, whichrepresents the difference between sales revenue andother incomes, if any, over the cost of sales and financialcharges. The profit and may either be withdrawn, orretained in the business.

ACCOUNTING STATEMENT prepared to serve theinformation needs of decision makers include all orsome of the following:

(i) Manufacturing or Production a/c(ii) Profit & Loss Account(iii) Balance Sheet

PRIMARY MOTIVES is to provide services to themembers or to the society at large. Profits arising outof any trading activities are used to further serviceobjectives.

PROPRIETORSHIP or interest of the members isknown as Capital Fund or Accumulated Fund whichrepresents the Accumulated surplus of subscriptions,donations and profits from trading and social activitiesover expenses.

RESULT OF ENTITY’S ACTIVITIES is the surplus,which represents the excess of revenue income overrevenue expenditure during a period, and indicates theextent of utilization of incomes for the pursuit of serviceobjects. It increases the Accumulated Fund of themembers and cannot be withdrawn by them.

ACCOUNTING STATEMENTS prepared to serve theinformation needs of decision makers include

(i) Receipt & Payment Account,(ii) Income & Expenditure Account,(iii) Balance Sheet.

8.2 Distinction between Not-for-Profit and Commercial Entities

A Not-for-profit organization can be differentiated from a profit seeking organizationon the following basis:

Exhibit : 8.1

Basis Commercial entity Not-for-Profit entity

1. Primary motive

2. Ownership

3. Distributions of profit.

4. Result

To carry on the activities for earningprofits.

Proprietors of business are owners andhence, entitled to share the profits.

Profits are distributed among theowners.

Result of the entity’s activities is calledprofit, which is the difference betweensales and other incomes, if any, over theexpenses. The profit either bewithdrawn or retained in a business.Excess of expenses over incomes iscalled loss.

To provide services to the members orto the public at large. Profits earned outof any trading activities are used tofurther the service objectives.

Subscribers to the membership of theNot-for-profit entity are called themembers.

Profits are not distributed among themembers.

Result of the entity’s activities is calledthe surplus, which is the excess ofincome over expenses. It increases theCapital Fund and cannot be withdrawnby the members. The excess ofexpenses over incomes is called deficit.


8.3 Concept of Fund Accounting

Government and Not-for-profit organi-zations are required to organize theiraccounting systems on a fund basis. Afund is defined as an independent fiscaland accounting entity with a self-balancing set of accounts recording cashand/or other resources together withliabilities, obligations, reserves, andequities which are segregated for thepurpose of specific activities to achievecertain objectives in accordance withspecial regulations, restrictions andlimitations. Thus, each type of fund is asub accounting entity for the purpose ofinternal as well as external reporting offinancial estimates, budgets andperformances to the stakeholders. Not-for-profit organization uses it, which arelegally responsible for ensuring thatcertain funds are used only for suchspecific purpose for which the same havebeen contributed by the donors. Hence,there is a need for separate accountabilitywhenever, a Not-for-profit organizationreceives such restricted contributions.

8.3.1 Features of Fund Accounting

Following are the features of fundaccounting:

1. This system of accounting is used by

Not-for-profit organizations of bothtypes, viz., Governmental and Non-Governmental.

2. Each fund is a separate entity foraccounting and accountability.

3. Each fund has to balance for incomereceived and expenditure made inaccordance with the restrictionsplaced on their use.

4. Budget approval and appropriation isthe basis of income generation andspending.

5. Despite restrictions being placed onthe use of specific funds, there willalways be a general fund from whichorganizational expenses will bepassed.

6. In addition to fund accountingentities, there will be memo-accountgroups which disclose the assetsrequired and liabilities incurred. Incase of large borrowings, organizationmay choose to crate “Debt Fund”. Itis to be noted that cash generated toraising of debt is treated as revenue.In order to better understand the

mechanism of accounting under FundAccounting System, the relationship ofvarious accounts can be expressed asfollows:Assets + Expenditure + Encumbrances +Estimated revenues + Interfund Claims =

Basis Commercial entity Not-for-Profit entity

5. AccountingStatements

The accounting statements are preparedto serve the information needs of theusers include all or some of thefollowing:

(i) Manufacturing Account(ii) Profit and Loss Account(iii) Balance Sheet.

The accounting statements prepared toserve the information needs of the usersinclude:

(i) Receipts and PaymentsAccount,

(ii) Income and ExpenditureAccount and

(iii) Balance Sheet.

ACCOUNTANCY342

Liabilities + Appropriations + Revenues +Interfund Obligations + Fund Balance.

8.3.2 Terminology of FundAccounting

Some of the new terms used in the aboveequation as also the other terms used infund accounting are explained hereunder:

Expenditure: It is an amount paid fortransfer of an asset, for acquiring servicesor assets or for settling a loss.

Encumbrances: Obligations/liabilitiescommitted during the accounting year byagreement of purchase or contract. Aportion of general funds may be set asideto meet the obligations on account ofpurchase orders.

Interfund Claims/Transfers: This impliesearmarking of resources for specificpurpose or use. Usually, this is done bytransfers from general revenues or fromother funds. For the purpose of full-disclosure, it is necessary that Interfundtransfers/claims be shown clearly to avoidthe mis-reading of financial statement. Ifnot properly presented along withexplanations, such transfers may give theimpression of willful manipulation ofreported income. Since, transfers aremerely internal allocations, they must notbe shown as income of the receiving fundand expense of transferring fund.

Appropriation: Appropriations areinternal authorizations to spend money ona given expenditure head. It is defined asone that sets out the amount earmarkedor authorized to be spent for a particularactivity or function. Expenses incurredout of Appropriate Funds should becharged as expenses in the year incurred,

and the related appropriations should bereversed if there is excess. Disclosureshould be made by way of a note.Revenues: Revenues are the currentincomes received by way of cash inflowsthrough gifts, fees, grants, interest,dividend, rent etc.

8.4 Objectives of Accounting forNot-for-Profit Entities:

Following are the objectives of accountingfor Not-for-profit entities:● To compare the actual financial

results of operations withorganization’s approved and legallyadopted budget.

● To assess financial performance of theentity during the current accountingyear.

● To determine the compliance withrules, regulations and laws underwhich Not-for-profit accountingsystem is operating.

● To evaluate the organization’sefficiency in spending money onmeeting the assigned tasks andresponsibilities.

8.5 Types of Funds

Following are the most commonly usedgroup of funds:

● Current Unrestricted or GeneralFunds: This fund is created to carryout the general activities and is alsocalled “Operating Fund”,“Unrestricted Fund” or “GeneralFund”. This fund does not containany restrictions on the use of assetscontributed to it. This fund is usedfor the attainment of objectives for


which the organization wasestablished. All unrestricted grants,gifts, contributions and incomes arerecorded in this fund. If theorganization does not receive anyrestricted fund, this fund would showall activities of the organization.Common example of Unrestrictedfunds are – annual membership fee,non-specified gifts and grants,contributions.

Accounting Entries for General Fund

(a) Receipt of Fund:Bank/Cash a/c Dr.

Contributions a/c

(b) Use of Funds:Contributions a/c Dr.

Fund Balance a/c

● Current Restricted fund: This fundaccounts for contributions received bythe Not-for-profit organization forcarrying out those activities for whichsuch contributions are made. Thisfund is also called “Donor-restrictedFund” or “Fund for SpecifiedPurposes”. For example, a school mayreceive Rs. 1 Lakh for a programmeof Public Education for Drug Abuse.In this case, this is a restricted fund,which is to be used for promotingDrug abuse programme. Suchamounts are recorded in the specificfunds. In the given example, theamount will be recorded in DrugAbuse Fund Account. Often theCurrent Restricted Funds arerelatively small in amount and areused either in the current year or inthe following year. Usually, all

Good Luck Community Service CentreCurrent Unrestricted Fund

Statement of Income, Expenses and Charge inFund Balances for the year ended 31 March 2002

Particulars Amount Rs. Amount Rs.

Income: 5,40,000Contribution and Gifts 4,00,000Service Fees 1,00,000Investment Income from endowment fund 25,000Other Incomes 15,000

Expenses: 3,50,000Salaries 2,00,000Rent 75,000Utilities 50,000Other 25,000

Excess of income: 1,90,000Over expenses 10,000Fund balance, beginning of the year 2,00,000Less: Transfer to fixed asset fund 1,50,000Fund balance at the end of the year 50,000

ACCOUNTANCY344

Current Restricted Funds are clubbedunder one head. Another examplewould be, the Research Grants Fundwhich is the sum-total of the grantsreceived by different teachers indifferent departments of a college tocarry out specific individual researchprojects. It is to be noted that detailsof each research project with respectto the amount sanctioned, amountreceived, amount spent and balancewill be shown for each scheme ofresearch project.

Accounting Entries

If a Not-for-Profit Organization:

(a) For Receipt of Funds:

Cash Operating a/c Dr. Restricted Fund a/c

(b) Use of Fund: Restricted Fund a/c Dr.

Contributions for Research a/c

● Endowment Fund: EndowmentFunds are the assets donated to Not-for-profit organizations with the legalcondition that the principal amountwill be maintained in perpetuity andonly the income earned from theseassets can be used for the variousactivities of the organization. Usually,income arising from the investment ofEndowment Fund, is unrestricted foruse hence, should be reported in theCurrent Unrestricted Funds.

In some cases, endowment donationsare received with restriction on the use ofincome from the fund investment. In suchcases, the income is added to theEndowment Fund and relatedexpenditure is subtracted from the fund

Good Luck Community Service CentreCurrent Restricted Fund

Statement of Income, Expenses and Charge inFund Balances for the year ended 31 March 2002

Particulars Amount Rs. Amount Rs.

Income: 3,00,000Contributions 2,00,000Gifts 75,000Other Incomes 25,000

Expenses: 2,58,000Sports prizes 1,75,000Welfare Programme 45,000Other expenses 38,000

Excess of income:Over expenses 42,000Fund balance, beginning of the year 18,000

Fund balance at the end of the year 60,000


income. Any excess of income overexpense is added to the fund and isinvested to generate further income for theoriginal purpose. For example, aUniversity may receive Rs. 1 Lakh forawarding gold medal to the meritoriousstudent. In this case, the endowment forGold Medal is a restriction and hence, theexpenditure on the Gold Medal will beless than or equal to the interest incomearising from the investment In case ofsurplus, the same will be invested andadded to the fund.

Another possibility is that a donation/grant may be received by the organization.Such donation is invested and income ispaid to the beneficiary as per the directivesof the donor. For example, an organizationmay donate Rs10 lakh for promoting studyof literature. In this case the Rs10 lakh willbe invested and income arising out of thatwill be distributed by way of Scholarshipto people pursuing study of Literature.The donations so received will be shownas “Scholarship Fund”.Accounting entries:(a) Receipt of Endowment:

Cash/bank a/c Dr.Endowment Fund a/c

(b) Making of Investment:Investment a/c Dr.

Cash/Bank a/c

(c) Receipt of Interest/Dividend:Cash/bank a/c Dr.

Interest/Dividend a/c

(d) Transferring interest toEndowment and matching

expensesInterest/dividend a/c Dr.

ExpenditureEndowment

(e) Purchase of Medals etc.Expenditure a/c Dr.

Cash/Bank

(f) Transfer to Unrestricted FundEndowment Fund a/c Dr.

Unrestricted Fund

● Fixed Asset Fund: The gifts andcontributions received by Not-for-profit organisations for theacquisition/creation of assets arerecorded in “Fixed Assets Fund”/“Building & Equipment Fund”/“Plant Fund”. Often amount spent arefunded by both donor restricted andunrestricted gifts. This fund will alsoinclude unspent Building Fundcontributions. Creating a separatefund and thereby indicating that thisamount is not available for day-to-day operations of the Not-for-ProfitOrganizations. Sometimes, the

Abstract Balance Sheet as at 31 March 2001

Liabilities Amount Rs. Assets Amount Rs.

Current Restricted Fund 60,000 Current Restricted Fund 60,000Investment with

HDFC Bank 30,000Bank of Baroda 20,000Cash 10,000 60,000

ACCOUNTANCY346

amount of unrestricted gifts/generalfund may be transferred to anotherfund. Such transfer of amount is knownas Interfund transfer. Depreciation isshown in the Plant Fund or in the

unrestricted fund. In the latter case, anamount equal to the depreciationcharge is transferred from the unres-tricted funds to Plant Fund. Thefollowing explains this process:

Unrestricted Fund

Particulars Rs. Rs.

Provision for Depreciation XXXXXX Transfer to Plant Fund XXXXXX

Plant Fund

Particulars Rs. Rs.

Transfer from Unrestricted Fund XXXXXX Accumulated Depreciation XXXXXX

Good Luck Community Service CentreFixed Asset Fund

Statement of Change inFund Balances for the year ended 31 March 2002

Particulars Amount Rs.

Fund balance in the beginning of the year 8,00,000Add: Transfer from ensuer fund 1,50,000

Fund balance at the end of the year 9,50,000

Abstract Balance Sheet as on 31 March, 2001.(Rs. In lakhs)

Liabilities Amount Rs. Assets Amount Rs.

Sir SayajiRao Diamond Sir SayajiRao DiamondJubilee Fund 20 Jubilee Fund 20

Investment withAs per last Account 15 HDFC Bank 10Exp. As per last Account 3 Bank of Baroda 5Add: Donations 2 Addition to Building 5


Difference between Fund Accounting and Non-fund Accounting

Fund Accounting Non-Fund Accounting

1. Basis of Book-keeping

2. Use of Money

Cash Basis.

Except general funds, all other funds areused for specific purpose and separatefunds are created for recording.

Accrual Basis.

All resources are used for any of theobjectives or basis and all resources areclassified as owner’s equity and loans.

Good Luck Community Service CentreAbstract Balance Sheet as on 31st March, 2001.

(Rs. In lakhs)

Liabilities Rs. Assets Rs.

Fixed Assets Fund 9.5 Fixed Assets 9.5

Fund Accounting Non-Fund Accounting

3. EquityAccounting

4. Entity ofAccounting

5. Accountability

6. FinancialStatements

7. Surplus v/s.income

8. Budget

There is no individual or group of personswho have economic interest and hencethere is no equity.

Each fund is a fiscal and financialaccounting entity.

Accountability is towards law,regulations, legislature, Parliament,contributors and donors of funds.

Budget, income and expenditure account,statement of changes in funds alongwiththeir utilization, summary of debts.

Usually expenditures are more or equalto receipts, hence deficit is the commonfeature. Sometimes individual funds mayhave excess of current income overexpenses because of restrictions.

Approval of budget is fundamental forfinancial transactions. Hence,authorizations and appropriations aresacrosanct. Moreover, all account headsemanate from budget.

Equity accounting is of primary focus asthese are ownership equities.

Business enterprise is the accountingentity for recording and reportingbusiness transactions.

Accountability is towards allstakeholders viz., owners, creditors,workers, Government, regulators,consumers and all other general public.

Profit & Loss Account, Balance sheet,cash-flow statement and statement ofchanges in financial position of businessentity.

The result of matching of revenues andexpenses may either be profit or loss.

Commercial principles of codification ofaccounting are followed and budgetsystem is optional.

ACCOUNTANCY348

8.4 Governmental Accounting System

It is to be noted that the discusstion thatfollows hereunder is to give a synoptic viewof Government Accounting System of theGovernment of India. For further details,one can refer to Government AccountingRules framed and enforced from time-to-time.

The fundamental objective ofGovernmental Accounting System is toforecast with greatest possible accuracywhat is expected to be received and paidduring the year and whether the receiptsalong with previous years balance of fundis sufficient to cover the expenses. For this,every year a Budget is laid before theParliament/State Legislature showing theCapital and Revenue receipts and capitaland revenue disbursements. Further,division is made between plan and non-plan expenditure. The budget has to bevoted and passed by the Parliament/Legislature and a separate AppropriationBill is to be passed to indicate autho-rizations for different receipts anddisbursements. On the basis of the budgetand accounts the Government determines(a) whether it will be justified in curtailingthe expenditure or expanding theactivities, and (b) whether it can or shouldraise revenues accordingly. In brief,

following are the purposes of GovernmentAccounting System:

1. Historical record of financialoperations of the Governmentalongwith the legally adopted budget.

2. Report expenditure incurred onvarious activities.

3. Provide information about howGovernment financed its activitiesand met its cash requirements.

4. Provide aggregate information usefulin evaluating the Governmentsperformatnce in terms of services,cost–efficiency and accomplishments.

5. Provide help in the financialmanagement of the country/state/union territory through periodicalreporting.

8.4.1 Method of GovernmentalAccounting

The mass of Government transactions arecash based, hence cash system ofaccounting is followed. However, forcertain transactions for whichGovernment acts as banker, remitter,borrower or lender, accrual System ofAccounting is followed. There are threepillars viz., elements (expense, revenue,receipt, disbursements, liabilities, cashbalance), measurement and recongnition.

9. Adjustment

10. Depreciation

Under cash system, outstanding and pre-paid expenses, accrued income are notrecorded. However, for restrictedpurposes under modified accrual system,such adjustments are recorded.

Depreciation is not recorded as cost ofcarrying on operations. Depre-ciation istreated as allocation of funds based onreplacement cost of the asset in use as isfollowed in Indian Railways.

All adjustments are made by invokingthe Generally Accepted AccountingPrinciples (GAAP).

Depreciation is recorded as Businessexpense and proper asset accounting isdone.

Exhibit : 8.2


These are explained below:

1. Element is and item of transactionrelating to expense, income, receipt,disbursement, liability, or asset.

2. Measurement is the process ofdetermining the monetary amounts atwhich elements are to be recorded.

3. Recognition is the processs ofincorporating in a financial statementan item that is within the definitionof an element and satisfies the criteriafor recognition.

Cash Basis of Accounting:

● Recognises transaction at exchange ofcash.

● Financial result is expressed in termsof cash received and cash paid.

● Elements covered are:

(a) Receipts(b) Expenditure(c) Cash balance

Accrual Basis of Accounting: Accrualsystem of Accounting follows GenerallyAccepted Accounting Principles and isrecommended for use in case of trusts,capital projects, special assessment, andInter-Governmental transfer of funds. Themodified Accrual basis of accounting isused for general funds, special reveruesand Debt Service Funds. The modifiedaccrual basis of accounting is defined asthat method of accounting in whichexpenditures and revenues are recordedat the exchange of cash except for materialand approved revenues. Revenue sourceswhich give rise to legally enforceableclaims (such as property taxes, which canbe duly ascertained and Inter-Governmental transfers are recorded on

accrual basis. Following are the elementscovered:

● Revenues● Expenses● Assets including physical assets● Liabilities● Net assets● Cash flows

Receipts: Receipts are cash inflows arisingfrom reciprocal and non-reciprocaltransactions, borrowings, interest, orcustodial contributions/receipts.

Non-Reciprocal Transactions:

● Taxation● Issue of currency● Grants● Donations● Contributions

Reciprocal Transactions:

● Sale of goods and services● Sale of Assets.

Financial Inflows:

● Interest receipts● Borrowings● Capital contributions● Custodial receipts

Payments:

Reciprocal Transactions:● Purchase of goods and services● Acquisition of asssets● Capital investment and loans

Non-reciprocal Transactions:

● Governmental transfers● Grants● Contributions● Donations

ACCOUNTANCY350

Financial Outflows:

● Interest payment● Repayment of debt

Custodial payments

Assets: An asset is a resource controlledby the entity as a result of past event andfrom which future economic benefits areexpected to flow. Assets may be financial(bonds, securities, shares, debentures etc.),physical (gold, silver, land & building,bridges, furniture, fixtures, equipmentand plant, currency) and intangible(patents, copyrights, licences etc.).

Liabilities: A present obligation arisingfrom past events settlement of which isexpected to result in the outflow ofresources embodying economic benefits.Examples of liabilities are accountspayable, accrued interest payable, accruedwages and salaries, pension and otheraccrued terminal benefits, guarantees andindemnities likely to be invoked, currency

issued, debt, obligation under accidentcompensation.

Commitment: It is a Governmentresponsibitlity for a future liability basedon contractual agreement. Obligation isnot certain but when it occurs, it is to berecognized as a liability because it ceasesto be a commitment.

8.4.2 Classification of GovernmentAccounts

Government accounts are kept in threeparts, viz., Part I Consolidated Fund ofIndia, Part II Contingency Fund of Indiaand Part III Public Account of India (SeeExhibit 8.3)

Consolidated Fund of India

It is the account of all revenues received,all loans raised and all money received bythe Government in repayment of loans.This account has two divisions. The first

Government Account

Consolidated Fund of India Contingency Fundof India

Public Account of India

Receipts

● Tax Revenue.

● Non-Tax Revenue.

● Grants in aid &Contributions.

Expenditures

● General Services.

● Social Services.

● Economic Services. ●

Grants in aid &Contributions.

RevenueSection

CapitalSection

Receipts

● Small Savings.

● Deposits & Advances.

● Reserve Fund.

● Suspense &Miscellanceous.

● Remittances.

● Cash Balance

Expenditures

● General Services.

● Social Services.

● Economic Services. ●

Grants in aid &Contributions.

Exhibit 8.3: Structure of Government Account


division consists of revenue account,detailing about revenue receipts andexpenditure heads. The second divisioncomprises capital receipts and capitalexpenditure. The third section relates toPublic Debt and Loans and Advanceswhich include loans raised and theirrepayment by Government such asInternal debt, external debt of CentralGovernment, Loans and Advances madeby Government and their recoveries.

Contingency Fund: It is Part II ofGovernment Accounts. The ContingencyFund is in the nature of an imprest createdthrough the law by the Parliament andplaced at the disposal of the Governmentto enable advances to be made for meetingunforeseen expenditure, pendingauthorization by the Parliament.

Public Account of India: This is the thirdpart of Government Accounts. All othermoneys received by or on behalf of theGovernment of India shall be credited tothe Public account of India. Thetransactions leading to debt (other than inPart I), deposits, advances, remittancesand suspense are recorded in this account.

Sectors and Sub-sectors of Accounts:Under each division and section of theConsolidated Fund of India, thetransactions are grouped into Sectors such

as General Services, Social and Commu-nity Services. This classifi-cationhighlights the Function or the Servicecarried on by the Government. The Sectorsmay be divided into Sub-sectors. EachSector in a section is distinguished by analphabet.

Major, Minor and Detailed Heads: Majorhead of account falling in the ConsolidatedFund of India corresponds to the functionsof Government such as services likeagriculture, defense provided by theGovernment. A Minor head identifies aprogramme undertaken and asub-minor head indicates the scheme oractivity undertaken. A detailed head istermed as an object classification. It ismeant for itemized control overexpenditure such as salaries, officeexpenses, grant-in aid, loans, andinvestments.

Codification of Accounts: A four-digitArabic-numerical code is assigned toMajor Heads followed by two-digit codefor the relevant Major Sub-head followedby a three-digit code for Minor Heads (SeeExhibit 8.4). This is illustrated by thefollowing example:

Procedure for Receipts, Payments andInter-Government Transfers: All receipts(taxes, borrowings, interest receipts and

Major Head Code in the section for

Receipt Heads Expenditure Expenditure Loans andFunction Revenue Heads Heads Capital Advances

Account Revenue AccountAccount

1. Medical andPublic Health 0210 2210 4210 6210

2. Shipping 1052 3052 5052 7052

ACCOUNTANCY352

others), payments (expenses for civil,defense, and general services for eachhead) and inter-governmental transfersare carried out through the use ofvouchers, formats whereof are prescribed

in Government of India Accounting Rules,1990. The procedure for receipts,payments and inter-governmentaltransfers is presented in a synoptic formin Exhibit 8.5.

Classification andCodification of Accounts

Characteristics of the Function

Part

Division

Section

Sector

Sub-sector

Sub-sub-sector

Function Itself

Major Head Function 4 Digit Code

Sub-Major Head Sub-Function 2 Digit Code

Minor Head Programme 3 Digit Code

Sub-Minor Head Scheme 2 Digit Code

Detailed Head Sub-Scheme 2 Digit Code

Object Head Item Class 2 Digit Code

▼

▼ ▼

Exhibit 8.4: Coding System

Reserve Bank of India


Exhibit 8.5: Procedure for Receipts, Payments and Transfers.

ACCOUNTANCY354

As revenues are received, cash account is debited and revenue account is credited.Assuming that (out of Rs. 5,00,000 tax revenue) Rs. 4,50,000 is collected (and distributedas follows)

Recording of Transactions

1. Recording Estimated Revenue

Estimated revenue is, being an Asset account is debited and Fund Balance is credited.

General Ledger (Rs.) Subsidiary Ledger (Rs.)

Debit Credit Debit CreditEstimated Revenue 9,00,000

Fund Balance 9,00,000

Estimated Revenues LedgerTax Revenue 5,00,000Licenses and Permits 2,00,000Service charges 1,20,000Fines and others 80,000

2. Recording Appropriations


Debit Credit Debit CreditFund Balance 8,00,000

Estimated other uses 30,000Appropriations 7,70,000

Appropriations LedgerGeneral Government 4,00,000Public Safety 2,00,000Public Parks 60,000Health and Welfare 1,10,000Estimated other uses 30,000


Debit Credit Debit CreditCash 4,50,000

Revenue 4,50,000Revenue Ledger

General Government 3,00,000Public Safety 30,000Public Parks 40,000Health and Welfare 80,000


3. Recording ExpenditureWhen the authorized liabilities have beenincurred, an appropriation is consideredexpended. Expected liabilities are calledencumbrances/obligations. In order torecord an encumbrance, usually in case of

purchase or other commitments, theEncumbrances Controlling Account isdebited and Reserve for Encumbrances iscredited. For example, encumbrances forthe year 2002 are of Rs. 1,00,000. Thetransaction is recorded as follows:


Debit Credit Debit CreditEncumbrances 2002 1,00,000

Reserve for Encumbrances 2002 1,00,000Revenue Ledger

General Government 50,000Public Safety 25,000Public Parks 20,000Health and Welfare 5,000


Debit Credit Debit CreditEncumbrances 2002 1,00,000

Reserve for Encumbrances 2002 1,00,000Revenue Ledger


When expenditures are actually paid,expenditures (and its subsidiary account)is debited and liability account is created

for the amount paid to the creditor. Forexample, Rs. 90,000 of Rs. 1,00,000 of theencumbrances is paid as follows:


Debit Credit Debit CreditReserve for Encumbrances 2002 90,000

Encumbrances 2002 90,000Encumbrances Ledger


Expenditure 2002 90,000Vouchers Payable 90,000

Expenditure LedgerGeneral Government 45,000Public Safety 20,000Public Parks 20,000Health and Welfare 5,000

ACCOUNTANCY356

In this way, all transactions arerecorded in the General Fund(Consolidated Fund of India) and entriesare made in the Budgeting Process. A

Illustration 1

A college has received endowments for furtherance of research. Following are the detailsof the various endowments:

Balances as on 1 April, 2000 Rs.

IPCL Research fund in Management 20,00,000

IPCL Research fund in Microbiology 10,00,000

GSFC Fellowship 20,00,000

Interest Balance as on 1 April, 2000




Interest received during the year ending 31 March, 2001.




Expenditure during the year



GSFC Fellowship 2,00,000Contribution received for GSFC Fellowship Fund. 2,00,000

Investment at the end of the year


IPCL Research fund in Microbiology

(In Government Bonds) 14,00,000

GSFC Fellowship (LIC Annuities) 36,00,000

pictorial representation of the flow ofreceipts and payment procedure is shownin exhibit 8.5.

Balances of funds are maintained in the Bank Account with the State Bank of India.From the above information, you are required to prepare Statement of Change in

Endowment Fund. Show the relevant items in the Statement of Affairs.


Solution

Statement of Change in Endowment Fund


A. IPCL Research fund in ManagementOpening Balance of Interest 40,00,000Add: Interest Received 6,00,000

46,00,000Less: Expenditure during the year 5,00,000Closing Balance of Interest 41,00,000Opening Balance of Fund 20,00,000Closing Balance of Fund 61,00,000

B. IPCL Research Fund in MicrobiologyOpening Balance of Interest 5,00,000Add: Interest Received 1,50,000

6,50,000Less: Expenditure during the year 3,50,000Closing Balance of Interest 3,00,000Opening Balance of Fund 10,00,000Fund received during the year 2,00,000 Closing Balance of Fund 15,00,000

C. GSFC Fellowship FundOpening Balance of Interest 3,00,000Add: Interest Received during the year 3,00,000

6,00,000Less: Expenditure during the year 2,00,000Closing Balance of Interest 4,00,000Add: Opening Balance of Fund 30,00,000Add: Contributions Received 2,00,000Closing Balance of Fund 36,00,000

Total Endowment Fund 1,12,00,000

Statement of Affairs as at 31 March 2001


Endowment Fund: Endowment Fund:A. IPCL Research fund

in Management 61,00,000 A. IPCL Research fund inManagement

Govt. Bonds 50,00,000Bank Balance* 11,00,000 61,00,000

B. IPCL Research fund B. IPCL Research fund inin Microbiology 15,00,000 Microbiology

Govt. Bonds 14,00,000Bank Balance* 1,00,000 15,00,000

C. GSFC Fellowship C. GSFC Fellowship FundFund 36,00,000 LIC Annuities 36,00,000

TOTAL 1,12,00,000 TOTAL 1,12,00,000

* Balance of Bank account for respective fund

ACCOUNTANCY358

8.2 Accounting Statement for Non-Governmental Not-for-ProfitOrganizations

The Not-for-Profit organization being adifferent type of entity necessitates adifferent type of accounting treatment. Thisneed arises on account of the type ofinformation required to be generated tosupport the various decisions of themanagement. Besides, their funding patternis also different as these entities receivemoney from members and other agenciesto promote their activities, which is usuallynot in the case of business enterprises.All the accounts are compiled at the endof the financial year and presented in theform of following statements:1. Receipt and payment account (also

known as Receipt and Disbursementaccount) stating the actual receiptsand payments made during the year.This includes for revenue receipts andpayments.

2. Budget is an estimate of receipts andpayments of next financial year-presented to the Parliament/Legislatureindicating expenses to be charged, voted,expenditure to be voted on account andthe receipts under various head such astax collection, interest and other receiptssuch as revenue receipts and capitalreceipts. The capital receipts and disbur-sement and revenue receipts and disbur-sement are shown in two sub-heads :● Planned expenditure● Non-Planned expenditure.

3. Appropriation bill is placed in theParliament for seeking approval ofthe house for the proposal made inthe budget for raising revenue fromreceipts, disbursements and payments.

4. Along with receipt and paymentaccount, a statement of position ofconsolidated fund is presented in theform of a statement.

8.3 Receipt and Payment AccountReceipt and Payment account is a similarto cashbook; therefore it serves thepurpose of cashbook. Proper classificationof receipts and payments help indifferentiating receipt of capital natureand revenue nature and of the expenses.Apart from this, it indicates the openingand closing balance of cash. Such aclassification can help in the preparationof cashbook from the receipt and paymentaccount. It is also called Receipt andDisbursement Account.

The Receipt and Payment Account isgenerally presented horizontally (in T-form) with cash receipts on the left handor debit side and cash payments on theright hand or credit side, as:

Debit || Credit Receipts Payments

8.3.1 Preparation of Receipt andPayment Account

Receipt and payment account is preparedby keeping in view the following points:

1. This account starts with the openingbalance of cash in hand and cash atbank. Cash in hand always have adebit balance and, therefore, appearson the debit side. Cash at bank haveeither a debit or favourable balanceor a credit (overdraft) or onfavourable balance. If it has afavourable balance (debit balance) itwill be shown on the debit side andan overdraft (credit balance) will beshown on the credit side.


2. All cash collections made during theaccounting year as shown on thereceipts or debit side and all cashpayment made during the year asshown on the payments (credit) side.The period to which the transactionsmay belong (i.e. previous year (s),current year or future years (s)) and thenature of the transaction, (whethercapital or revenue) is recorded on thedebit side. For example the payment ofrent, (revenue item) outstanding rentor prepaid rent will be shown on thecredit side. Similarly, the paymentfor the purchase of furniture (capital

item) will also be shown on the creditside.

3. Only actual receipt of cash and paymentof cash are recorded. All non-cash itemssuch as outstanding expenses,depreciation on fixed assets and accruedincomes do not form the part of theReceipts and Payments account.

4. The Receipts and Payments accountis balanced at the end of theaccounting year to show the closingbalance of cash in hand and at bankor bank overdraft, as the case may be.

The format of the Receipt and PaymentAccount is as given below:

Receipt and Payment Account

Receipts Amount Rs. Payments Amount Rs.

Salary xxxWages xxxHonorarium xxxRent xxxTaxes xxxInsurance xxxElectric Changes xxxPrinting xxxPostage and Stationary xxxRepairs xxxRefreshments purchased xxxConveyance xxxTournament xxxInterest on Loan xxxInterest on Bank xxxOverdraft xxxBuilding xxxFurniture xxxOffice Equipment xxxBooks xxxSports Goods xxxSports Equipment xxxInvestments xxxLoan Advanced xxxFixed Deposit xxxBalance c/f xxx Cash————— Bank—————(Balancing fig.—————) xxx

Balance b/f xxxCash ———-Bank———— xxx

Subscriptions2000————-2001————-2002————- xxx

Donations xxxLocker Room Rent xxxCloak Rent xxxHall Rent xxxSale of old news papers xxxand magazines xxxSale of refreshments xxxInterest received xxxLife membership xxxTournament Fund xxxSubscriptions xxxAdmission Fee xxxSpecific Donations xxxGrants xxxLoan Obtained xxxSale of Investments xxxSale of Fixed Assets xxx

ACCOUNTANCY360

8.3.2. Items of Receipt andPayment Account

These items may be classified as follows:

(i) Revenue Receipts(ii) Capital Receipts(iii) Revenue Payments, and(iv) Capital Payments.

These items have been discussed on thefollowing lines.

(i) Revenue Receipts: These are theamounts received on a recurringbusiness and include:

a) Annual membership subscriptions;b) Donations, grants and legacies

received regularly for generalpurposes;

c) Admission fees not capitalized;d) Locker rent and cloakroom rent from

members for the use of locker andcloakroom;

e) Hall rent received from outsiders forthe use of hall;

f) Receipts from sale of old newspapersand magazines;

g) Receipts from sale of refreshments,dinner coupons, tickets for dances andother social functions;

h) Interest received on investment, fixeddeposit and loans advanced;

i) Any other item of the similar nature.

(ii) Capital Receipts: These refer to thoseamounts received during the yearwhich will yield benefits to theorganization during the current yearas well as in the future years.Amounts of capital receipts are not

received at regular intervals.Following items are included in thecapital receipts-

a) Life membership subscriptions i.e.amounts received for the life timemembership of the organizations;

b) Admission fees to the extentcapitalized;

c) Donations from outsiders or membersfor specific purposes such asconstructions of building;

d) Legacies i.e. amounts given to theorganizations under a will on thedeath of the contributors for specificpurposes such as prizes andscholarships;

e) Grants received for meeting capitalexpenditure from the governmentsuch as construction of a publicdispensary;

f) Amount received as loan;g) Sale proceeds of fixed assets such as

investment, furniture, books etc.h) Amount received on account of any

other similar item.

iii) Revenue Payments: These are thepayments for amounts spent atregular intervals not resulting in theformations of fixed assets. Revenuepayments include the following-

(a) Payments for the salaries, wages andhonorarium;

(b) Payments made for rent, taxes,insurance premia, electricity charges,printing, postage and stationarycharges and repairs.

(c) Payments for travelling andconveyance


(d) Payments for purchase ofrefreshments, dinners;

(e) Payments for organizing sport meetsand tournaments;

(f) Interest paid on loans and on bankoverdraft and

(g) Payments for other items of similarnature.

iv) Capital Payments: These arepayments for those items whosebenefits are available to theorganization during the currentaccounting year as well as futureaccounting year also. Capitalpayments are not made at regularintervals. Following are included inthe capital payments-

(a) Payments for construction andextension of building, purchase offurniture and office equipment;

(b) Payments for purchase of books forthe library;

(c) Payments made for purchase of sportsgoods and equipment by a sportsclock;

(d) Cost investments purchased;(e) Amounts invested in banks as fixed

deposits;(f) Amounts advanced to outsiders as

loans and;(g) Any other payment of similar nature.

8.3.3. Uses of Receipt andPayment Account

On the basis of accounting system adoptedby an organization the Receipt andPayment account can be used in twoalternative ways.

i. Those organizations, which followcash basis of accounting, this accountplays a vital role. On the one hand, itserves the purpose of cashbook, whileon the other hand it provides supportin the preparation of financialstatements, income statement, andstatement of affairs to be presented tothe members at the year-end as aresult of the enterprise’s activities. Insuch a case, the surplus will be the diffe-rence of receipts and payments. Whenpayments will be more than receiptsthen it will be a situation of deficit.

ii. In organizations using accrual basisof accounting the Receipt andPayment account works as asummarized cashbook and is asupplement to the Income andExpenditure account and the BalanceSheet. These are the basic statementspresented to the members to showsurplus or deficit and the financialposition respectively.

Illustration 2

Membership subscription received byModern Cricket Club during the year 2001amounted to Rs 15,600, which includes Rs900 received in arrears for the year 2000and Rs 2,100 received in advance for 2002.It is found that Rs 2,500 has not beenreceived as subscription for the currentyear (2001) and that Rs 1,000 was receivedin advance in 2000 as subscription for 2001.Calculate the income from subscription forthe year 2001.

In the above illustration the totalsubscription of the current year have beenworked out by doing additions and

ACCOUNTANCY362

subtractions of the items of information tothe subscriptions received in cash during thecurrent year. The total amount ofsubscriptions due for the current year conalso be prepared by preparing subscriptionsaccount as has been illustrated in theillustrations given below:

Illustration 3

Rs.51.500 subscriptions were received by

Sita Tracking Club during the year 2001,which includes Rs 1,500 received in arrearsfor the year 2000 and Rs2,500 received inadvance for the year 2002. It is found thatRs3000 has not been received assubscriptions for the current year and thatRs 1,800 was received in advance in the2000 for the year 2001. Find out the incomefrom subscriptions for the year 2001 bypreparing a subscription account.

Solution: Rs

Amount collected for subscription in cash. 15,600Add subscriptions received in 2000 for 2001 1,000Add subscriptions received in 2001 not yet received 2,500

________18,100

Less subscriptions received in arrears for 2000 900Subscriptions received in advanced for 2002 1,200

2,100

Income from subscriptions to be transferred to Income andExpenditure Account 17000

Dr. Subscription Account Cr.

Date Particulars Amount Date Particulars AmountRs. Rs.

1 Balance b/f Cash-outstanding 1,500 subscriptionsubscription received 51,500received for 2000 AdvanceAdvance subscription 1,800subscription received in 2000(Income and balance c/fExpenditure 2,500 outstandingAccount) subscription of 3,000Subscription for current year)current year 52,300

56,300 56,300

Solution:


Illustration 4

With the help of the following information extracted from the books of Rajdhani Club,Calculate Sub-scriptions for the Current Year, 2001.Subscriptions received during the year Rs.1,50,000Additional Information

Year 2000 Year 2001

Rs. Rs.Outstanding Subscription 3,700 4,200Advance Subscriptions 3,900 5,000

Solution

Statement showing calculations of subscription of the current year 2001.Rs.

Subscriptions received in cash for 2001 1,50,000Add: Outstanding received in cash Rs.4,200

Advance Subscription received Rs.3,900 8,100In 2000 for 2001. 1,58,100

Less: Outstanding subscription of Rs.3,700the year 2000 received in 2001

Advance subscriptions received Rs.5,000 8,700in 2001 for 2002.

Subscription 2001 14,940

Dr. Subscription Account Cr.

Date Particulars Amount Date Particulars AmountRs. Rs.

Balance b/f 3,700 Pay Balance c/f 3,900(outstanding (advanceSubscription in subscriptionsthe beginning) in the beginning.)

Income & 1,49,400 Cash - Subscription 1,50,000Expenditure received.

Account By Balance c/f 4,200Subscription (outstandingfor current year. subscription

Balance c/f 5,000 in the end.)(advancesubscriptionin the end.)

1,58,100 1,58,100

Alternatively the problem can be solved by preparing a subscription account as shownbelow:

ACCOUNTANCY364

Illustration 5In 2001 the subscriptions received wereRs.2,10,000/-. These subscriptions includeRs.3,000/- for the year, 2000 and Rs4,000/- for the year, 2002. On 31.12.2001subscription due but not received were

Rs.5,000/. Pass necessary journal entriesto record the above transactions, preparesubscriptions account, subscriptionsoutstanding account and subscriptionreceived in advance account of RoyalGym.

Royal GymJournal


2001 Rs. Rs.

Dec. 31 Cash a/c Dr. 2,10,000 Subscription a/c 2,10,000(Subscriptions received during, 2001)

Dec. 31 Subscriptions a/c Dr. 3,000 Subscriptions Outstanding a/c 3,000(Amount of subscriptions relating to 2000transferred from subscriptions A/c tosubscription outstanding account)

Dec. 31 Subscriptions a/c Dr. 4,000 Subscriptions received in advance a/c 4,000(Advance subscriptions received in 2001 for2002 transferred to subscriptions received inadvance account)

Dec. 31 Subscription outstanding a/c Dr. 5,000 Subscriptions a/c 5,000(Amount of subscriptions still due for2001 but not yet received. Credited tosubscriptions account)

Dec. 31 Subscription a/c Dr. 2,08,000 Income & Expenditure a/c 2,08,000(Subscription for 2001 credited toSubscription a/c)

Dr. Subscriptions Account Cr.


March 31 Subscription 3,000Outstanding Dec. 31 Cash 2,10,000

2001 Outstanding 5,000March 31 Subscription 4,000 Dec. 31 Subscription

received in advance

Income & Expenditure 2,08,000

Dec. 31 2,15,000 2,15,000


Illustration 6From the following particulars relating to Golden Point Club, prepare a Receipts and Payments account forthe year ending 31st March 2002.

Sale of old sports materials 1,200Rs. Donation received for pavilion 4,600

Opening cash balance 1,000 Rent paid 3,000Opening bank balance 7,200 Sports materials purchased 4,800Subscriptions collected for: Purchase of refreshments 600

Expenses for maintenance of tennis:1999 Rs. 500 court 2,0002000 Rs. 7,600 Salary paid 2,5002001 Rs. 900 9,000 Tournament expenses 2,400

Furniture purchased 1,500Office expenses 1,200

Sale of refreshments 1,000 Closing cash in hand 400Entrance fees received 1,000

SolutionGolden Point Club,

Receipts and Payments AccountFor the year ending 31st March 2002

Dr. Cr.

Receipts Amount Payments AmountRs. Rs.

Balance b/f Rent 3,000Cash 1,000 Sports materials purchased 4,800Bank 7,200 Purchase of refreshments 600Subscriptions Maintenance expenses for tennis court1999 500 Salary 2,0002000 7,600 Tournament 2,5002001 900 9,000 Furniture purchased 1,500Sale of refreshments 1,000 Office expenses 1,200Entrance fees 1,000 Balance c/f:Sale of old sports 1,200 Cash 400materials Bank (balancing figure) 6,600Donation for 4,600

pavilion 25,000 25,000

Dr. Subscriptions Outstanding Account Cr.


Dec. 31 Balance b/f 3,000 Dec. 31 Cash 2,10,000

Subscription 5,000 OutstandingSubscription 5,000

2002 8,000 8,000Jan., 1 Balance c/f 5,000

ACCOUNTANCY366

8.4 The Income and ExpenditureAccount

The Income and Expenditure account is arevenue account of a Not-for-Profit entity,like a charitable or cultural society,educational institutions, hospitals, sportsclub etc. It is a type of income statementsimilar to profit and loss of other businessorganizations. The income andexpenditure account is prepared on thebasis of some principles, which areapplicable in the preparation of profit andloss account. Fund based expenses arefirst matched against the income arising/accrued from the same fund. Fund basedexpenses cannot be in excess of the incomeaccrued from the fund however a transfermay be made from general fund to thespecific fund to set off the deficit.

Any surplus arising on the income ofa firm has to either accumulate in the funditself or is to be disposed off as for thespecific provisions. Items of revenuenature alone are dealt with in this accountbut they are not confined to actual cashtransacted during the accounting period.Gains whether received or accrued arecredited and expenses and loses whetherpaid or incurred are debited to the Incomeand Expenditure Account. Any advancereceipt of income on payment or expenseis duly adjusted. After due adjustment ofaccruals, prepayments, provisions,depreciation etc, the final balance of theaccount represent an excess of income overexpenditure which is called surplus.When the expenditure is in excess over theincome then the balance is called deficit.[Incomes- Expenditures = Surplus],[Expenditures-Income = Deficit]. It must

be kept in mind that in the context ofincome and Expenditure account the term‘ expenditure’ is used interchangeably butin the same sense the word ‘expense’.

8.4.1 Preparation of Income andExpenditure Account

Following steps are involved in thepreparation of the Income andExpenditure Account:

(i) It is generally prepared in ‘T’ formwith revenue expenditure on the debitside (left hand side) and revenueincome on the credit side (right handside). It follows the rules given below:

Debit Expenditure || Credit Income

(ii) This account can also be prepared ina vertical form where in incomes arefirst shown and added up. There after,the expenditures are presented andadded up. From the totals of theincome s the totals of expenditure arededucted to ascertain surplus ordeficit.

(iii) The Income and Expenditure accountdoes not start with any openingbalance, because it is prepared toascertain only the current year’ssurplus or deficit. The previous year’ssurplus or deficit is therefore , notrelevant.

(iv) This account shows only the revenueitems and hence the capital items arenot recorded. For example buildingowned by a sport club should not betaken into consideration.

(v) In this account only the expenses andincomes of the particular current


accounting year are shown. Hence,the revenue receipt and paymentpertaining to the pervious year(s) andfuture year(s) should be suitably or allto be adjusted. Similarly, outstandingexpenses and accrual incomespertaining to the previous accountingyear of which the income andexpenditure account is beingprepared must be included in the totalof the expenses and incomes.

(vi) The closing balance of this accountshows surplus i.e. excess of revenueincome and revenue expenses. Thesurplus is added to and the deficit isdeducted from the ‘Not-for-Profit’organization’s ‘capital fund ‘.

8.4.2 Items of Income andExpenditure Account

The above discussion makes it clear that theIncome and Expenditure account includesonly the revenue items of the particularaccounting year for which it is prepared.Some of the important items, which arerelevant to this account, have been discussedin the following lines:

Revenue Expenditure: It generally refersto the revenue expenses paid and due fora particular year and non-cash losses. Itcan be shown as follows in the form of anequation.

Revenue Expenditure = RevenuePayments made during the year +(outstanding revenue payments of theyear + prepaid revenue payments of theyear at the beginning of the year) -(outstanding revenue payments in thebeginning of the year + prepaid revenuepayments at the end of the year)Revenue Income: It refers to the revenuereceipts accruing during a particular year.Therefore;

Revenue Income = Revenue Receiptduring the year + (accrued revenue receiptat the end of the year + revenue receiptsreceived in advance at the beginning of theyear) - (accrued revenue receipts in thebeginning of the year + revenue receiptsreceived in advance at the end of the year)+ gain on sale of fixed assets.

The format of Income and expenditureaccount is given below:

Subscription

Total received in current year

Add outstanding at the end

Less outstanding in the beginning

Add advance receipt in the previous year

Less advanced received in current year

Total subscription of current year

Gain on sale of assets

Sale price of assets

Expenses

Total paid in current year

Add outstanding at the end

Less outstanding in the beginning

Add Advance paid in previous year

Less Advance paid in current year

Current year’s expenditure

Purchase of consumable stores:

Opening stock of the item

Add payment /or credits for the items

Income and Expenditure Account of (Name of the Not-for-Profit organizations)for the year ended (date)

......... .........

ACCOUNTANCY368

Less closing stock of the itemLess creditors for the items in the beginningAdd creditors for the items at the endAdd advance payments in the previous yearLess advance payment in the current yearValue of items actually usedExpenses out of special collectionsExpenses paidLess collectionNet ExpensesLoss on sale of assetsBook of value of assets soldLess sale priceNet lossOther expenses and loses with adjustmentDepreciationExcess of income over expenditure carried overto balance sheet-surplus

Less book value of assets sold

Net gain on sale of assetsReceipt for special expensesAmount receivedLess expenses paidNet incomeOther incomes and gains with adjustmentExcess of expenditure over income carried overto balance sheet -deficit

Note: There shall be one of these items at a timenot both.

Note: There shall be one of these items at a time not both.

Difference between Receipt and Payment Account and Income and Expenditure Account

S.No Basis Receipt and Payment Income and ExpenditureAccount Account

1. Assets v/sRevenue

2. Openingbalance

3. Capital v/sRevenue

4. Cash v/sNon-cash

5 Cashbalance v/sSurplus/deficit

It is a summary of the cash transactionsof a not-for-profit organization showingcash inflows (Receipt) on the debit sideand cash out flows (Payments) a thecredit side as in case of a cash book.

It starts with an opening balance of cashin hand and cash at bank.

Capital receipt and payment in cash areincluded in this account.Revenue receipts and payments in cashare also included in this account.

Non-cash expenses such as depreciationon fixed assets; bad debts, provisions etc.are not included in this account.

The closing balance of this accountrepresent the closing cash in hand andat bank or bank overdraft.

It is the revenue account of a not -for -profitorganization similar to profit and loss accountof a profit seeking organization. Incomes areshown on the credit side and expenditure onthe debit side.

It does not start with any balance.

Capital receipts and payments are excludedfrom this account only.Revenue receipts and payments in cashconcerning the current year are also shown inthis account and hence capital receipt isexcluded.

Non-cash expenses relating to the currentaccounting year are also included in thisaccount.

The closing balance of this account excess ofincome over expenditure i.e. surplus. Whenexpenditure is more than income the differenceis called deficit.

.........

.........

.........

.........

.........

.........

..................

.........


8.4.3 Difference between Incomeand Expenditure Accountand Profit and Loss Account

Though Income and Expenditure Accountand Profit and Loss Account are seems to

be similar still they differentiate on thefollowing grounds:

● Type of organizations● End results● Sharing surplus and profit

S.No. Income and Expenditure Account Profit and Loss Account

1. It is presented to ascertain the amount ofsurplus or deficit as a result of the not-for- profit entity’s activities.

2. The surplus always increases the capitalfund of the entity and can be used forfurther enhancing the objectives of theorganization. It can never be distributedamong the members in any form.

It is prepared to ascertain the net profit earnedwhich will be paid out to the proprietors, partners,or shareholders, as the case may be, or retained inthe business.

The net profit obtained belongs to the owner(s) whomay withdrawn it or retain in the business.

Rs.Prepaid expenses on 31.12.2000 1,500Expenses Outstanding on 31.12.2000 2,300Expenses Outstanding on 31.12.2001 2,500Prepaid Expenses on 31.12.2001 1,400

Ascertain the amount of expenses, which will be debited to the income and expenditureaccount for the year, 2001.

Solution

Rupees Rupees

Amount of expenses actually paid. 12,650

Add: Expenses of 2001 paid in advanceIn 2000. 1,500Expenses Outstanding on 31.12.2001 2,500 4,000

Less: Expenses of 2000 paid in 2000. 2,300Expenses paid in advance in 2001 1,400 3,700Expenses of 2001 to be debited to Income &Expenditure Account.

12,950

Illustration 7Miscellaneous expenses actually paidduring the year, 2001 amounted to

Rs.12,650.00. Information about prepaidand outstanding expenses is as under:

ACCOUNTANCY370

Illustration 8From the following particulars of Faridabad Sports Club, prepare the Income and Expenditure account forthe year ending 31 March 2002

Subscriptions collected (including Rs. 2,000 for 2001 and Rs. 1,5000 for 2003) 30,000Subscriptions due but not received in 2002 3,000Salary paid (including Rs. 300 for 2001 4,500Salary outstanding for 2002 400Donations received 1,000Entrance fees (of which 40 percent is to be treated as capital receipt) 2,000Entertainment expense 600Tournament expense 1,500Rent 1,800Printing, postage and stationary 1,200Purchase of sports equipment 5,000

SolutionFaridabad Sports Club

Income and Expenditure AccountFor the year ended 31 March 2002

Dr. Cr.

Expenditure Amount (Rs.) Income Amount (Rs.)

Salary 4,600 Subscription 29,500Entertainment expenses 600 Donation 1,000Rent 1,500 Entrance fees 1,200Tournament expenses 1,800Printing postage and stationery 1,200Excess of income over expendituretransferred to Capital Fund 22,000

31,700 31,700

Notes(1) The income from subscriptions for 2002 is as follows: Rs

Subscriptions received in cash 30,000Add: Subscriptions due for 2002 but not received during the year 3,000

33,000Less: Subscriptions received in arrears for 2001 2,000

Subscriptions received in advance for 2002 1,500 3,500

29,500

(2) Donation received is not for any special purpose and is thus treated as a revenue item.

(3) Since it is the policy of the Club to treat 40 per cent of entrance fees received duringthe year as a capital receipt, the remaining 60 per cent is a revenue receipt.

(4) Expenses for salary during 2002 is ascertained below: Rs.Salary paid in cash during 2002 4,500Add: Salary outstanding for the year 400

4,900Less: Salary paid for 2001 300

4,600


Nagi’s ClubReceipts and Payments Account

for the year ending 31.3.2002Dr. Cr.


Balance c/d – Bank 25,000

Subscriptions2001 1,5002002 10,0002003 500 12,000

Donations 2,000Hall rent 300Interest on bank 450depositsEntrance fees 1,000

40,750

Purchase of furniture (1.4.88) 5,000Salaries 2,000Telephone expenses 300Electricity charges 600Postage and Stationery 150Purchase of books 2,500Entertainment expenses 900Purchase of 5% Government 8,000papers (1.7.88)Miscellaneous expenses 600Balance c/d 300Cash 20,400Bank

40,750

The following additional information is available:

(i) salaries outstanding – Rs 1500;(ii) entertainment expenses outstanding – Rs 500;(iii) bank interest receivable – Rs 150;(iv) subscriptions accrued – Rs 400;(v) 50 per cent of entrance fees is to be capitalised;(vi) furniture is to be depreciated at 10 per cent per annum.

Nagi’s ClubIncome and Expenditure Account

for the year ending 31.3.2002Dr. Cr.


Salaries paid 2,000Add: Outstanding 1,500 3,500 Subscriptions 10,400Telephone expenses 300 Donation 2,000

Entrance Fees (50% of 500Electricity charges 600 Rs.1,000)Postage and stationery 150 Bank interest 600Entertainment expenses 1,400 Interest on investment 200Miscellaneous expenses 600 Hall rent 300Depreciation on furniture 375Excess of Income over 7,075Expenditure transferred tothe Capital Fund

14,000 14,000

Illustration 9From the undermentioned Receipts andPayments Account for the year ending 31st

March 2002 of Nagi’s Club, prepare anIncome and Expenditure Account for thesame period:

ACCOUNTANCY372

Rs.Notes(1) Income from subscriptions for 2002

Subscriptions received for 2002 10,000Add: Accrued Outstanding subscriptions 400

10,400(2) Donations are not for any specific purpose and are,

therefore, treated as revenue income

(3) Income from bank interest for 2002Bank interest received 450Add: Interest receivable 150

600(4) Interest receivable from investments for 2002

5 6–––– × 8000 × –––– = Rs. 200 200100 12

(5) Entertainment expenses for 2002:Entertainment expenses paid 900Add: Outstanding amount 500

1400(6) Depreciation on furniture for 2002

10 9–––– × 5000 × –––– = Rs. 375 375100 12

8.5 Balance Sheet for Not-for-Profit Organization

The proforma Balance Sheet of a Not-for-Profit organization is given below:

Balance Sheet of (Name) of Not-for-Profit Organisation as at (Date on which it is prepared)

Liabilities Amount Assets Amount

AssetsLast balance b/fAdd purchase in current yearLess book value of assets soldLess depreciationClosing balance –––––––Stock of consumable itemsClosing stock as given orLast balance b/fAdd purchases in current yearLess value actually consume incurrent year. Closing balance –––––––Cash/bank saving A/c

Capital FundLast balance b/fAdd capitalized incomesof current yeara) General Donationsb) Entrance feec) Legaciesd) Life membership fee etc.Special Fund Donation –––––––Last balance b/fAdd a) receipts for theitems during the current yearsb) income arising from fund.Less expenses out of fund/


Illustration 10Good luck sports club has 2000 members. Theannual subscriptions per member is Rs.50/-during the year, 2001 only 1900 members paidthe subscriptions for the current year. On1.1.2001, the subscriptions in arrears were from50 members out of which 30members cleared

SolutionGood Luck Sports Club,

Balance Sheet (Memorandum)of as on 31.12.2000.


Advance 1,250 Outstanding 2,500subscriptions subscriptions

Illustration 11The receipt and payment account of RoyalGym shows a payment of Rs.25,000/-towards salary for the year, 2001 ended31.3.2001. In the records of the Royal Gymindicate the following details:

31.3.2000 31.3.2001

Rs. Rs.Outstanding Salary 3,000 2,700Prepaid Salary 4,000 1,500

donationCreditors for purchase –––––––Bank overdraftOutstanding expensesLast balance b/fLess paid in current yearAdd o/s for current year –––––––Income received in advanceIncome and Expenditure A/cLast balance (Cr) b/fAdd surplusLess deficit if any –––––––

Fixed deposit accountAccrued incomes –––––––Last balance b/fLess received in current yearAdd accrued for current yearPrepaid expenses –––––––

their arrears. 25 members paid the subscrip-tions in advance in the year 2000 and30members paid the subscriptions in advanceduring the year, 2001. Show how thesubscriptions outstanding will be shown in thebalance sheet as on 31.12.2000 and 31.12.2001respectively.

Good Luck Sports Club,Memorandum Balance Sheet

of as on 31.12.2000.


Advance 1,500 Outstandingsubscriptions subscriptions

Year, 2000 :1,000Year,2001:3,750 4,750

Pass the necessary adjustment journalentries and find out the amount ofsalary which will be debited to theincome and expenditure account ended31.3.2001, also indicate on which sideof the balance sheets as on 31.3.2000and 31.3.2001 respectively these itemwill appear.

ACCOUNTANCY374

Royal GymJournal


2001 Rs. Rs.

March 31 Salary a/c Dr. 25,000 Cash a/c 25,000(salary paid during the year ended 31.3.2001)

March 31 Outstanding salary a/c Dr. 3,000 Salary a/c 3,000(salary for the year ended 31.3.2000paid during the current year)

March 31 Salary a/c Dr. 2,700 Outstanding Salary a/c 2,700(outstanding salary for the current year ended31.3.2001 recorded)

March 31 Salary a/c Dr. 4,000 Prepaid salary a/c 4,000(salary paid in advance during the year ended31.3.2000 transferred to salary account)

March 31 Prepaid salary a/c Dr. 1,500 Salary a/c 1,500(advance salary paid during theyear ended 31.3.2001)

March 31 Income and Expenditure a/c Dr. 27,200 Salary a/c 27,200(Total salary for the current year ended31.3.2001 transferred to Income andExpenditure account)

Dr. Salary Account Cr.

Date Particulars Amount Date Particulars Amount2001 Rs. Rs.

March 31 Cash 25,000 2001 Salary 3,000March 31 outstanding

March 31 Prepaid Salary 4,000 March 31 Prepaid Salary 1,500

March 31 Outstanding 2,700 Income andsalary Expenditure A/c 27,200

31,700 31,700


Salaries outstanding are liabilitiesand prepaid salaries are assets,therefore, outstanding salary Rs 3000as on 31.3.2000 will be shown on theliabilities side of the balance sheet ason 31.3.2000 and the outstanding salaryof Rs 2,700 as on 31.3.2001 will beshown on the liabilities side of the

balance sheet as on 31.3.2001. Prepaidsalary 4,000 for the year-ended31.3.2000 will be shown. On the assetside of the balance sheet as on 31.3.2000and the prepaid salary Rs 1,500 for theyear ended 31.3.2001 will be shown onthe asset side of the balance sheet ason 31.3.2001.

Dr. Outstanding Salary Account Cr.


March 31 Salary 3,000 March 31 Balance b/f 3,000

March 31 Balance c/f 2,700 March 31 Salary 2,700

5,700 5,700

Balance b/f 2,700

Dr. Prepaid Salary Account Cr.


March 31 Balance b/f 4,000 March 31 Salary 4,000

March 31 Salary 1,500 Balance c/f 1,500

5,500 5,500

April 1 Balance b/f 1,500

TERMS INTRODUCED IN THIS CHAPTER

● Entity● Non-profit seeking entity● Receipt and Payment Account● Income and Expenditure Account● Surplus● Deficit● Entrance Fees

● Subscriptions

● Donations and Legacies

● Subscription in arrears or accruedsubscription

● Subscription paid in advance

● Accumulated/Capital/General Fund

● Special Funds

ACCOUNTANCY376

SUMMARY WITH REFERENCE TOLEARNING OBJECTIVES

1. Not-for-Profit Organization is an entity to carry on activities of social and welfarenature and whose primary purpose is not profit-making.

2. Fund Accounting is a system of accounting that combines fiscal and accounting entity.

3. Appropriation is the process of authorizing the future payments from budgeted income.

4. Budget is the estimate of future income and expenditures and spells out fiscal andaccounting entities for controlling and reporting purposes.

5. Accounting entity is the budget head of expenditure and income.

6. General/Unrestricted Fund is the revenue income pooled in a fund from various sourcessuch as membership fees, gifts, contributions, grants, interest and dividend which canbe used for any activity.

7. Current Restricted Fund is grant, gift, contribution, donation, received to carry onspecific activities as specified in the agreement by the donor.

8. Endowment Fund is the contributions that require the entity to invest and maintainprincipal in perpetuity and only interest income to be used.

9. Plant/Assets Fund is created out of specific grants or general funds for acquisition ofassets such as land, building, machinery, furniture etc.

10. Debt Fund is meant for raising loan/debt/borrowings of long term nature.

11. Difference between profit–seeking and Not-for-profit seeking entities.

Profit-seeking entities undertake activities such as manufacturing, trading, bankingand insurance to bring financial gain to the owners.

Not-for-profit-seeking entities exist to provide services to the members or to the societyat large. Such entities might sometimes carry on trading activities but the profitsarising there from are used to further the service objectives.

12. Appreciation of the need for separate accounting treatment for non-profit organizations.

Since Not-for-profit-seeking entities are guided primarily by a service motive, thedecisions made by their managers are different from those made by their counterpartsin profit-seeking entities. Differences in the nature of decisions implies that thefinancial information on which they are based, must also be different in content andpresentation.

13. Explanation of the nature of the principal financial statements prepared by Not-for-profit organizations.

Not-for-profit organizations that maintain accounts based on the double-entry systemof accounting, generally prepare three principal statements to fulfill their informationneeds. These include Receipts and Payments Account, and Income and ExpenditureAccount and a Balance Sheet.

The Receipts and Payments Accounts is a summarized cashbook, which records allcash receipts and cash payments without distinguishing between capital and revenue

1


items, and between items relating to the current year and those relating to previousor future years.

The Income and Expenditure Account is an income statement which is prepared toascertain the excess of revenue income over revenue expenditure or vice versa, for aparticular accounting year, as a result of the entity’s overall activities. Although it isconsidered to be a substitute for the Profit and Loss Account of a profit-seeking entity,there are certain conceptual differences between the two statements, which have beendiscussed at length in the chapter.

The Balance Sheet is prepared at the end of the entity’s accounting year to depict thefinancial position on that date. It includes the Capital fund or Accumulated Fund,special purpose funds, and current liabilities on the left had or liabilities side, andfixed assets and current assets on the right hand or assets side.

14. Difference between the Receipts and Payments Account and the Income andExpenditure Account

Many differences exist between the Receipts and Payments Account and the Incomeand Expenditure Account, which are evident from the nature and purpose of twostatements.

While the former records both capital and revenue receipts and payments relating toany accounting year, the latter records only revenue items relating to the currentaccounting year. Non-cash expenses such as depreciation on fixed assets andoutstanding incomes and expenses are shown in the latter but omitted in the former.The Receipts and Payments Account has an opening balance while the Income andExpenditure Account does not. The closing balance of the former account representscash and bank balances on the closing date while in the latter account it indicatessurplus or deficit from the activities of the enterprise.

15. Conversion of a Receipts and Payments Account into an Income and ExpenditureAccount.

This essentially involves five steps namely (i) adjusting the revenue receipts on thedebit side to include outstanding incomes and incomes relating to the currentyear received earlier and to exclude amounts received in arrears or in advance; (ii)adjusting revenue payments on the credit side; (iii) identifying and showing non-cash expenses and losses on the debit side of the Income and Expenditure Account(iv) computing and showing profits/losses from trading and/or social activities onthe credit/debit side of the Income and Expenditure Account; and (v) ascertainingthe surplus or deficit as the closing balance of the Income and ExpenditureAccount.

16. Government Accounts for Not-for-Profit entities are maintained as per the accountingrules in force from time-to-time by Government of India. All accounts are maintainedin Consolidated Fund of India which has Revenue and Capital sub-sections both forreceipts and expenditures. Part II of the Account relates to Contingency Fund andPart III Public Account for Loans, Advances, borrowings and Public Debt. Allaccounting heads are classified into Major, Sub-major, Minor, Sub-minor,Detailed Head and Objects. All accounts are codified by following a four-digit codingsystem.

ACCOUNTANCY378

EXERCISES

Objective type Questions

1. Fill in the blanks:

a. Fund Accounting is used by ___________________organizations.

b. Restricted Fund can be used for _____________________purpose only.

c. Endowment Fund is ______________________ fund.

d. General fund can be transferred to ___________________fund.

e. Appropriation is a budgetary head with a ________________ balance.

f. When expenditures are paid out of Current Restricted Fund, cash/bankis credited and _____________ is debited.

g. When cash is transferred, General Fund is debited, and ______is credited.

h. When endowment fund is used for specific purpose, the expense is

charged to _________ account.

i. A Receipts and Payments Account makes no distinction between

____________ and ____________ receipts and payments account.

j. The closing balance of the Receipts and Payments Account represents____________.

k. Expenditure is shown on the __________ side of the Income and ExpenditureAccount.

l. Amount received in respect of _________ or ___________ subscriptions shouldbe eliminated while preparing the Income and Expenditure Account.m._____________ represents the excess of assets over liabilities.

2. Multiple choice questions:

(a) Not-for-Profit Organization is

(i) Profit seeking in nature.

(ii) Not profit seeking but can earn surplus.

(iii) Earning money.

(iv) None of the above.

(b) Fixed Assets Fund is

(i) Endowment Fund.

(ii) Current Restricted Fund.

(iii) Current Unrestricted Fund.

(iv) Meant for accounting of assets and depreciation.


(c) Loan fund is for

(i) Paying the loan.

(ii) Raising the loan.

(iii) Payment of interest.

(iv) Loan transactions

3. Select one from the possible alternatives to make the following statements correct:

(i) Subscription received in advance during the accounting year is

(a) an income

(b) an expense;

(c) An asset;

(d) A liability.

(ii) Income and Expenditure Account shows a balance of:

(a) Cash in hand;

(b) Capital account;

(c) Net profit;

(d) Excess of revenue over expenditure or vice versa.

(iii) Donations received for special purposes should be:

(a) Credited to a separate fund account and shown in the Balance Sheet

(b) Treated as revenue;

(c) Treated as revenue unless the amount is large;

(d) Not recorded at all.

(iv) Subscription in arrears for the current year are shown:

(a) On the credit side of the income and expenditure account and the assetsside of a Balance Sheet;

(b) Debit side of the Profit and Loss Account and the liabilities side of a BalanceSheet;

(c) Only on the assets side of a Balance Sheet.

(v) The Receipts and Payments Account generally shows:

(a) A credit balance;

(b) Cash/Bank balance;

(c) Capital fund or accumulated fund;

(d) Surplus or deficit.

ACCOUNTANCY380

4. State whether the following statements are true or false, giving reasons.

(a) A public library is a not-for-profit seeking accounting entity;

(b) A not-for-profit organization never undertakes trading activities;

(c) Outstanding expenses need not be adjusted, its accounts are kept on accrual basis;

(d) Entrance fee to a club is shown as a payment;

(e) Only capital expenses are shown in the Receipts and Payments Account.

(f) Donations received for construction of an auditorium by a club is to becredited to a separated building fund account.

5. Choose the correct answer from the alternatives given below:

(a) Second hand furniture worth Rs. 5,000 was purchased. It was repaired for Rs. 500and installed by to whom Rs. 100 was paid as wages. Thefurniture should be capitalized for:

(i) Rs. 5,000

(ii) Rs. 5,500

(iii Rs. 5,600

(b) Subscription received in cash during the year amounted to Rs. 4,000; the amountreceived in advance for the next year is Rs. 300; the amount outstanding for the currentyear is Rs. 200 and the amount received last year for the current year was Rs. 400. Theamount to the credited to the Income and Expenditure Account is:

(i) Rs. 4,000

(ii) Rs. 4,300

(iii) Rs. 4,200

(iv) Rs. 4,600

(c) At the beginning of the accounting year, a club has Rs. 18,000 assets; Rs. 5,000 liabilities;Rs. 1,800 debit balance of the Income and Expenditure Account. The opening CapitalFund is:

(i) Rs. 18,000

(ii) Rs. 11,200

(iii) Rs. 14,800

(iv) Rs. 24,800

(d) The opening balance of the Prize Fund of a sports club was Rs. 5,400. Further donationstowards this fund received during the accounting year amounted to Rs. 4,800. Duringthe year, Rs. 3,500 was spent on prizes and Rs. 400 was received as interest oninvestment of the Prize Fund. The closing balance of the Prize Fund is:

(i) Rs. 1,900

(ii) Rs. 10,200


(iii) Rs. 10,600

(iv) Rs. 7,100

(e) Salaries payable for the current year amount to Rs. 7,500 at the end of the year,outstanding salaries amount to Rs. 300. Salaries paid in advance last year pertainingto the current year amounted Rs. 500. Prepaid salaries for the next year amount to Rs.250. Total amount paid for salaries during the year is:

(i) Rs. 7,550

(ii) Rs. 7,500

(iii) Rs. 6,950

(iv) Rs. 6,550


6. What is Fund Accounting?

7. What is Consolidated Fund of India?

8. Explain Endowment Fund.

9. What are encumbrances?

10. Define Public Fund Account.

11. Explain inter-fund transfer.

Long Answer Questions

12. What is an accounting entity? How are such entities classified?

13. The Receipts and Payments Account is a summarized cashbook explains

14. the statement.

15. The Income and Expenditure Account is another name for the Profit and

16. Loss Account. Do you agree with this statement? Given reasons.

17. Discuss the structure and codification of Accounts of Government of

18. India?

19. Enumerate the points of difference between Receipts and Payments

20. Account and an Income and Expenditure Account.

21. (a) What steps would you take to convert a Receipts and Payments

Account into an Income and Expenditure Account?

(b) List the steps to be followed to transform an Income and ExpenditureAccount into a Receipts and Payments Account.

ACCOUNTANCY382

18. Explain the accounting treatment of the following items:

(a) Life membership subscription(b) Entrance fees

(c) Purchase of sports goods by a sports club(d) Donations received for the construction of a building by a public library

(e) Annual subscriptions received in arrears.

19. Explain briefly the following

(a) Not-profit seeking entity.

(b) Accumulated or capital fund

(c) Membership subscriptions.

20. What is Fund Accounting? What are the objectives of Fund Accounting?21. Explain different type of funds used in Fund Accounting.22. Explain the rationale of Fund Accounting and state the Accounting treatment of

different type of funds.

Problems23. Record the following transactions in the books of Jindal Public School.

Particulars Rs.

Grant received from Government 30,00,000

Fee collected from students 10,00,000

Building Fund raised 30,00,000

Salaries and allowances paid from General Fund 30,00,000Student Welfare Activities 10,000

Gold Medals and Prizes Fund 5,00,000

Interest received on Gold Medal Fund 25,000

Expenditure on Medals and Prizes 20,000

You are required to prepare the appropriate fund accounts and show them in theBalance Sheet.

24. From the under mentioned particulars relating to Life-Line Clinic, prepare thesubscriptions account for the year ending 31st march 2002.

(a) There are 200 members and the subscription payable is Rs 50 each p.a.(b) Subscription received during the year 20002 is as follows:

For 2001 Rs. 300For 2002 Rs. 9,300

For 2003 Rs. 400(c) Subscriptions outstanding at the end of

2001 Rs. 400

2002 Rs. 500


Salaries and wages 1,350Printing and stationary 320Purchase of sports 1,610equipmentPurchase of refreshments 1,350Rent of grounds 1,200Other expenses 200Balance c/f 1,170

7,300

Receipt and Payment Account for the year ending 31.3.2002

Dr. Cr.


Balance b/f 340Entrance fees 1,000Subscriptions 5,450Sale of Refreshments 1,410

7,3000

(d) Subscription received in advance for 2002 in 2001 was Rs. 300

25. The following particulars of Hygiene Club have been provided and you are requiredto prepare:

(a) Salaries and Wages Account(b) Locker Rent Account

Salaries and Wages payable during the year 2002 amounted to Rs. 9,000. Salariesoutstanding on 1.1.2002 were Rs. 300 and that on 31.12.2002 was Rs. 550. Rs. 600 waspaid in 2002 as advance wages for 2003.

Locker Rent received during the year amounted to Rs. 3,200. Rent outstanding on1.1.2002 was Rs. 160 and that on 31.3.2002 was Rs. 230.

26. The Receipts and Payments Account of Aurobindo Sport Club is given below:

The following additional information has been provided.

(a) The stock of stationary on 1.1.2002 was Rs. 25 and at the end of the year it was Rs. 45.

(b) Outstanding subscription on 31.12.2002 was Rs. 230

Outstanding subscription on 1.1.2002 was Rs. 250Subscription paid in advance in 2001 for 2002 was Rs. 180

(c) The depreciation charge on sports equipment for the year was Rs. 200. You are requiredto prepare an Income and Expenditure Account for the year ending 31.12.2002.

27. From the following Receipt and Payment Account and additional information relatingto Khalid Social Club, prepare the Income and Expenditure Account for the year ending31.3.2002 and a Balance Sheet as on the date.(a) On 1.4.2001 the club owned sports equipment worth Rs. 1,200.

subscription in arrears on that date was Rs. 350.(b) Sports equipment is depreciated @ 10% p.a. on the reducing balance

basis.(c) On 31.3.2002 locker rent in arrears was Rs. 50, outstanding rent was

Rs. 120 and Rs. 250 was due for subscriptions.

ACCOUNTANCY384

28. From the following Income and Expenditure Account and Balance Sheet of ClaytonTennis Club, Prepare a Receipts and Payments Account for the year ending 31.12.2002.

Khalid Social ClubReceipt and Payment Account for the year ending 31.3.2002

Dr. Cr.


Balance b/f 1,650 Wages 450Entrance fees 1,300 Printting, postage and stationery 240Subscriptions for: Charity show expenses 1,0002000-2001 300 Investment in 10% Government 4,0002001-2002 2,500 secyrutues (1.7.2002)2002-2003 200 3,000 Electricity 370Locker Rent 150 Periodicals & Newpapeers 240Interest on investment 200 Sports Expenses 660Charity show receipts 1,400 Rent 600Sale of old newspapers 160 Blance c/f 300and periodicals

7,860 7,860

Clayton Tennis ClubIncome and Expenditure Account for the year ending 31.12.2002

Expenditure Amount Income AmountRs. Rs.

Remuneration to coach 12,000 Subscription 1,00,000Salaries & Wages 24,000 Surplus from cafeteriaRent 18,000 Receipts 20,000Secretary’s honorarium 15,000 Expenses 16,000 4,000Depreciation on sport equipment 6,000 Bank interest 2,000Miscellaneous expenses Repairs 9,000 Club hall rent 14,000Surplus 11,000

25,000

1,20,000 1,20,000

Clayton Tennis ClubBalance Sheet as at ———-

2001 Liabilities 2002 2001 Assets 2002

Capital fund 44,000 27,000 Sports 21,000Add: Surplus 25,000 EquipmentEntrance fees 10,000 6,000 Outstanding 10,000

44,000 79,000 subscription 3,000 Subscription in advance 2,000 Accrued rent 4,000 2,000 Outstanding liabilities for 3,000 10,000 Fixed deposit 40,000

Salaries 3,000 3,500 Cash at bank 5,750Repairs 5,000 Cash in hand 7.500

2,500 Rent 1,250

51,500 88,250 51,500 88,250


29. The following information relates to Himalayan Maintaining Club

Income and Expenditure Account for the year ending 31.3.2002

Expenditure Amount Income AmountRs. Rs.

Salaries & wages 12,000 Admission fees 15,000Remuneration to trainers 15,600 Subscriptions 30,000General office expenses 16,400 Rent receivable 4,800Printing and stationary 3,200 Hire charges of equipment 3,300Deprecation on: Surplus from annual dinner:Building 1,500 Sale of tickets 7,200Furniture 500 Less expenses 5,900 1,300Equipment 4,000 6,000Surplus 1,200

54,400 54,400

Receipt and Payment Account for the year ended 31.3.2002


Balance b/f 6,000 Salaries and wages (including 11,600Admission fees for: Rs. 600 for 2001-2002)2001-2002 4,0002002-2003 12,600 16,600 Remuneration to trainers 15,000

Purchase of equipment 16,000Subscription for: Printing and stationary 3,2002001-2002 3,600 General officer expenses 15,7002002-2003 27,400 (including prepaid insurance2003-2003 1,800 32,800 Rs. 200 and electric bill forRent 4,400 2000-2001 Rs. 300)Hire charges of equipment 3,000 Annual dinner 5,900Sale of annual dinner tickets 7,200 Balance c/f 2,600

70,000 70,000

30. From the following Trial Balance for the year ended 31.3.2002, and other relevantinformation of Apeejay School, prepare Income and Expenditure Account and theBalance Sheet.

Debit Amount Credit AmountRs. Rs.

School furniture 16,000 Creditor for supplies 4,000Science laboratory 40,000 School fees 1,50,000School library 50,000 Entrance fees 3,000School building 2,00,000 Hall rent 5,000Securities 1,00,000 Miscellaneous Receipts 1,500

ACCOUNTANCY386

31. The governing board of Soclean Foundation decides to raise funds to build anendowment. The governing board of Soclean solicits gifts/contributions. The terms ofgifts specify that gifts will be invested and the return from the investment will be usedfor tree plantation in the city. The foundations furnishes to you the followinginformation:

ParticularsRs.Tree-guards received 2,00,000Contributions 3,00,000Opening balance of Endowment Fund 4,00,000Investment in Government Securities 4,00,000Interest received during the year 40,000Tree saplings purchased 10,000Wages and salaries 15,000Watering charges 2,000Gifts made to other Voluntary Organisations 1,000Value of investment at the end of the year 7,00,000

From the information given above prepare a Statement of Changes in EndowmentFund of Soclean Foundation as it would be shown in the financial statements for theyear ended on 31st March, 2002.

ANSWERS

1. Objective Type Questions(a) not-for-profit(b) Specific(c) Journal

Staff salaries 1,60,000 Grant received 30,000Office stationary 10,000 General Fund 3,60,000General school expenses 6,000 Donation Received for 40,000Annual function expenses 2,000 computeCash in hand 500 Sale of old school furniture 7,000Cash at bank 16,000

6,00,500 6,00,500

Additional Information:Fees still receivable Rs. 6,000Salaries still payable Rs.14,000On 1 Oct 2001 not yet recordedFurniture sold carries a book value of Rs.10,000Depreciation charged:School furniture 10% p.a.Science laboratory 20% p.a.School library 10% p.a.


(d) Any other(e) Debit(f) Restricted Fund(g) Endowment Fund(h) Cash(i) Endowment Fund(j) Cash/Bank Balance(k) Debit(l) Outstanding/Prepaid(m) Capital Fund/Equity Fund/Corpus Fund

2.(a) (ii)(b) (iv)(c) (iv)

3.(i) a(ii) d(iii) a(iv) a(v) b

4.(a) True, because it exists to serve the needs of the reading public.(b) False, a not-profit organization may undertake trading activities to further its

service objectives(c) False, outstanding expenses relate to the current accounting year and must be

added to the cash expenses.(d) False, entrance or admission fees represent amounts which members of not-for-

profit organizations are required to pay at the time of their admission. It is thusan item of receipt from the viewpoint of the organizations.

(e) False, both capital and revenue expenditures are shown in the Receipts andPayments Account if they are received in cash.

(f) True, as the donation is received for a special purpose and may be utilized for theconstruction of the auditorium only, it should be created to Building Fund Accountand not to the Income and Expenditure Account.

5.(a) (iii)(b) (ii)(c) (iii)(d) (iv)(e) (ii)

ACCOUNTANCY388

25. Subscriptions credited to the Income and Expenditure Account Rs. 10,000. closingbalance of subscription account Rs. 400 (Credit) and Rs. 500 (Debit)

26. (a) Salaries and Wages paid during the year- Rs. 9,410(b) Locker rent credited to the Income and Expenditure Account Rs. 3,270

27. Excess of income and expenditure Rs. 2,310 Total of Balance Sheet Rs. 5,830 (openingcapital fund Rs. 3,200; subscription for 2001-2002 Rs. 2,750; subscription outstandingon 31.3.2002 Rs. 300)

28. Total of the Receipts and Payments Account Rs. 1,45,500 (subscription received in2002 Rs. 95,000; rent received Rs. 19,250, fixed deposits during the year Rs. 30,000.

29. Closing cash in hand and at bank Rs. 11,510, total of Balance Sheet Rs. 85,260 (openingcapital fund Rs. 80,800)

30. Total of opening Balance Sheet Rs. 68,600. Total of closing Balance Sheet Rs. 74,100(opening capital fund Rs. 68,300)

31. Balance sheet 4,33,900, Deficit 4,100

CHAPTER 9

Accounts from Incomplete Records

LEARNING OBJECTIVES


● state the meaning of incomplete records;

● distinguish between Balance Sheet and Statement of Affairs;

● calculate Profit or Loss using the Statement of Affairs Method;

● prepare Profit and Loss Account and the Balance Sheet;

● detect the missing figures/information by preparing the relevantaccount.

ACCOUNTANCY390

We have so far studied accounting recordsof firms, which follow the double entrysystem of book keeping. This gives us animpression that all business units followthis system. However, in practice all firmsdo not maintain accounting records as perthe accrual system, and hence, theGenerally Accepted Accounting Principles(GAAP) are not fully observed by them.Many small size enterprises keep partialrecords of their transactions. But, it isessential for them to know the profit orloss and the financial position of the firmfor a year. This chapter deals with theascertainment of profit or loss andfinancial position of the firm from itsincomplete records. For this purpose,chapter is divided into three sections.Section I explains the meaning ofincomplete records and reasons thereof.Section II deals with the ascertainment ofprofit or loss by statement of affairsmethod. Section III outlines the processwhereby the profit or loss and financialposition could be ascertained by usingprinciples of double entry system.

9.1 Meaning of Incomplete Records

Accounting records, which are not keptaccording to double entry system, areknown as incomplete records. Though somemay refer to it as single entry system it is amisnomer. There is no system defined assingle entry system. It is also not a ‘shortcut’ method as an alternative to the doubleentry system. One can say that when a firmdoes not have a double entry system of bookkeeping, it is having partial records. Thus,records are usually referred to as incompleterecords.

Under such a situation, normallytransactions of cash, debtors and creditorsare recorded by maintaining cashbook,debtors and creditors accounts. Otherinformation relating to assets, liabilities,expenses and revenues are partiallyrecorded which requires careful scrutinyto prepare the accounts.

9.2 Reasons for Incomplete Records

Incomplete records may be due to partialrecording of transactions as is the casewith small shopkeepers such as grocersand vendors. In case of large sizedorganisations, the accounting records maybe rendered to the state of incompletenessdue to natural calamity, theft or fire. Thus,partial recording of business transactionsmay takes place due to:

● Lack of knowledge about doubleentry system.

● Deliberate omission to maintainrecords to take advantage oftaxation.

● Unable to maintain his/herbusiness transactions because ofthe time, effort and cost involved.

● Loss of records due to fire, theft ornatural calamity.

9.2.1 Limitations of IncompleteRecords

Incompleteness of accounting records byitself is a drawback of the system.Following are the limitations of partialrecords:

● Arithmetical accuracy of tran-sactions recorded in the bookscannot be checked from

ACCOUNTS FROM INCOMPLETE RECORDS 391

incomplete records because trialbalance cannot be prepared.

● Internal checks cannot be enforced,which increase the chances ofcheating and fraud.

● Correct ascertainment andevaluation of the financial resultsof business operations cannot bemade. This hampers the futuredecisions about the business.

9.3 Accounts from IncompleteRecords

It is necessary to know the result ofbusiness activities to assess the efficiencyand success or failure of the organization.This gives rise to the need for preparingthe financial statements to disclose:

● The profits made or loss sustainedby the firm during a given period,and

● To disclose the amount ofassets and liabilities as at theclosing date of the accountingperiod.

This is true even for firms which haveincomplete records. The problem faced inthis situation is how to ascertain profit orloss for an accounting year and determinethe financial position of the entity at theend of that year form the incompleterecords. This problem can be solved by-

● Ascertaining the profit or loss bypreparing the Statement of Affairsat the beginning and at end of theaccounting period, and then analysethe changes in owner’s equityduring the accounting period.

● Preparing profit and loss accountand balance sheet by putting the

accounting records in proper order.

9.3.1 Ascertainment of Profit or Lossby preparing the Statement ofAffairs

Under this method, statement of assetsand liabilities at the beginning and at theend of the relevant accounting period areprepared to ascertain the change in ownersequity at the end of accounting period.This is followed by the statement showingascertainment of profit by analyzing nonoperating changes in owner’s equity. Thestatements so prepared show assets on oneside and the liabilities on the other just asin case of a balance sheet. The differencebetween the totals of the two sides isknown as owner’s equity. This can be alsoexpressed in the form of accountingequation as follows:


The above equation is rearranged toascertain the owner’s equity as follows-

Owner’s Equity = Assets – Liabilities

Conversely, there may be a situation whenthe liabilities may exceed the total assets.In such a case, the difference will indicate‘loss’ carried forward from the previousyear. In this case, owner’s equity will benegative.

Though the Statement of Affairsappears to resemble with the balancesheet, but it is not a balance sheet, becausethe balances of various assets andliabilities are not derived from the ledgeraccounts.

The difference between owner’sequity at two points, i.e. opening andclosing, represents the increase or decrease

ACCOUNTANCY392

which is to be adjusted for withdrawalsmade by the owner and the new capitalintroduced by the him during theaccounting period to ascertain the changein owner’s equity due to operatingactivities. In case, the balance is positive itwill indicate the profit earned during theyear, while in case of negative balance itwill be the loss sustained by the firm.

To ascertain the profit or loss,following steps are to be taken:

Step 1Calculate owner’s equity at the beginning(opening owner’s equity) and at the endof the period (closing owner’s equity).

Step 2Subtract the opening balance of owner’sequity from closing balance of owner’sequity. Here, there may be two situations:

(i) The change in owner’s equity maybe positive, i.e., excess of closingowner’s equity over openingowner’s equity.

(ii) The change in owner’s equity maybe negative, i.e., excess of openingowner’s equity over closingowner’s equity.

Step 3In case of introduction of fresh capitaland/or withdrawals made by the ownerthe following adjustments are required:

(i) Subtract the amount of capitalintroduced during the period fromthe amount calculated in step 2.

(ii) Add the amount of withdrawalsmade by the owner during the

period to the amount calculated instep 2.

Step 4If the net result is positive, it representsprofit and if it is negative, it representsearned loss sustained during theaccounting year.

This process of measuring profit orloss is summarized as follows:Profit (Loss) = O1 – O0 + d – I

where;

O0 = A0 – L0

O1 = A1 – L1

O0 = Owner Equity at the beginningA0 = Assets at the beginning

L0 = Liability at the beginning

O1 = Owner’s Equity at the end

A1 = Assets at the endL1 = Liability at the end

I = Introduction or addition to thecapital during the period

D = Withdrawals during the period

∆O = Change in owner’s equity

Illustration 1 (Preparation of Statement ofProfit)Calculate the profit or loss from thefollowing data:Withdrawals by the proprietor during theyear Rs. 30,000.Capital at the beginning of the year i.e., 1Jan. 2001 Rs.1,20,000.Capital at the end of the year i.e., 31 Dec2001 Rs. 2,00,000.Capital brought in by the proprietorduring the year Rs. 50,000.


Illustration 2 (Preparation of ClosingStatement of Affairs)

Bharat started his readymade garmentsbusiness on January 1, 2001 with a capitalof Rs. 50,000. He was pur-chasingreadymade dresses of well-known brands.He was able to procure credit from thesuppliers. There were a few shopkeepersfrom nearby markets who were alsopurchasing from him on credit basis. During

the year, he introduced fresh capital of Rs.15,000. He withdrew Rs. 10,000 for hispersonal use. On Dec 31, 2001 his positionwas as follows:

Accounts payable Rs.90,000; AccountsReceivable Rs.1,25,600; Stock Rs. 24,750;Cash at Bank Rs. 24,980

Calculate profit and loss made byBharat during the first year of his business,using (i) Statement of Affairs Method (ii)Equations Method.

Solution

Statement of Profit for the year ended 31-12-2001


Owner’s equity as on 31 December (O1) 2,00,000

Less : Owner’s equity as on 1 January (O0) 1,20,000

Change in owner’s equity (∆o) 80,000

Add : Drawings (D) 30,000

1,10,000

Less : Additional capital introduced (I) 50,000

Profit made during the year (P) 60,000

Solution

I. Statement of Affairs Method

Books of BharatStatement of Affairs as on 31.12.2001


Accounts Payable 90,000 Cash at Bank 24,980Accounts Receivable 1,25,600

Owner’s Equity 85,330 Stock 24,750

1,75,330 1,75,330

ACCOUNTANCY394

Statement of Profit for year ending 31-12-2001


Owner’s equity as on 31 December (O1) 85,330Less : Owner’s equity as on 1 January (O0) 50,000Change in owner’s equity (∆0 ) 35,330Add : Drawings (D) 10,000

45,330Less : Additional capital introduced (I) 15,000

Profit made during the year (P) 30,330

II. Equations Method

O 1 = A 1 - L 1 (1)

O0 = A1 - L1 (2)

P = O 1 - O0 + D – I (3)

where :

O1 = Closing Capital as on 31.12.2001A 1 = Assets as on 31.12.2001L 1 = Liability as on 31.12.2001O0 = Opening Capital as on 1.1.2001A0 = Assets as on 1.1.2001L0 = Liability as on 1.1.2001D = Drawings during the year 2001I = Introduction of additional capital

during the yearP = Profit and Loss for the year

∆O = Change in owners equity

Calculation of Assets as on 31.12.2001

Rs.

Cash at Bank 24,980Account Receivable 1,25,600Stock 24,750

Assets (A1) 1,75,330

Calculation of Liabilities ason 31.12.2001

Rs.Accounts Payable 90,000

Liability (L1) 90,000

Calculation of Owners equity as on31.12.2001

O1 = A1 - L 1

O1 = Rs. 1,75,330 – 90,000Owners equity Rs. 85,330

Ascertaining Profit or Loss during the year

P = O1 - O0 + D – I= (85,330 – 50,000) + 10,000 – 15,000= 35,330 + 10,000 – 15,000= 45,330 – 15,000 Profit = Rs. 30,330

Illustration 3 (Preparation of opening andclosing statement of Affairs)

Akhilesh runs ABC printers, a smallprinting firm. He was maintaining onlysome records, which he thought, weresufficient to run the business. On 1 April2000 available information from hisrecords indicated that ABC printers hadthe following assets and liabilities:Printing Press Rs. 5,00,000; Building Rs.2,00,000; Stock of press material Rs. 50,000;Cash at bank Rs. 65,600; Cash in HandRs.7,980; Dues from customers Rs.20,350;Payments due to Accounts PayableRs.75,340; and Wages pending to workersRs.5,000. He withdrew Rs. 8,000 everymonth for meeting his expenses. He had


also introduced Rs. 15,000 during the year as additional capital. On 31 March 2001 hisposition was as follows: Press Rs. 5,25,000; Building Rs. 2,00,000; Stock of press materialRs. 55,000; Cash at Bank Rs. 40,380; Cash in hand Rs.15,340; Dues from CustomerRs.17,210; Payments due to accounts payable Rs. 65,680. Using Statement of Affairsmethod, calculation the profit made by ABC printers during the year.

9.4 Preparation of Profit andLoss Account and Balance Sheetfrom Incomplete Records

Generally, the Statement of Affairs methodis used where it is difficult to compile even

a reasonable summary of cash transac-tions. There is a need to obtain as far asmuch information as possible about theassets and liabilities at the beginning aswell as at the close of the year. Bank

ABC PrintersStatement of Affairs as on 31.3.2001

Liabilities 1.4.2000 31.3.2001 Assets 1.4.2000 31.3.2001Rs. Rs. Rs. Rs.

Accounts 75,340 65,680 Printing Press 5,00,000 5,25,000Payable

Wages pending 5,000 - Building 2,00,000 2,00,000

Change inOwner’s equity 7,63,590 7,87,250 Stock of press 50,000 55,000

Material

Dues from 20,350 17,210customers

Cash at bank 65,600 40,380

Cash in hand 7,980 15,340

8,43,930 8,52,930 8,43,930 8,52,930

Statement of Profit for year ending 31-3-2000


Owner’s equity as on 31 Dec. (O1) 7,87,250Less : Owner’s equity as on 1 Jan.(O0) 7,63,590

Change in owner’s equity (D0 ) 23,660Add : Drawings (D) 8000 x 12 96,000

1,19,660

Less : Additional capital introduced (I) 15,000

Profit made during the year (P) 1,04,660

ACCOUNTANCY396

balance can be obtained from the passbookand cash book with bank column. Valueof fixed assets, may be ascertained fromthe purchase documents if available withthe trader or estimated by inquiring fromthe supplier of such an asset. Informationshould be obtained from the variousdocuments/vouchers such as invoices forsales and purchases receipts for a paymentmade and cash obtained.

In some firms detailed informationmay be available about business activities.If details of accounts payable, purchases,cash received, sales, accounts receivable,bills receivables, bills payable, cashpayments, with cash summary oftransactions are available, it may bepossible to workout some of the missingfigures by using the logic of double entrysystem of accounting. This in turn, willhelp in the preparation of Profit and LossAccount and Balance Sheet.

Hereunder, we demonstrate howavailable information can be used toprepare the accounts to ascertainmissing figures, which will help inpreparation of Profit and Loss account andBalance Sheet.

9.4.1 Ascertainment of MissingInformation about CreditPurchases and Payables

Credit purchases and Accounts Payables(creditors and bill payables) are inter-

connected. Therefore, missing informationabout the credit purchases and any itemrelating to creditors and bills payables canbe obtained by preparing these accountssimultaneously. Typical Accounts Payableand Bills Payable accounts are given in(figure 11.2).

When available information is placedin these two accounts, one can ascertainwhich items are missing. The connectingitems between Bills Payable and AccountsPayable accounts are: bill accepted duringthe year against credit purchases, anddishonoured bills payable. By making useof connecting items, missing informationcan be ascertained. For example, to calculatemissing information about purchases, thebills payable account is to be completed/closed.

Once the bills payable account iscompleted with all the required itemsthen accounts payable account needs tobe completed. The total credit purchasesmade during the year will be availableon the credit side of accounts payableaccount. By adding cash purchases(available from the cashbook summary)to this figure we obtain total purchasesmade during the period. If there arepurchase returns, they have to bededucted from the total purchases to getthe net purchases. This figure of netpurchases can be placed on the debitside of the Profit and Loss Account.


Dr. Total Creditors Account Cr.

Particulars Amount Particulars Amount Rs. Rs.

Cash (Paid) **** Opening balance ****

Bank **** Bank ****(Cheques issued) (Cheques dishonoured)

Bills Receivable Bills payable ****(Endorsed) (Bills dishonoured)

Bills Payable **** Credit Purchases ****(Bills accepted)

Discount received ****

Purchases returns ****

Closing Balance ****

***** *****

Bills Payable Account

Dr Cr


Bank (bills matured) **** Opening Balance ****

Creditors **** Creditors ****(Bills accepted)

(Bills dishonoured) ****Closing balance ****

***** *****

Figure : 11.2

Illustration 4 (Computation of creditpurchases)

The following information is available toyou from the books of M/s Linsa Traders.Prepare accounts payable account to findout the missing information, if any.Cash paid to accounts payable Rs. 15,000

Cheques paid through bank Rs. 10,000

Bills endorsed Rs 14,500

Bills accepted during the year Rs. 35,000

Discount received Rs. 5,000

Purchases returns Rs. 2,500

Opening balance of accounts Rs. 15,000payable as on 1 April 2002

Cheques dishonoured Rs. 8,000

Bills dishonoured (bills payable) Rs. 10,000

Balance of accounts payable Rs. 25,000as on 31 March 2003

▼▼▼

▼

ACCOUNTANCY398

Solution

M/s Linsa TradersDr. Accounts Payable Account Cr.


Cash (paid) 15,000 Balance b/f 15,000

Bank 10,000 Bank 8,000(cheques dishonored) (cheques issued)

Bills Receivable 14,500 Bills payable 10,000(Bill endorsed) (bills dishonoured)

Bills Payable 35,000 Purchases (Credit) 74,000(Balancing figure)

Discount received 5,000

Purchases returns 2,500

Closing Balance 25,000

1,07,000 1,07,000

Illustration 5 (Calculation of netpurchases)From the following information, you arerequired to calculate Net purchases:

Rs.Opening Balance of Bill Payable 15,000

Opening Balance of Creditors 18,000

Closing Balance of Bills Payable 21,000

Closing Balance of Creditors 12,000Bills Payable honoured by firm 26,700during the year

Returns outwards 3,600

Cash Purchases 77,400

Cash paid to Creditors 90,600

Solution

Dr. Total Creditors Account Cr.


Bills Payable 32,7001 Opening Balance 18,000Bills issuedduring the year)

Credit Purchases 1,20,9002

(Balancing figure)Returns outward 3,600Cash 90,600(Bills honoured)Closing balance 12,000

1,38,900 1,38,900


Solution

Dr. Bills Payable Account Cr.


Cash 26,700 Opening balance 15,000(Bills honoured)Closing balance 21,000 Total Creditors 32,7001

(Balancing figure)Bills issuedduring the year

47,700 47,000

9.4.2 Ascertainment of MissingInformation about CreditSales and Receivables

As you have already studied in the chapter6 based on bills of exchange, that in thepresent times sales are made against billsreceivables by raising bills of exchange onthe customers. Only when accepted by the

customers, the bills of exchange becomebills receivable. It is to be noted that creditsales, Debtors and bills receivable areinterrelated. Debtors and Bills Receivableaccount are therefore, prepared simulta-neously. The formats of AccountsReceivables (total debtors and BillsReceivable) are as follows:

Calculation of Net Purchases


Cash Purchases 77,400

Add: Credit Purchases 1,20,9002

Total Purchases 1,98,300

Less: Returns Outward 3,600

Net Purchases 1,94,700

ACCOUNTANCY400

The linking items between theaccounts receivable and bills receivableare: Bills receivable by customers duringthe period and bills receivabledishonoured during the period. Bymaking use of connecting items missinginformation can be ascertained. Forexample, to calculate missing informationabout net sales, at first stage, billsreceivable account is to be completed.

After completing the bills receivableaccounts with all the items, one canattempt to complete the accountsreceivable account. Once all the items inboth the account are available the creditsales during the period is ascertained. Thismust be added to the cash sales figureavailable from the cash book summary toobtain total sales for the period. In caseany information is available regarding

Total DebtorsDr. Cr.


Opening Balance **** Cash (received) ****Bills Receivables Bank ****(Dishonoured) **** (Cheque received)Bank Discount allowed ****(Cheque dishonoured) Bad debts ****

Sales returns ****Bills Receivable ****(bills received)Closing Balance ****

***** ****

Bills ReceivableDr. Cr.


Cash (bills honoured) ****Opening Balance **** Bank and Discount ****Debtors **** (Bills discounted) (bills received) Debtors (Bills ****

Retained & Dishonored)Accounts Payable ****(endorsed to creditors)Closing Balance ****

***** *****

▼

▼

▼

▼


sales returns, it is deducted from the totalsales to obtain net sales. The figure of netsales is placed on the credit side of Profitand Loss Account.

9.4.3 Preparing summary statementof cash transaction to ascertainmissing information

Summary of cash transactions record thecash receipts and cash payments. Cashreceipts indicates opening balance of cashand receipts on account of cash sales, cashreceived from debtors, cash collected onmaturity of bills receivable and otherreceipts such as interest, commission andtax refund. The cash payments includespayment to creditors, payment onretirements of bills payables, paymentsof dues, expenses and taxes. The

with-drawals made by the proprietor/partner is also shown on the payments sidealong with the closing balance. Whilepreparing a cash book summary one mayfind a missing figure. In case of banktransactions, a bank overdraft appears onthe other side. The balancing figure has tobe carefully identified as the missingfigure.

To ascertain missing information forpreparation of final accounts, all theinformation available should be carefullyrecorded by simultaneously openingrelevant accounts. Then, balance thoseaccounts, which have only one missinginformation pass transfer entries bymaking use of connecting items.

Particulars Source of Information

Closing Assets (except stock) and Closing Statement of Affairs

Liabilities, Capital.

Opening Assets, Liabilities and Capital Opening Statement of Affairs

Purchases (Cash and Credit) Accounts Payable, Purchases Account, Cash SummaryStatement

Sales (Cash and Credit) Cash Sales from Cash Summary, Credit Sales fromAccounts Receivable Account and Sales Account

Expenses and Revenues As per Cash Summary Statement and additionalinformation for outstanding and prepaid expenses

Losses and Gains From all the accounts and scattered information

Bills Receivable received Bills receivable Account/Account Receivable Account

Bills Payable accepted Bills Payable Account/Accounts Payable Account

Opening and Closing balance of Cash Summary of Cash and bank transactions.

Figure 11.2: Detecting the Missing Information

ACCOUNTANCY402

Illustration 6 (Preparation of AccountsReceivable Account)

From the following information suppliedby Excel Enterprises of Ganesh, preparethe accounts receivable account and findout the missing figure, if any.

Rs.

Opening balance of AccountsReceivable as on 1 April 2002 1,00,000

Bills Receivable dishonoured

during the year 10,000Cheque dishonoured (Bank) 5,000Cash received from AccountsReceivable 25,000Cheque received and deposited 10,000in the bankDiscount Allowed 4,500Bad debts 2,500Sales Returns 6,000Closing balance of Accounts 10,000Receivable as on31 March 2002

Illustration 7 (Ascertainment of Credit Sales)

From the following information, Calculate the accounts of credit salesTransactions 1.1.2000 31.12.2000

Rs. Rs.

Balance of Debtors 30,000 22,500Balance of Bill Receivables 9,000 12,000Transactions made during the year:Cash received from customers during the year 1,48,500

Solution

Dr. Accounts Receivable Account Cr.


1 Apr Opening balance of 1,00,000 Cash (received from 25,000Accounts Receivables Accounts Receivable) Balance b/f

2000 Bills Receivables 10,000 Bank (cheque 10,000(Dishonoured) received)Bank 5,000 Discount allowed 4,500(cheque dishonoured) Bad debts 2,500

Sales returns 6,000Bills receivable 57,000(Balancing figurebeing billsreceivable issuedduring the year)Balance c/f 10,000(Closing balance ofof Accounts Receivables)

1,15,000 1,15,000


Dr. Tatal Debtors Account Cr.

Date Particulars J.F Amount Date Particulars J.F Amount2000 Rs. 2000 Rs.

1 Jan Balance b/f 30,000 31 Dec Cash 1,48,500Bills Receivable 7,500 (Collected from(Dishonoured) accountsSales 1,77,000 receivable)(Balancing figure) Discount 1,500being credit sales Bills receivable 31,5001

(Transfer frombills receivableaccount)Return Inwards 6,000Bad Debts 4,500Balance c/f 22,500

2,14,500 2,14,500

Solution

Dr. Bills Receivable Account Cr.


1 Jan Balance b/f 9,000 31 Dec Cash 21,000Accounts Receivable 31,500 Accounts 7,500

Receivable(B/R received) (Dishonoured)(Balancing figure Balance c/f 12,000being billsreceivable duringthe year)

40,500 40,500

Discount allowed 1,500Returns Inwards 6,000Cash Received against Bills 21,000Bad Debts 4,500Bills Receivable (Dishonoured) 7,500

Solution

I. Calculation of credit sales during the year

ACCOUNTANCY404

Illustration 8 (Colcutation of Net Sales)

From the following information calculate the net sales made during the year.

Transactions AmountRs.

Debtors on 1.1.2000 61,200

Cash received from debtors 1,82,400during the year

Returns Inward 16,200

Accounts Receivable on 82,80031.12.2000Bad Debts 7,200

Cash Sales as per Cash Book 1,69,200

Solution

I Calculation of Credit Sales made during the year



1 Jan Balance b/d 31 Dec Cash 1,82,400(Opening Bal) 61,200 received fromSales 2,27,400 Accounts(Balancing figure) Receivable)being credit sales Return Inwards 16,200

Bad Debts 7,200Balance c/f 82,800(Closing Balance)

2,88,600 2,88,600

II Calculation of Net Sales during the year


Cash Sales as per cash book 1,69,200

Add: Credit Sales 2,27,400

Sales 3,96,600

Less: Returns Inwards 16,200

Net Sales 3,80,400


Solution



Balance b/f (Opning) 9,000 Cash 30,000Credit Sales 34,400 Discount Allowed 1,400(Balancing Figure) Balance c/f 12,000

(Closing)

43,400 43,400

9.5 Preparation of Final AccountsLet us now take up few comprehensiveillustrations and study how complete finalaccounts can be prepared from incompleterecords.

Illustration 9Roshan Washing House did not keep his

book of accounts under double entrysystem. From the following informationavailable from his records, prepare Profitand Loss account for the year ending31-3-2000 and a balance sheet as on thatdate, depreciating the washing equipment@ 10%.

Other Information31.3.2000 31.3.2001

Rs. Rs.

Accounts Receivable 9,000 12,000Accounts Payable 14,400 6,800Stock of Materials 10,000 16,000Washing Equipment 40,000 40,000Furniture 3,000 3,000Discount allowed during the year 1,400Discount Received during the year 1,700


Balance b/f Cash Purchases 14,000

(Opening Balance) 8,000 Paid to Creditors 20,000

Cash Sales 40,000 Sundry Expenses 6,000

Received from accounts 30,000 Cartage 2,000

Drawings 8,000Balance c/f 28,000(Closing balance)

78,000 78,000

receivables

ACCOUNTANCY406

Statement of Affairs as on 1-4-2000


Accounts Payable 14,400 Washing Equipment 40,000Owner’s Equity 55,600 Furniture 3,000(Balancing Figure) Stock of Material 10,000

Accounts Receivable 9,000Cash 8,000

70,000 70,000

Profit and Loss Account for the year ending 31-3-2000

Particulars Amount Amount Particulars Amount AmountRs. Rs. Rs. Rs.

Opening Stock 10,000 Sales:Purchases: Cash 40,000Cash 14,000 Credit 34,400 74,400Credit 14,100 28,100Cartage 2,000 Closing Stock 16,000Gross Profit c/f 50,300

90,400 90,400

Sundry Expenses 6,000 Gross profit b/f

Discount Allowed 1,400Discount Received 50,300

Depreciation on 4,000washing equipment 1,700

Net Profit transferred to 40,600Capital a/c

52,000 52,000

Dr. Accounts Payable Account Cr.


Cash 20,000 Balance b/f 14,400Discount 1,700 (Opening)Received Credit Purchase 14,100Balance c/f (Closing) 6,800 (Balancing Figure)

28,500 28,500

Dr. Cr.


Balance Sheet as on 1-3-2001


Owner Equity 55,600 Washing equipment 40,000Add: Net Profit 40,600 Less: Depreciation 4,000 36,000

96,200 Furniture 3,000Less: Drawings 8,000 88,200 Stock of materials 16,000Accounts Payable 6,800 Accounts Receivable 12,000

Cash 28,000

95,000 95,000


● Incomplete Records

● Statement of Affairs


Incomplete Records: Incomplete records refer to lack of accounting records according tothe double entry system. Degree of incompleteness may vary from highly disorganizedrecords to organized but still not complete.

Difference between Statement of Affairs and Balance Sheet: A Statement of Affairs is astatement showing various assets and liabilities of a firm on date, with difference betweenthe two sided denoting owner’s equity. Since the records are incomplete, the values of assetsand liabilities are normally estimates based on information available. They are not thebalances taken from properly maintained ledger like in the case of Balance Sheet. The balancesheet is derived from a set of books maintained on the basis of double entry system.

Computation of Profit and Loss from Incomplete Records: The statement of affairs is usedto compute Profit or Loss when a firm has a highly disorganized set of incomplete records.It may not be possible to prepare a cash summary in such a situation. Two statements ofaffairs are prepared to find out opening and closing equity amounts. To the differencebetween the closing and opening equity , any sum withdrawn from business are addedback and any additional capital introduced during the year are deducted. To find out Profitand Loss made for the period.

Preparation of Profit and Loss Account and Balance Sheet: When cash summary of a firmis available along with information about personal accounts of creditors and customers, anattempt can be made to prepare the Profit and Loss Account and Balance Sheet. Missingfigures about purchases, sales, debtors, and creditors can be obtained by preparing performaaccounts of debtors, creditors, bills receivables and bills payable using the logic of doubleentry system. Once a Profit and Loss Account and Balance Sheet are prepared, it will bepossible for the firm to start a complete accounting system for future.

ACCOUNTANCY408

EXERCISES


1. Multiple Choice Questions

(a) Incomplete records are generally found in use by

(i) Small Traders(ii) Society(iii) Company(iv) Government

(b) When Closing Owner’s Equity is greater than Opening Owner’s Equity, it denotes

(i) Profit(ii) Loss(iii) Profit, if there is no introduction of fresh capital(iv) No profit no loss

(c) If owner’s equity in the beginning is Rs 21,000. Fresh capital introduced duringthe year is Rs. 7,000. Amount withdrawn during the year is Rs. 13,000, then theclosing owner’s equity will be:

(i) Rs. 27,000(ii) Rs. 15,000(iii) Rs. 41,000(iv) Rs. 1,000

(d) Credit Sales is obtained from:

(i) Bills Receivables(ii) Accounts Receivables(iii) Accounts Payable(iv) Cash Summary

(e) Credit purchases can be obtained from:

(i) Statement of Affair(ii) Bank(iii) Bills Receivable(iv) Account Payable

Information about bills received dishonoured can also be obtained from:(v) Summary of cash transaction(vi) Profit and Loss account(vii) Accounts Payable(viii) Accounts Receivable

(f) Discount received from accounts payable may be obtained from(i) Cash statement(ii) Bills Receivables(iii) Accounts Receivables(iv) Accounts Payables


2. Fill in the blanks

(a) To find out the profit, closing capital is to be adjusted by ________________drawings and _____________________ introduction of fresh capital.

(b) If closing owner’s equity is Rs 1,000; opening owner’s equity is Rs. 500; profit is Rs700, then there must be a ___________________________ of Rs 200 during the year.

(c) Credit purchase can be ascertained as the balancing figure in the_____________________.

(d) The amount received from debtors can be traced from ___________________.

(e) Increase in owner’s equity at the end of the period represents ________________.

3. Calculate the following amounts

(a) Calculate value of Opening Stock

Purchases Rs. 17,500Sales Rs. 45,000Closing Stock Rs. 13,000Gross Profit @ 331/3% on Sales.

(b) Calculate the amount of closing stock

Opening Stock Rs. 17,500

Purchases Rs. 37,500

Sales Rs. 60,000

Gross Profit @ 25% on Cost.

(c ) Mr. Anshul started a business on 1.1.96 without maintaining proper accounts. OnpersonalInquiries and scruting of other papers the following information is obtained.

1996 1997Rs. Rs.

Purchases 74,000 68,500Sales 75,000 90,000Closing Stock

30,000Goods privately consumed 1,000 1,500Prepare Profit and Loss accountCalculate Closing Stock of 1996 and Opening Stock of 1997.

Q 4. From the following information calculate the amount of Net Sales, Net Purchasesand Closing Stock in Trade.

Particulars 1.1.98 31.12.98 Rs. Rs.

Account Receivables 31,800 26,500Account Payables 24,000 16,000

ACCOUNTANCY410

Bills Payable 21,000 29,000Bills Receivable 8,800 7,000Stock in Trade 10,000 ?

Transaction during the year:

Discount allowed 1,000Discount received 800Bills Payable discharge 35,600Bills Receivable collected 20,900Return Inwards 8,700Return Outward 4800Bad Debts 2,800B/R Dishonoured 1,800Cash paid to Creditors 1,20,000Cash received from Debtor 69,000Cash Sales 40,900Cash Purchased 1,03,200

Uniform Sales Price of goods being cost plus 25 per cent


5. What are incomplete records?

6. What are the possible reasons for maintaining incomplete records?

7. Differentiate between a Statement of Affairs and a Balance Sheet?

8. What practical difficulties are encountered by a trader due to the incompleteness ofaccounting records?

Long Answers Questions

9. What is meant by a ‘Statement of Affairs’? How can the Profit or Loss of a trader beascertained with the help of a Statement of Affairs?

10. “Is it possible to prepare the Profit and Loss Account and the Balance Sheetfrom the incomplete books of accounts kept by a trader”. Do you agree?Explain?

11. Describe the procedure of ascertaining credit sales, collection from accountsreceivables, payments to accounts payable closing balance and bills receivable.

12. Explain how the following may be ascertained from incomplete records:

(a) Opening owner’s equity and closing owner’s equity

(b) Credit sales and credit purchases

(b) Payments to creditors and collection from debtors

(c) Closing balance of cash


13. Jeevan Lal owns a tailoring shop. He does not maintain complete double entry books ofaccounts. From the following information, help Jeevan Lal to prepare Statement of Affairsand Profit earned during the year ending 31 December 2001.

Particulars Amount (Rs.) Amount (Rs.)

Cash in Hand 20,000 25,000Bank Overdraft 70,000 45,000Stock in trade 9.25.000 1,07,500Sundry Creditors 65,000 55,000Sundry Debtors 80,000 75,000Bills receivables 20,000 12,500Furniture and fittings 12,500 10,000Machinery 1,00,000 90,000Building 1,25,000 1,22,500Bills Payables 10,000 15,000Motor Vehicles — 60,000Unpaid Expenses 2,000 1,500

14. Mr Kishan who owns a food grains shop, does not maintain complete double entrybooks of accounts. From the following details determine the Profit for the year andStatement of Affairs at the end of the year.

Rs 10,000 (cost) furniture was sold for Rs 50,000 on 1 January 2001; 10% depreciation isto be charged on furniture . Mr Kishan has drawn Rs 10,000 per month . An amount ofRs 20,000 was invested by Mr Kishan in 2001.

Particulars 1 Jan 2001 31 Dec 2001(Rs.) (Rs.)

Stock 4,00,000 6,00,000Accounts Receivable 3,00,000 4,00,000Cash 20,000 10,000Bank 1,00,000 (overdraft) 5,000Accounts Payable 1,50,000 2,50,000Out standing expenses 50,000 80,000Furniture 30,000 20,000

Bank balance on 1 January 2001 is as per cash book, but there was a bank overdraft on 31December 2001 as per bank statement. Rs 20,000 cheques drawn in December, 2001 have notbeen encashed within the year.

15. The following figures are available with Suresh who keeps his books on Single EntrySystem

ACCOUNTANCY412

Particulars 1-1-98 31-12-98(Rs.) (Rs.)

Sundry Creditors 3,600 3,800Sundry Debtors 3,900 4,500Bills Receivable 2,500 3,400Bills Payable 1,600 2,300Cash in Hand or at Bank 7,000 1,200

Additional Information is given below:

Cash Received against Bills Rs. 10,000Cash Paid against Acceptance Rs. 14,300Payment made to Creditors Rs. 14,700Discount allowed to Customers Rs. 200

Find out Credit sale and Credit Purchases made during the year.

16. Mr Rajan who was not keeping a full accounting system gives you the followinginformation for the year 31 March 2001.

Summary of Cash Book

Dr. Cr


Balance at Bank 43,500 Ranjan’s Drawings 1,55,200Accounts Receivables 3,84,000 Accounts Payable 2,71,000

Bills Payable 93,000Accounts Receivable 1,20,000 Wages 3,20,000realised Salaries 1,65,000Commission 15,000 Rent and taxes 44,000receives Insurance 8,000Cash sales 4,86,000 Carriage 12,000Balance c/d Advertising 13,300

10,82,000 10,82,000


Particulars of other assets and liabilities


April 1 2000 March 31 2001

Stock in hand 1,87,000 23,400Accounts receivable 1,20,000 1,40,000Accounts payable 90,000 15,000Bills receivable 40,000 50,000Bills payable 10,000 12,000Furniture 6,000 6,000Machinery 1,20,000 1,20,000

A provision of Rs 14,500 is required for doubtful debts and depreciation at 15% is written offon machinery and furniture. Rs 30,000 is outstanding for wages andRs.12,000 for salaries. Insurance has been paid to the extent of Rs. 2,500. Legal expensesoutstanding are Rs. 7,000. Prepare the opening Statement of Affairs, Closing Statement ofAffairs, Statement of Profit and Balance Sheet.

17. Mr Kishore could give only the following information about his business transactions.Prepare a Profit and Loss Account for the year ended 31 March 2002, together withBalance Sheet on that date.

Summary statement of transactions


Intrest 1,000 Balance at bank as 24,250charges 20,000 on 31 March 2001Personal 85,000 Cash in hand as on 750withrawals 79,000 31 March 2001Staff salaries 1,50,000 Accounts receivable 2,50,000Other business Cash sales 1,50,000expensesAccountspayable paid

ACCOUNTANCY414

Further details are:

Particulars Amount Amount Particulars Amount AmountRs. Rs. Rs. Rs.

1 April 31 1 April 31 March2001 March 2001 2002

2002

Stock 90,000 1,02,200 Furniture 10,000 10,000Accounts 80,000 55,000Payable Office 1,50,000 1,50,000

premisesDebtors 3,00,000 3,00,000

Provide 5% interest on Kishore’s Capital balance as on 1 April 2001. ProvideRs 15,000 for doubtful debts, 5% depreciation on all fixed assets, 5% group incentivecommission to staff has to be provided for on net profit after meeting all expenses andcommissions.

18. Babulal ,keeps a cash book , carbon copies of the customers statements, which aremarked off when settled and a file of creditors for running his stationary business.Analysis of cash record for the year ended 30 June 2002, shows :


Debt due by 2,32,430 Rent rates and taxes 10,200customers collected Trade expenses 15,360Creditors accounts 1,94,070 Purchase of a delivery 4,800for goods paid van 5,600Cash purchases 18,230 Cash drawn for 15,360Wages 24,190 personal use 4,800

5,600

Particulars 1 July 30 Particulars 1 July 30 June2001 June 2001 2002

2002

Balance at — 18,200 Crediors 16,320Bank Rent 11,460 1,750Till float 300 — Trade 1,500 960on imprest expenses 3,200system Delivery van 740Debtors 12,620 14,790Stock 17,400 19,250


Sales made during the year were Rs 2,85,300.You are required to prepare :

(a) The Profit and Loss account for the year ending 30 June 2002.(b) Balance Sheet as on that date.

19. Radha Garments commenced business on 1 April 2001 with Rs. 45,000 as capital. Shemaintains books on single entry system. On 31 March 2002, books revealed the followinginformation:

Account Payable Rs. 25,000

Furniture and Fittings Rs. 50,000

Stock of ready-made garments Rs. 40,000

Accounts Receivables Rs. 45,000Cash Rs. 10,000

Drawings Rs. 750 per month

Additional Capital introduced: Rs. 20,000

5% accounts receivable proved as badInterest on capital 5% p.a.

Depreciation on furniture and fittings 10% p.a.

Provision for baddebts @ 2.5% and Statement of Affairs ended 31 March 2002.

20. Ganesh is conducting business as a retail merchant. He does not maintain regularaccount books. From cash sales effected, by him he makes business and other payments.He always retains cash of Rs. 10,000 on hand and deposit the balance in the bank. Theinventories for for the year ended 31 December 2001 are lost. However, he informs youthat he has sold goods invariably at a price which yields him a profit of 33.33 % oncost. From the following information supplied to you, prepare Profit and Loss Accountand a Balance Sheet for the year ended 31 December 2001.

Assets and Liabilities 1 Jan 2001 31 Dec 2001Rs. Rs.

Cash in hand 10,000 10,000Cash at bank 40,000 90,000Accounts receivable N.A. 80,000 Stock of goods 10,00,000 3,50,000

2,80,000 N.A.

ACCOUNTANCY416

Analysis of the bank pass book reveals the following information:


Payment to accounts payables 7,00,000Business expenses 1,20,000Receipts from accounts receivables 7,50,000Loan from Ajhit(taken on 1 Jan 2000 @ 10% p.a) 1,00,000Deposit in the bank 1,00,000

In addition he paid cash Rs 20,000 to accounts payables and salaries Rs 40,000. He retainedRs 8,000 cash for his personal expenses.

21. Nagi furnishes you the following particulars:

Make 5% provision for doubtful debts and provide 10% depreciation on furniture.The difference in cash may be taken as drawings on cash sales.

Particulars 31 Dec 1999(Rs.) 31 Dec 2000(Rs.)

Cash at Bank 32,000 48,000Stock 2,24,000 1,76,000Account Receivables 4,00,000 3,60,000Furniture 8,000 8,000Account Payables 1,76,000 1,92,000Out standing salary 40,000 6,400

Other Transactions:

Rates and Taxes 6,400Postage Stamps 7,200Salary 46,000Creditor 6,24,000Debtors 7,84,000Conveyance 4,000Bad Debts 4,000Discount Received 2,400Discount Allowed 6,400Purchase return 8,000Sales Return 16,000

22. Mr. S. Senapati Started business as a provision merchant on Jan 1 1996. He opened abank account for the business with Rs. 25,000 and immediately spend Rs 12,500 onfixtures and fittings. The only records kept were of cash Sales which amounted to Rs.37,500 in 1996 and Rs. 45,000 in 1997. There were no Credit Sales. The following factswere ascertained.


(1) All expenses of the business had been met by cheque, and an analysis of the bank passbook showed the following payments in 1996 and 1997:

Rs.

Purchases (Rs.37, 000 on related to 1996) 63,750Rent and rates 5,100Salaries 11,000Advertising 1,400Other expenses 2,880

(2) The value of the stock on 31 December 1997 was Rs.15, 000. No stock was taken on 31December 1996,but a uniform rate of gross profit may be assumed.

(3) Liabilities outstanding and on 31 December 1997, were : Rs.

Purchases 7,500Advertising 500Other expenses (light, heat, telephone, etc.) 170

(4) Amounts paid in advance at 31 December 1997 were: Rs.

Rates 100Other Expenses (insurance ) 50

(5) All business expenses arose equally in two periods.

(6) Goods were taken from stock for private consumption, the estimated cost being Rs. 500in 1996 and Rs 7,50 in 1997.

(7) Private Drawings amounting Rs. 6,620 were met out of cash received and balance wasbanked.

(8) Private Income of Rs 2,250 had been paid into the bank.The fixtures and fittings are to be written off over 10 years in equal installments.

On the basis of the foregoing information prepare :

(a) The Trading and Profit and Loss Account of each of the years 1996 and 1997; and

(b) The Balance Sheet as on 31 December 1997.

23. Saxena keeps his books by Single Entry System. An analysis of his CashBook for the year ended 31 December 1993, is as follows:

Cash Receipts: Rs.

From Accounts Receivables 41,000From Cash Sales 37,000From Saxena as additional Capital on 1 April 1993 10,000

Total Cash Receipts 88,000

ACCOUNTANCY418

Cash Payments: Rs.

Cash Purchases 24,000Paid to Accounts Payables 16,200Productive Expenses 5,400Salary Paid 8,100Sundry Expenses 6,500New Furniture purchased 4,000Private Payments 7,800

Total Cash Payments 72,000

Assets and Liabilities as on: 31 Dec. 1992 31 Dec. 1993Rs. Rs.

Accounts Receivables 12,000 ?Accounts Payables 6,200 ?Cash 8,000 ?Stock 20,200 16,100Furniture 6,000 9,500

Other Information’s

(1) Credit Sales during the year were Rs.48,000(2) Sales Returns Rs.2,600(3) Credit Purchases during the year were Rs.20,000(4) Discount allowed to Debtors Rs.200(5) Discount received from creditors Rs.300(6) Bad Debts written off during the year were Rs.1,200

Adjustments

(1) Write off further bad debts Rs.1,000(2) Provide 5% for doubtful debts and 2% for discount on Accounts Receivables(3) Allow interest on Capital @ 10% per annum

ANSWERS

1. (a) i(b) ii(c) i(d) ii(e) iv(f ) i

2. (a) Adding, Subtracting(b) Drawing(c ) Accounts Payables(d) Cash Summary(e) Profit


3. Opening owner’s equity Rs. 3,03,000Closing owner’s equity Rs. 3,86,000Profit Rs. 83,000

4. Opening owner’s equity Rs. 6,50,000Closing owner’s equity Rs. 6,30,000

5. Credit Sales Rs. 10,800Credit Purchase Rs. 29,200

6. Opening owner’s equity Rs. 4,16,500Closing owner’s equity Rs. 4,22,200Profit during the year Rs. 1,60,900Balance Sheet Rs. 5,31,700

7. Net profit Rs. 52,848

8. Gross Profit Rs. 45,800Net Profit Rs. 18,170Balance Sheet Rs. 55,740

9. Gross Profit Rs. 3,67,200Net Profit Rs. 1,54,000Balance Sheet Rs. 4,70,000

10. Gross Profit Rs. 3,10,000Net Profit Rs. 1,40,000Balance Sheet Rs. 5,60,000

11. Gross Profit Rs. 64,000Net Profit Rs. 29,200Balance Sheet Rs. 5,73,200

12. Gross Profit Rs. 12,500Rs. 15,000

Net Profit Rs. 800Rs. 3,300

Balance Sheet Rs. 31,650

13. Gross Profit Rs. 28,900Net Profit Rs. 5,984Balance Sheet Rs. 62,634