IMTS BBA (Financial and management accounting) by IMTS INSTITUTE

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FI NANCI ALAND MANAGEMENT ACCOUNTI NG

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BBA- FINANCE & MANAGEMENT ACCOUNTING

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FINANCIAL AND MANAGEMENT ACCOUNTING

CONTENTS:-

UNIT-I

01-137

Introduction to Financial Accounting - Meaning, Scope, Principles, Concepts and Conventions - Preparation of Financial Statements, Trial Balance - Manufacturing, Trading Account - Profit and Loss Account Balance Sheet , Final accounts of sole traders, Depreciation Methods and Accounting.

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FINANCE & MANAGEMENT ACCOUNTING

1 UNIT -I

FINANCIAL AND MANAGEMENT ACCOUNTING Objectives: This Unit will help you to understand â&#x20AC;&#x201C; The nature and Role of Accounting The method of preparation of Final Accounts Various methods of Depreciation Accounting Structure: Introduction to Financial Accounting Meaning, Scope, Principles, Concepts and Conventions Preparation of Financial Statements, Trial Balance Manufacturing, Trading Accounts Profit and Loss Account Balance Sheet Depreciation Methods and Accounting

INTRODUCTION:

Much of modern business management is made possible only by accounting information. Initially, business is finance oriented. It is the process of using money to make money. The finance function cannot work effectively unless it draws on the disciplines, which are closely associated with it. Management is a proven of converting information with action; and accounting in a source of most of the information that is used for this purpose. Management is heavily dependent on accounting for operating facts.

Accounting is the measurement and Communication of Financial and economical data. It is the science of book keeping and establishes the principles and concepts, which should govern the collection and presentation of financial date.

A systematic record of the daily events of business leading to presentation of a complete financial picture is known as accounting. It is primarily concerned with the design of the system of records, the preparation of reports based on the recorded data, the interpretation of the reports and finally communicating the results of the interpretation to persons who are interested in such results.

Accounting in often referred to as the language of business. It records business transactions and events taking place during the accounting period with a view to prepare financial statements, According to the committee of Terminology set up by the American Institute of certified Public Accountants.

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‘’Accounting is the art of records, classifying and summarizing in a significant manner and in terms of money, transactions and event which are, us part at least, of a Financial character, and interpreting the result thereof’’.

The above-mentioned definition does not reflect the present day accounting function. The dimension of accounting is much broader than that described in the above definition.

A widely

accepted definition of accounting is given by the American Accounting Association in 1966, which treated accounting as ‘’The process of indentifying measuring and communicating economic information to permit informed judgments and decisions by the users of accounts.

As per the former definition, accounting is simply an art of record keeping. Every good record keeping system includes suitable classification of transactions and events of financial nature as well as their summarization for ready reference. The later definition shows the role of accounting. There are certain users of accounts. The users need date for judgment and decisions. And accounting is a process of identifying user’s information requirements, and also generating, recording and communicating such information to the users.

Nature of Accounting: a. It is the art of recording and classifying business transactions and events.

b. The transactions or events of a business must be recorded in monetary terms.

It is an art of making, summarize, analysis and interpretation of the transactions.

d. The results of such analysis must be communicated to the persons who are to make decisions or form judgments.

(Transaction is used to mean a business, performance of an art and agreement, which event is used to mean a happening, as a consequence of transactions, a result)

Objectives, Advantages functions (or) Importance of Accounting: The means objectives of accounting are (i) Maintenance of business records :

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All Financial transactions are records are a systematic manner in books of accounts so that there is no need to relay in memory. It is not possible for any human being to remember all what happens in daily operations of a business.

(ii) Preparation of Financial statements :

Systematic records enable the accountant to prepare financial statements â&#x20AC;&#x201C; trading and profit and loss account to calculate profit or loss during a particular accounting period and balance sheet to state the financial position of the business as a particular date. Profit is a measure of the successful running of the business.

a. Comparison of Results :

Systematic maintenance of business records enables the accountant to compare profit of one year with those of earlier years to know the significant facts about the charges. This helps the business to plan its future affairs accordingly.

(iii) Decision making :

One accountant helps the management by providing the relevant information for various decisions to be taken by them then and there.

(iv) Good evidence is courts :

Records of business transactions are treated satisfactory evidence in court of law.

(v)

Planning and control operations :

Planning operations like sales, production, cash requirements for next accounting periods are achieved with the help of accounting information of estimates based on that information.

(vi)

Provides information to the interested group : Various interested groups like owners, creditors, management, employees, Government,

consumers, etc are interested in a accounting information related to various aspects such as profits, production, sales etc.

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(vii)Taxation problems :

In settlement of taxation matters, systematic maintenance of records is a big help.

(viii)

Valuation of business :

Accounting records kept in a proper way enables a business unit to determine the purchase or sale price in a simple manner.

(ix) An insolvent reasons is able to explain the past transactions without difficulty if proper accounting records are maintained.

(x) Differences between Book keeping and Accounting :

Book Keeping and Accounting are often considered synonymous. But they are not. There are some differences between them. They are :

1. Book-keeping concerns itself with the recording of business transactions in the journal or in the subsidiary books and the posting of the entries to the relevant ledger accounts. On the other hand, accounting concerns itself not only with the recording of business transactions in the journal or in the subsidiary books and posting them to the ledger accounts, but also with the presenting of the information in the ledger through Financial statements and the interpretation of the Financial statement for drawing conclusions.

2. Book-keeping first maintains information about a business in the books of accounts, where as accounting analyses and interprets the information considered in the books of accounts. So, it is proper to that accounting begins where book-keeping ends.

3. The work of book keeping in of routine and mechanical nature, but the book of accounting is of complicated nature.

4. The book-keeping work in usually performed by the book-keepers and accounting work is done by accounts.

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Differences between Accountancy, Accounting and Accounts

The terms ‘Accountancy’ ‘Accounting’ and Accounts are often considered identical. But they can be differentiated. One main differences between them are :

1. Accountancy is concerned with the formulation of principles to be followed in the recording of business transactions. Accounting is the actual recording of business transactions. Accounting in the books of accountancy. Account5s are the classified and summarized records of the various business transactions. Obtained through the work of accounting performed in accordance with the principles of accountancy.

2. In accountancy is operated with the technique of production, accounting is the process of production and accounts are the finished product.

3. In respect of their relative importance in the maintenance of business records, accountancy can be considered as the father, accounting as the mother and accounts as the children.

Persons Interested In Accounting Information

The persons who are interested in accounting information and the extent to which the accounting information is useful to them are stated below : 1. Owners : One owners of business who have invested capital, are naturally interested in knowing the return they would get on their capital. They would also be interested in knowing the Financial stability of there business which is an index of the safety of there capital.

2. Creditors : The suppliers of goods and services and lenders of money (know as creditors) of i concern are interested in knowing the Financial solvency or stability of the concern.

3. Prospective Investors : Prospective or potential investors require information on the Financial stability and the excreting of an enterprise for deciding about the derivability or otherwise of investing funds in the enterprise.

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4. Employees : The employees of a concern would like to have information about the Financial stability of there concern, So that they can have clear idea about the security of there jobs.

5. Management : The managers of a business required Financial information for guiding there performances. They require financial of data for planning control and decision making. 6. Public : The public, who all the consumers of the products among like to have information about the cost of the products produced the concern and the profit made by the concern so that they can determine the reduction in prices which they can demand from the concern.

7. Government : The Government is interested in the accounts of every business concern for the purposes of taxation.

8. Research scholars : Research scholars are interested in interpreting the Financial statements of a concern for their study.

Accounting Principles/Accounting standardâ&#x20AC;&#x2122;s Meaning: Accounting principles refer to general laws a rules adopted in accounting as a guide to action or as the basis of conduct of practice.

Need for Accounting Principles: Accounting is the language used by a concern for communicating Financial facts or information about itself to those who are interested in knowing them. As such, the language of business, viz the accounting, should be intelligible to the persons to whom the communication is made. In other words, the persons to from the communication is made should receive the message in the same sense in which it is slight to the conveyed to them. To make the language of business or

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accounting intelligible to the different groups of persons, a number of principles have been agreed upon and followed by accountants in the writing up of accounts and in the presentation of financial statements.

The term principle can be defined ‘’as a guide to action, a settled ground as basis of conduct or practice’’. In short, the accounting principles are only the creeps and conventions which have been adopted as a general guide by the accounting profession

Some accountants prefer to use the term ‘standards’ instead of wrong the word ‘Principles’.

Characteristics of Accounting Principles: The following are the main characteristics of accounting principles :

1. Accounting principles are man made, So they do not have the authoritativeness as universal principles like the principles of physics, Chemistry and other natural sciences. They represent the herd possible gridlines based on reasons and observations and have been developed by accounts to chance the usefulness of accounting data in an ever changing society.

2. The science of accounting is not in a finished form, it is in the process of evolution. One principle are instanced by business practices groups.

3. The general acceptance of an accounting principle wantanly depends on how well it meets three criteria: relevance, objectivity and feasibility. A principle is relevant to the extent that it results in information that is useful to those who went to know something about a certain business. A principle is objective to the extent that the accounting information is our influenced by the personal bias of those who furnish the information. The accounting information given in the financial statements though the free form personal liras of the persons who have taken part on the preparation of such statements. A principle is feasible to the extent that it can he applied without undue compressing or cost.

Classification of accounting principles: One accounting principles can be classified as (i) Accounting concepts and (I) Accounting Conventions.

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Accounting concepts: Accounting concepts may be considered as postulates it, basic assumptions or conditions upon which the science of accounting is based. Any district idea serving a systematized function is regarded as concepts. There is no authoritative into of these concepts but must of the following concepts have family general support.

Accounting Conventions : The term ‘’Convention’’ denotes circumstances or traditions which guide the accounts which preparing the accounting statements. It refers to a statement or rule of practice which by common consent, express or implied, is employed in the solution of a given class of problem or guide behavior of a certain cannot of situation. Thus debit on the left hand side and credit on the right hand side of an account is example of convention.

Accounting concepts : Accounting concepts, generally, mean postulates, assumptions or conditions upon which accounting is based. They have been developed to make accounting convey the same meaning to all people, as far as practicable.

There are a number of accounting concepts agreed upon and adopted by accountants. Some of the important accounting concept are :

1. Money Measurement Concept or Common Denominator Concept : The money measurement concept signifies that in accounting, a record is made only of those transactions or events which can be expressed in terms of money. Non-monetary events like the retirement of the managing director of a concern, the good quality of the products produced by the concern, the good quality work that is found in the concern, etc, are not recorded, through they are also material events, as they cannot be expressed in terms of money.

Another important feature of this concept is that business transactions are recorded in books of accounts in terms of the value of money at the time the transactions are recorded. Subsequent changes in the value of money or the purchasing power of money are ignored. In other words, business transactions are recorded on the presumption that the value of money is always stable and does not change form time to time. It is true that such a presumption is not realistic in these days of

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rising price and falling values of money all over the world. But the recording of business transactions in terms of money without bothering about the changes in its purchasing power is justified on two grounds. First, it gives a certain measure of objectivity to the transactions. Secondly, on account of this presumption, assets acquired on different dates can be easily added up for the purpose of knowing their total worth.

The money measurement concept has one great advantage. It helps a concern to express heterogeneous items (i.e., items of diverse nature), such as bank balance, stock-in-trade, furniture, machinery, buildings and so on in terms of a common denominator, viz., money, and add them up for the purpose of knowing the total worth of assets at any particular time. But for this concept, adding up the diverse items which exist indifferent forms will not be possible. For instance, if a concern has bank balance of Rs.10,000,1,000 tonnes of stock-in-trade, 5 type-writers and 10 steel cabinets, 5 machines and 2 buildings, in the absence of a common denominator, viz., money, these diverse items cannot be added up to give any meaningful and useful figure. But, if they are expressed in terms of money as bank balance of Rs.10,000, stock-in-trade of Rs.50,000, furniture of Rs.38.000 (type-writers of Rs.20.000 + steel cabinets of Rs.18.000), machinery of Rs.50.000 and buildings of Rs.1.00.000, it is possible to add up the value of all these assets and to state the total worth of the assets of the business as Rs.2,48,000.

However, the money measurement concept has one serious limitation. As only monetary transactions are recorded in account books, and no record is kept of non-monetary events, accounting records do not give a complete record of all the happenings in a concern.

Business Entity Concept : No doubt, legally, only a joint stock company is as distinct entity apart from the shareholders

owning it. But in accounting, every business undertaking, whether it is a sole-trading concern or a partnership firm or a joint stock company, is considered as a distinct entity from the persons who own it. As the business and the proprietors, who own the business, are regarded as two separate entities (i.e., parties), the transactions of the business are distinguished from those of the proprietors, and in the books of the business, accounts are kept only for the transactions of the business, and not for those of the proprietors.

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This concept has proved very useful in recording the transactions of a business in its books. Without this concept, it would be impossible for a concern to keep a meaningful record of its business transactions in its books.

The transactions of the business will get mixed up with the private

transactions of the proprietors, and consequently, a true picture of the state of affairs of the business will not be available.

Further, because of this concept, it is possible to record in the books of the firm even the transactions that take place between the business and the proprietors. It is on the basis of this concept that the money or moneyâ&#x20AC;&#x2122;s worth introduced by the proprietors into the business, the withdrawals made by the proprietors from the business and the profit or loss of the business belonging to the proprietors are recorded in the books of the business as transactions between the business and a distinct party, viz., the proprietors.

Again, by extending the business entity concept to the various departments of a concern, and by maintaining separate accounting records for the transactions of each of the departments of the concern, a clear picture of the efficiency (i.e., the profit or loss) of each of the departments of the concern can be obtained.

Going â&#x20AC;&#x201C; concern Concept : The going-concern concept means that, in accounting, enterprises considered as a going

concern (i.e., a concern that will continue to operate for a long time), and it is from this point of view, its transactions are recorded in its books.

This concept or assumption has two-fold significance. Firs, it makes a distinction between revenue expenditures and capital expenditures possible and meaningful.

It is only when this

assumption is made and accounts are prepared for a short period for a concern which is deemed to have a long life, that some expenditures (i.e., expenditures whose benefit will be exhausted within a year) can be treated as revenue expenditures and other (i.e., those whose benefit will list for many years) can be treated as capital expenditures. If this assumption is not made, and accounts are prepared on the assumption that the concern will last just for a short period of one year, then, all expenditures have to be treated as revenue expenditures, and the question of distinction between revenue expenditures and capital expenditures will not arise.

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Secondly, it is because of this assumption that the fixed assets of a concern, which are not intended for immediate sale, but are means for use in the business, are shown in its accounting records at cost prices less depreciation written off to date, and not at their realizable values.

Cost concept : The cost concept signifies that the fixed assets of a business are ordinarily, recorded in its

books of accounts at their const prices (i.e., the prices paid for their acquisition), and not at their current market prices.

Suppose buildings worth Rs.10,00,000 are purchased by a concern for

Rs.8,00,000, the buildings are recorded in the books of the concern only at their cost price of Rs.8,00,000 and not at their market price of Rs.10,00,000.

From the cost concept, it naturally follows that, if a concern has not paid anything for an item i.e., and asset, which it has, then that item is, usually, not recorded in its books. It is for this reason that goodwill (i.e., good reputation) built by a business is usually not recorded in its books as an asset. Of course, if a concern has paid something for goodwill on the acquisition of business from another concern, then, goodwill will appear in its books at the cost price.

Another point to be noted is that the cost concept does not imply that the assets of a business should remain in its books at their const prices always, i.e., as long as they are owned by the concern. What it really means is that the assets should appear in the books of the concern at their cost prices at the time of their acquisition, and in subsequent years, they should appear at their cost prices less depreciation written off to date.

Recording of an asset in the books of a business at its cost price is justified on many grounds. First, cost price is the actual price that is agreed upon by both the parties to a contract, i.e., the purchaser and the seller. So, there is some objectively. Secondly, this practice contributes to true accounting records. Thirdly, the cost concept prevents a concern from giving arbitrary value to an asset. Lastly, the cost price of an asset is stable, while the market price of an asset is variable.

Dual-aspect Concepts, Equation Concept or Accounting Equation Concept : Every business transaction always results in receiving of some benefit of some value and

giving of some other benefit of equal value. For instance, when a business purchases god for cash, it receives goods of some value and gives cash of equal value. Similarly, when it sells goods for cash,

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it receives cash of some value and gives goods of equal value. Thus, every business transaction involved dual or double aspects of equal value. So, in accounting, a record is made of the dual or two aspects of each transaction.

The dual aspect or the equation concept can also be explained in another way.

Each

transaction of a concern has dual or double effects, viz., (a) an increase in the assets and a corresponding increase in the liabilities or the proprietor’s capital or (b) a decrease in the assets and a corresponding decrease in the liabilities or the proprietor’s capital or (c) a decrease in some asset or assets and a corresponding increase in some other asset or assets without any change in the liabilities or (d) a decrease in some liability or liabilities and a corresponding decrease in some other liability or liabilities without any change in the assets. For instance, when the proprietor invests some capital in the business, there is an increase in the assets of the business, and there is also a corresponding increase in the proprietor’s capital. When the business buys some goods on credit, there is an increase in the assets of the business, and there is also a corresponding increase in the liabilities of the business, and there is also a corresponding increase in the liabilities of the business. When the proprietor withdraws some amount from the business for his private expenses, there is a decrease in the assets of the business, and there is also a corresponding decrease in the proprietor’s capital. When the business pas off one of its creditors, there is a decrease in the assets of the business, and there is also a corresponding decrease in the liabilities of the business. If the business sells goods for cash, there is a decrease in one asset, viz., goods, and there is a corresponding increase in another asset, viz., cash. When the business gives a promissory note or a bill payable to one of its creditors, there is a decrease in another liability, viz., and bills payable. Thus, each business transaction undertaken by a concern has a two-fold effect, an effect on its assets on the one hand and an effect on some asset or assets and an equal effect on some other asset or assets, or an effect on some liability or liabilities and an equal effect on some other liability or liabilities. As such, each transaction will always result in equality of assets and liabilities, and at nay point of time, the total assets of the concern will be equal to its total liabilities plus the proprietor’s capital. In short, in the books of any business, at any moment of time,

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Assets = liabilities + proprietorâ&#x20AC;&#x2122;s capital.

This equation or accounting equation, viz., assets = liabilities + proprietorâ&#x20AC;&#x2122;s capital can be explained with a few examples.

Suppose the business receives Rs.30,000 form the proprietor as capital. In this case, on the one hand, the assets of the business increase by Rs.30,000 on account of the receipt of cash, and on their other hand, the capital of the proprietor increases by Rs.30,000. If the two-fold effect of this transaction is put in the form of an accounting equation, the equation will be

Assets

Liabilities + Capital Rs.

Rs. Cash 30,000

+ 30,000

Now, let us suppose the business borrows Rs.10,000 from some lender, In this case, the assets of the business increase by Rs.10,000 on account of the receipt of cash, and the liabilities of the business also increase by Rs.10,000 because of the borrowing of loan. If the dual effect of this transaction is recorded, the accounting equation will be :

Assets

Liabilities + Capital

Rs.

Cash

Loan

30,000 + 10,000

10,000

+ 30,000

Suppose the business buys goods worth Rs.15,000 from some supplier on credit. In this case, the assets of the business increase by Rs.15,000 on account of receipt of goods and the liabilities also increase by Rs.15,000 on account of the purchase of goods on credit. If the two-fold effect of this transaction is recorded, the accounting equation will be :

Assets

Liabilities + Capital

Rs.

Cash + Stock 30,000 + 10,000

Loan =

10,000 +

Creditors + Capital 15,000

+ 30,000

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The accounting equation, assets – liabilities + capital, given above can also be expressed in two other ways. They are :

Assets – Liabilities = Capital.

2. Assets – Capital = Liabilities.

The dual aspect concept or the accounting equation concept is very useful in accounting. It forms the very basis for recording every business transaction in the books of a concern.

Again, the accounting equation, assets – liabilities = capital, helps a concern to determine its profit or loss. At any point of time, the capital of the proprietor of a business is its assets minus its liabilities.

On the basis of the above accounting equation, the capital of the proprietor can be calculated at various points of time, say, at the beginning of the accounting year and at the end of the accounting year. The capital of the proprietor calculated at two different points of time (viz., at the beginning of the accounting year and at the end of the accounting year) can be compared and the profit or loss of the business during the accounting year can be easily ascertained. If the proprietor’s capital of the accounting year, the difference can be taken as the profit for the year. On the other hand, if the proprietor’s capital at the end of the accounting year is less than his capital at the beginning of the accounting year is less than his capital at the beginning of the accounting year, the difference can be taken as the loss for the year.

Illustration: Anand had the following transactions. Use Accounting Equation to show their effect on his assets, liabilities and capital.

Invested Rs.15,000 in cash

2. Purchased securities for cash Rs.7,500

3. Purchased a building for Rs.15,000 giving Rs.5,000 in cahs and the balance through a loan.

4. Sold securities costing Rs.1,000 for Rs.1,500

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5. Purchased for cash an old car for Rs.2,800

6. Received cash towards salary Rs.3,600

7. Paid cash of Rs.500 for loan and Rs.300 for interest

8. Paid cash for household expensed Rs.300

9. Received cash for dividend on securities Rs.200

Solution:

This transaction brings in cash of Rs.15,000; does not result in any liability result in a capital

of Rs.15,000. So, the ultimate accounting equation will be :

Assets

Liabilities

Rs.

+ Owner’s Capital

Rs.

Cash 15,000 =

Nil

15,000

1. This transaction brings in securities or investments of Rs.7,500 and decreases the cash by Rs.7,500; does not result in any liability; does not result in any change in owner’s capital. So, the ultimate accounting equation will be: Assets Cash

Liabilities Rs. + Securities

+ Owner’s Capital Rs.

Rs.

( 15,000 - 7,500) 7,500 + 7,500 =

15,000 = Nil +

15,000

2. This transaction brings in building of Rs.15,000 and reduces the cash by Rs.5,000; result in a loan, i.e., a liability of Rs.10,000; does not result in any change in owner’s capital. So the ultimate accounting equation will

Assets =

Cash

Liabilities

Owner’s Capital

Rs.

Securities

Rs. +

( 7,500 - 5,000) 2,500 + 7,50

Buildings Loan +

15,000 = 25,000

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16 15,000

This transaction reduces the securities by Rs.1,000; and increases the cash by Rs.15,000; does not result in any change in any liability, increases the owner’s capital by Rs.500 as a result of the profit made on the sale of securities.

So, the ultimate

accounting equation will be :

4. This transaction brings in a car of Rs.2,800 and reduces the cash by Rs.2,800; does not result in any change in any liability; does not result in any change in the Owner’s capital. Therefore, the final accounting equation will be :

Assets =

Liabilities

Rs. Cash

Owner’s Capital

Rs. + Securities

Rs. + Buildings + Car Loan

( 4,000 - 2,800) 1,200 + 6,500

+ 15,000 + 25,000 = 25,000

10,000 + 15,000

5. This transaction increase the cash by Rs.3,600; does not result in any change in any liability; increases the owner’s capital by Rs.3,600 on account of the income resulting from the salary received. So, the final accounting equation will be :

Assets =

Liabilities

Rs. Cash

Owner’s Capital

Rs. + Securities

Rs. + Buildings + Car Loan

( 1,200 + 3,600) 4,800 + 6,500

+ 15,000 + 2,800 = 29,100

+ (15,000+3,600)

10,000

19,100

6. This transaction reduces the cash by Rs.800; reduces the loan by Rs.500; reduces the owner’s capital by Rs.300 because of the expenses, i.e., interest paid on loan. So, the final accounting equation will be :

Assets =

Liabilities

Owner’s Capital

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Rs.

(4,800 - 800) 4,800 + 6,500 + 15,000 + 2,800 = 28,300

(10,000-500) = 9,500+ (19,100-300) 18,800

7. This transaction reduces the cash by Rs.300; does not result in any change in any liability; reduces the owner’s capital by Rs.300 on account of withdraw of cash from the business for his household expenses. So, the final accounting equation will be :

Assets = Rs. Cash

Liabilities

Owner’s Capital

Rs. + Securities

Rs. + Buildings + Car Loan

( 4,000 - 300) 3,700 + 6,500 + 15,000 + 2,800 = 28,000

9,500 + (18,800-300) = 18,500

8. This transaction increases the cash by Rs.200; does not result in any change in any liability; increases the owner’s capital by Rs.200 because of the receipt of an income, viz., and dividend on securities. Therefore, the ultimate accounting equation will be :

Assets = Rs. Cash

Liabilities

Owner’s Capital

Rs. + Securities

Rs. + Buildings + Car Loan

( 3,700 + 200) 3,900 + 6,500 + 15,000 + 2,800 = 28,000

9,500

+ (18,500+200) = 18,700

Accounting Period Concept: It is true that, in any concern, business activity is a continuous process continuing for a long

period of several years. But, to determine the progress of the concern (i.e., the profit or loss made by

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the concern) from time to time, in the books of accounts, the continuity of the business is broken for each accounting period, usually a year .

The accounting period concept has a great significance.

But for this accounting period

concept, it would not be possible to determine the performance, i.e., profit or loss, of a business except on its termination.

But there is no use in knowing the performance of a business of its

termination. It is only if the performance of a business is known from time to time, that steps can be taken from time to time for the improvement.

Objective Evidence Concept : This concept means that all accounting entries should be evidenced and supported by

business documents, such as invoices, vouchers, etc.

This concept also implies that the evidences, (i.e., the business documents supporting the accounting entries) must be completely objective (i.e., must state the facts as that are without bias or fraud) and must be subject to verification by auditors. It is only when the accounting entries are supported by objectively determined evidences, which are subject to verification by auditors, the accounting records will be accepted by various groups of people interested in accounting information with confidence.

Matching Concept : The aim of every business concern is to earn profit. As such, every business concern would like to measure (i.e., calculate) its not profit or loss. To measure the net profit or loss of a business, certain techniques are adopted in accounting. One of the important accounting techniques employed for measuring the net profit or loss of a business is the matching (i.e., setting off) of costs or expenses against revenues for the purpose of the determination of the net profit or loss of a business is popularly known as the matching concept.

The matching concept implies that, to determine the net profit or loss of a business for any particular accounting year, three steps have to be taken. First, the total revenues (i.e., the revenues from sales and services and also the non-operating revenues like rents received, interests received and dividends received) of the business during the year have to be measured or determined. Secondly, the total expired costs or expenses (i.e., the operating expenses, such as the costs of

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goods sold, the administration expenses, selling and distribution expenses and Financial expenses and also the non-operating expenses and losses, such as loss by fire, loss on sale of fixed assets, etc,) of the business during the year have to be measured or calculated. Finally, the total expenses of the business during the year have to be matched or set off against the total revenues of the business during the year, and the residual amount (i.e., the difference between the total revenues and the total revenues of the year are more than the total expenses of the year, the difference has to be taken as the net profit. On the other hand, if the total expenses of the year are more than the total revenues of the year, the difference has to be taken as the net loss.

Realisation Concept: It is true that revenue from the sale of goods or from the service rendered. But the question is as to when (i.e., at what point of time ) the revenue results from the sale of goods or the service rendered. The realization concept gives clarification on this point. The realization concept states that the revenue from the sale of goods or from the service rendered should be recognized (i.e., should be considered to have been earned or realized) neither on the date on which the order for the supply of goods or request for the service is received for the goods sold or service rendered, but on the date on which the goods are transferred from the seller to the buyer, and the buyer becomes legally liable to pay for the goods sold or the date on which the service is rendered and the receiver of the service becomes legally liable to pay for the service. This point can be explained with an example. Suppose an order for the supply of goods was received on 1st April, 2007, the goods were actually sold and legally transferred to the buyer on

1st May, 2007 and the payment for the goods sold was received

on 1st June,2007. In this case, the revenue from the sale of goods should be recognized i.e., should be considered to have been realized or earned) neither on 1st April, 2007 nor on 1st June, 2007, But only on 1st May, 2007.

The rationale for this concept is that accounting is only a historical, and not an astrological, record of business transactions, and as such, it must record only those transactions that have actually materialized or taken place, and not those that are likely to happen.

Accrual Concept : The accrual concept signifies that net increase or net decrease in the ownerâ&#x20AC;&#x2122;s capital between the beginning and the end of any accounting year accruing or resulting from any transaction, other

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than the additional capital brought in by the proprietor or the withdrawal made by the proprietor from the business for his personal use, is the net profit or the net loss for that accounting year.

Sales of goods (of course, at a price higher than their cost price and services rendered during any accounting year will result in increases in owner’s capital, and So, they are called revenues. For instance, when goods of the value of Rs.800 are sold for Rs.1,000 for cash, the stock of the business decreases by Rs.800, and the cash of the business increases by Rs.1,000. That means, there is a net increase of Rs.200 in the assets. But there is no change in the liabilities of the firm. When there is only an increase in the assets, but not an increase in the liabilities of the firm, the implication is that there is an increase in the owner’s capital. This increase in the owner’s capital is called revenue. Similarly, if goods of the value of Rs.2,000 are sold for Rs.2,500. That means, there is a net increase of Rs.500 in the assets of the business.

However, there is no increase in the liabilities of the

business. When there is a increase in the assets of the business without any increase in the liabilities of the firm, the proprietor’s capital increases, and so, revenue accrues.

So also, if the business renders a service, say acts as a selling agent of some concern and receives some commission, say, Rs.300 on account of the receipt of cash for commission. But there is no corresponding increase in the liabilities of the firm, That means, the owner’s capital increases by Rs.300, and So, revenue accrues to that extent.

Cost of goods purchased for sale, transport charges, office expenses, advertisement, etc. incurred to effect sales or expenses incurred to render services reduce the owner’s capital. So, they are considered as expenses. For instance, when the business spreads Rs.500 on advertisement to effect sales, there is a decrease in the assets of the firm by Rs.500 on account of payment of cash for advertisement. But there is no corresponding decrease in the liabilities of the firm. That means, there is a decrease in the owner’s capital by Rs.500. The decrease in the owner’s capital is called an expense.

Thus, owner’s capital increases because of some revenues, and decreases on account of some expenses. When the total increases in the owner’s capital or total revenues exceed the total decreases in the owner’s capital or total expenses (i.e., when there is a net increase in the owner’s capital),there will be net profit. On the other hand, if the total decreases in the owner’s capital or total

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expenses exceed the total increases in the ownerâ&#x20AC;&#x2122;s capital or total revenues (i.e., when there is a net decrease in the ownerâ&#x20AC;&#x2122;s capital), there will be net loss.

The accrual concept also suggests that, as revenues accrue in the year in which they are earned, and not in the year in which they are actually received, and expenses accrue in the year in which they are incurred and not in the year in which they are actually paid, for the accounting year, the total revenues accrued or earned during the accounting year (i.e, revenues earned and received during the accounting year plus revenues earned, but not received during the accounting year and the total expenses accrued or incurred during the accounting year (i.e., expenses incurred and paid during the accounting year plus the expenses incurred, but not paid during the accounting year) should be taken into account.

The accrued concept also means that, in case the revenues actually received during a particular accounting year include some revenues not yet earned for the year i.e., if there are revenues which relate to the next accounting year), the revenues received, but not year earned during the year should be adjusted (i.e., deducted) from the total revenues received during the accounting year.

Similarly, if the expenses actually paid during a particular accounting year include some

expenses not due for the year (i.e., if there are expenses which relate to the next accounting year), the expenses paid, but not due should be adjusted (i.e., deducted) from the total expenses paid during the accounting year.

Important Accounting Conventions: Accounting conventions refer to customs, traditions, usages or practices followed by accountants as a guide in the preparation of financial statements. They are adopted to make the Financial statements clear and meaningful.

There are a number of accounting conventions adopted by accountants.

Some of the

important accounting conventions are :

Convention of Materiality: This convention means that, in accounting, a detailed record is made only of those business transactions which are material (i.e., signification). No detailed record is made of transactions which are trivial (i.e., insignificant), as the work of recording the minute details of such transactions is not

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justified by the usefulness of the results. In the case of such trivial transactions, only a broad view is taken. Let us consider as to how a trivial transaction is recorded in the books of accounts. A new pencil purchased and supplied to the office is, no doubt, an asset for the concern. Everyday when someone in the office writes with the pencil, a portion of the pencil is used up, and as such the value of the pencil decreases. Theoretically, it is possible to ascertain daily the part of the pencil used up and the part that remains. But the cost of such an effort will be very high. So, in accounting, a simpler, through less exact, treatment is given to pencil. The pencil is taken as used up at the time it is purchased or at the time it is issued to the office.

Convention of Conservatism : The convention of conservatism means the convention of caution or the policy of playing safe. In other words, it means that in the accounting records and the financial statements of a business, all the prospective losses, risks and uncertainties should be taken note of and provided for, but prospective profits should be ignored. In short, ‘’provide for all possible losses, but anticipate not profits’’ is the implication of this convention. It is on account of this convention that provision of this convention. It is on account of his convention that provision for doubtful debts, provision for discount on debtors, provision for functions in the prices of investments, etc, are made. Again, it is because of his convention that sock in trade is valued at cost price or market price, whichever is lower, and intangible assets like goodwill are written off.

The idea behind the convention of conservatism is that the Financial position of a firm should not be shown better than what it is.

It may be noted that this convention does not mean that the Financial position of a concern should be shown worse than what it is. In other words, it does not permit the creation of secret or hidden reserves.

Convention of Consistency: The convention of consistency signifies that the accounting practices and methods should remain consistent (i.e., unchanged) from one accounting year to another. For instance, when once a particular method of depreciation is adopted for a particular fixed asset, the same method should be followed for that asset year after year. Similarly, when once stock-in-trade is valued at cost price or market price, whichever if lower, the same practice should be continued for all the years.

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The idea behind the convention of consistency is that, unless the same accounting practices and methods are followed from year to year, comparison of the accounting figures of one year with those of another would be difficult, and consequently, drawing of conclusions about the progress of the concern over a number of year becomes difficult.

It should be noted that the convention of consistency does not mean that the accounting treatment of various categories of assets should be consistent with one another. For instance, this convention does not mean that the same method of valuation should be followed for both current assets and fixed assets. What it really means is that, whatever accounting practice is followed for a particular asset, the same practice should be followed for that asset from year to year.

Another point to be noted is that this convention does not mean that the accounting practices and methods, once adopted, should not be changed. The accounting practices and methods can be changed; when needed. But any change made in the accounting practices and methods should be clearly disclosed and adequately explained.

Convention of Disclosure: The convention of disclosure means that all the material facts must be disclosed in the Financial statements. For instance, as regards the investments, not only the various securities held by a concern should be disclosed, but also the mode of their valuation should be stated. In the case of sundry debtors, not only the total amount of sundry debtors should be disclosed, but also the amount of goods and secured debtors, the amount of goods, but unsecured debtors and the amount of doubtful debts should be mentioned.

In the case of fixed assets, their cost prices and the

depreciation written off to date should be disclosed. If there are any contingent liabilities, a reference should be made to them in the balance sheet.

Similarly, in the profit and loss account, all the

expenses and incomes should be clearly stated.

For a better understanding of accounting, it is necessary to know beforehand the meanings of certain terms, which are frequently used in accounting.

Double Entry System: This system owes its origin to an Italian merchant named Loco Pacholi who wrote the first book entitled it compotes yet scriptures on double entry accounting in the year 1494. Every business

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transaction has two aspects, it when we receive something we give something else in return. For Eg. whom we purchase goods for each, receive goods and give cash in return, similarly in a credit sale of goods, goods, are given to the customer and the customer becomes debtor for the amount of goods sold to him. This method of writing every transaction in two accounts is known as Double entry system of accounting. Of the two accounts one account in given debit while the other account in given credit with an equal amount. Then, on any date, the total of all debits must be equal to the total of all credit because every debit has a corresponding credit.

Rules of the Double entry system: There are separate rules of the double entry system in respect of personal, real and nominal accounts. 1.

Personal Accounts : These accounts record a business’s dealings with persons or firms. One person receiving

something in given debit and the person giving something is given credit. For eg. If x sells goods to y on credit, Y’s account will be given debit (in x’s book) as he is the receiver of goods and x’s account will be credited (in y’s book) as he is the giver of goods. When Y makes the payment for these goods, X’s account will be deleted in Y’s books as he in the receiver of cash and Y’s account will be given credit in the books of X as he is the giver of cash. So, the rule is; debit the receiver and credit the giver.

2. Real account : These are the accounts of assets. Assets entering the business in given debit and credits leaving the business is given credit. For eg. When goods are sold for cash, cash account will be given debit as cash comes in and goods account will be credited as goods go out. So, the rule is ; Debit what comes in and credit what goes out. 3.

Nominal account :

The accounts deal with expenses, incomes, profits and losses. Accounts of expenses and losses are debit and accounts of incomes and gains are credited. For eg. when rent is paid to the landlord, rent account is deleted as it is an expense and the cash account is credited as it goes out. So, the rule is Debit all expenses and losses and credit all incomes and gains.

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Rules of the Double entry system: Personal Accounts

Real Accounts

Nominal Accounts

Debit

Credit

Debit

Credit

Debit

Credit

Receiver

Giver

What comes in

What goes out

All Expenses

All Income and

and Losses

Gains

Steps involved in analysis of Transactions: It make a correct record of transactions in asset of books, each transaction by should be analyzed. The following steps must be taken in this respect.

Step : 1

Fund out which are the two accounts involved in the transaction to be recorded.

Step : 2

Identify whether the two accounts involved in the transactions are personal, real or nominal.

Sept : 3

Apply the rules of debit and credit which are applicable to the accounts involved.

Setps : 4

Decide which account should be debited or credited.

For e.,g: The transaction in: Goods purchased for cash for Rs.10,000/-under step I, the two accounts involved in the above transaction are (a) goods and 9b) cash (purchasing is an activity â&#x20AC;&#x201C; students must know)

Under step 2, the above said two accounts namely goods and cash are Real accounts.

Under step 3, the rule of real accounts is debit what come in and credit what goes out. Hence goods comes in and cash goes out.

Under step 4, Goods account must be debited and cash account must be credited. So, the entry will be,

(xi)

Drawings :

Any amount or goods with drawn by the owner of the business for personal

use is called drawings.

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Loss:

A loss is an expenditure without any benefit to the concern. On the other

land, expense is incased to result in some benefits.

(xiii)

Voucher : Any written document in support of a business transaction

(xiv)

Turnover : It means total trading income from cash sales and credit sales.

Accounting Equation: American accountants have devised the rules of debit and credit through accounting equation which is given below.

Assets =

Equities (or)

Assets =

Liabilities + Capital

Rule of Accounting Equation: 1.

Regarding assets : Increase in assets is debits and decreases in assets are credits.

2. Regarding Liabilities : Increases in liabilities are credits and decreases in liabilities are debits.

3. Regarding Capital : Increases in capital are credits and decreases are debits.

4. Regarding expenses : Increases in expensed are debits and decreases are credits.

5. Regarding Incomes a Profits : Increase in income or profits are credits and decrease are debits.

Advantages of Double Entry system: The following are the main advantages of double entry system.

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By following the double entry system, a complete record of the Financial transactions is maintained because it record both the aspects of every Financial transaction. 1. It gives accurate information of amount due to and due by the business unit at any time because complete record of amount due from various debtors and amount due to various creditors is kept by maintaining personal accounts of debtors and creditors. 2. Arithmetical accuracy of the account books can be tested by preparing a trial balance by taking balances of all ledger accounts.

3. It is helpful in preventing errors and trends.

4. It enable the business unit to take action to increase the profit by comparing the profit and loss account of the current year with that of previous years.

5. Financial position of the business entity can be ascertained by preparing the Balance Sheet.

6. It makes available readymade information to the sent to income tax and sales tax authorities.

7. It is helpful in filing account claim for loss of stock as a result of this to the coinsurance company.

Disadvantages of Double Entry system:

The following are the main disadvantages of this system.

1. This system repairs the maintenance of a number of books of account which is the practical in small concerns.

2. This system is costly because a number of accounts are to the maintained.

3. There is no guarantee of absolute accuracy of the books of accounts in spite of agreement of the trial balance.

1.10 Journal Journal is derived from the French work ‘’ Jour’ which means a day. Journal means daily record. It is a book of original record where every transaction is recorded in the first instance and the

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nit is posted to the ledger. The form in which it is recorded is called journal entry and recording or entering a transaction in the journal is known as journalizing.

Ruling of Journal: The specimen ruling of journal is given below : JOURNAL Date

Particulars

Year

Name of Account to be debited

Month

Date

Name

Dr. Amount

Cr. Amount

Rs.

Account to be credited (narration

explanation)

The columns have been numbered only to make these clear to the reader otherwise in practice they are never numbered.

Column(1). The date of transactions is written in the first column after writing the year on the top, the column is subdivided into two sub-columns one for month and the second for date.

Column (2). In this column the account to be debited and credited are written in such a way So that it may start leaving few spaces from the date line and the work Dr. is written against it near the line L.F. In the next line the account to be credited is written preceded by the word â&#x20AC;&#x2DC;Toâ&#x20AC;&#x2122; leaving few space from the line of debit entry. Narration or explanation is given in the brackets.

Column (3). It indicates the page number of the ledger where the account is opened and posting from the journal is made.

Column (4 &5).

In these columns, the amount to be debited and credited is written separately

mentioning the nature of currency.

Rules of Journalizing:

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Rules of debit and credit have already been discussed in the previous chapter but in order to recapitulate, these are given again :

Based on Accounting Equation 1. Increases in assets are debits, decreases are credits.

2. Increases in liabilities are credits, decreases are debits.

3. Increases in capital are credits, decreases are debits.

4. Increases in profits are credits, decreases are debits.

5. Increases in expenses are debits, decreases are credits.

Based on Traditional Approach: 1. Debit the receiver, credit the giver.

2. Debit what come in, credit what goes out.

3. Debit all expenses and losses, credit all incomes and gains.

Point to be noted in journalizing : 1. Capital Account : If the proprietor has introduced cash or goods or property in business, It is known as capital. It should be debited to Cash / Stock of Goods / Property Account and credited to the Proprietorâ&#x20AC;&#x2122;s Capital Account. It must be clearly understood that the entity of the proprietor is totally different from the business.

2. Drawing Account : If the proprietor has withdrawn cash or goods from the business for his personnel or domestic use, it is called Drawings.

It should be debited to Drawings Account and

credited to Cash/Purchases Account.

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3. Cash / Credit Transactions : When Goods are purchased or sold for cash, it is known as cash transaction. If the goods are purchased or sold on credit i.e., the payment will be made or received after some time, it will be a credit transaction. If nothing is mentioned whether it is a credit or cash transaction, the nit should be treated as a credit transaction. For example, goods sold to X for Rs.2,000 or goods purchased from Y for Rs.1,000 etc.

4. Casts and carry forwards: When journal entries extend to several pages of the journal, the totals are cast (done) at the end of each page. At the end of each page the words ‘Total C/f (C/f stands for carried forward) are written in the particulars column against the debit and credit totals. On the next page, in the beginning the words ‘’Total b/f (b/f stands for brought forward) are written the particulars column against the debit and credit totals. At the end of a specified period or on the last page, the grand total is cast.

5. Goods given away as charity: If some goods from the business are given away as charity to a particular person on institution, it should be debited to Charity Account and credited to purchases account.

6. Compound journal entry: If there are two or more transactions of a similar nature occurring on the same day and either Dr. or Cr. Account is common, such transactions can be conveniently recorded in the form of one journal entry instead of making a separate entry for each transaction. Such entry is known as compound journal entry.

7. Opening Entry: The balances of the previous year are brought forward in the beginning of the year by means of an entry in a going concern. Such entry is made on the basis of accounting equation i.e. by debiting all assets and crediting liabilities and capital account.

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Illustration: The following balances appeared in the books of Bali on 31st March 2007.

Pass the

necessary opening entry for 2007-2008.

Credit balances :

Capital Rs.30,000; Bills payable Rs.5,000 ; Creditors Rs.10,000

Debit balances : Furniture Rs.4,000 ; Machinery Rs.18,000 ; Debtors

Rs.12,000 ; B/R Rs.9,000 ; Cash Rs.2,000.

Solution: JOURNAL ENTRIES Date

Particulars

Dr. amount

2007

Furniture Account

40,000.00

April

Dr.

18,000.00

Machinery Account

12,000.00

Dr.

9,000.00

Debtors Account

2,000.00

Dr.

Bills Receivable Account

Dr.

Cr. Amount

30,000.00

5,000.00

10,000.00

Dr.

To capital Account

To Bills payable account

To Creditors Account

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(Being opening entry)

Cash Discount : This discount is allowed by a creditor to a debtor when the latter pays the amount of goods purchased by him either immediately or within a specified period. It is an incentive given to a debtor for making an early payments. Thus if the seller allows 2% discount for payment within a month. On a bill of Rs.20,000, the customer would pay Rs.19,600 if the payment is made within a month otherwise he would have to pay Rs.20,000 i.e. full amount of the bill. This discount is recorded in the books of accounts and a separate account is opened in the ledger. Being a nominal account discount allowed is debited and discount received credited. For example :

(i)

Cash received from Tharani Rs.1,900 and allowed him discount Rs.100

Cash A/c

Dr.

1,900

Discount a/c

100

To Tharaniâ&#x20AC;&#x2122;s A/c

2,000

(For cash received and discount allowed)

(ii)

Paid to Ganapathi Rs.20,000 less 2% cash discount. Ganapathi A/c

Dr.

20,000

To Cash A/c To Discount A/c

19,600 400

(Cash paid and discount received)

9. Trade Discount : It is a deduction on the gross value or list price of goods allowed by the manufacturer to the wholesaler or a wholesaler to a retailer in order to enable them to sell the goods further at list price to the consumer and yet earn a profit.

Suppose a manufacturer

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produced an article for Rs.40 may fix Rs.100 as list price and allows 35% discount to the wholesaler. The wholesaler will thus get it at Rs.65 and may sell to the retailer at 20% trade discount.

The retailer would thus get it for Rs.80 and sell to the consumer at

Rs.100. This, the manufacture earns a profit of Rs.25, the wholesaler Rs.15 and the retailer Rs.20. It is deducted from the invoice or cash memo itself from gross value of goods and is not recorded at all in the books of account. The journal entry will be passed with the net value of goods. For example bought goods worth Rs.6, 000 from Ram-less 20% trade discount.

Purcahses A/c

Dr.

4,800

To Arun ‘ s A/c

4,800

(For goods purchased from Arun)

Sometimes the purchaser may get the benefits of both discounts. In such a case, firstly trade discount is calculated on the gross value of goods sole and them cash discount is calculated on the net value of goods (i.e., gross value of gods – trade discount). For example – Bought goods worth Rs.6,000 from Arun less 20% trade discount and paid in cash full less 2% cash discount.

Purchases Account

Dr.

4,800

To Cash A/c

4,704

To discount A/c

(For goods purchased for cash and discount received)

If payment is made in part, them cash discount is calculated only on the amount paid and not on the total value of goods bought or sold. For example-Bought goods worth Rs.6,000 less 20% trade discount and 2% cash discount and paid half the amount in cash.

Purchases Account

Dr.

4,800

To supplier’s A/c

2,400

To Cash A/c

2,352

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To discount A/c

(For goods purchased and half the amount paid in cash less 2% cahs discount) Difference between Trade Discount and Cash Discount The following are the main differences between trade discount and cash discount. Basis of distinction 1.When allowed

Trade Discount

Cash Discount

It is allowed on a certain

It is allowed when payment is

quantity being purchased or as

made before a certain date

a trade practice.

2.Purpose

It is given to promote sales

It is allowed to encourage early cash payment

3.Vary with

It may vary with the quantity of

It may vary with the period

goods purchased

within which the payment is to be made.

4.Entry in books

It is not recorded in the books

A separate account in the

of account

ledger is maintained for such discount

5.Deduction

It is deducted from the invoice

It is not deducted from the invoice.

6.When offered

7.Form

It is offered at the time of sale

It is offered at the time of

of purchase

getting quick payment.

usually

given

percentage. It is given on the

It may be given in percentage or in absolute figure.

list price or catalogue price or retail price

10. Purchase of Shares : When share or securities are purchased, the entry is made at market value and not at face value. Brokerage paid on the purchase of such investment is also added in the

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amount or investment. For example, if shares of Rs.50,000 are purchased at Rs.90 a nd Rs.200 is paid as brokerage, the purchase price would be Rs.45,200 (50,000 x 90 / 100 + 200) It is debited to investment Account and credited to Cash Account. 11. Sale of shares : If shares or securities are sold, the entry should be passed at market value less brokerage, if any, paid on such shares. For example, if Rs.50,000 shares are sold at Rs.95 at 2% brokerage, the entry should be passed at Rs.93.

it is debited to cash

account and credited to investment account with Rs.46,500.

12. Expenses incidental to the purchase of Fixed assets: If some expenses are incurred on the purchase of a fixed asset, these should be added to the cost of the asset to the buyer. Such expenses should be debited to the asset account and not to any expense account. Thus installation charges paid on the purchase of machinery are debited to machinery account.

13. Insurance of Life Policy : Premium paid on the proprietor’s life insurance policy is debited to Drawing Account and not to insurance premium account. It is a personal expense and not relating to the operation of the business.

14. Carriage paid on Buyer’s Account :

When goods are sold and carriage/freight etc. is paid on buyer’s behalf, it should be debited to buyer’s personal account and not to carriage/freight account. 15. Goods distributed as free samples : If goods are distributed as free samples to promote the sale of the business. It should be debited to Advertisement Account and credited to Purchases Account.

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16. Bad Debts : When an amount is irrecoverable from a customer because of his insolvency or otherwise it is a loss for the business. It should be debited to Bad Debts Account and credited to Customerâ&#x20AC;&#x2122;s Account.

17. Interest due on loans : When a loan is taken from a person and interest is yet to be paid, it should be debited to interest account and credited to be account. 18. Loss of stock by fire: If some stock is lost by fire, it should be debited to loss of stock by fire and credited to purchases account. If any part of such loss is recoverable from insurance company, it should be debited to Insurance Claim Account and credited to loss of Stock by Fire account.

19. Commission : It is the remuneration which is given by an enterprise to an employee or an agent who is performing some services relating to purchase, sale, collections and other types of business transactions.

It is generally calculated on the basis of amount involved.

Commission paid to selling/buying agents, commission paid to bankers and porkers for services rendered, commission paid a consignee for selling goods on behalf of consignor, commission paid to property dealers for helping in getting the premises on rental basis or purchase or sale of properties etc. are some examples of commission. Commission is a nominal account, when paid will be debited as on expense and credited when received.

It is different from discount. Commission is always shown in the books of account whereas trade discount is not shown in the books. Discount is generally given on purchase or sale of goods or discounting the bills or an issue of shares or debentures but commission is always given to the agents or porkers for assisting in certain business transactions.

Illustration: Journalize the following transactions in the books of Arun :

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37 Particulars

Amount Rs.

2005 June

1 Started business with cash

45,000

2005 June

1 Paid into bank

25,000

2005 June

2 Goods purchased for cash

15,000

2005 June

3 Purchase of furniture and payment by cheque

5,000

2005 June

5 Sold goods for cash

8,500

2005 June

8 Sold goods to Chandar Walia

4,000

2005 June

10 Goods purchased from Selvam

7,000

2005 June

12 Goods returned to Selvam

1,000

2005 June

15 Goods returned by Chandar Walia

2005 June

18 Cash received from Chandar Walia Rs.3,760

200

and discount allowed to him

21 Withdrew from bank for private use

1,000

Withdrew from bank for use in the business

5,000

2005 June

25 Paid telephone rent for one year

28 Cash paid to Selvam in full settlement of his

400

5,940

account

30 Paid for : stationery

200

2005 June Rent

1,000

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Salaries to staff

2,500

Solution: JOURNAL OF ARUN Date

Particulars

L.F.

2005 June 1

Cash Account Dr.

Dr. amount

Cr.Amount

45,000

To capital Account (Being cash brought in to start business) 2005 June 1

Bank Account

Dr.

45,000

25,000

To Cash Account 25,000

(Being cash paid into bank) 2005 June 2

Purchase Dr.

Account

15,000 15,000

To cash Account (Being goods purchased for cash) 2005 June 3

Furniture Account Dr.

5,000

To Bank Account

5,000

(being purchase of furniture and payment made by cheque) 2005 June 5

Cash Account Dr.

8,500

To Sales Account

8,500

(Being goods sold for cash) 2005 June 8

Chandar Walia To Sales Account

4,000 4,000

(Being goods soldto Chandar Walia on credit)

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Purchases Dr.

Account

7,000 7,000

To Selvam (Being purchases Selvam ) 2005 June 12

Selvam

credit from

Dr.

1,000

To Returns Outwards Account

1,000

(Being goods returned to Selvam ) 2005 June 15

Return inwards A/c Dr

200 200

To Chandar Walia (Being goods returned by chandar Walia) 2005 June 18

Cash Account Dr.

3,76,040

Discount Account 3,800

To Chandar Walia (Being Rs.3,760 received from Chandar Walia and Rs.40 discount allowed to him) 2005 June 21

Drawings Dr.

Account

Cash Dr.

Account

1,000

5,000

To Bank Account (Being cash withdrawn from bank for personal use and for use in the business) 2005 June 25

Telephone Account Dr.

Rent

6,000

400

To Cash Account 400 (being

payment

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telephone rent) 2005 June 28

Selvam

Dr.

6,000

To Cash Account To Discount A/c

5,94,060

(Being cash paid to Selvam and discount allowed by him) 2005 June 30

Stationery Dr.

Account

Rent Dr.

Account

Salaries Dr.

Account

200

1,000

2,500 To Cash Account (Being payment of stationery, rent and salaries)

TOTAL

3,700

1,30,600

Illustration: Journalize the following transactions.

(i)

Goods worth Rs.5,000 given as charity

(ii)

Received Rs.9,750 from Ramkrishana in full settlement of his account for Rs.10,000

(iii)

Received a first and final dividend of 60 paise in the rupee from the official receiver of Mr.Raj, who owed in Rs.10,000.

(iv)

Sole to Mohan goods worth Rs.10,000 less 3% cash discount and received Rs.9,700 net on account by cheque.

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Bought from Kumar 7 Co, goods worth Rs.50,000 at 10% trade discount and 2% cash discount terms and paid them half the amount in cash.

(vi)

Paid Rs.500 in cash as wages on installation of machine.

(vii)

Supplied goods costing Rs.1,000 to Mathan issued invoice at 20% above cost less 5% trade discount.

(viii)

Goods worth Rs.2,000 were used by the proprietor for personal use.

(ix)

Goods uninsured worth Rs.8,000 were destroyed by fire.

Solution: JOURNAL S.No. i.

Particulars Charity A/c

LF Dr

Amount

5,000

To Purchase A/c (Goods given as 5,000 Charity) ii.

Cash A/c

9,750

Discount A/c

250

To Ramakrishnan (Cash received and 10,000 discount allowed) iii.

Cash A/c.

6,000

Bad Debts A/c.

4,000

To Rajini A/c (Being 60% cash received 10,000 and balance treted as bad debts). iv.

Bank A/c.

9,700

Discount A/c.

300

To Sales (Being goods sold & cheque 10,000 received after allowing discount) v.

Purchases A/c. To Raman & Co. To Discount received To Cash A/c. (Being purchases made

45,000 22,500 450 22,050

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and half amount paid in cash after receiving 2% discount) vi.

Machinery A/c.

500

To Cash (Wages paid on installation of 500 machine) vii.

Mohan A/c.

1,140

To Sales A/c. (Goods of Rs.1,000 supplied to Mohan at 20% more less

1,140

trade discount 5%) viii.

Drawing A/c.

2,000

To Purchase A/c. (Being goods used by 2,000 the proprietor for personal use) ix.

Goods lost by fire A/c.

8,000

To Purchase A/c. (Being goods of 8,000 Rs.8,000 destroyed by fire)

Meaning of Ledger: The term Ledger is derived from the Dutch word â&#x20AC;&#x2DC;Ledgerâ&#x20AC;&#x2122; which means to lie. therefore, means a book where the various accounts lie.

(i.e., are kept).

Ledger,

It is the book where

transactions of similar nature (i.e., transactions pertaining to a particulars person, thing of service) are grouped together in one place in the form of an account through a process called posting (i.e., the transferring of entries from the journal to the ledger) It contains accounts for all the persons with whom the business deals, for all the assets or things held by the business and for all the expenses incurred and incomes earned by the business.

Main Features of a Ledger: The main features of a ledger are: 1.

It is a derived or secondary record, as the entries in the ledger are derived from the

entries in the journal. 2.

It is a book of final entry. All business transactions are first recoded in the journal,

and are, finally, entered in the ledger.

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No doubt, the ledger is a derived record. But it is the principal book of accounts, it is

rightly called cannot of books of accounts. It is the principal or main book of accounts because it is from this book that a businessman can obtain the final information relating to the profit or loss and the Financial position of his business.

Need for Ledger :

As stated earlier, transactions are recorded in the journal in the order of date. As such, in the journal, transactions of similar nature (i.e., transactions relating to a particular account) may be found on different pages. As transactions of similar nature are found on different pages of the journal, one cannot know easily from the journal the net effect of similar transactions (i.e., the actual position of an account) on any particular date. To know easily the exact position of each account on any particular date, it becomes necessary to maintain the ledger where transactions of similar nature (ie., transactions relation to each account can be brought together in one place.

Journal Vs. Ledger :

A journal differs from a ledger in many respects. The main differences between a journal and a ledger are :

(1) As all transactions are first recorded in the journal, a journal is a book of primary, original of first entry. On the other hand, a ledger is a book of final entry, as it is the book in which the final entries of all transactions are made.

(2) A journal is only a subsidiary book, as it merely helps in the preparation of ledger accounts. But a ledger is a principal books, as it is the book which provides the accounting information relating to a business.

(3) As a legal evidence, a journal has greater weight than a ledger.

(4) In a journal, transactions are recorded daily, whereas in a ledger, entries are made Periodically, say, weekly, fortnightly, monthly or quarterly, depending upon the convenience and the requirements of the business.

(5) In a journal, information relating to a particular account is not found in one place, whereas in the ledger, information relating to any particular account is found in one palace.

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(6) The unit of entries in the journal is a transactions where as the unit of entries in the ledger is an account.

(7) Each entry in the journal shows both the debit and credit aspects of a transaction. But each entry in a ledger account shows only one aspect of transaction.

(8) Narration (i.e., a brief explanation to an entry) is written in the journal. But no narration is written in the ledger.

(9) Vouchers, receipts, invoices, debit and credit notes form the basis for the recording of transactions in a journal. On the other hand, journal entries form the basis for the writing up of accounts in the ledger.

Maintenance of Ledger:

A ledger may be maintained in the form of a bound book or in the form of loose-leaf book or in the form of cards.

Formerly, the ledger of every business concern, whether small or big, was kept in the form of abound book with pages numbered consecutively (i.e., continuously). Even today, small concerns keep only bound ledgers. However, a bound ledger is quite inconvenient, especially for a big concern which has to maintain a large number of accounts.

As a bound ledger has been found inconvenient, in recent years, big concerns have introduced loose-leaf ledgers. In the case of a loose/leaf ledger, the leaves of the ledger are not bound together in the ordinary way. They are punched and inserted in a binder in such a way that the leaves can be taken out or inserted easily. Generally, the loose-leaf ledger is that additional leaves fully written can be removed. Further, as there is locking arrangement, ledger the work of preparing ledger accounts can be distributed among a number of ledger clerks because of the possibility of removal and insertion of leaves.

Of late, some very big concerns maintain ledgers in the form of cards. Under the card system of ledger, a separate card is provided for each ledger account. The various cards are properly filed in cabinets. The cards can be taken out or inserted easily. The card system has certain advantages. First, there is the facility for withdrawing card containing closed accounts and inserting new cards.

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Secondly, the work of preparing ledger accounts can be distributed among many clerks on account of the possibility of removal and insertions of cards. However, there is no locking arrangement under this system.

Sub Division of Ledger:

In the case of a small concern with a few ledger accounts, it is possible to keep all the ledger accounts in a single ledger. But in a big concern where there are too many ledger accounts, it is inconvenient, if not impossible, to keep all the ledger accounts in a single ledger is sub-divided into three or more ledgers, depending upon the requirements of the business, to facilitate easy maintenance and quick reference. Usually, the single ledger is sub-divided into the following ledgers.

1. Debtors’ Ledger, Customers’ Ledger, Sales Ledger or Sold Ledger: This ledger contains the personal accounts of all the trade debtors (i.e., the debtors to whom goods are sold on credit). It may be noted that the personal accounts of all other debtors (i.e., debtors for assets. Sold, money lent and services rendered) are maintained in the general ledger.

2. Creditors’ Ledger, suppliers’ Ledger, Purchase Ledger or Bought, Ledger : This ledger contains the accounts of all the trade creditors (i.e., the creditors from whom goods are bought on credit). The personal accounts of all other creditors (i.e., creditors for assets purchased, money borrowed and services received) are found in the general ledger.

3. Impersonal Ledger, General Ledger, Principal Ledger of Nominal Ledger : This ledger contains all the accounts other than the personal accounts of trade bettors and trade creditors in other words; it contains all the personal accounts (i.e., all personal accounts other than the personal accounts of trade debtors and trade creditors), all asset accounts and all nominal accounts.

Form of a Ledger Account :

In the ledger, each account is allotted one or more pages depending upon the number of transactions relating to the account. Generally, an index is provided at the beginning of the page.

Ledger to facilitate easy reference to any particular account: Usually, each ledger account has the shape of the English alphabet ‘T’. It is divided into two sides, viz., (1) debit side or left-hand side and (2) credit side or right – hand side. The debit side is

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meant for recording the debit aspect of a transaction, and the credit side is meant for recording the credit aspect of a transaction. In other words, the benefit received by an account is entered on the debit side of that account, and the benefit given by an account is entered on the credit side of that account.

Working of accounting system: A ledger account is ruled as follows: Dr. 1 Date

Account 2 Particulars

3 J.F.

4 Amount

1 Date

2 Particulars

3 J.F.

4 Amount Rs.

The first column, i.e., the date column, is mean for recording the date of the transaction.

The second column, i.e., the ‘Particulars’ column, is meant for recording the details of the Transaction, i.e., the name of the Other account involved in the transaction.

The Third column, i.e., the ‘J.F.’ column (abbreviation of Journal Folio) is meant for entering the page number of the Journal from where the transaction is posted or transferred.

The fourth column, i.e., the ‘amount’ column is meant for writing the amount of the Transaction.

Alternative Form of ledger Account: There is an alternative form of ledger account adopted by banks and other concerns which would like to ascertain the balance of an account after every transaction. The alternative form of ledger account is as follows:

1 Date

2 Particulars

3 J.F.

4 Debit

5 Credit

6 Debit or Credit

7 Balance

The first column, the ‘Date’ column, is meant for recording the date of the Transaction.

The second column, i.e., the ‘Particulars ‘ column, is meant for recording the name of the other account which is debited or credited.

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The third column, i.e., ‘J.F.’ column, is meant for recording the page number os the journal from where the entry is posted.

The fourth column, i.e., the ‘Debit’ column, is meant for recording the amount debited to this account.

The fifth column, i.e., ‘Credit’ column, is meant for stating the nature of the Balance after the transaction is entered.

The last column, i.e., ‘Balance’ column, is meant for recording the amount of the balance.

Points to be noted while preparing ledger accounts: While preparing ledger accounts, the following points should be noted:

1. In the ledger, a separate account should be opened for each account found in the journal.

2. For all the transactions relating to any particular account, only one account should be maintained.

3. The name of the account should be written in bold letter at the top and in the center of each account.

4. The ‘Dr’ (i.e., the abbreviation of debit) should be written at the left-hand top corner of each account to indicate the debit side of the account and the world ‘Cr’.

5. Each account should be allowed sufficient space for posting all the entries relating to that account.

6. The journal entries should be posted to the ledger account in the order of their dates.

7. While making an entry in any ledger account, the name of that account should not appear either on the debit side or on the credit side of that account.

8. The date of each item should be entered in the date column against the entry.

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9. Every entry made on the debit side of an account should begin with the work ‘To’ in the particulars column, and every entry made on the credit side of an account should begin with the work ‘By’ in the particulars column.

10. The account which is debited in the journal should be posted to the debit side of the concerned ledger account, and the account which is credited in the journal should be posted to the credit side of the concerned ledger account.

11. While posting to the debit side of an account, the name of the account which is credited

in the journal should be written in the particulars column. On the other hand, while posting to the credit side of an account, the name of the account which is debited in the journal should be written in the particulars column.

12. A compound journal entry has to be posted in the same manner as a simple journal entry.

13. While posting an opening entry, the following points should be borne in mind:

The opening balance (or value) of each asset should be entered on the debit side of that asset account. But, while centering on the debit side of each asset account, we should not write ‘’to capital a/c’’. We should merely write ‘’ To Balance b/d’’.

The opening balance of each liability should be entered on the credit side of that liability account. But, while entering on the credit side of each liability account, we should not write ‘’By Capital Account’’. We should merely write ‘’By Balance b/d’’.

The opening capital should be entered in the capital account. But, while entering the capital account, we should not write ‘’By Assets Accounts’’ on the credit side and ‘’To Liabilities Accounts’’ on the debit side. We should merely write ‘’By Balance b/d’’ on the credit side.

From the above discussion, it is clear that an opening entry is not literally (i.e. actually) posted. The opening balances of assets, liabilities and capital are merely entered in the concerned assets accounts, liabilities accounts and capital account as ‘’To balance b/d’’ in each asset account, ‘’by balance b/d’’ in each liability account and ‘’By Balance b/d’’ in capital account.

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14. The page number of the journal from where the entry is posted should be written in the ‘J.F.’ column.

15. Every ledger account should be balanced or closed.

1.12 Balancing of Ledger Accounts: Meaning of Balancing of Ledger Account : Balancing of a ledger account or striking the balance of a ledger account is the process or act of ascertaining the balance (i.e., the difference between the two sides) of that account.

Process of Balancing a Ledger Account: The balancing of ledger account in done as follows: First, each of he two sides of the account is totaled up roughly on a separate sheet of paper, the difference between the two totals is ascertained. Then, the difference between the two totals is entered in the amount column of the lighter side to make the totals of both the sides equal. (While entering the difference in the amount column on the lighter side, the words ‘’To balance carried down, ‘’ (or To balance c/d) or ‘’By Balance carried down’’ (or By balance c/d) is written against the amount in the ‘particulars’ column to indicate that the balance is again shown below, i.e. in the account of the next balancing period). After entering the balance on the lighter side, the two sides are totaled, and lines are drawn above and below the totals. Again, at the beginning of the next balancing period, the balance is written on the opposite side with the words ‘’By Balance brought down’’ (or By Balance b/d) or ‘’to Balance brought down’’ (or To Balance b/d) in the particulars column to indicate that the balance in that account has been brought down from the previous balancing period. The balance in an account is carried from one balancing period to the next balancing period just to continue the account during the next balancing period.

Need for Balancing of Leger Accounts : Every ledger account has two sides, viz., (1) the debit side and (2) the credit side. The benefits received by an account are entered on its debit side, and the benefits given by that account are entered on its credit side. Now, the question arises whether a particular account has received more benefits that it has given or vice versa as any particular date. To find out whether a particular

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account has received more benefits than it has given or vice versa as on a particular date, it is necessary to balance that account on the give date.

To be more specific, every business concern would like to have various information and also would like to ensure the correctness of that information, either periodically or at the close of the accounting year. For instance, every concern would, naturally like to know whether the amount of cash in hand is correct or not. It can check the correctness of the cash in hand only by comparing the physical cash balance with the cash balance shown by the cash account. That means, for the verification of the cash in hand, ascertainment of the cash balance is a must. Similarly, every business concern would like to know whether the bank balance as shown by the bank pass book is correct or not. The verification of the bank balance can be done only by comparing the bank balance as shown by the bank pass book with the bank balance as shown by the bank account. That means for the verification of the bank account is quite necessary. So also, every concern would be interested in knowing periodically the amounts due from its various trade debtors So that necessary action can be taken in time for the collection to the debits. And it world also be interested in knowing periodically the amounts due to its various trade creditors So that it could make the necessary arrangement for the payment of the liabilities, the amounts due from the various trade debtors and amounts due to the various trade creditors can be found out only by balancing the personal accounts of the various trade debtors and trade creditors periodically. Above all, every business concern would be interested in knowing the net profit or net loss made during every accounting year, and its Financial position, i.e., the values of its assets, liabilities and capital, at the end of every accounting year, for this purpose, a concern should know the amounts of its various expenses and incomes for every accounting year, and the values of its assets, liabilities and capital at the end of every accounting year. To know these amounts, the accounts of expenses and incomes, and assets, liabilities and capital should be balanced at the end of every accounting year. Thus, for one reason or another, ledger accounts are required on the closing day of the accounting year.

Balancing Date, i.e., the Date on which ledger Accounts should be balance : There are no hard and fast rules regarding the date on which the various ledger accounts of a concern should be balanced. The ledger accounts may be balanced daily, weekly fortnightly, monthly, quarterly, half yearly or annually, depending upon the convenience and the requirements of the concern.

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Again, it is not necessary that all the ledger account should be balanced simultaneously on the same date. Some accounts cab be balanced daily, some weekly, some monthly, some quarterly and some only on the last date of the accounting year.

The usual balancing dates of the various ledger accounts are as follows:

a) Personal accounts of trade debtors (i.e., the persons to whom goods have been sold on credit) are, generally, balanced every month. The balances of these accounts are carried from one balancing period to the next balancing period (i.e., from one month to the next month), and the balances of these accounts as on the closing date of the accounting year are carried to the next accounting year.

b) Personal accounts of trade creditors (i.e., the persons from whom goods have been purchased on credit) are, usually, balanced every month. The balances of these accounts are carried from one balancing period to the next balancing period (i.e., from one month to the next month) and the balances in these accounts as on the closing date of the accounting year are carried to the next accounting year.

c) Personal accounts of the debtors (i.e., the persons to whom assets such as investments, furniture, machinery, etc. have been sold on credit the persons to whom loans have been advanced and the persons who owe money for the services rendered) are balanced monthly, if there are more transactions pertaining to these accounts taking place every month or only once a year, i.e., are at the end of the accounting year, if the transactions relating to these accounts are not many and do not take place regularly. If these accounts are balanced monthly, their balances are carried from one month to the next month, and the balances as on the last date of the accounting year are carried to the next accounting year, then, the balances in these accounts as on the closing date of the accounting year are carried to the next accounting year.

d) Personal accounts of other creditors (i.e., persons from whom assets have been purchased on credit, the persons from whom loans have been taken and the persons from whom money is due for their services) are balanced monthly, if there are more transactions relating to these accounts taking place every month, or only once a year, i.e., at the end of the accounting year, if the transactions relating to these accounts are not many and do not take place

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regularly. If these accounts are balanced monthly, their balances are carried from one month to the next month, and the balances as on the last date of the accounting year are carried to the next accounting year. On the other hand, if these accounts are balanced only on the last date of the accounting year then, the balances as on the closing date of the accounting year are carried to the next accounting year.

e) Proprietorâ&#x20AC;&#x2122;s capital account is, usually, balanced only once a year, on the last date of the accounting year, as there are not many transactions relating to this account. The balance in the proprietorâ&#x20AC;&#x2122;s capital account as on the last date of the accounting year is carries to the next accounting year.

Real accounts relating to goods may represent opening stock, closing stock, purchases returns, sales returns, purchases and sales. Opening stock account will show a debit balance. It indicates the stock account will show a debit balance. It indicates the stock of goods at the end of the accounting year. Purchases returns account will show a credit balance. It indicates the amount of goods returned by the business to its suppliers. Sales returns account will show a debit balance. It indicates the amount of good is returned to the business by its customers. Purchases account will show a debit balance. It indicates the amount of goods purchased by the business. Sales account will show a credit balance. It indicates the amount of goods sold by the business.

A nominal account may show a debit balance or a credit balance. A debit balance in a nominal account indicates the amount of expense or loss under that item. A credit balance in a nominal account represents the amount of income or gain under that item.

Third stage: Ascertainment of the arithmetical accuracy of the ledger balances through the preparation of Trial Balance, and the preparation of Final accounts:

Trial Balance: After all the transactions of any given period are recorded in the journal, and the journal entries are posted for a concern to verify the arithmetical accuracy of the ledger entries, before proceeding with the preparation of final accounts (i.e., the Trading and Profit and loss Account and the Balance sheet). For the purpose of verifying the arithmetical accuracy of the ledger entries, a list of debit and credit totals, or a list of debit and credit balances, of all the ledger accounts is prepared on

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any particular date. This list or statement is called a Trial Balance. So, a trial balance can be defined as a list of debit and credit totals, or a list of debit and credit balances, of all ledger accounts, prepared on any given date, for the purpose of verifying the arithmetical accuracy of the ledger entries.

Objects or Trial Balance: A trial balance serves two main purposes. They are: 1. It gives the balances of all the ledger accounts. As such, the balance of any particular ledger account can be found out easily from the trial balance without going through the ledger.

2. It is a check on the accuracy of books of accounts. If the trial balance agrees, one can reasonably be sure that the books of accounts are arithmetically accurate.

Principle Behind the Preparation of Trial Balance : The preparation of a trial balance is based on the fundamental principle of double-entry bookkeeping that for every debit in one account, there is a corresponding credit in some other account. Since every debit in the account has a corresponding credit in some other account, it naturally follows that the total debits given to all the accounts or the total debit balances of all the accounts. If the total debits given to the entire accounts tally with the total credits given to all the accounts or if the total debit balances of all the accounts, we can reasonably be sure that entries are correctly made in the ledger accounts. On the other hand, if there is some difference between the total debits and the total credits given to all the accounts or between the total debit balances and the total credit balances of all the accounts, we can conclude that there are some mistakes in the books of accounts (In this context, it should be noted that the agreement of the trial balance books of accounts, because, sometimes, the trial balance may agree, but still there may be some errors.)

Preparation of trial balance: The trial balance can be prepared at any time, say, at the end of a year, a half year, a quarter or a month. But , it is, generally, prepared at the end of a year.

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The trial balance can be prepared in two ways, viz., (1) with the debit and credit totals of the various ledger accounts, and (2) with the debit and credit balances of the various ledger accounts. But the usual practice is to prepare a trial balance with the debit and credit balances of the various ledger accounts.

The trial balance is usually prepared on a loose sheet of paper. It is ruled as follows: Trial Balance as at………………………

Serial No,

Heads (.e. Names) of Accounts

Ledger Folio

Debit Total or Debit Balance

Credit Totals or Credit Balances

Rs.

The first column is used for recording the serial numbers of the various ledger accounts whose totals or balances appear in the trial balance.

The second column is used for recording the names of the various ledger accounts appearing in the trial balance.

The third column is used for recording the page number of the ledger where these a accounts (i.e., the accounts appearing in the trial balance) are found.

The fourth column is used for recording the debit totals or debit balances of the various ledger accounts that appear in the trial balance.

The fifth column is used for recording the credit totals or credit balances of the various ledger accounts that appear in the trial balance.

Points to be noted while preparing a Trial balance :

While preparing a trial balance with the balances of the ledger accounts, the following points should be noted :

1) Only those ledger accounts which show balances should appear in the trial balance.

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2) If a ledger account shows a debit balance, it should appear on the debit side of the trial balance. On the other hand, if a ledger account shows a credit balance, it should appear on the credit side of the trial balance.

3) The nature of the balances of the various ledger accounts and their position are as follows :

a) Capital account will, generally, show a credit balance. Therefore, it should appear on the credit side of the trial balance.

b) Drawings account will show a debit balance. Therefore, it should appear on the debit side of the trial balance.

c) Sundry debtors account (i.e., the accounts of many customers grouped under a single account) will show a debit balance. So it should appear on the debit side of the trial balance. (As it would be inconvenient to show the balances of the accounts of debtors individually in the trial balance, the balances of the accounts of various debtors are grouped under a single account called sundry creditors account.)

d) Sundry creditor account (i.e., the accounts of many suppliers grouped under a single account) will show a credit balance. So, it should appear on the credit side of the trial balance. (In the case of creditors also, the balances of the accounts of various creditors are brought together under a single account called sundry creditors account.)

e) Bank account may show a debit balance or a credit balance. If the bank account shows a debit balance, it means cash at bank. So, it should appear on the debit side of the trial balance. On the other hand, if the bank account shows a credit balance, it means bank overdraft, and So, it should appear on the credit side of the trial balance.

Cash account will always show a debit balance. The debit balance of cash account means cash in hand. It should appear on the debit side of the trial balance.

g) Purchases account will show a debit balance. Therefore, it should appear on the debit side of the trial balance.

h) Sales account will have a credit balance. Therefore, it should appear on the credit side of the trial balance.

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Purchases returns, account will show a credit balance. So , it should appear on the credit side of the trial balance.

Sales returns will have debit balance. So, it should appear on the debit side of the trial balance.

k) Opening stock account will show a debit balance. Therefore is should appear on the debit side of the trial balance.

Generally, closing stock will not appear in the trial balance.

m) Investment account will show a debit balance. So, i twill appear on the debit side of the trial balance.

n) Accounts of fixed assets, such as furniture, machinery, vehicles, buildings, lands, etc. will show debit balances. So, they should appear on the debit side of the trial balance.

o) Bills receivable account will show a debit balance. Therefore, it should appear on the debit side of the trial balance.

p) Bills payable account will have a credit balance. So, it should appear on the credit side of the trial balance.

q) Accounts of expenses and losses will have debit balances. So, they should appear on the debit side of the trial balance.

Accounts of incomes and gains will show credit balances. So, they should appear on the credit side of the trial balance.

Let us consider the passing of journal entries the posting of the journal entries to

The fifth column is used for recording the credit totals or credit balances of the various ledger accounts that appear in the trial balance.

Points to be noted while preparing a Trial balance: While preparing a trial balance with the balances of the ledger accounts, the following points should be noted:

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1) Only those ledger accounts which show balances should appear in the trial balance.

3) The nature of the balances of the various ledger accounts and their position are as follows :

a) Capital account will, generally, show a credit balance. Therefore, it should appear on the credit side of the trial balance.

b) Drawings account will show a debit balance. Therefore, it should appear on the debit side of the trial balance.

Cash account will always show a debit balance. The debit balance of cash account means cash in hand. It should appear on the debit side of the trial balance.

g) Purchases account will show a debit balance. Therefore, it should appear on the debit side of the trial balance.

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h) Sales account will have a credit balance. Therefore, it should appear on the credit side of the trial balance.

Purchases returns, account will show a credit balance. So, it should appear on the credit side of the trial balance.

Sales returns will have debit balance. So, it should appear on the debit side of the trial balance.

k) Opening stock account will show a debit balance. Therefore is should appear on the debit side of the trial balance.

Generally, closing stock will not appear in the trial balance.

m) Investment account will show a debit balance. So, it will appear on the debit side of the trial balance.

n) Accounts of fixed assets, such as furniture, machinery, Vehicles, buildings, lands, etc. will show debit balances. So, they should appear on the debit side of the trial balance.

o) Bills receivable account will show a debit balance. Therefore, it should appear on the debit side of the trial balance.

p) Bills payable account will have a credit balance. So, it should appear on the credit side of the trial balance.

q) Accounts of expenses and losses will have debit balances. So, they should appear on the debit side of the trial balance.

Accounts of incomes and gains will show credit balances. So, they should appear on the credit side of the trial balance.

Let us consider the passing of journal entries, the posting of the journal entries to appropriate ledger accounts (i.e., the preparation of ledger accounts) and the preparation of trial balance from the ledger balances with the help of an illustration.

Illustration:

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Journalize the following transactions, post them to the concerned ledger accounts and prepare a trial balance from the balances of ledger accounts.

2006 June

Ganapathi Commenced business with Rs.5,000 of his own and Rs.10,000 borrowed from his friend, Ganesh.

2. 2006 June

Took loan from bank

3. 2006 June

Bought office furniture

4. 2006 June

Carriage paid for bringing the furniture of office

5. 2006 June

Paid his cricket club bill

6. 2006 June

Bought as scooter for his office use

7. 2006 June

Bought of Suresh

8. 2006 June

Bought goods from Ram subjected to a trade Discount of 5%

9. 2006 June

Sold good of padmanbhan subject to a discount of 3%

10. 2006 June

11. 2006 June

Returned goods to Suresh

Brought into the business the sale proceeds of his house hold furniture.

12. 2006 June

13. 2006 June

Paid Ganapathi on behalf of Mani.

Repaid the loan taken from his friend, Ganapathi with interest of Rs.

14. 2006 June

Gave charity

15. 2006 June

Cash sales paid into bank

16. 2006 June

Drew from bank for personal use

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Bought shares of the value of Rs.1,000 for and pad brokerage on the same.

18. 2006 June

Received from Murugesh to be credited to

Monish

19. 2006 June

Sold shares of the value of Rs.1,000 for and brokerage paid for the same

20. 2006 June

21. June 2006

Furniture destroyed by fire

Brought into the business the amount received from his uncle as presents

22. June 2006 28

Received cash from Sadanand in full settlement of his account.

23. June 2006

Shankaranand bought goods

24. June 2006

Goods given to Devanand as free samples

25. June 2006

Interest on capital

26. June 2006

Paid Salaries to Vijayanand

Paid rent to Sampath

Paid for stationery

Paid for postage

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Solution: Journal Entries Date

2005 1 Jun 1

Particulars

L.F.

Dr.

Cr.

Rs.

Cash Account To Paramanandâ&#x20AC;&#x2122;s Loan Account

Dr.

30000

Capital Account

10000

(Being the business started with loan from

20000

Paramanand and Capital) 2 Jun 3

Bank Account

Dr.

10000

To Bank Loan Account

10000

(Being the loan taken from the bank and left with the bank by way of a bank account). Note: Generally, when a bank loan is taken, the amount will be left with the bank by way of a bank account. That is why, bank account is debited and not cash account). 3 Jun 5

Office Furniture Account

Dr.

2000

To Bank A/c.

2000

(Being the office furniture bought for cash). 4 Jun 6

Office Furniture A/c.

Dr.

To Cash A/c.

100 100

(Being the carriage paid for bringing the office furniture to office). Note: Whether carriage or any other transport charge is paid on bringing of a fixed asset to the business premised, the amount

should

debited

the

concerned fixed asset, account, and not to

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Particulars

62 L.F.

Dr.

Cr.

Rs.

carriage or any other transport charge account). 5 Jun 8

Drawings A/c.

Dr.

300

To Cash A/c

300

(Being the private expenses, i.e. cricket club bill of the proprietor paid out of firm’s cash. 6 Jun 9

Vehicles (Scooter) A/c.

Dr.

5000

To Cash A/c.

5000

(Being the scooter bought for cash for the business). 7 Jun 10

Purchase A/c.

3000

To Nithiyanand’s A/c.

3000

(Being the goods bought from Nithiyanand on credit). Note: Bought of Nithiyanand means goods bought from Nithish on credit. 8 Jun 12

Purchase A/c.

1900

To Brahmanand’s A/c.

1900

(Being the goods bought from Praba on credit). Note: The net purchase price of goods (i.e.price of goods Rs.2000 less trade discount of Rs.100) viz. Rs.1900 should be taken into account. 9 Jun 14

Sathyananda’s Account To Sales A/c.

Dr.

2910 2910

(Being the goods sold to Sathyananda on credit).

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Particulars

63 L.F.

Dr.

Cr.

Rs.

Note: The net sales price of Rs.2910 (i.e.3000 – 90) should be considered. 10 Jun 15

Nithyanand’s A/c.

Dr.

200

To Purchase Returns A/c.

200

(Being the goods returned to Nithyanand). 11 Jun 16

Cash A/c.

Dr.

3000

To Capital A/c.

3000

(Being the sale proceeds of his private asset brought into the business). Note: Sale proceeds of any private asset brought into the business should be considered as capital introduced. 12 Jun 18

Dayanand’s A/.

Dr.

4000

To Cash A/c.

4000

(Being cash paid to Premanand on behalf of Dayanand) Note: Whenever money is paid to a party on behalf of somebody, the debit should be given, not to the payee’s account (i.e. the party to whom money is paid), but to the party on whose behalf money is paid. 13 Jun 19

Paramanand’s Loan A/c.

Dr.

10000

Interest on Loan A/c.

Dr.

100

To Cash A/c.

10000

(Being Paramanand’s Loan repaid with interest). 14 Jun 20

Charity (or Sundry Expenses) A/c. To Cash A/c.

Dr.

100 100

(Being the charity paid).

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Particulars

L.F.

Dr.

Cr.

Rs.

Note: The charity paid is assumed to be charity paid on behalf of the business. That is why, charity account or sundry expenses account is debited. On the other hand, if the charity is considered as charity paid on behalf of the proprietor, then it should be taken as a private expenses of the proprietor

and

debited

drawings

account) 15 Jun 21

Bank A/c.

Dr.

4000

To Sales A/c.

4000

(Being the cash sales paid into bank). Note: As the sale proceeds are paid into the bank, the debit should be given to bank account, and not to cash account. 16 Jun 22

Drawings A/c.

Dr.

1000

To Bank A/c.

1000

(Being the amount withdrawn from bank for the personal use of the proprietor). 17 Jun 23

Investment (or Shares) A/c.

Dr.

To Cash A/c.

980 980

(Being the shares bought) Note: Whenever shares or some other securities are bought, their cost price, and not their face value, should be taken into account. Further the brokerage paid for the purchase

any

security

should

considered as part of the cost of the securities.

It is for this reason that

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Particulars

brokerage

added

L.F.

the

cost

Dr.

Cr.

Rs.

investments. 18 Jun 24

Cash A/c.

Dr.

1000

To Ramanand’s A/c.

1000

(Being the cash received from Shivanand to be credited from Ramanand). Note: Whenever money is received from a party to be credited to some other party’s account, the credit should be given, not to the payer’s account, but to the party for whose credit the money is received. 19 Jun 25

Cash A/c.

Dr.

980

To Investments (or Shares) A/c.

980

(Being the investments sold for cash). Note: Whenever shares or some other securities are sold, their sale price, and not their face value, should be considered. Further the brokerage paid for the sale of securities should be deducted from the sale price, and only the net sale price should be taken into account. It is for this reason that the net sale price of Rs.980 has been taken into account. 20 Jun 26

Loss of Furniture by Fire A/c.

Dr.

200

To Furniture A/c.

200

(Being furniture lost by fire) 21 Jun 27

Cash A/c. To Capital A/c.

Dr.

5500 5500

(Being the presents received from his

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Particulars

66 L.F.

Dr.

Cr.

Rs.

uncle brought into the business as capital). Note: Any private receipt of the proprietor brought into business should be treated as capital introduced. 22 Jun 28

Cash A/c.

Dr.

2860

Discount A/c.

Dr.

To Sadanandâ&#x20AC;&#x2122;s Account

2910

(Being the cash received from Sadanand on account and discount allowed to him). 23 Jun 29

Shankaranandâ&#x20AC;&#x2122;s A/c.

Dr.

3000

To Sales A/c.

3000

(Being the goods sold to Shankaranand). 24 Jun 29

Advertisement A/c.

Dr.

100

To Purchase A/c.

100

(Being the goods given as free samples). Note: Free samples given should be considered as advertisement. Further as they are at cost and reduce the purchases available for the business, they should be credited to purchases account, and not to sales account. 25 Jun 30

Interest on Capital A/c.

Dr.

500

To Capital A/c.

500

(Being the interest allowed on capital) 26 Jun 30

Salaries A/c.

Dr.

1000

Rent A/c.

Dr.

2000

Stationery A/c.

Dr.

Postage A/c.

Dr.

To Cash A/c.

3100

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Particulars

L.F.

Dr.

Cr.

Rs.

(Being the cash paid for salaries, rent, stationery and postage). Note: As there is a common item, viz. cast, in all these payments, and as all these transactions take place on the same date a compound entry is passed for all these payments instead of separate entries.

Ledger Account - Capital Account Dr.

Cr. 2005

June 30

Rs.

To Balance C/d.

14000

2005

June 1

By Cash A/c.

5000

June 16

By Cash A/c.

3000

June 27

By Cash A/c.

5500

June 30

By Interest A/c.

500

July 1

By Capital A/c.

4000

14000

Drawings Account: Dr.

Cr. 2005

June 8

To Cash A/c.

Rs.

2007

300

June 30

By Balance A/c.

1300

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FINANCE & MANAGEMENT ACCOUNTING June 22

To Bank A/c.

1000

To Balance B/d

1300

Paramanand’s Loan Account: Dr.

Cr. 2005

June 19

Rs.

To Cash A/c.

10000

2007

June 1

By Cash A/c.

10000

Nithyananand’s Loan Account: Dr.

Cr. 2005

Rs.

2007 June 10

June 15

To Purchase A/c.

200

June 30

To Balanced B/d

2800 3000

By Purchase A/c.

3000

By Balanced July 1

B/d

2800

Brahmanand’s Loan Account: Dr.

Cr. 2005

June 30

To Balance B/d

Rs.

2007

1900

June 12

By Purchase A/c.

1900

July

By Balance B/d.

1900

Sadanand’s Loan Account: Dr.

Cr.

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2005

June 14

To Sales A/c.

Rs.

2007

2910

June 28

By Cash A/c.

2860

By Discount A/c.

2910

Dayanand’s Loan Account: Dr.

Cr. 2005

Rs.

2007

June 30

June 18

To Cash A/c.

4000

July 1

To Balance B/d.

4000

By Balance B/d

4000

Ramanand’s Loan Account: Dr.

Cr. 2005

June 30

To Balance C/d

Rs.

2007

1000

June 24

By Cash A/c.

1000

July 1

By Balance B/d

1000

Shankaranand’s Loan Account: Dr.

Cr. 2005

June 29

To Sales A/c.

Rs.

2007

3000

June 30

3000 July 1

To Balance B/d

By Balance C/d

3000 3000

3000

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Bank Loan Account: Dr.

Cr. 2005

June 30

Rs. To Balance C/d

10000

2007 June 3

By Bank A/c.

10000

10000 July 1

By Balance B/d

10000

Bank Loan Account: Dr.

Cr. 2005

June 3

To Bank Loan A/c

June 21

To Sales A/c.

Rs.

2007

10000

June 22

By Drawings A/c.

4000

June 30

By Balance C/d

1000

13000

14000

To Balance B/d

14000

13000

Cash Account: Dr.

Cr. 2005

Rs.

June 1

To Paramanand’s Loan A/c.

June 1

2007

10000

June 5

By Office Furniture A/c.

2000

To Capital A/c.

5000

June 6

By Office Furniture A/c.

100

June 16

To Capital A/c.

3000

June 8

By Drawings A/c.

300

June 24

To Ramanand’s A/c.

1000

June 18

By Vehicles A/c.

5000

June 25

To Investments A/c.

980

June 19

By Dayanand’s A/c.

4000

June 27

To Capital A/c.

5500

June 19

By Paramanand’s Loan A/c.

10000

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FINANCE & MANAGEMENT ACCOUNTING June 28

To Sadanand’s A/c.

71 2860

June 20

By Interest on Loan A/c.

100

June 23

By Charity A/c.

100

June 30

By Investments A/c.

980

June 30

By Salaries A/c.

1000

By Rent A/c.

2000

By Stationery A/c.

By Postage A/c.

28340 Jul 1

To Balance B/d

28340

2660

Office Furniture Account: Dr.

Cr. 2005

Rs.

2007

2000

June 26

By Loss – Furniture by June 5

To Cash A/c.

200 Fire A/c.

June 6

To Cash A/c.

100

June 30

By Balance C/d

1900

2100

July 1

To Balance B/d

2100

1900

Vehicle Account: Dr.

Cr. 2005

Rs.

2007

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FINANCE & MANAGEMENT ACCOUNTING June 9

To Cash A/c.

72 5000

June 30

By Balance C/d

5000

July 1

To Balance B/d

5000

Investment Account: Dr.

Cr. 2005

June 23

To Cash A/c.

Rs.

2007

980

June 25

By Cash A/c.

980

Purchase Account: Dr.

Cr. 2005

June 10

To Nithyanand’s A/c.

Rs.

2007

3000

June 29

By Advertisement A/c.

1900

June 30

By Balance C/d

100

Brahmanand’s

June 12

4800

A/c.

4900

To Balance B/d

4900

4800

Purchase Return Account:

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FINANCE & MANAGEMENT ACCOUNTING

Dr.

Cr. 2005

June 5

To Balance C/d

Rs.

2007

200

June 15

By Nithyanand’s A/c.

200

July 1

By Balance B/d

200

Sales Account: Dr.

Cr. 2005

June 30

To Balance C/d

Rs.

2007

9190

June 14

By Sadanand’s A/c.

2910

June 21

By Bank A/c.

4000

June 29

By Shankaranand’s A/c.

3000

9190

July 1

By Balnce B/d

9190

Interest on Loan Account: Dr.

Cr. 2005

Rs.

2007

June 30

June 19

To Cash A/c.

100

July 1

To Balance B/d

100

By Balance C/d

100

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FINANCE & MANAGEMENT ACCOUNTING

Charity Account: Dr.

Cr. 2005

Rs.

2007

June 31

June 20

To Cash A/c.

100

July 1

To Balance B/d

100

By Balance C/d

100

Loan of Furniture by Fire Accident: Dr.

Cr. 2005

Rs.

2007 June 30

June 26

To Furniture A/c.

200

July 1

To Balance B/d

200

By Balance C/d

200

Advertisement Account: Dr.

Cr. 2005

Rs.

2007 June 30

June 29

To Purchase A/c.

100

July 1

To Balance B/d

100

By Balance C/d.

100

Interest on Capital Account: Dr.

Cr. 2005

June 30

Rs.

2007

To Capital A/c.

500

June 30

To Balance B/d

500

By Balance C/d

500

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Salaries Account: Dr.

Cr. 2005

Rs.

2007 June 30

June 30

To Cash A/c.

1000

July 1

To Balance B/d

1000

By Balance C/d

1000

Rent Account: Dr.

Cr. 2005

Rs.

2007 June 30

June 30

To Cash A/c.

2000

July 1

To Balance B/d

2000

By Balance C/d

2000

Stationery Account: Dr.

Cr. 2005

Rs.

2007 June 30

June 30

To Cash A/c.

July 1

To Balance B/d

By Balance C/d

Postage Account: Dr.

Cr. 2005

June 30

To Cash A/c.

Rs.

2007

June 30

By Balance C/d

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FINANCE & MANAGEMENT ACCOUNTING July 1

To Balance B/d

76 30

Discount Allowed Account: Dr.

Cr. 2005

Rs.

2007

June 30

June 28

To Sadanand’s A/c.

July 1

To Balance B/d

By Balance C/d

Trial Balance of Anand as on 30 June, 2005 S.No .

Name of Accounts

L.F.

Debit Balance Rs.

Credit Balance Rs.

Capital A/c.

14000

Drawings A/c.

Nithayanand’s A/c.

2800

Brahmanand’s A/c.

1900

Dayanand’s A/c.

Ramanand’s A/c.

Shankaranand’s A/c.

Bank Loan A/c.

Bank A/c.

13000

Cash A/c.

2660

Office Furniture A/c.

1900

1300

4000 1000 3000 1000

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Name of Accounts

L.F.

Debit Balance Rs.

Credit Balance Rs.

Vehicle A/c.

5000

Purchase A/c.

4800

Purchase Returns A/c.

Sales A/c.

Interest on Loan A/c.

100

Charity A/c.

100

Loss of Furniture by Fire A/c.

200

Advertisement A/c.

100

Interest on Capital A/c.

500

Salaries A/c.

1000

Rent A/c.

2000

Stationery A/c.

Postage A/c.

Discount Allowed A/c.

200 9190

39810

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FINAL ACCOUNTS OF SOLE TRADERS Meaning of Final Accounts: Today, almost all businessmen adopt accounting.

The two important objectives with which accounting is adopted by every businessman are (1) ascertainment of profit or loss made by his business during a given trading period and (2) ascertainment of the Financial position of his business as or a given date, i.e., on the last date of the given trading period. To ascertain the profit or loss of his business, a businessman prepares a Revenue Account (i.e., an account of incomes and expenses) called Trading and Profit and Loss Account, and to ascertain the Financial position of his business, he prepares a Position Statement called Balance Sheet. The Trading and Profit and Loss Account and the Balance Sheet prepared by a businessman at the end of a trading period are collectively called Final Accounts. They are called final accounts for the following reasons :

1. They are prepared at the end of a trading period.

2. They are prepared finally, i.e., after all the books of accounts.

3. They show the final results of a business.

It is proper to call the Trading and Profit and Loss Account and the Balance Sheet Final Accounts?

Strictly speaking, it is not proper to call the Trading and Profit and Loss Account and the Balance Sheet Final Accounts, because on of the parts, viz., the Balance Sheet, is only a statement, and not an account. So, they should be called Final Account and Statement. But. In actual practice, they are called Final Accounts, and not Final Account and Statement.

Sources of Material for Final Accounts : The final accounts are prepared from the various ledger balances incorporated in the trial balance and the adjustments, if any, made at the time of the preparation of final accounts.

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Meaning of a Trading Accounts : A Trading Account is an account, which shows merely the result of trading (i.e., buying and selling of goods) called gross profit or gross loss.

When we are taking only the net profit or net loss revealed by the profit and Loss Account for preparing the Balance Sheet, why should we prepare a separate Trading Account?

The net profit or the net loss revealed by the profit and Loss Account is the ultimate result of the business after the adjustment of all management, selling, maintenance and financial expenses and non-trading losses and gains. As a result, we cannot ascertain the profitability or otherwise of the goods in which the concern is dealing. For instance, if there is low net profit or net loss, we cannot say that the line of business carried on by the concern is not profitable, because the low net profit or net loss may be due to higher management, selling, maintenance and Financial expenses and other non-trading losses. Similarly, if the net profit is high, we cannot say that the line of business carried on by the concern is very profitable, because the higher profit may be due to efficient and economical administration. Thus, the Profit and Loss Account cannot indicate the profitability or otherwise of the goods in which the concern is dealing. In order to know the profitability or otherwise of the goods in which the concern is dealing. In order to know the profitability or otherwise of the goods in which the concern is dealing, the Trading Accountant has to be prepared.

The gross profit or gross loss

revealed by the Trading Account is an indicator of the profitability or otherwise of the goods in which the concern is dealing.

Again, the gross profit revealed by the Trading Account is helpful to a concern to ascertain the gross profit-turnover (i.e., sales) ratio, which is useful in two respect. First, it enables a concern to ascertain whether or not the expected rate of profit on sales has been earned. Secondly, it enables a concern to ascertain the value of stock destroyed or damaged by fire, floods, etc. for the purpose of computing the insurance claim.

Preparation of the Trading Account: As stated earlier, the Trading Account shows only the gross profit or gross loss. The gross profit or gross loss is the difference between net sales (i.e., sales minus sales returns) and the cost of goods sold.

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The cost of goods sold does not refer to the mere cost price of goods purchased during the year. It refers to the cost of the portion of goods actually sold during the year. In order to ascertain the cost of goods sold, we have to add to the value of opening stock (i.e., stock of goods at the beginning of the year), the value of not purchases (i.e., purchases minus purchases returns) and the amount of direct or non-recurring expenses (i.e., all expenses incurred in obtaining the supply of goods and in changing the goods into saleable condition, such as carriage, freight, import duty and clearing charges, wages, power, etc.). From that total, we have to deduct the value of closing stock (i.e., stock of goods at the end of the year). Therefore, cost of goods sold means opening stock of goods plus net purchases plus all direct expenses incurred on good minus closing stock of goods.

If the net sale proceeds of goods are more than the cost of goods sold, there is gross profit. On the other hand, if the cost of goods sold is more than the net sale proceeds, there is gross loss.

Final accounts of Sole Traders : To ascertain the gross profit or gross loss, all those items which are required in finding out the gross profit or gross loss have to be taken into consideration. In other words, the opening stock of goods net, purchases, all direct expenses closing stock of foods and net sales have to be taken into account.

The gross profit or gross loss can be ascertained in the form of a Statement as follows :

Opening Stock of Goods

Xxx

Add: Net Purchases (i.e. Purchased less Purchase Returns)

Xxx

Add: Direct Expenses

Xxx Xxx

Less: Closing Stock of Goods Xxx Xxx Cost of Goods Sold Xxx Net Sales (i.e. Sales less Sales Returns)

Xxx

Less: Cost of Goods Sold

Xxx

Gross Profit or Gross Loss

Xxx

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However, the usual way to ascertain the gross profit or gross loss is by means of an account called the Trading Account. If the items required for the ascertainment of gross profit or gross loss are shown by way of an account called the Trading Account, that account i.e., the Trading Account, will appear as follows :

Trading Account for the year ended…………………… To Opening Stock

Xxx

By Sales

Xxxx

Purchases

Xxx

Less: Sales Xxxx

*Less: Purchase Returns Xxxx

Xxxx

*Closing Stock

Xxx

*Direct Expenses, such as carriage,

Xxx

*Profit and Loss Account

Xxx

cartage, freight, import duty, clearing

(Gross loss transferred to

charges, dock dues, excise duty,

Profit and Loss A/c.

octroi,

wages,

power

and

other

manufacturing expenses *Profit and Loss Account (Gross loss

Xxx

transferred to Profit and Loss A/c. Xxx

Xxx

Meaning of profit and Loss Account: The profit and Loss Account is an account which shows the net profit and net loss (i.e., the ultimate profit or loss) of a business for a ;particular trading period. The net profit or net loss is the profit earned or loss suffered after charging all business expenses (including depreciation and provisions). It is the final profit or loss of a business.

Preparation of Profit and Loss Account: To prepare the Profit and Loss Account, the gross profit or gross loss (as shown by the Trading Account) has to be, first, entered in the Profit and loss Account. If there is gross profit, it has to be entered on the credit side of the Profit and Loss Account. If there is gross loss, it has to be entered in the Profit and Loss Account. If there is gross profit, it has to be entered on the credit side of the Profit and Loss Account. If there is gross loss, it has to be entered on the debit side of profit and Loss Account. Then, all non-trading incomes, (i.e., all incomes other than those entered in the Trading Account), such as interest received, commission received, rent received, discount received, income

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from investment, bad debts recovered, interest on drawings, etc, have to be entered on the credit side of the profit and Loss Account. All indirect expenses (i.e., all expenses other than those direct expenses entered in the Trading Account) have to be entered on the debit side of the profit and loss Account. All expenses which usually appear on the debit side of a profit and Loss Account into four categories, viz., (a) administrative, management or office expenses, (b) maintenance expenses, (c) selling and distribution expenses and (d) Financial expenses office expenses are those expenses which are connected with the day-to-day administration of a concern. Examples of office expenses are office salaries, office rent, printing and stationery, postage and telegram, office insurance, office lighting and heating, audit fees, legal charges, etc. Maintenance expenses are those expenses which are incurred for maintaining the fixed assets of a concern in a working condition. Examples of maintenance expenses are repairs and renewals and depreciation of fixed assets. Selling and distribution expenses are those expenses connected with the selling and distribution of goods. Examples of selling and distribution expenses are advertisement, traveling, salesmenâ&#x20AC;&#x2122;s salaries, traveling expenses of salesmen, rent and insurance of warehouse, packing charges, commission paid, carriage outwards, bad debts, etc. Financial expenses are those expenses incurred for acquiring the finance necessary for running the business. Examples of Financial expenses are interest paid on loans, interest on capital, cash discount allowed, discount on bills discounted etc. After entering all the indirect expenses, the profit and loss Account will be balanced. The balance of the profit and Loss Account indicates the net profit or net loss for the given trading exceeds the debit side, the difference will be net profit. On the other hand, if the debit side of the profit and Loss Account of the proprietor. If there is net profit. It will be credited to (i.e., added to ) the Capital Account of the proprietor. On the other hand, if there is net loss, it will be debited to (i.e., deducted from) the Capital Account of the proprietor.

If the above items are entered in the profit and Loss Account, the profit and Loss Account will appear as follows:

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Profit and Loss Account for the year ended…………… Dr.

Cr.

Rs. Xxx To Trading Account (Gross loss transferred form Trading Account) Xxx

Trading

Account

(Gross

profit

transferred from Trading Account)

Office expenses, such as office salaries, office rent, printing and

Non-Trading Incomes, such as rent

stationery, postage and telegram,

received, interest received, commission

office insurance, office lighting and

received, discount received, bad debts

heating, audit fees, legal charges,

recovered, income form investments

general expenses, etc.

and interest on drawings. Maintenance Expenses, such as repairs and renewals and depreciation of assets.

Capital Accounts (Net loss transferred to Capital Account)

Selling and Distribution Expenses,

Xxx

such as advertisement, traveling salesmen’s salaries, traveling

Financial Expenses, such as interest

expenses commission paid,

paid on loans, interest on capital, cash

packing charges carriage outwards rent and insurance of

discounts allowed, discount on bills Xxx

discounted, etc.

warehouse bad debts, etc. Capital Account (Net profit transferred to Capital Account)

Xxx

Preparation of the Balance Sheet: The Balance sheet of a concern is divided into two sides, viz, the left-had side and the righthand side. The left-hand side is called the liabilities side and the right-hand side is called the assets side. (It should be noted that the two sides of the Balance Sheet are not called the debit and the credit sides, because the Balance Sheet is only a statement and not an account). All the liabilities and the

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capital of the proprietor have to be entered on the liabilities side and all the assets have to be entered on the assets side. If all the liabilities and the capital of the proprietor and all the assets are properly entered in their respective sides, the two sides of the Balance Sheet must tally or agree. The agreement of the totals of the two sides of the Balance Sheet is a further proof of the arithmetical accuracy of posting. It also indicates that the Revenue is not called the debit and the Account (i.e., the Trading and Profit and loss Account) is arithmetically accurate.

The assets and liabilities of a business are shown in the Balance sheet in certain order or form. The arrangement of assets and liabilities in the Balance sheet is called the marshalling or grouping of assets and are shown in the Balance Sheet viz., (1) in the order of liquidity or reliability of assets and dischargeability or payment of liabilities and (2) in the order of fixity or performance of assets which can be easily converted into cash come first, and the assets which cannot be easily realized come next.

In this context, it should be noted that, though there is no hard and fat rule regarding the order of arrangement for both assets and liabilities, it is preferable to follow the same order of arrangement for both assets and liabilities. If the assets are arranged in the order of liquidity or reliability, it is preferable to arrange the liabilities in the order of dischargeability or payment. On the other hand, if the assets are arranged in the order of fixity or permanent, it is preferable to arrange the liabilities also in the order of fixity or permanence.

If the assets are arranged in the order of reliability and the liabilities are arranged, in the order of payment, the assets and liabilities will appear in the Balance Sheet as follows :

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Balance Sheet as at……………

Liabilities

Rs.

Assets

Rs.

Bank Overdraft

Xxx

Cash in hand

Xxx

Bills Payable

Xxx

Cash at Bank

Xxx

Sundry creditors

Xxx

Bills Receivable

Xxx

Outstanding Expenses

Xxx

Sundry Debtors

Xxx

Incomes received in advance

Xxx

Closing Stock

Xxx

Long-term Loans

Xxx

Prepaid Expenses

Xxx

Capital

Xxx

Outstanding Incomes

Xxx

Investments

Xxx

Loose Tools

Xxx

Furniture and Fixtures

Xxx

Vehicles

Xxx

Plant and Machinery

Xxx

Land and buildings

Xxx

Goodwill

Xxx

Rs.

Xxx

Rs.

Xxx

If the assets and liabilities are arranged in the order of fixity or permanence, the assets and liabilities will appear as follows:

Balance Sheet as at…………….

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Liabilities

Rs.

Assets

Rs.

Capital

Xxx

Goodwill

Xxx

Long-term Loans

Xxx

Land and Buildings

Xxx

Incomes received in advance

Xxx

Vehicles

Xxx

Outstanding Expenses

Xxx

Furniture and Fixtures

Xxx

Sundry Creditors

Xxx

Loose Tools

Xxx

Bills Payable

Xxx

Investments

Xxx

Outstanding Incomes

Xxx

Prepaid Expenses

Xxx

Closing stock

Xxx

Sundry Debtors

Xxx

Bills Receivable

Xxx

Cash at Bank

Xxx

Cash in Hand

Xxx

Rs.

Xxx

Rs.

Xxx

Note : It is the usual practice for sole trading concerns to show their assets in the order of liquidity or reliability, and liabilities in the order of dischargeability or payment.

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Adjustments in Final Accounts : At the end of every trading period, it is quite usual that certain expenses of the current period are not paid, and therefore, are not recorded in the books of accounts, while certain expenses paid and recorded during the current period belong to the future period. Similarly, it is quite possible that certain incomes of the current period are not received, and So, are not recorded in the books of accounts, while certain incomes received and recorded during the current belong to the future period. Further, there are certain expenses connected with current period which are not yet incurred, but are likely to arise in the future (i.e., anticipated expenses or losses, such as provision for bad debts, provision for discount on debtors, etc.) Similarly, there are certain likely to accrue in the future. Again, there are certain expenses, such as depreciation, interest on capital, etc., which are not recorded in the books of the current period, but have to be taken into account in the final accounts of the current period. Similarly, there are certain incomes, like interest on drawings which are not recorded in the books of the current period, but have to be taken into account in the final accounts of the current period. All these items of expenses and incomes require to be adjusted while preparing the final accounts, if the final accounts are to disclose the correct result of the business (i.e., correct net profit or net loss) and the true financial position of the business. All those items which require to be adjusted at the time of preparing the final accounts are called adjustments.

In actual practice, the adjustments are made by passing entries called Adjustment or Adjusting Entries. But, in the examination, the adjusting entries need not be passes, unless we are specifically instructed to pass such entries. However, we must be familiar with the adjusting entries. So the final accounts correctly.

As the adjustments items have not bet been recorded in the books of accounts, they are found outside the Trial Balance. So, while preparing the final accounts, each adjustment item (i.e., item given outside the trial balance) has to be treated twice So as to complete the debit and credit aspects of each transaction.

Usual Adjustments in Final Accounts : The usual items requiring adjustments at the time of the preparation of final accounts are as follows :

1. Closing Stock.

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2. Outstanding or Unpaid Expenses

3. Prepaid Expenses or Expenses paid in advance.

4. Out standing incomes earned, but not received,

5. Incomes received in advance or incomes received, but not earned.

6. Bad Debts.

7. Provision or Reserve for Doubtful Debts.

8. Provision or Reserve for Discount on Debtors.

9. Provision or Reserve for Discount on Creditors.

10. Depreciation of Fixed Assets.

11. Interest on capital

12. Inters on Drawings.

Closing Stock: The stock of goods remaining unsold at the end of the trading period is called Closing Stock. It has to be valued and brought into books of account. Its value is calculated by a process known, as ‘’stock-taking’’. Under the process of stocktaking, a list of the unsold goods is sold and those unsold goods are valued at cost price or market price, whichever is lower. Then, it is brought into books of account by means of an adjusting entry. The adjusting entry necessary for recording the closing stock will be :

Closing Stock Account

Dr.

To Trading Account.

The closing stock has to be treated in the final accounts as follows :

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First it has to be entered on the credit side of the Trading Account. Secondly, it has to be entered on the assets side of the Balance Sheet under the head ‘’Current Assets’’.

2. Outstanding Expenses: It is quite usual that certain expenses like wages, salaries, etc, incurred during a particular trading period are not paid during that period due to some reason or other. The expenses incurred during a particular trading period, but not paid during that period are called outstanding or Unpaid expenses. All such expenses must be brought into account in the final accounts by means of an adjusting entry. The adjusting entry required for bringing the outstanding expenses into account will be: Various Expenses Accounts

Dr.

To Outstanding Liabilities For Expenses Account The outstanding expenses have to be treated in the final accounts as follows : First, the outstanding amounts of various outstanding expenses have to be entered on the liabilities side of the Balance Sheet as ‘’Outstanding Liabilities for Expenses’’ under the head ‘’ Current Liabilities’’.

3. Prepaid Expenses : Sometimes, it is found that certain expenses like insurance premium, rent, etc. Paid during the current period relate to the next period, but relate to the next period are called ‘’prepaid Expenses’’ or ‘’Expenses paid in advance’’. Such prepaid expenses must be adjusted in the final accounts by means of an adjusting entry. The entry necessary for adjusting the prepaid expenses will be :

Prepaid Expenses Account

Dr.

To Various Expenses Accounts

A.A/c. 20

The prepaid expenses have to be treated in the final accounts as follows :

First, the prepaid amounts of the various expenses have to be deducted form the respective expenses on the debit side of the Trading Account of Profit and Loss Account, as the case may be.

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Secondly, the total amounts of the various prepaid expenses have to be entered on the assets side of the Balance Sheet as ‘’prepaid Expenses’’ under the head’’ Current Assets’’.

4. Outstanding Income: Like expenses incurred, but not paid during a particular trading period, there may be certain incomes like interest, commission, etc., earned during a particular trading period, but not actually received during the period. The incomes earned during a particular trading period but not actually received during that period are called ‘’Outstanding incomes’’ or Incomes Earned, but Not Received’’. The outstanding incomes must be brought into account while preparing the final accounts by means of an adjusting entry. The adjusting entry necessary for bringing the outstanding incomes into account will be :

Outstanding incomes Account

Dr.

To Various Incomes Accounts

The outstanding incomes have to be treated in the final accounts as follows :

First, the outstanding amounts of the various incomes have to be added to the respective incomes on the credit side of the profit and Loss Account.

Secondly, the total amounts of the various outstanding incomes have to be entered on the assets side of the Balance Sheet as ‘’Outstanding Incomes’’ under the head ‘’Current Assets’’.

5. Incomes Received in Advance: Sometimes, it is found that certain income received during the current period relate to the next period. All those incomes received during the current period, but relate to the next period (i.e., not earned during the current period) are called ‘’Incomes Received, but Not Earned’’. Such incomes must be adjusted in the final accounts by means of an adjusting entry. The entry necessary for adjusting the incomes received in advance will be: Various Incomes Accounts

Dr.

To Incomes Received in Advance Account

The incomes received in advance have to be treated in the final accounts as follows :

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First, the amounts of the various incomes received in advance have to be deducted form the respective incomes on the credit side of the profit and loss Account.

Secondly, the total amounts of the various incomes received in advance have to be entered on the liabilities side of the Balance Sheet as ‘’Incomes Received in Advance’’ under the head ‘’ Current Liabilities’’.

Bad Debts : Debts which are definitely proved to be irrecoverable are called ‘’Bad Debts’’.

These bad

debts must be written off by debiting the Bad Debts Account and crediting the Sundry Debtors Account. The bad debts that are written off during the course of the trading period are recorded in the books of accounts and are included in the trial balance.

But, sometimes, after the preparation of the trial balance, but before the preparation of the final accounts, a businessman may find that there are additional or further bad debts. Such additional or further bad debts given outside the trial balance (i.e., given in the adjustment) must be recorded at the time of preparation of final accounts by means of an adjusting entry. The adjusting entry required for writing off the further bad debts will be : Bad Debts Account

Dr.

To Sundry Debtors’ Account

The further bad debts given in the adjustment have to be treated in the final accounts as follows :

First, the bad debts given in the adjustments must be shown on the debit side of the Profit and Loss Account as an addition to the bad debts already appearing in the trial balance.

Secondly, the bad debts given in the adjustment must be deducted form the Sundry Debtors on the assets side of the Balance Sheet.

Provision or Reserve for Doubtful Debts : Some times, after the preparation of the trial balance, a trader may find that there are some

debts the recovery of which is doubtful. Such debts are called ‘’Doubtful Debts’’.

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The doubtful debts are not known losses, as their recovery is uncertain.

They are only

anticipated or expected losses.

As the doubtful debts are only expected losses, they cannot be written off as bad and charged to the Profit and Loss Account. But, as the same time, the doubtful debts cannot be ignored, if the final accounts are to give the correct business result and the true Financial position of the business. Therefore, it is proper that a provision or reserve is made out of current year’s profits to meet the losses that may arise when the doubtful debts actually become bad. The provision or reserve made out of current year’s profit for meeting the losses arising out of doubtful debt is called’’ Provision for Doubtful Debts’’ or ‘’Reserve for Doubtful Debts’’. (It should be noted that though both the terms ‘’Provision for Doubtful Debts’’ and ‘’Reserve for Doubtful Debts’’ are used in actual practice, it is better to use the term ‘’ Provision for Doubtful Debts’’, as it is only a provision charged to the Profit and Loss Account, and not a reserve built out of net profits.)

The Provision for Doubtful Debts is created (i.e., calculated) at a certain percentage on the Debtors after deducting the bad debts given in the adjustments.

The Provision for Doubtful Debts is made or created in the books of accounts by means of an adjusting entry. The adjusting entry required for making provision for doubtful debts will be :

Profit and Loss Account

Dr.

To Provision for Doubtful Debts has to be treated in the final accounts as follows :

In the Profit and Loss Account, the Provision for Doubtful Debts will appear as follows :

(a) If the total of bad debts for the year and the Provision for Doubtful Debts required at the end of that year (i.e., New Provision for Doubtful Debts) is greater that the Provision for Doubtful Debts already existing in the books (i.e., Old provision for doubtful Debts), the difference will appear on the debit side of the Profit and Loss Account as follows:

Profit and Loss Account Dr.

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To Bad Debts for the year xxx Rs. Add : New Provision for doubtful Debts i.e.,

Provision

required

the

for end

Doubtful of

the

Rs.

Debts year)

Xxx

Xxx Less : Old Provision for Doubtful Debts (i.e., Provision for Doubtful Debts already Existing in the books) Xxx

(b)

On the other hand, if the provision for Doubtful Debts already existing in the books

(i.e., Old Provision for Doubtful Debts) is greater than the total to bad debts for the year and the Provision for Doubtful Debts required at the end of the year (i.e., New Provision for Doubtful Debts), the difference will appear on the credit side of the Profit and Loss Account as follows :

Profit and Loss Account Dr.

Cr. Rs.

Old Provision for Doubtful Debts (i.e., Provision

Rs.

for Doubtful Debts already existing in the books Xxx

Less Bad Debts for the year xxx Less

New Provision for Doubtful (i.e.,

Provision for Doubtful Debts required at the end of the year xxx

xxx

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In the Balance Sheet, the New Provision for Doubtful Debts must be shown as a deduction form the Sundry Debtors on the assets side (but not separately on the liabilities side). The New provision for Doubtful Debits must be shown as a deduction form the Sundry Debtors on the assets side of the Balance Sheet, because this procedure reveals to the reader of the Balance Sheet, at one glance, the gross amount due from the Sundry Debtors and also the net amount that can definitely be received form the Sundry Debtors.

Provision or Reserve for Discount on Debtors: If a business concern has the practice of allowing cash discount to the debtors who pay their

promptly, then, in respect of the debtors whose accounts appear in the books of the concern at the end of the current trading period, discount will have to be allowed in the subsequent period., when they pay their dues promptly. But, at the end of the current trading period, the concern cannot know how much cash discount

it will have to allow to its debtors in the subsequent period. All that is

possible for the concern is to make an estimate of the amount of discount that will have to be allowed to the debtors in the subsequent period and provide for that will have to be allowed to the debtors in the subsequent period is known as ‘’provision for Discount on Debtors’’ or ‘’Reserve for Discount on Debtors’’.

The provision for Discount on Debtors is created (i.e., calculated) at a certain percentage on good debtors (i.e., debtors minus the bad debts given in the adjustment and new provision for doubtful debts) because cash discount is allowed only to the debtors who make prompt payment, and prompt payment can be expected only form good debtors.

The provision for Discount on Debtors is created in the books of account by means of an adjusting entry. The adjusting entry required for the creation of provision for Discount on Debtors will be :

Profit and Loss Account

Dr.

To provision for Discount on Debtors Account

The treatment of provision for Discount on Debtors in the final accounts 1 similar to that of provision for Doubtful Debts. The provision for Discount on Debtors has to be treated in the final accounts as follows :

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In the profit and loss Account, the provision for Discount on Debtors will appear as follows :

(a) If the total of cash discount allowed during the current period and provision for Discount on Debtors required at the end of the current period (i.e., New provision for discount on debtors) is greater than the provision for discount on debtors already existing in the books (i.e., Old provision for discount on debtors). The difference will appear on the debit side of the profit and loss Account as follows :

Profit and Loss Account Dr.

Cr. Cash Discount allowed during the year xxx To

Add : New Provision for Discount on Debtors (ie., Provision for Discount on Debtors required

the

end

the

year

xxx

Xxx

Less : Old provision for Discount on debtors

Xxx

(ie., Provision for Discount on Debtors on Debtors already Existing in the books)

(b) On the other hand, if the provision for discount on debtors already existing in the books (i.e., Old provision for Discount on Debtors) is greater than the total of cash discount allowed during the current period and the provision for Discount on Debtors required at the end of the current period (i.e., New provision for Discount on Debtors). The difference will appear on the credit side of the profit and Loss Account as follows : Profit and Loss Account

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Dr.

Cr. Provision for Discount on Debtors (ie., Rs.

Provision for Discount on Debtors already

Existing in the books

Rs.

Xxx Less Cash Discount allowed during the year xxx Less New Provision for Discount on Debtors

Xxx

(ie., Provision for Discount on Debtors required

the

end

the

year

)

xxx xxx

Basic Divisions of Balance Sheet: Assets

Liabilities

1. Current Assets

1. Current Liabilities

2. Fixed Assets

2. Non-current Liabilities

3. Intangible Assets

3. Net Worth

4. Other Assets

5. Deferred Expenditure A brief discussions regarding the meaning, nature and contents of various groups of Balance Sheet is given below:

1. Current Assets: ‘’The goods of the merchant yield him revenue profit till he sells them for money and the money yields him as little till it is again exchanged for goods’’. His capital is continuously going from him in one shape and returning to him in another and it is only by means of such circulation or successive exchanges that it can yield him any profit. Such a capital can properly called circulating capital. The term Current Assets, in the words of Alexander Wall, ‘’are such assets as in the ordinary and natural course of business move onward, through the various processes of production,

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distribution and payment for goods, until they become cash or its equivalent, by which debts may be rapidly and immediately paid.â&#x20AC;&#x2122;â&#x20AC;&#x2122; Current Assets are the assets acquired through cash and easily convertible into cash during the normal course of business. The normal course takes a period of one year. The accounting period is of one-year duration. In other words, current Assets are those resources of the firm which are either held in the form of cash or are expected to be converted into cash within the accounting period or the operating cycle of the business. The operating cycle is the time period, which is taken to convert raw materials into finished goods, sell finished goods, and convert receivables into cash. All assets, which are acquired for reselling during the course of business, are to be treated as current Assets. For instance, furniture purchased by a furniture purchased by a hotel-owner will be treated as non-current asset. Thus, it is clear that the nature i.e., current asset or non-current asset is to be decided with reference to its objective of acquisition and not to its name by which it has been termed in the accounting system. Generally, the operating cycle is equal to or less than the accounting period. The following are generally included in current Assets.

1. Cash in hand and at Bank

2. Book debts (of Debtors or Account Receivables)

3. Bills Receivables (or Notes Receivables)

4. Stocks-Raw Materials, Work-in-progress, Finished goods

5. Government and other marketable securities

6. Advance payments.

2. Fixed Assets: Fixed assets are those asses, which are acquired for the purpose of using them in the conduct of business operations and not for reselling to earn profit. They are of such a nature that they will be used over a considerable period of time, ana are not meant for resale. Since these are not for reselling, these assets are not readily convertible into cash in the normal course of business operations. Some examples of assets coming into the fixed asset categories are :

1. Land

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2. Buildings

3. Plant, Machineries, Equipment etc.

4. Furniture and Fixtures

5. Leasehold Improvements etc.

The above list is not exhaustive one. A number of other assets may be included in the list, if they are acquired primarily for the purpose of continuous use in the business operations.

Intangible Assets: Fixed Assets may be either tangible or intangible.

The tangible assets have a definite

physical existence. They can be seen and can, if necessary, sold separately. The intangible assets cannot be seen though their existence has some effect, often very material, on the profit-earning capacity of the business. While the tangible assets often have a value as things apart from their profit-earning capacity, the intangible assets usually have not physical value whatever. They are not available for the payment of the debts of a going concern.

They depreciate greatly in case of

liquidation. Intangible assets represent the firmâ&#x20AC;&#x2122;s rights and include the following :

Patents and Trademarks

2. Copyright, Formula, License etc.

3. Goodwill etc.

Parents are the exclusive rights granted by the Government enabling the holder to control the use of an invention.

Copyrights are the exclusive rights to reproduce and sell literary, musical and

artistic works. Franchises are the contracts giving exclusive rights to perform certain functions or to sell certain services or products. Goodwill represents the excessive earning power of a firm due to special advantages that it possesses. Costs of intangible fixed assets are amortized over their useful lives.

Other Assets:

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All other assets, which cannot be including in any of the above categories, are grouped as Other Assets. These assets possess a tangible form but these are not directly used in the operations of business. Such assets may be :

Investments excluding marketable securities

2. Non-trade Debtors

3. Fund earmarked for assets.

5. Deferred Expenditure: There are certain expenditure which are not incurred repeatedly or which are not or recurring nature and which do not arise from the present operations. These expenditures contribute income or benefit in the future years also. These expenditures are written off gradually over several years of operations, treating each yearâ&#x20AC;&#x2122;s share in such expenditure as a charge on operational profit for that year. The amount of such expenditure not written off at a point of time is shown as an asset in the Balance Sheet at that point of time. Prepayments for services or benefits for period longer than the accounting period are referred to as deferred charges and the expenditure preliminary expenses etc.

6. Current Liabilities: Current liabilities include such debts and obligations or charges which are payable either at demand or within one year from the date of Balance sheet. All short-term obligations generally due and payable within one year are described as Current Liabilities. All long-term loans and borrowings may take the character of current liabilities as and when they become due for payment. Typical examples of current liabilities are :

Trade Creditors or Accounts Payables

Bills Payables or Notes Payables

Short-term Public Deposits

Outstanding or accruals

Short-term Loans

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100

Bank overdraft but not bank loan

Provision for Taxes

Unclaimed Dividends

Current maturity of long-term due payable within the Period of the current year.

7. Non –Current Liabilities:

These are also called Long-Term liability or debt. All such liabilities payable over a longer period of time, say after one year, are known as Non-current liabilities. Some examples of such liabilities are :

1. Loan on Mortgage

2. Debentures or Bonds

3. Bank Loan

4. Loan from Financial Institutions etc.

8.. Net Worth: The financial interests of owners are called owners’ equity. The owners’ interest is residual in nature, reflecting the excess of the firm’s assets over its liabilities. It has several names, such as Net Assets, Shareholders’ Fund, Owners’ Equity, Net Capital Employed etc.

What remains after

deducting all liabilities (both current and long-term) from total assets is called Net Worth or Shareholders’ Fund. As liabilities are the claims of outside parties, owners’ equity represents owners’ claim against the business entity as of the Balance Sheet date. The nature of the owners’ claim is not same as the claims of creditors. Creditors’ claim is defined and has to be met within a specified period. The claim of owner’s changes and the amount payable to them can be determined only when the firm is liquidated. In the beginning stage, owners’ equity arises on account of the funds invested by them. But it changes due to the earnings of the firm and their distribution. The firm’s earnings (or losses) doe not affect creditors’ claim will be reduced. ‘Shareholders’ equity or capital has two parts.

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101

Paid up share capital and (ii) Reserves and surplus (retained earnings), i.e., representing undistributed profits.

1. Preference Share Capital

2. Equity Share Capital

3. General Reserve

4. Capital Reserve

5. Other Reserves and undistributed profits.

Final Accounts of Sole Traders: In the Balance Sheet, the New provision for Discount on Debtors must be shown as a deduction from the goods Sundry Debtors on the assets side as follows :

Assets Sundry Debtors Liabilities

Rs.

Xxx

Rs.

Less; Bade Debts given in the adjustment Xxx Xxx Less New Provision for doubtful Debts Xxx Xxx Less New Provision for Discount on Debtors xxx

Xxx

9. Provision or Reserve for Discount on Creditors: If a businessman is receiving regularly cash discount from his creditors for making prompt payment, then, in respect of the creditors whose accounts appear in his books at the end of the current year, he can expect to receive discount in the subsequent year when he pays the creditors promptly.

Therefore, he can make an estimate of the discount which he is likely to receive form his

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102

creditors in the subsequent year and make a provision for the discount expected form the creditors in the current year’s accounts. The provision or reserve made by a businessman during the current year for the discount expected from his creditors in the subsequent year is called ‘’Provision for Discount on Creditors’’ or ‘’Reserve for Discount on Creditors’’.

The provision for Discount on Creditors is made or calculated at a certain percentage on the Sundry Creditors.

The Provision for Discount on Creditors is made in the books of account by means of an adjusting entry. The adjusting entry required for making the provision for Discount on Creditors will be :

Provision for Discount on Creditors Account

Dr.

To Profit and Loss Account

The Provision for Discount on Creditors has to be treated in the final accounts as follows :

In the profit and Loss Account, the Provision for Discount on Creditors will appear as follows :

(a)

If the total of the cash discount received during the current year and the Provision for Discount on Creditors made at the end of the current year. (i.e., New Provision for Discount on Creditors) is greater to that the provision for Discount on Creditors already existing in the books (i.e., Old Provision for Discount on Creditors), the difference will appear on the credit side of the Profit and Loss Account as follows :

Dr.

Cr.

Rs.

Cash

Rs.

Discount received during the Current year ax Add : New Provision for Discount on Creditors (i.e, Provision for Discount On the Creditors made at the end of the Current year )ax Ax :

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Less; Old Provision for Discount on Creditors (ie., Provision for Discount on creditors already existing in the Books) ax

(b)

On the other hand, if the provision for Discount on Creditors already existing in the books.

(ie., Old Provision for Discount on Creditors) is greater than the total of cash discount received during the current year and the Provision for Discount on Creditors made at the end of the current year (ie., New Provision for Discount on Creditors), the difference will appear on the debit side of the Profit and Loss Account as follows:

Profit and Loss Account Dr.

Cr. Old Provision for Discount on Creditors (ie., Provision for Discount on Creditors already

Rs.

existing in the books) xxx

Less : Cash Discount received during

The current year xxx To

Rs. Less : New Provision for Discount on Creditors (ie., Provision for Discount on Creditors made at the end of the Current year) xxxx Xx xx

In the Balance Sheet, the New Provision for Discount on Creditors must be shown as a deduction form the Sundry Creditors on the liabilities side.

10. Depreciation: Depreciation is the diminution (ie., fall) in the value of an asset due to wear and tear, passage of time, obsolescence (ie., getting out of date or old-fashioned). Etc.

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Depreciation is a loss to a business. As depreciation is a loss to the business, it must be taken into account, while preparing the final accounts. If it is not taken into account, the final accounts will not show the correct net profit or net loss and the true Financial position of the business.

The depreciation is, usually, charged at a certain percentage on the books value of the asset for the period for which the asset is used. Depreciation on an additional asset purchased or provision an asset sold during the current year need not be charged, if the date of addition or the date of sale is not given. If the date of addition or the date of sale is given, then, depreciation has to be charged for the proportionate period, ie., from the date of addition to the end of the current year in the case of an additional asset purchased, and form the beginning of the current year till the date of sale in the case of an asset sold.

Generally, depreciation is provided at the time of preparation of final accounts by means of an adjusting entry. The adjusting entry required for providing for depreciation will be :

Depreciation Account

Dr.

To Concerned Asset Account

The depreciation has to be treated in the final accounts as follows :

First, the depreciation must be entered on the debit side of the profit and Loss Account.

Secondly, the depreciation must be deducted from the concerned asset on the assets side of the Balance Sheet.

11. Interest on capital: A business concern may allow interest on the capital invested by the proprietor in the business. The idea behind allowing interest on capital is to ascertain the net profit or net loss made by a business over and above a fair return on the capital. Allowing interest on the proprietorâ&#x20AC;&#x2122;s capital is based on the ground that if the same amount of capital were invested by the proprietor elsewhere, he would have received a certain rate of interest or dividend there on.

Interest on capital is calculated at a certain percentage with reference to the period during which the capital is used in the business.

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Interest on capital is allowed at the time of preparation of final accounts by means of an adjusting entry. The adjusting entry necessary for allowing interest on capital will be :

Interest on Capital Account

Dr.

To Capital Account

The interest on capital has to be treated in the final accounts as follows :

First, the interest on capital must be entered on the debit side of the profit and Loss Account, as it is an expense or a loss for the business.

Secondly, it must be added to the capital of the proprietor on the liabilities side of the Balance Sheet.

13. Interest on Drawings: Just as a business allows interest on the proprietor’s capital, it any charge interest on the proprietor’s drawings also. Charging interest on the proprietor’s drawings is based on the ground that the amount withdrawn by the proprietor from the business for his personal use amounts to a loan given by the business to the proprietor, and just as interest is charged by the business on a loan given to an outsider, interest on loan given by the business to the proprietor (ie., drawings) also has to be charged.

Interest on drawings is calculated with reference to the amount of drawings and the date of drawings.

Interest on drawings is charged at the time of preparation of final accounts by means of an adjusting entry. The adjusting entry required for charging interest on drawings will be :

Capital or Drawings Account

Dr.

To Interest on Drawings Account

The interest on drawings has to be treated in the final accounts as follows :

First, the interest on drawings must be entered on the credit side of the profit and Loss Account, as it is an income or gain for the business.

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106

Secondly, the interest on drawings must be deducted from the proprietorâ&#x20AC;&#x2122;s capital on the liabilities side of the Balance Sheet.

Treatment of Adjustment Items given in the Trial Balance: Sometimes, some of the adjustment items may be given in the trial balance. The adjustment items given in the trial balance indicate that the adjustments regarding those items have already been made, accounts have been opened and those accounts have been included in the Trial balance. Therefore, those items do not require any further adjustments, and they have to be entered only once either in the Trading Account or in the Profit and Loss Account or in the Balance Sheet.

The adjustment items that may be given in the trial balance are : 1.

Closing Stock.

Outstanding Expenses.

3. Prepaid Expenses

4. Outstanding Incomes.

5. Incomes Received in Advance.

6. Depreciation: The treatment of the adjustment items given in the trial balance, in the final accounts, will be as follows:

1. Closing Stock : If closing stock is given in the trial balance, it means :

(a) The Trading Account has already been prepared and the gross profit or gross loss is given in the trial balance. OR (b) The closing stock has already been adjusted in the Purchases Account (ie., credited or deducted from the Purchases Account) and the Adjusted Purchases are given in the trial balance. (It should be noted that the effect of crediting the Purchases Account with the closing stock is the same as crediting the Trading Account with the closing stock).

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107 OR

(c)

The closing stock has already been adjusted in the Sales Account (ie., credited or added to the Sales Account) and the Adjusted Sales are given in the trial balance. (It should be noted that the effect of crediting the Sales Account with the closing stock is the same as crediting the Trading Account with the closing stock).

If closing stock is given in the trial balance, it should appear only in one place, viz. in the assets side of the Balance Sheet, as an asset. 9it should not appear on the credit side of the Trading Account, as it has already been credited to the Trading Account or the Purchases Account or the Sales Account.)

Outstanding Expenses : Outstanding expenses given in the trial balance must appear only in one place, viz., on the

liabilities side of the Balance Sheet. ( They must not be added to the respective expenses on the debit side of the Trading Account or the profit and Loss Account, as they have already been adjusted with (ie., added to) the respective expenses and the total expenses have been given in the trial balance).

Pre paid Expenses : Prepaid expenses given in the trial balance must appear only in one place, viz., on the assets

side of the Balance Sheet. ( They must not be deducted from the respective expenses, on the debit side of the Trading Account or the Profit and Loss Account, as they have already been adjusted with (ie., deducted from) the respective expenses and the net expenses have been given in the trial balance).

3. Outstanding Incomes : Outstanding incomes given in the trial balance appear only in one place, viz., on the assets side of the Balance Sheet. (They must not be added to the respective incomes on the credit side of the Profit and Loss Account, as they have already been adjusted with (ie., added to) the respective incomes and the total incomes are given in the trial balance).

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108

Incomes Received in Advance : Incomes received in advance given in the trial balance must appear only in one place, viz., on

the liabilities side of the Balance Sheet. (They must not be deducted from the respective incomes on the credit side of the profit and Loss Account, as they have already been adjusted with (ie., deducted from) the respective incomes and the net incomes are given in the trial balance).

5. Depreciation : Depreciation given in the trial balance must appear only in one place, viz., on the debit side of the profit and Loss Account. ( It must not be deducted from the concerned asset on the assets side of the Balance Sheet, as it has already, been adjusted with (ie., deducted from) the asset and the net value of the asset is given in the trial balance.)

Illustration : From the following balances taken form the books of shankar prepare a Trading and Profit and Loss Account for the year ended 31st March, 2006 and a Balance Sheet as on that date. Rs. Sampath Capital

1,19,400

Sampath Drawings

10,550

Sundry Creditors

59,630

6% Loan (Credit)

20,000

Cash in hand

3,030

Cash at Bank of Baroda

18,970

Sundry Debtors (Including Gupta for dish-honoured bill of Rs.1000)

62,000

Bills Receivable

9,500

Provision for Doubtful Debts

2,500 Fixtures and Fittings 8,970 Plant and Machinery 28,800

Opening stock

89,680

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109

Purchases

2,56,590

Wages

40,970

Sales

3,56,430

Inwards

Return

2,780

Salaries

11,000

Taxes

Rent

and

5,620

Interest and Discount (Dr.)

5,870

Travelling expenses

1,880

Repairs and Renewals

3,370

Insurance (Including premium of Rs.300 per annum paid up to 30th September, 2005)

400 Bad debts 3,620

Commission received

5,640

Stock in hand on 31st march, 1984 was Rs. 1,28,960. Write off half of Guptaâ&#x20AC;&#x2122;s dishonored bill. Create a provision of 5% interest on capital. Manufacturing wages include Rs. 1,200 for erection of new machinery by 5% and fixtures and fittings by 10%. Commission earned, but not received amounts to Rs.600. interest on loan for the last two months is not paid.

Solution: Shankar Trading and profit and Loss Account for the year ended 31st March 2005. Dr.

Cr.

Opening stock

89680

Sales

Less : Purchases

356430

Returns

256590

2780

353650

Inwards

Wages

40970

Closing Stock

128960

Less :

Wages for erection

1200

39770

of new machinery

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110

included in wages

Gross Profits C/d

482610

Salaries

Gross Profits b/d

96570

Commission 5640 received Rent and Taxes

5620

Add :

commission earned, but not 600

6240

received

Travelling 1880 Expenses

400 Insurance

Less :

Prepaid 150

(300x1/2)

250

Bad debts

3620

Add : further Bad debts

(in

the

adjustment)

ie.,

half of the amount due from Gupta for dis-honoured (1000x1/2)

bill 500

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Add :

New

Provision doubtful

111

for debts

3,050

961,000 x 5/10) 7,170

Less : provision

Old for 2,500

doubtful debts

Repairs

4,670

and

Renewals 3,370

Depreciation

Fixtures

and 897

Fittings

(8m970x10/10) Plant

and 1,500

machinery

(28800+1,200

= 2,397

(30000x5/100

Interest

and 5,870

discount

Add : Outstanding interest on loans 200

6,070

(20000x6/100

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112

x2/12)

Interest on capital 5,970 (1,19,400 x 5/100

61,583 Net

profits

transferred

1,02,810 102,810

capital account

Balance Sheet as on 31st March 2005 Liabilities

Rs.

Assets

Rs.

Sundry 59630

3030

20000

18970

Creditors

6% Loan

Add: Bills Receivable

Outstanding

9500 interest

200

20200

Sundry debtors

loan

62000

Capital : Less : Bad Debts Opening capital

500 119400

61500

in the adjustment

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FINANCE & MANAGEMENT ACCOUNTING Liabilities

Add :

Rs.

113 Rs.

5970

Assets

Less;

Rs.

3050

58450

Provision

Interest on for doubtful Debts capital

Add;

Net 61583

Profits

186953

Less : 10550

176403

Closing stock

128960

Drawing

Prepaid 150 Insurance Commission earned

but

not 600

received

Fixtures

and 8970

fittings

Less : 897

8073

Depreciation

Plant

& 28800

Machinery

Add : Wages for erection of plant

1200

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FINANCE & MANAGEMENT ACCOUNTING Liabilities

Rs.

114 Rs.

Assets

Rs.

30000

Less: 1500

28500

256233

Depreciation

Notes : 1. Wages of Rs.1,200 paid for the erection of new machinery is a capital expenditure, and not a revenue expenditure. So, its should be deducted form wages on the debit side of the Trading Account, and would be added to plant and machinery on the assets side of the Balance Sheet.

2. Prepaid insurance of Rs.150 has been calculate as follows :

Insurance per annum is Rs.300. It has been paid up to 30th September 1965,

i.e., paid in advance for six months. So, the prepaid insurance at the rate of 300 per annum for six months will be (300x6/12 Rs.150).

3. The new provision for doubtful debts, viz., Rs.3,050, has been arrived at as follows :

The total debtors including the amount due form Gupta for dishonored bill is Rs.62,000. Of the amount of Rs.1,000 due from Gupta, we are asked to write off half. That means, half of the amount due from Gupta must be bad, and remaining half due from Gupta must be good. As reserve for Doubtful debts is neither required for bad debts nor for good debts, the reserve for doubtful debts should be created on sundry debtors excluding Rs.1,000 due from Gupta.

In short, reserve for

doubtful debts should be created on the debits of Rs. (62,000-1,000) 61,000 at 5%. So, the new provision for doubtful debts will be : 61,000 x 5/100 : Rs.3,050.

4. Depreciation on plant and machinery has been calculated as follows : Plant and machinery as stated in the trial balance

28,800

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115

Add : Wages on the erection of a new plant purchases in The Previous year

1,200

Value of plant as at 1st April 2000.

30,000

Depreciation on plant should be charged at 5% per annum on the value of plant as on 1st April 2000, viz, Rs.30,000. So, depreciation on plant will be : 30,000x5/100 = Rs.1,500.

TEST YOUR KNOWLEDGE 1. Journalise the following transactions in the books of a trader :

April 1, 2005

Debit Balances : Cash in hand Rs.8,000; Cash at bank Rs.25,600;

Stock of Goods Rs.20,000

Furniture Rs.4,000; and Building Rs.10,000

Debtors : Mani Rs.2,700; Jain Rs.1,500; Moorthi, Rs.2,000; Kumar Rs.1,800; and Senthil Rs.100.

Creditors : Suresh Rs.5,400; Sri & Co. Rs.7,700 and Vikas Rs.5,200, Mrs. Loans, Rs.10,000.

Date

2000 April 1

Particulars

Purchased goods worth Rs.5,000 less 20% trade discount and 5% cash discount.

2000 Apirl 3

2000 April 5

Rs.2,646 received from Mani and allowed him discount Rs.54 Bought 100 shares in Bharat Ltd @ 15 per share, brokerage paid Rs.30

2000 April 8

Goods worth Rs.500 were damged in transit; a claim was made on the railway authorities for the same.

2000 April 10

2000 April 13

Cash Rs.5,292 paid to Suresh and discount allowed by him Rs.108. Received cash from the railway in full settlement of claim for damaged in transit

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FINANCE & MANAGEMENT ACCOUNTING 2000 April 15

116

Kumar is declared insolvent and a dividend of 50 paise in the rupee is received from him in full settlement.

2000 April 18

Sold 40 shares in Bharat Ltd @ Rs.18 per share, brokerage paid Rs.15

2000 April 20

Bought a horse for Rs.2,000 and a carriage for Rs.100 for delivering goods to customers.

2000 April 22

2000 April 30

Paid for Charity

Rs.101

Postage

Rs.200

Stationery

Rs.199

One monthsâ&#x20AC;&#x2122;s interst on Mrs.Loan @ 12% p.a became due but could not be paid

2000 April 30

The horse bought on April 20 died, its car case was sold for Rs.50 Received from travelling salesman Rs.3,000 for goods sold by him after deducting his travelling expenses Rs.150

2000 April 30

Paid for Salaries Rent

2000 April 30

Rs.3,500 Rs.1,500

Sold goods worth Rs.10,000 less 10% trade discount.

The following balance were taken from the books of Shri.Gupta on 31st March,2001. Rs.

Rs. Capital

100,000

Rent (Cr)

2,100

Drawings

17,600

Railway freight & order expenses on goods sold

Purchase

80,000

Carriage inward

2,310

140,370

Office Expenses

1,340

Sales Purchase returns Opening stock Bad debts

16,940

2,840

Printing & stationary

660

11,460

Postage & telegrams

820

1,400

Sundry Debtors

62,070

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Bad Debts Provision

3,240

Sundry Creditors

18,920

(1st April 2000)

1,300

Cash at Bank

12,400

190

Cash in Hand

2,210

Rates & Insurance Discount (Cr)

1,240

Office Furniture

3,500

Bills Receivable

4,240

Salary & Commission

9,870

Sales returns

6,280

Buildings

Wages

7,000

25,000

Additional Building

Prepare trading Profit and loss account and balance sheet as on 31s March, 2005, after keeping in view these adjustments : (1) Depreciate old building at 20% and new additions to building at 2% and office furniture at 5% (2) Write off future bad debts Rs,570. (3) Increasing the bad debt provision to 6% of debtors. (4) On 31st March 2005, Rs.570 are outstanding for salary, (5) Rent Receivable Rs.200 (6) Interest on capital at 5%. (7) On 31st March 2005, Rs.570 are outstanding for salary, (5) Rent receivable Rs.200. (6) Interest on capital at 5%. (7) On 31st March, 2005.

The following Trading and Profit and Loss Account has been prepared by a Junior

Accountant of AA Firm. Criticize it and redraft it correctly.

TRADING ACCOUNT & PROFIT AND LOSS A/C. For the Year Ended March 31, 2005 To

Opening

Stock

Raw

7352

Materials

Closing

Stock

Raw

9368

Materials

To Purchases

63681

By Sales

To Sundry Creditors

25375

By Sundry Debtors

40659

To Carriage Inwards

2654

By Gross Loss C/d

8182

To Carriage Outwards

170852

394

To Salaries

24370

To Wages

51963

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FINANCE & MANAGEMENT ACCOUNTING To Rent, Rates & Taxes

118 3981

To Repairs to Factory

35368

To Insurance

13923 229061

229061

To Gross Loss B/d

8182

By Bank Overdraft

To Interest on Loans

6180

By Interest on Bank Overdraft

123

To Dividend from Investments

9375

By Net Loss transferred to B/s

39691

To Furniture Purchase

17681

To Telephone Charges

985

To Electric Charges To

Depreciation

17681

2756 –

Plant

663

Machinery To General Charges

11673 57495

57495

DEPRECIATION METHODS AND ACCOUNTING

Meaning of the term “Depreciation”:

Depreciation is a permanent decline in the value of an asset. The gradual decrease in the value and usefulness of an asset due to its nature and usage is termed as depreciation.

Also

depreciation is the process of spreading the cost of fixed assets over the different accounting periods, which derive the benefit from their use. The cost of fixed assets apportioned to a given period forms part of the overall cost to be matched with the revenues generated in that period. Definition of the term “Depreciation”:

According to the Spicex and Pegler “Depreciation is the measures of the exhaustion of the effective life of an asset from any cause during a given period. According to international accounting standards committee, “Depreciation is the allocation of the depreciable amount of an asset over its estimated useful life. Depreciation for the accounting period is charged to income either directly or indirectly.

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Characteristic of Depreciation: i.

Depreciation is a reduction in the book value of fixed assets except land.

ii.

It is a charge against profit for a particular accounting period.

iii. It reduces the book value of the asset but not its market value. iv. It is a process of allocation of expired cost and not of valuation of fixed assets. v.

It is always compiled in a systematic and rational manner since it is not a sudden loss.

vi. It may be physical and functional. vii. It takes place gradually unless there is a quick physical deterioration or obsolescence due to technological development. viii. It is continuing process. The book value is reduced either with the use of the assets or reduced either with the use of the asset or due to passage of time.

Depreciation

once charged will have to be charged in the subsequent periods also till the asset is totally exhausted or discarded. ix. The reduction in the boot value of an asset is permanent. When the book value of an asset is reduced, it is not possible to restore it to its original cost. x.

The exact amount of depreciation cannot be calculated, whatever method of charging depreciation is followed. It can simply be estimated.

Causes of Depreciation: a)

Physical wear and tear

With the passage of time

When assets are exposed to the forces of nature like weather, wind, rain etc.

Changes in economic environment.

Expiration of legal rights.

Obsolescence

Accident

Disuse

In-adequacy

Depletion

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Objectives and Necessary for Providing Depreciation:

Ascertainment of the True Result of Operations or True Profits: For proper matching of cost with revenues, it is necessary to change the depreciation (cost)

against income (revenue) in each accounting period. Unless the depreciation is charged against income, the result of operation would stand overstated. As a result the income statement would fail to present a true and fair view of the result of operation entry.

Presentation of True Financial Position: If depreciation is not provided for the balance sheet will not disclose a true and fail view of the

firms, state of affairs, since the assets will be shown at figures, which are in excess of their true value.

Replacement:

The amount debited in the P&A/c. is retained in the business.

There are available for

replacement of the assets when its life is over. So, by making an annual charge for depreciation, a concern would be accumulating enough resources to enable it to replace as asset when necessary.

No Distortion of Divisible Profit: If depreciation is not charged to profit, trading result are vitiated and divisible profit are

distorted. Hence to provide for depreciation before declaring dividends according to the Companies Act, 1956. 5.

To Ascertain the True Cost of Production: For ascertaining the cost of production as an item of cost of production. If the depreciation

records, would not present a true and fair view of the cost of production. 6.

To Comply with Legal Requirements: In case of companies, it is compulsory to change depreciation on fixed assets before it declare

dividend (Sec 205 [i] of the Companies Act, 1956). Factors Determining the Amount of Depreciation: The amount of depreciation is usually based on the following three factors:

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Historical Cost: Historical Cost of a depreciable asset implies the cost incurred on its acquisition, installation,

commissioning and for addition to or improvements thereof which are of capital nature. b.

Expected Useful Life: Expected useful life of a depreciable asset implies either the period over which a depreciable

asset is expected to be used by the enterprise or the number of production of similar units expected to be obtained from the use of the assets by the enterprise. c.

Estimation Residual Value: Estimated residual value of depreciable assets implies the value expected to be realized on its

sale or exchange on the empty of its useful life.

Methods of Recording Depreciation:

Depreciation can be recorded in the books of accounts by two different methods. i.

When a Provision for Depreciable Account is not maintained:

Under this method the amount of depreciation is debited to the depreciation account and credited to the asset account. Depreciation account is closed by the transfer to P&A/c and is shown as a deduction from the value of the assets on shown as a deduction from the value of the assets on the assets side of the balance sheet. The following journal entries are passed in case depreciation is provided according to this method. a.

For providing Depreciation

Depreciation A/c.

Dr.

To Asset A/c. b.

For providing Depreciation to the P&A/c

P&A/c

Dr.

To Depreciation

In the case of assets is sold, the sale proceeds are credited to the Assets A/c. Any profit or loss on sale of the asset is transformed to the P&A/c. The entries will be: c.

When the assets is sold

Bank A/c.

Dr.

To Asset A/c.

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122

For the depreciation (on the sold assets) of the current period:

Depreciation A/c.

Dr.

To Asset A/c. e.

For loss on sale of asset:

P&A/c.

Dr.

To Asset A/c. f.

For profit on sale of asset:

Asset A/c.

Dr.

To P&A/c.

ii.

When a Provision for Depreciation A/c. is maintained:

Under this method, the amount of depreciation to be provided in a particular year is created to provision for depreciation account and debited to P&A/c. The asset account appears in the book at original cost. In this case, provision for depreciation appears on the liabilities side of the balance sheet and the assets appears at cost on the assets side. In case the asset is sold, the provision for depreciation account is transferred to the asset account. Any amount realized on sale of the assets is also credited to the asset account. The balance if any, in the P&A/c. the following journal entries are passed under this method: a.

For providing Depreciation Depreciation A/c.

Dr.

To provision for depreciation A/c. b.

For transferring Depreciation to P&A/c. P&A/c.

Dr.

To Depreciation A/c. c.

When assets is sold: i.

For transferring accumulated depreciation:

Provision for Depreciation A/c.

Dr.

To Asset A/c. ii.

For sale proceeds of the assets:

Bank A/c. iii.

Dr.

For profit on sale:

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FINANCE & MANAGEMENT ACCOUNTING Asset A/c. iv.

123 Dr.

For loss on sale:

To Asset A/c.

Dr.

METHODS OF PROVIDING DEPRECIATION

Straight Line Method or Fixed Installment Method or Original Cost Method: Under this method, a fine and equal amount in the form of depreciation, according to fixed

percentage on the original cost, is written off during each accounting period over the expected useful life of the asset. The amount and rate of depreciation is calculated as under:

Original Cost less Residual Value Amount of Depreciation Expected useful life of the Asset

Rate of Depreciation

Amount of Depreciation x 100 Original Cost

Merits: 1.

It is easy to understand

It is very simple and easy to calculate

The value of asset can be reduced to zero under this method.

It is recognized by the companyâ&#x20AC;&#x2122;s amended act of 1988.

Demerits: The same amount of depreciation is charged every year irrespective of the use of the asset. Thus, it does not take into account the effective utilization of the asset. In this method, it becomes difficult to calculate depreciation on additional made during the particular year. It does not make any provision for the interest on capital invested in fixed cost. As the amount of depreciation remains fixed even during the inflation period, maintenance of capital becomes difficult. This method tends to report an increasing rate of return on investment in the asset on account of the fact that net balance of the asset account is taken.

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E.g. A company purchased a plant for Rs.50,000. The useful life of the plant is 10 years and the residential value is Rs.10,000. Find out the rate of the depreciation under the Straight Line Method. 50,000 â&#x20AC;&#x201C; 10,000 =

= Rs.4,000 10 Years

Depreciation Rate of Depreciation= Original Value 4,000 =

x 100 = Rs.4,000 50,000 st A machine purchased on 1 July 2003 at a cost of Rs.14000 and Rs.1000 was spent

E.g.

on its installation. The depreciation written off at 10% on the original cost every year. The books are st

closed on 31 Dec. each year. The machine was sold for Rs.9500 on 31 March 2006. Show the machinery account for all the years. Machinery A/c. Dr. Date

01.07.

Particulars

To Bank

Amount

15,000

Date

31.12.03

Cr. Particulars

By Depreciation (14000 + 1000) (15000 x 10% x 6/12

650

By Balance C/d

14,250

15,000

01.08.

To Balance B/d

Amount

15000

31.12.04

By Depreciation

1,500

By Balance C/d

12,750

14,250

01.01.

To Balance B/d

12,750

By Balance C/d

11,250

14,250

31.12.05

By Depreciation

1,500

12,750

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FINANCE & MANAGEMENT ACCOUNTING Date

Particulars

01.01.

To Balance B/d

125

Amount

11,250

Date

Particulars

Amount

31.03.06

By Bank (Sale)

9,500

By Depreciation

375

By P & A/c. (Loss on Sale)

1,375

11,250

E.g. A machine was purchased on 01.01.2000 for Rs.30,000 and repair charge amounted to st

Rs.6,000. It was installed at a cost of Rs.4,000 on 1 July, 2001, another machine was purchased for st

Rs.26,000 on 1 July, 2002; the first machine was sold for Rs.30,000 on the same day; one more st

machine was bought for Rs.25,000. On 31.12.2002, the machine bought on 1 July 2001 was sold st

for Rs.23,000. Accounts are closed every year on 31 Dec. Depreciation is written off at 15% p.a. Prepare Machine A/c. for 3 years ending 31.12.2002. Machinery A/c. Dr. Date

Particulars

01.01.00

To Bank A/c. (30000+6000+40

Amount

40,000

Date

31.12.00

Cr. Particulars By Depreciation

Amount

6,000

(40000 x 15%)

00)

By Balance C/d 40,000

34,000 40,000

By Depreciation 01.01.01

To Balance

34,000

01.07.01

To Bank

26,000

31.12.01

(40000x15%) + (26000x15%) x 6/12

7,950

By Balance C/d

52,050

60,000 01.01.02

To Balance B/d

52,050

01.07.02

To Bank A/c.

25,000

01.07.02

31.12.02

To P & A/c. (Profit on sale Macine I) To P & A/c. (Profit on sale Macine II)

5,000

2,850

60,000 01.07.02

31.12.02

By Bank (Sale)

30,000

By Depreciation (On sold machine I)

3,000

By Bank (Sale) By Depreciation (On sold machine II)

23,000

3,900

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FINANCE & MANAGEMENT ACCOUNTING Date

Particulars

126

Amount

Date

Particulars By Depreciation By Balance C/d

84,900 01.01.03

1,875 23,125 84,900

23,125

To Balance C/d

Working Notes:

Amount

Calculation of Profit on Sales:

For Machinery purchased on 01.01.2000: Cost of Machinery

Rs.

Less: Depreciation for 2 ½ years (i.e. 01.07.2001 to 31.12.2002)

Rs.

Book Value

40,000

15,000

Rs.

Sale Proceeds

Rs.

Profit on Sale

25,000

30,000 Rs.

5,000

Rs.

26,000

For Machinery purchased on 01.07.2001: Cost of Machinery Less: Depreciation for 1 ½ years (i.e. 01.07.2001 to 31.12.2002)

Rs.

Book Value

5,850

Rs.

Sale Proceeds

Rs.

Profit on Sale

20,150

23,000 Rs.

2,850

Eg. The following balance appears in the books of M. 01.01.00 Machinery A/c.

Rs.

50,000

01.01.00 Provision for Depreciation A/c. Rs.

20,000

On 01.01.2000, they decided to sell a machine for Rs.4,500. This machine was purchased for Rs.9,000 for depreciation A/c. on 31.12.2000 assuming the firm has been charging depreciation at 101 p.a. on Straight Line Method. Machinery A/c. Dr.

Cr. Date

Particulars

Amount

Date

To Balance 01.01.00

50,000 C/d

01.01.00

Particulars By Provision

Amount

3,600

Depreciation A/c. By Bank C/d

4,500

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FINANCE & MANAGEMENT ACCOUNTING Date

Particulars

Amount

127 Date

Particulars

Amount

By P & A/c. (Loss on Sale of Machinery) (9000-3600-4500) By Bal. C/d (B/f) 50,000 01.01.90

31.12.00

To Machinery A/c. (900x4) To Bal. C/d B/f

By Bal. B/d 31.12.00

By P & A/c. (50000-90000) 40000 x 10%

24,100

41,000 50,000

3,600

20,500

900

20,000

4,100 24,100

Diminishing Balance or Reducing Installment or Written Down Value Method: Under this method, depreciation is charged at fixed rate on the reducing balance (i.e. cost less depreciation) every year. Thus, the amount of depreciation goes on decreasing every year. A fixed rate percent on diminishing value of the asset is written off each year; so as to reduce the asset is written off each year, so as to reduce the asset to its break up value at the end of its life. Merits: 1. This method is recognized by Income Tax authorities as well as companies amendment act 1988. 2. Eliminations of a major portion of cost in earlier years also minimized the impact of obsolescence. 3. Fresh calculation of depreciation is not necessary as and when additional are made. 4. The assets are never completely written off, so that some charge is made to revenue, every year. Demerits: 1) Under this method, the calculation of depreciation is slightly completed. 2) As completed to the straight line method, it is difficult to determine the suitable rate of depreciation. 3) The value of the asset cannot be brought down to zero. 4) This method lays too much emphasis on the historical cost. 5) This method does not provided any fund for the replacement of asset.

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A company purchased a plant for Rs.10,000 it is expected that its useful life will be 3 years and salvage value Rs.1000. Determine the rate of depreciation and amount of depreciation to be provided in the first year as per written down value method. 3

r=1- √S C Where n – the expected life of years s – residual value c – acquisition cost r – rate of depreciation

r = 1 - √ 10,000 1,000 r = 1 - 1 1/3 10 =1= 1 – 0.464 = 0.536 1/3 Rate of Depreciation = 0.536 x 100 = 53.6%

5.36 = 1000 -

= Rs.5,360 100 E.g. A company acquired a machine on 01.01.2000 at a cost of Rs.40,000 and spent Rs.1,000 its installation. The firm writes off depreciation at 10% on the diminishing balance. The st

books are closed on 31 Dec. of each year. Show machinery account for 2 years. Machinery A/c. Dr. Date

Cr. Particulars

Amount

Date

To Bank 01.01.00

41,000

31.12.00

(40000+1000)

Particulars By Dep. A/c.

41,000 To Bal. B/d

4,100

(41000 x 10%) By Bal. C/d

01.01.01

Amount

36,900

36,900 41,000

31.12.01

By Dep. (36900 x 90%) By Bal. C/d

01.01.02

To Bal. B/d

33,210

36,900 33,210

36,900

24,100

Annuity Method:

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Under this method, interest at a fixed rate is calculated on the capital investment involved in the purchase of the asset, on the assumption that, if the same amount of capital was employed in some other investment, it would have earned a certain rate of interest. The cost of the asset is also the interest thereon are written down annually by equal installments until the book value of the asset in question is reduced either to zero or its residual value at the end of its usefulness to the business. The amount of depreciation is found out from ‘Annual Tables’. It should be noted that the amount of depreciation includes some portion of asset and some portion of this expected amount of interest also. Merits: 1. This method does not ignore interest on capital investments. This is the only method which consider interest on capital ‘sunk’. 2. It is most suitable for those firms in which more capital is invested in lease hold property. 3. It is considered as the most exact and scientific form from the point of view of calculation. Demerits: 1) Interest so calculated is based on an arbitrary rate and not based on the law.

Depreciation Fund or Sinking Fund Method:

Under this method the amount of depreciation is calculated with reference to sinking fund labels. It is debited to depreciation account and credited to sinking fund account. At the end of the year, the depreciation is charged to P & A/c. This amount is invested in outside securities in order to earn compound interest on the investment. This process continues in all the years of the life of the asset. In the last year, the investment. This process continues in all the year of the life of the asset. In the last year, the investments are sold and whatever amount that is realized from the sale of securities is utilized to the replacement of the asset. Merits: 1. Financial position is not adversely affected at the time of replacement of asset due to the fact that adequate amount can be realized by the sale of depreciation fund investment.

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2. The management will not be tempted to use the depreciation fund for some other purpose as it is invested in outside securities. Demerits: 1) There is a risk of loss in selling the investment. 2) It is complicated due to difficulties in relation and reinvestment of interest. 3) P & A/c. is burned with increasing repairs every year. 4) Every year same amount of depreciation is transferred to P & A/c. is not realistic. E.g. A company purchased a 3 year lease on 01.01.2000 for Rs.50,000. It decides to provide for the replacement of lease at end of three years by setting up a sinking fund. It is expected that the investment will fetch interest at 5% sinking fund tables show that to provide the requisite sum at 5% at end of these years, an investment are made to the end of three years, an investment at Rs.15,864 is required every year. Investments are made to the nearest rupee. st

On 31 Dec. 2002, the investment were sold for Rs.30,500. On 01.01.2003 the same lease was reviewed for a further period of 3 years by payment of Rs.60,000. Give Lease A/c. Sinking Fund A/c. and Sinking Fund Investment A/c.

Lease A/c. Dr.

Cr. Date

Particulars

01.01.00

To Bank A/c.

01.01.01 01.01.02

Amount

Date

Particulars

Amount

50,000

31.12.00

By Balance C/d

50,000

To Balance B/d

50,000

31.12.01

By Balance C/d

50,000

To Balance B/d

50,000

31.12.02

By Sinking Fund A/c.

50,000

Sinking Fund A/c. Dr. Date

Cr. Particulars

Amount

Date

Particulars

Amount

31.12.00

To Balance C/d

15,864

31.12.00

By Depreciation

15,864

31.12.01

To Balance C/d

32,521

01.01.01

By Balance C/d

15,864

By Interest on Sinking 31.12.01

793 Fund Investment

31.12.01 32,521

By Depreciation

15,864 32,521

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131 01.01.02

31.12.02

To Sinking Fund

2,021

By Balance B/d

32,521

By Interest on Sinking Investment

50,000

01.01.02

1,626 Fund Investment

31.12.02

To Lease A/c.

31.12.02

By Depreciation

15,864

By P & A/c.

2,010

52,021

Sinking Fund Investment A/c. Dr. Date

Cr. Particulars

Amount

Date

Particulars

Amount

31.12.90 31.12.00

To Bank

15,864

By Balance C/d

15,864 01.01.01

To Balance C/d

15,864

01.01.02

To Bank

16,657

15,864 31.12.91

By Balance C/d

32,521 01.01.02

To Balance B/d

32,521

15,864

32,521

32,521 31.12.02

By Bank (Sale)

30,500

By Sinking Fund A/c 31.12.02

2,021 (Loan Transferred)

32,521

Insurance Policy Method: Under this method, a policy is taken for the amount of the asset to be replaced, at the end of

the policy period.

A definite amount is required from insurance company, which is used for

purchasing new asset. Premium is paid every year and this premium is equal to the amount of depreciation of year. In the beginning of each year premium is paid. E.g.

X Co. Ltd. purchased a lease of Rs.50,000 on 01.01.2000 to be replaced at the end

of five years for this purpose, one insurance policy is taken out for which the annual premium is Rs.9,400. At the end of the period the lease is renewed for Rs.45,000. Show the various ledger account in the books of the company.

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Depreciation Reserve A/c. Dr.

Cr. Date

Particulars

31.12.00

To Balance C/d

Amount 9,400

Date

Particulars

Amount

31.12.00

By P & A/c.

9,400

9,400 31.12.01

To Balance C/d

18,800

9,400 01.01.01

By Balance B/d

9,400

31.12.01

By P & A/c.

9,400

18,800 31.12.02

To Balance C/d

28,200

18,800 01.01.02

By Balance B/d

31.12.02

By P & A/c.

18,800 9,400

28,200 31.12.03

To Balance C/d

37,600

28,200 01.01.03

By Balance B/d

31.12.03

By P & A/c.

28,200 9,400

37,600 31.12.04

To Lease A/c.

50,000

37,600 01.01.04

By Balance B/d

31.12.04

By P & A/c.

37,600 9,400

By Dep. Insurance 31.12.04

3,000 Policy A/c.

50,000

Depreciation Insurance Policy A/c. Dr. Date

Cr. Particulars

01.01.00

To Bank

Amount 9,400

Date

Particulars

31.12.00

By Balance C/d

9,400 01.01.01

To Balance B/d

9,400

01.01.01

To Bank

9,400

To Balance B/d

01.01.02

To Bank

18,800

9,400 9,400

31.12.01

By Balance C/d

28,200 01.01.02

Amount

18,800

28,200 31.12.02

By Balance C/d

28,200

9,400

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FINANCE & MANAGEMENT ACCOUNTING Date

Particulars

133

Amount

Date

Particulars

Amount

28,200 01.01.03

To Balance B/d

01.01.03

To Bank

28,200

28,200 31.12.93

By Balance C/d

37,600

9,400 37,600

01.01.04

To Balance B/d

01.01.04

To Bank

37,600

37,600 31.12.04

By Bank

50,000

9,400

To Depreciation of Reserve A/c. 31.12.04

3,000 (Profit on Relaxation of Policy) 50,000

50,000

Lease A/c. Dr.

Cr. Date

Particulars

01.01.00

To Bank

Amount 50,000

Date

Particulars

31.12.00

By Balance C/d

50,000 01.01.01

To Bank

50,000

To Bank

50,000

31.12.01

By Balance C/d

To Bank

50,000

50,000 50,000

31.12.02

By Balance C/d

50,000 01.01.03

50,000 50,000

50,000 01.01.02

Amount

50,000 50,000

31.12.03

By Balance C/d

50,000

50,000 50,000

By Balance C/d 01.01.04

To Bank

50,000

31.12.04

50,000 Reserve /c

50,000

To Bank 01.01.05 (Renewal) 50,000

Merits:

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1. Drawbacks of depreciation fund method are removed. 2. This method is used in case of those assets which are to be replaced at the end of their lives. 3. Better security is provided to investors by assumption of risk by insurance company. Demerits: 1) This method is more expensive since insurance company keeps its own margin. 2) This method is found unsuitable where additions are made to assets during the period of its working life. 3) P & A/c. does not show the true position because same amount of depreciation is charged every year to P & A/c.

Revaluation Method: This method is restored to incase of assets, which call for special consideration, such as

livestock, patents etc. and where no other methods can be employed to secure satisfactory results. At the end of each financial period the assets are revalued. The difference between the book value at the beginning and at the end is depreciated and charged to P & A/c. On the other hand, if revaluation amount is more than book value, this excess is ignored. Merits: 1. Very simply to understand and use. 2. Most suitable for certain types of assets like loose tools. Demerits: 1) P & A/c. is charged with different sums every year. 2) Revaluation is based on market value which is against the basic principles of depreciation. 3) Revaluation is to be made by the experts, and the estimates of expert may go wrong, knowing or unknowing.

E.g. A firm which started business on 01.01.2002. Bought crates whose estimated value in different years is given below:

Creates bought (on 1

2002 Rs. 24,000

2003 Rs. 9,600

2004 Rs. 17,700

16,200

15,900

21,000

Jan) Estimated Value on

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31 Dec. Prepare crates amounts for two years.

Crates A/c. Dr. Date

Cr.

01.01.02

Particulars

Amount

To Bank A/c

24,000

Date

Particulars

31.12.02

By Depreciation B/f

31.12.02

By Balance C/d

24,000 01.01.03

To Balance B/d

16,200

7,800 16,200 24,000

31.12.03

By Depreciation B/f

31.12.03

By Balance C/d

25,800 01.01.04

Amount

9,900 15,900 25,800

15,900

To Balance B/d

Depletion or Output Method: This method is suitable for wasting assets mines, quarries etc. form which certain quantity of

output can be obtained, when a mine quality of output can be obtained, when a mine quality of output can be obtained, when a mine becomes useless or reaches a stage of depletion. Under this method, an estimate is made about the total quality of mineral in the mine and then depreciation is found out in the following manner: Cost of the Asset Depreciation Rate = Total Mineral to be Extracted Depreciation

Annual Output x Depreciation Rate

E.g. X Ltd. Leased on July 30, 2000 an iron ore line for a sum of Rs.1,00,000. It is estimated that the total quantity of one in the mine is 20,000 tonnes. The annual output is as follows: 2000

1,000

tonnes

2001

4,000

tonnes

2002

3,200

tonnes

2003

4,200

tonnes

Using the depletion method of depreciation show the mine a/c for 2 years. Cost of the Asset Depreciation Rate = Total Mineral to be Extracted

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Depreciation Rate / Tonne=

= Rs.5 per tone. 20,000 Books of X Ltd. Mine A/c.

Dr.

Cr. Date

Particulars

Amount

Date

30.06.00

To Bank

1,00,000

31.12.00

Particulars

Amount

By Depreciation 5,000 (100 x 5) 31.12.00

By Balance C/d

1,00,000

95,000 1,00,000

By Depreciation 01.01.01

To Balance B/d

95,000

31.12.01

20,000 (4000 x 5)

31.12.01

By Balance C/d

95,000 01.01.02

To Balance B/d

75,000 95,000

75,000

Machine Hour Rate Method: Under this method, the working life of a machine is estimated in terms of hours. The hourly

rate of depreciation is calculated by dividing the cost less scrap value of machine by the total working hours. Then every year a actual record for the actual number of hours for which the machine works is kept. The depreciation for any year is arrived at by multiplying the hourly rate with the number of hours for which the machine has worked during the year. Merits: 1. It is very simple. 2. Most advantages to factories where production based on machine, manual labour being secondary. Demerits: 1) It is difficult to assess the life of machine quite accuracy. 2) It does not equalize the burden on P & A/c. of depreciation repair and renews.

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Eg. A machine was acquired on 1

Apr. 2002 at a cost of Rs.2,70,000.

The cost of

installation being Rs.30,000. It is expected that its total life will be 60,000 hours. During 2002, it worked for 15,000 hours and during 2003 for 24,000 hours. Write up the machinery amount for 2002 and 2003. Cost of the Machine

3,00,000 = Rs.5 per hour

Estimated Total Hours of Life

60,000

Machinery A/c. Dr.

Cr. Date

Particulars

01.04.02

To Bank (2,70,000 + 30,000)

Amount

Date

3,00,000

31.12.02 31.12.02

Particulars By Depreciation (15000 Hrs x Rs.5) By Balance C/d

3,00,000 01.01.03

To Balance B/d

2,25,000

01.01.04

To Balance B/d

75,000 22,500 3,00,000

31.12.03 31.12.03

2,25,000

Amount

By Depreciation (24,000 x Rs.5) By Balance C/d

1,20,000 1,05,000 2,25,000

1,50,000

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