Preparatory Course for AFM

IBS Hyderabad
A Constituent of The ICFAI Foundation for Higher Education
(A Deemed-to-be-University under Section 3 of the UGC Act, 1956)
Dontanapalli, Shankerpalli Road, Hyderabad-501203, Telangana State
 IBS Hyderabad
Academic Year: 2019-20 (June 2019 – October 2019)
Course Handout

Course Name: Preparatory Course for AFM Semester: Preparatory

Faculty Name: Room No:
Mobile No: Email ID:
Consultation hours: Credits: NIL

Course Overview:
This course is designed to help the students develop an understanding of the accounting processes by
learning the basic accounting principles, concepts and standards. At the end of this course, students will
be able to understand the processes involved in systematic recording of financial transactions.

Course Objectives:
• To develop conceptual knowledge required for preparation of books of accounts.
• To be able to prepare different books of accounts (Journal, Ledger and Cash Book) on the basis of
principles and regulations of accounting.

Learning Outcomes:
At the end of the course, the student will be able to:
• Understand the need, importance and process of the book keeping system
• Understand the concepts of accounting and accounting standards.
• Familiarity with terminologies, accounting methods and various books of account used.

Reading Material:
Financial Accounting by SP Jain and KL Narang (12 Revised Edition), Kalyani Publishers

Evaluation:
The evaluation for the course will be based on Online examination (MCQs) at the end of the course.

Session Cases to be
Topic to be covered
No. discussed
1–2 Introduction to Accounting
Chart of Accounts
3–4 Can you help
Accounting Terminology (Assets, Liabilities, Expenses, Revenues)
Ajay?
Accounting Cycle
5–6
Accounting Concepts and Conventions with appropriate examples
Types of accounts --
7
Golden Rules of Accounting and Identification of transactions
8 – 11 Journal – Format, Preparation, Entries with illustrations --
12 – 13 Ledger – Format, Preparation, Posting with illustrations --
14 – 15 Cash Book – Types, Format, Bank Reconciliation Statement --
16 Preparation of Trial Balance, Need for Adjustment Entries --
Fundamental Accounting Equation --
17 – 18
Linking of Golden Rules to Accounting Equation
19 Online Examination
Case to be discussed in Class

Can you help Ajay?

After completion of mechanical engineering from IIT, Mumbai; Ajay joined with Tata Motors in the year
2015. After gaining three years of experience, Ajay decided to fulfil his dream to start a small automobile
components manufacturing unit in his hometown, Pune. He decided to manufacture two components.
Even though Ajay had good entrepreneurial skills, he was struggling to convert his business idea into a
real business venture. Finally, he decided to meet his friend and one of the popular business consultants in
the city, Kiran, for getting some insights.

During the discussion, Kiran’s first advice was to conduct a small market survey for getting estimation
about the existing demand in the market and also understand the competitors. Next day, Ajay started
analysing the market and finally he decided to set up a plant having capacity of 5,000 units per month for
each component. After fixing the estimated demand figure, Ajay started to estimate the value of various
resources required for starting the unit. Finally, he prepared a list of resources, but the next dilemma was
to identify the sources of funds to finance these resources. Finally, he prepared a list of sources of funds
and resources required and as follows:-

Sources of funds Amount Resources required Amount

Ajay’s savings 20,00,000 Land 10,00,000
Bank Loan Buildings 15,00,000
-Long term 28,00,000 Machineries 7,00,000
-Short term 2,00,000 30,00,000 Furniture and fixtures 8,00,000
Raw materials 5,00,000
Cash 5,00,000

Total 50,00,000 Total 50,00,000

Ajay has taken one month for converting the idea into reality and he named his business unit as Sunrise
AutoCompo Pvt. Ltd. The new company has started its operation on 01/04/2019 and at the end of the first
month the company has produced and sold 5,000 units of each component. The expenses paid related with
production and sales are:- wages Rs 3,00,000; raw materials consumed Rs 4,00,000; administration
expenses Rs 2,00,000; electricity Rs 1,00,000; stationary expenses Rs 20,000; interest on loan Rs 10,000
and miscellaneous expenses Rs 80,000 (ignore depreciation for one month).

The company fixed the selling price per unit for the first component at Rs 200 and for the second
component at Rs 100. Fortunately they could sell the entire components and received the entire amount of
sales in cash. But, with limited knowledge of accounting, now Ajay doesn’t know whether the business is
making any profit or loss? Can you help Ajay to understand the financial performance and financial status
of the business unit after one month of its operation.......?

This case is developed by Prof. Anto Joseph, IBS Hyderabad and exclusively for the purpose of class room
discussion.
The following is a sample chart of accounts. It does not represent a comprehensive chart of all the accounts used in
this textbook but rather those accounts that are commonly used. This sample chart of accounts is for a company that
generates both service revenue as well as sales revenue. It uses the perpetual approach to inventory. If a periodic system
was used, the following temporary accounts would be needed to record inventory purchases: Purchases, Freight-In,
Purchase Returns and Allowances, and Purchase Discounts.

CHART OF ACCOUNTS
Owner’s and
Stockholders’
Assets Liabilities Equity Revenues Expenses
Cash Notes Payable Owner’s Capital Service Revenue Advertising
Expense
Accounts Accounts Payable Owner’s Drawings Sales Revenue
Receivable Amortization
Unearned Service Common Stock Sales Discounts Expense
Allowance for Revenue
Doubtful Paid-in Capital in Sales Returns and Bad Debt Expense
Accounts Salaries and Excess of Par— Allowances
Wages Payable Common Stock Cost of Goods Sold
Interest Interest Revenue
Receivable Unearned Rent Preferred Stock Depreciation
Revenue Gain on Disposal Expense
Inventory Paid-in Capital in of Plant Assets
Interest Payable Excess of Par— Freight-Out
Supplies Preferred
Dividends Payable Stock Income Tax
Prepaid Insurance Expense
Income Taxes Treasury Stock
Prepaid Rent Payable Insurance Expense
Retained Earnings
Land Bonds Payable Interest Expense
Dividends
Equipment Discount on Bonds Loss on Disposal of
Payable Income Summary Plant Assets
Accumulated
Depreciation— Premium on Bonds Maintenance and
Equipment Payable Repairs Expense

Buildings Mortgage Payable Rent Expense

Accumulated Salaries and Wages

Depreciation— Expense
Buildings
Supplies Expense
Copyrights
Utilities Expense
Goodwill

Patents
 Preparatory Course for AFM

Chapter 1

Introduction to Accounting
• Types of Financial Statements
• Users of Financial Statements

The concept of accounting has been in vogue for many centuries. It was more than 3000 years ago that scribes in
Babylonia and Egypt received what in effect was formal accounting training in schools. Accounting profession
declined in the middle ages but was revived in Italy during the crusades. Full blown double entry bookkeeping
appears in Genoese records of 1340. For centuries, accounting was primarily associated mainly with
government activities. However, the industrial revolution brought additional accounting needs. Large scale
enterprises required huge capital to finance them and large number of people to direct their operations. This led
to investor-manager combination. The investor who finances the project like to know how the firm is protecting
and utilizing the resources entrusted to it. This led to the growth of accounting as a profession.
The importance of accounting further grew with managers realizing the importance of accounting information in
improving the effectiveness of decision making process. Thus accounting took a new shape of management
accounting.
Today, most organizations have the accounting group as the largest staff unit. The accounting group essentially
consists of two types of people: (1) Book keepers and other clerical employees who maintain the detailed
operating records and (2) Professional accountants who decide how items should be reported, prepare the
reports, interpret them, analyze, design and operate the systems through which information flows and ensure
that the information is accurate.
Although accounting is a staff function performed by accounting professionals within an organization, the
ultimate responsibility for the generation of accounting information - financial or managerial - rests with
management. Management’s responsibility for accounting is the reason that one of the top officers of many
businesses is the controller. The controller’s responsibility is to satisfy the needs of other managers related to
management accounting information and comply with the requirements of financial reporting. For proper flow
of such information, the controller’s office employs accounting professionals in both management and financial
accounting. These accountants design, install and operate the information systems required to generate financial
and managerial reports.
Bookkeeping: It is an art of recording or noting the facts of financial transactions in simple and easy to
understand way. This forms the basis to measure the operating performance of the business and to analyze the
financial position of the business.
“Accounting is the process of identifying, measuring and communicating economic information so that they can
make informed judgments and decisions”. Accounting as a function is related to all the functions in an
organization like planning, implementation, marketing, control, etc. This wide range of involvement of
accounting as a function increases the scope of accounting as a profession. Accounting professionals are
responsible for preparing and finalizing the financial statements.

TYPES OF FINANCIAL STATEMENTS

Typically, major financial statements, which result from accounting, are:
• Profit and Loss statement
• Balance sheet
A profit and loss statement depicts how much profits or losses an organization has made in a time period. A
balance sheet is a statement of what an organization owes and what it owns at any given point of time. The
above statements are used by many groups of people with different purposes.

USERS OF FINANCIAL STATEMENTS

Management
Managers are responsible for the financial performance of an organization. They must periodically compile and
interpret financial statements to measure the financial performance. The managers are also interested in various cost
and control information pertaining to different departments or functions to understand how far the organization has
been successful in achieving its financial goals and to take corrective measures.

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Shareholders, Security Analysts and Investors

Shareholders and investors are the owners of a firm. They need to have information to know how the firm is
performing. Analysts who advise the potential investors are largely interested in assessing the profitability,
examining the financial strength and estimating value of firms.
Lenders
Financial statements are normally used by lenders to judge the profitability and liquidity of a business and to
assess the security of the fund they are going to lend. The lenders and creditors are primarily interested in
ensuring the safety of their loans. Banks use financial statements of a firm to assess its working capital needs.
The focus of all the above groups is to evaluate the risk in investing in a firm.
Suppliers
Suppliers of raw materials to a company are usually interested in the short-term liquidity of the company.
Information in financial statements helps them analyze the liquidity position of a firm.
Customers
The quality of goods and services of the firm, legal obligations associated with guarantees, warranties and
after-sales-service contracts tend to establish long-term relationships between a business and its customers.
The financial statements may be used by the customers to draw inferences about the long-term viability of the
firm.
Employees
Employees have a vested interest in the continued and profitable operations of the organization in which they
are working. Financial statements can be used as important sources for obtaining information regarding the
current and future profitability and solvency.
Government and Regulatory Authorities
Income tax authorities are interested in assessing the taxable profits generated by a firm. Similarly, regulatory
authorities may use financial statements to check whether organizations have followed the rules and procedure
set by them.
Others
Diverse persons such as academicians, researchers and analysts may approach business firms for financial
information. To draw conclusions, they study the financial statements in depth.

End-users of financial statements need not be from finance background. They might not be in a position to
understand the complex technicalities of financial statements. People who do not have detailed understanding of
financial accounting process and the related legal provisions are sure to fail to make any sense out of the
information presented in annual reports. Therefore, annual reports provide summarized information from
balance sheets and profit and loss accounts in non-technical language. Experts, however, feel that in this process
of summarization, the meaning content of financial information may be diluted or lost. Because of lack of well
laid out procedures, rules and regulations for financial reporting, experts felt that the accompanying graphs, pie
charts, etc. tend to overplay the accomplishment of a company and downplay the information which shows its
poor performance. This has paved way for Financial Accounting Standard Board (FASB) in USA (Similar to
Accounting Standard Board of the Institute of Chartered Accountants of India) to issue a series of guidelines
on financial reporting concepts and practices.

According to FASB, there are two main objectives of financial reporting:

1. Information about enterprise earnings and its components measured by accrual accounting provides a better
indication of enterprise performance than information about current cash receipts and payments.
2. Financial reporting should also provide information about an enterprise’s economic resources, obligations
and owner’s equity, liquidity or solvency and management explanations and interpretations of information
provided.

FASB has issued several guidelines for improving the information provided in financial statements. Each new
disclosure provides some additional useful information to readers of financial statements. But again financial
statements, footnotes, supplementary statements, etc. complicate the entire reporting process. Many users of
financial statements argue that more summarized presentation may result in effective communication of
financial information. Summary reporting is something less than the full text of current annual reports to
shareholders but something more than the brief presentation of financial highlights and summary indicators that
generally appear in the annual reports. However, one should clearly understand that summary report would not
eliminate the statements to be included in the filing of annual report. The summary report would just serve as
primary information for the people who are not experts in reading financial statements.

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Chapter 2

Accounting Concepts
• Business Entity Concept
• Going Concern Concept
• Cost Concept
• Money Measurement Concept
• Duality or Accounting Equivalence Concept
• Accounting Period Concept
• Matching Concept
• Conservatism Concept
• Consistency Concept
• Materiality Concept
• Realization Concept

This Chapter focuses on various accounting concepts, which should be understood before learning the
accounting mechanism.

BUSINESS ENTITY CONCEPT

The legal entity of a corporate business is distinct from the entity of its owners and managers and people
understand it well. Less understood, however, is that the accounting entity of a business is distinct from its
owners. For example, for many purposes, legal entity of a sole proprietary business may not be very distinct
from the entity of the proprietor himself. However, the business entity concept requires that this should not
come in the way of treating the business as a distinct accounting entity for the purposes of treating transactions
relating to the operations of the business. It is in accordance with this concept that when an owner brings capital
into the business, the business in turn is deemed to owe the capital to the owner. Again, coming to the business
between the sole proprietary concern and its sole proprietor, usually the proprietor may not pay himself a salary,
even when he works for his business. However, in accordance with the business as a separate entity, his
position as an owner must not come in the way of his charging a salary to the business for the services rendered
by him. This is because (as far as the business is concerned) the service rendered cannot be regarded cost free.
The reward of ownership is to be manifested only in the form of profit, which must be arrived at after charging
‘all costs’.

GOING CONCERN CONCEPT

A business entity is assumed to carry on its operations forever. Even if all the members of the management die,
the concern will continue to exist. Going concern concept implies that the resources of the concern should be
used for the purposes for which they are meant to be used. This concept implies that the land, buildings,
machinery, etc., which are required for carrying out the production and selling of certain products, would
continue to be with the concern for a long time.

COST CONCEPT
Cost concept implies that in accounting, all transactions are generally recorded at cost, and not at market value.
For example, if a piece of land is acquired for Rs.2 lakh, it would continue to be shown in the balance sheet at
Rs.2 lakh, even when the market value of the land rises to say Rs.5 lakhs. The cost concept is closely related to
going concern concept. If the land is acquired for the operations of the business and would continue to be used
for its operations and would not be sold shortly, then it is largely immaterial what the land’s market value is,
since it is not going to be sold anyway. Thus, it is consistent with going concern concept to keep recording the
land at cost i.e. Rs.2 lakhs on an ongoing basis.

MONEY MEASUREMENT CONCEPT

All transactions are recorded through a common denominator, namely the monetary unit. Thus, if a certain
event, which cannot be measured in monetary terms, no matter how significant it is for the health of or even
existence of the business, cannot be recorded in accounts. For example, the purchase of an inconsequential asset
such as tables and chairs, which is easily measured in rupee terms, is accounted for in the business. However,
the retirement or death of the Chairman of a company has far reaching consequences for the health of the
business. It is not accounted for, since no monetary measurement of the event is feasible.

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DUALITY OR DOUBLE ENTRY CONCEPT

This concept states that for every transaction, there will be two aspects. For example, when capital is introduced
into the business, there is a cash inflow and capital forms a liability and the cash inflow is an asset. Similarly,
when an equipment is purchased for cash, the new asset comes in (use of fund), and the cash will decrease
(source of fund). Or when the equipment is purchased for credit, the new asset comes in (use of fund) and a
liability will occur (source of fund). So for every transaction, there are two aspects. In effect, all the transactions
affect the basic equation given as under:
Owners’ equity + Outside liability = Assets.

ACCOUNTING PERIOD CONCEPT

To be able to prepare the income statement for a business, the period for which it is to be prepared must first be
specified. An accounting period may be a calendar year or a financial year. In some businesses, such as trading,
the operating period may be relatively small, say a month or even less, while in other cases, it may stretch well
beyond a year. Under the Companies Act, a company is normally not permitted to have the accounting period
extending beyond fifteen months.

MATCHING CONCEPT
In order to determine the profits or losses accrued in an accounting period, the expenses must relate to the goods
or services sold during the period. The expenses incurred in the production of goods and services should be
matched with the revenues realized from the sale of the goods and services.

CONSERVATISM CONCEPT
The idea behind this concept is that recognition of revenue requires better evidence than recognition of
expenses. This concept emphasizes that revenues are recognized only when they are reasonably certain and
expenses are to be recognized as soon as possible. For example, a sales manager might have finalized a deal
with his client for a sale of 100 units of a product. But, unless these items are produced and delivered to the
client, there is no reasonable certainty about receiving the payment for these 100 units. It is only thereafter that
he can record the sales amount on those 100 units as due from the client. But on the other hand, if we come to
know that a customer has lost all his assets and is likely to default payment, then we should immediately either
make provision for such loss or write them off.

CONSISTENCY CONCEPT
The consistency concept requires that once an entity has decided on one method, it will treat all subsequent
events of the same character in the same fashion unless it has a sound reason to change the method of treatment
of that event. For example, if a concern is charging depreciation by one method it is expected to follow the same
method in the subsequent years also.

MATERIALITY CONCEPT
All financial transactions need to be recorded in the books of accounts. However, there may be transactions
which may be insignificant and are not shown separately. They are usually clubbed with others. There is no
agreement as to the exact line separating material events from immaterial events. The decision depends on
judgment and common sense.

REALIZATION CONCEPT
According to this concept, revenues are recognized only when the goods and services have been delivered and
there is certainty that the revenue will be realized. If from the past experience, it is realized that revenue is
realized for the 95% of the sales, a provision of 5% can be created for doubtful accounts. For example, orders
may be obtained at time 1, which may be accepted at time 2, the work towards the production of the order may
commence at time 3, the production process is completed at time 4, the goods are dispatched at time 5, and the
cash is received at time 6 and so on. At which time, can one say that the revenue is realized, or a sale is made?
Normally, revenue is said to be realized when efforts rendered are rewarded either in cash (or kind) or in the
form of a promise of reward sometime in future. Now in the above context, a reward or a promise of reward
sometime in future may be normally forthcoming only after the goods are dispatched. Thus, revenue is
normally recognized only when goods or services are transferred and a reward or a promise of reward is
forthcoming. If there is no transfer of goods or services, normally no reward may be expected either now or in
future and hence no revenue will be realized. Similarly, if there is no reward or a promise of reward in return for
the goods or services rendered, then such rendering of goods or services would merely be an act of philanthropy
or squandering and cannot be construed as a “Sale”. Thus, normally, revenue is recognized at the time of
transfer of goods or services irrespective of whether the payment is made immediately or in future. However,
there are exceptions to the above rule of revenue recognition.

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Chapter 3

Journal

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Problems
1. Ascertain which account is to be debited and credited for each of the following transactions:
Transaction Two Nature of Effect Debit or
accounts accounts Credit
1.Started business with Cash
2.Bought goods for cash
3.Sold goods for Mohan
4.Depsoited cash into bank
5.Recevied cash from x
6.Paid salary to Ramesh
7.Rent Paid to landlord
8.Paid wages
9.Drew cash from bank for office use
10. Proprietor withdrew cash for domestic use

2. Journalize the following transactions in the books of Ravi for month of June,2018 :
June 1 Started business with cash Rs.50,000
June 2 Paid into bank Rs.25,000
June3 Goods purchased for cash Rs.25,000
June 4 Purchased furniture and paid by cheque Rs.15,000
June 6 Sold goods for cash Rs.10,500
June 9 Sold goods to Arvind Rs.4,500
June11 Goods purchased from Sharma Rs.10,000
June12 Goods returned to Sharma Rs.1,000
June18 Cash received from Arvind Rs.4,000
June21 Withdrew from bank for private use Rs.1,000
June23 Withdrew from bank for use in the business Rs.5,000
June24 Paid telephone rent Rs.400
June28 Cash paid to Lakshmi Rs.5,000
June30 Paid salary to staff Rs.5,000

3. Journalize the following transactions of Narasimha for the month of January 1998.
Jan. 1 Narasimha commenced his business with a capital of Rs.10,000
Jan 5 Credit sales to Hari Rs.3,200
Jan 5 Bought goods from Kamal (Credit) Rs.1,920
Jan 6 Bought goods from Jaimal on credit Rs.2,300
Jan 8 Bought office furniture for cash from Modern Furniture Rs.3,050
Jan12 Paid cartage to Golden Company Rs.70
Jan 15 Paid carriage out to Hamid Rs.20
Jan17 Paid trade expenses Rs.10
Jan 18 Paid advertisement expenses to Anil Agencies Rs.200
Jan 19 Received interest from Anil Rs.50
Jan 20 Deposited cash into bank Rs.1,000
Jan 22 Paid Rent Rs.150
Jan 27 Paid insurance premium Rs.30
Jan 29 Paid salary to Narendra a clerk Rs.200

4. Journalize the following transactions in the books of Amar for the month of January,2017
1 Amar started business with cash Rs.50,000; goods worth Rs.4,000 and furniture worth Rs.500.
2 Purchased building for Rs.10,000
3 Purchased goods for cash Rs.3,000
4 Purchased goods on credit Rs.2,500
5 Paid cartage Rs.20

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6 Sold goods for cash Rs.2,550

7 Sold goods for cash to Avtar Rs.240
8 Sold goods to Mahendra on credit Rs.4,650
9 Paid freight Rs.120
10 Deposited cash into bank Rs.8,000
11 Paid salary Rs.460
12 Withdrew from the bank Rs.200 for office use
13 Withdrew from the bank Rs.300 for private use
14 Charged interest on capital Rs.1,250.

5. Journalize the following transactions of Kashinath for the month of March 1998
March 1 Kashinath commenced business with a Capital of Rs. 30,000
2 Bought Machinery Rs.5,000
3 Bought goods for cash from Madan Lal Rs.2,500
4 Sold goods for cash to Giri Rs.4,000
5 Purchased goods from Jaisimha Rs.3,000
6 Cash Sale Rs.5,000
10 Received interest from Mukund Rs.2,000
11 Deposited Cash into Bank Rs.2,000
14 Paid cash to Jaisimha Rs.2,900 in full settlement of his account
16 Sold goods to Venkat Rs.4,000
18 Venkat settled his account by cheque for Rs.3,890
29 Paid rent by cheque Rs.500

6. Journalize the following transactions in the books of a trader for the month of Dec,2018:
Dec,1 Started business with cash Rs.60,000
Dec,2 Goods purchased for cash Rs.30,000
Dec,5 Furniture purchased for cash Rs.15,000
Dec,8 Sold goods for cash Rs.10,000
Dec,9 Sold goods to Kumar Rs.8,000
Dec,12 Goods purchased from Vinod Rs.5,000
Dec,15 Goods sold to Anil and allowed him 10% trade discount Rs.6,000
Dec,20 Cash received from Kumar in full settlement of his account 7,600
Dec,25 Cash paid to Vinod Rs.4,900 and he allowed discount Rs.100
Dec,28 Cash paid for purchase of stationery Rs.250
Dec,31 Paid office rent Rs.1,800
Dec,31 Paid salaries to staff Rs.2,000

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Chapter 4

Subsidiary Books, Ledger and Trial

Balance
• Subsidiary Books
• Ledger
• Trial Balance

SUBSIDIARY BOOKS
A small business may be able to record all its transactions in a single book − Journal. But as the business
expands and the number of transactions increases, it becomes complex to record all the transactions in the same
book, and the posting of these transactions to the concerned ledger accounts also becomes difficult. Most
transactions are repetitive in nature and it becomes easier to record them in special or subsidiary books each of
which is meant to record transactions of similar nature. For example, all credit sales can be recorded in sales
book, all credit purchases in a purchases book, all cash transactions in a cash book and so on. These subsidiary
books are also called day books and can be ruled differently on the basis of the nature of transactions. Various
types of subsidiary books are discussed below.
i. Cash Book
ii. Purchases Book
iii. Purchase Returns Book
iv. Sales Book
v. Sales Returns Book
vi. Bills Receivable Book
vii. Bills Payable Book
viii. Journal Proper

Cash Book
This book contains all the cash transactions and bank transactions occurred during the period. This book serves
as both a journal and also as an account. There are different types of cash books.

Single Column Cash Book

Single column cash book is also called as simple cash book and contains cash transactions only. It has a single
column for amount – representing cash at office.

The following is the proforma of a cash book:

Dr Cash Book Cr
Date Particulars LF Amount Date Particulars LF Amount

Debit Side Columns

1. The first column on debit side is used to record the date on which the cash is received.
2. The second column is meant for recording the name of the account from which cash is received.
3. The third column is used for recording the ledger folio of the account in which the transaction is posted.
4. The fourth column is used to record the amount received.

Credit Side Columns

1. In first column, the date on which payment is made is recorded.
2. The second column is used for recording the name of the account to which the amount is paid.
3. The third column is used for recording the ledger folio of the account in which the transaction is posted.
4. The fourth column is used to record the amount paid.

Balancing the Cash Book - Just like any other account, cash book is also balanced. There will always be a
difference between debit and credit columns of a cash book because, apart from transactions, there will always
be some cash in hand. The difference between these two columns should equal to the cash in hand. This cash in
hand is written on the credit side of cash book with a narration ‘By balance c/d’.

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Posting from Cash Book - For all cash transactions entered in a cash book, only one aspect, i.e. cash aspect, is
completed. Therefore, to complete double entry system, the postings must be made from cash book to the
accounts affected by the transactions. From the debit side of the cash book, the postings are made to the credit
side of the accounts affected and from credit side to the debit side of the accounts affected.
For example, if cash is received from Vinay, his account is credited in ledger with the amount as “By Cash”.
Similarly if cash is paid to Ajay his account is debited as “To Cash”.

Double Column Cash Book

In modern business, traders usually keep only a small amount of cash in the office for immediate requirements
and deposit the remaining with banks. Therefore, transactions with banks are more frequent. It is very
convenient if the cash book contains another column to record bank transactions. This cash book is an extension
of single column cash book. Under this method, an additional column is provided both on debit side and credit
side for recording bank transactions.
Dr Cash Book Cr
Date Particulars LF Cash Bank Date Particulars LF Cash Bank

The following points must be noted while making entries into this type of cash book:
1. Opening Balances - The opening balance of cash in hand and at bank is written on the debit side as “To
Balance b/d”. The amount of cash in hand is written in cash column and that at bank in bank column. In
case of bank overdraft, it is written on the credit side as “By Balance b/d”.
2. All the receipts will be written on the receipt side or debit side of cash book − cash receipts in cash column
and cheques in bank column. If a cheque is received and then deposited in the bank, a debit entry should be
passed in the bank column.

Cash Discount - It is a rebate or an allowance made by the receiver of cash to the payer. Cash discount arises,
when payment is made before a specified date. For instance, the supplier may say that if payment is made within
one month, a discount of 2% will be allowed. It means that a debt of Rs.100 can be discharged by paying only
Rs.98 before the end of the month.
3. All payments are written on credit side-cash payments in cash column and payments by cheque in bank
column.
4. Contra Entries - If cash is deposited in the bank, it should be entered in the bank column on the debit side
as ‘To Cash’ and again on credit side of the cash book under the cash column as ‘By Bank’. If cash is
withdrawn from bank for use in office, it should be entered in cash column on the debit side as ‘To Bank’
and again on the credit side in Bank column as ‘By Cash’. These transactions are not posted in the ledger as
both the accounts (Cash and Bank) are in the cash book itself. For such entries, letter “C” is written in LF
column on each side to indicate that contra effect of this transaction is recorded on the opposite side. Such
entries are called contra entries.

Balancing - The cash columns are balanced exactly in the same manner as indicated for simple cash book. The
process is similar for balancing the bank columns also. But, it is possible that the bank may allow the firm to
withdraw more than the amount deposited, i.e. to have an overdraft. In such a case, the total of the bank column
on the credit side shows a higher balance than the one on the debit side. The difference is written on the debit
side as “To Balance c/d”. Then, the totals are written on the two sides opposite to one another. For the next
period, the balance is entered on the credit side as “By Balance b/d”.

Three Column Cash Book

A cash book which has cash, bank and discount columns on both the sides is called three column cash book.
Cash discount allowed by a trader to his debtor is recorded on the debit side of cash book. Cash discount
received by him from his creditors is recorded on credit side of the cash book.
However, cash discount should not be confused with trade discount. Trade discount is an allowance made by a
manufacturer or wholesaler to his retailers off the catalogue price of goods sold. It is granted either to old and
regular customers, in case of bulk sales or as a custom of trade. The main idea behind providing the trade
discount is to enable the retail trader to sell goods at catalogue price by keeping margin to meet his business
expenses and profit. Trade discount is deducted from catalogue price and the balance is recorded in the books of
account. In other words, trade discount is allowed for pushing sales of the dealer and hence the retailer records
net price as purchases while cash discount is made for speedy collections for the sales already made.
Balancing – The discount columns are totaled but not balanced.

Multiple Column Cash Book

When a business concern has more than one bank account, a cash book will have the cash column, bank
columns for as many bank accounts as it has and also the discount column. For example: Bank A/c No.1, Bank
A/c No.2, etc.

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 Preparatory Course for AFM

Petty Cash Book

Businesses of every size have payments that are of small amounts and high frequency. For example, payments
for postage, telegrams, stationery, carriage travelling, etc. When a petty cash fund is operated as an imprest
fund, the recording of the petty expenses will be made in the petty cash book. This would also avoid recording
too many small value transactions in the main cash book. The petty cash book would contain a number of
analytical columns for grouping the various expenses to facilitate subsequent posting into the general ledger. A
specimen petty cash book is given below.

Petty Cash Book

Date Receipts Total Date Payments Voucher Conveyance Carriage Stationary Postage Miscellaneous
expenditure

When an analytical petty cash book is maintained for recording the petty expenses, it will be more convenient to
consider the petty cash as a separate account and consider cash paid for all petty expenses. Once the imprest
fund is exhausted or at the end of a particular duration, say, a month, the petty cash columns are totaled and a
journal entry is passed. The amount spent is reimbursed to the petty cash account.

Purchases Book
This is also known as purchases journal and is used to record credit purchases of goods only. The term ‘goods’
covers only those items procured by the business for resale.
Date Name of the Supplier LF Inward Invoice No. Amount (Rs.)

Purchase Returns Book

This book is used to record the goods purchased on credit and sent back to suppliers because of nonconformance
to specifications or for any other reasons.
Date Name of the Supplier LF Debit Note No. Amount Rs.

Sales Book
Also known as sales journal, this subsidiary book is used to record all sale of goods on credit.
Date Name of the Customer LF Outward invoice No. Amount Rs.

Sales Returns Book

This book is used to record the transactions relating to goods sent back by the customers who bought the goods
on credit as they were not conforming to the specifications or any other reason.
Date Name of the Customer LF Credit Note No. Amount Rs.

Bills Receivable Book

The bills receivable of an enterprise consist of all promissory notes given or bills of exchange accepted by
customers in respect of amounts due from them.
S. Date From whom Acceptor Date Term Date of When Amount How
No received of bill maturity payable Rs. disposed

At the end of the day, the total of the bills receivable book is debited to Bills receivable account by crediting the
concerned debtors’ account.

Bills Payable Book

The bills payable book records information about all promissory notes or bills of exchange accepted by the
business in respect of amounts owing to its suppliers.
S. No Date Name of Payee Date of Term Date of When Amount Remarks
the drawer bill maturity payable Rs.

At the end of the day, the total of the bills payable book is posted to the credit of Bills Payable account by
debiting the concerned creditors account.

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 Preparatory Course for AFM

Journal Proper
This book is used to record all transactions which cannot be included in the cash book or any of the other six
subsidiary books discussed above. For example: purchase or sale of furniture on credit. The format of journal
proper is similar to that of a Journal.

Account
An account is a summarized record and systematic arrangement of transactions for a period affecting one
person, one kind of property or one class of gains or losses. Every account is divided into two sides - debit side
(the left hand side) and credit side (the right hand side).

LEDGER
Ledger is a set of accounts. It is a book in which various accounts of nominal, personal and real nature are
opened. The proforma of a ledger is as under:
Dr Name of the Account Cr
Date Particulars JF Amount Date Particulars JF Amount

These ledger accounts are posted from the books of original entry, viz. cash book, sales book, purchases book,
sales returns book, purchase returns book, bills receivable book, bills payable book and journal.

Posting
It is a process of entering the information given in the journals to the ledger. The guiding rules for posting
transactions are as follows:
The debit aspect of the journal entry is posted to the debit side of the ledger account and the credit aspect of the
journal entry is posted to the credit side of the ledger account.

Balancing an account
After the transactions have been posted and the various accounts have been prepared, they are balanced.
The procedure for balancing an account is as follows:
• Take up the total of both sides separately
• Find out the difference between the debit total and credit total. The difference is called “balance”.
• Record the above balance as the last item on the side having smaller total.
• If the balance is written on the debit side, write “To Balance c/d” in the particulars column; and if the
balance is to be placed on credit side, write “By Balance c/d”.
• Now, write the total of each side in the account. These totals are similar. The total must be written on both
sides of the account on the same horizontal level.
• Finally, the amount of closing balance should be brought down as opening balance at the beginning of the
next accounting period with the narration ‘Balance b/d’ along with To and By as the case may be.
When the account has to be continued in the next page, the account is balanced and it is written as ‘Balance
Carried forward’ on the page where the account is closed and it is opened writing ‘Balance Brought Forward’ on
the next page.

TRIAL BALANCE
One very important aspect of double entry system of book-keeping is that for each and every transaction, there
is debit and credit of equal amounts in two or more accounts. Thus, the total of debit balance must be equal to
the total of the credit balance. Trial balance is a statement showing the balances, or total of debits and credits of
all the accounts in the ledger with a view to verifying the equality of debits and credits posted to the ledger
accounts. Trial balance is prepared on a particular date. If the debit and the credit columns of a trial balance are
equal, it is presumed that the posting to the ledger in terms of debit and credit amounts is accurate.
Objectives of preparing the trial balance are (a) to ascertain the arithmetical accuracy of the ledger accounts (b)
to help in locating errors (c) to help in the preparation of final accounts.

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 Preparatory Course for AFM

Problems
1. Enter the following transactions in a three column cash book
April 1 cash in hand Rs.20,000 and at Bank Rs.50,000
April 2 Paid into Bank Rs.16,000
April 5 Bought machinery and issued cheque Rs.12,000
April 8 purchased goods for cash Rs.5,000
April 12 Received from Sumanth Rs.2,980, discount allowed Rs.20
April 14 Cash sales Rs.6,000
April 16 Paid to Amar by cheque Rs.11,950, discount allowed 50
April 19 Withdrew from bank for private expenses Rs.600
April 23 Paid to bank Rs.10,400
April 24 Received cheque from Patel 1,980, allowed him discount 20
April 26 Deposited Patel’s cheque into the bank
April 28 Withdrew cash from bank for office use Rs.2,500
April 30 Paid rent by cheque Rs.1,800

2. Enter the following transactions in a Three Column cash book:

Jan 1, Cash in hand Rs.30,000; Balance at Bank Rs.65,000
Jan 3, Cash sales Rs.16,400
Jan 6, Received a cheque for Rs.15,700 from Krishna
Jan 8, Paid into bank Krishna’s cheque for Rs.Rs.15,700
Jan 10, Paid to A by cheque Rs.980 and discount allowed by him Rs.20
Jan 12, Cash purchases Rs.12,500
Jan 14, Withdraw from bank for office use Rs.2,500
Jan 15, Received cheque for Rs.2,950 from Ravi & co allowed him discount Rs.50
Jan 18, Cash sales Rs.7,500
Jan 19, Paid into bank Ravi &co cheque
Jan 20, Cash deposited into bank Rs.10,000
Jan 21, Cash paid for stationery Rs.150
Jan 23, Paid commission to Rakesh by Cheque Rs.400
Jan 29, Drew a cheque for Rs.600 for personal use
Jan 31, Paid salaries by cheque Rs.2,500 and by cash Rs.500

3. Madanlal operates two bank accounts both of which are maintained in the columnar cash book itself. You
are required to prepare a proforma of the cash book, record the following transactions therein and draw the
closing balances as on 30th June, 1997.
June 20 Opening Balance of cash Rs.1,180
20 Progressive Bank Rs.19,040
20 Goodwill Bank Rs.6,460 (Overdraft)
20 Received cheque for Rs.1,800 from a debtor Mr.X and deposited in Goodwill Bank. The
bank credited the amount on 23 June, 1998 and debited Rs.4 to the account as its
collection charges.
21 Purchased goods for Rs.18,210 and a cheque issued on Progressive Bank.
22 Paid office expenses Rs.410 and Rs.80 for stationery in cash.
23 Deposited a cheque in Progressive Bank for Rs.21,090 as sale proceeds of goods. The
bank credited the amount on the same day and debited Rs.21 as cheque discounting
charges.
23 A cheque for Rs.8,000 drawn by Mr.Madanlal himself on Progressive Bank was deposited
in his account with Goodwill Bank.
25 Cash drawn from the account with Progressive Bank Rs.600 for office expenses.
25 A Cheque for Rs.1,100 received from Mr.A and earlier deposited in the account with
Goodwill Bank (on 14th June, 1998) was returned unpaid and the Bank debited Rs.10
towards its charges. Mr. Madanlal received the amount of returned cheque and the bank
charges in cash from Mr. A.
28 Deposited cash Rs.1,500 in the account with Goodwill Bank.
29 Purchased postal stamps for Rs.200 and paid in cash.

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4. Enter the following transactions in a cash book with cash, discount and bank columns and balance the cash
book on 30th September 1997.
Sept 1 Cash in hand Rs.400; Bank overdraft Rs.5,000
4 Injected fresh capital of Rs.10,000; Rs.5,000 from it (Out if fresh capital)
was deposited in the bank.
5 Sold goods in cash for Rs.3,000
6 Collected Rs.8,000 from X by cheque and allowed discount Rs.200
10 Purchased goods for Rs.2,000 by cash and Rs.3,000 by cheque
11 Paid Rs.2,500 by cheque and received Rs.100 as discount
12 Paid commission to an agent Rs.500
15 Purchased office Furniture by cash for Rs.2,000
16 Rent paid Rs.100
17 Drew a cheque for personal use Rs.1,000
18 Cash sales Rs.5,000
20 Collected from Y Rs.4,000 in cash and deposited into Bank the next day.
23 Dividend received by cheque Rs.100 and deposited into Bank.
28 Paid office salaries by cheque Rs.2,000
29 Deposited cash into Bank Rs.7,000

5. Journalize the following and post them into a ledger:

Sept,1 Started business with Rs.1,50,000
Sept,2 Bought furniture for Rs.15,000 and machinery for Rs.20,000
Sept,3 Purchased goods for Rs.20,000
Sept,6 Sold goods for Rs.80,000
Sept,8 Purchased goods from M& Co Rs.20,000
Sept,30 Paid for stationery Rs.500

6. Record the following transactions in journal and post them to ledger:

(a) Commenced business with cash of Rs.50,000
(b) Purchased supplies on account Rs.16,000
(c) Paid rent for the month Rs.1,000
(d) Purchased equipment for cash Rs.6,000
(e) Paid miscellaneous expenses Rs.600
(f) Paid creditors on account of Rs.11,000
(g) Received Rs.1,200 as commission
(h) Received from cash sales Rs.12,000

7. Journalize the following transactions and post them in the appropriate ledger accounts of Prabhakar.
Jan 1 Started business with Rs.2,00,000 in the bank and Rs.40,000 cash;
1 Bought shop fittings for Rs.40,000 and a van for Rs.60,000 and paid by cheques
2 Paid rent by cheque for Rs.5,000
3 Bought goods for resale on credit from Zakir & Co Rs.50,000
5 Cash sales Rs.5,000
8 Paid wages of Rs.1,000 to assistant in cash
10 Paid insurance premium by cheque Rs.500
12 Cash sales Rs.8,000
15 Paid wages of Rs.1,000 to assistant in cash; Goods returned to Zakir & Co for Rs.6,000
17 Paid Zakir & Co Rs.30,000 by cheque
19 Bought goods for resale on credit from Rao & Co for Rs.25,000
19 Cash sales Rs.7,000
22 Paid wages of Rs.1,000 to assistant in cash
24 Bought Stationery in cash for Rs.500
25 Cash Sales Rs.15,000
27 Paid Rao & Co Rs.14,000 by cheque
29 Paid wages of Rs.1,000 to assistant in cash
31 Deposited Rs.20,000 in the bank

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8. Write the following transactions in the ledger of Mr.Kamesh Reddy for the month of July, 1997.
July 1 Started business with Rs.80,000 in the bank and Rs.30,000 cash
2 Paid rent by cheque Rs.3,000; and
Bought goods on credit from Barnali Sengupta & Co for Rs.15,000
3 Sold goods in cash for Rs.3,000 and on credit to P Sengupta & Co for Rs.5,000;
4 Paid insurance premium of Rs.250 by cheque and bought stationery for Rs.100 in cash;
5 Paid wages in cash for Rs.500; Sold goods for Rs.700 in cash
8 Deposited cash Rs.1,000 in bank and returned goods to Barnali Sengupta & Co for Rs.3,000
9 Paid Rs.10,000 to Barnali Sengupta by cheque
11 Sold goods to G Basu on credit for Rs.8,000
12 Paid wages in cash for Rs.500; goods returned by P Sengupta & Co for Rs.1,000
15 Rs.1,500 cash deposited in bank; goods returned by P Sengupta & Co for Rs.1,000; bought
shop furniture for Rs.500 and payment was made through cheque
17 Cheque received from P Sengupta & Co for Rs.4,000
19 Paid wages in cash for Rs.500; Sales for Rs.2,000 in cash
21 Bought goods on credit from Barnali Sengupta & Co for Rs.6,000
22 Goods sold on cash for Rs.5,000 and on credit to P Sengupta & Co for Rs.10,000
26 Rs.4,000 cash deposited in bank; bought postage stamps for Rs.50 in cash
27 Paid telephone bill for Rs.500 and electricity bill for Rs.400 by cheque
30 Paid wages in cash for Rs.500

9. Journalize the following transactions, post them in the concerned ledger accounts and balance the accounts.
1998 Rs.
Jan 1 Manohar commenced business with 80,000
2 Deposited in bank 75,000
5 Bought goods on credit from Srinath 8,000
8 Sold goods to Sridhar on credit 10,000
10 Purchased machinery, payment made through cheque 25,000
12 Paid Srinath by cheque 6,000
16 Received cash from Sridhar 7,500
20 Bought Stationery from Govind Venkatesh for Cash 300
24 Paid Rs.500 as travelling expenses to Mukhesh
27 Bought goods for cash 3,000
31 Paid rent to landlord by cheque 400

10. Below are given the balances as shown by Murali Mohan on Jan 1, 1998 as well as his transactions for the
month. Enter them in Journal, and make Ledger Posting.
1998 Jan.1 Opening Balances
Assets:-Cash in hand 3,800; Cash at Bank Rs.5,000; Stock Rs.2, 000; Sundry Debtors - Ajay-Rs.1, 000;
Bhaskar Rs.1,000; Chetan-Rs.600; Machinery Rs.1, 200
Liabilities - Sundry Creditors-Dinesh Rs.700; Ganesh Rs.600; Bank Loan Rs.2, 000
Jan.1 Bought goods for cash Rs.400
2 Purchased from Dinesh Rs.300
3 Returned goods to Dinesh Rs.100
4 Paid to Dinesh Rs.350
5 Sold goods to Ajay Rs.600
9 Received a cheque from Ajay for Rs.1,200
11 Settled Ganesh A/c by cheque Rs.540
11 Received Discount 60
19 Sold goods to Chetan Rs.100
20 Paid back bank loan Rs.2,000
21 Murali Mohan withdrew from bank for his personal use Rs.300
23 Purchased new machine Rs.300
25 Sold old machine Rs.600
27 Chetan sent us a cheque Rs.280
27 Discount given to Chetan Rs.20
30 Paid for carriage Rs.40
30 Postage Rs.60
30 Salaries Rs.400
31 Paid rent by cheque Rs.200

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 Preparatory Course for AFM

11. From the following list of balances, prepare a trial balance as on 30.6.1997:

1. Opening Stock(Dr) Rs.18,000 13. Plant & Machinery(Dr) Rs.7,500

2. Wages(Dr) Rs.10,000 14. Loose Tools(Dr) Rs.1,800
3. Sales(Cr) Rs.1,20,000 15. Lighting(Dr) Rs.2,300
4. Bank Loan(Cr) 4,400 16. Creditors(Cr) Rs.8,000
5. Coal and Coke(Dr) Rs.3,000 17. Capital(Cr) Rs.40,000
6. Purchases(Dr) Rs.75,000 18. Miscellaneous Receipts(Cr) Rs.600
7. Repairs(Dr) Rs.2,000 19. Office Salaries(Dr) Rs.2,500
8. Carriage(Dr) Rs.1,500 20. Office Furniture(Dr) Rs.600
9. Income Tax(Dr) Rs.1,500 21. Patents(Dr) Rs.1,000
10. Debtors(Dr) Rs.20,000 22. Goodwill(Dr) 15,000
11. Leasehold Premises(Dr) Rs.6,000 23. Cash at Bank(Dr) Rs.5,100
12. Cash in hand(Dr) Rs.200

12. From the following Ledger Accounts balances, prepare a trial balance of Ghosh Brothers as on 31.12.97:
1. Opening Stock Rs.78,000 16. Insurance Rs.2,000
2. Freehold Premises Rs.1,50,000 17. Bad Debt Reserve Rs.1,500
3. Plant and Machinery Rs.45,000 18. Commission Received Rs.15,000
4. Wages Rs.10,000 19. Commission paid Rs.5,000
5. Sundry Debtors Rs.60,000 20. Bad Debts Rs.1,500
6. Carriage Inward Rs.900 21. office expenses Rs.7,500
7. carriage outward Rs.1,000 22. Salaries Rs.10,000
8. Factory expenses Rs.8,000 23. Travel Expenses Rs.1,000
9. Royalty Rs.1,000 24. Legal expenses Rs.1,000
10. Purchase of Raw Material Rs.75,000 25. Cash at Bank Rs.4,200
11. Factory Rent Rs.11,000 26. Cash in hand Rs.4,000
12. Capital Rs.80,000 27. Loan taken Rs.30,000
13. Discount Allowed Rs.4,000 28. Office Rent Rs.4,000
14. Discount Received Rs.3,600 29. Sales(Net) Rs.3,30,000
15. Sundry Creditors Rs.20,000

13. The clerk of a businessman wrongly prepared the following Trial Balance.
You are required to draw up a Trial Balance correctly stating reasons thereof:
Debit Credit
1 Capital Rs.60,000
2 Stock at commencement Rs.5,000
3 Discount allowed Rs.500
4 Commission Received Rs.700
5 Fixed Assets Rs.60,000
6 Sales Rs.85,000
7 Purchases Rs.45,000
8 Return outward Rs.1,000
9 Return inward Rs.2,000
10 Carriage Inward Rs.600
11 Carriage Outward Rs.700
12 Wages & Salary Rs.25,000
13 Bills receivable Rs.7,500
14 Debtors Rs.9,000
15 Bills Payable Rs.7,000
16 Rent Rs.3,000
17 Interest Paid Rs.2,000
18 Cash Rs.800
19 Creditors Rs.6,900
20 .Stock at the End Rs.33,800

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 Preparatory Course for AFM

14. The following Trial Balance is incorrect, although it adds up to the same total on both sides. Draw up a
corrected Trial Balance.
Trial Balance of Allan Border as at 31.12.1997
Sl. No Head of Accounts L.F Debit Balance Credit Balance
1 Capital (1 January 1997) Rs.8,900
2 Drawings Rs.1,000
3 Stock (1 January 1997) Rs.3,700
4 Purchases Rs.23,125
5 Sales Rs.39,400
6 Motor Vehicles Rs.1,450
7 Cash in hand Rs.135
8 Sundry Debtors Rs.4,976
9 Sundry Creditors Rs.13,970
10 Bank Overdraft Rs.900
11 Wages & Salaries Rs.6,200
12 Lighting & Heating Rs.315
13 Equipment Rs.3,500
14 Carriage Outward Rs.231
15 Return Inwards Rs.205
16 Provision for Bad Debts Rs.425
17 Return Outwards Rs.316
18 Discount Allowed Rs.280
19 Discount Received Rs.315
20 Rent, Rates & Insurance Rs.1,121
Total Rs.55,232 Rs.55,232

15. B. Bright who is weak in bookkeeping is not a strong point asked you to audit his accounts for the year
ended on 31.11.97. As on that date, his closing stock was valued at Rs.574. As a basis for you audit, Bright
furnished you with the following statement:
Sl. No Head Accounts L.F. Debit Balance Credit Balance
1 B. Bright Capital Rs.1,556
2 B. Bright, Drawing Rs.564
3 Leasehold premises Rs.750
4 Sales Rs.2,750
5 Due from Customers Rs.530
6 Purchases Rs.1,259
7 Purchases return Rs.264
8 Loan from Bank Rs.256
9 Creditors Rs.528
10 Trade expenses Rs.700
11 Cash at Bank Rs.226
12 Bills payable Rs.100
13 Salaries & Wages Rs.600
14 Stock (1.1.97) Rs.264
15 Rent & Rates etc. Rs.463
16 Sales Return Rs.98
Total Rs.5,454 Rs.5,454
Audit the above trial balance and confirm the correctness of the statement.

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 Preparatory Course for AFM

Chapter 5

Final Accounts
• Trading Account
• Profit and Loss Account
• Balance Sheet

The main objective of maintaining the books of accounts is to find out the net profit or loss made by a business
at the end of the period and to ascertain the financial position of the business as on a particular date. The
following financial statements help in finding out the net profit or loss and the financial position of a business as
on a particular date:
• Trading account
• Profit and Loss account, and
• Balance Sheet.
Once the trial balance is ready and the errors are rectified, trading, and profit and loss account are prepared by
transferring balances of relevant accounts from the trial balance. All real and personal accounts are shown in the
balance sheet.

TRADING ACCOUNT
This is an account which shows the result of buying and selling of goods and services. It shows all the
transactions occurring during a trading period which have a direct relation to the goods in which a business
deals in a concise form. This account helps in finding out the gross profit or gross loss of a business during a
time period.

PROFIT AND LOSS ACCOUNT

The profit and loss account is designed to highlight the net profit earned or net loss incurred by a business entity
during an accounting period. It contains all the items of revenue gains, losses and operating expenses pertaining
to the accounting period. The purpose of preparing the profit and loss account is to ascertain net profit or net
loss of a business enterprise during an accounting period.

BALANCE SHEET
Balance sheet is a statement of assets and liabilities of a business enterprise at a given date. It shows what a
business owns and what it owes. The left hand side shows the liabilities and the right hand side shows the assets.
The purpose of preparing a balance sheet is to ascertain the nature and value of assets of a business to determine the
nature and amount of liabilities of a business and to determine its solvency.
Various items of a balance sheet are discussed below. The understanding of these items will help in analyzing
balance sheets better.

Assets
Assets represent resources which a firm values. They are acquired at a specific monetary cost by the firm for
carrying out its operations. Assets are classified as follows:
1. Fixed Assets
2. Investments
3. Current Assets
4. Miscellaneous Expenditure and Losses
Fixed assets: They have two characteristics. They are acquired for carrying out a firm’s operations over a long
period of time and they are ordinarily not meant for resale. Examples of fixed assets are land, buildings, plant,
machinery, patents, copyrights, etc.
Investments: These are financial securities owned by a firm. Some investments represent long-term
commitment of funds. (Usually these are the equity share of other firms held for income and control purposes)
Other investments are short-term in nature and may rightly be classified under current assets for managerial
purposes.
Current assets: This category consists of cash and other resources which are converted into cash during the
operating cycle of a firm. Current assets are held for a short-period of time as against fixed assets which are held
for relatively longer periods. The major components of current assets are: cash, debtors, inventories, loans and
advances, and pre-paid expenses. Cash denotes funds readily disbursable by the firm. The bulk of it is usually in

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the form of bank balance, the rest comprises of currency held by the firm. Debtors (also called accounts
receivable) represent the amounts owed to the firm by its customers who have bought goods, services on credit.
Debtors are shown in the balance sheet at the amount owed, less an allowance for the bad debts. Inventories
consist of stocks of raw material, work in progress, finished goods, and stores and spares. They are usually
reported at the lower of either the cost or market value. All loans and advances to employees, advances given to
suppliers and contractors, and deposits made with governmental and other agencies fall in this category. They
are shown at the actual amount. Pre-paid expenses are expenditures incurred for services to be obtained in the
future.
Miscellaneous expenditures and losses: This category consists of two items: (i) Miscellaneous expenditures
and (ii) Losses. Miscellaneous expenditures represent certain outlays such as preliminary expenses and pre-
operative expenses which have not been written off.

Liabilities
Liabilities are defined as what the business entity owes to others. They include:
1. Capital
2. Reserves
3. Secured loans
4. Unsecured loans
5. Current liabilities
6. Provisions
Capital: Capital is owners’ contribution to their businesses as their investment.
Reserves: Reserves are profits which are retained in a firm. There are two types of reserves – revenue reserve
and capital reserve. Revenue reserves represent accumulated retained earnings from the profits of normal business
operations. These are held in various forms such as general reserve, investment allowance reserve, etc. Capital
reserves arise out of gains which are not related to normal business operations. Examples of such gains are the
gain from the revaluation of assets.
Secured loans: They denote borrowings of a firm against which specific securities are provided. The important
components of secured loans are loans from financial institutions and commercial banks.
Unsecured loans: They are borrowings of a firm against which no specific security is provided. The major
components of unsecured loans are loans from friends and relatives and unsecured loans from banks.
Current Liabilities: Current liabilities are obligations which are expected to mature in the next twelve months.
They include the following:
i) loans which are payable within one year, ii) accounts payable (creditors) on account of goods and services purchased
on credit for which payment is made within one year, iii) provision for taxation, iv) accruals for wages, salaries,
rentals, interest, and other expenses (these are expenses for services that the company has received but for which the
payment has not fallen due), v) advance payments received for goods or services to be supplied in the future.
Provisions: A certain amount is set aside to provide for the outstanding expenses, depreciation, bad and
doubtful debts, etc.

Adjustments: Rationale
On the basis of accrual principle, the impact of events on assets and liabilities is recognized in the time period
when services are rendered or utilized, instead of when cash is paid or received. Revenue is recognized as it is
earned and expenses are recognized as they are incurred.
The distinction between capital and revenue items is an important consideration in the preparation of final
accounts. Items of revenue income, revenue expenditure and revenue losses are shown in the trading and profit
and loss account. Capital expenditure, capital losses, capital income and capital receipts are excluded from these
accounts.
The general guideline for the preparation of trading and profit and loss account on accrual basis is that only
revenue income and revenue expenditure for the current period are included in this account. The guidelines may
be spelt out as under;
• An expenditure which pertains to the future, though already incurred, is excluded.
• An expense, which has already been incurred but the payment has not been made such as outstanding
salaries of employees, will be included.
• Income or receipts which pertain to the current period whether received in cash or not, are included.

Adjustments Treatment in Trading or Profit and Loss Treatment in

Account Balance Sheet
Closing Stock On the credit side of trading account Assets sides
Outstanding expenditure Add to the respective expenditure on the debit side Liabilities side
of trading or profit and loss account
Prepaid expenses Deduct from the respective expenditure on the debit Assets side
side of trading or profit and loss account

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Preparatory Course for AFM

Income due but not yet Add to the respective income account on the credit Assets side
received side of the profit and loss account
Income received but not yet Deduct from the respective income account on the Liabilities side
due credit side of the profit and loss account
Depreciation Debit side of the profit and loss account Deduct from the
respective asset
account
Bad debts Debit side of the profit and loss account Deduct from the
debtors balance on the
assets side
Provision for bad and Debit the profit and loss account. Shown as a current
doubtful debts liability on the
(To be calculated after liabilities side of the
deducting the bad debts balance sheet
from the debtors)

Provision for discount to Debit side of profit and loss account Deduct from the
debtors (To be calculated debtors balance in the
after deducting the bad assets side
debts (given as adjustment)
and provision for discount
on creditors)
Provision for discount from To be shown on the credit of profit and loss account Deduct from creditors
creditors in the liabilities side
Interest on capital On the debit side of profit and loss account As an addition to the
capital on the
liabilities side
Interest on drawings Credit side of profit and loss account As an addition to the
drawings which is a
deduction from the
capital on the
liabilities side

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 Preparatory Course for AFM

Problems
1. A Bookkeeper has submitted to you the following Trial Balance wherein the totals of debit and credit
balances are not equal:

Debit (Rs.) Credit (Rs.)

Capital 7,670
Cash in hand 30
Purchases 8,990
Sales 11,060
Cash at bank 885
Fixtures and fittings 225
Freehold premises 1,500
Lighting and heating (factory) 65
Bills receivable 825
Returns inwards 30
Salaries 1,075
Creditors 1,890
Debtors 5,700
Stock on 1st Jan 1997 3,000
Printing 225
Bills payable 1,875
Rates taxes and insurance 190
Discount received 445
Discount allowed 200
Total 24175 21705

You are required to:

- Redraft the Trial Balance correctly.
- Prepare a trading, profit and loss account and balance sheet after taking into consideration the
following adjustment:
a. Stock on hand on 31st December 1997 was valued at Rs.1,800
b. Depreciate Fixtures and Fittings by Rs.25
c. Rs.35 was due and unpaid in respect of salaries
d. Rates and Insurance had been paid in advance to the extent of Rs.40

2. Prepare trading and profit and loss account for the year ended 31 December 1997, and balance sheet as at
that date from the following trial balance of Rajamohan:

Debit (Rs.) Credit (Rs.)

Capital 1,00,000
Drawings 15,000
Sundry creditors 60,000
9% loan (taken on 1-1-1997) 10,000
Interest on loan 450
Cash in hand 1,100
Cash at bank 17,500
Provision for doubtful debts 2,000
Furniture 20,000
Plant & machinery 40,000
Stocks at commencement 60,000
Purchases 2,31,000
Manufacturing wages 30,000
Sales 3,40,000
Salaries 17,300
Rent and taxes 4,800
Discount allowed 6,800
Discount received 5,200

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 Preparatory Course for AFM

Debit (Rs.) Credit (Rs.)

Repairs & renewals 1,800
Insurance 600
Bad debts 4,100
Sundry debtors 68,000
Sundry expenses 4,800
Bills receivable 7,950
Bills payable 14,000
Total 5,31,200 5,31,200

Adjustments:
a. Closing stock was Rs.1,20,000
b. Provision for doubtful debts is to be maintained at 5% on sundry debtors
c. Insurance premium for Rs.200 prepaid
d. Charge 8% interest on capital
e. Depreciate plant and machinery by 10% and furniture by 15%
f. Provide for outstanding interest on loan

3. The following trial balance is extracted from the books of Ram Goyal on June 30, 1997. Taking into
account the following adjustments prepare trading, profit & loss account for the year ended June 30, 1997
and a balance sheet as on that date.
a. Stock on hand on June 30, 1997 was Rs.6,800
b. Machinery is to be depreciated at 10% and patents at 20%
c. Salaries outstanding Rs.1,500
d. Provision for bad & doubtful debts is to be created at 5% of sundry debtors.
e. Insurance premium prepaid amounts to Rs.85
f. Transfer Rs.2,000 from wages to building account.

Particulars Dr (Rs.) Cr (Rs.)

Cash in hand 540
Cash at bank 2,630
Purchases & Sales 40,675 98,780
Returns inwards & Outwards 680 500
Wages 10,480
Fuel & Power 4,730
Carriage on Sales 3,200
Carriage inwards 2,040
Opening Stock 5,760
Building 30,000
Freehold Land 10,000
Machinery 20,000
Patents 7,500
Salaries 15,000
General expenses 3,000
Insurance 600
Drawings 5,245
Capital account 71,000
Sundry Debtors & Creditors 14,500 6,300
Total 1,76,580 1,76,580

4. The following trial balance was extracted from the books of Neeraj on December 31, 1997. Prepare a
trading and profit & loss account for the year ended on December 31, 1997 and a balance sheet as on that
date after considering the additional information:

Trial Balance
Particulars Dr. (Rs.) Cr. (Rs.)
Furniture and fittings 640
Motor vehicle 6,250
Buildings 7,500
Capital 12,500

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 Preparatory Course for AFM

Provision for bad debts 200

Bad debts 125
Sundry debtors& creditors 3,800 2,500
Opening stock 3,460
Purchases & sales 5,474 15,450
Bank overdraft 2,850
Sales & purchases returns 200 125
Advertising 450
Interest 118
Commission 375
Cash 650
Taxes & insurance 1,250
General expenses 783
Salaries 3,300
Total 34,000 34,000

Additional information:
a. Stock in hand on 31,December 1997 was Rs.3,250
b. Depreciate building at 5 percent, furniture and fittings at 10% and motor vehicle at 20%.
c. Rs.85 is due for interest on overdraft.
d. Salaries for Rs.300 and taxes for Rs.120 are outstanding.
e. Insurance premium amounting to Rs.100 is prepaid.
f. Write off further Rs.100 as bad debts and provision for bad debts is to be made equal to 5% of Sundry
Debtors.
g. One third of commission is received in advance.

5. Prepare trading and profit and loss account and a balance sheet from the following figures:

Trial Balance as on 31st December, 1997

Particulars Dr. (Rs.) Cr. (Rs.)
Capital account 2,10,000
Drawings A/c 13,000
Purchases 80,000
Investments in Govt. securities 20,000
Interest 1,000
Wages 30,000
Sundry debtors 70,300
Legal expenses 4,000
Cash in hand 1,200
Cash at bank 11,000
Freehold property 60,000
Plant & machinery 1,20,000
Bills payable 6,500
Bills receivable 7,000
Salaries 13,000
Office expenses 3,000
Discount account 4,500
Sales 2,16,000
Stock on 1st January 1997 45,000
Office rent 2,400
Bad debts 1,700
Insurance 1,500
Gas and fuel 2,700
Freight and carriage 3,500
Loose tools 4,500
Patent rights 6,000
Factory lighting 5,000
Sundry creditors 50,000
Returns inwards 3,200

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 Preparatory Course for AFM

Particulars Dr. (Rs.) Cr. (Rs.)

Return outwards 4,000
Loan on mortgage at 5% 30,000
Office furniture and fittings 5,000
Total 5,17,500 5,17,500

Stock on 31st December 1997 was Rs.60,000. There were outstanding liabilities of Wages for Rs.3,000;
Salaries Rs.1,200; Office Rent Rs.500. Provide for half years interest on loan on mortgage. Depreciate
freehold property by 2 percent, plant and machinery by 10%, Office furniture by 5%, patent rights by 20%.
Loose tools are revalued on 31st December 1997 and their new value is Rs.3,700. Write off Rs.1,300 as
further bad debts and provide 5% of debtors as reserve for doubtful debts.

6. From the following trial balance of Harikumar, prepare trading, profit and loss account for the year ended
31 December 1997 and balance sheet as on that date.

Particulars Dr. (Rs.) Cr. (Rs.)

Capital 1,28,500
Stock 25,000
Purchases & Sales 1,30,500 2,45,000
Returns inwards and outwards 3,000 2,000
Provision for doubtful debts 1,000
Bills receivable and bills payable 50,000 5,000
Carriage inwards 7,500
Plant & machinery 60,000
Office furniture 3,500
Sundry debtors and sundry creditors 70,000 46,000
Coal, gas and water 1,500
Wages 12,500
Duty and clearing charges 1,500
Office rent 4,800
Printing & stationery 1,000
Insurance 400
Carriage outwards 6,200
Salaries 27,000
Factory rent 2,400
Sundry expenses 1,290
Drawings 12,000
Cash in hand 1,610
Cash at bank 5,800
Total 4,27,500 4,27,500

The following adjustments are to be taken into consideration

a. Closing stock Rs.50,000
b. Outstanding liabilities to be provided for Salary Rs.4,800 and factory rent Rs.2,400
c. Provision for doubtful debts to be adjusted to 2.5 percent after elimination of bad debts amounting to
Rs.4,000.
d. Goods withdrawn Rs.3,000 for domestic use.
e. Depreciation on plant and machinery at 10% and on furniture at 10%.
f. Interest on capital at 5% per annum.

7. The following balances were taken from the books of Sri Gowri Shankar on 31st December 1997:
Capital 1,00,000 Carriage Inwards 2,310
Drawing 17,600 Office Expenses 1,340
Purchases 80,000 Printing and Stationery 660
Sales 1,40,370 Postage and telegrams 820
Stock(1-1-1997) 11,460 Sundry debtors 62,070
Sundry creditors 18,920 Cash at bank 12,400
Purchase returns 2,820 Cash in hand 2,210
Bad debts 1,400 Office furniture 3,500

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 Preparatory Course for AFM

Rates and insurance 1,300 Travelers’ salary and commission 9,870

Discount(Cr) 190 Income tax 5,000
Bills receivable 1,240 Railway freight and other 18,940
Sales returns 4,240 expenses on goods sold
Wages 6,280 Provision for Doubtful debts 3,240
Buildings 25,000 Rent (Cr) 2,100

Prepare trading and profit and loss account for the year 31st December, 1997 and balance sheet as on 31st
December, 1997 after making following adjustments:
1. On 31st December, 1997 stock was valued at Rs.16,500
2. Outstanding travelers’ salary Rs.600
3. Depreciate buildings at 2.5% and office furniture 5%
4. Increase the provision for doubtful debts by Rs.760
5. Rent receivable Rs.250
6. Charge interest on capital at 5% p.a. and Rs.400 on drawings.

29
 ACCOUNT CLASSIFICATION AND PRESENTATION
Normal
Account Title Classification Financial Statement Balance
A
Accounts Payable Current Liability Balance Sheet Credit
Accounts Receivable Current Asset Balance Sheet Debit
Accumulated Depreciation—Buildings Plant Asset—Contra Balance Sheet Credit
Accumulated Depreciation—Equipment Plant Asset—Contra Balance Sheet Credit
Advertising Expense Operating Expense Income Statement Debit
Allowance for Doubtful Accounts Current Asset—Contra Balance Sheet Credit
Amortization Expense Operating Expense Income Statement Debit
B
Bad Debt Expense Operating Expense Income Statement Debit
Bonds Payable Long-Term Liability Balance Sheet Credit
Buildings Plant Asset Balance Sheet Debit
C
Cash Current Asset Balance Sheet Debit
Common Stock Stockholders’ Equity Balance Sheet Credit
Copyrights Intangible Asset Balance Sheet Debit
Cost of Goods Sold Cost of Goods Sold Income Statement Debit
D
Debt Investments Current Asset/Long-Term Balance Sheet Debit
Investment
Depreciation Expense Operating Expense Income Statement Debit
Discount on Bonds Payable Long-Term Liability—Contra Balance Sheet Debit
Dividends Temporary account closed Retained Earnings Debit
to Retained Earnings Statement
Dividends Payable Current Liability Balance Sheet Credit
E
Equipment Plant Asset Balance Sheet Debit
F
Freight-Out Operating Expense Income Statement Debit
G
Gain on Disposal of Plant Assets Other Income Income Statement Credit
Goodwill Intangible Asset Balance Sheet Debit
I
Income Summary Temporary account closed Not Applicable (1)
to Retained Earnings
Income Tax Expense Income Tax Expense Income Statement Debit
Income Taxes Payable Current Liability Balance Sheet Credit
Insurance Expense Operating Expense Income Statement Debit
Interest Expense Other Expense Income Statement Debit
Interest Payable Current Liability Balance Sheet Credit
Interest Receivable Current Asset Balance Sheet Debit
Interest Revenue Other Income Income Statement Credit
Inventory Current Asset Balance Sheet (2) Debit
 Normal
Account Title Classification Financial Statement Balance
L
Land Plant Asset Balance Sheet Debit
Loss on Disposal of Plant Assets Other Expense Income Statement Debit
M
Maintenance and Repairs Expense Operating Expense Income Statement Debit
Mortgage Payable Long-Term Liability Balance Sheet Credit
N
Notes Payable Current Liability/ Balance Sheet Credit
Long-Term Liability
O
Owner’s Capital Owner’s Equity Owner’s Equity and Credit
Balance Sheet
Owner’s Drawings Temporary account closed Owner’s Equity Debit
to Owner’s Capital
P
Patents Intangible Asset Balance Sheet Debit
Paid-in Capital in Excess of Par— Stockholders’ Equity Balance Sheet Credit
Common Stock
Paid-in Capital in Excess of Par— Stockholders’ Equity Balance Sheet Credit
Preferred Stock
Preferred Stock Stockholders’ Equity Balance Sheet Credit
Premium on Bonds Payable Long-Term Liability Balance Sheet Credit
Prepaid Insurance Current Asset Balance Sheet Debit
Prepaid Rent Current Asset Balance Sheet Debit
R
Rent Expense Operating Expense Income Statement Debit
Retained Earnings Stockholders’ Equity Balance Sheet and Retained Credit
Earnings Statement
S
Salaries and Wages Expense Operating Expense Income Statement Debit
Salaries and Wages Payable Current Liability Balance Sheet Credit
Sales Discounts Revenue—Contra Income Statement Debit
Sales Returns and Allowances Revenue—Contra Income Statement Debit
Sales Revenue Revenue Income Statement Credit
Selling Expenses Operating Expense Income Statement Debit
Service Revenue Revenue Income Statement Credit
Stock Investments Current Asset/Long-Term Balance Sheet Debit
Investment
Supplies Current Asset Balance Sheet Debit
Supplies Expense Operating Expense Income Statement Debit
T
Treasury Stock Stockholders’ Equity—Contra Balance Sheet Debit
U
Unearned Service Revenue Current Liability Balance Sheet Credit
Utilities Expense Operating Expense Income Statement Debit
(1) The normal balance for Income Summary will be credit when there is a net income, debit when there is a net loss. The Income
Summary account does not appear on any financial statement.
(2) If a periodic system is used, Inventory also appears on the income statement in the calculation of cost of goods sold.