Commercial Accountancy

Book-keeping in Private Sector

Table of Contents
Chapter Title Page No.
Preface i
1 Introduction 1
2 Form of Business Organization 21
3 Conceptual framework of Accounting 41
4 Double Entry Accounting System 57
5 Accounting process: Journal 63
6 Accounting process: Ledger 83
7 Accounting process: Cash Book and Subsidiary Books 95
8 Bank Reconciliation Statement 121
9 Trial Balance 131
10 Rectification of Errors 135
11 Depreciation Accounting 143
12 Accounting of Bills of Exchange 151
13 Final Accounts 161
 Introduction

Preface

N
ational Academy of Audit and Accounts, Shimla imparts two-year training to Indian
Audit & Accounts Officer Trainees on Public Sector Auditing and Accounting. Since
some of the entities and operations of the government would be on commercial lines,
moreover the government regulates the commercial entities, the Officer Trainees also acquire
knowledge and skills of private sector accounting and auditing. The curriculum makes a
distinction between book-keeping in the public sector and in the private sector; similarly
financial reporting in the public and private sector.
Commercial Accounts (book-keeping in private sector) is one the twelve core subjects
taught to the Officer Trainees. A lot of reading material on this subject is available in the
market and also in the public domain. However, this text book has been written to meet the
specific needs of the Officer Trainees.
This book has been written in a simple language and with a lucid style so as to explain
the principles and practices of Commercial Accounting in a manner understandable to all.
Several texts, interpretations and problems have been carefully selected from the publications
of different academic and professional institutes and examinations to supplement the
theoretical aspects covered in the book. While a vast body of literature is available on the
Book Keeping and Commercial Accounting in the academic realm to cater to the interests of
both the amateur as well as the advanced learner, this book stands out as it has been designed
to meet the exact requirements of a newly recruited IA&AS Officer Trainee.
This text is prepared by Shailesh Kumar Jakhotiya, Director and Ranjeet Singh,
Assistant Director at the Academy. External review of this book was done by Shri V. Kurian,
Director General (Commercial) O/o the C&AG of India, New Delhi.
While we have taken every possible care to remove printing errors, it is possible that
some may still remain. If the reader comes across any such error, s(he) is requested to point
out the same to us so that we can make necessary corrections in the forthcoming edition.
I am confident that in its present form the book will not only be very useful to the
Officer Trainees, but also to all other young officers and staff of the department who are
interested in the subject.
Further suggestions for improvement of the book are eagerly solicited.

August, 2016 L.V. Sudhir Kumar

Director General
National Academy of Audit and Accounts
Shimla

i
Commercial Accountancy

ii
 Introduction

CHAPTER 1 Introduction

Introduction

E
very individual performs some kind of economic activity throughout the life. A day
starts with sipping a cup of tea which requires milk and tea leaf to prepare. Buying
or producing tea leaf and milk is an economic activity. Similarly, the meal we take
or transportation we use, everything is economic activity. These activities can be run by
an individual or by group of people in un-organized such as coolie or organized form like
company. Not necessarily all the economic activities are run for any individual benefit; such
economic activities may create social benefit i.e. benefit for the public, at large. Anyway such
economic activities are performed through ‘Transactions and Events’. Any occurrence in
human life is an event. Transaction is an economic event where values get exchanged.
For Example, the Central Government raised money through taxes, paid salaries to
the employees, and spent on various developmental activities. Whenever receipts of the
Government are more than expenses it has surplus, but if expenses are more than receipts
it runs in deficit. Here raising money through various sources can be termed as transaction
and surplus or deficit at the end of the accounting year can be termed as an event. Similarly,
a shopkeeper buys goods and sells it by keeping some margin. Purchases and sales are
transactions and the stock which is left to him for sale (closing stock) will be an event.
The economic resources are limited so, it is important to keep records of all transactions
and events and to have adequate information about the economic activity as an aid to decision-
making. Accounting discipline has been developed to serve this purpose as it deals with the
measurement of economic activities involving inflow and outflow of economic resources,
which helps to develop useful information for decision-making process.
Accounting has universal application for recording transactions and events and
presenting suitable information to aid decision-making regarding any type of economic activity
ranging from a family function to functions of the national government. But hereinafter we
shall concentrate only on business activities and their accounting because the objective of
this study material is to provide a basic understanding on accounting for business activities.
Nevertheless, it will give adequate knowledge to think coherently of accounting as a field of
study for universal application.
The growth of accounting discipline is closely associated with the development of the
business world. Thus, to understand accounting as a field of study for universal application,

1
Commercial Accountancy

it is best identified with recording of business transactions and communication of financial

information about business enterprise to facilitate decision-making. The aim of accounting is
to meet the information needs of the rational and sound decision-makers, and thus, called the
language of business.

Meaning of Accounting
The Committee on terminology set up by the American Institute of Certified Public
Accountants formulated the following definition of accounting in 1961:
“Accounting is the art of recording, classifying and summarizing in a significant manner
and in terms of money, transactions and events which are, in part at least, of a financial
character and interpreting the result thereof.”
As per this definition, accounting is simply an art of record keeping. The process
of accounting starts by first identifying the events and transactions which are of financial
character and then be recorded in the books of account. This recording is done in Journal or
Subsidiary Books, also known as primary books. Every good record keeping system includes
suitable classification of transactions and events as well as their summarization for ready
reference. After the transactions and events are recorded, they are transferred to secondary
books i.e. Ledger. In ledger transactions and events are classified in terms of income, expense,
assets and liabilities according to their characteristics and summarized in profit & loss account
and balance sheet. Essentially the transactions and events are to be measured in terms of
money. Measurement in terms of money means measuring at the ruling currency of a country,
for example, rupee in India, dollar in U.S.A. and like. The transactions and events must have
at least in part, financial characteristics. Accounting also interprets the recorded, classified and
summarized transactions and events.
However, the above-mentioned definition in very narrow definition as it does not reflect
the present day accounting function. The dimension of accounting is much broader than that
described in the above definition. According to the above definition, accounting ends with
interpretation of the results of the financial transactions and events but in the modern world
with the diversification of management and ownership, globalization of business and society
gaining more interest in the functioning of the enterprises, the importance of communicating
the accounting results has increased and therefore, this requirement of communicating and
motivating informed judgement has also become the part of accounting as defined in the
widely accepted definition of accounting, given by the American Accounting Association in
1966 which treated accounting as:
“The process of identifying, measuring and communicating economic information to
permit informed judgments and decisions by the users of accounts.”
In 1970, the Accounting Principles Board (APB) of American Institute of Certified
Public Accountants (AICPA) enumerated the functions of accounting as follows:

2
 Introduction

“The function of accounting is to provide quantitative information, primarily of financial

nature, about economic entities, that is needed to be useful in making economic decisions.”
Thus it can be said that accounting or accountancy is the measurement, processing
and communication of financial information about economic entities. It was established as a
discipline by the Italian mathematician Luca Pacioli, in 1494. Accounting measures the results
of an organization’s economic activities and conveys this information to a variety of users
including investors, creditors, management, and regulators. Practitioners of accounting are
known as accountants. The terms accounting and financial reporting are often used as synonyms.
Accounting can be divided into several fields including financial accounting,
management accounting, auditing, and tax accounting. Financial accounting focuses on the
reporting of an organization’s financial information, including the preparation of financial
statements, to external users of the information, such as investors, regulators and suppliers; and
management accounting focuses on the measurement, analysis and reporting of information
for internal use by management.
The recording of financial transactions, so that summaries of the financials may be
presented in financial reports, is known as book keeping, of which double-entry book keeping
is the most common system.

Objectives of Accounting
Following are the objectives of accounting: -
1. Systematic recording of transactions- Basic objective of accounting is to systematically
record the financial aspects of business transactions i.e. book-keeping. These recorded
transactions are later on classified and summarized logically for the preparation of
financial statements and for their analysis and interpretation.
2. Ascertainment of results of above recorded transactions – Accountant prepares profit
and loss account to know the results of business operations for a particular period of time. If
revenues exceed expenses, then it is said that business is running profitably but if expenses
exceed revenues then it can be said that business is running under loss. The profit and loss
account helps the management and different stakeholders in taking rational decisions. For
example, if business is not proved to be remunerative or profitable, the cause of such a state
of affair can be investigated by the management for taking remedial steps.
3. Ascertainment of the financial position of the business – Businessman is not only
interested in knowing the results of the business in terms of profits or loss for a particular
period but is also anxious to know that what he owes (liability) to the outsiders and what
he owns (assets) on a certain date. To know this, accountant prepares a financial position
statement popularly known as Balance Sheet. The balance sheet is a statement of assets
and liabilities of the business at a particular point of time and helps in ascertaining the
financial health of the business.

3
Commercial Accountancy

4. Providing information to the users for rational decision-making- Accounting as a

‘language of business’ communicates the financial results of an enterprise to various
stakeholders by means of financial statements. Accounting aims to meet the information
needs of the decision-makers and helps them in rational decision-making.
5. To know the solvency position: By preparing the balance sheet, management not only
reveals what is owned and owned by the enterprise, but also it gives the information
regarding concern’s ability to meet its liabilities in the short run (liquidity position) and
also in the long-run (solvency position) as and when they fall due.
An overview of objectives and the source of information from the accounting can be seen as
below: -

4
 Introduction

Procedure of accounting
Accounting procedure can be understood with the following diagram: -

In order to accomplish its main objective of communicating information to the users,

accounting embraces the following functions.
(i) Identifying: Identifying the business transactions from the source documents.
(ii) Recording: The next function of accounting is to keep a systematic record of all
business transactions, which are identified in an orderly manner, soon after their
occurrence in the journal or subsidiary books.
(iii) Classifying: This is concerned with the classification of the recorded business
transactions so as to group the transactions of similar type at one place. i.e., in
ledger accounts. In order to verify the arithmetical accuracy of the accounts, trial
balance is prepared.
(iv) Summarising: The classified information available from the trial balance are
used to prepare profit and loss account and balance sheet in a manner useful to
the users of accounting information.
(v) Analysing: It establishes the relationship between the items of the profit and loss
account and the balance sheet. The purpose of analysing is to identify the financial
strength and weakness of the business. It provides the basis for interpretation.
(vi) Interpreting: It is concerned with explaining the meaning and significance of the
relationship so established by the analysis. Interpretation should be useful to the
usersses, so as to enable them to take correct decisions.
(vii) Communicating: The results obtained from the summarised, analysed and
interpreted information are communicated to the interested parties.

5
Commercial Accountancy

Accounting cycle
An accounting cycle is a complete sequence of accounting process that begins with the
recording of business transactions and ends with the preparation of final accounts.
The accounting cycle can be understood with the following diagram: -

When a businessman starts his business activities, he records the day-to-day transactions
in the Journal. From the journal the transactions move further to the ledger where accounts
are written up. Here, the combined effect of transaction pertaining to each account is arrived
at in the form of balances.
To prove the accuracy of the work done, these balances are transferred to a statement
called trial balance. Preparation of trading and profit and loss account is the next step. The
balancing of profit and loss account gives the net result of the business transactions. To know
the financial position of the business concern balance sheet is prepared at the end.
These transactions which have completed the current accounting year, once again come
to the starting point – the journal – and they move with new transactions of the next year.
Thus, this cyclic movement of the transactions through the books of accounts (accounting
cycle) is a continuous process. The detailed explanation of steps/items involved in accounting
process are indicated below: -

6
 Introduction

Voucher: The basic record of any accounting system is ‘Voucher’. A voucher is a documentary
evidence in support of a transaction. Transaction is an economic activity where values get
exchanged. For example a cash memo showing cash sales/purchases/payments, invoice
showing credit sales etc. Sale and Purchase activity is termed as a transaction.
Journal: Once the transaction takes place, it is necessary to enter these transactions in books
of accounts. The basic record (primary record) in which day to day transaction are recorded
on chronological order, as per order of its happening, is called Journal.
Ledger: Since in a journal the transactions are recorded in chronological order, it defies
classification. This problem is obviated by the ledger which helps the classification of
transaction relating to a particular account in such a manner that it helps obtaining necessary
information about the account which is used for decision making. For easy posting and
location, accounts are opened in the ledger in some definite order.
Trial Balance: In order to provide a summary statement view of the balances of various
accounts, we need to prepare the trial balance. Thus trial balance is a summary of balances of
all accounts recorded in the ledger.
Trading Account: This account gives the overall trading i.e purchase and sell of goods.
Trading account may be defined as an account which is prepared to ascertain gross profit or
gross loss of business concern for a given period.
Profit & Loss Account: Having ascertained the Gross Profit/Loss with the help of Trading
Account, the owner is interested in finding out the net result of the operations of business. This
is done with the help of Profit & Loss Account. In this account all expenses other than those
taken into trading account are accounted.
Balance Sheet: Balance Sheet is a statement and not an account and is prepared to ascertain
the financial position of the business as on a specific date. This statement set out the assets and
liabilities of a concern as at a specific.

7
Commercial Accountancy

User of Accounting information and their purpose

Users of the accounting information can broadly be categorised into two

categories: internal user and external user. Internal users such as owners, management
and employees have their distinguish purpose and use of accounting information
similarly external users such as Creditors, investors, potential investors, government,
regulator, competitor, researchers, suppliers/buyers/market have their own purpose in
the accounting information of an entity.
Owner: - Owner is normally interested in maximizing his wealth. Same time owner also
wants to make management accountable for its performance.
Management: - Management is interested in most economic and efficient operation of its
business. They are interested in cutting the unnecessary cost and get the complete value for
money. Their aim is to ensure the long-term growth of the business.
Employees/Trade union: - Growth of the employees is directly related to the growth of the
organization and therefore, they are interested to know the stability, continuity and growth
of the enterprise and its ability to provide remuneration, retirement and other benefits and to
enhance employment opportunities.

8
 Introduction

Creditor/Banker/Lender: - Creditor/Banker/Lender wants to know the liquidity/solvency

position of the organization and its financial viability to ensure their money.
Investor: - Their interest is to know whether their investment is secure and would be
getting adequate return.
Potential investor: - Potential investor is interested in the long term outlook of the
entity. It may also like to know the future cash flow to assure himself of due return to
his investment.
Government/Tax authority: - Tax authority is interested to know whether entity is
paying due tax or not and whether it is hiding any tax liability.
Regulator: - Regulator is interested in knowing the fulfillment of regulatory framework
and follow up of all rule and regulation related to the industry.
Researcher: - Researcher uses the information of financial statements to analyze the
market and various trends.
Competitors: - Competitors always keep their eyes on the financial performance of their
competitor. It gives them good opportunity to check how they are performing vis-à-vis
their competitor and also helps them in deciding the future strategies.
Suppliers/buyers/market: - They are also interested to know the ability of the enterprise to
pay their dues, which helps them to decide the credit policy for the relevant concern, rates to
be charged and so on. Sometimes, they also become interested in long-term continuation of
the enterprise of their existence becomes dependent on the survival of that business. Suppose,
small ancillary units supply their products to a big enterprise, if the big enterprise collapses,
the fate of the small units also becomes sealed. Buyers are also concerned with the stability

9
Commercial Accountancy

and profitability of the enterprise because their functioning is more or less dependent on the
supply of goods, suppose, a company produces some chemicals used by pharmaceutical
companies and supplies chemicals on three month’s credit. If all of a sudden it faces some
trouble and is unable to supply the chemical, the customers will also be in trouble.
Society: - The society is mainly interested in its overall development. The public at large
is interested in the functioning of the enterprise because it may make a substantial contribution
to the local economy in many ways including the number of people employed and their
patronage to local suppliers. Same time it also wants to have check on the environmental
impact by the entity on the local ecological system.

Book-Keeping and Accounting

Book-keeping is that branch of knowledge which tells us how to keep a record of
business transactions. It is often routine and clerical in nature. It is important to note that only
those transactions related to business which can be expressed in terms of money are recorded.
The activities of book-keeping include recording in the journal, posting to the ledger and
balancing of accounts.
The essential idea behind maintaining book-keeping records is to show correct position
regarding each head of income and expenditure. A business may purchase goods on credit as
well as in cash. When the goods are bought on credit, a record must be kept of the person to
whom money is owed. The proprietor of the business may like to know, from time to time,
what amount is due on credit purchase and to whom. If proper record is not maintained, it
is not possible to get details of the transactions in regard to the expenses. At the end of the
accounting period, the proprietor wants to know how much profit has been earned or loss has
been incurred during the course of the period. For this, lot of information is needed which can
be gathered from a proper record of the transactions. Therefore, in book-keeping, the proper
maintenance of books of account is indispensable for any business.
Accounting is the process of preparing and analyzing financial statements based on
the transactions recorded through the book keeping process. There are several standard
methods of book keeping, such as the single-entry book keeping system and the double-entry
book keeping system, but, any process that involves the recording of financial transactions
is a book keeping process.

Objective of Book-Keeping
Following are the objectives of book keeping: -
 To have permanent record of all the business transactions.
 To keep records of income and expenses in such a way that the net profit or net loss
may be calculated.

10
 Introduction

 To keep records of assets and liabilities in such a way that the financial position of the
business may be ascertained.
 To keep control on expenses with a view to minimise the same in order to maximise
profit.
 To know the names of the customers and the amount due from them.
 To know the names of suppliers and the amount due to them.
 To have important information for legal and tax purposes.

Advantage of Book-Keeping
Following are the advantages of book keeping: -
 Permanent and Reliable Record: Book-keeping provides permanent record for all
business transactions, replacing the memory which fails to remember everything.
 Arithmetical Accuracy of the Accounts: With the help of book keeping trial balance
can be easily prepared. This is used to check the arithmetical accuracy of accounts.
 Net Result of Business Operations: The result (Profit or Loss) of business can be
correctly calculated.
 Ascertainment of Financial Position: It is not enough to know the profit or loss; the
proprietor should have a full picture of his financial position in business. Once the full
picture (say for a year) is known, this helps him to plan for the next year’s business.
 Ascertainment of the Progress of Business: When a proprietor prepares financial
statements every year, he will be in a position to compare the statements. This will
enable him to ascertain the growth of his business. Thus book keeping enables a long
range planning of business activities besides satisfying the short term objective of
calculation of annual profits or losses.
 Calculation of Dues: For certain transactions payments may be made later. Therefore,
the businessman has to know how much he has to pay others.
 Control over Assets: In the course of business, the proprietor acquires various assets
like building, machines, furniture, etc. He has to keep a check over them and find out
their values year after year.
 Control over Borrowings: Many businessmen borrow from banks and other sources.
These loans are repayable. Just as he must have a control over assets, he should have
control over liabilities.
 Identifying Do’s and Don’ts: Book keeping enables the proprietor to make an
intelligent and periodic analysis of various aspects of the business such as purchases,
sales, expenditures and incomes. From such analysis, it will be possible to focus his
attention on what should be done and what should not be done to enhance his profit
earning capacity.

11
Commercial Accountancy

 Fixing the Selling Price: In fixing the selling price, the businessmen have to consider
many aspects of accounting information such as cost of production, cost of purchase
and other expenses. Accounting information is essential in determining selling prices.
 Taxation: Businessmen pay sales tax, income tax, etc. The tax authorities require
them to submit their accounts. For this purpose, they have to maintain a record of all
their business transactions.
 Management Decision-making: Planning, reviewing, revising, controlling and
decision-making functions of the management are well aided by book-keeping records
and reports.
 Legal Requirements: Claims against and for the firm in relation to outsiders can be
confirmed and established by producing the records as evidence in the court.

Distinction between Book-Keeping and Accounting

Some people mistake book-keeping and accounting to be synonymous terms, but
in fact they are different from each other. Accounting is a broad subject. It calls for a
greater understanding of records obtained from book-keeping and an ability to analyse and
interpret the information provided by book-keeping records. Book-keeping is the recording
phase while accounting is concerned with the summarising phase of an accounting system.
Book-keeping provides necessary data for accounting and accounting starts where book-
keeping ends.
Sr. No. Book-Keeping Accounting
1. It is a process concerned with It is a process concerned with
Recording of transactions. summarizing of the recorded transactions.
2. It constitutes as a base for It is considered as a language of the
accounting business.
3. Financial statements do not form Financial statements are prepared in this
part of this process. process on the basis of book-keeping
records.
4. Managerial decisions cannot Management takes decisions on the basis
be taken with the help of these of these records.
records.
5. There is no sub-field of book- It has several sub-fields like financial
keeping. accounting, management accounting etc.
6. Financial position of the business Financial position of the business is
Cannot be ascertained through ascertained on the basis of the accounting
book-keeping records. reports.

12
 Introduction

Relationship of Accounting and Book-keeping can be depicted in the following manner:

Sub-Fields of Accounting
The various sub-fields of accounting are:

Financial Accounting
It covers the preparation and interpretation of financial statements and communication
to the users of accounts. It is historical in nature as it records transactions which had already
been occurred. The final step of financial accounting is the preparation of Profit and Loss
account and the Balance Sheet. It primarily helps in determination of the net result for an
accounting period and the financial position as on the given date.

Management Accounting
It is concerned with internal reporting to the managers of a business unit. To discharge
the functions of stewardship, planning, control and decision-making, the management needs
variety of information. The different ways of grouping information and preparing reports as
desired by managers for discharging their functions are referred to as management accounting.
A very important component of the management accounting is cost accounting which deals
with cost ascertainment and cost control.

Cost Accounting
The terminology of Cost Accounting published by the Institute of Cost and Management
Accountants of England defines cost accounting as:
“the process of accounting for cost which begins with the recording of income and
expenditure or the basis on which they are calculated and ends with the preparation of
periodical statements and reports for ascertaining and controlling costs.”

13
Commercial Accountancy

Social Responsibility Accounting

The demand for social responsibility accounting stems from increasing social awareness
about the undesirable by-products of economic activities. As already discussed earlier,
social responsibility accounting is concerned with accounting for social costs incurred by the
enterprise and social benefits created.

Human Resource Accounting

Human resource accounting is an attempt to identify, quantify and report investments
made in human resources of an organization that are not presently accounted for under
conventional accounting practice.

Concept of accounts from owners’ point of view

Financial accounting (or financial accountancy) is the field of accounting concerned
with the summary, analysis and reporting of financial transactions pertaining to a business.
Shareholders need financial statements to evaluate their equity investments and help them
make informed decisions as to how to vote on corporate matters. When evaluating investments,
shareholders are able to glean meaningful data found on financial statements.
There are a number of tools shareholders can use to make equity evaluations, and
it is important for them to analyse their stocks using a variety of measurements. Available
evaluation metrics include profitability ratios, liquidity ratios, debt ratios, efficiency ratios
and price ratios.
Accounts from Managers’ point of view (Cost Management Accounts)
Management accounting is a profession that involves partnering in management decision
making, devising planning and performance management systems and providing expertise in
financial reporting and control to assist management in the formulation and implementation
of an organization’s strategy.
In Management accounting, managers use the provisions of accounting information in
order to better inform themselves before they decide matters within their organizations, which
aids their management and performance of control functions.
Management accounting information differs from financial accountancy information in
several ways:
 While shareholders, creditors, and public regulators use publicly reported financial
accountancy information, only managers within the organization use the normally
confidential management accounting information;
 While financial accountancy information is historical, management accounting
information is primarily forward-looking;

14
 Introduction

 While financial accountancy information is case-based, management accounting

information is model-based with a degree of abstraction in order to support generic
decision making;
 While financial accountancy information is computed by reference to general financial
accounting standards, management accounting information is computed by reference
to the needs of managers, often using management information systems.

Accounts from Finance point of view (Cash Flow)

Essentially, the cash flow statement is concerned with the flow of cash in and out of
the business. The statement captures both the current operating results and the accompanying
changes in the balance sheet. As an analytical tool, the statement of cash flows is useful in
determining the short-term viability of a company, particularly its ability to pay bills.
The cash flow statement is intended to serve following purpose: -
 Provide information on a firm’s liquidity and solvency and its ability to change cash
flows in future circumstances
 Provide additional information for evaluating changes in assets, liabilities and equity
 Improve the comparability of different firms’ operating performance by eliminating
the effects of different accounting methods
 Indicate the amount, timing and probability of future cash flows
 When combined with other financial information, the statement of cash flows can be
a useful tool to analyze key relationships in the financial statements, evaluate past
performance, and predict future performance.
 Further, because the income and expenditure statement uses the accrual method, the
statement of cash flows is needed to show cash generated and spent.
 The statement of cash flows can reveal circumstances in which earnings growth
does not correlate with operating cash flow growth. This may alert users to the need
to look closely at the drivers of earnings or may be an indicator of other lifecycle
considerations for emerging or declining businesses.
 The statement also facilitates a user’s assessment of a company’s ability to generate
cash from core business activities, which is often a key variable when valuing a
business and assessing its ability to repay debt, make capital expenditures, and pay
dividends.

Limitations of Accounting
There are certain misconceptions regarding financial statements. A common man
presumes that an income statement shows the correct income or loss of the enterprise

15
Commercial Accountancy

and that a balance sheet depicts a perfectly true and fair picture of financial standing
of that enterprise. It must be recognized that the accounting as a language has its own
limitations. The figures of profit or loss generated by the accounting process are subject to
various constraints within which the accounting works. The assumptions and conventions,
on which the accounting is based, become the limitations of accounting. The financial
statements are never free from subjectivity factor as these are largely the outcome of
personal judgment of the accountant with regard to the adoption of the accounting
policies. Following are certain instances:
1. Some factors which may be relevant in assessing the worth of the enterprise don’t
find place in the accounts as they cannot be measured in terms of money. The
Balance sheet cannot reflect the value of certain factors like loyalty and skill of the
personnel which may be the most valuable asset of an enterprise these days.
2. Balance Sheet shows the position of the business on the day of its preparation
and not on the future date while the users of the accounts are interested in
knowing the position of the business in the near future and also in long run and
not for the past date. Business dynamics change within the time, annual reports
reach the ultimate users. To resolve this, auditors disclose the events occurring
after the balance sheet date but before approval of financial statements in the
financial reports.
3. Though with the emergence of some accounting standards (AS) like AS-11 (The
Effects of Changes in Foreign Exchange Rates), AS-26 (Intangible Assets), AS-28
(Impairment of Assets) etc., market/fair value of assets is taken into consideration but
still there remains some subjectivity. Accounting ignores changes in some money
factors like inflation etc.
4. There are occasions when accounting principles conflict with each other.
5. Certain accounting estimates depend on the sheer personal judgement of the
accountant, e.g., provision for doubtful debts, method of depreciation adopted,
recording certain expenditure as revenue expenditure or capital expenditure,
selection of method of valuation of inventories and the list is quite long.
6. Financial statements only consider those assets which can be expressed in monetary
terms. Human resources although the very important asset of the enterprise are
not shown in the balance sheet. There is no generally accepted formula for the
valuation of human resources in money terms.
7. Different accounting policies treatment of same item adds to the probability of
manipulations. Though through various laws and Accounting Standards, efforts are
made to reduce these options to minimum but certainly could not be reduced to zero.
In a nutshell, it can be said that the language of accounting has certain practical
limitations and, therefore, the financial statements should be interpreted carefully keeping in
mind all various factors influencing the true picture.

16
 Introduction

Basic Accounting Terms

The understanding of the subject becomes easy when one has the knowledge of a few
important terms of accounting. Some of them are explained below.

Transactions
Transactions are those activities of a business, which involve transfer of money or goods
or services between two persons or two accounts. For example, purchase of goods, sale of
goods, borrowing from bank, lending of money, salaries paid, rent paid, commission received
and dividend received. Transactions are of two types, namely, cash and credit transactions.
Cash Transaction is one where cash receipt or payment is involved in the transaction. For
example, When Mr Rajkamal buys goods from Mr Surjith paying the price of goods by cash
immediately, it is a cash transaction.
Credit Transaction is one where cash is not involved immediately but will be paid or received
later. In the above example, if Mr Rajkamal, does not pay cash immediately but promises to
pay later, it is credit transaction.

Proprietor
A person who owns a business is called its proprietor. He contributes capital to the
business with the intention of earning profit.

Capital
It is the amount invested by the proprietor/s in the business. This amount is increased by
the amount of profits earned and the amount of additional capital introduced. It is decreased
by the amount of losses incurred and the amounts withdrawn. For example, if Rakesh Sajjan
starts business with ` 5,00,000, his capital would be ` 5,00,000. It also represents the excess
of asset over the liabilities.

Assets
Assets are the properties of every description belonging to the business. Cash in hand,
plant and machinery, furniture and fittings, bank balance, debtors, bills receivable, stock of
goods, investments, Goodwill are examples for assets. Assets can be classified into tangible
and intangible.
Tangible Assets: These assets are those having physical existence. It can be seen and touched.
For example, plant & machinery, cash, etc.
Intangible Assets: Intangible assets are those assets having no physical existence but their
possession gives rise to some rights and benefits to the owner. It cannot be seen and touched.
Goodwill, patents, trademarks are some of the examples.

17
Commercial Accountancy

Liabilities
Liabilities refer to the financial obligations of a business. These denote the amounts
which a business owes to others, e.g., loans from banks or other persons, creditors for goods
supplied, bills payable, outstanding expenses, bank overdraft etc.

Drawings
It is the amount of cash or value of goods withdrawn from the business by the proprietor
for his personal use. It is deducted from the capital.

Debtors
A person (individual or firm) who receives a benefit without giving money or money’s
worth immediately, but liable to pay in future or in due course of time is a debtor. The debtors
are shown as an asset in the balance sheet. For example, Mr. Arul bought goods on credit from
Mr. Vinod for ` 10,000. Mr. Arul is a debtor to Mr. Vinod till he pays the value of the goods.

Creditors
A person who gives a benefit without receiving money or money’s worth immediately
but to claim in future, is a creditor. The creditors are shown as a liability in the balance sheet.
In the above example Mr Vinod is a creditor to Mr. Arul till he receives the value of the goods.

Purchases
Purchases refers to the amount of goods bought by a business for resale or for use in the
production. Goods purchased for cash are called cash purchases. If it is purchased on credit, it
is called as credit purchases. Total purchases include both cash and credit purchases.

Purchases Return or Returns Outward

When goods are returned to the suppliers due to defective quality or not as per the
terms of purchase, it is called as purchases return. To find net purchases, purchases return is
deducted from the total purchases.

Sales
Sales refers to the amount of goods sold that are already bought or manufactured by the
business. When goods are sold for cash, they are cash sales but if goods are sold and payment is
not received at the time of sale, it is credit sales. Total sales include both cash and credit sales.

Sales Return or Returns Inward

When goods are returned from the customers due to defective quality or not as per the
terms of sale, it is called sales return or returns inward. To find out net sales, sales return is
deducted from total sales.

18
 Introduction

Stock
Stock includes goods unsold on a particular date. Stock may be opening and closing
stock. The term opening stock means goods unsold in the beginning of the accounting period.
Whereas the term closing stock includes goods unsold at the end of the accounting period.
For example, if 4,000 units purchased @ ` 20 per unit remain unsold, the closing stock is
` 80,000. This will be opening stock of the subsequent year.

Revenue
Revenue means the amount receivable or realized from sale of goods and earnings from
interest, dividend, commission, etc.

Expense
It is the amount spent in order to produce and sell the goods and services. For example,
purchase of raw materials, payment of salaries, wages, etc.

Income
Income is the difference between revenue and expense.

Voucher
It is a written document in support of a transaction. It is a proof that a particular
transaction has taken place for the value stated in the voucher. It may be in the form of cash
receipt, invoice, cash memo, bank pay-in-slip etc. Voucher is necessary to audit the accounts.

Invoice
Invoice is a business document which is prepared when one sell goods to another. The
statement is prepared by the seller of goods. It contains the information relating to name and
address of the seller and the buyer, the date of sale and the clear description of goods with
quantity and price.

Receipt
Receipt is an acknowledgement for cash received. It is issued to the party paying cash.
Receipts form the basis for entries in cash book.

Account
Account is a summary of relevant business transactions at one place relating to a person,
asset, expense or revenue named in the heading. An account is a brief history of financial
transactions of a particular person or item. An account has two sides called debit side and
credit side.

19
Commercial Accountancy

20
 Form of Business Organization

Forms of Business
CHAPTER 2 Organization

A
business enterprise can be owned and organized in several forms. Each form of
organization has its own merits and demerits. The ultimate choice of the form of
business depends upon the balancing of the advantages and disadvantages of the
various forms of business. The right choice of the form of the business is very crucial because
it determines the power, control, risk and responsibility of the entrepreneur as well as the
division of profits and losses. Being a long term commitment, the choice of the form of
business should be made after considerable thought and deliberation.

The choice of the form of business is governed by several interrelated and interdependent
factors such as: -
 The nature of business is the most important factor. Businesses providing direct services
like tailors, restaurants and professional services like doctors, lawyers are generally
organized as proprietary concerns. While, businesses requiring pooling of skills
and funds like accounting firms are better organized as partnerships. Manufacturing
organizations of large size are more commonly set up as private and public companies.
 Scale of operations i.e. volume of business (large, medium, small) and size of the market
area (local, national, international) served is the key factors. Large scale enterprises
catering to national and international markets can be organized more successfully
as private or public companies. Small and medium scale firms are generally set up
as partnerships and proprietorship. Similarly, where the area of operations is wide
spread (national or international), company ownership is appropriate. But if the area
of operations is confined to a particular locality, partnership or proprietorship will be
a more suitable choice.
 The degree of control desired by the owner(s). A person, who desires direct control of
business, prefers proprietorship, because a company involves separation of ownership
and management.
 Amount of capital required for the establishment and operation of a business. A
partnership may be converted into a company when it grows beyond the capacity and
resources of a few persons.
 The volume of risks and liabilities as well as the willingness of the owners to bear it
is also an important consideration.
 Comparative tax liability.

21
Commercial Accountancy

In this chapter we are discussing following form of business organizations: -

 Sole Proprietorship
 Partnership
 Company
o Private Limited Company
o Public Limited Company
 Limited Liability Partnership
 Co-operative organization
 Club

Sole Proprietorship
A sole proprietorship is the oldest and the most common form of business. It is a business
owned by a single individual where one person provides the finances and in return, has full
control of the business and is able to keep all the profits. The individual who owns the business is
called Proprietor and hence the name Proprietorship Concern. In the eyes of law, the Proprietor
and the proprietorship business is a single entity and they do not differentiate between both of
them. This means that all the assets, liabilities, profit, loss etc. of the business are property of the
proprietor and they are also taxed at individual rates instead of business rates. This is also the
reason why proprietorship businesses do not have a separate PAN card for them and the PAN
card of the Proprietor is used for any tax related purposes. This is the most common form of
business organization. Most of the small businesses are run in this form.
Its main features are: -
(a) Ease of formation: It is its most important feature because it is not required to go
through elaborate legal formalities. No agreement is to be made and registration of
the firm is also not essential. However, the owner may be required to obtain a license
specific to the line of business from the local administration.
(b) Personal touch: The capital required by the organization is supplied wholly by the
owner himself and he depends largely on his own savings and profits of his business.
(c) No Separation of Ownership and Management: The owner himself/herself manages
the business as per his/her own skill and intelligence. There is no separation of
ownership and management as is the case with company form of business organization.
(d) Complete control: Owner has a complete control over all the aspects of his business
and it is he who takes all the decisions though he may engage the services of a few
others to carry out the day-to-day activities.
(e) No sharing of profit: Owner alone enjoys the benefits or profits of the business and
he alone bears the losses.

22
 Form of Business Organization

(f) No separate legal existence: Proprietorship has no legal existence separate from its owner.
(g) Unlimited liability: The liability of the proprietor is unlimited i.e. it extends beyond
the capital invested in the firm.
(h) Lack of continuity: The existence of a sole proprietorship business is dependent on
the life of the proprietor and illness, death etc. of the owner brings an end to the
business. The continuity of business operation is therefore uncertain.
Advantages
(a) Easy to Form and Wind Up: It is very easy and simple to form a sole proprietorship
form of business organization. No legal formalities are required to be observed.
Similarly, the business can be wind up any time if the proprietor so decides.
(b) Quick Decision and Prompt Action: As stated earlier, nobody interferes in the affairs
of the sole proprietary organization. So he/she can take quick decisions on the various
issues relating to business and accordingly prompt action can be taken.
(c) Direct Motivation: In sole proprietorship form of business organizations. The entire
profit of the business goes to the owner. This motivates the proprietor to work hard
and run the business efficiently.
(d) Flexibility in Operation: It is very easy to effect changes as per the requirements
of the business. The expansion or curtailment of business activities does not require
many formalities as in the case of other forms of business organization.
(e) Maintenance of Business Secrets: The business secrets are known only to the
proprietor. He is not required to disclose any information to others unless and until he
himself so decides. He is also not bound to publish his business accounts.
(f) Personal Touch: Since the proprietor himself handles everything relating to business,
it is easy to maintain a good personal contact with the customers and employees.
By knowing the likes, dislikes and tastes of the customers, the proprietor can adjust
his operations accordingly. Similarly, as the employees are few and work directly
under the proprietor, it helps in maintaining a harmonious relationship with them, and
run the business smoothly.

Disadvantages
(a) Limited Resources: The resources of a sole proprietor are always limited. Being
the single owner it is not always possible to arrange sufficient funds from his own
sources. Again borrowing funds from friends and relatives or from banks has its own
implications. So, the proprietor has a limited capacity to raise funds for his business.
(b) Lack of Continuity: The continuity of the business is linked with the life of the
proprietor. Illness, death or insolvency of the proprietor can lead to closure of the
business. Thus, the continuity of business is uncertain.

23
Commercial Accountancy

(c) Unlimited Liability: You have already learnt that there is no separate entity of the
business from its owner. In the eyes of law, the proprietor and the business are one and
the same. So personal properties of the owner can also be used to meet the business
obligations and debts.
(d) Not Suitable for Large Scale Operations: Since the resources and the managerial
ability is limited, sole proprietorship form of business organization is not suitable for
large-scale business.
(e) Limited Managerial Expertise: A sole proprietorship from of business organization
always suffers from lack of managerial expertise. A single person may not be an
expert in all fields like, purchasing, selling, financing etc. Again, because of limited
financial resources, and the size of the business it is also not possible to engage the
professional managers in sole proprietorship form of business organizations. Hence,
this form of organization is suitable for the businesses which involve moderate risk,
small financial resources, capital requirement is small and risk involvement is not
heavy like automobile repair shops, small bakery shops, tailoring, etc. It accounts for
the largest number of business concerns in India.

Partnership
Partnership is defined as a relation between two or more persons who have agreed to
share the profits of a business carried on by all of them or any of them acting for all. The
owners of a partnership business are individually known as the “partners” and collectively as
a “firm”. A partnership is formed by an agreement, which may be either written or oral. When
the written agreement is duly stamped and registered, it is known as “Partnership Deed”.
Ordinarily, the rights, duties and liabilities of partners are laid down in the deed. But in
the case where the deed does not specify the rights and obligations, the provisions of the Indian
Partnership Act, 1932 will apply. The deed generally contains the following particulars: -
 Name of the firm.
 Nature of the business to be carried out.
 Names of the partners.
 The town and the place where business will be carried on.
 The amount of capital to be contributed by each partner.
 Loans and advances by partners and the interest payable on them.
 The amount of drawings by each partner and the rate of interest allowed thereon.
 Duties and powers of each partner.
 Any other terms and conditions to run the business.

24
 Form of Business Organization

Its main features are: -

(a) Ease of formation: A partnership is easy to form as no cumbersome legal formalities
are involved. Its registration is also not essential. However, if the firm is not registered,
it will be deprived of certain legal benefits. The Registrar of Firms is responsible for
registering partnership firms.
(b) Two or more persons: The minimum number of partners must be two, while the
maximum number can be 10 in case of banking business and 20 in all other types of
business.
(c) Personal touch: The firm has no separate legal existence of its own i.e., the firm and
the partners are one and the same in the eyes of law. Thus liability of the partners
is unlimited. Legally, the partners are said to be jointly and severally liable for the
liabilities of the firm.
(d) Ease of legal formalities: A partnership is easy to form as no cumbersome legal
formalities are involved. Its registration is also not essential. However, if the firm is
not registered, it will be deprived of certain legal benefits. The Registrar of Firms is
responsible for registering partnership firms.
(e) Contractual Relationship: Partnership is created by an agreement among the
persons who have agreed to join hands. Such persons must be competent to contract.
Thus, minors, lunatics and insolvent persons are not eligible to become the partners.
However, a minor can be admitted to the benefits of partnership firm i.e., he can have
share in the profits without any obligation for losses.
(f) Sharing Profits and Business: There must be an agreement among the partners to
share the profits and losses of the business of the partnership firm. If two or more
persons share the income of jointly owned property, it is not regarded as partnership.
(g) Existence of Lawful Business: The business of which the persons have agreed to share
the profit must be lawful. Any agreement to indulge in smuggling, black marketing
etc. cannot be called partnership business in the eyes of law.
(h) Principal Agent Relationship: There must be an agency relationship between the
partners. Every partner is the principal as well as the agent of the firm. When a partner
deals with other parties he/she acts as an agent of other partners, and at the same time
the other partners become the principal.

Advantages
(a) Easy to Form: A partnership can be formed easily without many legal formalities.
Since it is not compulsory to get the firm registered, a simple agreement, either in oral,
writing or implied is sufficient to create a partnership firm.

25
Commercial Accountancy

(b) Availability of Larger Resources: Since two or more partners join hands to start
partnership firm it may be possible to pool more resources as compared to sole
proprietorship form of business organization.
(c) Better Decisions: In partnership firm each partner has a right to take part in the
management of the business. All major decisions are taken in consultation with and
with the consent of all partners. Thus, collective wisdom prevails and there is less
scope for reckless and hasty decisions.
(d) Flexibility: The partnership firm is a flexible organization. At any time, the partners
can decide to change the size or nature of business or area of its operation after taking
the necessary consent of all the partners.
(e) Sharing of Risks: The losses of the firm are shared by all the partners equally or as
per the agreed ratio.
(f) Keen Interest: Since partners share the profit and bear the losses, they take keen
interest in the affairs of the business.
(g) Benefits of Specialization: All partners actively participate in the business as per their
specialization and knowledge. In a partnership firm providing legal consultancy to
people, one partner may deal with civil cases, one in criminal cases, another in labour
cases and so on as per their area of specialization. Similarly, two or more doctors of
different specialization may start a clinic in partnership.
(h) Protection of Interest: In partnership form of business organization, the rights of each
partner and his/her interests are fully protected. If a partner is dissatisfied with any
decision, he can ask for dissolution of the firm or can withdraw from the partnership.
(i) Secrecy: Business secrets of the firm are only known to the partners. It is not required
to disclose any information to the outsiders. It is also not mandatory to publish the
annual accounts of the firm.

Disadvantages
(a) Unlimited Liability: The most important drawback of partnership firm is that the
liability of the partners is unlimited i.e., the partners are personally liable for the debt
and obligations of the firm. In other words, their personal property can also be utilized
for payment of firm’s liabilities.
(b) Instability: Every partnership firm has uncertain life. The death, insolvency, incapacity
or the retirement of any partner brings the firm to an end. Not only that any dissenting
partner can give notice at any time for dissolution of partnership.
(c) Limited Capital: Since the total number of partners cannot exceed 20, the capacity
to raise funds remains limited as compared to a joint stock company where there is no
limit on the number of shareholders.
(d) Non-transferability of share: The share of interest of any partner cannot be transferred to
other partners or to the outsiders. So it creates inconvenience for the partner who wants to
transfer his share to others fully and partly. The only alternative is dissolution of the firm.

26
 Form of Business Organization

(e) Possibility of Conflicts: You know that in partnership firm every partner has an equal
right to participate in the management. Also every partner can place his or her opinion
or viewpoint before the management regarding any matter at any time. Because of
this, sometimes there is friction and quarrel among the partners. Difference of opinion
may give rise to quarrels and lead to dissolution of the firm.
(f) Liability for the actions of other partners: In partnership, partners are personally
and jointly responsible for action of one another. Failure of action of one partner
makes other partner legally responsible for any subsequent action.

Types of Partners
Normally every partner in a firm contributes to its capital, participates in the day-to-
day management of firm’s activities, and shares its profits and losses in the agreed ratio. In
other words, all partners are supposed to be active partners. However, in certain cases there
are partners who play a limited role. They may contribute capital and such partners cannot
be termed as active partners. Similarly, some persons may simply lend their name to the firm
and make no contribution to capital of the firm. Such persons are partners only in name. Thus,
depending upon the extent of participation and the sharing of profits, liability etc., partners
can be classified into various categories. These are summarized here under.
A. Based on the extent of participation in the day-to-day management of the firm
partners can be classified as ‘Active Partners’ and ‘Sleeping Partners’. The
partners who actively participate in the day-to-day operations of the business
are known as active partners or working partners. Those partners who do not
participate in the day-to-day activities of the business are known as sleeping or
dormant partners. Such partners simply contribute capital and share the profits
and losses.
B. Based on sharing of profits, the partners may be classified as ‘Nominal Partners’
and ‘Partners in Profits’. Nominal partners allow the firm to use their name as
partner. They neither invest any capital nor participate in the day-to-day operations.
They are not entitled to share the profits of the firm. However, they are liable to
third parties for all the acts of the firm. A person who shares the profits of the
business without being liable for the losses is known as partner in profits. This is
applicable only to the minors who are admitted to the benefits of the firm and their
liability is limited to their capital contribution.
C. Based on Liability, the partners can be classified as ‘Limited Partners’ and
‘General Partners’. The liability of limited partners is limited to the extent of
their capital contribution. Indian Partnership Act doesn’t allow this as a legal
form of partnership. This form is allowed as Limited Liability Partnership and is
governed by separate Act passed by the Parliament.
D. Based on the behaviour and conduct exhibited, there are two more types of
partners besides the ones discussed above. These are (a) Partner by Estoppel;

27
Commercial Accountancy

and (b) Partner by Holding out. A person who behaves in the public in such a
way as to give an impression that he/she is a partner of the firm, is called ‘partner
by estoppel’. Such partners are not entitled to share the profits of the firm, but are
fully liable if somebody suffers because of his/her false representation. Similarly,
if a partner or partnership firm declares that a particular person is a partner of their
firm, and such a person does not disclaim it, then he/she is known as ‘Partner by
Holding out’. Such partners are not entitled to profits but are fully liable as regards
the firm’s debts.
Partnership is an appropriate form of ownership for medium sized business involving
limited capital. This may include small scale industries, wholesale and retail trade; small
service concerns like transport agencies, real estate brokers; professional firms like charted
accountants, doctors’ clinic, attorney or law firms etc.

Company
A company is a very organized form of business organization. It comes into existence
only when it has been registered after completion of all formalities required by the Indian
Companies Act, 2013.A company has its own separate existence independent of its members.
It means that a company can own property, enter into contracts and conduct any lawful business
in its own name. It can sue and can be sued by others in the court of law. The shareholders are
not the owners of the property owned by the company. Also, the shareholders cannot be held
responsible for the acts of the company.
A company continues to exist as long as it fulfils the requirements of law. It is not
affected by the death, lunacy, insolvency or retirement of any of its members.
Companies have democratic management and control. Normally, the shareholders
elect representatives from among themselves known as ‘Directors’ to manage the affairs
of the company. Its members contribute money for some common purpose. The money so
contributed constitutes the capital of the company. The capital of the company is divided into
small units called shares. Since members invest their money by purchasing the shares of the
company, they are known as shareholders and the capital of the company is known as share
capital. Liability of the shareholder is restricted to the shares he is holding.
Main features of the company are:
(a) Artificial Person: A company is an artificial person in the sense that it is created by
law and does not possess physical attributes of a natural person. However, it has a
legal status like a natural person.
(b) Formation: The formation of a company is time consuming and it involves preparation
of several documents and compliance of several legal requirements before it starts its
operation. A company comes into existence only when it is registered under the Indian
Companies Act.

28
 Form of Business Organization

(c) Separate Legal Entity: Being an artificial person, a company exists independent
of its members. It can make contracts, purchase and sell things, employ people and
conduct any lawful business in its own name. It can sue and can be sued in the court
of law. A shareholder cannot be held responsible for the acts of the company.
(d) Common Seal: Since a company has no physical existence, it must act through
its Board of Directors. But all contracts entered by them shall have to be under
the common seal of the company. This common seal is the official signature of the
company. Any document with the common seal and duly signed by an officer of the
company is binding on the company.
(e) Perpetual Existence: The company enjoys continuous existence. Death, lunacy,
insolvency or retirement of the members does not affect the life of the company. It
goes on forever. Since it is created by law, it can only be dissolved by law.
(f) Limited Liability of Members: The company form of business is able to attract large
number of people to invest their money in shares because it offers them the facility
of limited risk and liability. The liability of a member is limited to the extent of the
amount of shares he holds. In other words, a shareholder can be held liable only to
the extent of the face value of the shares he holds, and if he has already paid it, which
is normally the case, he cannot be asked to pay any further amount. For example, if
‘A’ holds one share of ` 100 and has paid ` 75 on that share, his liability would be
limited only upto ` 25.
(g) Transferability of Shares: The members of the company (Public company) are
free to transfer the shares held by them to others as and when they like. They do
not need the consent of other shareholders to transfer their shares. Shareholder of
Private limited company can also transfer shares after getting consent of the other
shareholders.
(h) Membership: To form a company, a minimum of two members are required in case
it is private limited company and seven members in case of public limited company.
The maximum limit is fifty in case of private limited company. There is no maximum
limit of membership for a public limited company.
(i) Separation of Ownership and Management: You know that people of different
categories and areas contribute towards the capital of a company. So, it is not possible
for them to look after the day-to-day management of the company. They may take
part in deciding the general policies of the company but the day-to-day affairs of the
company are managed by their elected representatives, called Directors.
Company form of business organization can broadly be categories into two forms:
• Private Limited Company
• Public Limited Company

29
Commercial Accountancy

Advantages
A company form of business organization is very popular for undertaking big business.
It has the following advantage –
(a) Large Resources: A company can raise large financial resources because of its large
number of members and it can raise funds through debentures, public deposits, loans
from financial institutions without much difficulty.
(b) Limited Liability: In a joint stock company the liability of its members is limited to
the extent of shares held by them. This attracts a large number of small investors to
invest in the company. It helps the company to raise huge capital. Because of limited
liability, a company is also able to take larger risks. This helps in making investment
decisions easily.
(c) Continuity of Existence: A company is an artificial person created by law and
possesses independent legal status. It is not affected by the death, insolvency etc. of
its members. Thus, it has a perpetual existence.
(d) Benefits of Large-scale Operation: The company is the only form of business
organization which can provide capital for large-scale operations. It results in large-
scale production consequently leading to increase in efficiency and reduction in the
cost of operation. It further opens the scope for expansion.
(e) Liquidity: The transferability of shares acts as an added incentive to investors as the
shares of a public company can be traded easily in the stock exchange. The public can
buy shares when they have money to invest and convert shares into cash when they
need money.
(f) Professional Management: Companies, because of the complex nature of their
activities and large volume of business, require professional managers at every level
of organization. Because of the size of their business and the financial strength they
can afford to appoint such managers. This leads to efficiency in management of their
affairs.
(g) Research and Development: A company generally invests a lot of money on research
and development for improved processes of production, designing and innovating
new products, improving quality of product, new ways of training to its staff, etc.
(h) Tax Benefits: Although the companies are required to pay tax at a high rate, in effect
their tax burden is low as they enjoy many tax exemptions under Income Tax Act.

Disadvantages
Inspite of several advantages of a company as discussed above, this form of business
organization also suffers from many limitations. The important disadvantages are given below:

30
 Form of Business Organization

(a) Difficult to Form: The formation of a company involves compliance with a number
of legal formalities under the companies Act and compliance with several other rules
and regulations framed by the government from time to time.
(b) Control by a Group: Theoretically a company is supposed to be managed by trained
and experienced Directors. But practically this is not so in many cases. Most of the
companies are managed by the Directors belonging to the same family. Since most
of the shareholders are widely dispersed, they have indifferent attitude towards the
management of the company. The shareholders holding majority of the shares take all
decisions on behalf of the company. Thus, the democratic virtues of a company do not
really exist in practice.
(c) Excessive Government Control: A company is expected to comply with the
provisions of several Acts. Non-compliance with these, invites heavy penalty. This
affects the smooth functioning of the companies.
(d) Delay in Decision Making: A company has to fulfil certain procedural formalities
before making certain decisions, as they require the approval of the Board of Directors
and/or the General Body of shareholders. Such formalities are time consuming and
therefore, some important decisions may be delayed.
(e) Lack of Secrecy: It is difficult to maintain secrecy in many matters as they may
require approval of board of directors and/or general body whose proceedings are
usually open to public.
(f) Social abuses: A joint stock company is a large-scale business organization having
huge resources. This provides a lot of power to them. Any misuse of such power
creates unhealthy conditions in the society e.g. having monopoly of a particular
business, industry or product; influencing politicians and government in getting their
work done; exploiting workers, consumers and investors, etc.

Private Limited Company

A private limited company is a voluntary association of not less than two and not
more than fifty members, whose liability is limited, the transfer of whose shares is limited
to its members and who is not allowed to invite the general public to subscribe to its shares
or debentures. It has an independent legal existence from its shareholders. The Indian
Companies Act, 2013 contains the provisions regarding the legal formalities for setting up of
a private limited company. Registrars of Companies (ROC) appointed under the Companies
Act covering the various States and Union Territories are vested with the primary duty of
registering companies floated in the respective states and the Union Territories. The liability
of its members is limited to the shareholding in the company.

31
Commercial Accountancy

Main features of the private limited company are:

(a) Less cumbersome to form: It is relatively less cumbersome to organise and operate
it as it has been exempted from many regulations and restrictions to which a public
limited company is subjected to. Some of them are: -
• It need not file a prospectus with the Registrar.
• It need not obtain the Certificate for Commencement of business.
• It need not hold the statutory general meeting nor need it file the statutory report.
• Restrictions placed on the directors of the public limited company do not apply to
its directors.
(b) Restriction in transfer of shares: The shares allotted to its members are also not
freely transferable between them. These companies are not allowed to invite public to
subscribe to its shares and debentures.
(c) Continuous existence: It enjoys continuity of existence i.e. it continues to exist even
if all its members die or desert it.
(d) Control over business: Hence, a private company is preferred by those who wish to
take the advantage of limited liability but at the same time desire to keep control over
the business within a limited circle and maintain the privacy of their business.

Advantages
(a) Continuity of existence: the existence of a private limited company is not dependent
on existence of its shareholders. It continuous to exist irrespective of whether its
shareholders desert it or not.
(b) Limited liability: liability of its shareholder is limited to the share he is holding.
(c) Less legal restrictions: Private limited company is not subject to restriction imposed
on public limited company.
(d) Control over business: this form of business allows owner/main promoter to have
total control over the company as there is restriction over the transfer of shares.

Disadvantages
(a) Shares are not freely transferable: Share of the private limited company is not freely
transferable. Consent of all shareholders is required to transfer the shares.
(b) Not allowed to invite public to subscribe to its shares: Private limited company is
not allowed to go to the public inviting to subscribe its share. It cannot issue the IPO.
(c) Scope for promotional frauds: As the control of the company is vested to the limited
persons there is greater scope of fraud by promoters.

32
 Form of Business Organization

(d) Undemocratic control: the restriction of transfer of shares results into autocratic
control over the management by the majority shareholders, who usually are from the
closely-knitted group.

Public Limited Company

For starting a business on a large scale, one needs a huge capital, which, even fifty
members of a private company cannot provide. In such a situation, a public company is suitable.
A public limited company is a voluntary association of members which is incorporated and,
therefore has a separate legal existence and the liability of whose members is limited. A public
company must have the following features:
(a) Unrestricted source of capital: It can invite the public to subscribe to its shares and
debentures by open invitation.
(b) Separate legal existence: The company has a separate legal existence apart from its
members who compose it.
(c) Well defined legal framework: Its formation, working and its winding up, in fact, all
its activities are strictly governed by laws, rules and regulations.
(d) Governed by the Indian Companies Act: The Indian Companies Act, 2013 contains
the provisions regarding the legal formalities for setting up of a public limited company.
Registrars of Companies (ROC) appointed under the Companies Act covering the
various States and Union Territories are vested with the primary duty of registering
companies floated in the respective states and the Union Territories.
(e) Required minimum number of persons: A company must have a minimum of seven
members but there is no limit as regards the maximum number.
(f) Freely transferable shares: The shares of a company are freely transferable and that
too without the prior consent of other shareholders or without subsequent notice to
the company.
(g) Limited liability: The liability of a member of a company is limited to the face
value of the shares he owns. Once he has paid the whole of the face value, he has no
obligation to contribute anything to pay off the creditors of the company.
(h) Separation of management with ownership: The shareholders of a company do
not have the right to participate in the day-to-day management of the business of
a company. This ensures separation of ownership from management. The power of
decision making in a company is vested in the Board of Directors, and all policy
decisions are taken at the Board level by the majority rule. This ensures a unity of
direction in management.

33
Commercial Accountancy

Advantages
(a) Continuity of existence: Company exists irrespective of existence of its shareholder.
There is specific procedure as defined in the Companies Act to winding up the
company.
(b) Larger amount of capital: Unrestricted number of shareholders ensures that large
sum of capital can be generated.
(c) Unity of direction: Public limited company has democratic management. Its
management is selected with majority and by voting. Hence it has the clear direction
of going ahead.
(d) Efficient management: Management is separated from the ownership. This ensures
the professional management.
(e) Limited liability: Liability of the shareholders is restricted to the shares they have
subscribed.

Disadvantages
(a) Scope for promotional frauds: The management is selected by the majority
shareholders hence in case of promoters have dominating shareholding, there is a
scope of promotional frauds.
(b) Scope for directors using resources for personal profit: Shareholders are not
involved in the day to day affairs of the company hence there is a scope that directors
can use the resources for their private gain.
(c) Subjected to strict regulations: Public limited company is subject to regulation of
the Companies Act. The regulations related to its all activities are very well defined in
the Act hence they have to strictly follow all of them. It has to submit periodic returns
and information to Registrar of Companies.
(d) Cumbersome to form: There are number of formalities one has to complete before
forming a public limited company. A detailed paper work and legal formalities makes
formation of company as a costly affair.

Limited Liability Partnership (LLP)

LLP, a legal form available world-wide is now introduced in India and is governed
by the Limited Liability Partnership Act 2008, with effect from April 1, 2009. It combines
the flexibility of a partnership and the advantages of limited liability of a company at a low
compliance cost. In other words, it is an alternative corporate business vehicle that provides the
benefits of limited liability of a company, but allows its members the flexibility of organising
their internal management on the basis of a mutually arrived agreement, as is the case in a
partnership firm.

34
 Form of Business Organization

Owing to flexibility in its structure and operation, it would be useful for small and
medium enterprises, in general, and for the enterprises in services sector, in particular.
Internationally, LLPs are the preferred vehicle of business, particularly for service industry or
for activities involving professionals.
LLP is governed by the provisions of the Limited Liability Partnership Act 2008, the
salient features of which are as follows: -
(a) A formal structure: The LLP is a body corporate and a legal entity separate from its
partners. Any two or more persons, associated for carrying on a lawful business with
a view to profit, may by subscribing their names to an incorporation document and
filing the same with the Registrar, form a Limited Liability Partnership. The LLP has
a perpetual succession.
(b) Governed by the agreement: The mutual rights and duties of partners of an LLP
inter se and those of the LLP and its partners are governed by an agreement between
partners or between the LLP and the partners subject to the provisions of the LLP Act
2008. The act provides flexibility to devise the agreement as per their choice.
(c) Separate legal entity: The LLP is a separate legal entity, liable to the full extent of
its assets, with the liability of the partners being limited to their agreed contribution
in the LLP which may be of tangible or intangible nature or both tangible and
intangible in nature. No partner would be liable on account of the independent or
un-authorized actions of other partners or their misconduct. The liabilities of the
LLP and partners who are found to have acted with intent to defraud creditors or
for any fraudulent purpose shall be unlimited for all or any of the debts or other
liabilities of the LLP.
(d) Two or more partners required: Every LLP requires having at least two partners and
needs to have at least two individuals as Designated Partners, of whom at least one
shall be resident in India. The duties and obligations of Designated Partners shall be
as provided in the law.
(e) Legal requirement: The LLP shall be under an obligation to maintain annual accounts
reflecting true and fair view of its state of affairs. A statement of accounts and solvency
shall be filed by every LLP with the Registrar every year. The accounts of LLPs shall
also be audited, subject to any class of LLPs being exempted from this requirement
by the Central Government.
The Central Government has powers to investigate the affairs of an LLP, if
required, by appointment of competent Inspector for the purpose. The compromise or
arrangement including merger and amalgamation of LLPs is well defined in provisions
of the LLP Act 2008.
A firm, private company or an unlisted public company is allowed to be converted into
LLP in accordance with the provisions of the Act. Upon such conversion, on and from the date
of certificate of registration issued by the Registrar in this regard, the effects of the conversion

35
Commercial Accountancy

shall be such as are specified in the LLP Act. On and from the date of registration specified
in the certificate of registration, all tangible (moveable or immoveable) and intangible
property vested in the firm or the company, all assets, interests, rights, privileges, liabilities,
obligations relating to the firm or the company, and the whole of the undertaking of the firm
or the company, shall be transferred to and shall vest in the LLP without further assurance, act
or deed and the firm or the company, shall be deemed to be dissolved and removed from the
records of the Registrar of Firms or Registrar of Companies, as the case may be.
The winding up of the LLP may be either voluntary or by the Tribunal to be established
under the Companies Act, 2013. Till the Tribunal is established, the power in this regard has
been given to the High Court.
The LLP Act 2008 confers powers on the Central Government to apply provisions of
the Companies Act, 2013 as appropriate, by notification with such changes or modifications
as deemed necessary.
The Indian Partnership Act, 1932 is not applicable to Limited Liability Partnerships.

Advantages
(a) Lower cost of formation: Cost of framing LLP is much lower than forming a company.
(b) Lesser compliance requirements: LLP has advantage of company and partnership
both. One of the advantages is that it is not governed by the stringent provisions of the
Companies Act 2013.
(c) Easy to manage and run: LLP requires minimum two partners and an agreement.
This makes LLP very flexible form of business organization.
(d) Easy to wind-up and dissolve: LLP doesn’t require legal formalities similar to
winding up a company. This makes dissolution of the LLP much simpler.
(e) No requirement of minimum capital contributions: There is no requirement of
minimum capital contribution by the partners to form a LLP.
(f) Partners are not liable for the acts of the other partners: One of the advantages
of this form is that partner is not responsible to the act committed by other partner.
In case of partnership, all partners are jointed and individually responsible for act of
each other.

Disadvantages
(a) LLP cannot raise money from the public: LLP cannot go to the public and raise
money like Public Limited Company.

36
 Form of Business Organization

(b) Financial Institution may not lend the large amount the LLP: As it has limitation
in raising fund and partners’ liability is limited, financial institutions may not be
interested in lending money to it.

Co-operatives
Co-operative organisation is a society which has as its objectives the promotion of the
interests of its members in accordance with the principles of cooperation. It is a voluntary
association of ten or more members residing or working in the same locality, who join together
on the basis of equality for the fulfilment of their economic or business interest. The basic
feature which differentiates the co-operatives from other forms of business ownership is that
its primary motive is service to the members rather than making profits.
There are different types of cooperatives like consumer co-operatives, producer’s
co-operatives, marketing co-operatives, housing co-operatives, credit co-operatives, farming
co-operatives etc. The aim of all such co-operatives is to promote the welfare of their members.
Its main features are: -
(a) It is a voluntary organisation as a member is free to leave the society and withdraw his
capital at any time, after giving a notice.
(b) The minimum number of members is 10, but there is no limit to the maximum number
of members. However, the members must be residing or working in the same locality.
(c) Registration of a co-operative enterprise is compulsory. A co-operative society may be
registered with the Registrar of Co-operatives Societies.
(d) After registration a co-operative enterprise becomes a body corporate independent of
its members i.e. a separate legal entity.
(e) It is subject to the provisions of the Co-operative Societies Act, 1912 or State
Co-operative Societies Acts. It has to submit annual reports and accounts to the
Registrar of Societies.
(f) The liability of every member is limited to the extent of his capital contribution.
(g) The shares of co-operative society cannot be transferred but can be returned to the
society in case a member wants to withdraw his membership.
(h) Being a separate legal entity a co-operative enjoys continuity of existence which is not
affected by death, insolvency, retirement, etc. of the members.

Advantages
(a) Greater amount of capital: By involving number of individuals it generates relatively
higher amount of capital.

37
Commercial Accountancy

(b) Reasonable price, good quality or better service: As the organization exists for
benefit to all and it charges minimal or no profit from its members, members get
services/product at very reasonable price without compromising with the quality.
(c) Better conditions of service to employees: As the organization believe in one for
all and all for one philosophy, it offers better conditions of service to its employee
compare to other form of business.
(d) Continuity of existence: Its existence is not depending on its members, hence there is
continuity of existence in this form of business.
(e) Limited liability: Liability of members is restricted to the shares they hold; it saves
them in case of failure.

Disadvantages
(a) Inability to collect sufficient capital: Members of co-operative are not from
economically strong background hence it faces difficulty in collecting sufficient
capital. Same time, there are restriction on collecting money from the non-members
hence generating large sum of capital is always difficult.
(b) Inability to provide efficient managerial services: As it is governed by the member
and due to financial constraint they are unable to hire professionals hence efficient
management can be an issue.
(c) Organisational limitation: This is not very structured form of business organization.
Its organization doesn’t provide adequate flexibility to operate.

Club
A club is an association of two or more people united by a common interest or goal.
A service club, for example, exists for voluntary or charitable activities; there are clubs devoted
to hobbies and sports, social activities clubs, political and religious clubs, and so forth. This is
not exactly a business organization but it is an organization which may be involve in economic
activity to fulfil its common goal.
Main features of Club are: -
(a) Club can be of various type depends on the activity.
(b) Professional Clubs are partly social, partly professional in nature and provide
professionals with opportunities for advanced education, presentations on current
research, business contacts, public advocacy for the profession and other advantages.
(c) A social activity clubs are a modern combination of several other types of clubs
and reflect today’s more eclectic and varied society. These clubs are centered on the
activities available to the club members in the city or area in which the club is located.

38
 Form of Business Organization

(d) Social clubs are centric towards social outreach of its members. They organize various
events and social activities for benefit of society at large.

Advantages
(a) No legal hassle: The formation of club is relatively free from legal hassle. Clubs are
mainly for non-commercial activities hence it has lesser legal formalities involved in
it.
(b) Flexibility: Its volunteer nature makes it very flexible.
(c) Voluntary: Participation in activities of club is totally voluntary.

Disadvantages
(a) Lack of professionalism: Club are mainly form for non-commercial activities hence
they lack professionalism in operating their commercial activities.
(b) Casual: Functioning and environment of the club is mainly casual hence it lacks
seriousness required for successful business. Members mainly come to club for
recreational purpose.
(c) Nepotism/vested interest: Club often invites nepotism and vested interest because of
its nature.
(d) Chance of fraud: Clubs are controlled by mainly interested groups hence there are
high probability of getting its resources misused by them.

39
Commercial Accountancy

40
 Conceptual framework of Accounting

Conceptual framework
CHAPTER 3 of Accounting

L
et us imagine a situation where you are a proprietor and you take copies of your books of
account to five different accountants. You ask them to prepare the financial statements
on the basis of the above records and to calculate the profits of the business for the year.
After few days, they are ready with the financial statements and all the five accountants have
calculated five different amounts of profits and that too with very wide variations among them.
Guess in such a situation what impact would it leave on you about accounting profession. To
avoid this, a generally accepted set of rules have been developed. This generally accepted set
of rules provides unity of understanding and unity of approach in the practice of accounting
and also in better preparation and presentation of the financial statements.
Financial statements prepared by the accountant communicate financial information
to the various stakeholders for decision-making purpose. Therefore, it is important that
financial statements prepared by different organizations should be prepared on uniform basis.
Also there should be consistency over a period of time in the preparation of these financial
statements. If every accountant starts following his own norms and notions for accounting of
different items, then there will be an utter confusion.
To avoid confusion and to achieve uniformity, accounting process is applied within the
conceptual framework of ‘Generally Accepted Accounting Principles’ (GAAPs). The term
GAAPs is used to describe rules developed for the preparation of the financial statements and
is called concepts, conventions, postulates, principles, etc. These GAAPs are the backbone
of the accounting information system, without which the whole system cannot exists. These
principles are the ground rules, which define the parameters and constraints within which
accounting reports are generated. Accounting principles are basic norms and assumptions
on which the whole accounting system has been developed and established. Accountant
also adheres to various accounting standards issued by the regulatory authority for the
standardization of accounting policies to be followed under specific circumstances. These
conceptual frameworks, GAAPs and accounting standards are considered as the theory base
of accounting.
Accounting is the language of business. It records business transactions taking place
during the accounting period. Accounting communicates the result of the business transactions
in the form of final accounts. With a view to make the accounting results understood in the
same sense by all interested parties, certain accounting assumptions, concepts and principles
have been developed over a course of period.

41
Commercial Accountancy

Framework of accounting
Framework of accounting consist of basic assumptions, concepts and modified principles.

Frame Work of Accounting

Basic Assumptions
The basic assumptions of accounting are like the foundation pillars on which the
structure of accounting is based. The four basic assumptions are as follows:

Accounting Entity Assumption

According to this assumption, business is treated as a unit or entity apart from its
owners, creditors and others. In other words, the proprietor of a business concern is always
considered to be separate and distinct from the business which he controls. All the business
transactions are recorded in the books of accounts from the view point of the business. Even
the proprietor is treated as a creditor to the extent of his capital. Let us presume that President
Mess Committee (PMC) started a commercial venture named M/s Yarrows Mess by investing
capital worth ` 5 lakh. If we prepare the accounts of M/s Yarrows Mess, this ` 5 lakh will be
considered as Capital and would come on liability side of the Balance Sheet. There will be no
difference in M/s Yarrows Mess and PMC in eyes of law and taxation authority but accounting
treatment differentiate owner from the entity.

42
 Conceptual framework of Accounting

Money Measurement Assumption

As per this concept, only those transactions, which can be measured in terms of money
are recorded. Since money is the medium of exchange and the standard of economic value,
this concept requires that those transactions alone that are capable of being measured in terms
of money be only to be recorded in the books of accounts. Transactions, even if, they affect
the results of the business materially, are not recorded if they are not convertible in monetary
terms. Transactions and events that cannot be expressed in terms of money are not recorded
in the business books. For example, if M/s Yarrows Mess is dealing in catering service and
operating the guest house and Shimla is having jaundice outbreak, business of M/s Yarrows
Mess is going to suffer. As this fact is not recordable in monetary term, it will not be recorded
in books of M/s Yarrows Mess.
Measuring unit for money is taken as the currency of the ruling country i.e., the ruling
currency of a country provides a common denomination for the value of martial objects. The
monetary unit though an inelastic yardstick, remains indispensable tool of accounting.
It may be mentioned that when transactions occur across the boundary of a country, one
may transact in multiple currencies. Suppose there is an international delegation comprising
delegates from the multi nationality background visited M/s Yarrows Mess. They decided to
clear the bills in the US Dollars (USD). How M/s Yarrows Mess would show its sales? In
multiple currency? These are not amenable to even arithmetic treatment. So transactions are
to be recorded at uniform monetary unit i.e. in one currency. Money Measurement Concept
imparts the essential flexibility for measurement and interpretation of accounting data.
This concept ignores that money is an inelastic yardstick for measurement as it is based
on the implicit assumption that purchasing power of the money is not of sufficient importance
as to require adjustment. Also, many material transactions and events are not recorded in
the books of accounts just because it cannot be measured in monetary terms. Therefore, it is
recognized by all the accountants that this concept has its own limitations and inadequacies.
Yet it is used for accounting purposes because it is not possible to adopt a better measurement
scale. Entity and money measurement are viewed as the basic concepts on which other
procedural concepts hinge.

Going Concern Assumption

As per this assumption, the business will exist for a long period and transactions are
recorded from this point of view. There is neither the intention nor the necessity to wind up
the business in the foreseeable future.
Concept of revenue and capital expense also has a relevance because entity is a going
concern. This concept also drives the entity to charge depreciation on asset and not to write
them off immediately. Same time it also helps in understanding why asset to be evaluated at
historic cost and not at market value in books of the entity.

43
Commercial Accountancy

Accounting Period Assumption

This is also called the concept of definite accounting period. As per ‘going concern’
concept an indefinite life of the entity is assumed. For a business entity it causes inconvenience
to measure performance achieved by the entity in the ordinary course of business. If a textile
mill lasts for 100 years, it is not desirable to measure its performance as well as financial
position only at the end of its life.
So a small but workable fraction of time is chosen out of infinite life cycle of the
business entity for measuring performance and looking at the financial position. Generally,
one-year period is taken up for performance measurement and appraisal of financial position.
However, it may also be 6 months, 9 months or 15 months depending on the regional or
industrial convention.
According to this concept accounts should be prepared after every period & not at the
end of the life of the entity. Usually this period is one calendar year. In India we follow
from 1st April of a year to 31st March of the immediately following year. Many United
Nations organizations follow calendar year (1st January to 31st December of the year) as an
accounting period.
Thus, for performance assessment it is not necessary to look into the revenue and
expenses of an unduly long time-frame. This concept makes the accounting system workable
and the term ‘accrual’ meaningful. If one thinks of indefinite time-frame, nothing will accrue.
There cannot be unpaid expenses and non-receipt of revenue. Accrued expenses or accrued
revenue is only with reference to a finite time-frame which is called accounting period.
Thus, the periodicity facilitates in:
(i) Comparing of financial statements of different periods;
(ii) Uniform and consistent accounting treatment for ascertaining the profit and
assets of the business and
(iii) Matching periodic revenues with expenses for getting correct results of the
business operations for the accounting period.
Basic Concepts of Accounting
These concepts define the assumptions on the basis of which financial statements of
a business entity are prepared. Certain concepts are perceived, assumed and accepted in
accounting to provide a unifying structure and internal logic to accounting process. The word
concept means idea or notion, which has universal application. Financial transactions are
interpreted in the light of the concepts, which govern accounting methods. On the basis of the
four basic assumptions of accounting the following concepts (principles) of accounting have
been developed:

44
 Conceptual framework of Accounting

Dual Aspect Concept

Dual aspect principle is the basis for Double Entry System of book-keeping. All business
transactions recorded in accounts have two aspects - receiving benefit and giving benefit. For
example, when a business acquires an asset (receiving of benefit) it must pay cash (giving of
benefit). For an example, if the M/s Yarrows Mess decide to purchase grocery or vegetables
or kitchen equipment in cash it needs to pay amount in return of this purchase. So while
recording the transactions, cash will get reduced and stock and asset (kitchen equipment) will
get added.
Thus, the duality concept is commonly expressed in terms of fundamental accounting
equation:

Assets = Liabilities + Owners equity

The above accounting equation states that the assets of a business are always equal to
the claims of owner/owners and the outsiders. This claim is also termed as capital or owner’s
equity and that of outsiders, as liabilities or creditors’ equity.
The knowledge of dual aspect helps in identifying the two aspects of a transaction
which helps in applying the rules of recording the transactions in books of accounts. The
implication of dual aspect concept is that every transaction has an equal impact on assets and
liabilities in such a way that total assets are always equal to total liabilities.
Let us analyse some more business transactions in terms of their dual aspect:
1. Capital brought in by the owner of the business
The two aspects in this transaction are:
(i) Receipt of cash
(ii) Increase in Capital (owners’ equity)
2. Purchase of machinery by cheque
The two aspects in the transaction are
(i) Reduction in Bank Balance
(ii) Owning of Machinery
3. Goods sold for cash
The two aspects are
(i) Receipt of cash
(ii) Delivery of goods to the customer
4. Rent paid in cash to the landlord
The two aspects are
(i) Payment of cash
(ii) Rent (Expenses incurred).

45
Commercial Accountancy

Once the two aspects of a transaction are known, it becomes easy to apply the rules of
accounting and maintain the records in the books of accounts properly.
The interpretation of the Dual aspect concept is that every transaction has an equal
effect on assets and liabilities in such a way that total assets are always equal to total liabilities
of the business.

Revenue Realization Concept

Revenue realization concept is also known as accrual accounting concept. According
to this concept, revenue is considered as the income earned on the date when it is realized.
Unearned or unrealized revenue should not be taken into account. The realization concept is
vital for determining income pertaining to an accounting period. It avoids the possibility of
inflating incomes and profits. In other words, under accrual concept, the effects of transactions
and other events are recognized on mercantile basis i. e., when they occur (and not as cash
or a cash equivalent is received or paid) and they are recorded in the accounting records and
reported in the financial statements of the periods to which they relate. Financial statements
prepared on the accrual basis inform users not only of past events involving the payment and
receipt of cash but also of obligations to pay cash in the future and of resources that represent
cash to be received in the future.
Accrual means recognition of revenue and costs as they are earned or incurred and
not as money is received or paid. The accrual concept relates to measurement of income,
identifying assets and liabilities.
To understand accrual concept knowledge of revenues and expenses is required.
Revenue is the gross inflow of cash, receivables and other consideration arising in the course
of the ordinary activities of an enterprise from sale of goods, from rendering services and
from the use by others of enterprise’s resources yielding interest, royalties and dividends. For
example, if M/s Yarrows Mess has made the sale of ` 1,00,000 and received ` 60,000 out of
it in cash. The total sale would be considered as ` 1,00,000 not the ` 60,000 which is received
in cash. Similarly, if it has received an advance of ` 2,00,000 from National Academy for the
party to be organized in next accounting period, it will consider this advance as a liability and
not as a revenue received (sales) for the period.
Expense is a cost relating to the operations of an accounting period or to the revenue
earned during the period or the benefits of which do not extend beyond that period.
For example, if M/s Yarrows Mess incurs expense of ` 70,000 to prepare and sell
the material for ` 1,00,000. ` 70,000 will be considered as expense to earn the revenue
and will be booked. Similarly, if M/s Yarrows Mess has paid salary advance to its cook, the
advance will be considered as prepaid expense and will be considered as an asset. It will not
be considered as an expense incurred immediately.

46
 Conceptual framework of Accounting

Accrual Concept provides the foundation on which the structure of present day
accounting has been developed.

Historical Cost Concept

Under this concept, assets are recorded at the price paid to acquire them and this cost is
the basis for all subsequent accounting for the asset.
This concept also ensures the objective treatment while showing the asset in the Balance
Sheet. If asset needs to be valued and shown based on the realizable value, it would involve
lot of discretion and can distort the financial position of the entity hence to ensure objectivity,
accountant values and record the asset in historic or acquisition cost. For example, if
M/s Yarrows Mess buy a piece of land in ` 5,00,000 and its market value is ` 8,00,000 at
the time of preparing final accounts the land value is recorded only for ` 5,00,000. Thus, the
balance sheet does not indicate the price at which the asset could be sold for.
However, the historic cost concept creates a lot of distortion too as outlined below:
(a) In an inflationary situation when prices of all commodities go up on an average,
acquisition cost loses its relevance. For example, a piece of land purchased on 1.1.1995
for ` 20,000 may cost ` 5,00,000 as on 1.1.2016. So if the accountant makes valuation
of asset at historical cost, the accounts will not reflect the true position of the asset.
(b) Historical cost-based accounts may lose comparability. For example, Mr. X invested
` 1,00,000 in a machine on 1.1.1995 which produces ` 20,000 cash inflow during the
year 2016, while Mr. Y invested ` 5,00,000 in a machine on 1.1.2015 which produced
` 50,000 cash inflows during the year 2016. Mr. X earned at the rate 20% while
Mr. Y earned at the rate 10%. Who is more-efficient? Since the assets are recorded at
the historical cost, the results are not comparable.
(c) Many assets do not have acquisition costs. Human assets of an enterprise are an
example. The cost concept fails to recognize such asset although it is a very important
asset of any organization.

Matching Concept
Matching the revenues earned during an accounting period with the cost associated
with the period to ascertain the result of the business concern is called the matching concept.
It is the basis for finding accurate profit for a period which can be safely distributed to the
owners. The matching concept is follow up of accounting period assumption and closely
related to the accrual concept.
The cost/expense can be booked by following two criteria:
1. Cost associated directly to the revenue generated and
2. Cost related to the accounting period.

47
Commercial Accountancy

Let us see how the accrual and periodicity concepts operate.

Periodicity Concept fixes up the time-frame for which the performance is to be
measured and financial position is to be appraised. If M/s Yarrows Mess has incurred expenses
of ` 10,000 to generate sale of ` 20,000; accrual concept will guide the accountant to book
expenses of ` 10,000 against the sale of ` 20,000. Same time, the expenses on salary, water
charges, electricity charges, depreciation will be booked based on the accounting period.
Revenue associated to them would be ignored and they will be booked even if there is no
revenue generated during the period.

Full Disclosure Concept

The financial statement must disclose all the reliable and relevant information about
the business enterprise to the management and also to their external users for which they
are meant, which in turn will help them to take a reasonable and rational decision. For it,
it is necessary that financial statements are prepared in conformity with generally accepted
accounting principles i.e. the information is accounted for and presented in accordance with
its substance and economic reality and not merely with its legal form. The disclosure should
be full and final so that users can correctly assess the financial position of the enterprise.
The Principle of full disclosure implies that nothing should be omitted while principle
of fair disclosure implies that all the transactions recorded should be accounted in a manner
that financial statement purports true and fair view of the results of the business of the
enterprise and adequate disclosure implies that the information influencing the decision of
the users should be disclosed in detail and should make sense.
This principle is widely used in corporate organizations because of separation of
management and ownership. The Companies Act, 2013 in pursuant of this principle has
come out with the format of balance sheet and profit and loss account. The disclosures of
all the major accounting policies and other information are to be provided in the form of
footnotes, annexes etc. The proactive of appending notes to the financial statements is the
outcome of the principle.

Verifiable and Objective Evidence Concept

This principle requires that each recorded business transactions in the books of
accounts should have an adequate evidence to support it. For example, each payment should
be supported by the cash receipt/payment voucher. The documentary evidence of transactions
should be free from any bias. As accounting records are based on documentary evidence which
are capable of verification, it is universally acceptable. This principle ensures the objectivity
of the accounting process and frees it from any personal bias.

48
 Conceptual framework of Accounting

Modifying Principles
To make the accounting information useful to various interested parties, the basic
assumptions and concepts discussed earlier have been modified. These modifying principles
are as under:

Cost Benefit Principle

This modifying principle states that the cost of applying a principle should not be more
than the benefit derived from it. If the cost is more than the benefit, then that principle should
be modified.

Materiality Principle
Materiality principle permits other concepts to be ignored, if the effect is not considered
material. This principle is an exception of full disclosure principle. According to materiality
principle, all the items having significant economic effect on the business of the enterprise
should be disclosed in the financial statements and any insignificant item which will only
increase the work of the accountant but will not be relevant to the users’ need should not be
disclosed in the financial statements.
The term materiality is a subjective term. It is on the basis of the judgment, common
sense and discretion of the accountant that an item is considered material or not. For
example, stationary purchased by the organization though not used fully in the accounting
year purchased is still shown as an expense of that year because of the materiality concept.
Similarly, depreciation on small items like books, calculators etc. is taken as 100% in the
year of purchase though used by the company for more than a year. This is because the
amount of books or calculator is very small to be shown in the balance sheet though it is the
asset of the company.
The materiality depends not only upon the amount of the item but also upon the size
of the business, nature and level of information, level of the person making the decision
etc. Moreover, an item material to one person may be immaterial to another person. What
is important is that omission of any information should not impair the decision-making of
various users.

Consistency Principle
In order to achieve comparability of the financial statements of an enterprise through
time, the accounting policies are followed consistently from one period to another; a change
in an accounting policy is made only in certain exceptional circumstances.

49
Commercial Accountancy

The concept of consistency is applied particularly when alternative methods of

accounting are equally acceptable. For example, a company may adopt any of several
methods of depreciation such as written-down-value method, straight-line method, etc.
Likewise, there are many methods for valuation for inventories. But following the principle
of consistency it is advisable that the company should follow consistently over years
the same method of depreciation or the same method of valuation of Inventories which
is chosen. However, in some cases though there is no inconsistency, they may seem to
be inconsistent apparently. In case of valuation of Inventories if the company applies the
principle ‘at cost or market price whichever is lower’ and if this principle accordingly
results in the valuation of Inventories in one year at cost price because that is lower and the
market price in the other year, because market price is lower there is no inconsistency here.
It is only an application of the principle.
But the concept of consistency does not imply non-flexibility as not to allow the
introduction of improved method of accounting.
An enterprise should change its accounting policy in any of the following circumstances only:
a. To bring the books of accounts in accordance with the issued Accounting Standards.
b. To comply with the provisions of law.
c. When under changed circumstances it is felt that new method will reflect more true
and fair picture in the financial statement.
The aim of consistency principle is to preserve the comparability of financial statements.
The rules, practices, concepts and principles used in accounting should be continuously
observed and applied year after year. Comparisons of financial results of the business among
different accounting period can be significant and meaningful only when consistent practices
were followed in ascertaining them.

Prudence (Conservatism) Principle

Prudence principle takes into consideration all prospective losses but leaves all
prospective profits. The essence of this principle is “anticipate no profit and provide for
all possible losses”. For example, while valuing stock in trade, market price or cost price
whichever is less is considered. Similarly, when there are many alternative values of an asset,
an accountant should choose that method which leads to the lesser value. Later on we shall
see that the golden rule of current assets valuation – ‘cost or market price’ whichever is lower
originated from this concept.
The Realization Concept also states that no change should be counted unless it has
materialized. The Conservatism Concept puts a further brake on it. It is not prudent to count
unrealized gain but it is desirable to guard against all possible losses.

50
 Conceptual framework of Accounting

For this concept there should be at least three qualitative characteristics of financial
statements, namely,
1. Prudence, i.e., judgment about the possible future losses which are to be guarded,
as well as gains which are uncertain.
2. Neutrality, i.e., unbiased outlook is required to identify and record such possible
losses, as well as to exclude uncertain gains,
3. Faithful representation of alternative values.
Many accounting authors, however, are of the view that conservatism essentially leads
to understatement of income and wealth and it should not be the basis of the preparation of
financial statements.

Financial Statements
The aim of accounting is to keep systematic records to ascertain financial performance
and financial position of an entity and to communicate the relevant financial information to
the interested user position of an entity and to communicate the relevant financial information
to the interested user groups. The financial statements are basic means through which the
management of an entity makes public communication of the financial information along
with selected quantitative details. They are structured financial representations of the financial
position and the performance of an enterprise. To have a record of all business transactions
and also to determine whether all these transactions resulted in either ‘profit or loss’ for the
period, all the entities will prepare financial statements viz., balance sheet, profit and loss
account, cash flow statement etc. by following various accounting concepts, principles, and
conventions which have been already discussed in detail in this chapter.

Qualitative Characteristics of Financial Statements

Qualitative characteristics are the attributes that make the information provided in
financial statements useful to users. The following are the important qualitative characteristics
of the financial statements:
1. Understandability: An essential quality of the information provided in financial
statements is that it must be readily understandable by users. For this purpose, it is
assumed that users have a reasonable knowledge of business and economic activities
and accounting and study the information with reasonable diligence. Information
about complex matters that should be included in the financial statements because
of its relevance to the economic decision-making needs of users should not be
excluded merely on the ground that it may be too difficult for certain users to
understand.

51
Commercial Accountancy

2. Relevance: To be useful, information must be relevant to the decision-making

needs of user. Information has the quality of relevance when it influences the
economic decisions of users by helping them evaluate past, present or future events
or confirming, or correcting, their past evaluations.
The predictive and confirmatory roles of information are interrelated. For example,
information about the current level and structure of asset holdings have value to
users when they endeavor to predict the ability of the enterprise to take advantage
of opportunities and its ability to react to adverse situations. The same information
plays a confirmatory role in respect of past predictions about, for example, the way
in which the enterprise would be structured or the outcome of planned operations.
Information about finical position and past performance is frequently used as the
basis for predicting future financial position and performance and other matters
in which users are directly interested, such as dividend and wage payments, share
price movements and the ability of the enterprise to meet its commitments as they
fall due. To have predictive value, information need not be in the form of an explicit
forecast. The ability to make predictions from financial statements is enhanced,
however, by the manner in which information on past transactions and events is
displayed. For example, the predictive value of the statement of profit and loss is
enhanced if unusual, abnormal and infrequent items of income and expense are
separately disclosed.
3. Reliability: To be useful, information must also be reliable, Information has the
quality of reliability when it is free from material error and bias and can be depended
upon by users to represent faithfully that which it either purports to represent or
could reasonably be expected to represent.
Information may be relevant but so unreliable in nature or representation that its
recognition may be potentially misleading. For example, if the validity and amount
of a claim for damages under a legal action against the enterprise are highly
uncertain, it may be inappropriate for the enterprise to recognize the amount of the
claim in the balance sheet, although it may be appropriate to disclose the amount
and circumstances of the claim.
4. Comparability: Users must be able to compare the financial statements of an enterprise
through time in order to identify trends in its financial position, performance and
cash flows. Users must also be able to compare the financial statements of different
enterprise in order to evaluate their relative financial position, performance and cash
flows. Hence, the measurement and display of the financial effects of like transactions
and events must be carried out in a consistent way throughout an enterprise and over
time for that enterprise and in a consistent way for different enterprise.

52
 Conceptual framework of Accounting

An important implication of the qualitative characteristic of comparability is that

user be informed of the accounting policies employed in the preparation of the
financial statements, any changes in those polices and the effects of such changes.
Users need to be able to identify differences between the accounting policies for
like transactions and other events under the same enterprise from period to period
and by different enterprises. Compliance with Accounting Standards, including
the disclosure of the accounting policies used by the enterprise, helps to achieve
comparability.
The need for comparability should not be confused with mere uniformity and
should not be allowed to become an impediment to the introduction of improved
accounting standards. It is not appropriate for an enterprise to continue accounting
in the same manner for a transaction or other event if the policy adopted is not in
keeping with the qualitative characteristics of relevance and reliability. It is also
inappropriate of an enterprise to leave its accounting policies unchanged when
more relevant and reliable alternatives exist.
Users wish to compare the financial position, performance and cash flows of an
enterprise over time. Hence, it is important that the financial statements show
corresponding information for the preceding period (s).
The four principal qualitative characteristics are understandability, relevance,
reliability and comparability.
5. Materiality: The relevance of information is affected by its materiality.
Information is material if its misstatement (i.e., omission or erroneous statement)
could influence the economic decisions of users taken on the basis of the financial
information. Materiality depends on the size and nature of the item or error, judged
in the particular circumstances of its misstatement. Materiality provides a threshold
or cut-off point rather than being a primary qualitative characteristic which the
information must have if it is to be useful.
6. Faithful Representation: To be reliable, information must represent faithfully the
transactions and other events it either purports to represent or could reasonably be
expected to represent. Thus, for example, a balance sheet should represent faithfully
the transactions and other events that result in assets, liabilities and equity of the
enterprise at the reporting date which meet the recognition criteria.
Most financial information is subject to some risk of being less than a faithful
representation of that which it purports to portray. This is not due to bias, but rather
to inherent difficulties. Either in identifying the transactions and other events to be
measured or in devising and applying measurement and presentation techniques
that can convey massages that correspond with those transactions and events.

53
Commercial Accountancy

In certain cases, the measurement of the financial effects of items could be so

uncertain that enterprises generally would not recognize them in the financial
statements; for example, although most enterprises generate goodwill internally
over time, it is usually difficult to identify or measure that goodwill reliably.
In other cases, however, it may be relevant to recognize items and to disclose the
risk of error surrounding their recognition and measurement.
7. Substance Over Form: If information is to represent faithfully the transactions
and other events that it purports to represent, it is necessary that they are accounted
for and presented in accordance with their substance and economic reality and
not merely their legal form. The substance of transactions or other events is not
always consistent with that which is apparent from their legal or contrived form.
For example, where rights and beneficial interest in an immovable property are
transferred but the documentations and legal formalities are pending, the recording
of acquisition/disposal (by the transferee and transferor respectively) would in
substance represent the transaction entered into.
8. Neutrality: To be reliable, the information contained in financial statements must
be neutral, that is, free from bias. Financial statements are not neutral if, by the
selection or presentation of information, they influence the making of a decision or
judgment in order to achieve a predetermined result or outcome.
9. Prudence: The preparers of financial statements have to contend with the
uncertainties that inevitably surround many events and circumstances, such as
the collectability of receivables, the probable useful life of plant and machinery,
and the warranty claims that may occur, such uncertainties are recognized by
the disclosure of their nature and extent and by the exercise of prudence in the
preparation of the financial statements. Prudence is the inclusion of a degree of
caution in the exercise of the judgments needed in making the estimates required
under conditions of uncertainty, such that assets or income are not overstated and
liabilities or expenses are not understated. However, the exercise of prudence does
not allow, for example, the creation of hidden reserves or excessive provisions, the
deliberate understatement of assets or income, or the deliberate overstatement of
liabilities or expenses, because the financial statements would then not be neutral
and, therefore, not have the quality of reliability.
10. Full, fair and adequate disclosure: The financial statement must disclose all the
reliable and relevant information about the business enterprise to the management
and also to their external users for which they are meant, which in turn will
help them to take a reasonable and rational decision. For it, it is necessary that
financial statements are prepared in conformity with generally accepted accounting
principles i.e. the information is accounted for and presented in accordance with its

54
 Conceptual framework of Accounting

substance and economic reality and not merely with its legal form. The disclosure
should be full and final so that users can correctly assess the financial position of
the enterprise.
The Principle of full disclosure implies that nothing should be omitted while
principle of fair disclosure implies that all the transactions recorded should be
accounted in a manner that financial statement purports true and fair view of the
results of the business of the enterprise and adequate disclosure implies that the
information influencing the decision of the users should be disclosed in detail and
should make sense.
This principle is widely used in corporate organizations because of separation
in management and ownership. The Companies Act, 2013* in pursuant of this
principle has come out with the format of balance sheet and profit and loss account.
The disclosures of all the major accounting policies and other information are to be
provided in the form of footnotes, annexes etc. The practice of appending notes to
the financial statements is the outcome of the principle.
11. Completeness: To be reliable, the information in financial statement must be
complete within the bounds of materiality and cost. An omission can cause
information to be false or misleading and thus unreliable and deficient in terms of
its relevance.
Thus, if accounting information is to present faithfully the transactions and other
events that it purports to represent, it is necessary that they are accounted for and
presented in accordance with their substance and economic reality, not by their legal
form. For example, if a business enterprise sells its assets to others but still uses the
assets as usual for the purpose of the business by making some arrangement with
the seller, it simply becomes a legal transaction. The economic reality is that the
business is using the assets as usual for deriving the benefit. Financial statement
information should contain the substance of this transaction and should not only
record going by legality. In order to be reliable the financial statements information
should be neutral i.e., free from bias. The preparers of financial statements
however, have to contend with uncertainties that inevitably surround many events
and circumstances, such as the collectability of doubtful receivables, the probable
useful life of plant and equipment and the number of warranty claims that may
occur. Such uncertainties are recognized by the disclosure of their nature and extent
and by exercise of prudence in the preparation of financial statements. Prudence is
the inclusion of a degree of caution in the exercise of judgment needed in making
the estimates required under condition of uncertainty such that assets and income
are not overstated and loss and liability are not understated.

55
Commercial Accountancy

56
 Double Entry Accounting System

Double Entry
CHAPTER 4 Accounting System

R
ecording of business transactions has been in vogue in all countries of the world. In
India, maintenance of accounts was practiced not in such a developed form as we have
today. Kautilya’s famous ‘Arthasastra’ not only relates to Politics and Economics, but
also explains the art of account keeping in a separate chapter. Written in 4th century BC, the
book gives details about account keeping, methods of supervising and checking of accounts
and also about the distinction between capital and revenue, income and expenses etc.
Double entry system was introduced to the business world by an Italian merchant
named Lucas Pacioli in 1494 A.D. Though the system of recording business transactions in
a systematic manner has originated in Italy, it was perfected in England and other European
countries during the 18th century only i.e., after the Industrial Revolution. Many countries
have adopted this system today.

Double Entry System

There are numerous transactions in a business concern. Each transaction, when closely
analyzed, reveals two aspects. One aspect will be “receiving aspect” or “incoming aspect”
or “expenses/loss aspect”. This is termed as the “Debit aspect”. The other aspect will be
“giving aspect” or “outgoing aspect” or “income/gain aspect”. This is termed as the “Credit
aspect”. These two aspects namely “Debit aspect” and “Credit aspect” form the basis of
Double Entry System.
The double entry system is so named since it records both the aspects of a transaction. In
short, the basic principle of this system is, for every debit, there must be a corresponding credit
of equal amount and for every credit, there must be a corresponding debit of equal amount.
According to J.R.Batliboi “Every business transaction has a two-fold effect and that it
affects two accounts in opposite directions and if a complete record were to be made of each
such transaction, it would be necessary to debit one account and credit another account. It
is this recording of the two-fold effect of every transaction that has given rise to the term
Double Entry System”.
Features of double entry accounting system can be described as follow:
(a) Every business transaction affects two accounts.
(b) Each transaction has two aspects, i.e., debit and credit.

57
Commercial Accountancy

(c) It is based upon accounting assumptions concepts and principles.

(d) Helps in preparing trial balance which is a test of arithmetical accuracy in accounting.
(e) Preparation of final accounts with the help of trial balance.

Approaches of Recording
There are two approaches for recording a transaction.
I. Accounting Equation Approach
II. Traditional Approach
I. Accounting Equation Approach
This approach is also called as the American Approach. Under this method transaction
are recorded based on the accounting equation, i.e.

Assets = Liabilities + Capital

This is also known as golden equation of the accounting.

II. Traditional Approach

This approach is also called as the British Approach. Recording of business transactions
under this method are formed on the basis of the existence of two aspects (debit and credit) in
each of the transactions.
All the business transactions are recorded in the books of accounts under the ‘Double
Entry System’.

Advantages
The advantages of this system are as follows:
i. Scientific system: This is a scientific system of recording business transactions. It
helps to attain the objectives of accounting.
ii. Complete record of transactions: This system maintains a complete record of all
business transactions.
iii. A check on the accuracy of accounts: By the use of this system the accuracy of the
accounting work can be established by the preparation of trial balance.
iv. Ascertainment of profit or loss: The profit earned or loss occurred during a period
can be ascertained by the preparation of profit and loss account.
v. Knowledge of the financial position: The financial position of the concern can be
ascertained at the end of each period through the preparation of balance sheet.

58
 Double Entry Accounting System

vi. Full details for control: This system permits accounts to be kept in a very detailed
form, and thereby provides sufficient information for the purpose of control.
vii. Comparative study: The results of one year may be compared with those of previous
years and the reasons for change may be ascertained.
viii. Helps in decision making: The management may be able to obtain sufficient
information for its work, especially for making decisions. Weaknesses can be detected
and remedial measures may be applied.
ix. Detection of fraud: The systematic and scientific recording of business transactions
on the basis of this system minimizes the chances of fraud.

Account
Every transaction has two aspects and each aspect has an account. It is stated that ‘an
account is a summary of relevant transactions at one place relating to a particular head’.

Classification of Accounts
Transactions can be divided into three categories.
i. Transactions relating to individuals and firms
ii. Transactions relating to properties, goods or cash
iii. Transactions relating to expenses or losses and incomes or gains.
Therefore, accounts can also be classified into Personal, Real and Nominal. The classification
may be illustrated as follows:

59
Commercial Accountancy

Personal Accounts

The accounts which relate to persons are called personal accounts. Personal accounts include
the following:
i. Natural Persons: Accounts which relate to individuals. For example, Mohan’s A/c,
Shyam’s A/c etc.
ii. Artificial persons: Accounts which relate to a group of persons or firms or
institutions. For example, Comptroller and Auditor General of India, Accountant
General, Reliance Industries, State Bank of India, Life Insurance Corporation of
India, Officers’ club etc.
iii. Representative Persons: Accounts which represent a particular person or group of
persons. In books the names of parties will appear. Since these accounts are in many
number and of the same nature, the accounts standing against these accounts are added
and put under one common title. For example, if business is not able to pay rent, say
for 15 shops, then all landlords of these shops stand as creditor and the amount due to
them are added and put under one common head known as “rent Outstanding”. This`
account is a personal account representing so many landlords. Similar is case with
the Salary Outstanding account, rent prepaid account, interest received in advance
account etc.
The business concern may keep business relations with all the above personal accounts,
because of buying goods from them or selling goods to them or borrowing from them or
lending to them. Thus they become either Debtors or Creditors.

The proprietor being an individual his capital account and his drawings account are also
personal accounts.

Impersonal Accounts
All those accounts which are not personal accounts. This is further divided into two
types viz. Real and Nominal accounts.

Real Accounts
Accounts relating to properties and assets which are owned by the business concern.
Real accounts include tangible and intangible accounts. For example, Land, Building,
Goodwill, Purchases, etc.

Nominal Accounts
These accounts do not have any existence, form or shape. They relate to incomes and
expenses and gains and losses of a business concern. For example, Salary Account, Dividend
Account, etc.

60
 Double Entry Accounting System

Illustration:

Classify the following items into Personal, Real and Nominal Accounts.
1. Capital
2. Sales
3. Drawings
4. Outstanding salary
5. Cash
6. Rent
7. Interest paid
8. Indian Bank
9. Discount received
10. Building
11. Bank
12. Seetaram
13. Accountant General
14. Advertisement
15. Purchases
Solution
1. Capital Personal account
2. Sales Real account
3. Drawings Personal account
4. Outstanding salary Personal (Representative) account
5. Cash Real account
6. Rent Nominal account
7. Interest paid Nominal account
8. Indian Bank Personal (Legal Body) account
9. Discount received Nominal account
10. Building Real account
11. Bank Personal account
12. Seetaram Personal account
13. Accountant General Personal (Legal Body) account
14. Advertisement Nominal account
15. Purchases Real Account

61
Commercial Accountancy

62
 Accounting process: Journal

Accounting process:
CHAPTER 5 Journal

A
ccounting process starts with identifying the transactions to be recorded in the books
of accounts. Accounting identifies only those transactions and events which involve
money. They should be of financial character. Accountant does so by sorting out
various cash memos, invoices, bills, receipts and vouchers.
In the accounting process, the first step is the recording of transactions in the books of
accounts. The origin of a transaction is derived from the source document.

Source Documents
Source documents are the evidence of business transactions which provide information
about the nature of the transaction, the date, the amount and the parties involved in it.
Transactions are recorded in the books of accounts when they actually take place and are duly
supported by source documents. According to the verifiable objective principle of Accounting,
each transaction recorded in the books of accounts should have adequate proof to support it.
These supporting documents are the written and authentic proof of the correctness of the
recorded transactions. These documents are required for audit and tax assessment. They also
serve as the legal evidence in case of a dispute.

The following are the most common source documents: -

Cash Memo
When a trader sells goods for
cash, he gives a cash memo and when
he purchases goods for cash, he receives
a cash memo. Details regarding the
items, quantity, rate and the price are
mentioned in the cash memo.

63
Commercial Accountancy

Invoice or Bill
When a trader sells goods on credit, he prepares a
sale invoice. It contains full details relating to the amount,
the terms of payment and the name and address of the seller
and buyer. The original copy of the sale invoice is sent to
the purchaser and its duplicate copy is kept for making
records in the books of accounts. Similarly, when a trader
purchases goods on credit, he receives a credit bill from the
supplier of goods.

Receipt
When a trader receives cash from a
customer, he issues a receipt containing the date,
the amount and the name of the customer. The
original copy is handed over to the customer and
the duplicate copy is kept for record. In the same
way, whenever we make payment, we obtain a
receipt from the party to whom we make payment.

Debit Note
A debit note is prepared by the buyer and
it contains the date of the goods returned, name
of the supplier, details of the goods returned and
reasons for returning the goods. Each debit note
is serially numbered. A duplicate copy or counter
foil of the debit note is retained by the buyer. On
the basis of debit note, the suppliers account is
debited in the books.

64
 Accounting process: Journal

Credit Note
A credit note is prepared by the
seller and it contains the date on which
goods are returned, name of the customer,
details of the goods received back, amount
of such goods and reasons for returning
the goods. Each credit note is serially
numbered. A duplicate copy of the credit
note is retained for the record purpose.
On the basis of credit note, the customer’s
account is credited in the books.

Pay-in-slip
Pay-in-slip is a form
available in banks and is
used to deposit money into
a bank account. Each pay-
in-slip has a counterfoil
which is returned to the
depositor duly sealed and
signed by the bank official.
This source document relates to bank transactions. It gives details regarding date, account
number, amount deposited (in cash or cheque) and name of the account holder.

Cheque
A cheque is a document in writing drawn upon a specified banker to pay a specified
sum to the bearer or the person named in it and payable on demand. Each cheque book has a
counterfoil in which the same details in the cheque are filled. The counterfoil remains with the
account holder for his future reference. The counterfoil forms the source document for entries
to be made in the books of accounts.

Vouchers
A voucher is a written document in support of
a business transaction. Vouchers are prepared by an
accountant and each voucher is counter signed by an
authorized person of the organization. The vouchers
are properly filed according to their serial numbers
so that the auditors may easily vouch them and these
may also serve as documentary evidence in future.

65
Commercial Accountancy

Accounting Equation
The source document is the origin of a transaction and it initiates the accounting process,
whose starting point is the accounting equation.
Accounting equation is based on dual aspect concept (Debit and Credit). It emphasizes
on the fact that every transaction has a two sided effect i.e., on the assets and claims on
assets. Always the total claims (those of outsiders and of the proprietors) will be equal to the
total assets of the business concern. The claims are also known as equities, are of two types:
i) Owners equity (Capital); ii) Outsiders’ equity (Liabilities). This is also known as golden
accounting equation. This equation can also be shown as: -
Asset = Capital + Liability
Hence, Capital = Asset – Liability; and
Liability = Asset – Capital
This equation establishes that excess of asset over liability is owners’ share in the
business. It is called Capital in the business. At the end of the year, resultant profit or loss of
the business gets adjusted to the Capital. Profit increases the Capital and loss reduces it. So,
expense/loss results into reducing the capital and income/gain increases the capital.

Effect of transaction on the accounting equation

Let us understand how any transaction affects this accounting equation.
Transaction 1: -Shri Rakesh Sajjan commenced business with cash ` 1,00,000.
As a result of this transaction, business receives the cash (an asset) of ` 1,00,000 and
same time it is introduction of capital into business. The accounting equation will look like-
Cash = Owner’s Equity
1,00,000 = 1,00,000
Transaction 2: - He purchased goods for cash from Mr Rajkamal and paid the full price
of ` 80,000.
As a result of this transaction, business paid ` 80,000 to Shri Rajkamal and received the
goods worth the same amount. Now the accounting equation will look like-
Cash + Stock = Owner’s Equity
20,000 + 80,000 = 1,00,000

Transaction 3: - He purchased goods on credit worth ` 80,000 from Shri Ananth Dwevedi.
As a result of this transaction, business received goods worth ` 80,000 and raised a liability
of ` 80,000 as creditor Shri Ananth Dwevedi. Now the accounting equation will look like-

66
 Accounting process: Journal

Cash + Stock = Owner’s Equity + Creditor

20,000 + 1,60,000 = 1,00,000 + 80,000
Transaction 4: - He purchased furniture for cash from Shri Atul Tirky and paid ` 3,000.

With this transaction, asset has increased by ` 3,000 in form of furniture and cash (an asset)
has decreased by ` 3,000. The accounting equation will look like-
Cash + Stock + Furniture = Owner’s Equity + Creditor
17,000 + 1,60,000 + 3,000 = 1,00,000 + 80,000
Transaction 5: - He paid rent of ` 2,000 to landlord Shri Pavendran.
All expenses reduce the capital hence with this transaction capital will get reduced by
` 2,000 and cash has also gone out hence cash will get reduced by ` 2,000. The accounting
equation will look like-
Cash + Stock + Furniture = Owner’s Equity + Creditor
15,000 + 1,60,000 + 3,000 = 98,000 + 80,000
Transaction 6: - He sold goods worth ` 45,000 for ` 60,000 for cash to Shri Kencho Dorji.
In this transaction, business has sold the goods worth ` 45,000 for ` 60,000 hence
made profit of ` 15,000 (60,000-45,000). As a result, cash will increase by ` 60,000 and stock
will get reduced by ` 45,000. In other side of equation, capital will get increased by ` 15,000
as profit of the business belongs to the owner. Now accounting equation will look like this-
Cash + Stock + Furniture = Owner’s Equity + Creditor
75,000 + 115,000 + 3,000 = 113,000 + 80,000
Transaction 7: - He paid to creditor Shri Rajkamal ` 20,000.
In this transaction will take cash of ` 20,000 away as well as reduces the creditor by the
same amount. The accounting equation will look like-
Cash + Stock + Furniture = Owner’s Equity + Creditor
55,000 + 115,000 + 3,000 = 113,000 + 60,000
Transaction 8: - He withdrew cash of ` 10,000 for personal use.
The accounting entity assumption clearly tells to treat owner different then business. Hence
withdrawal for personal use will reduce the capital. The accounting equation will now look like-
Cash + Stock + Furniture = Owner’s Equity + Creditor
45,000 + 115,000 + 3,000 = 103,000 + 60,000

67
Commercial Accountancy

Transaction 9: - He paid salary of ` 5,000 to the accountant Shri Shyam.

Salary is an expense for the business hence it reduces the capital and same time
cash also get reduced by the same amount. Now the accounting equation will look
like-
Cash + Stock + Furniture = Owner’s Equity + Creditor
40,000 + 115,000 + 3,000 = 98,000 + 60,000
Transaction 10: - He sold goods worth ` 60,000 in ` 80,000 on credit to Shri Simranjeet.
This credit transaction will raise debtor (Shri Simranjeet) by ` 80,000 and stock get
reduced by ` 60,000. The profit from this transaction ` 20,000 will be added to the capital.
The accounting equation will be-
Cash + Stock + Furniture + Debtor = Owner’s Equity + Creditor
40,000 + 55,000 + 3,000 + 80,000 = 118,000 + 60,000
The same accounting equation can be presented in form of Balance Sheet.
Balance Sheet depicts the financial position of the business as on particular date. The
Balance Sheet of M/s Yarrows Mess (the proprietorship of Shri Rakesh Sajjan) will
look like this-
Balance Sheet of M/s Yarrows Mess
(As on ..........)
Liability Amount (in ` ) Asset Amount (in ` )
Capital 1,18,000 Stock 55,000
Creditor 60,000 Debtor 80,000
Furniture 3,000
Cash 40,000
Total 1,78,000 Total 1,78,000
Rules for Debiting and Crediting
In actual practice, the individual transactions of similar nature are recorded, added
and subtracted at one place. Such place is customarily the meaning of debit and credit, it is
essential to understand the meaning and form of an account.
An account is a record of all business transactions relating to a particular person or
asset or liability or expense or income. In accounting, we keep a separate record of each
individual, asset, liability, expense or income. The place where such a record is maintained is
termed as an ‘Account’.

68
 Accounting process: Journal

All accounts are divided into two sides. The left hand side of an account is called Debit
side and the right hand side of an account is called Credit side. In the abbreviated form Debit
is written as Dr. and Credit is written as Cr. The format of account is as under: -

Name of Account
Dr. Cr.
Particular Amount Particular Amount

In order to decide when to write on the debit side of an account and when to write on
the credit side of an account, there are two approaches. They are: 1) Accounting Equation
Approach, 2) Traditional Approach.

Nature of Account
The accounting equation is a statement of equality between the debits and the credits.
The rules of debit and credit depend on the nature of an account. For this purpose, all the
accounts are classified into the following five categories in the accounting equation approach:-
1. Asset
2. Liability
3. Capital
4. Income/gain
5. Expense/loss
As per accounting equation, if there is increase in any of the category there will be
corresponding increase or decrease on other category so the resultant accounting equation will
be balanced. In rule of debit and credit for these categories will be as follows: -
• Increases in assets are debits and decreases in assets are credits.
• Increases in capital/owners equity are credits and decreases in capital/OE are
debits.
• Increases in liabilities are credits and decreases in liabilities are debits.
• Increases in incomes and gains are credits and decreases in incomes and gains
are debits.
• Increases in expenses and losses are debits and decreases in expenses and losses
are credits
In the traditional approach, all the accounts are classified into the following three types.
1. Personal Accounts 2. Real Accounts 3. Nominal Accounts

69
Commercial Accountancy

Golden Rules for Debit and Credit

Personal Accounts { a)b) Debit the receiver

Credit the giver

Real Accounts { a)b) Debit what comes in

Credit what goes out

Nominal Accounts { a)b) Debit all expenses and losses

Credit all incomes and gains

Journal: Meaning and Format

Journal is a book of accounts in which all day to day business transactions are recorded
in a chronological order i.e. in the order of their occurrence. Transactions when recorded in
a Journal are known as entries. It is the book in which transactions are recorded for the first
time. Journal is also known as ‘Book of Original Record’ or ‘Book of Primary Entry’.
Journalizing
Business transactions of financial nature are classified into various categories of
accounts such as assets, liabilities, capital, revenue and expenses. These are debited or
credited according to the rules of debit and credit, applicable to the specific accounts. Every
business transaction affects two accounts. Applying the principle of double entry, one account
is debited and the other account is credited. Every transaction can be recorded in journal. This
process of recording transactions in the journal is’ known as ‘Journalising’. In small business
houses generally one Journal Book is maintained in which all the transactions are recorded.
But in case of big business houses as the transactions are quite large in number, therefore
journal is divided into various types of books called Special Journals in which transactions are
recorded depending upon the nature of transaction i.e. all credit sales in Sales Book, all cash
transactions in Cash Book and soon.

Format of Journal
Every page of Journal has the following format. It is a columnar book. Each column is
given a name written on its top. Format of journal is given below:

Date Particulars Ledger Folio Debit (in `) Credit (in `)

Date: In the first column, the date of the transaction is entered. The year and the month is
written only once, till they change. The sequence of the dates and months should be strictly
maintained.

70
 Accounting process: Journal

Particulars: Each transaction affects two accounts, out of which one account is debited and
the other account is credited. The name of the account to be debited is written first, very near
to the line of particulars column and the word Dr. is also written at the end of the particulars
column. In the second line, the name of the account to be credited is written, starts with the
word ‘To’, a few space away from the margin in the particulars column to the make it distinct
from the debit account.
Narration: After each entry, a brief explanation of the transaction together with necessary
details is given in the particulars column with in brackets called narration. The words ‘For’
or ‘Being’ are used before starting to write down narration. Now, it is not necessary to use the
word ‘For’ or ‘Being’.
Ledger Folio (L.F): All entries from the journal are later posted into the ledger accounts. The
page number or folio number of the Ledger, where the posting has been made from the Journal
is recorded in the L.F column of the Journal. Till such time, this column remains blank.
Debit Amount: In this column, the amount of the account being debited is written.
Credit Amount: In this column, the amount of the account being credited is written.

Steps in Journalizing
The process of analyzing the business transactions under the heads of debit and credit
and recording them in the Journal is called Journalizing. An entry made in the journal is
called a ‘Journal Entry’.

• Determine the two accounts which are involved in the transaction.

Step 1

• Classify the above two accounts under Personal, Real or Nominal.

Step 2

• Find out the rules of debit and credit for the above two accounts.
Step 3

• Identify which account is to be debited and which account is to

be credited
Step 4

71
Commercial Accountancy

• Record the date of transaction in the date column. The year and
month is written once, till they change. The sequence of the dates
Step 5 and months should be strictly maintained.

• Enter the name of the account to be debited in the particulars

column very close to the left hand side of the particulars column
followed by the abbreviation Dr. in the same line. Against this,
the amount to be debited is written in the debit amount column in
Step 6
the same line.

• Write the name of the account to be credited in the second line

starts with the word ‘To’ a few space away from the margin in
the particulars column. Against this, the amount to be credited is
Step 7 written in the credit amount column in the same line.

• Write the narration within brackets in the next line in the

particulars column
Step 8

• Draw a line across the entire particulars column to seperate one

journal entry from the other.
Step 9

Let us understand the process of journalizing with some examples:

First transaction: - Shri Rakesh Sajjan started the business with ` 1,00,000. Let us
follow all steps and find all important component of journal entry.
Step 1 Shri Rakesh Sajjan Started the Business with ` 1,00,000
Determination of two accounts involved in the
Step 2 Cash Capital
transaction
Personal
Step 3 Classifying these accounts Real Account
Account
Debit what
Step 4 Finding out the rule for debit and credit Credit the giver
comes in

72
 Accounting process: Journal

Thus for journal entry Cash will be debited and capital a/c will be credited
Journal entry will be: -
Date Particulars L.F. Debit Credit
(in ` ) (in ` )
1st Cash A/c Dr 1,00,000
To Capital A/c 1,00,000
(Being capital invested to start Business)
Second transaction: -He received ` 20,000 from Shri Rajkamal Ranjan.
Step 1 He received ` 20,000 from Shri Rajkamal Ranjan
Rajkamal
Determination of two accounts involved in the
Step 2 Cash Ranjan
transaction
Account
Real Personal
Step 3 classifying these accounts
Account Account
Debit
Credit the
Step 4 finding out the rule for debit and credit what
giver
comes in
Thus Cash will be debited and Rajkamal Ranjan Account will be credited
Journal entry will be: -
Date Particulars L.F. Debit Credit
(in `) (in `)
2nd Cash A/c Dr 20,000
To Rajkamal’s A/c 20,000
(Being loan received from Shri Rajkamal Ranjan)
Third transaction: - He paid cash of ` 15,000 to Shri Vinod.
Step 1 He paid cash of ` 15,000 to Shri Vinod
Determination of two accounts involved
Step 2
in the transaction Vinod Account Cash
Step 3 classifying these accounts Personal Account Real Account
Credit what
Step 4
finding out the rule for debit and credit Debit the receiver goes out

73
Commercial Accountancy

Thus Vinod account will be debited and Cash will be credited.

Journal entry will be: -
Date Particulars L.F. Debit Credit
(in `) (in `)
3rd Vinod’s A/c Dr 15,000
To Cash A/c 15,000
(Being loan given to Shri Vinod)
Forth transaction: -He bought goods in cash for ` 50,000 from Shri Vipul Bava.
Step 1 He bought goods in cash for ` 50,000 from Shri Vipul Bava.
Determination of two accounts involved in Purchase
Step 2 Cash
the transaction Account
Step 3 classifying these accounts Real Account Real Account
Debit what Credit what
Step 4 finding out the rule for debit and credit
comes in goes out
Thus Purchase account will be debited and cash account will be credited
Journal entry will be: -
Date Particulars L.F. Debit Credit
(in `) (in `)
4th Purchase A/c Dr 50,000
To Cash A/c 50,000
(Being cash purchased made)
Fifth transaction: - He sold goods in cash for ` 90,000 to Shri R Shyam.
Step 1 He sold goods in cash for ` 90,000 to Shri R Shyam
Determination of two accounts involved in
Step 2 Cash Sales
the transaction
Step 3 classifying these accounts Real Account Real Account
Debits what Credit what
Step 4 finding out the rule for debit and credit
comes in goes out
Thus Cash account will be debited and sales account will be credited

74
 Accounting process: Journal

Journal entry will be: -

Date Particulars L.F. Debit Credit
(in `) (in `)
5th Cash A/c Dr 90,000
To Sales A/c 90,000
(Being cash sales made)
Transaction 6: - He paid remuneration of ` 20,000 to Shri Hariram Shankar for expert opinion

Step 1 He paid remuneration of ` 20,000 to Shri Hariram Shankar for expert opinion
Determination of two accounts involved Expense
Step 2
in the transaction (remuneration) Cash

Step 3
classifying these accounts Nominal Account Real Account
Credit what goes
Step 4
finding out the rule for debit and credit Expenses debit out
Thus Expense (remuneration) account will be debited and cash will be credited
Journal entry will be: -
Date Particulars L.F. Debit Credit
(in `) (in `)
6th Remuneration A/c Dr 20,000
To Cash A/c 20,000
(Being remuneration for expert opinion paid to Shri
Hariram Shankar)
Transaction 7: - He bought good on credit of ` 80,000 from Shri Tashi.
Step 1 He bought good on credit of ` 80,000 from Shri Tashi
Determination of two accounts involved in Creditor
Step 2
the transaction Purchase (Tashi)
Personal
Step 3
classifying these accounts Real account account
debit what
Step 4
finding out the rule for debit and credit comes in credit the giver
Thus Purchase account will be debited and Creditor account will be credited.

75
Commercial Accountancy

Journal entry will be: -

Debit Credit
Date Particulars L.F.
(in `) (in `)
Purchase A/c Dr
7 th
To Tashi A/c 80,000
80,000
(Being credit purchase made)
Transaction 8: - He sold goods on credit of ` 1,50,000 to Shri Dorji.
Step 1 He sold goods on credit of ` 1,50,000 to Shri Kencho Dorji
Determination of two accounts involved in Debtor (Kencho
Step 2 Sales
the transaction Dorji)
Step 3 classifying these accounts Personal Real
Debit the Credit what
Step 4 finding out the rule for debit and credit
receiver goes out
Thus Debtor account will be debited and sales account will be credited
Journal entry will be: -
Debit Credit
Date Particulars L.F.
(in `) (in `)
Kencho Dorji A/c Dr
8 th
To Sales A/c 1,50,000
1,50,000
(Being credit sales made)
Transaction 9: - He received commission ` 40,000 for services from Shri Ananth Dwivedi.
Step 1 He received commission ` 40,000 for services from Shri Ananth Dwivedi
Determination of two accounts involved in Commission
Step 2 Cash
the transaction (income)
Nominal
Step 3 classifying these accounts Real account
Account
Debit what Credit the
Step 4 finding out the rule for debit and credit
comes in income
Thus Cash account will be debited and Commission (income) account will be credited

76
 Accounting process: Journal

Journal entry will be: -

Date Particulars L.F. Debit Credit
(in `) (in `)
9th Cash A/c Dr 40,000
To Commission A/c 40,000
(Being commission received)
Transaction 10: - He paid rental charges of ` 30,000 to Shri Masroor Ahmad.
Step 1 He paid rental charges of ` 30,000 to Shri Masroor Ahmad
Determination of two accounts involved
Step 2 Rent (Expense) Cash
in the transaction
Nominal
Step 3 classifying these accounts Real Account
Account
Debit the Credit what
Step 4
finding out the rule for debit and credit expenses goes out
Thus rent account will be debited and cash account will be credited
Journal entry will be: -
Date Particulars L.F. Debit Credit
(in `) (in `)
10th Rent A/c Dr 40,000
To Cash A/c 40,000
(Being rent paid)
Transaction 11: - He paid salary of ` 50,000 to Shri Akshay Khandare.
Step 1 He paid salary of ` 50,000 to Shri Akshay Khandare
Determination of two accounts involved
Step 2 Salary (Expense) Cash
in the transaction
Step 3 classifying these accounts Nominal Account Real Account
Debit the Credit what
Step 4 finding out the rule for debit and credit
expenses goes out
Thus salary account will be debited and cash account will be credited

77
Commercial Accountancy

Journal entry will be: -

Date Particulars L.F. Debit Credit
(in `) (in `)
11th Salary A/c Dr 50,000
To Cash A/c 50,000
(Being salary paid)
Transaction 12: -
Step 1 He hired Shri Surjith as consultant and paid consultancy charges of ` 20,000
Determination of two accounts involved in Consultancy
Step 2
the transaction charges (expense) Cash
Step 3 classifying these accounts Nominal Account Real Account
Debit the Credit what
Step 4
finding out the rule for debit and credit expenses goes out
Thus consultancy account will be debited and cash account will be credited
Journal entry will be: -
Date Particulars L.F. Debit Credit
(in `) (in `)
12th Consultancy A/c Dr 20,000
To Cash A/c 20,000
(Being consultancy charges paid)
Transaction 13: - He paid ` 15,000 as transportation charges to Shri Paventhan.
Step 1 He paid ` 15,000 as transportation charges to Shri Paventhan
Determination of two accounts involved in Transportation
Step 2 Cash
the transaction (expense)
Nominal
Step 3 classifying these accounts Real Account
Account
Debit the Credit what
Step 4 finding out the rule for debit and credit
expenses goes out
Thus Transportation account will be debited and cash account will be credited

78
 Accounting process: Journal

Journal entry will be: -

Debit Credit
Date Particulars L.F.
(in `) (in `)
Transportation A/c Dr 15,000
13 th
To Cash A/c 15,000
(Being transportation charges paid)
Transaction 14: -He took a loan of ` 1,00,000 from Shri Atul Tirky.
Step 1 He took a loan of ` 1,00,000 from Shri Atul Tirky
Determination of two accounts involved in
Step 2 Cash Loan
the transaction
Personal
Step 3 classifying these accounts Real Account
Account
Debit what Credit the
Step 4 finding out the rule for debit and credit
comes in giver
Thus cash account will be debited and Loan account will be credited
Journal entry will be: -
Date Particulars L.F. Debit Credit
(in `) (in `)
14th Cash A/c Dr 1,00,000
To Loan from Atul Tirky A/c 1,00,000
(Being loan taken from Shri Atul Tirky)
Transaction 15: - He bought furniture of ` 20,000 from Shri Sunil Kumar Sharma.
Step 1 He bought furniture of ` 20,000 from Shri Sunil Kumar Sharma
Determination of two accounts involved in
Step 2
the transaction Furniture Cash
Step 3 classifying these accounts Real Account Real Account
debit what credit what
Step 4
finding out the rule for debit and credit comes in goes out
Thus furniture account will be debited and cash account will be credited

79
Commercial Accountancy

Journal entry will be: -

Date Particulars L.F. Debit Credit
(in `) (in `)
15th Furniture A/c Dr 20,000
To Cash A/c 20,000
(Being furniture bought)
Transaction 16: - He sold old furniture to Shri Simranjeet Singh for ` 10,000
Step 1 He sold old furniture to Shri Simranjeet Singh for ` 10,000
Determination of two accounts involved in
Step 2 Cash Furniture
the transaction
Step 3 classifying these accounts Real Account Real Account
debit what credit what goes
Step 4 finding out the rule for debit and credit
comes in out
Thus Cash account will be debited and furniture account will be credited
Journal entry will be: -
Date Particulars L.F. Debit Credit
(in `) (in `)
16th Cash A/c Dr 10,000
To Furniture A/c 10,000
(Being old furniture sold)
Compound Journal Entry
When two or more transactions of similar nature take place on the same date, such
transactions can be entered in the journal by means of a combined journal entry is called
Compound Journal Entry. The only precaution is that the total debits should be equal to total
credits.
Transaction 17: - Shri Jitendra Tiwari and Kaushal Karthik started the business with
` 1,00,000 and ` 1,50,000 cash.
In this transaction here are three accounts involved. Cash account and capital accounts
of Shri Jitendra Tiwari and Shri Kaushal Karthik. By following the steps of debit and credit,
the journal entry will be: -

80
 Accounting process: Journal

Date Particulars L.F. Debit Credit

(in `) (in `)
DD/ Cash A/c Dr 2,50,000
MM To Jitendra Tiwari’s Capital A/c 1,00,000
To Kaushal Karthik’s Capital A/c 1,50,000
(Being initial capital contribution made by the
owners)
Transaction 18: - Ms. Shikha Sharma contributed ` 50,000 in cash and ` 1,00,000 as
building for the business.

Again in this transaction three accounts are involved. Business has received cash and building
in form of capital from Ms. Shikha Sharma. The journal entry will be: -
Date Particulars L.F. Debit (in `) Credit (in `)
DD/ Cash A/c Dr 50,000
MM Building A/c Dr 1,00,000
To Shikha Sharma’s Capital A/c 1,50,000
(Being capital contribution made by Shikha
Sharma in form of cash and building)
Transaction 19: - Business bought goods worth ` 10,000 and paid by ` 5,000 as cash and
` 4,000 by cheque from Ms. Subhranjani. Due to immediate payment she gave discount of
10% on the purchase.
There are four accounts involve in the transaction. There is purchase of goods and
payment made by cash and bank account. Same time, trade discount of 10% (` 1,000) is also
received. The journal entry will be: -
Date Particulars L.F. Debit Credit
(in `) (in `)
Purchase A/c Dr
To Cash A/c
DD/ To Bank A/c 10,000 5,000
MM To Trade Discount A/c 4,000
(Being purchase made and payment was made by 1,000
cash and cheque. 10% trade discount received)

81
Commercial Accountancy

Opening Entry
Opening Entry is an entry which is passed in the beginning of each current year to
record the closing balance of assets and liabilities of the previous year. In this entry asset
accounts are debited and liabilities and capital account are credited. If capital is not given in
the question, it will be found out by deducting total of liabilities from total of assets.
Transaction 20: - The following balances appeared in the books of M/s Yarrows Mess
as on 1st April 2017 – Cash ` 75,000, Bank ` 70,000, Stock ` 80,000, Furniture ` 10,000,
Computer ` 50,000, Debtors ` 35,000 and Creditors ` 90,000.
The opening entry will be as follows: -

Date Particulars L.F. Debit (in `) Credit (in `)

Cash A/c Dr 75,000

Bank A/c Dr 70,000
Stock A/c Dr 80,000
DD/
Furniture A/c Dr 10,000
MM
Computer A/c Dr 50,000
Debtor A/c Dr 35,000
90,000
To Creditor A/c
2,30,000
To Capital A/c (balancing figure)
(Being Assets and liabilities brought forward)
Advantages
The main advantages of the Journal are:
• It reduces the possibility of errors.
• It provides an explanation of the transaction.
• It provides a chronological record of all transactions.

Limitations
The limitations of the Journal are:
• It will be too long if all transactions are recorded here.
• It is difficult to ascertain the balance of each account.

82
 Accounting process: Ledger

Accounting process:
CHAPTER 6 Ledger

I
n the Journal, each transaction is dealt with separately. Therefore, it is not possible to
know at a glance, the net result of many transactions. So, in order to ascertain the net
effect of all the transactions relating to particular account are collected at one place in the
Ledger. A Ledger is a book which contains all the accounts whether personal, real or nominal,
which are first entered in journal or special purpose subsidiary books.
According to L.C. Cropper, ‘the book which contains a classified and permanent record
of all the transactions of a business is called the Ledger’.
The ledger that is normally used in a majority of business concern is a bound note book.
This can be preserved for a long time. Its pages are consequently numbered. Each account
in the ledger is opened preferably on a separate page. If one page is completed, the account
will be continued in the next or some other page. But in bigger concerns, it is not practical to
keep the ledger as a bound note book, Loose-leaf ledger now takes the place of a bound note
book. In a loose-leaf ledger, appropriate ruled sheets of thick paper are introduced and fixed
up with the help of a binder. Whenever necessary additional pages may be inserted, completed
accounts can be removed and the accounts may be arranged and rearranged in the desired
order. Therefore, this type of ledger is known as Loose-leaf Ledger.

Advantage
Ledger is a principal or main book which contains all the accounts in which the
transactions recorded in the books of original entry are transferred. Ledger is also called
the ‘Book of Final Entry’ or ‘Book of Secondary Entry’, because the transactions are finally
incorporated in the Ledger. The following are the advantages of ledger: -
Complete information at a glance: All the transactions pertaining to an account
are collected at one place in the ledger. By looking at the balance of that account, one can
understand the collective effect of all such transactions at a glance.
Arithmetical Accuracy: With the help of ledger balances, Trial balance can be prepared
to know the arithmetical accuracy of accounts.
Result of Business Operations: It facilitates the preparation of final accounts for
ascertaining the operating result and the financial position of the business concern.

83
Commercial Accountancy

Accounting information: The data supplied by various ledger accounts are summarized,
analyzed and interpreted for obtaining various accounting information.
Knowledge of book value of assets and liabilities: Ledger records every asset and
liability separately. Hence, you can get the information about the Book value of any asset and
pending liabilities whenever you need.
Useful for management: The information given in different ledger accounts will help
the management in preparing budgets. It also helps the management in keeping the check on
the performance of business it is managing.

Format of Ledger
Name of the Account
Dr Cr

Date Particulars J.F. Amount Date Particulars J.F. Amount

DD/MM/ To (Name of Credit DD/MM/ By (Name of Debit

YYYY Account in Journal) YYYY Account in Journal)

i. Each ledger account is divided into two parts. The left hand side is known as the debit
side and the right hand side is known as the credit side. The words ‘Dr.’ and ‘Cr.’ are
used to denote Debit and Credit.
ii. The name of the account is mentioned in the top (middle) of the account.
iii. The date of the transaction is recorded in the date column.
iv. The word ‘To’ is used before the accounts which appear on the debit side of an account
in the particulars column. Similarly, the word ‘By’ is used before the accounts which
appear on the credit side of an account in the particulars column.
v. The name of the other account which is affected by the transaction is written either in
the debit side or credit side in the particulars column.
vi. The page number of the Journal or Subsidiary Book1 from where that particular entry
is transferred is entered in the Journal Folio (J.F.) column.
vii. The amount pertaining to this account is entered in the amount column.
Let us see the relationship of posting in ledger with the type of different accounts: -
Personal Account: - Accounts of natural, artificial and representative persons.

1 There are few types of transactions which occur in the business. For economic reasons, instead of recording
all the transactions in journal, the similar transactions are recorded separately in subsidiary books. e.g cash
book, sales Examples of subsidiary books are cash book, Purchase Book. Purchase Return Book, Sales
Book, Sales return book, Bills Payable Book, Bill Receivable Book.

84
 Accounting process: Ledger

Personal Account
Dr. Cr.
Debit the account when it receives any Credit the account when it gives any goods,
goods, service or money from business. service or money to business.
Real Account: - Account related to asset: tangible or intangible.
Real Account
Dr. Cr.
Debit the account when asset is Credit the account when asset is disposed.
purchased.
Nominal Account: - Account related to income, gain, expenses and losses.
Nominal Account
Dr. Cr.
Debit expenses and losses Credit income and gains
Posting
The process of transferring the entries recorded in the journal or subsidiary books to the
respective accounts opened in the ledger is called Posting. In other words, posting means
grouping of all the transactions relating to a particular account at one place. It is necessary
to post all the journal entries into various accounts in the ledger because posting helps us to
know the net effect of various transactions during a given period on a particular account. It
helps us in summarizing the transactions in related accounts and eventually helps in preparing
the final outcome of the business activity during the accounting period.
Procedure of posting
The procedure of posting is given as follows:
Procedure of posting for an Account which has been debited in the journal
entry:

• Locate in the ledger, the account to be debited and enter the date
of the transaction in the date column on the debit side.
Step 1

85
Commercial Accountancy

• Record the name of the account credited in the Journal in the

particulars column on the debit side as “To..... (name of the
Step 2 account credited)”.

• Record the page number of the Journal in the J.F column on the
debit side and in the Journal, write the page number of the ledger
on which a particular account appears in the L.F. column.
Step 3

• Enter the relevant amount in the amount column on the debit side.
Step 4

Procedure of posting for an Account which has been credited in the journal
entry:

• Locate in the ledger, the account to be credited and enter the date
of the transaction in the date column on the credited side.
Step 1

• Record the name of the account debited in the Journal in the

particulars column on the credit side as “By...... (name of the
Step 2 account debited)”

• Record the page number of the Journal in the J.F column on the
credit side and in the Journal, write the page number of the ledger
Step 3 on which a particular account appears in the L.F. column.

• Enter the relevant amount in the amount column on the credit

side.
Step 4

86
 Accounting process: Ledger

Transaction 1: -Shri Rakesh Sajjan started the business with ` 1,00,000.

Now the ledger posting needs to be done of this transaction in two accounts Cash
Account and Capital Accounts. Let see how it is to be done: -

Transaction 1: -Shri Rakesh Sajjan started the business with ` 1,00,000.

Now the ledger posting needs to be done of this transaction in two accounts Cash
Account and Capital Accounts. Let see how it is to be done: -

Journal entry will be: -

Date Particulars L.F. Debit Credit
(in `) (in `)
1st Cash A/c Dr 1,00,000
To Capital A/c 1,00,000
(Being capital invested to start Business)

Cash Account
Dr. Cr.
Date Particulars JF Amount Date Particulars JF Amount
To Capital A/c 1,00,000

Capital Account
Dr. Cr.
Date Particulars JF Amount Date Particulars JF Amount
By Cash A/c 1,00,000
Illustration: - Journalize following transaction happened in the month of March 2017 in
books of M/s Yarrows Mess and post them into ledger.
Date Transaction
Shri Rakesh Sajjan Started M/s Yarrows Mess with ` 1,00,000
He received ` 20,000 from Shri Rajkamal Ranjan as loan
He paid cash of ` 15,000 to Shri Vinod as loan
He bought goods in cash for ` 50,000 from Shri Vipul Bava
He sold goods in cash for ` 90,000 to Shri R Shyam

87
Commercial Accountancy

He paid remuneration of ` 20,000 to Shri Hariram Shankar for expert opinion

He bought good on credit of ` 80,000 from Shri Tashi
He sold goods on credit of ` 1,50,000 to Shri Kencho Dorji
He received commission ` 40,000 for services from Shri Ananth Dwivedi
He paid rental charges of ` 30,000 to Shri Masroor Ahmad
The journal entries will be as follows: -
Date Particulars LF Debit Credit
(in `) (in `)
1st March Cash A/c Dr 1,00,000
To Capital A/c 1,00,000
(Being capital invested to start Business)
2nd March Cash A/c Dr 20,000
To Rajkamal’s A/c 20,000
(Being loan received from Shri Rajkamal
Ranjan)
3rd March Vinod’s A/c Dr 15,000
To Cash A/c 15,000
(Being loan given to Shri Vinod)
4th March Purchase A/c Dr 50,000
To Cash A/c 50,000
(Being cash purchase made)
5th March Cash A/c Dr 90,000
To Sales A/c 90,000
(Being cash sales made)
6th March Remuneration A/c Dr 20,000
To Cash A/c 20,000
(Being remuneration for expert opinion paid
to Shri Hariram Shankar)
7th March Purchase A/c Dr 80,000
To Tashi’s A/c 80,000
(Being credit purchase made)

88
 Accounting process: Ledger

8th March Kencho Dorji’s A/c Dr 1,50,000

To Sales A/c 1,50,000
(Being credit sales made)
9th March Cash A/c Dr 40,000
To Commission A/c 40,000
(Being commission received)
10th Rent A/c Dr 40,000
March To Cash A/c 40,000
(Being rent paid)
There are 11 accounts involved in above transaction. They will be opened in the ledger and
date wise posting will be done.
Cash Account
Dr. Cr.
Date Particulars JF Amount Date Particulars JF Amount
1/3 To Capital A/c 1,00,000 3/3 By Vinod’s A/c 15,000
2/3 To Rajkamal’s 20,000 4/3 By Purchase A/c 50,000
A/c
5/3 To Sales A/c 90,000 6/3 By Remuneration 20,000
A/c
9/3 To Commission 40,000 10/3 By Rent A/c 40,000
A/c

Capital Account
Dr. Cr.
Date Particulars JF Amount Date Particulars JF Amount
1/3 By Cash A/c 1,00,000
Rajkamal’s Account
Dr. Cr.
Date Particulars JF Amount Date Particulars JF Amount
2/3 By Cash A/c 20,000

89
Commercial Accountancy

Vinod’s Account
Dr. Cr.
Date Particulars JF Amount Date Particulars JF Amount
3/3 To Cash A/c 15,000

Purchase Account
Dr. Cr.
Date Particulars JF Amount Date Particulars JF Amount
4/3 To Cash A/c 50,000
7/3 To Tashi’s A/c 80,000

Sales Account
Dr. Cr.
Date Particulars JF Amount Date Particulars JF Amount
5/3 By Cash A/c 90,000
8/3 By Kencho 1,50,000
Dorji’s A/c

Remuneration Account
Dr. Cr.
Date Particulars JF Amount Date Particulars JF Amount
6/3 To Cash 20,000

Tashi’s Account
Dr. Cr.
Date Particulars JF Amount Date Particulars JF Amount
7/3 By Purchase A/c 80,000
Kancho Dorji’s A/c
Dr. Cr.
Date Particulars JF Amount Date Particulars JF Amount
8/3 To Sales A/c 1,50,000

90
 Accounting process: Ledger

Commission Account
Dr. Cr.
Date Particulars JF Amount Date Particulars JF Amount
9/3 To Cash A/c 40,000
Rent Account
Dr. Cr.
Date Particulars JF Amount Date Particulars JF Amount
10/3 By Cash A/c 40,000
Posting of Compound Journal Entries
Compound or Combined Journal Entry is one where more than one transactions are
recorded by passing only one journal entry instead of passing several journal entries. Since
every debit must have the corresponding equal amount of credit, special care must be taken
in posting the compound journal entry, where there may be only one debit aspect but many
corresponding credit aspects of equal value or vice-versa. The posting of such transactions is
done in the same way as already explained.

Posting the Opening Entry

The opening entry is passed to open the books of accounts for the new financial year.
The debit or credit balance of an account what we get at the end of the accounting period is
known as closing balance of that account. This closing balance becomes the opening balance
in the next accounting year.
The procedure of posting an opening entry is same as in the case of an ordinary journal
entry. An account which has a debit balance, the words ‘To balance b/d’ are recorded on
the debit side in the particulars column. An account which has a credit balance, the words
‘By balance b/d’ are recorded in the particulars column on the credit side. In fact, opening
entry is not actually posted but the accounts are merely incorporated in the ledger, if the ledger
is a new one or old.

Balancing an Account
Balance is the difference between the total debits and the total credits of an account.
When posting is done, many accounts may have entries on their debit side as well as credit
side. The net result of such debits and credits in an account is the balance.
Balancing means the writing of the difference between the amount columns of the two
sides in the lighter (smaller total) side, so that the grand totals of the two sides become equal.

91
Commercial Accountancy

Significance of Balancing
There are three possibilities while balancing an account during a given period. It may
be a debit balance or a credit balance or a nil balance depending upon the debit total and the
credit total.

Debit Balance
The excess of debit total over the credit total is called the debit balance. When there are
only debit entries in an account, the amount itself is the balance of that account, i.e., the debit
balance. It is first recorded on the credit side, above the total. Then it is entered on the debit
side, below the total, as the first item for the next period.

Let us balance the Cash Account from above illustration:

Cash Account
Dr. Cr.
Date Particulars JF Amount Date Particulars JF Amount
1/3 To Capital A/c 1,00,000 3/3 By Vinod’s A/c 15,000
2/3 To Rajkamal’s 20,000 4/3 By Purchase A/c 50,000
A/c
5/3 To Sales A/c 90,000 6/3 By Remuneration 20,000
A/c
9/3 To Commission 40,000 10/3 By Rent A/c 40,000
A/c
10/3 By Closing 1,25,000
Balance (c/f)
Total 2,50,000 Total 2,50,000
11/3 To Opening 1,25,000
Balance (b/d)
Credit Balance
The excess of credit total over the debit total is called the credit balance. When there
are only credit entries in an account, the amount itself is the balance of that account i.e., the
credit balance. It is first written in the debit side, as the last item, above the total. Then it is
recorded on the credit side, below the total, as the first item for the next period.

Let us balance the Capital Account from above illustration:

92
 Accounting process: Ledger

Capital Account
Dr. Cr.
Date Particulars JF Amount Date Particulars JF Amount
1/3 To Closing 1,00,000 1/3 By Cash A/c 1,00,000
Balance (c/f)
Total 1,00,000 Total 1,00,000
1/3 By Opening 1,00,000
Balance (b/d)
Nil Balance
When the total of debits and credits are equal, it is closed by merely writing the total on
both the sides. It indicates the equality of benefits received and given by that account.

Balancing of different accounts

Balancing is done periodically, i.e., weekly, monthly, quarterly, half-yearly or yearly,
depending on the requirements of the business.

Personal Accounts
These accounts are generally balanced regularly to know the amounts due to the persons
(creditors) or due from the persons (debtors).

Real Accounts
These accounts are generally balanced at the end of the financial year, when final
accounts are being prepared. However, cash account is frequently balanced to know the cash
on hand. A debit balance in an asset account indicated the value of the asset owned by the
business. Assets accounts always show debit balances.

Nominal Accounts
These accounts are in fact, not to be balanced as they are to be closed by transfer to final
accounts. A debit balance in a nominal account indicates that it is an expense or loss. A credit
balance in a nominal account indicates that it is an income or gain.
All such balances in personal and real accounts are shown in the Balance Sheet and the
balances in nominal accounts are taken to the Profit and Loss Account.

93
Commercial Accountancy

Procedure for Balancing

While balancing an account, the following steps are involved:

• Total the amount column of the debit side and the credit side
separately and then ascertain the difference of both the columns.
Step 1
• If the debit side total exceeds the credit side total, put such
difference on the amount column of the credit side, write the
date on which balancing is being done in the date column and
the words “By Balance c/f” (c/f means carried forward) in the
particulars column.
Step 2 OR
• If the credit side total exceeds the debit side total, put such
difference on the amount column of the debit side, write the date
on which balancing is being done in the date column and the
words “To Balance c/f” in the particulars column.

• Total again both the amount columns, put the total on both the
sides and draw a line above and a line below the totals.
Step 3

• Enter the date of the beginning of the next period in the date
column and bring down the debit balance on the debit side along
with the words “To Balance b/d” (b/d means brought down) in the
Step 4 particulars column and the credit balance on the credit side along
with the words “By balance b/d” in the particulars column.

94
 Accounting process: Cash Book and Subsidiary Books

Accounting process:
Cash Book and Subsidiary
CHAPTER 7 Book

F
or a business having a large number of transactions it is practically impossible to write
all transactions in one journal, because of the following limitations.

• Periodical details of some important business transactions cannot be known, from

the journal easily, e.g., monthly sales, monthly purchases.
• Such a system does not facilitate the installation of an internal check system since
the journal can be handled by only one person.
• The journal becomes bulky and voluminous.

Need
Moreover, transactions can be classified and grouped conveniently according to their
nature, as some transactions are usually of repetitive in nature. Generally, transactions are
of two types: Cash and Credit. Cash transactions can be grouped in one category whereas
credit transactions can be grouped in another category. Thus, in practice, the main journal is
sub-divided in such a way that separate book is used for each category or group of transactions
which are repetitive and sufficiently large in number.
Each one of the subsidiary books is a special journal and a book of original or prime
entry. Though the usual type of journal entries is not passed in these sub-divided journals, the
double entry principles of accounting are strictly followed.

Kinds of Subsidiary Books

The number of subsidiary books may vary according to the requirements of each
business. The following are the special purpose subsidiary books: -

95
Commercial Accountancy

Purpose
 Purchases Book records only credit purchases of goods by the trader.
 Sales Book is meant for entering only credit sales of goods by the trader.
 Purchases Return Book records the goods returned by the trader to suppliers.

96
 Accounting process: Cash Book and Subsidiary Books

 Sales Return Book deals with goods returned (out of previous sales) by the customers.
 Bills Receivable Book records the receipts of bills (Bills Receivable).
 Bills Payable Book records the issue of bills (Bills Payable).
 Cash Book is used for recording only cash transactions i.e., receipts and payments of
cash.
 Journal is the journal which records the entries which cannot be entered in any of the
above listed subsidiary books.

Advantages
The advantages of maintaining subsidiary books can be summarized as under: -
 Division of Labour: The division of journal, resulting in division of work, ensures
more clerks working independently in recording original entries in the subsidiary
books.
 Efficien cy: The division of labour also helps the reduction in work load, saving in
time and stationery. It also gives advantages of specialization leading to efficiency.
 Prevents Errors and Frauds: The accounting work can be divided in such a manner
that the work of one person is automatically checked by another person. With the use
of internal check, the possibility of occurrence of errors and frauds may be avoided.
 Easy Reference: It facilitates easy references to any particular item. For instance,
total credit sales for a month can be easily obtained from the Sales Book.
 Easy Postings: Posting from the subsidiary books are made at convenient intervals
depending upon the nature of the business.

Cash Book
Presume, that your batch decided to convert your mess into commercial venture. You
just initiated it. For beginning of the month whole batch collected contribution from each
officer in cash. In the meantime, you got back some money from the due got cleared from the
academy. Some guest has also made the payment of mess bill while leaving from Yarrows.
You spent some amount in procuring grocery, vegetable, dairy items. You cleared some
pending salary bills of the employees of the Yarrows Mess. As per habit Treasurer noted
down all receipts and payments in your note book. At the end of the month, he calculated
the balance of cash in hand and tallied it with the actual cash balance with himself. He may
maintain separate book to record these items of receipts and payments, this book is known
as Cash Book.
A cash book is a special journal which is used to record all cash receipts and cash
payments. The cash book is a book of original entry or prime entry since transactions are
recorded for the first time from the source documents. The cash book is a ledger in the
sense that it is designed in the form of a cash account and records cash receipts on the

97
Commercial Accountancy

debit side and cash payments on the credit side. Thus, the cash book is both a journal and
a ledger. Cash Book will always show debit balance, as cash payments can never exceed
cash available. In short, cash book is a special journal which is used for recording all cash
receipts and cash payments.

Advantages
Saves time and labour: When cash transactions are recorded in the journal a lot of
time and labour will be involved. To avoid this all cash transactions are straight away recorded
in the cash book which is in the form of a ledger.
To know cash and bank balance: It helps the proprietor to know the cash and bank
balance at any point of time.
Mistakes and frauds can be prevented: Regular balancing of cash book reveals the
balance of cash in hand. In case the cash book is maintained by business concern, it can avoid
frauds. Discrepancies if any, can be identified and rectified.
Effective cash management: Cash book provides all information regarding total
receipts and payments of the business concern at a particular period. So that, effective policy
of cash management can be formulated.

Simple Cash Book/Single column Cash Book

A Simple Cash Book records only cash receipts and cash payments. It has two sides,
namely debit and credit. Cash receipts are recorded on the debit side i.e. left hand side and
cash payments are recorded on the credit side i.e. right hand side. In this book there is only
one amount column on its debit side and on the credit side. In fact, this book is nothing but
a Cash Account. Hence, there is no need to open cash account in the ledger. The format of a
Simple Cash Book is as under:
Cash Book
Dr. Cr.
Date Receipts RNo LF Amount Date Payments VNo LF Amount

Date: This column appears in both the debit and credit side. It records the date of
receiving cash at debit side and paying cash at credit side.
Receipts: This column shows what is debited to Cash Book hence represents receipts
of cash to the business. It records the names of parties (personal account), heads (nominal
account) and items (real account) from whom payment has been received.

98
 Accounting process: Cash Book and Subsidiary Books

Receipt Number (R. No): This refers to the serial number of the cash receipt.
Payments: This column shows what is credited to Cash Book hence represents
payments of cash from the business. It records the names of parties (personal account), heads
(nominal account) and items (real account) to whom payment has been made.
Voucher Number (V.N): This refers to the serial number of the voucher for which
payment is made.
Ledger Folio (L.F): This column is used in both the debit and credit side of cash book.
The ledger page (folio) of every account in the cash book is recorded against it.
Amount: This column appears in both sides of the cash book. The actual amount
of cash receipt is recorded on the debit side. The actual payments are entered on the
credit side.

Preparation of Cash Book

Cash Book is in a way, a cash account with debit and credit side and Cash account is an
asset account, so the rule followed is Increase in assets to be debited and Decrease in asset is
to be credited. This implies that Cash Bookies a book where all the receipts in terms of cash
are recorded on the debit side of the Cash Book and all the payments in terms of cash are
recorded on its credit side.
On the debit side in the Receipt column, the name of the account, for which cash is
received is recorded. Similarly, on the credit side, the name of account for which cash is
paid, is recorded. In the amount column the actual cash paid or received is recorded. At the
end of the month, cash book is balanced. The cash book is balanced in the same manner an
account is balanced in the ledger. The total of the debit side of the cash book is compared
with the total of the credit side and the difference if any is entered on the credit side of the
cash book under the particulars column as balance c/f. In case of Simple Cash Book, the
total of debit side is always more than the total of the credit side, since the payment can
never exceed the available cash. The difference is written in the amount column and total
of the both sides of the cash book becomes equal. The closing balance of the credit side
becomes the opening balance for the next period and is written as Balance b/d on the Debit
side of the Cash Book for the following period.
Let us understand the entries in the simple cash book through illustration.

99
Commercial Accountancy

Illustration 1: Enter the following transactions in a Simple Cash Book:

2016 ` 2016 `
Jan. 1 Cash in 12,000 Jan. 5 Received 3,000
Hand from Ram
Jan. 7 Paid rent 300 Jan. 8 Sold 3,000
goods
Jan. 10 Paid to 7,000 Jan. 15 Purchased 5,000
Shyam goods
from
Mohan
Jan. 27 Purchased 2,000 Jan. 31 Paid 1,000
furniture salaries
Solution:
Cash Book
Dr. Cr.
Date Receipts RNo LF Amount Date Payments VNo LF Amount
1 Jan To Opening
st
12,000 7 Jan
th
By Rent A/c 300
Balance (b/f)
5th Jan To Ram’s A/c 3,000 10th Jan By Shyam’s A/c 7,000
8th Jan To Sales A/c 3,000 15th Jan By Purchase A/c 5,000
27th Jan By Furniture A/c 2,000
31st Jan By Salary A/c 1,000
By Closing 2,700
Balancing figure
balance (c/d)
Total 18,000 Total 18,000
Posting of Cash Book in the Ledger
As we know that cash receipts are shown on debit side of Cash Book and the cash
payments are shown on the credit side of Cash Book. Account appearing on the debit side of
the Cash Book is posted on the credit side in the relevant ledger. Similarly, account appearing
on the credit side of Cash Book is posted on the debit side of the relevant ledger.
Cash Book in itself is a Cash account, so no separate cash account will be maintained
in the ledger.

100
 Accounting process: Cash Book and Subsidiary Books

Double Column Cash Book

The most common double column cash books are: -
i. Cash book with discount and cash columns
ii. Cash book with cash and bank columns.
(Cash Discount: A cash discount is a deduction allowed by the seller of goods or by the
provider of services in order to motivate the customer to pay within a specified time.
Trade Discount: A trade discount is the amount by which a manufacturer reduces the retail
price of a product when it sells to a reseller, rather than to the end customer.)

Cash Book with discount and cash columns

On either side of the single column cash book, another column is added to record
discount allowed and discount received. The format is given below:
Cash Book with Discount column
Dr. Cr.
Discount Discount
Date Receipts RNo LF Amount Date Payments VNo LF Amount
Allowed Received

It should be noted that in the double column cash book, cash column is balanced like
any other ledger account. But the discount column on each side is merely totalled and it is
closed by transfer to P&L Account. The total of the discount column on the debit side shows
the total discount allowed to customers and is debited to Discount Allowed Account. The
total of the discount column on the credit side shows total discount received and is credited to
Discount Received Account.

Illustration 2: Prepare a Double Column Cash Book from the following transactions of M/s
Yarrows Mess:
2016 Amount (`)
Jan. 1 Cash in hand 4,000
6 Cash Purchases 2,000
10 Wages paid 40
11 Cash Sales 6,000

101
Commercial Accountancy

12 Cash received from NAAA 1,980andallowed the Academy discount of 20

19 Cash paid to M/s Kanchand 2,470 and discount received 30
27 Cash paid to Shikha Sharma 400
28 Purchased goods for cash 2,070
Solution:
Cash Book with Discount column for M/s Yarrows Mess
Dr. Cr.
Discount Discount
Date Receipts RNo LF Amount Date Payments VNo LF Amount
Allowed Received
1st To 4,000 6th By 2,000
Jan Opening Jan Purchase
balance A/c
11th To Sales 6,000 10th By Wages 40
Jan A/c Jan A/c
12th To NAAA 20 1,980 19th By 30 2,470
Jan A/c Jan Kanchand
A/c
27th By Shikha 400
Jan Sharma A/c
28th By 2,070
Jan Purchase
A/c
To Closing 20 By Closing 30 5,000
Balance Balance
Total 11,980 Total 11,980

Cash Book with Cash and Bank Columns

When bank transactions are more in number, it is advisable to open a cash book by
providing a separate column on either side of the cash book to record the bank transactions
therein. In such case, it is not necessary to open a separate Bank Account in the Ledger because
the two columns in the cash book serve the purpose of Cash Account and Bank Account
respectively. It is a combination of Cash Account and Bank Account. The format of this cash
book is given below:
Cash Book with Bank column
Dr. Cr.
Date Receipts RNo LF Bank Cash Date Payments VNo LF Bank Cash

102
 Accounting process: Cash Book and Subsidiary Books

There are two amount columns on debit side one for cash receipts and the other for bank
deposits (i.e., payment made into Bank Account). Similarly, there are two amount columns on
the credit side, one for payments in cash and the other for payments by cheques respectively.
It is to always remember that cheque received are treated as cash received and when cheque
is deposited into Bank, a contra entry is passed.

Contra Entry
When an entry affects both cash and bank accounts it is called a contra entry. Contra
in Latin means opposite. In contra entries both the debit and credit aspects of a transaction are
recorded in the cashbook itself.

Example 1: Cash paid into bank

Bank A/c Dr. xxx
To Cash A/c xxx
(Cash paid into bank)
This is a contra entry. As the cash book with cash and bank columns is a combined cash
and bank account, both the aspects of the transaction will be entered in the same book. In
the debit side ‘To Cash A/c’ will be entered in the particulars column and the amount will be
entered in the bank column. In the credit side ‘By Bank A/c’ will be entered in the particulars
column and the amount will be entered in the cash column.
Such contra entries are denoted by writing the letter ‘C’ in the L.F. column, on
both sides of the cash book. They indicate that no posting in respect thereof is necessary
in the ledger.

Example 2: Cash withdrawn from bank for office use.

Cash A/c Dr. xxx
To Bank A/c xxx
(Cash withdrawn for office use)
This is also a contra entry. In the debit side ‘To Bank A/c’ will be entered in the particulars
column and the amount will be entered in the cash column. In the credit side ‘By Cash A/c’
will be entered in the particulars column and the amount will be entered in the bank column.
Such contra entries are denoted by writing the letter ‘C’ in the L.F. column, on
both sides of the cash book. They indicate that no posting in respect thereof is necessary
in the ledger.

103
Commercial Accountancy

Illustration 3: Record the following transactions in a Double Column Cash Book with Cash
and Bank Columns and balance the book on 31st January,2016:
Date Particulars ` Date Particulars `
2016
Jan.1 Cash balance 100 Jan. 16 Bought goods 600
Jan. 1 Bank balance 1,450 Jan.19 paid to Shyam by cheque 370
Jan.1 Cash received from 6,000 - -
sale of shares
Jan.2 Paid into bank 5,000 Jan.20 Drew from bank 300
Jan.3 Purchased goods from 1,200 Jan.22 Cash drawn from bank
M/S Agarwal for ` For personal use 200
1,200 and paid by
Jan.24 Cash Sales 170
cheque
Jan.4 Paid wages 250 Jan.27 Received from Sharma 1,800
Jan.5 Received from Mohan Allowed him Discount 200
a cheque for ` 980. In Jan.28 Deposited cash into bank 1,500
full claim of ` 1,000
Jan.28 Gave cheque for Cash Purchases 200
Jan.8 Mohan’s cheuqe
deposited into bank
Jan.14 Paid for stationery 150
Solution: -
Cash Book with Bank column
Dr. Cr.
Date Receipts RNo LF Cash Bank Date Payments VNo LF Cash Bank
1.1.16 To Opening 100 1450 2.1.16 By Bank C 5000
Balance B/D A/C
1.1.16 To Sales 6000 3.1.16 By 1200
A/C Purchase
A/C
2.1.16 To Cash A/C C 5000 4.1.16 By Wages 250
A/C
5.1.16 To Mohan 980 8.1.16 By Bank C 980
A/C A/C
8.1.16 To Cash A/C C 980 14.1.16 By 150
Stationary
A/C

104
 Accounting process: Cash Book and Subsidiary Books

20.1.16 To Bank C 300 16.1.16 By 600

A/C Purchase
A/C
19.1.16 By Shyam 370
A/C
24.1.16 To Sales 170 20.1.16 By Cash C 300
A/C A/C
27.1.16 To Sharma 1800 22.1.16 By 200
A/C Drawing
A/C
28.1.16 To Cash A/C C 1500 28.1.16 By Bank C 1500
A/C
28.1.16 By 200
Purchase
A/C
By Closing 870 6660
Balance
C/D
Total 9350 8930 Total 9350 8930

Triple Column Cash Book

Large business concerns receive and make payments in cash and by cheques. Where
cash discount is a regular feature, a Triple Column Cash Book is more advantageous. This
cash book has three amount columns (cash, bank and discount) on each side. All cash
receipts, deposits into bank and discount allowed are recorded on debit side and all cash
payments, withdrawals from bank and discount received are recorded on credit side. Format
of triple column cash book is as follows: -
Cash Book with Bank column
Dr. Cr.
Payments

Received
Discount

Discount
Receipts

Allowed

Bank

Bank
Cash

Cash
Date

Date
RNo

VNo
LF

LF

Let us understanding the entries with one illustration.

105
Commercial Accountancy

Illustration 3: -
Enter the following transactions in Cash Book with Cash, discount and Bank Columns.
2016 `
Jan. 1 Atul commences business with cash 20,000
Jan. 3 He paid into Current A/c 19,000
Jan. 4 He received cheque from Simranjeet & Co. on account 600
Jan. 7 He pays in bank Simranjeet & Co.’s cheque 600
Jan. 10 He pays Vinod & Co. by cheque and is allowed discount ` 20. 330
Jan.12 Shikha & Co pays into his Bank A/c 475
Jan. 15 He receives cheque from Rakesh and allows him discount ` 35 450
Jan.20 He receives cash ` 75 and cheque ` 100 from Kencho Dorji for cash sale
Jan. 25 He pays into Bank, including cheques received on 15th and 20th 1,000
Jan. 27 He pays by cheque to Paventhen for cash purchase 275
Jan. 30 He pays sundry expenses in cash 50
Solution:
Cash Book with Bank column
Dr. Cr.

Received
Discount

Discount
Allowed
Date

Date
RNo

VNo
Receipts Cash Bank Payments Cash Bank
LF

LF

To
Opening By Bank
1.1 20,000 3.1 C 19,000
Balance A/c
b/d
To Cash By bank
3.1 C 19,000 7.1 C 600
A/c A/c
To Simran By Vinod
4.1 600 10.1 330 20
& Co. A/c & Co. A/c
To Shikha By Bank
12.1 475 25.1 C 1,000
& Co. A/c A/c
To By
15.1 Rakesh’s 450 35 27.1 Purchase 275
A/c A/c
By Sundry
To Sales
20.1 175 30.1 Expenses 50
A/c
A/c
By balance
1,050 18,395
c/d
Total 21,700 19,000 35 Total 21,700 19,000 20

106
 Accounting process: Cash Book and Subsidiary Books

Postings from cash book to concerned ledger accounts

1. Opening (Cash and Bank) balance appearing in the cash book is not posted to any
account in the ledger.
2. Contra entries are not posted to any account.
3. Each item of discount allowed appearing on the debit side of the cash book will
be posted to the credit of respective personal account. Total of discount allowed
column should be posted to the debit side of discount allowed account with the
words “To Sundry Accounts”.
4. Each item of discount received appearing on the credit side of the cash book will
be posted to the debit of respective personal account. Total of discount received
column should be posted to the credit of discount received account with the words
“By Sundry Accounts”.
5. The other transactions recorded on the debit side of the cash book are posted to the
credit of the respective accounts in the ledger.
6. The other transaction recorded on the credit side of the cash book are posted to the
debit of the respective accounts in the ledger.

Petty Cash Book

In every business, of whatever size, there are many small cash payments such as
conveyance, carriage, postage, telegram, etc. These expenses are generally repetitive in
nature. If all these small payments are recorded in the cash book, it will be difficult for the
cashier to maintain the records all by himself. In order to make the task of the cashier easy,
these small and recurring expenses are recorded in a separate cash book called “Petty Cash
Book” and the person who maintains the petty cash is called the “Petty Cashier”.
Petty means ‘small’. The petty cash book is a book where small recurring payments
like carriage, cartage, postage and telegram, printing and stationery etc., are recorded by the
petty cashier, a person other than the main cashier.

Imprest System
Imprest means ‘money advanced on loan’. Under this system the amount required to
meet out various petty expenses is estimated and given to the petty cashier at the beginning
of the specified period, usually a month. All the payments are supported by vouchers. At the
end of the given period or earlier, when the petty cashier has spent the petty cash amount, he
closes the petty cash book for the period and balances it. Then he submits the accounts to the
cashier. He verifies the petty cash book with the vouchers. After satisfying himself as to the
correctness and genuineness of the payments an amount equal to the cash spent is given to the
petty cashier. This amount together with the unspent amount will bring up the cash in hand
to the amount with which he originally started i.e., the imprest amount. Thus the system of

107
Commercial Accountancy

reimbursing the amount spent by the petty cashier at fixed period, is known as the imprest
system of petty cash.
For example, On June 1, 2016, ` 10,000 was given to the Assistant Audit Officer of
the National Academy to manage the day to day expenses of the on-going training of officer’s
trainees. He had spent ` 9400 during the month. He will be paid ` 9400 on 30th June by the
cashier so that he may again have ` 10,000 for the next month i.e., July.

Other Subsidiary Book

Purchases Book
Purchases (journal) book is also a book of original entry. This book records only credit
purchases of goods in which the firm deals. Cash purchases of goods are recorded in the cash
book. Credit purchases of items not for resale are not recorded in the Purchases Book for an
example, if a firm deal in Computer parts, any item of furniture purchased on credit is not
recorded in this book. These are recorded in another book which is known as ‘journal proper’.
In case of Purchase of goods on credit, an Invoice or Bill prepared by the supplier is
received. It contains information about the date of transaction, details of items purchased at
List Price less trade discount, if any, Invoice Number, and the net amount payable. Trade
discount and other details of invoice is optional to record in this book.
Before discussing the Purchase Day Book, in detail we are to explain the most significant
terms, Trade Discount and Cash Discount.

Trade Discount
Trade discount is an allowance or concession granted by the seller to the buyer, if the
customer purchases goods above a certain quantity or above a certain amount. The amount of
the purchase made, is always arrived at after deducting the trade discount, i.e., only the net
amount is considered. For example, if the list price (price prescribed by the manufacturers
or wholesalers) of a commodity is ` 100, and trade discount granted by manufacturer to the
wholesaler is 20% then cost price of the commodity to the wholesaler is ` 80. Trade discount
is not recorded in the books. They are used for determining the net price.

Cash Discount
Sale of goods on credit is a common phenomenon in any business. When goods are
sold on credit the customers enjoy a facility of making payment on some date in the future.
In order to encourage them to make the payment before the expiry of the credit period a
deduction is offered. The deduction so made is known as cash discount. For example, If
Ram purchases goods worth ` 5,000on 30 days’ credit then, as per the terms of contract,
he is authorized to make payment 30 days after the date of purchase. If he is offered a cash

108
 Accounting process: Cash Book and Subsidiary Books

discount of 2% on payment within 10 days and if he does so, he is entitled to deduct `100
from the invoice price and pay ` 4,900. In this case ` 100 is cash discount. But if he does
not choose to make payment within 10 days then he will not get any cash discount. In this
case he will pay ` 5,000 after 30 days.

Format of Purchase Book

Purchase Book of ………….
Date Particulars V No LF Price Trade Discount Tax Freight charges Total

Date Column – Represents the date on which the transaction took place.

Particulars Column – This column includes the name of the seller and the particulars of
goods purchased.

Inward Invoice No. (V No) Column – Reveals the serial number of the inward invoice.

LF Column – This column shows the page number of the suppliers account in the ledger
accounts.

Price Column – this column reveals the amount of goods purchased.

Trade Discount Column – In this column trade discount is entered.

Tax Column – In this column amount of tax payment is recorded.

Freight Charges – All other charges like coolie, freight is recorded here.

Total Column – This column represents the net price of the goods, i.e., the amount which is
payable to the creditors after adjusting discount and expenses if any.

Let us understand the Purchase Book with an illustration.

Enter the following transactions in Purchase Book and post them into ledger.
2016
April 4 Purchased from Ajay Enterprises, Delhi
100 Doz Rexona Hawai Chappal
@ ` 120 per Doz.
200 Doz Palki Leather Chappal
@ ` 300 per Doz

109
Commercial Accountancy

Less: trade discount @ 10%

Freight charged ` 150.
April 15 Purchased from Balaji Traders, Delhi
50 Doz Max Shoes
@ ` 400 per Doz
100 pair Sports Shoes.
@ ` 140 per paid.
Less: trade discount @ 10%.
Freight charged ` 200.
April 28 Purchased from Tripti Industries, Bahadurgarh
40 pair leather shoes
@ ` 400 per pair
100 Doz Rosy Hawai Chappal
@ ` 180 per Doz
Less: trade discount @ 10%
Freight charged ` 100.
Purchases are subject to Sales Tax @ 10%.
Solution:
Discount

charges
Freight
Date
Trade
Price

Total
V No

10%
Tax

Particulars
LF

2016

4.4 Ajay Enterprises

Rexona 100 Doz @120 12,000
Chappal 200 Doz@300 60,000
Trade discount 10% 72,000 7,200 150 64,950
15.4 Balaji Trader
Max Shoes 50 Doz @400 20,000
Sport shoes 100 pair @140 14,000
Trade discount 10% 34,000 3,400 200 30,800
28.4 Tripti Industries
Leather shoes 40 pair @400 16,000

110
 Accounting process: Cash Book and Subsidiary Books

Chappal 100 Doz@180 18,000

Trade discount 10% 34,000 3,400 3,060 100 33,760
Total 14,000 3,060 450 1,29,510
At the end of each month, the purchase book is totalled. The total shows the total
amount of goods or materials purchased on credit.

Posting and Balancing

Once transactions are properly recorded in purchases journal, they are posted into the
ledger. The procedure for posting is stated as under: -

• Entries will be posted to the credit side of the respective creditors

(supplier) account in the ledger by writing “By Purchases A/c” in
Step 1 the particulars column.

• Periodic total is posted to the debit of purchases in the ledger

account by writing “To sundries as per purchases book” in the
Step 2 particulars column.

Always remember that purchase account always has a debit balance.

Sales Book
Transactions relating to Sale of goods on credit are recorded in the Sales Journal. Cash
sales are recorded in the Cash Book. It means that Sales Journal records only credit sales of
goods. For example, sale of old furniture by a firm which is dealing in computers is not treated
as goods and items relating to computer are regarded as goods.
In case of sale of goods on credit, one copy of an Invoice or Bill prepared by the vendor
firm is given to the customer. It contains information about the date of transaction, details of
items sold at List Price less trade discount if any. Invoice Number and the amount receivable
or payable by customer.
When a customer purchases goods in bulk, the vendor may allow him a discount, which
is called trade discount. In the invoice, trade discount is deducted from the list price of the
goods and the customer is debited only with the net amount. This discount is quite different
from the cash discount, which is allowed for payment within a stipulated period.

111
Commercial Accountancy

Format of Sales Book

Sales Book of ………….
Date Particulars V No LF Price Trade Discount Tax Freight charges Total

Date Column – Represents the date on which the transaction took place.
Particulars Column – This column includes the name of the buyer and the particulars of
goods sold.
Outward Invoice No. (V No) Column – Reveals the serial number of the outward invoice.
LF Column – This column shows the page number of the buyers account in the ledger
accounts.
Price Column – this column reveals the amount of goods sold.
Trade Discount Column – In this column trade discount is entered.
Tax Column – In this column amount of tax collected is recorded.
Freight Charges – All other charges like coolie, freight is recorded here.
Total Column – This column represents the net price of the goods, i.e., the amount which is
receivable from the debtors after adjusting discount and expenses if any.
Let us understand the preparation of sales book with an illustration.
Illustration: -
From the following transactions, prepare the Sales Book:
2016
March 1 Sold X vide Invoice No. 2005,3 chests of tea for ` 1,800 less Trade Discount @
10% and VAT is charged@ 10%
March 4 Sold to Mohan & Sons vide Cash Memo NO. 5785, 20 butter @ ` 150 per kg. less
Trade Discount @ 5% and VAT is Charged @ 10%
March 5 Sold to Y vide Invoice No. 2006, 20kg Assam Tea @ ` 60 per kg less Trade
Discount @ 5% charged CST @ 10% freight and packing charges were separately
charged in the invoice at ` 160.
March 6 Sold to Z vide Invoice no. 2007, 20 packs (1 K.g) of Darjeeling Tea @ ` 75 per
Kg less Trade Discount ` 100 charged VAT @ 10 %

112
 Accounting process: Cash Book and Subsidiary Books

Solution: -
Sales Book of ………….

Discount

charges
Freight
Trade
Price

Total
V No
2016
Date

Tax
Particulars

LF
M/s X
1/3 2005 1800 180 162 -- 1782
3 Chest of tea
M/s Y
5/3 2006 1200 60 114 160 1414
20kg Assam Tea @ ` 60 kg
M/s Z
6/3 2007 1500 100 140 -- 1540
20 kg Darjeeling Tea @ ` 75 kg
As you can see the transaction of 4th March 2016 is not recorded as it is Cash Transaction.
The word used for evidence of the transaction is Cash Memo It will directly be recorded in
the cash book.

Posting and Balancing

Once transactions are properly recorded in sales journal, they are posted into the ledger.
The procedure for posting is stated as under: -

• Entries will be posted to the credit side of the respective creditors

(supplier) account in the ledger by writing “By Purchases A/c” in
the particulars column.
Step 1

• Periodic total is posted to the credit of sales account in the ledger

by writing “To sundries as per purchases book” in the particulars
Step 2 column.

Always remember that sales account always has a credit balance.

113
Commercial Accountancy

Returns Books
Returns Books are those books in which the goods returned to the suppliers and goods
returned by the customers are recorded.

The reasons for the return of goods are

i. Not according to the order placed.
ii. Not upto the samples which were already shown.
iii. Due to damage condition.
iv. Due to difference in the prices charged.
v. Undue delay in the delivery of the goods.

Kinds of Returns Books

The following are the kinds of Returns Books;
i. Purchases Return or Returns outward book
ii. Sales Return or Returns inward book
When the business concern returns a part of the goods purchased on credit, the returns
fall under the category Purchases Return or Returns Outward. When the business concern
receives a part of the goods sold on credit, the returns fall under the category of Sales Return
or Returns Inward. Goods sold/ purchased on cash and are returned are not recorded in these
books, but are recorded in the cash book

Purchase Returns Book

Return of goods purchased is recorded in this book. Sometimes goods purchased from
the supplier is returned for various reasons such as goods are not as per our order, or are
defective. These goods are returned to the supplier. For this purpose, a debit note is prepared
and sent to the supplier for making necessary entries. The record of such return of goods in a
journal is called Purchase Returns journal, the format of which is as under:

Format of Purchase Return Book

Date Debit Note No. Supplier LF Detail Amount Remark

Date: In this column, Year, Month and Date of transactions are recorded in chronological
order.

114
 Accounting process: Cash Book and Subsidiary Books

Debit Note Number: In this column, the debit note number is written.
Name of Supplier: In this column, the Name of the supplier from whom the goods were
purchased is written.
Ledger Folio: In this column, the page number of the ledger book on which supplier account
is prepared is recorded.
Detail: In this column the details of the goods returned to the supplier is recorded.
Amount: In this column, it records the amount of the total goods returned to the supplier.
Remark: In this column reason for return is recorded.
Let us understand the preparation of Purchase Return Book with an illustration.
Illustration: Record the following in purchases Return book and post them in a ledger Book:
2016
Dec. 10 Returned two washing machines purchased from M/s Manohar Electronics at
the list price of ` 7,000 per machine less trade discount 20% and issued debit
note E/45.
Dec.24 Returned six tape recorders to M/s Sonika electronics purchased @ ` 1,000
per tape recorder and issued debit note E/46.
Solution:
Date Debit Supplier LF Details Amount Remark
Note
No.

10/12/2016 E/45 M/s Manohar 2 washing machine @ 11,200

electronics ` 7000 with Discount 20%

24/12/2016 E/46 M/s Sonika 6 tape recorder @ ` 1000 6,000

Electronics

Posting and Balancing

Once transactions are properly recorded in purchase return journal, they are posted into
the ledger. The procedure for posting is stated as under: -

115
Commercial Accountancy

• Individual amounts are daily posted to the debit of supplier

accounts in the ledger by writing “To Purchases Return A/c” in
the Particulars column.
Step 1

• Periodic total is posted to the credit of purchases return account

in the ledger by writing “By Sundries as per Purchases Return
Step 2 Book” in the particulars column.

Always remember that purchase return account always has a credit balance.

Sales Return Book

This book is used to record all returns of goods to the business by the customers. The
entries in the sales return book are usually on the basis of credit notes issued to the customers
or debit notes issued by the customers.

Format of Sales Return Book

Date Credit Note No. Buyer LF Detail Amount Remark

Date: In this column, Year, Month and Date of transactions are recorded in chronological
order.
Credit Note Number: In this column, the credit note number is written.
Name of Buyer: In this column, the Name of the buyer whom the goods were sold is written.
Ledger Folio: In this column, the page number of the ledger book on which buyer account is
prepared is recorded.
Detail: In this column the details of the goods returned by the buyer is recorded.
Amount: In this column, it records the amount of the total goods returned by the buyer.
Remark: In this column reason for return is recorded.
Let us understand the preparation of Sales Return Book with an illustration.
Illustration: Enter the following transactions in Sales Return Book: -
2016
April 6 Returned by Shankar 30 shirts each costing ` 150, due to inferior quality.

116
 Accounting process: Cash Book and Subsidiary Books

April 8 Amar Tailors returned 10 Baba suits, each costing ` 100, on account of being
not in accordance with their order.
Solution:

Date Credit Buyer LF Detail Amount Remark

Note No.
6/4/2016 Shankar 30 shirts @ ` 150 4,500 Due to inferior quality
8/4/2016 Amar 10 baba suits @ 1,000 not in accordance with
Tailors ` 100 order

Bill of exchange
When one wants to increase the business transactions, credits may be allowed and the
amounts are received after some time. If the amount involved in the credit transaction is large,
the seller needs security and evidence over the dealings. Here the Bill of Exchange solves the
problems of the seller.

Definition
According to the Negotiable Instruments Act, 1881, ‘Bill of Exchange is an instrument
in writing containing an unconditional order, signed by the maker, directing a certain person
to pay a certain sum of money only to, or to the order of a certain person or to the bearer of
the instrument’.
An analysis of the definition given above highlights the following important features
of a bill of exchange: -
i. It is a written document.
ii. It is an unconditional order.
iii. It is an order to pay a certain sum of money.
iv. It is signed by the drawer.
v. It bears stamp or it is drafted on a stamp paper.
vi. It is accepted by the acceptor.
vii. The amount is paid to drawer or endorsee.

Important terms
Explanation of some terms connected with bill of exchange is given below.

Drawing of a Bill
The seller (creditor) prepares the bill in the prescribed form. The act of preparing the
bill in its complete form with the signature is known as ‘drawing’ a bill.

117
Commercial Accountancy

Parties
There are three parties to a bill of exchange as under: -
Drawer: The person who prepares the bill is called the drawer i.e., a creditor.
Drawee: The person who has to make the payment or who accepts to make the payment
is called the drawee i.e., a debtor.
Payee: The person who receives the payment is payee. He may be a third party or the
drawer himself.
Acceptance
In a bill drawee gives his acceptance by writing the word ‘accepted’ and also puts his
signature and the date. Now the bill becomes a legal document enforceable in the court of law.
Due date and Days of grace
When a bill is drawn payable after a specified period the date on which the payment
should be made is called ‘Due Date’. In the calculation of the due date three extra days are
added to the specified period of the bill are known as ‘Days of Grace’. If the date of maturity
falls on a holiday, the bill will be due for payment on the preceding day.
Endorsement
Endorsement means writing of one’s signature on the face or back of a bill for the
purpose of transferring the title of the bill to another person. The person who endorses is
called the “Endorser”. The person to whom a bill is endorsed is called the “Endorsee”. The
endorsee is entitled to collect the money.
Discounting
When the holder of a bill is in need of money before the due date of a bill he can convert
it into cash by discounting the bill with his banker. This process is referred to as discounting
of bill. The banker deducts a small amount of the bill which is called discount and pay the
balance in cash immediately to the holder of the bill.

Retiring of Bill
An acceptor may make the payment of a bill before its due date and discharge his
liability, it is called as retirement of a bill. Usually the holder of the bill allows a concession
called rebate to the drawee for the unexpired period of the bill.

Renewal
When the acceptor of a bill knows in advance that he will not be able to meet the bill
on its due date, he may approach the drawer with a request for extension of time for payment.
The drawer of the bill may agree to cancel the original bill and draw a new bill for the amount
due with interest thereon. This is referred to as renewal.

118
 Accounting process: Cash Book and Subsidiary Books

Dishonour
Dishonour of the bill means the non-payment of bill, when it is presented for payment.
Noting and Protesting
If a bill is dishonoured, the drawer may approach the court, and file a suit against the
drawee. In order to collect documentary evidence, the drawer may approach a lawyer and
explain the fact of the dishonour of the bill. The lawyer will take the bill to the drawee and ask
for the payment. If the drawee does not make the payment, the lawyer will note the statement
of the drawee and get the statement signed by him. The lawyer will then put his signature. The
statement noted by the lawyer will be the documentary evidence for the dishonour of the bill.
Writing this statement by the lawyer is known as noting of the bill. The lawyer performing
this work of noting the bill is called as the ‘Notary Public’. A notary public is an official
appointed by the Government. After recording a note of dishonour on the dishonoured bill, the
Notary Public issues a certificate to this effect which is called protest. A protest is a certificate
issued by the Notary Public attesting that the bill has been dishonoured.

Bills Books
When the number of bills received or issued is large journalizing of all bill transactions
will result in enormous waste of time. Hence, suitable registers like bills receivable book and
bills payable book are maintained to record the receipt of bills receivable and issue of bills
payable respectively. These books are also called Bills Journals/Books.

Bills Receivable Book

Bills receivable (B/R) book is used for the purpose of recording the details of bills
receivable. The individual accounts of parties from whom bills are received will be credited
with the amount in the bills receivable book. The periodic total is posted to the debit of bills
receivable account in the ledger by writing “To sundries as per Bills Receivable Book”.

Bills Payable Book

Bills payable (B/P) book is used for the purpose of recording the details of bills payable.
The individual accounts of the parties to whom the bills are issued will be debited with the
corresponding amount in the bills payable book. The periodic total is posted to the credit of
bills payable account in the ledger by writing “By Sundries as per Bills Payable Book”.

Journal Proper
Journal proper is used for making the original record of such transactions for which
no special journal has been kept in the business. The usual entries that are put through this
journal is explained below:

119
Commercial Accountancy

Opening Entries
Opening entries are used at the beginning of the financial year to open the books by
recording the assets, liabilities and capital appearing in the balance sheet of the previous year.

Closing Entries
Closing entries are recorded at the end of the accounting year for closing accounts
relating to expenses and revenues. These accounts are closed by transferring the balances to
the Trading, Profit and Loss Account.

Adjusting Entries
To arrive at a correct figure of profits and loss, certain accounts require some adjustments.
Entries for making such adjustments are called as adjusting entries. These are needed at the
time of preparing the final accounts.
Transfer Entries
Transfer entries are passed in the journal proper for transferring an item entered in one account
to another account.
Rectifying Entries
Rectifying entries are passed for rectifying errors which might have committed in the
book of accounts.

Miscellaneous Entries or Entries of Casual Nature

These are entries of casual nature which do not occur so frequently. Such transactions
include the following:
i. Credit purchases and credit sale of assets which cannot be recorded through purchases
or sales book
ii. Endorsement, renewal and dishonour of bill of exchange which cannot be recorded
through bills book.
iii. Other adjustments like interest on capital and loan, bad debts, reserves etc.

120
 Bank Reconciliation Statement

Bank Reconciliation
CHAPTER 8 Statement

Y
ou operate a bank account in which you deposit money and withdraw money from
time to time. You maintain a record with yourself of these deposits and withdrawals.
One day when you got your pass-book (statement issued by the bank) updated you
were surprised to find that the balance shown by the pass book was different from what it
should have been as per your records. What will you do in this case? It is obvious that you will
compare the two sets of records and find out items which are recorded in one but not in the
other. Similar situation may arise in case of a business concern which operates a bank account.
These business concerns maintain record of all of their banking transactions in their bank
column of the cash book. On any particular date the bank balance shown by the bank column
of cash book and that shown by the pass book should be the same. But if there is difference
between the two, the business concern will find out the reasons to reconcile the balance.
Business concern maintains the cash book for recording cash and bank transactions. The
Cash book serves the purpose of both the cash account and the bank account. It shows the balance
of both at the end of a period. On the debit side of the cash book, the bank column represents:
1. Cheques deposited into bank for collection.
2. Cash paid into bank and
3. Some entries that are made only after receiving the information from the bank viz.,
i. Amounts collected by the bank on our behalf as per the standing instructions, for
example, Interest collected on investment.
ii. Interest given by the banker for the balance kept by us in our bank account.
iii. The amount paid by our customers directly into our bank account.
On the other hand, on the credit side of the cash book, represents:
1. Cheques issued for payment.
2. Cash withdrawn from bank for office use and personal use.
3. In addition, some entries are made after receiving information from the bank viz.,
i. Amounts paid by the bank on our behalf as per the standing instructions, for
example, payment of insurance premium.
ii. Interest charged by the bank for the amount drawn over and above the actual
balance kept in the bank account.
iii. Bank charges payable for the agency and utility services rendered by the bank.

121
Commercial Accountancy

Bank also maintains an account for each customer in its book. All deposits by the
customer are recorded on the credit side of his/her account and all withdrawals are recorded
on the debit side of his/her account. A copy of this account is regularly sent to the customer
by the bank. This is called ‘Pass Book’ or Bank statement. It is usual to tally the firm’s bank
transactions as recorded by the bank with the cash book. But sometimes the bank balances
as shown by the cashbook and that shown by the pass book/bank statement do not match. If
the balance shown by the pass book is different from the balance shown by bank column of
cashbook, the business firm will identify the causes for such difference. It becomes necessary
to reconcile them. To reconcile the balances of Cash Book and Pass Book a statement is
prepared. This statement is called the ‘Bank Reconciliation Statement’.

Bank Reconciliation Statement

The balance of the bank column in the double or triple column cash book represents
the customer’s cash balance at bank. It should be the same as shown by his bank pass book
on any particular day. For every entry made in the cash book if there is a corresponding entry
in the pass book (maintained by the banker) or vice versa, the bank balance will be the same
in both the books.
However, it must be noted that the cash book and the pass book are maintained by
two different parties and hence it is not certain that entry in one book will always have a
corresponding entry in the other. Normally entries in the cash book should tally (agree) with
those in the pass book and the balances shown by both the books should be the same. But in
practice, the balances generally differ. In case of disagreement in the balance of the cash book
and the pass book, the need for preparing Bank Reconciliation Statement arises.
‘Bank reconciliation statement’ is a list in which the various items that cause
a difference between bank balance as per cash book and pass book on any given date are
indicated.

Need and Importance

After tracing the various items of difference, a bank reconciliation statement is prepared.
The following are its advantages in which lies its importance.
i. The errors that might have taken place in the cash book in connection with bank
transactions can be easily found.
ii. Regular preparation of bank reconciliation statement prevents frauds.
iii. It indirectly imposes moral check on the accounting staff.
iv. By the preparation of bank reconciliation statement, uncredited cheque can be
detected and steps can be taken for their collection.

122
 Bank Reconciliation Statement

Reasons for differences

When a businessman compares the Bank balance of its cash book with the balance
shown by the bank pass book, there is often a difference. As the time period of posting the
transactions in the bank column of cash book does not correspond with the time period of
posting in the bank pass book of the firm, the difference arises. The reasons for difference in
balance of the cash book and pass book are as under:
Cheques issued by the firm but not yet presented for payment: When cheques
are issued by the firm, these are immediately entered on the credit side of the bank column
of the cash book. Sometimes, receiving person may present these cheques to the bank for
payment on some later date. The bank will debit the firm’s account when these cheques are
presented for payment. There is a time period between the issue of cheque and being presented
in the bank for payment. This may cause difference to the balance of cash book and pass book.
Cheques deposited into bank but not yet collected: When cheques are deposited
into bank, the firm immediately enters it on the debit side of the bank column of cash book. It
increases the bank balance as per the cash book. But, the bank credits the firm’s account after
these cheques are actually realized. A few days are taken in clearing of local cheques and in
case of outstation cheques few more days are taken. This may cause the difference between
cash book and pass book balance.
Amount directly deposited in the bank account: Sometimes, the debtors or
the customers deposit the money directly into firm’s bank account, but the firm gets the
information only when it receives the bank statement. In this case, the bank credits the firm’s
account with the amount received but the same amount is not recorded in the cash book. As
a result, the balance in the cash book will be less than the balance shown in the Pass book.
Bank charges: The bank charge in the form of fees or commission is charged from
time to time for various services provided from the customers’ account without the intimation
to the firm. The firm records these charges after receiving the bank intimation or statement.
Example of such deductions is: Interest on overdraft balance, credit cards’ fees, outstation
cheques, collection charges, etc. As a result, the balance of the cash book will be more than
the balance of the pass book.
Interest and Dividend received by the bank: Sometimes, the interest on
debentures or dividends on shares held by the account holder is directly deposited by the
company through Electronic Clearing System (ECS). But the firm does not get the information
till it receives the bank statement. As consequence, the firm enters it in its cash book on a date
later than the date it is recorded by the bank. As a result, the balance as per cash book and
passbook will differ.

123
Commercial Accountancy

Direct payments made by the bank on behalf of the customers: Sometimes,

bank makes certain payments on behalf of the customer as per standing instructions. Telephone
bills, rent, insurance premium, taxes, etc. are some of the expenses. These expenses are directly
paid by the bank and debited to the firm’s account immediately after their payment. But the
firm will record the same on receiving information from the bank in the form of Pass Book or
bank statement. As a result, the balance of the pass book is less than that of the balance shown
in the bank column of the cash book.
Dishonour of cheques/bill discounted: If a cheque deposited by the firm or bill
receivable discounted with the bank is dishonoured, the same is debited to firm’s account by
the bank. But the firm records the same when it receives the information from the bank. As a
result, the balance as per cash book and that of pass book will differ.
Errors committed in recording transactions by the firm: There may be certain
errors from firm’s side, e.g., omission or wrong recording of transactions relating to cheques
deposited, cheques issued and wrong balancing etc. In this case, there would be a difference
between the balances as per Cash Book and as per Pass Book.
Errors committed in recording transactions by the bank: Sometimes, bank
may also commit errors, e.g., omission or wrong recording of transactions relating to cheques
deposited etc. As a result, the balance of the bank pass book and cash book will not agree.

Preparation of Bank Reconciliation Statement

To reconcile the bank balance as shown in the pass book with the balance shown by
the cash book, Bank Reconciliation Statement is prepared. After identifying the reasons of
difference, the Bank Reconciliation statement is prepared without making change in the cash
book balance.
We may have the following different situations with regard to balances while preparing
the Bank Reconciliation statement. These are:

Favourable Balances
1. Debit balance as per cash book is given and the balance as per pass book is to be
ascertained.
2. Credit balance as per pass book is given and the balance as per cash book is to be
ascertained.

Unfavourable Balance/Overdraft Balance

1. Credit balance as per cash book (i.e. overdraft) is given and the balance as per pass book
is to be ascertained.

124
 Bank Reconciliation Statement

2. Debit balance as per pass book (i.e. overdraft) is given and the balance as per cash book
is to be ascertained.
The following steps are taken to prepare the bank reconciliation statement:
Favourable Balances: When debit balance as per cash book or credit balance as
per pass book is given:

• Take balance as a starting point say Balance as per Cash Book.

Step 1

• Add all transactions that have resulted in increasing the balance

of the pass book.
Step 2

• Deduct all transactions that have resulted in decreasing the

balance of pass book.
Step 3

• Extract the net balance shown by the statement which should be

the same as shown in the pass book.
Step 4

In case balance as per pass book is taken as starting point all transactions that have
resulted in increasing the balance of the Cash book will be added and all transactions that have
resulted in decreasing the balance of Cash book will be deducted. Now extract the net balance
shown by the statement which should be the same as per the Cash book.
Unfavourable balances/Overdraft: Sometimes a businessman withdraws
excess amount from the bank account and the closing bank balance of a month is a debit
balance. This balance amount is called ‘overdraft balance’ as per Pass Book. This is shown
in the cash book as a credit balance. Overdraft balance is shown in the minus column of
statement as the starting point. The other steps shall remain same.

125
Commercial Accountancy

Procedure for Preparing Bank Reconciliation Statement

S. Transaction Entry in Cash Entry in Bank Effect Procedure to ascertain the
No. Book (bank Pass Book balance as per Pass Book
Column) (By Bank) from the Cash Book
Favourable Unfavourable
Balance Balance
1 When cash is Customer enters in Bank enters in Cash -- --
deposited the debit side the credit side Book=Pass
Book
2. When cash is Customer enters in Bank enters in Cash -- --
withdrawn the credit side the debit side Book=Pass
Book
3. Issue of cheque Customer enters Bank enters in Cash Add Less
in the credit side the debit side Book<Pass
immediately only when Book
cheque is
presented and
get encashed
4. Cheque received Customer debits Only after Cash Book Less Add
and entered in Cash Book collection > Pass book
the Cash Book amount will be
and sent to Bank entered in the
for collection credit side of
the pass book.
5. Bank Charges No entry is made in Bank debits it Cash Book Less Add
for the services the Cash Book > Pass
rendered by the Book
Bank
6. Interest, No entry is made in Bank credits the Cash Book Add Less
dividend etc. the Cash Book till amount <Pass Book
collected by pass book is verified
bank on behalf
of customer
7. Bank Interest No entry is made in Bank credits the Cash Book Add Less
the Cash Book till amount < Pass
pass book is verified Book
8. Amount directly No entry in Cash Bank credits the Cash Book Add Less
remitted to the Book till the Pass amount < Pass
Bank Book is verified Book
9. Payment made No entry in Cash Bank debits the Cash Book Less Add
by the Bank Book till the Pass amount > Pass
on Standing Book is verified Book
instruction

126
 Bank Reconciliation Statement

10. Dishonouring of No entry till the time Debits the pass Cash Book Less Add
Bills receivable bank intimates book > Pass
or Cheque Book
deposited to the
Bank
11. Dishonouring of No entry till the time Bank credits the Cash Book Add Less
bill payable or bank intimates amount < Pass
cheque issued Book
12. Wrong credit in No entry in the Cash Bank credits Cash Book Add Less
the Pass Book Book (wrongly) the < Pass
amount Book
13. Wrong debit in No entry in the Cash Bank debits Cash Book Less Add
the Pass Book Book (wrongly) the > Pass
amount Book

Format
The format of Bank Reconciliation Statement when bank balance as per cash book is
taken as the starting point is as follows: -
Bank Reconciliation Statement as on …………………..
Particulars Amount Amount
A Balance as per Cash Book ………
B Add:
• Cheques issued but not presented for payment ………
• Interest credited by bank but not recorded in cash
………
book
• Debtors directly paid into bank but not recorded in ………
cash book ………
• Wrong credit by banker
• Collections by banker as per customer standing ……….
instructions

………
Total (B)

………
Total (A+B)
C

127
Commercial Accountancy

D Less:
• Cheques deposited but not credited by the bank
• Dishonoured cheques appeared in the pass book
………
but not entered in the cash book
• Bank charges as per pass book
• Wrong debit by banker ………
• Payments as per standing instructions ………
………
Total (D) ………

Balance as per Pass Book (C-D) ………

………
Points to be noted:
To work out the problems on Bank Reconciliation Statement, the following points are to be
remembered:
(a) The heading is given as “Bank Reconciliation Statement as on ____________”
(b) All items to be added are grouped together and shown in the inner column and the
total is taken to the outer column for the purpose of addition (B).
(c) All items to be deducted are grouped together in the inner column and the total can
be shown in the outer column for deduction (D).
(d) Favourable balance means the cash book will have a debit balance and the
passbook will have a credit balance.
(e) Bank overdraft or unfavourable balance means cash book will have a credit
balance and passbook will have debit balance.
For easy reference the table given below will be useful.
Book Favourable Balance Unfavourable Balance
Cash Book Debit Credit
Pass Book Credit Debit
Let us see the Bank Reconciliation Statement with favourable and unfavourable balances.
When balance as per cash book is favourable.
From the following details, make out a bank reconciliation statement for M/s Yarrows Mess as
on December 31, 2016 to find out the balance as per pass book. (Amount in `)

128
 Bank Reconciliation Statement

1. Cheques deposited but not yet collected by the bank 1,500

2. Cheque issued to Mr. Srinivasa Vankatnathan has not yet been
presented for payment 2,500
3. Bank charges debited in the pass book 200
4. Interest allowed by the bank 100
5. Insurance premium directly paid by the bank as per standing instructions 500
6. Balance as per cash book 200
Solution:
Bank reconciliation Statement as on 31st December 2016
Particulars Amount (in `) Amount (in `)
A Balance as per Cash Book 200
B Add:
• Cheques issued to Mr. Srinivasa Vankatnathan
but not presented for payment
• Interest allowed by bank but not recorded in 2,500
cash book
100

Total (B) 2,600

Total (A+B)
C
2,800
D Less:
• Cheques deposited but not credited by the bank 1,500
• Bank has paid insurance premium as per
standing instructions 500
• Bank charges as per pass book 200
Total (D) 2,200

Balance as per Pass Book (C-D) 600

When balance as per cash book is unfavourable (overdraft).
Prepare a Bank Reconciliation Statement as at June 30, 2016 for M/s Yarrows Mess from the
information given below: -

129
Commercial Accountancy

1. Bank overdraft as per cash book 1,10,450

2. Cheques issued on June 20, 2016 but not yet presented for payment 15,000
3. Cheques deposited but not yet credited by bank 22,750
4. Bills receivable directly collected by bank 47,200
5. Interest on overdraft debited by bank 12,115
6. Amount wrongly debited by bank 2,400

Solution:
Particulars Amount (in `) Amount (in `)
A Overdraft as per Cash Book 1,10,450
B Add:
• Cheques deposited but not yet credited by
bank 22,750
• Interest on overdraft debited by bank
• Amount wrongly debited by bank 12,115
2,400

Total (B) 37,265

Total (A+B) 1,47,715
C
D Less:
• Cheques issued but not yet presented for
payment 15,000
• Bills receivable directly collected by bank
47,200
Total (D)
62,200
Balance as per Pass Book (C-D) 85,515

130
 Trial Balance

CHAPTER 9 Trial Balance

I
f you recall the steps in the accounting procedure you find that at first the transactions are
entered in the Journal and Special Purpose Books like Cash Book, Purchases Book, Sales
Book, etc. From these books items are posted in the ledger in their respective accounts.
Finally, at the end of the accounting year these accounts are balanced. To check the accuracy
of posting in the ledger a statement is prepared with two columns i.e. debit column and credit
column which contains debit balances of accounts and credit balances of accounts respectively.
Total of the two columns are if equal, it means the ledger posting is arithmetically correct.
This statement is called Trial Balance.
Trial balance is a statement which shows debit balances and credit balances of all accounts
in the ledger. Since, every debit should have a corresponding credit as per the rules of double
entry system, the total of the debit balances and credit balances should tally (agree). In case,
there is a difference, one has to check the correctness of the balances brought forward from the
respective accounts. Trial balance can be prepared on any date provided accounts are balanced.

Definition
“Trial balance is a statement, prepared with the debit and credit balances of ledger accounts
to test the arithmetical accuracy of the books” – J.R. Batliboi.

Objectives of Preparing a Trial Balance

Following are the objectives of preparing Trial Balance
To Check Arithmetical Accuracy: Arithmetical accuracy in ledger posting means
writing correct amount, in the correct account and on its correct side while posting transactions
from various original books of accounts, such as Cash Book, Purchases Book, Sales Book,
etc. It also means not only the correct balance of ledger account but also the totals of the
special purpose Books.
To Help in Preparing Financial Statements: The ultimate objective of the
accounting is to prepare financial statements i.e. Trading and Profit and Loss Account, and
Balance sheet of a business enterprise at the end of an accounting year. These statements
contain balances of various ledger accounts. As Trial Balance contains balances of all ledger
accounts, in financial statements the balances of ledger accounts are carried from the Trial
balance for proper analysis.

131
Commercial Accountancy

Helps in Locating Errors: If total of two columns of the trial balance agrees it is a
proof of arithmetical accuracy in the ledger posting. However, if the totals of the two columns
do not tally it indicates that there is some mistake in the ledger accounts. This prompts the
accountant to find out the errors.
Helps in Comparison: Comparison of ledger account balances of one year with the
corresponding balances with the previous year helps the management taking some important
decisions. This is possible by using the Trial Balances of the two years.
Helps in Making Adjustments: While making financial statements adjustments
regarding closing stock, prepaid expenses, outstanding expenses etc. are to be made. Trial
balance helps in identifying the items requiring adjustments in preparing the financial
statements.
Trial Balance is generally prepared at the end of the year. However, it can be prepared
at any time during the accounting year to check the accuracy of the posting.

Advantages
The advantages of the trial balance are:
i. It helps to ascertain the arithmetical accuracy of the book-keeping work done during
the period.
ii. It supplies in one place ready reference of all the balances of the ledger accounts.
iii. If any error is found out by preparing a trial balance, the same can be rectified before
preparing final accounts.
iv. It is the basis on which final accounts are prepared.

Methods
A trial balance can be prepared in the following methods.
i. The Total Method: According to this method, the total amount of the debit side of
the ledger accounts and the total amount of the credit side of the ledger accounts are
recorded.
ii. The Balance Method: In this method, only the balances of an account either debit or
credit, as the case may be, are recorded against their respective accounts.
iii. Balance Total Method: Trial Balance is prepared by combining the first and second
methods.
The balance method is more widely used, as it supplies ready figures for preparing the final
accounts.

132
 Trial Balance

Format
Trial Balance of ………….
(As on ………..)
Heads of Account L.F. Debit (in `) Credit (in `)

Points to be noted:
i. Date on which trial balance is prepared should be mentioned at the top.
ii. Heads of Account column contains the list of all ledger accounts.
iii. Ledger folio of the respective account is entered in the next column.
iv. In the debit column, debit balance of the respective account is entered.
v. Credit balance of the respective account is written in the credit column.
vi. The last two columns are totalled at the end.

Let us understand the Trial Balance with an illustration.

The following balances were extracted from the ledger of M/s Yarrows Mess on 31st March,
2016. You are requested to prepare a trial balance as on that date in the proper form.
` `
Salaries 36,320 Purchases 1,44,670
Sales 1,73,500 Sundry Debtors 1,430
Plant & Machinery 34,300 Travelling Expenses 2,630
Commission Paid 1,880 Carriage Inward 240
Stock on 1.4.2016 11,100 Sundry Creditors 14,260
Repairs 1670 Capital as on 31.3.2016 62,500
Sundry Expenses 460 Drawings 3,500
Returns Inward 1,000 Cash at Bank 1,090
Discount Allowed 1,150 Returns Outward 400
Rent and Rates 3,220 Investments 6,000

133
Commercial Accountancy

Solution: -
Trial Balance of M/s Yarrows Mess
(As on 31/03/2016)
Heads of Account L.F. Debit (in `) Credit (in `)
Salaries 36,320
Sales 1,73,500
Plant & Machinery 34,300
Commission Paid 1,880
Closing Stock 11,100
Repairs 1,670
Sundry Expenses 460
Return Inwards 1,000
Discount Allowed 1,150
Rent and rates 3,220
Purchase 1,44,670
Sundry Debtors 1,430
Travelling Expenses 2,630
Carriage Inward 240
Sundry Creditors 14,260
Capital as on 31.3.2016 62,500
Drawings 3,500
Cash at Bank 1,090
Returns Outward 400
Investments 6,000
Total 2,50,660 2,50,660
Limitations
Though the trial balance helps to ensure the arithmetical accuracy of the books of
accounts, it is possible only when the accountant has not committed any error. As all the errors
made are not disclosed by the trial balance, it would not be regarded as a conclusive proof of
correctness of the books of accounts maintained.

134
 Rectification of Errors

CHAPTER 10 Rectification of Errors

I
n our life we make many mistakes. As soon as these are detected, he/she corrects them.
In the similar manner, an accountant can also make mistakes or commit errors while
recording and posting transactions. The fundamental principle of the double-entry system
is that every debit has a corresponding credit of equal amount and vice-versa. Therefore,
the total of all debit balances in different accounts must be equal to the total of all credit
balances in different accounts, i.e., the total of the two columns should tally (agree). The
tallying of the two totals (debit balances and credit balances) of the trial balance ensures only
arithmetic accuracy but not accounting accuracy. If, however, the two totals do not tally, it
implies that some errors have been committed while recording the transactions in the books of
accounts. These are called ‘Accounting Errors’. So accounting errors are the errors committed
by persons responsible for recording and maintaining accounts of a business firm in the course
of accounting process. These errors may be in the form of omitting the transactions to record,
recording in wrong books, or wrong account or wrong totalling and so on.

Kinds of Errors
Keeping in view the nature of errors, all the errors committed in the accounting process can
be classified into two: -
i. Errors of Principle and
ii. Clerical Errors
Further accounting errors can take the following forms:
• Omission of recording a business transaction in the Journal or Special Purpose
Books.
• Not posting the recorded transactions in various books of accounts to the respective
accounts in ledger.
• Mistakes in totalling or in carrying forward the totals to the next page.
• Mistake in recording amount wrongly, writing it in a wrong account or on the
wrong side of the account.
Again there may be two types of accounting errors
i. That causes the disagreement of trial balance,
ii. That does not affect the agreement of Trial Balance.

135
Commercial Accountancy

Errors of Principle
Transactions are recorded as per generally accepted accounting principles. If any of
these principles are violated or ignored, errors resulting from such violation are known as
errors of principle. For example, Purchase of assets recorded in the purchases book. It is
an error of principle, because the purchases book is meant for recording credit purchases of
goods meant for resale and not fixed assets. A trial balance will not disclose errors of principle.

Clerical Errors
These errors arise because of mistakes committed in the ordinary course of accounting
work. These can be further classified into three types as follows: -

Errors of Omission
This error arises when a transaction is completely or partially omitted to be recorded in
the books of accounts. Errors of omission may be classified as below: -

136
 Rectification of Errors

Error of Complete Omission: This error arises when a transaction is totally omitted to
be recorded in the books of accounts. For example, Goods purchased from Ram completely
omitted to be recorded. This error does not affect the trial balance.
Error of Partial Omission: This error arises when only one aspect of the transaction
either debit or credit is recorded. For example, a credit sale of goods to Siva recorded in sales
book but omitted to be posted in Siva’s account. This error affects the trial balance.

Errors of Commission
This error arises due to wrong recording, wrong posting, wrong casting, wrong
balancing, wrong carrying forward etc. Errors of commission may be classified as follows: -
Error of Recording: This error arises when a transaction is wrongly recorded in the
books of original entry. For example, Goods of ` 5,000, purchased on credit from Viji, is
recorded in the book for ` 5,500. This error does not affect the trial balance.
Error of Posting: This error arises when information recorded in the books of original
entry are wrongly entered in the ledger. Error of posting may be
i. Right amount in the right side of wrong account.
ii. Right amount in the wrong side of correct account
iii. Wrong amount in the right side of correct account
iv. Wrong amount in the wrong side of correct account
v. Wrong amount in the wrong side of wrong account
vi. Wrong amount in the right side of wrong account, etc.
This error may or may not affect the trial balance.
Error of Casting (Totalling): This error arises when a mistake is committed while
totalling the subsidiary book. For example, instead of ` 12,000 it may be wrongly totalled
as ` 13,000. This is called overcasting. If it is wrongly totalled as ` 11,000, it is called
undercasting.
Error of Carrying Forward: This error arises when a mistake is committed in carrying
forward a total of one page to the next page. For example, Total of purchase book in page 282
of the ledger ` 10,686, while carrying forward the balance to the next page it was recorded
as ` 10,866.

Compensating Errors
The errors arising from excess debits or under debits of accounts being neutralized by the
excess credits or under credits to the same extent of some other account is compensating error.
Since the errors in one direction are compensated by errors in another direction, arithmetical

137
Commercial Accountancy

accuracy of the trial balance is not at all affected in spite of such errors. For example, if the
purchases book and sales book are both overcast (excess totalling) by ` 10,000, the errors
mutually compensate each other. This error will not affect the agreement of trial balance.

Errors disclosed and not disclosed by trial balance

If the impact of the errors on trial balance is considered, errors may be classified into two
categories – Errors disclosed by trial balance, and Errors not disclosed by trial balance.

Locating Errors
It is obvious that if there are errors they must be located at the earliest. After locating
the errors, they are to be rectified. In accounting also once it is established there are some
accounting errors these need to be located and detected as early as possible.

Steps to Locate the Errors

If the trial balance does not tally, it means there are some errors in the books of accounts.

• Check the total of the trial balance and ascertain the exact amount
of difference in the trial balance.
Step 1
• The difference is halved to find out whether there is any balance of
the same amount in the trial balance. It is because, such a balance
might have been recorded on the wrong side of the trial balance
Step 2 and hence, the difference is double the amount.

138
 Rectification of Errors

• If the second step fails to locate the error, the difference in the
trial balance is divided by 9. If it is divisible by 9 without any
remainder, the error is due to transposition of figures. For example,
Step 3 transposition of figures represents writing of ` 780 for ` 870.

• See whether the balance of all ledger accounts including cash and
bank balances are included in the trial balance.
Step 4

• Ensure that all the opening balances have been correctly brought
forward in the current year’s books.
Step 5
• If the difference in the trial balance is of large amount, the trial
balance of the current year is compared with that of the previous
year and an account showing a large difference over the figure in
Step 6 the previous year’s trial balance should be rechecked.
• If the error is not detected by the above steps, care should be
taken to scrutinise the totals of all the subsidiary books.
• Posting made from the journal and the subsidiary books to the
relevant ledger accounts.
Step 7
• Balances extracted from the various ledger accounts.
• Totalling of the ledger balances.
The various steps which may be taken to locate the errors include the following:
Even after following the above steps, if the error could not be located, the whole of the
prime entry must once again be checked and in case of need, the posting to the ledger should
be rechecked thoroughly.
Suspense Account
When it is difficult to locate the mistakes before preparing the final accounts, the
difference in the trial balance is transferred to newly opened imaginary and temporary account
called ‘Suspense Account’. Suspense account is prepared to avoid the delay in the preparation
of final accounts. If the total debit balances of the trial balance exceed the total credit balances,
the difference is transferred to the credit side of the suspense account. On the other hand, if
the total credit balances of the trial balance exceed the total debit balances the difference is
transferred to the debit side of the suspense account.

139
Commercial Accountancy

When the errors affecting the suspense account are located, they are rectified with
suspense account. Suspense account is continued in the books until the errors are located and
rectified. Such balance will be shown in the balance sheet. Debit balance will be shown on the
asset side and the credit balance will be shown on the liability side. When all the errors affecting
the trial balance are located and rectified, the suspense account automatically gets closed.

Rectification of Errors
Correction of errors in the books of accounts is not done by erasing, rewriting or striking
the figures which are incorrect. Correcting the errors that has occurred is called Rectification.
Appropriate entry is passed or suitable explanatory note is written in the respective account
or accounts to neutralise the effect of errors. From the point of rectification, errors may be
classified as follows:
i. Single sided errors are errors which affect one account in a transaction.
ii. Double sided errors are errors which affect both the accounts in a transaction.

Basic Principles for Rectification of Errors

All errors, whatever may be their kind or nature, result in one of the following four
positions in one or more accounts.
i. Excess debit in one or more accounts: This must be rectified by ‘crediting’ the excess
amount to the respective account or accounts.
ii. Short debit in one or more accounts: This must be rectified by a ‘further debit’ to
the respective account or accounts involved.
iii. Excess credit in one or more accounts: This can be rectified by ‘debiting’ the
respective account with the excess amount involved.
iv. Short credit in one or more accounts: This can be rectified by a ‘further credit’ to
the respective account or accounts involved.
The following three steps may be adopted while attempting to rectify an error:
i. Ascertain what has actually been done, i.e. what is the error?
ii. Make sure what ought to have been done, i.e., the correct record.
iii. Decide what is to be done in view of what has been done and what ought to have been
done. i.e., rectification.

Stages of Rectification
The stage in which rectification is done depends on identification or locating the error.
Rectification of errors may be explained in two stages.
i. Rectification before the preparation of trial balance: In this stage errors are located before
transferring the difference in the trial balance to Suspense Account.

140
 Rectification of Errors

ii. Rectification after the preparation of trial balance: In this stage the difference in the trial
balance would have been transferred to Suspense Account. So wherever applicable suspense
account is used while passing rectification entries.
Stage at which the errors are rectified Manner in which the errors are rectified
When the errors are rectified before By debiting or crediting respective account
transferring the difference in the trial with the required amount by giving an
balance to the suspense account. explanatory note in the particulars column.
When the errors are rectified after By writing a journal entry with the respective
transferring the difference in the trial account or accounts affected by the errors
balance to the suspense account and suspense account.
Illustration of rectification of errors: -
Let’s see how following mistakes can be rectified and what is their impact on Trail balance: -
1. The sales book is undercast by ` 2,000.
Solution: - This is an error of casting and it affect sales account only. The trial balance
will not tally.
2. The purchases book is overcast by ` 1,500.
Solution: -
3. The purchases return book is overcast by ` 5,000.
Solution: - This is an error of casting and it affect purchases return account only. The
trial balance will not agree.
4. The sales return book is overcast by ` 1,000.
Solution: - This is an error of casting and it affect sales return account only. The trial
balance will not agree.
5. Goods returned by Simranjeet worth ` 1,500 were not entered.
Solution: - This is an error of complete omission. Since both the aspects have been
omitted, this error will not affect the agreement of the trial balance.
6. Goods returned by Ananth & Co. ` 4,000 were not posted.
Solution: - This is an error of partial omission. Since the principles of double entry
are not completed, this error will affect the agreement of the trial balance.
7. Goods sold to Vipul for ` 2,600 has been debited to Rakesh’s A/c.
Solution: - This is an error of posting i.e., right amount in the right side of the wrong
account. This error will not affect the agreement of the trial balance.
8. A credit sale to Shikha for ` 3,500 was entered as ` 5300.
Solution: - This is an error of recording i.e., wrong entry in the subsidiary book.
Since the mistake is found in both debit and credit aspects to the same extent. The
agreement of the trial balance will not be affected.

141
Commercial Accountancy

9. A purchase of Machinery for ` 50,000 has been entered in the purchases book.
Solution: - This is an error of principle. This error will not affect the agreement of the
trial balance.
10. A credit purchase from Shubhranjani for ` 6,250 was debited to Kencho’s A/c. from
purchases book.
Solution: - This is an error of recording i.e., wrong entry in the subsidiary book.
Since, the mistake is found in both debit and credit aspects to the same extent. The
agreement of the trial balance will not affect.
11. Cash received for commission ` 2,735 was posted to the commission account as
` 2,375.
Solution: - This is an error of posting involving posting of wrong amount. Since the
commission account has an excess credit of ` 360, the trial balance will be affected.
12. The monthly total of discount column on the debit side of the cash book ` 1,350 was
credited to discount allowed account.
Solution: - This is an error of posting involving posting on the wrong side of an
account. The amount must have been debited to discount allowed account. The
trial balance will not agree to the extent of ` 2,700 i.e., twice the amount of the
transaction.
13. Cash paid for insurance ` 6,310 was posted to the insurance A/c. as ` 6,130.
Solution: - This is an error of posting involving posting of wrong amount. Since the
insurance account has a short debit of ` 180, the trial balance will be affected.
14. The monthly total of discount column on the credit side of the cash book ` 22,500
was debited to discount received account.
Solution: - This is an error of posting involving posting on the wrong side of an
account. The amount must have been credited to discount received account. The
trial balance will not agree to the extent of ` 45,000, ie., twice the amount of the
transaction.
15. A sale to Shyam ` 6,900 has been entered in the purchases book.
Solution: - This is an error of recording. In this transaction, error is made in the
book of original entry, the trial balance will not be affected. An entry has been made
wrongly in the purchases book instead of the sales book. To rectify this, Shyam A/c
is to be debited with ` 13,800 and Purchases A/c. and Sales A/c. are to be credited
with ` 6,900 each.

142
 Depreciation Accounting

CHAPTER 11 Depreciation Accounting

A
ssets are broadly divided into two categories- current assets (cash, debtors or
customer’s balances, stock of materials and goods) and fixed assets (buildings,
furniture and fixtures, machinery and plant, motor vehicles).
Fixed assets are also called long term assets as they provide benefits to the business for
more than one year. Most fixed assets lose their value over time as these are put in use and as
the years pass by. The fixed assets lose their usefulness due to arrival of new technologies and
change of fashions etc. These are then generally required to be replaced, as their useful life is
over. Hence, the cost of a fixed asset is allocated over its useful life.
Each year’s allocation of the cost is charged as depreciation expense for that year. For
example, an office chair is purchased for ` 2,500 and it is estimated that after ten years it will
be scrapped. The useful life of the chair is ten years over which the cost of ` 2,500 will be
distributed. Each year’s allocation may be calculated as ` 250. Thus, ` 250 is the depreciation
expense for each year.
Depreciation, thus, is an expense charged during a year for the reduction in the value of
fixed assets, arising due to:
• Normal wear and tear out of its use and passage of time
• Obsolescence due to change in technology, fashion, taste and other market
conditions

Causes of Depreciation
Following are the causes for which depreciation is provided:

Normal wear and tear

Due to usage - Every asset has a life for which it can run, produce or give service.
Thus, as we put the asset to use its worth decreases. Like decrease in the efficiency and
functioning of a bicycle due to its running and usage.
Due to passage of Time – As the time goes by elements of nature, wind, sun, rain
etc., cause physical deterioration in the worth of an asset. Like reduction in the worth of a
piece of furniture due to passage of time even when it is not used.

143
Commercial Accountancy

Obsolescence
Due to development of improved or superior equipment: Sometimes fixed
assets are required to be discarded before they are actually worn out due to either of the above
reasons. Arrival of superior equipment and machines etc. allow production of goods at lower
cost. This makes older equipment worthless as production of goods with their use will be
costlier and non-competitive. For example, Steam engines became obsolete with the arrival
of diesel and electric locomotives.
Due to change in fashion, style, taste or market conditions: Obsolescence may
also result due to decline in demand for certain goods and services with a change in fashion,
style, taste or market conditions. The goods and services that are no longer in vogue lead to
decrease in the value of the assets which were engaged in their production - like factories or
machines meant for making old fashioned hats, shoes, furniture etc. Loss in the value of fixed
assets for such reasons is called obsolescence and also charged as depreciation.

Objectives of charging depreciation

Following are the objectives of charging depreciation of Assets:

To show the true financial position of the business: Fixed Assets have
some effective working life during which it can be economically operated. Depreciation is the
gradual loss in the value of fixed assets. If depreciation is not provided, profit and loss A/c will
not disclose the true profit made during the accounting period. At the same time, the Balance
Sheet will not disclose the true Financial position as Fixed assets appearing in the Balance
Sheet will be overvalued. If depreciation in ignored year after year, ultimately when asset is
worn out, the proprietor will not be being a position to continue the business smoothly.
To retain funds in the business for replacement of the asset: Net profit
is the yield of the capital invested by proprietor and may be wholly withdrawn by him in
the form of cash. If depreciation is provided, this figure of net profit will be reduced and the
amount withdrawn by the proprietor will also be decreased. As such the cash equivalent to the
charge for depreciation will be left over in the business. This accumulated amount will enable
the proprietor to replace to a new asset.

Factors affecting the depreciation

Following are the factors that affect the amount of depreciation to be charged on an asset: -

Cost of Asset: Cost of asset is the purchase price of the asset and includes all such
expenses which are incurred before it is first put to use. For example, expenses on loading,
carriage, installation, transportation and unloading of the asset up to the point of its location,
expense on its erection and assembly.

144
 Depreciation Accounting

Useful Life of the Asset: Useful life is the expected number of years for which the
asset will remain in use.
Scrap Value: Scrap value is the residual value at which the asset could be sold to scrap
dealer (Kabadi) after its useful life.
Depreciable value of asset: Depreciable value is the cost of asset minus the scrap
value.

Method of charging depreciation

Most popularly used methods for charging depreciation are: i. Straight Line Method and
ii. Diminishing Balance Method

Straight Line Method of Charging Depreciation

Under this method, the amount of depreciation is uniform from year to year. Suppose, if an
asset costs ` 1,00,000 and depreciation is fixed @ 10%, then ` 10,000 would be written off
every year. That is why this method is also called ‘Fixed Installment Method’ or ‘Original
Cost Method’. In this method, the amount to be written off every year is arrived at as under:
Expected Life (in years)
Depreciation of Each year =
Cost of Asset-Scrap Value
Out of the cost of the asset, its scrap value is deducted and it is divided by the number of
years of its estimated life.
For example: A machine is purchased for ` 1,20,000 and it is estimated that its useful life
is 10 years. After its useful life its scrap value is ` 20,000. Depreciation of one year can be
calculated as under:
1,20,000-20,000=1,00,000
Depreciation for the year = =10,000
10
Merits of Straight Line Method
Simplicity: Calculation of depreciation under this method is very simple and therefore,
the method is widely popular. Once the amount of depreciation is calculated, the same amount
is written off as depreciation each year. Hence, this method is simple and calculations are
easier to understand.
Asset is completely Written Off: Under this method, the book value of an asset is
reduced to net scrap value or zero value. In other words, in the books of accounts the value of
the asset at the end of its useful life is equal to zero or its residual value.

145
Commercial Accountancy

Limitations of Straight Line Method

Difficulty in Computation: When there are various machines having different life-
spans, the computation of depreciation becomes complicated because the depreciation on
each machine will have to be calculated separately for each asset.
Lesser burden on P&L Account: It is well known that the expense on its repairs and
maintenance increases as the asset becomes older. Thus, the total burden on Profit and Loss
Account, depreciation plus repair expenses, is more in later years in comparison to earlier
years. This is illogical because the efficiency and productivity of the asset is more in earlier
years and less in later years.

Diminishing Balance Method

Under this method, as the value of asset goes on diminishing year after year, the amount
of depreciation charged every year goes on declining. The amount of depreciation is calculated
as a fixed percentage of the diminishing value of the asset shown in the books at the beginning
of each year. Under this method the value of an asset never comes to zero.
Suppose, the cost of the asset is ` 40,000 and the percentage to be written off each year
is 10%. In the first year the amount of the depreciation will be ` 4,000 i.e., 10% of ` 40,000.
This will reduce the book value to ` 36,000 i.e. ` 40,000 – ` 4,000. Now, at the beginning of
the next year the book value is ` 36,000. The amount of the depreciation for the next year will
be ` 3,600, i.e., 10% of ` 36,000. Thus, every year the amount of the depreciation will go on
reducing. This method of charging depreciation is also known as Reducing Balance Method
or written down value method.
For example: A machine was purchased on January 1, 2014 for ` 1,00,000 and its
useful life is 10 years. After completing its useful life, the machine will be scraped and
` 4,000 will be realized from it. It is decided to charge depreciation on this machine @ 10%
p. a. on Diminishing Balance Method. If we calculate amount of depreciation for each year
during the useful life of this machine, it will be as below: -
Year Book Value of the machine Rate of depreciation Amount of depreciation
1st 1,00,000 10% 10,000
2nd 90,000 10% 9,000
3rd 81,000 10% 8,100
4th 72,900 10% 7,290
5th 65,610 10% 6,561
6th 59,049 10% 5,905
7th 53,144 10% 5,314
8th 47,830 10% 4,783
9th 43,047 10% 4,305
10th 38,742 10% 3,874

146
 Depreciation Accounting

Amount of depreciation is decreased year after year in this method that is why this
method is called ‘Diminishing Balance Method’ or ‘Reducing balance method’ or ‘written
down value method’.

Merits of Diminishing Balance Method

Equal Burden on Profit & Loss Account: During the initial years the productivity of
the asset is more hence its contribution to profit is also relatively greater. Therefore, the cost
charged in terms of depreciation should also be greater. In the initial year, the depreciation
charges are more and repair expenses are less. In later years, depreciation charges are less
and repair expenses are more. Hence the total burden of depreciation plus repair expenses, is
somewhat equal on Profit & Loss Account for each year.

Demerits of Diminishing Balance Method

Asset cannot be completely written off: Under this method, the value of an asset is not
reduced to zero even when there is no scrap value.
Complexity: Under this method, the rate of depreciation cannot be determined easily.

Depletion Method
All natural resources like mines, fuel oil, gas and woods are ending by using them. We
calculate the depreciation with depletion method for such perishing assets. Under this method,
first, we estimate the total value of assets. After this, we calculate the rate of depreciation per
unit by dividing the estimated life in the term of production of units. For an example, if a marble
stone quarry estimated to contain 100,000 tonnes of marble stone, is acquired for ` 5,00,000, the
amount of depreciation to be provided will be ` 5 per tonnes of marble stone raised.

Depreciation Reserve
Depreciation reserve is the same as accumulated depreciation, i.e. when the business
acquires an asset and such asset will be used in the operations for a period longer than one
year, it is not possible to include acquisition cost of such asset into the P&L Account on the
acquisition date.
Instead of that the asset is depreciated, i.e. the cost of the asset is attributed to the P&L
Account over the useful life of the asset. Such attribution amounts are also charged to the
depreciation reserves (accumulated depreciation) each year in order for business to be ready
to replace the asset when it is totally depreciated.
For example, business acquired equipment for ` 1000. If we assume that equipment
will be used for 5 years, applying straight line depreciation method, each year we will charge
to the depreciation reserves 1000/5=` 200. At the end of the 5th year the equipment will be
fully depreciated and the depreciation reserve will amount to ` 1000.

147
Commercial Accountancy

Every year, depreciation charged is transferred to the Depreciation Reserve by passing

following journal entry: -
Depreciation Deserve A/c Dr. …..
To Depreciation Reserve A/c …..
Purpose of depreciation reserve
• Reduction in Value of the Asset: The reserve for depreciation ensures that by
the time the asset stops functioning, the company already collected sufficient
necessary funds to buy new ones. The company does not suffer losses when the
situation arises. Constant usage, wear-and-tear and obsolescence are responsible
for the decline in the value of the asset. Also, the availability of better and more
improved assets in the market causes the value to diminish.
• True Reporting: The depreciation reserve account is shown on the company’s
financial statements. It is listed under the “long-term liabilities” head. The
depreciation reserve account is also referred to as accumulated depreciation. The
amount by which the asset is depreciated each year is deducted from the value of
the asset. Each year, the amount set aside is deducted from the asset to show the
value at its true price. This is the price that the asset would command if it were to
be sold today in the market.
• Assets and Depreciation Reserve: Every asset that the company owns has its
own depreciation reserve account. The yearly depreciation on the asset is added to
the depreciation reserve account. For example, say the company bought the asset
for ` 50,000 and then decides to depreciate the asset at a constant rate of rate of 25
percent and assumes the productive life to be four years and the scrap value to be
` 10,000. Each year ` 10,000 would be added to the depreciation reserve account
and ` 10,000 would be subtracted from the asset account.
• Tax relief: The depreciation reserve may provide tax benefits to the company.
Income Tax gives certain exemption if depreciation reserve is maintained. This
increases the company’s profitability. This money is then either distributed to
the shareholders as dividends or retained back into the business for its growth
initiatives. When the extra money is paid out as dividends, the company has greater
numbers of satisfied shareholders. A company’s financial standing and goodwill
increase tremendously. When the money is retained back, the company gets a
chance to research further and try to improve its products, services and systems.

Journal Entries of depreciation

As we all know that depreciation is an expense and shows the reduction in value of the
asset hence the journal entry for the depreciation is
Depreciation A/c Dr. ….
To Asset A/c ….
(Being depreciation charged for the period)

148
 Depreciation Accounting

At the end of the year, being nominal account, balance of depreciation account is
transferred to the Profit and Loss Account.

Asset Disposal Account

If part of the asset is sold, it is appropriate to open a new account called as ‘Assets Disposal
Account’.
i. Provision for Depreciation A/c is not maintained.
ii. Provision for Depreciation A/c is maintained.
I. When Provision for Depreciation A/c is not maintained, Journal Entries will be:
Under this method depreciation is directly charged to the assets account. Thus, normally only
the assets account is prepared.
i. For Transfer of Book Value of Asset to Asset Disposal A/c
Assets Disposal A/c Dr. ….
To Assets A/c ….
ii. For Sale of Asset:
Bank A/c Dr. ….
To Assets Disposal A/c ….
iii. For profit on Sale of Asset
Assets Disposal A/c Dr. ….
To Profit & Loss A/c ….
iv. For loss on Sale of asset
Profit & Loss A/c Dr. ….
To Assets Disposal A/c ….
II. When Provision for Depreciation Account is maintained: (Accumulated
Depreciation Account) Under this method, depreciation is not directly charged to the asset
account. The amount of depreciation to be provided for the period is debited to depreciation
account and credited to ‘Provision for Depreciation Account’ or ‘Accumulated Depreciation
Account’. Thus, entry will be as follows:
i. For asset purchased:
Asset A/c Dr. ….
To Cash/Bank A/c ….

149
Commercial Accountancy

ii. For depreciation charged:

Depreciation A/c Dr. ….
To provision for Depreciation A/c ….
iii. For transfer of depreciation to Profit and Loss Account
Profit & Loss A/c Dr. ….
To Depreciation A/c ….
In the balance sheet, the asset appears at its original cost and provision for depreciation
(or accumulated depreciation) appears on the liabilities side. As the year passes, the balance of
the accumulated depreciation goes on increasing since constant credit is given to this account
in each accounting year. After the expiry of useful life, these two accounts are closed by
debiting Accumulated Depreciation Account and crediting Asset Account and balance in asset
account is transferred to Profit & Loss Account. Entry will be:
Provision for Depreciation A/c Dr. ….
To Asset A/c ….
(Balance of Provision for depreciation to Asset A/c)

Profit & Loss A/c Dr. ….

To Asset A/c ….
(For loss on asset)

OR

Asset A/c Dr. ….

To Profit & Loss A/c ….
(For profit on asset)

150
 Accounting of Bills of Exchange

Accounting of Bills
CHAPTER 12 of Exchange

Y
ou know that now-a-days in business transactions on credit are on the rise. When
goods are sold on credit a huge amount of capital is blocked. Then there is no certainty
when the amount will be paid. A solution of the problem is giving this fact in writing
in proper form so that the buyer or debtor has to pay a definite sum to the seller/creditor on
demand or after the expiry of a certain period. Such a formal document duly signed by both
the parties is called a Bill of Exchange.
When such a document is given by the debtor/buyer from his own side it is called
a promissory note. These two documents when prepared as per provisions of the Negotiable
Instruments Act, 1881 attain the position of money and are used for settlement of the amount due.
According to section 5 of the Negotiable Instruments Act, 1881, a bill of exchange is
an instrument is writing containing an unconditional order signed by the maker, directing a
certain person to pay a certain sum of money only to, or to the order of, a certain person, or to
the bearer of the instrument.

Features of Bill of Exchange

1. It is an instrument drawn by the creditor upon his debtor.
2. It contains an unconditional order to pay a specified amount.
3. The specified amount is payable to the person named in the bill or to his order or
to the bearer.
4. The bill must be signed/accepted by the maker.
5. The bill specifies the date by which the amount should be paid.
6. It can be payable to the bearer.

Parties to a Bill of Exchange

1. Drawer: Drawer is a person who writes/makes the Bill of Exchange. He is
generally the creditor who had sold goods on credit.
2. Drawee: Drawee is a person upon whom the bill is drawn. He is generally the
debtor to whom goods have been sold on credit. Bill is generally signed and
accepted by the Drawee.

151
Commercial Accountancy

3. Acceptor: He is the person who accepts the bill of exchange. Generally, debtor/
drawee is the acceptor but sometimes a bill of exchange may be accepted by
someone also on behalf of the debtor/drawee. Normally the drawee and acceptor
are the same parties.
4. Payee: Payee is the person named in the Bill of exchange. The amount in the bill
is paid to the payee. In most cases Drawer and the payee will be the same.

Promissory Note
According to Section 4 of the Negotiable Instruments Act, 1881, a Promissory Note is
an instrument in writing (not being a bank note or a currency note) containing an unconditional
undertaking signed by the maker to pay a certain sum of money only to or to the order of a
certain person.
Promissory Note is an unconditional undertaking in writing by the maker to pay the
specified amount to the specified person or to the bearer of the promissory note.

Features of a Promissory Note

1. It is an unconditional written undertaking to pay the specified amount.
2. It is drawn and signed by the maker/promisor.
3. It specifies the name of the payee.
4. The specific amount is payable to the specified person or to his order or to the
bearer.
5. Proper stamp duty is paid on Promissory Note.
6. It is not payable to the bearer.

Parties of a Promissory Note

1. Drawer: He is the person who makes the promise to pay the amount. He is the
debtor.
2. Drawee: He is the person in whose favour the promissory note is drawn. Generally,
he is the creditor. In a promissory note the drawee and payee are the same parties.
3. The Payee: The payee is a person to whom payment is to be made. He is the
creditor.

Difference between Bill of Exchange and Promissory Note

Bill of Exchange Promissory Note
1. It contains an order to pay. 1. It contains a promise to pay.
2. It requires acceptance. 2. It does not need acceptance.

152
 Accounting of Bills of Exchange

3. Creditor is the Drawer. 3. Debtor is the drawer.

4. The liability of the drawer arises only if 4. The promisor has the primary liability to
the acceptor does not pay. pay.
5. The drawer and payee are generally the 5. Drawee and Payee are the parties.
same parties. Acceptor and drawee is the
Same party.
Terms of Bill
1. Due Date: It is the date on which the payment of the bill becomes due.
2. Days of Grace: To ascertain the period of the bill, three extra days are added,
which can be called as ‘Days of Grace’ to calculate the date of maturity.
3. Bill at Sight: Bills which are payable on presentation to the Drawee are known as
‘Bill at Sight or Demand’.
4. Bill After Date: The period is counted from the date of acceptance of the bill in
‘Bill After Date’.
5. Discounting of Bill: The process of receiving the bill amount at a date earlier than
the due date from the bank, is known as ‘Discounting the Bill’. When the bill is
discounted the bank credits the trader’s account after deducting some discount.
The discount is calculated at the lending rate of the bank for the period that extends
between the date of discounting of the bill to the date of maturity.
6. Endorsement of the Bill: The drawer may transfer the bill in favour of his creditor
to settle the creditor’s account. The process of transferring the ownership of the
bill in favour of somebody by putting the signature of the holder at the back of the
instrument and delivering the same to transferee is known as endorsing the bill.
The person who delivers it is endorser and the person to whom it is delivered is
called the endorsee.
7. Terms of the Bill: Bills is generally drawn for a certain period, say for two months
or three months. Bills may be drawn payable at sight on demand, on presentation,
after date and so on.
8. Date of Maturity: It is the date of which the payment of the bill is due. It is
calculated by adding three days of grace. For example, a bill drawn on 1.1.2013
for a period of two months will mature on (2 months + 3 days) 3rd March, 2013.
9. Dishonour of a Bill: Dishonour means that the bill is not paid by a Drawee on the
due date. It arises when the acceptor refuses or is unable to pay the amount of bill,
i.e., Bill of Exchange, Promissory Note or cheque.
10. Notary Public: Notary Public is an officer appointed by the Central or State
Government to exercise the power and functions relating to noting and protesting of
negotiable instruments for dishonour. ‘Noting’ authenticates the fact of dishonour.

153
Commercial Accountancy

11. Noting Charges: Noting Charges is the fee paid to the Notary Public for noting
and protesting the Bill of Exchange of its dishonour.
12. Renewal of Bill: When the acceptor of a bill is not in a position to meet the bill
on due date, he may, with the consent of the holder accept a fresh bill in place of
the old bill, it is called Renewal of a Bill. The fresh bill may include interest for
the extended period (or it may be paid separately), stamp duty and other incidental
expenses incurred by the holder.
13. Retirement of Bill: When the Drawee pays the bill before its due date, it is called
Retirement of a Bill. The holder allows him a rebate of certain amount calculated
at a certain rate per cent per annum, from the date of retirement to the date of
maturity.

Recording of bill transactions

Before starting recording the bill transactions there are certain important aspects related
to recording that you must understand clearly. A bill transaction can be recorded in the books
of all the parties related to a bill of exchange if that transaction affects the concerned party in
any way. As you know that the person who draws the bill of exchange is called the drawer.
He is generally a creditor of the person upon whom the bill of exchange is drawn. The person
upon whom bill of exchange is drawn is called the drawee. He is generally the debtor of the
person who draws the bill of exchange. For the drawer who receives the bill of exchange after
its acceptance by the drawee, the bill of exchange is a bill receivable since he will receive the
payment on the maturity of the bill. Bills receivables are assets. For the drawee upon whom
the bill of exchange is drawn and who accepts it, the bill of exchange becomes a bills payable
because he has to make the payment of the amount on the maturity of the bill when the bill
will be presented to him. Bills payables are liabilities. The following procedure is followed for
recording the bill transactions in the books of the drawer/creditor and drawee/acceptor/debtor
in a comparative form: -
• In books of drawer/seller

o When sale of good taking place

Debtor’s A/c Dr. ….

To Sales A/c ….

o When drawing and receiving bill

Bills Receivables A/c Dr. ….

To Debtor’s A/c ….

154
 Accounting of Bills of Exchange

• In books of drawee/buyer
o When purchasing
Purchase A/c Dr. ….
To Creditor’s A/c ….
o When bill is accepted
Creditor’s A/c Dr. ….
To Bill Payable A/c ….
A bills receivable can be treated by its receiver in any of the following ways before its maturity.
i. He may retain the bill with him till the date of its maturity and present the same to the
acceptor for payment on the date of its maturity.
ii. He may discount the bill with his bank.
iii. He may endorse the bill in favour of his creditor.
iv. A few days before the maturity he may send the bill to his bank for the purpose of
collection.
The following accounting treatment will be done under the different situations given above:-
i. When the bill in retained by the drawer till its maturity and presented to the drawee/
acceptor on its maturity.
In Books of Drawer In books of Drawee
Bank A/c Dr. Bill Payable A/c Dr.
To Bill Receivable A/c To Bank A/c
i. On Discounting the Bill: The receiver of the bill may get the bill discounted from its
bank at any time before its maturity. The bank charges discount at the prevailing rate
of lending and credits the remaining amount in the account of the customer.
The following entry will be passed: -
In Books of Drawer In books of Drawee
Bank A/c Dr. No entry will be passed in drawee’s book
Discount on Bill receivable A/c Dr. as his books are not affected with the
discounting of the bill.
To Bill Receivable A/c
On the date of maturity, the bill, will be presented by the bank to the acceptor for payment.
The following entry will be passed: -
In Books of Drawer In books of Drawee
No entry will be passed in drawer’s book as his Bill Payable A/c Dr.
books are not affected with the transaction. To Bank A/c

155
Commercial Accountancy

(i) When the bill is endorsed by the receiver in favour of his creditor.
The following entry will be passed: -
In Books of Drawer In books of Drawee
Creditor’s A/c Dr. No entry will be passed in drawee’s book
To Bill Receivable A/c as his books are not affected with the
Transaction.
On the date of maturity, the bill, will be presented by the bank to the acceptor for payment.

The following entry will be passed: -

In Books of Drawer In books of Drawee
No entry will be passed in drawer’s book Bill Payable A/c Dr.
as his books are not affected with the To Bank A/c
transaction.
(ii) When the bill is sent to the bank for collection a few days before maturity.
The following entry will be passed: -
In Books of Drawer In books of Drawee
Bill Sent for collection A/c Dr. No entry will be passed in drawee’s book as his
To Bill Receivable A/c books are not affected with the Transaction.

On the date of maturity, the bill, will be presented by the bank to the acceptor for payment.

The following entry will be passed: -

In Books of Drawer In books of Drawee
Bank A/c Dr. Bill Payable A/c Dr.
To Bill sent for collection A/c To Bank A/c
Illustration 1
Nand Dulal sold goods ` 1000 to Rahul on credit. He drew a bill of exchange for the
same amount upon Rahul payable after date two months. Rahul accepted the bill and returned
the same to Nand Dulal. On the due date the bill was presented to Mohan who met the same.
Pass the necessary journal entries in the books of Nand Dulal and Rahul under the
following circumstances.
i. When the bill was retained by Nand Dulal till the date of its maturity.
ii. When Nand Dulal discounted the bill from the bank on the same day at 6% p.a.
iii. When Nand Dulal endorsed the bill in favour of his creditor Jitendra.
iv. When Nand Dulal sent the bill a few days before its maturity to its bank for collections.

156
 Accounting of Bills of Exchange

Solution: -
Book of Nand Dulal
Journal Entries
Date Particulars L.F. Debit (in `) Credit (in `)
1st
When the bill was retained by Nand Dulal till the date of its maturity.
(i) Rahul’s A/c Dr 1,000
To Sales A/c 1,000
(Being goods sold to Rahul)
(ii) Bill receivable A/c Dr 1,000
To Rahul’s A/c 1,000
(Being Rahul accepted the bill receivable after 2
months)
(iii) Bank A/c Dr 1,000
To Bill receivable A/c 1,000
(Being Bill was honoured by Rahul and payment
received at Bank)
2nd When Nand Dulal discounted the bill from the bank on the same day at 6% p.a.
(i) Rahul’s A/c Dr 1,000
To Sales A/c 1,000
(Being goods sold to Rahul)
(ii) Bill receivable A/c Dr 1,000
To Rahul’s A/c 1,000
(Being Rahul accepted the bill receivable after 2
months)
(iii) Bank A/c Dr 940
Discount on Bill receivable A/c Dr 60
To Bill receivable A/c 1,000
(Being Bill was honoured by Rahul and payment
received at Bank)
3rd When Nand Dulal endorsed the bill in favour of his creditor Jitendra
(i) Rahul’s A/c Dr 1,000
To Sales A/c 1,000
(Being goods sold to Rahul)

157
Commercial Accountancy

(ii) Bill receivable A/c Dr 1,000

To Rahul’s A/c 1,000
(Being Rahul accepted the bill receivable after 2
months)
(iii) Jitendra’s A/c Dr 1,000
To Bill receivable A/c 1,000
(Being Bill is endorsed to creditor Jitendra)
4 th
When Nand Dulal sent the bill a few days before its maturity to its bank for
collections.
(i) Rahul’s A/c Dr 1,000
To Sales A/c 1,000
(Being goods sold to Rahul)
(ii) Bill receivable A/c Dr 1,000
To Rahul’s A/c 1,000
(Being Rahul accepted the bill receivable after 2
months)
(iii) Bill receivable send for collection A/c Dr 1,000
To Bill receivable A/c 1,000
(Being Bill was honoured by Rahul and payment
received at Bank)
Book of Rahul
Journal Entries
Date Particulars L.F. Debit (in `) Credit (in `)
In all the cases
(i) Purchase A/c Dr 1,000
To Nand Dulal A/c 1,000
(Being goods purchased from Nand Dulal)
(ii) Nand Dulal A/c Dr 1,000
To Bills Payable A/c 1,000
(Being Bill from Nand Dulal accepted for
payment after 2 months)
(iii) Bills Payable A/c Dr 1,000
To Bank A/c 1,000
(Being Bill was honoured on presentation)

158
 Accounting of Bills of Exchange

Dishonour of a bill
If the acceptor fails to pay the amount of the bill on the due date, the bill is said to have
been dishonoured. When the bill is dishonoured all the previous transactions in connection
with the bill are treated as cancelled. Hence, the acceptor is liable to the drawer, the drawer to
the endorsee and the endorsee to the bank, with which it is discounted.
The dishonoured bill must be noted with the Notary Public. When the dishonoured bill
is noted with the Notary Public, it is a valid evidence of dishonour. The fees charged by the
Notary Public is termed as ‘Noting Charges.’

On Dishonour of a bill the journal entries will be as under:

In the books of Drawer
a) When the bill was retained by drawer and dishonoured and noting charges are paid
Drawee A/c Dr. ….
To Bills Receivable A/c ….
To Cash A/c ….
(Being B/R dishonoured on due date and noting charges paid)
b) When the bill was endorsed and dishonoured and noting charges are paid by endorsee.
Drawee A/c Dr. ….
To Endorsee A/c ….
(Being B/R received from drawee and endorsed is dishonoured, noting charges
` .........)
c) When the bill was discounted with the bank and dishonoured and bank paid noting
charges
Drawee A/c Dr. ….
To Bank A/c ….
(Being discounted bill is dishonoured and noting charges being ` ........)
d) When the bill was sent to bank for collection and dishonoured and bank paid noting
charge.
Drawee A/c Dr. ….
To Bills sent for collection A/c ….
To Bank ….
(Being B/R sent to bank for collection is dishonoured and noting charges ` .......... paid
by bank)
In the books of Drawee, the journal entry will be as under in all the four conditions:

159
Commercial Accountancy

Bills Payable A/c Dr. ….

Noting Charges A/c Dr. ….
To Drawer/creditor A/c …..
(Being B/P dishonoured and noting charges ` .........)

Renewal of Bill
If the acceptor finds it difficult to honour the bill on the due date, he can request the
drawer or the holder of the bill to substitute the old bill with a new one i.e., to extend
the period of the bill. When the drawer agrees to extend the period of the bill, the
bill is cancelled and a new bill is drawn. When the old bill is cancelled, it is treated
as dishonoured. Drawee will be charged with interest for the extended period. If the
interest is not paid in cash, the new bill amount will include interest also. Therefore, the
cancellation of the existing bill and drawing a new bill in its place to allow more time
to the acceptor is known as renewal of the bill. On renewal of a bill the entries will be
as under:
In Books of Drawer In books of Drawee
Drawee A/c Dr. Bill Payable A/c Dr.
To Bill Receivable A/c To Drawer A/c
(Being old bill cancelled) (Being cancellation of bill payable)
Drawee A/c Dr. Interest A/c Dr.
To Interest A/c To Drawer A/c
(Being interest charged for the extended (Being interest due to Drawer for
period) the extended period)
Bills Receivable A/c Dr. Drawer A/c Dr.
To Drawee A/c To Bills Payable A/c
(Being a new bill received from (Being a new bill issued for the
Drawee including the interest) amount plus interest)

160
 Final Accounts

CHAPTER 13 Final Accounts

Financial Statements: meaning and objectives

W
hen an officer trainee has undergone training for a year, he/she wants to know
how much he/she has learnt during that period. Similarly, every business enterprise
wants to know the result of its activities of a particular period which is generally
one year and what is its financial position on a particular date which is at the end of this
period. In short, he wants to know the profitability and the financial soundness of the business.
The trader can ascertain these by preparing the final accounts. The final accounts are prepared
at the end of the year from the trial balance. Hence the trial balance is said to be the connecting
link between the ledger accounts and the final accounts.

Objectives of preparing Financial Statements

Financial statements are prepared to ascertain the profits earned or losses incurred by a
business concern during a specified period and also to ascertain its financial position at the end
of that specified period. Financial statements are generally of two types (a) Income Statement
which comprises of Trading Account and Profit & Loss Account, and (b) Position Statement
i.e., the Balance Sheet.
Following are the objectives of preparing financial statements: -
1. Ascertaining the results of business operations: Every businessman wants to know
the results of the business operations of his enterprise during a particular period in
terms of profits earned or losses incurred. Income statement serves this purpose.
2. Ascertaining the financial position: Financial statements show the financial
position of the business concern on a particular date which is generally the last
date of the accounting period. Position statement i.e. Balance Sheet is prepared
for this purpose.
3. Source of information: Financial statements constitute an important source of
information regarding finance of a business unit which helps the finance manager
to plan the financial activities of the business and making proper utilization of the
funds.
4. Helps in managerial decision making: The Manager can make comparative
study of the profitability of the concern by comparing the results of the current
year with the results of the previous years and make his/her managerial decisions
accordingly.

161
Commercial Accountancy

5. An index of solvency of the concern: Financial statements also show the short term
as well as long term solvency of the concern. This helps the business enterprise in
borrowing money from bank and other financial institutions and/or buying goods
on credit.

Importance of Financial Statements

1. Pertaining to Finance: The term “financial statement” doesn’t make sense at first.
Numbers are for counting while statements need words, so how could these two
mix together? But when seen as “money statements,” then suddenly it’s a crucially
important matter.
2. Facilitate in Decision Making: Not only is it important for you, but for the
management and stockholders as well. It’s important for the management because
financial statements speak of the company’s success and competence, whereas
stockholders refer to financial statements to know whether or not to invest in a
company. In other words, financial statements tell whether the company made or
lost money.
3. Showing the Operational Performance: Financial statement hold the secrets of
a company. Aside from stating whether the company earns or loses money, they
also provide clues on where the management might find more resources to boost
its revenue. In addition, financial statements reveal a company’s past performance
and potential.

Capital Expenditure and Revenue Expenditure, Capital Receipts and

Revenue Receipts
The preparation of Trading Account and Profit and Loss Account requires the knowledge
of revenue expenditure, revenue receipts and capital expenditure and capital receipts. The
knowledge shall facilitate the classification of revenue items and put them in the Trading
account and Profit and Loss Account on one hand and prepare Balance Sheet based on capital
items (expenditure as well as receipts) on the other hand.
Capital Expenditure refers to the expenditure incurred for acquiring fixed assets or assets
which increase the earning capacity of the business. The benefits of capital expenditure to the
firm extend to number of years. Examples of capital expenditure are expenditure incurred for
acquiring a fixed asset such as building, plant and machinery etc.
Revenue expenditure, on the other hand, is an expenditure incurred in the course of
normal business transactions of a concern and its benefits are availed of during the same
accounting year. Salaries, carriage etc. are examples of revenue expenditure.
There is another category of expenditure called deferred revenue expenditure.
These are the expenses incurred during one accounting year but benefits from the same
are available wholly or in part in future periods also. These expenditures are otherwise

162
 Final Accounts

of a revenue nature. Example of deferred revenue expenditure are heavy expenditure on

advertisement say for introducing a new product in the market, expenditure incurred on
research and development, etc.

Capital and Revenue Receipts

Capital receipts are receipts which do not arise out of normal course of business.
Examples of such receipts are sale of fixed assets, and raising of loans etc. Such receipts are
not treated as income of the enterprise.
Revenue receipts are receipts which arise during the normal course of business, Sale of
goods, rent from tenants, dividend received, etc. are some of the examples of revenue receipts.
They are the items of incomes of the business entity.

Parts of Final Accounts

The final accounts of business concern generally include two parts. The first part is
Trading and Profit and Loss Account. This is prepared to find out the net result of the business.
The second part is Balance Sheet which is prepared to know the financial position of the
business. However, manufacturing concerns, will prepare a Manufacturing Account prior to
the preparation of trading account, to find out cost of production.

Trading Account
Let us, first study the Trading Account. A business firm either purchases goods from
others and sells them or manufactures and sells them to earn profit. These are known as
trading activities. A statement is prepared to know the results in terms of profit or loss of these
activities. This statement is called Trading Account.
Trading Account is prepared to ascertain the results of the trading activities of the
business enterprise. It shows whether the selling of goods purchased or manufactured has
earned profit or incurred loss for the business unit. Cost of goods sold is subtracted from the
net sales of the business of that accounting year. In case the total sales value exceeds the cost

163
Commercial Accountancy

of goods sold, the difference is called Gross Profit. On the other hand, if the cost of goods sold
exceeds the total net sales, the difference is Gross Loss.
All accounts related to cost of goods sold such as opening stock, net purchases i.e.
purchase less returns outward, direct expenses such as wages, carriage inward etc. and closing
stock with net sales (i.e. Sales minus Sales returns) are posted to the Trading Account. Then
this account is balanced. Credit balance shows the gross profit and debit balance shows the
gross loss.
It is necessary to understand the meaning of cost of goods sold before preparing Trading
Account.

Cost of goods sold and gross profit

A business enterprise either purchases goods or manufactures goods to sell in the market.
Cost of goods sold is computed to know the profit earned (Gross Profit) or loss incurred (Gross
Loss) from the trading activities of a business unit for a particular period.
Cost of goods sold = the amount of goods purchased + expenses incurred in bringing
the goods to the place of production or expenses incurred on manufacturing the goods (called
direct expenses).
In case there is a stock of goods to be sold in the beginning of the year or at the end of
the year, the cost of goods is calculated as follows:
Cost of goods sold = Opening stock + Net purchases + All direct expenses – Closing
stock
Gross Profit = Net sales – Cost of goods sold
Illustration: - Calculate cost of goods sold and gross profit from the following information.
Sales ` 62500
Sales Returns ` 500
Opening Stock ` 6400
Purchases ` 32000
Direct Expenses ` 4200
Closing Stock ` 7200
Solution: -
Net sales (Sales-Sales Returns i.e. ` 62500 – ` 500) ` 62000
Less : Cost of goods sold
Opening Stock ` 6400
Add Purchases ` 32000

164
 Final Accounts

Add Direct Expenses ` 4200

Less : Closing Stock (` 7200) ` 35400
Gross Profit ` 26600
Or Gross profit = Net sales – cost of goods sold
= ` 62000 – ` 35400 = ` 26600

Need of Trading Account

Trading Account serves the following purposes:
1. Knowledge of Gross Profit: Trading Account gives information about Gross
Profit. It is the profit earned by a business enterprise from its trading activities.
The percentage of gross profit on sales reflects the degree of success of business.
2. Knowledge of All Direct Expenses: All direct expenses are debited to trading
Account. Direct expenses are the expenses that can be directly attributed to
purchase or manufacturing of goods for sale. Percentage of Direct expenses on
sales of current year when compared with the same of previous years, helps the
manager to exercise control over direct expenses.
3. Precaution against Future Losses: Trading Account, if shows gross loss, reasons
for this loss can be found out and necessary corrective steps can be taken.

Format of Trading Account

Trading Account of …………………..
(for the year ending………)
Dr. Cr.
Particulars Amount (in `) Particulars Amount (in `)
Opening Stock Sales
Purchase (less) Sales
(less) Purchase Return Return
Direct Expenses: Closing Stock
• Carriage Inward
• Freight
• Wages
• Fuel & Power
• Excise Duty
• Factory Rent
• Heating & Lighting
• Factory Rent & Insurance
• Work Managers Salary Gross Loss
Gross Profit (balancing figure) (balancing figure)

165
Commercial Accountancy

Important Items of Trading Account

Important items of Trading Account are:
• Stock: Stock refers to the goods lying unsold on a particular date. It can be of two
types:
1. Opening stock and
2. Closing stock
 Opening Stock: Opening stock refers to the value of goods lying unsold at the
beginning of the accounting year. It is shown on the debit side of the Trading Account.
In the first year of business there is no opening stock.

 Closing Stock: It is the value of goods lying unsold at the end of the accounting year.
It is valued at the cost price or market price whichever is less. It is shown on the credit
side of the Trading Account.
• Purchases: Purchases mean total items purchased for resale during the year.
It can be both in cash and on credit. Purchases are shown on the debit side of
the Trading Account. These are always shown as net purchases i.e. amount of
purchases returned (Purchase returns or return outwards) is deducted from the
total amount of purchases made. Goods received on consignment basis are never
treated as purchases. Similarly, goods received on ‘sale or return’ basis are never
treated as purchases.
• Sales: Sales refer to the total revenue from sale of goods of the business enterprise
for which the Trading Account is being prepared. It includes both cash sales and
credit sales. These are recorded on the credit side of the Trading Account. Sales
are shown at their net value i.e. sales return or returns inward is deducted from
the total sales. Cash sales plus credit sales minus sales returns constitute net sales.
Goods sent on ‘sale or approval’ are not part of sales until approval is received.
• Direct Expenses: Direct expenses are the expenses that can be attributed directly
to the purchase of goods or goods manufactured. These are shown on the debit
side of the Trading Account. These are shown at the amount as shown in the Trial
Balance. For example, wages are recorded on the debit side of Trading Account at
the amount shown in the Trial Balance.
• Important Items of Direct Expenses
1. Wages i.e. wages relate to production. If amount under this head includes wages
paid for construction of building or manufacturing of furniture for office, it will be
subtracted from the amount of wages.

2. Carriage, Cartage and Freight i.e. amount paid for carriage of goods purchased for
sale or raw material purchased for manufacturing.

166
 Final Accounts

3. Other such direct expenses are customs and import duty, packing materials,
gas, electricity water, fuel, oil, gas grease, heating and lighting, factory rent and
insurance and many more such items.
• Gross Profit/Gross Loss: It is the excess of net sales revenue over cost of goods
sold. Gross Profit is equal to net sales minus cost of goods sold. If total of the
credit side exceeds the total of debit side, the excess amount is termed as ‘gross
profit’ and is shown on the debit side of Trading Account. On the other hand, if
debit side is more than the credit side, the difference in amount is called gross loss
and is shown on the credit side of the Trading Account.

Transfer Entries
Before preparing Trading Account, closing or transfer journal entries are made in the
journal proper of the business enterprise. These journal entries are:
• For transferring debit balances
Trading A/c Dr.
To Opening stock
To Purchases
To Direct expenses
To Sales returns
(Transfer of balances of opening Stock, Purchases, direct expenses & Sales Returns)
• For transferring credit balances
Sales A/c Dr.
Closing stock A/c Dr.
Purchase Returns A/c Dr.
To Trading A/c
(Transfer of credit balances of Sales, Closing Stock, Purchase return)
• For transferring gross profit
Trading A/c Dr
To Profit & Loss A/c
(Transferring of gross profit)

• For transferring gross loss

Profit & Loss A/c Dr.
To Trading A/c
(Transferring of gross loss)

167
Commercial Accountancy

Profit & Loss Account

As stated earlier, income statement consists of two accounts: Trading Account and
Profit & Loss Account. You have seen that Trading account is prepared to ascertain the gross
profit or gross loss of the trading activities of the business. But these are not the final results of
business operations of an enterprise. Apart from direct expenses, there are indirect expenses
also. These may be conveniently divided into office and administrative expenses, selling and
distribution expenses, financial expenses, depreciation and maintenance charges etc.
Similarly, there can be income from sources other than sales revenue. These may be
interest on investments, discount received from creditors, commission received, etc. Another
account is prepared in which all indirect expenses and revenues from sources other than sales
are presented. This account when balanced shows net profit (or net loss). This account is
termed as Profit and Loss Account. The profit shown by this account is called ‘net profit’ and
if it shows loss it is known as ‘net loss’.

Format of Profit and Loss Account

Profit and Loss A/c of M/s ................…..
for the year ended ...............
Dr. Cr.
Particulars Amount (in `) Particulars Amount (in `)
Gross Loss (b/d) Gross Profit (b/d)
Salaries Commission received
Rent, Rates and Taxes Interest received
Insurance Premium Dividend received
Advertisement Discount received
Commission paid Rent Received
Discount allowed
Repair and maintenance
Depreciation
Other selling and marketing
expenses
Other financial expenses
Net Profit (balancing figure)
Net Loss (balancing
Figure)
Some important items of Profit and Loss Account
As stated earlier indirect expense are shown on the debit side of Profit and Loss A/c.
These can be classified under the following heads:

168
 Final Accounts

Debit Items
1. Selling and Distribution Expenses: To materialize sales, the expenses incurred are
called selling and distribution expenses. Examples are: Carriage on sales/carriage
outwards, advertisement, selling expenses, travelling expenses and salesman
commission, depreciation of delivery van, salary of driver of the delivery van, etc.
2. Office and Administration Expenses: These are the expenses incurred on
establishment and maintenance of office. Some of the expenses that may be under
this head are: rent, rates and taxes, postage, printing and stationery, insurance, legal
charges, audit fees, office salaries, etc.
3. Financial Expenses: Finances are to be arranged for carrying on business. Expenses
that are incurred in this connection are called financial expenses. Some of the financial
expenses are: interest on loan, interest on capital, discount on bills, etc.
4. Depreciation and Maintenance Charges: The total value of a fixed asset like
machinery, building, furniture, etc. is not charged to profit and loss account in the
year in which it is purchased. Such assets help running business for a number of years
to come. Therefore, only a part of the value of such assets is treated as an expense and
is charged to Profit and Loss A/c as depreciation. Depreciation means decline in the
value of fixed asset due to wear and tear, lapse of time, obsolescence, etc. Expense
incurred on repairs and renewals and maintenance of assets are expenses other than
depreciation under this category.
5. Other Expenses: These are the expenses which are not included under the above
mentioned heads of expenses for example, losses and expenses due to fire, theft etc.

Credit Items
On the credit side of Profit and Loss Account, items of revenue and incomes are written.
The first item on this side of Profit and Loss Account is the gross profit transferred from trading
account. Other items of the credit side are: Interest on investment, interest on fixed deposits
etc. rent received, commission received, discount received, dividend on shares received etc.

Need of preparing Profit and Loss Account

Need of preparing profit and loss account by a business concern may be stated as follows: -
• To know the net profit or net loss of a business for an accounting year.
• Net profit of one year can be compared with net profits of previous year or years.
• It helps in ascertaining whether the business is being conducted efficiently or not.
• Different expenses which are taken to Profit & Loss A/c in one year can be
compared with the amounts incurred in previous year or years.
• This helps in ascertaining the need of applying control over such expenses.

169
Commercial Accountancy

Transferring Entries of Profit and Loss Account

Before preparing Profit and Loss Account as per the format given in the previous
section, closing entries are made in the journal proper of the enterprise. Following journal
entries are made:
(i) For transferring the indirect expense accounts:
Profit & Loss A/c Dr.
To Salaries A/c
To Insurance Premium A/c
To Bad Debts A/c
To Discount Allowed A/c
(Transfer of indirect expenses)
(ii) For transfer of items of incomes and gain
Interest on investment A/c Dr.
Rent Received A/c Dr.
Discount Received A/c Dr.
To Profit & Loss A/c
(Transfer of items of income)
(iii) For transferring Net Profit
Profit & Loss A/c Dr.
To Capital A/c
(Transferring of Net Profit to Capital A/c)
(iv) For transferring Net Loss
Capital A/c Dr.
To Profit & Loss A/c
(Transfer of Net Loss to Capital Account)

Operating Profit
Operating profit is the excess of gross profit over operating expenses. Gross Profit is the
excess of net sales revenue over cost of goods sold. Operating expenses includes office and
administration expenses, selling and distribution expenses, cash discount allowed, interest
on bills payable and other short term debt, bad debts and so on. Net sales means cash sales +
credit sales - sales returns.
Operating Profit = Net Sales - Operating Cost
= Net Sales - (Cost of goods sold + administration and office
exp. + Selling and Distribution expenses)

170
 Final Accounts

Operating Profit = Net Profit + Non-operating exp. - Non-Operating Income

Illustration: -
Compute Operating profit from the following particular.

` `
Gross Profit 44,000 Interest on loan 2200
Carriage outward 480 Interest on investment 280
Advertising 1200 Printing and Stationery 360
Salaries 17,800 Loss on Sale of furniture 3,500
Rent & Taxes 6,200 General expenses 140
Lighting 1,500 Donation 510
Insurance charge 240 Rent Received 600
Bad Debts 150 Loss by fire 2,000
Audit fees 200 Gain on sale of machine 5,000

Solution: -
Computation of Operating Profit
` ` `
Gross Profit 44,000
Less : Selling and Distribution expenses :
Carriage outward 480
Advertising 1,200
Bad Debts 150 1,830
Less : Office and Administrative Expenses
Salaries 17,800
Rent & Taxes 6,200
Lighting 1,500
Insurance 240
Audit fees 200
Printing & Stationery 360
General expense 140 26,440 (28,270)
Operating Profit 15,730

171
Commercial Accountancy

Illustration:

Stock 1.4.2016 5,800 Sales 72,000

Purchases - cash 42,000 Return Inward 2,000
Purchases - credit 18,000 Interest on Investment 1,500
Freight Inward 1,800 Discount Received 1,200
Wages 4,500 Closing stock (31.3.2017) 7,200
Carriage on Sales 800
Telephone Charges 1,600
Electricity Expenses 1,200
Office Rent Paid 6,000
Salaries 8,000
Depreciation 1,400

From the following information of M/s Yarrows Mess for the year ending 31st March,
2017 prepare Trading A/c and Profit and Loss A/c for the year ended 31st March, 2017.
Solution: -
Books of M/s Yarrows Mess
Trading Account
(for the year ended 31st March, 2017)
Dr Cr
Particulars Amount (in `) Particulars Amount (in `)
Opening Stock 5,800 Sales 72,000
Purchases- Cash 42,000 (less) Returns 2,000 70,000
Closing Stock 7,200
Purchases – Credit 18,000 60,000
Freight Inwards 1,800
Wages 4,500
Gross Profit (transferred to 5,100
P&L)
77,200 77,200

172
 Final Accounts

Profit and Loss Account

(for the year ended 31st March, 2017)
Dr Cr
Particulars Amount (in `) Particulars Amount (in `)
Carriage on Sales 800 Gross Profit (transferred from 5,100
Trading Accounts)
Telephone Charges 1,600
Discount Received
Electricity Expenses 1,200 1,200
Interest on Investment
Office Rent Paid 6,000 1,500
Net Loss (Transferred to Capital
Salaries 8,000 11,200
Account in B/S)
Depreciation 1,400
19,000 19,000

Balance Sheet
Apart from Trading Account and Profit and Loss Account, Balance Sheet is another
financial statement that is prepared by every business firm. Balance sheet is a statement which
shows the financial position of a business organization on a particular date which is generally
the last date of the accounting period. Financial position of a business unit is the amount of
claims against the resources of business. These resources are cash, stock of goods, furniture,
machinery, etc. The claims include the claims of the owner capital and the claims of outsiders
such as creditors, bankers, etc. Therefore, it can be stated that Balance Sheet is the statement
which shows assets owned by the business and liabilities owed by it on a particular date.
Balance Sheet is not an account. It has two sides. (i) Assets side and (ii) the Liabilities side.
The Asset side has a list of fixed as well current assets. The liabilities side has a list of items
of capital, long term as well as short term liabilities.

Need
1. Balance Sheet is prepared to measure the true financial position of a business entity
at a particular point of time.

2. It is a systematic presentation of what a business unit owns and what it owes.

3. Balance Sheet shows the financial position of the concern at a glance.

4. Creditors, financiers are particularly interested in the Balance Sheet of a concern so

that they can decide whether to deal with the concern or not.

173
Commercial Accountancy

Grouping of Assets and Liabilities

All the assets can be categorized in following groups:
1. Current Assets
2. Liquid Assets
3. Non-current Assets
4. Tangible Assets
5. Intangible Assets
All the liabilities can be categorized in two groups:
1. Current Liabilities
2. Non-current Liabilities

Marshalling of Assets and Liabilities

As stated above Balance sheet has two sides i.e. Assets side, which has various items of
assets of the concern and liabilities side which has the liability or claim of the owner as well
as of the outside parties.
Assets refer to the financial resources of the business and can broadly be divided into
Current Assets and Fixed Assets, Liabilities denote claims against the assets of the business.
Liabilities can be of two types owner’s liability or capital and outsider’s liabilities such as
creditors, bills payable, Bank Loan etc.
There is no prescribed form in which a Balance Sheet should be prepared by a sole
proprietary business or a partnership firm. However, an order is generally maintained in which
assets and liabilities are written. This is to maintain uniformity/consistency which facilitates
comparative analysis for decision making. Balance sheet may be prepared in any of the
following orders: -
(a) Liquidity order (b) Permanency order
(a) Liquidity Order
Liquidity means convertibility of assets into cash. Every asset cannot be converted
into cash at the same degree of ease and convenience. Assets are written in the order of
their liquidity, Assets of highest liquidity is written first and next highest follows and so on.
Similarly, liabilities are also written in this very order. Short term liabilities are written first
and then long term liabilities and lastly the capital.
A specimen of the balance sheet prepared in order of liquidity is given below:

174
 Final Accounts

Balance Sheet of ………..

(As on ………)
Liabilities Amount (in `) Asset Amount (in `)
Bank Overdraft Cash in hand
Outstanding Expenses Cash at Bank
Bill Payables Prepaid expenses
Sundry Creditors Investments (short term)
Loans Bill Receivables
Capital Sundry debtors
(Add) Net Profit Closing stock
(less) Drawing Investments
Furniture
Plant & Machinery
Land & Building
Goodwill
(Investments on short term basis are marketable securities; they form part of current assets.)
(b) Permanency order
While following the order of permanency, assets, which are to be used permanently i.e.
for a long time and not meant for resale are presented first. For example, Land and Building,
Plant and Machinery, furniture etc. are written first. Assets which are most liquid such as cash
in hand is written in the last. Order of liabilities is similarly changed. Capital is written first,
then the long term liabilities and lastly the short term liabilities and provisions. Specimen of a
Balance Sheet that can be prepared in the order of permanency is as follows: -
Balance Sheet of ………..
(As on ………)
Liabilities Amount (in `) Asset Amount (in `)
Capital Goodwill
(Add) Net Profit Land & Building
(less) Drawing Plant & Machinery
Loans Furniture
Sundry Creditors Investments
Bill Payables Closing stock
Outstanding Expenses Sundry debtors
Bank Overdraft Bill Receivables
Investments (short term)
Prepaid expenses
Cash in hand
Cash at Bank

175
Commercial Accountancy

Classification of Assets and Liabilities

Assets and Liabilities are of various types. These can be classified as under:

Assets
Assets can be classified as follows:
a) Fixed Assets: These are the assets that are purchased on permanent basis i.e. for long
term use and help the business to earn revenue. Examples of such assets are Building,
Machinery, Motor Vehicle, etc. These assets are not for sale in ordinary course of
business but can be disposed off, if no more needed for business use.
b) Current Assets: These are the assets which are acquired by the business either for
resale or for converting them into cash. These are normally realized within a period
of one year. Examples of such assets are: cash in hand, cash at bank, bill receivable,
debtors, stock etc.
c) Tangible Assets: These are the assets that can be seen, touched and have certain
volume. Building, Machinery, goods etc. are tangible assets.
d) Intangible Assets: Assets which can neither be seen nor touched and have no volume
are called intangible assets. Patents, trademark, goodwill etc. are the examples of such
assets.
e) Liquid Assets: These are the assets which are either in cash or can be easily converted
into cash. For example, cash, stock, marketable securities etc.
f) Wasting Assets: These are the assets which exhaust or reduce in value by their use.
Mines, quarries etc. come under this category.
g) Fictitious Assets: These are not the real assets. These are the items of such expenses
and losses which have not been written off in full. For example, preliminary expenses,
underwriting commission, etc.

Liabilities
Liabilities can be classified as follows:
a) Long term Liabilities: These are the liabilities which are not payable during the
current accounting year. Generally, the funds raised through such means are used for
purchase of fixed assets. Examples of such liabilities are loan on mortgage, loan from
financial institutions.
b) Current Liabilities: These are the liabilities which are payable during the current
year. These include Bank overdraft, trade creditors, bill payable etc.

176
 Final Accounts

c) Owners’ Funds: The amount owing to the proprietor or proprietors is called owners’
funds. As per business entity concept this is a liability of the business. Apart from
capital it also includes undistributed profits and reserves. Amount of drawings by the
proprietor is deducted from it.
Illustration: -
From the balances given below prepare Balance sheet of M/s Yarrows Mess as on 31st
December, 2017.
Particulars Amount Particulars Amount
` `
Capital 50,000 Sundry Debtors 24,000
Loan from Bank 20,000 Bills Payable 8,000
Cash in hand 2,500 Drawings 6,000
Cash at Bank 12,800 Building 25,000
Closing stock 24,700 Furniture 4,500
Sundry creditor 15,000 Investments 15,000
Net Profit 21,500
Solution: -
Balance sheet of M/s Yarrows Mess
(As on 31st December 2017)
Liabilities Amount (in `) Asset Amount (in `)
Capital 50,000 Building 25,000

(Add) Net Profit 21,500 Furniture 4,500

(Less) Drawing 6,000 65,500 Investment 15,000
Loan from Bank 20,000 Closing stock 24,700
Sundry creditor 15,000 Sundry Debtors 24,000

8,000 Cash at bank 12,800

Bills Payable
Cash in hand 2,500
108,500 108,500

177
Commercial Accountancy

178