MODULE -1

MEANING AND SCOPE OF ACCOUNTING

Accounting has rightly been termed as the language of Business.

The basic function of a language is to serve as a means of
communication. Accounting also serves this function. It
communicates the results of business operations to various parties
who have some stake in the business, viz., the proprietor, creditors,
investors, the government and other agencies. Though accounting is
generally associated with business, the government, and other
individuals also make use of it.

DEFINITION AND FUNCTIONS OF ACCOUNTING

The American Institute of Certified Public Accountant (AICPA)

defined accounting as follows: “Accounting is the art of recording,
classifying and summarizing in significant manner and in terms of
money transactions and events which are, in part, at least of
financial character and interpreting the results thereof”.

FUNCTIONS OF ACCOUNTING

Recording: This is the basic function of accounting. It is essentially

concerned not only with ensuring that all business transactions of a
financial character are recorded, but also that they are recorded in
an orderly manner. Recording is done in the book “Journal”. This
book may be further sub-divided into various subsidiary books such
as Cash Journal (for recording cash transactions), Purchases Journal
(for recording Credit purchase of goods), Sales Journal (for recording
Credit Sales of goods), etc. The number of subsidiary books to be
maintained will be according to the nature and size of the business.

Classifying: Classification is concerned with the systematic analysis

of the recorded data, with a view to group transactions or entries of
one nature at one place. The work of classification is done in the
book termed as “Ledger”. This book contains on different pages,
individual account heads under which, all financial transactions of
similar nature are collected.

Summarising: This involves presenting the classified data in a

manner which is understandable and useful to the internal as well as
external end-users of accounting statements. This process leads to
the preparation of the following statements:

(i) Trial Balance (ii) Income Statement and (iii) Balance Sheet.

Dealing with Financial Transactions: Accounting records only

those transactions and events in terms of money which are of a
financial character. Other transactions are not recorded in the books
of account. For example, if a company has a team of dedicated and
trusted employees, it is of great use to the business; but since it is
not of a financial character and not capable of being expressed in
terms of money, it will not be recorded in the books of business.

Analysing and Interpreting: This is the final function of

accounting. The recorded financial data is analysed and interpreted
in a manner that will enable the end-users to make a meaningful
judgement about the financial condition and profitability of the
business operations. The data is also used for preparing future plans
and framing the policies for executing such plans.

Communicating: The Accounting information after being

meaningfully analysed and interpreted, has to be communicated in
a proper form and manner, to the proper person. This is done
through preparation and distribution of accounting reports, which
include – besides the usual income statement and the balance sheet
– additional information in the form of accounting ratios, graphs,
diagrams, funds flow statements, etc. The initiative, imagination and
innovative ability of the accountant are put to test in this process.

BOOK – KEEPING AND ACCOUNTING

Book – keeping is mainly concerned with recording of financial data

relating to the business operations in a significant and orderly
manner. A book-keeper may be responsible for keeping all the
records of a business or only those of a manner segment such as the
customers’ accounts in a departmental store. A substantial portion
of the book-keeper’s work is of a clerical nature and is increasingly
being accomplished through the use of mechanical and electronic
devices.
Accounting is primarily concerned with designing the systems for
recording, classifying and summarizing the recorded data and
interpreting them for internal and external end-users. Accounts
often direct and review the work of the book-keepers. The larger the
firm, the greater is the responsibility of the accountant. The work of
an accountant may include some book-keeping initially. An
accountant is required to have a much higher level of knowledge,
conceptual understanding and analytical skill than what is required
for a book-keeper.

END-USERS OF ACCOUNTING DISCLOSURES

Accounting is of primary importance to the proprietors and the

managers. However, other persons such as creditors, prospective
investors, employees, etc. are also interested in accounting
information.

Proprietors: A Business is done with the objective of making profit.

Its profitability and financial soundness are, therefore, matters of
prime importance to the proprietors who have invested their money
in the business.

Managers: In a sole proprietary business usually the proprietor is

the manager. In the case of a partnership business either some or
all the partners, participate in the management of the business.
Therefore, they act both as managers as well as owners. In case of
joint stock companies, the relationship between owners and the
management becomes all the more remote. In most cases, the
shareholders act merely as rentiers of capital and the management
of the company passes into the hands of professional managers. The
accounting disclosures greatly help them in knowing about what has
happened and what should be done to improve the profitability and
financial position of the enterprise in the period to come.

Creditors: Creditors are the persons who have extended credit to

the company. They are also interested in the financial statements
because these will help them in ascertaining whether the enterprise
will be in a position to meet its commitment towards them-both
regarding the payment of interest and of the principal.

Prospective Investors: A Person who is contemplating an

investment in a business will like to know about its profitability and
financial position. A study of the financial statements will help him in
this respect.

Government: The Government is interested in the financial

statements of a business enterprise on account of taxation, labour
and corporate laws. If necessary, the Government may ask its
officials to examine the accounting records of a business.

Employees: The Employees are interested in the financial

statements on account of various profit-sharing and bonus schemes.
The interest may further increase in case they purchase shares of
the companies in which they are employed.

Citizen: An ordinary citizen may be interested in the accounting

records of the institutions with which he comes in contact in his daily
life, e.g. bank, temple, public utilities such as gas, transport,
electricity companies, etc. In a broader sense, he is also interested
in the accounts of a government company, a public utility concern,
etc. as a voter and a tax payer.

OBJECTIVES OF ACCOUNTING

The following are the main objectives of accounting:

To keep Systematic Records: Accounting is done to keep the

systematic records of financial transactions. In the absence of
accounting there would have been a terrific burden on human
memory which in most cases would have been impossible to bear.

To protect Business Properties: Accounting provides protection

to business properties from unjustified and unwarranted use. This is
possible because, accounting supplies the following information to
the manager or the proprietor:

(i) The amount of the Proprietor’s funds invested in the business.

(ii)How much the business has to pay to others

(iii) How much the business has to recover from others

(iv) How much the business has in the form (a) Fixed assets, (b) Cash in
hand, (c) Cash at bank, (d) Stock of Raw Materials, work-in-progress
and finished goods.
 (v) Information about the above matters helps the proprietor in assuring that
the funds of the business are not unnecessarily kept idle or under-
utilised.

To ascertain the Operational Profit or Loss: Accounting helps in

ascertaining the net profit earned, or loss suffered, on account of
carrying on the business. This is done by keeping a proper record of
revenue and expenses of a particular period. The Profit and Loss
Account is prepared at the end of a period and if the amount of
revenue for the period is more than the expenditure incurred in
earning that revenue, there is said to be a profit. In case the
expenditure exceeds the revenue, there is said to be a loss.Profit
and Loss Account will help the management, investors, creditors,
etc. in knowing whether running of the business has proved to be
remunerative or not. In case if it has not proved to be remunerative
or profitable, the cause of such a state of affair will be investigated
and necessary remedial steps will be taken.

To ascertain the Financial Position of Business: The Profit and

Loss Account gives the amount of profit or loss made by the
business during a particular period. However, it is not enough. The
business man must know about his financial position, i.e. what he
owes and what he own. This objective is served by the Balance
Sheet or Position Statement. The Balance Sheet is a statement of
assets and liabilities of the business on a particular date. It serves as
a barometer for ascertaining the financial health of the business.

To facilitate rational decision making: Accounting these days

has taken upon itself the task of collecting, analyzing and reporting
information at the required points of time to the required levels of
authority, in order to facilitate rational decision-making. The
American Accounting Association has also stressed this point while
defining the term ‘accounting’, when it says that accounting is “the
process of identifying, measuring and communicating economic
information to permit informed judgments and decisions by users of
the information”. Of course, this is by no means an easy task.
However, the accounting bodies all over the world, and particularly
the International Accounting Standards Committee, have been
trying to grapple with this problem and have achieved success in
laying down some basic postulates on the basis of which the
accounting statements have to be prepared. These postulates have
been explained in the next chapter.

MODULE-2

ACCOUNTING PRINCIPLES

Accounting is the language of business through which normally a

business house communicates with the outside world. In order to
make this language intelligible and commonly understood by all, it is
necessary that it should be based on certain uniform scientifically-
laid down standards. These standards are termed as accounting
principles.

Accounting principles may be defined as those rules of action or

conduct which are adopted by the accountants universally while
recording accounting transactions. “They are a body of doctrines
commonly associated with the theory and procedures of accounting,
serving as an explanation of current practices and as a guide for
selection of conventions or procedures where alternatives exist”.
These principles can be classified into two categories:

(i) Accounting Concepts

(ii)Accounting Conventions.

Accounting Concepts
Separate Entity Concept:

In accounting, business is considered to be a separate entity from

the proprietor(s). This concept is extremely helpful in keeping
business affairs strictly free from the effect of the private affairs of
the proprietor(s). Thus, when one person invests Rs.10,000 into
business, it will be deemed that the proprietor has given that much
of money to the business which will be shown as a ‘liability’ in the
books of the business. In case the proprietor withdraws Rs.2,000
from business, it will be charged to him and the net amount payable
by the business will be shown only as Rs.8,000.

Going Concern Concept

According to this concept it is assumed that the business will
continue for a fairly long time to come. There is neither the intension
nor the necessary to liquidate the particular business venture in the
foreseeable future. On account of this concept, the accountant while
valuing the asset does not take into account the forced sales values
of the assets. Moreover, he charges depreciation on fixed assets on
the basis of their expected lives rather than on their market values.

It should be noted that the ‘going concern concept’ does not imply
permanent continuance of the enterprise. It rather presumes that
the enterprise will continue in operation long enough to charge
against income, the cost of fixed assets over their useful lives, to
amortize over appropriate period other costs which have been
deferred under the accrual or matching concept, to pay liabilities
when they become due and to meet the contractual commitments.

MONEY MEASUREMENT CONCEPT

Accounting records only monetary transactions. Events or

transactions which cannot be expressed in terms of money do not
find a place in the books of accounts though they may be very
useful for the business. For example, if a business has got a team of
dedicated and trusted employees, it is definitely an asset to the
business but since their monetary measurement is not possible,
they are not shown in the books of the business.

COST CONCEPT

This concept is closely related to the going concern concept.

According to this concept

(a) An asset is ordinarily entered in the accounting records at

the price paid to acquire it, and

(b) This cost is the basis for all subsequent accounting for
the assets.

For example, if a business buys a plot of land for Rs.50,000, the

asset would be recorded in the books at Rs.50,000 even if its market
value at that time happens to be Rs.60,000. A year later if the
market value of the asset comes down to Rs.40,000, it will ordinarily
continue to be shown at Rs.50,000 and not at Rs.40,000.
The cost concept does not mean that the asset will always be shown
at cost. It has been stated above that cost becomes the basis for all
future accounting for the asset. It means that asset is recorded at
cost at the time of its purchase but it may systematically be reduced
in its value by charging depreciation. Cost concept has the
advantage of bringing objectivity in the preparation and
presentation of financial statements. In the absence of this concept,
the figures shown in the accounting records would have depended
on the subjective views of a person.

Dual Aspect Concept

This is the basic concept of accounting. According to this concept

every business transaction has a dual effect. For example, A starts a
business with a capital of Rs.10,000. There are two aspects of the
transaction. On one hand, the business has an asset of Rs.10,000
while on the other, the business has to pay to the proprietor a sum
of Rs.10,000 which is taken as proprietor’s capital. This expression
can be shown in the form of the following

Capital (Equities) = Cash (Assets)

10,000 = 10,000

ACCOUNTING PERIOD CONCEPT

According to this concept, the life of the business is divided into

appropriate segments for studding the results shown by the
business after each segments. This is because, thought the life of
the business is considered to be indefinite (according to going
concern concept), the measurement of income and studding the
financial position of the business after a very long period would not
be helpful in taking proper corrective steps at the appropriates time.
It is the there fore absolutely necessary that after each segment or
time interval the businessman must ‘stop’ and ‘see back’ how things
are going. In accounting, such segments or time interval is called
‘accounting period’, and is usually of a year.

At the end of each accounting period, an income statement and a

balance sheet are prepared. The income statement discloses the
profit or loss made by the business during the accounting period
while the balance sheet depicts the financial of the business as on
the last day of the accounting period. While preparing this
statement a proper distinction has to be made between capital and
revenue expenditures.

PERIODIC MATCHING OF COSTS AND REVENUES CONCEPTS

This is based on the accounting period concepts. The paramount

objective of running a business is to earn profit. In order to ascertain
the profit made by the business during a period, it is necessary that
‘revenues’ of the period should be matched with the costs or
‘expenses’ of the period. The term ‘matching’ means appropriate
association of related revenues and expenses. In other words,
income made by the business during a period can be measured only
when the revenue earned during a period is compared with the
expenditure incurred for earning that revenue. The question as to
when the payment was received or made is ‘irrelevant’. For
example, if a salesman is paid commission in January, 1999 for sales
made by him in December, 1998, the commission paid to the
salesman in January, 1999 should be taken as the cost for sales
made by him in December, 1998. This means that revenues of
December, 1998 should be matched with the costs incurred for
earning that revenue, i.e. salesman’s commission, in December,
1998 (though paid in January, 1999). On account of this concept,
adjustments are made for all outstanding expenses, accrued
incomes, prepaid expenses and unearned incomes, etc., while
preparing the final accounts at the end of the accounting period.

REALISATION CONCEPT

According to this concept, revenue is recognized when a sale is

made. Sale is considered to be made at the point when goods
passes to the buyer and he becomes legally liable to pay for it. This
can be well understood with the help of the following example:

A places an order with B for supply of certain goods which are yet to
be manufactured. On receipt of the order, B purchases raw
materials, employs workers, produces the goods and delivers them
to A. A makes payment on receipt of the goods. In this case the sale
will be presumed to have been made not at the time of receipt of
the order for the goods, but at the time when goods are delivered to
A.

ACCOUNTING CONVENTIONS
Conservatism

In the initial stages of accounting certain anticipated profits which

were recorded, did not materialize. This resulted in low acceptability
of accounting figures by the end-users. Because of this reason, the
accountant follows the rule ‘anticipate no profit but for all possible
losses’ while recording business transactions. In other words, the
accountant follows the policy of “playing safe”.

Full Disclosure

According to this convention, accounting reports should disclose

fully and fairly the information they purport to represent. They
should be honestly prepared and sufficiently disclose information
which is of material interest to proprietors, to present and potential
creditors and to investors. This convention is gaining more
importance because most of the big businesses are run by joint
stock companies where ownership is divorced from management.
The Companies Act, 1956 not only requires that the Income
Statement and Balance Sheet of a company should give a true and
fair view of the state of affairs of the company but also gives the
prescribed forms in which these statements are to be prepared. The
practice of appending notes to the accounting statements (such as
about contingent liabilities or market value of investments) is in
pursuant to the convention of full disclosure.

Consistency

According to this convention, accounting practices should remain

unchanged from one period to another. For example, if stock is
valued at “cost or market price whichever is less” this principle
should be followed year after year. Similarly if depreciation is
charged on fixed assets according to diminishing balance method, it
should be done year after year. This is necessary for purposes of
comparison. However, consistency does not mean inflexibility. It
does not forbid introduction of improved accounting techniques, but
if adoption of such a technique results in inflating or deflating the
figures of profit as compared to the previous period, a note to that
effect should be given in the financial statements.

Materiality

According to this convention, the accountant should attach

importance to material details and ignore insignificant details. This
is because accounting otherwise will be unnecessarily overburdened
with minute details. The question as to what constitutes a ‘material
detail’ is left to the discretion of the accountant. Moreover, an item
may be material for one purpose but immaterial for another. For
example, while sending each debtor a statement of his account,
complete details up to praise have to be given. However, when a
statement of outstanding debtors is prepared for sending to top
management, figures may be rounded off to the nearest ten or
hundred. The Companies Act also permits ignoring of ‘praise’ while
preparing financial statements. Similarly for tax purposes, income
has to be rounded off to the nearest ten.

The term ‘materiality’ is a subjective term. The accountant should

regard an item as material if there is reason to believe that
knowledge of it would influence the decision of the informed
investor.

SYSTEMS OF BOOK-KEEPING

Book-Keeping, as explained earlier, is the art of recording pecuniary

or business transactions in a regular systematic manner. This
recording of transactions may be done according to any of the
following two systems.

Single Entry System

An incomplete double entry can be termed as a single entry system.

According to Kohler, “it is a system of book-keeping in which as a
rule only records of cash and personal accounts are maintained, it is
always incomplete double entry, varying with circumstances”. This
system has been developed by some business houses where, for
their convenience, only some essential records are kept. Since all
records are not kept, the system is not reliable and can be used only
by small business firms.

Double Entry System

The System of ‘double entry’ book-keeping which believed to have

originated with the venetian merchants of the fifteenth century is
the only system of recording the two-fold aspect of the transaction.
This has been some extent, explained while discussing the ‘dual
aspect concept’ earlier in this chapter. The system recognizes that
every transaction has a two-fold effect. If some one receives
something then, either some other person must have given it, or the
first mentioned person must have lost something, or some service
must have been rendered by him.

Accounting Equation

The double entry system of book-keeping can very well be explained

by the “accounting equation” given below:

Assets = Equities

The properties owned by a business are called ‘assets’. The rights

over the properties are called ‘Equities’. Equities may be sub-divided
into two principal types – the right of the creditors and the rights of
the owners. The equity of creditors represents debts of the business
and are called liabilities. The equity of the owners is called capital,
or proprietorship, or owner’s equity.

Thus,

Assets = Liabilities + Capital or Assets – Liabilities =

Capital

SYSTEMS OF ACCOUNTING

There are basically two systems of accounting

Cash System of Accounting

This is a system in which accounting entries are made only when

cash is received or paid. No entry is made when a payment or
receipt is merely due. Government system of accounting is mostly
on the cash system. Certain professional people record their income
on cash basis, but while recording expenses they take into account
the outstanding expenses also. In such a case, the financial
statement prepared by them for determination of their income is
termed as Receipts and Expenditure Account.

Mercantile or Accrual System of Accounting

This is a system in which accounting entries are made on the basis

of amounts having become due for payment or receipt. This system
recognizes the fact that if a transaction or an event has occurred, its
consequences cannot be avoided and therefore should be brought
into books in order to present a meaningful picture of profit earned
or loss suffered, and also of the financial position of the firm
concerned.

MODULE-3
JOURNAL

The Journal records all daily transactions of a business in the order

in which they occur. A Journal may therefore be defined as a book
containing a chronological record of transactions. It is the book in
which the transactions are recorded first of all under the double
entry system. Thus, Journal is the books of original records. The
process of recording transaction in a Journal is termed as
‘Journalising’. A proforma of a Journal is given below:

Journal

Dat Particulars L.F. Debit Rs. Credit Rs.

e
(1) (2) (3) (4) (5)

1. Date The date on which the transaction was entered is

recorded here.

2. Particulars The two aspects of transaction are recorded in

this column, i.e. the details regarding accounts which have to
be debited and credited.

3. L.F. It means Ledger Folio. The transactions entered in the

Journal are later on posted to the Ledger. Procedure regarding
 posting the transactions in the Ledger has been explained in
the succeeding chapter.

4. Debit In this column, the amount to be debited is entered.

5. Credit In the column, the amount to be credited is shown.

RULES OF DEBIT AND CREDIT

Personal Accounts

Personal accounts include the accounts of persons with whom the

business has dealings. These accounts can be classified into three
categories.

Natural Personal Accounts The term ‘Natural Persons’ means

persons who are creation of God. For example, Mohan’s Account,
Sohan’s Account, Abha’s Account, etc.

Artificial Personal Accounts These Accounts include accounts of

corporation bodies or institutions which are recognized as persons in
business dealings. For example, the account of a Limited Company,
the account of a Co-operative Society, the account of a Club, the
account of Government, the account of an Insurance Company, etc.

Representative Personal Accounts These are accounts which

represent a certain person or group of persons. For example, if the
rent is due to the landlord, an outstanding rent account will be
opened in the books. Similarly for salaries due to the employees (not
paid), an outstanding salaries account will be opened. The
outstanding rent account represents the account of the landlord to
whom the rent is to be paid while the outstanding salaries account
represents the accounts of the persons to whom the salaries have to
be paid. All such accounts are therefore termed as ‘Representative
Personal Accounts’.

The Rule is

Debit – The Receiver

Credit – The Giver

Real Accounts

Real Accounts may be of the following types:

Tangible Real Accounts Tangible Real Accounts are those which

relate to such things which can be touched, felt, measured etc.
Examples of such accounts are cash account, building account,
furniture account, stock account, etc. It should be noted that bank
account is a personal account, since it represents the account of the
banking company – an artificial person.

Intangible Real Account These accounts represent such things which

cannot be touched. Of course, they can be measured in terms of
money. For example, patents accounts, goodwill account, etc.

Debit – What Comes

Nominal Accounts In

Nominal Accounts include accounts of all expenses, losses, incomes,

and gains. The examples of such accounts are rent rates, lighting,
insurance, dividends, loss by fire, etc.

The Rule is

Debit – All Expenses

& Losses
When some prefix or suffix is added to a Nominal Account, it
becomes a Personal Account. The Table given below explains the
above rule:

Nominal Account Personal Account

1.Rent Account Rent Prepaid Account, Outstanding Rent
2.Interest Account Account
Outstanding Interest Account, Interest
3.Salary Account received in advance account, Prepaid Interest
4.Insurance Account
Account Outstanding Salaries Account, Prepaid salaries
account
5.Commission Outstanding Insurance Account, Prepaid
Account Insurance Account
Outstanding Commission Account, Prepaid
Commission Account

From the following transactions, find out the nature of account and
also state which account should be debited and which account
should be credited.

(a) Rent Paid (g) Outstanding for Salaries

(b) Salaries Paid (h) Telephone Charges

Paid

(c)Interest Received (i) Paid to Suresh

(d) Dividends Received (j) Received from Mohan

(The Proprietor)

(e) Furniture Purchased for Cash (k) Lighting

(f) Machinery Sold

Solution

Transaction Accounts involved Nature of Debit /

Accounts Credit
Rent Paid Rent A/c Nominal A/c Debit
Cash A/c Real A/c Credit
Salaries Paid Salaries A/c Nominal A/c Debit
Cash A/c Real A/c Credit
 Interest Paid Cash A/c Real A/c Debit
Interest A/c Nominal A/c Credit
Dividends Cash A/c Real A/c Debit
Received Dividends A/c Nominal A/c Credit
Furniture Furniture A/c Real A/c Debit
Purchased Cash A/c Real A/c Credit
Machinery Sold Cash A/c Real A/c Debit
Machinery A/c Real A/c Credit
Outstanding for Salaries A/c Nominal A/c Debit
Salaries Outstanding Personal A/c Credit
Salaries A/c
Telephone Telephone Charges Nominal A/c Debit
Charges Paid A/c Real A/c Credit
Cash A/c
Paid to Suresh Suresh Personal A/c Debit
Cash A/c Real A/c Credit
Received from Cash A/c Real A/c Debit
Mohan Capital A/c Personal A/c Credit
(The Proprietor
Lighting Lighting A/c Nominal A/c Debit
Cash A/c Real A/c Credit

Classification of Goods Account

The term goods include articles purchased by the business for

resale. Goods purchased by the business may be returned back to
the supplier. Similarly, goods sold by the business to its customers
can also be returned by the customers back to the business due to
certain reasons. In business it is desired that a separate record be
kept for all sale, purchase and return of goods. Hence, Goods
Account can be classified into the following categories:

(i) Purchase Account The Account is meant for recording all

purchases of goods. Goods come in on purchasing of goods
and, therefore, the Purchases Account is debited on
purchase of goods.

(ii) Sales Account The Account is meant for recording of selling of

goods. The goods go out on selling of goods, and therefore,
on sale of goods, the Sales Account is credited.

(iii)Purchases returns Account The Account is meant for recording

return of goods purchased. The goods go out on returning of
 goods to the suppliers and, therefore, the account should be
credited on returning goods purchased.

(iv) Sales returns Account The Account is meant for recording

return of goods sold, by the customers. The goods come in
and therefore the Sales Return Account should be debited
on return of goods.

The above classification of Goods Account can be shown in the

form of the following chart:

Compound Journal Entry

Sometimes there are a number of transactions on the same date

relating to one particular account or of one particular nature. Such
transactions may be recorded by means of a single journal entry
instead of passing several journal entries. Such as entry is termed as
a “Compound Journal Entry”.

Pass a Compound Journal Entry in each of the following cases:

1. Payment made to Ram Rs.1,000. He allowed a cash discount of

Rs.50.

2. Received cash from Suresh Rs.800 and allowed him Rs.50 as

discount.

3. A running business was purchased by Mohan with following

assets and liabilities: Cash Rs.2,000, Land Rs.4,000, Furniture
Rs.1,000, Stock Rs.2,000, Creditors Rs.1,000, Bank Overdraft
Rs.2,000.

Solution
 Journal

Sl. Particulars L.F. Debit Credit

No. Rs. Rs.
1. Ram 1,050
Dr. 1,000
To Cash A/c 50
To Discount
(Being payment made to Ram
Rs.1,000 and he allowed Rs.50
as discount)
2. Cash A/c 800
Dr. 50
Discount A/c 850
Dr.
To Suresh
(Being cash received from
Suresh Rs.800, and discount
allowed Rs.50)
3. Cash A/c 2,000
Dr. 4,000
Land A/c 1,000
Dr. 2,000
Furniture A/c 1,000
Dr. 2,000
Stock A/c 6,000
Dr.
To Creditors
To Bank Overdraft
To Capital A/c
(Being commencement of
business by Mohan by taking
over a running business)

Journalise the following transactions. Also state the nature of each

account involved in the Journal entry.

1. Dec.1, 1998, Ajit started business with Cash Rs.40,000.

2. Dec.3, He paid into the Bank Rs.2,000.

3. Dec.5, He purchased goods for cash Rs.15,000.

4. Dec.8, He sold goods for cash Rs.6,000.

5. Dec.10, He purchased furniture and paid by Cheque Rs.5,000.

 6. Dec.12, He sold goods to Arvind Rs.4,000.

7. Dec.14, He purchased goods from Amrit Rs.10,000.

8. Dec.15, He returned goods to Amrit Rs.5,000.

9. Dec.16, He received from Arvind Rs.3,960 in full settlement.

10. Dec.18, He withdrew goods for personal use Rs.1,000.

11. Dec.20, He withdrew cash from business for personal use

Rs.2,000.

12. Dec.24, He paid telephone charges Rs.1,000.

13. Dec.26, Cash paid to Amrit in full settlement Rs.4,900.

14. Dec.31, Paid for stationary Rs.200, Rent Rs.500 and

salaries to staff Rs.2,000.

15. Dec.31, Goods distributed by way of Free Samples

Rs.1,000.

Journalise the following transactions in the books of a trader. Debit

Balances on Jan.1, 1999:

Cash in Hand Rs.8,000, Cash at Bank Rs.25,000, Stock of Goods

Rs.20,000, Furniture Rs.2,000, Building Rs.10,000, Sundry Debtors:
Vijay Rs.2,000, Anil Rs.1,000, and Madhu Rs.2,000. Credit Balances
on Jan.1, 1999:

Sundry Creditors: Anand Rs.5,000, Loan from Bablu Rs.10,000.

Following were further transactions in the month of January, 1999:

2. Jan. 1, Purchased goods worth Rs.5,000 for cash less 20%

trade discount and 5% cash discount.

3. Jan. 4, Received Rs.1,980 from Vijay and allowed him Rs.20

as discount.

4. Jan. 6, Purchased goods from Bharat Rs.5,000.

 5. Jan. 8, Purchased plant from Mukesh for Rs.5,000 and paid
Rs.100 as cartage for bringing the plant to the factory and
another Rs.200 as installation charges.

6. Jan. 12, Sold goods to Rahim on Credit Rs.600.

7. Jan. 15, Rahim became insolvent and could pay only 50 paise
in a rupee.

8. Jan. 20, Paid salary to Ratan Rs.2,000.

9. Jan. 21, Paid Anand Rs.4,800 in full settlement.

10. Jan. 26, Interest received from Madhu Rs.200.

11. Jan. 28, Paid to Bablu interest on Loan Rs.500.

12. Jan. 31, Sold Goods for cash Rs.500.

13.Jan. 31, Withdrew goods from business for personal use Rs.200.

LEDGER

Ledger is a book which contains various accounts. In the other

words, Ledger is a set of accounts. It contains all accounts of the
business enterprise, whether Real, Nominal or Personal, and may be
kept in any of the following two forms:

(i) Bound Ledger and (ii) Loose – Leaf Ledger.

Currently, the common practice is common to keep the Ledger in

the form of Loose-Leaf Cards. This helps in posting transactions
particularly when mechanized system of accounting in used.

POSTING

The term “Posting” means transferring the debit and credit items
from the Journal to their respective accounts in the Ledger. It should
be noted that the exact names of accounts used in Journal should be
carried to the Ledger.

Suppose salaries of Rs.10,000 have been paid in cash, the following

entry will be passed in the Journal:
 Salaries Account (i) Dr. 10,000

To Cash Account (ii)

10,000

Dr. Salaries Account

Particulars Rs. Particulars Rs.

To Cash A/c (ii) 10,000

Cash Account

Particulars Rs. Particulars Rs.

By Salaries A/c (i) 10,000

Journalise the following transactions, post them in the Ledger and

balance the accounts on 31st January.

1. Ram started business with a capital of Rs.10,000

2. He purchased goods from Mohan on credit Rs.2,000.

3. He paid cash to Mohan Rs.1,000

4. He sold goods to Suresh Rs.2,000.

5. He received cash from Suresh Rs.3,000.

6. He further purchased goods from Mohan Rs.2,000.

7. He paid cash to Mohan Rs.1,000.

8. He further sold goods to Suresh Rs.2,000.

9. He received cash from Suresh Rs.1,000.

TRIAL BALANCE

The various debit balances and the credit balances of the different
accounts are put down in a statement, which is termed a ‘Trial
Balance’. In other words, Trail Balance is a statement containing the
various ledger balances on a particular date. For example, with the
balances of the ledger accounts prepared in Illustration 4.2, a Trail
Balance can be prepared as follows:

TRIAL BALANCE

As on 31st January

Particulars Debit Rs. Credit

Rs.
Cash Account 12,000
Capital Account 10,000
Purchase Account 4,000
Mohan 2,000
Sales Account 4,000
16,000 16,000
OBJECTS OF PREPARING A TRAIL BALANCE

Checking of the Arithmetical Accuracy of the Accounting

Entries

As indicated above, Trial Balance helps in knowing the arithmetical

accuracy of the accounting entries. This is because, according to the
dual aspect concept, for every debit there must be an equivalent
credit. Trial Balance represents a summary of all ledger balances
and therefore, if the two sides of the Trail Balance tally, it is an
indication of the fact that the books of account are arithmetically
accurate. Of course, there may be certain errors in the books of
account in spite of an agreed Trail Balance. For example, if a
transaction has been completely omitted from the books of account,
the two sides of the Trail Balance will tally, in spite of the books of
account being wrong. This will be discussed in detail in a separate
chapter.

Basis for Financial Statements

Trail Balance forms the basis for preparing financial statements such
as the Income Statement and the Balance Sheet. The Trail Balance
represents all transactions relating to different accounts in a
summarized form for a particular period. In case the Trail Balance is
not prepared, it will be almost impossible to prepare the financial
statements as stated above to know the profit or loss made by the
business during a particular period or its financial position on a
particular date.

Summarised Ledger

It has already been stated that a Trail Balance contains the Ledger
balances on a particular date. Thus, the entire ledger is summarized
in the form of a Trail Balance. The position of a particular account
can be judged simply by looking at the Trail Balance. The Ledger
may be seen only when details regarding the accounts are required.

SUB DIVISION OF JOURNAL

In a big business, recording of all transactions in one Journal will not

only be inconvenient but also cause delay in collecting information
required. The Journal is, therefore, sub-divided into many subsidiary
books. This sub-division results in the following advantages:

Convenience: As stated above maintenance of a single Journal for

all transactions will make it quite bulky and difficult to handle. Sub-
division of Journal will result in reducing the size of Journal and
making it convenient to handle.

Division of Labour: Sub-Division of Journal helps in division of

Labour since each journal can be written by a different person.

Classified Information: Each Journal provides information relating

to a particular aspect of the business. For example, a Purchases
Journal gives information about the total credit purchases made by
the business. Similarly a Sales Journal gives information about the
total credit sales made by the business. Thus, the businessman gets
the information relating to different aspects of the business in a
classified form in the shortest possible time.
FINAL ACCOUNTS

The Accuracy of the books of account is determined by means of

preparing a Trail Balance. Having determined the accuracy of the
books of accounts, every businessman is interested in knowing
about two more facts. They are: (i) Whether he has earned a profit
or suffered a loss during the period covered by the Trail Balance (ii)
What is his current financial position.

The determination of the Profit or Loss is done by preparing Trading

and Profit and Loss Account otherwise known as an Income
Statement. The Financial position is judged by means of preparing a
Balance Sheet of the business. The Two statements together are
termed as Final Accounts. As the term indicates Final Account
means which are prepared at the final stage and which reflect the
financial position of the business.
Trading and Profit and Loss Account: The Trading and Profit and
Loss Account is a final summary of such accounts which discloses
the profit or loss position of the business other words, the account
contains items of Income and Expenses relating to a particular
period. The account is prepared in two parts – (i) Trading Account
and (ii) Profit and Loss Account

TRADING ACCOUNT

The Trading Account gives the overall result of trading i.e,

purchasing and selling of goods. In other words, it explains whether
purchasing of goods and selling them has proved to be profitable for
the business or not. It takes into account on the one hand the cost of
goods sold and on the other the value for which they have been
sold. In case the sales value is higher than the cost of goods sold,
there will be a profit; while in a reverse case, there will be a loss.
The profit disclosed by the Trading Account is termed as Gross
Profit. Similarly the loss disclosed by the Trading Account is termed
as Gross Loss.

The Trading Account can be prepared in the following form.

Trading Account

Dr. for the Period ending 31-12-1989

Cr.

Particulars Rs. Particulars Rs.

To Opening Stock …. By Sales less Returns ….
To Purchases less …. By Closing Stock ….
Returns …. ….
To Direct Expenses …. ….
PROFIT AND LOSS ACCOUNT

Profit and Loss Account considers all such expenses and incomes
and gives the net profit made or loss suffered by a business during a
particular period. It is generally prepared in the following form:

Profit and Loss Account

Dr. for the year ending….

Cr.

Particulars Rs. Particulars Rs.

To Gross Loss b/d …. By Gross Profit b/d ….
To Salaries …. By Discount received ….
To Rent …. By Net Loss
To Commission …. transferred to Capital ….
To Advertisements …. A/c
To Bad Debts ….
To Discount ….
To Net Profit
Transferred to Capital ….
Account
…. ….

From the following balances, taken from the Trail Balance of Shri
Suresh, prepare a Trading and Profit and Loss Account for the year
ending 31st Dec., 1998:

Particulars Dr.Rs. Cr.Rs.

Stock on 1.1.1998 2,000
Purchases and Sales 20,000 30,000
Returns 2,000 1,000
Carriage 1,000
Cartage 1,000
Rent 1,000
Interest Received 2,000
Salaries 2,000
General Expenses 1,000
Discount 500
Insurance 500
The Closing Stock on 31 December, 1998 is Rs.5,000.
st

BALANCE SHEET

A businessman will like to know the financial position of his business.

For this purpose, he prepares a statement of his assets and liabilities
as on a particular date. Such a statement is termed as “Balance
Sheet”. Thus, Balance Sheet is not an account but only a statement
containing the assets and liabilities of a business on a particular
date.
The Balance Sheet has two sides. On the left hand side, the
“liabilities” of the business are shown and on the right hand side,
the “assets”. These two terms have been explained later in the
chapter.

It will be useful here to quote definitions of the Balance Sheet given

by some prominent writers. According to Palmer, “The Balance
Sheet is a statement at a given date showing on one side the
trader’s property and possessions and on the other side his
liabilities”. According to Freeman, “A Balance Sheet is an itemized
list of the assets, liabilities and proprietorship of the business of an
individual at a certain date”. The definition given by the American
Institute of Certified Public Accountants makes the meaning of
Balance Sheet more clear. According to it, Balance Sheet is “a list of
balances in the asset and liability accounts. This list depicts the
position of assets and liabilities of a specific business at a specific
point of time”.

From the following balance extracted from the books of M/s

Rajendra Kumar Gupta & Co., pass the necessary closing entries,
prepare a Trading and Profit and Loss Account and a Balance Sheet.

Particulars Rs Particulars Rs
Opening Stock 1,250
Plant and Machinery 6,230
Sales 11,800
Returns Outwards 1,380
Depreciation 667
Cash in hand 895
Commission (Cr.) 211
Salaries 750
Insurance 380
Debtors 1,905
Carriage Inwards 300
Discount (Dr.) 328
Furniture 670
Bills Receivable 2,730
Printing Charges 481
Wages 1,589
Carriage Outwards 200
Returns Inwards 1,659
Capital 9,228
Bank Overdraft 4,000
Creditors 1,780
Purchases 8,679
Bills Payable 541
Petty Cash in hand 47
Bad Debts 180
The value of Stock on 31 December, 1998 was Rs.3,700.
st

ADJUSTMENT ENTRIES

Sometimes after the Books of Account are closed and the Trial
Balance is prepared, the accountant may come to know of certain
adjustments which have to be made in the books of account, to give
a true picture of the state of affairs of the business. These
adjustments usually relate to the following:

1. Closing Stock

2. Outstanding Expenses

3. Prepaid Charges

4. Outstanding or Accrued Income

5. Income received in Advance or Unearned Income

6. Depreciation

7. Bad Debts.

8. Provision for Bad Debts.

9. Provision for discount on debtors

10. Reserve for discount on creditors

11. Internet on Capital

12. Interest on Drawings.

TREATMENT OF ITEMS OF ADJUSTMENT APPEARING OUTSIDE THE TRIAL

BALANCE

If any item of adjustment appears outside the Trial Balance, it will be shown at
two appropriate places in the final accounts. The treatment of such items has
been shown below:

Treatment of Items of Adjustments Appearing Outside the Trial Balance

Treatment in
Item of Treatment in Treatment in
Adjusting Entry Profit & Loss
Adjustment Trading A/c Balance Sheet
A/c
(a) Closing Closing Stock Dr. Shown on the X Shown on the
Stock To Trading A/c Credit Side assets side as a
Current Asset
(b) Outstand Respective Added to the Added to the Shown on the
ing Expenses A/c Dr. respective direct respective liabilities side as a
Expenses To Outstanding expense on the indirect expense Current Liability
Expenses A/c debit side on the debit
side
(c) Prepaid Prepaid Deducted from Deducted from Shown on the
Expenses Expense A/c Dr. the respective the respective Assets side as a
(Unexpired To Respective direct expense on indirect expense Current Asset
Expenses Expense the debit side on the debit
side
(d) Accrued Accrued X Added to the Shown on the
Income (or Income A/c Dr. respective Assets side as a
Income To Respective Income on the Current Asset
earned but Income A/c Credit Side
not
received) or
Outstanding
Income
(e) Unearne Respective X Deducted from Shown on the
d Income (or Income A/c Dr. the respective liabilities side as a
Income To Unearned Income on the Current Liability
received in Income A/c Credit Side
advance)
(f) Deprecia Depreciation A/c Dr X Shown on the Shown on the
tion To Respective debit side as a assets side by
Asset A/c separate item way of deduction
from the value of
respective Fixed
Asset.
(g) Addition Bad Debts A/c Dr X Shown on the Shown on the
al Bad Debts debit side by Assets side by
way of addition way of deduction
to Bad Debts from the amount
(inside the Trial of Sundry
Balance) (If no Debtors.
Provision for
Doubtful Debts
is maintained)
or shown on the
debit side of
Provision
Account is
maintained)
(h) Provisio P & L A/c Dr. X Shown on the Shown on the
n for To Provision for debit side as a asset side by way
Doubtful Doubtful separate item of Deduction from
Debts Debts A/c the amount of
Sundry Debtors
(Net of additional
bad debts)
(i) Provisio P & L A/c Dr. X Shown on the Shown on the
n for To Provision for Debit Side as a Asset Side by way
Discount on Discount on Separate Item of deduction from
Debtors Debtors A/c the amount of
Sundry Debtors
(Net of additional
bad debts &
Provisions for
doubtful debts)
(j) Reserve Reserve for X Shown on the Shown on the
for Discount Discount on Credit side as a liabilities side by
on Creditors Creditors A/c Separate Item way of deduction
To P&L A/c Dr. from the amount
of Sundry
Debtors
(k) Interest Interest on X Shown on the Shown on the
on Capital Capital A/c Dr. Debit Side as a liabilities side by
 To Capital A/c Separate Item way of deduction
from the Capital
(l) Interest Capital A/c Dr. X Shown on the Shown on the
on Drawings To Interest on Credit Side as liabilities side by
Drawings a Separate Item way of deduction
from the Capital
(m) Manager’ Manager’s X Shown on the Shown on the
s Commission Dr. Debit Side as a liabilities side as a
Commission To Outstanding Separate Item Current Liability
on Profit Commission A/c
(n) Abnorma Loss of Stock A/c Dr Total Value of Total value of The amount due
l Loss of To Trading A/c abnormal loss of irrecovered loss from the insurance
Stock stock (Whether or of stock is company is shown
not recovered) is shown on the on the assets side
shown on the Debit Side as a as a Current
credit side as a separate item Asset
separate Item
(o) Goods (i) Sales A/c Dr. Shown on the X (i) Shown on the
sent on To Debotors A/c (S.P) Credit Side by asset side by way
Approval way of Deduction of deduction
from sales from debtors

(ii) Stock with Dr. Shown on the X (ii) Shown on the

Customers A/c (Cost) Credit Side by Assets side by
To Trading A/c way of addition way of addition to
to Closing Stock closing stock in
in hand hand
(p) Goods in Goods in Dr Shown on the X Shown on the
Transit Transit A/c Credit side by way assets side by
To Trading A/c of addition to way of addition to
closing stock in closing stock in
hand hand
TREATMENT OF ITEMS OF ADJUSTMENT APPEARING IN THE TRIAL
BALANCEIf any item of adjustment appears inside the Trial Balance, it will be
shown at one appropriate places in the final accounts. The treatment of such
items has been shown below:

Treatment of Items of Adjustments Appearing Inside the Trial Balance

Treatment in Profit and Loss

Item given in Trial Balance Treatment in Balance Sheet
A/c or Other Account
(a) Closing Stock --- Shown on the Assets side as a
Current Asset
(b) Outstanding Expenses / --- Shown on the Liabilities side as
Accrued Expense a Current Liability
(c) Prepaid Expense --- Shown on the Assets side as a
Current Asset
(d) Accrued Income --- Shown on the Assets side as a
Current Asset
(e) Unearned Income --- Shown on the Liabilities side as
a Current Liability
(f) Depreciation Shown on the debit side of P &L ---
A/c as a Separate item
(g) Bad Debts if no provision Shown on the debit side of P &L ---
for Doubtful Debts A/c A/c as a Separate item
appears
(h) Bad Debts if provision for Shown on the debit side of ---
Doubtful Debts A/c Provision for Doubtful Debts A/c
 appears
(i) Discount allowed if no Shown on the debit side of P &L ---
provision for Discount on A/c as a Separate item
Debtors A/c appears
(j) Discount allowed if Shown on the debit side of ---
provision for Discount on Provision for Discount on
Debtors A/c appears Debtors A/c
(k) Discount Received if no Shown on the debit side of P &L ---
Reserve for Discount on A/c as a Separate item
Creditors A/c appears
(l) Discount Received if Shown on the credit side of ---
Reserve for Discount on Reserve for Discount on creditors
Creditors A/c appears A/c
(m)Interest on Capital Shown on the debit side of P &L ---
A/c as a Separate item
(n) Interest on Drawings Shown on the debit side of P &L ---
A/c as a Separate item

1. The following is the Trial Balance of Mr.Wise as at 31st March 20X2

Additional Information

(a) Closing Stock as on 31st March 20X2 was Rs.42,000.

(b) Rent is payable at the rate of Rs.300 per month.

(c) Insurance Premium was paid for the year ending on 30th June 20X2.

(d) Write off further Rs.5,000 as bad.

(e) Create Provision for discount on Debtors @ 2%

 (f) Create a Provision for Doubtful debts @ 10%

(g) Create a Reserve for discount on Creditors @ 2%

(h) Provide for depreciation on fixed assets @ 10 p.a.

Required Prepare Trading and Profit and Loss Account for the year ending on
31st March 20X2 and a Balance Sheet as at 31st March 20X2.

2. A Book Keeper has submitted to you the following Trial Balance wherein the
totals of the Debit and Credit balances are not equal.

Particulars Dr.(Rs) Cr.(Rs)

Capital……………………………………………………………. --- 7,670

Cash in --- 30
hand…………………………………………………….. 8,990 ---
Purchases……………………………………………………… --- 11,060
… 885 ---
Sales………………………………………………………………. 225 ---
. 1,500 ---
Cash at bank……………………………………………………. 65 ---
Fixtures and --- 825
Fittings…………………………………………….. --- 30
Freehold 1,075 ---
Premises………………………………………………. --- 1,890
Lighting and 5,700 ---
Heating………………………………………….. 3,000 ---
Bills 225 ---
Receivable………………………………………………….. 1,875 ---
Returned 190 ---
Inward………………………………………………... 445 ---
Salaries…………………………………………………………… - 2
. -- 00
Creditors…………………………………………………………. 24,175 21,705
.
Debtors……………………………………………………………
Stock at 1 April
20X1……………………………………………
Printing……………………………………………………………
.
Bills
Payable………………………………………………………
Rates, Taxes &
Insurance………………………………………
Discounts
Received…………………………………………….
Discount Allowed……………………………………………….

You are required to

(i) Redraft the Trial Balance correctly as at 31st March 20X2.

 (j) Prepare a Trading and Profit and Loss Account and a Balance Sheet after
taking into account the following adjustments.

a. Stock on hand on 31st March 20X2 was valued at Rs.1,800.

b. Depreciate Fixtures and Fittings by Rs.25.

c. Rs.35 was due and unpaid in respect of Salaries.

d. Rates and insurance had been paid in advance to the extent of

Rs.40.

3.The following Trial Balance has been extracted from the books of Shri Santosh
Kumar on 31st March 20X2

Particulars Dr.(Rs) Cr.(Rs)

Plant and Machinery…………….……………………………. 1,00,000 ---

Furniture and Fixtures…………………. 12,000 ---
……………………….. 2,000 1,76,000
Capital Account / Drawing Account.……………………… 20,000 ---
Loose 10,000 ---
Tools……………………………………………………….. 20,000 ---
Goodwill…….……………………………………………………. 8000 4,000
Opening Stock (1.4.20X1) --- 6,000
…………………………………….. 2,12,000 4,68,000
Returns…………………………………………………………… 1,00,000 ---
. --- 2,000
Discount………………. 12,000 ---
………………………………………….. 41,600 ---
Purchases / 72,000 ---
Sales……………………………………………….. 14,400 ---
Wages and Other Expenses.. 4,000 ---
………………………………... --- 20,000
Provision for Doubtful Debts. 56,000 24,000
…………………………………. 2,000 ---
Carriage 14,0 -
Inwards……………………………………………….. 00 --
Salaries. 7,00,000 7,00,000
……………………………………………………………
General Expenses and
Insurance……………………………
Rent and
Taxes………………………………………………….
Postage and Telegrams.
………………………………………
Bank Overdraft………….………………………………………
Sundry Debtors /
Creditors…………………………………….
B.Barua……………………………………………………………
.
Cash and Bank
Balances……………………………………...
The following additional information is available.

(a) Stock on 31st March 20X2 was Rs.30,800.

(b) Depreciation is to be charged on Plant and Machinery at 5 p.a . and

Furniture and Fixtures at 6 p.a Loose Tools are revalued at Rs.16000.

(c) Provision for Doubtful debts is to be maintained at 5 on Sundry Debtors.

(d) Remuneration of Rs.2,000 paid to Mr.B.Barua a temporary employee,

stands debited to his personal account and it is to be corrected.

(e) Unexpired insurance was Rs.400.

Required Prepare Trading and Profit and Loss Account for the year ended 31st
March 20X2 and a Balance Sheet as on that date.
MANUFACTURING ACCOUNT

In the preceding pages, we have explained the preparation of the

Trading and Profit and Loss Account from the point of view of a
trade, i.e. a person who purchases and sells goods. However, a
person may manufacture goods by himself for selling them at a
profit. In case of such a person, i.e., a manufacturer, it will be
necessary to ascertain the cost of manufacturing the goods. In his
case, therefore, the profit or loss made by him will be ascertained by
preparing the following three accounts:

(i) Manufacturing : This account gives the cost of the goods

manufactured by a manufacturer during a particular period.

(ii) Trading Account : This account gives information about

the gross profit or loss made by a manufacturer in selling
the manufactured goods. In case a manufacturer also
functions as a trader, i.e. besides manufacturing and selling
goods of his own, he also purchases and sells goods of
other, he will be a manufacturer-cum-trader. In such a case,
his Trading Account will disclose not only the profit made by
him on selling his manufactured goods, but also the profit
made by him in selling the goods purchased by him from
others.
 (iii)Profit and Loss Account : This account gives the overall
profit or loss made or suffered by the manufacturer-cum-
trader during a particular period. The proforma of a
Manufacturing Account is given below:

MANUFACTURING ACCOUNT

Dr. For the year ending……

Cr.

Particulars Rs. Particulars Rs.

To Work-in-progress ……. By Work-in-progress …….
(Opening) (Closing) …….
To Raw Material By sale of Scrap
consumed: By Cost of Production of
Opening Stock Finishing goods during
…… the …….
Add: Purchases of Raw ……. Period transferred to the
Materials ……. Trading Account
…… …….
Less: Closing Stock of …….
Raw Materials …….
……. …….
To Direct or Productive
wages
To Factory Overheads:
Power and Fuel
Repairs of Plant
Depreciation on
Plant
Factory Rent ……. …….

The Trading Account in case of a manufacturer will appear as

follows:

TRADING ACCOUNT

Dr. For the year ending……

Cr.

Particulars Rs. Particulars Rs.

To Opening Stock of By Sales less Returns …….
Finished ……. By Closing Stock of Finished …….
Goods Goods
To Cost of Production of By Gross Loss c/d*
finished …….
goods transferred from ……. …….
Manufacturing Account …….
To Purchases of Finished …….
Goods less: Returns …….
To Carriage Charges on …….
goods
Purchased
To Gross Profit c/d*

Factory Rent ……. …….

*Only one figure of Profit or Loss will appear.

The Gross Profit or Loss shown by the Trading Account will be taken
to the Profit and Loss Account which will be prepared in the usual
way as explained in the preceding pages.

IMPORTANT POINTS REGARDING MANUFACTURING ACCOUNT

1. Stock : In case of a manufacturer, there can be stocks

of three types:

(i) Stock of Raw Materials : It includes stock of raw

materials or finished components which might have been
purchased by the manufacturer for using them in the
products manufactured by him but still lying unsold.

(ii) Stock of Work-in-process : This is also termed as

stock of work-in-progress. It includes goods in semi-finished
form.

(iii)Stock of Finished Goods : It includes stock of those

goods which have been completely processed and are lying
unsold at the end of a period with the manufacturer. It also
includes stock of those finished goods which might have
been purchased by a manufacturer-cum-trader from outside
parties, but still lying unsold with him at the end of the
accounting period.

2. Raw Materials Consumed :

It is customary to show
in the Manufacturing Account, the value of raw materials
 consumed for manufacturing goods during a particular period.
This is computed as follows:

Opening Stock of Raw Materials ……

Add: Purchase of Raw Materials ……

……
Less: Closing Stock of Raw Materials ……
Raw Materials Consumed ……

For example, if the opening stock of raw materials is Rs.5,000,

purchases of raw materials is Rs.20,000 and closing stock of Raw
materials is Rs.8,000, the value of raw materials consumed will be
calculated as follows:

Rs. Rs.
Opening Stock of Raw Materials 5,000
Add: Purchase of Raw Materials 20,000
25,000
Less: Closing Stock of Raw Materials
8,000
Raw Materials Consumed
17,000

3. Carriage Inwards, etc. : The expenses incurred for

bringing the raw materials to the factory or the octroi or
customs duty paid by the manufacturing on the raw materials
purchased or imported by him will also be charged to
Manufacturing Account.

4. Factory Overheads : The term “Overheads”

includes indirect material, indirect labour and indirect
expenses. The term “Factory Overheads”, therefore, stands for
all factory indirect material, indirect labour, and indirect
expenses. For example, in case of a manufacturer of chairs,
the cost of timber purchased will be taken as indirect material
and will be taken as an item of factory overheads. Similarly,
 the wages paid to the carpenters who have been employed for
making chairs will come as cost of direct labour since they are
actively engaged in manufacturing the chairs. However, the
salaries of the supervisor or the wages of the gatekeeper will
be taken as indirect labour cost and come in the definition of
factory overheads. Similarly the carriage charges paid for
bringing the raw materials to the factory are considered to be
direct charges since they can directly be charged to the raw
materials purchased. However, the rent for the factory,
depreciation of the factory machines, insurance of the factory
are all taken as indirect factory expenses and, therefore,
covered under the category of factory overheads.

5. Cost of Production : The Manufacturing Account

gives the cost of manufacturing the goods during a particular
period. This is computed by deducting from the total of the
debit side of the Manufacturing Account, the total of the
various items appearing on the credit side of Manufacturing
Account as shown in the proforma of the Manufacturing
Account given earlier in the chapter.

6. Sale of Scrap : In Manufacturing operations,

certain scrap is unavoidable. It may or may not have any sales
value. In order to calculate the true cost of manufacturing the
goods, it is necessary that the money realized on account of
sale of scrap (or realizable value of the scrap in case it had not
been sold) should be considered. The amount of scrap is,
therefore, credited to the Manufacturing Account.

1. From the following details prepare a Manufacturing and a Trading

Account for the year ending 31st December, 1998.

Rs.
Stock on 1.1.1998
Raw Materials
10,000
Work-in-process 5,000
 Finished goods 20,000
Stock on 31.12.1998
Raw Materials 5,000
Work-in-process 15,000
Finished goods 30,000
Purchase of Raw Materials
50,000
Direct Wages
10,000
Carriage Charges on purchase of Raw Materials
5,000
Factory Power 5,000
Depreciation on Factory Machines
5,000
Purchase of Finished Goods 30,000
Cartage paid on Finished Goods purchased
2,000

2. The Trial Balance of Jagfay Corporation, New Delhi, as on

30.9.1999 is as below:

Particulars Amount
Rs.
Capital Account (including Rs.5,000)
(Introduced on 1.4.1999) 22,500
Stock as on 1.10.1998
Finished Goods 3,500
Work-in-progress 7,000
Raw Materials 3,000 13,500
Purchase of Raw Material 70,500
Machinery 22,500
Sales 1,26,225
Carriage Inwards 750
Carriage Outwards 450
Rent (including Rs.450 for the factory 1,350
premises) 105
Rabates and Discounts allowed 210
Fire Insurance (for machinery) 18,900
Sundry Debtors 5,100
Sundry Creditors 60
Reserve for Bad and Doubtful Debts 180
Printing and Stationary 840
Miscellaneous Expenses 4,500
Advertisement 1,800
Drawings of Proprietor 5,400
Office Salaries 6,000
Manufacturing Wages 2,250
Furniture and Fixtures 300
Factory Power and Fuel 600
Cash in hand 3,750
Balance with Bank of Bikaner Ltd., (Dr.)

Adjustments

(i) Provide for interest @ 10% per annum on Capital (No interest
on drawings need be provided).

(ii)A motor car purchased on 1.4.1999 for Rs.6,000 has been

included in “Purchases”.

(iii) Provide depreciation:

Machinery @ 10% p.a., Motor Car @ 20% p.a., Furniture and

Fixtures @ 10% p.a.,

(iv)Provision for unrealized rent in respect of a portion of the

office sublet at Rs.50 per month from 1.4.1999 has to be
made.

(v)Sundry Debtors include bad debts of Rs.400 which must be

written off.

(vi)Provision for Bad and Doubtful Debts as on 30.9.1999 should

be maintained at 10% of the Debtors.

(vii) A Sum of Rs.2,000 transferred from the Current Account

with Bank of Bikaner Ltd., to Fixed Deposit Account on
1.2.1999 has been passed through books. Make suitable
adjustments and provide for accrued interest @ 6% p.a.
 (viii) Stock as on 30.9.1999.

Finished goods Rs.5,000, Raw Materials Rs.1,000, Work-in-

progress Rs.5,500.

Prepare the Manufacturing, Trading and Profit and Loss Account for
the year ended 30.9.1999 and Balance Sheet as on that date after
making the necessary adjustments (Journal entries are not required)
 BANK RECONCILIATION STATEMENT

Causes of Difference

The following are the causes of difference between the balance as

shown by the bank pass book and the balance as shown by the
firm’s cash book.

(i) Cheques issued but not presented for payment The Firm
issues cheques from time to time for making different
payments. As soon as a cheque is issued, the firm debits the
party’s account in whose favour the cheque is issued and
credits the bank’s account. However, the bank comes to
know of issue of such cheques only when they are
presented for payment. The bank, therefore debits the
firm’s account only when the cheque is actually presented
for payment. It may therefore, be possible that on a
particular date when the bank is submitting the firm’s
statement of account, it may not include certain cheques
which have been issued by the firm because they may not
have yet been presented. Thus, the balance shown by the
bank’s books in the firm’s account will be higher than the
balance shown by the firm’s books in the bank account. For
example, a firm issues a cheque in favour of a creditor on
28th December, 1998 for a sum of Rs.10,000. The Cheque is
presented by the creditor on 3rd January, 1999 for payment.
In case, the bank submits a statement of account to the firm
 upto 31st December,1998, there will be a difference of
Rs.10,000 between the balance as shown by the firm’s
books and the balance as shown by the pass book.

(ii) Cheques sent for Collection but not yet Collected A Firm
receives from time to time cheques from its customers
which is sent to its bankers for collection and for crediting
the proceeds to its account. The firm debits the account of
the bank as soon as it sends the cheques to the bank for
collection. However, the bank gives credit to the firm only
when the cheques are actually collected. Thus, on a
particular date it may be possible that certain cheques
which were sent for collection by the firm to the bank may
not have been collected by the bank and therefore not
credited to the firm’s account. The two balances – the
balance as shown by the bank passbook and the firm’s
cashbook – will therefore be different. For example, if a firm
sends a cheque Rs.5,000 on 25th December, 1998 to the
bank for collection which is collected by the bank on 5th
January, 1999, in the statement of account which may be
submitted by the bank for the year ending 31 st December,
1998, there will be no credit to the customer for the cheque
which it has not yet collected. Thus the balance shown by
the firm’s cash book will be different from the balance
shown by the firm’s cash book will be different from the
balance as shown by the bank pass book.

(iii)Bank Charges The bank its customers for the services it

renders to them from time to time. The bank may charge its
customer for remitting funds at his instruction from one
place to another. It may also charge for collecting outstation
cheques or bills of exchange of its customer. The bank debts
the customer’s account as soon as it renders such a service.
However a customer will know of such charges only when he
receives a statement of account from the bank. Thus, on a
particular date, the balance shown by the bank passbook
may be different from the balance shown by the cashbook.

(iv) Direct Collections on behalf of Customers A banker

may receive amounts due to the customer directly from
customer’s debtors. For example, the banker may get
 dividends, rents, interest, etc. directly from the persons
concerned on account of standing instructions of the
customer to such persons. The bank gives credit to the
customer for such collections as soon as it gets such
payments. However the customer comes to know of such
collections only when he receives the statement of account
from his banker. Thus, the balance shown by the bank
passbook and the firm’s cashbook may not be the same on
account of this reason.

(v) Errors There may be errors in the account maintained by the

customer as well as the bank. A wrong credit or debit may
be given by the customer or the bank. The two balances,
therefore, may not tally.

MEANING AND OBJECTIVE OF BANK RECONCILIATION

STATEMENT

A Bank Reconciliation Statement is a statement reconciling the

balance as shown by the bank passbook and the balance as shown
by the Cashbook. The objective of preparing such a statement is to
know the causes of difference between the two balances and pass
necessary correcting or adjusting entries in the books of the firm. It
should be noted that every variation or difference does not require
an adjusting or correcting entry. Some reasons for difference are
automatically adjusted. For example, a cheque that has been sent
for collection, but not yet collected, causes a difference between the
balance as shown by the bank passbook and the balance as shown
by the cashbook, but no adjusting entry is required in the cashbook
for such a difference because the bank will credit the firm’s account
as soon as the cheque is collected. This is only a question of time.
However, if the cheque sent for collection to the bank has been
returned by the bank on account of it being dishonored, the firm
should pass an adjusting entry for return of this cheque if it has not
already been passed. Similarly, the firm has also to pass in its books,
the entries for bank charges or direct payments received by the
bank on behalf of the firm.