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Notes on Book keeping and Accountancy

Book Keeping
It is the systematic method of recording transactions in a set of books. It is the technique and
device of entering transactions in the books of account in terms of money. In the words of
Northcott “Book-keeping is an art of recording in the books of account the monetary aspect of
commercial or financial transactions”.
Object of Book keeping
1. Ascertaining the result of trading of the business for a period.
2. Measuring the financial position of the business on a particular date.
3. Supplying necessary information for making management decisions
4. Aiding to assess the progress of the business
5. Minimizing errors and frauds
6. Ensuring a complete and permanent record of all the transactions
Advantages of bookkeeping
1.It helps to find out the profit or loss for a definite period.
2 It enables to measure the financial condition of the business on a particular date.
3 It provides necessary information for managerial decisions.
4 It shows the amounts due to the business from different persons and institutions and the
amounts due by the business to various parties.
5 It helps to find out the reasons for changes in profits
6 It facilitates the easy disposal of assets
7 It helps to get loans from financial institutions.
8 It helps for easy determination of tax liabilities
9 It prevents frauds and manipulations
Systems of bookkeeping
1. Single Entry System: The term single entry is used to describe the method of
maintaining accounts, which does not exactly follow the principles of Double Entry
System. It is 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
Advantages:
1. It is simple and can be operated without perfect accounting knowledge.
2. Since the numbers of account books are limited, the expenses of recording
transactions are minimum.
3. This system is quite suitable to service institution like hospitals, schools and small
business establishments.
Disadvantages:
1. No basis to check arithmetical accuracy as there is no scope to compare the debits and
credits.
2. It is not possible to ascertain the correct amount of profit and loss of the business for the
period as the nominal accounts are not kept.
3. Balance sheet will not reveal the true financial positions as the values placed on assets
and liabilities cannot be relied upon.
4. Chances of committing errors and frauds are more.

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Double Entry System: This was developed by an Italian named Luco Paciolli in 1494
AD. This is a method of recording transactions, that is universally applied in business
accounting, in which each transactions is recorded as a debit in one account and an equal
credit in another account., So the system depend on the basic principles that for every
debit there must be an equal and corresponding credit
Advantages:
1. It helps in the preparation of Trial Balance at the end of a period, with which accuracy of book
keeping can be established.
2. Profit or loss of the business for a period can be correctly estimated.
3. The balance sheet as on a particular date can be prepared without difficulty. Moreover the
balance sheet prepared under this system shows the exact financial position.
4. The system enables to make both internal and external comparisons and provides reliable
information for efficient management and control of the business.
5. Double entry system minimises the chances for misappropriation and manipulation.
Business transaction: Any exchange of money or money’s worth as goods and services
between two or more persons is called business transaction., It involves giving benefit in one
form and receiving benefit in another form., For instance, when goods are sold, the trader
receives cash and gives goods, when salary is paid, the trader gets services for which cash is
paid
Difference between single entry system and double entry system
Double entry system Single entry system
1. Both debit and credit aspects of all Some transactions are not recorded at all while some
transactions are recorded transactions are recorded in only one of their aspects,
– either debit aspect or credit aspect, and there are
some transactions which are recorded in the same
manner as they are recorded under double entry
system
2. Various subsidiary books are No subsidiary book except cash book is maintained
maintained

3. The ledger contains personal, real as The ledger contains some personal accounts only
well as nominal accounts
4. Arithmetical accuracy of accounts can It is not possible
be ascertained by preparing trial balance
5.Income statement and balance sheet Only a rough estimate can be prepared of profit
are prepared in a scientific manner earned or loss incurred and only a statement of affairs
can be prepared which does not present a
scientifically correct financial position.
Systems of accounting:
1. Cash System: When transactions are recorded only at the time of actual receipt
or payment of cash.
2. Mercantile System: When transactions are recorded as and when they are due,
irrespective of receipt or payment of cash
3. Mixed System: The trader records all cash transactions and some important
credit transactions like credit purchases and credit sale of goods and other assets.
Unlike mercantile system, the mixed system ignores accrued expenses and
incomes. This system is also known as “Hybrid System”

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Journal/Book of original entry/Book of prime entry/Day book

The book that is used to recorded transactions first, as when it occurs, is called a journal.
Transactions are recorded in the journal daily, in the order of their occurrence. The journal
shown the names of accounts and the amounts to be debited and credited in respect of each
transaction. The process of making entries in the Journal is known as “Journalising”. After
each journal entry, a brief description of the transactions is given, it is known as “Narration”
Journals are two types: General Journal and Special Journal. Transactions which do no not
occur frequently are recorded in the General Journal. A special journal is prepared to record
transactions of similar nature to save expense and avoid complications.
The books of original entry are:
i. Journal
ii. Cash book – single column, double column and petty cash book
iii. Other day books:
a. Purchases book
b. Sales book
c. Purchase returns book
d. Sales return book
e. Bills receivable book
f. Bills payable book
The following are the important special journals:
1. Purchase Day book: For recording all credit purchases of goods
2. Sales Day Book: For recording all credit sales of goods
3. Purchase Returns Book: For recording goods returned to the suppliers
4. Sales Returns Book: For recording goods returned by the customers
5. Cash Book: For recording all cash transactions
6. Bills receivable book: For recording all Bills Received from customers
7. Bills payable book: For recording acceptance given to suppliers
8. Journal proper: For recording transactions which are not entered in any of the
special journals. It is an ordinary journal used to record those transactions which
cannot be recorded in any of the special journals. E.g. Credit purchase and sale of
assets, opening entry and closing entry
Ledger
The term ledger is derived from Dutch word “legger” which means to lie. It is a book in which
various accounts lie. All the individual accounts recorded in the journal are written in the
ledger. Ledger is the principal or important book of any organisation because it provides a
summarised record of all transactions of the period. A ledger may be defined as “ a collection
of individual accounts”
Ledger accounts can be classified into Permanent accounts and temporary
Accounts.
Permanent accounts: accounts of assets, liabilities and capital(personal and real accounts)
are permanent accounts. These accounts are not closed during the course of the business. All
these accounts will appear in the Balance Sheet, unless the asset is sold or discarded or the
persons settled his accounts with the business.
Temporary accounts: Accounts of expenses (or loss) and income are closed and transferred
to trading and profit and loss account at the end of the accounting period. All nominal

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accounts are temporary accounts. These accounts will not show opening balance on the
opening date of the next accounting period as there is no closing balance on the closing date.
Format of a ledger
Dr Cr
Date Particulars J/F Amount Date Particulars J/F Amount
(Rs) (Rs)

To xxxxxxxxxxxxx By xxxxxxxxxx
Balancing of accounts:
After posting the transactions from the journal into the ledger the accounts are balanced
periodically to ascertain the cumulative effect of the debit and credit entries in the ledger.
Balance in an account means the difference between amount entered on the debit and credit
sides of the account. Balancing is the process of ascertaining of the difference between the
total of the amounts in the debit side and credit side of an account.
If the total of the debit side exceeds the total of the credit side, the account shows a debit
balance. If the total of the credit side exceeds the total of the debit side, the account shows a
credit balance. If the total of the two sides are equal, the account is said to be in balance.
Difference between Journal and Ledger
Journal Ledger
1. It is the book of original or primary entry It is the book of secondary entry in which the
in which all the transactions are recorded transactions recorded in the journal are
first posted
2. Supported by a source document Supported by Journal only
3. It is a chronological record of business It is an analytical record of transactions
transactions
4. Journal is not balanced Ledger is balanced
5. It does not give an idea about the It givens an idea about individual accounts
individual accounts
6. The process of recording a transaction in Recording of a transaction in the ledger is
the journal is called Journalising called posting

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Accounting
According to the American Institute of Certified Public Accountants, “Accounting is the Art of
recording, classifying and summarizing in a significant manner and in terms of money,
transactions and events which are at least of financial character and interpreting the results
thereof.” Modern Accounting is often called the language of business. The basic functions of
accounting are communicating the results of the business operations to various parties who are
interested in it. The persons interested in accounts are (i) Shareholders, (ii) Investors (iii)
Creditors, (iv) Labour (v) Government (vi) Researchers
The objectives of Accounting
The most important objective of accounting is to provide information to the interested users to
enable them to make decisions. The others objectives include:
a. Maintenance of records of business
b. Calculation of profit or loss
c. Depiction of financial position and
d. Making information available to various groups.
Assets
Cash or any valuable owned by the business that can be converted into cash or anything
beneficial to the future operations of business can be termed as an asset. Assets may be
either fixed or current. Assets which are acquired and employed by Business Concerns for
comparatively longer period of time are called fixed asset. Eg. Land and Building, Machinery,
Furniture etc.
Assets which are held for a short period are known as current assets. Such assets are
expected to be realized in cash or consumed during the normal operating cycle of the business.
Stock of goods, debtors, cash etc. is examples of current assets. Current assets are also called
floating assets or circulating assets.
Fixed Assets - Capital Assets
Current Assets - Circulating Assets, Floating Assets.
Liabilities
Liabilities are the obligations or debts payable by the enterprises in future in the form of money
or goods. It is the proprietors’ or creditors’ claim against the assts of the business. Liabilities
can be grouped under short term liabilities and long term liabilities.
Liabilities which become due and payable within a period of one year are called short term
liabilities. Creditors, bills payable, outstanding expenses etc. are examples of such obligations.
On the other hand liabilities which need not be discharged or paid off within a period of 12
months but remain in the business for a longer period is called long term liabilities.
Debentures, long term loans etc. are examples of fixed liabilities.
Opening Entry
Opening entry is an entry passed on the opening date of an accounting year in order to bring
down the assets and liabilities of a business from the previous year to the current year. In
opening entry all assets are debited and liabilities are credited. The excess of assets over
liabilities is considered as the capital of the proprietor.
Compound Journal Entry
Sometimes a number of transactions relating to one particular account and of similar nature
are taken place on the same day; such transactions may be recorded by means of a single
journal entry instead of passing several entries. Such an entry with more than one debit or
credit or both is called a compound journal entry.

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Accounting Concepts or Assumptions.

Accounting concepts refers to certain necessary assumptions or conditions on which the

accounting system is based. These assumptions provide a foundation for the accounting
process. No enterprise can prepare financial statements without considering these
assumptions. The following are some of the major and generally accepted concepts:

1. Accounting entity concept. Under this concept, it is assumed that Business Unit is
distinct and completely separate from its owners. The Business is treated as a unit or
entity separate from the parsons who controls it. Accounts are maintained for
business entity as distinguished from all categories of persons associated with it. The
proprietor is treated as a creditor to the extent of the amount invested by him on the
assumption that he has given money and the business has received it.

2. Going concern concept. As per this concept, the business unit is assumed to have
an indefinite life; it is deemed that there is no intention or necessity to wind up the
business activity in the immediate future. Hence the firm is treated as a going
concern.

3. Money measurement concept. As per this concept, transactions that can be

measured in terms of money only are recorded in the books of accounts. This helps to
record different kinds of economic activities on a uniform basis. The basic purpose of
using money is to apply an element of uniformity among diversity.

4. Verifiable objective concept. It expresses that accounting data must be capable of

verification. They are subject to verification by independent experts known as Auditors.
Therefore all transactions should be supported by documentary evidences such as
invoices, vouchers, etc.

5. Accounting period concept. The period of interval for which account is kept for
ascertaining the result of business during the period is called accounting period.
Generally the results are ascertained at short intervals. Usually a period of 365 days or
52 weeks is considered as fair interval. The performance of a business unit is
measured by matching the cost incurred during the accounting period against the
revenue earned during that period.

Accounting Conventions or Principles.

The term convention denotes a rule of practice which by common consent is employed in the
solution of a particular class of problem. Placing debits on the left hand side and credits on the
right hand side of an account is an example of convention. These conventions refer to an
accounting procedure followed by accountants all over the world on the basis of year old
customs. The following are the major principles used in the accounting procedure.

1. Principle of revenue realization.

This principle deals with the points of time at which the revenue is taken as earned. It
says that revenue is realized when goods are transferred or services are rendered to a
customer. An advance payment received from customers is not treated as revenue earned

2. Expense or cost.

According to this principle assets are recorded in the books of accounts at the price at
which they are acquired. All subsequent transactions in relation to this is made on the
basis of the recorded cost.

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3. Matching principle.

In order to ascertain the profit or loss of a business, the cost incurred during the
accounting period must be matched against the revenue earned during that period. All
expenses incurred during the relevant period may not be related to that period alone. Expenses
relating to the previous period or to the subsequent period might have been incurred during
the period under reference. Likewise, the entire amount of revenue received may not be of
the current period. As per the matching concept, only those expenses pertaining to the current
accounting period must be matched against the revenue relating to the same period.
4. Convention of Disclosure
This convention suggests that all accounting statements must be prepared honestly
and must contain all relevant material information. It implies that the published financial
statements must fully disclose the true and fair view of the state of affairs of the concern for a
particular period or on a particular date. Adequate disclosure creates confidence in those who
are interested in the affairs of the enterprise.
5. Dual Aspect.
This is the basic principle of accounting. According to this principle each and every
transactions has two aspects, ie. a giving aspect and a receiving aspect. The system of
recording business transaction on the basis of this concept is called Double Entry System. This
principle states that for every debit there is a corresponding credit. The relationship of assets
and liabilities is termed as accounting equation in this concept:
Capital = Assets – Liabilities.
Classification of accounts:
a. Personal Accounts, ie. accounts of persons (creditors, customers, etc,)
b. Impersonal Accounts”:
(i) Real Accounts ie. Accounts old properties and assets, and
(ii) Nominal Accounts, ie. Accounts of incomes, expenses and losses.

Basic Rules of Accounting

The three basic rules about recording transactions are:
a. Debit the receiver and
- Personal Accounts
credit the giver

b. Debit what comes in

- Real Accounts
and credit what goes out

c. Debit all expenses (and losses) and

- Nominal Accounts
credit all incomes (and gains).

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Cash Discount and Trade Discount

When a customer buys goods in a large quantity the seller may allow him a discount which is
called trade discount. In the invoice, trade discount is deducted from the list price of the
goods sold and the customer is debited only with the net amount. The cash discount is
allowed for payment within a stipulated period.
Trade Discount Cash Discount
1. It is allowed to encourage buyers to buy It is allowed to encourage the buyers of
goods in large quantities goods to make payment at an early date
2. It is reduction in the list price granted by It is a reduction in the amount payable for
the supplier either because of a trade payment within a certain period
practice or for purchases exceeding a
certain quantity
3. It is allowed at the time of purchase It is allowed at the time of payment for the
purchase
4. It is shown as a deduction in the invoice It does not appear in invoice
5. In the ledger, there is no trade discount Cash discount account is maintained in the
account ledger
Classification of Expenditure.
Depending on the period for which the benefit of an item of expense lasts, expenses can be
classified into
1. Capital expenditure
2. Revenue expenditure
3. Deferred revenue expenditure
Capital expenditure
An expenditure incurred to derive long term advantage is a capital expenditure. It is the
amount spent for acquisition of an asset or for increasing the earning capacity of a business.
Purchases of fixed assets, addition to the building, cost of removing the business to more
spacious and better suited building etc. are examples of such expenditure. Such expenses are
taken to Balance Sheet and are determined by the fact whether
The expenditure is made for the purpose of acquiring fixed assets
The expenditure results in some more or less long term benefits to the business
The exependiture increases the earning capacity of the business or reduces working expenses,.
Revenue expenditure
If the benefit of an item of expenditure lasts only for a period of 12 months, then it can be
referred to as an item of revenue expenditure. Such expenditure is incurred to maintain the
revenue earning capacity of the business. Payment of salary, rent, selling expense, amount
spend for purchase of raw materials, etc. come under this category. Such item appear in the
Trading and Profits and loss account,.
Deferred Revenue Expenditure.
It is the expenditure which would normally be treated as revenue expenditure. But it is not
written off in one accounting period as its benefits is not completely exhausted in the year in
which it is incurred. A part of the amount is charged to P&L account of each year and balance
is carried forward to subsequent years as deferred revenue expenditure and is shown as asset

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in the balance sheet. Eg. Heavy advertisement expenses, preliminary expenses, underwriting
commission, discount on issue of shares and debentures
Discount
A discount is a reduction or concession allowed either on selling price of goods or on the
amount due. Discounts are of two kinds (i) Trade Discount and (ii) Cash Discount.
Trade Discount - Deduction from the list price or catalogue price, usually allowed by the
wholesaler to retailer on bulk purchases is called Trade Discount. It is deducted in the invoice
from the list price and the net amount only is recorded in the books of the accounts.
Cash Discount - It is the reduction allowed by the creditor to the debtor usually on making
prompt payment. Such a reduction is an expense to the creditor who allows it and an income
to the debtor who make the payment at a lesser amount
Depreciation
Depreciation is a permanent continuing and gradual shrinkage in the book value of a fixed
asset. It is defined as a permanent and continuing diminution in the quantity or value of an
asset.
Causes of depreciation
(a) Wear and tear: The decrease in the value, efficiency and utility of fixed asset by
constant use is termed as depreciation due to wear and tear.
(b) Expiry of time: There are certain assets like lease hold property, patents, copy rights
etc. that are acquired for a particular period. On expiry of the period their value ceases
to exist.
(c) Obsolescence: Obsolescence is the loss in the value of an asset which arises out of
new invention.
(d) Depletion: Assets such as mines, quarries, etc. are of wasting nature. By extraction
of natural deposits, their value is reduced. This reduction in value of natural deposits
due to depletion is a cause of depreciation.
(e) Non-use: Machines which lie idle becomes less useful with the passage of time.
Importance or need for providing depreciation.
Depreciation is provided with the following objectives:
(i) To ascertain true profit
(ii) To ascertain true value of an asset
(iii) Provision of funds for replacement of assets
(iv) Ascertaining accurate cost of production
(v) To ensure that dividend is distributed only out of profit
(vi) Avoiding excess payment of Income Tax.
Trial Balance:
A Trial Balance is a list of all the balances in the ledger accounts of a concern at any given
date. It is a device to check the arithmetical accuracy of the entries in the ledger accounts.
Under double entry system every debit has a corresponding and equal credit. So the total of all
the debits must be equal to all credits. A trial balance may be described as a schedule or list of
balances, both debit and credit, extracted from all the accounts in the ledger and including
cash and bank balances taken from the cash book.

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Objectives of preparing the trial balance:

1. It is a check on the accuracy of postings. If the trial balance agrees, it can be assumed
that both the aspects of all the transactions have been correctly posted in the ledger.
2. It brings at one place, the balances of the accounts which facilitates the preparation of
final accounts.

Distinction between trial balance and balance sheet

Trial Balance Balance Sheet
1.Contents: Trial balance is a statement showing Balance sheet is a statement showing
debit and credit balances of all the assets and liabilities of the firm as on a
ledger accounts as on a particular date, particular date, it contains personal; and
it contains balances of personal, real as real accounts only
well as nominal accounts
2. Purpose: The purpose of preparing trial balance is Balance sheet is prepared to show the
to test the arithmetical accuracy of the financial position as on a particular date
books of accounts
3. Frequency: Trial balance is prepared much more Balance sheet is mostly prepared only at
frequently; it may be prepared weekly, the end of the accounting year
monthly, quarterly or half yearly. It is
definitely prepared at the end of the
accounting year before preparing the
final accounts
4. Use: Trial balance is prepared for internal use Balance sheet is prepared for internal
only use as well as external use; balance
sheet is always a part of published
accounts.

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Rectification of Errors.
If books of accounts are properly maintained according to the principles of double
entry system, both the debit and credit columns of the trial balance must be equal. In case
both these sides are not equal, there may be some errors in accounting. Accounting errors are
mistakes and omissions made unknowingly while recording transactions in books of accounts.
On the basis of nature, errors can be classified into the following categories.
1 Errors of Commission
2. Errors of Omission
3. Errors of Principle
4. Compensating Errors.
Errors of Commission
Errors committed when transactions are incorrectly recorded are called errors of commission.
These are the errors caused by wrong posting, wrong totaling, wrong balancing or carry
forwarding etc. Most of these errors of commission are reflected in the trial balance and hence
their location is easier
Errors of Omission.
When a transaction is not entered in the books of original entry or not posted from the original
entry to the ledger, an error of omission is caused. The omission may be complete or partial.
If a transaction is not entered in the subsidiary books, it is a case of complete omission as the
postings in the ledger accounts are also omitted. In an error of complete omission, as both the
debit and credit aspects go unrecorded, it does not affect the agreement of Trial Balance.
If only one aspect of a transaction is recorded, it is a case of partial omission. It happens while
postings from day book to ledger accounts; this will affect the agreement of trial balance.
Errors of principle.
If any accounting principle is violated in recording a transaction, it is an error of principle.
Errors of principle are committed in those cases where a proper distinction between revenue
and capital items is not made ie. A capital expenditure is taken as revenue expenditure or vice
versa. Similarly, a capital receipt may have been taken as a revenue receipt or vice versa.
Such errors by themselves do not affect the agreement of trial balance.
Compensating Errors.
Compensating errors are those errors which compensate each other. When two or more errors
are committed in such a way that the net effect of those errors on the debit and credit of
accounts in nil, compensating errors occur. These errors do not affect the agreement of trial
balance.
Errors which affect the Trial Balance
These are errors which affect one account only. These errors can be rectified by giving an
explanatory note or by passing a correcting entry with the help of a suspense account. These
errors are also called clerical errors:
1. Error in casting (totaling) of subsidiary books
2. Error in posting to the correct account but wrong side or posting to the correct
account but with wrong amount or posting to the wrong side with wrong amount
3. Error in carry forward or error in balancing
4. Error of partial omission

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Errors which do not affect the Trial Balance

These are errors which affect two or more accounts. Such errors can be rectified by posting a
journal entry by giving correct debit and credit to the concerned accounts. The errors which do
not affect the trial balance are:
i. Errors of complete omission: An error of omitting a transaction from recording
in the journal, it can be corrected by passing a fresh journal entry. If it is an
error of omission to post an entry to the ledger, it can be rectified by posting
to the ledgers.
ii. Error or recording When a wrong amount is recorded in the book of original
entry, it is the case of errors of recording. Such an error can be rectified by
passing a journal entry for the difference amount. Eg. A credit sale of Rs. 1000
to Aruna is recorded as Rs. 100. This results in shortage of Rs. 900 in two
accounts, viz. Aruna and Sales. This can be rectified by passing the following
entry:
Aruna Dr 900
To Sales 900
(Error in short recording of sales to Aruna now accounted)
iii. Error of posting to the correct side but of wrong account
This type of error is committed when posting is done to the correct side of a
wrong account. Eg. Credit sale of Rs. 750 to N. Ram is posted to M. Ram’s
account. In such cases, N. Ram’s account will be less by Rs. 75 and M. Ram’s
account will be more by Rs. 750. This can be rectified by following entry:
N. Ram Dr 750
To M. Ram 750
(Wrong positing of sales to M. Ram
rectified by transferring to N. Ram)
iv. Errors of principle
v. Compensating errors
Suspense Account
The suspense account is a temporary account opened to post the difference in trial balance
until it is closed when the errors are located and corrected. It is opened to rectify those errors
which affect the trial balance. So it shows the net effect of all one sided errors. Amount in the
suspense account is placed on the amount column of the trial balance which is found to be
shorter, to make the trial balance tally. Subsequently, when the one sided errors are located,
they are rectified by giving corresponding debit or credit to the suspense account. When all
the errors have been located and corrected, the suspense account will be wiped off. But if
some of the errors could not be located, the suspense account will show a balance. Such
balance in suspense account will be shown on the Balance Sheet on the Asset side (if the debit
balance) or on the Liabilities` side (if credit balance)

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Cash Book
Cash book is the most important subsidiary book of a business. It is used to record all
transactions relating to cash receipts and cash payments. A cash book is maintained by all
organizations irrespective of its size( big or small) and nature (profit making or not profit
making).
A cash book is a journal as well as a ledger. It is a journal because it is the book of original
entry in which cash transactions are first recorded. It is a ledger because it is drawn in the
form of an account and when a cash book is maintained no separate cash account is prepared.
A cash book always shows a debit balance or nil balance because actual payment can be
effected only when there is cash available. All receipts(capital or revenue) are recorded on the
debit side and all payments (capital or revenue) are recorded on the credit side of the cash
book.
Types of Cash Book
1. Single column or simple cash book
2. Double column cash book or cash book with cash and bank column
3. Three column cash book or cash book with cash, bank and discount columns
4. Cash book with cash and discount columns
5. Cash book with bank and discount columns
6. Petty cash book
1. Single column cash book: A cash book which contains only one column for amount
on either side is called a single column cash book. Its form is similar to a ledger
account. All receipts, capital and revenue, is recorded on the debit side of the cash
book and all payments on the credit side.
Contra Entry
If the debit and credit aspect of a transaction is recorded in both sides of an account or a
statement, it is called a contra entry, or a contra item. In cash book with cash and bank
column, payment of cash and cheques into bank and withdrawal from bank for office purpose
are contra entries
Eg. Deposit of cash and cheques into the bank
Bank account Dr
To Cash account ( C )
Withdrawal of cash from bank for business use
Cash account Dr
To Bank ( C )
Petty cash book
`1n every business, many payments of small amounts are frequently made for
postage, traveling, carriage, stationery, etc. Inclusion of all these payments in main cash book
will make the cash book unwieldy and bulky. Hence, a petty cash book is maintained to record
day to day small expense. A petty cashier will be appointed to handle such expenses. He will
record all his payments in a cash book called petty cash book
Mode of operation of petty cashier
a. At the beginning of a specified period, the main cashier advances certain amount called
imprest to the petty cashier
b. The petty cashier effects payments up to a prescribed limit and records the same daily in
the petty cash book

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c. At the end of the period he submits his account to the main cashier with vouchers for
petty payments and receives fresh advances. This process is called recoupment of
imprest.
The imprest system:
Under this system, a definite amount called imprest money will be advanced to the cashier at
the beginning of the period,. The petty cashier goes on making small payments from the
imprest money. At the end of the specified period, the petty cashier submits his accounts to
the main cashier with vouchers and gets reimbursement of the amount he spent. The
maximum amount which a petty cashier is authorized to keep at any time for meeting small
payment is called Imprest Money or cash float.
Bank Reconciliation Statement.
Banks usually gives their customers a true copy of their accounts with them. The copy of the
accounts of a customer given by the bank showing the transaction with it is known as the pass
book. All receipts for the customers are credited in the pass book and all payments for him are
debited in it.
If bank columns of the cash book of a trader shows debit balance, his pass book show credit
balance. This is a case of deposit balance. If the bank column of the cash book shows credit
balance, his pass book should show a debit balance and it is a case of bank overdraft.
If transactions recorded by the trader in the bank column of his cash book and those appearing
in his pass book are the same, both the books should show the same amount of balance, but
in practice, these two balances do not agree. Then it is needed to prepare a reconciliation
statement between them.
Reconciliation statement is a statement prepared by a customer of a bank, showing the causes
of disagreement of cash book and pass book as on a particular date. It is prepared to bring the
cash book balance in agreement with the balance as per pass book.
Causes of difference between Cash book and pass book balance.
Balance as per cash book or overdraft as per pass book:
1. Cheques issued but not presented for payment
2. Cheques paid in for collection but not collected.
3. Direct payment by a customer to the bank
4. Interest on deposit credited by the bank
5. Interest, dividend, rent etc., collected by bank
6. Payments made on behalf of the customer
7. Bank charges as per pass book
8. Bills receivable discounted, but dishonoured
9. Interest on overdrafts debited in pass book
10. Bill of exchange, Promissory Notes and other credit instruments collected by Bank
11. Errors at the time of recording
Contingent liabilities
A contingent liability is one which is not an actual liability on the date of balance sheet. Though
it is not an actual liability on the date of the balance sheet it may become an actual liability
later on the happenings of an event which is not certain. Such a liability may be due to past
dealings or action which may or may not become a legal obligation. The uncertainty as to
whether there will be any legal obligation differentiates a contingent liability from an actual
liability. Examples of contingent liabilities are Bills receivable discounted with bankers but not
matured, Guarantee given on behalf o others liabilities against the firm not acknowledged as
debt, uncalled liability on partly paid up shares, arrears of fixed cumulative divided etc.

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System of accounting
The following are the main systems of recording business transactions:
1. Cash System Under this system actual cash receipts and actual cash payments are
recorded. Credit transactions are not recorded at all until the cash is actually received
or paid. The receipts and payments account prepared in the case of non-trading
concerns can be cited as the best example of cash system. The system being based
on a record of actual cash receipts and actual cash payment will not be able to disclose
correct profit or loss for a particular period and will not exhibit true financial position of
the business on a particular day,
2. Mercantile (Accrual) System: Under this system all transactions relating to a period
are recorded in the books of account ie. in addition to actual receipts and payment of
cash, income receivable and expenses payable are also recorded. This system give a
complete picture of the financial transactions of the business as it makes a record of all
transactions relating to a period. The system being based on a complete record of the
financial transaction discloses correct profit or loss for a particular period and also
exhibits true financial position of the business on a particular day.
Distinction between Receipts and Payments account and income and
expenditure account
Receipts and Payments Account Income and Expenditure account
1. It is a real account It is a nominal account
2. It is prepared in non-trading concerns in It is prepared in non-trading concerns in lieu of
lieu of cash book Profit and Loss account
3. Its debit side show receipts and credit Debit side shows expenses and losses and
side shows payments credit side shows income and gains
4. It starts with opening balance of cash in There is no opening balance and closing
hand or cash at bank and ends with closing balance. The difference between the two sides
balance of cash or bank shows either surplus or deficit.
5. All items whether of capital or revenue Only revenue items are taken into consideration
nature are recorded
6. All receipts and payments whether Only current period
relating to the current period, succeeding
or preceding periods are taken into
consideration
7. It is not accompanied by a Balance It is accompanied by a Balance Sheet
Sheet
8. No adjustments are required to be made In order to find out the true income or
at the end of the year expenditure of the current year, necessary
adjustments are made at the end of the year
9. It is prepared on the basis of cash It is prepared on the basis of mercantile system
system of accounting of accounting
Provision and reserves
Provision and reserves are used in different senses in accounting terminology. The term
“Provision” means any amount written off or retained by way of providing for depreciation or
retained by way of providing for a known liability, the amount of which may not be determined
with substantial accuracy. If the amount of such liability can be ascertained it will be a liability
and not a provision eg. Provision for depreciation, provision for taxation, provision for bad debt
and doubtful debts.

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Any sum which is appropriated out of profit and is not meant to cover up liability, contingency
commitment or reduction in the value of an asset is a reserve. It is provided for meeting
prospective losses or liabilities, creation of reserve is to increase the working capital in the
business and strengthening its capital reserve and revenue reserve.
a. Capital Reserve: Any reserve which is created out of capital profits as against trading or
revenue profit and is not readily available for distribution as dividend is called capital reserve.
Profits prior to incorporation, premium on the issue of shares or debentures, profit on reissue
of shares etc. are examples.
b. Revenue Reserve: Any reserve which is available for distribution as dividend to the
shareholders is called revenue reserve. General reserve dividend equalization reserve,
contingency reserve are examples.
Distinction between provision and reserve
The following are the main points of distinction between a provision and a reserve:
1. Provision is a charge in the profit and loss accounts where as reserve is an
appropriation of profit.
2. Provision is made because of legal necessity but creating a reserve is a matter of
financial prudence and save the concern from prospective losses and liabilities
3. Provision is created for some specific object and must be utilized for the object for
which it is created. Reserve is created for probable losses and can be used for any future
liabilities ort loss.
4. Provisions cannot be distributed as profits or transferred to any general reserve.
Reserve can be distributed as profit if they remain unutilized for some period.
5, Provision reduces the net profit. Reserves reduce divisible profit.
Secret Reserve
A secret reserve is a reserve the existence and or the amount of which cannot be disclosed in
the balance sheet. Secret reserves are created in those concerns where public confidence is
required for its working like banking companies, insurance companies etc. Such reserves are
created by showing the assets at a lower figure and liabilities at a higher figure. Some of the
ways of creating secret reserves are:
(i) by charging excessive depreciation
(ii) by under valuing stock in trade and general works
(iii) by creating excessive or unnecessary provision for bad bets and other contingencies
(iv) by charging capital expenditure to Profit and Loss Account
(v) by suppressing sales
(vi) by showing contingent liabilities a real liability
General reserve and special reserve
General reserve are those reserves which are not created for any specific purpose and are
not available for any future contingency or expansion of the business. These are created to
provide additional working capital and strengthening the financial position of the concern.
Specific reserves are those reserves which are created for a specific purpose and can be
utilized only for that purpose. Dividend equalization reserve, debenture redemption reserve
are examples.

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Features of receipts and payments account

1. It is real account
2. It is classified summary of cash book generally uniting cash and bank items
3. All receipts are debited and all payments are credited
4. It usually begins with opening balance of cash in hand at bank and ends with closing
balances of cash/bank
5. It does not disclose the working results
6. It includes all receipts and payments of capital and revenue nature
7. It records all receipts and payments relating to previous, current and subsequent
years.
Goodwill
Goodwill is the value of the reputation of a firm in respect of profits expected in future over
and above the normal rate of profit, It is the present value of firms anticipated excess
earnings. It is the extra value attaching to prosperous business beyond the intrinsic worth of
the net assets. It is an intangible asset. It is not visible but subject to fluctuation. It is shown
in Balance Sheet
Reserve Capital
It is that part of uncalled capital which has been reserved by the company to be called only in
the event of its winding up. It is kept to instill confidence in the creditors of the company.
Over Subscription
When shares are issued by well managed and financially sound companies, they often receive
more number of applications than that they offer through prospectus and intend to allot. This
is known as over subscription. In such case, it becomes necessary to refuse allotment to some
applicants. When there is over subscription, a company can follow any of the following
alternatives:
a. accepting the required number of applications for the shares in full and totally rejecting
the remaining applications
b. making allotment to all applicants on some basis which is known as pro-rata allotment
c. Totally rejecting some applications and making pro-rata allotment to the remaining
applicants.
Pro rata allotment: In this case, no application is fully accepted or fully rejected. Each
applicant gets allotment for certain number of shares on the basis of number of shares applied
for, number of shares that the company intends to allot and the total number of applications
received. This method is also known as proportionate or partial allotment.
Minimum subscription: The minimum subscription is the minimum amount which, in the
opinion of the directors must be raised in cash by issue of shares. The amount must be
sufficient to provide for
(i) the purchase price of any property to be acquired
(ii) any preliminary expenses; including commission, payable by the company
(iii) the repayment of any money borrowed for the above expenditure, and
(iv) working capital
No allotment shall be made of any shares of a company offered to the public unless minimum
subscription stated in the prospectus has been received. If the minimum subscription is not
received within 120 days after the date of the first issue of prospectus, then, within next 10
days all application money received must be refunded without interest.

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Issue of shares at a premium

If a company issues its shares at a price higher than its face value, it is called issue of shares
at premium. The premium on issue of shares may be collected with application money,
allotment money or call money. The amount of share premium should be credited by the
company to a separate account called share premium account, which may be applied for the
following purposes:
(i) for the issue of fully paid bonus shares
(ii) for providing premium payable on the redemption of redeemable preference
shares, and
(iii) for writing off preliminary expenses, expenses or commission paid or
discount allowed for any issue of shares of debentures of the company.
Trading and Profit and Loss Account of Mr. …..
for the yeqar ended 31st March xxxxx
Particulars Amount Particulars Amount
(Rs) ( Rs)
To Opening Stock xxxxx By Sales xxxxx
Less Sales Returns or Returns
To Purchases xxxxx Inwards xxxxx xxxxxx
Less: Purchase Returns or By Closing Stock xxxxxx
Return Outwards xxxxx By Goods Lost by Fire/Insurance
Less: Drawings (if goods are Company’s Account (with the
used for personal xxxxx xxxxxx cost of the goods destroyed.
purposes) If the Insurance Co. admits
only part claim, the difference
will be debited to Profit and
To Direct Expenses: Loss Account as Loss by Fire )
Carriage inward xxxxx
Wages xxxxx
Fuel and Power xxxxx By Gross Loss c/d
Manufacturing expenses xxxxx
Coal, Water and Gas xxxxx
Motive Power xxxxx
Octroi xxxxx
Import Duty xxxxx
Customs Duty xxxxx
Consumable Stores xxxxx
Salary of Foreman/Works
Manager xxxxx
Royalty on Manufactured
Goods xxxxx

To Gross Profit c/d xxxxx

By Gross Profit b/d

To Gross Loss b/d
By Interest Received
By Discount
To Selling and Distribution
Expenses: By Commission

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Advertisement By Rent from Tenants

Travelers’ Salaries, Expenses By Income from Investments
and Commission By Apprenticeship Premium
Bad Debts By Interest on Debentures
Godown Rent By Income from any other
Export Expenses Source
Carriage Outwards
Bank Charges By Net Loss transferred to
Agent’s Commission Capital Account
Upkeep of Motor Lorries
To Management Expenses:
Rent, Rates and Taxes
Heating and Lighting
Office Salaries
Printing and Stationery
Postage and Telegrams
Telephone Charges
Legal Charges
Audit Fees
Insurance
General Expenses
To Depreciation and
Maintenance:
Depreciation
Repairs and Maintenance
To Financial Expenses:
Discount Allowed
Interest on Capital
Interest on Loans
Discount on Bills
To Extraordinary Expenses:
Loss by fire(not covered by
Insurance)
Cash defalcations

To Net Profit transferred to

Capital A/C

xxxxxxxxx xxxxxxxx

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Balance Sheet of Mr. …. As own 31 st March xxxxxxx

Liabilities Rs. Assets Rs.

Current Liabilities Liquid Assets:
Bills Payable Cash In hand
Sundry Creditors Cash at Bank
Bank Overdraft Floating Assets:
Outstanding expenses Sundry Debtors
Income received in Advance Investments
Long term Liabilities Bills Receivable
Loan from Bank Stock in Trade
Debentures Prepaid Expenses
Outstanding or Accrued
Income
Fixed Assets:
Machinery
Building
Furniture and Fixtures
Motor Car
Fixed Liabilities
Fictitious Assets:
Capital:
Advertisement
Opening xxxx
Miscellaneous Expenses
Add Net Profit xxxx
Profit and Loss Account
Add Interest on capital xxxx
Intangible Assets
Less Drawings xxxx
Goodwill
Less Interest on Drawings xxxx xxxxxx
Patents
Copyright

Total Total

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Adjustments
1. Closing Stock :
Closing stock will appear on the asset side of the Balance Sheet and it will be shown on
the credit side of the Trading Account.
Sometimes opening and closing stocks are adjusted through purchases account. In
this case, there will be no opening stock in the Trial Balance. Adjusted purchases and closing
stock (debit balance) will be given in the Trial Balance. Adjusted purchases will be taken on
the debit side of the Trading Account and Closing Stock will be shown on the assets side of the
Balance Sheet.
2. Outstanding Expenses: Those expenses which have been incurred and are due for
payment. i.e. not paid as yet are called outstanding expenses.
Outstanding Expenses will be shown on the debit side of the trading or profit and loss
account by way of addition to the expanses and the same will be shown on the liabilities side
of the Balance Sheet
3. Unexpired or Prepaid Expenses
Those expenses which have been paid in advance ie. Whose benefit will be available in future
are called unexpired or prepaid expenses.
Prepaid expenses will be shown in the profit and loss account by way of deduction from the
expenses and these will be shown on the assets side of the Balance sheet as prepaid expenses
4. Accrued Income: That income which has been earned but not received during the
accounting year is called accrued income
It will be shown on the credit side of the Profit and Loss account by way of addition to
the income and it will be shown on the assets side of the Balance Sheet as Accrued Income
5. Income Received in Advance: Income received but not earned during the accounting
year is called as income received in advance.
It will be shown on the credit side of profit and loss account by way of deduction from income
and it is shown on the liabilities side of the Balance Sheet as income received in advance.
6. Depreciation: It is a reduction in the value of the fixed asset due to its use, wear and
tear or obsolescence.
Depreciation is shown on the debit side of Profit and Loss Account and it is shown as deduction
from the value of concerned assets.
7. Bad Debts: Debts which cannot be recovered or become irrecoverable are called bad
debts. It is a loss for the business
Bad debts will be shown on the debit side of Profit and Loss Account and shown on the assets
side of the Balance Sheet by way of deduction from Sundry Debtors
8. Interest on Capital:
Interest on capital will be shown on the debit side of Profit and Loss Account and it will be
shown on the liabilities side of the Balance Sheet by way of addition to the capital.
9. Interest on Drawings: If interest on capital is allowed it is natural that interest on
drawings should be charged from the proprietor, as drawings reduce capital.
Interest on drawings will be shown on the credit side of Profit and Loss Account and shown on
the liabilities side of the Balance Sheet by way of addition to the drawings which are ultimately
deducted from the Capital.

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10. Provision for Doubtful Debts

Further bad debts shown in the adjustments (if any) will be first deducted from debtors and
then a fixed percentage will be applied on the remaining debtors left after deducting further
bad debts. If the amount of old provision for doubtful debts is greater than the amount of bad
debts, the unabsorbed balance is deducted from the amount to be debited to Profit and loss
account on account of new provision for doubtful debts. Sometimes a large provision may
have been created but actual bad debts in the next year may be very small and further a small
provision for bad debts may be required for future. In such cases, the excess standing to the
credit of Provision for Doubtful Debts will have to be taken back to the credit of Profit and Loss
account to reduce the provision to the required level
Required Provision
Add Bad Debts
Less Existing Provision
The net amount will be debited to Profit and Loss Account
Existing Provision
Less Bad Debts
Less Required Provision
The net amount will be credited to Profit and Loss Account.
11. Provision for Discount on Debtors
It is made on debtors after deduction of further bad debts and provision for doubtful debts
because discount is allowable to debtors who intend to make the payment.
Profit and Loss Account Dr
To Provision for Discount on Debtors
Such provision will be shown on the debit side of the Profit and Loss Account and it will be
shown by way of deduction from Sundry Debtors (after deduction of further bad debts and
provision for doubtful debts) on the assets side of the Balance Sheet.
12. Reserve for Discount on Creditors:
It is shown on the credit side of Profit and Loss Account and Shown on the liabilities side of the
Balance Sheet by way of deduction from Sundry Creditors
13. Deferred Revenue Expenditure:
The expenditure done in the initial stage but the benefit of which will also be available in
subsequent years is called deferred revenue expenditure.
It is shown on the debit side of Profit and Loss Account and is shown on the assets side by way
of deduction from capitalised expense.
14. Loss of Stock by Fire
15. Reserve Fund
Reserve Fund is only out of Profit and Loss Account and thus is an appropriation of net profit
for strengthening the financial position of the business.
Profit and Loss Account Dr
To Reserve Fund
It is shown on the debit side of the Profit and Loss Account along with net profit in the inner
column and is shown on the liabilities side of the Balance Sheet. If reserve fund is already
there, it will be shown by addition to the existing reserve fund on the liabilities side of the
Balance Sheet.

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16. Goods Distributed as Free Samples

Advertisement A/C Dr
To Trading or Purchases A/C
It is shown on the credit side of the Trading Account or deducted from the purchases and is
also shown on the debit side of the Profit and Loss Account as advertisement expenses
17. Manager’s Commission
Profit and Loss Account Dr
To Commission Payable Account
If commission is payable to the manager on the net profit after charging such commission
% of Commission x Residual Profit
Commission Payable =
100 + Rate of Commision
Such commission will be shown on the debit side of the Profit and Loss Account and is shown
on the liabilities side of the Balance Sheet as commission payable.
18. Goods on Sale or approval Basis
It will be shown on the credit side of the trading account by way of deduction from the sales at
sale price and added to the closing stock at cost price, and is shown on the Assets side of the
Balance sheet as a deduction from sundry debtors (sales price) and added to stock at cost on
the Assets.
19. Hidden Adjustments:
There are certain items given in the trial balance and require adjustments though specifically
no adjustment is given relating to such items. Eg. In the Trial Balance, the following balances
are given
Dr Cr
6 % Loan on (1.4.2002) 10,000
Interest on Loan (paid during the year) 200
Actually Rs. 600 interest on loan should have been paid but only Rs. 200 have been paid and
the rest Rs. 400 is yet payable and outstanding., In order to bring this into account, the
following entry will be passed:
Interest on Loan A/C Dr 400
To Loan Account 400
The effect of this entry will be that outstanding interest on loan will be shown on the debit side
of the Profit and Loss Account by way of addition to the interest on loan and is shown on the
liabilities side of the B/S

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Bills of Exchange
A bill of exchange has been defined by Section 5 of The Indian Negotiable Instruments Act
1881 as “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”. Features of bills of exchange are:
 It is an instrument in writing
 It contains an unconditional order
 The order must be to pay money only
 The sum payable must be specific
 The money must be payable to a definite person or to his order to the bearer
 The amount must be paid within a stipulated date or on demand
 It must be signed by the maker or drawer
 The name of the drawee must be clearly mentioned in the document
 It must be dated and stamped
Accommodation Bill
Usually a bill of exchange is drawn to settle a trade debt owing to the drawer by the drawee
because the last words in the body of a bill of exchange are “for value received” Such types of
bills are known as trade bills because these are drawn to settle trade debts. But sometimes, a
bill of exchange can be accepted without consideration just to oblige friend who is temporarily
in need of money. Such a bill is discounted at the bank and cash is utilized by the friend in
need of money for the period of the bill and he will give the amount to the acceptor on the due
date to enable him to meet the bill on the due date. Such a bill is accommodation bill. An
accommodation bill is defined as “as a bill which is drawn, accepted or endorsed without
consideration but simply to oblige and help to raise money by discounting or negotiating it”.
Such bills are also known as kite bills.
Parties to a bill of exchange:
a. Drawer: A person who draws or makes a bill is called the drawer. He is the person
to whom the benefit of the bill if due ie. The seller or creditor.
b. Drawee: The person on whom the bill is drawn is the drawee. He is the person who
is liable to pay the amount in the bill. Drawee’s acceptance to the draft bill converts
it to a valid bill of exchange
c. Payee: The drawer himself or a third person who is to receive the amount of the bill
is called the payee.
Promissory Note: An instrument in writing 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, or to
the bearer of the instrument.
Difference between bill of exchange and promissory note
a. content: Bill of exchange contain an unconditional order where as a promissory
note contains an unconditional promise
b. Parties: There are three parties to a bill of exchange viz. drawer, drawee and
payee. But there are only two parties to a promissory note viz maker and payee
c. Acceptance: Acceptance of the drawee is essential to convert a draft bill to a bill of
exchange. But no separate acceptance is necessary in a promissory note
d. Maker: A bill of exchange is made by the creditor on the debtor. But a promissory
note is prepared by the debtor in favour of his creditor.

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Types of bills of exchange:

a. Inland bills: Bills drawn and payable within the geographical territory of India as well
as bills drawn upon a person residing in India are called Inland Bills

b. Foreign Bills: A foreign bill is one which is drawn and made payable in a foreign
country or drawn on a person who is residing in a foreign country., A foreign bill is
usually drawn in sets of three., each of which is called a ‘via’ when one of them is
honoured the others become treated as cancelled.

c. Accommodation Bills: An accommodation bill is not a genuine bill. It is drawn and

accepted for the purpose of providing funds by discounting the bill., Such bills are also
called ‘fictitious bills’ or ‘kite’

d. Documentary and clean bills: If documentary evidence of the amount in the bill is
attached with the bill it is called documentary bill. Documents such as bill of lading,
railway receipt, invoice etc., are necessary to take delivery of the goods. A bill which
does not carry any documentary evidence on the amount in the bill is called a clean bill

e. Demand bills: These are bills payable on demand, ie. On presentation of the bill to the
drawee. Such bills are drawn payable ‘on demand’ or ‘at sight’

f. Time bills: Time bills are drawn payable on the expiry of a specified period, say three
months.

The date on which a bills falls due for payment or the date on which the term of the bill expires
is called ‘maturity date’ or ‘due date’ of the bill. In calculating the due date of a time bill, it is
customary to add three days to the stated time of the bill. These additional three day s are
called ‘days of grace’

Retiring of a bill under rebate: In certain cases the acceptor of the bill may have sufficient
funds to pay the amount of the bill before its maturity date. In such cases the acceptor with
the consent of the holder makes payment of the bill, usually at a rebate. Such premature
discharge of bill is called ‘retiring of a bill’ Rebate on bill is an income to the drawee and
expense to the holder.

Noting and protesting: When a bill is dishonoured, the holder can get it noted buy the Notary
Public who is a person appointed by the court. The Notary Public, on receipt of the
dishonoured bill, presents it again to the acceptor to confirm the dishonour. He makes an
official entry of dishonour in the bill and in his register. It is called ‘noting’. A formal certificate
of dishonour issued by the Notary Public to the holder is called ‘protest’. Fees charged by the
Notary Public fort his service is called “Noting Charges”. Noting is compulsory in the case of
foreign bills but is optional for Inland bills.

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A balance sheet is defined as a statement summarizing the financial position of a business on

a given date.
Arrangement of assets:
Liquidity Permanence
Cash in Hand Goodwill
Cash at bank Patents
Government securities Machinery
Sundry Debtors Furniture
Stock of finished goods prepaid expenses
Stock of raw materials Stock of partly finished goods
Stock of partly finished goods Stock of raw materials
Prepaid expenses Stock of finished goods
Furniture Sundry Debtors
Machinery Government securities
Patents Cash at Bank
Goodwill Cash in hand

Gross profit= Sales – Cost of goods sold

Cost of goods sold = Sales – Gross profit
Or
Opening stock + Purchases + Direct expenses – closing stock= Cost of goods sold
Sales = Cost of goods sold + Gross profit

Assets – Liabilities = Capital

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Methods of providing depreciation

1. Fixed Installment or fixed percentage on original cost or straight line method .

Under this method a fixed percentage of the original value of the asset is written off every year
so as to reduce the asset account to nil or to the scrap value of at the end of the estimated life
of the asset. The amount of depreciation charged during the life of asset is constant. This
method is useful for assets of lesser value such as furniture, short lease, patents etc.
Original Cost - Estimated Scrap Value
Depreciation =
Estimated life of the Asset
2. Diminishing balance or reducing installment or written down value method:

Under this method, depreciation is calculated at a certain percentage each year on the balance
of the asset which is brought forward from the previous year. The amount of depreciation
charged in each period is not fixed but it goes on decreasing year after year. This method is
useful to the assets with more value and longer life such as building, machinery etc.

3. Annunity method
Under this method the purchase of an asset is regarded as an interest bearing investment.
Every year interest at a specified rate is added to the book value of the assets. Interest is
calculated to the opening balance of the asset. The amount to be written off as depreciation is
calculated from the annuity table and credited to the asset account. The amount of
depreciation will be constant.

4. Depreciation fund method

Under this method, the amount written off as depreciation should be kept aside and invested in
readily saleable securities. The securities accumulates and when the life of the asset expires,
the securities are sold and with the sale proceeds a new asset is purchased. The amount to be
invested every year depends on the rate of interest which is easily calculated from sinking fund
tables. Under this method the asset account is kept in the books at its original cost throughout
at its life.

5. Depletion method:
This method is used in case of mines, quarries etc from which certain quantity of output is
expected to be obtained. The value of the mines depends only upon quantity of minerals that
can be obtained when the whole quantity is taken, the mines losses its value. The rate of
depreciation, is obtained by dividing the cost of the mines by the total quantity of minerals
expected to be available.

6. Insurance policy method

This method is similar to depreciation fund method but instead of making investment,
arrangements are made with an insurance company which will receive premium annually and
pay at the end of the fixed period the required amount. Premiums have to be paid at the
beginning of each year.
Other methods of providing depreciation are (a) revaluation method (b) Depletion method (c)
Machine hour rate method (d) Sums of years digits methods.
Minimum subscription : The minimum subscription is the minimum amount which, in the
opinion of the directors of the company must be raised in cash by issue of shares. The
amount must be sufficient to provide for (i) the purchase price of any property to be acquired
(ii) any preliminary expenses, including commission, payable by the company. (iii) the
repayment of any money borrowed for the above expenditure and (iv) working capital. No
allotment shall be made of any shares of a company offered to the public unless the minimum
subscription stated in the prospectus has been received. If the minimum subscription is not

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received within 120 days after the date of the first issue of prospectus, then, within next 10
days all application money received must be refunded without interest.
Issue of shares at a premium: If a company issues its shares at a price higher than its face
value, it is called issue of shares at premium. The premium on issue of shares may be
collected with application money, allotment money or call money . The amount of share
premium should be credited by the company to a separate account called share premium
account, which may be applied for the following purposes:
i. for the issue of fully paid bonus shares.
ii. for providing premium payable on the redemption of preference shares or debentures
iii. for writing off preliminary expenses, or commission paid or discount allowed on issue
of shares or debentures of the company.
Forfeiture of shares: Forfeiture of shares means cancellation of shares. If a shareholder
failed to pay the allotment or call money, the directors have the power to forfeit the shares
issued to the shareholder. The shareholder whose shares are forfeited ceases to be a member
of the company. The amount already paid by him lapses and becomes the property of the
company.
Difference between cost accounting and financial accounting.

The following are the important points of differences between cost accounting and financial
accounting.
Sl Financial accounting Cost accounting
No
1. Covers the accounts of the whole business Covers only the transactions relating to manufacturing
relating to all commercial transactions and sale of products and services.
2. Aims at ascertaining profitability of the Aims at guiding the management for proper planning,
undertaking, safeguards the interest of control and decision making.
proprietors and provides information to the
external users.
3. Records transactions according to the nature of Records transactions according to the purpose for which
expenditure they are incurred.
4. Costs are not classified as controllable and non- Costs are classified as controllable and non controllable,
controllable or fixed and variable. fixed and variable, direct and indirect etc.
5. Fails to guide the management in framing price Provides cost details for fixing prices to the products and
policy services
6. Stock is valued at cost price or market price Stock is valued at cost.
whichever is lower
7. Financial accounting is quite independent of Cost accounting is not independent. It depends on
cost accounting financial accounting

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COST ACCOUNTING

Fixed cost and variable cost:

Fixed costs are those costs which do not change with change in the volume or level of
activity within the limits of plant capacity. Fixed cost remains to be the same in total
irrespective of the level of activity. Fixed costs are also known as period cost or stable
cost. Egs of fixed costs: (I) rent of business premises (ii) insurance charges (iii) salary of
executives etc
Variable cost is one which tends to vary directly with variation in the volume of output.
It varies in direct proportion to the volume of production. Variable cost per unit remains
the same at all level of activity. Eg cost of direct materials, direct labour and other variable
expenses.
Prime cost: It is the total cost of direct materials, direct labour and direct expenses. It is the
cost of resources that are basic for bringing out the final output. It is also known as basic cost.
Marginal costing: The institute of Cost and management accountants, England, has defined
marginal costing as “the ascertainment of marginal cost and of the effect on profits of changes
in volume or type of output by differentiating between fixed cost and variable cost. In this
technique of costing, only variable costs are charged to operation, process or products, leaving
all fixed costs to be written off against profits in the period in which they arise.
Marginal cost: Marginal cost is the cost of producing one additional unit of output. It is the
amount by which total cost increases when one extra unit is produced or the amount of cost
which can be avoided by producing one unit less. Often marginal cost, variable cost and
product costs are used to mean the same.
Features of marginal costing.

 It is only a technique of analysis and presentation of costs which help management in

taking decisions.
 Elements of costs are divided on the basis of variability
 Variable costs are charged to products
 Fixed costs are treated as period costs and are charged to profit and loss account.
 Prices are determined on the basis of marginal cost only by adding contributions which is
the excess of sales over marginal cost.
 The selling price per unit remains unchanged at all level of activity.
 Volume of production is the only factor which influences the cost.

Contribution: Contribution is the differences between sales and marginal cost of sales. It is the
total of fixed cost and profit Contribution is also known as “Contribution margin” or “Gross margin”.
In marginal costing contribution is the basis of decision making.
Contribution =Sales – Variable cost or
C= F+P (fixed cost + Profit),
Marginal cost equation is sales –variable cost = Contribution or
Sales = Variable cost + contribution

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Profit/Volume ratio (P/V ratio)

It is also known as contribution to sales ratio or marginal income ratio. Profit volume ratio
is the ratio of contribution to sales of a concern. It is usually expressed in percentage. It is
the basic ratio for managerial decision. A high P/V ratio represent high profitability and a
low P/V ratio shows low profitability.
C
P/V ratio = S S= Sales
C
x100
When expressed in percentage, P/V ratio = S

Break even point: The BEP may be defined as that point of sales volume at which total
revenue is equal to total cost. It is a point of no profit - no loss. A business is said to be
break even when its total sales are equal to its total costs. At this point, contribution equals
the fixed cost and hence, this point is also called as “Critical point” or “Equilibrium point”
or balancing point or No profit - No loss point. If sales are increased beyond this
level, there shall be profit and if it is decreased from this level, there shall be loss to the
organisation.
Fixed Cost
BEP (in units) = Sales per unit - Variable Cost per unit or Fixed Cost/Contribution
FC x Sale price per unit FC
Break even sales = Sales price per unit −Variable Cost per unit or P/V ratio .
Break even sales is the minimum sales (In Rupees) required to maintain no profit – no loss
condition.

Margin of safety: Margin of safety is the excess of sales over break even sales. It is the
margin or range at which the concern is safe from the point of view of profit. The higher the
margin of safety, the more is the profitability of the concern. A low margin indicates low
profitability.
M/S= Sales-Break even sales

Profit
or P/V ratio .
Margin of Safety
Margin of safety ratio= Sales x 100 .

Managerial application of marginal costing

The technique of marginal costing is a very valuable aid to management in taking many
managerial decisions. Marginal costing helps management in decision making in respect of
the following crucial managerial problems.
1. Pricing decisions
2. Make or buy decisions
3. Selection of suitable sales mix.
4. Problem of key or limiting factor
5. Profit planning
6. Effect of change in sales price
7. Alternative methods of production
8. Determining optimum level of activity.

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Machine Hour Rate (MHR)

MHR is computed for the recovery of factory overhead in those industries where machines are
employed for most of the manufacturing operations. The formulae for computation of MHR is
Factory overhead
MHR = Machine hours .

Principle factors to be considered while calculating MHR

1. Identitfy the machine for which the MHR is to be calculated.
2. A base period must be decided for the machine identified for computing the rate.
3. Normal working hours for the base period for the machine is to be calculated. While
calculating the normal working hours, the hours required for maintenance, annual repairs
etc must be deducted.
4. All expenses must be divided into fixed charges and variable expenses. The standing
charges are rent and rates, lighting, and heating, supervision charges, managers salary,
insurance etc. Variable expenses are depreciation, repairs and maintenance, steam, water,
power, miscellaneous expenses.

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