BBAR - 102 - SLM Basics of Accounting

DR.
BABASAHEB AMBEDKAR
OPEN UNIVERSITY
BBA
BACHELOR OF BUSSINESS ADMINISTRATION
BBAR-102
Basics of Accounting
BASICS OF ACCOUNTING
ISBN : 978-81-945630-1-3
Editorial Panel
Author
Dr. Himani Sardar
Assistant Professor,
GLS University, Ahmedabad
Reviewer
Dr. H.C. Sardar
Professor,
S.D. School of Commerce, Gujarat University, Ahmedabad
Language Editor
Dr. Vasant .K. Joshi
Associate Professor,
G.B.Shah Commerce College, Ahmedabad.
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ROLE OF SELF INSTRUCTIONAL MATERIAL IN DISTANCE
LEARNING
The need to plan effective instruction is imperative for a successful distance

teaching repertoire. This is due to the fact that the instructional designer, the
tutor, the author (s) and the student are often separated by distance and may
never meet in person. This is an increasingly common scenario in distance
education instruction. As much as possible, teaching by distance should stimu-
late the student’s intellectual involvement and contain all the necessary learning
instructional activities that are capable of guiding the student through the
course objectives. Therefore, the course / self-instructional material are com-
pletely equipped with everything that the syllabus prescribes.
To ensure effective instruction, a number of instructional design ideas are
used and these help students to acquire knowledge, intellectual skills, motor
skills and necessary attitudinal changes. In this respect, students’ assessment
and course evaluation are incorporated in the text.
The nature of instructional activities used in distance education self- instruc-
tional materials depends on the domain of learning that they reinforce in the
text, that is, the cognitive, psychomotor and affective. These are further in-
terpreted in the acquisition of knowledge, intellectual skills and motor skills.
Students may be encouraged to gain, apply and communicate (orally or in
writing) the knowledge acquired. Intellectual- skills objectives may be met
by designing instructions that make use of students’ prior knowledge and
experiences in the discourse as the foundation on which newly acquired knowl-
edge is built.
The provision of exercises in the form of assignments, projects and tutorial
feedback is necessary. Instructional activities that teach motor skills need to
be graphically demonstrated and the correct practices provided during tuto-
rials. Instructional activities for inculcating change in attitude and behavior
should create interest and demonstrate need and benefits gained by adopting
the required change. Information on the adoption and procedures for prac-
tice of new attitudes may then be introduced.
Teaching and learning at a distance eliminates interactive communication
cues, such as pauses, intonation and gestures, associated with the face-to-
face method of teaching. This is particularly so with the exclusive use of
print media. Instructional activities built into the instructional repertoire pro-
vide this missing interaction between the student and the teacher. Therefore,
the use of instructional activities to affect better distance teaching is not
optional, but mandatory.
Our team of successful writers and authors has tried to reduce this.
Divide and to bring this Self Instructional Material as the best teaching and
communication tool. Instructional activities are varied in order to assess the
different facets of the domains of learning.
Distance education teaching repertoire involves extensive use of self- instruc-
tional materials, be they print or otherwise. These materials are designed to
achieve certain pre-determined learning outcomes, namely goals and objec-
tives that are contained in an instructional plan. Since the teaching process is
affected over a distance, there is need to ensure that students actively partici-
pate in their learning by performing specific tasks that help them to under-
stand the relevant concepts. Therefore, a set of exercises is built into the
teaching repertoire in order to link what students and tutors do in the frame-
work of the course outline. These could be in the form of students’ assign-
ments, a research project or a science practical exercise. Examples of instruc-
tional activities in distance education are too numerous to list. Instructional
activities, when used in this context, help to motivate students, guide and
measure students’ performance (continuous assessment)
PREFACE
We have put in lots of hard work to make this book as user-friendly as pos-
sible, but we have not sacrificed quality. Experts were involved in preparing
the materials. However, concepts are explained in easy language for you. We
have included may tables and examples for easy understanding.
We sincerely hope this book will help you in every way you expect. All the
best for your studies from our team!
Contents
BLOCK-1: BASICS OF ACCOUNTING
UNIT-1 ACCOUNTANCY MEANING AND SCOPE
Introduction, Definitions of Accounting, Origin and Growth
of Accounting, Need for Accounting, Functions of Account-
ing, Users of Accounting Information, Book Keeping, Defini-
tion of Book-Keeping, The objectives of Book-Keeping, Ac-
counting Mechanics, The Double Entry System,Terminology
of Financial Accounting, Accounting Documents, Accountant’s
Responsibility, Accounting Measurement, Basis of Account-
ing, Accounting Principles, The book-keeping and accounting
process, Type of Accounts, Rules for Debit (Dr.) and Credit
(Cr.)
UNIT-2 JOURNAL AND LEDGER
Introduction, The Journal, Advantages of using a Journal, Types
of Entries, Ruling of a Journal, The Ledger, Sub-division of
Ledger, Ledger Format, Ledger Posting, Balancing Ledger
Accounts, Difference between Journal and Ledger
UNIT-3 SUBSIDIARY BOOKS
Introduction, CashBook, Features of Cash Book, Types of Cash
Book, Single Column Cash Book, Double Column Cash Book,
Three Column Cash Book, Petty Cash Book, Sales Book, Pur-
chase Book, Sales Return Book, Purchase Return Book, Bills
Receivable Book, Bills Payable Book, Journal Proper.
BLOCK-2: TRIAL BALANCE, BANK RECONCILIATION STATE-
MENT, CAPITAL AND REVENUE TRANSACTION AND
ACCOUNTING FOR BAD DEBTS
UNIT-1 TRIAL BALANCE
Introduction, Objectives of Trial Balance, Limitations of Trial
Balance, Errors disclosed by a Trial Balance, Errors that are
not disclosed by a Trial Balance, Methods of preparing Trial
Balance, Methods of Locating Errors, Suspense Account
UNIT-2 BANK RECONCILIATION STATEMENT
Introduction, Causes of Difference, Need for Bank Reconcili-
ation Statement, Method of preparation (Without Adjustment).
UNIT-3 CAPITAL AND REVENUE TRANSACTION
Introduction, Capital Expenditure, Revenue Expenditure, De-
ferred Revenue Expenditures, Difference Between Capital
Expenditure, Revenue Expenditure and Deferred Revenue
Expenditure, Difference between Capital Expenditure and
Revenue Expenditure, Difference between Capital Expendi-
ture and Deferred Revenue Expenditure, Capital Receipt, Rev-
enue Receipt, Capital and Revenue Profits, Capital and Rev-
enue Losses.
UNIT-4 ACCOUNTING FOR BAD DEBTS
Introduction, Sundry Debtors, Bad Debts, Provision Reserve
for Bad Debts, Methods of Accounting, Provision for
Discounton Debtors, Provision for Discount on Creditors, Bad
Debts Recovery
BLOCK-3 : DEPRECIATION ACCOUNTING, FINAL ACCOUNTS
(WITHOUT ADJUSTMENTS) & FINAL ACCOUNTS
(WITH ADJUSTMENTS)
UNIT-1 DEPRECIATION ACCOUNTING
Introduction, Meaning of Depreciation, Characteristics of De-
preciation, Causes of Depreciation, Objectives of providing
Depreciation, Computation of Depreciation, Methods of charg-
ing Depreciation, Change of Method of Charging Deprecia-
tion, Salient Features of AS-6: Depreciation Accounting, Il-
lustrations
UNIT-2 FINAL ACCOUNTS (WITHOUT ADJUSTMENTS)
Introduction, Trading Account: Format of a Trading Account,
Trading Account Items (Dr.Side), Trading Account Items
(Cr.Side), Balancing of Trading Account, Profit and Loss Ac-
count: Profit and Loss Account Items (Dr.Side), Profit and
Loss AccountItems (Cr. Side), Balancing Profit and Loss Ac-
count, Adjustments, Difference between Trading A/c and Profit
and Loss A/c, Balance Sheet: Preparation and Presentation of
Balance Sheet, Difference between Trial Balance and a Bal-
ance Sheet, Explanation and Clarification of certain Items, Limi-
tations of balance Sheet, Illustrations
UNIT-3 FINAL ACCOUNTS (WITH ADJUSTMENTS)
Introduction, Objectives or need of adjustment, Types of ad-
justments, Various Illustrations
BLOCK-4: RECTIFICATION OF ERRORS, BILLS OF EXCHANGE,
ACCOUNTS FOR HIRE PURCHASE & ELEMENTS OF
COST
UNIT-1 RECTIFICATION OF ERRORS
Introduction, Errors which do not affect trial balance, Errors
which affect trial balance, Errors detected before preparation
of final accounts
UNIT-2 BILLS OF EXCHANGE
Introduction, Bill of exchange, Specimen to Bill of exchange,
Bills receivables and Bills payable, Terms of bill, Due date,
Days of grace, Disposal or uses of a bill, Dishonor of a bill,
Promissory note, Characteristics, Parties to promissory note,
Difference between Bills of exchange and Promissory note
UNIT-3 ACCOUNTS FOR HIRE PURCHASE
Introduction, Meaning, Difference between Hire Purchase and
Instalment system, Acertaining the interest rate, Accounting
records under Hire Purchase system
UNIT-4 ELEMENTS OF COST
Introduction, Meaning of Cost, Various elements of cost, Clas-
sification of cost
Dr. Babasaheb BBAR-102/DBAR-102
Ambedkar
OpenUniversity
BLOCK-1 BASICS OF ACCOUNTING
UNIT 1
ACCOUNTANCY MEANING AND SCOPE
UNIT 2
JOURNAL AND LEDGER
UNIT 3
SUBSIDIARY BOOKS
BLOCK 1 : BASICS OF ACCOUNTING
Block Introduction
In the field of management and commerce, accounting is considered to be
one of the most important subjects. As study of management and commerce
involves finance and revenue and for this purpose the role of accounting
becomes further more important and this is the reason behind inclusion of
this.
In this block you are provided detailed information on the basics of account-
ing i.e. in this block you are given an introduction, definition of accounting.
You are given information as to what gave rise to accounting. The objects of
accounting are explained in detail. The mechanics of accounting is also
explained to you in this section. The basics are explained in this section to
you even the rules of debit and credit are explained to you in a very simple
language. The second unit covers the topics of journal and ledger in detail.
You are given explanation on both of the important aspects in a very simple
and understandable language. In the first unit detailed about the various sub-
sidiary books such as cash book, the various types of cash books is explained
to the students. The students are also briefed about the sales, purchase, sales
return, purchase return, bills receivable and bills payable book.
In this block an introduction of accounting, discussing its functions, detailing
the various types of users of accounting information, Apart from this dis-
cussed the various principles of accounting with different books needed for
the recording of the transactions are also discussed.
Block Objective
After learning this block you will be able to understand:
 Introduction and role to Accounting
 Various users of Accounting Information
 Accounting principles
 Indian and international accounting standards
 Importance of journal and its techniques
 Process of posting entries into journal
 Transfer the entries into different types of subsidiary books
 Understanding the need and importance of every subsidiary book.
Block Structure
Unit1: Accountancy Meaning and Scope
Unit2: Journal and ledger
Unit3: Subsidiary Books

Unit
ACCOUNTANCY MEANING AND SCOPE
1
: UNIT STRUCTURE :
1.0 Learning Objectives
1.1 Introduction
1.2 Definition of Accounting
1.3 Origin and Growth of Accounting
1.4 Need for Accounting
1.5 Functions of Accounting
1.6 Users of Accounting Information
1.7 Bookkeeping
1.7.1 Definition of Book keeping
1.7.2 The Objectives of Book keeping
1.8 Accounting Mechanics
1.8.1 The Double Entry System
1.8.2 Terminology of Financial Accounting
1.8.3 Accounting Documents
1.8.4 Accountantes Responsibility
1.8.5 Accounting Measurement
1.9 Basis of Accounting
1.9.1 Accounting Principles
1.9.2 The Bookkeeping and Accounting Process
1.10 Types of Accounts
1.11 Rules for Debit (Dr.) and Credit (Cr.)
1.12 Let Us Sum Up
1.13 Answers for Check Your Progress
1.14 Glossary
1.15 Assignment
1.16 Activities
1.17 Case Study
1.18 Further Readings
After learning this unit, you will be able to understand:
 Need, Origin and Growth of Accounting.
 Functions of Accounting.
 Users of Accounting Information.
 Various Principles of Accounting and Book Keeping.
 Types of Accounts and Golden Rules of Accounting.
1
BASICS OF  Various Basis of Accounting.
ACCOUNTING 1.1 Introduction
Accounting is a prerequisite of finance. Finance is a vast subject of education
and knowledge of accounting serves as a ground for it. Knowledge and use
of accounting information is key factor in any business undertaking. Just as
there are various terminologies in medicine, which one has to know to be-
come a doctor, similarly in the field of finance various terminologies are used
such as revenue, net profits, cost, expense, operating margin and cash flow.
This terminologies have clearly defined meaning and often used in business
organisation.
Accounting is not an end but means to an end. The result of accounting infor-
mation is the decision that is made after analysis and interpretation of this
accounting information. Such information is vital to the owners, manage-
ment, creditors, governmental regulatory bodies, labour unions or the many
other groups that have stake in the financial performance of the company.
Accounting is extensively used to illustrate all types of business activity hence
it can be suitably called as language of business.
The main objective of accounting is to ascertain profit or loss during a spe-
cific period and to determine financial position of a business enterprise on a
particular date. Accounting is defined as “the art of recording, classifying and
summarising financial transactions and interpreting results to meet the objec-
tives”. Besides, it provides necessary business information to the interested
parties. Thus, accounting includes following activities:
 Recording of business transactions either in journal or subsidiary books
 Classifying business transactions by posting them to ledger accounts
 Closing ledger accounts and preparation of summary of all ledger ac-
counts called trail balance
 Preparation of final accounts viz. trading, profit and loss accounts and
balance sheet
During the nineteenth century, the quantum of business transactions increased
to great extent and it became clear that the journal was inadequate as the sole
book of original entry. In order to save time and efforts and avoid inconve-
nience of classifying transactions for posting purposes, similar types of trans-
actions are recorded in special journals called subsidiary books. This would
facilitate not only the division of journal but it would also make easier the job
of posting in the ledger as the postings are done in the form of totals, since
they are transactions of similar nature. Various subsidiary books are cash-
book, sales book, purchase book, sales returns book, purchases returns book,
bills receivable book, bills payable book, journal proper, etc.
1.2 Definition of Accounting
From the above discussion, it is clear that over a period of time the concept of
accounting and the role of accountants have undergone a revolutionary change.
There is no unison regarding exact definition of accounting. Different defini-
tions are drawn by various researchers. However, the central idea of all defi-
nitions has been almost the same except the fact that their emphasis has been
shifting from one aspect to other.
2
The American Institute of Certified Public Accountant (AICPA) in 1941, laid ACCOUNTANCY
the definition of accounting as “Significantly classifying in monetary terms MEANING AND SCOPE
the recording, classifying and summarising money, transactions and events
and interpreting the results, they should be at least partly of financial charac-
ter.”
According to The American Accounting Association (AAA), “Accounting is
the method in which identifying, measuring and communicating economic
information is done to allow the users to judge and take decisions.”
The Accounting Principles Board (APB) of AICPA in 1970 said that ac-
counting provides financial information about economies to take decisions
of economic nature.
Thus, accounting may be defined as the process of recording, classifying,
summarising, analysing, interpreting the financial transactions and commu-
nicating the results thereof to the persons interested in such information.
Check your progress 1
1. “Accounting is the method in which identifying, measuring and com-
municating economic information is done to allow the users to judge
and take decisions “ is given by
a. AAA c. ABB
b. APB d. ABP
1.3 Origin and Growth of Accounting
Many people have the opinion that accounting has been developed in recent
years. However, from the puranas we see that Chitragupta maintains ac-
counts for qualities and vices. In earlier days, there was financial minister in
each kingdom, who would look after financial matters like cash transactions,
taxes payable by people to king, etc.
The chapter, “The Business of Keeping of Accounts in the Office of Ac-
counts” from Arthashastra written by Kautilya, Minister of king Chandragupta,
shows that accountancy was practiced in India twenty-three centuries back.
However, the current accounting is based on the principles of double entry
system which was given to us by Luco Pacioli and Franciscan Monk who got
it published first in 1494 at Venice in Italy. The work was translated and
published in English by H. O. Castle in 1543. In the 1553, James Pule pub-
lished his work on How to Keep a Perfect Account of Debtors and Credi-
tors.
After various other publications, the most important publication was that of
Edward Jones (1795) who created the concept of two column journal. This
was followed by many other innovations, which were introduced later from
time to time.
The present system of accounting occupies a vital position in today’s
business. With the help of accounting, managers or owners can take count-
less important decisions and make right decisions at right time, which is the
key to success. Owners can know whether they have made profitable invest-
ment. The cost accountant can know how to control the cost of production.
Government can get date for tax and license purpose. Therefore, accounts
will provide information to every person regarding the particular concern.
3
BASICS OF Check your progress 2
ACCOUNTING 1. The current accounting is based on the principles of double entry sys-
tem which was given to us by.
a. Luco Pacioli and Franciscan Monk
b. Kautilya
c. Chandragupta
d. Edward Jones
1.4 Need for Accounting
Accounting is often called the speech of business. It serves as means of com-
munication. The information regarding the results of business operations to
interested parties in the business viz., the proprietor, creditors, government
and other agencies are to be communicated in the form of accounting data. In
order to provide correct information it is necessary for the business organisation
to record its transactions in clear and systematic manner. A clear and system-
atic record will serve twin purposes like
 Ascertaining transactions of business to determine profits or loss made
during any accounting period.
 Showcase of impact of business transactions on the net worth of the
business unit i.e. financial position of the business in terms of assets
and liabilities of business as a whole.
Since resources are scarce, it is wiser to maintain a check on them constantly,
to know whether there has been any generation of income or squeezing
or shrinking of resources. It is of primary importance and is considered an
indispensable tool of measuring operating efficiency of any profit making or
non- profit making entity.
Accounting information differs largely on the types of organisation. How-
ever, viewed broadly, the information needs of most organisations are similar.
This information need of an organisation is depicted as follows:
Fig 1.1 Information need of an organization
4
Considerable amount of operating information is required to conduct an ACCOUNTANCY
organisationes day-to-day activities, which consist of information about in- MEANING AND SCOPE
ventory, production, sales cash balance etc. Operating information provides
much of the basic data for management accounting, financial accounting and
tax accounting.
Financial accounting information is intended by different stakeholders of the
business, such as management, employees, financers, government authori-
ties, shareholders etc. In other words, financial accounting is the process of
summarising financial data taken from an organisationes accounting records
and publishing in the form of annual reports for the benefit of people outside
the organisation.
Management Accounting: The accounting information specifically prepared
to aid managers is known as Management Accounting. This information is
used in three managerial functions namely, planning, implementation and con-
trol. An important form of planning is budgeting. Budgeting is the process of
planning the overall activities of an organisation for a specified period of
time, usually a year.
Tax accounting information is required to comply with various legal require-
ments. Hence, it is useful for tax authorities, auditors and the management.
1. The accounting information specifically prepared to aid managers is
known as
a. Management Accounting
b. Cost Accounting
c. Financial accounting
d. None of above
1.5 Functions of Accounting
Following are the main functions of accounting:
1. Maintaining systematic records: The basic function of accounting is
to maintain proper records of transactions that take place in chrono-
logical order. These records provide a base analysis and decision-mak-
ing. It consists of recording in the original/subsidiary books of entry,
posting to ledger, preparation of trial balance and final accounts.
2. Meeting legal requirements: Under the provision of law, a business
person has to file various statements e.g. income tax returns, returns
for sales tax purpose etc. Accounting system aims at fulfilling the re-
quirements of law. Accounting is a base, with the help of which vari-
ous returns, documents, statements etc are prepared.
3. Protecting and safeguarding business assets: Records always serve
as an evidence in case of any dispute relating to ownership title of any
property or assets of the business. Accounting helps in this regard to a
very great extentit protects the property of business from unjustified
and unwanted use. The accounts manager thus has to design such a
system of accounting, which protects its assets from an unjustified and
unwanted use.
4. Accounting helps to very great extent in decision-making: The ac-
counting facilitates the right decision-making process. Most of the
5
BASICS OF managerial decisions are based on the figures. An effective price policy,
ACCOUNTING satisfied wage structure, inventory policy, advertisement and sales pro-
motion policy are a result of proper accounting structure. Accounting
provides necessary data on which managerial decision-making process
is based.
5. Communicating and reporting: Accounting can be said to be the
language of business. All the transactions of business are communi-
cated through accounting. All the interested parties such as entrepre-
neur, creditors, governments, and employees and so on, who are inter-
ested directly or indirectly in knowing the results of the firm are pro-
vided information through accounting. Accounting communicates the
results to interested parties. Accountant prepares report based on ac-
counting information to show financial position of firm to interested
parties. Thus, accounting shows a true and fair financial position of
firm.
1. The basic function of accounting is to maintain proper records of trans-
actions that take place in .
a. Chronological order b. Money order
c. Value order d. Order
1.6 Users of Accounting Information
Accounting information is of prime importance to its interested parties to
understand the financial position of firm and its future prospects. The inter-
ested parties or users of accounting can be divided into two main categories
namely, external and internal users.
External User Include Following
1. Creditors: People who have extended credit to the company are termed
as creditors. They are eager to know the financial position of firm to
determine whether the enterprise will be able to meet its obligations in
time. The statement of accounts helps to determine a liquidity position
on which creditors can rely upon and check their credit policy or sup-
ply decisions.
2. Investors: These individuals put their money in any business with the
aim of making more money. Any investor before making investments
considers three important factors i.e. safety of his principle amount,
rate of return on his investment in the form of dividend/interest and
regular and consistent rate of return. Detailed study of the financial
statements of firm enables investors in taking correct investment deci-
sion.
3. Government: The government is not interested in making money or
investments. It is concerned with accounting information of company
for purpose of taxation, labour and corporate law. Thus, it is interested
in allocation of resources, taxation policies and statistical interests.
4. Bankers: Banks and financial institutions who lend money to business
want to know the financial stability of the company in terms of the
companyes ability to pay interest and principle amount. They want to
know whether this company can turn into a defaulter if so banks would
6
not want to lend to such company. Thus before lending money, banks ACCOUNTANCY
want to be sure of the financial status of the company through its fi- MEANING AND SCOPE
nancial statements.
5. Competitors: Competitors of the company are interested in its finan-
cial to improve its own financial strat egies, policies and
systems.Comparison of one company with another can provide valu-
able clues about the financial health of the organisation. It helps to
benchmark its own financial results.
6. Others: In addition to the above, other users of accounting informa-
tion are researchers, consumers, stock exchange, brokers, underwrit-
ers, economists, press and public in general. However, their interests
and goals altogether being different in nature, yet require accounting
information for serving their own interests.
Internal Users Include Following
1. Owners: Owners include shareholders, partners and proprietors of the
firm. They are the backbone of the business in the sense that they pro-
vide necessary funds for its smooth running, growth and development.
Company’s profitability and financial security are, therefore of
prime importance to these people who have stake in the business. Such
information can be obtained through published accounts, annual re-
port and other supplementary statements.
2. Management: Accounting provides necessary information for mana-
gerial decision-making. The managerial tools, such as production bud-
get, sales budget and cash budget, capital budget, etc., are the result of
efficient accounting system. Various functions of management such as
planning, organising, coordination, motivation and control can be imple-
mented effectively through proper accounting system.
3. Employees: Healthy industrial relations between employer and em-
ployee are important to growth and development of firm. Accounting
information helps to settle industrial disputes, prevent strike or like-
wise situation arising from demand for wage hike, bonus, higher com-
pensation, etc. It helps employees to determine whether they are paid
fair wages or not. Sometimes employees are given shares of the com-
pany in which they work. Thus, accounting information becomes vital
for them too.
1. ........... are eager to know the financial position of firm to determine
whether the enterprise will be able to meet its obligations in time.
a. Creditors b. Investors
c. Shareholders d. a & b both
1.7 Book keeping
The process of recording financial transactions in the books of accounts is
called as bookkeeping. These transactions include sales, purchases, income
and payments by an individual or organisation. Bookkeeping should not be
confused with accounting. Accounting is the process of recording, classify-
ing, summarising, analysing, interpreting financial transactions and commu-
nicating the results thereof to the persons interested in such information.
7
BASICS OF Bookkeeping is just recording of transactions. Bookkeeping is the base of
ACCOUNTING accounting. The accountant analyses the books of accounts and prepares re-
ports from the financial transactions recorded by the book keeper. Normally
business organisations are using two types of bookkeeping systems: single-
entry system and the double-entry system of bookkeeping. In case single-
entry only income and expense accounts are recorded primarily in a revenue
and expense journal and this system is generally suitable for almost all of the
small businesses. On the other side the double entry bookkeeping requires
posting (recording) of each transaction twice in two different accounts, us-
ing debits and credits.
1.7.1 Definition of Book keeping
“Book-Keeping is a science and art of maintaining transactions of money
transfers entered in the books of accounts. It may also be defined as the art of
recording mercantile transactions in a regular and systematic manner, the art
of keeping accounts in such a manner that a man may know the true state of
his business and property by an inspection of his books”- Carter.
1.7.2 The Objectives of Book keeping:
The object of bookkeeping may be stated as under:
1. To have a permanent record of each transaction of the business and to
show its financial effect to the business.
2. To find the collective effect of all the transactions made during an ac-
counting period (usually a year) upon the financial position of the busi-
ness.
3. To meet the legal requirements.
4. One of the main objectives of bookkeeping is to determine the sales,
find the actual position of stock estimate the cash position of the busi-
ness at a given point of time or for a particular period.
1. .......... is just recording of transactions.
a. Book keeping b. Accounting
c. Balance sheet d. Journal Voucher
1.8 Accounting Mechanics
Accountancy is the science of recording, classifying and summarising trans-
actions. Generally, a business entity has multiple transactions every day dur-
ing an accounting period and unless and until these transactions are analysed
and recorded individually, it is very tough to determine the result of each
transaction in the above two basic statements. The business transactions may
be recorded in various ways. However, the double entry system is the most
suitable for this purpose.
1.8.1 The Double Entry System
The origins of double-entry system can trace as far back as from the 12th
century. According to sources Giovanni di Bicci dee Medici first gave this
method for the Medici bank.
The modern double-entry system is of Amatino Manucci, a Florentine mer-
chant who lived in 14th century. This system was used by the merchant ad-
venturer by the end of the 15th century. Luca Pacioli, a monk and collabora-
8
tor of Leonardo da Vinci was the first to codify the system in a mathematics ACCOUNTANCY
textbook in 1494. Pacioli was the first to publish a detailed description of MEANING AND SCOPE
double-entry system thus was called the „father of accountinge. His publish-
ing the double entry system enabled many to study and use it.
Under this system of double-entry bookkeeping, each and every transaction
is split into two aspects and both these aspects are recorded without any
exception, whatsoever, any change in the concern. Whenever there is any
action, there must be opposite and equal reaction. Thus, if furniture is pur-
chased with cash, cash is depleted as against furniture, which increases. If
furniture is purchased on credit, furniture increases as against increase in
liability.
Each and every transaction is entered in the documents providing all the
required information of the transaction. The most regular documents that
are used are as under:
1. Payment Voucher: This is usually on a printed standard form and it is
a record of payment. Whenever we pay for an expense, then mostly a
bill is prepared which records full particulars of the claim by the per-
son receiving payment. The accounts department prepares a voucher
for every payment to be made.
2. Money Receipt: Money receipt is a document, which is issued when-
ever cash / cheque are received. This document is an evidence that a
sum of money has been received from a person or organisation.
3. Journal Voucher: The journal voucher records all other residuary
transactions. Any internal transaction or a transactions not involving
any cash payment or cash receipt is posted in the journal voucher.
Now payment and receipt are done through NEFT and RTGS, i.e.
internet banking also.
1.8.2 Terminology of Financial Accounting
1. Event: It a process or part of process that occurs at a particular mo-
ment and has a definite place of occurrence. Events are the cause of
external transactions.
2. Transaction: It refers to any act of the business that changes the fi-
nancial position of the business unit.
3. Debit: It is the aspect of a financial transaction where we receive ben-
efit.
4. Credit: It is the aspect of a financial transaction where we give ben-
efit.
5. Entry: It is the process where we record the transaction in the books
of accounts.
6. Assets: Anything of value owned by a business is known as „assete.
7. Liability: Anything owed, a debt, a claim of an outsider against the
business is called a ‘liability’.
8. Accounts: An account is a summarised record and systematic arrange-
ment of transactions for a period affecting a person, entity, expense,
income, asset and liability.
9. Turnover: The total sales during a period, cash sales as well credit
sales is called turnover.
9
BASICS OF 10. Business: Any economic activity, which is legal and done with the in-
ACCOUNTING tention of earning profit, is called business.
11. Capital: Capital represents the amount of funds invested by the owner
in the business. It may be in the form of cash, goods or any other asset.
Capital is always equal to the difference between total assets and li-
abilities.
1.8.3 Accounting Documents
The various types of documents which have been put to use for record-
ing the occurrence of various business transactions are as under:
1. Official receipts: These receipts are received whenever any payment
is made over the counter to the cashier
2. Cash bills: This is proof of cash transaction which can be receipt or
payment.
3. Bills: These documents are received and issued when payment is made
or payment is received by a specified date. As for illustration: electric-
ity, water, rent and assessment services, cash sales etc.
4. Invoices: These documents are issued when physical goods are pur-
chased. It functions same as bills and the recipients have to pay dues
within the dates mentioned. Invoice can be for sales also.
5. Delivery Orders: This refers to the quantity of goods that has been
ordered. The order concerns the quantity and description of the goods
that are ordered and is different from invoice These are the two docu-
ments that are received while purchasing goods or services. These
documents are also issued to the clients during sale transactions.
Purchase invoicee and „Supplier invoicee are documents that clients
receive. The company that supplies the goods prepares the Sales
invoicee.
The other types of documents used in business are:
1. Purchase Orders: To place orders for raw material or any assets as
per specifications and quantity through proper documentation is called
Purchase Order.
2. Clients Orders: Order received from clients is called Clientse or-
ders.
3. Credit Notes: These are documents issued to clients mentioning the
credits incurred by the client, the reason for crediting from the account
is also mentioned generally it is issued for sales return.
4. Debit Notes: These are documents issued to clients mentioning the
debits incurred by the client, the reason for debiting from the account
is also mentioned. It is issued for purchase return.
5. Payment Vouchers: It is document of payments made, maintained in a
chronological manner.
6. Petty Cash Vouchers: It is a record of payments made, maintained in
a chronological manner in daily cash transactions
7. Goods Received Notes: Is a record of receipts of goods purchased. A
logbook is maintained regarding goods received
10
8. Stock Cards and Stock Ledger: Physical movement of stocks is main- ACCOUNTANCY
tained through Stock Cards and Stock Ledger. They are maintained MEANING AND SCOPE
by storekeepers. Quantities of stocks, stock codes and description of
stocks are made. Here unit price is not mentioned. Updating accord-
ing to stock in and stock out is done. Some business houses maintain
stock ledger in addition to stock cards
1.8.4 Accountant’s Responsibility
The primary responsibility of the accountant is to present the financial infor-
mation to the owners at the end of financial year. The role and responsibility
is multifold due to the introduction and practice of cost accounting, manage-
ment accounting and financial management. Thus the expectation from the
accountant in present era is very high.
The modern function of accounting has grown enormously and they can be
grouped under the following broad categories:
1 Finance function
2 Control function
3 Planning function
1 Finance Function
Finance is the major requirement in front of any business and many of the
business also face the problem of raising and using funds.
A finance accountantes major responsibility is to ensure:-
1. Obtaining hassle free funds at low cost
2. To make maximum use of funds and derive maximum benefit. The
problems faced by accountants are as follows:-
What type of expenses the firm should undertake i.e. in which type of projects
the firm should invest the fundse What is the amount of funds which should
be allocated towards that every project. What sources should be used to
raise the funds for a particular project. How to attain maximum funds What
should be the repayment terms and duration of borrowed funds. The deci-
sion on all issues is taken as per the policy and objectives of the enterprise.
2 Control Function
Here the accountant has the responsibility to communicate the management’s
goals to individuals in respective fields.
1. To assist managers and unit/department heads to achieve their goals
efficiently
2. To optimize results, the accountant has to coordinate the activities
across the organization
3. Based on the goals set for each centre they have to measure the perfor-
mance of the unit or department head. This helps to assess the effi-
ciency
4. Identify problem areas and take decision to find a solution to enhance
the efficiency and performance
3 Planning Function
Planning function which is the next function involves long term decision and
short term actions.
In the short term decision has the following are to be done:
11
BASICS OF 1. Making the best choice out of selected alternatives
ACCOUNTING 2. Should priority be given to maximizing profit or minimizing loss
To address the problems encountered in planning function the accountant has
to take an overall view such as accounting information and outside informa-
tion. Planning for continuity and development of the firm comes under long
term planning.
1.8.5 Accounting Measurement
Quantification of accounting information in the form of money or other units.
Transactions are recorded in the accounts in terms of money (e.g. dollar,
rupee yen etc.) based on historical cost. Some accounting measurements have
to be expressed in volume such as direct labor hours used to apply overhead
in a cost accounting system.
The accountant should check the correctness of accounting policies which
has been employed by the management. Detailed description of the
company’s accounting policies should be presented to their users in a sepa-
rate section preceding the footnotes to the financial statements or as the first
footnote. The disclosure of accounting policies should always include Ac-
counting Principles and should also include the methods of application that
involve
1. Selection from generally accepted alternatives
2. Peculiar to the industry
3. Unusual or different applications of Generally Accepted Accounting
Principles (GAAP) for example depreciation method and inventory pricing.
Disclosure of accounting policies helps readers in better interpreting a
company’s financial statements. Thus, it results in fair presentation of the
financial statements.
1. ............ was the first to publish a detailed description of double-entry
system thus was called the „father of accountinge.
a. Luca Pacioli b. Amatino Manucci
1.9 Basis of Accounting
1.9.1 Accounting Principles
Accounting principles are in general decision rules derived from accounting
concepts. According to AICPA (US), a principle means “a general law or rule
adopted or professed as guide to action: a settled ground or basis of conduct
or practice”.
Accounting principles are man made. Accounting principles do not suggest
exactly how each transaction will be recorded. This is the reason that ac-
counting practice differs from enterprise to another.
There are various principles of accounting according to GAAP (US):
1. Historical Cost principle: says that companies should record and re-
port the cost of assets on the basis of cost incurred in it rather than fair
market value of assets and liabilities. This principle states that the in-
formation that is reliable (removing opportunity to provide subjective
and potentially biased market values) but not very relevant. Thus, there
12
is a tendency to use fair values. Most debts and securities are now ACCOUNTANCY
reported at market values. MEANING AND SCOPE
2. Revenue principle: As per this principle the companies should record
the revenue when either has been (1) realised or is realisable or when
(2) it is earned and not when cash is received. This method of account-
ing is also known as „accrual basis accountinge.
3. Matching principle: As per this principle the expenses have to be
matched with revenues so long it is logical to do so. Expenses should
be identified not when the work has been done or when a product is
produced but when the work or the product actually makes its part to
revenue.
4. Disclosure principle: In short this principle is based on the principle
that each and every such information should be disclosed to the users
of such information which may affect their willingness to continue their
relationship with the company, as per this principle the quantum and
kinds of information to be disclosed should be based on trade-off analysis
as a larger amount of information costs more to prepare and use. While
also keeping costs reasonable.
5. Objectivity principle: The financial statements that have been pre-
pared by the accountant of the company should be based on objective
evidence. Discloser or information should have quality of objectivity
6. Materiality principle: As per this principle all information on materi-
als should be disclosed to its users. The importance of an item should
be considered when it is reported. Information is considered important
when it may affect the willingness and decision of a reasonable indi-
vidual.
7. Consistency principle: It means that the company should use the same
accounting rules and principles and methods over the year.
8. Prudence principle: As per this principle there are two alternatives
before us, where one will be least likely to overstate assets and income
should be chosen.
Accounting Postulates:
Accounting postulates are basic assumptions which are generally ac-
cepted as self-evident truth in accounting. Postulates are established or gen-
eral truth which donot require any evidence to prove them. They are the
propositions taken for granted these postulates are as follows:
1. Entitdy postulates: The entity postulates assumes that the financial
statements and other accounting information are for the specific busi-
ness enterprise which distincts from its owners. In brief from account-
ing theory business and owners of business are separate entity.
2. Going concern postulates: According to this postulates, time period
of business units is not is not predetermined an business entity is viewed
as continuing in operation in the absence of evidence to the contrary.
Because of the relative permance of enterprise, financial accounting is
formulated assuming that the business will continue to operate for an
indefinitely long period in the future.
13
BASICS OF 3. Accounting period postulates: The creation or happening of this pos-
ACCOUNTING tulates is due to going concern postulates. This postulate is developed
for measurement of economic activities of the business. The time pe-
riod is identified in the financial statements. The time periods are usu-
ally of tweleve months. This is useful for comparative performance evalu-
ation.
4. Money Measurement Postulates: A unit of exchange and measure-
ment is necessary to account for the transactions of business enter-
prises in a uniform manner. The common denominator chosen in ac-
counting is the monetary unit. Money is the common denominator in
the terms of goods and services including labour, natural resources and
capital are measured. Money measurement concepts holds that account-
ing is a measurement and communication process of the activities of the
firm that are measurable in monetary terms.
1.9.2 The Book keeping and Accounting Process
The bookkeeping process refers primarily to recording the financial effects of
financial transactions only into accounts. The difference between manual and
any electronic accounting system is the time delaybetween the recording of
the financial transaction and posting it in the concerned account. This delay is
absent in electronic accounting systems due to instantaneous posting into
relevant accounts, is not replicated in manual systems.
Generally in a business, a document has to be produced each time a transac-
tion occurs. Similarly in case sales and purchases they have invoices or re-
ceipts. In the same way deposit slips are produced whenever deposits are
made in a bank account. The bookkeeping involves recording the details of
all such source documents into multi-column journals. As for illustration, all
credit sales are recorded in the sales journal; all cash payments are recorded
in the cash payments journal.
By using the rules of double entry system, the journal entries posted into the
journal there after they are transferred to their respective accounts in the
ledger, or book of accounts and this process of transferring summaries or
individual transactions to the ledger is called posting. Once we are finished
with the posting process we go for balancing, which is simply a process to
arrive at the balance of the account.
In order to ensure that posting process was performed correctly, a working
document called an unadjusted trial balance is created. In the simplest form,
this is a three-column list. The first column contains the names of those ac-
counts in the ledger, which have non-zero balance. If an account has a debit
balance, the balance amount is copied into column two (the debit column). If
an account has a credit balance, then the amount is written on credit side.
Thereafter the totaling is done of both the sides as for example i.e. both debit
and credit side is totaled. The two totals must agree and if the two totals do
not agree it means an error has been made either in the journal or during the
posting process. Therefore the error must be located and rectified and the
totals of debit column and credit column re- calculated to check for agree-
ment before any further processing can take place.
Once there are no errors, the accountant produces a number of adjustments
and changes the balance amount of some of the accounts. As for example the
14
„inventorye account and „office suppliese asset accounts are changed to bring ACCOUNTANCY
them in line with the actual numbers counted during a stock take. At the same MEANING AND SCOPE
time, the expense accounts associated with usage of inventory and with the
usage of office supplies, are adjusted. It is the accounts in this list and their
corresponding debit or credit balances that are used to prepare the financial
statements.
Finally, financial statements are drawn from the trial balance, which may
include:
 The income statement, also known as a statement of financial results,
profit and loss statement, or simply P&L
 The balance sheet
 The cash flow statement
 The statement of retained earnings
Fig 1.2 Activities in Accounting Process

1. Only such information should be made available to its users which are
relevant and helpful for achieving its objectives.
a. Convention of Relevance
b. Convention of Objectivity
c. Convention of Feasibility
1.10 Types of Accounts
An account can be explained as a summary record of all transactions related
to a particular type of item. It may be an asset, a liability, income, expenses,
etc. These accounts are then classified in different types. Broadly, the ac-
counts are divided into two types as follows:
1. Personal Account: Personal accounts include the accounts of persons
with whom the business deals. These accounts show the transactions
with the clients, suppliers, money lenders, bank, etc. The main pur-
pose of preparing personal accounts is to ascertain the balances due to
or due from persons or organisation.
2. Impersonal Accounts: The accounts other than personal accounts are
termed as impersonal accounts and divided into two parts, real and
nominal.
a. Real Accounts: Accounts of each property or assets acquired by the
firm named real accounts. These accounts are both tangible and intan-
15
BASICS OF gible. Tangible real accounts relate to the real properties, which we can
ACCOUNTING see, touch, or feel, such as building furniture, etc. Intangible real ac-
counts consists of such things, which cannot be touched but may be
measured in terms of money, such as Goodwill, trademarks, patents,
etc.
b. Nominal Accounts: These are the accounts of incomes, expenses, gains
and losses. The business has to incur certain expenses to earn certain
income or to meet the requirements or certain business transaction. As
for illustration these accounts are rent, wages or salary paid, telephone
expenses, purchase, sale, etc.
Table Types of Accounts
Type Represent As for illustrations
Tangibles - Plant and Machinery,

Tangible things which are
Furniture and Fixtures, Computers
available physically in the real
Real and Information Processing
world and certain intangible
Equipment etc., Intangibles -
things not existing physically
Goodwill, Patents and Copyrights
Individuals, Partnership Firms,

Corporate entities, Non-Profit
Personal Legal and Business Entities organisations, any local or
(Natural and artificial persons) statutory bodies including local,
state and national governments
To recognise the implications

of financial transactions during
each fiscal year till finalisation Sales, Purchases, Electricity
Nominal
of accounts at the end, Income Charges, Commission,
and Expenditure Accounts are Rent, Interest.
Temporary accounts.
As for illustration 1: Classify the following accounts:

(i) Capital A/c, (ii) Drawings A/c, (iii) Goodwill A/c, (iv) Bank A/c, (v) Rent
paid A/c, (vi) Interest A/c, (vii) Building A/c, (viii) Stock A/c, (ix) A& Co. A/
c, (x) Salaries A/c, (xi) Purchase A/c, (xii) Sales A/c, (xiii) Outstanding Wages
A/c, (xiv) Prepaid Salary A/c.
Solution:
(i) Capital A/c = Personal A/c
(ii) Drawings A/c = Personal A/c
(iii) Goodwill A/c = Real A/c
(iv) Bank A/c = Personal A/c
(v) Rent paid A/c = Nominal A/c
(vi) Interest A/c = Nominal A/c
16
(vii) Building A/c = Real A/c ACCOUNTANCY
(viii) Stock A/c = Real A/c MEANING AND SCOPE
(ix) A& Co. A/c = Personal A/c
(x) Salaries A/c = Nominal A/c
(xi) Purchase A/c = Nominal A/c
(xii) Sales A/c = Nominal A/c
(xiii) Outstanding Wages A/c = Personal A/c
(xiv) Prepaid Salary A/c = Personal A/c
1. Include the accounts of persons with whom the business deals
a. Personal account
b. Real account
c. Nominal account
d. None of above
1.11 Rules of Debit (Dr.) and Credit (Cr.)
Fig 1.3 Debit and Credit Rules

The complete process of accounting is driven by
 Concept of separate or dual entity
 Nature of accounts
 Debit and Credit rules (also called Golden rules of Accounting)
There are rules for every type of account whether it is credit or debit. Let us
study those rules in detail now.
Real Account:
As for example let us take the following transaction: Bought furniture from
M/s Classic Wood on credit
The two accounts that have been affected here by the transaction are
1. Furniture A/c (Real Account)
2. M/s Classic Wood A/c (Personal A/c)
As furniture has been bought, we can say that it is coming in to us.
Thus, we say that furniture A/c is to be debited based on the principle “debit
what comes in”. classic wood a/c will be credited, based on principle “credit
the giver.”
Credit what goes out Consider the following transaction: Sold goods to Mr.
Gaurav on credit. The two elements that have been affected here by the
transaction are
17
BASICS OF 1. Goods A/c (Real Account)
ACCOUNTING 2. Mr. Gaurav A/c (Personal A/c)
As we are selling goods, we can say that it is going out from us.
Thus, we say that goods A/c is to be credited based on the principle „Credit
what goes out. Mr. Gavrav A/c will be debited based on principle “debit the
receiver.”
To make a decision whether a particular Real a/c (element) affected by an
accounting transaction is to be debited or credited; we need to simply identify
whether the element is coming into the organisation or going out of the
organisation.
Personal Accounts
Debit the benefited person i.e. the receiver
Let us take the following transaction: Paid cash to Mr. Singh.
1. Cash A/c (Real Account)
2. Mr. Singh A/c (Personal A/c)
As the cash is being paid, we can say that Mr. Singh is the receiver of cash
i.e the person receiving the benefit from the organisation. Thus, we say that
Mr. Singh A/c is will debited based on the principle „Debit the benefit receivere.
On the other hand cash is being paid that means that cash is going out form us
so it has been credited. Cash A/c will be credited based on principle “credit
whatever goes out.”
Credit the benefited person i.e. the giver
Let us Consider the following transaction: Purchased goods on credit from
M/s Singh &Co..
The two accounts that have been affected here by the transaction are:
1. Goods A/c (Real Account)
2. M/s Singh &Co.. A/c (Personal A/c)
As the goods are being purchased on credit, that goods are coming to us so
being a real account going by its rule “debit what comes in” we will debit the
goods account on the other handM/s Singh & Co. is giving (benefit) to the
organisation. So, we can say that M/s Singh & Co. a/c is to be credited based
on the principle “Credit the benefit giver”.
Therefore in order to make a journal entry make decision whether a particu-
lar Personal a/c affected by a transaction is to be debited or credited; we
should first of all identify whether the element is giving the benefit to the
particular organisation or it is taking the benefit from the organisation.
Nominal Accounts
While making journal entries where nominal accounts are involved, in most
of the cases we come across the situations where the transaction is either
related to an expenditure/loss or income/gain to the organisation.
Going as per the rules of nominal account
Debit all Expenses and Losses
Let us take the following transaction for illustration: Paid Salary to staff The
two accounts that have been affected here by the transaction are
1. Cash A/c (Real Account)
18
2. Salaries A/c (Nominal A/c) ACCOUNTANCY
Since salaries are being paid, it amounts to expenditure for the organisation. MEANING AND SCOPE
Thus, we say that salaries a/c is to be debited based on the principle “Debit
all expenses and losses”. Cash being a real account is moving out of the
organisation so it will be credited.
Credit all Incomes and Gains
Let us consider the following transaction: Received Commission from M/s
Garima Enterprises by cheque
1. Bank A/c (Personal Account) and
2. M/s Commission A/c (Nominal A/c)
Here commission has been received, which is an income for the organisation.
Thus, the Commission a/c is to be credited based on the rule of nominal
account “Credit all incomes and gains”. Bank account will be debited based
on principle “Debit the receiver.”
In order to make a journal entry decisionand whether a particular Nominal a/
c (element) affected by an accounting transaction is to be debited or cred-
ited; we simply need to identify whether it is an expenditure (or loss) or an
income (or gain) to the organisation.
1. In Cash paid to Ram, should cash be
a. Credited b. debited
1.12 Let Us Sum Up
In this unit we have studied the basics of the subject accounting .We learnt
that accounting is not an end, but a means to an end. The end result of ac-
counting information is the decision that is made after analysis and interpre-
tation of this accounting information. Such information is vital to the own-
ers, management, creditors, governmental regulatory bodies, labour unions,
or the many other groups that have vested interest in the financial perfor-
mance of the company.
The study of this unit is important for the readers to understand this subject,
as this subject has made the basics very clear in the minds of the readers.
Accountancy Meaning and Scope
Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
19
ACCOUNTING Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
1.14 Glossary
1. Accounting - The process of identifying, measuring and communicat-
ing economic information to users of information to permit informed
judgments and decisions by the users.
2. Creditors - A list of suppliers to whom the business owes money, due
to credit purchase.
3. Debtors - A list of customers, to whom goods is sold on credit.
4. Drawing - The money taken out of a business by its owner(s) for per-
sonal. use in the form of cash or assets is known as drawings.
5. Principles (GAAP) - These are the uniform minimum standards for
financial accounting and reporting. They govern the form and content
of the financial statements of an entity is known as generally accepted
accounting principles.
1.15 Assignment
Study the Accounting Standards in India and compare it with International
Accounting Standards.
1.16 Activities
State which item is part of what type of account.
a) Copyrights account
b) Non-Profit Organisation account
c) Fixed assets account
d) Goodwill account
e) Salaries account
f) Commission account
g) Prepaid rent account
h) Municipal Corporation account
i) Mr. Mikees account
1.17 Case Study
Discuss the concept of “Accounting Measurement”
20
1.18 Further Readings ACCOUNTANCY
1. Advanced Accounting: Financial Accounting, Dr Ashok Sehgal, Dr MEANING AND SCOPE
Deepak Sehgal, Taxmann Allied Services Pvt. Ltd. , 2008
2. Modern Accountancy Volume I, Mukherjee, Tata Mcgraw Hill, 2008
3. Accounting theory and practice, Jawaharlal, Himalaya Publishing house
pvt ltd, 2011
21
BASICS OF
ACCOUNTING Unit
JOURNAL AND LEDGER
2
: UNIT STRUCTURE :
2.1 Introduction
2.2 The Journal
2.3 Advantages of Using A Journal
2.4 Types of Entries
2.5 Ruling of A Journal
2.6 The Ledger
2.7 Sub-Division of Ledger
2.8 Ledger Format
2.9 Ledger Posting
2.10 Balancing Ledger Accounts
2.11 Difference between Journal and Ledger
2.12 Let Us Sum Up
2.14 Glossary
2.15 Assignment
2.16 Activities
2.17 Case Study
 Techniques of Journalising transactions.
 Importance of Journal.
 Posting journal entries to Ledger.
 Techniques of Ledger posting.
 Sub-division of ledger.
 Format of Journal and Ledger.
2.1 Introduction
The total sequence of accounting procedures, which are required to be fol-
lowed in same order during each accounting period, is known as accounting
cycle. It includes:
 Recording: In the first step, all the transactions should be recorded in
the journal or books of original entry known as subsidiary books as and
when they take place.
 Classifying: Thereafter, in the next step all entries in the journal of
books of original entry are posted to the appropriate ledger accounts
22
to find out the total effect of all such transactions in a particular ac- JOURNAL AND
count. LEDGER
 Summarising: This is the last stage, here efforts are made to prepare
the trial balance and final accounts with a view to find out the profit or
loss made during a trading period and to know the financial position of
the business on a particular date.
Fig 2.1 Accounting Cycle

In this unit, the recording and classifying process of accounting cycle i.e.
meaning and importance of journal and ledger has been explained.
2.2 The Journal
The word „journale has been taken from a French word “jour” which means
a day. Thus journal means daily as the daily transactions are recorded in
journal and hence it has been named so. It is a book of original entry to
record chronologically (i.e. in order of date), as here transactions are re-
corded daily that is why it is also known as „day booke. It is also called as
book of prime entry. The process of recording transactions in a journal is
called journalising and the entries are called journal entries. As all the trans-
actions are first entered in the journals, which are then posted into ledger.
Journal is the beginning of the process of accounting. For accounting conve-
nience, journal is divided into different subsidiary books like purchase book,
sales book, purchase return book, sales return book, bills receivable book,
bills payable book, cashbook and journal proper.
Characteristics of Journal:
Journal is said to be the first step of the double entry system. A transaction is
first of all recorded in the journal. Therefore, the journal is the book of origi-
nal entry.
1. A transaction is recorded on the same day it takes place. Therefore,
journal is called ‘Day Book’.
23
BASICS OF 2. All the monetary transactions relating to business are recorded chro-
ACCOUNTING nologically hence the journal is called chronological book.
3. For each and every transaction the names of the two concerned ac-
counts indicating which is debited and which is credited, are clearly
written in two consecutive lines. This makes ledger posting easy. That
is why journal is called Assistant to Ledgere or subsidiary booke.
4. Narration is written below each entry.
The amount is written in the last two columns - debit amount in debit
column and credit amount in credit column.
5. There are five columns in journal entry- (1) Date (2) Particulars (3)
L.F. no. (4) Debit amount (5) Credit amount.
1. The is the book of original entry.
a. Journal
b. Ledger
2.3 Advantages of Using a Journal
The advantages of a journal can be studied through the following points:
1. Every transaction is recorded as it takes place. Therefore, there is al-
most no possibility of omission of any transaction from the books of
account.
2. As the transactions are recorded in the journal chronologically with
narration the reason behind why a transaction has taken place can as-
certained easily.
3. For each and every transaction the two concerned accounts that will be
debited and credited are clearly written in the journal. Therefore, there
is least possibility of committing any mistake in writing the ledger.
4. As all the debits of transaction are recorded in journal so there is no
need to repeat them in ledger. So the ledger is always kept tidy and
brief.
5. The Journal shows the complete story of every transaction in one entry.
6. Any mistake in ledger can be easily detected through the journal.
1. The shows the complete story of every transaction in one entry
a. Journal
b. Ledger
2.4 Types of Entries
There are two types of entries, which are recorded in the journal: simple
entry and compound entry. A simple entry involves two accounts only, one
affecting the debit side and other affecting the credit side with an equal amount.
Sometimes a journal entry may have more than one debit or more than one
credit entry. This type of journal entry is called compound journal entry. Re-
gardless of how many debits or credits are contained in a compound journal
entry, all the debits are entered before any credits are entered. The aggregate
amount of debits should be equal to the aggregate amount of credits.
24
As for illustration 2 JOURNAL AND
Sr As for illustrations of Simple Entry As for illustration of Compound LEDGER
Entry
1 Started business and introduced Started business and introduced
Rs.10,000 as capital Rs.10,000 cash and stock worth
Rs.10,000 as capital
Cash a/c Dr 10000
Cash a/c Dr10000 Stock a/c Dr 10000

To Capital a/c 10000
(Being capital introduced in the To Capital a/c 20000
(Being capital brought in, in the
business in the form of cash)
form of cash & stock)
2 Purchased Machinery from Kulkarni Purchased Machinery from

& Co. for Rs.10,000 cash Kulkarni & Co. for Rs.25,000 and
Machinery a/c Dr.10000 paid cash Rs.10,000
To cash a/c 10000
(Being machinery purchased for
cash) Machinery a/c Dr.25000
To cash a/c 10000
To Mr Kulkalrni?s a/c 15000
(Being machinery purchased from

Mr. Kulkarni partly in cash)

1. Sometimes a journal entry may have more than one debit or more than
one credit entry. This type of journal entry is called .
a. compound journal entry
b. simple entry
2.5 Format of a Journal
A journal is generally kept on a columnar basis. There are five columns in the
journal, which are as under:
Date Particulars Ledger Folio Amount (Dr) Amount(Cr)
1. Date: Recording Date and Year of transaction.

2. Particulars: This is meant for recording the titles, description of trans-
action and passing entries. Here the name of the Account to be debited
is written along with „Dr on the first line and the name of the Account
to be credited is written along with a prefix „To on the second line.
Finally, a short explanation of the transaction known as narration
begins on the line immediately below the account credited. The narra-
tion always appears within parentheses and is begun with the word,
Beinge – which means, what it is.
25
BASICS OF 3. L.F No: Recording ledger folio number, which helps in identifying where
ACCOUNTING the transaction is recorded in ledger.
4. Debit Amount: Recoding amount debited.
5. Credit Amount: Recording amount credited.
As for illustration 3
Record journal entries in the books of J. Smith & Co. from the follow-
ing transaction:
Transactions during January, 2020
1 Started business with a cash of R 50,000 and Building valued
R 5, 00,000 and stock of R 50,000.
6 Paid into bank R 30,000.
8 Cash Sales of R 10,000.
10 Purchased goods of R 4,000.
17 Goods sold to Ramakant of R 2,800 and cash received of R 2,750/-
25 Paid telephone Bill of R 300
26 Paid wages to workers R 5000
28 Withdrawn from Bank for personal use R 5000
31 Purchased computer and paid by cheque R 22,000
Solution:
Date
(2020 Particulars L.F Dr. Amount Cr. Amount
Jan.)
Cash A/c Dr. 50,000 -
Building A/c Dr. 5,00,000 -
Stock A/c Dr. 50,000 -
1 To Capital A/c - 6,00,000
(Being business started with
cash, building and stock)
Bank A/c Dr. 30,000 -

To Cash A/c - 30,000
6
(Being the cash paid to bank)
Cash A/c Dr. 10,000 -

To Sales A/c - 10,000
8 (Being cash sales made)
Purchases A/c Dr. 4,000 -

To Cash A/c - 4,000
10 (Being goods purchased for
cash)
Cash A/c Dr. 2,750 -

Discount Allowed A/c Dr. 50 -
17 To Sales A/c - 2,800
(Being good sold and allowed
discount)
26
Telephone Expenses A/c Dr. 300 - JOURNAL AND
To cash A/c - 300 LEDGER
25
Wages A/c Dr. 5,000 -

To Cash A/c - 5,000
(Being wages paid to the
26 workers)
Drawings A/c Dr. 5,000 -

To Bank A/c - 5,000
28 (Being the amount withdrawn
for personal use)
Computer A/c Dr. 22,000 -

To Bank A/c - 22,000
31 (Being the computer
purchased)

1. The numbers of columns in journal are .
a. four
b. five
2.6 The Ledger
Once the transactions have been entered in the journal the next step is to
classify or categorise them according to the accounts affected. All similar
transactions are brought together through the ledger. For instance, all trans-
actions relating to cash are brought to one place in the cash ledger or cash
book. In the same way all transactions with a clients or a supplier are also
written at one place. The book in which this classification is done is called
the ledger.
The Ledger is also called the king of all books of accounts because all entries
from the books of original entry are posted to the various accounts in the
ledger. It should always be kept in mind that journal contains a chronological
record while a ledger contains a classified record of all transactions.
The features of a ledger can be studied through the following points:
1. Two identical sides - The left hand side is called debit side and right
hand side is called credit side.
2. The debit aspects of every transactions is recorded on the debit side,
while credit aspect on credit side according to date.
3. The difference of the two sides represents the balance. The excess of
debit side over credit side indicates debit balance, while excess of credit
side over debit side indicates credit balance. If the two sides are equal
there will be no balance.
4. Normally balance is drawn at the year-end and recorded on the deficit
side to make the two sides equal. This balance is known as closing
balance.
27
BASICS OF The closing balance of the current year will become the opening bal-
ACCOUNTING ance of the next year.
1. The is also called the king of all books of accounts.
a. Ledger
b. journal
2.7 Sub-Division of Ledger
When the size of organisation is very large and number of accounts is abun-
dant, it is necessary to maintain a separate ledger for different accounts. Gen-
erally, the following three kinds of ledger are maintained by organisations:
 Debtorse Ledger
 Creditorse Ledger
 General Ledger
 Debtor’s Ledger: Debtors are the clients (customers) of the business
to whom goods are sold on credit. Debtores ledger contains all the
details of transactions with debtors. Entries in this ledger are made
mostly from sales daybooks, sales returns book and cashbook. There-
fore, it is also called as Sales ledger.
 Creditor’s Ledger: Creditors are suppliers of the material to business
from whom goods are purchased on credit. Purchase daybooks, pur-
chase return book are one of the main sources of entries for this ledger.
Therefore, it is also known as Purchase Ledger.
 General Ledger: This ledger contains all residual accounts – mainly
real and nominal accounts. This ledger is also called nominal ledger.
1. ..............are the clients of the business to whom goods are sold on
credit
a. Debtors
b. Creditors
2.8 Ledger Format
Ledger accounts are represented in “T” format. This consists of two sides,
the left side represents the debit side and the right side represents credit side.
Each side divided into four columns of varying sizes for the following:
 Date – used for date of transaction
 Particulars – Recording the name of the accounts debited or credited
 Journal Folio (J.F) – used to mark the page number of the journal for
which the transaction is being recorded.
 Amount – Recording the amount debited or credited It may be kept in
(i) Bound ledger or (ii) Loose leaf form
28
Ledger Format JOURNAL AND
Dr. Cr. LEDGER
Date Particulars J.F. Amount Date Particulars J.F. Amount

1. .............. accounts are represented in “T” format
a. Ledger
b. Journal
2.9 Ledger Posting
Ledger posting can be understood as the system of transferring of the debits
and credits from the journal to the ledger accounts. It should be kept in the
mind that the exact names of accounts used in the Journal should be carried
to the Ledger. Posting may be done at any time but should be completed
before the financial statements are prepared. It is advisable to keep more
active accounts posted to date.
As we know under double entry system, each transaction is transferred in
two different ledger accounts, affecting the debit side of one and credit side
of the other one. The following procedure is followed for posting:
1. Open separate ledger account for posting transactions relating to dif-
ferent accounts.
2. Consider each transaction separately for posting purposes.
3. Locate the transaction in Journals, to be posted in the ledger.
4. Locate in the ledger the first account named in the journal.
5. Enter the date of the transaction in the date column as per the dates of
journal entry.
6. In the particular column of the ledger bookse debit side, enter the
name of the account credited in the journal entry with a prefix „Toe.
7. In the Folio column of ledger book, enter the journal page number of
which the posting is being made.
8. Locate in the ledger the second account named in the journal.
9. Repeat step 5.
10. Enter in the credit side of the ledger in particular column, the name of
the account debited with a prefix „Bye.
11. Repeat step 7.
1. .............. can be understood as the system of transferring of the debits
and credits from the journal to the ledger accounts.
a. Ledger posting
b. Journal posting
29
BASICS OF 2.10 Balancing Ledger Accounts
ACCOUNTING All the accounts in the ledger are balanced periodically to ascertain the col-
lective effect of entries on the accounts. The balance at the end of tallying the
account is the difference between the two sides of an account. In the event
the total of the debit side exceeds the total of the credit side, then that every
account is said to have a debit balance. On the contrary when, when the total
of the credit side exceeds the total of the debit side, then that account is said
to have a credit balance.
The following steps should be followed for the purpose of balancing or clos-
ing of ledger accounts:
1. On a rough paper, total both the debit amount column and credit amount
column separately.
2. Find out the difference between the two sides if there is no difference;
close the account by showing the totals of both the sides which are
equal.
3. If the debit side total is more, put the difference on the credit side amount
column, by writing the words in particulars column „By Balance c/d to
make the totals of both sides equal. Conversely, if there is an excess of
credit side total, the same must be put to debit side as „To Balance c/d.
4. Carry forward the balance c/d to the opposite side of the account as To
Balance b/d or „By Balance b/d as applicable, in the beginning of
the accounting year.
As for illustration 4
Pass necessary journal entries for the following transactions and post them in
the appropriate ledger Accounts of P. Bhavsar.
2020
Jan. 1 Started business with R 2,00,000 in the Bank and R 40,000 cash.
1 Bought shop fittings R 40,000 and a van R 60,000 both paid by cheque.
2 Paid rent by cheque R 5,000.
3 Bought goods for resale on credit from Zakir & co. R 50,000.
5 Cash sales R 5,000.
8 Paid wages of assistant in cash R 1,000.
10 Paid insurance by cheque R 500.
15 Paid wages of assistant in cash R 1000; Goods returned to Zakir & co
R 6,000.
17 Paid Zakir & Co. R 30,000 by cheque.
19 Bought goods for resale on credit from Rao & Co R 25,000.
24 Bought stationery, paid in cash R 500.
27 Paid Rao & Co R 14,000 by cheque.
31 Paid R 20,000 into the bank.
30
Solution JOURNAL AND
In th e books of P.Bhavsar
LEDGER
Dr. Journal Cr.

Date Particulars L.F. Rs. Rs.
2020 Jan 1
1 Bank A/c Dr 2, 00,000 -
Cash A/c Dr 40,000 -
-
To Capital A/c 2, 40,000
(Being capital invested)

-
1 Furniture & Fittings A/c Dr 40,000
-
Van A/c 60,000
-
To Bank A/c 1, 00,000
(Bein g the purchase of
fittings and van for the

business)
-
2 Rent A/c Dr 5,000
To Bank A/c - 5,000
(Bein g rent paid by cheque)
31
BASICS OF 3 Purchases A/c Dr 50,000
ACCOUNTING
To Zakir & Co. A/c 50,000
(Being goods purchased on credit)
5 Cash A/c Dr 5,000

To Sales A/c 5,000
(Being goods sold for cash)

8 Wages Dr 1,000
To cash A/c 1,000
(Being wages paid to assistant)

10 Insurance A/c Dr 500
To Bank A/c 500
(Being insurance paid by cheque)

12 Cash A/c Dr 8,000
To Sales A/c 8,000

15 Wages A/c Dr 1,000
To Cash A/c 1,000
(Being wages paid in cash)

15 Zakir & Co A/c Dr 6,000
To Returns Outwards A/c 6,000
(Being goods returned)

17 Zakir& Co A/c Dr 30,000
To Bank A/c 30,000

(Being paid Zakir by cheque)
19 Purchases A/c Dr 25,000

To Rao & Co A/c 25,000
(Being goods purchased on credit)
32
19 Cash A/c Dr 7,000 JOURNAL AND
LEDGER
To Sales A/c 7,000

22 Wages A/c Dr. 1,000
To Cash A/c 1,000

(Being wages paid to assistant)
24 Stationery A/c Dr 500

To Cash A/c 500
(Being purchase of stationery)
25 Cash A/c Dr 15,000

To Sales A/c 15,000

27 Rao & Co A/c Dr 14,000
To Bank A/c 14,000

(Being paid by cheque)
29 Wages A/c Dr 1,000
To Cash A/c 1,000
(Being wages to assistant paid in cash)
31 Bank A/c Dr 20,000

To Cash A/c 20,000
(Being Cash paid into Bank)
Grand Total 5, 30,000 5, 30,000
33
BASICS OF Ledger Postings
ACCOUNTING Dr. Bank Account Cr.
Date Particulars J Amount Date Particulars J Amount
F F
1.1.20 To Capital 2,00,000 1.1.20 By Furniture 40,000

& Fittings
31.1.20 To Cash 20,000 1.1. 20 By Van 60,000
2.1. 20 By Rent 5,000
10.1. 20 By Insurance 500
17.1. 20 By Zakir 30,000
27.1. 20 By Rao 14,000
31.1. 20 By Balance c/f 70,500
2,20,000 2,20,000
1.2. 20 To Balance 70,500

b/d
Dr. Cash Account Cr.

Date Particulars J Amount Dat e Particulars J Amount
F F
1.1. 20 To Capital 40,000 8.1. 20d By Wages 1,000
5.1. 20 To Sales 5,000 15.1. 20 By Wages 1,000
12.1. 20 To Sales 8,000 22.1. 20 By Wages 1,000
19.1. 20 To Sales 7,000 24.1. 20 By Stationery 500
25.1. 20 To Sales 15,000 29.1. 20 By Wages 1,000
31.1. 20 By Bank 20,000
31.1. 20 By balance c/f 50,500

Total 75,000 Total 75,000
1.2. 20 To balance 50,500
b/d
34
Dr. Capital Account Cr. JOURNAL AND
LEDGER
Date Particulars J Amt. Date Particulars J Amt
F F
31.1.20 To 2,40,000 1.1.20 By Bank 2,00,000

Balance
40,000
c/f
1.1.20 By Cash
Total 2,40,000 Total 2,40,000
1.2.20 By balance c/f 2,40,000
Dr. Furniture Account Cr.
Date Particulars J Amt Date Particulars J Amt

F F
1.1.20 To Bank 40,000 31.1.20 By Balance c/f 40,000
1.2.20 By balance 40,000

b/f
Dr. Van Account Cr.

F F
1.2.20
By 60,000
balanc
e b/f
35
BASICS OF Dr. Rent Account Cr.
ACCOUNTING
F F
1.2.20 By balance 5,000

b/f
Dr. Zakir?s Account Cr.

F F
15.1.20 To Return 6,000 3.1.20 By Purchases 50,000

outward
17.1.20 To Bank 30,000
31.1.20 To Balance 14,000

c/f
1.2.20 By balance b/f 14,000
Dr Sales Account Cr.

F F
31.1.20 To Balance 35,000 5.1.20 By Cash 5,000

c/f
12.1.20 By Cash 8,000

19.1.20 By Cash 7,000
25.1.20 By Cash 15,000

Sales account
1.2.20 By Balance 35,000

b/d
36
Dr. Wages Account Cr. JOURNAL AND
LEDGER
F F
8.1.20 To cash 1,000 31.1.20 By Balance c/f 4,000
15.1.20 To cash 1,000
22.1.20 To cash 1,000
29.1.20 To cash 1,000
1.2.20 By Balance 4,000

b/d/
Dr. Insurance Account Cr.

F F
10.1.20 To Bank 500 31.1.20 By Balance c/f 500
Total 500 Total 500
Insurance a/c
1.2.20 By balance 500
b/f
Dr. Rao’s Account Cr.

F F
27.1.20 To Bank 14,000 19.1.20 By Purchases 25,000
31.1.20 To Balance 11,000

c/f
1.2.20 By Balance 11,000

b/d
37
BASICS OF Dr. Purchases Account Cr.
ACCOUNTING Date Particulars J Amount Date Particulars J Amount
F F
3.1.20 To Zakir 50,000 31.1.20 By Balance c/f 75,000
19.1.20 To Rao 25,000
1.2.20 To balance 75,000

b/d
Dr. Return Outward Account Cr.

F F
31.1.20 To Balance c/f 6,000 15.1.20 By Zakir 6,000
1.2.20 By Balance 6,000

b/d
Dr. Stationery Account Cr.

Date Particulars J Amount Date Particular J Amount
F s F
24.1.20 To Cash 500 31.1.20 By 500

balance
c/f
Total 500 Total 500
1.2.20 By Balance 500

b/ d

1. In the event the total of the debit side exceeds the total of the credit
side, then that very account is said to have a ............... balance.
a. Debit
b. Credit
2.11 Difference between Journal and Ledger
The differences between the Journal and the Ledger can be studied through
the following table:
38
Journal Ledger
JOURNAL AND
LEDGER
1. Journal is book of primary entry. 1. Ledger is book of final entry.
2. As soon as a transaction originates 2. Transactions come into the ledger

it is recorded into the journal. from the journal.
3. All the transactions are recorded in 3. The transactions are categorised into
chronological order. the accounts.
4. In journal narration is required and 4. No narration.

written in each and every entry.
5. Here the ledger folio number is 5. The Folio number of the journal or
written sub-journal is written.
6. The Relevant information cannot 6. As the transactions of particular

be ascertained readily. nature are grouped at one place
therefore the relevant information
can be ascertained easily.
7. The ledgers are prepared from the 7. Through Ledger trial balance is
journal and final accounts cannot prepared which is the basis of
be prepared directly from a journal. preparing the final accounts.
8. The accuracy of the accounts 8. The accuracy of the books is tested
books can?t be tested through by Trail balance which is prepared
journal. after closing of ledgers.
9. Debit and credit amounts are 9. The Debit and credit are recorded in
recorded in adjacent columns. two different sides of different
accounts.
10. In case of journal no balancing is 10. In ledger is balancing is done
done. periodically.

1. In ................. narration is required and written in each and every entry.
a. Journal
b. ledger
2.12 Let Us Sum Up
In this unit we have studied the about journal, ledger in very detail. We learnt
how to post the entries into the journal and how to transfer those entries to
their respective ledgers. Illustrations are given to explain this topic. Sub led-
ger is also discussed in detail.
The study of this unit will help the students to learn about accounting cycle,
the various types of accounts and entries and how to post entries in journal
and ledger.
39
BASICS OF 2.13 Answers for Check Your Progress
ACCOUNTING Check your progress 1
Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
2.14 Glossary
1. Bad Debts - The amount of un-recoverable debts from customers.
2. Book Value - It is an accounting term which usually refers to a busi-
ness historical cost of assets and liabilities.
3. Capital - An amount of money put into the business by the owner
4. Closing Balance - Balance of an account at the end (or close), of an
accounting period. This figure is then carried forward to the next ac-
counting period.
5. Closing Stock - Closing stock is the stock of inventory available with
the business at the end of the accounting period.
6. Cost - The value of money that has been used up to produce some-
thing, and hence is not available for use any more.
2.15 Assignment
1. Distinguish between journal and ledger.
2. Define ledger. Explain posting and balancing of ledger accounts
2.16 ActivitiesJournals And Ledger
Practical Questions
Journalise the following transactions in the books of Mahesh trading co.
1. Jan 1 Started business with cash R 2, 00,000, Building R 15, 00,000,
Furniture R 50,000.
40
2. Jan 2 Purchased goods from Mane on credit R 50,000. JOURNAL AND
3. Jan 3 Purchase stationery R 500. LEDGER
4. Jan 12 Open a current bank account for the business and deposited R
150000 in the same.
5. Jan14 sold good to Raman R 30000.
6. Jan 20 purchased good from Rajeev R 80,000
7. Jan 22 sold good for cash R 25000 and offer a cash discount of 2%.
8. Jan 25 sold goods to Rohit, of R 35000 and offered him a trade dis-
count of 1%.
Journalize the following transactions & post them into ledger in the
books of Swami Traders, for March 2007.
1. 1/3 Commenced business with cash R 27000, bank R 20000, Stock R
20000, Furniture R 50000 Building R 1500000.
2. 2/3 Purchased goods from Nitin of R 25000, he offered trade discount
of 1%.
3. 5/3 Purchased stationery R 1200
4. 6/3 sold goods for cash R 15000 and offered a cash discount of 2%.
5. 10/3 Sold goods to Navin Rs 20000.
6. 15/3 Paid cartage R 500.
7. 16/3 Paid wages R 4500.
2.17 Case Study
Write a short note on
a. Types of entries in journal
b. Sub-division of ledger
c. Advantages of ledger
d. Accounting process
e. Format of Journal
1. Advanced Accounts, M. C. Shukla & T. S. Grewal, S. Chand Pub-
lisher, 1997.
2. Advanced Accountancy, Hrishikesh Chakraborty, Oxford University
Press, 1978.
3. Financial Accounting, Paul S K, New Central Book Agency, 2001.
4. Modern Accountancy Volume I, Mukherjee, Tata McGraw Hill 2008.
41
BASICS OF
ACCOUNTING Unit SUBSIDIARY BOOKS
3
: UNIT STRUCTURE :
3.1 Introduction
3.2 Cash book
3.2.1 Features of Cash book
3.2.2 Types of Cash Book
3.2.3 Single Column Cash book
3.2.4 Double Column Cash book
3.2.4.1 Double column cash book with discount and cash
columns.
3.2.4.2 Double column cash book with bank and cash
columns.
3.2.5 Three Column Cash book
3.3 Petty Cash Book
3.4 Sales Book
3.5 Purchase Book
3.6 Sales Return Book
3.7 Purchase Return Book
3.8 Bills Receivable Book
3.9 Bills Payable Book
3.10 Journal Proper
3.11 Let Us Sum Up
3.13 Glossary
3.14 Assignment
3.15 Activities
3.16 Case Study
· Various Subsidiary Books. like:
· Concept of Cash Book.
· Application and Operations of Petty cashbook.
· Purchase and Sales book.
· Various types of Return Books.
· Bills Receivable.
· Bills Payable.
· Journal proper.
42
3.1 Introduction SUBSIDIARY
During the nineteenth century, the quantum of transactions of almost all the BOOKS
business houses rose enormously and it became clear that the journal was
inadequacies the sole book of original entry. In order to save time, efforts and
avoid inconvenience of classifying transactions for posting purposes, similar
types of transactions are recorded in special journals called subsidiary books.
The various subsidiary books are as follows:
1) Cashbook 2) Sales Book 3) Purchase Book 4) Sales Returns Book
5) Purchases Returns Book 6) Bills Receivable Book 7) Bills Payable Book
8) Journal Proper.
3.2 Cash Book
Cash book is a book of original entry. It records transactions involving re-
ceipts or payment of cash. Since the number of cash transactions is usually
large, it is a difficult task to classify and post them to their respective ledger
accounts. Though cashbook is a book of primary entry yet it serves as a
ledger account. Cashbook is called as journalised ledger since cash transac-
tions are primarily entered in cashbook and it shows the closing cash balance
at the end of the particular period.
3.2.1 Features of Cash Book
1. Only cash transactions find its place in cash book
2. Each and every cash receipts are posted on the debit side whereas ev-
ery cash payments are posted on the credit side of the cash book.
3. Only one aspect of a transaction is recorded in the cash book, i.e. cash.
4. All cash transactions are recorded chronologically in the cashbook.
5. It performs functions of both journal and ledger at the same time.
6. In case of cashbook at the end of accounting period either both the
sides will have same total hence no balance will be there or total of
debit side will be higher than credit side and difference will be shown as
closing balance.
3.2.2 Types of Cash Book
Cash book can be of following four types
1. Single column cashbook – with cash column only
2. Two column cashbook – with cash and bank column
3. Three column cashbook – with cash, bank and discount column
4. Petty cashbook for petty expenses
3.2.3 Single Column Cash Book
It records only cash receipts and payments. It has only one amount column
on each of the debit and credit sides of the cashbook and all the cash receipts
and cash payments are entered on the debit side and the credit side respec-
tively. Cash book, serves purpose of cash account and cash is a real account
so rule of debit what comes in and credit what goes out shall be applicable.
Points to be kept in mind while writing single column cash book:
1. The pages of the cashbook are vertically divided into two equal parts.
The left hand side is for recording receipts and the right hand side is for
recording payments.
43
BASICS OF 2. The cashbook with the balance brought forward from the preceding
ACCOUNTING period or with what we start. It appears at the top of the left sideas 'To
Balance' or 'To Capital' in case of a new business.
3. The transactions should be recorded in order of the date.
4. If any cash is received on an account, the name of that particular ac-
count is entered in the recepits column by the word 'To' on the left
hand side of the cashbook.
5. If any amount has been paid on an account, the name of the account is
written in a payments column as 'By' on the right hand side of the
cashbook.
6. It should be balanced at the end of said period.
The opening balance of the period is not posted but the other entries which
appear on the debit side of the cashbook are posted on the credit of the
respective accounts in the ledger and the entries appearing on the credit side
of the cashbook are posted on the debit of the proper accounts in the ledger.
Dr. Single Column Cash book Format Cr.
Datе Receipts L.F. Amount Datе Payments L.F. Amount
Illustration 5
Enter the following transitions in cashbook:
2020 April Rs.
1 Balancе of Cash 4,000
4 C ash Salеs 3,000

5 R еcеivеd from Anand 1,400
7 Paid for Cash Purchasеs 2,600
9 Sold goods for Cash 1,400

10 Dеpositеd into Bank 1,000
12 Sold goods for Cash 1,400
15 Bou ght Stationеry 1,000

20 W ithdrеw from Bank for officе 6,000
24 Purchasеd goods 9,000

25 Paid to Kishan 600
30 Paid Salariеs 1,600

30 C ash Salеs 1,800
30 Paid Rеnt 300
44
Solution: SUBSIDIARY
Dr. Cash Book for April 2020 Cr. BOOKS
Datе Receipts L Amount Datе Payments L Amount
F F
1.1.20 To balancе 4000 7.1.20 By purchasеs 2600
b/d a/c
4.1.20 To Salеs a/c 3000 10.1.20 By Bank a/c 1000
5.1.20 To Anand a/c 1400 15.1.20 By 1000

Stationеry
a/c
9.1.20 To Salеs a/c 1400 24.1.20 By Purchasеs 9000
a/c
12.1.20 To salеs a/c 1400 25.1.20 By Kishan a/c 600
20.1.20 To Bank a/c 6000 30.1.20 By Salary a/c 1600
30.1.20 To Salеs a/c 1800 30.1.20 By Rеnt a/c 300
31.1.20 By Balancе 2900

c/f
Total 19000 19000
3.2.4Double Column Cash Book

3.2.4.1 Double column cash book with discount and cash columns.
Double column cash book which is also known as the two column cash book
consists of two separate columns on the debit side and credit side for record-
ing cash and discount. In many organisation trader allow or to receive small
allowance off or against the dues. These allowances are provided for prompt
settlement of accounts. In some of the business almost all receipts or pay-
ments are accompanied by such discounts and in order to avoid unnecessary
postings separate columns in the cash book are introduced in order to record
the discounts received or allowed. These discount columns are only memo-
randum columns and they should never be considered as the discount ac-
count. The discount column on the debit side of the cash book will record
discounts allowed (ie. expense for business) and that on the credit side dis-
counts received (i.e. income for business).
The process of posting entries in the cash columns is in the same way as
single column cash book. But as far as discount column is concerned, each
item of discount allowed (Dr. side of the cash book) will be posted on the
credit side of the concerned personal accounts. On the other hand any dis-
count received will be posted to the debit of the concerned personal account.
The total of the discount column on the debit side of the cash book will be
posted to the debit side of the discount account in the ledger and the total of
discount column on the credit side of the cash book on the credit side of the
discount account. It should always be remembered that we never do balanc-
ing of discount column as we do in cash column.
45
BASICS OF Dr. Format of the Double Column Cash Book Cr.
ACCOUNTING With Discount and Cashbook
Datе Receipts V.N. L.F. Discount Cash Datе Payments V.N. L.F. Discount Cash
Illustration 5
Prepare two columner cash book (cash and discount) of Pankaj from the
following transactions.
2020 March
1. Opening cash balance R 8000.
4. Goods of R 6000 purchased at 10% trade discount.
7. Goods of R 3000 sold to Prakash for cash at 5% cash discount.
10. Goods of R 4000 sold for cash at 10% trade discount and at 5% cash
discount.
12. Furniture of R 5000 purchased from Nitu furniture mart.
15. R 1000 paid to Vishwas for settelment of R 1020.
16. R 900 paid for commission.
18. R 1500 received from Kamlesh towards fall settlement of R 1560.
20. Paid R 2000 for salary and R 400 for wages.
23. Goods of R 2000 purchased from Vishwan for cash at 10% cash dis-
count.
26. Cash of R 4000 introduced in the business.
28. Machine of R 8000 is purchased from Mehta equipment for which R
5000 is paid and balance amount is agreed to pay after one months.
46
SUBSIDIARY
BOOKS
19770
Cash
5000
1000
2000
1620
5000
3450
900
400
Discount
200
180
20
-
-
LF
No.
-
Voucher
Cr.
No.
-
Commission
By Purchase
By Purchase
By Vishwas
By Balance
Payments
Machinery
By Wages
By Salary
(Closing
(Discount and Cash Column)
balance)
2020 A/c
A/c
A/c
A/c
A/c
A/c
A/c
By
By
c/d
March
Date
15
16
20
20
23
28
31
-4
19770
Discount Cash
3420
8000
2850
3450
1500
4000
Cash Book of Shri Pankaj
390
150
180
60
-
-
LF
No.
-
Voucher
No.
-
(Opening
Receipts
Kamlesh
To Sales
To Sales
balance)
2020 Balnace
Balance
Capital
A/c
A/c
A/c
A/c
March- b/d
b/d
To
To
To
To
April -
Total
Date
10
18
26
1
1
Dr.
3.2.4.2 Double Column Cashbook With Bank and Cash column :-

In this type of cash book, an additional column (bank) is inserted on both the
sides of simple cash book. This column is kept to record the transactions
with the bank. Bank account is treated as ‘personal account’ hence ‘debit the
receiver’ and ‘credit the giver’ rule of personal account shall be applicable.
Such cash book has bank account and cash book. In this case, cash account is
treated as an asset and so the rule of ‘real account’ shall be applied.
When (1) cash is deposited (2) cheque is deposited (3) Draft is deposited (4)
amount deposited by debtors directly in bank account (5) any amount like
47
BASICS OF interest, dividend collected by the bank will be recorded at debited side of
ACCOUNTING bank column.
When (1) cash is withdrawn from bank (2) amount is paid by cheque (3) any
charges like commission, bank. In this transaction bank is giver, Hence bank
account will be recorded at credit side of bank column.
Formate of two columner cash book (with bank and cash column)
Date Receipts V. No. L F No. Cash (R) Bank (R) Date Payments V. No. L F No. Cash (R) Bank (R)
Illustration 6
Record the following transaction in a suitable cash book of Mr. P. Basu and
show the closing balances of cash and Bank
Jan 2020 R
1 Cash in hand 50,000
2 Opened a Bank Account 30,000
2 Received from Mr. T. Bose 4,000
3 Paid to Mr. N. Gopal by Cheque 500
3 Purchase made in cash 1,000
3 Paid rent 250
3 Withdrawn from Bank 3,000
4 Cash Sales 5,000
4 Received a cheque from Sunil Ranjan 10,000
4 Paid wages 200
4 Purchased furniture and paid by cheque 4,000
4 Cash Purchases 3,000
5 Withdrawn from Bank for personal use 3,000
5 Paid electricity Bill 52
5 Paid rates and taxes 100
5 Purchase made in cash 7,000
5 Cash Sales 12,000
5 Sold to Sree Nagrajan 5,000
5 Purchased from Mr. Nemai Bose 2,000
7 Received a cheque from Sree Nagarjan and sent to Bank 3,000
7 Paid railway fright 250
7 Purchased stamps and Stationery 25
7 Deposited in Bank Account 300
48
Solution: SUBSIDIARY
Dr. Two columnar Cash Book for Jan 2020 Cr. BOOKS
Dat е Recepits L Cash Bank Dat е Payments L Cash Bank
2020 F 2020 F
1.1 To bal. b/d 50,000 1.1 By Bank a/c 30,000
1.1 To Cash a/c 30,000 3.1 By N. Gopal 500
a/c
2.1 To Bosе a/c 4,000 3.1 By Purchasе 1,000
a/c
3.1 To Bank a/c 3,000 3.1 By Rеnt a/c 250
4.1 To Salеs a/c 5,000 3.1 By Cash a/c 3,000
4.1 To Rajan a/c 10,000 4.1 By Wagеs a/c 200
5.1 To Salеs a/c 12,000 4.1 By Furniturе 4,000

a/c
7.1 To Nagrajan 3,000 4.1 By Purchasеs 3,000
a/c a/c
7.1 To Cash a/c 300 5.1 By Drawing 3,000
a/c
5.1 By Еlcе. Chg 52
a/c
5.1 By Ratеs, taxеs 110
a/c
5.1 By Purchasеs 7,000
a/c
5.1 By Frеight a/c 250
7.1 By Stationеry 25
a/c
7.1 By Bank a/c 300
By balancе c/f 31,813 32,800
Total 74,000 43,300 Total 74,000 43,300
Note: Credit transactions will not be recorded in cashbook only cash

and bank related transactions are recorded.
3.2.5 Three Column Cash Book
A three column cashbook or triple column cashbook is one in which there are
three columns on each side of the cash book i.e.on both the debit and credit
side. First one is used to record cash transactions; the second is used to record
bank transactions and third is used to record discount received and paid.
When a trader maintains a bank account, it becomes necessary for him to
record the amounts deposited into bank and withdrawals from it. Because of
this reason, one additional column is added on each side of the cashbook. The
three coloumn cash book reveals the cash as well as bank deposits at a glance.
Process of writing a Three Column cashbook:
The first step is write the opening balance of cash in hand and cash at bank on
the debit side in the cashbook and bank columns. If the opening balance is
credit balance (overdraft) then it will be put in the credit side of the cashbook
in the bank column. i.e. opening bank balance would appear at debit side of
cashbook as a opening balance in bank column and and bank over draft at
credit side.
49
BASICS OF Cheque/ Chequeor Cash Received
ACCOUNTING When a cheque is received from any person and is paid into the bank on the
same date it will appear on the debit side of the cashbook. The amount will
be shown in the bank column. However if the cheque received could not be
deposited into the bank on the same date then the amount will appear in the
cash column. Cash received will be recorded in the usual manner in the cash
column.
Payment by Cheque/Chequeor Cash
Whenever we make payment by way of cheque, these will appear on the
credit side and the amount in the bank column. However if the payment is
made in cash, it will be recorded in usual manner in the cash column.
Contra entries
If an amount is entered on the debit side of the cashbook and the exact the
same amount is again entered on the credit side of the same account, it is
called 'contra entry'. In the same way If an amount is entered on the credit
side of an account also may have a contra entry on the debit side of the same
account.
Contra entries are passed when:
Cash is deposited into bank by us: This is a payment from cash and a receipt
in bank. Therefore, enter on credit side, cash column and on debit side bank
column. The reason for making two entries is to follow the principle of double
entry, which in such transactions is completed and therefore, no posting of
these items is necessary. Such entries are marked in the cashbook with the
letter 'C' in the folio column.
Cheque is drawn for office use: It is cash withdrawal from our bank account
i.e. payment from our bank and receipt in cash. Therefore enter on the debit
side, cash column 'To Bank' and on credit side, bank column 'By Cash'.
Bank Charges and Bank Interest Allowed
Bank charges paid appears on the credit side of bank column because on
credit side of bank account shows all payment under the head 'Bank Charges'.
Bank interest allowed appears on the debit side, bank column 'To Interest'.
Posting
The method of posting three-column cashbook into the ledger is as follows:
1. The opening balance of cash in hand and cash at bank are not posted.
2. Contra entries are marked with 'C' are not posted.
3. All other items on the debit side will be posted to the credit of respec-
tive accounts in the ledger and all other items on the credit side will be
posted to the debit of the respective accounts.
4. The total of the discount allowed will be posted to the debit of the
discount account in the ledger and total of the discount received to
the credit side of the discount account.
50
Format of Three-Column cashbook SUBSIDIARY
Dr. Cr. BOOKS
Datе Rec V.N. L.F. Dis cash Bank Datе Pay V.N. L.F. Dis Cash Bank
eipts men
ts
Illustration 7
From the following particulars you have to prepare a Three Column cash-
book. For the month of Jan 2020.
Jan 1 Cash in hand R 25,000 and at bank R 40,000.
1 Bought goods from Rajan for cash R 10,000 and R 10,000 on credit.
2 Bought good for R 8,000 paid by cheque, discount allowed is 2%.
3 Sold goods for cash R 15,000, with a cash discount of 1%.
4 Sold good to Rajesh of R 25,000.
5 Cash deposited into bank R 10,000.
6 Paid Rajan by cheque, he allowed discount of R 200.
7 Rajesh paid us by cheque R 25,000.
8 Paid Ramsharn by cheque R 9,800 in full settlement of his dues of R
10,000.
9 Sold goods to Mohan for cash R 22,0 00.
10 Cash deposited into bank R 25,000.
51
BASICS OF Solution:
ACCOUNTING Three Columnar cashbook for Jan 2008
Dr. Cr.
Datе Re ceipts L d/c ca sh bank Datе payments L d/c cash bank
2020 F 2020 F
1 To b al 25,000 40,000 2 By 10,000
b/d Purchasеs
4 To Salеs 150 14,850 3 By 160 7,840
Purchasеs
6 To cash c 10,000 6 By Bank c 10,000
8 To 25,000 7 By Rajan 200 9,800
Rajеsh
10 To Salеs 22,000 9 By 200 9,800
Ramsharn
11 To Cash c 25,000 11 By Bank C 25,000
11 By balancе 16,850 72560
c/f
Total 150 61,850 1,00,00 560 61,850 1,00,00
0 0

1. Though ............ is a book of primary entry yet it serves as a ledger
account.
a. Cashbook
b. Ledger
c. Journal
3.3 Petty Cash Book
In every business, whether large or small there are numerous small expenses
incurred regularly, e.g. stationery, cartage, newspaper and magazine, refresh-
ments etc. Generally, major payments are made by cheque for better control
over cash. In spite of this advantage, payment by cheque in the above cases
is impractical. As a solution, head cashiers transfer a small amount of cash to
a person who is designated to be responsible for it – the petty cashier. The
petty cashier will record all the petty transactions in an separate multi col-
umn book called petty cashbook. Amount received from the head cashier is
debited in the petty cashbook. All payments are entered on the credit side.
The petty cashbook is treated as book of original entry.
There are two systems of petty cash.
1. Simple system of petty cash: Under this method, petty cashier is given
any specific amount to be spent on petty expenses. After spending the
wholeamount, he submits the petty cashbook to the head cashier for
necessary verification. He also asks for more money to carry out fur-
ther transactions.
2. Imprest system of petty cash: A fixed amount of money for a fixed
period which may be a week or a month and it is allocated towards
meeting the petty small daily expenses. At the end of the period the
accounts are checked, verified and again cash equivalent to expenses
incurred is reimbursed to the petty cashier. It means the opening and
closing balance of the petty cashbook remains the same i.e. balance
held by petty cashier in the beginning and the end does not change.
52
Illustration 8 SUBSIDIARY
You are required to enter the following transactions in the columnar petty BOOKS
cashbook of Mr.Medhansh, the accountant who was given R 100 on 1st
April 2020 Partic

ulars
2 Paid for postagе 8
2 Paid for book 10
3 Paid for Photocopy 4
3 Paid for postagе stamps 6
8 Paid for papеr 1
12 Paid for cartagе 6
18 Paid for trips to officе pеons 2
23 Paid for ink and nibs 4
25 Paid for Tiffin to officе pеons 6
26 Paid for train fair 5
28 Paid for bus fair 4
29 Еnvеlops and lеttеr hеads 6
30 Printing addrеss on abovе 4
31 Taxi farе to managеr 10
Solution:
Printing
Amount Travеling
Datе Particulars V.N. Total Postagе and Cartagе Misc.
Rеcеivеd Еxpеnsеs
Stationary
Rs. 2020
Rs.100 March1To Cash
“2 By Postage 8 8 4
“2 By Stationary 10 10
“3 By photocopy 4
“3 By Postagе 6 6 2
“3 By Papеr 1 1 6
“ 12 By Cartagе 6 5 6
“ 18 By Tip to pеon 2 4
“ 23 By Ink & nibs 4 4
“ 25 By Tiffin to 6
“ 26 Pеon 5 10
“ 28 By train fair 4
“ 29 By bus fair 6 6
“ 30 By Еnvеlops еt. 4 4
“ 31 By printing 10
“ 31 By Taxi fair 24
By balancе c/d
100 100 14 25 10 19 8
24
76
53
ACCOUNTING 1. Amount received from the head cashier isin the petty cashbook
a. Debited
b. credited
3.4 Sales Book
In this book, all transaction related to credit sales are recorded. Generally
sale of assets on credits banks are recorded through journal. Only the credits
sale of goods in which you are dealing for trading purpose are recorded in
sales book. This book is also known as „sales journale or „sales day booke. It
should be remembered that sales daybook, records only those goods which
are sold on credit and the goods in which the business enterprise deals in. It
should be also noted that the goods any forward sale the delivery of which is
to be made in future will not find place in the daybook. However, the entries
are made with the net amount after allowing for trade discount.
Specimen of sales book
Date Name of the customer Invoice No. L F No. Amount (R)
It is to be noted that the sales book is a book of original entry and hence
perodic posting must be completed to ledger accounts concerned.
Illustration 9
From the following transactions write – up the sales day book of M/s X &
Co.:
Jan. 1 Sold to Premier Traders 100 bags of sugar @ R 650 per bag, less
trade discount @5 %.
Jan. 10 Sold to R & Co. 10 bags of milk powder @ R 500 per bag, less
trade discount @ 10%.
Solution:
In the books of M/s X & Co.
Sales Book
Date Name of the customer Invoice No. L F No. Amount (R)
Premier Traders.
100 × R650 = R65000 – 5% T.D
Jan - 1 – – 61750
R & Co.
Jan - 10 10 × R500 = R5000 – 10% T.D – – 4500
Total – – 66250

1. In ...................... book, all transaction related to credit sales are recorded.
a. Sales book
b. Cash book
c. Journal
d. Ledger
54
3.5 Purchase Book SUBSIDIARY
All transactions related to credit purchases of goods are primarily recorded in BOOKS
this book. It is also known as „purchase day booke, „bought day booke, or
purchase journale. On receiving the goods and the invoice, the receiving de-
partment compare both with the copy of the order placed by purchase de-
partment. If everything is found in order, the goods are sent to the stores.
Based on the invoice received from the supplier, necessary entry is passed in
the Purchase Book.
Specimen of Purchase Book
Date Name of the supplier Invoice No. L F No. Amount
Illustration 10
(Only purchase book no ledger entry)
Enter the following transactions in Purchases Book of m/sc X & Co.
Jan.1 Purchased on credit from Ambani & Co. 100 shirts @ 125 each less 5
% trade discount.
3 Purchased from Behri Brothers 60 shirts @ R 200 each, trade discount
allowed by them 10 %
10 Purchased a type writer from Big Brothers for R 5,000
12 Purchased 300 shirts @ R 175 each from Rehman & Co.
Solution :
Purchase Book
Invoice LF Amount
Date Name of the Supplier
No. No. (R)
Jan. Ambani & Co. 100 shrits @ R125 = R
1 - - 11875
12500 – 5% T.D.
Behri Bros
Jan.
60 shirts @ R200 = R12000 – 10% T.D. - - 10800
3
Jan. Rehman & Co.
- - 52500
12 300 shirts @ R175 = 52500
Total - - 75175

1. All transactions related to credit purchases of goods are primarily re-
corded in ............ book.
a. Purchase Book
b. Sales Book
55
BASICS OF 3.6 Sales Return Book
ACCOUNTING Goods may be returned by the customers for a variety of reasons such as
wrong quantity and/or quality. All goods returned by the customers are pri-
marily recorded in this. This book is also known as „return inward booke. It
only records the transaction of those goods returned by credit customers.
When goods are returned by the customer following procedure is followed:
1. Preparation of „credit notee: When credit customers return goods, the
company prepares a credit note in the customeres name. This note
mentions that the account of the customers has been credited with the
amount stated there in. The original being sent to the customer and the
duplicate is preserved in the file, which provides basis for recording
entries in the sales return book.
2. Posting from the sales return book: The total values of the goods re-
turned by customers are posted to various ledger accounts concerned
periodically
Specimen of Sales Return Book
Amount
Datе Namе of thе Customеr Credit note No. LF
(Rs.)
Illustration 11
Enter the following sales returns in the books of Shyamlal.
Datе Invoicе Particulars
No.
06.10.20 8256 M/s Navin tradеrs rеturnеd Samrat groundnut oil 900 ml,
15 packs @110.
12.11.20 8362 M/s Prabhat tradеrs rеturnеd Bornvita 500 gm., 25 packs
@125
18.12.20 8528 M/s Kanchan tradеrs rеturnеd Samrat Sunflowеr oil 900
ml, 15 packs @100.
Solution : In the books of Shyamlal

Sales Return Book
Invoice L F Amount
No. No. (R)
M/s Navin traders
6-10-20 8256 - 1650
15 × R110
M/s prabhat traders
12-11-20 8362 - 3125
25 × R125
M/s Kanchan traders
18-12-20 8528 - 1500
15 × R100
Total - - 6275

1. All goods returned by the customers are primarily recorded in
a. Sales return book b. Purchase return book
56
3.7 Purchase Return Book SUBSIDIARY
Goods may be returned by the company to the sellers for a variety of reasons BOOKS
such as wrong quantity and or quality. All goods returned by the company are
primarily recorded in this. This book is also known as „Return Outwards
Booke. It only records the transaction of those goods returned to the debit
sellers. When goods are returned to the sellers following procedureis fol-
lowed:
1. Preparation of „Debit Notee: When the goods are returned to the sup-
pliers, intimation is sent to them through what is known as a debit note.
These debit notes serveas vouchers for these entries. A debit note is a
statement sent by a businessman to another person, showing theamount
debited to theaccount of the later. Debit notes are usually serially num-
bered and are prepared in the same form as that of the invoice.
2. Posting from the Sales Return Book: The total of the purchases returns
or returns outwards book is credited to returns outward account or
purchases return account (being the goods sent out). Individual suppli-
ers to whom goods are returned are debited (because they receive the
goods).
Specimen of Purchase Return Book
Debit Note L F
Datе Namе of thе suppliеr Amount
No. No.
Entries in the purchase return book are made on the basis or original Credit
Note received from the supplier.
Illustration 11
Enter the following purchases returns in the books of Vikaram.
Datе Invoicе No. Particulars
12/5/20 78125 Rеturnеd to Gupta Tradеrs, 5sеts of Dining
tablеs @ 8,000
28/06/20 78256 Rеturnеd to Godrеj & co 3 Wardrobеs,
Costing Rs. 15,000, 18,500, 26,000
rеspеctivеly.
8/09/20 78345 Rеturnеd to Croma Furniturеs 2 sofa-sеts

costing Rs.25,000 &18,900 rеspеctivеly
Solution: In the books of Vikaram

Purchase Return Book
Invoic L F Amount
e No. No. (R)
Gupta traders
12-5-20 - - 40000
5 × R8000
Godrej & Co.
28-6-20 - - 59500
R15000 + R18500 + R26000
Croma Furnitures
8-9-20 - - 43900
R25000 + R18900
Total - - 143400
57
ACCOUNTING 1. All goods returned by the company are primarily recorded in ..............
a. Purchase return book
b. Sales return book
3.8 Bills Receivable Book
When goods are sold on credit, the funds are blocked in the form of debtors
and can be materialised in near future. Sometimes the seller wants a written
undertaking from the credit customer, to pay after a specific period. Such
document, containing an undertaking to pay with the details of payments is
termed as bills of exchange. When the bill is drawn by the seller and accepted
by the buyer it is termed as bills receivable from selleres point of view. All
such bills receivables are recorded in the books of accounts through a sub-
sidiary book called as bills receivable book.
Specimen of Bills receivable Book
No. Datе of Datе From Namе of L Duе Amount Rеmark
of rеcеipt of whom thе F datе
bill bill rеcеivеd of
accеptor
bill
The total of the bills receivable book indicates the total value of bills receiv-
able drawn during the period. Information about bill discounting, dishonour,
encashment etc is noted in the remark column. entries of endorsement,
dishonour of bills are recorded through journal proper. Bill encashment and
discounting is passed through cashbook.
1. The total of the .............. book indicates the total value of bills receiv-
able drawn during the period.
a. bills receivable b. bill payable
3.9 Bills Payable Book
When the business unit purchases goods on credit, the creditor may want an
undertaking from the unit, for the payment in future on or before a specific
date, such written promise to pay the specific amount on specific date, is
termed as bills of exchange. For the person or the organisation that prom-
ises, the bill is bills payable and for the one whom it is promised, it is bills
receivable. Bills payable book is maintained for the bills accepted by the
drawee.
Specimen of Bills payable Book
No. Datе of Datе Namе of LF Duе datе Amount Rеmark
of rеcеipt of bill thе of bill
bill drawеr
58
Check your progress 8 SUBSIDIARY
1. ................. book is maintained for the bills accepted by the drawee. BOOKS
a. Bills payable
b. Bill receivable
3.10 Journal Proper
Journal proper is used for making the original record of those transactions,
which do not find a place in any of the previously mentioned books of origi-
nal entry. The journal proper is used to record the following types of entries:
1. Opening entries: Opening entries are used at the beginning of the finan-
cial year to open the books by recording the assets, liabilities and capi-
tal, appearing in the Balance Sheet of the previous year. The rule to be
applied is:
Assets Account Dr
To Liabilities Account
To Capital Account
2. Closing entries: Closing entries are passed at the end of each year
whereby the revenue items (expenses and incomes losses and profits)
are transferred to revenue account (i.e. trading and profit and loss ac-
count). Balances in capital items (as assets, liabilities, and proprietary
balances etc) do not change and then these are transferred to balance
sheet. The closing entries are often avoided now and instead, in the
ledger itself the destination of the balances is indicated as: transfer to
trading account, transfer to profit and loss account etc.
3. Adjustment entries: Adjustment entries are passed at the time of
finalisation. These entries are needed to bring into books outstanding
expenses, accrued incomes, depreciation, provision for bad and doubt-
ful debt, provision for discounts etc.
4. Rectification entries: Rectification entries are required to rectify dif-
ferent types of errors located, as errors of omission, commission, prin-
ciple etc. (for details refer unit – V)
5. Transfer entries: These are needed for transfer of any amount from one
account to another account.
6. ShareIssueentries: Share issue entries are needed for issue of share and
making calls etc in case of companies.
Illustration 12
Pass necessary Journal entries:
(1) Opening Balance:
Rs. Rs.
Plant 80,000 Cash 5,000
Creditors 40,000 Debtors 40,000
Stock 10,000
(2) Closing figures as per Trial Balance include:
Rs.
Purchases 70,000
Sales 1,00,000
Expenses 12,000
(3) Closing Stock Rs 5,000
(4) Transfer Rs. 1,000 from credit of A to credit of B.
59
BASICS OF (5) Rs. 1,000 repairs to Furniture debited to Furniture Account by
ACCOUNTING mistake.
(6) Provide 10 % depreciation on assets of Rs. 60,000.
Journal
LF
Date Particular Debit Credit
No.
Plant A/c Dr. - 80000 -
Cash A/c Dr. - 5000 -
Debtors A/c Dr. - 40000 -
Stock A/c Dr. - 10000 -
1 To Creditors A/c - - 40000
To Reserve A/c - - 15000
To Capital A/c - - 80000
(Being opening balances are recorded)
Trading A/c Dr. - 80000 -
To purchase A/c - - 70000
2 To opening stock A/c - - 10000
(Being purchase and opening stock transfer
to tranding A/c)
Sales A/c Dr. - 100000 -
To trading A/c - - 100000
3 (Being closing stock transfer to trading
A/c)
Closing stock A/c Dr. - 5000 -
To trading A/c - - 5000
4 (Being closing stock transfer to trading
A/c)
Trading A/c Dr. - 25000 -
5 To P & L A/c - - 25000
(Beimg gross profit transferred to P & L)
Profit and loss A/c Dr. - 12000 -
6 To expense A/c - - 12000
(Being expense transferred to P & L A/c)
Profit and loss A/c Dr. Dr. - 13000 -
7 To capital A/c - - 13000
(Being net profit transferred to capital A/c)
Repair A/c Dr. - 1000 -
To furniture A/c - - 1000
8 (Being repairs wrongly debited to furniture
A/c is rectified)
Depriciation A/c Dr. - 6000 -
To assets A/c - - 6000
9
(Being depreciation charged on fixed
assets)
Total 377000 377000
60
Note : (1) Purchase 70,000 Sales 10,000 SUBSIDIARY
Opening 10,000 Closing 5,000 BOOKS
80,000
Gross profit 25000
1,05,000 1,05,000
(2) To Expense 12000 Gross profit 25000
Net Profit 13000
25000 25000
1. .................. is used for making the original record of those transac-
tions, which do not find a place in any of the previously mentioned
books of original entry.
a. Journal proper
b. Ledger
c. Journal
3.11 Let Us Sum Up
In this unit we have studied about various subsidiary books. In very details
we have discussed the various types of subsidiary books. The purpose of
these subsidiary book is different and they are of many types, almost all of
them have been discussed in detail.
In order to save time, efforts and avoid inconvenience of classifying transac-
tions for posting purposes, similar types of transactions are recorded in spe-
cial journals called subsidiary books. The various subsidiary books are cash-
book, sales book, purchase book, sales returns book, purchases returns book
bills, receivable book bills, payable book, journal proper.
Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
61
ACCOUNTING Answers: (1-a)
Answers: (1-a)
3.13 Glossary
1. Double-entry book-keeping - A system that accounts for every aspect
of a transaction – where it came from and where it went to. This from
and to aspect of a transaction (called crediting and debiting) is what
the term double-entry means.
3.14 Assignment
What are the books of original entrye explain in detail
3.15 Activities
Explain the Following:
a. Three Column cashbook
b. Transfer entries
c. Bills Payable Book
d. Purchase Return Book
3.16 Case Study
What do you mean by “Subsidiary Books”e Describe in brief each of these
subsidiary books.
1. Advanced Accounting - Financial Accounting, Dr Ashok Sehgal, Dr
Deepak Sehgal, Taxmann Allied Services Pvt. Ltd., 2008.
Press, 1978.
3. Advanced Accounts, M. C. Shukla& T. S. Grewal, S. Chand Publisher,
1997.
5. Financial Accounting, J C Varshney, Wisdom Publication, 2006.
6. Modern Accountancy VolumeI, Mukherjee, Tata McGraw Hill 2008.
62
Block Summary
In this block best efforts have been made to provide the basics of accounting
to the students in easy language. In the starting unit we discussed the very
basic topics of accounting, the basic terminologies of accounting. We dis-
cussed the various rule and principles of accounting. Through knowledge of
these principle is a must as they are the foundation of modern accounting.
These principles have been discussed with sufficient illustrations and ex-
amples. In the second unit of this block we studied in very detail about jour-
nal, ledger and how to post entries into the ledger. In this portion we have
covered and explained in detail how to post entries into the ledger, how to
transfer entries from journal to ledger and how to close the ledger account.
In the third unit we have studied about the subsidiary books, all the books of
subsidiary nature were discussed in detail
It has covered almost all the basic things in detail to the students and all the
required information has been included in this block which was essential for
the students to understand this subject.
Block Assignment
Short Answer Questions
1. Discuss the various forms of ledger.
2. Discuss the characteristics of Journal.
3. Write short notes on.
a. Bookkeeping
b. Type of accounts
c. Evolution of accounting
d. Origin and growth of accounting
e. Accounting mechanics
f. Rules for debit
4. Debit balance as per cash book.
5. Debit balance as per pass book.
6. Items to beadded and subtracted when overdraft balance as per cash
book is given.
7. Items to beadded and subtracted when credit balance as per pass book
is given.
Long Answer Questions
1. Discuss the documents used in recording accounting transactions of
business.
2. What is a journale Explain its features and advantages.
3. Define accounting. Explain the functions of accounting. Also, state the
users of accounting information.
4. What are the types of accountse Explain the rules of debit and credit
for various types of accounts.
5. Explain the principles of accounting.
6. Discuss the procedure of preparing sales return book.
63
BASICS OF Enrolment No
ACCOUNTING
1. How many hours did you need for studying the units
Unit N o 1 2 3
N os. of H rs
2. Please give your reactions to the following items based on your read-
ing of the block:
3. Any Other Comments

………………………………………………………………………………………………
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64
Ambedkar
OpenUniversity
BASIC OF ACCOUNTING
BLOCK 2 : TRIAL BALANCE, BANK RECONCILIATION
STATEMENT, CAPITAL AND REVENUE
TRANSACTION AND ACCOUNTING FOR BAD
DEBTS
UNIT 1
TRIAL BALANCE
UNIT 2
BANK RECONCILIATION STATEMENT
UNIT 3
CAPITAL AND REVENUE TRANSACTION
UNIT 4
65
TRIAL BALANCE, BLOCK 2 : TRIAL BALANCE, BANK RECONCILIATION
BANK STATEMENT, CAPITAL AND REVENUE
RECONCILIATION TRANSACTION AND ACCOUNTING FOR BAD
STATEMENT, CAPITAL DEBTS
AND REVENUE
Block Introduction
TRANSACTION AND
ACCOUNTING FOR Accounts is considered to be one of the most important subject for the
BAD DEBTS students of commerce and management and keeping in view this book has been
made to make the subject very simple and understandable for the student.
This block will be coverings topics of trial balance, bank reconciliation
statement, Capital & revenue transactions and Bad debts. All these topics are
considerd to be one of the most important topics in accounting. In the first unit the
studants will be told about the trial balance. The purpose and objectives of trial
balance will also be informed to the students .They will also be explained how to
prapare tha trial balance.In the second unit the students will also be told about the
bank reconciliation. They will be told about the purpose and uses of a bank
reconciliation statament and why is it nacessary in accounts. They will also explained
in detail the process of preparing bank reconciliation statement.
In the third unit we shall study in detail about the capital and revenue nature
of expenses. We will be discussing in detail the difference between the capital and
revenue expenditure. We will also be studying the deferred revenue expenditure
and how they are different from revenue and capital expenditure. In this block we
will be studying about capital and revenue receipts and capital and revenue losses.
This block will also cover a unit on bad debts, where we shall be studying what
are bad debts and what is the procedure of its role in accounting. We will also be
studying in this topic the provision for bad debts, provision for discount on debtors
and creditors and the accounting treatment on recovery of bad debts.
The study of this block is very usefull to the students as it will help them in
understanding the basic concepts of final accounts and knowledge of these topics
is very essential for the preparation of books of accounts.
Block Objective
After reading this block, you will be able to understand :
• Trial balance and its limitations.
• Errors disclosed by trial balance.
• Methods of preparing Trial Balance.
• What is Suspense account?
• Purpose of preparing Bank reconciliation.
• Capital and Revenue expenses and receipts.
• Bad debts and their accounting provisions.
Block Structure
Unit 1: Trial Balance
Unit 2: Bank Reconciliation Statement
Unit 3: Capital and Revenue Transaction
Unit 4: Accounting for Bad debts
66
Unit TRIAL BALANCE
1
: UNIT STRUCTURE :
1.1 Introduction
1.2 Objectives of Trial Balance
1.3 Limitations of Trial Balance
1.4 Errors Disclosed by a Trial balance
1.5 Errors that are not Disclosed by a Trial Balance
1.6 Methods of Preparing Trial Balance
1.7 Methods of Locating Errors
1.8 Suspense Account
1.9 Let Us Sum Up
1.11 Glossary
1.12 Assignment
1.13 Activities
1.14 Case Study
After learning this unit, you will be able to understand :
• Meaning and Objectives of preparing a Trial Balance.
• Limitations of Trial Balance.
• Various types of disclosed as well as undisclosed errors by Trial
Balance.
• Concept of Suspense account.
• Methods of locating errors.
1.1 Introduction
A trial balance is a detailed list of all the nominal ledger (general ledger)
accounts contained in the ledger of a business. It contains the name of the nominal
ledger account and the value of that nominal ledger account. The value of the
nominal ledger hold either a debit balance value or a credit value balance. The
debit balances are shown in the debit column of the trial balance and the credit
balances are shown in the credit column. The financial statements i.e. profit and
loss account and balance sheet are prepared by using the trial balance.
The name of Trial balance comes from its purpose i.e. the purpose of a trial
balance, the purpose of trial balance has been to prove that the value of all the
debit balances are equal the total of all the credit balances.
67
TRIAL BALANCE, Normally trial balance is prepared by a bookkeeper or accountant who has
BANK used day books to record financial transactions and then post them to the nominal
RECONCILIATION ledgers and personal ledger accounts. The trial balance is a part of the double–
STATEMENT, CAPITAL entry bookkeeping system and uses the classic ‘T’ account format for presenting
AND REVENUE values.
TRANSACTION AND 1.2 Objectives of Trial Balance
ACCOUNTING FOR
Trial Balance serves the following objectives :
BAD DEBTS
1. It makes sure that all transactions have been recorded with identical
debit and credit amounts and the balance of each account has been
computed correctly.
2. It provides for the test of arithmetical accuracy of various ledger
accounts.
3. As the Trial Balance contains the ledger balance on a particular date,
thus the entire ledger is summarised in the form of a Trial Balance.
Hence, it is a summarised ledger.
4. It provide base for preparing final accounts.
1. provides for the test of arithmetical accuracy of various ledger accounts
a. Journal b. Ledger
c. Trial balance
1.3 Limitations of Trial Balance
An agreed Trial Balance does not prove that :
1. All transactions have been correctly analysed and recorded in the
proper accounts. For instance, if the wages paid for the installation of
plant had been erroneously recorded by debiting the wages account
as opposed to the plant account, the trial balance would still agree.
2. All transactions have been recorded in the books of original entry. If,
for example, a sales invoice were to be completely omitted from being
recorded in the sales day book, the error would not be disclosed in
the trial balance.
To conclude, we can say that a trial balance should not therefore, be regarded
as conclusive proof of the correctness of the books of accounts.
1. should not therefore, be regarded as conclusive proof of the correctness of
the books of accounts.
a. Trial balance b. Journal
c. Errors
1.4 Errors Disclosed by a Trial Balance
In order to understand the types of errors and their rectification we have to
classify them into Errors disclosed and Errors not disclosed by trial balance.
Following are the errors in the books of accounts which are disclosed by a Trial
Balance :
68
1. Omission error : Both the sides of a trial balance will not agree when a TRIAL
transaction has not been correctly posted in the books of accounts.i.e. BALANCE
There will be differencein both debit and credit side of the trial balance.
2. Debit or Credit entries are not posted at all or posted twice : If only
one side of the transaction i.e. If only one aspect has been recorded or it
has been recorded twice, the trial balance will not agree.
3. Debits are wrongly posted as credits and vice versa : A trial balance
will always be in disagreement when a transaction is recorded on the wrong
side of an account.
4. Wrong totalling of subsidiary books : If the total of any subsidiary book
is wrongly cast, it will result in disagreement of the trial balance.
5. Difference in amount between theentries : If different amounts are
posted in two different accounts, the trial balance will never agree.
6. Error in computation of an account balance : If the balance of an account
is not correctly computed, the balance of the ledger will not show the true
position and will cause disagreement of the trial balance.
7. Omission of Account Balance : If the balance of an account is not listed
in the trial balance at all, it would fail to agree.
8. Balance of an account wrongly recorded in the trial balance : If the
balance of an account is wrongly recorded in the trial balance, there will be
some disagreement.
9. Errors in extraction of the trial balance : The trial balance will not tally
if any or both the columns are wrongly totalled up.
1. The trial balance will not tally if any or both the columns are wrongly totalled
up
a. Errors in extraction of the trial balance
b. Ommission error
c. totalling error
1.5 Errors that are not disclosed by a Trial Balance
1. Errors of omission : If a particular transaction omitted altogether from the
books of original entry.
2. Errors of principal : These errors results because of an incorrect application
of the principles of accounting, e.g. failure to differentiate between capital
and revenue expenditure.
3. Compensating errors : These area group of errors and the total effect of
which is not reflected in the trial balance. These errors are of a neutralizing
nature. One error is compensated by errors of an opposite nature.
4. Recording wrong amount in the books of original entry : If a transaction
is wrongly recorded in the books of original entry and there after carried
through the ledger it will not cause disagreement in the trial balance.
69
TRIAL BALANCE, 5. Recording a transaction more than once : The trial balance will agree if
BANK a transaction is recorded correctly more than once.
RECONCILIATION Check your progress 4
STATEMENT, CAPITAL 1. Errors disclosed by trial balance
AND REVENUE
a. Wrong totalling of subsidiary books
TRANSACTION AND
ACCOUNTING FOR b. Compensating error
BAD DEBTS 1.6 Methods of Preparing Trial Balance
A Trial Balance may be prepared based on the following methods :
1. Total method
2. Balance method
3. Total–cum–balance or compound method
1. Total Method : In this method, the totals of credit and the totals of debits
are transferred to the trial balance without finding out the difference of the
two sides. The excess of debit side over credit side or vice versa is
automatically adjusted and both the sides tally. This method is not so popular.
Illustration : 13
M/S Swaraj Traders
Trial Balanceas on 31/03/20
Name of accounts Total of debit side Total of credit

of A/c side of A/c
Capital Account - 90000
Drawings Account 20000 -
Param’s Account 3000 9500
Karam’s Account 4000 6000
Ashmita’s Account 8000 2000
Khushbhu’s Account 10000 3000
Sheth & Bros Account 9000 2000
Cash Account 57000 49500
Bank Account 30000 8000
Furniture Account 20000 -
Purchase Account 25000 -
Sales Account - 28000
Salary Account 5000 -
Wages Account 6000 -
Stationery Account 1000 -
Discount Account 2000 -
Purchase return Account - 2000
Total 200000 200000
2.Balance Method : In this method the differences of two sides i.e. debit and
credit for each ledger account is taken to the trial balance. The excess of debit
total over credit is put to the debit column and vice versa.
70
Illustration : 14 TRIAL
Trial Balance as on 31/03/20 BALANCE
Account Head Debit Credit
Amount Amount
Capital - 8,00,000
Drawing 50,000 -
Plant and Machinery 4,00,000 -
Building 6,00,000 -
Furniture 50,000 -
Stationary 3,000 -
Salary 28,000 -
Wages 18,000 -
Loan - 4,00,000
Bank OD - 1,20,000
Cash 18,000 -
Purchases 2,80,000 -
Sales - 3,20,000
Debtors 80,000 -
Sales return 8,000 -
Creditors 30,000 -
Purchase Return - 6,000
Investments 1,41,000 -
Total 16,76,000 16,76,000
3. Compound Method: In this system, a trial balance is prepared with both

the balances along with total of the various accounts. It is a combination of both
the two of the methods discussed above.
1. A Trial Balance may be prepared based on the following methods
a. Total method b. difference method
1.7 Methods of Locating Errors
Method or the procedure to be followed for detection and rectification of
errors varies according to the nature of the error. Some errors can be detected
and rectified while preparing the trial balance, whereas some errors remained
undetected and hence uncertified in preparation of trial balance. In order to maintain
maximum accuracy, some steps to be followed to avoid the omissions and errors.
These steps areas follows :
After balancing of ledger, the ledger balances should be confirmed with the
outside parties like debtors, creditors, lenders or financers, bankers, etc. And
reconciliation of the accounts to be made if the difference in the account. This
71
TRIAL BALANCE, would help in detection and rectification of errors and omissions.
BANK In the event of disagreement of trial balance, the following procedure should
RECONCILIATION be followed very carefully :
STATEMENT, CAPITAL
• First of all, check the extraction and listing of the ledger account
AND REVENUE
balances one by one very carefully
TRANSACTION AND
ACCOUNTING FOR • Check the totalling of both the columns of debit and credit of the Trial
BAD DEBTS Balance and find the difference if any.
• Now ,divide theexact difference by 9. If the differenceis completely
divisible by 9, this means that there is a possibility of either a
transposition error or a side error. A transposition error is committed
when the digit of an amount is misplaced. For example, Machine
account has a balance of Rs.4,860, but it has been written as 4,680
in the trial balance. The resulting error is Rs.90, which is divisible by
9. A slide error is committed when the decimal point is placed
incorrectly. For example, Rs 4250 is copied as Rs.42.50. The resulting
error is 4207.5 is completely divisible by 9.
• Divide the differences by 2 and scan the columns to see whether the
said figure appears on the correct sidei.e. Dr. or Cr.
• The next step is to check the additions of the subsidiary books.
• Now try to re–compute the balances of the ledger accounts.
• Check the posting from the subsidiary books to the ledger.
Illustration : 15
The Following is the Trial Balance of R. & Co. showing debit total of Rs.
3,18,200 and credit total of Rs. 3,76,200
You are required to ascertain the correct total of Trial Balance after pointing
out the causing the disagreement.
Trial Balanceas on 31 / 12/ 2020
Debit Credit
Rs. Rs.
Capital – 1,00,000
Cash in hand 1,200 –
Bills Payable 22,000 –
Bills Receivable – 20,000
Purchases 1,20,000 –
Opening Stock 35,000 –
Creditors 24,000 –
Sales – 2,00,200
Debtors 1000 –
Plant & Machinery 60,000 –
Furniture 15,000 –
72
Rent & Taxes 5,000 – TRIAL
Drawings 5,000 – BALANCE
Wages 10,000 –
Income –tax – 6,000
Salaries 20,000 –
3,18,200 3,76,200
Solution :
The above Trial Balance can be redrafted under any of the following ways :
Method 1
Trial Balanceas at 31st December 2020
Heads of Accounts Debit Credit

Rs. Rs.
Capital A/ c – 1,00,000
Cash A/ C 1,200 –
Bills ReceivableA/c – 22,000
Bills ReceivableA/c 20,000 –
Purchases A/c 1,20,000 –
Opening Stock 35,000 –
Creditors A/c – 24,000
Sales A/c – 2,00,200
Bad Debts ReserveA/c – 1,000
Debtors A/c 50,000 –
Plant and Machinery A/c 60,000 –
FurnitureA/c 15,000 –
Rent & Taxes A/c 5,000 –
Drawings A/c 5,000 –
Wages A/c 10,000 –
Income – Tax A/c 6,000 –
Salaries A/c 20,000 –
3,47,200 3,47,200
73
TRIAL BALANCE, Method II
BANK (Note: Under this method, only the wrong postings should be Correction
RECONCILIATION of Trial Balance)
STATEMENT, CAPITAL
Debit Credit
AND REVENUE
TRANSACTION AND Rs. Rs.
ACCOUNTING FOR Total as per Trial Balance 3,18,200 3,76,200
BAD DEBTS Bills payable being credit Balance but –22,000 +22,000
shown as debit balance 2,96,200 3,98,200
Bills Receivable being debit balance but +20,000 –20,000
shown as credit balance 3,16,200 3,78,200
Creditors being credit balance but shown –24,000 +24,000
as debit balance 2,92,200 4,02,200
Bad debts Reserve being a credit balance –1,000 +1,000
but shown as debit balance 2,91,200 4,03,200
Debit being debtors balance but shown + 50,000 – 50,000
as credit balance 3,41,200 3,53,200
Income tax being debit balance but + 6,000 – 6,000
shown as credit balance 3,47,200 3,47,200

1. Some errors can be detected and rectified while preparing the .
a. trial balance b. ledger
c. journal
1.8 Suspense Account

In accountancy, a suspense account is an account used temporarily to carry
doubtful receipts and disbursements or discrepancies pending their analysis and
permanent classification.
If it is not possible to locate theerrors in spite of the above steps, the difference
of the trial balance is transferred temporarily to an account known as
“SuspenseAccount”. After transferring the difference, the trial balance can thus be
totalled up and balanced. This account will be automatically closed when the error
or errors in trial balance are subsequently discovered or rectified. Entries in this
account are made temporarily and when the correct accounts are found the amounts
are transfer by transfer entries to the correct accounts.
1. A is temporarily used to carry doubtful receipts and
a. suspense account b. Ledger
c. Journal d. Trial balance
74
1.9 Let Us Sum Up TRIAL
BALANCE
In this block we have studied about the trial balance and suspense account.
We have studied about what are trial balance and its purpose. We have even
learnt the various methods of preparing it. Suspense account is a temporary account
which is created in order to tally our trial balance in case of difference; this topic
too was discussed in detail in this unit.
Trial Balance is the proof of accuracy of the books of account. If the trial
balance does not tally, it means there are certain errors. But certain errors may
not affect agreement of Trial Balance as the erroneous entries may not violate the
dual aspect concept. It means even if trial balance agrees, steps should be taken
to ensure that the records are free from errors. A suspense account is an account
used temporarily to carry doubtful receipts and disbursements or discrepancies
pending their analysis and permanent classification. If it is not possible to locate
the errors, their analysis and permanent pending disbursements or discrepancies
classification. the difference of the trial balance is transferred temporarily to an
account known as “Suspense Account”.
Answers: (1–c)
Answers: (1–a)
Answers: (1–a)
Answers: (1–b)
Answers: (1–a)
Answers: (1–a)
Answers: (1–a)
1.11 Glossary
1. Trial Balance : A statement showing all the accounts used in a business
and their balances.
2. SuspenseAccount : A temporary account used to force a trial balance to
balance if there is only a small discrepancy (or if an account’s balance is
simply wrong and one do not know why).
75
TRIAL BALANCE, 1.12 Assignment
BANK
RECONCILIATION 1. Correct the following trial Balance (all figures in rupee)
STATEMENT, CAPITAL Dr. Cr.
AND REVENUE
Particulars Amount Particulars Amount
TRANSACTION AND
ACCOUNTING FOR Rs. Rs.
BAD DEBTS Return Outward 16,000 Debtors 15,000
Opening Stock 34,200 Carriage Outward 5,000
Salaries 12,000 Capital 55,200
Creditors 28,000 Machinery 18,000
Bank 45,000 Return Inward 3,000
CarriageInward 6,000 Discount Received 4,000
Rent Received 3,000 TradeExpenses 6,000
Discount Allowed 2,000 Sales 1,40,000
Purchases 1,00,000 Building 20,000
Bills Payable 20,000
2,66,200 2,66,200
1. Correct the following trial Balance (All figures in rupee)

Account Head Debit Credit
Amount Amount
Purchases 1,50,000
Sales 3,45,000
Purchases Return 14,500
Sales Return 11,300
Salary & Wags 25,000
Cash 38,000
Bank 69,500
Bills Receivable 28,000
Creditors 41,000
Debtors 68,000
Stock 1,08,000
Loan 1,20,000
Capital 4,50,000
Drawings 22,000
Building 2,40,200
Investments 2,50,000
11,83,200 8,36,800
(Trial Balance Total 10, 10,000)
76
2. A Book–Keeper has submitted the following Trial Balance for your TRIAL
observation and suggestions and to correct the mistakes to make the Trail BALANCE
Balanceagree.
Particulars Amount Particulars Amount

Rs. Rs.
Land 60,000 Drawings 4,000
Plant & Machinery 80,000 Insurance premium 800
Office furniture 4,000 S. Creditors 31,000
Office Computer 8,000 Sales 2,20,000
Debtors 36,000 Capital 80,000
Purchases 1,00,000 Carriage outward 900
Loan on Mortgage 40,000 Discount allowed 400
Cash in Hand 600 Stock (Opening) 16,300
Cash at Bank 34,000 Rent and Rates 2,400
Bad debts 1,700 Purchases return 1,600
Trade expenses 900 Wages 15,000
Interest on loan 1600 Salaries 3,000
Factory power 3,600 Discount received 600
3,70,400 3,76,000
Ans. Trial Balance Totals Rs. 3, 73, 200
1.13 Activities
1. Explain the errors which are disclosed by the trial balance.
2. What do you mean by a trial Balance? Discuss the main objectives.
1.14 Case Study
Explain the steps for locating errors through the trial balance.
1. Modern Accountancy VolumeI, Mukherjee, Tata Mgraw Hill 2008.
Press, 1978.
4. Advanced Accounts, M. C. Shukla& T. S. Grewal, S. Chand
Publisher, 1997.
––––
77
TRIAL BALANCE,
BANK Unit BANK RECONCILIATION
RECONCILIATION
2 STATEMENT
STATEMENT, CAPITAL
AND REVENUE : UNIT STRUCTURE :
TRANSACTION AND
ACCOUNTING FOR
BAD DEBTS 2.1 Introduction
2.2 Causes of Difference
2.3 Need for Bank Reconciliation Statement
2.4 Method of Preparation (Without Adjustment)
2.5 Let Us Sum Up
2.7 Glossary
2.8 Assignment
2.9 Activities
2.10 Case Study
• The meaning and Objectives of Preparing a Bank Reconciliation
Statement.
• The various Causes of Difference.
• The methods of Preparing Bank Reconciliation Statement.
2.1 Introduction
For any business firm its cash balance is a very important element of its
financial conditions. For exercising greater control over cash, most of the business
concerns prefer to operate a Bank Account. The banker acts as a custodian of
the funds to be spent by business. Since the banker is the trustee of the customer,
the bank provides to its customer a Pass Book or Bank Statement (at regular
intervals), which summarizes payments as well as deposits and other charges for
the period. To know the bank balance a firm has two sources of information:
1. Bank column of the cash book; and
2. Bank Statement
On principal, two balances should be equal and opposite on a stated date.
But usually these two balances do not agree due to various reasons. In view of the
above mentioned explanation, it becomes necessary to reconcile the balances.
Therefore a reconciliation statement is prepared that tells us the reason behind
non agreement of cash balance per book and cash balance as per bank. Usually
these statements are prepared on monthly basis because the bank also provides
the statement on monthly basis.
78
Check your progress 1 BANK
1. Bank reconciliation statement is important to _____ RECONCILIATION
(a) Bank (b) Business STATEMENT
2.2 Causes of Difference

Generally it happens that balance as per bank statements do not agree with
the bank balance as per the cash book of the firm.
Few of the basic reasons for such difference areas follow :
1. Cheques issued but not presented for payment : Many a times it is
possible that at the time when the balances of the two books are being
reconciled, some of the cheques are such which might have been issued but
not have been presented for payment thus causing a disagreement between
the two balances.
2. Cheques paid into the bank but not yet credited : Whenever a cheque
is deposited into the bank. The bank never gives instant credit of that amount.
For clearing process cheques takes atleast 2–3 days. So many a times it
happens that in the process of reconciliation there are certain cheques which
though have been entered into our books of account but no credit of such
cheques have been given to us by the bank.
3. Dishonour of bill discounted with the bank : When customers get their
bills discounted with the bank and the bank is unable to get payment of
these bills on the due date due to any reason then the bank will recover the
amount by debiting the customers accounts with the amount of the bills
together with the noting charges, if any.
4. Interest allowed by the bank : The bank biannually gives us the interest
on our deposit into the bank. Bank never send us the acknowledgement of
that interest by bank and that is also one of the reason behind the difference.
Because in the books of bank that interest has been entered but we haven t
made any such entry into our books of account.
5. Interest and bank charges debited by bank : The bank charges interest
bank charges on overdraft account and are debited by the bank directly to
the customer’s account. But the entries in the cash book are made only
after receiving the bank statement or the pass book.
6. Interest and dividend collected by the bank : Many a times it happens
that interest on government securities or dividend on shares is collected by
the bank and is credited to customer’s account and if they are not entered in
the cash book then difference will always arise.
7. Direct payment by the bank : Many a times due to standing instructions
by the clients to their bank, banks makes payment automatically on their
own without asking for each payment individually .So the client is unaware
of those payments.
8. Direct payment into the bankaccount by a customer : Most of the time
it has been seen that the customers of the client keep the bank details with
them and without informing the client the deposit their dues into the bank
account of the client. This also results in difference between the two.
9. Error committed by the bank : Apart from the above reasons many a
times a bank may wrongly charge the customer account with charges or
give credit to customers account in both the cases it will cause disagreement
between the two balances.
79
TRIAL BALANCE, Check your progress 2
BANK 1. Cheques issued but not presented for payment is one of the reasons for
RECONCILIATION non agreement between and pass books.
STATEMENT, CAPITAL
a. cash book b. Ledger
AND REVENUE
TRANSACTION AND c. Journal
ACCOUNTING FOR 2.3 Need for Bank Reconciliation Statement
BAD DEBTS
1. It reflects the actual bank balance position.
2. It helps to detect any mistakein the cashbook and in the passbook.
3. It prevents frauds in recording the banking transactions.
4. It explains any delay in the collection of cheques.
1. Helps to detect any mistakein the cashbook and in the passbook.
a. Bank reconciliation statement b. Ledger
c. Journal
2.4 Method of Preparation (Without Adjustment)
Basically there are two methods of preparing bank reconciliation statement,
namely,
1. Bank Reconciliation Statement without any adjustment.
2. Bank Reconciliation Statement with adjustment.
Whenever a bank reconciliation statement is prepared without making the
necessary adjustments for omissions, errors in the cashbook the Bank Reconciliation
Statement is called as Bank Reconciliation Statement without adjustment.
However,whenever a bank reconciliation statement is prepared after making
such necessary adjustments for omissions, errors in the cashbook, it is called as
Bank Reconciliation Statement with adjustment i.e. the bank balance is adjusted
for the serrors in the cash book.
Bank Reconciliation Statement without adjustment
The bank balance of a business enterprise may either be favourable or
unfavourable. When the cashbook shows a debit balance of the bank or a pass
book shows a credit balance it is knownas favourable balance, wherein the deposits
are comparatively more than the withdrawals. On the other hand when the
cashbook has a credit balance or the pass book has a debit balance then it is
termed as unfavourable balance. Finding the balance as per cash book or as per
passbook is the first step in bank reconciliation, it is the starting point of reconciliation
process. So thereare four different points for preparing bank reconciliation
statement :
1. Debit balance as per cashbook (favourable).
2. Credit balance as per passbook (favourable).
3. Credit balance as per cashbook, (unfavourable).
4. Debit balance as per passbook (unfavourable).
80
Table: 3.1 The Causeand Effect relations in BRS BANK
RECONCILIATION
STATEMENT
The items which will increase the passbook balance more than the cash
book.
1. Interest credited by bank not presented for payment.
2. Debtors directly deposited into bank, not entered in cash Book.
3. Cheque issued but not presented for payment.
4. Dividend collected by bank not recorded in cash book.
5. Bank Charges recorded twice in cash book, etc.
The items which will decrease the passbook balance more than the cash
book.
1. Debit side of the cash book was overcast.
2. Cheque deposited but not presented for payment.
3. Dishonoured cheque appeared in the passbook but not entered in
the cash book.
4. The Direct payment by bank as per standing order has been left in
the Cash Book, etc.
5. Credit side of the cash book was under coats.
6. The Bank Charges are not recorded in the cash book.
81
TRIAL BALANCE, Illustration : 16
BANK From the following particulars, prepare Bank reconciliation Statement from
RECONCILIATION Shri. S. Banerjeeas at 31 March, 2020.
STATEMENT, CAPITAL
AND REVENUE Rs.
TRANSACTION AND (a) Bank balanceas per Cash book 7,000
ACCOUNTING FOR (b) Cheques issued but not presented for payment upto
BAD DEBTS
after 31st March 1,000
(c) Three cheques were issued for Rs. 500 Rs. 1,000 and
Respectively, but the cheque for 1,000 was not presented
for payment at all -
(d) Cheques issued for payment but forgot to enterin
Cash Book 750
(e) Cheques deposited into the bank but credit was Given
after 31 st March, 250
(f) 3 cheques of Rs. 1,000 Rs. 1,200 and Rs. 1,600,
were deposited but the cheque for Rs. 1,600 was
credited on 2nd April
(g) Cheques deposited into Bank no entry was madein
Cash Book 1,000
(h) Receipt side of the cash Book was overcastted or
over shown by 500
(i) The payment side of the Cash Book was under shown
by 800
(j) Bank Interest received Rs. 150 and bank charges
paid Rs. 50 Not recorded in Cash Book.
(k) Dividend collected directly by bank. 1,000
(i) A debtor directly made the payment into bank. 500
(m) Rs. 1,500 in respect of dishonoured chequeappeared
in the Pass book but No entry was donein the
Cash Book
(n) Bank paid a Bill Payable of the firm for Rs. 1,500 on
30th March, under advice to the firm on 2 nd April.
(o) Bank s Charges (postal) for a cheque bookissue charges
by Shri. S. Banerjee Rs. 5, was entered twice in the
Cash Book. 29
(p) A cheque for Rs. 50 drawn by Mr.Aadvik had been
charged to Shri. S. Banerjee account in error in
March 2020.
82
Solution : BANK
In the books of Shri. S. Banerjee RECONCILIATION
Bank Reconciliation Statement STATEMENT
As at 31st March 2014
Particular Rs. Rs.
Bank Balanceas per Cash book 7,000
Add: Cheques issued but not presented 1,000
Cheques issued but not presented 1,000
Cheques deposited into bank, but not recorded
in cash book 1,000
Interest credited by Bank not recorded in
Cash Book 150
Dividend collected by Bank not recorded in
Cash Book 1000
Dividend directly deposited into Bank, but
not recorded in cash book 500
Bank s Charges (Postal) recorded twice in
cash book 5 4,655
11,655
Less: Cheques issued but not recorded in
Cash Book 750
Cheques deposited but not credited by the Bank 250
Cheques deposited but not credited by the Bank 1,600
Debit side of the Cash Book was overcast 500
Credit side of the Cash Book was undercuts 800
Bank Charges debited by Bank not recorded in
Cash Book 50
Dishonoured cheques appeared in Pass Book
but not entered in Cash Book 1,500
Contd. Bank met a Bill Payable, but not recorded
in Cash Book 1,500
A Cheque drawn by Mr.Aadvik wrongly debited by 50
Bank to Shri. S. BanerjeeA/c 7,000
Bank Balanceas Per Pass Book 4,655
(ii) When Balanceas per Pass Book (favourable) is given :

When pass book balance is given and we have to find out the balance as
per cash book. In this case we have to find the impact of each item causing
difference, in the cash book favourable balance. To put in different words, we will
have to see whether a particular item increases or decreases the favourable balance
of the cash book.
83
TRIAL BALANCE, Add : The items, which will increase the cash book balance more than the
BANK pass book.
RECONCILIATION (i) The Cheque deposited but not credited;
STATEMENT, CAPITAL (ii) The Bank Charges but not recorded in the cash book;
AND REVENUE (iii) The Dishonoured cheque appeared in the pass book but not in the
TRANSACTION AND cash book;
ACCOUNTING FOR (iv) The Debit side of the cash book was overcast;
BAD DEBTS (v) The Direct payment by bank as per standing order not recorded in
the Cash Book, Etc.
Less : The items which will decrease the cash book balance more than the
pass book.
(i) The Cheque issued but not presented for payment;
(ii) The Interest credited by bank not presented for payment;
(iii) The Dividend collected by bank but not recorded in cash book;
(iv) The Debtors directly deposited into bank, but not entered in cash
Book;
(v) The Bank Charges recorded in cash book, etc.
Illustration : 17
From the following Particulars, Prepare a Bank Reconciliation Statement
showing the Balance as Per Cash Book on 31st March 2020:
Rs.
(a) Balanceas per Pass Bank 8,000
(b) Cheques deposited but not credited by the Bank 1,000
(c) Cheques issued but not Presented for Payment 500
(d) Cheques deposited into Bank without recording in 600
Cash Book
(e) Cheques issued to creditors but not recorded in 700
Cash Book
(f) Dividend collected by Bank, not recorded in
Cash Book 100
(g) Debtors directly deposited into Bank not recorded
in Cash Book 2,000
(h) Debit side of the Cash Book was under cats by 1,000
(i) Bank charges debited in Pass Book, not recorded
in cash Book 50
(j) Bank met a Bill Payable for Rs. 1,000 on
30 / 3/ 2020 under advice to the firm on 2/4/2020 –
(k) A bill for Rs. 2,000 discounted for Rs. 1,900
returned dishonoured by Bank noting Charge being 10
(l) A Bill for Rs. 1,000 discounted with the Bank is
entered in the Cash Book without recording the
discount charges 100
84
Solution : BANK
In the Books of ..... RECONCILIATION
Bank Reconciliation Statement STATEMENT
As at 31 st March 2020
Rs. Rs.
Bank Balance as per Book 8,000
Add: Cheques deposited but not credited by the
Bank 1,000
Cheques issued to creditors but not recorded in
Cash Book 700
Bank charges debited in the Pass Book, not
entered in Cash Book 50
Bank met a Bill Payable, not recorded in
Cash Book 1000
Bills discounted and dishonoured, not entered
in Cash Book 2,010
A bill discounted by the Bank without recording
the discounting charges 100
4,860
12,860
Less: Cheques issued but not presented for
payment 500
The Cheques deposited into Bank without
recording in
The Cash book 600
The Dividend collected by Bank, not recorded
in Cash Book 100
The Debtors directly deposited
into Bank not recorded in the Cash Book 2,000
The Debit side of the Cash Book was 1,000
Undercast 4,200
The Bank Balanceas per theCash Book 8,660
(iii) When Bank Overdraft as per the Cash Book is given :

If we start Reconciliation Statement with bank overdraft as per the Cash
Book, then we are to ascertain the impact of each item (causing difference) on
pass book overdraft. In other words, we will have to see whether a particular item
increases the overdraft as per the pass book or decreases as per the pass book.
85
TRIAL BALANCE, Add: The items, which will increase the, pass book overdraft more than the
BANK cash book overdraft.
RECONCILIATION (i) Cheques paid/deposited into bank but not credited;
STATEMENT, CAPITAL (ii) Bank met a pay order as per standing instruction;
AND REVENUE
(iii) Bank charges debited in the pass book, not in cash book;
TRANSACTION AND
ACCOUNTING FOR (iv) Deposited cheque dishonoured, not entered in the cash;
BAD DEBTS (v) Interest charged on overdraft, not entered in the cash book; etc.
Less : The items, which will decrease the, pass book overdraft more than
the cash book overdraft.
(i) Cheque issued but not presented for payment;
(ii) Direct deposit by debtor, not recorded in the cash book;
(iii) Interest on overdraft recorded in cash book, not in pass book;
(iv) Credit side of the cash book is overcast;
(v) Bank collected any income not entered in the cash book, etc.
Illustration : 18
From the following particulars preparea Bank Reconciliation Statement for
Sri S. Sarkar as at 31 st Dec. 2020 :
(a) Bank Balanceas per Cash Book (Cr.) Rs. 610.
(b) Cheques issued but not presented Rs. 3,000
(c) Cheques deposited but not credited by bank Rs. 2,500.
(d) A cheque drawn for Rs. 100 had been incorrectly entered as Rs. 10
in the Cash Book.
(e) A debtor directly deposited into Sarkar s Bank Account, but not
recorded in Cash Book Rs. 1,000
(f) Credit side of the Cash Book (Bank Column) was under cast by Rs.
500
(g) A cheque for Rs. 5,000 drawn by Mr. Banerjee had been charged
to Sri Sarkar s Account in error.
(h) Bank paid a Bill payable for Rs. 1,450 but it was recorded in Cash
Book as Rs. 1540.
(i) The receipt column of the Cash Book has been overcastted or
overshown by Rs. 1,000
(j) TheDiscount allowed Rs. 410 has been entered through mistake with
the chequein the Bank Column of the Cash Book.
(k) After theinstruction dated 30 the Dec. 2020, asking the Banker to
transfer Rs. 10,000 to Fixed deposit Account an entry for this was
made in the Cash Book but the BanK acted on Jan. 2021.
(i) The Bank also debited the account for Rs. 500 being the amount of
a cheque received from a customer and returned it dishonoured but
not entered in Cash Book.
(m) The Cheques amounting to Rs. 300 though actually banked were
not entered in Cash Book.
86
Solution : BANK
In the Books of Sri. S. Sarkar RECONCILIATION
Bank Reconciliation Statement As at 31st Dec. 2020. STATEMENT
Particular Rs. Rs.

Bank Balanceas per Cash Book (Cr.) 610
Add: Cheques deposited but not credited by
the Bank 2,500
Cheques drawn for Rs. 100 but recorded
only Rs. 90
10 in the Cash Book
Credit side of the Cash Book was under cast 500
Bank wrongly debited Sarkar s Account 5,000
Bank column of the Cash Book overcast 1,000
Discount Allowed Rs. 410 has been entered

through mistake with the cheque in the
Bank column of the Cash Book 410
Bank debited for a dishonoured cheque , not 500
entered in Cash Book 10,000
10,610
Less: Cheques issued but not presented 3,000
A debtor directly deposited into Bank but not
recorded in Cash Book 1,000 1,000
Transfer to Fixed Deposit Account not recorded
in Pass Book 90
Transfer to Fixed Deposit Account not recorded
in Pass Book 10,000
Cheques deposited but not recorded in
Cash Book 300 14,390
Bank Balance as per Pass Book (Cr.) 3,780
(iv) When Bank Overdraft as per Pass Book is given :

If we start Reconciliation Statement with bank overdraft as per the Pass
Book, then we are to ascertain the impact of each item (causing difference) on
cash book overdraft. In other words, we will have to see whether a particular item
increases the overdraft as per the cash book or decreases as per the cash book.
Add : The items, which will increase the cash book overdraft more than the
pass book overdraft.
(i) Cheque issued but not presented for payment;
87
TRIAL BALANCE, (ii) Direct deposit by debtor, not recorded in the cash book;
BANK (iii) Interest on overdraft recorded in cash book, not in pass book;
RECONCILIATION (iv) Credit side of the cash book is overcast;
STATEMENT, CAPITAL
(v) Bank collected any income not entered in the cash book; etc.
AND REVENUE
Less : The items, which will decrease the cash book overdraft more than
TRANSACTION AND
the, pass book overdraft.
ACCOUNTING FOR
BAD DEBTS (i) Cheques paid/deposited into bank but not credited;
(ii) Bank met a pay order as per standing instruction;
(iii) Bank charges debited in the pass book, not in cash book;
(iv) Deposited cheque dishonoured, not entered in the cash book;
(v) Interest charged on overdraft, not entered in the cash book; etc.
Illustration : 18
Preparea Bank Reconciliation Statement from the following data as on
30/11/2020
(i) Balance as per Pass Book on 30/11/2020 overdrawn Rs. 9,204.
(ii) Cheques drawn on 30/11/2020 but not cleared till Dec. 2020, Rs.
3,225; Rs. 745 and Rs. 926.
(iii) Bank Overdraft interest charged on 28/11/2020 not entered in Cash
Book Rs. 1,610
(iv) Cheques received on 29/11/2020 entered in Cash Book but not
deposited to Bank till 3rd December, 2020 Rs. 11,322 and Rs.
1,730.re
(v) Cheque reviewed amounting to Rs. 35 entered in the Cash book
twice.
(vi) Bills Receivable due on 29 / 11 / 20 was sent to Bank for collection
on 28/11/20 and was entered in Cash Book forth with but the
proceeds were not credited in Bank Pass Book till 3rd Dec. 2020
Rs. 2,980
(vii) Cheque Deposited on 30th Nov. 2020 dishonoured but the entry
there of Rs. 1890 was not made in the Cash Book.
Solution : In the books of...........
Bank Reconciliation Statement
Particular Rs. Rs.
Overdraft Balanceas per Pass Book 9,204
Add : Cheques drawn but not cleared
(Rs. 3,225 + Rs. 745 + Rs. 926) 4,896 4,896
14,100
Less :
Interest on bank Overdraft not entered in 1,610
Cash Book
Cheques received and entered in the Cash Book as
88
Deposited into Bank but actually not deposited BANK
till 3 rd Dec. 1988 (Rs. 11,322 + Rs. 1,730 0 13,052 RECONCILIATION
Cheque received and entered in the Cash Book STATEMENT
twice 35 bills sent to Bank for collection but not 35
credited till 3rd Dec 2,980
Cheques deposited and dishonoured but not 1,890
entered in Cash Book 19,567
Bank Balanceas per Cash (Dr.) 5,467
Illustration 19
Prepare a bank reconciliation statement as on 31st Dec. 2020, in the books
of Manish traders.
Balanceas per cash book (Debit balance) Rs 28,000.
1. A cheque deposited into bank Rs.25,000 but not credited by bank
till 31/12/20.
2. Two cheques of Rs. 15,000 and 4,800 issued were not presented in
the bank for payment.
3. TheBank collected dividend Rs.10,000, not accounted in the cash
book.
4. TheBank paid insurance premium Rs. 7,500 and a loan EMI
Rs.10,000 as per the standing instructions, entries for the same are
not recorded in cash book.
5. A cheque deposited in the bank of Rs.5,000 was dishonoured and
hence not credited by bank, the intimation of dishonour was not
received till Dec 20.
Solution :
M/S Manish Traders
Particular Rs. Rs.

Balance as per cash book 28,000
Add :
Cheque issued but not presented before bank 15,000
Dividend collected by bank, not accounted in 10,000
cash Book. 29,800 29,800
57800
Less :
89
TRIAL BALANCE, Cheque deposited but not credited by bank 25,000
BANK Insurance premium paid by bank not recorded in 7,500
RECONCILIATION Cash book 10,000
STATEMENT, CAPITAL
Loan EMI paid by bank not recorded in cash book 5,000 47,500
AND REVENUE
TRANSACTION AND Cheque deposited was dishonoured 47,500 10,300
ACCOUNTING FOR Illustration 20
BAD DEBTS
Take the illustration where the bank balance, as per cash book as an
overdraft balance & prepare the bank reconciliation statement with the information
given in the illustration 19
Solution :
M/S Manish Traders
Particular Rs. Rs.

Balance as per cash book(Overdraft) 28,000
Add :
The Cheque deposited but not credited by bank 25,000
The Insurance premium paid by bank not recorded in 7,500
Cash book
The Loan EMI paid by bank not recorded in
cash book 10,000
The Cheque deposited was dishonoured 5,000
47,500
75,500
Less :
Dividend collected by bank, not accounted in cash 10,000
Book. 29,800
Balanceas per pass book (overdraft) 45,700
Illustration 21
Prepare a bank reconciliation statement as on 31st March.2020, in the
books of ABC co.
Balance as per Pass book (credit balance) Rs 30,000.
1. A cheque deposited into bank Rs.12,000 but not credited by bank
till 31/3/20.
2. Two cheques of Rs. 18000 and 14800 issued but one of these of Rs
90
14,800 was not presented to bank for payment. BANK
3. Bank collected interest on investment of Rs.12,500, not accounted RECONCILIATION
in the cash book. STATEMENT
4. Bank paid Rent Rs. 7,500 and an Electricity bill Rs.4,000 as per the
standing instructions, entries for the same are not recorded in cash
book.
5. A cheque deposited in the bank of Rs.12,000 was dishonoured and
hence not credited by bank, the intimation of dishonour was not
received till March 20.
Solution :
M/S ABC co.
Particular Rs. Rs.
Balance as per pass book 30,000
Add :
Cheque deposited but not credited by bank
Rent paid by bank not recorded in cash book 12,000
Electricity bill paid by bank not recorded in 7,500
cash book 4,000
Cheque deposited was dishonoured 35,500
12,000
Continued from last page 35,500 65,500
Less :
Cheque issued but not presented before bank
Interest on investment collected by bank,
not accounted in cash book
14,800 27,300
12,500
Balance as per cash book 38,200
Considering the bank balance, as per pass book as an overdraft balance
and prepare the bank reconciliation statement with the information given in the
illustration 21.
91
TRIAL BALANCE, Solution :
BANK Bank Reconciliation Statement
RECONCILIATION M/S ABC co.
STATEMENT, CAPITAL
AND REVENUE Particulars Rs. Rs.
TRANSACTION AND Balance as per pass book (overdraft) 30,000
ACCOUNTING FOR Add :
BAD DEBTS Cheque issued but not presented before bank
Interest on investment collected by bank, not 14,800
accounted in cash book 12,500 27,300
57,300
Less :
Cheque deposited but not credited by bank 12000
Rent paid by bank not recorded in cash book 7500
Electricity bill paid by bank not recorded in cash 4000
book
Cheque deposited was dishonoured 12000
21,800
Balance as per cash book
Illustration 23
The bank column of the cash book showed an overdraft of Rs 5000 on
31– 03–2020, where as as per bank statement the overdraft is Rs 4,200. The
following differences were noticed between the two records :
1. Cheques of Rs 2,400 issued but not encashed by customers
2. Cheques deposited but not cleared Rs 1,200
3. Collection charges debited by bank not recorded in CB Rs 100
4. Bank interest charged by the bank not recorded in CB Rs 300
5. Cheques dishonoured debited by bank not in CB Rs 400
6. Interest directly received by bank not entered in CB Rs 400 Prepare
bank reconciliation statement
Solution :
Particulars Rs. Rs.

Balance as per cash book (Overdraft) 5,000
Add :
A Cheque deposited but not credited by bank 1,200
The Collection charges debited by bank not 100
entered in the Cash book
92
The Bank interest charged by bank but not entered 300 BANK
in cash book RECONCILIATION
Cheque dishonoured not entered in cash book 400 2,000 STATEMENT
7000
Less :
Cheque issued but not presented for payment Interest
directly received by bank not entered in 2,400
Cash book. 400 2,800
Balanceas per pass book (overdraft) 4200

1. Which of the following statements states the balance is favorable
(a) Cashbook shows debit balance of bank
(b) Passbook shows credit balance
(c) Both
2.5 Let Us Sum Up
In this particular unit bank reconciliation statement has been discussed in
very detail. Usually it happens that at the end of a period that there is a difference
between the balance as per pass book and cash book. In this chapter the reasons
behind such difference has been mentioned in detail and how to prepare a bank
reconciliation statement has been illustrated with sufficient examples. The purpose
of preparing a bank reconciliation statement is that it brings into agreement the
bank balance per cash book and cash balance per bank. It is normally prepared
on monthly basis because the bank provides the depositor a bank statement at the
end of every month
So after studying this chapter readers would have got the idea of what
actually is bank reconciliation. It also prevents frauds in recording the banking
transactions and explains any delay in the collection of cheques.
Answers: (1–b)
Answers: (1–a)
Answers: (1–a)
Answers: (1–c)
93
TRIAL BALANCE,
BANK 2.7 Glossary
RECONCILIATION 1. Dishonour of cheque – when a cheque received is deposited in our bank
STATEMENT, CAPITAL account and it is rejected and no payment is received against that cheque.
AND REVENUE
TRANSACTION AND 2.8 Assignment
ACCOUNTING FOR 1. Prepare Bank Reconciliation Statement as on 31.12.20 from the following
BAD DEBTS information and show the bank balance, as on that date, as per the Cash Book :
1) Bank overdraft, as on 31/12/20 as per the Pass Book Rs. 7,891.50.
2) Cheques issued before, but presented for payment after 1st January,
1921 Rs. 532.25
3) Cheques deposited with the bank on or before 30th December, but
collected after 1st January, 1921 Rs. 631. 75
4) Rs. 786 was repaid by debtors on 30 /12/20 by depositing the money
directly into the bank. The information was received from the bank
on 2/1/21
5) There was a wrong entry in the Bank column on the debit side of the
Cash book amounting to Rs. 300.00
6) Dividend received Rs. 125.00 though credited in the pass book prior
to 30/12/20 was recorded in the Cash Book on 3/1/21
7) From the following particulars, calculate the Cash Book balance of a
merchant as on 31st December, 1920 by means of Bank
Reconciliation Statement:
8) Balanceas per the Pass Book (Dr. ) Rs. 4,475.70
9) A Cheque for Rs. 399.50 was deposited on 24th December but the
same was returned by the bank on 29th, for which no entry was
made in the Cash Book.
10) A bill for Rs. 1,020 received from a debtor previously discounted
for Rs. 1,000 was dishonoured and the bank debited theaccount of
the merchant, but the same was not recorded in the Cash Book.
11) Two cheques issued on 27th December, but not en cashed before
5th January, next: Rs. 650.40 and Rs. 498.30
12) A cheque for Rs. 300 was debited twicein the Cash Book.
13) Interest on overdraft for Rs. 56 and the bank charges for Rs. 17
were not passed through the Cash Book.
14) Dividend of Rs. 200 collected by the bank on behalf of the merchant
but the matter was not recorded in the Cash Book.
2. From the following particulars, find out the adjusted bank Balance
as per the Cash Book and prepare there after, the Bank Reconciliation
Statement as on 31 –12–2020
94
1) Bank overdraft as per the Cash Book80,000 BANK
2) Cheques deposited as per bank the statement but not entered in the RECONCILIATION
Cash Book 3,000 STATEMENT
3) Cheques recorded for collection but not sent to the bank 10,000
4) Credit side of the Bank Column cast short 1,000
5) Premium on proprietor s LIP paid on standing advice 5,000
6) Bank charges recorded twicein the Cash Book 100
7) Customer s cheque returned as per Bank Statement only 4,000
8) Cheques issued but dishonoured on technical grounds 3,000
9) Bills collected by the Bank directly 20,000
10) Cheque for Rs. 50,000 deposited but collection as per
11) Bank Statement 49,980
12) Cheque received entered twicein the Cash Book 500
2.9 Activities
What do you mean by Bank Reconciliation Statement? Why it is required?
2.10 Case Study
What are the different causes for discrepancy between the balance as per
the cash book and the Pass book.
1. Accounting For Management, Jawahar Lal , HIMALAYA PUBLISHING
HOUSE.
2. Financial Accounting For Management : An Analytical Perspective, Ambrish
Gupta, Prentice Hall, 2008.
3. Financial Accounting For Business Managers, Phi Learning Pvt Ltd, 2009.
4. Accounting theory, Porwal L.S, TataMcGraw Hill Publishing company,
2001.
––––
95
TRIAL BALANCE,
BANK Unit CAPITAL AND REVENUE
RECONCILIATION
3 TRANSACTION
STATEMENT, CAPITAL
AND REVENUE : UNIT STRUCTURE :
TRANSACTION AND
ACCOUNTING FOR
BAD DEBTS 3.1 Introduction
3.2 Capital Expenditure
3.3 Revenue Expenditure
3.4 Deferred Revenue Expenditures
3.5 Difference between Capital Expenditure, Revenue Expenditure and
Deferred Revenue Expenditure
3.5.1 Difference between Capital Expenditure and Revenue
Expenditure
3.5.2 Difference between Capital Expenditure and Deferred
Revenue Expenditure
3.6 Capital Receipt
3.7 Revenue Receipt
3.8 Capital and Revenue Profits
3.9 Capital and Revenue Losses
3.10 Let Us Sum Up
3.12 Glossary
3.13 Assignment
3.14 Activities
3.15 Case Study

• The Need for classification of accounts as capital and revenue.
• The Meaning of Capital & Revenue Expenditure.
• The Deferred Revenue Expenditure.
• The Difference between Capital, Revenue and Deferred Revenue
Expenditure.
• The Meaning of Capital & Revenue Receipt.
• The Meaning of Capital & Revenue Loss and Profits.
96
3.1 Introduction CAPITAL AND
REVENUE
One of the most important objectives of financial accounting is to find out
correct amount of profit or loss and to ascertain the financial position of the business TRANSACTION
enterprise on a particular date. The concepts of capital and revenue are of
fundamental importance to the correct determination of accounting profit for a
period and recognition of business assets at the end of that period. The distinction
affects the measurement of profit in a number of accounting periods. Transaction
of a business enterprise may be classified into: (1) Capital Transactions and (2)
Revenue Transactions.
1. Capital Transactions : The transactions which provide benefits or supply
services to the business unit for more than one year or one operating cycle
of the business are known as capital transactions.
2. Revenue Transactions : The transactions which provide benefits or supply
services to the business unit for only one accounting year, are known as
Revenue transactions.
3.2 Capital Expenditure
Under this category comes those expenditure which are incurred for the
following purposes :
Purchase of building, land, plant and machinery, furniture and fitting and
vehicles that are called fixed assets. The assets that are purchased should be done
with the intention of using them for business purpose and not with the intention of
making profit through resale. All expenditure incurred on the particular asset to
prepare it for using in the enterprise forms the cost of the fixed asset.
Capital expenditure also includes extensions and additions on the fixed asset
purchased such as additions to buildings, plant, machinery since it contributes to
enhancing productivity during future use. It also includes expenses that would
reduce production cost, administrative costs and distribution costs such as expense
of shifting business premises, compensation to retrenched employee, etc.
Capital expenditure represents an asset or a liability and is reflected in the
balance sheet.
Items listed under capital expenditure are given below :
Goodwill, freehold land and building, legal charges, lease, expenses incurred
on machineries, plants, tools, fixtures, etc. The expenses incurred on trademarks,
patents, copyrights, designs are also examples of capital expenditure. Expenses
incurred on erection of plant and machinery also comes under capital expenditure.
1. expenditure also includes extensions and additions on the fixed asset.
a. Capital b. revenue
3.3 Revenue Expenditure
All the expenses are treated as revenue expenditures if it is incurred for the
following purposes :
Expenditure made on the purchase of assets meant for resale at a profit or
for being converted into saleable goods, such as the cost of goods, raw materials
and stores. Apart from this all those expenses which are incurred on the
97
TRIAL BALANCE, maintenance of assets in proper working order e.g., repairs to plant and machinery,
BANK building furniture and fittings etc. also comes under revenue expenditure. Even day
RECONCILIATION to day recurring expenses also comes under revenue expenditure for example
STATEMENT, CAPITAL expenses of carrying on a business e.g., salaries, rent, rates, taxes, stationery,
AND REVENUE postage, etc.
TRANSACTION AND All revenue expenditures which are incurred to get revenue income are taken
ACCOUNTING FOR to the profit and loss account.
BAD DEBTS
List of Revenue Expenditures – (Examples of Revenue Expenditures) :
The following is a list of the usual items of revenue expenditures :
1. All Expenses which are incurred for the ordinary administration and
carrying on the business.
2. All the Expenses incurred on the repairs, renewals and replacement
of permanent assets.
3. All the cost of goods for resale is treated as revenue expenditure.
4. All the Cost of raw materials and stores acquired for use in the
production process.
5. All the wages paid for production of goods for sale.
6. All the expenses which are incurred on the production and distribution
of the final product.
7. All the Loss arising from normal wear and tear and obsolescence of
assets.
8. All the Depreciation of lease.
9. Any type of Interest on loans borrowed for the purpose of business.
10. Any type of loss arising from sale of fixed assets.
11. Any type of Fees paid for renewal of patent rights, etc.
12. Any type of expenses incurred on the vehicle.
13. Any expenses incurred on the fan and lights etc.
14. Any loss arising due to assets discarded or totally damaged or
destroyed by fire or other reasons.
1. Expenditure made on the purchase of assets meant for resale at a profit is a
expenditure.
3.4 Deferred Revenue Expenditure
When a large sum of revenue expenditure is incurred in any particular year,
the benefit of such expenditure may carry on to several years; such expenditure is
called ‘Deferred Revenue’ Expenditure. The utilized portion of expenditure is
charged to Profit and Loss Account and the balance is carried forward and are
written off in future accounting periods and shown in assets side of the Balance
Sheet of the current year. Following are the main characteristics of deferred revenue
expenditure :
98
1. Such expenses are of revenue nature CAPITAL AND
2. These expenses are relatively of very large amount REVENUE
3. The benefit of such expenses is extended beyond the accounting TRANSACTION
year or several accounting year.
Deferred Revenue Expenditure is comprises of the following :
Expenditures wholly paid in advance: These are the expenses which are
usually paid in advance in full during the accounting year.
Expenditures partly paid in advance: such expenses include insurance
premium which is payable partly for the current year and partly for the next year.
The expired period expenditure is charged to profit & loss A/c and the unexpired
portion is taken into the side of balance sheet that has assets column.
Abnormal Losses : Loss incurred due to uninsured risk such as loss due
to fire, loss in transit due to accident or confiscation of property in a foreign
country. Such losses are spread over two to three years. This amount is written
off and is charged to profit and loss account and balance is shown to assets side
of the balance sheet.
1. When a large sum of revenue expenditure is incurred in any particular year,
the benefit of such expenditure may carry on to several years ?
a. revenue b. capital
c. deferred
3.5 Difference between Capital Expenditure, Revenue Expenditure and
Deferred Revenue Expenditure
3.5.1 Difference between Capital Expenditure and Revenue Expenditure
Point Capital Expenditure Revenue Expenditure
1) Incurred on Acquisition, extension, Day to day activities of
business.
modification of fixed asset E.g. Administrative,
e.g. purchase of a plant, maintenance expenditure.
modification of machinery.
2) Effect on These expenditures These expenditures maintain the
Earning increase the earning earning capacity of business,
Capacity capacity of the business expenses on regular
e.g. purchases of new, maintenance would help to
modern machine would avoid stoppage in performance.
increase the speed,
accuracy of performance.
3) Not Expenditure is not capital Expenditure is not revenue in
recognized on in nature only because the nature only because the amount
the basis of amount involved is quite involved is small.
amount spent huge.
99
TRIAL BALANCE, 4) Add value to This type of expenditure This type of expenditure does
BANK existing asset adds value to an existing not add any value to an existing
RECONCILIATION
asset, when modification, asset.
STATEMENT, CAPITAL
AND REVENUE extension to existing asset
TRANSACTION AND is done.
ACCOUNTING FOR 5) Benefit Benefits more than one Normally benefits one
BAD DEBTS derived accounting period or accounting period.
several periods.
6) Where Recorded in Balance Recorded in Income Statement
recorded Sheet subject to subject to prepaid and
depreciation. outstanding expenses.
3.5.2 Difference between Capital Expenditure and Deferred Revenue
Expenditure
1) Incurred on Acquisition, extension, An item the benefits of which
modification of fixed asset would be derived for 2 to 5
e.g. purchase of a plant, years in near future,
modification of machinery. An abnormal expense like loss
by fire and the amount is huge
that cannot be justifiably
accounted in a single period.
An expense which provide part
benefit in current period and part
in next period.
2) Effect on These expenditures No effect on earning capacity,
Earning increase the earning but some of these expenditures
Capacity capacity of the business may help in maintaining the
e.g. purchases of new, capacity as like revenue
modern machine would expenditures.
increase the speed,
accuracy of performance.
3) Not Expenditure is not capital Recognition is also based on the
recognized on in nature only because the amount spent e.g. loss by fire if
the basis of amount involved is quite it is small to be treated as
amount spent huge. revenue and written of during
the period but if heavy then
deferred over a period of time.
100
4) Add value to This type of expenditure Does not add value to an CAPITAL AND
existing REVENUE
existing asset adds value to an existing asset. TRANSACTION
asset, when modification,
extension to existing asset
is done.
5) Benefit Benefits more than one Benefits may be derived for
derived accounting period or more than one accounting
several periods. period, but for near future.
6) Where Recorded in Balance The part of the amount to be
recorded Sheet subject to written off during current period
depreciation. is recorded in Income
Statement and the rest of the
amount is recorded in Balance
Sheet

1. Generally expenses which are incurred to meet daily expenses are known as
a. Revenue expenses b. Capital expenses
c. Deferred revenue expenses
3.6 Capital Receipt
A receipt is the inflow of money into the business which indicates the money
received by a business enterprise. A receipt of money is considered as capital
receipt when a contribution is made by the proprietor, partners or shareholders
towards the capital of the business or a contribution of capital by someone outside
the business. As such capital receipt creates a liability for the business. Capital
receipts do not have any effect on profit or losses of the business enterprise.
Capital receipts can take one or more of the following forms :
Additional capital introduced by the proprietor or partners or shareholders
by issuing fresh shares.
When a loan or a mortgage on property is arranged. By selling assets,
previously not intended for resale.
1. A receipt of money is considered as receipt when it is received from
customers for goods supplied.
a. Revenue
b. Capital
3.7 Revenue Receipts
A receipt of money is considered as revenue receipt when it is received
from customers for goods supplied, or fees received for services rendered in the
ordinary course of business, which is result of the firm’s activity in the current
period. Revenue receipts increases the profits and reduce the losses of the firm
101
TRIAL BALANCE, and as such credited to trading, profit & loss account or income statement.
BANK Examples of Revenue Receipts :
RECONCILIATION
1. Sale proceeds of goods in which the firm deals.
STATEMENT, CAPITAL
AND REVENUE 2. Discount received.
TRANSACTION AND 3. Commission received.
ACCOUNTING FOR 4. Interest received.
BAD DEBTS 5. Dividend received on investment.
6. Subscriptions received.
7. Rent received etc.
1. A receipt of money is considered as receipt when a contribution is made by
the proprietor, partners or shareholders towards the capital
a. Capital
b. Revenue
c. Deferred revenue
3.8 Capital and Revenue Profits
There is a lot of difference between the capital and revenue profit. Capital
profit is the profit gained due to sale of a fixed asset. For example a building which
was earlier purchased for Rs. 2, 20,000 is sold for Rs.3,25,000 the profit
Rs.1,05,000 thus made is capital profit.
Revenue profit is a profit made by its normal business activities e.g., profit
made through sale of goods, income from investments, commission earned, etc.
Capital profit earned should be transferred to the capital account of the
proprietor or credited to capital reserve account and this appears as a earned
profit on the balance sheet. Capital profit is never transferred in the profit and loss
account as this contains items that are earned as revenue profit. Whenever there is
a transaction of revenue profit is done only receipts and payments are entered in
the P&L account and under no circumstances are capital profit transactions are
entered.
1. profit is a profit made by its normal business activities
a. Revenue b. capital
3.9 Capital and Revenue Losses
Capital loss is opposite of capital profit. It is a loss arising due to sale of
fixed asset or loss due to raising funds for business purpose. It is better to write off
capital loss in the balance sheet instead of even showing it as liability since the
asset is fictitious.
Revenue loss is loss occurred in normal business operations such as loss
incurred while selling goods. Unlike capital loss revenue losses are charged to
profit and loss account of the year in which they occur.
102
Illustration 24 CAPITAL AND
Give reasons for the items given below that are to be considered as capital REVENUE
and as Revenue : TRANSACTION
1. Rs. 20,000 is the expense incurred for remodelling the factory and
the enhancement value is Rs. 15,000.
2. Rs. 2000 on Expenses on Wages paid for machine installation &
carrige Rs. 500.
3. Cost of old plant is Rs. 3,000 (or W. D. V. Rs. 1,800) and it was
sold for Rs. 1,000.
4. Rs. 1000 is the cost incurred on stock removal from old factory to
the new one.
5. Rs. 4000 for white washing factory building.
6. Rs. 4000 for purchase of patent rights and Rs. 400 renewal fee for
the next year.
7. Rs. 800 expenses for repainting the factory building.
8. Rs. 2,000 as compensation paid to a retrenched employee for loss
of employment.
9. Rs. 2,000 for buying new tyres for an old car.
10. Rs. 20,000 for buying goods was which was confiscated by customs
authorities for non – disclosure of material facts.
11. Rs. 1,000 as lawyer fees for an immovable property.
12. Rs. 10,000 expenses incurred on research work for a particular
product that ultimately did not give fruitful result.
13. Rs. 20,000 for cost of conversion of gas plant to oil fuel plant for the
generation of electricity.
14. Rs. 8,000 book value for plant, Rs. 4,000 for stock that were
destroyed by fire and Rs. 10,000 and Rs. 5,000 recovered from
insurance company respectively.
15. Rs. 4,000 for re–decorating a cinema hall and Rs. 12,000 for
enhancing sitting accommodation.
16. Rs. 1,200 paid for premium for Fire insurance on 30th Nov. for one
year. The accounting date is 31st December.
17. Rs. 1, 60,000 paid for purchase of plot by a firm and construction of
quarter for officers. The rest of the plot is for building houses to be
sold to public.
18. Rs. 2,000 spent on a machine of which Rs. 400 is for replacement of
worn out parts and Rs. 1,600 for additions to new devices which
doubles the output.
19. Expenses incurred on the foreign visit of sales manager to U.K. was
Rs. 20,000 for promoting export sales. Visit was quite successful.
103
TRIAL BALANCE, Solution :
BANK 1. Rs. 15,000 (by which the value of factory is enhanced for remodelling
RECONCILIATION is capital expenditure as it increases the earning capacity of the firm)
STATEMENT, CAPITAL and Rs. 5,000 (i.e.20,000 – Rs. 15,000) that has also been used for
AND REVENUE remodelling is revenue expenditure since it does not increase earning
TRANSACTION AND capacity.
ACCOUNTING FOR 2. Rs. 2,000 paid for installing a machine and Rs. 500 paid for carriage
BAD DEBTS are capital expenditure since they are incidental to the acquisition of
fixed assets and its installation. They help in increasing earning capacity.
3. The loss on sale of old machine amounting to Rs. 800 (i.e. Rs. 1,800
– Rs. 1,000) is revenue loss since it represents under provision for
depreciation already made in the earlier years and the selling price
amounting to Rs. 1,000 is a capital receipt as it reveals the proceeds
of a sale of fixed assets.
4. The cost of removal of Stock amounting to Rs. 1,000 is a revenue
expenditure of special nature which may be written off against the
revenue of a number of years i.e. like deferred revenue expenditure
and does not increase the efficiency of the assets or earning capacity.
5. Rs. 4,000 is the expense for white washing the factory building is
regular expenditure in order to maintain the factory hence should be
treated as revenue expenditure.
6. The cost of patent rights amounting to Rs. 4,000 is a capital expenditure
as it is fixed asset and helps in earning revenue over a period of few
years. But the renewal fee 400 is revenue expenditure since it is
designed to supply benefit only for the current financial year.
7. Cost of repainting the factory building amounting to Rs. 800 may be
considered as a regular expenditure in order to maintain the building
and as such, it must be treated as revenue expenditure. In case this is
done at an interval of a few years, the expense of such painting may
be spread over the period when benefit is actually taken.
8. Rs. 2,000 paid as compensation to a retrenched employee is treated
as revenue expenditure of special type and of non – recurring nature
and then written off against Profit and loss Account over a number of
certain periods considering as deferred revenue expenditure. This is
because; compensation for loss of service is generally paid against
the salary payable to the employee for the period of notice before
retrenchment.
9. Purchase of a new tyre for an old card amounting to Rs. 2,000 is a
capital expenditure since it is nothing but a cost of replacement of a
part of an existing fixed asset.
10. Imported goods amounting to Rs. 20,000 which were confiscated
by customs authorities for non – disclosure of material facts is an
abnormal revenue loss and non – recurring in nature which are incurred
in the regular course of the business. As such it is better to treat the
same as deferred revenue expenditure which may be written off against
the period of few years.
104
11. Rs. 1,000 paid to a lawyer for drafting agreement of lease is a capital CAPITAL AND
expenditure as it is incidental as it is part of fixed asset. REVENUE
12. Expenditure on any type of scientific research if fruitful may be treated TRANSACTION
as capital expenditure. But if the product is unsuccessful then it should
be treated as an expenditure of special nature which again should be
written off against the profit and loss Account.
13. In this case, the purpose of conversion is not known to us. It may be
happened for two purposes viz.(i) the said conversion may increase
the efficiency of the plant, or (ii) the said conversion may arise since
three is non – availability of gas supply in the locality for any other
purpose. Needless to say, the former is a capital expenditure whereas
the latter is a revenue expenditure which is written off against the
revenue over a number of years by charging profit and loss account.
14. The excess amounts which are realized from insurance company over
the book value of plant amounting to Rs. 2,000 (i.e. Rs. 10,000 –
Rs. 8,000 ) is a capital Profit since plant is an item of fixed assets
while the excess amounts which are realized from the Insurance
company over the value of stock amounting to Rs. 1,000 (i.e. Rs.
5,000 – Rs. 4,000) is a revenue profit since stock is an item of current
assets and which are meant for re–sale.
15. Redecoration of a cinema hall amounting to Rs. 4,000 is revenue
expenditure as it does not enhance the earning capacity. But if it is a
substantiality large amount, the same may be treated as deferred
revenue expenditure and may be spread over two or three years.
But enhancement of sitting accommodation increases the earning
capacity. As such, it should be capitalized.
16. Fire insurance premium it usually paid in advance and such, Rs. 12,000
would have been paid for the following period. As premium is paid
on 30th Nov. and current year closes on 31st Dec. hence, one month
premium amounting to Rs. 100 (i. e. Rs. 1,200 / 12 x 1) would be
charged to revenue and the balance Rs. 1,100 (Rs. 1,200 – Rs.
100) would be carried forward as deferred revenue expenditure as
“Prepaid insurance Premium in the assets side of the Balance sheet.
17. Rs 40,000 (i.e. 1, 60,000 x 1/4) which is incurred by the builders
while erecting officers for own use should be capitalized and the
balance i.e. 1,20,000 (i.e. Rs. 1,60,000 – Rs. 40,000) which is spent
for constructing the building sold out to the public is a revenue
expenditure.
18. Rs. 400 which is incurred for replacing worn out parts is a revenue
charge since it’s a routine expenditure for maintaining the existing
earning capacity of the firm and Rs. 1,600 which is incurred for
additions to the new device is a capital expenditure since it results in
an increase in the earning capacity.
19. Visit of sales manager to U. K. for promoting export sales is
105
TRIAL BALANCE, expenditure in the nature of advertisement campaign. As the visit is
BANK found to be quite successful it is likely to render benefit for enhancing
RECONCILIATION export sales over a number of years and as such, it should be treated
STATEMENT, CAPITAL as deferred revenue expenditure and should be written off against
AND REVENUE Profit and Loss account spread over the related number of years.
TRANSACTION AND Check your progress 8
ACCOUNTING FOR
1. is a loss arising due to sale of fixed asset or loss due to raising funds for
BAD DEBTS
business purpose.
3.10 Let Us Sum Up
In this block we have studied in very detail about the revenue and capital
expenses and receipts. The nature of both revenue and capital has been very well
explained by the writer.
After study of this block you will be able to know about the capital and
revenue transactions. Which of those are classified under revenue and which of
them will be treated as capital? We studied that the transactions which provide
benefits or supply services to the business unit for more than one year or one
operating cycle of the business are known as capital transactions. We even studied
that the transactions which provide benefits or supply services to the business unit
for one accounting year only, are known as Revenue transactions. On the other
hand capital expenditure is the expenditure incurred to acquire an asset or service
that will benefit the business more than one accounting period. Capital expenditures
are those expenditure which are incurred on expenditures that either increases the
number of fixed asset units or have the effect of increasing production capacity or
efficiency, capital expenditure even increases the span of life or economy of
operation of an existing fixed asset whereas revenue expenditure consists of
expenditure the benefit of which is not carried over to the several accounting
periods. It is the outward movement of funds which are incurred to meet the
running expenses of a business and it will be of benefit for the current period only.
Answers: (1–a)
Answers: (1–a)
Answers: (1–c)
Answers: (1–a)
Answers: (1–a)
106
Check your progress 6 CAPITAL AND
Answers: (1–a) REVENUE
Check your progress 7 TRANSACTION
Answers: (1–a)
Answers: (1–a)
3.12 Glossary
1. Fixed Assets : It consist of any asset which a business owns or buys for
use within the business and which is retained at for a number of years and
put to production. The major items include land, buildings, equipment and
vehicles but can include smaller items like tools.
3.13 Assignment
1. Explain with reasons whether following items are Capital or Revenue :
i. Debenture issue expenses Rs. 2,000.
ii. Legal expenses in connection with infringement of trade mark Rs.
5,000
iii. Purchase of second–hand machinery Rs. 12,000, installation charge
Rs. 2,000 and repairs of the second–hand machine Rs. 1,000 before
installation.
iv. Legal expenses incurred for protecting trade mark Rs. 1,000.
v. Freight charge of Rs. 500 on acquiring a computer and a fax machine
for office.
(Ans. i) Capital ii) Capital iii) Capital iv) Revenue v) Capital
2. State whether following is Capital or Revenue
i. Confiscation of imported goods worth Rs. 50,000 for non–disclosure
of material facts.
ii. Fixing a new device in the plane to reduce power consumption at a
cost of Rs. 20,000 Capital and Revenue.
iii. Rs. 95,000 spent on publicity and advertisement in connection with
introduction of a new product.
iv. Spent Rs. 10,000 for providing temporary huts to workers, during
the construction of factory building.
v. Special repairs necessitated by accidental damage Rs. 1,750.
Ans. (i) Deferred Revenue (ii) Capital (iii) Deferred Revenue |(iv) Capital
(v) Capital
3. State with reason which of the items would be charged to Capital and
which Revenue.
i. Cost of dismantling, removing and re–installing plant to more suitable
place Rs. 30,000.
ii. Paid Rs. 1,300 for removal of stock to new site.
107
TRIAL BALANCE, iii. A sum of Rs. 1,000 spent on alteration of existing plant incorporating
BANK there by new device which could affect substantial reduction in power
RECONCILIATION consumption.
STATEMENT, CAPITAL iv. Imported goods worth Rs. 25,000 confiscated by custom by authority
AND REVENUE for non–disclosure of material facts.
TRANSACTION AND
Ans. (i) Deferred Revenue (ii) Revenue (iii) Capital (IV) Deferred Revenue.
ACCOUNTING FOR
BAD DEBTS 4. State which of the following Expenditure capital is and which is deferred
revenue expenditure or revenue?
i. Demolition of an old building of book value Rs. 10,000 and
construction of new building on its site costing Rs. 1,50,000.
ii. Replacement of vital part cost Rs. 99,000 for the one damaged in
transit of a newly purchased machine.
iii. Visit of a sale manager abroad total cost Rs. 16,000 for promoting
export sale. Visit is quite successful.
iv. Purchase of new tyres for an old van. Rs. 2,000
v. Cost of repairing factory building Rs. 5,000
Ans. (i) Deferred Revenue (ii) Capital (iii) Deferred Revenue (iv) Revenue
(v) Revenue
3.14 Activities
Define Capital Expenditure, Revenue expenditure and Deferred Revenue
Expenditure.
3.15 Case Study
Distinguish between Capital Expenditure, Revenue Expenditure and Deferred
Revenue expenditure.
1. Accounting For Management, JawaharLal , HIMALAYA PUBLISHING
HOUSE.
2. Financial Accounting For Management: An Analytical Perspective, Ambrish
Gupta, Prentice Hall,.
3. Financial Accounting For Business Managers, Asish K. Bhattacharyya, Phi
Learning Pvt Ltd, 2009 .
4. Advanced Accounts, M. C. Shukla & T. S. Grewal, S. Chand Publisher,
1997.
5. Advanced Accounting – Financial Accounting, Dr Ashok Sehgal, Dr Deepak
Sehgal, Taxmann Allied Services Pvt. Ltd. , 2008.
––––
108
ACCOUNTING
Unit FOR BAD DEBTS
4
: UNIT STRUCTURE :
4.1 Introduction
4.2 Sundry Debtors
4.3 Bad Debts
4.4 Provision Reserve for Bad Debts
4.5 Methods of Accounting
4.6 Provision for Discount on Debtors
4.7 Provision for Discount on Creditors
4.8 Bad Debts Recovery
4.9 Let Us Sum Up
4.11 Glossary
4.12 Assignment
4.13 Activities
4.14 Case Study
• The Concept of Bad Debts, the Provision for Bad Debts, the Sundry
Debtors, Provision for Discount on Debtors, Provision for Discount
on Creditors.
• Types of Debtors.
• VariousAccounting Methods for Calculating and Recording Provision
for Bad Debts.
• Recording of Transactions related to Provision for Discount Allowed
and Received.
• Concept and Accounting Treatment of Bad Debt Recovery.
• Provision for Discount on Creditors.
4.1 Introduction
In today’s competitive world, many methods are used to attract and maintain
customers. Offering credit to customers is a one such trend. Customer satisfaction
and customer care are buzz words in this modern age. Formulating attractive
credit policy that will boost up the sales is the prime necessity of any marketing
division. This in turn gives prime importance to the management of receivables.
109
TRIAL BALANCE, The main source of revenue in many businesses is the sale of goods or
BANK services to customers. Generally, goods are sold on credit to customers. Despite
RECONCILIATION all precautions some customers turn out to be the non–paying culprits. In business,
STATEMENT, CAPITAL debts become irrecoverable owing to various reasons, namely, insolvency, wilful
AND REVENUE non–payment, etc. Bad debt is an amount which is due from a debtor and which is
TRANSACTION AND not expected to be received. Bad debt is a loss to the business so it is treated as an
ACCOUNTING FOR operating expense of doing business, since it is inevitable to any business that
BAD DEBTS extends credit to its customers.
4.2 Sundry Debtors
The sum total or aggregate of the amounts, which the customers owe to the
business for purchasing goods on credit, is known as Sundry Debtors, or Trade
Debtors, or Book Debts or simply Debtors. These sundry debtors may again be
classified as under :
(1) Good Debt : The debts which are sure to be realized are called Good
Debt.
(2) Doubtful Debts : The debts which may or may not be realized are called
Doubtful Debts.
(3) Bad Debts : The Debts which cannot be realized at all are called Bad
Debts or Unrealizable or irrecoverable Debts.
1. The sum total or aggregate of the amounts, which the customers owe to the
business for purchasing goods on credit, is known as .
a. Sundry Debtors b. Sundry creditors
4.3 Bad Debts
It is an amount which is written off by the business as a loss to the business
and considered as an expense because the debtors of the business have turned to
be bad and now no amount could be collected from them any more even after
making all reasonable efforts. This usually occurs when the debtor has been declared
bankrupt or the cost of pursuing further action in an attempt to collect the debt
exceeds the debt itself.
The accounting process is that the debtor’s account is immediately written
off by crediting the debtor’s account and this writes off any balance remaining in
the account of debtor. A bad debt represents the loss of income that is why it is
regarded as an expense.
The following entries are required to be passed :
(i) For actual bad debt (if there is no provision for bad debts)
Bad Debts A/c Dr.
To Sundry Debtors A/c
Profit & Loss A/c Dr.
To Bad Debts A/c
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(ii) For actual bad debts (if there is an existing provision i.e., old reserve) ACCOUNTING
Provision for Bad Debts A/c Dr. (Actual amount) FOR BAD DEBTS
To Bad Debts A/c
Thus, for Final Accounts:
Bad Debts –
(iii) If given in the Trial Balance: To be debited to Profit & Loss A/c
(iv) If outside the Trial Balance: To be debited to Profit & Loss A/c
(i.e., in the adjustment) And, to be deducted from Sundry Debtors in
the Balance Sheet
1. is an amount which is written off by the business as a loss to the business
and considered as an expense because the debtors of the business have
turned to be bad.
a. Bad debts b. loss
4.4 Provision Reserve for Bad Debts
Doubtful debts are those debtors from whom the chances of getting the
payment are very low. There may be many reasons for non–payment that may be
able to include disputes over supply, delivery, and conditions of goods, the
appearance of financial stress within customers operation. In the business whenever
such a dispute occurs it is very sensible to add this debt or portion thereof to the
doubtful debt reserve. This is based on the principle of conservatism and this is
done to avoid over–stating the assets of the business as trade debtors is reported
net of Doubtful debt.
Accounting Steps
To sum up, the following entries are required to be passed for Bad Debts and
Provision for Bad Debt –
(a) Whenever provision is made for the 1st time (at the end of the first year)
(i) Bad Debts –
Profit & Loss A/c Dr. (With the actual amount)
To Provision / Reserve for Bad Debts A/c
(ii) For creating provision for Bad debts –
To Provision / Reserve for Bad Debts A/c (With the amount
of further provision)
(b) At the end of subsequent year –
(i) For Bad Debts –
Provision / Reserve for Bad debts Dr. (With the actual amount)
To Bad Debts A/c
(ii) Then the next year’s provision is estimated which is carried forward and
111
TRIAL BALANCE, the extra or excess provisions are adjusted (against the old provision) which
BANK is transferred to Profit & Loss Account, that is, the entry will be –
RECONCILIATION Profit and Loss A/c Dr.
STATEMENT, CAPITAL To Provision / Reserve for Bad Debts A/c (With the amount
AND REVENUE of further provision)
TRANSACTION AND
If any reserve for bad debt is in excess will be credited to P&L A/c
ACCOUNTING FOR
BAD DEBTS
1. are those debtors from whom the chances of getting the payment are very
low.
a. Doubtful debts b. Bad debts
4.5 Methods of Accounting
Basically there are two methods used for recording for bad and doubtful
debts.
First Method
In the first method Provision for Bad and Doubtful Debts is created by
debiting the Profit and Loss Account. Any bad debts arising in the subsequent
years are adjusted against this Provision for Bad and Doubtful Debts.
Journal Entries in the First Year
1. When a provision is created for the first time.
Profit &Loss A/c Dr.
To Provision for Bad and Doubtful Debts A/c
2. For bad debts after Trial Balance:
Bad Debts A/c Dr.
3. For writing–off bad debts in the Profit & Loss Account
To Bad Debts A/c (Trial Balance figure & Bad Debts after
Trial Balance)
Journal Entries in the Second and Subsequent Years
1. For bad debts after Trial Balance :
Bad Debts A/c Dr.
2. For writing–off bad debts in the Profit & Loss Account:
Provision for Bad and doubtful Debts A/c Dr.
To Bad Debts A/c
3. For creating necessary provision at the year end:
To Provision for Bad and Doubtful Debts A/c The amount of
provision to be created is calculated as under:
Illustration 25
Mr. Vishal. A small business man, had incurred a loss of Rs. 3,000 as bad
112
debt during the year 2013, and thereafter decided to create a Provision in this ACCOUNTING
regard at 5% on good debtors amounting to Rs.50,000 on 31st December 2013. FOR BAD DEBTS
During the year ended 31st December, 2013, the bad debt loss was Rs.2,000 on
31st December, 2014; his good debtors amounted to Rs.65,000 and decided to
maintain the Provision at 4% for Bad and Doubtful Debts.
Solution :
Rs.
Closing Provision required (65000*4%) 2,600
Add : Bad Debt 2,000
4,600
Less: Opening balance (50000*5%) 2,500
To be provided from P & L A/c 2,100
Second Method
Here bad debt is directly charged to Profit and Loss Account in the 1st
year and in subsequent years as well. Provision to be created depends on the
amount of provision at the beginning of the year.
Journal Entries in the First Year
1. For the bad debts of the period for which no entry has been made
Bad Debts A/c Dr.
2. For writing–off bad debts in the Profit and Loss Account
To Bad Debts A/c
3. When provision is created for the first time
To Provision for Bad & Doubtful Debts A/c
Journal Entries in the Second and Subsequent Years
1. For the bad debts of the period for which no entry has been made
Bad Debts A/c Dr.
2. For writing–off bad debts in the Profit & Loss Account:
To Bad Debts A/c
(Bad Debts during the year and after the Trial Balance)
3. For creating provision at the year end :
(a) (Closing provision > Opening provision
Profit &Loss A/c Dr.
To Provision for Bad and Doubtful Debts A/c
(b) (Closing provision < Opening provision)
Provision for Bad and Doubtful Debts A/c Dr.
To Profit & Loss A/c
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TRIAL BALANCE, This method differs from the first method in the manner that it shows bad
BANK debts and provision for Bad and doubtful Debts is maintained in the Profit and
RECONCILIATION Loss Account. This is done as bad debts are not adjusted against the Provision for
STATEMENT, CAPITAL bad & Doubtful Debts Account.
AND REVENUE Illustration 26
TRANSACTION AND Prepare provision for bad and doubtful debts account and show it in financial
ACCOUNTING FOR statements of respective accounting years given below:
BAD DEBTS Year I Debtors at the end 25000
Year II Debtors at the end 15000
Bad debts written off 500
Bad debts not recorded 800
Year III Debtors at the end 10000
Bad debts written off 800
Maintain provision for bad and doubtful debts @ 10%
Solution :
Provision for Bad and Doubtful debts Account
Dr. Cr.
Yr 1 To Balance c/f 2500 Yr 1 By Profit and loss 2500
Yr.2 To Bad debts A/c 500 Yr 2 By Balance b/d 2500
To Bad debts A/c 800 By P&L A/c 220
To Balance c/f **1420 (Balancing fig.)
Yr.2 Total 2720 Yr.2 Total 2720
Yr.3 To Bad debts A/c 800 Yr.3 By bal b/d 1420
To Balance c/f ***1000 By P&L A/c 380
1800 (Balancing fig.) 1800
** 15000 - 800 = 14200×10% = 1420 *** 10000×10% = 1000
1. Provision for Bad and Doubtful Debts is created by debiting the .
a. Profit and Loss Account
b. Trading account
4.6 Provision for Discount on Debtors
In almost all the business there is always an effort to collect our payments
from the debtors quickly so in order to promote quick payments from the debtors
we offer they discount for all the early payment. Here all those debtors who clear
their dues before their due dates are given some discount. It is advisable to charge
this expenditure i.e. discount to debtors to the period in which sales has been
made, so a provision is created in the same manner, as in case of provision for
doubtful debts
No discount should be allowed on debts which have turned bad. Here the
provision is created only on good debtors. So the amount of provision for discount
should be calculated after deducting the provision for bad debts from sundry
debtors.
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Accounting Steps ACCOUNTING
(a) When provision is made for the first time (at the end of first year) FOR BAD DEBTS
(i) for Discount Allowed –
Profit & Loss A/c Dr. (with the amount of actual discount)
To Discount Allowed A/c
(ii) For Provision for Discount on Debtors –
Profit & Loss A/c Dr. (with the amount of Provision
To Provision for Discount on Debtors A/c for Discount on
Debtors)
(b) At the end of subsequent years
(i) for Discount Allowed –
Provision for Discount on Debtors A/c Dr. (with the amount of discount
To Discount Allowed A/c allowed)
(ii) Then, the next year’s provision is estimated which is carried forward and
the extra or excess provision is adjusted (against the old provision which is
transferred to Profit & Loss Account. That is, the entry will be –
Profit & Loss A/c Dr. (with the amount of further provision)
To Provision for Discount on Debtors A/c
The Balance Sheet contains The Bad Debts (after Trial Balance), Provision
for Bad and Doubtful Debts and Provision for Discount on Debtors as follows:
Balance Sheet as on…….
Less : Bad Debts
Less : Provision for Bad & doubtful Debts
Less : Provision for Discount on Debtors
1. To promote quick payments from the debtors we offer them
a. Discount b. Goods
c. money
4.7 Provision for Discount on Creditors
Just as we give discount to our debtors in the same way our creditors give
us discount for any prompt payments. But whether this discount is considered as
income in the period when purchases were made or the period when the payment
is made when both belong to different accounting years. Therefore it should be
treated as income in the period when the particular purchase was made. Hence,
on the last date of accounting period if some amount is still payable to creditors, a
provision should be made to account for it in the profit and loss account of that
year when purchases are made. Following adjusting entry is passed :
Provision for discount on creditor’s a/c Dr.
To Profit and loss account
Accounting Steps
Accounting procedures are similar to provision for Discount on Debtors
but the entries are converse.
115
TRIAL BALANCE, Check your progress 6
BANK 1. Our give we discount for any prompt payments.
RECONCILIATION a. Creditors b. debtors
STATEMENT, CAPITAL
AND REVENUE 4.8 Bad Debts Recovery
TRANSACTION AND As states earlier, when the seller mentions any loss due to bad debt, it is
ACCOUNTING FOR written off by debiting account of Bad Debt and crediting the account of Sundry
BAD DEBTS Debtors. Sometimes the debts determined as bad debts and are not likely to
receive is received, such bad debt realised is known as Bad Debt Recovered.
Such an amount of debts realised is to be credited to Bad Debts Recovery Account.
It is transferred to Profit & Loss Account in the year in which the same is recovered.
Thus following entries should be passed for the purpose –
(i) For recovering Bad Debts –
Cash / Bank A/c Dr.
(With the amount of bad debt recovery)
To Bad Debts Recovery A/c
(ii) For transferring to Profit & Loss Account –
Bad Debts Recovery A/c Dr.
To Profit &Loss A/c
1. When the seller mentions any loss due to bad debt, it is written off by debiting
account of
a. bad debt b. Profit and los
4.9 Let Us Sum Up
In this unit we have studied in detail about bad debts and regarding its
provision. Normally in every business, the business in done on credit basis and
many a times it happens that we are unable to collect our payment due to inability
of payer or due to any reason i.e. that amount which we have to received turns to
be bad.
Bad debt is the sum total or aggregate of the amounts, which the customers
owe to the business for purchasing goods on credit. These sundry debtors may
again be classified as Good Debt, Doubtful Debts and Bad Debts. It is a loss to
the business and classified as an expense because the debt owed to the business is
unable to be collected. Doubtful debts are those debts which a business or individual
is unlikely to be able to collect. The reasons for potential non–payment can include
disputes over supply, delivery, and conditions of goods, the appearance of financial
stress within customers operation. Provision for Discount on Debtors is created to
take care of discount to be allowed to debtors for prompt payment. This is an
incentive given to customers for prompt payment. But before calculating provision
for discount, bad debt and provision for doubtful debts are to be deducted from
debtors. Bad Debt Recovery Sometimes the debt, which was written off as bad
previously, may be recovered partially or wholly. Such a realized bad debt is
known as Bad Debt Recovered. The amount is to be credited to Bad Debts
Recovery Account. Since it is a clear profit, it is transferred to Profit & Loss
Account in the year in which the same is recovered.
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4.10 Answers for Check Your Progress ACCOUNTING
FOR BAD DEBTS
Answers: (1–a)
Answers: (1–a)
Answers: (1–a)
Answers: (1–a)
Answers: (1–a)
Answers: (1–a)
Answers: (1–a)
4.11 Glossary
1. Creditors : A list of suppliers to whom the business owes money.
2. Debtors : A list of customers who owe money to the business.
4.12 Assignment
1. The figure of Sundry Debtors in a Trial Balance is Rs. 70,000. You are
asked to write off Rs.500 as Bad Debts and make Provision for Doubtful
Debts @10% on Sundry Debtors. Pass the necessary journal entries.
2. From the following particulars, prepare the necessary accounts:
3. Certain Balances in a company’s ledger at 30th June 1999 were:
On 30th June, 2000 stock of coke was valued at Rs.750, and provision for
bad debts was adjusted equally to 5% of the Debtors. On 6th August,
2000 the company paid its electricity account of Rs.1, 010 for the quarter
ended 31st July, 2000. Show the debtors and provision for bad debts
accounts in the company’s Ledger for the year ended 30th June 2000.
4.13 Activities
1. What do you mean by Provision for Bad and Doubtful Debts? Justify
its creation
2. Explain the concept of sundry debtors and different types of sundry
4.14 Case Study
Explain in detail the accounting procedure of bad debts
1. Modern Accountancy Volume I, Mukherjee, Tata Mgraw Hill 2008.
3. Advanced Accountancy, Hrishikesh Chakraborty, Oxford University Press,
1978.
4. Advanced Accounts, M. C. Shukla& T. S. Grewal, S. Chand Publisher,
1997.
117
TRIAL BALANCE, Block Summary
BANK
In this block we have studied in very detail about the trial balance, bank
RECONCILIATION
reconciliation statement, Capital and revenue transactions and Accounting for Bad
STATEMENT, CAPITAL
debts. Unit one covered the topic trial balance, this topic is considered to be one
AND REVENUE
of the most important topic as trial balance is the key statement through which final
TRANSACTION AND
accounts are prepared, these final accounts are the report card of the business it
ACCOUNTING FOR
shows the performace of the business during a particular period of time. In trial
BAD DEBTS
balance we even studied about the suspense account, which is required in a situation
when there is non agreement between the trial balance in that situation this trial
balance is used to tally the differences. Second unit covered the topic bank
reconciliation statement which was even discussed with sufficient examples and
illustrations.
Through the study of this block the reader will get a detailed insight of the
next unit of capital and revenue transactions. He will also get a detailed knowledge
of how to make distinction between the revenue and capital expenditure. Not only
expenditure but the readers will get a detailed knowledge about capital and revenue
receipts and I am sure enough that after going through this block the readers could
easily distinguish between the expenses and revenue of both capital and revenue
nature. In the fourth unit we studied about the bad debts in very detail and its
accounting treatment too was studied in detail.
All these topics were of great importance to the students undergoing the
courses of commerce or management. These topics were discussed very througly
with illustrations.
118
Block Assignment
1. Methods of preparing Trial Balance.
2. Errors not disclosed by Trial Balance
3. Limitations of Trial Balance
4. Suspense account
5. Method of locating errors
6. Provision for Discount on creditors
7. Bad debts recovery
8. Discount on Debtors
9. Misconceptions about depreciation
10. Bad debts
11. Capital Profit and Capital Loss
12. Capital Receipts and examples of capital receipts.
13. Revenue transactions.
14. Capital Transactions.
15. Revenue receipts
1. Explain Bank Reconciliation Statement and also explain its
importance.
2. What are the different reasons for discrepancy between the balance
as per the cash book and the Pass book.
3. Explain the errors which are not disclosed by the trial balance.
4. Explain in detail why there is a difference in treatment of capital and
revenue expenditure?
5. Why should provision for Bad debts be maintained?
119
TRIAL BALANCE,
BANK Enrolment No. :
RECONCILIATION
STATEMENT, CAPITAL 1. How many hours did you need for studying the units?
AND REVENUE Unit No 1 2 3 4
TRANSACTION AND Nos of Hrs
ACCOUNTING FOR
2. Please give your reactions to the following items based on your reading of
BAD DEBTS
the block :

______________________________________________________
______________________________________________________
______________________________________________________
______________________________________________________
______________________________________________________
120
Ambedkar
OpenUniversity
BASIC OF ACCOUNTING
BLOCK-3 DEPRECIATION ACCOUNTING, FINAL

ACCOUNTS (WITHOUT ADJUSTMENTS), FINAL
ACCOUNTS (WITH ADJUSTMENT)
UNIT 1
DEPRECIATION ACCOUNTING
UNIT 2
FINALACCOUNTS (WITHOUT ADJUSTMENT)
UNIT 3
FINALACCOUNTS (WITH ADJUSTMENT)
DEPRECIATION BLOCK 3: DEPRECIATION ACCOUNTING, FINAL ACCOUNTS
ACCOUNTING, FINAL (WITHOUT ADJUSTMENTS), FINAL ACCOUNTS (WITH
ACCOUNTS AND ADJUSTMENT)
ELEMENTS OF COST
Block Introduction
Accounting is considered to be one of the most important subjects in the
field of commerce or management and therefore this subject has been intro-
duced here in this course.
This block covers one of the most important topics of accounting. It covers
important topics such as depreciation accounting, final accounts both with
and without adjustments. In the depreciation accounting students have been
explained the basic concept of depreciation, various methods which are used
to calculate the depreciation, sufficient numerical illustrations have been pro-
vided to help the students in understanding this topic. In the next unit the
topic final accounts have been covered and special emphasis has been given
on this topic to make students understand this topic, sufficient illustrations
and problems have been given to help them in understanding this topic in
depth.
The readers will get a through insight of accounting through this block. They
will get good knowledge about depreciation, final accounts, how are final
accounts made.
Block Objective
After learning this block, you will be able to understand:
 Meaning of Depreciation.
 The Accounting Cycle.
 Objectives of Preparing Final Accounts.
 Profit and loss account and balance sheet.
 The differences between trading and profit and loss account, balance
sheet and trial balance.
Block Structure
Unit1: Depreciation Accounting
Unit2: FinalAccounts (without adjustments)
Unit3: Final Accounts (without adjustments)
122
Unit
DEPRECIATION ACCOUNTING
1
: UNIT STRUCTURE :
1.1 Introduction
1.2 Meaning of Depreciation
1.3 Characteristics of Depreciation
1.4 Causes of Depreciation
1.5 Objectives of Providing Depreciation
1.6 Computation of Depreciation
1.7 Methods of Charging Depreciation
1.8 Change of Method of Charging Depreciation
1.9 Salient Features of AS-6: Depreciation Accounting
1.10 Illustrations
1.11 Let Us Sum Up
1.13 Glossary
1.14 Assignment
1.15 Activities
1.16 Case Study
1.0 LearningObjectives
 The Concept of Depreciation
 Various Methods of Recording Depreciation
 Cause of Depreciation
 The Features of AS-6
 Objectives of depreciation
 Calculation of Depreciation
 Change of method of charging depreciation
1.1 Introduction
Fixed assets are acquired to be utilized in the process of providing goods and
services to the customers. They are one time investment and needs only main-
tenance. Value of a fixed asset diminishes with passage of time and its utiliza-
tion over the period. This decrease in value of the fixed asset is taken care of
in accounting system by way of charging depreciation to the asset.
123
DEPRECIATION The value of a fixed asset is spread over its life time and a proportionate
ACCOUNTING, FINAL amount is deducted from the assets? value in the form of depreciation at the
ACCOUNTS AND end of each period. Thus Depreciation is the portion of cost of a fixed asset
ELEMENTS OF COST allocated to a particular period.
Except for land, most fixed assets, such as building, plant, machinery, office
equipment, etc. have a limited useful life. Depreciation denotes decrease in
the value of an asset due to wear and tear, lapse of time, obsolescence, ex-
haustion and accident. Depreciation is one of the most important compo-
nents of income determination. In order to ascertain the true profit for the
business, it is necessary that depreciation is charged on the fixed assets of the
business.
1.2 Meaning of Depreciation
Depreciation means the gradual decrease or loss in the value of asset due to
its usage, passage of time and normal wear and tear. This gradual decrease in
the value of the asset is of permanent nature, which cannot be made good by
normal repair and maintenance.
Accounting Standards issued by Institute of Chartered Accountants of India
defines depreciation as follows:
“Depreciation is a measure of wearing out consumption or loss in value of
assets that are depreciable due to use, time period or obsolescence due to
new technology and market changes. Depreciation is allocated in order to
charge a some amount of money as depreciation amount in each accounting
period during the expected useful life of the assets.”
Whereas International Accounting Standard Committee defines, “Deprecia-
tion is the allocation of the depreciable amount of an asset over its estimated
life.”
We can summarize that depreciation as a „process of allocation of the cost of
depreciable assets? over it suse full if einarational and systematic manner.
1. Means the gradual decrease or loss in the value of asset due to its
usage.
a. Depreciation
b. Asset
c. demolition
1.3 Characteristics of Depreciation

The important characteristics of depreciation are noted below:
 Depreciation is charged on fixed and tangible assets only.
 Depreciation refers to a permanent / gradual and continuous decrease
in the utility value of a fixed asset and it continues till the end of the
useful life of the asset.
 Depreciation is a charge against profit for a particular accounting
period.
124
 Depreciation is always computed in a systematic and rational manner
DEPRECIATION
since it is not a sudden loss.
ACCOUNTING
 Depreciation is a process of allocation of expired cost and not of valu-
ation of fixed assets.
 Depreciation represents only an estimate and not the exact amount.
 Depreciation may be physical and functional.
 Total depreciation cannot exceed the cost of the depreciable asset.
 It is non-cash charge and hence does not involve outflow of cash.
 The basis of charging depreciation is economic life of the asset and the
cost thereof. Market value has no relevance for calculating deprecia-
tion.
 Depreciation is different and distinct from Amortization, Depletion Ob-
solescence, Dilapidation and Fluctuation.
1. Depreciation is charge don ........... assets only.
a. Fixed and tangible asset
b. Current asset
c. Intangible asset
1.4 Causes of Deprecation
The depreciation may broadly be divided into two:-
 Internal causes
 External causes.
In detail :
1. Internal causes: Depreciation that is a result of certain inherent nor-
mal causes is known as internal depreciation. The causes of internal
depreciation are:
a. Wear and Tear: The life of an asset reduces due to its continued
use as for e.g. the life of building, plant, machinery, etc. such de-
cline and the quantum depends of use of an asset and in the event
of double- shift depreciation on plant and machinery will be doubled.
It is very obvious that such loss is unavoidable. A time will come
when the asset will become unfit for repairs, when it will no longer
be suitable.
b. Depletion: Some assets decline in value proportionate to the quan-
tum of production or use as for example mines, quarry, etc. As we
extract coal, etc. from coal mine, the total deposit in the mine re-
duces gradually and after some time it will be fully exhausted. Then
its value will be nil.
2. External: Whenever depreciation is caused by some external factors
then it is called external depreciation.
a. Obsolescence: Some of the assets, though still new and still hav-
125
DEPRECIATION ing their life left that too in proper condition can result in becoming
ACCOUNTING, FINAL obsolete. For example with the advent of new technology and mod-
ACCOUNTS AND ern machinery, an old machine can become obsolete unable to bear
ELEMENTS OF COST the brunt of invasion of new technologies. This is also possible
because new and modern machinery bring in higher productivity,
better quality and lower cost of production. Thus it becomes nec-
essary to install new machinery in a competitive environment.
b. Passage of time: Certain assets which have not been used also lose
their value in course of time, for example lease hold property, patent
rights, copy rights, etc.
c. Accidents: Disasters such as floods, earthquakes cause major de-
struction of assets reducing its usage. In such cases the assets are
described as loss and new asset can be purchased.
1. Some assets decline in value proportionate to the quantum of produc-
tion or use as for example mines, quarry, etc. It isknown as .
a. Depletion
b. Wear and tear
c. Obsolescence
1.5 Objectives of Providing Depreciation
Following are the objectives of providing depreciation in any business:
1. In order to keep the owners capital intact the recovery of cost incurred
on fixed assets is made over their useful life.
2. In the event of retirement of original assets the cope up with the re-
placement cost.
3. To determine the actual cost of production by considering depreciation
as also one of the component of cost.
4. To determine the actual profit for the year.
5. To find out the actual financial position through balance sheet.
1. To determine the actual profit for the year is one of the objective of
a. Depreciation
b. Trading account
c. Balance sheet
1.6 Computation of Depreciation
Calculation of depreciation is a complex process. Several factors are to be
kept in mind while calculating depreciation. These factors are as under:
1. Cost of the depreciable asset
Cost of the asset plays is the most important factor in determining deprecia-
tion. Here, cost implies to historical cost of the assets. This idea is also sup-
126
ported by cost concept which maintains that the fixed assets should be re-
DEPRECIATION
corded at cost and not market price. Thus, Cost includes price (less discount ACCOUNTING
if any), freight or handling charges, legal charges, installation charges or trans-
fer charges, sales tax, insurance in transit, etc. which assist in acquisition and
putting the asset onto working condition. When a used asset is bought, the
preliminary cost of putting the asset in working condition such as expendi-
ture for new parts, repairs/renovation, etc. are added to the cost of assets.
It is to be remembered that the interest on loan to purchase an asset does not
form part of cost of asset. Instead interest paid on a loan during construction
period will be treated part of cost of an asset.
2. Useful life of the Depreciable asset
As per accounting standard 6(7) the useful life of an asset that is depreciating
is less than its physical life and is:
(i) Is calculated much earlier before commencing the usage based on legal
and contractual limits like the expiry date of the lease periods.
(ii) Very often it is governed by consumption and extraction.
(iii) The usage and physical deterioration due to wear and tear and opera-
tional entities such as how long it has been used in different shifts,
repair and maintenance and the policy of the company determines the
depreciation.
(iv) Obsolescence can be due to the following:-
(a) Change in Technology
(b) Any change in production process
(c) Change in market demand of product or service
(d) Legal or other restrictions
3. Residual value
The amount that is likely to receive when asset is sold as scrap or asset is
discarded. Nevertheless, the amount of expenses incurred on sale or disposal
is to be deducted from the sale proceeds of asset discarded. According to
AS-6, computation of residual value of an asset is generally considered a
difficult task.. In such cases the value is considered as nil as it is termed
irrelevant. In case the residual value is important then the calculation of the
value is made at the time of purchase or instalment during revaluation of the
asset. The residual value of the asset is calculated by its realizable value of
the asset which is similar in nature and is completely used completing its
useful life and has been operated similarly as the asset.
Therefore, calculation of depreciation consists of three variables – the cost
of asset, useful or economic life of the depreciating asset and the residual
value thereof.
127
DEPRECIATION Check your progress 5
ACCOUNTING, FINAL 1. The cost of ............... includes price freight or handling charges, legal
ACCOUNTS AND charges, installation charges or transfer charges, sales tax, insurance
ELEMENTS OF COST in transit, etc.
a. Asset
b. Depreciation
1.7 Methods of Charging Depreciation
The difference in the nature of fixed assets is so wide that the same method of
depreciation cannot be applied to each other. Let us discuss few of the widely
used methods of depreciation.
1. Straight line also known as Original cost method or fixed instalment
method.
2. Written down value method or Diminishing Balance Method also known
as Reducing Instalment method.
3. Annuity Method.
4. Sinking fund amortization fund method or Depreciation fund method.
5. Insurance policy method.
6. Revaluation method.
1) Straight line method: Straight line method or fixed instalment method
which is also known as or original cost method. In this method the
expected life of the asset is the calculated. The total cost of the asset
i.e. cost incurred in bringing the asset to its working condition is taken
and scrap value at the end of its expected life is deducted from it and
then the balance amount is divided by the number of years of its ex-
pected life, the result we get is the amount of depreciation that would
be charged per year. Here the amount of depreciation remains same
from year to year. This method is known as straight line method be-
cause if a graph of annual depreciation is drawn, it would be a straight
line.
The formula or equation used to calculate depreciation under Straight
line method is as follows
Annual Depreciation = [(Cost of Assets - Scrap Value)/Estimated Life
of assets.
The journal entries under this method are very simple. The journal en-
tries will be as under:
Depreciation account A/c Dr.
To Asset account
(Being the depreciation charged)
Profit and loss account A/c Dr.
To Depreciation account
(Being the amount of depreciation transferred to P& L a/c)
128
The above entries are passed at the end of each year as long as the asset is
DEPRECIATION
with us in working condition and in the last year, the scrap will be sold and
ACCOUNTING
with the amount that realised by the sale the following entry will be passed:
Cash account
To Asset account
(Being the cash realised on the sale of scrap.)
Advantages:
1. Straight line method of depreciation is the most simple and easy method
to work out.
2. Under this method the book value of the asset can even be reduced to
zero.
Disadvantages:
1. In spite being the simplest method, it is not a popular method here the
approach is not very logical to charge depreciation each year’s in equal
amount, the charge for repairs and renewals goes on increasing as the
asset becomes older.
2. Some of the methods of depreciation consider the interest payment on
money which is locked up in purchase of assets but unlike the other
methods this method does not consider the interest factor.
3. In straight line method there is no provision made for the replacement
of the asset.
4. Sometimes even a little difficulty is faced in calculation of depreciation
on account of additions during the year.
So, from the above discussion it is clear that straight line method is more
suitable for assets having small investments and on whom there is no repair
and renewals expenses for example copyright, patents, short leases, etc.
Illustration 27
Mr. Aadvik purchased machinery on 1st January 1991 for Rs.21, 000. The
life of machinery was estimated to be 10 years. At the end of its life it would
sold for Rs. 1,000 only. You are required to calculate the amount of annual
depreciation according to Straight line method and prepare the machinery
account for the first three years.
Solution :
Annual depreciation = Cost of assets - Scrap value
Estimated Life of assets
= 21000 - 1000
10
= Rs. 2000
129
DEPRECIATION Dr. Machinery Account Cr.
ACCOUNTING, FINAL Amount Amount
Date Particular Date Particular
ACCOUNTS AND (Rs.) (Rs.)
ELEMENTS OF COST 2018 To Bank A/c 2018 By Depreciation A/c
21000 2000
Jan - 1 Dec - 31
Dec - 31 By Balance c/d 19000
21000 21000
2019 To Balance b/d 2019 By Depreciation A/c
19000 2000
Jan - 1 Dec - 31
Dec – 31 By Balance c/d 17000
19000 19000
17000 2000
Jan - 1 Dec - 31
17000 17000
2) Written down value method: Written down value method is also
known as diminishing balance method or reducing installment method.
Under this method the value of asset is depreciated or reduced at fixed
percentage which is calculated on the closing balance of the asset every
year which is diminished year after year on account of depreciation.
Unlike the straight line method here the rate of depreciation remains
the same but the amount of depreciation varies every year.
Here the journal entries will follow the straight line method and is similar to
those that are discussed. The amount of depreciation is the only difference.
Advantages:
1. It is the most popular method adopted as the total burden of profit and
loss due to depreciation and repairs remains almost equal year after
year because the amount of depreciation goes on decreasing and with
the passage of time the amount on repairs goes on increasing.
2. Separate calculations for additions and extensions of new assets are
not required.
Disadvantages:
1. Like the first method even this method ignores the interest on capital
investment and the replacement of the asset.
2. This method does not reduce the book value to zero as is in the case of
the straight line method.
3. To write an asset value to residual value takes a long time therefore
high depreciation rate is required.
Generally this is one of the most popular method which has been adopted in
our country even our Income tax act prefers this method. This method is
considered to be most suitable for plant and machinery where additions and
extensions take place quite often. However this method does not suit the case
of lease, whose value has to be reduced to zero.
130
Illustration 28
DEPRECIATION
Mr. Medhansh purchased, a merchant purchased plant and machinery cost- ACCOUNTING
ing Rs.25,000 1st January, 2018. It has been decided to depreciate it at the
rate if 20 percent p.a. on the written down value method. Show the plant and
machinery account in the first three years.
Plant and Machinery Account
Amount Amount
(Rs.) (Rs.)
2018 To Bank A/c 2018 By Depreciation A/c
25000 5000
Jan - 1 Dec - 31
Dec - 31 By Balance c/d 20000
25000 25000
20000 4000
Jan - 1 Dec - 31
20000 20000
16000 3200
Jan - 1 Dec - 31
16000 16000
Formula or equation for the above calculation may be written as
follows:
*First year: 25,000 × 20% = 5000
**Second Year: (25000 - 5000) × 20% = 4,000
***Third Year: [25000 - (5,000 + 4,000)] × 20% = 3,200
3) Annuity method: Under this method, the asset in question is consid-
ered as an investment of capital, earning interest at certain rate. Thus
the cost of the asset and also interest there on are written down annu-
ally by equal installments unless and until the book value of the asset
comes to nil. With the help of annuity table the annual charge of depre-
ciation is found out. In the books of accounts the annual charge for
depreciation will be credited to asset account and debited to deprecia-
tion account, while the interest will be debited to asset account and
credited to interest account.
In this method the journal entries are a little different. The entries are
to be made in respect of interest and depreciation. As far as calculation
of interest is concerned it is to be calculated on the debit balance of the
131
DEPRECIATION asset account at the commencement of the period, at the given rate.
ACCOUNTING, FINAL The journal entry will be:
ACCOUNTS AND Particular Asset account Dr.
ELEMENTS OF COST
To Interest account
(Being interest on capital sunk in asset)
After finding the depreciation amount from the depreciation annuity
table, the following entry is passed:
Depreciation account Dr.
To Particular Asset account
(Being the depreciation of asset)
It should also be kept in mind that the interest is charged on the diminishing
balance of the asset account, the amount of interest goes on declining year
after year. But the amount of depreciation remains the same during the life
time of the asset.
Illustration 29
Ms Asmita Steels purchased a 5 years’ lease for Rs.40, 000 on first January.
The company decides to write off depreciation on the annuity method. Pre-
suming the rate of interest to be 5% per annum.
Show the lease account for the first 3 years. Calculations are to be made to
the nearest rupee
Annuity Table
Years 3% 3.5% 4% 4.5% 5%
3 0.353530 0.359634 0.360349 0.363773 0.367209
4 0.269027 0.272251 0.275490 0.278744 0.282012
5 0.218355 0.221418 0.224627 0.227792 0.230975
6 0.184598 0.187668 0.190762 0.193878 0.197017
7 0.160506 0.163544 0.166610 0.169701 0.172820
8 0.142456 0.145477 0.148528 0.151610 0.154722
Solution:
According to the annuity table given above, the annual charge for deprecia-
tion reckoning interest at 5 percent p.a. for 5 years would be:
230975 × 40,000 = Rs.9,239
132
Lease Account
DEPRECIATION
Dr Cr.
ACCOUNTING
Date Particular Rs. Date Particular Rs.
1st 1st
Year Year
By
Jan. 1 To Cash 40,000 Dec. 31 Depreciation 9,239
Dec. By Balance
31 To Interest 2,000 c/d 32,761
42,000 42,000
2nd 2nd
Year Year
By
Jan. 1 To Balance b/d 32,761 Dec. 31 Depreciation 9,239
Dec. By Balance
31 To Interest 1,638 c/d 25,160
34,399 34,399
3rd
Year
By Depreciation
Jan. To Balance b/d 25,160 Dec. 9,239
1 31
Dec. By Balance c/d

31 To Interest 1,258 17,179
26,418 26,418
3rd
Year
Jan. To Balance b/d 17,179
1
Advantages:
1. This method is technically more sound and scientific as it takes interest
on capital invested in the asset into consideration.
2. Of the several method of depreciation it is regarded as one of the most
exact and precise from the point of view of calculations and so consid-
ered to be most scientific.
Disadvantages:
1. This system is one of the most complicated.
133
DEPRECIATION 2. With the passage of time there is a consistent increase in profit and loss
ACCOUNTING, FINAL account with the charge on depreciation remaining constant and there
ACCOUNTS AND is a diminishing rate of interest every year. Hence the net profit and loss
ELEMENTS OF COST becomes heavier each year.
3. When the asset requires frequent additions and extensions, the calcula-
tion have to be changed frequently, which is very inconvenient.
This method is suitable for those assets that require considerable in-
vestment and where there are no frequent additions e.g., long lease.
4. Sinking fund method: Sinking fund method is also known as deprecia-
tion fund method or amortization fund method. In this method, a fund
know as sinking fund is created and every year and the profit and loss
account is debited and the fund account credited with
A certain sum, which is so calculated that the annual sum credited to the fund
account and accumulating throughout the life of the asset may be equal to the
amount which would be required to replace the old asset. The main logic
behind this method is to ensure the availability of the funds at the time of
replacement of the asset. For this purpose an amount equal to that credited to
the fund account is invested outside the business, generally in some securi-
ties. The asset appears in the balance sheet year after year at its original cost
while depreciation fund account appears on the liability side.
The following entries are necessary to record the depreciation and replace-
ment of an asset by this method.
(a) First year (at the end)
(1) Profit and loss account Dr.
To depreciation fund account
(With the amount of the annual depreciation charge).
(2) Depreciation fund investment account Dr.
To cash account
(With an equal amount.)
(b) In subsequent years.
(1) Cash / Bank Account Dr.
(With the amount of interest earned and reinvested.)
(2) Profit and loss account Dr.
(With the annual depreciation instalment.)
(3) Depreciation fund investment account Dr.
To cash account
(Provision + Interest will be invested.)
(c) Last year.
(i) and (ii) entry remain same as in (b) but amount is not invested.
134
(1) On sale of investment.
DEPRECIATION
Bank Account Dr.
ACCOUNTING
Dep. Fund Account Dr. (In case of loss)
To Dep. Fund invvestment Account
To Dep. Fund invvestment Account (In case of profit)
(2) On sale of Asset.
Bank Account Dr.
To Asset Account
(3) Close dep.fund Account and transfer to asset Account
Dep.Fund Account Dr.
To Asset Account.
(4) Close Asset Account and Transfer to P&L Account.
(i) In case of Debit balance of Asset Account
P&L Account Dr.
To asset Account.
(ii) In case of Credit balance of Asset Account
Asset Account Dr.
To P&L Account.
The amount of annual depreciation to be provided for by the depreciation
fund method is ascertained from sinking fund table.
Sinking Fund Table
Annual sinking fund installment to provide Rs.1.
Years 3% 3.5% 4% 4.5% 5%
3 0.323540 0.321934 0.320349 0.318773 0.317208
4 0.239027 0.237251 0.235490 0.233741 0.232012
5 0.188350 0.186481 0.184627 0.182792 0.180975
6 0.154598 0.152668 0.150762 0.148878 0.147017
7 0.130506 0.128544 0.126610 0.124701 0.122820
8 0.112446 0.110477 0.108528 0.106610 0.104722
Illustration 30
Mr. Anjan Mazumdar on 1st January, 2017 purchased a four years lease
forRs.20,000 and was decided to make provision for the replacement of the
lease by means of a depreciation fund, the investment yielding 4 percent per
annum interest. Show the necessary ledger account.
Solution:
To get Re.1 at the end of 4 years at 4 percent an annual investment of
Rs.235490 is necessary. Therefore, for Rs. 20,000 an annual investment of
Rs.4,709.80 (i.e., 2,35,490 × 20,0000 will be necesary.
135
DEPRECIATION Dr. Depreciation Fund account Cr.
ACCOUNTING, FINAL Amount Amount
ACCOUNTS AND (Rs.) (Rs.)
ELEMENTS OF COST 2017 To Balance c/d 4710 2017 By P&L A/c 4710
Dec - 31 Dec - 31
4710 4710
2018 To Balance c/d 9608 2017 By Balance b/d 4710
Dec – 31 Dec - 31
Dec – 31 By Bank A/c 188
Dec – 31 By P&L A/c 4710
9608 9608
2019 To Balance c/d 14702 2019 By Balance b/d 9608
Dec – 31 Jan –1
Dec – 31 By P&L A/c 4710
14702 14702
2020 To Lease A/c 20000 2020 By Balance b/d 14702
Dec – 31 Jan –1
Dec – 31 By P&L A/c 4710
20000 20000
Depreciation Fund account
Amount Amount
(Rs.) (Rs.)
2017 To Bank A/c 4710 2017 By Balance c/d 4710
Dec - 31 Dec – 31
4710 4710
2018 To Balance b/d 4710 2018 By Balance c/d 9608
Jan - 1 Dec – 31
Dec – 31 To Bank A/c 4898
9608 9608
Jan – 1 Dec – 31
14702 14702
2020 To Balance b/d 14702 2020 By Bank A/c 20000
Jan - 1 Dec - 31
20000 20000
Lease Account
Amount Amount
(Rs.) (Rs.)
2017 To Bank A/c 20000 2017 By Balance c/d 20000
Dec - 31 Dec – 31
20000 20000
Jan - 1 Dec – 31
20000 20000
Jan – 1 Dec – 31
20000 20000
2020 To Balance b/d 20000 2020 By Depriciation fund A/c 20000
Jan - 1 Dec - 31
20000 20000
136
Note : The cash installment at the end of the final year is not invested
DEPRECIATION
as there is no need of buying the investment and selling them on the same ACCOUNTING
date.
Advantages
1. The most important advantages of this method are that it helps in mak-
ing the money available at the time when the replacement of the asset
is needed. In the absence of such a provision the sum required to pur-
chase a new asset will have to be withdrawn from the business which
might affect its financial position adversely.
Disadvantages:
1. As the year passes by the burden on profit and loss account goes on
increasing because the amount of depreciation every year remains same
but the amount spent on repairs goes on increasing with the age of the
asset.
2. This is a little difficult method because the work of investing money is
complicated one.
3. Loss may be suffered because the prices of securities may fall at the
time when they are to be realized.
4. This method is suitable wherever it is desired to replace the asset as
happens in the case of plant and machinery and other wasting assets.
5. Revaluation Method: Here in this method as the name suggests un-
der revaluation method, the valuation of assets done at the end of each
period so as to calculate the difference between the old value and the
new value and this difference is the actual depreciation which is charged
to the profit and loss account. This method is most accepted method in
case of assets like bottles, horses, packages, loose tools, casks etc.
Sometimes rarely during the process of revaluing the asset is increased
it will be temporary and will not be taken into account.
There are many objections on the method and they are :
1. There is no clarity on the value that the experts will consider for esti-
mation at the end of each year. It is our assumption that this is the
market value. If so, to assess depreciation with reference to market
value is against the basic principles and theory of depreciation. A fixed
asset has nothing to do with market value.
2. The amount charged to profit and loss account on account of depre-
ciation will vary every year although the asset renders the same service
throughout of its life time.
137
DEPRECIATION 3. This is one of the most unscientific because there are great chances of
ACCOUNTING, FINAL manipulations.
ACCOUNTS AND Check your progress 6
ELEMENTS OF COST
1. Annuity Method is one of the method of calculating .................
a. Cost of asset
b. Depreciation
1.8 Change of Method of Charging Depreciation

It should be kept in mind that once a method of depreciation has been adopted
then it should be applied consistently to ensure comparison over the years.
Accounting standard AS-6 says that “to provide comparisons from time to
time of the enterprise a consistency is maintained to the method of applying
depreciation. If an alternate method of calculating depreciation is applied, it
should be done as per the statute or compliance of the accounting standards.
This is adopted only if it is seen that it is more appropriate in preparing finan-
cial statements of the enterprise. When such change in the method of depre-
ciation is made, the un-amortized depreciable amount of the asset is charged
to revenue over the remaining useful life by applying the new method”.
Hence it quite clear that a business enterprise may change the method either:
1. To comply with statutory requirements or
2. To enhance or improve quality of preparation or presentation of finan-
cial statements.
There are two ways to change the method of the depreciation:
• A Change made effective from the current year only – When a change is
made effective form the current year only, the unexpired cost of the
asset should be charged to Profit & Loss account over the remaining
useful life of the asset by applying the new method of depreciation.
Such a change is treated as a change in accounting policy and as such it
is disclosed in the financial statements.
• A change in method with retrospective effect – When a change in method
of depreciation is made with retrospective effect then following steps
must be taken.
 Find out the book value / cost of the assets in the beginning of
year, from that date change is to be made effective. For example if
on 31st March 2021 it is decided to change the method with effect
from 1stApril 2018, then the book value of the assets on 1stApril
2018 has to be worked out. And similarly if the change is to be
made from the date of acquiring of such assets then cost of the
assets has to be found out.
 Find out total depreciation charged on the assets till date on the
basis of old rate i.e. depreciation already provided.
 Calculate the depreciation on the basis of new method with retro-
spective effect up to the end of previous year.
138
 Find out the difference between (ii) and (iii) above.
DEPRECIATION
 Debit or Credit the asset account by adjusting the difference. If ACCOUNTING
there is excess of old accumulated depreciation over the total de-
preciation calculated in accordance with the new rate, assets ac-
count will be debited with the difference. And if it is otherwise,
asset account will be credited with the differential figure.
 Charge depreciation according to new method for the current year.
1. Asper .................. toprovide comparisons from time to time of the
enterprisea consistency is maintained to the method of applying de-
preciation
a. AS6 b. AS7
c. AS 5
1.9 Salient features of AS-6: Depreciation Accounting
Following is the synopsis of Depreciation policy as per accounting standards:
• Standard does not apply to depreciation in respect of forests, planta-
tions and similar regenerative natural resources, wasting assets includ-
ing expenditure on exploration and extraction of minerals, oils, natural
gas and similar non- regenerative resources, expenditure on research
and development, goodwill and livestock. Special considerations apply
to these assets.
• Allocate depreciable amount of a depreciable asset on systematic basis
to each accounting year over useful life of asset.
• Useful life may be reviewed periodically after taking into consideration
the expected physical wear and tear, obsolescence and legal or other
limits on the use of the asset.
• Basis for providing depreciation must be consistently followed and dis-
closed. Any change to be quantified and disclosed.
• A change in method of depreciation should be made only in that case
where it is required by statute, for any kind of compliance with an
accounting standard or for any of the appropriate presentation of the
financial statements and such a revision in method of depreciation should
be made from date of use. Such a change in method of depreciation
should be considered a change in accounting policy and it should be
quantified and disclosed to users of accounting information.
• If there is any addition or extension which becomes an important part
of the existing asset depreciation to be provided on adjusted figure
prospectively over the residual useful life or at the rate that is appli-
cable.
• If there is a change in cost due to fluctuation in exchange rate or price
adjustment, etc. then the depreciation on the revised unamortized
amount should be given for the balance useful life of the asset.
139
DEPRECIATION • On revaluation of asset depreciation should be based on re-valued amount
ACCOUNTING, FINAL over balance useful life. Material impact on depreciation should be dis-
closed.
ACCOUNTS AND
• Deficiency or surplus in case of disposal, destruction, and demolition
ELEMENTS OF COST etc.be disclosed separately, if material.
• Historical cost, amount substituted for historical cost, depreciation for
the year and accumulated depreciation should be disclosed.
Depreciation method used should be disclosed. If rates applied are dif-
ferent from the rates specified in the governing statute then the rates and the
useful life are also disclosed.
1. As per AS 6 Basis for providing .................... must be consistently
followed and disclosed. Any change to be quantified and disclosed. a.
Depreciation
b. Standard
c. depletion
1.10 Illustrations
1. Medhansh Ltd. Purchased a computer for Rs. 90,000 including printer
on 01-04-2018. It purchased another computer on 01-10-2018 costing
Rs.60,000 and on 01-07-2019 costing Rs.30,000. On 01-01-2020 the
printer of the computer purchased on 01-07-2019 costing Rs.30,000
became ineffective and was sold for Rs.10,000.
a. You are required to prepare Computer A/c in the Books of
Medhansh Ltd Ltd. whose accounting year is the calendar year
and charges depreciation @10% p.a. on Straight Line Method.
b. Year ending is on 31st December
Solution:
Dr. Computer A/c Cr.
Amount Amount
Date Particulars Date Particulars
(Rs.)
2018 To Bank A/c 90,000 Dec. By Depreciation A/c 8,250
Apr1 31 (6750+1500)
To Bank 60,000 Dec. By Balance c/d 1,41,750
Oct. 1
A/c 31
- - 1,50,000 - - 1,50,000
Jan. To Balance b /d 1,41,750 Dec. By Depreciation A/c 16,500
2019 1 31 (9000+6000+1500)
To Bank 30,000 Dec. By c/d balance 1,55,250
July 1
A/c 31
- - 1,71,750 - - 1,71,750
Jan.1 To Balance 1,55,250 By Bank A/c 10,000
Jan. 1
2020 b/d
By Profit & 18 500 By Depreciation A/c 15,000
Dec.
Jan. 1 Loss A/c (9000+6000)
31
Dec. 31 By balance c/d 148750
- - 173 750 - - 173750
2. On 1-1-2018 the machinery account of a company had a balance of

Rs.1,40,000. on 1-7-2018 a part of the above Machinery whose book
140
value on 1-1-2018 was Rs.28,000 was surrendered to the vendor at an
agreed price of Rs.11,200 in part exchange for a new machinery cost- DEPRECIATION
ing Rs.23,800. The net invoice of Rs.12,600 was passed through the ACCOUNTING
Purchase Book. At the same time Rs.1,400 incurred on installation of
new machine wrongly debited to wages account. Record Journal En-
tries and prepare Machinery Account for the year ended 31st Decem-
ber 2018. Depreciation is charged @ 10% p.a. on Diminishing Bal-
ance.
Solution: Journal Entries
Debit Credit
Date Particular L.F.
(Rs.) (Rs.)
2018 Vendor A/c Dr. 11200 -
July Depreciation A/c Dr. 1400 -
1. P & L A/c (Loss) Dr. 15400 -
To Machinery A/c - 28000
(Being part of old machine transferred to vendor)
July Machinery A/c Dr. 23800 -
1. To Vendor A/c - 11200
To Bank A/c - 12600
(Being new machine received against exchange of
old machine)
July Machinery A/c Dr. 1400 -
1. To wages A/c - 1400
(Being installation expense debited to wages is
corrected)
Dec Deprecation A/c Dr. 12460 -
31. To Machinery A/c - 12460
(Being Deprecation of current year is charged)
Dr. Machinery account Cr.
Amount Amount
(Rs.) (Rs.)
2018 To Balance b/d 2018 By Vendor A/c
140000 11200
Jan 1 July 1
To Vendor A/c By Depreciation A/c
July 1 11200 July 1 1400
(Machine sold)
July 1 To Bank A/c 12600 July 1 By P & L A/c 15400
July 1 To Wages A/c 1400 Dec 31 By depreciation A/c 12460
Dec 31 By Balance c/d 124740
165200 165200
Working Note : 43
(1) Part sold :- 2800
less : Depreciation@
10% for 6 months 1400
26600
less Exchanges 11200
loss to P & L A/c 15400
(2) Depreciation
(a) Opening Balance : 140000
Exchanged 28000
112000 @10% 11200
(b) New Machine 23800
+ installation 1400
25200 @10% for 6 months 1260
12460
141
DEPRECIATION 1.11 Let Us Sum Up
ACCOUNTING, FINAL
In this block we studied about depreciation in very detail. We studied that
ACCOUNTS AND
Depreciation refers to gradual decrease or loss in the value of asset due to
ELEMENTS OF COST
usage, passage of time and normal wear and tear. Whereas International Ac-
counting Standard Committee defines, “Depreciation is the allocation of the
depreciable amount of an asset over its estimated life.”There are host of In-
ternal and External factors causing depreciation such as usage, time span,
obsolescence, depletion, accident, etc. All the fixed assets differ from each
other in their nature that the same depreciation methods cannot be applied to
each and every asset. The methods of depreciation are Straight line, Written
down value method, Annuity Method, Depreciation fund method, Insurance
and Revaluation method.
Through this chapter the readers will get very detailed information about
depreciation .Sufficient illustrations and examples have been provided to make
the topic easily understandable
Answers: (1-a)
Answers: (1-a) 46
Answers: (1-a)
Answers: (1-a)
Answers: (1-a)
Answers: (1-b)
Answers: (1-a)
Answers: (1-a)
1.13 Glossary
1. Accumulated Depreciation - Cumulative charges against the fixed
assets of a company for wear and tear or obsolescence.
2. Assets - Assets represents the ownership of enterprise already existing
or its purchase in due course of time. Examples are the equipment,
vehicles, buildings, creditors, money in the bank, cash.
3. Book Value - It is an accounting term which usually refers to a busi-
ness historical cost of assets less liabilities.
142
4. Depreciation - With time there is a decrease in value of assets. Depre-
DEPRECIATION
ciation is the percentage of decrease in value.
ACCOUNTING
5. Fixed Assets - This could be anything which is owned by the enter-
prise for business purpose and has a value even at the end of the year.
They are land, buildings, equipment and vehicles but can include smaller
items like tools. Fixed assets are part of non current assets.
1.14 Assignment
Practical Questions
1. On 1/7/2018 Emerald Corporation purchased a second-hand machin-
ery for Rs.80, 000 and spent Rs.12, 000 on reconditioning and install-
ing it. On 1/1/2019 another machine was purchased worth Rs.48, 000.
On 30/6/2000 the machine purchased on 1/1/2019 was sold for Rs.32,
000. On 1/7/2020 a new plant was purchased for Rs.60, 000.
Depreciation is charged @10% on original cost. The books of Ac-
counts are closed on 31st March each year. Prepare Plant & machinery
A/c for three years ending 31st March 2021.
2. On 1/04/2019 M/s Eastern Manufacturing Co. Ltd. purchased 6 ma-
chines of Rs.30, 000 each. On 1/4/2020 one machine became defective
and was sold for Rs.25, 000, and a gain on 1/4/2021 a second machine
was also sold for Rs.25, 000. On 1/10/2020 a new machine of higher
technical reliability was acquired for Rs.56, 000. Depreciation is charged
@10% on initial cost and debited profit & Loss A/c and Credited to
Provision for Depreciation Account on 31st March each year.
Prepare necessary accounts in the Books of the Company.
3. New Age Corporation had a balance of Rs.1,62,000 to the debit of
Plant & Machinery A/c on 1/1/2020. During the year 2020 Part of the
plant purchased on 1/1/2018 for Rs.20, 000 was sold for Rs.12, 500
on 1/7/2020 and a new machinery at a cost of Rs.23,500 was pur-
chased and installed at the same date, the installation charges being
Rs.1,500.
The Corporation charges depreciation @10% on diminishing balance.
It was decided to change the method of charging depreciation to straight
Line Method retrospectively w.e.f. 1/1/2018. The rate of depreciation
remains same as earlier.
Prepare the Plant & Machinery A/c
4. Thompson Bros. A firm, purchased a machinery by cheque for
Rs.1,00,000 on 1st January, 2020. The estimated scrap value of the
machinery is Rs.20,000. At the end of each year depreciation is pro-
vided at eh rate of 10% p.a. by the diminishing balance method. Show
Machinery Account and Balance Sheet (extracted) for the first two
financial years, which is ending on December, 31st every year.
(When no Provision for depreciation account is maintained; and (b)
When Provision for Depreciation Account is maintained.
143
DEPRECIATION 1.15 Activities
ACCOUNTING, FINAL
What is depreciation? What are the various methods of calculating deprecia-
ACCOUNTS AND
tion?
ELEMENTS OF COST
1.16 Case Study
Explain the nature and need for depreciation.
1. Financial Accounting : A Simplified Approach, Naseem Ahmed, Atlan-
tic Publishers & Distributors (p) Ltd. , 2005
2. Modern Accountancy Volume I, Mukherjee, Tata Mgraw Hill 2008
3. Financial Accounting, Paul S K, New Central Book Agency, 2001
Press, 1978
1997
144
Unit FINAL ACCOUNTS (Without Adjustment)
2
: UNIT STRUCTURE :
2.1 Introduction
2.2 Trading Account
2.2.1 Format of a Trading Account
2.2.2 Trading Account Items (Dr. Side)
2.2.3 Trading Account Items (Cr. Side)
2.2.4 Balancing of Trading Account
2.3 Profit and Loss Account
2.3.1 Profit and Loss Account Items (Dr. Side)
2.3.2 Profit and Loss Account Items (Cr. Side)
2.3.3 Balancing Profit and Loss Account
2.4 Difference between Trading A/c and Profit & Loss A/c
2.5 Balance Sheet
2.5.1 Preparation and Presentation of Balance Sheet
2.5.2 Difference between Trial Balance and a Balance Sheet
2.5.3 Explanation and Clarification of certain Items
2.5.4 Limitations of Balance Sheet
2.6 Illustrations
2.7 Let Us Sum Up
2.9 Glossary
2.10 Assignment
2.11 Activities
2.12 Case Study
 Stages of the Accounting Cycle.
 Various Statements / Accounts which Comprise Final Accounts of
Business Entity.
 Treatment of different items in Preparation of the Final Accounts.
 Preparation of Trading, Profit & Loss Account and Balance Sheet.
 Limitations of Balance Sheet.
145
DEPRECIATION  Difference between Trial Balance &Balance Sheet.
ACCOUNTING, FINAL  Difference between Trading and Profit and loss A/c.
ACCOUNTS AND
ELEMENTS OF COST 2.1 Introduction
The objective of accounting is to estimate the profit and loss of a business
during the accounting period. This helps in ascertaining the financial position
at a given time. This can be done by financial statements.
Preparation of Final Accounts comprises:
 Preparation of a Trading Account;
 Preparation of a Profit and Loss Account; and
 Preparation of a balance Sheet.
Trading and Profit and Loss account are prepared in order to determine in-
come received or loss incurred during the accounting period. Balance Sheet
indicates the financial position of the enterprise. Thus, preparation of final
account is the end of accounting process which provides accurate and con-
cise information of the firm for beneficiaries of accounting information of
that firm.
2.2 Trading Account
It is prepared to know the result of trading operation. The main objective of
this Account is to ascertain gross profit or gross loss of a business during an
accounting period –i.e.usually a year. It measures the overall performance of
the business during a particular period. In accounting terminology, gross profit
means overall profit. It is the difference between sale proceeds of a particular
period and the cost of the goods actually sold. Thus in order to arrive at the
gross profit there is no deduction made, i.e. any sort of deduction like gen-
eral, administrative or selling and distribution expenses are deducted. Gross
Profit is said to be made when the sale proceeds exceed the cost of goods
sold. On the other hand, when cost of goods sold exceeds sale proceeds,
gross loss is incurred.
2.2.1 Format of Trading Account
The format of a Trading Account and the usually appearing entries there in
are shown below:
146
Particulars Amount Amount Particulars Amount Amount
(Rs.) (Rs.) (Rs.) (Rs.)
To Opening Stock *** By Sales ***
To Purchase *** Less: Returns *** ***

Less: Returns *** *** Inwards
Outwards By Abnormal ***

To Direct Expenses *** Losses ***
Freight & Carriage *** Loss by fire *** ***
Customs &Insurance *** Loss by ***
Wages Accident
***
Packing Loss by theft
***
(essential) Gas By Closing
***
Stock
& Water Fuel & *** *** By Gross Loss
power *** c/d
Factory expenses (Balancing

figure)
Royalty on
production Dock
Dues
To Gross Profit c/d
(Balancing figure
*** ***
2.2.2 Trading Account Items (Dr. Side)

1. Opening Stock: During the beginning of any accounting period, the
closing balances of all assets, liabilities and capital of last financial year
are brought forward by passing of the opening entry and entering the
balance in respective account and stock is one of such account. The
amount of stock recorded in the beginning of the accounting period
remained unchanged during the period and appears in the trial balance
as stock or opening stock. This account is closed at the end of the
period by transferring the same to trading accounts:
Trading account Dr.
To Opening Stock a/c
2. Purchases: This denotes the value of goods purchased either for cash
147
DEPRECIATION or on credit for the purpose of resale. The balance of the purchase
ACCOUNTING, FINAL account, which appears in the Trial Balance, shows the total purchases
ACCOUNTS AND made during a particular accounting period. In respect of purchases the
ELEMENTS OF COST following points must be noted:
 The purchase of any type capital asset should not be added with the
normal purchases of the business. Because the nature of both the
purchases are different. If it is already included in purchases, it should
be deducted from there.
 If any type of personal goods have been purchased should be ex-
cluded from the purchases. This type of purchases should be treated
as drawings.
 If some of the goods purchased are still in transit at the year-end i.e.
it is not yet received by us then in that case it is always better to
debit Stock-in-transit Account and pass reverse entry.
 If the purchases include goods which have been received on con-
signment, or on approval basis or on hire purchase, these should
even be excluded from purchases they are not the part of purchases.
 This account is closed at the end of the period by transferring the
same to trading accounts:
Trading account Dr.
To Purchases a/c
3. Purchases Returns / Returns Outwards: Purchase return is the re-
turn of goods or raw material to the supplier for any reason such as
damages, goods not as per description, wrong items and not as per
order etc. in such case the supplier’s account is debited and the Pur-
chase return account is credited. Thus a purchase return account shows
a credit balance and appears on credit side of trial balance. This Pur-
chase return account appears to the debit side of trading account as a
deduction from purchases. Purchase return is often termed as Return
Outward.
This account is closed at the end of the period by transferring the same
to trading account as:
Purchase Return A/c Dr.
To Trading A/c
4. Direct Expenses: In case of trading concern direct expenses consists
of all expenses incurred on purchase of goods and bringing them in
saleable condition. Whereas in case of manufacturing concern this con-
stitutes all expenses incurred on manufacture of those goods in which
the firm deals in.
Direct expenses are debited to trading account as:
Trading account Dr.
To wages a/c
To Carriage inward a/c
148
To factory lighting, heating a/catch.
FINALACCOUNTS
 Wages incurred on manufacture or merchandise is called direct wages. (WITHOUT
These wages are to be recorded on trading account debit side.While ADJUSTMENT)
indirect wages are to be debited to profit and loss account. When
there is no prefix like direct or indirect, wages are to be treated as
direct and debited to trading account. Moreover when the phrase
„wages and salary? issued and no explanation of the same is given,
in such case the account is to be transferred to trading account debit
side. Whereas when the term salary and wages? is used the account
is to be transferred to profit and loss account. All the wages in-
curred on installation of machinery or on construction or repairs of
building do not form part of wages. All such expenses which are
incurred on machinery to bring it in working condition shall be con-
sidered as cost of that very machine and therefore capitalized Thus
payments to the workers for manufacture or merchandise only are
considered as part of wages and thus debited to trading account.
 Carriage inward, freight, insurance, etc. incurred on purchases are
also to be debited to trading account. As they are considered as the
cost of the purchases hence part of that purchase. It should always
be kept in mind that all these expenses such as carriage inward,
freight, insurance should be considered as cost of purchase as these
have been incurred to bring the goods to our store are considered as
the cost of purchases, however all those expenses which have been
incurred on the Carriage outward, freight outward etc., are not deb-
ited to trading account because those have been incurred on sales so
they will not be considered as direct cost but will be considered as
indirect cost. Trading account contains on direct expenses thus they
will not be considered as indirect cost and be taken to P&L account.
Thus the transportation expenses incurred on purchase of raw ma-
terial or merchandise are to be debited to trading account. The phrase
inward or in indicates the expenses are related to purchases, whereas
the phrase outward out indicate the expenses are related to sales.
 Factory lighting, heating, power and fuel etc. are to be debited to
trading account as all the expenses that have been done in the fac-
tory are treated as direct expenses the reason being that production
takes place in factory and all the expenses relating to factory are
considered as direct cost of production. Sometimes separate manu-
facturing account is opened and all expenses related to manufactur-
ing are transferred to manufacturing account first and then to trad-
ing account in the form of cost of production.
 Custom duty: Whenever the goods or raw is bought from a vendor
in abroad, then in that case the tax or duty paid on import of goods
is called custom duty. This is an expense and thus debited to trading
account.
 Royalty: This is the amount paid by a lessee to the owner of an asset
for the use of that asset. E.g. royalty paid for extracting coal from a
coalmine, royalty paid to the author of a book, etc. Royalty based
149
DEPRECIATION on the raw material extracted e.g. coal, iron ore, etc. is charged to
ACCOUNTING, FINAL trading account as direct expenses. Whereas the royalty which is
ACCOUNTS AND based on sale e.g. royalty paid to the author of a book on the basis of
ELEMENTS OF COST number of copies sold is to be charged to profit and loss account.
 Other expenses: The expenses like repairs of plant, depreciation of
plant, factory building, etc. are considered as expenses related to
manufacturing activity and hence debited to trading account.
2.2.3 Trading Account Items (Cr. Side)
1. Sales: It refers to the sale of goods in which the business deals in and
includes both cash and credit sales. It does not include sale of old, ob-
solete or depreciated assets, which were acquired for use in business.
However goods sent to customers on approval basis, free samples and
GST, if any, included in the sales figure should be excluded. GST some-
times included in the total sales revenue, should also be deducted as it is
the tax collected and to be deposited with tax authorities. Sales account
is a revenue account (nominal account), which denotes income earned
from the main business activity or activities. The income is earned when
goods or services are sold to customers. As per the accrual concept,
income should be recognized as soon as it is accrued and not necessar-
ily only when the cash is paid for. Revenue should be recognized only
when significant risks and rewards (vaguely referred to as ownership in
goods) are transferred to the customer. For example, if an invoice is
made for sale of goods and the term of sale is door delivery; then sale
can be recognized only on getting the proof of delivery of goods at the
door of customer. If such proof is pending at the end of accounting
period, then this transaction cannot be taken as sales, but will be treated
as unearned income. Sales account in trail balance constitutes gross
sales made during the accounting period and it is to be transferred to
trading accounts:
Sales A/c Dr.
To Trading A/c
2. Sales Returns / Returns Inward: Whenever goods are returned by
the buyers to the sellers for some reasons, in the books of account “Re-
turns Inwards Account or “Sales Returns Account” is debited and that
particular buyer is credited. In the Trial Balance such trial balance ap-
pears on the debit side. There are two ways in which such return may be
reflected in the trading account. It can be shown as deduction from
sales in Trading Account or as sales returns on the debit side of the
Trading Account. It is transferred to trading account by passing an en-
try as:
Trading account Dr.
To Sales Return a/c
3. Abnormal Loss: Any loss in excess of normal loss is considered as
abnormal loss of stock due to fire, theft or accident. Since Trading Ac-
150
count is prepared under normal conditions of the business, abnormal
FINALACCOUNTS
loss if any is credited fully to the Trading Account.
(WITHOUT
4. Closing Stock: This is the value of goods lying unsold at the end of ADJUSTMENT)
any accounting year. The stock at the end is valued either at cost or
market price whichever is less. As trial balance generally does not in-
clude closing stock, the following entry is recorded to incorporate the
effect of closing stock in the Trading Account.
Closing Stock A/c Dr.
To Trading A/c
It should be kept in mind that if closing stock form the part of Trial
Balance then it will not be transferred to Trading Account but taken to
Balance Sheet only. In case the goods have been sent to customers on
approval (Sale/Return) basis, such goods should be included in the value
of closing stock.
2.2.4 Balancing of Trading Account
After posting all the above items, on the respective side of the Trading Ac-
count, Gross Profit or Gross Loss is found by calculating the balance. If the
credit side shows more than the debit side then it is said to be gross Profit
and if the debit side is more than the credit side then it is the gross loss. Later
the Gross Profit is transferred to the Profit side of the account and vice
versa.
1. In case oftradingconcern ............... consists of all expenses incurred
on purchase of goods and bringing them in saleablecondition.
a. directexpenses
b. indirectexpenses
2.3 Profit and Loss Account
With the above statement and the profit and loss account the trader under-
stands which way his business is moving. And to what percentage is the
profit earned or loss incurred. For trading this is the first step i.e. the Profit
and Loss account. Next is writing indirect expenses and losses are entered in
the P&L account. Then comes the incomes and gains that are credited. Ex-
cess in income left after cutting down the losses incurred is the net profit.
Anything less than the figure after cutting down the losses is the Net Loss.
The account is closed after transferring the net profit or loss to capital ac-
count.
The format of Profit and loss account is as follows:
151
DEPRECIATION Particular Amount Particular Amount
ACCOUNTING, FINAL To Trading A/c ** By Trading A/c **
ACCOUNTS AND To Office and By Interest
ELEMENTS OF COST administrative ** received **
Expenses:
To Salaries for Office By Dividend
** Received **
Staff
To Office Rent, Rates By Rent
** Received **
& Taxes
To Printing and By Discount
Received **
Stationery
To Books and By Profit on
**
Periodicals Postage and sale of fixed
** **
assets
Telephones **
To Insurance Premium By Profit on
for office ** sale of **
investments
To Audit Fees By Dividend
from shares
** **
Insurance
Claims
To Repairs & By Duty
** Drawbacks **
Maintenance
To Audit Fees By
** **
Apprenticeship
To Legal Expenses By Premium **
To Office Lighting By
Miscellaneous
**
Receipts Bad
Debt recovered
To Depreciation of
**
Office Assets
To Other office
**
expenses
To Selling and
**
Distribution Expenses:
To Salesmen’s Salaries **
To Selling Commission **
To Traveling Expenses **
To Brokerage **
To Trade Expenses **
152
To Advertisement & Publicity ** FINALACCOUNTS
To Sales Promotion Expenses ** (WITHOUT
ADJUSTMENT)
To Carriage Outward **
To Godown rent **
To Bad debts **
To Provisionfor Bad debts **
To Repairs of Vehicles **
To Godown Insurance **
To Delivery Van Expenses **
To Packing Expenses **
To Rebate to Customer
To Royalty (based on units sold) **
To Financial Expenses: **
To Discount Allowed
To Interest on Loan paid
To Interest on Capital
To Discount on Bills
To Bank Charges
To Abnormal Losses:
To Loss on Sale of machinery
To Loss on sale of Investment
To Loss by fire
To Misc. Expenses **
To Net Profit transferred to **
CapitalA/c (Balancing figure)

** **
2.3.1 Profit And Loss Account Items (Dr. Side)

Let us discuss those items that will appear in the debit side of a Profit and
Loss Account:
 Management Expenses: For meeting day to day business expenses
these type of expenses are met, they generally include office salaries,
office rent and lighting, printing and stationery and telegrams, tele-
phone charges, etc.
153
DEPRECIATION  Selling and Distribution Expenses: These are incurred to meet all the
ACCOUNTING, FINAL expenses which are incurred in order to make our sales and all the
ACCOUNTS AND expenses which are incidental to its distribution. Without meeting all
ELEMENTS OF COST these expenses the sales of a trading concern will not take place. These
expenses are necessary to effect and continue our sales and distribution
into the market.
 Maintenance Expenses: These expenses are necessary for maintain-
ing the fixed assets of the administrative office in a good and working
condition. They include repairs and renewals, etc.
 Financial Expenses: These expenses have to be incurred for arranging
finance which is necessary for running the business because finance is
the most required thing in any business. So this includes all the ex-
penses which have been incurred in order to arrange finance forth or-
ganization. These include interest on loans, discount on bills, broker-
age and legal expenses for raising loan, etc.
 Abnormal Losses: Abnormal expenses and losses are those losses which
occur over and above the normal loss. In every type of business there
are certain losses which are incidental to the nature of the business.
The normal losses generally occurs if such a business is conducted .They
are generally pre estimated that these will take place but any loss that
arises over and above the normal losses or which was not pre estimated
or calculated then it will be treated as abnormal loss. These type of
losses may or may not occur during an accounting year. All types of
abnormal losses are treated as extra ordinary expenses and debited to
Profit and Loss Account. Examples are stock lost by fire and not cov-
ered by insurance, loss on sale of machinery, cash defalcation, etc.
 Expenses – Whether salary are paid or unpaid these are considered
while preparing the profit and loss account and in the same way rent,
electricity, telephone expenses are to be taken into consideration whether
paid or outstanding during the accounting period. To ascertain the
amount of expenses to be debited to the Profit and Loss Account, four
types of event are needed to be considered and the cash payment made
in connection with these events. They are as under:
o Expenses incurred and paid out in that year: If expenditure has
been incurred during a year and also paid in the same year, the same
will be debited to the Profit and Loss Account.
o Expenses incurred but not paid out, partly or fully during the cur-
rent year: There are a few expenses, although which have been in-
curred in the current accounting period, but not paid or paid partly or
they are fully unpaid, by the end of the period, they are termed as “Out-
standing Expenses”. Liabilities are the unpaid expenses, which are cal-
culated at the end of accounting year. In fact, on the date of the final
accounts, outstanding expenses, both an expenses and a liability exists
without having been recorded in the books of account. For recording
it, the following entry is to be passed:
154
Expenses A/c Dr. (will be shown in the P & L A/c)
FINALACCOUNTS
To Outstanding Expenses A/c (will appear in the liabilities side of (WITHOUT
Balance Sheet) ADJUSTMENT)
o Expenses paid for during the current year, but not yet incurred,
partly or fully: Sometimes in business, it happens that few of the ex-
penses are paid during the current year, but they have not yet been
incurred, these are known as “Prepaid Expenses”. Prepaid expense is
an asset to the business and will be shown in the Balance Sheet. The
journals entry to be passed”.
Prepaid Expenses A/c Dr. (to be shown as asset in the Bal-
ance Sheet)
To Expenses A/c (balance of this account is to be
deducted from Expenses remaining
amount is debited to P&L A/c)
 There may be expenses of the current year which may arise in
subsequent period: Sometimes in business an expense or a loss may
arise in the future which is the result of with current year’s business. In
all the cases, we make a provision of that future anticipated loss and a
charge is created against the profit for the current period. This is called
contingent liability. In a balance sheet it is seen as deduction from some
other asset such as provision for bad debts.
2.3.2 Profit And Loss Account Items (Cr. Side)
Below mentioned are the items included in the debit side of profit and loss
account:
1. Gross Profit: It is transferred from trading account and it is the first
item of profit and loss account.
2. Non-trading Income: They are those income which are income apart
from our business activities example of such income are interest re-
ceived from bank, dividend and interest incomes received from outside
investments like share and debenture are known as non-trading incomes.
3. Other incomes: All those incomes are those incomes which arise apart
from income from sale of goods. As for example discounts or commis-
sion received.
2.3.3 Balancing Profit And Loss Account
Once the balances of all the accounts have been transferred from trial bal-
ance to P&L account, gross profit/loss transferred from trading account and
and adjustments are take care of, the next step in preparation of P&L which
is balancing of the account. Here the total of debit and credit side is com-
puted and difference of these totals is either the net profit or net loss. If the
total of credit side exceeds that of debit side then it is net profit and vice
versa. Net profit is the last item to be entered in the debit side and vice versa.
After computing net profit/loss the totals of two sides of P & L match.
155
DEPRECIATION The balance in the Profit and Loss Account represents the net profit or net
ACCOUNTING, FINAL loss. The following entry is made when the Profit and Loss Account shows a
ACCOUNTS AND net profit:
ELEMENTS OF COST Profit & Loss A/c Dr.
To Capital A/c
If the Profit and Loss Account shows a net loss, the entry will be reversed.
1. is transferred from trading account and it is the first item of profit and
loss account.
a. Gross profit b. Net Profit c. depreciation
2.4 Difference between Trading A/c and Profit & Loss A/c
1. Trading Account shows the result of trading operation of an enterprise
whereas Profit and loss Account shows the overall result of the busi-
ness as a whole.
2. Trading Account takes into account only the direct cost involved in-
cluding direct expenses whereas Profit and Loss Account deals with
the remaining costs and expenses, which are of indirect in nature.
3. Trading Account is prepared under normal conditions of the business
& hence normal loss if any, is credited to this account. Profit and Loss
Account accounts for all abnormal losses.
1. shows the overall result of the business as awhole.
a. Profit and lossAccount
b. Tradingaccount
2.5 Balance Sheet

The balance sheet details out the financial position of the company. It not
only lists the items controlled or owned by the company, but also includes the
debts owed by the organization. A well evaluated balance sheet should have
the value of company assets equaling the total of the value of the equity held
by stock holders and a lost the liability of the company.
Balance sheet includes five basic elements. They are current and non current
assets, current and non current liabilities and also equity.
The word ‘current’ refers to a period which is one year from the date of
preparation of balance sheet or lesser. Hence, if we refer to current assets, it
implies hard cash present in the company during the period of one year or the
assets that would be turned into cash during this time period. The current
assets include accounts receivable and also the inventory. Services compa-
nies do not have any inventory and hence it would be a total of cash as well as
the accounts receivable.
Non current Fixed assets refer to the equipment invested that affects your
accounting process. Typically, this refers to machinery, building as well as
156
vehicles purchased and used on a daily basis. Net fixed assets refer to the
FINALACCOUNTS
value obtained from actual value of purchase minus the depreciated value.
(WITHOUT
Current liabilities refer to those debts that would be settled within one year ADJUSTMENT)
of the preparation of balance sheet. Non current liabilities refer to long-term
debts and mortgages of the organization. Equity includes the equity of stock
holders, preferred stocks, treasury stock, retained earnings and paid-in capi-
tal.
2.5.1 Preparation and Presentation of Balance Sheet
The Process of preparation and presentation of Balance Sheet involves two
steps:
Grouping and
Marshalling
The first step refers to proper grouping of the various items, which are to be
shown in the Balance Sheet as assets and liabilities. For this purpose items of
similar nature are grouped under one head so that the Balance Sheet could
convey true message to its users. For example, stock, debtors, Bills receiv-
ables, Bank, Cash in Hand etc. are ground under the heading „Current As-
sets? and Land and Building, Plant and Machinery, Furniture and Fixtures,
Tools and Equipments under “Fixed assets”. Similarly „Sundry creditors?
for goods must be shown separately and distinguished from money owing
other than due to credit sales of goods.
The second step involves marshalling of assets and liabilities. It means or-
derly arrangement in which various assets and liabilities are presented or
shown in the Balance Sheet. There are two methods of presentation:
In the order of liquidity
In the order of permanence
Under liquidity order, assets are shown on the basis of liquidity or reliability.
These are rearranged in an order of most liquid, more liquid, and liquid, least
liquid and not liquid (Fixed) assets. Similarly, liabilities are arranged in the
order in which these are to be paid or discharged.
Under the “Order of permanence” the assets are arranged on the basis of
their useful life. The assets, which are to serve business for the longest period
of time, are shown first. In other words, this method puts the first method in
the reserve gear. Similarly, in case of liabilities, after capital, the liabilities are
arranged as long term, medium term, short term and current liabilities. New
format is given in companies Act, 2013
Following are the respective formats of Balance Sheets to bring out the clar-
ity of concept
I. Liquidity Order
BALANCE SHEET OF ……as on.
157
DEPRECIATION Liabilities Amt (Rs.) Assets Amt
ACCOUNTING, FINAL (Rs.)
ACCOUNTS AND
ELEMENTS OF COST Current Liabilities Current Assets
Bank Overdraft Cash in hand

Outs trading Expenses Cash at bank
Bills Payable Marketable Securities
Sundry Creditors Short term Investment
Income Received in Bills Receivables
Advance Sundry Debtors
Prepaid Expenses
Long Term Liabilities
Mortgaged Loan Loan from Accrued Income Long term
Bank Investment
Fixed assets Furniture &

Capital Add Profit Less Loss
Fixtures Motor Vehicles Tools
Less Drawings
& Equipment s Plant &
Machinery Land & Building
Intangible Assets Patents
Copyrights Trademarks
Goodwill
II. Order of Permanence (As per companies Act, 2013)

BALANCE SHEET OF ……as on.
Liabilities Amt (Rs.) Assets Amt (Rs.)
Capital Add Profit Non Current Assets :
or (Less Loss) Less Fixed assets
Drawings Goodwill
Long Term Liabilities Land and Building Plant &
Mortgage Loan Machinery Tools &
Loan from Bank Equipments Motor Vehicles
Furniture & Fixtures
Patents
Trademarks
Current Liabilities Investments (Long Term)
Income Received in Current Assets Stock
Advance Accrued Income Prepaid
Sundry Creditors Bills Expenses Sundry Debtors
Payable Outstanding Bills Receivables
Expenses Bank Short term Investments
Overdraft Marketable Securities Cash
and Bank Balance
Fictitious Assets
Advertisement
Profit and Loss Account
Miscellaneous Expenses
158
2.5.2 Difference between Trial Balance and Balance Sheet
FINALACCOUNTS
The following are the points of distinction/difference between trial balance
(WITHOUT
and balance sheet:
ADJUSTMENT)
Trial Balance Balance Sheet
1 It is a list of balance extracted 1 It is a statement of assets and
from the ledger accounts liabilities
2 It contains the balance of all 2 It contains the balance of only those
accounts - real, nominal and accounts which represents assets and
personal. liabilities.
3 It is prepared before the 3 It is prepared after the preparation of
preparation of trading and profit trading and profit and loss account.
and loss account.
4 Generally it does not contain the 4 It contains the value of closing
value of the closing stock of stock, which appears on the assets
goods. side.
5 Expenses due but not paid and 5 Expenses due but not paid appear on
incomes due but not received do the liability side and income due but
not appear in the trial balance not received appear on the asset side
of the balance sheet.
2.5.3 Explanation and Clarification of Certain Items

For a better understanding of how various items should be placed, it is im-
portant to know the type and nature of assets and liabilities that are to be
classified and arranged in either of two orderly manners discussed earlier.
For the purpose of presentation of assets in the Balance Sheet, assets are
classified as under:
 Fixed Assets
 Intangible Assets
 Current Assets
 Fictitious Assets
 Wasting Assets
 Contingent Assets
 Fixed assets: Fixed assets are those assets, which are acquired for the
purpose of producing goods or rendering services. These are not held
for resale in the normal course of business. Fixed assets are used for
the purpose of earning revenue and hence these are held for a longer
duration. These are also treated as Gross Block? and Net Block? (Fixed
assets after depreciation). Investment in the seassetsisknownas Sunk
Cost ? Examples of fixed as set sare Land & Building, Plant and Ma-
chinery, Furnitureand Fixtures, Tools and Equipment, Motor vehicles,
etc. All fixed assets are tangible by nature.
159
DEPRECIATION  Intangible assets: Intangible assets are those capital assets, which do
ACCOUNTING, FINAL not have any physical existence. Although these assets cannot be seen
ACCOUNTS AND or touched, they are long lasting and prove to be profitable to owner by
ELEMENTS OF COST virtue of the right conferred upon them by mere possession. They also
help the owner to generate income. Goodwill trademarks, copyrights
and patents are the examples of intangible assets. Fixed assets and in-
tangible assets are subheads of non current assets.
 Current assets: Current assets include cash and other assets, which
are converted or realized into cash within a normal operating cycle or
say, within a year. These are acquired for resale, assisting and helping
the process of production, rendering service or supplying of goods.
These assets constantly keep on changing their form and contribute to
routine transactions and operations of business. Examples are Cash,
Bank, Bills Receivables, Debtors, Stock, Prepaid expenses etc. Cur-
rent assets are also known as Floating Assets or Circulating Assets.
 Liquid or quick assets: Those current assets, which can be converted
into cash at a very short notice or immediately, without incurring much
loss or exposure to high risk, are quick assets. Quick assets can be
worked out by deducting Stock (raw materials, work-in-progress or
finished goods) and prepaid expenses out of total current assets.
 Fictitious assets: These are the non-existent worthless items which
represent unwritten-off losses or costs incurred in the past, which can-
not be recovered in future or realized in cash. Examples of such assets
are preliminary expenses (formation expenses), Advertisement suspense,
Underwriting commission, Discount on issue of shares and debentures,
Loss on issue of debentures and Debit balance of Profit & Loss Ac-
count. These fictitious assets are written off or wiped out by debiting
them to Profit & Loss Account.
 Wasting assets: An asset that has a limited life and therefore dwindles
in value over time is a wasting asset. This type of asset has a limited
useful life by nature and depletes over a limited duration. These assets
become worthless once their utility is over or exhausts fully. During the
life of productive usage, assets of this type produce revenue, but even-
tually reach a state where the worth of the assets begins to diminish.
Such assets are natural resources like timber and coal, oil, mineral de-
posits, etc.
 Contingent assets: Contingent assets are probable assets, which may
or may not become assets, as that depends upon occurrence or non-
occurrence of a specified event or performance or non-performance of
a specified act. For example, a suit is pending in the court of law against
ownership title of a disputed property. Subsequently, if the verdict goes
in favor of the business concern, it becomes the asset of the concern.
However, if the business firm does not win the lawsuit, it will not have
ownership rights of the property; it will be of no use to it. Thus, it
remains a contingent asset as long as the judgment is not pronounced
by court. Such assets are shown by means of footnotes and hence do
not form part of assets shown in the Balance Sheet. Besides this, hire-
160
purchase contract, uncalled share capital, etc. are the other examples
FINALACCOUNTS
of contingent assets.
(WITHOUT
Classification of Liabilities ADJUSTMENT)
 Long-term liabilities: These are the obligations that the business en-
terprise is expected to meet after a relatively long period. Such liabili-
ties do not become due for payment in the ordinary course of business
operation or within normal operating cycle. Debentures, long-term loans
from banks or financial institutions are the examples of long-term li-
abilities.
 Current liabilities: Current liabilities are those liabilities that are pay-
able within normal operating cycle, i.e. within a given accounting year.
These may arise out of realization from current assets or by creating
fresh, current liability (obligation). Trade creditors, Bills payable, Bank
overdraft, outstanding expenses, short–term loan (payable within twelve
months or within the accounting year) are examples of current liabili-
ties.
 Contingent liabilities: These liabilities may or may not be sustained
by an entity depending on the outcome of a future event such as a
court case. These liabilities are recorded in a company’s accounts and
displayed in the Balance Sheet when both probable and reasonably
estimable. It is not an actual liability but an anticipated (probable) li-
ability, which May or May not become payable. It depends upon the
occurrence of certain events or performance of certain acts. An ele-
ment of uncertainty is always attached to a contingent liability; it is a
potential liability that may or may not become a sure liability. Contin-
gent liabilities are exemplified in the liability for bills discounted, liabil-
ity for acting as surety, liability arising on a suit for damages pending in
the cour to flaw, liability for calls on partly paid shares etc. If a parent
guarantees a daughter’s first car loan, the parent has a contingent li-
ability. If the daughter makes her car payments and pays off the loan,
the parent will have no liability. If the daughter fails to make the pay-
ments, the parent will have a liability. Contingent liabilities are shown
as footnotes under the Balance Sheet.
In accounting, a contingent liability and related contingent loss are recorded
with a journal entry only if the contingency is probable as well as estimable.
If a contingent liability is only possible (not probable) or if the amount can-
not be estimated, a journal entry is not required. However, a disclosure is
required. When a contingent liability is remote (such as a nuisance suit),
neither a journal nor a disclosure is required.
2.5.4 Limitations of Balance Sheet
Balance Sheet is prepared by company to reveal its financial position.
Following are the limitations of balance sheet:
1. Fixed assets are shown in the Balance Sheet at historical cost less de-
preciation up to date. A conventional Balance Sheet cannot reflect the
161
DEPRECIATION true value of these assets. Again, Intangible assets are shown in the
ACCOUNTING, FINAL Balance Sheet at book values, which may bear no relationship to mar-
ACCOUNTS AND ket values.
ELEMENTS OF COST 2. Sometimes, Balance Sheet contains some assets which command no
market value such as preliminary expenses, debenture discount, etc.
The inclusion of these fictitious assets unduly inflates the total value of
assets.
3. The Balance Sheet cannot reflect the value of certain factors such as
skill and loyalty of staff.
4. A conventional Balance Sheet may mislead untrained readers in infla-
tionary situations.
The value of majority number of current assets depends upon some esti-
mates, so it cannot reflect the true financial position of the business.
1. Theword refers to a period which is one year from the date
of preparation of balance sheet orlesser.
a. current
b. Fixed
c. fluctuating
2.6 Illustrations
1) From the under noted Trial Balance of a Trader as on 31.12.2020 pre-
pare a trading and Profit and Loss Account for the year ended 31.12.2020
and a Balance Sheet as on that date.
Particulars Rs. Particulars Rs.
Cash in hand 1,200 Capital 80,000
Purchases 1,20,000 Bank Loan 20,000
Opening Stock 35,000 Bills Payable 22,000
Sundry Debtors 50,000 Sundry Creditors 24,000
Plant & Machinery 60,000 Sales 2,00,000
Furniture 15,000 Bad debts 1,200

Reserve
Rent and Taxes 10,000
Wages 16,000
Salaries 20,000
3,47,200 3,47,200
Additional Information supplied: I) Closing Stock Rs. 40,000

162
Solution:
FINALACCOUNTS
Trading and Profit & Loss Account for the year ended on 31stDecember (WITHOUT
2020 ADJUSTMENT)
Dr. Cr.
Particular Amount Particular Amount
To Opening Stock 35000 By Sales 200000
To Purchases 120000 By Closing Stock 40000
To Wages 16000
To Gross Profit 69000
240000 240000
To Rent and Taxes 10000 By Gross Profit b/d 69000
To Salaries 20000 By BDR A/c 1200
To Net Profit 40200
Total 70200 Total 70200
Balance Sheet as on 31stDecember,2020
Liabilities Rs. Assets Rs.

Capital : Opening Balance 80000 Plant and Machinery 60000
Add : Net Profit 40200 Furniture 15000
120200 Bills Receivable 20000
Bank loan 20000 Closing stock 40000
Bills Payable 22000 Sundry Debtors 50000
Sundry Creditors 24000 Cash on Hand 1200
Total 186200 Total 186200
2) The Trial Balance of M/s R.S. Corporation as on December 31, 2020
was as under:
163
DEPRECIATION Particulars Rs. Rs.
ACCOUNTING, FINAL
Rajeev’s capital A/c 80,000
ACCOUNTS AND
ELEMENTS OF COST Suresh’s Capital A/c 1,00,000
Stock as on 1.1.1990
Raw materials 2,500
Finished goods 6,500
Purchases 64,500
Sales 1,19,000
Sales returns 2,000
Wages 16,000
Manufacturing expenses 12,000

Salaries 8,000
Insurance 1,500
Postage 100
Advertisement 1,000
Bad debts 300

Discount 500
Land and Building 90,000

Plant and Machinery 70,000
Furniture 1,000
Sundry Debtors 25,400
Sundry Creditors 42,000

Drawings
Rajeev 1,800
Suresh 1,400
Cash in Hand 500
Cash at Bank 49,000
Total 3,53,500 3,53,500
Rajeev and Suresh share profit and Loss equally. Prepare Trading. Profit
& Loss Account for the year ended on 31st December 2020, and also the
balance Sheet as on that date after taking into consideration the following
adjustments:
1. Stock on 31st December, 2020: Raw materials Rs. 4,000; Finished goods
Rs.12 ,000
164
Solution
FINALACCOUNTS
M/s R.S. Corporation (WITHOUT
Trading and Profit & Loss Account for the year ended on 31stDecember ADJUSTMENT)
2020
Dr. Cr.
To Opening Stock 2,500 By Sales 1,19,000
Raw materials 6,500 Less: Sales 2,000
Finished goods 9,000 Returns 1,17,000
To Purchases 64500By Closing Stock
Raw Materials 4,000

To Wages 16000 Finished Goods 28000
To Manufacturing 12,000
expenses
To Gross Profit 31,500
Total 1,33,000 Total 1,33,000
To Salaries 8000 By Gross Profit b/d 31,500
To Insurance 1500By Discount Received 500
To Postage 100
To advertisement 1,000
To Bad Debt 300
To Net Profit
(transferred to
partner Capital A/c)
Rajeev 10,550
Suresh 10,550 21,100
165
DEPRECIATION Balance Sheet of M/s R S Corporation as on 31stDecember 2020
ACCOUNTING, FINAL
Liabilities Rs. Rs. Assets Rs. Rs.
ACCOUNTS AND
Capital Accounts: Fixed assets
ELEMENTS OF COST
Raj eev 80,000 Land and Building 90,000
Add: Share of
Profit Plant and machinery
10,550 70,000
Less:
Drawings 1,800 88750
Suresh
1,00,000
Add: Share of Profit 10,550
Less: Drawings 1,400 1,09,150
Sundry Creditors 42,000 Furniture 1000
Bil ls Payable 12,000 Current Assets
Closing Stock: Raw 4,000

Materials Finished 12,000 16,000
goods
Sundry Debt ors 25,400

Cash in hand 500
Cash at bank 49,000
Total 2,51, 900 Total 2,51,900
Check Your Progress 5

Sales return is to be mentioned at _____.
(a) Subtracting it from sales
(b) Posting on debit side of trading a/c
(c) Both
2.7 Let Us Sum Up
In this unit we have studied about final accounts and through this study we
came understood that after the preparation of Trial Balance, the next step in
accounting is “Preparation of Final Accounts”. Final Accounts are also called
“Financial Statement”. It involves preparation of Trading Account and Profit
and Loss Account; and Preparation of a balance Sheet. Trading Account is
prepared to ascertain gross profit or gross loss of a business during an ac-
counting period – usually a year. Debit side of trading account includes Opening
Stock, Purchases, Purchases Returns / Returns Outwards and all Direct Ex-
penses whereas credit side includes Sales, Sales Returns / Returns Inward,
Abnormal Loss, and Closing Stock.Along with trading account P&L account
is prepared to as certain net profit or loss as the case may be. We the readers
166
even learn that the Process of preparation and presentation of Balance Sheet
FINALACCOUNTS
involves two steps namely, Grouping and Marshalling. The first step refers
(WITHOUT
to proper grouping of the various items, and has to be shown as assetand
ADJUSTMENT)
liabilities on the balance sheet. It means orderly arrangement in which vari-
ous assets and liabilities are presented or shown in the Balance Sheet.
Through the study of this subject the students will get detailed information
about how to make the final books of accounts. Sufficient illustrations have
been provided to explain the topic effectively.
Answers: (1-a)
Answers :( 1-a)
Answers :( 1-a)
Answers :( 1-a) Final Accounts
Answers :( 1-c)
2.9 Glossary
1. Fixed Assets - Assets that the business owns or buys for use within the
business and which still retains a value at year end. They are major
items like land, buildings, equipment and vehicles but can include smaller
items like tools. Fixed assets are subhead of non current assets.
2. Goodwill - This is an extra value placed on a business, if the owner of
a business decides it is worth more than the value of its assets. Fixed it
is intangible assets and subhead of non current assets.
3. Gross loss - The balance of the trading account, assuming it has a debit
balance.
4. Gross profit - The balance of the trading account, assuming it has a
credit balance.
2.10 Assignment
1. Given below is the detail of Krishna stores for year ending on 31st
March 2020. The value of closing stock is Rs 3,00,000.
Opening stock 2,00,000 Purchase return 60,000
Purchases 10,00,000 Sales return 1,00,000
Sales 25, 00,000 Carriage on purchase 40,000
167
DEPRECIATION Octopi and freight 32,500 Carriage on sales 50,000
ACCOUNTING, FINAL Wages 1, 50,000 Factory rent 60,000
ACCOUNTS AND
Factory lightning 54,000 Office rent 37, 500
ELEMENTS OF COST
Coal, gas and water 11, 000 Import duty 1, 60,000
2.11 Activities
What are Final Accounts? What purpose do they serve?
2.12 Case Study
What is meant by Grouping and Marshalling of Assets and Liabilities?
1. Financial Accounting : A Simplified Approach, Naseem Ahmed, Atlan-
tic Publishers &Distributors (p) Ltd. ,2005.
Press, 1978.
1997.
168
Unit FINAL ACCOUNTS (With Adjustment)
3
: UNIT STRUCTURE :
3.0 Learning objectives
3.1 Introduction
3.2 Objectives or need of adjustment
3.3 Types of adjustments
3.5 Illustrations
3.5 Let us sum up
3.7 Glossary
3.8 Assignment
3.9 Activities
3.10 Case Study
 The concept of adjustment and its objectives
 Procedure to Pass Appropriate Adjustment Entries
 Illustrations to understand the practical view of the adjustments
3.1 Introduction
In order to calculate True Profit & Loss of a business for a particular year, it
is mandatory that all possible incomes and expenses relating to that year are
taken into consideration. For example, if we want to calculate the net profit
of the year ended on 31st March and the salary for the month of march has
not been paid yet, it would be suitable to include such expense along with
other expenses of the year. Similarly, it often happens that incomes such as
interest, dividend, commission etc are earned but not received during the
year. Adjustments for such incomes must be made in the current year so that
the P&L account may disclose the correct amount of Net Profit or Net
Loss. With P&L, balance sheet may present the correct financial position of
the business.
In simple words we can say that if there are transactions which are detected
while making the final accounts which are either omitted in the books or
which have been wrongly recorded or whose only one aspect has been re-
corded, then the entries could be passed to correct it and hence such are
known as adjustments.
169
DEPRECIATION Check your progress 1
ACCOUNTING, FINAL Adjustments are transactions which are either ____
ACCOUNTS AND
(a) Omitted (b) Wrongly recorded (c) Both
ELEMENTS OF COST
3.2 Objectives or Need of Adjustments

1. To calculate the true Net Profit or Loss
2. To ascertain the correct financial position of the business.
3. To make a record of transactions omitted from the books
4. To rectify the errors
5. To record the expenses which have been accured but have not been
paid
6. To make a record of the incomes which have been accrued but yet not
received.
Adjustments are needed to rectify the errors done or missed
(a) True (b) False
3.3 Types of Adjustments

1. Outstanding Expenses : Expense that has not been paid during a par-
ticular accounting period and has been taken up for the following new
accounting year is called outstanding or unpaid expenses. However it
is necessary that all expenses – paid and unpaid be accounted in that
accounting year. For e.g. if salaries for the last month are not paid, no
entry will appear in books of accounts unless these are paid. So profit
and loss account with regard to salaries will thus be seen indicating
more profit. Hence it’s recording is essential. It is liability.
2. Prepaid Expenses : Some of the expense of the next accounting year
which has already been paid in the present accounting year thus result-
ing in the benefit for the next accounting year is called prepaid expense.
These expenses are also entered in the books of accounts of that period
to which they do not relate. Hence the result seen in the final accounts
of a particular period will not be correct because such expenses relate
to future periods. Prepaid expenses must be adjusted in the books of
accounts to arrive at true profit. Generally insurance, taxes, telephone
subscriptions, rent, etc. are paid inadvance, thus requiring adjustment
e.g. Rent paidbyx for one year on 1.7.20 when his accounting year is
calendar year; thus rent for 6 months will remain un exhausted and will
be c/f to the next year. It is an assets.
3. Accrued Income: Incomes earned during the year but not yet received
till the end of the accounting year is called accrued income. Some ex-
amples are Income like interest on investments; rent and commission
etc. earned by a trader during a particular accounting period but actu-
ally not received in that period. Such income items have to be adjusted
170
before the preparation of final accounts. They have to be credited to
FINAL ACCOUNTS
that particular income account. This income so –earned but not re-
(WITH ADJUSTMENT)
ceived is an asset because the amount is still to bereceived.
Outstanding salaries are to be _____ to the concerned expense in the
Profit & Loss account
(a) Added
(b) Subtracted
(c) No effect in P & L account
4. Income Received in Advance: Incomes that are received in the ac-
counting period but is meant for the next accounting period even with-
out sending the goods for which this payment is made is called Income
received in advance. Though it is entered in the P&L balance sheet, it is
recorded as aliability. It is liability
5. Closing Stock: This is the stock that has remained unsold till the end
of the year. In the balance sheet it is carried forward to the next year.
For the next accounting year it is seen as the opening stock and is in the
debit side of trading account and hence closed.
6. Depreciation: Gradual decline in the value of fixed stock being used in
business is called depreciation. Even though the value declines on a
daily basis it is recorded and computed only at the end of the account-
ing period. The entry is seen as depreciation account to particularsasset.
7. Interest on Capital: The proprietor losses interest on the money when
he invests in the firm. In such cases he would like to know the profit he
will get from his business. Interest that is charged on the business is an
expense to the business and income to the proprietor. This is seen in
the balance sheet as - Interest on capital a/e To Capital a/c Interest on
capital being an expense is debited to profit and loss account and same
amount of interest on capital is added tocapital.
8. Interest on Drawings: Just as interest is charged on capital, a certain
amount of money as interest is charged on drawings as well. This is an
income for business and expense for the proprietor. Following adjust-
ing entry is passed at the end of accounting period: Capital a/e Dr. to
Interest on drawings a/e the interest on drawings being an income is
credited to profit and loss account is shown as a deduction from
thecapital.
9. Bad Debt to be written off: Sometimes customers don’t pay back
money taken from the business or don’t pay for the goods purchased in
the accounting year. When they are not recoverable they have to be
written off. These are recorded as follows: Bad debts a/c To Sundry
Debtors a/c It results in the reduction of customers debit balance and
addition to the loss i.e. Bad debts. At the end of the year when the trial
balance is drawn, these two accounts show debit balances. The balance
on sundry debtors account is the net balance, after deduction of any
171
DEPRECIATION bad debts recorded during the year. But after the trial balance is pre-
ACCOUNTING, FINAL pared and before the final accounts are drawn trader may find that there
ACCOUNTS AND are additional bad debts. Such bad debts must be recorded with the
ELEMENTS OF COST same adjusting entry and giving it following effect in ledger and
finalaccounts.
10. Provision for Bad Debts: Even as the irrecoverable bad debts are written
off there are certain customers who would not have paid the amount
due in that particular accounting period but may do so in future. There
has to be a provision for such debts. This entry allows sundry debtors to
come down to a realizable value. For this a reserve is created. This
adjustment is entered at the end of the accounting year.
Profit and Loss A/c Dr.
To Provision for bad debts A/c
Closing stock is always a part of adjustment?
(a) Yes
(b) No
(c) It’s a wrong question
11. Provision for discount on Debtors: In trade customers are offered
discountstoallowpromptpayment.Insomecasesgoodsaresoldoncredit
1. in one accounting period and payment is received in the next account-
ing period. It is a policy that the expenditure be put in the accounting
period where the sale is made hence a provision is made on debtors.
But if these doubtful debts turn bad then no discount is offered. Hence
the provision for discount will be calculated after deducting the provi-
sion for bad debts from sundry debtors.
12. Provision for discount on creditors: If the business man is a prompt
payer then he or she is entitled for discount. The accountants consider
the accounting year when the purchase was made as the income receipt
period. Hence if some amount is to be paid to the creditors then a
provision should be for probable income. The adjusting entry is passed
for it: Provision for discount on creditors a/c Dr. to Profit and
lossaccount.
13. Losses by Accidents: Losses incurred due to accidents or disasters
leading to destruction of property then the asset account is credited
and the profit and loss account is debited.
If goods (stock-in-trade) are lost by accident the value of closing stock
will be lower than what it would have been. This reduces the amount of
gross profit. Hence, the cost of goods lost by accident is debncted from
purcahse and debited to the profit and loss account. The increase in
gross profit will be neutralized by the debit to the profit loss account
and thus the net profit will not be affected. The entries to the passed are
as follows: Loss by accident a/c to Goods lost by accident a/c.
172
14. Commission to manager payable on profits: Sometimes the man-
FINAL ACCOUNTS
ager is entitled to a commission on profits. Such commission maybe:
(WITH ADJUSTMENT)
 Fixed percentage on net profits before charging suchcommission.
 Fixed percentage on net profits- after charging such commission. Such
commission being an expense is debited to commissionaccount.
Till the time the payment is made it is shown as liability in the balance
sheet.
Calculation of Commission: The trading account is prepared in usual
manner, then transferring of the gross profit or loss, all expenses and
incomes should be debited or credited except the commission which is
still to be calculated.
15. Goods used form business: Sometimes goods purchased for resale
are used in business for charitable purpose or distributing them as free
samples. Insuch cases purchases account is credited with an amount
equal to the cost of goods used in business and the same amount is
debited to charity or advertisement expenses account.
Check your Progress 5
Adjustments for Bad debts and provision for doubtful debts is same
(a) True (b) False
3.4 Illustrations
From the under noted Trial Balance of a Trader as on 31.12.2020 prepare a
trading and Profit and Loss Account for the year ended 31.12.2020 and a
Balance Sheet as on that date.
Trail balance
Cash in hand 1,200 Capital 80,000
Purchases 1,20,000 4% Bank Loan 20,000
Opening Stock 35,000 Bills Payable 22,000
Sundry Debtors 50,000 Sundry Creditors 24,000
Plant & Machinery 60,000 Sales 2,00,000
Furniture 15,000 Bad debts Reserve 1,200
Rent and Taxes 10,000
Wages 16,000
Salaries 20,000
3,47,200 3,47,200
173
DEPRECIATION Additional Information supplied: i) Closing Stock Rs. 40,000; (ii) Provide
ACCOUNTING, FINAL outstanding liabilities: Rent and Taxes Rs. 2,000; Wages Rs. 3,000; Salaries
ACCOUNTS AND Rs. 4.000; (iii) Depreciation: On Plant and Machinery @ 5%; On Furniture
ELEMENTS OF COST @ 10%;, (iv) Write-off Rs 500 bad debts; (v) Create bad debts reserve @ 2.5
on Sundry debtors.
Solution :
Trading and Profit & Loss Account for the year ended on 31stDecember
2020 Dr. Cr.
Particulars Rs. Rs. Particulars Rs.
To Opening Stock 35,000 By Sales 2,00,000
To Purchases 1,20,000 By Closing 40,000

Stock
To Wages 16,000
Add: Outstanding 3,000
19,000
To Gross Profit c/d 66,000 2,40,000
240000
By Gross Profit 66,000

To Rent and Taxes 10,000 b/d
Add: Outstanding 2,000 12,000
To Salaries 20,000
Add: Outstanding 4,000
24,000
To Bad debts 500
To Reserve for Bad

debts (note 1):
New Less: Old
1,238
1,200 38
To Interest on Bank 800
Loan @ 4% on Rs
20,000
3,000
1,500
To Depreciation:
On plant and
Machinery 4,500
On Furniture
To Net Profit 24,162
Total 66,000Total 66,000
174
Balance Sheet as on 31stDecember, 2020
FINAL ACCOUNTS
Liabilities Rs. Rs. Assets Rs. Rs. (WITH ADJUSTMENT)
Capital: Opening Plant and

Balance 80,000 Machinery 60,000
Add: Net Profit 24,162 1,04,162 Less:
Depreciation
-3,000 57,000
4% Bank Loan 20,000 Furniture 15,000

Add: Accrued Less:
Interest 800 20,800 Depreciation -1,500 13,500
Bills Payable 22,000 Bills Receivable 20,000
Sundry Creditors 24,000 Closing Stock 40,000
Outstanding Sundry Debtors 50,000

Liabilities: Less: Bad debts -500
Rent and Taxes 49500
2,000 Less: Reserve
Wages for bad debts
3,000 -1,238 48,262
Salaries
4,000 9,000
Cash on hand 1,200
Total
1,79,962 1,79,962
Working note: (i) New provision for bad debts = 2.5% of (Rs.50, 000) = Rs.
1,238. Additional provision required Rs. 1,238 – Rs. 1,200 = Rs.38.
OR
Bad debts Rs. 500 + New BDR 2.5% on 49500, Rs. 1238 = Rs. 1738 - Old
BDR 1200 = Rs. 538 to be Provided.
2) The Trial Balance of M/s R.S. Corporation as on December 31, 2020
was as under:
175
DEPRECIATION Particular Dr. Rs. Cr. Rs.
ACCOUNTING, FINAL
ACCOUNTS AND Rajeev’s capital A/c 80,000
ELEMENTS OF COST Suresh’s Capital A/c 1,00,000
Stock as on 1.1.2020
2,500
Raw materials Finished goods
6,500
Purchases 64,500
Sales 1,19,000
Sales returns 2,000
Wages 16,000
Manufacturing expenses 12,000
Salaries 8,000
Insurance 1,500
Postage 100
Advertisement 1,000
Bad debts 300
Discount 500
Land and Building 90,000
Plant and Machinery 70,000
Furniture 1,000
Drawings Rajeev
1,800
Suresh
1,400
Cash in Hand 500
Cash at Bank 49,000
Total 3,53,500 3,53,500
Rajeev and Suresh share profit and Loss equally. Prepare Trading. Profit &
Loss Account for the year ended on 31st December 2020, and also the bal-
ance Sheet as on that date after taking into consideration the following ad-
justments:
1. Stock on 31st December, 2020: Raw materials Rs. 4,000; Finished goods
Rs.12 ,000
176
2. Provide depreciation on land and building @ 5%; on furniture @10%;
FINAL ACCOUNTS
and on plant & machinery@5%.
(WITH ADJUSTMENT)
3. Outstanding expenses: Salaries Rs. 1.500; wages Rs.2,100.
4. Insurance paid for 15 months up to March 2021.
5. Write-off bad debts of Rs.400
6. Reserve for doubtful debts @5% ofDebtors.
7. Goods withdrawn by Rajeev for personal use Rs.2,000.
Solution
M/s R.S. Corporation
Particulars Rs. Rs. Particulars Rs. Rs.
To Opening Stock By Sales 1,19,000

Raw materials 2,500 Less: Sales
Finished goods 6,500 9,000 Returns 2,000 1,17,000
To Purchases 64,500 By Closing

Stock
Less: Goods taken Raw 4,000

for personal use 2,000 62,500 Materials
To Wages 16,000 Finished 12,000 16,000
Add: Outstanding 2,100 18,100 Goods
To Manufacturing 12,000
expenses
To Gross Profit c/d 31,400
Total 1,33,000 Total 1,33,000
To Salaries 8,000 By Gross 31,400
Add: Outstanding 1,500 9,500 Profit b/d
To Insurance 1,500 By Discount 500
Less: Prepaid 300 1,200 received
To Postage 100
To advertisement 1,000
To Bad Debt 300
Trading and Profit & Loss Account for the year ended on 31stDecember
2020
177
DEPRECIATION Dr. Cr
ACCOUNTING, FINAL
Add: Further Bad
ACCOUNTS AND
debts 400 700
ELEMENTS OF COST
To Provision for 1,250

Doubtful debts
To Depreciation:
On Land & Building

@ 5% 4,500
On Furniture @ 100
10%
On Plant & 3,500 8,100

machinery @5%
To Net Profit
(transferred to
partner Capital A/c)
Rajeev
5,025
Suresh
5,025 10,050
Balance Sheet of M/s R S Corporation as on 31st December 2020
Liabilities Rs. Rs. Assets Rs. Rs.

Capital Accounts: Fixed assets
Rajeev 80,000 Land and Building 90,000
Add: Share of Profit Less: Depreciation 4,500 85,500
Less: Drawings (Rs 5,025

1,800 + Rs. 2,000)
3,800 81,225 Plant and 70,000
Suresh machinery
1,00,000
Add: Share of Less:
5,025 3,500 66,500
Profit
1,400 1,03,625
Less : Drawings
178
Profit Depreciation
FINAL ACCOUNTS
Less: Drawings (WITH ADJUSTMENT)
Sundry 42,000 Furniture 1,000

Creditors
Less: Depreciation 100 900
Bills Payable 12,000 Current Assets
Outstanding Closing Stock: Raw

Expenses:
Materials Finished 4,000
Salaries 1,500
goods 12,000 16,000
Wages 2,100
3600
Less: Bad debts 400
25000
Less: Provision for
bad debts @ 5% 1,250 23,750
Cash in hand 500
Cash at bank 49,000
Prepaid Insurance 300
Total 2,42,450 Total 2,42,450
179
DEPRECIATION 3) Prepare final accounts from the following Trial Balance as on 31-03-
ACCOUNTING, FINAL 2020 of pankaj
ACCOUNTS AND Trial Balance of Pankaj as on 31-03-2020
ELEMENTS OF COST
Debit Credit
Name Of Account
(Rs.) (Rs.)
Drawings - Capital 24000 300000
Purchase - Sales 296000 800000
Goods Returns 80000 20000
Provident – Contribution to provident fund 10000 100000
Provident fund investment – Int. on provident fund
100000 8000
investment
Debtors - Creditors 200000 150000
Discount 46000 14000
Bad Debts & Bad debts reserve 30000 45000
Bills Receivables – Bills payable 15000 25000
Goods Stock (1-04-2019) 80000 -
Demurrage 3000 -
Tolai 1000 -
Custom duty 18000 -
Trade Expenses 90000 -
Cash balance 16000 -
Bank balance 25000 -
Fixed Assets (cost price 500000) 400000 -
Advertisement Expenses 28000 -
1462000 1462000
Adjustments :
(1) Stock as on 31-03-2020 is 2,00,000 out of which market value of 30%
stock is 20 % more. Market value of 50 % stock is less by 10 %. Whereas
remaining stock need to repairs expenses of 2000.
(2) Good of 5000 given as advertisement.
(3) Credit sales of 10,000 wrongly recorded as credit purchase.
(4) Write off 20,000 as bad debts from debtors and provide 10 % Bad debt
reserve.
(5) Calculate 10 % interest on Capital and 5 % interest on Drawings.
(6) Calculate depreciation at 10 % on fixed assets as per straight line method.
Solution :
Trading Account of Pankaj for the year ending on 31-03-2020
Amount Amount
Particular Particular
(Rs.) (Rs.)
To Opening 80000 By Sales 800000
stock
To purchase 296000 + Unrecorded
sales 10000
- Wrongly 10000 810000

Recorded
286000 - Sales return 80000 730000
- Goods
given for 5000
advertisement
- Purchase 20000 261000
return
To 3000
demurrage
To Tolai 1000
To Gross 555000 By Closing
188000
profit Stock
918000 918000
180
Amount Amount
(Rs.) (Rs.)
Administrative Expenses : By Gross Profit 555000
To Contribution to provi. By Discount
Fund Received
10000 14000
(Transferred from
trading A/c)
To Trade expenses By Interest on
90000 1200
Drawings
Sales-distribution
expenses :
To Discount given 46000
To Advertisement exp. 28000
+ Goods given as adv. 5000 33000
Financial Expenses :
To Interest on Capital 30000
Other expenses and Losses
:
Bad debt reserve account :
Bad Debts (Trial Bal.) 30000
+ Bad Debts (Adj.) 20000
+ Bad Debts Reserve (Adj.) 19000
69000
- Bad Debts Res. (Trial
45000 24000
Balance)
To Depreciation on fixed
50000
assets
To Net Profit A/c 287200
570200 570200
Am ount Amou nt
L iabili ties (R s.) A ssets (Rs.)
Capital : N on Curr ent
A sse ts :
Ca pi tal 300000 Fixe d A sse ts 400000
+ Int. on capita l 30000 - Deprecia tion 50000 350000
+ Ne t Profit 287200 (Cost Price 500000
× 10%)
(From P & L A /c) 617200 Investm ent :
- D rawing Provident Fund
24000 Inve stme nts 100000
+ Int. on drawings 1200 25200 592000 C urrent A ssets :
Non – Curr ent D ebtors 200000
Liabilitie s :
Cur rent + Unrecorded Sales
10000
Liabilitie s :
Provide nt Fund 100000 210000
+ Int. on PF - B ad D ebts
8000 108000 20000
Investment
Bills P ayabl e 25000 190000
Creditors 150000 + Bad De bt 19000 171000
Res.(10%)
- W rongl y 10000 140000 Bills receivables 15000
recorded
Cash Balance 16000
Bank Bala nce 25000
Closing Stock 188000
865000 865000
181
DEPRECIATION Explanation : Note no. 1 : Closing Stock 2,00,000
ACCOUNTING, FINAL 
ACCOUNTS AND   
ELEMENTS OF COST 30% 50% Remaining 20%
  
60,000 1,00,000 40,000
  
60,000 90,000 38,000
[1,00,000 - 10%] [40,000 - 2000]

60,000 + 90,000 + 38,000 = 1,88,000
Market value of 30 % stock is more, hence cost value will be considered.
Market value of 50 % stock is less, hence market value will be considered.
20 % stock has required repairing therefore repairing cost will be deducted
from stock value.
4) Prepare final accounts of Nirmi Traders from the following Trial Bal-
ance as on 31-03-2020 and adjustments.
Trial Balance of Nirmi Traders as on 31-03-2020
D e bit C re d it
N a m e o f A c c ou n t ( R s .)
(R s. )
C a pita l - 30 00 00
D r a w i ng s 18 00 0 -
L an d & Bu ilding 2 00 00 0 -
M a c hi ne r y 1 40 00 0 -
Furn it ure an d fixt ure s 25 00 0 -
L ea seh ol d B uilding ( D t. 1 -04 -201 9 fo r
50 00 0 -
five yea rs)
Sale s - 50 00 00
Purc ha se Re t urn s - 1 20 00
D eb tors 90 00 0 -
12 % L oa n f ro m S a ja n ( D t . 1 -10 -2 019 ) - 3 00 00
Purc ha se 2 00 00 0 -
Sale s re tur ns 10 00 0 -
Fre ight - O ctroi 15 00 0 -
Sund ry e xpe nses 1 00 0 -
Statione ry – printi ng 2 50 0 -
Insura nce pre m ium 14 20 0 -
Ba d-D e bts 15 00 0 -
Ba d -D e bts R e se rv e - 1 40 00
D i sco un t R e se rve o n D e b to rs - 5 00
Co m m ission r ec e iv ed - 80 00
G ood s Stoc k (D t. 1- 04-20 19) 11 00 0 -
Sa la ry an d w a ge s 54 00 0 -
Cre dito rs - 3 00 00
D e a d S toc k 5 00 0 -
Ba nk O v erd ra ft - 2 10 00
Ca sh B a la nc e 40 80 0 -
Ca rria ge Inw ard 11 00 0 -
Ca rria ge O utw a rd 4 00 0 -
Bi lls 18 00 0 1 00 00
D isc ou nt a llow e d 1 00 0 -
9 25 50 0 92 55 00
182
Adjustments :
FINAL ACCOUNTS
(1) Closing stock as on 31-03-20 was valued at 41,000. (WITH ADJUSTMENT)
(2) Fire occurred in business as on 31-01-20 due to which goods of 10,000
were destroyed and the insurance company accepted a claim of ? 7000.
(3) Out of debtors 5000 are not recoverable so they are to be written off.
Provide Bad debt reserve 10 % and discount reserve 2 % on debtors.
(4) Nirmi withdrew goods of 1000 for personal use which are not recorded
in the books of accounts.
(5) Credit purchases of 5000 were not recorded.
(6) Calculate depreciation, at 10 % on land and building, at 20 % on ma-
chinery and at 5 % on furniture and fixtures.
(7) Insurance premium included 1200 for the next year.
(8) Commission of 1000 is receivable.
Solution
Trading Account of Nirmi Traders for the year ending on 31-03-2020
Amount Amount
(Rs.) (Rs.)
To Opening By Sales
11000 500000
Stock
To Purchase - Sales
200000 10000 490000
Return
+ Unrecorded
5000
purchase
205000
- Purchase return 12000
193000
- Goods burnt by
10000
fire
Withdraw for
1000 11000 182000
personal use
To Freight -
15000
Octroi
To Carriage
11000
Inward
To Gross Profit 312000
(Transferred to P By Closing
41000
& L A/c) Stock
531000 531000
183
DEPRECIATION Profit & Loss Account of Nirmi Traders for the year ending on 31-03-2020
ACCOUNTING, FINAL Amoun Amount
ACCOUNTS AND t (Rs.) (Rs.)
ELEMENTS OF COST Administrative By Gross Profit
321000
Expenses :
To Sundry expenses (Transferred from
1000
Trading A/c)
To Stationery – premium 2500 By commission 8000
To Insurance Premium 14200 + Receivables 1000 9000
- Prepaid 1200 13000
To Salary - Wages 54000
Sales – Distribution
Expenses :
To Carriage Outward 4000
Financial Expenses :
To Interest on loan 1800
Other Expenses and
Losses :
To Written off
10000
Leasehold building
Bad Debts (Trial Bal.) 15000
+ Bad Debts (Adj.) 5000
+ Bad Debts Res. (Adj.) 8500
28500
+ Bad Debts Res. 14000 14500
(Trial Balance)
Dis. Reserve on debtors
A/c :
Discount given 1000
+ Disc. Res. On Debtors 1530
(Adjustment) 2530
+ Disc. res. On Debtors 500 2030
(Trial Balance)
To Loss due to fire 3000
Depreciation :
Land - Building 20000
+ Machinery 28000
+ Furniture - Fixture 1250 49250
To Net Profit 165920
(Transfer to Capital A/c)
321000 321000
184
Balance Sheet of Nirmi Traders as on 31-03-2020
Liabilities Amount Assets Amount
Non Current Assets
Capital : Fixed Assets :
Capital 300000 Land & Building 200000
+ Net Profit 165920 - Depreciation (10%) 20000 180000
(Transferred 465920 Machinery 140000
from P&L A/c)
- Drawings 18000 - Depreciation (20%) 28000 112000
+Goods 1000 Furniture and 25000
Withdraw for 19000 446920 Fixtures
Personal use
- Deprecation (5%) 1250 23750
Non Current Leasehold Building 50000
Liabilities :
12% Sajan Loan 30000 - Written off (1/5) 10000 40000
+ Int. on loan 1800 31800 Dead Stock 5000
Current Current Assets :
Liabilities :
Creditors 30000 Debtors 90000
+ Unrecorded - Bad Debts 5000
5000 35000
Credit Purchase
Bank Overdraft 21000 85000
Bills Payables - Bad Debt Res. 8500
10000 (10%)
76500
- Discount Reserve 1530 74970
on Debtors (2%)
Cash Balance 40800
Bills Receivables 18000
Closing Stock 41000
Insurance Company 7000
account
Prepaid Insurance 1200
Premium
Commission 1000
Receivables
544720 544720
Explanation : (l) Outstanding interest on Sajan's Loan.

Loan was taken from Sajan as on 1-10-2019
Final Account date : 31-03-2020
Unpaid interest on loan duration = 6 months
Interest = 30,000 X 12 % × 6/12 = 1800
Outstanding Interest = 1800
3.5 Let Us SumUp
In the last unit we learnt how to make final accounts in the books of sole
proprietorship which includes Trading account, Profit and loss account and
balance sheet for the business. These financial statement helps us to under-
stand the profitability of the business and the financial position as well.
185
DEPRECIATION This unit is focused on adjustments which tend to happen in final accounts.
ACCOUNTING, FINAL Adjustments are entries which have been missed during the recording of trans-
ACCOUNTS AND actions hence dual effect of these transactions are to be given in final ac-
ELEMENTS OF COST counts. Different types of transactions are explained if adjustments are to be
done in the final accounts. Through the study of this subject the students will
get a detailed information about how to make the final books of accounts.
Sufficient illustrations have been provided to explain the topic effectively.
3.6 Answers for Check YourProgress
Answers:(1-c)
Answers:(1-a)
Answers:(1-a)

Answers:(1-b)
Answers:(1-b)
3.7 Glossary
1.
. Commission - A commission is a fee that a business pays to a salesper-
son in exchange for his or her services in either facilitating, supervis-
ing, or completing a sale.
2. Financial Position - Financial position is the current balances of the
recorded assets, liabilities, and equity of an organization. This informa-
tion is recorded in the balance sheet, which is one of the financial state-
ments.
3. Net loss - The balance of the profit and loss account, assuming it has a
debit balance.
4. Net profit - The balance of the profit and loss account, assuming it has
a credit balance.
3.8 Assignment
1) From the following figurers extracted from the books of Shri Govind,
you are required to prepare a Trading and Profit & Loss Account for
the year ended 31st March, 2020 and a Balance Sheet as on that date
after making the necessaryadjustments.
186
Particulars Amount Particulars Amount FINAL ACCOUNTS
(WITH ADJUSTMENT)
(Rs.) (Rs.)
Shri Govind?s Capital 2,28,800 Stock 1.4.2019 38,500
Shir Govind?s Drawings 13,200 Wages 35,200

Plant & Machinery 99,000 Sundry Creditors 44,000
Freehold Property 66,000 Postage and 1,540

Telegram s
Purchases 1,10,000 Insurance 1,760
Returns Outwards 1,100 Gas and Fuel 2,970
Salaries 13,200 Bad debts 660
Office Expenses 2,750 Office Rent 2,860
Office Furniture 5,500 Freight 9,900

Discounts A/c (Dr.) 1,320 Loose Tools 2,200
Sundry Debtors 29,260 Factor y Lighting 1,100
Loan to Shri Krishna @ Provision of D/D 880

10% p.a. – balance as on
1.4.2019
44,000
Cash at Bank 29,260 Interest on loan to Shri 1,100
Krishna
Bills Payable 5,500 Cash in Hand 2,640

Sales 2,31,440
Adjustments :
1. Stock on 31st March, 2020 was valued at Rs.72,600
2. A new machine was installed during the year costing Rs.15,400, but it
was not recorded in the books as no payment was made for it. Wages
Rs.1,100 paid for its erection have been debited to wagesaccount.
3. Depreciate:
Plant and Machinery by % Furniture 10%
Freehold Property by 5%
4. Loo se tools were valued at Rs.1,760 on31.03.2020
5. Of the Sundry Debtors Rs.600 are bad and should be writtenoff.
6. Maintain a provision of 5% on Sundry Debtors for doubtfuldebts
187
DEPRECIATION 7. The manager is entitled to a commission of 10% of the net profits after
ACCOUNTING, FINAL charging suchcommission.
ACCOUNTS AND [Ans: Gross Profit: Rs.1,08,570, Net Profit: Rs.40,800, Balance Sheet
ELEMENTS OF COST total:Rs.3,25,380.]
2) The following is the Schedule of balances as on 31.03.2020 extracted
from the books of Shri. Borkhede, who carries on business under the
name and style of Messrs Borkhede Joshi& Co., atPune.
Particulars Dr. Amount (Rs). Cr. Amount (Rs.)
Cash in Hand 1,400
Cash at Bank 2,600
Stock as on 1.4.2019 62,000
Furniture and Fixture 21,400
Office Equipment 16,000
188
Buildings 60,000
FINAL ACCOUNTS
Motor Car 20,000 (WITH ADJUSTMENT)
Loan from Joshi 30,000
Reserve for Bad debts 3,000
Purchases 1,40,000
Purchase Returns 2,600
Sales 222600
Sales Returns 4,200
Salaries 11,000
Rent for Godown 5,500
Interest on loan form Joshi 2,700
Rates and Taxes 2,100
Discount received from Creditors 1,600
Freight on purchase 1,200
Carriage Outward 2,000
Drawings 12,000
Printing and Stationery 1,800
Electric Charges 2,200
Insurance Premium 5,500
General Office Expenses 3,000
Bad debts 2,000
Bank Charges 1,600
Motor Car Expenses 3,600
Capital Account 1,62,000
469800 469800
Prepare Trading and Profit and Loss Account for the year ended on
31st March 2020 and the Balance Sheet as at that date after making provi-
sion for the following:
a. Depreciate Building by5%
b. Furniture and Fixtures by 10%: one steel table purchased during the
year for Rs.1,400 was sold for same price but the wrongly credited to
salesaccount.
c. Office Equipment by 15%: Purchases of a typewriter during the year
for Rs.4,000 has been wrongly debited to purchasesaccount.
d. Motor Car by20%
1. Value of Stock at the close of the year wasRs.44,000
2. One month rent for godown isoutstanding.
3. One month salary isoutstanding.
4. Interest on Loan from Joshi is payable @12% p.a.
189
DEPRECIATION 5. Reserve for Bad debts is to be maintained at 5% on SundryDebtors
ACCOUNTING, FINAL 6. Insurance premium includes Rs.4,000 paid towards proprietor?s
ACCOUNTS AND life insurance policy and the balance of the insurance charges cover the
ELEMENTS OF COST period from 1.4.2019 to 30.6.2020
7. Half of the building is used for residential purposes of ShriBorkhede.
3.9 Activities
How is final accounts for Companies is different from final accounts of
sole proprietorship?
3.10 Case Study
What is meant by hidden adjustments?
1. Advanced Accountancy Vol-II, S N Maheshwari & V L Maheshwari,
Vikas Publishing co, 2010
Press, 1978.
1997.
190
Block Summary
In this block we have understood in detail about the Depreciation. We have
also studied in detail about the final accounts with and without adjustments.
The topics have been discussed in detail with proper illustrations. Through
the study of this block the reader will get a detailed insight of the topic
depreciation. He will also get a detailed knowledge of how to make distinc-
tion between the different parts of final accounts. Not only one part of final
accounts but the readers will get a detailed knowledge about Trading and
P&L account and I am sure enough that after going through this block
the readers could easily distinguish between them and the balance sheet. In
the third unit we have also studied the different transactions which have an
impact on Final accounts known as adjustments.
Block Assignment
Write Short Notes
1. Misconceptions about depreciation
2. Methods of depreciation
3. Provision for Discount on creditors
4. Bad debts recovery
5. Discount on Debtors

1. Explain different adjustment entries to be done in final accounts of sole
proprietorship
191
DEPRECIATION Enrolment No.:
ACCOUNTING, FINAL
ACCOUNTS AND 1. How many hours did you need for studying the units?
ELEMENTS OF COST
Unit No. 1 2 3
Nos of Hrs
2. Please give your reactions to the following items based on your reading
of the block:

………………………………………………………………………………………………
………………………………………………………………………………………………
………………………………………………………………………………………………
………………………………………………………………………………………………
………………………………………………………………………………………………
………………………………………………………………………………………………
………………………………………………………………………………………………
………………………………………………………………………………………………
192
Ambedkar
OpenUniversity
BASIC OF ACCOUNTING
BLOCK-4 RECTIFICATION OF ERRORS, BILLS OF

EXCHANGE, ACCOUNTING FOR HIRE PURCHASE
& ELEMENTS OF COST
UNIT 1
RECTIFICATION OF ERRORS
UNIT 2
BILLS OF EXCHANGE
UNIT 3
ACCOUNTING FOR HIRE PURCHASE
UNIT 4
ELEMENTS OF COST
RECTIFICATION OF BLOCK 4 : RECTIFICATION OF ERRORS, BILLS OF EXCHANGE,
ERRORS, BILLS OF ACCOUNTING FOR HIRE PURCHASE AND ELEMENTS
EXCHANGE, OF COST
ACCOUNTING FOR
HIRE PURCHASE & Block Introduction
ELEMENTS OF COST Accounting is considered to be one of the most important subjects in the
field of commerce or management and therefore this subject has been introduced
here in this course.
This block covers one of the most important topics of accounting. It covers
important topics such as rectification of errors, bills of exchange, accounting for
hire purchase elements of cost. In first unit students will be able to understand the
types of errors which happen while making final accounts and how to rectify them.
The second unit i.e. Bills of exchange explains how the credit section of the financial
market is handled by different instruments with its features. Third unit focuses on
the account system being created and managed in case of Hire Purchase
transactions. The last unit covers the topic of elements of cost. Though this topic is
small but very important each and every aspect has been made clear to the students
in understanding this topic.
The readers will get a through insight of accounting through this block. They
will get good knowledge about rectification of errors, bills of exchange, how are
accounts of hire purchase made, apart from this the readers will also get a complete
knowledge about elements of cost.
Block Objective
After learning this block, you will be able to understand :
• Rectification of errors
• Different stages of rectification of errors
• Bills of exchange– types and properties
• Promissory and its features
• Concept of hire purchase with its accounting treatment
• Meaning, element and classification of cost.
Block Structure
Unit 1 : Rectification of errors
Unit 2 : Bills of exchange
Unit 3 : Accounts for Hire Purchase
Unit 4 : Elements of Cost
194
Unit RECTIFICATION OF ERRORS
1
: UNIT STRUCTURE :
1.1 Introduction
1.2 Errors which do not affect trial balance
1.3 Errors which affect trial balance
1.4 Errors detected before the preparation of final accounts
1.5 Let us sum up
1.6 Answers for check your progress
1.7 Glossary
1.8 Assignment
1.9 Activities
1.10 Case study
1.11 Further reading
After learning this unit you will be able to understand :
Errors in financial accounting
Types of errors
Errors not affecting trial balance and their rectification
Errors affecting trial balance and their rectification
Accounting treatment of all the errors
1.1 Introduction
The motive of preparing Trial balance in financial accounts is to check the
accuracy and correctness of recording the transaction in Journal, later on posting
it in ledgers and closing or balancing those ledgers (accounts). If the trial balance
balances on both the sides then it is understood that recording, posting and balancing
has been done accurately. But agreement of trial balance need not always be the
accurate way to decide if the recording has been appropriately done. Even if trial
balance matches, there could be few errors which might have been spotted in
accounting records. Hence the errors which affect the trial balance and few of
those which don’t must be spotted and rectified?
For e.g. Non recording of credit sales transaction in sales book will not
affect the agreement of trial balance as both the effects of this transaction are not
recorded in this case. Hence such transaction need to be identified and placed
accordingly.
This process of correcting the errors committed and to set the accounting
records right is called rectification of errors. Accounting errors can be classified
into two parts, based on whether they affect the trial balance or not.
195
RECTIFICATION OF (i) Errors which do not affect trial balance
ERRORS, BILLS OF (ii) Errors which affect trial balance
EXCHANGE,
ACCOUNTING FOR 1. Rectification of errors are allowed in the process of accounting regardless
HIRE PURCHASE & of them affecting the trial balance.
ELEMENTS OF COST
a. True
b. False
1.2 Errors which do not affect trial balance
A trial balance is basically prepared to understand if the records or
transactions recorded are arithmetically correct or not. But as discussed above
trial balance cannot be considered as a base for the perfect accounting treatment.
Even in this scenario errors would have been occurred which, does not affect the
trial balance. These errors are difficult to be detected. These could be caught by
comparing the receipts from customer and payments from traders, vouchers of
purchase and sales and many other transactions by auditing the accounts.
To mark these errors in the books of accounts, rectified entries are to be
passed in the journal proper. The types in this category are:
1. Error of Omission : This error happens when a transaction is totally absent
to be recorded in books or journal or ledger, such an error is known as
Error of Omission. In such errors the trial balance gets tally even though the
error continues to be, as posting on both debit and credit side is left.
(a) A transaction is totally omitted can be recorded in journal or subsidiary
books or ledger in the form of entry. E.g. – Cash sales of Rs 2000 is not
recorded. So by writing the correct entry the above error can be rectified.
Cash a/c_____________ Dr
To Sales a/c
(b) A transaction is recorded in the journal or subsidiary book or ledger but
posting of both accounts has not been done. E.g. – Machinery purchased
on credit from Ram Electricals of Rs 50,000 is recorded in journal but their
effect in accounts of machinery and Ram electrical has not been given. This
could be rectified by debiting the machinery account and crediting ram
electrical account in ledger.
2. Error of Principle : When an error occurs because it’s not according to
the accounting principles it is an error of principle. This means that errors do
not affect the trial balance because they have been entered in the books of
accounts but instead of one account any other account is given the effect.
E.g. – Rs 40,000 worth furniture purchased is debited to purchase account.
This entry can be changed by:
Correct entry :
Furniture a/c_______ Dr
To cash a/c
196
Error committed :
RECTIFICATION
Purchase a/c_____ Dr OF ERRORS
To Cash a/c
Entry for rectification :
Furniture a/c_____ Dr
To Purchase a/c
1. When a transaction is left unrecorded in primary books, the error is known
as____.
(a) Error of omission
(b) Error of principle
(c) Error of compensatory
3. Error of Commission : In this transactions in primary books are recorded
not at original amount but either more or less than it. It could also be possible
that the entries might be recorded in wrong subsidiary books.
(a) Transaction recorded in correct book by wrong amount. E.g. – Goods of
Rs 5000 sold to Anand is recorded as Rs 500. This error will be rectified
by :
Error entry :
Anand a/c ____ Dr 500
To Sales a/c 500
Correct entry should have been
Anand a/c____ Dr 5000
To sales a/c 5000
Rectification done by
Anand a/c___ Dr 4500
To Sales a/c 4500
(b) Transaction recorded in wrong subsidiary book: E.g. – Goods of Rs 6000
sold to Ankit has been recorded in Purchase book which is a wrong
subsidiary book.
Error entry :
Purchase a/c___ Dr 6000
To Ankit a/c 6000
Ankit a/c_____ Dr 6000
To sales a/c 6000
Ankit a/c____ Dr 12000
To Sales a/c 6000
To Purchase a/c 6000
197
RECTIFICATION OF (c) Transaction recorded in wrong subsidiary book with wrong amount. E.g.–
ERRORS, BILLS OF Returned goods from Parth of Rs 800 was wrongly recorded in Purchase
EXCHANGE, book as Rs 8000.
ACCOUNTING FOR Error entry :
HIRE PURCHASE & Purchase a/c___ Dr 8000
ELEMENTS OF COST
To Parth a/c 8000
Sales return a/c___ Dr 800
To Parth a/c 800
Parth a/c____ Dr 7200
Sales return a/c 800
To Purchase a/c 8000
1. An error arises because of non–compliance of accounting principles is known
as
(a) Error of omission (b) Error of compensatory
(c) Error of Principle
4. Compensatory Errors : When more than one error is committed but their
effects are recorded on both the sides (i.e. debit and credit) and the trial
balance tallies such are known as compensatory errors. E.g.– Rs 100 is
debited instead of Rs 1000 to Gita’s account and Rs 1000 is credited instead
of Rs 100 to Sita’s a/c. To balance out the correct amount another entry
needs to be passed to rectify it and that would be
Gita’s a/c __Dr 900
To Sita’s a/c 900
1.3 Errors which affect Trial Balance
In certain cases the total of debit and credit balance of trial balance do not
match. So it becomes evident that there would have been certain errors committed
while making the trial balance, in posting, or recording the amount in writing. Let’s
understand the different kinds of errors affecting the trial balance and how they
can be rectified.
198
1.4 Errors detected before the preparation of final accounts RECTIFICATION
1. Errors of Posting OF ERRORS
(a) Omission of posting in any account: It is a type of omission. In this goods
worth Rs 8000 were sold to Akshay. This transaction is correctly recorded
in the sales book but the posting in akshay’s account is not done. Credit
sales ofAkshay is yet not recorded in his ledger, so the error will be rectified
by posting the amount on debit side of Akshay’s account.
(b) Twice posting in an account: In this error the same transaction is posted
twice. E.g. Salary paid Rs 30,000 is aptly recorded in cash book but by
mistake it has been recorded twice in salary account. Hence it will be rectified
by crediting the salary account by the same amount.
(c) Posting of a wrong account in an account: As the name suggests the entry
seems perfect but the amount recorded is wrong. For e.g. – The building is
purchased of Rs 50, 00,000 is recorded in building a/c as 5, 00,000.
So to balance it out with the correct amount the building a/c is debited with
Rs 45, 00,000.
1. An error arises when the same transaction is posted twice happens
(a) Before the preparation of trial balance
(b) After the preparation of trial balance
(d) Posting on the wrong side of the account: easy to understand that in this
kind of error the posting has been done in the wrong side of the account.
For e.g.– Paid salaries of Rs 5000. While recording or posting the salaries
a/c is credited by Rs 5000, while according to accounting rules it must be
debited in salaries a/c. To rectify it, proper treatment is to be done by
debiting the salaries a/c by Rs 10,000. So that credit effect of Rs 5000 will
be nullified and the original entry of Rs 5000 is recorded.
(e) Posting wrong amount to the wrong side of account: In this transaction are
recorded correctly in the subsidiary book but it is recorded on the wrong
side with wrong amount. E.g.– Paid rent of Rs 5000 is recorded correctly
in the cashbook but is recorded on the credit side of rent a/c by the amount
of Rs 500. To rectify it two errors need to be sorted that is debiting the rent
a/c by 5500. As it will nullify the effect of credit transaction of that amount
and with that the original effect will be given.
2. Errors regarding balance of an account
(a) Error in finding the balance of an account: If the balance of any account is
found either more or less the trial balance does not tally. If after the calculation
one gets to know that the balance is less on debit side, then put the deficit
amount on the debit side and if it’s less on the credit side then put the deficit
amount accordingly.
E.g. After calculation one spotted that the purchase account is worked
out as Rs 5000 instead of Rs 20000 on the debit side. Then write Rs
15000 which is debited less on the debit side of the account to rectify the
error.
199
RECTIFICATION OF (b) Error in writing the balance of an account: In this error the balance of an
ERRORS, BILLS OF account has been recorded at wrong amount. E.g. – the opening balance of
EXCHANGE, machinery a/c is Rs 1, 00,000 but it has been recorded as Rs 10,000. So
ACCOUNTING FOR the balance decreases by Rs 90,000. To rectify this error the account is to
HIRE PURCHASE & be debited with additional amount of Rs 90,000.
ELEMENTS OF COST (c) Balance of an account is omitted: It’s a general error in which opening balance
of an account is totally omitted– which means not recorded at all. So a new
original entry can be done in the ledger with proper effect and amount.
(d) Amount is written on the wrong side of account: Balance of Rs 500 of Ankit
(a debtor’s) account is written on the credit side. Error can be rectified by
writing double the amount i.e. 500 + 500 = 1000 on debit side of the account.
(e) Balance written as wrong amount and wrong side: Let’s take the above
example of Ankit (a debtor’s) account with balance of Rs 500. So the error
is committed is that account has been credited with Rs 50. So to balance
this error out Ankit’s account will be debited with Rs 550.
1. If the balance of an account has been recorded with wrong amount which is
lesser than the actual amount, the error can be rectified by
(a) Giving the same effect with the difference amount
(b) Giving the opposite effect with difference amount
3. Errors in totaling the subsidiary books : As discussed before the trial
balance will not tally if an error is committed while doing the total of subsidiary
books like in purchase, sales, goods return or cash book. This error can be
rectified by writing necessary notes in their resp account. A journal entry is
not necessary to rectify this type of error.
4. Errors committed while preparing trial balance : the possibility of errors
happening in preparing a trial balance is like the error in totaling of trial
balance, balance of an account is omitted, recorded twice, wrong amount
recorded, wrong side recorded or wrong amount recorded at wrong side.
After these errors are rectified new trial balance is to be prepared.
1.5 Errors detected after the preparation of final accounts
Normally in the accounting process if the trial balance gets tallied and final
accounts are prepared it means no error has been done while recording or posting
or at any step. But as seen above if error has occurred before making of final
accounts it could be rectified in different ways. Another set of error can occur
while making or after the making of final accounts. So while making trial balance if
errors are detected, it can delay the process of making final accounts. In such
situations the difference of trial balance in transferred to suspense a/c and later on
final accounts are prepared.
As explained if trial balance does not get tally the balance is amount is
shifted to suspense account as it leads to making of final accounts. If the difference
arises on the debit side of trial balance, it is created as a debit balance in suspense
account and shown on the asset side of balance sheet. And if the difference arises
on the credit side of trial balance, it is created as a credit balance in suspense
account and shown on the capital–liabilities side of balance sheet.
200
RECTIFICATION
1. When trial balance does not tally, it is tallied temporarily with help of ____ OF ERRORS
account
(a) Trading a/c (b) Profit and loss a/c
(c) Suspense a/c (d) Balance sheet
1.6 Let us sum up
“To err is human”. It is imperative for us not to commit mistakes when it
comes to accounts– while making it or analyzing it. This unit makes us understand
that while recording the transactions in the books of accounts, posting them to
ledger or preparing a trial balance it is very likely to commit errors. Hence the
next step comes is rectifying the errors, because if the errors aren’t rectified then
the Profit and Loss account might not show or disclose the true profit or loss of
the business.
There are different methods of rectification or errors but it all depends on
the stage at which the errors are rectified. As mentioned in the unit the errors are
classified into two types i.e. errors which do not affect trial balance and errors
which affect the trial balance. Another set of type is errors detected before making
the trial balance and the ones detected after the making of trial balance.
1.7 Answers for Check your progress
1–a
1–a
1–c
1–a
1–a
1–c
1.8 Glossary
1. Transaction : An agreement between buyer and seller to exchange goods,
services or financial instruments.
2. Rectification : It is the act of changing something wrong to make it correct
or satisfactory.
3. Deficit : It is the amount by which something, especially an amount of
money, is smaller than it should be.
4. Arithmetical : It is a branch of mathematics that consists studying of
numbers, especially the properties of traditional operations on them such
as addition, subtraction, multiplication and division.
201
RECTIFICATION OF 1.9 Assignment
ERRORS, BILLS OF
Study the concept of Suspense account and its uses in the accounting.
EXCHANGE,
ACCOUNTING FOR 1.10 Activities
HIRE PURCHASE &
Make rectification entries to rectify the following errors detected while making
ELEMENTS OF COST
the final accounts as on 31–3–2019
1. Purchase of machinery Rs 10,000 is left to be recorded.
2. Goods sold to Neelam of Rs 600 is recorded in purchase book by
mistake.
3. Rs 3800 paid to Rutu is mistakenly recorded in Prakash’s account.
4. Salary paid Rs 20000 is debited twice to salary account.
5. Opening balance of cash account Rs 2000 is brought forward as Rs
200.
1.11 Case study
Understand the effects of rectification on Profit and Loss account
1. Introduction to accounting, T S Grewal, S.Chand & Co, 2010
2. Financial Accounting, Dr V K Goyal, Excel Books, 2007
3. Financial Accounting, S N Maheshwari, Vikas Publishing House, 2018
––––
202
Unit BILLS OF EXCHANGE
2
: UNIT STRUCTURE :
2.1 Introduction
2.2 Bill of exchange
2.3 Specimen to Bill of exchange
2.4 Bills receivables and Bills payable
2.5 Terms of Bill, Due Date and Days of Grace
2.6 Disposal or uses of a bill
2.7 Dishonor of a bill
2.8 Promissory Note
2.9 Characteristics
2.10 Parties to promissory Note
2.11 Difference between Bills of exchange and Promissory Note
2.12 Let us Sum up
2.14 Glossary
2.15 Assignment
2.16 Activities
2.17 Case Study
2.18 Further Reading
After reading this unit you will be able to understand :
Meaning of bills of exchange and promissory note
Characteristics and different parties to bills
Specimen of bill and note
Difference between bill of exchange and promissory note
Terms of bill, due date and days of grace
Disposal or uses of a bill
2.1 Introduction
Under accounting system the transactions are usually categorized into two
sections i.e. Cash and Credit. Cash transactions as we all know are those in
which immediate transfer of payment (cash) is done. On the other hand credit
transactions are those where cash is not paid immediately but it is payable after a
specific period subject to whatever conditions were agreed at the time of transaction.
The time period decided for the future payment in credit transaction depends on
203
RECTIFICATION OF type of business, current situation, mutual understanding, amount of the transaction
ERRORS, BILLS OF and conditions of opposite party.
EXCHANGE, In present times the frequency of credit transactions has increased hence its
ACCOUNTING FOR importance is rising day–by–day. But if the payments of goods or services given
HIRE PURCHASE & on credit is not received on time, many businessmen have to face financial problems.
ELEMENTS OF COST Hence they always expect to get their payment on time. To maintain liquidity and
to overcome this situation, these businessmen use a document through which, the
person from whom an amount is receivable, accepts his debt in writing and states
the time of payment of amount or accepts to pay at the time stated in the document.
If the debtor fails to pay this document can be kept as a proof for the dues.
These documents can be written in two ways: (1) Bills of exchange (2) Promissory
note
Credit transactions are now a major part of businesses these days
(a) True
(b) False
2.2 Bills of exchange
Indian Negotiable Instrument Act, 1881 defines Bill of exchange as, “A bill
of exchange is an instrument in writing containing an unconditional order, signed by
the drawer, directing a certain person to pay a certain sum of money only at a
specified time to a certain person or according to his order or to the holder of the
instrument.”
It is also known as letter of exchange.
The acceptance of any bill is very situational but it could be considered as a
bill through following features :
1. It must be in writing. Any oral order cannot be considered as a bill.
2. It is an unconditional order to pay. Which means it shouldn’t be to
any condition and must not be a request.
3. The order to pay should be in the form of Indian currency not for a
product or anything in consideration of money.
4. The bill must be addressed to a particular person.
5. The amount mentioned in the bill must be clear.
6. The duration i.e. date mentioned on the bill should be certain and
clear.
7. The bill must be signed by the person who is writing the bill.
8. The payment of the bill is done on the demand by the drawer or after
the specified period.
Bill of exchange is a/an ______ order to pay money.
(a) Conditional
(b) Unconditional
204
There are different parties’ w.r.t this instrument. The three parties in bill of
BILLS OF
exchange are :
EXCHANGE
1. Drawer : He is the creditor or is the one who is selling (seller). He is the
person who makes and draws the bill. He is entitled to receive money from
the debtor.
2. Drawee : He is the debtor or the one who has purchased the goods. The
person upon whom the bill is drawn. He is the acceptor of the bill, the one
who has to pay.
3. Payee : Usually he is the drawer of bill or the person who is going to
receive the money or the one who holds it.
_____ is the party to the bill of exchange who accepts the bill.
(a) Drawer
(b) Drawee
(c) Payee
2.3 Specimen of Bill of exchange
Revenue
Shilp Society,
Rs 10,000 Navrangpura, Ahmedabad
Date: 25/09/2019
For the value received by you, pay Rupees Ten thousand only to Mitesh
or as per his order after three months from today.
To, Shri Soham (Soham) (Hitesh)
Sanidhya Flats, Signature of acceptor Signat ure of
Drawer
Jodhpur, Ahmedabad
From the above specimen of Bill of exchange, the contents of the bill are as
under :
1. Date : The date at which the bill is drawn should be written on top right
corner. This is important as to determine the maturity of bill.
2. Amount : the amount of the bill should be mentioned in figures as well as in
words. It should be clear and same at both the places.
3. Definite person : in each bill each party must be definite individuals. All
the names of parties as well as their addresses must be mentioned.
4. Period : this is the term or tenure of the bill which runs from the date of
issue of such bills. The period should be clearly mentioned after which the
amount is payable.
5. Signature : it must contain the signature of two persons. The drawer and
the drawee.
205
RECTIFICATION OF 6. Stamp : In order to recognize a bill legally, it is mandatory to fix a revenue
ERRORS, BILLS OF stamp in the proportion of the amount of the bill.
EXCHANGE, Check Your Progress 4
ACCOUNTING FOR A ___ stamp is required to make any bill of exchange a legal document.
HIRE PURCHASE &
(a) Postal (b) Cash
ELEMENTS OF COST
(c) Revenue
2.4 Bills Receivable and Bills Payable
A bill can mainly be of two types namely Bills Receivable and Bills Payable.
A person or trader who has to receive money from other person, he/she draws a
bill on that person. The person on whom the bill is drawn is the acceptor. So in this
situation where we have two parties, it is a bill receivable for the person who
draws the bill and for the acceptor it is bills payable. For e.g. Kashish has to
receive Rs 40000 from Ganesh. So in this case kashish would draw a bill on
Ganesh for Rs 40000 and Ganesh would accept the same. Hence this bill becomes
Bills receivable for kashish and becomes bills payable for Ganesh.
As we know a bill receivable is an asset for the drawer while liability for the
acceptor. Both the items are placed under current assets and current liability.
2.5 Terms of Bill, Due Date and Days of Grace
As read above date is one of the important components to be mentioned on
the bill of exchange. The date which is mentioned on the bill of exchange is called
as Date of drawing of the bill. The similar period is allowed for the payment by the
bills drawer to the bill acceptor is termed as Terms of the bill which could be two
months, three months. As the bill acceptor has to pay back to the bill drawer
whichever amount mentioned on the bill. Hence by the adding the period to the
date of the bill on which the bill was drawn becomes the Due date or the Maturity
date of the bill.
For e.g. the date on the bill is 21–1–2019 and the period is three months.
The due date can be decided as :
Date of drawing of the bill : 21–1–2019
Period of bill : 3 months
Due date of the bill : 21–4–2019
In order to facilitate the payment of money there is some extra period given
to the acceptor to pay his due which as known as Grace period of Three days. It
means time period of three more days is added to the due date of the bill. So if a
bill is dated of 5th march is payable after 3 months, it falls due on 5th June but if we
add grace days which are 3 days then the maturity date with days of grace would
be 8th June.
There are few conditions to be understood that if maturity date falls on a
Sunday or public holiday then the day preceding to the date of maturity of the bill
is to be considered. And if the payment of the bill cannot be made on the maturity
date due to abnormal circumstances like natural calamities, curfew, riots, close
down etc. then the next working day after the maturity date will be considered as
the new maturity date.
206
If the terms of bill is given in days instead of months then number of days
BILLS OF
should be considered to decide maturity date. E.g. date of drawing the bills is 21–
6–2019 and period of bill is 90 days. EXCHANGE
Date of drawing of the bill : 21–6–2019
Period of bill : 90 days
Due date of the bill : 21–9–2019
The maturity period mentioned on the bill could be in _____
(a) Months (b) Days
(c) Both
2.6 Disposal or Uses of a Bill
As discussed above there are three parties in a bill– Drawer, drawee and
payee. Mostly the drawer and receiver of the money both are the same. The
possession of the bill remains with the drawer of the bill or holder of the bill. The
following alternatives are possible to the person possessing the bill for the disposal
or use of the bill :
1. Keep the bill with oneself up to maturity : this is general or normal
condition in which the drawer of the bill keeps the bill as he doesn’t need
the money earlier or the duration of maturity is of short duration and hence
can collect the money on maturity date.
2. Discount the bill with bank or Shroff before maturity : sometimes the
drawer needs the money before the maturity date then the bill can be
discounted with a bank or a Shroff before the maturity date and the money
can be received. For this the holder of the bill must have a good credit in
the market. The bank or Shroff doesn’t pay the entire amount of the bill but
they do deduct a small amount of discount from the total amount. That
amount is called discount of bills. This is an income for the bank or Shroff
but expense for holder of the bill.
3. Endorse the bill before maturity date : A bill is a document and it can
be transferred easily under the negotiable instrument act 1881. This process
is endorsing a bill receivable in favor of his debt. The bill can be endorsed
by the drawer by putting his signatures at the back of the bill along with the
name of the party to whom it is transferred. The act of signing and transferring
the bill is called endorsement.
4. Send a bill for collection to a bank or Shroff : usually the holder of the
bill or businessmen are busy, hence in order to save time they assign this
task to a bank or a Shroff. The bill is sent to the bank or Shroff before its
maturity date. This bill doesn’t get discounted, but the bank collects the
money on the maturity date on behalf of the trader and gets that amount
credited to his account or pays it to them.
Before the date of maturity of bill, from whom is it discounted by the drawer
of a bill ?
(a) Debtor (b) State government
(c) Central government (d) Bank
207
RECTIFICATION OF 2.7 Dishonor of a bill
ERRORS, BILLS OF
Under normal situations the acceptor of the bill has to pay the money on its
EXCHANGE,
maturity but on the maturity date if the acceptor is not in a position to pay the
ACCOUNTING FOR
money or does not want to pay or does not pay the money due to any other
HIRE PURCHASE &
reason it can be called as dishonor of a bill.
ELEMENTS OF COST
Due to dishonor of the bill, drawer or other parties might face problems for
the collection of money. Usually when a bill is dishonored then it is required to be
noted.
2.8 Promissory Note
Along with Bills of exchange there is another instrument also mentioned in
Negotiable Instrument Act 1881 termed as Promissory Note. In promissory note
the person who has to pay the money to another person, he gives a written promise
to pay the amount. The debtor writes a note which is a promise to pay to the
creditor.
Negotiable instrument act 1881 defines promissory note as, “An instrument
in writing containing an unconditional undertaking, signed by the drawer to pay a
certain sum of money only at a specified time to a certain person or according to
his order or to the holder of the instrument”.
Bill of exchange and Promissory note are two different kinds of negotiable
instruments.
(a) True (b) False
2.9 Characteristics
1. A promissory note must be in writing and not an oral promise.
2. The note must contain a promise to pay certain amount
3. The amount mentioned in the note must be definite and clear
4. The promise mentioned in the note must be the payment of money
only, not a product or consideration of money.
5. The promise to pay money should be unconditional.
6. The duration of promissory note and the date of making of the note
must be clearly stated.
7. The promissory note must be drawn by a definite person and the
drawer must sign it.
8. A revenue stamp of the prescribed amount must be affixed on the
promissory note.
2.10 Parties to promissory Note
1. Drawer (maker): Usually he is the debtor.
2. Payee (receiver of money): He is the creditor or the holder of the
note.
208
Specimen of Promissory Note
BILLS OF
Luv Khush Society, EXCHANGE
Rs 12,000 Navrangpura, Ahmedabad
Date : 30/09/2019
I promise to pay Rupees Twelve thousand only to Kulin Bhai shah or as
per his order after two months from today, for the value received.
To,
Kulin bhai shah
Jodhpur, Ahmedabad Kalpesh Patel
Revenue
Stamp
From the following specimen we could understand the following details of

a promissory note :
1. Definite person : Maker i.e. drawer of the promissory note and the receiver
of the amount must be definite person in the note. In the above specimen
Kulin and Kalpesh are two definite person.
2. Date : The date mentioned on the promissory note while making it is the
same date for the issue of the promissory note.
3. Period : The period after which the amount is to be returned must be
clearly stated in the note.
4. Amount : The amount payable by the maker must be clearly mentioned in
promissory note
5. Signature : it is mandatory that the promissory note must be signed by its
maker in order to make a note legally valid document.
6. Revenue stamp : In order to recognize the note legally in the system, it is
necessary to affix the revenue stamp depending on the amount of the note.
A note without the stamp cannot be considered legal.
2.11 Difference between bill of exchange and promissory note
No. Basis of Bill of exchange Promissory note

difference
1 Order or A bill is an unconditional A note is an unconditional
promise order to pay money promise to pay money.
2 Who draws It is drawn by a creditor A note is made by a debtor
on whom on debtor and sent to his creditor
3 Parties There are three parties to a There are two parties to a
bill– drawer, drawee and note. Maker of the note and
payee receiver
4 Need for It is compulsory for the There is no need for any
acceptance acceptor to accept the bill acceptance as it is made by
on whom it is drawn. the debtor himself.
209
RECTIFICATION OF 5 Responsibility The acceptor is responsible The responsibility of
ERRORS, BILLS OF of payment for the payment payment in the note lies with
EXCHANGE,
the drawer.
ACCOUNTING FOR
HIRE PURCHASE & 6 Days of Three days of grace period No days of grace are
ELEMENTS OF COST Grace is allowed after the period allowed in case of
of bill to pay the amount. promissory note
7 Dishonor When the acceptor of a No notice is to be issued in
bill fails to pay the money case of dishonor
on maturity date it is
known as dishonor of bill.
Notice is to be issued.
8 Condition Any common person or
trader can draw a bill with
condition “Payment to
bearer on demand”.
Only RBI can issue a
promissory note with the
condition “Payment to
bearer on demand”.
2.12 Let us sum up
There are different ways to deal in business world, payments of goods and
services can be made in variety of ways. One such way is Bill of exchange. It is a
written agreement to pay a certain amount to the party at a predetermined date or
on demand. There are different entities which are a part of this agreement. There
are different dates which are important while dealing with bill of exchange. Another
such credit instrument is Promissory note which is different from BOE. Both the
instruments help in credit transaction and hence are important to be studied in
accountancy.
1–a
2–b
1–b
1–c
1–c
210
BILLS OF
1–d EXCHANGE
1–a
2.14 Glossary
1. Negotiable : It is a term used for any financial instrument when it is capable
of being transferred.
2. Unconditional: anything without conditions or restrictions.
3. Liability : It is an obligation to, or something that one owes to somebody.
4. Revenue stamp : Stamping of receipts or main documents evidencing
giving or taking money also need such revenue stamp as an affix in proof. A
properly stamped receipt or note gets a priority as an acceptable legal
proof over a plain receipt paper.
2.15 Assignment
Study the concept of Accommodation Bill and the different features of it
being part of bills of exchange
2.16 Activities
A bill dated February 1, 2018 payable 30 days after sight is accepted on
February 7, 2018. Please calculate the due date and the due date with days of
grace
2.17 Case study
Understand the journal entries in the books of drawer and acceptor of the
bills.
2.18 Further readings
1. Financial Accounting, Mukherjee and Hanif, McGraw Hill Education,
2018
3. An Introduction to accounting, S N Maheshwari, Suneel K
Maheshwari, Sharad K Maheshwari, Vikas Publishing House, 2013
4. Financial Accounting, S N Maheshwari, Vikas Publishing House,
2018
––––
211
RECTIFICATION OF
ERRORS, BILLS OF Unit
EXCHANGE, ACCOUNTING FOR HIRE PURCHASE
3
ACCOUNTING FOR
HIRE PURCHASE & : UNIT STRUCTURE :
ELEMENTS OF COST
3.1 Introduction
3.2 Meaning
3.3 Difference between Hire Purchase and Instalment system
3.4 Ascertaining the interest rate
3.5 Accounting records under Hire Purchase System
3.6 Let us sum up
3.8 Glossary
3.9 Assignment
3.10 Activities
3.11 Case Study
3.12 Further Reading
After learning this unit you will be able to understand :
Concept and terminology of Hire Purchase
Difference between Hire Purchase agreement and Instalment system
Calculation of interest rate with different information sources
Journal entries in the books of Hirer and vendor
Ledger making in the books of Hirer and vendor
3.1 Introduction
When the goods are sold the purchaser may either make the full payment at
one time or may defer the payment. When the payment is delayed, the amount
may be paid in monthly, quarterly or yearly instalments. When the price of an
article is paid by instalments, the total amount paid is higher than the actual cash
price of the article. The excess price is the charge for interest and the risk involved.
This arrangement of making the payment in instalments is beneficial to both the
seller and the buyer. The seller is able to sell more goods and the buyer can buy
expensive items with his limited resources. There are two systems of deferred
payments, namely, (i) Hire Purchase System, and (ii) Instalment Payment System.
In this unit we will learn in detail about the Hire Purchase System.
3.2 Meaning
A hire purchase agreement is one under which the buyer takes delivery of
goods, promising to pay the price in certain number of instalments and until full
payment is made, to treat the payment as hire charges for using the said goods. In
fact, a hire purchase agreement stipulates that
212
(i) The delivery of goods will be given by the owner of goods to the hire
ACCOUNTING
purchaser,
FOR HIRE PURCHASE
(ii) Payment will be made in instalments,
(iii) Each instalment will be treated as hire charge so that if default in
respect of payment of even the last instalment is made, the seller will
be entitled to take away the goods without compensating, the hire
purchaser in any form, and
(iv) If all instalments are paid and the other conditions are fulfilled, the
ownership of the goods will pass to the buyer.
The ownership of goods in Hire purchase system is transferred right after
the payment of ____ instalment.
(a) First (b) Second
(c) Last
Therefore in case of hire purchase, the seller i.e., the hire vendor gives only
the possession of the goods and retains the ownership with him until the last
instalment is paid. In other words, the hire purchase is the user of the goods and
not the owner. In case he fails to pay any of the instalments the vendor will take his
goods back. Apart from that the vendor will not pay back the amount received
.from the purchaser. Such an amount will be treated as hire charge for the goods.
Therefore till the last instalment is paid the hire purchaser has got an option, whether
to purchase that particular article or not.
As mentioned earlier, the payment made by the hire purchaser under this
system is always more than what he pays if he decided to go in for cash purchase.
The reason is that, apart from the cash price, the hire purchase price includes
i) interest for payment being made over a period of time,
ii) the payment of the risk taken by the seller,
iii) Expenditure on the registration, insurance and delivery of goods, etc.
The Hire purchase price includes
(a) Down payment (b) Interest
(c) Both
3.3 Difference between Hire Purchase and Instalment system
Points of Hire Purchase System Instalment System

Difference
Nature of It is a hiring goods agreement. It is an agreement of sale.
contract
Ownership Ownership of goods is Ownership of the goods passes
transferred after the payment to the buyer just signing the
of final instalment. agreement.
213
RECTIFICATION OF Rights The buyer cannot sell, destroy The buyer can sell, destroy or
ERRORS, BILLS OF or transfer the goods. mortgage or transfer as his/her
EXCHANGE,
wish.
ACCOUNTING FOR
HIRE PURCHASE & Risk All the risks are borne by the All the risks are to be borne by
ELEMENTS OF COST vendor before the payment of the buyer from the date of
final instalment. agreement.
Risk of return The buyer can return the The buyer cannot return the
goods before making the final goods to the seller.
instalment.
Repair and The liability of repair and The buyer is responsible for
maintenance maintenance lies with the repair and maintenance.
seller provided that the buyer
takes the utmost good care.
Forfeiture of In case of default in payment The act of forfeiture cannot be
instalment of instalment, paid instalment activated
paid will be forfeited and treated
as hire charges.
Depreciation is calculated by the Buyer in ____ system.
(a) Hire purchase
(b) Instalment
(c) Both
3.4 Ascertaining the interest rate
Aa mentioned earlier, when the goods are sold on hire purchase, the price
so charged by the vendor is always higher than the cash price. The excess price
Let, the difference between the hire purchase price and the cash price, includes
the interest charges and the compensation for risk. However for accounting purposes
the difference between the two prices is treated as the payment for interest. Thus
there are basically four figures to be remembered which are as follows :
1. Cash Price: It is a capital expenditure for purchase of an asset.
2. Interest
3. Down Payment
4. Instalments
Thus one can say that Hire Purchase price= Cash Price + Interest
Hire Purchase Price and Cash Price is the same concept when it comes to
Hire purchase
(a) True (b) False
(c) Depends on the situation
214
While calculating interest we may .be faced with the following two situations.
ACCOUNTING
a) When rate of interest, total cash price and instalments are given FOR HIRE PURCHASE
b) When total cash price and instalments are given but the rate of interest
is not given.
In both the above mentioned cases, the interest has to be calculated. Let us
now take them one by one
(a) When Rate of Interest, Total Cash Price and Instalments are given.
In this situation, before calculating the element of interest included in each
instalment, it will be helpful to ascertain the total amount of interest involved.
This will be ascertained by subtracting the Total Cash Price from the hire
purchase price. Then the following steps should be followed for calculating the
amount of interest on ‘ each instalment
I) Calculate the outstanding cash price at the time of first instalment by
subtracting down payment from the total cash price.
II) Calculate interest on the–first instalment. This is to be calculated on
the outstanding cash price at the time of first instalment by applying
the given rate of interest, in this connection, you should keep in view
the mode of instalment I.e., whether the instalment is annual, half–
yearly or quarterly. usually, in case of purchases for heavy equipment
the instalment is annual,
III) Calculate the amount of cash price included in the first instalment by
subtracting the amount of interest as calculated in step (ii) from the
amount of the first instalment.
IV) Calculate the outstanding cash price at the time of second instalment
by subtracting the amount of cash price of the first instalment from
the outstanding cash price at the time of first instalment i.e., (i) – (iii).
V) Calculate, interest on the second instalment by applying the rate of
interest to the outstanding cash price at the time of second instalment.
Illustration 1 will help you to calculate the interest with the help of the above
mentioned procedure.
Illustration–1
A ltd purchased a machine on Hire Purchase from B ltd on 1st April, 2008
the cash price being Rs 66,000, Rs 20,000 is payable on signing the agreement
and the balance in three annual instalments of Rs 20,000 each. The vendor company
charges interest @ 15% on the unpaid amount. Let us calculate interest included
in various instalments.
Solution :
The cash price is Rs 66000 but the total amount payable is 80,000. Hence
the amount of interest is Rs 14000 (80000–66000). This amount of interest is
spread over three years as follows:
215
RECTIFICATION OF Cash price of machine 66000
ERRORS, BILLS OF Less: down payment –20000
EXCHANGE, Amount outstanding 46000
ACCOUNTING FOR
Add: Interest on 46000 @15% for one year +6900
HIRE PURCHASE &
ELEMENTS OF COST Amount outstanding 52900
Less: first annual instalment paid –20000
Amount outstanding 32900
Add: interest on 32900 @15% for one year +4935
Less: second instalment paid –20000
Add: Interest (difference) +2165
Final instalment 20000
(b) When Total Cash Price and Instalments are given, but rate of interest
is not given
When the total cash price, down payment and the amount of each instalment
is given, put the rate of interest is not given, the interest will be calculated by
procedure mentioned below.
i) Calculate the total interest by subtracting the total cash price from the
total hire purchase price.
ii) Calculate the amounts of hire purchase outstanding at the beginning
of each year after subtracting the down payment.
iii) Find out the ratio of outstanding amounts calculated in step (ii). If the
amount of each instalment is equal, the ascertainment of ratio is simple.
For example, if there are four instalments of equal amounts the ratio
will be 4 : 3 : 2 : 1 and if there are three instalments of equal amounts,
it will be 3 : 2 : 1.
iv) Apply this ratio to the total interest and calculate the interest on each
instalment.
Let us now take an example and clarify the calculation of interest included in
each instalment.
Illustration –2
X co ltd purchased a machine on hire purchase from Y co ltd. the cash price
Rs 80,000. Rs 20000 is payable on signing the agreement and the balance in three
annual instalments of Rs 24000 each. Calculate the amount of interest to be paid
by X co ltd.
Solution :
Here the cash price is Rs 80000
Total contract price
= payment on signing the contract + total amount of instalments
= 20000 + 24000 3
= 20000 + 72000
= 92000
216
Now find out the balance of contract price (amount outstanding) when
ACCOUNTING
each instalment becomes due
FOR HIRE PURCHASE
Contract price 92000
Less: Down payment 20000
Amount o/s on first instalment 72000
Less: First instalment 24000
Amount o/s on second instalment 48000
Less: Second instalment 24000
Amount o/s on third instalment 24000
Less: final instalment ———
The above mentioned calculations show that the amount outstanding when
instalment becomes due is Rs 72000, Rs 48000 and Rs 24000 resp. As such the
interest will be in proportion of 72 : 48 : 24 = 3 : 2 : 1
Interest will be calculated as follows :
Total Payment 92000
Less: cash price 80000
—————
Total interest 12000
Interest for 1st instalment = 12000 3/6 6000
Interest for 2nd instalment = 12000 2/6 4000
Interest for 3rd instalment = 12000 1/6 2000
Apart from these two there are other different calculations also which are
to be studied. They are mentioned below :
Calculation of interest when interest is not included in the amount of
instalment
There may be certain cases where interest would not be given in the amount
of instalment. In such a case instalment given is the amount payable towards cash
price of the asset only. Interest must be separately calculated. It can understood
from given illustration.
Illustration–3
Bob & Co purchased a machine on hire purchase on 1st April 2012. The
terms of the agreement are :
The cash price of machine was Rs 5000
Rs 2000 were to be paid as down payment
The rest of the balance was to be paid in annual instalments of Rs 1000
plus interest.
Interest charged on outstanding balance was 6% per annum.
Depreciation @10% was calculated as per Straight line method
217
RECTIFICATION OF Solution :
ERRORS, BILLS OF Date Cash Inst. Including Interest Inst. Paid Balance
EXCHANGE,
Price interest (2) @6% (3) towards cash of cash
ACCOUNTING FOR
HIRE PURCHASE & (1) (4 + 3) (1 x 6%) price (4) price
ELEMENTS OF COST (1 – 4) (5)
1–4–2012 5000 2000 – 2000 3000
31–3–2013 3000 1180 180 1000 2000
31–3–2014 2000 1120 120 1000 1000
31–3–2015 1000 1060 60 1000 –
5360 360 5000
So here one can say that the cash price of the machine was Rs 5000 but
interest charged on instalment was Rs 360 and due to it the hire purchase price of
the machine turns out to be Rs 5360.
Calculation of interest when cash price is not given
Sometimes the cash price of the asset purchased is not given in the example
but the rate of interest and amount of instalment is mentioned. In such cases cash
price is to be found out. In such examples the calculations are to be made beginning
with the last instalment.
Illustration–4
Shri Rajesh Kapoor purchased a machine from Rakesh Khanna & Co on
1–4–2010 on hire purchase system. The balance amount payable in four annual
instalment at 10% interest as follows :
31–3–2010 Rs 10900
31–3–2011 Rs 9100
31–3–2012 Rs 7400
31–3–2013 Rs 8800
The down payment paid was Rs 10000. Find out the cash price of the
machine.
Solution :
Rate of interest is 10% and so interest at 10/110 will be included in each
instalment.
(1) Last instalment (4th) = Rs 8800 10/110
Rs 800 is the interest
So the cash price would be Rs 8800–Rs 800 = Rs 8000. This amount will
be added to the 3rd instalment.
(2) Third instalment = Rs 7400 + 8000 = 15400
Interest = 15400 10/100
So the cash price would be Rs 15400–Rs 1400 = Rs 14000. This amount
will be added to the 2nd instalment.
218
(3) Second instalment = Rs 9100 + 14000 = 23100
ACCOUNTING
Interest = 23100 10/100 FOR HIRE PURCHASE
So the cash price would be Rs 23100–Rs 2100 = Rs 21000. This amount
will be added to the 1st instalment.
(4) First instalment = Rs 10900 + 21000 = 31900
Interest = 31900 x 10/100
So the cash price would be Rs 31900–Rs 2900 = Rs 29000 which is the
balance of cash price outstanding will be added to the down payment of Rs
10000 to get cash price.
Cash price = Rs 10000 + Rs 29000 = Rs 39000
Total amount paid = Rs 46200 – cash price Rs 39000 = Rs 7200 is the
interest.
Calculation of interest when cash price and rate of interest are not given
When neither interest rate is given nor cash price but only amount of
instalments are given it may be presumed that equal amount is paid towards cash
price in all the instalments. Naturally the amount of interest will go on decreasing
along with each instalment.
We may assume that Rs X is the amount paid towards cash price and Rs Y
is the amount of interest paid with the last instalment. If amount is paid in three
instalments the interest would be 3Y along with the first instalment, Rs 2Y with
second instalment and Rs Y with third instalment. Thus,
1st instalment = Rs X + Rs 3Y
2nd instalment = Rs X + Rs 2Y
3rd instalment= Rs X + Rs Y
If the cash price of machine is Rs 80,000. The down payment made is Rs
20,000 and the hire purchase price is Rs 1,20,000. What will be the interest?
(a) Rs 40,000 (b) Rs 20,000
(c) Rs 60,000 (d) Rs 80,000
3.5 Accounting records under Hire Purchase System
There are two parties to a hire purchase agreement, i.e., the Vendor (Seller)
and Hirer (Purchaser). Both these parties have to maintain books of account and
record all the transactions relating to that particular hire purchase.
Before explaining the accounting records let us first see what information is
required for recording the hire purchase transaction in the books of account. The
list of items required for accounting records is as follows:
1. Date of Purchase and down payment
2. Date at which the instalments become due
3. Date of closure of accounts
219
RECTIFICATION OF 4. Cash Price
ERRORS, BILLS OF 5. Hire Purchase Price
EXCHANGE,
6. Number, Amount and Mode of each instalment
ACCOUNTING FOR
HIRE PURCHASE & 7. Rate of Interest VU –
ELEMENTS OF COST 8. Rate of depreciation
9. Method of Depreciation
Let us now see how accounting records are maintained in the books of the
purchase. There are two methods by which the purchaser can record the hire
purchase transaction in the books of account.
FIRST METHOD
You know that in case of hire purchase, the ownership of the goods passes
to the hire purchaser after the last instalment has been paid. Since the goods do
not become the property of the purchaser, he does not have any right to debit the
asset at its full price. Hence, no entry is passed when the asset is purchased unless
it involves down payment. The entries are passed as and when the instalments
become due and the amount is paid towards the price of the article. The journal
entries are as follows :
(Books of HIRER)
1. When the asset is purchased
No entry
2. When the down payments is made
Asset A/c Dr
To Bank A/c
3. When the instalment becomes due
Asset A/c Dr (cash price part of instalment)
Interest A/c Dr (interest on instalment)
To Hire Vendor
4. When instalment is paid
Hire Vendor Dr
To Bank A/c
5. When Depreciation is charged
Depreciation A/c Dr
To Asset A/c
6. When Interest and depreciation accounts are closed by transfer to Profit &
Loss A/c Profit & Loss A/c Dr
To Interest A/c
To Depreciation A/c
220
(Books of VENDOR)
ACCOUNTING
1. sale of goods under hire purchase FOR HIRE PURCHASE
Hire Purchaser Dr (with full cash price)
To Sales A/c
2. On receiving cash down payment
Bank A/c Dr
To Hire Purchaser
3. On instalment becoming due
Hire Purchaser Dr
To Interest A/c
4. On getting payment on the due instalment
Bank A/c Dr
To Hire Purchaser
Thereafter entries nos 3 to 6 would be made on payment of each instalment
at the end of the year.
SECOND METHOD
In this method when the asset is purchased on hire purchase, it is assumed
that the purchaser has full intention of paying all the instalments. It is believed that
hire purchase is just B method of financing fixed assets. Under this method, on
purchase of plant and machinery, the Plant & Machinery Account (Fixed Asset) is
debited with the total amount of Cash Price, and the corresponding credit is given
to Hire Vendor’s Account. Interest is recognised and accounted for at the time of
instalments becomes due by debiting the Interest Account and crediting the Hire
Vendor’s Account. For the purpose of accounting for initial cash down payment
and annual instalments, the Hire Vendor’s A/c is debited on the relevant date, and
the credit is given to Bank Account. The following journal entries are passed in
the books of the purchaser.
1. When the asset is purchased on hire purchase
Asset A/c Dr
To Hire Vendor
(With total cash price)
2. For cash down payment –
Hire Vendor Dr
To Bank A/c
3. When the first instalment becomes due
Interest A/c Dr
To Hire Vendor a/c
4. When the first instalment is paid
Hire Vendor a/c Dr
To Bank A/c
221
RECTIFICATION OF 5. For Depreciation Charge (at–the end of accounting period) –
ERRORS, BILLS OF Depreciation a/c Dr
EXCHANGE, To Asset A/c
ACCOUNTING FOR
6. For transfer of interest and depreciation to Profit & Loss A/c
HIRE PURCHASE &
ELEMENTS OF COST Profit & Loss A/c Dr
To Interest A/c
To Depreciation A/c
Entries 3 and 4 will be repeated for all subsequent instalments. Entries in
books of vendor are same for both the method.
Illustration :
Ajmer manufacturers ltd purchased on 1st april 2008, machinery costing
Rs 47500 from ABC co ltd on Hire Purchase System. The terms were as under:
Rs 20000 to be paid on 1st april 2008
Rs 10000 to be paid on 31st march 2009
You are required to make machinery account, interest account and ABC co
ltd a/c. interest rate is 5% per annum on yearly basis. Depreciation at 20% on the
original cost is to be written off each year. Give journal entries also in the books of
both the parties.
Solution :
Table showing calculation of interest
Date Opening bal of Interest Instalment Credited Balance

cash price toward of cash
cash price price
1–4–2008 47500 – 20000 20000 27500
31–3–2009 27500 1375 10000 8625 18875
31–3–2010 18875 944 10000 9056 9819
31–3–2011 9819 490 10309 9819 –
2809 50309 47500
Depreciation would be Rs 9500 every year at 20% on Rs 47500.

Entries in the books of purchaser (hirer)
1–4–2008 Machinery A/c Dr 20000
To bank A/c 20000
Interest A/c Dr 1375
To ABC co ltd a/c 10000
ABC co Ltd Dr 10000
To Bank A/c 10000
222
Depreciation A/c Dr 9500
ACCOUNTING
To Asset A/c 9500 FOR HIRE PURCHASE
Profit & Loss A/c Dr 10875
To Depreciation A/c 9500
To Interest A/c 1375
Interest A/c Dr 944
ABC co Ltd Dr 10000
To Bank A/c 10000
To Asset A/c 9500
To Interest A/c 944
Interest A/c Dr 490
ABC co Ltd Dr 10309
To Bank A/c 10309
To Asset A/c 9500
To Interest A/c 490
Entries in the books of ABC co ltd (Seller–vendor)
1–4–2008 Ajmer Mfg co ltd Dr 47500
To sales A/c 47500
Bank A/c Dr 20000
To Ajmer Mfg co ltd a/c 20000
To Interest a/c 1375
Bank A/c Dr 10000
Interest a/c Dr 1375
To Profit and loss a/c 1375
To Interest a/c 944
223
RECTIFICATION OF Bank A/c Dr 10000
ERRORS, BILLS OF To Ajmer Mfg co ltd a/c 10000
EXCHANGE,
Interest a/c Dr 944
ACCOUNTING FOR
HIRE PURCHASE & To Profit and loss a/c 944
ELEMENTS OF COST 31–3–2009 Ajmer Mfg co ltd Dr 490
To Interest a/c 490
Bank A/c Dr 10309
Interest a/c Dr 490
To Profit and loss a/c 490
Ledgers in the books of Ajmer Mfg Co ltd (Hirer)
Machinery Account
Rs Rs
1–4–08 To bank a/c 20000 31–3–09 By depreciation 9500
31–3–09 To Abc co ltd 8625 “ By Bal c/d 19125
28625 28625
28181 28181
28500 28500
ABC co Ltd a/c

Rs Rs
31–3–09 To bank a/c 10000 31–3–09 By machinery 8625
By Interest 1375
By interest 944
By interest 490
Interest A/c
Rs Rs
31–3–09 To ABC co ltd 1375 31–3–09 By P &L a/c 1375
224
Depreciation A/c
ACCOUNTING
Rs Rs FOR HIRE PURCHASE
31–3–09 To Machinery a/c 9500 31–3–09 By P &L a/c 9500
3.6 Let us sum up

Hire Purchase is one of the most commonly used methods of financing for
various acquired assets. It helps by spreading the huge costs of an asset over a
longer period of time. Hence it frees capital to be utilised in other options of
investment.
It is an agreement between Hirer and Vendor to buy and sell the goods with
an initial payment. But in this agreement the ownership is transferred after the last
instalment. Interest is charged by the vendor for the future payments or instalments.
The accounting treatment is also to be understood in the books of both
Hirer and vendor with necessary ledgers.
3.7 Answers to check your Progress
1–c
1–c
1–a
1–b
1–a
3.8 Glossary
1. Instalment : It is a sum of money paid in small parts over a fixed period of
time. It is usually a part of staged payment plan of a loan.
2. Down payment : It is an initial payment paid after something is bought on
credit.
3. Hirer : Hirer is defined as a person who has taken the goods on hire
purchase in the agreement. He is also known as buyer.
4. Vendor : Vendor is defined as a person who has sold the goods on hire
purchase to hirer. Also known as seller.
3.9 Assignment
Under the formal and legal procedure of Hire Purchase agreement with
proper required documentation.
225
RECTIFICATION OF 3.10 Activities
ERRORS, BILLS OF
On 1st April, 2018, Punjab Collieries obtained a machine on the hire
EXCHANGE,
purchase system, the total amount payable being Rs 5, 00,000. Payment was
ACCOUNTING FOR
to be made Rs 1, 00,000 down and the balance in four annual instalments of
HIRE PURCHASE &
Rs 1, 00,000 each. Interest charged was at the rate of 15 per cent. At what value
ELEMENTS OF COST
should the machine be capitalized?
3.11 Case study
Choose any three items which are normally available on hire purchase or
rental items. Find out the cost of buying by cash, hire purchase or leasing for a
year. Prepare a table find out findings. Explain the advantages and disadvantages
for three of them.
3.12 Further readings
1. Financial Accounting, Mukherjee and Hanif, McGraw Hill Education,
2018
3. Financial Accounting, Dr V K Goyal, Excel Books, 2007
4. Financial Accounting, S N Maheshwari, Vikas Publishing House, 2018
––––
226
Unit ELEMENT OF COST
4
: UNIT STRUCTURE :
4.1 Introduction
4.2 Meaning of Cost
4.3 Various Elements of Cost
4.4 Classification of Cost
4.5 Let Us Sum Up
4.7 Glossary
4.8 Assignment
4.9 Activities
4.10 Case Study
• Meaning of Cost
• Elements of Cost
• Classification of Cost
4.1 Introduction
In previous units we discussed about the various aspects of Financial
Accounting starting with the identification and recording of transactions till the
preparation of final accounts to know the profit or loss of the business. However,
financial accounting deals with historical data, reveals only the overall business
result rather than department or group wise, and doesn t classify the cost with its
various sub classification. Cost accounting has been developed as a means of
overcoming the limitations of financial accounting and also to provide detailed
Depreciation Accounting, Final Accounts and Elements of information regarding
the classification of cost and cost ascertainment. In this unit, you will learn about
the various elements of cost and its classification.
4.2 Meaning of Cost
The dictionary meaning of cost is „a loss or sacrifice , or „an amount paid
or required in payment for a purchase or for the production or up keep of
something, often measured in terms of effort or time expended . C I M A
Terminology defines cost as „resources sacrificed or forgone to achieve a specific
objective . Cost is generally measured in monetary terms. Cost is the amount of
expenditure (actual or notional) incurred on or attributable to, a specified thing or
activity. Thus, material cost of a product will mean the expenses incurred in
227
RECTIFICATION OF procuring, storing and using materials in the product. Similarly, labour cost will
ERRORS, BILLS OF represent that part of payment made to the workmen for time spent on the product
EXCHANGE, during its manufacture.
ACCOUNTING FOR Check your progress 1
HIRE PURCHASE &
1. _______is resources sacrificed or forgone to achieve a specific objective.
ELEMENTS OF COST
a. cost b. price
c. money
4.3 Various Elements of Cost
The various components of cost can be broadly classified into three
categories.
1. Material : It is the cost of raw materials purchased by the firm.
2. Labour : It is the amount of remuneration paid to the employees in the form
of wages, salaries, bonus, commission, etc.
3. Expenses : It is the cost of various services availed by the firm e.g., electricity,
rent, stationery, etc.
The above classification of cost is broad based and general. For cost
accounting purposes, these cost need to be further sub classified. These costs are
explained below.
Fig. 3.1 : Elements of Cost

1. Materials :
The original product from which the final product is manufactured is the
material. It may be in raw or semi manufactured state. Material may be Direct and
Indirect.
Direct material is material identified with or allocated to cost centers and
cost units. It is the raw or semi finished material out of which a product is
manufactured. For example, leather shoes are produced out of leather, butter is
produced out of milk, and steel utensils are produced out of stainless steel and so
on. Thus, leather, milk and stainless steel are the direct materials for the manufacture
of shoes, butter and steel utensils respectively.
Unlike direct material, another kind of material may be required for
manufacturing. For example, machines used for production require lubricants, jute
and cotton wastes etc. which are indirect materials.
228
Direct material is a component of prime cost and indirect material is a
ELEMENT
component of factory overhead. Direct material directly varies with the output
OF COST
whereas indirect material does not.
2. Labour :
To convert the raw materials into finished goods, human effort is required
which is called labour. Labour can be Direct and Indirect.
Direct wages are the wages which are allocated to cost centres and cost
units. They are wages paid to the workers who produce goods. In manual work,
the worker is the one who produces goods. When work is done by a machine,
the person who collects input and output and in whose Depreciation Accounting,
Final Accounts and Elements of Cost account the output is credited for the purpose
of payment of wages is direct worker.
Other workers help direct workers in supplying materials, power, supervision
and maintenance. These are indirect workers and wages of indirect workers at
different stages of production are indirect wages. Direct wage is a part of prime
cost while indirect wage is a part of factory overhead. The former directly varies
with the output whereas the latter may not vary so.
3. Expenses : Cost incurred on items apart from materials and labour is
grouped under the heading of expenses.
Apart from direct material and direct labour, there are expenses that might
be necessary for a particular production. This expense is called direct expense
and can be easily identified with or allocated to cost centres or cost units. For
example, when an order is received, a manufacturer will have to prepare a mould
exclusively for this purpose. The cost of the mould will be direct expense of the
production. Similarly, the charge for hiring a special plant for production is also
direct expense and it can be and allocated to cost centres or cost units. The cost
of preparing blue print for a production is another example of direct expense.
The expenses which cannot be related with indirect material or indirect
labour are called indirect expenses. These are expenses which cannot be identified
or linked with a particular cost centre or cost unit. For example rent, rates,
depreciation on fixed assets, insurance, etc. overhead is the indirect expense
incurred at different levels of activities of an enterprise. These expenses cannot be
conveniently identified with or allocated to cost centres or cost units. For a
manufacturing concern, overheads can be grouped under three categories.
a. Factory overheads : Factory or works overhead refers to all indirect
expenses of a factory. It includes the following :
• Wages of all factory staff excluding those of direct workers
• Indirect material
• Rent
• Rates
• Taxes of factory
• Depreciation of factory assets
• Excise duty
229
RECTIFICATION OF • Canteen expenses
ERRORS, BILLS OF • Labour welfare expenses
EXCHANGE,
b. Office and administrative overheads : All expenses related to general
ACCOUNTING FOR
administration. In administrative building, following things are included:
HIRE PURCHASE &
ELEMENTS OF COST • Salary of administrative staff
• Rent
• Rates
• Taxes of administrative accommodation
• Postage
• Telegram and telephone
• Stationery
• Lighting of administrative building
• Depreciation of office appliances
• Depreciation of office appliances, etc. is included in administration
overhead.
c. Selling overhead : All expenses related to sales. In selling overhead,
following things are included:
• Salary of sales staff
• Traveller s commission
• Advertisement
• Rent
• Rates
• Taxes of sales office
• Depreciation of sales office appliances
• Cost of participation in industrial fares and exhibitions
• Cost of free gifts
• Cost of free after sales service
• Normal bad debt
d. Distribution Overhead : All expenses related to the delivery of a product
after the sale is done. In distribution overhead, following things are included:
• Delivery van expenses
• Fright and insurance
• Packing for delivery loading and unloading
• Salary of the delivery men
• Customs duty
1. material is material identified with or allocated to cost centres and cost units.
a. Direct b. indirect
230
4.4 Classification of Cost ELEMENT
The different costs can be grouped according to their common characteristics. OF COST
They are :
1. Nature/Elements
2. Functions
3. Behaviour
4. Controllability
5. Normality
6. Time
7. Capital/Revenue
1. Nature/Elements : On the basis of nature or elements, costs can be
classified into three categories i.e. materials, labour and expenses. These
costs are further sub classified as direct and indirect. This classification of
cost has already been discussed in the earlier paragraphs.
2. Functions : In an organization which manufacture and sell goods, four
main costs are incurred i.e. manufacturing, office and administration, selling
and distribution and research and development. The first three types of
cost have already been discussed. Research and development cost is
explained below.
Research and development cost : Research cost is the cost incurred for
the improvement of the existing product or development of new product of
methods of new application of materials. Development cost involves the
cost of putting the research results on commercial basis.
3. Behaviour : Due to change in the volume of production, there are changes
in the level of cost. Such costs can be classified as fixed cost, variable cost
and semi variable cost. Fixed costs are the ones which have to be paid for
any level of production. Example, rent of the factory building. Variable costs
vary with the change in the production level. Example direct material cost.
Semi variable costs are the ones which partly vary and partly remain fixed
with the changes in the volume of production. For example, electricity bill.
If the volume of production is increased the use of electricity will also increase
which would result in the increased electricity bill. If the volume of production
decreases the use of electricity will also decrease which would result in the
reduced electricity bill. If there is zero production, still a fixed amount of
electricity rental has to be paid. Thus, the rent portion of the electricity bill
is fixed cost and the usage of the power is a variable cost.
4. Controllability : Costs can be either controllable or uncontrollable.
Controllable cost is affected by the actions of the people associated with it.
Such costs are within the control of management. The management can
decide how much is to be spent on the particular cost. Examples are direct
material, direct labour and direct expenses. Uncontrollable costs are beyond
the control of management. Most of the fixed costs are uncontrollable in
nature. For example the rent of the factory premises is fixed and has to be
paid whether there is production or not.
231
RECTIFICATION OF 5. Normality : Costs which are normally incurred to produce a certain level
ERRORS, BILLS OF of output is referred to as the normal cost. However, in abnormal situation
EXCHANGE, where cost need to be incurred even if there is no production, is referred to
ACCOUNTING FOR as the abnormal cost. For example, payment of wages to workers even
HIRE PURCHASE & when they have gone on strike. Abnormal cost is not included in cost of
ELEMENTS OF COST production, but recorded in the costing profit and loss account.
6. Time : Costs can be historical or predetermined. Historical cost is the one,
which is ascertained after its occurrence. Example, after purchasing the raw
materials, the cost of materials consumed is ascertained. Predetermined or
estimated costs are the ones which are computed in advance. They can also
be referred to as the forecasted cost.
7. Capital and revenue : Any cost incurred for buying an asset is referred to
as the capital cost. Example cost of heavy machinery purchased to produce
goods. Capital cost is incurred to increase the earning capacity of the
business. In order to maintain the machinery certain costs need to be incurred
like repairs, renewals and overhauling. These costs are referred to as the
revenue cost.
1. cost is affected by the actions of the people associated with it. Such costs
are within the control of management.
a. controllable b. uncontrollable
4.5 Let Us Sum Up
In this unit we studied about the elements of cost. We learnt the dictionary
meaning of cost is „a loss or sacrifice , or „an amount paid or required in payment
for a purchase or for the production or upkeep of something, often measured in
terms of effort or time expended . Cost is generally measured in monetary terms.
Cost is the amount of expenditure (actual or notional) incurred on or attributable
to, a specified thing or activity. We even came to know about the various elements
of cost which can be broadly categorised into three which are as under.
Material, Labour, Expenses
Best efforts have been made to explain these topics to the readers. The
readers will get a detailed insight about the cost and its elements. There are so
many types of cost, each of these cost have been explained in the detail with
example.
Answers: (1–a)
Answers: (1–c)
Answers: (1–a)
Answers: (1–b)
Answers: (1–a)
232
4.7 Glossary ELEMENT
1. Suspense Account : A temporary account used to force a trial balance to OF COST
balance if there is only a small discrepancy (or if an account’s balance is
simply wrong and one do not know why).
2. Trading Account : An account, which shows the gross profit or loss of a
manufacturing or retail business, i.e. sales less the cost of sales.
3. Trial Balance : A statement showing all the accounts used in a business
and their balances.
4.8 Assignment
Explain the elements of cost in context to Car as a Product.
4.9 Activities
Distinguish between fixed, variable and semi–variable cost.
4.10 Case Study
Distinguish between capital and revenue cost.
1. Rent is a _____ type of expense.
(a) Material (b) Labour
(c) Administrative (d) Selling & Distribution
1. ______ costs are to be paid for any level of production
(a) Production (b) Fixed
(c) variable
1. Prof. P. R. Bhonde and Dr. Shirish Limaye: Cost and Works Accounting.
2. Fundamentals Of Cost Accounting, Maheshwari Sn, Sultan Chand & Sons,
2007.
3. Cost Accounting, Jain S P, Narang K L, Kalyani, 2007.
4. Cost Accounting, Jawaharlal, McGraw Hill education, 2008
233
RECTIFICATION OF Block Summary
ERRORS, BILLS OF
After reading this block the readers would have got a detailed insight of
EXCHANGE,
topics such as rectification of errors, bills of exchange, accounts for hire purchase
ACCOUNTING FOR
and elements of cost. All these topics have been explained by the writers in them
HIRE PURCHASE &
best possible way.
ELEMENTS OF COST
After reading this block the best efforts were made by the writer to make
the students understand the basic concepts of all these topics. Sufficient theory
along with suitable illustrations, numerical were given to make the students
understand the topics. Apart from this the student were made to understand about
the various topic such as rectification of errors, bills of exchange, accounts for hire
purchase and elements of cost.
Each topic focuses on individual aspect of accounting such as rectification
talks about the changes to be done in the errors made while making the accounts.
Bills of exchange talk about the different instruments needed today to make any
credit transactions and how they turn out to be beneficial for the business. Hire
purchase throws some light on the different method used by business to purchase
goods while the payment is done in the instalments with certain conditions for the
buyer as well as seller. And lastly the elements of cost help understand students the
different kinds of costs and on which basis they are differentiated in the business.
234
Block Assignment

1. Discuss entries passed for Hirer and Vendor
2. What is Hire Purchase
3. Define Promissory Note
4. Days of grace
5. Down payment
6. Fixed and variable cost

1. Discuss the errors affecting trial balance
2. Explain the dishonor of a bill
3. Differentiate between Hire Purchase and Instalment system
4. Discuss the types of cost along with examples.
5. Difference between promissory note and bills of exchange
235
RECTIFICATION OF
ERRORS, BILLS OF Enrolment No :
EXCHANGE, 1. How many hours did you need for studying the units?
ACCOUNTING FOR
HIRE PURCHASE & Unit No 1 2 3 4
ELEMENTS OF COST Nos of Hrs
2. Please give your reactions to the following items based on your reading of
the block :

………………………………………………………………………………………………
………………………………………………………………………………………………
………………………………………………………………………………………………
………………………………………………………………………………………………
………………………………………………………………………………………………
………………………………………………………………………………………………
………………………………………………………………………………………………
………………………………………………………………………………………………
236
DR.BABASAHEB AMBEDKAR
OPEN UNIVERSITY
'Jyotirmay' Parisar,
Sarkhej-Gandhinagar Highway, Chharodi, Ahmedabad-382 481.
Website : www.baou.edu.in

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BLOCK-1 BASICS OF ACCOUNTING

Unit1: Accountancy Meaning and Scope

Unit2: Journal and ledger

Unit3: Subsidiary Books

Fig 1.1 Information need of an organization

Fig 1.2 Activities in Accounting Process

Type Represent As for illustrations

Tangibles - Plant and Machinery,

Individuals, Partnership Firms,

To recognise the implications

As for illustration 1: Classify the following accounts:

Fig 1.3 Debit and Credit Rules

Fig 2.1 Accounting Cycle

Cash a/c Dr10000 Stock a/c Dr 10000

2 Purchased Machinery from Kulkarni Purchased Machinery from

To Mr Kulkalrni?s a/c 15000

(Being machinery purchased from

Check your progress 3

Date Particulars Ledger Folio Amount (Dr) Amount(Cr)

1. Date: Recording Date and Year of transaction.

Bank A/c Dr. 30,000 -

Cash A/c Dr. 10,000 -

Purchases A/c Dr. 4,000 -

Cash A/c Dr. 2,750 -

Wages A/c Dr. 5,000 -

Drawings A/c Dr. 5,000 -

Computer A/c Dr. 22,000 -

Check your progress 4

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

Check your progress 7

Dr. Journal Cr.

1 Bank A/c Dr 2, 00,000 -

Cash A/c Dr 40,000 -

(Being capital invested)

fittings and van for the

(Bein g rent paid by cheque)

5 Cash A/c Dr 5,000

(Being goods sold for cash)

To cash A/c 1,000

(Being wages paid to assistant)

To Bank A/c 500

(Being insurance paid by cheque)

To Sales A/c 8,000

(Being goods sold for cash)

To Cash A/c 1,000

(Being wages paid in cash)

To Returns Outwards A/c 6,000

(Being goods returned)

To Bank A/c 30,000

19 Purchases A/c Dr 25,000

(Being goods sold for cash)

To Cash A/c 1,000

24 Stationery A/c Dr 500

25 Cash A/c Dr 15,000