Accounting Principles & Assumptions

Generally Accepted Accounting Principles

• Basic assumptions underlying the theory and practice of financial accounting

• Broad working rules for all accounting activities and developed by the accounting
profession.

The Basic Accounting Concepts are:

1. Accounting Entity Concept-: According to this Assumption business is treated as
unit or entity apart from its Owner, Creditors and others. Even the Proprietor of
the business is considered to be separate and distinct from the business which he
controls. He is treated as a Creditor to the extent of his Capital.

2. Money Measurement Concept-: In Accounting, only those business transactions

and events which are of financial nature are recorded.

3. Going Concern Concept: According to this Assumption the business will exist for
a long period and transactions are recorded from this point of view. There is
neither the intention nor the necessity to wind up the business in the
foreseeable future.

4. Cost Concept (Historical Cost Concept)-: Under this Concept assets are recorded
at the price paid to acquire them and this cost is the basis for all subsequent
accounting for the Asset.

5. Dual Aspect Concept: Dual Aspect Principle is the basis for Double Entry System
of Bookkeeping. All business transactions recorded in accounts have two aspects
debit side and credit side.

6. Accounting Period Concept: The accounts are closed at regular intervals. Usually
a period of 365 days or one year is considered as the Accounting Period.

7. Revenue Realisation Concept: According to this Concept, Revenue is considered

as the Income earned on the date when it is realised. Unearned or unrealized
income should not be taken into account.
 8. Accrual Concept: According to this concept, revenues are recognized when they
become receivable though cash is not received, and the expenses are recognized
when they become payable though no cash is paid immediately.

9. Matching Concept-: Matching the revenue earned during an Accounting period with
the cost associated with the period to ascertain the result of the business concern is
called the Matching Concept. Matching Concept is the basis for finding accurate
profit for period.

Profit or income is calculated primarily with the help of 2 items:

Revenue & b) Expense items.
Profit = Revenue – Expense
For profit (loss) determination, the revenue and the expense incurred to earn the
revenue must belong to the same accounting period.

10. Verifiable and Objective Evidence Concept-: This Principle requires that each
recorded business transactions in the books of accounts should have an
adequate evidence to support it.

MODIFYING PRINCIPLES: -
1. Cost benefit Principle-: This modifying Principle states that the cost of
applying a principal should not be more than the benefit derived from it.

2. Materiality Convention-: The Materiality Convention requires all relatively

relevant information should be disclosed in the Financial Statements. The
immaterial information are either left out or merged with other items.

3. Consistency Convention-: The same accounting practices will be used for

similar items from one accounting period to another. The aim of Consistency
Convention is to preserve the compatibility of Financial Statement.

4. Prudence Convention (Conservatism Convention)-: Prudence Convention

takes into consideration all prospective losses but leaves all perspective
profits. The essence of this Principle is "anticipate no profit and provide for all
possible losses".

5. Full Disclosure Concept-: Accounting Statements should disclose fully and

completely all the significant information.
 Introduction to Accounting
Why Accounting is required?
The businessman wants to know:-

1. What has happened to his business?

2. What are the earnings and expenses?
3. What is result of the business transactions?
4. How much amount is receivable from customers to whom goods have been sold on
credit? etc.

Definition: Accounting is defined as the process of identifying, and communicating

economic information to permit informed judgement and decisions by users of the
information.

Accounting Embraces the Following Functions:

1.Identifying-: From the source documents.
2.Recording-: In Journal or Subsidiary Books
3.Classifying-: To group the transactions of similar type at one place, that is, in
Ledger accounts.
3.Preparing Trial Balance to verify the arithmetical accuracy of the accounts.
4.Summarising-: Preparation of Profit and Loss Account and Balance Sheet.

5.Analysing-: The purpose of analysing is to identify the financial strength and weakness of
the business.

6. Interpreting
7.Communicating-: Result is communicated to the interested parties.

Accounting Overview:
When a businessman starts his business activities, he records the day-to-day transactions in
the journal. From the Journal the transactions further move to the Ledger where accounts
are written up.
To prove the accuracy of the work done, these balances of Ledgers are transferred to a
statement called Trial Balance. Preparation of Trading and Profit and Loss Account is the
next step. The balancing of Profit and Loss account gives the net result of the business
transactions. To know the financial position of the business concern Balance Sheet is
prepared at the end.

Users of Accounting Information-:

1. Internal user -: Those individuals or groups who are within the organization like:

a) Owners-: to know the Profitability and financial soundness of the business.

b) Management- to take the decisions to manage the business efficiently.
c) Employees and Trade Unions- to form judgement about the earning capacity of the
business since their remuneration and bonus depend on it.

2. External user -: Those individuals or groups who are outside the organisation like
creditors, investors. Some of them are:
a) Present investor- to know the position and prosperity of the business in order to ensure

the safety of their investment.

b) Potential investor-: To decide whether to invest in the business or not.
c) Government & Tax Authorities-: To know the earning in order to assess the tax
liabilities of the business.
d) Regulatory Agencies
e) Researchers
f) Banks-: To determine whether the principal and the interest thereof will be paid in
when due.

Limitations Of Financial Accounting:

1. Accounting is not fully exact: Although most of the transactions are recorded on the basis
of evidence, some estimates are also made for ascertaining Profit or Loss.
2. Accounting does not indicate the realisable value. Balance Sheet does not show the
amount of cash which the firm may realise by the sale of all the assets, because many assets
are not meant to be sold.
3. Accounting ignores the qualitative elements. Accounting is confined to monetary
matters only.
4. Accounting may lead to window dressing: Window dressing means manipulation of
account.
5. Financial Accounting does not provide detailed analysis.
 Basic Accounting Terms

Transactions: Those activities of a business which involve transfer of money or goods or

services between two persons or two accounts.

Cash Transactions: Cash Receipt or Cash Payment is involved in the transaction.

Example: Ram buys goods from Shyam paying the price of goods by cash immediately.

Credit Transactions: Cash is not involved immediately but will be paid later or received
later.

Proprietor: A person who owns a business is called Proprietor. He contributes Capital to the
business with the intention of earning Profit.

Capital: An amount invested by Proprietor (Owner) in his business.

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

Asset: Properties of every type belonging to the business.

Example: Cash, Plant & Machinery, Furnitures, Bank Balance, etc.

Tangible Assets: Assets having physical appearance. It can be seen and touched. Example:
Plant & Machinery, Cash, etc.
Intangible Assets: Assets having no physical existence but their possession give rise to some
sort of rights & benefits to the owner. It cannot be seen and touched. Example: Goodwill,
Patent, Copyright, etc.
Liabilities: Financial obligations of a business. These are the amount which a business owes
to others. Example: Loan from Bank or other persons, Creditors for goods supplied, Bank
overdraft, etc.
Debtors: A person which receives goods or service without giving money immediately but is
liable to pay in future is a debtor.
Example: Mr. A bought goods on credit from Mr. B for Rs. 10,000. Mr. A is debtor to Mr. B
till he pays the value of the goods.

Creditors: A person who gives a benefit without receiving money but he will take it in future
is a Creditor.

Purchases: Purchases refer to the amount of goods bought by a business for resale or for
use in the production.

Cash Purchases & Credit Purchases

Purchase Return or Return Outward:

When goods are returned to supplier due to defective quality or not as per the terms of
purchase, it is called Purchase Return.
Sales: Amount of goods sold that are already bought or manufactured by the business.

Cash Sale:
Credit Sale:

Sales Return or Return Inwards: When goods are returned by customers due to defective
quality or not as per the terms of sale, it is called Sales Return.

Stock: Stock includes goods unsold on a particular date.

Opening Stock:
Closing Stock:
Revenue: Revenue means amount receivable or realized from sale of goods and earning
from interest, dividend, commission, etc.

Expense: It is an amount spent in order to produce and sell the goods and service. Example:
Purchase of Raw Material, Payment of Salaries, etc.
Income = Revenue - Expense
 Single Entry & Double Entry System
1.Single Entry System is an incomplete, inaccurate, unscientific and
unsystematic system of book keeping.
2.The double aspects of business transactions are not recorded.
3.It maintains only personal and cash accounts. Real and nominal accounts
are not maintained. Therefore Balance Sheet & Profit & Loss Account cannot
be prepared.
4.Trial Balance cannot be prepared.

Date Particulars Revenue Expenses

8 April Salary Rs. 3,000

25 April Purchase of Goods Rs 18000

27 May Sale of Goods Rs 10890

5.It is a defective double entry system used by small trading concerns.

6.True financial position & Performance of the business cannot be
ascertained.
7.This system lacks uniformity as it is a mere adjustment ofdouble entry
system, according to the convenience of the individual. Therefore, profit
under this system is only an estimate.
8.Not accepted by tax authorities.
9.For information one has to depend on original vouchers. For example to
know total purchases and sales, one has to depend on copies of invoices.
10.All business transactions are notrecorded in the books of account. Some of
them are recorded in the books of accounts, certain transactions are noted in
the diary and some of them are in the memories.
11.Comparison with previous years performance is not possible.
12.Difficulty in obtaining loan
13.Difficult to locate frauds

14.Difficult to determine the price of the business

15.Suitable for small traders.
Double Entry System:
The basic principle of the system is, for every Debit, there must be a
corresponding Credit of equal amount and for every Credit, there must be a
corresponding Debit of equal amount.
Features of Double Entry System
• Every business transaction affects two accounts
• Each transaction has two aspects that is Debit and Credit.

• It is based upon Accounting assumptions concepts and principles.

• Helps in preparing Trial Balance which is a test of arithmetical accuracy
in Accounting.
• Preparation of Final Accounts with the help of Trial Balance.
Advantages of Double Entry System
• Scientific system
• Complete record of transaction

• Check on the accuracy of accounts: By the use of this system the

accuracy of the Accounting work can be established by the
preparation of Trial Balance.

Advantages of Double Entry System

• Ascertainment of profit or loss: The profit earned or loss occured
during a period can be ascertained by the preparation of profit and
loss account.

• Financial position: The financial position of the concern can be

ascertained through the preparation of balance sheet.
• Comparative study: The result of 1 year may be compared with those
of previous years and the reasons for change may be ascertained.
• Helps in decision making: The management may be able to obtain
sufficient information for its work, especially for making decisions.
Weaknesses can be detected and remedial measures may be applied.
• Detection of fraud: The systematic and scientific recording of business
transactions on the basis of this system minimise the chances of fraud.

System Of Accounting
• Cash System Of Accounting
• Accrual System Of Accounting
 Classification of Accounts &
Golden Rules Of Accounting

Classification of Accounts:
1. Personal accounts- The accounts that relates to person.
Personal accounts include the following:
Natural Person-: Accounts which relate to individual. For eg. Amit’s
Account, Shyam's Account etc.
Artificial Persons-: Accounts which relate to firms or institutions or
corporations etc. Eg., Pepsico India Ltd., State Bank Of India, Life
Insurance Corporation of India, etc.
Representative Persons-:Eg. prepaid insurance account,
outstanding salary account.
Note-: The proprietor being an individual, his Capital Account and his
Drawing Account are also Personal Account.

Real Accounts-: Accounts relating to properties and assets which are

owned by the business concern. Real accounts include tangible and
intangible accounts. For example, land, building, goodwill, purchases.

Nominal Accounts-: These accounts do not have any existence,

form or shape. They relate to incomes and expenses and gains and
losses of a business concern. For example, salary account, dividend,
discount, etc.

Salary Account
Electricity Bill Account
Rent Account
Proprietor’s Account
Patents Account
Golden Rules Of Accounting
Personal Account: Debit the receiver, Credit the giver.
Real Account: Debit what comes in, Credit what goes out.
Nominal Account: Debit all expenses and losses, Credit all incomes
and gains.
Note: The classification of accounts and Golden Rules of Accountancy
should be remembered very well.
 Journal

The first step in accounting is the recording of transactions in the

books of accounts. The origin of a transaction is derived from the
source document.
Books of Original Entry:
The books in which a transaction is recordedfor the first time
from the source document are called Books of Original Enty or
Prime Entry. Example: Journal, Cash Book, etc.

Journal: Journal is a book in which a transaction is recorded for the

first time from a source document.In Journal all the transactions
are recorded chronologically (date-wise).
Journal is also called Books of Original Entry or Prime Entry.
Ledger folio (L.F.): In this column the number of theledger page is
written to which the amount is posted in the ledger

Format of Journal
Date Particulars L.F. Debit Amt. Credit Amt.
(Rs.) (Rs.)
Source Document:
Evidence of business transaction.
Written and authentic proof of thecorrectness of the
recorded transactions.
Required for audit and tax assessment.
Also serve as the legal evidence in case of a dispute.
Some Common Source Document:
Cash Memo: When a trader sells goods for Cash, hegives a Cash
Memo and when he purchases goods for Cash, he receives a Cash
Memo.

Journal
Transaction 1:
a) Started or commenced business with Rs20000.
b) Goods purchased for Rs. 9,000 Or Cash purchases Rs. 9,000
c) Goods returned to Mohan Or Mohan admitted our claim for Rs.
100
d) Cash sales for 7000 Or Goods sold to Mohan for cash
e) Goods sold to Mohan for 4000 or Goods sold to Mohan on credit
f) Goods of Rs 100 returned by Mohan
g) Furniture purchased for Rs 12000
h) Salaries paid Rs 1200
i) Rent Received Rs 200
j) Amount withdrawn for personal use Rs 150
g) Goods withdrawn for personal use Rs 100

Some Common Source Document:

Invoice or Bill: When a trader sells goods on Credit,he prepares a
Sale Invoice. It contains full details relating to the amount, terms of
payment and the name and address of the seller and buyer. The
original copy of the Sale Invoice is sent to the Purchaser and its
duplicate copy is kept for making records in the books of accounts.
Receipt: When a trader receives Cash from a customer, he issues a
receipt containing the date, the amount and the name of the
customer. Theoriginal copy is handed over to the customer and the
duplicate copy is kept for record. In the same way when we make
payment we obtain a receipt from the party to whom we make
payment.
Debit Note: Debit Note is prepared by the buyer and it contains the
date of the goods returned, details of the goods returned and
reasons for returning the goods. A duplicate copy or counterfoilof
the Debit Note is retained by the buyer.

Credit Note: A Credit Note is prepared by the seller and it contains

the date on which goods are returned, name of the customer, deals
of the goodsreceived back, amount of such goods and reasons for
returning the goods.
Pay In Slip: Pay In Slip is a form available in banks and is used to
deposit money into a bank account. Each Pay in slip has a
counterfoil which is returned to the depositor duly sealed and
signed by the bankofficial.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Journal

Accounting Equation
Accounting Equation is based on dual aspect concept. According to
Accounting Equation, the total Liabilities (claims) will be equal to
the total Assets of the business concern.
Asset= Capital +Liabilities
Assets= Equity
Q.) Aman started business with Rs. 50,000 as capital.
We can express this transaction in the form of accounting
equation as follow:
Asset = Capital + Liabilities
Cash = Capital + Liabilities
50,000=50,000+ 0

Q.) Aman purchased furniture for cash Rs. 5,000.

The accounting equation is as follow:

Asset = Capital + Liabilities

Cash + Furniture = Capital + Liabilities
50,000 + 0 = 50,000 +0
(-)5,000 + 5000 = 50,000 +0

There are two approaches to Double Entry Transactions:

1. Accounting Equation Approach
2. Traditional Approach
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Accounting Equation Approach:

The rules may be summarised as follows:
1. Increase in assets are debits;
Decrease in assets are credits.

2. Increase in capitals are credit;

Decrease in capitals are debit

3. Increase in liabilities are credit;

Decrease in liabilities are debit

4. Increase in incomes and gain are credit;

Decrease in incomes and gain are debits.

5. Increase in expenses and losses are debited;

Decrease in expenses and losses are credits.

In traditional approach, all the Accounts are classified into the

following three types.
a. Personal Accounts
b. Real Account
c. Nominal Accounts
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775
 Ledger
Accounting involves recording, classifying and summarising
financial transactions. Recording is done in the Journal and
classification of the recorded transactions is done in the Ledger.
The Journal doesn't provide all the information regarding a
particular account at one place. Hence, to know the summary
of individual accounts Ledger is prepared.
The book which contains a classified and permanent record of
all the transactions of a business is called the Ledger.
Ledger is a main book which is also called the 'Book of
Secondary Entry', because the transactions are finally
incorporated in the Ledger.

Advantage:
1. Complete information at a glance.
2. Helps in preparing Trial Balance.
3. It facilitates the preparation of final accounts for ascertaining
the Operating Result and the Financial Position of the business
concern.

Posting
The process of transferring the entries recorded in Journal or
the Subsidiary Books to the respective accounts opened in the
Ledger is called Posting. (writing entries in Ledger is called
Posting).
Accounting Equation
Accounting Equation is based on dual aspect concept.
According to Accounting Equation, the total Liabilities (claims)
will be equal to the total Assets of the business concern.
Asset=Capital+Liabilities

Assets= Equity

Q.) Aman started business with Rs. 50,000 as capital.

We can express this transaction in the form of accounting
equation as follow:
Asset = Capital + Liabilities
Cash = Capital + Liabilities
50,000=50,000+ 0
Aman purchased furniture for cash Rs. 5,000.

The accounting equation is as follow:

Asset = Capital + Liabilities
Cash + Furniture = Capital + Liabilities
50,000 + 0 = 50,000 +0
(-)5,000 + 5000 = 50,000 +0
There are two approaches to Double Entry Transactions:

1.Accounting Equation Approach

2.Traditional Approach

Accounting Equation Approach:

The rules may be summarised as follows:
1.Increase in assets are debits;
Decrease in assets are credits.
2. Increase in capitals are credit;
Decrease in capitals are debit
3.Increase in liabilities are credit;
Decrease in liabilities are debit
4.Increase in incomes and gain are credit;
Decrease in incomes and gain are debits.
5.Increase in expenses and losses are debited;
Decrease in expenses and losses are credits.

In traditional approach, all the Accounts are classified into the

following three types.
a. Personal Accounts
b. Real Account
c. Nominal Accounts
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Subsidiary Books

Subsidiary Books
For businesses having large number of transactions it is practically
impossible to write all transactions in one Journal. To address this
issue Subsidiary book is maintained.

Kinds of Subsidiary Book:

1. Purchase Book- Records only credit purchases of goods.
2. Sales Book- Records only credit sales of goods.
3. Purchase Return Book- Records the goods returned by the
trader (out of previous purchases) to supplier.
4. Sales Return Book- Records the goods returned by the
customer (out of previous sales).

5. Cash Book- Records only cash transactions, ie. cash receipt and
cash payment.
6. Bills Receivable Book- Records the receipt of bills (Bills
Receivable).
7. Bills Payable Book- Records the receipt of bills (Bills Payable).
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

8. Journal Proper- Records all the transactions which cannot be

written in any of the above mentioned subsidiary books.

Bad Debts-: When the goods are sold to customer on Credit and if
the amount becomes irrecoverable due to his insolvency or for
some other reason, the amount not recovered is called bad debts.
For recording it, the bad debt account is debited because the
unrealized amount is a loss to the business and the customers
account is Credited.

Bad debts recovered-: Sometimes, the bad debts previously

written off are subsequently recovered. In such a case, cash
account is debited and bad debts recovered account is Credited
because the amount so received is gain to the business.

Discount: A Reduction in Amount

Trade Discount: This discount is given by seller to buyer if the
buyer purchases in bulk. It is not shown in the books. Only
discount amount will be reduced.
Example: M/s KT Enterprises sold 500 pens to its customer, Mr. A.
The retail price is Rs.10/pen. M/s KT Enterprise gave 20%
discount to its customer. Thus the total retail price of Rs. 5,000
(500*10) will be reduced to Rs. 4,000 (500*8). Here, the trade
discount is Rs. 1,000.

Discount: A Reduction in Amount

Cash Discount:A cash discount is a deduction allowed by some
sellers of goods or by some providers of services in order to
motivate customers to pay within a specified time. The cash
discount is also referred to as an early payment discount.
This Discount will be shown in the books as it is loss to the seller.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Treatment of Cash Discount allowed: Always Debit Cash

Discount

Treatment of Cash Discount received: Always Credit

Cash Discount

Let’s understand it through an example and Journal Entry:

On 15-6-18 M/s MP Enterprises sold 50 pens to its customer, Mr. X
on credit. The retail price is Rs.10/pen. M/s MP Enterprise gave
20% discount to Mr. X on early payment as he paid the money on
18-6-18. Here, the cash discount is Rs. 100.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Trial Balance

TRIAL BALANCE AND RECTIFICATION OF ERRORS

After Recording and Classifying the transactions, the next step is to
check arithmetical accuracy of the transactions recorded. Trial
Balance is a statement which shows debit balances and credit
balances of all accounts present in the ledger. Since, every debit
should have a corresponding credit as per the rules of double
entry system, the total of the debit balances and the credit
balances should tally.

Note:
1. Trial balance can be prepared on any date.
2. Trial Balance is made from Ledger & Subsidiary Books.
3. The purpose to prepare trial balance is to check the arithmetical
accuracy of the accounts.

Objectives Of Trial Balance:

1. To check the arithmetical accuracy of the Ledger Account.
2. To locate the Errors.
3. To facilitate the preparations of Final Accounts (P&L A/c &
Balance Sheet).
4. It is the basis on which Final Accounts are prepared.

Note:
1) A Debit balance is either an asset or loss or expense.
2) A Credit balance is either a liability or income or gain.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Limitations of Trial Balance:-

1. As all the Errors made are not disclosed by the Trial Balance,
it would not be regarded as a conclusive proof of
correctness of the books of accounts maintained.
The fundamental Principle of the double entry system is that
every debit has a corresponding credit of equal amount and
vice versa. The total of all debit balances in different
accounts must be equal to the total of all credit balances in
different accounts, that is, the total of the two columns
should tally.
Illustration: The following balances are extracted from the ledger
of Amit on 31 March 2019. Prepare a trial balance as on that date.

Salaries 36,320 Repairs 1670

Purchases 1,44,670 Capital 1-4-19 62,500
Sales 1,73,500 Sundry Expenses 460
Sundry Debtors 1,430 Drawings 3,500
Plant & Machinery 34,300 Returns Inward 1,000
Travelling Expenses 2,630 Cash at Bank 1,090
Commission Paid 1,880 Discount Allowed 1,150
Carriage Inward 240 Returns Outward 400
Stock on 1-4-19 11,100 Rent and Rates 3,220
Sundry Creditors 14,260 Investments 6,000
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Trial Balance-Kind of Error & Rectification of

Error
Kinds of Error: 1) Errors of Principle and 2) Clerical Errors
Errors of Principle: Transactions are recorded as per Generally
Accepted Accounting Principles (GAAP). If any of these Principles
is violated or ignored, Errors resulting from such violations are
known as Errors of Principle.
Eg.- Purchase of assets recorded in the Purchases Book.

Note: A Trial Balance will not disclose Errors of Principle.

Clerical Errors: These Errors arise because of mistake committed in

the ordinary course of accounting work. These can be further
classified into:
a) Errors of Omission b) Error of Commission

Errors of Omission: This Error arises when a transaction is

completely or partially omitted to be recorded in the books of
accounts. Errors of Omission may be classified as below:
1. Error of Complete Omission 2. Error of Partial Omission

1. Error of Complete Omission: Example, goods purchased but not

completely recorded. This
Error does not affect trial balance.

2. Error of Partial Omission: This Error arises when one aspect of

the transaction, either debit or credit is recorded. Example - a
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Credit sale of goods to Shiva recorded in sales book but not posted
in Siva's account. This Error affects the Trial Balance.

Error Of Commission: This Error arises due to wrong Recording,

wrong Posting, wrong Casting, wrong balancing, wrong carrying
forward. Error of commission may be classified as follows: (i) Error
of Recording (ii) Error of Posting

Error Of Recording: This Error arises when a transaction is wrongly

recorded in the Books of Original Entry. Eg.- goods of Rs. 5000
purchase on credit from Ravi, is recorded as Rs. 5500.

Note: This Error does not affect the trial balance.

(ii) Error of Posting: This Error arises when information in the

books of original entry are wrongly entered.
a) Right amount in the right side of wrong account.
b) Right amount in the wrong side of correct account.
c) Wrong amount in the right side of correct account.
d) Wrong amount in the wrong side of correct account.
e) Wrong amount in the correct side of wrong account.
f) Wrong amount in the wrong side of wrong account.

Note: This Error may or may not affect the Trial Balance

Error of Casting (totalling): This Error appears when a mistake is

committed while totalling an account. Eg.- A total of Rs. 12,000
may be wrongly totalled as Rs. 10,000 is called Under Casting. If it
is wrongly totalled as rupees 13,000 it is called Over Casting.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Error of Carrying Forward - When a mistake is committed in

carrying forward a total of 1 page to the next page. Total of
purchase book in page 282 of the ledger Rs. 10686, while carrying
forward the balance to the next page it was recorded as rupees
10866.

Compensating Error:-The Errors arising from excess debit or under

debit of accounts being neutralized by the excess credit or under
credits to the same extent of some other account is compensating
Error such that the Errors in one direction are compensated by
Errors in another direction.

Example - If the purchase book and sales book are both overcast
by rupees 10000, the Error mutually compensate each other.

Note: 1. This Error will not affect the agreement of Trial Balance.

2. Arithemetical accuracy of the Trial Balance is not at all affected

in spite of such Errors.

Suspense Account: When it is difficult to locate the mistake before

preparing the final accounts, the difference is transferred to newly
opened imaginary and temporary account called Suspense
Account. Suspense Account is prepared to avoid the delay in the
preparation of final accounts. If the total Debit balance of the Trial
Balance exceeds the total Credit balance the difference is
transferred to the credit side of suspense account. On the other
hand, if total credit balances of the trial balance exceed the total
debit balances the difference is transferred to the debit side of the
suspense account.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Suspense account is continued in the book until the Errors are

located and rectified. Such balance will be shown in the balance
sheet. Debit balance will be shown on the assets side and the
credit balance will be shown on the liabilities side. When all the
Errors affecting the trial balance are located and rectified, the
suspense account automatically gets closed.
Note: Types of Errors and Rectification of Errors is very important.
One must memorize well the Errors that are disclosed by trial
balance and the Error that are not disclosed by trial balance.

Illustration:
Rectify the following errors:
1. Purchases from Ravi for Rs. 500 has been posted to the debit
side of his account.
2. Sale to Nihal for Rs.120 has been posted to his credit as Rs.102.
3. Purchase from Simran for Rs.750 has been omitted to be posted
to the personal A/c.

Illustration: The following errors were found in the books of

Sujata. Give the necessary entries to correct them:
1. Salary of Rs. 8,000 paid to Tripti has been debited to her
personal account.
2. Rs.50,000 paid for a laptop was charged to purchases account.
3. Rs.8,000 paid for furniture purchased has been charged to office
expenses account.
4. Repairs made were charged to machinery account for Rs.4,500.
5. An amount of Rs.2,000 withdrawn by the proprietor for his
personal use has been debited to trade expenses account.
6. Rs.2,000 received from Raghu. has been wrongly entered as
from Raghav.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Cash Book
Cash Book is a special journal which is used for recording all Cash Receipts
and Cash Payments. The Cash Book is a book of Original Entry or Prime
Entry since transactions are recorded for the first time from the Source
Documents.
The Cash Book is considered as a Ledger also.
The total of the receipt column (debit side) will always be greater than the
total of the payment column (credit side). The difference will be written on
the credit side as "by balance c/d

Cash Book are of three types:

1) Single Column Cash Book
2) Double Column Cash Book
3) Triple Column Cash Book

Illustration: Enter the following transactions in Single Column Cash Book of

M/s. Mini Pig Co.
1-5-18 Started business with cash Rs. 1,000
3-5-18 Purchased goods for cash Rs. 500
5-5-18 Sold goods for cash Rs. 1,700
7-5-18 Cash received from Juli Rs. 200
8-5-18 Paid Balan Rs. 150
9-5-18 Bought furniture Rs. 200
10-5-18 Purchased goods from Ravi on credit Rs. 2,000

Note: Cash Book is also a Ledger of Cash a/c. The above posting can be
done after writing Journal Entry also.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Illustration: Prepare a double column cash book from the following

transactions of Mr. Atul
5-7-18 Cash in hand Rs. 4,000
6-7-18 Cash Purchases Rs. 2,000
10-7-18 Wages Paid Rs. 40
12-7-18 Cash received from Sidhu Rs. 1,980 and allowed him discount Rs.
20
13-7-18 Cash paid to Soni Rs. 2,470 and received discount Rs. 30
14-7-18 Cash Sales Rs. 6,000

Illustration: Prepare Triple Column Cash Book of Mr. Arush from the
following transactions:
1-6-18 Cash in Hand Rs. 30,000
Bank Balance Rs. 1,000
2-6-18 Ravi, our customer, has paid directly into our bank a/c Rs. 5,000
3-6-18 Paid rent by cheque Rs. 500
4-6-18 Cheque issued to Juneja Rs. 2,400
5-6-18 Recd. from Aman Rs. 2,225 Disc. allowed Rs. 75
6-6-18 Paid into bank Rs. 4,000
7-6-18 Cash withdrawn from bank Rs. 2,000

Note: When cash is deposited into bank, cash balance will decrease but
bank balance will increase. The transaction “Cash deposited into Bank” will
have two side effect on Cash Book. In the debit side of Cash Book, we will
debit Bank Column, whereas in credit side we will credit Cash Column.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Bank Reconciliation Statement

Bank Passbook: Bank Passbook is merely a copy of the customer's account

in the books of a bank. It shows all the deposit, withdrawal and the
balance available in the customer's account. In the Particulars column
Withdrawal and Deposits are recorded.

BANK RECONCILIATION STATEMENT

The balance of the bank column in the double or triple column cash book
represents the customers cash balance at Bank. It should be the same as
shown by his bank passbook on any particular day. For every entry made in
the cash book if there is a corresponding entry in the pass book
(maintained by the banker) or vice a versa, the bank balance will be the
same in both the books.
The Cash book and the Pass book are maintained by two different parties
and hence it is not certain that entry in one book will always have a
corresponding entry in the other. Normally entries in the cash book should
tally (agree) with those in the passbook and the balances shown by both
the books should be the same. In case of disagreement in the balance of
the cash book and the pass book, the need for preparing bank
reconciliation statement arises.

Need of Bank Reconciliation Statement

1. The errors that might have taken place in the cash book in connection
with bank transaction
can be easily found.
2. Regular preparation of bank reconciliation statement prevents frauds.
3. It indirectly imposes moral check on the accounting staff.
4. By the preparation of bank reconciliation statement, uncredited
cheques can be detected and steps can be taken for their collection.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Cause of Disagreement between the Balances shown by the Cash Book

and the Balances shown by the Passbook:
1. Cheques paid into bank but not yet collected.
2. Cheques Issued but not yet presented for payment.
3. Amount credited by the bank in the passbook without the
immediate knowledge of the customer.
4. Amount debited by the bank in the passbook without the
immediate knowledge of the customer.
5. Bank Overdraft:

Bank Overdraft
Bank Overdraft is an amount drawn over and above the actual balance
kept in the bank account. This facility is available only to the current
account holders. Interest will be charged for the amount overdrawn, ie.,
overdraft.
The cash book will show a credit balance that is, unfavourable balance. The
passbook will show a Debit balance.

Case 1: When balance as per cash book favourable is given: Example:

From following details, prepare B R S for M/s ABC as on 31-3-19 to find out
balance as per pass book.
1. Cheques deposited but not yet collected by the bank Rs. 1,500
2. Cheque issued to Mr. Raju has not yet been presented for payment Rs.
2,500
3. Bank charges debited in the pass book Rs. 200
4. Interest allowed by the bank Rs.100
5. Insurance premium directly paid by the bank as per standing
instructions Rs. 500
6. Balance as per cash book Rs. 200
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Case 2) Balance as per pass book (favourable) is given

Prepare Bank Reconciliation Statement and ascertain the balance as per
Cash Book in the following case. Mr. Amit’s Pass Book showed a balance of
Rs. 25,000 on 20-6-2019. His cash book shows a different balance. On
examination, it is found that:
1. No record has been made in the cash book for a dishonour of a cheque
of Rs. 250.
2. Cheques paid into Bank amounting to Rs. 3,500 on 15 June 2019 and the
same had not been entered in the passbook.
3. Bank charges of Rs. 300 have not been entered in the cash book.
4. Cheques amounting to Rs. 9000 issued to Mr. Harish has not been
presented for payment still.
5. Mr. Kishan who owed Rs. 3000 has directly paid the sum into the bank
account.

Case 3) When overdraft as per cash book is given:

Prepare a Bank Reconciliation Statement as at 15-6-2019 for M/s Jyoti
Sales Private Limited from the information given below:
1. Bank overdraft as per cash book Rs. 1,10,450
2. Cheques issued on 8-6-2019 but not yet presented for payment Rs.
15,000.
3. Cheques deposited but not yet credited by bank Rs. 22,750.
4. Bills receivable directly collected by bank Rs. 47,200.
5. Interest on overdraft debited by bank 12,115.
6. Amount wrongly debited by bank 2,400.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Case 4) When Overdraft as per Pass Book is given:

Prepare Bank Reconciliation Statement from the following information and
find balance as per Cash Book.
1) Bank Overdraft as on 31-3-2019 as per pass book Rs. 6,500.
2) Cheques amounting to Rs. 15,000 were paid into Bank out of which,
only cheques amounting to Rs. 4,500 was credited by the bank.
3) Cheques issued during March amounted in all to Rs. 11,000, out of
these, cheques amounting to Rs. 3,000 were unpaid till March 31 2019.
4) The account stands debited with Rs. 150 for interest and Rs. 30 for bank
charges.
5) The bank has paid the annual subscription of Rs. 100 to club according
to instructions.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Depreciation

Depreciation
Generally, the term ‘depreciation’ is used to denote decrease in
value, but in accounting, this term is used to denote decrease in
the book value of a fixed asset.

Need for Providing Depreciation

1. To ascertain correct profit / loss:
For proper matching of cost with revenues, it is necessary to
charge depreciation against revenue in each accounting year, to
calculate the correct net profit or net loss.
2. To present a true and fair view of the financial position:
If the amount of depreciation is not provided on fixed assets in the
books of account, the value of fixed assets will be shown at a
higher value than its real value in the balance sheet.
3. To ascertain the real cost of production:
For ascertaining the real cost of production, it is necessary to
provide depreciation.
4. To comply with legal requirements

Causes of Depreciation:
1. Wear and tear: Use of the tangible fixed asset.
2. When a machine is kept continuously idle, it becomes
potentially less useful.
3. The value of machine deteriorates rapidly because of lack of
proper maintenance.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

4. Depletion: It refers to the physical deterioration by the

exhaustion of natural resources eg., mines, quarries, oil wells etc.
5. Obsolescence: The old asset will become obsolete (useless) due
to new inventions, improved techniques and technological
advancement.
6. Time Factor: Lease, copy-right, patents are acquired for a fixed
period of time. On the expiry of the fixed period of time, the assets
cease to exist.

Terms used for Depreciation:

1. Amortization: This refers to loss in the value of intangible assets
such as goodwill, patents and preliminary expenses.
2. Depletion: Decrease in the value of mineral wealth such as coal,
oil, iron ore, etc. is termed as depletion.
3. Obsolescence: When an asset becomes useless due to new
inventions, improved techniques and technological advances, it is
termed as obsolescence.

Methods of Calculating Depreciation:

1. Straight line method or fixed instalment method.
2. Written down value method or diminishing balance method
3. Annuity method.
4. Depreciation Fund method.
5. Insurance Policy method.
6. Revaluation method
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Straight Line Method or Fixed Instalment Method or Original Cost

Method
The same amount of depreciation is charged every year
throughout the life of the asset.

Merits:
1. Simplicity: It is very simple and easy to understand.
2. Easy to calculate: It is easy to calculate the amount and rate of
depreciation.
3. Assets can be completely written off: Under this method, the
book value of the asset becomes zero or equal to its scrap value at
the expiry of its useful life.

Demerits:
The amount of depreciation is same in all the years, although the
usefulness of the machine to the business is more in the initial
years than in the later years.

Illustration :
Raheem & Co. purchased a fixed asset on 1.4.2000 for
Rs.2,50,000. Depreciation is to be provided @10% annually
according to the Straight line method. The books are closed on
31st March every year.
Pass the necessary journal entries, prepare Fixed asset Account
and Depreciation Account for the first three years.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Written Down Value Method or Diminishing Balance Method or

Reducing Balance Method
Under this method, depreciation is charged at a fixed percentage
each year. The amount of depreciation goes on decreasing every
year.
Attention Please: Under Written Down Value Method, scrap value
is not deducted and depreciation is calculated on the original cost.

Merits:
1. Uniform effect on the Profit and Loss account of different
years: The total charge (i.e., depreciation plus repairs and
renewals) remains almost uniform year after year, since in earlier
years the amount of depreciation is more and the amount of
repairs and renewals is less, whereas in later years the amount of
depreciation is less and the amount of repairs and renewals is
more.
2. Recognised by the Income Tax authorities: This method is
recognised by the Income Tax authorities
3. Logical Method: It is a logical method as the depreciation is
calculated on the diminished balance every year.

Demerits:
It is very difficult to determine the rate by which the value of asset
could be written down to zero.
Illustration :
A Company purchased Machinery for Rs.50,000 on 1st April 2002.
It is depreciated at 10% per annum on Written Down Value
method. The accounting year ends on 31st March of every year.
Pass necessary Journal entries, prepare Machinery account and
Depreciation account for three years.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Annuity Method:
 The annuity method considers that the business besides
loosing the original cost of the asset in terms of
depreciation, also looses interest on the amount used for
buying the asset.
 This is based on the assumption that the amount invested in
the asset would have earned in case the same amount
would have been invested in some other form of
investment.
 This method is used to calculate depreciation amount on
lease.

Depreciation Fund Method or Sinking Fund Method :

Under this method, funds are made available for the replacement
of asset at the end of its useful life.
 The depreciation remains the same year after year and is
charged to Profit and Loss account every year through the
creation of depreciation fund.
 The amount of annual depreciation is invested in good
securities bearing interest at a specified rate.
 ·When the asset is to be replaced, the securities are sold and
the amount so realised by selling securities is used to
replace the old asset

Insurance Policy Method:

 According to this method, an Insurance policy is taken for
the amount of the asset to be replaced.
 The amount of the policy is such that it is sufficient to
replace the asset when it is worn out.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

 A sum equal to the amount of depreciation is paid as

premium every year. The amount is received on maturity.
 The amount so received is used for the purchase of new
asset, replacing the old one.

Revaluation Method:
Under this method, the assets like loose tools are revalued at the
end of the accounting period and the same is compared with the
value of the asset at the beginning of the year. The difference is
considered as depreciation.

Recording Depreciation
1. Entry for the amount of depreciation to be provided at the end
of the year:
2) For transferring the amount of depreciation at the end of the
year.

Calculation of Profit or Loss on sale of asset

 This is done by comparing the selling price with the book
value of the asset.
 Book value = Cost Price less Total Depreciation provided till
the date of sale
 If the book value is less than the selling price, then it is Profit
on Sale.
 If the book value is more than the selling price, it is Loss on
Sale.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Illustration :
Robert & Co. purchased a Machinery on 1st April 2002 for
Rs.75,000. After having used it for three years it was sold for
Rs.35,000. Depreciation is to be provided every year at the rate of
10% per annum on Diminishing balance method.
Accounts are closed on 31st March every year. Find out the profit
or loss on sale of machinery.

Illustration :
Deepak Manufacturing Company purchased on 1st April 2002,
Machinery for Rs.2,90,000 and spent Rs.10,000 on its installation.
After having used it for three years it was sold for Rs.2,00,000.
Depreciation is to be provided every year at the rate of 15% per
annum on the Fixed Instalment method.
Pass the necessary journal entries, prepare machinery account and
depreciation account for three years ends on 31st March every
year.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Capital & Revenue Transactions

CAPITAL TRANSACTION & REVENUE TRANSACTION

Business Transactions can be Capital Transactions or Revenue
Transactions. Capital transaction forms part of Balance Sheet
whereas Revenue transaction forms part of Profit and Loss A/c.
That is the reason why we need to classify transactions between
Capital Transaction & Revenue Transaction.

CAPITAL TRANSACTION & REVENUE TRANSACTION

From Trial Balance we make Profit and Loss A/c and Balance Sheet.
Revenue transactions go in Profit and Loss A/c and Capital
Transactions go in Balance Sheet.

Capital Transactions-: The business transactions, which provide

benefit to the business concern for more than one year or one
operating cycle of the business, are known as Capital Transactions.
Capital Transactions are again sub-divided into Capital
Expenditure &Capital Receipt.

Capital Expenditure: Capital Expenditure consists of those

accounting expenditure, the benefit of which is carried over to
several accounting periods. In other words the benefit of it is not
consumed within one accounting period.

Characteristics of Capital Expenditure

1) Not required for sale.
2) It is non-recurring in nature.
3) Incurred to increase the operational efficiency of the
business concern.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

4) Purchase of a fixed asset.

Examples of Capital Expenditure:

1) Expenses incurred in the acquisition of, building, machinery,
furniture, goodwill, copyright, patent right, etc.
2) Expenses incurred for increasing the seating accommodation in
a cinema hall.
3) Expenses incurred for installation of fixed asset like wages paid
for installing a plant.
4) Expenses incurred for remodeling and reconditioning an existing
asset like remodeling a building.

Capital Receipt: Capital Receipt is one which is invested in the

business for a long period. It includes long term loan obtained
from others and any amount realised on sale of fixed assets. It is
generally nonrecurring in nature.

Characteristics of Capital Receipt:

1) Amount is not received in the normal course of business.
2) It is non-recurring in nature.
Examples:
1) Capital introduced by the owner
2) Borrowed Loans 3) Sale of Fixed Asset.

Revenue Transactions:
The business transactions, which provide benefits to a business
concern for an accounting period (one year) only, are known as
Revenue Transactions.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Revenue Transactions can be:

1) Revenue Expenditure; or
2) Revenue Receipt

Revenue Expenditure:
Revenue Expenditure consists of those expenditure, that occur in
the normal course of business. They are incurred in order to
maintain the existing earning capacity of the business and helps in
the upkeep of fixed assets. Generally it is recurring in nature.

Characteristics:
1. It helps in maintaining the earning capacity of the business
concern.
2. It is recurring in nature.

Examples: 1) Cost of goods purchased for resale.

2) Office and Administrative expenses.
3) Selling and Distribution expenses.
4) Depreciation of fixed assets, interest on borrowings etc.
5) Repair, renewals etc.

Revenue Receipt: It is the receipt of income which occurs during

the normal course of business. It is recurring in nature.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Characteristics:
1) It is received in the normal course of business.
2) It is recurring in nature.

Examples:
1) Sale of goods or services.
2) Commission and Discount received.
3) Dividend and Interest received on Investment etc.

Deferred Revenue Expenditure: Heavy Revenue Expenditure,

which may be extended over a number of years, and not for the
current year alone, is called Deferred Revenue Expenditure.
For example, a new firm may advertise very heavily in the
beginning to capture a position in the market. The benefit of this
advertisement campaign will last for quite a few years. It will be
better to write off the expenditure in 3 or 4 years and not only in
the first year.

Characteristics of Deferred Revenue Expenditure :

1) Benefit is enjoyed for more than one year
2) It is non-recurring in nature.

Examples:
1) Expenses incurred on research and development.
2) Abnormal loss arising out of fire or lightning (in case the
Asset has not been insured)
3) Huge amount spent on advertisement.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Capital profit: Capital profit is the profit which arises not from the
normal course of the business.
Example: Profit on Sale of Fixed Asset.

Revenue Profit: Revenue Profit is the profit which arises from the
normal course of the business that is,
Net Profit = Revenue Receipt – Revenue Expenditure

Capital losses: The losses which arise not from the normal course
of business.
Example: Loss on sale of fixed assets is an example of capital loss.

Revenue losses: The losses that arise from the normal course of
the business. In other words, Net Loss = Revenue Expenditure -
Revenue Receipts.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Bill Of Exchange

BILL OF EXCHANGE: Note: Bill of exchange is an instrument in writing

containing an unconditional order, signed by the maker, directing a certain
person to pay a certain sum of money only to, or to the order of a certain
person or to the bearer of the instrument'.

Thus Bill of Exchange :-

1. is a written document.

2. contains an unconditional order.

Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

3. is an order to pay a certain sum of money.

4. is signed by the drawer.

5. bears a stamp or it is drafted on a stamp paper.

6. is accepted by the acceptor.

7. the amount is paid to drawer or endorsee.

Parties to Bill Of Exchange

1. Drawer:- Prepares the bill

2. Drawee:- Accepts to make the payment

3. Payee:- Who receives the payment (third party over the drawer himself).

Drawing of a bill:-Seller prepares the bill

Due Date:- A bill is payable after a specified period (due date).

Days of grace:- 3 extra days will be given after due date. If the date of
maturity falls on a holiday, the bill will be due for payment on the preceding
date. In case of emergency holiday, the previous day.

Endorsement:- Writing of one's signature on the face or back of a bill for the
purpose of transferring the title of the bill to another person. The person who
endorses is called endorser. The person to whom a bill is endorsed is called
the Endorsee. The Endorsee is entitled to collect the payment.

Discounting:- When the holder of a bill needs money before the due date of a
bill, he can convert it into cash by discounting the bill with his banker. This
process is called discounting the bill. The banker deducts a small amount of
the bill which is called discount and pay the balance in cash immediately to
the holder of the bill.

Retiring of a bill: An acceptor may make the payment of a bill before its due
date and discharges its liability. This is called Retirement of Bill.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Renewal: When the acceptor of a bill knows in advance that he will not be
able to meet the bill on its due date, he may approach the drawer with a
request for extension of time. The drawer of the bill may cancel the original
bill and draw a new bill for the amount due and will charge a little interest for
the extended period. This is called renewal.

Dishonour: Non-payment of the bill, when it is presented for payment.

Noting &Protesting :
• If a bill is dishonoured, the Drawer may approach the court, and file a Suit
against the Drawee.
• In order to collect documentary evidence that the bill has really been
dishonoured, the Drawer will approach a lawyer and explain the fact of
dishonour of Bill.
• The lawyer will take the bill to the drawee and ask for the payment.

•If the drawee does not make the payment, the lawyer will write the
statement of drawer and get the statement signed by him.
• The Lawyer will then put his signature.

• The statement noted by the lawyer will be the documentary evidence for
the dishonour of the Bill.
• Writing this statement by the lawyer is known asNoting of the Bill.

• The lawyer performing this work of Noting the Bill is called as Notary Public.
• After recording a note of dishonour, the notary public issues a certificate
which is called Protest. A Protest is a certificate issued by the notary public
attesting that the Bill has been dishonoured.
After Noting, the lawyer issues a certificate that the bill has been
dishonoured. This certificate is called Protest. Protest is enforceable in the
court of law.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Final Accounts:

Profit & Loss Accounts & Balance Sheet

Final Accounts

The Businessman wants to know whether the business has resulted in Profit
or Loss and what the Financial Position of the business is at a given period. In
short, he wants to know the Profitability and the Financial Soundness of the
business. A trader can ascertain these by preparing the Final Accounts, that is,
Trading and Profit and Loss Account and Balance Sheet.

Parts of Final Accounts:

Trading Account: Trading means buying and selling. The Trading Account
shows the result of buying and selling of goods. Gross Profit or Gross Loss is
calculated by Trading Account.

Profit and Loss Account: This is prepared to find out the Net Result of the
Business, ie., Net Profit or Net Loss

Balance Sheet: This is prepared to know the financial position of the

business.
However Manufacturing concern, prepare Manufacturing Account prior to
the preparation of Trading Account, to find out cost of production.
A trader will first prepare Trading Account and then Profit & Loss Account to
ascertain the result of his business operation at the end of the year.

Example: Prepare Trading Account for the year ended 31-3-19.

Opening Stock Rs. 1,70,000

Purchase Return Rs. 10,000

Sales Rs. 2,50,000
Wages Rs. 50,000
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Sales Return Rs. 20,000

Purchases Rs. 1,00,000
Carriage Inwards Rs. 20,000
Closing Stock Rs. 1,60,000

Illustration: From following balances of M/S. Sani Enterprises prepare Profit

and Loss Account for the year ended 31-3-2019.

Office rent Rs. 30,000

Salaries Rs. 80,000
Printing Expenses Rs. 20,000
Gross Profit Rs. 2,50,000
Stationeries Rs. 3,000

Tax, Insurance Rs. 4,000

Discount allowed Rs. 6,000
Advertisement Rs. 36,000
Discount Received Rs. 4,000
Travelling Expenses Rs. 26,000

Note: Trading & PL Account is prepared for a period whereas Trial Balance &
Balance Sheet is prepared at a particular point (date).

Note:
1) If trial balance shows trading expenses as well as office expenses the
trading expenses should be shown in the trading account and office expenses
should be shown in profit and loss account. On the other hand, if the trial
balance shows only trading expenses, it should be shown in the profit and loss
account.
2) If in the trial balance, wages are clubbed with salaries and shown as "wages
and salaries", this item is shown in trading account. On the other hand, if it
appears as 'salaries and wages', this item is recorded in the profit and loss
account.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

3) Income Tax paid by a proprietor is considered as personal expenses. It

should be deducted from the capital.

Balance Sheet:
It is a statement showing the Financial Position of a business. Balance Sheet
shows net balance of Assets and Liabilities. Balance Sheet is prepared by
taking up all Personal Accounts and Real Accounts (Assets and Liabilities)
together with the Net Result obtained from Profit and Loss Account.
On the left hand side of the statement, Liabilities and Capital are
shown. On the right hand side, all the Assets are shown.
Balance Sheet is not an Account but it is a Statement.

Q.) From the following Trial Balance of MM Enterprises, prepare Trading,

Profit & Loss Account for the year ended 31-3-19 and Balance Sheet as on
date.
Trial Balance of MM Enterprieses as on 31-3-19
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

Need for preparing a Balance Sheet is as follows:

1) To know the nature and value of asset of the business
2) To ascertain the total Liabilities of the business.
3) To know the position of Owners Equity.

Format: Horizontal form and Vertical form

Classification of Assets:
Assets: Assets represent everything which a business owns and has money
value.
a) Tangible Assets: Assets which have some physical existence are known as
tangible assets. They can be scene, and felt. Example: plant and machinery.
Tangible assets are classified into:
1) Fixed Assets: Assets which are permanent in nature, having long period of
life and cannot be converted into cash in a short period are termed as fixed
assets.
2) Current Assets: Assets which can be converted into cash in the ordinary
course of business and are held for a short period is known as Current assets.
This is also termed as floating assets. Example, cash in hand, cash and Bank,
sundry debtors etc.

b) Intangible Assets: No physical existence and cannot be seen or touched.

They help to generate revenue in future, example goodwill, patent,
trademark, etc.

c) Fictitious Assets (Fake): These assets are nothing but the Expenses or
Losses which cannot be adjusted during an Accounting Year. They are really
not assets but are worthless items. Example: preliminary expenses.

Classification of Liabilities:

Liabilities: The amount which a business owes to others is liabilities.

a) Long term Liabilities: Liabilities which are repayable after a long period of
time are known as Long Term Liabilities.
Notes by:Tej Pratap Singh
Ex Assistant Audit Officer & Teacher
For Admission Enquiry: 9849316775

b) Current Liabilities: Current liabilities are those which are repayable within
a year. For example, creditors for goods purchased, short term loans etc.

c) Contingent Liabilities: It is an anticipated liability which may or may not

arise in future. For example, liability arising for bills discounted. Contingent
liabilities will not appear in the balance sheet but shown as footnote.

Note: 1) The Assets and liabilities can be shown in the order of permanence.
2)Assets will be said to be liquid if it can be converted into cash easily.

Balance Sheet Equation: In Balance Sheet, the total value of the Assets is
always equal to the total value of Liabilities. This is because the Liability of the
Owner is always made up of the difference between Assets and liabilities.
Thus,
Assets= Liabilities + Capital or,
Capital = Assets- Liabilities
Meaning and Characteristics of
Not-for-Profit Organisation:
Organisations that are for used for the welfare of the
society and are set up as charitableinstitutions which
function without any profit motive. Normally, they do
not manufacture, purchase or sell goods and may not
have credit transactions.

Hence they need not maintain many books of account (as

the trading concerns do) and Trading and Profit and Loss
Account.

The funds raised by such organisations are

credited to capital fund or general fund.

The main objective of keeping records in such

organisations is to meet the statutory requirement and
help them in exercising control over utilisation of their
funds.

The main characteristics of such organisations are:

Formed for providing service such as education, health
care, recreation, sports etc. Its sole aim is to provide
service either free of cost or at nominal cost, and not to
earn profit.

These are organised as charitable trusts/societies

and subscribers to such organisation are called
members.

The main sources of income of such organisations

are:
a) subscriptions from members,
b) donations,
c) legacies,
d) grant-in-aid,
e) income from investments, etc.

The funds raised by such organisations through various

sources are credited to Capital Fund or General Fund.

The surplus generated in the form of excess of income

over expenditure is not distributed amongst the
members. It is simply added in the capital fund.

Accounting Records of Not-for-Profit Organisations

The final accounts of a ‘not-for-profit organisation
consist of the following:
a) Receipt and Payment Account
b) Income and Expenditure Account,
c) Balance Sheet.

The Receipt and Payment Account is the summary of

cash and bank transactions which helps in the
preparation of Income and Expenditure Account and the
Balance Sheet.

Income and Expenditure Account is akin to Profit and

Loss Account. The Not-for-Profit Organisations usually
prepare the Income and Expenditure Account and a
Balance Sheet with the help of Receipt and Payment
Account.

Note: It is a legal requirement as the Receipts and

Payments Account, Income and Expenditure Account and
the Balance Sheet has to be submitted to the Registrar of
Societies.

Salient Features of Receipt & Payment Account:

a) It is a summary of the cash book. Its form is identical
with that of simple cash book (without discount and bank
columns) with debit and credit sides.
b) No distinction is made in receipts/payments made
in cash or through bank.
Income and Expenditure Account:
a) It is the summary of income and expenditure for the
accounting year.
b) It is just like a profit and loss account. It includes only
revenue items and the balance at the end represents
surplus or deficit.

Subscriptions: Subscription is a membership fee paid by

the member on annual basis. This is the main source of
income of such orgnisations. Subscription paid by the
members is shown as receipt in the Receipt and Payment
Account and as income in the Income and Expenditure
Account.

Donations: It is a sort of gift in cash or property received

from some person or organisation. It appears on the
receipts side of the Receipts and Payments Account.
Donation can be for specific purposes or for general
purposes.

Specific Donations: If donation received is to be utilised

to achieve specified purpose, it is called Specific
Donation. Such donation is to be capitalised and shown
on the liabilities side of the Balance Sheet irrespective of
the fact whether the amount is big or small. The
intention is to utilise the amount for the specified
purpose only.

General Donations: Such donations are to be utilised

to promote the general purpose of the organisation.
These are treated as revenue receipts.

Legacies: It is the amount received as per the will of a

deceased person. It appears on the receipts side of the
Receipt and Payment Account and is directly added to
capital fund/general fund in the balance sheet, because it
is not of recurring nature. However, legacies of a small
amount may be treated as income and shown on the
income side of the Income and Expenditure Account.

Life Membership Fees: Some members prefer to pay

lump sum amount as life membership fee instead of
paying periodic subscription. Such amount is treated as
capital receipt and credited directly to the
capital/general fund.

Entrance Fees: Entrance fee also known as admission

fee is paid only once by the member at the time of
becoming a member. In case of organisations like clubs
and some charitable institutions, is limited and the
amount of entrance fees is quite high. Hence, it is treated
as non- recurring item and credited directly to
capital/general fund. However, for some organisations
like educationalinstitutions, the entrance fees is a regular
income and the amount involved may also be small. In
their case, it is customary to treat this item as a revenue
receipt.

Sale of old asset: Receipts from the sale of an old asset

appear in the Receipts and Payments Account of the year
in which it is sold. But any gain or loss on the sale of asset
is taken to the Income and Expenditure Account of the
year.

Sale of Periodicals: Sale of Used Sports Materials:

Payments of Honorarium: It is the amount paid to the
person who is not the regular employee of the
institution. Payment to an artist for giving performance
at the club is an example of honorarium.

Endowment Fund: It is a fund arising from a bequest or

gift, the income of which is devoted for a specific
purpose. Hence, it is a capital receipt and shown on the
Liabilities side of the Balance Sheet as an item of a
specific purpose fund.
Government Grant: Schools, colleges, public hospitals,
etc. depend upon government grant for their activities.
The recurring grants in the form of maintenance grant is
treated as revenue receipt (i.e. income of the current
year) and credited to Income and Expenditure account.
However, grants such as building grant are treated as
capital receipt and transferred to the building fund
account.

Some Not-for -Profit organisations receive cash subsidy

from the government or government agencies.
This subsidy is also treated as revenue income for the
year in which it is received.

Special Funds:
The Not-for -Profit Organisations office create special
funds for certain purposes/ activities such as 'prize
funds', 'match fund' and 'sports fund', etc. Such funds
are invested in securities and the income earned on such
investments is added to the respective fund, not credited
to Income and Expenditure Account. Similarly, the
expenses incurred on such specific purposes are also
deducted from the special fund.

For example, a club may maintain a special fund for

sports activities. In such a situation, the interest income
on sports fund investments is added to the sports fund
and all expenses on sports deducted therefrom. The
special funds are shown in balance sheet. However, if,
after adjustment of income and expenses the balance in
specific or special fund is negative, it is transferred to the
debit side of the Income and Expenditure Account or
adjusted as per prescribed directions.
 Valuation of Inventory

As per the Accounting Standard AS-2, closing stock of the

business should be valued. Objective of Inventory Valuation:
Valuation of inventory is very important as it affects both
revenue of the business and the asset. Because if valuation
will be done at higher than actual, it will be shown in the
trading account as closing stock and resulting in to increase
in gross profit and the same value will also be shown in the
balance sheet as current asset. So, it will increase value of
asset.

Definition of Inventory: Inventory or closing stock includes

following things-
a) Items which are held for sale in the normal course of
business that is Finished Goods.
b) Work-In-Progress (WIP) - Goods which are not yet finished or
ready for sale.
c) Raw material - It also includes consumable stores item.
Following are not covered under the definition of inventory/
closing stock –
d) Work in progress in the construction contract
business including, directly related to service contract.
c) Any financial instruments such as shares, debentures, bonds
etc.
d) Other inventories like livestock, agricultural product and
forest product, natural gases etc.
e) Work in progress in the business of banking,
consulting and service business. That means incomplete
consulting service, merchant banking service and medical
service in process.

Methods of valuation of inventory as per AS 2

FIFO (First in First Out method): This method presumes that

materials which are received first are issued first. The ending
inventory consists of most recently purchased goods. The
closing stock is valued at latest purchase price.
The main defect of this method is that on a rising market, it
reports larger earnings.

LIFO (Last in First Out): This method is the reverse of FIFO

method. This method is based on the assumption that the
materials received last are issued first. Thus, the materials
which are purchased initially form part of closing stock.

Simple Average Method: is average of prices without any

regard to quantities purchased.
Specific Identification price: This method is used where
materials are purchased specially for a particular order or job.
Its application is confined to high cost items like cars,
computers, videos, antiques etc.

Weighted Average Cost

Illustration:The opening balance of inventory and purchases

made by Mr. X during the month of July, 2018 are given
below:
July 01: Beginning inventory, 500 units @ Rs.20 per unit.
July 18: Inventory purchased, 800 units @ Rs. 24 per unit.
July 25: Inventory purchased, 700 units @ Rs. 26 per unit.
Mr. X sold 1,400 units during the month of July.
Required: Compute value of inventory on July 31, 2018 and
cost of goods sold for the month of July using following
inventory costing methods:
1. First in, first out (FIFO) method 2. Last in, first out (LIFO)
method 3. Average cost method