MODULE - 1 Basic Accounting Principles

Business Environment

5
Notes

BASIC ACCOUNTING PRINCIPLES

5.0 INTRODUCTION

We have studied economic activities which have been converted

into business activities. In business activity a lot of “give &
take” exist which is known as transaction. Transaction involves
transfer of money or money’s worth. Thus exchange of money,
goods & services between the parties is known to have resulted
in a transaction. It is necessary to record all these transactions
very systematically & scientifically so that the financial
relationship of a business with other persons may be properly
understood, profit & loss and financial position of the business
may be worked out at a particular date. The procedure to
record all these transactions is known as “Book-keeping”.
In other words the book keeping may be defined as an
activity concerned with the recording of financial data
relating to business operations in an orderly manner. Book
keeping is the recording phase of accounting. Accounting is
based on an efficient system of book keeping.
Accounting is the analysis & interpretation of book keeping
records. It includes not only the maintenance of accounting
records but also the preparation of financial & economic
information which involves the measurement of transactions
& other events relating to entry.
There are various terminology used in the Accounting which
are being explained as under: -
1) Assets: An asset may be defined as anything of use in
the future operations of the enterprise & belonging to

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the enterprise. E.g., land, building, machinery, cash etc.
2) Equity: In broader sense, the term equity refers to total
claims against the enterprise. It is further divided into
two categories.
i. Owner Claim - Capital
Notes
ii. Outsider’s Claim – Liability
Capital: The excess of assets over liabilities of the
enterprise. It is the difference between the total assets
& the total liabilities of the enterprise. e.g.,: if on a
particular date the assets of the business amount to Rs.
1.00 lakhs & liabilities to Rs. 30,000 then the capital on
that date would be Rs.70,000/-.
Liability: Amount owed by the enterprise to the
outsiders i.e. to all others except the owner. e.g.,: trade
creditor, bank overdraft, loan etc.
3) Revenue: It is a monetary value of the products or
services sold to the customers during the period. It
results from sales, services & sources like interest,
dividend & commission.
4) Expense/Cost: Expenditure incurred by the enterprise
to earn revenue is termed as expense or cost. The
difference between expense & asset is that the benefit of
the former is consumed by the business in the present
whereas in the latter case benefit will be available for
future activities of the business. e.g., Raw material,
consumables & salaries etc.
5) Drawings: Money or value of goods belonging to
business used by the proprietor for his personal use.
6) Owner: The person who invests his money or money’s
worth & bears the risk of the business.
7) Sundry Debtors: A person from whom amounts are due
for goods sold or services rendered or in respect of a
contractual obligation. It is also known as debtor, trade
debtor, accounts receivable.
8) Sundry Creditors: It is an amount owed by the
enterprise on account of goods purchased or services
rendered or in respect of contractual obligations. e.g.,
trade creditor, accounts payable.

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5.1 OBJECTIVES

At the end of this lesson you will be able

z To maintain the books of accounts
z To prepare the annual accounts
Notes
5.2 ACCOUNTING CYCLE

After taking decisions such as selecting a business, selecting

the form of organisation of business, making decision about
the amount of capital to be invested, selectingsuitable site,
acquiring equipment & supplies, selecting staff, getting
customers & selling the goods etc. a business man finally
resorts to record keeping.
For all types of business organisations, transactions such as
purchases, sales, manufacturing & selling expenses,
collection from customers & payments to suppliers do take
place. These business transactions are recorded in a set of
ruled books such as journal, ledger, cash book etc. Unless
these transactions are recorded properly he will not be in a
position to know where exactly he stands.
The following is the complete cycle of Accounting
a) The opening balances of accounts from the balance sheet
& day to day business transaction of the accounting year
are first recorded in a book known as journal.
b) Periodically these transactions are transferred to
concerned accounts known as ledger accounts.
c) At the end of every accounting year these accounts are
balanced & the trial balance is prepared.
d) Then the final accounts such as trading & profit & loss
accounts are prepared.
e) Finally, a balance sheet is made which gives the financial
position of the business at the end of the period.

Transaction Journal Ledger Trial Balance

Balance Sheet Opening Balance Sheet Closing P & L a/c Trading A/c

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5.3 ACCOUNTING ASSUMPTIONS

In the modern world no business can afford to remain

secretive because various parties such as creditors,
employees, Government, investors & public are interested to
know about the affairs of the business. The affairs of the
business can be studied mainly by consulting final accounts Notes
and the balance sheet of the particular business. Final
accounts & the balance sheet are the end products of book
keeping. Because of the importance of these statements it
became necessary for the accountants to develop some
principles, concepts and conventions which may be regarded
as fundamentals of accounting. The need for generally
accepted accounting principles arises from two reasons:
1) to be logical & consistent in recording the transaction
2) to conform to the established practices & procedures
The International Accounting Standards Committee (IASC)
as well as the Institute of Chartered Accountants of India
(ICAI) treat (vide IAS-I & AS-I) the following as the
fundamental assumptions:
1. Going Concern: In the ordinary course accounting
assumes that the business will continue to exist & carry
on its operations for an indefinite period in the future.
The entity is assumed to remain in operation sufficiently
long to carry out its objects and plans. The values
attached to the assets will be on the basis of its current
worth. The assumption is that the fixed assets are not
intended for re-sale. Therefore, it may be contended that
a balance sheet which is prepared on the basis of record
of facts on historical costs cannot show the true or real
worth of the concern at a particular date. The
underlying principle there is that the earning power and
not the cost is the basis for valuing a continuing
business. The business is to continue indefinitely and
the financial and accounting policies are followed to
maintain the continuity of the business unit.
2. Consistency: There should be uniformity in accounting
processes and policies from one period to another. Material
changes, if any, should be disclosed even though there is
improvement in technique. Only when the accounting
procedures are adhered to consistently from year to year

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the results disclosed in the financial statements will be
uniform and comparable.
3. Accrual: Accounting attempts to recognize non-cash
events and circumstances as they occur. Accrual is
concerned with expected future cash receipts and
Notes payments. It is the accounting process of recognizing
assets, liabilities or income amounts expected to be
received or paid in future. Common examples of
accruals include purchases and sales of goods or
services on credit, interest, rent (unpaid), wages and
salaries, taxes. Thus, we make record of all expenses
and incomes relating to the accounting period whether
actual cash has been disbursed or received or not.
In order to keep a complete record of the entire
transactions of any business it is necessary to keep the
following accounts:
a) Assets Accounts: These accounts relate to tangible and
intangible assets. e.g., Land a/c, building a/c, cash a/c,
goodwill, patents etc.
b) Liabilities Accounts: These accounts relate to the
financial obligations of an enterprise towards outsiders.
e.g., trade creditors, outstanding expenses, bank
overdraft, long-term loans.
c) Capital Accounts: These accounts relate to the owners
of an enterprise. e.g., Capital a/c, drawing a/c.
d) Revenue Accounts: These accounts relate to the amount
charged for goods sold or services rendered or permitting
others to use enterprise’s resources yielding interest,
royalty or dividend. e.g., Sales a/c, discount received a/c,
dividend received a/c, interest received a/c.
e) Expenses Account: These accounts relate to the
amount spent or lost in the process of earning revenue.
e.g., Purchases a/c, discount allowed a/c, royalty paid
a/c, interest payable a/c, loss by fire a/c.
5.4 SYSTEMS OF RECORDING

There are three methods of recording of entries which are

explained as under:
Single Entry System: This system ignores the two fold aspect
of each transaction as considered in double entry system.

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Under single entry system, merely personal aspects of
transaction i.e. personal accounts are recorded. This method
takes no note of the impersonal aspects of the transactions
other than cash. It offers no check on the accuracy of the
posting and no safeguard against fraud and because it does
not provide any check over the recording of cash
Notes
transactions , it is called as “imperfect accounting”.
Double entry system: The double entry system was first
evolved by Luca Pacioli, who was a Franciscan Monk of Italy.
With the passage of time, the system has gone through lot of
developmental stages. It is the only method fulfilling all the
objectives of systematic accounting. It recognizes the two fold
aspect of every business transaction.
Indian (Deshi Nama) system: This is the Indian system. It
differs from region to region; community to community and
from business to business. Under this system books are
written in regional languages such as Muriya, Sarafi etc.
Books are called “Bahis”. It is older than double entry
system and is complete in itself.
5.5 BASIS OF ACCOUNTING SYSTEM
Cash or receipt basis is the method of recording
transactions under which revenues and costs and assets
and liabilities are reflected in accounts in the period in
which actual receipts or actual payments are made.
“Receipts and payments account” in case of clubs, societies,
hospitals etc., is the example of cash basis of accounting.
Accrual or mercantile basis is the method of recording
transactions by which revenues, costs, assets and liabilities
are reflected in accounts in the period in which they accrue.
This basis includes considerations relating to outstanding;
prepaid, accrued due and received in advance.
Hybrid or mixed basis is the combination of both the basis
i.e. cash as well as mercantile basis. Income is recorded on
cash basis but expenses are recorded on mercantile basis.
5.6 CLASSIFICATION OF ACCOUNTS

The classification of accounts and rules of debit and credit

based on such classification are given below:

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Classification of accounts

ACCOUNTS

Personal Impersonal
Notes

Real Nominal

Personal Accounts:

Accounts recording transactions relating to individuals or

firms or company are known as personal accounts. Personal
accounts may further be classified as:
(i) Natural Person’s personal accounts: The accounts
recording transactions relating to individual human
beings e.g., Anand’s a/c, Ramesh’s a/c, Pankaj a/c are
classified as natural persons’ personal accounts.
(ii) Artificial Persons’ Personal accounts: The accounts
recording transactions relating to limited companies,
bank, firm, institution, club, etc., Delhi Cloth Mill; M/s
Sahoo & Sahoo; Hans Raj College; Gymkhana Club are
classified as artificial persons’ personal accounts.
(iii) Representative Personal Accounts: The accounts
recording transactions relating to the expenses and
incomes are classified as nominal accounts. But in certain
cases (due to the matching concept of accounting) the
amount, on a particular date, is payable to the individuals
or recoverable from individuals. Such amount (i) relates to
the particular head of expenditure or income and (ii)
represent persons to whom it is payable or from whom it is
recoverable. Such accounts are classified as representative
personal accounts e.g., “wages outstanding account”, pre-
paid Insurance account, etc.
Real Accounts: The accounts recording transactions
relating to tangible things (which can be touched, purchased
and sold) such as goods, cash, building, machinery etc., are
classified as tangible real accounts.
Whereas the accounts recording transactions relating to
intangible things (which do not have physical shape) such as

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goodwill, patents and copy rights, trade marks etc., are
classified as intangible real accounts.
Nominal Accounts: The accounts recording transactions
relating to the losses, gains, expenses and incomes e.g. Rent,
salaries, wages, commission, interest, bad debts etc., are
classified as nominal accounts. Notes

Rules of debit and credit (classification based)

1. Personal accounts : Debit the receiver
Credit the giver (supplier)
2. Real accounts : Debit what comes in
Credit what goes out
3. Nominal accounts : Debit expenses and losses
Credit incomes and gains
Let us consider the following example to illustrate how the
rules of debit and credit are applied in practice:
Illustration 1.

Rs.
1. Mr. A commenced business with cash 70,000
2. Purchased goods on credit from Mr. B 14,000
3. Paid wages 500
4. Paid to Mr. B 10,000
5. Purchased furniture 1,000
6. Goods stolen by the Store-keeper 200
7. Received commission 100

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(a) (b) (c) (d) (e)
S. No. Explanation Account Equation based Classification based
Involved analysis analysis
Group Effect Rule Group Effect
I
1. Business Cash & Assets Increase 1 Real Comes in
commenced with Capital Personal Increase 3 Personal Giver
Notes
cash Rs.70,000
2. Purchased goods Goods & Assets Increase 1 Real Comes in
on credit from Mr. B Liability Increase 2 Personal Giver
Rs. 14,000
3. Paid wages Rs. 500 Wages & Expenses Increase 4 Nominal Expenses

Cash Asset Decrease 1 Personal go out

4. Paid to Mr. B Mr. B & Liability Decrease 2 Personal Receiver

Rs.10,000 Cash Asset Decrease 1 Real Goes out

5. Purchased furniture Furniture Assets Increase 1 Real Comes in

for cash Rs.1,000 & Cash Assets Decrease 1 Real Goes out
6. Goods stolen by Loss of Loss Increase 4 Nominal Loss

store-keeper Goods & Asset Decrease 1 Real Goes out

Rs.200 Goods
7. Received Cash & Assets Increase 1 Real Comes in

commission Commis- Income Increase 5 Nominal Income

Rs.100 sion

5.7 JOURNAL

Journal is a book which lists accounting transactions of a

business other than cash, before posting them to ledgers. The
journal is currently only used to a limited extent to cover item
outside the scope of other accounting books. Let us understand
the mechanism of recording business transaction in a journal.
Example:
Business transactions of Mr.A for the month of Jan.1997.
st A started business with cash Rs.20,000/-
1 January, 1997
rd Goods purchased for cash Rs.6,000/-
3 January, 1997
th Goods purchased from S Rs.4,000/-
5 January, 1997
th Goods sold for cash Rs.2,000/-
7 January,1997
th Goods sold to B Rs.6,000/-
10 January, 1997
th Cash paid to S Rs.2,000/-
12 January, 1997

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th Cash received from B Rs.4,000/-
17 January, 1997
rd Paid wages Rs.100/-
23 January, 1997
th Furniture purchased from R Rs.400/-
25 January, 1997
th Paid for interest Rs.200/-
28 January, 1997
st
31 January, 1997 Paid salaries Rs.200/-
Journal Entries Notes

Date Particulars Ledger Folio Dr. Amount Cr. Amount

(Rs.) (Rs.)
1997 Cash A/c Dr. 20,000/-
Jan. 1 To Capital A/c 20,000-
(Being cash introduced by A)
Jan.3 Purchase A/c Dr. 6,000/-
To Cash A/c 6,000/-
(Being cash purchases)
Jan.5 Purchase A.c Dr. 4,000/-
To S’s A/c 4,000/-
(Being credit purchase from S)
Jan.7 Cash A/c Dr. 2,000/-
To sales A/c 2,000/-
(Being cash sales)
Jan.10 B’s A/c Dr. 6,000/-
To Sales A/c 6,000/-
(Being the amount of credit sales)
Jan.12 S’s A/c Dr. 2,000/-
To Cash A/c 2,000/-
(Being the amount of credit sales)
Jan.17 Cash A/c Dr. 4,000/-
To B’s A/c 4,000/-
(Being receipt of cash from B)
Jan.23 Wages A/c Dr. 100/-
To Cash A/c 100/-
(Being payment of wages in cash)
Jan.25 Furniture A/c Dr. 400/-
To R’s A/c 400/-
(Being purchase of furniture
on credit from R)
Jan.28 Interest A/c Dr. 200/-

To Cash A/c 200/-

(Being payment of interest by cash)
Jan.31 Salaries A/c Dr. 200/-
To Cash a/c 200/-
(Being payment of salaries by cash)

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5.8 CASH BOOK

All business dealings ultimately resolve themselves into cash

transactions, therefore, recording of cash transactions in a
separate book becomes necessary. To keep record of all
receipts and payments of money in business, cash book is
Notes maintained. Cash book with regard to the nature of business
and the manner in which the cash is dealt with. Money
receipts are entered on debit side and payments are shown
on the credit side.
There are three distinct types of Cash Book, and each
business could get its cash book ruled in a manner as would
suit its own requirements. Thus the Cash Book may be ruled
so as to possess.
– Cash and Discount columns only on both sides or
– Cash, Bank and Discount columns on both sides or
– Bank and Discount columns only on both sides.
5.9 PRINCIPAL BOOK: LEDGER

A ledger is a group of accounts. Most of us have probably

seen a bound book with the word ‘ledger’ printed on the
cover. All the accounts of a small business/industry could
be entered in a ledger in concerned accounts in a
summarised and classified form.
From the journal a trader cannot know his total cash,
purchases, amount spent under each head of expense and
amount earned under each head of income. The journal will not
tell him what he owes to his creditors and what his customers
owe to him. Such classified information can be got only by
opening ledger accounts for every kind of transaction.
Every ledger has two sides namely debit and credit. Left
hand side is debit and right hand side is credit. Each side of
the ledger has columns on date, particulars, journal folio
and amount- In the particulars column of the debit side the
name of the account from which benefit is received is
recorded and on the credit side, the name of the account to
which benefit is given is recorded. The words ‘To’ and ‘By’ are
affixed to the name of the amount entered on debit and
credit sides respectively.
If a business is not able to accommodate all its accounts in

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one ledger it can have more than one ledgers. Business may
have an ‘accounts receivable ledger’ an ‘accounts payable
ledger’ and a ‘general ledger’ each containing the group of
accounts suggested by the title. The ledger is not necessarily
a bound book, it may consist of a set of loose leaf pages, a
set of punched cards, or if computerised a set of impulses on
Notes
a magnetic tape. No matter what its form may be, the
essential character of the account and the rules for making
entries to it remain exactly the same.
(i) Ledger Posting:

Transferring the entries from the journal or a subsidiary

book to the ledger is known as posting. Posting the ledger
from journal is easy as the transactions in the journal are
already classified into debit and credit. However, the
following points must be noted while posting the ledger.
– For the same person or expense only one account
should be opened.
– Cash and credit sales should be posted to Sales
Account and cash and credit purchases to Purchase
Account.
– The word Debit as Dr. and Credit as Cr. should not be
omitted.
– Date and folio columns should not be left blank.
(ii) Balancing of Ledger Accounts :

At periodic intervals, the debit and credit sides of

individual ledger accounts are totalled and balance of
each account indicated. If the total of the debit side of
any account is more than the credit side, there will be a
debit balance and, if the credit side is more than the
debit side there will be credit balance.
With the help of the illustration which we took for
recording journal entries, let us see how the ledger
postings and balancing will be done.
Based on the illustration the following accounts need to
be opened in ledger.

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Environment
Dr. Capital A/c Cr.

Date Particulars JF Amount Date Particulars JF Amount

Rs. Rs.
To balance c/d 20,000/- By Cash 20,000/-

20,000/- 20,000/-
Notes Feb.1 By balance 20,000/-
b/f

Dr. Cash A/c Cr.

Date Particulars JF Amount Date Particulars JF Amount

Rs. Rs.
1997 To capital 20,000 1997 By purchase 6,000
Jan.1 To sales 2,000 Jan.3 By S 2,000
Jan.7 To B 4,000 Jan.12 By wages 100
Jan.17 Jan.23 By interest 200
Jan.28 By salaries 200
Jan.31 By bal. c/d 200
Jan.31 17,500
26,000 26,000
Feb1 To bal. b/f 17,500
Dr. Purchase A/c Cr.

Date Particulars JF Amount Date Particulars JF Amount

Rs. Rs.
1997 1997
Jan.3 To cash 6,000 Jan 31 By balance c/d 10,000
Jan.5 To S 4,000 10,000
10,000
Feb.1 To bal. b/f 10,000
Dr. Sales A/c Cr.

Date Particulars JF Amount Date Particulars JF Amount

Rs. Rs.
1997 1997
Jan.31 To balance 8,000 Jan.7 By cash 2,000
8,000 Jan.10 By B 6,000
8,000
Feb.1 By bal. b/f 8,000
Dr. S’s A/c Cr.

Date Particulars JF Amount Date Particulars JF Amount

Rs. Rs.
1997 1997
Jan.12 To cash 2,000 Jan.5 By Purchase 4,000
Jan.31 To bal. c/d 2,000
4,000 4,000
Feb.1 By bal. b/f 2,000

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Dr. B’s A/c Cr.

Date Particulars JF Amount Date Particulars JF Amount

Rs. Rs.
1997 1997
Jan.10 To sales 6,000 Jan.17 By cash 4,000
Jan.31 By bal. c/d 2,000
6,000 6,000 Notes
Feb.1 To bal. b/f 2,000
Dr. Wages A/c Cr.

Date Particulars JF Amount Date Particulars JF Amount

Rs. Rs.
1997 1997
Jan.23 To cash 100 Jan.31 By bal. c/d 100
100 100
Feb.1 To bal. b/f 100
Dr. Furniture A/c Cr.

Date Particulars JF Amount Date Particulars JF Amount

Rs. Rs.
1997 1997
Jan.25 To R 400 Jan.31 By bal. c/d 400
400 400
Feb.1 To bal. b/f 400
Dr. Interest A/c Cr.

Date Particulars JF Amount Date Particulars JF Amount

Rs. Rs.
1997 1997
Jan.28 To Cash 200 Jan.31 By bal. c/d 200

200 200
Feb.1 To bal. b/f 200
Dr. R’s A/c Cr.

Date Particulars JF Amount Date Particulars JF Amount

Rs. Rs.
1997 1997
Jan.31 To bal. c/d 400 Jan.25 By furniture 400
400 400
Feb.1 By bal. b/f 400
Dr. Salaries A/c Cr.

Date Particulars JF Amount Date Particulars JF Amount

Rs. Rs.
1997 1997
Jan.31 To Cash 200 Jan.31 By bal. c/d 200
200 200
Feb.1 To bal. b/f 200

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5.10 FINAL ACCOUNTS

The final accounts of a business consists of :

(i) Manufacturing Account
(ii) Trading Account
Notes
(iii) Profit and Loss Account
(iv) Balance Sheet.
Before we look into the process of preparing final accounts we
must understand the meaning and importance of Trial Balance.
The Trial Balance

The trial balance is simply a list of names of the accounts,

and the balances in each account as at a given moment of
time, with debit balances in one column and credit balances
in another column. The preparation of trial balance serves
two principal purposes (i) it shows whether the equality of
debits and credits has been maintained and (ii) it provides a
convenient transcript of the ledger record as a basis for
making adjustments and closing entries for preparation of
final accounts.
When the total debits equal total credits, it does not mean that
there has been no error in recording the transactions. Entries may
have been omitted entirely; they may have been posted to the
wrong accounts; off-setting errors may have been made; or the
transactions may have been analysed incorrectly. For example
when a debit for purchase of a truck is made incorrectly to an
expense account, rather than correctly to a fixed assets account,
the total of the trial balance is not affected. Nevertheless, errors
that result in unequal debits and credits are common, and the
existence of such errors is revealed when a trial balance does not
balance, that is when the debit column does not add to the same
total as the credit column.

A trial balance may be prepared at any time. A pre-

adjustment trial balance is one prepared after the original
entries for the period have been posted, but prior to the
adjusting and closing process. A post closing trial balance is
prepared after the closing process.
(i) Manufacturing Account :

When a concern is engaged in both production and selling

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activities it will have to open a manufacturing account in the
general ledger. The manufacturing account is prepared in
the following manner.
Manufacturing Account of M/s ______________ for the
period from __________ to __________ .
Notes
Dr. Cr.

Particulars Amount Particulars Amount

Rs. Rs.
To Opening stock of By Closing stock of
materials ______ work in progress ———
To Opening stock of
work in progress ———
To Purchases ——— By Cost of manufacturing (B/F)
Less Purchases returns ——— ——— ———

To Carriage inward ———

To Manufacturing wages ———
To Factory rent ———
To Power ———
To Fuel ———
To Coal ———
To Water ———
To Factory insurance ———
——— ———

Manufacturing Account is balanced by adding debit side and

finding the excess of debit over credit. The excess of debit over
credit will indicate the cost of manufacturing of the finished
goods. This balancing figure will be inserted in the credit side of
the Manufacturing Account preceded by the word ‘By cost of
manufacturing’ during the period transferred to Trading
Account and the same figure will also be written on the debit
side of a ‘Trading Account’ to be opened in General Ledger. In
the Trading Account this figure will be preceded by the word ‘To
cost of production transferred from the Manufacturing
Account’. Thus Manufacturing Account is closed and the cost of
production of finished goods during the period is transferred to
the Trading Account. The debit balance of (a) opening stock of
finished goods, (b) purchase less returns, (c) nominal accounts
representing cost incurred in connection with purchase of
materials/goods, like carriage inward on such

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purchase etc. will then be cleared by crediting these

accounts and debiting the Trading Account.
(ii) Trading Account

When a concern is engaged in trading activities only, there will

Notes be no Manufacturing Account. The Trading Account on its debit
side will show certain entries regarding opening stock (of
saleable goods), purchase less returns and expenses relating to
purchase viz. freight, duty, carriage inward etc.
The credit balance of sales account (less the debit balance of
sales return accounts) will then be transferred to Trading
Account by debiting the former account and crediting the
latter account.
The excess of credit total of trading account over the debit
total is called the gross profit. This amount is computed and
an entry is passed by debiting this amount to Trading
Account (preceded by the word ‘To Gross Profit transferred to
Profit and Loss Account’) and crediting the Profit and Loss
Account (preceded by the word ‘By Gross Profit, brought over
from Trading Account’). The Trading Account .thus indicates
the gross result from selling of the goods.
(iii) Profit and Loss Account

At this stage Profit and Loss Account stands credited with gross
profit. The Profit and Loss Account also stands adjusted with
some of the adjustment entries like bad debts, depreciation,
insurance, rent etc. All the debit and credit balances lying in
different nominal accounts are then transferred to Profit and
Loss Account. The debit balances are closed by entering the
respective word ‘By Profit and Loss Account’. The respective
amounts are also entered on the debit side of the Profit and
Loss Account preceded by the words To
.................... . The credit balance of nominal accounts are
similarly closed by passing debit entries to the respective
nominal accounts preceded by the word ‘To Profit and Loss
Account’. In the credit side of the “Profit and Loss Account”
the corresponding credit entries are inserted preceded by the
word ‘By ...................’.

Thus, the Profit and Loss Account on its credit shows Gross

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Profit and items of miscellaneous incomes and on its debit

shows Gross Loss and expenses incidental to carrying of the
business and arising in course of running the business. The
excess of credit side over the debit side is known as net
profit and the excess of debit side over the credit side is
known as net loss. The net profit or net loss is transferred to Notes
Capital Accounts) in case of proprietary or partnership
business and to an account called Profit and Loss
Appropriation Account in case of corporate business.
Proforma of Profit & Loss Account

Profit and Loss Account of M/s …….………………….. for the

year ending ………………………..
Dr. Cr.
Particulars Amount Particulars Amount
Rs. Rs.
To Trading A/c (Gross Loss) By Trading A/c (Gross Profit)
To Travelling exp.A/c By Commission (Received)
To Salaries & Wages A/c By Interest A/c (Received)
To Audit Fee A/c By Discount A/c (Received)
To printing charges A/c By Rent A/c (Received)
To Office establishment A/c By Net Loss (trans-
To Discount Paid A/c ferred to Capital A/c
To Advertisement A/c or Profit & Loss
To Insurance A/c Appropriation A/c)
To Carriage outward A/c
To Dock dues outward A/c
To Depreciation A/c
To Bad debts A/c
To Repair a/c
To Office lighting A/c
To Postage, Telegram A/c
To Interest Paid
To Legal charges A/c
To Stationary A/c
To Trade expenses A/c
To Bank charges A/c
Rates and taxes A/c

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To Brokerage A/c
To Sundry expenses A/c
To Rent A/c
To Duty on exported goods A/c
To Net Profit (transferred
Notes to Capital A/c or Profit

& Loss Appropriation A/c)

(iv) The Balance Sheet

A balance sheet shows the financial position of an

organisation as on a specified moment of time; in fact it is
sometimes called a statement of financial position. It is
therefore a status report, rather than a flow report.
After Trial Balance is prepared; adjustments entries passed,
and revenue accounts drawn up, all the nominal accounts
will stand closed. The accounts still remaining open in the
general ledger will represent either personal accounts or real
accounts. The balance remaining after the preparations of
Trading and Profit and Loss Account in the Trial Balance
represents either assets or liabilities existing on the date of
the closing of the accounts. When they are arranged in a
proper manner, the resultant statement is called ‘Balance
Sheet’. The balance sheet is a statement of position and
strictly speaking not a part of double entry system of book
keeping. No transfer of ledger accounts balances is therefore
necessary. Only the relevant particulars are extracted from
the general ledger. The balance sheet is prepared on a
certain date and not for a period. Therefore, it is true only on
the date of its preparation and not on any other day.
Secondly, the total of liabilities including capital must be
equal to total of assets, otherwise it means that the double
entry system of book keeping has not been followed properly
in respect of all the transactions.
A balance sheet represents the assets of the business,
whether fixed or current or fictitious, on the right hand side
and liabilities, whether owned or borrowed, on the left hand
side. The balance sheet of an organisation can be prepared
in the following format :

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Proforma of Balance Sheet
Balance Sheet of M/s .......................………..
as on …………………………….
Liabilities Amount Assests Amount
Rs. Rs.
Capital — Land Notes
+ Fresh Capital — Building
+ Profit — (—) Less Depreciation —
- Losses __ Plant & Machinery
- Drawings __ (—) Less Dep. —
Term Loan — Office Furniture
Bank Over Draft — (—) Less Dep. —
Creditors — Stock in Trade
Bills Payables — Sundry Debtors
Outstanding — (—) Less Reserve for
Other Liabilities — Doubtful Debtors —
Bills Receivables
Prepaid Expenses —
Investments —
Cash at Bank —
Cash in Hand —

Total ——— Total ———

5.11 APPLICATION OF COMPUTERS AND INFORMATION

TECHNOLOGY TO ACCOUNTING AND FINANCIAL
MANAGEMENT
Business Accounting and Financial Management are crucial
management functions in every enterprise. Whether you
manage a small department, a major division, big company,
small company or your micro enterprise, you work with
numbers every day. Numbers are the language of business and
industrial enterprises. Use of computers in general and
electronic spread sheet in particular can economically and
effectively replace traditional tools of accounting like ledger
pager, stubby pencils, worn-out erasers, desktop calculators
etc. Use of computer and spread sheet in today’s complex
business can take you ahead in speed, accuracy and capability.

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Computer application in accounting and financial
management can help you in transaction recording, financial
planning, analysis, and forecasting. Best of all, it gives you a
method of examining the implications of endless “What if ?”
situations - the tough alternatives you face in running your
business profitably. Computer software developing
Notes
companies have developed a large number of accounting and
financial management softwares.
A brief account of some of the important soft wares available
in India is given below. The basic function of these softwares
is to enter the transactions and the rest of things i.e
posting , balance calculation is done by these software.
These software can prepare the trail balance, cash book,
balance sheet and profit and loss account.
1. Tally
2. Easy
3. Visipak
4. Fact
5. Fast
6. Ex 3.0
5.12 SUMMARY OF ACCOUNTING PROCESS

(i) The first and the most important part of the accounting
process is the analysis of transactions, i.e. the process
of deciding which account or accounts should be
debited, which should be credited, and in what
amounts, in order to reflect events in the accounting
records. This requires judgement.
(ii) Next comes the purely mechanical step of journalising
original entries, that is, recording the result of the analysis.
(iii) Next to journalising is ledger posting. Posting is the
process of recording transactions in the ledger accounts,
exactly as specified by the journal entries. This is
another purely mechanical step.
(iv) At the end of the accounting period Judgement is involved
in deciding on the adjusting entries, and these are
journalised and posted in the same way as original entries.

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(v) The closing entries are journalised and posted. This is
also a purely mechanical step.
(vi) Finally, the financial statements are required to be
prepared. This requires judgement and knowledge. The
accuracy of financial statements will depend upon the
quality of judgement made as suggested in steps (i) and Notes
(ii)
5.13 TERMINAL QUESTIONS

1. Discuss the principles of accounting.

2. Pass the journal entries for the following transactions in
the Books of Mr S.K.Jain
a) He Sold old furniture for Rs 5000/-
b) He received insurance commission of Rs 50000/-
c) Rent paid by cheque Rs 2000/-
d) He incurred traveling expenses of Rs 3900/-
3. Discuss the various financial statements prepared by
any insurance broker.

5.14 OBJECTIVE TYPE QUESTIONS

1. Choose the correct option

a. Accounting system is either on cash or receipt basis.
b. Accounting system is either accrual or mercantile
basis.
c. Accounting system is either hybrid or mixed basis.
d. All of the above
2. Statement A: Real accounts are maintained for tangible
things
Statement B: Real accounts are also maintained for
intangible things.
a. Only A is true b. Only B is true
c. Both are true d. Neither of two

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3. The final accounts of a business consists of
a. Trading account b. Profit & loss Account
c. Balance Sheet d. All of the above
4. Statement A: Balance sheet is summary of the financial
Notes
position as on date.
Statement B: Profit and loss account shows profit or
loss for the year.
a. Only A is true b. Only B is true
c. Both are true d. Neither of two
5. Choose the correct options:
a. Single entry system is a system of recording of
transactions.
b. Double entry system is a system of recording of
transactions.
c. Indian (desi nama) system is a system of recording
of transactions
d. All of the above

5.15 ANSWERS TO INTEXT QUESTIONS

5.1

1. Technical activities, Commercial activities, Financial

activities, Security activities, Accounting activities,
Managerial activities consisting of planning, organizing,
commanding, co-ordaining and controlling.
2. Planning means looking ahead or to foresee. To foresee
means “both to assess the future and make provision for
it. To plan means to foresee and provide means for future.

5.16 ANSWERS TO OBJECTIVE TYPE QUESTIONS

1.d 2. c 3. d 4. c 5. d

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