DELHI GLOBAL INSTITUTE OF MANAGEMENT, JASANA , FARIDABAD

MBA 2nd SEMESTER STUDY MATERIAL

BASICS OF ACCOUNTING

BY – ASSISTANT PROFESSOR

KAJAL NAGAR

UNIT- I

Accounting

Accounting is a process of identifying the events of financial nature, recording them in Journal,
classifying in their respective ledgers, summarising them in Profit and Loss Account and Balance
Sheet and communicating the results to the users of such information, viz. owner/s,
government, creditors, investors etc.
According to the American Institute of Certified Accountants, 1941, “Accounting is an art of
recording, classifying and summarising in a significant manner and in terms of money
transactions and events that are, in part at least, of a financial character and interpreting the
results thereof.”

Income statements (Trading and/or Profit and Loss Account)- An income statement that
includes Trading and Profit and Loss Account, ascertains the financial results of a business in
terms of gross (or net) profit or loss.
Balance Sheet- It depicts the true financial positions of a business that provides required
information like assets and liabilities of a business firm, to the users of accounting information
like owners, creditors, investors, government, etc.

Objectives of accounting

The main objectives of accounting are:

To maintain a systematic record of business transactions

 Accounting is used to maintain a systematic record of all the financial transactions in a

book of accounts.
 For this, all the transactions are recorded in chronological order in Journal and then
posted to principle book i.e. Ledger.
To ascertain profit and loss

 Every businessman is keen to know the net results of business operations periodically.
 To check whether the business has earned profits or incurred losses, we prepare a
“Profit & Loss Account”.
To determine the financial position

 Another important objective is to determine the financial position of the business to

check the value of assets and liabilities.
 For this purpose, we prepare a “Balance Sheet”.
To provide information to various users

 Providing information to the various interested parties or stakeholders is one of the

most important objectives of accounting.
 It helps them in making good financial decisions.
To assist the management

 By analysing financial data and providing interpretations in the form of reports,

accounting assists management in handling business operations effectively.

Basic accounting equation?

The basic accounting equation is,

Assets = Liabilities + Capital
It means that all the monetary value of all assets of a firm are equal to the total claims,
viz. owners and outsiders.

Fundamental steps in the accounting process

 A transaction should be recorded first in a journal because journal provides complete
details of a transaction in one entry. Further, a journal forms the basis for posting the
transactions into their respective accounts into ledger. Transactions are recorded in
journal in chronological order, i.e. in the order of occurrence with the help of source
documents. Journal is also known as ‘book of original entry’, because with the help of
source document, transactions are originally recorded in books. The process of
recording the transactions in journal and then in ledger is presented in the below given
flow chart.

What is Bookkeeping?
Bookkeeping is the process of systematic recording and classification of financial transactions of
an organisation.

Bookkeeping is said to be the basis of accounting, whereas accounting forms a part of the
broader scope in finance.

The most important focus of bookkeeping is to maintain an accurate record of all the monetary
transactions of a business. Companies use this information to take major investment decisions.
The bookkeeper maintains bookkeeping records. Accurate bookkeeping is critical for business
as it gives a piece of reliable information on the performance of a company.

Bookkeeping process consists of the following steps:

1. Identifying a financial transaction

2. Recording a financial transaction
3. Preparing a ledger account
4. Preparing trial balance

What are the Advantages of Accounting?

The following are the main advantages of accounting:

1. Provide information about financial performance

 Accounting provides factual information about financial performance during a given

period of time
 Like, profit earned or loss incurred over a period and financial position at a particular
point of time.
2. Provide assistance to management

 Accounting helps management in business planning, decision making and in exercising

control.
 For this, it provides financial information in the form of reports.
3. Facilitates comparative study

 By keeping systematic records and preparation of reports at regular intervals,

accounting helps in making a comparison.
4. Helps in settlement of tax liability

 Systematic accounting records help in settlement of various tax liabilities. Such as –

Income Tax, GST, etc.
5. Helpful in raising loan

 Banks and Financial Institutions grant a loan to the firm on the basis of appraisal of the
financial statement of the firm.
6. Helpful in decision making

 Accounting provides useful information to the management for taking decisions.

What Are the Limitations of Accounting?

Following are the limitations of accounting:

 Accounting is not precise: Accounting is not completely free from personal bias or
judgment.
 Accounting is done on historic values of assets: Accounting records assets at their
historical cost less depreciation. It does not reflect their current market value.
 Ignore the effect of price level changes: Accounting statements are prepared at
historical cost. So changes in the value of money are ignored.
 Ignore the qualitative information: Accounting records only monetary transactions. It
ignores the qualitative aspects.
 Affected by window dressing: Window dressing means manipulation in accounting to
present a more favourable position of the business than the actual position

Explain the Users of Accounting Information:

Users may be categorised into internal users and external users.

(A) Internal Users

 Owners: Owners contribute capital in the business and thus they are exposed to
maximum risk. So, they are always interested in the safety of their capital.
 Management: Accounting information is used by management for taking various
decisions.
 Employees: Employees are interested in the financial statements to assess the ability of
the business to pay higher wages and bonuses.
(B) External Users

 Banks and financial institutions: Banks and Financial Institutions provide loans to
business. So, they are interested in financial information to ensure the safety and
recovery of the loan.
 Investors: Investors are interested to know the earning capacity of business and safety
of the investment.
 Creditors: Creditors provide the goods on credit. So they need accounting information
to ascertain the financial soundness of the firm.
 Government: The government needs accounting information to assess the tax liability of
the business entity.
 Researchers: Researchers use accounting information in their research work.
 Consumers: They require accounting information for establishing good accounting
control, which will reduce the cost of production.
Explain the System of Accounting
System of accounting

 There are following two systems of recording transactions in the books of accounts:
 Double Entry System
 Single Entry System
Double-entry system

 The double entry system is based on the Dual Aspect Principle.

 Every transaction has two aspects, ‘a Debit’ and ‘a credit’ of an equal amount.
 This system of accounting recognises and records both aspects of the transaction.
Single entry system

 Under this system, both aspects are not recorded for all the transactions.
 Either only one aspect is recorded or both the aspects are not recorded for all the
transaction

What Are the Advantages of the Double-entry System of Accounting?

Following are the main advantages of the double-entry system of accounting:

Scientific system

 As compared to the other systems, this system of recording transactions is more

scientific and useful to achieve the objective of accounting.
A complete record of the transaction

 Since both the aspects of transactions are considered there is a complete recording of
each and every transaction.
 Using these records we are able to compute profit or loss easily.
Checks arithmetical accuracy of accounts

 Under this system, by preparing a Trial Balance we are able to check the arithmetical
accuracy of the records.
Determination of profit/loss and depiction of financial position

 Under this system by preparing ‘Profit & Loss A/c’ we get to know about the profit
earned or loss incurred.
 By preparing the ‘Balance Sheet’ the financial position of the business can be
ascertained, i.e. position of assets and liabilities is depicted.
Helpful in decision making

 Administration and management are able to take decisions on the basis of factual
information under the double-entry system of accounting.

What is GAAP (generally accepted accounting principles)?

GAAP (generally accepted accounting principles) is a collection of commonly followed

accounting rules and standards for financial reporting. The acronym is pronounced gap.

GAAP specifications include definitions of concepts and principles, as well as industry-specific

rules. The purpose of GAAP is to ensure that financial reporting is transparent and consistent
from one public organization to another, and from one accounting period to another

What are the 10 principles of GAAP?

GAAP is outlined by the following 10 general concepts or principles.

1. Regularity. The business and accounting staff apply GAAP rules as standard practice.

2. Consistency. Accounting staff apply the same standards through each step of the reporting
process and from one reporting cycle to the next, paying careful attention to disclose any
differences.

3. Sincerity. Accounting staff provide objective and accurate information about business
finances.

4. Permanence. Accounting staff use consistent procedures in financial reporting, enabling

business finances to be compared from report to report.

5. Noncompensation. Accountants provide complete transparency of positive and negative

factors without any compensation. In other words, they do not get paid based on how good
or bad the reporting turns out.
6. Prudence. Financial data is based on documented facts and is not influenced by guesswork.

7. Continuity. Financial data collection and asset valuations should not disrupt normal business
operations.

8. Periodicity. Financial data should be organized and reported according to relevant

accounting periods. For example, revenue or expenses should be reported within the
corresponding quarter or other reporting period.

9. Materiality. Accountants must rely on material facts and disclose all material financial and
accounting facts in financial reports.

10. Good Faith. There is an expectation of honesty and completeness in financial data collection
and reporting

 The accounting equation can be rearranged into three different ways:

o Assets = Liabilities + Owner’s Capital - Owner’s Drawings + Revenues - Expenses
o Owner’s equity = Assets - Liabilities
o Net Worth = Assets - Liabilities

Accounting Equation Fundamentals

The balance sheet always balances - Asset = Liability + Owner’s equities

It is pertinent to note that the term basic accounting equation is another name for the ‘Balance
Sheet Equation’. The reason balance sheet always balances is because of the following
equation:

Assets = Liabilities + Owners Equities

The ingredients of this equation - Assets, Liabilities, and Owner's equities are the three major
sections of the Balance sheet. By using the above equation, the bookkeepers and accountants
ensure that the "balance" always holds i.e., both sides of the equation are always equal.

Total debits always equal to total credits -Total Debits = Total Credits
The accounting equation represents an extension of the ‘Basic Equation’ to include another
fundamental rule that applies to every accounting transaction when a double-entry system of
bookkeeping is used by the businesses.

Debits = Credits
This Accounting Equation summarizes the following:

 Debit and Credit should be equal for every event that impacts accounts.

 Across any specified timespan, the sum of all debit entries must equal the total of all
credit entries, meaning the same balance applies for every pair of ‘entries’ that follows a
transaction.

UNIT-II

Journalizing

Journalizing transactions is the process of recording and tracking any transaction that your business
performs.

This recording is the building block for the business’ financial statements, which are created at the
end of the fiscal year

What Are Journalizing Transactions?

The business accounting cycle is a multi-step process that records and analyses your financial
information. This cycle starts with journalizing transactions.

The process of journalizing transactions refers to the initial recording of all the financial transactions
of a business. This recording is done by listing journal entries into the journal.

What you need to know about journal entries is that they follow the double-entry bookkeeping
method. In double-entry, every recorded transaction causes a change in at least two accounts,
where one gets debited and the other credited.

Once the journal entries are done, they go into the journal, which is the chronological, day-by-day
accounting book that summarizes business transactions.

What Is Double-Entry Bookkeeping?

As we previously stated, double-entry bookkeeping affects at least two accounts (hence the word
double) with the appropriate debit and credit entries.

But what exactly are debits and credits?

A debit is an entry that:

  Increases an asset or expense account
 Decreases liability, equity, or revenue account

Debits come first and go into the left side of the journal entry.

Whereas a credit does the opposite, meaning it:

 Increases a liability, equity, or revenue account

 Decreases an asset or expense account

Credits are recorded after debits, on the right side of the entry.

Types of Accounts

According to the double entry system of bookkeeping, there are three types of accounts that

help you to maintain an error-free record of your journal entries. Each account type has a rule

to identify its debit and credit aspect called as the Golden Rule of Accounting. The accounts are:

 Personal Accounts
 Real Accounts
 Nominal Accounts

Personal Accounts

Ledger accounts that contain transactions related to individuals or other organizations with

whom your business has direct transactions are known as personal accounts. Some examples of

personal accounts are customers, vendors, salary accounts of

employees, drawings and capital accounts of owners, etc.

The golden rule for personal accounts is: debit the receiver and credit the giver.

Example: Payment of salary to employees

In this example, the receiver is an employee and the giver will be the business. Hence, in

the journal entry, the Employee’s Salary account will be debited and the Cash / Bank

account will be credited.

Real Accounts

The ledger accounts which contain transactions related to the assets or liabilities of the

business are called Real accounts. Accounts of both tangible and intangible nature fall under

this category of accounts, i.e. Machinery, Buildings, Goodwill, Patent rights, etc. These account

balances do not come to zero at the end of the financial year unless there is a sale of

the asset or payment made towards a liability or closure or acquisition of the business. These

accounts appear in the Balance Sheet and the balances get carried forward to the next financial

year.

The golden rule for real accounts is: debit what comes in and credit what goes out.

Example: Payment made for a loan

In this transaction, cash goes out and the loan is settled. Hence, in the journal entry, the Loan

account will be debited and the Bank account will be credited.

Nominal Accounts

Transactions related to income, expense, profit and loss are recorded under this category.

These components actually do not exist in any physical form but they actually exist. For

example, during the purchase and sale of goods, only two components directly get affected i.e

money and stock. But, apart from this we may incur profit or loss out of such transactions and

we might incur some expenses for these transactions to happen. These secondary components

fall under the Nominal Category and the accounts that are in Profit and Loss statement are

shown under this category.

The golden rule for nominal accounts is: debit all expenses and losses

and credit all income and gains.

Example of Nominal Account: Shipping Charges account and Salary account.

Formatting When Recording Journal Entries

 Include a date of when the transaction occurred.

 The debit account title(s) always come first and on the left.
 The credit account title(s) always come after all debit titles are entered, and on the
right.
 The titles of the credit accounts will be indented below the debit accounts.
 You will have at least one debit (possibly more).
 You will always have at least one credit (possibly more).
 The dollar value of the debits must equal the dollar value of the credits or else the
equation will go out of balance.
 You will write a short description after each journal entry.
 Skip a space after the description before starting the next journal entry.

UNIT- III

Subsidiary Books – A Register for Similar Nature Transactions

In big organizations there are numerous transactions going on, in the midst of these
transactions, it is not possible to keep and maintain a record of each and every business affair.
While non-recording any minute transaction can be a havoc which the business will never
resort to. This is when the subsidiary books come into the action and play as a
saviour. Subsidiary books are nothing but an order of maintenance of recording similar natured
transactions. Subsidiary books are the subdivisions of Journal. In this content, we will know in
detail about these books and types of subsidiary books with its function.

Define Subsidiary Books

Subsidiary Books are the books that record the transactions which are similar in nature in an
orderly manner. They are also known as special journals or Daybooks. In big business
institutions, it is not easy to record all the transactions in one journal and post them into
various accounts. So, for the easy and accurate recording of all the transactions, the journal is
subdivided into many subsidiary books. For every type of transaction, there is a separate book.

Types of Subsidiary Books

There are basically 8 types of subsidiary books that are used for recording different types of
transactions. So, let us know the types.

The 8 Subsidiary books are as follows:

Cash Book

Purchase Book

Sales Book

Purchase Return Book

Sales Return Book

Bills Receivable Book

Bills Payable Books

Journal Proper

Set of Subsidiary Books – A Brief Study

Cash Book

The first and most important subsidiary book is the cash book. It records all the transactions
related to cash and bank receipts and payments.

There are 3 types of cash books that are maintained by an organization.

They are:
1.Single Column Cash Book: A single column cash book is like a ledger account. It contains a
debit side and a credit side. All Cash receipts are recorded on the debit side, and all the cash
payments are recorded on the credit side of the cash book.

Purchase Book

Purchase Book is a subsidiary book that is used to record all the transactions related to credit
purchases. The purchases of the asset are never recorded in the purchase book.

Sales Book

The Sales Book records all the transactions related to credit sales. The sales book cannot record
the sale of assets

Purchase Return Book

The purchase return book, also known as the return outward book, is used to record
transactions of all the returns made to the supplier. A debit note is issued against every return
and is recorded in the Purchase Return Book.

Sales Return Book

The sales return book records all the transactions related to inward returns. It is also known as
a return inward book. When the customer returns goods, a credit note is issued to the
customer for every return, and it is recorded in the Sales Return Book.

Bills Receivable Book

The Bills Receivable Book records all the transactions of bills drawn in favour of the business.
The total of the bills receivable book is posted on the debit side of the Bills Receivable account.

Bills Payable Book

The Bills Payable Book records all the transactions related to bills that are drawn on the
business and are payable by the business.

Journal Proper
There are certain transactions that cannot be recorded in any of the above-mentioned books;
these transactions are termed miscellaneous transactions. So, the Journal Proper is used to
record all the miscellaneous transactions. It includes transactions such as credit purchase and
sale of assets, depreciation, etc.

UNIT-IV

What is Trial Balance?

Trial Balance is a technique for checking the accuracy of the debit and credit amounts recorded
in the various ledger accounts. It is basically a statement that exhibits the total of the debit and
credit balances recorded in various accounts of ledger. Accordingly, Trial Balance is prepared to
check the accuracy of the various transactions that are posted into the ledger accounts. It is
certainly one of the important accounting tools as it reveals the final position of all accounts.
Further, it is used in preparing the final accounting statements of the business.
Typically, Trial Balance is prepared at the end of an accounting year. However, a business may
choose to prepare the Trial Balance at the end of any specific period. This could be at the end of
each month, quarter, half a year or a year as per the need.

Trial Balance Example

Kapoor Pvt Ltd entered into the following transactions for the month April 30, 2018.

1. April 1, 2018 – Kapoor Pvt Ltd started business with a capital of Rs 8,00,000
2. April 4, 2018 – Bought goods from Singhania Pvt Ltd on credit for Rs 2,00,000
3. April 5, 2018 – Sold goods to M/s Khanna for Rs 2,50,000
4. April 6, 2018 – Cash purchases Rs 2,50,000
5. April 8, 2018 – Cash sales Rs 1,50,000
6. April 10, 2018 – Goods returned to Singhania Pvt Ltd Rs 20,000
7. April 11, 2018 – Purchased furniture for Rs 1,50,000
8. April 12, 2018 – Cash paid to Singhania Pvt Ltd Rs 1,20,000
9. April 13, 2018 – Goods returned by M/s Khanna Rs 30,000
10. April 15, 2018 – Goods taken by Kapoor Pvt Ltd for private use Rs 30,000
11. April 16, 2018 – Cash received from M/s Khanna Rs Rs 1,20,000
12. April 17, 2018 – Kapoor Pvt Ltd took loan from M/s Sahani Rs 3,00,000
13. April 18, 2018 – Salary paid Rs 50,000
14. April 19, 2018 – Purchased stationery for Rs 10,000
15. April 20, 2018 – Money paid to M/s Sahani for loan Rs 1,80,000
16. April 21, 2018 – Interest received Rs 40,000

Cash Account
Dr. Cr.

Particular Amount
Date Date Particulars Amount
s (in Rs)

1/4/2018 To Capital 8,00,000 6/4/2018 By Purchases 2,50,000

8/4/2018 To Sales 1,50,000 11/4/2018 By Furniture 1,50,000

To M/s
16/4/2018 1,20,000 12/4/2018 By Singhania 1,20,000
Khanna

To M/s
17/4/2018 3,00,000 18/4/2018 By Salary 50,000
Sahani

21/4/2018 To interest 40,000 19/4/2018 By Stationery 10,000

20/4/2018 By M/s Sahani 1,80,000

30/4/2018 By Balance c/d 6,50,000

14,10,000 14,10,000

To
1/5/2018 Balance 6,50,000
b/d

Capital Account

Dr. Cr.

Amount
Date Particulars Date Particulars Amount
(in Rs)
30/4/2018 To Balance c/d 8,00,000 1/4/2018 By Cash 8,00,000

8,00,000 8,00,000

By Balance
1/5/2018 8,00,000
b/d

Stock Account

Dr. Cr.

Amount
Date Particulars Date Particulars Amount
(in Rs)

To
By M/s
4/4/2018 Singhania 2,00,000 5/4/2018 2,50,000
Khanna
Pvt Ltd

6/4/2018 To Cash 2,50,000 8/4/2018 By Cash 1,50,000

By
To M/s
13/4/2018 30,000 10/4/2018 Singhania 20,000
Khanna
Pvt Ltd

By
17/4/2018 15/4/2018 30,000
Drawings

By Balance
30/4/2018 30,000
c/d

4,80,000 4,80,000

To Balance
1/5/2018 30,000
b/d
Singhania Pvt Ltd’s Account

Dr. Cr.

Amount
Date Particulars Date Particulars Amount
(in Rs)

10/4/2018 To Goods Return 20,000 4/4/2018 By Stock 2,00,000

12/4/2018 To Cash 1,20,000

30/4/2018 To Balance c/d 60,000

2,00,000 2,00,000

By Balance
1/5/2018 60,000
b/d

M/s Khanna Account

Dr. Cr.

Amount
Date Particulars Date Particulars Amount
(in Rs)

By Goods
5/4/2018 To Stock 2,50,000 13/4/2018 30,000
Return

16/4/2018 By Cash 1,20,000

By Balance
30/4/2018 1,00,000
c/d
 2,00,000 2,00,000

To Balance
1/5/2018 1,00,000
b/d

Furniture Account

Dr. Cr.

Amount
Date Particulars Date Particulars Amount
(in Rs)

By Balance
11/4/2018 To Cash 1,50,000 30/4/2018 1,50,000
c/d

1,50,000 1,50,000

To Balance
1/5/2018 1,50,000
b/d

Drawings Account

Dr. Cr.

Date Particulars Amount (in Rs) Date Particulars Amount

By Balance
30/4/2018 To Stock 30,000 15/4/2018 30,000
c/d

30,000 30,000

By Balance
1/5/2018 30,000
b/d
M/s Sahani Account

Dr. Cr.

Amount
Date Particulars Date Particulars Amount
(in Rs)

20/4/2018 To Cash 1,80,000 17/4/2018 By Cash 3,00,000

To Balance
30/4/2018 1,20,000
c/d

3,00,000 3,00,000

1/5/2018 By Balance b/d 1,20,000

Salary Account

Dr. Cr.

Amount (in
Date Particulars Date Particulars Amount
Rs)

By Balance
18/4/2018 To Cash 50,000 30/4/2018 50,000
c/d

50,000 50,000

To Balance
1/5/2018 50,000
b/d

Stationery Account
Dr. Cr.

Amount (in
Date Particulars Date Particulars Amount
Rs)

By Balance
19/4/2018 To Cash 10,000 30/4/2018 10,000
c/d

10,000 10,000

To Balance
1/5/2018 10,000
b/d

Interest Account

Dr. Cr.

Amount (in
Date Particulars Date Particulars Amount
Rs)

To Balance
19/4/2018 40,000 21/4/2018 By Cash 40,000
c/d

40,000 40,000

By Balance
1/5/2018 40,000
b/d

Trial Balance of Kapoor Pvt Ltd As On April 31, 2018

Amount
Particulars Amount (Credit)
(Debit)
Cash 6,50,000 –

Capital – 8,00,000

Stock 30,000 –

Singhania Pvt Ltd – 60,000

M/s Khanna 1,00,000 –

Furniture 1,50,000 –

Drawings 30,000 –

M/s Sahani – 1,20,000

Salary 50,000 –

Stationery 10,000 –

Interest – 40,000

Total 10,20,000 10,20,000

Preparation of Trial Balance
Trial balance is prepared after the transactions are first recorded in the journal and then
subsequently posted in the general ledger.

Here are the steps involved in preparing the trial balance

1. For preparing a trial balance, it is required to close all the ledger accounts, cash book
and bank book first. Ledger account should be balanced, that means the entries of both
debit and credit should be equal
2. The next step is the creation of a worksheet having three columns which are having
account name, debit (Dr.) and credit (Cr.) details
3. The columns should be filled with all the appropriate details
4. Debit and credit columns are evaluated. Ideally, an error-free trial balance means the
amount in both the columns match.
5. If both the amounts match, then the trial balance sheet is closed, if any errors are
found, then it has to be rectified. Few reasons for the occurrence of error are listed
below:

 A mistake made while transferring balance amount to trial balance

 Error arising during balancing of the account
 Posting of the wrong amount in the ledger
 Wrong entry is made in the wrong column, i.e. debit entry posted instead of entry for
credit and vice-versa
 Mistakes made during the journal casting

 1. Trading Account
 Trading account is used to determine the gross profit or gross loss of a business which
results from trading activities. Trading activities are mostly related to the buying and
selling activities involved in a business. Trading account is useful for businesses that are
dealing in the trading business. This account helps them to easily determine the overall
gross profit or gross loss of the business. The amount thus determined is an indicator of
the efficiency of the business in buying and selling.
 The formulae for calculating gross profit is as follows:
 Gross profit = Net sales – Cost of goods sold
 Where
 Net sales = Gross sales of the business minus sales returns, discounts and allowances.
 The trading account considers only the direct expenses and direct revenues while
calculating gross profit. This account is mainly prepared to understand the profit earned
by the business on the purchase of goods.
 Items that are seen in the debit side include purchases, opening stock and direct
expenses while credit side includes closing stock and sales.
 Closing entries for Gross Loss or Gross Profit
  The following entries are passed
 In case of Gross Loss
 Profit and Loss A/c Dr.
 To Trading A/c
 In case of Gross Profit
 Trading A/c Dr.
 To Profit and Loss A/c
 Preparing Trading Account
 Trading account is prepared by closing all the temporary purchases and revenue
accounts and making adjustments in the inventory accounts by the use of a closing
journal entry
 For the following question, prepare a trading account

Particulars Amount Particulars Amount

Sales 2,05,000

Sales returns 15,000

Purchases 49,000

Purchases returns 3000

Opening
8000
inventory

Closing inventory 30,000

Trading Account 1,500

 The format of trading account after passing the closing entry is as follows:

Dr. Trading Account for the year ended

Cr.

Sales returns 15,000 Sales 205,000

Purchases 49,000 Purchase returns 3,000

Beginning inventory 8,000 Ending inventory 9,000

Balance c/d 145,000

Total 217,000 Total 217,000

Balance b/d 145,000

2. Profit and Loss Account

Profit and loss account shows the net profit and net loss of the business for the accounting
period. This account is prepared in order to determine the net profit or net loss that occurs
during an accounting period for a business concern.

Profit and loss account get initiated by entering the gross loss on the debit side or gross profit
on the credit side. This value is obtained from the balance which is carried down from the
Trading account.

A business will incur many other expenses in addition to the direct expenses. These expenses
are deducted from the profit or are added to gross loss and the resulting value thus obtained
will be net profit or net loss.

The examples of expenses that can be included in a Profit and Loss Account are:

1. Sales Tax

2. Maintenance

3. Depreciation

4. Administrative Expense

5. Selling and Distribution Expense

6. Provisions

7. Freight and carriage on sales

8. Wages and Salaries

These appear in the debit side of Profit and Loss Account while Commission received, Discount
received, profit obtained on sale of assets appear on the credit side.

Net profit can be determined by deducting business expenses from the gross profit and adding
other incomes obtained

Net profit = Gross profit – Expenses + Other income

Closing Entries for Net Loss or Net Profit:

i. In case of Net Loss

Capital A/c – Dr.

To Profit and Loss A/c

ii. In case of Net Profit

Profit and Loss A/c -Dr.

To Capital A/c

Difference between Trading and Profit and Loss Account

The following points of difference exist between the Trading and Profit and Loss Account

Parameters Trading Account Profit and Loss Account

Meaning Trading account used to Profit and loss account

find the gross profit/loss or Income statement is
of the business for an used to find the net
accounting period profit/loss of the
business for an
accounting period

Timing Trading Account is Profit/Loss Account is

prepared first and then prepared after the
profit and loss account is trading account is
prepared. prepared.

Purpose For knowing the gross For knowing the net

profit or gross loss of a profit or net loss of a
business business

Stage It is the first stage in the it is the second stage in

creation of the final the creation of the final
account. account.

Dependency It is not dependent on It is dependent on

trial balance trading account

Transfer The balance in the form The balance in the form

of Balance of Gross loss or Gross of Net loss or Net Profit
Profit of the trading of the profit and loss
account will be account will be
transferred to the Profit transferred to the
and Loss Account Balance Sheet

What Is a Balance Sheet?

The term balance sheet refers to a financial statement that reports a company's assets,
liabilities, and shareholder equity at a specific point in time. Balance sheets provide the basis
for computing rates of return for investors and evaluating a company's capital structure.

In short, the balance sheet is a financial statement that provides a snapshot of what a
company owns and owes, as well as the amount invested by shareholders. Balance sheets can
be used with other important financial statements to conduct fundamental analysis or
calculate financial ratios.

The balance sheet adheres to the following accounting equation, with assets on one side, and
liabilities plus shareholder equity on the other, balance out:

Assets=Liabilities+Shareholders’ EquityAssets=Liabilities+Shareholders’ Equity

This formula is intuitive. That's because a company has to pay for all the things it owns (assets)
by either borrowing money (taking on liabilities) or taking it from investors (issuing
shareholder equity).

Components of a Balance Sheet

Assets
Accounts within this segment are listed from top to bottom in order of their liquidity. This is
the ease with which they can be converted into cash. They are divided into current assets,
which can be converted to cash in one year or less; and non-current or long-term assets, which
cannot.

Here is the general order of accounts within current assets:

 Cash and cash equivalents are the most liquid assets and can include Treasury bills and
short-term certificates of deposit, as well as hard currency.
 Marketable securities are equity and debt securities for which there is a liquid market.
  Accounts receivable (AR) refer to money that customers owe the company. This may
include an allowance for doubtful accounts as some customers may not pay what they
owe.
 Inventory refers to any goods available for sale, valued at the lower of the cost or
market price.
 Prepaid expenses represent the value that has already been paid for, such as insurance,
advertising contracts, or rent.

Long-term assets include the following:

 Long-term investments are securities that will not or cannot be liquidated in the next
year.
 Fixed assets include land, machinery, equipment, buildings, and other durable,
generally capital-intensive assets.
 Intangible assets include non-physical (but still valuable) assets such as intellectual
property and goodwill. These assets are generally only listed on the balance sheet if
they are acquired, rather than developed in-house. Their value may thus be wildly
understated (by not including a globally recognized logo, for example) or just as wildly
overstated.

Liabilities
A liability is any money that a company owes to outside parties, from bills it has to pay to
suppliers to interest on bonds issued to creditors to rent, utilities and salaries. Current
liabilities are due within one year and are listed in order of their due date. Long-term liabilities,
on the other hand, are due at any point after one year.

Current liabilities accounts might include:

 Current portion of long-term debt is the portion of a long-term debt due within the
next 12 months. For example, if a company has a 10 years left on a loan to pay for its
warehouse, 1 year is a current liability and 9 years is a long-term liability.
 Interest payable is accumulated interest owed, often due as part of a past-due
obligation such as late remittance on property taxes.
 Wages payable is salaries, wages, and benefits to employees, often for the most recent
pay period.
 Customer prepayments is money received by a customer before the service has been
provided or product delivered. The company has an obligation to (a) provide that good
or service or (b) return the customer's money.
 Dividends payable is dividends that have been authorized for payment but have not yet
been issued.
 Earned and unearned premiums is similar to prepayments in that a company has
received money upfront, has not yet executed on their portion of an agreement, and
must return unearned cash if they fail to execute.
  Accounts payable is often the most common current liability. Accounts payable is debt
obligations on invoices processed as part of the operation of a business that are often
due within 30 days of receipt.

Long-term liabilities can include:

 Long-term debt includes any interest and principal on bonds issued

 Pension fund liability refers to the money a company is required to pay into its
employees' retirement accounts
 Deferred tax liability is the amount of taxes that accrued but will not be paid for
another year. Besides timing, this figure reconciles differences between requirements
for financial reporting and the way tax is assessed, such as depreciation calculations.

Some liabilities are considered off the balance sheet, meaning they do not appear on the
balance sheet.

Shareholder Equity
Shareholder equity is the money attributable to the owners of a business or its shareholders. It
is also known as net assets since it is equivalent to the total assets of a company minus its
liabilities or the debt it owes to non-shareholders.

Retained earnings are the net earnings a company either reinvests in the business or uses to
pay off debt. The remaining amount is distributed to shareholders in the form of dividends.

Treasury stock is the stock a company has repurchased. It can be sold at a later date to raise
cash or reserved to repel a hostile takeover.

Some companies issue preferred stock, which will be listed separately from common
stock under this section. Preferred stock is assigned an arbitrary par value (as is common
stock, in some cases) that has no bearing on the market value of the shares. The common
stock and preferred stock accounts are calculated by multiplying the par value by the number
of shares issued.

Additional paid-in capital or capital surplus represents the amount shareholders have invested
in excess of the common or preferred stock accounts, which are based on par value rather
than market price. Shareholder equity is not directly related to a company's market
capitalization. The latter is based on the current price of a stock, while paid-in capital is the
sum of the equity that has been purchased at any price.