Unit-1

INTRODUCTION

Accounting has rightly been termed as the language of the business. The basic
function of a language is to serve as a means of communication. Accounting also
serves this function. It communicates the results of business operations to various
parties who have some stake in the business viz., the proprietor, creditors, investors,
Government and other agencies. Though accounting is generally associated with
business but it is not only business which makes use of accounting. Persons like
housewives, Government and other individuals also make use of a accounting.

For example, a housewife has to keep a record of the money received and spent by her
during a particular period. She can record her receipts of money on one page of her
"household diary" while payments for different items such as milk, food, clothing,
house, education etc. on some other page or pages of her diary in a chronological
order. Such a record will help her in knowing about :

(i) The sources from which she received cash and the purposes for which it was
utilized.
(ii) Whether her receipts are more than her payments or vice-versa?
(iii) The balance of cash in hand or deficit, if any at the end of a period.

In case the housewife records her transactions regularly, she can collect
valuable information about the nature of her receipts and payments. For
example, she can find out the total amount spent by her during a period (say a
year) on different items say milk, food, education, entertainment, etc.
Similarly she can find the sources of her receipts such as salary of her
husband, rent from property, cash gifts from her relatives, etc. Thus, at the
end of a period (say a year) she can see for herself about her financial
position i.e., what she owns and what she owes. This will help her in
planning her future income and expenses (or making out a budget) to a great
extent.
The need for accounting is all the more great for a person who is running a
business. He must know :
(i) What he owns?
(ii) What he owes?
(iii) Whether he has earn a profit or suffered a loss on account of running
a business?
 (iv) What is his financial position i.e. whether he will be in a position to
meet all his commitments in the near future or he is in the process of
becoming a bankrupt

MEANING OF ACCOUNTING

The main purpose of accounting is to ascertain profit or loss during a specified period,
to show financial condition of the business on a particular date and to have control
over the firm's property. Such accounting records are required to be maintained to
measure the income of the business and communicate the information so that it may be
used by managers, owners and other interested parties. Accounting is a discipline
which records, classifies, summarizes and interprets financial information about the
activities of a concern so that intelligent decisions can be made about the concern.

The American Institute of Certified Public Accountants has defined the Financial
Accounting as "the art of recording, classifying and summarising in as significant
manner and in terms of money transactions and events which in part, at least of a
financial character, and interpreting the results thereof". American Accounting
Association defines accounting as "the process of identifying, measuring, and
communicating economic information to permit informed judgments and decisions by
users of the information.

From the above the following attributes of accounting emerge:

(i) Recording :
It is concerned with the recording of financial transactions in an orderly manner,
soon after their occurrence In the proper books of accounts.
(ii) Classifying :
It Is concerned with the systematic analysis of the recorded data so as to
accumulate the transactions of similar type at one place. This function is
performed by maintaining the ledger in which different accounts are opened to
which related transactions are posted.
(iii) Summarising :
It is concerned with the preparation and presentation of the classified data in a
manner useful to the users. This function involves the 5 preparation of financial
statements such as Income Statement, Balance Sheet, Statement of Changes in
Financial Position, Statement of Cash Flow, Statement of Value Added.
(iv) Interpreting :
Nowadays, the aforesaid three functions are performed by electronic data
processing devices and the accountant has to concentrate mainly on the
 interpretation aspects of accounting. The accountants should interpret the
statements in a manner useful to action. The accountant should explain not only
what has happened but also (a) why it happened, and (b) what is likely to
happen under specified conditions.

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OBJECTIVES OF ACCOUNTING

The following are the main objectives of accounting :

1. To keep systematic records : Accounting is done to keep a systematic record of

financial transactions. In the absence of accounting there would have been terrific
burden on human memory which in most cases would have been impossible to bear.

2. To protect business properties: Accounting provides protection to business

properties from unjustified and unwarranted use. This is possible on account of
accounting supplying the following information to the manager or the proprietor: (i)
the amount of the proprietor's funds invested in the business.

(ii) How much the business has to pay to others?

(iii)How much the business has to recover from others?

(iv) How much the business has in the form of (a) fixed assets, (b) cash in hand, (c)
cash at bank, (d) stock of raw materials, work-in-progress and finished goods?

Information about the above matters helps the proprietor in assuring that the funds of
the business are not necessarily kept idle or underutilized.

3.To ascertain the operational profit or loss : Accounting helps in ascertaining the
net profit earned or loss suffered on account of carrying the business. This is done by
keeping a proper record of revenues and expense of a particular period. The Profit and
Loss Account is prepared at the end of a period and if the amount of revenue for the
period is more than the expenditure incurred in earning that revenue, there is said to be
a profit. In case the expenditure exceeds the revenue, there is said to be a loss. Profit
and Loss Account will help the management, investors, creditors, etc. in knowing
whether the business has proved to be remunerative or not. In case it has not proved to
be remunerative or profitable, the cause of such a state of affairs will be investigated
and necessary remedial steps will be taken.
 4. To ascertain the financial position of the business : The Profit and Loss Account
gives the amount of profit or loss made by the business during a particular period.
However, it is not enough. The businessman must know about his financial position
i.e. where he stands ?, what he owes and what he owns? This objective is served by the
Balance Sheet or Position Statement. The Balance Sheet is a statement of assets and
liabilities of the business on a particular date. It serves as barometer for ascertaining
the financial health of the business.

5. To facilitate rational decision making : Accounting these days has taken upon
itself the task of collection, analysis and reporting of information at the required points
of time to the required levels of authority in order to facilitate rational decision-
making. The American Accounting Association has also stressed this point while
defining the term accounting when it says that accounting is the process of identifying,
measuring and communicating economic information to permit informed judgments
and decisions by users of the information. Of course, this is by no means an easy task.
However, the accounting bodies all over the 11 world and particularly the International
Accounting Standards Committee, have been trying to grapple with this problem and
have achieved success in laying down some basic postulates on the basis of which the
accounting statements have to be prepared.

6. Information System : Accounting functions as an information system for collecting

and communicating economic information about the business enterprise. This
information helps the management in taking appropriate decisions. This function, as
stated, is gaining tremendous importance these days.

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USERS OF ACCOUNTING INFORMATION

The basic objective of accounting is to provide information which is useful for persons
inside the organization and for persons or groups outside the organization. Accounting
is the discipline that provides information on which external and internal users of the
information may base decisions that result in the allocation of economic resources in
society.

I. External Users of Accounting Information : External users are those groups or

persons who are outside the organization for whom accounting function is performed.
Following can be the various external users of accounting information:
1. Investors,Those who are interested in investing money in an organization are
interested in knowing the financial health of the organization of know how safe the
investment already made is and how safe their proposed investment will be. To know
the financial health, they need accounting information which will help them in
evaluating the past performance and future prospects of the organization. Thus,
investors for their investment decisions are dependent upon accounting information
included in the financial statements. They can know the profitability and the financial
position of the organization in which they are interested to make that investment by
making a study of the accounting information given in the financial statements of the
organization.

2. Creditors. Creditors (i.e. supplier of goods and services on credit, bankers and other
lenders of money) want to know the financial position of a concern before giving loans
or granting credit. They want to be sure that the concern will not experience difficulty
in making their payment in time i.e. liquid position of the concern is satisfactory. To
know the liquid position, they need accounting information relating to current assets,
quick assets and current liabilities which is available in the financial statements.

3. Members of Non-profit Organizations. Members of non-profit organizations such

as schools, colleges, hospitals, clubs, charitable institutions etc. need accounting
information to know how their contributed funds are being utilised and to ascertain if
the organization deserves continued support or support should be withdrawn keeping
in view the bad performance depicted by the accounting information and diverted to
another organisation. In knowing the performance of such organisations, criterion will
not be the profit made but the main criterion will be the service provided to the
society.

4. Government. Central and State Governments are interested in the accounting

information because they want to know earnings or sales for a particular period for
purposes of taxation. Income tax returns are examples of financial reports which are
prepared with information taken directly from accounting records. Governments also
needs accounting information for compiling statistics concerning business which, in
turn helps in compiling national accounts.

5. Consumers. Consumers need accounting information for establishing good

accounting control so that cost of production may be reduced with the resultant
reduction of the prices of goods they buy. Sometimes, prices for some goods are fixed
by the Government, so it needs accounting information to fix reasonable prices so that
consumers and manufacturers are not exploited. Prices are fixed keeping in view fair
return to manufacturers on their investments shown in the accounting records.
6. Research Scholars. Accounting information, being a mirror of the financial
performance of a business organisation, is of immense value to the research scholars
who wants to make a study to the financial operations of a particular firm. To make a
study into the financial operations of a particular firm, the research scholar needs
detailed accounting information relating to purchases, sales, expenses, cost of
materials used, current assets, current liabilities, fixed assets, long term liabilities and
shareholders' funds which is available in the accounting records maintained by the firm

II Internal Users of Accounting Information.

Internal users of accounting information are those persons or groups which are within
the organization. Following are such internal users :

1. Owners. The owners provide funds for the operations of a business and they want
to know whether their funds are being properly used or not. They need accounting
information to know the profitability and the financial position of the concern in which
they have invested their funds. The financial statements prepared from time to time
from accounting records depicts them the profitability and the financial position.

2. Management. Management is the art of getting work done through others, the
management should ensure that the subordinates are doing work properly. Accounting
information is an aid in this respect because it helps a manager in appraising the
performance of the subordinates. Actual performance of the employees can be
compared with the budgeted performance they were expected to achieve and remedial
action can be taken if the actual performance is not up to the mark. Thus, accounting
information provides "the eyes and ears to management". The most important
functions of management are planning and controlling. Preparation of various budgets,
such as sales budget, production budget, cash budget, capital expenditure budget etc.,
is an important part of planning function and the starting point for the preparation of
the budgets is the accounting information for the previous year. Controlling is the
function of seeing that programmers laid down in various budgets are being actually
achieved i.e. actual performance ascertained from accounting is compared with the
budgeted performance, enabling the manager to exercise controlling case of weak
performance. Accounting information is also helpful to the management in fixing
reasonable selling prices. In a competitive economy, a price should be based on cost
plus a reasonable rate of return. If a firm quotes a price which exceeds cost plus a
reasonable rate of return, it probably will not get the order. On the other hand, if the
firm quotes a price which is less than its cost, it will be given the order but will incur a
loss on account of price being lower than the cost. So, selling prices should always be
fixed on the basis of accounting data to get the reasonable margin of profit on sales.
3. Employees. Employees are interested in the financial position of a concern they
serve particularly when payment of bonus depends upon the size of the profits earned.
They seek accounting information to know that the bonus being paid to them is
correct.

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Scope of Accounting:

1. Identification

Accounting is concerned with financial transactions and events which bring ‘about a
change in the resources (or wealth) position of the business firm. Such transactions
have to be identified first, as and when they occur. It is not difficult because. There
will be proof in the form of a bill or receipt (called vouchers). With the help of these
bills and receipts identification of a transaction is easy. For example, when you
purchase something you get a bill, when you make payment you gets a receipt.

2. Measurement.

These transactions are to be measured or expressed in terms of money, if not done

already. Generally, this problem will not arise, because the statement of proof
expresses the transaction in terms of money. For example, if ten books are purchased
at the rate of Rs. 20 each, then the bill is prepared for Rs. 200. But, if an event cannot
be expressed in monetary terms, it will not come under the scope of accounting.

3.Recording

The transactions which are identified and measured are to be recorded in a book
called journal or in one of its sub-divisions.

4 Classification

The recorded transactions are to be classified with a view to group transactions of

similar nature at one place. The work of classification is done in a separate book called
ledger. In the ledger, a separate account is opened for each item so that all transactions
relating to it can be brought to one place. For example, all payments of salaries are
brought to salaries account.

5. Summarizing
The recording and classification of many transactions will result in a mass of financial
data. It is, therefore, necessary to summaries such data periodically (at least once a
year), in a significant and meaningful form. The summarization is done in the form of
profit and loss account which reveals the profit made or loss incurred, and the balance
sheet which reveals the financial position.

6 Analyzing, interpretation and communication:

The summary results will have to be analyzed, interpreted (critically explained) and
communicated to interested parties. Accounting information is generally
communicated in the form of a 'report'. Big organizations generally present printed
reports, called published accounts

Concept of book keeping:

A double-entry bookkeeping system is a set of rules for recording financial

information in a financial accounting system in which every transaction or event
changes at least two different nominal ledger The name derives from the fact that
financial information used to be recorded using pen and ink in paper books – hence
"bookkeeping" (whereas now it is recorded mainly in computer systems) and that these
books were called journals and ledgers (hence nominal ledger, etc.) – and that each
transaction was entered twice (hence "double-entry"), with one side of the transaction
being called a accounts. debit and the other a credit. It was first codified in the 15th
century by the Franciscan Friar, Luca Pacioli. In deciding which account has to be
debited and which account has to be credited, the golden rules of accounting are used.
This is also accomplished using the accounting equation: Equity = Assets −
Liabilities. The accounting equation serves as an error detection tool. If at any point
the sum of debits for all accounts does not equal the corresponding sum of credits for
all accounts, an error has occurred. It follows that the sum of debits and the sum of the
credits must be equal in value. Double-entry bookkeeping is not a guarantee that no
errors have been made – for example, the wrong ledger Accounting entries account
may have been debited or credited, or the entries completely reversed.

DISTINCTION BETWEEN BOOK-KEEPING AND ACCOUNTING

Book-keeping is a part of accounting and is concerned with the recording of

transactions which is often routine and clerical in nature, whereas accounting performs
other functions as well, viz., measurement and communication, besides recording. An
accountant is required to have a much higher level of knowledge, conceptual
understanding and analytical skill than is required of the book-keeper. An accountant
designs the accounting system, supervises and checks the work of the book-keeper,
prepares the reports based on the recorded data and interprets the reports. Nowadays,
he is required to take part in matters of management, control and planning of economic
resources.

DISTINCTION BETWEEN ACCOUNTING AND ACCOUNTANCY

Although in practice Accountancy and Accounting are used interchangeably yet there
is a thin line of demarcation between them. The word Accountancy is used for the
profession of accountants - who do the work of accounting and are knowledgeable
persons. Accounting is concerned with 6 recording all business transactions
systematically and then arranging in the form of various accounts and financial
statements. And it is a distinct discipline like economics, physics, astronomy etc. The
word accounting tries to explain the nature of the work of the accountants
(professionals) and the word Accountancy refers to the profession these people adopt.

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LIMITATIONS OF FINANCIAL ACCOUNTING

Advantages of accounting discussed in this lesson do not suggest that accounting is

free from limitations. Anyone who is using accounting information should be well
aware of its limitations also. Following are the limitations:

(a) Financial accounting permits alternative treatments:

No doubt accounting is based on concepts and it follows "generally
accepted accounting principles", but there exist more than one principle for
the treatment of any one item. This permits alternative treatments within the
framework of generally accepted accounting principles. For example, the
closing stock of a business may be valued by any one of the following
methods: FIFO (First-in-first-out); LIFO (Last-in-first-out); Average price,
Standard price etc., Application of different methods will give different
results but the methods are generally accepted. So, the results are not
comparable.
(b) Financial accounting is influenced by personal judgments.
In spite of the fact that convention of objectivity is respected in accounting
but to record certain events estimates have to be made which requires
personal judgment. It is very difficult to expect accuracy in future estimates
and objectivity suffers. For example, in order to determine the amount of
depreciation to be charged every year for the use of fixed asset it is required
to estimate (1) future life of the asset, and (2) scrap value of the asset. Thus
in accounting we do not determine but measure the income. In other words,
the income disclosed by accounting is not authoritative but approximation.

(c) Financial accounting ignores important non-monetary information

financial accounting takes into consideration only those transactions and
events which can be described in money. The transactions and events,
however important, if non-monetary in nature are ignored i.e., not recorded.
For example, extent of competition faced by the business, technical
innovations possessed by the business, loyalty and efficiency of the
employees etc. are the important matters in which management of the
business is highly interested but accounting is not tailored to take note of
such matters. Thus any user of financial information is, naturally, deprived
of vital information which is of non-monetary character.

(d) Financial accounting does not provide timely informationfinancial

accounting is designed to supply information in the form of statements
(Balance Sheet and Profit and Loss Account) for a period, normally, one
year. So the information is, at best, of historical interest and only
postmortem analysis of the past can be conducted. The business requires
timely information at frequent intervals to enable the management to plan
and take corrective action. For example, if a business has budgeted that
during the current year sales should be Rs. 12,00,000 then it requires
information – whether the sales in the first month of the year amounted to
Rs. 1,00,000 or less or more? Traditionally, 19 financial accounting is not
supposed to supply information at shorter intervals than one year.

(e) Financial accounting does not provide detailed analysis

The information supplied by the financial accounting is in reality aggregate
of the financial transactions during the course of the year. Of course, it
enables to study the overall results of the business activity during the
accounting period. For proper running of the business the information is
required regarding the cost, revenue and profit of each product but financial
accounting does not provide such detailed information product-wise. For
example, if a business has earned a total profit of, say, Rs. 5,00,000 during
the accounting year and it sells three products namely petrol, diesel and
mobile oil and wants to know profit earned by each product. Financial
accounting is not likely to help him.
 (f) Financial accounting does not disclose the present value of the
business
In financial accounting the position of the business as on a particular date is
shown by a statement known as balance sheet. In balance sheet the assets are
shown on the basis of going concern concept. Thus it is presumed that
business has relatively longer life and will continue to exist indefinitely,
hence the asset values are going concern values. The realized value of each
asset if sold today can't be known by studying the balance sheet.

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BASIC ACCOUNTING TERMS

1. Business

Any legal action that is done in order to earn income or profit is called business. It
includes the production of goods and services, purchase and sale of goods and services,
banking, insurance, education transportation, and any other trading activity etc.

2. Trade

Purchase and sale of goods and services in order to earn profit is called trade.

3. Profession

Any work done in order to earn profit which necessarily requires prior training and
education is called a profession. For example doctors, lawyers, engineers etc..

4. Proprietor

The person who invests capital in the business and entitled to have all profits and losses
of the business is called proprietor or owner of the business. The nature of proprietor
depends upon the type or nature of the business organization. In a sole trade business,
sole trader is a proprietor, in a partnership firm, partners or proprietor and in company
shareholders are proprietors.
5. Capital

The amount of cash, goods or assets which is initially invested by proprietor while
commencing business is called capital. It is invested to earn profits. In other words, the
excess of assets over liability is capital.

6. Assets

All the resources of business having economic value are called assets. These resources
help the business to earn a profit and have future value. These are important for running a
business and are in the possession of businessman. These are of two types: –

a. Fixed assets

The assets which are used by business for a long time are called fixed assets or non-
current assets. These are continued to be used by the business for a period of more than
one year. For example:- land ,building ,plant, machinery ,furniture ,vehicle etc.

b. Current assets

The assets which are used up in one year or easily get converted into cash in one year are
called current assets. For example:- raw material, finished goods, debtors, cash balance
and bank balance etc.

7. Liabilities

The amount which business owes to others is called its liabilities. There is a certain
amount which business is under obligation to pay. There are two types of liabilities: –

a. Long-term liabilities

Those liabilities which are usually payable after a period of 1 year. Long-term loans from
Financial Institutions, debentures issued by companies etc.

b. Short-term liabilities

These are those which are payable within one year. For example creditors, bank
overdrafts etc.
8. Drawings

The amount of cash or goods which is withdrawn by proprietor from business for its
private uses is called drawings. It reduces the capital of the business.

9. Goods

The things which are bought and sold by business are called goods. Goods maybe raw
material work in progress of finished goods. In accounting, when goods are purchased it
is written as purchases. When goods are sold it is written as sales. It is written as a stock
if remain unsold at the end of the year.

10. Purchases

Goods bought for resale are called purchases. This may be in form of raw material or
finished goods. Purchase of assets is not called purchases because assets are not
purchased for resale.

11. Sales

When purchase goods are sold in order to earn a profit are called sales. When goods are
sold for cash it is called cash sales and goods sold on credit are called credit sales.

12. Purchase return

Goods once purchased by the business, are returned back due to any reason is called
purchase return or return outwards.

13. Sales return

Goods once sold to the customer when are returned back by them due to any reason then
such goods are called as sales returns or return inwards.

14. Stock

These are those goods which are left unsold in the business at the end of the year. The
goods unsold at the end of the accounting year are called closing stock. The same stock is
called opening stock at the beginning of a new accounting year.
15. Revenue

These are the amount received by a business for selling goods or services. This amount is
received from day to day business activity in the form of rent, interest, commission,
discount, dividend etc.

16. Expenses

The cost which business incurs for producing goods and services or for using services is
called expenses. These include payments made for wages, salaries, freight,
advertisement, rent, insurance etc. In other words, we can say that the cost of earning
revenue is an expense.

17. Expenditure

The amount which is paid for increasing profit earning capacity of business is called
expenditure. It is of long period nature.

18. Income

That amount which increases the capital of the business is called income. The excess of
revenue over expenses is also called income.

19. Loss

When expenses incurred are more than revenue then this excess of expenses is called
loss. This reduces the capital of the business.

20. Gain

It is a monetary receipt as a result of business transaction. The excess of revenue over the
expenses is called gain.

21. Cost

Total of direct or indirect expenses which are incurred for the production of goods and
services is called cost. Like the cost of raw material cost of labor and cost of other
services used to make the article is called its total cost.
22. Discount

Concession a rebate allowed by a businessman 2 its customer is called a discount. it may

be of two types: –

a. Trade discount

When a trader allows a concession to its customers on the list price, it is known as trade
discount. It is not recorded in the books. It is stated in the invoice.

b. Cash discount

When a trader allows a concession to the customer to make payment in cash or by

cheque, it is known as cash discount. It is recorded in the books. When cash discount is
allowed customer is required to pay the less due amount, so it encourages the customer to
pay as early as possible.

23. Debtor

The person, firm or an organization who takes goods or services on credit from the
business are called debtors of the business. In other words, the person, firm or an
organization who owes money or Money’s worth to the business is called debtor.

24. Creditors

The person, firm or an organization from whom goods or services are purchased on credit
by the business are called creditors of the business. The business owes money to them.
The amount payable to creditors is a liability of the business.

25. Receivables

The total amount which is to be received in business is called receivables.

26. Payables

The total amount which is to be paid by the business is called payables.

27. Entry

Recording of the transaction in account books is called making an entry or the record of a
transaction in books is called an entry.

28. Turnover

The total amount of cash and credit sales during a particular period is called turnover.

29. Insolvent

A person is said to be insolvent when he or she is incapable to meet all his or her
liabilities. Such a person has more liability than assets.

30. Bad debts

The amount which could not be recovered from debtors due to his insolvency or
disability to pay is called bad debts.

31. Vouchers

The written document through which financial transactions are recorded in the books is
called voucher.

32 Account

A list of all transactions relating to a person, property, income expenses is called into
account. It is a tabular statement containing all the transaction of same nature at one place
under a common heading in a systematic manner.

33 Debit and credit

Every account has two sides. Left side is called the debit side and the right side is called
the credit side. In short, it is Dr. and Cr.

34 Commission

In a business activity, a remuneration is paid to the agent for his services, is called
commission.
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ACCOUNTING CONCEPTS AND CONVENTIONS

The term ‘Concept’ is used to connote the accounting postulates, i.e., necessary
assumptions and ideas which are fundamental to accounting practice. In other words,
fundamental accounting concepts are broad general assumptions which underline the
periodic financial statements of business enterprises. The reason why some of the these
terms should be called concepts is that they are basic assumptions and have a direct
bearing on the quality of financial accounting information. The term ‘convention’ is
used to signify customs or tradition as a guide to the preparation of accounting
statements. The following are the important accounting concepts and conventions:

ACCOUNTING CONCEPTS

The more important accounting concepts are briefly described as follows:

1. Separate Business Entity Concept.

In accounting we make a distinction between business and the owner. All the
books of accounts records day to day financial transactions from the view point of
the business rather than from that of the owner. The proprietor is considered as a
creditor to the extent of the capital brought in business by him. For instance, when
a person invests Rs. 10 lakh into a business, it will be treated that the business has
borrowed that much money from the owner and it will be shown as a ‘liability’ in
the books of accounts of business. Similarly, if the owner of a shop were to take
cash from the cash box for meeting certain personal expenditure, the accounts
would show that cash had been reduced even though it does not make any
difference to the owner himself. Thus, in recording a transaction the important
question is how does it affects the business? For example, if the owner puts cash
into the business, he has a claim against the business for capital brought in

2. Money Measurement Concept.

 In accounting, only those business transactions are recorded which can be expressed
in terms of money. In other words, a fact or transaction or happening which cannot be
expressed in terms of money is not recorded in the accounting books. As money is
accepted not only as a medium of exchange but also as a store of value, it has a very
important advantage since a number of assets and equities, which are otherwise
different, can be measured and expressed in terms of a common denominator

3. Dual Aspect Concept.

Financial accounting records all the transactions and events involving financial
element. Each of such transactions requires two aspects to be recorded. The
recognition of these two aspects of every transaction is known as a dual aspect
analysis. According to this concept every business transactions has dual effect. For
example, if a firm sells goods of Rs. 10,000 this transaction involves two aspects.
One aspect is the delivery of goods and the other aspect is immediate receipt of
cash (in the case of cash sales). Infect, the term ‘double entry’ book keeping has
come into vogue because for every transaction two entries are made. According to
this system the total amount debited always equals the total amount credited. It
follows from ‘dual aspect concept’ that at any point in time owners’ equity and
liabilities for any accounting entity will be equal to assets owned by that entity.
This idea is fundamental to accounting and could be expressed as the following
equalities:

(1) Assets = Liabilities + Owners Equity ...............

(2) Owners Equity = Assets - Liabilities ........... The above relationship is known as the
‘Accounting Equation’. The term ‘Owners Equity’ denotes the resources supplied by
the owners of the entity while the term ‘liabilities’ denotes the claim of outside parties
such as creditors, debenture-holders, bank against the assets of the business. Assets are
the resources owned by a business. The total of assets will be equal to total of
liabilities plus owners capital because all assets of the business are claimed by either
owners or outsiders.

4. Going Concern Concept.

Accounting assumes that the business (9) entity will continue to operate for a long
time in the future unless there is good evidence to the contrary. The enterprise is
 viewed as a going concern, that is, as continuing in operations, at least in the
foreseeable future. In other words, there is neither the intention nor the necessity to
liquidate the particular business venture in the predictable future.

5. Accounting Period Concept.

This concept requires that the life of the business should be divided into
appropriate segments for studying the financial results shown by the enterprise
after each segment.

6. Cost Concept.

The term ‘assets’ denotes the resources land building, machinery etc. owned by a
business. The money values that are assigned to assets are derived from the cost
concept. According to this concept an asset is ordinarily entered on the accounting
records at the price paid to acquire it. For example, if a business buys a plant for
Rs. 5 lakh the asset would be recorded in the books at Rs. 5 lakh, even if its market
value at that time happens to be Rs. 6 lakh. Thus, assets are recorded at their
original purchase price and this cost is the basis for all subsequent accounting for
the business. The assets shown in the financial statements do not necessarily
indicate their present market values. The term ‘book value’ is used for amount
shown in the accounting records.

7. The Matching concept.

This concept is based on the accounting period concept. In reality we match

revenues and expenses during the accounting periods. Matching is the entire
process of periodic earnings measurement, often described as a process of matching
expenses with revenues. In other words, income made by the enterprise during a
period can be measured only when the revenue earned during a period is compared
with the expenditure

8. Accrual Concept.

It is generally accepted in accounting that the basis of reporting income is accrual.

Accrual concept makes a distinction between the receipt of cash and the right to
 receive it, and the payment of cash and the legal obligation to pay it. This concept
provides a guideline to the accountant as to how he should treat the cash receipts
and the right related thereto. Accrual principle tries to evaluate every transaction in
terms of its impact on the owner’s equity. The essence of the accrual concept is that
net income arises from events that change the owner’s equity in a specified period
and that these are not necessarily the same as change in the cash position of the
business. Thus it helps in proper measurement of income.

9. According to realization concept

Revenue is recognised when sale is made. Sale is considered to be made at the

point when the property in goods passes to the buyer and he becomes legally liable
to pay. This implies that revenue is generally realized when goods are delivered or
services are rendered. The rationale is that delivery validates a claim against the
customer.

ACCOUNTING CONVENTIONS

1. Convention of Materiality.

Materiality concept states that items of small significance need not be given
strict theoretically correct treatment. Infact, there are many events in business
which are insignificant in nature. The cost of recording and showing in financial
statement such events may not be well justified by the utility derived from that
information. For example, an ordinary calculator costing Rs. 100 may last for
ten years. However, the effort involved in allocating its cost over the ten year
period is not worth the benefit that can be derived from this operation. The cost
incurred on calculator may be treated as the expense of the period in which it is
purchased. Similarly, when a statement of outstanding debtors is prepared for
sending to top management, figures may be rounded to the nearest ten or
hundred.

2. Convention of Conservatism.

This concept requires that the accountants must follow the policy of ‘’playing
safe” while recording business transactions and events. That is why, the
 accountant follow the rule anticipate no profit but provide for all possible losses,
while recording the business events. This rule means that an accountant should
record lowest possible value for assets and revenues, and the highest possible
value for liabilities and expenses. According to this concept, revenues or gains
should be recognised only when they are realised in the form of cash or assets
(i.e. debts) the ultimate cash realisation of which can be assessed with
reasonable certainty. Further, provision must be made for all known liabilities,
expenses and losses, Probable losses regarding all contingencies should also be
provided for. ‘Valuing the stock in trade at market price or cost price whichever
is less’, ‘making the provision for doubtful debts on debtors in anticipation of
actual bad debts’, ‘adopting written down value method of depreciation as
against straight line method’, not providing for discount on creditors but
providing for discount on debtors’, are some of the examples of the application
of the convention of conservatism

3. Convention of Consistency.

The convention of consistency requires that once a firm decided on certain

accounting policies and methods and has used these for some time, it should
continue to follow the same methods or procedures for all subsequent similar
events and transactions unless it has a sound reason to do otherwise. In other
worlds, accounting practices should remain unchanged from one period to
another. For example, if depreciation is charged on fixed assets according to
straight line method, this method should be followed year after year.
Analogously, if stock is valued at ‘cost or market price whichever is less’, this
principle should be applied in each subsequent year.

Next topic:

ACCOUNTING STANDARDS

The accounting concepts and conventions discussed in the foregoing pages are
the core elements in the theory of accounting. These principles, however, permit
a variety of alternative practices to co-exist. On account of this the financial
results of different companies cannot be compared and evaluated unless full
information is available about the accounting methods which have been used.
The lack of uniformity among accounting practices have made it difficult to
 compare the financial results of different companies. It means that there should
not be too much discretion to companies and their accountants to present
financial information the way they like. In other words, the information
contained in financial statements should conform to carefully considered
standards. Obviously, accounting standards are needed.

OBJECTIVES OF ACCOUNTING SATANADRD

a) Provide a basic framework for preparing financial statements to be uniformly

followed by all business enterprises,

b) Make the financial statements of one firm comparable with the other firm
and the financial statements of one period with the financial statements of
another period of the same firm,

c) Make the financial statements credible and reliable, and

d) Create general sense of confidence among the outside users of financial

statements.

In order to harmonize varying accounting policies and practices, the Institute

of Chartered Accountants of India (ICAI) formed the Accounting Standards
Board (ASB) in April, 1977. ASB includes representatives from industry
and government. The main function of the ASB is to formulate accounting
standards. This Board of the Institute of Chartered Accountants of India has
so far formulated around 27 Accounting Standards, the list of these (17)
accounting standards is furnished. Regarding the position of accounting
standards in India, it has been stated that the standards have been developed
without first establishing the essential theoretical framework. As a result,
accounting standards lack direction and coherence. This type of limitation
also existed in UK and USA but it was remedied long back. Hence, there is
an emergent need to make an attempt to develop a conceptual framework
and also revise suitably the Indian Accounting Standards to reduce the
number of alternative treatments.

Ind AS have many benefits, some of which are discussed below:

• Wider acceptability:
Since Ind AS are converged form of IFRS which are widely acceptable and will give
confidence to the user of financial statements.
• Comparability of Financials:
Financial statements prepared using Ind AS are easily comparable with the financial
statements prepared by companies of other countries.

• Changes in standards as per economic situations:

Principles of Ind AS are revised/modified in case there is any major change in
economy. Ind AS 29 is ‘Financial Reporting in hyperinflationary Economies’ which
deals with situations related to inflation.
• Attracts Foreign Investment:
Adopting Ind AS may attract foreign investors to invest in Indian Companies as that
will ensure better comparability with similar companies across the globe.
• Saves financial statement preparation cost:
For multinational companies, it will be beneficial as it will be able to use the same
accounting standards in all the markets in which they operate. This will save
preparation costs of aligning financial statements of Indian company with other
operations.
Indian Accounting Standards
Accounting Standard 1 : Disclosure of Accounting Policies
Accounting Standard 2 : Valuation of Inventories
Accounting Standard 3 : Cash Flow Statements
Accounting Standard 4 : Contingencies and Events Occurring after the Balance
Sheet Date
Accounting Standard 5 : Net Profit or Loss for the Period, Prior Period Items and
Changes in Accounting Policies
Accounting Standard 6 : Depreciation Accounting
Accounting Standard 7 : Construction Contracts
Accounting Standard 8 : (Deleted)
Accounting Standard 9 : Revenue Recognition
Accounting Standard 10 : Property, Plant and Equipment
Accounting Standard 11 : The effects of changes in Foreign Exchange Rates
Accounting Standard 12 : Accounting for Government Grants
Accounting Standard 13 : Accounting for Investments
Accounting Standard 14 : Accounting for Amalgamations
Accounting Standard 15 : Employee benefits
Accounting Standard 16 : Borrowing Costs
Accounting Standard 17 : Segment Reporting
Accounting Standard 18 : Related Party Disclosures
Accounting Standard 19 : Leases
Accounting Standard 20 : Earnings Per Share
Accounting Standard 21 : Consolidated Financial Statements
Accounting Standard 22 : Accounting for Taxes on Income
Accounting Standard 23 : Accounting for Investments in Associates in
Consolidated Financial Statements
Accounting Standard 24 : Discontinuing Operations
Accounting Standard 25 : Interim Financial Reporting
Accounting Standard 26 : Intangible Assets
Accounting Standard 27 : Financial Reporting of Interest in Joint Ventures
Accounting Standard 28 : Impairment of Assets
Accounting Standard 29 : Provisions Contingent Liabilities and Contingent
Assets
Accounting Standard 30 : Financial Instruments : Recognition and
Measurements*
Accounting Standard 31 : Financial Instruments : Presentation*
Accounting Standard 32 : Financial Instruments : Disclosures*

Unit-2
MEANING OF DOUBLE ENTRY SYSTEM:
Double entry system owes its origin to an Italian merchant named LUCO
PACIOLI who wrote the first book entitled ‘De Computis et Scripturis’ on
double entry accounting in the year 1494. Every business transactions has
two aspects, i.e. when we receive something, we give something else in
return. For example, when we purchase goods for cash, we receive goods and
give cash in return. Similarly in a credit sale of goods, goods are given to the
customer and the customer becomes debtor for the amount of goods sold by
him. This method of writing every transaction in two accounts is known as
double entry system of accounting. Of the two accounts one account is given
debit while the other account is given credit with an equal amount. Thus, on
 any date, the total of all debits must be equal to the total of all credits because
every debit has a corresponding credit.

Rules for Double Entry System

An account is statement and it is a record of transactions relating to a person,

or a firm, or a property, or a liability, or an income or expenditure. There are
three kinds of rules for double entry system. They are as follows:-

1. Personal Accounts

Under this statement, a separate account will be prepared for each person. It
includes Natural person’s account, artificial person’s account and
representative personal accounts. Some of the examples of personal account
are Ram’s account, Bank account, any firms account, any companies
account, prepaid expense account, outstanding wages account etc.
Rule for personal Account:-
“Debit the receiver
Credit the giver”

2. Real Accounts

Under the real account, a separate account will create for each class of
property or asset. There will have an account relating to a property, an asset
or a possession of property. Some of the examples for real account are Cash
account, Furniture account, Goodwill account etc.
Rule for Real Account:-
“Debit what comes in
Credit what goes out”

3. Nominal Account
These includes the expenses and losses or incomes and gains of business.
Some of the examples of Nominal account are wages account, discount
received account, interest account etc.

Rule for nominal Account:-

 “Debit all expenses and losses
Credit all incomes and gains”

Next topic:
Advantages of Double Entry System
Double entry system is the most scientific method of keeping accounts. In the modem
age, this system is accepted as the best one.
In every organization whether big or small accounts are kept under double entry
system.
The advantages of the double entry system are stated in brief;

1. Complete accounts of transactions: Double entry system can keep complete

accounts of transactions as it is based on dual aspects of each transaction; i.e. debit
and credit are recorded simultaneously. For this reason, this system maintains
accounts of all parties relating transactions.
2. Verification of arithmetical accuracy: Arithmetical accuracy of accounting can be
verified through the preparation of trial balance if the accounts are maintained under
the double entry system. Under this system, every debit for a certain amount of
money will have corresponding credit for an equal amount. For this reason, the total
amount of debt will be equal to the total amount of credit. It can be detected through
trial balance whether two sides of accounts are equal or not and thereby the
arithmetical accuracy of the account is verified.
3. Determining profit or loss: Under double entry system, profit or loss of the
company for a particular accounting period can be known by preparing an income
statement. Since all accounts relating to income and expenditure are maintained
properly in the ledger under the double entry system, it becomes convenient to draw
income statement at the end of a particular accounting period.
4. Determining financial position: Under double entry system, the total assets and
liabilities of a business concern are recorded properly. As a result at the closing day
of the accounting period balance sheet is prepared with the help of all assets and
liabilities. Through this balance sheet financial position of the business concerned
can be ascertained.
5. Knowing asset and liabilities: Total amount of assets and liabilities can be
ascertained if the account is kept under double entry system and it becomes easier to
settle liability and assets.
6. Fixation of the price of commodities: It becomes easier to fix-up the price of
commodities as the accounts are maintained systematically under double entry
system.
7. Submission of income and VAT statements: Double entry system being the
reliable system of keeping accounts the submission of reliable income and VAT
statement under it are possible on the basis of which income tax and VAT are fixed
and paid.
8. Comparative analysis: Under this system of accounting future course of action can
be formulated by comparing income -expenditure, asset and liability of the current
year with that of the previous year.
9. Increase in profit: Under this system of accounting the picture of all incomes or
profits is reflected. It can be identified which item is more profitable for a business
comparing the items relating to a profit of the current year with that of the previous
year. In this way, attempts can be made in order to make more profit.
10.Expenditure control: Through comparative analysis expenditure may be controlled
curtailing expensive expenditure.
11.Detection and prevention of forgery: Under this system of accounts errors or
forgery of accounts can easily be detected. As a result moral qualities of an
accountant and other employees are upheld.
12.Supply of information: This system helps run the business properly supplying
necessary information and statistics to the management.
13.Future reference: Under this system as every transaction is permanently recorded
properly and completely, any necessary information can be detected easily in future.
14.Easy application: It is easier to record the transactions properly in the books of
accounts following the scientific method of double entry system.
15.Generally accepted method: Double entry system being a scientific method is a
generally accepted system. The accounts under double entry system become reliable
and acceptable to all concerned like income tax authority, creditors etc.
16.Efficiency evaluation of business concern: Capacity for earning a profit and
repaying liabilities can be evaluated with the help of various ratios relating to
accounts from financial statements. For example, creditors or loan givers evaluate
the loan repaying capacity of a business concern with the help of current ratio. If the
ratio is 2:1 then it is assumed that the loan repaying capacity of the business concern
is sound enough.
17.Timely step for correcting accounting errors: Accounting errors can properly be
detected and taking necessary measures for correction is possible under double entry
system of accounting; i.e. before going to next stage the errors of accounting can be
corrected.
18.Utility: The utility and application of this system in the accounts of all business
concerns whether big, medium or small are accepted by all.

Disadvantages or Limitations of Double Entry System

The double entry system is a generally accepted scientific method. In spite of its many
important advantages some limitations of it exist which are stated below:

1. Increased size of books of accounts: Under double entry system every transaction
is recorded in two sides of two accounts and in two steps (Journal & ledger) of books
of accounts.
2. Complexity in accounting process: Complexity arises in following rules,
principles, techniques, and methods etc. for keeping accounts under the double entry
system.
3. Expensive, time and labor consuming: Since accounting process under the double
entry system is extensive, a good number of books are to be kept and a large number
of employees are employed for accounting work. As a result, it requires enough
labor, time and money. Therefore, it becomes impossible to follow this system by
the small business concerns.
4. Persons of specialized knowledge required: The accountant should possess both
theoretical and practical knowledge of accounting for proper keeping of accounts
under double entry system. An inexperienced person in accounting fails and faces
problems in maintaining accounts under this double entry system
5. Possibility of mistake: As the accounting process under the double entry system is
complex and complicated, the possibility of errors and mistakes cannot be avoided
completely.
6. Limited scope of application: In a small business organization, daily shopping, a
cultural ceremony the application of single entry system of accounting is more
popular and advantageous than double entry system.
7. Problem in maintaining secrecy: A lot of people are engaged in maintaining
accounts under double entry system since the accounting process is very wide and
extensive. As a result, a problem arises in maintaining the secrecy of the accounts or
business.

Though there arise some problems in maintaining accounts under double entry
systems, its advantages and acceptability are so wide and comprehensive that at
present age in almost all field accounts is kept under this system.
 Next topic:
Journal
A journal is a place of record in which business transactions are recorded in
chronological order. A firm may use several specialized journals, such as a
purchases journal or sales journal, to separately record transactions in the more
high-volume areas. The general journal is used to record more general, lower-
volume transactions. Once entered into a journal, transactions are then posted to
general ledger accounts. Journals are the best source of information when
researching the nature of business transactions, since they identify source
documents.

Entries made into a journal employ double-entry accounting, where balancing

debits and credits are used. The entries also state the date, accounts impacted, and
amounts, as well as an identifier for the source document.

Illustration 1

Jeyaseeli is a sole proprietor having a provisions store. Following are the transactions
during the month of January, 2018. Journalise them.

Jan. Rs.

1 Commenced business with cash 80,000

2 Deposited cash with bank 40,000
3 Purchased goods by paying cash 5,000

4 Purchased goods from Lipton & Co. on credit 10,000

5 Sold goods to Joy and received cash 11,000

6 Paid salaries by cash 5,000

7 Paid Lipton & Co. by cheque for the purchases made on 4th Jan.
8 Bought furniture by cash 4,000

9 Paid electricity charges by cash 1,000

10 Bank paid insurance premium on furniture as per standing

instructions 300
Illustration 2
Ananth is a trader dealing in textiles. For the following transactions, pass journal
entries for the month of January, 2018.

Jan. Rs.

1 Commenced business with cash 70,000

2 Purchased goods from X and Co. on credit 30,000

3 Cash deposited into bank 40,000

4 Bought a building from L and Co. on credit 95,000

5 Cash withdrawn from bank for office use 5,000

6 Cash withdrawn from bank for personal use of Ananthu 4,000

7 Towels given as charities 3,000
8 Shirts taken over by Ananth for personal use 12,000

9 Sarees distributed as free samples 3,000

10 Goods (table clothes) used for office use 200

Illustration 3
Arun is a trader dealing in automobiles. For the following transactions, pass journal
entries for the month of January, 2018
Jan. Rs.

1 Commenced business with cash 90,000

2 Purchased goods from X and Co. on credit 40,000

3 Accepted bill drawn by X and Co. 20,000

4 Sold goods to D and Co. on credit 10,000

5 Paid by cash the bill drawn by X and Co.

6 Received cheque from D and Co. in full settlement and deposited the same in
bank 9,000

7 Commission received in cash 5,000

8 Goods costing Rs. 40,000 was sold and cash received 50,000
9 Salaries paid in cash 4,000

10 Building purchased from Kumar and Co. for Rs. 1,00,000 and an advance of Rs.
20,000 is given in cash

Illustration 4

Bragathish is a trader dealing in electronic goods who commenced his business in

2015. For the following transactions took place in the month of March 2018, pass
journal entries.

March Rs.

1. Purchased goods from Y and Co. on credit 60,000

2. Sold goods to D and Co. on credit 30,000
3. Paid Y and Co. through bank in full settlement 58,000

4. D and Co. accepted a bill drawn by Bragathish 30,000

5. Sold goods to L on credit 20,000

6. Sold goods to M on credit 40,000

7 Received a cheque from M in full settlement and deposited the same to the
bank 39,000
8. Goods returned to Y and Co. 4,000
9. L became insolvent and only 90 paise per rupee is received by cash in final
settlement

10. Goods returned by M 3,000

Illustration 5
Valluvar is a sole trader dealing in textiles. From the following transactions, pass
journal entries for the month of March, 2018.

March Rs.
1 Commenced business with cash 90,000

with goods 60,000

2 Purchased 20 readymade shirts from X and Co. on credit 10,000
3 Cash deposited into bank through Cash Deposit Machine 30,000

4 Purchased 10 readymade sarees from Y and Co. by cash 6,000

5 Paid X and Co. through NEFT

6 Sold 5 sarees to A and Co. on credit 4,000

7 A and Co. deposited the amount due in Cash Deposit Machine

8 Purchased 20 sarees from Z & Co. and paid through debit card 12,000

9 Stationery purchased for and paid through net banking 6,000

10 Bank charges levied 200

Illustration 7
Deri is a sole trader dealing in automobiles. From the following transactions, pass
journal entries for the month of January, 2018.

Jan. Rs.
1 Commenced business with cash 1,00,000
with goods 2,00,000

with buildings 5,00,000

2 Purchased goods from A and Co. on credit 3,00,000

3 Cash deposited into bank 80,000

4 Purchased goods from B and Co. and payment made through credit
card 5,000

5 Paid A and Co. through RTGS

6 Sold goods to C and Co. and cheque received 50,000

7 Deposited the cheque received from C and Co. with the bank
8 Purchased goods from Z & Co. and paid through debit card 12,000

9 Stationery purchased for and paid through net banking 6,000

10 Income tax of Deri is paid by cheque 10,000

Illustration 8

Chandran is a sole trader dealing in sports items. From the following transactions, pass
journal entries for the month of March, 2018.

March Rs.

1 Commenced business with cash 4,00,000

2 Cash deposited into bank 3,00,000

3 Purchased goods from Ravi and payment made through net banking 90,000
4 Sales made to Kumar, who deposited the money through CDM 10,000

5 Sales made to Vivek, who made the payment by debit card 60,000
6 Sold goods to Keerthana, who made the payment through credit card 50,000

7 Dividend directly received by bank 2,000

8 Money withdrawn from ATM 3,000

9 Salaries paid through ECS 6,000

10 Cricket bats donated to a trust 10,000

Illustration 9
Deepak is a dealer in stationery items. From the following transactions, pass journal
entries for the month of January and February, 2018.

Jan. Rs.

1 Commenced business with cash 2,00,000

2 Opened a bank account by depositing cash 1,00,000

3 ‘A 4 papers’ sold on credit to Padmini and Co. 60,000

4 Bills received from Padmini and Co. for the amount due
5 Bills received from Padmini and Co. discounted with the bank 58,000 Feb.

15 Bills of Padmini and Co. dishonoured

Next topic:
LEDGER
Introduction
Ledger account is a summary statement of all the transactions relating to a person,
asset, liability, expense or income which has taken place during a given period of time
and it shows their net effect. From the transactions recorded in the journal, the ledger
account is prepared. Ledger is known as principal book of accounts. It is a book which
contains all sets of accounts, namely, personal, real and nominal accounts.
Accountwise balance can be determined from the ledger. The ledger accounts are
prepared based on journal entries passed.

The balances in the ledger accounts show the net effect of transactions during a
particular period in various accounts. The personal accounts give the net amount due to
creditors and the net amount due from debtors, real accounts show the values of assets
and nominal accounts show incomes and expenses. The financial statements can be
prepared from the ledger balances.

Ledger may be maintained in the business enterprises in the form of a bound register or
in the form of loose sheets with spiral binding. Normally one page or one sheet may be
provided for one account. An index is provided in the beginning of the ledger giving
details of the accounts contained in it such as specific code for each account, page
number, etc. Where computerised accounting is followed, once the transactions are
recorded in the journal, ledger accounts are automatically prepared.

Utilities of ledger
Following are the utilities of ledger:
i) Quick information about a particular account

Ledger account helps to get all information about a particular account like sales,
purchases, machinery, etc., at a glance. For example, where there are several
transactions with a debtor, the net amount due from a debtor can be known from the
ledger account.

ii)Control over business transactions

From the ledger balances extracted, a thorough analysis of account balances can be
made which helps to have control over the business transactions.
iii)Trial balance can be prepared
With the balances of ledger accounts, trial balance can be prepared to check the
arithmetical accuracy of entries made in the journal and ledger.

iv) Helps to prepare financial statements

From the ledger balances extracted, financial statements can be prepared for
ascertaining net profit or loss and the financial position.

Format of ledger account

The ledger account is prepared in T format. It is divided into two parts. Left side is
debit side and right side is credit side. Each side contains four columns. The name or
title of the account is placed at the top middle and the details are entered in the ledger.
The format of ledger account is given below:

Following are the details contained in the various columns in the ledger:

Date : Date of the transaction is recorded in this column.

Particulars : The account debited or credited is recorded in this column. On the
debit side, the entries are made starting with ‘To’ and on the credit side, entries
are made starting with ‘By’.

Journal Folio (J.F.): In this column, the page number of the journal or subsidiary
books from which the entry has been posted to the ledger is noted.

Amount : The amount of the transaction is recorded in this column.

Next topic
MEANING OF TRIAL BALANCE:

Trial balance is a statement of debit and credit totals or balances extracted from various
accounts in the ledger with a view to test the arithmetical accuracy of the books. This
statement is usually prepared at the end of the year and is a connecting link between
the ledger accounts and the final accounts.

➢ Objective of Trial Balance:

The following are the main objective of trial balance.
1) To check the arithmetical accuracy of ledger
Trial balance is prepared on the basic of double entry systems of book keeping which
states that every debit should have equal and corresponding credit and vice versa, as a
result, the sum of the debit totals and credit totals of trial balances must be equal. If the
debit total does not agree with the credit total, it is assumed that the transactions are
not arithmetically accurate. Thus, one of the important objectives of trial balance is to
provide check on the arithmetical accuracy of the financial transactions.
2) To help in locating accounting errors
since the trial balance indicates whether there is an error committed in journal or
ledger, it helps to locate errors as trial balance is the starting point of locating error.
Thus locating error is one of the importance objectives of trial balance.
3) To provide the summary of transactions
A business organization performs number of financial transaction during a certain
period of time. These transaction themselves cannot depict any picture of financial of
the business organizations. To fulfill the purpose, the trial balance is prepared which
summarized the financial transactions of business in a certain date.
4) To serve as basic for preparing final accounts
Financial statements are prepared from trial balance. Trial balance contains all ledger
accounts, and provides a basis for further processing of accounting data i.e. preparation
of financial statements.
5) To facilitate auditors:
Total of all debit balances must be equal to total of all credit balances. Agreement of
trial balance assures auditors that all transactions have been recorded in books of
accounts.

➢ Limitations of Trial Balance:

Following are the main limitations of trial balance:

1) Trial balance can be prepared only in those concerns where double entry system
of accounting is adopted. This system is very costly and cannot be adopted by
the small concerns.
2) Though trial balance gives arithmetic accuracy of the books of accounts but
there are certain errors which are not disclosed by the trial balance. That is why
it is said that trial balance is not a conclusive proof of the accuracy of the books
of accounts.
3) If trial balance is not prepared correctly then the final accounts prepared will not
reflect the true and fair view of the state of affairs of the business. Whatever
 conclusions and decisions are made by the various groups of person will not be
correct and will mislead such persons.

➢ METHODS OF PREPARATION OF TRIAL BALANCE

The following are the two methods of preparing trial balance:
1. Total Method:
Under this method, every ledger account is totaled and that total amount (both
credit and debit side) is transferred to trial balance. The difference of totals of
each ledger account is the balance of that particular account. This method is not
commonly used as it cannot help in the preparation of financial statements
2. Balance Method:
Under this method, every ledger account is balanced and those balances only are
carried forward to the trial balance. Financial statements are commonly prepared
on the basis of this method
3. Total and Balance Method:
As name shows it is combination of above two methods. Under this method,
statement of trial balance shows to balance contains the balance in both ways as
explained in the above two methods.

SUBSIDIARY BOOKS – I
Introduction
Business entities carry on transactions of different nature. The types of transactions
depend on the nature of business and the management policy. Many transactions may
be of repetitive type, that is, similar nature of transactions take place repeatedly in a
business entity. Therefore, transactions can be classified and grouped conveniently
according to their nature. Generally, transactions are of two types: cash and non cash
transactions (credit). Cash receipts and payments can be grouped in one category and
credit transactions in another category. Thus, in practice, for easy, convenient, speedy
and appropriate maintenance of accounts, the main journal may be sub-divided in such
a way that a separate book is used for each category or group of transactions which are
repetitive and sufficiently large in number. Each subdivision of the books is a special
journal and a book of primary record or a book of primary entry

Types of subsidiary books

The number of subsidiary books may vary according to the requirements of each
business. Based on the nature of business and the volume of transactions, the following
subsidiary books are maintained:

i. Subsidiary book for entering cash transactions - Cash book

ii. Subsidiary books (special journal) for entering non-cash transactions:

· Purchases book or purchases journal – for recording only credit purchase of goods
in which the trader deals.

· Sales book or sales journal–for recording only credit sale of goods dealt in by the
trader.

· Purchases returns or returns outward book – for recording return of goods

purchased by the trader, for which no cash is immediately received.

· Sales returns or returns inward book – for recording the goods returned (out of
previous sale) by customers for which no cash is immediately paid.
· Bills receivable book – to record bills drawn or promissory notes received.

· Bills payable book – to record bills accepted or promissory notes given.

iii. Journal proper – The general journal or all purpose journal to record transactions
which do not find a place in the above seven subsidiary books.

or subsidiary book.

Journal entries are not passed when records are made in subsidiary books. When
journal is the only book of prime entry it is possible for only one book-keeper to enter
transaction in it at a time. In case of business entities having large volume of
transactions, one person cannot do all the recording work by himself. There is a need
for sub-division of the book-keeping work leading to the sub-division of the journal
into parts or subsidiary journal

Advantages of subsidiary books

The advantages of maintaining subsidiary books can be summarised as under:
Proper and systematic record of business transactions
All the business transactions are classified and grouped conveniently as cash and non
cash transactions, which are further classified as credit purchases, credit sales, returns,
etc. As separate books are used for each type of transactions, individual transactions
are properly and systematically recorded in the subsidiary books.

Convenient posting

All the transactions of a particular nature are recorded at one place, i.e., in one of the
subsidiary books. For example, all credit purchases of goods are recorded in the
purchases book and all credit sales of goods are recorded in the sales book. It facilitates
posting to purchases account, sales account and concerned personal accounts.

Division of work
As journal is sub-divided, the work will be sub-divided and different persons can work
on different books at the same time and the work can be speedily completed.
Efficiency

The sub-division of work gives the advantage of specialisation. When the same work is
done by a person repeatedly the person becomes efficient in handling it. Thus,
specialisation leads to efficiency in accounting work.
Helpful in decision making
Subsidiary books provide complete details about every type of transactions separately.
Hence, the management can use the information as the basis for deciding its future
actions. For example, information regarding sales returns from the sales returns book
will enable the management to analyse the causes for sales returns and to adopt
effective measures to remove deficiencies.

Prevents errors and frauds

Internal check becomes more effective as the work can be divided in such a manner
that the work of one person is automatically checked by another person. With the use
of internal check, the possibility of occurrence of errors or fraud may be avoided or
minimised.

Availability of requisite information at a glance

When all transactions are entered in one journal, it is difficult to locate information
about a particular item. When subsidiary books are maintained, details about a
particular type of transaction can be obtained from subsidiary books. The maintenance
of subsidiary books helps in obtaining the necessary information at a glance.
Detailed information available
As all transactions relating to a particular item are entered in a subsidiary book, it gives
detailed information. It is easy to arrive at monthly or quarterly totals.

Saving in time

As there are many subsidiary books, work of entering can be done simultaneously by
many persons. Thus, it saves time and accounting work can be completed quickly.

Labour of posting is reduced

Labour of posting is reduced as posting is made in periodical totals to the impersonal

account, for example, Purchases account.

Purchases book
Purchases book is a subsidiary book in which only credit purchases of goods are
recorded. When business wants to know the information about the credit purchases of
goods at a glance, the information can be made available if purchases of goods on
credit are separately recorded.

Goods here mean the items in which the business entity is dealing. In other words, it is
the item which is purchased for regular sales. For example, furniture will be treated as
goods in the case of the firm dealing in furniture. For other firms, which are not
dealing in furniture it will be an asset. Hence, while recording transactions in the
purchases book, it must be ascertained whether the credit purchase is related to the
item in which the firm is dealing. Purchases of assets and purchase of goods for cash
are not entered in purchases book.

i. Date

In the date column, the date of purchases of goods on credit is recorded.

ii. Particulars

In this column the name of the supplier from whom goods have been purchased and
details of goods purchased are given. It contains the name, quantity, quality and rate of
goods purchased, trade discount and any other specification and specialties of the
goods are recorded in this column.
iii. Invoice number

Invoice is the statement prepared by the seller of goods. It contains details about the
goods, its price and other expenses incurred. The invoice number is entered in this
column.

iv. Ledger Folio (L.F.)

The page number of the ledger in which the supplier’s account appears is recorded in
this column. Purchases of goods must be posted to the personal accounts of suppliers.
Purchases book contains the page number of supplier’s account in the ledger. It helps
in posting and also in checking the records.

v. Amount column (Details)

Amount column is divided into two parts, i.e., details and total. The details column is
used to record the amount of various individual items purchased from a particular
supplier. The amount of trade discount allowed is deducted. This column is used for
adjustment of additions and subtractions.

vi. Total amount column (Total)

The net amount payable to the supplier of goods is recorded in the total amount
column.

Purchases returns book

Purchases returns book

After purchases of goods, the business unit may find that some of the goods are not
upto the satisfactory level because of the following reasons:
· Goods may be defective.

· They might have been damaged in transit.

· Quantities delivered may not agree with the invoice.

· They might have been received quite late (off-season).

· They might not be as per the samples or specifications.

· There may be a breach of agreement.

Therefore, the buyer may return them to the suppliers.

Purchases returns book is a subsidiary book in which transactions relating to return of

previously purchased goods to the suppliers, for which cash is not immediately
received are recorded. Since goods are going out to the suppliers, they are also known
as returns outward and the book is called as ‘returns outward book or returns outward
journal’.

1. Posting from the purchases returns book

After the transactions are recorded in the purchases returns book, posting them to
ledger involves two steps:

Step 1: Posting to personal accounts of creditors: Every day, each entry in purchases
returns book is posted to the debit side of the respective personal account of the
creditor by writing the words ‘To Purchases Returns account’.

Step 2: Posting to Purchases returns account: At the end of the month, the aggregate
of the purchases returns is ascertained. It is the total purchases returns for the month
and is posted to the credit side of purchases returns account by debiting ‘Sundry
creditors account’.
2. Debit note – the source document for returns outward
A ‘debit note’ is a document, bill or statement sent to the person to whom goods are
returned. This statement informs that the supplier’s account is debited to the extent of
the value of goods returned. It contains the description and details of goods returned,
name of the party to whom goods are returned and net value of the goods so returned
with reason for return.

Sales book
Sales book

Sales book is a subsidiary book maintained to record credit sale of goods. Goods mean
the items in which the business is dealing. These are meant for regular sale. Cash sale
of goods and sale of property and assets whether for cash or on credit are not recorded
in the sales book. This book is also named as sales day book, sold day book, sales
journal or sale register.

The preparation of the sales book is similar to that of purchases book. The entries are
made in the sales book on the basis of copies of the invoice sent to the buyer.

In the date column of the sales book, the date of credit sales is recorded. Particulars
column contains the name of party purchasing goods or the party to whom goods have
been sold. It also shows the details of goods as regards its quantity, quality, other
descriptions and the rate of trade discount allowed. In Ledger Folio (L.F.) column the
page number of debtors account in the ledger is recorded for reference. The amount of
various items of the goods sold is entered in the details column. Adjustments for trade
discount, packing charges, etc., are made in the details column. In the total column, the
net amount payable by individual customer is recorded. The total of the amount
column is the total credit sales during the period.

1. Posting from sales book

After the transactions are recorded in the sales book, posting them to ledger involves
two steps:

Step 1: Posting to personal accounts of debtors: Every day, each entry is posted to
the debit side of the respective personal account of the debtor.

Step 2: Posting to Sales account: At the end of the month, the aggregate of the sales is
posted to the credit side of sales account by writing the words ‘By Sundry debtors
A/c’.
Sales returns book
Sales returns book

Sales returns book is a subsidiary book, in which, details of return of goods sold for
which cash is not immediately paid are recorded. Just as goods may be returned to
suppliers, goods may be returned by customers for the following reasons:

· Defect in the goods

· Delay in the dispatch of goods to the customers

· Over-supply of goods
· Goods not being in accordance with the samples and specifications
· Violation of the terms of the contract, etc.

Goods returned by the customers is known as ‘returns inwards’.

This book is not concerned with the return of assets or return of goods for which cash
is paid.

This book is prepared just like the other day books.

1. Posting from sales returns book

After the transactions are recorded in the sales returns book, posting them to ledger
involves two steps:

Step 1: Posting to personal accounts of debtors: Each entry in the sales returns book
is posted to the credit side of the respective personal account of the debtor on daily
basis by writing the words ‘By Sales returns account’.
Step 2: Posting to Sales returns account: At the end of the month, the aggregate of
the sales returns is posted to the debit side of sales returns account by writing the
words ‘To Sundry debtors A/c’.