LESSON 5 – RELEVANT ACCOUNTING STATEMENTS

Welcome all. In my last lecture we were talking about the accounting process,
where I discussed
with you that, what includes the accounting process. From where the
accounting process
starts and where it ends. So, I told you yesterday that accounting process starts
with the first
thing that is, transaction and it ends with the balance sheet. Normally it ends
with the
balance sheet, and after that the third statement is also required to be
prepared, which will
be generally prepared from the profit and loss account and balance sheet
which is called as the cash flow statement. So, cash flow statement has also
from 1997 onwards. In India
the cash flow statement also has become a mandatory st atement to be
prepared by companies by the firms. In 1994, International Accounting
Standard
Committee accepted this statement, that apart from the trading and profit and
loss account
and balance sheet. Firms must also prepare the cash flow statement. And in
India institute
of chartered accountants of India accepted this statement in 1997 that in India
also
now cash flow statement will be the statutory requirement, along with the first
two statements
that is profit and loss account and the balance sheet. So, these are the three
important statements. We will learn how to prepare all these statements in our
later part.
Now, apart from these three statements, I was talking to you about the one
more statement
that is called as the profit and loss appropriation account. Sometimes some
firms prepare the
profit and loss appropriation account as a separate account, or in some firms it
is prepared
as the extended version of the profit and loss account. So, the basic difference
between
these two statement is, profit and loss account helps us to work out the profit
or loss of
the firm. On the one side you put all the incomes, direct and indirect incomes.
On the other side you put all the expenses, direct and indirect expenses. And
finally,
the difference of these two is calculated the net operating profit before tax.
Then
we subtract the tax part, how much tax will be paid, as a corporate tax,
corporate tax will be paid to the government, after subtracting that calculate
the net operating profit after
tax. So, profit and loss account stops here. Now next thing is that whatever the
profit
is earned by the firms that profit has to be shared amongst the different stake
holders.
As I told you that if it is a public limited company, then large number of the
shareholders
are there, and they expect dividend from the companies at the end of the year.
So, one part of the profit will go to the shareholders as dividend. Another part
of
the profit can be kept as reserve for some specific purpose. The reserve say for
example,
the company has issued the debentures, and they are becoming due to be paid
in the next
year, and for that we need the funds. And if the profit or the part of the profit
is
going to be sufficient, then part of the profit can be kept reserve for
redemption of the
debentures next year. So, that reserve will be called as a specific reserve,
debenture
redemption reserve. Then we create another reserve which is called as general
reserve, which can be used for any unforeseen purpose or any unforeseen
requirement.
If we do not have any other source of funds for that, we can use the general
reserve. So, one part with the profit is kept as general reserve. So, these are
the three parts; one
is dividend to the shareholders, second is the specific reserve, third is the
general reserve, and still if some profit is left then that profit is passed on to
the balance
sheet and added in the capital. So, now, that statement is called as the profit
and loss
appropriation account, because that statement helps to apportion the profit
earned by the
firm to the different stakeholders or for the different requirements. So, t hat is a
additional statement, sometime it is a extended version of the profit and loss
account or sometime it is prepared separately. After this, there is another
statement which
is called as the funds flow statement. Funds flow statement is a kind of a c ash
flow statement,
but a enlarged version of the cash flow statement. In the cash flow statement
we talk only those
assets and liabilities which affect cash, but in fund flow statement, we include
almost
all the assets and liabilities, because in the long run, everything all the
liabilities and assets can be converted into cash. So, sometime we prepare the
funds flow statement
also, but that is not a mandatory requirement, that is only exercising the
internal control
in the firms, and to know the funds position in the firm, sometime the funds
flow statement
can be prepared, but the statutory statements are only three; that is profit and
loss account,
balance sheet and cash flow statement. And profit and loss appropriation
account is prepared
as extended version of the profit and loss account, which helps us to distribute
the
profit, earned by the firm and calculate it with the help of profit and loss
account.
So, yesterday I have talked to you about the profit and loss account and
balance sheet in detail and showed you the proforma’s also, that how to
prepare the profit and loss
account and the balance sheet. Now I will take you little back as I told you that
accounting
process starts with transaction, and that first means the book of accounts
where that
transaction goes, is the journal. Now I will take you little further with the
journal that
journal has different types, that book, original book of accounts journal that
has different
types. As a student of accounting we must understand; what are the different
types of
journals. So, I will discuss with you the different type of journals, because you
should
be knowing it about that what is journal, and what are the different types of
the journals,
and what is the basic difference among these different types. Now for example,
we have different type of journals like; 1 2 3 4 5 6 7 8 type of the
journals. 8 type of the journals, 8 type of the basic books of entries, where the
different
types of the transactions means, because we have the different types of the
transactions in the business, and those different types of the transactions have
to be taken to the
journal, to the different type of the journals. So that it becomes easier to
handle all these
transactions, and at any point of time if you want to know about any
transaction that has taken place in the business, we need not open a big
voluminous book, rather we can
go to a specific journal, we can open that journal, we can open that book and
we can get to know that what is there in, what is the situation or what is the
position of that
transaction, or with regard to the transaction. So, different type of the journals
are here;
like first journal is purchase book, then we have the second journal sal e book,
then
we have purchase return book, then we have sales return book, then we have
bills receivable
book, then we have bills payable book, and then we have cash book, and last
journal is
called as the journal proper. So, I will discuss with you all th ese different type
of the journals,
and you will understand why these different specific types of the books, specific
type
of the journals are required. So, here first journal is purchase book. purchase
book means, this is the journal, this is the book of accounts, original first book
of accounts,
which records those transactions, where the purchases of any kind, basically
the purchases
of the merchandising nature, means it records those transactions which are of
the merchandising
in nature, and which have been done on credit. We have not we have
purchased something, but
we have not paid the cash for that. Those kinds of the transactions will be
recorded
in the purchase journal or purchase book. For example, firm purchases the raw
material.
Now that raw material I told you that only those purchases will be recorded in
the purchase
book, which are of the merchandising in nature Now, what is the meaning of
merchandising
nature? Merchandising nature of the purchases are like; which are purchased
for reselling
in the market. We purchase something, we process that something, we add
value in that and after
that we resell that product in the market. For example, now it is a raw material
I am talking to you, raw material we purchase, we process that raw material,
convert that
raw material into a finished product, and that finished product is sold in the
market. On the other side there is another purchase; for example, we talk
about stationery purchased
by the firm for it is use in the firm. Now, the stationery, firm is not going to sell
that stationery back in the market, that stationery is being purchased and that
stationery
will be used by the firm and that is finished. So, that is not for the merchandise,
that
is the purchase of the stationery is not for the merchandising purpose, say
material is for the merchandising purpose, anything which is purchased by the
firm with objective of
reselling in the market, is the item of the merchandising nature, and if it is
purchased
on credit not on cash, then it will be recorded in the first journal, which is
called as the
purchase book or the purchase journal. Second journal is the sale book or the
sale
journals. All kind of the sales made by the firms which are on credit basis; all
kind
of sales made by the firms on the credit basis where for example, firm has sold
the finished
material in the market. For example, a company is manufacturing this color TV
and selling
it in the market. So, the firm selling these color TVs in the market on a credit
basis,
selling the material today and the cash will be received after 1 month, 2
months, or may
be 3 months. Then those all kind of the sales will be known as the sales on
credit, and
will be recorded in a separate journal in a separate book of accounts, which is
called as the sales book; so independent book, independent journal.
Then we have third journal purchase return book. in this journal we will record
those
transactions or those purchases, which were purchased earlier, but because of
certain
reasons, either the supplied material to the firm is defective, or it was not
ordered or
it was not according to the specifications, whatever the reasons, because of
any reason
if any material purchased by the firm has to be returned back to the supplier,
any kind
of the material purchased by the firm has to be returned back to the supplier,
in that case all those purchases which are returned, because of any reason will
be recorded in
the purchase return book, then means a separate journal for the return of the
purchases.
Now, fourth journal is sales return book. as I am talking to you that if the firm
when
they are buying something, and because of any reason they are returning it
back to the supplier; similarly, the firm which we are talking about firm in
question. If they have
sold something in the market, may be as a fence product. if some TVs, 10 TVs
are sold in the market to some dealer by this firm, or by Samsung, L G, or any
other firm, and
part two out of the 10 T Vs are defected, and that dealer returns two T V s back
to
L G or to Samsung or to any other company, then those returns will be called as
sale
returns, and they will be recorded in a different journal, different books o f
accounts, and
independent journal, independent book of accounts, which only will record all
the transactions
relating to the sales, which are returned by the buyers, who had bought it from
the
firm on credit. Now, after that we have the bills receivable
book. Now what is the first of all you must know that what is a bill receivable.
Bill
receivable is basically a document which verifies that firm X has sold some
material to firm
y, and firm Y has to pay that amount back to firm X after a certain period of
time.
Now when the firm X is selling the material to firm y, they need some proof
that they
have sold this material to firm y, and firm Y has to pay us after 30 days 45 days
or 60
days. So, what they do, on the one hand they sell the material to firm y, a nd on
the other hand firm X will prepare bill, that bill is basically
a legal document, prepared on a legal paper which is called as a judicial paper,
and on
that it is written like that material worth this much of rupees is sold by us, by X
company
to the Y company, and the credit period given to the Y company is say 60 days,
and the Y
company will make the payment to us after 60 days, or on the 60th day.
So, that everything will be done, a document will be prepared, and along with
the material
that document will be sent to the firm y. So, on the one hand firm Y will receive
the
material that is say for example, color t v s, and on the other they will. They are
not paying cash, if they are paying cash back to the firm X then this bill is not
required, but they are not paying cash, they will pay it after 60 days. So, firm X
needs some security,
some proof of the credit sales on the other side, along with the supply of
material they will present this document this bill to the firm y, who is the
buyer, and they firm Y
will put their authorized signature, will put their signature on the bill. It means
it is a proof that the firm X has sold to firm y, and the firm Y has received
the material, and firm Y has to pay to firm X after 60 days. So, that is called as
the
bill receivable for the firm x. So, it will be called as a bill receivable for the firm
x, who has to receive that bill after signing it back, and on the due date after
60 days,
they have to receive back the cash for the 10 TVs they have sold to fir m y. And
to firm
Y this bill becomes the bill payable. The firm Y has to pay this bill after 60 days,
the amount written in this bill on which they have put their signature then they
accepted, that yes we will have to pay to the firm x. So, for the one fir m, firm X
this bill is
called as the bill receivable, and for the firm Y this bill is called as the bill
payable.
So, we have the two different journals specific journals bill receivable book all
the bills
which will be received by the firm for it is credit sales, after some period of
time will be recorded in the bill receivable book. And likewise if this firm is
selling in the
market, it means it is obvious that they are also buying from the market. So,
when they are selling on credit they are also buying on credit. So, when they
are selling on credit
they are getting the bill received, recording in the bill receivable book, and
similarly when they are buying on credit, then their supplier is getting the bill
received from
the firm x, because they are the buyer now of the raw material. So, now they
will accept that bill put the signature and return that bill back to the
supplier and that bill will become to firm X as bill payable. So, for different
means,
payment which means the amount which we have to recei ve, that will be
recorded in the bills receivable book, and the amount which we have to pay to
their suppliers they will be recorded
under the bills payable book. Then we have other document which is very very
important
document and that is called as the cash book. Cash book is a that kind of
journal, that
kind of the book, that kind of the book of original entries, which records all the
transactions
happening on cash. As I told you say for example, in purchase book, when we
purchase anything on credit we record those in the purchase book, but
when we buy anything on cash, then that purchase will not go to the purchase
book, that will
go to the cash book. So, any transaction, because of which the cash is getting
affected,
will be recorded in the cash book. Irrespective of the fact that whether it is of
the merchandising
nature or it is of the non merchandising nature. Any kind of the transactions
taking place,
who are affecting the cash that is called as, all those transactions they are the
subject
matter of the cash book, and they will be recorded in the specific journal which
is called as the cash journal or in a business language we call it as the cash
book.
And last journal is the journal proper. What is journal proper? Journal proper
means any
transaction which is not recordable in any other book of accounts, in any of the
first
six journals, whether means neither it is recordable in the purchase book, nor i t
is
recordable in the sale book, nor it is recordable in the purchase return book,
nor it is recordable
in the sale return book, neither it is a bill of exchange, means a bill receivable,
or it
is a bill payable. In that case that transaction will be recorded in the journal
proper. For
example, I was talking to you that purchase of stationery. Now purchase of
stationery
if it is on cash, then it will be recorded in the cash book, but if it is on credit,
then it will be recorded in the journal proper, because it is on credit and it is
not of the
merchandising nature. So, those transactions which are not recordable
in the first six books,, then that will be recorded in the or in the first seven
books
you can say, that will be now the subject matter of the las t book which is called
as the journal proper. So, these are the different 8 type of the journals, 8 type
of the books
of accounts and it is better always to maintain different journals, different
book of accounts
for the different transactions. So, that at any point of time if you want to know
about
any transaction that has taken place in the business, we need not open a
voluminous book
we have to go to a specific journals, specific book,, open that journal open that
book and we will get to know about the transactions. For example now how the
problem comes. Yesterday
I talked to you about one statement that is called as the trial balance right. So,
what
is trial balance, as I told you in my previous lecture, that trial balance is
basically intervening
statement. Trial balance is basically a intervening statement, and in that
intervening statement
what we do. We first record the transactions in the journal, any kind of the
journal. Then
we post them in the ledger for proper classification, and from the ledger that
all those transactions
have to go to the profit and loss account and balance sheet. But we ensure that
in the, whatever the information is going to profit and loss account and
balance
sheet, that should be a correct information nothing incorrect, and the profit
depicted by the profit and loss account is a correct profit, and the balance
depicted by the balance
sheet, balance of the asset and liabilities, predicted by the balance sheet,
shown by the balance sheet is a correct balance. So, for that we pr epare the
intervening statement;
that is a connection between ledger and the profit and loss account and
balance sheet,
we prepare a trial balance. Now, trial balance as I told you in my previous
lecture that we put debit balances on the one side, credit balances on the other
side.
So, we are following a double entry accounting system, it means the total of
debit balances
should be equal to the total of credit balances. So, when both the balances are
equal, it means
we can say that at least there is no arithmetical mistake; there is no numerical
mistake, as
far as the recording of the transactions is concerned and posting o f these
transactions in the ledger is concerned. There can be other mistakes, journal is
not the proof, sole proof
of the complete accuracy of the transactions recorded in the journal and
classified in
the ledger. It is not a sole proof, it is only a proof of the arithmetical accuracy,
but there can be still the trial balance tallies, but still there can be other
mistakes, still
there and trial balance cannot check those mistakes. Now, for example, what
kind of the mistakes can be there? The mistake is kind of say for
example, some material is purchased from Mr. Ram by the firm, he is a supplier
and he has
supplied the material to this firm, while recording this transaction in the books
of
accounts in the purchased journal, unmindfully the person who is reco rding it
he has recorded
it in the account of Shyam, not in the account of ram. So it means That is a you
can call
it as error of commission, one person is a supplier, but wrongfully it is recorded
in
the account of the other person. So, trial balance will only look that material
say for purchased is for 10,000 rupees, 10,000 is debited, 10,000 is credited
and both the
sides balances are equal, but it will not check that whether it is ram is a
supplier
or Shyam is a supplier; that is not possible, trial balance cannot check.
Similarly, there
could be another error which is called as error of omission, completely omitting
some
transaction. Firm purchased the material from ram, he is a supplier, but the
person who
had to record that in the purchase book, and he completely forgot it to record
that transaction
in the purchase book. Now neither anything is debited nor anything is credited,
both
the sides are equal, and Ram’s account is not given the due credit. So, it is a
kind
of a error which is we call it as the error of omission, this is called as the error
of
omission. Then we have other kind of errors say for
example, error of principle, error of principle is kind of they say that firm
purchased machinery,
and that machinery required some little minor repair before installing it for it is
use
right. Now when that machinery is purchased, I told you yesterday, we have
two kind of
expenses; revenue expenses and capital expenses. When the machinery is being
purchased, machinery
is a long term asset, it is a fixed asset. So, any expense incurred to purchase
that machinery is called as a capital expense, because the benefit of that
expense will be
enjoyed by the firm for a period of more than 1 year, but minor repair to that
machinery
which was required, because it got defective on the way, it came from a very
distant place
on the way when it reached at the place then it had to be repaired, some
defect came up
and it had to be repaired, now that repair is of a short term nature, that is of a
revenue
nature. But if you consider both the items, both the expenses as a capital
expenses ;one is revenue, repair is a revenue nature expense, and the
machine is the, or the purchase of the machine is of the capital nature, but if
you feel that both are of the capital nature or both are of the revenue nature, if
you take the
entire amount of the purchase of machine and repair to the profit and loss
account, even then it is wrong, and if you take it to the balance sheet as a
asset even then it is wrong,
but so it will be there, there will be two accounts one will be repair account and
second will be the machinery account, but if you are not segregating these two
accounts, then
trial balance will not be able to detect this error, because this is a error of
principle,
means revenue difference, means recognizing that expense of revenue and the
capital nature, we have not been able to do that, and because of that trial
balance is not going to, means
pick up that that problem, that defect, and that error and trial balance will
tally.
So, there are some errors as I told you, errors of omission, errors of
commission, and errors
of principle. All these errors cannot be detected by the trial balance. Trial
balance can only
detect the errors which are numerical errors, errors of arithmetical nature. So,
all these
journals we will prepare first. So, my purpose of say talking to you about the
trial balance
today was, that why this different type of the journals are important, because
if the
some error comes up in the trial balance, trial balance is not tallying it means
now you have to refer back to the first two books, either you have to go back to
the ledger or
you have to go back to the journal to find out their difference. Now, that
difference is not locatable easily if all the transactions are recorded in the
one book of account, it is a voluminous book, finally get out on which page
where it is recorded, it is very difficult, but if you have created the proper
books of accounts,
in that case you can simply go, if it is a purchase related problem or first you
can check the purchase book, or you can check the sale book, or you can check
the purchase
return, sale return, bill receivable book, bills payable book, or if it is related to
cash, then the cash book and you will be, miscomparatably easily you will be
able to find out the problem, the difference. And one more thing I would like to
discuss
here with you that for example, we have checked all the records, and we are
not able to detect
that error in the trial balance, that defect in the; that means, you can call it as
a mismatch
figure in the trial balance, then what to do, because you have to prepare the
profit and loss account and balance sheet on the last day of your accounting
period, and that
period is approaching, and we are not able to tally the trial balance. So, what
we do. Temporarily you put that difference in one account in the trial balance,
that
account is called as the suspense account, and with that suspense account we
prepare
the profit and loss account, we tally the balance sheet, and once that
everything is
done, and last date is over this accounting period is over, then in the next year,
in
the beginning of the next year first we detect that error, remove that suspense
account from
the trial balance, remove that error from the profit and loss account or the
balance sheet, and finally, that suspense account has to be removed from the
previous year’s
trial balance, and that error also has to be removed from the profit and loss
account or from the balance sheet, but temporarily solution is that we can put
that difference
in the suspense account. So, this all is about the accounting process
I have already talked to you about the profit and loss account, balance sheet,
and all these things in my previous class. So, till now what we could discuss is,
the basics of accounting,
accounting gaap, different types of accounts their rules, concepts, conventions
and accounting
process. Now how to learn, how to prepare the journal and ledger, and go up
to the balance
sheet that I will discuss with you in the next class. Thank you very much.