Accounting

Accounting is a system of collecting and processing the financial information of a business. This
information is reported to different users to enable them to make appropriate decision.

The American Accounting Association (AAA) has defined it as ‘the process of identifying, measuring
and communicating economic information to permit informed judgments and decisions by users of
information’.

Basic Terminologies in Accounting

1) Transaction

All those activities of business which involve transfer of money/goods/services are called
transactions. For example: purchase and sale of goods, borrowing from bank, paying salaries and
wages, receiving commission received.

2) Proprietor/Owner

An individual who owns a business is called its proprietor. He contributes capital (owner equity) in
the business with the intention of earning profit.

3) Capital

Amount invested by the owner in the business is known as capital. The owner may invest in the form
of cash or assets. This amount is increased by the amount of profits earned and additional capital
introduction. Similarly the amount will be decreased by the amount of loss and drawings.

4) Drawing

The amount of cash or value of goods withdrawn from the business by the proprietor for his personal
use is called drawings. It is deducted from the capital.

5) Asset

These are economic resources of the business meant for earning profit. Assets are those items and
properties which are used by the business for its operations. For example: plant and machinery,
furniture and fittings, goodwill, bank balance, debtors, bills receivable, stock (inventory), goodwill
etc. Assets can be classified on different basis:

a) On the basis of touchability: Two types tangible and intangible assets

 Tangible Assets: Those assets which have physical existence and hence can be touched and
seen. For example plant and machinery, furniture and fittings, cash, inventory etc.
 Intangible Assets: Those assets which do not have physical existence but their possession
provide benefits to the businessman. For ex- goodwill of the firm.

b) On the basis of duration: Two types viz. fixed and current asset.
  Fixed Assets: These assets are held on a long term basis i.e. more than one accounting year.
Hence these are also known as non- current assets. For ex- land and building, plant and
machinery, furniture, investments etc.
 Current Asset: These assets are held on a short term basis i.e. less than one accounting year.
For ex- cash, inventory, debtors etc.

6) Liabilities

Liabilities refer to those financial obligations of a business that enterprise has to repay to others
some times in future. These denote the amounts which a business owes to others. For ex- capital,
loan from bank, creditors, outstanding expenses etc. Liabilities can be classified on different basis:

a) On the basis of duration: Two types viz. non-current liabilities and current liabilities

 Non-current liabilities: These are payable usually after a period of one year. For ex- loan for
more than one year. These are also known as long term liabilities.
 Current liabilities: these are short duration in nature and payable within one year. For ex-
creditors, outstanding expenses, bank overdraft etc.

b) On the basis of Internal and external: Owners equity is an example of internal liability while debt
or loan taken from outsider is an example of external liability.

7) Debtors

Debtors are those who are liable to pay to the business on account of purchase of goods on credit.
They are shown in the assets side of the balance sheet of business.

8) Creditors

Creditors provide goods to the business on credit and hence they are required to be paid by the
business. They are in the liabilities side of the balance sheet of the business.

9) Purchase

Purchase refers to the amount of goods bought by business with an intention to sale or use in
production. Goods can be purchased both on cash and/or credit.

10) Sale

Sale refers to the amount of goods sold by business. Goods can be sold both on cash or credits.

11) Goods

Those products which are used by business unit in buying and selling are called goods. It is
noteworthy that if such purchase is used in the business, then such items are not called goods. For
example: pencil for a stationery shop is goods but if pencil is used by the business itself then it is an
expense.

12) Revenue
The amount earned by business by selling goods, providing services and/or earning from interest,
dividend, commission, etc. Revenue is also called as income of the business.

13) Expenditure

Expenditure is any outlay incurred by the firm. Expenditure is a wider term and includes both assets
and expenses. If the benefit of expenditure is exhausted within a year, it is treated as an expense
(also called revenue expenditure). On the other hand, if the benefit of expenditure lasts for more
than a year, it is treated as an asset (also called as capital expenditure).

14) Expenses

The total outlays incurred by the business for earning revenue are called expenses. The items of
expenses are: raw materials, depreciation, rent, wages, interest, telephone etc. These are also known
as revenue expenditures.

Branches of Accounting

Large scale operations and increased sale has given rise to the specialised branches in accounting.
These are: Financial Accounting, Cost Accounting and Management Accounting.

Financial Accounting

Financial accounting is about recording of business transaction in a manner so as to know the

financial results and financial position of a business on a particular day. In this system systematic
recording of financial transactions and presentation of financial reports takes place and thus
ascertain the financial soundness of the organisation.

Cost Accounting

Cost accounting is about recording of transactions of the product(s) produced or service(s) provided
for the purpose of cost ascertainment and cost control. Cost accounting help in analysing the
expenditure incurred in the manufacturing of various products or service provided by the firm for
fixation of price and reduction of price.

Management Accounting

Management accounting is all about using the data of financial accounting and cost accounting for
the purpose of policy formulation, rational decision making and evaluating the impact of decision
taken. Various decisions taken by management are in the form of preparing budget, understanding
profitability, taking pricing decisions, capital expenditure decisions and so on.
General Accepted Accounting Principles
Certain rules and principles have been developed and accepted by professionals In order to maintain
uniformity and consistency in recording of accounting. These rules are known by different names
such as principles, concepts, conventions, postulates, assumptions and modifying principles. From
the practicability point of view it has been observed that these principles, concepts, conventions,
postulates, assumptions and modifying principles are used interchangeable and hence referred to as
general accepted accounting principles.

These are like the foundation pillars on which the theory and practise of financial accounting is
based. These concepts determine the broad working of all the accounting activities. The important
accounting concepts are listed below:

1) Business Entity Concept

As per this assumption proprietor (owner of the business) is considered to be a separate and distinct
entity from the business. Due to this assumption the amount invested by owner as capital is treated
as liability for the business towards the owner.

2) Money Measurement Concept

In accounting, only those transactions are recorded which are capable of being measured in
monetary terms. For ex-appointment of manger will not be recorded. But salary received by that
manager will be recorded.

3) Going Concern Concept

The business is assumed to last indefinitely or for a long period without any intention of being
winded up. This assumption is basis of recording of assets and liabilities in the balance sheet.

4) Consistency Approach

There must be uniform sets of rules, practices, concepts and principles to be used in accounting. It
will allow inter firm and inter period comparison. However, consistency does not prohibit change in
accounting policies. But these changes must be fully clarified and explained.

5) Dual Aspect Concept

Dual aspect is the basis of double entry accounting. Every accounting transaction has two
sides/effects and thus will be recorded at least in two places. For ex- Goods purchased worth rs.
10,000 for cash. In this two accounts viz. purchases account and cash account will be affected. Due to
this concept balance sheet’s assets side and liability side are always tallied. The duality concept is
commonly expressed in the fundamental accounting equation as Assets = Liabilities + Capital.

6) Accounting Period Assumption

The particular span of time, usually one year, is fixed for closing of accounts and this span of time is
known as accounting period. The book of account is required to be closed for the purpose of letting
users know profit earned by business during the financial year.
7) Full Disclosure Concept

As accounting information are used by different users, it is necessary that full, fair and adequate
accounting information along with their proper explanation and clarification are disclosed. To ensure
proper disclosure of material accounting information, the Indian Companies Act 2003 has provided a
format for the preparation of profit and loss account and balance sheet which needs to be
compulsorily adhered to by the companies.

8) Materiality Concept

Accounting should record material items with relevant facts and information while immaterial facts
should either be left out or be merged with other information. Any fact would be considered as
material if it is reasonably believed that its knowledge would influence the decision of informed user
of financial statements.

9) Objectivity Concept

The accounting information must be recorded in manner that is free from biasness. Each recording of
transaction must be supported by proper voucher and other documents.
System of Accounting
There are two way of recording business transactions: Double entry system and Single entry system.

Double entry system

Double entry system was invented by ‘Lucas Pacioli’ in 1494 in Italy but developed in England. This
system is based on dual aspect concept i.e. there cannot be any receiver unless there is a giver. In
this system at least two accounts are affected, one of which is debited and the other is credited. The
basic principle of this system is, for every debit, there must be a corresponding credit of equal
amount and for every credit there must be a corresponding debit of equal amount. In short,
recording of business transactions in terms of debit and credit is ‘double entry system’.

Features

1) Two or more accounts are affected: At least two accounts are involved in every business
transactions, one of them is debited and other is credited. In others words each transaction has
dual impact.
2) Two amount columns are prepared: Amount column is also divided in two parts: ‘debit amount’
and ‘credit amount’.
3) Follow basic concept and conventions of accounting: The double entry system is based upon
generally accepted accounting principles.
4) Trial balance and final accounts are prepared: Preparation of trial balance and final accounts
reveal that organisation is using double accounting system.

Advantages

1) Full record of every transaction: Business transactions are classified as capital, liabilities, assets,
revenue and expenses and they are recorded in journal. From journal, ledger is prepared, whose
balances are used to prepare trial balance and then final accounts.
2) Accuracy in information recording: As transactions are recorded in a systematic and scientific
manner, the chances of recording wrong information are very less.
3) Verification of information: Each transaction is supported by respective vouchers and other
documents. Hence the amount so record in the books can be scrutinised on the basis of
documentary proofs.
4) Knowledge of profit and loss: Knowledge about profit and loss can be obtained with the help
final account of a company.
5) Knowledge of assets and liabilities: Balance sheet of a company discloses the value of assets and
liabilities owned by it at the end of an accounting year.
6) Comparison of performance: The actual performance and expected performance of company
can be compared with final account and financial statement analysis.
7) Detection of fraud: The comprehensive and scientific nature of recoding increases the chances
of fraud detection, if any.

Disadvantages

1) Cannot always prevent recording of inaccurate information: for ex- one account is wrongly
debited by rs. 1500 and other account is wrongly credited by rs. 1500. This error will not be
detected as net impact is zero and total will be tallied.
2) Cannot guarantee recording of all accounting information: Double entry cannot guarantee that
all information are recorded. The accountant may not record any particular transaction.
3) Cannot ensure that generally accepted accounting principles are followed:

Single entry system

Single entry system is an incomplete and unsystematic system of recording financial transactions. As
the name suggests, it does not record two-fold effect of each transaction. This system does not
maintain complete record all transactions but maintain record of only few personal accounts and
cash book. Real accounts and nominal accounts are generally not prepared under this system.

Features

1) Incomplete system of accounting: Only few personal accounts and cash book are maintained.
Hence this is an incomplete system of account keeping.
2) Difficult to ascertain the financial position: Balance sheet is not prepared in this system. Hence
True financial position is difficult to ascertain.
3) Profit is just an estimate: The profit so arrived under this accounting system is just an estimate.
In fact true profit can never be obtained due to incomplete system.
4) Cash and credit transactions are mixed: cash book maintained under this system is a mixture of
both cash and credit transactions.

Advantages of Single Accounting System

1) Simple method of accounting: Unlike double entry system, there is no need of special
knowledge of accounting. Hence the method of recording transaction is easy and simple.
2) Economical: only few accounts are maintained under the system. Hence the cost of staff and
other related costs are less.
3) Saving of time: limited number of records and less number of books are maintained in very less
time.
4) Relevant for small firms: Simple method, less time and cost effective system, make it more
suitable for small firms.
5) Tax Evasion: Actual income is not revealed by this system. Firms usually end up paying less tax.

Limitations

1) Comparison of performance is not possible: Due to incomplete records and unsystematic way of
recording financial transactions, present performance of a company cannot be ascertained and
compared with previous performances.
2) Frauds cannot be easily detected: Actual value of assets cannot be determined in this case, as
balance sheet is not prepared. Hence management and control over assets becomes very hard.
3) Non adherence of generally accepted accounting principles: Generally accepted accounting
principles, assumptions, conventions etc are not followed by this system of accounting.
4) Loss of government’s revenue: Tax evasion by firm leads to loss of revenue to the government.
5) Difficulty in obtaining loan: Accounts prepared under the system are not acceptable to banks
and other financial institutions. Hence obtaining of loan from them becomes very difficult.
6) Correct knowledge of financial position is not possible: In other words, it is very difficult to
ascertain the financial position of the firm.

Single Entry System vs. Double Entry System

Basis of Difference Single Entry System Double Entry System
Dual Impact Dual impact of each transaction is not Each transaction has dual
considered. impact.
Recording of Only few personal accounts and cash All types of accounts i.e.
Accounts book is prepared. Real and nominal personal, real and accounts are
accounts are ignored. prepared.
Preparation of trial Preparation of trial balance and Trial Balance and balance sheet
balance & balance balance sheet are not possible. are prepared.
sheet.
Profit Calculation Profit is only an estimate. Actual net profit is calculated.
Financial Position Financial position is not ascertained. Financial position is ascertained.
Suitability to firms Only suitable for sole trader whose Suitable to all types of traders.
turnover is very less.
Evasion of tax Tax evasion is easy. Tax evasion is not possible.
Acceptability to Banking and other financial Banking and other financial
authorities. institutions do not accept this system. institutions accept this system.
Account
In accounting, we keep a separate record of each individual, asset, liability, expense or income. The
place where such record is maintained is termed as an ‘Account. An account is a summary of all the
related transactions relating to a particular head at one place.

Classification of Accounts

Transactions can be classified as follows:

1) Personal Accounts: Accounts relating to individuals and firms come under personal account. It
can be further sub classified as:

a) Natural person: The account is related to individuals. For ex- Kundan A/c.
b) Artificial person: it means accounts related to a group of persons or firms or institutions. For
ex- N K D & Co. Reliance Industries, Apna Club etc.
c) Representative person: This account represents a particular person or group of persons. For
ex- outstanding rent, prepaid salary, accrued interest etc.

2) Impersonal Accounts: All those accounts which are not personal come under impersonal
account. This is further divided into two types viz. Real and Nominal accounts.

a) Real Accounts: Accounts relating to assets such as properties, goods or cash comes under
this. Real accounts can be both tangible and intangible. For ex- Land, Goodwill, Purchases
etc.
b) Nominal Accounts: These accounts do not have any shape. These relate to incomes and
expenses and gains and losses of a business concern. For example, Salary A/c, Rent A/c etc.

Illustration

An illustrative list of items being classified into personal, real and nominal account is given a under:

Accounting Items Type of Account Accounting Items Type of Account

Capital Personal account Kundan Personal account
Cash Real account Bank Real account
Canara bank Personal account Interest Nominal account
Purchase Nominal account Sales Nominal account
Inventory Real account Building Real account
Furniture Real account Advertisement Nominal account
Loan liability Personal account Investment Real account
Short term securities Real account Carriage/Travelling Nominal account
Bad debt Nominal account Printing/stationery Nominal account
Salary Nominal account Outstanding salary Personal account
Insurance Nominal account Prepaid Insurance Personal account
Commission Nominal account Pre-received Commission Personal account
Goodwill Real account

Golden Rules of Accounts

There are three fundamental rules prescribed for personal, real and nominal accounts. They are:

1) Personal Account: Debit the receiver and credit the giver.

2) Real Account: Debit what come in and credit what goes out.
3) Nominal Account: Debit all expenses and losses and credit all incomes and gains.

Rules for Debit and Credit of Accounts

On the careful analysis of above classification of account we can find that all accounts are divided
into five broad categories for the purposes of recording the transactions: (a) Asset (b) Liability (c)
Capital (d) Expenses/Losses, and (e) Revenues/Gains. There are some fundamental rules followed to
record the changes in these accounts. They are as follows:

1) For recording changes in Assets: Increase in asset is debited, and decrease in asset is credited.
2) For recording changes in Liabilities: Increase in liabilities is credited and decrease in liabilities is
debited.
3) For recording changes in Capital: Increase in capital is credited and decrease in capital is debited.
4) For recording changes in Expense/Losses: Increase in expenses/losses is debited, and decrease
in expenses/losses is credited.”
5) For recording changes in Revenue/Gain: Increase in revenue/gain is credited and decrease in
revenue/gain is debited.

DEBIT NATURE OF A/Cs CREDIT

Increase Asset Decrease
Decrease Liability Increase
Decrease Capital Increase
Decrease Revenue/Gain Increase
Increase Expenses/Loss Decrease
Journal
Journal is a basic book in which transactions are recorded in the chronological order, as and when
they take place. The process of recording journal is known as journalising. Any entry made in the
journal is called a ‘journal entry’.

Format of the Journal

A specimen of the format of journal is given below.

Journal
Date Particulars L.F. Debit Amount (rs.) Credit Amount (Rs.)

Features of format of journal

1) Date: The first column is of date on which transaction had taken place.
2) Particulars: The second column is of particulars. Two or more accounts affected due to
transaction are recorded here.
3) Narration: A brief explanation of each entry is written just below the recording of each entry in
the particulars column.
4) Ledger Folio (L.F): it is a reference number of the ledger where the posting has been made from
journal.
5) Debit Amount: The actual amount of account being debited is recorded here.
6) Credit Amount: The actual amount of account being credited is recorded here

Advantages

The main advantages of the Journal are:

1) It reduces the possibility of errors by recording transaction on dual concept basis.

2) It provides an explanation of the transaction.
3) It provides a chronological record of all transactions.

Limitations

The limitations of the Journal are:

1) It will be too long if all transactions are recorded here.

2) It is difficult to ascertain the balance of each account.

Steps of Journalising

Passing of any journal entry involves following steps:

Step 1 Finding the two accounts which are involved in the transaction.
Step 2 Classifying the two accounts under Personal, Real or Nominal.
Step 3 Applying the rules of debit and credit for above two accounts.
Step 4 Recording the date of transaction in the first column i.e. date column.
Step 5 Recording of debit and credit entry in the second column i.e. particulars column.
 Name of the debit account is written first ending with the word ‘Dr.’. Then name of
credit account is written with the word starting with ‘To’.
Step 6 The narration is written next just below the entry being recorded. A line is drawn
below the narration to separate one journal entry from other.
Step 7 The amount of debit and credit in respective account is recorded in front of their
respective account in the fourth and fifth column respectively.

Illustrations 1:

January 1, 2016: Kundan started business with Rs. 1,00,000.

Analysis of Transaction

Step 1 Determining the two accounts Cash account Capital account

involved in the transaction.
Step 2 Classifying these accounts under Real Account Personal Account
personal, real or nominal.
Step 3 Applying the golden rules of accounts. Debit what comes in Credit the giver
business
Step 4 Identify which account is to be debited Debit Cash account Credit capital
and credited. account

Note: We can replace step 2 and step 3 in this manner.

Step 2 Classifying these A/cs. under expense (losses), Assets Capital

revenue (gain), assets, liabilities or capital.
Step 3 Applying the rules of debit and credit. Debit increase Credit increase
in assets. in capital.

Solution:
Journal
Date Particulars L.F. Debit (rs.) Credit (rs.)
Jan 1 Cash account Dr. 1,00,000
To Capital Account 1,00,000
(cash introduced into business)

Illustrations 2:

January 2, 2016: Kundan purchased goods with Rs. 1,00,000 from Sonali on credit.

Analysis of Transaction:

Step Determining the two accounts involved in Purchases account Sonali account
1 the transaction.
Step Classifying these accounts under Nominal Account Personal Account
2 personal, real or nominal.
Step Applying the golden rules of accounts. Debit all expenses Credit the giver
3
 Step Identify which account is to be debited Debit purchase Credit Sonali
4 and credited. account account

Note: We can replace step 2 and step 3 in this manner.

Step 2 Classifying these A/cs. under expense (losses), Assets Capital

revenue (gain), assets, liabilities or capital.
Step 3 Applying the rules of debit and credit Debit increase Credit increase
in asset. in capital.

Solution:

Journal
Date Particulars L.F. Debit (rs.) Credit (rs.)
Jan 2 Purchase account Dr. 1,00,000
To Sonali Account 1,00,000
(Goods Purchased on credit)

Illustrations 3:

January 4, 2016: sold goods with rs. 75,000 to Ganesh on credit.

Analysis of Transaction:

Step 1 Determining the two accounts Ganesh account Sales account

involved in the transaction.
Step 2 Classifying these accounts under Personal Account Nominal Account
personal, real or nominal.
Step 3 Applying the golden rules of Debit the receiver Credit all Incomes
accounts.
Step 4 Identify which account is to be Debit Ganesh Credit Sales account
debited and credited. account

Self-work: Replace step 2 and step 3 as per expense (losses), revenue (gain), assets, liabilities or
capital.

Solution:

Journal
Date Particulars L.F. Debit (rs.) Credit (rs.)
Jan 4 Ganesh account Dr. 75,000
To Sales Account 75,000
(Goods Sold on credit)

Illustrations 4:

January 15, 2016: Paid rent of rs. 10,000.

Analysis of Transaction:

Step 1 Determining the two accounts Rent account Cash account

 involved in the transaction.
Step 2 Classifying these accounts under Nominal Account Real Account
personal, real or nominal.
Step 3 Applying the golden rules of Debit all expenses Credit what goes
accounts. (losses). out.
Step 4 Identify which account is to be Debit Rent account Credit Cash
debited and credited. account

Self-work: Replace step 2 and step 3 as per expense (losses), revenue (gain), assets, liabilities or
capital.

Solution:

Journal
Date Particulars L.F. Debit (rs.) Credit (rs.)
Jan 15 Rent account Dr. 10,000
To Cash Account 10,000
(rent paid)

Illustration 5:

January 15, 2016: commission received of rs. 20,000.

Analysis of Transaction:

Step 1 Determining the two accounts Cash account Commission

involved in the transaction. account
Step 2 Classifying these accounts under Real Account Nominal Account
personal, real or nominal.
Step 3 Applying the golden rules of Debit what comes Credit all
accounts. in. revenues (gains).
Step 4 Identify which account is to be Debit Rent account Credit Cash
debited and credited. account

Self-work: Replace step 2 and step 3 as per expense (losses), revenue (gain), assets, liabilities or
capital.

Solution:

Journal
Date Particulars L.F. Debit (rs.) Credit (rs.)
Jan 15 Cash account Dr. 20,000
To Commission Account 20,000
(Commission received)

Illustrative lists of Journal Entry

No. Transactions Journal Entry Applying Debit and Credit Rule

1. Started business with Cash A/c Dr. Increase in asset is debited.
 cash To Capital A/c Increase in capital is credited.
2. Goods purchased for Purchases A/c Dr. Increase in asset is debited.
cash To Cash A/c Decrease in asset is credited.
3. Goods purchased on Purchases A/c Dr. Increase in asset is debited.
credit To Creditors A/c Increase in liability is credited.
4. Goods sold for cash Cash A/c Dr. Increase in asset is debited.
To Sales A/c Decrease in asset is credited.
5. Goods sold on credit Debtors A/c Dr. Increase in asset is debited.
To Sales A/c Decrease in asset is credited.
6. Purchase return Creditors A/c Dr. Decrease in liability is debited.
To purchases return A/c Decrease in asset in credited.
7. Sales return Sales return Dr. Decrease in revenue is debited.
To Debtors A/c Decrease in assets is credited.
8. Assets purchased Assets A/c Dr. Increase in asset is debited.
To cash A/c Decrease in assets is credited.
9. Assets sold Cash A/c Dr. Increase in asset is debited.
To Assets A/c Decrease in assets is credited.
10. Payment of expense Expenses A/c Dr. Increase in expenses is debited.
To cash A/c Decrease in assets is credited.
11. Income received Cash A/c Dr. Increase in asset is debited.
To Income A/c Increase in revenue is credited.
12. Received from Debtors, Cash A/c Dr. Increase in asset is debited.
after allowing discount Discount A/c Dr. Increase in expense is debited.
To debtors A/c Decrease in assets is credited.
13. Payment to Creditors, Creditors A/c Dr. Increase in liabilities is debited.
after discount To cash A/c Decrease in assets is credited.
To Discount A/c Increase in revenue is credited.
14. Depreciation on Assets Depreciation A/c Dr. Increase in expense is debited.
To Assets A/c Decrease in assets is credited.
15. Interest paid on Capital Interest A/c Dr. Increase in expenses is debited.
To Capital A/c Increase in capital is credited.
16. Outstanding expenses Expenses A/c Dr. Increase in expense is debited.
To Outstanding Exp. A/c Increase in liability is credited.
17. Prepaid expenses Prepaid exp. A/c Dr. Increase in asset is debited.
To Expenses A/c Decrease in expense is credited.
18. Cash/goods withdrawal Drawings A/c Dr. Decrease in capital is debited.
for personal use To cash A/c Decrease in asset is credited.
To purchases A/c Decrease in asset is credited.
19. Bad debt Bad debt A/c Dr. Increase in loss is debited.
To debtors A/c Decrease in asset is credited.
20. Bad debt recovered Cash A/c Dr. Increase in asset is debited.
To bad debt recovery Increase in income is credited.
A/c
21. Loss of goods by Lost by fire/theft A/c Dr. Increase in loss is debited.
fire/theft To purchases A/c Decrease in asset is credited.
22. Interest received Cash A/c Dr. Increase in asset is debited.
To interest A/c Increase in income is credited.
23. Bill receivable from Bills receivable A/c Dr. Increase in asset is debited.
debtor is drawn To debtor A/c Decrease in asset is credited.
24. Bill payable from Creditors A/c Dr. Decrease in liability is debited.
 debtor is accepted To bills payable A/c Increase in liability is credited.
25. Asset sold at profit Cash A/c Dr. Increase in asset is debited.
To assets A/c Decrease in asset is credited.
To Profit on sale of asset Increase in income is credited.
A/c.
26. Asset sold at loss Cash A/c Dr. Increase in asset is debited.
Loss on sale of Increase in loss is debited.
assets A/c Dr.
To assets A/c Decrease in asset is credited.
27. Amount deposited into Bank A/c Dr. Increase in asset is debited.
bank. To cash A/c Decrease in asset is credited.
28. Amount withdrawn Cash A/c Dr. Increase in asset is debited.
from bank. To bank A/c Decrease in asset is credited.
29. Bank charges paid Bank charges A/c Dr. Increase in loss is debited.
To cash A/c Decrease in asset is credited.
30. Sale of waste/scrap Cash A/c Dr. Increase in asset is debited.
To Misc. Income A/c Increase of income is credited.

Compound Journal Entry

When two or more transactions, occurring on same date are recorded by means of a combined
journal entry, it is called a Compound Journal Entry. One precaution in this case has to be taken is
that total debit amount must be equal to total credit amount.

Illustration 1:

January 1, 2016: Kundan commenced business with furniture rs. 20,000, machinery rs. 50,000 and
cash rs. 10,000.

Analysis of Transaction:

Step 1 Determining the two or Cash account Furniture Machinery Capital account
more accounts involved account account
in the transaction.
Step 2 Classifying these Real Account Real Real Personal
accounts under personal, Account Account Account
real or nominal.
Step 3 Applying the golden rules Debit what Debit what Debit what Credit the giver.
of accounts. comes in. comes in. comes in.
Step 4 Identify which account is Debit cash Debit Debit Credit Capital
to be debited and account furniture machinery account
credited. account account

Self-work: Replace step 2 and step 3 as per expense (losses), revenue (gain), assets, liabilities or
capital.

Solution:

Journal
 Date Particulars L.F. Debit (rs.) Credit (rs.)
Jan 1 Machinery account Dr. 50,000
Furniture account Dr. 20,000
Cash account Dr. 10,000
To Capital Account 80,000
(business started with machinery,
furniture and cash)

Illustration 2:

January 10, 2016: Purchased goods worth rs. 25,000 in credit and rs. 50000 for cash.

Analysis of Transaction:

Step 1 Determining the three accounts Purchase Cash account Creditors

involved in the transaction. Account account
Step 2 Classifying these accounts under Nominal Real Account Personal
personal, real or nominal. Account Account
Step 3 Applying the golden rules of Debit all Credit what Credit the
accounts. expenses. goes out. giver.
Step 4 Identify which account is to be Debit Purchase Credit cash Credit Creditor
debited and credited. Account account account

Self-work: Replace step 2 and step 3 as per expense (losses), revenue (gain), assets, liabilities or
capital.

Solution:

Journal
Date Particulars L.F. Debit (rs.) Credit (rs.)
Jan 10 Purchase A/c Dr. 75,000
To Cash A/c 50,000
To Creditors A/c 25,000
(goods purchased both in cash and credit)

Illustration 3:

January 15, 2016: Goods worth rs. 60,000 sold in credit and rs. 20,000 for cash.

Analysis of Transaction:

Step 1 Determining the three accounts Debtors Cash account Sales account
involved in the transaction. account
Step 2 Classifying these accounts under Personal Real AccountNominal
personal, real or nominal. Account Account
Step 3 Applying the golden rules of Debit the Debit what Credit all
accounts. receiver. comes in. incomes.
Step 4 Identify which account is to be Debit Purchase Credit Cash Credit Sales
debited and credited. account account account
Self-work: Replace step 2 and step 3 as per expense (losses), revenue (gain), assets, liabilities or
capital.
Solution:

Journal
Date Particulars L.F. Debit (rs.) Credit (rs.)
Jan 15 Debtors A/c Dr. 60,000
Cash A/c Dr. 20,000
To Sales A/c 80,000
(goods sold both in cash and credit)
Ledger Accounts
Business transactions are first recorded in the journal books. But it is not possible to know the net
balance of individual accounts at a glance. In order to ascertain the net balance of all the
transactions relating to a particular account, these transactions are collected at one place. It is known
as Ledger.

Ledger is the principal book of accounting system. It is a book which contains the classified and
permanent records of all the transactions of an account. It records transactions relating to all the
accounts whether personal, real or nominal.

Format of the Ledger

A specimen of the format of ledger is given below.

Name of the Account

Dr. Cr.
Date Particulars L.F. Amount Date Particulars L.F. Amount

Features of Format of Ledger

1) Name of the account: The account name is written at the top (middle) as the title of an account.
2) Two parts of account: Each ledger account is divided into two parts. The left hand side is known
as the debit side and the right hand side is known as the credit side. The words ‘Dr.’ and ‘Cr.’ are
used to denote Debit and Credit.
3) Date: Date of transactions is posted in chronological order in this column.
4) Particulars: Name of the item to be posted from the original book of entry is written on
debit/credit side of this column.
5) Journal Folio (J.F.): It records the page number of journal on the basis of which relevant
transaction is to be recorded.
6) Amount: The amount pertaining to this account is entered in the amount column.

Utility of Ledger

Ledger accounts are the most important record of business accounting. Its utility can be summarised
as under:

1) Separate accounts: For different parties and heads, individual ledger accounts are prepared.
Information about individual capital, assets, liabilities, expenses and revenues accounts are
obtained separately.
2) Requisite information available at a glance: Information regarding every account is present at
one place. The correct position of every account can be ascertained at a glance by going through
it.
3) Preparation of trial balance: Trial balance is prepared with the help of balances of each ledger
accounts.
4) Interpreting various accounting information: The data supplied by various ledger accounts are
summarised, analysed and interpreted for obtaining various accounting information.

Classification of Ledger Accounts

Ledger accounts are grouped into two categories: permanent ledger accounts and temporary ledger
accounts. Permanent accounts are further classified under three heads viz. assets, liabilities and
capital accounts. Temporary accounts are classifies as revenue/gain and expense/loss accounts.

Permanent ledger accounts usually have opening and closing balances, except for newly started
business. These accounts appear in the balance sheet. Temporary ledger accounts do not have
opening and closing balances. Their balances are closed by transferring it to trading account or P/L
account.

Steps for Posting into Ledger

Collection of required information of a particular account and presenting them under one head is
known as ‘ledger posting’. Ledger posting is the process of transferring entries from the books of
original entry (journal) to the ledger. The processes of posting are as follows:

Step 1: Identify the account to be debited or credited from journal. If an account is to be debited,
posting will be made in the debit side of the account and if account is to be credited, posting
will be made in the credit side of the account.
Step 2: Entering the date of transactions in the date column, either in debit side or credit side as the
case maybe.
Step 3: In the particulars column, write the name of ‘reverse account’ at the debit or credit side, as
the case may be. It means we write the name of the account being debited in the journal
while preparing credit ledger account.

For ex- Goods sold to Shyam for rs. 10,000. While recording journal entry, Shyam A/c is to be
debited while sales A/c is to be credited. While preparing sales ledger, we will write ‘Shyam
A/c’ in the credit side.

Step 4: Page number of the journal is written in the J.F. (Journal Folio) column of the ledger account.
Step 5: The relevant amount is entered in the amount column of debit or credit side of the ledger, as
the case may be. In case of compounding entries, the amount written against the accounts
being prepared is written.

For ex- Shyam paid rs. 9,900 against full settlement of his liability of rs. 10,000. Here Shyam
A/c will be credited while cash A/c and discount A/c will be debited. While preparing Shyam
ledger account, Cash A/c and Discount A/c will be written in its particulars column, with
amount rs. 9,900 and rs. 100 respectively.

Step 6: At last, ledger account is balanced and closed.

Note: In case of old company, the step 3 will start by writing down the carried forward opening
balance of the permanent ledger account. The word ‘balance b/d’ will be written in the particulars
column. B/d here means brought down from previous year.
Closing of Ledger Account

1) Permanent ledger accounts have certain closing balances. So their values are carried forward to
the next accounting period. While closing these accounts, we write the word ‘balance c/f’ in the
particulars column. The net difference between left side and right side is written in the deficit
amount column. C/f here means carried forward to next accounting period. This c/f amount
appears as the opening balance of ledger next year.
2) Temporary ledger accounts do not have closing balance. So they are not carried forward.
Revenue/gain accounts balances are posted to the credit side of trading account or profit and
loss account. Expense/loss accounts balances are posted to the debit side of trading account or
profit and loss account. All nominal accounts are temporary ledger accounts.
3) Representative personal accounts are treated as permanent ledger accounts. It means
outstanding, prepaid expenses, accrued or pre-received incomes have closing balances and
hence are C/f.

Illustrations

January 1, 2016: Kundan commenced business with furniture rs. 20,000, machinery rs. 50,000 and
cash rs. 100,000.
January 10, 2016: Purchased goods worth rs. 25,000 in credit and rs. 50000 for cash.

Pass the necessary journal entries and post the same into ledger account.

Solution:
Journal entry
Date Particulars L.F. Debit (rs.) Credit (rs.)
Jan 1 Machinery account Dr. 50,000
Furniture account Dr. 20,000
Cash account Dr. 100,000
To Capital Account 170,000
(business started with machinery,
furniture and cash)
Jan 10 Purchase A/c Dr. 75,000
To Cash A/c 50,000
To Creditors A/c 25,000
(goods purchased both in cash and credit)

Machinery Account
Dr. Cr.
Date Particulars L.F. Amount Date Particulars L.F. Amount
Jan 1 To Capital A/c 50,000

Furniture Account
Dr. Cr.
Date Particulars L.F. Amount Date Particulars L.F. Amount
Jan 1 To Capital A/c 20,000

Cash Account
Dr. Cr.
Date Particulars L.F. Amount Date Particulars L.F. Amount
Jan 1 To Capital A/c 100,000 Jan 10 By Purchases 50,000

Capital Account
Dr. Cr.
Date Particulars L.F. Amount Date Particulars L.F. Amount
Jan 1 By Machinery A/c 50,000
By Furniture A/c 20,000
By Cash A/c 100,000

Purchases Account
Dr. Cr.
Date Particulars L.F. Amount Date Particulars L.F. Amount
Jan 10 To Cash A/c 50,000
To Creditors A/c 25,000

Creditor Account
Dr. Cr.
Date Particulars L.F. Amount Date Particulars L.F. Amount
Jan 10 By Purchases A/c 25,000

Difference between Journal and Ledger Accounts

Both journal and ledger are the most important books of the double entry mechanism of accounting.
Journal and ledger account are different from each other in the following ways:

Basis of Distinction Journal Ledger

Type of record Journal is the primary record of Ledger is the principle, not primary
business transactions. record of business transactions.
Recording stage It is the first stage of recording It is the second stage of recording
accounting transactions. accounting transactions.
Process of recording is Process of recording is known as Process of recording is known as
known as Journalising. Posting.
Ascertainment of final The final position of a particular The final position of a particular
position account cannot be found. account can be found.
Use of data Ledger accounts are prepared with Ledger accounts are used as the
the help of journal. basis for preparing trial balance.
Balancing Journal is not balanced. Ledger account requires balancing.
Basis of classification of Transaction is the basis of data Account is the basis of data
data classification within the journal. classification within the ledger.
Trial Balance
In the previous chapters we have leant how to record, classify and balance the transactions in various
accounts. The next step in the accounting is to ensure the arithmetical accuracy of the transactions
recorded so for.

‘Trial balance is a statement, prepared with the debit and credit balances of all ledger accounts to
test the arithmetical accuracy of the books.’- J R Batliboi
Trial balance is prepared under the double entry system. If the totals of debit and credit amount are
equal, books of accounts so prepared is assumed to be correct. The trial balance is a tool for verifying
that both aspects of every transaction have been recorded accurately.

Features of Trial Balance

1) Trial balance is prepared on a particular date. This is why the word ‘as on …’ is used in its
heading.
2) All the ledger accounts are considered while preparing trial balance.
3) Total of debit and credit column must be equal. The difference in debit and credit side of the trial
balance points out that certain mistakes have been committed.
4) If both the debit side and credit side have same total, it does not mean that there is no mistake
in accounting. Some types of error are not detected even by the trial balance.
5) Trial balance is prepared under the double entry system.
6) Trial balance may be prepared with the balances methods or totals methods or totals-cum-
balances methods of ledger accounts.

Objectives of Trial Balance

Trial balance is prepared with the following objectives:

1) Testing the arithmetic accuracy of the ledger accounts: If both the debit side and credit side
have same total, it generally means that ledger accounts so prepared are recorded properly.
2) Helpful in locating errors: In case of non-matching of trial balance, one can know that some
errors have occurred. These errors may be made while a) posting journal entries in the ledger b)
totalling subsidiary books c) calculating account balances in ledger d) transferring account
balances to the trial balance and e) totalling the trial balance columns.
3) Obtaining the summarised information of ledger accounts: The summarised information of
ledger accounts can be obtained at a glance from the trial balance.
4) Facilitates the preparation of final accounts: The relevant information required for the
preparation of the final accounts is obtained from the trial balance. All revenue and expense
accounts appearing in the trial balance are transferred to the trading and profit and loss account
and all liabilities, capital and assets accounts are transferred to the balance sheet.

Format of Trial Balance

Trial Balance of ABC Ltd.

As on ………
Name of Accounts L.F. Debit (Rs.) Credit (Rs.)

Illustrative List of Important Accounts and their Balances

Name of Accounts L.F. Debit (Rs.) Credit (Rs.)

Capital **
Long Term Loan **
Bills Payable **
Sundry Creditors **
Land and Buildings **
Plant and Machinery **
Equipment and tools **
Furniture and Fixtures **
Goodwill **
Cash in Hand **
Cash at Bank **
Sundry Debtors **
Bills Receivable **
Stock of Raw Materials **
Work in Progress **
Stock of Finished Goods **
Purchases **
Carriage Inwards **
Carriage Outwards **
Sales **
Sales Return **
Purchases Return **
Expense (rent, salaries, interest etc.) Paid **
Commission/Discount Received **
Prepaid Insurance **
Outstanding Salaries **
Interest receivable accrued **
Advances from Customers **
Drawings **
Reserve Fund **
Provision for Doubtful Debts **