Ledger and Trial Balance 1

MODULE – 1
ACCOUNTING PROCESS
2 Accounting for Beginners: Financial Accounting I
 Ledger and Trial Balance 3

CHAPTER 1

ACCOUNTING PROCESS

Need for accounting

Decision making is a part and parcel of carrying on a business. There are many stakeholders in a
business enterprise. These include owners, managers, investors, lenders, customers, suppliers, labor
unions and the government. All these stakeholders make some or the other kind of decision. For
making decisions, the stakeholders need relevant economic information. "Accounting" provides the
relevant economic information required by stakeholders.

Book-keeping, accounting and accountancy

These three are sometimes considered as synonymous. However, there is a fundamental difference
amongst them.

Accountancy

Accounting

Book Keeping

Relationship of Accountancy, Accounting and Book-keeping

Book-keeping
Book-keeping is the recording of the transactions and events of an accounting entity. It therefore,
covers the following four activities: (i) identifying the transactions and events; (ii) measuring the
identified transactions and events; (iii) recording the identified and measured transactions and events
4 Accounting for Beginners: Financial Accounting I

in the vari ous journal books; (iv) classifying the recorded transactions and events in the ledger.
Hence, accounting starts where book-keeping ends.

Accounting
Accounting is concerned with the summarizing of classified transactions and events, analysing the
summarized records, interpreting the analysed results and communicating the interpreted
information to the interested users. The American Institute of Certified Public Accountant has
defined Financial
Accounting as “the art of recording, classifying and summarizing in a significant manner and in
terms of money, transactions and events which in part at least of a financial character and
interpreting the results thereof.”

Accountancy
Accountancy refers to the systematic knowledge of accounting. It describes as to why to do' and
'what to do' of the various aspects of accounting. It also describes as to how to prepare the book of
account and how to communicate the information to the interested users.

Difference between book-keeping and accounting

Book-keeping is the art of recording, classifying and summarizing the transactions in a systematic
manner. Accounting performs same functions as that of book-keeping, but it also includes analyzing
and interpretation.

Book -Keeping Accounting

Accounting is summarizing, interpreting and
It is the recording phase of accounting system
communicating phase of accounting system

Basic objective is to ascertain the financial

Basic objective is to maintain the systematic records
performance and financial position and to
of the financial events
communicate the same to interested users

It covers identifying transactions and events, Accounting is concerned with the summarizing of
measuring them, recording the measured classified transactions and events, analyzing the
transactions and classifying the recorded summarized records, interpreting them and
transactions and events into accounts communicating it to users

Junior level staff is required for book-keeping Senior level staff is required for accounting

The work of book keeping is normally routine and The work of accounting is normally analytical in
clerical in nature nature
 Ledger and Trial Balance 5

Book -Keeping Accounting

The person performing book keeping work is called The person performing accounting is called
book keeper accountant

Book keeper does not require higher level of The accountant requires higher level of
knowledge than that of accountant knowledge than that of book keeper

Book keeper may or may not have analytical skills Accountant must have analytical skills

It does not meet the legal requirement. It does meet the legal requirement.

It does not help in managerial decisions. It does help in managerial decisions.

Book keeping does not require special skills and

Accounting requires special skills and knowledge
knwoledge

Book keeping is the basis for accounting Accounting is the basis for business language

Objectives of accounting
1. To keep systematic record of business transactions.
2. To calculate profit or loss.
3. To know exact reasons leading to net profit or net loss.
4. To depiction the financial position of the business.
5. To ascertain the progress of the business from year to year.
6. To prevent and detect errors and frauds.
7. To provide information to various groups and users.
8. To file tax returns.
9. To ensure regulatory compliance

Users of accounting information

Accounting information has both (i) internal and (ii) external users.
Internal users are managers in all areas of functional responsibility such as marketing, finance,
human resources and general management. Marketing managers use accounting information to
make decisions relating to pricing of products, sales promotion, etc. Finance managers use
6 Accounting for Beginners: Financial Accounting I

accounting information to decide on making new investments, raising funds, payment of dividends,
etc. Human resources managers make decisions relating to pay revision, declaration of bonus, etc.
on the basis of accounting information. General managers make decisions on the product-mix of
the entity using accounting information. The type of reports generated by the accounting
information system for use by managers include forecasts of income, projections of funds
requirement and availability, comparison of financial results of alternative courses of action, etc.
External users of accounting information include investors, lenders, customers, suppliers, labor
unions and the government Owners and investors. are interested in knowing whether the business
would be able to provide a reasonable return on their investment and whether to continue with the
investment in the business, how to finance the expansion of business, etc. Lenders need information
for determining the capacity of the business to pay interest and to repay loans in time. Customers
want to know whether the business will continue producing the item they are using so that there are
no problems relating to servicing of its products and associated warranties. Suppliers want to satisfy
themselves about the ability of the business to make payments of their dues on time. Labor unions
are interested in knowing whether the business will be able to pay increased wages and bonuses.
Government wants to know whether the business is rightly determining its profit or loss and
whether it is duly paying the taxes due from it.

Branches of accounting
(i) Management Accounting
(ii) Financial Accounting
(iii) Cost Accounting
Information needed by managers and owners is more detailed, and the sub field of accounting that
generates this information is known as Managerial accounting. Managers use managerial
accounting information to set organizational goals, evaluate individual and departmental
performances, make decisions relating to the introduction of new products or entering new markets,
etc. Managerial accounting information need not be organized in a particular format. The
presentation depends on the decision at hand. A major part of managerial accounting consists of
information relating to the cost of products and services. Managerial accounting uses both historical
information and projections for the future.
The other sub-field of accounting is called Financial accounting. It relates to the preparation of
financial statements for use by both managers and external stakeholders. Financial accounting
reports present information about all activities of the business, be it operating activities (main
revenue-producing activities); investing activities (activities involving purchase and sale of long
lived assets and investments); or financing activities (activities that change the amount and
composition of financial resources). Financial accounting is basically historical in nature.
The third sub-field of accounting is called Cost accounting. Cost accounting deals with
ascertainment of cost of a product or service, cost control and cost reduction.
 Ledger and Trial Balance 7

Functions of accounting
The functions of accounting are described as follows:
(i) Maintenance of systematic accounting records: The transactions and other events of the
enterprise are maintained in a written form. The basic reason for maintaining written
records is that the human memory has a limitation that can retain in it only a limited number
of transactions and events Another reason is that the written records maintained in a
systematic manner work as a kind of evidence in the Court of Law, The written records
relate to incomes, expenses, assets, liabilities and equity.
(ii) Ascertainment of financial performance: The second function of accounting is to
ascertain the financial performance. Financial performance implies the net profit earned or
net loss suffered by an enter prise during a particular accounting period. To know this, an
income statement (or alternatively called Profit and Loss Statement or Profit and Loss
Account) is prepared at the end of the accounting period. For this purpose, the incomes of
the accounting period are matched with the expenses incurred during that accounting period
to earn the same and the difference between the two (1.e.. the difference between the
incomes and expenses) is either net profit or net loss. If the incomes exceed the expenses
of the accounting period, then the difference is net profit, whereas if the expenses exceed
the incomes, then the difference is net loss. The income statement may be prepared either
in horizontal form or in vertical form.
(iii) Ascertainment of financial position: The third function of accounting is the ascertainment
of financial position. The enterprise wants t to know the financial position at the end of an
accounting period. The financial position is expressed in terms of the assets on one hand
and the liabilities and equity on the other hand. The assets are also called resources or
application of funds and the liabilities and equity are also called the obligations or sources
of funds. Liabilities are the obligations of the enterprise to the external parties and equity
is the obligation of the enterprise to the internal party called the owner of the enterprise.
Hence, the liability holders and equity holders have the claim on the asset of the enterprise.
The financial position comprising assets, liabilities and equity is expressed in a statement
called position statement (or Balance sheet). The position statement may be prepared either
in horizontal form or in vertical form.
(iv) Ascertainment of cash flows: The fourth function of accounting is to prepare a Cash Flow
Statement at the end of the accounting period to show the sources of cash and the uses of
cash during the accounting period. This is normally prepared in the case of a company
under the Companies Act, 2013, or a body corporate under other special statutes to comply
with the legal requirements.
(v) Communication of the accounting information to the users of accounting: The fifth
basic function of accounting is to communicate the accounting information to various users.
As has been studied earlier, there are two kinds of users of accounting information, i.e.,
internal users and external users who take economic decisions based on the accounting
information supplied to them in the form of financial statements and reports.
8 Accounting for Beginners: Financial Accounting I

Advantages of accounting
Overcoming the limitation of human memory: Accounting records the transactions and events
of an enterprise in a written form. Human memory can retain in it only a limited number of
transactions and events and there is a probability of forgetting the same after a certain period of
time. Hence, this limitation of human memory is overcome by accounting.
Compliance with the legal requirements: Accounting helps in the compliance with the various
legal requirements. For example, Section 128 of the Companies Act, 2013, requires every company
to keep proper books of account and other relevant books and paper and to prepare financial
statements for every financial year. Furthermore, Section 44AA of the Income Tax Act, 1961, also
requires certain persons to maintain specified books of account. Similarly, other statutes also
require the enterprises governed by it to maintain proper books of account.
Help in the ascertainment of financial performance of an enterprise: Accounting
helps in the ascertainment of financial performance of an enterprise which helps the enterprise to
know the reason of dissatisfactory financial performance so that it may take steps to improve upon
the same.
Help in the ascertainment of financial position of an enterprise: Accounting helps in the
preparation of financial position statement of an enterprise at the end of every accounting period.
Based on this, the enterprise is able to know what it owns (i.c., the assets) and what it owes (i.e.,
the liabilities and equity)
Helping the users to take economic decisions: The ultimate purpose of preparing financial
statements is to help the various users to take economic decisions. The financial statements are
prepared as one of the function of accounting.
Ascertainment of the value of business: When an enterprise is sold to another enterprise, the
owners of the enterprise being sold get consideration for sale. This consideration is normally the
agreed values of the asset transferred minus the agreed amount of liabilities and such assets and
liabilities are taken form the Balance Sheet.
Help in legal evidence: The accounting statements prepared by an enterprise may be produced in
the Court of Law as legal evidence in case of disputes.
Helps the management in taking economic decision: Accounting also helps the management in
taking economic decisions for future for planning and controlling the activities of the organization.
For example, the projected cash flow statement helps the management in knowing the cash inflows
and cash outflows in future and the consequent surplus or deficit of cash so that they can plan to
take care of the shortage of cash or increase the surplus of cash flows.

Limitations of accounting
Ignoring non-monetary information: Accounting ignores the non-monetary information as it
records only those transactions and events that may be expressed in terms of money. However, it
 Ledger and Trial Balance 9

is important to note that in many cases, the non-monetary information is more important than the
monetary information for the enterprise.
Alternative treatments makes financial information lack consistency: In accounting, there are
various alternative treatments for the same item. For example, inventory cost may be computed by
adopting either FIFO basis or weighted average cost basis as per AS 2 or Ind AS 2. Similarly,
depreciation may be provided by adopting, inter alia, either Diminishing Balance Method or
Straight-line Method as per AS 10. In choosing one out of the two alternatives, there is always a
biased decision. Hence, the analysis and interpretation of the financial statements is not free from
bias.
Historical Information: Provides only historical information about the performance and financial
performance of business. It fails to provide estimates and projections for future which form the
basis of business decisions.
Financial accounting provides information about matters that can be quantified. Many other items
such as quality of management are important for the success of a business. Since these items cannot
be quantified, these are not reported by Financial Accounting.

Accounting Terms
ASSET
Assets are economic resources controlled by an entity whose cost (or fair value) at the time of
acquisition could be objectively measured. A resource is an economic resource if it provides future
cash flows to the entity. An asset can be: (i) cash or something convertible into cash (e.g. accounts
receivable), (ii) goods expected to be sold and cash received from them and (iii) items to be used
in future activities that will generate cash flows. Land and building, plant and machinery, furniture
and fixtures, inventories, debtors and cash balance are examples of assets.

LIABILITY
Liabilities are claims to assets. A business raises financial resources from both its owners and
outside parties. Both have claims to the assets of the entity. Liabilities are claims to assets of parties
other than owners. Loans, debentures (bonds), creditors, unpaid expenses are examples of
liabilities. Liabilities create negative future cash flows for the entity. For example, a business has
assets worth Rs. 10 million which are financed by owners' funds of Rs. 6 million and loans of Rs.
4 million. The loan of Rs. 4 million represents a claim to 40 percent of the assets and is termed as
a liability of the business.

CAPITAL/OWNERS' EQUITY
Capital (owners' equity) generally refers to the amount invested in an enter prise by the owners. It
is also used to refer to the claim of owners to the assets of an enterprise. The claims of owners to
assets are secondary to those of creditors and lenders.
10 Accounting for Beginners: Financial Accounting I

Changes in owners' equity occurs when: (i) owners either invest in or with draw cash or other assets
from the business and (ii) the business either earns income from profitable operations or incurs
losses from unprofitable operations.

REVENUE
Revenue is the gross inflow of cash, receivables or other consideration arising during the course of
ordinary activities of an enterprise from the sale of goods, rendering of services, and from the use
by others of enterprise resources yielding interest, royalties and dividends.

COST
Cost is a monetary measurement of the amount of resources used for some purpose. For example,
an entity incurs a cost when it purchases an item of equipment

EXPENSE
All costs incurred by an entity are not expenses. An expense is that cost which relates to the
operations of an accounting period (e.g. rent) or to the revenue earned during the period (cost of
goods sold) or the benefits of which do not extend beyond that period. Expenses, thus, have a
relation with the accounting period and represent that part of the cost of an asset or service that is
consumed during the accounting period.
For example, a businessman dealing in televisions buys 1,000 television sets at a cost of Rs. 20
million during an accounting year. This amount of Rs. 20 million is a cost as it represents the
amount of resource (cash) used. During this accounting period, the businessman sells only 800
televisions. The cost of 800 televisions, that is, Rs. 16 million is the expense of that accounting year
as it represents the cost that corresponds to the revenue earned during the year from the sale of 800
televisions.
A business that prepares its accounts every calendar year (January-December) buys an yearly
insurance cover on its assets on 1 April by paying a premium of Rs. 50,000. This amount of Rs.
50,000 is a cost as it represents the amount of resource (cash) used. However, the business will not
enjoy the entire benefit of this cost in the accounting period that ends on 31 December. The benefit
of the insurance cover extends to 31 March of the next accounting period. Only three fourth of this
cost relates to 9 months of the current accounting period, that is, Rs. 37,500 will be treated as an
expense of the current accounting period.

GOODS
The term 'Goods' refers to the property in which the business deals. Goods are purchased by a
business for resale and not for use in the business. For example, furniture acquired for resale by a
furniture dealer will be treated as goods and furniture acquired by such a dealer for use in his/her
office will be treated as an asset.
 Ledger and Trial Balance 11

DEBTORS (ACCOUNTS RECEIVABLE) Debtor refers to a person who owes money to the
business for goods pur chased from the business.
CREDITORS (ACCOUNTS PAYABLE) Creditor refers to the person to whom the business
owes money for goods purchased by the business from that person.

Debits and Credits

The accounting system keeps a separate record for each item of assets, lia bilities, income and
expense. This record is called an account. An account has two sides, the left-hand side and the right-
hand side. Accounting records are maintained using a double-entry accounting system. Under this
system, debit and credit entries of equal amount are made to record every business transaction.
Entering an amount on the left-hand side of the account is called debiting the account and entering
an amount on the right-hand side of an account is called crediting the account. Accounting records
are considered accurate only when the sum of all debits is equal to the sum of all credits.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

Generally accepted accounting principles (GAAP) are a set of conventions, rules and procedures
that define the accepted accounting practice at a particular time. These result from a broad
agreement on the theory and practice of accounting at a particular time. The purpose of GAAP is
to ensure that the information provided in the financial statements is reliable and understandable to
the users. The users should be able to meaningfully compare the current performance of a business
entity with its past performance and the performance of other business entities. The GAAP keep
changing from time to time as the circumstances or the information needs of the users change.
In India, the sources of GAAP include the Companies Act, 2013, Indian accounting standards and
the pronouncements of the accounting profession.
GAAP is again divided into four:
1. Accounting concepts
2. Accounting convention
3. Accounting standards
4. IFRS

Accounting concepts
Accounting concepts may be considered as postulates i.e., basic assumptions or conditions upon
which the science of accounting is based. Any abstract idea serving a systematised function is
regarded as concepts. There is no authoritative list of these concepts but most of the concepts have
fairly general support.
12 Accounting for Beginners: Financial Accounting I

(i) Business Entity Concept

This concept implies that a business unit is separate and distinct from the persons who supply capital
to it. Irrespective of the form of organisation, a business unit has got its own individuality as
distinguished from the persons who own or control it. The accounting equation (i.e., Assets =
Liabilities + Capital) is an expression of the entity concept because it shows that the business itself
owns the assets and in turn owes the various claimants. Business is kept separate from the proprietor
so that transactions of the business may also be recorded with him. In case this concept is not
followed, affairs of the business will be mixed up with the private affairs of the proprietor and the
true picture of the business will not be available. Thus, in the books of a sole trader, a firm or a
limited company, only business transactions are recorded and no note is taken of the personal
transactions of the sole proprietor, the partners of the firm and the shareholders of the company.
But their transactions with the business, (e.g., capital provided to the business, goods and amount
withdrawn from the business for the personal use of the sole trader and the partners of the firm,
income tax or life insurance premium paid from the business on the taxable income or life of the
proprietor etc.) are recorded separately so that true financial position and profitability of the
business may be disclosed. For example, if the proprietor of the business invests 25,000 into the
business, it will be deemed that he has given that much of money to the business as a loan which
will be shown as a liability in the books of the firm. On receipt of the amount, Cash Account will
be debited and the Proprietor's Capital Account will be credited. Similarly, on withdrawal of the
amount from the business for personal use of the proprietor, the Proprietor's Capital or Drawings
Account will be debited and Cash Account will be credited.
It may be mentioned that the business entity concept employed in accounting for a sole
proprietorship is distinct from the legal concept of a sole proprietorship. The non-business
expenses, incomes, assets and liabilities of a sole proprietor are excluded from the business
accounts. Legally, however, a sole proprietor is personally liable for his business debts and may be
required to use non-business assets (i.e., his private assets) to make the payment to his business
creditors. Conversely, business assets are not immune from claims of the sole proprietor's personal
creditors. In the eyes of law business and of a sole non-business assets and liabilities are treated
alike in case a proprietor. Similarly, in case of a partnership firm, business assets of the firm are
used first for paying business s liabilities of the firm and if a surplus remains after paying the firm's
liabilities a partner can use his share of the surplus for the payment of his private liabilities. In the
same way, private assets of the individual partners are first utilised for the payment of their
individual private liabilities and if there is a surplus in any partner's private estate, it shall be treated
as part of partnership property and can be utilised for the payment of firm's liabilities.
In case of joint stock companies, there is a legal distinction between the owners (ie. shareholders)
and the business. Shareholders are not liable for the debts of their company beyond the amount of
capital they have agreed to subscribe. The accounting treatment of capital contributed by
shareholders is the same as it is in case of sole trader and partnership, except of course that the
capital of a joint stock company is divided into a number of shares. Thus, the effect of the business
entity concept in case of a joint stock company is to recognise its separate identity from that of its
shareholders.
 Ledger and Trial Balance 13

(ii) Money Measurement Concept

Money is the only practical unit of measurement that can be employed to achieve. Homogeneity of
financial data, so accounting records only those transactions which can be expressed in terms of
money though quantitative records are also kept. The advantage of expressing business transactions
in terms of money is that money serves a common denominator by means of which heterogeneous
facts about a business can be expressed in terms of numbers (i.e. money) which are capable of
additions and subtractions. It can better, be illustrated by taking the following example.
A business unit has the following assets on March 31, 2011. Cash in hand and at bank 25,000
Sundry Debtors 748,500; Bills Receivable 6,500 Motor Cars 5, Stock 5,000 tons, Furniture 100
chairs and 20 tables; Machines 6: Building space 5,000 sq. meters and Land 10 acres.
The items given in different units of measurement cannot be added together to get an idea of the
total value of the assets owned by the business; to get an idea of the total value of the assets, all
items should be expressed in terms of money as given below:
Cash in hand and at bank 25,000 Sundry Debtors 48,500; Bills Receivable 6,500 Motor Cars &
1,15,000 Stock 4,00,000; Furniture 5,000; Machines 2,50,000; Building 4,40,000; and Land
1,00,000 - Total 13,90,000. The money measurement concept restricts the scope of accounting as
it does not record the fact that there is a strike in the factory or the sales manager is not on speaking
terms with the production manager. Accounting, therefore, does not give a complete account of the
happenings in a business unit. Money provides a common denominator for measuring but it does
not take care of inflation which takes place with the passage of time. Money is expressed in terms
of rupee value at the time a financial transaction is recorded in the books. Subsequent changes in
the purchasing power of money due to inflation do not affect this amount. In the example given
above cash in hand and at bank is expressed at the value of 31st March, 2011, but the amounts of
cars, furniture, machines, land and building are in terms of rupee of five years back when they were
acquired. The value of rupee of five years back was much more than value on 31st March, 2011
because the purchasing power of the rupee has decreased due to inflation. Thus, money
measurement concept of accounting has two major limitations
(i) It restricts the scope of accounting because it is not capable of recording transactions which
cannot be expressed in terms of money
(ii) It does not take care of the effects of inflation because it assumes a stability of money
measurement unit.
Generally, business entity concept and money measurement concept are called fundamental
accounting concepts as they go to the very roots of financial accounting. The alternative of either
of these two concepts would change the entire nature of financial accounting. The concepts given
below can be taken as procedural concepts.

(iii) Going Concern (or Continue of Activity) Concept

14 Accounting for Beginners: Financial Accounting I

It is assumed that a business unit has a reasonable expectation of continuing business at a profit for
an indefinite period of time. A business unit is deemed to be a going concern and not a gone concern.
It will continue to operate in the future. Transactions are recorded in the books keeping in view the
going concern aspect of the business unit. It is because of this concept that suppliers supply goods
and services and other business firm enter into business transactions with the business unit.
Suppliers will not supply goods and services and other persons will not have business dealings with
the business entity if they have the feeling that the concern will be liquidated. This assumption
provides much of the justification for recording fixed assets at original cost (EV, acquisition cost)
and depreciating them in a systematic manner without reference to their current realisable value. It
is useless to show fixed assets in the Balance Sheet at their estimated realisable values if there is no
immediate intention of selling them. Fixed assets are acquired for use in the business for earning
revenues and are not meant for resale, so they are shown at their book values and not at their current
realisable values. But when the concern is not a going concern and is to be liquidated, current
realisable values of fixed assets become relevant. Similarly, the going concern concept supports the
treatment of prepaid expenses as assets even though they may be virtually unsaleable. Prepaid
expenses are made assets, on the assumption that the business entity will continue in future and the
benefit of prepaid expenses will be utilised in future. A less direct effect of the going concern
concept is that it lays emphasis on the determination of net income rather than on the valuation of
assets. The earning capacity of the business entity is more significant than the market value of its
individual assets in judging the overall worth of a business. Because of this emphasis on the
earnings, the accountant directs his attention to the proper allocation of incomes and expenses to
the current period and does not bother about the market value of fixed assets which will not be sold.

(iv) Cost Concept

A concept of accounting, closely related to the going concern concept, is that an asset is recorded
in the books at the price paid to acquire it and that this cost is the basis for all subsequent accounting
for the asset. This concept does not mean that the asset will always be shown at cost but it means
that cost becomes basis for all future accounting for the asset. Asset is recorded at cost at the time
of its purchase but is systematically reduced in its value by charging depreciation. The market value
of an asset may change with the passage of time, but for accounting purpose it continues to be
shown in the books at its book value, i.e., the cost at which it was purchased minus depreciation
provided up to date.
The cost concept has the advantage of bringing objectivity in the accounts. Information given in
the financial statements is not influenced by the personal bias or judgment of those who furnish
such statements. In the absence of cost concept, assets will be shown at their market values which
will depend on the subjective views of persons who furnish financial statements. However, on
account of high degree of inflation in the economy in the recent past, the preparation of financial
statements on the basis of cost concept has become irrelevant for judging the financial position and
ascertaining the profitability of the business entity. To overcome the drawbacks of cost concept,
inflation accounting is advocated which makes a provision for recording all items regularly in the
financial statements at their current values. But keeping in view the practical difficulties and
 Ledger and Trial Balance 15

absence of legal provisions for inflation accounting historical cost accounting based on cost concept
still serves as a fair and adequate basis for reporting business performance.
According to this concept, it is possible to remove the cost of fixed assets from the accounts
altogether by writing off their cost as depreciation against income even though assets are still in
good condition and are being used in the business. As a result of this drawback secret reserves are
created and the auditor may overlook the verification of assets showing zero book value because
their accounts will no longer appear in the books.
The cost concept raises another problem. There are some assets which earn income for a concern
but are not shown in the books of account on account of this concept because no cost has been
incurred to acquire such assets. According to Glautier "often the major asset of a highly successful
firm is the knowledge and the skill created as a result of team work and good organisation. This
asset will not appear in the accounts, since the firm has paid nothing for it, except in terms of
salaries which have been written off against yearly profits. Allied to this problem is the failure in
making any mention in the balance sheet of the value of the human assets of the firm. Other
important assets of which no mention is made in financial accounting statements are, for example,
the value to the firm of its hold on the market, which may be a very valuable asset if the firm enjoys
a monopoly position, and the value of the firm's own information system, which will affect the
quality of its decisions."

(v) Dual Aspect (or Accounting Equivalence) Concept

This is the basic concept of accounting. According to this concept, every financial transaction
involves a two-fold aspect, (a) yielding of a benefit and (b) the giving of that benefit. For example,
if a business has acquired an asset, it must have given up some other asset such as cash or the
obligation to pay for it in future. Thus a giver necessarily implies a receiver and a receiver
necessarily implies a giver. There must be a double entry to have a complete record of each business
transaction, an entry being made in the receiving account and an entry of the same amount in the
giving account. The receiving account is termed as debtor and the giving account is called creditor.
Thus every debit must have a corresponding credit and vice versa and upon this dual aspect has
been raised the whole superstructure of Double Entry System of Accounting. The Accounting
Equation, lie, Assets Equities (or Liabilities+ Capital)] is based on dual aspect concept. The term
'Assets' denotes the resources owned by the business while the term 'Equities' denotes the claims of
various claimants including the proprietors of the business against the assets. For example, if the
business purchases machinery and furniture worth 25,000 and 5,000 respectively out of 7 40,000
provided by A (the proprietor) to the business, the situation will be as follows:
Assets = Equities
Machinery 25,000+ Furniture 5,000+ Cash 10,000 = Capital 40,000 Subsequently, if the business
purchases stock worth 8,000 on credit, the positing will be as follows: Machinery25,000+ Furniture
5,000 Cash 10,000+ Stock 8,000 = Creditors 78,000+ Capital 40,000
Thus, accounting equation demonstrates the fact that for every debit there is at équivalent crédit.
16 Accounting for Beginners: Financial Accounting I

(vi) Accounting Period Concept

Truly speaking, the measurement of income or loss of a business entity is relatively simple on a
whole-life basis. A complete and accurate picture of the degree of success achieved by a business
unit cannot be obtained until it is liquidated i.e., converts its assets into cash and pays off its debts.
On liquidation, it is possible to determine with finality its net income. But the owners, the investors
and overall the Government, all art impatient and do not want, until the dissolution of the concern,
to know what has been the results of the business activities. All these persons are interested in
regular reports and accounts at proper intervals to know "how things are going?" This means that
the final accounts must be prepared on a periodic basis rather than waiting till the business is
terminated.
Under the going concern concept it is assumed that a business entity has a reasonable expectation
of continuing business for an indefinite period of time. This assumption provides much of the
justification that the business will not be terminated, so it is reasonable to divide the life of the
business into accounting periods so as to be able to know the profit or loss of each such period and
the financial position at the end of such a period. Normally accounting period adopted is one year
as it helps to take any corrective action, to pay income-tax, to absorb the seasonal fluctuations and
for reporting to the outsiders. A period of more than one year reduces the utility of accounting data,
The principle of segregating capital expenditure from revenue expenditure is based on the
accounting period concept. The revenue expenditure for a particular period is transferred to the
Profit and Loss Account of that period whereas capital expenditure in carried forward to the extent
its benefit will be utilised in future accounting periods.
Thus, the accounting period concept plays a very important role in determining the income of a
particular accounting period. It is also helpful in ascertaining the true and fair financial position of
a business entity on a particular date at a particular point of time.

(vii) Matching Concept

This concept is based on the accounting period concept. The most important objective of running a
business is to ascertain profit periodically. The determination of profit of a particular accounting
period is essentially a process of matching the revenue recognised during the period and the costs
to be allocated to the period to obtain the revenue. It is, thus, a problem of matching revenues and
expired costs, the residual amount being the net profit or net loss for the period. Revenue is
considered to be earned on the date at which it is realised, i.e., on the date when the goods are
delivered or services rendered to the customer even though payment may be received at some future
date. Revenue may also be considered to be earned at the time the cash is collected, regardless of
this fact when the sale is made or service is rendered as is the practice with physicians, attorney and
other enterprises in which professional services are source of revenue. It has little theoretical
justification but has the practical advantages of simplicity of operation and avoidance of the
problem of estimating losses on account of bad debts. It is also advantageous from income tax point
of view because income tax paid only on cash income.
 Ledger and Trial Balance 17

Like revenue, all costs incurred during the period are not taken, but only costs related to the
accounting period are taken. The purchase price of fixed assets is not taken but only depreciation
on fixed assets related to the accounting period is taken. Expenses paid in advance are excluded
from the total costs and expenses outstanding are added to the total costs to arrive at the costs
attached to the period. Let us take an example to make the matching concept clear.
A businessman purchases 100 table fans at at cost of 30,000. He paid 1,000 as freight and insurance,
200 and octroi and carriage and rent outstanding was 2,000. He sells all table fans at a price of
40,000 against which should be matched cost of table fans 30,000, freight and insurance 1,000,
octroi and carriage 7 200 and outstanding rent 2,000. The net profit of the period would be 76,800,
(i.e., 40,000 -33,200), though some of the above expenses incurred are not paid for and sale price
of some of table fans may not have been realised as yet on account of being sold on credit.
It may be remembered that profit and cash are not synonymous because their nature is different.
For example, if a business has made a profit of 1,00,000, it does not mean that it has the same
amount of cash or cash is increased by the same amount. It is because there are outstanding expenses
and creditors and outstanding debtors. The profit earned will increase the capital of the business on
the liabilities side and a corresponding increase in the assets of the business will be made. Similarly,
an increase in cash does not mean increase in profit. Cash may have increased because of issue of
shares or sale of a fixed asset. Thus, income is tied to increase in owner's equity and has no direct
link to changes in cash.
Application of matching concept in practice, however, is beset with certain difficulties. There are
some expenses like preliminary expenses, share issue expenses, advertisement expenses etc., which
are not readily identifiable against the revenue of a particular period. Similarly, how much of the
capital expenditure should be written off by way of depreciation during the particular period poses
the question of finding out the expected life of the asset. Likewise, in case of long term contracts
when amount is not received in proportion to the work executed, the expenditure to be carried
forward not related to the income received may present some difficulties. In spite of these practical
difficulties, the matching concept stands on firm footing and should be followed while preparing
financial statements to have a true and fair view of the profitability and financial position of a
business entity.

(viii) Realisation Concept

According to this concept, revenue is considered as being earned on the date at which it is realised,
i.e., on the date when the property in goods passes to the buyer and he becomes legally liable to
pay. This can be made clear by taking the following example :
A customer at Ranchi places an order with a manufacturer at Delhi on 1st January. On receipt of
order, the manufacturer manufactures goods and delivers them to the customer at Ranchi on 1st
February who makes payment of goods on March 1 after enjoying the credit period of one month.
In this case, revenue was realised neither on January 1, when order was received nor on March 1,
when cash was realised but on February 1, when goods were delivered to the customer.
18 Accounting for Beginners: Financial Accounting I

However, in case of hire-purchase sales, the ownership of goods sold on hire-purchase does not
pass to the purchaser when the goods are delivered but it passes when the last installment is paid.
But sales are presumed to have been made to the extent of down payment, installments received
and installments due, but not received.
The realisation concept is criticised by economists on the ground that if an asset has increased in
value then it is irrelevant because it has not yet been sold. In other words, unrealised gains are not
considered in accounting. As a result of this concept, distinction is made between holding gains and
operating gains. Holding gains arise as a result of increases in value from holding an asset and
operating gains are realised as a result of selling assets. Holding gains are not recorded because
property in goods has not yet transferred but operating gains are reported because they have resulted
as a result of sale.

(ix) Objective Evidence Concept

Objectivity connotes reliability, trustworthiness and verifiability, which means that there is some
evidence in ascertaining the correctness of the information reported. Entries in accounting records
and data reported in financial statements must be based on objectively determined evidence.
Without close adherence to this principle, the confidence of many users of the financial statements
could not be maintained. Invoices and vouchers for purchases and sales, bank statements for amount
of cash at bank, physical checking of stock in hand etc., are examples of objective evidence which
are capable of verification. As far as possible, every entry in accounting records should be supported
by some objective evidence. Evidence should be such which will minimise the possibility of error
and intentional bias or fraud. Evidence is not always conclusively objective for there are numerous
occasions in accounting where judgments and other subjective factors play part. In such situations,
it should be seen that most objective evidence available should be used. For example, the Provision
for Doubtful Debts Account is an estimate of the losses expected from failure to collect sales made
on credit. Estimation of this account should be made on such objective factors as past experience
in collecting debtors and reliable forecasts of future business activities.

(x) Accrual Concept

The essence of the accrual concept is that revenue is recognised when it is realised that is when sale
is complete or services are given and it is immaterial whether cash received or not. Similarly,
according to this concept, expenses are recognised in the accounting period in which they help in
earning the revenue whether cash is paid or no Thus, to ascertain correct profit or loss for an
accounting period and to show the true an fair financial position of the business at the end of the
accounting period, we make record of all expenses and incomes relating to the accounting period
whether actual cash h been paid or received or not. Therefore, as a result of the accrual concept,
outstanding expenses and outstanding incomes are taken into consideration while preparing fin
accounts of a business entity.
 Ledger and Trial Balance 19

Accounting Conventions
The term 'conventions' denote circumstances or traditions which guide the accountants while
preparing the accounting statements. It refers to a statement or rule of practice which, by common
consent, express or implied, is employed in the solution of a given class of problem or guide
behaviour in a certain kind of situation. Thus debit on the left-hand side and credit on the right-
hand side of an account is an example of convention.
Concepts and conventions are often used inter changeably. The basic difference between them is
that concepts are concerned with maintenance of accounts whereas conventions are applicable
while preparing financial statements (i.e. Profit & Loss Account and Balance Sheet).
Accounting concepts and conventions are significant to the development of accounting theory in
two ways. First, they are themselves part of an empirical process for developing principles of
accounting. In this respect, they may be taken as belonging to the corpus of accounting theory.
Second, they reflect the influence of the social, economic, historical and legal forces which shape
the philosophy of accounting in a given environment. Their origin lies in a historical process of
development of viable theories of accounting.

(i) Convention of Consistency

Accounting rules, practices and conventions should be continuously observed and applied i.e., these
should not change from one year to another. The results of different years will be comparable only
when accounting rules are continuously adhered to from year to year. For example, the principle of
"valuing stock at cost or market price whichever is lower" should be followed year after year to get
comparable results. Similarly, if depreciation on fixed assets is provided on straight line method, it
should be done year after year. Consistency serves to eliminate personal bias because the accountant
will have to follow consistent rules, practices and conventions year after year. The rationale behind
this concept is that frequent changes in accounting treatment, would make the financial statements
unreliable to the persons who use them.
Consistency also implies external consistency, i.e., the financial statements of one enterprise should
be comparable with another. It means that every enterprise should follow same accounting methods,
and procedures of recording and reporting business transactions. The development of international
and national accounting standards is due to the convention of consistency.

(ii) Convention of Full Disclosure

According to this convention, all accounting statements should be honestly prepared and to that end
full disclosure of all significant information should be made. All information which is of material
interest to proprietors, creditors and investors should be disclosed in accounting statements. An
obligation is placed on the accounting profession to see that the books of accounts prepared on
behalf of others are as reliable and informative as circumstances permit. The convention is
becoming popular these days because most of big business units are in the form of joint stock
20 Accounting for Beginners: Financial Accounting I

companies where ownership is divorced from management. The Companies Act, 1956 has
prescribed the forms in which financial statements are to be prepared. The Act makes ample
provisions for the disclosure of essential information that there is no chance of any material
information being left out. For example, the basis of valuation of fixed assets, investments and stock
should be clearly stated in the Balance Sheet because it is of material interest to the proprietors,
creditors and prospective investors.

(iii) Convention of Conservatism (or Prudence)

Literally speaking, conservatism means taking the gloomy view of a situation. It is a policy of
caution or playing safe and had its origin as a safeguard against possible losses in a world of
uncertainty. It compels the businessman to wear a "risk-proof" jacket, for the working rule is:
anticipate no-profits, but provide for all possible losses." For example, closing stock is valued at
cost or market price whichever is lower. If market price is higher than the cost, the higher amount
is ignored in the accounts and closing stock will be valued at cost which is lower than the market
price. But if the market price is lower than the cost, the higher amount of cost will be ignored and
stock will be valued at market price which is lower than the cost. Thus, the principle of conservatism
is inherent in the valuation of stock.

(iv) Convention of Materiality

Whether something should be disclosed or not in the financial statements will depend on whether
it is material or not. Materiality depends on the amount involved in the transaction. For example,
minor expenditure of 20 for the purchase of a waste basket may be treated as an expense of the
period rather than an asset.
Custom also influences materiality. For example, only round figures (to the nearest rupee) may be
shown in the financial statements to make the figures manageable without affecting the accuracy
of the accounting data. Similarly, for income tax purposes the income has to be rounded to nearest
ten rupees.
The term "materiality" is a subjective term. The accountant should record an item as material even
though it is of small amount and its knowledge seems to influence the decision of the proprietors
or auditors or investors.

Accounting Standards
Accounting standards are pronouncements made by accounting bodies specifying the accounting
requirements for recognition, measurement, presentation and disclosure of different transactions
and events. Entities prepare their financial statements based on accounting standards. Financial
statements based on accounting standards are expected to make a fair presentation of an entity's
financial performance, financial position and cash flows to different users of financial statements.
Accounting standards also bring about uniformity in financial reporting and make financial
statements of different entities comparable.
 Ledger and Trial Balance 21

Accounting standards are pronouncements made by accounting bodies spec ifying the accounting
requirements for different transactions and events. Accounting bodies in different countries are
responsible for developing and implementing Accounting Standards in their respective countries.

Procedure for issuing accounting standards

In India, accounting standards are formulated by the Council of the Institute of Chartered
Accountants of India (ICAI) through its ASB. Thereafter, these accounting standards are considered
by the National Financial Reporting Authority (NFRA). The Central Government may prescribe
the Standards of Accounting or any addendum thereto, as recommended by the ICAI, in
consultation with and after examination of the recommendations made by the NFRA.

List of accounting standards in India

Currently, the following accounting standards, also commonly known as the Indian GAAP
(generally accepted accounting standards), have been notified:
1. AS 1: Disclosure of Accounting Policies
2. AS 2: Valuation of Inventories (Revised)
3. AS 3: Cash Flow Statement
4. AS 4: Contingencies and Events Occurring after the Balance Sheet date (Revised)
5. AS 5: Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies
6. AS 7: Construction Contracts:
7. AS 9: Revenue Recognition
8. AS 10: Property, Plant and Equipment (Revised)
9. AS 11: The Effects of Changes in Foreign Exchange Rates
10. AS 12: Accounting for Government Grants (Revised)
11. AS 13: Accounting for Investments
12. AS 14: Accounting for Amalgamations (Revised)
13. AS 15: Employee Benefits (revised 2005)
14. AS 16: Borrowing Costs
15. AS 17: Segment Reporting
16. AS 18: Related Party Disclosures
17. AS 19: Leases
18. AS 20: Earnings Per Share
22 Accounting for Beginners: Financial Accounting I

19. AS 21: Consolidated Financial Statements (Revised)

20. AS 22: Accounting for Taxes on Income
21. AS 23: Accounting for Investments in Associates in Consolidated Financial Statements
22. AS 24: Discontinuing Operations
23. AS 25: Interim Financial Reporting
24. AS 26: Intangible Assets
25. AS 27: Financial Reporting of Interests in Joint Ventures
26. AS 28: Impairment of Assets
27. AS 29: Provisions, Contingent Liabilities and Contingent Assets (Revised)

INTERNATIONAL FINANCIAL REPORTING STANDARDS

As the business world becomes closer in its financial and trade ties, many countries are moving
towards International Financial Reporting Standards IFRS). IFRS are common accounting rules for
financial reporting. IFRS comprise the following:
1. Two series of standards - those explicitly called International Financial Reporting
Standards and the older series of International Accounting Standards (IAS) and
2. Two series of interpretations - those issued by the former Standing Interpretations
Committee (SIC) and those issued by the existing International Financial Reporting
Interpretations Committee (IFRIC) of the International Accounting Standards Board.

ADVANTAGES OF ADOPTING IFRS

Adoption of IFRS has many advantages. Investors can compare financial statements of companies
located in different countries and decide where to invest money. It becomes easier for companies
to raise money outside their home country and for countries to attract foreign investment. As IFRS
are principle-based rather than rule-based, these can be adapted to specific business conditions in a
country.

Accounting Equation
The accounting equation is considered to be the foundation of the double-entry accounting system.
Based on this double-entry system, the accounting equation ensures that each entry made on the
debit side should have a corresponding entry (or coverage) on the credit side. Every business
transaction will result in the change in either of assets, liabilities or capital of the firm. It can be
expresses as:
Assets = Liability + Capital
 Ledger and Trial Balance 23

Illustration 1: Complete the gaps in following tables:

.
Sl. No Assets Capital + Liability
=
1 25000 = 3600 + ?

2 56000 = 9800 + ?

3 33600 = ? + 25000
4 39200 = ? + 32900

5 ? = 12600 + 38400

6 ? = 23300 + 79500

Solution: With the help of acconting equation: Assets = Capital + Liability

Sl. No Assets = Capital + Liability

1 25000 = 3600 + 21400

2 56000 = 9800 + 46200
3 33600 = 8600 + 25000
4 39200 = 6300 + 32900

5 51000 = 12600 + 38400

6 102800 = 23300 + 79500

Illustration 2: Show the effects of transaction on accounting equation

1. Jinesh commenced business with cash 6. Paid rent ₹3000
₹250000
7. Received interest ₹1000
2. Purchased goods for cash₹25000
8. Sold goods(costing ₹1500) on credit
3. Purchased furniture ₹1500 ₹1700
4. Purchased goods on credit ₹24000 9. Paid to creditors ₹4000
5. Withdrew for private use ₹ 1000 10. Paid salaries ₹2000
24 Accounting for Beginners: Financial Accounting I

Sl.
Particulars Assets = Capital + Liability
No

1 Started business with cash 250000 = 250000 + 0

New Equation 250000 = 250000

Purchased goods for cash +25000 = 0 + 0

2
-25000

New Equation 250000 = 250000

+1500 = 0 + 0
3 Purchased furniture
-1500

New Equation 250000 = 250000

4 Purchased goods on credit 24000 = 0 + 24000

New Equation 274000 = 274000

5 Withdrew for private use -1000 = -1000 + 0

New Equation 273000 = 273000

6 Paid rent -3000 = -3000 + 0

New Equation 270000 = 270000

7 Receives interest +1000 = +1000 + 0

New Equation 271000 = 271000

Sold goods costing 1500 -1500 = +200 + 0

8
+1700 (Profit)

New Equation 271200 = 271200

9 Paid to creditors -4000 = + -4000

 New Equation 267200 = 267200

10 Paid salary -2000 = -2000 + 0

New Equation 265200 = 265200

Illustration 3:
Show the effects of transaction on accounting equation:
1. Started business with 15000 6. Received 3600 as salary
2. Purchased securitiers for cash 7500 7. Paid cash 500 for loan and 300 for interest
3. Purchased a building for 15000 giving 8. Paid cash for household expense 300
5000 in cash and the balance through a loan
9. Received cash for dividend on securities
4. sold securities costing 1000 for 1500 200
5. Purchased an old car for 2800

Sl.
Particulars Assets = Capital + Liability
No

1 Started business with cash 15000 = 15000 + 0

New Equation 15000 = 15000

Purchased securities +7500 = 0 + 0

2
-7500

New Equation 15000 = 15000

+15000 = 0 + 10000
3 Purchased furniture
-5000

New Equation 25000 = 25000

sold securities +1500 = +500 + 24000

4
-1000
26 Accounting for Beginners: Financial Accounting I

New Equation 25500 = 25500

purchased old car +2800 = -1000 + 0

5
-2800

New Equation 25500 = 25500

6 received salary +3600 = +3600 + 0

New Equation 29100 = 29100

Paid loan and interest -500 = -300 + -500

7
-300

New Equation 28300 = 28300

8 Paid for household expense -300 = -300 + 0

New Equation 28000 = 28000

9 received dividend +200 = +200 + 0

New Equation 28200 = 28200

DID YOU KNOW?

The words ‘debits’ and ‘credits’ come from the Latin words ‘debitum’ and ‘creditum’

System of Book-keeping:
- Single Entry System: A single entry system of accounting is a form of bookkeeping in
which each of a company’s financial transactions are recorded as a single entry in a log.
This process does not require formal training and is usually used by new small businesses
because of its simplicity and cost effectiveness.
 Ledger and Trial Balance 27

Features:
i. No strict rules are followed
ii. It is incomplete, unscientific and unsatisfactory
iii. It is also called accounts from incomplete records
iv. Usually sole traders and rarely partners adopt this system. However, in case of companies
they must follow double entry system.

Merits:
i. It is very simple
ii. Compared to double entry this system is cost effective
iii. This is best suited for small organizations who cannot afford to adopt the double entry
system.

Demerits:
i. It is unscientific, incomplete and unsatisfactory
ii. Arithmetical accuracy cannot be known, trial balance cannot be prepared
iii. High scope for misappropriation and fraud
iv. Preparation of final accounts is impossibl

Double Entry System

Double-entry bookkeeping is an accounting method where you equally record a transaction in two
or more accounts. A credit is made in at least one account, and a debit is made in at least one other
account. This method is based on the idea that every business transaction has equal and opposite
effects on at least two accounts

Features:
i. All the aspects of a transaction will be recorded in detail
ii. Entries are made in two different accounts on the opposite sides
iii. Entries will be made for the same amount and at the same time.

Merits:
i. Since the system is scientific and systematic, reliable information of the business can be
obtained.
28 Accounting for Beginners: Financial Accounting I

ii. Errors and fraud can be checked.

iii. Final accounts can be prepared. Results of the business and the financial position can be
easily known.
iv. Comparing any two accounts becomes easier, for e.g. sales account, purchases account.
v. Government authorities recognize double entry system only.

Demerits:
i. All types of errors will not be disclosed, only the arithmetical accuracy can be checked.
ii. This is not cost effective.
iii. If the businessman does not have knowledge of accounts, then double entry becomes
complicated.

Classification of accounts
Accounts are classified into following types, wherein debit amount = credit amount

Classification of accounts Rules

Debit the Receiver
Personal Accounts
Credit the Giver

Debit What Comes In

Real Accounts
Credit What Goes Out

Debit all Expenses and losses

Nominal Accounts
Credit all Incomes and gains

Personal account: Personal accounts are the accounts of the persons with whom the business has
transactions. They are further classified as accounts of natural persons, accounts of artificial legal
persons and representative personal accounts. Raghu’s account comes under natural person, Canara
Bank account is artificial legal person and Salary payable is representative personal account. Any
business transaction will always result in receiving some benefit and giving some benefit. As such
the account of the person who receives the benefit of the transaction from the benefit should be
debited and the account of the person who gives the benefit should be credited.
E.g. Ram gave Rs 500 to Kumar, in this case Kumar receives the benefit hence his account should
be debited, Ram gives the benefit and his account should be credited.
Real Account: Real accounts refer to the accounts of properties, assets or things owned by business.
Tangible asset is one which has a physical existence. E.g. cash a/c, furniture a/c. Intangible asset is
any asset which doesn’t have a physical existence. E.g. goodwill a/c, patent rights a/c. Any asset
 Ledger and Trial Balance 29

that comes in should be debited and asset going out should be credited. E.g. Purchase of furniture
on cash, furniture is debited, and cash is credited.
Nominal Account: It is called fictitious account, which shows the different expenses and losses
what a firm incurs and the different incomes and gains what a firm earns. E.g. of revenue account
commission received a/c. The account of expense or loss is debited, and income and gain are
credited.
E.g. i) Paid office rent Rs 5000, in this case rent is an expense hence debited. ii) Received
Commission Rs 300, in this case commission received is credited.
How to identify if a given transaction is cash transaction or credit transaction

Party`s name

Mentioned Not mentioned

Question Specified Cash/credit* Cash/credit*

Not specified Credit Cash

*as mentioned in question

JOURNAL
Journal is derived from the word ‘jour’ which means day. Journal is a book that is maintained daily
in chronological order for recording all the financial entries of the day.
Journal entries are passed according to rules of debit and credit of double entry system.
Journal is the primary book of accounting. Recording in a journal is called journalizing and unit of
transaction in a journal is journal entry. Each journal entry is followed by narration.
Narration is brief explanation followed by a journal entry which usually starts with the word being.
Page total is carried forward and brought forward in journal

Important points to remember while passing journal entries

 Follow the separate entity concept and transactions are recorded only for the business unit
 If the proprietor starts the business by taking loan, then the accounts involved will be cash
account and loan account and NOT CAPITAL account.
30 Accounting for Beginners: Financial Accounting I

 In case of purchases and sales if party’s name is not given and the nature of the transaction
is not clear, consider it as cash transaction. If the party’s name is available and the nature of
transaction is not clear, then it is to be considered as credit transaction
 If the amount cannot be recovered from the debtors it is called bad debts, it will be recorded
in the books of accounts.
 When the investments are made, it is the actual price paid what is to be considered and not
the face value. E.g. if investments worth Rs 100 is purchased for Rs 80 then Rs 80 is to be
recorded.
 When expenditure is incurred on the purchase of an asset, then the installation expenses
should be added to the cost of the asset. E.g. brokerage paid on purchase of a car is added
to the cost of the vehicle. Two accounts involved will be car account and cash account and
not brokerage account.
 Cash discount is allowed by the business to the debtors for the prompt payment of cash, this
will be recorded in the books of accounts. Trade discount is allowed by the manufacturer to
the wholesaler or wholesaler to the retailer on the catalogue price and should not be recorded
in the books of accounts.
 If bad debts written off are recovered, then the two accounts involved will be cash account
and bad debts recovered account
 Journal entry with one debit and one credit is simple journal entry. If the entry has more
than one debit or credit, then it is called compound journal entry.
 Trade discount is not recorded in the books of accounts, but cash discount is always
recorded in the books of accounts.

Importance of Journal
 Journal provides chronological record (date wise) of all the transactions of the business unit
and it helps in easy reference
 Debit and credit of a transaction is recorded, and all the details will be immediately available
 Narration explains the purpose of the entry
 It helps in checking arithmetical accuracy and prevents in checking error and frauds.
 Journal stands as evidence in the court of law.

Limitations
 Since too many transactions are recorded it becomes bulky
 Writing the journal is a tedious job
 Merely by looking into journal it is not possible to find out the status of an account.
 Ledger and Trial Balance 31

 It is not a book of final entry. It is subsidiary to the ledger.

Let’s learn How to Journalise?

Vinod’s 3 Filter & 3 Step Approach
Filter 1 - Check whether the transaction is Business / Non- Business - Approve only Business
transactions
Filter 2 - Check whether the transaction is Monetary / Non - Monetary - Approve only Monetary
transactions
Filter 3- Credit Transaction (one out of two accounts will be personal)
Step 1 - Identify two aspects (Benefit aspect & Sacrifice aspect) in the transaction
Step 2 - Convert the two aspects into respective accounts and identify which type of a/c they fall
under (refer golden rule of accounting)
Step 3 - Match the accounts into Dr side and Cr side (refer golden rule of accounting)
Example : Purchased goods for credit from Shankar Rs. 3,000
Filter 1- Business Transaction -approved
Filter 2- Monetary Transaction - approved
Filter 3- Credit Transaction (one out of two accounts will be personal)
Step 1- Aspect 1 - Purchased goods & Aspect 2 - Credit from Shankar
Step 2- Account 1 - Purchases a/c (Nominal a/c) & Account 2 - Shankar a/c (Personal a/c)
Step 3- Purchases a/c - Nominal a/c - Dr
Shankar a/c - Personal a/c – C

Debit Credit
Date Particulars LF (Amt) (Amt)

1st Cash a/c Dr To Capital a/c (Being

March Business started with Cash ) 1,50,000 1,50,000

3rd Purchases a/c Dr To Shankar a/c

March (Being Purchases made on credit) 3,000 3,000
32 Accounting for Beginners: Financial Accounting I

Format of Journal
Journal Entry in the books of Jinesh Co Ltd.

Debit Credit
Date Particulars L.F
(₹ ) (₹ )
1 2 3 4 5

xxx xxxxxxxxx A/c Dr. xx

To xxxxxxxxx A/c Xx

(Narration)

1. It represents the date of transaction

2. The debit and credit account are written in particulars along with narration
3. Ledger Folio (L.F.) represents the page number of ledger account on which we post these
entries.
4. Amount to be debited
5. Amount to be credited

Notes:
 If there are multiple transactions in a day, the total amount of all the transaction through a
single journal entry may pass with total amount.
 If debit or credit entry is same and the corresponding entry is different, we may post a
combined entry for the same. It is called ‘compound entry’ regardless of how many debit
or credit entries are contained in compound journal entry.
Journalise the following transactions in the books of Akrur for March 2021
1. Commenced business with cash 20000 6. returned goods to kapil 500
2. Opened current account with bank 7. purchsed stationery 50
12000
8. paid kapil by cheque
3. Purchased goods from Kapil 4000
9. srikanth returned goods worth 200
4. sold goods to srikanth 3000
10. cash sales 150
5. bought tables 500
 Ledger and Trial Balance 33

Journal Entry in the books of Akrur

Date Particulars L.F Debit (₹) Credit (₹)

Cash a/c Dr 20000

To Capital a/c 20000

(Being capital introduced into business)

Bank a/c Dr 12000

To cash a/c 12000

(Being purchased goods on credit)

purchase a/c Dr 4000

To Kapil a/c 4000

(Being goods sold on credit)

Srikanth a/c Dr 3000

To Sales a/c 3000

(Being commission received)

Table a/c Dr 500

To cash a/c 500

(Being goods returned to Sarkar)

Kapil a/c Dr 500

To Return a/c 500

(Being goods returned to Mr. Kapil)

Stationery a/c Dr 50
34 Accounting for Beginners: Financial Accounting I

Journal Entry in the books of Akrur

To Cash a/c 50

(Being cash received from Mr. Diwan in full settlement)

Mr Kapil a/c Dr 3500

To Bank a/c 3500

(Being cash paid to Mr. Kapil in full settlement)

Returns a/c Dr 3500

To Srikanth a/c 3500

(Being cash paid to Mr. Kapil in full settlement)

Cash a/c Dr 150

To Sales a/c 150

(Being cash paid to Mr. Kapil in full settlement)

Total 47200 47200

DID YOU KNOW?

Income tax was originally introduced as a temporary measure to finance the war
against France.

Problems on Journal
1. Journalise the following transactions in the books of Mr. MAYANK, for the month
January 2021.
1. Started business with cash Rs 2,00,000.
2. Purchased goods for Rs 40,000.
3. Sold goods for Rs 46,000.
4. Purchased machinery Rs 30,000 from Paras Gold Palace.
5. Placed an order for buying goods Rs 30,000 with Aniket, advance amount Rs.6000 paid.
6. Paid Rs 10,000 to Paras Gold Palace.
7. Insurance premium paid Rs 500
 Ledger and Trial Balance 35

Journal Entry in the books of Mr. MAYANK

Date Particulars L.F Debit (₹) Credit (₹)

1/2/21 Cash a/c Dr 200000

To Capital a/c 200000

(Being capital introduced into business)

2/1/21 Purchases a/c Dr 40000

To Cash a/c 40000

(Being purchased goods)

3/1/21 Cash a/c Dr 46000

To Sales a/c 46000

(Being goods sold for cash)

4/1/21 Machinery a/c Dr 30000

To Paras Gold Palace Ltd 30000

(Being machinery purchased on credit)

5/1/21 Aniket Advance a/c Dr 800

To Cash a/c 800

(Being advance paid to aniket)

6/1/21 Paras Gold Palace a/c Dr 10000

To Cash a/c 10000

(Being cash paid to Paras Gold Palace)

Total 326800 326800

36 Accounting for Beginners: Financial Accounting I

2. Journalise the following transactions in the books of Mr. Sunil.

1/1/21: Started business with cash, debtors and creditors respective values being 1,00,000; 60,000
and 20,000.
5/1/21: Sold goods to Murthy on credit Rs 2,000.
15/1/21: Received rent Rs 2,000 from tenant Mr. Yadav.
25/1/21: Paid Commission Rs 3,000 to our agent Mr. Sunil.
26/1/21: Received cash from Murthy to settle his account at a discount of 10%.
26/1/21: Cash drawings Rs 5,000.
30/1/21: Paid carriage inwards Rs 200

Journal Entry in the books of Mr. Aditya

Date Particulars L.F Debit (₹) Credit (₹)

1/1/21 Cash a/c Dr 100000

Debtors a/c Dr 60000

To Creditors a/c 20000

To Capital a/c 140000

(Being business started with cash, creditors & debtors)

5/1/21 Murthy a/c Dr 2000

To sales a/c 2000

(Being goods sold on credit)

15/1/21 Cash a/c Dr 2000

To rent a/c 2000

(Being rent received)

25/1/21 Commission a/c Dr 3000

To cash Ltd 3000

(Being commission paid)

 Ledger and Trial Balance 37

Journal Entry in the books of Mr. Aditya

26/1/21 Cash a/c Dr 1800

Discount a/c Dr 200

To Murthy a/c 2000

(Being murthy`s account settled at 10% discount)

30/1/21 Carriage Inwards a/c Dr 200

To Cash a/c 200

(Being carriage inwards paid)

Total 169200 169200

3. Journalise the following transactions for the month of March 2021

1st: Deposited into bank Rs 1,00,000
2nd: Received cheque from Heena Rs 20,000
5th: Deposited Heena’s cheque into bank for collection
9th: Heena`s cheque is dishonoured
21st: Printing & Stationery expenses paid by cheque Rs 10,000
29th: Bank charges Rs 500.
Journal Entry in the books of ___________________

Date Particulars L.F Debit (₹) Credit (₹)

1/3/21 Bank a/c Dr 100000

To Cash a/c 100000

(Being cash deposited in bank)

2/3/21 Cash a/c Dr 20000

To heena a/c 20000

38 Accounting for Beginners: Financial Accounting I

(Being cheque received from heena)

5/3/21 Bank a/c Dr 20000

To cash a/c 20000

(Being Heena`s cheque deposited in bank)

9/3/21 Heena a/c Dr 20000

To Bank Ltd 20000

(Being heena`s cheque is dishonoured)

21/3/21 Printing and stationery a/c Dr 10000

To Bank a/c 10000

(Being printing and stationery expense paid through

cheque)

29/3/21 Bank charges a/c Dr 500

To bank a/c 500

(Being bank charges paid)

Total 170500 170500

4. Journalise the following transactions for the month of March 2021

1. Issued a cheque to Y Rs 15,000
2. Our cheque to Y is dishonoured
3. Bank interest Rs 1,500 received on deposits
4. Vijay, one of our customers deposited directly into our bank account Rs 19900 to close his
balance outstanding at Rs 20,000
5. Salary is Rs 10,000, of which Rs 8,000 is paid, rest is payable.
6. Commission received is Rs 2,000 which is 20% of commission earned, rest being payable
 Ledger and Trial Balance 39

Journal Entry in the books of ___________________-1

Date Particulars L.F Debit (₹) Credit (₹)

1/3/21 Y a/c Dr 15000

To bank a/c 15000

(Being cheque issued to Y)

2/3/21 Bank a/c Dr 15000

To Y a/c 15000

(Being cheque received from heena)

3/3/21 Interest a/c Dr 1500

To Bank a/c 1500

(Being Interest received on deposit)

4/3/21 Bank a/c Dr 19900

Discount Ac Dr 100

To Vijay A/c 20000

(Being Vijay`s account settled with discount)

5/3/21 Salary a/c Dr 10000

To Cash a/c 8000

To Salary Payable a/c 2000

(Being salary paid with a part being payable)

29/3/21 Commission a/c Dr 10000

To Commission receivable a/c 8000

To Cash a/c 2000

40 Accounting for Beginners: Financial Accounting I

Journal Entry in the books of ___________________-1

(Being Commission receivable)

Total 71500 71500

5. Journalise the followings in the books of Dolly for the month April, 2021.
5th – Purchased goods from Anil for Rs. 1,00,000 and paid Rs. 20,000 in cash.
20th: Goods withdrawn by proprietor for personal use Rs. 5,000.
21th: Goods donated by the business for the purpose of charity Rs. 750.
24th: Goods destroyed in a theft Rs. 1,000.
25th: Took an insurance policy on goods for Rs 1,00,000 and paid premium Rs 1,000.
29th: Goods given away as free samples Rs 1,000.
30th: Purchase returns Rs 500 to Vivek.

Journal Entry in the books of Dolly

Date Particulars L.F Debit (₹) Credit (₹)

5/4/21 Purchase a/c Dr 100000

To Cash a/c 20000

To Anil a/c 80000

(Being goods purchased on cash and credit)

20/4/21 Drawings a/c Dr 5000

To purchase a/c 5000

(Being goods withdrawn for personal use)

21/4/21 Charity a/c Dr 750

To Purchase a/c 750

(Being good given as charity)

 Ledger and Trial Balance 41

Journal Entry in the books of Dolly

24/4/21 Goods destroyed a/c Dr 1000

To Purchase a/c 1000

(Being goods destroyed in fire)

25/4/21 Policy premium a/c Dr 1000

To Cash a/c 1000

(Being policy premium paid)

29/3/21 Free Samples a/c Dr 1000

To Purchase a/c 1000

(Being goods distributed as free samples)

30/3/21 Vivek a/c Dr 500

To Purchase Return a/c 500

(Being goods returned to vivek)

Total 108750 108750

6. Journalise the followings in the books of Chotu for the month, 2019.
1ST Feb- Started business with cash Rs 50,000
16th Feb- Paid rent in advance Rs 2,000
19th Feb- Sold goods on credit Rs 1,000 to Anjan
20th Feb- Cheque Rs 5,000 is received as commission
25th Feb- Anjan is at the urge of bankruptcy, it is doubtful if he could clear his debts
26th Feb- The owner was able to realize 70% of bad debt that was doubtful earlier.
29th Feb- Commission cheque is deposited into bank for collection.
42 Accounting for Beginners: Financial Accounting I

Journal Entry in the books of Chotu

Date Particulars L.F Debit (₹) Credit (₹)

1/2/20 Cash a/c Dr 50000

To Capital a/c 50000

(Being capital introduced into business)

16/2/20 Advance Rent a/c Dr 2000

To Cash a/c 2000

(Being rent paid in advance)

19/3/21 Anjan a/c Dr 1000

To Sales a/c 1000

(Being goods sold to Anjan on credit)

20/3/21 Cash a/c Dr 5000

To Commission Ltd 5000

(Being cheque received as commission)

25/3/21 Doubtful Debt a/c Dr 1000

To Anjan a/c 1000

(Being Anjan is declared doubtful debt)

29/3/21 Cash a/c Dr 700

To Doubtful Debt a/c 700

(Being 70% of Anjan`s debt recovered)

Total 59700 59700

7. Journalise the following in the books of Jinesh for the month September 2021
1. Purchased goods on credit from Mr. Ted Rs 2,000
 Ledger and Trial Balance 43

2. Goods returned by Bahadur Rs 500

3. Cheque for Rs 700, received from Charan returned dishonored
4. Income tax paid Rs 300
5. Municipal tax paid on the business premises Rs 500
6. Rs 1,000 due from Mr. Kevin is written off as irrecoverable
7. Ria, owing Rs 5,000 to us settled the account by paying Rs 4,700 in full and final settlement.

Journal Entry in the books of Jinesh

Date Particulars L.F Debit (₹) Credit (₹)

1/9/21 Purchase a/c Dr 2000

To Mr.Ted a/c 2000

(Being goods purchased on credit)

2/9/21 Goods return a/c Dr 500

To Bahadur a/c 500

(Being goods returned by bahadur)

3/9/21 Charan a/c Dr 700

To Bank a/c 700

(Being Charan`s cheque dishonoured)

4/9/21 Income Tax a/c Dr 300

To Cash a/c 300

(Being Income Tax paid)

5/9/21 Municipal Tax a/c Dr 500

44 Accounting for Beginners: Financial Accounting I

Journal Entry in the books of Jinesh

To Cash a/c 500

(Being Municipal Tax paid)

6/9/21 Bad Debt a/c Dr 1000

To Mr.Kevin a/c 1000

(Being Mr.Kevin declared bad debt)

7/9/21 Cash a/c Dr 4700

Discount a/c Dr 300

To Ria a/c 5000

(Being Ria`s account settled at discount)

Total 10000 10000

8. Journalise the followings in the books of Adishwar for the month of January 2021.
1st – Started business with cash Rs. 5,00,000.
4th – Deposited Rs. 50,000 in bank.
7th – Purchased goods from Harsh Rs. 50,000, and paid 50% in cash.
9th – Sold goods to Revati Rs. 35,000, and received 50% in cash.
14th – Received goods worth Rs. 4,000 from Revati as defective.
16th – Returned goods worth Rs. 4,000 to Harsh.
19th – Rs. 6,000 was recovered from Dilip, which was written off as bad debts in the earlier years.
24th – Paid Rs. 2,000 for proprietor’s domestic use.
27th – Goods worth Rs. 3,000 was given as free samples.
 Ledger and Trial Balance 45

Journal Entry in the books of Adishwar

Date Particulars L.F Debit (₹) Credit (₹)

1/1/21 Cash a/c Dr 500000

To Capital a/c 500000

(Being business started with cash)

4/1/21 Bank a/c Dr 50000

To Cash a/c 50000

(Being cash deposited in bank)

7/1/21 Purchase a/c Dr 50000

To Cash a/c 25000

To Harsh a/c 25000

(Being goods purchased in cash and on credit)

9/1/21 Revati a/c Dr 17500

Cash a/c Dr 17500

To Sales a/c 35000

(Being goods sold on credit and cash)

14/1/21 Goods Returned a/c Dr 4000

To Revati a/c 4000

(Being Revati returned defective goods)

16/1/21 Harsh a/c Dr 4000

To Good returned a/c 4000

46 Accounting for Beginners: Financial Accounting I

Journal Entry in the books of Adishwar

(Being Goods returned to harsh)

19/1/21 Cash a/c Dr 6000

To Bad Debts a/c 6000

(Being Dilip`s bad debt partly received)

24/1/21 Drawing a/c Dr 2000

To Good returned a/c 2000

(Being Goods returned to harsh)

27/1/21 Free Samples a/c Dr 3000

To Purchase a/c 3000

(Being Goods distributed as free samples)

Total 654000 654000

9. Journalise the followings in the books of Mahaveer for the month January 2021.
1st – Started business with cash Rs. 2,00,000.
2nd – Bought furniture worth Rs. 25,000.
4th – Purchased goods from Rahul for cash Rs. 10,000.
5th – Purchased goods from Arjun worth Rs. 50,000.
7th – Sold goods for cash Rs. 12,500.
10th – Paid Rs. 47,500 to Arjun in full settlement for purchases.
15th–Sold goods to Alka on credit Rs. 70,000.
18th – Received defective goods from Alka worth Rs. 4,000.
21st – Alka settled her account by paying Rs. 64,000.
25th – Ashok deposited into bank Rs.65,000.
30th – Paid salary to manager, Mr. Ranveer Rs. 25,000.
 Ledger and Trial Balance 47

Journal Entry in the books of Mahaveer

Date Particulars L.F Debit (₹) Credit (₹)

1/1/21 Cash a/c Dr 200000

To Capital a/c 200000

(Being business started with cash)

1/1/21 Furniture a/c Dr 25000

To Cash a/c 25000

(Being furniture bought)

4/1/21 Purchase a/c Dr 10000

To Cash a/c 10000

(Being goods purchased)

5/1/21 Purchase a/c Dr 50000

To Arjun a/c 50000

(Being goods purchased from arjun)

7/1/21 Cash a/c Dr 12500

To Sales a/c 12500

(Being Goods sold on cash)

10/1/21 Arjun a/c Dr 50000

To discount a/c 2500

To Good returned a/c 47500

(Being arjun`s account settled in discount)

15/1/21 Alka a/c Dr 70000

48 Accounting for Beginners: Financial Accounting I

Journal Entry in the books of Mahaveer

To Sales a/c 70000

(Being Dilip`s bad debt partly received)

18/1/21 Goods return a/c Dr 4000

To Alka a/c 4000

(Being Goods returned by alka)

21/1/21 Cash a/c Dr 64000

Discount a/c Dr 2000

To Alka a/c 66000

(Being alka`s account settle discount)

25/1/21 Bank a/c Dr 65000

To Ashok a/c 65000

(Being Ashok deposited into bank)

30/1/21 Salary a/c Dr 25000

To Cash a/c 25000

(Being salary paid)

Total 577500 577500

10. Journalise the following in the books of Suvidhi for the month January 2021
1st – Started business with cash Rs. 1,99,000.
4th – Purchased goods from Neethu for Rs. 18,000, and paid cash Rs. 7,000.
7th – Sold goods to Kiran for Rs. 14,000, and received cash Rs.8,000.
12th – Goods worth Rs. 1,500 was given back to Neethu and settledher account for Rs. 9,000.
16th – Received goods worth Rs. 1,200 from Kiran, and Rs. 4,000 in cash for full settlement.
19th – Commission received from Yadav Rs. 500.
 Ledger and Trial Balance 49

22nd – Deposited Rs. 6,000 in bank.

25th – Cash purchases Rs. 10,000.
30th – Paid salaries Rs. 5,000, bills Rs. 2,000.

Journal Entry in the books of Suvidhi

Date Particulars L.F Debit (₹) Credit (₹)

1/1/21 Cash a/c Dr 199000

To Capital a/c 199000

(Being business started with cash)

4/1/21 Purchase a/c Dr 18000

To Neethu a/c 11000

To Cash a/c 7000

(Being goods purchased)

7/1/21 Kiran a/c Dr 6000

Cash a/c Dr 8000

To Sales a/c 14000

(Being goods sold)

12/1/21 Neethu a/c Dr 11000

To Discount a/c 500

To Cash a/c 9000

To Goods return a/c 1500

(Being goods returned and Neethu`s account settled in

discount)

16/1/21 Goods Returned a/c Dr 1200

50 Accounting for Beginners: Financial Accounting I

Journal Entry in the books of Suvidhi

Cash a/c Dr 4000

Discount a/c Dr 800

To Kiran a/c 6000

(Being goods returned and kiran`s account settled in

discount)

19/1/21 Commission a/c Dr 500

To Cash a/c 500

(Being Commission received)

22/1/21 Bank a/c Dr 6000

To Cash a/c 6000

(Being cash deposited in bank)

25/1/21 Purchase a/c Dr 10000

To Cash a/c 10000

(Being Goods purchsed)

25/1/21 Salaries a/c Dr 5000

Bills a/c Dr 2000

To Cash a/c 7000

(Being bills and salaries paid)

Total 271500 271500

Asynchronous Learning: https://bit.ly/3Acq410