Bank Reconciliation Statement

Definition: Bank Reconciliation Statement (BRS) refers to a statement which

an entity prepares on a particular date to match the bank balance indicated in
the cash book with the balance shown by the bank’s passbook, by displaying
the reasons for differences between the two.

The entity can prepare BRS any time during the financial period, as per the
requirement.

Significance of Bank Reconciliation

Statement
1. It is a useful mechanism for internal control of an entity’s cash inflows
and outflows, that facilitates the identification of frauds and errors, if
any, occurred while entering the transaction in the cash book or the
passbook.
2. It helps to ascertain any unnecessary delays in the cheque clearance.
3. It helps to know the exact position of the bank account.
4. It also prevents cash embezzlement, as there are instances when the
cashiers only pass entries in the books but don’t deposit the money in
the bank. Thus, with the help of BRS, it is always easy to keep a check
on such acts.
As the bank prepares the passbook, all the transactions are recorded from the
purview of the bank, but at the same time, in the cash book, the transactions
are recorded from the customer’s point of view, i.e. the entity’s standpoint.
However, the bank column of the cash book and bank statement, i.e.
passbook, keeps a track of the deposits and withdrawals made by the entity.

Therefore, the cash book and passbook are expected to tally, but practically,
this happens rarely due to the time gap between the entries made. That is
why, the preparation of Bank Reconciliation Statement is vital, to find out the
causes of differences in the two and eliminating them.

Reasons for Difference

  Timing: When there is timing difference in recording the transactions in
cash book and passbook, then also they will not tally.
Example: Alpha Ltd. issued a cheque to Beta Ltd. recorded immediately
in the bank column of cash book, but the bank will enter the transaction
in the passbook only when the cheque is presented by the Beta Ltd. in
the bank.
 Transactions: The bank undertakes some transactions without
notifying the customer.
Example: Interest Credited by bank, Locker rent charged by the bank,
Bank Charges debited by the bank, etc. In such cases, the bank credits
or debits the account immediately, but the entry is made to the cash
book when it comes to the knowledge of the customer.
 Errors: If there is any error or omission while preparing the account,
either by the bank or the client, may also lead to disagreement.
Nevertheless, the primary reason for the variance in the balance of the two is
items appearing in the cash book but not in the passbook and items showing
up in passbook but not in the cash book.

Rules for Addition and Subtraction

Credit
Credit Debit (Unfavorable)
When the Debit (favorable) (unfavorable)
(Favorable) balance or
reconciliation balance as per balance or
balance as per overdraft as per
begins with cash book overdraft as per
passbook passbook
cash book
Cheque Subtract Add Add Subtract
deposited in
bank but not
cleared
Cheque directly Add Subtract Subtract Add
deposited by
customer
Cheque issued Add Subtract Subtract Add
but not yet
presented
Interest income Add Subtract Subtract Add
collected by
bank
Expenses paid Subtract Add Add Subtract
by bank
 Credit
Credit Debit (Unfavorable)
When the Debit (favorable) (unfavorable)
(Favorable) balance or
reconciliation balance as per balance or
balance as per overdraft as per
begins with cash book overdraft as per
passbook passbook
cash book
Bank charges Subtract Add Add Subtract
charged by bank
Locker rent Subtract Add Add Subtract
charged by bank
Bank charges Add Subtract Subtract Add
recorded twice
in Cash book
Deposits Subtract Add Add Subtract
recorded twice
or excess
amount
recorded in cash
book
Bill discounted Subtract Add Add Subtract
and dishonored
Bills receivables Add Subtract Subtract Add
collected by
bank directly
Interest on bank Subtract Add Add Subtract
overdraft
charged by bank
Amount Subtract Add Add Subtract
withdrawn from
bank but not
recorded in cash
book
Wrong debit in Subtract Add Add Subtract
passbook
Wrong credit in Add Subtract Subtract Add
passbook
Wrong debit in Subtract Add Add Subtract
cash book
Wrong credit in Add Subtract Subtract Add
cash book
Undercasting of Add Subtract Subtract Add
debit side of the
bank column in
cash book
 Credit
Credit Debit (Unfavorable)
When the Debit (favorable) (unfavorable)
(Favorable) balance or
reconciliation balance as per balance or
balance as per overdraft as per
begins with cash book overdraft as per
passbook passbook
cash book
Overcasting of Subtract Add Add Subtract
debit side of the
bank column in
cash book
Undercasting of Subtract Add Add Subtract
credit side of
the bank
column in cash
book
Overcasting of Add Subtract Subtract Add
credit side of
the bank
column in cash
book
When answer is When answer is When answer is
When answer is
positive then it is positive then it is positive then it is
positive then it is
considered as considered as considered as
considered as
favorable (Cr.) unfavorable (Dr.) favorable (Dr.)
unfavorable (Cr.)
balance as per balance as per balance as per
balance as per cash
Final Balance passbook, but if it passbook, but if it cash book, but if
book, but if it is not
is not then it is is not then it is it is not then it is
then it is regarded
regarded as regarded as regarded as
as favorable (Dr.)
unfavorable (Dr.) favorable (Cr.) unfavorable (Cr.)
balance as per cash
balance as per balance as per balance as per
book.
pass book. passbook. cash book.

So, the Bank Reconciliation Statement is mainly used to locate the reasons
for discrepancies and errors (if any) in the two books. Furthermore, it is used
to identify and prevent frauds and cash embezzlement by the staff, while
recording the transactions.

Petty Cash Book

Definition: Petty Cash Book is a ledger book, which is used to record petty
cash expenses formally in chronological order, with the date. For this purpose,
a petty cashier is appointed by the firm, to pay for small payments (usually
below Rs. 200) and keep a record of the same.
Petty cash implies a small amount of cash in hand, with the petty cashier,
who uses the amount to pay for petty cash expenses.

Petty cash expenses are the expenses which occur regularly and repeatedly
but are not related to the usual business line such as postage, stationery,
stamp, carriage, travelling expenses, cartage, and other expenses (commonly
recorded under sundry expenses). These expenses are high in frequency but
too small in amount to pay through a cheque or credit/debit card.

Imprest System Petty Cash Book

In this system, the petty cashier is entrusted with a specified amount at the
beginning of every month, fortnight or week. The cashier makes payment out
of the amount granted to him. At the month end the petty cashier, after making
payments from the amount, gives the payment voucher to the main cashier,
who reimburses the amount to the petty cashier at the end of the month. So,
the petty cashier will have the same fixed amount at the beginning of the next
period.

This system is called the imprest system of petty cash and the amount so
granted is termed as a float. The amount of float is decided in such a manner,
that it may be sufficient to meet petty expenses, for the stipulated term. The
balance left in the petty cash book indicates the amount remaining with the
petty cashier.

Imprest system petty cash book is quite helpful when the firm uses analytical
petty cash book, wherein the book has one column to track the receipt of the
amount, from the chief cashier and several other columns to write down
expenses under the specific head. The various columns are totalled to show
the reason for making payments, and then the respective ledger accounts are
debited.

The reimbursement of the amount is made by the chief cashier, to the petty
cashier only when the latter prepares a statement that provides the details of
all expenses with a date which are backed by vouchers, as well as the
vouchers are arranged sequentially.

Format of Petty Cash Book

The extreme left column of the petty cash book is to record the receipts of
cash, then in the date column, dates on which transaction took place are
recorded.

Next to the date column, there is a column to record the voucher number. In
the particulars column, the purpose of an expense is written and
simultaneously in the money column, of various expenses, the amount is
recorded. There is a sundries column in the book, to record infrequent
payments. Lastly, there is a total column, to record the total amount.

Advantages of Petty Cash Book

 Saving of time of the main cashier.
 Convenient recording of small transactions.
 Effective control over cash payments.
 Saving of efforts in recording small expenses in the cash book and then
entering the same in the ledger.
The petty cashier balances the book periodically. The difference in the total
receipts and total disbursements is the balance left with the petty cashier,
which is carried forward to the next period as well as, he/she will be
reimbursed for the amount actually spent.

Book Cost
Definition: The Book Cost refers to those expenses which do not involve
actual cash payments, but rather the provisions are made in the books of
accounts to include them in the profit and loss accounts and avail the tax
advantages.

In other words, the expenses which are not payable in cash, but rather their
provisions are made in the books of accounts while finalizing the profit and
loss statement, is called as book costs. Simply, we can say that these are the
payments that firm pays it to itself. The provision for depreciation, unpaid
interest on owner’s fund or capital are the examples of book cost.
Ledger
Definition: Ledger implies the principal books of accounts, wherein all
accounts, i.e. personal, real and nominal are maintained. After recording the
transactions in the journal, the transactions are classified and grouped as per
their title, and so all the transactions of similar type into are put in a particular
account.

Format of Ledger
A ledger account is T-shaped, having two sides, wherein the left part of the
account represents the debit side, whereas the right part of the account, is the
credit one. Both the sides consist of four columns, as you can see in the
specimen below:

Posting
When the debit and credit items are transferred from journal to the specific
ledger accounts, the process is called as Posting. The rules with respect to
the ledger posting are discussed as under:

 Individual accounts are to be opened in ledger book for each group, i.e.
purchases, sales, cash etc. and the entries from the journal are posted
to their account.
 It should be kept in mind that the account name used in ledger should
be the same used in the journal.
 In the date column, we enter the date of the transaction.
 While posting the entries in the debit side, we add the prefix ‘To’ with
the concerned accounts posted in the particulars column and the prefix
‘by’ is used with the accounts entered in the particulars column of the
credit part.
  When it comes to posting the entries, the accounts debited in the journal
are to be debited in the ledger, however, reference is given to the
concerned credit account.
 The accounts are balanced at the end of each month or financial year.
And to do so both the sides are totalled first and then the difference
between the two sides is ascertained. This difference is called the
balance, which is added to the side which falls short. When the credit
side is greater than the debit side, it is called a credit balance which is
indicated as ‘To balance c/d’.On the other hand, when the debit side is
in excess of the credit side it is termed as debit balance, which is
indicated as ‘By balance c/d’. Here, the word c/d refers to carried down.
Similarly while opening the account for the next month or period. The
balance on the debit balance is taken to the debit side as ‘To Balance
b/d’ and vice versa. The word ‘b/d’ expands to brought down.
 In the folio column, we will enter the page number of the journal from
which entry is posted to the ledger.
 The amount column is filled with the respective amount against the
entry.

Subdivision of Ledger
The ledger is subdivided into two major categories:
 1. Personal Ledger: Personal Ledger, implies the ledger that records
details of every transaction about the persons, concerned with the
accounting unit.
o Debtors Ledger: Debtors are the persons to whom goods are
sold. So, it includes the accounts of individual trade debtors of the
entity are covered in this category.
o Creditors Ledger: Creditors are the persons or firm from whom
we purchase the goods. So, it encompasses the accounts of
individual trade creditors of the business enterprise.
2. Impersonal Ledger: The ledger that records all the entries relating to
assets, liabilities, incomes and Expenses. It is divided into two
categories:
o Cash Book: It is the book that contains all the cash and bank
transactions.
o General Ledger: The ledger in which all the entries with respect
to real and nominal account are recorded. It is known as the
general ledger. It is further divided into two categories:
1. Nominal Ledger: The ledger accounts relating to incomes
such as Sales A/c, Rent received A/c, Commission earned
A/c, Interest received A/c, etc. and expenses such as
Wages A/c, Salaries A/c, Purchases A/c, Electricity A/c.
Rent Paid A/c, Commission Paid A/c, etc. are covered in
this category.
2. Private Ledger: The ledger in which entries concerned with
assets and liabilities are entered is called Private Ledger.
Ledger is the King of all Books and that is why it is also known as the book of
final entry wherein account-wise balance of each account is ascertained. It
helps in the preparation of trial balance and financial statement, i.e. profit &
loss account, balance sheet, and cash flow statement.

Trial Balance
Definition: Trial Balance refers to a schedule, in which the balances of all
ledger books are assembled into debit and credit columns, to check the
arithmetical accuracy of the entries posted in the ledger accounts.
Trial Balance is a tabular statement, containing a specified date on which it is
prepared, indicated at the top of the statement. The balances of all the assets,
expenses, losses, drawings, cash and bank account are taken to the debit
column whereas the balances of all the liabilities, incomes, gains, capital are
transferred to the credit column.

Companies prepare trial balance periodically, usually at the end of the

financial year which forms a basis for preparing final accounts. However, it
can be prepared otherwise also, subject to the accounts are balanced.

When the total of debit and credit columns are equal, then the trial balance is
regarded as balanced, i.e. the accounts are mathematically accurate,
however, certain errors are still there, that might have occurred during
journalizing and posting the entries into a ledger.

Objectives of Preparing Trial Balance

1. To ensure arithmetical accuracy of the books of accounts, which
indicates that the books are free from any mathematical errors and both
the aspects of the account are recorded, in journal and ledger.
2. To prepare financial statement, as trial balance forms a base for
preparing final accounts at the end of the financial year.
3. To act as a summary of the ledger, as it compiles the balances of all
accounts.
Trial Balance prepared to verify as to whether the totals of the debit column
equals the total of credit columns.

Methods of Preparation of Trial Balance

 Total Method: Otherwise called gross trial balance method, under
this method all the ledger accounts are totalled and the total of both
 debit and credit side is carried forward to the trial balance.This method
saves time, as the time taken to balance the account is saved and the
trial balance can be prepared as and when the accounts are totalled.
However, this method is not used in general, because it does not help in
the preparation of the final accounts.
 Balance Method: This method is used by the companies, as the trial
balance is prepared on the basis of ledger account balances. As per this
method, first of all, the ledger accounts are totalled and balanced and
those balances are transferred to the trial balance. This method is also
known as net trial balance method.Here, balance refers to the
difference of totals of debit and credit side of a ledger account.
Balancing of ledger account implies tallying both the debit and credit
sides of the particular account by placing the balance on the side where
the amount falls short.
 Total and Balance Method: Also known as a compound method, as
its name suggests it is a combination of the two methods discussed
above. In this method, the statement contains columns for both totals as
well as balances.
Trial Balance is the third step of the accounting process, wherein once the
accounts are posted in the ledger, a statement is prepared to show the debit
and credit balances. It is prepared by listing all the accounts and then entering
them in their respective columns.

The totals of the debit and credit columns must agree irrespective of the
method is used for preparing Trial Balance. This is because of the dual effect,
i.e. every debit has an equivalent credit, and it indicates that the trial balance
does not contain any clerical errors. However, this is not absolute proof of
accuracy, as an error of principle, an error of omission and compensating
errors may still be there.

Adjusted Trial Balance

Suspense account is a temporary account is created when there is a
disagreement in the debit and credit column of the trial balance after carrying
forward all ledger account balances and errors are not detected at the right
time, then the trial balance is equalized by transferring the difference of the
two sides in this account, so as to proceed further and prepare final accounts.
Balance Sheet
Definition: A Balance Sheet refers to the position statement, which lists out
the balances of the assets, liabilities and owner’s equity, i.e. capital, of an
enterprise at a specified date. While the assets show the resources owned by
the company, liabilities and capital exhibits the funding of resources.

Characteristics of Balance Sheet

 The preparation of Balance Sheet is not for a period, but at a particular
date.
 The preparation of the balance sheet is possible only when profit and
loss account for the period is prepared because it reflects the financial
position of the company adequately. That is why the Profit & Loss
Account, Balance Sheet and Cash flow Statement are collectively called
as Final Accounts.
 The totals of the two sides, i.e. assets and liabilities of the balance sheet
must tally as Assets = Liabilities + Capital. If not so, then there must
be an error.
 The balance sheet reflects the nature and value of assets and
liabilities and the position of capital on a given date.
It can be prepared, taking into account the debit and credit balances of the
real and personal accounts, as per trial balance. The real account’s debit
balance is an indicator of the asset of the firm, whereas the credit balance of
the personal account is an indicator of liability.

Format of Balance Sheet

 Equity and Liabilities: It indicates what the firm ‘owes’ to others.
o Shareholder’s Funds: It shows the shareholder’s contribution to
the firm in any form.

o Share Capital: The portion of the firm’s capital, raised from

the issue of shares. It encompasses equity share
capital and preference share capital.
 o Reserves and Surplus: It covers retained earnings and
shares premium. It encompasses capital reserves,
debenture redemption reserves, general reserve,
revaluation reserve and surplus.

o Non-Current Liabilities: The liabilities which can be settled after

one year from the date of reporting, is called non-current liabilities.

o Long-term Borrowings: Term loans from banks and

financial institutions which have a tenor of more than a year
are called long-term borrowings.

o Deferred tax liabilities: A deferred tax liability arises when

the amount allowed for tax purposes exceeds the charge in
the financial statements.

o Long-term provisions: Provisions for employee benefits

comes under long-term provisions. It includes provident
fund, leaves encashment, gratuity, superannuation fund,
etc.

o Current Liabilities: These are short-term liabilities which need to

be settled within a period of one year or less.

o Short-term Borrowings: The borrowings that are to be

repaid within one year is called short-term borrowings and
includes commercial paper, working capital loans, corporate
deposits, etc.

o Trade Payables: The amount due to suppliers from whom

goods are bought on credit are called trade payables. It
includes sundry creditors and bills payables.

o Short-term provisions: It refers to the provisions made by

the firm for dividend and taxes.

 Assets: These are the resources owned by the firm, that provide future
economic benefits.
o Non-current Assets: The assets which remain with the entity for
more than a year are non-current assets.
 o Fixed Assets: Assets bought by the company for long-term
use, and are not converted into cash quickly are called fixed
assets.

o Tangible Assets: The assets that are used in their

physical form are called tangible assets. It includes
land, building, vehicles, furniture, plant, etc.

o Intangible Assets: Assets with no physical shape

and structure are called intangible assets, such as
copyright, patent, trademark, design, software, etc.

o Non-current Investments: It consists of financial securities

of other companies such as shares, debentures, bonds and
so forth.

o Long-term loans and advances: Loans and advances

made to subsidiary companies, associate companies,
comes under this category.

o Current Assets: The assets that can be converted into cash

within a period of one year or less are current assets.

o Current Investments: The holdings in shares of mutual

funds, usually for a short term are called current
investments.

o Inventories: It refers to the stock of goods in various forms

such as raw material, work-in-process and finished items.

o Trade Receivables: The amount owed by the customers to

the firm, to whom goods are sold, but not yet paid.

o Cash and cash equivalents: It includes cash owned by the

company and the credit balance with the bank and financial
institutions.

o Short-term loans and advances: Loans and advances

provided to parties such as suppliers and employees are
covered in this category.
As each and every transaction affects assets or liabilities of the business, that
is why, the balance sheet can be regarded as true only at that point in time,
when it is prepared. And due to this very reason, “as at” is written with the
date. Usually, it is prepared on the last day of the accounting period.

Liabilities
Definition: Liability, as the name suggests, is a legal obligation which reflects
an amount that the company owes to outside parties, i.e. banks, financial
institutions, individuals or entities, whose settlement may lead to the outflow of
the firm’s economic resources.

In finer terms, liabilities are a company’s financial debts, which indicates

creditors claim on business assets that need to be paid off when they become
due for payment. These liabilities arise as a result of past events, i.e. to
acquire a long term asset, to start another unit or to improve business
operations.

The liabilities appear in the first part of the balance sheet, as “equity and
liabilities“. The capital contributed by the owners is commonly called
as internal liability, whereas the liability paid to the outside parties is
considered as an external liability. External liability occurs out of credit
transactions or funds raised by the firm from external parties.

Classification of Liabilities
On the basis of the holding period, liabilities are classified as:

1. Non-current Liabilities: Otherwise called as long-term liabilities,

these are the debt owed by the company for a long period, which
implies that it will become due after a year. These are one of the
significant source of funds for the enterprise that they acquire to fulfil
their immediate cash requirements of buying a capital asset or invest in
new projects.
o Long-term borrowings: Long-term borrowing implies the amount
owed by the company to outside parties, for a term, more than a
year. It includes mortgage bonds, debentures, bonds
payable, term loan, long term notes payable. The long term debt
of a company decides its leverage and solvency position.
 o Other long-term liabilities: It refers to the financial obligations
which become due for payment after one year, such as capital
lease, pension or post-retirement benefits to employees, workmen
compensation fund, employee provident fund, etc.
o Deferred tax liabilities: It implies the tax liability of the
organisation, for the present financial year.
o Long-term provisions: Long term provision represents the
amount kept aside by the firm to fulfil, any anticipated obligation,
whose amount is uncertain and the period of occurrence is also
not known.
2. Current Liabilities: These are short term liabilities which are expected
to be repaid in the enterprise’s regular operating cycle, i.e. within one
year. These determine the company’s liquidity position as they play a
crucial role in working capital management of the enterprise.
o Short-term borrowings: These are the obligations which fall due
for payment within a period of one year. It includes bank overdraft,
short term loans and advances, etc.
o Trade payables: It refers to the amount payable by the firm to the
suppliers for raw material delivered or services consumed during
a financial year. It includes bills payable and creditors.
o Other current liabilities: The financial obligations which become
due for payment during the normal operating cycle, comes under
other current liabilities. It includes lease payments, interest
payable, accrued expenses, and so forth.
o Short term provisions: It covers the amount kept aside, for
future expected liability, that fall due within a year.
3. Contingent liabilities: These liabilities are not actual liabilities, but they
can turn out as actual liability as a result of happening of certain future
events. And so, if these events fail to occur, no such liability will arise.
Hence, in better words, it is a potential obligation whose occurrence
depends on the outcome of a future event. These do not appear in the
balance sheet; instead, it is an off-balance sheet item, as it appears as
a footnote.
Therefore, liability is the claim of the individuals or entities other than the
owners of the enterprise, which is denoted by assets less owner’s equity.
Working Capital
Definition: Working capital can be understood as the capital needed by the
firm to finance current assets. It represents the funds available to the
enterprise to finance regular operations, i.e. day to day business activities,
effectively. It is helpful in gauging the operating liquidity of the company, i.e.
how efficiently the company is able to cover the short-term debt with short-
term assets. It can be calculated as:

Working Capital = Current Assets – Current Liabilities

Current Assets represents those assets which can be easily transformed into
cash within one year. On the other hand, current liabilities refers to those
obligations which are to be paid within an accounting year.

Types of Working Capital

1. On the basis of Value

o Gross Working Capital: It denotes the company’s overall
investment in the current assets.
o Net Working Capital: It implies the surplus of current assets over
current liabilities. A positive net working capital shows the
company’s ability to cover short-term liabilities, whereas a
negative net working capital indicates the company’s inability in
fulfilling short-term obligations.
 2. On the basis of Time
o Temporary working Capital: Otherwise known as variable
working capital, it is that portion of capital which is needed by the
firm along with the permanent working capital, to fulfil short-term
working capital needs that emerge out of fluctuation in the sales
volume.
o Permanent Working Capital: The minimum amount of working
capital that a company holds to carry on the operations without
any interruption, is called permanent working capital.
Other types of working capital include Initial working capital and Regular
working capital. The capital required by the promoters to initiate the business
is known as initial working capital. On the other hand, regular working capital
is one that is required by the firm to carry on its operations effectively.

Working Capital Cycle

Working Capital Cycle or popularly known as operating cycle, is the length of

time between the outflow and inflow of cash during the business operation. It
is the time taken by the firm, for the payment of materials, wages and other
expenses, entering into stock and realizing cash from the sale of the finished
good.
In short, the working capital cycle is the average time required to invest cash
in assets and reconverting it into cash by selling the assets produced.

The working capital cycle may vary from enterprise to enterprise depending
on various factors, such as nature and size of business, production policies,
manufacturing process, fluctuations in trade cycle, credit policy, terms and
conditions for purchase and sales, etc.

Current Ratio
Definition: The Current Ratio is the part of the liquidity ratio that helps to
determine the firm’s ability to pay off its short-term obligations with its Current
Assets. Simply, a firm uses the current assets, such as cash, cash
equivalents, marketable securities, bills receivables, etc. to meet its short-term
debt.

Generally, the current assets more than twice the current liabilities are
considered favorable, as it shows the firm’s readiness to meet its obligations
when they arise. Current liabilities are generally the obligations that are
expected to become due within 12 months, and these are in the form of loans
and advances, creditors, bills payable, etc.

An ideal way to judge the performance of the company is to compare its

current ratio with the other companies within the same industry. This ratio
helps the firm to determine its efficiency to pay for the current debt as well as
helps in the planning of future payments on the basis of the trend followed by
the current ratios calculated in the past 5 to 7 years.

The formula for calculating the current ratio:

Current Ratio = Current Asset/ Current Liabilities

The Higher value of current ratio shows the readiness of a firm to pay for its
current obligations when they arise. Thus, higher the ratio higher is the
liquidity of the firm.
Example: Suppose a firm has its current assets and current liabilities worth
Rs 15,00,000 and Rs 5,00,000 respectively. Then the current Ratio of the firm
will be:

Current Ratio = 15,00,000/5,00,000 = 3:1

Liquidity Ratios
Definition: Liquidity Ratios are calculated to determine the capacity of a firm
to pay off its short-term obligations when they become due. In other words,
firm’s cash balance or the readiness to convert its asset into cash, to pay off
its current debt is called as liquidity and the ratios that compute it are called as
liquidity ratios.

Following are the Important liquidity ratios:

1. Current Ratio
2. Acid-test Ratio
3. Cash Ratio
Generally, the firm having a liquidity ratio greater than 1 is considered to be
financially sound and is able to meet its short-term obligations with ease.
Higher the liquidity ratio, higher will be the margin of safety. The liquidity ratios
are concerned with the current assets and the current liabilities.

Current Ratio
Definition: The Current Ratio is the part of the liquidity ratio that helps to
determine the firm’s ability to pay off its short-term obligations with its Current
Assets. Simply, a firm uses the current assets, such as cash, cash
equivalents, marketable securities, bills receivables, etc. to meet its short-term
debt.

Generally, the current assets more than twice the current liabilities are
considered favorable, as it shows the firm’s readiness to meet its obligations
when they arise. Current liabilities are generally the obligations that are
expected to become due within 12 months, and these are in the form of loans
and advances, creditors, bills payable, etc.

An ideal way to judge the performance of the company is to compare its

current ratio with the other companies within the same industry. This ratio
helps the firm to determine its efficiency to pay for the current debt as well as
helps in the planning of future payments on the basis of the trend followed by
the current ratios calculated in the past 5 to 7 years.

The formula for calculating the current ratio:

Current Ratio = Current Asset/ Current Liabilities

The Higher value of current ratio shows the readiness of a firm to pay for its
current obligations when they arise. Thus, higher the ratio higher is the
liquidity of the firm.

Example: Suppose a firm has its current assets and current liabilities worth
Rs 15,00,000 and Rs 5,00,000 respectively. Then the current Ratio of the firm
will be:

Current Ratio = 15,00,000/5,00,000 = 3:1

Acid-test Ratio
Definition: The Acid Test Ratio also referred to as a Quick Ratio is
calculated to determine the ability of a firm to pay off its current liabilities
with Quick Assets. What are Quick Assets? The quick assets are the current
assets that are highly liquid and can be converted into cash within 90 days or
in a short period of time.

Generally, all the current assets are the quick assets, but however,
the inventory is subtracted from its value because inventories are not
readily convertible into cash. The acid-test ratio is a key indicator for the
investor to know if the firm is capable of paying its short-term bills on time.

Ideally, the quick ratio equal to or more than 1 is considered favorable; that
shows the company is having more liquid assets and do not rely heavily on
the inventories. The formula for computing the Acid-test Ratio is:

Acid-test Ratio = Quick Asset/ Current Liabilities

Higher the Acid-test Ratio, the higher is the debt-paying capacity of a firm.

Example: Suppose a firm has a cash balance of Rs 50,000, the marketable

securities worth Rs 10,000, and account receivables amounting to Rs
1,00,000 (inclusive of inventories worth Rs 40,000). The current liabilities are
Rs 60,000. Then the Acid test ratio will be:

Acid-test Ratio = 1,20,000/60,000 = 2:1

[Quick Asset = (50,000+10,000+1,00,000) – 60,000 = 1,20,000]

Cash Ratio
Definition: The Cash Ratio shows how quickly the firm can pay off its
liabilities relative to Cash, bank balances, marketable securities since
these are considered as the most liquid component of the current assets.
Simply, this ratio measures the ability of a firm to meet its current obligations
with the cash or cash equivalents.
It is the most stringent liquidity ratio and is considered as an important
decision factor for the creditors regarding how much amount is to be lent to
the asking firm. The high value of cash ratio shows sufficient cash balance
with the firm and is capable of paying the current debts. The formula for
calculating the Cash Ratio is:

Cash Ratio = (Cash and Bank Balances+ Current Investments) / Current

Liabilities

A Higher value of ratio results in more lending from the creditors due to a
safety of returns.

Example: Suppose a firm’s cash balance is Rs 50,000, cash equivalents

worth Rs 15,000 and the current liabilities comprising of bills payable, current
long term liabilities and current taxes amounting to Rs 7,000, 10,000 and
3,000 respectively. Then the Cash ratio will be:

= 75,000/20,000 = 3.75 : 1

cash = 50,000+15,000 =75,000

Current liabilities= 7,000+10,000+3,000 = 20,000

Return on Assets Ratio

Definition: The Return on Assets Ratio shows how well a company can
convert its investment in assets into profits or simply, it is the ratio that
measures the ability of a company to convert the money spent on purchasing
the assets into net income and profits.

It is also referred to as Return on Investments, i.e. how much profit a firm is

generating out of the investments. Ideally, it is better to compare the
company’s current ROA with that of the previous years or with the ROA of a
similar company, since the industry standards can vary. The formula to
calculate this ratio is:

Return on Assets Ratio: Profit after tax/ Average Total Assets

Where, Average total assets = (Assets in the beginning+ Assets at the end of
the financial year) / 2

The Higher value of ratio shows that firm is able to earn more with fewer
investments and hence is able to utilize its assets more efficiently.

Example: Suppose a firm has a net profit of Rs 50,000 and the total assets as
on 1 July 2014 and 30 June 2015 were Rs 2,00,000 and 3,00,000
respectively. Then Return on Assets Ratio will be:

Return on Assets Ratio= 50,000/2,50,000 = 0.2 or 20%

[Average Assets = (200000+300000) /2 = 250000)]

Total Assets Turnover Ratio

Definition: The Total Assets Turnover Ratio shows how efficiently the total
assets of the firm are employed to generate sales. This ratio gives an idea to
the investor and the creditor about how the firm is managed, and the assets
are utilized to generate revenues.

Ideally, the firm’s asset turnover ratio is compared with the other companies
within the same industry because of the same business operations and the
similar amount of investments made in the fixed assets.

The formula to compute this ratio is:

Total Assets Turnover Ratio= Net Sales/ Average Total Assets

The higher the ratio, the better is the utilization of total assets in the firm. This
shows that a firm is able to generate revenues with the minimum amount of
total assets without raising an additional capital.

Example: Suppose a firm has a net sales of Rs 50,000 and the opening and
closing balance of the assets is Rs 1,00,000 and 50,000 respectively. The
Total Assets Turnover Ratio will be:

Total Assets Turnover Ratio = 50,000/75000 = 0.67 times

Average Total Assets = (1,00,000+50,000)/2 =75,000

Net Profit Margin Ratio

Definition: The Net Profit Margin Ratio shows the net income earned from
the sale of goods and services or simply, how much profits are generated at a
certain level of sales. This ratio shows the earnings or the revenues left for the
shareholders, both equity and preference shareholders, after making the
payment of all the operating expenses, interest, taxes, etc.

The net profit margin is all about how much a company can save from the sale
of one unit. The overall success of the company can be measured by this
ratio. The high value of net profit margin ratio shows that the company is
following the correct pricing policy and is efficiently controlling the cost of
production.

To assess the performance of the company, its net profit margin should be
compared with the other companies within the same industry since these will
have the same business environment and the common customer base. The
formula to compute this ratio is:

Net Profit Margin Ratio = Profit after tax/Net Sales

Higher the ratio, better is the ability of a firm to pay a profit share to the
shareholders and pay off the loans taken from the creditors.

Example: Suppose a firm has net sales of Rs 3,00,000, and the net profit is
Rs 30,000. Then the net profit margin ratio will be:

Net Profit Margin Ratio = 30,000/3,00,000 = 0.1 or 10%

Assets
Definition: Assets refers to the resources of economic value which are owned
and controlled by a business entity, owing to events in the past, which are
expected to generate monetary benefit in future. In the balance sheet, assets
appear in the second part, i.e. after equity and liabilities.
Classification of Assets
Assets are classified into two major categories, i.e. non-current assets and
current assets discussed as under:

1. Non-Current Assets: The assets which are acquired by the business

for long term use, to raise the profit potential of the company and whose
total value will not be realized in a financial year is called as Non-current
assets or Long term assets. Expenses incurred to acquire these assets
are capital in nature.
o Fixed Assets: As the name suggest, fixed assets are the capital
assets which are acquired by the business for a fixed term and
are not expected to be consumed or converted during the ordinary
course of business. Here, the word ‘fixed asset’ means the
resources which are supposed to last long and remain in use for
more than one accounting year. While entering in the Position
statement, i.e. Balance Sheet, these assets usually appear in their
in the book value, which is calculated by deducting depreciation
from the purchase price.
1. Tangible Assets: Tangible Fixed Assets are the assets
which can be seen and touched, i.e. they are available in
their material form. These assets are land, building, vehicles
(used for business purpose only), plant and machinery,
equipment, furniture and fixtures, etc. which are owned by
the enterprise for business use only and not for sale,
consumption or personal use. These assets can be used as
collateral security to extend loans for the enterprise.
2. Intangible Assets: These indicate intellectual property, i.e.
the long term assets which are not in physical form. Further,
intangible assets are classified as definite intangible assets
and indefinite intangible assets. In case of definite, tangible
assets, the assets are there with the company for a definite,
i.e. fixed term, and includes patent, copyright,
trademark, franchises, etc. On the other hand, indefinite
intangible assets are those that remain with the company,
until it continues, such as goodwill, brand name, etc.
o Non-Current Investments: As the name signifies, these are the
long term investments whose value will be received after a
definite term, usually more than a year.
 o Long-Term Loans and Advances: The loans and advances
provided by the company as debt, to individuals or companies for
more than a year.
2. Current Assets: These are the assets which a company holds for a
short period only. Current assets are supposed to be sold or consumed
within a period of one year. The cash generated by selling these assets
is used to funds business operations. It includes cash and cash
equivalents, debtors, bills receivable, inventory, prepaid expenses, short
term loans and advances, and marketable securities such as treasury
bills.
Hence, assets are nothing but the property that a company owns, having
financial value, that is capable of inducing cash flows. At the time of
emergency, these assets can be used to meet the business obligations.

Current Ratio
Definition: The Current Ratio is the part of the liquidity ratio that helps to
determine the firm’s ability to pay off its short-term obligations with its Current
Assets. Simply, a firm uses the current assets, such as cash, cash
equivalents, marketable securities, bills receivables, etc. to meet its short-term
debt.

Generally, the current assets more than twice the current liabilities are
considered favorable, as it shows the firm’s readiness to meet its obligations
when they arise. Current liabilities are generally the obligations that are
expected to become due within 12 months, and these are in the form of loans
and advances, creditors, bills payable, etc.

An ideal way to judge the performance of the company is to compare its

current ratio with the other companies within the same industry. This ratio
helps the firm to determine its efficiency to pay for the current debt as well as
helps in the planning of future payments on the basis of the trend followed by
the current ratios calculated in the past 5 to 7 years.

The formula for calculating the current ratio:

Current Ratio = Current Asset/ Current Liabilities

The Higher value of current ratio shows the readiness of a firm to pay for its
current obligations when they arise. Thus, higher the ratio higher is the
liquidity of the firm.

Example: Suppose a firm has its current assets and current liabilities worth
Rs 15,00,000 and Rs 5,00,000 respectively. Then the current Ratio of the firm
will be:

Current Ratio = 15,00,000/5,00,000 = 3:1

ash Ratio
Definition: The Cash Ratio shows how quickly the firm can pay off its
liabilities relative to Cash, bank balances, marketable securities since
these are considered as the most liquid component of the current assets.
Simply, this ratio measures the ability of a firm to meet its current obligations
with the cash or cash equivalents.

It is the most stringent liquidity ratio and is considered as an important

decision factor for the creditors regarding how much amount is to be lent to
the asking firm. The high value of cash ratio shows sufficient cash balance
with the firm and is capable of paying the current debts. The formula for
calculating the Cash Ratio is:

Cash Ratio = (Cash and Bank Balances+ Current Investments) / Current

Liabilities

A Higher value of ratio results in more lending from the creditors due to a
safety of returns.

Example: Suppose a firm’s cash balance is Rs 50,000, cash equivalents

worth Rs 15,000 and the current liabilities comprising of bills payable, current
long term liabilities and current taxes amounting to Rs 7,000, 10,000 and
3,000 respectively. Then the Cash ratio will be:

= 75,000/20,000 = 3.75 : 1
cash = 50,000+15,000 =75,000
Current liabilities= 7,000+10,000+3,000 = 20,000

Journal
Definition: In the accounting world, Journal refers to a book wherein
transactions are logged for the very first time, and that is why it is also called
as “Book of Original Entry“.

In this book, all the regular business transactions are entered sequentially, i.e.
as an when they arise. After that, the transactions are posted to the Ledger, in
the concerned accounts. When the transactions are recorded in the journal,
they are called as Journal Entries.

As per Double Entry System of Book Keeping, every transaction affects

two sides, i.e. debit and credit. So, the transactions are entered in the book as
per the Golden Rules of Accounting, to know which account is to be debited
and which one is to be credited.

Types of Journal
There are two types of the journal:

 General Journal: General Journal is one in which a small business

entity records all the day to day business transactions
  Special Journal: In the case of big business houses, the journal is
classified into different books called as special journals. Transactions
are recorded in these special journals on the basis of their nature.
These books are also known as subsidiary books. It includes cash
book, purchase day book, sales day book, bills receivable book, bills
payable book, return inward book, return outward book and journal
proper.
The journal proper is used for entering infrequent transactions such as
opening entries, closing entries and rectification entries.

Journalizing Process
The process of recording transactions in the journal is called Journalizing.
The transactions are recorded in the journal in the manner of their occurrence
along with a suitable explanation, called ‘Narration‘ which supports the entry.

The steps involved in the process of Journalizing are as under:

1. Identification of Accounts: The first and foremost step in any given

transaction is to identify the accounts which are being affected with it.
2. Recognition of Account type: Once the accounts are identified, the
type of account is ascertained, i.e. whether it is a personal account, real
account or nominal account.
3. Applying the golden rules of accounting: The rules of debit and
credit, i.e. the golden rules of accounting are to be applied to the
accounts which are affected by the transactions.
The debit and credit sides of the journal must be equal. There are some
transactions in which you will find there are more than one debit for a single
credit, more than one credit for a single debit or multiple debits and credits for
an entry. Such entries are called as a compound journal entry.
Nevertheless, the aggregate amount of debit and credit in an entry must tally.

Format of Journal
  Date: In this column, we mention the date of the transaction along with
the month in which the transaction took place. The year is indicated at
the top only once and not repeated with every date.
 Particulars: This column indicates the accounts which are affected, i.e.
debited or credited, by the transaction. In the very first line, we write the
account which is debited and then in the extreme right of the same line
and column we write Dr. which indicates Debit.
In the next line, after leaving some space, we write the account which is
credited starting with the preposition ‘to’. A small narration for the
respective transaction is given in the third line which explains the entry
in the brackets, and it starts with the word ‘being’.

 Voucher Number: In this column, we enter the number written on the

voucher of the concerned transaction.
 L.F. or Ledger Folio: As we know that transactions entered in the
journal are then taken to the Ledger, in their respective accounts. In this
column, the page number concerning the entry in the ledger is
mentioned.
 Dr. Amount: The amount to be debited for a particular entry is written in
the same line, where the debited account is indicated.
 Cr. Amount: The amount to be credited for a particular entry is written
in the same line, where the concerned credited account is written.
All the columns are to be filled at the time of recording the transaction in the
journal, except the ledger folio column which is filled when the transaction is
posted to the ledger.

The journal entries may extend to multiple pages, and so both the two
columns are totalled at the end of each page, with the word Total c/f, i.e.
carried forward. Further, at the beginning of the next page, the amounts in
debit and credit columns in the previous page is written with the words Total
b/f, i.e. brought forward. Finally, on the last page of the entry, the Grand
Total is written, and the columns are totalled.

Financial Statement
Definition: Financial Statement are systematically maintained, written
summary of all the ledger account heads, exhibited in a way that it provides a
clear view of the financial position, profitability and performance of the
enterprise.

These are prepared at the end of the accounting period, which is usually one
year, after that it is audited by the auditor, to check their accuracy,
transparency and fairness, for taxation and investment purposes.

Objectives of preparing financial statement

The objectives of the financial statement are as under:

 To ascertain the financial position, profitability and performance.

 To determine the cash inflows and outflows.
 To know the results of business operations.
 To provide information related to financial resources and obligations of
the concern.
 To disclose the accounting policies.
 To check the efficiency and effectiveness of the company’s
management.
A financial statement is a primary source of information to stakeholders to
know the profit earned or loss sustained by the enterprise during a particular
period and its financial status at the end of that particular period, which will
assist in the rational decision making.

Components of Financial Statement

A financial statement is a combination of five major statements, as shown in
the figure below:
Income Statement or Trading and Profit & Loss
Account
The profit earned or loss sustained by the enterprise during an accounting
period can be ascertained by the preparation of the income statement. The
profit/loss is calculated at two levels, i.e. gross profit and net profit. The
gross profit is nothing but the variance in the selling price and cost of goods
sold, which is measured by preparing a trading account.

On the other hand, net profit can be calculated by preparing a profit and loss
account. The profit and loss account is a summary of the company’s
revenues and expenses and reflects the outcome of the company’s operations
for the specified period.

Position Statement or Balance Sheet

A Balance Sheet can be understood as a snapshot indicating the company’s
obligations and resources, i.e. liabilities and assets, at a specified date.
Although a single transaction, can make a huge difference in the overall
picture of the company’s position, the balance sheet is correct at a specific
point of time. And only because of this very reason, we use the word ‘as
at’ along with the date. That is why it is called a position statement.

Cash Flow statement

Cash flow statement is a summary of company cash sources and
applications. It ascertains the firm’s effectiveness in generating cash to pay
off its obligations, funding the operations and investment activities.

The cash flow statement reflects the changes in the company’s cash and cash
equivalents, i.e. commercial paper, certificate of deposit, treasury bills,
marketable securities, short term government bonds, etc. between two
accounting period.

Statement of changes in equity (if applicable)

It is a statement that indicates the changes in the company’s share capital,
retained earnings and reserves over the accounting period, i.e. it reconciles
the equity balances at the beginning with the balances at the end.

Explanatory notes
Otherwise called as notes to accounts, these are supporting notes annexed
to any of the above statements. It provides additional information about the
company’s operations and finance.

Simply put, the financial statement is nothing but a basic formal annual report
that helps the company to conveys the financial information to the interested
parties such as owners. investors, employees, government, tax authorities
and so forth.

Fund Flow Statement

Definition: Fund Flow Statement implies a snapshot of the movement of
funds, i.e. inflow or outflows of the firm’s financial assets for a specific period.
It represents, “from where the funds are received and where the funds are
utilised” by the company during a particular period.

The word ‘fund‘ refers to a sum of money, which is used to finance the firm’s
day to day operations and acquire assets for the business. The flow of
funds represents the movement of funds, i.e. the change in economic
resources, from one asset or liability to another. In this way, the fund flow
statement implies a method of analysing the changes in the firm’s financial
position, between two balance sheet dates.

Fund flow statement is useful in knowing the changes in the structure of

assets, liabilities and capital. It shows whether the sources of funds coincides
with its application and indicates the accuracy of a firm’s financing
and investment decisions. Unlike the cash flow statement, which is prepared
on a cash basis, the fund flow statement is prepared on an accrual basis.

Preparation of Fund Flow Statement

 Step 1: Preparation of Statement of Changes in Working Capital:
Statement of Changes in working capital is a summary that shows the
net increase or decrease in the working capital of the business.
The working capital of the firm increases if there is an increase in the
current assets or decrease in the current liabilities. However, the
working capital of the firm decreases if there is a decrease in the current
assets and an increase in the current liabilities.

Further, there will be no change in the working capital if there is a

realization from debtors or bills receivable or payment made to creditors
or bills payable, goods are sold on credit and goods are purchased on
 credit.

 Step 2: Determination of Funds from Operations: Funds from

operations refers to the profit earned or loss incurred from the regular
business operation. The ascertainment of funds from the operation is
 vital for the preparation of fund flow statement.

 Step 3: Preparation of Fund Flow Statement: After recognizing the

funds/loss from operations, fund flow statement is prepared, which will
 show the net increase or decrease in the working capital.

Basically, any change in the assets and liabilities may result in the inflows and
outflows of funds, but not always, as in case of depreciation or revaluation of
assets, there is no inflow or outflow of funds. Hence, only those assets or
liabilities will become a part of the statement, which actually leads to the flows
of the fund to/from the business.

Golden Rules of Accounting

Definition: In Double entry system, due to its dual aspect, every transaction
affects two accounts, one of which is debited and other is credited. To record
the transactions in the journal, in a sequential way, certain rules are required,
and these rules are called as Golden Rules of Accounting.

Types of Account
To understand the golden rules of accounting, one should know the types of
accounts. Basically, there are two types of accounts, namely:

1. Personal Account: Accounts that deals with persons, i.e. human

beings and artificial judicial persons such as companies, government
organisations, HUF, etc.
o Natural Personal Account: Accounts that are concerned with
natural human beings are called natural personal account. It
includes accounts of debtors, creditors, proprietor, etc.
o Artificial Personal Account: All the business concern has a
separate legal identity in the eyes of the law, and so the entities
are different from its members. Therefore, the accounts of clubs,
charitable trust, company, bank, etc are covered under this
category.
o Representative Personal Account: The accounts which
represent persons or group thereof, are called representative
personal accounts, such as capital A/c, drawings A/c, prepaid A/c,
outstanding liability A/c.
2. Impersonal Account: As the name suggests, the accounts which are
not personal are called impersonal account.
o Real Account: Real accounts covers all the accounts related to
firm’s assets. It includes both tangible real account, such as cash
A/c, building A/c, furniture A/c, investment A/c, etc. and intangible
real account, such as goodwill A/c, patent A/c, intellectual
property A/c.
 o Nominal Account: These are fictitious accounts, that are
associated with expenses, losses, revenues and gains of the firm,
such as rent and rates account, travelling expenses A/c, the
commission received A/c, interest paid A/c.
As far as the business transactions are concerned, they are divided into three
categories:

 Personal transactions.
 Transactions related to business assets.
 Transactions related to expenses, losses, incomes and gains.
Personal Transactions are recorded in a personal account, transactions
concerning assets and properties are covered in real account. Lastly,
transactions related to expenses losses incomes and gains are considered in
the nominal account. In short, the golden rules of accounting are provided for
these three accounts only.

Golden Rules of Accounting

1. Personal Account
Debit the Receiver, Credit the Giver
2. Real Account
Debit what comes in, Credit what goes out
3. Nominal Account
Debit all expenses and losses, Credit all incomes and gains

Example
 Commenced business with cash Rs. 5,00,000

 Purchased goods from Alex Rs. 25,000

  Sold goods worth Rs. 10,000 to Sam for cash

 Office Rent paid Rs. 12,000

The Golden rules of Accounting are the mainstay of the entire process of
accounting. These are the rules for debit and credit, that helps in the
preparation and presentation of financial statement in a systematic manner.

Vouching
Definition: Vouching is the process of analysing vouchers of the business
enterprise. It is a step pursued in auditing, with an aim of checking the
accuracy and reliability of the transactions entered in the company’s books of
accounts.

In this process, the company’s transactions are thoroughly verified with the
documentary evidence and the authority, which forms a basis for recording
the transactions in the accounts books.

Further, it also validates that the amount stated in the voucher is accurately
entered in the relevant account, which indicates the nature of the respective
transaction when it is included in the financial statements.

What is a Voucher?
A voucher is nothing but a written or printed piece of documentary evidence,
which authenticate the transactions, i.e. it proves that the entries made in the
books of accounts are real and genuine.

Vouchers can be sales invoice, purchase invoice, bank statements, minutes

book, cash memo, bills, bank paying slip, purchase requisition slip, receipt,
salaries and wage sheet, gate keeper’s note, bank passbook, memorandum
and articles of association, delivery challans, stores, records, counterfoil of
cheque book, etc.

The points stated hereunder are to be considered at the first place while
checking vouchers:

1. It should be duly authorized by the stipulated signatory.

2. Date of the voucher.
3. Name of the party or client mentioned in the voucher.
4. It should be complete.
5. It belongs to the business entity.
Once the vouchers are examined, they must be imprinted with a stamp or
signed, to ensure that they are not presented further, as proof of another
transaction.

Objectives of Vouching
 To check whether proper documentary evidence is there in support of
the entries made in the books of accounts.
 To check whether the transactions are duly authenticated by the person
in charge.
 To make sure that all the transactions that have been occurred, are
entered in the books of accounts.
 To check whether there are any fake or fraudulent transactions
recorded in the books of accounts.
 To ensure that only business related transactions are entered in the
books of accounts.
 To check no entries are missing or omitted from the books of accounts.
 To examine the transaction for which money paid or received relates to
the business.
 To examine that capital and revenue expenses and receipts of the
business are properly classified.
 To examine that the entries are made in the relevant account only with
the correct amount.
  To check whether the transaction belongs to the entity.
 To check if there is any alteration made in the voucher, it has been
recorded or not.
As vouching examines the truth of the transactions entered in the company’s
accounts, it is known as an acid test of the audit.

Importance of Vouching
1. Evidence: One of the main benefits of the vouching is that all the
documentary evidence which substantiate transactions are thoroughly
examined, which helps in identifying the genuineness of the transaction.
2. Assurance: Vouching is the crux of auditing, wherein the auditor
confirms that transactions that actually occurred are properly recorded,
in the appropriate account, with exact amount and in the relevant
accounting period. Further, it also helps in identifying that there is a
proper classification of transactions, along with that proper disclosure of
accounting policies has been made.
3. Verification: Once vouching of the transactions recorded is over,
verification of assets and liabilities is done. Therefore, vouching acts as
a basis for verifying the assets and liabilities.
In a nutshell, in the vouching process, the auditor examines the genuineness,
authenticity, completeness, validity, authorization, classification and accuracy
of transactions and also checks that the disclosure of accounting policies and
principles has been done.

Single Entry System

Definition: Single Entry System, is the oldest and most straightforward
method of keeping records of financial transactions, which is rarely prevalent
these days. In this system, only one side of the transaction is recorded,
because of the absence of any prescribed rules and so the records
maintained are more or less incomplete.

In a nutshell, single entry system of bookkeeping lacks the duality

concept and so the financial transactions are recorded only once and not in
their two-fold aspects, as debit and credit.
Characteristics of Single Entry System
 Maintenance of Cash Book: Cash Book is prepared and maintained, in
which both business and personal transactions are included.
 Personal Accounts: Only personal accounts are created and
maintained, whereas the real and nominal accounts are not given due
weight, in this system.
 Original Vouchers: Under this system, original vouchers play an
important role, as they help in gathering information about the date of
transaction, amount, parties, discount (if any) and so forth.
 Final Accounts: In Single Entry System, it is quite difficult to prepare
final accounts, due to unavailability of nominal and real accounts. So, to
prepare the financial statement, the available information is analysed
and converted into a double entry system, by determining the missing
figures, after that Trading and Profit & Loss Account is prepared.
Further, the figures of assets and liabilities are calculated from the
information at hand, but they are also estimates. Hence, the Statement
of Affairs is prepared in place of the Balance Sheet.
 Profit or Loss: Profit earned or loss sustained is estimated, out of the
information available and so exact profits is not ascertained.
 Suitability: The system is appropriate for small businesses, like sole
proprietorship business and partnership firms, as they maintain records
of cash and credit transactions only.

Types of Single Entry System

 1. Pure Single Entry System: In this method, only the personal accounts
are maintained and there is no information present, concerning the
sales and purchases, cash in hand, and bank balance.
2. Simple Single Entry System: In a simple single entry system, cash
book is maintained along with the personal accounts and these are
maintained as per double entry system of bookkeeping. Cash received
or paid, from/to business debtors or creditors are merely written on the
bills issued or received.
3. Quasi Single Entry System: In this system, subsidiary books such as
sales book, purchases book, bills receivable book and bills payable
book are maintained in addition to cash book and personal accounts.
Single Entry System is simple and easy to maintain as it does not need any
professional accountant to keep the records up to date. And so this system is
quite helpful for small businesses and trades operated solely by individuals.
Further, the system is quite economical.

Limitations of Single Entry system

It is an unscientific method of keeping business records because it does not
follow the duality concepts (meaning that every transaction affects two sides).
Profit or loss ascertained and reported are simply estimates, which cannot be
considered as actual and accurate, because of not maintaining real and
nominal accounts.

Moreover, it is not easy to detect frauds and errors (if any). The firm may also
face difficulties in raising loans because the banks and financial institutions
cannot rely on financial information provided by the entity. Due to this very
reason, this method is not adopted by companies, and they have to maintain
their books of accounts as per the Companies Act,

Bookkeeping
Definition: Bookkeeping can be defined as the system of keeping records
and classifying all the financial transactions on a day-to-day basis concerning
the business operations, in a sequential manner.

The term “transaction” refers to the business activity, in which the exchange of
money or money’s worth for goods or services is involved.

It is the initial step to the accounting process, which supplies the preliminary
information required to prepare and maintain accounts. Hence, the accounting
is based on the proper system of bookkeeping. It involves:

1. Gathering basic financial data.

2. Identifying the transactions and events with the financial aspect, i.e. only
monetary transactions are to be entered in the books of accounts.
3. Measuring the transactions in monetary terms.
4. Keeping a record of the financial effect of the transactions, in the order
in which they arise.
5. Classifying the effect of transactions
6. Preparing statement, i.e. trial balance.

Objectives of Bookkeeping
The main objectives of bookkeeping are:
  To record the transactions: Bookkeeping is all about keeping a full-
fledged record of all the transactions, as and when they take place, in
an orderly manner.
 To ascertain financial effect: Bookkeeping tends to reflect the financial
effect of all the business transaction occurred in a financial year on the
business.
 To show the correct position: If bookkeeping work is adequately
performed, it shows the correct position of the business, concerning the
income and expenditure, assets and liabilities.
The purpose of bookkeeping is to make sure that the financial transaction is
correct, chronological, up-to-date and complete. The main aim of maintaining
records is to depict the exact position of the company regarding the incomes
and expenses.

Types of Bookkeeping System

There are two types of bookkeeping system:

1. Single Entry System: As the name itself signifies, single entry system
of bookkeeping involves the recording of only one side of the
transaction, as it does not follow any principles or rules. It is mainly used
by small businessman, which have minimal transactions.
 This system of bookkeeping is considered as incomplete and
inaccurate, as it only maintains a record of cash receipts and payments,
purchases and sales.

2. Double Entry System: This system is based on the duality concept, i.e.
every transaction affects two accounts. It means that each debit entry to
an account has a corresponding credit entry in another account and vice
versa.
This system of bookkeeping is universally adopted and considered as
accurate for recording business transactions.

Methods of Bookkeeping
There are two methods of bookkeeping, discussed as under:

 Manual Bookkeeping: It is the conventional method of bookkeeping

which involves manually writing the transactions in the books of
accounts. It is mainly used by small businessman having minimum
transactions, as it is cheaper and easier to maintain.
  Computerized Bookkeeping: With the introduction of computers,
nowadays all the bookkeeping work is carried out through computers or
laptops. It is an emerging method of keeping a record of financial
transactions wherein accounting/bookkeeping software packages are
used by the businesses.
This method of bookkeeping is common among business houses, due
to convenience and user-friendly interface.

The task of bookkeeping is performed by a bookkeeper, who keeps track of all

the financial data and organizes them systematically.

The work is clerical, which is often delegated to junior employees, in the

accounts department. The work involves entering the transactions in the
daybooks, i.e. purchase book, purchase return book, sales book, sales return
book, cashbook, journal, etc., posting the same to the ledger and finally
preparing a trial balance.