ACCOUNTING FOR MANAGEMENT

INTRODUCTION: Accounting is a business language. We can use this language to communicate

financial transactions and their results. Accounting is comprehensive system to collect, analyzes,
and communicates financial information. The origin of accounting is as old as money. In early
days, the numbers of transactions were very small, so every concerned person could keep the
record of transactions during a specific period of time. Gradually, the field of accounting has
undergone remarkable changes in compliance with the changes happening in the business scenario
of the world.

DEFINITION OF ACCOUNTING

Accounting is a system that identifies record and communicates information that is relevant,
reliable, and comparable to help user make better decision. As per the American Institute of
Certified Public Accountants (AICPA) – Accounting is an art of recording, classifying and
summarizing transactions and events which are in part at least of financial character, in a
significant manner and in terms of money, and interpreting the results thereof.

American Accounting Association defines accounting as "the process of identifying,

measuring, and communicating economic information to permit informed judgments and
decisions by users of the information.”
In the opinion of Bierman and Derbin, “Accounting may be defined as the identifying, measuring,
recording and communicating of financial information.”

From the above the following attributes/stapes of accounting emerge:

(i) Identifying business Transaction- Accounting recodes only those transactions and events
which can be measured in terms of money. This involves identifying transaction and events that
are part of economic activity, for example, purchase of raw material or sales of finished goods
by firm.

(ii) Measuring Business Transaction- Financial transaction and events are measured in terms of
money. An event which cannot be measured in terms of money is not recorded in the book of
account. For example, event like the caliber or quality of employ are not recorded in books of
accounting.
(iii) Recording: Accounting is an art of recording business transaction in the books of
original entry i.e. Journal.
 (iv) Classifying: Classifying is the process of grouping or entries of one nature at one
place. The transaction recorded in the Journal or the subsidiary books are classified or posted
in the main books of accounts know as ledger.

(v) Summarizing: This involves presenting the classified data in a manner which is
understandable and useful for internal as well as external users of financial statement. This
process leads to the preparation of trial balance for which:

1- Trading and Profit & Loss Account

2- Balance Sheet

(vi) Analysis and Interpreting: Analysis and Interpretation of the financial data are
carried out so that the users of financial data can make a meaningful judgment of the
profitability and financial position of the business. The accountant should explain not only
what has happened but also (a) why it happened, and (b) what is likely to happen under
specified conditions.

(vii) Communicating: Accounting function involves communicating the financial

information, i.e. financial statement, to its users. The accounting information should
be provided in time to the users so that appropriate decision may be taken at the
appropriate time.

Bookkeeping
Bookkeeping is the process of systematic recording and classification of financial transactions of
an organization.

Bookkeeping is said to be the basis of accounting, whereas accounting forms a part of the broader
scope in finance.

The most important focus of bookkeeping is to maintain an accurate record of all the monetary
transactions of a business. Companies use this information to take major investment decisions.

The bookkeeper maintains bookkeeping records. Accurate bookkeeping is critical for business as
it gives a piece of reliable information on the performance of a company.

Bookkeeping process consists of the following steps:

1. Identifying a financial transaction

2. Majoring a financial transaction
3. Recording a financial transaction
4. Preparing a ledger account
5. Preparing trial balance
Accounting
Accounting is the systematic process of recording, measuring and communicating information
about the financial transaction taking place in a business. Accounting helps in determining the
financial position of a firm and presents the same to stakeholders.

It helps a business in the short and long term decision making and also conveys the credibility of
a company to the market.

It is also known as the language of business.

The purpose of accounting is to provide a clear view of financial statements to its users, which
includes investors, creditors, employees, and government.

Accountancy- Accountancy is a systematic knowledge of accounting. It is an educating process

whereby various aspects of accounting are explained along with the reason, how to maintain the
books of account, summaries the accounting information and communicate it to the users. In the
words of Kohler, accountancy refer to the entire body of the theory and practice of accounting.
Difference Between Bookkeeping and Accounting

Parameters Bookkeeping Accountancy

It is the process in which a firm Accountancy is mostly concerned with

owner identifies, measures and interpreting, summarizing and
Definition
records everyday financial communicating financial data about
transactions. transactions.

It helps to measure a firm’s financial

It helps to record all financial
Objective standing and communicates the same to
transactions systematically.
concerned entities.

It uses all information compiled through

Analysis
It does not require to be analyzed. bookkeeping to analyze data and interpret
requirement
them to form informative reports.

Financial Financial statement is not a part of Financial statements are prepared through
statement bookkeeping. the course of accounting.
Decision- It does not facilitate or impact the It impacts the decision-making process
making role decision-making process of a firm. significantly.

It does not demand a particular skill Accounts are required to possess strong
Skills required
set. analytical skills.

SCPO OF ACCOUNTING

Accounting has got a very wide scope and area of application. Its use is not confined to the business
world alone, but spread over in all the spheres of the society and in all professions. Now-a-days,
in any social institution or professional activity, whether that is profit earning or not, financial
transactions must take place. So there arises the need for recording and summarizing these
transactions when they occur and the necessity of finding out the net result of the same after the
expiry of a certain fixed period. Besides, the is also the need for interpretation and communication
of those information to the appropriate persons. Only accounting use can help overcome these
problems. In the modern world, accounting system is practiced no only in all the business
institutions but also in many non-trading institutions like Schools, Colleges, Hospitals, Charitable
Trust Clubs, Co-operative Society etc. and also Government and Local Self-Government in the
form of Municipality, Panchayat. The professional persons like Medical practitioners, practicing
Lawyers, Chartered Accountants etc. also adopt some suitable types of accounting methods. As a
matter of fact, accounting methods are used by all who are involved in a series of financial
transactions. The scope of accounting as it was in earlier days has undergone lots of changes in
recent times. As accounting is a dynamic subject, its scope and area of operation have been always
increasing keeping pace with the changes in socio-economic changes. As a result of continuous
research in this field the new areas of application of accounting principles and policies are
emerged. National accounting, human resources accounting and social Accounting are examples
of the new areas of application of accounting systems.

NATURE OF ACCOUNTING: We know Accounting is the systematic recording of financial

transactions and presentation of the related information of the appropriate persons. The basic
features of accounting are as follows:
1. Accounting is a process: A process refers to the method of performing any specific job step by
step according to the objectives, or target. Accounting is identified as a process as it performs the
specific task of collecting, processing and communicating financial information. In doing so, it
follows some definite steps like collection of data recording, classification summarization,
finalization and reporting.

2. Accounting is an art: Accounting is an art of recording, classifying, summarizing and finalizing

the financial data. The word „art‟ refers to the way of performing something. It is a behavioral
knowledge involving certain creativity and skill that may help us to attain some specific objectives.
Accounting is a systematic method consisting of definite techniques and its proper application
requires applied skill and expertise. So, by nature accounting is an art

3. Accounting is means and not an end: Accounting finds out the financial results and position
of an entity and the same time, it communicates this information to its users. The users then take
their own decisions on the basis of such information. So, it can be said that mere keeping of
accounts can be the primary objective of any person or entity. On the other hand, the main objective
may be identified as taking decisions on the basis of financial information supplied by accounting.
Thus, accounting itself is not an objective, it helps attaining a specific objective. So it is said the
accounting is „a means to an end‟ and it is not „an end in itself.‟

4. Accounting deals with financial information and transactions; Accounting records the
financial transactions and date after classifying the same and finalizes their result for a definite
period for conveying them to their users. So, from starting to the end, at every stage, accounting
deals with financial information. Only financial information is its subject matter. It does not deal
with non-monetary information of non-financial aspect.

5. Accounting is an information system: Accounting is recognized and characterized as a

storehouse of information. As a service function, it collects processes and communicates financial
information of any entity. This discipline of knowledge has been evolved out to meet the need of
financial information required by different interested groups.
Advantages of Accounting

1. A complete and systematic record: Accounting is based on generally accepted principles

and a scientific way of presenting business transactions in books of accounts. Accounting as
such is the complete and systematic recording of all business transactions. The limitation of
people not being able to remember all transactions can be overcome by accounting because every
business transaction can be recorded and analyzed through it.

2. Determination of the selling price: The main function of management is decision-making.

Accounting helps and guides management in making decisions about setting the selling price,
deducting costs, increasing sales, etc.
3. Valuation of the enterprise: In the case of the sale of a business or conversion of one business
to another, the actual and fair value of the business is calculated. Through accounting, the correct
picture can be displayed on the balance sheet, and thus the purchase price can be determined. A
balance sheet shows the value of a business’s assets and liabilities, which can be used to calculate
its net worth.
4. It helps in obtaining a loan: For further expansion, the business must have sufficient funds.
Sometimes due to lack of funds, the business cannot do well. In these cases, additional funds can
be obtained by borrowing from some financial institutions, like banks, IDBI, ICICI, etc. These
financial institutions lend money based on the profitability and reliability of the business.
Profitability and reliability can be measured using the Profit and Loss Statements and the
Balance Sheet, the final results of the accounting process.
5. Evidence in court: Business transactions are recorded in accounting books supported by
certified documents, viz. vouchers, etc. Accounts can thus be used as evidence in court.
6. In accordance with the law: Every business has to deal with various government
departments, like Income Tax, Sales Tax, Customs and Excise, etc. Various regular returns need
to be filed with these departments. Accounting helps in the preparation and filing of such returns.
7. Inter-company or intra-company comparison: A trading account and a profit and loss
account show the net profit or net loss incurred by the business. With proper accounting, records
relating to various costs, sales, gross and net profit, etc., can be compared. As such, accounting
helps in inter-company and intra-company comparisons. Comparing the accounts of two
different companies for the same year is known as inter-company comparison and comparing
two different periods for the same company is known as an intra-company comparison. The
company’s performance is then compared with predetermined goals, and any deficiencies can
be corrected accordingly.
8. Facilitates auditing: Depending on the size, nature, and type of business, certification of the
books of account, known as an audit, is mandatory. The audit certificate issued by the accounting
auditor is a clean document of the organization, which proves that there are no irregularities in
the organization.
9. Effective management: Accounting facilitates proper management feedback. As such, it
helps the management in planning as well as controlling the various activities of the enterprise.
It also helps the management to evaluate the performance of the company and take timely
measures to eliminate management deficiencies.
Disadvantages of Accounting
1. Does not guarantee accuracy: Accounting records all financial transactions with past value.
It does not take into account the fair or market value of assets and liabilities. Values are easy to
manipulate.
2. Actual value of items: Financial account does not show the actual value of assets. It shows
the past value of assets. Depreciation can be charged in any way and at any rate.
3. Accounting ignores the qualitative element: It records all financial transactions that are in
monetary form but doesn’t consider qualitative factors, i.e., emotions, employees, relationships
and public relations.
4. Accounts can be manipulated: Accounts can be manipulated to avoid tax and show a false
position to investors. By making small changes to the account, the financial statements can be
manipulated.
5. Costly for a small business: A small business does not have a lot of finances, so it is very
expensive for them to get proper accounting tools, and get it audited by a chartered accountant.
6. Business Privacy: There is no privacy for those who prepare the accounts, as they have to
show it to the general public including your competitors.
Role of Accounting in business
1. Evaluates business performance: Financial situation of a business can be represented with
the help of Accounting statements. Once you have a clear idea of what is going on in your
business financially, you can easily plan your future tasks accordingly. You will be able to track
expenses effortlessly, further allowing you to allocate the budget accordingly.
2. Create budget projections: Accounting also helps in creating future projections that have
the power to make or break the business. It helps to evaluate business trends and projections to
keep the operations profitable. Thus, it’s important to have a well-structured accounting process.
3. Maintain financial statements: Accounting also helps in preparing financial statements.
Every business must file its financial statements for tax purposes. If you have proper records of
your business finances, you can easily handle all scenarios and achieve your goals.
4. Ensure compliance with the law: Businesses need legal compliance to ensure their
accounting system is validated against various laws and regulations. All liabilities, such as
income tax, sales tax, pensions, employee funds, etc., can be easily dealt with if we have a
structured accounting system.

USER OF ACCOUNTING INFORMATION

The progress and reputation of any business firm is built upon the sound financial footing. There
are a number of parties who are interested in the accounting information relating to business.
Accounting is the language employed to communicate financial information of a concern to such
parties.
(A) Internal Users:
Internal users of accounting information are those persons or groups which are within the
organization.

1. Owners:
The owners provide funds or capital for the organization. They possess curiosity in knowing
whether the business is being conducted on sound lines or not and whether the capital is being
employed properly or not.

Owners, being businessmen, always keep an eye on the returns from the investment. Comparing
the accounts of various years helps in getting good pieces of information. Properly kept accounts
are good proof in dispute, they determine the amount of goodwill and facilitate in assessing various
taxes.

2. Management:
The management of the business is greatly interested in knowing the position of the firm. The
accounts are the basis; the management can study the merits and demerits of the business activity.
Thus, the management is interested in financial accounting to find whether the business carried on
is profitable or not. The financial accounting is the “eyes and ears of management and facilitates
in drawing future course of action, further expansion etc.”

3. Employees:
Payment of bonus depends upon the size of profit earned by the firm. The more important point is
that the workers expect regular income for the bread. The demand for wage rise, bonus, better
working conditions etc. depend upon the profitability of the firm and in turn depends upon financial
position. For these reasons, this group is interested in accounting.

(B) External Users:

External users are those groups or persons who are outside the organization for whom accounting
function is performed.

Following are such external users:

1. Creditors:
Creditors are the persons who supply goods on credit, or bankers or lenders of money. It is usual
that these groups are interested to know the financial soundness before granting credit. The
progress and prosperity of the firm, to which credits are extended, are largely watched by creditors
from the point of view of security and further credit. Profit and Loss Account and Balance Sheet
are nerve centres to know the soundness of the firm.

2. Investors:
The prospective investors, who want to invest their money in a firm, of course wish to see the
progress and prosperity of the firm, before investing their amount, by going through the financial
statements of the firm. This is to safeguard the investment. For this, this group is eager to go
through the accounting which enables them to know the safety of investment.

3. Government:
Government keeps a close watch on the firms which yield good amount of profits. The state and
central Governments are interested in the financial statements to know the earnings for the purpose
of taxation. To compile national accounts the accounting is essential.

4. Consumers:
These groups are interested in getting the goods at reduced price. Therefore, they wish to know
the establishment of a proper accounting control, which in turn will reduce the cost of production,
in turn less price to be paid by the consumers. Researchers are also interested in accounting for
interpretation.

5. Research Scholars:
Accounting information, being a mirror of the financial performance of a business organization, is
of immense value to the research scholar who wants to make a study into the financial operations
of a particular firm.

To make a study into the financial operations of a particular firm the research scholar needs
detailed accounting information relating to purchases, sales, expenses, cost of materials used,
current assets, current liabilities, fixed assets, long-term liabilities and shareholders’ funds which
is available in the accounting records maintained by the firm.

6. Financial Institutions:
Bank and financial institutions that provide loan to the business are interested to know credit-
worthiness of the business. The groups, who lend money need accounting information to analyses
a company’s profitability, liquidity and financial position before making a loan to the company.
Further, they keep constant watch on the operating results and financial position of the business
through accounting data.

7. Regulatory Agencies:
Various Government departments such as Company law department, Reserve Bank of India,
Registrar of Companies etc. require information to be filed with them under law. By examining
this accounting information they ensure that concerned companies are following the rules and
regulations.

BRANCHES OF ACCOUNTING
To meet the ever increasing demands made on accounting by different
interested parties such as owners, management, creditors, taxation authorities etc.,the
various branches have come into existence. There are as follows :
1. Financial accounting. The object of financial accounting is to ascertain the
results (profit or loss) of business operations during the particular period and to state the
financial position (balance sheet) as on a date at the end of the period.

2. Cost accounting. The object of cost accounting is to find out the cost of goods
produced or services rendered by a business. It also helps the business in controlling the costs
by indicating avoidable losses and wastes.

3. Management accounting. The object of management accounting is to supply relevant

information at appropriate time to the management to enable it to take decisions and effect
control.

SYSTEMS OF ACCOUNTING

(a) Cash System. Under this system, actual cash receipts and actual cash payments
are recorded. Credit transactions are not recorded at all until the cash in actually received
or paid. The Receipts and Payments Account prepared in case
of non-trading concerns such as a charitable institution, a club, a school, a college, etc. and
professional men like a lawyer, a doctor, a chartered accountant etc. can be cited as the best
example of cash system. This system does not make a complete record of financial
transactions of a trading period as it does not record outstanding transactions like
outstanding expenses and outstanding incomes. The system being based on a record of actual
cash receipts and actual cash payments will not be able to disclose correct profit or loss
for a particular period and will not exhibit true financial position of the business on a
particular day.

(b) Mercantile (Accrual) system. Under this system all transactions relating to a
period are recorded in the books of account i.e., in addition to actual receipts and
payments of cash income receivable and expenses payable are also recorded. This system
gives a complete picture of the financial transactions of the business as it makes a record
of all transactions relating to a period. The system being based on a complete record of
the financial transactions discloses correct profit or loss for a particular period and also
exhibits true financial position of the business on a particular day.

ACCOUNTING PRINCIPLES

In dealing with the framework of accounting theory, we are confronted with a serious problem
arising from differences in terminology. A number of words and terms have been used by different
authors to express and explain the same idea or notion. The various terms used for describing the
basic ideas are: concepts, postulates, propositions, assumptions, underlying principles,
fundamentals, conventions, doctrines, rules, axioms, etc. Each of these terms is capable of precise
definition. But, the accounting profession has served to give them lose and overlapping meanings.
One author may describe the same idea or notion as a concept and another as a convention and still
another as postulate. For example, the separate business entity idea has been described by one
author as a concept and by another as conventions. It is better for us not to waste our time to discuss
the precise meaning of generic terms as the wide diversity in these terms can only serve to confuse
the learner. We do feel, however, that some of these terms/ideas have a better claim to be called
„concepts „ while the rest should be called „conventions‟. The term „Concept‟ is used to connote
the accounting postulates, i.e., necessary assumptions and ideas which are fundamental to
accounting practice. In other words, fundamental accounting concepts are broad general
assumptions which underline the periodic financial statements of business enterprises. The reason
why some of the these terms should be called concepts is that they are basic assumptions and have
a direct bearing on the quality of financial accounting information. The term „convention‟ is used
to signify customs or tradition as a guide to the preparation of accounting statements. The
following are the important accounting concepts and conventions:

ACCOUNTING CONCEPTS & CONVENTIONS ACCOUNTING CONCEPTS:

Enforced by law

Accounting concepts are the assumptions and conditions on the basis of which financial statements
of an entity are prepared. These are the concepts which are adopted by the organizations in
preparation of financial statements to achieve uniformity in reporting. Accounting concepts are the
base for formulation of accounting principles.

Accounting concepts have universal application. Concept” means any idea or notion, which has a
universal application.

✓ Accounting concepts are the basic conditions which lay down the foundation for
formulating the accounting principles.
✓ They are clearly defined and supported by reasoning.
1) Business entity concept: Entity concept assumes that business enterprise is separate from
its owners. Accounting transactions should be recorded with this concept only. The main
intention of this concept is to keep the business transactions keep away from the influence
of personal transactions of its owners.

Examples :- Insurance premiums for the owner’s house should be excluded from the expense
of the business

The owner’s property should not be included in the premises account of the business

Any payments for the owner’s personal expenses by the business will be treated as drawings
and reduced the owner’s capital contribution in the business
(2) Going concern concept: As per this concept financial statements are prepared on an
assumption that enterprise will continue its operations for the foreseeable future. Thus, it says that
enterprise has neither the intention nor the need to liquidate or curtail the scale of its operations.
Valuation of assets of a business entity is dependent on this assumption.

 Example

 Possible losses form the closure of business will not be anticipated in the accounts

 Prepayments, depreciation provisions may be carried forward in the expectation of

proper matching against the revenues of future periods

 Fixed assets are recorded at historical cost

(3) Accounting period Concept: As per going concern concept an entity is assumed to have
indefinite life. If we want to measure the financial performance of an entity then we need to divide
the operations of entity for a specific period, otherwise it’s very difficult to ascertain the
performance of business. Periodicity concept assumes a small but workable fraction of time period
for measuring the business performance. Generally it assumes 1 year is taken for this purpose.

(4) Matching concept: As per this concept all the expenses which can be matched with the revenue
of that period only should be taken into consideration for financial reporting. This concept is based
on Accrual concept as it gives importance to occurrence of an expense which is spent for
generating revenue. This concept leads to adjustments at the end like outstanding expenses, income
and Prepaid expenses, incomes.

 Example

 Expenses incurred but not yet paid in current period should be treated as
accrual/accrued expenses under current liabilities

 Expenses incurred in the following period but paid for in advance should be treated
as prepayment expenses under current asset.

 Depreciation should be charged as part of the cost of a fixed asset consumed during
the period of use
(5) Money measurement concept: As per this concept transactions which can be measured in
monetary terms only are to be recorded in books of accounts. Any transactions which can not be
converted into monetary terms should not be recorded in books. Since money is the medium of
exchange and unit of measurement for showing the financial performance , it doesn’t accept the
transactions other than monetary to record in books of accounts.

 Examples

 Market conditions, technological changes and the efficiency of management would

not be disclosed in the accounts

(6) Accrual concept: As per this concept transactions should be recognized in the books of
accounts only when they occur and not on any cash basis. The main advantage of this concept is
that financial Statements prepared as per this concept inform the users not only about past events
involving payment and receipt of cash but also about obligations to pay cash in the future and
resources that represent cash to be received in the future.

(7) Cost concept: As per this concept valuation of assets should be done at historical
costs/acquisition cost.

 Example

 The cost of fixed assets is recorded at the date of acquisition cost. The acquisition
cost includes all expenditure made to prepare the asset for its intended use. It
included the invoice price of the assets, freight charges, insurance or installation
costs

(8) Realization concept: This concept says that any change in value of an asset is to be recorded
only when the business realizes it. This concept highly prefers Realization of the value for which
we want to give effect in books of accounts.

 Example

 Goods sent to our customers on sale or return basis

  This means the customer do not pay for the goods until they confirm to buy. If they
do not buy, those goods will return to us

 Goods on the ‘sale or return’ basis will not be treated as normal sales and should
be included in the closing stock unless the sales have been confirmed by customers

(9) Dual Aspect concept: This concept is base for double entry Accountings of a transaction.
Under the system, aspects of transactions are classified into two main types:

1.Debit

2.Credit

Every transaction should have a Debit and credit. Debit is the portion of transaction that accounts
for the increase in assets and expenses, and the decrease in liabilities, equity and income. And
credit is the portion which is a results of decreases the asset, increases the liability, income, gains,
equity.

Assets = Liabilities + Capital

Moral value

ACCOUNTING CONVENTIONS: Accounting conventions are the generally accepted

guidelines in preparation of financials. They arise from customs and practical application. They
are not legally documented policies.

(a) Accounting Conventions are the general procedures emerging out of usage and practice of
accounting principles.

(b) Conventions may not have universal application.

(c) They may contradict the basic accounting principles.

(d) Further, certain conventions may be changed over a period of time, by Accounting Bodies like
ICAI, for improving the quality of Financial Statements.
Example: In India, pedestrians walk on the left side and the vehicles go on the right side of the
road. This is traditionally accepted practice and everybody follows it

(1) Conservatism : As per this concept while Accounting one should not anticipate the income
but should provide for all possible losses. When there are many alternative values to account an
asset then we should choose the lesser value. Inventory valuation is done as per this concept only
, as cost or Market value whichever is lower.

 Example

 Stock valuation sticks to rule of the lower of cost and net realizable value

 The provision for doubtful debts should be made

 Fixed assets must be depreciated over their useful economic lives

(2) Consistency : As per this concept the accounting policies followed in preparation and
presentation of financial statements should be consistent from one period to another period. A
change in Accounting policy can be made only when it is required by law, or for better presentation
of accounts or change in Accounting standards.

 Examples

 If a company adopts straight line method and should not be changed to adopt
reducing balance method in other period

 If a company adopts weight-average method as stock valuation and should not be

changed to other method e.g. first-in-first-out method

(3) Materiality: As per this concept items having significant economic effect on the business of
the enterprise should be disclosed in financial statements and any insignificant item which is not
relevant to the users should not be disclosed in financial statements.

 Example
  Small payments such as postage, stationery and cleaning expenses should not be
disclosed separately. They should be grouped together as sundry expenses

 The cost of small-valued assets such as pencil sharpeners and paper clips should be
written off to the profit and loss account as revenue expenditures, although they can
last for more than one accounting period.

ACCOUNTING PROCESS

1.Collecting and Analyzing Accounting Documents It is a very important step in which you
examine the source documents and analyze them. For example, cash, bank, sales, and purchase
related documents. This is a continuous process throughout the accounting period.

2.Posting in Journal On the basis of the above documents, you pass journal entries using double
entry system in which debit and credit balance remains equal. This process is repeated throughout
the accounting period.

3.Posting in Ledger Accounts Debit and credit balance of all the above accounts affected through
journal entries are posted in ledger accounts. A ledger is simply a collection of all accounts.
Usually, this is also a continuous process for the whole accounting period.

4.Preparation of Trial Balance As the name suggests, trial balance is a summary of all the
balances of ledger accounts irrespective of whether they carry debit balance or credit balance.
Since we follow double entry system of accounts, the total of all the debit and credit balance as
appeared in trial balance remains equal. Usually, you need to prepare trial balance at the end of the
said accounting period.

5.Posting of Adjustment Entries In this step, the adjustment entries are first passed through the
journal, followed by posting in ledger accounts, and finally in the trial balance. Since in most of
the cases, we used accrual basis of accounting to find out the correct value of revenue, expenses,
assets and liabilities accounts, we need to do these adjustment entries. This process is performed
at the end of each accounting period.
6.Adjusted Trial Balance Taking into account the above adjustment entries, we create adjusted
trial balance. Adjusted trial balance is a platform to prepare the financial statements of a company.

7.Preparation of Financial Statements Financial statements are the set of statements like Income
and Expenditure Account or Trading and Profit & Loss Account, Cash Flow Statement, Fund Flow
Statement, Balance Sheet or Statement of Affairs Account. With the help of trial balance, we put
all the information into financial statements. Financial statements clearly show the financial health
of a firm by depicting its profits or losses.

8.Post-Closing Entries All the different accounts of revenue and expenditure of the firm are
transferred to the Trading and Profit & Loss account. With the result of these entries, the balance
of all the accounts of income and expenditure accounts come to NIL. The net balance of these
entries represents the profit or loss of the company, which is finally transferred to the owner‟s
equity or capital account. We pass these entries only at the end of accounting period.

9.Post-Closing Trial Balance. Post-closing Trial Balance represents the balances of Asset,
Liabilities & Capital account. These balances are transferred to next financial year as an opening
balance.

JOURNALIZING

Journalizing in accounting is the system by which all business transactions are recorded for your
financial records. A business transaction is first recorded in a journal, also called a Book of
Original Entry. Your journal keeps a record of all your business transactions, tracking them in
chronological order, as they happen. Adding new journal entries is called journalizing. The process
of journalizing starts whenever a business transaction occurs. Let’s say your client pays an invoice.
You’d want to record that payment as a journal entry to log the transaction. Each journal entry
typically records the date, the account you’re debiting or crediting and a brief description of the
transaction that occurred.

Debit and Credit

An accounting expression starts with 'Debit' and 'Credit'. You might be wondering what is debit
and credit? Also, this is intriguing enough why is it that if we debit some accounts, it makes them
go up while when some other sets of accounts get debited, it goes down? More importantly, how
is this important for any business? In a nutshell, recording all the money owing into the account is
the basis of debit while recording all the money owing out of the account is the base of credit.

Debit and Credit in Accounting Debit and Credit are the two accounting tools. Business
transactions are to be recorded and hence, two accounts, which are debit and credit, get facilitated.
These are the events that carry a monetary impact on the financial system. While keeping an
account of this transaction, these accounting tools, debit and credit, comes in the play. Whenever
accounting transactions take place, it majorly affects these two accounts. 'In balance' is such an
accounting transaction where the total of the debit and credit matches or is equal. In contrast, if
the debit is not equal to the credit, creating a financial statement will be a problem.

1. Assets

2. Expenses

3. Liabilities

4. Equity

5. Revenue

Classification of Accounts: We can classify accounts in two different ways. These are:

1. Traditional classification of accounts

2. Modern classification of accounts

Traditional Classification of Accounts: This is very old method of classifying accounts and is not
used in most of the advanced countries. Under this method, accounts are classified into four types.
These are:

1. Personal accounts

2. Real accounts

3. Nominal accounts

4. Valuation accounts
These four types of accounts are briefly explained below:

Personal Accounts:

These accounts show the transactions with the customers, suppliers, money lenders, the bank and
the owner. A business may have many credit transactions with the above persons or organizations.
A separate account is to be prepared for each of them. Persons or organizations with whom the
business has credit transactions are either debtors or creditors. If they have to give some money to
the firm, they are called debtors. Conversely, if the firm is to pay them some money they are known
as creditors. The main purpose of preparing personal accounts is to ascertain the balances due to
or due from persons or organizations.

RULE FOR PERSONAL ACCOUNTS:

DEBIT THE RECEIVER AND CREDIT THE GIVER.

Real Accounts:

These accounts are accounts of assets and properties such as land, building, plant, machinery,
patent, cash, investment, inventory, etc. When a machinery is purchased for cash, the two accounts
involved are machinery and cash - both are real accounts. But if the same machine is purchased
from Z & Co. on credit, the two accounts involved will be those of machinery and Z & Co., the
former being a real account and the later being a personal account.

RULE FOR REAL ACCOUNTS:-

DEBIT WHAT COMES IN AND CREDIT WHAT GOES OUT.

Nominal Accounts:

These are the accounts of incomes, expenses, gains and losses. Examples of nominal accounts are
wages paid, discount allowed or received, purchases, sales, etc. These accounts generally
accumulate the data required for the preparation of income statement or trading and profit and loss
account.

RULE FOR NOMINAL ACCOUNTS:-

 DEBIT ALL THE EXPENSES AND CREDIT ALL THE INCOME.

Rules of Debit and Credit at a Glance Types of Account Account to be Debited Account to be
credited Personal account Receiver Giver Real account What comes in What goes out Nominal
account Expense and loss Income and gain Modern Classification Of Accounts:

Modern accountants classify accounts as follows:

ACCOUNTS
1 2 3 4 5 6
Assets Liabilities Capital Revenue Expenditure Withdrawal
Account Account Account Account Account

Rules of Debit and Credit When Accounts are classified According to Modern Classification of
Accounts:

SN. Types of Account Normal Balance Account to be Account to be

Debited Credited
1 Assets account Debit Increase Decrease
2 Liabilities Credit Decrease Increase
Account
3 Capital Account Credit Decrease Increase
4 Revenue Account Credit Decrease Increase
5 Expenditure Debit Increase Decrease
Account
6 Withdrawal Debit Increase Decrease
Account

Example: From the following transaction, state the nature of accounts and state which account will
be debited and which account will be credited:

1. Mr. A started business with Rs.50,000 5. Sold goods to B for Rs.6,000.

2. Purchased goods for cash Rs.10,000. 6. Purchased furniture for Rs.4,000.

3. Sold goods for cash Rs.15,000 7. Purchased plant or Rs.10,000.

4. Purchased goods from X for cash Rs.5,000 8. Paid wages Rs.400

Solution:

8. Cash Expense Asset 400 400 Increased Decreased

SN. Transaction Accounts. Nature of Debit (Rs.) Credit Reason

Involved Account (Rs.)
1 Mr. A started Cash Asset 50,000
business with Capital Liabilities 50,000
Rs.50,000
2 Purchased goods Purchase Expenses 10,000 Increase
for cash Cash Asset 10,000 Decrease
Rs.10,000.
3 Sold goods for Cash Asset 15,000 Increase
cash Rs.15,000 Sales Revenue 15,000 Increase
4 Purchased goods Purchase Expenses 5,000 Increase
from X for cash Cash Asset 5,000 Decrease
Rs.5,000
5 Sold goods to B B Asset 6,000 Increase
for Rs.6,000. Sales Revenue 6,000 Increase
6 Purchased Furniture Asset 4,000 Increase
furniture for Cash Asset 4,000 Decrease
Rs.4,000.
7 Purchased plant or Plant Asset 10,000 Increase
Rs.10,000. Cash Asset 10,000 Decrease
8 Paid wages Wages Expenses 400 Increase
Rs.400 Cash Asset 400 Decrease
Deferent Effects of Debit And Credit Are As Follows:

Account Increase By Decrease By

Assets Debit Credit
Expenses Debit Credit
Liabilities Credit Debit
Equity Credit Debit
Revenue Credit Debit

In effect, a debit increases an expense account in the income statement and a credit decreases it.
Liabilities, revenues and equity accounts have a natural credit balance. If the debit is applied to
any of these accounts, the account balance will be decreased. Difference between Debit and Credit
It is quite amusing that debits and credits are equal yet opposite entries. A debit increases an
account. Now to increase that particular account, we simply credit it. However, we use this account
or decreases equity liability or revenue accounts. For example, „Purchase of a new computer‟.
Here, the asset gained (computer) is to be notied on the left side of the asset account. Whilst the
right side is marked by the credit entry, it either increases equity, liability or revenue accounts or
decreases an asset or expense account. In the „Purchase of a new computer‟, the expense (payment
for the computer) is credited on the right side in this expense account. Given below is a comparison
chart to have a thorough understanding of the difference between the concept of debit and credit

JOURNALIZING TRANSACTIONS:

A STEP-BY-STEP GUIDE Journalizing involves recording business transactions to keep an

accounting record, using the double-entry accounting method. Here are the three steps to
journalizing transactions in accounting:

1. CLASSIFY BUSINESS TRANSACTIONS BY ACCOUNT Take a look at each business

transaction and classify it by the type of transaction. There will be two types of accounts involved
in each transaction: one account will be debited and one account will be credited.

2. DETERMINE THE ACCOUNT TYPE THAT’S INVOLVED There are different types of
accounts that can be included in a journal entry, and it’s important to identify the correct account
type when using double-entry bookkeeping. The types of accounts normally used by self-employed
workers include: asset, liability, expense and revenue. Here’s a full list of account types for your
reference.

3. APPLY THE FUNDAMENTAL ACCOUNTING EQUATION TO THE TRANSACTION

Remember the essential fact of the basic accounting equation: your financial transactions must
always be balanced, with the sum of your debits always equal to the sum of your credits. So you’ll
want to ensure that every time you debit one account, you credit the corresponding account.

4. JOURNALIZE THE TRANSACTION To complete the process, you’ll want to record the
business transaction as a journal entry in the correct journal. Don’t forget to include the date of the
transaction and a brief description of the financial event you’re recording.

JOURNAL –

THE BOOK OF ORIGINAL ENTRY: According to double entry system of bookkeeping,

transactions are recorded in the books of accounts in two stages:

First stage - Journal•

Second stage - Ledger•

The flow of accounting information from the time a transaction takes place to its recording in the
ledger may be illustrated as follows:

Business Transaction

Business Document Prepared

Entry Recorded in Journal

Entry Posted to Ledger

The initial record of each transaction is evidenced by a business document such as invoice, cash,
voucher etc. Transactions are first recorded in journal and there after posted to two or three
concerned accounts in the ledger.

DEFINITION AND EXPLANATION OF JOURNAL: The word journal has been derived
from the French word "Jour" Jour means day. So, journal means daily. Transactions are recorded
daily in journal and hence it has named so.

As soon as a transaction takes place its debit and credit aspects are analyzed and first of all
recorded chronologically (in the order of their occurrence) in a book together with its short
description. This book is known as journal. Thus we see that the most important function of journal
is to show the relationship between the two accounts connected with a transaction. This facilitates
writing of ledger. Since transactions are first of all recorded in journal, so it is called book of
original entry or prime entry or primary entry or preliminary entry, or first entry.

Entry: Recording a transaction in the appropriate place of the concerned book of account is called
entry. Entry may be of the following two types:

Journal Entry:

Recording a transaction in a journal is called journal entry or journalizing.

Ledger Entry: Recording a transaction from journal to the concerned account in the ledger is called
ledger entry. It is also known as ledger posting.

Narration: A short explanation of each transaction is written under each entry which is called
narration. The subject matter of the transaction can be ascertained through narration. Besides this,
if there be any mistake in determining debit or credit aspect of a transaction, it can be easily
detected from narration. "A journal entry is not complete without narration".

Characteristics: Journal has the following features:

1. Journal is the first successful step of the double entry system. A transaction is recorded first of
all in the journal. So, journal is called the book of original entry.

2. A transaction is recorded on the same day it takes place. So, journal is also called a day book.
3. Transactions are recorded chronologically. So, journal is called chronological book.

4. For each transaction the names of the two concerned accounts indicating which is debited and
which is credited, are clearly written into consecutive lines. This makes ledger - posting easy. That
is why journal is called "assistant to ledger" or "subsidiary book".

5. Narration is written below each entry.

6. The amount is written in the last two columns - debit amount in debit column and credit amount
in credit column.

Advantages of Journal: The following are the advantages of journal:

1. Each transaction is recorded as soon as it takes place. So there is no possibility of any

transaction being omitted from the books of account.

2. Since the transactions are kept recorded in journal chronologically with narration, it can be
easily ascertained when and why a transaction has taken place.

3. For each and every transaction which of the two concerned accounts will be debited and which
account credited, are clearly written in journal. So, there is no possibility of committing any
mistake in writing the ledger.

4. Since all the details of transactions are recorded in journal, it is not necessary to repeat them in
ledger. As a result ledger is kept tidy and brief.

5. Journal shows the complete story of a transaction in one entry.

6. Any mistake in ledger can be easily detected with the help of journal.

FORMAT OF JOURNAL:

Date Particular LF Amount Amount

Account to be debited .............................Dr. XXX
Account to be credited XXX
 (Narration)

Rules for Journalizing: How a transaction is recorded in journal, is discussed below:

Suppose the transaction is:

Purchased furniture from Ram on 10.09.2017 for Rs.16,000.

Here furniture accounting is debited and M A account is credited.

Date Particular LF Amount Amount

10/09/2017 Furniture Account .............................Dr. 16,000
To Ram 16,000
(Being Furniture Purchase From Ram )

The various columns of journal are explained in details below:

Date: This column is used to write the date of the business transaction. Different date formats are
used in different countries. Different formats of date are: 10.09.2017, 09.10.2017, 10 September
2017 etc.

Particulars or Details Column: In this column the names of the two connected accounts are
written in two consecutive lines - in the first line the name of account debited and in the second
line the name of account credited. While the name of account debited always placed close the the
left hand margin line, the name of account credited is commenced a short distance away from the
margin line. This arrangement will show clearly which account is debited and which credited. This
also shows that credit amount is placed on the right side of debit amount. The world "Dr" is used
at the end of the name of account debited. It is not necessary to place the word "Cr." after the name
of the credited account, because if one account is Dr. it follows that the other account must be Cr.
Below the names of the two accounts, i.e. in the third line narration is written usually within a
bracket. According to tradition, narration is written starting with a word "being". But modern
practice is not to use this word. In most of countries even in Great Britain using the word "To" at
the beginning of the name of account credited has become out-dated. So, here it has not been used
too. But it is optional for the students.

Ledger Folio (L.F): The page numbers of the ledger where the two concerned accounts have been
posted, are written in this column against the name of each account. This will help locating easily
the two concerned accounts from the ledger. On the other hand, when a transaction is posted to
ledger, the concerned folio number of the ledger is written in this column. Thus if a folio number
stands written in this column, it will mean that the transaction has already been posted to ledger

Amount: The debit amount is written in the first "amount" column against the name of account
debited and the credit amount in the second "amount" column against the name of account credited.

EXAMPLE OF JOURNAL: Journalise the following transactions:

2020 Feb. 3 X commenced business with a capital of Rs.15,000

05 Purchased good Rs.6,000

07 Purchased goods on credit from S & Co. Rs.3,000

10 Purchased furniture Rs.2,400

11 Sold goods Rs.3,900

15 Sold goods on credit to D Rs.2,250

20 Paid salaries Rs.960

25 Received commission Rs.75

26 Returned goods to S & Co. Rs.600.

27 Returned goods by D Rs.450

28 Received from D Rs.1,500

Paid to S & Co. Rs.1,800

X withdrew from business Rs.900

Charged depreciation on Rs.240

Borrowed from K Rs.1,500

Date Particular LF Amount Amount

10/09/2017 Furniture Account .............................Dr.
To Ram
(Being Furniture Purchase From Ram )

SUBSIDIARY BOOKS Subsidiary Books are the books that record the transactions which are
similar in nature in an orderly manner. They are also known as special journals or Daybooks. In
big organizations, it is not easy to record all the transactions in one journal and post them into
various accounts. So for the easy and accurate recording of all the transactions, the journal is
subdivided into many subsidiary books. For every type of transaction, there is a separate book.

Types of Subsidiary Books There are basically 8 types of subsidiary books that are used for
recording different types of transactions. Basically 8 types of subsidiary books, and they are:

i. Cash Book
ii. Purchase Book
iii. Sales Book
iv. Purchase Return Book
v. Sales Return Book
vi. Bills Receivable Book
vii. Bills Payable Book
viii. Journal Proper

Ledger Posting

Ledger posting is transferring debit and credit items from journal entries into their separate
accounts. To do this we should initially guarantee that everything contains a different account.
While posting entries, the account which has been debited in the journal entry must be charged in
the ledger also. In any case, we need to refer to the name of the other account. The account which
is credited in the journal entry is recorded on the credit side of the ledger. However, the reference
is given to the next account in the entry. It is standard to make reference to the words "To" and
"By" as a prefix before debited and credited accounts individually.

LEDGER

The ledger is the principal book of accounting system. It contains different accounts where
transactions relating to that account are recorded. A ledger is the collection of all the accounts,
debited or credited, in the journal proper and various special journal . A ledger may be in the form
of bound register, or cards, or separate sheets may be maintained in a loose leaf binder. In the
ledger, each account is opened preferably on separate page or card.

Name of Account

date Particular LF Amount Date Particular LF Amount

Distinction between Journal and Ledger JOURNAL LEDGER The Journal is the book of first
entry (original entry) The ledger is thebook of second entry. The Journal is the book for
chronological record ledger is the bookfor analytical recordThe Journal, as a book of source entry
Gets greater importance as legal evidence than the ledger. Transaction is the basis of classification
of data within the Journal Account is the basis of classification of data within the ledger. Process
of recording in the Journal is called Journalising The process of recording in the ledger is known
as Posting.

Example: Journalise the following transactions of M/s Mallika Fashion House and post the entries
to the Ledger:

Date Details Amount

June 05 Business started with cash 2,00,000

June 08 Opened a bank account with Syndicate Bank 80,000

June 12 Goods purchased on credit from M/s Gulmohar Fashion House 30,000

June 12 Purchase office machines, paid by cheque 20,000

June 18 Rent paid by cheque 5,000

June 20 Sale of goods on credit to M/s Mohit Bros 10,000

June 22 Cash sales 15,000

June 25 Cash paid to M/s Gulmohar Fashion House 30,000

June 28 Received a cheque from M/s Mohit Bros 10,000

June 30 Salary paid in cash 6,000

Journal entry in the Book of M/s Mallika Fashion House

For the Period of January 2020

Date Particular LF Amount Amount

05/06/2005 Cash A/c Dr 2,00,000
To Capital A/c 2,00,000
(Being business start with cash)
08/06/2005 Bank A/c Dr 80,000
To Cash A/c 80,000
(Being bank account opened )
12/06/2005 Purchase A/c Dr 30,000
To M/s Gulmohar 30,000
(Being goods purchase on credit)
12/06/2005 Machine A/c Dr 20,000
To Bank A/c 20,000
(Being machine purchased)
18/06/2005 Rent A/c Dr 5,000
 To Bank A/c 5,000
(Being rent Paid by bank Rs 5,000)
20/06/2005 M/s Mohit Bros Dr 10,000
To Sales 10,000
(Being credit sale made Rs 10,000)
22/06/2005 Cash A/c Dr 15,000
To Sales 15,000
(Being cash sales made 15,000)
25/06/2005 M/s Gulmohar Dr 30,000
To Cash A/c 30,000
(Being cash paid to M/s Gulmohar Rs
30,000)
28/06/2005 Bank A/c Dr 10,000
To M/s Mohit Bros 10,000
( Being cheque received from M/s Mohit Rs
10,000)
30/06/2005 Salary A/c Dr 6,000
To Cash A/c 6,000
(Being Salary paid)

Cash Account

date Particular LF Amount Date Particular LF Amount

2005 2005
05/06/ To Capital 2,00,000 08/06 By Bank 80,000
22/06 To Sales 15,000 25/06 By Gulmohar 30,000
30/06 By Salary 6,000
By Balance C/d 99,000
2,15,000 2,15,000
Bank Account

date Particular LF Amount Date Particular LF Amount

2005 2005
05/06/ To Cash 80,000 08/06 By Machinery 30,000
22/06 To Mohit 10,000 25/06 By Rent 5,000
30/06 By Balance C/d 55,000
90,000 90,000

Capital Account

date Particular LF Amount Date Particular LF Amount

2005 2005
05/06/ To Balance C/d 2,00,000 05/06 By cash 2,00,000

2,00,000 2,00,000

TRIAL BALANCE

MEANING OF TRIAL BALANCE A trial balance is a statement showing the balances, or total
of debits and credits, of all the accounts in the ledger with a view to verify the arithmetical
accuracy of posting into the ledger accounts. Trial balance is an important statement in the
accounting process. which shows final position of all accounts and helps in preparing the final
statements. The task of preparing the statements is simplified because the accountant can take the
account balances from the trial balance instead of looking them up in the ledger.

Showing format of a trial balance

Trial Balance

of ......as on March 31, 202

 Account TITLE LF AMOUNT(Dr) AMOUNT(Cr)

It is normally prepared at the end of an accounting year. However, an organization may prepare a
trial balance at the end of any chosen period, which may be monthly, quarterly, half yearly or
annually In order to prepare a trial balance following steps are taken:

• Ascertain the balances of each account in the ledger.

• List each account and place its balance in the debit or credit column, as the case may be. (If an
account has a zero balance, it may be included in the trial balance with zero in the column for its
normal balance).

• Compute the total of debit balances column.

• Compute the total of the credit balances column.

• Verify that the sum of the debit balances equal the sum of credit balances. If they do not tally, it
indicate that there are some errors. So one must check the correctness of the balances of all
accounts. It may be noted that all assets expenses and receivables account shall have debit balances
whereas all liabilities, revenues and payables accounts shall have credit balances

Objectives of Preparing the Trial Balance The trial balance is prepared to fulfill the following
objectives : 1. To ascertain the arithmetical accuracy of the ledger accounts.

2. To help in locating errors.

3. To help in the preparation of the financial statement depending upon its requirements.

Account TITLE LF AMOUNT(Dr) AMOUNT(Cr)

Capital ✓
Land and Building ✓
Plant and Machinery ✓
Equipment ✓
Furniture and Fixtures ✓
Cash in Hand ✓
 Cash at Bank ✓
Debtors ✓
Bills Receivable ✓
Stock of Raw Material ✓
Working in Progress ✓
Stock of Finished Goods ✓
Prepaid Insurance ✓
Purchase ✓
Carriage Inwards ✓
Carriage Outwards ✓
Sales ✓
Sales Return(Return inwards) ✓
Purchase Return(Return outwards) ✓
Interest Paid ✓
Commission/ Discount Received ✓
Salaries ✓
Long Term Loan ✓
Creditor ✓
Bills Payable ✓
Drawings ✓
Provision for Bad Debts ✓
Bad Debts ✓
Total XXXXX XXXXX

Preparation of Trial Balance A trial balance can be prepared in the following three ways :

(i) Totals Method

(ii) Balances Method
(iii) Totals-cum-balances Method
Totals method Under this method, total of each side in the ledger (debit and credit) is ascertained
separately and shown in the trial balance in the respective columns. The total of debit column of
trial balance should agree with the total of credit column in the trial balance because the accounts
are based on double entry system. However, this method is not widely used in practice, as it does
not help in assuming accuracy of balances of various accounts and preparation of the financial
statements.

Balances Method This is the most widely used method in practice. Under this method trial
balance is prepared by showing the balances of all ledger accounts and then totaling up the debit
and credit columns of the trial balance to assure their correctness. The account balances are used
because the balance summarizes the net effect of all transactions relating to an account and helps
in preparing the financial statements. It may be noted that in trial balance, normally in place of
balances in individual accounts of the debtors, a figure of sundry debtors is shown, and in place
of individual accounts of creditors, a figure of sundry creditors is shown.

Totals-cum-balances Method This method is a combination of totals method and balances

method. Under this method four columns for amount are prepared. Two columns for writing the
debit and credit totals of various accounts and two columns for writing the debit and credit
balances of these accounts. However, this method is also not used in practice because it is time
consuming and hardly serves any additional or special purpose.

CLASSIFICATION OF ERRORS Keeping in view the nature of errors, all the errors can be
classified into the following four categories:

1) Errors Disclosed by Trial Balance

2) Errors Not Disclosed By Trial Balance

Errors Disclosed by Trial Balance

1. Wrong Totaling of Subsidiary Books: If the total of any subsidiary book is wrongly cast, it
would cause a disagreement in the Trial Balance. For instance, Sales book has been under cast by
Rs 100. From the Sales book, all the personal accounts have been debited correctly but mistake
occurred only in Sales Account, to the extent of Rs 100 (Less). Thus, the Trial Balance disagrees
to the extent of Rs 100; credit side falls short of the amount.
2. Posting of the Wrong Amount: If a wrong amount is posted in one of the two accounts, the
Trial Balance disagrees. For instance sales made to Ram for Rs 570, wrongly debited to Ram’s
Account with Rs 750, instead of Rs 570. Ram’s account has been over debited by Rs 180. Thus,
the debit side of the Trial Balance will exceed by Rs 180. i.e., 750 – 570 = 180.
3. Posting an Amount on the Wrong side of the Account: For instance, a credit sales made to a
customer for Rs 500 has been credited to the customer account, instead of debit. As a result of this
error, the credit side of the Trial Balance will exceed by Rs 1,000 (double the amount of the error)
because there are two credits one in Sales Account and another in Personal Account and no debit
for the transaction.
4. Posting Twice to a Ledger: For instance, salary of Rs 500 paid has been debited to Salary
Account twice by mistake. This will cause disagreement of Trial Balance in debit side by excess
of Rs 500

Errors Not Disclosed By Trial Balance

• Errors of Commission

• Errors of Omission

• Errors of Principle

• Compensating Errors

ERRORS OF COMMISSION These are the errors which are committed due to wrong posting
of transactions, wrong totaling or balancing of the accounts, wrong casting of the subsidiary books,
or wrong recording of amount in the books of original entry, etc.

For example: Raj Hans Traders paid Rs. 25,000 to Preetpal Traders (a supplier of goods). This
transaction was correctly recorded in the cashbook. But while posting to the ledger, Preetpal‟s
account was debited with Rs. 2,500 only. This constitutes an error of commission. Such an error
by definition is of clerical nature and most of the errors of commission affect in the trial balance.

ERRORS OF OMISSION The errors of omission may be committed at the time of recording the
transaction in the books of original entry or while posting to the ledger. There can be of two types:
(i) Error of complete omission
(ii) Error of partial omission

When a transaction is completely omitted from recording in the books of original record, it is an
error of complete omission.

For example, credit sales to Mohan Rs. 10,000, not entered in the sales book. When the recording
of transaction is partly omitted from the books, it is an error of partial omission. If in the above
example, credit sales had been duly recorded in the sales book but the posting from sales book to
Mohan’s account has not been made, it would be an error of partial omission.

ERRORS OF PRINCIPLE Accounting entries are recorded as per the generally accepted
accounting principles. If any of these principles are violated or ignored, errors resulting from such
violation are known as errors of principle. An error of principle may occur due to incorrect
classification of expenditure or receipt between capital and revenue. This is very important
because it will have an impact on financial statements. It may lead to under/over stating of income
or assets or liabilities, etc. For example, amount spent on additions to the buildings should be
treated as capital expenditure and must be debited to the asset account. Instead, if this amount is
debited to maintenance and repairs account, it has been treated as a revenue expense. This is an
error of principle. Similarly, if a credit purchase of machinery is recorded in purchases book
instead of journal proper or rent paid to the landlord is recorded in the cash book as payment to
landlord, these errors of principle. These errors do not affect the trial balance.

COMPENSATING ERRORS When two or more errors are committed in such a way that the
net effect of these errors on the debits and credits of accounts is nil, such errors are called
compensating errors. Such errors do not affect the tallying of the trial balance.

For example, if purchases book has been overcast by Rs. 10,000 resulting in excess debit of Rs.
10,000 in purchases account and sales returns book is under cast by Rs. 10,000 resulting in short
debit to sales returns account is a case of two errors compensating each other’s effect. One plus is
set off by the other minus, the net effect of these two errors is nil and so they do not affect the
agreement of trial balance.

RECTIFICATION OF ERRORS
From the point of view of rectification, the errors may be classified into the following two
categories : (a) errors which do not affect the trial balance.

(b) errors which affect the trial balance. This distinction is relevant because the errors which do
not affect the trial balance usually take place in two accounts in such a manner that it can be easily
rectified through a journal entry whereas the errors which affect the trial balance usually affect
one account and a journal entry is not possible for rectification unless a suspense account has been
opened. Rectification of Errors which do not Affect the Trial Balance These errors are committed
in two or more accounts. Such errors are also known as two sided errors. They can be rectified by
recording a journal entry giving the correct debit and credit to the concerned accounts. Examples
of such errors are – complete omission to record an entry in the books of original entry; wrong
recording of transactions in the book of accounts; complete omission of posting to the wrong
account on the correct side, and errors of principle.

The rectification process essentially involves:

• Cancelling the effect of wrong debit or credit by reversing it; and

• Restoring the effect of correct debit or credit.

For this purpose, we need to analyses the error in terms of its effect on the accounts involved
which may be:

(i) Short debit or credit in an account ; and/or

(ii) Excess debit or credit in an account.

Therefore, rectification entry can be done by :

(i) debiting the account with short debit or with excess credit,
(ii) crediting the account with excess debit or with short credit.

Rectification of Errors Affecting Trial Balance

The errors which affect only one account can be rectified by giving an explanatory note in the
account affected or by recording a journal entry with the help of the Suspense Account. Suspense
Account is explained later in this chapter. Examples of such errors are error of casting; error of
carrying forward; error of balancing; error of posting to correct account but with wrong amount;
error of posting to the correct account but on the wrong side; posting to the wrong side with the
wrong amount; omitting to show an account in the trial balance. An error in the books of original
entry, if discovered before it is posted to the ledger, may be corrected by crossing out the wrong
amount by a single line and writing the correct amount above the crossed amount and initialing it.
An error in an amount posted to the correct ledger account may also be corrected in a similar way,
or by making an additional posting for the difference in amount and giving an explanatory note in
the particulars column. But errors should never be corrected by erasing or overwriting reduces the
authenticity of accounting records and give an impression that something is being concealed. A
better way therefore is by noting the correction on the appropriate side for neutralizing the effect
of the error.

Suspense Account

Even if the trial balance does not tally due to the existence of one sided errors, accountant has to
carry forward his accounting process prepare financial statements. The accountant tallies his trial
balance by putting the difference on shorter side as „suspense account‟.

Example: Rectify the following errors:

Credit purchases from Raghu Rs. 20,000

(i) were not recorded.

(ii) Were recorded as Rs. 10,000.
(iii) Were recorded as Rs. 25,000.
(iv) Were not posted to his account.
(iv) Were posted to his account as Rs. 2,000.
(v) Were posted to Reghav‟s account.
(vi) were posted to the debit of Raghu‟s account.
(vii) were posted to the debit of Raghav.
(viii) were recorded through sales book.
Date Particular LF Amount Amount
I Purchase Account .............................Dr. 20,000
To Raghu 20,000
(Being Goods Purchase From Raghu on credit but not
recoded now corrected )

Date Particular LF Amount Amount

Ii Purchase Account .............................Dr. 10,000
To Raghu 10,000
(Being Credit Purchase From Raghu Rs 20,000 but
recoded in Rs 10,000 now corrected )

Date Particular LF Amount Amount

iii Raghu.............................Dr. 5,000
To Purchase Account 5,000
(Being Credit Purchase From Raghu Rs 20,000 but
recoded in Rs 25,000 now corrected)

Iv Suspense Account .............................Dr. 20,000

To Raghu 20,000
(Being Credit Purchase From Raghu not posted now
corrected )
v Suspense Account .............................Dr. 18,000
To Raghu 18,000
(Being Credit Purchase From Raghu Rs 20,000 but
posted in account Rs 2,000 now corrected )

vi Raghv Account .............................Dr. 20,000

To Raghu 20,000
(Being Credit Purchase From Raghu Rs 20,000 but
recoded in Raghav account, now corrected )

vii Suspense Account .............................Dr. 40,000

To Raghu 40,000
(Being Credit Purchase From Raghu Rs 20,000 but
posted to debit his Account Rs 10,000 now corrected
)

viii Suspense Account .............................Dr. 40,000

To Raghu 20,000
To Raghav 20,000
(Being Credit Purchase From Raghu Rs 20,000 but
debited in Raghav account Rs 20,000 now corrected )

ix Sales account ………………………………….Dr, 20,000

Purchase Account .............................Dr. 20,000
To Raghu 40,000
(Being Credit Purchase From Raghu Rs 20,000 but
recoded in sales books Rs 20o0o0,000 now corrected
)