B.

Com I YEAR Financial Accounting

UNIT I

MEANING OF ACCOUNTING:

“Accounting is the process of identifying, recording, classifying and summarizing in a significant

manner and in terms of money, transactions and events which are, in part at least, of financial
character, interpreting and communicating the results thereof”.

Attributes of Accounting:

The above definition of accounting brings out the following attributes of accounting:

(1) Economic Events: It is the “happening of consequence” to a business entity and can be
divided into two parts:
(a) Internal Events: It is an economic event that occurs entirely within business. Example:
Supply of raw materials from stores department to manufacturing department.
(b) External Events: It is a transaction which involves the transfer or exchange of something
for value between two or more persons. Example: Sale of shoes by Bata and company to its
customers.
(2) Identifying: Accounting records only those transactions and events which are of financial
character, therefore it is necessary to identify the recordable transactions. If an event cannot be
expressed in terms of money, then it is not considered for recording. Example: manager’s
honesty cannot be expressed in terms of money, hence not recorded in books.
(3) Recording: It is concerned with recording of identified events and transactions in the book of
original entry i.e. in journal
(4) Classifying: It is concerned with classification of the recorded transactions of the basis of
their nature at one place. Book containing several separate accounts is called ledger.
(5) Summarizing: This involves presenting the classified data in an understandable manner,
useful for internal as well as external users. This involves preparation of trial balance and final
accounts (trading account, profit and loss account and balance sheet).
(6) Analyzing and interpreting: The recorded and classified data is analyzed and interpreted in a
manner so that the end users such as creditors, bankers, managers, proprietors etc, can make a
meaningful judgment about the financial condition and profitability of the company.
(7) Communicating: It involves presenting the analyzed data in the form of financial reports or
statements, to the end users of the financial information i.e. insiders and outsiders like officers,
staff members, shareholders, creditors, government, etc.

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FUNCTIONS OF ACCOUNTING:

Accounting process involves following functions:

(1) To keep systematic record of the financial activities: The first important function of accounting
is to keep a systematic record of the financial transactions of the business. In accounting only those
business transactions are recorded which can be expressed in terms of money. Business transactions
are properly recorded, classified into appropriate accounts and summarized into financial statements.

(2) To protect the properties of the business: Another important function of accounting is to protect
the properties of the business by maintaining proper records and providing up-to-date information to
the management. Thus, accounting records are called the eyes and ears of the business.

(3) To communicate the financial results: Accounting communicates the financial results and other
valuable financial information to the various interested groups such as officers, creditors, employees,
government, consumers.

(4) To prevent and detect errors and frauds: The most important function of accounting is that it
helps in detecting errors and frauds, if any take place by maintaining proper records.

ADVANTAGES OF ACCOUNTING:

The main advantages of accounting are:

(1) Helpful in taking managerial decisions: Accounting provides operating and financial
performance of the business which is needed by management for taking planning and controlling
decisions.

(2) Facilitates comparative study: A systematic record enables a businessman to compare one year’s
results with those of other years and locate significant factors leading to the change, if any.

(3) Facilitates control: Accounting records enable a business concern to keep a good control over
various activities and properties.

(4) Information about debtors and creditors: Accounting records disclose the amounts due to a
business and the persons from whom the amounts are due.

(5) Helpful in assessment of tax liability: A systematic accounting record helps in assessing the tax
liability. The tax requirements can be satisfied and tax liability can be calculated easily with the help
of accounting records.

(6) Facilitates sale of business: if someone desires to sell his business, the accounts maintained by
him will enable the ascertainment of the proper purchase price.

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LIMITATIONS OF ACCOUNTING:

(1) Based on accounting concepts and conventions: The results disclosed by financial statements
are not realistic as they are based on various accounting concepts and conventions. For instance,
fixed assets are shown at their historical cost and not at their market price.
(2) Accounting may lead to window dressing: The management of the business may present the
financial statements to suit their own requirement by showing more profit or less profit than the
actual value. This is done by window dressing, i.e. showing the items as per the convenience of the
management. For example, closing stock may be over or under valued than the true value.
(3) Accounting ignores the effect of changes in price level: Accounting statements are prepared at
historical cost. Assets are shown in the books of account at the original cost. Thus, assets do not
disclose true and fair view and balance sheet does not reflect about true financial position of the
entity.
(4) Accounting ignores the qualitative elements: Accounting is concerned with quantitative
elements only; qualitative elements like quality of management and labor force are ignored.
(5) Based on Unrealistic information: Actual profit of the business can be known only when the
business is shut down and closing stock is valued at realizable value. For example, assets are
recorded at historical cost and accounts are prepared on going concern basis, which provide
unrealistic financial information.

MEANING OF BOOK-KEEPING:
“Book-keeping is the art of recording the financial transactions of a business, in terms of money, in
a set of books accurately and systematically in order to obtain necessary information.”

Book-keeping is concerned with:

(a) Identifying financial transactions and events.
(b) Measuring them in terms of money.
(c) Recording the financial transactions and events in journal book
(d) Classifying recorded transaction and events i.e. posting them into ledger accounts.

MEANING OF ACCOUNTANCY:

Accounting refers to a systematic knowledge of accounting concerned with the principles and
techniques. It explains how to deal with various aspects of accounting. It educates as why and how
to maintain the books of accounts and how to summarize the accounting information and
communicate it to the various users.

According to Kohler, “Accountancy refers to the entire body of the theory and practice of
accounting.”

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DIFFERENCE BETWEEN BOOK-KEEPING AND ACCOUNTING:

S.No Basis of Book-Keeping Accounting

Difference
1 Nature It is concerned with identifying It is concerned with summarizing
financial transactions; measuring the recorded transactions,
them in monetary terms; recording interpreting them and
and classifying them. communicating the results.

2 Objective It is to maintain systematic records It aims at ascertaining business

of financial transactions. income and financial position by
maintaining records of business
transactions.

3 Function It is to record business transactions. It is the recording, classifying,

So its scope is limited. summarizing, interpreting
business transactions and
communicating the results. Thus
its scope is wide.

4 Basis Vouchers and other supporting Book-keeping work as the basis

documents are necessary as evidence for accounting information.
to record the business transactions.
5 Level of It is enough to have elementary For accounting, advanced and in-
knowledge knowledge of accounting to do depth knowledge and
book-keeping. understanding is required.

6 Relation Book-keeping is the first step of Accounting begins where book-

accounting. keeping ends.

BASIC TERMINOLOGY OF ACCOUNTING

It is necessary to understand the basic accounting terms which are used in the business. These
terms are a part of standard accounting terminology:

(1) Assets: Assets are the property or legal rights owned by an individual or business to which
money value can be attached. According to Finny, “Assets are future economic benefits, the
rights, which are owned or controlled by an organization or individual”.

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Assets can be classified as follows:

(a) Tangible assets: Tangible items are those which can be touched and their physical presence
can be noted/felt e.g. furniture, machine etc.
(b) Intangible assets: Intangible rights are those rights which one possesses but cannot see e.g.
patent rights, copyrights, goodwill etc.
(c) Fixed Assets: Fixed assets are those assets which are purchased for the purpose of operating
the business and not for resale. Example: land and building, machinery and furniture.
(d) Current Assets: Current assets are those assets of a business which are kept for short-term
with a purpose to convert them into cash or for resale. Example: bank, debtors, unsold goods.

(2) Liabilities: Liabilities means the amount which the business owes to outsiders, except the
proprietor. According to Finny and Miller, “Liabilities are debts, they are amounts owed to
creditors”. Liabilities can be classified as under:
(a) Long-term Liabilities: These are those liabilities which are payable after a long-term (after 12
months). Example: long-term loans, debentures.
(b) Current liabilities: These are liabilities which are payable in the near future (within a year).
Example: creditors, bank overdraft, bills payable, outstanding expenses.

(3) Capital: It is the amount invested in an enterprise by its owners e.g. paid up share capital in a
corporate enterprise. It also refers to the interest of owners in the assets of an enterprise. It is the
claim against the assets of the business. Any amount contributed by the owner towards the business
unit is a liability for the business enterprise. This liability is also termed as capital which may be
brought in the form of cash or assets by the owner.

(4) Expense: Costs incurred by a business in the process of earning revenue are called expenses.
In general, expenses are measured by the cost of assets consumed or services used during the
accounting period. The common items of expenses are: Depreciation, Rent, Wages, Salaries,
Interest, Cost of Heating, Light and water and Telephone, etc.

(5) Income: The difference between revenue and expense is called income. For example, goods
costing Rs.25000 are sold for Rs.35000, the cost of goods sold, i.e. Rs.25000 is expense, the sale of
goods, and i.e. Rs.35000 is revenue and the difference. i.e. Rs.10000 is income. In other words, we
can state that
Income = Revenue - Expense.
(6) Expenditure: Expenditure is the amount spent or liability incurred for the value received.
Expenditure is a payment for a benefit received. Expenditure may be categorized into:
(a) Capital Expenditure: Capital expenditure is the amount spent in purchasing assets which
will give benefits over a number of accounting periods. Capital expenditure is that expenditure
incurred to acquire fixed assets or its improvement.
(b) Revenue expenditure: Revenue expenditure is the amount spent to purchase goods and
services that are consumed during the accounting period. Revenue expenditure does not increase the
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earning capacity but it maintains the earning capacity in the current year. These expenses are shown
on the debit side of the profit and loss account.

(7) Revenue: Revenue means the amount, which as a result of operations, i.e. sale of goods or
services, is added to the capital. Revenue is the inflow of assets, which results in an increase in the
owner’s equity. Other items of revenue common to many businesses are: Commission, Interest,
Dividends, Royalties, and Rent received, etc. Revenue is also called Income.

(8) Debtor: Persons who are to pay for goods sold or services rendered or in respect of
contractual obligations. It is also termed as debtor, trade debtor, and accounts receivable. Example:
when goods are sold to a person on credit that person is called debtor.

(9) Creditor: Creditors are persons who have to be paid by an enterprise an amount for providing
goods and services on credit. Example: Mohan is a creditor of a firm when goods are purchased on
credit from him.

(10)Goods: Goods are the items forming part of the stock-in-trade of an enterprise, which are
purchased or manufactured with a purpose of selling. Example: Enterprise dealing in home
appliances such as T.V, fridge, Air conditioner, etc is goods.

(11)Cost: It is the amount of expenditure incurred on or attributable to a specified article, product or

activity.

(12)Gain: Gain is a profit that arises from transactions which are incidental to business such as sale
of investments or fixed assets at more than their book values. Gain may be operating gain or non-
operating gain.

(13) Purchase: This term is used for goods to be dealt-in i.e. goods are purchased for resale or for
producing the finished products which are meant for sale. Goods purchased may be Cash Purchases
or Credit Purchases. Thus, Purchase of goods is the sum of cash purchases and credit purchases.

(14) Sale: Sales are total revenues from goods or services provided to customers. Sales may be in
cash or in credit.

(15) Transaction: It is an event which involves exchange of some value between two or more
entities. It can be purchase of stationery, receipt of money, payment to a supplier, incurring
expenses, etc. It can be a cash transaction or a credit transaction.

(16) Profit: It is the excess of revenue of a business over its costs. It may be gross profit and net
profit. Gross profit is the difference between sales revenue and the proceeds of goods sold and/or

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services provided over its direct cost of the goods sold. Net profit is the profit made after allowing
for all types of expenses. There may be a net loss if the-expenses exceed the revenue.

(17)Drawings: It is the amount of money or the value of goods which the proprietor takes for his
personal use. Drawing reduces the investment of the owners.

(18) Voucher: Voucher is an evidence of a business transaction. Examples of voucher are: cash
memo, invoice or bill.

(19) Book Value: This is the amount at which an item appears in the books of accounts of financial
statements.

ACCOUNTING PROCESS:

The accounting process is a series of activities that begins with a transaction and ends with the closing
of the books. Because this process is repeated each reporting period, it is referred to as the accounting
cycle and includes these major steps:

1. Identify the transaction or other recognizable event.

2. Prepare the transaction's source document such as a purchase order or invoice.
3. Analyze and classify the transaction. This step involves quantifying the transaction in monetary
terms (e.g. dollars and cents), identifying the accounts that are affected and whether those
accounts are to be debited or credited.
4. Record the transaction by making entries in the appropriate journal, such as the sales journal,
purchase journal, cash receipt or disbursement journal, or the general. Such entries are made in
chronological order.
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5. Post general journal entries to the ledger accounts.

6. Prepare the trial balance to make sure that debits equal credits. The trial balance is a listing of
all of the ledger accounts, with debits in the left column and credits in the right column. At this
point no adjusting entries have been made. The actual sum of each column is not meaningful;
what is important is that the sums be equal. Note that while out-of-balance columns indicate a
recording error, balanced columns do not guarantee that there are no errors. For example, not
recording a transaction or recording it in the wrong account would not cause an imbalance.
7. Correct any discrepancies in the trial balance. If the columns are not in balance, look for math
errors, posting errors, and recording errors. Posting errors include:
o posting of the wrong amount,
o omitting a posting,
o posting in the wrong column, or
o Posting more than once.
8. Prepare adjusting entries to record accrued, deferred, and estimated amounts.
9. Post adjusting entries to the ledger accounts.
10. Prepare the adjusted trial balance. This step is similar to the preparation of the unadjusted trial
balance, but this time the adjusting entries are included. Correct any errors that may be found.
11. Prepare the financial statements.
o Income statement: prepared from the revenue, expenses, gains, and losses.
o Balance sheet: prepared from the assets, liabilities, and equity accounts.
o Statement of retained earnings: prepared from net income and dividend information.
o Cash flow statement: derived from the other financial statements using either the direct
or indirect method.
12. Prepare closing journal entries that close temporary accounts such as revenues, expenses,
gains, and losses. These accounts are closed to a temporary income summary account, from
which the balance is transferred to the retained earnings account (capital). Any dividend or
withdrawal accounts also are closed to capital.
13. Post closing entries to the ledger accounts.
14. Prepare the after-closing trial balance to make sure that debits equal credits. At this point, only
the permanent accounts appear since the temporary ones have been closed. Correct any errors.
15. Prepare reversing journal entries (optional). Reversing journal entries often are used when
there has been an accrual or deferral that was recorded as an adjusting entry on the last day of
the accounting period. By reversing the adjusting entry, one avoids double counting the amount
when the transaction occurs in the next period. A reversing journal entry is recorded on the first
day of the new period.

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VARIOUS USERS OF ACCOUNTING INFORMATION:

Accounting is an information system which identifies records and communicated this

information to the interest users in the form of financial statements. These financial reports are
transferred to the users in two forms-internal and external. Internal financial reports are used by an
individual who runs, manages and operates the daily activities of inside area of an organization.
Manager, supervisor, financial director are the most featured examples of internal users. External
financial reports are used by individuals and organizations who want financial accounting information.
External users are not the part of management of the company.

(1) Creditors: Creditors are generally focused on those information which are related to the
borrower before making a large loan such as the Bank will want information about the
borrower to repay the loan, the amount of assets and liabilities of the borrower, evidence of
income, tax policies and so on.

(2) Investors: Investors generally provide money to individual or organization to start a business.
Before investing money investors generally want to know whether they should invest or not or
if they would invest to start a business now then how much return they will get from their
investment.

(3) Government Regulatory agencies: Government regulatory agencies like State government
agencies and security and exchange commission want financial accounting information which
is related to the investors, business organizations or any individuals. These regulatory agencies
want the information to know that whether the business organizations are following the
business rules and regulation or not or whether the investors are able to invest or make
decisions or not.

(4) Taxing Authority: Taxing authority wants financial accounting information relating to the tax
policies, tax laws, amount of payable tax, etc from the individual or organization. Taxing
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authority wants financial accounting information to know that the business organizations are
following tax rules or not and their ability to pay income tax because income tax is based on
the financial accounting reports.

(5) Suppliers and Customers: Customers also want to know about company on issues like
warranty, product development, etc. Suppliers want to know about company’s future goals so
that they can serve best material in coming days.

(6) Employers and labor unions: Employers use accounting information for their own benefit.
Accounting information helps the employee to ensure their future benefit from the company
like pension, health provision, retirement benefit, etc. Labor union wants accounting
information to know their future salary.

ACCOUNTING CONCEPTS:

In order to maintain uniformity and consistency in preparing and maintaining books of accounts,
certain rules or principles have been evolved. These rules/principles are classified as concepts and
conventions. These are foundations of preparing and maintaining accounting records.

“Accounting concepts refers to the basic assumptions and rules and principles which work as the basis
of recording of business transactions and preparing accounts. The various accounting concepts are:

(1)Business Entity Concept: This concept assumes that, for accounting purposes, the business
enterprise and its owners are two separate independent entities. Thus, the business and personal
transactions of its owner are separate. For example, when the owner invests money in the business, it
is recorded as liability of the business to the owner. Similarly, when the owner takes away from the
business cash/goods for his/her personal use, it is not treated as business expense. This concept helps
in ascertaining the profit of the business as only the business expenses and revenues are recorded.
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(2) Money Measurement Concept: According to this concept, only those business transactions which
can be expressed in terms of money are recorded in the books of accounts. Another aspect of this
concept is that the records of the transaction are to be kept not in physical units but in the monetary
units. Example: Sale of goods Rs. 2, 00,000 can be expressed in terms of money; hence they are
recorded in the books of accounts.

(3) Going concern concept: This concept states that a business firm will continue to carry on its
activities for an indefinite period of time. This is an important assumption of accounting, as it provides
a basis for showing the value of assets in the balance sheet. Example: a company purchases a plant and
machinery of Rs.100000 and its life span is 10 years. According to this concept every year some
amount will be shown as expenses and the balance amount as an asset. In the absence of this concept,
the cost of a fixed asset will be treated as an expense in the year of its purchase.

(4) Accounting Period Concept: All the transactions are recorded in the books of accounts on the
assumption that profits on these transactions are to be ascertained for a specified period. This is known
as accounting period concept. Thus, this concept requires that a balance sheet and profit and loss
account should be prepared at regular intervals. This is necessary for different purposes like,
calculation of profit, ascertaining financial position, tax computation etc. It helps in predicting the
future prospects of the business.

Year that begins from 1st of January and ends on 31st of December, is known as Calendar Year. The
year that begins from 1st of April and ends on 31st of March of the following year, is known as
financial year.

ACCOUNTING PRINCIPLES:

(1) Accounting Cost Concept: Accounting cost concept states that all assets are recorded in the books
of accounts at their purchase price, which includes cost of acquisition, transportation and
installation and not at its market price. It means that fixed assets like building, plant and machinery,
furniture, etc are recorded in the books of accounts at a price paid for them. The cost concept is also
known as historical cost concept. This method helps in calculating depreciation on fixed assets.

(2) Dual Aspect Concept: Dual aspect is the foundation or basic principle of accounting. It provides
the very basis of recording business transactions in the books of accounts. This concept assumes
that every transaction has a dual effect, i.e. it affects two accounts in their respective opposite sides.
Therefore, the transaction should be recorded at two places. The implication of dual aspect concept
is that every transaction has an equal impact on assets and liabilities in such a way that total assets
are always equal to total liabilities. The duality concept is commonly expressed in terms of an
accounting equation:

ASSETS = CAPITAL + LIABILITIES

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(3) Revenue Recognition Concept: According to the Revenue Recognition concept, revenue is
considered to have been realized when a transaction has been entered into and the obligation to
receive the amount has been established. Recognizing revenue and receipt of an amount are two
separate aspects. Example: suppose an enterprise has received an advance in February 2009 for the
sale to be made in May 2009, revenue shall be recognized in May 2009, upon sale having been
made because the legal obligation to receive the amount has been established in May 2009.
Generally revenue is recognized at the point of sale or while rendering service.

(4) Matching Concept: According to the matching concept, cost incurred to earn the revenue
should be recognized as expense in the period when revenue is recognized as earned. Under this
concept the expenses for an accounting period are matched against related revenues. The matching
concept operates as follows:
(a) When an item of revenue is recognized as income, i.e. is entered in the profit and loss
account, all expenses incurred should also be recognized as expenses.
(b) If an expense is incurred against which the revenue will be earned in the next period, the
amount is carried to the next period and then next year be treated as an expense.
(c) If an amount of revenue is received during the year but against it service is to be rendered
or goods are to be sold in the next year, the amount received must be treated as revenue in
the next year after the services have been rendered or the goods have been sold.
(5) The Accrual Concept: According to the Accrual concept, a transaction is recorded at the time
when it takes place and not when the settlement takes place. Under this concept, profit is regarded as
earned at the time the goods or services are sold to a customer, i.e. the legal title is passed to the
customer, who has an obligation to pay for them. Similarly, expense is regarded as spent when the
goods or services are purchased and an obligation to pay for them has been assumed. Example: a firm
sells goods for Rs. 55,000 on 25th March 2011 and the payment is not received until 10th April 2011,
the amount is due and payable to the firm on the date of sale i.e. 25th March 2011. It must be included
in the revenue for the year ending 31st March 2011.

ACCOUNTING CONVENTIONS:

(1) Principle of materiality: According to this principle, only the material or important facts should
be recorded through the financial statements. All other unimportant or less important information
should either be totally ignored or recorded as footnotes or merged with important items. Examples: if
the value of remaining pencils, carbon paper, are not shown in the balance sheet at the end of the
accounting year, it will not affect the balance sheet.

(2) Principle of consistency: In order to enable the management to compare the results of one year
with those of other years or with those of other organizations in the same field, it is necessary to
prepare the financial statements on some uniform rules and assumptions. They should not be subject to
frequent changes. This is known as ‘principle of consistency’. Examples: If one year one method of
depreciation is followed but in next year an altogether different method is adopted, the results shown
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by the two financial statements will not be useful for comparison because they are based on different
conventions.

(3) Principle of conservatism or prudence: According to this principle, the anticipated losses should
be recorded in the books of accounts, but all unrealized gains should be ignored. In other words, the
accountant follows the policy of ‘playing safe’ as per principle of conservatism. Accordingly,
provision must be made for all known liabilities despite the uncertainty in their amount. Principle of
conservatism is normally followed in the following cases:

(a) Provision for bad and doubtful debt is made in anticipation of bad debts.

(b) Closing stock is valued at cost price or market price whichever is less.

ACCOUNTING EQUATION:
According to dual aspect concept, every transaction affects the business in two ways by the same
amount. Every transaction has its effect on the accounting equation in such a manner that both sides
remain equal. The recording of business transaction in books of accounts is based on a fundamental
equation called accounting equation.

ASSETS= CAPITAL + IABILITIES

JOURNAL

Meaning:

Journal is a book of accounts in which all day to day business transactions are recorded in a
chronological order i.e. in the order of their occurrence. Transactions when recorded in a Journal are
known as entries. It is the book
in which transactions are recorded for the first time. Journal is also known as ‘Book of Original
Record’ or ‘Book of Primary Entry’. Business transactions of financial nature are classified into
various categories of accounts such as assets, liabilities, capital, revenue and expenses. These are
debited or credited according to the rules of debit and credit, applicable to the specific accounts. Every
business transaction affects two accounts. Applying the principle of double entry one account is
debited and the other account is credited. Every transaction can be recorded in journal. This process of
recording transactions in the journal is’ known as ‘Journalizing’.

Format of Journal
Every page of Journal has the following format. It is a columnar book. Each column is given a name
written on its top. Format of journal is given below:

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Journal
DATE PARTICULARS LEDGER Dr. Amount (Rs) Cr. Amount (Rs)
FOLIO

(1) (2) (3) (4) (5)

1. Date
In this column, we record the date of the transactions with its month and accounting year. We write
year only once at the top and need not repeat it with every date.

2. Particulars
The accounts affected by a transaction i.e the accounts which have to be debited or credited are
recorded in this column. It is recorded in the following way:
(a) In the first line, the account which has to be debited is written and then the short form of Debit
i.e. Dr. is written against that account’s name in the extreme right of the same column.
(b) In the second line after leaving some space from the left of the entry in the first line, the
account which has to be credited is written starting with preposition ‘To’ Then in the third line,
Narration for that entry which explains the transaction, the affected accounts of which are
entered, is written within Brackets. Narration should be short, complete and clear. After every
journal entry, horizontal line is drawn in the particulars column to separate one entry from the
other.

3. Ledger Folio
The transaction entered in a Journal is posted to the various related accounts in the ‘ledger’ (which
is explained in another lesson). In ledger-folio column we enter the page-number where the account
pertaining to the entry is opened and posting from the Journal is made.

4. Dr. Amount
In this column, the amount to be debited is written against the same line in which the debited
account is written.

5. Cr. Amount
In this column, the amount to be credited. is written against the same line in which the credited
account is written.
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6. At the end of each page, both the Dr. and Cr. columns are totaled up. The total of both these
columns should be equal as the same amount is entered in the debit as well as in the credit columns.
The totals are carried forward to the next page with the words ‘total carried forward (c/f) and then at
the top of the next page in Particulars column, we write totals brought forward (b/f) and the amount
of totals is written in the respective amount columns.

PROCESS OF JOURNALISING:

Preparation of a Journal requires following steps to be followed:

(a) Identify the Accounts: First of all, the affected accounts of an accounting transaction are
identified. For example, if the transaction of “goods worth Rs.10000 are purchased for Cash”,
then ‘Purchases’ A/c and ‘Cash’ A/c are the two affected accounts.
(b) Recognize the type of Accounts: Next we determine the type of the affected accounts e.g. in
the above case, ‘Purchases A/c and Cash A/c are both asset accounts.
(c) Apply the Rules of Debit and Credit: Then the rules of ‘debit’ and ‘credit’ are applied to the
affected accounts.

Ledger

Ledger is the principal book or final book under double entry system of accounting in which the
transactions recorded in subsidiary books are classified in various accounts chronologically with a
view to knowing the position of business account-wise in a particular period.

Characteristics of Ledger
1. Major or principal book of accounts.
2. Index- The initial pages of ledger are left for indexing. These pages are not numbered. With the help
of index one can find on which page of ledger a particular account is opened.
3. Pages booked- For every account one separate page or pages called folio is engaged in ledger.
4. One debit one credit- For every transaction one account is debited and other account is credited.
5. Books of final entry- Ledger is the last stage of daily accounting or book keeping.
6. Classification of transactions- While journal a bunch of various accounts, ledger is the
classification of these accounts

Utility or importance or Advantages of Ledger

1. Knowledge of account
2. Details of income and expenditure
3. Assessment of financial position
4. Text of accuracy
5. Knowledge of profit and loss
6. Economy of time
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7. Knowledge of assets
8. Knowledge of liabilities
9. Assessment of overall position of business
10. Evidence in business disputes

Difference in Journal and Ledger

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Posting
When the transactions entered in journal are recorded in the ledger, it is called posting. It other words,
posting is the process transferring the debits and credits of journal entries to the ledger account. The
subject of such posting to have a fixed classified record of various transactions pertaining to each
account.

Procedure for Posting

1. Opening of separate account – Since each transaction affect two accounts. separate accounts.
therefore, will be opened in the ledger in the ledger, such accounts may be personal, real and nominal.
2. Posting journal entry to the concerning side – the debit side of the journal is posted to the debit side
of the account and on the side the reference is given of the fact which is put on the credit side of the
journal entry.
3. Sides to the posted - The credit side of the journal entry is posted to he credit side of the account
and on that side the reference is given of that fact which put on the debit side of the credit side of the
journal entry
4. use of ward,” To” and “By” – The word “To” is prefixed to the posting of debit side and the ward “
By“ is prefixed to the credit side in each account.

Ledger posting o Opening Journal Entry

While making ledger accounts of assets and liabilities appearing in the opening journal entry opening
balance as represented in the journal entry must be shown in the beginning of the ledger account a “To
Balance b/d” at the debit side for assets and “by balance b/d” at the credit side of liabilities. Remaining
posting in the concurred A/c will be made as usual.

Balancing of ledger Accounts

Assets, liabilities and capital accounts have certain closing balance of the end of accounting period, so
their values are to be carried forward to the next accounting period. This is why they are closed as “By
Balance b/d” or “To Balance c/d. The balance of those accounts carried forward to the next accounting
period, because the firm has to carry on tits business with these assets, liabilities and capital in hand.
While closing these accounts we write the ‘Balance c/d’ to show the closing balance of the account.
While closing nominal accounts or those accounts which are either an expense or revenue. we do not
use the word balance c/d because the balance of these accounts need be carried forward to the next
period. Whatever has been paid on account of expenses has been paid once and forever. This is the
expense of the business. so it should be directly posted to the debit side of the profit and loss account
or trading account. It the same way, account relating to income or gain or revenues are also closed by
transfer to profit and loss account. Receipts i.e. rent, interest and discount are revenue of the business,
so while closing these accounts their balance will be transferred to profit and loss account.

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TRIAL BALANCE

Meaning
When all the accounts of a concern are balanced off they are put in a list, debit balances on one side
and credit balances on the other side. The list so prepared is called trial balance. The total of the debit
side of the trial balance must be equal to that of its credit side. This is based on the principle that in
double entry system. For every debit there must be a corresponding credit. The preparation of a trial
balance is an essential part of the process because if totals of both the sides are the same then it is
proved that book are at least arithmetically correct.

Main Characteristics and uses of a Trial Balance

Following are the main characteristics of a trial balance :

1. It is a statement prepared in a tabular form. It has two columns- one for debit balance and another
for credit balances.
2. Closing balance, i.e., balance at the end of the period as shown by ledger accounts, are shown in the
statement.
3. Trial balance is not an account. It is only a statement of balance.
4. It can be prepared on any date provided accounts are balanced.
5. It is a consolidated list of all ledger balances at the end of a period at one place.
6. It is a method of verifying the arithmetical accuracy of entries made in the ledger. The agreement of
the trial balance means that the total of the debit column agrees with the total of the credit column of
the trial balance.
7. It is a big help in preparation of Trading A/c, Profit and Loss A/c and Balance Sheet at the end of
the period which exhibit the financial position of the firm.

Objects of preparing a Trial Balance

The following are the important objects or purposes of preparing a trial balance :
1. If the two sides of the trial balance are equal, it is proved that the book are at least arithmetically
correct.
2. Error in casting the books of subsidiary records in immediately known.
3. Error in posting from the books of subsidiary records to ledger is found out.
4. Error in balancing the ledger accounts is found out.
5. Schedules of debtors and creditors are verified to be correct.

Limitations of a Trial Balance

A trial balance is not a conclusive proof of the absolute accuracy of the accounts books. If the trial
balance agrees, it does not mean that now there are absolutely no errors in books. Even if trial balance
agrees, some errors may remain undetected and will not be disclosed by the trial balance. This is the
limitation of a trial balance.
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The errors which are not disclosed by a trial balance are as under:
Errors of Omission: - If an entry has not been recorded in the original or subsidiary book at all, then
both the aspects of the transaction will be omitted and the trial balance will not be affected.
1. Errors of Commission: - Posting an item on the correct side but to the wrong account.
2. Error it subsidiary books- Wrong amount entered in the subsidiary book.
3. Compensating errors- These are errors arising from the excess-debits on under debits of accounts
being neutralized by excess credit or under credit to the same extent of some other accounts.
4. Error of principle- Whenever any amount is not properly allocated between capital and revenue or
some double entry principles are violated the error so made is known as error of principle.
5. Compensatory Errors- Under it, the errors on one side of the ledger account are compensated by
errors of the same amounts on the other side or on the same side.

FINAL ACCOUNTS:

Financial statements are the statements that are prepared at the end of the accounting period, which is
generally one year. These include income statement i.e. Trading and Profit & Loss account and
position statement i.e. Balance Sheet.

Objectives of financial statements:

Financial statements are prepared to ascertain the profits earned or losses incurred by a business
concern during a specified period and also to ascertain its financial position at the end of that specified
period. Financial statements are generally of two types:

(a) Income statement which comprises of Trading Account and Profit & Loss Account, and
(b) Position Statement i.e., the Balance Sheet.

Following are the objectives of preparing financial statements: -

1. Ascertaining the results of business operations: Every businessman wants to know the
results of the business operations of his enterprise during a particular period in terms of profits
earned or losses incurred. Income statement serves this purpose.

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2. Ascertaining the financial position: financial statements show the financial position of the
business concern on a particular date which is generally the last date of the accounting period.
Position statement i.e. Balance Sheet is prepared for this purpose.

3. Source of information: Financial statements constitute an important source of information

regarding finance of a business unit which helps the finance manager to plan the financial
activities of the business and making proper utilization of the funds.

4. Helps in managerial decision making: The Manager can make comparative study of the
profitability of the concern by comparing the results of the current year with the results of the
previous years and make his/her managerial decisions accordingly.

5. An index of solvency of the concern: Financial statements also show the short term as well as
long term solvency of the concern. This helps the business enterprise in borrowing money from
bank and other financial institutions and/or buying goods on credit.

Capital Expenditure and Revenue Expenditure, Capital Receipts and Revenue Receipts

The preparation of Trading Account and Profit and Loss Account requires the knowledge of revenue
expenditure, revenue receipts and capital expenditure and capital receipts. The knowledge shall
facilitate the classification of revenue items and put them in the Trading account and Profit and Loss
Account on one hand and prepare Balance Sheet based on capital items (expenditure as well as
receipts) on the other hand.

Capital Expenditure refers to the expenditure incurred for acquiring fixed assets or assets which
increase the earning capacity of the business. The benefits of capital expenditure to the firm extend to
number of years. Examples of capital expenditure are expenditure incurred for acquiring a fixed asset
such as building, plant and machinery etc.

Revenue expenditure, on the other hand, is an expenditure incurred in the course of normal business
transactions of a concern and its benefits are availed of during the same accounting year. Salaries,
carriage etc. are examples of revenue expenditure.

There is another category of expenditure called deferred revenue expenditure. These are the
expenses incurred during one accounting year but are applicable wholly or in part in future periods.
These expenditures are otherwise of a revenue nature. Example of deferred revenue expenditure is
heavy expenditure on advertisement say for introducing a new product in the market, expenditure
incurred on research and development, etc.

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Capital and Revenue Receipts

Capital receipts are receipts which do not arise out of normal course of business. Examples of such
receipts are sale of fixed assets, and raising of loans etc. Such receipts are not treated as income of the
enterprise.

Revenue receipts are receipts which arise during the normal course of business, Sale of goods, rent
from tenants, dividend received, etc. are some of the examples of revenue receipts. They are the items
of incomes of the business entity.

TRADING ACCOUNT

Income statement consists of Trading and Profit and Loss Account. A business firm either purchases
goods from others and sells them or manufactures and sells them to earn profit. This is known as
trading activities. A statement is prepared to know the results in terms of profit or loss of these
activities. This statement is called Trading Account. Trading Account is prepared to ascertain the
results of the trading activities of the business enterprise. It shows whether the selling of goods
purchased or manufactured has earned profit or incurred loss for the business unit. Cost of goods sold
is subtracted from the net sales of the business of that accounting year. In case the total sales value
exceeds the cost of goods sold, the difference is called Gross Profit. On the other hand, if the cost of
goods sold exceeds the total net sales, the difference is Gross Loss. All accounts related to cost of
goods sold such as opening stock, net purchases i.e. purchase less returns outward, direct expenses
such as wages, carriage inward etc. and closing stock with net sales (i.e. Sales minus Sales returns) are
taken to the Trading Account. Then this account is balanced. Credit balance shows the gross Profit
and debit balance shows the gross loss.
The cost of goods is calculated as follows:

Cost of goods sold = opening stock + net purchases + all direct expenses – closing stock
Gross Profit = net sales – cost of goods sold.
Format of Trading Account
Trading Account
for the year ending …………..
Dr. Cr.
Particulars Amount (Rs) Particulars Amount (Rs)
Opening Stock Sales
Purchases Less: sales returns
Less: purchase returns Closing stock
Direct expenses: Gross loss transferred to profit
Carriage inward and loss account.
Freight
Wages
Fuel and power
Excise duty
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Factory rent
Heating and lighting
Factory rent & insurance
Work managers salary
Gross profit transferred to
profit and loss account

PROFIT & LOSS ACCOUNT

Trading account is prepared to ascertain the Gross profit or Gross loss of the trading activities of the
business. But these are not the final results of business operations of an enterprise. Apart from direct
expenses, there are indirect expenses also. These may be divided into office and administrative
expenses, selling and distribution expenses, financial expenses, depreciation and maintenance charges
etc. Similarly, there can be income from sources other than sales revenue. These may be interest on
investments, discount received from creditors, commission received, etc. Another account is prepared
in which all indirect expenses and revenues from sources other than sales are written. This account
when balanced shows profit (or loss). This account is termed as Profit and Loss Account. The profit
shown by this account is called ‘net profit’ and if it shows loss it is known as ‘net loss’.
Format of Profit and Loss Account
Profit and Loss A/c of M/s ................…..
for the year ended ...............
Dr. Cr.
Particulars Amount (Rs) Particulars Amount
(Rs)
Gross loss b/d Gross profit b/d
Salaries Discount received
Rent, rates and taxes Commission received
Insurance premium Dividend received
Advertising Interest on investment
Commission paid Rent received
Discount allowed Net loss transferred to capital
Repairs and renewals account
Bad debts
Establishment charges
Travelling expenses
Bank charges
Sales tax/value added tax
Depreciation on fixed assets
Net profit transferred to capital
account

Position Statement/Balance Sheet:

Position Statement or Balance Sheet is another basis of financial statement. Balance Sheet is a
statement prepared on a particular date, generally at the end of accounting year to ascertain the
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financial position of the entity. It consists of assets on the one hand and liabilities on the other.
Financial position of a business is the list of assets owned by the business and the claims of various
parties against these assets. The statement prepared to show the financial position is termed as Balance
Sheet

In the words of Francis R Steal, “Balance Sheet is a screen picture of the financial position of a
going business at a certain moment.”

In the words of Freeman, “A Balance Sheet is an item wise list of assets, liabilities and
proprietorship of a business at a certain date.”

ADJUSTMENTS AND THEIR INCORPORATION

The number and nature of adjustments differ from organisation to organisation. It depends upon the
volume and nature of activities in the organisation, However, certain adjustments are common in all
types of organisations. Moreover, while making adjustments you will have to follow the general
principle of double entry i.e. the amount is to be debited to one account and credited to another
account. Thus in the finanacial statements the item to be adjusted should appear at two places one
representing the debit and the other representing the credit.

Some of the items of adjustment and its accounting treatment in financial statements. These are
as under:
1. Closing Stock
2. Outstanding Expenses.
3. Prepaid Expenses
4. Accrued Income.
5. Income received in advance
6. Interest on Capital
7. Interests on Drawings
8. Depreciation.
9. Further Bad Debts.
10. Provision for Bad and Doubtful Debts.

1. Closing Stock: Closing Stock is the stock of goods remaining unsold at the end of the accounting
year. Ordinarily this does not appear in the Trial Balance. Hence, this needs to be incorporated in
financial statements. This appears on the credit side of the Trading Account as well as Assets side of
the Balance Sheet.

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The adjustment entry will be:

Closing Stock A/c Dr
To Trading A/c
(Closing stock transferred to trading A/c)

The effect of the adjustment entry on financial statements is as under:

Trading A/c
Dr. Cr.
Particulars Amount (Rs) Particulars Amount (Rs)
Closing Stock ………

Balance Sheet
Liabilities Amount (Rs) Assets Amount (Rs)
Closing Stock ………

2. Outstanding Expenses: Expense which is related to the current accounting period but not yet paid
is known as Outstanding Expense. Suppose the accounts are closed on 31st December every year.
Salary for the month of December is due but not paid. It is an example of salary outstanding.
Similarly, there are some other items like Rent outstanding, Wages outstanding etc. In case of Salaries
Outstanding following adjustment entry will be made:
Salary A/c Dr.
To Salary Outstanding A/c
(Salary outstanding for the month of December)
In financial statements it will be recorded as:
Profit & Loss A/c
Dr. Cr.
Particulars Amount (Rs) Particulars Amount (Rs)
Salaries
Add: salary outstanding

Balance Sheet
Liabilities Amount (Rs) Assets Amount (Rs)
Salary outstanding ……..

3. Prepaid expenses: A part of a certain expense paid may relate to the next accounting period. Such
expenses are called prepaid expense or expenses paid in advance. For example, insurance premium
paid in the current year may be for the year ending, the date of which falls in the next year. The part of

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insurance premium which relates to next accounting year is the insurance premium paid in advance is
deducted from the amount paid and is shown as an item of asset. Similarly, such items may be rent
prepaid, tax prepaid etc.

Adjustment entry for prepaid Insurance Premium

Prepaid Insurance Premium A/c Dr
To Insurance Premium A/c
(Insurance premium paid in advance)

In financial statements, it is recorded as:

Profit & Loss A/c
Dr. Cr.
Particulars Amount (Rs) Particulars Amount (Rs)
Insurance Premium
Less: Prepaid Insurance
premium

Balance Sheet
Liabilities Amount (Rs) Assets Amount (Rs)
Prepaid Insurance

4. Accrued income (Due but not received)

Accrued income means income earned but not received till the end of the accounting year. For
example, interest on securities or dividends on shares, which has become due but may be received on a
date falling in the next year. Such income does not appear in the trial balance but should be duly
accounted for in the year, because such income has accrued. Adjustment entry for the transaction :
suppose Rent receivable as it has become due but is not yet received

Rent Receivable (accrued) A/c Dr

To Rent Received A/c
(Amount of rent due but not received)
In financial statements, it will be recorded as;
Profit & Loss A/c
Dr. Cr.
Particulars Amount (Rs) Particulars Amount (Rs)
Rent Received
Add: Rent Accrued
Balance Sheet
Liabilities Amount (Rs) Assets Amount (Rs)
Rent Accrued

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5. Unearned income/income Received in Advance

When income is received before it becomes actually due it is called “unearned income” or “income
received in advance”. Since this income does not relate to the accounting year, it should be deducted
from the relevant head of income in the Profit & Loss A/c. It is a liability and hence is shown in the
liability side of the Balance Sheet. Example of such income is rent that has been received for the
months of January and February of the coming accounting year. Adjustment entry for the same is

Rent Received A/c Dr

To Rent Received in Advance A/c
(Rent received in advance)
Profit & Loss A/c
Dr. Cr.
Particulars Amount (Rs) Particulars Amount (Rs)
Rent Received
Less: Rent received in
advance

Balance Sheet
Liabilities Amount (Rs) Assets Amount (Rs)
Rent Received in advance

OTHER ADJUSTMENTS
6. Interest on capital
As per business entity concept capital of the proprietor is a liability for the business. Like other loans
interest can be paid on capital also. In case it is decided to allow interest on capital, adjustment entry
will be as follows:
Interest on Capital A/c Dr
To Capital A/c
(Interest allowed on capital)
Profit & Loss A/c
Dr. Cr.
Particulars Amount (Rs) Particulars Amount (Rs)
Interest on Capital

Balance Sheet
Liabilities Amount (Rs) Assets Amount (Rs)
Capital
Add: Interest on capital

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7. Interest on drawings
Interest may also be charged on money withdrawn by the proprietor for household use. Following
journal entry is made.

Capital A/c Dr
To Interest on Drawings A/c
(Interest on Drawings charged)

In financial statements, it will be shown as:.

Profit & Loss A/c
Dr. Cr.
Particulars Amount (Rs) Particulars Amount (Rs)
Interest on Drawings

Balance Sheet
Liabilities Amount (Rs) Assets Amount (Rs)
Capital
Less: Interest on
drawings

8. Depreciation
The value of fixed assets such as Plant and Machinery, Furniture and Fixtures, Land & Building,
Motor Vehicles etc. goes on reducing year after year due to wear and tear, obsolescence or for any
other reason. As the fixed assets are used for earning revenue the amount by which the value of a fixed
asset decreases is an item of expense, similar to other expenses. This is called depreciation. It should
be charged to the Profit and loss Account. The value of such assets should also be shown in the
Balance Sheet at the reduced value by the amount of depreciation. The adjustment entry for
depreciation will be
Depreciation A/c Dr
To Asset ( by name ) Account

It will be shown in the Profit and Loss A/c and Balance sheet as under:
Profit & Loss A/c
Dr. Cr.
Particulars Amount (Rs) Particulars Amount (Rs)
Depreciation on Plant &
machinery
Balance Sheet
Liabilities Amount (Rs) Assets Amount (Rs)
Plant & machinery
Less: Depreciation
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9. Further bad debts

When the goods are sold on credit basis some of the debtors partly pay the due amount or do not pay at
all. If this amount cannot be recovered it is called bad debts and is a loss to the firm. This is entered on
the debit side
of the Profit & loss A/c. But then there may be amount of bad debt which was not recorded in the
books of accounts and hence did not appear in the Trial Balance. But the same was discovered before
preparing the financial statements. It is called further bad-debts. Following adjustment entry is made
for the same :
Bad Debts A/c Dr
To Debtors A/c
(Further bad debts recorded)

In Profit and Loss A/c and Balance sheet it is shown as under:

Profit & Loss A/c

Dr. Cr.
Particulars Amount (Rs) Particulars Amount (Rs)
Bad Debts
Add: further bad debts

Balance Sheet
Liabilities Amount (Rs) Assets Amount (Rs)
Sundry Debtors
Less: further bad debts

Accounting standard

In order to ensure transparency, consistency, comparability, adequacy and correctness of financial

statements, it is essential that the financial process of accounting is well regulated. The main aim and
objective of framing accounting standards this to ensure that the financial statements are adequate in
disclosure, transparent without being shrouded in mystery consistent year after year and comparable
between periods and firms and are reliable. It is for this purpose accounting standards have been
framed by national and international accounting, accounting bodies and have assumed great
importance in recent times.

According to Mr. T.P. Ghosh, “Accounting standards are the policy documents issued by the
recognized expert accountancy body relating to various aspects of measurement, treatment and
disclosure of accounting transactions and events.” Simply, Accounting standards are such standards
which are issued by the recognized expert accountancy body for harmonization of accounting policies
and practices followed by business to standardize the diverse accounting practices. In India, Institute
of Chartered Accountants of India prepares and issued Accounting Standards considering the business
environment of India.
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Accounting Standards in India are issued By the Institute of Chartered Accountants of India (ICAI). At
present there are 30 Accounting Standards issued by ICAI.The following are the mandatory
Accounting Standards (AS) as on July 1 2012 as listed on the site of The Institute of Chartered
Accountants of India (ICAI) –

1. AS 1 Disclosure of Accounting Policies: Accounting Policies refer to specific accounting

principles and the method of applying those principles adopted by the enterprises in
preparation and presentation of the financial statements.
2. AS 2 Valuation of Inventories: The objective of this standard is to formulate the method of
computation of cost of inventories / stock, determine the value of closing stock / inventory at
which the inventory is to be shown in balance sheet till it is not sold and recognized as revenue.
3. AS 3 Cash Flow Statements: Cash flow statement is additional information to user of
financial statement. This statement exhibits the flow of incoming and outgoing cash. This
statement assesses the ability of the enterprise to generate cash and to utilize the cash. This
statement is one of the tools for assessing the liquidity and solvency of the enterprise.
4. AS 4 Contigencies and Events occuring after the balance sheet date: In preparing financial
statement of a particular enterprise, accounting is done by following accrual basis of
accounting and prudent accounting policies to calculate the profit or loss for the year and to
recognize assets and liabilities in balance sheet. While following the prudent accounting
policies, the provision is made for all known liabilities and losses even for those liabilities /
events, which are probable. Professional judgement is required to classify the likehood of the
future events occuring and, therefore, the question of contingencies and their accounting arises.
5. AS 5 Net Profit or Loss for the Period, Prior Period Items and change in Accounting
Policies : The objective of this accounting standard is to prescribe the criteria for certain items
in the profit and loss account so that comparability of the financial statement can be enhanced.
Profit and loss account being a period statement covers the items of the income and
expenditure of the particular period. This accounting standard also deals with change in
accounting policy, accounting estimates and extraordinary items.
6. AS 6 :- Depreciation Accounting : It is a measure of wearing out, consumption or other loss
of value of a depreciable asset arising from use, passage of time. Depreciation is nothing but
distribution of total cost of asset over its useful life.

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7. AS 7 Construction Contracts (revised 2002)''':- Accounting for long term construction

contracts involves question as to when revenue should be recognized and how to measure the
revenue in the books of contractor. As the period of construction contract is long, work of
construction starts in one year and is completed in another year or after 4-5 years or so.
Therefore question arises how the profit or loss of construction contract by contractor should
be determined. There may be following two ways to determine profit or loss: On year-to-year
basis based on percentage of completion or On completion of the contract.

8. AS 8 Accounting for Research and Development (AS-8 is no longer in force since it was
merged with AS-26)
9. AS 9 Revenue Recognition : The standard explains as to when the revenue should be
recognized in profit and loss account and also states the circumstances in which revenue
recognition can be postponed. Revenue means gross inflow of cash, receivable or other
consideration arising in the course of ordinary activities of an enterprise such as:- The sale of
goods, Rendering of Services, and Use of enterprises resources by other yeilding interest,
dividend and royalties. In other words, revenue is a charge made to customers / clients for
goods supplied and services rendered.
10. AS 10 Accounting for Fixed Assets: It is an asset, which is:- Held with intention of being
used for the purpose of producing or providing goods and services. Not held for sale in the
normal course of business. Expected to be used for more than one accounting period.
11. AS 11 The Effects of changes in Foreign Exchange Rates : Effect of Changes in Foreign
Exchange Rate shall be applicable in Respect of Accounting Period commencing on or after
01-04-2004 and is mandatory in nature. This accounting Standard applicable to accounting for
transaction in Foreign currencies in translating in the Financial Statement Of foreign operation
Integral as well as non- integral and also accounting for For forward exchange.Effect of
Changes in Foreign Exchange Rate, an enterprises should disclose following aspects:

• Amount Exchange Difference included in Net profit or Loss;

• Amount accumulated in foreign exchange translation reserve;
12. AS 12 Accounting for Government Grants : Governement Grants are assistance by the
Govt. in the form of cash or kind to an enterprise in return for past or future compliance with
certain conditions. Government assistance, which cannot be valued reasonably, is excluded
from Govt. grants,. Those transactions with Governement, which cannot be distinguished from
the normal trading transactions of the enterprise, are not considered as Government grants.
13. AS 13 Accounting for Investments : It is the assets held for earning income by way of
dividend, interest and rentals, for capital appreciation or for other benefits.
14. AS 14 Accounting for Amalgamation : This accounting standard deals with accounting to be
made in books of Transferee company in case of amalgamtion. This accounting standard is not
applicable to cases of acquisition of shares when one company acquires / purcahses the share
of another company and the acquired company is not dissolved and its seperate entity
continues to exist. The standard is applicable when acquired company is dissolved and seperate
entity ceased exist and purchasing company continues with the business of acquired company

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15. AS 15 Employee Benefits : Accounting Standard has been revised by ICAI and is applicable
in respect of accounting periods commencing on or after 1st April 2006. the scope of the
accounting standard has been enlarged, to include accounting for short-term employee benefits
and termination benefits.
16. AS 16 Borrowing Costs : Enterprises are borrowing the funds to acquire, build and install the
fixed assets and other assets, these assets take time to make them useable or saleable, therefore
the enterprises incur the interest (cost on borrowing) to acquire and build these assets. The
objective of the Accounting Standard is to prescribe the treatment of borrowing cost (interest +
other cost) in accounting, whether the cost of borrowing should be included in the cost of
assets or not.
17. AS 17 Segment Reporting : An enterprise needs in multiple products/services and operates in
different geographical areas. Multiple products / services and their operations in different
geographical areas are exposed to different risks and returns. Information about multiple
products / services and their operation in different geographical areas are called segment
information. Such information is used to assess the risk and return of multiple
products/services and their operation in different geographical areas. Disclosure of such
information is called segment reporting.
18. AS 18 Related Paty Disclosure : Sometimes business transactions between related parties
lose the feature and character of the arms length transactions. Related party relationship affects
the volume and decision of business of one enterprise for the benefit of the other enterprise.
Hence disclosure of related party transaction is essential for proper understanding of financial
performance and financial position of enterprise.
19. AS 19 Accounting for leases : Lease is an arrangement by which the lesser gives the right to
use an asset for given period of time to the lessee on rent. It involves two parties, a lessor and a
lessee and an asset which is to be leased. The lessor who owns the asset agrees to allow the
lessee to use it for a specified period of time in return of periodic rent payments.
20. AS 20 Earning Per Share :Earning per share (EPS)is a financial ratio that gives the
information regarding earning available to each equiy share. It is very important financial ratio
for assessing the state of market price of share. This accounting standard gives computational
methodology for the determination and presentation of earning per share, which will improve
the comparison of EPS. The statement is applicable to the enterprise whose equity shares or
potential equity shares are listed in stock exchange.
21. AS 21 Consolidated Financial Statements : The objective of this statement is to present
financial statements of a parent and its subsidiary (ies) as a single economic entity. In other
words the holding company and its subsidiary (ies) are treated as one entity for the preparation
of these consolidated financial statements. Consolidated profit/loss account and consolidated
balance sheet are prepared for disclosing the total profit/loss of the group and total assets and
liabilities of the group. As per this accounting standard, the conslidated balance sheet if
prepared should be prepared in the manner prescribed by this statement.
22. AS 22 Accounting for Taxes on Income : This accounting standard prescribes the accounting
treatment for taxes on income. Traditionally, amount of tax payable is determined on the
profit/loss computed as per income tax laws. According to this accounting standard, tax on
income is determined on the principle of accrual concept. According to this concept, tax should
be accounted in the period in which corresponding revenue and expenses are accounted. In
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B.Com I YEAR Financial Accounting

simple words tax shall be accounted on accrual basis; not on liability to pay basis.
23. AS 23 Accounting for Investments in Associates in consolidated financial statements : The
accounting standard was formulated with the objective to set out the principles and procedures
for recognizing the investment in associates in the cosolidated financial statements of the
investor, so that the effect of investment in associates on the financial position of the group is
indicated.
24. AS 24 Discontinuing Operations : The objective of this standard is to establish principles for
reporting information about discontinuing operations. This standard covers "discontinuing
operations" rather than "discontinued operation". The focus of the disclosure of the Information
is about the operations which the enterprise plans to discontinue rather than dsclosing on the
operations which are already discontinued. However, the disclosure about discontinued
operation is also covered by this standard.
25. AS 25 Interim Financial Reporting (IFR) : Interim financial reporting is the reporting for
periods of less than a year generally for a period of 3 months. As per clause 41 of listing
agreement the companies are required to publish the financial results on a quarterly basis.
26. AS 26 Intangible Assets : An Intangible Asset is an Identifiable non-monetary Asset without
physical substance held for use in the production or supplying of goods or services for rentals
to others or for administrative purpose
27. AS 27 Financial Reporting of Interest in joint ventures : Joint Venture is defined as a
contractual arrangement whereby two or more parties carry on an economic activity under
'joint control'. Control is the power to govern the financial and operating policies of an
economic activity so as to obtain benefit from it. 'Joint control' is the contractually agreed
sharing of control over economic activity.
28. AS 28 Impairment of Assets : The dictionary meanong of 'impairment of asset' is weakening
in value of asset. In other words when the value of asset decreases, it may be called impairment
of an asset. As per AS-28 asset is said to be impaired when carrying amount of asset is more
than its recoverable amount.
29. AS 29 Provisions, Contingent Liabilities And Contingent Assets : Objective of this standard
is to prescribe the accounting for Provisions, Contingent Liabilitites, Contingent Assets,
Provision for restructuring cost. Provision: It is a liability, which can be measured only by
using a substantial degree of estimation. Liability: A liability is present obligation of the
enterprise arising from past events the settlement of which is expected to result in an outflow
from the enterprise of resources embodying economic benefits.
30. 'AS 30 Financial Instruments: Recognition and Measurement and Limited:- Financial
Instrument: Recognition and Measurement, issued by The Council of the Institute of
Chartered Accountants of India, comes into effect in respect of Accounting periods
commencing on or after 1-4-2009 and will be recommendatory in nature for An initial period
of two years. This Accounting Standard will become mandatory in respect of Accounting
periods commencing on or after 1-4-2011 for all commercial, industrial and business Entities
except to a Small and Medium-sized Entity. The objective of this Standard is to establish
principles for recognizing and measuring Financial assets, financial liabilities and some
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B.Com I YEAR Financial Accounting

contracts to buy or sell non-financial items. Requirements for presenting information about
financial instruments are in Accounting Standard.
31. AS 31 Financial Instrument: presentation : The objective of this Standard is to establish
principles for presenting financial instruments as liabilities or equity and for offsetting
financial assets and financial liabilities. It applies to the classification of financial instruments,
from the perspective of the issuer, into financial assets, financial liabilities and equity
instruments; the classification of related interest, dividends, losses and gains; and the
circumstances in which financial assets and financial liabilities should be offset. The principles
in this Standard complement the principles for recognising and measuring financial assets and
financial liabilities in Accounting Standard Financial Instruments:
32. AS 32 Financial Instruments, Disclosures and Limited revision to accounting
standards: The objective of this Standard is to require entities to provide disclosures in their
financial statements that enable users to evaluate:
33. the significance of financial instruments for the entity’s financial position and performance;
and
34. the nature and extent of risks arising from financial instruments to which the entity is exposed
during the period and at the reporting date, and how the entity manages those risks.

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B.Com I YEAR Financial Accounting

UNIT II

On the basis of accounting concept of going concern, assets are classified as fixed assets and current
assets. Fixed assets are used in the business to derive benefits for more than one accounting period.
Periodic profit is measured by charging cost against periodic revenue. Since fixed assets are used to
generate periodic revenue, an appropriate proportion of the cost of fixed assets which is believed to be
used or expired for generation of periodic revenue needs to be charged as cost. Such an appropriate
proportion of the cost of fixed assets is termed as ‘Depreciation’.

Meaning

Depreciation means a fall in the value of an asset because of usage or efflux of time due to
obsolescence or accident. It is the permanent and continuing diminution in the quality, quantity of
value of an asset.

Definition

According to Spicer & Pegler, “Depreciation is the measure of the exhaustion of the effective life of
an asset from any cause during a given period.”

Thus, depreciation may be defined as continuing and gradual shrinkage in the value of fixed asses. It
has a significant impact in presenting the financial position and result of operations of a business
enterprise. It is charged in every accounting period as an expense/ loss to the extent of shrinkage in the
valure of fixed assets so that cost of production can be determined properly.

Features or Characteristics of Depreciation

1. Depreciation is charged on fixed assets except land.

2. Depreciation is calculated on the book value (as shown in the books after charging of
depreciation) and not on market value of assets.

3. Depreciation is charged on permanent basis. Once the depreciation is charged, it reduces the
value of the asset permanently.

4. Depreciation is charged on a continuous basis. Once the depreciation is charged, it must be

charged on regular basis in the succeeding period also.

5. The charge of depreciation will decrease the value of asset gradually. In other words, it must
reduce the value of assets slowly and steadily.

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B.Com I YEAR Financial Accounting

6. The process of computation of depreciation implies allocation of cost of an asset over the
effective and useful life of the assets.

Causes of Depreciation

The principal causes of depreciation are as follows:

1. By Constant use: Wear and tear of an asset due to its constant use is a cause of decline in the
value of an asset. A fixed asset begins to lose its value when it is used in the business e.g. plant
& machinery, building, furniture etc.

2. By expiry of time: Certain assets get decreased in their value with the expiry of time whether
they are used in the business or no. this is true in case of assets like leasehold properties,
patents or copyrights etc. For example, if a lease is obtained for 25 years for Ts. 1,00,000, it
will lose 1/25th i.e. Rs. 4,000 of its value every year whether it is used in the business or not.
So at the end of 25th year, its value will be reduced to zero.

3. By Obsolescence: Some assets are discarded before they are worn out because of changed
conditions. For example, an old machine which is still workable may have to be replaced by a
new machine because of the later being more efficient and economical. Such a loss on account
of new inventions or charged fashions is termed as loss on account of obsolescence.

4. By Depletion: Some assets like mineral mines, oil wells etc. get exhausted or depleted through
working. On account of continuous extraction of minerals or oil, a stage comes when the mine
or oil gets completely exhausted and nothing is left.

5. By Accidents: An asset may meet an accident and therefore, it may get depreciated in its
value.

6. By Permanent fall in market price: Though the fall in the market value of fixed assets is not
recorded because such assets are not resale for use in the business. Sometimes, the fall in the
value of certain fixed assets is treated as depreciation e.g. permanent fall in the value of
investment.

7. Changes in economic environment: There may be instances when slackening of demand for
the services of an asset may bring about a fall in its value. Such a change in conditions arises
due to a number of factors e.g. technological changes within an industry, changes in tastes and
habits of consumers, changes in availability of natural resources and so on.

Thus, depreciation applies to fixed assets, depletion to wasting assets, amortization to intangible assets
and damage due to dilapidations of building or other property during tenancy.

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Need or Objects or Significance of Providing Depreciation

The following are the objectives of providing depreciation:

1. Ascertainment of true profit or loss: Depreciation being a loss, will certainly affect the
business profits. Therefore, to arrive at the true profit or loss, depreciation must be provided for
and records in the books of accounts.

2. Presentation of true financial position: In a balance sheet, assets must be shown at their true
values. This is not possible unless depreciation is provided and deducted from the values of
these assets.

3. Replacement of assets: Some assets used in the business need replacement after the expiry of
their service life. By providing depreciation, a part of the profit of the business is kept in the
business which can be used for purchase of new asserts when the old fixed asserts become
useless.

4. Calculation of correct cost of production: Correct cost of production cannot be calculated

unless depreciation is properly provided and accounted for an item of cost of production.

5. Prevention to withdrawal of capital: Capital of a business remains invested in different

assets. If no depreciation is charged, assets and capital are shown at enhanced figures due to
such misrepresentation; capital itself may be withdrawn in the guise of imaginary profit.

6. Excess payment of income tax: Depreciation accounting is required for correct computation
of profit for tax purposes and for computation of tax liability, otherwise more income tax will
be paid on account of excess profit.

7. To prevent distribution of profit out of capital: If no depreciation is charged, it will result in

showing more profit. Such excess profit may either be withdrawn by the owner or may be
distributed among shareholders of the company as dividend. This will mean payment out of
capital to the shareholders.

8. Other objectives: The workers may demand an increase in the wages or salary or in the
payment of bonus as more profit will be shown if depreciation is not provided.

Factors Affecting Depreciation

Calculation of depreciation is a difficult work. Following three basic factors are of utmost importance
in the calculation of depreciation:

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B.Com I YEAR Financial Accounting

Total cost of the assets: The cost of the asset includes the invoice price of the asset, less any trade
discount plus all costs essential to bring the asset to a useable condition. In other words, cost includes
all expenses upto the installation of the assets e.g. freight, carriage, installation charges etc.

Estimated useful life of an asset: This is represented by the number of years of the estimated
serviceable life span of an asset. Thus, if an asset is expected to last for 15 years before completely
losing its usefulness for business operations, its life is taken to be 15 years. If a machine can work for
15 years but it is likely to become obsolete in 10 years due to availability of better type of machine, its
useful life will be considered as 10 years.

Estimates scrap value of an asset: The term scrap value means the residual or break up or salvage
value which is estimated to be realized on account of the sale of the asset at the end of its useful life.
An important part in this connection is that an asset may not necessarily have a scrap value e.g.,
leasehold property.

Example: if a machine is bought for Rs. 50,000; Rs. 3,000 are spent on its freight, Rs. 2,000 for its
installation, it is estimated by the expert that its working life will be 10 years and at that time residual
value will be Rs. 2,500. In such case, depreciation will be calculated as follows:

Cost of the asset = Rs. 50,000 + Rs. 3,000 + Rs. 2,000 = Rs. 55,000 Working life of the asset = 10
years Scrap value of asset Rs. 2,500. It means Rs. 52,500 (Rs. 55,000 – Rs. 2,500) will be written off
in the time span of 10 year i.e. Rs. 5,250 every year as depreciation.

Depreciation and other Related Concepts

Depreciation and Depletion: Depreciation refers to a reduction in the value of all kinds of fixed
assets arising from then wear and tear. Depletion is used in respect of the extraction of natural
resources like quarries, mines, etc. that reduces the availability of the quantity of material or asset.

Depreciation and Obsolescence: Obsolescence refers to decrease in usefulness caused on account of

the asset becoming out of date, old fastioned, etc, and it is one of the causes of depreciation.
Depreciation is the loss in the value of an asset on account of wear and tear.

Depreciation and Amortization: Amortization refers to writing off of the proportionate value of the
intangibles such as goodwill patents, copyrights while depreciation refers to writing off of the expired
cost of the tangible assets like machinery, building, etc.

Depreciation and Fluctuation : The points of difference are as follows :

Depreciation Fluctuation

1. Charged on fixed assets. 1. It appears in respect of current assets

2. It is consistent in nature 2. It is inconsistent in nature.

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B.Com I YEAR Financial Accounting

3. It has a virtue of continuity. 3. It has no continuity

4. It always reduces the value of the asset. 4. It may cause increase in the value of asset.

Use of word per annum for calculation of amount of depreciation

In case the word “per annum” is given with the rate of deprecation than the amount of deprecation is
calculated for the number of months the asset is used in business. When sale or purchase of asset takes
place in between the year the deprecation is calculated for the period for which the asset was used.

In case per annum word is not given than the concept of number of months for which asset is used is
over looked and depreciation is charged for whole year irrespective of asset being purchased in
between the year and in case of sale of asset in between the year no deprecation is charged in selling
year.

Methods of Charging Depreciation:

1) Fixed Installment Method/ Original Cost Method: In fixed installment method, a fixed part
of the original cost of the asset is transferred to P & L A/c every year as depreciation. The
amount transferred as depreciation is fixed or the same. In this method when the asset becomes
useless, its value becomes zero. When the asset has no residual value: Original cost of asset /
Each year’s Dep. = Number of years of estimated life of the asset

When the asset has residual value: Original cost of the asset – Its estimated resident value
Each year’s Dep. = Number of years of estimated life of the asset

2) Diminishing Balance Method/ Reducing balance method/ Written down value method: In
this method, depreciation is charged on the residual balance of the asset by a fixed rate of
percentage. Thus, as the value of asset keeps going down year by year, depreciation also goes
down in proportion. In this method the amount of depreciation is decreased every year. Rate of
depreciation is fixed in this method, but depreciation at this rate is calculated on the balance of
the asset standing in the books on the first day of each year. This method is suitable in case of
those assets whose repair charges increase as they become old, e.g., Machinery. Also known as
Reducing Balance method and written down value method.

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B.Com I YEAR Financial Accounting

Basis of different Fixed Installment Method Reducing Balance Method

1. Calculation Depreciation is calculated on the Depreciation is calculated on the

of original cost. remaining balance or opening book value
Depreciation of the asset.

2. Variation in Amount of annual Amount of annual depreciation keeps

depreciation depreciation remains same. decreasing.

amount

3. Balance at the end Under this method, balance of asset According to this method balance of the
of life account is either equal to zero or is asset can never be equal to zero.
equal to scrap value at the end of life

of an asset.

4. Rate of Rate of depreciation is not kept high. Rate of depreciation is normally kept
Depreciation high.

5. Burden on Burden of repairs and depreciation Burden to total cost of running the asset

Profit & Loss is not equitable under this method. is almost equitable.

6. Applicability This method is adopted on the assets This method is more suitable for those
which are of less value and shorter assets which lose their utility gradually
life. and heavy repair cost is incurred on

them.

7. Validity This method is not approved by This method is approved by tax laws and
income tax laws.
tax rebate is given on depreciation
calculated by this method.

8. Practicability Same depreciation is charged even As the utility of the asset reduces, the
when the asset is of less value. amountof depreciation keeps on

decreasing.

Journal entries in case of Depreciation

On asset purchase

Asset A/c Dr

To cash/ Bank
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B.Com I YEAR Financial Accounting

On depreciation charged

Depreciation on asset A/c Dr

To asset A/c

On Transfer of depreciation to P&L A/c

P&L A/c Dr

To depreciation

On sale of asset at profit

Cash/ Bank A/c Dr

To P&L A/c To asset A/c

On sale of asset at loss

Cash/ Bank a/c Dr

P&L A/c Dr

To asset A/c

Journal entries for Depreciation when provision of Depreciation is made.

For providing depreciation

Depreciation a/c Dr

To provision For Depreciation A/c

For transfer of depreciation to P&L A/c

P&L A/c Dr

To Depreciation A/c

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B.Com I YEAR Financial Accounting

On sale of asset

Provision for Depreciation A/c Dr

To Assets A/c

In case of profit or loss on sale of asset

If Profit:

Asset A/c Dr

To P&L A/c

If Loss:

P&L A/c Dr

To asset A/c

Alternately, on sale asset, an asset disposal account may be opened. Change of Method:

In case of change of method of charging depreciation from straight line method to diminishing balance
method, the depreciation is charged on the reduced balance of asset on the date when change is
applicable.

In case of change of method of charging depreciation from diminishing balance to straight line
method, the depreciation is charged on the original cost of asset when change is applicable.

Change of method from previous date (Retrospective effect)

The change of method from straight line to diminishing balance and from diminishing to straight line
can be made effective from the original/ previous date. In such a case there might be extra depreciation
already charged or to be charged as change is to be made effective from previous date. The treatment
of this extra of less depreciation is to be made. Such change of method is known as change of method
from previous date i.e. retrospective effect. As per AS-6 when any change of method of depreciation is
recommended, then the change is to be made effective from retrospective effect and not immediate
effects.

3) Annuity Method: In annuity method the amount invested in an asset is considered as an

investment and interest is calculated on such amount. Every year the amount of interest is
calculated and same is transferred to debit side of the asset A/c and depreciation A/c is
credited. Thus the effect of depreciation and interest keeps increasing on the P & L A/c
because every year the P & L A/c is debited with the amount of depreciation and credited with
the interest. Under this method amount of depreciation is found out from annuity table. When
as asset is purchased, the purchaser not only loses the amount spent in purchasing the asset but

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B.Com I YEAR Financial Accounting

he also loses the expected amount of interest which he would have earned had he invested this
amount elsewhere instead of purchasing this asset. Under this method amount of depreciation
includes some portion of the asset and some portion of this expected amount of interest also.

4) Depreciation Fund Method: In this method, Govt. Investments are purchased every year by
the amount of depreciation. More securities are purchased by the return on previous securities.
Thus the depreciation is invested in securities. Compound interest is received on such ecurities.
Investments are not made in the last year; instead all securities are sold out and the return is
used for renewal. Amount of depreciation is not deducted from the value of the asset; instead it
is transferred to the credit side of Depreciation Fund A/c. Asset is shown on the original cost
every year.
5) Depreciation Repairs & Renewals Fund Method: In this method, the life of the asset,
depreciation thereon, scrap value at the end of its life and repairing expenses of the asset are
estimated in advance. Such estimated amount is transferred to the P & L A/c in equal parts. In
this method a Depreciation Repairs and Renewals Fund a/c is opened. In this account, the
estimated installment calculated in the above mentioned manner is transferred to the P & L A/c
every year. When the life of the asset is over, it is disposed of. The balance of Fund A/c is
transferred to the asset A/c and both accounts are closed. If some balance remains in the Asset
A/c it is transferred to the P & L A/c.

6) Insurance Policy Method: In Insurance Policy Method the amount of depreciation is not
invested in external securities. Instead, an insurance policy is taken for renewal of the asset.
Every year a fixed amount is paid as premium of the policy and after a certain period the
insurance company pays back in lump sum, which is used for renewal.

7) Revaluation Method: In this method at the end of each year the asset is revalued by an expert
before the preparation of final accounts and any reduction in the value of the asset is assumed
as depreciation and is duly charged. If there is an appreciation in the value of such asset, it is
overlooked. When the asset is revalued at a lower price, the amount by which it is reduced is
assumed as depreciation. The Depreciation A/c is debited with this amount and asset A/c is
credited with the same.

8) Sum of the year digits method: First of all the estimated cost of assets is calculated by
deducting scrap value from original cost. The total of digits of the assets is made in an order. If
the life of a company is five years – 5 + 4 + 3 + 2 + 1 = 15 will be sum of the digits. For
calculation of depreciation assets of first year will be assumed to be equal in use of the asset
throughout its life. In the following years the period will gradually be reduced. The following

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B.Com I YEAR Financial Accounting

formula is used to calculate depreciation: In second and following years one year respectively
will be reduced from the total number of years.

9) Machine hour rate method: In this method the life of machinery is estimated in hours and the
whole loss on the machinery (Cost - Scrap Value) is divided by such hours. Thus the
depreciation is calculated on per hour use of the machinery.

10) Depletion Method : In this method, an estimate of the profits which the assets is supposed to
yield in the future is made and the amount invested in the asset is divided in such profit and
depreciation per unit is calculated.

11) Difference between Reserves & Provisions

S. Basis of Reserve Provision

Difference
No

1 Meaning A reserve is meant for meeting an A provision is created for some

specific
unanticipated situation.
object

2 Mode of A reserve is created only out of profit. A provision is a charge against profit.
creation It
If there is no sufficient profit, a reserve
cannot be created. is created even though there is no
profit.

3 Time of A reserve is created after ascertaining A provision is created

before

creation the profit ascertaining the profit or loss of a

business.

4 Object The object of creating such reserves is The object of making provisions is
to strengthen the financial position of arrangement made to provide funds
the business and to increase the for known liability.

working capital.

5 Utilization Reserve can be used in the payment of Provision can be utilized only for the
any liability or loss. purpose for which it is meant.

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B.Com I YEAR Financial Accounting

6 Distribution General reserve are always available A provision cannot be utilized for the
distribution of profit e.g. as dividend.
for distribution of profits e.g. as
dividend.

7 Place in Reserves show excess of assets over A provision is not shown as excess of
accounting liabilities. asset over liabilities but it is helpful
for

determining the real valuation of

assets.

8 Presenting in Reserves are always on the liabilities A provision is shown as an item of

balance sheet side in the balance sheet.
deduction from its related asset or
shown on liability side.

Branch Accounts

Branch Account: - Account which are opened in the book Head office and branches related to Branches
are called branch account. The main objective of these branches Account is to know the working ability and
profit and loss of branches. The also include the financial account related to them by which their
financial condition is known.

Kinds of Branches :-

Dependents Branches:- These branches do not prepare any accounts their accounts are prepared by
the H.O. These braches cash book, sales boo and stock book only for money. They do not keep any
journal entries of ledger accounts. Dependent branches may be any of the following three kinds (a)
branches making cash sales only (b) Branches making cash and credit sales (c) Branches to
when goods are sent on sale price.

Stock & Debtors Method:- The branches which under take both cash & credit sales and whole sale is
more due to expanded business area then it is difficult to prepare branch A/c only and these are more
possibilities of errors due to more transaction amount.When goods sent to branch at cost price:- The
following accounts are prepared under this method:-

(1) Branch stock A/c (2) Goods sent to Branch (3) Branch Debtors A/c (4) Branch expenses

5) Branch P & L A/c

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B.Com I YEAR Financial Accounting

When goods sent to Branch at invoice price:- The following accounts as prepare under this method.

(1) Branch stock A/c (ii) Goods sent to Branch A/c (iii) Branch Debtors (iv) Branch Expenses (v)
Branch stock Reserve A/c (vi) Branch adjustment a/c

Simple system or Debtors system:- When branch are very small than this method is adopted in this
method only branch account is prepared in the bank of H.O. whose credit balancer indicate profit and
debit balance indicates the loss. The method is also called debtor method. The branch account
prepared under this method is of the nature of nominal account.

Financial account system:- In this method branch trading account & profit & loss of H.O. along with
Branch A/c. The Branch account prepared under this method is of the nature of personal a/c.

Whole sale Branch method:- This is method applied when the manufacturers supplier the goods to
the whole seller and also to the consumer a from their own branch. The goods use transferred to the
branch at the same value at which it is transferred to whole sellers.

Multiple Account Method or Stock and Debtor Method

In this method for ascertaining trading results many accounts are opened in the books of branch
instead of only branch account.

(+) Branch Stock A/c (I.P.) (-)

To Bal. b/d By B. Cash A/c (Cash Sales)

To Goods sent to Br. A/c By B. Debtors A/c (Credit Sales)

To B. Debtors A/c (S.R.) By Goods to Br. A/c (Ret. To H.O.)

To B. Stock Res. (loading) By B. Stock Res. (loading)

To B. P & L. A/c (Cost) (Surplus) By B. P & L. A/c (Cost) (Shortage)

To ……. B. Stock a/c (Trans. Recd.) By Goods in transit a/c

To B.P. & L A/c (B.F.) By… B Stock A/c (transfer given)

By Bal. c/d

The converted trail balance is prepared as under:

Fixed assets- Fixed assets are converted at the rate prevailing at the date of its purchase. If this rate is
not in the opening rate may be applied.

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B.Com I YEAR Financial Accounting

Fixed Liabilities:- The are converted at the rate prevailing when these liabilities arose. If nothing is
given, opening rate may be applied.

Current assets and current liabilities:- These are converted at the closing rate.

Opening and closing stock:- Opening rate is applied for opening stock and closing rate is applied for
closing stock.

Depreciation- The rate applied for the concerned asset, is used to convert the deprecation also.

Provision for bad & doubtful debts- This is converted at the rate at which debtors are converted i.e.
closing rate.

Revenue items:- Except, deprecation, provision for doubtful debts, opening and closing stocks, all the
revenue items are converted at average rate.

Remittance by branch- No rate is applied for this item, but the amount standing in the books of H.O. in
this respect is considered.

H.O. account- This is also not converted by any rate, but the balance of branch account in H.O.’s
books is considered.

Conversion Table

Particulars Rate to be applied

Fixed Assets Fixed Liabilities Opening Rate

Current Assets Current Opening Rate
Liabilities Closing Rate
Closing Rate
Goods, Expanses and Income
Average Rate

Exchange suspense or reserve account- When the branch trial balance is converted as per the above
mentioned rules, obviously the totals of converted trial balance do not agree. So the difference in
converted trial balance is transferred to a newly opened ‘exchange suspense or exchange reserve
account’. This account is shown in balance sheet. If it is one the credit side, it is shown on liabilities
side or vice versa.

For incorporation of branch trail balance, at first the trial balance is converted and then final accounts
are prepared.

Note:- Some authors prefer to transfer ‘exchange suspense account’ to profit & loss A/c if the amount
of this account is more or less equal to the other revenue accounts.

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B.Com I YEAR Financial Accounting

Incorporation of Branch Trial Balance in H.O. Books

Every Branch is an integral part of the business of its Head Office. The Assets and Liabilities of the
Branch are a part of the Assets & Liabilities of the Head Office. Hence it is essential that a Joint
Balance Sheet be prepared for the Head Office and all its Branches which may show a clear &
complete position of the business organisation. For this Joint Balance sheet, the adjustment of Trial
Balances of all the Branches is to be made in the books of the Head Office. Its procedure is as
follows:-

First Method- According to this method, the incorporation of the Trial Balance of the Branch is done
once together i.e. only one entry is made for all the items of debit side and credit side as given below:

All items in the Dr. side of branch Trial Balance Dr.

To Branch A/c

(Being all the Dr. balance of Branch incorporated)

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B.Com I YEAR Financial Accounting

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UNIT III

Royalty Accounts
Royalty is payable by a user to the owner of the property or something on which an owner has some
special rights. A royalty agreement is prepared between the owner and the user of such property or
rights. If payment is made to purchase the right or property that will be treated as capital expenditure
instead of a Royalty.
Payment made by the lessee on account of a royalty is normal business expenditure and will be debited
to the Royalty account. It is a nominal account and at the end of the accounting year, balance of
Royalty account need to be transferred to the normal Trading and Profit & Loss account. Royalty,
based on the production or output, will strictly go to the Manufacturing or Production account. In case,
where the Royalty is payable on sale basis, it will be part of the selling expenses.

Types of Royalties

There are following types of Royalties –

• Copyright − Copyright provides a legal right to the author (of his book/s), the photographer (on
his photographs), or any such kind of intellectual works. Copyright royalty is payable by the
publisher (lessee) of a book to the author (lessor) of that book or to the photographer, based on
the sale made by the publisher.

• Mining Royalty − Lessee of a mine or quarry pays royalty to lessor of the mine or quarry,
which is generally based on the output basis.

• Patent Royalty − Patent royalty is paid by the lessee to lessor on the basis of output or
production of the respective goods.

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Basis of Royalty

In case of the patent, publisher of the book pays royalty to the author of the book on the basis of
number of books sold. So, holder of patent gets royalty on the basis of output and the mine owner gets
royalty on the basis of production.

Important Terms

Following are the important terms, which are used in Royalty agreements −
➢ Royalty:- A periodic payment, which may be based on a sale or output, is called Royalty.
Royalty is payable by the lessee of a mine to the lessor, by publisher of the book to the author
of the book, by the manufacturer to the patentee, etc.
➢ Landlord :- Landlords are the persons who have the legal rights on mine or quarry or patent
right or copybook rights.
➢ Tenet :- An Author or publisher; lessee or patentor who takes out rights (usually commercial
or personal rights) from the owner on lease against the consideration is called tenet..
➢ Minimum Rent :- According to the lease agreement, minimum rent, fixed rent, or dead rent is
a type of guarantee made by the lessee to the lessor, in case of shortage of output or production
or sale. It means, lessor will receive a minimum fix rent irrespective of the reason/s of the
shortage of production.
Payment of royalty will be minimum rent or actual royalty, whichever is higher for example −
Q1. M/s Hyderabad publication printed a book on Java on the minimum rent of Rs. 1,000,000/- per
annum royalty being payable @ Rs. 20 per book sold. In the first year of publication, Hyderabad
publication sold 75,000 copy of the books and in the second year, number of sold books fell down to
45,000 only. Amount of royalty will be payable as under −

Minimum Royalty
Rent Payable

Ist Year 1,0,00,000 Rs. 1,5,00,000

75,000 Books X Rs. 20 per book = Rs.

1,5,00,000

1,0,00,000 Rs. 1,0,00,000

IInd Year
45,000 Books X Rs. 20 per book = Rs.
9,00,000

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➢ Short workings: - Difference of minimum rent and actual royalty is known as short workings
where payment of Royalty is payable on the basis of minimum rent due to shortage in the
production or sale. For example, if calculated royalty is Rs. 900,000/- as per sale of books
based on the above example, but royalty payable is Rs. 1000,000 as per minimum rent, short
working will be Rs. 100,000 (Rs. 1,000,000 – Rs. 9,00, 000).
➢ Ground Rent:- The rent, paid to the landlord for the use of land or surface on the yearly or half yearly
basis is known as Ground Rent or Surface Rent.

➢ Right of Recouping:- It may contain in the royalty agreement that excess of minimum rent
paid over the actual royalty (i.e. short workings), may be recoverable in the subsequent years.
So, when the royalty is in excess of the minimum rent is called the right of recoupment (of
short workings).
Right of recoupment will be decided for the fixed period or for the floating period. When the
right of recoupment is fixed for the certain starting years from the date of royalty agreement, it
is said to be fixed or restricted. On the other hand, when the lessee is eligible to recoup the
short workings in next 2 or 3 years from the year of its commencement, it is said to be floating.
Short working will be shown on the asset side of Balance sheet up to allowable year of
recouping after that it will be transferred to profit & loss account (after expiry of
allowable period).
➢ Lease Premium:- An Extra payment in addition to royalty, if any, paid by lessee to lessor is
called Lease premium and will be treated as capital expenditure and it will be written off on
yearly basis through profit and loss account as per the suitable method.
➢ TDS (Tax Deducted at Source):- If there is an applicability of TDS (Tax deducted at source)
as per Income Tax Act, lessee will make the payment to lessor after deducting TDS as per
applicable rate and lessee is liable to deposit it to the credit of Central Government. Amount of
royalty will be gross amount of royalty (inclusive of TDS), that will be charged to profit and
loss account.
For example, if royalty amount is 1,000,000/-& rate of TDS is 10%, then lessee will pay Rs.
900,000/- to lessor. Amount of royalty charge to profit and loss account will be Rs. 1,000,000/-
and balance amount of Rs. 100,000/- will be deposited in the credit of central Government
account.
➢ Stoppage of Work:- Sometime, there may be stoppage of work due to conditions beyond control like
strike, flood, etc. in this case, minimum rent is required to be revised as provided in the agreement.

Revision of the minimum rent will be −

• Reduction of minimum rent in the proportion of the stoppage of work;
• On the basis of fixed percentage; or
• By a fixed amount in the year of stoppage.

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Sub Lease :- Sometime, landlord or lessor allows lessee to sublet some part of the mine or land as a
sub-lessee. In this case, lessee will become lessor for sub lessee and lessee for main landlord.

In such a case, as Lessee, he will maintain the following books of accounts −

As a Lessee As a Sub Lessor

• Landlord Account • Royalties receivable
• Minimum Rent Account • Lessee Account
• Royalty Account • Short workings Allowable Account
• Short workings
• Recoupable Accounts

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B.Com I YEAR Financial Accounting

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Departmental Accounts

If a business consists of several independent activities, or is divided into several departments, for carrying on separate
functions, its management is usually interested in finding out the working results of each department to ascertain their
relative efficiencies. This can be made possible only if departmental accounts are prepared. Departmental accounts are of great
help and assistance to the managements as they provide necessary information for controlling the business more intelligently
and effectively. It is also helpful in readily identifying all types of wastages, e.g., wastage of material or of money; Also,
attention is drawn to inadequacies or inefficiencies in the working of departments or units into which the business may be
divided.

Advantages Of Departmental Accounting

The main advantages of departmental accounting are as follows:

1. Evaluation of performance: The performance of each department can be evaluated separately on the
basis of trading results. An en deavour may be made to push up the sales of that department which is earning
maximum profit.

2. Growth potential of each department: The growth potential of a department as compared to others can
be evaluated.

3. Justification of capital outlay: It helps the management to determine the justification of capital
outlay in each department.

4. Judgement of efficiency: It helps to calculate stock turnover ratio of each department separately, and thus
the efficiency of each department can be revealed.

5. Planning and control: Availability of separate cost and profit figures for each department facilitates better
control. Thus effective planning and control can be achieved on the basis of departmental accounting
information.
Basically, an organization usually divides the work in various departments, which is done on the principle of division of
labour. Each department prepares its separate accounts to judge its individual performance. This can improve efficiency of
each and every department of the organization.

METHODS OF DEPARTMENTAL ACCOUNTING

There are two methods of keeping departmental accounts:
• Accounts of all departments are kept in one book only :- To prepare such accounts, it will be
necessary first, for the income and expenditure of department to be separately recorded in subsidiary books and then
for them to be accumulated under separate heads in a ledger or ledgers. This may be done by having columnar
subsidiary books and a columnar ledger.

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• Separate set of books are kept for each department :- A separate set of books may be kept for each
department, including complete stock accounts of goods received from or transferred to other departments or as also
sales.
Nevertheless, even when separate sets of books are maintained for different departments, it will also be necessary to
devise a basis for allocation of common expenses among the different departments, if an organisation is interested in
determining the separate departmental net profit in addition to the gross profit.

Basis Of Allocation Of Common Expenditure Among Different Departments

Expenses should be allocated among different departments on a rational basis while preparing departmental
accounts.

Individual Identifiable Expenses: Expenses incurred specially for a particular department are charged directly
thereto, e.g., insurance charges of stock held by the department.

Common Expenses: Common expenses, the benefit of which is shared by all the departments and which are capable of
precise allocation are distributed among the departments concerned on some equitable basis considered suitable in the
circumstances of the case.

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Note: There are certain expenses and income, most being of financial nature, which cannot be
apportioned on a suitable basis; therefore they are recognised in the combined Profit and Loss
Account, for example, interest on loan, profit/loss on sale of investment, etc.

Types Of Departments
There are two types of departments: Dependent and Independent Departments.
1. Independent Departments: - Departments which work independently of each other and have negligible
inter- department transfers are called Independent Departments.

2. Dependent Departments: - Departments which transfer goods from one department to another department
for further processing are called dependent departments. Here, the output of one department becomes the
input for the other department. These transfers may be done at cost or some pre-decided selling price. The price
at which this is done is known as transfer price. In these departments, unloading is required if the transfer price is
having a profit element. The method of eliminating unrealized profit is being discussed in the succeeding para.
INTER-DEPARTMENTAL TRANSFERS
Whenever goods or services are provided by one department to another, their cost should be separately recorded and
charged to the department benefiting thereby and credited to that providing the goods or services. The totals of such
benefits (inter-departmental transfers) should be disclosed in the departmental Profit and Loss Account, to distinguish
them from other items of expenditure.
Basis of Inter-Departmental Transfers
Goods and services may be charged by one department to another usually on either of the following three bases:
➢ Cost,
➢ Current market price,
➢ Cost plus agreed percentage of profit.
Elimination of Unrealised Profit
When profit is added in the inter-departmental transfers the loading included in the unsold inventory at the
end of the year is to be excluded before final accounts are prepared so as to eliminate any anticipatory
(internal) profit included therein.
Stock Reserve
Unrealised profit included in unsold stock at the end of accounting period is eliminated by creating
an appropriate stock reserve by debiting the combined Profit and Loss Account. The amount of stock
reserve will be calculated as:

Transfer price of unsold stock × Profit included in transfer

price Transfer price

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Journal Entry
At the end of the accounting year, the following journal entry will be passed for elimination of unrealized profit
Profit and Loss Account Dr.

To Stock Reserve
(Being a provision made for unrealised profit included in closing stock)
In the beginning of the next accounting year, the aforesaid journal entry will be reversed as under:
Stock Reserve Dr.
To Profit and Loss Account
(Being provision for unrealized profit reversed.)
Disclosure in Balance Sheet
The unsold closing stock acquired from another department will appear on the assets side of the balance
sheet as under:(An extract of the assets side of the balance sheet)
Current assets xxx
Stock xxx
Less: Stock reserve xxx
xxx

Memorandum Stock And Memorandum Mark Up Account Method

Under this method, goods supplied to each department are debited to a Memorandum Departmental Stock account at
cost plus a ‘mark up’ (loading) to give the normal selling price of the goods. The sale proceeds of the department are
credited in Memorandum Departmental Stock account and amount of ‘Mark up’ is credited to the Departmental Mark up
Account. When it is necessary to reduce the selling price below the normal selling price, i.e., cost plus mark up, the
reduction (mark down) is entered in the Memorandum Stock account as well as in the Mark up account. This method helps to
achieve effective control of stock movements of various departments.
Difference between Departmental and Branch Accounts

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UNIT IV

Non-for -Profit Organizations

Non-for -Profit Organizations refer to the organisations that are for used for the welfare of the society
and are set up as charitable institutions which function without any profit motive. Their main aim is to
provide service to a specific group or the public at large. Normally, they do not manufacture, purchase
or sell goods and may not have credit transactions. Hence they need not maintain many books of
account (as the trading concerns do) and Trading and Profit and Loss Account. The funds raised by
such organisations are credited to capital fund or general fund. The major sources of their income
usually are subscriptions from their members donations, grants-in-aid, income from investments, etc.
The main objective of keeping records in such organisations is to meet the statutory requirement and
help them in exercising control over utilisation of their funds. They also have to prepare the financial
statements at the end of each accounting period (usually a financial year) and ascertain their income
and expenditure and the financial position, and submit them to the statutory authority called Registrar
of Societies.

The main characteristics of such organisations are:

1. Such organisations are formed for providing service to a specific group or public at large such as
education, health care, recreation, sports and so on without any consideration of caste, creed and
colour. Its sole aim is to provide service either free of cost or at nominal cost, and not to earn profit.

2. These are organised as charitable trusts/societies and subscribers to such organisation are called
members.

3. Their affairs are usually managed by a managing/executive committee elected by its members.

4. The main sources of income of such organisations are:

(i) subscriptions from members,

(ii) donations (general).

(iii) legacies(general).

(iv) grantin-aid,

(v) income from investments, etc.

5. The funds raised by such organisations through various sources are credited to capital fund or
general fund.
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6. The surplus generated in the form of excess of income over expenditure is not distributed amongst
the members. It is simply added in the capital fund.

7. The Not-for-Profit Organisations earn their reputation on the basis of their contributions to the
welfare of the society rather than on the customers’ or owners’ satisfaction.

8. The accounting information provided by such organisations is meant for the present and potential
contributors and to meet the statutory requirement.

Accounting Records of Non-for-Profit Organisations

As stated earlier, normally such organisations are not engaged in any trading or business activities.
The main sources of their income are subscriptions from members, donations, financial assistance
from government and income from investments. Most of their transactions are in cash or through the
bank. These institutions are required by law to keep proper accounting records and keep proper control
over the utilization of their funds. This is why they usually keep a cash book in which all receipts and
payments are duly recorded. They also maintain a ledger containing the accounts of all incomes,
expenses, assets and liabilities which facilitates the preparation of financial statements at the end of the
accounting period. In addition, they are required to maintain a stock register to keep complete record
of all fixed assets and the consumables.

They do not maintain any capital account. Instead they maintain capital fund which is also called
general fund that goes on accumulating due to surpluses generated, life membership fee, etc., received
from year to year. In fact, a proper system of accounting is desirable to avoid or minimise the chances
of misappropriations or embezzlement of the funds contributed by the members and other donors.

Final Accounts or Financial Statements: The Non-Profit Organisations are also required to prepare
financial statements at the end of the each accounting period. Although these organisations are non-
profit making entities and they are not required to make Trading and Profit & Loss Account but it is
necessary to know whether the income during the year was sufficient to meet the expenses or not. Not
only that they have to provide the necessary financial information to members, donors, and
contributors and also to the Registrar of Societies. For this purpose, they have to prepare their final
accounts at the end of the accounting period and the general principles of accounting are fully
applicable in their preparation as stated earlier, the final accounts of a ‘not-for-profit organisation’
consist of the following:

(i) Receipt and Payment Account

(ii) Income and Expenditure Account, and

(iii) Balance Sheet.

The Receipt and Payment Account is the summary of cash and bank transactions which helps in the
preparation of Income and Expenditure Account and the Balance Sheet. Besides, it is a legal

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requirement as the Receipts and Payments Account has also to be submitted to the Registrar of
Societies along with the Income and Expenditure Account, and the Balance Sheet.

Income and Expenditure Account is akin to Profit and Loss Account. The Not-for-Profit
Organisations usually prepare the Income and Expenditure Account and a Balance Sheet with the help
of Receipt and Payment Account. However, this does not imply that they do not make a trial balance.
In order to check the accuracy of the ledger accounts, they also prepare a trial balance which facilitates
the preparation of accurate Receipt and Payment Account as well as the Income and Expenditure
Account and the Balance Sheet.

In fact, if an organisation has followed the double entry system they must prepare a trial balance for
checking the accuracy of the ledger accounts and it will also facilitate the preparation of Receipt and
Payment account. Income and Expenditure Account and the Balance Sheet.

Receipt and Payment Account

It is prepared at the end of the accounting year on the basis of cash receipts and cash payments
recorded in the cash book. It is a summary of cash and bank transactions under various heads. For
example, subscriptions received from the members on different dates which appear on the debit side of
the cash book, shall be shown on the receipts side of the Receipt and Payment Account as one item
with its total amount. Similarly, salary, rent, electricity charges paid from time to time as recorded on
the credit side of the cash book but the total salary paid, total rent paid, total electricity charges paid
during the year appear on the payment side of the Receipt and Payment Account. Thus, Receipt and
Payment Account gives summarised picture of various receipts and payments, irrespective of whether
they pertain to the current period, previous period or succeeding period or whether they are of capital
or revenue nature. It may be noted that this account does not show any non cash item like depreciation.
The opening balance in Receipt and Payment Account represents cash in hand/cash at bank which is
shown on its receipts side and the closing balance of this account represents cash in hand and bank
balance as at the end of the year, which appear on the credit side of the Receipt and Payment Account.
However, if it is bank overdraft at the end it shall be shown on its debit side as the last item.

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Income and Expenditure Account

It is the summary of income and expenditure for the accounting year. It is just like a profit and loss
account prepared on accrual basis in case of the business organisations. It includes only revenue items
and the balance at the end represents surplus or deficit. The Income and Expenditure Account serves
the same purpose as the profit and loss account of a business organisation does. All the revenue items
relating to the current period are shown in this account, the expenses and losses on the expenditure
side and incomes and gains on the income side of the account. It shows the net operating result in the
form of surplus (i.e. excess of income over expenditure) or deficit (i.e. excess of expenditure over
income), which is transferred to the capital fund shown in the balance sheet.

The Income and Expenditure Account is prepared on accrual basis with the help of Receipts and
Payments Account along with additional information regarding outstanding and prepaid expenses and
depreciation etc. Hence, many items appearing in the Receipts and Payments need to be adjusted.

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Balance Sheet

‘Not-for-Profit’ Organisations prepare Balance Sheet for ascertaining the financial position of the
organisation. The preparation of their Balance Sheet is on the same pattern as that of the business
entities. It shows assets and liabilities as at the end of the year. Assets are shown on the right hand side
and the liabilities on the left hand side. However, there will be a Capital Fund or General Fund in place
of the Capital and the surplus or deficit as per Income and Expenditure Account which is either added
to/deducted from the capital fund, as the case may be. It is also a common practice to add some of the
capitalised items like legacies, entrance fees and life membership fees directly in the capital fund.

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Besides the Capital or General Fund, there may be other funds created for specific purposes or to meet
the requirements of the contributors/donors such as building fund, sports fund, etc. Such funds are
shown separately in the liabilities side of the balance sheet.

Some times it becomes necessary to prepare Balance Sheet as at the beginning of the year in order to
find out the opening balance of the capital/general fund.

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Difference in Receipt and Payments and Income and Expenditure Method

Some Peculiar Items

Final accounts of the Not-for-Profit organisations are prepared on the similar pattern as that of a
business orgnisation. However, a few items of income and expenses of such orgnisations are
somewhat different in nature and need special attention in their treatment in final accounts. They are
peculiar to these orgnisations. Some of the common peculiar items are explained as under:

Subscriptions: Subscription is a membership fee paid by the member on annual basis. This is the main
source of income of such orgnisations. Subscription paid by the members is shown as receipt in the
Receipt and Payment Account and as income in the Income and Expenditure Account. It may be noted
that Receipt and Payment Account shows the total amount of subscription actually received during the
year while the amount shown in Income and Expenditure Account is confined to the figure related to
the current period only irrespective of the fact whether it has been received or not.
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Donations: It is a sort of gift in cash or property received from some person or organisation. It appears
on the receipts side of the Receipts and Payments Account. Donation can be for specific purposes or
for general purposes.

(i) Specific Donations: If donation received is to be utilised to achieve specified purpose, it is called
Specific Donation. The specific purpose can be anextension of the existing building, construction of
new computer laboratory, creation of a book bank, etc. Such donation is to be capitalised and shown
on the liabilities side of the Balance Sheet irrespective of the fact whether the amount is big or small.
The intention is to utilise the amount for the specified purpose only.

(ii) General Donations: Such donations are to be utilised to promote the general purpose of the
organisation. These are treated as revenue receipts as it is a regular source of income hence, it is taken
to the income side of the Income and Expenditure Account of the current year.

Legacies: It is the amount received as per the will of a deceased person who may or may not specify
the use of the amount. Legacies, use of which is specified are specific legacy and is shown in the
balance sheet as liability. If the use is not specified it is considered as revenue nature and credited to
income and expenditure account.

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Life Membership Fees: Some members prefer to pay lump sum amount as life membership fee
instead of paying periodic subscription. Such amount is treated as capital receipt and credited directly
to the capital/general fund.

Entrance Fees: Entrance fee also known as admission fee is paid only once by the member at the
time of becoming a member. In case of organisations like clubs and some charitable institutions, is
limited and the amount of entrance fees is quite high. Hence, it is treated as non-recurring item and
credited directly to capital/general fund.

Sale of old asset: Receipts from the sale of an old asset appear in the Receipts and Payments Account
of the year in which it is sold. But any gain or loss on the sale of asset is taken to the Income and
Expenditure Account of the year. For example, if an item furniture with a book value of Rs. 800 is
sold for Rs. 700, this amount of Rs. 700 will be shown as receipt in Receipts and Payments Account
and Rs. 100 on the expenditure side of the Income and Expenditure Account as a loss on sale of old
asset and while showing furniture in the balance sheet Rs. 800 will be deducted from its total book
value.

Sale of Periodicals: It is an item of recurring nature and shown as the income side of the Income and
Expenditure Account.

Sale of Sports Materials: Sale of sports materials (used materials like old balls, bats, nets, etc) is the
regular feature with any Sports Club. It is usually shown as an income in the Income and Expenditure
Account.

Payments of Honorarium: It is the amount paid to the person who is not the regular employee of the
institution. Payment to an artist for giving performanceat the club is an example of honorarium. This
payment of honorarium is shown on the expenditure side of the Income and Expenditure Account.

Endowment Fund: It is a fund arising from a bequest or gift, the income of which is devoted for a
specific purpose. Hence, it is a capital receipt and shown on the Liabilities side of the Balance Sheet as
an item of a specific purpose fund.

Government Grant: Schools, colleges, public hospitals, etc. depend upon government grant for their
activities. The recurring grants in the form of maintenance grant is treated as revenue receipt (i.e.
income of the current year) and credited to Income and Expenditure account. However, grants such as
building grant are treated as capital receipt and transferred to the building fund account. It may be
noted that some Not-for-Profit organisations receive cash subsidy from the government or government
agencies. This subsidy is also treated as revenue income for the year in which it is received.

Special Funds :- The Not-for-Profit Organisations office create special funds for certain
purposes/activities such as 'prize funds', 'match fund' and 'sports fund', etc. Such funds are invested in
securities and the income earned on such investments is added to the respective fund, not credited to
Income and Expenditure Account. Similarly, the expenses incurred on such specific purposes are also
deducted from the special fund. For example, a club may maintain a special fund for sports activities.
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In such a situation, the interest income on sports fund investments is added to the sports fund and all
expenses on sports deducted there from. The special funds are shown in balance sheet. However, if,
after adjustment of income and expenses the balance in specific or special fund is negative, it is
transferred to the debit side of the Income and Expenditure Account or adjusted as per prescribed
directions.

Investment Account

When a person introduces his capital for earning more income it is known as investment. It can be
done in any way like investing in business or in fixed assets or investment in such assets through
which interest, dividend can be earned.

1) Fixed Income Bearing Securities – It includes those types of securities from which there would be
fixed source of income/interest like government securities, debentures, bonds etc.

2) Variable income bearing securities – It includes those type of securities from which there is no fixed
source of income like equity shares or stock of the company Dividend on shares or stock is distributed
only when there is a profit in the company.

Interest on Investments

Interest on Government Securities, Semi government securities or securities of private sector

companies are distributed twice in a year at every six months interval. Interest on investment is
calculated on the face value of the securities Interest of 6 months is payable to the person whose name
is registered at the time of distributing interest irrespective of the period for which he holds the
security. Now if a person after receiving interest of 6 months but before receiving the interest of next 6
months, sells his securities then he will take from the buyer both value of investment as well as interest
which has been accrued.

Cum-interest and ex-interest purchase and sale

Market value of the securities may be quoted cum-interest or ex-interest. In case of cum-interest
quotation, the price quoted is inclusive of interest which is accrued from the last date of payment of
interest to the date of transaction, and in case of ex-interest, the price quoted is exclusive of interest
from the last date of interest payment to the date of transaction i.e. in this case buyer has to pay to the
seller the accrued in addition to the price paid for the investment. In case of cum-interest quotations
the accrued interest will be deducted from the price and the remaining amount will be recorded in
investment account. In case of ex-interest quotations the price (without deducting accrued interest)
will be recorded in investment account. But in both the cases interest account will be recorded by the
same amount.

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Accounting of investments

A person who does the trading of investment, i.e. does the business of purchase and sale of investment
of different types, keeps the record of transactions systematically where the investment are not many ,
they can be recorded in the “general ledger” itself. But where the investments are substantial, a
separate ledger may be kept for recording the investments. Such a ledger is known as investment
ledger. Separate account will be kept for each scrip. Traders of investment earns income from
investment in two ways –

1) By purchasing and selling the investment and

2) By way of interest from holding the investment. Profit from purchase and sale of investment is
derived from investment account while income from interest is derived from interest account.
Accounting for investment is done in the following manner:

Journal entries

1) Investments purchase –

Investment A/c Dr.

Interest / Dividend A/c Dr.

To Bank A/c

(Being investments purchased)

2) Investments Sold –

Bank A/c Dr.

To Investment A/c

To Interest / Dividend A/c

(Being investments sold)

3) Interest / Dividend received on due date –

Bank A/c Dr.

To Interest / Dividend A/c

(Being interest sold)

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4) Amount of interest or dividend transfer to profit & loss account at the end of year –

Interest / Dividend A/c Dr.

To Profit and Loss A/c

(Being Interest transferred)

5) Profit or loss on sale of investment transferred to profit & loss account –

i) for profit –

Investment A/c Dr.

To Profit and Loss A/c

(Being profit transferred)

ii) For loss –

Profit and Loss A/c Dr.

To Investments A/c

(Being loss transferred)

6) For accrued interest of previous year at the beginning of the year –

Interest A/c Dr.

To Accrued Interest A/c

(Being accrued interest transferred)

7) For accrued interest at the end of the year –

Accrued interest A/c Dr

To Interest A/c

(Being accrued interest)

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Consignment Accounts

When a businessman appoints an agency (may be a person, firm, company or any other institution) as
his representative or agent to sell his goods through such agency, such a business relation is known as
consignment transaction.’ The businessman sending the goods is called ‘Principal’ or ‘Consignor’; the
person receiving and selling the goods on behalf of principal is called representative, ‘agent’ or
‘consignee’ and the goods are called ‘goods sent on consignment’.
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Consignment Procedure –
1) An agreement between both the parties
2) Dispatch off goods by principal
3) Advance or security
4) Receipt of goods by consignee
5) Sale of consigned goods
6) Payment of balance amount

Terminology Some typical terms are used in consignment transaction and one should know the
meaning of such terms. Some of them are as under –

1) Agency – The transaction between the owner of goods and the agent are called ‘agency transitions’
and such relation is called agency.

2) Consignment – The goods sent to the agent for sales is called consignment also known as
‘Challan’. For consignment it is ‘consignment outward’ and for consignee it is ‘consignment inward’.

3) Consigner – The principal or owner of the consigned goods on whose behalf and risk such goods
are sold by agent is called ‘consignor’ also known as ‘Challaner’.

4) Consignee – He is the agent whom goods are consigned for sale at pre-decide amount or rate of
remuneration. He is also known as ‘challance’.

5) Goods sent on consignment – The goods dispatched to the agent for sale are called ‘goods sent on
consignment’. This is recorded by the consignor in his books in separate account ‘goods sent on
consignment account’ which is real account. Consignee passes no entry for such goods.

6) Pro-forma invoice – For the goods consigned, the consignor makes and sends an invoice
mentioning therein the quantity and quality of the goods consigned. The price of the goods mentioned
in such invoice is called ‘invoice price’ Sometime the proposed selling price is also mentioned. Such
an invoice is called ‘Pro-forma invoice’.

7) Consignment expenses – The expenses incurred by consignor and consignee for consignment are
called consignment expenses. Consignor’s expenses are packing, loading, carriage, freight, transit
insurance, export duty etc. Consignee’s expenses for receiving goods are octroi, entry tax, import duty,
custom duty, dock dues, clearing charges, unloading carriage upto his godown. Consignee’s expenses
for storing the goods are godonw rent, godown insurance, godown depreciation etc. Consignees
expenses for selling the goods are advertisement, publicity, free samples, demonstrations, brokerage,
his own commission etc.

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8) Consignment transactions – The transactions concluded by the consignor and consignee for
consignment are called ‘Consignment transactions’.
9) Remuneration or commission of consignee – For his services to the consignor, a consignee is
compensated by consignor. Such compensation or consideration is called remuneration or commission
of consignee.

10) Account Sale – This is a statement of sales prepared and sent by the consignee to consignor
periodically. In this statement sales realization by consignee his expenses and commission and balance
to be remitted are mentioned.

11) Consignment stock – The goods lying unsold with consignee at the end of the accounting
periodmarket price. The consignor makes accounting for such stock in his books but consignee does
not show such stock in his books.

12) Consignment account – It is account prepared by the consignor, at the end of his accounting
period, to ascertain profit or loss on consignment called ‘consignment account’. Consignee does not
make any such account.

Difference in Consignment and Sales

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Remuneration of Consignee

1) General or ordinary commission – This is the usually given to every consignee on the sales
affected by him. Higher the sales greater is the amount of commission.

2) Del credere commission – Consignee sells the goods on behalf and risk of consignor. So for the
credit sales the consignor himself is liable in case of bad debts. But if the consignor wants to shift this
liability on consignee he will have to give additional commission to consignee which is called del
credere commission. So del credere commission is a special commission given in addition tonormal
omission to the consignee against which consignee agrees to bear the loss due to bad debts. This
reduces the commission income of consignee.

3) Overriding Commission – Normally the consignee sales the goods at invoice price mentioned in
the proforma invoice sent by consignor. The consignee does not make special efforts to sell the goods
over invoice price. To encourage the consignee to sell the goods over invoice price the consignor gives
him a special commission on the excess of selling price over invoice price of the goods sold. Such a
type of commission is called overriding commission. As the name itself suggests this is a commission
given to him to make special effort (override) to sell the goods over and above the invoice price (again
override). This is a motivational commission to the consignee. In the absence of any different
instruction in the question, overriding commission is calculated on the difference between the actual
selling price and invoice price of the goods sold.

Difference between Ordinary Commission and Del Credere Commission

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Difference between Del Credere Commission and overriding commission

Journal Entries In The Books Of Consigner

Consignment Account

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Journal Entries In The Books Of Consignee

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UNIT V

Introduction to Dissolution of partnership

Dissolution of partnership firm is a process in which relationship between partners of firm is dissolved or
terminated. If a relationship between all the partners of firm is dissolved then it is known as dissolution
of firm. In case of dissolution of partnership firm, the firm ceases to exist.
According to Section 39 of the Indian Partnership Act, 1932, the dissolution of partnership between all
the partners of a firm is called “Dissolution of the Firm”. A firm may be dissolved with the consent of all
the partners or in accordance with a contract between the partners.

Modes of Dissolution of a Firm

A firm can be dissolved either voluntarily or by an order from the Court.

Voluntary Dissolution of a Firm (without the order of the Court):- (Section 40-43)

By Agreement (Section 40)

According to Section 40 of the Indian Partnership Act, 1932, partners can dissolve the partnership by
agreement and with the consent of all the partners. Partners can also dissolve the partnership based
on a contract that has already been made

Compulsory Dissolution (Section 41)

An event can make it unlawful for the firm to carry on its business. In such cases, it is compulsory for
the firm to dissolve. However, if a firm carries on more than one undertakings and one of them
becomes illegal, then it is not compulsory for the firm to dissolve. It can continue carrying out the legal
undertakings. Section 41 of the Indian Partnership Act, 1932, specifies this type of voluntary
dissolution.

On the happening of certain contingencies (Section 42)

According to Section 42 of the Indian Partnership Act, 1932, the happening of any of the following
contingencies can lead to the dissolution of the firm:
• Some firms are constituted for a fixed term. Such firms will dissolve on the expiry of that term.
• Some firms are constituted to carry out one or more undertaking. Such firms are dissolved when
the undertaking is completed.
• Death of a partner.
• Insolvency of a partner.

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By notice of partnership at will (Section 43)

According to Section 43 of the Indian Partnership Act, 1932, if the partnership is at will, then any
partner can give notice in writing to all other partners informing them about his intention to dissolve the
firm. In such cases, the firm is dissolved on the date mentioned in the notice. If no date is mentioned,
then the date of dissolution of the firm is the date of communication of the notice.

Dissolution of the Firm by the Court (Section 44)

According to Section 44 of the Indian Partnership Act, 1932, the Court may dissolve a firm on the suit of
a partner on any of the following grounds:

Insanity/Unsound mind
If an active partner becomes insane or of an unsound mind, and other partners files a suit in the court,
then the court may dissolve the firm. Two things to remember here:
• The partner is not a sleeping partner
• The sickness is not temporary

Permanent Incapability
If a partner becomes permanently incapable of performing his duties as a partner, and other partners file
a suit in the court, then the court may dissolve the firm. Also, the incapacity may arise from a
physical disability, illness, etc.

Misconduct
When a partner is guilty of conduct which is likely to affect prejudicially the carrying on of the business
and the other partners file a suit in the court, then the court may dissolve the firm.
Further, it is not important that the misconduct is related to the conduct of the business. The court
looks at the effect of the misconduct on the business along with the nature of the business.

Persistent Breach of the Agreement

A partner may will fully or persistently commit a breach of the agreement relating to
• the management of the affairs of the firm, or
• a reasonable conduct of its business, or
• conduct himself in matters relating to business that is not reasonably practicable for other
partners to carry on the business in partnership with him.
In such cases, the other partners may file a suit against him in the court and the court may order to
dissolve the firm. The following acts fall in the category of breach of agreement:
1. Embezzlement
2. Keeping erroneous accounts
3. Holding more cash than allowed
4. Refusal to show accounts despite repeated requests, etc.

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Transfer of Interest
A partner may transfer all his interest in the firm to a third party. Now, if the other partners file a suit
against him in the court, then the court may dissolve the firm.

Continuous/Perpetual losses
If a firm is running under losses and the court believes that the business of the firm cannot be carried
on without a loss in the future too, then it may dissolve the firm.

Just and equitable grounds

The court may find other just and equitable grounds for the dissolution of the firm. Some such grounds
are:
• Deadlock in management: It occurs, when two process competing for two resources in
opposite order. It is a situation in which two computer programs sharing the same resources are
effectively preventing each other from accessing the resource resulting in both programs
ceasing to function.
• Partners not being in talking terms with each other
• Gambling by a partner on the stock exchange.

Difference between dissolution of partnership and dissolution of a firm

Basis Dissolution of Partnership Dissolution of Partnership firm
Meaning It is the only change in the present It is the discontinuance of all the
Agreement. The firm may continue. Business activities of the firm.
Books of Accounts In this situation, books of accounts may In this situation books of
not be closed. accounts are necessarily closed.
Court’s There is no intervention of court. The court intervenes, it deemed
intervention necessary.
Effect on Assets Assets are revalued and liabilities are Assets are realized and liabilities
and Liabilities reassessed by preparing Revaluation are paid by preparing Realization
Account. Account.
Nature Dissolution of partnership is voluntary. It Dissolution of the firm may be
emerges out of the agreement. both voluntary and compulsory.

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Steps in the dissolution process –

Step 1 Prepare a balance sheet of the firm as on the date of the dissolution of the firm.
Step 2 Realize the non-cash assets which are not acceptable for distribution in their present
form, pay the debts of the firm to third parties. Realization account is prepared to
calculate the loss or profit on realization of assets and settlement of liabilities. Loss
or profit on realization of assets and settlement of liabilities is transferred to partners’
capital accounts.
Step 3 Pay the amount due to each partner ratably for advances (or Loan)
Step 4 Pay the available cash to the partners.

Accounting treatment on dissolution of firm –

In case of dissolution of firm the following accounts are prepared to close the books of the firm –
1) Realisation Account
2) Partners’ loan account
3) Parnters’ capital account
4) Cash or bank account
Realization account – This is a special type of account. It is a nominal account. The purpose of
preparing this account is to find out the result of realization of assets and discharge of liabilities.
The following steps involved in preparing this account.

Step 1. For Transfer of all accounts given in the balance sheet

1) For transfer of assets – All the assets except cash in hand, cash at bank, debit balance of
current accounts of partners and fictitious assets are transferred to debit of this account at book
values as under –
Realisation A/c Dr.
To Various assets (individually)
(For transfer of various assets to realization a/c)
2) For transfer of outside liabilities – All the external liabilities including partners loan are
transferred to the credit of realization account at book value as under –
Various Liabilities A/c Dr.
To Realisation A/c
(For transfer of various liabilities to realisation a/c)
Note: Liabilities have got credit balance, so debiting to close them.
Step 2. Disposal of assets
a. For sale of assets
Cash / Bank A/c Dr.
To Realisation a/c
(For assets realised in cash)

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b. Asset taken over by partner

Partner's Capital A/c Dr.
To Relisation A/c
(For assets taken over by a partner)

Step 3. Entry for payment of dissolution expenses

a. For cash payment
Realisation A/c Dr.
To Cash / Bank A/c
(For payment of dissolution expenses)
b. For payment made by a partner
Realisation A/c Dr.
To Partner's Capital A/c
(For dissolution expenses paid by a partner)
Note : if any partner is to bear all expenses of realisation, no journal entry is required in the books
of the firm but in this case if the partner is paid the realisation expenses, the following entry will be
made :
Partner's Capital A/c Dr.
To Cash / Bank A/c
(For dissolution expenses paid on behalf of a partner.)
Step 4. Entry for payment of outside liabilities :
a. For cash payment
Realisation A/c Dr.
To Cash / Bank A/c
(For payment to outside liabilities)
b. For liabilities taken over by a partner
Realisation A/c Dr.
To Partner's Capital A/c
(For liabilities taken over by a partner)

Step 5. Entry for closing realisation account

a. In case of profit
Realisation A/c Dr.
To Partners' Capital A/c
(For profit on realisation transferred to partner's capital a/cs in their profit sharing ratio)
b. In case of loss
Partners' capital A/cs Dr.
To Realisation A/c
(For loss on realisation transferred to partners' capital a/cs in their profit sharing ratio)

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Note : (1) Intangible assets such as goodwill, patents, copyrights, prepaid expense are normally
value less in case of dissolution. So if a question is silent it should be presumed that nothing could be
realised from such assets.

Partner’s loan Account – This are transferred to the credit side of realization account and the
payments there of are shown on debit side of realization account. Alternatively the payment can be
credited directly to cash account.
Partner’s capital accounts – All the reserved and undivided profit or loss, realization profit or
loss, balance of current accounts. Now the difference is adjusted in cash if there is credit balance it
is surplus to be withdrawn by the concerned partner from their personal resources. Entry for
surplus withdrawn or deficiency brought in by the concerned partner from their personal
resources. Entry for surplus withdrawn or deficiency brought in are as under –

a) Cash/Bank A/c Dr.

To Partner’s capital A/c
(For deficit amount of capital brought in cash)

b) Partner’s Capital A/c

To cash/Bank A/c
(For final payment made to a partners)

Cash account – At first opening balance is written. Then cash at bank is also transferred to this
account. Amount realized from assets and deficiency brought in by partners is debited to this
account and payment of liabilities, realization expenses and surplus withdrawn by partners are
credited. Now both side of cash account will be equal. The agreement of both the sides of cash
account is the cross checks of accounting and arithmetical accuracy.
Partner’s capital accounts – All the reserved and undivided profit or loss, realization profit or
loss, balance of current accounts. Now the difference is adjusted in cash if there is credit balance it
is surplus to be withdrawn by the concerned partner from their personal resources. Entry for
surplus withdrawn or deficiency brought in by the concerned partner from their personal
resources. Entry for surplus withdrawn or deficiency brought in are as under –
a. Cash/Bank A/c Dr.
To Partner’s capital A/c
(For deficit amount of capital brought in cash)
b. Partner’s
Capital A/c
To cash/Bank A/c
(For final payment made to a partners)

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Cash account – At first opening balance is written. Then cash at bank is also transferred to this
account. Amount realized from assets and deficiency brought in by partners is debited to this
account and payment of liabilities, realization expenses and surplus withdrawn by partners are
credited. Now both side of cash account will be equal. The agreement of both the sides of cash
account is the cross checks of accounting and arithmetical accuracy.

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Limited Liability Partnership

Limited Liability Partnership enterprise, the world wide recognized form of business organization, has
now been introduced in India by enacting the Limited Liability Partnership Act, 2008. LLP Act was
notified on 31.03.2009.

A Limited Liability Partnership, popularly known as LLP combines the advantages of both the
Company and Partnership into a single form of organization. Limited Liability Partnership (LLP) is a
new corporate form that enables professional knowledge and entrepreneurial skill to combine,
organize and operate in an innovative and proficient manner.

It provides an alternative to the traditional partnership firm with unlimited liability. By incorporating
an LLP, its members can avail the benefit of limited liability and the flexibility of organizing their
internal management on the basis of a mutually-arrived agreement, as is the case in a partnership firm.

Characteristics of an LLP:
1. LLP is governed by the Limited Liability Partnership Act 2008, which has come into force with
effect from April 1, 2009. The Indian Partnership Act, 1932 is not applicable to LLP.

2. LLP is a body incorporate and a legal entity separate from its partners having perpetual succession,
can own assets in its name, sue and be sued.
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3. The partners have the right to manage the business directly, unlike corporate shareholders.

4. One partner is not responsible or liable for another partner’s, misconduct or negligence.

5. Minimum of 2 partners and no maximum limit.

6. Should be ‘for profit’ business.

7. The rights and duties of partners in an LLP, will be governed by the agreement between partners
and the partners have the flexibility to devise the agreement as per their choice. The duties and
obligations of Designated Partners shall be as provided in the law. 8. Limited liability of the partners
to the extent of their contributions in the LLP. No exposure of personal assets of the partner, except in
cases of fraud.

9. LLP shall maintain annual accounts. However, audit of the accounts is required only if the
contribution exceeds Rs. 25 lakh or annual turnover exceeds Rs. 40 lakh. A statement of accounts and
solvency shall be filed by every LLP with the Registrar of Companies (ROC) every year.

Difference between/among a Company, Partnership firm and an LLP:

Features Company Partnership firm LLP

Registration Compulsory Not compulsory. Compulsory

registration with Unregistered registration
the ROC. Partnership Firm required with the
Certificate of won’t have the ROC
Incorporation is ability to sue.
conclusive
evidence.

Name At the end of the No guidelines. Name to end with

name word “LLP” Limited
“limited” of the Liability
name of a public Partnership”
company, and
“private limited”
with a private
company.

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Capital contribution Private company Not specified Not specified

should have a
minimum paid up
capital of lakh and
Rs. 5 lakhs for a
public company

Legal entity A separate legal Not a separate A separate legal

entity legal entity entity

Liability Limited to the Unlimited, can Limited to the

extent of unpaid extend to the extent of the
capital. personal assets of contribution to
the partners the LLP.

No. ofshareholders / Minimum of 2. In a 2- 20 partners Minimum of 2.

Partners private company, No maximum.
maximum of 50
shareholders

Foreign Nationals as Foreign nationals Foreign nationals Foreign

shareholder / Partner can be shareholders. cannot form nationals can
partnership firm. be partners.

Meetings Quarterly Board of Not required Not required.

Directors meeting,
annual shareholding
meeting is
mandatory

Annual Return Annual Accounts No returns to be Annual

and Annual Return filed with the statement of
to be filed with Registrar of Firms accounts and

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ROC solvency &

Annual Return
has to be filed
with ROC

Audit Compulsory, Compulsory Required, if

irrespective of share the
capital and turnover contribution is
above ? 25
lakhs or if
annual
turnover is
above ? 40
lakhs.

How do the bankers High Creditworthiness Perception is

view creditworthiness, depends on higher
due to stringent goodwill and credit compared to
compliances and worthiness of the that of a
disclosures required partners partnership but
lesser than a
company.

Dissolution Very procedural. By agreement of the Less

Voluntary or by partners, insolvency procedural
Order of National or by Court Order compared to
Company Law company.
Tribunal Voluntary or
by Order of
National
Company Law
Tribunal

Whistle blowing No such provision No such provision Protection

provided to

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employees and
partners who
provide useful
information
during the
investigation
process.

Advantages of LLP:
The first LLP was registered on 2nd April, 2009 and till 25th April, 2011, 4580 LLPs were registered.
This form of Organization offers the following benefits:

1. The process of formation is very simple as compared to Companies and does not involve much
formality.

2. Just like a Company, LLP is also body corporate, which means it has its own existence as compared
to partnership. LLP and its Partners are distinct entities in the eyes of law. LLP is known by its own
name and not the name of its partners.

3. An LLP exists as a separate legal entity different from the lives of its partners. Both LLP and
persons, who own it, are separate entities and both function separately. Liability for repayment of
debts and lawsuits incurred by the LLP lies on it and not different from the lives of its partners, the
owner. Any business with potential for lawsuits should consider LLP form of organisation and it will
offer an added layer of protection.
4. LLP has perpetual succession. Notwithstanding any changes in the partners of the LLP, the LLP
will remain the same entity with the same privileges, immunities, estates and possessions. The LLP
shall continue to exist till it is wound up in accordance with the provisions of the relevant law.

5. LLP Act 2008 gives an LLP flexibility to manage its own affairs. Partners can decide the way they
want to run and manage the LLP, as per the form of LLP Agreement. The LLP Act does not regulate
the LLP to large extent rather than allows partners the liberty to manage it as per their agreement.

6. It is easy to join or leave the LLP or otherwise it is easier to transfer the ownership in accordance
with the terms of the LLP Agreement.

7. An LLP, as legal entity, is capable of owning its Separate Property and funds. The LLP is the real
person in which all the property is vested and by which it is controlled, managed and disposed off. The
property of LLP is not the property of its partners. Therefore, partners cannot make any claim on the
property in case of any dispute among themselves.

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8. Another main benefit of incorporation is the taxation of a LLP. LLP is taxed at a lower rate as
compared to Company. Moreover, LLP is also not subject to Dividend Distribution Tax as compared
to company, so there will not be any tax while you distribute profit to your partners.

9. Financing a small business like sole proprietorship or partnership can be difficult at times. An LLP
being a regulated entity like company can attract finance from Private Equity Investors, financial
institutions etc.

10. As a juristic legal person, an LLP can sue in its name and be sued by others. The partners are not
liable to be sued for dues against the LLP.

11. Under LLP, only in case of business, where the annual turnover/contribution exceeds Rs. 40 lakh
Rs. 25 lakh are required to get their accounts audited annually by a chartered accountant. Thus, there is
no mandatory audit requirement.

12. In LLP, Partners, unlike partnership, are not agents of the partners and therefore they are not liable
for the individual act of other partners, which protects the interest of individual partners.

13. As compared to a private company, the numbers of compliances are on a lesser side in case of
LLP.

Disadvantages of LLP:
The major Disadvantages of Limited Liability Partnership are listed below:

1. An LLP cannot raise funds from Public.

2. Any act of the partner without the other may bind the LLP.
3. Under some cases, liability may extend to personal assets of partners.
4. No separation of Management from owners.
5. LLP might not be a choice due to certain extraneous reasons. For example,, Department of Telecom
(DOT) would approve the application for a leased line only for a company. Friends and relatives
(Angel investors), and venture capitalists (VC) would be comfortable investing in a company.
6. The framework for incorporating a LLP is in place but currently registrations are centralized at
Delhi.
Insolvency of Partners

At the time of dissolution of a partnership firm, the capital account of a partner may show a debit
balance after his share of realisation loss or profit and accumulated profits or losses etc. have been
transferred to his capital account. In such a case, the partner is a debtor of the firm to the extent of debit
balance in his capital account and he has to bring in the necessary cash to make up the deficiency in his
capital account. If the partner is unable to bring in the necessary cash, e.g. when he cannot pay in full the
amount of debit balance in the capital account, he is said to be insolvent. The solvent partners have to bear
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the capital deficiency of the insolvent partner. There is no provision in the Indian Partnership Act., 1932
regarding this matter. Therefore, if there is a provision regarding this matter in the partnership deed it
would be decisive. The partners may provide in partnership deed that loss due to insolvency of a partner
will be shared by the solvent partners in their profit sharing ratio or any other ratio. But the problem
arises when there is no provision in the partnership deed regarding this matter.

Decision in Garner V/s Murray

In this case Garner, Murray and Wilkins were equal partners in England. Their capitals were
unequal. The Balance Sheet of the firm after satisfying all the liabilities were as follows:

Balance Sheet
Liabilit £ As £
ies set
Capital Cash 1,916
Accounts: 2,500 Wilkins— Overdrawn 263
Garner 314 Deficiency (Realisation loss) 635
Murray 2,814 2,814

Wilkins was insolvent and unable to pay anything. Thus the assets of the firm were not
sufficient to repay the capitals in full. There was a dispute between the solvent partners
regarding the method of sharing of loss due to insolvency of Wilkings. Justice Joyce held in
1904 as follows:

"The solvent partners are only liable to make good their share of the deficiency, and that the
remaining assets should be divided among them in proportion to their capitals,"

In other words, the learned judge held as follows:

1. The solvent partners should bring in cash their share of the realisation loss.
2. The loss due to insolvency of a partner should be borne by the solvent partners in
proportion to their last agreed capitals.
It should noted that a partner having a debit balance or nil balance, will not have to bear the loss due to
insolvency of a partner.
The decision in the above case has taken into consideration only the book capital of the partners.
It ignores the private estate of the solvent partners.

Meaning of last agreed capitals

In case of fixed capital method, the expression, "Last Agreed Capitals" means the fixed capital. In
case of fluctuating capital method, it means the capitals after malting adjustment for accumulated
profits and losses, drawings, interest on capital, salary to a partner etc. to the date of dissolution
but before transferring realisation loss or profit.
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Applicability of Garner V/s Murray to India

It is reasonable to assume that Garner v. Murray case will also apply to India as S. 48 of the
Indian Partnership Act., 1932 is almost identical with S.44 of the English Partnership Act and
there has been no case law which has examined the question of sharing of loss due to the
insolvency of a partner. However, some Accountants contend that the above decision is not
inconformity with S.48 (a) of the
Indian Partnership Act., 1932. The students, in an examination problem, should indicate whether or
not the ruling in Garner v. Murray has been applied.

Piecemeal distribution of cash

It has been presumed so far that all the assets are realised on the date of dissolution and all the
liabilities are also simultaneously discharged on the same day itself. But usually this is not true
in practice. In actual practice, assets are realised gradually and liabilities are paid gradually
depending upon the amount realised from the sale of assets. Therefore, the realsiation loss or
profit can be ascertained only after the realisation of all assets and payment of all liabilities.
Available cash is used in the following order:
1. Payment of realisation expenses or a provision is made for realisation expenses.
2. Payment of outside liabilities i.e., bank loan, sundry creditors, bills payable,
outstanding expenses etc. It must be noted here that a secured creditor has priority
whenever an asset provided by way of security to the concerned creditor is
realised. After satisfying the claim of the secured creditor the surplus, if any, is paid
to unsecured creditors. Amount realised from an asset which is not charged or
mortgaged is used to pay all the creditors, whether secured or unsecured in the
ratio of their claims.
3. Payment of partners' loan in the ratio of their respective loans.
4. Payment of partners capitals.

If there is any contingent liability an account of bills discounted, a provision should be made in
the beginning for the same and when provision is no longer required, the amount should be
distributed.

Amalgamation of Partnership Firms

Meaning: When two or more businesses (run under sole proprietorship or partnership) engaged
in the similar types of activities, decide to join or combine their businesses, it is called
amalgamation. The purpose may be to reduce competition, to take advantage of internal and
external economies derived due to large scale production, or to make expansion of business. On
amalgamation the existence of the old firms ceases. The amalgamation is carried out on the basis
of mutual agreement. A new partnership deed is framed for the newly constituted firm.

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Accounting In the books of old firms:

The following procedure is adopted to close the books of old firms:
1. The old firms prepare their balance sheets on the date of amalgamation.
2. Both the firms verify the values of assets and liabilities of each other and if
necessary suggest the revaluation of assets and liabilities. For this purpose a
revaluation account is opened and the increase or decrease in the value of assets and
liabilities are passed through this account.
The result of this account (profit or loss) is transferred to the capital accounts of the partners of
the respective firms in the profit sharing ratio.
Entry
Profit on revaluation Loss on revaluation
Revaluation A/c Dr. Partner's Capital A/c Dr.
To Partners' Capital A/c To Revaluation A/c
(Being profit on revaluation) (being loss on revaluation)

3. The goodwill account is raised by the agreed

amount as under: Goodwill A/c Dr.
To Partners'
Capital A/c (Being
goodwill A/c reified)
4. All the reserves and credit balance of profit & loss account is credited to the
partners in their profit sharing ratio. Similarly the debit balance of profit & loss
account and other fictitious assets are debited to partners' capital accounts.
Profit & Loss A/c Dr. Partner's Capital A/c Dr.
General reserves A/c Dr. To Profit & Loss A/c
To Partners' Capital A/c
(Being transfer to capital A/cs) (Being transfer to capital A/cs)

5. All the assets not taken over by the new firm are disposed of. Similarly all the
liabilities not assumed by the new firm are paid off or otherwise settled.
Alternatively such assets and liabilities and transferred to partners' capital accounts
in the capital ratio (according to some accountants in the profit sharing ratio too)

a. Assets taken by partners:

Partners' Capital A/c Dr.
Revaluation A/c (loss) Dr.
To Assets A/c .
To Revaluation A/c (Profit)
(Being asset taken over)

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b. Liabilities taken over by partners :

Liabilities A/c (Agreed value) Dr.
Revaluation A/c (Loss) Dr.
To Partners' Capital A/c
To Revaluation A/c (Profit)
(Being liabilities taken over)
c. Assets sold :
Cash A/c Dr.
Revaluation A/c (Loss) Dr.
To Assets A/c (Book Value)
To Revaluation A/c (Profit)
(Being assets sold)

d. Liabilities paid :
Liabilities A/c (Book value) Dr.
Revaluation A/c (Loss) Dr.
To Cash A/c
To Revaluation A/c (Profit)
(Being liabilities paid off)
6. The following entries are made for assets and liabilities taken over by the new firm
a. Assets taken :
New firm's A/c Dr.
To Assets A/c (agreed values)
b. Liabilities taken:
Liabilities A/c (agreed values) Dr.
To New Firm's A/c

Accounting in the books of new firm

The new firm will record only those assets and liabilities which are taken over by it. T entries
will be passed by the agreed values.
Assets (Individually) A/c Dr. (Agreed values)
To Liabilities (Individually) Agreed values
To Partners Current A/c
To Partners Capital A/c
[Being Assets & Liabilities recorded.]

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Conversion of Partnership Firm into Joint Stock Company

Meaning: To avail the facilities and advantages available to joint stock companies under
Companies Act 1956, some partnership firms convert themselves into company. A company is
formed to purchase the business of the firm. The purchase consideration is discharged by the
company in the agreed mode. The shares and debentures received in the payment of purchase
consideration are divided amongst partners. The partners become the shareholders of the
company. Thus the firm is dissolved and a new company comes into being. The following are the
two major advantages of conversion:

1. Number of members can exceed 20.

2. Member’s liabilities become limited.

Purchase Consideration Meaning: The value paid by the company to the firm for taking
over the business of the firm is called purchase consideration which can be calculated by
the following methods:

1.Lump sum method – Here the purchase price is clearly given in the question.
2.Net Payment method – Here the purchase price is the total of all the payments
given by the company to the firm in discharge of purchase consideration.
3. Net Assets Method – In this method the purchase price is calculated by the
following formula : Purchase consideration = Assets taken over at agreed values-
Liabilities taken over at agreed values.
The following points should be considered while calculating purchase consideration:
1. Only those assets will be considered which are taken over by the company. The
agreed values of such assets are added.
2. Only those liabilities are considered which are assumed by the company. The
agreed values of such liabilities are deducted.
3. Normally cash and bank balance are included in purchase price but if they are not
taken over, they will be ignored. Goodwill and prepaid expenses are also included in
the assets taken over.
4. Fictitious assets and debit balance of P & L account are never included in the assets.
5. If it is given that business is taken over it means assets as well as liabilities both are
taken over. But if it is given that asset are taken over then only assets are
considered and liabilities are ignored.

Distribution of purchase price amongst partners

The shares and debentures received from the company are divided amongst the partners in their
final capital ratio. According to some author these are divided in the profit sharing ratio also.

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For this purpose if any ratio is given in the agreement of the partnership deed, it should be
followed.
Note: If the question is silent about the ratio, the student can use any of the two ratio i.e. final
capital ratio or profit sharing ratio and a note must be appended to this effect.

Accounting treatment
Entries in the books of vendor firm
The following entries are passed to close the books of vendor firm:
1. Transfer of assets to realisation account:
Realisation A/c Dr.
To Assets (individually) A/c
(Being assets transferred)
The following points must be remembered while passing this entry:
• All the assets whether or not taken over by the company are transferred to relisation
account at book value.
• Cash and bank balance are transferred to realisation account only when they too are
taken over by the company along with the other assets.
• Fictitious assets such as debit balance of P & L account and other unwritten off
expenses are not transferred to realisation account. They are debited to partners’
capital account in their profit sharing ratio.
• Goodwill and other intangible assets such as prepaid expenses, trademarks, patent
etc. are also debited to realisaion account.
• If any provision is made against any assets the gross value of the assets is debited to
realisation account and the provisions are credited to realisation account:
•
2. Transfer of liabilities to realisation account:
Liabilities (individually) A/c Dr.
To Realisation A/c
(Being Liabilities transferred)
Note: All the liabilities whether or not taken over by the, company are transferred to
realization account with the exception of reserves and surplus, Capital and current accounts of
partners.
3. For purchase consideration
Purchasing Company Dr.
To Realisation A/c
(For purchase consideration due.)

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4. On receipts of purchase price

Cash/Bank A/c Dr.
Shares in purchasing co. A/c Dr.
To Purchasing company
(For purchase consideration received)

5. Realisation of assets not taken by company :

Bank A/c Dr.
To Realisation A/c
(For cash recovered on sales of assets)

6. Payment of Liabilities not assumed by the company:

Realisation a/c Dr.
To Bank A/c
(Being payment made)

7. Realisation expenses (if borne by the firm)

Realisation A/c Dr.
To Bank A/c
(For payment of expenses of liquidation)

Note : If realisation expenses are borne by the company no entry is passed.

8. Payment of contingent liability :

Realisation A/c Dr.
To Bank A/c
(For the payment of contingent liabilities)

9. Profit on realisation :
Realisation A/c Dr.
To Partner's Capital A/c
(For profit on realisation transferred to partner's capital a/c)

10. Loss on realisation :

Partners' Capital A/c Dr.
To Realisation A/c
(For loss on realisation transferred)

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11. Payment to partners :

Partner's Capital A/c Dr.
To Bank A/c
To Shares in purchasing co.
(For cash and shares distributed amongst partners).

Entries in the books of purchasing company

1. For Purchase consideration:
Business Purchase A/c Dr.
To Vendor's firm A/c
(For purchase consideration becoming due.)
2. For assets and liabilities taken over :
Sundry Assets (individually) A/c Dr. Agreed Value
Goodwill A/c Dr. (Balancing figure)
To Sundry Liabilities (individually) Agreed value
To Vendor firm A/c Purchase consideration
To Capital Reserve A/c Balancing figure
(Being assets and liabilities taken over)

3. For discharge of purchase price:

Vendor firm A/c Dr.
To Share Capital A/c
To Bank A/c
(Being payment made)

4. For bearing realisation expenses of Vendor:

Goodwill A/c or Capital Reserve A/c Dr.
To Bank

5. For formation expenses:

Preliminary Expenses A/c Dr.
To Bank

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UNIT-VI

Meaning of Computerized Accounting System

As its name suggests, "computerized accounting" is accounting done with the aid of a computer. It
tends to involve dedicated accounting software and digital spreadsheets to keep track of a business or
client's financial transactions.

• Computerized accounting is a beneficial use of current technological advances. Not only has it
revolutionized the traditional paper methods of accounting, but it has also created new types of
accounting applications for business. Companies now create entire accounting information systems
that integrate all business operations, including external suppliers and vendors in the value chain.

• Computerized accounting systems (or software) have replaced manual based accounting in virtually
all businesses and organizations, providing accountants, managers, employees and stakeholder’s
access to vital accounting information at the touch of a button. Computerized accounting systems
automate the accounting process--improving efficiency and cutting down costs.

• Computerized accounting has many advantages over traditional manual accounting. Computerized
accounting tends to be more accurate, is faster to use, and is less subject to error than its manual
counterpart.

Features of computerized accounting

1) Simple and integrated :- It is designed to automate and integrate all the business operations
such as purchase, sales, finance, inventory and manufacturing. The CAS may be integrated
with enhanced Management Information System (MIS), multi-lingual and data organisation
capabilities to simplify all the business processes of the organisation easily and cost-
effectively.

2) Speed:- It can perform functions at much higher speed than doing the same manually.

3) Accuracy:- Computers perform functions with high degree of accuracy. If hardware, software
and input by people are proper, the computerised accounting system can assure of accurate
outcome.

4) Reliability:- Computers are used to process large volumes of data and hence, data provided by
it are reliable.

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5) Versatility:-Computer and accounting software have the ability to perform diverse tasks. For
example, by simply recording accounting entries through accounting software, one can get trial
balance, trading account, profit and loss account, balance sheet and diverse reports.

6) Transparency :-With computerised accounting, the organisation will have greater

transparency of day-today business operations and access to the vital information.

7) Scalability :-computerized accounting enables processing of any volume of data in tune with
the change in the size of the business.

8) On-line facility :-computerized accounting offers online facility to store and process
transaction and data so as to retrieve information to generate and view financial reports in any
part of the world.

9) Security :-In computerized accounting, only the authorised users are permitted to have access
to accounting data. Under manual accounting system, it is very difficult to secure such
information as it is open to inspection by any person dealing with the books of accounts.

Components of Computerized Accounting System

Components of Computerized Accounting can be classified into six categories, namely, i) Hardware ii)
Software iii) People iv) Procedure v) Data and vi) Connectivity.

i) Hardware:- The physical components of a computer constitute its hardware. Hardware consists of
input devices and output devices that make a complete computer system. Examples of input devices
are keyboard, optical scanner, mouse, joystick, touch screen and slylus which are used to feed data
into the computer. Output devices such as monitor and printer are media to get the output from the
computer.

ii) Software:-A set of programs that form an interface between the hardware and the user of a
computer system are referred to as software. The following are the various types of software:
a) System software: A set of programs to control the internal operations such as reading data from
input devices, giving results to output devices and ensuring proper functioning of components is called
system software. The system software includes the following:

(1) Operating system: A set of tools and programs to manage the overall working of a computer using
a defined set of hardware components is called an operating system. It is the interface between the user
and the computer system. Example: DOS, Windows, UBUNTU, imac, etc.

(2) Programming software: Special software to accept data and interpret them in the form of
machine/assembly language understandable by a computer. Example: C, PASCAL, COBOL, etc.
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(3) Utility software: These are designed specifically for managing the computer
device and its resources. Example: File manager, Anti-virus software, etc.

b) Application software: Programs designed to perform a specific function for a user. An application
software can be classified as follows:
(i) General purpose software: This type of application can be used for a variety of tasks and not limited
to one particular function. Example: MS-Office.
(ii) Specific purpose software: This software is created to execute one specific task and they are
customised to the needs of user. Example: Accounting software, payroll software, etc.

iii) People :- The most important element of a computer system is its users. They are also called live-
ware of the computer system. The following types of people interact with a computer system.
a) System analysts: People who design the operation and processing of the system.
b) System programmers: People who write codes and programs to implement the working of the
system.
c) System operators: People who operate the system and use it for different purposes.

iv) Procedure :-Procedure is a step by step series of instructions to perform a specific function and
achieve desired output. In a computer system there are three types of procedures.
a) Hardware oriented procedure: It defines the working of a hardware component.
b) Software oriented procedure: It is a set of detailed instructions for using the software.
c) Internal procedure: It maintains the overall working of each part of a computer system by directing
the flow of information.

v) Data :-The facts and figures that are fed into a computer for further processing are called data. Data
are raw input until the computer system interprets them using machine language, stores them in
memory, classifies them for processing and produces results in conformance with the instructions
given to it. Processed and useful data are called information which is used for decision making.

vi) Connectivity:- When two or more computers are connected to each other, they can share
information and resources such as sharing of files (data/music, etc), sharing of printer, sharing of
facilities like the internet. This sharing is possible using wires, cables, satellite, infra-red, bluetooth,
microwave transmission, etc.

Advantages of Computerized Accounting

1. Better Quality Work: The accounts prepared with the use of computerized accounting system are
usually uniform, neat, accurate, and more legible than a manual job.

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2. Lower Operating Costs: Computer is a reliable and time-saving device. The volume of job
handled with the help of computerized system results in economy and lower operating costs. The
overall operating cost of this system is low in comparison to the traditional system.

3. Improves Efficiency: This system is more efficient in comparison to the traditional system. The
computer makes sure speed and accuracy in preparing the records and accounts and thus, increases the
efficiency of employees.

4. Facilitates Better Control: From the management point of view, there is greater control possible
and more information may be available with the use of the computer in accounting. It ensures efficient
performance in accounting records.

5. Greater Accuracy: Computerized accounting make sure accuracy in accounting records and
statements. It prevents clerical errors and omissions in records.

6. Relieve Monotony: Computerized accounting reduces the monotony of doing repetitive accounting
jobs. Which are tiresome and time-consuming.

7. Facilitates Standardization: Computerised accounting provides standardization of accounting

routines and procedures. Therefore, it ensures standardization in the accounting records.

8. Minimizes Mathematical Errors: While doing mathematical work with computers, errors are
virtually eliminated unless the data is entered improperly in the system.

9. Legibility : The data displayed on computer monitor is legible. This is because the characters
(alphabets, numerals, etc.) are type written using standard fonts. This helps in avoiding errors caused
by untidy written figures in a manual accounting system.

10. Efficiency : The computer based accounting systems ensure better use of resources and time. This
brings about efficiency in generating decisions, useful informations and reports.

11. Quality Reports : The inbuilt checks and untouchable features of data handling facilitate hygienic
and true accounting reports that are highly objective and can be relied upon.

12. speed : Accounting data is processed faster by using a computerized accounting system than it is
achieved through manual efforts. This is because computers require far less time than human beings in
performing a task.

Disadvantages of Computerized Accounting:

1. Reduction of Manpower: The introduction of computers in accounting work reduces the number
of employees in an organization. Thus, it leads to greater amount of unemployment.

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2. High Cost: A small firm cannot install a computer accounting system because of its high
installation and maintenance cost. To be more economical there should be large volume of work. If the
system is not used to its full capacity, then it would be highly uneconomical.

3. Require Special Skills: Computer system calls for highly specialized operators. The availability of
such skilled personnel is very scarce and very costly.

4. Other Problems: Frequent repair and power failure may affect the accounting work very much.
Computers are prone to viruses. Often time’s people will assume the computer is doing things
correctly and problems will go unchecked for long period of time.

5. Cost of Training: The sophisticated computerised accounting packages generally require

specialised staff personnel. As a result, a huge training costs are incurred to understand the use of
hardware and software on a continuous basis because newer types of hardware and software
areacquired to ensure efficient and effective use of computerised accounting systems.

6. Staff Opposition : Whenever the accounting system is computerised, there is a significant degree of
resistance from the existing accounting staff, partly because of the fear that they shall be made
redundant and largely because of the perception that they shall be less important to the organisation.

7. Disruption : The accounting processes suffer a significant loss of worktime when an organisation
switches over to the computerised accounting system. This is due to changes in the working
environment that requires accounting staff to adapt to new systems and procedures

8. System Failure : The danger of the system crashing due to hardware failures and the subsequent
loss of work is a serious limitation of computerized accounting system. However, providing for back-
up arrangements can obviate this limitation. Software damage and failure may occur due to attacks by
viruses. This is of particular relevance to accounting systems that extensively use Internet facility for
their online operations. No full-proof solutions are available as of now to tackle the menace of attacks
on software by viruses.

Difference Between Manual Accounting and Computerized Accounting

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Accounting software

The main function of CAS is to perform the accounting activities in an organisation and generate
reports as per the requirements of the users. To obtain the desired results optimally, need based
software or packages are to be installed in the organisation. Depending upon the suitability of business
requirements there are three types of software, namely, (i) Readymade software, (ii) Customised
software and (iii) Tailormade software.

(i) Readymade software: - These packages are standardised or readymade packages which can be
used by the business enterprises immediately on procurement. These packages are used by small and
conventional business enterprises. Cost of installation and maintenance is very low. Training cost is
negligible and sometimes the vendor provides free of cost training. These softwares are used by those
enterprises where financial transactions are simple, uniform and routine in nature. Few examples of
such type of software are Tally, Busy, Marg, Profitbooks.
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(ii) Customised software:- Many a time, it is not possible that ready-to-use packages suit the
requirements of the business enterprise. In such circumstances, customised packages may help the
business enterprise for fulfilling their requirements. Customised packages can be modified according
to the need of the enterprise. For example, software can record attendance of the employees and on the
requirement of the customer it can also count the absence of employees in a month, etc.

These packages are used by medium or large business enterprises. Cost of installation, maintenance
and training is relatively higher than that of ready-to-use packages. These software’s are used by those
enterprises where financial transactions are somewhat peculiar in nature.

(iii) Tailor-made software: - Large enterprises have their own way of functioning. For effective
management information system, varied and specific information is frequently required by many users
which may not be needed in case of small or medium scale enterprises. In such enterprises, depending
upon their functioning, need based software known as tailored packages are installed. The cost of these
packages is very high and specific training for using these packages is also required.

Grouping and codification of accounts

In any organisation, the main unit of classification is the major head which is further divided
into minor heads. Each minor head may have number of sub-heads. After classification of
accounts into various groups namely, major, minor and sub-heads and allotting codes to each
account these are programmed into the computer system.

In general, the basic classifications of different accounts embodied in a transaction are resorted
through accounting equation.

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Assets = Liabilities + Capital + (Revenues – Expenses)

Each component of the above equation can be divided into groups of accounts as follows:

A .Liabilities and capital

➢ Capital
➢ Reserves and surplus

Non-Current Liabilities

➢ Long-term borrowings
➢ Other long-term liabilities

Current liabilities

➢ Short term borrowings

➢ Trade payables
➢ Other current liabilities

B. Assets

Fixed tangible assets

➢ Land and building

➢ Plant and machinery
➢ Furniture and fixtures

Intangible assets

➢ Goodwill
➢ Copyright
➢ Patents

Current Assets

➢ Short term investments

➢ Inventories
➢ Trade receivables
➢ Cash and cash equivalents
➢ Short term loans and advances
➢ Other current assets

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C. Revenues

➢ Sales
➢ Other income

D. Expenses

➢ Material consumed
➢ Wages
➢ Manufacturing expenses
➢ Depreciation
➢ Administrative expenses
➢ Interest
➢ Selling and distribution expenses, etc.

Codification of accounts

Code is an identification mark. Generally, computerised accounting involves codification of accounts.

Codification of accounts is needed where there are numerous accounts heads in an organisation. There
is a hierarchical relationship between the groups and its components. In order to maintain the
hierarchical relationships between a group and its sub-groups, proper codification is required.

The coding scheme of account heads should be such that it leads to grouping of accounts at various
levels so as to generate various reports. For example, the codes for various accounts may be allotted as
follows:

i. Liabilities and Capital

ii. Assets

iii. Revenues

iv. Expenses

Under Liabilities and Capital

i. Capital

ii. Non-current liabilities

iii. Current liabilities

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Under Assets

i. Non-current assets

ii. Current assets

The above codification scheme utilises the hierarchy present in grouping of accounts. Major
advantage of such coding is that if the account codes are listed in ascending order, these will be
automatically listed as per the desired hierarchy.

Methods of codification

Following are the three methods of codification.

a. Sequential codes

In sequential code, numbers and/or letters are assigned in consecutive order. These codes are applied
primarily to source documents such as cheques, invoices, etc. A sequential code can facilitate
document search. For example:

Code Accounts

CL001 ABC LTD

CL002 XYZ LTD

CL003 SCERT

b. Block codes

In a block code, a range of numbers is partitioned into a desired number of sub-ranges and each sub-
range is allotted to a specific group. In most of the cases of block codes, numbers within a sub-range
follow sequential coding scheme, i.e., the numbers increase consecutively. For example:

Code Dealer type

100 – 199 Small pumps

200 – 299 Medium pumps

300 – 399 Pipes

400 – 499 Motors

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c. Mnemonic codes

A mnemonic code consists of alphabets or abbreviations as symbols to codify a piece of information.

For example:

Code Information

SJ Sales Journals

HQ Head Quarters

VOUCHERS

Meaning: ‘Voucher’ is the original documentary evidence in support of any payment or receipt of
money by the business. It would be with the help of the voucher that the accuracy of entry can be
checked. Voucher alone can tell us about the nature and sources of the transaction, its value and
authority.

Types of Accounting Vouchers

➢ Sales Voucher
➢ Purchase Voucher
➢ Payment Voucher
➢ Receipt Voucher
➢ Contra Voucher
➢ Journal Voucher
➢ Credit Note Voucher
➢ Debit Note Voucher

Sales Voucher in Tally :- Sales voucher is one of the most used accounting vouchers in Tally. Users
can create this voucher in two different formats; as an invoice, or as a voucher. The invoice format
enables users to print a copy of invoices for customers.

Purchase Voucher in Tally :- Like sales vouchers, purchase voucher belongs to the accounting
category and is available in both invoice and voucher formats. Editing and modifying receipt entries in
Tally are easy, as its voucher format helps accountants to do so quickly.

Payment Voucher in Tally :-The payment voucher is another accounting voucher in Tally that helps
create and print cheques against the order. Once the payment voucher gets passed, the corresponding
cheque can be printed by clicking on ‘banking’ and then on ‘cheque printing’.

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Receipt Voucher in Tally :-When accountants make a receipt voucher in Tally, all the invoices which
have pending payments pop up as a reminder. As soon as the client makes the payment through any
mode, the receipt can be updated with the payment method details.

Contra Voucher in Tally :- Contra vouchers are used to withdraw or deposit money in banks with
the help of instruments such as cheques/ATM/DD or e-transfer to another account through
NEFT/IMPS. With the help of contra vouchers in Tally, accountants can also generate deposit slips for
recordkeeping.

Journal Voucher in Tally :-Unlike other vouchers, a journal voucher in Tally can come under the
roof of both accounting and inventory vouchers. There are multiple uses of a journal voucher in Tally
depending on the type of business it is being used for.

Credit Note Voucher in Tally :-Credit note voucher in Tally has to be enabled manually. It is
usually enabled by pressing F11 and they manually configuring its features. Credit note can also be
passed by checking the original invoice. When a client is selected, Tally shows the transaction invoice
history that have been raised.

Debit Note Voucher in Tally:-

Debit note voucher is one of the most-used types of voucher in Tally ERP 9, that is used for managing
purchase returns. With the help of this, accountants can generate a debit note for invoicing as well as a
voucher.

How do you create, Edit and delete of voucher TYPE?

Create Voucher Type

1) Gateway of Tally
2) Inventory info
3) Voucher Type
4) Create
5) Enter Voucher type
6) press Yes to save

Edit Voucher Type

➢ Gateway of Tally
➢ Inventory info
➢ Voucher Type
➢ Alter
➢ Enter Voucher type
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➢ press Yes to save

Delete Voucher Type

➢ Gateway of Tally
➢ Inventory info
➢ Voucher Type
➢ Alter
➢ Enter Voucher type
➢ Press Alt + D
➢ press Yes

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