Financial Accounting 1

Chapter:- Introduction to Accounting

B.COM ( SEM:-I)

Presented By,
Teacher:-SB And JJ
 Financial Accounting 1
SYLLABUS
✓ UNIT 1: INTRODUCTION (5 MARKS)

✓ UNIT 2: CONCEPT FOR DETERMINATION OF BUSINESS INCOME (15 MARKS)

✓ UNIT 3: INTRODUCTION TO ACCOUNTING STANDARDS (10 MARKS)

✓ UNIT 4: FINAL ACCOUNTS OF TRADING CONCERN (15 MARKS)

✓ UNIT 5: FINANCIAL STATEMENT FROM INCOMPLETE RECORDS AND OF NPO (10 MARKS)

✓ UNIT 6: ACCOUNTING FOR SPECIAL SALES TRANSACTION (25 MARKS)

Chapter:- Introduction to Accounting
 NATURE OF ACCOUNTING

✓ Man made system

✓ Accounting is a process

✓ Accounting is an art

✓ Monetary events

✓ Accounting is a means and not an end

• RELIABILITY
QUALITATIVE CHARACTERISTICS OF
✓ a) Faithful representation

ACCOUNTING
✓ b) Neutrality INFORMATION
✓ c) Prudence

✓ d) completeness
• RELEVANCE
• UNDERSTANDABILITY
• COMPARABILITY
 Recording and
classification of
FUNCTION OF ACCOUNTING transaction
Best utilisation Reflecting the
of available financial
resources results

Reflecting the
Protection of
financial
capital
position

Sorting of Communicating
economic financial
events information
BRANCHES OF ACCOUNTING
FINANCIAL
ACCOUNTING

MANAGEMENT COST
ACCOUNTING ACCOUNTING
BASIS FOR COMPARISON FINANCIAL ACCOUNTING MANAGEMENT ACCOUNTING
Meaning Financial Accounting is an accounting system that focuses on the The accounting system which provides relevant information to the
preparation of a financial statement of an organization to provide managers to make policies, plans and strategies for running the
financial information to the interested parties. business effectively is known as Management Accounting.

Orientation Historical Future

Users Both internal and external users Only internal users

Nature of statements prepared General-purpose financial statements Special purpose financial statements

Rules Rules of GAAP are followed No fixed rules for the preparation of reports

Reports Only financial aspects Both financial and non-financial aspects

Time Span Financial statements are prepared for a fixed period, i.e. one year. Management Reports are prepared whenever needed.

Objective To create periodical reports To assist internal management in planning and decision-making
process by providing detailed information on various matters.

Publishing and auditing Required to be published and audited by statutory auditors It is not meant to be published or audited. It is for internal use only.

Format Specified Not Specified

USERS Proprietor / shareholder/
INTERNAL USERS Management Employees
partner

EXTERNAL USERS Investors Lenders Suppliers

Customers Government
✓ Owners/Shareholders
✓ The primary object of accounting is to provide necessary information to the owners/shareholders related to their business.
✓ Managers
✓ The managers of business houses are more concerned with the accounting information because they are responsible to the owners.
✓ Employees
✓ Employees are also interested in financial statements because an increase in their salaries, incentives, and wages and payment of
bonus depends on the size of the profit earned.
 ✓ The persons who are interested to make an investment in business will like to know about its profitability and financial position.
Thus, they derive this information from the accounting reports of the business.
✓ Lender
✓ lending institutions would like to be ensured that they will be paid on time. Moreover, the financial reports help them in judging
such position. Thus, Banks and other lending agencies rely upon accounting statements for determining the acceptability of a loan
application.
✓ Customers
✓ Customers may also have either a short-term or long-term interest in the business entity to know the profitability, liquidity and
solvency position of the business.
✓ Government
✓ The Government is interested in the financial statements of business organization on account of taxation, labour, and corporate
laws.
✓ Researchers
✓ Accounting information is also used by the research scholars in their research in accounting theory as well as business affairs and
practices.
✓ Regulatory Agencies
✓ Various Government agencies and departments like Registrar of Companies, Company Law Board and Tax Authorities, etc. use
accounting information.

✓ They not only require it as a basis for tax assessment but also in evaluating how well various businesses are operating under law
related requirements.
Basic Accounting Concepts
1] Business Entity Concept
This accounting concept separates the business from its owner. As far as accounting is concerned the owner and the
business are two separate entities. This will help the accountant identify the business transactions from the personal ones.
All forms of business organizations (proprietorship, partnership, company, AOP, etc) must follow this assumption.
So for example, if the owner brings in additional capital into the business, we will treat this as a liability on the balance
sheet of the business.

2] Money Measurement Concept

This accounting concept states that only financial transactions will find a place in accounting. So only those business
activities that can be expressed in monetary terms will be recorded in accounting. Any other transaction, no matter how
significant, will not find a place in the financial accounts.
3] Going Concern Concept
The going concern concept assumes that a business will continue to operate indefinitely. So it assumes that for the
foreseeable future the business will not be winding up. This leads to the assumption that the business will not have to sell
its assets any time soon and it will meet all its obligations as well.

4] Accounting Period Concept

Every organization, according to its needs, chooses a specific period of time to complete an accounting cycle. Generally, the
time chosen is a year we call the accounting year. The time period is mentioned in the financial statements.

5] Cost Concept
This accounting concept states that all assets of the firm are entered into the books of account at their purchase price (cost
of acquisition + transport + installation etc). In the subsequent years to, the price remains the same (minus depreciation
charged). The market price of the asset is not taken into consideration.
6] Dual Aspect Concept
This concept is the basic principle of accounting, it is the heart and soul. It basically is one of the golden rules of accounting
– for every credit, there must be a corresponding debit. So every transaction we record must have a two-fold effect, i.e. it
will be recorded in two places. This is the core concept of the double-entry system of accounting.

7] Realisation Concept
According to the realization accounting concept, revenue is only recognized when it is realized. Now revenue is the cash
inflow for a business arising from the sale of goods or services. And we assume this revenue as realized only when it legally
arises to be received. So in simpler terms, the profit earned will be recorded when it is actually earned.

8] Matching Concept
This concept states that the revenue and the expenses of a transaction should be included in the same accounting period.
So to determine the income of a period all the revenues and expenses (whether paid or not) must be included.
9] Full Disclosure Concept
This concept states that all relevant information will be disclosed in the accounting statements. A lot of external users
depend on these financial statements for their information to make investing decisions. So no information/transactions etc
of relevance to anyone of them will be omitted from these statements for the benefit of the company.

10] Consistency Concept

Once the company decides on a certain accounting policy it should not be frequently changed. Unless there is a statutory
requirement or it allows better representation of the accounts accounting policies should be consistent for long periods of
time. This allows users to make inter-firm and inter-period comparisons. Also, frequent changes in policies may be to
manipulate the accounts and this must be prevented.
11] Conservatism Concept
This accounting concept promotes prudence in accounting. It states that profit should not be included until it is realized.
However, losses even those not realized but with the remote possibility of occurring should be included in the financial
statements. So all losses are recognized – those that have occurred or are even likely to occur. But only realized profits
are recognized.

12] Materiality Concept

Materiality states that all material facts must be a part of the accounting process. But immaterial facts, i.e. insignificant
information should be left out. The materiality of a transaction will depend on its nature, value and its significance to the
external user. If the information can affect a person’s investing decision then it is definitely a material fact.
Accounting conventions were established with a motive to bring uniformity in the books of accounts at the time of
preparing them. Conventions are like customs/traditions that help the accountant to communicate clear accounting picture.
In other words, accounting convention sets the guideline for the accountant that in turn helps him/her to prepare
accounting statements and reports.
 4 Major Accounting Conventions
✓Conservatism Convention

✓Consistency Convention

✓Accounting Convention of Materiality

✓Convention of Full Disclosure

Conservatism Convention

As per the Conservatism convention at the time of recording any financial transaction, you should recognize no profit but
provide for all possible losses. This is the most important convention as it depends upon the theory that the future is
uncertain. For instance, the value of inventory is recorded at cost or market price whichever is less. In a similar way, the
provision for doubtful debts is also created. However, conservatism impacts current assets and liabilities.
Convention of Full Disclosure

Full disclosure convention helps the user in the proper interpretation of the financial statements of the company. As per
this convention at the time of preparing records, full disclosure of financial information shall be made by the accountant.

Full disclosure can be made in two ways:-

• Either in the body of the financial statements, or

• In notes accompanying such financial statements

Consistency Convention

According to the convention of consistency once the company has decided to follow a method of accounting then it shall
consistently follow the same method throughout. Along with this, changing the accounting method often would make
the comparison of its own financial statements of different period difficult for the company.
Accounting Convention of Materiality

As per the accounting convention of materiality, an item is material if it can influence the decision of users of the financial
statements. This convention is related to the significant importance of any event or item. Moreover, the materiality of an
item depends on its amount and an events materiality depends upon its nature.
 GAAP ( Generally Accepted Accounting Principles )

Generally Accepted Accounting Principles (GAAP) are basic

accounting principles and guidelines which provide the framework
for more detailed and comprehensive accounting rules, standards
and other industry-specific accounting practices. For example, the
Financial Accounting Standards Board (FASB) uses these principles
as a base to frame their own accounting standards. Thus GAAP
encompasses:
GAAP encompasses:-

✓Basic accounting principles/guidelines

✓Accounting Standards usually issued by the premier accounting

body of the country

✓Industry-specific accounting practices to cover unusual

scenarios
✓Principle of consistency: This principle ensures that consistent standards are followed in
financial reporting from period to period.

✓Principle of permanent methods: Closely related to the previous principle is that of

consistent procedures and practices being applied in accounting and financial reporting to
allow comparison.

✓Principle of non-compensation: This principle states that all aspects of an organization’s

performance, whether positive or negative, are to be reported. In other words, it should
not compensate (offset) a debt with an asset.

✓Principle of prudence: All reporting of financial data is to be factual, reasonable, and not
speculative.

✓Principle of regularity: This principle means that all accountants are to consistently
abide by the GAAP.
✓Principle of sincerity: Accountants should perform and report with basic honesty and accuracy.

✓Principle of good faith: Similar to the previous principle, this principle asserts that anyone involved in financial
reporting is expected to be acting honestly and in good faith.

✓Principle of materiality: All financial reporting should clearly disclose the organization’s genuine financial position.

✓Principle of continuity: This principle states that all asset valuations in financial reporting are based on the assumption
that the business or other entity will continue to operate going forward.

✓Principle of periodicity: This principle refers to entities abiding by commonly accepted financial reporting periods, such
as quarterly or annually.
✓ Accounting Standards can be any form of statement which consists of rules and guidelines, issued by the
accounting institutions, for the preparation of uniform and consistent financial statements. This also includes
ACCOUNTING STANDARDS
disclosures required by the different users of accounting information.

✓ Accounting Standards (AS 1- AS 32) have been issued by the Accounting Standards Board of ICAI, to establish uniform
standards for preparation of financial statements, in accordance with the Indian GAAP (Generally Accepted Accounting
Practices), for better understanding of the users.

✓ Accounting standards ensure the financial statements from multiple companies are comparable. Because all entities
follow the same rules, accounting standards make the financial statements credible and allow for more economic
decisions based on accurate and consistent information.
✓ Brings uniformity in Accounting system

✓ Easy comparability of financial statements

✓ Assist auditors

✓ Avoid fraud & manipulation

✓ Provide reliability to financial statement

✓ Make Accounting information easy & simple

✓ Measure management performance

 IFRS
International Financial
Reporting Standards
✓ Consistent preparation of financial statements by different firms & different industries has been assured leading to the possibility of
inter firm & inter industry comparison of affairs.

BENEFITS OF AS
✓ Helps accountant and auditors by providing the guidelines prepared by body of wise and expert practitioner.

✓ It require certain information to be disclosed in the financial statement

✓ It ensures that financial statement reveal true and fair view of affairs of the concern.
✓ It ensure financial statement indicate same meaning and same ideas to all the users in domestic and international
sphere.so that financial statement of different concerns in different countries can be meaningfully analysed and used for
taking decisions.
✓ Restrict alternative solution of a particular accounting problem.

LIMITATIONS
✓ It make financial statement more rigid and rule oriented
✓ AS obfuscate the judgement of the auditors as the standards are mandatory.
✓ International Financial Reporting Standards (IFRS) are a set of accounting rules for the financial

IFRS
statements of public companies that are intended to make them consistent, transparent, and easily
comparable around the world.

✓ IFRS Standards contribute to economic efficiency by helping investors to identify opportunities and risks
across the world, thus improving capital allocation. Use of a single, trusted accounting language lowers
the cost of capital and reduces international reporting costs for businesses.
✓ An accounting theory is a notion that uses speculations, methodologies, and frameworks in the study of
financial reporting (as well as how financial reporting principles are applied in the accounting industry).
ACCOUNTING THEORY
✓ Basically, accounting theories serve as a basis for the understanding of financial reporting and how
companies channel their financial statements using the appropriate strategies.
✓ An in depth study of accounting theory entails a look into existing accounting practices, how they evolved,
and the modifications or additions done to them overtime. These accounting principles serve as framework
for accurate financial reporting and statements.
 OBJECTIVES
✓ Evaluate and explain accounting practices

✓ Simplify a complex phenomenon

✓ Solve the problem created by the happening of various events

✓ Pre calculate the effects of an event on future

✓ Forecast any future events

✓ Helps in investigation,observation,explanation and conclusion of an event.

 FEATURES
✓ Practice originated

✓ Logic to accounting practice

✓ flexibility
 Procedure for Issuing Accounting Standards
✓ ASB shall determine the broad areas in which Accounting Standards need to be formulated and ‘priority in regard to the selection
thereof.

✓ In the preparation of Accounting Standards, ASB will be assisted by Study Groups constituted to consider specific subjects. In the
formation of Study Groups, provision will be made for wide participation by the members of the institute and others.
✓ The draft of the proposed standard will include the following basic points:

✓ A Statement of concepts and fundamental accounting principles relating to the Standard.

✓ Definitions of the terms used in the Standard.

✓ The manner in which the accounting principles have been applied for.

✓ The presentation and disclosure requirements in complying with the Standard.

✓ Class of enterprises to which the Standard will apply.

✓ Date from which the Standard will be effective.

✓ After taking into consideration the comments received, the draft of the proposed Standard will be finalized by ASB and submitted to
the Council of the Institute.

✓ The Council of the Institute will consider the final draft of the proposed Standard, and it found necessary, modify the same in
consultation with ASB. The Accounting Standard on the relevant subject will then be issued under the authority of the Council.
IFRS and Convergence with
AS
Convergence With IFRS
Benefits of Convergence
1] Beneficial to the Economy
If the accounting standards are converged it will promote international business and increase the influx of capital into the country. This
will help India’s economy grow and expand. International investing will also mean more capital for domestic companies as well.
2] Beneficial to Investors
Convergence is a boon for investors who wish to invest in foreign markets or economies. It makes it much easier for them to study and
compare the financial statements of foreign companies. Since the financial statements are made using the same set of standards it is
also easier for the investors to understand and analyze them.
3] Beneficial to the Industry
With globally accepted standards the industry can also surge ahead. So convergence is important for the industry as well. It will allow
the industry to lower the cost of foreign capital. If companies are not burned by adopting two different sets of standards it will allow
them easier entry into the market.
4] More Transparency
Convergence will benefit the users of the financial statements as well. It will make it easier for them to understand the financial
statements. And this will generate better transparency and raise the confidence of the investors to invest funds.
5] Cost Saving
Firstly it will exempt companies from maintaining separate accounting books according to separate standards. This will save a lot of
work hours and money for the finance department. And also planning and executing auditing will also become easier.
It will be especially helpful for those companies that have subsidiaries in many countries. And the cost of capital will also reduce since
capital would be more accessible and easily available.
 BASIS FOR COMPARISON GAAP IFRS
Acronym Generally Accepted Accounting International Financial Reporting
Principles Standard
Meaning A set of accounting guidelines and IFRS is the universal business language
procedures, used by the companies to followed by the companies while
prepare their financial statements is reporting financial statements.
known as GAAP.

Developed by Financial Accounting Standard Board International Accounting Standard

(FASB). Board (IASB).
Based on Rules Principles
Inventory valuation FIFO, LIFO and Weighted Average FIFO and Weighted Average Method.
Method.
Extraordinary items Shown below. Not segregated in the income
statement.
Development cost Treated as an expense Capitalized, only if certain conditions
are satisfied.
Reversal of Inventory Prohibited Permissible, if specified conditions are
met.
Accounting Equation
An Accounting Equation is also called the Balance Sheet Equation. We all know that we record all the business
transactions using the Dual Aspect concept. This means that each debit has an equal credit and vice-versa.

There are two approaches to record the transactions in financial accounting. One is the Traditional approach or the
British Approach and another is the Modern Approach or the American Approach. Under the Modern Approach, we do
not debit and credit the accounts. Here, we use the Accounting Equation to debit or credit an account. Thus, it is also
called the Accounting Equation Approach.
This approach classifies the accounts as follows:

Assets Accounts: Assets are the properties, possessions or economic resources of a business which help
in business operations and in earning revenues. These are measurable in terms of money. However, assets of a firm
may be tangible or intangible. Also, we can classify the assets as Fixed Assets and Current Assets. For example, land,
building, furniture and fixtures, plant and machinery, vehicles, debtors, bills receivable, bank balance, cash, stock, etc.

Liabilities Accounts: Liabilities are the amounts that an entity owes to the outsiders or the obligations or the debts
payable by the entity. We can also classify the liabilities as Long-term and Current. For example, debentures, bank
loans, creditors, bills payable, rent outstanding, short-term loans, bank overdraft, etc.

Capital Accounts: Capital or Owner’s Equity is the money that the owner brings into the business. The owner can bring
Capital in the form of cash or assets. It is an obligation of the business and the business has to pay back this amount
to the owner as business is a separate entity from its owner. Therefore, we show the Capital on the liabilities side of
the Balance Sheet. Also, we show Capital account after deducting the Drawings by the owner. Drawings are the
amount of cash, goods or assets that the owner takes for personal use from the business. Also, the profits increase
the Capital and losses decrease it.
The Accounting Equation is:
Assets = Liabilities + Capital (Owner’s Equity)

Or

Capital = Assets – Liabilities

Example on Accounting Equation:-

✓ Commenced business with cash ₹500000

✓ Purchased goods ₹25000
✓ Paid salary ₹10000
✓ Sold goods costing ₹20000 at a profit of 25% on the cost
✓ Paid salary in advance ₹2000
✓ Introduced additional capital ₹10000
✓ Purchased computer ₹15000
✓ Deposited ₹50000 into the bank
✓ It increases the Cash thus, add to cash. Also, it increases the Capital, hence add to Capital.
✓ Goods are purchased thus, cash is decreasing. While, goods are coming in thus, they are increasing. Therefore,
deduct cash and add goods.
✓ Salary is paid therefore cash is decreasing. While salary is an expense. Thus, deduct cash and also deduct from
Capital.
✓ Goods are going out thus, deduct them. Thus cash is coming in, add it. Also, add the profit to Capital.
✓ Salary is paid in advance which is a current asset. Deduct Cash is and add salary paid in advance.
✓ Cash and Capital both are increasing. Hence, add Cash and Capital.
✓ Cash is decreasing while the computer is increasing. Therefore, deduct cash and add to the computer.
✓ Cash is decreasing and bank balance is increasing. Therefore, deduct cash and add to the bank.
 ASSETS LIABILITIES + CAPITAL

Bank
Total Total
Cash Stock Computer Pre-paid Salary Capital

1. 500000 500000 500000 500000

2. (25000) 475000 25000 25000 500000 500000 500000

3. (10000) 465000 25000 490000 (10000) 490000 490000

4. 25000 490000 (20000) 5000 495000 5000 495000 495000

5. (2000) 488000 5000 2000 2000 495000 495000 495000

6. 10000 498000 5000 2000 505000 505000 505000

7. (15000) 483000 5000 15000 2000 505000 505000 505000

8. (50000) 433000 5000 15000 2000 50000 505000 505000 505000

 Classification of Accounting

✓ Natural Personal Accounts: Natural Persons are human beings. Therefore, we include the accounts belonging to
them under this head. For instance, Debtors, Creditors, Capital A/c, Drawings A/c, etc.
✓ Artificial Personal Accounts: Artificial persons are not human beings but can act and work like humans. They have a
separate identity in the eyes of law and are capable to enter into agreements. These
include H.U.F, partnership firms, insurance companies, co-operative societies, companies, municipal corporations,
hospitals, banks, government bodies, etc. For example, Bank of Baroda, Oriental Insurance Co,
✓ Representative Personal Accounts: These accounts represent the accounts of natural or artificial persons. When the
expenses become outstanding or pre-paid and incomes become accrued or unearned, they fall under this category.
For example, Outstanding Salary A/c, Pre-paid Rent A/c, Accrued Interest A/c, Unearned Brokerage A/c, etc.
✓ Real Accounts: These are the accounts of all the assets and liabilities of the organization. We do not close these
accounts at the end of the accounting year and appear in the Balance Sheet. Thus, we carry forward the balances
of these accounts to the next accounting year. Therefore, we can also say that these are permanent accounts. We
can further classify these into:
✓ Tangible Real Account: It consists of assets, properties or possessions that can be touched, seen and measured. For
example, Plant A/c, Furniture and Fixtures A/c, Cash A/c, etc.
✓ Intangible Real Account: It consists of assets or possessions that cannot be touched, seen and measured but
possess a monetary value and thus can be purchased and sold also. For example, Goodwill, Patents, Copyrights, etc.
✓ Nominal Accounts: Nominal Accounts are the accounts relating to the expenses, losses, incomes, and gains. These
are temporary accounts and thus we need to transfer their balances to Trading and Profit and Loss A/c at the end of
the accounting year. Therefore, these accounts have no balance to be carried forward next year as they are closed.
Accounts Debit Credit

Personal Receiver Giver:

Real What comes in What goes out
Nominal Expenses and Losses Incomes and Gains
Rules for Debit and Credit for all types of accounts:-
Personal Account:
Debit the Receiver

Credit the Giver

Real Account:
Debit what comes in

Credit what goes out

Nominal Account:
Debit all expenses and losses

Credit all incomes and gains

✓ Mr D commenced business with cash ₹ 1, 00,000.
✓ Purchased machinery for cash ₹ 10,000
✓ Purchased goods from Mr A on credit ₹ 50,000
✓ Sold goods for cash ₹ 10000
✓ Paid wages to Jaimin ₹ 15,000
✓ Paid to Mr A ₹ 25000
✓ Wages to be paid to Mr C is outstanding ₹ 5000
✓ Brokerage earned but not received ₹ 2000
✓ Deposited ₹ 15000 into the bank.
✓ Mr D withdrew cash for personal use ₹ 10000
 Analysis of transactions

Transaction Accounts Nature of Accounts Reason for Effect on Accounts Debited or Credited

1. Cash A/c Capital A/c Real A/c Personal A/c Cash is coming in Mr D is the giver Debit Credit

2. Machinery A/c Cash A/c Real A/c Real A/c Machinery is coming in Cash is going out Debit Credit

3. Purchases A/c Mr A’s A/c Real A/c Personal A/c Goods are coming in Mr A is the giver Debit Credit

4. Cash A/c Sales A/c Real A/c Real A/c Cash is coming in Goods are going out Debit Credit

5. Wages A/c Cash A/c Nominal A/c Real A/c Wages are an expense Cash is going out Debit Credit

6. Mr A’s A/c Cash A/c Personal A/c Real A/c Mr A is the receiver Cash is going out Debit Credit

Nominal A/c
Wages A/c Wages Outstanding Wages is an expense Wages is payable to Mr C and
7. Representative Debit Credit
A/c thus he is our creditor.
Personal A/c

Representative
Accrued Brokerage A/c Brokerage Brokerage is receivable from the client, so the client is
8. Personal A/c Nominal Debit Credit
A/c our debtor Brokerage is an income
A/c

The bank is receiving the

9. Bank A/c Cash A/c Personal A/c Real A/c Debit Credit
amount Cash is going out

10. Drawings A/c Cash A/c Personal A/c Real A/c Mr D is the receiver Cash is going out Debit Credit
Debit and Credit
• A debit is an accounting entry that either increases an asset or expense account. Or decreases a liability
or equity account. It is positioned on the left in an accounting entry.
• A credit is an accounting entry that increases either a liability or equity account. Or decreases an asset or expense
account. It is positioned on the right in an accounting entry.
The following are the rules of debit and credit which guide the system of accounts, they are known as the Golden Rules of
accountancy:

• First: Debit what comes in, Credit what goes out.

• Second: Debit all expenses and losses, Credit all incomes and gains.
• Third: Debit the receiver, Credit the giver.

A debit and credit entry have a broad impact on different accounts. For example, in

• Asset accounts, a debit increases the balance and a credit decreases the balance.
• Liability accounts, a debit decreases the balance and a credit increases the balance.
• Equity accounts, a debit decreases the balance and a credit increases the balance.
• Revenue accounts, a debit decreases the balance and a credit increases the balance
a. Cash Sale

b. Cash Purchase

c. Repayment of loan

Solution:

Sale for cash

Cash A/c – Dr.

To Sale A/c

2. Purchase of inventory from the supplier for cash

Inventory A/c – Dr.

To Cash A/c

3. Repaying a loan

Loan payable A/c – Dr.

To cash A/c
 Double Entry System

Double Entry System of accounting deals with either two or more accounts for every business transaction.

ASSETS = LIABILITIES + EQUITY

A systematic accounting process, the activities are recorded into various accounts to keep the data bifurcated and
classified under account heads. There are majorly seven types of accounts wherein all the business accounting entries and
transactions are classified. These are:

• Assets
• Liabilities
• Equity
• Gains
• Losses
• Expenses
• Revenues
Debit and Credit
Debits and Credits are essentials to enter data in a double entry system of accounting and book-keeping. While posting
an accounting entry, an entry on the left side of the account ledger is a debit entry and right side entry is a credit entry.

Advantages of Double Entry System

• This system increases the Accuracy of the accounting, through the trial balance device
• Profit and loss suffered during the Year can be calculated with details
• By following this system the company can keep the accounting records in detail which eventually helps in
controlling
 Accounting Cycle
Accounting cycle is a process of recording all the financial transactions and processing them. When a complete sequence
of recording and processing financial transactions is followed which happens frequently on a continuous basis during an
accounting period is known as the accounting cycle. It thus begins with the occurrence of financial transactions, from
when it occurs, its representation on the financial statements and closing the accounts of an entity.
Recording of transactions
Journal
Next step in this accounting cycle is to record the financial transactions in the journal. We record financial transactions in
Journal chronologically.

There can be one or more than one accounts debited and one or more accounts can be credited. An accountant shall check
that both the debit and the credit balance match.

Ledger
All the journal entries prepared in the earlier step are posted into respected ledgers chronologically. A ledger shows the
summary of all the financial transactions related to such account. For example: – In cash ledger, we find a summary of all
the cash transactions.
Trial balance
After completion of the posting of entries to ledgers, we need to prepare a trial balance. We prepare trial balance after considering all the
ledger account closing balances.

We prepare it at the end of the accounting period for the preparation of financial statements. Accounting period may be monthly, quarterly
or yearly based on the entity’s requirements.
Adjustment Entries
We need to record the adjustment entries properly. We need to make these entries before the preparation of financial statements of an
entity. At the end of the accounting period, adjusting entries must be posted to the ledgers.

Adjusted Trial Balance

After preparation of trial balance and making adjustment entries (if any), an adjusted trial balance may also be prepared. An accountant
shall also check that the debit and credits on the trial balance match.

Closing Entries
We shall make proper entries for the closure of nominal accounts. We shall close accounts by transferring the balances to Trading Account &
Profit and Loss Account.

Financial Statements
After following the above steps, we can prepare financial statements easily. Financial statements will show the true financial position and
operating results of the entity’s business.
 Journal
Journal is the book of primary entry in which we record all transactions before posting them into the ledger. We need to
keep a journal in a columnar form. There are some function and advantages of journal day book

Functions of Journal
(i) Analytical Function: While recording a transaction in the journal each transaction is analyzed into the debit aspect and
the credit aspect. This helps to find out how each transaction will financially affect the enterprise.

(ii) Recording Function: Accountancy is a business language which helps to keeps the record of the transactions based on
the principles. Each such recording entry is supported by a brief narration, which explains, every transaction in simple
language.

(iii) Historical Function: Journal book contains a chronological record of the transactions for future references.
Advantages of the Journal
The following are the advantages of a journal:

(i) Chronological Record: Journal book records transactions as and when it happens. Therefore it is possible to get day-to-
day information.

(ii) Minimizing the possibility of errors: The nature of the transaction and its effect on the financial position of the business
is ascertained by recording and analyzing into debit and credit aspect.

(iii) Narration: It means the explanation of every recorded transaction.

(iv) Helps to finalize the accounts: It is the basis of ledger posting and the ultimate Trial Balance.
➢ Journal records all business transactions in one place on the time and date basis.
➢ All transactions which are recorded, are supported with a receipt or bill, so we can check the authenticity of each
journal entries with their bills.
➢ There is a minimum chance to avoid any particular transaction because in a journal we record every transaction on a
date basis.
➢ Accountant writes each journal entry’s narration below that journal entry, so another auditor can know what is the
reason of that journal entry.
➢ In a journal, we record each transaction after deep analysis of two accounts on the basis of double entry system, so
there is a minimum chance of mistake in the journal.
➢ Journal is the basis of posting transactions in ledger accounts. Without making of the journal, an accountant can not
make ledger accounts.
➢ If there is a mistake in ledger accounts, we can easily rectify it with the help of journal or rectify journal entry in the
journal.
➢ All opening journal entries, closing journal entries and all other transactions which we cannot record in any other
subsidiary books, we record them in the journal proper.
Date Particulars L. Dr. Cr.

F. Amount Amount

Rs Rs
Jan. 1 Commenced business with a capital 20,000

3 Amount deposited in S.B.I 5,000

6 Goods purchased for cash 7,000

10 Furniture purchased from Chinmoy 5,000

11 Goods sold to Anil Majumdar for cash 8,000

13 Goods sold to Ashim Das 2,000

25 Cash drew for private uses 500

31 Salaries paid 800

 Ledger Accounts Meaning and Definition

Ledger is a book that contains the accounts. Any financial statement related to the financial position of the company
emerges only from the accounts. Thus, this ledger is known as the principal book. So, the result of all this is that it is
necessary to relate all the information for any account available is from the ledger. This book of accounts is the most
important book for any business and that is why it is known as the king of all books. Also, the ledger book is also known as
the book of the final entry.
There are 3 types of Ledgers –
• Sales Ledger
• Purchase Ledger
• General Ledger

1. Sales Ledger – Sales Ledger is a ledger in which the company maintains the transaction of selling the products, services
or cost of goods sold to customers. This ledger gives the idea of sales revenue and income statement.

2. Purchase Ledger – Purchase Ledger is a ledger in which the company organizes the transaction of purchasing the
services, products, or goods from other businesses. It gives the visibility of how much amount the company paid to other
businesses.

3. General Ledger – General Ledger is divided into two types – Nominal Ledger and Private Ledger. Nominal ledger gives
information on expenses, income, depreciation, insurance, etc. And Private ledger gives private information like salaries,
wages, capitals, etc. Private ledger is not accessible to everyone.
Ledger Account Examples
Assets
• Cash

• Land

• Accounts receivable

• Equipment

Liabilities
• Debt

• Accounts Payable

• Loans

• Accrued expenses

Stock
• Stockholders Equity

• Common Stocks

• Retained Earnings

Operative Revenues
• Sales

• Services Fees

Operating Expenses
• Salaries and wages

• Office Expenses

• Depreciation Expense
Liabilities: This decreases on the side of debt and increases on the credit side.

Assets: In assets, the figure increases on the left side or you can say the debit side. While this decreases on the credit size or
the right side.

Capitals: This follows the same rule as liabilities.

Gains or Income: In this, there is a decrease on the debit side. Also, there is an increase in the credit side.

Expenses: The expenses in the ledger decreases on the credit side while increases on the debit side.

There are some rules that students should understand according to the nature of debit and credit.
Debits and Credits
Credit
• For properties and goods, the credit represents that the value and stock of goods and properties have decreased. This
is moreover related to real accounts.
• In the case of different accounts like dividend or interest or commission received, or the discount to be gained, it is
reported that the firm has made again. This is moreover related to the nominal account.
Debit
• For goods or properties, the value and use of such goods have been increased. This is related to real accounts.
• Also, there is a case in which a person has received some benefit against some service given by him or will be
rendered by him in the future. Thus, when a person is liable to do something for a firm, the fact is mentioned using
that person’s account. This is moreover related to the personal account.
• For other accounts like expenses or losses, a certain expense has been incurred by the firm or has lost money. This can
be related to the nominal account.
Sales Day Book

Sales day book is also known as a sales book, sales journal, sold book etc. It is a subsidiary book, i.e. a book of original
entry. It is a manually maintained account, with the purpose of recording all credit sales of the business in one place.

This means all the sales of the firm done on credit are recorded in the sales day book. No cash sales will be recorded here,
they are recorded in the cash book. And only the sale of goods will be recorded here.
• Sold goods to X for 600/-
• A credit sale of 10 units to Y for 35/- per unit
• Sold 50 units to Z for 1350/- inclusive of 10% cash discount
• Q bought units worth 500/- on credit
 Invoi
Date Buyer Names LF Amount
ce

01/01 X 600/-

02/01 Y (10 × 35) 350/-

03/01 Q 500/-

Total 1450/-

Sales Day Book

Note that the goods sold to Z will not be a part of the sales book as the transaction is a cash transaction. So that transaction will be recorded in the cash book.
Purchase Day Book

Purchase day book is also known as purchase journal, purchase book, invoice book, bought book etc. is a type of subsidiary
book. It is also a book of original entry.

The purpose of the purchase day book is to record all the credit purchases of the business that are meant for resale.

This means that it does not record any cash purchase transactions. Such transactions will be recorded in the cash book.
Advantages of Purchase Day Book
• All entries of purchases of goods on credit are recorded in one place. It is easy to reference and browse these entries.
• Important information about these transactions (like the number of goods or the rate of purchase etc.) are written in
the journal
• Bought 20 computers from ABC Co. at 20,000/- per computer and a 10% trade discount
• Bought 100 phones from LMN Co. at 1000/- on credit
• 350 televisions from DEF Co. at 24500/- each and a 5% cash discount
• Purchased 200 radios from JKL Co. at 500/- each on credit
 Invoic
Date Name of Supplier LF Amount
e

ABC Co.
4/6/1
3,60,000/-
8
20,000 × 20 @ 10% discount

8/6/1 LMN Co.

1,00,000/-
8 100 × 1000

15/6/ JKL Co.

1,00,000
18 200 × 500

Total 5,60,000/-
Sales Book

✓ A Sales Book is a Subsidiary Book and is, therefore, also a book of Original Entry. A Sales Book or Sales Day Book contains
the records of all-credit sales of goods. While a Cash Book holds the records of all-cash sales of goods.

✓ The entries in the Sales Book are also made with the net amount of the invoice. Therefore, Sales Book does not contain a
Trade Discount and other details are given on the invoice.
 Sales Book

Date Invoice No. Name of the Customer L.F. Amount

Sales Return Book

A Credit Note is prepared for every return of goods. It is prepared in duplicate. The Credit Note contains the name of the
customer, details of goods returned and reason thereof. Each Credit Note is dated and serially numbered. The Credit Note
serves as the source document for entries in the Sales Return Book.
Date Details

10 Aug Sold to A Ltd. (Invoice No. 24): 2000 shirts @ ₹ 500 per piece.

16 Aug Sold to B Ltd. (Invoice No. 26): 100 ties @ ₹ 200 per piece. Trade discount 20%

18 Aug Sold to C Ltd. (Invoice No. 28): 50 coats for ₹100000. Trade discount 10%

21 Aug Sold to D Ltd. (Invoice No. 30): 100 trousers @ ₹ 400 per piece. Trade discount 15%

25 Aug Sold to E Ltd. (Invoice No. 33): 50 ties @ ₹ 250 per piece. Trade discount 10%
 Sales book

Date Invoice No. Name of the Customer L.F. Amount

10 Aug 24 A Ltd. 1000000

2000 shirts @ ₹ 500 per piece

16 Aug 26 B Ltd. 16000

100 ties @ ₹ 200 per piece. = 20,000

Less: 20% T.D. = 4,000

18 Aug 28 C Ltd. 90000

50 coats @ ₹ 2,000 per piece = 100000

Less: 10% T.D. = 10000

21 Aug 30 D Ltd. 32000

100 trousers @ ₹ 400 per piece = 40,000

Less: 15% T.D. = 6,000

25 Aug 33 E Ltd. 11250

50 ties @ ₹ 250 per piece = 12,500

Less: 10% T.D. = 1,250

31 Aug Total 1149250

Record the following transactions in the books of M/s. Z and Co. and also show the ledger accounts.

Date Details

5 Aug Goods returned by M Ltd. (Credit Note No. 2): 2 bags @ ₹ 500 per piece.

11 Aug Goods returned by D Ltd. (Credit Note No. 3): 10 suitcases @ ₹ 2500 per piece. Trade discount 20%

28 Aug Goods returned by X Ltd. (Credit Note No. 5): 5 duffle bags for ₹5000. Trade discount 10%
 Sales Return Book

Date Credit Note No. Name of the Customer L.F. Amount

5 Aug 2 M Ltd. 1000

2 bags @ ₹ 500 per piece.

11 Aug 3 D Ltd. 20000

10 suitcases @₹ 2500 per

piece = 25000

Less: 20%
T.D. = 5000

28 Aug 5 X Ltd. 4500

5 duffle bags @ ₹1000 per

piece = 5000

Less: 10%
T.D. = 500

31 Aug Total 25500

Purchase Book

Purchase book is a Subsidiary book. The Purchase book or Purchase day book contains the record of all credit-purchase.
Cash book accommodates the records of all goods-purchase.

A Purchase book does not hold the record of purchases of assets. The Journal proper contains those records. The entries
are recorded in the Purchase book from source documents. Invoices or bills received from the suppliers of goods serve as
the source documents.
Purchase Return Book

When the goods purchased on credit are returned to the supplier, these are recorded in the Purchase return book.
Sometimes, goods purchased can be defective or of low quality, etc. and hence, need to be returned. A separate book is
maintained for the purchase return and these are not deducted from the purchases in the Purchase book. Also, Purchase
return is recorded at the net amount on the invoice.
Date Details

1 Aug Purchased from ABC Ltd. (Invoice No. 524): 2000 balls @ ₹ 5 per piece.

15 Aug Purchased from XYZ Ltd. (Invoice No. 611): 100 bats @ ₹ 250 per piece. Trade discount 20%

29 Aug Purchased from Con Ltd. (Invoice No. 444): 200 skates for ₹100000. Trade discount 10%

29 Aug Purchased from ABC Ltd. (Invoice No. 741): 200 Chess for ₹2000. Trade discount 15%

30 Aug Purchased from Con Ltd. (Invoice No. 521): 100 skates for ₹40000. Trade discount 8%
Date Invoice No. Name of the Supplier L.F. Amount (₹)
1 Aug 524 ABC Ltd. 10000
2000 balls@ ₹ 5 per piece.
15 Aug 611 XYZ Ltd. 20000

100 bats@ ₹ 250 per piece. = 25000

Less: 20% T.D. = 5000

29 Aug 444 Con Ltd. 90000

200 skates @ ₹ 500 per piece = 100000

Less: 10% T.D. = 10000

29 Aug 741 ABC Ltd. 1700

200 Chess @ ₹ 100 per piece = 2000

Less: 15% T.D. = 300

30 Aug 521 Con Ltd. 36800

100 skates @ ₹ 400 per piece = 40000

Less: 8% T.D. = 3200

31 Aug Total 167500

Record the following transactions in the books of M/s. Zen and Co. and also show the ledger accounts:-

Date
Details
2018

3 Aug Returned goods purchased from MNC Ltd. (Debit Note No. 24): 2 T.V. @ ₹ 50000 per piece.

Goods returned purchased from D Ltd. (Debit Note No. 26): 10 DVD Players @ ₹ 2500 per piece. Trade
17 Aug
discount 20%

Returned goods purchased from X Ltd. (Debit Note No. 28): 5 refrigerators for ₹60000.
30 Aug
Trade discount 10%
 In the Books of M/s. Zen and Co.

Purchase Return Book

Date Debit Note No. Name of the Supplier L.F. Amount (₹)

3 Aug 24 MNC Ltd. 100000

2 T.V. @ ₹ 50000 per piece

17 Aug 26 D Ltd. 20000

10 DVD Players @ ₹ 2500 per

piece. = 25000

Less: 20%
T.D. = 5000

30 Aug 28 X Ltd. 54000

5 refrigerators @ ₹ 12000 per

piece = 60000

Less: 10%
T.D. = 6000

Total 174000
Purchases Return A/c
 Journal Proper
A Journal proper in the accounting system is a book of original entry in which all type of miscellaneous credit transactions,
which usually do not fit in any other books are recorded.
Opening Entries
These entries include entries for opening a new business. For example, a business is opened with Cash Rs 100, debtors Rs
200, stock Rs 300 bank loan Rs 400 and capital Rs 200

Date Particulars Debit Credit

1st April Cash A/c Dr 100

Debtors A/c Dr 200

Stock A/c Dr 300

To Loan A/c 400

To Capital A/c 200

Closing Entries
At the end of the year, certain closing entries will be required to transfer the balance of all the income and expenses
accounts to trading and profit and loss account. For example on 31st December the balance in expenses accounts are Salary
Rs 500, rent Rs 200, Stationary Rs 50, legal charges Rs 100, and income accounts are commission received Rs 50.

Date Particulars Debit Credit

31st
Profit & Loss A/c Dr 850
March

To Salary A/c 500

To Rent 200

To Stationary 50

To Legal Charges A/c 100

Date Particulars Debit Credit

31st
Commission Received A/c Dr 50
March

To Profit & Loss A/c 50

✓ Transfer Entries
When accounts are transferred from one account to another fora combination of allied items,
it is necessary to pass transfer entry. Such Entries are passed in the Journal proper for the sake
of record keeping.

✓ Adjustment Entries
Modification of the accounts at the end of an accounting period is called adjustments. If there
are any events affecting the related period of accounts but left out of the books, the same
should be incorporated in the books before the preparation of the final accounts. This is done
by means of adjusting entries through the journal proper.
 Examples of transfer entries and adjusting entries.

Date Particulars Debit Credit

21st
Capital A/c Dr 50,000
March

To DrawingsA/c 50,000
 Example of an adjusting entry is rent outstanding.

Date Particulars Debit Credit

31st
Rent A/c Dr 8500
March

To Rent Outstanding A/c 8500

 Trial Balance
When using the Double Entry System of Accounting at the end of the year, the firm prepares a bookkeeping worksheet of
all the debit and credit balances of all the ledgers. This is a trial balance statement, a summary of the closing balances of all
accounts. Let us learn more about its features, preparation, and significance.

Objectives of Trial Balance

i. It ensures that the posting from the ledgers is done correctly. If there are any arithmetic errors in
the accounting then this will get reflected in the trial balance. And we can determine this when the total of the
debit column and the credit column do not match.
ii. Similarly, it will also detect clerical errors, like a fault in posting, mixing up of figures, etc.
iii. Trial balance will also help in the preparation of the final accounts. The balances for the financial statements are
taken from the trial balance.
iv. And the trial balance will also serve as a useful summary of all accounting records. It is a summary of all the ledger
accounts of a firm. We will only refer to the individual ledger accounts if any details are needed. Otherwise, we
rely on the trial balance.
 Limitations of Trial Balance

• A transaction that is completely missing, was not even journalized

• When the wrong amount was written in both the accounts
• If a posting was done in the wrong account but in the right amount
• An entry that was never posted in the ledger altogether
• Double posting of entry by mistake
Definition of Cash Accounting
The basis of accounting in which the recognition of revenues and expenses are done only when there is actual receipt or
disbursement of cash takes place. In this method, in which the income or expense is recognised when the inflow or
outflow of cash exists in reality.
• It does not coincide with matching concept.
• Time lags in the occurrence of a transaction and its recognition.
• Lacks in accuracy.
Definition of Accrual Accounting
Accrual Accounting is the base of present accounting. It is also known as the mercantile system of accounting wherein the
transactions are recognised as and when they take place. Under this method, the revenue is recorded when it is earned,
and the expenses are reported when they are incurred.
• Unearned Income
• Accrued Income
• Prepaid Expenses
• Outstanding Expenses
 BASIS FOR COMPARISON CASH ACCOUNTING ACCRUAL ACCOUNTING

Meaning The accounting method in which the income or The accounting method in which the income
expense is recognized only when there is actual or expense is recognized on mercantile basis.
inflow or outflow of cash.

Nature Simple Complex

Method Not recognized method as per companies act. Recognized method as per companies act.

Income statement Income statement shows lower income. Income statement will show a comparatively
higher income.

Applicability of matching concept No Yes

Recognition of revenue Cash is received Revenue is earned

Recognition of expense Cash is paid Expense is incurred

Degree of Accuracy Low Comparatively high

Example:-

Mr X is a Lawyer. Particulars of the Income And Expenses for the year ended 31/12/2016

1.Fees Received from clients in cash Rs.64800/-

2.Salary of Clerks And Assistant Paid Rs.24000/-

3.Rent of Chamber Paid (Gross) Rs.27000/-

4.Salary And Clerks And Assistants Outstanding Rs.2160/-

5.Accured Fees Rs.14400/-

6.Rent of Chamber Paid in Advance Rs.1800/- ( Including Above)

7.Misc Expenses Rs.5040/-

8.Telephone Charges Rs.2880/-

 Particulars Amount ( Rs) Amount ( Rs)
Fees Received in Cash 64800
Add:- Accured Fees 14400 79200

Less:-
Expences 24000
Add:- Outstanding 2160 -26160

Rent of Chamber Fees 27000

Less:- Paid In Advance 1800 -25200

Misc Expences 5040

Telephone Charges 2880 -7920

Net Income Under Accrual Basis 19920

 Particulars Amount ( Rs) Amount ( Rs)
Net Income Under Accural Basis 19920
Add:- Outstanding Salary 2160
22080

Less:-Rent Paid In Advance 1800

Accrued Fees Not Yet Received 14400 -16200

Net Income Under Cash Basis 5880