Unit – 4

Financial Accounting -
II
Ledger
• A Ledger is a book which contains various accounts. In other words, a Ledger is a set of accounts.
• It contains all accounts of the business enterprise whether Real, Nominal or Personal.
• The term “Posting” means transferring the debit and credit items from the Journal to their
respective accounts in the Ledger.
• It should be noted that the exact names of accounts used in the Journal should be carried to
the Ledger
• The Ledger Folio (L.F.) column in the Journal is used at the time when debits and credits are
posted to the Ledger.
• The page number of the Ledger on which the posting has been done is mentioned in the L.F.
column of the Journal.
• Similarly, a folio column in the Ledger can also be kept where the page from which the posting
has been done from the Journal may be mentioned.
• Thus, there are cross references in both the Journal and the Ledger.
Relationship between Journal and
Ledger
• Both the Journal and the Ledger are the most important books used
under the Double Entry System of book-keeping. Their relationship
can be expressed as follows:
i. The transactions are recorded first of all in the Journal and then they are
posted to the Ledger. Thus, the Journal is the book of first or original entry,
while the Ledger is the book of second entry.
ii. The Journal records transactions in a chronological order, while the Ledger
records transactions in an analytical order.
iii. The Journal is more reliable than the Ledger since it is the book in which
the entry is passed first of all.
iv. The process of recording transactions is termed as “Journalising” while
the process of recording transactions in the Ledger is called as “Posting”.
Rules regarding Posting
• The following rules should be observed while posting transactions in the Ledger
from the Journal:
• Separate accounts should be opened in the Ledger for posting transactions relating to
different accounts recorded in the Journal. For example, separate accounts may be opened
for sales, purchases, sales returns, purchases returns, salaries, rent, cash, etc.
• The concerned account which has been debited in the Journal should also be debited
in the Ledger. However, a reference should be made of the other account which has been
credited in the Journal. For example, for salaries paid, the salaries account should be
debited in the Ledger, but reference should be given of the Cash Account which has been
credited in the Journal.
• The concerned account, which has been credited in the Journal should also be credited in
the Ledger, but reference should be given of the account, which has been debited in the
Journal. For example, for salaries paid, Cash Account has been credited in the Journal. It
will be credited in the Ledger also, but reference will be given of the Salaries Account in
the Ledger.
Rules regarding Posting
• Suppose salaries of Rs 10,000 have been paid in cash, the following
entry will be passed in the Journal:

• In the Ledger two accounts will be opened (i) Salaries Account, and
(ii) Cash Account.
• Since Salaries Accounts has been debited in the Journal, it will also
be debited in the Ledger.
• Similarly, since the Cash Account has been credited in the Journal it
will also be credited in the Ledger, but reference will be given of the
other account involved.
Rules regarding Posting
• Thus the accounts will appear as follows in the Ledger:
Use of the words “To” and “By”
• It is customary to use words “To” and “By” while making posting in
the Ledger.
• The word “To” is used with the accounts which appear on the debit
side of a Ledger Account.
• For example, in the Salaries Account, instead of writing only “Cash” as shown
above, the words “To Cash” will appear on the debit side of the account.
• Similarly, the word “By” is used with accounts which appear on the
credit side of a Ledger Account.
• For example, in the above case, the words “By Salaries A/c” will appear on
the credit side of the Cash Account instead of only “Salaries A/c”.
Balancing of an Account
• In business, there may be several transactions relating to one particular account.
• In a Journal, these transactions appear on different pages in a chronological order while they
appear in a classified form under that particular account in the Ledger.
• At the end of a period (say a month, a quarter or a year), the businessman will be
interested in knowing the position of a particular account.
• This means, he should total the debits and credits of the account separately and find
out the net balance.
• This technique of finding out the net balance of an account, after considering the totals of
both debits and credits appearing in the account is known as ‘Balancing the Account’.
• The balance is put on the side of the account which is smaller and a reference is given
that it has been carried forward or carried down (c/f or c/d) to the next period.
• On the other hand, in the next period a reference is given that the opening has been
brought forward or brought down (b/f or b/d) from the previous period.
Trial Balance
• In case the various debit balances and the credit balances of the
different accounts are taken down in a statement, the statement so
prepared is termed as a Trial Balance.
• In other words, Trial Balance is a statement containing the various
ledger balances on a particular date.
• If the two sides of the Trial Balance tally, It means the books of
accounts is arithmetically accurate.
Objectives of Preparing Trial Balance
1. Checking of the arithmetical accuracy of the accounting entries
2. Basis for financial statements
• Trial Balance forms the basis for preparing financial statements such as the Income
Statement and the Balance Sheet.
• The Trial Balance represents all transactions relating to different accounts in a
summarized form for a particular period.
3. Summarized ledger
• It has already been stated that a Trial Balance contains the ledger balances on a
particular date.
• Thus, the entire ledger is summarized in the form of a Trial Balance.
• The position of a particular account can be judged simply by looking at the Trial
Balance.
• The Ledger may be seen only when details regarding the accounts are required.
Financial Statements
• Accuracy of the books of accounts is determined by means of preparing a Trial
Balance
• After preparing trial balance, a businessman wants to know about two facts (i) has he
earned profit or loss? And (ii) what is his financial position?
• The determination of the profit or loss is done by preparing a Trading and Profit and
Loss Account (or an Income Statement)
• Financial position is judge by means of preparing a Balance Sheet of the business.
• Balance sheet is a summary of a particular date about assets and liabilities
• The two statements together, i.e. Income Statement and Balance Sheet, are termed
as Final Accounts.
• Final Accounts means accounts which are prepared at the final stage to give the
financial position of the business.
Income Statements
• Trading Account:
• Meant only for goods
• Cost Of Goods Sold [COGS]
• Sales – COGS = Profit [Gross]
• Opening Stock [The goods that we already have to sell]
• To Purchase [Something more purchased by us]
• Return [Something returned from purchase]
• Direct Expenses [Expenses made to make or transport the goods; expenses from
purchase or production to godown]
• Indirect Expenses [From Godown to Customer]
• Indirect Income [Not coming from goods, but others like rented space of company,
commission or discount received on sales, etc.]
• COGS = (Opening Stock + Purchases + Direct Expenses) – Closing Stock
Structure of Trading Account
Trading Account
• Closing stock
• We assume that all goods purchased have been sold away by the trader.
However, it does not normally happen.
• At the end of the accounting year, a trader my be left with unsold goods
• Such stock of goods with a trader unsold at the end of the accounting period
is termed as Closing Stock
• Such stock will become the opening stock for the next period
Trading Account
• Stock. The term ‘Stock’ includes goods lying unsold on a particular date.
The Stock may be of two types:
i. Opening Stock
ii. Closing Stock
• The term ‘Opening Stock’ means goods lying unsold with the
businessman at the beginning of the accounting year. This is shown on
the debit side of the Trading Account.
• The term ‘Closing Stock’ includes goods lying unsold with the
businessman at the end of the accounting year. It should be noted that
stock at the end of the accounting year is taken after the books of
accounts have been closed.
Trading Account
• Purchases. The term “Purchases” includes both cash and credit
purchases of goods.
• The term “goods” means items purchased for resale.
• Assets purchased for permanent use in the business such as purchase
of plant, furniture, etc., are not included in the purchase of goods.
• Similarly, purchase of articles such as stationery meant for using in the
business will also not be included in the item of purchases.
• In case certain goods are given by way of free samples, etc., the value
of such goods should be charged to the advertisement account and
deducted from purchases.
Trading Account
• Sales. The term ‘Sales’ includes both cash and credit sales.
• Wages. The amount of wages is taken as a direct expense and, therefore, is debited to the
Trading Account
• Customs and import duty. In case the goods have been imported from outside the country,
customs and import duty may have to be paid. The amount of such duty should be charged to
the Trading Account
• Freight, carriage and cartage. Freight, Carriage and Cartage are taken as direct expenses
incurred on purchasing of the goods. They are therefore, taken to the debit side of the Trading
Account.
• Freight, carriage and cartage. Freight, Carriage and Cartage are taken as direct expenses
incurred on purchasing of the goods. They are therefore, taken to the debit side of the Trading
Account
• Gas, electricity, water, fuel, etc. All these expenses are direct expenses and, therefore, they are
charged to the Trading Account.
Closing Entries
• Closing Entries are entries passed at the end of the accounting year to
close different accounts.
• These entries are passed to close the accounts relating to incomes,
expenses, gains and losses.
• In other words, these entries are passed to close the different
accounts which pertain to Trading and Profit and Loss Account.
• The accounts relating to assets and liabilities are not closed but they
are carried forward to the next year.
• Hence, no closing entries are to be passed regarding those accounts
which relate to the Balance Sheet.
Profit and Loss Account
• The Trading Account simply tells about the gross profit or loss made
by a businessman on purchasing and selling of goods.
• It does not take into account the other operating expenses incurred
by him during the course of running the business.
• For example, he has to maintain an office for getting orders and
executing them, taking policy decisions and implementing them.
• All such expenses are charged to the Profit and Loss Account.
• Profit and Loss Account considers all such expenses and incomes and
gives the net profit made or loss suffered by a business during a
particular period.
Structure of Profit and Loss Account
Important Points Regarding Profit and Loss
Account
• Gross Profit or Gross Loss. The figure of gross profit or gross loss is
brought down from the Trading Account. Of course, there will be only
one figure, i.e., either of gross profit or gross loss.
• Salaries. Salaries payable to the employees for the services rendered
by them in running the business
• Interest. Interest on loans whether short-term or long-term is an
expense of an indirect nature and, therefore, is charged to the Profit
and Loss Account
• Commission. Commission may be both an item of income as well as
an item of expense.
Important Points Regarding Profit and Loss
Account
• Printing and stationery. This item of expense includes expenses on printing
of bills, invoices, registers, files, letter heads, ink, pencil, paper and other
items of stationery, etc.
• Advertisements. Advertisement expenses are incurred for attracting the
customers to the shop and, therefore, they are taken as selling expenses.
They are debited to the Profit and Loss Account.
• Bad debts. Bad Debts denotes, the amount lost from debtors to whom the
goods were sold on credit. It is a loss and therefore, should be debited to
the Profit and Loss Account.
• Depreciation. Depreciation denotes decrease in the value of an asset due
to wear and tear, lapse of time, obsolescence, exhaustion and accident.
Importance of Profit and Loss
Account
1. It provides information about the net profit or net loss earned or
suffered by the business during a particular period
2. The Profit figure disclosed by the Profit and Loss Account for a
particular period can be compared with that of the other period.
• Thus, it helps in ascertaining whether the business is being run efficiently or
not
3. The projections based on this account will help the business in
planning the future course of action.
Balance Sheet
• Having prepared the Trading & Profit and Loss Account, a
businessman will like to know the financial position of his business.
• For this purpose, he prepares a statement of his assets and liabilities
as on a particular date.
• Such a statement is termed as ‘‘Balance Sheet’’.
• Thus, Balance Sheet is not an account but only a statement containing
the assets and liabilities of a business on a particular date.
• Balance Sheet has two sides. On the left hand side, the ‘‘liabilities’’ of
the business are shown while on the right hand side the “assets” of
the business appear.
Structure of Balance Sheet
Liabilities
• Liabilities. The term ‘‘Liabilities’’ denotes claims against the assets of a firm whether
those of owners of the business or of the creditors. There are two types of liabilities:
1. Current liabilities: The term “Current Liabilities” is used for such liabilities which are
payable within a year from the date of the Balance Sheet.
i. Accounts Payable, i.e., bills payable and trade creditors.
ii. Outstanding Expenses, i.e., expenses for which services have been received by the business but
for which payments have not been made.
iii. Bank Overdraft.
iv. Short-term Loans, i.e., loans from Bank which are payable within one year from the date of the
Balance Sheet.
v. Advance payments received by the business for the services to be rendered or goods to be
supplied in future.
2. Fixed liabilities: liabilities which do not become due for payment in one year and
which do not require current assets for their payment
Assets
• Assets. The term ‘‘Assets’’ denotes the resources acquired by the
business from the funds made available either by the owners of the
business or others.
• It includes all rights or properties which a business owns.
• Cash, investments, bills receivable, debtors, stock of raw materials,
work-in-progress and finished goods, land, buildings, machinery, trade
marks, patent rights, etc., are some examples of assets
Difference Between Trial Balance and
Balance Sheet
1. Meaning: A trial balance is a statement containing various ledger balances on a
particular date while a balance sheet is a statement of various assets and liabilities of
the business on a particular date.
2. Objective: The objective of preparation of a trial balance is to check the arithmetical
accuracy of the books of account of the business. While the objective of preparation
of a balance sheet is to ascertain the financial position of the business.
3. Item covered: A trial balance contains all items relating to incomes, expenses, assets
and liabilities while a balance sheet incorporates only assets and liabilities.
4. Preparation: A trial balance is prepared before preparation of a balance sheet. While
a balance sheet is prepared not only on the basis of trial balance but also of any
additional information which may not have been incorporated in the trial balance.
5. Use: A trial balance is meant only for internal use. While a balance is prepared both
for internal as well as external use.
References
• Dr. S.N. Maheshwari: Financial Accounting, Sultan Chand Publication
• Ledger Posting & Trial Balance: https
://www.youtube.com/watch?v=z_KO49Pk3DM
• Trading A/c & Profit & Loss A/c: https://
www.youtube.com/watch?v=Y4azRCTTWoU