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FINANCIAL ACCOUNTING

INDEX

Chapter No. Chapter Name

Chapter 1 Meaning & Scope of Accounting

Chapter 2 Accounting Principles, Conventions And

Concepts

Chapter 3 Accounting Standards

Chapter 4 Systems of Book-Keeping & Accounting

Chapter 5 Depreciation & Its Methods

Chapter 6 Final Accounts & Adjustments

CHAPTER-1 MEANING & SCOPE OF ACCOUNTING

At the end of the chapter you will be conversant with:

1.1 Meaning of Accounting

1.2 The Accounting Process/Accounting Cycle

1.3 Accountancy, Accounting & Book-keeping

1.4 Branches of Accounting

1.5 Objectives of Accountancy

1.6 Users of Financial Statement

1.7 Advantages of Accounting

1.1 MEANING OF ACCOUNTING


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All of us do some accounting, often without realizing it. It is a part of our life. Let us say

you realize suddenly, one morning, that you needed to buy a book urgently. You ask one of

your parents for the money. But the parent says, What happened to the money I gave last

week? You either recollect how you spent it or if you believe in being systematic and have

noted it in your diary you explain how the money was spent. You are accounting for the

money given to you. When a housewife tries to note down her household expenses, strikethe balance she has on hand at the end of the month, or determines how much she needs for

the expenses which would arise, she is accounting for the money she withdrew or was

given to run the household.

In business, however, it is a more serious matter. The student may not be questioned by his

parents or the housewife may just meet her expenses as and when they come without

bothering to find out how much she spent, but in business it is a must. You cannot run a

business unless you know how much you owe outsiders and how much outsiders owe you.

And when you invest money in a business, wouldnt you like to know whether youve

recovered it, increased it or lost it?

All this requires systematic record keeping of all that happens on a day-to-day basis in

business and analyzing this information to aid business decision making.

In simple words, accounting merely means, reckoning or recounting. In an

organizational context too, accounting has more or less the same meaning. As an

organization comes into being and commences operations, one would like to evaluate the

organizations past performance for various reasons. However, in order to be able to do so, it

is necessary that as far as possible whatever has transpired in the organization be reckoned

or recounted in a summarized form in monetary terms. Thus, the process of accounting

involves recording, classifying and summarizing of past events and transactions of financial

nature, with a view to enabling the user of accounts to interpret the resulting summary.

The American Institute of Certified Public Accountants defines accounting as the art of

recording, classifying and summarizing in a significant manner and in terms of money

transactions and events which are, in part at least, of a financial character, and interpreting

the results thereof.

This definition brings out the following as attributes of accounting:

1. Events and transactions of a financial nature are recorded while the events

of a non-financial nature cannot be recorded.

2. The record should reflect the importance of the transactions so recorded both

individually and collectively, which includes summarization, thereby making it amenable to

analysis.

3. The users of the financial statements should be able to obtain the message

encompassed in such financial statements.

1.2 The Accounting Process/Accounting Cycle:

It is a complete sequence beginning with the recording of the transactions & ending with the

preparation of final accounts. The steps involved in accounting cycle are as follows:


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Step 1: - Identification of Transactions & Events:- Accounting identifies transactions &

events of a specific entity. A transaction is an exchange in which each participant receives or

sacrifices value (e.g. purchase of raw material). An event is a happening of consequences to

an entity (e.g. use of raw material for production). An entity means an economic unit that

performs economic activities.

Step 2: Preparation of Business Documents:- After identifying, we measure those

transactions & events in monetary terms & to record them we prepare business documents.

Step 3:- Journalizing:- It is concerned with the recording of identified & measured financial

transactions in an orderly manner, and this process is called as Journalizing.

Step 4:- Posting:- It is concerned with classification of the recorded transactions so as to

group the transactions of similar type at one place. This function is performed by maintaining

the ledger in which different accounts are opened to which related transactions are brought to

one place by posting

Step 5: - Preparation of Trial Balance:- It is concerned with the balancing &

summarization of the classified transactions in a manner useful to users. It can further be

classified into preparation of unadjusted trial balance & passing the adjustment entries. After

balancing all the accounts, we do some adjustments to match our expenses & revenues &

then prepare adjusted accounts.

Step 6:- Preparation of Income Statement & Position Statement:- After preparing Trial

Balance we prepare Income Statement i.e. Trading & Profit & Loss Account & position

statement i.e. Balance Sheet.

We can present the same graphically as follows:


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1.3 ACCOUNTANCY, ACCOUNTNG & BOOK-KEEPING: -

Book-keeping is a part of Accounting. Accounting is a part of Accountancy. Accountancy:

refers to a systematic knowledge of accounting.

Accounting: Refers to the actual process of preparing & presenting the accounts.


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Book-keeping: is the part of accounting & is concerned with record keeping or maintaining

of books of accounting which is often routine & clerical in nature.

Diagrammatically the relationship can be viewed as follows:

Relationship B/w These Three:

We must also understand the difference & relationship between the terms accounting &

book-keeping. Accounting is broader in scope than bookkeeping, which is merely

concerned with orderly record keeping. Going beyond the narrow confines of bookkeeping,accounting involves analysis and judgment at different stages such as recording of

transactions, classification, summarization and interpretation.

Distinction B/w Accounting & Book-keeping in Tabular form can be presented as

follows:

Basis of Distinction Book-keeping Accounting

1 Scope It involves identification,

measurement, recording &

classification of

transaction

In addition it involves

summarizing classified

transactions. Analyzing,

interpreting & communicatingthe same.

2 Stage Its a primary stage Its a secondary stage, starts

where book-keeping ends

3 Basic Objective To maintain systematic

records

To ascertain net results of

operations & financial position of

the co

4 Who Performs Performed by junior staff By senior staff

5 Knowledge level Not required a high level

of knowledge

It needs a high level of

knowledge

6 Analytical Skill Not required Required

7 Nature of Job Routine & clerical Analytical

8 Supervision &

Checking

Supervised by an

accountant

Whereas its work is not

supervised by a book-keeper

AccountancyAccounting

Book-Keeping


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1.4 BRANCHES OF ACCOUNTING:

Classification of Accounting

Financial Accounting:- Accounting involves recording, classifying and summarizing

of past events and thus is historical in nature. It is Historical accounting which is

better known as Financial accounting whose primary intention is to prepare the

Statements revealing the Income and financial position of the business on the basis of

events which have happened in the period being reckoned.

Cost Accounting:- It shows classification and analysis of costs on the basis offunctions, processes, products, centers etc. It also deals with cost computation, cost

saving, cost reduction, etc.

Management Accounting:- It deals with the processing of data generated in financial

accounting and cost accounting for managerial decision-making. It also deals with

application of managerial economic concepts for decision-making.

1.5 OBJECTIVES OF ACCOUNTANCY:

1. It is a means of recording the monetary transactions and events.

2. It required to ascertain the earnings of the company, which is achieved by

preparation of Profit and Loss account.

3. It is required to identify the obligations (liabilities) and resources (asset) of the

organization.

4. Accounting records are required to be maintained statutorily by certain

government and regulatory bodies.

5. Accounting records are also required by the management for taking the financial

decisions.

6. Generally, investors and certain lenders also require the preparation of financial

statements.

1.6 USERS OF FINANCIAL STATEMENT

Management

Shareholders, Security Analyst & Investors

Lenders (Long-term)

Suppliers/Creditors (short-term)

Customers

Employees

Government & Regulatory Agencies Researchers


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1.7 ADVANTAGES OF ACCOUNTING

Facilitate To Replace Memory

Facilitate to comply with legal requirement

Facilitate to ascertain net result of operations

Facilitate to ascertain financial position

Facilitate the users to take decision

Facilitate a comparative study

Facilitate control over assets

Facilitate the settlement of tax liability

Facilitate the ascertainment of value of business

Facilitate Raising Loan

Acts as legal evidence

Test Questions:

Q1 The prime function of accounting is to:

(a) record economic data

(b) provide the information basis for action

(c) classifying & recording business transactions

(d) attain non-economic goals.

Q2 The basic function of financial accounting is to:

(a) record all business transactions

(b) interpret financial data

(c) assist the management in performing functions effectively

(d) All of the above

Q3 Management Accounting provides invaluable services to the management in performing:

(a) All management functions

(b) Co-ordinating management functions

(c) Controlling functions

(d) None of the above


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Q4 Book-keeping is mainly concerned with

(a) recording of financial data relating to business operations

(b) designing the systems in recording, classifying, summarizing the recorded data.

(c) Interpreting the data for internal & external end users.

(d) All of the above.

Q5 Who among the following is not considered as an external user of Financial Statements?

(a)Government Agencies

(b) Creditors

(c)Customers

(d)Board of Directors.

Q6 Which of the following events is/are not recorded in the books of a business?

(a) Significant Monetary events after the balance sheet dates.

(b) Death of a chief executive of the business

(c) Government Investigation into the pricing of the business

(d) Both (b) & (c) aboveQ7 Which of the following is/are the objectives of Accounting:

(a) To keep systematic records

(b) To ascertain the Financial Position of the company

(c) To compare the balance sheets of two dates.

(d) Both (a) & (b) Above

Q8 Which of the following is/are branches of accounting:

(a) Cost Accounting

(b) Management accounting

(c) Social Responsibility Accounting

(d) All of Above

Q9 Which of the following is/are the internal users of accounting information:

(a) Creditors

(b) Employees

(c) Investors

(d) Both (a) & (b) Above

Q10 Which of the following is not a function of accounting:

(a) Recording

(b) Classifying

(c) Summarizing

(d) Controlling


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CHAPTER 2 ACCOUNTING PRINCIPLES, CONVENTIONS

AND CONCEPTS

At the end of second chapter you will get to know:

2.1 Meaning of GAAP

2.2 Acceptance Criteria

2.3Accounting Concepts2.4 Accounting Conventions

2.1 GENERALLY ACCEPTED ACCOUNTING PRINCIPLES:

The double entry system of accounting is based on a set of principles which are called

Generally Accepted Accounting Principles (GAAP). GAAP may be defined as those rules of

action or conduct which are derived from experience and practice and when they prove

useful, they become accepted as principles of accounting.

These principles enable to a certain extent standardization in recording and reporting of

information so that the users, once they are aware of the principles, can read and understand

the financial statements prepared by diverse organizations.

2.2 Acceptance of accounting principles depends on following three criteria:

Relevance:- A principle is relevant to the extent it results in information that is

meaningful & useful to the users of accounting information.

Objectivity:- it connotes reliability & trustworthiness.

Feasibility:- A principle is feasible to the extent it can be implemented without much

complexity & cost.

Principles can be classified into two categories:

(i) Accounting concepts

(ii) Accounting conventions

2.3 ACCOUNTING CONCEPTS:


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The term concepts includes those basic assumptions or conditions upon which the science of

accounting is based. The following are the important accounting concepts:

(1) Money Measurement Concept:

In financial accountancy, a record is made only of information that can be

expressed in monetary terms. Recording, classification and summarization of

business transactions requires a common unit of measurement which is taken asmoney. If events cannot be quantified in monetary terms then they do not facilitate

accounting. Money is the standard of exchange and the changes in purchasing

power caused by inflation are ignored for the purpose of accounting because the

assumption about the stability of money, notwithstanding its limitations, is a

necessity for ensuring a smooth accounting process. Hence, all transactions are

recorded through a common denominator, namely the monetary unit.

(2) Cost Concept:-

Cost concept implies that in accounting, all transactions are generally recorded at

cost, and not at market value. For example, if a piece of land is acquired for Rs.1

lakh, it would continue to be shown in the balance sheet at Rs.1 lakh, even when

the market value of the land rises to say Rs.2 lakhs. Why should this be so? This isbecause, cost concept is in fact closely related to the going concern concept. If the

land is acquired for the operations of the business and would continue to be used

for its operations and would not be sold shortly, then it is largely immaterial what

the lands market value is, since it is not going to be sold anyway. Thus, it is

consistent with going concern concept to keep recording the land at cost, i.e. Rs.1

lakh on an ongoing basis.

(3) Business Entity/Separate Entity Concept:

The legal entity of a corporate business, as distinct from the entity of its owners is

well understood today. Less understood, however, is the accounting entity of a

business as distinct from its owners. For example, for many purposes, the legal

entity of a sole proprietary business may not be very distinct from the entity of the

proprietor himself. However, the business entity concept requires that this should

not come in the way of treating the business as a distinct accounting entity for the

purposes of treating transactions relating to the operations of the business. It is in

accordance with this concept that when an owner brings capital into the business,

the business in turn is deemed to owe the capital to the owner.

(4) Going Concern Concept:

A business entity is assumed to carry on its operations forever. Seemingly

inconsequential, this is a fundamental concept which has far reaching

consequences. This is because it is difficult to envisage any economic activity on

the part of a business entity if its liquidation were shortly expected. Going concernconcept implies that the resources of the concern would continue to be used for

the purposes for which they are meant to be used. For instance, in a manufacturing

concern, the land, buildings, machinery etc., are primarily required for carrying

out the production and selling of certain products. Going concern concept implies

that these land, buildings, machinery etc., would continue to be used for this

purpose

(5) Duality or Accounting Equivalence Concept:

It can easily be seen that in business, as elsewhere, funds can be raised in any of

the following ways:

Additional capital (increases owners equity)


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Additional loans (increases outside liability)

Earning revenue (increases owners equity)

Making profits (increases owners equity)

Disposing or reducing some of the assets (reduces assets).Thus, all increases in liabilities (including owners equity) and reduction in

assets represent sources of funds.

Similarly, the funds thus raised, may be put to any of the following uses:

Purchasing of assets (increases assets)

Incurring operational expenses (decreases owners equity)

Discharging earlier liabilities (decreases liability)

Keeping idle funds so that cash balance increases (increases assets)

Suffering losses (decreases owners equity).

Thus all increases in assets and decreases in liabilities (including owners equity) are

uses of funds.

A little reflection must reveal that in a business, the sum of the Sources of Funds

must equal the sum ofUses of Funds. This is because, whatever funds are raised bythe business, either through capital or operations or from outsiders, must be tied up

in one or the other form of uses.

Thus the duality or accounting equivalence concept implies that:

Owners Equity + Outside Liability = Assets

This equation is known as the Fundamental Accounting Equation.

(6) Accounting Period Concept:To be able to prepare the income statement for a business, the period for which it is to

be prepared must first be specified. Very often the accounting period chosen is a

calendar year (January 1 December 31) or a fiscal year (April 1 March 31).

(7) Realization Concept: With this concept, accounts recognise transactions (and

any profits arising from them) at the point of sale or transfer of legal ownership -

rather than just when cash actually changes hands. For example, a company that

makes a sale to a customer can recognise that sale when the transaction is legal - at

the point of contract. The actual payment due from the customer may not arise until

several weeks (or months) later - if the customer has been granted some credit terms.

(8) Matching Concept:

In order to determine the profits or losses accrued in an accounting period, the

expenses must relate to the goods or services sold during the period. For instance,

assume a situation where nine products are manufactured in an accounting period,

seven products are dispatched and money is received on only five. Let the selling

price and cost per product be Rs.10 and Rs.6 respectively. Then, depending on

whether the sale is recognized at production or dispatch or collection, the revenue

would be Rs.90 or Rs.70 or Rs.50 respectively. And the cost of goods sold under the

three situations will be Rs.54, Rs.42 and Rs.30 respectively. Thus it is clear that the

cost derives its relevance only from the sale and not vice-versa. It is for this

reason that revenue recognition always precedes the matching of cost. If revenue orsale is not defined, the cost cannot be defined either.


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2.4 ACCOUNTING CONVENTIONS:

Conventions are based on what is practicable, these are the methods or procedures employed

generally by accounting practitioners. For example, dividing a centimeter into ten equal parts

is a convention rather than a concept. They are based on custom and are subject to change as

new developments arise.Some of the accounting conventions are as follows:

(1) Materiality:

An important convention. As we can see from the application of accounting standards and

accounting policies, the preparation of accounts involves a high degree of judgment.

According to this , the accountant should attach importance to material details & ignore

insignificant details.

(2) Prudence/Conservatism:

Profits are not recognized until a sale has been completed. In addition, a cautious view is

taken for future problems and costs of the business. For example, a sales manager might

have finalized a deal with his client for, say, sale of 100 units of their product. But unless

these items are produced and delivered to the client there is no reasonable certainty about

receiving the payment for these 100 units. It is only thereafter that he can record the sales

amount on those 100 units as due from the client. But, on the other hand, if he comes to

know that a customer has lost all his assets and is likely to default payment, then he should

immediately provide for such loss.

(3) Consistency:

There are in practice several ways of treating an event that may be recorded in the accounts.

The consistency concept requires that once an entity has decided on one method, it will treat

all subsequent events of the same character in the same fashion unless it has a sound reason

to change the method of treatment of that event. For example, if a concern is valuing its

inventory by a particular method in one year it is expected to value its inventory in the

subsequent years also in the same method unless there is a strong reason to change the

same. Similarly, if it is charging depreciation by one method it is expected to follow the

same method in the subsequent years also.

(4) Full disclosure:

According to this convention accounting report should disclose fully & fairly the

information they purport to represent. They should be honestly prepared & sufficiently

disclose information which is of material interest to proprietors, to present & potential

creditors & to investors.


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Test Questions:

Q1 Accounting principles are generally based on:

(a) Practicability

(b) Subjectivity

(c) Convenience in recording

(d) All of above

Q2 The basic concepts related to balance sheet are

(a)Cost Concept

(b) Business Entity

Accounting period concept

(d)Both (a) & (b) Above

Q3 The basic concepts related to P&L Account are

(a)Realization Concept

(b) Matching Concept

Cost Concept

(e) Both (a) & (b) above

Q4 As per the double entry concept

(a) Assets + Liability = Capital

(b) Capital= Assets -Liability

(c) Capital Liability = Assets

(d) Capital +Assets =LiabilitiesQ5 Only the significant events which affect the business must be recorded as per the

principle of:

(a) Separate Entity

(b) Accrual Concept

(c) Materiality Concept

(d) None of above

Q6 P&L account is prepared for a period of one year by following:

(a) Consistency Principle

(b) Conservatism Principle

(c) Time period concept

(d) Cost Concept

Q7 Under which of the following concepts are shareholders treated as creditors for the

amount they paid on the shares they subscribed to?

(a) Cost Concept

(b) Duality Concept

(c) Separate Entity Concept

(d) Cost Concept


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Q8 The underlying accounting principle(s) necessitating amortization of intangible asset(s)

is/are:

(a) Cost Concept


(c) Realization Concept(d) Both (b) & (c) above

Q9 Which of the following practices is not in consonance with the convention of

conservatism?:

(a) Creating Provision for bad debts

(b) Creating provision for discount on debtors

(c) Creating provisions for discount on creditors

(d) Creating provision for tax

Q10 Recording of fixed assets at cost ensures adherence of:

(a) Cost Concept


(c) Realization Concept

(d) Both (b) & (c) above

CHAPTER 3 ACCOUNTING STANDARDS

At the end of this chapter you will be conversant with:

3.1 Meaning of Accounting Standards

3.2 International Accounting Standards


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3.3 List of accounting standards issued by IASC

3.4 Auditors duties in relation to accounting standards

3.5 Accounting Standards Issued By ASB of the Institute of Chartered Accountants of

India

3.1 MEANING OF ACCOUNTING STANDARDS

An accounting standard is a selected set of accounting policies or broad guidelines

regarding the principles & methods to be chosen out of several alternatives. Accounting

Bodies all over the world have tried to achieve some uniformity in the accounting policies

by prescribing certain accounting standards in order to narrow the range of alternatives

available to an organization in respect of collection and presentation of accounting

information.

The main objective of accounting standards is to harmonize the diverse accounting policies

and practices & ensure comparability of accounts because of uniformity in their

presentation.

3.2 INTERNATIONAL ACCOUNTING STANDARDS

Accounting Bodies throughout the world are striving to achieve a reasonable degree of

uniformity in the accounting policies by prescribing certain accounting standards with

respect to collection and presentation of accounting information. To formulate the

accounting standards, they have established a committee called the International

Accounting Standards Committee (IASC) in 1973. Accounting bodies of most of thecountries, including the Institute of Chartered Accountants of India, are members of this

body and these members have resolved to conform to the standards developed by IASC,

subject to variations needed due to local conditions or laws.

The objectives of the committee according to its constitution are:

a. formulating, publishing and promoting the use of the accounting standards

worldwide, and

b. to work for the improvement and harmonization of regulations, accounting standards

and procedures relating to financial statements

The International Accounting Standards have assumed great importance in recent times for

the following reasons:

a. Globalization of the economy has led to Indian companies expanding their

operations across the borders and this calls for uniformity in accounts of units located in

different countries.

b. Foreign investors would give more weightage to the accounts of those companies

which are based on International Accounting Standards.

If there is a conflict between the International Accounting Standards and the local standards

or the local laws and regulations, the local standards, laws and regulations will prevail.

3.3 The list of accounting standards issued by the IASC is given below:

IAS 1 Presentation of Financial Statements


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IAS 2 Inventories

IAS 7 Cash Flow Statements

IAS 8 Net Profit or Loss for the Period, Fundamental Errors and Changes in

Accounting Policies

IAS 10 Events after the Balance Sheet Date

IAS 11 Construction Contracts

IAS 12 Income Taxes

IAS 14 Segment Reporting

IAS 15 Information Reflecting the Effects of Changing Prices

IAS 16 Property, Plant and Equipment

IAS 17 Leases

IAS 18 Revenue

IAS 19 Employee BenefitsIAS 20 Accounting for Government Grants and Disclosure of Government

Assistance

IAS 21 The Effects of Changes in Foreign Exchange Rates

IAS 22 Business Combinations

IAS 23 Borrowing Costs

IAS 24 Related Party Disclosures

IAS 26 Accounting and Reporting by Retirement Benefit Plans

IAS 27 Consolidated Financial Statements

IAS 28 Investments in Associates

IAS 29 Financial Reporting in Hyperinflationary Economies

IAS 30 Disclosures in the Financial Statements of Banks and Similar

Financial Institutions

IAS 31 Financial Reporting of Interests in Joint Ventures

IAS 32 Financial Instruments: Disclosure and Presentation

IAS 33 Earnings per Share

IAS 34 Interim Financial Reporting

IAS 35 Discontinuing Operations

IAS 36 Impairment of Assets


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IAS 37 Provisions, Contingent Liabilities and Contingent Assets

IAS 38 Intangible Assets

IAS 39 Financial Instruments: Recognition and Measurement

IAS 40 Investment Property

IAS 41 Agriculture

3.4 AUDITORS DUTIES IN RELATION TO ACCOUNTING STANDARDS

In case the company does not conform to any of the mandatory accounting standards, the

auditor will have to qualify his report justifying his deviation. In case he fails to do so theICAI can take disciplinary action against him on the ground of professional misconduct.

3.5 ACCOUNTING STANDARDS ISSUED BY ASB OF THE INSTITUTE OF CHARTERED

ACCOUNTANTS OF INDIA

(AS 1) Disclosure of Accounting Policies

(AS 2) Valuation of Inventories

(AS 3) Cash Flow Statements

(AS 4) Contingencies and Events Occurring after the Balance Sheet Date

(AS 5) Net Profit or Loss for the Period, Prior Period and Extraordinary Items and

Changes in Accounting Policies

(AS 6) Depreciation Accounting

(AS 7) Construction Contracts (Revised Accounting Standard)

(AS 8) Accounting for Research and Development

(AS 9) Revenue Recognition

(AS 10) Accounting for Fixed Assets

(AS 11) (Revised 2003), The Effects of Changes in Foreign Exchange Rate

(AS 12) Accounting for Government Grants

(AS 13) Accounting for Investments

(AS 14) Accounting for Amalgamations

(AS 15) Accounting for Retirement Benefits in the Financial Statement of

Employers

(AS 16) Borrowing Costs

(AS 17) Segment Reporting


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(AS 18) Related Party Disclosures

(AS 19) Leases

(AS 20) Earnings Per Share

(AS 21) Consolidated Financial Statements (AS 22) Accounting for Taxes on Income

(AS 23) Accounting for Investments in Associates in Consolidated Financial

Statements

(AS 24) Discontinuing Operations

(AS 25) Interim Financial Reporting

(AS 26) Intangible Assets

(AS 27) Financial Reporting of Interests in Joint Ventures

(AS 28) Impairment of Assets

(AS 29) Provisions, Contingent Liabilities and Contingent Assets

Test Exercise:

Q 1 The Objective of Formulating Accounting Standards is to:(a) harmonize the diverse accounting policies and practices & ensure comparability of

accounts.

(b) To control the cost

to Increase the profitability of the Organization

(d) All of Above

Q2 When International Accounting Standards Committee (IASC) was formulated:

(a) 1970

(b) 1973

(c) 1980

(d) 1982

Q3 How many international accounting standards are there:

(a) 20

(b) 30

(c) 41

(d) 50

Q4 Which one is IAS 2:

(a) Inventories

(b) Events after the Balance Sheet Date

(c) Income Taxes(d) Segment Reporting


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Q5 Which one is IAS 8 :

(a) Segment Reporting

(b) Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting

Policies

(c) Events after the Balance Sheet Date(d) None of above

Q6 Which one IAS 20:

(a) Events after the Balance Sheet Date

(b) The Effects of Changes in Foreign Exchange Rates

(c) Accounting for Government Grants and Disclosure of Government Assistance

(d) None of above


(a) Segment Reporting

(b) Leases

(c) Revenue(d) Employee benefits


(a) Earnings per Share

(b) Financial Reporting in Hyperinflationary Economies

(c) Financial Instruments: Disclosure and Presentation

(d) Interim Financial Reporting

Q9 Which one is IAS 35:(a) Interim Financial Reporting

(b) Discontinuing Operations(c) Investments in Associates


Q10 Which on is IAS 39:

(a) Investments in Associates(b) Investment Property(c) Financial Instruments: Recognition and Measurement

(d) Agriculture


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CHAPTER 4 SYSTEMS OF BOOK-KEEPING &

ACCOUNTING

At the end of this chapter you will be conversant with:

4.1 Single Entry System

4.2 Double Entry System

4.3 Systems of Accounting

4.1 SINGLE ENTRY SYSTEM:-

An incomplete double entry can be termed as a single entry system. According to Kohler it

is a system of book-keeping in which as a rule only records of cash & personal accounts are

maintained, it is always incomplete double entry, varying with circumstances. This system

has been developed by some business houses where, for their convenience, only some

essential records are kept. Since all records are not kept, the system is not reliable & can be

used only by small business firms.

4.2 DOUBLE ENTRY SYSTEM:-

All the business transactions have two fold effect. Recording of both aspects of a

transaction is called Double Entry system of bookkeeping.

Accounting Equation:

In Chapter 2, it was stated that, under the duality concept that sources of funds must always

equal to uses of funds and from this equality was derived. The fundamental accounting

equation:

Total Liabilities = Total Assets

(or)

Owners Equity + Outside Liability = Assets

(or)

Assets = Capital + Liabilities

(or)

Resources = Sources of Finance

(or)

Assets = Internal Equity + External Equity

Where assets refer to resources which are owned by business enterprises, liabilities are

debts payable to parties external to business and capital means the amount payable to owner

of the business enterprise.

It was also evident from the earlier discussions that any of the following is a source of

funds, in business:

Incurring Liability (including owners equity)

Earning Revenue

Making Profits.


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It stands to reason that a decrease in liability, revenue or profit must be a use of funds being

the opposite of a source.

Similarly, any of the following is a use of funds:

Acquiring Assets

Incurring Expenses Incurring Losses.

A business is started with a capital of Rs.10,000 brought in cash. The above event gives rise

to a cash balance of Rs.10,000, which, being an increase in an asset (namely cash), is a use.

At the same time, the business now owes Rs.10,000 to the owner who invests the capital in

it, so that the owners equity in the business is Rs.10,000. This being a liability of the

business towards the owner, constitutes a source.

Steps Involved In Developing Accounting Equation:

An accounting equation may be developed by taking the steps given below:

Step 1Ascertain the variables of an equation affected by a transaction

Step 2- Find out the effect of a transaction on the variables of an equation

Step 3 Show the effect on the appropriate side of an equation and ensure that the total of

right hand side is equal to the total of left hand side

Illustration 1:- A started business with Rs 1,00,000. Analyze the transaction and give

Accounting Equation.

Step 1- Variables affected Asset & Capital

Step 2- Effect of transactions on affected variables Increase in asset & Capital

Step 3- Accounting equation Asset = Liability + Capital

1,00,000 = 0+ 1,00,000

Illustration 2:- Borrowed Rs 50,000 from ICICI Bank.

Step 1- Variables affected Asset & Liability

Step 2- Effect of transactions on affected variables Increase in asset & Liability


1,00,000 = 50,000+ 0

Illustration 3: - Purchased furniture worth Rs. 100000.

Step 1- Variables affected Assets

Step 2- Effect of transactions on affected variables Increase & Decrease in assets


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+1,00,000 1,00,000 = 0 + 0

Illustration 4: - Purchased goods for cash 20,000.


Step 2- Effect of transactions on affected variables Increase & Decrease in assets


+20,000-20,000 = 0 + 0

Illustration 5: - Purchased goods on credit for Rs 50000.

Step 1- Variables affected Asset and Liability

Step 2- Effect of transactions on affected variables Increase in asset & Liability


50,000 = 50,000 + 0

Illustration 6 :- Sold goods costing Rs 10,000 for Rs 12000.

Step 1- Variables affected Assets & Capital

Step 2- Effect of transactions on affected variables Increase in one asset & Decrease

in another asset & Increase in

Capital


+12,000-10,000 = 0 + 2000

Illustration 7: - Sold goods costing Rs 20,000 on credit for Rs 25,000.

Step 1- Variables affected Assets & Capital


in another asset & Increase in

Capital


+25,000-20,000 = 0 + 5000

Illustration 8:- Returned goods costing Rs 5,000 to suppliers of goods.

Step 1- Variables affected Asset & Liability


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Step 2- Effect of transactions on affected variables decrease in asset & Liability


-5000 = -5000+ 0

Illustration 9:- Received cash from a customer Rs 20,000.



in another asset.


+20,000 20,000 = 0+ 0

Illustration 10: -Withdrew cash Rs 2,000 for personal use.

Step 1- Variables affected Asset & Capital

Step 2- Effect of transactions on affected variables decrease in asset & Capital


-2000 = 0 - 2000

Problem:-Mr. Irshad has the following transactions. Draw accounting equation to show the effect

of these transactions on his assets, liabilities and capital. Also show his balance sheet:

1. Commenced business with cash Rs 20,000.

2. Purchase goods for cash Rs 5000 and credit Rs 6000.

3. Purchased office equipment for cash Rs 8000.

4. Paid office rent Rs 1000.

5. Sold goods for cash Rs. 10,000 (costing Rs 7000)

6. Sold goods on credit for Rs 6000 (costing Rs 3000)

7. Fore insurance premium paid in advance Rs 500

8. Salary due but not paid yet (o/s) Rs 1500

Systems of Accounting:-

ACCRUAL BASIS OF ACCOUNTING & CASH BASIS OF ACCOUNTING

Accrual Basis of accounting is a method of recording transactions by which revenue, cash,

assets & liabilities are reflected in the accounts for the period in which they accrue. Whereas

cash basis accounting in which actual receipts or actual payments are made. These two

methods can be differentiated in tabular form as follows:

BASIS OF DISTINCTION ACCRUAL

BASIS

CASH

BASIS


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1 Prepaid/outstanding

expenses/accrued/unaccrued

income

These things are treated

in this accounting

Whereas no entry is done in

cash basis accounting

2 Income status in case of

prepaid expenses & accrued

income

Income statement will

show a relatively high

income

Income statement will show

lower income

3 Income status in case of o/s

exp and unaccrued income

Income statement will

show a relatively lower

income

Income statement will show a

high income

4 Recognition under companies

Act 1956

It is recognized Not recognized

5 Availability of choosing

accounting option like

LIFO/FIFO/SLM/WDV

Under this an accountant

has an option

Whereas under this an

accountant has no option to

make a choice as such

Test Questions:

Problem 1: Show the accounting equation on the basis of the following transactions &

present a balance sheet: -

Rs

Mohan commenced business with 70,000

Purchased goods on credit 14,000

Withdrew for private use 1,700

Purchased goods on cash 10,000

Paid wages 300Paid to creditors 10,000

Sold goods on credit 15,000

Sold goods for cash (cost price 3000) 4,000

Purchased furniture 500

Problem2 Show accounting equation on the basis of the following transactions, also prepare

balance sheet:

Rs

i. Manu started business with cash 50,000

ii. Purchased goods on credit 2,500

iii. Purchased goods on cash 6000

iv. Purchased furniture for 3000


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v. Paid rent 1200

vi. Withdrew for private use 4200

vii. Received interest for 600

viii. Sold goods on credit (cost Rs 300) for 4200

ix. Paid to creditor 24000

x. Paid salaries for 1200

Problem 3: Show the accounting equation on the basis of following transactions:

(i) Harish started business with cash Rs 15000

(ii) He purchased goods on credit Rs 7000.

(iii) He purchased furniture for cash Rs 500

(iv) He deposited into bank Rs 2000.

(v) He sold goods on credit to Satish costing Rs 4000 for Rs 6000.

(vi) He withdrew cash fir private use Rs 200.

(vii) He paid salaries Rs 300.

MULTIPLE CHOICE QUESTIONS:

Q1 Cash purchases:

(a) Increase assets

(b) Results in no change of assets

(c) Decrease Assets

(d) Increase liability

Q2 Purchase of goods on credit from A increases:

(a) Assets

(b) Liability & Assets(c) Capital

(d) Assets & Capital

Q3 Rent outstanding Rs 400 :

(a) Increases capital by 400 & increase liability by 400.

(b) Decreases capital by 400 & increase liability by 400.

(c) Does not affect capital

(d) Increase assets by 400

Q4 Paid for salaries Rs 10,000:

(a) Decrease asset & increase capital(b) Increase assets & liability both

(c) No effect on asset

(d) Decrease in Assets & Capital both

Q5 Drew for personal use Rs 500:

(a) Increase assets & Capital

(b) Decrease liability

(c) Decrease assets & capital both

(d) None of above

Q6 If a firm borrows a sum of money, there will be:

(a) Increase in capital

(b) Decrease in capital


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(c) No effect on capital

(d) Increase liability

Q7 Which of the following is correct:

(a) Assets = Liability Capital

(b) Assets = capital liability

(c) Liability = Assets capital(d) Assets = External equity

Q8 Ram has assets of Rs 10,000 & liability of Rs 2,000, his capital would be :

(a) 10,000

(b) 2000

(c) 8000

(d) 12000

Q9 Mr Mohan has assets of Rs 60,000 & Capital of 45,000. Liabilities as on date shall be:

(a) 15000

(b) 45000

(c) 105000

(d) 60,000Q10 He sold goods on credit for Rs 10,000:

(a) Increase assets & Liability

(b) Increase one asset & decrease another asset

(c) Increase capital

(d) Increase liability & Capital

CHAPTER 5 RECORDING OF ACCOUNTING

TRANSACTIONS

At the end of this chapter you will be conversant with :5.1Classification of accounts

5.2 Rules of Debit & Credit

5.3 Meaning & Format of Journal

5.4 Steps in Journalizing

5.5 Compound Entry

5.6 Opening Entry

5.9 Cash discount v/s Trade discount

5.8 Ledger

5.9 Balancing

5.1 TYPES OF ACCOUNTS:The accounts maintained by a business organization are classified into three types asshown in the Figure 5.1:

Figure 5.1 Types of Accounts


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Personal Account: It deals with accounts of individuals like creditors, debtors, bank, etc. It

shows the balance due to these individuals or due from them on a particular date.

Real Account: It represents assets like plant and machinery, land and buildings, goodwill,

etc. As on a particular date, this account shows the worth of the asset.

Nominal Account: It consists of different types of expenses or incomes or loss or profit.

These accounts show the amount of income earned or expenses incurred for a particular

period say a month, a year, etc.

Illustration1:

Classify the following a/c among real, nominal & personal

Capital brought in, drawings A/c, building purchased, purchase A/c, sales A/c, Carriage

inward paid, carriage outward paid, cash received, cash paid, interest paid, interest received,

discount allowed, repairs, bank a/c, bank overdraft, outstanding rent.

Solution:

Personal Account:- Capital brought in, Drawings, bank a/c, bank overdraft

Real Account:- Building purchases, purchase a/c, sales a/c, cash received, cash paid

Nominal Account:-carriage inward paid, carriage outward paid, interest paid, interest

received, discount allowed, repairs, outstanding rent

5.2 DEBIT & CREDIT:

It is necessary to point out at the outset that the words debit and credit

represent two different concepts. The nature of Debit and Credit is explained in theFigure 5.2:

Figure 5.2 Nature of Debit & Credit


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RULES OF DEBIT & CREDIT:

Whether an Account has to be debited or credited is decided by using the rules

indicated in Figure 5.3.

Figure 5.3: Rules of Debit and Credit

5.3 MAENING & FORMAT OF JOURNAL

A journal is a book in which transactions are recorded in chronological order. It is called a

book of prime entry or original entry.

FORMAT OF JOURNAL


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Date Particulars L.F. Debit

Rs.

Credit

Rs.

The date on which transactions have taken place is entered in the date column. Two aspects of

the transaction are recorded in the particulars column. A brief description of the transaction

is also given in the particulars column. The Ledger Folio (L.F.) column is meant for writingthe number of the page in the ledger in which the particular transaction is entered. The

amount to be debited is entered in the debit column and the amount to be credited is entered

in the credit column.

5.4 STEPS IN JOURNALIZING

1. Ascertain what accounts are involved in a transaction?

2. Ascertain what is the nature of the accounts involved?

3. Ascertain what rule of debit & credit is applicable for each of the accounts involved?

4. Ascertain what account is to be debited and credited?

5. Record the date of transaction in the date column.6. Write the name of accounts to be debited & credited (with abbreviation Dr. & Cr.) in

particular column.

7. Write narration in brief describing the transaction.

8. Draw a line to separate one journal entry from other.

Note:- L.F. column is filled at the time of posting into the ledger.

Illustration 2:-

XYZ Ltd. received Rs.1,000 from Geet & Co. on 5-1-2001

Recording the journal entry in the books of XYZ Ltd.

Step 1 The two accounts involved in the above transaction are (i) money being received, and

(ii) the person paying the amount i.e., Geet & Co.

Step 2 The nature of the accounts are (i) Real account, and (ii) Personal account

respectively.

Step 3

(a) The rule applicable to real account is debit what comes in and credit what goes

out. In the given transaction, cash is coming in, therefore debit cash account.(b) The rule for personal account is debit the receiver and credit the giver. In the above

transaction, Geet & Co. is the giver, therefore credit Geet & Co.

Journal

Date Particulars L.F. Debit.

Rs.

Credit

Rs.

5.1.2001 Cash a/c Dr.

To Geet & Co. a/c

(Being cash received from Geet & Co.)

1,0001,000


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Let us apply the rules of debit and credit for a few sample transactions after ascertaining dual

aspects

Transaction Aspects Account

Debited

Reason for

the Debit

Account

Credited

Reason for the

Credit

ABC Ltd.received

Rs.5,000

from Gupta

& Company

(In the books

of ABC Ltd.)

Aspect 1 cashof Rs.5,000 is

received.

Aspect 2 The

amount is given

by Gupta & Co.

Cash a/c Cash a/c is aReal a/c.

The rule of

Debit what

comes in

applies.

Gupta & Co. Gupta & Co a/c is aPersonal a/c. The

rule of Credit the

giver applies.

PQR Ltd.

purchased

Rs.6,000

worth ofgoods from

X Co.

(In the books

of PQR Ltd.)

Aspect 1 Goods

of Rs.6,000 are

received.

Aspect 2 Thegoods are

supplied by X

Co.

Inventory

a/c (or

Purchase

s a/c)

Inventory

a/c or

Purchases

a/c inNominal

a/c. The

Rule is Debt

all

Expenses.

X Co. a/c X Co. a/c is a

personal a/c. The

rule of Credit the

giver applies.

XYZ Ltd.

paid the

salaries of

Rs.15,500 to

its staff for

the month

through bank

transfer.

(In the books

of XYZ Ltd.)

Aspect 1

Payment of an

expense of

Rs.15,500.

Aspect 2 Bank

balance is

reduced by

Rs.15,500.

Salaries

a/c

Salaries a/c

is a

Nominal

a/c. The rule

of Debit all

expenses

applies.

Bank a/c Bank a/c is a

personal a/c the rule

of Credit the giver

applies

Illustration 3:

Journalize the following transactions in the books of Dixit Enterprises.

i. Started business with a capital of Rs.7,50,000.

ii. Opened a bank account with State Bank of India for Rs.2,00,000.

iii. Purchased goods from Tandon & Co. for cash Rs.1,00,000.

iv. Purchased goods from Burman for Rs.2,00,000.

v. Goods returned to Mr Burman Rs.50,000.

vi. Paid Rs.1,40,000 to Mr Burman in full settlement of his dues.

vii. Paid Mr Dharam, the landlord Rs.50, 000 towards rent.

viii. Withdrew cash for household expenses Rs.60,000.


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ix. Sold goods to Mr. Karan for cash Rs.2,50,000.

x. Sold goods to Mr Dev on credit Rs.1,00,000.

xi. Goods returned by Mr. Dev for Rs.25, 000.

xii. Received cash from Mr. Dev Rs.70, 000 in full settlement.

xiii. Paid cartage on goods purchased Rs.35, 000.

xiv. Paid cartage on goods sold Rs.80,000.

xv. Purchased furniture for office purpose Rs.1,00,000.

xvi. Purchased furniture for re-sale Rs.1, 00,000.

xvii. Sold furniture out of those meant for resale Rs.1, 50,000.

xviii. Paid rent out of personal cash Rs.40, 000.

Solution:

Date Particulars L.FDebit

Rs.Credit

Rs.

i.

ii.

iii.

iv.

v.

vi.

vii.

viii.

ix.

x.

xi.

Cash A/c Dr

To Capital A/c

(Being cash invested in the business)

Bank A/c Dr.To Cash A/c

(Being cash deposited in the Bank)

Purchases A/c Dr.To Cash A/c

(Being goods purchased from Tandon & Co. for cash)Purchases A/c Dr.

To Burman A/c(Being goods purchased from Burman on credit)Burman A/c Dr.

To Returns outward A/c

(Being goods returned to Burman)

Burman A/c Dr.To Returns outward A/cTo Discount Received A/c

(Being cash paid to Mr Burman and received discount)Rent A/c Dr.

To Cash A/c(Being rent paid in cash)Drawings A/c Dr.

To Cash(Being cash withdrawn for household expenses)

Cash A/c Dr.To Sales A/c

(Being goods sold for cash)Dev A/c Dr.

To Sales A/c(Being goods sold to Dev on credit)

Returns Inward A/c Dr.To Dev A/c

7,50,000

2,00,000

1,00,000

2,00,000

50,000

1,50,000

50,000

60,000

2,50,000

1,00,000

25,000

7,50,000

2,00,000

1,00,000

2,00,000

50,000

1,40,00010,000

50,000

60,000

2,50,000

1,00,000

25,000


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xii.

xiii.

xiv.

xv.

xvi

xvii.

xviii.

(Being goods returned by Dev)Cash A/c Dr.

Discount Allowed A/c Dr.To Dev A/c

(Being cash received from Dev and allowed himdiscount)Cartage Inward A/c Dr.

To Cash A/c(Being cartage paid on goods purchased)Cartage Outwards A/ Dr.

To Cash A/c(Being cartage paid on goods sold)

Furniture A/c Dr.To Cash A/c

(Being furniture purchased on cash for office)Purchases A/c Dr.

To Cash A/c(Being furniture purchased on cash for re-sale)

Cash A/c Dr.To Sales A/c

(Being furniture meant for resale sold for cash)Rent A/c Dr.

To Capital A/c(Being rent paid out of personal cash)

70,000

5,000

35,000

80,000

1,00,000

1,00,000

1,50,000

40,000

75,000

35,000

80,000

1,00,000

1,00,000

1,50,000

40,000

Illustration 4:

Special transactions:

Journalize the following transactions in the Books of Rakesh for the month of January, 2001

Date Transactions

2.1.2001

8.1.2001

9.1.2001

10.1.2001

11.1.2001

12.1.2001

12.1.2001

25.1.2001

28.1.200

Withdrawn cash for personal use Rs.2,500

Withdrawn goods for personal use (Sale price Rs.1,500, CostRs.1,250)

Goods distributed to children in an orphanage (Sale price Rs.2,000 Cost

Rs.17,000)

Goods distributed as free samples (Sale price Rs.1,200; Cost Rs.1,000)

Goods stolen (Sale price Rs.1,000 Cost Rs.800)

Goods destroyed by fire (Sale price Rs.1,500 Cost Rs.1,250)

Goods used in furnishing the office (Sale prices Rs.2,000 Cost price Rs.1,750)

Recovered from Pramod half the amount which was written off as bad Rs.300 was

written off as bad earlier.

Rs.250 payable by Rakesh was written off as bad.

Solution:

In the Books of Rakesh

Journal Entries

Date Particulars L.F.Debit

Rs.

Credit

Rs.

2.1.2001

8.1.2001

Drawings a/c Dr.

To Cash a/c

(Being cash withdrawn for personal use)

Drawings a/c. Dr.

To Purchases a/c

(Being goods withdrawn for personal use)

2,500

1,250

1,700

2,500

1,250


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9.1.2001

10.1.2001

11.1.2001

12.1.2001

12.1.2001

25.1.2001

28.1.2001

Donation a/c Dr.

To Purchases a/c

(Being goods distributed to the children in an orphanage)

Sales Promotion a/c Dr.

To Purchases a/c

(Being goods distributed as free samples)Loss by Theft a/c Dr.

To Purchases a/c

(Being goods stolen)

Loss by fire a/c Dr.

To Purchases a/c

(Being goods destroyed by fire)

Office furniture a/c Dr.

To Purchases a/c

(Being goods used in furnishing the office)

Cash a/c Dr.

To Bad Debts Recovered a/c

(Being cash recovered out of an amount which waswritten off as bad earlier)

Bad Debts a/c Dr.

To Rakesh a/c

(Being amount due from Rakesh written off as bad)

1,000

800

1,250

1,750

150

250

1,700

1,000

800

1,250

1,750

150

250

5.5 COMPOUND JOURNAL ENTRY:

Sometimes there are a number of transactions on the same date relating to one particular

account or of one particular nature. Such transactions may be recorded by means of a single

entry instead of passing several journal entries. Such an entry is termed as compound journal

entry. It may be recorded in any of the following three ways:(i) One particular account may be debited while several other accounts may be credited.

(ii) One particular account may be credited while several other accounts may be debited.

(iii) Several accounts may be debited and several accounts may be credited.

Illustrations 5:

Journalize the following transactions in the Books of Rakesh for the month of January, 2001.

Date Transactions

2.1.2001

8.1.2001

15.1.2001

20.1.2001

25.1.2001

Purchased goods from Arora at the list price of Rs.8,000. A trade discount

of 10% was allowed.

Sold goods to Flora at a list price of Rs.4,000. A trade discount of 5% wasallowed.

Received a cheque from Flora for Rs.3,600 in full settlement.

Paid Arora Rs.7,000 by cheque in full settlement.

Shyam is declared insolvent and received from his official receiver, a first &

final dividend of 60 paise in a rupee against a debt of Rs.2,500

Solution:

Journal Entries

Date Particulars L.F.Debit

Rs.

Credit

Rs.

2.1.2001 Purchases a/c Dr. 7,200


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8.1.2001

15.1.2001

20.1.2001

25.1.2001

To Arora a/c(Being goods purchased from Arora for

Rs.8,000 at a trade discount of 10%)Flora a/c Dr.

To Sales a/c

(Being goods sold to Flora for Rs.4,000at a trade discount of 5%)

Bank a/c Dr.

Discount Allowed a/c Dr.To Flora a/c

(Being cheque received from Flora in fullsettlement)

Arora a/c Dr.To Bank a/c

To Discount received a/c

(Being cheque paid to Arora in fullsettlement)

Cash a/c Dr.Bad Debts a/c Dr.

To Shyam a/c(Being 60 paise in a rupee received fromShyam in full settlement of dues)

3,800

3,600200

7,200

1,5001,000

7,200

3,800

3,800

7,000200

2,500

5.6 OPENING ENTRY:

A journal entry by means of which the balances of various assets, liabilities & capital

appearing in the balance sheet of previous accounting period are brought forward in the

books of current accounting period, is known as opening entry.

Illustration 6:

Pass the opening entry in the journal of Ram (as on 1st April 2008):

Cash in Hand Rs 50,000, stock of Rs 20,000, land & building Rs 1,0,00,00 plant &

machinery Rs 50,000, furniture 20,000 owings from X ltd 15000, loan from Y ltd 10,000.

Solution:

Date Particulars L.F. Dr (Rs) Cr (Rs)

2008

April1

Cash in hand Dr

Stock Dr.

Land & Building Dr.

Plant & Machinery Dr

Furniture DrTo X Ltd

To Loan from Y Ltd

To Rams capital A/c

(being the balance brought forward

from the last year)

50,000

20,000

1,00,000

50,000

20,000 15000

10,000

2,15,000

5.7 TRADE DISCOUNT V/S CASH DISCOUNT

TRADE DISCOUNT:

It is a reduction granted by a supplier from the list price of goods or service on business

considerations (such as quantity bought, trade practices etc) other than for prompt payment.


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For example: If a supplier sells goods worth Rs 10,000 at trade discount of 10%, trade

discount will be calculated as follows:

Price of Goods Rs 10,000

Less: Trade discount Rs 1,000

Amount payable as per invoice Rs 9,000

CASH DISCOUNT:

A reduction granted by a supplier from the invoice price in consideration of immediate

payment or payment within a stipulated period. Example: If in the above example, terms of

payment 2%, 30 days, it means buyer will get 2% cash discount if he makes payment within

30 days. And the cash discount will be calculated as follows:

Amount payable as per invoice Rs 9,000

Cash discount Rs 180

Cash paid within 30 days Rs 8,820

Difference between these two discounts can be presented in tabular form as follows:

Trade Discount Cash DiscountIt is a reduction granted by supplier from

the list price of goods/ service on business

consideration other than for prompt

payment

A reduction granted by supplier from the

invoice price in consideration of immediate

payment or payment in stipulated period.

It is given to promote sales It is allowed to encourage prompt payment

It is allowed on purchase It is given at the time of payment within

stipulated time period

It is shown in invoice itself. It is not shown in invoice

Trade discount account is not opened in

ledger

It is opened in ledger

It may vary with quantity purchased It may vary with the payment period

5.8 LEDGER

Ledger contains a classified summary of all transactions recorded in Cashbook and journal.

It is the main book of account. Ledger is also called Principal book as final information

pertaining to the financial position of a business emerges only from the accounts

Format of ledger:

Dr. Account Title Cr.

Date Particulars J.F. Amou

nt

Date Particulars J.F. Amoun

t

The date column records the year, month and date of the transactions. Particulars column

records the title of the other account affected. Name of the account in particulars column on

the debit and credit side are preceded by the words To and By respectively. Journal Folio

(J.F.) column records the page number of the journal from which the posting to the ledger has

taken place. Amount column on debit and credit side records the amount mentioned in

journal entry against the title of the account prepared.

Ledger Posting

The process of transferring of debits and credits entries from the journal to the ledger is calledledger posting.


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STEPS IN LEDGER POSTING:

First of all the opening balance (if any) has to be posted. The opening entry for variousassets should be posted by writing To Balance b/fon the debit side of the relevantaccount. Similarly, liabilities accounts should be posted by writing By Balance b/f on

the credit side of the relevant account.1. Enter the date of the transaction on the debit side of the relevant account.

2. The title of the account to be credited is preceded by the word To is entered inthe particulars column.

3. In Journal Folio (J.F.) column enter the page number of the journal on which thejournal entry is passed.

4. Amount column records the amount mentioned in the journal against title of theaccount under consideration.

For posting of the account to be credited, above mentioned steps are followed but with

one difference. Now the recording is done on the credit side of the account and in the

particulars column title of the amount to be debited is preceded by the word By.

Illustration 7

Cash received from Geet & Co. Rs.1,000 on 5.1.2001

Cash a/c Dr. 1,000

To Geet & Co. a/c 1,000

Dr CASH A/C Cr

Date Particulars J.F. Amount Date Particulars J.F. Amount

5.1.2001 To Geet & Co 1,000

Dr. Geeta & Co A/c Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount

5.1.2001 By Cash a/c 1,000

5.9 BALANCING OF LEDGER

After the posting has been completed accounts are balanced. Balancing of an account

means to make the total of amounts column appearing on the debit and credit sideequal to each other. If the total of debit side is greater than the credit side, thedifference between the two sides is known as debit balance and likewise, if the total ofcredit side is greater, the difference is known as credit balance. The difference is placedon the shorter side, saying To (or By) balance carried down. The total is written onboth sides opposite each other and the account is ruled off. Personal accounts and realaccounts like capital accounts, machinery account, building account, etc. are balanced.

But nominal accounts representing expenses, revenues and incomes are not balanced.They are transferred to the trading and profit and loss account at the end of the year.

Illustration 8From the following information prepare the ledger account of Garewal in the books of

Rahman and bring down the balance as on 31st January, 2001.


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1.1.2001 Sold goods for Rs.1,00,000 less 25% trade discount.

4.1.2001 Garewal paid Rs.40,000 on account, discount allowed Rs.4,000.

6.1.2001 Sold goods for Rs.50,000 less 25% trade discount.

9.1.2001 Received back 1/3rd of the goods sold on 6th January.

15.1.2001 Received cheque for Rs.60,000, discount allowed thereonRs.6,000.

18.1.2001 Sold goods Rs.2,00,000 less 25% trade discount.

20.1.2001 Bills Receivable accepted by Garewal for Rs.1,00,000.

25.1.2001 Cheque received on 15th January was returned dishonored.

28.1.2001 Received cash Rs.75,000.

Solution:

In the Books of Rahman

Garewals Account

Dr. Cr.

Date Particulars J.F.Amount

Rs.

Date Particular J.F. Amount

Rs.

1.1.2001

6.1.2001

18.1.200125.1.2001

25.1.2001

1.2.2001

To Sales A/c

To Sales A/c

To Sales A/cTo Bank A/cCheque dishonored

To Discount Allowed

Cancellation of discount

To Balance b/d

75,000

37,500

1,50,000

60,000

6,000

3,28,500

31,000

4.1.2001

4.1.2001

9.1.200115.1.200115.1.2001

28.1.200131.1.2001

By Cash A/c

By Discount Allowed a/cBy Returns Inward

By Bank A/cBy Discount Allowed

A/c

By Bills Receivable A/cBy Cash a/c

By Balance c/d

40,000

40,00012,50060,0006,000

1,00,000

75,00031,000

3,28,500


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Test Exercise:-

Problem 1. Journalize the following transactions:

i. Ganesh Started his business with Rs 20,000

ii. Borrowed Rs 5,000 from Mahesh.

iii. Deposited into the bank Rs 10,000.

iv. Purchased Fixed Assets for Rs 5,000

v. Bought goods for Rs 1,500.

vi. Sold goods for Rs 9,000.

vii. Purchased goods on credit from Ramesh for Rs 20,000.

viii. Sold goods on credit to Shyam fro Rs 12,000.

ix. Received Rs 11,880 from Shyam after allowing him cash discount Rs 120.

x. Paid Rs19,800 to Ramesh after receiving cash discount Rs 200.xi. Withdrew goods worth Rs 1000 for personal use.

xii. Cash withdrew from bank for personal purpose Rs 1000

Problem 2:

Journalize: -

1. March 1, 08 Received a cheque from Ramesh & Co to whom goods were sold for Rs

2000 last year, allowed his 1% discount.

2. March 2,08 Ramesh & cos cheque deposited into bank.

3. March 5, 08 Ramesh & Cos cheque dishonored (bank charged Rs 10)4. March 20 Ramesh & Co settled his A/c by means of a cheque for Rs 2025, Rs 15

being for interest charged.

5. March 22, 08 Paid rent of building Rs 12000, half of the building is used by the

proprietor for residential use.

Problem 3: Journalize: -

1. March 21, 08 Purchased machinery from Rajiv for Rs 5000 and paid him by means of

bank draft purchased from bank for Rs 5020.

2. March 22, 08 Discounted a bills of exchange for Rs 10,000 at 1% through bank.

3. March 24, 08 Honored our acceptance in favour of Shyam by cheque Rs 5000.4. March 25, 08 Received payment of a loan of Rs 5000 and deposited Rs 3000 out of it

into bank.

5. March 28, 08 Supplied goods costing Rs 600 to Mohan & issued invoice at 10%

above cost & allowed 5%

6. Received an order of goods for Rs 40,000 from Ram.

7. Paid s 150 in cost as wages for installation of Machine.

8. Sold goods to Kitty. List price is 10,000. Sales is subject to 10% trade discount. And

5% cash discount if payment is made immediately. Kitty availed of cash discount.

9. goods worth Rs 4200 distributed as samples.


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MULTIPLE CHOICE QUESTIONS:

Select the most appropriate answer:

Q1 Which of the following is an example of personal account?:

(a) Machinery

(b) Cash

(c) Rent

(d) Creditor

Q2 Payment of salary is recorded by:

(a) Debiting salary A/c, crediting cash a/c

(b) Debiting cash A/c, crediting salary a/c

(c) Debiting employee a/c, crediting co a/c


Q3 Journal is a:

(a) Book of original entry

(b) Classified summary of all transactions

(c) Permanent record

(d) Both (a) & (b) above

Q4 Purchase of goods on credit from A is recorded as:

(a) Debit purchase A/c, credit cash a/c

(b) Debit purchase A/c, credit As A/c

(c) Debit As A/c, Credit purchase A/c

(d) Debit Cash A/c, credit purchase A/c

Q5 Goods returned from X is entered as:

(a) Debit X A/c, credit purchase return A/c

(b) Debit X A/c, credit cash a/c

(c) Debit sales return a/c, credit Xs A/c

(d) Debit Xs A/c, credit sales A/c

Q6 Trade discount allowed at the time of sale of goods:

(a) Is recorded in sales book

(b) Is recorded in cash book

(c) Is recorded in journal

(d) Is not recorded in books of account

Q7 XYZ Ltd. paid wages of Rs.8,000 for erection of machinery. The journal entry for the

transaction is:

(a) Debit wages & credit cash a/c


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(b) Debit Machinery A/c & Credit cash A/c

(c) Debit cash a/c, credit wages a/c

(d) Debit machinery a/c & credit

Q 8 The process of balancing of an account involves equalization of both sides of the

account. If the debit side of an account exceeds the credit side, the difference is put on thecredit side. The said balance is i. A debit balance, ii. A credit Balance iii. It represents

either expenditure or an asset or both iv it is either income or liability or both:

(a) Only (i) above

(b) Only (ii) above

(c) Both (i) & (iii) above

(d) Both (ii) & (iii) above

Q9 Which of the following statements is/are true?

i. Drawings account is a nominal account.

ii. Capital account is a real account.iii. Salaries account is a nominal account.

iv. Outstanding salaries account is a nominal account.

v. Patents account is a personal account.

(a) Both (i) & (ii)

(b) Only (iii)

(c) (i), (ii) & (iii)

(d) (iv) &(v)

Q10 The entry to record the collection of cash from sundry debtors would involve a i.

Debit to sundry debtors ii. Debit to cash account iii. Credit to sundry debtors iv. Credit to

cash account.:

(a) Only (i) above

(b) Only (ii) above

(c) Only (iii) above

(d) Both (ii) & (iii) above


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CHAPTER 5 DEPRECIATION & ITS METHODS

After reading this chapter, you will be conversant with:

9.1Concept of Depreciation

9.2 Methods of Charging Depreciation

9.3 Comparison between SLM & WDV methods of depreciation

9.4 Recording Depreciation in the books of accounts

9.5 Change in the method of depreciation

9.1 Meaning of Depreciation:Provision is created in a companys account towards depreciation to account for the wearand tear of its assets caused by usage, passage of time, technological obsolescence, etc.

while depreciation does not involve payment of money to any third party, it isnevertheless an accounting entry in the books.

Depreciation is the acquisition cost of an asset (less the expected salvage value)spread over the economic life of that asset. The purpose of charging depreciation overthe economic life of the asset is to match the cost of the asset over the period forwhich revenue is earned by using the asset.

9.2DEPRECIATION METHODS

The two methods which are basically used for charging depreciation are

1.Straight Line Method

Under the straight-line method, the net acquisition cost or construction cost is chargedoff in equal proportion during the useful economic life and the quantum of the

depreciation is arrived at by dividing the net acquisition or construction cost by thenumber of years of useful economic life. The net acquisition or construction cost is

calculated by deducting salvage value from the acquisition or construction cost.

Depreciation =

For example, if the cost of an asset is Rs.1,00,000, the expected salvage value is

Rs.20,000 and the estimated useful life is 8 years, the annual depreciation would be =

Rs.10,000 or 10% per annum.This method has the following advantages:

1. the amount of depreciation and the rate does not change over the usefuleconomic life of the asset;

2. the calculation is relatively simple; and

3. it realistically matches cost and revenue.

2. The Written Down Value Method/Diminishing Balance Method

Under this method the depreciation charged in the various years will not be equal overthe useful life of the asset. This is because the depreciation charge every year iscalculated as a percentage of the outstanding balance of the asset as at the beginning of

that particular year and not on the original cost of the asset.


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While preparing final accounts, if depreciation is shown as an item under adjustments,calculate the amount of depreciation and charge it off to profit and loss account bydebiting P & L account and crediting depreciation; show depreciation as a deduction fromthe asset value on the assets side of Balance Sheet.

If depreciation is shown in the trial balance, then, the amount of depreciation should

be charged to only P & L account.The percentage of depreciation to be charged under the declining balance method can bedetermined as under

r = 1 (or) 1 (s/c)1/n

where,

r = rate of depreciation under the written down value method

n = estimated useful life of the asset in years

s = residual value or scrap value of the asset

c = original cost of the asset.

Please note that if the residual or scrap value of an asset is zero, the rate of depreciationcannot be determined using the above formula.

Illustration 1

Original Cost of the Machine- Rs.1,00,000

Estimated Scrap Value - Rs.30,000

Useful Life - 6 years

The calculation of depreciation for each of the years would be as follows:

r = 1 (30,000/1,00,000)1/6 = 18%

At the end of the 1st year, the depreciation is calculated by applying the rate to the originalcost. Then the written down value is arrived at by deducting the depreciation so arrived at

from the original cost. At the end of the 2nd year, the depreciation rate is applied to the

written down value at the end of the 1st year. This depreciation amount is again deducted to

arrive at the written down value at the end of the 2nd year. In the above

mentioned asset the depreciation calculations will be as follows:

Year Calculation of depn.

Depreciation Written down value

1 1,00,000 x 18% 18,000 82,000

2 82,000 x 18% 14,760 67,2403 67,240 x 18% 12,103 55,137

4 55,137 x 18% 9,925 45,212

5 45,212 x 18% 8,138 37,074

6 37,074 x 18% 6,673 30,401

(The small difference between the estimated scrap value and the written down value at the

end of the sixth year is due to approximation of the depreciation rate)

The following are the advantages of Diminishing Balance Method.

1. It matches the service of the asset in the sense that higher depreciation is charged in

the initial years, when the machine is most efficient compared to later years.


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2. It recognizes the risk of obsolescence by concentrating the major part of the

depreciation in the early years of the life of the asset.

3. It equalizes the expenses of depreciation and repair charges taken together. It is

assumed that repairs are the lowest in the initial years and higher in the later years

while the depreciation under this method is higher in the initial years and lower in thelater years.

4. It results in a better cash flow through tax deferral as under this method the net

income to be taxed is lower in the initial years and higher in the subsequent years.

The disadvantages of declining balance method are:

1. It requires elaborate bookkeeping.

2. As the amount of the depreciation varies from year to year, intra-enterprise

comparability is lost and that income is understated in early years and overstatedin subsequent years.

9.3 COMPARISON BETWEEN SLM & WDV METHODS OF DEPRECIATION

1

Explanation: In the above diagram we see that irrespective of the time period the amount of

depreciation charged is same under the straight line method. But in case of written down

value method, the amount of depreciation charged falls down as the time period increases.

The depreciation charged under this method is more in the initial years and keeps on falling

as the number of years of usage increase.

We can draw the following differences between the diminishing balance method and straight

line method. They are:

Straight Line Diminishing Balance


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An enterprise whose accounting period ends on 31st March, purchased three cars for

Rs.90,000 each on 1st April, 1998. Depreciation is charged @ 10% on cost of the Machinery.

On 1st January, 2000 one car was damaged in an accident and was sold for Rs.60,000.

Another car was sold for Rs.80,000 on 30th September, 2000.

You are required to prepare necessary accounts on the basis of straight line method while: (a)charging to the Asset Account (b) maintaining Provision for Depreciation Account.

Solution:

a. Direct Charge to the Asset AccountCars Account

Dr. Cr.

Rs. Rs.

1998

Apr. 1

1999

Apr. 1

2000

Apr. 1

2001

April 1

To Cash/Bank a/c

(purchase of cars)

To Balance b/d

To Balance b/d

-

To Balance b/d

2,70,000

2,70,000

2,43,000

2,43,000

1,44,000

1,44,000

63,000

1999

Mar. 31

Mar. 31

2000

Jan. 1

Mar. 31

Mar. 31

2000

Sept. 1

2001

Mar. 31

By Depreciation a/c

By Balance c/d

By Car disposal a/c (2)

By Depreciation (1)

By Balance c/d

By Car disposal a/c (4)

By Depreciation a/c (3)

By Balance c/d

27,000

2,43,000

2,70,000

74,250

24,750

1,44,000

2,43,000

67,500

13,500

63,0001,44,000

Car Disposal Account*Dr. Cr.

Particulars Rs. Particulars Rs.

2000 To Cars a/c 74,250

Jan. 1

2000 By Cash/Bank a/c 60,000Jan. 1Mar. 31 By Profit & Loss a/c 14,250

(Loss)

74,250 74,250

Car Disposal Account*


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Dr. Cr.

Date Particulars AmountRs.


2000Sept.1

2001Mar.31

To Cars a/c

To Profit & Loss a/c(Profit)

67,500

12,500

2000Sept 1

By Cash/Bank a/c 80,000

80,000

80,000

* As two cars have been disposed off on two different dates Car Disposal Account has

been opened twice.

Depreciation account



1999Mar.

31

2000Mar.31

2001Mar.31

To Cars a/c

To Cars a/c

To Cars a/c

27,000

27,000

24,750

24,750

13,500

1999Mar. 31

2000Mar. 31

2001Mar. 31

By Profit & Loss a/c



27,000

27,000

24,750

24,750

13,500

13,500 13,500

Working Notes:

1. Depreciation for 1999-00 Rs.

For two cars 9,000 x 2 18,000

For the third car for 9 months 9,000 x 9/12 6,750

24,750

2. Determination of book value of car:

Cost 90,000

Depreciation provided up to the date of disposal (9,000

+ 6,750)

15,750

74,250

3. Depreciation for 2000-01

For one car for one year 9,000


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Another car for 6 months 4,500

13,500

4. Determination of book value of the car sold in September,2000:

Cost of the car 90,000

Less: Depreciation provided up to the date of disposal(9,000 + 9,000 + 4,500)

22,500

67,500

b. If Provision for Depreciation Account is maintained

Cars Account

Dr. Cr.Particulars Rs. Particulars Rs.

1998Apr. 1

1999Apr. 1

2000

Apr. 1

2001Apr. 1

To Cash/Bank a/c

To Balance b/d

To Balance b/d

To Balance b/d

2,70,000

2,70,000

2,70,000

2,70,000

1,80,000

1,80,000

90,000

1999Mar.31

2000Jan.1

Mar.31

2000Sep. 1

2001Mar.31

By Balance c/d

By Sale of Cars a/c

By Balance c/d

By Sale of Cars a/c

By Balance c/d

2,70,000

2,70,000

90,000

1,80,000

2,70,000

90,000

90,000

1,80,000

Provision for Depreciation Account

Dr. Cr.Rs. Rs.

1999 To Balance c/d 27,000 1999 By Profit & Loss a/c 27,000


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Mar.31

2000Mar. 31

2000Sep. 1

2001

Mar.31

To Sale of Cars a/c

To Balance c/d

To Sale of Cars a/c (4)

To Balance c/d

27,000

15,750

36,000

51,750

22,500

27,000

49,500

Mar.31

1999Apr. 1

2000Jan. 1Mar. 31

2000Apr. 1

Sep. 1

2001

Apr. 1

By Balance b/d



By Balance b/d



By Balance b/d

27,000

27,00

0

6,750

18,000

51,750

36,00

0

4,500

9,000

49,50027,000

Sale of Cars AccountDr. Cr.

Date Particulars Rs. Date Particulars Rs.

2000Jan. 1

2000

Sep. 1

2001Mar.31

To Cars a/c

To Cars a/c

To Profit & Loss a/c(Profit)

90,000

90,000

90,000

12,500

1,02,500

2000Jan. 1

Mar. 31

2000

Sep. 1

By Provision forDepreciation a/c

By Cash a/c


(loss)

By Provision forDepreciation a/c

By Cash a/c.

15,750

60,000

14,250

90,000

22,500

80,000

1,02,500


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Illustration 2.

On 1st January 1999, the Supreme Manufacturers purchased a machine for Rs.2,50,000.

Depreciation is provided annually according to the straight line method. The estimated useful

life of the machine is 10 years and the scrap value is Rs.10,000. You are required to find out

the rate of depreciation and also show the machine account as on 31st December, 2001.

Determination of amount of depreciation:

Depreciation =

= = 2,40,000/10 = Rs.24,000

Determination of rate of depreciation:

r = (Amount of Depreciation/Cost of the Machine) x 100

= (24000/250000) * 100= 9.6%

Machinery Account

Dr. Cr.

Date Particulars Rs. Date Particulars Rs.

1999Jan. 1

2000

Jan. 1

2001Jan. 1

2002Jan. 1

To Cash/Bank a/c(Purchase of

Machinery)

To Balance b/d

To Balance b/d

To Balance b/d

2,50,000

2,50,000

2,26,000

2,26,000

2,02,000

2,02,0001,78,000

1999Dec.31

2000Dec. 31Dec. 31

2001Dec. 31

Dec. 31

By Depreciation a/cBy Balance c/d

By Depreciation a/c ByBalance c/d

By Depreciation a/c ByBalance c/d

24,0002,26,000

2,50,000

24,0002,02,000

2,26,000

24,0001,78,000

2,02,000


50