Study Note - 1

ACCOUNTING PROCESS

This Study Note includes

1.1 Introduction
1.2 Definitions
1.3 Book-Keeping
1.4 Accounting Cycle
1.5 Basic Accounting Terms
1.6 Generally Accepted Accounting Principles
1.7 Accounting Concepts and Conventions
1.8 Events and Transactions
1.9 Voucher
1.10 Double Entry System
1.11 The Concepts of “Account”, “Debit” and “Credit”
1.12 Types of Accounts
1.13 The Accounting Process
1.14 Accounting Equation
1.15 Accrual Basis & Cash Basis of Accounting
1.16 Capital & Revenue Transactions
1.17 Accounting Standards
1.18 Double Entry System, Books of Prime Entry, Subsidiary Books
1.19 Trial Balance
1.20 Measurement, Valuation & Accounting Estimates
1.21 Opening entries, Closing entries, Transfer entries and Rectification entries

1.1 INTRODUCTION

Business is an economic activity undertaken with the motive of earning profits and to maximize the
wealth for the owners. Business cannot run in isolation. Largely, the business activity is carried out by
people coming together with a purpose to serve a common cause. This team is often referred to as an
organization, which could be in different forms such as sole proprietorship, partnership, body corporate
etc. The rules of business are based on general principles of trade, social values, and statutory framework
encompassing national or international boundaries. While these variables could be different for different
businesses, different countries etc., the basic purpose is to add value to a product or service to satisfy
customer demand.
The business activities require resources (which are limited & have multiple uses) primarily in terms of
material, labour, machineries, factories and other services. The success of business depends on how
efficiently and effectively these resources are managed. Therefore, there is a need to ensure the
businessman tracks the use of these resources. The resources are not free and thus one must be careful
to keep an eye on cost of acquiring them as well.
As the basic purpose of business is to make profit, one must keep an ongoing track of the activities
undertaken in course of business. Two basic questions would have to be answered:
(a) What is the result of business operations? This will be answered by finding out whether it has made
profit or loss.
(b) What is the position of the resources acquired and used for business purpose? How are these
resources financed? Where the funds come from?
The answers to these questions are to be found continuously and the best way to find them is to record all
the business activities. Recording of business activities has to be done in a scientific manner so that they
reveal correct outcome. The science of book-keeping and accounting provides an effective solution. It

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Accounting Process

is a branch of social science. This study material aims at giving a platform to the students to understand
basic principles and concepts, which can be applied to accurately measure performance of business.
After studying the various chapters included herein, the student should be able to apply the principles,
rules, conventions and practices to different business situations like trading, manufacturing or service.

1.2 DEFINITIONS

Definition of Accounting
Definition by the American Institute of Certified Public Accountants (Year 1961):
“Accounting is 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 result thereof”.
Definition by the American Accounting Association (Year 1966):
“The process of identifying, measuring and communicating economic information to permit informed
judgments and decisions by the users of accounting”.

(a) Objectives of Accounting

(i) Providing Information to the Users for Rational Decision-making
The primary objective of accounting is to provide useful information for decision-making to
stakeholders such as owners, management, creditors, investors, etc. Various outcomes of business
activities such as costs, prices, sales volume, value under ownership, return of investment, etc. are
measured in the accounting process. All these accounting measurements are used by stakeholders
(owners, investors, creditors/bankers, etc.) in course of business operation. Hence, accounting is
identified as ‘language of business’.
(ii) Systematic Recording of Transactions
To ensure reliability and precision for the accounting measurements, it is necessary to keep a
systematic record of all financial transactions of a business enterprise which is ensured by book-
keeping. These financial records are classified, summarized and reposted in the form of accounting
measurements to the users of accounting information i.e., stakeholder.
(iii) Ascertainment of Results of above Transactions
‘Profit/loss’ is a core accounting measurement. It is measured by preparing profit and loss account
for a particular period. Various other accounting measurements such as different types of revenue
expenses and revenue incomes are considered for preparing this profit and loss account. Difference
between these revenue incomes and revenue expenses is known as result of business transactions
identified as profit/loss. As this measure is used very frequently by stockholders for rational decision-
making, it has become the objective of accounting.
For example, Income Tax Act requires that every business should have an accounting system
that can measure taxable income of business and also explain nature and source of every item
reported in Income Tax Return.
(iv) Ascertain the Financial Position of Business
‘Financial position’ is another core accounting measurement. Financial position is identified by
preparing a statement of ownership i.e., Assets and Owings i.e., liabilities of the business as on
a certain date. This statement is popularly known as balance sheet. Various other accounting
measurements such as different types of assets and different types of liabilities as existed at a
particular date are considered for preparing the balance sheet. This statement may be used by
various stakeholders for financing and investment decision.

1.2 I FUNDAMENTALS OF ACCOUNTING

(v) To Know the Solvency Position
Balance sheet and profit and loss account prepared as above give useful information to
stockholders regarding concerns potential to meet its obligations in the short run as well as in the
long run.
Providing Information to the Users for Rational
Decision-making

Systematic Recording of Transactions

Ascertainment of Results of above Transactions

Ascertain the Financial Position of Business

To Know the Solvency Position

Function of Accounting
The main functions of accounting are as follows:
(a) Measurement: Accounting measures past performance of the business entity and depicts its
current financial position.
(b) Forecasting: Accounting helps in forecasting future performance and financial position of the
enterprise using past data.
(c) Decision-making: Accounting provides relevant information to the users of accounts to aid rational
decision-making.
(d) Comparison & Evaluation: Accounting assesses performance achieved in relation to targets
and discloses information regarding accounting policies and contingent liabilities which play an
important role in predicting, comparing and evaluating the financial results.
(e) Control: Accounting also identifies weaknesses of the operational system and provides feedbacks
regarding effectiveness of measures adopted to check such weaknesses.
(f) Government Regulation and Taxation: Accounting provides necessary information to the
government to exercise control on die entity as well as in collection of tax revenues.
Accounting – Classification
The various sub-fields of the accounting are:

ACCOUNTING

Financial Cost Management

Accounting Accounting Accounting

1. Financial Accounting Determining the financial results for Stewardship Accounting

the period and the state of affairs on
the last day the accounting period.
2. Cost Accounting Information generation for Controlling Control Accounting
operations with a view to maximizing
efficiency and profit.
3. Management Accounting Accounting to assist management in Decision Accounting
planning and decision making.

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Accounting Process

(a) Financial Accounting

It is commonly termed as Accounting. The American Institute of Certified Public Accountants defines
Accounting as “an art of recoding, 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.”

(b) Cost Accounting

According to the Chartered Institute of Management Accountants (CIMA), Cost Accountancy is defined
as “application of costing and cost accounting principles, methods and techniques to the science,
art and practice of cost control and the ascertainment of profitability as well as the presentation of
information for the purpose of managerial decision-making.”
(c) Management Accounting
Management Accounting is concerned with the use of Financial and Cost Accounting information to
managers within organizations, to provide them with the basis in making informed business decisions
that would allow them to be better equipped in their management and control functions.

Difference between Management Accounting and Financial Accounting

The significant difference between Management Accounting and Financial Accounting are :

Management Accounting Financial Accounting

1. Management Accounting is primarily 1. Financial Accounting is based on the
based on the data available from Financial monetary transactions of the enterprise.
Accounting.
2. It provides necessary information to the 2. Its main focus is on recording and classifying
management to assist them in the process monetary transactions in the books of
of planning, controlling, performance accounts and preparation of financial
evaluation and decision making. statements at the end of every accounting
period.
3. Reports prepared in Management 3. Reports as per Financial Accounting are
Accounting are meant for management meant for the management as well as for
and as per management requirement. shareholders and creditors of the concern.
4. Reports may contain both subjective and 4. Reports should always be supported by
objective figures. relevant figures and it emphasizes on the
objectivity of data.
5. Reports are not subject to statutory audit. 5. Reports are always subject to statutory audit.
6. It evaluates the sectional as well as the 6. It ascertains , evaluates and exhibits the
entire performance of the business. financial strength of the whole business.

1.3 BOOK-KEEPING

As defined by Carter, ‘Book-keeping is a science and art of correctly recording in books-of accounts
all those business transactions that result in transfer of money or money’s worth’.
Book-keeping is an activity concerned with recording and classifying financial data related to business
operation in order of its occurrence.
Book-keeping is a mechanical task which involves:
• Collection of basic financial information.
• Identification of events and transactions with financial character i.e., economic transactions.
• Measurement of economic transactions in terms of money.

1.4 I FUNDAMENTALS OF ACCOUNTING

• Recording financial effects of economic transactions in order of its occurrence.
• Classifying effects of economic transactions.
• Preparing organized statement known as trial balance.
The distinction between book-keeping and accounting is given below:

Distinction between Book-keeping and Accounting

Book-Keeping Accounting
1. Output of book-keeping is an input for 1. Output of accounting permit informed
accounting. judgments and decisions by the user of
accounting information.
2. Purpose of book-keeping is to keep 2. Purpose of accounting is to find results of
systematic record of transactions and operating activity of business and to report
events of financial character in order of its financial strength of business.
occurrence.
3. Book-keeping is a foundation of 3. Accounting is considered as a language of
accounting. business.
4. Book-keeping is carried out by junior staff. 4. Accounting is done by senior staff with skill of
analysis and interpretation.
5. Objects of book-keeping is to summarize 5. Object of accounting is not only bookkeeping
the cumulative effect of all economic but also analyzing and interpreting reported
transactions of business for a given period financial information for informed decisions.
by maintaining permanent record of each
business transaction with its evidence and
financial effects on accounting variable.

1.4 ACCOUNTING CYCLE

When complete sequence of accounting procedure is done which happens frequently and repeated
in same directions during an accounting period, the same is called an accounting cycle.

Steps/Phases of Accounting Cycle

The steps or phases of accounting cycle can be developed as under:

Recording of
Transaction

Financial
Journal
Statement

Closing
Ledger
Entries

Adjusted Trial Trial

Balance Balance

Adjustment
Entries

ACCOUNTING CYCLE

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Accounting Process

(a) Recording of Transaction : As soon as a transaction happens it is at first recorded in subsidiary book.
(b) Journal : The transactions are recorded in Journal chronologically.
(c) Ledger : All journals are posted into ledger chronologically and in a classified manner.
(d) Trial Balance : After taking all the ledger account closing balances, a Trial Balance is prepared at
the end of the period for the preparations of financial statements.
(e) Adjustment Entries : All the adjustments entries are to be recorded properly and adjusted
accordingly before preparing financial statements.
(f) Adjusted Trial Balance : An adjusted Trail Balance may also be prepared.
(g) Closing Entries : All the nominal accounts are to be closed by the transferring to Trading Account
and Profit and Loss Account.
(h) Financial Statements : Financial statement can now be easily prepared which will exhibit the true
financial position and operating results.

1.5 BASIC ACCOUNTING TERMS

In order to understand the subject matter clearly, one must grasp the following common expressions
always used in business accounting. The aim here is to enable the student to understand with these
often used concepts before we embark on accounting procedures and rules. You may note that these
terms can be applied to any business activity with the same connotation.
(i) Transaction: It means an event or a business activity which involves exchange of money or money’s
worth between parties. The event can be measured in terms of money and changes the financial
position of a person e.g. purchase of goods would involve receiving material and making payment
or creating an obligation to pay to the supplier at a future date. Transaction could be a cash
transaction or credit transaction. When the parties settle the transaction immediately by making
payment in cash or by cheque, it is called a cash transaction. In credit transaction, the payment
is settled at a future date as per agreement between the parties.
(ii) Goods/Services : These are tangible article or commodity in which a business deals. These articles or
commodities are either bought and sold or produced and sold. At times, what may be classified as
‘goods’ to one business firm may not be ‘goods’ to the other firm. e.g. for a machine manufacturing
company, the machines are ‘goods’ as they are frequently made and sold. But for the buying
firm, it is not ‘goods’ as the intention is to use it as a long term resource and not sell it. Services are
intangible in nature which are rendered with or without the object of earning profits.
(iii) Profit: The excess of Revenue Income over expense is called profit. It could be calculated for each
transaction or for business as a whole.
(iv) Loss: The excess of expense over income is called loss. It could be calculated for each transaction
or for business as a whole.
(v) Asset: Asset is a resource owned by the business with the purpose of using it for generating future
profits. Assets can be Tangible and Intangible. Tangible Assets are the Capital assets which have
some physical existence. They can, therefore, be seen, touched and felt, e.g. Plant and Machinery,
Furniture and Fittings, Land and Buildings, Books, Computers, Vehicles, etc. The capital assets which
have no physical existence and whose value is limited by the rights and anticipated benefits that
possession confers upon the owner are known as lntangible Assets. They cannot be seen or felt
although they help to generate revenue in future, e.g. Goodwill, Patents, Trade-marks, Copyrights,
Brand Equity, Designs, Intellectual Property, etc.
Assets can also be classified into Current Assets and Non-Current Assets.

1.6 I FUNDAMENTALS OF ACCOUNTING

 Current Assets – An asset shall be classified as Current when it satisfies any of the following :
(a) It is expected to be realised in, or is intended for sale or consumption in the Company’s normal
Operating Cycle,
(b) It is held primarily for the purpose of being traded ,
(c) It is due to be realised within 12 months after the Reporting Date, or
(d) It is Cash or Cash Equivalent unless it is restricted from being exchanged or used to settle a
Liability for at least 12 months after the Reporting Date.
Non-Current Assets – All other Assets shall be classified as Non-Current Assets. e.g. Machinery held
for long term etc.
(vi) Liability: It is an obligation of financial nature to be settled at a future date. It represents amount
of money that the business owes to the other parties. E.g. when goods are bought on credit, the
firm will create an obligation to pay to the supplier the price of goods on an agreed future date
or when a loan is taken from bank, an obligation to pay interest and principal amount is created.
Depending upon the period of holding, these obligations could be further classified into Long Term
on non-current liabilities and Short Term or current liabilities.
Current Liabilities – A liability shall be classified as Current when it satisfies any of the following :
(a) It is expected to be settled in the Company’s normal Operating Cycle,
(b) It is held primarily for the purpose of being traded,
(c) It is due to be settled within 12 months after the Reporting Date, or
(d) The Company does not have an unconditional right to defer settlement of the liability for
at least 12 months after the reporting date (Terms of a Liability that could, at the option of
the counterparty, result in its settlement by the issue of Equity Instruments do not affect its
classification)
Non-Current Liabilities – All other Liabilities shall be classified as Non-Current Liabilities. E.g. Loan
taken for 5 years, Debentures issued etc.
(vii) Internal Liability : These represent proprietor’s equity, i.e. all those amount which are entitled to the
proprietor, e.g., Capital, Reserves, Undistributed Profits, etc.
(viii) Working Capital : In order to maintain flows of revenue from operation, every firm needs certain
amount of current assets. For example, cash is required either to pay for expenses or to meet
obligation for service received or goods purchased, etc. by a firm. On identical reason, inventories
are required to provide the link between production and sale. Similarly, Accounts Receivable
generate when goods are sold on credit. Cash, Bank, Debtors, Bills Receivable, Closing Stock,
Prepayments etc. represent current assets of firm. The whole of these current assets form the working
capital of a firm which is termed as Gross Working Capital.
Gross Working capital = Total Current Assets
= Long term internal liabilities plus long term debts plus the current liabilities
minus the amount blocked in the fixed assets.
There is another concept of working capital. Working capital is the excess of current assets over
current liabilities. That is the amount of current assets that remain in a firm if all its current liabilities
are paid. This concept of working capital is known as Net Working Capital which is a more realistic
concept.
Working Capital (Net) = Current Assets – Currents Liabilities.
(ix) Contingent Liability : It represents a potential obligation that could be created depending on the
outcome of an event. E.g. if supplier of the business files a legal suit, it will not be treated as a liability
because no obligation is created immediately. If the verdict of the case is given in favour of the

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supplier then only the obligation is created. Till that it is treated as a contingent liability. Please note
that contingent liability is not recorded in books of account, but disclosed by way of a note to the
financial statements.
(x) Capital : It is amount invested in the business by its owners. It may be in the form of cash, goods,
or any other asset which the proprietor or partners of business invest in the business activity. From
business point of view, capital of owners is a liability which is to be settled only in the event of closure
or transfer of the business. Hence, it is not classified as a normal liability. For corporate bodies, capital
is normally represented as share capital.
(xi) Drawings : It represents an amount of cash, goods or any other assets which the owner withdraws
from business for his or her personal use. e.g. if the life insurance premium of proprietor or a partner
of business is paid from the business cash, it is called drawings. Drawings will result in reduction in
the owners’ capital. The concept of drawing is not applicable to the corporate bodies like limited
companies.
(xii) Net worth : It represents excess of total assets over total liabilities of the business. Technically, this
amount is available to be distributed to owners in the event of closure of the business after payment
of all liabilities. That is why it is also termed as Owner’s equity. A profit making business will result in
increase in the owner’s equity whereas losses will reduce it.
(xiii) Non-current Investments : Non-current Investments are investments which are held beyond the
current period as to sale or disposal. e. g. Fixed Deposit for 5 years.
(xiv) Current Investments : Current investments are investments that are by their nature readily realizable
and are intended to be held for not more than one year from the date on which such investment
is made. e. g. 11 months Commercial Paper.
(xv) Debtor : The sum total or aggregate of the amounts which the customer owe to the business for
purchasing goods on credit or services rendered or in respect of other contractual obligations, is
known as Sundry Debtors or Trade Debtors, or Trade Payable, or Book-Debts or Debtors. In other
words, Debtors are those persons from whom a business has to recover money on account of goods
sold or service rendered on credit. These debtors may again be classified as under:
(i) Good debts : The debts which are sure to be realized are called good debts.
(ii) Doubtful Debts : The debts which may or may not be realized are called doubtful debts.
(iii) Bad debts : The debts which cannot be realized at all are called bad debts.
It must be remembered that while ascertaining the debtors balance at the end of the period certain
adjustments may have to be made e.g. Bad Debts, Discount Allowed, Returns Inwards, etc.
(xvi) Creditor : A creditor is a person to whom the business owes money or money’s worth. e.g. money
payable to supplier of goods or provider of service. Creditors are generally classified as Current
Liabilities.
(xvii) Capital Expenditure : This represents expenditure incurred for the purpose of acquiring a fixed asset
which is intended to be used over long term for earning profits there from. e. g. amount paid to
buy a computer for office use is a capital expenditure. At times expenditure may be incurred for
enhancing the production capacity of the machine. This also will be a capital expenditure. Capital
expenditure forms part of the Balance Sheet.
(xviii) Revenue expenditure : This represents expenditure incurred to earn revenue of the current period.
The benefits of revenue expenses get exhausted in the year of the incurrence. e.g. repairs, insurance,
salary & wages to employees, travel etc. The revenue expenditure results in reduction in profit or
surplus. It forms part of the Income statement.
(xix) Balance Sheet : It is the statement of financial position of the business entity on a particular date.
It lists all assets, liabilities and capital. It is important to note that this statement exhibits the state of
affairs of the business as on a particular date only. It describes what the business owns and what
the business owes to outsiders (this denotes liabilities) and to the owners (this denotes capital). It is
prepared after incorporating the resulting profit/losses of Income statement.

1.8 I FUNDAMENTALS OF ACCOUNTING

(xx) Profit and Loss Account or Income Statement : This account shows the revenue earned by the
business and the expenses incurred by the business to earn that revenue. This is prepared usually
for a particular accounting period, which could be a month, quarter, a half year or a year. The net
result of the Profit and Loss Account will show profit earned or loss suffered by the business entity.
(xxi) Trade Discount : It is the discount usually allowed by the wholesaler to the retailer computed on the
list price or invoice price. e.g. the list price of a TV set could be ` 15000. The wholesaler may allow
20% discount thereof to the retailer. This means the retailer will get it for ` 12000 and is expected to
sale it to final customer at the list price. Thus the trade discount enables the retailer to make profit
by selling at the list price. Trade discount is not recorded in the books of accounts. The transactions
are recorded at net values only. In above example, the transaction will be recorded at ` 12000
only.
(xxii) Cash Discount : This is allowed to encourage prompt payment by the debtor. This has to be recorded
in the books of accounts. This is calculated after deducting the trade discount. e.g. if list price is
` 15000 on which a trade discount of 20% and cash discount of 2% apply, then first trade discount
of ` 3000 (20% of ` 15000) will be deducted and the cash discount of 2% will be calculated on
` 12000 (`15000 – ` 3000). Hence the cash discount will be ` 240 (2% of ` 12000) and net payment
will be ` 11,760 (`12,000 - ` 240)
Illustration 1.
Fill in the blanks:
(a) The cash discount is allowed by ———— to the —————.
(b) Profit means excess of ——— over —————.
(c) Debtor is a person who ——— to others.
(d) In a credit transaction, the buyer is given a ——— facility.
(e) The fixed asset is generally held for —————.
(f) The current liabilities are obligations to be settled in ——— period.
(g) The withdrawal of money by the owner of business is called ————
(h) The amount invested by owners into business is called —————.
(i) Transaction means exchange of money or money’s worth for ————.
(j) The net result of an income statement is ———— or ————.
(k) The ——————— shows financial position of the business as on a particular date.
(l) The ————— discount is never entered in the books of accounts.
(m) Vehicles represent ———— expenditure while repairs to vehicle would mean ————— expenditure.
(n) Net worth is excess of —— ——— over ——— ———.
Solution:
(a) creditor, debtor
(b) income, expenditure
(c) Owes
(d) Credit
(e) Longer period
(f) Short
(g) Drawings
(h) Capital
(i) Value

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Accounting Process

(j) Profit, loss

(k) Balance sheet
(l) Trade
(m) Capital, revenue
(n) Total assets, total liabilities
Illustration 2.
Give one word or a term used to describe the following:-
(a) An exchange of benefit for value
(b) A transaction without immediate cash settlement.
(c) Commodities in which a business deals.
(d) Excess of expenditure over income.
(e) Things of value owned by business to earn future profits.
(f) Amount owed by business to others.
(g) An obligation which may or may not materialise.
(h) An allowance by a creditor to debtor for prompt payment.
(i) Assets like brand value, copy rights, goodwill
Solution:
(a) Transaction, (b) credit transaction, (c) goods, (d) loss, (e) Assets, (f) liability, (g) contingent liability,
(h) cash discount, (i) intangible assets

1.6. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

A widely accepted set of rules, conventions, standards, and procedures for reporting financial information,
as established by the Financial Accounting Standards Board are called Generally Accepted Accounting
Principles (GAAP). These are the common set of accounting principles, standards and procedures that
companies use to compile their financial statements. GAAP are a combination of standards (set by policy
boards) and simply the commonly accepted ways of recording and reporting accounting information.
GAAP is to be followed by companies so that investors have a optimum level of consistency in the
financial statements they use when analyzing companies for investment purposes. GAAP cover such
aspects like revenue recognition, balance sheet item classification and outstanding share measurements.

1.7 ACCOUNTING CONCEPTS AND CONVENTIONS

As seen earlier, the accounting information is published in the form of financial statements. The three
basic financial statements are
(i) The Profit & Loss Account that shows net business result i.e. profit or loss for a certain periods
(ii) The Balance Sheet that exhibits the financial strength of the business as on a particular dates
(iii) The Cash Flow Statement that describes the movement of cash from one date to the other.
As these statements are meant to be used by different stakeholders, it is necessary that the information
contained therein is based on definite principles, concrete concepts and well accepted convention.
Accounting principles are basic guidelines that provide standards for scientific accounting practices
and procedures. They guide as to how the transactions are to be recorded and reported. They assure
uniformity and understandability. Accounting concepts lay down the foundation for accounting
principles. They are ideas essentially at mental level and are self-evident. These concepts ensure

1.10 I FUNDAMENTALS OF ACCOUNTING

recording of financial facts on sound bases and logical considerations. Accounting conventions are
methods or procedures that are widely accepted. When transactions are recorded or interpreted, they
follow the conventions. Many times, however, the terms-principles, concepts and conventions are used
interchangeably.
Professional Accounting Bodies have published statements of these concepts. Over years, many of these
concepts are being challenged as outlived. Yet, no major deviations have been made as yet. Path
breaking ideas have emerged and the accounting standards of modern days do require companies to
record and report transactions which may not be necessarily based on concepts that are in vogue for
long. It is essential to study accounting from the basic levels and understand these concepts in entirety.
Theory Base of Accounting

Modifying
Basic Assumptions Basic Principles
Principles

(a) Basic Principles (a) Revenue Realization Concept (a) Materiality Concept
(b) Going Concern Concept (b) Matching Concept (b) Consistency Concept
(c) Money Measurement Concept (c) Full Disclosure Concept (c) Conservatism Concept
(d) Accounting Period Concept (d) Dual Aspect Concept (d) Timeliness Concept
(e) Accrual Concept (e) Verifiable Objective Evidence Concept (e) Industry Practice Concept
(f) Historical Cost Concept
(g) Balance Sheet Equation Concept

A. BASIC ASSUMPTIONS
(a) Business Entity Concept
This concept explains that the business is distinct from the proprietor. Thus, the transactions of business
only are to be recorded in the books of business.
(b) Going Concern Concept
This concept assumes that the business has a perpetual succession or continued existence.
(c) Money Measurement Concept
According to this concept only those transactions which are expressed in money terms are to be
recorded in accounting books.
(d) The Accounting Period Concept
Businesses are living, continuous organisms. The splitting of the continuous stream of business events into
time periods is thus somewhat arbitrary. There is no significant change just because one accounting
period ends and a new one begins. This results into the most difficult problem of accounting of how to
measure the net income for an accounting period. One has to be careful in recognizing revenue and
expenses for a particular accounting period. Subsequent section on accounting procedures will explain
how one goes about it in practice.
(e) The Accrual Concept
The accrual concept is based on recognition of both cash and credit transactions. In case of a cash
transaction, owner’s equity is instantly affected as cash either is received or paid. In a credit transaction,
however, a mere obligation towards or by the business is created. When credit transactions exist (which
is generally the case), revenues are not the same as cash receipts and expenses are not same as cash
paid during the period.
Today’s accounting systems based on accrual concept are called as Accrual system or mercantile
system of accounting.

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B. BASIC PRINCIPLES

(a) Realization Concept

This concept speaks about recording of only those transactions which are actually realized. For example
Sale or Profit on sales will be taken into account only when money is realized i.e. either cash is received
or legal ownership is transferred.
(b) Matching Concept
It is referred to as matching of expenses against incomes. It means that all incomes and expenses
relating to the financial period to which the accounts relate should be taken in to account without
regard to the date of receipts or payment.
(c) Full Disclosure Concept
As per this concept, all significant information must be disclosed. Accounting data should properly be
clarified, summarized, aggregated and explained for the purpose of presenting the financial statements
which are useful for the users of accounting information. Practically, this principle emphasizes on the
materiality, objectivity and consistency of accounting data which should disclose the true and fair
view of the state of affairs of a firm.
(d) Duality Concept
According to this concept every transaction has two aspects i.e. the benefit receiving aspect and
benefit giving aspect. These two aspects are to be recorded in the books of accounts.
(e) Verifiable Objective Evidence Concept
Under this principle, accounting data must be verified. In other words, documentary evidence of
transactions must be made which are capable of verification by an independent respect. In the
absence of such verification, the data which will be available will neither be reliable nor be dependable,
i.e., these should be biased data. Verifiability and objectivity express dependability, reliability and
trustworthiness that are very useful for the purpose of displaying the accounting data and information
to the users.
(f) Historical Cost Concept
Business transactions are always recorded at the actual cost at which they are actually undertaken.
The basic advantage is that it avoids an arbitrary value being attached to the transactions. Whenever
an asset is bought, it is recorded at its actual cost and the same is used as the basis for all subsequent
accounting purposes such as charging depreciation on the use of asset, e.g. if a production equipment
is bought for ` 1.50 crores, the asset will be shown at the same value in all future periods when disclosing
the original cost. It will obviously be reduced by the amount of depreciation, which will be calculated
with reference to the actual cost. The actual value of the equipment may rise or fall subsequent to the
purchase, but that is considered irrelevant for accounting purpose as per the historical cost concept.
The limitation of this concept is that the balance sheet does not show the market value of the assets
owned by the business and accordingly the owner’s equity will not reflect the real value. However, on
an ongoing basis, the assets are shown at their historical costs as reduced by depreciation.
(g) Balance Sheet Equation Concept
Under this principle, all which has been received by us must be equal to that has been given by us and
needless to say that receipts are clarified as debits and giving is clarified as credits. The basic equation,
appears as :-
Debit = Credit
Naturally every debit must have a corresponding credit and vice-e-versa. So, we can write the above
in the following form –
Expenses + Losses + Assets = Revenues + Gains + Liabilities

1.12 I FUNDAMENTALS OF ACCOUNTING

And if expenses and losses, and incomes and gains are set off, the equation takes the following form
– Asset = Liabilities
or, Asset = Equity + External Liabilities
i.e., the Accounting Equation.

C. MODIFYING PRINCIPLES
(a) The Concept of Materiality
The materiality could be related to information, amount, procedure and nature. Error in description of
an asset or wrong classification between capital and revenue would lead to materiality of information.
Say, If postal stamps of ` 500 remain unused at the end of accounting period, the same may not be
considered for recognizing as inventory on account of materiality of amount. Certain accounting
treatments depend upon procedures laid down by accounting standards. Some transactions are by
nature material irrespective of the amount involved. e.g. audit fees, loan to directors.
(b) Consistency Concept
This Concept says that the Accounting practices should not change or must remain unchanged over
a period of several years.
(c) Conservatism Concept
Conservatism concept states that when alternative valuations are possible, One should select the
alternative which fairly represents economic substance of transactions but when such choice is not
clear select the alternative that is least likely to overstate net assets and net income.
It provides for all known expenses and losses by best estimates if amount is not known with certainty,
but does not recognizes revenues and gains on the basis of anticipation.
(d) Timeliness Concept
Under this principle, every transaction must be recorded in proper time. Normally, when the transaction
is made, the same must be recorded in the proper books of accounts. In short, transaction should
be recorded date-wise in the books. Delay in recording such transaction may lead to manipulation,
misplacement of vouchers, misappropriation etc. of cash and goods. This principle is followed
particularly while verifying day to day cash balance. Principle of timeliness is also followed by banks,
i.e. every bank verifies the cash balance with their cash book and within the day, the same must be
completed.
(e) Industry Practice
As that are different types of industries, each industry has its own characteristics and features. There
may be seasonal industries also. Every industry follows the principles and assumption of accounting
to perform their own activities. Some of them follow the principles, concepts and conventions in a
modified way. The accounting practice which has always prevailed in the industry is followed by it.
e.g Electric supply companies, Insurance companies maintain their accounts in a specific manner.
Insurance companies prepare Revenue Account just to ascertain the profit/loss of the company and
not Profit and Loss Account. Similarly, non trading organizations prepare Income and Expenditure
Account to find out Surplus or Deficit.

FUNDAMENTALS OF ACCOUNTING I 1.13

Accounting Process

1.8 EVENTS AND TRANSACTIONS

Transaction:
Transaction is exchange of an asset and discharge of liabilities with consideration of monetary value.
Events:
While event is anything in general purpose which occur at specific time and particular place.
We can also say that all transactions are events and but all events are not transactions. This is because
in order events to be called transaction an event must involve exchange of values.

1.9 VOUCHER

Voucher:
• It is a written instrument that serves to confirm or witness (vouch) for some fact such as a transaction.
• A voucher is a document that shows goods have bought or services have been rendered, authorizes
payment, and indicates the ledger account(s) in which these transactions have to be recorded.

Types of Voucher
Receipt Payment Non-Cash or Transfer Supporting
Voucher Voucher Voucher Voucher

(i) Receipt Voucher

Receipt voucher is used to record cash or bank receipt. Receipt vouchers are of two types. i-e.
(a) Cash receipt voucher – it denotes receipt of cash
(b) Bank receipt voucher – it indicates receipt of cheque or demand draft
(ii) Payment Voucher
Payment voucher is used to record a payment of cash or cheque. Payment vouchers are of two
types. i.e.
(a) Cash Payment voucher – it denotes payment of cash
(b) Bank Payment voucher – it indicates payment by cheque or demand draft.
(iii) Non Cash Or Transfer Voucher
These vouchers are used for non-cash transactions as documentary evidence. e.g., Goods sent
on credit.
(iv) Supporting Vouchers
These vouchers are the documentary evidence of transactions that have happened.

1.10 DOUBLE ENTRY SYSTEM

Double Entry System

It was in 1494 that Luca Pacioli the Italian mathematician, first published his comprehensive treatise on
the principles of Double Entry System. The use of principles of double entry system made it possible to
record not only cash but also all sorts of Mercantile transactions. It had created a profound impact on
auditing too, because it enhanced the duties of an auditor to a considerable extent.
Features of Double Entry System
(i) Every transaction has two fold aspects, i.e., one party giving the benefit and the other receiving
the benefit.

1.14 I FUNDAMENTALS OF ACCOUNTING

(ii) Every transaction is divided into two aspects, Debit and Credit.
One account is to be debited and the other account is to be credited.
(iii) Every debit must have its corresponding and equal credit.
Advantages of Double Entry System
(i) Since personal and impersonal accounts are maintained under the double entry system, both the
effects of the transactions are recorded.
(ii) It ensures arithmetical accuracy of the books of accounts, for every debit, there is a corresponding
and equal credit. This is ascertained by preparing a trial balance periodically or at the end of the
financial year.
(iii) It prevents and minimizes frauds. Moreover frauds can be detected early.
(iv) Errors can be checked and rectified easily.
(v) The balances of receivables and payables are determined easily, since the personal accounts are
maintained.
(vi) The businessman can compare the financial position of the current year with that of the past year/s.
(vii) The businessman can justify the standing of his business in comparison with the previous years
purchase, sales, and stocks, incomes and expenses with that of the current year figures.
(viii) Helps in decision making.
(ix) The net operating results can be calculated by preparing the Trading and Profit and Loss A/c for
the year ended and the financial position can be ascertained by the preparation of the Balance
Sheet.
(x) It becomes easy for the Government to decide the tax.
(xi) It helps the Government to decide sickness of business units and extend help accordingly.
(xii) The other stakeholders like suppliers, banks, etc take a proper decision regarding grant of credit or
loans.
Limitations of Double Entry System
(i) The system does not disclose all the errors committed in the books accounts.
(ii) The trial balance prepared under this system does not disclose certain types of errors.
(ii) It is costly as it involves maintenance of numbers of books of accounts.

1.11 THE CONCEPTS OF ‘ACCOUNT’, ‘DEBIT’ AND ‘CREDIT’

The concept of Account

• An account is defined as a summarized record of transactions related to a person or a thing e.g.
when the business deals with customers and suppliers, each of the customers and supplier will be a
separate account.
• The account is also related to things – both tangible and intangible. e.g. land, building, equipment,
brand value, trademarks etc are some of the things. When a business transaction happens, one
has to identify the ‘account’ that will be affected by it and then apply the rules to decide the
accounting treatment.
• Typically, an account is expressed as a statement in form of English letter ‘T’. It has two sides. The
left hand side is called as “Debit’ side and the right hand side is called as “Credit’ side. The debit is
denoted as ‘Dr’ and the credit by ‘Cr’. The convention is to write the Dr and Cr labels on both sides
as shown below. Please see the following example:

Dr. Cash Account Cr.

Debit side Credit side

FUNDAMENTALS OF ACCOUNTING I 1.15

Accounting Process

1.12 TYPES OF ACCOUNTS

Let us see what each type of account means.

(1) Personal Account : As the name suggests these are accounts related to persons.
(a) These persons could be natural persons like Suresh’s A/c, Anil’s a/c, Rani’s A/c etc.
(b) The persons could also be artificial persons like companies, bodies corporate or association
of persons or partnerships etc. Accordingly, we could have Videocon Industries A/c, Infosys
Technologies A/c, Charitable Trust A/c, Ali and Sons trading A/c, ABC Bank A/c, etc.
(c) There could be representative personal accounts as well. Although the individual identity of
persons related to these is known, the convention is to reflect them as collective accounts. e.g.
when salary is payable to employees, we know how much is payable to each of them, but
collectively the account is called as ‘Salary Payable A/c’. Similar examples are rent payable,
Insurance prepaid, commission pre-received etc. The students should be careful to have clarity
on this type and the chances of error are more here.
(2) Real Accounts : These are accounts related to assets or properties or possessions. Depending on
their physical existence or otherwise, they are further classified as follows:-
(a) Tangible Real Account – Assets that have physical existence and can be seen, and touched.
e.g. Machinery A/c, Stock A/c, Cash A/c, Vehicle A/c, and the like.
(b) Intangible Real Account – These represent possession of properties that have no physical
existence but can be measured in terms of money and have value attached to them. e.g.
Goodwill A/c, Trade mark A/c, Patents & Copy Rights A/c, Intellectual Property Rights A/c and
the like.
(3) Nominal Account : These accounts are related to expenses or losses and incomes or gains e.g. Salary
and Wages A/c, Rent of Rates A/c, Travelling Expenses A/c, Commission received A/c, Loss by fire
A/c etc.
The concept of Debit and Credit
• In double entry book-keeping, debits and credits (abbreviated Dr and Cr, respectively) are entries
made in account ledgers to record changes in value due to business transactions.
• Debit is derived from the latin word “debitum”, which means ‘what we will receive’. It is the
destination, who enjoys the benefit.
• Credit is derived from the latin word “credre” which means ‘what we will have to pay’. It is the
source, who sacrifices for the benefit.
• The source account for the transaction is credited (an entry is made on the right side of the
account’s ledger) and the destination account is debited (an entry is made on the left).

1.16 I FUNDAMENTALS OF ACCOUNTING

• Each transaction’s debit entries must equal its credit entries.
• The difference between the total debits and total credits in a single account is the account’s
balance. If debits exceed credits, the account has a debit balance; if credits exceed debits, the
account has a credit balance.

1.13 THE ACCOUNITNG PROCESS

There are two approaches for deciding an account is debited or credit.

1. American Approach 2. British Approach or

or Modern Approach Accounting Proces Traditional Approach

Mostly followed the British Rule.

A. American approach : In order to understand the rules of debit and credit according to this approach
transactions are divided into the following five categories:
(i) Transactions relating to owner, e.g., Capital – These are personal accounts
(ii) Transactions relating to other liabilities, e.g., suppliers of goods – These are mostly personal
accounts
(iii) Transactions relating to assets, e.g., land, building, cash, bank, stock-in-trade, bills receivable
– These are basically all real accounts
(iv) Transactions relating to expenses, e.g., rent, salary, commission, wages, cartage – These are
nominal accounts
(v) Transactions relating to revenues, e.g., interest received, dividend received, sale of goods –
These are nominal accounts

To Sum Up
For Assets Increase in Assets Dr.
Decrease in Assets Cr.
For Liabilities Decrease in Liabilities Dr.
Increase in Liabilities Cr.
For Capital Decrease in Capital Dr.
Increase in Capital Cr.
For Incomes Decrease in Income Dr.
Increase in Income Cr.
For Expense Increase in Expense Dr.
Decrease in Expense Cr.
For Stock Increase in Stock Dr.
Decrease in Stock Cr.

B. British Approach or Double Entry System :

When one identifies the account that is getting affected by a transaction and type of that account,
the next step is to apply the rules to decide whether the accounting treatment is to debit or credit that
account. The Golden Rules will guide us whether the account is to be debited or credited.

FUNDAMENTALS OF ACCOUNTING I 1.17

Accounting Process

These rules are shown below:

Personal Account Debit the receiver or who owes to business

Credit the giver or to whom business owes

Real Account Debit what comes into business

Credit what goes out of business

Debit all expenses or losses

Nominal Account Credit all income or gains

Illustration 3.
Ascertain the debit and credit from the following particulars under Modern Approach.
(a) Started business with capital.
(b) Bought goods for cash.
(c) Sold goods for cash.
(d) Paid salary.
(e) Received Interest on Investment.
(f) Bought goods on credit from Mr. Y
(g) Paid Rent out of Personal cash.

Solution:

Effect of Transaction Account To be debited/Credited

(a) Increase in Cash Cash A/c Debit
Increase in Capital Capital A/c Credit
(b) Increase in Stock Purchase A/c Debit
Decrease in Cash Cash A/c Credit
(c) Increase in Cash Cash A/c Debit
Decrease in Stock Sale A/c Credit
(d) Increase in Expense Salary A/c Debit
Decrease in Cash Cash A/c Credit
(e) Increase in Cash Cash A/c Debit
Increase in Income Interest A/c Credit
(f) Increase in Stock Purchase A/c Debit
Increase in Liability Y A/c Credit
(g) Increase in Expense Rent A/c Debit
Increase in Liability Capital A/c Credit

1.18 I FUNDAMENTALS OF ACCOUNTING

Illustration 4.
Ascertain the Debit Credit under British Approach or Double Entry System. Take Previous illustration.
Solution:

Step-I Step-II Step-III Step-IV

(a) Cash A/c Real Comes in Debit
Capital A/c Personal Giver Credit
(b) Purchase A/c Nominal Expenses Debit
Cash A/c Real Goes out Credit
(c) Cash A/c Real Comes in Debit
Sales A/c Nominal Incomes Credit
(d) Salary A/c Nominal Expenses Debit
Cash A/c Real Goes out Credit
(e) Cash A/c Real Comes in Debit
Interest A/c Nominal Incomes Credit
(f) Purchase A/c Nominal Expenses Debit
Y’ A/c Personal Giver Credit
(g) Rent A/c Nominal Expenses Debit
Capital A/c Personal Giver Credit

1.14 ACCOUNTING EQUATION

The whole Financial Accounting dependes on Accounting Equation which is also known as Balance
Sheet Equation. The basic Accounting Equation is:

Assets = Liabilities + Owner’s equity

or A = L + P
or P = A - L
or L = A - P
} Where A = Assets, L = Liabilities, P = Capital

While trying to do this correlation, please note that incomes or gains will increase owner’s equity and
expenses or losses will reduce it.
Students are advised to go through the following illustration to understand this equation properly.
Illustration 5.
Prepare an Accounting Equation from the following transactions in the books of Mr. X for January, 2012 :-
1 Invested Capital in the firm ` 20,000
2 Purchased goods on credit from Das & Co. for ` 2,000
4 Bought plant for cash ` 8,000
8 Purchased goods for cash ` 4,000
12 Sold goods for cash (cost ` 4,000 + Profit ` 2,000) ` 6,000.
18 Paid to Das & Co. in cash ` 1,000
22 Received from B. Banerjee ` 300
25 Paid salary ` 6,000
30 Received interest ` 5,000
31 Paid wages ` 3,000

FUNDAMENTALS OF ACCOUNTING I 1.19

Accounting Process

Solution:
Effect of transaction on Assets, Liabilities and Capital
Date Transaction Assets = Liabilities + Capital
January, 2013 Invested Capital in the firm ` 20,000 20,000 - 20,000
1
2 Purchased goods on credit from Das &
Co. ` 2,000 +2,000 +2,000 -
Revised Equation 22,000= 2,000+ 20,000
4 Bought Plant for cash ` 8,000 +8,000 - -
-8,000
Revised Equation 22,000 = 2,000+ 20,000
8 Purchased goods for cash ` 4,000 +4,000 - -
-4,000 - -
Revised Equation 22,000= 2,000+ 20,000
12 Sold Goods for cash (Cost ` 4,000 + Profit +6,000
` 2,000) -4,000 +2,000
Revised Equation 24,000 2,000+ 22,000
18 Paid to Das & Co. for ` 1,000 -1,000 -1,000
Revised Equation 23,000= 1,000+ 22,000
22 Received from B.Banerjee for ` 300 +300
-300
Revised Equation 23,000 = 1,000+ 22,000
25 Paid salary for ` 6,000 - 6,000 -6,000
Revised Equation 17,000 = 1,000+ 16,000
30 Received Interest for ` 5,000 +5,000 +5,000
Revised Equation 22,000= 1,000+ 21,000
31 Paid Wages for `3,000 -3,000 -3,000
Revised Equation 19,000= 1,000+ 18,000

1.15 ACCRUAL BASIS AND CASH BASIS OF ACCOUNTING

Accounting

Accrual Cash
Basis Basis

Accounting

1.20 I FUNDAMENTALS OF ACCOUNTING

(i) Accrual Basis of Accounting
Accrual Basis of Accounting is a method of recording transactions by which revenue, costs, assets
and liabilities are reflected in the accounts for the period in which they accrue. This basis includes
consideration relating to deferrals, allocations, depreciation and amortization. This basis is also referred
to as mercantile basis of accounting.
(ii) Cash Basis of Accounting
Cash Basis of Accounting is a method of recording transactions by which revenues, costs, assets and
liabilities are reflected in the accounts for the period in which actual receipts or actual payments are
made.
Distinction between Accrual Basis of Accounting and Cash Basis of Accounting
Basis of Distinction Accrual Basis of Accounting Cash Basis of Accounting
1. Prepaid/Outstanding Expenses/ Under this, there may be Under this, there is no
accrued/unaccrued Income in prepaid/outstanding expenses prepaid/outstanding
Balance Sheet. and accrued/unaccrued expenses or accrued/
incomes in the Balance Sheet. unaccrued incomes.
2. Higher/lower Income in case of Income Statement will show a Income Statement will
prepaid expenses and accrued relatively higher income show lower income.
income
3. Higher/lower income incase Income Statement will show a Income Statement will
of outstanding expenses and relatively lower income. show higher income.
unaccrued income
4. Availability of options to an Under this, an accountant has Under this an accountant
accountant to manipulate the options. has no option to make a
accounts by way of choosing the choice as such.
most suitable method out of several
alternative methods of accounting
e.g. FIFO/LIFO/SLM/WDV

Hybrid or Mixed Basis

Under the hybrid system of accounting, incomes are recognised as in Cash Basis Accounting i.e. when
they are received in cash and expenses are recognised on accrual basis i.e. during the accounting
period in which they arise irrespective of when they are paid.
Illustration 6.
Mr. Anil Roy, a junior lawyer, provides the following particulars for the year ended 31st December, 2013:
`
Fees received in cash in 2013 60,000
Salary paid to Staff in 2013 8,000
Rent of office in 2013 14,000
Magazine and Journal for 2013 1,000
Travelling and Conveyance paid in 2013 3,000
Membership Fees paid in 2013 1,600
Office Expenses paid in 2013 10,000

Additional Information:-
Fees include ` 3,000 in respect of 2012and fees not yet received is ` 7,000.
Office rent includes ` 4,000 for previous year and rent of ` 2,000 not yet paid.
Membership fees is paid for 2 years.
Compute his net income for the year 2013, under – (a) Cash Basis, (b) Accrual Basis and (c) Mixed or
Hybrid Basis.

FUNDAMENTALS OF ACCOUNTING I 1.21

Accounting Process

Solution:
(i)
Mr. Anil Roy
Statement of Income (Cash Basis)
For the year ended 31st December, 2013

Particulars Amount (`) Amount (`)

Fees received 60,000
Less :
Salary 8,000
Office Rent 14,000
Magazine & Journal 1,000
Travelling & Conveyance 3,000
Membership Fees 1,600
Office Expenses 10,000 37,600
Net Income 22,400

(ii) Mr. Anil Roy

Statement of Income (Accrual Basis)
For the year ended 31st December, 2013

Particulars Amount (`) Amount (`)

Fees received 60,000
Add: Accrued fees for 2013 7,000
67,000
Less: Fees for 2012 received in 2013 3,000 64,000
Less :
Salary 8,000
Office Rent 14,000
Add: Outstanding rent 2,000
16,000
Less: Rent for 2012 paid in 2013 4,000 12,000
Magazine & Journal 1,000
Travelling & Conveyance 3,000
Membership Fees 1,600
Less: Advance fee paid for 2014 ( ½ x 1600) 800 800
Office Expenses 10,000 34,800
Net Income 29,200

1.22 I FUNDAMENTALS OF ACCOUNTING

(iii)
Mr. Anil Roy
Statement of Income (Mixed or Hybrid Basis)
For the year ended 31st December, 2013

Particulars Amount (`) Amount (`) Amount (`)

Fees received 60,000
Less :
Salary 8,000
Office Rent 14,000
Add: Outstanding rent 2,000
16,000
Less: Fees for 2012 4,000 12,000
Magazine & Journal 1,000
Travelling & Conveyance 3,000
Membership Fees 1,600
Less: Advance 800 800
Office Expenses 10,000 34,800
Net Income 25,200

1.16 CAPITAL AND REVENUE TRANSACTIONS

There are 2 types of Transaction

1. Capital
2. Revenue
The concepts of capital and revenue are of fundamental importance to the correct determination of
accounting profit for a period and recognition of business assets at the end of that period.
• Capital Transactions:
Transactions having long-term effect are known as capital transactions.
• Revenue Transactions:
Transactions having short-term effect are known as revenue transactions.
• Capital Expenditure
Capital expenditure can be defined as expenditure incurred on the purchase, alteration or
improvement of fixed assets. For example, the purchase of a car to be use to deliver goods is capital
expenditure. Included in capital expenditure are such costs as:
• Delivery of fixed assets;
• Installation of fixed assets;
• Improvement (but not repair) of fixed assets;
• Legal costs of buying property;
• Demolition costs;
• Architects fees;

FUNDAMENTALS OF ACCOUNTING I 1.23

Accounting Process

• Revenue Expenditures
Revenue expenditure is expenditure incurred in the running / management of the business. For
example, the cost of petrol or diesel for cars is revenue expenditure. Other revenue expenditure:
• Maintenance of Fixed Assets;
• Administration of the business;
• Selling and distribution expenses.
Capitalized Expenditure
Expenditure connected with the purchase of fixed asset are called capitalized expenditure e.g. wages
paid for the installation of machinery.
The Treatments of Capital and Revenue Expenditures
Capital expenditures are shown in the Balance Sheet Assets Side while Revenue Expenditures are
shown in the Trading and Profit And Loss Account debit side.
Revenue Receipts
Amount received against revenue income are called revenue receipt.
Capital Receipts
Amount received against capital income are called capital receipts.
Capital Profits
Capital profit which is earned on the sale of the fixed assets.
Revenue Profit
The profit which is earned during the ordinary course of business is called revenue profit.
Capital Loss
The loss suffered by a company on the sale of fixed assets.
Revenue Loss
The loss suffered by the business in the ordinary course of business is called revenue loss.
Rules for Determining Capital Expenditure
An expenditure can be recognised as capital if it is incurred for the following purposes :
• An expenditure incurred for the purpose of acquiring long term assets (useful life is at least more than
one accounting period) for use in business to earn profits and not meant for resale, will be treated
as a capital expenditure. For example, if a second hand motor car dealer buys a piece of furniture
with a view to use it in business; it will be a capital expenditure. But if he buys second hand motor
cars, for re-sale, then it will be a revenue expenditure because he deals in second hand motor cars.
• When an expenditure is incurred to improve the present condition of a machine or putting an old
asset into working condition, it is recognised as a capital expenditure. The expenditure is capitalised
and added to the cost of the asset. Likewise, any expenditure incurred to put an asset into working
condition is also a capital expenditure.
• For example, if one buys a machine for ` 5,00,000 and pays ` 20,000 as transportation charges and
` 40,000 as installation charges, the total cost of the machine comes upto ` 5,60,000. Similarly, if a
building is purchased for ` 1,00,000 and ` 5,000 is spent on registration and stamp duty, the capital
expenditure on the building stands at ` 1,05,000.
• If an expenditure is incurred, to increase earning capacity of a business will be considered as of
capital nature. For example, expenditure incurred for shifting ‘the ‘factory for easy supply of raw
materials. Here, the cost of such shifting will be a capital expenditure.

1.24 I FUNDAMENTALS OF ACCOUNTING

• Preliminary expenses incurred before the commencement of business is considered capital
expenditure. For example, legal charges paid for drafting the memorandum and articles of
association of a company or brokerage paid to brokers, or commission paid to underwriters for
raising capital.
• Thus, one useful way of recognising an expenditure as capital is to see that the business will own
something which qualifies as an asset at the end of the accounting period.
Some examples of capital expenditure:
(i) Purchase of land, building, machinery or furniture; (ii) Cost of leasehold land and building; (iii) Cost of
purchased goodwill; (iv) Preliminary expenditures; (v) Cost of additions or extensions to existing assets;
(vi) Cost of overhauling second-hand machines; (vii) Expenditure on putting an asset into working
condition; and (viii) Cost incurred for increasing the earning capacity of a business.
Rules for Determining Revenue Expenditure
Any expenditure which cannot be recognised as capital expenditure can be termed as revenue
expenditure. A revenue expenditure temporarily influences only the profit earning capacity of the
business. An expenditure is recognised as revenue when it is incurred for the following purposes :
Expenditure for day-to-day conduct of the business, the benefits of which last less than one year. Examples
are wages of workmen, interest on borrowed capital, rent, selling expenses, and so on.
Expenditure on consumable items, on goods and services for resale either in their original or improved
form. Examples are purchases of raw materials, office stationery, and the like. At the end of the year,
there may be some revenue items (stock, stationery, etc.) still in hand. These are generally passed over
to the next year though they were acquired in the previous year.
Expenditures incurred for maintaining fixed assets in working order. For example, repairs, renewals and
depreciation.
Some examples of revenue expenditure
(i) Salaries and wages paid to the employees;
(ii) Rent and rates for the factory or office premises;
(iii) Depreciation on plant and machinery;
(iv) Consumable stores;
(v) Inventory of raw materials, work-in-progress and finished goods;
(vi) Insurance premium;
(vii) Taxes and legal expenses; and
(viii) Miscellaneous expenses.

Deferred Revenue Expenditures

Deferred revenue expenditures represent certain types of assets whose usefulness does not expire in the
year of their occurrence but generally expires in the near future. These type of expenditures are carried
forward and are written off in future accounting periods. Sometimes, we make some revenue expenditure
but it eventually becomes a capital asset (generally of an intangible nature). If one undertake substantial
repairs to the existing building, the deterioration of the premises may be avoided. We may engage our
own employees to do that work and pay them at prevailing wage-rate, which is of a revenue nature. If
this expenditure is treated as a revenue expenditure and the current year’s-profit is charged with these
expenses, we are making the current year to absorb the entire expenses, though the benefit of which
will be enjoyed for a number of accounting years. To overcome this difficulty, the entire expenditure is
capitalised and is added to the asset account. Another example is an insurance policy. A business can
pay insurance premium in advance, say, for a 3 year period. The right does not expire in the accounting
period in which it is paid but will expire within a fairly short period of time (3 years). Only a portion of

FUNDAMENTALS OF ACCOUNTING I 1.25

Accounting Process

the total premium paid should be treated as a revenue expenditure (portion pertaining to the current
period) and the balance should be carried forward as an asset to be written off in subsequent years.
AS 26 - Intangible Asset does not accept this view. Para 56 states, “Expenditure incurred to provide
future economic benefit to an enterprise that can be recognized as an expense when it is incurred.
e.g. expenditure incurred on Scientific Research is recognized as an expense when it is incurred”. In
short, the whole amount of expenditure is treated as expense for the current year only and will not
proportionately be transferred as deferred charge.

Illustration 8.
State whether the following are capital, revenue or deferred revenue expenditure.
(i) Carriage of ` 7,500 spent on machinery purchased and installed.
(ii) Heavy advertising costs of ` 20,000 spent on the launching of a company’s new product.
(iii) ` 200 paid for servicing the company vehicle, including ` 50 paid for changing the oil.
(iv) Construction of basement costing ` 1,95,000 at the factory premises.
Solution :
(i) Carriage of ` 7,500 paid for machinery purchased and installed should be treated as a Capital
Expenditure.
(ii) Advertising expenses for launching a new product of the company should be treated as a Revenue
Expenditure. (As per AS-26)
(iii) ` 200 paid for servicing and oil change should be treated as a Revenue Expenditure.
(iv) Construction cost of basement should be treated as a Capital Expenditure.
Illustration 9.
State whether the following are capital or revenue expenditure.
(i) Paid a bill of ` 10,000 of Mr. Kumar, who was engaged as the erection engineer to set up a new
automatic machine costing ` 20,000 at the new factory site.
(ii) Incurred ` 26,000 expenditure on varied advertisement campaigns under taken yearly, on a regular
basis, during the peak festival season.
(iii) In accordance with the long-term plan of providing a well- equipped Labour Welfare Centre, spent
` 90,000 being the budgeted allocation for the year.
Solution :
(i) Expenses incurred for erecting a new machine should be treated as a Capital Expenditure.
(ii) Advertisement expenses during peak festival season should be treated as a Revenue Expenditure.
(iii) Expenses incurred for Labour Welfare Centre should be treated as a Capital Expenditure.
Illustration 10.
Classify the following items as capital or revenue expenditure :
(i) An extension of railway tracks in the factory area;
(ii) Wages paid to machine operators;
(iii) Installation costs of new production machine;
(iv) Materials for extension to foremen’s offices in the factory;
(v) Rent paid for the factory;
(vi) Payment for computer time to operate a new stores control system,
(vii) Wages paid to own employees for building the foremen’s offices.
Give reasons for your classification.
1.26 I FUNDAMENTALS OF ACCOUNTING
Solution :
(i) Expenses incurred for extension of railway tracks in the factory area should be treated as a Capital
Expenditure because it will yield benefit for more than one accounting period.
(ii) Wages paid to machine operators should be treated as a Revenue Expenditure as it will yield
benefit for the current period only.
(iii) Installation costs of new production machine should be treated as a Capital Expenditure because
it will benefit the business for more than one accounting period.
(iv) Materials for extension to foremen’s offices in the factory should be treated as a Capital Expenditure
because it will benefit the business for more than one accounting period.
(v) Rent paid for the factory should be treated as a Revenue Expenditure because it will benefit only
the current period.
(vi) Payment for computer time to operate a new stores control system should be treated as Revenue
Expenditure because it has been incurred to carry on the normal business.
(vii) Wages paid for building foremen’s offices should be treated as a Capital Expenditure because it
will benefit the business for more than one accounting period.
Illustration 11.
For each of the cases numbered below, indicate whether the income/expenditure is capital or revenue.
(i) Payment of wages to one’s own employees for building a new office extension.
(ii) Regular hiring of computer time for the preparation of the firm’s accounts.
(iii) The purchase of a new computer for use in the business.
(iv) The use of motor vehicle, hired for five years, but paid at every six months.
Solution :
(i) Payment of wages for building a new office extension should be treated as a Capital Expenditure.
(ii) Computer hire charges should be treated as a Revenue Expenditure.
(iii) Purchase of computer for use in the business should be treated as a Capital Expenditure.
(iv) Hire charges of motor vehicle should be treated as a Revenue Expenditure.
Illustration 12.
State with reasons whether the following are capital or revenue expenditure :
(i) Freight and cartage on the new machine ` 150, and erection charges ` 500.
(ii) Fixtures of the book value of ` 2,500 sold off at ` 1,600 and new fixtures of the value of ` 4,000 were
acquired. Cartage on purchase ` 100.
(iii) A sum of ` 400 was spent on painting the factory.
(iv) ` 8,200 spent on repairs before using a second hand car purchased recently, to put it in usable
condition.
Solution :
(i) Freight and cartage totaling ` 650 should be treated as a Capital Expenditure because it will benefit
the business for more than one accounting year.
(ii) Loss on sale of fixtures ` (2,500 – 1,600) = ` 900 should be treated as a Capital Loss. The cost of new
fixtures and carriage thereon should be treated as a Capital Expenditure because the fixture will
be used for a long period. So ` (4,000+1,000)the cost of new fixture will be ` 4,100.
(iii) Painting of the factory should be treated as a Revenue Expenditure because it has been incurred
to maintain the factory building.

FUNDAMENTALS OF ACCOUNTING I 1.27

Accounting Process

(iii) Repairing cost of second hand car should be treated as a Capital Expenditure because it will
benefit the business for more than one accounting year.
Illustration 13.
State the nature (capital or revenue) of the following expenditure which were incurred by Vedanta &
Co. during the year ended 30th June, 2013 :
(i) ` 350 was spent on repairing a second hand machine which was purchased on 8th May, 2013 and
` 200 was paid on carriage and freight in connection with its acquisition.
(ii) A sum of ` 30,000 was paid as compensation to two employees who were retrenched.
(iii) ` 150 was paid in connection with carriage on goods purchased.
(iv) ` 20,000 customs duty is paid on import of a machinery for modernisation of the factory production
during the current year and ` 6,000 is paid on import duty for purchase of raw materials.
(v) ` 18,000 interest had accrued during the year on term loan obtained and utilised for the construction
of factory building and purchase of machineries; however, the production has not commenced
till the last date of the accounting year.
Solution :
(i) Repairing and carriage totaling ` 550 for second hand machine should be treated as a Capital
Expenditure.
(ii) Compensation paid to employees shall be treated as a Revenue Expenditure.
(iii) Carriage paid for goods purchased should be treated as a Revenue Expenditure.
(iv) Customs duty paid on import of machinery to be treated as a Capital Expenditure. However, import
duty paid for raw materials should be treated as a Revenue Expenditure.
(v) Interest paid during pre-construction period to be treated as a Capital Expenditure.
Illustration 14.
State with reasons whether the following items relating to Parvati Sugar Mill Ltd. are capital or revenue :
(i) ` 50,000 received from issue of shares including ` 10,000 by way of premium.
(ii) Purchased agricultural land for the mill for ` 60,000 and ` 500 was paid for land revenue.
(iii) ` 5,000 paid as contribution to PWD for improving roads of sugar producing area.
(iv) ` 40,000 paid for excise duty on sugar manufactured.
(v) ` 70,000 spent for constructing railway siding.
Solution :
(i) ` 40,000 (50,000 – ` 10,000) received from issue of shares will be treated as a Capital Receipt. The
premium of ` 10,000 should be treated as a Capital Profit.
(ii) Cost of land ` 60,000 to be treated as Capital Expenditure and land revenue of ` 500 to be treated
as Revenue Expenditure.
(iii) Contribution paid to PWD should be treated as a Revenue Expenditure.
(iv) Excise duty of ` 40,000 should be treated as a Revenue Expenditure.
(v) ` 70,000 spent for constructing railway siding to be treated as a Capital Expenditure.
Illustration 15.
State with reasons whether the following are Capital Expenditure or Revenue Expenditure :
(i) Expenses incurred in connection with obtaining a licence for starting the factory were ` 10,000.

1.28 I FUNDAMENTALS OF ACCOUNTING

(ii) ` 1,000 paid for removal of stock to a new site.
(iii) Rings and Pistons of an engine were changed at a cost of ` 5,000 to get full efficiency.
(iv) ` 2,000 spent as lawyer’s fee to defend a suit claiming that the firm’s factory site belonged to the
Plaintiff. The suit was not successful.
(v) ` 10,000 were spent on advertising the introduction of a new product in the market, the benefit of
which will be effective during four years.
(vi) A factory shed was constructed at a cost of ` 1,00,000. A sum of ` 5,000 had been incurred for the
construction of the temporary huts for storing building materials.
Solution :
(i) ` 10,000 incurred in connection with obtaining a license for starting the factory is a Capital
Expenditure. It is incurred for acquiring a right to carry on business for a long period.
(ii) ` 1,000 incurred for removal of stock to a new site is treated as a Revenue Expenditure because it
is not enhancing the value of the asset and it is also required for starting the business on the new
site.
(iii) ` 5,000 incurred for changing Rings and Pistons of an engine is a Revenue Expenditure because, the
change of rings and piston will restore the efficiency of the engine only and it will not add anything
to the capacity of the engine.
(iv) ` 2,000 incurred for defending the title to the firm’s assets is a Revenue Expenditure.
(v) ` 10,000 incurred on advertising is to be treated as a Revenue Expenditure (As per AS-26).
(vi) Cost of construction of Factory shed of ` 1,00,000 is a Capital Expenditure, similarly cost of construction
of small huts for storing building materials is also a Capital Expenditure.
Illustration 16.
State clearly how you would deal with the following in the books of a Company :
(i) The redecoration expenses ` 6,000.
(ii) The installation of a new Coffee-making Machine for ` 10,000.
(iii) The building of an extension of the club dressing room for ` 15,000.
(iv) The purchase of Snacks & food stuff ` 2,000.
(v) The purchase of V.C.R. and T.V. for the use in the club lounge for ` 15,000.
Solution :
(i) The redecoration expenses of ` 6,000 shall be treated as a Deferred Revenue Expenditure.
(ii) The installation of a new Coffee - Making Machine is a Capital Expenditure because it is the
acquisition of an asset.
(iii) ` 15,000 spent for the extension of club dressing room is a Capital Expenditure because it creates
an asset of a permanent nature.
(iv) The purchase of snacks & food stuff of ` 2,000 is a Revenue Expenditure.
(v) The purchase of V.C.R. and T.V. for ` 15,000 is a Capital Expenditure, because it is the acquisition
of assets.

FUNDAMENTALS OF ACCOUNTING I 1.29

Accounting Process

1.17 ACCOUNTING STANDARDS

Comparative Statement of AS & IND AS (Subject- Wise)

SL.No. Accounting IND AS No. Name of IND AS
Standards (AS)
I. Standards on Presentation
1 AS 1 Ind AS 1 Presentation of Financial Statements
2 AS 3 Ind AS 7 Statement of Cash Flows
3 AS 5 Ind AS 8 Accounting Policies, Changes in Accounting Estimates and
Errors
4 AS 4 Ind AS 10 Events after the Reporting Period
5 AS 25 Ind AS 34 Interim Financial Reporting
6 No Corresponding Ind AS 29 Financial Reporting in Hyperinflationary Economies
Standard
II. Standards on Consolidation
7 AS 21 Ind AS 27
Consolidated and Separate Financial Statements
8 AS 23 Ind AS 28
Investments in Associates
9 AS 27 Ind AS 31
Interests in Joint Ventures
10 AS 14 Ind AS 103
Business Combinations
III. Standards on Revenue
11 AS 2 Ind AS 2 Inventories
12 AS 7 Ind AS 11 Construction Contracts
13 AS 9 Ind AS 18 Revenue
14 AS 12 Ind AS 20 Accounting for Government Grants and Disclosure of
Government Assistance
15 AS 11 Ind AS 21 The Effects of Changes in Foreign Exchange Rates
IV. Standards on Liabilities and Provisions
16 AS 15 Ind AS 19 Employee Benefits
17 AS 29 Ind AS 37 Provisions, Contingent Liabilities and Contingent Assets
18 Guidance Note Ind AS 102 Share-based Payment
19 No Corresponding Ind AS 104 Insurance Contracts
Standard
V. Standards on Disclosures
20 AS 18 Ind AS 24 Related Party Disclosures
21 AS 20 Ind AS 33 Earnings Per Shares
22 AS 17 Ind AS 108 Operating Segments
VI. Standards on Assets
23 AS 16 Ind AS 23 Borrowing Costs
24 AS 28 Ind AS 36 Impairments of Assets
25 AS 26 Ind AS 38 Intangible Assets
26 No Corresponding Ind AS 40 Investment Property
Standard
27 AS 10 & AS 6 Ind AS 16 Property, Plant and Equipment
28 AS 19 Ind AS 17 Leases
29 AS 24 Ind AS 105 Non-Current Assets Held for Sale and Discontinued
Operations
30 Guidance Note Ind AS 106 Exploration for and Evaluation of mineral Resources
VII. Standards on Taxes

1.30 I FUNDAMENTALS OF ACCOUNTING

SL.No. Accounting IND AS No. Name of IND AS
Standards (AS)
31 AS 22 Ind AS 12
Income Taxes
VIII. Standards on Financial Instruments
32 AS 31 Ind AS 32 Financial Instruments: Presentation
33 AS 30 Ind AS 39 Financial Instruments: Recognition and Measurement
34 AS 32 Ind AS 107 Financial Instruments: Disclosures
IX. Standards on First Time Adoption
35 No Corresponding Ind AS 101 First Time Adoption of Ind AS
Standard

Comparative Statement of AS & IND AS (Ind As – wise)

SL.No. Accounting IND AS No. Name of IND AS

Standards (AS)
1 AS 1 Ind AS 1 Presentation of Financial Statements
2 AS 2 Ind AS 2 Inventories
3 AS 3 Ind AS 7 Statement of Cash Flows
4 AS 5 Ind AS 8 Accounting Policies, Changes in Accounting Estimates
and Errors
5 AS 4 Ind AS 10 Events after the Reporting Period
6 AS 7 Ind AS 11 Construction Contracts
7 AS 22 Ind AS 12 Income Taxes
8 AS 10 & AS 6 Ind AS 16 Property, Plant and Equipment
9 AS 19 Ind AS 17 Leases
10 AS 9 Ind AS 18 Revenue
11 AS 15 Ind AS 19 Employee Benefits
12 AS 12 Ind AS 20 Accounting for Government Grants and Disclosure of
Government Assistance
13 AS 11 Ind AS 21 The Effects of Changes in Foreign Exchange Rates
14 AS 16 Ind AS 23 Borrowing Costs
15 AS 18 Ind AS 24 Related Party Disclosures
16 AS 21 Ind AS 27 Consolidated and Separate Financial Statements
17 AS 23 Ind AS 28 Investments in Associates
18 No Corresponding Ind AS 29 Financial Reporting in Hyperinflationary Economies
Standard
19 AS 27 Ind AS 31 Interests in Joint Ventures
20 AS 31 Ind AS 32 Financial Instruments: Presentation
21 AS 20 Ind AS 33 Earnings Per Shares
22 AS 25 Ind AS 34 Interim Financial Reporting
23 AS 28 Ind AS 36 Impairments of Assets
24 AS 29 Ind AS 37 Provisions, Contingent Liabilities and Contingent Assets
25 AS 26 Ind AS 38 Intangible Assets
26 AS 30 Ind AS 39 Financial Instruments: Recognition and Measurement
27 No Corresponding Ind AS 40 Investment Property
Standard
28 No Corresponding Ind AS 101 First Time Adoption of Ind AS
Standard
29 Guidance Note Ind AS 102 Share-based Payment
30 AS 14 Ind AS 103 Business Combinations

FUNDAMENTALS OF ACCOUNTING I 1.31

Accounting Process

31 No Corresponding Ind AS 104 Insurance Contracts

Standard
32 AS 24 Ind AS 105 Non-Current Assets Held for Sale and Discontinued
Operations
33 Guidance Note Ind AS 106 Exploration for and Evaluation of mineral Resources
34 AS 32 Ind AS 107 Financial Instruments: Disclosures
35 AS 17 Ind AS 108 Operating Segments

Comparative Statement of AS & IND AS (AS- Wise)

SL.No. Accounting IND AS No. Name of IND AS

Standards (AS)
1 AS 1 Ind AS 1 Presentation of Financial Statements
2 AS 2 Ind AS 2 Inventories
3 AS 3 Ind AS 7 Statement of Cash Flows
4 AS 4 Ind AS 10 Events after the Reporting Period
5 AS 5 Ind AS 8 Accounting Policies, Changes in Accounting Estimates
and Errors
6 AS 7 Ind AS 11 Construction Contracts
7 AS 9 Ind AS 18 Revenue
8 AS 10 & AS 6 Ind AS 16 Property, Plant and Equipment
9 AS 11 Ind AS 21 The Effects of Changes in Foreign Exchange Rates
10 AS 12 Ind AS 20 Accounting for Government Grants and Disclosure of
Government Assistance
11 AS 14 Ind AS 103 Business Combinations
12 AS 15 Ind AS 19 Employee Benefits
13 AS 16 Ind AS 23 Borrowing Costs
14 AS 17 Ind AS 108 Operating Segments
15 AS 18 Ind AS 24 Related Party Disclosures
16 AS 19 Ind AS 17 Leases
17 AS 20 Ind AS 33 Earnings Per Shares
18 AS 21 Ind AS 27 Consolidated and Separate Financial Statements
19 AS 22 Ind AS 12 Income Taxes
20 AS 23 Ind AS 28 Investments in Associates
21 AS 24 Ind AS 105 Non-Current Assets Held for Sale and Discontinued
Operations
22 AS 25 Ind AS 34 Interim Financial Reporting
23 AS 26 Ind AS 38 Intangible Assets
24 AS 27 Ind AS 31 Interests in Joint Ventures
25 AS 28 Ind AS 36 Impairments of Assets
26 AS 29 Ind AS 37 Provisions, Contingent Liabilities and Contingent Assets
27 AS 30 Ind AS 39 Financial Instruments: Recognition and Measurement
28 AS 31 Ind AS 32 Financial Instruments: Presentation
29 AS 32 Ind AS 107 Financial Instruments: Disclosures
30 Guidance Note Ind AS 102 Share-based Payment
31 Guidance Note Ind AS 106 Exploration for and Evaluation of mineral Resources
32 No Corresponding Ind AS 29 Financial Reporting in Hyperinflationary Economies
Standard

1.32 I FUNDAMENTALS OF ACCOUNTING

33 No Corresponding Ind AS 40 Investment Property
Standard
34 No Corresponding Ind AS 101 First Time Adoption of Ind AS
Standard
35 No Corresponding Ind AS 104 Insurance Contracts
Standard

Need for Accounting Standards

1. It helps in dissemination of timely and useful financial information to all Stakeholders and users.
2. It helps to provide a set of standard accounting policies, valuation norms and disclosure requirement.
3. It ensures disclosures of accounting principles and treatments, where important information is not
otherwise statutorily required to be disclosed.
4. It helps to reduce or totally eliminate, accounting alternatives, thereby it leads to better inter-firm
and intra-firm comparison of Financial Statements.
5. It reduces scope of creative accounting, i.e. twisting of accounting policies to produce Financial
Statement favourable to a particular interest group.

1.18 DOUBLE ENTRY SYSTEM, BOOKS OF PRIME ENTRY, SUBSIDIARY BOOKS

Double Entry System - This part we have already explained in 1.10

Books of Prime Entry

A journal is often referred to as Book of Prime Entry or the book of original entry. In this book transactions
are recorded in their chronological order. The process of recording transaction in a journal is called as
‘Journalisation’. The entry made in this book is called a ‘journal entry’.
Functions of Journal
(i) Analytical Function : Each transaction is analysed into the debit aspect and the credit aspect. This
helps to find out how each transaction will financially affect the business.
(ii) Recording Function : Accountancy is a business language which helps to record the transactions
based on the principles. Each such recording entry is supported by a narration, which explain, the
transaction in simple language. Narration means to narrate – i.e. to explain. It starts with the word
– Being …
(iii) Historical Function : It contains a chronological record of the transactions for future references.
Advantages of Journal
The following are the advantages of a journal :
(i) Chronological Record : It records transactions as and when it happens. So it is possible to get a
detailed day-to-day information.
(ii) Minimising the possibility of errors : The nature of transaction and its effect on the financial position
of the business is determined by recording and analyzing into debit and credit aspect.
(iii) Narration : It means explanation of the recorded transactions.
(iv) Helps to finalise the accounts : Journal is the basis of ledger posting and the ultimate Trial Balance.
The Trial balance helps to prepare the final accounts.

FUNDAMENTALS OF ACCOUNTING I 1.33

Accounting Process

The specimen of a journal book is shown below.

Date Particulars Voucher Ledger folio Debit amount Credit amount

number (`) (`)
dd-mm-yy Name of A/c to be debited Reference of -----------
Name of A/c to be credited page number of -----------
----------- the A/c in ledger
(narration describing the
transaction)

Explanation of Journal
(i) Date Column : This column contains the date of the transaction.
(ii) Particulars : This column contains which account is to be debited and which account is to be
credited. It is also supported by an explanation called narration.
(iii) Voucher Number : This Column contains the number written on the voucher of the respective
transaction.
(iv) Ledger Folio (L.F.) : This column contains the folio (i.e. page no.) of the ledger, where the transaction
is posted.
(v) Dr. Amount and Cr. Amount : This column shows the financial value of each transaction. The amount
is recorded in both the columns, since for every debit there is a corresponding and equal credit.
All the columns are filled in at the time of entering the transaction except for the column of ledger folio. This
is filled at the time of posting of the transaction to ‘ledger’. This process is explained later in this chapter.
Example:
As per voucher no. 31 of Roy Brothers, on 10.05.2013 goods of ` 50000 were purchased. Cash was paid
immediately. Ledger Folios of the Purchase A/c and Cash A/c are 5 and 17 respectively. Journal entry
of the above transaction is given bellow:

In the books of Roy Brothers

Journal Entries
Dr. Cr.
Date Particulars Voucher Ledger Amount Amount
No. Folio (`) (`)
10.05.2013 Purchase A/c Dr. 31 5 50,000
To, Cash A/c 17 50,000
(Being goods purchased for Cash)
Illustration 17.
Let us illustrate the journal entries for the following transactions:
2013
April
1 Mr. Vikas and Mrs. Vaibhavi who are husband and wife start consulting business by bringing in their
personal cash of ` 5,00,000 and ` 2,50,000 respectively.
10 Bought office furniture of ` 25,000 for cash. Bill No. - 2013/F/3
11 Opened a current account with Punjab National Bank by depositing ` 1,00,000
15 Paid office rent of ` 15,000 for the month by cheque to M/s Realtors Properties. Voucher No. 3
20 Bought a motor car worth ` 4,50,000 from Millennium Motors by making a down payment of
` 50,000 by cheque and the balance by taking a loan from HDFC Bank. Voucher No. M/13/7

1.34 I FUNDAMENTALS OF ACCOUNTING

25 Vikas and Vaibhavi carried out a consulting assignment for Avon Pharmaceuticals and raise a bill
for ` 10,00,000 as consultancy fees. Bill No. B13/4/1 raised. Avon Pharmaceuticals have immediately
settled ` 2,50,000 by way of cheque and the balance will be paid after 30 days. The cheque
received is deposited into Bank.
30 Salary of one receptionist @ ` 5,000 per month and one officer @ ` 10,000 per month. The salary for
the current month is payable to them.
Solution:
The entries for these transactions in a journal will look like:

In the Books of Vikash & Vaibhavi

Journal Entries Journal Folio-1

Dr. Cr.
Date Particulars Voucher L.F Amount (`) Amount (`)
number
01-04-2013 Cash A/c Dr. 1 7,50,000
To Vikas’s Capital A/c 2 5,00,000
To Vaibhavi’s capital A/c 3 2,50,000
(Being capital brought in by the partners)
10-04-2013 Furniture A/c Dr. 2013/F/3 4 25,000
To Cash A/c 1 25,000
(Being furniture purchased in cash)
11-04-2013 Punjab National Bank A/c Dr. 5 1,00,000
To Cash A/c 1 1,00,000
(Being current account opened with
Punjab National Bank by depositing cash)
15-04-2013 Rent A/c Dr. 3 6 15,000
To Punjab National Bank A/c 5 15,000
(being rent paid to Realtors Properties for
the month)
20-04-2013 Motor Car A/c Dr. M/13/7 7 4,50,000
To Punjab National Bank A/c 5 50,000
To Loan from HDFC Bank A/c 8 4,00,000
(Being car purchased from Millennium
Motors by paying down payment and
loan arrangement)
25-04-2013 Punjab National Bank A/c Dr. B13/4/1 5 2,50,000
Avon Pharma A/c Dr. 9 7,50,000
To Consultancy Fees A/c 10 10,00,000
(Being amount received and revenue
recognized for fees charged)
30-04-2013 Salary A/c Dr. 11 15,000
To Salary payable A/c 12 15,000
(Being the entry to record salary
obligation for the month)

FUNDAMENTALS OF ACCOUNTING I 1.35

Accounting Process

Illustration 18.
Journalise the following transactions in the books of Mr. Roy
2013
April
1 He started business with a capital of – Plant ` 10,000, Bank ` 8,000, Stock ` 12,000
2 Bought furniture for resale ` 5,000
Bought furniture for Office decoration ` 3,000
3 Paid rent out of personal cash for ` 2,000
8 Sold furniture out of those for resale ` 6,000
12 Paid Salary to Mr. X for ` 1,200
15 Purchased goods from Mr. Mukherjee for cash ` 3,000
18 Sold goods to Mr. Sen on credit for ` 8,000
20 Mr. Sen returned goods valued ` 1,000
22 Received cash from Mr. Sen of ` 6,500 in full settlement
28 Bought goods from Mr. Bose on credit for ` 5,000
30 Returned goods to Mr. Bose of ` 500 and paid to Mr. Bose ` 4,000 in full settlement.

Solution:
In the Books of Mr. Roy
Journal Entries
Date Particulars L. F. Debit (`) Credit (`)
April,
2013
1 Plant A/c Dr. 10,000
Bank A/c Dr. 8,000
Stock A/c Dr. 12,000
To, Capital A/c 30,000
[Being Plant, Bank, Stock introduced to the business]
2 Purchase A/c Dr. 5,000
To, Bank A/c 5,000
[Being furniture purchased for resale]
Furniture A/c Dr. 3,000
To, Bank A/c 3,000
[Being furniture purchased for office decoration]
3 Rent A/c Dr. 2,000
To, Capital A/c 2,000
[Being rent paid out of personal cash]
8 Cash A/c Dr. 6,000
To, Sales A/c 6,000
[Being furniture out of those meant for resale are sold]
12 Salary A/c Dr. 1,200
To, Bank A/c 1,200
[Being salary paid to Mr. X]

1.36 I FUNDAMENTALS OF ACCOUNTING

 Date Particulars L. F. Debit (`) Credit (`)
April,
2013
15 Purchase A/c Dr. 3,000
To, Cash A/c 3,000
[Being goods purchased]
18 Mr. Sen A/c Dr. 8,000
To, Sales A/c 8,000
[Being goods sold on credit to Mr. Sen]
20 Returns Inward A/c Dr. 1,000
To, Mr. Sen A/c 1,000
[Being goods returned from Mr. Sen]
22 Cash A/c Dr. 6,500
Discount Allowed A/c Dr. 500
To, Mr. Sen A/c 7,000
[Being cash received from Mr. Sen in full settlement]
28 Purchase A/c Dr. 5,000
To, Mr. Bose A/c 5,000
[Being goods purchased from Mr. Bose on credit]
30 Mr. Bose A/c Dr. 5,000
To, Cash A/c 4,000
To, Returns Outward A/c 500
To, Discount Received A/c 500
[Being goods returned to Mr. Bose and paid cash in full
settlement]
Please observe the convention of entry. Accounts to be debited are written first with ‘Dr’ as a suffix, and
accounts to be credited are written subsequently with a prefix ‘To’.
Sub-division of Journals
Journal is divided into two types -(i) General Journal and (ii) Special Journal.

(i) General Journal

• This is a book of chronological record of transactions.
• This book records those transactions which occur so infrequently that they do not warrant the
setting up of special journals.
Examples of such entries : (i) opening entries (ii) closing entries (iii) rectification of errors.

FUNDAMENTALS OF ACCOUNTING I 1.37

Accounting Process

The form of this general journal, is as under :

JOURNAL

Date Particulars L.F. Dr. Cr.

Amount Amount
L.F. : Ledger Folio
Dr : Debit
Cr : Credit
Recording of transactions in this book is called journalising and the record of transactions is known as
journal entry.
(ii) Special Journal
It is subdivided into Cash Book, Purchase Day Book, Sales Day Book, Returns Inward Book, Returns
Outward Book, Bills Receivable Book and Bills Payable Book. These books are called subsidiary books.
Importance of Sub-division of journals
When the number of transactions is large, it is practically not possible to record all the transactions
through one journal because of the following limitations of Journal:
(i) The system of recording all transactions in a journal requires (a) writing down the name of the
account involved as many times as the transaction occurs; and (b) an individual posting of each
account debited and credited and hence, involves the repetitive journalizing and posting labour.
(ii) Such a system can not provide the information on a prompt basis.
(iii) Such a system does not facilitate the installation of an internal check system because the journal
can be handled by only one person.
(iv) The journal becomes huge and voluminous.
(v) To overcome the shortcomings of the use of the journal only as a book of original entry, the journal
is sub-divided into special journal.
The journal is sub-divided in such a way that a separate book is used for each category of transactions
which are repetitive in nature and are sufficiently large in number.
Compound Journal
If for a single transaction, only one account is debited and one account is credited, it is known as simple
journal.
If the transaction requires more than one account which is to be debited or more than one account is
to be credited, it is known as Compound Journal.
The following illustration will make it clear :

Illustration 19.
(i) Started business with Cash `50,000; Plant `24,000; Stock `4,000
(ii) Sold Goods for Cash `8,000 and to Ms. Agarwal for `10,000
(iii) Ms. Agarwal settled her account less discount ` 600

1.38 I FUNDAMENTALS OF ACCOUNTING

Solution:
In the Books of ………
Journal

Date Particulars L.F. Debit Credit

` `
(i) Cash A/c Dr. 50,000
Plant A/c Dr. 24,000
Stock A/c Dr. 4,000
To Capital A/c 78,000
(Being business started with cash, plant and
stock as capital)
(ii) Cash A/c Dr. 8,000
Ms. Agarwal’s A/c Dr. 10,000
To Sales A/c 18,000
(Being goods sold for cash ` 8,000 and on
credit ` 10,000)
(iii) Cash A/c Dr. 9,400
Discount Allowed A/c Dr. 600
To Ms. Agarwal’s A/c 10,000
(Being cash received as final settlement and
discount allowaed)

Subsidiary Books
Subsidiary Books refers to books meant for specific transactions of similar nature. Subsidiary Books are
also known as Special journals or day books. To overcome shortcoming of the use of the journal only as
a book of original entry, the journal is subdivided into specific journals or subsidiary books.
The sub-division of journal is done as follows:
Transaction Subsidiary Book
All cash and bank transactions Cash Book - has columns for cash, bank and cash
discount
All credit purchase of goods – only those Goods Purchase Day Book or Purchase register
that are purchased for resale are covered here.
All credit sale of goods Sales Day Book or sales register
All purchase returns – i.e. return of goods back to Purchase Return Book or Return Outward Book
suppliers due to defects
All sales returns – i.e. return of goods back from Sales Return Book or Return Inward Book
customers
All bill receivables – these are bills accepted by Bills Receivable Book
customers to be honoured at an agreed date. This
is dealt with in depth later in the study note
All bills payable - these are bills accepted by the Bills Payable Book
business to be honoured by paying to suppliers at
an agreed date.
For all other transactions not covered in any of the Journal Proper
above categories – i.e. purchase or sale of assets,
expense accruals, rectification entries, adjusting
entries, opening entries and closing entries.

FUNDAMENTALS OF ACCOUNTING I 1.39

Accounting Process

Recording of cash and Bank Transactions

Cash Book
A Cash Book is a special journal which is used for recording all cash receipts and all cash payments.
Cash Book is a book of original entry since transactions are recorded for the first time from the source
documents. The Cash Book is larger in the sense that it is designed in the form of a Cash Account and
records cash receipts on the debit side and cash payments on the credit side. Thus, the Cash Book is
both a journal and a ledger.
Illustration 20:
Write up a Cash Book of Mr. Y for the month of April 2013, which serves as the only book of original entry

April 2013
1. Balance in hand ` 5,000
4. Sold goods to Mr. Z on credit ` 3,000
6. Sold goods for Cash ` 1,000
8. Purchased goods on credit from Mr. P for ` 3,000
12. Paid to Mr. P for ` 2,000 and Received Discount ` 200
15. Returned goods to Mr. P for ` 800
20. Goods Returned by Mr. Z for ` 300
25. Z settled his account for ` 2,500
26. Paid salary by cheque for ` 1,000
30. Received interest for ` 1,000

Solution:
In the books of Mr. Y Cash Book (as the only Book of Single Entry)
Date Particulars L/F Amount Date Particulars L/F Amount
` `
2013 2013

Apr.1 To Balance b/d 5,000 Apr. 4 By Z A/c 3,000

(Goods sold on credit)
4 ,, Sales A/c 3,000 8 ,, Purchase A/c 3,000
(Goods sold to Mr. Z) (Goods purchased on credit)
6 ,, Sales A/c 1,000 12 ,, P A/c 2,000
(Goods sold for cash) (Paid to P)
8 ,, P A/c 3,000 ,, P A/c 200
(Goods purchased on credit) (Discount Received)
12 ,, Discount Received A/c 200 15 P A/c (Goods returned) 800
15 ,, Returns Outwards A/c 800 20 ,, Returns Inwards A/c 300
(Goods Returned) (Goods returned by Mr. Z)
20 ,, Z A/c 300 ,, Discount Allowed A/c 200
(Goods returned by Z)
25 ,, Z A/c 2,500 26 ,, Salary A/c (Paid Salary) 1,000
(Received from Z)
,, Z A/c (Discount Allowed) 200 ,, Balance c/d 7,500
26 ,, Bank A/c (Withdrawn by cheque) 1,000
30 `` Interest A/c 1,000
(Interest Received)

18,000 18,000
May. 1 To Balance b/d
7,500

1.40 I FUNDAMENTALS OF ACCOUNTING

Types of Cash Book
There are different types of Cash Book as follows:
(i) Single Column Cash Book- Single Column Cash book has one amount column on each side. All
cash receipts are recorded on the debit side and all cash payments on the payment side, this
book is nothing but a Cash Account and there is no need to open separate cash account in the
ledger.
(ii) Double Column Cash Book- The Double Column Cash Book having two amounts. Columns on
each side as under:
(a) Cash and discount columns
(b) Cash and bank columns
(c) Bank and discount columns
(iii) Triple Coulmn Cash Book- Triple Column Cash Book has three amount columns ,one for cash, one
for Bank and one for discount , on each side. All cash receipts, deposits into book and discount
allowed are recorded on debit side and all cash payments, withdrawals from bank and discount
received are recorded on the credit side. In fact, a triple-column cash book serves the purpose
of Cash Account and Bank Account both . Thus, there is no need to create these two accounts in
the ledger.
(iv) The multi-column cash book having multiple columns on both the sides of the cash book.
(v) The petty Cash Book.

Dr. Specimen of Single Column Cash Book Cr.

Receipts Payments
Date Particulars L.F. Cash Date Particulars L.F. Cash
               
               
               

Dr. Specimen of Double Column Cash Book Cr.

Receipts Payments
Date Particulars L.F. Cash Disc. Date Particulars L.F. Cash Disc.
Allowed Received
                   
                   
                   

Dr. Specimen of Triple Column Cash Book Cr.

Receipts Payments
Date Particulars L.F. Cash Bank Discount Date Particulars L.F. Cash Bank Discount
Allowed Received
                       
                       
                       

FUNDAMENTALS OF ACCOUNTING I 1.41

Accounting Process

Is the Cash Book Journal or Ledger?

• Cash Book is a book of original entry since transactions are recorded for the first time from the source
documents.
• The cash book is ledger in the sense that it is designed in the form of a Cash Account and records
cash receipts on the debit side and cash payments on the credit side.
Thus the cash Book is both a journal and a ledger.

(I) Contra Transactions

Transactions which relates to allowing discount or receiving discount in cash after the settlement of the
dues are known as Contra Transactions.
Example:
1. Received ` 500 as discount from Mr. Ghosh whose account was previously settle in full.
Cash A/c Dr. 500
    To  Discount Received A/c 500
(Being cash received as discount from Mr. Ghosh whose account was previous settled in full)

2. Paid ` 400 as discount to Mr. Ghosh Dastidar who settled his account in full previously.
Discount Allowed A/c Dr. 400
    To  Cash A/c 400
(Being discount allowed in cash to Mr. Ghosh Dastidar who settled his account in full)
(II) Cheque Transactions
When a cheque is received and no any other information at a later date about the same is given, it
will be assumed that the said cheque has already been deposited into bank on the same day when it
was received. Then the entry should be as under:
Bank A/c Dr.
To Debtors/Party A/c
But if it is found that the said cheque has been deposited into the bank at a later date, then the entry
will be:
(i) When the cheque is received
Cash A/c Dr.
To Debtors/Party A/c
(ii) When the same was deposited into bank at a later date
Bank A/c Dr.
To Cash A/c
(iii) When the said cheque is dishonoured by the bank
Debtors/Party A/c Dr.
To Bank A/c

1.42 I FUNDAMENTALS OF ACCOUNTING

Illustratio 21.
Let us see an illustration for the following cash and bank transactions in the books of Mr. Abhishek
January 1 Opening cash balance was ` 3,800 and bank balance was ` 27,500
January 4 Wages paid in cash ` 1,500
January 5 received cheque of ` 19,800 from KBK enterprises after allowing discount of ` 200
January 7 Paid to consultancy charges by cheque for ` 7,500
January 10 Cash of ` 2,500 withdrawn from bank
January 12 Received a cheque for ` 4,500 in full settlement of the account of Mr. X at a discount of
10% and deposited the same into the Bank.
January 15 X’s cheque returned dishonoured by the Bank

Solution:

In the Books of Mr. Abhishek

Dr. Cash Book Cr.
Receipts Payments
Date Particulars L.F. Cash Bank Discount Date Particulars L.F. Cash Bank Discount
(`) (`) Allowed (`) (`) received
(`) (`)
1-Jan Opening Balance   3,800 27,500   4-Jan Wages paid 1,500    
5-Jan Recd from KBK     19,800 200 7-Jan Consultancy fees     7,500  
10-Jan Cash withdrawn   2,500     10-Jan Cash withdrawn     2,500  
12-Jan Mr. X 4,500 500 15-Jan Mr. X 4,500 500
              Closing balance   4,800 37,300  
      6,300 51,800 700       6,300 51,800 500

Please note that the balance of discount columns is not taken and these are posted directly to the
respective ledger account separately. The balance of cash and bank columns are posted into cash
and bank accounts periodically. The posting into ledger is explained later in this chapter.
Purchase Day Book
The purchase day book records the transactions related to credit purchase of goods only. It follows
that any cash purchase or purchase of things other than goods is not recorded in the purchase day
book. Periodically, the totals of Purchase day book are posted to Purchase account in the ledger. The
specimen Purchase day book is given below:
In the Books of .........
Purchase Day Book
Name of the Suppliers and details Invoice
Date of Goods purchased reference L. F. Amount (`) Remarks
           
           
           
The format for Purchase Return is exactly the same; hence separate illustration is not given.
Let us see an illustration for following transactions for a furniture shop:

FUNDAMENTALS OF ACCOUNTING I 1.43

Accounting Process

Illustration 22.
1. Bought 20 tables @ ` 500 per table from Majestic Appliances on credit @ 12% trade discount as
per invoice number 22,334 on 2nd March.
2. Purchased three dozen chairs @ ` 250 each from Metro chairs as per invoice number 1112 on
4th March.
3. Second hand furniture bought from Modern Furnitures on credit as per invoice number 375 for
` 1200 on 7th March.
4. Purchased seven book racks from Mayur Furnitures for ` 4,900 paid for in cash on 6th March.
5. Purchased Machinery for ` 30,000 from Kirloskar Ltd on 9th March as per invoice number 37.

Solution:
In the Books of Furniture Shop
Purchase Day Book
Date Name of the Suppliers and Details of goods purchased Invoice L. F. Amount
reference (`)
2nd March Majestic Appliances     8,800 
  20 tables@ 500 and 12% trade discount 22334  
  (20 * 500) = 10000 less 12% discount      
4th March Metro Chairs     9,000 
  3 dozen chairs @ 250 per chair 1112  
7th March Modern Furnitures 375   1,200
  Total     19,000
Please note that the transaction for purchase of book rack will not be entered in the purchase book as
it is not purchased on credit. (Where will it go then? it will go to the cash book!). Similarly purchase of
machinery will not form part of purchase book. It will be entered in Journal Proper.
Sales Day Book
The sales day book records transaction of credit sale of goods to customers. Sale of other things, even on
credit, will not be entered in the sales day book but will be entered in Journal Proper. If goods are sold
for cash, it will be entered in cash book. Total of sales day book is periodically posted to sales account
in the ledger. The specimen of a sales day book is given below.
In the books of ...........
Sales Day Book
Date Particulars Invoice reference L. F. Amount Remarks
           
           
           
The format of sales return book is exactly the same; hence a separate illustration is not given.
Let us see how will be the following transaction recorded in the books of a Cloth Merchant.
Illustration 23.
1st July Sold Tip Top clothing 50 suits of ` 2,200 each on two months credit on invoice number -2
11th July Sold to New India Woolen 100 sweaters @ ` 250 each on invoice number 55
13th July Received an order from Modern clothing for 100 trousers @ ` 500 at trade discount of 10%
17th July Sold 50 sarees to Lunkad brothers @ ` 750 each
25th July Sold T-shirts at exhibition hall for cash for ` 7,500

1.44 I FUNDAMENTALS OF ACCOUNTING

Solution:
In the books of Cloth Marchant
Sales Day Book
Date Particulars Invoice reference L. F. Amount
1st July Tip Top Clothing      
  50 suits @ ` 2,200 2   1,10,000
11th July New India Woolen      
  100 sweaters @ ` 250 55   25,000
17th July Lunkad brother 50 sarees @ ` 750     37,500
  Total     1,72,500
Here again, cash sales at exhibition hall are not recorded. Also, merely getting an order for goods is not
a transaction to be entered in sales book.

Other Subsidiary Books – Returns Inward, Return Outward, Biils Receivable, Bills Payable.
(i) Return Inward Book- The transactions relating to goods which are returned by the customers for
various reasons, such as not according to sample, or not up to the mark etc contain in this book. It is
also known as Sales Return Book.
Generally when a customer returns good to suppliers he issues a Debit Note for the value of the goods
returned by him. Similarly the supplier who receives those goods issues a Credit Note.

Returns Inward Day Book

Date Particulars Outward L.F. Details Totals Remarks

Invoice

(ii) Return Outward Book- This book contains the transactions relating to goods that are returned by us to
our creditors e.g. goods broken in transit, not according to the sample etc.It’s also known as Purchase
Return Book.
Return Outward Day Book
Date Particulars Debit Note L.F. Details Totals Remarks

(iii) Bills Receivable Book- It is such a book where all bills received are recorded and therefrom posted
directly to the credit of the respective customer’s account. The total amounts of the bills so received
during the period ( either at the end of the week or month ) is to be posted in one sum to the debit of
Bills Receivable A/c.
Bills Receivable Day Book

No. of Date of From Name Name Name of Date of Due L.F. Amount How
Bills Receipt whom of the of Acceptor Bill Date of Bill disposed
of Bill Receiver Drawer off

(iv) Bills Payable Book- Here all the particulars relating to bills accepted are recorded and therefrom
posted directly to the debit of the respective creditor’s account. The total amounts of the bills so

FUNDAMENTALS OF ACCOUNTING I 1.45

Accounting Process

accepted during the period (either at the end of the week or month ) is to be posted in one sum to the
credit of Bills Payable Account.
Bills Payable Day Book
No. Date of To Name Name Where Date Term Due L.F. Amount How
of Acceptance whom of of the Payable of Bill Date of Bill disposed
Bills given Drawer Payee off

Journal Proper
Credit transactions that cannot be entered in any other subsidiary book are entered in journal proper.
It will cover purchase or sale of assets, expense accruals, rectification entries, adjusting entries, opening
entries and closing entries. The format of journal proper is exactly the same as given in the section 1.17
of Journal entries. The entries here recorded in the same way as shown in that illustration.
Ledger Accounts
The book which contains accounts is known as the ledger. Since finding information pertaining to the
financial position of a business emerges only from the accounts, the ledger is also called the Principal
Book. As a result, all the necessary information relating to any account is available from the ledger.
This is the most important book of the business and hence is rightly called the “King of All Books”. Also
Known as Book of Final Entry.
The specimen of a typical ledger account is given below:

Dr Ledger-Account Cr
Date Particulars J. F. Amount (`) Date Particulars J. F. Amount (`)
               
               
               
               

Ledger Posting
As and when the transaction takes place, it is recorded in the journal in the form of journal entry. This
entry is posted again in the respective ledger accounts under double entry principle from the journal.
This is called ledger posting.
The rules for writing up accounts of various types are as follows :
Assets : Increases on the left hand side or the debit side and decreases on the credit
side or the right hand side.
Liabilities : Increases on the credit side and decreases on the debit side.
Capitals : The same as liabilities.
Expenses : Increases on the debit side and decreases on the credit side.
Incomes or gain : Increases on the credit side and decrease on the debit side.
To summarise
Dr. Assets Cr. Dr. Liabilities & Capital Cr.
Increase Decrease Decrease Increase
Dr. Expenses or Loses Cr. Dr. Income or Gains Cr.
Increase Decrease Decrease Increase

1.46 I FUNDAMENTALS OF ACCOUNTING

The student should clearly understand the nature of debit and credit.
A debit denotes :
(a) In the case of a person that he has received some benefit against which he has already rendered
some service or will render service in future. When a person becomes liable to do something in favour
of the firm, the fact is recorded by debiting that person’s account : (relating to Personal Account)
(b) In case of goods or properties, that the value and the stock of such goods or properties has
increased, (relating to Real Accounts)
(c) In case of other accounts like losses or expenses, that the firm has incurred certain expenses or has
lost money. (relating to Nominal Account)
A credit denotes :
(a) In case of a person, that some benefit has been received from him, entitling him to claim from the
firm a return benefit in the form of cash or goods or service. When a person becomes entitled to
money or money’s worth for any reason. The fact is recorded by crediting him (relating to Personal
Account)
(b) In the case of goods or properties, that the stock and value of such goods or properties has
decreased. (relating to Real Accounts)
(c) In case of other accounts like interest or dividend or commission received, or discount received,
that the firm has made a gain (relating to Nominal Account)
At a glance :
Dr. (Debit side) Cr. (Credit side)
DESTINATION Where the economic SOURCE of each economic benefits
benefit reaches / is received.
Receiver Given
What comes in What goes out
All expense and losses All income and gains
Let us now understand the mechanism of posting transaction into the ledger account. Consider the
transaction: Rent paid in cash for ` 10000. The journal entry for this transaction would be:
Jan 15 Rent A/c Dr 10,000
To Cash A/c 10,000
We will open two ledger accounts namely Rent A/c and Cash A/c. Let us see how the posting is made

Rent Account
Dr. Cr.
Date Particulars J. F. Amount (`) Date Particulars J. F. Amount (`)
Jan15 To Cash A/c   10,000        
               
               

Cash Account
Dr. Cr.
Date Particulars J. F. Amount (`) Date Particulars J. F. Amount (`)
         Jan 15 By Rent A/c   10,000
               
Please observe the following conventions while posting a transaction into ledger accounts. Note that
both the effects of an entry must be recorded in the ledger accounts simultaneously.

FUNDAMENTALS OF ACCOUNTING I 1.47

Accounting Process

1) The posting in the account which is debited, is done on the debit side by writing the name of the
account or accounts that are credited with the prefix ‘To’.
2) The posting in the account which is credited, is done on the credit side by writing the name of the
account or accounts that are debited with the prefix “By’.
Illustration 24.
Let us now see how we can create ledger account for the seven journal entries that we passed for
Illustration 17.
Folio No. 1
Dr. Cash Account Cr.
Date Particulars J. F. Amount Date Particulars J. F. Amount
(`) (`)
1.4.2013 To Vikas’s capital  1 500,000  10.4.2013 By Furniture  1 25,000
1.4.2013  To Vaibhavi’s capital  1 250,000  11.4.2013 By Punjab National Bank  1 1,00,000
         30.4.2013 By Balance c/d   6,25,000
      750,000         7,50,000
1.5.2013 To Balance b/d   625,000        

Folio No. 2
Dr. Mr. Vikas’s Capital Account Cr.
Date Particulars J. F. Amount (`) Date Particulars J. F. Amount (`)
30.4.2013 To Balance c/d   5,00,000 1.4.2013  By Cash  1 5,00,000
      5,00,000       5,00,000 
      1.5.2013  By Balance b/d   5,00,000

Folio No. 3
Dr. Mrs. Vaibhavi’s Capital Account Cr.
Date Particulars J. F. Amount (`) Date Particulars J. F. Amount (`)
30.4.2013 To Balance c/d    2,50,000 1.4.2013  By Cash   1 2,50,000
2,50,000 2,50,000
1.5.2013  By Balance b/d  2,50,000

Folio No. 4
Dr. Furniture Account Cr.
Date Particulars J. F. Amount (`) Date Particulars J. F. Amount (`)
 10.04.2013  To Cash    25,000 30.4.2013  By Balance c/d  25,000
   25,000  25,000
1.05.2013  To Balance b/d    25,000

Folio No. 5
Dr. Punjab National Bank Account Cr.
Date Particulars J. F. Amount (`) Date Particulars J. F. Amount (`)
11.4.2013  To Cash  1 1,00,000 15.4.2013  By Rent  1 15,000
25.4.2013 To Consultancy Fees  1 2,50,000 20.4.2013  By Motor Car  1 50,000
By Balance c/d  2,85,000
3,50,000 3,50,000
1.05.2013  To Balance b/d    2,85,000

1.48 I FUNDAMENTALS OF ACCOUNTING

 Folio No. 6
Dr. Rent Account Cr.
Date Particulars J. F. Amount (`) Date Particulars J. F. Amount (`)
15.4.2013 To Punjab National Bank 1 15,000
Folio No. 7
Dr. Motor Car Account Cr.
Date Particulars J. F. Amount (`) Date Particulars J. F. Amount (`)
20.4.2013  To Punjab National Bank 1  50,000        
“ To Loan from HDFC Bank  1 4,00,000        
Folio No. 8
Dr. Loan from HDFC Bank Account Cr.
Date Particulars J. F. Amount (`) Date Particulars J. F. Amount (`)
        20.4.2013  By Motor Car  1 4,00,000
Folio No. 9
Dr. Avon Pharmaceuticals Account Cr.
Date Particulars J. F. Amount (`) Date Particulars J. F. Amount (`)
25.4.2013 To Consultancy Fees 1 7,50,000
Folio No. 10
Dr. Consultancy Fees Account Cr.
Date Particulars J. F. Amount (`) Date Particulars J. F. Amount (`)
25.4.2013 By Punjab National Bank 1 2,50,000
25.4.2013 By Avon Pharma 1 7,50,000
Folio No. 11
Dr. Salary Account Cr.
Date Particulars J. F. Amount (`) Date Particulars J. F. Amount (`)
30.4.2013   To Salary payable  1 15,000        
Folio No. 12
Dr. Salary Payable Account Cr.
Date Particulars J. F. Amount (`) Date Particulars J. F. Amount (`)
        30.4.2013  By Salary  1 15,000
Please carefully observe the posting of journal entries into various ledger accounts. Do you see some
further calculation in the cash A/c and Mr. Vikas’s Capital A/c? What is done is that after posting all
transactions to these accounts, the difference between the debit and credit sides is calculated. This
difference is put on the side with smaller amount in order to tally grand totals of both sides. The convention
is to write “To Balance c/d” or “By balance c /d” as the case may be. This procedure is normally done
at the end of an accounting period. This process is called as “balancing of ledger accounts’.
Once the ledgers are balanced for one accounting period, the balance needs to be carried forward
to the next accounting period as a running balance. This is done by writing “To Balance b/d” or
“By balance b/d” as the case may be after the grand totals. This is also shown in the Cash A/c and
Mr. Vikas’s Capital Account.
Could you now attempt to balance the other ledger accounts and carry the balances to the next
accounting period?
Important note: Please remember the balances of personal and real accounts only are carried down
to the next accounting period as they represent resources and obligations of the business which will
continue to be used and settled respectively in future. Balances of nominal accounts (which represent

FUNDAMENTALS OF ACCOUNTING I 1.49

Accounting Process

incomes or gains and expenses or losses) are not carried down to the next period. These balances are
taken to the Profit and Loss account (or Income statement) prepared for the period. The net result of the
P & L Account will show either net income or net loss which will increase or decrease the owner’s equity.
In the above example, please note that the balances of Rent Account, Consultancy Fees Account and
Salary Account will not be carried down to the next period, but to the P & L Account of that period. As
illustration, we have shown it for Rent Account.
Posting to Ledger Accounts from Subsidiary books
In the above section, we explained posting to ledger accounts directly on the basis of journal entries.
In practice, however, we know that use of subsidiary books is in vogue. Let us see how the posting to
ledger accounts is done based on these records.
For each of the subsidiary books, there is a ledger account e.g. for purchase book, there is Purchase Account,
for sales book there’s Sales A/c, for cash book there will be Cash A/c as well as Bank A/c and so on.
Illustration 25.
Let us continue with illustration seen in the section Illustration 21above and post the totals into respective
ledger accounts.
Solution:
Dr. Cash Account Cr.
Date Particulars J. F. Amount Date Particulars J. F. Amount
(`) (`)
1st Jan  To Balance b/d   3,800   By sundries as per   1,500
cash book
  To Miscellaneous Receipts   2,500   By Balance c/d   4,800
6,300 6,300

Dr. Purchases Account Cr.

Date Particulars J. F. Amount (`) Date Particulars J. F. Amount (`)
  To sundries as per purchase   19,000   By transfer to   19,000
book P & L A/c

Dr. Sales Account Cr.

Date Particulars J. F. Amount (`) Date Particulars J. F. Amount (`)
  To transfer to P & L A/c   1,72,500   By sundries as per   1,72,500
sales book
Typical Ledger Account Balances
We have seen how to balance various ledger accounts. It can be seen that while some accounts will
show debit balance, while the other will show credit balance. Is there any relationship between the
type of account (whether it is the account of asset, liability, capital, owner’s equity, incomes or gain,
expenses or losses) and the kind of balance (debit or credit) it should show?
The answer is generally ‘Yes’. You may test to find the following are typical relationships.
Type of Account Type of balance
All asset accounts Debit balance
All liability accounts Credit balance
Capital & Owner’s equity account Credit balance
Expenses or loss accounts Debit balance
Incomes or gain accounts Credit balance
Let us test these possibilities for confirmation. How does one go about testing this? Consider ‘Cash A/c’.
Whenever business receives cash we debit it, and whenever it is paid we credit it. Is it possible to see
a situation that credits to cash are more than debits? In other words could we have negative cash in

1.50 I FUNDAMENTALS OF ACCOUNTING

hand? No. Cash account will therefore always show a debit balance. So is true for all real asset accounts.
After solving problems, if the contrary is observed, there is every chance that an error has been made
while passing the accounting entries.
Closing Balance and Opening Balance
The debit or credit balance of an account what we get at the end of the accounting period is known
as closing balance of that account.
The “balance of the nominal accounts” is closed by transferring to trading account and the profit and
loss account which shows the net operating results – net profit or net loss.
The “balance of the personal accounts and real accounts” representing assets, liabilities, owners equity
are reflected in the Balance sheet, which shows the financial position of a business on a particular
date. These balances are transported as opening balance in the succeeding accounting period.
Some terms used:
Casting — totaling
Balancing — to find the difference between debit side total and credit side total of an account.
C/d -Carried down B/d -Brought down
C/o - Carried over       B/o - Brought over
C/f - Carried forward       B/f -  Brought forward
Subdivisions of Ledger
Practically, the Ledger may be divided into two groups -
(a) Personal Ledger & (b) Impersonal Ledger. They are again sub-divided as :
LEDGER

PERSONAL LEDGER IMPERSONAL LEDGER

Debtors’ Ledger Creditors’ Ledger Cash Book General Ledger

Nominal Ledger Private Ledger

Personal Ledger: The ledger where the details of all transactions about the persons who are related to
the accounting unit, are recorded, is called the Personal Ledger.
Impersonal Ledger: The Ledger where details of all transactions about assets, incomes & expenses etc.
are recorded, is called Impersonal Ledger.
Again, Personal Ledger may be divided into two groups:
Viz. (a) Debtors’ Ledger, & (b) Creditors’ Ledger.
(a) Debtors’ Ledger: The ledger where the details of transactions about the persons to whom goods
are sold, cash is received, etc. are recorded, is called Debtors’ Ledger.
(b) Creditors’ Ledger: The ledger where the details of transactions about the persons from whom are
purchase goods on credit, pay to them etc. are recorded, is called Creditors’ Ledger.
Impersonal Ledger may, again be divided into two group, viz, (a) Cash Book; and (b) General Ledger.
(a) Cash Book: The Book where all cash & bank transactions are recorded, is called Cash Book.

FUNDAMENTALS OF ACCOUNTING I 1.51

Accounting Process

(b) General Ledger: The ledger where all transactions relating to real accounts, nominal accounts,
details of Debtors’ Ledger and Creditors’ Ledger are recorded, is called General Ledger.
General Ledger may, again, be divided into two groups. Viz, Nominal Ledger; & Private Ledger.
(a) Nominal Ledger: The ledger where all transactions relating to incomes and expenses are recorded,
is called Nominal Ledger.
(b) Private Ledger: The Ledger where all transactions relating to assets and liabilities are recorded, is
called Private Ledger.

Advantages of sub-division of Ledger.

The advantages of sub-division of ledger are:
(a) Easy to Divide work : As a result of sub-division, the division of work is possible and records can be
maintained efficiently by the concerned employee.
(b) Easy to handle : As a result of sub-division, the size and volume of ledger is reduced.
(c) Easy to collect information: From the different classes of Ledger a particular type of transactions
can easily be found out.
(d) Minimizations of mistakes : As a result of sub-division chances of mistakes are minimized.
(e) Easy to compute : As a result of sub-division, the accounting work may be computed quickly
which is very helpful to the management.
(f) Fixation of responsibility: Due to sub-division, allotment of different types of work to different
employees is done for which concerned employee will be responsible.

1.19 TRIAL BALANCE

Trial balance may be defined as a statement or a list of all ledger account balances taken from various
ledger books on a particular date to check the arithmetical accuracy.
According to the Dictionary for Accountants by Eric. L. Kohler, Trial Balance is defined as “a list or abstract
of the balances or of total debits and total credits of the accounts in a ledger, the purpose being to
determine the equality of posted debits and credits and to establish a basic summary for financial
statements”. According to Rolland, Trial Balance is defined as “The final list of balances, totaled and
combined, is called Trial Balance”.
As this is merely a listing of balances, this will always be as on a particular date. Further it must be
understood that Trial Balance does not form part of books of account, but it is a report prepared by
extracting balances of accounts maintained in the books of accounts.
When this list with tallied debit and credit balances is drawn up, the arithmetical accuracy of basic
entries, ledger posting and balancing is ensured. However, it does not guarantee that the entries are
correct in all respect. This will be explained later in this chapter.
Although it is supposed to be prepared at the end of accounting period, computerized accounting
packages are capable of providing instant Trial Balance reports even on daily basis, as the transactions
are recorded almost on line.

1.52 I FUNDAMENTALS OF ACCOUNTING

Let us prepare the trial balance for the ledger accounts from the illustration 17.
Trial Balance as on...

Account name Debit (`) Credit (`)

Cash A/c 6,25,000
Vikas’s capital A/c 5,00,000
Vaibhavi’s capital A/c 2,50,000
Furniture A/c 25,000
Punjab National Bank A/c 2,85,000
Rent A/c 15,000
Motor Car 4,50,000
Loan from HDFC A/c 4,00,000
Avon Pharmaceuticals 7,50,000
Consultancy fees A/c 10,00,000
Salary A/c 15,000
Salary payable A/c 15,000
Total 21,65,000 21,65,000

It can be seen that the totals of debit and credit balances is exactly matching. This is the result of double
entry book-keeping wherein every debit has equal corresponding credit.
Feature’s of a Trial Balance
1. It is a list of debit and credit balances which are extracted from various ledger accounts.
2. It is a statement of debit and credit balances.
3. The purpose is to establish arithmetical accuracy of the transactions recorded in the Books of
Accounts.
4. It does not prove arithmetical accuracy which can be determined by audit.
5. It is not an account. It is only a statement of account.
6. It is not a part of the final statements.
7. It is usually prepared at the end of the accounting year but it can also be prepared anytime as
and when required like weekly, monthly, quarterly or half-yearly.
8. It is a link between books of accounts and the Profit and Loss Account and Balance sheet.
Preparation of Trial Balance:
1. It may be prepared on a loose sheet of paper.
2. The ledger accounts are balanced at first. They will have either “debit-balance” or “credit balance”
or “nil-balance”.
3. The accounts having debit-balance is written on the debit column and those having credit-balance
are written on the credit column.
The sum total of both the balances must be equal, for “Every debit has its corresponding and equal
credit”.
Purpose of a Trial Balance
It serves the following purposes :
1. To check the arithmetical accuracy of the recorded transactions.
2. To ascertain the balance of any ledger Account.
3. To serve as an evidence of fact that the double entry has been completed in respect of every
transaction.
4. To facilitate the preparation of final accounts promptly.

FUNDAMENTALS OF ACCOUNTING I 1.53