Definition of Accounting, Accounting-Principles, Concepts and Conventions.

Journal, Cash Book,

Subsidiary Books and Ledger, Capital Expenditure and Revenue Expenditure. Trial Balance,
Rectification of Errors, Final Accounts, Provisions and Reserves, Methods of Depreciation –Fixed
Instalment Method and Diminishing Balance Method.
SCOPE OF ACCOUNTING

Accounting is the process of recording, classifying, summarizing, and interpreting financial transactions
to provide useful information for decision-making. The scope of accounting is quite broad and
encompasses several areas, including:
 1. Financial Accounting: This branch of accounting is concerned with the preparation of financial
statements that communicate a company’s financial performance to external stakeholders such
as investors, creditors, and regulatory bodies.
2. Managerial Accounting: This branch of accounting is concerned with providing information to
internal stakeholders, such as managers, to help them make informed business decisions.
3. Tax Accounting: This branch of accounting is concerned with preparing tax returns and ensuring
compliance with tax laws and regulations.
4. Auditing: This branch of accounting is concerned with providing independent assurance that
financial statements are reliable and conform to accounting standards.
5. Forensic Accounting: This branch of accounting is concerned with investigating financial crimes
such as fraud, embezzlement, and money laundering.
6. Cost Accounting: This branch of accounting is concerned with determining the cost of producing
goods or services and helping companies make decisions related to pricing, profitability, and
cost management.

ADVANTAGES OF ACCOUNTING

1. Helps in decision-making: Accounting provides financial information that can help business
owners and managers make informed decisions about the company’s future.
2. Facilitates financial analysis: Accounting helps in analyzing financial data, which helps in
understanding the financial health of the business, identifying areas that need improvement,
and making changes accordingly.
3. Enables compliance with legal requirements: Accounting provides accurate financial
statements that can be used to meet legal requirements such as tax filings and regulatory
reporting.
4. Facilitates budgeting and forecasting: Accounting provides information that is useful for
preparing budgets and forecasts, which helps in planning for the future.
5. Helps in raising capital: Accounting helps in preparing financial statements that can be used to
attract investors and lenders, which can help in raising capital.
6. Improves accountability and transparency: Accounting provides a clear picture of a company’s
financial situation, which improves accountability and transparency.
7. Facilitates performance measurement: Accounting helps in measuring the financial
performance of a business, which can be used to set goals, track progress, and identify areas for
improvement.

LIMITATIONS OF ACCOUNTING

1. Historical in nature: Accounting records only the past transactions and events of an
organization. This makes it difficult for accountants to predict future trends and events
accurately.
2. Subjective judgments: Accounting requires subjective judgments to be made, which can lead to
biased financial statements. For example, the choice of accounting methods and estimates can
significantly impact financial statements.
 3. Incomplete picture: Accounting records only those transactions that can be measured in
monetary terms. This means that important non-financial information such as employee morale,
customer satisfaction, and environmental impact may be ignored.
4. Lack of transparency: Financial statements can be complex and difficult to understand for
people who are not trained in accounting. This can make it difficult for stakeholders to fully
understand a company’s financial performance.
5. Manipulation: Accounting information can be manipulated to present a more favorable picture
of a company’s financial health. This can occur through creative accounting practices, such as
using aggressive revenue recognition techniques.
6. Limited scope: Accounting focuses mainly on financial transactions within an organization. It
does not capture the external factors that may impact the business, such as changes in the
regulatory environment or economic conditions.
7. Cost: Maintaining an accounting system can be expensive, especially for small businesses that
do not have the resources to hire dedicated accounting staff or purchase expensive accounting
software.

USERS OF ACCOUNTING
Accounting is used by a variety of individuals and entities, including:

1. Business owners: Accounting is crucial for business owners to track their financial transactions,
understand their financial position, and make informed decisions about their operations.
2. Accountants: Accounting professionals use their expertise to help businesses and individuals
manage their finances, prepare financial statements, and comply with regulatory requirements.
3. Investors: Investors use financial statements prepared by companies to analyze their financial
performance and make investment decisions.
4. Regulators: Government agencies use accounting information to ensure that businesses are
complying with accounting and financial regulations and to detect any fraudulent activities.
5. Lenders: Financial institutions use accounting information to evaluate the creditworthiness of
businesses and individuals before providing loans.
6. Managers: Managers use accounting information to monitor their company’s financial
performance, make strategic decisions, and set goals.
7. Tax authorities: Tax authorities rely on accounting records to ensure that individuals and
businesses are accurately reporting their income and paying the correct amount of taxes.
ACCOUNTING CONCEPTS
Accounting concepts define the assumptions on the basis of which financial statements of a business
entity are prepared.

1. Business Entity Concept: This concept assumes that, for accounting purposes, the business
enterprise and its owners are two separate independent entities. Thus, the business and
personal transactions of its owner are separate. For example, when the owner invests money in
the business, it is recorded as liability of the business to the owner. Similarly, when the owner
takes away from the business cash/goods for his/her personal use, it is not treated as business
expense.
2. Money Measurement Concept: This concept assumes that all business transactions must be in
terms of money, that is in the currency of a country. In our country such transactions are in
terms of rupees. Thus, as per the money measurement concept, transactions which can be
 expressed in terms of money are recorded in the books of accounts. For example, sale of goods
worth Rs.200000, Rent Paid Rs.10000 etc. are expressed in terms of money, and so they are
recorded in the books of accounts. But the transactions which cannot be expressed in monetary
terms are not recorded in the books of accounts.
3. Going Concern Concept: This concept states that a business firm will continue to carry on its
activities for an indefinite period of time. Simply stated, it means that every business entity has
continuity of life. Thus, it will not be dissolved in the near future. This is an important
assumption of accounting, as it provides a basis for showing the value of assets in the balance
sheet.
4. Accounting Cost Concept: It states that all assets are recorded in the books of accounts at their
purchase price, which includes cost of acquisition, transportation and installation and not at its
market price. It means that fixed assets like building, plant and machinery, furniture, etc are
recorded in the books of accounts at a price paid for them.
5. Dual Aspect Concept: Dual aspect is the foundation or basic principle of accounting. It provides
the very basis of recording business transactions in the books of accounts. This concept assumes
that every transaction has a dual effect, i.e. it affects two accounts in their respective opposite
sides. Therefore, the transaction should be recorded at two places. It means, both the aspects
of the transaction must be recorded in the books of accounts.
Thus, the duality concept is commonly expressed in terms of fundamental accounting equation:
Assets = Liabilities + Capital
6. Accounting Period Concept: All the transactions are recorded in the books of accounts on the
assumption that profits on these transactions are to be ascertained for a specified period . This
is known as accounting period concept. Thus, this concept requires that a balance sheet and
profit and loss account should be prepared at regular intervals. This is necessary for different
purposes like, calculation of profit, ascertaining financial position, tax computation etc.
7. Matching Concept: The matching concept states that the revenue and the expenses incurred to
earn the revenues must belong to the same accounting period. So once the revenue is realized,
the next step is to allocate it to the relevant accounting period. This can be done with the help
of accrual concept If the revenue is more than the expenses, it is called profit. If the expenses
are more than revenue it is called loss. This is what exactly has been done by applying the
matching concept.
8. Realisation Concept: This concept states that revenue from any business transaction should be
included in the accounting records only when it is realized. The term realization means creation
of legal right to receive money. Selling goods is realization, receiving order is not. In other
words, it can be said that: Revenue is said to have been realized when cash has been received or
right to receive cash on the sale of goods or services or both has been created.
9. Accrual Concept: The meaning of accrual is something that becomes due especially an amount
of money that is yet to be paid or received at the end of the accounting period. It means that
revenues are recognized when they become receivable. Though cash is received or not
received and the expenses are recognized when they become payable though cash is paid or not
paid. Both transactions will be recorded in the accounting period to which they relate.
ACCOUNTING CONVENTION
An accounting convention refers to common practices which are universally followed in recording and
presenting accounting information of the business entity. Conventions denote customs or traditions or
usages which are in use since long. To be clear, these are nothing but unwritten laws. The accountants
have to adopt the usage or customs, which are used as a guide in the preparation of accounting reports
and statements. These conventions are also known as doctrine.

1. Convention of Consistency: The convention of consistency means that same accounting

principles should be used for preparing financial statements year after year. A meaningful
conclusion can be drawn from financial statements of the same enterprise when there is
comparison between them over a period of time. But this can be possible only when accounting
policies and practices followed by the enterprise are uniform and consistent over a period of
time. If different accounting procedures and practices are used for preparing financial
statements of different years, then the result will not be comparable.
2. Convention of Full Disclosure: Convention of full disclosure requires that all material and
relevant facts concerning financial statements should be fully disclosed. Full disclosure means
that there should be full, fair and adequate disclosure of accounting information. Adequate
means sufficient set of information to be disclosed. Fair indicates an equitable treatment of
users. Full refers to complete and detailed presentation of information. Thus, the convention of
full disclosure suggests that every financial statement should fully disclose all relevant
information.
3. Convention of Materiality: The convention of materiality states that, to make financial
statements meaningful, only material fact i.e. important and relevant information should be
supplied to the users of accounting information. The materiality of a fact depends on its nature
and the amount involved. Material fact means the information which will influence the decision
of its user.
4. Convention of Conservatism: This convention is based on the principle that “Anticipate no
profit, but provide for all possible losses”. It provides guidance for recording transactions in the
books of accounts. It is based on the policy of playing safe in regard to showing profit. The main
objective of this convention is to show minimum profit. Profit should not be overstated. If profit
shows more than actual, it may lead to distribution of dividend out of capital. This is not a fair
policy and it will lead to the reduction in the capital of the enterprise. Thus, this convention
clearly states that profit should not be recorded until it is realized. But if the business
anticipates any loss in the near future provision should be made in the books of accounts for
the same

ACCOUNTING STANDARDS
Accounting standards are written policy documents covering the aspects of recognition, measurement,
treatment, presentation and disclosure of accounting transactions in financial statements. Accounting
standard is an authoritative statement issued by ICAI, a professional body of accounting in our country.
The objective of accounting standard is to bring uniformity in different accounting policies in order to
eliminate non-comparability of financial statements for enhancing reliability of financial statements.
Secondly, the accounting standard provides a set of standard accounting policies, valuation norms and
disclosure requirements. In addition to improving credibility of accounting data, accounting standard
enhances comparability of financial statements, both intra and inter enterprises. Such comparisons are
very effective and widely used for assessment of firms’ performance by the users of accounting.

Benefits of Accounting Standards

1. Accounting standard helps in eliminating variations in accounting treatment to prepare financial

statements.
2. Accounting standard may call for disclosures of certain information which may not be required
by law, but such information might be useful for general public, investors and creditors.
3. Accounting standard facilitate comparability between financial statements of inter and intra
companies.
Classification of Accounts

Transactions can be divided into three categories.

i. Transactions relating to individuals and firms

ii. Transactions relating to properties, goods or cash
iii. Transactions relating to expenses or losses and incomes or gains.

Therefore, accounts can also be classified into Personal, Real and Nominal. The classification maybe
illustrated as follows

I. Personal Accounts: The accounts which relate to persons. Personal accounts include the
following.
i. Natural Persons: Accounts which relate to individuals. For example, Mohan‘s A/c,
Shyam‘s A/c etc.
ii. Artificial persons : Accounts which relate to a group of persons or firms or
institutions. For example, HMT Ltd., Indian Overseas Bank, Life Insurance
Corporation of India, Cosmopolitan club etc.
iii. Representative Persons: Accounts which represent a particular person or group of
persons. For example, outstanding salary account, prepaid insurance account, etc.

The business concern may keep business relations with all the above personal accounts,
because of buying goods from them or selling goods to them or borrowing from them or
lending to them. Thus, they become either Debtors or Creditors.
The proprietor being an individual his capital account and his drawings account are also
personal accounts.

II. Impersonal Accounts: All those accounts which are not personal accounts. This is further
divided into two types viz. Real and Nominal accounts.
i. Real Accounts: Accounts relating to properties and assets which are owned by the
business concern. Real accounts include tangible and intangible accounts. For
example, Land, Building, Goodwill, Purchases, etc.
 ii. Nominal Accounts: These accounts do not have any existence, form or shape.
They relate to incomes and expenses and gains and losses of a business concern.
For example, Salary Account, Dividend Account, etc

JOURNAL, CASH BOOK, SUBSIDIARY BOOKS AND LEDGER,

Double Entry System

The double entry system of accounting or bookkeeping means that every business transaction will
involve two accounts (or more). For example, when a company borrows money from its bank, the
company's Cash account will increase and its liability account Loans Payable will increase.

Definition

According to J.R.Batliboi ―Every business transaction has a two-fold effect and that it affects two
accounts in opposite directions and If a complete record were to be made of each such transaction, it
would be necessary to debit one account and credit another account.

Features

i. Every business transaction affects two accounts.

ii. Each transaction has two aspects, i.e., debit and credit.
iii. Every debit must have its corresponding and equal credit
iv. It is based up on accounting assumptions concepts and principles.
v. Helps in preparing trial balance which is a test of arithmetical accuracy in accounting.
vi. Preparation of final accounts with the help of trial balance.
Book-keeping
Book-keeping is that branch of knowledge which tells us how to keep a record of business transactions.
It is often routine and clerical in nature. It is important note that only those transactions related to
business which can be expressed in terms of money are recorded. The activities of book-keeping include
recording in the journal, posting to the ledger and balancing of accounts.

Definition

R.N. Carter says, ―”Book-keeping is the science and art of correctly recording in the books of account all
those business transactions that result in the transfer of money or money‘s worth”.

Objectives

The objectives of book-keeping are

i. To have permanent record of all the business transactions.

ii. To keep records of income and expenses in such a way that the net profit or net loss may be
calculated.
iii. To keep records of assets and liabilities in such a way that the financial position of the business
may be ascertained.
iv. To keep control on expenses with a view to minimize the same in order to maximize profit.
v. To know the names of the customers and the amount due from them.
vi. To know the names of suppliers and the amount due to them.
vii. To have important information for legal and tax purposes.

JOURNAL
When the business transactions take place, the first step is to record the same in the books of original
entry or subsidiary books or books of prime or journal. Thus, journal is a simple book of accounts in
which all the business transactions are originally recorded in chronological order and from which they
are posted to the ledger accounts at any convenient time. Journaling refers to the act of recording each
transaction in the journal and the form in which it is recorded, is known as a journal entry.

Functions of Journal

(i) Analytical Function: Each transaction is analyzed 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) Minimizing 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 finalize the accounts: Journal is the basis of ledger posting and the ultimate Trial
Balance. The Trial balance helps to prepare the final accounts.
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.

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 credit 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 has two amount columns on each
side as under:
(a) Cash and discount columns
(b) Cash and bank columns
(c) Bank and discount columns
(iii) Triple Column 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 bank 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: The petty cash book is the record of petty cash expenditures that are
sorted by date. In most cases, this petty cash book is a ledger book and not a computer
record. This book is a part of the manual record-keeping system in the accounting
department. There are two primary types of entries in the petty cash book.
SUBSIDIARY BOOKS
Subsidiary Books are those books of original entry in which transactions of similar nature are recorded
at one place and in chronological order. Subsidiary Books are books of Original Entry. They are also
known as Day Book or special journals, which record transactions of similar nature.

They are helpful in overcoming the limitations of journal book or journal entries. Subsidiary books are
special-purpose accounting books that record transactions belonging to the same category in a
particular book in a sequential manner. Also, the transactions are recorded in their original form, i.e. as
and when the transactions occur, they are entered in the subsidiary book before posting them anywhere
that is why they are also known as the book of original entry.

Advantages of Subsidiary Books

 Automatic classification of transaction: As a separate book exists for every category of the
transaction, so the transactions belonging to a specific category are recorded in one place.
 Facilitates division of work: As the journal is divided into multiple subsidiary books, the work of
recording the transactions is divided among different employees, which helps in the instant
recording of transactions. And so, the responsibility of maintaining the book can be entrusted to
an employee who will keep it up to date.
 Identification of Error: In case the Trial Balance does not tally, the errors can be easily located and
rectified.
 Internal Check system: As the recording of different transactions is done by different employees,
the work is divided in a manner in which the work performed by one person is automatically
checked by another person. In this way, it enables internal checks and prevents the occurrence of
errors and frauds.
  Ease in transfer: When the entries are made in separate books, they can be easily transferred to
their concerned ledger account.
 Classification of transaction: Transactions can be easily classified into cash transactions and credit
transactions.
 Helpful in Decision Making: Subsidiary books provide accurate and complete details about each
type of transaction separately. Thus, the management can use the information as the basis for
deciding the future actions.
 Efficiency: The work is being divided here which gives the advantage of specialization. When the
same work is done by a person repeatedly and continuously the person becomes efficient in
handling it.
 Convenience While Posting: The transactions of a nature are recorded at a single place, in one of
the subsidiary books. Example, all the credit purchases of the goods are recorded in the purchases
book while all the credit sales of goods are recorded in the sales book.
 Easy to obtain required information: Subsidiary books use separate books for recurring
transactions. One can quickly get the necessary information at any time on such vital business
transactions.

LEDGER
CAPITAL EXPENDITURE AND REVENUE EXPENDITURE.
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.

There are 2 types of Transaction

1. Capital: Transactions having long-term effect are known as capital transactions

2. Revenue: 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 used 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;

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 Capital Expenditure

An expenditure can be recognized 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 recognized as a capital expenditure. The expenditure is
capitalized 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 Rs 5,00,000 and pays Rs 20,000 as transportation charges
and Rs 40,000 as installation charges, the total cost of the machine comes upto Rs 5,60,000.
Similarly, if a building is purchased for Rs 1,00,000 and Rs 5,000 is spent on registration and
stamp duty, the capital expenditure on the building stands at Rs 1,05,000.
 If an expenditure is incurred to increase earning capacity of a business, it will be considered as
capital expenditure. 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.
 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 recognizing expenditure as capital is to see that because of the expenditure, the
business will own something which qualifies as an asset at the end of the accounting period.

REVENUE EXPENDITURES
Revenue expenditure is the 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.

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.

Rules for Determining Revenue Expenditure

Any expenditure which cannot be recognized 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 recognized 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.

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.

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 types 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).

Treatment of Revenue Expenditure as Capital Expenditure:

The following are some of the instances where an item of expenditure which is in the nature of revenue
expenditure will be treated as capital expenditure.

1. Repairs: Repairs expenditure is revenue in nature, but huge amount incurred on a second-hand
machinery in order to bring it to working condition can be treated as capital expenditure and
should be added to the cost of Machinery.
2. Wages: Normally, wages are revenue in nature. But wages paid to the workers for the
construction or installation of fixed assets, will be treated as capital expenditure and added to
the cost of that asset.
3. Preliminary Expenses: All the expenses paid in the process of formation of a company should be
treated as capital expenditure and recorded in the balance sheet on asset side
4. Brokerage, Government Stamp Duty and Legal Expenses: All the expenses paid on the purchase
of a property will be regarded as capital expenditure.
5. Raw Materials and Stores: These are generally revenue in nature, but if raw materials and
stores are consumed in the making of a fixed asset, the same should be treated as capital
expenditure.
 6. Development Expenditure: All the expenditure incurred for the development of mines and
plantations should be treated as capital expenditure.

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”.

It is normally prepared at the end of an accounting year. However, an organization may prepare a trial
balance at the end of any chosen period, which may be monthly, quarterly, half yearly or annually
depending upon its requirements.

Features of Trial Balance

 It is a list of balances of all ledger accounts and the cash book.
 It is just a statement and not an account.
 It is neither a part of the double entry system, nor does it appear in the actual books of
accounts.
 It can be prepared at any time during the accounting period, say, at the end of every month,
every quarter or every year.
 It is always prepared on a particular date and not for a particular period.
 It is prepared to check the arithmetical accuracy of the ledger accounts

Trial Balance – Utility and Interpretation

The utility of Trial balance could be found in the following:
(1) It forms the basis for preparation of Financial statements i.e. Profit and Loss Account and
Balance sheet.
(2) A tallied trial balance ensures the arithmetical accuracy of the entries made. If the trial balance
does not tally, the errors can be found out, rectified and then financial statements can be
prepared.
(3) It acts as a quick reference. One can easily find out the balance in any ledger account without
actually referring to the ledger.
(4) If the listing of ledger accounts is systematically done in the trial balance, one can do quick time
analysis. Hence, listing is usually done in the sequence of Asset accounts, Liability accounts,
Capital accounts, Owner’s equity accounts, Income or gain accounts and Expenses or losses
accounts in that order.
Significance of Agreement of Trial Balance
It is important for an accountant that the trial balance should tally. Normally a tallied trial balance
means that both the debit and the credit entries have been made correctly for each transaction.
However, as stated earlier, the agreement of trial balance is not an absolute proof of accuracy of
accounting records. A tallied trial balance only proves, to a certain extent, that the posting to the ledger
is arithmetically correct. But it does not guarantee that the entry itself is correct. There can be errors,
which affect the equality of debits and credits, and there can be errors, which do not affect the equality
of debits and credits.

Some common errors include the following:

• Error in totaling of the debit and credit balances in the trial balance.
• Error in totaling of subsidiary books.
• Error in posting of the total of subsidiary books.
• Error in showing account balances in wrong column of the trial balance, or in the wrong amount.
• Omission in showing an account balance in the trial balance.
• Error in the calculation of a ledger account balance.
• Error while posting a journal entry: a journal entry may not have been posted properly to the
ledger, i.e., posting made either with wrong amount or on the wrong side of the account or in
the wrong account.
• Error in recording a transaction in the journal: making a reverse entry, i.e., account to be debited
is credited and amount to be credited is debited, or an entry with wrong amount.
• Error in recording a transaction in subsidiary book with wrong name or wrong amount.

CLASSIFICATION OF ERRORS
Keeping in view the nature of errors, all the errors can be classified into the following four categories:

• Errors of Commission: These are the errors which are committed due to wrong posting of
transactions, wrong totaling or wrong balancing of the accounts, wrong casting of the
subsidiary books, or wrong recording of amount in the books of original entry, etc. Such an
error by definition is of clerical nature and most of the errors of commission affect in the trial
balance.
• Errors of Omission : The errors of omission may be committed at the time of recording the
transaction in the books of original entry or while posting to the ledger . These can be of two
types: (i) error of complete omission (ii) error of partial omission. When a transaction is
completely omitted from recording in the books of original record, it is an error of complete
omission. When the recording of transaction is partly omitted from the books, it is an error of
partial omission.
• Errors of Principle : Accounting entries are recorded as per the generally accepted accounting
principles. If any of these principles are violated or ignored, errors resulting from such
violation are known as errors of principle. An error of principle may occur due to incorrect
classification of expenditure or receipt between capital and revenue. This is very important
because it will have an impact on financial statements. It may lead to under/over stating of
income or assets or liabilities, etc. These errors do not affect the trial balance.
 • Compensating Errors: When two or more errors are committed in such a way that the net effect
of these errors on the debits and credits of accounts is nil, such errors are called compensating
errors. Such errors do not affect the tallying of the trial balance.

RECTIFICATION OF ERRORS
From the point of view of rectification, the errors may be classified into the following two categories:

(a) errors which do not affect the trial balance.

(b) errors which affect the trial balance.

This distinction is relevant because the errors which do not affect the trial balance usually take place in
two accounts in such a manner that it can be easily rectified through a journal entry whereas the errors
which affect the trial balance usually affect one account and a journal entry is not possible for
rectification unless a suspense account has been opened. Such errors are rectified by passing a
nullifying entry in the respective account

FINAL ACCOUNTS
Final accounts refer to the accounts prepared by a business entity at the end of every financial year.
These include the Balance Sheet, which shows the company's financial position [assets, liabilities, and
equity], and the Profit and Loss Account, which details the company's revenues and expenses to
display profit or loss.

Final accounts, also known as financial statements, are pivotal summaries of a company’s financial
performance and position at the end of a specific period, typically a fiscal year. Final accounts are
essential for assessing a business’s financial health, making informed decisions, and meeting
regulatory requirements. They provide a snapshot of the company’s financial well-being and help in
strategic planning and analysis. This information is of use to the management, investors, owners,
shareholders, and also to other users of such information.

 Trading Account: Trading account is used to determine the gross profit or gross loss of a
business which results from trading activities. Trading activities are mostly related to the buying
and selling activities involved in a business. Trading account is useful for businesses that are
dealing in the trading business.
 Profit and Loss Statement (P&L): The profit and loss (P&L) statement is a financial statement that
summarizes the revenues, costs, and expenses incurred during a specified period, usually a
fiscal quarter or year. The P&L statement is synonymous with the income statement. These
records provide information about a company's ability or inability to generate profit by
increasing revenue, reducing costs, or both.
 Balance Sheet: The balance statement shows the company’s financial situation as of a given
date. The company’s financial situation can be determined by adding up a company’s assets and
liabilities as of a specific date. The difference between assets and liabilities reflects the capital
invested in the company’s operations and its financial stability.
Preparation of Final Accounts when Transactions/Events are given:
Steps involved in preparation of Final Accounts when the organization concerned is engaged in trading
activity are as follows:

OBJECTIVES OF FINAL ACCOUNT PREPARATION

Final accounts are prepared with the following objectives:
1. To determine profit or loss incurred by a company in a given financial period
2. To determine the financial position of the company
3. To act as a source of information to convey the users of accounting information (owners,
creditors, investors and other stakeholders) about the solvency of the company.

ADVANTAGES OF FINAL ACCOUNT:

1. Financial Assessment: Final accounts offer a clear assessment of a company’s financial health,
helping stakeholders evaluate its profitability and stability.
2. Investor Confidence: Investors rely on final accounts to gauge a company’s potential, fostering
confidence and encouraging investments.
3. Creditor Evaluation: Creditors use these accounts to assess a company’s creditworthiness,
enabling informed lending decisions.
4. Strategic Planning: Businesses use final accounts to identify strengths and weaknesses,
facilitating strategic planning and future financial goals.
5. Legal Compliance: Final accounts ensure compliance with accounting standards and regulatory
requirements, maintaining legal integrity.

DISADVANTAGES OF FINAL ACCOUNT:

1. Limited Historical Data: Final account provide a snapshot of a specific period, limiting the view
of long-term financial trends.
2. Subjectivity: Interpretation of final account can vary, as accounting methods and estimations
involve subjectivity, leading to potential discrepancies.
 3. Doesn’t Reflect Real-Time Operations: Final account might not capture real-time financial
fluctuations, offering a delayed view of a company’s financial status.
4. Complexity for Small Businesses: Small businesses may find final accounts preparation complex
and time-consuming, requiring expertise or external help.
5. Potential Manipulation: In rare cases, final accounts can be manipulated, leading to fraudulent
activities that misguide stakeholders.

The Format for income statement in case of Trading concern is as follows:

Trading A/c for the year ----

P & L A/c for the year ----

The format for balance sheet is as follows:
Illustration 1: From the following ledger balance prepare final accounts :
Solution
Illustration 2
RESERVES AND PROVISIONS

Meaning of Reserves

Reserves are part of profits or gain that has been allotted for a specific purpose. Reserves are usually set
up to buy fixed assets, pay bonuses, pay an expected legal settlement, pay for repairs & maintenance
and pay off debt.

What are Reserves in Accounting?

When an enterprise earns a profit during the end of a year, a certain part of it is retained in the trading
concern to meet future exigencies, growth outlooks etc., The amount of money that is kept aside is
known as Reserves in Accounting.
They assist in securing the financial situation of an enterprise and can be utilized for different purposes
such as stable dividend repayments, expansion, meeting contingencies, legal requirements, investments,
improving the financial situation, etc.,
It is also termed as retained earnings. For instance – Reserve for Dividends Equalization, General
reserve, Reserve for Increased Cost of Replacement, Reserve for Expansion, Debenture Redemption
Reserve, Investment Fluctuation Reserve, etc.

Meaning of Provision
A provision can be described as a liability of uncertain timing or an amount. A liability, in turn, is a
present obligation of the entity which arises from past events. The settlement of this liability is expected
from the outflow of resources which embodies economic benefits.

What is Provision in Accounting?

Provisions in Accounting are to be described as an amount that is set aside to cover an expense in the
future which may occur in all probability. This means this is the reduction in the value of an asset.
This is the fund that is to be put aside by a company to cover the anticipated losses in the future.
Provision is a liability that responds to an uncertain expense. Provisions are listed on a firm’s balance
sheet.

These provision amounts are to be estimated. While conducting a financial report, these provisions are
recorded as the current liability on the balance sheet, and then it is matched to the appropriate expense
account on the income statement. Examples of provisions are Provision for Depreciation, Provision for
Doubtful Debts, Provision for Taxation, Provision for repairs, etc.

Difference Between Provision and Reserve: Tabular Representation

Point of Difference Provision Reserves
The portion set aside for The portion set aside from
Meaning meeting known liabilities or expenses the company’s profits to meet an
whose probability is certain. unforeseen business event.
It is a charge against profits, which It is an appropriation of profits, which
Nature means that they are created even if means that they are only created when
there is no profit. the company is profitable.
Reserves may or may not be made for
Provisions are always made for
Objective a defined purpose. Example- Debenture
a defined liability or expense.
Redemption reserve/General reserve.
Provisions are created to meet
Reserves are made to give strength to
Purpose a specific liability and fulfill
the financial position of the company.
the requirement of the law.
It is created by debiting Profit and It is created by debiting Profit and Loss
Mode of Creation
Loss Account. Appropriation Account.
It is not mandatory to create reserves.
It is mandatory to create provisions
Necessity They are only created when the
as per various laws.
company has surplus profits.
Payment of Dividends cannot be paid from Dividends can be declared and paid
Dividend provisions. from reserves to the shareholders.
Reserves are shown under the head
They are always shown on
of ‘Reserve and Surplus’ as
Presentation in the liabilities side as a current liability
the Owner’s Capital/Shareholders’
Balance Sheet or reduced from the concerned
Fund on the liability side of the balance
asset for which it is made.
sheet.
The amount of reserve can be invested
The amount of provision can never be outside the business, as in case of
Investment
invested outside the business. Debenture Redemption Reserve
Investment
Provisions can only be used for the
Reserves can be used to meet any
Utilization specific purpose for which they are
unknown loss or liability.
created.
METHODS OF DEPRECIATION –FIXED INSTALMENT METHOD AND DIMINISHING
BALANCE METHOD.

DEFINITIONS OF DEPRECIATION
“Depreciation may be defined as the permanent decrease in the value of an asset through wear and tear
in use or the passage of time.”

“The Primary meaning of the word depreciation is loss of the value through wear and tear or some other
form of material deterioration. The secondary sense of depreciation is the operation of adjusting the
book values of assets. As the machines or other assets get old, it is the practice of the Accountant to
reduce their values in the books of accounts and it is usual to call this as depreciation.”

Depreciation is an expense or loss involved in using machinery, motor vehicles, tools and other fixed
assets in the process of production and has to be provided for; this is done estimating the amount to be
written off the value of a particular asset each year and setting this amount against the profits for that
year.”

Causes of Depreciation
1. Wear and Tear: Some assets physically deteriorate due to wear and tear in use. When an asset
is constantly used for production, the asset wears out. Physical deterioration of an asset is
caused from movement, strain, friction, erosion, etc. For instance, building, machineries,
furniture, vehicles, plant etc. The wear is general but primary cause of depreciation.
2. Lapse of time: There are certain assets like leasehold property, patents, copy-right etc. That are
acquired for a particular period. After expiry of the period, they are rendered useless i.e. their
value ceases to exist. Thus, their cost is written off over their legal life.
3. Obsolescence: Appearance of new and improved machines results in discarding of old
machines. Thus, New inventions, change in fashion and taste, market condition, Government
policies etc., are the causes to discard the value of an asset. But this is not the cause of
depreciation and not depreciation in the real sense. A new machine performs the same
function more quickly and cheaply than the existing machine. As such, existing machine may
become out of date or outmoded or obsolete.
4. Exhaustion: Some assets are of wasting nature. For instance, quarries, mines, oil-well etc. It is
reduction in the value of natural deposits as resource, have been extracted year after year. As
such these assets are known as wasting sheets. The coalmine or oil well gets physically
exhausted by the removal of its content.
5. Non-use: Machines which are idly lying, becomes less useful with the passage of time. Certain
types of machines exposed to weather conditions, may have more depreciation from not using it
then from its use.
6. Non-Maintenance: A good maintenance of machines will naturally increase its life. When there
is no maintenance, there is more depreciated value. When there is good maintenance, there is
 longer life to the machines. The long life of machine depends upon good and skilled
maintenance.
7. Market Trend: The market price may fluctuate in case of certain assets, for instance,
investments in gilt-edged securities. When the prices go down, the concerned assets may
depreciate its value. In certain cases, accident causes diminution in the value of assets.

Need for Depreciation

1. To ascertain the true Working Result: The basic need of depreciation is to ascertain the true
income. If depreciation is ignored, the loss that is occurred on respect of fixed assets will be
ignored. So, depreciation should be debited to profit and loss account before profit is
ascertained.
2. To Ascertain the True Value of Asset: The function of Balance sheet is to show the true and
correct view of the state of affairs of a business. If no depreciation is charged and when assets
are shown at the original cost year after year, Balance Sheet will not disclose the correct state or
affairs of a business.
3. To Retain Funds for Replacement: When an asset is continuously used, a time will come when
the asset is to be given up and hence its replacement is essential. Therefore, if no depreciation
is charged against the profit, during the life time of the asset, it will be very difficult to find cash
to replace the asset and if replaced it may cripple resources. Therefore, it is necessary to make
provision and create funds to replace such assets, in proper time.
4. To Reduce Tax Liability: Depreciation is a tax-deductible expense. As such, it is permitted by the
prevailing taxation laws to be deducted from profit. Consequently, the owner of a business may
avail himself of this benefit by charging depreciation to his profit and reducing his tax liability.
5. To present True Position: Financial Position can be studied from the Balance Sheet and for the
preparation of the Balance sheet fixed assets are required to be shown at their true value. If
assets are shown in the Balance Sheet without any charge made for their use, (that is,
depreciation) then their value must have been overstated in the Balance sheet and will not
reflect the true financial position of the business. Therefore, for the purpose of reflecting true
financial position, it is necessary that depreciation must be deducted from the asset and then at
such reduced value may be shown in the Balance sheet.

Consequences of not Providing for Depreciation

1. Profit will be overstated.
2. Capital employed will be incorrect.
3. Valuation of assets will be understated.
4. Cost of production will be understated.
5. Periodic expenses will be understated.
6. Capital depletion will take place.
7. Net worth will be overstated
8. Correct sale price of price of products cannot be fixed.
9. No provision for replacement of assets.
 10. A true working result cannot be known.

Factors for the Measurement of Depreciation:

 Cost of asset (including installation & assemble cost and others admissible expenses, such as
commission etc.)
 Estimated useful life of the asset
 Estimated Residual or scrap value of the asset
 Depreciable amount

Methods of Depreciation:
A number of methods are available for calculating the amount of depreciation, these are:

 Straight Line Method (SLM)

 Written Down Value Method / Reducing Balance Method / Diminishing Balance Method
 Production Unit Method
 Annuity Method
 Depletion Method
 Sum-of-the-Years’ Digit Method
 Machine Hour Method
 Depreciation Fund / Sinking Fund Method

However, Straight Line Method (SLM) / Fixed Installment Method and Written Down Value Method /
Diminishing Balance Method are the only two methods allowed by the Income Tax Act, 1961 for
computation of depreciation for determination of income.

Straight Line Method (SLM) / Fixed Installment Method :

Under this method, an equal amount is provided each year for depreciation of each asset until the
asset has been written down to nil or its scrap value at the end of the estimated life of the asset . The
name of this method is derived from the fact that if the successive annual depreciation over the life of
the asset is plotted on a graph, the result will be a straight line with a slope equal to the annual
depreciation.

This method is also called ‘Fixed Installment Method’ because a uniform amount of depreciation is
charged each year. The formula of the annual depreciation under the method is:

Cost of Asset +Other Capital Expenses – Scrap Value

Depreciation p.a. =
Useful Life of Asset
Rate of Depreciation = Depreciation p.a. X 100 / Original Cost

This method can be recommended only when the following conditions are satisfied.

a. The asset is expected to render a uniform service throughout its estimated useful life.
b. Annual repairs and maintenance costs are assumed to remain constant over its life.
c. The asset is expected to earn an equal amount of revenue each year throughout its life.
d. The amount of depreciation is a function of time only.

Written Down Value Method / Diminishing Balance Method:

In this method, depreciation is charged at a fixed percentage each year to the net asset balance (i.e.
cost less accumulated depreciation). The depreciation charge is higher at the early stages than the later
stages i.e. the amount of depreciation decreases gradually although the depreciation rate is fixed. This
method is also known as ‘Declining Balance Method’, ‘Written Down Value Method’ etc.

Depreciation p.a. = For new asset: Original Cost × Rate of Depreciation

For existing asset: Opening WDV × Rate of Depreciation

Rate of depreciation = 1 -
√
n Residual Value
Cost of asset
X 100
Example 1
Depreciation under SLM- Proportionate charging of Depreciation

A Ltd. purchased a machine on 1st July, 2019 at a cost of Rs. 14, 00,000 and spent Rs. 1, 00,000 on its
installation. The firm writes off depreciation at 10% p.a. of the original cost every year. The books are
closed on 31st March every year. You are required to: Show the Machinery Account and Depreciation
Account for the year 2019 and 2020.

Solution:

In the books of Ltd. Machinery Account

Depreciation Account
Illustration: 2
On 1st January, 2003 a Company purchased a plant for Rs 20,000. On 1st July in the same year, it
purchased additional plant worth Rs 8,000 and spent Rs 2,000 on its erection. On 1st July, 2004, the
plant purchased on 1st Jan., 2003 having become obsolete, was sold off for Rs 12,500. On 1st October,
2005, fresh plant was purchased for Rs 28,000 and on the same date, the plant purchased on 1st July,
2003 was sold at Rs 6,000.

Depreciation is provided at 10% per annum on original cost on 31st December every year. Show the
plant account for 2003 to 2005.

Solution:
Example: 3
Depreciation under WDV- Purchase and Sale of Asset
A Ltd. purchased on 1st April, 2019 a machinery for Rs. 2,91,000 and incurred Rs. 9000 for installation.
On 1st October another machinery for Rs. 1,00,000 was purchased. On 1st October 2020 the machinery
purchased on 01/04/2019 having become useless was sold for Rs. 1,93,000 and on that day a new
machinery was purchased for Rs. 2,00,000.

Depreciation was provided on 31st March each year @ 10 percent p.a on written Down Value. You are
required to prepare machinery account.

Solution:

In the Books of a Ltd. Machinery A/c

Illustration 4
Widson enterprise purchases Plant and Machinery for Rs 1,00,000 on 1st October 2012. It decides to
write off depreciation 20% per annum on Written Down Value Method. On 1st January, 2015 purchases
additional Machinery for Rs 40,000.

Show Machinery Account upto the year ending 31st March, 1996. The accounting year ends on 31st
March.

Solution