ambo-104_accounting for managers

8/13/2019 AMBO-104_Accounting for Managers

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ACCOUNTINGFOR

MANAGERS

AMBO-104

AUOAccounting is an ancient art as old as money itself. Luca Pacioli is widely

regarded as Father of Accounting. He developed the double entry

bookkeeping system.Double-entry is defined as any bookkeeping systemin which there is a debit and credit entry for each transaction, or for which

the majority of transactions are intended to be of this form. In India,

Chanakya clearly indicates, in his Arthshastra, the existence and need of

proper accounting and audit.

AMITY UNIVERSITY


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Preface

As we read the term accounts or accountancy a curiosity arises as to what it is? Our brain starts

working and we feel that it is something related to figures and business. Similar is the scenario

when we say finance. As the management students we are expected to have good knowledge of

these topics.

Hence before going into the technical knowledge of these topics lets understand the basic

meaning of the terms accounting & finance.

Accounting or accountancy isthe 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 financial

character, and interpreting the results thereof.

Finance refers to the concept of time, money and risk and how they are interrelated.

Now, after having the working knowledge of these terms, lets proceed to the chapters for better

and through understanding of the subject.

This e-learning syllabus for Accounting and Finance is thus generated to help you understand the

concepts and principles of Accounting and Finance.

The entire syllabus is divided into eight chapters. Each chapter is comprehended with multiple

choices questions. Further there are three types of assignments

Assignment A - Five Analytical Questions (to cover the first half of the syllabus)

Assignment B - Three Analytical Questions (Questions covering second half of the

syllabus) and a Case Study.

Assignment C - 40 multiple choice Objective Questions . Answers can be in the form of

tick marking the most appropriate answer.


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Table of Contents

Preface............................................................................................................................................. 2

Chapter-1: Introduction to the Basics of Accounting ..................................................................... 9

1.1 Introduction ........................................................................................................................... 9

1.2 Concepts of Accounting ........................................................................................................ 9

1.3 Conventions regarding Financial Statements...................................................................... 10

1.4 Users of Accounting Information ....................................................................................... 10

1.5 Scope of and inter-relationship between financial, cost and management accounting....... 11

1.6 Meaning of HR Accounting ................................................................................................ 12

Multiple Choice Questions ....................................................................................................... 14

Chapter- 2: Accounting Equation ................................................................................................. 16

2.1 Basic Accounting Terminology .......................................................................................... 16

2.2 Accounting Equation .......................................................................................................... 19


Chapter-3: Journalizing, Posting & Balancing ............................................................................. 24

3.1Types of Books .................................................................................................................... 25

3.1.1 Double-Entry Accounting ............................................................................................ 25

3.2 Accounts ............................................................................................................................. 26

3.2.1 Classification of Accounts ........................................................................................... 26

3.2.2 Format for Accounts .................................................................................................... 26

3.2.3 The Ledger ................................................................................................................... 27

3.3 Journalizing ......................................................................................................................... 27

3.3.1 Journal Entries ............................................................................................................. 27

3.3.2 Debits and Credits of Accounts ................................................................................... 30

3.3.3 Normal Balances of Accounts ..................................................................................... 30


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3.4 Trial Balance ....................................................................................................................... 37

3.4.1 What is the difference between a trial balance and a balance sheet? ........................... 38

3.4.2 Methods of preparing trial Balance.............................................................................. 38

3.4.3 Format of trial balance ................................................................................................. 38

3.4.4 Preparation of Trial Balance Methods ...................................................................... 45

3.4.5 Errors in the trial balance ............................................................................................. 47


Chapter-4: Financial Statements ................................................................................................... 52

4.1 Preparation of Profit & Loss Account ................................................................................ 53

4.1.1 Introduction to the profit and loss account .................................................................. 53

4.1.2 Preparation of Balance sheet ........................................................................................ 67

4.1.3 Sample balance sheet structure .................................................................................... 70

4.2 Inventory Valuation and the matching of revenue and expenses ....................................... 73

4.2.1. Inventory and financial statements ............................................................................. 73

4.2.2. Methods of Inventory Valuation ................................................................................. 74

4.2.3 Using non-cost methods to value inventory................................................................. 74

4.2.4 Methods used to estimate inventory cost ..................................................................... 75

4.3 Fixed Assets and Depreciation............................................................................................ 75

4.4 Depreciation ........................................................................................................................ 76

4.1.1 Meaning of Depreciation ............................................................................................. 76

4.4.2 Special Features of Depreciation ................................................................................. 77

4.4.3 Causes of Depreciation ................................................................................................ 77

4.4.4 Importance or need for providing depreciation ........................................................... 78

4.4.5 Factors affecting the amount of depreciation............................................................... 79



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Chapter 5: Analysis of Financial Statements ................................................................................ 84

5.1 Meaning of Ratio Analysis ................................................................................................. 84

5.1.1 Sources of data for financial ratios .............................................................................. 85

5.1.2 Purpose and types of ratios .......................................................................................... 85

5.1.3 Financial ratios allow for comparisons ........................................................................ 85

5.1.4 Accounting methods and principles ............................................................................. 86

5.1.5 Abbreviations and terminology.................................................................................... 86

5.2 Classification of Ratios ....................................................................................................... 88

5.2.1. Profitability ratios ....................................................................................................... 88

5.2.2. Liquidity ratios ............................................................................................................ 92

5.2.3. Activity ratios.............................................................................................................. 93

5.2.4. Debt ratios (leveraging ratios) .................................................................................... 96

5.2.5. Market ratios ............................................................................................................... 97

5.2.6. Capital Budgeting Ratios .......................................................................................... 100

Multiple Choice Questions ..................................................................................................... 102

Chapter-6: Company Accounts ................................................................................................... 105

6.1 Introduction ....................................................................................................................... 106

6.1.1 Meaning of Company ................................................................................................ 106

6.1.2 Characteristics ............................................................................................................ 106

6.1.3 Kinds of Companies ................................................................................................... 106

6.1.4 Formation of Company .............................................................................................. 107

6.2 Shares and Share Capital .................................................................................................. 108

6.2.1 Meaning and Types of Shares .................................................................................... 108

6.2.2 Share Capital .............................................................................................................. 108

6.2.3 Classification of Share Capital................................................................................... 109


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6.2.4 Issue of Shares ........................................................................................................... 109

6.2.5 Forfeiture of Shares.................................................................................................... 113

6.2.6 Reissue of Forfeited Shares ....................................................................................... 115

6.3 Debentures ........................................................................................................................ 115

6.3.1 Meaning of Debentures .............................................................................................. 115

6.3.2 Types of Debentures .................................................................................................. 116

6.4 Liquidation ........................................................................................................................ 116

6.4.1 Meaning of liquidation ............................................................................................... 116

6.4.2 Types of Liquidation .................................................................................................. 116


Chapter-7: Cost & Management Accounting ............................................................................. 121

7.1 Introduction to Cost and Management Accounting .......................................................... 122

7.1.1 Management Accounting ........................................................................................... 122

7.1.2 Cost Accounting......................................................................................................... 124

7.2 Concept of Cost................................................................................................................. 127

7.3 Elements of Cost ............................................................................................................... 127

7.4 Cost Sheet ......................................................................................................................... 132

7.4.1 Components of Total Cost ......................................................................................... 132

7.4.2 Structure of Cost Sheet .............................................................................................. 133

7.5 Classification of Cost ........................................................................................................ 137

7.5.1. Fixed, Variable and Semi-Variable Costs ................................................................. 137

7.5.4. Decision-Making Costs and Accounting Costs ........................................................ 140

7.5.5. Relevant and Irrelevant Costs ................................................................................... 140

7.5.6. Shutdown and Sunk Costs ........................................................................................ 141

7.5.7. Controllable and Uncontrollable Costs ..................................................................... 141


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7.5.8. Avoidable or Escapable Costs and Unavoidable or Inescapable Costs .................... 141

7.5.9. Imputed or Hypothetical Costs ................................................................................. 142

7.5.10. Differentials, Incremental or Decrement Cost ........................................................ 142

7.5.11. Out-of-Pocket Costs ................................................................................................ 144

7.5.12. Opportunity Cost ..................................................................................................... 144

7.5.13. Traceable, Untraceable or Common Costs ............................................................. 144

7.5.14. Production, Administration and Selling and Distribution Costs ............................. 145

7.5.15. Conversion Cost ...................................................................................................... 146

7.6 Cost Unit and Cost Center ................................................................................................ 147

7.6.1 Cost Unit .................................................................................................................... 147

7.6.2 Cost Center................................................................................................................. 147

7.7 Cost Estimation and Cost Ascertainment ......................................................................... 148

7.8 Cost Allocation and Cost Apportionment ......................................................................... 149

7.9 Cost Reduction and Cost Control ..................................................................................... 149

7.10 Methods of Costing ......................................................................................................... 149

7.11 Techniques of Costing .................................................................................................... 152


Chapter 8: Process Costing ......................................................................................................... 157

8.1 Features/Characteristics of Process Costing ..................................................................... 157

8.2 Elements/Components of Process Cost ............................................................................ 159

8.3 Methodology of Recording/Accounting Costs ................................................................. 160

8.3.1 Process Accounts ....................................................................................................... 160

8.3.2 Process Stock Accounts ............................................................................................. 161

8.4 Process Losses & Gains .................................................................................................... 161

8.4.1 Process Losses ........................................................................................................... 161


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8.4.2 Abnormal Effectives/Gain ......................................................................................... 163


Chapter-9: Marginal Costing & Break Even Analysis ............................................................... 169

9.1 Marginal Costing .............................................................................................................. 170

9.1.1 Introduction ................................................................................................................ 170

9.1.2. Theory of Marginal Costing...................................................................................... 171

9.1.3 The principles of marginal costing ............................................................................ 173

9.1.4 Features of Marginal Costing..................................................................................... 174

9.1.5 Advantages and Disadvantages of Marginal Costing Technique .............................. 174

9.2 Marginal Costing Pro-Forma ............................................................................................ 176

9.3 Breakeven Analysis .......................................................................................................... 177

9.3.1 Introduction ................................................................................................................ 177

9.3.2 Cost-Volume-Profit (C-V-P) Relationship ................................................................ 178

9.3.3 Objectives of Cost-Volume-Profit Analysis .............................................................. 180

9.3.4 Assumptions and Terminology .................................................................................. 180

9.3.5 Limitations of Cost-Volume Profit Analysis ............................................................. 182

9.4 Marginal Cost Equations and Breakeven Analysis ........................................................... 183

Key to Multiple Choice Questions .............................................................................................. 197

Bibliography ............................................................................................................................... 198


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Chapter-1: Introduction to the Basics of Accounting

Contents:

1.1 Introduction

1.2 Concepts of accounting,

1.3 Conventions regarding financial statements,

1.4 Users of accounting information,

1.5 Scope of and inter-relationship between financial, cost and management accounting,

1.6 HR Accounting

1.1 Introduction

Accounting is an ancient art as old as money itself. Luca Pacioli is widely regarded as Father of

Accounting. He developed the double entry bookkeeping system.Double-entry is defined as any

bookkeeping system in which there is a debit and credit entry for each transaction, or for whichthe majority of transactions are intended to be of this form. In India, Chanakya clearly indicates,

in his Arthshastra, the existence and need of proper accounting and audit.

Accounting is an actual process of preparing and presenting the accounts. An account is a British

term for Financial Statements.

1.2 Concepts of Accounting

The various concepts of accounting are:

1. Business Entity Concept: According to it the business & the person owing it are

different entities.


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2. Money Measurement Concept: Accounting records only those transactions which are

expressed in monetary terms, though quantitative records are also recorded.

3. Cost Concept: Transactions are entered in the books of accounts at the amounts actually

involved.

4. Going Concern Concept: It is assumed that the business will continue for long period.

5. Dual-Aspect Concept: For each and every transaction there is an effect on both sides of

Balance Sheet i.e. Assets and Liabilities.

6. Realization Concept: According to it the transaction is recorded only when the money is

realized.

7. Accrual Concept: According to it the transaction must be recorded when it occurs, it

may or may not be settled at the time of recording.

1.3 Conventions regarding Financial Statements

For the proper interpretation of the Financial Statements the following are the conventions:

1. Consistency: There must be consistency in the accounting practices followed from yearto year. If a change becomes necessary, the change and its effect must be stated clearly.

2. Disclosure: Good accounting practice demands that all significant information must be

disclosed.

3. Conservatism: It means that Financial Statements must not disclose any illusionary data.

It must not be window dressed.

1.4 Users of Accounting Information

Besides the persons at the helm of affairs of the concerned firm or institution, there are numerous

other parties interested in the financial statements. These are:


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1. Shareholders: Get the knowledge of the performance of the company through the help of

financial statements.

2. Investors: Who are interested in buying the shares of the firm need Financial Statements

to determine the credentials, returns and overall performance of the firm.

3. Creditors: The Financial Statements greatly help them in properly assessing the

capability of the firm to pay back their money in time.

4. Labor: They need Financial Statements for conducting the wage negotiations.

5. Government: Need Financial Statements for compiling the statistics of the concerning

business which, in turn, help in compiling national accounts.

6. Researchers: The Financial Statements, being the mirror of business conditions, are of

inestimable value to research in to business affairs.

7. Public: Financial Statements may assist the public by providing information about trends

and recent developments in the prosperity of the enterprise and the range of its activities.

1.5 Scope of and inter-relationship between financial, cost and

management accounting.

Economic development and technological improvements have resulted in an increase in the scale

of business operations. This leads to the specialized branches of accounting such as Financial

Accounting, Cost accounting, Management Accounting & Social Responsibility Accounting.

Branches of

Accounting

Financial

AccountingCost Accounting

Management

Accounting

SocialResponsibility

Accounting


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Lets understand these branches of accounting:

1. Financial Accounting: It is the process of identifying, measuring, recording, classifying,

summarizing, analyzing, interpreting and communicating the financial transactions and

events. The purpose of this branch is to keep the systematic records to ascertain financial

position and performance of the enterprise.

2. Cost Accounting: It is the process of accounting and controlling the cost of a product,

operation or function. The purpose of this branch is to ascertain the cost, to control the

cost and to communicate information for decision making.

3. Management Accounting: It is the application of accounting techniques for providing

information designed to help all levels of management in planning and controlling the

activities of business enterprise and in decision making. The purpose of this branch is to

supply any and all information that management may need in taking the decisions.

4. Social Responsibility Accounting: It is the process of identifying, measuring and

communicating the social effects of business decisions to permit informed judgement and

decisions by the users of information.

1.6 Meaning of HR Accounting

Human Resource Accounting is the offshoot of various research studies conducted in

the areas of accounting and finance. Human resource is an asset whose value gets

appreciated over the period of time provided placed, applied and developed in the right

direction.

To ensure growth and development of any organization, the efficiency of people must be

augmented in the right perspective. Without human resources, the other resources cannot be

operationally effective.

The original health of the organization is indicated by the human behavior variables, like group

loyalty, skill, motivation and capacity for effective interaction, communication and decision

making.


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Men, materials, machines, money and methods are the resources required for an organization.

These resources are broadly classified into two categories

Animate

Inanimate (human and physical) resources.

Men, otherwise known as the human resources, are considered to be animate resources. Others,

namely, materials, machines, money and methods are considered to inanimate or physical

resources.

Till the recent past, organizations took few efforts to assign monetary value to human

resource in its accounting practice.

Presently the behavioral scientists initiated efforts to develop appropriate methodology for

finding out the value of human resource to the organization. They were against the conventional

accounting practice for its failure to value the human resource of an organization along with

physical resources. As a result the HR Accounting comes into the scenario. The various

approaches towards it are:

1. Historical Cost Approach.

2. Replacement Approach.

3. Present value of future earnings.

4. Value of the organization.

5. Expense Model.


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Multiple Choice Questions

1). Accounting is an art of:

a) Recording

b) Classifying

c) Interpretating

d) All of above

2). For each & every transaction there is an effect on both Assets & Liabilities:

a) Business Entity Concept

b) Money Measurement Concept.

c) Cost Concept.

d) Dual-Aspect Concept.

3). Consistency in Financial Statements means:

a) Same accounting practices must be followed in years to come.

b) All significant information must be disclosed.

c) It must not be window dressed.

d) None of above.


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4). According to HR Accounting the resources are:

a) Men

b) Material

c) Money

d) Machine

e) All of above

5). The purpose of this branch is to supply any and all information that management may need in

taking the decisions:

a) Financial Accounting

b) Management Accounting

c) Cost Accounting

d) HR Accounting


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Chapter- 2: Accounting Equation

Contents:

2.1 Basic Accounting Terminology

2.2 Accounting Equation

In order to understand the Accounting concepts its necessary to have the basic understanding of

accounting terminology.

2.1 Basic Accounting Terminology

1. Entity: An entity is something that has a distinct, separate existence, that performs

economic activities.

2. Event: It is the happening of consequence to an entity.

3. Transaction: A transaction is an agreement, communication, or movement carried outbetween separate entities or objects, often involving the exchange of items of value, such

as information, goods, services and money.

4. Voucher: It is the document which serves as an evidence for transaction.

5. Entry: It is the record made in the books of accounts in respect of a transaction or event.

6. Assets: In business and accounting, assets are everything of value that is owned by a

person or company. The two major asset classes are:

a. Tangible assets: Tangible assets contain various subclasses, including current

assets and fixed assets. Current assets include inventory, while fixed assets

include such items as buildings and equipment.


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b. Intangible assets: Intangible assets are nonphysical resources and rights that have

a value to the firm because they give the firm some kind of advantage in the

market place. Examples of intangible assets are goodwill, copyright, trademarks,

patents and computer programs and financial assets, including such items as

accounts receivable, bonds and stocks.

7. Liabilities: In financial accounting, a liability is defined as an obligation of an entity

arising frompasttransactions or events, the settlement of which may result in the transfer

or use of assets, provision of services or other yielding of economic benefits in the future.

Liabilities are reported on a balance sheet and are usually divided into two categories:

a. Current liabilities these liabilities are reasonably expected to be liquidated

within a year. They usuallyinclude payables such as wages, accounts, taxes, and

accounts payables, unearned revenue when adjusting entries, portions of long-

term bonds to be paid this year, short-term obligations (e.g. from purchase of

equipment), and others.

b. Long term liabilities these liabilities are reasonably expected not to be

liquidated within a year. They usually include issued long-term bonds, notes

payables, long-term leases, pension obligations, and long-term product warranties.

8. Capital: It is the excess of assets over external liabilities.

9. Drawings are the total amount of cash or goods or any other asset withdrawn by the

proprietor or the partner of the partnership enterprise for personal use.

10.Purchasesrefer to the total amount of goods obtained by an enterprise for resale or for

use in the production of goods or rendering of services in the normal course of business.

It may be for cash or credit.

11.Salesrefer to the amount for which goods are sold or services are rendered. It may be for

cash or credit.

12.Stockrefers to the tangible property held for sale in the ordinary course of business or for

consumption in the production of the goods or services.


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13.Trade creditorsrefer to the person to whom the amounts are due for goods purchased or

services rendered on credit basis.

14.Trade debtorsrefer to the person from whom the amounts are due for goods purchased

or services rendered on credit basis.

15.Receivables: includes both trade debtors and bills receivable.

16.Payables: includes both trade creditors and bills payable.

17.Expenditureis the costs incurred in acquiring an asset or service in the form of outflow

or depletion of assets or incurrence of liability.

18.Income is increases in economic benefits during the accounting period in the form of

inflows or enhancements of assets or decreases of liabilities that result in increases in

equity, other than those relating to contributions from equity participants.

19.Expenses decreases in economic benefits during the accounting period in the form of

outflows or depletions of assets or incurrence of liabilities that result in decreases in

equity, other than those relating to distributions to equity participants

20.Gainsare increase in equity (not assets)from incidental transaction of an entity and from

all other transaction and other events and circumstances affecting the entity during the

accounting period except that result from revenues or investment by equity participants.

21.Lossesare decrease inequity (not assets)from incidental transaction of an entity and from

all other transaction and other events and circumstances affecting the entity during the

accounting period except that result from revenues or investment by equity participants.

22.Revenue refers to the amount charged for the goods sold or services rendered or

permitting others to use enterprises resources yielding interest, royalty and dividend.

23.Net Profit is the excess of revenue over expenses

24.Net Lossis the excess of expenses over revenue.


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2.2 Accounting Equation

The basic accounting equation is the foundation for the double entry book keeping system. It

shows how assets were financed:

Either by borrowing money from someone (liability) or

By paying your own money (shareholders equity).

Assets = Liabilities + (Shareholders or Owners equity)

For example: A student buys a computer for $945. This student borrowed $500 from his best

friend and saved another $445 from his part-time job. Now his assets are worth $945, liabilities

are $500, and equity $445.

The formula can be rewritten:

Assets Liabilities = (Shareholders or Owners equity)

Now it shows owners interest is equal to property (assets) minus debts (liabilities). Since in a

company owners are shareholders, owners interest is called shareholders equity. Every

accounting transaction affects at least one element of the equation, but always balances. Simplest

transactions also include.

Transaction

NumberAssets Liabilities

Shareholders

EquityExplanation

1 + 6,000 + 6,000 Issuing stocks for cash or other assets

2 + 10,000 + 10,000Buying assets by borrowing money (taking a

loan from a bank or simply buying on credit)

3 - 900 - 900 Selling assets for cash to pay off liabilities:


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both assets and liabilities are reduced

4 + 1,000 + 400 + 600

Buying assets by paying cash by

shareholders money (600) and by borrowing

money (400)

5 + 700 + 700 Earning revenues

6 - 200 - 200Paying expenses (e.g. rent or professional

fees) or dividends

7 + 100 - 100

Recording expenses, but not paying them at

the moment

8 - 500 - 500 Paying a debt that you owe

9 0 0 0

Receiving cash for sale of an asset: one asset

is exchanged for another; no change in assets

or liabilities

These are some simple examples, but even the most complicated transactions can be recorded in

a similar way. This equation is behind debits, credits, and journal entries.

Also, the equation can be rewritten as:

Assets = Liabilities + Owners equity + (RevenueExpenses)

OR

Assets + Expenses = Liabilities + Owners equity + Revenue

This is often referred to as the expandedaccounting equation, because it yields the breakdown of

the equity component of the equation


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1). It is the document which serves as an evidence for transaction

a) Transaction

b) Voucher

c) Journal

d) Ledger

2). The tangible property held for sale in the ordinary course of business or for consumption in

the production of the goods or services.

a) Stock

b) Plant

c) Machine

d) Furniture

3). Which of the following is correct?

a) Assets = LiabilitiesCapital

b) Assets = CapitalLiabilities

c) Assets = Liabilities + Capital

d) Assets = External Equities


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a) Profit/loss = Closing Capital + Additional CapitalDrawings madeOpening Capital

b) Profit/loss = Closing CapitalAdditional CapitalDrawings madeOpening Capital

c) Profit/loss = Opening Capital + Drawings madeAdditional CapitalClosing Capital.

d) Profit/loss = Closing CapitalAdditional Capital + Drawings madeOpening Capital


a) Opening Capital = Closing Capital + Additional CapitalDrawingsProfits

b) Opening Capital = Closing Capital + DrawingsAdditional CapitalLosses

c) Opening Capital = Closing Capital + DrawingsAdditional CapitalProfits


a) Closing Capital = Opening Capital + Additional CapitalProfitDrawings.

b) Closing Capital = Opening Capital + Additional CapitalDrawings + Profit

c) Closing Capital = Opening CapitalAdditional CapitalLossesDrawings.

7). The liabilities of a firm are Rs.6000 and the capital of the proprietor is Rs.4000. The total

assets are:

a) Rs.6000

b) Rs.10000

c) Rs.2000


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8).If a firm borrows a sum of money, there will be:

a) Increase in capital

b) Decrease in capital

c) No effect on capital.

9). The assets on 31/12/2008 $60,000 and capital is $45,000. Its liabilities on that date shall be:

a) $60,000

b) $105,000

c) $15,000

10). Harry has assets of $10,000 and liabilities of $2,000. His capital would be:

a) $10,000

b) $8,000

c) $2,000


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Chapter-3: Journalizing, Posting & Balancing

Contents:

3.1 Types of Books

3.1.1 Double Entry Accounting

3.2 Accounts

3.2.1 Classification of Accounts

3.2.2 Format of Accounts

3.2.3 The Ledger

3.3 Journalizing

3.3.1 Journal Entries

3.3.2 Debits and Credits of Accounts

3.3.3 Normal Balances of Accounts

3.4 Trial Balance

3.4.1 What is the difference between a trial balance and a balance sheet?

3.4.2 Methods of preparing trial Balance

3.4.3 Format of trial balance

3.4.4 Preparation of Trial Balance

3.4.5 Errors in the trial balance


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Transactions are either written, as they occur, in a waste book or the various documents or

papers. This is recording of accounts and the documents are called vouchers. The steps for the

recording of transactions are:

1. Recording of transactions in Vouchers.

2. Recording of vouchers to Journal Entries.

3. Posting of journal entries to ledgers.

4. Preparation of Profit & Loss Statementby the help of ledgers.

5. Preparation of Balance Sheet.

3.1Types of Books

There are basically two types of books:

1. Principal Books:

2. Subsidiary Books:

3.1.1 Double-Entry Accounting

To record transactions, accounting system uses double-entry accounting.

Double-entry implies that transactions are always recorded using two sides, debit and credit.

Debit refers to the left-hand side and credit refers to the right-hand side of the journal entry or

account.

The sum of debit side amounts should equal to the sum of credit side amounts.


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3.2 Accounts

A record is the general ledger that is used to collect and store similar information. For example, a

company will have a Cash account in which every transaction involving cash is recorded.

Company selling merchandise on credit will record these sales in a Sales account and in anAccounts Receivable account.

3.2.1 Classification of Accounts

(a). Personal Accounts, i.e., accounts of persons (creditors, customers, etc)

(b). Impersonal accounts:

1. Real Accounts, i.e., accounts of properties and assets; &

2. Nominal Accounts, i.e., accounts of incomes, expenses and losses.

3.2.2 Format for Accounts

Dr.

Cr.

Date Particulars Folio Amount

Rs. P.

Date Particulars Amount

Rs. P.

April 1 To Balance b/d 10,000 00 April 30 By Balance b/d 10,000 00

10,000 00 10,000 00


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3.2.3 The Ledger

The book which contains accounts is known as the ledger. Since final information pertaining to

the financial position of a business emerges only from accounts, the ledger is also called the

Principal Book.

Other books like Purchase Books or Sales Book or Journal merely facilitate the preparation of

accounts or the ledgers and hence are called as Subsidiary Books or the Books of Original

Entries.

3.3 Journalizing

3.3.1 Journal Entries

Journal entry is an entry to the journal.

Journal is a record that keeps accounting transactions in chronological order, i.e. as they occur.

Account is a unit to record and summarize accounting transactions.

All accounting transactions are recorded through journal entries that show account names,amounts, and whether those accounts are recorded in debit or credit side of accounts.

A journal entry is called "balanced" when the sum of debit side amounts equals to the sum of

credit side amounts.

Transaction 1:Company A sold its products at $120 and received the full amount in cash.

Steps Self-Questions Answers

1 What did Company A receive? Cash.

2 If Company A received cash, how would this affect Receiving cash increases

the cash balance of the


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the cash balance? company.

3 Which side of cash account represents the increase in

cash?

Debit side (Left side).

4 What is the account name to record the sales of

products?

Sales.

5 Which side of sales account represents the increase in

sales?

Credit side (Right side).

6 Does the sum of debit side amounts equal to the sum

of credit side amounts? In other words, does this

journal entry balance?

Yes.

$120 = $120

[Journal entry to record transaction 1]

Debit Credit

Cash 120

Sales 120

Transaction 2: Company A purchased supplies and paid $50 in cash.

Steps Self-Questions Answers

1 What did Company A receive? Supplies.


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2 If Company A received supplies, how would this

affect the supplies balance?

It increases supplies

balance.

3 Which side of supplies account represents the increasein cash?

Debit side (Left side).

4 What did Company A pay? Cash.

5 Which side of cash account represents the decrease in

cash?

Credit side (Right side).

6 Does the sum of debit side amounts equal to the sum

of credit side amounts? In other words, does this

journal entry balance?

Yes.

$50 = $50

[Journal entry to record transaction 2]

Debit Credit

Supplies 50

Cash 50


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3.3.2 Debits and Credits of Accounts

Debit Credit

Increase in asset accounts Decrease in asset accounts

Increase in expense accounts Decrease in expense accounts

Decrease in liability accounts Increase in liability accounts

Decrease in equity accounts Increase in equity accounts

Decrease in revenue accounts Increase in revenue accounts

3.3.3 Normal Balances of Accounts

Accounts have normal balances on the side where the increases in such accounts are recorded.

Asset accounts have normal balances on debit side.

Expense accounts have normal balances on debit side.

Liability accounts have normal balances on credit side.

Equity accounts have normal balances on credit side.

Revenue accounts have normal balances on credit side.

On the financial statements, accounts are reported on the sides where they have normalbalances.

Liability accounts have normal balances on credit side.

Equity accounts have normal balances on credit side.


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Example 1: Financing Activities

Owner invested $10,000 in the company.

Analysis of Transaction

Steps Debit or Credit?

1 Increase in Assets (Cash) by $10,000 Debit

2 Increase in Owner's Equity by $10,000 Credit

Journal Entry

Debit Credit

Cash 10,000

Owner's Equity 10,000

Description of Journal Entry

Owner invested $10,000 in the company.

Results of Journal Entry

Cash balance increases by $10,000. --> Increase in Assets

Owner's Equity balance increases by $10,000. --> Increase in Owner's Equity

Example 2: Financing Activities

The company borrowed $20,000 from a bank.


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1 Increase in Assets (Cash) by $20,000 Debit

2 Increase in Liabilities (Borrowings) by $20,000 Credit

Journal Entry


Borrowed $20,000.



Borrowings balance increases by $20,000. --> Increase in Liabilities

Debit Credit

Cash 20,000

Borrowings 20,000

Example 3: Investing Activities

The company purchased $12,000 equipment and paid in cash.



1 Increase in Assets (Equipment) by $12,000 Debit

2 Decrease in Assets (Cash) by $12,000 Credit


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Journal Entry

Debit Credit

Equipment 12,000

Cash 12,000

Description of Journal Entry Purchased $12,000 equipment in cash.


Equipment balance increases by $12,000. --> Increase in Assets

Cash balance decreases by $12,000. --> Decrease in Assets

Example 4: Operating Activities

The company purchased $6,000 merchandise (600 units) on credit.



1. Increase in Assets (Merchandise) by $6,000 Debit

2. Increase in Liabilities (Accounts Payable) by $6,000 Credit

Journal Entry

Debit Credit

Merchandise 6,000

Accounts Payable 6,000


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Description of Journal Entry Purchased $6,000 merchandise on credit.


Merchandise balance increases by $6,000. --> Increase in Assets

Accounts Payable balance increases by $6,000. --> Increase in Liabilities

Example : 5 Operating Activities

The company sold 500 units of merchandise at the price of $11,000. Customer paid $9,000 in

cash at the time of sale.


Note: This transaction includes both "REVENUE" and "EXPENSE" components.

(1) REVENUE side

Steps Debit or Credit ?

1. Increase in Assets (Cash) by $9,000 Debit

2. Increase in Assets (Accounts Receivable) by $2,000 Debit

3. Increase in Revenue (Sales) by $11,000 Credit

(2) EXPENSE side


1 Increase in Expenses (Cost of Merchandise Sold) by $5,000

($6,000 / 600 units = $10 per unit)

($10 per unit X 500 units sold = $5,000 cost) Debit


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2 Decrease in Assets (Merchandise) by $5,000 Debit

(1) REVENUE Journal Entry

Debit Credit

Cash 9,000

Accounts Receivable 2,000

Sales Revenue 11,000

Description of Journal Entry Sold merchandise at $11,000 price and received $9,000 in

cash.



Accounts Receivable balance increases by $2,000. --> Increase in Assets

Sales Revenue account balance increases by $11,000. --> Increase in Revenue

(2) EXPENSE Journal Entry

Debit Credit

Cost of Merchandise Sold 5,000

Merchandise 5,000

Description of Journal Entry To record the cost of merchandise sold.


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Merchandise balance decreases by $5,000. --> Decrease in Assets

Cost of Merchandise Sold account balance increases by $5,000. --> Increase in Expense


The company paid $3,500 salaries.



1. Increase in Expenses (Salaries Expense) by $3,500 Debit

2. Decrease in Assets (Cash) by $3,500 Credit

Journal Entry

Debit Credit

Salaries Expense 3,500

Cash 3,500

Description of Journal Entry Paid $3,500 salaries.



Salaries Expense account balance increases by $3,500. --> Increase in Expenses


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The company paid $1,500 rent.



1. Increase in Expenses (Rent Expense) by $1,500 Debit

2. Decrease in Assets (Cash) by $1,500 Credit

Journal Entry

Debit Credit

Rent Expense 1,500

Cash 1,500


Paid $1,500 rent.



Rent Expense account balance increases by $1,500. --> Increase in Expenses

3.4 Trial Balance

In accounting, the trial balance is a worksheet listing the balance at a certain date, of each ledger

account in two columns, namely debit and credit. Under the double-entry system, in any

transaction the total of any debits must equal the total of any credits, so in a Trial Balance the


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total of the debit side should always be equal to the total of the credit side. The trial balance thus

serves as a tool to detect errors, which can result in the totals not being equal. Often credits will

be represented as a negative, in which case the total of the trial balance should be 0.

3.4.1 What is the difference between a trial balance and a balance sheet?

The trial balance is an internal documentit stays in the accounting department. It is a listing of

all of the accounts in the general ledger (balance sheet accounts and income statement accounts)

and their respective balances as of a specified point in time, such as March 31, 2009. The

purpose of the trial balance is to document that the total amount of account balances with debit

balances is equal to the total of amount of account balances with credit balances.

The balance sheet is a financial statement that reports the currency amounts of assets, liabilities,

and stockholders equity at a specified point, such as March 31, 2009. Since it is a financial

statement, it will be distributed outside of the accounting department. As a result, it should be

prepared in accordance with generally accepted accounting principles. (Often the balance sheet

accounts in the general ledger are summarized and combined so that the resulting balance sheet

is only 20 - 30 lines in length.)

3.4.2 Methods of preparing trial Balance

Totals method: In this method, the totals of debit and credit sides of the ledger accounts,

excluding the closing balances, are shown in the trial balance.

Balances method: Only the closing balances of the ledger accounts are shown in the trial

balance.

3.4.3 Format of trial balance

The most common format in which we find a trial balance is as below.


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Trial Balance of M/s _____ as on _____

Particulars L/FDebit Amount

(in Rs)

Credit Amount

(in Rs)

Account Head 1

Account Head 2

Account Head 3

Total xxxx xxxx

Header Row

The heading row contains the heading for the trial balance. It consists of the details relating to

name of the organization and the instance to which the ledger account balances pertain.

Particulars

Each row in the trial balance pertains to the information relating to an account. The name of the

Account head is written in the particulars column.

L/F Ledger Folio

Ledger Folio gives the information relating to the page number in the ledger from which the

information relating to the ledger is being extracted.

Debit amount

This is the amount whose information is extracted from the ledger account.

What the debit amount actually means is dependent on the method used for constructing the trial

balance.

Credit amount


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This is the amount whose information is extracted from the ledger account.

What the credit amount actually means is dependent on the method used for constructing the trial

balance.

Illustration General Ledger

The following is the General Ledger of Mr. Ibrahim, containing all the Ledger accounts within

the accounting system.

General Ledger

[Books of Mr. Ibrahim]

Dr Cash a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

15/06/05

19/06/05

24/06/05

24/06/05

To Capital a/c

To Goods/Stock a/c

To Mr. Natekar a/c

To Commission

Received a/c

2,00,000

12,000

2,000

500

17/06/05

17/06/05

18/06/05

18/06/05

21/06/05

By Furniture a/c

By Rent Paid a/c

By Bank a/c

By Goods/Stock a/c

By Wages Paid a/c

20,000

5,000

1,50,000

10,000

5,000

sub-total 2,14,500 sub-total 1,90,000

25/06/05 By Balance c/d 24,500

Total 2,14,500 Total 2,14,500

25/06/05 To Balance b/d 24,500

Dr Capital a/c Cr


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Amount

(in Rs)

15/06/05 By Cash a/c 2,00,000

sub-total 0 sub-total 2,00,000

25/06/05 To Balance c/d 2,00,000

Total 2,00,000 Total 2,00,000

25/06/05 By Balance b/d 2,00,000

Dr Furniture a/c Cr



Amount

(in Rs)

17/06/05 To Cash a/c 20,000

sub-total 20,000 sub-total 0

25/06/05 By Balance c/d 20,000

Total 20,000 Total 20,000

25/06/05 To Balance b/d 20,000

Dr Rent Paid a/c Cr

Date Particulars J/F

Amount

(in Rs) Date Particulars J/F

Amount

(in Rs)

17/06/05 To Cash a/c 5,000



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25/06/05 By Balance c/d 5,000


25/06/05 To Balance b/d 5,000

Dr Bank a/c Cr



Amount

(in Rs)

18/06/05 To Cash a/c 1,50,000 20/06/05

24/06/05

By Machinery a/c

By M/s Ramdas

& Bros. a/c

25,000

5,000

sub-total 1,50,000 sub-total 30,000

25/06/05 By Balance c/d 1,20,000

Total 1,50,000 Total 1,50,000

25/06/05 To Balance b/d 1,20,000

Dr Goods/Stock a/c Cr



Amount

(in Rs)

18/06/05

18/06/05

To Cash a/c

To M/s Ramdas

& Bros. a/c

10,000

10,000

19/06/05

21/06/05

By Cash a/c

By Mr. Natekar a/c

12,000

8,000

sub-total 20,000 sub-total 20,000



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Dr M/s Ramdas & Bros. a/c Cr

Date Particulars J/F Amount

(in Rs)Date Particulars J/F Amount

(in Rs)

24/06/05 To Bank a/c 5,000 18/06/05 By Goods/Stock a/c 10,000


25/06/05 To Balance c/d 5,000


25/06/05 By Balance b/d 5,000

Dr Machinery a/c Cr



Amount

(in Rs)

20/06/05 To Bank a/c 25,000


25/06/05 By Balance c/d 25,000


25/06/05 To Balance b/d 25,000

Dr Mr. Natekar a/c Cr



Amount

(in Rs)


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21/06/05 To Goods/Stock a/c 8,000 24/06/05 By Cash a/c 2,000


25/06/05 By Balance c/d 6,000


25/06/05 To Balance b/d 6,000

Dr Wages Paid a/c Cr



Amount

(in Rs)

21/06/05 To Cash a/c 5,000


25/06/05 By Balance c/d 5,000


25/06/05 To Balance b/d 5,000

Dr Commission Received a/c Cr



Amount

(in Rs)

24/06/05 By Cash a/c 500

sub-total 0 sub-total 500

25/06/05 To Balance c/d 500


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Total 500 Total 500

25/06/05 By Balance b/d 500

3.4.4 Preparation of Trial Balance Methods

There are two methods for preparing a trial balance (1) Traditional Method and (2) Modern

Method. Both serve the same purpose. The modern method is a derivative of the traditional

method.

Traditional Method

The traditional method considers the sub-totals of each ledger account.

It is prepared by presenting the sub-totals relating to each ledger account in the relevant columns

in the trial balance.

"Trial Balance"

[Traditional Method]



(in Rs)

Credit Amount

(in Rs)

Cash a/c

Capital a/c

Furniture a/c

Rent Paid a/c

Bank a/c

Goods/Stock a/c

M/s Ramdas & Bros. a/c

214,500

0

20,000

5,000

1,50,000

20,000

5,000

1,90,000

2,00,000

0

0

30,000

20,000

10,000


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Machinery a/c

Mr. Natekar a/c

Wages Paid a/c

Commission Received a/c

25,000

8,000

5,000

0

0

2,000

0

500

Total 4,52,500 4,52,500

Debit amount

Debit amount is the sub-total of the debit column in the Ledger Account.

Credit amount

Credit amount is the sub-total of the credit column in the Ledger Account.

Modern Method

The modern method considers only the balances of the ledger accounts.

It is prepared by presenting the balance relating to each ledger account in the relevant column in

the trial balance.

"Trial Balance"

[Modern Method]



(in Rs)

Credit Amount

(in Rs)

Cash a/c

Capital a/c

24,500

2,00,000


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Furniture a/c

Rent Paid a/c

Bank a/c

Goods/Stock a/cM/s Ramdas & Bros. a/c

Machinery a/c

Mr. Natekar a/c

Wages Paid a/c

Commission Received a/c

20,000

5,000

1,20,000

25,000

6,000

5,000

5,000

500

Total 2,05,500 2,05,500

3.4.5 Errors in the trial balance

A balanced trial balance does not guarantee that there is no error. The following are the main

classes of error that are not detected by the trial balance:

An error of original entryis when both sides of a transaction include the wrong amount.

For example, if a purchase invoice for 21 is entered as 12, this will result in an

incorrect debit entry (to purchases), and an incorrect credit entry (to the relevant creditor

account), both for 9 less, so the total of both columns will be 9 less, and will thus

balance.

An error of omission is when a transaction is completely omitted from the accounting

records. As the debits and credits for the transaction would balance, omitting it would

still leave the totals balanced.

An error of reversal is when entries are made to the correct amount, but with debits

instead of credits, and vice versa. For example, if a cash sale for 100 is debited to the

Sales account, and credited to the Cash account. Such an error will not affect the totals.


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An error of commission is when the entries are made at the correct amount, and the

appropriate side (debit or credit), but one or more entries are made to the wrong account

of the correct type. For example, if fuel costs are incorrectly debited to the postage

account (both expense accounts). This will not affect the totals.

An error of principle is when the entries are made to the correct amount, and the

appropriate side (debit or credit), as with an error of commission, but the wrongtype of

account is used. For example, if fuel costs (an expense account), are debited to stock (an

asset account). This will not affect the totals.

Compensating errors are multiple unrelated errors that would individually lead to an

imbalance, but together cancel each other out.

A Transposition Error is a Computing error caused by switching the position of two

adjacent digits. Since the resulting error is always divisible by 9, accountants use this fact

to locate the misentered number. For example, a total is off by 72, dividing it by 9 gives 8

which indicates that one of the switched digits is either more, or less, by 8 than the other

digit. Hence the error was caused by switching the digits 8 and 0 or 1 and 9. This will

also not affect the totals.


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1). The information provided in the annual financial statements of an enterprise pertains to:

a) Individual business enterprise

b) Business enterprise

c) The economy as a whole

d) None of the above.

2). Journal is a book of:

a) Original entry

b) Secondary entry

c) All cash transactions

d) All non cash transactions.

3). Ledger is a book of:

a) Original entry

b) Secondary entry

c) All cash transactions

d) All non cash transactions


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4). If a firm borrows a sum of money, there will be:

a) Increase in capital

b) Decrease in capital

c) No effect on capital.

5). Debit means:

a) An increase in assets

b) An increase in liability

c) A decrease in asset

d) An increase in proprietors equity.

6). Which of the following is a cash transaction:

a) Sold goods

b) Sold goods to Ram

c) Sold goods to Ram on credit

d) Sold goods to Ram on account.

7). Patent right is:

a) Personal account

b) Real account

c) Nominal account

d) Expense account.


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8). Drawings are deducted from:

a) Sales

b) Purchases

c) Returns outward

d) Capital

9). Purchase of an asset is:

a) An expense

b) A loss

c) An asset

d) None of these

10). The following account has a credit balance:

a) Carriage inward

b) Carriage outward

c) Return inward

d) Returns outward


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Chapter-4: Financial Statements

Contents:

4.1 Preparation of Profit and Loss account and Balance Sheet

4.1.1 Introduction to the profit and loss account

4.1.2 Preparation of Balance sheet

4.1.3 Sample balance sheet structure

4.2 Inventory valuation and the matching of revenue and expenses

4.2.1 Inventory and financial statements

4.2.2 Methods of Inventory Valuation

4.2.3 Using non-cost methods to value inventory

4.2.4 Methods used to estimate inventory cost

4.3 Fixed assets and depreciation,

4.4 Depreciating a Fixed Asset

4.4.1 Meaning of Depreciation

4.4.2 Special Features of Depreciation

4.4.3 Causes of Depreciation

4.4.4 Importance or need for providing depreciation

4.4.5 Factors affecting the amount of depreciation


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Once the trial balance is prepared the next step is to prepare the trading and profit and loss

account. There after the balance sheet is drafted on this basis.

4.1 Preparation of Profit & Loss Account

Income statement, also called profit and loss statement (P&L) and Statement of Operations, is a

company's financial statement that indicates how the revenue (money received from the sale of

products and services before expenses are taken out) is transformed into the net income (the

result after all revenues and expenses have been accounted for).

The basic purpose of the income statement is to show managers and investors whether the

company made or lost money during the period being reported.

4.1.1 Introduction to the profit and loss account

Richard Bowett introduces the important concept of the profit and loss account

(a). Introduction - the Meaning of Profit:

The starting point in understanding the profit and loss account is to be clear about the meaning of

"profit".

Profitis the incentive for business. It is the reward for taking risk; generally speaking high risk =

high reward (or loss if it goes wrong) and low risk = low reward. People wont take risks without

reward. All business is risky (some more than others) so no reward means no business. No

business means no jobs, no salaries and no goods and services.

Profit also has an important role in allocating resources(land, labor, capital and enterprise). Put

simply, falling profits (as in a business coming to an end e.g. black-and-white TVs) signal that

resources should be taken out of that business and put into another one; rising profits signal that

resources should be moved into this business. Without these signals we are left to guess as to

what is the best use of societys scarce resources.


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(b). The Task of Accounting - Measuring Profit

The main task of accounts is to monitor and measure profits.

Profit = Revenue less Costs

Thus monitoring profit is monitoring and measuring revenue and costs.

There are two parts to this:-

1. Recording financial data. This is the book-keeping part of accounting.

2. Measuring the result. This is the financial part of accounting. It is studied in detail in

Ratio Analysis.

(c). Profits are spentin three ways.

1. Retained for future investment and growth.

2. Returned to owners eg a dividend.

3. Paid as tax.

(d). Parts of the Profit and Loss Account

The Profit & Loss Account aims to monitor profit. It has three parts.

1) The Trading Account.

This records the money in (revenue) and out (costs) of the business as a result of the business

trading i.e. buying and selling. This might be buying raw materials and selling finished goods;

it might be buying goods wholesale and selling them retail. The figure at the end of this section

is the Gross Profit.


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2) The Profit and Loss Account proper

This starts with the Gross Profit and adds to it any further costs and revenues, including

overheads. These further costs and revenues are from any other activities not directly related to

trading. An example is income received from investments.

3) The Appropriation Account.

This shows how the profit is appropriated or divided between the three uses mentioned above.

(e). Uses of the Profit and Loss Account.

1. The main use is to monitor and measure profit, as discussed above. This assumes that the

information recording is accurate. Significant problems can arise if the information is

inaccurate, either through incompetence or deliberate fraud.

2. Once the profit(loss) has been accurately calculated, this can then be used for comparison

ie judging how well the business is doing compared to itself in the past, compared to the

managers plans and compared to other businesses.

3. There are ways to fix accounts. Internal accounts are rarely fixed, because there is

little point in the managers fooling themselves (unless fraud is going on) but public

accounts are routinely fixed to create a good impression out to the outside world. If you

understand accounts, you can usually (not always) spot these fixes and take them out to

get a true picture.

(f). Example Profit and Loss Account:

An example profit and loss account is provided below:


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Illustration: 1

To get an understanding and feel of the process of final accounting, let us go through an exampleof an organizations accounting consisting of a few transactions during an accounting period.

Following are the transactions relating to M/s Trinity Foods, over an accounting period from 1st

June 2005 to 30th June 2006.

Started business with Capital Rs. 1,00,000


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Paid into Bank Rs. 10,000

Bought Furniture and paid cash Rs. 25,000

Bought goods for cash Rs. 50,000

Bought goods from Ram on Credit Rs. 15,000

Sold a part of the goods for Rs. 75,000 and paid the proceeds into bank directly

Sold the remaining goods on credit for Rs. 50,000 to Rahim

Paid Salaries and Wages Rs. 5,000

Paid rent by cheque Rs. 8,000

Illustration: 1 Solution [Journal and Ledger]:

Journal Entries

Journal in the books of M/s Trinity Foods for the period from 1st June 2005 to 30th June

2005

DateV/R

No.Particulars L/F

Debit

Amount

(in Rs)

Credit

Amount

(in Rs)

1st to

30th

Cash a/c

To Capital a/c

Dr

1,00,000

1,00,000

[For the amount brought in by the proprietor

towards his capital contribution.]

1st to

30th

Bank a/c

To Cash a/c

Dr

10,000

10,000

[For the amount paid into bank.]


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1st to

30th

Furniture a/c

To Cash a/c

Dr

25,000

25,000

[For the amount paid towards purchase of

Furniture.]

1st to

30th

Purchases a/c

To Cash a/c

Dr

50,000

50,000

[For the amount paid towards purchase of

goods/stock.]

1st to

30th

Purchases a/c

To Ram a/c

Dr

15,000

15,000

[For the value of goods bought from Ram on

credit.]

1st to

30th

Bank a/c

To Sales a/c

Dr

75,000

75,000

[For the sales made for cash and the proceeds

paid into bank directly.]

1st to

30th

Rahim a/c

To Sales a/c

Dr

50,000

50,000

[For the value of goods sold on credit to

Rahim.]

1st to

30th

Salaries and Wages a/c

To Cash a/c

Dr

5,000

5,000

[For the amount paid in cash towards salaries

and wages.]


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1st to

30th

Rent Paid a/c

To Bank a/c

Dr

8,000

8,000

[For the amount paid towards rent by cheque.]

Ledger Accounts:

Dr Cash a/c Cr

Date Particulars J/F

Amount

(in Rs) Date Particulars J/F

Amount

(in Rs)

1st-30th To Capital a/c 1,00,000 1st-30th

"

"

"

30/06/05

By Bank a/c

By Furniture a/c

By Purchases a/c

By Sal. & Wages a/c

By Balance c/d

10,000

25,000

50,000

5,000

10,000

Total 1,00,000 Total 1,00,000

30/06/05 To Balance b/d 10,000

Dr Capital a/c Cr



Amount

(in Rs)

30/06/05 To Bal c/d

1,00,000 01/06/05 By Cash a/c

1,00,000

Total 1,00,000 Total 1,00,000

30/06/05 By Balance b/d 1,00,000


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Dr Bank a/c Cr



Amount

(in Rs)

1st-30th To Cash a/c

To Sales a/c

10,000

75,000

1st-30th

30/06/05

By Rent Paid a/c

By Bal c/d

8,000

77,000


30/06/05 To Balance b/d 77,000

Dr Furniture a/c Cr



Amount

(in Rs)

1st-30th To Cashl a/c 25,000 30/06/05 By Bal c/d 25,000


30/06/05 To Balance b/d 25,000

Dr Purchases a/c Cr



Amount

(in Rs)

1st-30th

"

To Cash a/c

To Ram a/c

50,000

15,000

30/06/05 By Bal c/d 65,000


30/06/05 To Balance b/d 65,000

Dr Ram a/c Cr


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Amount

(in Rs)

30/06/05 To Bal c/d 15,000 1st-30th By Purchases a/c 15,000


30/06/05 By Balance b/d 15,000

Dr Sales a/c Cr



Amount

(in Rs)

30/06/05 To Bal c/d

1,25,000 1st-30th

"

By Bank a/c

By Rahim a/c

75,000

50,000

Total 1,25,000 Total 1,25,000

30/06/05 By Balance b/d 1,25,000

Dr Rahim a/c Cr

Date Particulars J/F Amount(in Rs)

Date Particulars J/F Amount(in Rs)

1st-30th To Sales a/c 50,000 30/06/05 By Bal c/d 50,000


30/06/05 To Balance b/d 50,000

Dr Salaries and Wages a/c Cr



Amount

(in Rs)

1st-30th To Cash a/c 5,000 30/06/05 By Bal c/d 5,000


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30/06/05 To Balance b/d 5,000

Dr Rent Paid a/c Cr



Amount

(in Rs)

1st-30th To Bank a/c 8,000 30/06/05 By Bal c/d 8,000


30/06/05 To Balance b/d 8,000

Illustration: 1 Solution [Trial Balance]

The trial balance is nothing but a statement of ledger account balance as on a particular instance.

Trial Balance of M/s Trinity Foods" as on 30th June 2005


(in Rs)

Credit Amount

(in Rs)

Cash a/c

Capital a/c

Bank a/c

Furniture a/c

Purchases a/c

Ram a/c

Sales a/c

Rahim a/c

Salaries and Wages a/c

Rent Paid a/c

10,000

77,000

25,000

65,000

50,000

5,000

8,000

1,00,000

15,000

1,25,000


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Total 2,40,000 2,40,000

Preparing Trading and Profit and Loss Account: Journal & Ledger

Consider the above Trial Balance. There are a total of 4 nominal accounts with either debit or

credit balances

Purchases a/c [Debit Balance]

Sales a/c [Credit Balance]

Salaries and Wages a/c [Debit Balance]

Rent Paid a/c [Debit Balance]

To ascertain the profit or loss made by the organization, the balance in these accounts should be

transferred to the "Trading and Profit & Loss a/c". The journal entries for these transfers would

be:

Journal Entries

Journal in the books of M/s Trinity Foods for the period from 1st June 2005 to 30th June 2005

DateV/R

No.Particulars L/F

Debit

Amount

(in Rs)

Credit

Amount

(in Rs)

June

30th

Trading and Profit & Loss a/c

To Purchases a/c

To Salaries & Wages a/c

To Rent Paid a/c

Dr

78,000

65,000

5,000

8,000

[For the transfer of debit balances in nominal accounts at the end

of the accounting period to the Trading and Profit & Loss a/c for

the purpose of ascertaining profits.]


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June

30th

Sales a/c

To Trading and Profit & Loss a/c

Dr

1,25,000

1,25,000

[For the transfer of credit balances in nominal accounts at the

end of the accounting period to the Trading and Profit & Loss a/cfor the purpose of ascertaining profits.]


The "Trading and Profit & Loss a/c" would be

Dr Trading and Profit & Loss a/c Cr



Amount

(in Rs)

30/06/05

"

"

To Purchases a/c

To Salaries & Wages a/c

To Rent Paid a/c

65,000

5,000

8,000

30/06/05 By Sales a/c 1,25,000

sub-total 78,000 Sub-total 1,25,000

30/06/05 To Bal (Profit) 47,000

Total 1,25,000 Total 1,25,000

Since the credit side total is greater, the account has a credit balance. Since a credit balance in a

nominal account indicates a gain, we can say that there is a profit.

Other Ledger Accounts Affected

Dr Purchases a/c Cr




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(in Rs) (in Rs)

1st-30th

"

To Cash a/c

To Ram a/c

50,000

15,000

30/06/05 By Bal c/d 65,000


30/06/05 To Balance b/d 65,000 30/06/05 By Trdg. P/L a/c 65,000


Dr Sales a/c Cr



Amount

(in Rs)

30/06/05 To Bal c/d

1,25,000 1st-30th

"

By Bank a/c

By Rahim a/c

75,000

50,000

Total 1,25,000 Total 1,25,000

To Trdg, & P/L a/c

1,25,000 30/06/05 By Balance b/d

1,25,000

Total 1,25,000 Total 1,25,000

Dr Salaries and Wages a/c Cr



Amount

(in Rs)

1st-30th To Cash a/c 5,000 30/06/05 By Bal c/d 5,000



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Dr Rent Paid a/c Cr



Amount

(in Rs)

1st-30th To Bank a/c 8,000 30/06/05 By Bal c/d 8,000




The balance in these nominal accounts becomes zero after the balances are transferred to the "Tradingand Profit & Loss a/c". Thus, nominal accounts are closed at the end of the accounting period by transfer

to the "Trading and Profit & Loss a/c".

In the subsequent accounting period, if the same nominal account heads are used, they are openedanew. Thus these accounts pertaining to the current accounting period are independent of the nominalaccounts with the same name in any other accounting period.

Trial Balance Redrawn/Remade

The trial balance is a list of ledger account balances at an instance when it is drawn. If we

consider the instance after having prepared the "Trading and Profit & Loss a/c", we do not find a

balance in any nominal account. All the nominal accounts are closed by transfer to the "Trading

and Profit & Loss a/c", thereby leaving a nil balance in all of them.

The "Trading and Profit & Loss a/c" is also a nominal account and has a credit balance if there is


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a profit and a debit balance if there is a loss. If we make a trial balance after having prepared the

"Trading and Profit & Loss a/c" we will find only real and personal accounts in it apart from the

nominal account "Trading and Profit & Loss a/c".

Trial Balance of M/s Trinity Foods" as on 30th June 2005

[After closing Nominal accounts]


(in Rs)

Credit Amount

(in Rs)

Cash a/c

Capital a/c

Bank a/c

Furniture a/c

Ram a/c

Rahim a/c


10,000

77,000

25,000

50,000

1,00,000

15,000

47,000

Total 1,62,000 1,62,000

4.1.2 Preparation of Balance sheet

In financial accounting, a balance sheet or statement of financial position is a summary of a

person's or organization's balances. Assets, liabilities and ownership equity are listed as of a

specific date, such as the end of its financial year. A balance sheet is often described as a

snapshot of a company's financial condition. Of the four basic financial statements, the balance

sheet is the only statement which applies to a single point in time.

A company balance sheet has three parts: assets, liabilities and ownership equity. The main

categories of assets are usually listed first and are followed by the liabilities. The difference


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between the assets and the liabilities is known as equity or the net assets or the net worth of the

company and according to the accounting equation, net worth must equal assets minus liabilities.

Assets

Current assets

Cash and cash equivalents

Inventories

Accounts receivable

Prepaid expenses

Long-term assets

Property, plant and equipment

Investment property, such as real estate held for investment purposes

Intangible assets

Financial assets (excluding investments accounted for using the equity method, accounts

receivables, and cash and cash equivalents)

Investments accounted for using the equity method

Biological assets, which are living plants or animals. Bearer biological assets are plants

or animals which bear agricultural produce for harvest, such as apple trees grown to

produce apples and sheep raised to produce wool.

Liabilities

Accounts payable


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Provisions for warranties or court decisions

Financial liabilities (excluding provisions and accounts payable), such as promissory

notes and corporate bonds

Liabilities and assets for current tax

Deferred tax liabilities and deferred tax assets

Minority interest in equity

Issued capital and reserves attributable to equity holders of the Parent company

Unearned revenue

Equity

The net assets shown by the balance sheet equals the third part of the balance sheet, which is

known as the shareholders' equity. Formally, shareholders' equity is part of the company's

liabilities: they are funds "owing" to shareholders (after payment of all other liabilities); usually,

however, "liabilities" is used in the more restrictive sense of liabilities excluding shareholders'

equity. The balance of assets and liabilities (including shareholders' equity) is not

ambo-104_accounting for managers

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