INTRODUCTION TO ACCOUNTING

STRUCTURE

1.0 Objectives

1.1 Introduction

1.2 Development of accounting discipline

1.3 An accountant’s job profile: functions of accounting 1.4 Utility of accounting

1.5 Types of accounting

1.5.1 Financial accounting

1.5.2 Management accounting

1.5.3 Cost accounting

1.5.4 Distinction between financial and management  accounting

1.6 Summary

1.7 Keywords

1.8 Self assessment questions

1.9 References/suggested readings

1.0 OBJECTIVES

After going through this lesson, you will be able to-

∙ Understand the meaning and nature of accounting. ∙ Differentiate between various types of accounting.

∙ Know development of accounting principle.

∙ Explain the importance of accounting.

1.1 INTRODUCTION

Accounting is a system meant for measuring business activities,  processing of information into reports and making the findings available  to decision-makers. The documents, which communicate these findings  about the performance of an organisation in monetary terms, are called  financial statements.

Usually, accounting is understood as the Language of Business.  However, a business may have a lot of aspects which may not be of  financial nature. As such, a better way to understand accounting could  be to call it The Language of Financial Decisions. The better the  understanding of the language, the better is the management of financial  aspects of living. Many aspects of our lives are based on accounting,  personal financial planning, investments, income-tax, loans, etc. We have  different roles to perform in life-the role of a student, of a family head, of  a manager, of an investor, etc. The knowledge of accounting is an added  advantage in performing different roles. However, we shall limit our scope  of discussion to a business organisation and the various financial aspects  of such an organisation.

When we focus our thoughts on a business organisation, many  questions (is our business profitable, should a new product line be  introduced, are the sales sufficient, etc.) strike our mind. To answer  questions of such nature, we need to have information generated through  the accounting process. The people who take policy decisions and frame  business plans use such information.

All business organisations work in an ever-changing dynamic  environment. Any new programme of the organisation or of its competitor  will affect the business. Accounting serves as an effective tool for  measuring the financial pulse rate of the company. It is a continuous

cycle of measurement of results and reporting of results to decision makers.

Just like arithmetic is a procedural element of mathematics, book  keeping is the procedural element of accounting. Figure 1 shows how an  accounting system operates in business and how the flow of information  occurs.

People make decision

Business transactions occur

Accountants prepare  

reports to show the results  

of business operations

FIG 1: THE ACCOUNTING SYSTEM

Source: Liorngren, Harrison and Robinson, Financial and Management  Accounting, Prentice Hall, New Jersey, 1994.

1.2 DEVELOPMENT OF ACCOUNTING DISCIPLINE

The history of accounting can be traced back to ancient times.  According to some beliefs, the very art of writing originated in order to  record accounting information. Though this may seem to be an  exaggeration, but there is no denying the fact that accounting has a long  history. Accounting records can be traced back to the ancient  civilizations of China, Babylonia, Greece and Egypt. Accounting was used  to keep records regarding the cost of labour and materials used in  building great structures like the Pyramids.

During 1400s, accounting grew further because the needs for  information of merchants in the Venis City of Italy increased. The first  known description of double entry book keeping was first published in

1994 by Lucas Pacioli. He was a mathematician and a friend of Leonardo  Ileda Vinci.

The onset of the industrial revolution necessitated the development  of more sophisticated accounting system, rather than pricing the goods  based on guesses about the costs. The increase in competition and mass  production of goods led to the rise of accounting as a formal branch of  study.

With the passage of time, the corporate world grew. In the  nineteenth century, companies came up in many areas of infrastructure  like the railways, steel, communication, etc. It led to a rapid growth in  accounting. As the complexities of business grew, ownership and  management of business was divorced. As such, managers had to come  up with well-defined, structured systems of accounting to report the  performance of the business to its owners.

Government also has had a lot to do with more accounting  developments. The Income Tax brought about the concept of ‘income’.  Government takes a host of other decisions, relating to education, health,  economic planning, for which it needs accurate and reliable information.  As such, the government demands stringent accountability in the  corporate sector, which forces the accounting process to be as objective  and formal as possible.

1.3 AN ACCOUNTANT’S JOB PROFILE: FUNCTIONS OF  ACCOUNTING

A man who is involved in the process of book keeping and  accounting is called an accountant. With the coming up accounting as a  specialised field of knowledge, an accountant has a special place in the  structure of an organisation, because he performs certain vital functions.

The following paragraphs examine the functions of accounting and what  role does an accountant play in discharging these functions.

An accountant is a person who does the basic job of maintaining  accounts as he is the man who is engaged in book keeping. Since the  managers would always want to know the financial performance of the  business. An accountant prepares profit and loss account which reports  the profits/losses of the business during the accounting period, Balance  Sheet, which is a statement of assets and liabilities of the business at a  point of time, is also proposed by all accountants. Since both statements  are called financial statements, the person who prepares them is called a  financial accountant.

Accounting information serves many purposes. A part from  revealing the level of performance, it throws light on the causes of  weakness and deviation from plans (in any). In this way an accountant  becomes an important functionary who plays a vital role in the process of  management control, which is a process of diagnosing and solving a  problem. Seen from this point of view, an accountant can be referred to  as a management accountant.

Tax planning is an important area as far as the fiscal management  of a company is concerned. An accountant has a suggestive but very  specific job to do in this regard by indicating ways to minimise the tax  liability through his knowledge of concessions and incentives available  under the existing taxation framework of the country.

An accountant can influence a company even by not being an  employee. He can act as a man who verifies and certifies the authenticity  of accounts of a company by auditing the accounts. It is a strictly  professional job and is done by persons who are formally trained and  qualified for the purpose. They have an educational status and a

prescribed code of conduct like the Chartered Accountants in India and  Certified Public Accountants in USA.

Information management is another area which keeps an  accountant busy. He is the one who classifies the financial information  into information for internal use (management accounting function); and  information or external use (financial accounting function). Irrespective of  the size and degree of automation of a business, information  management is a key area and many organisations are known to have  perished because they failed to recognise this as an important function of  an accountant because information system is imperative for effective cost  control, to forecast cash needs and to plan for future growth of the  organisation.

1.4 UTILITY OF ACCOUNTING

The preceding section has just brought out the importance of  information. Effective decisions require accurate, reliable and timely  information. The need for quantity and quality of information varies with  the importance of the decision that has to be taken on the basis of that  information. The following paragraphs throw light on the various users of  accounting information and what do they do with that information.

Individuals may use accounting information to manage their  routine affairs like operating and managing their bank accounts, to  evaluate the worthwhileness of a job in an organization, to invest money,  to rent a house, etc.

Business Managers have to set goals, evaluate progress and initiate  corrective action in case of unfavourable deviation from the planned  course of action. Accounting information is required for many such  decisions—purchasing equipment, maintenance of inventory, borrowing  and lending, etc.

Investors and creditors are keen to evaluate the profitability and  solvency of a company before they decide to provide money to the  organisation. Therefore, they are interested to obtain financial  information about the company in which they are contemplating an  investment. Financial statements are the principal source of information  to them which are published in annual reports of a company and various  financial dailies and periodicals.

Government and Regulatory agencies are charged with the  responsibility of guiding the socio-economic system of a country in such  a way that it promotes common good. For example, the Securities and  Exchange Board of India (SEBI) makes it mandatory for a company to  disclose certain financial information to the investing public. The  government’s task of managing the industrial economy becomes simplify  if the accounting information such as profits, costs, taxes, etc. is  presented in a uniform manner without any manipulation or ‘window

dressing’.

Central and State governments levy various taxes. The taxation  authorities, therefore, need to know the income of a company to calculate  the amount of tax that the company would have to pay. The information  generated by accounting helps them in such computations and also to  detect any attempts of tax evasion.

Employees and trade unions use the accounting information to  settle various issues related to wages, bonus, profit sharing, etc.  Consumers and general public are also interested in knowing the amount  of income earned by various business houses. Accounting information  helps in finding whether or not a company is over charging or exploiting  the customers, whether or not companies are showing improved business  performance, whether or not the country is emerging from the economic

recession, etc. All such aspects draw heavily on accounting information  and are closely related to our standard of living.

1.5 TYPES OF ACCOUNTING

The financial literature classifies accounting into two broad  categories, viz, Financial Accounting and Management Accounting.  Financial accounting is primarily concerned with the preparation of  financial statements whereas management accounting covers areas such  as interpretation of financial statements, cost accounting, etc. Both these  types of accounting are examined in the following paragraphs.

1.5.1Financial accounting

As mentioned earlier, financial accounting deals with the  preparation of financial statements for the basic purpose of providing  information to various interested groups like creditors, banks,  shareholders, financial institutions, government, consumers, etc.  Financial statements, i.e. the income statement and the balance sheet  indicate the way in which the activities of the business have been  conducted during a given period of time.

Financial accounting is charged with the primary responsibility of  external reporting. The users of information generated by financial  accounting, like bankers, financial institutions, regulatory authorities,  government, investors, etc. want the accounting information to be  consistent so as to facilitate comparison. Therefore, financial accounting  is based on certain concepts and conventions which include separate  business entity, going concern concept, money measurement concept,  cost concept, dual aspect concept, accounting period concept, matching  concept, realization concept and conventions of conservatism, disclosure,  consistency, etc. All such concepts and conventions would be dealt with  detail in subsequent lessons.

The significance of financial accounting lies in the fact that it aids  the management in directing and controlling the activities of the firm and  to frame relevant managerial policies related to areas like production,  sales, financing, etc. However, it suffers from certain drawbacks which  are discussed in the following paragraphs.

∙ The information provided by financial accounting is  consolidated in nature. It does not indicate a break-up for  different departments, processes, products and jobs. As  such, it becomes difficult to evaluate the performance of  different sub-units of the organisation.

∙ Financial accounting does not help in knowing the cost  behaviour as it does not distinguish between fixed and  variable costs.

∙ The information provided by financial accounting is historical  in nature and as such the predictability of such information  is limited.

The management of a company has to solve certain ticklish  questions like expansion of business, making or buying a component,  adding or deleting a product line, deciding on alternative methods of  production, etc. The financial accounting information is of little help in  answering these questions.

The limitations of financial accounting, however, should not lead  one to believe that it is of no use. It is the basic foundation on which  other branches and tools of accounting analysis are based. It is the  source of information, which can be further analysed and interpreted  according to the tailor-made requirements of decision-makers.

1.5.2Management accounting

Management accounting is ‘tailor-made’ accounting. It facilitates  the management by providing accounting information in such a way so

that it is conducive for policy making and running the day-to-day  operations of the business. Its basic purpose is to communicate the facts  according to the specific needs of decision-makers by presenting the  information in a systematic and meaningful manner. Management

accounting, therefore, specifically helps in planning and control. It helps  in setting standards and in case of variances between planned and actual  performances, it helps in deciding the corrective action.

An important characteristic of management accounting is that it is  forward looking. Its basic focus is one future activity to be performed and  not what has already happened in the past.

Since management accounting caters to the specific decision  needs, it does not rest upon any well-defined and set principles. The  reports generated by a management accountant can be of any duration– short or long, depending on purpose. Further, the reports can be  prepared for the organisation as a whole as well as its segments.

1.5.3Cost accounting

One important variant of management accounting is the cost  analysis. Cost accounting makes elaborate cost records regarding various  products, operations and functions. It is the process of determining and  accumulating the cost of a particular product or activity. Any product,  function, job or process for which costs are determined and accumulated,  are called cost centres.

The basic purpose of cost accounting is to provide a detailed break up of cost of different departments, processes, jobs, products, sales  territories, etc., so that effective cost control can be exercised.

Cost accounting also helps in making revenue decisions such as  those related to pricing, product-mix, profit-volume decisions, expansion  of business, replacement decisions, etc.

The objectives of cost accounting, therefore, can be summarized in  the form of three important statements, viz, to determine costs, to  facilitate planning and control of business activities and to supply  information for short- and long-term decision. Cost accounting has  certain distinct advantages over financial accounting. Some of them have  been discussed succeedingly. The cost accounting system provides data  about profitable and non-profitable products and activities, thus  prompting corrective measures. It is easier to segregate and analyse  individual cost items and to minimize losses and wastages arising from  the manufacturing process. Production methods can be varied so as to  minimize costs and increase profits. Cost accounting helps in making  realistic pricing decisions in times of low demand, competitive conditions,  technology changes, etc.  

Various alternative courses of action can be properly evaluated  with the help of data generated by cost accounting. It would not be an  exaggeration if it is said that a cost accounting system ensures maximum  utilization of physical and human resources. It checks frauds and  manipulations and directs the employer and employees towards  achieving the organisational goal.

1.5.4Distinction between financial and management  accounting

Financial and management accounting can be distinguished on a  variety of basis like, users of information, criterion for decision making,  behavioural implications, time frame, type of reports.

Table 1 presents a summary of distinctions between financial and  management accounting.

TABLE 1: FINANCIAL ACCOUNTING VS MANAGEMENT ACCOUNTING

Source: Horngren, Harrison and Robinson, Financial and Management  Accounting, Prentice Hall, New Jersey, 1994.

1.6 SUMMARY

Accounting can be understood as the language of financial  decisions. It is an ongoing process of performance measurement and  reporting the results to decision-makers. The discipline of accounting can  be traced back to very early times of human civilization. With the  advancement of industry, modern day accounting has become formalized  and structured. A person who maintains accounts is known as the  accountant. He is engaged in multifarious activities like preparing  financial statements, facilitating the control process, tax planning,  auditing and information management. The information generated by  accountant is used by various groups like, individuals, managers,  investors, creditors, government, regulatory agencies, taxation  authorities, employees, trade unions, consumers and general public.  Depending upon purpose and method, accounting can be of broadly two

types– financial accounting and management accounting. Financial  accounting is primarily concerned with the preparation of financial  statements mainly for outsiders. It is based on certain well-defined  concepts and conventions and helps in framing broad financial policies.  However, it suffers from certain limitations which are taken care of by the  other branch of accounting, viz.; management accounting. Management  accounting is meant to help in decision-making by analyzing and  interpreting the information generated by financial accounting. As such,  management accounting is futuristic and decision-oriented. The methods  of management accounting are not very exact as they have to be varied  according to the requirements of the decision. Cost accounting is an  important aspect of management accounting. It emphasizes on cost  determination, aiding the planning and control process and supplying  information for short- and long-run decisions. The basic differences  between financial and management accounting arises due to differences  in users of information, differences in time frame and type of reports  generated. The criterion for decision making and the behavioural  implications of both types of accounting are also different.

1.7 KEYWORDS

Accrual: Recognition of revenues and costs as they are earned or  incurred. It includes recognition of transaction relating to assets and  liabilities as they occur irrespective of the actual receipts or payment.

Cost: The amount of expenditure incurred on or attributable to a  specified article, product or activity.

Expenses: A cot relating to the operations of an accounting period. Revenue: Total amount received from sales of goods/services. Income: Excess of revenue over expenses.

Loss: Excess of expenses over revenue.

Capital: Generally refers to the amount invested in an enterprise  by its owner.

Fund: An account usually of the nature of a reserve or provision  which is represented by specifically Ear Market Assets.

Gain: A monetary benefit, profit or advantage resulting from a  transaction or group of transactions.

Investment: Expenditure on assets held to earn interest, income,  profit or other benefits.

Liability: The financial obligation of an enterprise other than  owners’ funds.

Net Profit: The excess of revenue over expenses during a particular  accounting period.

1.8 SELF ASSESSMENT QUESTIONS

1. Define accounting. What purpose is served by accounting? 2. Discuss the role and activities of an accountant.

3. What are the various interested parties which use accounting  information? How is such information used?

4. Explain the different types of accounting.

5. Differentiate Financial Accounting and Management  Accounting in detail.

1.9 REFERENCES/SUGGESTED READINGS

1. Ashish K. Bhattacharyya (2004), “Financial Accounting for  Business Managers”, Prentice Hall of India Pvt. Ltd., New  Delhi.

2. R.L. Gupta (2001), “Advanced Accountancy”, Sultan Chand &  Sons, New Delhi.

3. P.C. Tulsian (2000), “Financial Accounting”, Tata McGraw  Hill, New Delhi.

4. Shashi K. Gupta (2002), “Contemporary Issues in  Accounting”, Kalyani Publishers, New Delhi.

5. S.N. Maheshwari (2004), “Management Accounting and  Financial Control”, Sultan Chand and Sons, New Delhi.

ACCOUNTING CONCEPTS AND CONVENTIONS

STRUCTURE

2.0 Objectives

2.1 Introduction

2.2 Meaning and Features of accounting Principles

2.3 Kinds of Accounting Principles

2.4 Accounting Concepts

2.5 Accounting Conventions

2.6 Summary

2.7 Keywords

2.8 Self assessment questions

2.9 References/suggested readings

Exhibits I to III

2.0 OBJECTIVES

After studying this lesson, you should be able to-

∙ Appreciate the need for a conceptual framework of  accounting.

∙ Understand and describe the generally accepted accounting  principles (GAAP).

∙ Know the importance and advantages of uniformity in  accounting policies and practices.

2.1 INTRODUCTION

Accounting is often called the language of business because the  purpose of accounting is to communicate or report the results of  business operations and its various aspects to various users of  accounting information. In fact, today, accounting statements or reports  are needed by various groups such as shareholders, creditors, potential  investors, columnist of financial newspapers, proprietors and others. In  view of the utility of accounting reports to various interested parties, it  becomes imperative to make this language capable of commonly  understood by all. Accounting could become an intelligible and commonly  understood language if it is based on generally accepted accounting  principles. Hence, you must be familiar with the accounting principles  behind financial statements to understand and use them properly.

2.2 MEANING AND FEATURES OF ACCOUNTING PRINCIPLES

For searching the goals of the accounting profession and for  expanding knowledge in this field, a logical and useful set of principles  and procedures are to be developed. We know that while driving our  vehicles, follow a standard traffic rules. Without adhering traffic rules,  there would be much chaos on the road. Similarly, some principles apply  to accounting. Thus, the accounting profession cannot reach its goals in  the absence of a set rules to guide the efforts of accountants and  auditors. The rules and principles of accounting are commonly referred to  as the conceptual framework of accounting.

Accounting principles have been defined by the Canadian Institute  of Chartered Accountants as “The body of doctrines commonly associated  with the theory and procedure of accounting serving as an explanation of  current practices and as a guide for the selection of conventions or  procedures where alternatives exists. Rules governing the formation of  accounting axioms and the principles derived from them have arisen

from common experience, historical precedent statements by individuals  and professional bodies and regulations of Governmental agencies”.  According to Hendriksen (1997), Accounting theory may be defined as  logical reasoning in the form of a set of broad principles that (i) provide a  general frame of reference by which accounting practice can be  evaluated, and (ii) guide the development of new practices and  procedures. Theory may also be used to explain existing practices to  obtain a better understanding of them. But the most important goal of  accounting theory should be to provide a coherent set of logical principles  that form the general frame of reference for the evaluation and  development of sound accounting practices.

The American Institute of Certified Public Accountants (AICPA) has  advocated the use of the word “Principle” in the sense in which it means  “rule of action”. It discuses the generally accepted accounting principles  as follows:

Financial statements are the product of a process in which a large  volume of data about aspects of the economic activities of an enterprise  are accumulated, analysed and reported. This process should be carried  out in conformity with generally accepted accounting principles. These  principles represent the most current consensus about how accounting  information should be recorded, what information should be disclosed,  how it should be disclosed, and which financial statement should be  prepared. Thus, generally accepted principles and standards provide a  common financial language to enable informed users to read and  interpret financial statements.

Generally accepted accounting principles encompass the  conventions, rules and procedures necessary to define accepted  accounting practice at a particular time....... generally accepted  accounting principles include not only broad guidelines of general

application, but also detailed practices and procedures (Source: AICPA  Statement of the Accounting Principles Board No. 4, “Basic Concepts and  Accounting Principles underlying Financial Statements of Business  Enterprises “, October, 1970, pp 54-55)

According to ‘Dictionary of Accounting’ prepared by Prof. P.N.  Abroal, “Accounting standards refer to accounting rules and procedures  which are relating to measurement, valuation and disclosure prepared by  such bodies as the Accounting Standards Committee (ASC) of a  particular country”. Thus, we may define Accounting Principles as those  rules of action or conduct which are adopted by the accountants  universally while recording accounting transactions. Accounting  principles are man-made. They are accepted because they are believed to  be useful. The general acceptance of an accounting principle usually  depends on how well it meets the following three basic norms: (a)  Usefulness; (b) Objectiveness; and (c) Feasibility.

A principle is useful to the extent that it results in meaningful or  relevant information to those who need to know about a certain business.  In other words, an accounting rule, which does not increase the utility of  the records to its readers, is not accepted as an accounting principle. A  principle is objective to the extent that the information is not influenced  by the personal bias or Judgement of those who furnished it. Accounting  principle is said to be objective when it is solidly supported by facts.  Objectivity means reliability which also means that the accuracy of the  information reported can be verified. Accounting principles should be  such as are practicable. A principle is feasible when it can be  implemented without undue difficulty or cost. Although these three  features are generally found in accounting principles, an optimum  balance of three is struck in some cases for adopting a particular rule as  an accounting principle. For example, the principle of making the  provision for doubtful debts is found on feasibility and usefulness though

it is less objective. This is because of the fact that such provisions are not  supported by any outside evidence.

2.3 KINDS OF ACCOUNTING PRINCIPLES

In dealing with the framework of accounting theory, we are  confronted with a serious problem arising from differences in  terminology. A number of words and terms have been used by different  authors to express and explain the same idea or notion. The various  terms used for describing the basic ideas are: concepts, postulates,  propositions, assumptions, underlying principles, fundamentals,  conventions, doctrines, rules, axioms, etc. Each of these terms is capable  of precise definition. But, the accounting profession has served to give  them lose and overlapping meanings. One author may describe the same  idea or notion as a concept and another as a convention and still another  as postulate. For example, the separate business entity idea has been  described by one author as a concept and by another as a convention. It  is better for us not to waste our time to discuss the precise meaning of  generic terms as the wide diversity in these terms can only serve to  confuse the learner.

We do feel, however, that some of these terms/ideas have a better  claim to be called ‘concepts’ while the rest should be called ‘conventions’.  The term ‘Concept’ is used to connote the accounting postulates, i.e.,  necessary assumptions and ideas which are fundamental to accounting  practice. In other words, fundamental accounting concepts are broad  general assumptions which underline the periodic financial statements of  business enterprises. The reason why some of these terms should be  called concepts is that they are basic assumptions and have a direct  bearing on the quality of financial accounting information. The term  ‘convention’ is used to signify customs or tradition as a guide to the

preparation of accounting statements. The following are the important accounting concepts and conventions:

2.4 ACCOUNTING CONCEPTS

The more important accounting concepts are briefly described as  follows:

1. Separate Business Entity Concept

In accounting we make a distinction between business and the  owner. All the books of accounts records day to day financial  transactions from the view point of the business rather than from that of  the owner. The proprietor is considered as a creditor to the extent of the  capital brought in business by him. For instance, when a person invests  Rs. 10 lakh into a business, it will be treated that the business has  borrowed that much money from the owner and it will be shown as a  ‘liability’ in the books of accounts of business. Similarly, if the owner of a  shop were to take cash from the cash box for meeting certain personal  expenditure, the accounts would show that cash had been reduced even  though it does not make any difference to the owner himself. Thus, in  recording a transaction the important question is how does it affects the

business? For example, if the owner puts cash into the business, he has  a claim against the business for capital brought in.

In so-far as a limited company is concerned, this distinction can be  easily maintained because a company has a legal entity like a natural  person it can engage itself in economic activities of buying, selling,  producing, lending, borrowing and consuming of goods and services.  However, it is difficult to show this distinction in the case of sole  proprietorship and partnership. Nevertheless, accounting still maintains  separation of business and owner. It may be noted that it is only for  accounting purpose that partnerships and sole proprietorship are treated  as separate from the owner (s), though law does not make such  distinction. In fact, the business entity concept is applied to make it  possible for the owners to assess the performance of their business and  performance of those whose manage the enterprise. The managers are  responsible for the proper use of funds supplied by owners, banks and  others.

2. Money Measurement Concept

In accounting, only those business transactions are recorded which  can be expressed in terms of money. In other words, a fact or transaction  or happening which cannot be expressed in terms of money is not  recorded in the accounting books. As money is accepted not only as a  medium of exchange but also as a store of value, it has a very important  advantage since a number of assets and equities, which are otherwise  different, can be measured and expressed in terms of a common  denominator.

We must realise that this concept imposes two severe limitations.  Firstly, there are several facts which though very important to the  business, cannot be recorded in the books of accounts because they  cannot be expressed in money terms. For example, general health

condition of the Managing Director of the company, working conditions in  which a worker has to work, sales policy pursued by the enterprise,  quality of product introduced by the enterprise, though exert a great  influence on the productivity and profitability of the enterprise, are not  recorded in the books. Similarly, the fact that a strike is about to begin  because employees are dissatisfied with the poor working conditions in  the factory will not be recorded even though this event is of great concern  to the business. You will agree that all these have a bearing on the future  profitability of the company.

Secondly, use of money implies that we assume stable or constant  value of rupee. Taking this assumption means that the changes in the  money value in future dates are conveniently ignored. For example, a  piece of land purchased in 1990 for Rs. 2 lakh and another bought for  the same amount in 1998 are recorded at the same price, although the  first purchased in 1990 may be worth two times higher than the value  recorded in the books because of rise in land prices. In fact, most  accountants know fully well that purchasing power of rupee does change  but very few recognise this fact in accounting books and make allowance  for changing price level.

3. Dual Aspect Concept

Financial accounting records all the transactions and events  involving financial element. Each of such transactions requires two  aspects to be recorded. The recognition of these two aspects of every  transaction is known as a dual aspect analysis. According to this concept  every business transactions has dual effect. For example, if a firm sells  goods of Rs. 5,000 this transaction involves two aspects. One aspect is  the delivery of goods and the other aspect is immediate receipt of cash (in  the case of cash sales). In fact, the term ‘double entry’ book keeping has  come into vogue and in this system the total amount debited always

equals the total amount credited. It follows from ‘dual aspect concept’ that at any point of time owners’ equity and liabilities for any accounting  entity will be equal to assets owned by that entity. This idea is  fundamental to accounting and could be expressed as the following  equalities:

Assets = Liabilities + Owners Equity …(1)

Owners Equity = Assets- Liabilities …(2)

The above relationship is known as the ‘Accounting Equation’. The  term ‘Owners Equity’ denotes the resources supplied by the owners of the  entity while the term ‘liabilities’ denotes the claim of outside parties such  as creditors, debenture-holders, bank against the assets of the business.  Assets are the resources owned by a business. The total of assets will be  equal to total of liabilities plus owners capital because all assets of the

business are claimed by either owners or outsiders.

4. Going Concern Concept

Accounting assumes that the business entity will continue to  operate for a long time in the future unless there is good evidence to the  contrary. The enterprise is viewed as a going concern, that is, as  continuing in operations, at least in the foreseeable future. In other  words, there is neither the intention nor the necessity to liquidate the  particular business venture in the predictable future. Because of this  assumption, the accountant while valuing the assets does not take into  account forced sale value of them. In fact, the assumption that the  business is not expected to be liquidated in the foreseeable future  establishes the basis for many of the valuations and allocations in  accounting. For example, the accountant charges depreciation on fixed  assets. It is this assumption which underlies the decision of investors to  commit capital to enterprise. Only on the basis of this assumption  accounting process can remain stable and achieve the objective of

correctly reporting and recording on the capital invested, the efficiency of  management, and the position of the enterprise as a going concern.

However, if the accountant has good reasons to believe that the  business, or some part of it is going to be liquidated or that it will cease  to operate (say within six-month or a year), then the resources could be  reported at their current values. If this concept is not followed,  International Accounting Standard requires the disclosure of the fact in  the financial statements together with reasons.

5. Accounting Period Concept

This concept requires that the life of the business should be  divided into appropriate segments for studying the financial results  shown by the enterprise after each segment. Although the results of  operations of a specific enterprise can be known precisely only after the  business has ceased to operate, its assets have been sold off and  liabilities paid off, the knowledge of the results periodically is also  necessary. Those who are interested in the operating results of business  obviously cannot wait till the end. The requirements of these parties force  the businessman ‘to stop’ and ‘see back’ how things are going on. Thus,  the accountant must report for the changes in the wealth of a firm for  short time periods. A year is the most common interval on account of  prevailing practice, tradition and government requirements. Some firms  adopt financial year of the government, some other calendar year.  Although a twelve month period is adopted for external reporting, a  shorter span of interval, say one month or three month is applied for  internal reporting purposes.

This concept poses difficulty for the process of allocation of long  term costs. All the revenues and all the cost relating to the year in  operation have to be taken into account while matching the earnings and  the cost of those earnings for the any accounting period. This holds good

irrespective of whether or not they have been received in cash or paid in  cash. Despite the difficulties which stem from this concept, short term  reports are of vital importance to owners, management, creditors and  other interested parties. Hence, the accountants have no option but to  resolve such difficulties.

6. Cost Concept

The term ‘assets’ denotes the resources land building, machinery  etc. owned by a business. The money values that are assigned to assets  are derived from the cost concept. According to this concept an asset is  ordinarily entered on the accounting records at the price paid to acquire  it. For example, if a business buys a plant for Rs. 5 lakh the asset would  be recorded in the books at Rs. 5 lakh, even if its market value at that  time happens to be Rs. 6 lakh. Thus, assets are recorded at their original  purchase price and this cost is the basis for all subsequent accounting  for the business. The assets shown in the financial statements do not  necessarily indicate their present market values. The term ‘book value’ is  used for amount shown in the accounting records.

The cost concept does not mean that all assets remain on the  accounting records at their original cost for all times to come. The asset  may systematically be reduced in its value by charging ‘depreciation’,  which will be discussed in detail in a subsequent lesson. Depreciation  has the effect of reducing profit of each period. The prime purpose of  depreciation is to allocate the cost of an asset over its useful life and not  to adjust its cost. However, a balance sheet based on this concept can be  very misleading as it shows assets at cost even when there are wide  difference between their costs and market values. Despite this limitation  you will find that the cost concept meets all the three basic norms of  relevance, objectivity and feasibility.

7. The Matching concept

This concept is based on the accounting period concept. In reality  we match revenues and expenses during the accounting periods.  Matching is the entire process of periodic earnings measurement, often  described as a process of matching expenses with revenues. In other  words, income made by the enterprise during a period can be measured  only when the revenue earned during a period is compared with the  expenditure incurred for earning that revenue. Broadly speaking revenue  is the total amount realised from the sale of goods or provision of services  together with earnings from interest, dividend, and other items of income.  Expenses are cost incurred in connection with the earnings of revenues.  Costs incurred do not become expenses until the goods or services in  question are exchanged. Cost is not synonymous with expense since  expense is sacrifice made, resource consumed in relation to revenues  earned during an accounting period. Only costs that have expired during  an accounting period are considered as expenses. For example, if a  commission is paid in January, 2002, for services enjoyed in November,  2001, that commission should be taken as the cost for services rendered  in November 2001. On account of this concept, adjustments are made for  all prepaid expenses, outstanding expenses, accrued income, etc, while  preparing periodic reports.

8. Accrual Concept

It is generally accepted in accounting that the basis of reporting  income is accrual. Accrual concept makes a distinction between the  receipt of cash and the right to receive it, and the payment of cash and  the legal obligation to pay it. This concept provides a guideline to the  accountant as to how he should treat the cash receipts and the right  related thereto. Accrual principle tries to evaluate every transaction in  terms of its impact on the owner’s equity. The essence of the accrual

concept is that net income arises from events that change the owner’s  equity in a specified period and that these are not necessarily the same  as change in the cash position of the business. Thus it helps in proper  measurement of income.

9. Realisation Concept

Realisation is technically understood as the process of converting  non-cash resources and rights into money. As accounting principle, it is  used to identify precisely the amount of revenue to be recognised and the  amount of expense to be matched to such revenue for the purpose of  income measurement. According to realisation concept revenue is  recognised when sale is made. Sale is considered to be made at the point  when the property in goods passes to the buyer and he becomes legally  liable to pay. This implies that revenue is generally realised when goods  are delivered or services are rendered. The rationale is that delivery  validates a claim against the customer. However, in case of long run  construction contracts revenue is often recognised on the basis of a  proportionate or partial completion method. Similarly, in case of long run  instalment sales contracts, revenue is regarded as realised only in  proportion to the actual cash collection. In fact, both these cases are the  exceptions to the notion that an exchange is needed to justify the  realisation of revenue.

2.5 ACCOUNTING CONVENTIONS

1. Convention of Materiality

Materiality concept states that items of small significance need not  be given strict theoretically correct treatment. In fact, there are many  events in business which are insignificant in nature. The cost of  recording and showing in financial statement such events may not be  well justified by the utility derived from that information. For example, an

ordinary calculator costing Rs. 100 may last for ten years. However, the  effort involved in allocating its cost over the ten year period is not worth  the benefit that can be derived from this operation. The cost incurred on calculator may be treated as the expense of the period in which it is  purchased. Similarly, when a statement of outstanding debtors is  prepared for sending to top management, figures may be rounded to the  nearest ten or hundred.

This convention will unnecessarily overburden an accountant with  more details in case he is unable to find an objective distinction between  material and immaterial events. It should be noted that an item material  for one party may be immaterial for another. Actually, there are no hard  and fast rules to draw the line between material and immaterial events  and hence, It is a matter of judgement and common sense. Despite this  limitation, It is necessary to disclose all material information to make the  financial statements clear and understandable. This is required as per  IAS-1 and also reiterated in IAS-5. As per IAS-1, materiality should  govern the selection and application of accounting policies.

2. Convention of Conservatism

This concept requires that the accountants must follow the policy  of ‘‘playing safe” while recording business transactions and events. That  is why, the accountant follow the rule anticipate no profit but provide for  all possible losses, while recording the business events. This rule means  that an accountant should record lowest possible value for assets and  revenues, and the highest possible value for liabilities and expenses.  According to this concept, revenues or gains should be recognised only  when they are realised in the form of cash or assets (i.e. debts) the

ultimate cash realisation of which can be assessed with reasonable  certainty. Further, provision must be made for all known liabilities,  expenses and losses, Probable losses regarding all contingencies should

also be provided for. ‘Valuing the stock in trade at market price or cost  price which ever is less’, ‘making the provision for doubtful debts on  debtors in anticipation of actual bad debts’, ‘adopting written down value  method of depreciation as against straight line method’, not providing for  discount on creditors but providing for discount on debtors’, are some of  the examples of the application of the convention of conservatism.

The principle of conservatism may also invite criticism if not  applied cautiously. For example, when the accountant create secret  reserves, by creating excess provision for bad and doubtful debts,  depreciation, etc. The financial statements do not present a true and fair  view of state of affairs. American Institute of Certified Public Accountant  have also indicated that this concept need to be applied with much more  caution and care as over conservatism may result in misrepresentation.

3. Convention of Consistency

The convention of consistency requires that once a firm decided on  certain accounting policies and methods and has used these for some  time, it should continue to follow the same methods or procedures for all  subsequent similar events and transactions unless it has a sound reason  to do otherwise. In other worlds, accounting practices should remain  unchanged from one period to another. For example, if depreciation is  charged on fixed assets according to straight line method, this method  should be followed year after year. Analogously, if stock is valued at ‘cost  or market price whichever is less’, this principle should be applied in  each subsequent year.  

However, this principle does not forbid introduction of improved  accounting techniques. If for valid reasons the company makes any  departure from the method so far in use, then the effect of the change  must be clearly stated in the financial statements in the year of change.  The application of the principle of consistency is necessary for the

purpose of comparison. One could draw valid conclusions from the  comparison of data drawn from financial statements of one year with that  of the other year. But the inconsistency in the application of accounting  methods might significantly affect the reported data.

Accounting standards

The accounting concepts and conventions discussed in the  foregoing pages are the core elements in the theory of accounting. These  principles, however, permit a variety of alternative practices to co-exist.  On account of this the financial results of different companies can not be  compared and evaluated unless full information is available about the  accounting methods which have been used. The lack of uniformity among  accounting practices have made it difficult to compare the financial  results of different companies. It means that there should not be too  much discretion to companies and their accountants to present financial  information the way they like. In other words, the information contained  in financial statements should conform to carefully considered  standards. Obviously, accounting standards are needed to:

a) provide a basic framework for preparing financial statements  to be uniformly followed by all business enterprises,

b) make the financial statements of one firm comparable with  the other firm and the financial statements of one period  with the financial statements of another period of the same  firm,

c) make the financial statements credible and reliable, and d) create general sense of confidence among the outside users  of financial statements.

In this context unless there are reasonably appropriate standards,  neither the purpose of the individual investor nor that of the nation as a  whole can be served. In order to harmonise accounting policies and to

evolve standards the need in the USA was felt with the establishment of  Securities and Exchange Commission (SEC) in 1933. In 1957, a research  oriented organisation called Accounting Principles Boards (APB) was  formed to spell out the fundamental accounting principles. After this the  Financial Accounting Standards Board (FASB) was formed in 1973, in  USA. At the international level, the need for standardisation was felt and  therefore, an International Congress of accountants was organised in  Sydney, Australia in 1972 to ensure the desired level of uniformity in  accounting practices. Keeping this in view, International Accounting  Standards Committee (IASC) was formed and was entrusted with the  responsibility of formulating international standards.  

In order to harmonise varying accounting policies and practices,  the Institute of Chartered Accountants of India (ICAI) formed the  Accounting Standards Board (ASB) in April, 1977. ASB includes  representatives from industry and government. The main function of the  ASB is to formulate accounting standards. This Board of the Institute of  Chartered Accountants of India has so far formulated around 27  Accounting Standards, the list of these accounting standards is  furnished. Regarding the position of Accounting standards in India, it  has been stated that the standards have been developed without first  establishing the essential theoretical framework. As a result, accounting  standards lack direction and coherence. This type of limitation also  existed in UK and USA but it was remedied long back.  

Hence, there is an emergent need to make an attempt to develop a  conceptual framework and also revise suitably the Indian Accounting  Standards to reduce the number of alternative treatments.

2.6 SUMMARY

Accounting principles may be defined as rules of action or conduct  which are adopted by the accountants universally while recording

accounting transactions. Accounting principles are accepted because  they are believed to be useful. The general acceptance of an accounting  principle usually depends on how well it meets the three basic norms i.e.,  usefulness, objectiveness and feasibility. The accounting principles  broadly classified into two categories namely accounting concepts and  accounting conventions. The term concept is used to cannot the  accounting postulates, i.e., necessary assumptions and ideas which are  fundamental to accounting practice. Accounting concepts are separate  business entity concepts, money measurement concept, dual aspect  concept, accounting period concept, cost concept, matching concept,  accrual concept, realisation concept. The term convention is used to  signify customs or tradition as a guide to the preparation of accounting  statement, main conventions of accounting are- (i) convention of  materiality, convention of conservatism. Convention of consistency.

2.7 KEYWORDS

Creditor: Amount owned by an enterprise on account of goods  purchased or services received.

Debtor: Persons from whom amounts are due for goods sold or  services rendered.

Reserve: The portion of earnings of an enterprise appropriated by  the management for a general or specific purpose.

Provision: Amount retained by way of providing for any known  liability the amount of which cannot be determined with substantial  accuracy.

Net Realisable Value: Actual selling price of an asset in the  ordinary course of business less cost incurred in order to make the sale.

Inventory: Tangible property held for sale in the ordinary course of  business or in the process of production for such sale.

Interim Report: The information provided with reference to a date  before the close of the accounting period to owners or other interested  persons concerning its operations/financial position.

Depreciation: Decrease in the value of fixed assets.

Balance Sheet: A statement of the financial position of an  enterprise as at a given date.

Capital: Generally refers to the amount invested in an enterprise  by its owners.

2.8 SELF ASSESSMENT QUESTIONS

1. State whether the following statements are true or false: a) The ‘materiality concept’ refers to the state of ignoring  small items and values from accounts.

b) Accounting principles are rules of action or conduct  which are adopted by the accountants universally  while recording accounting transactions.

c) The ‘separate entity concept’ of accounting is not  applicable to sole trading concerns and partnership  concerns.

d) The ‘dual aspect’ concept result in the accounting  equation: Capital+Liabilities = Assets.

e) The ‘conservatism concept’ leads to the exclusion of all  unrealised profits.

f) The balance sheet based on ‘Cost concept’ is of no use  to a potential investor.

g) Accounting standards are statements prescribed by  government regulatory bodies.

h) Accounting statements are statements prescribed by  professional accounting bodies.

i) Accounting concepts are broad assumptions.

2. Choose the correct answer from the alternations given:

(I) Accounting standards are statements prescribed by a) Law

b) Bodies of shareholders

c) Professional accounting bodies

(II) Accounting Principles are generally based on

a) Practicability

b) Subjectivity

c) Convenience in recording

(III) The Policy of ‘anticipate no profit and provide for all  possible losses’ arises due to convention of  

a) Consistency

b) Disclosure

c) Conservatism

(IV) Which is the accounting concept that requires the  practice of crediting closing stock to the trading  account

a) Going concern

b) Cost

c) Matching

(V) The convention of conservatism, when applied to the  balance sheet, results in

a) understatement of assets liabilities

b) understatement of  

c) understatement of capital.

3. Examine the role of accounting concepts in the preparation  of financial statements. Do you find any of the accounting  concepts conflicting with each other? Give examples.

4. Discuss briefly the basic concepts and conventions of  accounting?

5. Write short notes on

a) Going concern concept

b) Dual aspect concept

c) Business entity concept

d) Convention of materiality

e) Convention of conservatism.

6. Why accounting practices should be standardised? Explain.

7. What progress has been made in India regarding  standardisation of accounting practices?

2.9 REFERENCES/SUGGESTED READINGS

1. R. Narayanaswamy (2003), “Financial Accounting”, Prentice  Hall of India, New Delhi.

2. S.P. Jain (2001), “Advanced Accountancy”, Kalyani  Publishers, New Delhi.

3. Ashok Banerjee (2005), “Financial Accounting”, Excel Book,  New Delhi.

4. George Foster (2002), “Financial Statement Analysis”,  Pearson Education.

5. S.P. Jain (2001), “Corporate Accounting”, Kalayani  Publishers, New Delhi.

EXHIBIT-I

INTERNATIONAL ACCOUNTING STANDARDS  ISSUED BY ISAC  

IAS-1 Disclosure of Accounting Policies.  

IAS-2 Valuation and Presentation of Inventories in the context of  historical cost system.  

IAS-3 Consolidated financial statements.  

IAS-4 Depreciation accounting  

IAS-5 Information to be disclosed in financial statements IAS-6 Accounting responses to changing prices  

IAS-7 Cash flow statement  

IAS-8 Unusual and prior period items and changes in accounting  policies  

IAS-9 Accounting for research and development activities IAS-10 Contingencies and events occurring after balance sheet  date

IAS-11 Accounting for construction contracts

IAS-12 Accounting for taxes on income  

IAS-13 Presentation of current assets and current liabilities IAS-14 Reporting financial information by segments IAS-15 Information reflecting the effects of changing prices IAS-16 Accounting for property, plant and equipment IAS-17 Accounting for leases

IAS-18 Revenue recognition

IAS-19 Accounting for retirement benefits in the financial  statements of employees

IAS-20 Accounting for government grants and disclosure of  government assistance.  

IAS-21 Accounting for effects of changes in Foreign Exchange  Rates

IAS-22 Accounting for business combinations

IAS-23 Capitalisation of borrowing costs

IAS-24 Related party disclosures

IAS-25 Accounting for investments

IAS-26 Accounting and reported by retirement benefit plans IAS-27 Consolidated financial statements and accounting for  investments in subsidiaries

IAS-28 Consolidated financial statements and accounting for  investments in subsidiaries

IAS-29 Financial reporting in Hyper inflationary economics IAS-30 Disclosure in the financial statements of bank and similar  financial institutions

IAS-31 Financial reporting of interests in joint ventures IAS-32 Financial instruments: disclosure and presentation.

EXHIBIT-II

REVISED IAS ISSUED BY ISAC  

IAS-2 Inventories  

IAS-8 Net Profit or loss for the period, fundamental Errors  changes in Accounting Policies

IAS-9 Research and Developments costs

IAS-11 Construction Contracts

IAS-16 Property, Plant and Equipment

IAS-18 Revenue

IAS-19 Retirement Benefit costs

IAS-21 The effects of changes in foreign exchanges rates IAS-22 Business Combinations

IAS-23 Borrowing Costs

EXHIBIT-III

ACCOUNTING STANDARDS ISSUED BY ASB  

AS-1 Disclosure of Accounting policies

AS-2 Valuation of Inventories  

AS-3 Changes in Financial Position  

AS-4 Contingencies and Events Occurring after the Balance  Sheet Date  

AS-5 Prior period and Extraordinary Items and changes in  Accounting policies  

AS-6 Depreciation Accounting  

AS-7 Accounting for Construction Contracts

AS-8 Accounting for Research and Development  AS-9 Revenue Recognition  

AS-10 Accounting for Fixed Assets  

AS-11 Accounting for Changes in Foreign Exchange Rate  AS-12 Accounting for Government Grants

AS-13 Accounting for Investments  

AS-14 Accounting for Amalgamations  

AS-15 Accounting for Retirement Benefits in the Financial  Statements of Employers/Employees

RECORDING OF TRANSACTIONS- VOUCHER  SYSTEM, ACCOUNTING PROCESS, JOURNAL

STRUCTURE

3.0 Objectives

3.1 Introduction

3.2 Voucher

3.3 Journal

3.3.1 Classification of Accounts

3.3.2 Goods Account

3.4 Important considerations for recording the business  transactions

3.5 Summary

3.6 Keywords

3.7 Self assessment questions

3.8 References/suggested readings

3.0 OBJECTIVES

After going through this lesson, you will be able to-

∙ Know the meaning and steps of accounting process. ∙ Understand the meaning and importance of journal. ∙ Know the rules of journalising.

3.1 INTRODUCTION

A business enterprise generally prepares the following two basic  financial statements:

Profit and Loss Account to ascertain the profit earned or loss  incurred during an accounting period.

Balance Sheet to ascertain the financial position of the business  as on a particular date.

Generally, a business enterprise has numerous transactions every  day during an accounting period. Unless the transactions are recorded  and analysed, it is not possible to determine the impact of each  transaction in the above two basic statements. Traditionally, accounting  is a method of collecting, recording, classifying, summarising, presenting  and interpreting financial data aspect of an economic activity. The series  of business transactions occurring during the accounting period and its  recording is referred to an accounting process/mechanism. An  accounting process is a complete sequence of accounting procedures  which are repeated in the same order during each accounting period.  Therefore, accounting process involves the following steps or stages:

1. Identification of transaction  

In accounting, only business transactions are recorded. A  transaction is an event which can be expressed in terms of money and  which brings change in the financial position of a business enterprise. An  event is an incident or a happening which may or may not being any  change in the financial position of a business enterprise. Therefore, all  transactions are events but all events are not transactions. A transaction  is a complete action, to an expected or possible future action. In every  transaction, there is movement of value from one source to another. For  example, when goods are purchased for cash, there is a movement of  goods from the seller to the buyer and a movement of cash from buyer to  the seller. Transactions may be external (between a business entity and a  second party, e.g., goods sold on credit to Hari or internal (do not involve  second party, e.g., depreciation charged on the machinery).

Illustration: State with reasons whether the following events are  transactions or not to Mr. K. Mondal, Proprietor.

(i) Mr. Mondal started business with capital (brought in  cash)Rs. 40,000.

(ii) Paid salaries to staff Rs. 5,000.

(iii) Purchased machinery for Rs. 20,000 in cash.

(iv) Placed an order with Sen & Co. for goods for Rs. 5,000. (v) Opened a Bank account by depositing Rs. 4,000.

(vi) Received pass book from bank.

(vii) Appointed Sohan as Manager on a salary of Rs. 4,000 per  month.

(viii) Received interest from bank Rs. 500.

(ix) Received a price list from Lalit.

Solution: Here, each event is to be considered from the view point  of Mr. Mondal’s business. Those events which will change the financial  position of the business of Mr. Mondal, should be regarded as  transaction.

(i) It is a transaction, because it changes the financial position  of Mr. Mondal’s business. Cash will increase by Rs. 40,000  and Capital will increase by Rs. 40,000.

(ii) It is a transaction, because it changes the financial position  of Mr. Mondal’s business. Cash will decrease by Rs. 5,000  and Salaries (expenses) will increase by Rs. 5,000

(iii) It is a transaction, because it changes the financial position  of Mr. Mondal’s business. Machinery comes in and cash goes  out.

(iv) It is not a transaction, because it does not change the  financial position of the business.

(v) It is a transaction, because it changes the financial position  of the business. Bank balance will increase by Rs. 4,000 and  cash will decrease by Rs. 4,000.

(vi) It is also not a transaction, because it does not change the  financial position of Mr. Monal.

(vii) It is also not a transaction, because it does not change the  financial position of Mr. Monal.

(viii) It is a transaction, because it changes the financial position  of Mr. Mondal’s business. Bank interest will increase by Rs.  500 and cash will increase by the same amount.

(ix) It is not a transaction, because it does not change the  financial position of the business of Mr. Mondal.

2. Recording the transaction  

Journal is the first book of original entry in which all transactions  are recorded event wise and date-wise and presents a historical record of  all monetary transactions. It may further be divided into sub-journals as  well which are also known subsidiary books.

3. Classifying  

Accounting is the art of classifying business transactions.  Classification means statement setting out for a period where all the  similar transactions relating to a person, a thing, expense, or any other  subject are groped together under appropriate heads of accounts.

ACCOUNTING PROCESS

4. Summarising  

Summarising is the art of making the activities of the business  enterprise as classified in the ledger for the use of management or other  user groups i.e. Sundry debtors, Sundry creditors etc. Summarisation  helps in the preparation of Profit and Loss Account and Balance sheet for  a particular fiscal year.

5. Analysis and Interpretation  

The financial information or data as recorded in the books of a  account must further be analysed and interpreted so to draw useful  conclusions. Thus, analysis of accounting information will help the  management to assess in the performance of business operation and  forming future plans also.

6. Presentation or reporting of financial information  

The end users of accounting statements must be benefited from  analysis and interpretation of data as some of them are the ‘stock  holders’ and other one the ‘stake holders’. Comparison of past and  present statement and reports, use of ratio and trend analysis are the  different tools of analysis and interpretation.

From the above discussion one can conclude that accounting is a  art which starts and includes steps right from recording of business  transactions of monetary character to the communicating or reporting  the results thereof to the various interested parties.

3.2 VOUCHER  

Each transaction is recorded in books of accounts providing all the  required information of the transaction. Since each transaction has an  effect on the financial position of the business, there should be a

documentary evidence to establish the monetary accounts at which  transactions are recorded and also the transactions are properly  authorised. The common documents that are generally used are as  under:

(i) Payment voucher;

(ii) Receipt voucher; and

(iii) Transfer voucher.

(i) A Payment voucher usually on a printed standard form, is a  record of payment. When payment is made for an expense,  generally a bills is prepared to record full particulars of the  claim by the person or organisation receiving payment. From  the bill, the accounting department prepares a voucher for  each payment to be made, no matter whether the amount  that is paid for the goods purchased, or to pay employee’s  salaries, or to pay for services or to pay for any other asset  acquisition.

(ii) A Receipt voucher is a document which is issued against cash  receipts. It may also be a printed standard form. This  document shows that a certain sum of money was received  from a person or organisation and also, contains information  of the purpose for which the money is received. It is signed  by a responsible employee, authorised by the management to  receive the money.

(iii) A Transfer voucher is used to record the residuary  transactions. An internal transaction or a transaction not  involving any cash payment or cash receipt, is recorded in  the transfer voucher. Examples are: Goods purchased on  credit; depreciation of assets, outstanding expenses, accrued  income, etc.

3.3 JOURNAL

Journal is a historical record of business transaction or events. The  word journal comes from the French word “Jour” meaning “day”. It is a  book of original or prime entry. Journal is a primary book for recording  the day to day transactions in a chronological order i.e. the order in  which they occur. The journal is a form of diary for business  transactions. This is called the book of first entry since every transaction  is recorded firstly in the journal.

Journal Entry

Journal entry means recording the business transactions in the  journal. For each transaction, a separate entry is recorded. Before  recording, the transaction is analysed to determine which account is to  be debited and which account is to be credited.  

The performa of journal is shown as follows:

JOURNAL

Column 1 (Date): The date of the transaction on which it takes  pale is written in this column.  

Column 2 (Particulars): In this column, the name of the accounts  to the debited is written first, then the names of the accounts to be

credited and lastly, the narration (i.e. a brief explanation of transaction)  are entered.

Column 3 (L.F.): L.F. stands for ledger folio which means page of  the ledger. In this column are entered the page numbers on which the  various accounts appear in the ledger.

Column 4 (Dr. Amount): In this column, the amount to be debited  against the ‘Dr.’ Account is written along with the nature of currency.

Column 5 (Cr. Amount): In this column the amount to be credited  against the ‘Cr.’ Account is written along with the nature of currency.

Advantages of Using Journal

Journal is used because of the following advantages:

∙ A journal contains a permanent record of all the business  transactions.

∙ The journal provides a complete chronological (in order of the  time of occurrence) history of all business transactions and  the task of later tracing of some transactions is facilitated.

∙ A complete information relating to one single business  transaction is available in one place with all its aspects.

∙ The transaction is provided with an explanation technically  called a narration.

∙ Use of the journal reduces the possibility of an error when  transactions are first recorded in this book.

∙ The journal establishes the quality of debits and credits for a  transaction and reconciles any problems. If a business  purchases a bicycle, it is necessary to decide whether the  bicycle represents ordinary goods or machinery. Further any  amount paid is debited to bicycle account and credited to  cash account.

∙ The use of journals avoids omission or duplication of  transactions or parts of transaction. Without the journal the  accountant would be forced to got to the individual account  to enter debits and credits. Therefore it is possible for  accountant to miss part of a transaction, duplicate all or part  of a transaction or incorrectly record debits and credits. Even  with the Journal, it is still possible to omit transactions and  make other errors. However, the Journal reduces these  problems.

∙ Once a transaction is recorded in the journal, it is not  necessary to post it immediately in the ledger accounts. In  this, way, the journal allows the delayed posting.  

In connection with the journal, the following points are to be  remembered:

∙ For each transaction, the exact accounts should be debited  and credited. For that, the two accounts involved must be  identified to pass a proper journal entry.

∙ Sometimes, a journal entry may have more than one debit or  more than one credit. This type of journal entry is called  compound journal entry. Regardless of how many debits or  credits are contained in a compound journal entry, all the  debits are entered before any credits are entered. The  aggregate amount of debits should be equal to the aggregate  amount of credits.

∙ For a business, journal entries generally extend to several  pages. Therefore, the total are cast at the end of each page,  against the debit and credit columns, the following words  and written in the particular column, which indicates,  carried forward (of the amount on the next page) “Total c/f”.

The debits and credits totals of the page are then written on the  next page in the amount columns; and opposite to that on the left, the  following words are written in the particulars column to indicate brought  forward (of the amount of the previous page) “Total b/f”. This process is  repeated on every page and on the last page, “Grand Total” is cast.

3.3.1Classification of Accounts

1. Personal Accounts  

Accounts which are related with accounts of individuals, firms,  companies are known as personal accounts. The personal accounts may  further be classified into three categories:

(i) Natural Personal Accounts: Accounts of individuals relating to  natural persons such as Akhil’s A/c, Rajesh’s A/c, Sohan’s  A/c are natural personal accounts.

(ii) Artificial Personal Accounts: Accounts of companies,  institutions such as Reliance Industries Ltd; Lions Club, M/s  Sham & Sons, National College account are artificial  personal accounts. These exist only in the eyes of law.

(iii) Representative Personal Accounts: The accounts which  represent some person such as wage outstanding account,  prepaid insurance account, accrued interest account are  considered as representative personal accounts.

2. Real Accounts  

Real accounts are the accounts related to assets/properties. These  may be classified into tangible real account and intangible real account.  The accounts relating to tangible assets such as building, plant,  machinery, cash, furniture etc. are classified as tangible real accounts.  Intangible real accounts are the accounts related to intangible assets  such as goodwill, trademarks, copyrights, franchisees, Patents etc.

3. Nominal Accounts  

The accounts relating to income, expenses, losses and gains are  classified as nominal accounts. For example Wages Account, Rent  Account, Interest Account, Salary Account, Bad Debts Accounts.  

RULES FOR DEBIT AND CREDIT

Illustration: How will you classify the following into personal, real  and nominal accounts?  

(i) Investments

(ii) Freehold Premises

(iii) Accrued Interest

(iv) Punjab Agro Industries Corporation

(v) Janata Allied Mechanical Works

(vi) Salary Accounts

(vii) Loose Tools Accounts

(viii) Purchases Account

(ix) Indian Bank Ltd.

(x) Capital Account

(xi) Brokerage Account

(xii) Toll Tax Account

(xiii) Dividend Received Account

(xiv) Royalty Account

(xv) Sales Account

Solution

Real Account: (i), (ii), (vii), (viii), (xv).

Nominal Account: (vi), (ix), (xi), (xii), (xiii), (xiv)

Personal Account: (iii), (iv), (v), (x)

Journalizing

Journalism is the process of recording journal entries in the  Journal. It is a systematic act of entering the transaction in a day book in  order of their occurrence i.e., date-wise or event-wise. After analysing the  business transactions, the following steps in journalising are followed:

(i) Find out what accounts are involved in business transaction. (ii) Ascertain what is the nature of accounts involved? (iii) Ascertain the golden rule of debit and credit is applicable for  each of the accounts involved.

(iv) Find out what account is to be debited which is to be  credited.

(v) Record the date of transaction in the “Date Column”.

(vi) Write the name of the account to be debited very near to the  left hand side in the ‘Particulars Column’ along with the word  ‘Dr’ on the same line against the name of the account in the  ‘Particulars Column’ and the amount to be debited in the  ‘Debit Amount column’ against the name of the account.

(vii) Record the name of the account to be credited in the next  line preceded by the word ‘To’ at a few space towards right in  the ‘Particulars Column’ and the amount to be credited in  the ‘Credit Amount Column’ in front of the name of the  account.

(viii) Record narration (i.e. a brief explanation of the transaction)  within brackets in the following line in ‘Particulars Column’. (ix) A thin line is drawn all through the particulars column to  separate one Journal entry from the other and it shows that  the entry of a transaction has been completed.

Illustration: Analyse the following transactions.

(a) Ramesh started his business with cash

(b) Borrowed from Nikhil

(c) Purchased furniture

(d) Purchased furniture from Mohan on credit

(e) Purchased goods for cash

(f) Purchased goods from Ram on credit

(g) Sold goods for cash

(h) Sold goods to Hari on credit

(i) Received cash from Hari

(j) Paid cash to Ram

(k) Deposited into bank

(l) Withdrew cash for personal use

(m) Withdrew from bank for office use

(n) Withdrew from bank for personal use

(o) Received cash from a customer, Shyam

(p) Paid salary by cheque

(q) Received donation in cash

(r) Paid to Ram by cheque

(s) Paid salary

(t) Paid rent by cheque

(u) Goods withdrawn for personal use

(v) Paid an advance to suppliers of goods

(w) Received an advance from customers

(x) Paid interest on loan

(y) Paid instalment of loan

(z) Interest allowed by bank.

Solution

ANALYSIS OF TRANSACTIONS

Illustration: Prepare Journal in the books of K.K. Co. from the  following transactions:

Solution

IN THE BOOKS OF K.K. CO.

Journal

Dr. Cr.

Date Rs.

1999

Dec. 1.

50,000

6.

20,000

8.

4,000

9.

1,980

20

10.

3,000

12.

2,000

15

4,000

18.

300

20.

1,050

22.

3,000

25.

500

31.

200

90,050

3.3.2Goods Account  

Generally, the term goods include every type of property such as  Land, Building, Machinery, Furniture, Cloth etc. However, in  accountancy its meaning is restricted to only those articles which are  purchased by a businessman with an intention to sell it. For example, if  a businessman purchased typewriter, it will be goods for him if he deals  in typewriter but if he deals in other business say clothes then typewriter  will be asset for him and clothes will be goods.

Sub-Division of Goods Accounts  

The goods account is not opened in accounting books and it is to  be noted goods includes purchases, sales, sales returns, purchases  return of goods. However, purchase account, sales account, sales return  account and purchase return account are opened in the books of  account.

Purchases Account: This is opened for goods purchased on cash  and credit.

Sales Account: This account is opened for the goods sold on cash  and credit.

Purchase Returns Account or Return Outward Account: This  account is opened for the goods returned to suppliers.

Sales Returns Account or Return Inward Account: This account  is opened for the goods returned by customers.

Opening Entry  

In case of going concern at the beginning of the new year, new  books of accounts are opened and the balances relating to personal and  real Accounts appearing in the books at the close of the previous year are  brought forward in new books. The entry for this purpose in the books is  called opening entry.

The opening entry is passed by debiting all assets and crediting all  liabilities including capital. If the amount of capital is not given then this  can be found out with the help of the accounting equation: Assets = Liabilities + capital

Capital = Assets- Liabilities

Illustration: On 1st April 1998, Singh’s assets and liabilities stood  as follows:

Assets: Cash Rs. 6,000, Bank Rs. 17,000, Stock Rs. 3,000;  Bills receivable 7,000; Debtors 3,000; Building  

70,000; Investments 30,000; Furniture 4,000

Liabilities: Bills payable 5000, Creditors 9000, Ram’s loan  13,000

Pass on opening Journal entry.

Date Credit  

Amount

1998

April 1

5,000

9,000

13,000

1,13,000

1,40,000

3.4 IMPORTANT CONSIDERATIONS FOR RECORDING THE  BUSINESS TRANSACTIONS  

1. Trade Discount  

Trade discount is usually allowed on the list price of the goods. It  may be allowed by producer to wholesaler and by wholesaler to retailer  for purchase of goods in large quantity. It is not recorded in the books of  account and entry is made only with the net amount paid or received, for  example, purchased goods of list price Rs. 8,000 at 15% trade discount  from X. In this case the following entry will be passed:

Rs. Rs.

Purchases Account Dr. 6,800

To X 6,800

(Being goods purchased at 15% trade discount Less list price)

2. Amount paid or received in full settlement or cash  discount  

Cash discount is a concession allowed by seller to buyer to  encourage him to make early cash payment. It is a Nominal Account. The  person who allows discount, treat it as an expenses and debits is his  books and it is called discount allowed and the person who receives  discount, treat as an income and it is called discount received and credits  in his books of account “Discount Received Account.” For example, X  owes Rs. 6,000 to Y. He pays Rs. 5,950 in full settlement against the  amount due. In the books of X the journal entry will be:

Rs. Rs.

Y Dr. 6,000

To Cash Account 5,950 To Discount Received account 50 (Being Cash paid and discount received)

In the books of Y Rs. Rs. Cash Account Dr. 5,950 Discount Allowed Account Dr. 50 To X 6,000

(Being cash received and discount allowed)  

3. Goods distributed as free samples  

Some times business distributes goods as free samples for the  purpose of advertisement. In this case Advertisement Account is debited  and Purchases Accounts is credited. For example, goods costing Rs. 8000

were distributed as free sample. to record this transactions following  entry will be passed:

Rs. Rs.

Advertisement Account Dr. 8,000

To Purchases Account 8,000 4. Interest on capital  

Interest paid on capital is an expense. Therefore interest account  should be debited. On the other hand the capital of the business is  increases. So the capital account should be credited. The entry will be as  follows:

Interest on Capital Account Dr.

To Capital Account

5. Interest charged on Drawings  

If the interest is charged on drawings then it will be an increase in  the income of business, so interest on drawings will be credited. On the  other hand there will be increase in Drawings or decrease in Capital. So  Drawings Account will be debited. To record this, following entry will be  passed:

Drawing Account or Dr.

Capital Account Dr.

To Interest on Drawing Account

6. Depreciation charged on Fixed Assets  

Depreciation is the gradual, permanent decrease in the value of an  assets due to wear and tear and many other causes. Depreciation is an  expense so the following entry will be passed:

Depreciation Account Dr.

To Asset Account

7. Bad Debts  

Sometimes a debtor of business fails to pay the amount due from  him. Reasons may be many e.g. he may become insolvent or he may die.  Such irrecoverable amount is a loss to the business. To record this  following entry will be passed:

Bad Debts Account Dr.

To Debtor’s Account

8. Bad Debts Recovered  

When any amount becomes irrecoverable from any costumer or  debtor his account is closed in the books. If in future any amount is  recovered from him then his personal account will not be credited  because that does not exist in the books. So the following entry is passed:

Cash Account Dr.

To Bad Debts Recovered Account

9. Purchase and Sale of investment  

When business has some surplus money it may invest this amount  is shares, debentures or other types of securities. When these securities  are purchased, these are recorded at the purchase price paid. At the time  of sale of investment the sale price of an investment is recorded in the  books of accounts. The following entry is passed to record the purchase  of investment:

Investment Account Dr.

To Cash Account

In case of sale of these securities the entry will be:

Cash Account Dr.

To Investment Account

10. Loss of Goods by Fire/Accident/theft  

A business may suffer loss of goods on account of fire, theft or  accident. It is a business loss and a nominal account. It also reduces the  goods at cost price, and increases the loss/expenses of the business. The  entry will be passed as:

Loss by fire/Accident/theft Account Dr (for loss)

Insurance Company Account Dr. (for insurance claim  admitted)

To Purchases Account

11. Income Tax Paid  

Income Tax paid should be debited to Capital Account or Drawings  Account and credited to cash Account in case of sole proprietorship and  partnership firms. The reason behind this is that income tax is a  personal expense for the sole trader and partners because it is paid on  income of proprietor. The entry will be as follows:

Capital Account Dr.

Drawing Account Dr.

To Cash Account

12. Bank Charges  

Bank provide various services to their customers. Bank deducts  some charges by debiting the account of customers. It is an expenses for  the business. To record this following entry will be passed in the books of  businessman/customer:

Bank Charges Account Dr.

To Bank Account

13. Drawings Account  

It is a personal account of the proprietor. When the businessman  withdraws cash or goods form the business for his personal/domestic  use it is called as ‘drawings’. Drawings reduce the capital as well as  goods/cash balance of the business. The journal entry is:

Drawings Account Dr.

To Cash Account

To Purchases Account

14. Personal expenses of the proprietor  

When the private expenses such as life insurances premium,  income tax, home telephone bill, tuition fees of the son of the proprietor  etc. are paid out of the cash or bank account of business it should be  debited to the Drawing Account of the proprietor. The journal entry is:

Capital/Drawings Account Dr.

To Cash/Bank

15. Sale of Asset/Property  

When the asset of a business is sold, there may occur a profit or  loss on its sale. It should be noted carefully that sales account is never  credited on the sale of asset. The journal entry is:

(i) In case there is a profit on sale of Property/Assets Cash/Bank Account Dr.

To Asset/Property Account

To Profit on sale of Asset Account

(ii) In case of a loss on sale of asset

Cash/Bank Account Dr.

Loss on sale of Asset Account Dr.

To Asset Account

16. Amount paid or Received on behalf of customer  

(i) When the business entity pays the amount on behalf of old  reputed customers such as carriage in anticipation of recovering the  same later on, carriage account should not be opened because carriage is  not the expense of the seller. It should be debited/charged to customer’s  Personal account. The journal entry is:

Customer/Debtor’s Account Dr.

To Cash/Bank Account

(ii) When the business entity receives the amount on behalf of  customers from the third party as mutually settled between the third  party and the customer, the account of the third party/person making  the payment should not be opened in the books of the receiving entity.  The journal entry in the books of the entity is:

Cash/Bank Account Dr.

To Customer/Debtor’s Account

17. Amount paid on behalf of creditors  

When the creditors/supplier instructs the business entity to make  payment on their behalf, the amount so paid should be debited to  creditors account and liability of the business will decrease accordingly.  The journal entry is:

Suppliers/Creditors Account Dr.

To Cash/Bank Account

18. The events affecting business but they do not involve any  transfer/exchange of money for the time being, they would not be  recorded in the financial books. Examples of them are:

(i) On 1st January 2006 placed on order to Geeta & Sons for the  supply of goods worth Rs. 1,00,000.

(ii) Babanjot, a B.Com. graduate has been appointed Sales  Assistant on a salary of Rs. 5,000 p.m. on Jan., 2006.

(iii) Raman, a proprietor contracted with Bahia Builders Ltd. for  the renovation of the building at an estimated cost of Rs.  5,00,000.

(iv) A shop in Adalt Bazar Patiala contracted to be taken on a  rent @ Rs. 4,000 pm.

19. Paid wages/installation charges for erection of machinery  

Wages and installation charges are the expenses of nominal  nature. But for erection of machinery no separate account should be  opened for such expenses because these expenses are of capital nature  and it will be merged/debited to the cost of assets i.e. machinery. The  journal entry is:  

Machinery Account Dr.

To Cash/Bank Account

(Being wages/installation charges paid for the erection of  machinery)

Illustration: Journalise the following transactions for the month of  January 2006:

2006

Jan.1 Invested in shares of Tata Cotton Mills Ltd. and paid for the same  in cash Rs. 2,000.

 2 Placed on order with Mr. Shah for goods to be received a month  later Rs. 1,500.

 3 Invoiced goods to Mr. Love worth Rs. 1,000 and allowed a trade  discount of 2 per cent.

 4 Carriage Rs. 25 and freight Rs. 70 were paid by the proprietor for  the above goods but which are to be charged to Mr. Love Account.

the above goods but which are to be charged to Mr. Love Account. 5 Paid rent to landlord of office premises- Rs. 150, which he spent  on purchase of our goods.

 6 Goods valued at Rs. 700 were delivered to Ahmedabad Merchants  under instructions from Mr. Gobind. They were to be charged to  the latter’s Account.

 7 Mr. Love paid Rs. 500 due from him, and the same was spent on  purchasing goods from Mr. Deepu.

 8 Sold one old motor car belonging to the proprietor for Rs. 5,000  and the amount was invested in the business.

 9 The proprietor paid Rs. 180 in full settlement of Mr. Manpreet for  goods worth Rs. 200 purchased by him for personal use.  10 Mr. Gobind was declared insolvent and paid Rs. 450 in full  settlement. The balance Rs. 250 was written off as a bad debt.  11 Mohinder our debtors, on our advice, directly paid Narinder, our  creditor Rs. 2,000.

Solution

JOURNAL

Dr. Cr.

3.5 SUMMARY

An accounting process is a complete sequence of accounting  procedures which are repeated in the same order during each accounting  period. Accounting process involves six steps or stages i.e. identification  of transactions, recording the transaction, classifying, summarising,

analysis and interpretation and reporting of financial information. In  accounting, all the transactions are recorded on the basis of  evidence/document which are mainly three– (i) payment voucher; (ii)  receipt voucher; and (iii) transfer voucher. Recording the transaction is  the first step in the process of accounting which is performed in the book  called ‘Journal’. Journal is a primary book for recording the day to day  transactions in a chronological order, i.e., the order in which they occur.  The process of recording journal entries in the journal is called  journalising. For the journalising, all the accounts are classified into  three categories namely personal account; real account; and nominal  account.

3.6 KEYWORDS

Bad Debt: Debt owned to an enterprise which is considered to be  irrecoverable.

Capital: It refers to the interest of owners in the assets of an  enterprise.

Depreciation: Decrease in the value of fixed assets.

Trade Discount: Reduction on print prices of goods.

Cash Discount: A reduction granted by a supplier from the  invoiced price in consideration of payment with in a stipulated period.

3.7 SELF ASSESSMENT QUESTIONS

1. “Recording of transaction is an important step in accounting  process” Comment.

2. What is Journal? Distinguish between Journal and  Journalising.

3. How you will classify the accounts? State the rules of  journalising with respect to each class of accounts.

4. What will be the Journal entry in the following cases: (i) Loss of goods by theft

(ii) Loss of cash from the cash box

(iii) Sale and purchase of investments

(iv) Goods taken by the proprietor for his private use.

(v) Amount paid/received on behalf of others by the  business entity

(vi) Satinder, a marketer appointed at a salary of Rs. 3000  p.m.

5. Mr. Ravindra’s position as on 1st Jan. 1999 is follows: Property and Assets: Buildings Rs. 15,000

Furniture Rs. 1,500.

Stock of Goods Rs. 20,000

Cash at Bank Rs. 5,000

Cash in hand Rs. 1,000, and

Customer’s Accounts Rs. 15,000.

Liabilities: Suppliers Accounts Rs. 12,500 and Loan Account Rs. 30,000.

Pass necessary entries to record the above.

6. Miss Twinkle Punia started a restaurant investing Rs.  5,00,000 on Jan. 1, 2000 and further submits the details of  the transactions:

2006

Jan.5: She purchased furniture for Rs. 2,75,000; Crockery Rs.  75,000 and cooking utensils Rs. 38,000

Jan. 10: She paid Rs. 1,00,000 as Salami for taking the shop on  lease for ten years at Daryaganj, Delhi.

Jan. 15: She took a temporary loan of Rs. 75,000 from her  brother Rupinder, a financier.

Jan. 25: She took a bank loan of Rs. 50,000 and repaid the loan  taken from her brother, Rupinder partly.

Jan. 31: She appointed Lavina as a manager at a salary of Rs.  5000 p.m. and took from her a security deposit of Rs.  50,000.

Pass Journal entire in the books of Twinkle Punia.

7. Are the following entries correctly made by an Accountant  Gurudev. If not give the correct entries:

Rs. Rs.

a) Cash Account Dr. 4,200 To Anil Kumar Account 4,200 (Received cash from Ajit Kumar on behalf  

of his friend Ramesh Chandra)

b) Goods Account Dr. 3,000 To Dinesh Singh Account 3,000 (Bought goods from Dinesh Singh for cash)

c) Salary Account Dr. 450 To Gopal Krishan Account 450 (Paid salary to Gopal Krishan)

d) Landlord Account Dr. 600 To Bank Account 600 (Paid rent to Landlord by cheque)

e) Furniture Account Dr. 1150 To Cash Account 150 (Paid for repairs of Furniture)

8. Journalise the following transactions:

2006 Rs. July 2 Commenced business with Cash 25,000 4 Purchased furniture for cash 2,000 4 Cash purchases 14,500 7 Bought of Somal 2,600 7 Sold of Monica 808 9 Rent for two years paid in advance 2,400 9 Drawings by the proprietor for

household expenses 400 9 Goods taken out by the proprietor for

domestic use 50 9 Cash withdrawn from Bank 2,700 10 Sold to Manohar 985 11 Purchases made, payment through cheque 290 14 Cash received from Popli on account 1,000 14 Cash paid to Somal after deduction of

discount Rs.130 2,470 17 Cash received from Manohar in full

settlement of his account 975 18 Monica becomes insolvent. A dividend of

Rs. 50 paise in a rupee is received. 404

18 Purchase of a scooter for cash 13,000 20 Sold goods to Amrik 864 20 Sold to Neena 378 24 Electricity bill paid 510 24 Cartage paid in cash 5 24 Repairs to scooter, payment not yet made 17 26 Payment of cash for petrol 115 26 Purchases of goods for cash 1,200 26 Purchases of office equipment for cash 1,250 27 Repairs bill paid in cash 17 28 Amrik returns goods 40 31 Depreciation of furniture 110 31 Depreciation of Scooter 220 31 Adjustment for the month’s rent 180 31 Bank charges for the month 5 31 Interest on capital for the month 125 31 Salary to be credited to proprietor 200 31 Sonal agrees to take some defective goods 70 purchased from him and immediately

refunds the money.

9. Journalise the following transactions:

(i) Paid by cheque fire insurance premium Rs. 327 (ii) Paid by cheque proprietor’s life insurance premium Rs.  210

(iii) Paid by cheque A’s bill for repairs to machinery Rs.  265

(iv) Drew a cheque for pretty cash Rs. 120.

(v) Sent our acceptance at two months for Rs. 735 to M. (vi) Bill payable due this day met at bank Rs. 330. (vii) Received B/s acceptance for Rs. 780 from A is  settlement of latter’s account for Rs. 800

(viii) Discounted N’s acceptance for Rs. 585 at Rs. 570 (ix) Sold goods to Murthi and he endorsed M’s bill to us. (x) Bank collected interest on our investments Rs. 95 (xi) Received dividend on shares of A & Co. Ltd. Rs. 137 (xii) Received a cheque for Rs. 93 for commission due to us. (xiii) Invested in Government securities Rs. 5,000 (xiv) Bought shares in Best & Co. Ltd. for Rs. 3,000 (xv) Purchased Plant and Machinery for Rs. 15,500. (xvi) Interest allowed by bank on our current account  Rs. 15

(xvii) Bank charges made by bank Rs. 17

(xviii) Paid for an insertion in “The Hindu” Rs. 15 (xix) Bought goods from Seth & Co. for Rs. 750 accepted  their bill for Rs. 500 Rs. 500 and gave them a cheque  for Rs. 250

(xx) Sold goods to John and Co. for Rs. 650, received their  acceptance for Rs. 500 and gave them a cheque for Rs.  250.

(xxi) Returned goods to A.A. Rs. 75

(xxii) B.B. returned goods to us Rs. 94

(xxiii) Bought of C & Co., goods for cash Rs. 500 (xxiv) Received dividend on shares Rs. 55.

(xxv) Bought Prize Bonds of Indian Government for Rs. 150. (xxvi) Bought National Savings Certificates for Rs. 100 (xxvii)Paid by cheque A. Anand’s bills for repairs to  machinery Rs.120.

(xxviii)Received a cheque for Rs. 350 from B. Balu to be  credited to M. Mani’s account.

(xxvix) Received from D. Datta Rs. 970.

(xxx) Paid d. Data’s cheque into the bank.

(xxxi) Bank returned D. Datta’s cheque dishonoured.

(xxxii)Borrowed for the bank Rs. 5,0000.

(xxxiii) Repaid M’s loan of Rs. 500 with interest Rs. 25.

3.8 REFERENCES/SUGGESTED READINGS

1. Ashok Sehgal (2005), “Fundamentals of Financial  Accounting”, Taxmann’s Publishers, New Delhi.

2. Anthony N. Robert (1998), “Accounting Principles”, AITBS  Publishers, New Delhi.

3. S.M. Shukla (1982), “Advanced Accountancy”, Sahitya  Bhavan, Agra.

4. Aggarwal, M.P. (1981), “Analysis of Financial Statements”,  Natioanl Publishing House, New Delhi.

5. Michael Tones (2002), “Accounting for Non-Specialists”, John  Wiley & Sons, Singapore.

LEDGER POSTING AND TRIAL BALANCE

STRUCTURE

4.0 Objectives

4.1 Introduction

4.2 Posting

4.2.1 Rules Regarding Posting

4.2.2 Balancing of an Account

4.3 Trial Balance

4.3.1 Objectives of Preparing a Trial Balance

4.4 Summary

4.5 Keywords

4.6 Self assessment questions

4.7 References/suggested readings

4.0 OBJECTIVES

After going through this lesson, you should be able to-

∙ Know meaning and importance of ledger.

∙ Understand the rules regarding posting.

∙ Know balancing of an account.

∙ Know meaning and objectives of trial balance.

4.1 INTRODUCTION

It has already been discussed in earlier lesson that accounting  involves recording, classifying and summarising the financial  transactions. Recording is made in Journal, which has been explained in

the preceding lesson. Classification of the recorded transactions is made  in the ledger. This is being discussed in the present lesson.

Ledger is a book which contains various accounts. In simple  words, ledger is a set of accounts. It includes all accounts of the business  enterprise whether Real, Nominal or Personal. Ledger may be kept in any  of the following two forms:

∙ Bound Ledger; and

∙ Loose Leaf Ledger.

It is common to keep the ledger in the form of loose-leaf cards these  days instead of keeping them in bounded form. This helps in posting  transactions particularly when mechanised system of accounting is used.  Interestingly, nowadays, mechanised system of accounting is preferred  over the manual system of accounting.

4.2 POSTING

The term ‘Posting’ means transferring the debit and credit items  from the Journal to their respective accounts in the ledger. It is  important to note that the exact names of accounts used in the Journal  should be carried to the ledger. For example:

If in the Journal, Salary Account has been debited, it would not be  correct to debit the Outstanding Salary Account in the Ledger. Therefore,  the correct course would be to use the same account in both the Journal  and Ledger.

Ledger posting may be done at any time. However, it must be  completed before the annual financial statements are prepared. It is  advisable to keep the more active accounts posted upto date. The  examples of such accounts are the cash account, personal accounts of  various parties, etc.

The Ledger posting may be made by the book-keeper from the  Journal to the Ledger by any of the following methods:

∙ He may take a particular side first. For example, he may take  the debits first and make the complete postings of all debits  from Journal to the Ledger.

∙ He may take a particular account first and post all debits  and credits relating to that account appearing on one  particular page of Journal. He may then take some other  account and follow the same procedure.

∙ He may complete posting of each journal entry before  proceeding to the next entry.

It is advisable to follow the last method. Further, one should post  each debit and credit item as it appears in the Journal.

The Ledger Folio (L.F.) column in the Journal is used at the time  when debits and credits are posted to the Ledger. The page number of the  Ledger on which the posting has been done is mentioned in the L.F.  Column of the Journal. Similarly a folio column in the Ledger can also be  kept where the page from which posting has been made from the  Journal. Thus, these are cross references in both the Journal and the  Ledger. A proper index must be maintained in the Ledger giving the  names of the accounts and the page number. A specimen of Ledger is  given below:

DALMIA’S A/C

Dr. Cr.

All entries relating to Dalmia’s A/c shall be posted in this specimen  a/c and finally the balance either debit or credit may be drawn. All rules  regarding the posting must strictly be followed.

4.2.1Rules Regarding Posting

The following rules must be observed while posting transactions in  the Ledger from the Journal:

i) Separate accounts should be opened in the Ledger for  posting transactions relating to different accounts recorded in the  Journal. For example, separate accounts may be opened for sales,  purchases, sales returns, purchases returns, salaries, rent, cash, etc.

ii) The concerned account which has been debited in the  Journal should also be debited in the Ledger. However, a reference  should be made of the other account which has been credited in the  Journal. For example, for salaries paid, the salaries account should be  debited in the Ledger, but reference should be given of the Cash Account  which has been credited in the Journal.

iii) The concerned account, which has been credited in the  Journal; should also be credited in the Ledger, but reference should be  given of the account, which has been debited in the Journal. For  example, for salaries paid, Cash Account has been credited in the  Journal. It will be credited in the Ledger also, but reference will be given  of the Salaries Account in the Ledger.

Thus, it may be concluded that while making posting in the Ledger,  the concerned account which has been debited or credited in the Journal  should also be debited or credited in the Ledger, but reference has to be  given of the other account which has been credited or debited in the  Journal, as the case may be. This will be clear with the following  example:

Suppose salaries of Rs. 10,000 have been paid in cash, the  following entry will be passed in the Journal:

Salaries Account Dr. 10,000

To Cash Account 10,000

In the Ledger two accounts will be opened (i) Salaries Account, and  (ii) Cash Account. Since Salaries Account has been debited in the  Journal, it will also be debited in the Ledger. Similarly Cash Account has  been credited in the Journal and, therefore, it will also be credited in the  Ledger, but reference will be given of the other account involved. Thus,  the accounts will appear as follows in the Ledger:

SALARIES ACCOUNT

Dr. Cr.

Cash A/c (i)

CASH ACCOUNT

Dr. Cr.

Rs. 10,000

Use of the words “To” and “By”: It is customary to use words ‘To’ and ‘By’ while making posting in the Ledger. The word ‘To’ is used with  the accounts which appear on the debit side of a Ledger Account. For  example in the Salaries Account, instead of writing only “Cash” as shown  above, the words “To Cash” will appear on the debit side of the account.  Similarly, the word “By” is used with accounts which appear on the credit  side of a Ledger Account. For example in the above case, the words “By  Salaries A/c” will appear on the credit side of the Cash Account instead  of only “Salaries A/c”. The words ‘To’ and ‘By’ do not have any specific  meanings. Modern accountants are, therefore, ignoring the use of these  words.