UNIT II

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THE ACCOUNTING PROCESS

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JOURNAL

• The book in which the business transactions are recorded in a chronological order, after analyzing them and classifying the benefits according to the principles of debit & credit is called JOURNAL.

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• As all the day to day transactions are recorded in journal, this book is also called as “Day book” or “Daily record”

• All the transactions related to business like Purchases, Purchase returns, sales, sales returns, cash receipts, cash payments, loans & advances taken (given), assets acquired, salaries paid are first recorded in the book of JOURNAL.

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• Hence Journal is called as “Book of Prime Entry”.

JOURNAL ENTRY

• The process of recording the business transactions in a chronological order in the journal after analyzing, classifying & identifying them as Dr and Cr is called entry.

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• All the transactions are recorded in the book of Journal are in the form of Entry.

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• For easy identification of the transaction a brief description is given under each entry with in brackets. (Narration)

Journalize the following transactions

1. Ram commenced business with Rs 50,000
2. Purchase furniture for cash Rs 3,000
3. Purchase machinery from Manoj on credit Rs 40,000
4. Received cash from pavan Rs 8,000 on account
5. Paid rent to land lord Rs 5,000

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Journalize the following transactions

• Jan 1 Raja commenced business with Rs 50,000
• Jan 2 Deposited in bank Rs 40,000
• Jan 5 Purchased goods from Krishna on credit Rs 10000
• Jan 7 Sold goods to ram on credit 8,000
• Jan 9 Purchased goods from Mahesh for cash 5000
• Jan 12 Sold goods for cash to Sailesh 8500
• Jan15 Purchased machinery from Ajay engineering company, payment made by cheque 20,000

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• Jan 18 Issued cheque to Krishna 7500
• Jan 20 Received interest from raja 700
• Jan 22 Cash withdrawn from bank for office use 2000
• Jan 24 Amount with drawn from bank for personal use 800
• Jan 27 Loan taken from Rajiv Varma 15000
• Jan 29 Cash with drawn from office for personal use 1000
• Jan 30 Goods withdrawn for personal use 2000
• Jan 31 Paid rent to landlord by cheque 600

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LEDGER

• Journal cannot give net results of various transactions related to any account, at a given date the full information is not made available, with regard to value of assets, incomes & expenses.

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• This limitation can be overcome by opening a LEDGER, which shows the net results of different accounts on given date.

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• LEDGER is also called the “Book of final entry”

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• From the Journal it is not possible to know the total purchases, sales, rent, salaries paid etc, this limitation can be over come by LEDGER.

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• It is a book, where the various accounts pertaining to particular person, asset, expense are grouped together in one place in the form of an account.

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• The process of transferring the transactions from Journal to Ledger is called “Posting”

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• LEDGER is the principal book of business & hence called “king of books of accounts”

1. Journalize the following transactions, post them into ledger and balance the accounts.

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Jan 1 Kittu commenced business 1,00,000

Jan 2 Purchased goods from Ravi 10,000

Jan 4 Sold goods to Gopi 20,000

Jan 5 Cash purchases 20,000

Jan 7 Paid salaries 5,000

Jan 8 Sold for cash 15,000

Jan 9 Purchased furniture paid by cheque 2,000

Jan 9 Bought goods from Sobhan 10,000

Jan 14 Cash paid to Ravi 9800, discount received 200

Jan 17 Received cash from Gopi 19,500, discount allowed 500

Jan 18 Deposited with bank 10,000

Jan 20 Paid for advertisement by cheque 700

Jan 22 Stationary expenses 800

Jan 24 Sold old furniture 1,700

Jan 28 Paid cash to shoban 4,000

Jan 26 Received interest through cheque (sent to bank on the same day) 500

Jan 31 Proprietors’ personal use 1,000

TRIAL BALANCE

• The Trial Balance contains the debit and credit balances of all LEDGER accounts, it is very much useful in preparation of FINAL ACCOUNTS.

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• It is a connecting link between the Ledger & Final Accounts.

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• Trial Balance can be prepared at any time & not necessarily at the end of a calendar or accounting year.

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• It is the only base for preparation of Final Accounts

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PREPARATION OF TRIAL BALANCE

Prepare the Trial Balance from the Ledger account balances

Capital 65,500 Bills payable 4,500

Creditors 18,200 Reserve for bad debts 3,250

Debtors 21,350 Tax outstanding 1,110

Cash 6,750 Interest on investment 2,150

Sales 1,20,000 Drawings 1510

Purchases 69,100 Fixed deposits 45,000

Cash at bank 7,800 Rent 950

Machinery 35,000 Insurance prepaid 4,200

Discount allowed 5,000 Wages 3,150

Discount received 3,200 Salaries outstanding 7,200

Furniture 4,000 Bills receivables 21,300.

TRIAL BALANCE

CAPITAL & REVENUE ITEMS IN FINAL ACCOUNTS

• The expenditure of the firm has been divided into Capital expenditure & Revenue expenditure.

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• Items of Revenue expenditure are taken in trading account & Profit & Loss account.

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• Items of Capital expenditure are considered in Balance Sheet

• Capital Expenditure is an “Expenditure intended to benefit future periods in contrast to the Revenue expenditure, which benefits the current period”.

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• The transactions of Capital expenditure give benefits for more than one accounting period such as acquisition and improvements of assets.

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• Capital expenditure is non recurring in nature.

CAPITAL EXPENDITURE

REVENUE EXPENDITURE

• “In Accounting revenue expenditure is synonymous with expenses”.

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• It is incurred for generating revenue in the current accounting period & its benefits expires within such period.

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• Revenue expenditure is recurring in nature.

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• Examples of Revenue expenditure:

Production expenses, selling expenses, financial expenses etc.

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DEFERRED REVENUE EXPENDITURE

• It is a peculiar type of Revenue Expenditure that spreads more than one accounting periods.

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• Example of deferred Revenue expenditure: advertisement

FINANCIAL STATEMENTS

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INCOME STATEMENT BALANCE SHEET

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TRADING A/C PROFIT & LOSS A/C

PREPARATION OF FINAL ACCOUNTS

Preparation of final accounts involves following three steps

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• Trading Account
• Profit & Loss Account &
• Balance Sheet

TRADING ACCOUNT

• Trading account is prepared at the end of each accounting period to assess the Gross Profit / Loss.
• Gross Profit = Net sales – COGS
• Gross Loss = COGS – Net sales
• Net sales = sales – sales returns
• COGS or cost of production or cost of goods sold = opening stock + purchases + direct expenses – closing stock

• Direct expenses:

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The following are direct expenses

• carriage inwards
• wages
• cartage or freight
• import duty
• excise duty
• coal, fuel, power
• factory expense,
• manufacturing expenses

TRADING ACCOUNT PROFORMA

PROFIT & LOSS ACCOUNT

• It is prepared to ascertain the Net profit/loss of the firm for the accounting period.

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• Net profit can be arrived by deducting the administrative expenses from the Gross profit.

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• By nature Profit & Loss account is a Nominal account and should not have opening & closing balances

• If the total of credit column exceeds the total of debit column the difference is called net profit, which is transferred to the capital account or added to the existing share capital while preparing the balance sheet.

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• Net profit will increase the capital and net loss will decrease the capital.

PROFIT AND LOSS A/C OF …………………….FOR THE YEAR ENDED…………

BALANCE SHEET

• The preparation of Balance sheet is the last and third stage of Final accounts.

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• The balance sheet has to be prepared only after the preparation of Trading & Profit & Loss account.

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• Trading & Profit & Loss account are prepared for a period of time where as the Balance sheet is prepared on a particular point of time

• “Balance sheet is a Statement prepared on particular date to reflect the financial position of the firm with all the assets and liabilities of the firm”

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• Balance sheet is not an account but it is a final statement of the financial position of a business on a closing date.

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• Assets are shown on the right side, liabilities including Capital is shown on the left side of the Balance sheet.

BALANCE SHEET OF ……………………… AS ON …………………………………….

Final Accounts Preparation Process

• Prepare Format or Proforma for Trading A/c, Profit & Loss A/c & Balance sheet
• Identify the adjustments in Trial balance, circle or highlight those adjustments
• Post the items from Trial balance to Trading A/c, Profit & Loss A/c & Balance sheet as per their nature in the sequence only
• Post the adjustments as per their nature –post twice each item (Double entry system)
• Calculate Gross Profit/Gross Loss (Check Dr side balance with Cr side)-Trading A/c
• Transfer Gross Profit/Gross Loss to Profit & Loss A/c
• Calculate Net Profit/Net Loss (Check Dr side balance with Cr side)-P/L A/c
• Transfer Net Profit/Net Loss to Balance sheet-Add Net Profit to Capital & subtract Net Loss from Capital from Liability side of Balance sheet
• As per the Accounting Equation, Balance sheet would be balanced.

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LIABILITIES+CAPITAL =ASSETS

ADJUSTMENTS

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(a) Closing Stock Rs. 30,000

(b) Rates and taxes paid in advance Rs. 30.

(c) Rent paid in advance Rs.200

(d) Provide for bad debts Rs.200.

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The above are the balances taken on 31st December, 20022 from the books of Mr. R. Sivaji, prepare Trading and Profit & Loss account and Balance sheet.

2. The following trial balance of Abhiram was prepared on 31st March 2006.

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Prepare, Trading and Profit and Loss A/c and Balance Sheet.

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Adjustments

Closing stock was valued at Rs.60,000

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3. The following are the balances extracted from the books of Z Ltd.

On 31st December 2020:

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Z’s Capital 30,000 Discount (Dr.) 1,600

Z’s drawings 5,000 Discount (Cr.) 2,000

Furniture & Fittings 2,600 Taxes and Insurance 2,000

Bank Overdraft 4,200 General expenses 4,000

Creditors 13,800 Salaries 9,000

Business Premises 20,000 Commission (Dr.) 2,200

Opening stock 22,000 Carriage inward 1,800

Debtors 18,000 Bad debts 800

Rent from tenants 1,000 Sales 1, 50,000

Purchases 1, 10,000 Sales Returns 2,000

Adjustments:

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(a) Closing stock was Rs. 20,060.

(b) Write off depreciation on Business Premises Rs. 300 Furniture & Fittings Rs. 250

(c) Make a reserve of 5% on Debtors for doubtful debts.

(d) Allow interest on capital at 5%

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From the above information prepare profit and loss account and balance sheet.

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Rectification of Errors

Rectification of errors in accounting means correcting mistakes made in the books of accounts. These mistakes may occur when transactions are recorded incorrectly, partially, or omitted

Rectification of Errors in Accounting

• Errors are of different types, and the rectification method depends on the type of error and when it is discovered.

Types of Errors

A. Errors of Omission

A transaction is completely omitted from the books.

Example: Credit sales not recorded.

Rectification:

→ Pass the journal entry as if recording it for the first time.

Example : Cash sales ₹5,000 completely omitted

Rectification entry:

Cash A/c Dr 5,000

To Sales A/c 5,000

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B. Errors of Commission

A transaction recorded wrongly(wrong amount, wrong posting, wrong casting).

Example: ₹5,000 received from Ravi entered as ₹500.

Rectification:

Correct the wrong amount with an additional entry or reversal + correct entry. 

Example : Purchase of furniture recorded as Purchases

Wrong entry passed:

Purchases A/c Dr

To Cash A/c

Correct entry should be:

Furniture A/c Dr

To Cash A/c

Rectification:

Furniture A/c Dr

To Purchases A/c

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C. Errors of Principle

Incorrect application of accounting principles.

Errors of principle occur when accounting rules

are violated. This usually happens when a

capital item is treated as revenue or vice-versa.

Example: Treating purchase of machinery as an expense.

Rectification: Reverse incorrect entry + pass correct entry.

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Example: Treating capital expenditure as revenue expenditure

1.Wages paid for installation of machinery ₹5,000 is entered as Wages Expense.

Wrong treatment:

Wages A/c Dr 5,000

To Cash A/c

Correct treatment:

Machinery A/c Dr 5,000

To Cash A/c

Rectification Entry:

Machinery A/c Dr 5,000

To Wages A/c 5,000

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2. Treating revenue expenditure as capital expenditure

Example: Repairs to building ₹3,000 posted to Building A/c.

Wrong:

Building A/c Dr

To Cash A/c

Correct:

Repairs A/c Dr

To Cash A/c

Rectification:

Repairs A/c Dr 3,000  

To Building A/c 3,000

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D. Compensating Errors

Two or more errors cancel each other.

Example: Under-casting purchases by ₹1,000 and under-casting sales by ₹1,000.

Rectification:

Identify and correct each error separately.

Example : Amount received from Raj ₹2,500 posted to Ram**

Rectification entry:

Ram A/c Dr 2,500

To Raj A/c 2,500

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How to Identify Errors in Accounting

Identifying errors in accounting becomes easy when you know where to look and what symptoms to check:

Errors may appear in trial balance, ledger, subsidiary books, or when balances do not match expected results.

1. Check the Trial Balance

If the trial balance does not tally, it signals an error such as:

Clerical or arithmetic errors

• Wrong casting (addition error)
• Wrong balance carried forward
• Wrong posting amount
• Amount posted on the wrong side (debit instead of credit)

Compare ledger balances with trial balance.

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2. Check for Suspense Account

If a Suspense A/c appears, it means:

✔ Difference between debit and credit sides

✔ Some errors are still not located

✔ Commonly due to partial posting or wrong totals

Use it as a clue to check ledger entries on both sides.

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3. Compare Journal Entries With Ledgers

Trace transactions from: Source documents:

✔ Journal →

✔ Ledger →

✔ Trial Balance

This helps find: Errors of posting, Errors of duplication, Errors of omission

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4. Look for Logical Mismatches

These are errors of principle.

Examples of logical mismatch:

• Machinery repairs posted to Machinery A/c instead of Repairs
• Capital and revenue items interchanged
• Personal expenses posted as business expenses

If the transaction does not follow accounting rules, it is an error.

5. Cross-check Subsidiary Books:

Check: Sales book, Purchase book, Cash book, Journal proper

You can identify: Wrong totals, Wrong postings to customer/supplier

Missed transactions

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6. Check Ledger Balances for Unusual Figures

Sometimes errors show through unusual balances:

Examples:

• Debtors unusually low → sales omitted
• Creditors too high → payment missed
• Cash balance negative → error in cash book

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7. Look for Non-matching Items

Compare: Bank statement vs. cash book (Bank Reconciliation), Inventory records vs. stock register, Fixed assets register vs. ledger. Differences show possible errors.

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8. Check for Suspicious Patterns:

Some errors appear as:

• Same amount added multiple times
• An exact multiple difference (₹100, ₹500, ₹1,000)
• Reversed digits (e.g., 540 recorded as 450)
• Exact mistaken posting (same amount on wrong account)

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9. Analyze When Trial Balance Tallies but Errors Exist

Even if trial balance matches, errors may still exist:

These include: Error of omission, Error of commission, Error of principle, Compensating error

Tip: Trial balance tallying does not mean “no error”; it just means debit = credit.

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Summary Table: How to Identify Each Error

Systems of Accounting

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Single Entry & Double Entry System

Single Entry & Double Entry System

• The Single Entry System is an incomplete and unscientific method of accounting in which a business does not record all types of accounts. Only cash transactions and personal accounts (customers & suppliers) are generally recorded.

Imagine a small kirana shop owner who:

• Writes only cash received and cash paid in a notebook
• Maintains lists of customers who owe money
• Does not prepare proper ledger accounts, trial balance, or balance sheet
• Does not record transactions like depreciation, purchases return, outstanding expenses, etc.

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Features of Single Entry System

• No uniformity
• Lacks accuracy
• Difficult to detect errors and fraud
• Not suitable for large organizations

Double Entry System

• The Double Entry System is a scientific and complete method of accounting where every transaction has two equal and opposite effects:

✔ One account is Debited

✔ Another account is Credited

This system follows the rule:

Debit = Credit

• Because two aspects are recorded, the accounting records become accurate, reliable, and complete.

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Features of Double Entry System

• Accurate and reliable
• Trial balance can be prepared
• Helps in detecting errors
• Suitable for all types of businesses

Differences

Single entry system-Accounts

Methods to ascertain Profit

🡪Statement of Affairs Method (Capital Comparison Method)

🡪Conversion Method (Preparing Final Accounts from Incomplete Records)

Statements of P(or)L Vs. P &L A/c

Statement of Affairs Vs. Balance sheet

Procedure to Calculate Profit

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