Introduction to Accounting

Accounting is one of the fastest-growing profession and is amount the most popular
fields of study in colleges, universities and business schools. Accounting offers interesting,
challenging and rewarding careers.

Meaning of Accounting
It is common experience of all of us that money must be spent carefully. If a person is
careless in spending money, a day will come when he will be left with no money. Same is true
for a business firm.
In business numerous transactions take place everday. It is humanly impossible to remember
all of them. Hence, it is necessary to record them. The recording of Business transaction is the
main function served by Accounting. Accounting is rightly termed as the language of business.
With the help of accounting records, the business person is able to ascertain the profit or loss
for the specified period and the financial position of his business on given specified date and
communicate such information to all interested parties. The accounting information is useful
both for the management and the outside agencies like Tax Authorities, Banks, and Creditor
etc. The management needs it for the purpose of planning, controlling and decision-making.
The Banks and Creditors require it for assessing the credit worthiness of the business and the
tax authorities use it for determining the amount of Income Tax, Sales Tax etc. In fact,
accounting is necessary not only for business organization but also for non-business
organizations like schools, colleges, hospitals etc.

Definition of Accounting
In the words of Committee on terminology, appointed by the American Institute of
Certified Public Accountants,

“Accounting is the art of recording, classifying and summarizing in a significant

manner and in terms of money, transactions and events which are in part at least, of a
financial character and interpreting the results thereof.”
This is the popular definition of accounting and it outlines fully the nature and scope of
accounting activity.
1. Recording of transactions.
This is done in the book termed as “JOURNAL”.
2. Classifying the transactions.
This is done in the book termed as “LEDGER”.
3. Summarising the transactions.
This includes preparation of Trial Balance, Profit & Loss Account and Balance Sheet
of the Business.
4. Interpreting the results.
This involves computation of various accounting ratios etc. to know about the
liquidity, solvency and profitability of business.

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Scope of Accounting.
The scope of accounting can be outlined as follows.
1. Accounting is concerned with the transactions and events which are of a financial
character. Such transactions have to be identified by the accountant. He can do so with
the help of various bills and receipts.
2. The transactions should be measured or expressed in terms of money.
3. The transactions identified and measured are to be recorded in a book called
“JOURNAL”.
4. The recorded transactions have to be classified in order to group transactions of similar
nature at one place. This work is done in a separate book called “LEDGER”. In the
Ledger a separate account is opened for each group of transactions of similar nature so
that all transactions relating to it can be brought at one place.
5. To verify the arithmetical accuracy of the data, a summary of all the ledger accounts is
being prepared. This is known as TRIAL BALANCE.
6. To make the summarised data more meaningful and to assess the performance of the
business firm at the end of particular period an account known as “ PROFIT & LOSS
ACCOUNT “ is being prepared. Also to ascertain the financial position of the business
firm on a particular point of time, a statement of affairs known as “ BALANCE
SHEET “ is being prepared.
7. To help the management in taking effective decisions and to help in making business
more profitable, the financial statements (PROFIT & LOSS A/C AND BALANCE
SHEET) are being analysed and interpreted with the statistical tools like ratios,
averages, etc.

Advantages of Accounting
1. Replaces Memory.
Since all the financial events and transactions are recorded in the books, there is no
need to rely on memory. The books of accounts will serve as historical records. Any
information required at any time can be easily traced from these records.
2. Provides Control over Assets.
Accounting provides information regarding all the assets such as cash in hand, cash at
bank, the stock of goods, the amounts receivable from various parties, the amounts
invested in various other assets etc. Information about such matters help the owners
and the management to have better control over the assets and also helps them to make
use of the assets in the best possible way
3. Facilitates the preparation of Financial Statements.
The business person is always interested in assessing the performance of the business
and in ascertaining the financial position of his business at the end of a particular
period. With the help of information contained in the accounting records the profit and
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 loss account and Balance Sheet can be easily prepared which in turn will help in
assessment of the performance of a business firm.
4. Works as information Tool.
Various interested parties such as owners, lenders, creditors etc. can have necessary
information at desired intervals to equip them in taking better decisions.
5. Intra Firm comparison & Inter Firm comparison.
With the help of accounting information, it becomes possible to compare the present
performance of the business firm with its past performance. It also becomes possible to
compare the performance of the business firm with other business firms of similar type.
These comparisons assist the management and the owner to gear up the business
operations for better. It also helps them in taking effective decisions in planning and
controlling all business activities.
6. Works as safeguard against possible Fraud and/or Theft.
Recorded accounting transactions make it possible to verify arithmetical accuracy
which in turn works as moral barries for the persons having malafied intentions of
committing fraud. Thus the accounting works as safeguard against frauds and thefts. In
large organisation the book-keeping work can be divided amongst many persons which
minimize the chances of frauds.
7. Ascertaining value of Business.
The accounting records will help in ascertaining the correct value of business in the
event of sale of the entire business.
8. Acts as Reliable Evidence.
Systematic record of business transactions is generally treated as good evidence in
Court of Law in case of disputes.
9. Tax matters.
Properly maintained accounting records helps in preparation of tax statements and also
helps in explaining the queries raised by the tax authorities.

Limitations of Accounting
1. The transactions and events which are not of financial character are not being
recorded. Facts like quality of human resources, licences possessed, location
advantages, business contacts etc. do not find place in the books of accounts. Thus
accounting does not provide complete picture of the business.
2. The recorded data is always historic in nature. It always depicts historical value of all
assets and liabilities for the business firm. In inflationary trend, to have better idea of
the state of affairs of the business, the current values of the assets and liabilities are
more relevant. Thus to this extent the accounting does not provide relevant
information.
3. Facts recorded in the financial statements are greatly influenced by accounting
conventions and personal judgments. Decisions taken on the basis of such information
may not prove to be as effective as it should be.

Users of Financial Accounting Information

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Investors, Suppliers / Creditors, Money Lenders / Bank, Employees, Customers, Government
and Regulatory Services, Public, Management, Security Analysis and Advisors.

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Methods & Systems of Book-keeping.
Generally, one of the following three methods of book-keeping is being followed.
Deshi-Nama System
It is one of the methods of Book-keeping followed in India. About 90 % of the
businesses are using this method for preparing their books of accounts. This method is very
simple less expensive and suitable to all business entities. Under this method two important
books are maintained. i.e. (a) Rojmel and (b) Khatavahi.

Double Entry System of Book-keeping

It is a method which has its origin in Europe. Though it is costlier compared to Deshi
Nama System and requires skilled man-power, because it is a scientific and complete method,
more and more business firms are now a days following this method.
In this method, the transactions are recorded as per the "RULES OF DEBIT AND
CREDIT". In Double Entry Accounting system every business transaction has a two fold
effect. The receiving aspect and the giving aspect. Thus, in commercial context it is a famous
dictum that
“Every receiver is also a giver and every giver is also a receiver.”
Single Entry System
It is an incomplete form of double entry system of book-keeping. Under this method
only one aspect of the transactions is being recorded and so it is known as “ SINGLE ENTRY
SYSTEM “. It is in fact a defective and incomplete method because it does not provide all the
information of the business. If one who is following this system wants to prepare final
accounts, first of all he will have to find out missing information, then only he can proceed
further.

Branches of Accounting
Accounting has three main branches, viz., Financial Accounting, Cost Accounting, and
Management Accounting. These branches of accounting have been developed to serve
different objectives.
Financial Accounting
In the words of Committee on terminology, appointed by the American Institute of
Certified Public Accountants,
“Accounting is the art of recording, classifying and summarizing in a significant
manner and in terms of money, transactions and events which are in part at least, of a
financial character and interpreting the results thereof.”
Financial Accounting is primarily concerned with record keeping directed towards the
preparation of Profit and Loss Account and Balance Sheet.
The main purposes of financial accounting are:
1. Recording of the transactions concerning and affecting the business;
2. Preparation of necessary accounts and balance sheet as required by statutes;
3. Apprising the owners of the business about the results of the business over a period
of time.

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 Financial accounting is the accounting for revenues, expenses, assets and liabilities that
is commonly carried on in the general office of a business. It is a term often limited to the
accounting concerned with published financial reports in contrast to internal aspects of
accounting such as cost accounting.

Cost Accounting
Cost Accounting is the process of ascertaining cost from the point at which
expenditure is incurred or committed to the establishment of its ultimate relationship with cost
centre and cost units. It is the process of accounting for costs. It is a systematic procedure for
determining the unit cost of output produced or services rendered. Its Primary functions are to
ascertain the cost of product and to help the management in the control of cost. So, this
branch deals with the classification, recording, allocation, summarization and reporting of
current and prospective costs.

Management Accounting
“Such of its techniques and procedures by which accounting mainly seeks to aid the
management collectively have come to be known as Management Accounting.”
- The Institute of Chartered Accountants of India
Management is primarily concerned with the supply of information which is useful to
management in decision making for the efficient running of the business and, thus, in
maximizing profit. Management Accounting is the reproduction final accounts in such a way
as will enable the management to take decisions and to control activities.
Management Accounting is the term used to describe the accounting methods, systems
and techniques which coupled with special knowledge and ability, assist management in its
task of maximizing profit or minimizing losses.
So, it is the blending together into a coherent whole, Financial Accounting, Cost
Accounting and all aspects of financial management.

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Basic Accounting Terms

In order to understand the subject matter clearly, one must grasp the following common
expressions always used in business accounting. The aim here is to enable the student with these
often used concepts before we embark on accounting procedures and rules. You may note that
these terms can be applied to any business activity with the same connotation. Please study
them carefully.

(1) Transaction: It means a business activity which involves exchange of money or money’s
worth between parties. E.g. purchase of goods would involve receiving material and making
payment or creating an obligation to pay to the supplier at a future date. Transaction could be a
cash transaction or credit transaction. When the parties settle the transaction immediately by
effecting payment in cash or by cheque, it is called a cash transaction. In credit transaction, the
payment is settled at a future date as per
agreement between the parties.

(2) Goods: These are things of article or commodity in which a business deals. These articles or
commodities are either bought and sold or produced and sold. E.g. A grocer will buy and sell
grocery items or a pharmaceutical company will manufacture a drug and sell it. At times, what
may be classified as ‘goods’ to one business firm may not be ‘goods’ to the other firm. E.g. for a
machine manufacturing company, the machines are ‘goods’ as they are frequently made and
sold. But for the buying firm, it is not ‘goods’ as the intention is to use it as resource and not sell
it. This subtle difference must be carefully understood.

(3) Profit: The excess of Income over expenditure is called profit. It could be calculated for
each transaction or for business as a whole.

(4) Loss: The excess of expenditure over income is called Loss. It could be calculated for each
transaction or for business as a whole.

(5) Asset: Asset is a resource owned by the business with the purpose of using it for generating
future profits. It could be tangible resource like land, building, factory, machinery & equipment,
computers and vehicles. It could be intangible asset like brand value, copy right, patents &
trademarks and goodwill. These assets are held for relatively longer period and are called as
Fixed Assets. The intention of holding such assets is not to sell them but to make best possible
use to earn profits during the working life of the assets. While there are other assets held by the
business for relatively shorter period, which are called as Current Assets. E.g. stock of goods is
held with the purpose of selling, cash is held for making payments for services or goods.
Understanding the concepts of Fixed and Current Assets is important as you will notice a
separate accounting treatment is required for them.

(6) Liability: It is an obligation of financial nature to be settled at a future date. It represents

amount of money that the business owes to the other parties. E.g. when goods are bought on
credit, the firm will create an obligation to pay to the supplier the price of goods on an agreed
future date or when a loan is taken from bank, an obligation to pay interest and principal
amount is created. Depending upon the period of holding, these obligations could be further
classified into Long Term liabilities and Short Term or current liabilities. A credit purchase of
goods on 60 day credit will be a short term liability or the salary
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payable to the staff is a short term liability. A seven year term loan would be a long term liability.
The difference between the two is important from the disclosure point of view.

(7) Contingent Liability: It represents a potential obligation that could be created depending
on the outcome of an event. E.g. if supplier of the business files a legal suit, it will not be treated
as a liability because no obligation is created immediately. If the verdict of the case is given in
favour of the supplier then only the obligation is created. Till that it is treated as a contingent
liability. Please note that contingent liability is not recorded in books of account, but disclosed
by way of a note to the financial statements.

(8) Capital: It is amount invested in the business by its owners. It may be in the form of cash,
goods, or any other asset which the proprietor or partners of business invest in the business
activity. From business point of view capital of owners is a liability which is to be settled only in
the event of closure or transfer of the business. Hence, it is not classified as a normal liability.
For corporate bodies capital is normally represented as share capital.
A8
(9) Drawings: It represents an amount of cash, goods or any other assets which the owner
withdraws from business for his or her personal use. E.g. if the life insurance premium of
proprietor or a partner of business is paid from the business cash, it is called drawings. Drawings
will result in reduction in the owners’ capital. The concept of drawing is not applicable to the
corporate bodies like limited companies.

(10)Net worth: It represents excess of total Assets over total liabilities of the business.
Technically, this amount is available to be distributed to owners in the event of closure of the
business after satisfying all liabilities. That is why it is also termed as Owner’s equity. A profit
making business will result in increase in the owner’s equity whereas losses will reduce it.

(11)Debtor: A debtor is a person who owes money or money’s worth to the business. The
money receivable from customers against supply of goods is called trade debtors or trade
receivables. The money recoverable for transaction other than for sale of goods is called
‘Amount receivable”. E.g. a travel advance given to the employee that is recoverable will be
classified as “Other Receivable” or “Amount Receivable”. Receivables are generally classified as
current asset.

(12)Creditor: A creditor is a person to whom the business owes money or money’s worth. e.g.
money payable to supplier of goods or provider of service. Creditors are generally classified as
Current liabilities.

(13)Capital Expenditure: This represents expenditure incurred for the purpose of acquiring a
fixed asset which is intended to be used over long term for earning profits there from. E. g.
amount paid to buy a computer for office use is a capital expenditure. At times expenditure may
be incurred for enhancing the production capacity of the machine. This also will be capital
expenditure. Capital expenditure forms part of the Balance Sheet.

(14)Revenue expenditure: This represents expenditure incurred to earn revenue of the current
period. The benefits of revenue expenses get exhausted in the year of the incurrence. E.g.
repairs, insurance, salary & wages to employees, travel etc. The revenue expenditure results in
reduction in revenue. It forms part of the Income statement.
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(15)Deferred Revenue Expenditure: When benefits of a revenue expense extend beyond an
accounting year, it is called deferred revenue expenditure. E.g. if a company incurs expenditure
of Rs 10 lacs on advertising campaign for a new product. This campaign is expected to benefit
the marketing of this new product for 3 to 4 years. This will be charged against the income for
those 3 or 4 years. Accordingly, in the current year only one-third or one-fourth of Rs 10 lacs
will be charged against the current year revenues. The deferred portion of this expenditure is
reflected in the balance sheet.

(16)Balance Sheet: It is the statement of financial position of the business entity as of a

particular date. It lists all assets, liabilities and capital in a particular way as explained later. It is
important to note that this statement exhibits the state of affairs of the business as on a
particular date only. It describes what the business owns and what the business owes to
outsiders (this denotes liabilities) and to the owners (this denotes capital). It is prepared after
incorporating the results of Income statement.
(17)Profit and Loss Account or Income Statement: This account shows the revenue earned
the business and the expenses incurred by the business to earn that revenue. This is prepared
usually for a particular accounting period, which could be a quarter, a half year or a year. The net
result of the Profit and Loss Account will show profit earned or loss made by the business
entity.

(18)Trade Discount: It is the discount usually allowed by the wholesaler to the retailer
computed on the list price or invoice price. E.g. the list price a TV set could be Rs 15000. The
wholesaler may allow 20% discount thereof to the retailer. This means the retailer will get it for
Rs 12000/- and is expected to sale it to final customer at the list price. Thus the trade discount
enables the retailer to make profit by selling at the list price. Trade discount is never entered in
the books of accounts. The transactions are recorded at net values only. In above example, the
transaction will be recorded at Rs 12000/- only.

(19)Cash Discount: This is allowed to encourage prompt payment by the debtor. This has to
be entered in the books of accounts. This is calculated after deducting the trade discount. E.g. if
list price is Rs 15000/- on which a trade discount of 20% and cash discount of 2% apply, then
first trade discount of Rs 3000/- (20% of Rs 15000/-) will be deducted and the cash discount of
2% will be calculated on Rs 12000/- (Rs15000 – Rs 3000). Hence the cash discount will be Rs
240/- (2% of Rs 12000/-) You will find repetitive use of these terminologies all along and hence
must grasp them thoroughly. Let us see if we can apply these in the following examples.

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MEANING OF JOURNAL AND JOURNALISING.
A Journal is a book in which the transactions are recorded in the order in which they
occur, i.e. in chronological order. It is called a book of prime entry (also original entry)
because all business transactions are entered first in this book. The process of recording a
transaction in the Journal is called “Journalising”. An entry made in the Journal is called a
‘Journal Entry’. A format of a Journal is shown below.

JOURNAL
Date Particulars L.F. Debit Credit
Rs. Rs.

CLASSIFICATION OF ACCOUNTS AND RULES OF DEBIT AND CREDIT

An account is a summary of relevant transactions at one place relating to a particular
head. It records not only the amount of transaction but also their effect and direction. The
transactions in the journal are recorded on the basis of the rules of debit and credit. For this
purpose business transactions have been classified into three categories.
1. Transactions relating to persons.
2. Transactions relating to properties and assets.
3. Transactions relating to incomes and expenses.
The classification of accounts can be given as under.

Types of account Meaning

1. Personal Accounts These accounts relate to natural persons, artificial persons and
representative persons.
(When some prefix or suffix is added to a Nominal Account, it
becomes Personal Account)
2. Real Accounts These accounts relate to the tangible or intangible real assets.
3. Nominal Accounts These accounts relate to expenses, losses, profit & gains.

Thus, three classes of accounts are maintained for recording all business transactions.
They are (1) Personal accounts, (2) Real accounts and (3) Nominal accounts.

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 Basically, debit means to enter an amount on the left side of an account and credit
means to enter an amount on the right side of an account. In the abbreviated form Dr. stands
for Debit and Cr. stands for Credit. Both debit and credit may represent either increase or
decrease depending upon the nature of an account.
The Rules for Debit and Credit are given below.
Type of Account Rules for Debit Rules for Credit
1. Personal Accounts Debit the receiver Credit the giver
2. Real Accounts Debit what comes in Credit what goes out
3. Nominal Accounts Debit all expenses & losses Credit all gains & profit

Type of Account When to Debit When to Credit

1. Personal Accounts If he receives something from If he gives something to the
the business. business.
2. Real Accounts When asset comes in When assets goes out

3. Nominal Accounts Respective expense or loss Respective income or profit

account is debited. account is credited.

MEANING OF LEDGER
A Ledger is a principal book which contains all the accounts (Assets Accounts,
Liabilities Accounts, Capital Account, Revenue Accounts, Expenses Accounts) to which the
transactions recorded in the books of original entry are transferred. As the Ledger is the
ultimate destination of all transactions, it is called the “BOOK OF FINAL ENTRY”. It is
considered as a permanent record and is frequently referred to. It may be noted that an
account is a formal record of all transactions relating to change in particular item. A Ledger
may be kept in form of bound books, loose leaf sheets, floppy diskettes (in case computer is
used) or any other like device.

POSTING
Posting is the process of transferring transactions recorded in the books of original
entry to the concerned accounts opened in the ledger. It may be daily, weekly, fortnightly, or
monthly according to the convenience and requirements of the business. It is necessary to post
all journal entries into various accounts in the ledger because posting helps us to know the net
effect of various transactions during a given period on a particular account. Posting in the
ledger account is considered complete only when both the debit and credit aspects of all
journal entries have been posted.

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BALANCING
Balance of an account is the difference between the total of debit items and total of
credit items appearing in an account. It signifies the net effect of all transactions posted to that
account during a given period. It may be a debit balance or a credit balance or a nil balance
depending upon whether the debit or the credit total is higher. Normally, personal accounts
and real accounts are balanced. Nominal accounts are not usually balanced but closed by
transfer to Trading, and Profit & Loss Account. Balancing an account is necessary to ascertain
the effect of all transactions posted to that account during a given period.

TRIAL BALANCE
All transactions are first juornalised in the JOURNAL or the SUBSIDIARY BOOKS
where from these entries are transferred to relevant accounts in the ledger. At the end of the
year in order to verify whether the books of accounts are written properly and correctly, trader
prepare a statement which is known as TRIAL BALANCE. It is prepared mostly on the basis
of the balances of various accounts in the ledger.
1. The trial balance is not an account but is a statement.
2. It shows the arithmetical accuracy. The total of debit side must be equal to the
total of credit side. An agreed trial balance is a must for the preparation of final
accounts. Disagreement of trial balance clearly indicates that there are errors.
On the other hand trial balance agrees even when there are errors.
3. This statement is prepared on the basis of all accounts of ledger.
4. This statement is prepared before the preparation of final accounts at the end of
the year. It is link between the ledger and final accounts.

A Trial Balance may be prepared either following Balance Method or Total Amount
Method.

Balance Method:-
Under this method, the balances of all the accounts (including Cash and Bank
Account) in the ledger are incorporated in the trial balance. It may be noted that a trial balance
by this method can be prepared only when all the ledger accounts have been balanced.

Total Amount Method:-

Under this method, the total amount of debit items and credit items in each ledger
account are incorporated in the trail balance. It may be noted that a trial balance by this
method can be prepared immediately after the completion of posting from the books of
original entry to the ledger.

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 BOOK-KEEPING AND ACCOUNTANCY
Book-keeping: Book-keeping is a process of using business transactions in books of
account. It includes entering the transactions in the books of original entry like journal or other
subsidiary books, posting them into the ledger and preparing a trial balance at the end of a
specified period.
Accountancy: Accountancy is something more than book-keeping. It includes
preparing final accounts after the accounts are written, analysing and interpreting them,
rectifying the errors etc. Accountancy is therefore, used at the higher level of management. It
assists the management in taking important policy decisions.

CASH AND CREDIT TRANSACTIONS.

Cash transactions: A transaction in which there is a receipt or payment of cash is a cash
transaction. Cash balance is affected by such transaction.
Credit transactions: In credit transaction, there is no receipt or payment of cash immediately,
but it is postponed to some future date. Cash balance is not affected by such transaction.
1. If the word ‘CASH’ is mentioned in the transaction, it is treated as cash transaction.
2. If the transaction does not mention the word ‘CASH’ but contains only the name of a
person, it is a credit transaction.
3. If the transaction does not indicate ‘CASH’ or ‘CREDIT’, and does not mention the
name of any person, then it must be cash transaction.
4. If in a transaction, the name of any person is mentioned and also cash receipt or
payment is indicated, then it is a cash transaction.

1 Purchase goods Rs. 1000 for cash Cash Transaction

2 Purchase goods Rs. 1000 for cash form Mr. X Cash Transaction
3 Purchase goods Rs. 1000 from Mr. X Credit Transaction
4 Purchase goods Rs. 1000 Cash Transaction

Non-Cash Transactions – Cash / Money is not involved either on the date of transfer or on a
future date (credit) in these transactions. Money / Cash is NEVER involved either as receipt
or payment. (Depreciation, Loss due to natural calamities etc.)

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Types of Accounts
Personal Accounts Real Accounts Nominal Accounts
R. M. Patel Cash Salary, Wages
Patel Brothers Building Office Expenses
Patel & Sons Machinery Selling Expenses
Patel Trading Company Furniture & Fixture Factory Expenses
ONGC Dead Stock Selling Expenses
VNSU Live stock Carriage inward and outward
Prof. S. M. Parikh Goodwill Custom duty
SBI, ICICI, HDFC,BOB Patent Dock charges
Surat Muni Corporation Trade mark Demurrage
Reliance Industries Copy Right Charity Expenses
P P Savani University Investments Stationery & Printing
Gayatri Mandir Trust Purchase Miscellaneous Expenses
Patel Education Trust Sales Rent
Lions Hospital Purchase Return Interest
Capital A/c Sales Return Discount
Drawings Goods withdrawn - personal use Commission
Debtors Goods given as samples Loss by Fire
Creditors Goods destroyed by fire Loss by Rain
Loan Given to X Goods sunk Sample Expenses
Loan Received form X Goods Stolen Royalty
Bills Receivable Laboratory Equipments Insurance Premium
Bills Payable Stationery stock Repairing–Machinery, Build.
Bank overdraft Closing Stock Dividend
Outstanding Salary Computer System Bad Debts
Prepaid Insurance Vehicles Postage–Telegram-Telephone
Rent Received in Advance Technical know how Electricity – Power – Light
Salary paid in Advance Legal Expenses
Rent paid in Advance Bank charges-commission
Income Tax Depreciation
GST Payable Profit/Loss on sale of asset
Reserve for discount on Goods and Service Tax
Creditors and Debtors
Prov. for doubtful debts Adjusted purchase
Personal I T (drawings) Bad debts recovered

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Trade Discount & Cash Discount

Basis of Trade Discount Cash Discount

Distinction
1 Meaning It is a reduction granted by a A reduction granted by a supplier
supplier from the list price of from the invoice price in
goods or services on business consideration of immediate
consideration (such as quantity payment or payment within a
bought, trade practices etc.) other stipulated period.
than for prompt payment.
2 Purpose It is allowed to promote the sales It is allowed to encourage the
or as a trade practice. prompt payment.
3 Time when It is allowed on purchase of It is allowed on immediate
allowed goods. payment or payment within a
specified period.
4 Disclosure in It is shown by way of deduction It is not shown in the invoice.
the Invoice in the invoice itself.
5 Ledger Trade Discount Account is not Cash Discount Account is
Account opened in the ledger. opened in the ledger.
6 Variation It may vary with the quantity It may vary with the period
purchased. within which the payment is
made.

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Journal and Ledger

Journal Ledger
1 Nature of It is book of original or prime It is book of final or secondary
book entry. entry.
2 Basis for It is prepared on the basis of It is prepared on the basis of
Preparation source documents of journal.
transactions.
3 Stage of Recording in the journal in the Recording in the ledger is the
Recording first stage. second stage.
4 Object It is prepared to record all It is prepared to know the net
transactions in chronological effect of various transactions
order. affecting a particular account.
5 Format In journal, there are five column- In ledger there are identical four
-- column on debit side and credit
side---
1. Date
1. Date
2. Particulars
2. Particulars
3. Ledger Folio
3. Folio
4. Debit Amount
4. Amount
5. Credit Amount
6 Balancing Journal is not balanced. All ledger accounts (except
nominal account) are balanced in
the ledger.
7 Narration Narration is written for each No narration is given.
entry.
8 Name of the The process of recording in The process of recording in the
Process of journal is called ledger is called POSTING.
recording JOURNALISING.
entries
9 Basis of Journal directly does not serve Ledger serves the basis for the
Preparation as basis for the preparation of preparation of final accounts.
of Final final accounts.
Accounts

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 Fixed Assets and Current Assets

Fixed Assets Current Assets

1 Purposes of These are the assets which are These are the assets which are held-
holding held for the purpose of --
providing or producing goods 1. in the form of cash
or services and those which
are not held for resale in the 2. for their conversion into
normal course of business. cash
3. for their consumption in the
production of goods or
rendering of services in the
normal course of business
2 Valuation Fixed assets are valued at cost These assets are valued at cost or
less depreciation. net realizable value price whichever
is lower.
The Current Assets are meant for
converting into cash during the
normal operating cycle of business,
hence they are valued on the
principle of “ Cost or Market price
whichever is Less”
3 Subject to These assets are usually not These assets are usually subject to
change subject to change. change.
4 Pledge These assets cannot be These assets can be pledged.
pledged.
5 Fixed vs. Fixed charge can be created on Floating charge can be created on
Floating charge these assets. these assets.
6 Nature of profit Profit on sale of these assets is Profit on sale of these assets is of
on sale of capital nature. revenue nature.
7 Revaluation In case of appreciation in the In case of appreciation in the value
reserve in case value of such assets, of such assets, revaluation reserve
of appreciation revaluation reserve can be cannot be created.
in the value created.
8 Source of These assets are financed out These assets are mainly financed out
finance of long-term funds. of short-term funds.

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Trial Balance and Balance Sheet

Trial Balance Balance Sheet

1 Need for It is prepared to check the It is prepared to know the
Preparation arithmetical accuracy of the financial position of an enterprise
posting of transactions to the at a particular point of time.
ledger.
2 Contents All the ledger accounts are shown The balances of only those ledger
in the Trial Balance. accounts which have not been
closed till the preparation of
Trading and Profit & Loss
Account are shown in the
Balance Sheet.
3 Format The headings of the two columns The headings of the two sides are
are ‘debit balances’ and ‘credit ‘Liabilities’ and ‘Assets’.
balances’ (in case of a Trial
Balance by Balance Method)
4 Closing Stock Generally, the closing stock does In a Balance Sheet, only the
not appear in the Trial Balance closing stock appears on the
whereas the opening stock Assets side as a current assets.
appears.
5 Items of It can be prepared without It cannot be prepared without
Adjustments incorporating the items of incorporating the items of
(e.g., adjustments. adjustments.
Outstanding
Exp., Prepaid
Exp., Accrued
Income, etc.,)
6 Net Profit/ Information about net profit / net Information about net profit /
Net Loss loss is not provided in a Trial loss is provided.
Balance.
7 Periodicity It can be prepared periodically It is generally prepared at the end
(say) at the end of a of an accounting period.
month/quarter/half-year.
8 Can the Its preparation can be dispensed Its preparation cannot be
preparation be with. dispensed with.
dispensed
with?

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Trading and Profit & Loss A/C and Balance Sheet

Trading and Profit & Loss A/C Balance Sheet

1 Need for The Trading and Profit & Loss A/c The Balance Sheet is prepared to
Preparation is prepared to ascertain the results know the financial position of an
of business operations during an enterprise at a particular time.
accounting period.
2 Contents The balances of all the ledger The balance of only those ledger
accounts of revenue nature are accounts which have not been
shown in the Trading and Profit & closed till the preparation of
Loss Trading and Profit & Loss A/c,
A/c. are shown in the Balance Sheet.
3 Format The Trading & Profit and Loss A/c The Balance Sheet is only a
is a ledger account. It has debit side statement and not an account. It
and a credit side. It is closed by has no debit side and credit side.
transferring its balance to the The headings of the two sides are
Capital Account. ‘Liabilities’ and ‘Assets’.

Difference between Book-keeping and Accounting

Book-keeping Accounting
1 Scope Book-keeping involves Accounting in addition to book-
keeping involves
1. identifying the transaction
Summarizing the classified Tr.,
2. Measuring the identified Tr.
analyzing the summarized results,
3. Recording the measured Tr. interpreting the analyzed results and
4. classifying the recorded Tr. communicating the interpreted
information to the interested
parties.
2 Stage Book-keeping is primary stage. Accounting is the secondary stage.
It starts where book-keeping ends.
3 Objective The basis objective of Book-keeping The basis objective of accounting is
is to maintain systematic records of to ascertain net results of
financial transaction. operations and financial position
and to communicate information to
the interested parties.
4 Who Book-keeping work is performed by Accounting work is performed by
performs junior staff. senior staff.
5 Knowledge The book-keeper is not required to The accountant is required to have
level have higher level of knowledge that higher level of knowledge than that
of an accountant. of book-keeper.
6 Analytical The book-keeper may or may not An accountant is required to posses
skill possess analytical skill. analytical skill.
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7 Nature of The job of a book-keeper is often The job of an accountant is
job routine and clerical in nature. analytical in nature.
8 Designing It does not cover designing of It covers designing of accounting
of A/c accounting system. system.
system
9 Supervision The book-keeper does not supervise An accountant supervises and
& and check the work of an checks the work of a book-keeper.
Checking accountant.

 At the year end, only Nominal Accounts are closed. Real Accounts and Personal
Accounts are not closed. They are only balance.
 Petty Cash Book is maintained on Imprest System.

Mr. X has prepared the following notes from the vouchers of his business transaction for June
20xx. State the accounts to be debited and credited as per the rules of debit and credit.

1 Started business with cash Rs. 100000.

2. A loan of Rs 15000 received from Mr. F.
3. Deposited Rs. 5000 in the Current account with Bank of India
4. Purchased goods for Rs. 25000.
5. Sold goods of Rs. 5000 for cash.
6. Purchased goods of Rs. 5000 for cash from Mr. Y.
7. Purchased goods of Rs. 6000 from Mr. J.
8. Purchased goods of Rs. 4000 from Mr. C. on credit.
9. Sold goods of Rs. 2000.
10. Sold goods of Rs. 1000 to Ms. S. for Cash.
11. Sold goods of Rs. 2200 to Mr. R. and Sold goods of Rs. 5000 to Mr. N. on Credit.
12. Goods of Rs. 1000 returned by Mr. R. Goods of Rs 500 returned to Mr. J.
13. Wages paid Rs. 1000.
14. Insurance premium of the shop Rs. 300 is paid by cheque.
15. Commission received Rs. 500.
16. Loan of Rs. 5000 given to Mr. G.
17. Paid Rs. 750 to Mr. J.
18. A cheque for Rs. 1000 received from Mr. R.
19. Mr. N has paid Rs. 500 on our behalf to to Mr. C.
20. Purchased Furniture of Rs.5000.
21. A piece of land of Rs. 10000 was given by the proprietor for the business.
22. Furniture worth Rs.200 was sold at cost.
23. Purchased Machinery of Rs.50000.
24. Purchased a Cycle of Rs.1500.
25. Purchased stationery of Rs.500.
26. Withdrawn Rs.2000 from the business for personal use.
27. Paid house rent (for residence) Rs.500.
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28. A table of Rs.500 purchased by exchanging goods.
29. Goods of Rs.500 distributed as samples.
30. Withdrawn Rs.1000 from the current account of Bank of India.
31. Rs.5000 given to Mr. F against loan account.
31. Bank of India has debited a service charge of Rs.20 in our account.

Tr. Name of the A/c Type of the Reason for Debiting Debit/ Amount
No. Account And Crediting Credit Rs.
1 Cash A/c Real A/c Cash comes in Debit 100000
Capital A/c Personal A/c Proprietor is giver Credit 100000
2 Cash A/c Real A/c Cash comes in Debit 15000
Loan of Mr. F Personal A/c Mr. F is giver Credit 15000
3 Bank of India A/c Personal A/c Bank is receiver Debit 5000
Cash A/c Real A/c Cash goes out Credit 5000
4 Purchases A/c Real A/c Goods comes in Debit 25000
Cash A/c Real A/c Cash goes out Credit 25000
5 Cash A/c Real A/c Cash comes in Debit 5000
Sales A/c Real A/c Goods goes out - Sales Credit 5000
6 Purchase A/c Real A/c Goods comes in Debit 5000
Cash A/c Real A/c Cash goes out Credit 5000
7 Purchase A/c Real A/c Goods comes in Debit 6000
Mr. J. A/c Personal A/c Mr. J. is giver Credit 6000
8 Purchase A/c Real A/c Goods comes in Debit 4000
Mr. C. A/c Personal A/c Mr. C. is giver Credit 4000
9 Cash A/c Real A/c Cash comes in Debit 2000
Sales A/c Real A/c Goods goes out Credit 2000
10 Cash A/c Real A/c Cash comes in Debit 1000
Sales A/c Real A/c Goods goes out credit 1000
11 Mr. R. A/c Personal A/c Mr. R is receiver debit 2200
Sales A/c Real A/c Goods goes out credit 2200
11 Mr. N. A/c Personal A/c Mr. N. is receiver debit 5000
Sales A/c Real A/c Goods goes out credit 5000
12 Sales Return A/c Real A/c Goods comes in debit 1000
Mr. R. A/c Personal A/c Mr. R. is giver credit 1000
12 Mr. J. A/c Personal A/c Mr. J. is receiver debit 500
Purchase Return A/c Real A/c Goods goes out credit 500
Page 21 of 26
13 Wages A/c Nominal A/c Expenses are incurred debit 1000
Cash A/c Real A/c Cash goes out credit 1000
14 Insurance Prem. A/c Nominal A/c Expenses are incurred debit 300
Bank of India Personal A/c Bank is the giver credit 300
15 Cash A/c Real A/c Cash comes in debit 500
Commission A/c Nominal A/c Income received credit 500
16 Mr. G. Loan A/c Personal A/c Mr. G is receiver debit 5000
Cash A/c Real A/c Cash goes out credit 5000
17 Mr. J. A/c Personal A/c Mr. J is receiver debit 750
Cash A/c Real A/c Cash goes out credit 750
18 Bank A/c Personal A/c Bank is receiver debit 1000
Mr. R. A/c Personal A/c Mr. R. is giver credit 1000
19 Mr. C. A/c Personal A/c Mr. C. is receiver debit 500
Mr. N. A/c Personal A/c Mr. N. is giver credit 500
20 Furniture A/c Real A/c Furniture comes in debit 5000
Cash A/c Real A/c Cash goes out credit 5000
21 Land a/c Real A/c Land comes in debit 10000
Capital A/c Personal A/c Owner is the giver credit 10000
22 Cash A/c Real A/c Cash comes in debit 200
Furniture A/c Real A/c Furniture goes out credit 200
23 Machinery A/c Real A/c Machinery comes in debit 50000
Cash A/c Real A/c Cash goes out credit 50000
24 Vehicle A/c Real A/c Cycle comes in debit 1500
Cash A/c Real A/c Cash goes out credit 1500
25 Stationery A/c Nominal A/c Expenses incurred debit 500
Cash A/c Real A/c Cash goes out credit 500
26 Drawings A/c Personal A/c Owner is the receiver debit 2000
Cash A/c Real A/c Cash goes out credit 2000
27 Drawing A/c Personal A/c Owner is receiver debit 500
Cash A/c Real A/c Cash goes out credit 500
28 Furniture A/c Real A/c Furniture comes in debit 500
Sales A/c Real A/c Goods goes out credit 500
29 Sample Exp. A/c Nominal A/c Exp. Incurred debit 500
Goods Given as Real A/c Goods goes out credit 500
Samples A/c
30 Cash A/c Real A/c Cash comes in debit 1000
Bank of India Personal A/c bank is giver credit 1000
31 Mr. F. Loan A/c Personal A/c Mr. F. is receiver debit 5000
Cash A/c Real A/c Cash goes out credit 5000
31 Bank Charges A/c Nominal A/c Exp. incurred debit 20
Bank of India Personal A/c Bank is giver as credit 20
services provided by
bank

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While preparing a Trial Balance from a given balances, please note that
1. All accounts of expenses (including purchases and losses) will be debit
balances.
2. All accounts of incomes (including sales and gains) will be credit balances.
3. All accounts of assets will be debit balances.
4. All accounts of liabilities will be credit balances.
5. Capital a/c will normally be credit balance.
6. Drawings a/c will be debit balance.
7. Rent, Discount, Commission, and Interest is usually indicated by mentioning
Dr. or Cr. Against each item OR the word ‘received’ or ‘paid’ is written after
each item.

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 TABLE OF ADJUSTMENTS
T = Trading a/c, P & L = Profit & Loss a/c B/S = Balance Sheet Dr. = Debit
Cr.= Credit
Sr. Adjustment Adjustment Entry Effects on Final
No Accounts
1. Closing Stock Closing Stock a/c Dr Shown on Cr. side of T.
To Trading a/c Shown on Assets side of B/S.
2. Outstanding Expenses a/c Dr Shown on Dr. side of T. or P & L by add
Exp. to respective a/c.
To Outstanding Exp. a/c Shown on the liability side of B/S
3. Prepaid Exp. Prepaid Exp. a/c Dr Deducted from the exp. concerned on
debit side of profit and loss a/c.
To Exp. A/c Shown on the assets side of B/S.
4. Outstanding Outstanding Income a/c Dr Shown on credit side of P & L a/c, by
Income adding it to respective income account.
To Income a/c Shown on the assets side of balance
sheet.
5. Income received Income a/c Dr Deducted from the concerned income on
in advance To Income received in Cr. Side of P & L a/c.
Advance a/c. Shown on the liabilities side of B/S.
6. Depreciation on Depreciation a/c Dr Shown on the debit side of P & L a/c.
Assets. To Asset a/c. Deducted from the concerned assets on
assets side B/S.
7. Interest on Interest on Capital a/c Dr Shown on the debit side of P & L a/c
Capital To Capital a/c Added to the Capital a/c on the liabilities
side of B/S.
8. Interest on Drawing a/c Dr Shown on the credit side of P & L a/c
Drawings To interest on Drawing Added to the Drawings deducted from
Capital a/c on liabilities side of B/S.
9. Bad Debts Bad debts a/c Dr Shown on the debit side of P & L a/c.
Written off added to Bad debts a/c.
To Debtors a/c. Deducted from debtors on the assets side
of B/S.
10. Provision for P & L a/c. Dr Shown on the debit side of P & L a/c.
Doubtful Debts To provision for discount Deducted from the debtors a/c on the
reserve on debtors a/c. assets side of B/S.
11. Provision for P & L a/c. Dr Shown on the Dr. side of P & L a/c.
discount reserve To Provision for discount Deducted from the debtors a/c. On the
on debtors assets side of B/S.
Reserve on debtors a/c.
12. When credit Purchase a/c. Dr On the debit side of T. It will be added
purchase was to purchases.

Page 24 of 26
 omitted to be To Creditors a/c In the balance sheet on the liabilities side
recorded it will be added to creditors.

13. When credit Debtors a/c. Dr On the credit side of T. It will be added
sales was To Sales a/c. to sales.
omitted to be In the B/S on the assets side, it will be
recorded added to debtors.
14. Unrecorded Creditors a/c Dr Deducted from the purchases in the T.
purchases To Purchase Ret. A/c In the B/S on the liabilities side it will be
returned deducted from the creditors.
15. Unrecorded Sales returned a/c. Deducted from the sales in the T.
sales returned Dr In the B/S on the assets side it will be
To Debtors a/c. deducted from the debtors.
16. Goods gone in Ins. Co. a/c On the credit side of T will be shown the
(I) other way e.g. Dr cost price of goods burnt.
goods burnt by Loss by fire is shown on the debit side of
fire when the
Loss by fire a/c P & L a/c.
insurance co.
Dr The amount of claim admitted by
has admitted
Insurance Co. will be shown on assets
claim for lesser
side of B/S.
amount To goods burnt by fire a/c.
(II) Goods taken by Drawing a/c. Dr The B/S if will be added to drawings.
personal use is To Goods withdrawn a/c The cost price of goods withdrawn will
unrecorded. be shown on credit side of T.
(III) Goods Advertisement a/c. Dr Advertisement expense. It will be
distributed as debited in P & L account.
samples for Goods distributed for advertisement, it
To Goods distributed for
advertisement. will be credited in T.
advertisement a/c.
(IV Goods stolen Loss by Theft a/c Dr Loss by stolen account, it will be debited
) in P & L a/c.
To Goods stolen a/c Goods stolen a/c. It will be credited in T
(V) Goods given as Charity Exp. Dr Charity a/c. as an exp. it will be debited
charity in P & L a/c.
To Goods given as charity Goods given as charity a/c. it will be
credited in T.

Page 25 of 26
 TREATMENT OF ADJUSTMENTS ITEMS INSIDE THE TRIAL BALANCE
If any item of adjustment appears in the Trial Balance, it will be shown only at the appropriate
place in the final accounts. The following table shows how each item of adjustment will be
treated if given in the Trial Balance.
Item given in Trial Balance Treatment in Profit & Loss a/c Treatment in Balance Sheet
or Other Account
Closing stock X Shown on the Assets side as a
Current Asset
(b) Outstanding Expense X Shown on the Liabilities side as
a Current Liabilities
Shown on the Assets side as a
(c) Prepaid Expense X Current Asset
Shown on the Assets side as a
(d) Accrued Income X Current Asset
Shown on the Liabilities side as
Unearned Income X a Current Liabilities
X
Depreciation Shown on the debit side of P &
L a/c as a separate item X
Bad Debts if no Provision for Shown on the debit side of P &
Bad & Doubtful Debts a/c L a/c as a separate item
appears
X
Bad Debts if Provision for Bad Shown on the debit side of
& Doubtful Debts a/c Provision for Bad & Doubtful
appears Debts a/c
Discount allowed if no Shown on the debit side of P & X
Provision for Discount on L a/c as a separate item
Debtors a/c appears
Discount allowed if Provision Shown on the debit side of X
for Discount on Debtors Provision for Discount on
a/c appears Debtors a/c
Discount received if no Shown on the credit side of P &
Reserve for Discount on L a/c X
Creditors a/c appears
Discount received if Reserve
for Discount on Creditors Shown on the credit side of
Reserve for Discount on X
a/c appears
Creditors a/c
Interest on Capital
Shown on the debit side of P &
L a/c as a separate item
X
(n) Interest on Drawings Shown on the debit side of P &
L a/c as a separate item
X

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