Financial Accounting for Online

ABF 103

[Financial Accounting]

[ACeL]

In business, however, it is a more serious matter. The student may not be questioned by his parents or the housewife may just meet her expenses as and when they come without bothering to find out how much she spent, but in business it is a must. You cannot run a business unless you know how much you owe outsiders and how much outsiders owe you. And when you invest money in a business, wouldn‟t you like to know whether you‟ve recovered it, increased it or lost it?

[Amity University]

PREFACE This Financial Accounting module seeks to discuss the concept of accounting & their application in the organization. The principle concern of the book is to show how financial accounting theory can be applied to solve the problems in practice. An attempt has been made to relate theory to practice to make it understandable easily for all kind of students i.e. from accounts or non-accounts background. Each chapter is having various illustrations relating to each topic covered and followed by numerous questions and multiple choice questions also, which are designed to reinforce concepts & procedure presented in the body of chapter. I wish to express my sincere thanks to many of the authors who have received due acknowledgements, without whom, this module would not have been completed. I have taken every possible effort to remove the errors either of principle or of printing. Even then, if the reader comes across any error, he/she is requested to point out the same to me. I hope that many students will find this module interesting & helpful. Further suggestion for the improvement of the module is solicited. By- Tanu Agrawal

Table of Contents PREFACE ........................................................................................................................................................ 2 CHAPTER-1 MEANING & SCOPE OF ACCOUNTING ...................................................................................... 6 1.1 MEANING OF ACCOUNTING.................................................................................................................... 6 1.2 The Accounting Process/Accounting Cycle: ............................................................................................ 7 1.3 ACCOUNTANCY, ACCOUNTNG & BOOK-KEEPING: - ............................................................................... 8 1.4 BRANCHES OF ACCOUNTING: ............................................................................................................... 10 1.5 OBJECTIVES OF ACCOUNTANCY: ........................................................................................................... 10 1.6 USERS OF FINANCIAL STATEMENT ........................................................................................................ 10 1.7 ADVANTAGES OF ACCOUNTING ........................................................................................................... 11 Chapter1- End Chapter Quizzes .................................................................................................................. 12 CHAPTER 2 ACCOUNTING PRINCIPLES, CONVENTIONS AND CONCEPTS ................................................. 14 2.1 GENERALLY ACCEPTED ACCOUNTING PRINCIPLES: .............................................................................. 14 2.2 Acceptance of accounting principles depends on following three criteria: ......................................... 14 2.3 ACCOUNTING CONCEPTS: ..................................................................................................................... 15 2.4 ACCOUNTING CONVENTIONS: .............................................................................................................. 17 End Chapter Quizzes ................................................................................................................................... 18 CHAPTER 3 ACCOUNTING STANDARDS ..................................................................................................... 20 3.1 MEANING OF ACCOUNTING STANDARDS ............................................................................................. 20 3.2 INTERNATIONAL ACCOUNTING STANDARDS ........................................................................................ 20 3.3 The list of accounting standards issued by the IASC is given below: .................................................... 21 3.4 AUDITOR’S DUTIES IN RELATION TO ACCOUNTING STANDARDS ......................................................... 23 3.5 ACCOUNTING STANDARDS ISSUED BY ASB OF THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA ........................................................................................................................................................... 23 End Chapter Quizzes ................................................................................................................................... 25 CHAPTER 4 SYSTEMS OF BOOK-KEEPING & ACCOUNTING ...................................................................... 27 4.1 SINGLE ENTRY SYSTEM:- ....................................................................................................................... 27 4.2 DOUBLE ENTRY SYSTEM:- ..................................................................................................................... 27 End Term Quizzes........................................................................................................................................ 32 CHAPTER 5 RECORDING OF ACCOUNTING TRANSACTIONS ..................................................................... 35 5.1 TYPES OF ACCOUNTS: ........................................................................................................................... 35

5.2 DEBIT & CREDIT: .................................................................................................................................... 36 5.3 MAENING & FORMAT OF JOURNAL ...................................................................................................... 37 5.4 STEPS IN JOURNALIZING ....................................................................................................................... 37 5.5 COMPOUND JOURNAL ENTRY: ............................................................................................................. 42 5.6 OPENING ENTRY:................................................................................................................................... 43 5.7 TRADE DISCOUNT V/S CASH DISCOUNT ............................................................................................... 43 5.8 LEDGER .................................................................................................................................................. 44 5.9 BALANCING OF LEDGER ........................................................................................................................ 45 End Term Quizzes........................................................................................................................................ 49 CHAPTER 6 SUBSIDIARY BOOKS I- CASH BOOK ......................................................................................... 51 6.1 MEANING OF SPECIAL JOURNALS OR SUNSIDIARY BOOKS: ................................................................. 51 6.2 ADVANTAGES OF SPECIAL JOURNALS (SUBSIDIARY BOOKS) ................................................................ 51 6.3 CASH BOOK ........................................................................................................................................... 52 6.4 TYPES OF CASH BOOK ........................................................................................................................... 53 6.5 CONTRA ENTRIES .................................................................................................................................. 57 MULTIPLE CHOICE QUESTIONS: .................................................................................................................. 60 CHAPTER 7 SUBSIDIARY BOOK II- OTHER BOOKS ..................................................................................... 62 7.1 MEANING .............................................................................................................................................. 62 7.2 PURCHASE BOOK................................................................................................................................... 62 7.3 PURCHASES RETURNS BOOK:................................................................................................................ 63 7.4 SALES BOOK: ......................................................................................................................................... 63 7.5 SALES RETURNS BOOK : ........................................................................................................................ 64 7.6 BILLS RECEIVABLE BOOK ....................................................................................................................... 64 7.7 BILLS PAYABLE BOOK ............................................................................................................................ 65 7.8 JOURNAL PROPER ................................................................................................................................. 65 End Chapter Quizzes ................................................................................................................................... 69 CHAPTER 8- BANK RECONCILIATION STATEMENT .................................................................................. 71 8.1 MEANING: ............................................................................................................................................. 71 8.2 REASONS FOR DIFFERENCE BETWEEN BANK BALANCES AS PER CASHBOOK AND PASSBOOK: ............ 71 8.3 Advantages of Bank Reconciliation Statement ..................................................................................... 72 8.4 Steps in Preparation of BRS .................................................................................................................. 72 End Chapter Quizzes ................................................................................................................................... 76 CHAPTER 9 DEPRECIATION & ITS METHODS ............................................................................................. 78

9.1 Meaning of Depreciation: ..................................................................................................................... 78 9.2 DEPRECIATION METHODS ..................................................................................................................... 78 9.3 COMPARISON BETWEEN SLM & WDV METHODS OF DEPRECIATION .................................................. 80 9.4 RECORDING DEPRECIATION .................................................................................................................. 81 9.5 CHANGE IN THE METHOD OF DEPRECIATION....................................................................................... 87 End Chapter Quizzes ................................................................................................................................... 91 CHAPTER 10 FINAL ACCOUNTS & ADJUSTMENTS .............................................................................. 93 10.1 TRIAL BALANCE: .................................................................................................................................. 93 10.2 CAPITAL AND REVENUE EXPENDITURE ............................................................................................... 95 10.3Preparation of Trading & Profit and Loss account from a given Trial Balance .................................... 95 10.4 Adjustment Entries: ............................................................................................................................ 98 End Chapter Quizzes ................................................................................................................................. 114 CHAPTER- 11 BILLS OF EXCHANGE.................................................................................................. 116 11.1 CONCEPT ........................................................................................................................................... 116 11.2 ACCOUNTING FOR BILLS OF EXCHANGE ........................................................................................... 116 11.3 Dishonor of Bills ................................................................................................................................ 121 End Chapter Quizzes ................................................................................................................................. 134 BIBLIOGRAPHY.......................................................................................................................................... 137

CHAPTER-1 MEANING & SCOPE OF ACCOUNTING At the end of the chapter you will be conversant with: 1.1 Meaning of Accounting 1.2 The Accounting Process/Accounting Cycle 1.3 Accountancy, Accounting & Book-keeping 1.4 Branches of Accounting 1.5 Objectives of Accountancy 1.6 Users of Financial Statement 1.7 Advantages of Accounting

1.1 MEANING OF ACCOUNTING All of us do some accounting, often without realizing it. It is a part of our life. Let us say you realize suddenly, one morning, that you needed to buy a book urgently. You ask one of your parents for the money. „But‟ the parent says, “What happened to the money I gave last week?” You either recollect how you spent it or if you believe in being systematic and have noted it in your diary you explain how the money was spent. You are „accounting‟ for the money given to you. When a housewife tries to note down her household expenses, strike the balance she has on hand at the end of the month, or determines how much she needs for the expenses which would arise, she is „accounting‟ for the money she withdrew or was given to run the household. In business, however, it is a more serious matter. The student may not be questioned by his parents or the housewife may just meet her expenses as and when they come without bothering to find out how much she spent, but in business it is a must. You cannot run a business unless you know how much you owe outsiders and how much outsiders owe you. And when you invest money in a business, wouldn‟t you like to know whether you‟ve recovered it, increased it or lost it? All this requires systematic record keeping of all that happens on a day-to-day basis in business and analyzing this information to aid business decision making. In simple words, „accounting‟ merely means, „reckoning‟ or „recounting‟. In an organizational context too, „accounting‟ has more or less the same meaning. As an organization comes into being and commences operations, one would like to evaluate the organization‟s past performance for various reasons. However, in order to be able to do so, it is necessary that as far as possible whatever has transpired in the organization be „reckoned‟ or „recounted‟ in a summarized form in monetary terms. Thus, the process of accounting involves recording, classifying and summarizing of past events and transactions of financial nature, with a view to enabling the user of accounts to interpret the resulting summary.

The American Institute of Certified Public Accountants defines accounting as “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 definition brings out the following as attributes of accounting: 1. Events and transactions of a financial nature are recorded while the events of a nonfinancial nature cannot be recorded. 2. The record should reflect the importance of the transactions so recorded both individually and collectively, which includes summarization, thereby making it amenable to analysis. 3. The users of the financial statements should be able to obtain the message encompassed in such financial statements.

1.2 The Accounting Process/Accounting Cycle: It is a complete sequence beginning with the recording of the transactions & ending with the preparation of final accounts. The steps involved in accounting cycle are as follows: Step 1: - Identification of Transactions & Events:- Accounting identifies transactions & events of a specific entity. A transaction is an exchange in which each participant receives or sacrifices value (e.g. purchase of raw material). An event is a happening of consequences to an entity (e.g. use of raw material for production). An entity means an economic unit that performs economic activities. Step 2: Preparation of Business Documents:- After identifying, we measure those transactions & events in monetary terms & to record them we prepare business documents. Step 3:- Journalizing:- It is concerned with the recording of identified & measured financial transactions in an orderly manner, and this process is called as Journalizing. Step 4:- Posting:- It is concerned with classification of the recorded transactions so as to group the transactions of similar type at one place. This function is performed by maintaining the ledger in which different accounts are opened to which related transactions are brought to one place by posting Step 5: - Preparation of Trial Balance:- It is concerned with the balancing & summarization of the classified transactions in a manner useful to users. It can further be classified into preparation of unadjusted trial balance & passing the adjustment entries. After balancing all the accounts, we do some adjustments to match our expenses & revenues & then prepare adjusted accounts. Step 6:- Preparation of Income Statement & Position Statement:- After preparing Trial Balance we prepare Income Statement i.e. Trading & Profit & Loss Account & position statement i.e. Balance Sheet. We can present the same graphically as follows:

1.3 ACCOUNTANCY, ACCOUNTNG & BOOK-KEEPING: Book-keeping is a part of Accounting. Accounting is a part of Accountancy. Accountancy: refers to a systematic knowledge of accounting. Accounting: Refers to the actual process of preparing & presenting the accounts.

Book-keeping: is the part of accounting & is concerned with record keeping or maintaining of books of accounting which is often routine & clerical in nature. Diagrammatically the relationship can be viewed as follows: Relationship B/w These Three: Accountancy Accounting Book-Keeping

We must also understand the difference & relationship between the terms „accounting’ & „book-keeping’. Accounting is broader in scope than bookkeeping, which is merely concerned with orderly record keeping. Going beyond the narrow confines of bookkeeping, accounting involves analysis and judgment at different stages such as recording of transactions, classification, summarization and interpretation. Distinction B/w Accounting & Book-keeping in Tabular form can be presented as follows: Basis of Distinction Book-keeping Accounting 1 Scope It involves identification, In addition it involves measurement, recording & summarizing classified classification of transactions. Analyzing, transaction interpreting & communicating the same. 2 Stage It‟s a primary stage It‟s a secondary stage, starts where book-keeping ends 3 Basic Objective To maintain systematic To ascertain net results of records operations & financial position of the co 4

Who Performs

Performed by junior staff

5

Knowledge level

6 7

Analytical Skill Nature of Job

Not required a high level It needs a of knowledge knowledge Not required Required Routine & clerical Analytical

8

Supervision Checking

& Supervised accountant

by

By senior staff high

level

of

an Whereas its work is not supervised by a book-keeper

1.4 BRANCHES OF ACCOUNTING: Classification of Accounting

Financial Accounting:- Accounting involves recording, classifying and summarizing of past events and thus is historical in nature. It is Historical accounting which is better known as Financial accounting whose primary intention is to prepare the Statements revealing the Income and financial position of the business on the basis of events which have happened in the period being reckoned. Cost Accounting:- It shows classification and analysis of costs on the basis of functions, processes, products, centers etc. It also deals with cost computation, cost saving, cost reduction, etc. Management Accounting:- It deals with the processing of data generated in financial accounting and cost accounting for managerial decision-making. It also deals with application of managerial economic concepts for decision-making.

1.5 OBJECTIVES OF ACCOUNTANCY: 1. It is a means of recording the monetary transactions and events. 2. It required to ascertain the earnings of the company, which is achieved by preparation of Profit and Loss account. 3. It is required to identify the obligations (liabilities) and resources (asset) of the organization. 4. Accounting records are required to be maintained statutorily by certain government and regulatory bodies. 5. Accounting records are also required by the management for taking the financial decisions. 6. Generally, investors and certain lenders also require the preparation of financial statements.

1.6 USERS OF FINANCIAL STATEMENT Management Shareholders, Security Analyst & Investors

Lenders (Long-term) Suppliers/Creditors (short-term) Customers Employees Government & Regulatory Agencies Researchers

1.7 ADVANTAGES OF ACCOUNTING Facilitate To Replace Memory Facilitate to comply with legal requirement Facilitate to ascertain net result of operations Facilitate to ascertain financial position Facilitate the users to take decision Facilitate a comparative study Facilitate control over assets Facilitate the settlement of tax liability Facilitate the ascertainment of value of business Facilitate Raising Loan Acts as legal evidence

Chapter1- End Chapter Quizzes Test Questions: Q1 The prime function of accounting is to: (a) record economic data (b) provide the information basis for action (c) classifying & recording business transactions (d) attain non-economic goals. Q2 The basic function of financial accounting is to: (a) record all business transactions (b) interpret financial data (c) assist the management in performing functions effectively (d) All of the above Q3 Management Accounting provides invaluable services to the management in performing: (a) All management functions (b) Co-ordinating management functions (c) Controlling functions (d) None of the above Q4 Book-keeping is mainly concerned with (a) recording of financial data relating to business operations (b) designing the systems in recording, classifying, summarizing the recorded data. (c) Interpreting the data for internal & external end users. (d) All of the above. Q5 Who

among the following is not considered as an external user of Financial Statements? (a)Government Agencies (b) Creditors (c)Customers (d)Board of Directors.

Q6 Which of the following events is/are not recorded in the books of a business? (a) Significant Monetary events after the balance sheet dates. (b) Death of a chief executive of the business (c) Government Investigation into the pricing of the business (d) Both (b) & (c) above Q7 Which of the following is/are the objectives of Accounting: (a) To keep systematic records (b) To ascertain the Financial Position of the company (c) To compare the balance sheets of two dates. (d) Both (a) & (b) Above Q8 Which of the following is/are branches of accounting: (a) Cost Accounting

(b) Management accounting (c) Social Responsibility Accounting (d) All of Above Q9 Which of the following is/are the internal users of accounting information: (a) Creditors (b) Employees (c) Investors (d) Both (a) & (b) Above Q10 Which of the following is not a function of accounting: (a) Recording (b) Classifying (c) Summarizing (d) Controlling

CHAPTER 2 ACCOUNTING PRINCIPLES, CONVENTIONS AND CONCEPTS At the end of second chapter you will get to know: 2.1 Meaning of GAAP 2.2 Acceptance Criteria 2.3Accounting Concepts 2.4 Accounting Conventions

2.1 GENERALLY ACCEPTED ACCOUNTING PRINCIPLES: The double entry system of accounting is based on a set of principles which are called Generally Accepted Accounting Principles (GAAP). GAAP may be defined as those rules of action or conduct which are derived from experience and practice and when they prove useful, they become accepted as principles of accounting. These principles enable to a certain extent standardization in recording and reporting of information so that the users, once they are aware of the principles, can read and understand the financial statements prepared by diverse organizations. 2.2 Acceptance of accounting principles depends on following three criteria: Relevance:- A principle is relevant to the extent it results in information that is meaningful & useful to the users of accounting information. Objectivity:- it connotes reliability & trustworthiness. Feasibility:- A principle is feasible to the extent it can be implemented without much complexity & cost. Principles can be classified into two categories: (i) Accounting concepts (ii) Accounting conventions

2.2 Acceptance of accounting principles depends on following three criteria: Relevance:- A principle is relevant to the extent it results in information that is meaningful & useful to the users of accounting information. Objectivity:- it connotes reliability & trustworthiness. Feasibility:- A principle is feasible to the extent it can be implemented without much complexity & cost. Principles can be classified into two categories: (iii) Accounting concepts (iv) Accounting conventions

2.3 ACCOUNTING CONCEPTS: The term concepts includes those basic assumptions or conditions upon which the science of accounting is based. The following are the important accounting concepts: (1) Money Measurement Concept: In financial accountancy, a record is made only of information that can be expressed in monetary terms. Recording, classification and summarization of business transactions requires a common unit of measurement which is taken as money. If events cannot be quantified in monetary terms then they do not facilitate accounting. Money is the standard of exchange and the changes in purchasing power caused by inflation are ignored for the purpose of accounting because the assumption about the stability of money, notwithstanding its limitations, is a necessity for ensuring a smooth accounting process. Hence, all transactions are recorded through a common denominator, namely the monetary unit. (2) Cost Concept:Cost concept implies that in accounting, all transactions are generally recorded at cost, and not at market value. For example, if a piece of land is acquired for Rs.1 lakh, it would continue to be shown in the balance sheet at Rs.1 lakh, even when the market value of the land rises to say Rs.2 lakhs. Why should this be so? This is because, cost concept is in fact closely related to the going concern concept. If the land is acquired for the operations of the business and would continue to be used for its operations and would not be sold shortly, then it is largely immaterial what the land‟s market value is, since it is not going to be sold anyway. Thus, it is consistent with going concern concept to keep recording the land at cost, i.e. Rs.1 lakh on an ongoing basis. (3) Business Entity/Separate Entity Concept: The legal entity of a corporate business, as distinct from the entity of its owners is well understood today. Less understood, however, is the accounting entity of a business as distinct from its owners. For example, for many purposes, the legal entity of a sole proprietary business may not be very distinct from the entity of the proprietor himself. However, the business entity concept requires that this should not come in the way of treating the business as a distinct accounting entity for the purposes of treating transactions relating to the operations of the business. It is in accordance with this concept that when an owner brings capital into the business, the business in turn is deemed to owe the capital to the owner. (4) Going Concern Concept: A business entity is assumed to carry on its operations forever. Seemingly inconsequential, this is a fundamental concept which has far reaching consequences. This is because it is difficult to envisage any economic activity on the part of a business entity if its liquidation were shortly expected. Going concern concept implies that the resources of the concern would continue to be used for the purposes for which they are meant to be used. For instance, in a manufacturing concern, the land, buildings, machinery etc., are primarily required for carrying out the production and selling of certain products. Going concern concept implies that these land, buildings, machinery etc., would continue to be used for this purpose (5) Duality or Accounting Equivalence Concept:

It can easily be seen that in business, as elsewhere, funds can be raised in any of the following ways: Additional capital (increases owners‟ equity) Additional loans (increases outside liability) Earning revenue (increases owners‟ equity) Making profits (increases owners‟ equity) Disposing or reducing some of the assets (reduces assets). Thus, all increases in liabilities (including owners‟ equity) and reduction in assets represent sources of funds. Similarly, the funds thus raised, may be put to any of the following uses: Purchasing of assets (increases assets) Incurring operational expenses (decreases owners‟ equity) Discharging earlier liabilities (decreases liability) Keeping idle funds so that cash balance increases (increases assets) Suffering losses (decreases owners‟ equity). Thus all increases in assets and decreases in liabilities (including owners‟ equity) are uses of funds. A little reflection must reveal that in a business, the sum of the Sources of Funds must equal the sum of Uses of Funds. This is because, whatever funds are raised by the business, either through capital or operations or from outsiders, must be tied up in one or the other form of uses. Thus the duality or accounting equivalence concept implies that: Owners’ Equity + Outside Liability = Assets This equation is known as the „Fundamental Accounting Equation‟. (6) Accounting Period Concept: To be able to prepare the income statement for a business, the period for which it is to be prepared must first be specified. Very often the accounting period chosen is a calendar year (January 1 – December 31) or a fiscal year (April 1 – March 31). (7) Realization Concept: With this concept, accounts recognise transactions (and any profits arising from them) at the point of sale or transfer of legal ownership - rather than just when cash actually changes hands. For example, a company that makes a sale to a customer can recognise that sale when the transaction is legal - at the point of contract. The actual payment due from the customer may not arise until several weeks (or months) later - if the customer has been granted some credit terms. (8)

Matching Concept:

In order to determine the profits or losses accrued in an accounting period, the expenses must relate to the goods or services sold during the period. For instance, assume a situation where nine products are manufactured in an accounting period, seven products are dispatched and money is received on only five. Let the selling price and cost per product be Rs.10 and Rs.6 respectively. Then, depending on whether the sale is

recognized at production or dispatch or collection, the revenue would be Rs.90 or Rs.70 or Rs.50 respectively. And the cost of goods sold under the three situations will be Rs.54, Rs.42 and Rs.30 respectively. Thus it is clear that the „cost‟ derives its relevance only from the „sale‟ and not vice-versa. It is for this reason that revenue recognition always precedes the matching of cost. If revenue or sale is not defined, the „cost‟ cannot be defined either.

2.4 ACCOUNTING CONVENTIONS: Conventions are based on what is practicable, these are the methods or procedures employed generally by accounting practitioners. For example, dividing a centimeter into ten equal parts is a convention rather than a concept. They are based on custom and are subject to change as new developments arise. Some of the accounting conventions are as follows: (1) Materiality: An important convention. As we can see from the application of accounting standards and accounting policies, the preparation of accounts involves a high degree of judgment. According to this , the accountant should attach importance to material details & ignore insignificant details. (2) Prudence/Conservatism: Profits are not recognized until a sale has been completed. In addition, a cautious view is taken for future problems and costs of the business. For example, a sales manager might have finalized a deal with his client for, say, sale of 100 units of their product. But unless these items are produced and delivered to the client there is no reasonable certainty about receiving the payment for these 100 units. It is only thereafter that he can record the sales amount on those 100 units as due from the client. But, on the other hand, if he comes to know that a customer has lost all his assets and is likely to default payment, then he should immediately provide for such loss. (3) Consistency: There are in practice several ways of treating an event that may be recorded in the accounts. The consistency concept requires that once an entity has decided on one method, it will treat all subsequent events of the same character in the same fashion unless it has a sound reason to change the method of treatment of that event. For example, if a concern is valuing its inventory by a particular method in one year it is expected to value its inventory in the subsequent years also in the same method unless there is a strong reason to change the same. Similarly, if it is charging depreciation by one method it is expected to follow the same method in the subsequent years also. (4) Full disclosure: According to this convention accounting report should disclose fully & fairly the information they purport to represent. They should be honestly prepared & sufficiently disclose information which is of material interest to proprietors, to present & potential creditors & to investors.

End Chapter Quizzes Test Questions: Q1 Accounting principles are generally based on: (a) Practicability (b) Subjectivity (c) Convenience in recording (d) All of above Q2 The basic concepts related to balance sheet are (a)Cost Concept (b) Business Entity ©Accounting period concept (d)Both (a) & (b) Above Q3 The basic concepts related to P&L Account are (a)Realization Concept (b) Matching Concept © Cost Concept (e) Both (a) & (b) above Q4 As per the double entry concept (a) Assets + Liability = Capital (b) Capital= Assets -Liability (c) Capital – Liability = Assets (d) Capital +Assets =Liabilities Q5 Only the significant events which affect the business must be recorded as per the principle of: (a) Separate Entity (b) Accrual Concept (c) Materiality Concept (d) None of above Q6 P&L account is prepared for a period of one year by following: (a) Consistency Principle (b) Conservatism Principle (c) Time period concept (d) Cost Concept

Q7 Under which of the following concepts are shareholders treated as creditors for the amount they paid on the shares they subscribed to? (a) Cost Concept (b) Duality Concept (c) Separate Entity Concept (d) Cost Concept Q8 The underlying accounting principle(s) necessitating amortization of intangible asset(s) is/are: (a) Cost Concept (b) Matching Concept (c) Realization Concept (d) Both (b) & (c) above Q9 Which of the following practices is conservatism?:

not in consonance with the convention of

(a) Creating Provision for bad debts (b) Creating provision for discount on debtors (c) Creating provisions for discount on creditors (d) Creating provision for tax Q10 Recording of fixed assets at cost ensures adherence of: (a) Cost Concept (b) Matching Concept (c) Realization Concept (d) Both (b) & (c) above

CHAPTER 3 ACCOUNTING STANDARDS At the end of this chapter you will be conversant with: 3.1 Meaning of Accounting Standards 3.2 International Accounting Standards 3.3 List of accounting standards issued by IASC 3.4 Auditor‟s duties in relation to accounting standards 3.5 Accounting Standards Issued By ASB of the Institute of Chartered Accountants of India

3.1 MEANING OF ACCOUNTING STANDARDS An accounting standard is a selected set of accounting policies or broad guidelines regarding the principles & methods to be chosen out of several alternatives. Accounting Bodies all over the world have tried to achieve some uniformity in the accounting policies by prescribing certain accounting standards in order to narrow the range of alternatives available to an organization in respect of collection and presentation of accounting information. The main objective of accounting standards is to harmonize the diverse accounting policies and practices & ensure comparability of accounts because of uniformity in their presentation.

3.2 INTERNATIONAL ACCOUNTING STANDARDS Accounting Bodies throughout the world are striving to achieve a reasonable degree of uniformity in the accounting policies by prescribing certain accounting standards with respect to collection and presentation of accounting information. To formulate the accounting standards, they have established a committee called the International Accounting Standards Committee (IASC) in 1973. Accounting bodies of most of the countries, including the Institute of Chartered Accountants of India, are members of this body and these members have resolved to conform to the standards developed by IASC, subject to variations needed due to local conditions or laws. The objectives of the committee according to its constitution are: a. formulating, publishing and promoting the use of the accounting standards worldwide, and b. to work for the improvement and harmonization of regulations, accounting standards and procedures relating to financial statements

The International Accounting Standards have assumed great importance in recent times for the following reasons: a. Globalization of the economy has led to Indian companies expanding their operations across the borders and this calls for uniformity in accounts of units located in different countries. b. Foreign investors would give more weight age to the accounts of those companies which are based on International Accounting Standards. If there is a conflict between the International Accounting Standards and the local standards or the local laws and regulations, the local standards, laws and regulations will prevail.

3.3 The list of accounting standards issued by the IASC is given below: IAS 1

Presentation of Financial Statements

IAS 2

Inventories

IAS 7

Cash Flow Statements

IAS 8

Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies Events after the Balance Sheet Date Construction Contracts Income Taxes Segment Reporting Information Reflecting the Effects of Changing Prices Property, Plant and Equipment Leases Revenue Employee Benefits

IAS 10 IAS 11 IAS 12 IAS 14 IAS 15 IAS 16 IAS 17 IAS 18 IAS 19 IAS 20

Accounting for Government Grants and Disclosure of Government Assistance

IAS 21

The Effects of Changes in Foreign Exchange Rates

IAS 22

Business Combinations

IAS 23

Borrowing Costs

IAS 24

Related Party Disclosures

IAS 26

Accounting and Reporting by Retirement Benefit Plans

IAS 27

Consolidated Financial Statements

IAS 28

Investments in Associates

IAS 29

Financial Reporting in Hyperinflationary Economies

IAS 30

Disclosures in the Financial Statements of Banks and Similar Financial Institutions

IAS 31

Financial Reporting of Interests in Joint Ventures

IAS 32

Financial Instruments: Disclosure and Presentation

IAS 33

Earnings per Share

IAS 34

Interim Financial Reporting

IAS 35

Discontinuing Operations

IAS 36

Impairment of Assets

IAS 37

Provisions, Contingent Liabilities and Contingent Assets

IAS 38

Intangible Assets

IAS 39

Financial Instruments: Recognition and Measurement

IAS 40

Investment Property

IAS 41

Agriculture

3.4 AUDITOR’S DUTIES IN RELATION TO ACCOUNTING STANDARDS In case the company does not conform to any of the mandatory accounting standards, the auditor will have to qualify his report justifying his deviation. In case he fails to do so the ICAI can take disciplinary action against him on the ground of professional misconduct.

3.5 ACCOUNTING STANDARDS ISSUED BY ASB OF THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA (AS 1) Disclosure of Accounting Policies (AS 2) Valuation of Inventories (AS 3) Cash Flow Statements (AS 4) Contingencies and Events Occurring after the Balance Sheet Date (AS 5) Net Profit or Loss for the Period, Prior Period and Extraordinary Items and Changes in Accounting Policies (AS 6) Depreciation Accounting (AS 7) Construction Contracts (Revised Accounting Standard) (AS 8) Accounting for Research and Development (AS 9) Revenue Recognition (AS 10) Accounting for Fixed Assets (AS 11) (Revised 2003), The Effects of 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 Statement of Employers (AS 16) Borrowing Costs (AS 17) Segment Reporting (AS 18) Related Party Disclosures (AS 19) Leases (AS 20) Earnings Per Share (AS 21) Consolidated Financial Statements (AS 22) Accounting for Taxes on Income (AS 23) Accounting for Investments in Associates in Consolidated Financial Statements

(AS 24) Discontinuing Operations (AS 25) Interim Financial Reporting (AS 26) Intangible Assets (AS 27) Financial Reporting of Interests in Joint Ventures (AS 28) Impairment of Assets (AS 29) Provisions, Contingent Liabilities and Contingent Assets

End Chapter Quizzes Q 1 The Objective of Formulating Accounting Standards is to: (a) harmonize the diverse accounting policies and practices & ensure comparability of accounts. (b) To control the cost © to Increase the profitability of the Organization (d) All of Above Q2 When International Accounting Standards Committee (IASC) was formulated: (a) 1970 (b) 1973 (c) 1980 (d) 1982 Q3 How many international accounting standards are there: (a) 20 (b) 30 (c) 41 (d) 50 Q4 Which one is IAS 2: (a) Inventories (b) Events after the Balance Sheet Date (c) Income Taxes (d) Segment Reporting Q5 Which one is IAS 8 : (a) Segment Reporting (b) Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies (c) Events after the Balance Sheet Date (d) None of above Q6 Which one IAS 20: (a) Events after the Balance Sheet Date (b) The Effects of Changes in Foreign Exchange Rates (c) Accounting for Government Grants and Disclosure of Government Assistance (d) None of above Q7 Which one is IAS 17: (a) Segment Reporting (b) Leases (c) Revenue (d) Employee benefits Q8 Which one is IAS 29: (a) Earnings per Share (b) Financial Reporting in Hyperinflationary Economies

(c) Financial Instruments: Disclosure and Presentation (d) Interim Financial Reporting Q9 Which one is IAS 35: (a) Interim Financial Reporting (b) Discontinuing Operations

(c) Investments in Associates (d) None of the above Q10 Which on is IAS 39: (a) Investments in Associates (b) Investment Property (c) Financial Instruments: Recognition and Measurement (d) Agriculture

CHAPTER 4 SYSTEMS OF BOOK-KEEPING & ACCOUNTING At the end of this chapter you will be conversant with: 4.1 Single Entry System 4.2 Double Entry System 4.3 Systems of Accounting

4.1 SINGLE ENTRY SYSTEM:An incomplete double entry can be termed as a single entry system. According to Kohler “it is a system of book-keeping in which as a rule only records of cash & personal accounts are maintained, it is always incomplete double entry, varying with circumstances.” This system has been developed by some business houses where, for their convenience, only some essential records are kept. Since all records are not kept, the system is not reliable & can be used only by small business firms.

4.2 DOUBLE ENTRY SYSTEM:All the business transactions have two fold effect. Recording of both aspects of a transaction is called Double Entry system of bookkeeping. Accounting Equation: In Chapter 2, it was stated that, under the duality concept that sources of funds must always equal to uses of funds and from this equality was derived. The fundamental accounting equation: Total Liabilities = Total Assets (or) Owners‟ Equity + Outside Liability = Assets (or) Assets = Capital + Liabilities (or) Resources = Sources of Finance (or) Assets = Internal Equity + External Equity Where assets refer to resources which are owned by business enterprises, liabilities are debts payable to parties external to business and capital means the amount payable to owner of the business enterprise.

It was also evident from the earlier discussions that any of the following is a source of funds, in business: –

Incurring Liability (including owners‟ equity)

–

Earning Revenue

–

Making Profits.

It stands to reason that a decrease in liability, revenue or profit must be a use of funds being the opposite of a source. Similarly, any of the following is a use of funds: –

Acquiring Assets

–

Incurring Expenses

–

Incurring Losses.

A business is started with a capital of Rs.10,000 brought in cash. The above event gives rise to a cash balance of Rs.10,000, which, being an increase in an asset (namely cash), is a use. At the same time, the business now owes Rs.10,000 to the owner who invests the capital in it, so that the owners‟ equity in the business is Rs.10,000. This being a liability of the business towards the owner, constitutes a source. Steps Involved In Developing Accounting Equation: An accounting equation may be developed by taking the steps given below: Step 1 –Ascertain the variables of an equation affected by a transaction Step 2- Find out the effect of a transaction on the variables of an equation Step 3 – Show the effect on the appropriate side of an equation and ensure that the total of right hand side is equal to the total of left hand side Illustration 1:- A started business with Rs 1,00,000. Analyze the transaction and give Accounting Equation. Step 1- Variables affected

Asset & Capital

Step 2- Effect of transactions on affected variables

Increase in asset & Capital

Step 3- Accounting equation

Asset = Liability + Capital 1,00,000 = 0+ 1,00,000

Illustration 2:- Borrowed Rs 50,000 from ICICI Bank. Step 1- Variables affected

Asset & Liability

Step 2- Effect of transactions on affected variables

Increase in asset & Liability

Step 3- Accounting equation

Asset = Liability + Capital 1,00,000 = 50,000+ 0

Illustration 3: - Purchased furniture worth Rs. 100000. Step 1- Variables affected

Assets

Step 2- Effect of transactions on affected variables

Increase & Decrease in assets

Step 3- Accounting equation

Asset = Liability + Capital +1,00,000 – 1,00,000 = 0 + 0

Illustration 4: - Purchased goods for cash 20,000. Step 1- Variables affected

Assets

Step 2- Effect of transactions on affected variables

Increase & Decrease in assets

Step 3- Accounting equation

Asset = Liability + Capital +20,000-20,000 = 0 + 0

Illustration 5: - Purchased goods on credit for Rs 50000. Step 1- Variables affected

Asset and Liability

Step 2- Effect of transactions on affected variables

Increase in asset & Liability

Step 3- Accounting equation

Asset = Liability + Capital 50,000 = 50,000 + 0

Illustration 6 :- Sold goods costing Rs 10,000 for Rs 12000. Step 1- Variables affected

Assets & Capital

Step 2- Effect of transactions on affected variables

Increase in one asset & Decrease in another asset & Increase in Capital

Step 3- Accounting equation

Asset = Liability + Capital +12,000-10,000 = 0 + 2000

Illustration 7: - Sold goods costing Rs 20,000 on credit for Rs 25,000. Step 1- Variables affected

Assets & Capital

Step 2- Effect of transactions on affected variables

Increase in one asset & Decrease in another asset &

Increase in Capital Step 3- Accounting equation

Asset = Liability + Capital +25,000-20,000 = 0 + 5000

Illustration 8:- Returned goods costing Rs 5,000 to suppliers of goods. Step 1- Variables affected

Asset & Liability

Step 2- Effect of transactions on affected variables

decrease in asset & Liability

Step 3- Accounting equation

Asset = Liability + Capital -5000 = -5000+ 0

Illustration 9:- Received cash from a customer Rs 20,000. Step 1- Variables affected

Assets

Step 2- Effect of transactions on affected variables

Increase in one asset Decrease in another asset.

Step 3- Accounting equation

Asset = Liability + Capital

&

+20,000 – 20,000 = 0+ 0

Illustration 10: -Withdrew cash Rs 2,000 for personal use. Step 1- Variables affected

Asset & Capital

Step 2- Effect of transactions on affected variables

decrease in asset & Capital

Step 3- Accounting equation

Asset = Liability + Capital -2000 = 0 - 2000

Problem:Mr. Irshad has the following transactions. Draw accounting equation to show the effect of these transactions on his assets, liabilities and capital. Also show his balance sheet: 1. Commenced business with cash Rs 20,000. 2. Purchase goods for cash Rs 5000 and credit Rs 6000. 3. Purchased office equipment for cash Rs 8000. 4. Paid office rent Rs 1000. 5. Sold goods for cash Rs. 10,000 (costing Rs 7000) 6. Sold goods on credit for Rs 6000 (costing Rs 3000) 7. Fore insurance premium paid in advance Rs 500

8. Salary due but not paid yet (o/s) Rs 1500 Systems of Accounting:ACCRUAL BASIS OF ACCOUNTING & CASH BASIS OF ACCOUNTING Accrual Basis of accounting is a method of recording transactions by which revenue, cash, assets & liabilities are reflected in the accounts for the period in which they accrue. Whereas cash basis accounting in which actual receipts or actual payments are made. These two methods can be differentiated in tabular form as follows: BASIS OF DISTINCTION CASH ACCRUAL BASIS BASIS 1 Prepaid/outstanding These things are treated Whereas no entry is done in expenses/accrued/unaccrued in this accounting cash basis accounting income 2 Income status in case of Income statement will Income statement will show prepaid expenses & accrued show a relatively high lower income income income 3 Income status in case of o/s Income statement will Income statement will show a exp and unaccrued income show a relatively lower high income income 4 Recognition under companies It is recognized Not recognized Act 1956 5 Availability of choosing Under this an accountant Whereas under this an accounting option like has an option accountant has no option to LIFO/FIFO/SLM/WDV make a choice as such

End Term Quizzes Problem 1: Show the accounting equation on the basis of the following transactions & present a balance sheet: Rs Mohan commenced business with 70,000 Purchased goods on credit 14,000 Withdrew for private use 1,700 Purchased goods on cash 10,000 Paid wages 300 Paid to creditors 10,000 Sold goods on credit 15,000 Sold goods for cash (cost price 3000) 4,000 Purchased furniture 500 Problem2 Show accounting equation on the basis of the following transactions, also prepare balance sheet: Rs i. Manu started business with cash 50,000 ii. Purchased goods on credit 2,500 iii. Purchased goods on cash 6000 iv. Purchased furniture for 3000 v. Paid rent 1200 vi. Withdrew for private use 4200 vii. Received interest for 600 viii. Sold goods on credit (cost Rs 300) for 4200 ix. Paid to creditor 24000 x. Paid salaries for 1200 Problem 3: Show the accounting equation on the basis of following transactions: (i) Harish started business with cash Rs 15000 (ii) He purchased goods on credit Rs 7000. (iii) He purchased furniture for cash Rs 500 (iv) He deposited into bank Rs 2000. (v) He sold goods on credit to Satish costing Rs 4000 for Rs 6000. (vi) He withdrew cash fir private use Rs 200. (vii) He paid salaries Rs 300.

MULTIPLE CHOICE QUESTIONS: Q1 Cash purchases: (a) Increase assets (b) Results in no change of assets (c) Decrease Assets (d) Increase liability Q2 Purchase of goods on credit from A increases: (a) Assets (b) Liability & Assets (c) Capital (d) Assets & Capital Q3 Rent outstanding Rs 400 : (a) Increases capital by 400 & increase liability by 400. (b) Decreases capital by 400 & increase liability by 400. (c) Does not affect capital (d) Increase assets by 400 Q4 Paid for salaries Rs 10,000: (a) Decrease asset & increase capital (b) Increase assets & liability both (c) No effect on asset (d) Decrease in Assets & Capital both Q5 Drew for personal use Rs 500: (a) Increase assets & Capital (b) Decrease liability (c) Decrease assets & capital both (d) None of above Q6 If a firm borrows a sum of money, there will be: (a) Increase in capital (b) Decrease in capital (c) No effect on capital (d) Increase liability Q7 Which of the following is correct: (a) Assets = Liability – Capital (b) Assets = capital – liability (c) Liability = Assets – capital (d) Assets = External equity Q8 Ram has assets of Rs 10,000 & liability of Rs 2,000, his capital would be : (a) 10,000 (b) 2000 (c) 8000 (d) 12000 Q9 Mr Mohan has assets of Rs 60,000 & Capital of 45,000. Liabilities as on date shall be:

(a) 15000 (b) 45000 (c) 105000 (d) 60,000 Q10 He sold goods on credit for Rs 10,000: (a) Increase assets & Liability (b) Increase one asset & decrease another asset (c) Increase capital (d) Increase liability & Capital

CHAPTER 5 RECORDING OF ACCOUNTING TRANSACTIONS At the end of this chapter you will be conversant with: 5.1 Classification of accounts 5.2 Rules of Debit & Credit 5.3 Meaning & Format of Journal 5.4 Steps in Journalizing 5.5 Compound Entry 5.6 Opening Entry 5.9 Cash discount v/s Trade discount 5.8 Ledger 5.9 Balancing

5.1 TYPES OF ACCOUNTS: The accounts maintained by a business organization are classified into three types as shown in the Figure 5.1: Figure 5.1 Types of Accounts

Personal Account: It deals with accounts of individuals like creditors, debtors, bank, etc. It shows the balance due to these individuals or due from them on a particular date. Real Account: It represents assets like plant and machinery, land and buildings, goodwill, etc. As on a particular date, this account shows the worth of the asset. Nominal Account: It consists of different types of expenses or incomes or loss or profit. These accounts show the amount of income earned or expenses incurred for a particular period say a month, a year, etc. Illustration1: Classify the following a/c among real, nominal & personal

Capital brought in, drawings A/c, building purchased, purchase A/c, sales A/c, Carriage inward paid, carriage outward paid, cash received, cash paid, interest paid, interest received, discount allowed, repairs, bank a/c, bank overdraft, outstanding rent. Solution: Personal Account:- Capital brought in, Drawings, bank a/c, bank overdraft Real Account:- Building purchases, purchase a/c, sales a/c, cash received, cash paid Nominal Account:-carriage inward paid, carriage outward paid, interest paid, interest received, discount allowed, repairs, outstanding rent

5.2 DEBIT & CREDIT: It is necessary to point out at the outset that the words „debit‟ and „credit‟ represent two different concepts. The nature of Debit and Credit is explained in the Figure 5.2:

Figure 5.2 Nature of Debit & Credit

RULES OF DEBIT & CREDIT: Whether an Account has to be debited or credited is decided by using the rules indicated in Figure 5.3.

Figure 5.3: Rules of Debit and Credit

5.3 MAENING & FORMAT OF JOURNAL A journal is a book in which transactions are recorded in chronological order. It is called a book of prime entry or original entry. FORMAT OF JOURNAL Date Particulars L.F. Debit Credit Rs. Rs. The date on which transactions have taken place is entered in the date column. Two aspects of the transaction are recorded in the particulars column. A brief description of the transaction is also given in the particulars column. The Ledger Folio (L.F.) column is meant for writing the number of the page in the ledger in which the particular transaction is entered. The amount to be debited is entered in the debit column and the amount to be credited is entered in the credit column.

5.4 STEPS IN JOURNALIZING 1. 2. 3. 4. 5. 6.

Ascertain what accounts are involved in a transaction? Ascertain what is the nature of the accounts involved? Ascertain what rule of debit & credit is applicable for each of the accounts involved? Ascertain what account is to be debited and credited? Record the date of transaction in the date column. Write the name of accounts to be debited & credited (with abbreviation Dr. & Cr.) in particular column. 7. Write narration in brief describing the transaction. 8. Draw a line to separate one journal entry from other. Note:- L.F. column is filled at the time of posting into the ledger.

Illustration 2:XYZ Ltd. received Rs.1,000 from Geet & Co. on 5-1-2001 Recording the journal entry in the books of XYZ Ltd. Step 1 The two accounts involved in the above transaction are (i) money being received, and (ii) the person paying the amount i.e., Geet & Co. Step 2 The nature of the accounts are (i) Real account, and (ii) Personal account respectively. Step 3 (a) The rule applicable to real account is „debit what comes in and credit what goes out‟. In the given transaction, cash is coming in, therefore debit cash account. (b) The rule for personal account is „debit the receiver and credit the giver‟. In the above transaction, Geet & Co. is the giver, therefore credit Geet & Co. Journal Date

Particulars

Let

L.F. Debit. Rs. 1,000

Credit Rs.

5.1.2001 Cash a/c Dr. 1,000 To Geet & Co. a/c (Being cash received from Geet & Co.) apply the rules of debit and credit for a few sample transactions after ascertaining dual aspects Transaction ABC Ltd. received Rs.5,000 from Gupta & Company (In the books of ABC Ltd.)

us

Aspects

Account Reason for Account Reason for the Debited the Debit Credited Credit Aspect 1 cash Cash a/c Cash a/c is Gupta & Co. Gupta & Co a/c is a of Rs.5,000 is a Real a/c. Personal a/c. The received. The rule of rule of „Credit the Aspect 2 The „Debit what giver‟ applies. amount is comes in‟ given by Gupta applies. & Co.

PQR Ltd. Aspect 1 Inventor Inventory purchased Goods of y a/c (or a/c or Rs.6,000 Rs.6,000 are Purchase Purchases worth of received. s a/c) a/c in goods from Aspect 2 The Nominal X Co. goods are a/c. The (In the books supplied by X Rule is of PQR Ltd.) Co. Debt all Expenses.

X Co. a/c

X Co. a/c is a personal a/c. The rule of „Credit the giver‟ applies.

XYZ Ltd. Aspect 1 Salaries Salaries a/c paid the Payment of an a/c is a salaries of expense of Nominal Rs.15,500 to Rs.15,500. a/c. The its staff for Aspect 2 Bank rule of the month balance is „Debit all

Bank a/c

Bank a/c is a personal a/c the rule of „Credit the giver‟ applies

Transaction

Aspects

through bank transfer. (In the books of XYZ Ltd.)

reduced by Rs.15,500.

Account Reason for Debited the Debit expenses‟ applies.

Account Credited

Illustration 3: Journalize the following transactions in the books of Dixit Enterprises. i.Started business with a capital of Rs.7,50,000. ii.Opened a bank account with State Bank of India for Rs.2,00,000. iii.Purchased goods from Tandon & Co. for cash Rs.1,00,000. iv.Purchased goods from Burman for Rs.2,00,000. v.Goods returned to Mr Burman Rs.50,000. vi.Paid Rs.1,40,000 to Mr Burman in full settlement of his dues. vii.Paid Mr Dharam, the landlord Rs.50, 000 towards rent. viii.Withdrew cash for household expenses Rs.60,000. ix.Sold goods to Mr. Karan for cash Rs.2,50,000. x.Sold goods to Mr Dev on credit Rs.1,00,000. xi.Goods returned by Mr. Dev for Rs.25, 000. xii.Received cash from Mr. Dev Rs.70, 000 in full settlement. xiii.Paid cartage on goods purchased Rs.35, 000. xiv.Paid cartage on goods sold Rs.80,000. xv.Purchased furniture for office purpose Rs.1,00,000. xvi.Purchased furniture for re-sale Rs.1, 00,000. xvii.Sold furniture out of those meant for resale Rs.1, 50,000. xviii.Paid rent out of personal cash Rs.40, 000.

Solution:

Reason for the Credit

Date Particulars i. ii.

iii. iv. v. vi.

vii.

viii. ix. x. xi. xii.

xiii. xiv. xv. xvi xvii.

Cash A/c Dr To Capital A/c (Being cash invested in the business) Bank A/c Dr. To Cash A/c (Being cash deposited in the Bank) Purchases A/c Dr. To Cash A/c (Being goods purchased from Tandon & Co. for cash) Purchases A/c Dr. To Burman A/c (Being goods purchased from Burman on credit) Burman A/c Dr. To Returns outward A/c (Being goods returned to Burman) Burman A/c Dr. To Returns outward A/c To Discount Received A/c (Being cash paid to Mr Burman and received discount) Rent A/c Dr. To Cash A/c (Being rent paid in cash) Drawings A/c Dr. To Cash (Being cash withdrawn for household expenses) Cash A/c Dr. To Sales A/c (Being goods sold for cash) Dev A/c Dr. To Sales A/c (Being goods sold to Dev on credit) Returns Inward A/c Dr. To Dev A/c (Being goods returned by Dev) Cash A/c Dr. Discount Allowed A/c Dr. To Dev A/c (Being cash received from Dev and allowed him discount) Cartage Inward A/c Dr. To Cash A/c (Being cartage paid on goods purchased) Cartage Outwards A/ Dr. To Cash A/c (Being cartage paid on goods sold) Furniture A/c Dr. To Cash A/c (Being furniture purchased on cash for office) Purchases A/c Dr. To Cash A/c (Being furniture purchased on cash for re-sale) Cash A/c Dr.

L.F

Debit Rs. 7,50,000

Credit Rs. 7,50,000

2,00,000 2,00,000 1,00,000 1,00,000 2,00,000 2,00,000 50,000 50,000 1,50,000 1,40,000 10,000 50,000 50,000 60,000 60,000 2,50,000 2,50,000 1,00,000 1,00,000 25,000 25,000 70,000 5,000 75,000 35,000 35,000 80,000 80,000 1,00,000 1,00,000 1,00,000 1,00,000 1,50,000 1,50,000

To Sales A/c xviii. (Being furniture meant for resale sold for cash) Rent A/c Dr. To Capital A/c (Being rent paid out of personal cash)

40,000 40,000

Illustration 4: Special transactions: Journalize the following transactions in the Books of Rakesh for the month of January, 2001 Date

Transactions

2.1.2001 8.1.2001 9.1.2001 10.1.2001 11.1.2001 12.1.2001 12.1.2001 25.1.2001

Withdrawn cash for personal use Rs.2,500 Withdrawn goods for personal use (Sale price Rs.1,500, CostRs.1,250) Goods distributed to children in an orphanage (Sale price Rs.2,000 Cost Rs.17,000) Goods distributed as free samples (Sale price Rs.1,200; Cost Rs.1,000) Goods stolen (Sale price Rs.1,000 Cost Rs.800) Goods destroyed by fire (Sale price Rs.1,500 Cost Rs.1,250) Goods used in furnishing the office (Sale prices Rs.2,000 Cost price Rs.1,750) Recovered from Pramod half the amount which was written off as bad Rs.300 was written off as bad earlier. Rs.250 payable by Rakesh was written off as bad.

28.1.200

Solution: In the Books of Rakesh Journal Entries Date

Particulars

2.1.2001

Drawings a/c Dr. To Cash a/c (Being cash withdrawn for personal use) Drawings a/c. Dr. To Purchases a/c (Being goods withdrawn for personal use) Donation a/c Dr. To Purchases a/c (Being goods distributed to the children in an orphanage) Sales Promotion a/c Dr. To Purchases a/c (Being goods distributed as free samples) Loss by Theft a/c Dr. To Purchases a/c (Being goods stolen) Loss by fire a/c Dr. To Purchases a/c (Being goods destroyed by fire) Office furniture a/c Dr. To Purchases a/c (Being goods used in furnishing the office) Cash a/c Dr.

8.1.2001

9.1.2001

10.1.2001

11.1.2001

12.1.2001

12.1.2001

L.F.

Debit Rs.

Credit Rs.

2,500 2,500 1,250 1,250 1,700 1,700

1,000 1,000 800 800 1,250 1,250 1,750 1,750 150

150

25.1.2001

28.1.2001

To Bad Debts Recovered a/c (Being cash recovered out of an amount which was written off as bad earlier) Bad Debts a/c Dr. To Rakesh a/c (Being amount due from Rakesh written off as bad)

250 250

5.5 COMPOUND JOURNAL ENTRY: Sometimes there are a number of transactions on the same date relating to one particular account or of one particular nature. Such transactions may be recorded by means of a single entry instead of passing several journal entries. Such an entry is termed as „compound journal entry‟. It may be recorded in any of the following three ways: (i) One particular account may be debited while several other accounts may be credited. (ii) One particular account may be credited while several other accounts may be debited. (iii) Several accounts may be debited and several accounts may be credited. Illustrations 5: Journalize the following transactions in the Books of Rakesh for the month of January, 2001. Date Transactions 2.1.2001

Purchased goods from Arora at the list price of Rs.8,000. A trade discount of 10% was allowed. 8.1.2001 Sold goods to Flora at a list price of Rs.4,000. A trade discount of 5% was allowed. 15.1.2001 Received a cheque from Flora for Rs.3,600 in full settlement. 20.1.2001 Paid Arora Rs.7,000 by cheque in full settlement. 25.1.2001 Shyam is declared insolvent and received from his official receiver, a first & final dividend of 60 paise in a rupee against a debt of Rs.2,500 Solution: Journal Entries Date 2.1.2001

Particulars

Purchases a/c Dr. To Arora a/c (Being goods purchased from Arora for Rs.8,000 at a trade discount of 10%) 8.1.2001 Flora a/c Dr. To Sales a/c (Being goods sold to Flora for Rs.4,000 at a trade discount of 5%) 15.1.2001 Bank a/c Dr. Discount Allowed a/c Dr. To Flora a/c (Being cheque received from Flora in full settlement)

L.F.

Debit Rs.

Credit Rs.

7,200 7,200 3,800 3,800 3,600 200 3,800

20.1.2001 Arora a/c Dr. To Bank a/c To Discount received a/c (Being cheque paid to Arora in full settlement) Dr. 25.1.2001 Cash a/c Bad Debts a/c Dr. To Shyam a/c (Being 60 paise in a rupee received from Shyam in full settlement of dues)

7,200

7,000 200

1,500 1,000

2,500

5.6 OPENING ENTRY: A journal entry by means of which the balances of various assets, liabilities & capital appearing in the balance sheet of previous accounting period are brought forward in the books of current accounting period, is known as „opening entry‟. Illustration 6: Pass the opening entry in the journal of Ram (as on 1st April 2008): Cash in Hand Rs 50,000, stock of Rs 20,000, land & building Rs 1,0,00,00 plant & machinery Rs 50,000, furniture 20,000 owings from X ltd 15000, loan from Y ltd 10,000. Solution: Date Particulars L.F. Dr (Rs) Cr (Rs) 2008 Cash in hand Dr 50,000 April1 Stock Dr. 20,000 Land & Building Dr. 1,00,000 Plant & Machinery Dr 50,000 Furniture Dr 20,000 To X Ltd 15000 To Loan from Y Ltd 10,000 To Ram‟s capital A/c 2,15,000 (being the balance brought forward from the last year)

5.7 TRADE DISCOUNT V/S CASH DISCOUNT TRADE DISCOUNT: It is a reduction granted by a supplier from the list price of goods or service on business considerations (such as quantity bought, trade practices etc) other than for prompt payment. For example: If a supplier sells goods worth Rs 10,000 at trade discount of 10%, trade discount will be calculated as follows: Price of Goods Rs 10,000 Less: Trade discount Rs 1,000 Amount payable as per invoice Rs 9,000

CASH DISCOUNT: A reduction granted by a supplier from the invoice price in consideration of immediate payment or payment within a stipulated period. Example: If in the above example, terms of payment 2%, 30 days, it means buyer will get 2% cash discount if he makes payment within 30 days. And the cash discount will be calculated as follows: Amount payable as per invoice Rs 9,000 Cash discount Rs 180 Cash paid within 30 days Rs 8,820 Difference between these two discounts can be presented in tabular form as follows: Trade Discount Cash Discount It is a reduction granted by supplier from A reduction granted by supplier from the the list price of goods/ service on business invoice price in consideration of immediate consideration other than for prompt payment or payment in stipulated period. payment It is given to promote sales It is allowed to encourage prompt payment It is allowed on purchase It is given at the time of payment within stipulated time period It is shown in invoice itself. It is not shown in invoice Trade discount account is not opened in It is opened in ledger ledger It may vary with quantity purchased It may vary with the payment period

5.8 LEDGER Ledger contains a classified summary of all transactions recorded in Cashbook and journal. It is the main book of account. Ledger is also called Principal book as final information pertaining to the financial position of a business emerges only from the accounts Format of ledger: Dr. Date Particulars

Account Title J.F. Amou Date Particulars nt

Cr. J.F. Amoun t

The date column records the year, month and date of the transactions. Particulars column records the title of the other account affected. Name of the account in particulars column on the debit and credit side are preceded by the words „To‟ and „By‟ respectively. Journal Folio (J.F.) column records the page number of the journal from which the posting to the ledger has taken place. Amount column on debit and credit side records the amount mentioned in journal entry against the title of the account prepared. Ledger Posting The process of transferring of debits and credits entries from the journal to the ledger is called ledger posting. STEPS IN LEDGER POSTING:

First of all the opening balance (if any) has to be posted. The opening entry for various assets should be posted by writing „To Balance b/f‟on the debit side of the relevant account. Similarly, liabilities accounts should be posted by writing „By Balance b/f‟ on the credit side of the relevant account. 1.

Enter the date of the transaction on the debit side of the relevant account.

2.

The title of the account to be credited is preceded by the word “To” is entered in the particulars column.

3.

In Journal Folio (J.F.) column enter the page number of the journal on which the journal entry is passed.

4.

Amount column records the amount mentioned in the journal against title of the account under consideration.

For posting of the account to be credited, above mentioned steps are followed but with one difference. Now the recording is done on the credit side of the account and in the particulars column title of the amount to be debited is preceded by the word “By”.

Illustration 7 Cash received from Geet & Co. Rs.1,000 on 5.1.2001 Cash a/c To Geet & Co. a/c

Dr

1,000

CASH A/C

Date

Particulars

5.1.2001

To Geet & Co

Dr. Date

Dr. 1,000

Cr

J.F. Amount Date

Particulars

1,000

Geeta & Co A/c Particulars

J.F. Amount

J.F. Amount Date

Cr. Particulars

5.1.2001 By Cash a/c

J.F. Amount 1,000

5.9 BALANCING OF LEDGER After the posting has been completed accounts are balanced. Balancing of an account means to make the total of amounts column appearing on the debit and credit side equal to each other. If the total of debit side is greater than the credit side, the difference between the two sides is known as debit balance and likewise, if the total of credit side is greater, the difference is known as credit balance. The difference is placed on the shorter side, saying “To (or By) balance carried down. The total is written on both sides opposite each other and the account is ruled off. Personal accounts and real accounts like capital accounts, machinery account, building account, etc. are balanced. But nominal accounts representing expenses, revenues and incomes are not balanced. They are transferred to the trading and profit and loss account at the end of the year.

Illustration 8 From the following information prepare the ledger account of Garewal in the books of Rahman and bring down the balance as on 31st January, 2001.

1.1.2001

Sold goods for Rs.1,00,000 less 25% trade discount.

4.1.2001

Garewal paid Rs.40,000 on account, discount allowed Rs.4,000.

6.1.2001

Sold goods for Rs.50,000 less 25% trade discount.

9.1.2001

Received back 1/3rd of the goods sold on 6th January.

15.1.2001

Received cheque for Rs.60,000, discount allowed thereon Rs.6,000.

18.1.2001

Sold goods Rs.2,00,000 less 25% trade discount.

20.1.2001

Bills Receivable accepted by Garewal for Rs.1,00,000.

25.1.2001

Cheque received on 15th January was returned dishonored.

28.1.2001

Received cash Rs.75,000.

Solution: In the Books of Rahman Garewal’s Account Dr. Date

Particulars

J.F. Amount Date Rs.

Particular

Cr. J.F. Amount Rs.

1.1.2001 To Sales A/c 6.1.2001 To Sales A/c 18.1.2001 To Sales A/c 25.1.2001 To Bank A/c Cheque dishonored

25.1.2001 To Discount Allowed Cancellation of discount

75,000 4.1.2001 By Cash A/c 37,500 4.1.2001 By Discount Allowed a/c By Returns Inward 1,50,000 9.1.2001 By Bank A/c 15.1.2001 By Discount Allowed 60,000 15.1.2001 A/c By Bills Receivable A/c By Cash a/c By Balance c/d 28.1.2001 6,000 31.1.2001

3,28,500 1.2.2001 To Balance b/d

40,000 40,000 12,500 60,000 6,000 1,00,000 75,000 31,000

3,28,500

31,000

Test Exercise:Problem 1. Journalize the following transactions: i. Ganesh Started his business with Rs 20,000 ii. Borrowed Rs 5,000 from Mahesh. iii. Deposited into the bank Rs 10,000. iv. Purchased Fixed Assets for Rs 5,000 v. Bought goods for Rs 1,500. vi. Sold goods for Rs 9,000. vii. Purchased goods on credit from Ramesh for Rs 20,000. viii. Sold goods on credit to Shyam fro Rs 12,000. ix. Received Rs 11,880 from Shyam after allowing him cash discount Rs 120. x. Paid Rs19,800 to Ramesh after receiving cash discount Rs 200. xi. Withdrew goods worth Rs 1000 for personal use. xii. Cash withdrew from bank for personal purpose Rs 1000 Problem 2: Journalize: 1. March 1, 08 Received a cheque from Ramesh & Co to whom goods were sold for Rs 2000 last year, allowed his 1% discount. 2. March 2,08 Ramesh & co‟s cheque deposited into bank. 3. March 5, 08 Ramesh & Co‟s cheque dishonored (bank charged Rs 10) 4. March 20 Ramesh & Co settled his A/c by means of a cheque for Rs 2025, Rs 15 being for interest charged.

5. March 22, 08 Paid rent of building Rs 12000, half of the building is used by the proprietor for residential use. Problem 3: Journalize: 1. March 21, 08 Purchased machinery from Rajiv for Rs 5000 and paid him by means of bank draft purchased from bank for Rs 5020. 2. March 22, 08 Discounted a bills of exchange for Rs 10,000 at 1% through bank. 3. March 24, 08 Honored our acceptance in favour of Shyam by cheque Rs 5000. 4. March 25, 08 Received payment of a loan of Rs 5000 and deposited Rs 3000 out of it into bank. 5. March 28, 08 Supplied goods costing Rs 600 to Mohan & issued invoice at 10% above cost & allowed 5% 6. Received an order of goods for Rs 40,000 from Ram. 7. Paid s 150 in cost as wages for installation of Machine. 8. Sold goods to Kitty. List price is 10,000. Sales is subject to 10% trade discount. And 5% cash discount if payment is made immediately. Kitty availed of cash discount. 9. goods worth Rs 4200 distributed as samples.

End Term Quizzes Select the most appropriate answer: Q1 Which of the following is an example of personal account?: (a) (b) (c) (d)

Machinery Cash Rent Creditor

Q2 Payment of salary is recorded by: (a) (b) (c) (d)

Debiting salary A/c, crediting cash a/c Debiting cash A/c, crediting salary a/c Debiting employee a/c, crediting co a/c None of the above

Q3 Journal is a: (a) (b) (c) (d)

Book of original entry Classified summary of all transactions Permanent record Both (a) & (b) above

Q4 Purchase of goods on credit from A is recorded as: (a) (b) (c) (d)

Debit purchase A/c, credit cash a/c Debit purchase A/c, credit A‟s A/c Debit A‟s A/c, Credit purchase A/c Debit Cash A/c, credit purchase A/c

Q5 Goods returned from X is entered as: (a) (b) (c) (d)

Debit X A/c, credit purchase return A/c Debit X A/c, credit cash a/c Debit sales return a/c, credit X‟s A/c Debit X‟s A/c, credit sales A/c

Q6 Trade discount allowed at the time of sale of goods: (a) (b) (c) (d)

Is recorded in sales book Is recorded in cash book Is recorded in journal Is not recorded in books of account

Q7 XYZ Ltd. paid wages of Rs.8,000 for erection of machinery. The journal entry for the transaction is: (a) (b) (c) (d)

Debit wages & credit cash a/c Debit Machinery A/c & Credit cash A/c Debit cash a/c, credit wages a/c Debit machinery a/c & credit

Q 8 The process of balancing of an account involves equalization of both sides of the account. If the debit side of an account exceeds the credit side, the difference is put on the credit side. The said balance is i. A debit balance, ii. A credit Balance iii. It represents either expenditure or an asset or both iv it is either income or liability or both: (a) (b) (c) (d)

Only (i) above Only (ii) above Both (i) & (iii) above Both (ii) & (iii) above

Q9 Which of the following statements is/are true? i. Drawings account is a nominal account. ii. Capital account is a real account. iii. Salaries account is a nominal account. iv. Outstanding salaries account is a nominal account. v. Patents account is a personal account. (a) Both (i) & (ii) (b) Only (iii) (c) (i), (ii) & (iii) (d) (iv) &(v) Q10 The entry to record the collection of cash from sundry debtors would involve a i. Debit to sundry debtors ii. Debit to cash account iii. Credit to sundry debtors iv. Credit to cash account.: (a) (b) (c) (d)

Only (i) above Only (ii) above Only (iii) above Both (ii) & (iii) above

CHAPTER 6 SUBSIDIARY BOOKS I- CASH BOOK At the end of this chapter you will be conversant with: 6.1 Meaning 6.2 Advantages 6.3 Meaning of Cash book 6.4 Types of cash book:- Single Column, Double Column, Triple Column & Petty Cash book 6.5 Contra Entry

6.1 MEANING OF SPECIAL JOURNALS OR SUNSIDIARY BOOKS: When the number of transactions is large, it is practically impossible to record all the transactions through one journal. Special journal refer to journals meant for specific transactions of similar nature. Special journals are also known as subsidiary books or day books. The Performa & number of special journals vary according to the requirements of each enterprise. In any large organization following special journals are generally used: Name of special journal 1 Cash Journals (a) Simple cash book (b) cash book with discount column © cash book with bank & discount column (d) petty cash book 2 Goods Journals (a) Purchase book (b) Sales book © Sales return book (return inward book)

Specific transactions to be recorded Cash transactions Cash & discount transactions Cash, bank & discount transactions Petty cash transactions

Credit purchases of goods Credit sales of goods Goods returned by those customers to whom goods were sold on credit (d) Purchase return book (return outward Goods returned to those customers from book) whom goods were purchased on credit 3. Bills Journals (a) Bills receivable book Bills receivable drawn (b) Bills payable book Bills payable accepted Those transactions which do not fall within 4 Journal Proper the scope of special journal

6.2 ADVANTAGES OF SPECIAL JOURNALS (SUBSIDIARY BOOKS) 1. 2. 3. 4.

Facilitates division of work Permits the installation of internal check system Permits the use of specialized skill Time & labour saving in journalizing & posting

6.3 CASH BOOK Cashbook is a special journal in which all cash transactions are recorded directly. Cashbook shows the cash receipts and the cash payments. The Cashbook resembles a ledger with the debit and credit sides, and the balance represents cash on hand at the end of the accounting period. As soon as the cash transaction takes place, it is recorded in the Cashbook. Cash account is not opened separately, when a Cashbook is maintained because Cashbook serves the purpose of the ledger also. Conceptual framework is presented for Financial Accounting in the following figure: Figure: Conceptual Framework and Financial Accounting

In other words: The subject of Financial Accounting is based on the double entry system of accounting using debits and credits. Cash transactions are entered in Cashbook. Credit transactions (non-cash transactions) are entered in the Journal. The transactions of Cashbook and journal are integrated into the Ledger, which is a summary of all cash and credit entries. When all the ledger accounts are tabulated as a summary statement it is known as „Trial Balance‟.

Trial Balance establishes the arithmetical accuracy of the accounting records. From the trial balance two separate accounting documents are prepared namely Profit and Loss Account and Balance Sheet. All income and expenditure accounts are taken to Profit and Loss Account. All assets and liabilities accounts are taken to Balance Sheet. The net result of Profit and Loss Account namely Profit or Loss is taken to Balance Sheet. Thus the Balance Sheet tallies. The recording of transactions in the books of accounts may be represented as in Figure 3.5. Figure 3.5: Recording of Transactions

6.4 TYPES OF CASH BOOK 1.

Simple Cashbook/Single Column Cashbook

2.

Double Column Cashbook

3.

Three Column Cashbook

4.

Petty cash book

1. SIMPLE CASH BOOK: In simple Cashbook all the cash transactions are recorded in chronological order. All cash receipts are entered on the debit side and cash payments on the credit side of the Cashbook. The difference between the two sides is the cash in hand. Illustration: Prepare a single column Cashbook of Raja Ram from the following particulars:

1.1..2001

He commenced business with Rs 1,00,000of which 20,000 was borrowed from Mr Basant

2.1.2001

Purchased furniture for office use worth Rs 5,000

3.1.2001

Paid petty cash expenses of Rs.2,000.

4.1.2001

Bought goods from Mohan for cash Rs.20,000.

4.1.2001

Paid Rs.20,000 to Charat for goods purchased on credit.

5.1.2001

Sold goods to Shyam for cash Rs.10,000. Received Rs.38,000 from Hari for goods sold on credit.

16.1.2001

Drew cash for personal use Rs.1,000.

31.1.2001

Paid salary to Sri Ram, an employee, Rs.1,500.

31.1.2001

Repaid the loan taken from Mr. Basant including interest @18% p.a.

Solution: Cash book Dr. Date

Cr. Particulars

1.1.2001. To Capital a/c 1.20011 To Loan from Basant a/c 5.1.2001 To Sales 5.1.2001 To Hari‟s a/c

LF

Rs.

Particulars

LF

Rs.

80,000 2.1.2001 By Furniture a/cBy 20,000 3.1.2001 Petty Expenses a/c

5,000 2,000

10,000 4.1.2001 By Purchases a/c 38,000 4.1.2001 By Charat a/c 16.1.2001 By Drawings a/c 31.1.2001 By Salary a/c 31.1.2001 By Interest on Loan a/c 31.1.2001 By Loan from Basant a/c 31.1.2001 By Balance c/d 1,48,000

To Balance b/d

Date

20,000 20,000 1,000 1,500 300 20,000 78, 200 1,48,000

78,200

2. Double Column Cashbook (Cashbook with cash and discount columns) This Cashbook is an extension of simple Cashbook. An additional column is maintained to record discount involved in the settlement of debtors and creditors in the double column Cashbook. Cash discount usually occurs in the settlement of trade debts. It is an allowance made by the receiver of cash to the payer for the prompt payment. Cash received from debtors is recorded in the cash column and discount allowed in the discount column on the debit side of the Cashbook. Similarly, credit side of the Cashbook records cash paid to the creditors in cash column and discount received in the discount column Double column cashbook also can be with cash and bank columns. In this type of cashbook, the transactions involving cash and transactions involving receipts and payments by cheques are recorded. It facilitates and enables the business to maintain both cash and bank accounts simultaneously. Illustration: Compile Cashbook with discount column from the following transactions for the month of March, 2001

1.3.2001

Mr. Ganesh commenced business with cash Rs.65,000.

3.3.2001

Bought goods for cash Rs.6,850.

4.3.2001

Paid Mr. Mohan cash Rs.950; discount was allowed thereon Rs.50.

6.3.2001

Deposited in bank Rs.40,000

6.3.2001

Paid for office furniture by cash Rs.4,650.

9.3.2001

Sold goods for cash Rs.30,000.

12.3.2001

Paid wages by cash Rs.1,200.

13.3.2001

Paid for stationery Rs.400.

15.3.2001

Sold goods for cash Rs.25,000.

17.3.2001

Paid for Miscellaneous expenses Rs.450.

19.3.2001

Received cash from Mr. Tilak 4,850; Allowed him discount Rs.150.

21.3.2001

Purchased a radio set for Rs.2,500 for personal use.

22.3.2001

Paid salary Rs.4,000.

25.3.2001

Paid rent Rs.900.

28.3.2001

Paid electricity bill Rs.350.

29.3.2001

Paid advertising expenses Rs.400.

31.3.2001

Paid into bank Rs.25,000.

Solution: CASH BOOK Date

Particulars

1.3.2001 To Capital 9.3.2001 A/c 15.3.2001 To Sales A/c 19.3.2001 To Sales A/c To Tilak A/c

LF Discount Rs.

150

150

Cash Rs.

L.F Discount Rs.

Date

65,000 30,000 25,000 4,850

3.3.200 By Purchases 14.3.2001 a/cBy Mohan a/c 6.3.200 By Bank a/c 16.3.2001 By Office Furniture a/c 12.3.2001 By Wages a/c 13.3.2001 By Stationary a/c 17.3.2001 By Miscellaneous Expenses a/c 21.3.2001 By Drawings a/c 22.3.2001 By Salary a/c 25.3.2001 By Rent a/c 28.3.2001 By Electricity a/c 29.3.2001 By Advertising a/c 31.3.2001 By Bank a/c 31.3.2001 By Balance c/d

1,24,850

50

Cash Rs. 6,850 950 40,000 4,650 1,200 400 450 2,500 4,000 900 350 400 25,000 37,200

50

1,24,850

3. Three Column Cashbook (Cashbook with cash, discount and bank columns) With the development of banking sector, and frequent use of banking instrument, Cashbook with additional column for bank transactions came into existence. Thus, the three column Cashbook is nothing but ledger accounts for cash and bank with additional information about discount allowed and discount received. An illustrative format of this type of Cashbook is given below: Cashbook of Excellent Enterprises Dr. Date

Receipts

Discount Cash allowed

Bank

Date

Payments

Cr. Discount Cash received

Bank

2001 April, 1 6 7 11 20

2001 1,500 13,000 April, 2

To Balance b/f

800 To Sales To Arvind Co

50

2,000

60

2,350 500

5 8 15 30

By Wage for Casual Sweeper By Electricity By Plumbing Repairs By Y Ltd. By Balance c/f

50 400 400 150 2,350

10,800 6,150

To Beta Corpn To sales

110

2,800

17,350

150 2,850 17,350

The Cashbook normally carries columns for Cash Memo No., Ledger Folio No., Voucher No., etc. The unique feature of the Cashbook is that it performs the functions of a Journal and the General Ledger with regard to the cash and bank transactions. In other words, Cashbook is the book of first entry for all such transactions and the ledger accounts for cash in hand and cash at bank will not be maintained in the General Ledger.

4. PETTY CASHBOOK: When the petty cash fund is operated as an imprest fund, the recording of the petty expenses paid will be made in the Petty Cashbook. This would also avoid recording too many small value transactions in the main Cashbook. The Petty Cashbook would contain a number of analytical columns for grouping the various expenses under a few classifications which would facilitate subsequent posting into the General Ledger. THE IMPREST SYSTEM

:

When an analytical Petty Cashbook is maintained for recording the petty expenses, it will be practically more convenient to consider the petty cash as a separate account and take cheques issued for the petty cash imprest as a debit to petty cash account and all petty expenses paid as credits in petty cash account.

6.5 CONTRA ENTRIES If a transaction affects both cash account and bank account in the opposite sides, the entry for recording the transaction is called a contra entry. Entries which are made on both sides of the Cashbook are called contra entries. For contra entries no posting is required because the double entry is completed in the Cashbook itself. For example, cash deposited into bank and cash withdrawn from bank affect cash and bank account only. Both aspects of these transactions are recorded in cash column and bank column of the Cashbook respectively. No ledger posting is required, because both aspects of the transaction are recorded in the Cashbook itself. This fact is indicated in the Cashbook by writing „C‟ in L.F. column

Illustration

1.3.2001

Cash in hand

2,500

Cash at bank

10,000

2.3.2001

Paid into bank

1,000

5.3.2001

Bought furniture and issued cheque

2,000

8.3.2001

Purchased goods for cash

500

Received cash from Mohinder

980

12.3.2001

Discount allowed to him

20

14.3.2001

Cash Sales

4,000

16.3.2001

Paid to Amaranth by cheque

1,450

Discount received

50

19.3.2001

Paid into Bank

400

23.3.2001

Withdrawn from Bank for private expenses

600

24.3.2001

Received cheque from Patel allowed him discount

28.3.2001

Withdrawn cash from bank for office use

30.3.2001

Paid rent by cheque

1,430 20 2,000 800

Solution:

CASH BOOK

Dr. Date

Cr. Particulars

LF Discount Cash Allowed

Bank

Date

1.3.2001

To Balanceb/f

-

- 2,500 10,000

2.3.2001

2.3.2001

To Cash a/c

C

-

1,000

5.3.2001

12.3.2001 To Mohinder a/c

-

20

980

-

8.3.2001

14.3.2001 To Sales a/c

-

-

4,000

-

16.3.2001

19.3.2001 To Cash

C

-

-

400 19.3.2001

-

1,430 23.3.2001

24.3.2001 To Patel a/c 28.3.2001 To Bank

20 C

-

2,000

28.3.2001 30.3.2001

Particulars By Bank a/c By Furniture a/c By Purchases a/c By Aamranth a/c By Bank a/c By Drawings a/c By Cash a/c By Rent a/c By Balance c/d

LF Discount Cash C C

C

– 50 -

30.3.2001 31.3.2001 To Balance b/d

40 9,480 12,830 7,580 5,980

-

Problem 1 Record the following transactions in Three Column Cash book: Balances: Cash Rs 500 and Bank (cr) Rs 12000. Investment additional capital of Rs 12000. Deposited Rs 8000 in the bank. Received from Roy Rs 890, allowed him discount Rs 5. Paid Rs 1200 to Ghose who allowed us discount of Rs 30. Bought merchandise for cash Rs 1000. purchased furniture by cheque Rs 1500. received a crossed cheque of Rs 230 from Sundram in full settlement of debt of Rs 240. Paid commission Rs 150 by cheque. Withdrew for personal use Rs 300. Paid to Krishnan Rs 700 by cheque, discount received Rs 20. Withdrew for personal use Rs 300. received dividend by an order cheque Rs 30, deposited in the bank on the same day. cleared telephone bill Rs 50.

Jan 31 paid manager‟s salary Rs 350, rent Rs 200 & wages Rs 150.

1,000 – 2,000 500 1450 400 600 -2,000 7580 800 5,980

40 9,480 12,830 -

Test Questions:

1996 Jan 1 Jan 2 Jan 5 Jan 8 Jan 12 Jan 15 Jan 18 Jan 19 Jan 22 Jan 25 Jan 26 Jan27 Jan 29 Jan 30

Bank

MULTIPLE CHOICE QUESTIONS: Choose the most appropriate answer: Q1 Which of the following statements is/are true? i. Cash book records all cash receipts and cash payments. ii. Cash book records all sale and purchase transactions of goods both in cash and on credit. iii.Cash book records discount on cash payments. (a) Only (i) (b) Only (ii) (c) Only (iii) (d) Both (i) & (iii) Q2 The periodical total of discount column on receipts side of a triple column cash book is recorded to the: (a) Credit side of discount column (b) Credit side of provision of discount column (c) Debit side of discount column (d) Credit side of debtor‟s account Q3 Which of the following statements is false? (a) Credit side of total of discount column is an income (b) Debit balance of bank column is a liability (c) Debit balance of cash column is an asset (d) None of the above Q4 Cash book is used to record (a) All receipts only (b) All payment only (c) All cash & credit sale (d) All receipts & payments of cash Q5 Single column cash book may show: (a) Only debit balance (b) Only credit balance (c) Either debit or credit balance (d) None of the above Q6 When a cheque is received on a particular dale is not deposited into bank on the same dale, it is entered in: (a) Cash column on the debit side (b) Bank column on debit side (c) Cash column on credit side (d) Bank column on credit side Q7 When a cheque is returned dishonored, it is recorded in: (a) Cash column on credit side (b) Cash column on debit side (c) Bank column on credit side (d) Bank column on debit side Q8 If the debit as well as credit aspects of a transaction are recorded in the cash book itself, it is called: (a) An opening entry (b) A compound entry

(c) A transfer entry (d) A contra entry Q9 Which is not a contra entry: (a) Cash deposited into bank (b) Cash withdrew from bank (c) Cash withdrew from bank for personal use (d) None of above Q 10 Bank column may show: (a) Only a debit balance (b) Only a credit balance (c) Either debit balance or credit balance (d) None of above

CHAPTER 7 SUBSIDIARY BOOK II- OTHER BOOKS At the end of this chapter you will be conversant with: 7.1 Meaning 7.2 Purchase Book 7.3 Purchases Returns Book 7.4 7,5 7.6 7.7 7.8

Sales book Sales return book Bills receivable Book Bills payable book Journal Proper

7.1 MEANING The Books of Accounts maintained by an organization other than the Cashbook may be classified into Journals and Ledgers. The Journal is used as the book of first entry for all transactions which cannot be recorded in the Cashbook. In other words, all non-cash transactions should be recorded in the journal. The journal is inadequate as the single book of the original entry when the transactions are voluminous in number. The journal is divided into divisions and they are commonly termed as subsidiary books. Some of the subsidiary books are: i.Purchase Book ii.Purchase Returns Book iii.Sales Book iv.Sales Returns Book v.Bills Receivable Book vi.Bills Payable Book vii.Journal Proper.

7.2 PURCHASE BOOK Also known as the Purchases Journal, this book is used to record credit purchases of goods only. The term „goods‟ covers only those items procured by the business for resale. A simple format of purchase book is given below:

Purchase book of XYS Ltd Particulars Ledger Inward (Name of Supplier, etc.) Folio Invoice No.

Date

Amount Rs.

2001 April 2 12

Y Limited Sharp Enterprises

3354

10,950

401

2,700

20

Best and Company

5542

3,900

Total

17,550

7.3 PURCHASES RETURNS BOOK: This subsidiary book is used to record the goods purchased on credit and sent back to suppliers as not conforming to specifications or for any other reason. simple format of purchase return book is given below: Date

Purchase return book of XYZ Ltd

Name of Supplier

2001 April, 15 25

Ledger Folio

Debit Note No.* 80 81

Sharp Enterprises Best and Company

Total

Amount Rs. 1,000 900

1,900

* Debit note is document prepared by the purchaser to inform the supplier that his account has been debited with the amount mentioned & for reason stated therin. Debit note contains the date of return, name of supplier to whom the goods has been returned, details of goods. Each debit note is serially numbered.

7.4 SALES BOOK: Also known as the Sales Journal, this subsidiary book is used to record the sale of goods on credit. simple format of sales book is given below: SALES BOOK OF XYZ Ltd Date

Name of Customer

2001 April,3 5 6 15 25

Beta Corporation Zeta Company Quality Dealers Sooraj Traders Star Enterprises

Ledg er Folio

Outwar d Invoice No. 1001 1002 1003 1004

Amount Rs.

2,410 3,940 4,900 1,800

1005

19,500

Total

32,550

7.5 SALES RETURNS BOOK : This book is used to record the transactions relating to goods sold on credit and received back from the customers as not conforming to the specifications or for any other reason. Simple format of sales return book is given below SALES RETURN BOOK OF XYZ LTD Date

Name of Customer

2001 April,1 0 27

Ledger Folio

Zeta Company Star Enterprises

Credit Note No.* 10 11

Total

Amount Rs.

540 2,000 2,540

* A credit note is a document prepared by the seller to inform the buyer that his account has been credited with the amount mentioned & for he reason stated therein.

7.6 BILLS RECEIVABLE BOOK The Bills Receivable of an enterprise consists of all Promissory Notes given or Bills of Exchange accepted by customers in respect of amounts due from them. The bills receivable book is used to record all promissory notes given or Bills of Exchange accepted by customers Simple format of Bill Receivable Book is given below: BIILS RECEIVABLE BOOK OF XYZ LTD S. No . 1

Date

2001 April 12

2 April 18

From Acceptor whom receive d Quality Quality Dealer Dealers s Sooraj Trader s

Sooraj Traders

Date of Bill

Ter m

Date of Maturity

L F

Where Payable

8.4.01

90 days

10.7.01

Bank of India, Mumbai

16.4 X 1

60 days

10.6.01

Union Bank, Mumbai

Amount Rs.

4,900

1,800

6,700

How Disposed

Discounted on 20.4.01

7.7 BILLS PAYABLE BOOK The Bills Payable consists of all Promissory Notes given or Bills of Exchange accepted by the business in respect of amounts owing to its suppliers. The Bills Payable Book is used to record all such Promissory Notes given or Bills of Exchange accepted by the business. Simple format of Bill Payable Book is given below:

BIILS PAYABLE BOOK OF XYZ LTD S. No .

Date Accepte d

1

2001 April 25

Name of the drawer

Payee

Date of Bill

Ter m

Date of Maturity

Best & Co.

Best & Co.

25.04.01

90 days

27.07.01

L F

Where Payable

Amount Rs.

Bank of India, Mumbai

Remarks

4,900

7.8 JOURNAL PROPER This book is used to record all transactions which cannot be included in the Cashbook or any of the other six subsidiary books discussed so far. The transactions that will be recorded in journal proper are, purchase or sale of fixed assets and investments on credit, adjusting entries, rectification entries, etc. Format Given below: JPURNAL PROPER OF XYZ LTD Date Particulars Doc. Ref. Ledger Debit Credit Folio Rs. Rs. 2001 Furniture and Fittings a/c Dr. April,10 To Furniture Marta/c

4,000 4,000

(being the purchase of furniture on credit) April,30 Repairs to Machinery a/c Dr.

500

To Machinery a/c

500

(being the rectification of a wrong posting of a repair expense to asset a/c) We will now take up the transactions of a business during a month and study how they will be recorded in the various subsidiary books of accounts: ILLUSTRATION: During January 2001, Narayan transacted the following business: Dat e

Rs.

1.

Commenced business with cash

40,000

2.

Purchased goods on credit from Shyam

30,000

3.

Purchased goods for cash

1,000

4.

Paid Gopalan an advance for goods ordered

2,000

Dat e

Rs.

5.

Received cash from Murthy as advance for goods ordered by him

3,000

6.

Purchased furniture for office use for cash

2,000

7.

Paid wages

500

8.

Received commission (in cash)

600

9.

Goods returned to Shyam

200

10.

Goods sold to Kamal

10,000

11.

Paid for postage and telegrams

200

13.

Goods returned by Kamal

500

15.

Paid for stationery

200

18.

Paid into bank

500

20.

Goods sold for cash

22.

Bought goods for cash

25.

Paid salaries

28.

Paid rent

31.

Drew cash for personal use

750 1,000 700 500 1,000

SOLUTION: Cashbook Dr. Date

Cr. Receipts

Le dg er Fol io

Cash Rs.

Bank Rs.

2001

Date

Payments

Le dg er Fol io

Cash Rs.

Bank Rs.

2001

Jan. 1

To Capital a/c

40,000

Jan. 3

By Purchases a/c

1,000

Jan. 5

To Murthy a/c

3,000

Jan. 4

By Gopalan a/c

2,000

Jan. 8 Jan.18

To Commission a/c

600

Jan. 6

By Furniture a/c

2,000

Jan. 7

By Wages a/c

Jan.20

To Cash a/c

Jan.12

By Postage & Telegrams a/c

C 750

500

To Sales a/c

500 200 200

Jan.15

By Stationery a/c

Jan,18

By Bank a/c

Jan.22

By Purchases a/c

Jan,25

By Salaries a/c

700

Jan.28

By Rent a/c

500

Jan.31

By Drawings a/c

1,000

Jan.31

By Balance c/d

34,750

C

500 1,000

500

Date

Receipts

Le dg er Fol io

Cash Rs.

Bank Rs.

44,350

Date

Payments

500

Le dg er Fol io

Cash Rs.

44,350

Bank Rs.

500

Note: The letter „C‟ in the Ledger Folio column denotes a „contra entry‟. That is an entry for which the debit and credit aspects are found in the Cashbook itself

Purchases Book

Date

Name of Supplier

Ledger Folio

Inward Invoice No.

Amount Rs.

2001 Jan.2

Shyam

30,000 330,000 Total

Purchases Returns Book

Date

Name of Supplier

Ledger Folio

Debit Note No.

Amount Rs.

2001 Jan. 9

Shyam

200 200

Total Sales Book Name of Customer 200 1

Ledger Folio

Outward Invoice No.

Kamal

Amo unt Rs. 10,0 00

Jan. 10 Total

10,0 00

Sales Returns Book Name of Customer 2001 Jan. 13

Ledger Folio

Credit Note No.

Amoun t Rs.

Kamal Total

500 500

End Chapter Quizzes Choose the most appropriate answer: Q (1) Purchase book is maintained to record: (a) Purchase of goods (b) All cash purchases (c) All credit purchases (d) All credit purchases of goods Q (2) The periodical total of purchase book is posted to the: (a) Debit of purchase a/c (b) Debit of sales a/c (c) Credit of purchase a/c (d) Credit of cash a/c Q3 sales book is mainained to record: (a) Credit sales of goods only (b) Cash sales of goods only (c) All credit sales (d) Both (a) & (c) Q4 the periodical total of the sales book is posted to the: (a) Debit of sales a/c (b) Credit of sales a/c (c) Credit of cash a/c (d) Credit of customer‟s a/c Q5 Return inward book is maintained to record: (a) Return of goods purchased (b) Return of goods sold (c) Return of anything purchased (d) Return of anything sold Q6 Return inward book‟s periodical total is posted to: (a) Credit of return inward a/c (b) Debit of return outward book (c) Debit of return inward a/c (d) Credit of supplier Q7 The debit notes are used to prepare: (a) Sales book (b) Sales return book (c) Purchase return book (d) Purchase book Q8 Closing entries are recorded in: (a) Cash book (b) Ledger (c) Journal proper (d) Balance sheet Q9 Cash book is: (a) Ledger a/c (b) A book of original entry (c) Journal as well as ledger

(d) None of these Q10 When a customer returns the goods: (a) An invoice is sent to him (b) A debit note is sent to him (c) A credit note is sent to him (d) Both (a) & (b) above

CHAPTER 8- BANK RECONCILIATION STATEMENT At the end of this chapter you will be conversant with: 8.1 Meaning of BRS

8.2 Reasons for difference between Bank Balances as per Cashbook and Passbook 8.3 Advantages of Bank Reconciliation Statement 8.4 Steps in Preparation of BRS

8.1 MEANING: The Bank Reconciliation Statement is an aid used to ensure the accuracy of transactions appearing in the bank columns of the Cashbook. Such transactions can be verified through an external record, namely, the bank statement received periodically from the banker. While the business keeps a record of its transactions through the bank columns in the Cashbook, the banker in turn maintains the bank‟s transactions with the business in his ledger. An extract from this ledger showing details of the transactions during a specified period is sent at frequent intervals by the bank to the business and this extract is referred to as a bank statement.

8.2 REASONS FOR DIFFERENCE BETWEEN BANK BALANCES AS PER CASHBOOK AND PASSBOOK: The relationship between the customer and the banker is that of a creditor and a debtor. So, if the bank column of the Cashbook shows a debit balance as on a specified date the bank statement should show an equal amount of credit balance as on that date and vice versa. However, the balances shown by the two independent records may not always agree due to the following: 1.

Cheques issued by the business to its suppliers or other parties may not have been presented for payment.

2.

Cheques received from customers and deposited may not have been collected by the banker.

3.

Deposits may have been directly made by the customers into the bank account of the enterprise.

4.

Collection charges, service charges and interest on overdraft are charged by the banker. The business can ascertain the exact amount of charges and record them in the Cashbook only after the receipt of the bank statement.

5.

Interest credited by bank for the balance maintained with it and any other income such as interest on securities, dividend, etc. collected by the bank on behalf of the business can be ascertained only from the bank statement.

6.

Wrong entries made by the business in the Cashbook or errors committed by the bank in its ledger.

7.

Omission of entries in the two sets of books.

8.

Dishonor of customer‟s cheques deposited in the bank account

8.3 Advantages of Bank Reconciliation Statement (1) Error Detection: It helps in detection of errors of omission of transactions or wrong recording of transactions either by the bank or the business enterprises. Errors identified in the books by preparing BRS can be rectified. (ii) Delay in Collection Revealed: The delay in the collection of cheques, bills, etc., if any, is revealed, when BRS is prepared. The matter can be pursued to avoid unnecessary delays in collection. It also helps the management to keep track of the cheques and bills sent for collection. (iii) Completion of Cashbook: Business enterprises get information about bank charges, cheques dishonored, direct payments, direct deposits, etc. from the bank statement only. Entries of the same are made in the Cashbook on the basis of bank statement. Thus to complete the Cashbook, comparison and reconciliation of Cashbook and bank book is essential. (iv) Chances of Embezzlements are Reduced: Periodical comparison of Cashbook and passbook keeps a check on the office staff. For example, entry for cash deposit is appearing in the Cashbook but not in the passbook, indicates fraud being committed by the staff. This type of frauds come to light when Bank Reconciliation Statement is prepared.

8.4 Steps in Preparation of BRS (1) Take the Cashbook or passbook balance as starting point. The following points have to be noted while taking the opening balance. 1.

Dr. balance as per Cashbook indicates favorable balance.

2.

Cr. balance as per Cashbook means overdraft or unfavorable balance.

3.

Dr. balance as per passbook means overdraft or unfavorable balance.

4.

Cr. Balance as per passbook means favorable balance.

If the starting point denotes a favorable balance as per Cashbook or passbook, take it as a positive figure. However, if the starting point denotes negative unfavorable balance, take it as a negative figure. (2) Adjust the starting point amount as per the information given and analyze its impact on the other balances. (3) After adjusting all the differences or errors, the balance as per the other book is obtained. If the final balance is positive, it denotes favorable balance (Dr. balance as per Cashbook or credit balance as per the passbook). However, if the final balance is negative, it denotes the unfavorable balance or overdraft. (Cr. balance as per Cashbook or debit balance as per passbook). The following table summarizes the impact of various differences and errors on the starting balance.

Bank Reconciliation Statement (BRS) Items

Rs

Rs

Bank Balance as per Cashbook Or

xxxx

Overdraft balance as per Passbook Add: 1 2 3 4 5

Cheques issued but not presented for payment Direct payments made by customers Amount collected by bank (rent, dividends, interest on investments, etc.) Cheques deposited but omitted to be recorded in Cashbook

xxxx

Wrong credit on the credit side of Passbook

xxxx

xxxx xxxx xxxx

xxxx 1

xxxx

5

Less: Cheques deposited but not collected Cheques paid into the bank but dishonored Bank charges and interest charges Payments made by the banker on behalf of the trader Cheques issued but not recorded in the Cashbook

6

Wrong entry on the debit side of the passbook

xxxx

2 3 4

xxxx xxxx xxxx xxxx Xxxx

Balance as per other book Illustration:

xxxx

On March 31, 2001, the bank column of Cashbook of Prithvi Limited showed a bank balance (debit) of Rs.48,500. However, the bank statement showed a credit balance of Rs.53,900 as on the same date. A detailed comparison of entries revealed the following: 1.

Customers‟ cheques amounting to Rs.8,450 had not been collected by the bank as on 31.3.2001.

2.

Certain cheques amounting to Rs.8,850 had not been presented for payment as on 31.3.2001.

3.

Bank charges of Rs.1,000 and interest on investments of Rs.2,500 collected by the banker appear only in the bank statement.

4.

On 30.3.2001, there was a wrong credit of Rs.2,500 in the bank statement.

5.

Swaroop Limited, a customer, had paid into the bank directly a sum of Rs.3,000 on March 29, 2001. This has not been recorded in the Cashbook.

6.

A cheque for Rs.2,000 received from Excel Limited, a customer, which was deposited had been returned unpaid. The dishonor of this cheque has not been entered in the Cashbook.

Solution: Prithvi Limited will first pass the necessary rectification entries in the Cashbook and then prepare a reconciliation statement

Cashbook of Prithvi Limited (Bank Columns only)

Date

Receipts

Bank

Date

Payments

Bank

Rs. 2001

Rs. 2001

March,31

To Balance b/d

48,500 March,31

By Bank Charges

1,000

March,31

To InterestReceived

2,500 March,31

By Excel Limited

2,000

March,31

To SwaroopLimited

3,000 March,31

By Balance c/d

54,000

51,000

54,000

Bank Reconciliation Statement as on March 31, 2001

Particulars

Rs.

Rs.

Bank balance as per Cashbook Add: Cheques issued but not presented for payment Wrong credit in the bank statement Less: Cheques deposited and remained uncollected Bank balance as per bank statement

51,000 8,850 2,500

11,350 62,350 8,450 53,900

Test Questions: Problem 1. From the following particulars, prepare a Bank Reconciliation Statement as on 31st December, 2007: Balance as per Cash book Rs 5,800. Cheques issued but not presented for payment RS 2,000. Cheques sent for collection but not collected up to 31st December,2007 rs 1500. The bank had wrongly debited the account of the firm by Rs200, which was rectified by them after 31st December. Balance as per Pass book is Rs 6,100. Problem 2: Prepare a Bank reconciliation Statement from the following particulars. You are required to ascertain the bank balance as it would appear in the cash book of Shri Gobind as on 31st December, 1995. (a) The bank pass book showed an overdraft of Rs 9500 on 31st December, 1995. (b) Interest of Rs 250 on overdraft for six month ending 31st December, 1995 is debited in the pass book, but is not entered in the bank column of cash book. (c) Cheques issued but not cashed, prior to 31st December, 1995 amounted to Rs 1500. (d) Club bill for Rs 2700 was directly debited to his bank account and not yet reflected in the cash book.

(e) Cheques paid into bank, but not cleared and credited before 31st December, 1995 amounted to Rs 2500. (f) Interest on investments collected by the Bankers and credited in the pass book amounted to Rs 1800. Shri Govind issued a cheque of Rs 900 for his LIC premium, which was returned as the amount mentioned in figure and in words did not tally. Shri Govind, therefore paid the premium by cash but this was not reflected in his books of account. th

Problem 3: on 30 November 1997, the cash book of Mrs P Ali showed an overdrawn position of

Rs 3630 although her bank statement showed different balance. Detailed examination of the two records revealed the following: 1. The debit side of the cash book had been undercast by Rs 300. 2. (A cheque for Rs 1560 in favour of X suppliers Ltd had been omitted by the bank from its statement, the cheque having been debited to another customers‟s account. 3. A cheque fro Rs 182 drawn for payemnet of telephone bill had been enetered in the cash book at Rs 128 but was shown correctly in the bank st. 4. A cheque of Rs 210 from A banerjee having been paid into bank was dishonoured and shown as such on the bank st, although no entry relating to the dishpnoted chqque had been made in the cash book 5. The bank had debited a cheque for Rs 126 to Mrs Ali‟s account in error; it should have been debited by them to Mr Kali‟s account 6. A dividend of RS 90 had been collcted ny the bank, but not recorded in the cash book 7. Cheques totaling Rs 1260 drawn on Nov, had not been presented for payment. 8. Cheque of Rs 1080 deposited on 30th Nov, had not been credited by the bank. 9. Int amounting to Rs 228, had been debited by the bank, but noy entered in the cash book. You are required to prepare a BRS on 30th Nov 1997

End Chapter Quizzes Choose the most appropriate answer:

Q1 The Bank Reconciliation Statement is prepared : (a) To rectify the mistakes of the cash book (b) To rectify the mistakes of the bank statement (c) To arrive at its bank balance (d) To bring out the reasons for the differences between the balance as per cash book & balance as per bank statement Q2 A bank pass book is a copy of: (a) A customer‟s account in the bank‟s books. (b) Cash book relating to bank column. (c) Cash book relating to cash column (d) None of the above Q3 A bank reconciliation statement is prepared to know the causes for the difference between: (a) Balance as per cash column of cash book & balance as per pass book (b) Balance as per bank column of cash book & balance as per pass book (c) Balance as per cash column of cash book & balance as per bank column of cash book (d) Neither of above Q4 A BRS is: (a) Part of cash book (b) Part of bank account (c) Both of above (d) None of above Q5 A BRS is prepared with the help of: (a) Bank pass book & bank column of cash book (b) Bank pass book & cash column of cash book (c) Cash column of cash book & bank column of cash book (d) None of the above Q6 The balance shown on the bank statement is Rs.3,093 but this does not agree with the cash book. The differences are found to be a cheque written by the firm for Rs.30 not yet presented; a standing order of the firm to bank for payment of Rs.21 recorded in cash book only; a dividend of Rs.84 paid direct to the bank. (a) 2958 (b) 2988 (c) 3000 (d) 3126 Q7 If a cheque has been issued for payment to the supplier, but the same is not presented into the bank for payment till date, this would: (a) Increase the balance of bank column as per cash book (b) Increase the balance of cash column as per cash book (c) Increase the balance as per pass book (d) None of the above

Q8 If a cheque has been collected for payment from the customer, but the same is not presented into the bank for payment till date, this would: (a) Decrease the balance of bank column as per cash book (b) Increase the balance of cash column as per cash book (c) Decrease the balance as per pass book (d) None of the above Q9 Bank has credited interest of Rs 500 directly in customer‟s account, but the same has not been entered in the cash book. Due to this: (a) Cash book balance will be more than pass book balance by Rs 500 (b) Cash book balance will be less than pass book balance by Rs 500 (c) It will not affect both the balances. (d) None of the above Q10 When cash is withdrawn from the bank, the bank ____ the customer‟s account: (a) Debit (b) Credit (c) Does not touch (d) None of the above

CHAPTER 9 DEPRECIATION & ITS METHODS After reading this chapter, you will be conversant with: 9.1 Concept of Depreciation 9.2 Methods of Charging Depreciation 9.3 Comparison between SLM & WDV methods of depreciation 9.4 Recording Depreciation in the books of accounts 9.5 Change in the method of depreciation

9.1 Meaning of Depreciation: Provision is created in a company‟s account towards depreciation to account for the wear and tear of its assets caused by usage, passage of time, technological obsolescence, etc. while depreciation does not involve payment of money to any third party, it is nevertheless an accounting entry in the books. Depreciation is the acquisition cost of an asset (less the expected salvage value) spread over the economic life of that asset. The purpose of charging depreciation over the economic life of the asset is to match the cost of the asset over the period for which revenue is earned by using the asset.

9.2 DEPRECIATION METHODS The two methods which are basically used for charging depreciation are 1.Straight Line Method Under the straight-line method, the net acquisition cost or construction cost is charged off in equal proportion during the useful economic life and the quantum of the depreciation is arrived at by dividing the net acquisition or construction cost by the number of years of useful economic life. The net acquisition or construction cost is calculated by deducting salvage value from the acquisition or construction cost.

Depreciation = For example, if the cost of an asset is Rs.1,00,000, the expected salvage value is Rs.20,000 and the estimated useful life is 8 years, the annual depreciation would be = Rs.10,000 or 10% per annum. This method has the following advantages: 1.

the amount of depreciation and the rate does not change over the useful economic life of the asset;

2.

the calculation is relatively simple; and

3.

it realistically matches cost and revenue.

2. The Written Down Value Method/Diminishing Balance Method

Under this method the depreciation charged in the various years will not be equal over the useful life of the asset. This is because the depreciation charge every year is calculated as a percentage of the outstanding balance of the asset as at the beginning of that particular year and not on the original cost of the asset. While preparing final accounts, if depreciation is shown as an item under adjustments, calculate the amount of depreciation and charge it off to profit and loss account by debiting P & L account and crediting depreciation; show depreciation as a deduction from the asset value on the assets side of Balance Sheet. If depreciation is shown in the trial balance, then, the amount of depreciation should be charged to only P & L account. The percentage of depreciation to be charged under the declining balance method can be determined as under

r= 1–

(or) 1 – (s/c)1/n

where, r = rate of depreciation under the written down value method n = estimated useful life of the asset in years s = residual value or scrap value of the asset c = original cost of the asset. Please note that if the residual or scrap value of an asset is zero, the rate of depreciation cannot be determined using the above formula. Illustration 1 Original Cost of the Machine- Rs.1,00,000 Estimated Scrap Value - Rs.30,000 Useful Life - 6 years The calculation of depreciation for each of the years would be as follows: r = 1 – (30,000/1,00,000)1/6 = 18% At the end of the 1st year, the depreciation is calculated by applying the rate to the original cost. Then the written down value is arrived at by deducting the depreciation so arrived at from the original cost. At the end of the 2nd year, the depreciation rate is applied to the written down value at the end of the 1st year. This depreciation amount is again deducted to arrive at the written down value at the end of the 2nd year. In the above mentioned asset the depreciation calculations will be as follows: Year

Calculation of depn.

Depreciation

Written down value

1 2 3

1,00,000 x 18% 82,000 x 18% 67,240 x 18%

4 5 6

55,137 x 18% 45,212 x 18% 37,074 x 18%

18,000 14,760 12,103 9,925 8,138 6,673

82,000 67,240 55,137 45,212 37,074 30,401

(The small difference between the estimated scrap value and the written down value at the end of the sixth year is due to approximation of the depreciation rate) The following are the advantages of Diminishing Balance Method. 1. It matches the service of the asset in the sense that higher depreciation is charged in the initial years, when the machine is most efficient compared to later years. 2. It recognizes the risk of obsolescence by concentrating the major part of the depreciation in the early years of the life of the asset. 3. It equalizes the expenses of depreciation and repair charges taken together. It is assumed that repairs are the lowest in the initial years and higher in the later years while the depreciation under this method is higher in the initial years and lower in the later years. 4. It results in a better cash flow through tax deferral as under this method the net income to be taxed is lower in the initial years and higher in the subsequent years. The disadvantages of declining balance method are: 1. It requires elaborate bookkeeping. 2. As the amount of the depreciation varies from year to year, intra-enterprise comparability is lost and that income is understated in early years and overstated in subsequent years.

9.3 COMPARISON BETWEEN SLM & WDV METHODS OF DEPRECIATION

Explanation: In the above diagram we see that irrespective of the time period the amount of depreciation charged is same under the straight line method. But in case of written down value method, the amount of depreciation charged falls down as the time period increases. The depreciation charged under this method is more in the initial years and keeps on falling as the number of years of usage increase. We can draw the following differences between the diminishing balance method and straight line method. They are: Straight Line Diminishing Balance 1 A fixed amount of depreciation is charged A fixed rate of depreciation is charged 2 The rate of depreciation is the reciprocal The rate of depreciation is ascertained of the life of the asset by applying the formula 3 The asset may or may not have scrap The asset must have a significant value scrap value 4 The amount of depreciation per year is The amount of depreciation goes on same reducing with each passing year. 5 In the first year, the depreciation is In the first year, the depreciation is charged on the cost of the asset, less scrap charged on the asset value, if any 6 At the end of its life, the book value of the The book value of the asset never asset becomes zero reduces to zero.

9.4 RECORDING DEPRECIATION There are two methods of recording depreciation. When no provision for depreciation account is maintained When Provision for depreciation account is maintained When no provision for depreciation account is maintained Under the first method, the asset account is directly credited for the depreciation and the written down value is readily ascertained. The journal entry to record depreciation under the method is Depreciation a/c Dr To Asset a/c For transferring depreciation to Profit and Loss Account Profit and Loss Account To Depreciation account

Dr.

When Provision for depreciation account is maintained Under the second method, the depreciation charged is credited to a depreciation provision and the written down value of the asset is shown in the balance sheet by deducting the provision from the original cost of the asset. The journal entry recorded under this method is:

Depreciation a/c Dr To Depreciation Provision a/c (Being the depreciation provided for the accounting period) After the expiry of useful life of the asset, these two accounts are closed by debiting accumulated depreciation account and crediting asset account and – any balance in asset account is transferred to the Profit and Loss account. P&L a/c Dr To Depreciation a/c Illustration 2 An enterprise whose accounting period ends on 31st March, purchased three cars for Rs.90,000 each on 1st April, 1998. Depreciation is charged @ 10% on cost of the Machinery. On 1st January, 2000 one car was damaged in an accident and was sold for Rs.60,000. Another car was sold for Rs.80,000 on 30th September, 2000. You are required to prepare necessary accounts on the basis of straight line method while: (a) charging to the Asset Account (b) maintaining Provision for Depreciation Account. Solution: a. Direct Charge to the Asset Account Cars Account Dr.

Cr. Rs.

1998 Apr. 1

To Cash/Bank a/c (purchase of cars)

2,70,000

Rs.

1999 Mar. 31 By Depreciation a/c Mar. 31 By Balance c/d

2,70,000 1999 Apr. 1

To Balance b/d

2,43,000

2,70,000 2000 Jan. 1 By Car disposal a/c (2) Mar. 31 By Depreciation (1) Mar. 31 By Balance c/d

2,43,000

2000 Apr. 1

To Balance b/d

1,44,000

-

27,000 2,43,000

74,250 24,750 1,44,000 2,43,000

By Car disposal a/c (4)

67,500

2001 By Depreciation a/c (3) Mar. 31 By Balance c/d

13,500 63,000

2000 Sept. 1

1,44,000 1,44,000 2001

To Balance b/d

April 1

63,000

Car Disposal Account* Dr. Particulars 2000

Rs.

To Cars a/c

74,250

Jan. 1

Cr. Particulars Rs. 2000 By Cash/Bank a/c 60,000 Jan. 1 Mar. 31 By Profit & Loss a/c 14,250 (Loss)

74,250

74,250

Car Disposal Account* Dr.

Cr. Date

Particulars

2000 Sept.1 2001 Mar.31

To Cars a/c

Amount Date Rs.

67,500 2000 Sept 1 To Profit & Loss a/c 12,500 (Profit)

Particulars

Amount Rs.

By Cash/Bank a/c

80,000

80,00 0

80,00 0

* As two cars have been disposed off on two different dates ‘Car Disposal Account’ has been opened twice. Depreciation account Date

Particulars

1999 Mar. 31

To Cars a/c

2000 Mar. 31

To Cars a/c

2001 Mar. 31

Amount Rs. 27,000

Date

Particulars

1999 By Profit & Loss a/c Mar. 31

27,000 24,750

27,000 2000 Mar. 31

By Profit & Loss a/c

24,750

To Cars a/c

13,500

24,750 24,750

2001 Mar. 31

By Profit & Loss a/c

13,500

13,500 13,500

Working Notes: 1.

Amount Rs. 27,000

Depreciation for 1999-00

Rs.

For two cars 9,000 x 2

18,000

For the third car for 9 months 9,000 x 9/12

6,750 24,750

2.

Determination of book value of car: Cost

90,000

Less: Depreciation provided up to the date of disposal + 6,750)

(9,000 15,750 74,250

3.

Depreciation for 2000-01 For one car for one year

9,000

Another car for 6 months

4,500 13,500

4.

Determination of book value of the car sold in September, 2000: Cost of the car

90,000

Less: Depreciation provided up to the date of disposal 22,500 (9,000 + 9,000 + 4,500) 67,500

b.

If Provision for Depreciation Account is maintained Cars Account

Dr. Particulars 1998 To Cash/Bank a/c Apr. 1

Cr. Rs. 2,70,000

Particulars 1999 By Balance c/d Mar.31

2,70,000 1999 Apr. 1 To Balance b/d

2,70,000

2000 Jan.1

By Sale of Cars a/c

90,000 1,80,000

2,70,000

2,70,000

1,80,000

2,70,000

2,70,000

Mar.31 By Balance c/d

2000 To Balance b/d Apr. 1

Rs.

2000 Sep. 1

By Sale of Cars a/c

90,000

2001 By Balance c/d Mar.31

90,000

1,80,000 1,80,000 2001 Apr. 1 To Balance b/d

90,000

Provision for Depreciation Account Dr.

Cr.

Rs. 1999 Mar.31

Rs. To Balance c/d

27,000

1999 Mar.31

By Profit & Loss a/c

27,000

27,000 2000 Mar. 31 To Sale of Cars a/c To Balance c/d

15,750 36,000

27,000 1999 Apr. 1

By Balance b/d

2000 By Profit & Loss a/c Jan. 1 Mar. 31 By Profit & Loss a/c

27,00 0 6,750 18,000

51,750 2000 Sep. 1 2001 Mar.31

To Sale of Cars a/c (4)

To Balance c/d

22,500

2000 Apr. 1 Sep. 1

27,000

51,750 By Balance b/d 36,00 0

By Profit & Loss a/c By Profit & Loss a/c

4,500 9,000

49,500 2001 Apr. 1

49,500

By Balance b/d

27,000

Sale of Cars Account

Dr.

Date

Particulars

Rs.

Date

Particulars

2000 Jan. 1

To Cars a/c

90,000

2000 Jan. 1

By

Cr.

Provision

Rs.

for 15,750

Depreciation a/c 60,000 By Cash a/c Mar. 31

14,250 By Profit & Loss a/c (loss) 90,000

90,000 2000 2000 Sep. 1

2001 Mar.31

Sep. 1 90,000

To Cars a/c

To Profit & Loss a/c 12,500 (Profit) 1,02,500

By Provision Depreciation a/c

for

22,500 80,000

By Cash a/c.

1,02,500

Illustration 2. On 1st January 1999, the Supreme Manufacturers purchased a machine for Rs.2,50,000. Depreciation is provided annually according to the straight line method. The estimated useful life of the machine is 10 years and the scrap value is Rs.10,000. You are required to find out the rate of depreciation and also show the machine account as on 31st December, 2001. Determination of amount of depreciation: Depreciation

=

=

= 2,40,000/10

= Rs.24,000

Determination of rate of depreciation: r = (Amount of Depreciation/Cost of the Machine) x 100

= (24000/250000) * 100= 9.6%

Machinery Account Dr.

Cr.

Date Particulars 1999 To Cash/Bank Jan. 1 (Purchase Machinery)

Rs. a/c 2,50,000 of

Date 1999 Dec.31

Particulars By Depreciation By Balance c/d

2,50,000 2000 To Balance b/d Jan. 1

2,26,000

2,26,000

To Balance b/d

2,02,000

2001 Jan. 1

2,50,000 24,000 2000 By Depreciation a/c By 2,02,000 Dec. 31 Balance c/d Dec. 31 2,26,000

2001 Dec. 31 By Depreciation a/c By 24,000 Dec. 31 Balance c/d 1,78,000

2,02,000 2002 Jan. 1

To Balance b/d

Rs. a/c 24,000 2,26,000

2,02,000

1,78,000

9.5 CHANGE IN THE METHOD OF DEPRECIATION The depreciation that is charged under the straight line method remains the same every year. Under the WDV method it reduces gradually. This gives rise to variations in the depreciation charge calculated as per the two different methods. For instance, let us assume that the following particulars relate to an asset X: Original Cost = Rs.12,000 Salvage Value = Rs.2,000 Useful Life = 5 years Depreciation as per straight line method =

= Rs.2,000 per annum Rate of depreciation = (2000/12000) x 100 = 16.67% Depreciation percentage as per WDV method

r= = 1–

The depreciation each year will be as follows: Year

Depn. as per SLM

1 2 3 4 5

2,000 2,000 2,000 2,000 2,000

Depn. as per WDV method 3,600 2,520 1,764 1,235 864

We see that the depreciation in the initial years is higher under the written down value method and is higher under the straight line method in the latter years of the life of the asset. A company may use this to manipulate its profits by switching over from one method to another. Procedure for recording a change in the Method of depreciation Step 1 – Calculate the total depreciation already provided on assets existing as at the end of previous accounting year (i.e. assets other than sold/discarded/destroyed up to the end of previous year) under the existing method up to the end of previous accounting year. Step 2- Calculate the total depreciation on asset existing as at the end of previous accounting year by adopting the new method. Step 3- Calculate the difference between the total depreciation under existing method (as per step 1) & under new method (as per step 2) Step 4- Adjust the short depreciation (excess of step 2 over step 1) by debiting Profit & Loss A/c & crediting the Asset Account/Provision for depreciation a/c OR Adjust the excess depreciation (excess of step 1 over step 2) by debiting Asset A/c/Provision for Depreciation A/c & crediting Profit & Loss A/c. Step 5- Charge depreciation from current accounting year & onwards by adopting new method. The following illustration shows the effect of change in the method of depreciation on the profits of a company: Illustration: On 1st January 2001 Bharat Steel Ltd purchased two machines I & II costing Rs 50,000 each & provided depreciation @10% p.a. on straight line method basis. At the end of 2004, the company decided to change the method of depreciation from staraight line to written down value method, the rate remaining the same. Prepare the Machinery Account upto 2004. Solution: Step 1- Calculation of depreciation as per old method (SLM) for 3 years = 1,00,000 *10% * 3 = Rs 30,000

Step 2- Calculation of depreciation as per new method (WDV) = Rs A. Cost as on 1.1.2001 1,00,000 B. Less: Depreciation for 2001 10,000 C. Book value as on 1.1.2002 90,000 D. Less: Depreciation for 2002 9000 E. Book Value as on 1.1.2003 81000 F . Less: Depreciation for 2003 8100 E. Book Value as on 1.1.2004 72900 Total Depreciation under new method: = Rs 10,000 + Rs 9000 + Rs 8100= Rs 27,100 Step 3- Calculate the difference between the total depreciation as per Step 1 & Step 2: A Total depreciation under old method Rs 30,000 B Total depreciation under new method Rs 27100 C Difference being excess Depreciation Rs 2900s Step 4-Journal Entry to adjust excess depreciation Machinery A/c Dr. Rs 2,900 To Profit & Loss A/c Rs 2,900 Step 5- Depreciation for the current accounting year = 10% of Rs 72,900 = Rs 7,290 Step 6Dr. Date

MACHINERY ACCOUNT Particulars

Rs

Date

Particulars

Rs

1.01.2001

To Bank A/c

1,00,000

31.12.2001

By Depreciation A/c By Balance c/d

10,000 90,000 1,00,000 10,000 80,000 90,000 10,000 70,000 80,000 7,290

Cr.

1,00,000 1.01.2002

To Balance b/d

90,000

31.12.2002

By Depreciation A/c By Balance c/d

1.01.2003

To Balance b/d

90,000 80,000

31.12.2003

By Depreciation A/c By Balance c/d

1.01.2004

To Balance b/d To P&L A/c (Excess dep written back on account of change from WDV method to SLM)

80,000 70,000

31.12.2004

By Depreciation A/c (10% of Rs 72,900) By Balance c/d

2,900

72,900

65,610

72900

Test Exercise: Problem1 A firm purchased on 1st Jan,1989, a second hand Machinery for Rs 36000 and spent Rs 4000 on its installation. On 1st July in the same year another Machinery costing Rs 20000 was purchased. On 1st July, 1991, the Machinery bought on 1st Jan., 1989 was sold off for Rs. 12000 & on the same date a fresh Machine is purchased for Rs 64000. Depreciation is provided annually on 31 st Dec, @ 10% p.a. on the written down value method. Show the Machine a/c from 1989 to 1992. Problem 2: On 1st July, 1987, a company purchased a plant for Rs 20000. Depreciation was provided at the rate of 10% per annum on straight line method on 31st December every year. With effect from 1.1.1989, the company decided to change the method of depreciation to Dimishing balance method @ 15% p.a. on 1.7.1990, the plant was sold for Rs 12000. Prepare a plant account from 1987 to 1990 and make adjustments for arrears of depreciation in the year 1989. Problem 3: A manufacturing firm purchased on 1st January, 1989 certain mill machinery for Rs. 19,4000 and spent Rs. 600 on its erection. On 1st July in the same year additional machinery costing Rs. 10,000 was acquired. On 1st July, 1991, the machinery purchased on 1st January , 1989 having become obsolete, was auctioned for Rs. 8000 and on the same date fresh machinery was purchased at a cost of Rs 15,000. Depreciation was provided annually on 31st Dec @ 10% p.a. on the original cost of asset. In 1992, however the firm changed this method of providing depreciation and adopted the method of writing off 15% on the written down value. Give the machinery account as it would stand at the end of each year from 1989 to 1992. Make your calculations to the nearest rupee.

End Chapter Quizzes Choose the most appropriate answer: Q1 Property, plant and equipment are conventionally presented in the balance sheet at: (a) Replacement cost less accumulated depreciation (b) Historical cost less depreciation portion thereof (c) Historical cost less salvage value (d) None of the above Q2 Which of the following is true with respect to providing depreciation under diminishing balance method? (a) The amount of depreciation keeps increasing while the rate of depreciation keeps decreasing (b) The amount of depreciation & the rate of depreciation decrease every year. (c) The amount of depreciation decreases while the rate of depreciation remains same. (d) The amount of depreciation & the rate of depreciation increases every year. Q3 Which of the following statements best describes the purpose of depreciation? (a) Regular reduction of asset value to correspond to change in market value as per asset age (b) A process of correlating the market value of an asset with its gradual decline in physical efficiency. (c) Allocation of cost of an asset to the period in which services are received from the asset (d) None of the above Q4 The main objective of providing depreciation is to: (a) To calculate the true profit (b) Show the true financial position in the balance sheet (c) Reduce tax burden (d) Both (a) & (b) above Q5 Depreciation is a process of (a) Valuation (b) Valuation & Allocation (c) Allocation (d) Appropriation Q6 The portion of the acquisition cost of the asset yet to be allocated is known as: (a) Written down value (b) Salvage value (c) Net Realizable value (d) Accumulated value Q7 Which of the following statements is true with regard to written down value method of depreciation? i. The rate at which the asset is written off reduces year after year ii. The amount of depreciation provided reduces from year to year iii. The rate of depreciation as well as the amount of depreciation reduce year after year iv. The value of the asset gets reduced to zero over a period of time. (a) Only (i) (b) Only (ii)

(c) Both (i) & (iii) (d) Both (iii) & (iv) Q8 The accounting process of gradually converting the unexpired cost of fixed assets into expenses over a series of accounting periods is: (a) Depreciation (b) Physical deterioration of the asset (c) Decrease in market value of the asset (d) Valuation of asset at a point of time Q 9 In which of the following methods, the cost of the asset is spread over in equal proportion during its useful economic life?: (a) Straight Line Method (b) Written down value Method (c) Unit of production method (d) None of the above Q 10 Provision is: (a) An appropriation of profit (b) Charge against the profit (c) Allocation of resources (d) None of the above

CHAPTER 10 FINAL ACCOUNTS & ADJUSTMENTS

After reading this chapter, you will be conversant with: 10.1 Preparation of a Trial Balance from General Ledger Balances 10.2 Concept of Capital, Revenue & Deferred Revenue expenditure 10.3Preparation of Trading & Profit & Loss account from a given Trial Balance 10.4 Adjustments Entries given outside the Trial Balance 10.5 Preparation of Balance Sheet

10.1 TRIAL BALANCE: A Trial Balance is a summary of all the General Ledger Balances outstanding as on a particular date. All the debit balances from the ledger are shown on one side and all the credit balances are shown on the other side. You are aware that a debit balance in a general ledger account indicates an excess of debit side over the credit side of the ledger. Similarly, a credit balance in a ledger account indicates the excess of credit side over the debit side. Now, if all the debit and credit balances were recorded on the two sides of the Trial Balance, it stands to reason that the two sides should be equal, since in the journal for each item of debit, there was a credit item. With the help of following illustration, you will get to know „how to prepare Trial Balance from the ledger balances: Illustration: From the following balances pertaining to Kiran Kumar, prepare the Trial Balance as on March 31, 2001.

Particulars Kiran Kumar‟s Capital Salaries Purchases Sales Trade expenses Wages Freight inwards Office expenses Discount received Commission paid Postage & Telegrams Accounts receivable (1) Accounts payable (2) Furniture

Rs. 25,000 (Cr) 6,000 (Dr) 26,000 (Dr) 47,000 (Cr) 1,000 (Dr) 7,800 (Dr) 400 (Dr) 500 (Dr) 200 (Cr) 600 (Dr) 1,200 (Dr) 30,000 (Dr) 21,000 (Cr) 3,000 (Dr)

Particulars Machinery Insurance Bills receivable (3) Bills payable (4) Opening inventory (5) Cash in hand Cash at bank

Rs. 10,000 (Dr) 400 (Dr) 2,000 (Dr) 6,800 (Cr) 7,000 (Dr) 500 (Dr) 3,600 (Dr)

Notes: 1. Receivables indicate the total of all personal accounts which have a debit balance. They owe money to Kiran Kumar. 2. Payables indicate the total of all personal accounts, which have a credit balance. Kiran Kumar owes money to them. 3. Bills receivable indicate the bills of exchange accepted by Kiran Kumar‟s debtors. Bills receivable become due for payments by debtors on specified dates. 4. Bills payable indicate the bills of exchange accepted by Kiran Kumar himself in favor of his creditors. Bills payable become due for payments by Kiran Kumar on specified dates. 5. Opening inventory indicates the opening inventory of goods at the beginning of the period. Solution: Trial Balance of Kiran Kumar as on 31.03.2001 Particulars

Debit Rs.

Kiran Kumar‟s Capital Salaries Purchases

25,000 6,000 26,000

Sales

47,000

Trade expenses

1,000

Wages

7,800

Freight inwards

400

Office expenses

500

Discount received Commission paid Postage & Telegrams Accounts receivable

200 600 1,200 30,000

Accounts payable Furniture Machinery

Credit Rs.

21,000 3,000 10,000

Particulars Insurance Bills receivable

Debit Rs. 400 2,000

Bills payable Opening inventory

Credit Rs.

6,800 7,000

Cash in hand

500

Cash at bank

3,600

Total 1,00,000

1,00,000

10.2 CAPITAL AND REVENUE EXPENDITURE Capital Expenditure Capital expenditure refers to expenditure that the benefit of which is not fully derived in one year but spread over several periods. Examples for capital expenditure are – acquisition of assets for the purpose of earning, additions to fixed assets to improve its capacity, expenditure resulting in long-term benefit to the business, etc. Expenses like Preliminary expenses, Research and Development expenditure, Interest paid during Construction period, etc. are taken to assets side of Balance Sheet and shown under „Miscellaneous Expenditure‟. Revenue Expenditure It is an expenditure incurred and the benefit of which is derived in the year in which the expenditure was incurred. Examples are – raw materials, repairs, depreciation, rent, wages, etc. Such expenses are debited to Profit and Loss account. Any incomes and gains are credited to Profit and Loss account. Examples are – Commission received, Dividend received, Interest received etc. Net Profit is transferred to capital account in the balance sheet. Format of Profit and Loss account is given below. Deferred Revenue Expenditure Deferred revenue expenditure is that expenditure is that expenditure which yields benefits which extend beyond a current accounting period, but to relatively a short period as compared to the period for which a capital expenditure is expected to yield benefits. These are also known as future expenditure. Such expenditure should normally be written off over a period of 3 to 5 years. The example of such expenditure include advertisement, research & development expenditure.

10.3Preparation of Trading & Profit and Loss account from a given Trial Balance From a given Trial Balance we can prepare a Trading and Profit and Loss account to determine the profit or loss made by a business organization during a particular period. At the time of preparation of Profit and Loss account, the following points may be kept in mind:

1. All expenses are debited to Profit and Loss account. 2. All incomes are credited to Profit and Loss account. 3. In addition to treating the incomes and expenses found in the Trial Balance, we may have to give special treatment to certain „Adjustments‟ also (They are discussed in detail in the subsequent paragraphs). 4. The profit is credited to Reserves account. If there is net loss, it is debited to Reserves account in the Balance Sheet, in the case of companies and in the case of sole trader and partnership, the net profit is credited to capital account and net loss is debited to capital account. Trading account is prepared to ascertain the Gross Profit. Gross profit is the difference between sales and cost of goods sold. And by deducting all administrative and selling expenses from gross profit we determine the net profit. Profit and Loss account is prepared to ascertain net profit. It is necessary to emphasize here that Profit and Loss account (including Trading account) is usually prepared on ‘Accrual’ basis. In other words all expenses incurred and due are debited to Profit and Loss account whether they are actually paid for or not. Similarly all incomes earned and due are credited to Profit and Loss account whether they are actually received or not. Format of a Trading account is given below: Trading Account of XYZ Co. for the year ending 31st March, 2001 Dr.

Date

Cr.

Particulars To Opening stock Add: Purchases Less: Returns To Wages To Carriage inward To Gas, Water, Fuel, etc. To Packaging charges To Other factory expenses Gross Profit

J.F

Amount Date Particulars Rs. By Sales Less: Returns

J.F

Amount Rs.

By Closing stock

Format of a Profit & Loss account is given below: Profit and Loss Account for the year ending 31st March, 2001

Date

Particulars

J.F Amount Date Rs.

Particulars

To Office salaries and wages

By Gross profit

To Office rent, rates and taxes

By Cash discounts received

To Office lighting and insurance By Bad debts recovered To Printing and stationery To Postage and telegrams To Legal expenses

By Income from investments By Commission received

To Trade expenses By Interest on deposits To Audit fees To Car upkeep expenses To Telephone expenses To General expenses To Cash discounts allowed To Interest on capital To Interest on loans To Discount or Rebate on bills of exchange To Bad debts To Store charges To Carriage, Freight, Cartage outwards To Cost of samples, catalogue expenses To Salesmen‟s salaries, expenses and commission To Advertising expenses To Depreciation on fixed assets To Net profit (transferred to capital

By Gain on sale of fixed assets

J.F

Amount Rs.

Date

Particulars

J.F Amount Date Rs.

Particulars

J.F

Amount Rs.

account)

10.4 Adjustment Entries: Before an accountant can proceed to prepare the financial statements from the trial balance, he has to process some additional information, which he either already knows or receives from some other divisions or departments. The following are a few examples showing where adjustment entries would be required: a. The accountant may know (or be instructed by the Accounts Manager) that the depreciation on building is to be charged at the rate of 5%. b. The accountant would ascertain that the salary of three workers for January is unpaid at the end of the month. c. The accountant is informed by the storekeeper that the goods lying unsold in the store (representing closing stock) is worth Rs.17,000 at cost. In view of the above information, certain “adjustment entries” will have to be made in the Journal. Adjustment entries usually represent the recording of additional information and not actual transactions. Different types of adjustment entries are discussed below. 1. Closing Inventory: Closing stock refers to the stock of unsold goods at the end of current accounting period which is carried forward to next accounting period as opening stock. It is valued at cost or net realizable value whichever is lower. Adjustment Entrynt for the same is given below: Closing Inventory a/c Dr To Trading a/c While the closing inventory appears on the credit side of the trading account to reduce the cost of goods sold, it also appears as an asset in the balance sheet. 2. Outstanding or Accrued Expense The nominal accounts record the actual expense paid during the accounting period. However, prior to the preparation of the financial statements, it must be ensured that all expenses which have fallen due to be paid but which have not been paid during the accounting period are also brought into the books to help in the proper matching of revenues and expenses. For example, ABC Trading Company has the practice of paying the salaries of the employees on the 4th of the subsequent month. During the financial year ending 31st March, 2001 the salaries account shows a debit balance of Rs.55,000. The salaries of Rs.6,000 pertaining to March, 2001 were paid on 4th April, 2001. While preparing the financial statements for the year ending 31st March, 2001, the salaries of Rs.6,000 of March must also be included. This is done with the following adjusting journal entry:

Salaries a/c Dr 6,000 To Outstanding Salaries a/c

6,000

The above journal entry increases the salaries to the correct amount of Rs.61,000 and the outstanding salaries of Rs.6,000 will be shown as a liability in the balance sheet. The adjusting journal entry to record any outstanding or accrued expense is Expense a/c Dr To Outstanding Expense a/c While the amount of expense taken from the trial balance will be increased by the amount outstanding and shown in the trading and profit and loss account, the actual amount outstanding will be shown as a liability in the balance sheet. In the subsequent accounting period, the outstanding expense liability will be transferred to the expense or nominal account and will be set-off by the entry of actual payment when it is made. 3. Prepaid Expense: Certain expenses paid may relate to more than one accounting period. In such cases, it is necessary to identify that portion of the expenditure for which the benefit is yet to be received by the concern and treat that part of the expenditure as prepaid. ABC Trading Company took an insurance cover for all assets against fire on 1st October, 2000 and paid the annual premium of Rs.2,400 on the same day. Since the benefit of the entire expenditure will expire only on 30th September, 2001, it becomes necessary to recognize this aspect while preparing the financial statements as on 31st March, 2001. The amount of expense prepaid on 1st October, 2000 = (1/2) 2,400 = Rs.1,200 The adjusting entry to record the prepaid insurance is, Prepaid Insurance a/c Dr 1,200 To Insurance a/c 1,200 This entry ensures that the insurance expense is reported at the correct figure of Rs.1,200 in the profit and loss account and the prepaid amount is shown as an asset in the balance sheet. The journal entry to record any prepaid expense is, Prepaid Expense a/c To Expense a/c

Dr

In the subsequent accounting period, the balance in the prepaid expense account will be transferred back to the expense account. 4. Outstanding or Accrued Income

An income appearing in the ledger account may not represent the income that must have been received during the year. If a portion of an income has not yet been received or is outstanding as at the end of the accounting period then the outstanding amount must be brought into books. ABC Trading Company holds 14% Debentures of the face value of Rs.5,000 in Bright Limited as investments. The interest is payable on 30th June and 31st December of every year. The debentures were purchased on 1st July, 2000. While ABC Trading Company would have received the interest of Rs.350 (5,000 (14/100) 1/2) during the accounting period ending 31st March, 2000 the interest of Rs.350 for the next six months will be received only in the subsequent accounting period. However, while preparing the financial statements, the total interest revenue to be recognized is the amount of Rs.350 actually received plus the interest of Rs.175 pertaining to the period 1st January, 2001 to 31st March, 2001. The following adjusting entry will bring into books the amount of outstanding interest: Outstanding Interest a/c

Dr

To Interest Received a/c

175

175

While the interest received will be increased to Rs.525 and shown in the profit and loss account, the outstanding interest account will be listed as an asset in the balance sheet. In the subsequent accounting period, the amount in the Outstanding Interest a/c will be transferred to Interest Received a/c and the actual receipt of the interest will offset the former transfer entry. To record any outstanding income in the books of accounts, the journal entry is: Outstanding Income a/c

Dr

To Income A/c 5. Income Received in Advance While preparing the financial statements, adjustments may be necessary in respect of any incomes received in advance. Law Publications has received subscriptions amounting to Rs.50,000 during the financial year ending 31st December, 2001. Out of this Rs.2,500 represent subscriptions relating to the next financial year. The entry to adjust for the income received in advance will be, Subscriptions a/c Dr 2,500 To Subscriptions received in Advance a/c

2,500

With the posting of the above journal entry, the subscriptions account will be shown in the profit and loss account at the correct figure of Rs.47,500 and in the balance sheet, the subscriptions received in advance will be listed as a liability. Any income received in advance is a liability as benefits are yet to be conferred to the person from whom the amount has been received. The journal entry to record the adjustment of any income received in advance is Income a/c

Dr

To Income Received in Advance a/c

6. INTEREST ON CAPITAL: Interest on capital means the cost of using the capital invested in an enterprise by the proprietor or partners. It is accounting treatment is summarized as follows: Interest on Capital A/c Dr. To Capital A/c It is shown on debit side of P&L A/c & on liability side of Balance Sheet as addition to capital. 7. ADJUSTMENT OF ABNORMAL LOSS OF STOCK: It is usually caused by fire, theft, abnormal spoilage/leakage/breakage/pilferage, etc. its accounting treatment is summarized as given below: Loss of stock A/c Dr. To Trading A/c Total value of abnormal loss (whether recovered or not) is shown on the credit side of trading account. And total value of irrecovered loss of stock (i.e. total loss less amount if any recovered for insurance co) is shown on the debit side as a separate item in Profit & Loss A/c. The amount if any due from the insurance co is shown on Asset Side as a „Current Assets‟ in the Balance Sheet. 8. PROVISIONS FOR BAD DEBTS, CASH DISCOUNTS PAYABLE AND CASH DISCOUNTS RECEIVABLE (i) Bad Debts The sales revenue recorded in the books of accounts of an organization represents the amount realized/to be realized from the sale of goods. When goods are sold on credit it may sometimes not be able to be realized. That unrealized sale is considered to be bad debt. For instance, if a customer, subsequent to the date of credit sales, is adjudged as insolvent and his estate cannot pay anything towards satisfaction of the amount due from him, then, logically, the entry passed at the time of sale should be removed by reversing it, as the situation is similar to the sale not having taken place. In practice, however, instead of reversing the previous entry, the amount which cannot be recovered is considered as a loss called “bad debts”. The general journal entry for recording bad debts is Bad debts a/c Dr To Accounts Receivable a/c (ii) Provision for Bad and Doubtful Debts: When bad debts are expected to occur in the future, (a) the exact amount of loss may not be known and (b) a particular debtor‟s account cannot be identified to write-off the expected loss. To circumvent these problems, usually, a provision is made for the expected bad debts loss out of profits of the current year. This reduces the profit. For creating the provision for bad and doubtful debts, the journal entry is, Profit and Loss a/c Dr To Provision for Bad Debts a/c Treatment of Bad Debts when a Provision for Bad Debts Exists Let us extend the example of PQR Ltd., to the financial year ending 31st March, 2000.

The following details are available: Bad debts during the year

3,500

Accounts receivable as on 31/3/1999

1,70,000

PQR Ltd., would like to maintain the provision at 5% of sundry debtors. The accounts receivable of Rs.1,70,000 as on 31/3/2000 is after accounting for the bad debts of Rs.3,500. When bad debts occurred, the following entry would have been passed. Bad Debts a/c Dr 3,500 To Sundry Debtors a/c

3,500

Since a provision for bad debts to the extent of Rs.5,000 already exists, the actual bad debts of Rs.3,500 will be transferred at the end of the year to this provision account and not to the profit and loss account. The entry for the transfer will be, Provision for Bad Debts a/c Dr To Bad Debts a/c

3,500 3,500

At this point the provision account will appear as under: Provision for Bad Debts Account Particulars 31.3.2000 To Bad Debts a/c

Rs. 3,500

Particulars 1.4.1999 By Balance b/d

Rs. 5,000

Since the provision has been utilized to the extent of Rs.3,500, only Rs.1,500 is left for setting off any bad debts in the forthcoming year. However, PQR Ltd. wishes to maintain the provision at 5% on debtors. So, the balance required in the provision account as on 31.3.2000 is, (5/100) 1,70,000 = Rs.8,500 To bring up the provision to the required balance a further appropriation of Rs.7,000 (8,500 – 1,500) will have to be made from the profit and loss account. Entry will be, Profit and Loss a/c

Dr

7,000

To Provision for Bad Debts a/c

7,000

The provision account, after posting this entry, will appear as follows: Provision for Bad Debts Account Dr.

Cr. Particulars

31.3.2000 To Bad Debts 31.3.2000 To Balance c/d

Rs.

Particulars

1.4.1999 3,500 By Balance b/d 31.3.2000 8,500 By Profit and Loss a/c 12,000

Rs.

5,000

7,000 12,000

The balance sheet will again show the Accounts Receivable at their realizable value.

Balance Sheet of PQR Ltd. as on 31.3.2000 Liabilities

Assets

Rs.

Rs

Accounts Receivable 1,70,000 Less: Provision for

8,500

1,61,500

Bad Debts

(iii) Recovery of Bad Debts Written off Sometimes, an amount written off as bad debts may be subsequently recovered. Any such recovery must be treated as a windfall and transferred to the Profit and Loss account as a gain. The journal entries will be, At the time of receipt of the amount Cash a/c Dr To Bad Debts Recovered a/c At the end of the financial year, Bad Debts Recovered a/c Dr To Profit and Loss a/c (iv) Provision for Discounts on Debtors/Accounts Receivable The organizations which allow the facility of making payments before the due date and enable their debtors to avail of cash discounts, must take into account the possible amount of discounts that may be allowed on closing debtors in the forthcoming year. The principles for creation and maintenance of the provision for discounts on debtors are the same as those discussed in the section on provision for bad debts. The only additional point to be noted is that discounts will be estimated on debts considered good, i.e. closing sundry debtors minus provision for bad debts. Adjusting entry for the same is as follows: Profit & Loss A/c Dr. To Provision for discount on debtors A/c The following illustration clearly explains the mechanics of maintaining a provision for discounts on debtors. Illustration : Following are the extracts from Trial Balance of a firm as at 31st March,2002: Name of account Dr Balance Rs Cr Balance Rs Sundry Debtors 2,05,000 Bad debts 3,000 Discount 1,800 (i) Credited a provision for doubtful debts @10% on debtors.

(ii) Credit a provision for discount on debtors @2% on debtors. (iii) Additional discount given to the debtors Rs 5000. Required: Pass necessary journal entries & show the relevant accounts. Solution: Journal entries Particulars L.F. Discount allowed A/c Dr. To sundry Debtors A/c (Being the additional discount allowed to debtors) Profit & Loss A/c Dr. To Bad Debts A/c To Discount Allowed A/c (Being the transfer of bad debts & discount to P&L A/c) Profit & Loss A/c Dr. To provision for doubtful debts A/c (being the provision for DD created @10% on 2,00,000) Profit & Loss A/c Dr. To Provision for discount on debtors A/c (being the provision for discount created @2% on debtors of Rs 1,80,000 (i.e. Rs 2,00,000 – Rs 20,000)

Dr (Rs) 5,000

Cr (Rs) 5,000

9.800 3,000 6,800 20,000 20,000 3,600 3,600

Sundry Debtors Account Dr Particulars To balance b/d

Cr. Rs 2,05,000

Particulars By discount Allowed A/c By balance c/d

2,05,000

Rs 5,000 2,00,000 2,05,000

Bad debts Account Dr Particulars To balance b/d

Rs 3,000

Particulars By profit & Loss A/c

Cr. Rs 3,000

Provision for Doubtful debts Account Dr Particulars To balance c/d

Cr. Rs 20,000

Particulars By P&L A/c

Rs 20,000

Discount Allowed Account Dr Particulars To balance b/d To S Debtors

Cr. Rs 1,800 5,000 6,800

Particulars By P&L A/c

Rs 6,800 6,800

Provision for Discount on Debtors Account Dr Particulars To Balance b/d

Cr. Rs 3,600

Particulars By P&L A/c

Rs 3,600

Profit & Loss A/c for the year ended 31st March,2002 Dr. Particulars To Bad Debts (as given in the Trial balance) To provision for doubtful debts To discount 1,800 (as given in the trial balance) Add: Additional discount 5,000 To provision for discount on debtors

Liabilities

Rs

Rs 3,000

Particulars

Cr. Rs

20,000

6,800 3,600

Balance Sheet as at 31st March 2002 Assets Rs Current Assets: Debtors 2,05,000 Less: Additional Discount 5,000 2,00,000 Less: provision for doubtful debts @10% 20,000 1,80,000 Less: Provision for Discount @2% 3,600 1,76,400

(v)Reserve for Discounts on Accounts Payable/Creditors: Organizations may like to show the sundry creditors in the balance sheet at the net payable value by estimating in advance the amount of cash discounts that may be received at the time of settlement of amounts due. This is usually done by creating a reserve for discounts on creditors and then transferring the discounts received to such reserve. Since, income in respect of discounts receivable is recognized in advance, the journal for creation of the reserve will be Reserve for Discount on Accounts Payable a/c To Profit and Loss a/c

Dr

9. ADJUSTMENT OF DEPRECIATION: Depreciation represents that portion of the cost of a fixed asset which has been used in the business for the purpose of earning profits. Its accounting treatment is given below: Depreciation A/c Dr. To respective A/c Note: If depreciation already appears in the Trial Balance, then no adjusting entry is required to be passed. It will be shown only in P&L A/c , not in the balance sheet. BALANCE SHEET:

A balance sheet is a statement of assets and liabilities of a business organization at any particular date. At the end of each accounting period, every business organization prepares a Balance Sheet to have a clear understanding of its assets and liabilities, which indicate the financial position of the concern. The Balance Sheet is prepared from the point of view of the business (as a separate entity, distinguished from its owners). Another way to understand a Balance Sheet is to consider it as a statement of sources of funds (i.e., liabilities) and utilization of funds (i.e., assets). Balance Sheet can be prepared in order of (a) liquidity basis and (b) permanence basis. When assets and liabilities are arranged according to their realizability and payment preference, it is liquidity order basis. When fixed assets and liabilities are arranged on the assumption that these will be sold and paid only on the liquidation of business it is the permanence/fixity basis. Format of a Balance Sheet in order of Liquidity: Balance Sheet of ……..as at…… Liabilities

Rs

Current Liabilities:

Assets

Rs

Current Assets:

xxxx

Bank overdraft

xxxx

Cash in hand

xxxx

Bills payable

xxxx

Cash at bank

xxxx

Outstanding expenses

xxxx

Bills receivable

xxxx

Sundry creditors

xxxx

Sundry Debtors

xxxx

Income received in advance

xxxx

Prepaid expenses

xxxx

Long term Liabilities:

xxxx

Accrued income

xxxx

Loan

Closing stock

xxxx

Capital:

Fixed Asset:

Opening Balance

xxxx

Investment

xxxx

Add: Net Profit

xxxx

Furniture & Fixture

xxxx

Or Less: Net Loss

xxxx

Plant & Machinery

xxxx

Less: Drawing

xxxx

Building

xxxx

Land

xxxx

Building

xxxx

xxxx

xxxx

Xxxx

Format of a Balance Sheet in order of Permanence: Balance Sheet of ……..as at…… Liabilities

Rs

Assets

Rs

Loan

xxxx

Fixed Asset: Investment

xxxx

Capital:

xxxx

Furniture & Fixture

xxxx

Long term Liabilities:

Opening Balance

xxxx

xxxx

Plant & Machinery

xxxx

Add: Net Profit

xxxx

xxxx

Building

xxxx

Or Less: Net Loss

xxxx

xxxx

Land

xxxx

Less: Drawing

xxxx

xxxx

Building

xxxx

Current Liabilities: Sundry creditors

xxxx

Current Assets: Closing stock

xxxx

Income received in advance

xxxx

Bills receivable

xxxx

Outstanding expenses

xxxx

Sundry Debtors

xxxx

Bills payable

xxxx

Prepaid expenses

xxxx

Bank overdraft

xxxx

Accrued income

xxxx

Cash in hand

xxxx

Cash at bank

xxxx

xxxx

xxxx

LINKAGE BETWEEN TRIAL BALANCE, PROFIT & LOSS ACCOUNT AND BALANCE SHEET It is necessary to understand the linkage between Trial Balance, Profit and Loss Account and Balance Sheet as shown in the following Figure:

In other words, –

We start with a tallied trial balance.

–

We give double-entry effect to all adjustments outside trial balance.

– We take some of the trial balance items (including adjustments) to Profit and Loss Account. – We take the result of profit and loss Account (net profit or net loss) to Balance Sheet (Reserves or Capital). –

We take the rest of the items of trial balance (including adjustments) to Balance Sheet.

Hence the Balance Sheet has to tally. Assets side should be equal to liabilities side. Utilization of Funds (Assets) should be equal to sources of funds (Liabilities). We can sum up the whole process of preparation of final accounts in the following steps:  Start with a tallied trial balance. It proves the arithmetical accuracy of entries made in the books namely cash book, journal and ledger. However, there are certain errors which are not disclosed by a trial balance.  On account of certain errors if the trial balance is not tallied, the Suspense Account is opened with the difference of two sides and the same is inserted on the side having deficit.  Adjustments given at the end of a trial balance should be given double-entry effect. Otherwise accounts will not be complete.The balance sheet will not tally.  The treatment of adjustments for expenses and incomes in balance sheet is: 1.Outstanding liabilities for expenses shown on liabilities side; 2.Prepaid expenses shown on assets side; 3.Income received in advance shown on liabilities side; 4.Income earned but not received, and income accrued but not due, shown on assets side; 5.Fixed assets are recorded at cost minus depreciation; 6.Closing stock recorded at cost price or market price whichever is less. To sum up our discussion on Profit and Loss Account and Balance Sheet let us take note of the following important points. Profit and loss account may be divided into three components: Trading Account

To reflect gross profit or loss arising out of trading and manufacturing operations.

Profit and Loss Account

To reflect the net profit or loss of the entire business after duly accounting for all administrative and selling expenses.

Profit and Loss

To reflect the various appropriations

Appropriation Account

made out of disposable profits like dividends, transfer to reserves etc.

Illustration From the following Trial Balance of Sun Shine and Company prepare Trading, Profit and Loss account and Balance Sheet. Trial Balance as on 31.12.2001

Particulars

Debit Rs.

Credit Rs.

Capital

25,000

Loans

5,000

Sales

35,000

Accounts Payable

4,000

Bills Payable

5,000

Purchase Returns

2,000

Dividends Received

3,000

Plant & Machinery

13,000

Buildings Receivables Purchases Discount allowed Wages Salaries Traveling Expenses Freight Insurance Commission paid Cash on hand Bank Repairs Interest on loans Opening Inventory

17,000 9,650 18,000 1,200 7,000 3,000 750 200 300 100 100 1,600 500 600 6,000

Total

79,000

Additional Data:

79,000

1. Closing Inventory Rs.8,000. 2. Depreciation on Plant & Machinery at 15% and 10% on Buildings. 3. Provision for doubtful receivables Rs.500. 4. Insurance prepaid Rs.50 5. Outstanding rent Rs.100. Solution: Sun Shine and Company

Trading Account for the year ending 31.12.2001 Particulars

R s. 6,000

To Opening Inventory To Purchases

18,000

Less: Returns To Wages

2,000

To Gross Profit c/d

Particulars By Sales By Closing Inventory

Rs.

35000 8000

16,000 7,000 14,000

43,000 Profit and Loss Account for the year ending 31.12.2001

43,000

To Discount allowed To Salaries To Traveling expenses To Freight To Insurance Less: Prepaid

1,200 By Gross Profit b/d 3,000 By Dividends received 750 200 300 50

To Commission paid

14,000 3,000

250 100

To Repairs To Interest on loan To Rent outstanding To Provision for doubtful receivables To Depreciation: Plant & Machinery Buildings To Net Profit c/d

500 600 100 500 1,950 1,700 6,150 17,000

17,000

Sun Shine and Company Balance Sheet as on 31.12.2001 Liabilities Capital Add: Net Profit

Rs. 25,000 6,150

Loan Current Liabilities: Accounts Payable Bills Payable Outstanding Rent

Rs.

AssetsRs.Rs. Fixed Assets :

31,150 Plant & Machinery Less: Depreciation 5,000 4,000 Buildings 5,000 100

Less: Depreciation Current Assets: Cash on hand Cash at Bank Accounts Receivable Less: Provisions for doubtful debts Closing Inventory Insurance

45,250

Test Exercise:

13,000 1,950

11,050

17,000 1,700

15,300 100 1,600

9,650 500

9,150

8,000 50 45,250

Solve the following questions: Problem1 . From the following Trial Balance of Sh. Rama Nand Sagar, prepare Trading and Profit & Loss Account for the year ended 31st December, 1993 and a Balance Sheet as on that date:Dr. Balances Rs. Cr. Balances Rs. Opening Stock 20,000 Sales 2,70,000 Purchases 80,000 Purchase Return 4,000 Sales Return 6,000 Discount 5,200 Carriage inwards 3,600 Sundry Creditors 25,000 Carriage outwards 800 Bills Payable 1,800 Wages 42,000 Capital 75,000 Salaries 27,500 Plant & Machinery 90,000 Furniture 8,000 Sundry Debtors 52,000 Bills Receivable 2,500 Cash in Hand 6,300 Traveling Expenses 3,700 Lighting (Factory) 1,400 Rent and Taxes 7,200 General Expenses 10,500 Insurance 1,500 Drawings 18,000 3,81,000 3,81,000 Adjustments:(1) Stock on 31st December, 1993 was valued at Rs. 24,000 (Market Value Rs. 30,000) (2) Wages outstanding for December 1993 amounted to Rs. 3,000. (3) Salaries outstanding for December 1993 amounted to Rs. 2,500. (4) Prepaid Insurance amounted to Rs. 300. (5) Provide depreciation on Plant and Machinery at 5% and on Furniture at 20%. Problem 2 . From the following Trial Balance of Mr A, prepare Trading and Profit & Loss Account for the year ended 31st March,2002 and a Balance Sheet as on that date:Particulars Dr(Rs) Cr(Rs) Cash 10,000 Sales 180500 Stock 40,800 Returns 195 Wages 22525 Loans at 12% (on 20000 Purchases 130295 1.7.2001) 30305 Returns 2400 Creditors 530 repairs 1675 Discount 37500 Bad debts 2310 capital Interest on loan 600 Salaries 8000 Sales tax 800 Octroi 500

insurance charity rent machinery debtors (including Shyma for dishonoured bill of Rs 800)

1000 125 2000 16000 30000

269030

269030

Adjustments: 1) Wages include Rs 2000 for erection of new machinery on 1.4.2001 2) Stock on 31st March 2002 was Rs 40925. 3) Provide depreciation on machinery @ 5% p.a. 4) Salaries unpaid Rs 800. 5) Half the amount of Shyma‟s bills is irrecoverable. 6) Create a provision at 5% on other debtors. 7) Rent paid upto 31st July,2002. 8) Insurance unexpired Rs 300 Problem 3: The following trial balance has been extracted from the books of Binod Kumar on 31st Dec.1991:Debit balance Rs Credit balance Rs Machinery 4000 Capital 9000 Cash at bank 1000 Sales 16000 Cash in hand 500 Sundry creditors 4500 Wages 1000 Interest received 300 Purchased 8000 Stock on 1.1.91 6000 Sundry debtors 4400 Bills receivable 2900 Rent 450 Commission 250 General exp 800 Salaries 500 29800 29800 Provide for interest on capital at 5% p.a.. Depreciate machinery at 10%, wages out standing amount to Rs 50, rent prepaid amounts to Rs 100, stock on 31.12.1991 was Rs 8000. Prepare Trading & P&L for year ending 31st Dec,1991 & Balance Sheet as on 31.12.91

End Chapter Quizzes 1. Outstanding salaries is shown as: (a) An asset in the balance sheet (b) A liability (c) By adjusting in P & L A/c (d) Both (b) & (c) both 2. Depreciation appearing in the trial balance should be: (a) Should be debited to P & L A/c (b) Shown in balance sheet on liability side (c) Adjusted in balance sheet by deducting from assets (d) Both (a) & (b) above 3. A club paid subscription fees of Rs.1,400. Out of which Rs.200 is prepaid. In such case: (a) P & L a/c is debited with Rs 1400 (b) P & L A/c is debited with Rs 1200 (c) Rs 200 is shown in assets (d) Both (b) & (c) above 4. Bad debts recovered is: (a) Debited to P & L A/c (b) Credited to P& L A/c (c) Deducted from debtors in balance sheet (d) Added to debtors in balance sheet 5. Bank overdraft is shown as a: (a) Current liability (b) Contingent liability (c) Current asset (d) Unsecured loan 6. Which of the following is a liability of a firm? (a) Credit balance of bank pass book (b) Debit balance of petty cash book (c) Credit balance of bank column of cash book (d) Debit balance of bank column of cash book 7. Which of the following relationships is/are false?: (a) Net profit= Gross profit- administrative & other expenses (b) Net profit= Gross profit + administrative & other expenses (c) Opening Stock + purchases – closing stock= cost of sales (d) Both (b) & (c) above 8. Gross profit is equal to (a) Sales – cost of goods sold (b) Sales – purchases – opening stock (c) Net profit - administrative expenses (d) Opening stock + purchases 9. Depreciation is calculated on the: (a) Cost price of an asset (b) Cost price + transport + installation charges

(c) Market value of an asset (d) Cost price of an asset or Market value of an asset whichever is lower 10. Which of the following will not appear in Profit and Loss Account of a business? (a) Drawings (b) Bad debts (c) Accrued expenses (d) Provision for doubtful debts

CHAPTER- 11 BILLS OF EXCHANGE At the end of the chapter you will be conversant with: 11.1 Concept of bills of exchange 11.2 Accounting for Bills of Exchange 11.3 Dishonor of Bills 11.4 Renewal of Bills 11.5 Accommodation Bills

11.1 CONCEPT The Negotiable Instruments Act defines a bill of exchange as “an instrument in writing, containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of, a certain person or to the bearer of the instrument”. The features of bills of exchange are: 1. It is a written document. 2.

It is an unconditional order to pay a certain sum of money.

3.

It is signed by the maker (or drawer) of the bill.

4.

It must be dated and properly stamped.

5. The amount must be payable to a definite person or to his order or the bearer of the instrument. 6.

It must be accepted by the drawee.

The person who draws the bill is called the Drawer. The person who accepts the order is known as drawee and the person to whom the amount has to be paid is known as the payee. Drawer and the payee can be the same person.

11.2 ACCOUNTING FOR BILLS OF EXCHANGE A bill of exchange is treated as bills receivable by the party entitled to receive the payment, and as bills payable by the party liable to make payment. Journal entries in the books of Drawer and Drawee in the following cases. a. In case the bill is retained by the drawer till the due date A Books of Drawer B Books of Drawee A

B

i.

ii.

Entry for sale of goods Customer‟s a/c Dr. To Sales a/c s

Purchases a/c Dr. To Supplier‟s a/c

On receipt of acceptance from the drawee Supplier‟s a/c Dr. To Bills Payable a/c

Bills Receivable a/c Dr. To Customer‟s a/c iii

On receiving payment on the due date Cash a/c Dr. To Bills Receivable a/c

Bills Payable a/c Dr. To Cash a/c

IILUSTRATION 1: X sold goods on credit to A for Rs.5,000 on 10.4.2001. on the same date. A accepted a bill drawn by X payable after 3 months. On the due date, the bill is duly honored by X. Pass journal entries in the books of both the parties. Journal of X (Drawer) Date 10.4.01

10.4.01

13.7.01

Particulars A‟s a/c Dr. To Sales a/c (For credit sales to A) Bills Receivable a/c Dr. To A‟s a/c (Bills received from A) Cash a/c Dr. To Bills Receivable a/c (Being cash received on maturity of bill)

Debit Rs. 5,000

Credit Rs. 5,000

5,000 5,000 5,000 5,000

Journal of A (Drawee) Date 10.4.01

Particulars Purchases a/c

Dr.

Debit Rs. 5,000

Credit Rs.

To X‟s A/c (For credit purchases from X)

5000

10.4.01

X‟s a/c

Dr. To Bills Payable a/c

5,000 5000

(For the acceptance given) 13.7.01

Bills Payablea/c

Dr.

5,000

To Cash a/c (For payment made on the due date)

5000

B When the bill is discounted with the bank If the holder of the bill receivable needs cash before the due date, he can get the bill discounted from the bank. Books of drawer

Books of drawee No entry

i. Entry at the time of discounting the bill:- Cash a/c Dr. Discount a/c Dr. To Bills Receivable a/c ii. On the due date No Entry

Bills Payable a/c To Cash a/c

Dr.

ILLUSTRATION 2. A draws a bill on B for Rs.6,000 on 1.6.2001 payable after two months. On 4.7.01 he got the bill discounted from bank at 10% p.a. The bill is duly honored on the due date. Pass journal entries in the books of A and B. Journal of A Date

Particulars

Dr. Cr. Amount Amoun t 6,000 6,000

1.6.01

Bills Receivable a/c To B‟s a/c (Being bill drawn on B)

Dr

4.7.01

Cash a/c

Dr.

Discount a/c

Dr.

50 6,000

Dr. Amount 6,000

Cr. Amount

5,950

To Bills Receivable a/c (Being bills discounted with bank) Journal of B Date

Particulars

1.6.01

B‟s a/c

Dr.

6,000

To Bills Payable a/c (Being bill accepted) 4.8.01

Bills Payable a/c

Dr.

6,000

To Cash a/c

6,000

(Being bills honored on the due date) c.When the bill is endorsed to a third party

i.

Books of Drawer At the time of endorsement

Endorsee a/c

ii.

Books of Drawee No Entry

Dr.

To Bills Receivable a/c At the time of payment No Entry

Bills Payable a/c

Dr

To Cash a/c

ILLUSTRATION 3. On April 09, 2001 Ashwini draws on Rohini a bill of exchange for Rs.10,000 payable after 2 months. The bill was duly accepted by Rohini on 9th April, 2001. Ashwini endorsed the bill in favor of Bharini on 16th April, 2001. The bill is honored on the due date. Pass journal entries in the books of Ashwini, Rohini and Bharini. 9.4.01

Bills Receivable a/c

16.4.01

Dr. To Rohini‟s a/c (For bill drawn on Rohini for the amount due) Bharini‟s a/c

Journal of Ashwini (Drawer) 10,000

10,000

10,000

Dr. To Bills Receivable a/c (For bill endorsed in favor of Bharini JOURNAL OF BHAIRINI 16.4.01 Bills Receivable a/c To Ashwini‟s a/c (Being the bill endorsed)

10,000

Dr.

10,000 10,000

12.6.01

Cash a/c

Dr.

10,000

To Bills Receivable a/c

10,000

(Being amount received on maturity) ILLUSTRATION 4 P draws a bill for Rs.15,000 on Q on 1.4.2001 payable after 3 months. After receiving Q‟s acceptance the bill was sent to bank for collection on 8.5.2001. The bill was duly honored on the due date. Collection Charges paid were Rs.150. Pass journal entries in the books of P and Q. Journal of P Date

Particulars

1.4.01

Bills Receivable a/c

Dr.

Dr.

Cr.

Amount

Amount

15,000

To Q‟s a/c

15,000

(Being bill drawn) 8.5.01

Bills sent for collection a/c

Dr.

15,000

To Bills Receivable a/c

15,000

(Being bill sent for collection) 4.7.01

Bank a/c

Dr.

15,000

To Bills sent for collection a/c

15,000

(Being the bill collected by the bank on the due date) 4.7.01

Collection charges a/c Dr.

150

To Bank a/c

150

(Being collection charges paid to bank) Journal of Q Date

Particulars

Dr. Amount

1.4.01 P‟s a/c

Dr.

Cr. Amount

15,000

To Bills Payable a/c

15,000

(Being acceptance given) 4.7.01 Bills Payable a/c To Bank a/c

Dr.

15,000 15,000

(For payment of bill on the due date)

11.3 Dishonor of Bills The bill is presented to the drawee for payment on the due date. When the payment is made on the due date, the bill is said to be honored. However, if the drawee fails to meet the bill on the due date then the bill is said to be dishonored. The bill must be noted by the notary public. Recording the fact of dishonor on the bill by the Notary Public is called noting, and the amount charged by him for his services is called noting charges. Journal Entries for Dishonor of Bill Books of Drawee a.

Books of Drawer

When the bill is retained till due date Drawee a/c Dr. To Bills Receivable a/c To Cash a/c

Bills Payable a/c Noting Charges a/c To Drawer a/c

(Drawer‟s a/c is credited with the amount of bill and the noting paid in cash) b.

Dr. Dr.

(Drawee‟s a/c is debited with the amount of bill and the charges charges reimbursed.)

When the bill is discounted with the bank Drawee a/c

Dr.

Bills Payable a/c Noting Charges a/c To Drawer a/c

To Cash a/c (Amount of bill and noting charges paid are debited to drawee a/c) c. When the bill is endorsed Drawee a/c

Dr.

To Endorsee a/c

Dr. Dr.

(Drawer a/c is credited by the bill amount and the noting charges)

Bills Payable a/c Noting Charges a/c

Dr Dr.

To Drawer a/c (With the bill amount and the noting (With the amount of bill and noting charges paid by the endorsee ) charges paid in cash) Entry in the books of Endorsee Drawer (or endorser) a/c To Bills Receivable a/c

Dr.

To Cash (Noting Charges) a/c d.

When the bill is sent for collection Drawee a/c Dr. To Bills sent for Collection a/c To Bank a/c (Noting Charges)

(Entry for the dishonor of the bill sent to bank for collection)

Bills Payablea/c Noting Charges a/ To Drawer a/c

Dr. Dr

(Being the bill dishonored and noting charges paid in cash)

ILLUSTRATION 5: X sold goods worth Rs.10,000 to Y on 1.4.2001. On the same date Y accepted a bill of exchange payable after 2 months. On maturity Y failed to honor the bill. X paid Rs.20 as noting charges. Pass journal entries in the books of X and Y if a.

He had retained the bill with him till maturity.

b.

He had endorsed the bill to A.

c.

He had discounted the bill with his bank at 6% on 4.05.2001.

d.

He had sent it to bank for collection Journal of X (Drawer)

Date

Particulars

1.04.01

Y‟s a/c

1.04.01

To Sales a/c (Being goods sold to Y) Bills Receivable a/c

Dr. Amount 10,000

Dr.

Cr. Amount

10,000 Dr.

10,000

To Y‟s a/c (Being the entry for bills received) a. If bill is retained till maturity and dishonored 4.06.01 Y‟s a/c Dr. 10,020 To Bills Receivable a/c To Cash a/c

10,000

10,000 20

(Being bill dishonored, noting charges paid) b. If the bill is endorsed in favor of A A‟s a/c To Bills Receivable a/c

Dr.

(Being bill endorsed in favor of A)

10,000 10,000

Y‟s a/c To A‟s a/c

4.06.01

Dr.

10,020

(Being the bill dishonored and noting charges paid) c. If the bill is discounted with bank at 6% 4.05.01 Bank a/c Dr. Discount a/c

10,020

Dr.

9,950 50 10,000

To Bills Receivable a/c (Being the bill discounted with bank) Y‟s a/c To Bank a/c

4.06.01

Dr.

10,020 10,020

(Being bill dishonored and noting charges paid) d. If the bill is sent to bank for collection Bills for Collection a/c Dr. To Bills Receivable a/c

10,000 10,000

(Being bills sent to bank for collection) 4.06.01

10,020

Y‟s a/c Dr.

10,000

To Bills sent for Collection a/c To Bank a/c (Noting Charges)

20

(Being the bill sent to bank for collection dishonored and noting charges paid) Journal of Y (Drawee) Date

Particulars

1.04.01 Purchases a/c To X‟s a/c

Dr. Amount Dr.

Cr. Amount

10,000 10,000

(Being goods purchased from X) 1.04.01 X‟s a/c Dr. To Bills Payable a/c (Being bill accepted in favor of X)

10,000 10,000

a.

When the bill is retained till the due date

Bills Payable a/c Noting Charges a/c To X‟s a/c

Dr. Dr.

10,000 20

10,020

(Being the bill dishonored and noting charges paid) b. 4.06.01

When the bill is endorsed in favor of A Bills Payable a/c Noting Charges a/c To X‟s a/c

Dr. Dr.

10,000 20 10,020

(Being the endorsed bill dishonored) c. 4.06.01

When the bill is discounted Bills Payable a/c Noting Charges a/c To X‟s a/c

Dr. Dr.

10,000 20 10,020

(Being the bill dishonored and noting charges paid) d.

When the bill is sent for collection

4.06.01 Bills Payable a/c Noting Charges a/c

Dr. Dr.

To X‟s a/c

10,000 20 10,020

(Being the bill dishonored and noting charges paid) ILLUSTRATION 6: A sold goods worth Rs.20,000 to B on 1.4.2001. On the same date, B accepted a bill of exchange payable after 2 months. On maturity B failed to honor the bill. A paid Rs.20 as noting charges. Pass journal entries in the books of A and B if

a.

He had retained the bill with him till maturity.

b.

He had endorsed the bill to X.

c.

He had discounted the bill with his bank at 6% on 4.5.2001.

d.

He had sent it to bank for collection. Journal of A (Drawer) Date

Particulars

1.4.01 B‟s a/c

Dr.

Dr.

Cr.

Amount

Amount

20,000

To Sales a/c

20,000

(Being goods sold to B) 1.4.01 Bills Receivable a/c Dr.

20,000

To B‟s a/c

20,000

(Being the entry for bill received) a.

If bill is retained till maturity and dishonored

4.6.01 B‟s a/c

Dr.

20,020

To Bills Receivable a/c

20,000

To Cash a/c

20

(Being bill dishonored, noting charges paid) b.

If the bill is endorsed in favor of X X‟s a/c

Dr.

20,000

To Bills Receivable a/c

20,000

(Being bill endorsed in favor of X) B‟s a/c To X‟s a/c (Being the bill dishonored and noting charges paid)

Dr.

20,020 20,020

c.

If the bill is discounted with bank at 6%

4.5.01

Bank a/c Discount a/c

Dr.

19,900

Dr.

100

To Bills Receivable

20,000

a/c (Being the bill discounted with bank) B‟s a/c

4.6.01

Dr.

20,020

To Bank a/c

20,020

(Being bill dishonored and noting charges paid) d.

If the bill is sent to bank for collection Bills sent for Collection a/c

Dr.

20,000

To Bills Receivable a/c

20,000

(Being bill sent to bank for collection) 4.6.01 B‟s a/c

Dr.

20,020

To Bills sent for Collection a/c

20,000

To Bank a/c (Noting charges)

20

(Being the bill sent to bank for collection dishonored and noting charges paid) Journal of B (Drawee) Date

Particulars

1.4.01 Purchases a/c

Dr. Amount Dr.

Cr. Amount

20,000

To A‟s a/c

20,000

(Being goods purchased from A) 1.4.01 A‟s a/c To Bills Payable a/c (Being bill accepted in favor of A)

Dr.

20,000 20,000

a.

When the bill is retained till the due date

4.6.01 Bills Payable a/c Noting Charges a/c

Dr.

20,000

Dr.

20

To A‟s a/c

20,020

(Being the bill dishonored and noting charges paid) b. When the bill is endorsed in favor of X 4.6.01 Bills Payable a/c Noting Charges a/c

Dr.

20,000

Dr.

20

To A‟s a/c

20,020

(Being the endorsed bill dishonored) c.When the bill is discounted 4.6.01 Bills Payable a/c Noting Charges a/c

Dr.

20,000

Dr.

20

To A‟s a/c

20,020

(Being the bill dishonored and noting charges paid) d.

When the bill is sent for collection

4.6.01 Bills Payable a/c

D

20,000

Noting Charges a/c To A‟s a/c

20 20,020

(Being the bill dishonored and noting charges paid) 11.4 RENEWAL OF BILLS Sometimes, when the drawee is unable to meet the bill on the due date he may request the drawer for extension of time for paying the amount of the bill. The drawee may make partpayment of the bill in cash and accept a new bill for the remaining amount payable. The drawer by accepting his request for cancelation of the old bill, draws a new bill on him for the balance due. This is known as renewal of bill. For renewal of bill, interest is charged by the drawer for the period of new bill. Interest may be paid in cash or it can be added to the amount of old bill and a new bill is accepted by the drawee. Journal entries for cancellation and renewal of a bill are as follows:

Books of Drawer 1.

Books of Drawee

For Cancellation of old bill Drawee‟s a/c

Dr.

Bills Payable a/c To Drawer‟s a/c

To Bills Receivable a/c

Drawer‟s a/c

2. For the part-payment received Cash a/c

Dr. Dr.

To Cash a/c

Dr.

To Drawee‟s a/c 3. For interest receivable on renewal of bill a. When interest is paid in cash Interest a/c Cash a/c Dr. To Cash a/c To Interest a/c b. When interest is included in the new bill Drawee‟s a/c Dr.

Dr.

Interest a/c

To Interest a/c

Dr.

To Drawer‟s a/c

4. For the new bill received Bills Receivable a/c

Dr.

Drawer‟s a/c

Dr.

To Drawee‟s a/c To Bills Payable a/c ILLUSTRATION 7 Suraj draws a bill on Chandra for Rs.10,000 on 1.4.2001 payable after 2 months. Chandra was unable to pay the amount. He approached Suraj before the due date and requested him to draw a new bill payable after three months for Rs.8,000 plus interest @10% p.a. and the balance amount is paid in cash. New bill is duly honored on the due date. Pass journal entries in the books of Suraj and Chandra. Journal of Suraj Date

1.4.01

Particulars

Bills Receivable a/c

Dr.

Dr.

Cr.

Amount

Amount

10,000

To Chandra‟s a/c

10,000

(Being the entry for acceptance received from Chandra) Chandra‟s a/c

Dr.

To Bills Receivable a/c

10,000 10,000

(Being the old bill canceled for renewal) Chandra‟sa/c

Dr.

200

To Interest a/c

200

(Being the entry for the interest) (8,000 x 10 x 3)/(12 x 100) Bills Receivable a/c

Dr.

8,200

To Chandra‟s a/c

8,200

(Being the entry for the new bill accepted) Cash a/c

Dr.

2,000

To Chandra‟s a/c (Being the entry for the balance paid in cash) Cash a/c

2,000 8,200

To Bills Receivable a/c (Being the payment received on the due date)

Journal of Chandra

Dr. 8,200

Date

Particulars

1.04.01 Suraj‟s a/c

Dr.

Dr.

Cr.

Amount

Amount

10,000

To Bills Payable a/c

10,000

(Being acceptance given) Bills Payable a/c

Dr.

10,000

To Suraj‟s a/c

10,000

(Being the old bill canceled) Interest a/c

Dr.

200

To Suraj‟s a/c

200

(Being the entry for the interest on the new bill) Suraj‟s a/c

Dr.

8,200

To Bills Payable a/c

8,200

(Being the entry for the new bill accepted) Suraj‟s a/c

Dr.

2,000

To Cash a/c

2,000

(Being cash paid to Suraj) Bills Payable a/c To Cash a/c

Dr.

8,200 8,200

(Being the payment made on the due date) 11.5 ACCOMMODATION BILLS Normally bills are drawn and accepted to facilitate trade. But sometimes bills are drawn and accepted for the purpose of helping one or both the parties involved without any genuine business transaction between them. These bills are known as accommodation bills or fictitious bills. The main purpose of accommodation bills is to raise funds for a short period by discounting the bill with the bank. The discounting charges are shared by the parties in the ratio of funds they receive. Journal entries are passed in the similar way as for ordinary bills. The only additional entry to be passed is for sending or receiving the amount ILLUSTRATION 8

A, for the mutual accommodation of himself and B, draws upon the later, a bill at 4 months date for Rs.1,800 dated 1st March. The bill is discounted by A at 5 percent, and half the proceeds are remitted to B. B, at the same time, draws a bill at 4 months on A for Rs.900. After securing A‟s acceptance, the bill is discounted at 6% by B, who remits half the proceeds to A. B becomes insolvent on 31st May, and 25 paise in the rupee is received on 15th July as first and final dividend from his estate. Write journal entries in the books of both the parties. In the Books of A Journal Entries Date

Debit Rs.

Particulars

1st March Bills receivable a/c

Dr.

Credit Rs.

1,800

To B a/c

1,800 Dr.

1,770

Dr.

30

Bank a/c Discount a/c To Bills receivable a/c

1,800 Dr.

900

B a/c 885 To Bank a/c 15 To Discount received a/c Dr.

900

B a/c 900 To Bills Payable a/c Dr.

441

Dr.

9

Bank a/c Discount allowed a/c 450 To B a/c Dr.

1,800

4th July B a/c To Bank a/c

1,800 Dr.

900

Bills payable a/c To Bank a/c

900 Dr.

337.5

Bank a/c To B a/c

337.5 Dr.

Bad debts a/c To B a/c

1012.5 1012.5

In the Books of B Date

Particulars

1st A a/c March To Bills Payable a/c Bank a/c Discount allowed a/c To A a/c Bills receivable a/c To A a/c Bank a/c Discount a/c To Bills receivable a/c A a/c To Bank a/c To Discount received a/c 4th Bills Payable a/c July To A a/c A a/c To Bank a/c To Deficiency a/c

Debit Rs. Dr.

1,800

Dr. Dr.

885 15

Credit Rs.

1,800

900 Dr.

900 900

Dr. Dr.

882 18 900

Dr.

450 441 9

Dr.

1,800 1,800

Dr.

1,350 337.5 1012.5

ILLUSTRATION 9: A and B, business partners, on 1st January agree to draw on the other a bill of exchange for Rs.1000 for 3 months and to discount the other‟s bill each meeting his own bill when it falls due and paying the expenses of discounting the other‟s bill. Both bills are accepted and discounted at 6%. On the due date, B meets his acceptance. A, however, notifies B of his inability to meet his bill and B has therefore to take it up. A pays Rs.400 on 3rd April and accepts another bill drawn on him by B at 2 months date for Rs.610 including interest. This bill of exchange is honored by A at maturity. Give the journal entries in the books of A. Date

Journal Entries in the books of A Particulars

1st January Bills receivable a/c To B a/c B a/c To Bills payable a/c Bank a/c

Dr.

Debit Rs.

Credit Rs.

1,000 1,000

Dr.

1,000 1,000

Dr.

985

3rdApril

Discount a/c To Bills receivable a/c Bills payable a/c To B a/c Interest a/c To B a/c B a/c To Bank a/c To Bills payable a/c

Dr.

15 1,000

Dr.

1,000 1,000

Dr.

10 10

Dr.

1,010 400 610

TEST EXERCISE: Problem 1: A bill for Rs 5,000 is drawn by B and accepted by C. Show what entries would be passed in the books of B in each of the following circumstances: (a) If he retains the bill till due date and then realized it on maturity. (b) If he discounted it with his bank for Rs 4,800. (c) If he endorsed it over to his creditor M in settlement of a debt.

End Chapter Quizzes Select the most appropriate choice: In each of the following cases indicate the alternative which you consider to be correct: 1)

A four months bill drawn on 1st January 1993 will mature for payment on(a) 3rd May 1993 (b) 4th May 1993 (c) 5th May 1993 (d) 4th January,1993 2) If Ram‟s acceptance that was endorsed by us to Saleem is dishonoured, the amount should be debited in our books to(a) Saleem‟s account (b) Ram‟s account (c) Bills receivable account. (d) Bills payable account 3) When bill discounted with the bank is dishonored?: (a) Acceptor‟s account is debited in the books of drawer (b) Bills receivable account is credited in the books of drawer (c) Bank account is debited in the book of drawer (d) Bills payable account is debited in the books of drawer 4) In the books of the drawer, the accounting treatment involved on receipt of a bill of exchange duly accepted by the drawee is. i) Debit Bills Receivable account ii. Debit drawee‟s account iii. Credit drawee‟s account (a) only (i) above (b) both (i) & (ii) above (c) both (i) & (iii) above (d) only (ii) above 5) The noting charges levied on dishonour of an endorsed bill by the Notary Public are to be borne by (a) The drawer of the bill (b) The person responsible for dishonor of bill (c) The holder of the bill (d) The endorser of the bill 6) The drawer of a trade bill passes relevant entries with regard to the transaction involved in it. But, in case of an accommodation bill, he passes an entry in addition to the usual entries. The additional entry so passed is with respect to (a) Discounting of the bill with the bank (b) Payment of bill on due date

(c) Remitting or receiving the amount (d) Sending bill for collection 7) If a bill is endorsed to a third party, the accounting entry in the books of the endorser, at the time of endorsement involves: (a) Credit endorsee account (b) Debit endorsee account (c) Debit bill receivable account (d) Credit bills payable account 8) Bills receivable book is a part of the – (a) journal (b) ledger (c) profit and loss account. (d) Balance sheet 9)

A bills receivable book is a (a) principal book (b) subsidiary book (c) book containing blank forms for writing bills of exchange (d) none of above

10)

Bills payable book is a part of the (a) journal (b) ledger (c) profit and loss account (d) none of above

KEY TO END CHAPTER QUIZES: CHAPTER 1 1(c), 2 (a), 3 (a), 4 (a), 5 (d), 6 (d), 7 (d) 8 (d), 9 (b) 10 (d) CHAPTER 2 1 (C), 2 (D), 3 (d), 4 (b), 5 (c), 6 (c), 7 (c), 8 (b), 9 (c), 10 (a) CHAPTER 3 1 (a), 2(b), 3 (c), 4 (a), 5 (b), 6 (c), 7 (b), 8 (b), 9 (b), 10 (c) CHAPTER 4 1 (b), 2 (b), 3 (b), 4 (d), 5 (c), 6 (d), 7 (c), 8 (c), 9 (a), 10 (b) CHAPTER 5 1 (d), 2 (a), 3 (a), 4 (b), 5 (c), 6 (d), 7 (b), 8 (c), 9 (b), 10 (d) CHAPTER 6 1 (d), 2 (c), 3 (b), 4 (d), 5 (a), 6 (a), 7 (c), 8 (d), 9 (c), 10 (c) CHAPTER 7 1 (d), 2 (a), 3 (a), 4 (b), 5 (b), 6 (c), 7 (c), 8 (c), 9 (c), 10 (c) CHAPTER 8 1 (d), 2 (a), 3 (b), 4 (d), 5 (a), 6 (a), 7 (c), 8 (c), 9 (b), 10 (a) CHAPTER 9 1 (b), 2 (c), 3 (c), 4 (d), 5 (c), 6 (a), 7 (b), 8 (a), 9 (a), 10 (b) CHAPTER 10 1 (d), 2 (a), 3 (d), 4 (b), 5 (a), 6 (c), 7 (d), 8 (a), 9 (b), 10 (a) CHAPTER 11 1 (b), 2 (b), 3 (a), 4 (c), 5 (b), 6 (b), 7 (b), 8 (a), 9 (b), 10 (a)

BIBLIOGRAPHY 1. 2. 3. 4. 5.

Dr. S.N. Maheshwari, Finacial Accounting D.K. Goyal & Rajesh Goel, Higher Accoutancy P.C Tulsian, Financial Accounting BS Raman. Financial Accounting Grewal and Gupta, Advanced Accounting