FA Notes

ACCOUNTING & FINANCIAL MANAGEMENT
MCA - SEM 2
As per Mumbai University Syllabus
prepared and circulated by mumbai university
www.missionmca.com Mission MCA

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ACCOUNTING PROCESS AND

PRINCIPLES, FINANCIAL, COST AND
MANAGEMENT ACCOUNTING
Unit Structure:
1.0 Objectives
1.1 Introduction
1.2 Meaning of Accounting
1.3 Accounting Principles
1.4 Branches of Accounting
1.5 Accounting process
1.6 Funds Flow Statement
1.7 Cash Flow Statement
1.8 Distinction between Funds Flow Statement and Cash Flow
Statement
1.9 Exercises
1.0 OBJECTIVES
After studying the unit the students will be able to:

Understand the meaning of Accounting.
Explain the Accounting Principles and Concepts.
Know the Process of Accounting.
Understand and explain the process of Accounting.
1.1 INTRODUCTION
Every person performs some kind of economic activity. A

worker daily works and get wages and he spends to buy goods,
cloths and some part of earnings saves for future. A business man
purchases goods and sales it. He incurred various expenses like
salaries, rent etc. A partner in firm contributes towards capital in the
firm which carries on business may be trading in goods. Similarly
companies, Governments are also carries on some financial
activities. All are carrying some kind of economic activities. Such
economic activities are performed through transactions and / or

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events. Thus the business transactions include purchase, sale of

goods, rendering various services, receipts and payments for such
transactions. In a business concerns the transactions are
numerous. The details of all transactions cannot be remembered by
the business man. Therefore it is necessary to keep written records
of all such transactions. The records of written transaction will help
business to settle disputes and also possible to provide valuable
information to the owner of business. Book-keeping disciple has
been developed to serve this purpose. The aim of Book-keeping is
to provide the information needed by the businessmen and also it
helps him to take decisions.
1.2 MEANING OF ACCOUNTING
The American Institute of Certified Public Accounts (AICPA)

defined Accounting as “Accountancy is the art of recording
classifying and summarizing in a significant manner and in terms of
money transactions and events which are in part of at least a
financial characters and interpreting the result there of”.
Again in 1966, AICPA defines Accounting as “The process of

identifying, measuring and communicating economic information to
permit; informed judgement and decisions by the uses of accounts”.
Thus accounting may be defined as the process of

recording, classifying, summarizing, analysing and interpreting the
financial transactions and communicating the results. There of to
the persons interested in such information.
The utility of accounting information is greatly increased

when it is compiled in a systematic manner and financial
statements are prepared at periodic intervals.
There is difference between the terms “Book keeping” and

“Accounting”. Book keeping is merely concerned with orderly record
keeping and recording business transactions and financial
Accounting is border in scope than book keeping. Accounting
involves analysis and judgements at different stages such as
recording of transactions, classification, summarization and
interpretation.
1.3 ACCOUNTING PRINCIPLES
The basis aims of book-keeping and accountancy are to

record the business transactions and events in a summarised form.
Transactions are recorded in chronological order in proper books of
accounts book-keeping. Accountancy and science based or
fundamental truth and rules or conducts or procedures which are

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universally accepted. These rules of conducts to record business

transactions are called accounting principles. These principles are
developed over long period of time.
The classification of accounting principles is as under:
Accounting Principles
Accounting Concepts Accounting Conventions
a) Business entity a) Disclosure

b) Going Concern b) Materiality
c) Money Measurement c) Consistency
d) Cost Concept d) Conservatism
e) Accounting period
f) Duel aspect
g) Accrual Concept
h) Matching Cost
i) Realisation
1.3.1 Accounting Concepts:

Concepts mean a general idea which conveys certain
meaning. Accounting concepts may be considered as basis
assumption or conditions on which the science of accounting is
based. Concepts are based on logical consideration. Accounts and
Financial statements are always interpreted in light of concepts
which govern accounting method.
Different accounting concepts are discussed as follows:
a. Business Entity Concepts

According to Entity concept, business is treated as a unit of
entity form separate from its Owner, Creditors and Management
etc. Accounts are kept for business entity as distinguished form a
person associated with it. All business transactions are recorded in
the books of Accounts from the point of view of business only.
Every type of business organisation is treated as separate
Accounting entity.

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The failure to recognise the business as separate accounting

entity would make it extremely difficult to evaluate the performance
of business alone.
The overall effect of adopting this concept is –

1) Only the business transactions are reported and not the
personal transactions of the owners.
2) Profit is the property of business unless distributed to the
owners.
3) The personal assets of the owners are not considered while
recording and reporting the assets of the business entity.
b. Going Concern
Business transactions are recorded on the assumption that
the business will continue for a long time. There is neither the
intention nor the necessity to liquate the particular business in near
future. Therefore, it would be able to meet its contractual obligation
and use its resources according to the plans and predetermined
goals. Therefore, Fixed Assets are recorded at cost and
depreciation is calculated on cost / written down value. Similarly
prepaid expenses are treated as Assets on the presumption that
the business will continue and these expenses will be utilized in
future.
When an enterprise liquidates a branch or one division or

one segment of its business, the ability of the enterprise to continue
as a going concern is not imparted.
In case of enterprise going to liquidate or become insolvent.

Then the enterprise cannot be considered as a going concern.
c. Money Measurement Concept

A unit of exchange and measurement is necessary to
account for business transaction in a uniform manner. Money is
common denominator in terms of which the exchange ability of
goods and services are measured. Only such transactions and
events as can be interpreted in terms of money are recorded.
Non monetary events like public political contract, location of

business; certain disputes, efficient Sales Force etc. can not be
recorded in the books of Accounts even through these have great
effects.
However, a unit of money measurement over period of time

has its own drawbacks. Money has time value, which can not be
considered. Time value of money is affected seriously by economic
differences etc. System of accountancy treats all units of money
same irrespective of time of original and settlement of it say after

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two years. It will be the same amount. However value of Money

true sense will be less. This is a great drawback. This leads to the
introduction of inflation accounts.
d. Cost Concepts
According to cost concept the various assets acquired by
enterprise should be recorded on the basis of actual cost incurred.
The cost concept does not mean that the basis for all subsequent
accounting for the assets. As per cost concept Fixed Assets are
shown at cost less depreciation charged from year to year. It may
be noted that if nothing has been paid for acquiring something it
would not be shown/recorded in the books of accounts maintain.
Financial statement based on historical cost may not be

much relevant for investors and other users because they are more
interested in knowing what the business actually worth today rather
than the original cost.
e. Accounting Period Concept

It is customary that the life of the business is divided into
appropriate parts or segments of analysing the results shown by
the business. Each part divided is known as an accounting period.
It is an internal of time at end of which the income statement and
balance sheet are prepared. Normally the accounting period
consists of twelve months.
f. Duel Aspect Concept

This concept based on double Entry book-keeping which
means that Accounting system is set up in such a way that a record
is made of the two aspects of each transaction that affects the
record. The recognition of the two aspects of every transaction is
known as duel aspects concept. Modern Financial Accounting
considers both aspects of every transaction.
One entry consists of debit to one or more accounts and

another effect consist of credit to some other one or more accounts.
However, the total amount debited is always equal to the total
amount credited. Therefore at any point of time total assets of a
business are equal to its total liabilities. Liabilities to outsider are
known as liabilities, liabilities to the owner are referred to as capital.
Assets = Liabilities + Capital

Therefore, Capital = Assets – Liabilities
Assets referred to valuable things owned by the business, Capital
refers to the owner‟s contribution to the business.

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g. Accrual Concept
This accounting concept states that revenue is recognised
when they are earned and when they are not received similarly,
cost are recognised as and when they are incurred and not when
they are paid. This concept implies that the income should be
measured as difference between revenues and expenses rather
that the difference between cash received and disbursements.
Therefore certain adjustments are required while preparing Final
Accounts. In case of revenue accounts; prepaid expenses, out
standing expenses, Income received in advance / Receivable are
adjusted. These adjustments have their impact on both the income
statement and the Balance sheet.
h. Matching Cost Concept

This concept is based on accounting period concept for
determining accurate profit / Income has to compare the revenues
of the business with the cost that is incurred to earn that revenue.
The term “Matching” means appropriate association of related
revenues and expenses. According to this concept adjustments
should be made for all outstanding expenses, income receivable,
prepaid expenses, Income received in advance, depreciation etc.
While preparing final accounts at the end of accounting period.
i. Realisation Concept
This accounting concept explains that sell is supposed to be
completed only when ownership of goods are passed on from the
seller to the buyer. Income is considered to be earned on the date
when sales take place. No profit is supposed to accrue on the
acquisition of any thing, however, income earned / realised will be
earn only when goods are sold at a profit. Therefore closing stock is
valued at cost or market price whichever is less. It prevents
business Firms from inflecting their profits by recording income that
is expected in future.
1.3.2 Accounting Conventions:

The term „Convention‟ denotes customs or traditions or
practice based on general agreement between the accounting
bodies which guide the accountant while preparing the financial
statements.
a. Disclosure
According to convention of full disclosure, accounting must
disclose all the material facts and informations so that interested
parties after reading such accounting report can get a clear view of
the state of affairs of the business. All information which are of

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material interest to proprietors, creditors and investors should be

disclosed in accounting statement.
The Companies Act makes various provisions for disclosure

of essential information that their is no chance of any material
information being left out.
b. Materiality
The term material means “relative importance”, Accounting
to the convention of materiality; account should report only what is
material and ignore insignificant details while the preparing the final
accounts. Materiality will differ or changed with nature, size and
tradition of the business. What is material for one enterprise may be
immaterial for another enterprise. This is because otherwise
accounting will unnecessarily be overburdened with minute details.
It is not possible to lay down any fixed standard by which Materiality
can be judged. The decision is to be made by the accountant or the
Auditor based on their professional experience.
c. Consistency
This accounting convention state that ones a particular
accounting practice, method or policy is adopted to prepare
accounts, statements and Reports. It should be continued for years
together and should not charge unless it is forced to change it.
Accounting practices should remain the same from one year to
another. The results of different years will be comparable only when
accounting rules are continuously adhered to from years to years
i.e. Valuation of stock in trade, method of depreciation, treatment of
approval sale etc. Since methods of accounting consistence the
financial statements are reliable to the people who use it.
d. Conservatism
Financial Statements are usually drawn up on a conservative
basis. Their are two principles which stem directly from
conservatism.
a) The accountant should not anticipate income and should
provide all possible losses, and
b) Faced with the choice between two methods of valuing an asset
the accountant should choose a method which leads to the
lesser value.
It is also called “Principles of prudence”. Therefore, provision

for bad and doubtful debts is also permitted and made every year.
Accounting convention must be followed continuously. If not
followed continuously it would result into understatement of
incomes, assets and overstatement of liabilities and provisions and
expenses.

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1.4 BRANCHES OF ACCOUNTING
Accounting has forms of branches as under
Accountancy
Financial Cost Management Tax

Accounting Accounting Accounting Accounting
1.4.1 Financial Accounting

It is concerned with record keeping directed towards the
preparation of Trial balance, profit and loss account and balance
sheet.
1.4.2 Cost Accounting

Cost Accounting is the process of accounting for costs. It
shows classification and analysis of cost on the basis of functions
process, products etc. It also deals with cost computation, cost
saving, cost reduction etc. In cost accounting cost per unit of output
produced or services rendered is ascertained. It helps management
in the control of cost of output or services rendered.
1.4.3 Management Accounting

It deals with the processing of data sentenced in financial
accounting and cost accounting for managerial decision making. It
also deals with application of managerial economic concepts for
decision making for the efficient running of the business and thus in
maximising profits.
1.4.4 Tax Accounting

This branch of accounting is becoming important because of
complex tax laws governing income-tax, Excise duty, value added
tax etc. Tax planning is now a days is very important as well to
save tax, Account for tax deducted at sources, payment of advance
tax, Filing of various tax returns in time as well as taking Cenvat
credit for various taxes whenever is available.

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1.5 ACCOUNTING PROCESS
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 utility of accounting information is greatly increased

when it is complied in a systematic manner and financial
statements prepared at periodic intervals.
The Accounting Process
STEP I Identification of Transaction
STEP II Preparation of Documents
STEP III Recording of Transaction

in Journal
STEP IV Posting to ledger
STEP V Preparation of Trial

Balance
STEP VI Passing Adjusting Entries
STEP VII Preparation of Final A/cs Profit & Loss A/c

Balance Sheet
Fund Flow Statement
Cash Flow Statement
Note: As final Accounts are separately explains in subsequent

chapter, here only fund flows & cash flows statements are
explained.

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CHECK YOUR PROGRESS

Define the following terms:
1. Cost Concept
2. Business entity concept
3. Going concern concept
4. Duel aspect concept
Explain the following Accounting conventions:
1. Disclosure
2. Consistency
Draw the chart showing Accounting Process.
1.6 FUND FLOW STATEMENT
The fund flow statement reflects movement of fund during

particular period i.e. movement of working capital. Funds means
working capital and not only cash/Bank balances. Sources consider
of the transactions that increases net working capital and their
applications consist of transactions that decrease working capital.
Specimen of funds flow statement

Funds flow statement for the year ended.....
Sources Applications
Issue of Share Capital x Redemption of preference x
shares
Issue of Debentures x Redemption Debentures x
Sale of Fixed Assets x Repayment of loan Term x
loans
Sale of Investments x Purchased of Fixed x
Assets
Long term Loans x Purchased of Investment x
Decrease in working x Dividend paid x
capital
Funds from operations x Income Tax paid x
(Cash Trading Profit)
Buy-Back of Equity shares x
Increase in working capital x
xx xx
In short fund flows statement indicates various sources of

working capital and its applications.

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1.7 CASH FLOW STATEMENT
Cash flow statement shows inflows and outflows of cash/

cash equivalent. It is prepared as per A.S-3.
As per A.S-3, the cash flow statement should report cash

flows during the period classified as operating, Investing and
financing activities.
Activities that do not require use of cash / cash equivalents

should be excluded from a cash flow statement. e.g. Issue of Bonus
shares conversion of Debentures into new Debentures / Shares.
Cash flow statement can be prepared by Direct method or

Indirect method.
Under direct method, major classes of gross cash receipts

and gross cash payments are obtained for showing it in funds from
operations.
Indirect method, cash flow operating activities is calculated

by adjusting net profit. Net profit is adjusted, with non cash
transaction such as depreciation, Goodwill w/off etc, result figure
indicates cash operating profit, which further adjusted with net
increases / decreases in current Assets / Current liabilities. The
final amount resulted indicates cash flows operating activities.
Proforma of cash flow statement As per A.S-3 (Indirect Method)
Cash Flow statement for the year ended .........
Rs. Rs.
I) Cash flows from operating Activities
Net profit before taxations x
Add: Adjustment for
Depreciation, Goodwill w/off x
Loss on sale of fixed Assets / Investment x
Interest / Dividend Income x
Operating profit before working capital changes xx
Increases in working capital (x)
Decreases in working capital x
Cash generated from operations x
Cash Income Tax paid (x)
Net cash from operating activities x

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II) Cash flows from Investing Activities

Sale of Fixed Assets / Investment x
Interest / Dividend received x
Purchased of fixed assets / Investment (x)
Net cash flow from investing activities x
III) Cash flows from financing Activities

Proceeds from Issurance of share capital x
Proceeds from Issurance of Debentures x
Proceeds from long term loans x
Repayment of long term loans (x)
Redemption of Pref. Shares / Debenture (x)
Interest / Dividend paid (x)
Net cash used in financing activities x
Net increases or decreases in cash / cash equivalents xx
Add: Cash/ cash equivalents at the beginning of the x
period.
Cash / cash equivalent at the end of period. xx
1.8 DISTINCTION BETWEEN FUNDS FLOW

STATEMENT AND CASH FLOW STATEMENT
Both the above statement are used in analysis of past performance

of the business firm.
Fund Flow Statement Cash Flow Statement

1. It is based on accrued 1. All cash and cash
accounting system equivalents are taken into
consideration
2. It analyses the sources & 2. Cash flows statements
application in Long term considers only the
funds affecting working transactions affecting
capital increases or decreases in
current assets or / and
current liabilities.
3. It is more useful in Long-run 3. It help form in identifying
planning the current liquidity
problems.
4. It is broader concepts, 4. It only deals with current
considering short term / assets/ current liabilities
long term funds into shown in Balance sheet.
accounts in analysis.

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5. It tallies the funds generated 5. It shows in increases or

from various sources with decreases in cash/ cash
various uses to which they equivalent during the
are put. period, which tallies with
difference in opening /
closing cash / Bank
balances.
6. It shows the funds 6. It shows the cash flows
generated and applied as from operating, financing
regards long term assets & and investing activities.
liabilities.
1.9 EXERCISES :
1. Are the accounting concepts and conventions necessary?

2. Explain meaning of:
a) Accounting concepts
b) Accounting conventions
c) Accounting principles
3. Explain accounting conventions of:
a) Conservatism
b) Consistency
c) Disclosure
d) Materiality
4. Define and explain:
a) Concept of entity
b) Concept of continuity
c) Cost concept
d) Cost attach concept
e) Periodic matching of costs and revenues
5. Explain different branches of Accounting.


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2
ELEMENT OF BOOK-KEEPING,
JOURNAL, CASH AND BANK BOOK-I
Unit Structure:
2.0 Objectives
2.1 Meaning of Book-keeping
2.2 Objective of Book-keeping
2.3 Utility of Book-keeping
2.4 Book-keeping and Accountancy
2.5 Accounting system
2.6 Account
2.7 Classification of Accounts
2.8 Rules of Debit & Credit
2.9 Books of Accounts
2.10 A conceptual framework of financial accounting
2.11 Journal
2.12 Solved Problems
2.13 Exercises
2.0 OBJECTIVES

Know the Meaning, utility and objectives of Book keeping.
Explain the Accounting system.
Know the Classification of Accounts.
Understand the rules of Debit and Credit.
Explain the Meaning and Utility of Journal.
Journalise the Business transactions.
2.1 MEANING OF BOOK-KEEPING

The oxford dictionary defines Book-keeping as “The
activities of keeping records of financial dealings”.

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J.R. Batiboi defines book-keeping as, “Book-keeping is the

art of recording business dealings in set of Books”.
R.N. Carter defines book-keeping as “The science and art of
correctly recording in the books of accounts. All those business
transactions and events inset of books, as and when such
transactions take place. It is a systematic recording interms of
money in set of books.”
2.2 OBJECTIVES OF BOOK-KEEPING
The main objectives of Book-keeping are given below:

1. To maintain the permant records of the business transactions.
2. To ascertain the profit earned or loss suffered during accounting
period.
3. To know various business Assets and liabilities apart from the
above main objectives.
4. To know amount due to businessman from his customers.
5. To know amount payable to Suppliers.
6. To know various taxes and duties payable to government.
7. To defect and prevent errors and frauds committed by
employees and other person.
8. To provide valuable informations for taking for taking various
decisions.
9. To take decision on significant business matters.
10. To compare and measure the optional efficiency of his business
with other firm, companies in same type of Industry.
11. To review the progress of the business from year to year.
12. To maintain permanent record of all transactions of business for
future reference.
13. To excise effective control on various expenses, incomes
earned over business assets, business liabilities.
14. Other firms, Companies and within the firm compare current
year with previous years. Such comparison is known as
infra-firm comparison.
2.3 UTILITY OF BOOK- KEEPING
Utility means usefulness. The utilities to different persons

and entities are as under:
1) Businessman:

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The owner who invest his money and assets into his
business. He must know the profitabilities, financial stability. The
owner can take various decisions on the basis of the valuable
information obtained from books of accounts.
2) Evidence:
Books of Accounts can be produced as evidence in a court
of law in case of disputes.
3) Book-keeping ensures proper calculation of Income Tax, Sales

Tax, VAT and other tax liabilities.
4) Lenders:
On the basis of information from books, it is possible to
obtain additional finance for business and working capital. On the
basis of such information, lender can be provided any additional
information along with various financial statements.
5) Trade Union:
On the basis of financial statement Trade union can insist
like in Wages, Bonus etc.
6) Prospective Investors:
Prospective Investor can take investment decision by
studying financial statements.
7) Comparative Study:
Financial statement of business enterprise may be
compared over a period of years inter firm and can be compared
with two or more business enterprise in same type of Business over
period of years. This is known as inter firm comparison. Such
comparison helps businessman to judge profitabilities and efficient
of his business.
2.4 BOOK- KEEPING AND ACCOUNTANCY
Book-keeping and Accounting they are differ from each

other. Book-keeping is mainly concern with recording of financial
data relating to business operations in a significant and orderly
manner. It is mechanical and repetitive.
Accounting is a broader and more analytical subject. It

includes the design of accounting system which book-keepers use
to preparation of financial statement, audit, cost studies, Income
tax, value added tax etc. Analysis and interpretation of accounting
information for internal and external end users as on aid to making
business decision. Book-keeping provides the basis of accounting.

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2.5 ACCOUNTING SYSTEM
There are two accounting system of keeping records.
Accounting System
Single Entry Double Entry System

System
Cash System Accrual System
2.5.1 Single Entry System:

The single entry system appears to be time saving and
economical but it is unscientific, having number of defects. Under
single Entry system only few personal accounts are kept, as
nothings; Expenses / Income accounts are totally ignored. This
system is followed by sole proprietor, having total control on cash
as well as on goods. However this system is not generally followed
by any trader.
2.5.2 Double Entry System:

The Double entry system is based on scientific principle and
is used universally by most of business organisations. This system
recognises the fact that every transaction has two aspects and
records both aspects of each and every transaction. Every
business transaction involves exchange of equal values or benefits.
Exchange means the act of giving or receiving one thing in return of
the other thing or service or benefit. Thus every transaction has two
aspects i.e. receiving and giving. The receiving aspect is also
known as the incoming aspect (Debit) and going aspect is known
as the outgoing aspect (credit).
Under double entry system books of accounts can be

maintained by either cash basis or accrual basis.
Cash System of Accounting

Under cash system of accounting entries are made only
when cash is received or paid. No entry is made when amount is
due for receipts or payments. Income is received is accounted
irrespective of period for which relates. Similarly expenses are
restricted to the actual payments made in cash, during the current

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period is immaterial whether the payments have been made for

previous year or subsequent year.
The financial statement prepare under this system do not

present a true and fair view of Income, operating results of
enterprise. However it is suitable in following cases.
i) For very small business organisation.
ii) For individual to record his own transactions.
iii) For professionals like Doctors, Lawyers, Chartered Accountant
etc.
In cash system financial statements are prepared on the

basis of Receipts and payments accounts.
Accrual System of Accounts

This is also known as mercantile system of accounts. Under
this system business transactions are recorded as and when it take
place irrespectful of amount / cash received or paid. Income earned
as well as expenses incurred are recorded related to the Particular
period. The following are the essential features of accrual basis.
a) Revenue is recognised on it is earned irrespective of
whether cash is received or not.
b) Costs are matched against revenues on the basis of relevant
time period to determined periodic income.
c) Costs which are not charged to income are carried forward.
Any cost that lost its utility is written off as a loss.
2.6 ACCOUNT
An account is summarised record or statement of all

transactions relating to a particular person or to a Assets or liability
or income or expense.
According to Kohler‟s Dictionary for accounts, An account

has been defined as a formal record of a particular type of
transaction expressed in money.
Each account is divided into two parts by the vertical line

drawn in the middle.
Dr. ...............Account Cr.
Date Particulars JF Amount Date Particulars JF Amount

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The left hand side is termed as Debit (Dr.) side and the right
hand side is termed as credit (cr.) side.
In order to keep full record of all the transactions the

business has to keep.
i) An account of each head of expenses or income earned by the
business and
ii) An account of each property which belongs to the business and
iii) An account of each party with whom business deals.
2.7 CLASSIFICATION OF ACCOUNTS :
Accounts are classified into two classes:

Personal Accounts
Impersonal Accounts
Impersonal Accounts are further sub divided into

1. Real Accounts
2. Nominal Accounts
3. Valuation Accounts
Thus all accounts can be classified into Personal, Real and

Nominal Accounts.
2.7.1 Personal Accounts:

These accounts show the transactions with customers,
suppliers, Money lenders, the banks and the owner.
For example: Mohan‟s A/c, Rajesh‟s A/c, M/s XY and Co. Reliance
Industries Ltd., Apna Bazar Co-operative Society Ltd., Mumbai
University, Dena Bank etc.
2.7.2 Real Accounts:

Real accounts may be the following types.
a) Tangible real Accounts: These are accounts of such things

which are tangible i.e. which can be seen touched or felt physically.
Example: Land, Building, Furniture, Cash etc.
b) Intangible real Accounts: These accounts represent such

things which cannot be touched, seen or felt physically.
Example: Goodwill, Trade marks, Patent right etc.
2.7.3 Nominal Accounts:

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Nominal Accounts includes accounts of all expenses, losses,

incomes and gains. Nominal Accounts represent only services or
uses.
2.7.4 Valuation Accounts:
Valuation accounts are accounts open to adjust values of
assets e.g. provision for Depreciation, Stock Reserve, Provision for
doubtful debt A/c.
Accounts
Personal A/c Impersonal A/c
Relating to persons
or Institutions decite
Shinde A/c, Real A/cs Nominal A/cs
Anil‟s A/c,
Sunil‟s A/c,
Bank A/c, University, Relating to Relating to
School, Company Assets or expenses and
Firm etc. property Incomes.
Examples: Land Examples:
& Building A/c, Salaries A/c,
Cash A/c, Rent A/c,
Debtors A/c, Commission A/c,
Stock A/c, Discount A/c etc.
Goodwill A/c etc.
CHECK YOUR PROGRESS:

Draw the chart showing the classification of Accounts.
1. Account
2. Personal Accounts
3. Tangible Real Accounts
4. Valuation Accounts
5. Single Entry System
6. Accrual System of Account
7. Book Keeping
2.8 RULES OF DEBIT AND CREDIT :
The two sides of any account are arbitrarily distinguished.

The left hand side of an Account is called Debit side and Right
hand side is called the Credit side.

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When entry on the left side is made it is called account is

debited, and an Entry made on the right hand side of account is
called account is credited.
An account is capable of receiving and giving values. When
an account receives a value / benefit. It is debited and when it gives
a value / benefit it is credited. Each business transactions affects at
least two accounts. One account receives benefit of certain value,
another account would give the benefit of the same value. The
difference between the total debits and total credits in the accounts
is considered as balance.
Golden Rules for Debit and Credit
A B C
Personal A/c Real A/c Nominal A/c
Debit the receiver, Debit what comes in, Debit expenses or losses,
Credit the giver Credit what goes out Credit Incomes and gains
A) Personal Accounts
The personal Account which receives the benefit is debited,
while the personal account which gives the benefit is credited. The
fundamental rule of Debit and Credit regarding personal Account is
Debit the Receiver
And Credit the Giver
The rule means, if a person receives anything from the

business, his account will be debited in the books of business, and
if person gives anything to the business, his account will be
credited.
Illustrations 1
Suppose Goods sold on credit to Sunil from the view point of
business Sunil is a receiver because he receives goods and
therefore Sunil‟s Account will be debited.
Subsequently cash is received from Sunil. Mr. Sunil

becomes a giver because he gives cash and hence his account will
be credited.
B) Real Accounts
As a thing either comes in into business or goes out of
business.
Debit-What Comes In
Credit-What Goes Out
Real account relates to things or property. Hence the above

rule says if anything is coming into business, account of thing is to

22
be debited and anything is going out of business account of that

thing is to be credited.
In the Illustration goods are sold to Mr. Sunil on credit.

Goods are going out of business and therefore „Goods A/c‟ is to be
credited subsequently cash is received from Sunil. Cash is comes
in therefore cash Account is to be debited.
C) Nominal Accounts
Being the accounts of losses and expenses or gains and
incomes.
Debit Expenses and Losses
Credit Incomes and Gains.
Dr. Nominal Accounts Cr.

Payment of Salary, rent loss Received Commission.
on sale of Assets. Bad Interest Discount etc.
Debts etc
Debit losses and expenses. Credit Incomes and Gains
The accounts of expenses or losses of the business are to

be debited where as the accounts of Incomes or profits are to be
credited Exp. Paid salaries.
Here Salary is on expenditure of the business and there fore

Salary account is to be debited.
In the transaction “Received Interest from A & Co” Interest is

an Income of the business and hence Interest Account is to be
credited.
Illustration. 2
State the names of the accounts to be debited or credited in
the following transactions.
No. Transactions Name of Classification Application Answers

accounts of account of the rules
affected
1. Sujit Sujit‟s Personal A/c Credit the Credit
Commenced Capital giver
business with A/c
cash
Cash A/c Real A/c Cash comes Debit
in Debit
what comes
in
2. Purchased Goods Real A/c Goods are Debit
goods for cash A/c comes in

23
Cash A/c Real A/c Cash is Credit

goes out

24
3. Sold goods on Avinash‟s Personal A/c Avinash is Debit

credit to Mr. A/c receiver
Avinash
Goods Real A/c Goods are Credit
A/c goes out
4. Cash received Cash A/c Real A/c Cash comes Debit
from Mr. In
Avinash
Avinash‟s Personal A/c Avinash is Credit
A/c giver
5. Cash deposited Cash A/c Real A/c Cash goes credit
into the Bank out
Bank A/c Personal A/c Bank is Debit
receiver
2.9 BOOKS OF ACCOUNTS :
A business organisations maintains three types books of

Accounts; namely,
Cash Book:
To record cash receipts and payments including receipts and

Payments through Bank. A separate cash book is kept to record
petty expenses.
Journal:
To record non cash transactions like credit sales, credit

purchases, Sales Returns, Purchase Returns. These Books are
called Subsidiary books.
Ledger:
Ledger contains a classified summary of all transactions

recorded in cash book and journal. All personal, Real and Nominal
Accounts are prepared into the ledger.
Few additional books of account may be maintained as per

requirement of business organisation e.g. Stock Register, Members
Register etc.

25
2.10 A CONCEPTUAL FRAMEWORK OF FINANCIAL

ACCOUNTING :
Financial Accounting
Principle : Double Entry System
For Cash transaction For credit transaction

Cash Book Journal
Posted to
Ledger
Out put: Trial Balance
Adjustments
Out put
Profit & Loss A/c, Balance Sheet Assets

Income & Expenditure & Liabilities
For Analysis
Cash Flow Fund Flow

Statement Statement
2.11 JOURNAL :
2.11.1 Meaning:
It is essential in a business to record each and every
transaction immediately after it takes place. To record credit
transaction a separate book, called „Journal‟ is maintain, Journal
can be defined as, „a subsidiary book in which all day-to-day

26
monetary transactions of business are recorded first as and when

they take place in chronological order (i.e. date wise), in debit and
credit form and in a systematic manner. Journal is also known as
„Prime entry‟ or „Original entry‟ book. Because transactions are first
entered in this book and then they are posted in the Ledger.
As Business transactions are numerous and large in size,

the Journal may be split up into number of separate Journals to
record particular type of transaction. These journal are known as
the subsidiary books. Some of the subsidiary books are:
i) Purchase Book
ii) Purchase Return Book
iii) Sales Book
iv) Sales Return Book
v) Bills Receivable Book
vi) Bills Payable Book
vii) Journal Proper
2.11.2 Necessity or Utility of Journal
1. Direct recording of transactions in the ledger may result in

committing errors and omissions and it would be difficult to
correct them later on. Hence, Journal is necessary.
2. A complete record (i.e. Debit and credit aspects of each
transaction) is available at one place.
3. As the transactions are recorded date wise, it facilitates
quick and easy reference to any transaction, whenever
necessary.
4. Narration to Journal entry explains the purpose of the entry
and helps in understanding the transaction recorded.
5. Entries in the ledger can be made at leisure by the clerk
concerned according to his convenience.
6. Cross checking between Journal and Ledger is facilitated to
check the accuracy.
7. As the entries in the Journal are made from basic documents
like invoices. Vouchers, receipts etc. The court considers the
entries in the Journal as proof of transactions.

27
2.11.3 Specimen of Journal:
Date Particulars Voucher LF Dr. Cr.

No. Amt. Amt.
(Rs.) (Rs.)
Journalising: The act of recording a transaction in the Journal in

the form required is called Journalising.
2.11.4 How to Journalise the Transactions
1. First find out the two accounts involved in a transaction.

2. Ascertain the types of those accounts and then decide by
applying rules of Debit and Credit as to which account is to be
debited and which account is to be credited.
3. The name of the account is to be debited is to be written first
under „Particulars‟ column. It is written close to the first margin
line and the name of the account to be credited is to be
proceeded by the word “To” and is to be written on the Second
line.
4. The amount involved in the transactions is written under the “Dr”
and “Cr” columns against the names of debit and credit
accounts respectively.
5. A brief explanation of the entry is given in the bracket just below
the entry. It is called “narration”.
6. A line is drawn below each Journal Entry from first margin line to
the second margin line to keep the entries of the transaction
separate from one another.
7. Ledger folio (L.F.): It means page number in the ledger. The
page on which the particular account is opened in the “Ledger”
is stated under “L.F.” column to facilite easy reference.
8. Date: The date of the transaction is written under the column
“Date”.

28
2.11.5 Debit note and Credit note:

Debit Note:
When goods are received from the supplier, the Supplier
account is credited. When goods are returned from him the supplier
account is debited, so in case of purchase returns a debit note is
prepared. It should contain all the details of purchase returns.
Generally a debit note will be made in duplicate, one copy will be
sent to the customer and other will be kept as office copy.
Credit Note:
It is a statement sent by the seller to his customer intimating
that, his account has been credited with the amount of goods return
by him or any other allowances granted to him.
2.12 SOLVED PROBLEMS
Illustration 1
Journalise the following transactions in the books of “Ketan”.
2009
Jan. 1 Purchased goods from Nalini on Credit Rs. 1000/-.
Jan. 2 Sold goods to Mr. Sharma on credit Rs. 2,500/-
Jan. 3 Purchased furniture for cash Rs. 10,000/-
Jan. 4 Received interest Rs. 800
Jan. 5 Paid salaries Rs. 3,500/-
After deciding the accounts to be debited and accounts to be

credited the Journal Entries are passed as shown below.
In the Books of Ketan

Journal Entreis
Date Particulars L.F. Dr. Cr.

Rs. Rs.
2009
Jan.1 Purchases A/c .............. .Dr. 1,000
To Nalini‟s A/c 1,000
(Being goods purchased on
credit from Nalini)
2 Mr. Sharma‟s A/c ............Dr. 2,500
To Sales A/c 2,500
(Being goods sold on credit to
Mr. Sharma)
3 Furniture A/c ...................Dr. 10,000
To Cash A/c 10,000
(Being furniture purchased for
Cash)

29
4 Cash A/c ....................... .Dr. 800

To Interest A/c 800
(Being interest received)
5 Salaries A/c ....................Dr. 3,500
To Cash A/c 3,500
(Being Salaries paid)
Total 17,800 17,800
Illustration 2
Journalise the following transactions in the books of Shri. More.
2009
Dec. 1 Shri More started business with cash Rs. 15000.
2 Purchased goods from Mr. Singh Rs. 30,000
3 Deposited cash into the Bank Rs. 4,000
4 Sold goods to Mr. Gujar Rs. 2,500
5 Purchased furniture of Rs. 2,500 from furniture and Co.
6 Paid to Mr. Singh by cheque Rs. 1,000
7 Received a cheque from Mr. Gujar Rs. 1,200
8 Paid Interest Rs. 450
9 Withdraw cash Rs. 3,000 for personal use
10 Cheque received from Mr. Gujar Deposited into the Bank.
11 Returned goods to Mr. Singh Rs. 500
12 Received goods returned by Mr. Gujar Rs. 300
13 Paid salary by cheque Rs. 4,000
14 Received a cheque for rent Rs. 900. The cheque is
deposited into the Bank.
15 Withdraw cash Rs. 3,000 from Bank for office use.
16 Returned Furniture of Rs. 400 to Furniture and company.
In the books of Shri. More.

Journal Entries

Rs. Rs.
2009
Dec.1 Cash A/c . ................. .Dr. 15,000
To Capital A/c 15,000
(Being started business with
cash)
2 Purchases A/c ..................Dr 30,000
To Mr. Singh‟s A/c 30,000
(Being credit purchases from
Mr. Singh)

30
3 Bank A/c .......................Dr. 4,000

To Cash A/c 4,000
(Being Cash deposited in the
bank)
4 Gujar‟s A/c .....................Dr. 2,500
To Sales A/c 2,500
(Being goods sold on credit to
Mr. Gujar)
5 Furniture A/c .................Dr. 2,500
To Furniture & Co. A/c 2,500
(Being furniture purchased on
credit)
6 Singh‟s A/c ...............Dr. 1,000
To Bank A/c 1,000
(Being issued a cheque to Mr.
Singh)
7 Cash A/c ........................ Dr. 1,200
To Mr. Gujar‟s A/c 1,200
(Being Cheque received from
Mr. Gujar)
8 Interest A/c ...............Dr. 450
To Cash A/c 450
(Being Interest paid)
9 Drawings A/c ...............Dr. 3,000
To Cash A/c 3,000
(Being Mr. More withdraw
cash for personal use)
10 Bank A/c ................Dr. 1,200
To Cash A/c 1,200
(Being cheque deposited into
the Bank)
11 Mr. Singh‟s A/c ...............Dr. 500
To Purchase Return A/c 500
(Being Goods returned to Mr.
Singh)
12 Sales Return A/c ......... Dr. 300
To Mr. Gujar‟s A/c 300
(Being Goods returned by
Mr. Gujar)
13 Salaries A/c .....................Dr. 4,000
To Bank A/c 4,000
(Being cheque issued for
Salaries)

31
14 Bank A/c .................Dr. 900

To Rent A/c 900
(Being a cheque from the
subtenant in payment of Rent
and the cheque is deposited
into the Bank)
15 Cash A/c ...................Dr. 3,000
To Bank A/c 3,000
(Being cash withdrawn from
Bank for office use)
16 Furniture and Co‟s A/c .....Dr. 400
To Furniture A/c 400
(Being Furniture returned to
Furniture and Co‟s A/c)
Total 69,950 69,950
The students will note that the total Debits is always equal to
total of credits.
The entries in which there are more than one debit or more
than one credit are called compound Entries.
Illustration 3
Journalise the following transactions in the books of Mr. Ashok.
March, 2009
March 1 Mr. Ashok commenced business with Rs. 10,000 of his
own and Rs. 5,000 borrowed from his friend Pramod.
2 Opened a current account in the Bank of Maharashtra by
depositing Rs. 4000.
3 Purchased goods worth Rs. 3,000 from Anil and Co.
subject to the 2% Trade Discount.
4 Credit Sales of Rs. 4,000 to Mr. Desai.
5 Cash Sales of Rs. 6,000 to Mr. Kulkarni.
6 Purchased furniture costing Rs. 4,000 of which furniture
of Rs. 600 was for residential use of Mr. Ashok.
7 Received cash from Mr. Desai Rs. 3,800 and he was
allowed cash discount Rs. 200.
8 Cash purchases of Rs. 1,000 paid carriage Rs. 300.
8 Withdrew from Bank Rs. 2,000 for office use.
10 Returned goods to Anil and Co. Rs. 100.

32
15 Paid cash to Anil & Co Rs. 980, who allowed us discount

Rs. 20.
16 Received a cheque for Rs. 300 in exchange of cash from
Raju.
18 Received Interest from M/s Shah and Sons Rs. 800.
20 Sale og goods to Kadam Rs. 500.
21 Distributed goods of Rs. 500 as free samples.
22 Goods of Rs. 500 were used by Ashok for his private
purposes.
25 Paid Rs. 400 to Manan on behalf of our creditor, Anil
and co.
30 Our debtor Ketan paid our office Rent Rs. 800.
30 Received goods returned by Kadam Rs. 100.
31 Ashok brought into business sale proceeds of his
personal Furniture Rs. 7,000.
31 Invested Rs. 10,000 in the shares of ABB Co. Ltd.
31 Received Rs. 360 in full settlement of Kadam dues.
In the Books of Ashok

Journal
Rs. Rs.
2009
Mar. 1 Cash A/c . ................. .Dr. 15,000
To Pramod Loan A/c 10,000
(Being Ashok Started business
with cash Rs. 10,000 of his own
and Rs. 5,000 borrowed from
Pramod)
2 Bank of Maharashtra A/c Dr. 4,000
To Cash Ac 4,000
(Being Cash is deposited into
Bank)
3 Purchases A/c .........Dr. 2,940
To Anil and Co‟s A/c 2,940
(Being Purchased goods from
Anil & Co.)
4 Mr. Desai‟s A/c ................Dr. 4,000
To Sales A/c 4,000
(Being goods Sold on credit)

33
5 Cash A/c ...................Dr. 6,000

To Sales A/c 6,000
(Being goods Sold for cash)
6 Furniture A/c ...............Dr. 3,400
Drawings A/c ...............Dr. 600
To cash A/c 4,000
(Being Furniture purchased for
office use and personal use)
8 Cash A/c .............Dr. 3,800
Discount A/c ............Dr. 200
To Mr. Desai‟s A/c 4,000
(Being cash received from Mr.
Desai)
8 Purchases A/c ..............Dr. 1,000
Carriage A/c ..............Dr. 300
To Cash A/c
(Being Goods purchased for 1,300
cash and carriage paid
thereon)
9 Cash A/c ................Dr. 2,000
To Bank A/c 2,000
(Being cash withdrawn from
Bank)
10 Anil and Co‟s A/c ..........Dr. 100
To Goods A/c (Pur. Return) 100
(Being Goods returned to Anil
and Co.)
15 Anil and Co‟s A/c ..........Dr. 1,000
To Cash A/c 980
To Discount A/c 20
(Being cash paid to Anil and Co
and received discount from
him)
18 Cash A/c .............Dr. 800
To Interest A/c 800
(Being interest received from
Shah and Co.)
20 Kadam‟s A/c .............Dr. 500
To Sales A/c 500
(Being goods sold for credit to
Kadam)

34
21 Advertisement A/c ..........Dr. 500

To Goods A/c 500
(Being Goods distributed as
free samples)
22 Drawings A/c ..........Dr. 500
To Goods A/c 500
(Being Goods withdrawn by
proprietor for personal use)
25 Anil and Co‟s A/c ...............Dr. 400
To Cash A/c 400
(Being cash paid to Manan of
behalf of Anil and Co‟s A/c)
30 Rent A/c ...........Dr. 800
To Ketan‟s A/c 800
(Being Ketan paid rent behalf of
us)
30 Goods A/c / Sales Return A/c 100
...... Dr.
To Kadam‟s A/c 100
(Being Goods returned by
Kadam)
31 Cash A/c ............Dr. 7,000
(Being Proprietor introduced
additional capital into the
business)
31 Investment‟s / Shares A/c Dr. 10,000
To Cash A/c 10,000
(Being investment made in
shares of ABB Co. Ltd)
31 Cash A/c ...........Dr. 360
Discount A/c ...........Dr. 40
To Kadam‟s A/c 400
(Being cash received from
Kadam and allowed him to
Discount)
Total 65,340 65,340
Note: Transaction dated 16 march, 2009 does not require Journal

Entry as cash exchanged for a cheque. It is not a transaction.
Illustration 4

35
Journalise the following transactions in the books of Dhawal

2008.
Rs.
Mar. 2 Commenced business with cash 2,50,000
4 Purchased furniture for cash 20,000
4 Cash purchases 1,45,000
5 Deposited with bank 30,000
6 Bought from Z 40,000
Sold to Natu for cash 14,300
7 Stationery purchased 1,050
7 Bought from Mona 20,000
7 Sold to Rakesh 8,000
9 Rent for two years paid in advance 14,000
9 Drawings by the proprietor for household
Expenses 4,000
Goods taken out by the proprietor for
domestic use 1,500
9 Cash withdrawn from Bank 25,000
10 Sold to A & Co on credit 9,000
11 Purchases made, payment through cheque 2,900
14 Cash received from Z on account 10,000
14 Cash paid to Mona after deduction of
discount Rs. 130 3,870
17 Cash received from A & Co. in full
settlement of his account 8,750
28 Purchase of office furniture 40,000
30 Sold goods to Agarwal for cash 8,000
Sold to Nana 3,000
31 Cartage paid in cash 150
Solution:
Journal in books of Dhawal

Rs. Rs.
2008
Mar. 2 Cash A/c ........Dr. 2,50,000
To Capital A/c 2,50,000
(For cash brought in by
proprietor as his capital)
4 Furniture A/c ........Dr. 20,000
To Cash A/c 20,000
(For purchase of furniture for
cash)
4 Purchases A/c .........Dr. 1,45,000

36
To Cash A/c 1,45,000

(For purchase of goods in
trade for cash)
5 Bank A/c .........Dr. 30,000
To Cash A/c 30,000
(For cash deposited in bank)
6 Purchases A/c ........Dr. 40,000
To Z‟s A/c 40,000
(Goods purchased from Z on
credit)
6 Cash A/c .......Dr. 14,300
To Sales A/c 14,300
(For cash sales made to Natu)
7 Stationery A/c .......Dr. 1,050
To Cash A/c 1,050
(For purchase of stationery for
cash)
7 Purchases A/c ........Dr. 20,000
To Mona‟s A/c 20,000
(For credit purchases of goods
to Mona)
7 Rakesh‟s A/c .........Dr. 8,000
To Sales A/c 8,000
(For credit sales of goods to
Rakesh)
9 Rent paid in Advance A/c ..Dr. 14,000
To Cash A/c 14,000
(For rent paid in advance)
9 Drawings A/c ........Dr. 5,500
To Cash A/c 4,000
To Purchases A/c 1,500
(For drawings in cash and
goods made by the proprietor)
9 Cash A/c .........Dr. 25,000
To Bank A/c 25,000
(For cash withdrawn from
Bank)
10 A & Co‟s A/c .........Dr. 9,000
To Sales A/c 9,000
(For sales to Mathur on credit)

37
11 Purchases A/c ........Dr. 2,900

To Bank A/c 2,900
(For purchases of goods,
payment made by means of
cheque)
14 Cash A/c .........Dr. 10,000
To Z‟s A/c 10,000
(For cash received from Z)
14 Mona‟s A/c .........Dr. 4,000
To Cash A/c 3,870
To Discount A/c 130
(For cash paid to Mona and
discount received from him)
17 Cash A/c .........Dr. 8,750
Discount A/c .........Dr. 250
To A & Co. A/c 9,000
(For cash received from A &
Co. and discount allowed)
28 Furniture A/c ........Dr. 40,000
To Cash A/c 40,000
(For purchase of a scooter)
30 Cash A/c .........Dr. 8,000
Nana A/c ........Dr. 3,000
To Sales A/c 11,000
(For sales made in cash and
Nana on credit on this day)
31 Cartage A/c ........Dr. 150
To Cash A/c 150
(Cartage paid)
Illustration 5
Shri Sona started his business with cash Rs. 35,000 and
furniture of Rs. 5,000 on 1st April 2009.
April. 4 Paid cash into Bank Rs. 10,000

6 Purchased furniture and issued a cheque Rs. 4,000.
8 Credit purchases from Ketan Rs. 20,000 less 5% trade
discount.
14 Returned goods to Ketan Rs. 400
19 Cash Sales Rs. 10,000
27 Credit Sales to Natu Rs. 4,000 less trade discount 3%

38
29 Natu returned goods of Rs. 196

30 Distributed goods of Rs. 4,000 as free samples and Sona
used goods of Rs. 1,000 for personal use.
Solution:
In books of Sona
Journal
Rs. Rs.
2009
April. 1 Cash A/c .......Dr. 35,000
Furniture A/c .......Dr. 15,000
(Sona started business by
bringing cash & furniture)
April. 4 Bank A/c .......Dr. 10,000
To Cash A/c 10,000
(Paid cash into Bank)
April 6 Furniture A/c ......Dr. 4,000
To Bank A/c 4,000
(Purchased furniture by
issuing a cheque in payment)
April 8 Purchase A/c ......Dr. 19,000
To Ketan‟s A/c 19,000
(Credit purchases from
Ketan‟s)
April 14 Ketan‟s A/c .......Dr. 400
To Return outwards A/c 400
(Returned goods to Ketan)
April 19 Cash A/c .......Dr. 10,000
To Sales A/c 10,000
(Cash Sales)
April 27 Natu‟s A/c .......Dr. 3,880
To Sales A/c 3,880
(Credit Sales to Natu)
April 29 Return Inwards A/c .....Dr. 196
To Natu‟s A/c 196
(Natu Returned goods to us)

39
April 30 Advertisement A/c ......Dr. 4,000

Drawings A/c 1,000
To Purchases A/c 5,000
(Distributed goods as free
samples & Madhav took
goods for personal use)
2.13 EXERCISE
2.13.1 Theory Questions

1. Explain term „Book Keeping.
2. What is Account?
3. Distinguish between:
a) Book-keeping and Accountancy
b) Personal Accounts and impersonal Accounts
c) Real Accounts and Nominal Accounts
d) Single Entry system and Double Entry system
e) Cash system of Accounts and Accrual system of
Accounts.
4. Discuss the principles of debit and credit of Accounts.
5. Explain Journal & its utility.
6. “By sub-division of journal, there will be a division of
labour”. Explain.
2.13.2 Practical Problems
1) Journalise the following transactions in the books of Ram for the

month of March 2010.
March 1 Ram commenced business with cash Rs. 60,000.
2 Purchased furniture for Rs. 5,000.
4 Purchased goods for cash Rs. 2,000.
7 Bought goods from M/s. Raj & Co. for Rs. 4,000.
10 Sold goods costing Rs. 3,000 on cash.
15 Purchased stationery for office use Rs. 1,000.
19 Received cash Rs. 1,250 from Mr. Ketan in full
settlement of his account for Rs. 1,500.
20 Paid salaries by cheque Rs. 1,500.
25 Introduced additional capital Rs. 20,000.
27 Paid to Raj Rs. 3,250 in full settlement of Rs. 3,500
29 Sold goods for Rs. 15,000 to Mr. Dohi.
31 Deposited Rs. 3,000 into the Bank.

40
2) Journalise the following transactions in the books of Mr. Shiva

for the month of April 2010.
April 1 Started business with cash Rs. 25,000/-
2 Purchased goods worth Rs. 10,000/-
4 Deposited cash Rs. 3,000 into the Bank.
6 Purchased goods of Rs. 6,000 from M/s. Raju Trading
Company.
9 Sold goods to Mr. Ramesh for Rs. 3,000.
12 Paid to M/s. Raju Trading Company Rs. 3,000.
15 Received Rs. 1,000 from Mr. Ramesh.
20 Paid salaries Rs. 1,000/- and paid commission
Rs. 1,600/- in cash.
25 Bought stationery for office use Rs. 300.
27 Withdrew Rs. 2,500 from business for personal use.
29 Withdrew Rs. 4,000 from bank for office use.
3) Journalise the following transactions in the journal of Mr. Anand

for the month of February, 2010.
Feb 1 Borrowed from Bank @ 15% interest Rs. 20,000.
3 Purchased goods from Mr. Sam for Rs. 3,500.
4 Paid carriage and cartage Rs. 250
7 Sold goods on cash Rs. 3,000.
10 Paid Rs. 2,250 to Mr. Sam.
15 Purchased office furniture for Rs. 6,000.
18 Paid interest Rs. 450/- to Mr. Bank.
20 Paid salaries Rs. 6,000.
22 Cash sales Rs. 20,000.
26 Cash purchases Rs. 15,000
28 Paid Rs. 2,000 to Bank in part payment of loan.
4) Journalise the following transactions in the books of Mr. Vishal

for the month of March, 2010.
Mar. 1 Vishal started business with cash Rs. 35,000, goods
worth Rs. 10,000.
2 Opened bank account in the Bank of India by
depositing Rs. 5,000.
4 Bought goods worth Rs. 6,000 @ 10% trade discount
term.
7 Sold goods worth Rs. 3,000

41
9 Purchased furniture of Rs. 4,000 for office use and

furniture of Rs. 1,000 for home use.
14 Withdrawn goods of Rs. 1,000 for self use.
17 Received Rs. 2,400 from Mr. Ravindra in full
settlement of Rs. 2,450.
19 Paid salaries Rs. 500 to office clerk and paid
electricity bill of Rs. 750 in cash.
24 Paid Mr. Raj Rs. 1,960 in full settlement of Rs. 2,000.
26 Paid insurance premium of Rs. 1,200 on the life of Mr.
Vishal, a proprietor.
5) Draft journal entries for the business transactions given below.

Apr. 1 Mr. Atul started business with cash Rs. 5,000/-, goods
Rs. 7,500 and furniture Rs. 2,500/-
3 Purchased goods worth Rs. 4,500 from Mr.
Kamalakar.
5 Cash sales Rs. 6,000
8 Purchased stationery for office use Rs. 500.
10 Paid to Mr. Kamalakar Rs. 4,350 in full settlement of
Rs. 4,500.
16 Received Rs. 500 from Mr. Kiran.
19 Withdrawn Rs. 200 from business for self use.
23 Paid Rs. 150 for commission and paid Rs. 450 for
rent.
27 Paid wages Rs. 600 in cash, and paid sundry
expenses Rs. 200/- by cheque.
29 Borrowed Rs. 5,000 from wife for business purpose.
30 Cash purchases Rs. 1,000.




42
3
ELEMENT OF BOOK-KEEPING,
JOURNAL, CASH AND BANK BOOK-II
Unit Structure:
3.0 Objectives
3.1 Cash Book
3.2 Cash Discounts
3.3 Petty Cash Book
3.4 Three Column Cash Book
3.5 Exercises
3.0 OBJECTIVES

Know the Meaning of Cash book.
Understand the meaning of Cash discount and effect of cash
discount.
Understand the types of Cash Book.
Record the transactions in the Cash Book.
3.1 CASH BOOK
This records all receipts of and payments in cash. Usually

the deposits into bank accounts maintained by the business,
withdrawals from such accounts and cheques payments are also
recorded in the Cash Book. Sometimes a separate book for
recording receipts and payments by cheques / DDs etc., is kept
known as the Bank Book. A Cash Book which is used to record
both cash and bank transactions is referred to as a Two-column
Cash Book. The format of this cash book is given below:

43
Illustration 1
Cash Book of Anand & Co.
Dr. Cr.
Date Receipts Ledger Cash Bank Date Payments Ledger Cash Bank
Folio Folio
2008 2008
July July
1 To Balance b/f 11,500 13,000 2 By Wages 150
6 To Sales 1,800 5 By Electricity 800
7 To Z & Co. 7,000 8 By Salaries 4,400
11 To R.K. Corporation 2,000 15 By O Ltd 11,200
30 To Sales 2,500 By Plant
22 4,000
31 By Balance c/f 7,250 10,000
15,800 22,000 15,800 22,000
3.2 CASH DISCOUNTS
Sometimes, in order to encourage early payments due from

customers, a company may offer a certain percentage of the
amount as a discount. For example, if a customer owes the
company Rs. 11,000, the company may allow 3% discount if the
payment is made before a certain date. In such a case, the
customer would pay an actual cash of Rs. 10,670 only
(Rs. 11000-3% of Rs. 11,000) and Rs. 330 would be treated as
discount expense by the company. A cash discount may be
distinguished from a trade discount which is given on the invoice
price, especially when orders for large quantities are placed. The
trade discount is therefore reflected as a reduction in the sale price
itself. Therefore Trade discount not recorded in books of Accounts.
A cash book can also be used to record the cash discounts

that are allowed to customers for prompt payments and the cash
discounts that are earned on payments made to suppliers within a
stipulated time period. Since discounts will be allowed to customers
at the time of receipt of money and received from suppliers at the
time of payment of dues, it is convenient to maintain the column for
discounts allowed on the receipts side of the cash book and the
column for discounts received on the payments side. A cash book
in which the cash and bank transactions and the details of cash
discounts are recorded is referred to as a Three-column cash book.
An illustrative format of this type of cash book is given below:

44
Illustration 2
Cash Book of Anand & Co.

Dr. Cr.
Date Receipts Discount Cash Bank Date Payments Discount Cash Bank
allowed received
2010 2010
April April
1 To Balance b/f 11,500 6,500 1 By Salaries 6,200
6 To Sales 8,000 3 By Wages 2,500
7 To Z & Co. 100 10,000 5 By Printing 4,000
11 To Balu Corpn. 100 600 22,350
8 By Repairs 4,000
20 To Sales 1,500 15 By K Ltd 100 12,700 10,900
20 By Drawings 1,000 4,000
30 By Balance c/f 1,400 13,750
200 21,600 38,850 100 21,600 38,850
Illustration: 3
Enter the following transactions in simple cash book.

April, 2010
1 Started business with Cash Rs. 50,000
3 Made Cash purchases Rs. 8,000
4 Made Cash Sales Rs. 12,000
6 Purchased furniture Rs. 4,000
7 Received Cash from Mr. Kulkarni Rs. 8,000
8 Paid Salaries Rs. 5,000

45
Cash Book
Dr. Cr.
Date Particulars V. JF Rs. Date Particulars V. JF Rs.
No. No No. No
2010 2010
April, April,
1 To Capital A/c 50,000 3 By Purchases A/c 8,000
4 To Sales A/c 12,000 6 By Furniture A/c 4,000
7 To Kulkarni‟s A/c 8,000 8 By Salaries A/c 5,000
30 By bal. c/d 53,000
70,000 70,000
Illustration: 4
From the following particulars of Kahan‟s. Prepare a cash
book with discount and cash column only.
2010
Jan 1 Balance of cash in hand Rs. 50,000
2 Purchased goods worth Rs. 25,000 for cash and paid
carriage inward Rs. 700.
5 Paid into Bank current A/c Rs. 15,000
13 Paid by cheque to Malini Rs. 4,800 infull settlement of
Rs. 5,000.
13 Received for cash sales Rs. 1500 cash and cheque
Rs. 5,000
14 Drew for sister‟s marriage Rs. 8,000/- by cheque.
16 Paid for wages Rs. 400 and salaries Rs. 2,000.
17 Received interest on investment Rs. 900 and paid the
same into the Bank.
20 Paid by cheque Rs. 5,000 on account Mr. Mali and was
allowed discount of Rs. 300.
25 Drew two cheques for petty cash and office use Rs. 150
and Rs. 100 respectively.
31 Received a cheque from Bharat Rs. 2,880 infull
31 Paid in cash in excess of Rs. 4,000 into Bank.

46
Solution: Cash Book

Receipts
Payments
Date Particulars R. LF Dis. Rs. Date Particulars R.
No No Cash No.
2010 2010
Jan.1 To bal b/d - 50,000 Jan. 2 By Purchases A/c
13 To Sales A/c - 6,500 By Carriage Inward A/c
15 To Bank A/c - 4,800 5 By Bank A/c
14 To Bank A/c - 8,000 13 By Malini‟s A/c
17 To Interest A/c - 900 14 By Drawings A/c
20 To Bank A/c - 5,000 16 By Wages A/c
25 To Bank A/c - 250 By Salaries A/c
31 To Bharat‟s A/c 120 2,880 17 By Bank A/c
20 By Mali A/c
25 By Petty Cash
31 By Bank A/c
By Bal c/d
120 73,530

47
3.3 PETTY CASH BOOK
When the petty cash fund is operated as an imprest fund,

the recording of the petty expenses paid will be made in the petty
cash book. This would also avoid recording too many small value
transactions in the main cash book. The petty cash book 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. A specimen petty
cash book is given below:
Illustration 1:
Analytical Petty Cash Book of Anand & Co.
Amount Date Particulars Total Postage Printing & Carriage Traveling Sundry
Received Amount & Stationery Expenses Expenses
paid Telegrams
2010
April, 1 To Bank A/c
(Cheque encashed)
3000
April, 7 By Postal 190 190
stamps
April, 10 By Stationery 232 232
April, 15 By Carriage 616 616
April, 20 By Auto fare of 400 400
salesman
April, 22 By Telegrams 10 10
April, 27 By Carriage 110 110
April, 30 By Stationery 206 206
1764 200 438 616 400 110
April, 30 By Balance c/d 1236
3000 3000
2010
1236 May, 1 To Balance b/d
1764 May, 1 To Bank A/c
(Cheque encashed)
Separate Petty Cash A/c is open in Ledger & total Exp.

credited to Petty Cash A/c. Individual expenses total is debited to
concerned expenses A/c in the Ledger.
3.4 THREE COLUMN CASH BOOK
Cash book with Discount, cash and bank column is known

as three column cash-book. In this cash book along with cash
transactions banking transactions are also recorded.

48
Dr. Receipts Cash book Payments Cr.

Date Particulars R LF Disc Cash Bank Date Particulars R LF Disc Cash Bank
No. No. ount Rs. Rs No. No. ount Rs. Rs
Journal Entries for cash and Banking Transactions
Accounting Entry
1) Investment of capital in cash by proprietor Cash A/c ......Dr.
To Capital A/c
2) Sale of goods on cash basis Cash A/c ......Dr.
To sales A/c
3) Receipt of Income in cash Cash A/c ......Dr.
To Income A/c
4) Cash deposited in to the Bank Bank A/c ......Dr.
To Cash A/c
5) Cash withdrawn from Bank for office use Cash A/c .....Dr.
To Bank A/c
6) Sale of goods and amount received by Bank A/c .....Dr.
Cheque and same cheque is deposited To Sales A/c
into Bank immediately.
7) When bearer cheque is received from Cash A/c ....Dr.
outside party. To Party‟s A/c
8) When order or crossed cheque received Bank A/c ......Dr.
from outside party. To Party‟s A/c
9) When cheque received from outside Party Bank A/c ......Dr.
and deposited in into the bank on the To Party‟s A/c
same day
10) Cheque received on earlier day and Bank A/c .....Dr.
deposited to day To Cash A/c
11) Cheque issued to other Party Bank A/c .....Dr.
Dishonoured To Party‟s A/c
12) When customer directly deposits the Bank A/c .....Dr.

49
amount into the Bank To Customers A/c

50
13) When bank collects our income and Bank A/c ......Dr.
deposit into our account To Incomes A/c
14) Cheque received, deposited and then Party‟s A/c ......Dr.
dishonoured To Bank A/c
15) Purchase of goods on cash basis / cash Purchases A/c ....Dr.
purchase To Cash A/c
16) Payment of expenses in cash Expenses A/c ....Dr.
To Cash A/c
17) Entry for Bank charges and commissions Bank charges A/c..Dr.
Commission A/c ..Dr
To Bank A/c
18) Transfer of amount from current A/c to Fixed Deposit A/c .Dr
Fixed Deposit or savings A/c Savings A/c .... Dr.
To Bank A/c
19) When cheque is issued to outside Party Party‟s A/c ........Dr.
To Bank A/c
Illustration 2:
During January 2010 Ram transacted the following business:
2010 Rs.
Jan
1. Commenced business with cash 20,000
2. Purchased goods on credit from Nadu. 1,00,000
3. Purchased goods for cash 4,000
4. Paid Gopal an advance for goods ordered 10,000
5. Received cash from Maruti as advance for 6,000
goods ordered by him
6. Purchased furniture, office use for cash 2,000
7. Paid Rent 1,000
8. Received commission (in cash) 1,600
9. Goods returned to Nadu 2,000
10. Goods sold to Kishore 10,000
11. Paid for postage and telegrams 200
13. Goods returned by Kishore 2,000
14. Purchase furniture (amount cheque paid) 16,000
15. Paid for stationery 1,200
18. Paid into Bank 5,000
20. Goods sold for cash 27,750

51
22. Bought goods for cash 3,000

25. Paid salaries by cheque 3,200
28. Paid rent 1,000
31. Drew cash for personal use 4,000
31. Deposited cash into Bank 12,000
Journal Entries in the books of Ram

Rs. Rs.
2010
Jan. 1 Cash A/c .......Dr. 20,000
To Ram‟s Capital A/c 20,000
(Being the cash brought into
business as capital)
Jan. 2 Purchase A/c .......Dr. 1,00,000
To Nandu‟s A/c 1,00,000
(Being the goods purchased
on credit)
Jan. 3 Purchases A/c .....Dr. 4,000
To Cash A/c 4,000
for cash)
Jan. 4 Gopal A/c .....Dr. 10,000
To Cash A/c 10,000
(Being the amount paid to
Gopal)
Jan. 5 Cash A/c .....Dr. 6,000
To Maruti A/c 6,000
(Being the cash received
from Maruti)
Jan. 6 Furniture A/c .....Dr. 2,000
To Cash A/c 2,000
(Being the furniture
purchased for office use for
cash)
Jan. 7 Rent A/c ......Dr. 1,000
To Cash A/c 1,000
(Being the wages paid)

52
Jan. 8 Cash A/c ......Dr. 1,600

To Commission Received A/c 1,600
(Being the commission
received)
Jan. 9 Nandu A/c .....Dr. 2,000
To Purchase return A/c 2,000
(Being goods returned to
Nandu)
Jan. 10 Kishore A/c ......Dr. 10,000
To Sales A/c 10,000
(Being goods sold to Kamal
on credit)
Jan. 12 Postages & Telegrams A/c..Dr. 200
To Cash A/c
(Being the amount paid for 200
postages & Telegrams)
Jan. 13 Sales returns A/c ...Dr. 2,000
To Kishore‟s A/c 2,000
(Being the goods returned by
Kamal)
Jan. 14 Furniture A/c .....Dr. 16,000
To Bank A/c 16,000
(Being cheque issued for
purchase of Furniture)
Jan. 15 Stationery A/c ......Dr. 1,200
To Cash A/c 1,200
(Being the amount paid for
stationery)
Jan. 18 Bank A/c ......Dr. 5,000
To Cash A/c 5,000
(Being the amount deposited
into the Bank)
Jan. 20 Cash A/c ....Dr. 27,750
To Sales A/c 27,750
(Being the goods sold for
cash)
Jan. 22 Purchases A/c .....Dr. 3,000
To Cash A/c 3,000
for cash)

53
Jan. 25 Salaries A/c .....Dr. 3,200

To Bank A/c 3,200
(Being the amount paid as
salaries)
Jan. 28 Rent A/c ......Dr. 1,000
To Cash A/c 1,000
(Being the rent paid)
Jan. 31 Ram Drawings A/c ..Dr. 4,000
To Cash A/c 4,000
(Being the cash drawn for
personal use)
Jan. 31 Bank A/c .....Dr. 12,000
To Cash A/c 12,000
(Being cash deposited)
Posting in the Ledger Accounts:

Now let us prepare the ledger accounts based on the entries
passed earlier. A separate account is opened in ledger for each
account. All the debit entries and credit entries are duly entered. At
the end, the accounts are properly balanced. In other words, the
total of all debit entries is adjusted against the total of credit entries
and balance is carried forward to the next accounting period.
In the Books of Ram

Cash Book, Subsidiary Books and General Ledger
Cash Book
(Three Column)
Date Receipts L.F. Cash Bank Date Payments L.F. Cash Bank
Rs. Rs. Rs. Rs.
2010 2010
Jan.1 To Capital A/c 20,000 Jan. 3 By Purchases A/c 4,000
Jan. 5 To Maruti‟s A/c 6,000 Jan. 4 By Gopal A/c 10,000
Jan. 8 To Commission A/c 1,600 Jan. 6 By Furniture A/c 2,000
Jan. 18 To Cash A/c C - 5,000 Jan. 7 By Rent A/c 1,000
Jan. 20 To Sales A/c 27,750 Jan. 12 By Postage A/c 200
Jan. 31 To Cash A/c C - 12,000 Jan. 14 By Furniture A/c 16,000
Jan. 15 By Stationery A/c 1,200
Jan. 18 By Bank A/c C 5,000
Jan. 22 By Purchases A/c 3,000
Jan. 25 By Salaries A/c 3,200
Jan. 28 By Rent A/c 1,000
Jan. 31 By Bank A/c C 12,000
Jan. 31 By Drawings A/c 4,000
Jan. 31 By Balance c/d 11,950 12,000
55,350 17,000 55,350 17,000

54
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 Cash Book itself.
Purchases Book
Date Name of Supplier Ledger Inward Amount

Folio Invoice No. Rs.
2010
Jan.2 Nandu 1,00,000
Total 1,00,000
Purchase Returns Book
Date Name of Supplier Ledger Debit Note Amount

Folio No. Rs.
2010
Jan.9 Nandu 2,000
Total 2,000
Sales Book
Date Name of Ledger Outward Amount

Customer Folio Invoice No. Rs.
2010
Jan.10 Kishore 10,000
Total 10,000
Sales Returns Book
Date Name of Ledger Credit Note Amount

Customer Folio No. Rs.
2010
Jan.13 Kishore 2,000
Total 2,000
General Ledger
Ram’s Capital A/c

Dr. Cr.
No Rs. No Rs.
2010 2010
Jan.31 To Balance c/d 20,000 Jan.1 By Cash A/c 20,000
20,000 20,000
Feb.1 By Balance b/d 20,000

55
Nandus A/c
Dr. Cr.
No Rs. No Rs.
2010 2010
Jan.9 To Purchase Jan.2 By Purchases 1,00,000
Returns A/c 2,000 A/c
Jan.31 To Balance c/d 98,000
1,00,000 1,00,000
Purchases A/c
Dr. Cr.
No Rs. No Rs.
2010 2010
Jan.2 To Nandu‟s A/c 1,00,000 Jan.31 By Balance c/d 1,07,000
Jan.3 To Cash A/c 4,000
Jan.22 To Cash A/c 3,000
1,07,000 1,07,000
Feb.1 To Balance b/d 1,07,000
Sales A/c
Dr. Cr.
No Rs. No Rs.
2010 2010
Jan.31 To Balance c/d 37,750 Jan.13 By Kishore‟s A/c 10,000
Jan.20 By Cash A/c 27,750
37,750 37,750
Purchase Return A/c

Dr. Cr.
No Rs. No Rs.
2010 2010
Jan.31 To Balance c/d 2,000 Jan.9 By Nandu‟s A/c 2,000
2,000 2,000

56
Sales Return A/c

Dr. Cr.
No Rs. No Rs.
2010 2010
Jan.13 To Kishore‟s A/c 2,000 Jan.31 By Balance c/d 2,000
2,000 2,000
Feb.1 To Balance b/d 2,000
Gopal’s A/c
Dr. Cr.
No Rs. No Rs.
2010 2010
Jan.6 To Cash A/c 10,000 Jan.31 By Balance c/d 10,000
10,000 10,000
Rent A/c
Dr. Cr.
No Rs. No Rs.
2010 2010
1,000 1,000
Commission Received A/c

Dr. Cr.
No Rs. No Rs.
2010 2010
Jan.1 To Balance c/d 1,600 Jan.31 By Cash c/d 1,600
1,600 1,600

57
Kishore’s A/c
Dr. Cr.
No Rs. No Rs.
2010 2010
Jan.10 To Sales A/c 10,000 Jan.31 By Sales
Returns A/c 2,000
Jan.31 By Balance c/d 8,000
10,000 10,000
Postage & Telegram A/c

Dr. Cr.
No Rs. No Rs.
2010 2010
Jan.12 To Cash A/c 200 Jan.31 By Balance c/d 200
200 200
Feb.1 To Balance b/d 200
Stationery A/c
Dr. Cr.
No Rs. No Rs.
2010 2010
1,200 1,200
Salaries A/c
Dr. Cr.
No Rs. No Rs.
2010 2010
Jan.25 To Bank A/c 3,200 Jan.31 By Balance c/d 3,200
3,200 3,200

58
Rent A/c
Dr. Cr.
Date Particulars JF Amou Date Particulars JF Amou
No nt Rs. No nt Rs.
2010 2010
1,000 1,000
Feb. 1 To Balance b/d 1,000
Drawings A/c
Dr. Cr.
No nt Rs. No nt Rs.
2010 2010
4,000 4,000
Maruti’s A/c
Dr. Cr.
No nt Rs. No nt Rs.
2010 2010
Jan.31 To Balance c/d 6,000 Jan.5 By Cash A/c 6,000
6,000 6,000
Furniture A/c
Dr. Cr.
No nt Rs. No nt Rs.
2010 2010
2,000 2,000
Feb. 1 To Balance b/d 2,000
Illustration 3:
Enter the following transactions in Raj‟s Cash show
„Discount Allowed‟ and „Discount Received A/c‟. March 2010.
1 Cash on hand Rs. 2,400 and bank overdraft Rs. 500.

59
3 Atmaram bought goods from us worth Rs. 300 on credit for 2

months, but he paid cash on the spot after deducting
discount Rs. 6.
5 Received a cheque for Rs. 150 and cash Rs. 100 from
Govind. He was allowed discount RS. 10. The cheque was
deposited into the Bank.
6 Purchased goods from Mehta and paid for same by cheque
Rs. 150.
8 Cheque from Govind is returned dishonoured.
10 Deposited Rs. 1,300 into Bank.
12 Received Bank Pass Book showing interest charged by
Bank Rs. 10.
13 K. Nath paid by cheque Rs. 100 in full settlement of his debt
to us Rs. 105.
14 Above cheque is paid into Bank.
15 Transferred Rs. 1,000 from fixed deposit to current account.
18 Paid rent of residential quarters of Rajkumar by issuing a
cheque for Rs. 75.
20 Withdrew for office use Rs. 300.
22 Received for cash sales from Manikchand a crossed cheque
for Rs. 525.
25 Purchased safe from Kolhapur Steel Company for Rs. 700
and issued a cheque for the same.
26 Paid into bank a cheque on a National Bank, Bombay for
Rs. 800 collection charges being charged by Bank Rs. 3.
28 Received a cheque for Rs. 200 from P. Pant in full
settlement of his account for Rs. 205.
29 P. Pant‟s cheque was endorsed to S. Sant in full settlement
of his account for Rs. 210.
30 Issued a cheque in payment of office rent Rs. 150.
31 Our cheque to Kolhapur Steel Company was returned
dishonoured.
31 Cancelled the cheque issued for rent and paid the amount in
cash.
31 Excess over Rs. 500 deposited into Bank.

60
Solution:
Date Particulars R. L.F. Discount Cash Bank Date Particulars R

No. Rs. Rs. Rs. No
2005 2005
Mar. 1 To Balance b/d 2,400 Mar.1 By Balance b/d
3 To Sales (Cash Sales & 6 294 6 By Purchases (Issue
Cash discount) Cheque No.)
5 To Govind (Received 10 100 150 8 By Govind (Cheque
cheque, cash & received is
discount, allowed, dishonored, dis.
cheque is paid into Allowed cancelled).
Bank)
10 To Cash (Deposited into C 1,300 10 By Bank (Deposited
Bank) into Bank)
13 To K. Nath (Cheque 5 100 12 By Interest (Bank
received & Discount charged Interest)
allowed)
14 To Cash (Cheque C 100 14 By Bank (Cheque
deposited) deposited)
15 To Fixed deposit 1,000 18 By Drawings (Issued
(Transferred from fixed cheque No. for rent of
deposit). residence.)
20 To Bank (Withdrew for C 300 20 By Cash (Withdrew for
office use.) office use.)

61
20 To Sales (A crossed 525 25 By Furniture (Issued

cheque received from, cheque No. for
Manikchand for Cash purchase of safe.)
sales.)
26 To Cash (Paid cheque) C 800 26 By Bank (Paid into
Bank)
28 To P. Pant (Received 5 200 26 By Bank Charges
cheque.) (Collection charges.)
30 To Kolhapur Steel Co. 700 29 By S. Sant (Cheque
(Cheque No. endorsed.)
dishonoured.)
31 To Rent (Cancelled 150 30 By Rent (Paid by
cheque No.) cheque.)
31 To Cash (Paid into C 344 31 By Rent (Paid cash in
Bank) cancellation of
cheque.)
31 By Bank (Paid into
Bank).
31 By Balance c/d
26 3,394 5,069
1-4 To Balance b/d 500 3,031

62
Illustration: 4
Enter the following transactions in a cash book with 3

columns that is Discount, Cash and Bank in the books Yashshri for
the month of June, 2010.
2010
Jan 1 Cash in hand Rs. 8,000 and at Bank Rs. 10,000

2 Sold goods to Swami and Co. for Rs. 6,000 and received
a cheque of Rs. 2,000 as part payment.
3 Purchased goods from Patel for Rs. 8,000 less trade
discount 2% and paid the amount by issue of cheque.
5 Transferred Rs. 5,000 from Private Banking A/c to
Business Bank A/c.
10 Issued a cheque for Rs. 3,000 to furniture mart for the
furniture purchased for last month in full settlement of Rs.
3,200
12 Withdrew for personal use from Bank Rs. 8,000
14 Issued a cheque to petty cashier for Rs. 2,000
15 Withdrew for office use Rs. 4,000
16 Swami and Co. infored that they paid directly into our
Bank A/c in; the remaining balance amounting Rs. 4,000.
19 Bank collected Dividend and credited to our Account to
Rs. 1,400.
20 Paid Insurance premium for goods Rs. 3,000, by cheque.
25 Paid Salaries by cheque Rs. 800
30 Purchased Govt. securities of Rs. 900.

63
Solution:
In the books of
Yashshri
Three column
Cash Book
Receipts
Payments
Date Particulars R. LF Dis. Cash Bank Date Particulars R.
No No No.
2010 2010
Jan. 1 To bal. b/d - 8,000 10,000 Jan. 3 By Purchases A/c
2 To Sales A/c - - 2,000 10 By furniture Mant.
A/c
5 To Capital A/c - - 5,000 12 By Drawings A/c
15 To Bank A/c C - 4,000 - 14 By Petty Cashier
A/c
16 To Swami & - - 4,000 15 By Cash A/c
Co‟s A/c
19 To Dividend - - 1,400 20 By Insurance A/c
A/c
20 To Sales A/c - 8,000 - 25 By Salaries A/c
31 To Bank over - - 5,440 30 By Investment A/c
draft c/fd (Govt. Securities)
By Balance c/d
- 20,000 27,840

64
3.5. EXERCISES
7. Explain term „Book Keeping.

8. What is Account?
9. Distinguish between:
a) Book-keeping and Accountancy
b) Personal Accounts and impersonal Accounts
c) Real Accounts and Nominal Accounts
d) Single Entry system and Double Entry system
e) Cash system of Accounts and Accrual system of
Accounts.
10. Discuss the principles of debit and credit of Accounts.
11. Explain Journal & its utility.
12. What is Ledger? What is a ledger Account?
13. Explain how a ledger account is balance? What is indicates
by Debit or Credit balance?
14. “By sub-division of journal, there will be a division of
labour”. Explain.
15. Which type of transactions will be recorded in sales Book
and purchase Book.
16. What is cash Book? What are different types of cash book.
17. What do you mean by “Contra Entries” in the cash book
with Cash & Bank columns?
18. What is the petty cash?
1) Journalise the following transactions in the books of Ram for the

month of March 2010.
March 1 Ram commenced business with cash Rs. 60,000.
2 Purchased furniture for Rs. 5,000.
4 Purchased goods for cash Rs. 2,000.
7 Bought goods from M/s. Raj & Co. for Rs. 4,000.
10 Sold goods costing Rs. 3,000 on cash.
15 Purchased stationery for office use Rs. 1,000.
19 Received cash Rs. 1,250 from Mr. Ketan in full
settlement of his account for Rs. 1,500.

65
20 Paid salaries by cheque Rs. 1,500.

25 Introduced additional capital Rs. 20,000.
27 Paid to Raj Rs. 3,250 in full settlement of Rs. 3,500
29 Sold goods for Rs. 15,000 to Mr. Dohi.
2) Journalise the following transactions in the books of Mr. Shiva
for the month of April 2010.
April 1 Started business with cash Rs. 25,000/-
6 Purchased goods worth Rs. 10,000/-
4 Deposited cash Rs. 3,000 into the Bank.
6 Purchased goods of Rs. 6,000 from M/s. Raju Trading
Company.
9 Sold goods to Mr. Ramesh for Rs. 3,000.
12 Paid to M/s. Raju Trading Company Rs. 3,000.
15 Received Rs. 1,000 from Mr. Ramesh.
20 Paid salaries Rs. 1,000/- and paid commission
Rs. 1,600/- in cash.
25 Bought stationery for office use Rs. 300.
27 Withdrew Rs. 2,500 from business for personal use.
3) Journalise the following transactions in the journal of Mr. Anand

for the month of February, 2010.
Feb 1 Borrowed from Bank @ 15% interest Rs. 20,000.
7 Purchased goods from Mr. Sam for Rs. 3,500.
8 Paid carriage and cartage Rs. 250
9 Sold goods on cash Rs. 3,000.
11 Paid Rs. 2,250 to Mr. Sam.
16 Purchased office furniture for Rs. 6,000.
19 Paid interest Rs. 450/- to Mr. Bank.
20 Paid salaries Rs. 6,000.
26 Cash purchases Rs. 15,000
28 Paid Rs. 2,000 to Bank in part payment of loan.
4) Journalise the following transactions in the books of Mr. Vishal

for the month of March, 2010.
Mar. 1 Vishal started business with cash Rs. 35,000, goods
worth Rs. 10,000.

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4 Opened bank account in the Bank of India by

depositing Rs. 5,000.
4 Bought goods worth Rs. 6,000 @ 10% trade discount
term.
7 Sold goods worth Rs. 3,000
9 Purchased furniture of Rs. 4,000 for office use and
furniture of Rs. 1,000 for home use.
14 Withdrawn goods of Rs. 1,000 for self use.
17 Received Rs. 2,400 from Mr. Ravindra in full
19 Paid salaries Rs. 500 to office clerk and paid
electricity bill of Rs. 750 in cash.
24 Paid Mr. Raj Rs. 1,960 in full settlement of Rs. 2,000.
26 Paid insurance premium of Rs. 1,200 on the life of Mr.
Vishal, a proprietor.
5) Draft journal entries for the business transactions given below.

Apr. 1 Mr. Atul started business with cash Rs. 5,000/-, goods
Rs. 7,500 and furniture Rs. 2,500/-
5 Purchased goods worth Rs. 4,500 from Mr.
Kamalakar.
9 Cash sales Rs. 6,000
10 Purchased stationery for office use Rs. 500.
10 Paid to Mr. Kamalakar Rs. 4,350 in full settlement of
Rs. 4,500.
16 Received Rs. 500 from Mr. Kiran.
19 Withdrawn Rs. 200 from business for self use.
23 Paid Rs. 150 for commission and paid Rs. 450 for
rent.
27 Paid wages Rs. 600 in cash, and paid sundry
expenses Rs. 200/- by cheque.
29 Borrowed Rs. 5,000 from wife for business purpose.
30 Cash purchases Rs. 1,000.
6) On 1st July, 2010, Mr. X commenced business with cash Rs.

25,000, Bank balance Rs. 25,000, Stock Rs. 43,000 &
Computer Rs. 18,000.

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July 2 Borrowed Rs. 20,000 from Mr. Y for business

purpose.
6 Sold goods to Mr. Z for Rs. 10,000 @ 5% T.D.
7 Paid for business stationery by cheque Rs. 500.
7 Sold goods to Mr. A on credit Rs. 5,000.
9 Sold goods to Mr. B on cash Rs. 10,000 and amount
deposited into the bank.
11 Received cheque from Mr. Z in payment for goods
sold to him on 4th July less 5% C.D. and deposited
into the bank.
13 Mr. A paid us cash Rs. 4,900 for goods sold to him on
7th July.
15 Bought printer for Rs. 2,000 and amount paid by
cheque.
18 Withdrawn Rs. 600 from Bank to pay insurance
premium on the life policy.
19 Withdrawn goods of Rs. 500 from stock for private
use.
22 Purchased second hand car for Rs. 15,000 for
business purpose and amount paid by cheque.
25 Paid monthly wages Rs. 1,000 in cash.
26 Purchased 1,500 shares of M/s. ABC Co. Ltd. at Rs.
10 per share.
27 Transferred Rs. 10,000 from Current A/c to Fixed
Deposit A/c.
28 Issued a cheque to chartered accountant for auditing
Rs. 800.
30 Deposited into Bank Rs. 6,000.
You are required to prepare three columns cash book
and balance the same.
7) Record the following transactions in a cash book with cash,

bank and discount columns and balance the same.
Aug. 1 Mr. Arvind kumar started business with cash
Rs. 30,000.
2 He opened a Current A/c into the city Co-operative
Bank by depositing Rs. 20,000.
4 He received a cheque from Mr. Ram for Rs. 5,000 for
goods sold to him, which was deposited in Bank.
6 Paid by cheque an amount of Rs. 11,500 to Mr. Shah
for goods purchased from him for Rs. 12,000 (cheque
is issued for full settlement)

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11 Bank informed that Ram cheque is dishonoured, and

our account is debited by Rs. 50 for bank charges.
17 Paid salaries Rs. 1,600, commission Rs. 1,000 and
rent Rs. 1,000 by cheque.
18 Bank informed that our account is credited by Rs.
3,000 for receipt of dividend and debited our account
for payment of insurance premium for Rs. 1,600.
23 Purchased key board for Rs. 3,000 for home use and
a computer for Rs. 40,000 for office use, total amount
paid by cheque.
24 Borrowed Rs. 7,500 from our business friend Mr. Sam
for business purpose.
27 Bought stationery worth Rs. 500 for business purpose
and fan for home use for Rs. 2,000. Both the
payments were made by cheques.
28 Mr. Kishor deposited Rs. 1,750 into our bank account
directly.
29 Issued a cheque to Art & Creative Co. for
advertisement Rs. 12,500/-
8) Compile a Cash Book having cash, discount and bank columns

from the following transactions for the month of May, 2010 and
balance the same.
May. 1 Cash in Cash Box Rs. 20,000 and Bank balance
Rs. 25,000.
2 Deposited into the bank Rs. 7,500.
4 Cheque of Rs. 14,000 received from Mr. Arjun in full
6 Mr. Arjun‟s cheque deposited into the bank along with
cash Rs. 1,500/-
7 Amount of Rs. 1,000 directly deposited into the our
Bank A/c by Mr. Anu.
9 Paid to M/s. Z and sons by cheque Rs. 1,090 and
earned discount of Rs. 10.
12 Cash sales Rs. 2,520 and allowed cash discount of
Rs. 30.
14 Cash purchases Rs. 6,000 and amount paid by
issuing across cheque for the same amount.
16 Bank informed that Mr. Arjun‟s cheque is dishonoured
and he is paid Rs. 13,500 immediately to settle his
account.
19 Purchased stationery for Rs. 250 and office furniture
for Rs. 2,250.

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20 Paid commission Rs. 1,000 and Staff salaries

Rs. 1,000 through bank.
24 Withdrawn cash Rs. 750 from office for self use and
cash Rs. 1,500 from bank for petty expenses.
26 Received a crossed cheque of Rs. 14,500 from
Mr. Ashok.
28 Endorsed a cheque received from Mr. Ashok in favour
of Mrs. Jani.
29 Borrowed from wife Rs. 20,000 for business purpose.
30 Mr. Ashok‟s cheque endorsed to Mrs. Jani was
dishonoured.
31 Transferred Rs. 10,000 from Current A/c to Fixed
Deposit A/c.
9) Prepare the three column cash book from the following details
June 1 Cash office Rs. 40,500/- and Overdraft Bank balance
Rs. 16,600/-.
2 Purchased goods worth Rs. 15,000/- @ 10% T.D. and
5% C.D. from M/s. Randhir and Sons. 50% of the
amount paid immediately and balance after 15 days.
4 Bought office furniture for Rs. 15,000 and paid
Rs. 12,500 as first installment.
6 Purchased stationery for office use costing Rs. 400.
7 Sold goods worth Rs. 20,000 @ 2% C.D. and amount
deposited into Bank.
9 Received a cheque of Rs. 12,000 from Mr. Anand on
account.
11 Deposited Mr. Anand‟s cheque into the Bank.
13 Paid Mr. Ramesh by cash Rs. 1,500 and by cheque
Rs. 750 in full settlement of his account of Rs. 2,400.
14 Gave loan of Rs. 10,000 to wife by issuing cheque.
16 Cheque issued to Mr. Ramesh returned dishonoured
and cash Rs. 1,000 paid to him.
18 Transferred Rs. 20,000 from Fixed deposit A/c. to
Current A/c.
20 Withdrawn from bank cash Rs. 4,000 for office use
and withdrawn from office cash Rs. 10,000 for
daughter‟s marriage.
22 Issued a cheque of Rs. 6,700 to M/s. Randhir and
Sons and earned discount of Rs. 50.
25 Bank has debited our account by Rs. 550 for payment
of insurance premium.

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28 Issued a cheque of Rs. 2,500 for payment of salaries.

Paid office rent Rs. 1,600 in cash.
29 Deposited into Bank all the cash in excess of
Rs. 1,400.
10) From the following information prepare cash book with cash,
bank and discount column and balance the Cash Book.
Mar. 1 Opening balance of cash Rs. 21,000 and at bank
Rs. 16,000
3 Received from Jayant Rs. 12,900 and allowed
discount Rs. 100.
5 Paid to Babar by cheque Rs. 2,910 in full settlement
of their account for Rs. 2,930.
10 Sanjay deposited directly into our bank account Rs.
3,000.
15 Received a cheque of Rs. 2,000 for interest on
investments which was deposited into the bank.
20 Drew cheque for personal use Rs. 5,000.
24 Paid salaries Rs. 2,250 and rent Rs. 4,000 by cheque.
26 Sold goods costing Rs. 18,000 at 25% profit on cost
and received half the amount in cash and half by
cheque which is deposited into the bank.
28 Bank pass book shows that bank has debited our
account by Rs. 200 for bank charges and credited
account by Rs. 1,000 for interest on investment.
30 Transferred Rs. 5,000 from savings account to current
account.
11) From the following details prepare three column cash book and
balance the same.
Jan 1 Opening cash balance Rs. 20,000 and bank balance
Rs. 25,000.
5 Received cash from Kaka Rs. 9,500 and allowed
discount Rs. 500.
8 Received a cheque from Anil for Rs. 7,000 and
immediately deposited into bank.
10 Paid to Suresh by cheque Rs. 3,000 for rent.
14 Paid salary by cash Rs. 3,000 and by cheque Rs.
10,000.
16 Received by cheque Rs. 14,000 and cash Rs. 6,000
from Nagori and deposited the same cheque into the
bank immediately.
20 Paid to Rakesh Rs. 4,000 by cash and Rs. 1,500 by
cheque on account.

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22 Paid to Narayan by cheque Rs. 4,500 and received

discount Rs. 500.
25 Cash sales Rs. 20,000 at 5% C.D.
27 Cash purchases Rs. 20,000 at 5% C.D.
28 Paid to Nagori on account Rs. 5,000 by cheque.
29 Received from Arun Rs. 4,500 towards full settlement
of Rs. 5,000.
30 Paid telephone bill by cheque Rs. 450.
12) Enter the following transactions in a three column cash book

May 1 Opening cash balance Rs. 30,000 and bank balance
Rs. 42,500.
2 Cash purchases Rs. 20,000 at 3% C.D.
5 Cash sales Rs. 25,000 at 3% C.D.
9 Received cash from ABC Co. Rs. 5,900 and allowed
discount Rs. 100.
11 Received a cheque from Delta Co. for Rs. 2,000 and
deposited it into the bank immediately.
13 Paid rent by cash Rs. 1,000 and by cheque Rs. 5,000.
15 Paid to XYZ Co. Rs. 2,000 by cash and Rs. 4,000 by
cheque.
18 Received cash Rs. 9,750 from Bata & Co. and
allowed a discount of Rs. 250.
22 Deposited into bank Rs. 5,000.


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4
BANK RECONCILIATION STATEMENT
Unit Structure:
4.0 Objectives
4.1 Meaning
4.2 Reasons for differences in Bank balance of Cash Book with
Pass Book
4.3 Prepares of Bank Reconciliation Statement
4.4 Chart for solving the problems
4.5 Specimen of Bank Reconciliation Statement
4.6 Bank Overdraft
4.7 Importance of Bank Reconciliation Statement
4.8 Illustrations
4.9 Exercises
4.0 OBJECTIVES
Define and explain bank reconciliation statement.

Know the reasons of disagreement of the balances of cash
book and bank statement.
Prepare the format of the statement.
Prepare bank reconciliation statement.
4.1 MEANING
A customer of the bank opens a Bank Account in his Cash

book to record all his bank transactions. Similarly a bank maintains
a Customer‟s Account in its ledger, and gives a Bank Pass Book to
the customer. From the entries in the pass book a customer can
have knowledge of the transactions recorded by the bank in his
account. When we make entries on the debit side of Bank Account
the bank makes entries on the credit side of our account for the
same transactions and vice versa. As a result when the Bank
Account shows debit balance, the pass book shows credit balance
and vice-versa.

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As a matter of fact balance shown by the Bank Account and

by the bank pass book on a particular day must tally. But in actual
practice they differ due to reasons given below. It is therefore,
becomes necessary to reconcile the difference to ascertain that
there are no mistakes committed. Thus a Bank Reconciliation
Statement is a statement prepared to reconcile the difference
between the balances as shown by the Bank Account in a Cash
Book and by the Bank Pass Book.
4.2 REASONS FOR DIFFERENCES IN BANK

BALANCE OF CASH BOOK WITH PASS BOOK
Some of the transactions are entered in the Cash Book

(Bank column only) whereas some are entered only in the Pass
Book. In addition to this there may be some mistakes committed,
either in the Cash book or in the Pass Book.
A) Transactions entered in the Cash Book (Bank Column) or in

the pass book.
i) Cheques issued: When a cheque is issued, Bank Account is

at once credited, but the Customers Account is debited by
the Banker only when the payment of that cheque is effected
by the Bank.
ii) Cheques paid or deposited into the Bank : When a cheque is

received and paid into the bank, the customer debits at once
the Bank Account in his Cash Book, but the Customer‟s
Account is credited by the Banker only when the cheque is
collected by the bank.
B) Generally the following transactions are entered first in the

Pass Book and subsequently they are entered in the Cash
Book from the Pass Book.
1. Bank Charges
2. Interest allowed or charged by Bank
3. Dividend, Interest on Investment collected by Bank on behalf of
a customer.
4. Dishonour of cheque paid into Bank and credited to Customer‟s
Account by Bank.
5. Amount collected or paid for Bills of Exchange by Bank, Sale of
Securities on behalf of a customer.
6. Payment by Bank, such as Club Subscription, Insurance
Premium, Purchases of Securities on behalf of a customer.

74
4.3 PREPARATION OF BANK RECONCILIATION

STATEMENT
In actual practice, we have both Cash Book (Bank Account)

and the Bank Pass Book on hand, to compare the entries in them
during a particular period. As the entries which are made in both
the books do not cause the difference in balance, they are to be left
out. The entries which are recorded only in one of the two books
are taken into consideration.
Generally, Bank balance either as per Cash Book or as per

Pass Book of a particular date is given and the balance as per
other book is required to be traced out.
A) First ascertain balance that is whether a debit balance or a

credit balance.
B) Out of the transactions given, those which are recorded in both
the books that is Cash Book and Pass Book before the date of
reconciliation are not to be considered.
C) Transaction which is recorded in only one of two books either in
the Cash Book or in the Pass Book is to be considered.
Bank Reconciliation Statements helps the customer to know

which cheques are yet to be realized and which cheques are not
yet encashed.
It reduces the chances of misappropriation by the Bank

employees.
4.4 CHART FOR SOLVING THE PROBLEMS
The following charts will help the students in solving the problems:
Given Bank Given Bank

balance as per balance as per
Transactions Cash Book or Pass Book or
overdraft as per overdraft as per
Pass Book Cash Book
1. Cheques issued but not
encashed recorded in the Cash Add Less
Book only.
2. Interest allowed or collected by
Bank, Sale of Investments Add Less
recorded in Pass Book only.
3. Direct payment into bank by our Add Less
customer etc.

75
4. Wrong amount taken in Cash

Book
i) Short Amount Add Less
ii) Excess Amount Less Add
5. Cheque paid into Bank but not Less Add
credited by Bank.
6. Bank Charges, Interest charged
by Bank or dishonour of cheque
Less Add
etc. are recorded in Pass Book
only.
7. Bank charges, Interest charged
by Bank or dishonour of cheqe
Less Add
etc. are recorded in Pass Book
only.
8. Payment by bank for insurance
premium, club subscription,
Less Add
Purchase of Securities etc. are
recorded in Pass Book only.
4.5 SPECIMEN OF BANK RECONCILIATION

STATEMENT
Particulars Rs. Rs.

Balance as per Cash / Pass Book given XX
Add : The transaction that would increase the

balance in the other Book. XX XX
Less : The transaction that would reduce the

balance of the other book XX (XX)
Balance as per Cash / Pass Book XXX

(i.e. other book) as on
4.6 BANK OVERDRAFT
Normally, Traders keeps depositing cash into Bank Account

and withdraws by issuing cheques to various parties. However,
trader makes arrangement with the bank, to withdraw more than his
bank balance. This is known as Bank Overdraft. The upper limit of
such overdraft is fixed in advance. When there is overdraft Bank
Account in trader‟s books shows credit balance and in the books of
Bank, trader‟s account will show debit balance, and he is a debtor.

76
For preparing reconciliation statement, taking Bank overdraft

as base, it will be exact opposite that of Bank Balance, add items
will become Less and less items will be Add.
4.7 IMPORTANCE OF BANK RECONCILIATION

STATEMENT
After getting Bank Statement / Pass Book, businessmen,

compares entries in Cash Book (recorded by trader) and Bank
Statement (recorded by bank in relation to businessmen) and
prepare Bank Reconciliation. While preparing reconciliation
statement, numbers of entries are not matching with each other
these discrepancies may lead to notice frauds, errors,
misappropriation of cash, by cashier. It reduces the charges of
misappropriation by the employees, so timely action may be taken.
At the same time, it is possible that Bank might have made wrong
entry of deposit or withdrawal, businessmen can be inform bank to
correct it.
It presents sinero, of e-banking of increasing use of credit

card / debit card facilities / Net banking. Their may be number of
transaction are not recorded in time which can be brought to notice.
For wrong entry by bank, immediate action can be taken, asking
bank to verify the mistake(s).
CHECK YOUR PROGRESS

Give the examples of various transactions which are
generally entered first in the Pass Book.
If the Bank balance as per Cash Book is given, how the
following transactions affect:
1. Interest allowed or collected by Bank, Sale of
Investments recorded in Pass Book only.
2. Cheque paid into Bank but not credited by Bank.
3. Payments by bank for insurance premium, club
subscription, Purchase of Securities etc. are recorded in
Pass Book only.
4. Direct payment into bank by our customer.
5. Bank Charges, Interest charged by Bank or dishonour of
cheque etc. are recorded in Pass Book only.
4.8 ILLUSTRATIONS
Illustration 1 : On 31st December 2010, M/s. M.D. & Co.‟s bank

column of Cash Book showed a debit balance Rs.17,800/- from the

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following particulars prepare a Bank Reconciliation Statement

showing the balance as per Bank Pass Book as on 31 st December
2010.
1. Cheques deposited into the Bank but not cleared and credited
before 31st December amounted to Rs.8,950/-.
2. Cheques issued on 31st December but presented for payment
on the 7th January 2011 amounted to Rs.6,750/-.
3. Purchases of securities of Rs.4,000/- by the Bank on behalf of
M/s. M.D. & Co. appeared in Pass Book only.
4. Interest Rs.95/- was credited in the Pass Book but was entered
in the Cash Book as Rs.59/-.
5. Bank charges Rs.45/- were recorded in the Pass Book but no
entry was made in the Cash Book.
Bank Reconciliation Statement as on 31-12-2010
Particulars Rs. Rs.

Balance at the bank as per Cash Book as on
31-12-2010. 17,800
Add :
(i) Cheques issued on 31st December but not
cashed upto 31st December 2010. 6,750
(ii) Interest recorded in the Cash Book as
Rs.59/- instead of Rs.95/-, hence the
difference. 36 6,786
24,586
Less :
(i) Cheques paid into Bank but not cleared upto
31st December 2010. 8,950
(ii) Payment made by Bank for purchase of
securities not entered in the Cash Book. 4,000
(iii) Bank charges appearing in the Pass Book. 45 (6,390)
Balance as per Pass Book as on 31st December

2010. 8,710
Illustration 2 : On 30th June, 2010 the Cash Book of M/s. Patil &
Co. showed a Bank balance of Rs.12,000/-.
1. Cheques sent to Bank for collection of Rs.10,000/- before 30-

06-2010 but only one cheque of Rs.4,000/- is credited in June
2010.
2. Cheque issued for Rs.5,000/- in the month of June, but cheques
of Rs.2,500/- presented for payment in July 2010.

78
3. The following entries were passed in the Pass Book before 30 th

June, 2010 but no corresponding entry was made in the Cash
Book.
a) Rs.320/- paid a Insurance Premium.
b) Interest on Investment collected by the Bank Rs.600/-.
c) Bank has charged Rs.50/- as interest and commission
Rs.20/-.
Prepare a Bank Reconciliation Statement as on 30 th June,

2010 from the above particulars.
Solution :
Particulars Rs. Rs.

Balance as per Cash Book as on 30-06-2010. 12,000
Add :
(i) Cheques issued but not encashed before
30th June 2010. 2,500
(ii) Interest collected by Bank. 600 3,100
15,100
Less :
(i) Cheques paid in to Bank but not credited by
Bank. 6,000
(ii) Insurance Premium paid by Bank. 320
(iii) Interest and Commission charged by Bank. 70 (6,390)
Balance as per Pass Book as on 3-06-2010. 8,710
Illustration 3 : Bank Account as per Bank Pass Book of Mr. Kant

showed Credit Balance of Rs.20,168/- on 31-03-2010. From the
following particulars prepare Bank Reconciliation Statement arriving
at the balance as per Cash Book as on 31st March, 2010.
1. Two cheques for Rs.458/- and Rs.760/- were paid into the Bank
in March 2010 but they were not credited in the Pass Book by
the Bank till 31-03-2010.
2. Three cheques for Rs.1,065 Rs,545/- and 335/- were issued on
28-03-2010 out of which (i) the cheque for Rs.335/- was
presented to the bank on 30-03-2010. (ii) the cheque for
Rs.545/- was presented on 2-04-2010 and (iii) the cheque for
Rs.1,065/- was lost and not presented at all.

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3. The Bank has charged Rs.5/- as Bank charges and has credited
interest of Rs.30/-. The bank has also collected interest on
investment on behalf of Mr. Kant Rs.100/-. These are not
recorded in the Cash Book.
4. A customer of Mr. Kant has paid Rs.500/- directly in the Bank
Account of Mr. Kant has paid Rs.500/- directly in the Bank
Account of Mr. Kant on 31-03-2010 of which Mr. Kant has no
intimation.
Solution :
Particulars Rs. Rs.

Add :
(i) Cheques paid into Bank but to credited by
Bank upto 31-03-2010. 1,218
(ii) Bank charges entered in Pass Book. 5 1,223
21,391
Less :
(i) Cheques issued but not presented for
payment upto 31-03-2010. 1,610
(ii) Interest credited by Bank. 30
(iii) Interest on investments collected & credited
by Bank. 100
(iv) Direct payment into Bank by a customer. 500 (2,240)
Illustration 4 : On 31st December 2010 the Pass Book of Dr. Raj

showed a credit balance of Rs.11,000/-. On comparing it with Cash
Book, following differences were discovered.
(i) Cheaues deposited with Bank before 31-12-2010, but not yet
collected Rs.1,400/-.
(ii) Cheque issued upto 31-12-2010 but not yet presented for
payment Rs.450/-.
(iii) The Bank has collected dividend Rs.250/- and has charged
Rs.15/- as collection charges. Entries of these transactions do
not appear in Cash Book.
(iv) The Bank has paid his electricity bill Rs.410/- for the month of
November 2010. This transaction appears only in Pass Book.

80
(v) The debit column of Bank Account in Cash Book is added

shorted by Rs.40/-.
Prepare Bank Reconciliation Statement.
Solution :
Particulars Rs. Rs.

Add :
(i) Cheques paid into Bank but to collected and
credited by Bank. 1,400
(ii) Bank Charges not entered in Cash Book. 15
(iii) Payment of electricity bill by Bank not
entered in Cash Book. 410 1,825
12,825
Less :
(i) Cheques issued but not encashed 450
(ii) Collection of dividend by bank not entered in
Cash Book. 250
(iii) Undercasting of debit column of Bank
Account in Cash Book. 40 (740)
Bank Balance as per Cash Book as on 31-12-

2010. 12,085
Illustration 5 : On 31st December 2010 the Bank Pass Book of a

company showed an overdraft of rss.12,060/-. Comparison of
the Pass Book and the Cash Book showed the following.
a) The company had sent to the Bank three cheques on 28 th

December 2010. The cheques were for Rs.4,100/-, Rs.900/-,
and Rs.560/- of these only the cheque for Rs.4,100/- was
credited by the Bank before 31st December 2010.
b) The company had issued on 27th December, 2010 cheques for
Rs.800/-, Rs.500/- and Rs.1,760/-. The cheque for Rs.1,760/-
was paid before 31st December, 2010. The other cheques were
paid on 3rd January, 2011.
c) The Bank had debited the company with Rs.120/- as Bank
charges and with Rs.5,120/- as interest. The entries had not yet
been made in the Cash Book.
d) A customer had deposited in Company‟s Account Rs.1,500/- but
the fact was not recorded in the Cash Book.
Prepare Bank Reconciliation Statement as on 31st December,
2010.

81
Solution :
Particulars Rs. Rs.

Balance as per Pass Book as on 31-12-2010.
12,060
Add :
(i) Cheques issued but not encashed before 31-
12-2010 (Rs.800/- + Rs.500/-) 1,300
(ii) Direct payment into Bank by the customer
not recorded in Cash Book. 1,500 2,800
14,800
Less :
(i) Cheques paid into Bank but not credited by
Bank before 31-12-2010 (Rs.560/- +
Rs.900/-). 1,460
(ii) Bank charges and interest not recorded in
Cash Book as on 31-12-2010 (Rs.120/- +
Rs.5,120/-) 5,240 (6,700)
Illustration 6 : On 1st January, 2010 the Cash Book of Dayand

showed a Bank balance overdrawn to the extent of Rs.3,117/-. On
comparing his Cash Book with the Pass Book he finds that :
1. A Cheque for Rs.125/- sent to Shah has not been entered in the
Cash Book.
2. Bank charges of Rs.47/- at 31st December, 2010 were not
entered in the Cash Book at all.
3. The Bank has debited Dayand‟s Account with a cheque for
Rs.410/- received from Damodar which had been returned
dishonoured. The fact of dishonour was not shown in the Cash
Book.
4. The Bank column on the receipt side of the Cash Book was
found to be under cast by Rs.70/-.
5. Unpresented cheques amounted to Rs.1,450/-.
Prepare a Bank Reconciliation Statement of Doyand as on

st
1 January 2010.

82
Solution :
Particulars Rs. Rs.

Overdraft as per Pass Book as on 1-1-2010. 3,117
Add :
(i) Bank charges not entered in Cash Book 47
(ii) Entry for dishonour of cheque not recorded
in Cash Book 410
(iii) Cheque issued to Shah and encashed is not
entered in the Cash Book. 125 582
3,699
Less :
(i) Undercasting of the debit side of Bank
column. 70
(ii) Cheques issued but not presented for
payment till 01-01-2011. 1,450 (1,520)
Bank Balance as per Pass Book as on 1-1-2011. 2,179
Different Periods:
Sometimes entries in the Pass Book and in the Cash Book
(Bank Account) are given. But they are not for the same month but
they are two different months. In such a case following entries only
in the Cash Book are to be considered for preparation of
Reconciliation Statement.
Cash Book entries which appear also in the Pass Book;

common entries in the both Books are to be consider for
preparation of Reconciliation.
Illustration 7 Prepare Bank Reconciliation Statement as on 30-04-

2010 from the following.
Cash Book (Bank Column)
2010 2010
Receipts Rs. Payments Rs.
April April
1 To Balance b/d 500 5 By Wages A/c 100
10 To Kasab A/c 100 15 By Shanti A/c 200
15 To Interest 50 20 By Pawar A/c 150
20 To Sales A/c 200 25 By Purchases A/c 100
22 To Ashok A/c 300 30 By Balance c/d 600
1,050 1,050

83
Pass Book
2010 2010
Particulars Rs. Particulars Rs.
May May
To Shanti A/c 200 1 By Balance b/d 550
To Pawar A/c 150 2 By Kasab A/c 100
To Charges A/c 25 3 By Sales A/c 200
To Kulkarni A/c 100 10 By Jani A/c 1,100
To Mane A/c 1,010
Common entries in both book are consider in reconciliation.

Uncommon month, common entries appear in Reconciliation.
Solution
Bank Reconciliation Statement as on 30th April 2010
Particulars Rs. Rs.

Bank balance as per Cash Book 600
Add :
(i) Cheques issued but not presented
Shanti 200
Pawar 150 350
Less : 950
(i) Cheques deposited but not cleared
Kasab 100
Sales 200
(ii) Cash Book payment total over casted 100 (400)
Bank Balance as per Pass Book as on 1st May

2010. 550
Illustration 8 :
Cash Book (Bank column only)

Dr. Cr.
Date Receipts Rs. Date Payments Rs.
2010 2010
Mar 2 To Sales A/c 6,200 Mar 1 By Balance b/d 6,010
4 To A & Co. A/c 1,200 2 By Salaries A/c 7,200
6 To Data‟s A/c 3,000 4 By Wages A/c 2,100
10 To Moti‟s A/c 6,300 10 By Zandu A/c 4,200

84
14 To Cash A/c 7,000 15 By Commission A/c 1,400

19 To Malini‟s A/c 3,000 19 By Drawings A/c 6,100
26 To Ketan‟s A/c 7,000 29 By Purchases A/c 6,750
30 By Balance c/d 7,160
43,940 43,940
Pass Book (Extract only)

Dr. Cr.
Date Particulars Rs. Date Particulars Rs.
2010 2010
Apr 1 To Balance b/d 9,630 Apr 1 By A & Co. A/c 1,200
6 To Rakesh A/c 1,000 2 By Z & Co. A/c 3,100
7 To Joshi A/c 620 4 By RK & Co. A/c 1,420
9 To Salaries A/c 7,200 9 By Moti‟s A/c 6,300
10 To Wages A/c 15,000 10 By Ketan‟s A/c 7,000
16 To Furniture A/c 3,000 20 By Plant A/c 7,950
19 To Purchase A/c 6,750 25 By Drawings A/c 1,650
20 To Suresh A/c 1,350
Bank Reconciliation Statement as on 31.03.2010
Particulars Rs. Rs.

Bank balance as per Cash Book 7,180
Add :
(ii) Cheques issued but not presented
Salaries 7,200
Furniture 3,000
Purchases 6,750 16,950
24,130
Less :
(ii) Cheques deposited but not cleared
A & Co. 1,200
Moti 6,300
Ketan 7,000 (14,500)
Bank Balance as per Pass Book as on 1st April

2010. 9,630
Note : When Cash Book & Pass Book are different month, common
entry should be taken in Reconciliation Statement.

85
Illustration 9 : Following information is supplied by Chitra and she

ask you to prepare B.R.S.
Cash Book (Bank column)

Dr. Cr.
2010 2010
May 2 To Balance b/d 2,100 May 1 By Salaries A/c 9,210
4 To Sales A/c 3,000 4 By Printing A/c 6,200
10 To P‟s A/c 1,450 6 By Purchases A/c 7,500
12 To T‟s A/c 1,900 10 By Plant A/c 16,000
16 To R‟s A/c 2,000 21 By Travelling A/c 600
18 To RK‟s A/c 4,100 24 By Office Exp. A/c 1,250
21 To Sales A/c 3,600 26 By Drawings A/c 14,000
22 To Fixed Deposit A/c 11,000 29 By Purchases A/c 6,000
29 To Interest A/c 1,150 30 By Fixed Deposit A/c 15,000
31 To Balance c/d 55,460 31 By Audit Fees A/c 10,000
85,760 85,760
Bank Pass Book for the month ended 31st May 2010
Date Particulars Withdrawal Deposits Balance

2010
May 1 Balance b/d - 2,100 2,100 CR
2 Salaries 9,210 7,110 DR
4 Sales 3,000 4,110 DR
6 Purchases 7,500 11,810 DR
10 T‟s A/c 1,900 9,710 DR
24 Office Expenses 1,250 10,960 DR
25 RK‟s A/c 4,100 6,860 DR
29 Purchases 6,000 12,860 DR
30 Sales 3,600 9,260 DR
31 OT & Co. 6,000 15,260 DR
31 Commission 7,500 7,760 DR
29,960 22,200 7,760 DR

Bank Overdraft

86
Solution :
Chitra
Bank Reconciliation Statement as on 31st May 2010
Particulars Rs. Rs.

Bank overdraft as per Cash Book as on 31st May 55,460
2010.
Add :
(i) Cheques deposited but not presented
P 1,450
R 2,000
Fixed Deposit 11,000
Interest 1,150
(ii) Cheques issued to OT & Co. not accounted
in Cash Book. 6,000 21,600
77,060
Less :
(i) Cheques issued but not presented
Printing 6,200
Plant 16,000
Travelling Expenses 600
Drawings 14,000
Transferred to Fixed Deposits 15,000
Audit Fees 10,000
Commission received but not accounted in
Cash Book 7,500 (69,300)
7,760
4.9 EXERCISES
4.9.1 Theory Questions :

i) What is Bank Reconciliation Statement?
ii) What are different reasons for disagreement between Bank
balance as per Cash Book & Pass Book / Bank Statement?
iii) Discuss procedure for preparation of Bank Reconciliation
Statement.
iv) A Trader feels that it is not necessary to prepare Bank
Reconciliation Statement, do you as Finance Manager agrees
with trader? Why?
v) Discuss need of preparing Bank Reconciliation Statement.

87
4.9.2 Practical problems:
1) The Cash Book of Mr. Raj shows a balance of Rs.26,700/- on

31st October, 2011. From the following information you are
required to prepare a Bank Reconciliation Statement as on 31 st
October, 2010.
i) A cheque of Rs.5,000/- received from Miss Varma,

deposited into the Bank but not yet credited in the Pass
Book by the bank.
ii) A cheque of Rs.6,000/- drawn in favour of Miss Meena, had
not been presented into the Bank.
iii) As per our instruction the bank had a promissory note of
Rs.1,000/-. It is not yet recorded in the Cash Book.
iv) A cheque of Rs.7,500/- received from Mr. Madhu recorded in
the Cash Book, but the same cheque was sent to the bank
on 1st November, 2010.
v) Bank collected proceeds of Bill Receivable amounted to
Rs.5,500/- and credited in the Pass Book but not yet
vi) Post dated cheque amounted to Rs.10,500/- issued to Mr.
Shanti, recorded in the Cash Book but not yet presented to
the bank.
vii) Pass Book shows credit entries in respect of Rs.4,500/- as
interest collected on investment and Rs.2,000/- as dividend
collected by bank. These were not recorded in the Cash
Book.
2) Prepare Bank Reconciliation Statement as on 31st January,

2011 from the following particulars.
i) Bank balance as per Cash Book Rs.22,510/-.

ii) Cheque amounted to Rs.13,500/- sent to the bank for
collection as on 28th January, 2010 but collected by the bank
as on 2nd February, 2010.
iii) Bank column of Cash Book credit side cast short by
Rs.2,250/-.
iv) Cheques of Rs.7,500/- deposited into the bank and collected
by the bank and credited in the Pass Book but recorded
twice in the Cash Book.
v) Cheques of Rs.16,000/- issued in favour of Mr. Rane
returned dishonoured for lack of fund. Dishonour of cheque
not yet recorded in the Cash Book.

88
vi) Proprietor has closed his savings account and transferred

the balance of Rs.9,500/- to current account, not recorded in
Cash Book.
vii) Bank Pass Book shows debit entry for payment of electricity
charges of Rs.1,800/- and credit entry of Rs.9,500/- for
collection of salaries. Corresponding entries were not found
in the Cash Book.
3) On 31st December, 2010 the Cash Book showed an overdraft of

Rs.16,600/-. From the following particulars, prepare Bank
Reconciliation Statement as on 31st December, 2010.
i) Cheques paid into the bank but not cleared Rs.4,040/-.

ii) Cheques drawn but not cashed for Rs.3,100/-.
iii) A Bill Receivable for Rs.1,500/- previously discounted with
the bank had been dishonoured and debited in the Pass
Book along with bank charges Rs.100/-.
iv) Pass Book debit total undercasted by Rs.100/- whereas
credit total of Cash Book under.
v) Interest on Bank overdraft amounting Rs.6,750/- not
accounted in Cash Book.
vi) ECS claring for telephone charges Rs.710 not accounted in
Cash Book.
vii) Debit total of Cash Book Page No. 11 = Rs.3,100/- wrongly
carried on credit side of Cash Book.
4) Prepare a Bank Reconciliation Statement from the following

particulars as on 31st March 2010.
i) Cash Book showed an overdraft of Rs.41,000/- as on 31st

March, 2010.
ii) Cheques deposited worth Rs.6,500/- into the bank out of
which only Rs.5,500/- were credited.
iii) Cheques issued worth Rs.3,000/- were not presented until
4th April, 2010.
iv) The bank has entered in the Pass Book the interest collected
on investment Rs.2,500/- and bank charges Rs.400/-, but
same were not entered in the Cash Book.
v) Rs.1,050/- in respect of dishonour of issued cheques
appears in the Pass Book and not in the Cash Book.

89
5) Prepare Bank Reconciliation Statement as on 28 th February,

2010.
i) Credit balance as per Cash Book was Rs.10,000/- on 28th

February, 2010.
ii) Interest charged by bank Rs.125/- was recorded in the Pass
Book only.
iii) Dividend on shares Rs.1,750/- was collected by bank but not
recorded in cash.
iv) Cheques paid into the bank Rs.2,000/- but cheques of
Rs.1,000/- were only cleared and credited by the bank.
v) Two cheques of Rs.4,000/- and Rs.4,200/- were issued, but
only the cheque of Rs.4,100/- was presented for payment
before the end of month.
6) The Cash Book of Mr. Kamat shows a credit balance of

Rs.10,350/-. Prepare the Bank Reconciliation Statement as on
30th April, 2010.
i) Cheques of Rs.4,250/- received and deposited in the bank,

but same were not collected upto 30th April, 2010.
ii) Cheques of Rs.850/- issued, but not presented for payment.
iii) Interest on investment Rs.275/- and dividend of Rs.510/-
collected by the bank and recorded only in the Pass Book.
iv) Cheques of Rs.2,250/- deposited in the bank and collected
by the bank but recorded twice in the Cash Book.
v) Cheques of Rs.1,502/- issued and presented for payment,
but entered in the Pass Book as Rs.1,052/-.
7) Cash Book of Mr. Dinesh shows a credit balance of Rs.30,000/-

on 31st January, 2010. However, his Pass Book shows a
different balance. You are therefore, requested to prepare a
Bank Reconciliation Statement as on 31st January, 2010 from
the following information :
i) Cheques amounting to Rs.15,000/- issued to supplier Mr.

Rane, not yet presented for payment.
ii) Cheques amounting to Rs.14,000/- deposited into the bank
but not yet collected by the bank.
iii) Bank has charged Rs.450/- as interest on overdraft for six
months ending 31st December, 2010 and also charged
Rs.100/- as bank charges for above period. Same were not
iv) Total of Cash Book at credit side cast short by Rs.520/-.

90
v) Cheque amounted to Rs.10,525 issued and presented into

the bank for payment but recorded in the Pass Book as
Rs.10,652/-.
vi) Transfer of Rs.15,000/- from fixed deposit account to current
account, not recorded in the Cash Book.
8) The following are the extracts given from the Cash Book (Bank
column only) and bank Pass Book of Mr. V. S. K. You are
required to prepare a Bank Reconciliation Statement as on 31 st
December, 2010.

Dr. Cr.
2010 2010
Dec16 To Interest A/c 900 Dec15 By Wages A/c 4,400
19 To Vichare & Sons 7,800 18 By Interest A/c 2,700
25 To D.D. Sharma A/c 2,200 22 By Sunder & Sons 1,500
30 To Mukesh‟s A/c 2,600 31 By Kishore & Sons 2,100
13,500 13,500
2011
Jan 1 To Balance b/d 2,800
Pass Book (Extract only)

Dr. Cr.
2010 2010
Dec18 To Wages A/c 2,400 Dec19 By Interest A/c 900
21 To Interest A/c 1,700 22 By Vichare A/c 7,800
25 To Sunder & Sons 1,500 28 By D.D. A/c 2,200
27 To Janata Trader 400 29 By Jaya A/c 2,020
29 To Service Charges 20
31 To Balance c/d 6,900
12,920 12,920
2011
Jan 1 By Balance c/d 6,900

91
9) From the following extracts of Cash Book and Pass Book,

prepare a Bank Reconciliation Statement as on 30.06.2010.
Dr. Cr.
2010 2010
June 1 To Balance b/d 1,070 June 3 By Keshav & Sons 1,400
5 To Madhav A/c 1,650 9 By Drawing 150
7 To White & Co. A/c 1,340 12 By Lala & Sons 1,810
14 To M/s. Ram Ratan 19 By Nutan Stores 360
& Sons A/c 180 20 By Salary 1,350
17 To Commission A/c 2,250 23 By Vivek & Co. 1,150
22 To Bhave & Sons 1,985 29 By Shinde 600
26 To Govind A/c 1,000 30 By Balance c/d 2,655
9,475 9,475
Bank Pass Book (Extract only)
Dr. Cr.
2010 2010
Jun 1 To Keshav & Sons 1,400 Jun 1 By Balance b/d 1,070
9 To Drawings A/c 150 9 By Madhav A/c 1,650
18 To Lala & Sons A/c 1,810 11 By Dividend A/c 175
25 To Nutan Stores A/c 360 17 By Commission A/c 2,250
27 To Salary A/c 1,350 23 By White & Co. A/c 1,340
29 To Bank Charges 16 29 By Interest A/c 78
6,563 6,563

92
10) From the following extracts of Cash Book and Pass Book
prepare a Bank Reconciliation Statement as on October 31,
2010.
Dr. Cr.
2010 2010
Oct 1 To Balance b/d 4,250 Oct 3 By Salary A/c 2,600
6 To Mr. A A/c 2,000 7 By Commission A/c 175
9 To Mr. B A/c 1,200 10 By Mr. Pal A/c 1,930
16 To Mr. C A/c 2,000 17 By Mr. Bal A/c 1,190
28 To Mr. D A/c 1,600 29 By Mr. Lal A/c 2,500
29 To Mr. E A/c 1,075 30 By Mr. Jal A/c 1,300
31 To Mr. F A/c 1,300 31 By Mr. Dal A/c 1,150
Bank Pass Book
Dr. Cr.
Debit Credit Balance
Date Particulars
Rs. Rs. Rs.
2010
Oct 1 By Balance 2,600 1,250
4 To Salary 175 1,350
8 To Commission 2,000 1,525
9 By Mr. A 1,200 475
12 By Mr. B 1675
13 To Mr. Pal 1,930 255
18 By Mr. C 200 55
19 To Mr. Bal 1,190 1,245
26 By Interest 145 1,100
28 By Dividend on Share 12,200 11,100
29 To Subscription to a Club 450 10,650
30 To Life Insurance Premium 450 10,200

93
11) Prepare a Bank Reconciliation Statement for the month of

September i.e. as on 30.09.10 from the following.
Dr. Cr.
2010 2010
Sep 1 To Balance b/d 400 Sep 2 By Wages A/c 900
To PZ A/c 300 By Purchases A/c 300
To Sales A/c 800 By MO A/c 200
To Interest A/c 150 By KT A/c 250
To Commission A/c 50 By Rent A/c 200
To IT A/c 200 29 By Drawings A/c 100
30 To Balance c/d 50
1,950 1,950
Bank Pass Book
Dr. Cr.
2010 2010
Sep 2 To Wages A/c 900 Sep 1 By Balance b/d 300
To N Cheque By S A/c 100
dishonoured A/c 90 By Interest A/c 150
To KT A/c 250 By B/R 550
To MO A/c 200 28 By Sale of
To Charges A/c 10 29 Investment A/c 300
30 To Drawings A/c 100 By T A/c 200
To Balance c/d 50
1,600 1,600

94
12) Set out below are extracts from Cash Book (Bank column) &
Bank Pass Book of A. Prepare Bank Reconciliation Statement
as on 31st March, 2010.
Cash Book
2010 2010
Mar 1 To Balance b/d 500 Mar 5 By Salaries A/c 100
5 To Kaju A/c 100 8 By S. A/c 200
10 To Interest A/c 50 11 By S. Pawar A/c 50
15 To Sales A/c 200 12 By Purchases A/c 100
15 By Balance c/d 400
850 850
Bank Pass Book (A’s A/c)
Dr. Cr.
Date Payments Rs. Date Receipts Rs.
2010 2010
Mar 5 To Salaries A/c 100 Sep By Soman A/c 400
9 To S. A/c 200 1 By Balance b/d 200
12 To Purchases A/c 100 6 By Kaju A/c 100
13 To Commission A/c 25 9 By Interest A/c 50
15 To Insurance 12 By Kulkarni A/c 50
Premium A/c 775 15 By Balance c/d 400
1,200 1,200

95
13) Given below are the extracts from the Cash Book (Bank
columns) and the Bank Pass Book of Shri. Vora. Prepare a
Bank Reconciliation Statement as on 31-12-2010.
Cash Book (Bank Column)
Dr. Cr.
Date Payments Rs. Date Receipts Rs.
2010 2010
Dec 1 To Balance b/d 1,600 Dec 5 By Wages A/c 100
8 To Ramkant A/c 700 10 By Nair A/c 250
12 To Ram Prasad A/c 1,400 15 By Furniture A/c 200
13 To Sales A/c 500 20 By Drawings A/c 450
15 To Interest A/c 100 25 By Salaries A/c 175
20 To S. Suresh A/c 2,350 31 By Commission A/c 125
6,650 6,650
2010
Jan 1 To Balance b/d 1,200
Pass Book

2010 2010
Jan 2 To Wages A/c 150 Jan 1 By Balance b/d 825
4 To Commission A/c 125 2 By Ram Prasad A/c 1,400
5 To Nair A/c 250 5 By Interest A/c 100
6 To Drawings A/c 450 8 By S. Suresh A/c 2,350
6 To Kulkarni A/c 150

5
96
LEDGER AND TRIAL BALANCE

Unit Structure:
5.0 Objectives
5.1 Meaning
5.2 How to open an Account in the ledger
5.3 Posting
5.4 Balance and Balancing of Accounts
5.5 Meaning of Balances
5.6 Illustrations-1
5.7 Trial Balance
5.8 Some important items and their balance
5.9 Illustrations-2
5.10 Exercises
5.0 OBJECTIVES

Know the meaning of Ledger.
Understand the process of opening a Ledger Account.
Prepare a Ledger Account from the given information.
Explain the types of Trial Balance.
Prepare the Trial Balance from the balances given.
5.1 MEANING
The ledger is the principal book of accounts relating to a

particular person or property or revenue or expenses are recorded
in summarized form. It is a set of accounts. It contains all accounts
of the business enterprise whether real, nominal or personal. The
main function of a ledger is to classify or sort out all items
appearing in the journal or other subsidiary books under their
appropriate accounts & that at the end of the accounting period
each account will contain the entire information of all the
transactions relating to in a summarized or condensed form.
All the transactions are recorded first in the journal and then
from the journal they are posted in the respective accounts in the
ledger. Ledger is a book where in all the transactions would

97
ultimately find their place under the respective heads of accounts.

Ledger is a book of final entry.
5.2 HOW TO OPEN AN ACCOUNT IN THE LEDGER :
The pages of all books of accounts must be numbered to

facilitate reference. The page is divided into two parts by vertical
line in between. The left hand side is used as a debit side of an
account and the right hand side is used as a credit side.
____________ Name (Account)

Dr. Cr.
Date Particulars J.F. Amt. Date Particulars J.F. Amt.
5.3 POSTING :
Every transaction is first recorded in the book of original

entry and then it is posted into the ledger. Posting is made to the
debit side account which is debited in the journal entry and to the
credit side of an account which is credited in the journal entry.
Name of the credit account is written on the debit account and the
name of debit account is written on the credit side of account.
Entry on the debit side of an account starts with “To” whereas on
the credit side starts with “By”.
5.4 BALANCE AND BALANCING OF ACCOUNTS :
The object of recording the business transactions in various

ledger accounts to enable a trader to ascertain balance in account
easily at any time. For the preparation of Trial balance all accounts
are to be closed.
Each account in the ledger may have same entries on the

debit side and some entries on the credit side of an account. Find
out difference between totals of each side. The difference in the
total of both the side is termed as Balance of an account. The
process of extracting the balance and inserting it on lesser side of
an account is called balancing or closing of an account.

98
Types of Balances
A) Debit Balance : If the debit side of an account is heavier than

its credit side, the balance is called debit balance.
B) Credit Balance : If the credit side of an account is heavier than

its debit side, the balance is called credit balance.
5.5 MEANING OF BALANCES :
5.5.1 Personal Accounts : Personal Accounts may have debit or

credit balance.
Debit balance shows that person owes to the firm. He is

debtors.
Credit balance shows that persons owed to him. He is creditor.
5.5.2 Real Accounts : Real accounts always have debit balance.

These are value of Assets, properties owned by businessmen.
5.5.3 Nominal Accounts : Nominal Account may have debit or

credit balance debit balances shows total expenses / losses for
the period. Credit balances shows total income / gain for the
period.
At the end of accounting period balances of nominal

accounts transferred to Trading, Profit & Loss Account, whereas
balances shown of Personal Accounts & Real accounts in the
Balance Sheet, and next year these balances considered as
opening balances.
CHECK YOUR PROGRESS
Fill in the blanks:

1. If the debit side of an account is heavier than its credit
side, the balance is called----------------------------.
2. The left hand side of a Ledger Account is used as a ---------
----- and the right hand side is used as a --------------------.
3. -----------------and ---------------- Accounts may have debit or
credit balance.
4. Debit balance of the -----------Account shows that person
owes to the firm. It means he is the ------------of the firm.
5. Credit balances of the Nominal Account shows total ---------
-----------------for the period.
6. Real accounts always have -------------- balance.

99
Define Ledger and draw the proforma of Ledger Account.
5.6 ILLUSTRATIONS-1 :
Illustration 1: Enter the following transactions in the proper

subsidiary books and post them to the Ledger Accounts and
balance the Account 30 June 2010.
1 Commenced business with Cash Rs.5,000/- (of which

Rs.2,000/- borrowed from friend Ram) and furniture Rs.1,400/-
2 Purchased goods from Kanta Rs.1,800/- less 5%. Trade
Discount.
6 Sold goods to Ketual costing Rs.400/- at 10% Profit.
7 Cash purchases Rs.500/-.
8 Cash sales – Rs.1,200/-.
9 Purchased goods from Baba Rs.500/-.
9 Paid into Bank Rs.2,000/-.
10 Returned to Kanta goods worth Rs.150/-.
11 Purchased office furniture for Rs.1,200/- and paid for same by
cheque.
16 Issued a cheque to Kanta for Rs.910/-.
21 Invoiced goods to Ketual Rs.5,000/- less 2% Trade discount.
23 Ketual paid cash Rs.400/- and returned goods of Rs.140/-.
24 Purchased goods from Kanta Rs.1,300/-.
28 Returned damaged goods to Janta Rs.160/- & to Baba
Rs.150/-.
28 Sold goods to Kant Rs.1,200/-.
29 Received a cheque for Rs.1,100/- from Kant and banked the
same.
30 Kant, who owes us Rs.100/- pays rent Rs.100/- to our landlord
on our behalf.
30 We paid Rs.75/- to Raju on instructions from our creditor
Kanta on his behalf.
Solution :
Journal
Date Particulars L.F. Debit Credit

100
Rs. Rs.
2010 Furniture A/c ………………... …… Dr. 1,400
June 1 To Capital A/c 1,400
(Furniture brought in by Proprietor.)
30 Rent A/c …………………………… Dr. 100

To Kant A/c 100
(Rent paid by Kant on our behalf.)
Purchases Book
Date Name of Supplier Inward L.F. Amount

Invoiced No. Rs.
2010
June 2 Kanta - - 1,710
9 Baba - - 500
24 Kanta - - 1,300
Total 3,510
Returns Outward Book
Date Particulars Debit L.F. Amount

Note No. Rs.
2010
June 10 Kanta - - 150
28 Kanta - - 160
28 Baba - - 150
Total 460
Sales Book
Date Particulars Debit L.F. Amount

Note No. Rs.
2010
June 6 Ketual - - 440
21 Ketual - - 4,900
28 Kant - - 1,200
Total 6,540
Returns Inward Book
Date Particulars Credit J.F. Amount
Note No. Rs.

101
2010
June 23 Ketual - - 140
Total 140
Cash Account
Dr. Cr.
Date Particulars L.F. Bank Cash Date Particulars L.F. Bank Cash
2010 2010
June 1 To Capital A/c 3,000 June 7 By Purchases
1 To Ram Loan 9 A/c 500
8 A/c 2,000 11 By Bank A/c C 2,000
23 To Cash A/c C 2,000 30 By Kanta A/c 910
29 To Ketual A/c 400 30 By Kanta A/c 75
To Kant‟s A/c 1,100 By Balance c/d 990 4,025
3,100 6,600 3,100 6,600

July 1 To Balance b/d 990 4,025
Capital Account
Dr. Cr.
Date Particulars J.F. Rs. Date Particulars J.F. Rs.
2010 2010
June 30 To Balance c/d 4,400 June 1 By Cash A/c 3,000
By Furniture A/c 1,400
4,400 4,400
July 1 By Balance b/d 4,400
Furniture Account
Dr. Cr.
2010 2010
June 30 To Capital A/c 1,400 June 30 By Balance c/d 2,600
11 To Bank A/c 1,200
2,600 2,600
July 1 To Balance b/d 2,600
Purchases Account
Dr. Cr.

102
2010 2010
June 7 To Cash A/c 500 June 30 By Balance c/d 4,010
30 To Sundries A/c 3,510
(as per purchase
Book)
4,010 4,010
Sales Account
Dr. Cr.
2010 2010
30 By Sundries A/c 6,540
7,740 7,740
Return Outward Account

Dr. Cr.
2010 2010
June 30 To Balance c/d 460 June 30 By Sundries A/c 460
(as per R. O. Book)
460 460
July 1 By Balance b/d 460
Return Inward Account

Dr. Cr.
2010 2010
June 30 To Balance c/d 140 June 1 By Balance c/d 140
140 140
July 1 To Balance b/d 140
Ram’s Loan Account

Dr. Cr.

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2010 2010
2,000 2,000
Kanta’s Account
Dr. Cr.
2010 2010
June 10 To Return June 2 By Purchases A/c 1,710
Outward A/c 150 24 By Purchases A/c 1,300
19 To Bank A/c 910
28 To Returns
Outward A/c 160
30 To Cash A/c 75
3,010 3,010
Ketual’s Account
Dr. Cr.
2010 2010
June 6 To Sales A/c 440 June 23 By Return Inward
21 To Sales A/c 4,900 A/c 140
By Cash A/c 400
By Bal. c/d 4,800
5,340 5,340
Rent Account
Dr. Cr.
2010 2010
June 30 To Kant A/c 100 June 30 By Balance c/d 100
100 100
Baba’s Account
Dr. Cr.

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2010 2010
June 28 To Return June 9 By Purchases A/c 500
Outward A/c 150 30
30 To Balance c/d 350
500 500
July 1 By Balance b/d 350
Kant’s Account
Dr. Cr.
2010 2010
June 28 To Sales A/c 1,200 June 29 By Bank A/c 1,100
By Rent A/c 100
1,200 1,200
Illustration 2 :
M. D. as on 1st March 2010
Debit Balance Rs. Credit Balance Rs.

Cash A/c 15,000 Capital A/c 60,000
Bank A/c 12,000 Mr. Chandra A/c 9,000
Stock A/c 14,000
ZaCo A/c 28,000
2010
March 2 Borrowed Rs.30,000/- from sister Maya for business
purpose.
4 Bought goods from Mr. Chandra for Rs.6,000/- @ 5%
trade discount.
7 Sold goods worth Rs.15,000/- to Mr. ZaCo @ 2% trade
discount.
9 Received Rs.7,000/- from Mr. ZaCo.
10 Cash deposited into Bank Rs.7,000/-.
12 Paid Rs.5,000/- to Mr. Chandra by issuing a cheque.
15 Paid for new equipment of office Rs.4,000/-.
17 Purchased new furniture for Rs.2,500/- for personal use.
19 Cash purchases Rs.15,000/- and cash sales Rs.27,100/-.
22 Paid salaries Rs.1,700/-, rent Rs,1,250/-, commission
Rs.800/- by cash.

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26 Withdrew Rs.8,500/- from the business for daughter‟s

marriage by a cheque.
27 Goods worth Rs.1,000/- withdrawn from the business for
house use, out of opening stock.
31 Paid interest Rs.300/- to sister Maya on borrowings.
You are required to journalise the above transactions including

Cash / Bank and post them to the ledger and balance the same.
Solution :
In the books of M.D.
Date Particulars L. Debit Credit

F. Rs. Rs.
2010 Cash A/c ………………... ………… Dr. 30,000
March 2 To Maya‟s Loan A/c 30,000
(Being amount borrowed.)
4 Purchase A/c ……………………… Dr. 5,700
To Chandra‟s A/c 5,700
(Being goods purchased.)
7 ZaCo A/c …………………………… Dr. 14,700
To Sales A/c 14,700
(Being cash received from ZaCo.)
9 Cash A/c …………………………… Dr. 7,000
To ZaCo A/c 7,000
(Being cash received from ZaCo.)
10 Bank A/c …………………………… Dr. 7,000
To Cash A/c 7,000
(Being cash deposited into Bank.)
12 Chandra‟s A/c ……………………… Dr. 5,000
To Bank A/c 5,000
(Being cheque issued.)
15 Office Equipment A/c ……………… Dr. 4,000
To Cash A/c 4,000
(Being office equipment purchased.)
17 Drawing A/c …………………………Dr. 2,500
To Cash A/c 2,500
(Being furniture purchased for
personal use.)

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19 Purchases A/c ………………………Dr. 15,000

To Cash A/c 15,000
(Being goods purchased.)
19 Cash A/c …………………………… Dr. 27,100
To Sales A/c 27,100
(Being goods sold.)
22 Salaries A/c …………………………Dr. 1,700
Rent A/c …………………………… Dr. 1,250
Commission A/c ……………………Dr. 800
To Cash A/c 3,750
(Being Salaries, Rent & Commission
paid.)
26 Drawing A/c ……………………….. Dr. 8,500
To Bank A/c 8,500
(Being amount withdrawn by cheque
for personal use.)
27 Drawing A/c …………………………Dr. 1,000
To Stock A/c 1,000
(Being goods taken for personal use.)
31 Interest A/c …………………………. Dr. 300
To Cash A/c 300
(Being interest paid on Maya‟s loan.)
Ledger Accounts
Cash Account
Dr. Cr.
2010 2010
Mar 1 To Bal b/d 15,000 Mar 10 By Cash A/c 7,000
2 To Maya‟s 30,000 15 By Office
Loan A/c 17 Equipment A/c 4,000
To ZaCo A/c 7,000 19 By Drawings A/c 2,500
19 To Sales A/c 27,100 22 By Purchases A/c 15,000
22 By Salaries A/c 1,700
22 By Rent A/c 1,250
31 By Commission 800
31 A/c
By Interest A/c 300
By Balance c/d 46,550
79,100 79,100
Apr 1 To Balance b/d 46,550

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Bank Account
Dr. Cr.
2010 2010
Mar 1 To Bal b/d 12,000 Mar 12 By Chandan‟s A/c 5,000
10 To Cash A/c 7,000 26 By Drawings A/c 8,500
19,000 19,000
Stock Account
Dr. Cr.
2010 2010
Mar 1 To Bal b/d 14,000 Mar 27 By Drawings A/c 1,000
14,000 14,000
Purchase Account
Dr. Cr.
2010 2010
Mar 1 To Chandra‟s 5,700 Mar 31 By Bal c/d 20,700
A/c
19 To Cash A/c 15,000
20,700 20,700
Apr 1 To Bal b/d 20,700
Sales Account
Dr. Cr.
2010 2010
Mar 31 To bal c/d 41,800 Mar 1 By ZaCo A/c 14,700
31 By Cash A/c 27,100
41,800 41,800
Apr 1 By Balance b/d 41,800

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Salaries Account
Dr. Cr.
2010 2010
Mar 22 To Cash A/c 1,700 Mar 31 By Balance c/d 1,700
1,700 1,700
Rent Account
Dr. Cr.
2010 2010
Mar 22 To Cash A/c 1,250 Apr 1 By Balance c/d 1,250
1,250 1,250
Commission Account
Dr. Cr.
2010 2010
Mar 22 To Cash A/c 800 Apr 1 By Balance c/d 800
800 800
Apr 1 To Balance b/d 800
Interest Account
Dr. Cr.
2010 2010
Mar 31 To Cash A/c 300 Apr 1 By Balance c/d 300
300 300
Apr 1 To Balance b/d 300

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ZaCo’s Account
Dr. Cr.
2010 2010
Mar 1 To Balance b/d 28,000 Mar 9 By Cash A/c 7,000
7 To Sales A/c 14,700 31 By Bal c/d 35,700
42,700 42,700
Capital Account
Dr. Cr.
2010 2010
Mar 31 To bal c/d 60,000 Mar 1 By Balance b/d 60,000
60,000 60,000
Apr 1 By Balance b/d 60,000
Mr. Chandra’s Account

Dr. Cr.
2010 2010
Mar 12 To Bank A/c 5,000 Mar 1 By Balance b/d 9,000
31 To Balance c/d 9,700 2 By Purchase A/c 5,700
14,700 14,700
Maya’s Loan Account

Dr. Cr.
2010 2010
Mar 31 To Balance c/d 30,000 Apr 1 By Cash A/c 30,000
30,000 30,000

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Office Equipment Account

Dr. Cr.
2010 2010
4,000 4,000
Drawings Account
Dr. Cr.
2010 2010
26 To Bank A/c 8,500
27 To Goods A/c 1,000
(stock)
12,000 12,000
5.7 TRIAL BALANCE
5.7.1 Introduction :
The fundament principle of double entry book keeping is that
debit must be equal to credit. In other words, debit aspect of any
transaction is always equal to its credit aspect.
All ledger accounts are balances. A debit balance in a
general ledger account indicates an excess of debit side over credit
side of the account. A credit balance in a ledger account indicates
the excess of credit side over debit side of the account. A trial
balance is a summary of all the ledger balances outstanding as on
particular date. List of debit balances and credit balances should
be equal. It said that Trial balance is tallied. When trial balance
tallies is establishes the arithmetical accuracy of record. It is a
statement prepared before preparing the final accounts. It is a link
between books of account and final accounts i.e. the Trading &
Profit & Loss A/c and Balance Sheet.
5.7.2 Types of trial balances

Trial balances are of two types.
1) Gross Trial Balance
2) Net Trial Balance

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1 Gross Trial Balance :

Gross Trial Balance is prepared by taking all ledger account
debit total and credit total, instead of considering ledger balances,
as on a particular date.
Illustration 3 : Gross Trial Balance can be as under –

Sr. Total debit Total credit
Name of Account
No. side (Rs.) side (Rs.)
1 Ketan‟s Capital 5,000 76,000
2 Opening Stock 10,000 -
3 Purchases 2,10,000 2,000
4 Sales 2,000 3,05,000
5 Sales Return 18,000 -
6 Expenses 27,000 -
7 Customers 1,20,000 26,000
8 Suppliers 12,000 80,000
9 Cash 6,000 -
10 U. C. Bank 96,000 17,000
5,06,000 5,06,000
2 Net Trial balance :

Net trial balance is list of debit & credit balance, taken from
ledger accounts on particular date. Normally, net trial balance is
prepare, since it is transferred to final accounts and personal and
real accounts balance are carried forward from current year to
subsequent year.
Illustration 4 : Trial Balance as on 31st March 2010.

Sr. Total debit Total credit
Name of Account
No. side (Rs.) side (Rs.)
2 Capital - 1,02,000
3 Purchases 2,10,000 -
4 Purchase Return - 6,000
5 Sales - 3,11,000
6 Sales Return 4,000 -
7 Expenses 28,000 -
8 Plant & Machinery 1,20,000 -
9 Customers 80,000 -
10 Suppliers - 62,000
11 Cash 6,000 -
12 Bank balance 21,000 -
4,81,000 4,81,000

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5.8 SOME IMPORTANT ITEMS AND THEIR

BALANCES
1. Capital : Credit balance

2. Drawings : Debit balance
3. Purchases : Debit balance
4. Expenses : Debit balance
5. Incomes : Credit balance
6. Carriage Inwards : Debit balance
7. Carriage Outwards : Debit balance
8. Stock (opening) : Debit balance
9. Loan taken : Credit balance
10. Interest paid : Debit balance
11. Loan given : Debit balance
12. Interest received : Credit balance
13. Assets : Debit balance
14. Suppliers : Credit balance
15. Sales Return : Debit balance
16. Purchases : Debit balance
17. Return Outwards : Credit balance
18. Investments : Debit balance
19. Goodwill : Debit balance
20. Cash : Debit balance
Note : Closing stock should not be taken in trial balance. However,

it Gross Profit is given in trial balance then it should be taken
as Debit balance.
5.9 ILLUSTRATIONS-2
Illustration 5 : From the following prepare Gross Trial balance and

net Trial balance as on 31st March 2010.
Particulars Totals
Cash (Dr.) 21,500
Bank (Dr.) 13,000
Furniture (Dr.) 21,000
Creditors (Dr.) 13,700
Debtors (Dr.) 22,000
Rent (Dr.) 5,500
Salaries (Dr.) 2,900
Cash (Cr.) 14,300

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Capital (Cr.) 10,000

Bank (Cr.) 2,900
Furniture (Cr.) 400
Creditors (Cr.) 14,000
Debtor (Cr.) 4,800
Rent (Cr.) 900
Solution :
(A) Gross Trial Balance as on 31.03.2010
Particulars Debit Credit

(i.e. Names of Accounts) Total Total
(Rs.) (Rs.)
Cash 21,500 14,300
Bank 13,000 2,900
Furniture 21,000 400
Creditors 13,700 14,000
Debtors 22,000 4,800
Rent 5,500 900
Salaries 2,900 -
Capital - 62,300
99,600 99,600
(B) Net Trial Balance

Balance Balance
(Rs.) (Rs.)
Cash (Dr. – Cr.) 7,200 -
Bank (Dr. – Cr.) 10,100 -
Furniture (Dr. – Cr.) 20,600 -
Creditors (Cr. – Dr.) - 300
Debtors (Dr. – Cr.) 17,200 -
Rent (Dr. – Cr.) 4,600 -
Salaries 2,900 -
Capital - 62,300
62,600 62,600

114
Illustration 6 : Prepare a Trial Balance from the following items :
Particulars Totals
Capital 7,63,050
Furniture & Fixture 40,000
Land & Building 4,03,000
Plant & Machinery 2,00,000
Drawings 60,000
Patents 20,000
Stock 4,00,000
Purchases 9,50,000
Wages 50,000
Salaries 72,000
Sundry Debtors 3,50,000
Sales 13,20,000
Sales Returns 61,000
Purchases Returns 10,000
Loan from Ketan 4,00,000
Rent, Rates & Taxes 48,000
Bad Debts 4,000
Sundry Creditors 2,24,000
Discount received 9,000
Trade Expenses 700
Interest on Loan 4,500
Insurance 6,500
Traveling Expenses 3,000
Cash in Hand 2,100
Cash at Bank 51,250
Solution :
Trial balance
Particulars Debit (Rs.) Credit (Rs.)

Capital - 7,63,050
Furniture & Fixture 40,000 -
Land & Building 4,03,000 -
Plant & Machinery 2,00,000 -
Drawings 60,000 -
Patents 20,000 -

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Stock 4,00,000 -
Purchases 9,50,000 -
Wages 50,000 -
Salaries 72,000 -
Sundry Debtors 3,50,000 -
Sales - 13,20,000
Sales Returns 61,000 -
Purchases Returns - 10,000
Loan from Ketan - 4,00,000
Rent, Rates & Taxes 48,000 -
Bad Debts 4,000 -
Sundry Creditors - 2,24,000
Discount received - 9,000
Trade Expenses 700 -
Interest on Loan 4,500 -
Insurance 6,500 -
Traveling Expenses 3,000 -
Cash in Hand 2,100 -
Cash at Bank 51,250 -
27,26,050 27,26,050
Illustration 7 : Prepare Trial balance from ledger Account open in

Illustration No. 1.
Solution :
Trial balance as on 31st June 2010
Sr. Debit Credit

Particulars L.F.
No. (Rs.) (Rs.)
1 Cash 990 -
2 Bank 4,025 -
3 Capital - 4,400
4 Furniture 2,600 -
5 Purchases 4,010 -
6 Sales - 7,740
7 Return Outwards - 460
8 Return Inwards 140 -
9 Ram‟s Loan - 2,000
10 Kanta‟s A/c - 1,715

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11 Ketual‟s A/c 4,800 -

12 Rent A/c 100 -
13 Baba‟s A/c - 350
16,665 16,665
Illustration 8 : Prepare Trial balance from ledger accounts opened

in illustration No. 2.
Solution :
Trial balance as on 31st March 2010
Sr. Debit Credit

Particulars L.F.
No. (Rs.) (Rs.)
1 Cash 46,550 -
2 Bank 5,500 -
3 Stock 13,000 -
4 Purchases 20,700 -
5 Sales - 41,800
6 Salaries 1,700 -
7 Rent 1,250 -
8 Commission 800 -
9 Interest 300 -
10 ZaCo 35,700 -
11 Capital - 60,000
12 Chandras - 9,700
13 Maya‟s Loan - 30,000
14 Office Equipment 4,000 -
15 Drawings 12,000 -
1,41,500 1,41,500
5.10 EXERCISES :
5.10.1 Theory questions :

1. What is ledger?
2. How entries from Journal posted to Ledger?
3. Why Real Account have always debit balance or nil balance.
4. What are different types of Trial Balance?

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5. Why Trial Balance tallies?

6. Distinguish between Gross Trial Balance and Net Trial Balance.
7. Why Trial Balance prepared?
5.10.2 Practical Problems :
Q.1 Prepare a Trial balance from the following as on March 31st,

2010.
Particulars Totals
Stock 60,000
Purchases 1,50,000
Capital 70,000
Drawings 22,000
Sales 2,50,000
Salaries 11,200
Rent, Taxes & Insurance 5,600
Returns Outwards 2,600
Advertising 840
Wages 7,000
Bank Overdraft 20,000
General Trade Expenses 1,350
Returns Inwards 5,400
Discount allowed 600
Interest & Commission paid 430
Bad Debts 800
Sundry Creditors 60,000
Cash in hand 2,060
Sundry Debtors 92,000
Furniture 10,000
Plant & Machinery 20,000
Buildings 12,000

118
Q.2 Following are the balances extracted from the ledger of Shri.
Ketan. Prepare a Trial Balance as on 31st Dec. 2010.

Capital A/c 40,000 Purchases 26,500
Drawings A/c 4,000 Printing & Stationery 3,000
Sundry Creditors 18,440 Rent & Taxes 2,500
Motor Car Expenses 3,000 Office Expenses 7,000
Sales 29,560 Commission paid 5,000
Trade Expenses 8,500 Sundry Debtors 18,000
Insurance 1,030 Discount Allowed 2,970
Opening Stock 8,500 Interest Received 2,000
Q.3 The following balances appeared in the ledger of M/s. Tata

Traders as on 1st July 2010.

Bank A/c 30,000 Kamath‟s A/c 5,000
Goods A/c 35,000 10% Term Loan 20,000
Mehta‟s & Son‟s A/c 15,000
1,05,000 1,05,000
2010
July1 Borrowed Rs.25,000/- from wife for expansion of the
business and deposited Rs.20,000/- in Bank.
4 Deposited Rs.15,000/- into the Bank.
6 Received from Mr. Mehta and Sons Rs.9,550/- in part
payment of Rs.10,000/-.
8 Paid Rs.1,900/- to Mr. Kamath in part payment of
Rs.2,000/-.
20 Withdrew from bank Rs.5,000/- for office use and
Rs.4,000/- for private use.
24 Cash sales Rs.20,000/-.
25 Paid Salaries Rs.1,250/-, rent Rs.1,400/- and received
commission Rs.2,600/- in cash.

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28 Paid Rs.20,000/- for part payment of wife‟s loan. Also

interest of Rs.1,250/- due on loan.
31 Deposited Rs.11,500/- into the Bank.
From the above transactions, draft journal entries, post them

to respective ledger accounts and balance them, also prepare
Trial Balance.
Q.4 The following balances appeared in the ledger of Shri as on 1st

March 2010.

Bank A/c 10,000 Mr. Nair A/c 16,000
Goods A/c 35,000
Govinda‟s A/c 6,000
2010
Mar.1 Introduced further capital in cash Rs.25,000/-.
2 Deposited Rs.15,000/- into the bank.
4 Received Rs.3,000/- from Mr. Govind.
7 Paid Rs.4,000/- to Mr. Nair.
9 Bought goods costing Rs.17,500/- on credit from Nair.
15 Sold goods to Mr. Govind for Rs.16,000/-.
20 Bought goods from Mr. Nair for Rs.40,000/-.
24 Withdrew Rs.12,000/- from bank for office use.
25 Good costing Rs.20,000/- sold @ 25% Profit.
26 Rent paid by cheque Rs.6,000/-.
27 Salaries paid Rs.10,000/- a wages Rs.2,000/-.
29 Received cash from Govind Rs.9,000/- and allowed him
discount Rs.100/-.
30 Withdrawn cash Rs.4,000/- and Rs.6,000/- by cheque
for personal use.
You are required to journalise above transaction and prepare

necessary ledger accounts and prepare trial balance.

120
Q.5 Following balances appeared in the ledger of Mr. Raman as

on 1st March, 2010.

Goods A/c 10,000 M/s. Godreja Co. 14,000
Bank A/c 30,000
Mr. H.O.‟s A/c 5,000
Furniture A/c 14,000
Transactions during the month ending 31.03.2010.

2010
Mar.1 Introduced cash Rs.40,000/- into the business as
capital.
6 Bought goods worth Rs.15,000/- from Mr. Ketan @ 5%
trade discount.
14 Cash purchases Rs.10,500/-.
20 Sold goods worth Rs.10,500/- to Mr. H.O. @ 2% trade
discount.
21 Paid carriage Rs.100/-.
22 Cash sales Rs.35,000/-.
24 Paid Rs.7,000/- to Mr. Godreja Co. and earned discount
Rs.100/-.
27 Received Rs.6,900/- from H.O. in full settlement of
Rs.7,200/-.
29 Purchase goods from David costing Rs.25,000/-.
30 Half of goods purchased were return to David.
31 Balance due to David paid @ 10% discount.
Pass necessary journal entries, open necessary ledger

accounts & prepare Trial balance as on 31st March 2010.

6
121
FINAL ACCOUNTS OF A SOLE TRADER

Unit Structure:
6.0 Objectives
6.1 Introduction
6.2 Trading Account
6.3 Profit & Loss Account
6.4 Balance Sheet
6.5 Marshalling of Balance Sheet
6.6 Classification of Assets
6.7 Classification of Liabilities
6.8 Limitations of Balance Sheet
6.9 Adjustments.
6.10 Illustrations
6.11 Exercises
6.0 OBJECTIVES

Know the meaning of Final Accounts and proforma of Final
Accounts.
Explain the Classification of Assets and Liabilities.
Make the adjustment entries.
Prepare Final Accounts from the given Trial Balance.
6.1 INTRODUCTION
The transactions of a business are first recorded in Journal /

subsidiary books, then posted there form to the Ledger and at the
end of accounting year, Trial balance is prepare to test accuracy,
both the aspects of the transactions have been correctly recorded
in the books of accounts of original entry as well as in the Ledger.
The last stage in accounting process is the preparation of final
Accounts.
From given trial balance a Trading, Profit & Loss A/c &
Balance Sheet is prepared.

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A Trading, Profit & Loss A/c is prepared to determine the

Profit or Loss made during a particular year, and Balance Sheet is
prepare which consists of all assets, Liabilities and Capital of
proprietor.
For preparing Final Accounts from Trial Balance following

procedure should be followed.
i) Debit Account balances :-
Balances appearing on the debit column of the trial balance

may represent - (a) assets (b) Expenses and Losses. Assets are
shown on right hand side of the balance sheet while expenses and
loss are debited either to the Trading A/c or to the Profit & Loss A/c,
depending upon nature of expenditure or loss.
ii) Credit Account balances :-
Credit items in the trial balance represents (a) Capital,

Liabilities, expenses. These items are entered on the left hand side
of the balance sheet (b) Income and gains. These are either
credited to Trading A/c or Profit and Loss A/c.
6.2 TRADING ACCOUNT :-
Trading A/c is prepared to ascertain the Gross Profit. Gross

Profit is difference between net sales and cost of goods sold. A
specimen of Trading Account is given below:
Trading A/c for the year ended…

Dr. Cr.
To Opening Stock X By Sales X X
To Purchases X Less: Returns (X)
Less: Returns (X) X By Closing Stock X
To Carriage Inwards X
To Wages X
To Direct Expenses X
To Gross Profit X
XX XX
However, Gross Profit is the balancing figure, in case debit

side total exceeds the credit side, then balance will be Gross Loss,
it is shown on credit side of Trading A/c as „By Gross Loss‟.

123
6.3 PROFIT AND LOSS ACCOUNT
Profit and Loss A/c is prepared to calculate the net profit or

net loss. The balance of Trading A/c i.e. Gross profit / Gross loss is
transferred to the Profit and Loss Account. Therefore, all those
expenses and Losses are debited to the Profit and Loss A/c. Other
income / gains are credited to this A/c e.g. commission received,
discount earn etc.
The Profit and Loss accounts measures net profit by

matching revenues and expenses according to the accounting
principles, Net profit is the excess of revenue over total expenses.
It should be kept in mind that all expenses / incomes must be
adjusted in respect of outstanding / prepaid / paid or received in
advance. Expenses or incomes are considered on mercantile
basis. At end Net Profit or Net Loss transferred to Capital Account
in the balance sheet.
A specimen of Profit & Loss Account is given below :
Profit & Loss Account for the year ended…

Dr. Cr.
To Salaries X By Gross Profit b/d X
To Rent, Rates & Taxes X By Discount earned X
To Insurance X By Commission received X
To Printing & Stationery X By Interest earned X
To Legal Exp X By Profit on sale of assets X
To Audit Fees X
To Discount allowed X
To Interest paid on Loans X
To Bad debts X
To Carriage outwards X
To Advertising expenses X
To Depreciation on assets X
To Loss due to fire X
To Net Profit X
[transferred to capital]
XX XX
It may be noted that:

1) Direct Expenses which are debited to Trading A/c are not
debited again to Profit & loss A/c.

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2) Personal expenses are not debited to this account.

3) Income Tax, Wealth Tax or Life insurance premium paid are
personal expenses of proprietor / partners.
4) Items shown in Trial Balance should be given one effect and
adjustment given below Trial Balance should be given two
effects.
5) It should be noted that:
Trading Account and Profit & Loss Account are not prepares
separately as shown above but they are prepared as one
account split up into two sections. As such the combined
heading is given as „Trading and Profit & Loss A/c for the year
ended…‟
6.4 BALANCE SHEET
Balance Sheet is a statement which shows the financial

position of a business entity on a given date. It is prepared from
trial balance, after all nominal accounts and accounts relating to
Trading, Profit & Loss account. Accounts left out are Real accounts
and personal accounts. Accounts having debit balances
transferred to Assets side of balance sheet and account having
credit balance transferred to Liabilities side of Balance Sheet, in
some cases credit balances may be deducted from particular asset.
e.g. provision for depreciation deducted from Fixed Asset; Reserve
for bad & doubtful, is deducted from sundry debtors. Balances
shown in Balance Sheets are carried forward for next year.
The Balance Sheet has also two sides. The Left hand side
is headed as „Liabilities‟ and Right hand side is headed as „Assets‟.
It is not an account, therefore in no „To‟ or „By‟ proceeding the
names of the Account recorded in the Balance Sheet.
Balance Sheet shows financial position as on a particular

date and not for the year. Therefore the heading of Balance Sheet
is worded as
“Balance Sheet of ….. as on …..”
6.5 MARSHALLING OF BALANCE SHEET

[Order of Assets and Liabilities]
1) Assets are arranged in order of their Liquidity i.e. in order in
which they can be converted into cash and Liabilities they are
payable. As assets which can be immediately converted into
cash will be taken first and then in order will follow the others.
Similarly, Liability which is to be paid off immediately will be
taken first and then next and so on.

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2) The assets & liabilities are arranged in exactly the reverse order
of the above arrangement.
A specimen of Balance Sheet is given below :
Balance Sheet of ….. as on …..
[According to Liquidity order]
Liabilities Rs. Assets Rs.

Outstanding Expenses X Cash in hand X
Sundry Creditors X Bank Balance X
Bills Payable X Investments X
Bank Overdrafts X Sundry Debtors X
Loans X Bills Receivable X
Capital X Outstanding Income X
Stock in trade X
Loose tools X
Prepaid Expenses X
Patents, Trade Marks X
Furniture X
Plant & Machinery X
Building X
Land X
Goodwill X
XXX XXX
The totals of the two sides of the balance sheet must agree
because of the equation
Assets = Liabilities + Capital
6.6 CLASSIFICATION OF ASSETS
6.6.1 Fixed Assets :-

These assets are acquired for long use in the business itself
and not for sale. e.g. Building, Plant & Machinery etc.
6.6.2 Current or Floating Assets :-

These assets are to be converted into cash as soon as
possible. e.g. stock of goods, Sundry Debtors, Bills Receivable.
6.6.3 Liquid / Quick Assets :-

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These assets can be converted into cash as quickly as

possible, without undue Loss. e.g. Sundry Debtors, Bank Balance,
short term govt. securities.
6.6.4 Wasting Assets :-

Are those fixed assets which have fixed content like coal in
coal mine.
6.6.5 Intangible Assets :-

Are those Fixed Assets which can not be seen or touched or
felt, i.e. having no physical existence, e.g. Goodwill.
6.6.6 Fictitious Assets :-

Are worthless assets but shown as assets in the Balance
Sheet. E.g. preliminary expenses, Discount on issue of
debentures.
6.7 CLASSIFICATION OF LIABILITIES
6.7.1 Fixed and Long-term Liabilities :-
Are those Liabilities which are payable after a long period of

time e.g. Bank Loan, Debentures.
6.7.2 Current Liabilities :-

These are short term Liabilities payable usually with in year
e.g. sundry creditors, Bills Payable, outstanding expenses.
6.7.3 Contingent Liabilities :-
These are not actual Liabilities as on date of Balance Sheet,

which may or may not be payable in future, depend on the
happening of certain events. In future, however due present
circumstances; whether to pay or not, depends upon further
happenings. Therefore existence of contingent liabilities shown
below total liabilities by way of note for the sake of information and
disclosure. e.g. investment in partly paid shares, compensation suit
pending in court, Bills discounting but not matured, such Liabilities
are shown as a foot note in the Balance Sheet on liabilities side.
6.8 LIMITATIONS OF BALANCE SHEET
Balance sheet is considered to be a static document. The real

position of the concern keeps on changing.

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Stock valuation / method of depreciation are different, which

affects on financial position.
Change in accounting policy may not followed consistally.
Window-dressing is accomplished in general ways, e.g. not
making adequate provisions.
Fixed assets are shown at historical cost less depreciation.
However, actual value of fixed assets, like Land might have
appreciated much more.
6.9 ADJUSTMENTS
Before an accountant can proceeds to prepare the Final

Accounts from trial balance, he has to process some additional
information, which is not consider in trial balance.
The following are a few examples showing where adjustment

entries would required :
1 Closing Stock / Inventory :-
Unsold goods in stock at the end of the period. Closing

stock is valued at cost or market value which ever is lower. For
accounting following entry is pass
Closing Stock A/c…………………....Dr XX

To Trading A/c XX
While closing stock appears on credit side of Trading A/c

and it also appears on an assets, in the Balance Sheet.
2 Outstanding Expenses :-
The nominal accounts records the actual expenses paid

during the period, However some expenses are incurred, (due) but
not paid, hence it is not accounted, are also brought into the books
to help in proper matching of revenues and expenses. e.g. Firm
pays wages on 10th of the subsequent mouth. These for at the end
of the year say 31st march ‟10, wages account is debited up to Feb.
10; since March wage not paid. These unpaid / outstanding
expenses must also be included. This is done by passing following
adjustment entry.
Wages A/c……………………………..Dr XX
To outstanding wages A/c XX
The above entries increases wages in Trading A/c and it is

since not paid shown a Liability in the balance sheet.

128
3 Prepaid Expenses :-
Certain expenses paid may relate to more than one

accounting period. It is necessary to ascertain that portion of
expense which the benefit is not yet received by the concern. e.g.
In such premium paid Rs. 6000, for the year ended 31st march
2010. Prepare Final Accounts for the ended 31st Dec 2009. Hence
Jan to March, three month insurance premium benefit to the
subsequent three month. Such expenses paid in a advance are
called „pre-paid expenses‟. Adjustment entry pass as under :
Prepaid Expenses A/c…………..…...Dr XX

To Expenses A/c XX
Prepaid expenses deducted from concern period and shown

in the balance sheet an assets.
4 Depreciation :-
It is the reduction or fall in the value of a Fixed Assets due to

its use. Thus, the depreciation is loss to the business, to account
for following adjustment entry is passed.
Depreciation A/c……………………...Dr XX
To Fixed Assets A/c XX
Depreciation is debited to Profit & Loss A/c and it is

deducted from concerned Fixed Assets in the Balance Sheet.
5 Outstanding / Accrued Income :-
Income earned during the period but not received, Entry-
Outstanding Income A/c……………..Dr XX

To Income A/c XX
It added to Income in Profit & Loss A/c and shown as assets

in the Balance Sheet.
6 Income Received in Advance :-
Income received, however it relate to subsequent year;

Entry-
Income A/c…………………………....Dr XX
To Income Received in Advance A/c XX
Advance income deducted from income on credit side of

Profit & Loss A/c and shown it on Liability side of Balance Sheet.

129
7 Bad debts :-
When goods are sold on credit the amount is recoverable
from customer. However amount receivable is not possible to
recover, then such debts is to be written off, as Loss to business;
Entry-
Bad debts A/c………………………...Dr XX
To Customer A/c XX
It is debited to Profit & Loss A/c as bad debts and deducted

from sundry Debtors in the balance sheet.
These are money adjustment, however, only few basis

adjustment discuss above:
8 Hidden Adjustment in Trial Balance :-

These adjustments not directly however from Trial Balance,
these are apparent, and hence must be consider.
Trial Balance On Trading, Profit &

Balance Sheet
31-03-2010 Loss A/c
1. Rent paid (Including Deduct Rs.400/- Show Rs.400/- as
Rs.400/- for April) from Rent Paid A/c Rent Prepaid on
Assets side
2. Rent paid (upto Feb.) Add Rs.200/- to Rent Show Rs.200/- as
Rs.2,200/- Paid A/c O/S Rent on
Liability side
3. Rent Received (upto Add Rs.300/- to Rent Show Rs.300/- as
Feb.) Received A/c Rent Due on Assets
side
4. Rent Received (incl. Deduct Rs.500/- Show Rs.500/- as
Rs.500/- for April) from Rent Received Advance Rent on
A/c Liability side
5. Leasehold Land : Write off Rs.10,000/- Deduct Rs.10,000/-
Rs.1,00,000/- (for 10 on Dr. side form Leasehold
years from 01-04- Land on Assets
2010) side
6. (a) Loan from Add Rs.500/- to Show Rs.500/- as
ABC Interest Paid A/c Interest Due on
Rs.20,000/- Liabilities side
(b) Interest to 10%
p.a. Rs.1,500/-
7. (a) Machinery Show Profit Deduct Rs.7,500/-
(W.D.V.) : Rs.1,500/- on Cr. from Machinery A/c
Rs.7,500/- side in Balance Sheet
(b) Machinery sold
for Rs.9,000/-

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CHECK YOUR PROGRESS

Give the effects of the following adjustments:
1. Salary Rs. 4000 is Outstanding.
2. Prepaid rent Rs.1000.
3. Wages included Rs.4000 which is used for installation of
Machinery.
4. Interest on Investment Rs.3000 received in advance.
6.10 ILLUSTRATIONS
Illustration 1:
From the following Trial Balance of Shri - Atul Sheth prepare
Trading and Profit and Loss A/c for the year ended 31st March,
2010 and a Balance Sheet on that date.
Trial Balance as on 31st March, 2010
Particulars Dr. Rs. Cr. Rs.

Machinery 90,000
Building 50,000
Stock (01-04-09) 10,200
Purchases 80,800
Wages & Salaries 17,000
Carriage Outwards 3,000
General expenses 9,100
Rent 1,700
Bad Debts 650
Income Tax 600
Legal Charges 800
Atul Sheth‟s Drawing 18,000
Cash In hand 24,000
Cash at bank 18,000
Atul Sheth‟s Capital 1,20,200
Bills Payable 23,000
Returns Outwards 1,800
Interest 3,300
Sales 2,07,550
3,73,850 3,73,850

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Adjustments :-
The following adjustments should be taken into

consideration :-
1) Stock on 31st March,2010 was Rs.70,000/- valued at cost and

market price Rs.82,000/-.
2) Depreciate Machinery at 10% and Building @ 5%.
3) Rent Outstanding Rs.800/-.
Solution :-
Shri Atul Sheth’s
Trading and Profit & Loss Account for the year ended as on
31st March 2010
Dr. Cr.
To Opening Stock 10,200 By Sales 2,07,550
To Purchases 80,800 By Closing Stock 70,000
(-) P. Return 1,800 79,000
To Wage and Salaries 17,000
To Gross Profit c/d 1,71,350
2,77,550 2,77,550
To Carriage Outward 3,000 By Gross Profit b/d 1,71,350
To General Expenses 9,100 By Interest 3,300
To Rent 1,700
(+) Outstanding 800 2,500
To Bad Debts 650
To Legal Charges 800
To Depreciation
On Machinery 9,000
On Building 2,500
To Net Profit c/d 1,47,100
1,74,650 1,74,650

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Shri Atul Sheth’s

Balance sheet as on 31/03/2010
Liabilities Rs. Rs. Assets Rs. Rs.
Capital balance 1,20,200 Machinery 90,000

(+) Net Profit 1,47,100 (-) Depreciation (9,000) 81,000
(-) Drawings (18,000) Building 50,000
(-) Income Tax (600) 2,48,700 (-) Depreciation (2,500) 47,500
Sundry Creditors 18,000 Sundry Debtors 50,000
Bills Payable 23,000 Cash in hand 24,000
O/s Rent 800 Cash at Bank 18,000
Closing Stock 70,000
2,90,500 2,90,500
Illustration 2:
From the following Trial balance extracted from the books of
Shri Sunit as on 31st December 2009. Prepare his final accounts
as on 31st December 2009 after taking into consideration following
adjustments.
Trial balance as on Dec. 31, 2009

Rent 5,000
Cash at Bank 42,000
Cash in hand 28,000
Stock as on 1 Jan. 2009 18,000
Bad debts 900
Discounts 1,800 1,200
Purchase and Sales 65,000 1,08,000
Carriage on Sales 3,500
Plant and Machinery 48,000
Sales Return 1,200
Purchase Return 1,800
Carriage on Purchases 7,500
Furniture and Fixtures 80,000
Insurance 8,000
Salaries 9,000
Bills Receivable 18,000
Drawings 22,000

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Wages 6,000
Capital 3,50,000
Commission 4,200
4,89,000 4,89,000
Adjustments –
1) Depreciate Plant and Machinery 10%.
2) Insurance prepaid Rs.1,500/-.
3) Outstanding Salaries Rs.1,200/-.
4) Closing Stock Rs.81,000/-.
Solution :
Shri Sunit’s Final Accounts

Trading and Profit and Loss Account for the year ended as on
31st December 2009
Dr. Cr.
Particulars Rs. Rs. Particulars Rs. Rs.
To Purchases 65,000 (-) Sales Return (1,200) 1,06,800
(-) Purchase Return (1,800) 63,200 By Closing Stock 81,000
To Carriage on
Purchases 7,500
To Wages 6,000
To Gross Profit c/d 93,100
1,87,800 1,87,800
To Rent 5,000 By Gross Profit b/d 93,100
To Insurance 8,000 By Discount 1,200
(-) Prepaid (1,500) 6,500
To Bad Debts 900
To Discount 1,800
To Salaries 9,000
(+) Outstanding (1,200) 10,200
To Carriage on Sales 3,500
To Commission 4,200
To Depreciation on
Plant & Mach. 4,800
To Net Profit 57,400
[transferred to
Capital]
94,300 94,300

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Shri Sunit’s
Balance Sheet as on 31st December 2009

Capital balance 3,50,000 Plant & Mach. 48,000
(+) Net Profit 57,400 (-) Depreciation (4,800) 43,200
(-) Drawings (22,000) 3,85,400 Cash at Bank 42,000
Sundry Creditors 28,000 Cash in hand 28,000
O/s Salaries 1,200 Furniture &
Fixtures 80,000
Prepaid
Insurance 1,500
4,14,600 4,14,600
Illustration 3:
From the following Trial Balance and additional information
prepare Profit and Loss Account for the year ended 31/03/2008 and
Balance Sheet as on that date of Shri Ankur.
Trial Balance as on 31/03/2008

Capital 3,16,300
Salaries 9,000
Commission 800
Furniture 90,000
Creditors 81,000
Dividend 4,000
Machinery 1,56,000
Bad debts 2,250
Advertisement 1,000
Investments 38,000
Opening Stock (01/04/07) 32,000
Insurance 11,000
Drawings 17,000
Cash in hand 35,000
Cash at Bank 51,000

135
Interest 900
Purchases 1,34,500
Sales Returns 1,800
Wages 6,500
Purchase Return 2,300
Sales 2,10,000
Carriage Inward 2,100
Octroi 1,500
7,09,450 7,09,450
Adjustments –
1) Closing Stock Rs.33,000/-.
2) Wages Outstanding Rs.2,000/-.
3) Insurance prepaid Rs.2,500/-.
4) Depreciate Machinery at the rate of 10% and Furniture 15%.
Solution :
Shri Ankur’s Final Account

Trading Account for the year ended 31st March 2008
Dr. Cr.

To Purchases 1,34,500 (-) Sales Return (1,800) 2,08,200
(-) Purchase Return (2,300) 1,32,200 By Closing Stock 33,000
To Wages 6,500
(+) Outstanding 2,000 8,500
To Carriage Inward 2,100
To Octroi 1,500
2,41,200 2,41,200

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Profit and Loss Account for the year ended 31st March 2008
Dr. Cr.
To Insurance 11,000 By Gross Profit 64,900

(-) Prepaid 2,500 8,500 By Dividend 4,000
To Salaries 9,000 By Interest 900
To Commission 800
To Bad Debts 2,250
To Advertisement 1,000
To Depreciation
On Machinery 15,600
On Furniture 4,500
[carried to Capital]
69,800 69,800
Balance sheet as on 31st March, 2008
Capital balance 3,16,300 Machinery 1,56,000

n
(+) Net Profit 28,150 (-) Dep 10% (15,600) 1,40,400
(-) Drawings (17,000) 3,27,450 Sundry Debtors 88,000
O/s Wages 2,000 Bills Receivable 32,000
Creditors 81,000 Closing Stock 33,000
Bills Payable 18,000 Prepaid Insurance 2,500
Bank Overdraft 76,950 Furniture 90,000
n
(-) Dep 5% (4,500) 85,500
Investments 38,000
Cash in hand 35,000
Cash at Bank 51,000
5,05,400 5,05,400

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Illustration 4:
Following is the trial balance of Amir Khan as on 31st March, 2010.

Capital Account 80,000
Drawing Account 6,000
Stock (01/04/2009) 45,000
Purchases 2,60,000
Sales 3,10,000
Furniture 10,000
Freight and Octroi 4,600
Trade Expenses 500
Salaries 5,500
Rent 2,400
Advertisement Expenses 5,000
Insurance Premium 400
Commission 1,300
Discount 200
Bad debts 1,600
Creditors 20,900
Cash in hand 5,200
Bank 5,800
Goodwill (at cost) 20,000
4,12,200 4,12,200
Adjustments –
a) Stock on 31st March, 2010 was valued at Rs.53,000/-.
b) Salaries have been paid only for 11 months.
c) Unexpired insurance included in the figure of Rs.400/-
appearing in trial balance is Rs.100/-.
d) Commission earned but not yet received amounting to Rs.422/-
is to be recorded in books of account.
e) Furniture is depreciated @ 10% per annum.
f) Only 1/4th of advertising expenses are to be written off.
Prepare Trading and Profit and Loss Account for the year ended
31st March, 2010 and balance sheet as on that date.

138
Solution :
Trading and Profit and Loss Account for the year ended 31st
March, 2010
Dr. Cr.
To Stock (01.04.09) 45,000 By Sales 3,10,000

To Purchases 2,60,000 By Stock (31.03.10) 53,000
To Freight &
Octroi 4,600
To Gross Profit
transferred to
P&L Account 53,400
3,63,000 3,63,000
To Trade Exp. 500 By Gross Profit 53,400

To Salaries 5,500 transferred from
(+) O/s Salaries 500 6,000 Trading Account
To Rent 2,400 By Commission 1,300
To Advertising Exp. 5,000 (+) Commission
(-) Amount c/f (3/4) (3,750) 1,250 earned but
To Insurance not received 422 1,722
Premium 400
(-) Unexpired Ins. (100) 300
To Discount
200
To Bad Debts
1,600
To Depreciation
1,000
To Net Profit
transferred to
Capital Account 41,872
55,122 55,122

139
Amir Khan
Balance sheet as on 31st March, 2006
Capital : Fixed Assets :

Opening Balance 80,000 Goodwill (at cost) 20,000
(+) Net Profit 41,872 Furniture 10,000
1,21,872 (-) Depreciation (1,000) 9,000
(-) Drawings (6,000) 1,15,872 Current Assets :
O/s Salary 500 Unexpired Insurance 100
Creditors 20,900 Unexpired Advt.
Expenses 3,750
Commission earned
but not received 422
Stock 53,000
Cash at Bank 5,800
Cash in hand 5,200
1,37,272 1,37,272
6.11 EXERCISES

1) Explain what is Final Account?
2) Distinguish between Trial balance and Balance sheet
3) Write short notes on
a) Adjustment
b) Outstanding Expenses
c) Gross Profit
d) Prepaid Expenses
e) Fixed Assets
f) Floating Assets
4) What are the limitations of Balance Sheet.

140
6.11.2 Practical Problems
Q.1 Below is the trial balance of Suresh as at 31st March, 2010
Debit balance Rs. Credit balance Rs.

Suresh‟s Current A/c 1,500 Capital Account 50,000
Purchases 7,60,450 Loan from Mohan @ 9% 20,000
st
Salaries 4,200 (taken on 1 October, 09)
Carriage on Purchases 400 Sales 7,20,000
Carriage on Sale 500 Discount 500
Lighting 300 Sundry Debtors 20,000
Rates and Insurance 400
Buildings 27,000
Furniture 6,000
Cash in hand 250
Cash at bank 1,500
8,10,500 8,10,500
Rates have been prepaid to the extent of Rs.175/-, Bad debts

totaling Rs.500/- have to be written off. Buildings have to be
depreciated at 2% and Furniture @ 10%.
You are required to prepare the Profit and Loss Account for the
year ended 31st March, 2010 and the balance sheet as on that
date.
Q.2 From the following prepare Trading Account Profit and Loss
Account and Balance Sheet.
Trial Balance as 31st March, 2011
Debit Credit
Sr. No. Name of the Account L.F.
(Rs.) (Rs.)
1 Sundry Debtors 15,000 -
2 Buildings 40,000 -
3 Goodwill 30,000 -
4 Bills Payable - 45,000
5 Sundry Creditors - 25,000
6 Plant & Machinery 1,60,000 -
8 Sales - 1,40,000

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9 Bank Overdraft - 1,25,000

10 Bills Receivable 40,000 -
11 Purchases 1,25,000 -
12 Sales Returns 1,000 -
13 Wages 45,000 -
14 Purchase Returns - 1,500
15 Carriage Inwards 600 -
16 Carriage Outwards 300 -
17 Office Salaries 12,000 -
18 Office Rent 500 -
19 Commission 600 -
20 Postage & Telegram 100 -
21 Depreciation 500 -
22 Printing & Stationery 45 -
23 Bad Debts 200 -
24 Prepaid Insurance 150 -
25 Cash in hand 6,000 -
26 Cash at Bank 9,000 -
27 Income Receivable 400 -
28 Capital Account - 1,90,000
29 Drawings 5,105 -
5,26,500 5,26,500
Closing stock valued at Rs.1,10,000/-.
Q.3 Prepare Trading and Profit and Loss Account from the
following trial balance and adjustments for the year ending 31 st
December, 2008. Prepare Balance sheet as at that date.
Trial balance as on 31st December, 2008
Debit Credit
Name of the Account L.F.
(Rs.) (Rs.)
Capital Account - 2,00,000
Drawings Account 86,000 -
Stock (01/01/2008) 75,000 -
Bills Receivable 15,000 -
Sales - 1,62,350
Purchases 50,000 -
Returns 2,000 3,000
Salaries & Wages 12,000 -

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Creditors - 15,000
Insurance 3,500 -
Carriage Inwards 1,500 -
Carriage Outwards 850 -
Debtors 68,000 -
Commission 3,000 2,000
Interest 4,500 3,000
Discount 3,500 3,000
Bills Payable - 12,000
Printing & Stationery 2,500 -
Trade Expenses 1,500 -
Furniture & Fixtures 11,000 -
Cash in hand 46,000 -
Cash at bank 12,000 -
Rent & taxes 2,500 -
4,00,350 4,00,350
Adjustments –
1) Closing Stock was valued at Rs.1,05,000/-.
2) Furniture valued at Rs.10,000/-.
3) Outstanding Expenses : Salaries at 1,200/-, Rent & Taxes
Rs.600/- and prepaid insurance Rs.650/-.
Q.4 Following is the trial balance of M/s. Anjali. You are required
to prepare Trading Account, Profit and Loss Account and
Balance Sheet for the year ended 31st December, 2010, after
considering the adjustment given below.
Debit Credit
Sr. No. Name of the Account
(Rs.) (Rs.)
1 Stock on 01-01-2010 60,000 -
2 Purchases & Sales 80,000 1,00,000
3 Returns 1,500 2,500
4 Drawings 2,400 -
5 Wages – productive 3,000 -
6 Wages – unproductive 2,000 -
7 Salaries 4,000 -
8 Rent, rates & insurance 1,500 -
9 Bad debts 1,000 -
10 Discount 600 1,000
11 Machinery 20,000 -

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12 Buildings 60,000 -
13 Sundry Debtors & Creditors 16,000 18,000
14 Cash 12,000 -
15 Capital - 1,17,200
16 Bank Overdraft - 40,000
17 Furniture 7,500 -
18 Carriage Inward 1,250 -
19 Carriage Outward 1,450 -
20 Interest 4,000 16,000
21 Commission 750 11,000
22 Goodwill 25,000 -
23 Gas & Fuel 1,750 -
3,05,700 1,05,700
Adjustments –
1) On 31st December, 2010 the cost price of closing stock was
Rs.51,000/- and its market price was Rs.52,000/-.
2) Goods worth Rs.6,000/- taken over by the proprietor for the his
personal use, were not entered in the books of accounts.
Q.5 From the following Trial balance, you are required to prepare
Trading and Profit and Loss Account for the year ended 31 st
December, 2010 and the Balance Sheet as on that date, after
taking into consideration the additional information.
Trial balance (31-12-2010)
Debit Credit
Sr. No. Name of the Account L.F.
(Rs.) (Rs.)
1 Drawings 23,800 -
2 Capital - 1,95,000
4 Creditors - 1,75,000
5 Purchases 60,000 -
6 Sales - 1,55,000
7 Royalties 6,000 -
8 Trade Expenses 8,000 -
9 Returns Outwards - 1,000
10 Advertisement 1,500 -
11 Bills Payable - 2,000
12 Wages and Salaries 4,800 -
13 Reserve Fund - 6,000

144
14 Cash in hand 8,500 -

15 Debtors 68,000 -
16 Bad debts 4,400 -
17 Investments 1,30,000 -
18 Bills Receivable 12,000 -
19 Discount 2,500 2,500
20 Motor Van 15,000 -
21 Furniture 8,000 -
22 Office Rent 3,000 -
23 Plant & Machinery 25,000 -
24 Freehold Property 1,30,000 -
5,36,500 5,36,500
Q.6 The following figures were taken from the books of Ashok on
31st March, 2010.

Cash at bank 26,400 Royalties received 400
Cash in hand 30 Trade and General
Sales 2,61,230 Expenses 5,020
Stock (1st April, 2009) 27,410 Reserve on Patents 5,000
Sales Returns 3,300 Interest on Loan 1,240
Discount (Dr.) 6,380 Repairs 840
Bills Receivable 1,820 Sundry Debtors 20,780
Sundry Debtors 52,720 Buildings 95,820
Depreciation 4,780 Patent rights 50,000
Purchases 1,84,030 Loan (raised on 45,000
Discount on Purchases 3,900 mortgage of buildings)
Wages 14,040 Agent‟s Commission 6,500
Provision for bad debts 5,400 Bad Debts 1,900
Provision for discounts Plant and Machinery 30,000
on Debtors 1,970 Capital 2,00,000
Drawings 30,000
Advertising 1,000
Carriage 450
In addition, the following information is given.

a) Stock on 31st March, 2010 was Rs.82,500/-.
Prepare Trading and Profit and Loss Account of Ashok for

the year ended 31st March, 2010 and his balance sheet as on that
date.

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7
PARTNERSHIP FINAL ACCOUNTS
Unit Structure:
7.0 Objectives
7.1 Introduction
7.2 Definition
7.3 Characteristics of Partnership
7.4 Types of Partners
7.5 Partnership Deed
7.6 Provisions of Partnership Act 1932
7.7 Methods of maintaining Capital Account
7.8 Partnership Final Accounts
7.9 Adjustments
7.10 Recent addition (L.L.P.)
7.11 Illustrations
7.12 Exercises
7.0 OBJECTIVES
After studying the Unit the students will be able to:

Define partnership and explain the characteristics of
Partnership.
Explain the types of Partners.
Understand the methods of maintaining Capital accounts
Make the adjustment entries and prepare the Final accounts
of a partnership firm.
7.1 INTRODUCTION
In small business, sole trader can manage business. He can

himself provide the capital and supervise the work. However, there
are numbers of limitations : To over come limitations, businessmen
may convert his business into Partnership. Each partner contribute

146
capital and in return each partner get a share in the profits of the
firm.
7.2 DEFINITION :
As per Indian Partnership Act 1932, “Partnership is the

relation between persons who have agreed to share the Profit /
Loss of a business carried on by all or any of them acting for all.”
7.3 CHARACTERISTICS OF PARTNERSHIP
a) It is a voluntary association of persons.

b) The relations among them are contractual.
c) Each partner is Principal as well as Agent.
d) All the partners can take active part in business.
e) Profit / Loss are shared by the partners as per Partnership
Deed.
f) Minimum two and maximum 10 partners are allowed for banking
business, however maximum 20 partners are all for the general
business.
g) The liability of the partners is unlimited.
7.4 TYPES OF PARTNERS
i) Active Partner : taking active part in firm business

ii) Sleeping / Dormant : Not taking active part in business,
Partner provides capital.
iii) Nominal Partner : Only he lends his name in firm.
iv) Partners by holding : He represents himself as partner,
out / by Estoppel even though he is not a partner.
v) Minor Partner : He is less than 18 year old, shares in
only Profit of business.
vi) Limited Partner : His liabilities is limited to the extent,
the capital contributed by him.
7.5 PARTNERSHIP DEED
It is much agreement, in writing between the partners of the

firm. The terms of contracts are written in Deed. It is prepared on
stamp paper and signed by all partners. Copy partnership deed are
submitted to the Bank, Income Tax Departments, Sales Tax
Departments etc. Deed indicates the rights, duties and liabilities of
the partner. Partnership Deed contents various term, conditions,

147
Profit / Loss sharing, Interest on Capital and drawings, method of

valuation of Goodwill etc.
7.6 PROVISION OF PARTNERSHIP ACT 1932
Normally all terms and condition are stated in Partnership

Deed. In case of deed is silent on certain matters, provision of
Partnership Act, 1932 are applicable;
1. Profit and Losses shares by all partners equally.
2. No interest on capital and drawings.
3. No salary commission etc. payable to partner.
4. Interest @ 6% p.a. can be paid on Loan from partner.
5. Every partner can take active part in the Partnership business
and can inspect the books of accounts.
6. Partner cannot start any parallel business in competition.
7.7 METHODS OF MAINTAINING CAPITAL

ACCOUNT
There are two methods of maintaining Partner‟s Capital

Accounts.
a) Fixed Capital Method
b) Fluctuating Capital Method
7.7.1 Fixed Capital Method :
Under this method, capital contributed by partners remain

fixed forever. Capital balances are not changed. Partners Current
Account are open for recording transactions like interest on capital,
drawing in cash or kind, share in Profit or Loss etc. Therefore
Partners Current Account may have debit balance or credit
balance. Debit balances of Current Account are shown on assets
side of the Balance Sheet and vice versa.
7.7.2 Fluctuating Capital Method :
Under this method Capital Account of partner always

fluctuates. It do not remains fixed as internal transactions of
partner with firm are recorded in Capital Account only. Due to
recording of internal transactions, capital balance fluctuates /
changes.
7.8 PARTNERSHIP FINAL ACCOUNTS

Partnership Final Accounts consist of :

148
i) Trading Account
ii) Profit & Loss Account
iii) Profit and Loss Appropriation A/c
iv) Balance Sheet of Firm
7.8.1 Trading, Profit & Loss Account

Partnership Trading, Profit and Loss A/c are prepared on
same line as Sole Proprietor. As these are discuss earlier, so not
explain again.
7.8.2 Profit & Loss Appropriation Account

Net Profit or Net Loss from business is ascertain in Profit &
Loss Account. This Net Profit / Net Loss transferred to Profit &
Loss Appropriation A/c. Internal amount payable to partners like
partner Salaries, Commission, Interest on Partners Capital, Interest
on drawings etc. are charges against Net Profit. Balance Net Profit
/ Net Loss is transferred to Partners Current Account / Capital
Account as the case may be, specimen of Profit & Loss
Appropriation is as under –
Profit & Loss Appropriation Account

for the year ended ______
Dr. Cr.
To Partner‟s Salaries By Net Profit XX
A/c XX (transferred from
To Partner‟s Profit and Loss A/c)
Commission A/c XX By Interest on
To Interest on Partners Drawings A/c XX
Capital A/c XX
To Interest on Partner‟s
Loan A/c XX
To Transferred to
Reserves A/c XX
To Net Profit
transferred to
partners Capital A/c XX
(in their Profit
sharing ratio)
A XX XX
B XX

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XX XX
7.8.3 Balance Sheet of Partnership Firm :
Balance Sheet of Partnership Firm is also like a Balance

Sheet of Sole Proprietor only differ is that instead of sole proprietor
capital alone, there will be each partners capital balances, may
have Partners Current Account balances, Specimen of Balance
Sheet as under.
Balance Sheet as on ________

Partner‟s Capital A/c Cash on hand XX
R XX Bank balance XX
K XX Sundry Debtors XX
G XX XX Bills Receivable XX
Partners Current A/c Prepaid Expenses XX
R XX Income receivable XX
G XX XX Investments XX
Sundry Creditors XX Office Equipments XX
Bank Loan XX Plant & Machinery XX
Outstanding Expenses XX Patents XX
Income received in Land & Building XX
advance XX Goodwill XX
Provident Fund XX Partners Current A/c
Reserve Fund XX K XX XX
XX XX
Balance Sheets Liabilities side total must be equal to total

Assets.
7.9 ADJUSTMENTS
In addition to normal adjusts discuss in Final Accounts of

Sold Trader, there may few more adjustment in respects of firm as
under.
7.9.1 Interest on Capital :
Calculate interest on Capital @ rate given,

Profit & Loss Appropriation A/c …………………… Dr. XX

150
To Interest on Partners Capital A/c XX

(Being interest on partners‟ capital provided.)
Interest on Capital A/c ……………………………. Dr. XX

To Partner Capital A/c XX
(Being interest on Capital transferred.)
7.9.2 Interest on Partners drawings :
Interest may be charged on drawings made by Partner to

make distribution of Profit more equitable. Since drawing are made
through the year it is calculated as under –
If amount are withdrawn equally every month.

a) Middle of each month = Int. for 6 months
b) On 1st Day of month = Int. for 6½ month
c) On Last Day of month = Int. for 5½ month
Entry :
a) Interest on drawing A/c …………………… Dr. XX

To Profit & Loss Appropriation A/c XX
b) Partners Capital A/c ………………………. Dr. XX

To Interest on drawings A/c XX
7.9.3 Salaries to Partners :
Profit & Loss Appropriation A/c ……………… Dr. XX

To Partner‟s Capital A/c XX
Remaining balance in Profit & Loss Appropriation Account

indicates distributable Profit / Loss which should be transferred to
Partner‟s Capital Account.
In case of Profit
Profit & Loss Appropriation A/c ……………….. Dr. XX

To A‟s Capital A/c XX
To B‟s Capital A/c XX
(Being Net Profit transferred to partners in their Profit / Loss sharing
ratio.)
Note : 1) If Partners Capital are fixed, then instead of Capital

Account, all above i.e. Interest, Salary, Net Profit etc. are
transferred to Partner‟s Current Account.

151
2) Profit adjustment due to Guarantee etc. are not specially

covered in syllabus & hence not considered.
7.10 LIMITED LIABILITY PARTNERSHIP ACT (L.L.P.)
The Act called Limited Liability Partnership Act (L.L.P.)

extended scope and working of Partnership. A present partnership
firm can also be converted into L.L.P. It has number of advantages
over Partnership Firm or Private Ltd. Company. Number of
partners limits not applicable to L.L.P. Here are number of
advantages over Partnership Firm mainly liabilities of partners
rusticated to capital contribution by partners. L.L.P. enjoys more or
less advantages like in private limited company.
7.11 ILLUSTRATIONS
Illustrations 1: From the following trial balance of Neela and

Sheela. You are required to prepare Trading and Profit & Loss
Account for the year ended 31st March 2007 and Balance sheet as
on that date after considering the following adjustments.
Trial Balance as on 31st March 2007
Particulars Rs. Rs.

Opening Stock 17,500 -
Salaries and Wages 4,600 -
Purchase and Sales 1,12,600 2,65,000
Office Expenses 4,300 -
Productive Wages 7,000 -
Legal Expenses 3,300 -
Bad debts 1,900 -
Works Managers Salary 5,600 -
Investments 42,000 -
Debtors 67,500 -
Creditors - 92,000
Bank overdraft - 88,000
Patents 38,000 -
Loose Tools 28,000 -
Furniture 65,000 -
Goodwill 80,000 -
Interest - 1,600
Land & Building 1,25,000 -
Capital Accounts :
Neela - 1,10,000
Sheela - 1,05,000
Drawings :

152
Neela 20,000 -
Sheela 30,000 -
6,64,100 6,64,100
Adjustments :
1) Partners shares Profit and losses equally.
2) The Closing Stock cost Rs.25,000/- market value Rs.19,000/-.
3) Neela has withdrawn goods worth Rs.800/- for personal use.
4) Depreciate Land and Building at 10% p.a. and Loose Tools 15%
p.a.
Trading Account for the year ended 31st March 2007

To Purchases 1,12,600 By Goods withdrawn
To Productive Wages 7,000 by Neela 800
To Works Manager‟s 5,600 By Closing Stock 19,000
Salary
To Gross Profit 1,42,100
2,84,800 2,84,800
Profit & Loss Account for the year ended 31st March 2007
To Salaries & Wages 4,600 By Gross Profit 1,42,100

To Office Expenses 4,300 By Commission 2,500
To Legal Expenses 3,300 By Interest 1,600
To Bad Debts 1,900
To Commission 1,800
To Depreciation
Loose Tools 4,200
Land & Building 12,500
To Net Profit
Neela 56,800
Sheela 56,800 113600
1,46,200 1,46,200

153
Balance Sheet as on 31st March 2007

Capital Accounts Cash in hand 6,000
Neela : balance 1,10,000 Bills Receivable 4,000
(+) Net Profit 56,800 Investments 42,000
(–) Drawings 20,000 Sundry Debtors 67,500
(–) Goods taken 800 1,46,000 Stock 19,000
Patents 38,000
Sheela : balance 1,05,000 Loose Tools 28,000
n
(+) Net Profit 56,800 (–) Dep 15% 4,200 23,800
(–) Drawings 30,000 1,31,800 Furniture 65,000
Goodwill 80,000
Bank Overdraft 88,000 Land & Building 1,25,000
n
Sundry Creditors 92,000 (–) Dep 10% 12,500 1,12,500
4,57,800 4,57,800
Illustration 2 : From the following Trial balance of Ram and

Shyam. You are required to prepare Trading and Profit & Loss
Account for the year ending 31st Dec. 2006 and balance sheet as
on that date after consideration the adjustments given below.
Dr. Cr.
Stock (01.04.05) 35,000 Sales 3,30,000
Salary and Wages 9,200 Discount 4,800
Cash 10,000 Creditors 20,000
Purchases 2,25,200 Bank Overdraft 10,000
Sundry Expenses 8,600 Interest on Investments 7,200
Productive Wages 14,000 Capital Accounts
Bills Receivable 8,000 Ram 60,000
Law charges 3,000 Shyam 40,000
Bad Debts 1,000
Works Expenses 6,000
Commission 3,000
Investments 20,000
Debtors 40,000
Trade Marks 8,000
Tools and Equipments 6,000
Furniture 12,000

154
Goodwill 13,000
Building 50,000
4,72,000 4,72,000
Adjustments :
1) Partners shares Profit and Losses in the equal ratio.
2) Closing Stock cost price Rs.40,000/- market value Rs.45,000/-.
3) Uninsured goods worth Rs.10,000/- were lost by fire.
4) Unpaid Salary and Wages Rs.2,100/-.
Trading Account for the year ended 31st December 2006

To Purchases 2,25,200 By Uninsured Goods
To Productive Wages 14,000 lost by fire 10,000
To Works Expenses 6,000 By Closing Stock 40,000
3,80,000 3,80,000
Profit & Loss Account for the year ended 31st December 2006
To Sundry Expenses 8,600 By Gross Profit 99,800

To Law Charges 3,000 By Discount 4,800
To Bad Debts 1,000 By Interest on
To Commission 3,000 Investment 7,200
To Salaries 9,200
(+) Outstanding 2,100 11,300
To Uninsured Goods
lost by fire 10,000
To Net Profit
Ram 37,450
Shyam 37,450 74,900

155
1,11,800 1,11,800
Balance Sheet as on 31st December 2006

Capital Accounts Cash 10,000
Ram : balance 60,000 Bills Receivable 8,000
(+) Net Profit 37,450 97,450 Investments 20,000
Debtors 40,000
Shyam : balance 40,000 Trade marks 8,000
(+) Net Profit 37,450 77,450 Tools and
Equipments 6,000
Creditors 20,000 Closing Stock 40,000
Bank Overdraft 10,000 Furniture 12,000
Outstanding Goodwill 13,000
Salaries & Wage 2,100 Building 50,000
2,07,000 2,07,000
Illustration 3 : (Goods withdrawn, Loss by Fire)

From the following Trial Balance of Jagan and Magan, you are
required to prepare a Trading and Profit and Loss Account for the
year ended 31st March 2010 and the Balance Sheet as on that
date, after taking into the consideration the additional information :
Trial Balance as on 31st March 2010

(Rs.) (Rs.)
Opening Stock 17,500 -
Salaries and Wages 4,600 -
Purchases and Sales 1,12,600 1,65,000
Office Expenses 4,300 -
Productive Wages 7,000 -
Legal Expenses 1,500 -
Bad Debts 500 -
Works Manager‟s Salary 3,000 -
Investments 10,000 -
Debtors and Creditors 20,000 10,000
Bank Overdraft - 5,000

156
Patents 4,000 -
Loose Tools 3,000 -
Furniture 6,000 -
Goodwill 6,500 -
Interest on Investment - 3,600
Land and Building 25,000 -
Capital Accounts :
Jagan - 30,000
Magan - 20,000
2,36,000 2,36,000
Adjustments :
1. Partners share Profits and Losses in their capital ratio.
2. The Closing Stock – Cost Rs.20,000/- Market Value Rs.22,500/-
3. Jagan has withdrawn goods worth Rs.600/- for his personal use.
4. Uninsured goods worth Rs.5,000/- were destroyed by fire.
5. Rs.225/- written off as bad debts from Debtors.
6. Outstanding Salaries and Wages Rs.400/-.
7. Depreciation on Land and Building at 7½ %.
Solution :
M/s. Jagan and Magan
Trading, Profit & Loss Account for the year ended 31-03-2005
Dr. Cr.
To Purchases 1,12,600 By Goods withdrawn (Jagan) 600
To Productive Wages 7,000 By Goods Lost by Fire 5,000
To Work Manager‟s Salary 3,000 By Closing Stock 20,000
1,90,600 1,90,600
To Salaries & Wages 4,600 By Gross Profit c/d 50,500
(+) Outstanding 400 5,000 By Commission 2,400
To Office Expense 4,300 By Interest on Investment 3,600
To Legal Expense 1,500
To Bad Debts 500
(+) Additional B.D. 225 725
To Commission 1,500
To Loss by Fire 5,000
To Depreciation on
Land & Building 1,875
To Net Profit trd Capital A/c

157
Jagan (3/5) 21,960

Magan (2/5) 14,640 36,600
56,500 56,500
Balance Sheet as on 31-3-2005

Jagan‟s Capital Goodwill 6,500
Balance b/d 30,000 Land & Building 25,000
(+) Net Profit 21,960 (-) Depreciation 1,875 23,125
51,960 Furniture 6,000
(-) Drawings 600 51,360 Loose Tools 3,000
Magan‟s Capital Patents 4,000
Balance b/d 20,000 Investments 10,000
(+) Net Profit 14,640 34,640 Bills Receivable 4,000
Creditors 10,000 Debtors 20,000
Bank Overdraft 5,000 (-) Bad debts 225 19,775
Outstanding Closing Stock 20,000
Salaries & Wages 400 Cash in Hand 5,000
1,01,400 1,01,400
Illustration 4 : A & B are partners and the trial balance and the
necessary adjustments of there are given below :
Trial balance as on 31st March, 2010

Purchase 2,59,000 Capital :
Sales Returns 4,250 A 1,27,000
Debtors 50,200 B 1,35,000
Opening Stock 21,000 Sales 3,05,000
Salaries 13,600 Purchase Returns 3,230
Wages 20,100 Creditors 21,070
Furniture Balance as on Dividend on Investment 10,825
1-4-2009 16,750
(+) Purchases 31.3.2010 1,700
Machines 16,229
Bad debts 315
Advertisements 46,000
(for 5 years w.e.f.
1/10/2009)
Investments 1,20,500
Current Account :
A 3,000

158
B 1,500
Cash and Bank balance 27,981
6,02,125 6,02,125
Adjustments :
1. Closing Stock Rs.75,000/-.
2. Depreciation on machines at 5% and on furniture at 10% p.a.
3. Salaries to A Rs.2,000/- p.m.
4. Interest on Capital at 5%.
After considering the adjustments, prepare the trading and

Profit & Loss Accounts for the year ended 31st March 2010 and
Balance Sheets as on that date.
Solution :
In the books of M/s. An Co. & Co.
Trading, Profit and Loss Account for the year ended
31st March 2010
Dr. Cr.

To Purchases 2,59,000 (-) Returns (4,250) 3,00,750
(-) Returns (3,230) 2,55,770 By Closing Stock 75,000
To Wages 20,100
3,75,750 3,75,750
To Salaries 13,600 By Gross Profit b/d 78,880
To Depreciation on By Dividend on
Machinery 811 Investment 10,825
Furniture 1,675 2,486
To Bad Debts 315
To Advertisements 46,000
(-) Prepaid (41,400) 4,600
46,000 6
×
5 12
To Net Profit c/d 68,704
89,705 89,705

159
Profit & Loss Appropriation Account for the year ended

31.03.2010
Dr. Cr.
To Int. on Capital By Net Profit b/d 68,704
A 6,350
B 6,750 13,100
To A‟s Salaries 24,000
(2,000 12)
To Net Profit c/d to
Current A/c
A 15,802
B 15,802 31,604
68,704 68,704
Partner’s Current Account

Dr. Cr.
Particulars A B Particulars A B
To Bal b/d 3,000 1,500 By Int. on Capital
(Opening) A/c 6,350 6,750
To Bal c/d 43,152 21,052 By Salaries 24,000 -
By Net Profit 15,802 15,802
46,152 22,552 46,152 22,552
Balance Sheet as on 31st March 2010

Partners Capital Machinery 16,229
n
A 1,27,000 (-) Dep @ 5% (811) 15,418
B 1,35,000 2,62,000 Furniture (op. bal) 16,750
Partners Current (+) Purchased on 1,700
A/c 31.03.10
A 43,152
n
(-) Dep @ 10% p.a. (1,675) 16,775
B 21,052 64,204 (10,750 10%)
Investments 1,20,500
Stock in Trade 75,000
Cash & Bank bal. 27,981
Prepaid Advt. 41,400

160
3,47,274 3,47,274
7.12 EXERCISES
7.12.1 Theory Questions :
a) What is Partnership Deed?

b) What are provisions of Partnership Act relating Accounts of
Partnership?
c) State different methods of maintaining Capital Account.
d) What are provisions of Indian Partnership Act 1932 in respect of
interest on Capital, Drawings and Loan‟s from Partner?
e) What are different types of Partners?
7.12.2 Practical Questions
Q.1 R and K are partners in a firm sharing Profits and Losses in

the ratio 3:2. Their trial balance on 31/03/2010 was as follows:
Particulars Debit Particulars Credit

(Rs.) (Rs.)
Opening Stock 26,700 R‟s Capital 36,000
Purchases 60,000 K‟s Capital 24,000
Plant & Machinery 21,000 Sales 1,50,000
Furniture 1,400 Creditors 4,400
Carriage 1,500 Unpaid Wages 900
Wages and Salaries 45,000 Return Outwards 1,500
Taxes and Rent 1,950
Debtors 24,000
Return Inwards 3,750
Bank 13,500
Commission 1,500
Bad Debts 600
Cash in hand 150
R‟s Drawing 1,800
K‟s Drawing 1,200

161
2,16,800 2,16,800
Prepare Trading and Profit & Loss Account for the year ending
31/03/2010 and the Balance Sheet as on that date after making the
following adjustments.
1) Closing Stock was valued at Rs.27,900/-.
2) Depreciation Plant & Machinery by 10% p.a.
Q.2 Usha, Uma and Urmila were partners sharing profits & losses
in the ratio 2:2:1 respectively. The trial balance of their firm on
31st March, 2010 was follows :
Trial balance

(Rs.) (Rs.)
Opening Stock 8,000 Capital Accounts :
Purchases 50,000 Usha 20,000
Wages 7,000 Uma 20,000
Carriage Inwards 2,000 Urmila 10,000
Electricity & Insurance 1,900 Current Accounts :
Return Inwards 4,000 Usha 4,000
Salaries 9,700 Uma 2,550
Bad debts 4,100 Urmila 500
Bills Receivable 7,800 Sales 90,000
Debtors 10,200 Rent received 4,400
Building 30,000 Creditors 30,000
Traveling Expenses 4,900 Sundry income 350
Cash at Bank 5,900
Prepaid Insurance 100
Vehicle 10,000
Audit Fees 700
Machinery 25,500
1,18,800 1,81,800
Prepare Trading and Profit & Loss Account for the year ended 31st
March, 2010 and the Balance Sheet as on that date after making
the following adjustments :
1) Goods worth Rs.6,000/- were destroyed by fire and
Insurance Company admitted the claim for Rs.5,300/-.
2) Outstanding Expenses were Wages of Rs.1,500/- and
Electricity Rs.400/-.
3) Closing Stock was valued at Rs.42,500/-.

162
4) Provide Salary to Partner Usha Rs.1,000/- p.a. and Interest

on Capital @ 12% p.a.
Q.3 From the following trial balance prepare the Trading and Profit
& Loss Account for the year ending 31st March, 2010 and a
balance sheet as on that date, after taking into considerations
the following adjustments.

(Rs.) (Rs.)
Opening Stock 20,000 Bills Payable 10,000

Sundry Debtors 28,000 Returns Outwards 2,500
Purchases 40,000 Sundry Creditors 21,500
Wages 8,500 Sales 70,000
Salaries 2,700 10% Loan (taken on 3,000
1st Oct. 2009)
Office Expenses 2,445
Commission
Insurance 1,300 1,400
Discount Received
Plant & Machinery 30,000 500
Rent Received
Rent 1,800 700
Capital of Partners :
A
Return Inwards 3,500 40,000
B
Land & Building 44,800 50,000
Bank Balance 6,655
Furniture 2,400
Sundry Expenses 1,400
Advertisement 700
1,99,600 1,99,600
Adjustments :
1) Stock as on 31.03.2010 was valued at Rs.25,000/-.
2) Outstanding Salaries Rs.6,000/- not provided.
3) Prepaid Insurance Rs.250/-.
4) Provide Interest on Capital @ 10% p.a.

163
Q.4 From the following Trial Balance of Jayshree trader, Jalgaon,

prepare Trading and Profit and Loss Account for the year
ending 31/3/2010 and Balance Sheet on that date :
Trial Balance

(Rs.) (Rs.)
Opening Stock 10,000 Bank Overdraft 35,000

Purchases 60,000 Creditors 22,000
Wages 7,000 Reserve for doubtful
Carriages 2,500 debts 700
Salaries and Wages 4,900 Sales 1,20,000
Printing 2,700 Capital Account :
Advertisement 1,000 Hemant 32,000
Bad debts 2,900 Shantanu 16,000
Discount 2,500 Current Account :
Debtors 16,000 Hemant 3,000
Bills Receivable 13,200 Shantanu 2,000
Building 30,000
Machinery 42,000
Cash in hand 5,200
Motor Car 20,000
Drawings :
Hemant 4,800
Shantanu 6,000
2,30,700 2,30,700
Adjustments :
1) Depreciate Building by 5% and Machinery by 10%.
2) Otstanding expenses were : Printing Rs.200/-, Wages
Rs.1,200/-.
3) Goods of Rs.1,000/- purchased on 31st March, 2010 were
included in Closing Stock but were not recorded in
Purchases Book.

164
4) Cost price of Closing Stock was Rs.20,500/- while its

market price was Rs.25,000/-.
Q.5 The trial balance of M/s. Shrikant Traders as on 31st March,
2010 is given below.

(Rs.) (Rs.)
Drawings 750 Sales 75,500
Land and Building 20,000 Purchase Returns 1,000
Plant & Machinery 6,000 Sundry Creditors 12,600
Cash at Bank 550 Discount earned 50
Purchases 47,500 Outstanding Salaries 100
Sales Returns 1,500
Carriage Inward 350 Capital Account :
Opening Stock 11,000 A 15,000
Wages 6,000 B 20,000
Sundry Debtors 17,600 Current Account :
Salaries 2,500 A 1,000
Postage & Telegram 200 B 750
Rent & Insurance 400
Bad debts 250
Discount 100
Trade Expenses 300
Furniture 5,000
Commission 500
Prepaid Insurance 300
Printing & Stationery 700
Cash in hand 2,000
Patents 2,500
1,26,000 1,26,000
Adjustments :
1) Stock as on 31st March, 2010 was valued at Rs.25,000/-.
2) Outstanding wages Rs.600/- and outstanding rent Rs.700/-
3) Provide 10% depreciation on Plant & Machinery and 5%
depreciation of Furniture.
4) 5% interest allowed on capital.

165
Prepare a Trading Account and Profit and Loss Account for

the year ended 31st March, 2010 and the Balance Sheet as on
that date.
Q.6 From the following Trial Balance of M/s Chavan and

Deshpande, you are required to prepare Trading and Profit
and Loss Account for the year ended 31st March, 2010 and the
Balance Sheet as on that date after taking into account the
necessary adjustment.
Trial Balance

(Rs.) (Rs.)
Chavan‟s Capital - 1,80,000
Deshpande‟s Capital - 1,50,000
Chavan‟s Drawings 14,450 -
Deshpande‟s Drawings 10,000 -
Stock on 01/04/2009 2,00,000 -
Purchases 2,75,000 -
Sales - 4,00,000
Bills Payable - 60,000
Returns Inward 5,000 -
Returns Outward - 4,500
Plant and Machinery 1,00,000 -
Loose Tools 25,000 -
Patents 25,000 -
Sundry Debtors 1,25,000 -
Sundry Creditors - 1,40,000
Cash at Bank 77,550 -
Wages 19,000 -
Salaries 17,500 -
Rates & Taxes 7,500 -
Insurance 3,000 -
Printing and Stationery 2,000 -
Power and Fuel 3,500 -
9,34,500 9,34,500
Adjustments :
1) Stock as on 31st March 2010 valued at Rs.2,42,000/-.
2) Depreciate Plant & Machinery by 10% p.a.

166


8
COST ACCOUNTING
Unit Structure:
8.0 Objectives
8.1 Introduction
8.2 Limitations of Financial Accounting
8.3 Meaning of Cost, Costing and Cost Accounting
8.4 Cost Centre and Cost Units
8.5 Objectives of Cost Accounting
8.6 Classification of Cost
8.7 Elements of Cost
8.8 Methods Of Costing
8.9 Key Points
8.10 Additional Readings
8.11 Exercise
8.0 OBJECTIVES
After studying this chapter, you should be able to

understand:
Need for Cost Accounting
Meaning of Cost, Costing and Cost Accounting
Objectives of Cost Accounting
Classification of Cost
Elements of Cash
Methods of Costing
8.1 INTRODUCTION
Cost Accounting is the system of accounting which is

concerned with determination of costs of doing something which
can be manufacturing or rendering service or even conducting any

167
activity or function. The objective of Cost Accounting is to render

detailed and useful information for guidance to Management.
Financial accounting is developed over the time to record,

summarise and present the financial transaction or events which
can be expressed in terms of money. This function was primarily
concerned with record keeping, leading to preparation of Profit and
Loss Account and Balance Sheet. The information obtained
through financial statements is useful to the Management or Owner
in several respects. However, the information provided by financial
accounting is not sufficient for several purposes of decision making
in many areas such as : determining output level, determining
product selection – addition or dropping or changing product
combination in the case of multi product company, determining or
revising prices of products, whether Profit earned is optimum as
compared with competitors and in comparison to earlier years.
The need of data for such details lead to the development of

Cost Accountancy.
8.2 LIMITATIONS OF FINANCIAL ACCOUNTING
Financial accounting does not help in day to day

management of the organisation. Cost Accounting has emerged
mainly because of certain limitations of financial accounting, which
are summarized as follows –
1) Financial accounting provides information about the business as

a whole. But it does not reveal Profit or loss of each department
or product or process.
2) Material and supplies can not be controlled effectively. There is
no proper system of control of material which may in losses in
the form of deterioration, scrap, misappropriation etc.
3) It does not provide cost information for fixation of prices of
products and services.
4) It does not classify the expenses into direct and indirect, fixed
and variable and controllable and non-controllable.
5) There is no system of recording loss of labour, i.e. idle time and
labour cost is not recorded by jobs, processes etc.
6) Financial accounting is a historical record. It does not help in
controlling the cost.
7) It does not facilitate cost reduction which is very important and
necessary for cost control.
8) It fails to supply useful information to management for taking
various decisions like replacement of labour by machine,

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introduction of new product, make or buy, selection of most

profitable product mix etc.
Therefore, Cost Accounting has developed as a separate

branch of accounting. Both cost and financial accounting are
concerned with systematic recording and presentation of financial
data. Financial accounting reveals Profit / Loss of business as a
whole for a certain period. But Cost Accounting reveals Profit /
Loss of different product lines. It helps to decide profitability of
each process or each product.
8.3 MEANING OF COST, COSTING and COST

ACCOUNTING
8.3.1 Cost :
Institute of Cost and Works Accountants of India, defines

cost as “measurement, in monetary terms, of the amount of
resources used for the purpose of production of goods or rendering
services”.
Thus the term cost means the amount of expenditure, actual

or notional incurred or attributable to a given thing. It can be
regarded as the price paid for attaining the objective. For e.g.
Material cost is the price of materials acquired for manufacturing a
product.
8.3.2 Costing :
The term costing has been defined as “the techniques and

processes of ascertainment of costs. Whelden, has defined costing
as, “the classifying recording and appropriate allocation of
expenditure for the determination of costs the relation of these
costs to sale value and the ascertainment of profitability.”
Therefore costing involves the following steps.
1) Ascertaining and Collecting of Costs

2) Analysis or Classification of Costs
3) Allocating total costs to a particular thing i.e. product, a contract
or a process.
Thus costing simply means cost finding by any process or

technique.
8.3.3 Cost Accounting :

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Cost Accounting is a formal system of accounting by means

of which cost of products or service, are ascertained and controlled.
“Whelden” defines Cost Accounting as “Classifying,

recording and appropriate allocation of expenditure for
determination of costs of products or services and for the
presentation of suitably arranged data for the purpose of control
and guidance of management.”
Therefore, Cost Accounting is the application of costing

principles, methods and techniques in the ascertainment of costs
and analysis of savings or / and excesses as compared with
previous experience or with standards. It provides, detailed cost
information to various levels of management for efficient
performance of their functions. The information supplied by Cost
Accounting as a tool of management for making optimum use of
scarce resources and ultimately add to the profitability of business.
Cost Accounting = Costing (+) Application of Cost

control methods and ascertainment of profitability (+)
Presentation of relevant information for managerial
decision making.
8.4 COST CENTRE AND COST UNITS
8.4.1 Cost Centre :
It is a location, person or item of equipment for which cost

may be ascertained and used for the purpose of cost control. It is a
convenient unit of the organisation for which cost may be
ascertained. The main purpose of ascertainment of cost is to
control the cost and fill up the responsibility of the person who is
incharge of the cost centre.
Types of cost centers :
I. Personal Cost Centre :
It consists of a person or group of persons.

e.g. machine operator, salesmen, etc.
II. Impersonal Cost Centre :
It consists of a location or an item of equipment or group of

these. E.g. Factory, Machine etc.
III. Operational Cost Centre :

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This consists of machines or persons carrying on similar

operations.
IV. Process Cost Centre :
This consists of a continuous sequence of operation or specific

operations.
V. Production Cost Centre :
This is the centre where actual production takes place or these

include, those departments that are directly engaged in
manufacturing activity and contribute to the content and form of
finished product.
e.g. Cutting, Assembly and Finishing Departments etc.
VI. Service Cost Centre :
This is the Centre which renders services to production centres.

These contribute to the production process in an indirect
manner.
e.g. Stores department, Repairs and Maintainance department,

H.R. Department, Purchase Department etc.
8.4.2 Cost unit :
It is a unit of product, service or time in terms of which cost

are ascertained or expressed. It is basically, a unit of quantity of
product or service in relation to which costs may be ascertained or
expressed.
Few examples of cost unit are given below.
Name of Industry Cost unit

Textiles Meter, yards
Transport Passenger km
Power Kilowatt – hour
Paints Litre
Iron and Steel Tonne
Canteen Per meal
Chemical Litre, kilogram

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Readymade Garments Number

Petrol Litre
8.5 OBJECTIVES OF COST ACCOUNTING
Objectives of Cost Accounting are as follows :
1) Ascertain Cost : To ascertain the cost of product or a services

reveled and enable measurement of profit by proper valuation of
inventory.
2) Analyse Costs : To analysis costs or to classify the expenses
under different heads of accounts viz. material, labour,
expenses etc.
3) Allocate and Apportion the Costs : To allocate or charge the
direct expenses or specific costs such as Raw Material, Labour
to particular product, contract or process and to distribute
common expenses to each product, contract or process on a
suitable basis.
4) Cost Reporting : Cost Reporting or presentation includes :
a) What to report i.e. what is the nature of information to be
presented?
b) Whom to Report i.e. to whom the report is to be addressed.
c) When to Report i.e. when the report is to be presented i.e.
Daily weekly monthly yearly etc.
d) How to Report i.e. in what format the report is to be
presented.
5) Assist the Management : Cost Accounting assist the
management in the following ways
a) Indicate to the management any inefficiencies and extent of
various forms of waste of Raw Material, Time, Expenses etc.
b) Help the management in fixing of selling price.
c) Provide information to enable management to take decision
of various types.
6) Cost Control : Cost Accounting assist the management in cost
control. Cost control includes the following stages.
a) Setting up of targets of cast and production for each period.
b) Measuring the actual figures of performance relating to cost,
production etc. for the period concerned.

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c) The figures of actual performance are to be compared with

the targets to find out the variation.
d) Analysing the variance, whether favourable or adverse.
e) Immediate action has to be taken in case of adverse
variation.
7) Controlling Inventory : Assist the management in controlling
Inventory of Raw Material, goods in process, finished goods,
spares and consumables etc.
8) Optimum Product Mix : Advise the management in deciding
optimum product mix merits and demerits of alterative courses
of action viz. make of buy decisions, introduction or Automation
mechanization, rationalization, system of production etc.
9) Future Policies : Advise management on future policies
regarding Expansion, growth, capital investment, etc.
8.6 CLASSIFICATION OF COST
Classification is the process of grouping costs according to

their common characteristics. It is a systematic placement of like
items together according to their common features. There are
various ways of classifying costs, according to their common
features as given below.
Chart showing classification of cost :
Classification of Cost
On the basis of On the basis of On the basis

Identification Controlliability of Time
Direct Indirect Controllable Uncontrollable Historical Predetermined

Cost Cost Cost Cost Cost Cost
On the basis of On the basis of

behaviour of cost function
Fixed Variable Semi-Variable

Cost Cost Cost
Manufacturing Administration Selling and Research and

Cost Cost Distribution Development
Cost Cost
Other Basis
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I On the basis of Identification :

On the basis of identification of cost with cost units or jobs or
processes, costs are classified into –
1) Direct Costs
2) Indirect Costs
1) Direct Costs : These are the costs which are incurred for and
conveniently identified with a particular cost unit process or
department. These are the expenditures which can be directly
allocated to a particular job, product or an activity. Eg. Cost of
Raw Material used, wages paid to labourers etc.
2) Indirect Costs : These are general costs and are incurred for
the benefit of a number of cost units, processes or departments.
These costs can not be conveniently identified with a particular
cost unit or cost centre.
Example : Depreciation of Machinery, Insurance, Lighting,
Power, Rent of Building, Managerial Salaries, etc.
II On the basis of behaviour of Cost

Behaviour means change in cost due to change in output.
Costs behave differently when the level of production rises or falls.
Certain costs change in direct proportion with production level while
other costs remain unchanged. As such on the basis of behaviour
of cost – costs are classified into
1) Fixed Costs.
2) Variable Costs.
3) Semi Variable Costs.
1) Fixed Costs : It is that portion of the total cost which remain

constant irrespective of output upto the capacity limit. It is the
cost which does not very with the change in the volume of
activity in the short run. These costs are not affected by
temporary fluctuation in the activity of an enterprise. These are
also known as period costs as it is concerned with period. Rent
of premises, tax and insurance, staff salaries, are the examples
of fixed cost.
Characteristics of Fixed Cost are :

1) Large in value

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2) Fixed amount within an output range

3) Fixed cost per unit decreases with increased output
4) Indirect Cost
5) Lesser degree of controllability
6) Influence Variable Cost and Working Capital
Y
Cost (Rs.)
Total Fixed Cost
Fixed C
ost per Un
it
O X
Output (Units)
Behaviour of Fixed Cost
2) Variable Cost: It is that cost which directly very with the volume
of activity. In other words, it is a cost which changes according
to the changes in the volume of output. It tends to very in direct
proportion to output. It means when the volume of output
increases, total variable cost also increases when the volume of
output decreases, total variable cost also decreases. But the
variable cost per unit remains same. Direct material, Direct
Labour, Direct Expenses are the examples of variable costs.
Characteristics of Variable Cost are :
1) Total cost changes in direct proportion to the change in total
output.
2) Cost per unit remains content.
3) It is quite divisible.
4) It is identifiable with the individual cost unit.
5) Such costs are controlled by functional manager.

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st
Co
e
bl
ia
ar
lV
Cost (Rs.)
ta
To
Variable Cost per Unit
O Output (in Units) Y

Behaviour of Variable Cost
3) Semi-Variable Cost : This is also referred as semi-fixed costs.
These costs include both a fixed and a variable component. i.e.
These are partly fixed and partly variable. They remain
constant upto a certain level and registers change afterwards.
These costs vary in some degree with volume but not in direct
or same proportion. Such costs are fixed only in relation to
specified constant condition.
For example : Repairs and maintainance of machinery,

telephone charges, maintainance of building, supervision,
professional tax, compensation for accidents, light and power
etc.
Semi Variable Cost

Cost (Rs.)
Output (in Units)

Behaviour of Semi-Variable Cost
III. On the basis of Controllability
On the basis of controllability, costs are classified into two

types :
1) Controllable Cost

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2) Uncontrollable Cost
1) Controllable Cost : These are the costs which can not be

influenced or controlled by the concerned cost centre or
responsibility centre. These costs may be directly regulated at a
given level of management authority.
2) Uncontrollable Cost : These are the costs, which can not be

influenced or controlled by the action of a specific member of an
enterprise. For eg. it is very difficult to control costs like factory
rent, managerial salaries etc.
The important points to be noted regarding this classification.

First, controllable cost can not be distinguished from non-
controllable costs, without specifying the level and scope of
management authority. It means cost which is uncontrollable at
one level of management may be controllable at another level of
management. Eg. Rent and Factory Building may be beyond
control for the production department but can be controlled by
the administrative department by negotiations. Secondly all
costs are controllable in the long run and at the some
appropriate management level.
IV On the basis of Functions
An organisation performs many functions. On the basis of

functions costs can be classified as follows :
1) Manufacturing Costs : It is the cost of all items involved in the

manufacturing of a product or service. It includes all direct costs
and all indirect costs related to the production. It includes cost
of direct materials, direct labour, direct expenses, and overhead
expenses related to production. Overhead expenses, means all
indirect costs involved in the production process. This is termed
as factory overhead or manufacturing overheads. Eg. Salaries
of staff for production department, technical supervision,
Expenses of stores department, Depreciation of Plant and
Machinery, Repairs and maintainance of Factory Building and
Machineries etc.
2) Administration Cost : These are costs incurred for general

management of an organisation. It is the cost which is incurred
for formulating the policy, directing the organisation of
controlling the operations. These are in the nature of indirect
costs and are also termed as administrative overhead. Eg.
Salaries of Administrative Stall, General Office expenses like
rent, lighting, telephone, stationery, postage etc.

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3) Selling and Distribution Costs : Selling costs are the indirect

costs relating to selling of products or services. They include all
indirect cost in sales management for the organisation. Selling
costs include all expenses relating to regular sales and sales
promotion activities. Examples of expenses which are included
in selling costs are :
1) Salaries, Commission and traveling expenses for sales
personnel
2) Advertisement cost
3) Legal Expenses for debt realization
4) Market research cost
5) Show room expenses
6) Discount allowed
7) Sample and free gifts
8) Rent on Sales room
9) After sale services
Distribution costs are the costs incurred in handling a
product from the time it is completed in the works until it reaches
the ultimate consumer. Distribution expenses include all these
expenses which are incurred in connection with making the
goods available to customers. These expenses include the
following.
1) Packing charges
2) Loading charges
3) Carriage on Sales
4) Rent of warehouse
5) Insurance and lighting of warehouse
6) Transportation costs
7) Salaries of godown keeper, driver, packing staff etc.
4) Research and Development Cost : Research and

development costs are incurred to discover new ideas,
processes, products by experiment. It includes the cost of the
process which begins with the implementation of the decision to
produce or improved product.
V On the basis of Time
On the basis of time of computation, costs are classified into

historical costs and predetermined costs.

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1) Historical Costs : These are the costs which are ascertained

after these have been incurred. Historical costs are then
nothing but actual costs. They represent the costs of actual
operational performance. These costs are not available until
after the completion of manufacturing operations.
2) Pre determined Costs : These are the future costs which are
ascertained in advance of production on the basis of a
specification of all the factors affecting cost and cost data.
Predetermined costs are future costs determined in advance on
the basis of standards or estimates. These costs are
extensively used for the purpose of planning and control.
VI Other Basis
1) Normal Cost : Normal cost may be defined as a cost which is
normally incurred on expected lines at a given level of output, in
the condition in which that level of output in normally attained.
This cost is a part of production.
2) Abnormal Cost : Abnormal cost is that cost which is not

normally incurred at a given level of output, in the condition in
which that level of output is normally attained. Such cost is over
and above the normal cost and is not treated as a part of the
cost of production.
3) Avoidable Cost : The cost which can be avoided under the

present conditions is an avoidable cost. These are the costs
which under given conditions of performance efficiency should
not have been incurred. They are logically associated with
some activity and situation and are ascertained by the
difference of actual cost with the happening of the situation and
the normal cost. Eg. when spoilage occurs in manufacturing in
excess of normal limit, the resulting cost of spoilage is avoidable
cost.
4) Unavoidable Cost : The cost which can not be avoidable under

the present condition is an unavoidable cost. They are
inescapable costs which are essentially to be incurred within the
limits or norms provided for. It is the cost that must be incurred
under a programme of business restriction.
CHECK YOUR PROGRESS

Draw the chart showing Classification of Cost.
1. Costing
2. Cost Accounting
3. Impersonal cost center

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4. Service Cost center

5. Direct Cost
6. Uncontrollable cost
7. Predetermined cost
Give Examples:
1. Fixed cost
2. Variable cost
3. Semi variable cost
4. Manufacturing cost
5. Administration cost
6. Selling cost
7. Distribution Cost
8.7 ELEMENTS OF COST
A cost is composed of three elements i.e. material, labour

and expenses. Each of these elements may be direct or indirect.
This is shown as follows :
Direct Costs Indirect Costs

Direct Material Indirect Material
Direct Labour Indirect Labour
Direct Expenses Indirect Expenses
8.7.1 Material Cost
It is the cost of material of any nature used for the purpose of

production of a product or a service. Materials may be Direct
Material or Indirect Material.
Direct material : It is the cost of basic raw material used for

manufacturing a product. Direct materials generally became a
part of the finished product. No finished product can be
manufactured without basic raw material. This cost is easily
identifiable and chargeable to the product. For e.g. Leather in
leather products, Steel in steel furniture, Cotton in textile etc.
Direct material includes the following.
1) All materials specially purchased for production or the process.

2) All components purchased for production or the process.
3) Material transferred from one cost centre to another or one
process to another process.

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4) Primary packaging materials, wrappings, cardboard boxes etc

necessary for production or protection of product.
However, in many cases, though a material forms a part of

the finished product, yet it is not treated as direct material. Eg. nails
used in furniture, thread used in stitching garments etc. This is
because value of such materials is so small that it is quite difficult to
measure it.
Indirect material : It is the cost of material other than direct
material which cannot be charged to the product directly. It can
not be treated as part of the product. These are minor in
importance. It is also known as expenses materials. It is the
material which cannot be allocated to the product but can be
apportioned to the cost units.
Examples : Lubricants, Cotton waste, Grease, Oil, Small tools,

Minor items like thread in dress making, nails in furniture (nuts,
bolts in furniture) etc.
Therefore, indirect materials can not be easily identified with
specific job. They may not vary directly with the output. It is
considered as a part of overheads.
8.7.2 Labour Cost

This is the cost of remuneration in the form of wages,
Salaries, Commissions, Bonuses etc. paid to the workers and
employees of an organisation.
Direct Labour Cost : Direct Labour Cost is the amount of

wages paid to those workers who are engaged on the
manufacturing line. It consists of wages paid to workers
engaged in converting of raw materials into finished products.
The amount of wages can be conveniently identified with a
particular line, product, job or process. These workers directly
handle machines on the production line. Direct wages include
payment made to the following group of workers.
1) Labour engaged on the actual production of the product

2) Labour engaged in aiding the operation viz. supervisor,
foremen, shop Clerks and worker on internal transport.
3) Inspectors, Analysts, needed for such production.
Example : Carpenter in furniture making unit, tailor in readymade

wear unit, Labour in construction work etc.
Indirect Labour Cost : It is the amount of wages paid to those

workers who are not engaged on the manufacturing line. It is of
general character and can not be directly identified with a

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particular cost unit. This indirect labour is not directly engaged

in the production operations but such labour assist or help in
production operations. It can not be easily identified with
specific job, contract of work order. It may not vary directly with
the output. It is treated as part of overheads.
Example : Labour in Human Resource department, Labour in

payroll department, Labour in stores, Labour in Securities
Department, Labour in power house department etc.
8.7.3 Expenses
All costs other than material and labour are termed as

expenses. It is defined as the cost of services provided to an
undertaking and the notional cost of the use of owned assets.
Direct Expenses : It is the amount of expenses which is directly
chargeable to product manufactured or which may be allocated
to product directly. It can be easily identified with the product.
These are the expenses which are specifically incurred in
connection with a particular job or cost unit. They are also
called as chargeable expenses.
Example : Hire of special plant for a particular job, Travelling

expenses in securing a particular contract, Carriage paid for
materials purchased for specific job, Royalty paid in mining or
production etc.
Indirect Expenses : All indirect costs other than indirect

materials and indirect labour costs, are termed as indirect
expenses. It is the amount of expenses which can not be
charged to the product directly. These can not be directly
identified with particular job, process or work order and are
common to cost units‟ or cost centres. Indirect expenses
include factory expenses, administrative overheads, selling and
distribution expenses etc.
8.7.4 Overhead
This is the aggregate of indirect material cost, indirect labour

cost and Indirect expenses.
Thus overhead= Indirect Material + Indirect Labour + Indirect Expenses
8.8 METHODS OF COSTING
Methods of Cost Accounting signify the systems used to

assign cost elements to cost objects. These are the procedures by
which product costs are accumulated. Different methods of cost

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determination are used because business vary in their nature and

the type of products or services they produce. Following are the
different methods of costing.
8.8.1 Job costing and Batch Costing:
Job costing is designed to accumulate cost data for a

manufacturing firm which produces goods to specific order. It is
also known as specific orders costing or production order costing.
According to “ICMA”, London, it is that category of basic costing
method which is applicable where the work consists of separate
contract job or batches each of which is authorized by specific
order or contract. It is followed by manufacturing and non-
manufacturing concerns. It is employed in industries in which –
a) A production is done on the basis of customer‟s own

specifications.
b) Products are manufactured in distinguishable lots.
c) Products are not uniform.
d) It is practical to maintain a separate record of each lot from the
time production is begun until it is completed.
Following is the list of concerns which generally employ job costing

method.
a) Printing Work.
b) Design Engineering Concerns.
c) Repair Works.
d) Construction companies.
e) Furniture makers.
f) Hardware industry.
g) Automobile garages.
h) Interior decoration etc.
Batch Costing
It is a form of job costing in which a batches of identical

products is taken as the cost unit. It is used when production
consists of limited repetition work and a definite number of articles
are manufactured in each batch to be held in stock for sale to
customers generally. Thus batch is a cost unit consisting of a
group of identical units.
Batch costing is applied in the manufacture of shoes,

readymade garments, component parts of cars, radios, watches etc
and manufacture of drugs, engineering equipments etc.

183
For eg. in foot wear industry it is not just economical to

manufacture a pair of shoes to meet the requirement of one
customer. But batches say 500 to 5000 shoes of each size, style
colour etc are economically made and held in stock for sale on
demand.
8.8.2 Contract Costing:
It is a method of costing in which each contract is taken as a

separate costing unit for the purpose of cost ascertainment and
control. The objective is find out the Profit or loss on each contract
separately. Contract costing is employed in business undertakings
engaged in building construction, road construction, bridge
construction, dam construction and other civil engineering works,
ship building etc.
Contracts are generally of large size. A contract generally

takes more than one year to complete. Work on contract is carried
out at the site of the contracts and not in factory premises.
Payments by the customer (contractee) are made at various stages
of completion of the contract based on architects certificate for the
completed stage.
8.8.3 Process Costing:

It is a method of costing used to ascertain the cost of the
product at each process operation or stage of manufacture where
processes are carried on. According to ICMA London, “It is that
form of operation costing where standardized goods are produced.”
Process costing is used to ascertain the cost of product at

each stage of manufacture where material is passed through
various operations to obtain a final product. This method of costing
is used by those concern which manufacture articles of uniform
standards. These concerns manufacture articles on a continuous
flow basis.
Each process is treated as a cost centre and separate

account is opened for each process. All costs related to a process
are debited to its process account. The output passing through the
process is also recorded. The output of one process becomes the
input of next process and so on until the finished product is
obtained. This method is suitable for Textile mills, Chemical works,
Oil refining, Cement manufactures, Paper Manufacture, Steel
production, Paint manufacture, Sugar works, Plastic manufactures
etc.
8.8.4 Single (output) or unit costing:

184
It is a method of costing in which cost is ascertained in

convenient units of product turned out by continuous manufacturing
activity. The unit of costing is chosen according to the nature of
product. This method of costing is used in those industries, in which
the production consists of a single product or a few varieties of the
same product with variations in size, shape, quality etc. and
production is uniform and on continuous basis.
Examples of industries in which this method is commonly

used are : Cement, Steel, Sugar, Paper brick works, dairies etc.
Cost of units in these industries are a tonne of cement, or steel, or
sugar, 1000 bricks, a gallon of milk etc.
This method is also known as single costing.

8.8.5 Operating Costing:
It is a method of costing which is used in those industries,

which are engaged in providing services such as transport,
electricity etc. The cost of providing a service is termed as
operating cost. Operating costing is used in those industries,
where services rendered to customers are of unique and
standardized type.
The selection of a suitable cost unit (unit of service) is very

important. The cost unit may be different for different type of
industries. A few examples are given below.
Undertakings Cost Unit

Transport Per passenger km
Hospital Per bed per day
Hotel Per room per day
Electricity Per kilowatt hour
Cinema Per seat per show
8.8.5 Operation Costing:
Under this method each operation is treated as a cost

centre. Costs are accumulated in each operation instead of each
process. This method is used by industries engaged in repetitive
mass production with continuous flow of work. These industries
could be those engaged in the manufacture of leather products,
toys, bicycles, ceiling fans, weighing machines etc.
8.9 KEY POINTS

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Cost : It is the amount of expenditure, actual or notional

incurred on a given thing.
Costing : It is process of ascertaining the cost.
Cost Centre : It is a convenient unit for which cost may be
ascertained.
Cost Unit : It is a unit of product or service for which cost is
ascertained.
Cost Control : It involves comparing actual cost with the target
and taking remedial action.
Objectives of –
Cost Accounting : Ascertain Cost, Analyse Cost, allocate and

apportion Cost, Cost Reporting, Assist the management, Cost
control, Optimum product mix, Future policies.
Elements of Cost : Direct Cost – Direct material, Direct labour,
Direct expenses. Indirect Cost – Indirect material, Indirect
labour, Indirect expenses.
Methods of Costing : Job and Batch Costing, Contract
Costing, Process Costing, Output Costing Operating Costing,
Operation Costing.
8.10 ADDITIONAL READINGS
1) Cost Accounting – Principles and practice by M.N. Arora

2) Cost Accounting – An introduction by Nigam and Jain
3) Cost Accounting – Chopade and Choudhary
8.11 EXERCISE
1) What is meant by Cost Accounting? Explain in brief different

ways of Cost Classification.
2) What is Cost Accounting? What are the elements of Cost
Accounting?
3) What is Cost Accounting? Explain the methods of Costing.
4) What is Cost Accounting and what are the objectives of Cost
Accounting?

186

FINANCIAL MANAGEMENT
Unit Structure:
9.0 Objectives
9.1 Meaning
9.2 Scope of Financial Management
9.3 Role of Financial Management
9.4 Functional areas of Financial Management
9.5 Various Financial Management Tools
9.6 Exercise
9.0 OBJECTIVES

Know the meaning of Financial Management.
Explain the Scope and role of Financial Management.
Elaborate the Functional areas of Financial Management.
Understand the various tools of FM, advantages and
disadvantages of various tools.
9.1 MEANING
Finance may be defined as the art and science of managing

money. The major areas of finance are Financial Services and
Managerial Finance or Financial Management.
Financial Services is concerned with the design and delivery

of advice and financial products to individuals, businesses and
governments within the areas of banking are related institutions,
personal financial planning, investments, real estate, insurance and
so on.

187
Financial Management is concerned with the duties of the

financial managers in the business firm. Financial managers
actively manage the financial affairs of any type of business,
namely, financial and non-financial, private and public, large and
small, profit seeking and not for profit. They perform such varied
tasks as budgeting, financial forecasting, cash management, credit
administration, investment analysis, funds management and so on.
Financial Management as an integral part of overall

management is not a totally independent area. It shows heavily
related disciplines and fields of study, such as economic,
accounting, marketing, production and quantitative methods.
9.2 SCOPE OF FINANCIAL MANAGEMENT
Financial management provides a conceptual and analytical

framework for financial decision making. Financial management is
an integral part of overall management. It covers both financial
function of acquisition of funds and allocation of funds. Thus, apart
from this involves acquiring the external funds and the main
concern of financial management is the efficient and allocation of
funds to various uses.
The financial management consider various financial

problems of a firm. The main contents of this approach are –
What is the total volume of a firm or enterprise?
What should an enterprise acquire specific assets?
How should the funds required be financed?
It also consider How should be enterprise large and how fast

should it grow?
In what form should it hold assets and what is the position of

its liabilities.
The financial management covers the major problems of the

firm. The main solutions to this problem corresponding under the
various decisions taken by the financial managers. Mostly it covers
various fields like investment, financing, dividend policy, capital
budgeting, working capital management and so on.
9.3 ROLE OF FINANCIAL MANAGEMENT
Role of financial management is very important which are

undertaken by finance manager.

188
1. In performing financial analysis and planning : The concern

of financial analysis and planning is –
a. Transforming financial data into a form that can be used to
monitor financial condition.
b. Evaluating the need for increased / reduced productive
capacity and
c. Determining the additional / reduced financing required.
This activity is fully depend on the financial management. It

proves financial management plays on important role in
performing financial analysis and planning.
2. In making investment decisions : Financial management

plays an very important role in making investment decisions like
current assets as well as fixed assets. Financial manager must
determine and maintain certain optimum level of each assets.
He should also decide which of the best fixed asset acquired
and when the existing assets need to be modified or replaced or
liquidated.
3. In making financing decisions : Financial management again

plays an vital role in making financing decision. It means the
finance manager consider which appropriate mix of short term
and long term financing selected and the best individual short
term or long term sources of financing at a given point of time.
These decisions are dedicated as per necessities, but same
require an in-depth analysis of the available financing
alternatives, the financial manager considers their costs and
their long term implications.
9.4 FUNCTIONAL AREAS OF FINANCIAL

MANAGEMENT
Financial management can be broken down into three

different functional areas are as follows –
1. The investment decision
2. The financing decision and
3. The dividend policy decision
1. The Investment Decision : The investment decision relates to

the selection of assets in which the funds will be invested by
firm. The assets can be acquired fall into 2 categories :
i) Long term assets (fixed assets) which yields a return over a
period of time.

189
ii) Short term or current assets defined as those assets which

in the normal course of business are convertible into cash
without diminution in value usually within a year.
The investment decision policy is also known as capital

budgeting management. If the funds are invested in a long term
period for acquiring fixed assets is called as capital budgeting
management and vice-versa. If the funds are invested in a
current assets is popularly for short term period known as
working capital management.
2. Financing Decision : The second major decision involved in

financial management is the financing decision. This is concern
with the financing mix or capital structure or leverage. The term
capital structure refers to the proportion of debt and equity
capital. It means the choice of the proportion of these sources
of finance is the capital requirement. It gives the theoretical
relationship between the employment of debt and the return to
the shareholders.
3. Dividend policy decision : The major third decision area of

financial management is decision relating to the dividend policy.
The dividend decision should be analysed in relation to the
financing decision of a firm. The two alternatives are available,
i.e. i) The available profits can distributed among the
shareholders in the form of dividend or ii) The available profits
can be reinvested into business. The decision as to which
course should be followed depends largely on a significant
element in the dividend decision, the dividend pay our ratio, that
is, what proportion of net profits should be paid out to the
shareholders.
9.5 VARIOUS FINANCIAL MANAGEMENT TOOLS
Following are various financial management tools:

1. Cash flow statement
2. Fund flow statement
3. Ratio analysis
9.5.1 Cash Flow Statement :
Cash flow statement means a statement of showing net

changes in the position of cash and cash equivalents.
As per as 3, this would include cash in hand and savings,

current account balances with banks, demand deposits with banks
and cash equivalents.

190
Cash equivalents are defined as short term and highly liquid

investments that are readily convertible into cash which are subject
to insignificant risk of changes in values.
Uses / advantages of Cash Flow Statement :
1. Efficient Cash Management : The most important function of

management is to manage the cash resources in such a way
that adequate cash is available for meeting the expenses. It
helps to plan and co-ordinate the financial operation of the
business.
2. Internal Financial Management : It provides a clear picture of

cash flow operations. Therefore, it is very useful for internal
financial management.
3. Knowledge of changes in Cash Position : It enables the

management to know about the causes of changes in cash
position. The finance manager can explain the relationship
between profit and cash balance.
4. Success or failure of Cash Planning : Cash flow statement

helps to management in making the comparison between actual
and budgeted cash flow statement to know the success or
failure in cash management. It also helps in taking necessary
remedial measures in cash of any deviations.
5. Projected Cash Flow : It helps to know the projected cash

inflow and cash outflow.
6. Supplemental to Fund Flow Statement : It is supplementary

to Fund flow statement for analysis of cash.
7. Tool of Analysis : It analysis is certainly a better tool of

analysis than the fund flow analysis for short term decisions.
Limitations of Cash Flow Statement :
1. Misleading of Inter – Industry Comparison : Cash flow

statement does not measure the economic efficiency of one
company in relation to another company. Therefore, due to
inter-industry comparison of cash flow may mislead.
2. Misleading Inter – Firm Comparison : The terms and

conditions of purchases and sales of different firms may not be
the same. Hence, inter firm comparison becomes misleading.

191
3. Influence of Management Policies : Management policies

influence the cash easily by making certain payments in
advance or by postponing certain payments.
4. Can not tally with Income Statement : Cash Flow Statement

can not be tally with income statement. Therefore, net cash
flow does not mean income of the business.
5. Not a substitute to other statement : It can not be substitute

to other statements. For eg. Fund Flow Statement and Balance
Sheet.
9.5.2 Fund Flow Statement :
Fund flow statement shows the sources and uses of funds

as well as net change in working capital. It is a financial statement
which shows as to how a business entity has obtained its funds and
how it has applied or employed its funds between the opening and
closing Balance Sheet dates during the particular year or period.
Uses / advantages of Fund Flow Statement :
1. Fund flow statement helps the management in the assessment

of long range forecasts of a cash requirements and availability
of liquid resources. The manager can judge the quality of
management decisions.
2. With the help of Fund Flow Statement, the investors are able to
measure as to how the company has utilized the funds supplied
by them and its financial strength. Also, the investors can judge
the company‟s capacity to generate funds from operations.
3. It serves as effective tools to the Management for economic

analysis as it supplies additional information which can not be
provided by financial statement based on historical data.
4. Fund flow statement explains the relationship between changes

in working capital and net profits.
5. Fund flow statement helps the management in making planning

process of a company. It is also useful in assessing the
resources available and the manner of utilization of the
resources.
6. It explains the financial consequences of business activities. It

also provides explicit and clean answer to questions regarding
liquid and solvency position of the company.

192
7. Fund Flow Statement provides clues to the creditors and

financial institutions as to the ability of a company to use funds
effectively in the best interest of the investors, creditors and
owners of the company.
Limitations of Fund Flow Statements
1. It should not be overlooked that Fund Statements ignore non-
cash transactions, therefore it is considered as cruder device
than the financial statement.
2. Fund Flow Statements merely rearrange a part of the

information contained in financial statements. They do not
serve as original evidence of financial status.
3. Though changes in cash resources are more significant, they

are not highlighted by Fund Statements except being shown by
them as a part of working capital.
4. As Fund Flow Statements are prepared from information

provided by financial statements, they are essentially historical
in nature.
Distinction between Cash Flow Statement & Fund Flow
Statement
Cash Flow Statement Fund Flow Statement

It shows net change in the It shows change in the position
position of cash and cash of „working capital‟.
equivalents
It is based on narrower concept It is based on broader concept
of funds i.e. cash and cash of funds i.e. working capital.
equivalents.
Now, it is mandatory for all the It is not mandatory and it is not
listed companies and is more being used by the companies.
widely used in India or abroad.
Changes in working capital are Statement of changes in
adjusted for ascertaining cash working capital is prepared
generated from operations. under fund flow statement.
In Cash flow statement, In working capital, decrease in
decrease in current liability or current liability or increase in
increase in current assets current asset brings increase in
results in decrease in cash and working capital and vice –
vice – versa. versa.
9.5.3 Ratio Analysis:

193
Financial statement gives us clear idea about the financial

position of the company. It will help the proprietor whether to
continue the business or closed down or to make changes in
working style of the business. Every businessman is interested in
profit margin only. Financial statement gives the clear idea of the
profit margin in amounting term. But with the help of ratio, we get
the clear idea of comparison and with the help of ratio we are able
to express the relationship between different figures.
Ratios express the relationship between two number as well

as accounting figures. It shows the process of computing and
presenting the relationship between items of the financial
statement.
The ratio can be expressed in 3 terms:

1. Simple or pure ratio.
2. Percentage.
3. Rate.
9.6 EXERCISE
1. Explain fund flow and cash flow.

2. Distinguish between Fund flow and Cash flow.
3. Define financial management. Briefly explain the functional
areas of FM.
4. Explain the tools of Financial Management.
5. Elaborate the role of Financial Management in decision
making.

10
RATIO ANALYSIS-I
Unit Structure:

194
10.0 Objectives
10.1 Introduction
10.2 Meaning
10.3 Forms
10.4 Classification
10.5 Balance Sheet Ratio
10.6 Revenue Statement Ratio
10.7 Composite Ratio
10.8 Advantages and Limitations of Ratio Analysis
10.9 Exercise
10.0 OBJECTIVES

Define Ratio.
Understand the classification of ratio.
Know the forms in which the ratios can be expressed.
Explain the advantages and limitations of ratio analyses.
10.1 INTRODUCTION
Financial statement gives us clear idea about the financial

position of the company. It will help the proprietor whether to
continue the business or closed down or to make changes in
working style of the business. Every businessman is interested in
profit margin only. Financial statement gives the clear idea of the
profit margin in amounting term. But with the help of ratio, we get
the clear idea of comparison and with the help of ratio we are able
to express the relationship between different figures.
10.2 MEANING
Ratios express the relationship between two number as well

as accounting figures. It shows the process of computing and
presenting the relationship between items of the financial
statement.
10.3 FORMS:-
The ratio can be expressed in 3 terms:
1. Simple or pure ratio.

195
2. Percentage.
3. Rate.
1. Simple or pure ratio -
It gives a simple relationship between two figures. We take

simple example of current ratio, it means consider the relationship
between current assets and current liabilities, if the current assets
are Rs.4,00,000/- and current liabilities are Rs.2,00,000/-, the ratio
is derived by dividing Rs.4,00,000/- by Rs.2,00,000/-, then the
answer is 2 which will be expressed on 2:1.
2. Percentage -
Some ratio‟s is expressed in terms of percentage. The

relationship between profit and sales is expressed in percentage.
For example- If sales are Rs.10, 00,000/- and gross profit is
Rs.5,00,000/- then it is expressed as gross profit being 50% of
sales.
3. Rate-
Ratios are also expressed in terms of rates. i.e. number of

times or certain period. The relationship between stock is
expressed in terms of rates. For Example- If stock turn over rate is
said to be 6 times in a year, it mean that the stock is converted into
sales 6 times in 12 months.
10.4 CLASSIFICATION
Ratios are classified as follow:

1. Based on financial statement
2. Based on function
3. Based on user
10.4.1 Based on financial statement :
The relationship between two figures which is expressed, it

is taken from financial statement i.e. profit and loss a/c, balance
sheet or both. This can be grouped as follows.
I. Balance sheet ratio -
The relationship between two figures is expressed by taking

figures from balance sheet itself. There is no need to refer income
statement. Actually, the relationship between the assets and
liabilities is current ratio, liquid ratio, proprietary ratio capital gearing
ratio, debt equity ratio, and stock-working capital ratio.

196
II. Income statement ratio -
The relationship between two groups is expressed from

income statement itself. Mostly, it shows the relationship between
profitability and sales of the firm. For Example - gross profit ratio,
operating ratio, net profit ratio, net operating profit ratio and stock
turnover ratio.
III. Combined ratios -
Under these ratio‟s the relationship between two figures is

expressed by taking figures on from Balance Sheet and another
from Income Statement. It shows the relationship between the
profits and investment of the firm. For e.g. Return on Capital
employed, Earning Per Share, Debtors Turnover Ratio, etc.
10.4.2 Based on Functions :
Accounting Ratio‟s can be classified on the basis of their

function or according to their purpose, that is, Liquidity Ratio,
Leverage Ratio, Activity Ratio, Profitability Ratio and Coverage
Ratio or valuation Ratios.
I. Liquidity Ratio -
It analyse the short term and immediate financial position of

the business organization and it also indicates the relationship
between current assets and current liabilities. For e.g. Current
Ratio, Liquid Ratio, Quick Ratio.
II. Leverage Ratio -
It shows the relationship between debts and own funds in

financing the assets of the business. It includes debt equity ratio,
capital gearing ratio and proprietary ratio. It also helps in knowing
the solvency or the company and so it is known as capital structure
ratio or solvency ratio.
III. Activity Ratio -
This ratio shows comparison of sales with different items of

income statement and Balance Sheet. It shows the utilization of
funds and efficiency of business important activity ratios of stock
turnover ratio, debtors turnover ratio etc.
IV. Profitability Ratio -
It makes comparison of profits with sales and assets of the

business profits include gross profit, operating net profit, profit
before tax etc. It reflects overall efficiency of business. It includes
gross profit ratio, net profit ratio, return on capital employed etc.

197
V. Coverage Ratio -
It is the relationship between profits of the company and

amounts payable to outsider. Out of such profits in the form of
dividends, interests, etc. it includes dividend payout ratio, debt ratio
etc.
10.4.3 Based on users :
1. Ratio for shareholders –
Shareholders are interested in the safety of their funds and

capital appreciation. It includes return on proprietors‟ funds and
return on equity capital.
2. Ratio for Short Term Creditors:
Basically, creditors are interested in knowing the firms ability

to meet short term obligation in time. This includes current ratio,
liquid ratio.
3. Ratio for Management :-
The management is interested in the returns on their

investment. For e.g. Return on capital employed, turnover ratio,
operating ratio etc.
4. Ratios for Long Term Creditors :-
They are interested in companies ability to pay interest and

repay the debts when it is actually due. E.g. Debt Equity Ratio,
Proprietary Ratio etc.
Classification of Ratios
Solvency Ratio Leverage Activity Profitability Valuation

or Credit Ratio Ratio Ratio Ratios
1. Proprietary Ratio 1. Earning Per

2. Capital Gearing Share
Ratio 2. Earning Yield
Ratio
3. Dividend Yield
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CHECK YOUR PROGRESS

Draw the chart showing Classification of Ratios.
1. Ratio
2. Balance sheet ratio
3. Liquidity ratio
4. Activity ratio
5. Coverage ratio
10.5 BALANCE SHEET RATIO
For making easy calculation or Ratio draw up Vertical

Statement of Balance Sheet.
10.5.1 Vertical Format or Balance Sheet
Particulars Amt Amt Amt

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I. SOURCES OF FUNDS
1. Equity Share Capital XX
2. Reserves & Surplus XX
Equity Shareholders (1 + 2) Funds XX
3. Preference Share Capital XX
Proprietors Fund (1 + 2 + 3) XX
4. Borrowed Funds XX XX
Total Sources of Funds XXX
II. APPLICATION OF FUNDS

1. Fixed Assets
Goodwill XX
Plant & Machinery XX
Land & Building XX XX
2. Investment XX
3.a) Current Assets
i) Debtor XX
ii) Cash XX
iii) Bills Receivable XX
Quick Assets (I + ii + iii) XX
iv) Closing Stock XX
v) Prepayments XX XX
Total Assets (a) XX
4.b) Current Liabilities
i) Creditors XX
ii) Bills Payable XX
Quick Liabilities XX
iii) Bank Overdraft XX
iv) Other Quick Liabilities XX XX
Total Current Liabilities (b) XX
5. Working Capital (a - b) XX XX
Total Application of Funds / Total Capital XXX

Employed (1 + 2 + 5)
10.5.2 Current Ratio -
This ratio compares the current assets with the current

liabilities. It is expressed in the form of pure ratio. E.g. 2:1.
Current Assets
a. Current Ratio =
Current Liabilities
b. Current assets include assets which are circulated and
liquidated in cash within one accounting period. E.g. Debtors

200
(net), bills receivables, short term investment, inventories, loose

tools etc.
c. Current Liabilities, any liability which is due to be paid within one
accounting period is a current liability. E.g. Creditors, bills
payable, outstanding expenses, proposed dividend, bank
overdraft etc.
d. Significance - It indicates the strength of working capital and
measures short term solvency of the business. It reflects the
ability of business to pay its short term liabilities.
e. Standard - Normally, 2:1 is regarded as standard ratio which
means current assets must be nearly two times of current
liabilities.
f. Limitations - It ignores the components of working capital by
considering liquid assets and deferred assets as same. It also
ignores the quality of working capital by including dead stock in
working capital.
g. Example:
Current Assets or a company on Rs. 4,00,000 and on the
same data, current liabilities are Rs. 2,00,000. Then
Current Assets
Current Ratio
Current Liabilities
4,00,000
2,00,000
2 :1
10.5.3 Quick Ratio / Liquid Ratio / Acid Test Ratio -
Liquid ratio compares the quick assets with the quick

liabilities. It is expressed in the form of a pure ratio and it is also
known as quick ratio and Acid Ratio.
Quick Assets
a. Quick Ratio
Quick Liabilities
b. Quick Assets include all current assets minus stock and prepaid
expenses.
c. Quick Liabilities includes all current liabilities minus advances
received and bank overdraft.
d. Significance - It helps to know the immediate short term
liabilities and abilities of business to pay them.
e. Standard - Normally, 1:1 is the standard quick ratio which
means quick assets must be at least equal to quick liabilities.
f. Limitation- It may not indicate the long term solvency of the
business.

201
g. Example:
From the following information given calculate 1) Quick
Assets 2) Quick Liabilities and 3) Quick Ratio.
Particulars Amt Particulars Amt

Cash 5,000 Outstanding Salaries 1,000
Debtors 10,000 Bank Overdraft 2,000
Creditors 5,000 Stock 3,000
Prepaid Expenses 2,000 Bills Payable 4,000
Solution:-
Quick Assets:-
Cash 5,000
Debtors 10,000
Total 23,000
Quick Liabilities:-
Creditors 5,000
Outstanding Salary 1,000
Bills Payable 4,000
Total 10,000
Quick Assets
Quick Ratio
Quick Liabilities
23,000
10,000
2 : 3 :1
10.5.4 Stock-Working Capital Ratio -
This ratio shows the relationship between the closing stock

and the working capital.
Stock
a. Stock Working Capital Ratio 100
Working Capital
b. Stock means closing stock.

202
c. Working capital is equal to current assets minus current

liabilities.
d. Significance - It shows the quality of working capital and the
quantum of stock in it.
e. Standard - It is practically not possible to have a standard.
f. Example:
If inventory is Rs.80,000/- & Working Capital Rs.1,20,000/-

the stock to Working Capital Ratio would be
Stock
100
Working Capital
80,000
100
1,20,000
Stock working capital ratio 67%
10.5.5 Proprietary Ratio / Net Worth Ratio / Assets Backing

Ratio-
It compares proprietor‟s funds with total liabilities or total

assets. It is expressed in terms of percentage.
Proprietors Funds
a. Proprietory Ratio 100
Total Assets
b. Proprietors funds, includes paid up preference share capital,
paid up Equity Share Capital, Capital Reserve, Revenue
Reserve, Security Reserve , Profit & Loss Account minus
Accumulated losses and fictitious assets.
c. Total Assets includes Fixed Assets, investments and current
assets.
d. Significance - It determines to what extent total assets are
financed by proprietors. It also compares proprietors funds with
total assets and total liabilities. It also indicated as Total Assets
= Total Liabilities, Total Liabilities = Proprietors Funds + Loans +
Current Liabilities.
e. Standard - It should be very high or very low. Normally, it
should be guided as 65%-75% considered. But, it differs from
business to business.
f. Example: Proprietary Ratio -
From the following information calculate proprietary Ratio or S Ltd.
Particulars Amt
Equity share capital 1,50,000

203
Preference share capital 50,000

Reserves 30,000
Proprietors funds 2,30,000
Current Assets 1,00,000
Fixed Assets 2,50,000
Total Assets 3,50,000
Proprietors Fund
Proprietory Ratio 100
Total Assets
23,000
100
35,000
66%
10.5.6 Debt Equity Ratio -
This ratio compares the long term debts with shareholders‟

funds. It is usually expressed as a pure ratio.
Debt
a. Debt Equity Ratio
Equity
OR
Loan Funds
Owned Funds
b. Debt includes borrowed funds as secured / Unsecured loans
including debentures, interest accrues and due on loans.
c. Proprietors funds includes paid up share capital, Reserves and
surplus minus fictitious assets and accumulated losses.
d. Significance - This is a solvency ratio and it also indicated the
proportion of debt and equity in financing the funds of the
concerns. It also shows protection cover for long term creditors.
The low debt equity ratio is considered as favourable to
creditors. It indicates, low ratio means less dependence on long
term debts.
e. Standard - If debts equity ratio is two third then it is considered
as satisfactory ratio. It implies that out of three total funds debts
would be 2 and Equity would be 1.
f. Example: Debt Equity Ratio -
From the following information calculate Debt - Equity Ratio or P

Ltd.
Particulars Amt
5 % Debentures 4,00,000

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7 % Preference share Capital 2,00,000

Equity Capital 3,00,000
Borrowed funds
Debt Equity Ratio
Funds
4,00,000
5,00,000
0.8
10.5.7 Capital Gearing Ratio / Financing Leverage Ratio /

Capital Structure Ratio -
Gearing means the process of increasing the equity

shareholders‟ return through the use of debt. Equity shareholders
earn more when the rate or return on total capital is more than the
rate of interest on debts.
Capital Bearing Fixed Rate
of Interest & Dividend
a. Capital Gearing Ratio
Capital Not Bearing Fixed Rate
of Interest & Dividend.
b. Capital bearing fixed rate of interest and dividend includes

Preference share capital, debentures, loans etc.
c. Capital not bearing fixed rate of interest and dividend includes
equity share capital, reserves and surplus, fictitious assets and
accumulated losses.
d. Significance - It shows balance between debt and equity and it
also shows whether a company is practicing trading on equity.
e. Example: Capital Gearing Ratio-
The following are the relevant extract from Balance sheet or

ABC Ltd as on 31st Dec, 2003. Calculate the capital gearing ratio.
Liabilities Amt
8,000 Equity share or Rs.10/- each Fully Paid 80,000
9% Preference Shares or Rs.100/- cash fully paid 1,50,000
Security (share) Premium 10,000
Capital Reserve 16,000
10% Debentures 50,000

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Capital entitled to fixed Interest / Dividend

Capital Gearing Ratio
Capital not entitled to fixed Interest / Dividend
OR
Preference Capital Debentures

=
Equity Capital Share Premium Capital Re serve
1,50,000 50,000
80,000 10,000 16,000
2,00,000
1,06,000
1.89
10.6 REVENUE STATEMENT RATIO
10.6.1 Format of Revenue statement
Profit & Loss A/c.

Vertical Income / Revenue Statement

Credit Sales XX
Cash Sales XX
Total Sales XX
Opening Stock XX
Credit Purchases XX
Cash Purchases XX
Total Purchases XX
Direct Expenses XX
(-) Closing Stock (XX)
Cost of Good Sold (XX)
Gross Profit XX
Operating Exp
Administrative Exp XX
Selling Expenses XX
Finance Exp (Excl. Interest) XX (XX)
Operating Profit XX
(+) Non Operating Income XX
XX
(-) Non Operating Exp (XX)
Profit Before Interest & Tax XX
(-) Interest on loans (XX)

206
Net Profit Before Tax XX

(-) Income Tax (XX)
Net Profit after Tax XX
(-) Preference Dividend (XX)
Profit available for Equity Shareholders XX
(-) Equity Dividend (XX)
Retained Earnings XX
10.6.2 Gross Profit Ratio -
This ratio compares gross profit with net sales.

Gross Pr ofit
a. Gross Pr ofit Ratio 100
Net Sales
b. Gross Profit = Sales minus Cost of Goods Sold
(Cost of Goods Sold = Opening Stock + Purchases + Direct

Expense - Closing Stock)
c. Net Sales = Sales minus Sales Returns minus Allowances.
d. Significance - It indicates basic profitability of business concern,

it also indicate the efficiency of the purchase department,
production department and the sales department. It shows the
percentage of mark up on the goods sold.
e. Example: Gross Profit Ratio -
Net Sales Rs. 5,00,000

(-) Cost of Goods Sold Rs. 4,20,000
Gross Profit 80,000
Calculate Gross Profit Ratio.
Gross Pr ofit
Gross Pr ofit Ratio 100
Sales
80,000
100
5,00,000
16%
10.6.3 Operating Ratio -

207
It expresses the relationship between total operating costs

and net sales.
Operating Cost
a) Operating Ratio 100
Net Sales
cos t of goods sold Operating Expenses
= 100
Net Sales
b) It expresses the relationship between each item of expenditure
with sales. It brings out the relationship between elements of
operating cost and net sales.
c) Significance - This enables the management in controlling cost
and improving profit ability as well as the auditor and income tax
department to judge the correctness and reliability of various
expenses.
d) Limitations - If expenses of fixed amount the ratio of expenses
to sales may be increased or decreased in value. The ratio of
variable expenses may remain same even though sales are
increased.
e) Example: Operating Ratio -
Calculate operating ratio from the following information.

Sales Rs. 20,00,000
Gross Profit Rs. 7,00,000
Operating Expenses Rs. 5,00,000
Cost of goods sold = Sales less Gross Profit

1,30,000 = 20,00,000 - 7,00,000
Cost of Goods Sold Operating exp enses

Operating Ratio 100
Net Sales
13,00,000 5,00,000
100
20,00,000
90%
Calculate various expenses ratios and operating ratio from the
following information.
i) Cost of goods sold Rs. 40,000

ii) Office & Administrative expenses Rs. 20,000
iii) Selling & distribution Expenses Rs. 15,000
iv) Sales Rs. 1,00,000
cos t of goods sold

i) Cost of goods sold Ratio = 100
Sales

208
40,000
= 100
10,000
= 40%
ii) Office & administrative Expenses Ratio
Office & Administrative Expenses

= 100
Sales
20,000
= 100
1,00,000
= 20%
iii) Selling & distribution Expenses Ratio
Selling & distribution Expenses

= 100
Sales
15,000
= 100
1,00,000
= 15%
Cost of goods sold Operating Exp
iv) Operating Ratio = 100
Net Sales
40,000 20,000 15,000
= 100
1,00,000
= 75%
10.6.4 Net Profit Ratio -
Net profit ratio indicates the relationship between net profit

and the sales. It is usually expressed in the form of a percentage.
a) It is calculated in three ways.
Net Operating Pr ofit
i. Net Operating Pr ofit Ratio 100
Net Sales
Net Pr ofit before tax
ii. Net Pr ofit Ratio 100
Net Sales
Net Pr ofit after tax
iii. Net Pr ofit Ratio 100
Net Sales
b) Net Profit before tax = Operating Net profit + Non operating
income - Non operating expenses.
Net profit after tax = Net profit before tax - income tax

209
c) Net Sales = Gross sales minus Returns minus allowances

d) Significance - It indicates overall profitability of business
organization, it also indicates as to what portion of net profit is
available to the proprietors.
e) Limitations - It cannot be used as a text Net profit Ratio without
considering other revenue statement ratio. It may be also
affected by non operating income of expenses, income from
extra ordinary transaction. In such cases, Net profit ratio may
be showing higher or lower volume even though sales and other
cost may be showing the same tendency as before and hence
net profit Ratio is isolation cannot provide clear idea about the
company‟s profitability.
f) Example: Net Profit Ratio -
Calculate Net Profit Ratio from the following :
Operating Net Profit Rs.1,50,000
Non Operating Income Rs.25,000
Non Operating Expenses Rs.20,000
Net Sales Rs.10,00,000
Net Profit before Tax

Net Profit Ratio 100
Sales
NPBT = Operating Net Profit + Non Operating Income - Non

Operating Expenses
= 1,50,000 + 25,000 - 20,000
= 1,55,000
1,55,000
NP Ratio 100
10,00,000
15.5%
10.6.5 Stock Turnover Ratio / Stock velocity Ratio / inventory

Turnover Ratio -
Stock turnover ratio shows the relationship between the cost

of goods sold and the average stock.
cos t of goods sold
a) Stock turnover Ratio
Average stock
OR
Net Sales
Average stock at selling price

210
b) Cost of goods sold = Opening stock + Purchases + Direct

expenses - closing stock
Opening stock closing Stock
c) Average stock
2
d) Significance - Stock turnover ratio helps in determining the
frequency of inventory replacement. It also helps in determining
the liquidity of business organization.
e) Limitations - It should be studied along with current ratio stock
working capital ratio. Stock being differed from current assets,
current ratio may be satisfactory due to large stock, but it may
suffer bud quick ratio.
f) Example: Stock Turnover Ratio -
If cost of sales is Rs.25,00,000/- and opening stock

Rs.3,00,000/- and closing stock Rs.2,00,000/-. Calculate Stock
Turnover Ratio.
Opening Stock Clo sing Stock

Average Stock
2
3,00,000 2,00,000
2
2,50,000
Cost of Sales
Stock Turnover Ratio
Average Stock
25,00,000
2,50,000
10 times
10.6.6 Operating Profit Ratio -

Operating profit ratio indicates the relationship between
Operating profit and Sales.
Operating Pr ofit
a) Operating Pr ofit Ratio 100
Net Sales
b) Operating profit = Gross profit minus operating expenses,
Operating expenses =
1 Office and administrative expenses
2 Selling a distribution expenses

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3 Finance expenses excluding interest on loans and

Debentures.
c) Net Sales = Sales less Returns less Allowances.
d) Significance - It is a profitability ratio, which shows the
relationship between profits and sales, it also indicates profits
from operations.
e) Example: Operating Profit Ratio -
Calculate operating net profit ratio from the following data.

Gross Profit Rs.4,00,000
Office Expenses Rs.1,50,000
Selling Expenses Rs.1,00,000
Sales Rs.10,00,000
Operating Net Profit = Gross Profit less Selling Expenses less

Office Expenses
1,50,000 = 4,00,000 - 1,00,000 - 1,50,000
Operating Net Pr ofit

Operating Net Pr ofit Ratio 100
Net Sales
1,50,000
100
10,00,000
15%
10.7 COMPOSITE RATIO
10.7.1 Return on capital employed -

This ratio measures the relationship between net profit
(before interest & tax) and the capital employed to earn it. It is
expressed as a percentage.
Net profit before
int erest, Tax,dividend
a) Re turn on capital employed 100
Capital employed
b) Net Profit before interest, tax and dividend
c) Capital Employed = Proprietors fund + Long Term Loans
OR
Fixed Assets + Current Assets - current liabilities.
d) Significance - It gives clear index or utilization of assets earning
capacity. This ratio measures the overall profitability from the
total funds employed. It means, measures the relationship

212
between net profit before interest, tax and capital employed to

earn net profit.
e) Limitations - This ratio is based on earning and capital
employed of the business. These components are subject to
various manipulations by management or based on various
different accounting policies.
f) Example: Return On Capital Employed -
Calculate return on capital employed from the following data.
Net Profit Rs. 2,00,000
Capital Employed Rs. 20,00,000
Net Pr ofit
Re turn on Capital Employed 100
Capital Employed
2,00,000
100
20,00,000
10%
1.7.2 Return on proprietors fund / Return on proprietors

Equity -
It measures the relationship between profits available to
proprietor funds.
Net profit after Tax
a) Re turn on proprietors fund 100
proprietors fund
b) Net profit after Tax
c) Proprietors funds includes paid up Preference share capital,
paid up equity share capital, capital Reserve, Revenue Reserve,
Security Reserve, Profit and Loss A/C surplus minus
Accumulated losses and fictitious Assets.
d) Significance - Higher ratio signifies better utilization of funds. It
also measures the overall performance of a business in regards
utilization of total resources available.
e) Example: Return on Proprietors fund-
The following is the relevant extract from the Profit & Loss
A/c & Balance Sheet of SR Ltd. as on 31. 03. 2004
Profit & Loss A/c, for the year ended 31. 03. 04
Dr. Cr.
Particulars Amt Particulars Amt
To Administrative Exp. 80,000 By Gross Profit b/d 2,00,000

213
To Selling Expenses 30,000

To Provision for Tax 20,000
2,00,000 2,00,000
Balance Sheet as on 31. 03. 2004
Particulars Amt Amt

Share Capital
600, 7% Preference Shares of Rs.100/-
each fully paid 60,000
1,500, Equity Shares of Rs.100/- each
fully paid
1,50,000 2,10,000
Reserves
General Reserve
40,000
Capital Redemption Reserve
30,000
Dividend Equalisation Fund
20,000 90,000
3,00,000
Net Pr ofit
Re turn on Pr oprietors Fund 100
Pr oprietors Fund
70,000
100
3,00,000
23.3%
10.7.3 Return on Equity Share Capital –

It indicates the rate of earning on equity share capital.
Net Profit after Tax – Preference Dividend
a) Return on Equity = 100
Equity Share Capital
Share Capital
b) Net Profit after Tax minus Preference dividend.
c) Equity Share Capital includes paid up equity share capital.
d) Significance - It includes an investor in shares of company
whether continue to hold or dispose off such shares. It also
enables investors to compare earnings of the company with that
another company. Higher ratio signifies better utilization of
shareholders fund and higher return on equity share capital.

214
e) Example: Return on Equity Share Capital -

From the following information calculate Return on Equity
Capital Ratio.
Net Profit after Tax 3,25,000
7% Preference share capital 1,50,000
Paid up Equity share capital 10,00,000
Net Pr ofit less Pr eference dividend

Re turn on Equity Capital 100
Paidup Equity Capital
3,25,000 – (7% of 1,50,000)

100
10,00,000
3,25,000 – 10,500
100
10,00,000
3,14,500
100
10,00,000
31.45%
10.7.4 Earning Per Share -
It shows earning per equity share, whether or not company
declares dividend.
Net Pr ofit after Tax – Pr eference Dividend
a) Earning per share
Number of Equity Shares
b) Net profit after Tax minus Preference dividend.
c) Number of equity shares outstanding.
d) Significance - Higher ratio signifies better utilization of funds
available and the company may pay dividend at a higher rate in
future. Higher ratio indicates higher overall profitability and
effective utilization of equity capital.
e) Example: Earning Per Share-
Net Profit after Tax Rs.2,25,000
8% Preference Share Capital Rs.2,00,000
Paid up Equity Share Capital Rs.10,00,000
(Rs. 100/- each)
Net Pr ofit after Tax – Pr eference dividend

Earning Per Share
No. of Equity Share

215
Share Capital
No. of Equity Shares
Face Value Per Share
10,00,000
100
10,000 Shares
2,25,000 – (8% of 2,00,000)

10,000
2,25,000 – 16,000
10,000
2,09,000
10,000
Rs. 20.90
10.7.5 Dividend Payout Ratio -
It shows the relationship between the dividend paid to equity

shareholders out of the profits available to equity shareholders.
Dividend Per Equity Share
a) Dividend Payout Ratio
Earning per Share
b) Dividend per share equity share means dividend paid on one
equity share.
c) Earning per share is calculated as per above formula.
d) Significance - It measures dividend paying capacity of the
company. Higher ratio signifies the company has utilized larger
portion of its earning for payment of dividend. Low ratio
indicates that smaller portion of earning has been utilized for
payment of dividend. It also indicated that larger portion of
earnings had been retained.
e) Example: Dividend Payout Ratio -

Net Profit after Tax Rs. 3,25,000
7% Preference Share Capital Rs. 2,00,000
Paid up Equity share
Capital of Rs. 10 per share Rs. 10,00,000
Equity Dividend @ Rs. 1 per share

216
Dividend to Equity Shareholders

Dividend Payout Ratio 100
Pr ofit available to Equity shareholders
10,00,000
100
3,25,000 – 14,000
10,00,000
100
3,25,000 (7% of 2,00,000)
10,00,000
100
3,11,000
32.15%
10.7.6 Dividend Yield Ratio -
It shows the relationship between dividend per share earned

by shareholder on market price of each share.
Dividend Per Share
a) Dividend Yield Ratio
Market Pr ice per share
b) Dividend per share is derived by dividing Total Dividend payout
to Number of Shares.
c) Market price per share is the quotation price in the stock market.
d) Significance - This ratio indicates the ultimate current return
which investors will get as a percentage on its current market
value of shares. It also indicates dividend policy of the
company.
e) Example: Dividend Yield Ratio -
Dividend per Share Rs.10
Market Price per Share Rs.100
Dividend Per Share

Dividend Yield Ratio
Market Pr ice Per Share
10
100
100
10%
10.7.7 Price Earnings Ratio -
It brings out the relationship between market price per share

with earning per share.

217
Market Pr ice Per share

a) Pr ice Earning Ratio
Earning per Share
b) Market price of one share is value of one share in the market.
c) Earning per share.
d) Significance - It indicates the relationship between market price

of share and current earning per share. It also helps in
determining the future value of the share.
e) Example: Price Earnings Ratio -
Net Profit after Tax Rs.3,25,000

7% Preference Share Capital Rs.2,00,000
Paid up Equity Share
Capital of Rs. 100 per share Rs.10,00,000
Market Price per share Rs.210/-
Net Pr ofit ater Tax – Pr eference dividend

Earning Per Share
Equity Share Capital

Face Value Per Share
Market Pr ice Per Share

Pr ice Earning Ratio
Earning Per Share
10,00,000
No. of Equity Shares 10,000 Shares
100
3,25,000 – 14,000
EPS 31.10
10,000
210
PER 6.75
31.10
10.7.8 Fixed Assets Turnover Ratio –
It indicates the frequency of fixed assets utilization.

Net Assets
a) Fixed Assets Turnover Ratio
Fixed Assets
b) Net Sales = Gross Sales minus Sales Return minus Allowances.

218
c) Fixed Assets includes assets acquired for long term use in the
business and not for sale in ordinary course of business. For
e.g. Goodwill, Land & Building, Plant & Machinery, Vehicles etc.
d) Significance - It indicates efficiency in or extend of utilization of
fixed assets. Higher ratio indicates high degree of efficiency in
utilization and low degree signifies vice-versa.
e) Example: Fixed Assets Turnover Ratio -
If sales are Rs.10,00,000/- and Fixed Assets are

Rs.3,00,000/- calculate Fixed Assets.
Net Sales 1,00,000

Turnover Ratio 3.33
Fixed Assets 3,00,000
10.7.9 Total Assets Turnover Ratio -
It shows the relationship between net sales and total assets.

Net Sales
a) Total Assets Turnover Ratio
Total Assets
b) Net Sales = Gross sales minus Returns minus Allowances.
c) Total Fixed Assets = Fixed Assets + Investment + Current
Assets but excluding fictitious assets.
d) Significance - It indicates how efficiency assets are employed
overall.
e) Example: Total Assets Turnover Ratio -
Total Assets = Fixed Assets + Current Assets

5,00,000 = 3,00,000 + 2,00,000
Turnover Rs.10,00,000/-
Net Sales
Total Assets Turnover Ratio
Total Assets
10,00,000
5,00,000
20
10.7.10 Debt Service Ratio / Interest Coverage Ratio -
This ratio shows the relationship between earning before

interest and interest on long term loans. The main purpose of this

219
ratio is to find out the number of times the fixed interest charges are
covered by the income before interest and tax.
Net Pr ofit before Interest & Tax

a) Debt Service Ratio
Fixed Interest Charges
b) Profit before interest & tax means the amount of net profit
before interest and tax. Interest means the interest payable on
loans.
c) Fixed interest charges mean interest on long term loans.
d) Significance - Its main purposed is to measure the interest

paying capacity of the company.
e) Example: Debt Service Ratio -
Find out the Debt Service Ratio from the following details
a) Profit before interest and tax Rs.1,00,000/-
b) Interest payable Rs.25,000/-
Profit before Interest & Tax

Debt Service Ratio
Interest
1,00,000
25,000
4
10.7.11 Debt Service Coverage Ratio -
It shows the relationship between net profits and interest

plus installments payable on loans. It is expressed as a pure
number.
Cash Pr ofits available for
debt servicing
a) Debt Service Coverage Ratio
Interest Installment due
on loans
b) Cash profits available for debt servicing are calculated as
follows:
i) Net Profit after interest and Tax
ii) (+) Non cash debits to Profit & Loss A/c
(E.g. Depreciation, goodwill w/off, loss on sales of Fixed
Assets etc)

220
iii) Cash Profits for debt servicing.

c) Interest means interest on long term loans during the year.
Installment means installments due on long term loans during
the year.
d) Significance - This ratio indicates the company‟s ability to pay
interest and principal amount on time as it indicates whether
company is able to pay interest and repayment of loan out of
earnings of the company. It is more useful for lender as it takes
care of total repayment liability.
e) Example: Debt Service Coverage Ratio
Find out the Debt Service Coverage Ratio from the
following details.
1) Profit after interest and tax Rs.2,50,000/-

2) Interest Payable Rs.25,000/-
3) Depreciation Rs.15,000/-
4) Loan installment payable during the year Rs.1,45,000/-.
Net Pr ofit before Interest & Tax

Debt Equity Ratio
Fixed Interest Charges
2,50,000 15,000 25,000

25,000 1,45,000
1.70
10.7.12 Debtors Turnover Ratio / Debtors Velocity / Accounts

Receivable Turnover -
This shows the relationship between net credit sales and

average trade debtors. It is expressed as a rate.
Net Credit Sales
a) Debtors Turnover Ratio
Debtors Bills Receivables
OR
Credit Sales
Average Account Receivable
b) Net Credit Sales = Gross Credit Sales minus Sales Returns
c) Debtors and bills receivable may be taken at the average of
opening and closing amounts. If the details are not available
only the closing balance may be considered.
d) Example: Debtors Turnover Ratio -

221
From the following information calculate the Debtors

Turnover Ratio -
Net Credit Sales 7,30,000

Net Debtors 75,000
Net Bills Receivable 25,000
Credit Sales
Debtors Turnover Ratio
Debtors BillsReceivable
7,30,000
1,00,000
7.3 times
10.7.13 Creditors Turnover Ratio –

This shows the relationship between the net credit
purchases and the average trade creditors. This ratio is normally
expressed as a “rate”.
Credit Purchases
a) Creditor Turnover Ratio
Average Accounts Payable
OR
Credit Purchases
Creditors Bills Payable
b) Net Credit Purchases = Gross Credit Purchases - Purchase
Return - Allowances on Credit Purchases
c) Creditors and bills payable may be taken at the average of the
opening and closing amount. If the details are not available,
only the closing balance may be considered.
d) Example: Credit turnover ratio.
From the following information calculate the credit turnover
ratio.
Net Credit Purchases Rs. 1,00,000

Creditors Rs. 20,000
Bills Payable Rs. 5,000

222
Credit Purchases
Creditor Turnover
Creditors BillsPayable
1,00,000
20,000 5,000
1,00,000
25,000
4 times
10.7.14 Debt Collection Period –

This ratio gives average debt collection period and indicates
the extend to each the debts have being collected in time.
Number of days or months in a year
a) Debt Collection Period
b) Significance - It indicates credit and collection policy and it also
indicates effectiveness of collection from debtors.
c) Example: Debt Collection Period -
Debt collection period is calculated from above illustration of

the point 10.7.12
365
Debt Collection Period
365
7.33
50 days.
10.7.15 Creditors Payout Ratio -

This shows the relationship between Number of days or
months in a year with the promptness in payment of credit
purchases.
No. of day sin a year
a) Creditor Payout Ratio
Creditor Turnover Ratio
b) Significance - It should be compared with actual credit available
from suppliers and whether the company is taking full benefit of
the credit period allowed by creditors.
c) Example: Credit Collection Period -
It is calculated from above illustration No. 10.7.13

223
365
Credit Collection Period
Creditors Turnover Ratio
365
4
12
91 days or 3 months.
4
10.8 ADVANTAGES AND LIMITATIONS OF RATIO

ANALYSIS
10.8.1 Advantages of Ratios Analysis:
Ratio analysis is an important and age-old technique of

financial analysis. The following are some of the advantages /
Benefits of ratio analysis:
1. Simplifies financial statements: It simplifies the

comprehension of financial statements. Ratios tell the whole
story of changes in the financial condition of the business
2. Facilitates inter-firm comparison: It provides data for inter-

firm comparison. Ratios highlight the factors associated with
with successful and unsuccessful firm. They also reveal
strong firms and weak firms, overvalued and undervalued
firms.
3. Helps in planning: It helps in planning and forecasting.

Ratios can assist management, in its basic functions of
forecasting. Planning, co-ordination, control and
communications.
4. Makes inter-firm comparison possible: Ratios analysis

also makes possible comparison of the performance of
different divisions of the firm. The ratios are helpful in
deciding about their efficiency or otherwise in the past and
likely performance in the future.
5. Help in investment decisions: It helps in investment

decisions in the case of investors and lending decisions in
the case of bankers etc.
10.8.2 Limitations of Ratios Analysis:
The ratios analysis is one of the most powerful tools of

financial management. Though ratios are simple to calculate and
easy to understand, they suffer from serious limitations.

224
1. Limitations of financial statements: Ratios are based only on

the information which has been recorded in the financial
statements. Financial statements themselves are subject to
several limitations. Thus ratios derived, there from, are also
subject to those limitations. For example, non-financial changes
though important for the business are not relevant by the
financial statements. Financial statements are affected to a very
great extent by accounting conventions and concepts. Personal
judgment plays a great part in determining the figures for
financial statements.
2. Comparative study required: Ratios are useful in judging the

efficiency of the business only when they are compared with
past results of the business. However, such a comparison only
provide glimpse of the past performance and forecasts for future
may not prove correct since several other factors like market
conditions, management policies, etc. may affect the future
operations.
3. Ratios alone are not adequate: Ratios are only indicators, they
cannot be taken as final regarding good or bad financial position
of the business. Other things have also to be seen.
4. Problems of price level changes: A change in price level can

affect the validity of ratios calculated for different time periods.
In such a case the ratio analysis may not clearly indicate the
trend in solvency and profitability of the company. The financial
statements, therefore, be adjusted keeping in view the price
level changes if a meaningful comparison is to be made through
accounting ratios.
5. Lack of adequate standard: No fixed standard can be laid down

for ideal ratios. There are no well accepted standards or rule of
thumb for all ratios which can be accepted as norm. It renders
interpretation of the ratios difficult.
6. Limited use of single ratios: A single ratio, usually, does not

convey much of a sense. To make a better interpretation, a
number of ratios have to be calculated which is likely to confuse
the analyst than help him in making any good decision.
7. Personal bias: Ratios are only means of financial analysis and

not an end in itself. Ratios have to interpreted and different
people may interpret the same ratio in different way.
8. Incomparable: Not only industries differ in their nature, but also

the firms of the similar business widely differ in their size and
accounting procedures etc. It makes comparison of ratios
difficult and misleading.

225
10.9 EXERCISE
1. Explain the advantages and limitations of ratio analyses.

2. Briefly explain the classification of Ratios.
3. Give significance of Following Ratios:
Proprietors ratio
Debt Equity ratio
Gross profit ratio
Stock turnover ratio
Earnings per share
Creditors payout ratio
4. Give formula of the ratio:
Current Assets
Quick liabilities
Proprietors fund
Capital gearing ratio
Net profit before tax
Capital employed
Total Assets

11
RATIO ANALYSES-II
Unit Structure:
11.0 Objectives
11.1 Solved Problems
11.2 Exercise

226
11.0 OBJECTIVES
After studying the unit the students will be able to solve the
practical problems on Ratio analyses.
11.1 SOLVED PROBLEMS
Q.1 The following are summarized Profit and Loss Account for the
year ending 31st March, 2005 and the Balance Sheet as on that
date of A Ltd.
Profit & Loss Account

Dr. Cr.
To Gross Profit 50,000
1,15,000 1,15,000
To Administrative By Gross Profit 50,000
Expenses 15,000
To Interest 3,000
50,000 50,000
Balance Sheet

Share Capital 1,00,000 Land & Building 50,000
(Rs.10/- each) Plant & Machinery 30,000
Profit & Loss Account 20,000 Stock 15,000
Bills Payable 15,000 Bills Receivable 12,500
Cash & Bank 17,500
Furniture 20,000

227
1,60,000 1,60,000
Average Debtors Rs.12,500/-

Credit Purchases Rs.40,000/-
Credit Sales Rs.80,000/-
Calculate –
(i) Stock Turnover Ratio (ii) Debtors turnover ratio,
(iii) Creditors turnover ratio, (iv) Working Capital turnover ratio,
(v) Sales to Capital employed, (vi) Return on shareholders funds,
(vii) Gross Profit Ratio, (viii) Net Profit ratio,
(ix) EPS, (x) Operating ratio.
Solution :
Cost of goods sold
i) Stock turnover ratio =
AverageStock
50,000 [Sales – G.P.]

=
10,000 + 15,000 / 2
50,000
=
12,500
= 4 times
Credit Sales
ii) Debtors turnover ratio =
Average Debtors
80,000
=
12,500
= 6.4 times
Credit Purchases
iii) Creditors turnover ratio =
Average Accounts Payable
40,000
=
40,000 [Crs + B.P.]
= 1 time
Sales
iv) Sales to Capital employed = (working Capital)
[Current Assets – Current Liabilities]
228
1,00,000
=
20,000
= 5 times
Sales
v) Sales to Capital Employed = 100
Capital employed
1,00,000
= 1,00,000 + 20,000
Equity P&L A/c
1,00,000
=
1,20,000
= 83 : 1
Net Profit
vi) Returns on Shareholders funds = 100
Shareholders funds
20,000
= 100
1,20,000
= 16.67 %
Gross Profit
vii) Gross Profit Ratio = 100
Sales
50,000
= 100
1,00,000
= 50 %
Net Profit
viii)Net Profit Ratio = 100
Sales
20,000
= 100
1,00,000
= 20 %
Net Profit
ix) EPS =
20,000
=
10,000
= Rs.2/-
Cost of Good Sold + Operation Expenses

x) Operating ratio =
Sales

229
50,000 + 27,000 100

=
1,00,000
= 77 %
Q.2 From the following information, you are required to prepare a
Balance Sheet.
Particulars Rs.
Working Capital 75,000
Reserves and Surplus 1,00,000
Current Ratio 1.75
Liquid Ratio 1.75
Fixed assets to proprietors‟ Funds .75
Long-term liabilities Nil
Solution :
Balance Sheet
Share capital 2,00,000 Fixed Assets 2,25,000
Reserves & Surplus 1,00,000 Stock 60,000
Bank Overdraft 60,000 Debtors and Cash 1,15,000
Creditors 40,000
4,00,000 4,00,000
Workings :
1. Current Assets
Current Ratio = 1.75
Working Capital should be = .75
175 175
Working Capital = Rs.75,000 = Rs.1,75,000
75 75
2. Liquid Assets (Debtors and Cash)
Liquid Ratio – 1.15
If current assets are 175 liquid assets should be 115
175 115
Current Assets = Rs.1,75,000 = Rs.1,15,000
175 175
3. Stock

230
Current Assets – Liquid Assets

= Rs.1,75,000 – Rs.1,15,000
= Rs.60,000
4. Fixed Assets
Shareholders‟ Equity should be equal to total net assets.
Proprietory ratio – 7.5
If fixed assets are 75 to proprietors‟ funds, net current assets

should be 25 of the total net assets.
75 75
Net Current Assets = Rs.75,000 = Rs.2,25,000
25 25
5. Shareholders’ Funds
If fixed assets are 75 shareholders‟ funds should be 100
100 100
Fixed Assets = Rs.2,25,000 = Rs.3,00,000
75 75
Share Capital = Shareholder‟s Funds – Reserves and Surplus

Rs.3,00,000 – 1,00,000 = Rs.2,00,000
6. Creditors
Current assets – Working Capital – Bank Overdraft
Rs.1,75,000 – 75,000 – 60,000 = Rs.40,000
Q.3 From the following Balance Sheet of Tara Ltd. calculate

Long Term Debt Equity, Proprietory, Capital Gearing, Stock
Working Capital Ratios.

Equity Share Capital 2,00,000 Land and Building 1,40,000
8% Preference Share Plant & Machinery 80,000
Capital 60,000 Furniture & Fixtures 20,000

231
Reserves 30,000 Debtors 80,000

Profit & Loss A/c 20,000 Stock 70,000
9% Debentures 40,000 Cash in hand 30,000
Creditors 60,000 Prepaid Expenses 10,000
Outstanding Exp 5,000 Preliminary Expenses 20,000
Provision for Taxation 20,000
Proposed Dividend 15,000
4,50,000 4,50,000
Solution :
Vertical Balance Sheet of Tara Ltd.

I. SOURCES OF FUNDS
1. Proprietors’ Fund :
a) Equity Share Capital (EC) 2,00,000
b) Reserves & Surplus
Reserves 30,000
Profit & Loss A/c 20,000
50,000
c) Less : Preliminary Exp. (PC) (20,000)
(RS) 30,000
(EF) 2,30,000
d) 8% Preference Share Capital 60,000
Proprietors‟ Funds (PF) 2,90,000
2. Loan Funds :
Capital Employed (CE) 3,30,000

232

1. Fixed Assets
Plant & Machinery 80,000
Furniture & Fixtures 20,000
(FA) 2,40,000
2. Working Capital
a) Current Assets
Debtor 80,000
Cash-in-hand 30,000
Stock (CST) 70,000
Prepaid Expenses 10,000
(CA) 1,90,000
b) Current Liabilities
Creditors 60,000
Outstanding Expenses 5,000
Provision for Taxation 20,000
(CL) (1,00,000)
Working Capital (WC) 90,000
Capital Employed (CE) 3,30,000
Long Term Debt BF

1) Long Term Debt Equity = =
Shareholder ' s Fund PF
40,000
=
2,90,000
= 0.14 : 1
Proprietor ' s Funds

2) Proprietory Ratio = 100
Total Assets
PF
= 100
TA
2,90,000
= 100
4,30,000
= 67.44%
TA = FA + CA = 2,40,000 + 1,90,000 = 4,30,000

233
Capital Entitled to Fixed

Rate of Dividend / Interest
3) Capital Gearing Ratio =
Other Capital
PC + BF
=
EF
Preference Capital + Debentures
+ Long Term Loans
=
Equity Capital + Net Reserves
– Prelim inary Expenses
60,000 + 40,000
=
2,30,000
1,00,000
= = 0.43 : 1
2,30,000
Stock
4) Stock Working Capital Ratio = 100
Working Capital
CST
= 100
WC
70,000
= 100
90,000
= 77.78%
Q.4 X Ltd. and Y Ltd. are in the same line of business. Following
are their Balance Sheets as on 31st December 2003.
Balance Sheet as on 31st December, 2003
Liabilities X Ltd. Y Ltd. Assets X Ltd. Y Ltd.

(Rs.) (Rs.) (Rs.) (Rs.)
Equity Share Capital 7,00,000 2,00,000 Land 1,00,000 80,000
Reserve & Surplus 1,00,000 1,00,000 Building 2,50,000 2,00,000
12% Debentures 2,00,000 5,00,000 Plant & Machinery 5,00,000 3,00,000
Creditors 1,20,000 70,000 Debtors 2,10,000 1,10,000
Bills Payable 40,000 20,000 Stock 1,00,000 2,00,000
Proposed Dividend 20,000 20,000 Cash & Bank 55,0000 40,000
Provision for Tax 35,000 20,000
12,15,000 9,30,000 12,15,000 9,30,000

234
You are required to rearrange the Balance Sheets (in Vertical form)
and calculate the following ratios for both the companies (any
three)
a) Proprietory Ratio b) Capital – Gearing Ratio
c) Current Ratio d) Stock Working Capital Ratio
(Mar 2003, adapted)
Solution :
Particulars Amt Amt

I. SOURCES OF FUNDS
1. Shareholders Fund
a) Share Capital 7,00,000 2,00,000
b) Reserves & Surplus 1,00,000 1,00,000
Proprietors‟ Funds (A+B) (PF/EF) 8,00,000 3,00,000
2. Borrowed Funds :
12% Debentures (BF) 2,00,000 5,00,000
Total Funds Available (1 + 2) 10,00,000 8,00,000

1. Fixed Assets
Land 1,00,000 80,000
Building 2,50,000 2,00,000
Plant & Machinery 5,00,000 3,00,000
(FA) 8,50,000 5,80,000
2. Working Capital
Current Assets
Debtor 2,10,000 1,10,000
Cash & Bank 55,000 40,000
Stock (CST) 1,00,000 2,00,000
(CA) 3,65,000 3,50,000
Current Liabilities
Creditors 1,20,000 70,000
Bills Payable 40,000 20,000
Proposed Dividend 20,000 20,000
Provision for Tax 35,000 20,000
(CL) 2,15,000 1,30,000
Working Capital (CA – CL) (WC) 1,50,000 2,20,000
Total Funds Employed (1 + 2 + 3) 10,00,000 8,00,000

235
Calculation of Ratios:
Ratios X Ltd. Y Ltd.

No.
1 Proprietory Ratio
Proprietors ' Funds 8,00,000 3,00,000
= 100 = 100 = 100
Total Assets 12,15,000 9,30,000
PF
= 100 = 65.84 % = 32.26 %
TA
[TA = FA – CA]
2 Capital Gearing Ratio

Capital Entitled
to Fixed Yield 2,00,000 5,00,000
= = =
Capital not so Entitled 8,00,000 3,00,000
to any Fixed Yield
= 0.25 : 1 = 1.67 : 1
PC + BF
=
EF
3 Current Ratio
Current Assets CA 3, 65,000 3,50,000
= = = =
Current Liabilities CL 2,15,000 1,30,000
= 1.70 : 1 = 2.69 : 1
4 Stock Working Capital
Ratio
Stock 1,00,000 2,00,000
= 100 = 100 = 100
Working Capital 1,50,000 2,20,000
= 90.90 %
CST = 66.67 %
= 100
WC
Q.5 Following figures have been extracted from the book of

Voodoo Ltd.

Land and Building 6,00,000 Misc. Current Assets 5,000
Plant and Machinery 5,00,000 P&L Acccount 2,00,000
Equity Capital 5,00,000 General Reserves 1,00,000
Preference Capital 2,00,000 Sundry Creditors 80,000
Stock 2,40,000 Bills Payable 60,000
Debtors 2,00,000 Misc. Current Liabilities 60,000
Cash and Bank 55,000 Debentures 4,00,000

236
You are required to –

a) Rearrange above figures in the vertical form and
b) Calculate – (i) Debt-Equity Ratio (ii) Proprietory Ratio (iii) Capital
Gearing Ratio.
(April 98, adapted)
Solution :
Balance Sheet of Voodoo Ltd. as on ……
Particulars Amt Amt

I. SOURCES OF FUNDS
1. Proprietors’ Fund
a) Equity Share Capital (EC) 5,00,000
b) P&L Account 2,00,000
c) General Reserve 1,00,000
Equityholders‟ Funds (A+B) (EF) 8,00,000
d) Preference Capital (PC) 2,00,000
Proprietors Funds (PF) 10,00,000
2. Borrowed Funds :
Debentures (BF) 4,00,000
Capital Employed (1 + 2) (CE) 14,00,000

1. Fixed Assets
(FA) 11,00,000
2. Working Capital
Debtors 2,00,000
Cash / Bank 55,000
Misc. Current Assets 5,000
Stock (CST) 2,40,000
Current Assets (CA) 5,00,000
Misc. Current Liabilities 60,000
Current liabilities (CL) 2,00,000
Working Capital (WC) 3,00,000

237
Borrowed Fund BF
1) Debt – Equity Ratio = =
Proprietors' Fund PF
4,00,000
= = 0.4
10,00,000
OR
Borrowed Fund
=
Borrowed Fund + Proprietor ' s Fund
BF 4,00,000
= = = 0.29
BF + PF 14,00,000
Proprietors ' Fund

Total Assets
PF
= 100
TA
10,00,000
= 100 = 62.50 %
16,00,000
Capital Entitled to Fixed Rate

of Dividend / Interest
Other Capital
PC + BF 6,00,000
= = = 0.75 : 1
EF 8,00,000
Note : Total Assets = Fixed Assets + Current Assets

= 11,00,000 + 5,00,000
= 16,00,000
Q.6 Following is the Balance Sheet of Roland Ltd.
Balance Sheet as on 31st March, 2004

Equity Share Capital 1,00,000 Cash in hand 2,000
6% Preference Share Cash at Bank 10,000
Capital 1,00,000 Bills Receivable 30,000
7% Debentures 40,000 Debtors 70,000
8% Public Deposits 20,000 Stock 40,000
Bank Overdraft 40,000 Advances 20,000

238
Creditors 60,000 Furniture 30,000

Unpaid Dividend 10,000 Machinery 1,00,000
Outstanding Exp. 7,000 Land & Building 2,20,000
Reserves 1,50,000 Goodwill 30,000
Provision for Tax 20,000 Preliminary Expenses 10,000
Profit & Loss Account 20,000 Calls in Arrears in
Equity Shares 5,000
5,67,000 5,67,000
Convert the above Balance Sheet in vertical form and calculate – (i)
Current Ratio (ii) Quick Ratio (iii) Proprietary Ratio (iv) Capital
Gearing Ratio (v) Stock Working Capital Ratio.
(Oct. 01, adapted)
Solution :
Vertical Balance Sheet as on 31st March, 2003

I. SOURCES OF FUNDS
1. Owners’ Fund
a) Equity Share Capital
Equity Share Capital 1,00,000
Less : Calls-in-arrears (5,000)
(EC) 95,000
b) Reserves and Surplus
Reserve 1,50,000
Profit & Loss Account 20,000
1,70,000
c) Less : Preliminary Exp. (10,000)
Reserves & Surplus (RS) 1,60,000
Equityholders‟ Funds (EF) 2,55,000
d) 6% Preference Capital (PC) 1,00,000
Proprietors Funds (PF) 3,55,000
2. Borrowed Funds :
a) Secured Loans
b) Unsecured Loans
8% Public Deposit 20,000
(BF) 60,000

239

1. Fixed Assets
Goodwill 30,000
Machinery 1,00,000
Furniture 30,000
(FA) 3,80,000
2. Working Capital
a) Current Assets
Cash-in-hand 2,000
Cash at Bank 10,000
Debtors 70,000
Advances 20,000
(QA) 1,32,000
(CST) 40,000
(CA) 1,72,000
b) Current liabilities
Creditors 60,000
Unpaid Dividend 10,000
Provision for Tax 20,000
(QL) 97,000
(CL) 1,37,000
Working Capital (WC) 35,000
Calculation of Ratios :
Current Assets CA
1) Current Ratio = =
Current Liabilities CL
1,72,000
= = 1.26 : 1
1,37,000
Quick Assets QA
2) Quick Ratio = =
Quick Liabilities QL
1,32,000
= = 1.36 : 1
97,000

240
Proprietor ' s Funds

Total Assets
PF
= 100
TA
Proprietors ' Fund
= 100
Fixed Assets + Current Assets
3,55,000
= = 64.31%
5,52,000
Capital Entitled to Fixed Rate of

Interest or Dividend
Capital not so entitled to Fixed
Rate of Dividend
PC + BF
=
EF
1,60,000
= = 0.63 : 1
2,55,000
Stock
5) Stock Working Capital Ratio = 100
Working Capital
40,000
= 100 = 114.29%
35,000
Q.7 From the following given below prepare Balance Sheet in a
vertical form, suitable for analysis and calculate the following ratios:
a) Capital Gearing Ratio b) Proprietory Ratio
c) Current Ratio d) Liquid Ratio
e) Stock to Working Capital
(Oct. 06, adapted)
Cash at Bank 12,500 Land & Building 2,00,000
Expenses paid in Advance 15,500 Stock 68,250
Creditors 1,01,500 Debtors 1,30,750
Bills Receivable 5,250 Plant & Machinery 1,36,000
12% Debentures 62,500 Loan from Director 1,00,000
Equity Share Capital 2,50,000 (Repayable after three
Profit & Loss A/c (Cr.) 54,250 years)
5,67,000 5,67,000

241
Solution:
Vertical Balance Sheet as on …
I. SOURCES OF FUNDS
1. Shareholder’s Fund
a) Share Capital
Equity Share Capital 2,50,000
b) Reserves and Surplus
Profit & Loss Account – Cr. bal 54,250
Own fund / Net Worth (A + B) 3,04,250
2. Loan Funds :
a) Secured Loans
b) Unsecured Loans
Loan from Directors (Repayable for 1,00,000
3 years) 1,62,500
Total Funds Available (1 + 2) 4,66,750

1. Fixed Assets
A. Tangible Assets 2,00,000
B. Intangible Assets NIL 3,36,000
2. Long Term Investments NIL
Total Fixed Assets 3,36,000
3. Working Capital
A. Current Assets
a. Quick Assets
Cash at Bank 12,500
Debtors 1,30,750
Total Quick Assets 1,48,500
b. Non-Quick Assets
Expenses paid in Advance 15,500
Stock 68,250 83,750
Total Current Assets 2,32,250
B. Less : Current Liabilities
a. Quick Liabilities
Creditors 1,01,500
b. Non-Quick Liabilities NIL
Total Current Liabilities 1,01,500
Working (A – B) 1,30,750
Total Funds Employed (2 + 3) 4,66,750

242
Ratios :
Capital Entitled to Fixed Rate of

Interest or Dividend
a) Capital Gearing Ratio =
Capital not so entitled to Fixed
Rate of Dividend
Preference Share Capital +
Borrowed Funds
=
Equity Share Capital + Re serves
Misc. Expenses
1,62,500
=
2,50,000 + 54,250
1,62,500
= = 0.534 : 1
3,04,250
Shareholders Funds
b) Proprietory Ratio =
Total Assets
3,04,250
= = 0.535 : 1
5,68,250
Total Assets = Fixed Assets + Investment + Current Assets
= 3,36,000 + Nil + 2,32,250 = Rs.5,68,250
Current Assets
c) Current Ratio =
Current Liabilities
2,32,250
= = 2.288 : 1
1,01,500
Quick Assets
d) Liquid Ratio =
Quick Liabilities
1,48,500
= = 1.463 : 1
1,01,500
Stock
e) Stock to Working Capital =
Working Capital
68,250
= = 0.522 : 1
1,30,750

243
Q.8 (A) Following is the Profit and Loss Account of Saurav

Limited for the year ended 31st March, 2003. You are required to
prepare Vertical Income Statement for the purpose of analysis.

To Opening Stock 700 By Sales
To Purchases 900 Cash 520
To Wages 150 Credit 1,500
To Factory Expenses 350 2,020
To Office Salaries 25 Less : Returns &
To Office Rent 39 Allowances 20 2,000
To Postage & Telegram 5 By Closing Stock 600
To Directors Fee 6 By Dividend on
To Salesmen Salaries 12 Investment 10
To Advertising 18 By Profit on Sale of
To Delivery Expenses 20 Furniture 20
To Debenture Interest 20
To Depreciation
On Office Furniture 10
On Plant 30
On Delivery Van 20
To Loss on Sales of Van 5
To Income Tax 175
To Net Profit 145
2,630 2,630
(B) From the above Vertical Income Statement Calculate:

(i) Gross Profit Ratio, (ii) Operating Costs Ratio excluding Finance
expenses (iii) Stock Turnover Ratio.
(Oct. 2003, adapted)
Solution :
Vertical Income Statement for the year ended 31st March, 2003
Particulars Rs. Rs.

Credit Sales CRS 1,500
Cash Sales 520
Less : Returns (20)
1. Total Sales S 2,000
Opening Stock OST 700
Purchases CRP 900
Factory Expenses 350

244
Wages 150
Depreciation : Machinery 30
Less : Closing Stock (CST) (600)
2. Cost of Goods Sold COGS 1,530
3. Gross Profit GP 470
4. Administration Expenses
Office Rent 39
Salaries 25
Postage 5
Depreciation 10
Directors Fees 6
AE 85
5. Selling Expenses
Salaries 12
Advertising 18
Depreciation 20
Delivery Expenses 20
SE 70
6. Operating Expenses OE 155
7. Operating Profit [GP – OE] OP 315
Dividend 10
Profit on Sale of Furniture 20
Loss on Sale of Van (5)
8. Net Non-Operating Profit / Loss NO 25
9. Profit before Interest & Tax PBIT 340
Interest on Debentures INT 20
10. Net Profit Before Tax NPBT 320
Income Tax 175
11. Net Profit After Tax NPAT 145
Preference Dividends 0
12. Profit Av. For Equityholders PAES 145
Equity Dividends ED 0
13. Retained Earnings RET 145
Calculation of Ratios :
Gross Profit
i) Gross Profit Ratio = 100 Gr
Net Sales
470
= 100 = 23.5%
2,000
Operating Cost
ii) Operating Cost Ratio = 100
Net Sales
1,685
= 100 = 84.25%
2,000

245
Operating Cost = Cost of Sales + Operating Expenses

= 1,530 + 175 = 1,705
Cost of Goods Sold

iii) Stock Turnover Ratio =
Average Stock
1,530
= = 2.35 Times
650
Opening Stock + Closing Stock

Average Stock =
2
700 + 600
= = 650
2
Q.9 The following figures relate to the trading activities of Z Ltd.,

for the year ended 31st March 2003.
Particulars Rs.
Sales 10,57,000
Closing Stock 4,60,000
Purchases 8,35,000
Loss on Sales of Assets 45,000
Advertising 32,750
Rent 18,750
Profit on Sale of Shares 25,000
Provision for taxation 1,00,000
Salaries 35,750
Salesmen‟s Salaries 14,250
Depreciation 36,000
Sales Returns 57,000
Depreciation on Delivery Van 8,000
Printing and Stationery 17,500
Audit Fees 12,000
Opening Stock 2,25,000
Dividend received on Shares 15,000
You are required to rearrange above income statement in vertical

form and compute the following ratios.
a) Gross Profit Ratio,
b) Operating Ratio
c) Net Operating Profit Ratio
d) Selling and Distribution Expenses to Sales Ratio
e) Net Profit Ratio (Oct. 96 adapted)

246
Solution :
Vertical Income Statement for the year ended 31-03-2003
Particulars Rs. Rs. Rs.

1. Gross Sales 10,57,000
2. Returns 57,000
3. Net Sales (1 – 2) S 10,00,000
4. Less : Cost of Goods Sold
a) Opening Stock 2,25,000
b) add : Purchases 8,35,000
c) Less : Closing Stock (4,60,000)
COGS 6,00,000
5. Gross Profit (3 – 4) GP 4,00,000
6. Less :
a) Operating Expenses
Administrative Expenses :
Rent 18,750
Salaries 35,750
Depreciation 36,000
Printing & Stationery 17,500
Audit Fees 12,000
AE 1,20,000
b) Selling and Distribution Expenses
Advertisement 32,750
Salesman Salaries 14,250
Depreciation of Delivery Vans 8,000
SE 55,000
Operating Expenses OE 1,75,000
7. Operating Net Profit (5 – 6) OP 2,25,000
8. Add : Non-operating Income
Profit on Sale of Shares 25,000
Dividend on Shares 15,000 40,000
9. Less : Non-Operating Expenses 2,65,000
Loss on Sale of Assets 45,000
10. Net Profit before Tax (7 + 8 – 9) NPBT 2,20,000
11. Less : Provision for Taxation IT 1,00,000
12. Net Profit after Tax (10 – 11) NPAT 1,20,000

247
G.P.
a) Gross Profit Ratio = 100
Net Sales
4,00,000
= 100 = 40%
10,00,000
COGS + OE
b) Operating Ratio = 100
Net Sales
7,75,000
= 100 = 77.50%
10,00,000
c) Net Operating Profit Ratio

Operating N. P. 2,25,000
= ×100 = ×100 = 22.50%
Net Sales 10,00,000
d) Selling & Distr. Exp. to Sales Ratio

Selling & Dist. Expenses
= ×100
Net Sales
Net Profit Before Tax 2,20,000

e) Net Profit Ratio = ×100 = ×100
Sales 10,00,000
22%
Compute Various Ratios
Q.10 (Two Companies)
The summarised final accounts of two companies are as

follows:
Balance Sheet
Liabilities X Ltd. Y Ltd. Assets X Ltd. Y Ltd

Rs. Rs. Rs. Rs.
Share Capital 88,000 88,000 Fixed Assets 1,21,000 96,800
Reserves 42,900 35,200 Current Assets 1,25,400 1,03,400
8% Debentures 22,000 22,000 Less: Current 93,500 55,000
Liabilities
1,52,900 1,45,200 1,52,900 1,45,200

248
Revenue Statement for the year
Particulars X Ltd. Y Ltd.

Rs. Rs.
Sales 3,30,000 2,64,000
Less: Cost of Sales 2,37,600 1,98,000
Gross Profit 92,400 66,000
Less: Operating Expenses 63,800 44,000
Net Profit before Tax 28,600 22,000
Less: Tax 12,100 9,240
Profit after Tax 16,500 12,760
Less: Dividend 8,800 6,600
Retained Earning 7,700 6,160
You are required to calculate the following ratios:

(1) Proprietory ratio (2) Capital gearing ratio (3) Gross profit ratio
(4) Operating ratio (5) Return on capital employed ratio (6) Return
on proprietor‟s equity ratio (7) Expenses ratio (8) Net profit ratio.
(Apr. 95, adapted)
Solution:
Vertical Balance Sheet

Rs. Rs. Rs. Rs.
i) Sources of Funds
a. Equity Capital EC 88,000 88,000
b. Reserves RS 42,900 35,200
1. Equity Funds EF/PF 1,30,900 1,23,200
2. Borrowed Funds
8% Debentures BF 22,000 22,000
_______ _______
Capital Employed CE 1,52,900 1,45,200
ii) Application of Funds 1,21,000 96,800
1. Net Fixed Assets FA
2. Working Capital
a. Current Assets CA 1,25,400 1,03,400
b. Less: Current Liabilities CL 93,500 55,000
WC 31,900 48,400

249
No Ratio X Ltd. Y Ltd.

(1) Proprietory Ratio
Proprietors Funds 88, 000 42, 900 88, 000 35, 200
×100 100 100
Total Assets 1, 21, 000 1, 25, 400 96, 800 1, 03, 400
1, 30, 900
100 53%
PF 2, 46, 400 1, 23, 200
×100 100
TA 2,00, 200
Note: TA = FA + CA or CE 62%
+ CL
(2) Capital Gearing Ratio
Capital Entitled to
Fixed Interest/ Dividend 22,000 22,000
Capital not so Entitled 88,000 42,900 88,000 35, 200
PC + BF 22,000 22,000
= 0.17:1 0.18 :1
EF 1,30,900 1, 23, 200
(3) Gross Profit Ratio
Gross Profit
× 100 92, 400 66, 000
Sales 100 28% 100 25%
3, 30, 000 2, 64, 000
GP
×100
S
(4) Operating Ratio
COGS + OE 2, 37, 600 63, 800 1,98,000 + 44,000

×100 100 = ×100
Sales 3, 30, 000 2,64,000
3, 01, 400
100 2, 42, 000
3,30, 000 100
2, 64, 000
91.33%
91.67%
(5) Return on Capital
Employed Ratio
PBIT 28, 600 22,000

×100 100 100
Capital Employed 1,52,900 1, 45, 200
18.71% 15.15%
(6) Return on Proprietors
Equity Ratio
N.P.A.T 16,500 12,760

×100 100 100
Proprietors Equity (Fund) 1,30,900 1, 23, 200
12.61% 10.36%

250
(7) Expenses Ratio
COGS 2, 37, 600

(a) 100 100 72%
1, 98, 000
Sales 3, 30, 000 100 75%
2, 64, 000
O.E.
(b) 100
63,800 44, 000
Sales 100 100
3,30, 000 2, 64, 000
19.33% 16.67%
(8) Net Profit Ratio
N.P.B.T.
×100
Sales 28, 600 22,000
100 100
3,30, 000 2,64,000
8.67% 8.33%
Q.11 From the following Balance Sheet of X Ltd. compute –

(a) Liquid Ratio (b) Proprietory Ratio (c) Stock Turnover Ratio
(d) Capital Gearing Ratio (e) Debtors Velocity and offer you
comments in brief.

Preference Share Capital 2,00,000 Fixed Assets 12,00,000
Equity Share Capital 5,00,000 Stock 5,40,000
Reserves 10,00,000 Sundry Debtors 8,00,000
Secured Loans 4,00,000 Advance Income-tax 1,20,000
Current Liabilities 5,40,000 Cash at Bank 7,90,000
Provisions 8,10,000
Total 34,50,000 Total 34,50,000
Total Sales during the year was Rs. 77,76,000 (including Cash
Sales Rs. 5,76,000) which yielded a Gross Profit of 25% on Sales.
The Stock on 31st March, 2002 was Rs. 4,32,000. Assume for your
working 360 days for the year.
Solution:
Quick Assets QA 15,90,000

(a) Liquid Ratio = =
Quick Liabilities QL 13,50,000
1.18 :1

251
Proprietor's Funds PF
(b) Proprietory Ratio = ×100 = ×100
Total Assets TA
17,00,000
100
34,50,000
49%
COGS
(c) Stock-Turnover Ratio =
Avg.Stock
Sales - GrossProfit 58,32, 000

Opening Stock + Closing Stock 4,86, 000
2
12 times
No. of days in year 360

Stock Velocity =
Stock Turnover Ratio 12
30 days
Pref. Capital + Borrowed Funds

(d) Capital Gearing Ratio =
Equity Share Capital + Reserves
6,00,000
15,00,000
0.40:1
Debtors + BR 8,00,000
(e) Debtors Velocity = × 360 360
Credit Sales 72,00,000
40 days

252
Working Note:
X Ltd.

I) Sources of Funds
a. Capital
Equity Share Capital EC 5,00,000
Reserves & Surplus RC 10,00,000
Equity Funds EF 15,00,000
Preference Share Capital PC 2,00,000
Proprietor‟s Funds PF 17,00,000
b. Borrowed Fund:
Secured Loans BF 4,00,000
________
Capital Employed CE 21,00,000
II) Application of Funds

a. Fixed Assets FA 12,00,000
b. Working Capital
Debtors DR 8,00,000
Cash at Bank ... ... ... 7,90,000
Add: Stock CST 5,40,000
Advance Tax ... ... ... 1,20,000
Current Assets CA 22,50,000
Less: Quick/Current Liabilities
Current Liabilities ... ... ... 5,40,000
Provisions ... ... ... 8,10,000
CL 13,50,000
Working Capital (CA-CL) WC 9,00,000
________
Q. 12 Following are the Trading and Profit and Loss Account of

Sarmer Ltd. for the year ending 31st December, 2002 and Balance
Sheet on that date:
P and L Account

To Opening Stock 1,45,000 By Sales 7,50,000
To Purchases 6,10,000 By Closing Stock 1,55,000
To Gross Profit C/d 1,50,000
9,05,000 9,05,000
To Sundry Expenses 80,000 By Gross Profit B/d 1,50,000
1,50,000 1,50,000

253
Balance Sheet

Share Capital 7,00,000 Net Block 5,50,000
Reserve & Surplus 50,000 Stock 1,55,000
Add: Profit for the year 70,000 1,20,000 Debtors 1,80,000
Bank Overdraft 35,000 Cash 1,20,000
Creditors 1,50,000
10,05,000 10,05,000
You are required to calculate the following ratios. Current Ratio,

Quick Ratio, Gross Profit to Sales, Stock Turnover, Debtors
Turnover Ratio, NP to paid up Capital.
(April 98, adapted)
Solution:
Gross Profit GP
(1) Gross Profit Ratio = ×100 = ×100
Net Sales S
1,50,000
100
7,50,000
20%
COGS COGS
(2) Stock Turnover Ratio = =
Average Stock OST + CST
2
6,00,000
1,50,000
4 times

Average Stock = 1,50,000
2

(3) Current Ratio = =
Current Liabilities CL 1,85,000
2.46:1

(4) Quick Ratio = =
Quick Liabilities QL 1,50,000
2 :1

254
Credit Sales CRS

(5) Debtors Turnover Ratio = =
Debtors + Bill Receivable DR + BR
7,50,000
1,80,000
4.17 times
(period 88 days)
N.P.A.T.
(6) N.P. to Paid-up Capital = ×100
Paid-up Share Capital
NPAT 70,000
= ×100 100
EC 7,00,000
10%
Note:
Vertical Income Statement
Particulars Rs. Rs.
Sales S 7,50,000
Less: Cost of Goods Sold:
Opening Stock OST 1,45,000
Add: Purchases ... ... ... ... 6,10,000
... ... ... ... 7,55,000
Less: Closing Stock CST 1,55,000
Cost of Goods Sold COGS 6,00,000
Gross Profit GP 1,50,000
Less: Operating Expenses OE 80,000
Net Profit NP 70,000

I) Sources of Funds
Equity Capital EC 7,00,000
Reserves & Surplus RS 1,20,000
Shareholders Funds EF/PF 8,20,000
Borrowed Funds BF Nil
_______

255
II) Application of Funds FA 5,50,000

Fixed Assets (Net Block)
Working Capital: DR 1,80,000
Debtors ... ... ... 1,20,000
Cash QA 3,00,000
Quick Assets CST 1,55,000
Add: Stock CA 4,55,000
Current Assets
Quick Liabilities: CD/QL
Creditors ... ... ...
Add: Bank O.D. CL 1,50,000 1,85,000
Current Liabilities WC 35,000 2,70,000
Working Capital (CA-CL) _______
CE 8,20,000
Capital Employed
Q.13 From the following Profit and Loss Accounts and Balance
Sheets after calculating following ratios: (1) Current ratio (2)
Proprietory ratio (3) Debt-Equity ratio (4) Stock working capital ratio
(5) Liquid ratio (6) Cost of sales to sales ratio (7) Administrative
exp. to sales ratio (8) Selling expenses to sales ratio.
Balance Sheet
Liabilities 2003 2002 Assets 2003 2002

Rs. Rs. Rs. Rs.
Capital of Rs. 10 70,000 70,000 Fixed 90,000 92,000
each Assets
Reserves 80,000 68,000 Current 1,10,000 1,12,000
Assets
Secured Loans 22,000 24,000 Loans and 52,000 40,000
Advances
Current Liabilities 26,000 30,000
Provisions 54,000 52,000
2,52,000 2,44,000 2,52,000 2,44,000
Profit and Loss Account for the year Ended .....
Particulars 2003 2002 Particulars 2003 2002

Rs. Rs. Rs. Rs.
To Opening Stock 44,000 40,000 By Sales 2,10,000 2,00,000
To Purchases 84,000 72,000 By Closing 46,000 44,000
Stock
To Wages 40,000 36,000
To Factory Exp. 32,000 28,000
To Administrative 8,000 6,000
Expenses

256
To Selling Exp. 6,000 10,000

To Managerial 2,000 2,000
Remuneration
To Tfd. to Reserve 2,000 2,000
To Income Tax 22,000 24,000
To Proposed 6,000 8,000
Dividend
To Balance C/fd. 10,000 16,000
2,56,000 2,44,000 2,56,000 2,44,000
(Oct. 95, adapted)

Solution:
No Ratio 31-03-2003 31-03-2002

(1) Current Ratio
Current Assets CA 1,10, 000 52, 000

=
Current Liabilities CL 26, 000 54, 000 1,12, 000 40, 000
30, 000 52, 000
1, 62, 000
2.03 :1 1,52, 000
80, 000 1.85 :1
82, 000
(2) Proprietory Ratio
Proprietor's Funds 1,50,000 1,38,000
×100 100 100
Total Assets* 2,52,000 2, 44,000
PF = 59.52% or = 0.6:1 = 56.56% or = 0.57:1

×100
TA
*Fixed + Current
(3) Debt-Equity Ratio
Borrowed Fund BF
(i) = 22, 000 24, 000
Proprietor's Fund PF 0.15 :1 0.17 :1
OR 1, 50, 000 1, 38, 000
Borrowed Fund
(ii)
Borrowed Proprietor's
Fund + Fund
BF
22, 000 24, 000
BF + PF 0.13 :1 0.15 :1
1, 72, 000 1, 62, 000

257
(4) Stock to W.C. Ratio

Closing Stock
= ×100 46, 000 44, 000
W.C. 100 100
82, 000 70, 000
CST
= ×100 62.86%
WC 56.10%
(5) Liquid Ratio
Quick Assets QA 1,16, 000

= = 1.45 :1 1, 08, 000
Quick Liabilities QL 80, 000 1.32 :1
82, 000
(6) Cost of Sales to Sales Ratio
COGS COGS
×100 = ×100 1,54, 000 1, 32, 000
Sales S 100 100
2,10, 000 2, 00, 000
73.33% 66%
(7) Administrative Expenses
Ratio
Administrative Expenses 10, 000

×100 100 8, 000
Sales 2,10, 000 100
2, 00, 000
AE 4.76% 4%
= ×100
S
(8) Selling Expenses Ratio
Selling Expenses 6, 000 10, 000

= ×100 100 100
Sales 2,10, 000 2, 00, 000
SE 2.86% 5%
= ×100
S
Note: Before calculating the ratios, it is necessary to convert

Horizontal Financial Statements in Vertical Form.

258
Commentary Limited
Vertical Balance Sheets
Particulars 2003 2002

Rs. Rs. Rs. Rs.
I) Sources of Funds
Owners Funds:
Capital EC 70,000 70,000
Reserves RS 80,000 68,000
Equity / Proprietory
Funds EF/PF 1,50,000 1,38,000
Loan Funds:
Secured Loans BF 22,000 24,000
_______ _______
II) Application of Funds

Fixed Assets FA 90,000 92,000
Working Capital
Quick Assets QA 1,16,000 1,08,000
(CA + LA – Stock)
Stock CST 46,000 44,000
Current Assets CA 1,62,000 1,52,000
Less:
Quick Liabilities /
Current Liabilities QL/CL 80,000 82,000
WC 82,000 70,000
Particulars 2003 2002

Rs. Rs. Rs. Rs.
Sales S 2,10,000 2,00,000
Less: Cost of Goods Sold
Opening Stock ... ... ... 44,000 40,000
Add: Purchases ... ... ... 84,000 72,000
Wages ... ... ... 40,000 36,000
Factory Expenses ... ... ... 32,000 28,000
2,00,000 1,76,000
Less: Closing Stock ... ... ... 46,000 44,000
COGS 1,54,000 1,32,000
Gross Profit GP 56,000 68,000
Less: Operating Expenses ... ... ...
Administration Expenses AE 10,000 8,000
(incl. Managerial
Remuneration)
Selling & Dist. Expenses SE 6,000 10,000
Operating Expenses OE 16,000 18,000

259
Operating Profit OP 40,000 50,000

Less: Income-tax IT 22,000 24,000
Profit after Tax PAT 18,000 26,000
Less: Proposed Dividends ED 6,000 8,000
12,000 18,000
Less: Tfd. to Reserves ... ... ... 2,000 2,000
______ ______
Profits retained RE 10,000 16,000
Q.14 Profit & Loss A/c. and Balance Sheet of SIDHARTH LTD. for
the year ended 31st March, 2007:
Trading Profit & Loss Account for the year ended 31st March 2007
Dr. Cr.
To Purchases 5,40,000 By Closing Stock 80,000
To Wages 2,14,000
To Gross Profit c/d 1,56,000
9,80,000 9,80,000
To Salaries 26,000 By Gross Profit b/d 1,56,000
To Rent 5,000 By Interest on Investment 5,000
To Miscellaneous Exp. 15,000
To Selling Exp. 10,000
To Depreciation 30,000
To Interest 5,000
To Provision for Tax 20,000
1,61,000 1,61,000

Equity Share Capital 1,50,000 Fixed Assets 1,60,000
(Rs. 10) (-) Depreciation 30,000 1,30,000
8% Preference Share 1,00,000 Investment 1,00,000
Capital (Rs. 100)
Reserve & Surplus 62,000 Stock 80,000
10% Debenture 50,000 Debtors 60,000
Bank Loan (Payable 40,000 Bills Receivable 50,000
after 5 years)

260
Creditors 60,000 Cash 85,000

Provision for Tax (C.Y.) 20,000 Preliminary Expenses 5,000
Proposed Pref. 8,000
Dividend
5,10,000 5,10,000
Note: Market value of Equity share is Rs. 12 and Dividend paid per
Equity share is Rs. 2. Calculate the following ratio:
(a) Acid Test Ratio (b) Capital Gearing Ratio
(c) Operating Ratio (d) Dividend Payout Ratio
(e) Debt Service Ratio (f) Creditors Turnover Ratio
(g) Earning per Share (h) Stock Turnover Ratio
(i) Price Earning Ratio
(Mar. 08, adapted)
Solution:
Balance Sheet Ratios:

QA 60,000 50,000 85,000
1. Quick/Liquid Ratio = =
QL 60,000 20,000 8,000
1,95,000
2.22
88,000
PC + BF 1,00,000 50,000 40,000

2. Capital Gearing Ratio = =
EF 1,50,000 62,000 5,000
1,90,000
0.92
2,07,000
Profit & Loss Ratios:
COGS + OE
3. Operating Ratio = ×100
S
(70,000 5,40,000 2,14,000 80,000)

(26, 000 5, 000 15, 000 10, 000 30, 000)
9, 00, 000
8,30,000
100 92%
9,00,000
COGS 7, 44, 000

Stock Turnover Ratio = 9.92
(OST CST ) / 2 75, 000

261
Composite Ratios:
PBIT Sales - COGS - OE + Interest

4. Debt Service = =
INT Interest on Debentures
9, 00, 000 8,30, 000 5, 000 75, 000

15.00
5, 000 5, 000
CRP 5, 40, 000

5. Creditors Turnover = 9.00
(CD BP) 60, 000
365 365
6. Creditors Velocity = 40.56
CTR 9.00
ED 30, 000
7. Dividend Pay-out Ratio = 100 0.71
PAES 42, 000
Profitfor Equityholders 42,000

8. EPS = = = Rs.2.80
No. of Equity Shares 15,000
Marke Price 12
9. Price Earning Ratio = = = 4.29
EPS 2.80
Working Note:

I) Sources of Funds
Equity Share Capital EC 1,50,000
Reserves & Surplus ... ... ... 62,000
Less: Preliminary Expenses ... ... ... (5,000)
Net Reserves & Surplus RS 57,000
Equity Shareholder‟s Funds EF 2,07,000
Pref. Share Capital PC 1,00,000
Proprietor‟s Funds PF 3,07,000
Borrowed Funds
10% Debentures ... ... ... 50,000
Bank Loan (payable after 5 years) ... ... ... 40,000
BF 90,000
_______
Capital Employed (PF+BF) CE 3,97,000
II) Use of Funds

Fixed Assets ... ... ... 1,30,000
Trade Investments ... ... ... 1,00,000
Total Fixed Assets FA 2,30,000

262
Quick Assets
Debtors DR 60,000
Bills Receivable BR 50,000
Cash /Bank ... ... ... 85,000
QA 1,95,000
Closing Stock CST 80,000
Quick Liabilities
Creditors CD 60,000
Prov. For Tax ... ... ... 20,000
Proposed Dividends ... ... ... 8,000
QL 88,000
Bank Overdraft OD 20,000
Current Liabilities CL 1,08,000
Working Capital WC 1,67,000
_______
Capital Employed (FA+WC) CE 3,97,000

Credit Sales CRS 9,00,000
Total Sales S 9,00,000
Opening Stock OST 70,000
Credit Purchases CRP 5,40,000
Wages ... ... ... 2,14,000
Less: Closing Stock (CST) (80,000)
Gross Profit GP 1,56,000
Admin. Expenses
Salaries ... ... ... 26,000
Rent ... ... ... 5,000
Misc. Expenses ... ... ... 15,000
AE 46,000
Selling Expenses SE 10,000
Depreciation ... ... ... 30,000
Operating Expenses OE 86,000
Operating Profit OP 70,000
Interest on Investments ... ... ... 5,000
Profit Before Int. & Tax PBIT 75,000
Interest on Debentures INT 5,000
Net Profit Before Tax NPBT 70,000
Income Tax ... ... ... 20,000
Net Profit After Tax NPAT 50,000
Preference Dividends ... ... ... 8,000
Profit Avl. For Eq. holders PAES 42,000
Equity Dividends (Rs. 2 x 15,000) ED 30,000
______
Retained Earnings RET 12,000

263
Q.15 Following is the Profit and Loss A/c and Balance Sheet of
Adhiraj Ltd:
Profit and Loss A/c for the Year ended 31st December, 2006

To Purchases 2,00,000 By Closing Stock 80,000
To Wages 50,000
To Factory Exp. 70,000
To G.P. c/d 1,90,000
5,30,000 5,30,000
To Administrative Exp. 60,000 By Gross Profit b/d 1,90,000
To Selling Exp. 40,000 By Interest Received 5,000
To Interest on Loan 5,000
To Debenture Interest 8,000
1,95,000 1,95,000
To Tax Provision By Net Profit 82,000
To Proposed Dividend
To Balance Profit
82,000 82,000

Equity Share Capital 2,00,000 Land & Building 1,75,000
(Rs. 10)
9% Preference Share 1,50,000 Machinery 1,50,000
Capital
8% Debenture 1,00,000 Furniture 1,00,000
Reserve 50,000 Goodwill 50,000
Profit & Loss A/c 30,000 Patents 50,000
Short Term Loan 1,00,000 Vehicles 1,40,000
(Repaid within one
year)
Bank Overdraft 75,000 Investment 50,000

264
Sundry Creditors 1,40,000 Stock 80,000

Bills Payable 30,000 Debtors 90,000
Provision for Tax 20,000 Bills Receivable 30,000
9,15,000 9,15,000
Market price of equity share is Rs. 7.

Calculate the following ratios:
(a) Acid Test Ratio (b) Capital Gearing Ratio
(c) Stock Turnover Ratio (d) Debtors Turnover Ratio
(e) Creditors Turnover Ratio (f) Return on Capital Employed
(g) Stock Working Capital Ratio Ratio
(h) Operating Ratio (i) Earning Per Share
(j) Price Earning Ratio
(Mar. 07, adapted)
Solution:
Ratios:
Quick Assets
(a) Quick/Liquid/Acid Test Ratio =
Quick Liabilities
1, 20, 000
0.387 :1
3,10, 000
(b) Capital Gearing Ratio

Preference Share Capital + Borrowed Funds
=
Equity Share Capital + Reserves - Misc. Expenses
2,50, 000
0.893
2,80, 000
Cost of Goods Sold

(c) Stock Turnover Ratio =
Average Stock
2, 60, 000
5.20 times
50, 000

Average Stock =
2
20, 000 80, 000

50, 000
2

265
Credit Sales CRS

(d) Debtors Turnover Ratio = =
Debtors (DR + BR)
4,50,000
3.75
1, 20,000
Credit Purchases CRP

(e) Creditors Turnover Ratio = =
Creditors (CD + BP)
2, 00, 000
1.176
1, 70, 000
PBIT×100
(f) Return on Capital Employed =
CE
90,000
100 16.98%
5,30,000
Stock
(g) Stock to Working Capital =
Working Capital
80, 000
(0.43)
(1,85, 000)
COGS + OE × 100 3,65,000

(h) Operating Ratio = 100 81.11%
S 4,50,000
PAES 48,500
(i) Earning Per Share = = = 2.425
No. of Equity Shares 20,000
Market Price 7
(j) Price Earnings Ratio = = = 2.90
EPS 2.425
Working Note:
Particulars Rs. Rs.
I) SOURCES OF FUNDS
1. Owner’s Funds
(a) Equity Share Capital EC 2,00,000
(b) Reserves and Surplus RS
Reserve ... ... ... ... 50,000
Profit & Loss A/c ... ... ... ... 30,000
Equity Shareholder‟s Funds EF 2,80,000

266
(c) Preference Share Capital PC 1,50,000

Proprietor’s Funds PF 4,30,000
2. Borrowed Funds
8% Debentures BF 1,00,000
_______
CAPITAL EMPLOYED CE 5,30,000
II) APPLICATION OF FUNDS

1. Fixed Assets
Land & Building ... ... ... ... 1,75,000
Machinery ... ... ... ... 1,50,000
Furniture ... ... ... ... 1,00,000
Vehicles ... ... ... ... 1,40,000
Goodwill ... ... ... ... 50,000
Patents ... ... ... ... 50,000
2. Trade Investments FA 50,000
Total Fixed Assets 7,15,000
3. Working Capital
A. Current Assets
a. Quick Assets
Debtors DR 90,000
Bills Receivable BR 30,000
Total Quick Assets QA 1,20,000
b. Non-Quick Assets
Closing Stock CST 80,000
Total Current Assets CA 2,00,000
B. Less: Current Liabilities
a. Quick Liabilities
Creditors CD 1,40,000
Bills Payable BP 30,000
Prov. for Tax 20,000
Proposed Dividends 20,000
Short Term Loan 1,00,000
QL 3,10,000
b. Non-Quick Liabilities
Bank Overdraft OD 75,000
Total Current Liabilities CL 3,85,000
Working Capital (CA-CL) WC (1,85,000)
_______
CAPITAL EMPLOYED (FA+WC) CE 5,30,000

267
Vertical Income Statement for the Year Ended 31st December, 2006
Particulars Rs. Rs.
Net Sales S 4,50,000

Less:
(a) Opening Stock OST 20,000
(b) Credit Purchases CRP 2,00,000
(c) Wages ... ... ... ... 50,000
(d) Factory Expenses ... ... ... ... 70,000
3,40,000
Less: (e) Closing Stock CST (80,000)
1,90,000
Gross Profit GP
Less: Operating Expenses
(a) Administration Expenses ... ... ... ... 60,000
(b) Selling Expenses ... ... ... ... 40,000
(c) Finance Expenses
Interest on Short term Loan ... ... ... ... 5,000
Total Operating Expenses OE 1,05,000
Operating Profit ... ... ... ... 85,000
Non-Operating Interest Income ... ... ... ... 5,000
Profit Before Interest & Tax PBIT 90,000
Interest on Debentures ... ... ... ... (8,000)
Net Profit Before Tax NBIT 82,000
Less: Income Tax IT 20,000
Net Profit After Tax NPAT 62,000
Less: Preference Dividends ... ... ... ... 13,500
(9% x 1,50,000)
Profit Available for Equity holders PAES 48,500
Less: Equity Dividends ... ... ... ... 6,500
(20,000 – 13,500) _______
Retained Earnings ... ... ... ... 42,000

268
11.2 EXERCISE
Q.1 Re-arrange the following Balance Sheet, and Profit and Loss
Account of Eden woods Ltd. in a form suitable for analysis and
calculate the following ratios:
(a) Current Ration (b) Stock Turnover Ratio
(c) Liquidity Ratio (d) Debt Equity Ratio
(e) Gross Profit Ratio (f) Net Profit Ratio
Balance Sheet as at 31st March, 2003

Bills Payable 25,000 Fixed Assets 1,25,000
Debentures 1,00,000 Bank Balance 25,000
Reserves 50,000 Inventory 1,25,000
Equity Share Capital 50,000
Preference Share 50,000
Capital
Total 3,25,000 Total 3,25,000
Profit and Loss Account for the year ended 31st March, 2003

To Opening 75,000 By Sales 5,00,000
Inventories
To Purchases 1,50,000 By Closing 1,25,000
Inventories
To Manufacturing 50,000 By Profit on sale of 25,000
Expenses Shares
To Direct Wages 1,00,000
To Administrative 25,000
Expenses
To Loss on Sale of 27,500
Assets
To Interest on 5,000
Debentures
To Net Profit 1,92,500
Total 6,50,000 Total 6,50,000
(April 96, adapted)

[Ans.: B/S (v) Total Rs. 2,50,000; (a) 2.67:1 (b) 2.5 (c) 1 : 1
(d) 0.67 : 1 or 0.4 : 1 (e) 50% (f) 38.5%]

269
Q.2 The following is the Trading and Profit and Loss A/c and
Balance Sheet of Sham Ltd.
Trading and Profit and Loss Account as on 31st March, 2003

To Wages 20,000
To Power & Fuel 10,000
1,65,000 1,65,000
To Administration By Gross Profit b/d 70,000
Expenses
To Interest By Rent Received 1,500
To Depreciation on
Machinery
To Selling Expenses
To Loss by Fire
To Provision for Tax
To Net Profit
71,500 71,500
To Interim Dividend 10,000 By Opening 15,000
Balance
To Closing Balance 25,000 By Net Profit 20,000
35,000 35,000

Equity Share Capital 1,00,000 Land & Building 50,000
Profit & Loss A/c 25,000 Plant & Machinery 30,000
Creditors 15,000 Furniture 20,000
Secured Loans 10,000 Stock 15,000
Bank Overdraft 25,000 Debtors 15,000
Provision for Tax 5,000 Investments 12,500
Outstanding 5,000 Cash 17,500
Expenses
Goodwill 20,000
Miscellaneous 5,000
Expenditure
1,85,000 1,85,000

270
Calculate the following ratios after converting above financial

statements in vertical form :-
(1) Inventory Turnover Ratio (2) Gross Profit Ratio
(3) Operating Ratio (4) Current Ratio
(5) Proprietory Ratio (6) Liquid Ratio
(April 2002, adapted)
[Ans.: B/S (v) Total Rs. 1,30,000; (1) 6.8 (2) 43.33%
(3) 74.67% (4) 0.95 : 1 (5) 66.67% (6) 1.30 : 1]
Q.3 (From Details): Given below are extracts of Financial

Statement of M/s. D.K. Ltd.
Particulars 31-3-2004
Rs.
Stock 2,60,000
Debtors 1,00,000
Cash 1,40,000
Bills Receivable 1,00,000
Creditors 1,00,000
Bank Balance (Cr.) 30,000
Total Purchases 8,00,000
Cash Purchases 2,00,000
Cash Sales 3,00,000
Credit Sales 12,00,000
Credit allowed to Customers 1½ months
Credit allowed to Suppliers 3 months
From the above find out the following Ratios and give your
comment for the year ended 31-3-2004:
(1) Current Ratio (2) Liquid Ratio (3) Debtors Turn Over Ratio and
Age of Debtor. (4) Creditors Turn Over Ratio and Age of Creditors.
(October 2001, adapted)
[Ans.: (1) 3.16 : 1 (2) 2.13 : 1 (3) 6 (4) 4 times, 3 months]

271
Q.4 Following are the financial statements of two similar

companies :
Balance Sheet as at 31st December, 2006

Rs. Rs. Rs. Rs.
Share Capital
Equity Share of 4,000 4,000 Land and 1,400 1,200
Rs. 10/- each Building
Revenue 1,950 1,600 Plant 4,100 3,200
Reserve
8% Debenture 1,000 1,000 Stock 2,850 2,100
Trade Creditors 2,800 1,400 Debtors 2,600 1,900
Other Creditors 250 200 Investment - 300
(Long Term)
Provision for 900 700 Bank 100 300
Tax
Proposed 300 200 Deposit 150 100
Dividend
11,200 9,100 11,200 9,100
Income Statement for 2006
X Ltd. Y Ltd. X Ltd. Y Ltd.

Rs. Rs. Rs. Rs.
Cost of Sales 10,800 9,000 Sales 15,000 12,000
Operating Exps 2,900 2,000
Taxation 550 410
Net Profit after 750 590
Tax
15,000 12,000 15,000 12,000
On the basis of above information. You are required to compute

separately the following ratio:
(1) Capital Gearing Ratio (2) Current Ratio
(3) Debtors Turnover Ratio (4) Return on Proprietory Fund
Vertical final accounts need not be prepared.
(Oct. 07, adapted)
[Ans: X Ltd (1) 0.168 (2) 1.34 : 1 (3) 5.77 (4) 12.61%
Y Ltd (1) 0.179 (2) 1.76 : 1 (3) 6.32 (4) 10.54 %]

272
Q.5 Following are the Balance Sheets of X Ltd. and Y Ltd as on

31st March, 2004 together with supplementary information for
the year ended on that date:

Rs. Rs. Rs. Rs.
Paid-up Share 2,00,000 3,50,000 Goodwill 30,000 50,000
Capital
Reserves 50,500 60,000 Building 1,20,000 2,40,000
Profit & Loss 12,250 1,02,200 Plant and 29,000 42,000
A/c Machinery
Bank Overdraft 11,250 14,800 Stock 66,000 93,000
Sundry 36,000 58,000 Debtors 85,000 1,75,000
Creditors
Provision for 20,000 15,000
Taxation
3,30,000 6,00,000 3,30,000 6,00,000
Additional Information:

Rs. Rs.
Sales for the year 8,40,000 10,50,000
st
Stock on 31 March, 2003 60,000 1,07,000
Gross Profit 2,10,000 2,50,000
You are required to compute the following ratios of both companies

(a) Current Ratio
(b) Liquid Ratio
(c) Proprietary Ratio
(d) Stock Turnover Ratio and
(e) Debtors Turnover Ratio in no. of times
All sales are on credit basis.
[Ans: X Ltd. (a) 2.245: 1 (b) 1.52 : 1 (c) 0.80 : 1 (d) 10 (e) 9.88
Y Ltd. (a) 3.05 : 1 (b) 2.40 : 1 (c) 0.85 : 1 (d) 8 (e) 6]

273
Q.6 (From Details): The following are the extracts from the
financial statements of M/s. Salman Ltd., as on 31st March
2002 and 2003 respectively.
Particulars 31-3-2002 31-3-2003

Rs. Rs.
Stock 10,000 25,000
Debtors 20,000 20,000
Bills Receivable 10,000 5,000
Advances (Recoverable in Cash or kind) 2,000 --
Cash on Hand 18,000 15,000
Creditors 25,000 30,000
Bills Payable 15,000 20,000
Bank Overdraft -- 2,000
9% Debentures 5,00,000 5,00,000
Sales for the year 3,50,000 3,00,000
Gross Profit 70,000 50,000
You are required to compute for both these years: (i) Current Ratio;
(ii) Liquid Ratio; (iii) Stock Turnover Rate; (iv) Number of days
outstanding of debtors; (v) Stock-Working Capital Ratio.
[Ans: C.R: 1.5 & 1.25; L.R: 1.25 & 0.8; S.T.R: 28 & 14.29 times;
D.T.R: 31 & 30 days; S.W.C: 0.5 & 1.92]
Q.7 (From Details): Calculate from the following details furnished

by Suraj Ltd. (a) Current Ratio (b) Liquid Ratio (c) Creditors
Turnover Ratio and Average Credit Period (d) Debtors
Turnover Ratio and Average Credit Period (e) Stock Turnover
Ratio.
Particulars Rs.
Stock 8,00,000
Debtors 1,70,000
Cash 30,000
Creditors 3,00,000
Cash Purchases 30,000
Gross Profit Rates
(April 2000, adapted)
[Ans: (a) CR 2.5: 1 (b) LR 0.56 : 1 (c) CTR 3 times (d) DTR 7.29 times
(assume Opening Stock = Closing Stock) (e) STR 1.16 times]

274
Q.8 Calculate from the following details furnished by Pardeshi Ltd.:

(a) Current Ratio
(b) Liquid Ratio
(c) Credit Turnover Ratio and Average Credit Period
(d) Debtors Turnover Ratio and Average Credit Period
(e) Stock Turnover Ratio
Rs.
Stock 1,00,000
Debtors 1,40,000
Cash 60,000
Creditors 1,60,000
Cash Purchases 20,000
Gross Profit Ratio 33 13 %

[Ans: (a) 1.5: 1 (b) 1.18 : 1 (c) 4 times (d) 7.07 times (e) 6.6 times]
Q.9 From the following information, relating to a limited company,

prepare a statement of Proprietor‟s Funds.
(i) Current Ratio 2

(ii) Liquid Ratio 1.5
(iii) Fixed Assets /Proprietor‟s Funds 3/4
(iv) Working Capital Rs. 75,000
(v) Reserves and Surplus Rs. 50,000
(vi) Bank Overdraft Rs. 10,000
There were no long-term loans or fictitious assets.
All workings must form part of your answer.
[Ans: (i) Shareholder’s Funds – Rs. 3,00,000

(ii) Fixed Assets – Rs. 2,25,000 (iii) Working Capital – Rs. 75,000)

275
Q.10 From the following information of X Engineering Co.

complete the Proforma Balance Sheet if sales are
Rs. 16,00,000.
Sales to Net Worth 2.3 times

Current Liabilities to Net Worth 42%
Total Liabilities to Net Worth 75%
Current Ratio 2.9
Sales to Closing Inventory 4.5
Average Collection Period 64 days
Proforma Balance Sheet

Net Worth ? Fixed Assets ?
Long term Liabilities ? Cash ?
Current Liabilities ? Stock in Trade ?
? Debtors ?
Calculations are to be made to the nearest rupee.
[Ans: Net worth Rs. 6,95,652; Long term liabilities Rs. 2,29,565;
Current Liabilities Rs. 2,92,174; Fixed Assets Rs. 3,70,086;
Debtors Rs. 2,80,548; Stock Rs. 3,55,555; Cash Rs. 2,11,202]
Q.11 From the following information, prepare a summarised

Balance Sheet as at 31st March, 2004.
Rs.
Working Capital 1,20,000
Reserves & Surplus 80,000
Fixed Assets Proprietory Ratio 0.75
Current Ratio 2.50
Liquid Ratio 1.50
Your working notes should form part of the answer.
[Ans: B/S Total Rs. 5,60,000; Fixed Assets Rs. 3,60,000;

Stock Rs. 80,000; Capital Rs. 4,00,000]

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Q.12 Based on the following information of the financial ratios,

prepare Balance Sheet of Star Enterprises Ltd. as on
December 31st, 2002. Explain your working and
assumptions.
Current Ratio 2.5
Liquidity Ratio 1.5
Net Working Capital Rs. 6,00,000
Stock Turnover Ratio 5
Ratio of Gross Profit to Sales 20%
Turnover Ratio to Net Fixed Assets (COGS /FA) 2
Average Debt Collection Period 2.4 months
Fixed Assets to Net Worth 0.80
Long-term Debt to Capital and Reserve 7/25
Ans:
st
Balance Sheet as on December 31 2002

Share Capital and 12,50,000 Fixed Assets (Cost)
Reserves
Long-term Debts 3,50,000 Less Depreciation 10,00,000
Current Liabilities 4,00,000 Current Assets:
Stock in Trade 4,00,000
Cash 1,00,000
20,00,000 20,00,000
Q.13 From the following information prepare a Balance Sheet with

as many details as possible.
(1) Current Ratio 2.5 : 1
(2) Liquid Ratio 1.5:1
(3) Fixed Assets / Proprietor‟s Fund 0.75
(4) Working Capital Rs. 60,000
(5) Reserves and Surplus Rs. 40,000
(6) Bank Overdraft Rs. 10,000
(7) There is no long-term loan or fictitious asset.
Ans:
Balance Sheet
Share Capital 2,00,000 Fixed Assets 1,80,000
Reserves and Surplus 40,000 Current Assets
Current Liabilities Liquid Assets 45,000
Bank Overdraft 10,000 Stock 55,000 1,00,000
Quick Liabilities 30,000 40,000
2,80,000 2,80,000

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Q.14 From the following information, prepare a summarised

Balance Sheet as at 31st March, 2002.
Stock Turnover 6
Fixed Assets Turnover Ratio
(Sales ÷ Fixed Assets) 4
Capital Turnover Ratio (Sales ÷ Capital) 2
Gross Profit Ratio 20%
Debt Collection Period 2 months
Gross Profit Rs. 60,000
Closing Stock was Rs. 5,000 in excess of opening stock
Creditors 49,000
All workings should form part of your answer.
Ans:
Balance Sheet as on 31-3-2002

Capital 1,50,000 Fixed Assets 75,000
Cash & Bank 31,500
(Bal. Fig.)
1,99,000 1,99,000
Q.15 Shri Devdas asks you to prepare his Balance Sheet from the
particulars furnished hereunder:
Gross Profit margin 20%
Stock velocity: 6
Capital Rs. 1,50,000
Fixed Assets Rs. 75,000
Debt collection period 2 months
Creditors payment period 73 days
Gross Profit was Rs. 60,000
Excess of closing stock over opening stock was Rs. 5,000
Difference in Balance Sheet represents bank balance.
[Ans: Bank – Rs. 31,500]

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
12
WORKING CAPITAL MANAGEMENT
278
Unit Structure:
12.0 Objectives
12.1 Introduction
12.2 Meaning and Definition of working capital
12.3 Working Capital Cycle
12.4 Classification of working capital
12.5 Factors determining working capital requirements
12.6 Need for working capital (Importance of working capital)
12.7 Working capital management
12.8 Changes in working capital
12.9 Key points
12.10 Additional readings
12.11 Exercise
12.0 OBJECTIVES
After studying this chapter you should be able to understand

Concept of Working Capital
Nature of Working Capital
Need for Working Capital
Working Capital Cycle
Classification of Working Capital
Determinants of Working Capital
12.1 INTRODUCTION
Every organization requires Fixed Capital for purchase of

fixed assets viz. Land and Building, Plant and Machinery, Furniture,
Vehicles etc. In addition to fixed capital an organisation also
requires additional capital for financing day to day activities. Such
capital which is required for financing day to day activities in the
business is called Working Capital.
Working Capital is that part of the funds of a business which

is used for day to day operation. It is the money required to keep
the business running smoothly. (It is required for smooth conduct
of business activities.) In the absence of Working Capital, fixed
assets can not be employed gainfully. It is the working capital

279
which decides success or failure of an organisation. It is the life

blood of an organisation.
Forecasting Working Capital and Control of Working Capital

is a continuous process and therefore, part of parcel of the overall
management of the business.
12.2 MEANING AND DEFINITION OF WORKING

CAPITAL
The term Working Capital has been defined by different

authors in different ways.
According to “Hoagland”, “Working Capital is descriptive of that

capital which is not fixed. But, the more common use of Working
Capital is to consider it as the difference between the book value of
the current assets and the current liabilities.
Gerestenberg defines Working Capital as, “Circulating capital

means, Current Assets of a Co. that are changed in the ordinary
course of business from one form to another as for example from
cash to inventories, inventories to receivables and receivables to
cash.”
The accounting principles Board of the American

Institute of Certified Public Accountants define Working
Capital as, “Working Capital is represented by the excess of
current assets over current liabilities and identifies the relatively
liquid portion of the total enterprise, capital which constitutes a
margin or buffer for maturing obligation within the ordinary
operating cycle of the business.”
From the above definitions, Working Capital means the

excess of Current Assets over Current Liabilities. Working Capital
is the amount of net Current Assets. It is the investments made by
a business organisation in short term Current Assets like Cash,
Debtors, Bills receivable etc.
Current Assets are those assets which will be converted into

Cash or will be realised within a year. These assets will be
liquidated in the near future.
Current liabilities are those liabilities which will have to be

paid within a year and include such income received in advance for
which are to be given within 12 months.
Working Capital = Current Assets – Current Liabilities

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12.3 WORKING CAPITAL CYCLE
Working Capital cycle is also known as operating cycle

concept. This concept is based on continuity of flow of funds
through business operations. This flow of value is caused by
different operational activities during a given period of time. The
operational activities of an organisation may include :
a) Purchase of raw materials.

b) Conversion of raw materials into finished products.
c) Sale of finished products.
d) Realisation of accounts receivables.
The operating cycle of a manufacturing concern begins on

the day it purchases raw material to produce the goods and ends
on the day it receives the sale price from debtors. The period
between these two days is the duration of the entire operating
cycle.
Operating cycle of a manufacturing organisation
Cash
Purchase of Raw Materials
Collection from
Debtors (Bills receivables)
Work in Progress
Finished
goods
Operating cycle of a Trading Organisation :
In case of trading organisation, operational activities include:

1) Purchase of finished goods.
2) Sale of finished goods on cash or credit.
3) Collection from debtors (Bills Receivables).
Operating Cycle

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Cash
Purchase of finished goods
Collection from
Debtors (Bills receivables)
Sales of Finished
goods
When the goods are sold on credit basis, the sale of goods
cannot be converted into cash instantly because of time lag
between sales and realization of cash. Due to time lag between
sales and realization of receivables, there is a need for sufficient
Working Capital to deal with the problem which arises due to lack of
immediate realization of cash against goods sold. The operating
cycle is the length of time required for conversion of cash into raw
material, raw material into work in progress, work in progress into
finished goods, finished goods into bills receivables, bills
receivables into cash and the same cycle repeats. Therefore
operating cycle is a continuous process.
12.4 CLASSIFICATION OF WORKING CAPITAL
Working Capital can be classified into :

1) Gross and Net Working Capital.
2) Permanent and Temporary Working Capital.
3) Balance Sheet and Cash Working Capital.
4) Positive and Negative Working Capital.
1) Gross and Net Working Capital
Gross Working Capital is equal to total current assets only.

It is identified with current assets alone. It is the value of non –
fixed assets of an organisation and includes all current assets only.
Items of current assets are stock of raw material, work in progress,
finished goods spares and consumables, stores, sundry debtors,
bills receivables, cash and bank balances, prepaid expenses,
accrued income, advance payments, short term investments etc.

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Gross Working Capital indicates the quantum of Working

Capital available to meet current liabilities. This is very useful for
planning of business activities in normal course.
Therefore, Gross Working Capital = Total Current Assets
Net Working Capital is the excess of current assets over

current liabilities i.e. current assets less current liabilities.
Net Working Total Current Total Current

Capital
=
Assets (–) Liabilities
In other words, total value of current assets is reduced by

total current liabilities such as sundry creditors, bills payable, bank
overdraft, income received in advance, outstanding liabilities, etc.
This is most common type of Working Capital. It indicates

the amount available to meet short term dues of the concern. This
concept is useful for calculating the amount of current assets
available to meet the current liabilities. It indicates the liquidity of
the concern in the immediate future.
2) Permanent and Temporary Working Capital
Permanent Working Capital

A business organisation must always have a minimum
amount of Working Capital to meet the current liabilities as and
when they arise. In other words a concern must have minimum
amount of fund to ensure liquidity and solvency. It is the minimum
aggregate of cash, inventory and debtors maintained to carry on
business operations smoothly at any time during an accounting
period such minimum amount of Working Capital required to enable
the concern to operate at the any level of activity is called
permanent Working Capital. The quantum of permanent Working
Capital will very according to the level of business activities from
time to time.
Permanent Working Capital is of two types :
a) Initial Working Capital

b) Regular Working Capital
a) Initial Working Capital
This is the amount of Working Capital required at the

inception of an organisation. In the initial stages, when the

283
revenues are not regular, it may be difficult for a company to obtain

credit from banks and at the same time it may be required to grant
credit to its customers. In such cases, adequate Working Capital is
required to activate the circulation of capital and keep it moving till
the collection from debtors and other cash receipts exceed the
payment. Therefore, it is the Working Capital in the initial stage to
start the business and to commence the operating cycle.
b) Regular Working Capital :
This is the amount of Working Capital required for the

continuous operations of an enterprise. It refers to the excess of
current assets over current liabilities. Every organisation has to
maintain a minimum stock of materials, finished goods and cash to
ensure its smooth working and to meet its immediate obligations.
This is the minimum amount of capital required to enable the
concern to operate at the lowest level of activity. Such minimum
amount of Working Capital is called Permanent Working Capital or
Core Working Capital.
Then Permanent Working Capital is the quantum of funds

required permanently for the production of goods and services on a
continuing basis to satisfy the demands of customers Permanent
Working Capital has following features.
a) It is constantly changing. They change from one current asset
to another as in case of raw materials. Raw materials as they
are in process, become semi finished goods, then finished
goods and when they are sold become debtors, debtors when
realized become cash and so on.
b) The size of permanent Working Capital will increase as long as

the business is growing and expanding.
c) Permanent Working Capital is different from fixed assets which

are sunk in the business operations and retain their firm for a
long period.
Temporary or Variable Working Capital
If the business organisation wants to increase its level of

activity and produce and sell more goods, naturally it will need
additional amount of Working Capital. If the increase in level of
activity is temporary or seasonal, the additional Working Capital
required is called Temporary Working Capital.
The amount of Temporary Working Capital varies with the

level of activity (level of production). When the production is at
higher level, larger Temporary Working Capital is needed, when the
production level is lower, smaller amount of Temporary Working

284
Capital is required. Therefore, Temporary Working Capital is also

called as Variable or Fluctuating Working Capital.
Sometimes temporary Working Capital may be Seasonal

Working Capital. It is the amount of Working Capital required at
stated intervals to meet the changing seasonal requirements.
When the season approaches, business needs more funds to meet
the seasonal pressure of demand. For e.g. Sugar factories require
large amount of Working Capital during peak season and much
smaller amount of Working Capital once the season is over.
Temporary Working Capital can be financed through

temporary sources of finance. E.g. short term loans, deposits, bank
overdraft etc.
3) Balance sheet and Cash Working Capital
Balance Sheet Working Capital
Working Capital is determined on the basis of the balances

of current assets and current liabilities as per the closing balance
sheet of the business. Such Working Capital which is computed on
the basis of book values of current assets and current liabilities is
called Balance Sheet Working Capital. Therefore, Balance Sheet
Working Capital shows the amount of Net Current Assets as on the
last day of accounting year of a concern. This concept of Working
Capital helps in judging the liquidity and solvency of a concern.
Cash Working Capital
It is that part of gross Working Capital which is essentially in

liquid term. It is available in cash or cash resources. It is
calculated from the items appearing in the Balance sheet. It shows
the real flow of money at a particular time. It is considered to be
the most realistic approach in Working Capital management. Cash
Working Capital indicates the adequacy of the cash flow.
4) Positive and Negative Working Capital
Positive Working Capital
When current assets exceed current liabilities, the Working

Capital is said to be positive Working Capital. In other words when
current assets are more than current liabilities, the net current asset
is a positive figure and hence it is called Positive Working Capital.
Such Working Capital indicates favourable liquidity and solvency
position of the business.
Negative Working Capital

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When the current assets are less than the current liabilities,
the Working Capital is said to be Negative Working Capital. In
other words when current assets are less than current liabilities the
net current asset is negative figure and hence it is called Negative
Working Capital. Such Working Capital indicates lack of liquidity
and adverse solvency position of the business.
12.5 FACTORS DETERMINING WORKING CAPITAL

REQUIREMENTS
The amount of Working Capital required by a business

organisation depends on many factors. They are as follows.
1) Nature of Business : The quantum of Working Capital required

by a business organisation is related to the type and nature of
its business activities. Public utilities (like railway companies)
require less Working Capital as they sell services on cash basis
only. But a trading organisation requires proportionately larger
amount of Working Capital as it has to carry large inventories
and allow credit to customers. Similarly, a manufacturing
concern requires more Working Capital as compared to a firm
engaged in trading. However, the requirement of Working
Capital varies from industry to industry and from time to time in
the same industry.
2) Size of Business : It is an important factor for determining the

proportion of Working Capital. If the size of the business
organisation in big, it require more Working Capital. On the
other hand, small scale organisation requires less amount of
Working Capital.
3) Production Policies : Production policies of a business

organisation exert considerable influence on the requirement of
Working Capital. But production policies depend on the nature
of product. The level of production, decides the investment in
current assets which in turn decides the quantum of working
capital required.
4) Terms of Purchase and Sale : A business organisation making

purchases of goods on credit and selling the goods on cash
terms would require less Working Capital whereas an
organisation selling the goods on credit basis would require
more Working Capital. If the payment is to be made in advance
to suppliers, then large amount of Working Capital would be
required.

286
5) Production Process : If the production process requires a long

period of time, greater amount of Working Capital will be
required. But, simple and short production process requires
less amount of Working Capital. If production process in an
industry entails high cost because of its complex nature, more
Working Capital will be required to finance that process and also
for other expenses which very with the cost of production
whereas if production process is simple requiring less cost, less
Working Capital will be required.
6) Turnover of Circulating Capital : Turnover of circulating

capital plays an important and decisive role in judging the
adequacy of Working Capital. The speed with which circulating
capital completes its cycle i.e. conversion of cash into inventory
of raw materials, raw materials into finished goods, finished
goods into debts and debts into cash decides the Working
Capital requirements of an organization. Slow movement of
Working Capital cycle requires large provision of Working
Capital.
7) Dividend Policies : Dividend policies of a business

organisation also influence the requirement of Working Capital.
If a business is following a liberal dividend policy, it requires
high Working Capital to pay cash dividends where as a firm
following a conservative dividend policy will require less amount
of Working Capital.
8) Seasonal Variations : In case of seasonal industries like

Sugar, Oil mills etc. More Working Capital is required during
peak seasons as compared to slack seasons.
9) Business Cycle : Business expands during the period of

prosperity and declines during the period of depression. More
Working Capital is required during the period of prosperity and
less Working Capital is required during the period of depression.
10) Change in Technology : Changes in Technology as regards

production have impact on the need of Working Capital. A firm
using labour oriented technology will require more Working
Capital to pay labour wages regularly.
11) Inflation : During inflation a business concern requires more
Working Capital to pay for raw materials, labour and other
expenses. This may be compensated to some extent later due
to possible rise in the selling price.

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12) Turnover of Inventories : A business organisation having low

inventory turnover would require more Working Capital where
as a business having high inventory turnover would require
limited or less Working Capital.
13) Taxation Policies : Government taxation policy affects the

quantum of Working Capital requirements. High tax rate
demands more amount of Working Capital.
14) Degree of Co-ordination : Co-ordination between production

and distribution policies is important in determining Working
Capital requirements. In the absence of co-ordination between
production and distribution policies more Working Capital may
be required.
12.6 NEED FOR WORKING CAPITAL (IMPORTANCE

OF WORKING CAPITAL)
„Working Capital‟ discussed in the earlier paragraphs mean

excess of current assets over current liabilities. Such Working
Capital is required to smooth conduct of business activities. It is as
important as blood to body. An organisation‟s profitability depends
on the quantum of Working Capital available to it. Adequate
Working Capital is a source of energy to any business organisation.
It is the life blood of an organisation.
The following points will highlight the need of Working

Capital.
Adequate Working Capital :
a) Enables a company to meet its obligations.
b) Ensures the credit standing of a company.
c) Facilitates obtaining Credit from banks without any difficulty.
d) Ensures solvency of a company.
e) Enables a company to make prompt payments to its creditors
and thereby take advantage of cash and quantity discounts
offered by them.
f) Enhances the goodwill of a company as it can meet its
operational expenses and maturing liabilities in time.
g) Improves the prospects of prosperity and progress of a
company.
h) Enables an organisation to tide over difficult periods
successfully.

288
Thus, adequate Working Capital is an important factor for

prosperity and smooth running of a business organisation. It is
rightly called as the “backbone” of the financial structure of a
business organisation.
12.7 WORKING CAPITAL MANAGEMENT
Working Capital as it is explained in the earlier paragraphs,

means excess of current assets over current liabilities. Working
Capital management means all aspects of managing and
controlling current assets and current liabilities. It is an attempt to
solve the problems that arise in the management of current assets
and current liabilities.
The main objective of Working Capital management is to

manage the current assets and current liabilities of a business
efficiently with the idea to bring about a satisfactory level of
Working Capital so that the business can run smoothly. It aims to
strike a judicious balance between individual items of current
assets and current liabilities and thereby achieves a reasonable
safety margin.
Working Capital management policies exercise strong

influence on a company‟s profitability, liquidity and its structural
health. Estimating the amount of Working Capital required and
identification of the source from which the required funds have to
be raised, are the two main objectives of Working Capital
management. Thus Working Capital management aims at best
utilization of scarce resources to bring about satisfactory level of
Working Capital and so that the business can run smoothly.
12.8 CHANGES IN WORKING CAPITAL
Working Capital means excess of current assets over

current liabilities. It ensures the solvency of a company. It also
ensures the credit standing of a company. But if the value of
current assets increases, the Working Capital also increases and if
value of current liabilities increases the Working Capital decrease.
Therefore, change in current assets and current liabilities also
change the Working Capital of the organisation.
The following list shows the effect of change in current

assets or current liabilities on the Working Capital.
Change in Current Assets or Current Effects on Working Capital

289
Liabilities
Increase in Current Assets Increase in Working Capital

Decrease in Current Assets Decrease in Working Capital
Increase in Current Liabilities Decrease in Working Capital
Decrease in Current Liabilities Increase in Working Capital
Realization from Debtors No change in Working Capital
Obtaining Bills Receivable from Debtors No change in Working Capital
Bills payable issued to Creditors No change in Working Capital
Sales of goods on credit No change in Working Capital
Purchase of Stocks on credit No change in Working Capital
Payment of cash to Creditors No change in Working Capital
Payments of Cash against Bills Payable No change in Working Capital
Collection of Cash on Bills Receivable No change in Working Capital
12.9 KEY POINTS

Working Capital is excess of Current Assets over Current
Liabilities.
Current Assets include Stock, Debtors, Work in Progress, Bills
Receivables, Cash / Bank, Prepaid Expenses.
Current liabilities include Creditors, Bills Payable, Bank
Overdraft, and Outstanding Expenses.
Operating cycle of a manufacturing organisation includes
operational activities like purchase of raw materials, payment of
wages and expenses, production of finished goods, sale of
finished goods on cash and credit, collection from debtors.
Operating cycle of a trading organisation includes operational
activities like purchase of finished goods, sale of finished goods
on cash and credit, collection from debtors.
Classifications Working Capital
o Gross and Net Working Capital
o Permanent and Temporary Working Capital
o Balance Sheet and Cash Working Capital
o Positive and Negative Working Capital
o Determinants of Working Capital
12.10 ADDITIONAL READINGS
1) Introduction to Management Accounting by Chopade and

Chaudhari

290
2) Introduction to Management Accounting by Ainapure.
12.11 EXERCISE
1) Define Working Capital. Explain the importance of Working

Capital in business.
2) What is Working Capital and what are the types of Working
Capital?
3) What is Working Capital? Explain the factors determining
Working Capital requirements.
4) Write short notes on :
a) Permanent and Temporary Working Capital
b) Gross and Net Working Capital
c) Balance Sheet and Cash Working Capital
d) Positive and Negative Working Capital.
5) What is Working Capital? Explain the need for Working Capital.

13
BUDGETING-I
Unit Structure:
13.0 Objectives
13.1 Meaning of Budget
13.2 Purpose of Budget
13.3 Budgetory Control
13.4 Preparation of Budget & Types
13.5 Methods of Preparation of Cash Budget
13.6 Exercises

291
13.0 OBJECTIVES

Understand the meaning of Budget and Budgetary control.
Know the purpose of Budget.
Explain the types of Budget.
Understand how to prepare cash budget.
13.1 MEANING OF BUDGET
Budget means a financial and quantitative statement prepared and

approved prior to a defined period of time. It is plan of expected
achievements based on most efficient operating standards in effect. It may
be considered as a guide.
13.2 PURPOSE OF BUDGET
1. Planning
2. Co-ordination
3. Control
1. Planning – It helps in combining ideas of different management

levels. So that maximum profitability is achieved.
2. Co-ordination – It brings different people together in accomplishing

the organizational goals.
3. Control – It helps in comparing the actual results with the estimates

and putting controls wherever required.
13.3 BUDGETORY CONTROL
It is a system of planning and controlling costs. It helps in

comparing the actual results with budgeted estimates to secure by
individual action the objective of that policy or to provide basis for its
revision.
STEPS IN BUDGETORY CONTROL
1. ESTABLISHMENT OF BUDGETS – Budgets are prepared for

each division and are well co-ordinated with each other to prepare
the master budget of a firm.
2. MEASUREMENT OF ACTUAL PERFORMANCE – The
actual results are measured to compare with the budgets.

292
3. COMPARISON AND VARIANCES – The actual results after

comparing with standards, deviations are work out known as
variances.
4. ANALYSIS OF CAUSES OF VARIATION – The deviations
between budgeted and actual results are studied and analysed help
in taking the right action in right time.
13.4 PREPARATION OF BUDGETS AND TYPES
13.4.1 MASTER BUDGET – It is defined as summary budget which

includes different functional budgets and which is finally approved
adopted and employed. It is defined as a budget which summarises all
functional budgets when all functional budgets are prepared they are
summarized to produce.
i. Profit & Loss Account and Profit & Loss Appropriation Account.
ii. Balance Sheet.
Master Budget takes the form of budged Profit & Loss Account
and Balance Sheet. It is overall business plan and familiar to financial
statements. The only difference is that the accountant here deals with
expected future data rather than historical data.
The budget committee will prepare the master budget based on the
functional budget. Once it is approved by the committee it becomes the
target for the firm during the budget period.
13.4.2 FIXED BUDGET – Budget prepare at single level of activity are

referred to as Fixed Budget. Such budgets focus only on a specific
activity and a specific level. All adjustments are made considering only
this level of activity.
13.4.3 FLEXIBLE BUDGET – Flexible Budget estimates cost of several

level of activities. Instead of one estimates it contains several estimates in
different assumed circumstances. The construction of flexible budget is
similar to fixed budget is based on cost and other business operations at
one level, the flexible budget consider several operations. The essence of
flexible budget is the presentation of estimated cost date in a manner that
permits there determination at various levels of volume. This means that
all costs must be identified into fixed and variable. Fixed cost remain
unchanged. They are fixed for a relevant range of volume for a given
budget period.
Variable cost fluctuate in direct proportion to the activity/ volume

with in relevant range for a given budget period. Mixed cost contents both
fixed and variable element.

293
13.4.4 CASH BUDGET – A Cash Budget is a projected cash transaction

in future that is utilized in controlling actual receipts and payments by
mending for the variances. It starts with a given ‘Cash Balance’ which
may be either big or small. But the said balance is, in any case, desired to
be ‘the optimum balance’. The sign of optimality for a given cash balance
is obviously its ability to produce the highest rate of return for the
minimum cost for mainly the said cash balance.
The main aim of Cash Budget is to ascertain whether there is

excess or deficit of cash. It involves different steps.
i. The First element is selection of time period to be covered which is

known as planning horizon. This coverage will differ from firm to
firm depending upon its nature and degree of accuracy.
ii. The Second element is the factors affecting the cash flows. Non cash
items such as, depreciation are excluded from Cash Budget. The cash
flow is affected by two factors operating and financial. The operating
category includes cash flow generated by operations of the firm and
are known as operating cash flows. The other category is known as
financial cash flow.
a) Operating Cash Flow contains the following.
INFLOW OUTFLOW
1. Cash Sales 1. Cash Purchases

2. Collection from Debtors 2. Payment to Creditors
3. Sale of Assets 3. Purchase of Assets.
4. Operating Expenses Paid
b) Financial Cash Flow contains the following.
INFLOW OUTFLOW
1. Loans taken 1. Repayment of Loan

2. Sale of Investments 2. Purchase of Investment
3. Issue of Shares 3. Redemption of Shares
4. Interest, Divided, 4. Interest, Dividend, Rent Paid
Rent Received.
13.5 METHODS OF PREPARATION OF CASH

BUDGET

294
Methods used for cash forecasting – There are two recognized

ways of preparing a cash forecasting.
13.5.1 The Receipt & Payment Method.
13.5.2 The Income Statement Cash Flow Method (Adjusted Profit & Loss
method)
13.5.1 THE RECEIPT AND PAYMENT METHOD – Under this

method, all expected cash receipts and payments during the period; under
consideration are taken into account. The expected cash balance of a
week or month will be equivalent to the difference between total expected
Cash Receipts including opening balance, if any, and total expected Cash
Payment during that period. The budget is generally prepared from
various plans.
i. Cash Receipts from Customers, based on sales forecast, the term of

sale, lag in payment etc. are generally taken into consideration.
ii. Cash Receipts from other sources, such as dividend on trade
investments, rent, issue of capital, sale of; investment and fixed assets
etc.
iii. Cash requirements for materials, wages and salaries and overhead
expenses based on purchasing, personnel and overhead budgets. The
policy of the business with regard to the payment of supplier’s
accounts, the term of cash discount, the lag in payment of wages etc.
are given due consideration.
iv. Cash requirements for capital expenditure as per capital expenditure
budget.
v. Cash requirement for other purposes, such as payment of dividend,
income tax, fines, penalties etc.
FORMAT OF CASH BUDGET (Monthly / Quarterly)
Month/ Quarter 1 2 3 4 Total

Particulars
Opening Balance x x
Cash Sales
Collection from Debtors
Income from Investments
Loans
Share Capital
Others

295
Total Receipts (A)
Cash Purchases
Creditors
Salaries & Wages
Overhead Expenses
Dividend
Income Tax
Capital Expenditure
Repayment of Loan
Others
Total Payments (B)
Closing Balance (A-B) y y
13.5.2 THE INCOME STATEMENT CASH FLOW METHOD

(ADJUSTED PROFIT & LOSS ACCOUNT) –
This method is based both on cash and non-cash transactions.
Under this method, budgeted net profit is adjusted by adding back non-
cash charges and deducting non-cash credits and adding or deducting
changes in assets or liability accounts which affect cash. The theory is
based upon the basic assumption that profit will be equivalent to cash, or
in other words, the earning of profit brings equal amount of cash into the
business. This also leads one to another assumption that the business will
remain static. That is, there will not be wearing out or expansion of assets;
balances of debtors, creditors, stock etc will remain unchanged. So that
total cash available for distribution would be equal to the profit earned.
But in practice a business does not remain stationery so that an adjustment
will have to be made in respect of many items like fluctuations of stock,
appropriation of profit, provisions, accruals etc.
Thus, the preparation of a cash budget under this method depends on
the availability of the following information :-
a. Budgeted Profit & Loss Account for the budget period in respect
of which the cash budget is to be prepared.
b. Budgeted Balance Sheet as at the end of the same period and
c. The Balance Sheet as at the end of the previous period.

296
This method may be employed for making long term cash

forecasts.
(Note: First Method of Cash Budget is a part of the syllabus.)
13.6 EXERCISE
1. Define Budget. Explain the purpose of Budget.

2. Which are the types of Budget?
3. Explain the Methods of preparation of Cash budget.
4. Explain Cash Budget briefly.

14
BUDGETING-II
Unit Structure:
14.0 Objectives
14.1 Illustrations
14.0 OBJECTIVES
After studying the unit the students will be able to solve the practical
problems of Cash Budget.
14.1 ILLUSTRATIONS
Illustration 1 : Prepare Cash Budget for the 6 months ending 31st
December, 2003 from the monthly budgeted operating results of the
company and other additional information is given below :
Month Sales Material Wages Production Adminis- Selling Distribu- Research

Purchased tration tion &
& Develop-
Consumed ment

297
March 8,00,000 3,60,000 80,000 48,000 40,000 20,000 10,000 11,000

April 12,00,000 6,00,000 1,28,000 64,000 56,000 29,000 14,000 16,000
May 9,60,000 5,20,000 1,20,000 62,000 48,000 25,000 10,000 12,000
June 6,40,000 3,36,000 56,000 30,000 20,000 11,000 6,000 6,000
July 8,00,000 3,84,000 80,000 44,000 32,000 16,000 8,000 10,000
Aug. 8,80,000 4,00,000 96,000 49,000 40,000 21,000 10,000 12,000
Sept. 11,20,000 4,96,000 1,20,000 62,000 52,000 26,000 12,000 13,000
Oct. 12,80,000 6,00,000 1,04,000 54,000 40,000 20,000 10,000 12,000
Nov. 14,40,000 6,40,000 1,36,000 72,000 56,000 29,000 15,000 16,000
Dec. 16,00,000 8,00,000 1,52,000 74,000 58,000 30,000 16,000 17,000
1. New machinery which was installed in April at a cost of Rs. 120000 is

to be paid on 1st August. Extension to the Research & Development
Department amounting to Rs. 8,00,000 in total was contemplated from
September, at the rate of Rs. 1,60,000 per month.
2. Rs. 2, 40,000 per month is to be paid under a hire purchase scheme
agreement.
3. The Sales Commission of 4% on sales not included in Selling
Overheads is to be paid within the month following actual sales.
4. The period of credit allowed by supplier is 4 months, and that allowed
to customers is 3 months. The delay in the payment of overheads is 2
months and that in payment of wages is one-fourth of a month.
5. Preference Share Dividend of 8% on the capital of Rs. 1,60,00,000 is
payable on 1st December.
6. 8% Calls on Equity shares at the rate of Rs. 9,60,000 is due on 1st July,
1st Sept, and 1st November.
7. Taxation of Rs. 8,00,000 is payable on 1st November. Dividend on
investment amounting to Rs. 2,40,000 is expected on 1st July and 1st
December. Cash sales of Rs. 80,000 per month are expected on which
no commission is payable. This cash sales is not included in the
details for sales given above.
8. Cash balance on 1st July was expected to be Rs. 2,00,000.
SOLUTION :
CASH BUDGET FOR 6 MONTHS ENDED 31ST December, 2003
Month/ Quarter JULY AUG SEPT OCT NOV DEC

Particulars
Opening Balance 2,00,000 8,44,600 7,35,600 12,48,400 10,99,600 11,07,400
Cash Sales 80,000 80,000 80,000 80,000 80,000 80,000
Collection from Debtors 12,00,000 9,60,000 6,40,000 8,00,000 8,80,000 11,20,000
Share Capital 9,60,000 -- 9,60,000 -- 9,60,000 --
Dividend on Investment 2,40,000 -- -- -- -- 2,40,000
Total Receipts (A) 26,80,000 18,84,600 24,15,600 21,28,400 30,19,600 25,47,400

298
Creditors 3,60,000 6,00,000 5,20,000 3,36,000 3,84,000 4,00,000

Wages 62,000 84,000 1,02,000 1,16,000 1,12,000 1,40,000
Production overhead 62,000 30,000 44,000 49,000 62,000 54,000
Administration overhead 48,000 20,000 32,000 40,000 52,000 40,000
Selling overhead 25,000 11,000 16,000 21,000 26,000 20,000
Distribution overheads 10,000 6,000 8,000 10,000 12,000 10,000
Research & Development 12,000 6,000 10,000 12,000 13,000 12,000
Machinery Purchase -- 1,20,000 -- -- -- --
Extension to R & D -- -- 1,60,000 1,60,000 1,60,000 1,60,000
Hire Purchase Installment 2,40,000 2,40,000 2,40,000 2,40,000 2,40,000 2,40,000
Sales Commission 25,600 32,000 35,200 44,800 51,200 57,600
Preference Dividend -- -- -- -- -- 12,80,000
Taxation -- -- -- -- 8,00,000 --
Total Payments (B) 18,35,400 11,49,000 11,67,200 10,28,800 19,12,200 11,46,400
Closing Balance (A-B) 8,44,600 7,35,600 12,48,400 10,99,600 11,07,400 14,01,000
Working Note :
for Wages June July Aug Sept Oct Nov Dec
Actual Wages 56,000 80,000 96,000 1,20,000 1,04,000 1,36,000 1,52,000
Paid 1/4 in Current Month 14,000 20,000 24,000 30,000 26,000 34,000 38,000
3/4 paid in next month 90,000 42,000 60,000 72,000 90,000 78,000 1,02,000
Wages Paid 1,04,000 62,000 84,000 1,02,000 1,16,000 1,12,000 1,40,000
Working Note:
Mar April May Jun July Aug Sep Oct Nov

Material Paid to Creditors
Purchased 3,60,000 6,00,000 5,20,000 3,36,000 3,84,000 4,00,000 4,96,000 6,00,000 6,40,000
1 2 3 4
4 months (March paid in July) 3,60,000 6,00,000 5,20,000 3,36,000 3,84,000

Creditors
Debtors Collection from Debtors
Read
Sales 8,00,000 12,00,000 9,60,000 6,40,000 8,00,000 8,80,000 11,20,000 12,80,000 14,40,000
3 months 1 2 3 80,00,000 12,00,000 9,60,000 6,40,000 8,00,000 8,80,000
credit
(March Received in June)
Selling Overheads
(4% of Sales)
Commission 32,000 48,000 38,400 25,600 32,000 35,200 44,800 51,200 57,600
(Paid in the following month it means next months)
Sales -- 32,000 48,000 38,400 25,600 52,000 35,200 44,800 51,200

Commission
(Other overheads for e.g. Production oh./ Administration Overheads /Selling Distribution / Research & Development Exp.)
(Overheads paid after 2 months)
Production 48,000 64,000 62,000 30,000 44,000 49,000 62,000 54,000 72,000
on
1 2

299
(March paid in May)
48,000 64,000 62,000 30,000 44,000 49,000 62,000
Illustration 2 : Prepare a Profit Budget and a Cash Budget for the 1st
Quarter April – June 2004 for KG Industrial Ltd. From the following
information:
a. The company produces two products and their unit sale prices and
material contents are as under :-
Sale Price Material Content
Product A Rs.75,000 60% of sale price

Product B Rs.25,000 50% of sale price
(In addition Excise duty and sales tax as per item (f) below is
recovered)
b. The production target has been fixed as under :
Month Product A Product B
April 50 Nos. 50 Nos.

May 60 Nos. 60 Nos.
June 70 Nos. 60 Nos.
Production for January, February and March 2004 was at 80% level of
April 2004 production.
c. The monthly expenses are as under :

i. Salaries & Wages Rs. 7.50,000 payable in the following month.
ii. Variable overheads – 5% of sale value payable in the following
month.
iii. Fixed overheads – Rs. 2,00,000 payable 50% in the current month
and 50% in the following month.
d. Payment for material is made in the third month from the month of
procurement.
e. The company maintains a constant level of inventory. No Stock of

finished goods is kept and the entire production is invoiced the same
month. The company gives 30 days credit to its customers.

300
f. Company’s products attract Excise Duty @ 15% and Sales Tax @ 2%

on sales payable to the authorities in the following month.
g. The company enjoys a Cash Credit facility from its Banker to the
extent of Rs. 35,00,000, which is fully drawn. The interest payable is
@ 17% which is charged every quarter that is, June, September,
December and March. The Company carries its banking operation
presently through a Current Account.
SOLUTION :
Cash Budget
PARTICULARS APRIL 04 MAY 04 JUNE 04

RECEIPTS :
Debtors A 3519000 4398750 5278600
B 1173000 1466250 1759500
Total Receipts (1) 4692000 5865000 7038100
Payments :
Creditors 2300000 2300000 2300000
Salaries & Wages 750000 750000 750000
Variable Overheads A 150000 187500 225000
B 50000 62500 75000
Fixed Overhead 200000 200000 200000
Excise Duty A 450000 562500 675000
B 150000 187500 225000
Sales Tax A 69000 86250 103500
B 23000 28750 34500
Total Payments (2) 4142000 4365000 4588000
Net (3 = 1-2) 550000 1500000 2450000
Add : Overdraft (Opening) 3500000 2950000 1450000
Overdraft (Closing) 2950000 1450000 1000000
(-) Interest 111917
888083
Working note
No.1
Interest on Overdraft
April - 35,00,000
May - 29,50,000
June - 14,50,000
79,00,000

301
Interest 79,00,000 17% 1 1,11,917

12
No. 2
Jan Feb Mar April May June

Sales (80% of 50
A (40 x (50 x (60 x (70 x

75,000) 75000) 75,000) 75,000)
30,00,000 30,00,000 30,00,000 37,50,000 45,00,000 52,50,000
B (80% of
50)
(40 x (50x25,000) (60x25,000) (60 x
2,50,000) 25,000)
10,00,000 10,00,000 10,00,000 1,25,000 15,00,000 15,00,000
Collection from DB following month it means in the next month.

Month Debtors collected in April
Product A - 30,00,000
(+) Excise duty @ 15% of 3,00,000 4,50,000 Receivable
(+) Sales Tax @ 2% of 34,50,000 69,000 Receivable
Collection from Debtors = 35,19,000
Product B - 10,00,000
(+) Excise Duty @ 15% of 10,00,000 1,50,000 Receivable
(+) Sales Tax @ 2% of 11,50,000 23,000 Receivable
Collection from Debtors 1,17,30,000
Same as next month
Material Cost Creditors

Purchases of Jan, Feb & March paid in April, May, June
respectively.
Product A (80% of 50 Units)
75,000 x 40 x 60% 18,00,000
B (80% of 50 Units)
25,000 x 40 x 50% 5,00,000
Payment to creditors 23,00,000
Variable overheads 5% of sales value payable in the following month
means next month. (March paid in April)
Product A 75,000 x 40 x 5% 1,50,000

302
B 25,000 x 40 x 5% 50,000
2,00,000
Illustration 3 : The following is the Balance Sheet of Amar Industries

Ltd. As at 31st March, 2006.
Liabilities Rs. In Lakhs

Capital & Reserves 1,650
12% Debentures 900
Creditors for Purchases 600
Creditors for Expenses 70
Provision for Bonus 30
Provision for Tax 100
Proposed Dividend 50
Total 3,400
Assets Rs. In Lakhs
Fixed Assets at Cost 1,300
Less : Depreciation - 400
Sundry Debtors 900
Stocks and Stores 700
Loans and Advances 1,200
Cash and Bank Balances 500
100
The projected Profit & Loss Account for the first four months in the year
2006-07 shows the followings:
Particulars April May June July

Sales 800 800 900 900
excise duty Recoveries 80 80 90 90
880 880 990 990
Material
opening stock 1,200 1,200 1,260 1,320
Add : Purchases 600 660 720 720
Less : Closing Stock 1,200 1,260 1,320 1,320
Net 600 600 660 7,200
Expenses 180 180 200 200
Excise Duty 80 84 88 90
TOTAL 860 864 948 1,012
Profit / Loss 20 16 42 (20)

303
The following are relevant additional information:

1. 10% of sales are for cash and the balance on 30 days credit.
2. Creditors for purchases are paid in 30 days.
3. Expenses include :
a. Interest payable at the end of each quarter.
b. Depreciation of Rs. 10 lakhs per month.
c. Provision for bonus to workmen of Rs. 5 lakhs per month, payable
only in October, 2006
d. One half of the rest of the expenses payable in the month
concerned and the following month.
4. Rs. 200 lakhs of debentures are redeemable by 30th June.
5. Provision for taxation includes Rs. 20 lakhs of surplus provisions
carried forward earlier years besides the balance for the year 2005-06
payable before 31st May, 2006.
6. Annual General Meeting is to be held on 31st May, 2006.
7. Overdraft is permissible interest on which may be ignored.
You are required to prepare Cash Budgets for the months of April to July
2006 on a monthly basis.
SOLUTION :
Amar Industries Ltd.
Cash Budget
(Rs. In Lakhs)
Particulars APRIL MAY June July
Opening Balance 100 60 20 --
Cash Sales 88 88 99 99
Credit Sales 700 792 792 891
Overdraft -- -- 272 --
Total Receipts (1) 888 940 1183 990
Payments :
Creditors 600 600 660 720
Expenses (1/2) 78 78 80 80
(1/2) 70 78 78 80
Interest Debentures -- 27 --
Debentures Redem -- 200 --
Dividend -- 50 --
Tax -- 80 -- --
Excise Duty 80 84 88 90
O/D Repayment -- -- -- 20

304
Total Expenses 828 920 1183 990

Closing Balance/ Overdraft. 60 20 -- - 252
Working Note
Collection from Debtors:
Balance of March 2006 paid in April
Sundry Debtors – 700
May- Sales of April 880
(-) 10% Cash Sales 88
792
June – Sales of May 880
(-) 10% Cash Sales 88
792
July – Sales of June 990
(-) 10% of Cash Sales 99
891
Creditors for purchases
Balance of march 2006 paid in April
Sundry creditors = 600
April paid in May = 600
May paid in June = 660
June paid in July = 720
Breaking of expenses:
Particulars April May June July

Total Expenses 180 180 200 200
(-) Non-Cash exp.
Depreciation 10 10 10 10
Int on Debenture 9 9 9 9
Bonus 5 5 5 5
24 24 24 24
Balance Exp 156 156 176 176
Half paid in concern month 78 78 88 88
Half in the next month - 78 78 88
March half exp paid in April 70 - - -

305
Total Exp paid 148 156 166 176
Illustrations 4 : Prepare Cash Budget for April – October 2011 from the
information supplied by Mahesh Stores.
Liabilities Amount Assets Amount

Proprietors Capital 1,00,000 Cash 20,500
Outstanding Liabilities 17,000 Stock in trade 50,500
Furniture 25,000
Less : Depreciation 5,000 20,000
1,17,000 1,17,000

306
Expected for Sales (Rs.) Salaries (Rs.)

April 30,000 3,000
May 52,000 3,500
June 50,000 3,500
July 75,000 4,000
August 90,000 4,000
September 35,000 3,000
Other Expenses :- Rent Rs. 1000 pm.

Sales Commission – 1% of sales
Misc. Exp. Rs. 500 pm.
Sales – 80% on Credit and 20% on cash
Out of the Credit sales – 70% collected after one month and remaining in
next month.
Gross margin is 70% purchases equal to requirement of next months sales

are made for which payment is against delivery.
Debtor on 31st March, 2011 included Rs.20,000 for February and

remaining for January.
Cash on Hand should be Rs. 10000 at all times. The deficiency to be met
by short term loans.
Prepare Cash Budget for April to August 2011 and ascertain the
borrowing to be made from time to time.
SOLUTION:
M/s Mahesh Stores

Cash Budget from April to August.
Particulars April May June July Aug
Opening Balance 20,500 10,000 10,000 10,000 10,000
Receipts:
Debtors
20% Cash sales 6,000 10,400 10,000 15,000 18,000

Out of 80% -70% Credit Sales 14,000 16,800 29,120 28,000 42,000
Out of 80% -30% Credit Sales 6,000 6,000 7,200 12,480 12,000
Total Receipts (1) 46,500 43,200 56,320 65,480 82,000

307
Payments :
Outstanding Liabilities 17,000 -- -- -- --

Salaries 3,000 3,500 3,500 4,000 4,000
Rent 1,000 1,000 1,000 1,000 1,000
Sales Commission 300 520 500 750 900
Misc. Expenses 500 500 500 500 500
Cash Purchases 15,600 15,000 22,500 27,000 10,500
(Next month sales * 30%) --
Short term loan repaid -- 900 -- -- --

Total Payments (2) 37,400 21,420 28,000 33,250 16,900
Short term loan taken 900 -- -- -- --
closing Balance of Cash (3) 10,000 21,780 28,320 32,230 65,100
Invested in Securities (1-2-3) -- 11,780 18,320 22,230 55,100
Working Note
Particulars April May June July Aug Sep

Sales 30,000 52,000 50,000 75,000 90,000 35,000
20% cash sales 6,000 10,400 10,000 15,000 18,000 7,000
80% creditors 24,000 41,600 40,000 60,000 72,000 28,000
70% in next 14,000 16,800 29,120 28,000 42,000 50,400
month
30% in next to 6,000 6,000 7,200 12,480 12,000 18,000
next
Creditors 30% of sales of the next month
Creditor previous month of sales
30% 52,000 50,000 75,000 90,000 35,000 -
15,600 15,000 22,500 27,000 10,500 -
Sales 1% of sales of the respective months
commission
Commission 300 520 500 750 900 350
Sales
Illustration 5: Microsoft Ltd. Wants you to prepare the cash budget of the
company for the three months, April to June 2011. You are given the
following information:

308
1) Operation
2011 Sales Purchases Rs. Wages Other

Rs. Rs. Rs.
April 60,000 20,000 15,000 10,000
May 50,000 20,000 15,000 10,000
June 80,0000 40,000 15,000 15,000
July 1,00,000 50,000 25,000 20,000
August 1,40,000 70,000 25,000 20,000
September 1,60,000 60,000 30,000 20,000
2) Sales are 20% cash and the balance at two months credit; purchases
are at one months credit; subject to a cash discount of 5%.
3) Wages are paid ½ month in arrear and other expenses are paid one
month in arrear.
4) During August the company pays a dividend of 15% on its equity
capital of Rs. 2,00,000 and during September deferred payment
installment (quarterly) of Rs. 25,000 will fall due.
5) It is expected that at the end of the June 2009 there will be cash
balance of Rs. 14,000.
Prepare the cash budget as requested by the company.
Solution:
M/s Microsoft Ltd.
Cash Budget from July to September 2011.
Particulars July Aug Sept
Opening Balance 14,000 1,000 - 29,500
Receipts
Cash Sales 20,000 28,000 32,000
Collected from Debtors 40,000 64,000 80,000
Total Receipts (1) 74,000 93,000 82,500
Payments :
Creditors 38,000 47,500 66,500
wages 20,000 25,000 27,500
Other Expenses 15,000 20,000 20,000
Dividend Paid -- 30,000 --
Deferred installment -- -- 25,000
Total Payments (2) 73,000 1,22,500 1,39,000
Closing Balance of Cash (3) (1 – 2) 1,000 - 29,500 - 56,500
Working Notes

309
Sales given 60,000 50,000 80,000 1,00,000 1,40,000 1,60,000
20% Cash 12,000 10,000 16,000 20,000 28,000 32,000

80% credit 48,000 40,000 64,000 80,000 1,12,000 1,28,000
Collection - - 48,000 4,00,000 64,000 80,000
from
Debtors
Creditors 20,000 20,000 40,000 50,000 70,000 60,000
5% discount 1,000 1,000 2,000 2,500 3,500 3,000
Net payment 19,000 19,000 38,000 47,500 66,500 57,000
to CB
One month - 19,000 19,000 38,000 47,500 66,500
credit
Wages 15,000 15,000 15,000 25,000 25,000 30,000
50% 1 7,500 7,500 7,500 12,500 12,500 15,000

2
month
arrears
50% 1 - 7,500 7,500 7,500 12,500 12,500

2
next month
Total wages 7,500 15,000 15,000 20,000 25,000 27,500
paid
Other Exp 10,000 10,000 15,000 20,000 20,000 20,000
Paid in next - 10,000 10,000 15,000 20,000 20,000
month
Illustration 6: Mr. Tushar promoted a company Tushar Enterprises

Limited on 1st Oct 2011. It received certificate to commence business on
15th Nov.,2011.
On 1st December, 2011 the company issued 5000 Equity Shares of

Rs. 10/- each at par to promoters against full cash payment In the same
month allotted 20,000 shares to friends and relatives at par for full cash
payment.
On 15th December, 2011, company bought premises costing Rs.

2,00,000 and equipment costing Rs. 3,00,000 On the same date a loan to
the extent of 60% of cost of these assets was received from bank. The
loan is to be repaid by twenty equal quarterly installments payable on 15th
March, June, September, and December each year. Interest @ 15% p.a.
on unpaid balance is to be paid with installment.

310
The commercial production began from 1st January, 2012. The

target sales are as under:
Jan 1000 units
Feb 1500 units
March 2500 units
The cost and sales per units are as under:
Raw material Rs. 5 units @ Rs. 10/- 50 per unit
Wages 2 hour @ Rs. 20/- 40 per unit.
Factory Expenses
Variable Rs. 20 per unit.
Fixed Rs. 10,000 per month.
Administration Exp. Rs. 5,000 per month
Selling Expenses Rs. 20 per unit.
Sales Price Rs. 200 per unit.
The stock of raw materials is to be maintained at 5,000 units and of

finished goods at 1,000 units. The purchase/ production for the stock
should be effected in January.
The processing time may be ignored. The terms of credit are-

1. Cash sales will be 500 units per month and remaining sales will be on
credit of one month.. It is expected that 60% will pay within credit
period and remaining will pay a month later.
2. Payment for purchases of material is to be made as 25% on delivery
and balance one month later.
3. Wages are to be paid fortnightly but after lapse of 3 days thereafter.
4. Fixed factory expenses are payable at the end of the month to which
they relate.
5) Remaining factory and administration expenses are payable 60% in
same month and balance in following month.
6) Selling expenses are to be paid a month after sales is effected.
You are required to prepare Cash budget for period from
December-2011 to March -2012.
Solution :
Cash Budget from December to March 2012.

Particulars Dec Jan Feb March
Opening Balance -- 35,500 - 74,750
Receipts
Equity Shares issued

311
to promoters 50,000 50,000 -- --

to friends 2,00,000 -- -- --
Bank Loan 3,00,000 -- -- --
Cash Sales -- 1,00,000 1,00,000 1,00,000
Collected from Debtors -- -- -- 12,000
Collected from Debtors -- -- 60,000 40,000
Total Receipts (1) 5,50,000 1,50,000 1,95,500 1,85,250
Payments :
Plant 2,00,000 -- -- --
Equipment 3,00,000 -- -- --
Bank Loan -- -- -- 15,000
Interest on Bank Loan -- -- -- 11,250
Creditors for -- 37,500 18,750 31,250
Material -- -- 1,12,500 56,250
wages -- 40,000 30,000 50,000
-- -- 40,000 30,000
Factory Exp (Fixed) -- 10,000 10,000 10,000
Factory Exp (Variable) -- 24,000 18,000 30,000
-- -- 16,000 12,000
Administration Expenses -- 3,000 3,000 3,000
-- -- 2,000 2,000
Selling Expenses -- -- 20,000 30,000
Total Payments (2) 5,00,000 1,14,500 2,70,250 2,80,750
closing Balance of Cash (3 = 1 - 2) 50,000 35,500 - 74,750 - 95,500
Working Note 1:-

Production of 1000 units of finished goods - 5000 units.
Closing stock of 1000 units of finished goods - 5000 units.
Closing stock of raw materials - 5000 Units.
15000 Units.
Feb 2012 1500 * 5 7500 Units.
Mar 2012 2500 * 5 12500 Units.
Finished goods to be produced

Jan 2012 Production 1000 Units
Closing Stock 1000 Units.
Feb 2012 2000 Units.
Mar 2012 2500 Units.

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Working Note 2:
Jan – Sales 1,000
Closing stock 1,000
2,000 – Production. Jan
1,500 – Feb
2,500 – Month
Particulars Jan Feb March

Production (op stock + cl. stock 3,000 1,500 2,500
+ Production)
Raw material per unit 50 50 50
Total creditors 1,50,000 75,000 1,25,000
*25% against delivery 37,500 18,750 31,250
*75% in next month - 1,12,500 56,250
Wages (units) 2,000 1,500 2,500
Per unit 40 40 40
Total wages 80,000 60,000 1,00,000
* 50% paid in the month 40,000 30,000 50,000
* 50% paid in the next month - 40,000 30,000
Sales
Cash sales (Units) 500 500 500
Selling price per unit 200 200 200
* Total cash sales 1,00,000 1,00,000 1,00,000
Total sales units 1,000 1,500 2,500
(-) cash sales units 500 500 500
Balance credit sales 500 1,000 2,000
Selling price per units 200 200 200
1,00,000 2,00,000 4,00,000
*60% in the next month - 60,000 1,20,000
* 40% in next-next month - - 40,000
Factory expenses-variable @ 20
per unit
40,000 30,000 50,000
*60% in same month 24,000 18,000 30,000

313
*40% in next month - 16,000 12,000

Administrative overheads 5000
p.m.
* 60% in same month 3,000 3,000 3,000
* 40% in next month - 2,000 2,000
Illustration 7 : Asha Limited is incorporated to take over running

business of Nish and Co. from 1st January, 2000. The tangible assets of
Nisha and co. comprises Premises Rs. 25,000; Plant Rs. 10,000 Equipment
Rs. 5,000 and Stock Rs. 6,000.
The consideration is settled by issue of 5,000 Equity shares of Rs.

10/- each par.
In addition, to provide working capital for initial period of

operations, it issued for cash consideration 500 Equity Shares of Rs. 10
each and 12% Debentures of same face value. The above transaction were
completed in January, 2000.
a. The expected Sales for January are Rs.16,000. Therefore it is expected

to increase @ 25% over sales of previous month for February and
March thereafter @ 20% of sale of preceding month till June 2000.
b. The cost of goods sold is @ 60% of sales.
c. The 20% of sales and purchases are for cash and rest on credit of one
month.
d. Preliminary expenses will be Rs.10,000 payable 50% in February and
balance in April.
e. Stock level is to remain unchanged.
f. Administration expenses will be Rs. 3,000 for first one month and
Rs.5,000 thereafter of these 50% is payable in same month and
balance in the following month.
g. Selling expenses expected @10% of sales payable two months after
sales.
Prepare cash budget for January to June 2000.

Solution :
Cash Budget from January to June.

Particulars Jan Feb Mar April May June
Opening Balance -- 9,780 7,500 9,300 7,700 12,680
Receipts
Cash Sales 3,200 4,000 5,000 6,000 7,200 8,640

314
Collected from Debtors -- 12,800 16,000 20,000 24,000 28,800

Equity Shares Capital 5,000 -- -- -- -- --
12% Debentures 5,000 -- -- 50,000 -- --
Total Receipts (1) 13,200 26,580 28,500 1,50,000 38,900 50,120
Payments :
Cash Purchases 1,920 2,400 3,000 3,600 4,320 5,184

Creditors -- 7,680 9,600 12,000 14,400 17,280
Administration Expenses 1,500 4,000 5,000 5,000 5,000 5,000
Selling Expenses -- -- 1,600 2,000 2,500 3,000
Preliminary Expenses -- 5,000 -- 5,000 -- --
Total Payments (2) 3,420 19,080 19,200 27,600 26,220 30,464
closing Balance of Cash 9,780 7,500 9,300 7,700 12,680 19,656
(3 = 1 - 2)
Working note
Sales 16,000 20,000 25,000 30,000 36,000 43,200
(increase) +25% +20% +20% +20% +20%
20% cash 3,200 4,000 5,000 6,000 7,200 8,640
sales
80% credit 12,800 16,000 20,000 24,000 28,800 34,560
Collection
from
Debtors next - 12,800 16,000 20,000 24,000 28,800
month
Cost of 9,600 12,000 15,000 18,000 21,600 25,920
goods sold
(60% of
sales)

315
20 % cash 1,920 2,400 3,000 3,600 4,320 5,184

purchase
80% on - 7,680 9,600 12,000 14,400 17,280
month credit
Preliminary - 5,000 - 5,000 - -

Exp
Selling - - 1,600 2,000 2,500 3,000

expenses
10% of sales
Illustration 8 : MG Ltd. Deals in a single product which is sold @ Rs 150

p.m.
a. The cost of goods sold is 80% of sales which includes material cost @
25% of sales and wages @ 36% of sales. The remaining portion of
cost represents manufacturing and administration expenses.
b. The sales are seasonal as under –
March to June @ 1000 units per month.
September to December @ 1500 per month.
Remaining months @ 800 units per month.
c. The sales pattern is as under –

i. Cash Sales – 20%
ii. One months credit -40%
iii. Against bill of exchange for 60 days. Bills to be discounted
immediately subject to discount charges @ 5%.
d. Wages to be paid on 7th of the following month
e. The purchase pattern is as under –

i. Cash purchases -30%
ii. One months credit -70%
f. Manufacturing and administration includes fixed expenses @ Rs.

10,000 per month, payable at the end of month to which it relates. The
remaining expenses are subject to credit of half a month.
g. The capital of the company comprises 12% preference Capital Rs.
5,00,000. The dividend for previous year @ 15% is to be paid I
November. The current year dividend on preference shares is to be
paid in March.

316
h. Cash on hand at the end of October is Rs. 20,000. It is the policy of

the company to have minimum balance of Rs. 10,000 and maximum
balance of Rs. 30,000. Excess balance to be invested and shortfall to
be met by en-cashing investment.
Prepare Cash budget for November to March.
Solution :-
In the books of MG Ltd.
Cash Budget from November to March.

Particulars Nov Dec Jan Feb Mar
Opening Balance 20,000 10,000 30,000 27,450 30,000
Receipts
Cash Sales 45,000 45,000 24,000 24,000 30,000
Collected from Debtors 90,000 90,000 90,000 48,000 48,000
Bills discount 85,500 85,500 45,600 45,600 57,000
Total Receipts (1) 2,40,500 2,30,500 1,89,600 1,45,050 1,65,000
Payments :
Wages 81,000 81,000 81,000 43,200 43,200
Cash Purchases 16,875 16,875 9,000 9,000 11,250
Creditors 39,375 39,375 39,375 21,000 21,000
Fixed Manu. & Adm. 10,000 10,000 10,000 10,000 10,000
Overheads
Manu. & Adm. Overheads 16,375 16,375 6,400 6,400 9,250
(50%)
(50%) of previous month 16,375 16,375 16,375 6,400 6,400
Preference Dividend 75,000 -- -- -- 60,000
Total Payments (2) 2,55,000 1,80,000 1,62,150 96,000 1,61,100
closing Balance of Cash - 14,500 50,500 27,450 49,050 3,900
(3 = 1 - 2)
Investment Sold 24,500 -- -- -- 6,100
Investment Purchased -- 20,500 -- 19,050 --
Closing Balance 10,000 30,000 27,450 30,000 10,000
Working Note 1:
Cost Sheet (Per Unit) % to Sale Cost per unit

317
(Rs.)
Material 25% 37.50
Wages 36% 54.00
Overhead 19% 28.50
Cost of Goods Sold 80% 120
Add : Profit 20% 30
Sales 100% 150
Working note 2:
Particulars Nov Dec Jan Feb Mar

Sales (Units) 1,500 1,500 800 800 1,000
(Per unit selling price) 150 150 150 150 150
Total sales 2,25,000 2,25,000 1,20,000 1,20,000 1,50,000
20% cash sales 45,000 45,000 24,000 24,000 30,000
40% one month credit 90,000 90,000 90,000 48,000 48,000
40% Bills of exchange 85,500 85,500 45,600 45,600 60,000
(-days) same as Sap,
Oct, Nov sales) 1500 x
150= 2,25,000
Sep
Wages 1500 1500 800 800 1000
1,500
(units)
54 54 54 54 54 54
Per unit
Paid in
next month 81,000 81,000 81,000 43,200 43,200 54,000
- 81,000 81,000 81,000 43,200 43,200
Particulars Oct Nov Dec Jan Feb Mar

Units 1,500 1,500 1,500 800 800 1,000
Produced
(Material 37.50 37.50 37.50 37.50 37.50 37.50
cost per

318
unit)
Total 56,250 56,250 56,250 30,000 30,000 37,500
Amount
30% Cash 16,875 16,875 16,875 90,000 90,000 11,250
Purchase
70% on - 39,375 39,375 39,375 21,000 21,000
month credit
Overheads 28.50 28.50 28.50 28.50 28.50 28.50
(per unit)
Total 42,750 42,750 42,750 22,800 22,800 28,500
Overheads
50% of same 16,375 16,375 16,375 6,400 6,400 9,250
month
50% of next - 16,375 16,375 6,400 6,400 9,250
month
Fixed Exp 10,000 10,000 10,000 10,000 10,000 10,000
Total overheads – Fixed expenses and Balance will be distributed as 50% of the
same month & 50% to the next month.
14.2 EXERCISES
Q.1 B. Ltd has anticipated sales as under –

January to March Rs. 4,00,000 pm.
April to August Rs. 6,00,000 pm.
September to December Rs. 2,00,000 pm
The Material cost is 25% and Labour cost is 15% of sales. The
production overhead 20% of Sales.
The sales commission is 5% on sales and general overhead are @
10% on sales.
The credit period for sales is 1 ½ month and purchases is 1 month.
The Labour Cost is payable at the end of month. The other
expenses have credit period of ½ month.
The minimum cash balance is Rs. 50,000.
Irregular payments–
a. Income Tax instrument in June, September, December @ Rs.
50,000
b. Dividend Rs. 2,00,000 in August

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c. Interest on borrowing Rs. 1,00,000 in September and March.

Prepare Cash Budget for April to September for 6 months.
Q.2 Prepare Cash Budget for January – June from the following
information:
a. The estimated sales are as follows :
Nov Dec Jan Feb

2,00,000 2,20,000 1,20,000 1,00,000
March April May June
1,50,000 2,40,000 2,00,000 2,00,000
b. 20% of the sales are on cash basis and the balance on credit.
c. The Firm has gross margin of 25% on sales.
d. 50% of the credit sales are collected in the month following the
sales, 30% in the second months and 20% in the third month.
e. Material for sales of each month is purchased on month in
advance on a credit for two months.
f. The time lag in the payment of wages and salaries is one third of
a month and miscellaneous expenses one month.
g. Debentures worth Rs. 40,000 were issued in January.
h. Cash balance at the end of December is Rs. 60,000.
i. Salaries and office Expenses are Rs. 30,000 p.m. in November,
December and April and 80% of the same January to March and
90% in May and June.
j. Dividend is payable in June Rs. 20,000.
k. Selling expenses @ 10% on sales payable one month after sales.
l. The firm can maintained minimum balance should be Rs. 40,000
and the firm can borrow from bank @ 12% pa in multiples of
Rs. 1,000. Interest payable at the time of repayment. The
borrowing and repayment should be resorted to as and when
required.
Q.3 Prepare a Cash Budget for three months ending 30thJune, 2006
from the information given below :
a)
Month Sales Materials Wages Overheads
February Rs. 14,000 9,600 3,000 1,700

March Rs. 15,000 9,000 3,000 1,900
April Rs. 16,000 9,200 3,200 2,000

320
May Rs. 17,000 10,000 3,600 2,200

June Rs. 18,000 10,400 4,000 2,300
b) i. Credit terms are:

Sales/ Debtors 10% sales are on Cash basic.
50% of credit sales are collected next month and balance in the
following month.
ii. Creditors Materials 2 Months
Wages 1/4th Month
Overhead ½ Month
c) Cash and bank balance on 1st April 2006 is expected to be Rs.

6,000.
d) Other relevant information is :
i) Plant and machinery will be installed in February, 2006 at a

cost of Rs. 96,000. The monthly installment of Rs. 2,000 is
payable from April onwards.
ii) Dividend @ 5% on preference share capital of Rs. 2,00,000

will be paid on 1st June.
iii) Advance to be received for sales of vehicle Rs. 9,000 in June.
iv) Dividend from investment amounting to Rs.1,000 are

expected to be received in June.
v) Income Tax (advance) to be paid in June is Rs. 2,000.
Q.4 Prepare Cash Budget for July-December from the following

information.
1. Estimated Sales, expenses etc. are as follows (Rs. In lakhs)
June July Aug Sept Oct Nov Dec

Sales 35 40 40 50 50 60 65
Purchases 14 16 17 20 20 25 28
Wages & Salary 12 14 14 18 18 20 22
Misc. Exp. 05 06 06 06 07 07 07
Int. Received 02 -- -- 02 -- -- 02
Sales of Shares -- -- 20 -- -- -- --
2. 20% of the sales are on cash and the balance on credit.

321
3. 1% of the Credit Sales are returned by Customers, 2% of the

Total Accounts Receivable constitute bad debt Losses. 505 of
the good accounts receivable are collected in the month of the
sales and the rest in the next month.
4. The times lag in payment of miscellaneous expenses and
purchases in one month. Wages and salaries are paid fortnightly
with a time lag of 15 days.
5. The company keeps minimum cash balance of Rs. 5 lakhs. Cash
in Excess of Rs. 7 lakhs in invested in Government Securities in
the multiple of Rs. 1 lakh. Short falls in minimum cash balance
are made good by borrowing from banks. Ignore interest
received and paid.
Q. 5. From the information given below prepare cash budget of ‘X’ Ltd.
From January 2006 to March 2006.
Particulars Dec Jan Feb Mar April

Sales budge units 60 60 65 75 80
Selling Price per unit Rs. 1000 1000 1000 1000 1000
Off season discount 20% 20% 10% -- --
End of month inventory 10 12 15 25 25
units
1. Half of the sale proceeds are collected in the month of sales and
other half in the month following.
2. Materials amounting to Rs. 300 per unit manufactured are
purchased one month in advance of manufacture and paid for in
cash, earning 5% discount of half of material purchased.
3. Direct labour budget was Rs. 50 per unit and variable overheads
Rs. 100 per unit.
4. Indirect labour budget was Rs. 6000 per month.
5. Depreciation was provided uniformly at Rs. 3000 per month.
6. Fixed overhead budget was Rs. 6000 per month during off
season and Rs. 7000 per month during the season. Out of this,
the Quarterly premium for life insurance amounting to Rs. 600
was payable in the first month of each quarter.
7. Dividends for the year 2006 amounting to Rs. 20,000 were
expected to be declared in March 2006 and payments were to be
spread over March and April equally.
8. A machine was sold for Rs. 10000 in December, 2005 on 3
months credit.
9. The company had overdraft arrangement with Bank up to Rs.
50,000.

322
Q.6 The following information is available in respect of Padmavati

Textiles Ltd.
Particulars Jan Feb Mar April May June

Sales 40 50 60 60 60 40
Purchase (R. M) 15 16 18 18 18 16
Direct Labour 6 7 8 8 8 6
Manufacturing Expenses 13 13 14 14 14 13
Administrative Expenses 2 2 2 2 2 2
Distribution Expenses 2 3 4 4 4 2
The following financial flows are expected during the period.
o Interest to be received in January Rs. 2,00,000.

o Dividend to be received during March Rs. 2,00,000.
o Sale of investment in June Rs. 60,00,000.
o Interest to be paid in February Rs. 1,00,000
o Dividend to be paid in April Rs. 4,00,000
o Installment payment on Machine to be paid in June
Rs. 20,00,000.
Assume that 10% of the sales are on cash, the balance 90% are on
credit. The terms and credit experience of the company are :
1. No cash discount.
2. 1% of credit sales is returned by the customers.
3. 1% of the total accounts receivable is bad debt.
4. 50% of all accounts that are going to pay, do so within 30
days.
5. 100% of all accounts that are going to pay, so within 60 days.
6. Raw materials are purchased on 30 day’s credit.
Balance is to be maintained by the end of the month by borrowing

temporarily from bank in multiples of Rs. 10,000 (ignore interest).
Prepare a Cash Budget for six months.
Q.7 A newly established company manufacturing two products

furnished the cost sheet as under –
Particulars Product L Product B

Direct Material 40 20
Direct Labour 30 15
Variable Overhead 14 7

323
Selling Price 100 50
Fixed overheads excluding bank interest amount to Rs. 6,00,000 p.a.

spread over evenly throughout the year.
Sales forecasts is as under –
Product July Aug Sept Oct Nov.

L units 4200 4600 3600 4000 4500
B Units 2100 2300 1800 2000 1900
Production: 75% of each months sales will be produced in the

month of sales and 25% in the previous month.
Sales Pattern –
Product L -
 One third of sales will be on cash basis on which cash discount of

2% is allowed.
 One third will be on documents against payment basis. The
documents will be discounted by the bank in the month of sales
itself.
 Balance of one third on documents against acceptance basis.
 The payments under this scheme will be received in third month
e.g. sales in September payment will be received in November.
Product B –
 80% of the sales will be against cash to be received in the month

of sales and the balance.
 20% will be received in the following month.
Direct Materials – 50% of the direct materials required for each

month’s production will be purchased in the previous month and the
balance in the month of the production itself. The payments will be
made in the month following the purchases.
Direct Wages – 80% of the direct wages will be paid in the month
of use of direct labour for production and the balance in the
following month.
Variable Overheads – 50% to be paid in the month of incurrence

and the balance in the following month.

324
Fixed Overheads – 40% will be paid in the month of occurrence

and the other 40% in the following month. The balance 20%
represents depreciation.
The bill discounting charges payable to the bank in the month in

which the bills are discounted. The Cash balance of Rs. 1,00,000
will be maintained on 1st July.
Prepare Cash Budget monthwise for July, August and September.
Q. 8 The following results are expected by XYZ Ltd. For Jan. to July
2004, from which you are required to prepare Cash Budget.
1. The estimated sales, expenses etc. are as follows:
Particulars Jan Feb Ma Apr May Jun Jul

r
Sales 70 80 80 100 100 120 130
Purchases 28 32 34 40 40 50 56
Wages and Salaries 24 28 28 36 36 40 44
Sundry Expenses 10 12 12 12 14 14 14
Receipt of Rent 4 -- -- 4 -- -- 4
Sale of Asset -- -- 40 -- -- -- --
2. 20% of the sales are on cash and balance on credit.

3. 1% of the Credit sales are returned by the customers, 2% debts
are uncollectable, 50% of the good accounts receivables are
collected in the month of the sales and the rest during next
month.
4. The time lag in payment of Sundry Expenses and Purchase is of
one month. Wages and salaries are paid fortnightly with a time
lag of 15 days.
5. The company started its commercial activities in Jan 2004 with
cash balances of Rs. 10 lakhs.
6. The company keeps a minimum cash balance of Rs. 10 lakhs.
Cash in excess of Rs. 14 lakhs is invested in Govt. Bonds in
multiples of Rs. 1 lakh. Short fall in the minimum cash balance
is made good by borrowings from the bank. Ignore interest
received/ paid on these accounts.
Q.9 Sankalp Products Ltd. Who commenced business in March 2004

submits to you the following estimates :
Month Estimated production Sale Price (Per Unit)

(Units)

325
March 30,000 40
April 36,000 44
May 28,000 44
June 20,000 45
July 28,000 46
August 34,000 48
September 35,000 48
You are provided the following information:

1. 20% of the current months production is held as closing stock.
2. Raw material pricing is 50% of the sales price for the month.
3. There is no wastage or spoilage of raw materials. Raw materials
is not held in stock. Raw material purchases equals the number
of units produced in that month.
4. 20% of the materials are purchased on cash basis, 50% of the
suppliers are paid in next month and the balance suppliers are
paid in the month after next.
5. 10% of the sales are on cash basis. The company provides one
months credit to 40% of its customers. The balance 50% of the
customers pay up in the second month after sale.
6. Wages account for 20% of the sales price and workers are paid
on the seventh day of the next month for the previous months
production.
7. Variable overheads account for 5% of the sales price and are
paid in the month of production.
8. Fixed overheads are 18,000 per month and are paid in the next
month.
9. It is anticipated that there would be a debenture issue of Rs.
5,00,000 in the month of June 2004 and debenture issue
expenses to the tune of 10% there of would be incurred in May
2004.
10. The cash balance on 1.04.2004 is Rs. 40,000.
11. The company would acquire trade investments of Rs. 5,00,000
in June 2004 and Rs. 2,00,000 in September, 2004. Ignore
interest on trade investment.
12. If there is any deficit during any month, there is a standing cash
credit facility, which will be utilized so as to maintain minimum
cash balance of Rs. 40,000.
13. Any surplus over Rs. 40,000 during a particular month is first
utilized to wipe of the cash credit and then the balance is
converted into temporary Bank Fixed Deposit in multiples of Rs.
1000/- (Ignore interest on Cash Credit and Bank FD).

326
As Finance Manager of Sankalp Products Ltd., you are required to

prepare monthly based estimated Cash Budget for the six months
period from April 2004 upto September , 2004.
Q.10 M/s Sudesh sales corporation is a trading concern with three

partners. The sales estimated are as under.
August to October Rs. 1,00,000 per month.
March to May Rs. 1,20,000 per month.
November to February Rs. 80,000 per month.
June and July Rs. 60,000 per month.
The cost of purchases is 60% of sales. The stock level remains
unchanged. Other expenses are as under :
Office Expenses Rs. 5,000 per month.
Selling expenses Rs. 5% of sales.
The partners withdraw for personal use @ Rs. 5,000 per partner per
month. The terms of credit are as under :
a. Sales – 20% of cash,
40% against Bill of Exchange payable 30 days later. Bill are
discounted with bank immediately, discounting charges being
2%.
40% on one month credit.
b. Purchases 30% on cash and balance on one month credit.
c. Selling expenses two month after sale.
The other transactions are as under :
i. Income tax payable Rs. 60,000 in three equal installments due
on Septmber, December and March.
ii. A portion of the premises is let out at a rent of Rs. 5,000 per
month receivable at the end of the relevant month for May to
August.
iii. In April one delivery van is purchased at a cost of Rs. 1,20,000.
This is financed to extent of 75% by loan taken from bank and
balance payable immediately. Loan is repayable in three years
with quarterly installment of Rs. 7,500 commencing from July.
Interest @ 12% p.a. is payable separately. You are required to
prepare cash budget from April to December, 2001.
Q.11 M. ltd. Has anticipated Sales are as under :
January to March Rs. 2,00,000 p.m.
April to August Rs. 3,00,000 p.m.
September to December Rs. 1,00,000 p.m.
The material cost is 25% and Labour cost is 15% of sales. The
production overhead 20% of sales.

327
The sales commission is 5% on sales and general overheads are @

10% on sales. The credit period for sales is 1 ½ months and
purchases is 1 month.
The labour cost is payable at the end of month. The other expenses
have credit period of ½ month.
The minimum cash balance is Rs. 25,000.
Irregular payments:
a. Income tax installment is June, September and December @ Rs.
25,0000.
b. Dividend Rs. 1,00,000 in August.
c. Interest on borrowings Rs.50,000 in September and March.
Prepare cash budget for April to September.


Syllabus
M.C.A. Semester-II
Accounting and Financial Management
1. Accounting process and principles, financial, cost and

management accounting.
2. Elements of book keeping, Journal, cash and handbook, Book
reconciliation statement, Ledger, trial balance, profit and loss
accounts, final accounts of proprietary and partnership concern
and balance sheet.
3. Cost accounting – Objectives, elements of cost, understanding
of the different methods of costing.
4. Financial Management – Meaning, scope and role, a brief study
of functional areas of financial management. Introduction to
various FM tools: Ration Analysis
Meaning
Basis of comparison
Types of ratios
5. Working Capital Management: Theory of Working Capital
Management: Introduction, Nature of Working Capital, Concepts
and Definitions of Working Capital, Need for Working Capital,
Permanent and Temporary Working Capital, Changes inn
Working Capital, Determinants of Working Capital.
6. Budgeting – budgets, purpose, budgetary control, preparation of
budgets, master budget, fixed and flexible budgeting.

328
Reference Books:
1. “Book Keeping and Accountancy” Choudhari, Chopde.
2. “Cost Accounting”: Choudhari, Chopde.
3. “Financial Management” Text and Problems: M.Y.Khan, P.K.
Jain.
4. “Financial Management Theory & Practice” Prasanna Chandra
Tata McGraw Hill.
5. Managerial Economics & Financial Analysis, Siddiqui S.A.
Siddiqui A.S. New Age.


Question Paper
M.C.A. Semester-II
(Revised Course)
3 Hours Total Marks: 100
N.B. : 1) Question No. 1 is compulsory.

2) Attempt any two questions from Question Nos. 2 to 4.
4) Answers to the questions should be grouped and written
together.
5) Figures to the right indicate full marks assigned to the
question.
Q.1 a) What is the need of a fund flow statement for an

organization? (10)
b) From the following Trial balance, prepare trading, profit and

loss account and balance sheet of Ujwala enterprises for
the year ended on 31st March 2009. (10)
Debit balance Rs. Credit balance Rs.

Power and fuel 500 Purchase return 3,700
Land and building 70,000 Sundry creditors 32,000
Plant and machinery 50,000 Sales 1,20,000
Sundry expenses 2,600 Capital 1,78,000
Sales return 6,000 Interest on Investments 2,000
Investments 10,000 Loan 32,300
Insurance 1,600
Purchases 98,000
Carriage outward 1,000

329
Salary 19,300
Furniture 16,000
Cash in hand 5,800
Stock (1-4-08) 20,000
Sundry debtors 28,000
Legal charges 500
Drawings 800
Bad debts 1,400
Wages 13,000
Cash in hand 20,000
Carriage inward 2,000
3,68,000 3,68,000
Adjustments: Stock on 31st March 2009 cost price

Rs. 25,000/- market price Rs. 30,000/-
Q.2 a) i) What is the difference between a debit note and credit
note? (8)
ii) What is the difference between trade discount and cash
discount?
b) Journalise the following transactions in the journal of

Mr. Shashi Raja for the month of June 2008: (12)
June 1 Mr. Shashi commenced his business with cash

Rs. 10,000/-, building Rs. 1,50,000 and Bank balance
Rs. 43,000/-
3 Bought goods worth Rs. 21,000 on credit from „Avi‟
with trade discount at 5%.
4 Sold goods of Rs. 5,600/- with a cash discount of Rs.
600/-.
5 Paid wages Rs. 2,000/-.
6 Goods costing Rs. 500/- were distributed as free
samples.
10 Paid Insurance premium for business office Rs. 350/-
and for the life of the owners life Rs. 500/- by
cheques.
14 Invested Rs. 5,000/- by cheque in debentures of XYZ
Co. Ltd.
30 Settled Avi‟s account by issuing a cheque of the
necessary amount after deducting cash discount
at 3%.
Q.3 a) What is Bank reconciliation statement? And explain

different reasons for differences in balances. (8)

330
b) From the following transactions in sonu‟s cash book with

cash, bank and discount columns: (12)
May
2002 1 Opening cash balance Rs. 25,000 and bank balance
Rs. 18,000.
2 Purchased goods worth Rs. 25,000 at 10% trade
discount and 5% cash discount term. Half of the
amount paid in cash and half the amount by cheque.
3 Cash sales Rs. 22,000 at 10% TD and 5% CD.
4 Received a cheque of Rs. 5,750/- from Manohar
and deposited the same into bank.
7 Paid to Jyoti by cheque Rs. 4,900 and earned
discount of Rs. 100/-.
8 Cheque received from Manohar returned
dishonored by Bank.
9 Drawn from Bank Rs. 4,000/- for office use.
10 Deposited all the cash in bank in excess of Rs. 500/-
Q.4 a) Explain trading account and profit and loss account with
specimen form. (8)
b) What is an account and explain different types of accounts
with examples. (12)
Q.5 a) What is Cost Accounting and What are elements of cost

Accounting? (8)
b) i) Calculate the stock turn-over ratios from the following
data: (12)
Opening stock Rs. 8,000, closing stock Rs. 10,000, Sales
Rs. 54,000 and Profit 20% on cost.
ii)Calculate the creditors turn over ratio and the payment

period from the following:
Credit purchase – Rs. 6,00,000
Creditors – Rs. 1,00,000
Q.6 a) What are accounting ratios? How can the accounting ratios
be classified? Enumerate any two ratios covered by each
classification. (8)

331
b) Following details are available from the records of a India

Ltd. Prepare cash Budget for the three months ending on
30th June 2008: (12)
Month Sales Materials Wages Overheads

Rs. Rs. Rs. Rs.
February 42,000 28,800 9,000 5,100
March 45,000 27,000 9,000 5,700
April 48,000 27,600 9,600 6,000
May 51,000 30,000 10,800 6,600
June 54,000 31,000 12,000 6,900
Additional information:
1) 10% sales are on cash basis.
2) 50% of the credit sales are collected in the next month
and balance in the following month.
3) Delay in payment of overheads is one month.
4) Delay in payment of wages by ¼ month.
5) Period of credit allowed by suppliers is two months.
6) Advance income tax is to be paid in the month of June
2008 Rs. 5,000/-.
Q.7 a) Short Notes: (8)

i) Batch costing
ii) Contract costing
b) What is working capital and what are the types of working

capital? (12)


332
Question Paper
M.C.A. Semester-II
(Revised Course)

4) Attempt all the questions in same answer sheet only.
5) Use legible hand writing. Use a blue/black ink pen to
write answers. Use of pencil should be done only to
draw diagram and graphs.
6) All questions carry equal marks.
Q.1 a) Explain fund flow and cash flow. (10)
b) From the following Trial balance of Ms. Sahana, Prepare

trading and profit and loss account for the year ended 3-3-
08 and balance sheet as on that date: (10)
Debit Credit
Particulars Balance Particulars Balance
Rs. Rs.
Cash in hand 2,400 Capital 2,00,000
Sales returns 200 Bills payable 40,000
Purchases 2,40,000 Sundry creditors 48,000
Stock (1 April, 07) 25,000 Sales 3,00,200
Sundry debtors 1,10,000 Commission 800
Plant and Machine 1,20,000 Bank OD 2,500
Furniture 40,000 Rent received 2,000
Bills receivable 30,000 Interest received 4,000
Rent and taxes 4,000 Income received 2,500
Insurance 3,000
Commission 2,000
Interest 1,500
Wages 21,000
Carriage inward 900

333
6,00,000 6,00,000
The stock of goods on hand on 31st March 08 was valued at

Rs. 1,25,000.
Q.2 a) What is cash book? What are the types of cash books. (8)
b) Journalise the following transaction in the books of Vallari:

2008 (12)
Jan 1 Vallari commenced business with cash Rs. 40,000
2 Purchased goods for cash Rs. 500
3 Sold goods for cash Rs. 15,000
6 Paid cartage Rs. 110
7 Received commission Rs. 600
8 Withdrawn cash for personal use Rs. 300
9 Paid salary Rs. 5,000
10 Yogita paid us on account Rs. 590 after
Deducting cash discount of Rs. 10
11 Borrowed a loan at 10% form Samant Rs. 10,000
12 Deposited into Bank Rs. 2,500
Q.3 a) Explain the accounting concepts and accounting

conventions. (8)
b) Why is bank reconciliation statement prepared? And what

are the usual reasons for disagreement between the cash
book balance and pass book balance. (12)
Q.4 a) i) Differentiate between a debit note and credit note and (8)
ii) Differentiate between a Trade discount and cash
discount.
b) From the following transactions, prepare a cash book with

three columns of Ms. Hansika : (12)
2008
Jan 1 Cash balance Rs. 10,000
Bank overdraft Rs. 20,000
2 Received a cheque for Rs. 800 from Savita and
deposited it into bank.
3 Gave a cheque of Rs. 1,580 in full settlement of 1,600
to Puri.
4 Received interest Rs. 140 by cheque.
5 Deposited into bank the cheque of Rs. 1400.

334
7 Goods worth Rs. 15,000 were sold for cash, half of

which was banked immediately.
Q.5 a) What is Cost Accounting and What are elements of Cost

Accounting? and What are the methods of Cost? (8)
b) From the following details supplied by Eastern Ltd, prepare

a cash budget from September 1, 2007 to December 31,
2007: (12)
Month Credit Credit Wages Selling Overheads

Purchases Sales Rs. expenses Rs.
Rs. Rs. Rs.
July 85,000 1,60,000 32,000 8,000 10,000
August 92,000 1,85,000 37,000 9,500 11,500
September 1,00,000 2,10,000 42,000 10,500 13,000
October 1,20,000 2,45,000 49,000 12,500 14,500
November 90,000 1,78,000 35,500 8,900 10,500
December 98,000 1,82,000 36,000 9,000 11,000
Additional information:
1. Cash balance on September 1, 2007 Rs. 10,500.
2. Period of credit allowed to debtors 1 month.
3. Period of credit allowed by creditors 1 month.
4. Time lag in payment of wages, selling expenses and
overheads 1 month.
5. Selling commission @ 2% on credit sales is payable one
month after sales.
6. Expenses on machinery, worth Rs. 50,000 is payable in
October, 2007.
7. Expected cash sales per month Rs. 15,000.
8. No commission is payable on cash sales.
Q.6 a) Explain the advantages and limitations of Ratio analysis.

(8)
b) From the following details prepare a summarized balance
sheet of ABC Ltd, as at December 31, 2007: (12)
Fixed assets to net worth 0.75 : 1
Current ratio 5:2
Acid test ratio 3:2
Reserves to proprietor‟s funds 1:4
Current liabilities Rs. 2,00,000
Cash at bank Rs. 10,000
Fixed assets Rs. 6,00,000
Q.7 a) State the advantages of preparing a cash budget for an

organization. (8)

335
b) What points must be considered while estimating Working

Capital requirements of an organization?

(12)



Question Paper
M.C.A. Semester-II
(Revised Course)

4) Attempt all the questions in same answer sheet only.
5) Use legible hand writing. Use a blue/black ink pen to
write answers. Use of pencil should be done only to
draw diagram and graphs.
6) All questions carry equal marks.
Q.1 a) Explain the advantages and limitations of ratio analysis.

(10)
b) From the following Trial balance, prepare Trading, Profit

and Loss Account and Balance Sheet of Ankita Enterprises
for the year ended on 31st March, 2008 (10)
Debit Credit Rs.

Particulars Rs. Particulars
Opening Stock 50,000 Sales 16,00,000
Purchases 7,50,000 Return Outwards 5,000
Carriage Inwards 5,000 Creditors 50,000
Wages 75,000 Capital 3,80,520
Conveyance 500
Fees, Licences & 3,755
Subscriptions
Salaries 1,35,765
Return Inwards 50,000
Office Expenses 8,950
Rent (Rs. 1000 p.m.) 11,000
Machinery 3,50,000
Debtors 1,75,000
Investments (Long 1,00,000
Term)
Bank 2,95,000

336
20,35,520 20,35,520
i) Market value of Closing Stock as on 31st March, 2008 was
Rs. 85,000. Its cost on the same day was Rs. 57,500.
Q.2 a) What do you mean by Accounting Concepts? Explain in
detail any two accounting concepts. (8)
b) Journalise the following transactions in books of Rikhi

Enterprises. (12)
1) Commenced business with following on January 1:

Cash 20,000, Bank 28,000, Stock of Goods 4,000,
Machinery Rs. 10,000, Furniture 1,000 & Amount due
from customer Veeru & Co. Rs. 1,500.
2) Bought goods on credit from Sahana & Co. Rs. 1,000.
3) Sold Goods to Dhi & Co. Rs. 4,000.
4) Sold Goods to Veeru & Co. Rs. 10,000 on credit.
5) Received from Veeru & Co. Rs. 1,450 in full settlement
of the amount due on Jan 15.
6) Purchased goods from ABC & Co. Rs. 10,000 for cash.
7) Sold goods to Pinku worth Rs. 10,000 to earn a profit of
Rs. 3,500.
8) Sold old Furniture for cash Rs. 800.
9) Purchased Machinery by cheque Rs. 15,000.
10) Depreciate Machinery @ 10% on cost.
11) Purchased Goods of Jansy Bros. Rs. 5,000 on credit.
12) Paid Freight on the above goods Rs. 75.
13) Received cheque from Veeru & Co. Rs. 10,000 &
deposited in our bank.
14) The Bank informs that the bank has returned the above
cheque dishonored.
15) Withdrew from bank for private use Rs. 1,000.
Q.3 a) What is meant Ledger? Why is it necessary to prepare a

Ledger? (8)
b) Give Balance Sheet format in as much details as is

possible. (12)
Q.4 a) What is meant by Cash Book? What are the different types
of cash book? (8)

337
b) Prepare a Three Column Cash Book for the following

transactions and balance the same: (12)
2008 Rs.
Jan 1 Started business with cash 80,000
Jan 2 Deposited cash in Bank 60,000
Jan 3 Bought goods from Pinku on credit 30,000
Jan 6 Sent him a cheque for balance amount in final 29,500
settlement
Jan 7 Cash Sales 16,000
Jan 7 Credit sales to Ridhi & Sons 25,000
Jan 10 Received from Ridhi & Sons cash 5,000
Jan 11 Received a cheque from Ridhi & Sons in final 19,750
settlement
Jan 12 Conveyance Expenses paid to office clerk 200
Jan 13 Sent Free samples of goods to a prospective 750
customer
Jan 14 Gave away in charities 501
Jan 15 Paid for traveling expenses in cash to office 750
salesman
Jan 20 Withdrew from bank for office use 5,000
Jan 21 Used goods for domestic consumption by the 1,000
proprietor
Jan 25 Paid for office cleaning 200
Jan 26 Distributed sweets for anniversary Function in 1,000
Office
Jan 31 Paid Staff Salary by cheque 6,500
Q.5 a) What is meant by Cost Accounting? Explain in brief three

different ways of cost classification. (8)
b) From the following budgeted data, prepare a Cash Budget
for the quarter ending 30th June, 2008. (12)
Months Sales Purchase Wages Manufacturing Selling
Rs. Rs. Rs. Exp (Rs.) Expenses
Jan‟08 70,000 45,000 16,000 4,000 2,200
Feb‟ 08 60,000 43,000 16,600 4,200 2,400
Mar‟08 64,000 45,000 17,000 4,300 2,500
April‟08 80,000 55,000 17,400 4,500 2,700
May‟ 08 84,000 59,000 18,400 5,200 3,400
June‟08 76,000 45,000 19,000 5,000 3,000

338
The expected cash balance as on 1 April is Rs. 30,000. Other

information is as follows:
1) Purchases & expenses are to be paid with a lag of one
month.
2) Wages are to be paid during the month in which they are
incurred.
3) 40% of the credit sale is collected in the month of sale,
40% in the following month and balance in the month
thereafter.
4) 5% sales commission is to be paid within the month
following actual sales.
5) Equity Share Capital Call Money of Rs. 10,000 is
receivable in each of the three months under
consideration.
6) Manufacturing Overheads include Rs. 1,000 as
depreciation.
Q.6 a) Distinguish between Fund Flow and Cash Flow. (8)
b) The following are the extracts of Balance sheets of Efficient

Ltd. (12)
Liabilities 2006 2007 Assets 2006 2007

Creditors 25,000 30,000 Stocks 10,000 25,000
Bills 15,000 20,000 Debtors 20,000 20,000
Payable
Bank - 2,000 Bills 10,000 5,000
Overdraft Receivable
9% 5,00,000 5,00,000 Prepaid 2,000 -
Debentures Expenses
Cash on Hand 18,000 15,000
Sales 2006: Rs. 3,50,000 & Gross Profit 70,000
Sales 2007: Rs. 3,00,000 & Gross Profit 50,000
Calculate the following Ratios for both the years:
i) Current Ratio
ii) Liquid Ratio
iii) Stock to Working Capital Ratio
iv) Debtors Turnover Ratio & Debtor‟s Velocity
Q.7 a) Explain cash budget briefly. (8)
b) Define Working Capital. Explain the importance of working

capital in business. (12)

339

Mission MCA
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ACCOUNTING & FINANCIAL MANAGEMENT

As per Mumbai University Syllabus

prepared and circulated by mumbai university

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ACCOUNTING PROCESS AND

After studying the unit the students will be able to:

Every person performs some kind of economic activity. A

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events. Thus the business transactions include purchase, sale of

1.2 MEANING OF ACCOUNTING

The American Institute of Certified Public Accounts (AICPA)

Again in 1966, AICPA defines Accounting as “The process of

Thus accounting may be defined as the process of

The utility of accounting information is greatly increased

There is difference between the terms “Book keeping” and

1.3 ACCOUNTING PRINCIPLES

The basis aims of book-keeping and accountancy are to

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universally accepted. These rules of conducts to record business

The classification of accounting principles is as under:

Accounting Concepts Accounting Conventions

a) Business entity a) Disclosure

1.3.1 Accounting Concepts:

Different accounting concepts are discussed as follows:

a. Business Entity Concepts

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The failure to recognise the business as separate accounting

The overall effect of adopting this concept is –

When an enterprise liquidates a branch or one division or

In case of enterprise going to liquidate or become insolvent.

c. Money Measurement Concept

Non monetary events like public political contract, location of

However, a unit of money measurement over period of time

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two years. It will be the same amount. However value of Money

Financial statement based on historical cost may not be

e. Accounting Period Concept

f. Duel Aspect Concept

One entry consists of debit to one or more accounts and

Assets = Liabilities + Capital

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h. Matching Cost Concept

1.3.2 Accounting Conventions:

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material interest to proprietors, creditors and investors should be

The Companies Act makes various provisions for disclosure

It is also called “Principles of prudence”. Therefore, provision

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1.4 BRANCHES OF ACCOUNTING

Accounting has forms of branches as under

Financial Cost Management Tax

1.4.1 Financial Accounting

1.4.2 Cost Accounting

1.4.3 Management Accounting

1.4.4 Tax Accounting

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1.5 ACCOUNTING PROCESS

The process of accounting involves recording classifying and