Accounting Cycle: Capturing Business Activities

Every business organization, irrespective of the size, nature, form, and ownership
undertakes several transactions on the day-to-day basis. It will be difficult for the
business owners, managers, and employees to remember such transactions. That explains
the need for recording the transactions in a systematic manner. Recording of transactions
in systematic and scientific manner is called accounting. One of the ways of
understanding the business transaction is to understand the accounting equation. The
concept of accounting equation was discussed in detail the Chapter –

In this chapter we will understand the following:

  Rules for capturing business transactions
  Process of recording the business transactions

Accounts
Account is an accounting record of increase or decrease in a financial item. For
examples: A company can have several accounts, viz. Cash Account, Furniture Account,
Building Account, Bank Account, Capital Account, Loan Account, Customer Account,
Supplier Account etc. An Account is generally shown in the following form:

Stock Account
DateParticulars Debit Amount Date Particulars Credit Amount
1 2 3 4 5 6

Where:
1 & 4: Date of transaction
2 & 5: Particulars: Details of the transaction
3 & 6: Debit and Credit Amount respectively

You may be having the following questions at this juncture;

  What transactions will appear on the debit side or credit side?
  Is there is method for remembering the process of recording the items on
the debit side or credit side?
  Are these rules apply to all types of business transactions?

To answer the above questions, it is necessary to classify the financial items. The
financial items1[1] can be divided into the following three types of accounts;
a) a) Real Accounts
b) b) Persona Accounts
c) c) Nominal Account

1[1]
Another form of classifying the financial items has been discussed in the previous chapter.
Real Accounts: Represent the physical properties belonging to the business. Land,
Building, Furniture, Stock, Cash are some of the examples of real accounts. These are
also called the assets of the business. Let us take a look the nature of change that can
happen with these items (assets):
  Increase: When you acquire or revalue the asset.
  Decrease: When you sell/ Just reduction in the value i.e. depreciation

So for the purpose of recording of transactions relating to the these items, we classify
these transactions as follows:
  Increase in Assets : Debit
  Decrease in Assets: Credit

In typical accounting language,

  When we purchase assets: Debit the Asset Account
  When we sell assets: Credit the Asset Account
  When assets are depreciated: Credit the Asset Account

Personal Accounts: Represent individuals, corporate entities, and other artificial legal
juridical entities. Ram or Peter (a natural person) Account, Capital Account ( represents
the owners), Bank Account, Infosys Limited (corporate entities) , are some of the
examples of personal accounts. These individuals and the organisations can be divided
into two categories
  Persons who owe money to the business (Debtors)
  Persons to whom the business owe money (Creditors/Shareholders/Loan
giver)

Let us take a look the nature of change that can happen with these items (assets):

  Increase in debtors: Debit

  Decrease in debtors: Credit
  Increase in Creditors/Shareholders/Loan giver: Credit
  Decrease in Creditors/Shareholders/Loan giver: Debit

So in typical accounting language:

  When a customer purchases on credit: Increase in Debtors: Debit the
person’s account
  When the customer makes the payment: Decrease in Debtors: Credit the
person’s account
  When the business purchases goods on credit: Increase in Creditors: Credit
the person’s account
  When the business makes payment to the supplier: Decrease in Creditors:
Debit the person’s account
  When we purchase stock on credit from Mr. X(supplier): Credit the
Supplier’s account
   When sell stock on Credit to Mr. Y(Customer): Debit the customer’s
account

In other words, a person either receives something (for service, sale of goods, loan
given ) or pays something (for service taken, purchase of goods, loan taken|)So we can
also say the following

Nominal Accounts: Refer to the expenses, losses, incomes and gains. Salary, Interest
received or given, commission, rent etc. are some of the examples of nominal accounts.
Some of the transactions relating to these accounts are as follows:

  Salary paid: Debit the salary Account

  Interest received : Credit the interest account
  Interest paid: Debit the interest account

So one can say the following:

  All expenses: Debit
  All Incomes : Credit

Now let us summaries the above discussion;

Financial items can be classified into the following three types of accounts
  Real Accounts
  Personal Accounts
  Nominal Accounts

To facilitate the recording of the financial transactions the following rule can be used:
  Real Accounts: Debit what comes in (increase in asset) and Credit what
goes out (Decrease in asset)
  Personal Accounts: Debit the receiver (increase in debtor, decrease in
creditor), and credit the giver (decrease in debtor, increase in creditor)
  Nominal Accounts: Debit all expenses/losses, and credit all incomes and
gains
  Increase in asset: Debit
  Decrease in asset: Credit
  Increase in loan(liability): Credit
  Decrease in Loan (liability): Debit
  Increase in expense/loss: Debit
  Increase in income/profit: Credit
Debit and Credit can also be explained as followings

Debit Credit
Increase in Asset Increase in Liabilities
Increase in
Debtor Increase in Creditor
Decrease in Loan Increase in Loan
Decrease in
Creditor Decrease in Debtor
Increase in Decrease in
Expense Expense
Decrease in
Income Increase in Income

Now we will understand the use of debits and credits for recording transactions. Steps
required for recording the transactions are as follows

  Read the transaction

  Identify the two (debit and credit) financial items affected by the
transactions
  Use the above debit and credit rule discussed in the previous section.

1. 1. A and B started AB ltd. A contributed cash Rs. 100,000 as capital and B

transferred two computers worth of Rs. 50,000 to the business.

Two Items:
  Cash (Real Account): Cash is coming into the business: Debit Cash
Account
  Capital Account (Representative Personal Account): The owners are
giving the money: Credit the Capital Account

Recording of Transaction

  Increase in
cash
  Increase in
Debit Credit Capital
Cash 10000
Capital 10000

2. 2. They took 10% loan from IDBI: Rs.100 000.

Two Items:
   Cash (Real Account): Cash is coming into the business: Debit Cash
Account
  Bank Account (Personal Account): The owners are giving the money:
Credit the Bank Account

Recording of Transaction

  Increase in
cash
Debit Credit   Increase in
Cash 10000
Bank
Loan 10000

3. 3. Purchased machinery costing Rs.20 000 for cash.

Two Items:
  Cash (Real Account): Cash is going out of the business: Credit Cash
Account
  Machinery (Rea Account): Machinery is coming into the business:
Debit the Capital Account

Recording of Transaction

  Increase in
machinery
  Decrease in
Debit Credit cash
Machiner
y 20000
Cash 20000

4. 4. Purchase furniture on credit from X ltd for Rs. 30 000.

Two Items:
It is a credit transaction
  Mr. X (Personal Account): Mr. X extended loan: Credit M. X Account
  Furniture (Real): Machinery is coming into the business: Debit the
Furniture Account

Recording of Transaction
Debit
  Increase in
Furniture
  Increase in loan
(X)
 Credit
Furnitur
e 30,000
X 30,000

5. 5. Purchased land for cash Rs. 50 000.

It is a cash transaction
  Cash (Real Account): Cash is going out of the business: Credit Cash
Account
  Land (Real): Land is coming into the business: Debit the Land
Account

Recording of Transaction

  Increase in Land
  Decrease in
Debit Credit Cash
Land 50,000
Cash 50,000

6. 6. Purchased goods worth of Rs. 50 000 for cash.

It is a cash transaction
  Cash (Real Account): Cash is going out of the business: Credit Cash
Account
  Goods (Real): Goods is coming into the business: Debit the Goods
(stock) Account

Recording of Transaction

  Increase in Land
  Decrease in
Debit Credit Cash
Goods 50,000
Cash 50,000
7. 7. Purchased goods worth of Rs. 70 000 on credit from Y Ltd.

It is a credit transaction
  Y (personal Account): Y extended credit: Credit Y Account
  Goods (Real): Goods is coming into the business: Debit the Goods
Account

Recording of Transaction

  Increase in Land
  Increase in loan
Debit Credit (Y)
Goods 50,000
Y 50,000

8. 8. Sold all goods for Rs. 160 000 on credit to Mr. Z

It is a credit transaction
  Z (Personal Account): Z receives goods and owes money to the
business: Debit Z Account
  Goods (Real): Goods is going out of the business: Credit Debit the
Goods (stock) Account

Recording of Transaction

  Increase in
Goods
Debit Credit   Decrease in
Z 160,000
Goods 160000

9. 9. Sold all goods for Rs. 150 000 for cash

It is a cash transaction
  Cash (Real Account): Cash is coming into the business: Debit Cash
Account
  Goods (Real): Goods is going out of the business: Credit Debit the
Goods (stock) Account
 Recording of Transaction
  Increase in Cash
  Decrease in
Goods
Debit Credit
Cash 50,000
Goods 50,000

  Sold all goods for Rs. 175000 on credit to Mr. Z

  Sold 75% of the stock on credit at profit of 25% on cost

The above process is called journalizing the transactions. After recording all transactions,
it is necessary to post the same to ledger accounts.

Ledger accounts show all information relating to a particular account at one place. So
‘Cash Account’ will show all transactions (receipts and payments) relating to cash. The
process of transferring the financial items from Journal to Leger is called Posting. See the
following diagrammatic representation of posting

Purchase of land for Rs. 50,000

Debit
Credit

Land
50,000
 

Cash
 
Land Account 50,000 Cash Account
Particulars Particulars
Dr. Amount Dr. Amount
Particulars Particulars
Cr. Amount Cr. Amount
Let us see another transaction
To Cash To Goods
Sold goods for cash: Rs. 80000
50, 000 80000
By Cash Goods
50,000 Particulars Dr. Amount Particulars Cr. Amount
By Cash 80000
Debit Credit
Cash 80000
Goods 80000
Balancing of Ledger Accounts

After posting all transactions to the respective ledger accounts, it is necessary to balance
the ledger accounts periodically (daily, monthly, quarterly, half-yearly and yearly). Steps
required to balance a ledger account are as follows;
  Total the debit side
  Total the credit side
  Find the difference
  Put the difference on the lesser side
  If the debit side is greater than the credit side, it is called Debit Balance
  If the credit side is greater than the debit side, it is called Credit Balance

See the following ledger account

Cash
ParticularsDr. Amount Particulars Cr. Amount
To Capital 100000By Machine 50000
To Sales 50000Stock 25000

Expenses 10000
Balancing Figure
By closing Balance 65000
Total 150000Total 150000

Total of Debit side: 150000

Total of Credit side (excluding the closing balance) = 85000
Difference between Dr. Side and Cr. Side = 150 000 – 85000 = 65000
Since the Dr Side > Cr. Side: 65000 is called Debit balance

General Rules of Balancing of Ledger Accounts:

  Personal Accounts: There can Debit Balance or Credit Balance or no
Balance
  Real Accounts: There be Debit Balance or No balance
  Nominal Accounts: There will be No Balance
 Work To Do

1. 1. Following are some of the journal entries. You are required to explain the
transactions

Debit Credit
Cash 10000
Bank
Loan 10000 Debit Credit
Loan 10000
Debit Credit Cash 10000
Salary 10000
Cash 10000

Debit Credit
Goods 10000
Mr. Y 10000
Debit Credit
Interest 5000
Cash 5000

Debit Credit
Goods 25000
Capital 25000

Debit Credit
Furnitur
e 2500
Mr. X 2500

2. 2. Following are the transactions of X ltd.

  Took IDBI Loan: Rs. 10 lakhs
  Purchased furniture for cash: 250000
  Purchased 2 computers: Rs.50000
  Salary paid: Rs. 10000
  Rent due but not paid
  Electricity bill paid: Rs.2500
  Purchased goods for sale: Rs. 250000
  Sold the goods on credit to Mr. X at a profit of 20% on Sales.
  Telephone charges due but not paid: Rs.1500
Required: Journal entries and the corresponding ledger accounts.
 3. 3. Following are the transactions of A ltd.
  A ltd purchased a Machinery on credit from Mr. R: 50000
  A ltd. purchased goods on credit from Mr. X: Rs.25000
  Altd. sold 75% goods on credit and balance for cash. Goods are sold at
cost plus 25% profit.
  A ltd. charged depreciation on the machine: 10% on the cost
Required: Journal entries

4. 4. Explain the following:

  A debit of Rs. 5000 to Furniture Account
  A debit of Rs. 5000 to Loan (taken) Account
  A debit to Rs. 5000 to Loan (given) Account
  A credit of Rs. 5000 to Mr. X ( Customer)
  A credit of Rs. 5000 to Mr. Y (Supplier)
  Credit balance of Rs. 5000 in the Bank Account
  A credit of Rs. 5000 to Cash Account

5. 5. Classify the following financial items into Real, Nominal and Personal
Accounts

Financial Items
Capital Cash
Outstanding Salary Customer
Salary paid UTI Bank
Rent received Infosys Technologies Limited
Outstanding Rent XIMB
Commission Share Capital
 
6. 6. From the following transactions you are required to prepare the cash
account and check the balance.

Transactions for the month of January 2004

Started business with cash 50000
Purchased computers for cash 25000
Purchased goods on credit from X 10000
Sold 50% of the goods for Cash 8000
Sold 50 %of the balance goods on credit to Y 4500
Rent due but not paid 5000
Salary paid 8000
Electricity charges paid 1000
Received 50% of the money due from Y
Paid 5% commission on all sales to Z
7. 7. Refer to the question no.2. what will be the impact on the cash balance in
the following cases (treat each case separately)
  Computers are purchased on credit
  All goods are sold on credit
  All expenses are paid in cash.
8. 8.
  X started business with cash: Rs.150000
  Purchased goods on credit from Mr. Y: Rs. 50000
  Purchased furniture on credit from F ltd.: Rs.25000
  Sold goods costing Rs. 10000 at a profit of 20% on sales for cash.
  Bought goods costing Rs. 20000 for cash.
  Drawn for personal use: Rs. 5000
  Sold the available goods to Ms. Z on credit at a profit of 25% on cost.
  Paid Salaries: Rs. 80000
  Rent due but not paid: Rs. 5000
  Received 75% of the money due from Ms. Z
  Paid 50% of the money due to Mr. Y
  Purchased 5 shares of Infosys @ Rs.4000.

Required: Journal Entries and the corresponding ledger accounts

 9. 9. Mr. A started a business on Ist January 2004. Following the transactions
upto April 30th

Date Transaction Amount

1-Jan-04Started business with own money 100,000
10-Jan-04Took a 12% loan from SBI 250,000
15-Jan-04Purchased computers 50,000
25-Jan-04Purchased Satyam shares for cash 75,000
30-Jan-04Paid the following
Rent 5,000
Electricity Charges 2,000
Internet connection charges 1,500

5-Feb-04Sold 50% of the Satyam Shares 45,000

10-Feb-04Purchased SBI shares 25,000
27-Feb-04Paid the following
Rent 5,000
Electricity Charges 2,000
Internet connection charges 1,500
10-Mar-04Purchased the shares of UTI Bank 50,000
25-Mar-04Purchased Timex Shares 80,000
2-Apr-04Sold 50% of the Satyam Shares 55,000
Sold SBI shares 45,000
15-Apr-04Sold Timex shares 70,000
30-Apr-04Paid the following
Rent 5,000
Electricity Charges 2,000
Internet connection charges 1,500

Required: Necessary Ledger Accounts up to the end of the accounting year ending March
2004

10. 10. In the above question post the transactions of the month of April in their
respective ledger accounts
 11. 11. Following are the transactions of GM Ltd. s
  Started business with Rs. 400,000 in bank and cash in hand: 100000
  Bought furniture with Rs. 50000 and paid by cheque.
  Bought textile on credit from Mr. M: Rs.100000
  Sold 50% of the textile at75000.
  Paid wages : Rs. 1000
  Paid Mr. M: Rs.25000
  Bought T Shirts from Tirupur: Rs.50000. Paid by cheque
  Sold all Tshirts to a local retailer at Rs. 60000.
  Bought stationery: Rs. 5000
  Paid rent: Rs.5000
  Electricity charge due but not paid: Rs.2000
  Insurance premium paid by cheque: Rs. 10000
  Sold 10% of the balance textile on credit to Mr. Y at Rs.7500.
  Mr. Y failed to make the payment on the due date. The entire money was
declared bad-debt.

Required: Pass the necessary journal entries and post the transactions to the relevant
ledger accounts

12. 12. Following is the Cash Account of X ltd.

Cash Account
Date Particulars Debit Amt. Date Particulars Credit Amt.
1..04.04Opening Balance500000 5.04.04 Goods 50000
goods 150000 furniture 10000
Shares of RIL 30000 Shares of RIL 50000
Old Newspapers 500 Salary 5000
Old Furniture 2000 Rent 2500
Shyam 5000 Interest 500
Loan 50000

30.04.04Closing Balance 619500

737500 Total 737500

Explain the transactions behind the above Cash Account. You are also required to
prepare the necessary ledger accounts.
 Book Keeping :The Accounting Flow/Accounting Equation/Ledgers/Trial Balance

The book keeping is the recording of transactions in scientific and systematic manner. So
book keeping is a art, as one can learn it with practice, it is a science as the recording is
based on certain principles

Transactions: Exchange of goods and services between two or more entities, both
business and social.

Let us take an hypothetical organisation called ABC ltd. and understand the entire process
of recording in the following two different methods:

1. 1. Direct Recording in Balance Sheet and Income Statement

2. 2. Conventional Recording: Tracing the entire accounting flow
3. 3. Computerised Recording

Direct Recording:

Steps:
  Analyse the transaction
  Identify the items:
  Transfer Incomes and Expenses to the INCOME STATEMENT
  Transfer Sources and Applications to the BALANCE SHEET

The entire process can be explained as follows:

Transactions

Incomes
Expenses Sources Application

Income Statement Balance Sheet

This requires understanding of the following concepts:
  Incomes and Expenses
  Sources The liability side of a balance sheet represents the various sources
from which a company obtains the funds which are needed for its business
  Applications: The assets side of a balance sheet indicates the manner in which
the resources of a company have been utilised
  Balance Sheet: Balance Sheet is a statement which shows the sources and
application of funds. Sources and application are also known as liabilities and assets
respectively. Balance sheet is prepared to show the financial position of the
organisation as on a particular date. A balance sheet is always correct as on the date of
preparation (for details see Chapter I)
  Income Statement The income statement of an organisation shows the net
operating result of the activities undertaken during a particular period of time. The
income statement is also known as the Profit and Loss Account (P/L Account) (for
details see Chapter I)

Conventional Recording: Tracing the entire accounting flow

:

Transactions

Journals

Ledgers

Trial Balance

Income Statement Balance Sheet

 Transactions for Tally Exercise

  Started business with Rs. 100000

  Availed 12% ICICI Loan: Rs. 200 000
  Promoter contributed Computer as capital: Rs.25000
  Purchased Plant for cash: Rs.25000
  Purchased Furniture: Rs.10000
  Paid Rent: Rs. 5000
  Paid Salary: Rs.10000
  Purchased goods from X on credit: Rs. 50000
  Purchased goods for cash: Rs. 100000
  Sold 70% of the goods to Y on credit: Rs. 150000
  Sold balance stock for cash 75000
  Received 50% due from Y
  Depreciation on plant and furniture: 10%
 SEBI (Disclosure & Investor Protection) Guidelines, 2000 as
amemended till date

CHAPTER III

PRICING BY COMPANIES ISSUING SECURITIES

3.0 The companies eligible to make public issue can freely price their equity
shares or any security convertible at later date into equity shares in the following
cases:

3.1 Public / Rights Issue by Listed Companies

3.1.1 A listed company whose equity shares are listed on a stock exchange, may
freely price its equity shares and any security convertible into equity at a later
date, offered through a public or rights issue.

3.2 Public Issue by Unlisted Companies

3.2.1 An unlisted company eligible to make a public issue and desirous of getting
its securities listed on a recognised stock exchange pursuant to a public issue,
may freely price its equity shares or any securities convertible at a later date into
equity shares.

Infrastructure company

3.2.3 An eligible infrastructure company shall be free to price its equity shares

subject to the compliance with the disclosure norms as specified by SEBI from

time to time.
3.3 Initial public Issue by Banks

3.3.1 The banks (whether public sector or private sector) may freely price their
issue of

equity shares or any securities convertible at a later date into equity share
subject

to approval by the Reserve Bank of India.

3.4 Differential Pricing

3.4.1 Any unlisted company or a listed company making a public issue of equity
shares or securities convertible at a later date into equity shares, may issue such
securities to applicants in the firm allotment category at a price different from the
price at which the net offer to the public is made provided that the price at which
the security is being offered to the applicants in firm allotment category is higher
than the price at which securities are offered to public.

Explanation:

The net offer to the public means the offer made to the Indian public and does
not include firm allotments or reservations or promoters’ contributions.

3.4.2 A listed company making a composite issue of capital may issue securities
at differential prices in its public and rights issue.

3.4.3 In the public issue which is a part of a composite issue differential pricing
as per sub-clause 3.4.1 above is also permissible.

3.4.4 Justification for the price difference shall be given in the offer document for
sub-clauses 3.4.1 and 3.4.2.

3.5 Price Band

3.5.1 Issuer company can mention a price band of 20% (cap in the price band
should not be more than 20% of the floor price) in the offer documents filed with
the Board and actual price can be determined at a later date before filing of the
offer document with ROCs.
3.5.2 If the Board of Directors has been authorised to determine the offer price
within a specified price band such price shall be determined by a Resolution to
be passed by the Board of Directors.

3.5.3 24(The Lead Merchant Bankers shall ensure that in case of the listed
companies, a 48 hours notice of the meeting of the Board of Directors for passing
resolution for determination of price is given to the Designated Stock Exchange.)

3.5.4 The final offer document, shall contain only one price and one set of
financial projections, if applicable.

3.6 Payment of Discounts / Commissions, etc;

3.6.1 No payment, direct or indirect in the nature of a discount, commission,

allowance or otherwise shall be made either by the issuer company or the
promoters in any public issue, to the persons who have received firm allotment in
such public issue.

3.7 Freedom to determine the denomination of shares for public / rights

issues and to change the standard denomination

3.7.1 An eligible company shall be free to make public or rights issue of equity
shares in any denomination determined by it in accordance with sub-section (4)
of section 13 of the Companies Act, 1956 and in compliance with the norms as
specified by SEBI in circular no.SMDRP/POLICY/CIR-16/99 dated June 14, 1999
and other norms as may be specified by SEBI from time to time.

3.7.2 The companies which have already issued shares in the denomination of
Rs.10/-

or Rs.100/- may change the standard denomination of the shares by splitting or

consolidating the existing shares.

3.7.3 The companies proposing to issue shares in any denomination or changing
the

standard denomination in terms of clause 3.7.1 or 3.7.2 above shall comply with

the following:

(a) the shares shall not be issued in the denomination of decimal of a rupee;

(b) the denomination of the existing shares shall not be altered to a denomination

of decimal of a rupee;

(c) at any given time there shall be only one denomination for the shares of the

company;

(d) the companies seeking to change the standard denomination may do so after

amending the Memorandum and Articles of Association, if required;

(e) the company shall adhere to the disclosure and accounting norms specified
by

SEBI from time to time.

Footnotes:

24 Substituted for “The Lead Merchant Bankers shall ensure that in case of the listed
companies, a 48 hours notice of

the meeting of the Board of Directors for passing resolution for determination of price is
given to the regional Stock

Exchange.” vide SEBI/CFD/DIL/DIP/Circular No. 11 dated August 14, 2003