RUNGTA COLLEGE OF SCIENCE & TECHNOLOGY,DURG

BBA SEMESTER I
SUBJECT- FINANCIAL ACCOUNTING

UNIT-I
Introduction

In order to understand the subject matter with clarity, let us study some of the definitions which depict
the scope, content and purpose of Accounting. The field of accounting is generally sub-divided into: (a)
Book-keeping (b) Financial Accounting (c) Cost Accounting and (d) Management Accounting Let us
understand each of these concepts.

(a) Book-keeping The most common definition of book-keeping as given by

J. R. Batliboi is “Book-keeping is an art of recording business transactions in a set of books.” As can be
seen, it is basically a record keeping function.
One must understand that not all dealings are, however, recorded. Only transactions expressed in terms
of money will find place in books of accounts. These are the transactions which will ultimately result in
transfer of economic value from one person to the other. Book-keeping is a continuous activity, the
records being maintained as transactions are entered into. This being a routine and repetitive work, in
today’s world, it is taken over by the computer systems. Many accounting packages are available to suit
different business organizations. It is also referred to as a set of primary records. These records form the
basis for accounting. It is an art because, the record is to be kept in such a manner that it will facilitate
further processing and reporting of financial information which will be useful to all stakeholders of the
business.

(b) Financial Accounting It is commonly termed as Accounting. The American Institute of Certified
Public Accountants defines Accounting as “an art of recoding, classifying and summarizing in a
significant manner and in terms of money, transactions and events which are in part at least of a financial
character, and interpreting the results thereof.” The first step in the cycle of accounting is to identify
transactions that will find place in books of accounts. Transactions having financial impact only are to be
recorded. E.g. if a businessman negotiates with the customer regarding supply of products, this will not
be recorded. The negotiation is a deal which will potentially create a transaction and will have exchange
of money or money’s worth. But unless this transaction is finally entered into, it will not be recorded in
the books of accounts.
Secondly, the recording of the business transactions is done based on the Golden Rules of accounting
(which are explained later) in a systematic manner. Transaction of similar nature are grouped together
and recorded accordingly. e.g. Sales Transactions, Purchase Transactions, Cash Transactions etc. One
has to interpret the transaction and then apply the relevant Golden Rule to make a correct entry thereof.
Thirdly, as the transactions increase in number, it will be difficult to understand the combined effect of
the same by referring to individual records. Hence, the art of accounting also involves the step of
summarizing them. With the aid of computers, this task is simplified in today’s accounting world. The
summarization will help users of the business information to understand and interpret business results.
Lastly, the accounting process provides the users with statements which will describe what has happened
to the business. Remember the two basic questions we talked about, one to know whether business has
made profit or loss and the other to know the position of resources that are used by the business. It can be
noted that although accounting is often referred to as an art, it is a science also. This is because it is based
 on universally applicable set of rules. However, it is not a pure science as there is a possibility of
different interpretation.

Meaning and Definition of Accounting

Accounting has rightly been termed as the language of the business. It records, classifies, analyses and
communicates all the business transactions that have taken place during a particular period. It is a system
of recording and reporting business transactions in financial terms, to interestedparties. According to
American Institute of Certified Public Accountants, “Accounting is the art of recording, classifying and
summarizing in a significant manner in terms of money, transactions and events which are, in part at
least, of a financial character and interpreting the results thereof”. Thus accounting is the art of
recording, classifying, summarizing, analyzing and interpreting the financial transactions and
communicating the results thereof to the interested person

According to American Institution of Certified Public Accountant Committee:-

“Accounting as the art of recording, classifying and summarizing in a significant manner and in terms of
money transactions and events which are in part at least, of a financial character, and interpreting the
results thereof”.
From the above definition, it can be said that “Accounting is science of recording and classifying trading
transaction of financial nature and is an art in which financial results are summarized and interpreted.”

Accounting Cycle

When complete sequence of accounting procedure is done which happens frequently and repeated in
same directions during an accounting period, the same is called an accounting cycle. Steps/Phases of
Accounting Cycle The steps or phases of accounting cycle can be developed as under:
(a) Recording of Transaction:- As soon as a transaction happens it is at first recorded in subsidiary book.
(b) Journal : The transactions are recorded in Journal chronologically.
(c) Ledger: All journals are posted into ledger chronologically and in a classified manner.
(d) Trial Balance: After taking all the ledger account’s closing balances, a Trial Balance is prepared at
the end of the period for the preparations of financial statements.
(e) Adjustment Entries : All the adjustments entries are to be recorded properly and adjusted accordingly
before preparing financial statements.
(f) Adjusted Trial Balance: An adjusted Trail Balance may also be prepared.
(g) Closing Entries : All the nominal accounts are to be closed by the transferring to Trading Account
and Profit and Loss Account.
(h) Financial Statements : Financial statement can now be easily prepared which will exhibit the true
financial position and operating results.
Users of Accounting Information
Accounting provides information both to internal users and the external users. The internal users are all
the organizational participants at all levels of management (i.e. top, middle and lower). Generally top
level management requires information for planning, middle level management which requires
information for controlling the operations. For internal use, the information is usually provided in the
form of reports, for instance Cash Budget Reports, Production Reports, Idle Time Reports, Feedback
Reports, whether to retain or replace an equipment decision reports, project appraisal report, and the like.

Accounting’s Relation with Other Disciplines

 Accounting and Management
 Accounting and Economics
 Accounting and Mathematics
  Accounting and Computer Science
 Accounting and Statistics
 Accounting and Law
 Accounting and Political Science
 Accounting and Engineering
 Accounting and Management

Accounting and Management

Accounting and Management are very closely related.

Because management depends entirely on accounting for information in financial affairs to make
decisions. Accounting provides all kinds of financial information in project planning and implementation of a business
concern.
As a result, management can take decisions comfortably regarding project planning and implementation.
The scope of Management is extended from individual life to various fields of social life. The overall development of
trading, non-trading, government, semi-government, autonomous bodies, etc. depends on management.
In the modem age the responsibilities of making decisions, planning and management have been shifted from owners
to professional-managerial persons.
For this reason, all functions of managers are directed to the development of business concerns.
In this respect Accounting helps the management in taking timely decisions, interpreting and analyzing overall and
information based matters.
Managers cannot take the best and most dynamic course of action for their respective business concerns without the
information-based financial statements and other statements of accounts.
The success of management fully depends on accounting information.

Accounting and Economics

The relation of Economics with Accounting is very close. Economics is a science related to human activities to fulfill
demand with limited wealth.
Economics analyzes how people earn and spend, how purchasers and sellers behave under different circumstances etc.
On the other hand; accounting records transactions of income and expenditure measurable in terms of money and
provides necessary and relevant information to purchasers and sellers for taking decisions.
Economics studies the behaviors of buyers and sellers as a whole. Accounting provides all required financial
information to individual buyers and sellers for taking an economic decision. So, these two subjects are interrelated. In
this perspective bringing about a synthesis between the concept of economics and accounting, the concept of social
sciences is being applied.

Accounting and Mathematics

Accounting and Mathematics are closely related. Accounting is the language of business.
On the other hand, Mathematics is the language of Accounting. At different stages of accounting addition, subtraction,
multiplication, and division of arithmetic are applied.
Accounting expresses all its transactions and events of financial changes in the language of mathematics. At all stages
of accounting i.e. in preparing journal, ledger, trial balance, and financial statements mathematical principles are
applied. For this reason, the processes of keeping accounts become easy and short. So, Mathematics is an
indispensable part of Accounting.

Accounting and Computer Science

There is a close and effective relationship between Accounting and Computer Science. The word “computer” has been
derived from the word compute. The word “compute” means counting and the meaning of the computer is counter.
It is possible to solve mathematical problems involving millions or even billions of figures within a few seconds by
computer and these can be preserved in it as well.
Accounting accounts of various transactions are to be recorded and the results are to be determined.
It takes huge time and labor and even then the accuracy of Accounting cannot be a hundred percent ensured. The
computer has eliminated all these obstacles. Because using all kinds of information and data relating transactions as
per definite table and program in a computer, preparation of accurate accounting is possible within a very short time. It
saves time and labor. Besides, with the help of a computer, preparation of various accounts as per need, preservation,
and verification of the validity of ratio are possible very quickly.
In the developed countries of the modem world, the application of computers is growing fast in solving accounting
problems. In our country also the application of computers is increasing in the field of accounting problems.
Therefore, the relation between Accounting and Computer is very close.

Accounting and Statistics

Accounting and Statistics are deeply related.

The main object of these two sciences is to make arithmetical figures understandable and logical and to present these
in the form of statements making them usable to owner, directors or all others concerned.
It makes the act of planning and decision-making easier. The main function of statistics is to collect classify, analyze
the quantitative data of various events and present them to the individuals or organizations concerned. For this reason,
a statistician presents the data in quite a short form of reports to the individuals or organizations concerned so that they
can make a decision depending on this information.
On the other hand, in Accounting after completion of some accounting processes of transactions, final accounts and
financial statements are prepared and based on various information of such financial statements; the owners and the
directors of the organization concerned can take decisions.

Accounting and Law

The prevailing laws of a land control trade and commerce mostly.

So, Accounting and Law are closely related. The accountant and accounts officer must have a clear knowledge of
partnership law, company law, tax law, industrial law, cooperative law, and other relevant laws. Because accounts of
an organization are kept following accepted principles and by relevant laws.
For example, accounts of every company are kept properly and accurately in light of company law. In partnership
business accounts are maintained in the light of the partnership act or agreement as the case may be. Keeping
accounts, auditing of accounts of a company are mandatory as per the specific provision of the companies act.
Similarly, accounts of other organizations are to be kept by the provisions of the relevant law. In this context, lawyers
are to know the provision of laws relating to methods of accounting, direction and controlling. Otherwise, it is
impossible on their part to extend their help in settling conflicts and cases properly. Therefore, both Accounting and
Law are closely related subjects.

Accounting and Political Science

The main object of Political Science is to ensure law and order for establishing rule of law in society. Political science
gives directives in achieving welfare for the people of the society as a whole.
For this reason issues like national income and expenditure; national development expenditure and probable income
from national prospects, etc. arise from political science.
Keeping proper accounts of this national income, expenditure and providing information in this regard are the tasks of
Accounting. Besides maintaining accounts and auditing of accounts of government tax administration, the expenditure
of various projects, income tax, etc. are performed by accounting.
Therefore there exists a close relationship between Accounting and Political Science.

Accounting and Engineering

Among the important branches of modem social sciences accounting and engineering. These two subjects jointly work
in the process of production and building. A special type of plant and machinery is needed in factories. These plants
and machines are made by the engineers engaged in engineering work.
The estimation regarding types of goods and quantity of goods to be produced and the amount of expenditure to be
involved in machinery etc. of concern is to be accounted for.
For this reason the entrepreneurs, directors, managers of a production-oriented business concern should know about
engineering. The function of an accountant is to find out the ratio between money invested in plant and machinery and
results arising out of it and present the same to the managers in the form of statements. Without the knowledge of
engineering, an accountant cannot provide accurate information regarding plant and machinery So, in the modem age
of complex and large-scale production, the knowledge of accounting as well as engineering is essential for achieving
the target by running a business successfully
 Characteristics of Accounting
1) Accounting is science as well as an art.
2) The transaction and events relating to financial nature are recorded in it.
3) All transaction and events are recorded in monetary terms.
4) It maintain complete, accurate, permanent and legible records of all transaction in a systematic
manner.
5) It analyses the results of all the transaction in detail.

Objectives of Accounting

1. To Maintain a Systematic Record

Accounting is done to maintain a systematic record of the monetary transactions of the firm which is
the initial step leading to the creation of the financial statements. Once the recording is complete, the
records are classified and summarized to depict the financial performance of the enterprise.
2. To Ascertain the Performance of the Business
The income statement also known as the profit and loss account is prepared to reflect the profits earned
or losses incurred. All the expenses incurred in the course of conducting the business are aggregated and
deducted from the total revenues to arrive at the profit earned or loss suffered during the relevant period.
3. To Protect the properties of the Business
The information about the assets and liabilities with the help of accountancy, provides control over the
resources of the firm, because accounting gives information about how much the business has to pay to
others ? And how much the business has to recover from others?
4. To Facilitate Financial Reporting
Accounting is the precursor to finance reporting. The vital liquidity/solvency position is comprehended
through the Cash and Funds Flow Statement elucidating the capital transactions.
5. To Facilitate Decision making
Accounting facilitates in decision making. The American Accounting Association has explained this
while defining the term accounting, it says accounting is, the process of identifying measuring and
communicating economic information to permit informed judgments and decisions by users of the
information.

Accounting As Science and Art

Accounting is both a science and an art. Science as well we know is the systematical body of knowledge
establishing relationship between causes and their effects. In other words, science has its own concepts,
assumptions and principles which are universal and verifiable. Accounting as discipline has also its own
assumptions, concepts and principles, which have got universal application. Accounts have
systematically and scientifically developed accounting equation and rules of debit and credit. It makes
accounting, Science.
Art is the practical application of the knowledge. Accounting as discipline is used in the maintenance of
books of accounts practically in the real life situations and day-to day affairs of the business, so it is an
art also. It can now be safely concluded that Accounting is both science and an art.
Advantages, importance or necessity of Book-Keeping & Accountancy

Advantages to Businessmen
1) To raise loan for business – It helps the proprietor to raise loan for business. Property
maintained accounts are good security for loan.
2) Important information – It helps in acquiring importance information about the profit/loss,
debtors, creditors, assets and liabilities of business.
3) To control – It helps in controlling and checking the employees.
4) To compare the progress of business – It helps the proprietor to compare the progress of
business in various years and to get important information.
5) Disputes – In the case of incoming and outgoing partnership firms or its dissolution disputes can
easily be stored out if the accounts are properly kept.
6) Good evidence – It helps the proprietor to produce a good evidence in the court of law as and
when dispute arises.
7) Large scale business – For large scale business, it is almost necessary.
8) Tax-liability – It helps in the assessment of tax liability.
9) Valuation of goodwill – Properly kept accounts act as a good basis for valuation of goodwill
of business.
10) Take over a business concern – It helps in buying and selling of going business concern.

Advantages to Employees –
1) Assessing the efficiency – Systematically kept accounts, help in assessing efficiency of workers.
2) To settle the disputes – Accounting records help the employees to settle the disputes.

Advantages to Government –
1) Tax-liability – Properly kept accounts helps the government in deciding the tax liability.
2) Amendments in laws – It helps the government in making amendments in law pertaining to
business.
3) Progress of Business – The progress of business can be ascertained with the help of properly kept
account. On the basis of this progress the trend of business and industrial growth can be
measured on national level.
4) Drafting policy – It helps the government in drafting the policy for granting license.
5) Financial assistance – Properly kept accounts help the government in deciding the financial
assistance to the business concerns applying for it.

Advantages to Consumers –
Accurate accounting records enable the proprietor to ascertain the cost of production and to fix the
selling price. Hence, the consumer may get the articles at reasonable prices.

Advantages to Investors and creditors –

1) Authentic information – Potential investors, suppliers and financiers may get adequate and
authentic information from the books of accounts.
2) Setting disputes – Properly kept accounts helps in setting disputes arising in any dealing.

Advantages to other groups –

Properly kept accounts are beneficial to management of a concern for chalking out future plan and
policies. New entrepreneurs, desirous of setting up a business are also benefitted by accounting system.
Similarly, research scholars, competitive concerns and political parties are also benefitted by properly
kept accounts.

Limitations of Accountancy –
In spite of utility or importance or advantages of accounting for profit or loss and financial position of
business and for taking decision in future, there are certain limitations or drawbacks of accounting which
are under –
1) Not free from bias – There are a number of incidents when the accountant has to decide any one
of the given options, for example selection of methods of charging depreciation on fixed assets,
valuation of closing stock etc.
2) Danger of window dressing – When the management uses fictitious data to show exaggerated
profit, assets and liabilities, the income statement does not disclose correct profit or loss and
the position statement does not disclose the correct financial positions of business.
3) Ignoring qualitative elements – Accounting takes into consideration only quantitatively
expressed financial transactions. Qualitative aspects are totally ignored like efficiency of
management and labour, government policy, competition in market, economic and political
scenario, and change in the taste of consumers etc. which do affect the financial matters.
4) Ignoring price level changes – The financial statements are prepared on the basis of historical
cost of fixed asset whereas its replacement values are more than the historical cost. Unless and
until we take into consideration the changes in price level, we cannot draw accurate conclusions
for comparison.
5) Uncertainly of accounting traditions – Different business concerns adopt different accounting
customs and traditions according to their interest, for example valuation of closing stock,
deprecation or fixed assets, reserve for bad debts etc.
6) Ignorance about the value of business assets – The financial position shows the value of fixed
assets at cost less depreciation which always varies from actual market price. Thus the financial
position exhibits the estimated value and not actual market value.
7) Showing of value less assets in balance sheet – There are certain assets which have no value but
 they are written in balance sheet, for example, preliminary expenses, underwriting expenses
etc.
Accounting Concepts

Meaning and Significance: - Accounting concepts are those basic assumptions or conditions upon
which the accounting system is based. Some of the important accounting concepts are as follows :
1) Business Entity Concept : As per this concept, business is treated as a separate entity or unit distinct
from that of the proprietor. The significance of this concept is that without such a distinction the affairs
of the business will be mixed up with the private affairs of the proprietor and the true picture of the
business will not be available. The transactions between the proprietor and the business will be recorded
in the business books separately and shown separately under the heading capital account. For example, if
when the proprietor invests Rs. 50000 in this business, it will be assumed that the owner has given that
much money to the business and will be shown as a liability for the business. When he withdraws, say
Rs. 10000 from the business it will be charged to his capital account and the net amount due to him will
be only Rs. 40000.
2) Going Concern Concept : As per this concept it is assumed that a business unit has a perpetual
succession or continued existence and transactions are recorded from this point of view. Hence, while
valuing the business assets, the accountant does not take into account the realizable or market values of
the assets. Assets are valued at cost at which they were originally purchased less depreciations till date,
which is calculated on the basis of the original cost only.
The concept presumes that the business will continue in operation long enough to charge the cost of fixed
assets over their useful life against the business income. It is only on the basis of this concept that a
distinction is made between capital expenditure and revenue expenditure. If it is expected that the
business will exist only for a limited period, the accounting records will be kept accordingly.

3) Dual Aspect Concept : Each business transaction has two aspects, i.e., the receiving of a benefit
[debit] and giving of a benefit [credit]. For example, if a business purchases furniture, it must have given
up cash or have incureed an obligation to pay for it in future. Technically speaking, for every debit,
there is a credit this concept is the core of accountancy and upon this the whole superstructure of Double
entry system of book keeping has been raised. As each transaction has giving account and receiving
account equally, the total assets of a business firm will always be equal to its total equities [i.e. liabilities].
That is
External liabilities + Capital = Total
Assets Total Liabilities = Total Assets
This is called the Accounting or Balance Sheet equation.

4) Historical Cost Concept : This concept is based on the going concern concept According to this
concept, assets purchased are normally entered in the accounting books at the cost at which they are
purchased and this cost is the basis for all subsequent accounting for asset. The market value is
immaterial for accounting purpose since the business is not going to be liquidated but is to be continued
for a long time to come. This concept also prevents arbitrary values being used for recording purposes,
mainly those resulting in the acquisition of assets.

5) Money Measurement Concept : According to this concept, accounting records only those
transactions, which can be expressed in terms of money. Events or transactions, which cannot be
expressed in terms of money cannot find place in the books, however important they may be. Qualitative
or non monetary transactions are either omitted or recorded separately. For example a strained
relationship between production manager and sales manager, which may affect directly the operating
results of the business, does not find place in accounting records.

6) Realization Concept : According to this concept, the revenue is recognized only when the sale is
made. But the sale is a gradual process, which starts with the purchase of raw materials for production
and ends with the sale. If no sale is effected, no revenue is recognized. This is important to stop business
firms from inflating their profits. However, there are certain exceptions to this concept like hire purchase
sale, or contract etc.

7) Accrual Concept : This concept is based on the economic that all transactions are settled in cash but
even if cash settlement has not yet taken place, it is proper to bring the transaction or event
concerned into the books. Expenditure incurred during the year but not paid and Income earned but
not received is called as accrued items. According to this concept these items will be taken into
consideration while arriving at profit or loss. This concept enables to define income and expense.

8) Matching Concept : The matching concept provides the guidelines as to how the expense be
matched with revenues. In other words, costs are reported as expenses in the period in which the
associated revenue is reported. Note that costs are matched with, revenues, not the other way round. The
expense shown in an income statement must refer to the same accounting period, production units,
division or department of business unit to which revenue refers.

9) Accounting Period concept: - It is also known as periodicity concepts or time period assumption.
According to this assumption, the economic life of an enterprise is artificially split into periodic intervals
which are known as accounting periods, at the end of which financial position. The use of this
assumption further requires the allocation of expenses between capital and revenue. That portion of
capital expenditure which is consumed during the current period is charged as an expense to income
statement and t he unconsumed during the current period is charged as an expense to income statement
and the unconsumed portion is shown in the balance sheet as an asset for future consumption. Truly
speaking, measuring since, actual income can be determined only on the liquidation of the enterprise.
It may be noted that the custom of using twelve month period applied only for external reporting. For
internal reporting, accounts can be prepared even for shorter periods, say monthly, quarterly or half
yearly.

10) Verifiable Objective Concept:- according to this principle, the accounting data should be definite,
verifiable and free from personal bias of the accountant. in other words, this principle requires that
each recorded transaction/event in the books of accounts should have an adequate evidence to support it.
in historical cost
accounting, the accounting data are verifiable since, the transactions are recorded on the basis of
source documents such as vouchers, receipts, cash memos, invoices, and the like. the supporting
documents form the basis for their verification by auditors afterwards.
 Accounting Conventions
Meaning and Significance :- Accounting conventions, are those customs, usage and traditions that are being
followed by the accountant for along time while preparing the accounting statements.
1) Convention of Conservatisms : According to this convention, financial statements are usually drawn up
on a conservative basis. While preparing accounts and statements, the accountants are expected not to take
into account anticipated profits but to provide for all possible anticipated losses. It is only on the basis of this
convention, the inventory is valued at cost or market price whichever is lower. Similarly provision for bad
and doubtful debts is made in the books before ascertaining profits.
2) Convention of Consistency : According to this convention, accounting practices should remain
unchanged for a fairly long time. And they should not be changed unless it becomes absolutely essential to
change them. For example, if a particular method of charging depreciation on a particular asset is followed, it
should be followed consistently. However, consistency does not prevent the introduction of new improved
accounting methods or techniques. If any change is required, such change and its effects should be stated
clearly. The aim of this convention is to provide for continuity in accounting practices and methods and
enable meaningful comparison of accounting statements over a period or between different firms.
3) Convention of Material Disclosure : Apart from the legal requirements, good accounting practice
demands that all vital information should be disclosed. For example, in addition to asset values, the mode of
valuation should also be disclosed. The practice of giving footnotes, references, and parentheses in the
statements is in accordance with this convention only. Accountants should report only material information
and ignore insignificant details while preparing the accounting statements. What is material depends upon the
circumstances and the discretion of the accountant.

Scope of Financial Accounting

Following activities are included within the framework of financial accounting:
(1) Book-keeping
(2) Financial Statements
(3) Analysis and interpretation of financial statements.
(4) Financial reporting
(5) Accounting principles
(6) Accounting standards.

Accounting Process
Accounting process begins when a financial transactions takes place. Firstly day to day
transactions are recorded in the journal or subsidiary books. From the journal the transactions move further to ledger. Here
entries are posted in the appropriate accounts, and then accounts are balanced to get the effect of debit and credit. These
balance moves to a statement called trial balance. From the trial balance, we can prepare trading and profit and loss
accounts and balance sheet. The different stages through which the transactions move from journal to final accounts are
collectively known as accounting cycles or accounting process.

Difference between Book-keeping and Accountancy

Sl Points of Book Keeping Accountancy

No. difference
1. Meaning Book-keeping is considered as end. Accountancy is considered as beginning.
2. Functions The primary stage of accounting function is The overall accounting functions are guided by
called Book keeping. accountancy.
3 Depends Book-keeping can provide the base of Accountancy depends on Bookkeeping for its
Accounting. complete functions.
4. Data The necessary data about financial Accountancy can take its decisions, prepare
performances and financial positions are reports and statements from the data taken
taken from Book-keeping. from Book-keeping.
5. Recording of Financial transactions are recorded on the Accountancy does not take any principles,
Transactions basis of accounting principles, concepts and concepts and conventions from Book-keeping.
conventions.
Accounting Process

Accounting process begins when a financial transactions takes place. Firstly day to day transactions are recorded in the
journal or subsidiary books. From the journal the transactions mov further to ledger. Here entries are posted in the
appropriate accounts, and then accounts are balanced to get the effect of debit and credit. These balance moves to a
statement called trial balance. From the trial balance, we can prepare trading and profit and loss accounts and balance
sheet. The different stages through which the transactions move from journal to final accounts are collectively known as
accounting cycles or accounting process.
Journal and Ledger
A book of original entry in which transactions are recorded in the order of their occurrence is called journal. Journal is a
primary record of business transactions. Recording of transactions in the journal is known as journalizing and recorded
transactions are called journal entries Ledger is a book, which contains various accounts it is said to be secondary books
of account. It is a collection of all
accounts debited or credited in journal. Ledger is defined as “a book in which all the personal, real, and nominal accounts
of business are kept for permanent records so that up to date statement of an account can be easily known”.
Rules of accounting
Accounts are classified in to three namely real accounts, personal accounts and nominal accounts. There are separate rules
for each type of accounts they are as follows
1. Real accounts
An account relating to an asset or property is called real account. Cash, furniture, plant and machinery etc., are examples
of real accounts the debit, credit rule applicable to real account is:
Debit what comes in
Credit what goes out
2. Personal accounts
It includes the account of person with whom the business deals. These accounts are classified in to three categories
a) Natural personal accounts – the term natural persons mean persons who are creation of god. For e.g.;- Raja’s
accounts, Gupta’s accounts etc.,
b) Artificial personal accounts - these accounts includes accounts of corporate bodies or institutions
c) Representative personal account-these are accounts which represents certain person or group of persons. For example
salary due, rent outstanding etc., the rule of personal account is
Debit the receiver
Credit the giver
3) Nominal accounts
Accounts relating to expenses and losses and incomes and gains are called nominal accounts. Salary accounts,
commission account etc., are examples.
Debit all expenses and losses
Credit all incomes and gains
Posting
The term posting means transferring the debit and credit items from the journal to their respective accounts in the ledger.
It is the process of recording the transaction from journal to ledger.
The following rules should be observed while posting transactions in the ledger from the journal:
a) separate account should be opened in the ledger for posting transactions relating
to different accounts recorded in the journal
b) The concerned account, which has been debited in the journal should also be debited in the ledger
c) The concerned account, which has been credited in the journal should also be
credited in the ledger
Sub-Division of Journal
The journal is sub-divided into many subsidiary books called special journals. The journal in which transaction of a
similar nature is recorded is known as special journal or day book. The special journals are ruled differently on the basis
of the nature of transactions to be recorded. Transactions that cannot be recorded in any of the special journals are
recorded in a journal called journal proper or miscellaneous journal.
Advantages of Special Journals
1. Division of work: since there are so many subsidiary books, the accounting work may be divided
amongst a number of clerks.
2. Specialization: when the same work is allotted to a period of time he acquires full knowledge of it
and becomes efficient thus the accounting works will be done more efficiently.
3. Save in time: the trader can save time and labor by avoiding repetitions
4. Availability of information: since separate subsidiary book is kept for each class of transactions,
information relating to that will be readily available.
5. Facility in checking: checking is facilitated in subsidiary books which will prevent errors and frauds
Important special journals
The journal is sub divided in to the following subsidiary books
1. Cash Book: For recording all cash transactions
2. Purchases Book: For recording credit purchases of goods
3. Sales Book: For recording credit sales
4. Purchase Returns Books: For recording the goods returned by the trader to the suppliers
5. Sales Returns Book: For recording the goods returned to the trader by his customer
6. Bills Receivable Books: For recording all bills received by the trader from his customer
7. Bills Payable Book: For recording all the bills given (accepted) to suppliers
8. Journal Proper: For all transactions that do not find a place in any of the above books
Trial Balance
Trial balance is a statement containing the various ledger balances on a particular date. This
statement is prepared to check the correctness of ledger posting and balancing of accounts. If the total
of the debit balances is equal to the credit balances. It is implied that posting and balancing of accounts
are correct
Features of Trial Balance
1. It is prepared on a specific date
2. It is not a part of double entry and not an account
3. It is a statement of balance of all accounts or totals of ledger accounts
4. Total of the debit and credit columns of the trial balance must tally
5. If the debit and credit columns are equal it is presumed that accounts are arithmetically accurate
6. Difference in the debit and credit columns indicate that some mistakes have been committed
7. Tallying of trial balance is not a conclusive proof of accuracy of books of accounts; it serves to
prove only the arithmetical accuracy of books
Objectives of Trial Balance
The following are the objectives of preparing trial balance.
1. To ascertain the arithmetical accuracy of the ledger accounts
2. To help in locating errors
3. To help in the preparation of final accounts

The concepts of capital and revenue are of fundamental importance to the correct determination of accounting profit for a
period and recognition of business assets at the end of that period. The distinction affects the measurement of profit in a
number of accounting periods.
Capital has been defined by economists as those assets which are used in the production of goods and rendering of
services for further production of assets. In accounting, on the other hand, the capital of a business is increased by that
portion of the periodic income which has not been consumed by the owner.
The relationship between capital and revenue is that of between a tree and its fruits. It is the tree which produces the fruits,
and it is the fruit that can be consumed. If the tree is tendered with care, it will produce more fruits, conversely, if the tree
is destroyed, there will be no more fruits. Likewise, revenue comes out of capital and capital is the source of revenue.
Capital is invested by a person in the business so that it may produce revenue. Moreover, as a fruit may give birth to
another new tree, different revenues may also produce further new capital.
Capital can be brought in by a person into the business in different forms-cash or kind. When capital is brought in the
form of cash, it is spent away on various items of assets that make the business a running concern. Capital of the firm is
thus, represented by its inventory of assets.
Capital of a business can be increased in a two fold way:
1. When the owner brings in more capital to the business; and/or
2. When the owner does not consume the entire periodic income.
When the owner brings in further capital to his business, the amount is credited to the Capital Account. Likewise, the net
income for a period is credited to the Capital Account, and if his drawings are less than that income, the capital is
increased by the difference. Example, Capital ` 500, Profit ` 300, drawings ` 350. So the revised capital will be ` 450 (`
500 + ` 300 - ` 350)
The difference between the two terms ‘revenue’ and ‘receipt’ should be carefully distinguished. A receipt is the inflow of
money into business, whereas revenue is the aggregate exchange value received for goods and services provided to the
customers.
1.15.1 Capital and Revenue Expenditures
Capital expenditure is the outflow of funds to acquire an asset that will benefit the business for more than one accounting
period. A capital expenditure takes place when an asset or service is acquired or improvement of a fixed asset is effected.
These assets are expected to provide benefits to the business in more than one accounting period and are not intended for
resale in the ordinary course of business. In short, it is an expenditure on assets which is not written off completely against
income in the accounting period in which it is acquired.
Revenue expenditure is the outflow of funds to meet the running expenses of a business and it will be of benefit for the
current period only. A revenue expenditure is incurred to carry on the normal course of business or maintain the capital
assets in a good condition.
It may be pointed out here that an expenditure need not necessarily be a payment made to somebody in cash - it may be
made by the exchange of another asset, or by assuming a liability. Expenditure incurrence and expenditure recognition are
distinct phenomena. Expenditure incurrence refers to the receipt of goods and services, whereas expenditure recognition is
a matter to be decided whether the expenditure is of capital or revenue nature. For example, the buying of an asset is a
capital expenditure but charging depreciation against profit is a revenue expenditure, over the entire life of that asset. On
the application of periodicity, accrual and matching concepts, accountants identify all revenue expenditures for a given
period for ascertaining profit. An expenditure which cannot be identified to a particular accounting period is considered of
capital nature.
The accounting treatment of capital and revenue expenditure are as under:
Revenue expenditures are charged as an expense against profit in the year they are incurred or recognised. Capital
Expenditures are capitalised-added to an Asset Account.
The following are the points of distinction between Capital Expenditure and Revenue Expenditure :

Capital Expenditure Revenue Expenditure

The economic benefits of Capital Expenditures The economic benefits of Revenue Expenditures
are enjoyed for more than one accounting period. are enjoyed within a particular accounting
period.

Capital Expenditures are of non-recurring in Revenue Expenditures are of recurring in nature.

nature.

All Capital Expenditures eventually become Revenue Expenditures are not generally capital
Revenue Expenditures like depreciation expenditures

Capital Expenditures are not matched with All Revenue Expenditures are matched with
Capital Receipts. Revenue Receipts

Rules for Determining Capital Expenditure

An expenditure can be recognized as capital if it is incurred for the following purposes :
An expenditure incurred for the purpose of acquiring long term assets (useful life is at least more than one accounting
period) for use in business to earn profits and not meant for resale, will be treated as a capital expenditure. For example, if
a second hand motor car dealer buys a piece of furniture with a view to use it in business; it will be a capital expenditure.
But if he buys second hand motor cars, for re-sale, then it will be a revenue expenditure because he deals in second hand
motor cars.
When an expenditure is incurred to improve the present condition of a machine or putting an old asset into working
condition, it is recognised as a capital expenditure. The expenditure is capitalised and added to the cost of the asset.
Likewise, any expenditure incurred to put an asset into working condition is also a capital expenditure.
For example, if one buys a machine for ` 5,00,000 and pays ` 20,000 as transportation charges and ` 40,000 as installation
charges, the total cost of the machine comes upto ` 5,60,000. Similarly, if a building is purchased for ` 1,00,000 and `
5,000 is spent on registration and stamp duty, the capital expenditure on the building stands at ` 1,05,000.
If an expenditure is incurred, to increase earning capacity of a business that will be considered as of capital nature. For
example, expenditure incurred for shifting the factory for easy supply of raw materials. Here, the cost of such shifting will
be a capital expenditure.

Preliminary expenses incurred before the commencement of business is considered capital expenditure. For example,
legal charges paid for drafting the memorandum and articles of association of a company or brokerage paid to brokers, or
commission paid to underwriters for raising capital.
Thus, one useful way of recognising an expenditure as capital is to see that the business will own something which
qualifies as an asset at the end of the accounting period.
Some examples of capital expenditure:
(i) Purchase of land, building, machinery or furniture; (ii) Cost of leasehold land and building; (iii) Cost of purchased
goodwill; (iv) Preliminary expenditures; (v) Cost of additions or extensions to existing assets; (vi) Cost of overhauling
second-hand machines; (vii) Expenditure on putting an asset into working condition; and (viii) Cost incurred for
increasing the earning capacity of a business.
Rules for Determining Revenue Expenditure
Any expenditure which cannot be recognised as capital expenditure can be termed as revenue expenditure. A revenue
expenditure temporarily influences only the profit earning capacity of the business. An expenditure is recognised as
revenue when it is incurred for the following purposes :
Expenditure for day-to-day conduct of the business, the benefits of which last less than one year. Examples are wages of
workmen, interest on borrowed capital, rent, selling expenses, and so on.
Expenditure on consumable items, on goods and services for resale either in their original or improved form. Examples
are purchases of raw materials, office stationery, and the like. At the end of the year, there may be some revenue items
(stock, stationery, etc.) still in hand. These are generally passed over to the next year though they were acquired in the
previous year.
Expenditures incurred for maintaining fixed assets in working order. For example, repairs, renewals and depreciation.
Some examples of Revenue Expenditure
(i) Salaries and wages paid to the employees; (ii) Rent and rates for the factory or office premises; (iii) Depreciation on
plant and machinery; (iv) Consumable stores; (v) Inventory of raw materials, work-in-progress and finished goods; (vi)
Insurance premium; (vii) Taxes and legal expenses; and (viii) Miscellaneous expenses.
Replacement of Fixed Assets
The above rules of capital and revenue expenditure do not hold good when an existing asset is replaced for another. If an
asset is replaced with a similar kind of asset, the expenditure incurred is treated as Revenue Expenditure. For example, if a
set of weighing machines in a shop becomes defective and is replaced with a similar set, the cost of replacement should be
treated as revenue expenditure and it should be charged to the Profit and Loss Account. However, if an asset is replaced
with an asset which is superior than the previous one, the expense is partly capital and partly revenue. For example, if a
manual typewriter costing ` 5,000 is replaced with an electronic typewriter costing ` 15,000, then ` 5,000 will be revenue
expenditure and the excess value of the new typewriter over the old one, ` 10,000 will be capital expenditure.
Deferred Revenue Expenditures
Deferred revenue expenditures represent certain types of assets whose usefulness does not expire in the year of their
occurrence but generally expires in the near future. These type of expenditures are carried forward and are written off in
future accounting periods. Sometimes, we make some revenue expenditure but it eventually becomes a capital asset
(generally of an intangible nature). If one undertake substantial repairs to the existing building, the deterioration of the
premises may be avoided. We may engage our own employees to do that work and pay them at prevailing wage-rate,
which is of a revenue nature. If this expenditure is treated as a revenue expenditure and the current year’s-profit is charged
with these expenses, we are making the current year to absorb the entire expenses, though the benefit of which will be
enjoyed for a number of accounting years. To overcome this difficulty, the entire expenditure is capitalised and is added to
the asset account. Another example is an insurance policy. A business can pay insurance premium in advance, say, for a 3
year period. The right does not expire in the accounting period in which it is paid but will expire within a fairly short
period of time (3 years). Only a portion of the total premium paid should be treated as a revenue expenditure (portion
pertaining to the current period) and the balance should be carried forward as an asset to be written off in subsequent
years.
AS 26 - Intangible Asset does not accept this view. As per AS-26, “Expenditure incurred to provide future economic
benefit to an enterprise that can be recognized as an expense when it is incurred. e.g. expenditure incurred on Scientific
Research is recognized as an expense when it is incurred”. In short, the whole amount of expenditure is treated as
expense for the current year only and will not proportionately be transferred as deferred charge.

Capital and Revenue Receipts

A receipt of money may be of a capital or revenue nature. A clear distinction, therefore, should be made between capital
receipts and revenue receipts.
A receipt of money is considered as capital receipt when a contribution is made by the proprietor towards the capital of
the business or a contribution of capital to the business by someone outside the business. Capital receipts do not have any
effect on the profits earned or losses incurred during the course of a year.
Additional capital introduced by the proprietor; by partners, in case of partnership firm, by issuing fresh shares, in case of
a company; and, by selling assets, previously not intended for resale.
A receipt of money is considered as revenue receipt when it is received from customers for goods supplied or fees
received for services rendered in the ordinary course of business, which is a result of the firm’s activity in the current
period. Receipts of money in the revenue nature increase the profits or decrease the losses of a business and must be set
against the revenue expenses in order to ascertain the profit for the period.

Capital and Revenue Profits

While ascertaining the trading profit of a business for a particular period, a proper distinction is to be made between
capital and revenue profits. If profit arises out of an ordinary nature, being the outcome

of the ordinary function and object of the business, it is termed as ‘Revenue Profit’. But, when a profit arises out of a
casual and non-recurring transaction, it is termed as Capital Profit. Revenue profit arises out of the sale of the merchandise
that the business deals in.
Capital Profit arises from :-
(a) Profit prior to incorporation;
(b) Premium received on issue of shares;
(c) Profit made on re-issue of forfeited shares;
(d) Redemption of Debenture at a discount;
(e) Profit made on sale or revaluation of a Fixed Asset.
Generally, capital profits arise out of the sale of assets other than inventory at a price more than its book value or in
connection with the raising of capital or at the time of purchasing an existing business. For example, if an asset, whose
book value is ` 5,000 on the date of sale, is sold for ` 6,000 then ` 1,000 will be considered as capital profit. Likewise,
issue of shares at a premium is also a capital profit. Revenue profits are distributed to the owners of the business or
transferred to General Reserve Account, being shown in the balance sheet as a retained earning. Capital profits are
generally capitalised-transferred to a capital reserve account which can only be utilised for setting off capital losses in
future. Capital profits of a small amount (arising out of selling of one asset) is taken to the Profit and Loss Account and
added with the revenue profit-applying the concept of materiality.
Capital and Revenue Losses
While ascertaining losses, revenue losses are differentiated from capital losses, just as revenue profits are distinguished
from capital profits. Revenue losses arise from the normal course of business by selling the merchantable at a price less
than its purchase price or cost of goods sold or where there is a declining in the current value of inventories. Capital losses
may result from the sale of assets, other than inventory for less than written down value or the diminution or elimination
of assets other than as the result of use or sale (flood, fire, etc.) or in connection with raising capital of the business (issue
of shares at a discount) or on the settlement of liabilities for a consideration more than its book value (debenture issued at
par but redeemed at a premium). Treatment of capital losses are same as that of capital profits. Capital losses arising out
of sale of fixed assets generally appear in the Profit and Loss Account (being deducted from the net profit). But other
capital losses are adjusted against the capital profits. Where the capital losses are substantial, the treatment is different.
These losses are generally shown on the balance sheet as fictitious assets and the common practice is to spread that over a
number of accounting years as a charge against revenue profits till the amount is fully exhausted.

Illustration .
State whether the following are capital, revenue or deferred revenue expenditure.
(i) Carriage of ` 7,500 spent on machinery purchased and installed.
(ii) Heavy advertising costs of ` 20,000 spent on the launching of a company’s new product.
(iii) ` 200 paid for servicing the company vehicle, including ` 50 paid for changing the oil.
(iv) Construction of basement costing ` 1,95,000 at the factory premises.
Solution :
(i) Carriage of ` 7,500 paid for machinery purchased and installed should be treated as a Capital Expenditure.
(ii) Advertising expenses for launching a new product of the company should be treated as a Revenue Expenditure. (As
per AS-26)
(iii) ` 200 paid for servicing and oil change should be treated as a Revenue Expenditure.
(iv) Construction cost of basement should be treated as a Capital Expenditure.

Meaning of Subsidiary Books

In the past, traders use to keep record of the transaction in the journal. But it was later found not convenient. If all the
transaction is recorded in the journal then the journal book becomes more thick and difficult to handle it. In big business
houses, it becomes impossible to carry on thework of recording business transaction. Therefore now a days large scale
business firms like to keep record of transaction in subsidiary books instead of journal. Subsidiary books are the book
of original entry and it is also called primary records because the first entry of transaction is made in subsidiary books.
Subsidiary Books refers to books meant for specific transactions of similar nature. Subsidiary Books are also known as
Special journals or day books. To overcome shortcoming of the use of the journal only as a book of original entry, the
journal is subdivided into specific journals or subsidiary books. In practice, the journal is sub-divided in such a way
that a separate book is used for each category of transactions which are repetitive in nature and are sufficiently large in
number. In any large business the following subsidiary books are generally used.

1. Cash Book: It is used for recording all receipts and payments of cash, including cash purchases and cash sales of
goods.
2. Purchases Book: It is used for recording credit purchases of goods only.
3. Purchases Returns Book: It is used for recording goods returned to suppliers.
4. Sales Journal: It is used for recording credit sales of goods only.
5. Sales Returns Book: It is used for recording goods returned by the customers.
6. Bills Receivable Book: It is used for recording bills of exchange and promissory notes received from the debtors.
7. Bills Payable Book: It is used for recording bills of exchange and promissory notes accepted by the business in favor of
creditors.
8. Journal Proper: This book is used for recording all such transactions which are not covered by any of the above
mentioned special journals, for example, credit purchases of fixed assets, opening entry, rectification entries, etc.
It must, however, be noted that there is no rigidity as to the number of special journals. Depending on the necessity, the
number of journals may be increased or decreased.
What is meant by the Non-cash transaction?

A non-cash transaction is a transaction in terms of credit and conditions of the enterprise.

The non-cash transactions shall include the following transactions of the enterprise, which
do not involve any cash; they are as follows:
1. Credit sales Book
2. Credit purchases Book
3. Credit Sales Return Book
4. Credit Purchases Return Book
5. Bills Payable Book – Outcome of Credit transaction, and
6. Bill Receivable Book – Outcome of Credit transaction
6.1.1 Advantages of Subsidiary Books
The following are the advantages of having a number of subsidiary books:
1. Classification of transactions becomes automatic: As there is a separate book for each type of transactions, the
transactions of same nature are automatically brought at one place.
2. Reference becomes easy: If any reference is required, it can be traced easily by referring to the appropriate subsidiary
book. You do not have to go through all the transactions recorded in the journal.
3. Facilitates division of work: The division of journal into various subsidiary books facilitates division of work among
many persons. This, in turn, facilitates prompt recording of transactions and saves a lot of time.
4. More particulars: More details about the transactions can be given-in subsidiary books than would be possible in one
book.
5. Responsibility can be fixed: The work of maintaining a particular book can be entrusted to a particular person. He will
be responsible for keeping it up-to-date and in order.
6. Facilitates checking: When the Trial Balance does not agree, the location of errors will be relatively easy.
6.2 Cash Book

Having outlined various subsidiary books, we shall now discuss the most important subsidiary book called ‘Cash Book’.

Cash book is the book of accounts where most of the transactions are generally related with the receipts and payment of
cash. It may be either purchase of goods for cash or sale of goods for cash or it may be either payment of expenses or
receipts of income. Inany business there would be numerous cash transactions which involve either receipts orpayments of
cash. Cash sales, receipt of cash from debtors, cash purchases, and payments to creditors, payment of various expenses
such as salaries, wages, rent, taxes, etc., are some examples
of transactions involving cash. AU these are recorded in cash book, receipts on one side and payments on the other.
Every business unit, small or big, maintains a cash book. It enables the businessman to know and verify the amount of
cash in hand from time to time. As a matter of fact, cash book plays a dual role. It is a book of prime entry and also serves
the purpose of a Cash Account. It is designed Notes in the form of a ledger account and records cash receipts on the debit
side and payments on credit side. It is also balanced in the same way. Hence, when cash book is maintained, there is no
need to have a Cash Account in the ledger.

Kinds of Cash Book

There are different types of cash books maintained by the business. They are:
1. Simple or Single Column Cash Book
2. Two or Double Column Cash Book
3. Three or Triple Column Cash Book
4. Petty Cash Book

We shall now consider them one by one and learn how they are prepared and posted into ledger.

6.2.1 Single Column Cash Book

Look at the pro forma of a Single Column Cash Book shown below. Doesn’t it look like a ledger account? Yes, it does. In
fact a Single Column Cash Book is nothing but a Cash Account. It is used for recording all cash receipts and cash
payments and serves the purpose of Cash Account as well. It is called Single Column Cash Book just because it has only
one amount column on each side.
 Date Particul L.F. Amou Date Particul L.F. Amou
ars nt ( ars nt (
(Receipt ) (Paymen )
s) ts)

Recording in Single Column Cash Book

You know that Cash Account is a real account. According to rules, Cash Account is to be debited when cash is
received and credited when cash is paid. Hence, the debit side of the cash book is used for recording all cash
receipts and the credit side for all cash payments. Let us now discuss how entries are made in this book.
As explained above, whenever cash is received, it is to be recorded on the debit side. The date on which it is received is
recorded in the date column. The name of the account from which it is received is mentioned in the particulars column.
In the L.F. (Ledger Folio) column the page number of the account in the ledger, where the posting is made, is to be
recorded at the time of posting. The amount column is meant for recording the amount received. Similarly,
whenever cash is paid, it is recorded on the credit side. Here, in particulars column we write the name of the party
to whom payment is made, and complete the other columns in the same manner as on the debit side.

Posting the Single Column Cash Book

As said earlier, Cash Book also serves the purpose of a Cash Account, so there is no need to open a Cash Account in
the ledger. When a cash transaction is recorded in the cash book, posting of the cash aspect of the transaction in Cash
Account stands fully covered. What remains to be posted is the other aspect of the transaction. The posting of this
aspect will complete the double entry. The rules of posting therefore are:
For all transactions entered on the debit side of the cash book, credit the concerned Subsidiary Books: C
accounts in the ledger individually by writing ‘By Cash Account’;
For all transactions entered on the credit side, debit the concerned accounts in the ledger individually by writing To
Cash Account’.
Thus, the posting into the ledger accounts is completed
Balancing of Single Column Cash Book

You have already learnt how to balance a ledger account. The cash book is balanced just like any other ledger account.
The cash book will always show a debit balance. This is because the cash payments can never exceed the amount of
cash available. For example, if you have 10 in your pocket, can you pay 15? You cannot. So the total of the debit side
in the cash book will always be more than the total of the credit side his difference indicates the cash in hand. It shall
be entered on the credit side by writing ‘By Balance c/d’ in particulars column and showing the amount in the amount
column. Now total the amount columns and you will find that the two sides are equal.
After closing the cash book, the balance is shown on the debit side by writing ‘To Balance b/d’. It becomes the
opening balance of cash for the next period. Note that the cash book shall generally show a debit balance and
occasionally a nil balance. Look at example it shows the recording, posting and balancing of a Single Column
Cash Book.
Example: Prepare a cash book from the following:

2010 ()
June 1 Cash in hand 7,850
June 2 Cash Purchases 2300
June 3 Cash Sales 6,250
June 4 Wages paid in cash 25
June 6 Cash paid to Ram 1,220
June 7 Cash Received from Mohan 2260
June 8 Paid to a creditor in full Settlement of his account Amounting 4,410
to 4500
June 9 Paid cartage 15
June 10 Issued a cheque to a creditor 11,50
0
June 11 Goods purchased from Arun on credit 2,750
June 14 Cash Sales 2,670
June 15 Goods sold to Amit on credit 6,500
June 17 Cash Sales of 7500 of which 5700 were deposited in bank
June 18 Received a cheque from Amit and deposited in a bank 2,500
June 24 Rent paid 500
June 29 Electricity paid 1,210
June 30 Cash purchases 2,450

Solution
Cash Book

Date Particulars L.F () Date Particulars L.F ()

. .
2010 2010
June 1 To Balance b/d 7,850 June 2 By Purchases a/c 2,300
June 3 To Sales a/c 6,250 June 4 By Wages a/c 25
June 7 To Mohan’s a/c 2,260 June 6 By Ram’s a/c 1,220
June 14 To Sales a/c 2,670 June 8 By Creditor’s a/c 4,410
June 17 To Sales a/c 7,500 June 9 By Cartage 15
June 18 To Amit a/c 2,500 June 17 By Bank a/c 5,700
June 18 By Bank a/c 2,500
June 24 By Rent a/c 500
June 29 By Electricity a/c 1,210
June 30 By Purchases a/c 2,450
June 30 By Balance c/d 8,700
29,030 29,030
July 1 To Balance b/d 8,700

Two Column Cash Book

When cash is received from a debtor, some discount may be allowed to him. Similarly, when payment is made to a
creditor, some discount may be allowed by him. This is termed as Cash Discount and it has to be recorded in the
books of account. While making compound journal entries for such transactions, you learnt that cash and discount
go together. You know that receipts from debtors and payments to creditors are to be recorded in the cash book.
Now the question arises as to how to record the cash discount. One method is to record the discount aspect separately in
the journal. But this would be cumbersome, and the possibility of failing to record can also happen. Hence
accountants have developed a practice of recording the discount aspect in tile cash book itself. For this, an extra
amount column is added on both sides of the cash book. Look at the proforma shown below. The discount given to
debtors is recorded on the debit side and the discount received from creditors is recorded on the credit side. Thus,
now there are two amount columns on both sides of the cash book, one for discount and the other for cash. It is
called ’Two Column Cash Book’.
The following is the form of Double Columns Cash Book.

Date Particul L.F Discou Cas Date Particul L.F Discou Cas
ars . nt ( ) h( ars . nt ( ) h(
(Receipt ) (Payme )
s) nt)

Recording in Two Column Cash Book

Recording of cash transactions in a Two Column Cash Book is similar to Single Column Cash Book. As for cash
discount, it is entered on the debit side if allowed to the debtor and on the credit side if received from the creditor.
For example, Roop owes 1000 to M/s Goyal Traders of Muzaffar Nagar. The firm offers a discount of 1% if
payment is made within one month. Roop makes the payment within stipulated time. So he is offered 10 as discount
and he makes the payment of 990 to the firm. The following entry is required to be passed in the Journal if no
Cash Book is used in the books of M/s Goyal Traders

Date Particul L. () ()
ars F.
Cash A/c Dr 990
Discount . 10
A/c Dr 1000
.
To Roop
(Being Cash received and
discount allowed.)
If Cash Book is used, then both the accounts namely cash and discount are to be recorded on the debit side of the
Cash Book. Similarly, if discount is received for making prompt payment then such items are to be recorded on
the credit side of the Cash Book, i.e., amount received or paid in the Amount/Cash column and discount
allowed/received in the discount column.

Posting the Two Column Cash Book

The entries in the cash columns of Two Column Cash Book are posted to the ledger accounts in the same way as we
did in the case of single column cash book. The entries in the discount columns are also to be posted to the respective
personal accounts. The entries in discount allowed column will be posted to the credit side of the respective personal
accounts by writing ‘By Discount Allowed A/c’. Similarly, the entries in the discount received column will be
 posted to the debit side of the respective personal accounts by writing ‘To Discount Received A/c’.

Example: Cash received from Devi Traders 490 and discount allowed10: This transaction will be entered in particulars
column on the debit side of the cash book by writing ‘To Devi Traders A/c’. An amount of 10 will be shown in
discount allowed column and 490
in cash column. Its posting into Devi Traders’ Account in the ledger will be made as follows:
Devi Traders Account
Dr. Cr
(
)
By Cash A/c 490
By Discount Allowed A/c 10
As for the transactions relating to cash, the double entry is complete as soon as postings have been made to the
respective personal accounts. But it is not so for the discount aspect. The cash book does not serve the purpose of
discount account. We have to open ‘Discount Allowed Account’ and ‘Discount Received Account’ in the ledger.
The total of discount allowed columns on the debit side of the cash book is posted to the debit side of the
‘Discount Allowed Account’ in the ledger by writing ‘To Sundries’. Similarly, the total of discount received
column on the credit side of the cash book is posted to the credit side of the ‘Discount Received Account’ in the ledger
by writing ‘By Sundries’. This will complete the double entry in respect of discount allowed and discount
receivedBalancing the two Column Cash Book

In case of Two Column Cash Book, only the cash columns are balanced. Procedure is similar to Single Column
Cash Book. The discount columns are not balanced, they are simply totalled. This is because the two discount
columns relate to two separate accounts-the Discount Allowed Account and the Discount Received Account.

Example: From the following transactions write up a two column cash book and post into ledger:
1991
Jan. 1 Cash in hand 2,000
Jan. 7 Received from Riaz & Co. 200; discount allowed 10
Jan. 12 Cash sales 1,000
Jan. 15 Paid Zahoor Sons 500; discount received 15
Jan. 20 Purchased goods for cash 300
Jan. 25 Received from Salman 500; discount allowed 15
Jan. 27 Paid Hussain & Sons 300
Jan. 28 Bought furniture for cash 100
Jan. 31 Paid rent 100
Solution:

Cash Book
Dr. Cr.
Date Particulars V.N. J.F. Discount Cash Date Particulars V. L. Discount Cash
N. F.
1991 1991
Jan.1 To Balance Jan.5 By Zahoor & 15 500
Sons
Jan.7 b/d 10 2,000 Jan.20 By purchase A/c 300
Jan.12 To Riaz & Co. 15 200 Jan.27 By Hussan & 300
Sons
Jan.25 To Sales A/c 1,000 Jan.28 By Furniture A/c 100
To Salman 500 Jan.31 By Rent A/c 100
By Balance c/d 2,400
25 3,700 15 3,700
1991
Feb.1 To Balance
b/d 2,400

BASIC ACCOUNTING TERMS

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

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

(ii) Goods/Services : These are tangible article or commodity in which a business deals. These articles or commodities
are either bought and sold or produced and sold. At times, what may be classified as ‘goods’ to one business firm may not
be ‘goods’ to the other firm. e.g. for a machine manufacturing company, the machines are ‘goods’ as they are frequently
made and sold. But for the buying firm, it is not ‘goods’ as the intention is to use it as a long term resource and not sell it.
Services are intangible in nature which are rendered with or without the object of earning profits.

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

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

(v) Asset: Asset is a resource owned by the business with the purpose of using it for generating future profits. Assets can
be Tangible and Intangible. Tangible Assets are the Capital assets which have some physical existence. They can,
therefore, be seen, touched and felt, e.g. Plant and Machinery, Furniture and Fittings, Land and Buildings, Books,
Computers, Vehicles, etc. The capital assets which have no physical existence and whose value is limited by the rights
and anticipated benefits that possession confers upon the owner are known as lntangible Assets. They cannot be seen or
felt although they help to generate revenue in future, e.g. Goodwill, Patents, Trade-marks, Copyrights, Brand Equity,
Designs, Intellectual Property, etc. Assets can also be classified into Current Assets and Non-Current Assets. Current
Assets – An asset shall be classified as Current when it satisfies any of the following : (a) It is expected to be realised in,
or is intended for sale or consumption in the Company’s normal Operating Cycle, (b) It is held primarily for the purpose
of being traded , (c) It is due to be realised within 12 months after the Reporting Date, or (d) It is Cash or Cash Equivalent
unless it is restricted from being exchanged or used to settle a Liability for at least 12 months after the Reporting Date.
Non-Current Assets – All other Assets shall be classified as Non-Current Assets. e.g. Machinery held for long term etc.

(vi) Liability: It is an obligation of financial nature to be settled at a future date. It represents amount of money that the
business owes to the other parties. E.g. when goods are bought on credit, the firm will create an obligation to pay to the
supplier the price of goods on an agreed future date or when a loan is taken from bank, an obligation to pay interest and
principal amount is created. Depending upon the period of holding, these obligations could be further classified into Long
Term on non-current liabilities and Short Term or current liabilities. Current Liabilities – A liability shall be classified as
Current when it satisfies any of the following : (a) It is expected to be settled in the Company’s normal Operating Cycle,
(b) It is held primarily for the purpose of being traded, (c) It is due to be settled within 12 months after the Reporting
Date, or (d) The Company does not have an unconditional right to defer settlement of the liability for at least 12 months
after the reporting date (Terms of a Liability that could, at the option of the counterparty, result in its settlement by the
issue of Equity Instruments do not affect its classification) Non-Current Liabilities – All other Liabilities shall be
classified as Non-Current Liabilities. E.g. Loan taken for 5 years, Debentures issued etc.

(vii) Internal Liability : These represent proprietor’s equity, i.e. all those amount which are entitled to the proprietor, e.g.,
Capital, Reserves, Undistributed Profits, etc.

(viii) Working Capital : In order to maintain flows of revenue from operation, every firm needs certain amount of current
assets. For example, cash is required either to pay for expenses or to meet obligation for service received or goods
purchased, etc. by a firm. On identical reason, inventories are required to provide the link between production and sale.
Similarly, Accounts Receivable generate when goods are sold on credit. Cash, Bank, Debtors, Bills Receivable, Closing
Stock, Prepayments etc. represent current assets of firm. The whole of these current assets form the working capital of a
firm which is termed as Gross Working Capital.
Gross Working Capital = Total Current Assets = Long term internal liabilities plus long term debts plus the current
liabilities minus the amount blocked in the fixed assets. There is another concept of working capital. Working capital is
the excess of current assets over current liabilities. That is the amount of current assets that remain in a firm if all its
current liabilities are paid. This concept of working capital is known as Net Working Capital which is a more realistic
concept. Working Capital (Net) = Current Assets – Currents Liabilities.

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

(x) Capital : It is amount invested in the business by its owners. It may be in the form of cash, goods, or any other asset
which the proprietor or partners of business invest in the business activity. From business point of view, capital of owners
is a liability which is to be settled only in the event of closure or transfer of the business. Hence, it is not classified as a
normal liability. For corporate bodies, capital is normally represented as share capital.

(xi) Drawings : It represents an amount of cash, goods or any other assets which the owner withdraws from business for
his or her personal use. e.g. if the life insurance premium of proprietor or a partner of business is paid from the business
cash, it is called drawings. Drawings will result in reduction in the owners’ capital. The concept of drawing is not
applicable to the corporate bodies like limited companies.

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

(xiii) Non-current Investments : Non-current Investments are investments which are held beyond the current period as to
sale or disposal. e. g. Fixed Deposit for 5 years.

(xiv) Current Investments : Current investments are investments that are by their nature readily realizable and are
intended to be held for not more than one year from the date on which such investment is made. e. g. 11 months
Commercial Paper.

(xv) Debtor : The sum total or aggregate of the amounts which the customer owe to the business for purchasing goods on
credit or services rendered or in respect of other contractual obligations, is known as Sundry Debtors or Trade Debtors, or
Trade Receivable, or Book-Debts or Debtors. In other words, Debtors are those persons from whom a business has to
recover money on account of goods sold or service rendered on credit. These debtors may again be classified as under: (i)
Good debts : The debts which are sure to be realized are called good debts. (ii) Doubtful Debts : The debts which may or
may not be realized are called doubtful debts. (iii) Bad debts : The debts which cannot be realized at all are called bad
debts. It must be remembered that while ascertaining the debtors balance at the end of the period certain adjustments may
have to be made e.g. Bad Debts, Discount Allowed, Returns Inwards, etc.

(xvi) Creditor : A creditor is a person to whom the business owes money or money’s worth. e.g. money payable to
supplier of goods or provider of service. Creditors are generally classified as Current Liabilities.
(xvii)Capital Expenditure : This represents expenditure incurred for the purpose of acquiring a fixed asset which is
intended to be used over long term for earning profits there from. e. g. amount paid to buy a computer for office use is a
capital expenditure. At times expenditure may be incurred for enhancing the production capacity of the machine. This also
will be a capital expenditure. Capital expenditure forms part of the Balance Sheet.

(xviii)Revenue expenditure : This represents expenditure incurred to earn revenue of the current period. The benefits of
revenue expenses get exhausted in the year of the incurrence. e.g. repairs, insurance, salary & wages to employees, travel
etc. The revenue expenditure results in reduction in profit or surplus. It forms part of the Income Statement.

(xix) Balance Sheet : It is the statement of financial position of the business entity on a particular date. It lists all assets,
liabilities and capital. It is important to note that this statement exhibits the state of affairs of the business as on a
particular date only. It describes what the business owns and what the business owes to outsiders (this denotes liabilities)
and to the owners (this denotes capital). It is prepared after incorporating the resulting profit/losses of Income Statement.

(xx) Profit and Loss Account or Income Statement : This account shows the revenue earned by the business and the
expenses incurred by the business to earn that revenue. This is prepared usually for a particular accounting period, which
could be a month, quarter, a half year or a year. The net result of the Profit and Loss Account will show profit earned or
loss suffered by the business entity.

(xxi) Trade Discount : It is the discount usually allowed by the wholesaler to the retailer computed on the list price or
invoice price. e.g. the list price of a TV set could be ` 15000. The wholesaler may allow 20% discount thereof to the
retailer. This means the retailer will get it for ` 12000 and is expected to sale it to final customer at the list price. Thus the
trade discount enables the retailer to make profit by selling at the list price. Trade discount is not recorded in the books of
accounts. The transactions are recorded at net values only. In above example, the transaction will be recorded at ` 12000
only.

(xxii) Cash Discount : This is allowed to encourage prompt payment by the debtor. This has to be recorded in the books of
accounts. This is calculated after deducting the trade discount. e.g. if list price is ` 15000 on which a trade discount of
20% and cash discount of 2% apply, then first trade discount of ` 3000 (20% of ` 15000) will be deducted and the cash
discount of 2% will be calculated on `12000 (`15000 – ` 3000). Hence the cash discount will be ` 240/- (2% of ` 12000)
and net payment will be ` 11,760 (`12,000 - ` 240)